Good Faith and Fair Dealing

By Herrick K. Lidstone, Jr.

All of our clients are parties to contracts. These contracts may be a page or two in length; they may be a hundred or more pages. The contract may be for a home improvement project or for a complex business transaction. The contract may even be on the back of a napkin or oral. Regardless, there is something in common with each of these contracts – parties enter into the contracts with certain legitimate expectations, and not all of those expectations are set forth in the contract itself.

As long as things work well, the contract may never be raised again. Many contracts are simply performed by the parties and then find themselves in the dustbin of business history, never to be thought about again. There are those exceptions, however, where the parties who originally negotiated and entered into the contract so willingly come to believe that there is a misunderstanding as to performance obligations, or a breach by one party or the other. This is frequently where lawyers become involved after the initial discussions between the parties to the contract fail to reach a resolution.

All contracts go beyond the words of the contract, even though the typical legal analysis is that a contract is to be “interpreted within its four corners” unless there is ambiguity within the four corners of the contract, itself. The Colorado Supreme Court has said that all contracts in Colorado will be governed by an implied covenant of good faith and fair dealing in each party’s performance and enforcement of the contract.

The doctrine exists under Colorado law to effectuate the parties’ intentions and honor their reasonable expectations when entering into the contract. Violating the contractual obligation of good faith and fair dealing may give rise to a claim for breach of contract. Of course, determining whether a violation occurred because one of the parties breached its obligations of good faith and fair dealing is a factual question.

In Colorado, the Court of Appeals has said that the obligation “of good faith and fair dealing may be relied upon ‘when the manner of performance under a specific contract term allows for discretion on the part of either party.’” “Discretion in performance occurs ‘when the parties, at formation, defer a decision regarding performance terms of the contract’ leaving one party with the power to set or control the terms of performance after formation.” The Court of Appeals has found that a breach of the implied covenant of good faith and fair dealing may occur “[w]hen one party uses discretion conferred by the contract to act dishonestly or to act outside of accepted commercial practices to deprive the other party of the benefit of the contract.”

Some examples may be appropriate. Many contracts provide the right to a party to inspect certain records of another party. Generally these contracts specify that the inspection may occur “during normal business hours upon not less than three days’ notice.” Occasionally there is no such definition. Does the absence of any such definition mean that the person holding the records can dictate that records inspection may only occur at midnight? May a person obligate the other to enter into a confidentiality agreement before inspecting records? Once the records are inspected, may the person inspecting the records copy them or publicize them on a website or in the newspaper?

Reasonableness is the key. The covenant of good faith and fair dealing has been held to require parties to refrain from arbitrary or unreasonable conduct that prevents the other party from receiving the reasonable expectations of the contract. Where the parties agree that inspection of records may only occur at midnight, the contract should so state and it will then be enforceable. Where the parties agree that records of performance do not constitute confidential information, the contract should so state. Where the contract does not so state, reasonableness would suggest that the inspection should occur at a reasonable time and in a reasonable place, and confidential records should be kept confidential.

Thus, even when contracts are to be interpreted within the four corners of the agreement and there is no ambiguity, the contractual obligation of good faith and fair dealing applies to each agreement.