This post discusses and explains the covenant of good faith and fair dealing.
For decades, courts have held that this covenant is implied in every California contract.
Purpose of Good Faith and Fair Dealing
In 1942, the California Supreme Court stated that “in every contract there exists an implied covenant of good faith and fair dealing.” The intent of this covenant is that “neither party shall do anything which will have the effect of destroying or injuring the right of the other party to receive the fruits of the contract“. (Universal Sales Corporation v. California Press Manufacturing – emphasis added.)
The most significant limitation is that this implied covenant of good faith and fair dealing does not exist if there is no contract between the parties. For example, during negotiations there typically is no obligation to negotiate in good faith. (Racine & Laramie v. Dept. of Parks and Recreation)
Agreements to Negotiate
However, it is possible for parties to enter into an agreement to negotiate. This might occur, for example, if parties sign a letter of intent or another instrument by which they agree to negotiate the terms of a definitive agreement. Then, the covenant of good faith and fair dealing would apply to the negotiation process.
That is what happened in Copeland v. Baskin Robbins. In that case, Copeland and Baskin Robbins (“BR”) signed a letter agreement by which they agreed to negotiate the terms of (i) sale of a manufacturing facility and equipment and (ii) an agreement by which BR would buy ice cream from Copeland.
Two months later, BR informed Copeland that BR was terminating negotiation of the second agreement. BR knew that Copeland would not want either agreement without the other. BR returned the deposit that Copeland had provided, and all negotiations ended.
The Court of Appeal held that BR had breached the implied covenant of good faith and fair dealing. Unfortunately for Copeland, however, the only damages to which he was entitled were those for out-of-pocket negotiating costs and, perhaps, lost opportunity costs. The Court held that Copeland could not recover lost profits “because there is no way of knowing what the ultimate terms of the agreement would have been or even if there would have been an ultimate agreement.”
In summary, once you enter into a contract in California, you are obligated to carry out its terms in a way that allows the other party to receive the benefits of that contract.
Dana H. Shultz, Attorney at Law +1 510-547-0545 dana [at] danashultz [dot] com
This blog does not provide legal advice and does not create an attorney-client relationship. If you need legal advice, please contact a lawyer directly.