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The Implied Covenant of Good Faith and Fair Dealing

Categories: Real Estate, Article

Contracts and good faith

Anybody who has ever had a child has heard the refrain “but that’s NOT FAIR.”  While the concept of “fairness” plays a big role in how the world should operate in the minds of children, there is sometimes a disconnect between “fairness” and the “justice” that is doled out by the legal system.  One notable exception is the application by the courts of the concept of “the implied covenant of good faith and fair dealing.” 

Every contract, whether it is a contract for the purchase and sale of real estate, a lease, a listing agreement, or any other contract, consists of one or more express agreements, legally referred to as “covenants” between the parties.  Such express covenants can usually be readily understood by simply reading the contract.  What is not so obvious, however, is that inherent in every contract is also an unwritten “implied” additional covenant that is not expressly set forth; namely, the implied covenant of good faith and fair dealing. 

The implied covenant of good faith and fair dealing legally obligates the contracting parties to perform in “good faith” the obligations imposed by their contract.  In other words, such implied covenant requires the parties to act in such a manner that does not violate, nullify, or significantly impair the rights or benefits that the other party has in the contract. The courts will enforce the implied covenant of good faith and fair dealing to protect the right of a contracting party to receive the benefits of the contract that they have entered into.  Even if the conduct is otherwise allowed by the express terms of the contract, the covenant of good faith and fair dealing precludes a party from acting in bad faith or treating the other party unfairly.  The covenant is particularly applicable when one party has discretionary power affecting the other party’s rights. 

This concept may be best explained by an example.  Say that Landlord and Tenant enter into a five year lease at a certain rental rate, and that the lease includes an option giving Tenant the right to extend the lease for an additional five years at a rate to be set by Landlord.  Say further that the lease is silent as to the basis upon which Landlord may set the option rental rate.  A strict interpretation of the express language in the lease would allow Landlord to set the option rental rate at any price at all, even if such rental rate is far in excess of then-prevailing market rents.  However, the implied covenant of good faith and fair dealing, which is deemed to be part of the contract (lease), legally obligates Landlord to set an option rental rent that is “fair,” thereby not depriving Tenant from realizing the full benefit of its option.  And while what is “fair” under the circumstances may itself be open to interpretation, forcing Landlord to act in “good faith” at least provides Tenant with the protection that Tenant would not otherwise have in the absence of the existence and application of this doctrine. 


About the Author: David Allen, a partner in the Phoenix law firm of Jaburg & Wilk, has been representing clients in both transactional and litigation real estate and business related matters for over thirty years.  He is licensed as an attorney in both Arizona and California, and is also a licensed Arizona real estate broker.