A contract cannot anticipate every situation that will arise during its performance. Gaps appear, circumstances change, and parties encounter scenarios the written agreement never addressed. The law fills some of those gaps with an implied obligation that runs through every commercial contract in the United States: the duty of good faith and fair dealing. This duty is not typically written into agreements — it is implied as a matter of law. Yet it has real legal consequences, and failing to understand it can leave business owners exposed.
The good faith duty is simultaneously one of the most important and one of the most frequently misunderstood doctrines in contract law. Some business owners treat it as a vague ethical requirement to be nice to their counterparties. Others believe it is primarily a consumer protection concept with limited relevance to sophisticated commercial relationships. Both views are mistaken. The duty of good faith and fair dealing is a substantive legal obligation that applies to commercial contracts at every level of complexity — and courts take it seriously.
What the Duty Requires: The Core Concept
The Restatement (Second) of Contracts and the Uniform Commercial Code both recognize the duty of good faith and fair dealing as an implied term of every contract. The UCC defines good faith for merchants as ‘honesty in fact and the observance of reasonable commercial standards of fair dealing.’ This two-part definition captures what the duty requires: subjective honesty (you must actually believe you are acting properly) and objective reasonableness (your conduct must meet the standards that reasonable commercial parties would recognize as acceptable).
At its core, the duty prohibits a party from taking actions that, while not technically in violation of any express contract term, nonetheless deprive the other party of the benefit of the bargain they struck. Courts describe this as preventing a party from exercising their contractual rights in a way that is arbitrary, unreasonable, or designed to frustrate the other party’s legitimate expectations. The duty does not create new obligations beyond those in the contract — it regulates how existing obligations and rights are exercised.
The classic good faith cases involve parties who hold discretion under the contract — the right to approve or reject, the right to set prices, the right to terminate at will — and exercise that discretion in bad faith. For example, if your contract gives you discretion to approve the other party’s subcontractors, you cannot exercise that discretion to block every subcontractor they propose simply to avoid your own performance obligations. Exercising contractual discretion capriciously, for pretextual reasons, or for a purpose unrelated to the legitimate purposes that discretion was meant to serve can violate the good faith duty.
What Good Faith Does Not Require
Understanding the limits of the good faith duty is as important as understanding its scope. The duty does not require a party to subordinate their own interests to their counterparty’s. It does not require altruism, generosity, or charity in contractual performance. Parties to commercial contracts are entitled to act in their own economic interest, negotiate hard, and take full advantage of favorable contract terms — as long as they do so honestly and without the specific conduct that courts recognize as bad faith.
The good faith duty generally does not override express contract terms. If your contract expressly gives you a right — to terminate on notice, to adjust pricing under a formula, to withhold approval in your sole discretion — exercising that right, standing alone, is not a breach of good faith simply because it disadvantages the other party. Courts are reluctant to use the implied duty to rewrite what the parties expressly agreed to. The doctrine fills gaps in contracts; it does not negate their express terms.
The good faith duty also does not impose an obligation to renegotiate a contract when circumstances change unfavorably for one party. If your supplier’s costs increase and their profit margins shrink under your long-term supply agreement, that economic hardship does not obligate you to renegotiate the price in their favor. You can insist on the contract as written. The difficulty is not your bad faith; it is the natural risk of commercial contracting. Good faith obligations do not convert fixed contracts into flexible ones.
Another important limit: the implied duty of good faith does not create a cause of action independent of the contract in most US jurisdictions. You cannot sue for ‘breach of the duty of good faith’ as a standalone tort in the way you can sue for fraud. The good faith duty is a contractual obligation; breach of it is a breach of contract, giving rise to contract remedies. A handful of states allow tort claims based on bad faith in certain narrow contexts, most notably insurance contracts, but this is the exception rather than the rule in commercial contracting.
Common Situations Where Good Faith Issues Arise
Good faith disputes arise most frequently in certain recurring patterns. Discretionary approval rights are a common trigger. When a contract gives one party the right to approve plans, specifications, personnel, or subcontractors, courts imply that the approval right will be exercised reasonably and not withheld for illegitimate reasons. A party who uses approval rights as a weapon to hold the other side hostage or to extract concessions unrelated to the subject of the approval is at risk of a good faith claim.
Termination rights are another frequent source of good faith disputes, particularly termination for convenience clauses. Some jurisdictions impose good faith constraints on the exercise of termination-for-convenience rights, particularly when one party has made substantial investments in reliance on the contract. The argument is that terminating a contract for the sole purpose of depriving the other party of earned compensation — rather than any legitimate business reason — is bad faith. Courts in different states resolve this differently, and the specific contract language matters greatly.
Requirements contracts — where a buyer agrees to purchase all of their requirements for a product from a single seller — are subject to UCC good faith constraints. A buyer under a requirements contract cannot disingenuously claim to have zero requirements in order to avoid purchasing from the seller. The duty of good faith prevents a buyer from manipulating their stated requirements in a way that defeats the seller’s legitimate commercial expectations. Similarly, the seller cannot refuse to sell in quantities that are unreasonably disproportionate to prior patterns.
Output contracts (where a seller agrees to sell all of their output to a single buyer) raise symmetric issues. A seller cannot dramatically increase output to levels never contemplated by the contract in order to flood the buyer with more than they can reasonably absorb. The good faith duty prevents extreme manipulation of contractual quantities in either direction.
State Law Variations
The scope of the good faith duty varies meaningfully among US states, and this is one area where the applicable law can make a significant practical difference. New York courts take a relatively narrow view of the implied covenant, emphasizing that it cannot be used to create obligations that contradict or go beyond express contract terms. New York courts are particularly skeptical of good faith claims that amount to arguments about how express contractual rights should have been exercised differently.
California courts have historically been more willing to find good faith obligations in commercial relationships, though recent decisions have also imposed limits. Delaware, a major jurisdiction for business contracts, generally aligns with the narrower New York approach for sophisticated commercial parties, emphasizing party autonomy and the sanctity of negotiated terms. Courts in jurisdictions that apply the UCC broadly may be more willing to find good faith obligations because the UCC expressly incorporates good faith as a statutory requirement.
The distinction between the majority rule (good faith cannot override express terms) and the minority rule (good faith can sometimes require conduct beyond what express terms contemplate) is one that a business owner in a significant commercial dispute should discuss carefully with counsel. The applicable law matters, and where you litigate or arbitrate can affect the outcome substantially.
Drafting Considerations
While you cannot contractually eliminate the implied duty of good faith, you can draft contracts that define the scope of discretionary rights in ways that reduce good faith exposure. When you include discretionary approval rights, consider specifying the criteria for approval and disapproval. This reduces the risk that a court will second-guess your exercise of discretion by providing an express standard against which your conduct can be measured.
If you want a termination right to be truly unconditional, use language that makes the unconditional nature explicit and consider including a requirement that the terminating party pay a breakup fee or cover the other party’s reliance costs. Courts are more willing to enforce broad termination rights when the contract includes something for the terminated party, because it suggests the parties genuinely agreed to allocate the risk in that way rather than one party simply holding all the power.
In requirements and output contracts, include language setting minimum purchase or sale quantities and specifying what happens if quantities deviate significantly from historical or projected levels. These provisions provide an express contractual framework that reduces the space in which a good faith dispute can arise. The more clearly your contract addresses the scenarios where bad faith claims tend to arise, the less room there is for a court to fill gaps in ways you did not anticipate.