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Saggi, Conferenze e Seminari 10. Reproduced with permission of Centro di studi e ricerche di diritto comparator e straniero, diretto da M.J. Bonell

The Concept of Good Faith in American Law

Allan Farnsworth
Roma (April 1993)

Good afternoon. Comparative law has traditionally been the province of European scholars. We of the common law tradition have shown less proficiency at comparative law and have often depended on Europeans, such as Ernst Rabel, Max Rheinstein, and Rudi Schlesinger for leadership. I want to return to the subject of comparative law in common law countries at the end of my remarks, but first I turn to the title of my talk. It is possible that you will be deceived by this title, "The Concept of Good Faith in American Law." Some time ago, my distinguished British colleague Professor Roy Goode of Oxford University delivered a lecture here entitled "The Concept of Good Faith in English Law."[1] Since he and I are both common lawyers, you might be fooled into thinking that today you were going to hear many of the same thoughts that he expressed, but with an American accent rather than an English accent. Nothing could be farther from the truth, I want at the outset to point out some important differences in these two common law systems with respect to good faith.

To begin with, my distinguished British colleague began his lecture by telling you that "we in England find it difficult to adopt a general concept of good faith" and he went on to explain why the English have resisted adopting a general concept of good faith. We in the United States, however, have had a generally accepted concept of good faith for decades. In the course of my lecture, I will explain to you what it means to us and will describe two disputes that it has engendered.

My distinguished British colleague went on to say that "we [English] do not have either a civil code or a commercial code" and so he was limited to a description of some English cases. On the other hand we Americans have not only a widely adopted Uniform Commercial Code but we also have a Restatement (now a Restatement Second) of Contracts which functions somewhat as a civil code. In the course of my lecture, I will tell you what those two sources say about good faith and I will also describe a few American cases.

Both the Uniform Commercial Code and the Restatement Second impose on parties to a contract an obligation of good faith. Section (you would say "article") 1-203 of the Code provides that "every contract or duty within this Act imposes an obligation of good faith in its performance or enforcement." And Section 205 of the Restatement, which was drafted later than the Code and was inspired by the Code, declares that "Every contract imposes upon each party a duty of good faith and fair dealing in its performance and enforcement." As students of comparative law, you may find it interesting to learn that the principal author of our Code, Professor Karl Llewellyn, had studied and taught in Leipzig (Germany) and was familiar with the German concept of Treu und Glauben when he introduced "good faith" into our Code.[2]

You should note two things about the scope of these provisions. First, neither one says anything about a doctrine of good faith purchase as opposed to good faith performance. Although we Americans are familiar with the concept of good faith purchase, we regard good faith purchase as a different problem and I will say nothing more about it. Second, these provisions omit any reference to good faith in negotiation as opposed to good faith in performance. That is because, like most of the common law world -- including England -- we Americans do not recognize a duty of good faith in negotiation -- in precontractual relations. We do have a variety of other concepts that often serve as a substitute for good faith in precontractual relations, but I will not take the time to discuss them. I was, however, interested to observe that when my distinguished British colleague R. Goode gave examples of what he considered to be troublesome applications of the concept of good faith, all of his examples involved precontractual relations. I will not address any of these examples and will say nothing further about good faith in negotiation.

Finally, my distinguished British colleague R. Goode observed that "we [English] do not know quite what it [good faith] means." We Americans, however, are not lacking in definitions of good faith. Indeed, it can almost be said that there are as many definitions of good faith as there are purported experts in the field. Even our Uniform Commercial Code has not one but two definitions of good faith that apply to contracts for the sale of goods. Under the general definition in Section 1-201(19), "'Good Faith' means honesty in fact in the conduct or transaction concerned." This is the definition traditionally used for good faith purchase, which the Code makes applicable to good faith performance as well. Under the special definition in Section 2-103 applicable to merchants in sales transactions, "'Good Faith' . . . means honesty in fact and the observance of reasonable commercial standards of fair dealing in the trade." (You should note that the duty described by the Restatement encompasses not only "good faith" but also "fair dealing.") In my view the addition of fair dealing makes this definition particularly suitable for good faith performance. I will return to this later.

The fact that we have statutory definitions of "good faith" does not, however, mean that we Americans are in complete agreement as to what "good faith" means in the context of good faith performance. Three scholars who have written on the subject have stressed three different aspects of good faith performance.

In the first major article on the subject after the enactment of the Uniform Commercial Code, I observed that the duty of good faith performance can be the source of what we common lawyers would call an implied term. I speculated that the Code's duty of good faith performance might serve as a basis for implying a wide range of terms.[3] And a number of courts have followed this suggestion -- Justice Antonin Scalia having observed, before ascending to our Supreme Court (DCApp), "correct ... is the perception of Professor Farnsworth that the significance of the doctrine is 'in implying terms in the contract."[4]

In the second major article on the subject, Professor Robert Summers, now of Cornell University, stressed a different role for good faith, arguing that good faith is one of those terms that do not have a general positive meaning of their own but function instead as "excluders" to rule out various things according to context. Its effect was to rule out those types of improper behavior that should be regarded as bad faith performance. He noted that "in cases of doubt, a lawyer will determine more accurately what the judge means by using the phrase 'good faith' if he does not ask what good faith itself means, but rather asks: What, in the ... situation, does the judge intend to rule out by this use of this phrase." Professor Summers listed, as excluded by the phrase "good faith": "evasion of the spirit of the deal, lack of diligence and slacking off, willful rendering of only substantial performance, abuse of power to specify terms, abuse of a power to determine compliance, and interference with or failure to cooperate in the other party's performance."[5] This kind of definition by exclusion has not only found favor with a number of courts [6] but is reflected in the comments to the Restatement Second's section on the duty of good faith performance. The comments note that "A complete catalogue of types of bad faith is impossible ...," and goes on to give a list very similar to that just quoted.[7]

In the third major article on the subject, Professor Steven Burton of the University of Iowa, lamented that "neither courts nor commentators have articulated an operational standard that distinguishes good faith performance from bad faith performance." He attempted to fashion a standard based on the expectations of the parties, arguing that good faith "limits the exercise of discretion in performance conferred on one party by the contract," so that it is therefore bad faith to use discretion "to recapture opportunities forgone in contracting" as determined by the other party's reasonable expectations -- to refuse "to pay the expected cost of performance."[8] As is true of the two other views just discussed, this definition in terms of forgone opportunities has also found favor with a number of courts.[9]

Professors Summers and Burton have engaged in a lively debate in which each criticizes the other's views. Summers says Burton's analysis is not "necessarily any more focused" than the excluder analysis "in a novel good faith performance case."[10] Burton faults the excluder analysis as implying that courts "typically use the doctrine to render agreed terms unenforceable or to impose obligations that are incompatible with the agreement reached at formation," rather than "to effectuate the intentions of the parties."[11] Courts have cited all three views -- mine, Summers' and Burton's -- often indiscriminantly as if they were entirely consistent with each other.[12] I think that there is much to be said for treating all three views as cumulative and consistent as these courts have done. Let me, in the common law tradition, give you an example of how this might be so, based on some recent American cases involving satisfaction clauses.

Suppose that you are a publisher and I am a printer and we make a contract under which I am to print some books for you and you are to take them and pay me if you are "satisfied" with my printing. The contract gives you some discretion in deciding whether you are "satisfied." You have to exercise that discretion in good faith. But is the test of your good faith objective or purely subjective? Suppose you refuse to take the books and do not pay me, saying you are not satisfied. Since we have not specified which test applies, a court would have to decide. A common law court would look on this as a question of interpretation: What does "satisfied" mean? A court would probably decide that, because it is not so difficult to judge the quality of printing, the test should be objective: Ought you reasonably to have been satisfied with my printing? If a jury decides that you ought reasonably to have been satisfied, the court will hold that you have broken our contract even if you were honestly not satisfied.

Now suppose that you are a publisher and I am an author and we make a contract under which I am to write a novel for you and you are to publish it and pay me royalties if you are "satisfied" with my novel. (Such "satisfaction" clauses are common in publishing contracts in the United States.) Suppose you refuse to publish my novel and pay me royalties, saying you are not satisfied? This time, since it is so difficult to judge the quality of a novel, a court is likely to decide that the test should be purely subjective: Were you honestly not satisfied with the quality of my novel? The judge will not ask a jury to attempt to decide whether you ought reasonably to have been dissatisfied with my novel.[13] But you would be in breach of contract if I could show that your expression of dissatisfaction was actually a subterfuge or pretext to get out of publishing my novel because, for example, of my unpopular political views. Then, you were not honestly dissatisfied with the novel.

Now suppose that, when you tell me that you are not satisfied with my novel, I ask you for your help in editing it so that it would be satisfactory to you. Are you expected to do this as part of your duty of good faith performance? Our courts have held that you are not expected to do this: your duty of good faith performance does not impose on you a duty to edit my manuscript.[14] Suppose, however, that my request is more modest, and I merely ask you to point out those aspects of my novel that you find unsatisfactory so that I can improve it myself in the hope of making it satisfactory to you. Although no court has addressed this situation, I believe that a court would hold that your duty of good faith performance includes a duty to specify the grounds of your dissatisfaction -- at least if doing so might enable me to edit it to eliminate those grounds. I wonder, however, whether what we should be talking about here is good faith in the sense of honesty -- entirely suitable for good faith purchase -- or rather fair dealing, a term better suited to performance.

What can we deduce from this example about the role of the duty of good faith performance? First, note that, in accordance with my own view in my early article, the duty of good faith performance can be the source of what we common lawyers would call an implied term -- a duty that would be supplied by a court to specify the grounds for your dissatisfaction with my manuscript. Second, note that, in accordance with Professor Summers' view, the duty of good faith performance would be the basis for holding you in breach of contract if you were to state that you were dissatisfied with my novel as a subterfuge or pretext to get out of publishing my novel for some other reason. Third and finally, note, in accordance with Professor Burton's view, that the duty of good faith performance provides the grounds for controlling your exercise of the discretion that you have under the contract. I conclude that courts have been right to regard all three of these three views as cumulative and consistent and to avoid taking sides in the scholarly debate between Professor Summers and Burton.

But this is not a debate that has greatly troubled judges and lawyers. A different debate has assumed practical -- as distinguished from scholarly -- importance. My example of the author and publisher suggests the nature of this debate. To what extent is good faith purely subjective -- requiring only that a party "honestly" believe that it is acting properly? And to what extent is good faith objective -- requiring that a party in addition act in a "reasonable" manner? In the United States the distinction between a subjective test of good faith and an objective test takes on added importance because the latter -- an objective test -- often means that the issue of good faith in terms of reasonableness goes to a jury for decision. Thus, as we have seen, in the case of the publishing contract containing the "satisfaction" clause, a jury would not be asked whether the publisher ought reasonably to have been satisfied. But in the case of the printing contract containing a similar clause, a jury would be asked whether the author ought reasonably to have been satisfied.

Because choosing between a subjective and an objective standard is regarded as a matter of interpretation, the parties can determine the standard themselves if they use clear language. But they usually neglect to do so and the choice of the standard is commonly left to the courts. The definitions of good faith endorsed by some courts are so abstract and sweeping as to be of little help in determining the proper standard. For example, it has been said that the duty of good faith performance enjoins each party "to do nothing destructive of the other party's right to enjoy the fruits of the contract and to do everything that the contract presupposes they will do to accomplish its purpose."[15] Is this an objective or subjective standard? It is certain that the standard is not as demanding as the standard of good faith imposed on agents and other fiduciaries. Thus it has been said that "A duty of good faith does not mean that a party vested with a clear right is obligated to exercise that right to its own detriment for the purpose of benefiting another party to the contract."[16] But this still does not help courts perplexed as to whether, in particular situations, good faith is to be judged solely by the traditional subjective standard of honesty or also by an objective standard of reasonableness.

If the duty of good faith is taken to include a component of fair dealing as judged by those in similar activities, this plainly incorporates an objective standard. Surely this is so under Article (you would say "Part" or "Chapter") 2 of the Uniform commercial Code, which you will recall imposes on a merchant a duty of good faith that includes "the observance of reasonable commercial standards of fair dealing int he trade." Under this provision, courts may consider the testimony of witnesses familiar with the behavior of others in the trade in order to determine whether a party has passed the objective test of "reasonable commercial standards of fair dealing" in that trade. While this testimony may be similar to that used to establish trade usage, there is the important difference that testimony relating to the standard of fair dealing plainly need not be limited to the period before the making of the contract and may extend up to the time of the claimed breach of the duty of good faith.

Here is in example from an actual case.[17] Eastern Airlines, at the time a leading air carrier, and Gulf Oil Corporation, a major oil company, had dealt with each other for many years. In 1972 they made a five-year contract under which Eastern was to buy and Gulf to sell all of Eastern's requirements of jet fuel at specified airports. These airports were some but not all of the airports to which Eastern flew. Although the contract contained a price-escalation clause, the clause failed to keep pace with Gulf's claimed costs after 1973, when the Middle East exploded in another war and the Arab oil-producing nations staged an embargo against the United States and some of its allies.

Gulf sought to terminate the contract; Eastern insisted on performance. One of the grounds that Gulf claimed for termination was that Eastern had itself broken the contract by "fuel freighting." This is a term used to describe the practice of adjusting one's liftings (purchases) of fuel according to price. (You do this when you drive across borders, I am sure.) If the price at an airport where Eastern had to buy Gulf fuel was higher than the price at another airport, Eastern would "tank up" at the other airport. Conversely, if the Gulf price was lower, Eastern would "tank up" at the Gulf airport. Was this a breach of Eastern's duty of good faith?

The federal district court that decided the case held that it was not a breach. It began by quoting the Code's definition of good faith as applied to Eastern, a merchant buyer of goods -- "honesty in fact and the observance of reasonable commercial standards of fair dealing in the trade." It noted that during the 30 years that the parties had dealt with each other, Eastern's liftings (i.e., purchases) had been subject to variations depending on factors ranging from whether the flight was on time or late to fuel prices and taxes, all in the judgment of the flight captain. But the opportunities for "fuel freighting" were, in practice, relatively limited, and Gulf had never complained of the "swings" in Eastern's liftings before 1973. The court concluded "that fuel freighting is an established industry practice, inherent in the nature of the business, that had long been part of the established courses of performance and dealing between Eastern and Gulf" and that had "gone on unchanged and unchallenged for many years accepted as a fact of life by Gulf without complaint." The court concluded on this factual basis that Eastern was not in breach of its duty of good faith and that Gulf therefore had no ground for termination. It ordered Gulf to perform its contract.

The court's conclusion seems right, even though Eastern was held to the more rigorous standard applicable to merchants. Eastern had behaved fairly according to the understanding of the parties based on their longtime relationship and on the understanding of others in the trade.

Having given you an idea of how we Americans regard good faith, I now have a different kind of case to tell you about.[18] That case arose out of a dispute between a government agency and a building contractor who had been engaged to build two pumping stations for a government sewerage project. The contract provided that in the case of a default by the contractor, the agency could suspend progress payments and require the contractor to show cause why the contract should not be terminated. If the contractor did not show cause "to the satisfaction of" the agency, the agency would terminate the contract. The dispute was over whether it was enough for the agency to be honestly dissatisfied, or whether it had to be reasonably dissatisfied.

Why, you may ask, do I tell you about this case now, since the issue is the same as the issue I discussed earlier in connection with the American cases involving satisfaction clauses. I do so because this is not an American case at all, but one from the Court of Appeal of New South Wales in Australia. But since Australian law is so heavily influenced by English law, what can this case have to tell us about good faith? After all, as my distinguished British colleague has told us, the English "find it difficult to adopt a general concept of good faith."

In fact, it has a great deal to say about good faith, because of the wide-ranging scholarship of a perceptive Australian judge, Justice Priestly. In 1989, Justice Priestly had written an article entitled "A Guide to a Comparison of Australian and United States Contract Law," in which he enumerated as "excellent quarries for the Australian searcher to work in," the Restatement of Contracts, the Uniform Commercial Code, and our casebooks and treatises. He gave special attention to good faith performance, citing works by Professors Summers and Burton and observing that its "explicit recognition" in American law "seems to be a marked distinction from the Australian position," though the "positions may not be so far apart as appears at first sight."[19]

Three years later, when the case I have described came to his court, Justice Priestly argued powerfully for analyzing the issue of "satisfaction" as one of good faith. His remarks may not have been essential to the outcome of the case, but they say much about the vitality of the principle of good faith performance and its ability to survive voyages to distant places on the globe. "The kind of reasonableness I have been discussing," he wrote, "seems to me to have much in common with the notions of good faith which are regarded in many of the civil law systems of Europe and in all States in the United States as necessarily implied in many kinds of contract. Although this implication has not yet been accepted to the same extent in Australia as part of judge-made Australian contract law, there are many indications that the time may be fast approaching when the idea, long recognized as implicit in many of the orthodox techniques of solving contractual disputes, will gain explicit recognition in the same way as it has in Europe and in the United States."

Since the English generally use only those "orthodox techniques," it may be surprising that Justice Priestly leaned heavily on the arguments of a creative English judge, Justice Johan Steyn of the High Court, Queen's Bench Division -- not arguments from one of his judicial opinions, but rather from a lecture that Justice Steyn gave at Oxford University -- 1991. In his lecture, Justice Steyn listed various reasons why English law might in the future be more receptive to the principle of good faith performance. Among these was the acceptance of that doctrine by common law jurisdictions in the United States. (Another, interestingly, was the ratification by many countries of the Vienna sales convention, which contains a provision on good faith.)

So, you see, the principle of good faith performance, which Llewellyn brought from Germany to the United States and planted in the Uniform Commercial Code, has made its way to Australia, where it now has at least a foothold in New South Wales. In your study of comparative law you have undoubtedly observed the influence of one legal system or another, through the spread of ideas from one legal system to another and the borrowing of principles by one legal system from another. All this you have seen by studying the relationships of civil law systems one to another and to common law systems. From what I have told you about the principle of good faith, you can see that the same sort of influence is at work within the common law world. There was, of course, a time when English law was the great -- and virtually exclusive -- source of inspiration for the common law world -- the former British Empire. Today, although to a much lesser extent, American law also serves as a source of inspiration for the common law world. Admittedly, we Americans, with fifty of our own jurisdictions to contend with, have often been lacking in showing reciprocal curiosity about new ideas in other common law systems, such as that of Australia. Perhaps it would help all of us -- Australians, Americans and other common lawyers -- if we began the study of comparative common law. Nowhere in the world, to my knowledge, is there a center, or even a course, in comparative common law. Perhaps it is time for common lawyers to create one, drawing inspiration from European centers such as your new and exciting Centro di Studi e Ricerche di Diritto Comparato e Staniero.

I thank your Centro for its hospitality and you yourselves for your patience.


FOOTNOTES

1. See generally R. Goode, The Concept of "Good Faith" in English Law (in this series, n. 2, Roma 1992).

2. See W. Twining, Karl Llewellyn and the Realist Movement, 1985, p. 312.

3. Farnsworth, Good Faith Performance and Commercial Reasonableness Under the Uniform Commercial Code, 30 U. Chi. L. Rev. 666, 679 (1963).

4. Tymshare v. Covell, 727 F.2d 1145 (D.C. Cir. 1984).

5. Summers, "Good Faith" in General Contract Law and the Sales Provisions of the Uniform Commercial Code, 54 Va. L. Rev. 195, 200, 232-33 (1968).

6. E.g., Best v. United States National Bank, 739 P.2d 554 (Or. 1987).

7. Restatement, Second, of Contracts 205, Comment d.

8. Burton, Breach of Contract and the Common Law Duty to Perform in Good Faith, 94 Harv. L. Rev. 369, 369, 372-73 (1980). See also Burton, Good Faith Performance of a Contract Within Article 2 of the Uniform Commercial Code, 67 Iowa L. Rev. 1 (1981).

9. E.g., Richard Short Oil Co. v. Texaco, 799 F.2d 415 (8th Cir. 1986).

10. Summers, The General Duty of Good Faith - Its Recognition and Conceptualization, 67 Cornell L. Rev. 810 (1982).

11. Burton, More on Good Faith Performance of a Contract: A Reply to Professor Summers, 69 Iowa L. Rev. 497, 499 (1984).

12. E.g., Foley v. Interactive Data Corp., 765 P.2d 373 (Cal. 1988)(citing both Summers and Burton).

13. See generally E. A. Farnsworth, Contracts 8.4 (1990).

14. Doubleday & Co. v. Curtis, 763 F.2d 495 (2d Cir.), cert. dismissed, 474 U.S. 912 (1985).

15. Conoco v. Inman Oil Co., 774 F.2d 895, 908 (8th Cir. 1985).

16. Rio Algom Corp. v. Jimco Ltd., 618 P.2d 497, 505 (Utah 1980).

17. Eastern Air Lines, Inc. v. Gulf Oil Corp., 415 F. Supp. 429 (S.D. Fla. 1975).

18. Renard Constructions v. Minister for Public Works, 26 N.S.W.L.R. 234 (1982).

19. 12 UNSW L.J. 4, 4, 6-7, 17-19 (1989).


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