As the Birch Broadcasting case notes, “implied good-faith obligations fall into three general categories: (1) contract formation; (2) termination of at-will employment agreements; and (3) limitation of discretion in contractual performance.” The third category is the one most relevant to construction contracts. It prohibits an exercise of contractual discretion “inconsistent with the parties’ agreed-upon common purpose and justified expectations as well as ‘with common standards of decency, fairness and reasonableness.’” Id.
The first thing to notice is that the implied covenant comes into play only when one party has the discretion to act in a way that could deprive the other party of the expected benefits of its bargain. Discretion exists where “a legal directive or contract term is indeterminate because it fails to identify a single specific action that is legally permitted, prohibited, or required under the circumstances.” Milford-Bennington R. Co. v. Pan Am Railways, Inc., No. 10-cv-00264-PB, 2011 WL 6300923 at *5 (D.N.H. Dec. 16, 2011), aff’d, 695 F.3d 175 (1st Cir. 2012). In other words, not everything is nailed down; the contract presents an opportunity for one party to move the goal posts on the other party after the contract has been entered into. Conversely, if the claimant has an express contractual right to the benefit it seeks, the other party’s refusal to tender that benefit is simply a breach of an express rather than an implied contract term. No true discretion exists.
The second thing to notice is the tension between “two apparently inconsistent principles: that the covenant of good faith and fair dealing should be implied to limit the exercise of a discretionary power, and that express terms of a contract cannot be varied by an implied covenant.” Hobin v. Coldwell Banker Residential Affiliates, Inc., 144 N.H. 626, 630 (2000). Hobin resolved the dilemma by focusing on whether the exercise of discretion by one party would destroy the consideration needed to make the contract legally enforceable. It “distinguished between the proper implication of a covenant of good faith and fair dealing ‘to contradict an express contractual grant of discretion when necessary to protect an agreement which otherwise would be rendered illusory and unenforceable,’ and situations in which a court may not imply such a covenant because ‘regardless of how such [discretionary] power [is] exercised, the agreement [is] supported by adequate consideration.’” [citation omitted]. The implied covenant overrides a contractual grant of discretion when necessary to make the contract binding on both sides and avoid a finding that the promise is illusory.
In construction settings, claims of breach of the implied covenant will almost always be “upstream” claims, by a subcontractor against a general contractor or by a general contractor against an owner. Where I see the implied covenant of good faith and fair dealing implicated most often is in the rescheduling of work. An instance is New Design Construction Co., Inc. v. Hamon Contractors, Inc., 215 P.3d 1172 (Colo.App.Div. 2 2008). As is commonly the case, Hamon, the general contractor, had the contractual right to modify the project schedule. When it did so to the detriment of its paving sub, it crossed the line. The Court noted that “Hamon was responsible for developing and maintaining a schedule, NDCC was responsible for completing its work when directed by Hamon to do so, and Hamon was required not to abuse its discretion when directing NDCC to complete its work.” Id. at 1182.
The wise contract drafter attempts to identify areas of discretion, and tries to limit them. Nothing prevents contracting parties from flagging potential instances of application of the implied covenant -- for example, with language making one party’s action subject to the other’s consent but providing that such consent shall not be unreasonably withheld.