The debate between shareholder primacy and stakeholder theory concerns the legal obligations of corporate directors. Introduction A corporation is never just a machine for making money. It is a legal institution, a social system, and a vehicle for allocating power, risk, and responsibility. That is why one of the most important debates in corporate governance continues to divide scholars, executives, regulators, and investors: should corporations exist primarily to maximize shareholder value, or should they balance the interests of all the people and institutions affected by their actions? This debate is commonly framed as shareholder primacy vs. stakeholder theory. Shareholder primacy says the corporation's central obligation is to its owners, the shareholders. Stakeholder theory says the corporation owes duties to a wider circle of affected parties, including employees, customers, suppliers, creditors, communities, and sometimes society at large. This is not a purely academ...
The implied covenant of good faith and fair dealing requires parties to exercise contractual rights consistently with the bargain they made. This article examines its legal foundations across jurisdictions, its scope in commercial contracts, and the limits that preserve freedom of contract.
By Kateule Sydney - Researcher and Writer | Last Fact-Checked: 2026-10-14 | Published by Kat-Syd Resources Hub
The implied covenant of good faith and fair dealing is best understood as a narrow doctrine of contractual fidelity. Used carefully, it can curb opportunism and protect the integrity of agreements; used broadly, it can create uncertainty and invite judicial overreach.
Table of Contents
- 1. Introduction
- 2. Defining the Implied Covenant
- 3. Legal Foundations and Jurisdictional Variation
- 4. Scope of the Covenant in Commercial Contracts
- 5. Limits of the Covenant
- 6. Gap-Filling and Incomplete Contracts
- 7. Opportunism and Commercial Relationships
- 8. Uncertainty and the Risk of Overreach
- 9. Freedom of Contract
- 10. Comparative Perspective
- 11. Conclusion
- 12. References
1. Introduction
Commercial contracts are central to economic activity because they allocate risk, define obligations, and give legal form to business relationships. Yet even carefully drafted agreements cannot anticipate every contingency. Ambiguity, silence, and unforeseen developments can create room for conduct that exploits the letter of a contract while undermining its practical purpose.
The implied covenant of good faith and fair dealing addresses that problem, but only within limits that vary by jurisdiction. In its most defensible formulation, the covenant requires parties to exercise contractual rights and perform contractual duties in a manner consistent with the bargain they made and the legitimate expectations the bargain creates. It is not a general requirement of altruism, nor is it a license for courts to rewrite commercial agreements in the name of fairness.
This article argues that the covenant is best understood as a narrow but important doctrine of contractual fidelity. Used carefully, it can curb opportunism, protect the integrity of agreements, and support commercial reliability. Used broadly, it can create uncertainty and invite courts to substitute their own sense of fairness for the parties' negotiated terms. The central question is therefore not whether good faith belongs in contract law, but how far it should extend.
2. Defining the Implied Covenant
The implied covenant of good faith and fair dealing is a doctrine that limits how parties may exercise contractual rights and perform contractual obligations. Its core idea is that neither party should take deliberate advantage of an omission, ambiguity, or discretionary power in a way that destroys the value of the agreement for the other party.
That said, good faith does not mean the same thing in every legal system. In some jurisdictions, it operates as a general implied duty in contract performance and enforcement. In others, it appears more selectively, through express terms, implication in fact, or specific doctrinal categories. Its content may include honesty, cooperation, fidelity to the bargain, or restraints on arbitrary discretion, but the exact formulation depends on the governing law.
The important distinction is between a doctrine that polices abuse of the contractual relationship and one that imposes broad external standards of fairness. The former is widely defensible; the latter is much harder to justify in commercial law.
3. Legal Foundations and Jurisdictional Variation
United States
In the United States, the implied covenant is widely recognized in contract law. Section 205 of the Restatement (Second) of Contracts provides that every contract imposes upon each party a duty of good faith and fair dealing in its performance and enforcement. The Uniform Commercial Code also imposes an obligation of good faith in contracts within its scope, and defines good faith for merchants in terms that include honesty and observance of reasonable commercial standards in the relevant context.
These authorities support the proposition that American contract law does not treat contractual performance as a purely literal exercise. They do not, however, eliminate all limits. Courts commonly refuse to use the covenant to contradict express terms or create obligations that the parties did not undertake.
England and Wales
English law is more cautious. It does not generally recognize a universal implied duty of good faith across all commercial contracts in the same way that American doctrine does. Instead, English courts have been willing in some settings to imply duties of good faith or to recognize that the nature of a particular contract may justify such an obligation.
The decision in Yam Seng Pte Ltd v International Trade Corporation Ltd is often cited for the proposition that honesty and fidelity to the bargain may be relevant in certain commercial relationships. Later cases, including Bates v Post Office Ltd (No 3), have discussed good faith in the context of relational contracts. These authorities support a contextual approach rather than a general rule that every commercial contract contains the same implied duty.
The defensible conclusion is therefore narrower than some commentary suggests: English law permits good faith in appropriate cases, but it does not establish a blanket doctrine applicable to all commercial agreements.
International Commercial Instruments
International instruments also recognize the importance of good faith, though in different ways. Article 7(1) of the United Nations Convention on Contracts for the International Sale of Goods refers to good faith as a consideration in interpreting the Convention. The UNIDROIT Principles of International Commercial Contracts go further, stating in Article 1.7 that each party must act in accordance with good faith and fair dealing in international trade.
These instruments show that good faith is a serious concept in international commercial law. They do not, however, collapse the differences between interpretation, direct obligation, and remedy. The scope of the duty still depends on the legal instrument and the forum applying it.
4. Scope of the Covenant in Commercial Contracts
Performance of Contractual Duties
One of the covenant's clearest functions is to restrain conduct that deliberately undermines performance. A party may breach a contract without acting in bad faith, and bad faith may exist even when the contract is not formally breached in an obvious way. The relevant question is whether the party used the contract in a manner that frustrated the agreement's purpose or deprived the other party of a benefit the bargain reasonably promised.
For that reason, the covenant is best understood as regulating manner and purpose, not guaranteeing success or equal outcomes. A supplier's genuine operational failure is not the same as deliberate obstruction. The former may be ordinary breach or unavoidable nonperformance; the latter can raise a good-faith issue because it involves abuse of the contractual relationship.
Discretionary Powers
Commercial contracts often give one party discretion to approve, determine, adjust, or assess. Such discretion is useful because it allows the agreement to operate flexibly in changing conditions. But discretion also creates opportunities for abuse if it is exercised for a purpose inconsistent with the contract.
The covenant is therefore especially relevant where one party controls a decision that affects the other party's entitlement. A court may legitimately ask whether the discretion was exercised honestly, rationally within the contractual framework, and for a proper contractual purpose. It should be much more cautious about replacing the contractually empowered party's business judgment with its own.
This is a central boundary point: the covenant can limit abuse of discretion, but it does not entitle courts to conduct a general review of commercial wisdom.
Prevention of Contractual Benefits
Good faith also has force where one party controls whether the other can obtain a contractual benefit. If a party deliberately prevents a condition from being satisfied in order to avoid paying a bonus or to defeat an entitlement, that conduct may properly be characterized as inconsistent with the bargain.
This is not the same as saying that every disappointed expectation amounts to bad faith. The stronger and more defensible claim is narrower: where one party intentionally manipulates the operation of the contract to prevent the other from receiving an agreed benefit, the covenant may supply an answer that literal reading alone would miss.
Cooperation and Information Sharing
Some business relationships require ongoing cooperation, communication, and practical coordination. Joint ventures, franchises, distribution agreements, and long-term supply contracts often depend on conduct that is not fully specified in advance.
In such settings, good faith may support limited duties of cooperation or disclosure where those duties are justified by the structure of the agreement. But it does not follow that a party must reveal all commercially relevant information or subordinate its own interests to the other side. The legal question is contextual: what level of cooperation is required to make the bargain work as intended?
5. Limits of the Covenant
Express Terms Remain Primary
The starting point in any contract dispute is the contract itself. Where the parties have expressly allocated risk or defined a relevant power, an implied covenant should normally complement that allocation rather than override it.
If a contract clearly permits termination on notice, good faith should not be used to eliminate that right merely because the result is commercially harsh. A court may ask whether the right was exercised dishonestly or for a purpose that contradicts the bargain, but it should not use the covenant to impose a different deal.
This limit is essential to preserving contractual certainty.
No General Duty to Prefer the Other Party's Interests
Good faith does not ordinarily require a party to act against its own commercial interests. Businesses enter contracts to pursue profit, manage risk, and allocate resources efficiently. A party may lawfully insist on its rights, refuse to confer additional concessions, or decline to renew a contract where it has that contractual freedom.
The covenant is therefore not equivalent to fiduciary loyalty. It is a narrower doctrine that polices abuse of the agreement, not ordinary self-interest.
The Need for a Legal Basis
A court should identify the legal basis for any implied duty before enforcing it. The source may be statute, an express clause, a term implied in law, or a term implied in fact under the relevant test. The doctrinal basis matters because different routes justify different levels of judicial intervention.
This point is especially important in jurisdictions such as England and Wales, where implication in fact is demanding and context-specific. A contract's commercial importance or long duration does not, by itself, justify imposing a broad good-faith duty.
Judicial Restraint
The covenant should not become a tool for correcting all perceived imbalance in bargaining power or every outcome that later seems unfavorable. Commercial parties often accept asymmetrical risks in exchange for price, certainty, or strategic advantage. Courts should be slow to disturb those choices absent a defensible legal basis.
The proper function of good faith is to protect the integrity of the agreed exchange, not to guarantee that the exchange remains equally beneficial over time.
6. Gap-Filling and Incomplete Contracts
One of the strongest reasons to preserve the implied covenant is that no contract can anticipate every future development. Incomplete drafting is not necessarily a failure of legal craftsmanship; it is often an inevitable feature of commercial life.
The covenant can help address genuine gaps where the parties' express terms leave room for opportunistic conduct. It may also provide a principled basis for resolving disputes in long-term relationships where the practical operation of the contract depends on cooperation that was assumed rather than exhaustively specified.
That said, gap-filling must not be confused with rewriting. Courts should first interpret the express agreement as a whole. Only then, and only where the governing law permits, should they consider whether an implied obligation is necessary to make the contract function coherently.
7. Opportunism and Commercial Relationships
The best case for good faith is that it discourages opportunism. Opportunism arises when a party uses its position under the contract to capture value in a way that defeats the bargain's intended operation.
This concern is especially acute in relationships involving sunk investments, repeated interaction, or one party's control over essential information or approvals. A party that has made relationship-specific investment is vulnerable to being exploited once it becomes dependent. Good faith can help reduce that risk by limiting manipulative conduct that takes advantage of the other side's dependence.
At the same time, opportunism is not the same as hard bargaining. Commercial actors are entitled to negotiate aggressively, insist on legal rights, and protect their own position. The challenge is to distinguish legitimate self-interest from conduct that uses the contract itself as an instrument of unfair surprise or strategic exploitation.
8. Uncertainty and the Risk of Overreach
The principal objection to the covenant is that it can be difficult to define with precision. Depending on the jurisdiction, it may refer to honesty, reasonableness, fidelity to the bargain, or the proper exercise of discretion. Those ideas overlap, but they are not identical.
That flexibility can be useful, but it also creates uncertainty. Parties may not know in advance whether a particular decision will later be characterized as bad faith, especially when broad discretion is involved. The result can be more litigation, more cautious drafting, and higher transaction costs.
There is also a broader institutional concern: if courts treat good faith as a general invitation to correct unfair results, they may end up revising contracts rather than enforcing them. That risk is real, but it should not be overstated. Contract interpretation itself often requires context-sensitive judgment. The issue is not whether judgment is involved, but whether it remains tied to the contract's text, purpose, and structure.
9. Freedom of Contract
Freedom of contract and good faith are often presented as opposing principles, but they need not be. Freedom of contract protects the parties' authority to make their own bargain. Good faith protects the bargain from being hollowed out by conduct that undermines its operation.
The strongest criticism of the covenant is that it may interfere with express terms and reduce predictability. That criticism has force when courts use good faith to override a clear allocation of risk. It is less persuasive when the covenant is used to prevent a party from exploiting discretion, manipulating conditions, or frustrating the bargain's expected performance.
The most defensible position is therefore a limited one: good faith should operate as a principle of contractual fidelity, not as a general judicial power to redesign commercial outcomes. In that form, it can support rather than displace contractual autonomy.
10. Comparative Perspective
Comparative law shows that there is no single model of good faith. The United States tends to recognize a more general implied covenant, though its application is jurisdiction-specific. English law is more cautious and context-driven. International instruments recognize good faith explicitly, but do so in different doctrinal forms and with different legal effects.
The lesson is not that one system is simply right and another wrong. Rather, the debate turns on institutional design: how much flexibility a legal system should allow, how much certainty commercial parties need, and how courts should distinguish interpretation from revision.
A useful comparative conclusion is that good faith is most defensible when it responds to identifiable contractual abuse and least defensible when it becomes a free-standing standard of general fairness.
11. Conclusion
The implied covenant of good faith and fair dealing occupies an important but limited place in commercial contract law. Its strongest justification is practical: contracts are incomplete, business relationships are dynamic, and literal enforcement alone may not always prevent one party from exploiting the other in ways that defeat the agreement's purpose.
Used carefully, the covenant can protect the integrity of the bargain, reduce opportunism, and support confidence in long-term commercial relationships. Used expansively, it can create uncertainty, invite judicial overreach, and weaken the predictability that makes contract law useful in the first place.
The best position is therefore neither to treat good faith as a universal license for fairness review nor to deny it any meaningful role. It should be applied where the governing law supports it and where the facts show that a party has used contractual rights in a way that undermines the bargain itself. That approach preserves commercial autonomy while recognizing that contractual fidelity sometimes requires more than literal compliance.
12. References
Primary and Institutional Authorities
- Restatement (Second) of Contracts, Section 205 (American Law Institute, 1981).
- Uniform Commercial Code, Section 1-304.
- Uniform Commercial Code, Section 2-103(1)(b).
- United Nations Convention on Contracts for the International Sale of Goods, Article 7(1) (1980).
- UNIDROIT, Principles of International Commercial Contracts, Article 1.7 (2016).
Cases
- Yam Seng Pte Ltd v International Trade Corporation Ltd [2013] EWHC 111 (QB).
- Bates v Post Office Ltd (No 3) [2019] EWHC 606 (QB).
Secondary Reading
- Ewan McKendrick, Contract Law: Text, Cases, and Materials (Oxford University Press, latest available edition).
- Steven J. Burton, Breach of Contract and the Common Law Duty to Perform in Good Faith, 94 Harvard Law Review 369 (1980).
- Robert S. Summers, Good Faith in General Contract Law and the Sales Provisions of the Uniform Commercial Code, 54 Virginia Law Review 195 (1968).
- Emily M.S. Houh, The Doctrine of Good Faith in Contract Law: A (Nearly) Empty Vessel? 10 University of Colorado Law Review 1 (2004).
- Roger Brownsword, Contract Law: Themes for the Twenty-First Century (Oxford University Press).
- Mindy Chen-Wishart, Contract Law (Oxford University Press, latest available edition).
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Written by Kateule Sydney - Researcher and Writer
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