Performance, breach, and discharge - Obligations of good fai...

Learning Outcomes

This article examines the implied duty of good faith and fair dealing in contract law for MBE purposes, including:

• Defining the implied covenant under both common law and the UCC and distinguishing the merchant and non‑merchant good‑faith standards.
• Identifying when the duty applies during performance, enforcement, and the exercise of contractual discretion in exam fact patterns.
• Analyzing how good faith constrains requirements and output contracts, satisfaction clauses, open price terms, termination rights, and exclusive dealing arrangements.
• Evaluating conduct such as hindrance, failure to cooperate, opportunistic termination, and drastic quantity changes to determine whether it constitutes bad faith or merely hard bargaining.
• Distinguishing the role of the implied covenant from related doctrines like conditions, waiver, estoppel, mistake, impracticability, and unconscionability.
• Connecting a breach of the implied covenant to contract remedies, including expectation and consequential damages, and recognizing when equitable relief may be appropriate.
• Developing an exam strategy for spotting good‑faith issues quickly, eliminating distractor doctrines, and selecting the answer that best reflects commercially reasonable behavior and the parties’ expected benefits.

MBE Syllabus

For the MBE, you are required to understand obligations of good faith and fair dealing within the broader topic of performance, breach, and discharge, with a focus on the following syllabus points:

• Recognition that an implied duty of good faith applies to virtually all contracts
• UCC definitions of “good faith” and how they differ for merchants and non‑merchants
• The role of fair dealing in cooperation and in avoiding hindrance of the other party’s performance
• Application of the covenant in requirements and output contracts, satisfaction clauses, open terms, and exclusive dealings
• How the implied covenant functions alongside express terms and conditions
• When conduct amounts to a breach of the implied covenant and what remedies follow
• The good‑faith requirement for UCC modifications, demands for adequate assurances, and commercial reasonableness
• Exam‑style applications in at‑will termination clauses, bonus and commission arrangements, and price‑setting provisions

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

1. The implied covenant of good faith and fair dealing applies to:
   1. Only contracts for the sale of goods under the UCC.
   2. Only common law service contracts.
   3. Virtually all contracts, whether governed by the UCC or common law.
   4. Only contracts where the parties explicitly include such a term.
2. Under UCC Article 2, "good faith" for a merchant requires:
   1. Honesty in fact only.
   2. Honesty in fact and the observance of reasonable commercial standards of fair dealing.
   3. Strict adherence to the contract's express terms, regardless of commercial standards.
   4. Subjective belief that one's actions are fair.
3. A party with discretionary power under a contract (e.g., a "satisfaction" clause) generally breaches the duty of good faith and fair dealing if they exercise that discretion:
   1. In any way that disadvantages the other party.
   2. To recapture opportunities forgone when entering the contract.
   3. Based on personal taste, even if honestly held.
   4. Reasonably and consistent with the contract's purpose.
4. Which of the following actions is most likely to constitute a breach of the implied covenant of good faith and fair dealing?
   1. Refusing to modify a contract term when the other party encounters unexpected difficulty.
   2. Insisting on strict performance of an express condition.
   3. Terminating an at-will employment contract for a stated, non-discriminatory reason.
   4. Deliberately hindering the other party's ability to perform their contractual duties.

Introduction

Beyond the express terms written into an agreement, contract law imposes certain implied obligations on the parties. One of the most significant is the implied covenant of good faith and fair dealing. This covenant is implied in nearly every contract and requires each party to exercise contractual rights and perform contractual duties in a way that does not unfairly deprive the other party of the benefit of the bargain.

Good faith and fair dealing operate mainly during the performance and enforcement of a contract, rather than during pre‑contract negotiations. Both the common law and the UCC recognize this covenant, though they define and apply it somewhat differently.

Key Term: Good Faith and Fair Dealing
An implied covenant in every contract requiring each party to perform and enforce the agreement honestly and fairly, to observe reasonable commercial standards where applicable, and not to act in a way that frustrates the other party’s reasonably expected benefits.

Key Term: Implied Covenant
A term supplied by law rather than by the parties’ express agreement, requiring good faith and fair dealing in the performance and enforcement of a contract.

A breach of the implied covenant is treated as a breach of contract, giving rise to standard contract remedies (expectation damages, and occasionally equitable relief). On the MBE, questions will often present conduct that does not blatantly violate an express clause but clearly seems “unfair” or “opportunistic.” The correct analysis usually runs through the implied duty of good faith rather than through doctrines like mistake or impracticability.

Several exam‑relevant points follow from that:

• The covenant is not a free‑floating fairness standard; it operates within the framework of the parties’ bargain.
• It does not require altruism. Parties can still act in their own economic self‑interest.
• It does prevent a party from using contractual rights as weapons to destroy the other party’s expected benefits or to reclaim opportunities relinquished when the contract was made.

Scope and Meaning of the Covenant

The covenant has two closely related components: good faith and fair dealing. Both are contextual. What counts as good faith in a sophisticated commercial sale between merchants may look different from good faith in a consumer transaction, but the core principles remain constant.

Good Faith under Common Law and the UCC

At a high level, “good faith” tracks honesty and legitimacy in the performance and enforcement of contractual obligations.

Key Term: Implied Covenant
A term supplied by law rather than by the parties’ express agreement, requiring good faith and fair dealing in the performance and enforcement of a contract.

• Common Law (services, real estate, most non‑goods contracts):

  • Good faith generally means honesty in fact in performing and enforcing duties.
  • Courts also use the concept to police:
    • Abuse of discretion (e.g., using a contractual option for a purpose totally outside the bargain)
    • Evasion of the spirit of the bargain (doing what the contract literally permits while undermining its purpose)
    • Opportunistic behavior that seeks to capture value the party clearly did not bargain for.

  Under common law, the covenant is often described as requiring parties to do nothing that will “destroy or injure the right of the other party to receive the fruits of the contract.” That language captures the idea that you may act in your own self‑interest, but you cannot strip the other side of the core benefit your deal contemplated.

  In practice, common law courts ask whether the disputed behavior is consistent with the parties’ reasonable expectations at the time of contracting, or instead reflects a post‑contract attempt to exploit gaps or technicalities.

• UCC Article 1 – General Definition:

  • For UCC contracts, good faith is defined as “honesty in fact and the observance of reasonable commercial standards of fair dealing.”
  • This adds an objective element—what honest parties, acting fairly in that commercial context, would do.

• UCC Article 2 – Merchants:

  • For merchants, UCC Article 2 reinforces this: a merchant must act with honesty in fact and must observe reasonable commercial standards of fair dealing in the trade.

Key Term: Merchant
A person who regularly deals in goods of the kind involved or otherwise holds themself out as having special knowledge or skill regarding the goods or practices involved in the transaction.

Key Term: Good Faith (UCC Merchant Standard)
For merchants under Article 2, good faith means honesty in fact combined with adherence to reasonable commercial standards of fair dealing in the relevant trade.

The merchant standard matters a lot in MBE fact patterns. A merchant cannot defend opportunistic conduct by claiming sincere belief that the conduct was acceptable if, in that trade, such conduct is regarded as unfair or sharp practice. The bar examiners often use trade usage or industry custom facts (e.g., “in that industry, suppliers never do X”) to signal what commercial standards of fair dealing require.

Two exam‑useful contrasts:

• Subjective honesty vs. objective fairness:
  • A non‑merchant’s good faith is mostly about subjective honesty.
  • A merchant’s good faith includes both subjective honesty and objective commercial reasonableness.
• Good faith vs. negligence:
  • A party can act in good faith yet be negligent (e.g., honestly but carelessly miscalculate a quantity). That is still a breach, but not necessarily a breach of the implied covenant.
  • The covenant is primarily about intentional or reckless misuse of contractual rights, not every careless performance error.

Fair Dealing and Cooperation

“Fair dealing” concerns how performance occurs:

• Parties must cooperate so that each can obtain the benefits they reasonably expected.
• A party may not:
  • Wrongfully hinder or prevent the other party’s performance, or
  • Exploit technicalities or discretionary powers to sabotage the other party’s rights.

Key Term: Hindrance
Conduct by one party that improperly interferes with or prevents the occurrence of a condition or the other party’s performance, often breaching the implied covenant.

Examples of lack of fair dealing include:

• Refusing to provide information or approvals that are plainly needed for the other side’s performance.
• Creating delays that make timely performance impossible and then claiming breach.
• Invoking minor or curable defects as a pretext to escape a contract you now regret.

Fair dealing does not turn parties into fiduciaries. Each may pursue their own interests, but cannot do so in a way that intentionally frustrates the contract’s purpose.

On the MBE, if one party’s conduct appears designed to manufacture a default or to avoid a payment coming due, think about the implied covenant—even if the party can cite some contract language in their favor.

Good Faith and “Sole Discretion” Language

Contracts often include phrases like:

• “in Seller’s sole discretion”
• “as Buyer deems appropriate”
• “on terms acceptable to Lender”

Students sometimes assume such language wipes out any limits. It does not. Even broad discretion must be exercised in good faith. That means:

• The decision‑maker can choose among outcomes within the range contemplated by the bargain, but
• Cannot use the clause as a pretext to recapture a better deal or punish the counterparty for unrelated reasons.

Exam tip: When you see “sole discretion” in a fact pattern, immediately ask:

• What range of outcomes did the parties reasonably contemplate?
• Is the party’s actual choice consistent with that range, or does it clearly serve some ulterior motive outside the contract’s purpose?

If the latter, the best answer will often invoke the implied covenant.

Where the Duty Applies (and Where It Does Not)

The implied covenant:

• Does apply to:

  • Performance of duties (e.g., supplying goods, paying money, making reasonable efforts)
  • Exercise of contractual discretion (e.g., quantity decisions, satisfaction determinations, termination options)
  • Enforcement of rights (e.g., acceleration, conditions, remedies, demands for adequate assurance)

• Does not generally apply to:

  • Pre‑contract negotiations (though other doctrines, like misrepresentation or promissory estoppel, might apply)
  • Attempts to override clear, unambiguous express terms; courts use the covenant to interpret and fill gaps, not to rewrite the deal.
  • Purely gratuitous, non‑contractual interactions between the parties.

On MBE questions, a common trap is an answer that uses “good faith” language to contradict a clear express provision. The covenant supplements and constrains discretion; it does not nullify the express bargain.

For example:

• If the contract clearly says “no refunds, for any reason,” a buyer’s appeal to fairness alone will not overcome that term.
• If the contract says “payment is due on the first of each month, without grace period,” a seller insisting on timely payment is not acting in bad faith simply because the buyer had a good excuse.

Similarly, parties cannot disclaim the covenant outright. A clause saying “there is no duty of good faith between the parties” would not be enforced. However, under the UCC the parties may agree on standards by which the performance of good faith is to be measured, so long as those standards are not manifestly unreasonable.

Express Terms vs. the Implied Covenant

Courts use the implied covenant to:

• Fill gaps where the contract is silent (e.g., open quantity, open price, “reasonable efforts”)
• Constrain discretionary language, such as:
  • “in Buyer’s sole discretion”
  • “to Seller’s satisfaction”
  • “requirements as needed”
  • “output as produced”
  • “may terminate at any time”

But the covenant cannot:

• Create obligations directly contrary to unambiguous express terms
• Require a party to renegotiate or modify a contract simply because performance becomes more burdensome than expected
• Convert a clearly at‑will arrangement into one terminable only for cause

A useful exam approach:

• Ask: Did the parties address this issue expressly?
  • If yes, the express term normally controls unless the exercising party is using it as a weapon for a purpose unrelated to the bargain.
  • If no, good faith often supplies a “default rule” (e.g., reasonable efforts, commercially reasonable price, reasonably proportionate quantity).

The bar exam often tests this boundary. If a party is simply insisting on a clear express right (no extension, no price change, strict condition) without more, that usually is not bad faith. But if the facts make clear that the insistence is a pretext to recapture a better deal or avoid an earned payment, the covenant is likely in play.

Interactions with Conditions, Waiver, and Estoppel

Good faith often overlaps with other doctrines:

• Conditions: A party who has some control over whether a condition occurs has an implied duty to make reasonable efforts and not to prevent the condition. Wrongful prevention both breaches the covenant and can excuse the condition.
• Waiver: If a party intentionally relinquishes a known right (e.g., repeatedly accepting late payments), later insisting on strict compliance may be limited by good faith and waiver doctrines.
• Estoppel: If one party’s conduct reasonably induces another to rely on a more lenient interpretation, good faith and estoppel may prevent a sudden about‑face that would be unfairly harmful.

On the MBE, however, answer choices invoking waiver or estoppel when the key fact is affirmative obstruction (e.g., not even applying for a required permit) usually yield to an answer focused on prevention plus breach of the implied covenant.

Application in Common Scenarios

The duty of good faith and fair dealing is most visible in situations where one party has discretion or where cooperation is needed. The examiners repeatedly test the same clusters of scenarios.

Requirements and Output Contracts (UCC § 2‑306)

In these UCC quantity contracts, dueling incentives create a clear need for good faith constraints.

Key Term: Requirements Contract
An agreement in which a buyer promises to purchase from the seller all the goods of a particular kind that the buyer requires during a specified period, and the seller agrees to supply those requirements.

Key Term: Output Contract
An agreement in which a seller promises to sell to the buyer all the goods of a particular kind that the seller produces during a specified period, and the buyer agrees to buy that entire output.

Under UCC § 2‑306:

• The stated quantity is “the actual output or requirements as may occur in good faith.”
• Neither party may demand or tender a quantity that is unreasonably disproportionate to:
  • Any stated estimate, or
  • Any prior actual output or requirements.

This provision addresses two risks:

• Buyer in a requirements contract might try to:

  • Dramatically cut requirements to buy cheaply elsewhere.
  • Dramatically increase requirements to resell at a profit, turning a requirements contract into a speculative arbitrage play.

• Seller in an output contract might try to:

  • Stop producing altogether to sell assets or chase a different, more lucrative business.
  • Greatly increase production beyond what the buyer reasonably contemplated.

Good faith here has bite:

• A buyer in a requirements contract may reduce requirements for legitimate business reasons, such as:

  • Product line discontinued because of poor sales.
  • Regulatory changes making the product noncompliant.
  • Business downturn significantly reducing overall demand.

• But a buyer may not slash requirements solely to:

  • Escape a bad fixed price because market prices have fallen.
  • Take advantage of a cheaper supplier while keeping the old contract “technically alive.”
  • Expand requirements to levels never contemplated just to profit from a favorable price.

Similarly, a seller in an output contract may reduce output if, for example, the business becomes genuinely unprofitable or the plant suffers a catastrophic failure. But the seller may not:

• Arbitrarily cease production simply to divert output to a different buyer at a higher price.
• Expand production far beyond normal levels solely to dump excess goods at a locked‑in high price.

When analyzing an MBE problem about requirements or output contracts, focus on:

• Past course of dealing (usual quantities).
• Whether the change is connected to real business developments (shutdown, decline in demand, change in product line).
• Whether the new quantity appears designed to exploit a price movement rather than to reflect actual needs or capabilities.

Also remember the “unreasonably disproportionate” limit. Even if a buyer’s demand is made in subjective good faith (e.g., “we sold far more than expected”), a demand wildly beyond the stated estimate or historical range can still be disallowed as unreasonably disproportionate.

Worked Example 1.1

Bakery entered into a written agreement with Flour Mill, under which Bakery agreed to purchase "all the organic whole wheat flour Bakery requires for its operations for the next 12 months" from Flour Mill at a fixed price per pound. For the first six months, Bakery ordered an average of 1,000 pounds per month. Market prices for organic flour then dropped significantly. Bakery, wanting to buy cheaper flour elsewhere, drastically reduced its operations for the next two months, ordering only 50 pounds per month from Flour Mill, while secretly purchasing large quantities of similar flour from another supplier for a slightly altered (but substantially similar) product line. Flour Mill sued Bakery. Did Bakery breach the implied covenant of good faith and fair dealing?

Answer:
Yes. This is a requirements contract. While Bakery can adjust its requirements, that discretion is bounded by good faith and UCC § 2‑306’s prohibition on unreasonably disproportionate changes. Here, Bakery’s dramatic drop in orders is not tied to genuine reductions in overall needs; it is tied to market price changes and secret purchases from others. That opportunistic behavior is bad faith and breaches the implied covenant.

Exam pointer: An answer choice saying “Buyer may reduce requirements in good faith for any business reason, including buying elsewhere more cheaply” would be wrong. The contract’s core promise is exclusivity of supply; buying elsewhere to undercut the agreed price is the very behavior § 2‑306 and the covenant forbid.

Exclusive Dealing and “Best Efforts” (UCC § 2‑306(2))

UCC § 2‑306(2) provides that an exclusive dealing agreement imposes an obligation on the seller to use best efforts to supply the goods and on the buyer to use best efforts to market and sell them. Even if the contract does not use the words “best efforts,” the UCC implies:

• A duty on the seller not to sabotage supply (e.g., by deliberately diverting production).
• A duty on the buyer not to sit on the product or to market a competitor’s goods instead, when the contract contemplates exclusivity.

Key Term: Best Efforts
A performance standard, implied in exclusive dealing arrangements, requiring active, diligent, and honest attempts to fulfill the contract’s objectives, judged in light of reasonable commercial practices in the trade.

Key Term: Exclusive Dealing Agreement
A contract giving one party the exclusive right to buy or sell certain goods in a defined territory or channel, triggering implied best‑efforts obligations under UCC § 2‑306(2).

Exclusive dealing comes up in:

• Franchise and distributorship arrangements.
• Agreements giving one party the sole right to sell within a territory.
• Manufacturer‑distributor relationships where the distributor has the exclusive right to carry the product.

Good faith here functions as a baseline performance standard when the contract grants latitude but expects genuine effort. Failure to make any real effort to market the goods, or deliberate steering of customers toward competing products, can be treated as a breach even if the contract does not specify a sales quota.

On an exam, be alert to answer choices that say “Because there was no minimum‑quantity term, the distributor had no duty to sell any of the manufacturer’s goods.” Under § 2‑306(2), that statement is incomplete; best efforts fill the quantity gap.

Satisfaction Clauses

Some contracts condition performance on a party’s “satisfaction.”

Key Term: Satisfaction Clause
A contract provision making a party’s duty to perform conditional on that party’s approval or satisfaction with the other party’s performance.

There are two main types:

• Objective satisfaction – applies where the subject is utility, mechanical fitness, commercial quality, or performance that can be measured against a standard.

  • Standard: Would a reasonable person be satisfied?
  • Dissatisfaction must be both genuine and reasonable in good faith.

• Subjective satisfaction – applies where the subject is aesthetics, personal taste, or artistic judgment.

  • Standard: Is the party actually satisfied?
  • Even here, dissatisfaction must be honest, not a pretext to avoid payment or escape the deal.

The implied covenant prevents a party from using a satisfaction clause to walk away for ulterior reasons (e.g., financial problems, buyer’s remorse) while pretending dissatisfaction. On exam questions, look for facts showing that the “dissatisfied” party privately admits some non‑aesthetic motive.

MBE trick: Where the contract uses general words like “satisfactory performance,” you may be asked whether the standard is objective or subjective. Tie it to the nature of what is being evaluated:

• Structural soundness, commercial quality, conformity to specs → objective.
• Portraits, custom jewelry design, musical performances → subjective.

Worked Example 1.2

Patron commissioned Artist to paint a portrait of Patron's prize‑winning poodle, Fluffy. The contract stated, "Patron's duty to pay the $5,000 fee is conditioned upon Patron's complete satisfaction with the final portrait." Artist completed the portrait, which art critics acclaimed as a masterpiece of canine portraiture. Patron, however, refused to pay, stating only, "I just don't like it. The ears aren't quite right." Evidence shows Patron recently suffered major investment losses and told a friend, "I can't afford that painting now, so I'll just say I don't like Fluffy's ears." Can Artist recover the$5,000 fee?

Answer:
Yes. Although the contract involves personal taste (subjective satisfaction), Patron’s dissatisfaction must be genuine. The evidence shows Patron is using the satisfaction clause as a pretext to avoid paying because of financial trouble, not because of honest artistic dissatisfaction. That is bad faith. Patron’s breach of the implied covenant excuses the satisfaction condition, and Patron is liable for the price.

Note how the covenant interacts with conditions: Patron’s wrongful prevention or manipulation of the condition (satisfaction) prevents him from relying on the condition’s nonoccurrence to avoid payment.

Discretion Over Conditions: Cooperation and Prevention

Contracts often make one party’s duty conditional on an event that the other party can influence (e.g., securing financing, obtaining permits, passing an inspection). The implied covenant requires reasonable efforts to cause the condition to occur and prohibits wrongful prevention.

Key Term: Condition Precedent
A contractual event that must occur before a party’s duty to perform becomes due. The implied covenant often requires reasonable efforts to bring about a condition within a party’s control.

Typical contexts:

• Financing contingencies in real estate or business sale contracts.
• Inspection or approval conditions (architect approvals, lender approvals).
• Third‑party consent conditions (landlord consent to assignment, shareholder approval).

If a party:

• Does not genuinely attempt to satisfy the condition, or
• Actively blocks it,

then the condition may be deemed excused, and that party is in breach. The prevention doctrine and the implied covenant work together: a party cannot rely on the nonoccurrence of a condition it wrongfully prevented.

Worked Example 1.3

Buyer agreed in writing to purchase Seller’s house for $250,000 “on condition that Buyer obtain mortgage financing within 30 days.” After 30 days, Buyer told Seller the financing condition had not been met and refused to close. When Seller asked where Buyer had applied for financing, Buyer replied, “I was busy and didn’t have time to seek mortgage financing.” Seller sues Buyer for breach. Has Buyer breached the implied covenant?

Answer:
Yes. The financing provision is a condition precedent largely within Buyer’s control. The implied covenant obligates Buyer to make reasonable, good‑faith efforts to obtain financing. Doing nothing and then invoking the failure of the condition is classic bad faith. The condition is treated as excused, and Buyer is in breach for refusing to close.

Exam tip: If the facts show Buyer applied to several lenders and was turned down for reasons beyond Buyer’s control, the appropriate conclusion is usually that the condition genuinely failed, not that Buyer breached good faith.

Hindrance and Failure to Cooperate

Even apart from express conditions, good faith requires parties not to make the other side’s performance unreasonably difficult.

Examples of hindrance:

• A buyer refuses to give delivery instructions, making on‑time shipment impossible.
• A landlord repeatedly denies reasonable access to a tenant’s contractor needed for build‑out.
• A party with contractual approval rights unreasonably delays review to pressure the other side into a concession.

In each case, the obstructing party is likely breaching the implied covenant by failing to cooperate as required for fair dealing.

Note the difference between:

• Insisting on contractually guaranteed protections in a timely way (usually permitted), and
• Using minor rights (e.g., approval of blueprints) to exert pressure unrelated to their intended function (potentially bad faith).

Termination, At‑Will Clauses, and Good Faith

Many contracts include termination clauses, sometimes granting one party broad power to end the relationship.

• At‑will employment or at‑will distributorships typically allow termination at any time, for almost any reason not prohibited by other law.
• The implied covenant does not ordinarily negate an at‑will term by requiring “good cause.”

However, even in at‑will settings, good faith may limit how termination is used, particularly where:

• One party terminates solely to avoid paying benefits or commissions that have already been effectively earned, or
• The parties’ course of dealing creates a clear expectation that commissions will be paid on transactions procured before termination.

Key Term: Discretionary Power
A contractually granted choice (e.g., to terminate, set terms, or approve performance) that must be exercised in good faith so as not to destroy the other party’s expected benefits.

A classic example is an employer who terminates a salesperson days before closing a major sale, solely to avoid paying a large commission that the salesperson’s work has already generated. Courts often treat this as a breach of the implied covenant, even though the termination was technically permitted.

Worked Example 1.4

CarCo hired Sam as a commissioned salesperson under a written agreement. Sam would earn a commission when customers took delivery of their cars. The contract also allowed either party to terminate the relationship “at any time, with or without cause.” In one month, Sam secured orders entitling him to $100,000 in commissions if the cars were delivered. Two days before the scheduled deliveries, CarCo terminated Sam’s employment and reassigned the deliveries to another salesperson, expressly to avoid paying Sam. Sam sues for his unpaid commissions. Does CarCo have a good defense based on the at‑will termination clause?

Answer:
No. Even though CarCo had a contractual right to terminate “at any time,” exercising that right solely to avoid paying commissions Sam had effectively earned violates the implied covenant. CarCo’s termination is in bad faith and constitutes a breach; Sam can recover the commissions.

On exam questions, be careful to distinguish:

• Termination before any benefit has accrued (typically okay).
• Termination after the other party has already substantially generated a benefit the terminating party seeks to keep without paying (often bad faith).

If CarCo had terminated Sam months earlier, when no sales were in the pipeline, the outcome would likely be different.

Open Terms and Good Faith Pricing

The UCC allows some contracts to omit a specific price term, leaving the price to be set later in good faith.

Common patterns:

• “Price to be fixed by Seller at time of shipment.”
• “Price is the seller’s list price in effect on the date of delivery.”
• “Price to be agreed upon by the parties.”

In such cases:

• If the contract says “price to be fixed by Seller,” good faith requires Seller to set a commercially reasonable price, not one designed to punish the buyer or capture an unbargained‑for windfall.
• If the parties’ market, trade usage, and prior dealings suggest a range, a price dramatically outside that range is potential evidence of bad faith.

Key Term: Commercially Reasonable
Consistent with reasonable commercial standards of fair dealing in the relevant trade, considering market conditions and the parties’ expectations.

If the parties are unable to agree on a price where the contract requires mutual agreement, and neither party is acting in bad faith, there may be no contract at all. But where one party has discretion to set the price, the implied covenant fills in what would otherwise be an unfair or arbitrary gap.

UCC Modifications and Good Faith

Under UCC § 2‑209, a modification to a contract for the sale of goods:

• Does not require new consideration, but
• Must be made in good faith.

Bad‑faith modifications include:

• Threatening to withhold performance unless the other party agrees to pay more, without any legitimate commercial reason (beyond “I want more money”).
• Exploiting the other party’s dire circumstances solely to extract a better deal.

This overlaps with economic duress. If a seller refuses to deliver unless the buyer agrees to a much higher price, in the absence of any real change in circumstances, the modification fails the UCC’s good‑faith requirement and may be unenforceable.

By contrast, if a seller’s costs genuinely and unforeseeably spike (e.g., an unexpected raw‑material shortage), and the seller negotiates a moderate price increase while being candid about the reason, the modification is more likely to be considered good faith.

Under common law, consideration is still generally required for modification, but good faith plays a role in determining whether a purported modification is enforceable (e.g., courts are less likely to enforce a modification extracted by threats or concealment).

Identifying Bad Faith on the MBE

On the exam, look for patterns rather than magic words. The facts will often give you clues such as:

• Pretextual behavior – a party asserts a contractual right (satisfaction, termination, condition) but the facts clearly show other motives (price changes, financial trouble, personal animus).
• Unreasonably disproportionate changes – drastic shifts in requirements, output, or price without genuine business justification.
• Failure to act where action is obviously expected – a party sits on its hands regarding a condition (financing, permits) and then claims the condition failed.
• Evasion of nearly completed benefits – termination or refusal to perform just as the other party is about to realize the core benefit (commissions, earn‑out payments, construction milestones).

At the same time, it is important to recognize conduct that may be harsh but still in good faith, such as:

• Insisting on strict compliance with clear express terms (price, deadlines, written approval).
• Refusing to voluntarily modify the contract when performance becomes more difficult.
• Making objectively reasonable decisions within the range the contract allows, even if those decisions favor the decision‑maker.

A simple exam framework:

• Identify the contractual source of discretion or power (requirements clause, satisfaction term, termination right, open price, condition).
• Ask what benefit the other party reasonably expected when agreeing to that term.
• Compare the actor’s behavior with those expectations and with normal commercial practice.
• If the behavior looks designed to recapture a lost opportunity or to inflict unnecessary harm unrelated to the bargain, consider a bad‑faith breach.

Comparing Good Faith to Other Doctrines

The implied covenant sometimes overlaps with, but is distinct from:

• Mistake: Usually concerns parties’ beliefs at formation. Good faith concerns performance and enforcement after formation.
• Impracticability / Frustration: Address extreme changes in circumstances that make performance or the contract’s purpose different from what the parties contemplated. Good faith assumes the contract remains in force but polices how parties behave within it.
• Unconscionability: Typically focuses on terms that are grossly unfair at the time of formation. The implied covenant addresses unfair conduct later.

When answer choices mix these doctrines, look at timing:

• Is the unfairness about a risk allocated at formation? Think mistake or unconscionability.
• Is the unfairness about how a party is exercising rights during performance? Think good faith and fair dealing.

Breach and Remedies

A violation of the implied covenant of good faith and fair dealing is a breach of contract. You do not need a separate “tort of bad faith” for MBE purposes (with the possible exception of specialized insurance contexts, which the MBE rarely emphasizes).

Key Term: Breach of the Implied Covenant
Conduct that, while not necessarily violating an express provision, frustrates the other party’s reasonable expectations by dishonest or unfair exercise of contractual rights or failure to cooperate, and is treated as a breach of contract.

Key points for remedies:

• Material vs. minor breach:

  • Severe bad‑faith conduct (e.g., preventing occurrence of a key condition, shutting down performance for opportunistic reasons, diverting requirements to another supplier) is likely a material breach, allowing the other party to:

    • Suspend their own performance.
    • Terminate the contract.
    • Seek full expectation damages.

  • Less severe bad faith (e.g., isolated unreasonable refusals, minor hindrances quickly cured) may be a partial breach, giving rise to damages but not discharging the other party’s duties.

• Damages:

  • Expectation damages are the primary remedy: put the non‑breaching party in the position they would have been in had both sides acted in good faith.

    • For example, the salesperson wrongfully terminated to avoid commissions should receive the commissions he would have earned.
    • A supplier harmed by a buyer’s bad‑faith reduction in requirements can recover lost profits on the quantity that should have been ordered in good faith.

  • Consequential damages may be available if they are reasonably foreseeable (e.g., lost resale profits from a seller’s bad‑faith withholding of conforming goods).

  • Under the UCC, a buyer may cover (purchase substitutes) and recover the difference between cover price and contract price plus consequential and incidental damages. A seller may recover lost profits as a lost‑volume seller if bad‑faith buyer conduct prevents expected sales.

  • Punitive damages are almost never available for breach of contract, including breach of the implied covenant, unless an independent tort is established under applicable state law. For MBE purposes, assume contract‑style damages (expectation, incidental, consequential) unless the problem expressly involves areas like insurance bad faith where tort remedies might appear.

• Equitable relief:

  • Specific performance or injunctive relief may be available where:
    • The subject is unique (e.g., real estate, rare goods), and
    • Damages are inadequate, especially if one party’s bad faith threatens irreparable harm.

  For example, a seller’s bad‑faith attempt to back out of a land sale contract in a rising market may justify specific performance.

Worked Example 1.5

Seller and Buyer enter into a contract for Buyer to purchase 10,000 units of a specialty component each quarter, with the price “to be set by Seller in good faith at its list price in effect at the time of shipment.” For several quarters, Seller’s list price is $10 per unit. When a shortage arises and demand spikes, Seller raises its list price to$500 per unit and insists that Buyer must pay the new price for the next quarter’s shipment, even though Seller continues selling to new customers at $12 per unit. Buyer refuses and sues for breach. Has Seller likely breached the implied covenant?

Answer:
Yes. The contract delegates price‑setting discretion to Seller, but explicitly requires good faith. A sudden jump from $10 to$500 per unit, while selling to others at $12, is not consistent with reasonable commercial standards of fair dealing and is clearly opportunistic. Seller’s conduct breaches the implied covenant and the UCC good‑faith requirement.

Here, “good faith” is doing real work. If the list price had increased modestly (e.g., from $10 to$12) due to a legitimate shortage, Seller’s conduct would likely pass muster. The dramatic increase, tied only to Buyer and not to the broader market, indicates an attempt to exploit the open price term beyond what the parties contemplated.

Worked Example 1.6

Contractor agrees to build a custom house for Owner. The contract provides that Owner “in Owner’s sole satisfaction” must approve the final landscaping before final payment. Contractor fully performs the agreed landscaping plan. Owner is thrilled with the yard but, after learning that real estate values have dropped sharply, refuses to pay the final installment, stating: “I’m just not satisfied with paying that much for a house now.” Contractor sues for the unpaid amount. How should the court rule?

Answer:
For Contractor. Even though the clause states “Owner’s sole satisfaction,” the implied covenant prevents Owner from using that discretion in bad faith. Owner’s dissatisfaction is clearly tied to falling market values, not to the landscaping itself. This is an improper attempt to avoid payment using a satisfaction clause, breaching the implied covenant.

Exam trap: An answer that states, “Because the contract says ‘sole satisfaction,’ Owner may withhold payment for any reason whatsoever” is too literal. The discretion is broad but not unlimited; good faith prevents using it to defeat the bargain for unrelated reasons.

Worked Example 1.7

Manufacturer and Distributor enter a written agreement giving Distributor the exclusive right to sell Manufacturer’s appliances in a three‑state region. The contract is silent on minimum sales levels. For the first year, Distributor actively markets the appliances and sales are strong. In year two, Distributor signs a separate exclusive deal with a competing manufacturer and quietly stops advertising Manufacturer’s appliances, directing customers to the competitor’s products instead. Manufacturer sues Distributor for breach. Distributor argues that it never promised to sell a particular quantity. How should a court rule?

Answer:
For Manufacturer. Even though the agreement does not specify sales quotas, UCC § 2‑306(2) implies a duty of “best efforts” in exclusive dealing contracts. Distributor’s decision to stop actively marketing Manufacturer’s appliances and to steer customers to a competitor is inconsistent with best efforts and violates the implied covenant of good faith and fair dealing. The absence of a quantity term does not excuse this conduct.

Worked Example 1.8

Retailer contracts with Supplier for the purchase of “all winter jackets Retailer requires for its chain of stores for the upcoming season” at a fixed price. Retailer initially projects that it will need 20,000 jackets and tells Supplier this estimate. After a fashion influencer makes the jackets popular, Retailer decides to double its stores’ orders and demands 60,000 jackets from Supplier to take advantage of the favorable contract price. Supplier can produce only 25,000 jackets without cancelling other commitments and refuses to deliver more than 25,000. Retailer sues for breach. Who prevails?

Answer:
Supplier. This is a requirements contract governed by UCC § 2‑306. Retailer may increase its requirements only in good faith and not in an amount unreasonably disproportionate to the stated estimate (20,000) or prior requirements. A jump to 60,000 jackets to exploit popularity and low fixed pricing, far beyond what was originally contemplated, is unreasonably disproportionate and inconsistent with good faith. Supplier is entitled to limit deliveries to a reasonable level and has not breached.

Worked Example 1.9

Software Company licenses its software to Client for a three‑year term. The contract states that either party may terminate the agreement “for any reason upon 30 days’ notice,” and that Client will pay a bonus if Software Company successfully completes a custom implementation scheduled to go live in six months. After five months of intensive work by Software Company, and one week before the planned go‑live date, Client gives notice of termination, stating that it wants to avoid paying the bonus and plans to hire a cheaper vendor to finish the last few steps. Software Company sues for the bonus. Is Client’s termination in breach of the implied covenant?

Answer:
Likely yes. While the contract permits termination for any reason on 30 days’ notice, the implied covenant of good faith limits how that discretionary power is exercised. Terminating solely to avoid paying a bonus that Software Company has effectively earned by substantially performing the implementation undermines Software Company’s expected benefit. A court would likely treat this as a bad‑faith termination and award the bonus or its equivalent expectation damages.

Worked Example 1.10

Owner contracts with Builder to construct a house. Builder’s obligation is conditioned on Owner obtaining architectural approval from a third‑party architect “satisfactory to Owner and Architect.” Owner never submits the plans to the architect despite repeated emails from Builder, because Owner is considering a different investment and is no longer sure she wants the house. At the end of the approval period, Owner states that the condition failed and therefore the contract is discharged. Builder sues for damages. What result?

Answer:
Builder should recover. The implied covenant requires Owner to make reasonable efforts to obtain the architect’s approval and not to hinder the occurrence of conditions within her control. Owner never even submitted the plans, thereby preventing the condition from occurring. The condition is excused by prevention, and Owner’s refusal to proceed is a breach of the implied covenant and the contract. Builder is entitled to damages based on the profits it would have earned.

These additional examples show how the covenant operates across different contract types: exclusive dealing, requirements contracts, discretionary termination, and architect‑approval conditions.

Key Point Checklist

This article has covered the following key knowledge points:

• The duty of good faith and fair dealing is implied in virtually all contracts, under both common law and the UCC.
• Under common law, good faith largely means honesty in fact and avoiding conduct that destroys the other party’s expected benefits.
• Under the UCC, especially for merchants, good faith adds an objective requirement: observance of reasonable commercial standards of fair dealing in the trade.
• Fair dealing requires cooperation and prohibits hindering the other party’s performance or the occurrence of conditions.
• The covenant constrains how parties exercise contractual discretion (requirements and output contracts, open price terms, satisfaction clauses, termination options, exclusive dealing).
• UCC § 2‑306 limits requirements and output variations to good‑faith levels that are not unreasonably disproportionate to estimates or prior history.
• Exclusive dealing agreements incorporate an implied “best efforts” obligation on both seller and buyer under UCC § 2‑306(2).
• Parties must make reasonable efforts to satisfy conditions within their control; they may not rely on unfulfilled conditions they made no genuine effort to fulfill.
• The covenant cannot be used to override clear express terms but fills gaps and polices abuse of contractual rights.
• Bad faith often appears as pretextual dissatisfaction, drastic unjustified changes in quantity or price, failure to cooperate, or opportunistic termination to avoid earned benefits.
• Breach of the implied covenant is treated as breach of contract, with expectation and possibly consequential damages, and occasionally equitable relief.
• On the MBE, recognizing when a party’s behavior is opportunistic or pretextual is central to spotting good‑faith issues.
• At‑will termination clauses are not absolute shields; they cannot be used solely to deprive the other party of benefits that are effectively earned under the contract.
• Open price and open terms are policed by good faith and commercial reasonableness; they cannot be used to impose arbitrary or punitive terms on the other party.
• UCC modifications do not require consideration but must be supported by a good‑faith commercial reason; purely coercive modifications are unenforceable.

Key Terms and Concepts

• Good Faith and Fair Dealing
• Implied Covenant
• Merchant
• Good Faith (UCC Merchant Standard)
• Hindrance
• Requirements Contract
• Output Contract
• Satisfaction Clause
• Condition Precedent
• Discretionary Power
• Commercially Reasonable
• Breach of the Implied Covenant
• Best Efforts
• Exclusive Dealing Agreement