Difference Between Implied Covenant of Good Faith and Fair Dealing and the Fiduciary Duty of Good Faith

Despite both containing the term “good faith,” the concepts of the fiduciary duty of good faith and the implied covenant of good faith and fair dealing are two distinct legal concepts. Nonetheless, many business owners and even attorneys are unaware of the differences between the two concepts that frequently come up in commercial litigation. Before exploring the differences between the two concepts, it is important to have an understanding of what each concept is.

The duty of good faith is the principle that directors and officers of a company in making all decisions in their capacities as fiduciaries must act with a conscious regard for their responsibilities as fiduciaries. The duty applies equally to members of a limited liability company as well as partners in a partnership. Courts generally acknowledge that the duty of good faith is not capable of an exhaustive definition or reduction to a definitive list of accepted and prohibited actions. Defined simply, the duty requires fiduciaries to have subjectively honest and honorable intentions in all professional actions. Numerous courts have found that the duty of good faith requires controlling shareholders to exercise their powers in good faith and in a way that does not oppress the minority. This subjective aspect of the duty of good faith separates it from the duty of care which is typically determined on an objective basis.

Under the common law of contracts, the obligation of “good faith and fair dealing” is an implied and inescapable term of every agreement. Per the Restatement (Second) of Contracts, § 201, “Every contract imposes upon each party a duty of good faith and fair dealing in its performance and its enforcement.” The official comments suggest that a complete definition is impossible—the duty “excludes a variety of types of conduct characterized as involving ‘bad faith’ because they violate community standards of decency, fairness or reasonableness,” but “[a] complete catalogue of types of bad faith is impossible.”

The implied covenant is a tool of contract interpretation meant to ensure that the parties' reasonable expectations are fulfilled. The implied covenant prevents a party to a contract from violating the “spirit” of the contract, even if the contract does not expressly prohibit the party’s actions. When invoking the implied covenant, courts are guided primarily by the goal of compelling fairness. The implied covenant is by design limited by the written terms of a contract. Courts will not use the implied covenant to contradict or change the written terms of a contract.

Unlike the duty of good faith, the implied covenant of good faith does not create a requirement that a party act in a morally commendable sense. Instead “good faith” in context of the implied covenant refers to a party’s faithfulness to the scope, purpose, and terms of the parties’ contract.

Another important difference between the implied covenant of good faith and fair dealing and the fiduciary duty of good faith is the source of the obligation. The implied covenant is purely a matter of common contract law. The fiduciary duty of good faith, on the contrary, can be statutory or arise under common law depending on the jurisdiction. While under Illinois law a fiduciary relationship can be created by contract, it can also arise by virtue of the nature of the parties’ relationship.

Notably, the implied covenant of good faith and fair dealing is included in every contract whereas the duty of good faith requires the existence of a fiduciary relationship. This means that every party to a contract is subject to the implied covenant. Every party to a contract is not, however, subject to the duty of good faith as not every contract creates a fiduciary relationship.

A final difference involves the parties’ ability to waive or limit each concept. The implied covenant of good faith and fair dealing is automatically included in every contract and cannot be waived by the parties. To the contrary, numerous jurisdictions permit the parties to waive or limit certain fiduciary duties, including the duty of good faith, by agreement.

Because the duty of good faith can be waived in many jurisdictions, courts will not allow parties to use the implied covenant as a substitute for the duty of good faith or to get around a decision to waive the fiduciary duty. As one court explained, a plaintiff that “seeks to re-introduce fiduciary review through the backdoor of the implied covenant, fails to state a colorable claim.”

Our Chicago fiduciary duty and breach of contract attorneys have litigated member and shareholder oppression, business divorce, stolen corporate opportunity and breach of fiduciary duty lawsuits for more than three decades. We spend considerable time going over all the business and accounting issues to develop a comprehensive strategy for prosecuting and defending the claims that arise in the case.

Serving clients in Chicago and beyond, our business litigation attorneys have acted as lead counsel in accounting actions including a complex dispute involving tens of millions of dollars in damages that was resolved through an extended multi-year trial where we worked closely with the accounting and damages experts to develop winning strategies. We have built a reputation on the ability to take complex legal concepts and arguments and present them to the court in plain, clear manner that makes them easily understandable. We offer free consultations to let business owners, shareholders or LLC members decide if we are the best attorneys to represent their interests in complex breach of contract or fiduciary duty litigation. We take the time to learn about your business and the issues it faces. To set up a consultation with one of our Chicago LLC member dispute attorneys and Chicago business trial lawyers, please call us toll-free at 630-333-0333 or contact us online.