Summer 2010-#6. Vermont's Implied Covenant of Good Faith and Fair Dealing in Commercial Contracts.

Authorby W. Scott Fewell, Esq.

Vermont Bar Journal


Summer 2010-#6.

Vermont's Implied Covenant of Good Faith and Fair Dealing in Commercial Contracts

THE VERMONT BAR JOURNALVolume 36, No. 2Summer 2010Vermont's Implied Covenant of Good Faith and Fair Dealing in Commercial Contractsby W. Scott Fewell, Esq.Vermont law imposes a duty of good faith and fair dealing ("implied covenant" or "good faith") on all contracts. As explained in Shaw v. DuPont(fn1) the crux of the duty is that neither party to a contract may do anything to interfere with the other party's right to enjoy the benefit of the contract. While a claim for breach of contract addresses the breaking of express promises and obligations, a claim for breach of the covenant of good faith and fair dealing addresses the breaking of the implicit promises that make the contract possible in the first place.(fn2) The implied covenant claim, as applied in Vermont, is nothing short of a moral litmus test for what constitutes socially acceptable conduct between contracting parties and is intended to prevent any dichotomy between the spirit and letter of the agreement.

Since Shaw, the implied covenant has undergone a rather striking evolution. Initially treated as a mere aid in interpreting existing contract terms, the implied covenant has been transformed by the Vermont Supreme Court into a derivative but distinct tort action requiring an independent factual basis from that supporting a breach of contract action. The protections afforded by the implied covenant have been extended to a variety of contractual relationships, including employment and insurance law. However, the duties imposed in one substantive area of law does not neatly apply to other contractual relationships.

Contracting parties who are ignorant of their obligation of good faith under Vermont law run the risk of incurring liability for conduct that arguably does not violate their contractual obligations. A clear understanding of the duties imposed by the implied covenant is necessary to avoid breach of the duty and also to avoid super imposing obligations on contracting parties in the name of good faith that are not required. For the commercial litigator, the breach of implied covenant claim is an indispensible cause of action greatly expanding the scope of relevant evidence available for trial and increasing available damages to the non-breaching party.

This article surveys the current status of good faith as it is applied to arms-length commercial transactions in Vermont, and offers practical insight into the pleading, prosecuting, and defending of good faith claims.(fn3) In sum, Vermont has created a unique cause of action that provides litigants with an opportunity to expand available damages in a contract dispute, and further creates an opportunity to introduce evidence that would otherwise be excluded in an ordinary breach of contract case.

Contractual Good Faith in Vermont Jurisprudence

The concept of good faith as applied to contracts has existed in American jurisprudence for nearly two centuries and purportedly derives its origins from the Latin legal maxim pecta sunt servanda, or the "obligation to keep agreements."(fn4) Sinceits early formulation, the concept has been applied to a variety of contractual relationships, including insurance, employment, and arms-length commercial agreements. Both the Uniform Commercial Code and the Restatement (Second) of Contracts contain requirements for good faith performance of contracts, although their respective approaches differ.(fn5)

In Vermont, the idea of contractual good faith emerged during the early nineteenth century, but did not become well-established until the middle of the twentieth century.(fn6) The modern formulation of this duty, first articulated in Shaw, is that good faith attaches to all contracts as a matter of law and requires that the contracting parties do nothing to destroy the rights of the other party to receive the benefit of the bargain.(fn7)

In the 1994 decision in Carmichael v. Adirondack Bottled Gas of America, the Supreme Court adopted the Second Restatement's formulation of the implied covenant.(fn8) Section 205 of the Second Restatement imposes a duty of good faith and fair dealing in the performance and enforcement of contracts, but not in contract formation.(fn9) Under the Second Restatement, "good faith performance or enforcement" requires that the parties adhere to an agreed-upon common purpose consistent with the justified expectations of the parties.(fn10)

The Second Restatement adopts the socalled "excluder" concept of good faith, advocated by Professor Robert S. Summers, which defines the contours of good faith by its opposite corollary bad faith, and is expressly concerned with the enforcement of fairness, justice, and community standards in the commercial area.(fn11) The excluder approach permits the courts to develop the outer boundaries of the duty based on the particular contract, transaction, and applicable community standards. However, this "negative" approach, while having the benefit of flexibility, provides little guidance as to what constitutes goodfaith performance and enforcement and creates unnecessary uncertainty.

In addition to adopting the Second Restatement approach, the Supreme Court has further tailored good faith claims in ways not required under the Second Restatement's approach. First, the Court has construed good faith as a tort under the rationale that the obligation of good faith is imposed on contracting parties as a matter of public policy rather than arising from the agreement of the parties.(fn12) Second, the Court permits good faith to be pled as a separate and distinct claim from breach of contract provided the claim has a distinct factual predicate.(fn13) These modifications have created a relatively unique cause of action in Vermont.

The Development and Application of the Implied Covenant in Vermont Case Law

The Vermont Supreme Court has used the implied covenant in a number of different commercial contexts. In Shaw, the Supreme Court used the implied covenant in a licensing dispute to infer missing terms that were "necessarily implied" from the expressed terms.(fn14) The Court observed that the "implication that the defendant is not to exceed the limits of his license an inference which follows from the language of the parties and becomes spelled out in explicit terms."(fn15) As such, the Court appeared to use the implied covenant as an aid in interpreting the terms of the contract, and little more.

However, in Sullivan v. Lochearn, Inc., the Court applied the implied covenant to course of dealing conduct. In Sullivan, the Court examined the parties' course of dealing and inferred the absence of a contractual right to unilaterally terminate a contract, even though the contract was silent on this issue.(fn16) In Carmichael v. Adirondack, the Supreme Court relied upon the implied covenant to infer obligation arising from the parties' obligations in winding down the contract. The Court observed that the course of dealings between the parties in the winding down of the contract created obligations that, while not expressly stated, were enforceable when breached.(fn17) Thus, the Court reaffirmed that course of dealing can create expectations that, while not contractual, nonetheless create obligations of good faith based on the expectations of the parties.

The Supreme Court has also applied the implied covenant to situations in which one of the contracting parties has interfered with the ability of a party to perform its part of the contract. In Carter v. SherburneCorp., the Court applied the implied covenant to prevent a contracting party from obstructing contractual performance and then seeking damages for the...

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