Good Faith and Fair Dealing Developments-part I

• Publication year: 1998
• Pages: 115

27 Colo.Law. 115 Colorado Lawyer 1998.

1998, June, Pg. 115. Good Faith and Fair Dealing Developments-Part I

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115

Vol. 27, No. 6, Pg. 115

The Colorado Lawyer
June 1998
Vol. 27, No. 6 [Page 115]

Specialty Law Columns
Business Law Newsletter
Good Faith and Fair Dealing Developments-Part I
by E. Lee Reichert

Over the past two years, the Colorado Supreme Court has shown a marked interest in addressing "good faith and fair dealing" issues. Beginning with its 1996 decision in Amoco Oil Company v. Ervin,1 the Supreme Court has devoted substantial attention to such issues in nine opinions, a sizable percentage of its commercial litigation cases. This recent attention has not been limited to the Supreme Court In adopting the Colorado Uniform Partnership Act ("CUPA") in its 1997 session, the Colorado legislature statutorily codified an obligation of good faith and fair dealing

This two-part article addresses the recent Colorado developments in good faith and fair dealing. This Part I discusses the cases decided by the Supreme Court since 1996 and the implications for business attorneys. Part II of this article, which will be published in the July issue, focuses on the obligation of good faith and fair dealing in CUPA and highlights the drafting issues Colorado attorneys now face

To appreciate good faith and fair dealing issues fully, it is necessary to understand the recent development of the doctrine in both tort and contract cases. While the Supreme Court has provided rough contours to the doctrine, this article points out a number of issues that remain unanswered, particularly in the contractual area. The resulting uncertainties create constraints that later may be placed on performance under agreements. Hence, transactional attorneys need to be familiar with these issues in negotiating and drafting contracts, and in advising their clients.

Overlap of Tort and Contract Theories

The law governing good faith and fair dealing has long been confusing in many jurisdictions, and the precise treatment of good faith and fair dealing issues varies significantly from state to state. The confusion has arisen in large part from the blurring of the distinctions between tort and contract theories. Of course, the determination of whether a tort or contract action is involved is critical because it affects the measure and availability of certain damages (for example, punitive damages), statutes of limitations, and other procedural requirements. While Colorado courts have attempted to differentiate between tort and contract theories in a number of cases, their varying degree of success has led to requests for judicial clarification of the overlapping theories.2

Language in the opinions compounds the problem, particularly the constant interchanging of the terms "covenant" and "duty." To add further confusion, § 7-64-404(3) of CUPA uses the term "obligation of good faith and fair dealing," while § 4-1-203 of Colorado's Uniform Commercial Code ("UCC") simply uses the phrase "obligation of good faith."3 [Emphasis added.]

In an attempt to create some level of consistency, this article uses the term "duty of good faith and fair dealing" when dealing with tort issues. As discussed below, in certain circumstances, Colorado law imposes a legal duty on a party, which, if breached, leads to tort liability.

On the other hand, this article uses the term "covenant of good faith and fair dealing" when dealing with contract issues. The law implies a mutual covenant of good faith and fair dealing with respect to certain obligations in certain contracts. The implied covenant does not create an independent cause of action for breach of contract, but is a principle of contract interpretation that is applied by courts to an express contract term as a gap-filling device. In addition, as discussed below, parties may agree to an express covenant of good faith or fair dealing which, if breached, will result in an ordinary breach of contract action. While the distinction between "duties" and "covenants" may appear overly simplistic, consistent use of such terminology could alleviate some of the confusing overlap in judicial opinions between contract and tort theories.

Recognition of Tort Duty

The overlap of tort and contract theories is particularly noticeable in the insurance context. In large part, the overlap exists because the contractual relationship creates the insurers' tort duty recognized in Colorado (and in the majority of other jurisdictions). As a result, the Supreme Court occasionally discusses the contours of an insurer's tort duty by reference to the underlying insurance contract.

In Farmers Group, Inc. v. Trimble,4 the Supreme Court first addressed the distinction between contractual and tort theories of good faith and fair dealing in the insurance coverage context. In imposing a good faith legal duty on an insurer, the Trimble court focused on the different nature of contract and tort remedies and the "special nature of the insurance contract and the relationship that exists between the insurer and insured." As a result of the "quasi-fiduciary" relationship that arose from the underlying insurance contract, the Supreme Court concluded that an insured could assert a separate and additional tort cause of action apart from a contract action.

In Traveler's Insurance Company v. Savio,5 the Supreme Court extended Trimble's basic rationale to permit tort actions where an insurer allegedly handled a workers' compensation claim in bad faith. The Savio court noted that the duty of good faith and fair dealing "permeates all of the dealings between the insurer and the insured." Following these two decisions, the Colorado legislature has recognized the duty of good faith and fair dealing for insurers.6

Recent Tort Decisions

Following the Trimble/Savio insurance cases, Colorado litigants have attempted to extend the doctrine by analogizing different relationships to the insurance context. Previously, the Colorado Court of Appeals has shown a strong predisposition to reject such efforts, refusing on a number of occasions to recognize or create new tort causes of action.7 In the past year, the Supreme Court has addressed both the continuing viability of the Trimble/Savio doctrine, and its extension to other areas.

Continuing Viability of a Common Law Tort Action

Last fall, in Vaughn v. McMinn,8 the Supreme Court concluded that its Savio decision had not been abrogated by subsequent legislative changes to Colorado's workers' compensation statutes. In doing so, the Supreme Court stressed that the legislative changes following Savio did not explicitly bar the common law tort action for breach of an insurer's duty of good faith and fair dealing.

Expansion of Common Law Tort Action

On two separate and recent occasions, the Supreme Court also addressed whether the Trimble/Savio doctrine should be extended or expanded. As discussed below, the majority and dissenting opinions in these cases suggest factors that Colorado appellate courts likely will apply to determine whether a tort duty of good faith and fair dealing applies to other relationships.

In Transamerica Premier Insurance Company v. Brighton School District 27J,9 the Supreme Court considered whether the Trimble/Savio doctrine should be extended to commercial sureties. The Supreme Court concluded (over a vigorous dissent) that it was proper to impose a legal duty of good faith and fair dealing on a commercial surety, thereby allowing a tort action to proceed.

In finding a special relationship sufficient to support the legal duty, the majority opinion considered: (1) the purposes of commercial sureties and insurers; (2) the legislative statutes governing commercial sureties; (3) the nature of the relationship between commercial sureties and obligors; (4) case law from other jurisdictions; and (5) the sufficiency of contract damages. In contrast, the dissenting opinion found essential differences between the surety/obligee relationship and the insured/insurer relationship. The dissent did not find a tort duty because none of the considerations underlying the special relationship in the insured/insurer context (such as quasi-fiduciary obligations, protection against unforeseeable loss, and unequal bargaining power) existed in the suretyship context.

"While the Supreme Court
has provided rough contours
to the doctrine, a number
of issues remain
unanswered, particularly in
the contractual area."

Conversely, in Decker v. Browning-Ferris Industries (Thomas Decker),10 the Supreme Court refused to extend the Trimble/Savio doctrine to the...