The contractual provision implied in every agreement – the implied covenant of good faith and fair dealing

Adam Keilen Business/Corporate Law

Generally, the implied covenant of good faith and fair dealing is a presumption that parties to a contract will handle the contract’s affairs in a manner that is honest, fair, and in good faith, meaning, neither party will, in bad faith, attempt to destroy the other party’s right to receive the benefits of the agreement. In other words, despite not being an independent cause of action, “[e]very contract imposes upon each party a duty of good faith and fair dealing in its performance and its enforcement.” Restatement (Second) of Contracts §205. In Kirke La Shelle Company v. The Paul Armstrong Company et al., 263 N.Y. 79; 188 N.E. 163 (N.Y. 1933), the New York Court of Appeals described the covenant as follows:

“[I]n every contract there is an implied covenant that neither party shall do anything, which will the effect of destroying or injuring the right of the other party, to receive the fruits of the , which means that in every contract there exists an implied covenant of good faith and fair dealing.”

The implied covenant of good faith and fair dealing is included in the Uniform Commercial Code (UCC), and was codified by the American Law Institute in Section 205 of the Restatement (Second) of Contracts; however, jurisdictions vary with respect to their view and interpretation of the same. Under Michigan law, as of July 1st, 2013, under MCL § 440.1201(2), under the UCC, good faith is defined as “honesty in fact and the observance of reasonable commercial standards of fair dealing.”

What does that really mean? The implied covenant of good faith does not replace written provisions of the agreement; however, it requires good faith for discretionary decisions provided for in the agreement. Stephenson v Allstate Ins Co, 141 F Supp 2d 784 (ED Mich 2001), aff’d, 328 F3d 822 (6th Cir 2003); Van Arnem Co v Manufacturers Hanover Leasing Corp, 776 F Supp 1220 (ED Mich 1991). In other words, Michigan courts affirmed the position that parties exercising discretionary power under an agreement must do so honestly and in good faith.

Case Example – FERRELL V. VIC TANNY INT’L, INC. A fitness club put a dress code in place for certain areas of the club, thereby promoting certain programs. The rules were made pursuant to the club’s contractual authority to make rules, guidelines, and regulations. Thus, the undisputed purpose of the dress code was as follows: “the principal purpose of such a dress code in its larger clubs is to provide for a uniformity upon patrons working out, which assists in avoiding feelings of embarrassment or self-consciousness in the exercise rooms which, experience has shown, is often detrimental to the willingness of some patrons to participate in exercise programs.” Ferrell v Vic Tanny Int’l, Inc137 Mich App 238, 243–244, 357 NW2d 669 (1984). The court held that the purpose of the enacted dress code program, and the discretionary rulemaking, was in good faith; the court held that the code was not made in bad faith to deprive club members of the benefits of club membership. Rather, the dress code was a good faith exercise of the club’s discretionary power, power provided by the contract, to make club rules for various programs and locations; thereby, the club acted with good faith and fair dealing with respect to its discretionary contractual authority when it enacted the dress code program. Id.

The take away. If your business has a contract that gives you discretionary power, that contract, and every contract, requires that you exercise such power honestly and in good faith. Burkhardt v City National Bank of Detroit, 57 Mich App 649; 226 NW2d 678 (1975).