Chapter 8 - § 8.3 • ELEMENTS DEFINED

• Jurisdiction: Colorado

§ 8.3 • ELEMENTS DEFINED

§ 8.3.1—Existence of a Contract

The duty of good faith and fair dealing is an implied contractual term. Accordingly, there must be a valid contract between the parties for a claim to arise.⁷ Bad faith refusal to enter into a contract, for example, does not constitute a breach of the implied duty of good faith and fair dealing.⁸

§ 8.3.2—Defendant Had Discretion in Performance

"The duty of good faith and fair dealing applies when one party has discretionary authority to determine certain terms of the contract, such as quantity, price, or time."⁹ Determining whether the contractual term in question creates discretion is central to bringing or defending a claim for breach of the implied duty. "Discretion occurs when the parties, at formation, defer a decision regarding performance terms of the contract."¹⁰

The leading case of Amoco Oil Co. v. Ervin¹¹ is instructive to understand what sorts of contractual discretion give rise to an implied duty of good faith and fair dealing. Amoco Oil Company, a nationwide manufacturer and marketer of petroleum products, used two distribution channels: it owned some gas stations, and it also owned land that it leased to independent service station dealers to operate Amoco stations. Amoco's lease agreements with the independent dealers permitted Amoco to adjust the monthly rent due to Amoco. These open rental terms meant the dealers had to rely upon Amoco's good faith in setting the rent. The jury found that, by double-charging for an item in the rent calculation, Amoco violated the dealers' justified expectations, and thus breached the implied duty of good faith and fair dealing. The Colorado Supreme Court affirmed.

Discretion is present in many contractual provisions insofar as they permit, but do not necessarily require, certain actions. Certain contract terms — such as price, quantity, or time — clearly give rise to the duty of good faith and fair dealing if they are left open for one party to determine. Other contract terms are less clear, and it is not always predictable whether a court will determine that the duty of good faith and fair dealing is implicated. For example, one court held that an at-will termination provision in a management services contract was not a "performance term" that was "subject . . . to the duty of good faith and fair dealing."¹² In another case, a court found that a contract term requiring a condominium association to submit a purchase and sale contract to unit owners for ratification conferred sufficient discretion upon the association to invoke the implied duty of good faith and fair dealing.¹³ It is not clear from these decisions why discretion to terminate a contract was not sufficient to invoke the implied duty, but the discretion to submit a contract for ratification was.

There is some support for concluding that the discretion granted by the contract must be explicit, rather than implicit. For example, when mortgage documents give the lender the option to foreclose in the event of default, the lender cannot breach the duty of good faith and fair dealing when it does foreclose.¹⁴ But some courts have found discretion sufficient to invoke the implied duty of good faith and fair dealing even when no specific term of the contract is implicated. For example, a contract that did "not materially describe the relative obligations" of the parties nevertheless contained an implied duty of good faith and fair dealing that could be violated because industry practice indicated that the contractor for a highway construction project had discretion about when to begin blasting operations.¹⁵

Practice Pointer
Whether a contract term at issue grants discretion is often the key element for a defendant on summary judgment. Courts can determine whether the contract grants discretion as a matter of law. But if the court finds that the contract term does grant the party discretion, it will be difficult to obtain summary judgment because whether the defendant acted in good faith when exercising its discretion is a question of fact.¹⁶

Finally, the duty of good faith and fair dealing also applies to the enforcement of contracts, though this is infrequently litigated.¹⁷ For example, when a contract gives a seller a right to cure, the buyer breaches the duty of good faith and fair dealing if he or she forecloses the seller's right to cure and then asserts a breach of warranty claim.¹⁸

In dicta, courts...