Breach of implied covenant of good faith and fair dealing statute of limitations California

Good Faith and Fair Dealing

In every contract made in California, there is an implied covenant of good faith and fair dealing. What is the implied covenant of good faith and fair dealing? It is a covenant made by each party to the contract not to do anything that will deprive the other parties to the contract of the benefits of that contract. Initially, the covenant provides that each party to the contract will refrain from doing anything that would make the other party’s performance of their contractual obligations impossible (“bad faith” acts). However, the covenant of good faith and fair dealing goes further, and imposes an affirmative duty on each party to do everything that a reasonable interpretation of the contract presupposes he will do to accomplish the purpose of the contract, even if those acts are not expressly required by the contract itself. A breach of the covenant may result in litigation, and the party who acted in bad faith may be compelled to complete his performance and/or pay damages to the other party.

The covenant is elastic and failures to act in good faith can take on almost any form, because it is the spirit of good faith and fair dealing that governs. Examples of conduct that violate the covenant are subterfuges, evasions, willfully imperfect performances, failures to cooperate in the other party’s performance, or inaction. The list of examples is unending, limited only by the limitations on people’s ability to dream up different ways to weasel out of promises they have made.

A common situation where breaches of the implied covenant of good faith and fair dealing have been found is where one party is invested with a discretionary power, the exercise of which will affect the rights of the other party. For example: Seller and Buyer enter into a contract for the purchase of a home, leaving some minor details (i.e., which kitchen appliances are to be included, or whether certain window treatments will remain) to be negotiated within a certain period of time. During that period, Seller receives a higher offer for the home from a third party. Seller, desirous of selling for the higher price, refuses to engage in any dialogue whatsoever, the decision-making period lapses, and Seller seeks to cancel the contract because the parties were “unable to agree” within the allotted time period. Seller’s conduct may be found to be a breach of the implied covenant, as general notions of fairness and good faith dictate that, where the parties have agreed to negotiate a few (relatively minor) details of the transaction, the seller is actually required to negotiate. While courts may differ over the extent to which any negotiations that occur have actually been done in good faith, there should be fairly universal agreement that the failure to negotiate at all, and then to try to get out of the contract on the basis of non-agreement, will not be condoned.

Courts look to, and promote, good faith dealings between parties to a contract. The implied covenant of good faith and fair dealing allows the courts to close any “loopholes” contained within the four corners of the agreement that a reneging party might use to try to justify non-performance of his obligations, and enforce the intent of the parties at the time the contract was made.

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In business litigation cases, attorneys often draft lawsuits with causes of action for both breach of contract and breach of the implied covenant of good faith and fair dealing. Oftentimes these claims of breach of the implied covenant are simply duplicative of the breach of contract action and are subject to challenge by way of demurrer (a motion in California that attacks the initial pleading). The general rule in California precludes tort recovery for noninsurance contract breach, at least in the absence of violation of an independent duty arising from principles of tort law. In other words, a cause of action for breach of the covenant of good faith and fair dealing is rarely viable in commercial litigation.

“A ‘breach of the implied covenant of good faith and fair dealing involves something beyond breach of the contractual duty itself’ and it has been held that ‘[b]ad faith implies unfair dealing rather than mistaken judgment….” Careau & Co. v. Security Pacific Business Credit, Inc. (1990) 222 Cal.App.3d 1371, 1394. “If the allegations do not go beyond the statement of a mere contract breach and, relying on the same alleged acts, simply seek the same damages or other relief already claimed in a companion contract cause of action, they may be disregarded as superfluous as no additional claim is actually stated.” Id. at 1395.

Case law demonstrates that the breach of implied covenant has been available in insurance cases where the courts have found a ‘special relationship’ between the insurer and the insured, which is characterized by elements of public interest, adhesion and fiduciary responsibility. Id. The court mentioned how problematic that would be in noninsurance cases. In the Careau case, which involved a commercial lending transaction, the court found that the case presented “a rather common banking transaction” involving “arms length negotiations”. Id. at 1400.

“There were no indicia of unequal bargaining here, no adhesive agreement, no indication that one party had any particular advantage over the other. Indeed, it appears that the terms of the central document, the August 25 letter, was the product of meaningful negotiations between the parties. Moreover, it does not appear that plaintiffs were neither in a particularly vulnerable position nor in need of any special protection. Finally, ordinary contract damages are obviously adequate to make plaintiffs whole for any compensable misconduct on the part of the defendants.” Id.

Continuing to review the history of the cause of action, the Careau & Co. court described how in 1984 the court in Wallis v. Superior Court (1984) 160 Cal.App.3d 1109 announced a five part description of the characteristics of the ‘special relationship’ which must be present in a noninsurance contractual dispute in order to justify tort recovery for a breach of the implied covenant: (1) the contract must be such that the parties are in inherently unequal bargaining positions; (2) the motivation for entering the contract must be a nonprofit motivation, i.e., to secure peace of mind, security, future protection; (3) ordinary contract damages are not adequate, because (1) they do not require the party in the superior position to account for its action, and (b) they do not make the inferior party ‘whole’; (4) one part is especially vulnerable because of the type of harm it may suffer and of necessity places trust in the other party to perform; and (5) the other party is aware of this vulnerability. Id. at 1398.

The Supreme Court in Foley v. Interactive Data Corp. (1988) 47 Cal.3d 654 suggested that any extension of tort remedies to noninsurance cases is not justified given (1) the limited purpose and scope of contract damages, (2) the strong need in our commercial system for predictability of the cost of contractual relationships and (3) the difficulty of formulating a workable test for distinguishing between a simple breach of contract and a ‘tortious’ breach of the implied covenant.” Careau & Co., supra., 222 Cal.App.3d at 1398. The Foley court noted the obvious: to claim that tort damages are appropriate by simply alleging ‘bad faith’ does nothing to limit the cause of action or differentiate between a run-of-the-mill breach of contract case. Id. at 1399.

The courts have rejected the argument that a ‘special relationship’ exists for employer/employee, commercial grower/grain hauler, insurance company/general agent, distributor/vendor, franchisor/franchisee, bank/commercial borrowers and guarantors and stock broker/investor context. Id.

The Careau & Co. court concludes that “[f]rom this history, it seems clear to use that the recognition of a tort remedy for a breach of the implied covenant in a noninsurance contract has little authoritative support.” Id. With regard to the specific facts of the case, the court held that “[t]his case presents a rather common commercial banking transaction. …There were no indicia of unequal bargaining here, no adhesive agreements, no indication that one party had any particular advantage over the other. Indeed, it appears that the terms of the central document, the August 25 letter, was the product of meaningful negotiations between the parties. Moreover, it does not appear that plaintiffs were either in a particularly vulnerable position nor in need of any special protection. Finally, ordinary contract damages are obviously adequate to make plaintiffs whole for any compensable misconduct on the part of the defendants.” Id. at 1400.

In affirming the trial court’s sustaining of the demurrer without leave to amend, the court concluded that “[g]iven the allegations set out in plaintiffs’ second amended pleadings, the ‘transaction here is the quintessentially ordinary arms-length commercial transaction between two parties of equal bargaining strength, breaches of which are adequately remedied by ordinary contract damages.” Id.

If you are the attorney drafting a lawsuit against another company, it is likely that a breach of contract action will provide you with the remedy you need. If you are the attorney defending a party subject to a breach of the covenant of good faith and fair dealing, consider challenging the complaint and asking that the plaintiff not be given leave to amend. It is important to eliminate a tort cause of action quickly as this can affect the potential risk your client faces.

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