The Implied Duty of Good Faith & Fair Dealing in Texas

You’ve dotted every “i” and crossed every “t” on your contract. You’ve conducted due diligence, sat across the table from the other party, and you’ve each agreed to abide by the terms of a contract. Months, weeks or even hours later, you discover that the party you contracted with seems dead set on frustrating your ability to realize the benefits of the agreement.

What recourse do you have? The express terms of the contract may not have been violated, but the implied obligations of the agreement have. That’s where the implied duty of good faith and fair dealing comes in.

Nearly every state has a precedent on how to interpret and enforce the implied duty of good faith and fair dealing in contracts, but there remains no uniform standard for how states define its scope or determine what constitutes a breach.

For parties who contract in Texas specifically, knowing just how narrow the state’s application of implied duty is can provide the motivation to more judiciously evaluate contractual relationships involving an imbalance of power, and whether other claims or protections exist prior to entering into contracts.

Have the implied obligations of your contract been violated? Call (713) 909-7323 or contact us online to speak with a lawyer about your options.

What is the Implied Duty of Good Faith and Fair Dealing?

Most jurisdictions, including Texas in limited situations, recognize that parties to a contract are bound by an implied duty of good faith and fair dealing in both the performance and enforcement of a contract.

The implied duty does not bestow new rights upon parties to a contract, but rather requires contracted parties to act in a reasonable manner when performing or enforcing their contractual rights. Generally, this means the implied duty requires a contracted party to:

1. Not take advantage of the other in a manner the parties did not expressly provide for or contemplate when entering into the contract.
2. Act in a manner that impairs or inhibits the other party’s right to receive contractual benefits.

In Texas, the duty of good faith and fair dealing arose, in part, from the inherently unequal bargaining power between insurance companies and the insured. By implying a duty for powerful parties to act reasonably, the pull to exert its power in disregard to a communal sense of what is fair and decent is diminished, and the more vulnerable party is given cause of action to remedy such an act.

Amid COVID-19, the implied duty of good faith and fair dealing may become an even more significant point of consideration for contracting parties, as financial fallout from the pandemic causes many to perform contractual obligations in the face of deeply uncertain futures.

But, of course, whether parties to a contract are able to bring such claims will depend greatly on the controlling jurisdiction and specific circumstances.

Breach of Implied Duty Claims: Factors to Consider

Courts presiding over breach of implied duty claims have the ability to imply obligations in contracts outside of a contract’s express provisions. In determining whether a breach occurred, courts may consider many factors, including the contract’s express terms and the circumstances under which the contract was created.

1. Express Terms of the Contract

A contract’s express terms define the contours of implied duty, and enable the court to imply obligations that give effect to the intent of the parties and the purpose of the contract.

Even when contracts do not explicitly provide for specific performance, courts may compel parties to perform based on the intent and purpose it interprets from the terms of the contract. However, the court cannot imply obligations inconsistent with the contract’s terms.

Implied duty, therefore, is not a viable option in the absence of bona fide contractual breaches or force majeure clauses nor a means to impose obligations contradictory to a contract’s terms.

2. Context and Circumstances Surrounding the Contract

Courts may consider how a contract came to be when analyzing breach of implied duty claims. This can include the prior conduct of contracted parties that previously engaged in other transactions or contractual engagements with one another.

In such a situation, the nature of a previous relationship could define the scope of implied duty in the following relationship. For example, if one party has a history of being difficult in its performance of contractual obligations, but is by letter of the law compliant nonetheless, a court may rule that the party asserting a breach of implied duty should have reasonably foreseen issues and rule that no breach occurred.

3. Contracts that Give Rise to a “Special Relationship”

In Texas and other jurisdictions with narrow views on the implied duty of good faith and fair dealing, the nature of the parties’ relationship can be a critical factor in a court’s finding of breach. In Texas, the common law duty of good faith and fair dealing applies only in contracts that give rise to a special relationship between the parties. It does not apply to ordinary, arms-length commercial transactions.

The Texas Supreme Court has greatly limited its interpretation of what constitutes such a relationship, and imposes the good faith and fair dealing duty only upon parties in two special relationships:

• The insured to its insurer; and
• The executive rights holder to non-executive mineral interest owners.

4. The Duty of Good Faith and Fair Dealing in an Employment Context

Notably in Texas, an employer does not owe a duty of good faith and fair dealing to its employees. This precedent was set by a case decided by the Texas Supreme Court in June 2000. The Court noted that the elements which make the relationship between an insurer and an insured “special” are absent in the relationship between an employer and its employees: “If an insured suffers a loss, he cannot simply contract with another insurance company to cover that loss,” the Court stated. “By contrast, an employee who has been demoted, transferred, or discharged may seek alternative employment.”

5. Other Factors

• Discretionary power: Courts may rule that a party breaches its implied duty when exercising discretionary power in a manner that is arbitrary, unfair and unreasonable; to impair accrued rights after the fact; or as a means to accomplish illegitimate goals outside of the contract.
• Self-interest: Implied duty is not intended to undermine a party’s right to act in its own best interests, and courts may rule against a finding of breach if a party acted with self-interest but within the contract’s contemplated boundaries.

Breach of Implied Duty Elements

To win a breach of implied duty claim, the following must be established:

1. The parties have existing obligations under a contract.
2. Plaintiff fully or substantially performed its obligations or was excused from performance.
3. The Defendant unreasonably and unfairly interfered with the other party’s right to receive contractual benefits. This may include:
   • Preventing the other party from performing its obligations.
   • Engaging in schemes to deprive the other party of its right to benefits or withholding contractual benefits.
   • Seeking to obtain benefits prohibited by contract.
   • Having no intent to complete a contract or engaging in a contract that is unreasonable or deceitful
4. The Plaintiff suffered injury due to the Defendant’s conduct.

Breach of Implied Duty Damages

A contracted party that prevails in a breach of implied duty claim may generally recover the same damages available for breach of contract. This can include:

• Compensatory damages
• Consequential damages
• Liquidated damages
• In certain cases, statutory, tort, and / or punitive damages

Texas’ Narrow Implied Duty of Good Faith & Fair Dealing

Texas’ application of the implied duty of good faith and fair dealing is notoriously narrow, and exists only in contracts involving special relationships.

Though its remedies are available only to disadvantaged parties, Courts have deemed to be part of a special relationship, it can be an important tool for leveling the playing field in contractual relationships where an imbalance of power is a true underlying reason for rift.

It can also alert contracted parties to the importance of evaluating any power imbalances and options for enforcement when entering into new contracts, and the importance of continuing to act in good faith when performing or enforcing an existing contract in the age of COVID.

If you are dealing with a breached contract or accused of such, turn to the business attorneys at Hendershot Cowart for guidance. We are standing by to help you interpret and act upon complex contractual issues.