The Covenant Of Good Faith And Fair Dealing Can Turn A Small Case Into A Big One.

Most non-lawyers understand the basics of a breach of contract claim. The two sides make a deal, and if one side does not honor his obligations, the other side can sue for damages.

The problem with a contract claim, from a practical point of view, is that the damages are limited. Basically, you can get what you lost based on the contemplation of the parties at the time the contract was formed. For instance, if you contract to provide a service, you provide it, and the other side does not pay, you can sue for the value of those services. Depending on the contract, you might get interest on that money, and you might get back some or all of your attorney’s fees.

But that’s it. If the contract provides for future exchanges of services for money, which are now lost to you, you might or might not get something for that. You don’t get money for pain and suffering. You don’t get damages for the ripple effect that runs through your business. You can’t get punitive damages, even if the other side’s conduct was particularly egregious. Sometimes, the result of all this is that, from a cost-benefit point of view, it doesn’t make sense to file your lawsuit. The attorney’s fees and costs may even exceed what you stand to win.

However, most non-lawyers do not know about another legal concept that arises in a contract setting. Every contract includes an implied term – in other words, not an express term of the contract – requiring compliance with the covenant of good faith and fair dealing. The covenant says that neither side can do anything, whether expressly prohibited in the contract or not, which destroys the other side’s fundamental reason for entering the contract.

For instance, we are doing a case right now regarding an employment-type contract gone bad. A ran a series of stores offering a service. A wanted to open a new store. So A entered a 2-year contract with B under which, if B made the new store successful, B would get a 49% interest after two years. The store was successful. But after one year, A terminated the contract with B. The termination was arguably permitted by the express terms of the contract, which required no reason for termination. But the effect of the termination was to deprive B of his main reason for entering the contract, namely, getting the vested ownership interest after two years. This amounts, potentially, to a breach of the covenant of good faith and fair dealing, even though permitted by the express terms of the contract.

The real significance of the resulting claim for breach of the covenant is that, increasingly under Arizona law, B can now claim not just contract damages, but what are called tort damages. In other words, he can claim future lost profits, pain and suffering, and even punitive damages. Suddenly, a lawsuit that might not have been worth bringing becomes more than worth it.

This is not something that laymen would know about. But both A and B would have benefitted by going to see an attorney specializing in fraud or business litigation at the very outset. There, they would have learned about the covenant, which may end up determining the outcome of this case.

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