Markovits: good faith in the U.S

In this section, we will face the theoretical issue head on through a comparative look at the doctrinal developments of good faith in U.S. contract law. This comparative look will further elucidate the varying paths to interpreting Bhasin and why the SCC is headed in the wrong direction with Callow and Wastech. I illustrate the SCC’s conceptual unclarity through their discussion of remedies for a breach of good faith. I suggest that Markovits’s theory of good faith can vindicate Bhasin, and I then highlight some strengths and weaknesses of Markovits’s view.

The English common law can trace good faith to Lord Mansfield in Boone v. Eyre,[1] which was adopted into American jurisprudence in Kirke La Shelle Co. v. Paul Armstrong Co.[2] The Uniform Commercial Code adopted a duty of good faith in performance for all contracts within its scope,[3] and it understands this duty to mean “honesty in fact and the observance of reasonable commercial standards of fair dealing.”[4] In other words, “the range of permissible variation is limited by what is commercially reasonable.”[5] The Restatement of Contracts echoes this and “imposes upon each party a duty of good faith and fair dealing in its performance and its enforcement.”[6] The policy rationale is to stop conduct that “violate community standards of decency, fairness or reasonableness.”[7] Examples include, “evasion of the spirit of the bargain, lack of diligence and slacking off, willful rendering of imperfect performance, abuse of a power to specify terms, and interference with or failure to cooperate in the other party’s performance.”[8] Of course, this is a non-exhaustive list and good faith only serves to “effectuate the intentions of the parties, or to protect their reasonable expectations.”[9] In fact, it may be futile to attempt to generalize the duty of good faith to capture all fact patterns. Reasonable expectations and contractual intentions are often incomplete and nebulous, and therefore the nature of good faith being rooted in these concepts makes it difficult to boil down to a rigid test. Put differently, “An account that understands good faith as a rule of decision, thus commits a circle.”[10]

The idea of reasonable expectation and not abusing discretion is a common thread between Canada and the US. Broadly, good faith looks at the purpose of the contract and protects against sharp practices that are manipulative or exploitative or “advantage taking.”[11] When parties fail to foresee some outcome ex ante, they must make good faith arrangement to address this unforeseen gap.[12] But it does not obligate parties to alter their agreements and good faith is “not a principle of substantive fairness even just in the face of new contingencies that arise within the contract relation.”[13] Substantive fairness is irrelevant for good faith even to the point where “one side to a contract has leveraged undeserved bargaining advantages in contract formation, so that the substantive terms of an exchange unfairly favor her over the other, she may perform her contract in good faith.[14] Good faith prevents parties from exploiting a strategic vulnerability to secure a private advantage. The strategic vulnerability arises from a rigid interpretation of contractual obligations and shirking an obligation that may not be expressly stated. Nevertheless, “even after you have signed a contract, you are not obliged to become an altruist toward the other party.”[15] 

Markovits is keenly attuned to the problem of navigating between the two poles of fraud-like egoism on the one side and fiduciary-like altruism on the other. The common illustration to make this point is that if a beneficiary asks their fiduciary to walk a kilometre with them, the fiduciary has a duty to walk two kilometres if it is in the beneficiary’s best interest; in contrast, in contractual relations, a party that agrees for self-interested reasons to walk with another party for one kilometre, then they must walk one kilometre and not a metre more. As Markovits puts it, “The inner and outer bounds of good faith are thus easy to discern.”[16] While the current law states a duty to abide by the community’s standards of reasonableness in contracts, good faith does not “require contracting parties to adopt even an attitude of substantive impartiality between their contractual interests and the interests of their contracting partners.”[17] Good faith permits self-interested behavior so long as parties honor the terms of their agreements. It is clear that contract law does not try, “in the name of good faith, to make every contract signatory his brother’s keeper.”[18] However, again, the intentions of the parties and the emergent reasonable expectations are often unclear and a matter of interpretation, so we cannot derive a duty of good faith from the reasonable expectations of parties since it is the very subject of interpretation and construction. It is therefore difficult to see how good faith could be understood as a substantive contractual obligation implied ex ante.

Markovits’s conception of good faith is tied to his larger project of understanding contracts as “collaboration.”[19] Ambitiously, he understands the duty of good faith as “the core doctrinal expression of freedom of contract.”[20] In short, he understands the altruism in fiduciary relations as partly paternalistic just as “lawyers must override the choices of their clients” if their client is “self-destructive or even just imprudent client initiatives.”[21] In contrast, contractual relationships are necessarily anti-paternalistic, which is “just another facet of freedom of contract.”[22] He explains that, unlike beneficiaries in a fiduciary relationship, promisees must not be at the “mercies of her promisor’s paternalism” as it would deprive the promisee of a “reliable mechanism for pursuing her own purposes” within the contract.[23] He continues, “Good faith thus underwrites a distinctive form of recognition in which contracting parties recognize one another’s expressed intentions, at face value. When they do so, the parties to contracts recognize one another as sovereign wills, whose freedom and hence also choices must be respected. Fiduciary relations lack this variety of respect, not in spite but rather because of the substantive other-regard that they involve.”[24] For Markovits, the impartiality of contractual relationships is key to the freedom of contract which is understood as freedom from paternalism or the imposition of the will of others. On this view, the duty of good faith must necessarily be thin and formal because anything more substantive would no longer be an arm’s length contractual relationship. The contractual relationship is different in kind to fiduciary relationships, and good faith in contracts cannot cross the line into the kind of altruism in fiduciary relationships or else it collapses the core of the institution of contract law. In Markovits’s words, good faith is a “distinctively contractual notion.”[25] While fascinating, we need not concern ourselves with the entire story Markovits tells about good faith as collaboration.

The lesson we can take from Markovits is that good faith is more of an interpretive tool or “a practical analog to the principle of charity in interpretation of theoretical communications.”[26] To be clear, good faith must be connected to the actual intentions of the parties, that is, according to Markovits, “their actual joint plan.”[27] This is in contrast to idealizing good faith to what parties may have ideally agreed to or “what they would have agreed ex ante had they known then what they have discovered ex post.”[28] This is the familiar worry of post hoc judicial scrutiny or judges interpreting the intentions of the parties instead of tending to the parties’ actual intentions. The upshot is that good faith is taken to be an exercise of looking at counterfactuals only insofar as it relates to the joint intentions of the parties and not scrutinizing the mind of a single party or some abstract rational agent. Markovits understands good faith among parties as an attitude of respect, but he also understands good faith as an interpretive tool for judges to what is ex ante reasonable (although not perfect) interpretation of the parties’ intentions.

Reinterpreting Bhasin a la Markovits

In Bhasin, the SCC seems to be aligned with Markovits in understanding good faith as an “organizing principle” and not a “free-standing rule.” The SCC can be understood to be expressing what good faith means among contracting parties. The SCC is stating, similar to Markovits, that there is no explicit rule of good faith that parties can point to; rather, good faith is a general attitude parties are expected to have towards one another when contracting and it expresses a mutual respect between arms-length parties. The specific four doctrines of the duty of good faith that is derived from the general principle of good faith can be understood as the interpretive tools which judges use to analyze the intentions of the parties. The intentions of the parties and their reasonable expectations must be understood as objective or else it would undermine the arms-length nature of contracts that is critical to the freedom of contract, which Markovits takes to be the raison d’être of contract law. My exegesis of Bhasin vis-à-vis Markovits requires further unpacking.

The SCC intentionally avoids a conceptual debate as to “whether a good faith obligation is being imposed as a matter of law, as a matter of implication or as a matter of interpretation.”[29] This was a missed opportunity for the SCC to provide some much-needed clarity.[30] This debate sheds light on how to properly conceptualize good faith and how to understand its role for parties and its utility for judges. Understandably, this is a vexed topic that is more theoretical than having practical guidance. The American jurisprudence seems equally ambiguous as some suggest that good faith should be “an implied covenant that neither party shall do anything which will have the effect of destroying or injuring the right of the other party.”[31] Others suggest that good faith is a interpretative tool or “that the doctrine of good faith merely directs a court towards interpreting contracts within the commercial context in which they are created, performed, and enforced, and does not create a separate duty of fairness and reasonableness which can be independently breached.”[32] Markovits identifies this as “very similar to that which jurisdictions in the United States have imposed through substantive unconscionability.”[33] Economic theorists, like Richard Posner, understand good faith as to perfecting the imperfect intentions of the parties to “give the parties what they would have stipulated for expressly if at the time of making the contract they had had complete knowledge of the future and the costs of negotiating and adding provisions to the contract had been zero.”[34] On this view, idealizing the intentions of parties would ultimately be more efficient since it would conceive of contracts as if parties reasoned perfectly and take away inefficient transaction costs. Markovits is against the view of implying terms of good faith into a contract and teaches us that it “does not establish affirmative duties of other-regard so much as articulate respect among parties who remain at arm’s length.”[35]

As argued by Markovits, the most plausible account seems to be a thinner account of good faith such that it regulates the attitudes of contracting parties and functions as an interpretive tool for judges. This interpretive tool must be constrained by the realities of the intentions of the parties. Good faith does not add substantive contractual obligations because that would paternalistically interfere with the actual intentions of the parties and undermine their freedom to contract. Similarly, good faith cannot be understood as modifying the substantive terms according to some ideal of reasonableness or efficiency because this would again fail to tend to the actual intentions of the parties. The reasonable expectations of parties are decided between the parties and it is the parties that generate the norms of reasonableness within their particular contractual relation. Imposing idealized norms from outside of the norms established by the parties, whether through judicial scrutiny or ideals of substantive fairness, would thus undermine the freedom of parties to plan and structure their own contractual relations. Good faith must instead be understood as a thin attitude of respect between parties and the reasonable expectation among parties is to respect the autonomy of the other party. It is therefore not possible to contract out of good faith since it animates the existence conditions of a legally enforceable contract. The contents of what constitutes mutual respect among parties is furnished by the norms established between the parties when forming the contract.[36] The duty of good faith “thus expresses a commitment to a particular normative (and indeed legal) relation” and to reject good faith is “to deny the contractual obligation to which good faith attaches.”[37]

Markovits’s approach seems consistent with the Canadian general principle of good faith not being a “free-standing rule,” but, on first glance, it seems contrary to the four specific doctrines of good faith; although, it is still not clear that Canada understands the four doctrines as “affirmative duties.” Moreover, while the principle of good faith is not freestanding, the four doctrines are and can be used as a cause of action.  The SCC is supposedly agnostic to how a duty of good faith is generated—whether implied through law, intention, or by facts—but it seems that there are additional “thick” obligations of good faith.[38] Perhaps the four doctrines of good faith are a useful guide to the “attitude” Markovits refers to and does not add any new obligations. The attitude can be too abstract and spelling out distinct doctrines can be a useful heuristic or guide for future cases. This is a possible way to interpret the SCC even more narrowly, especially because the four doctrines have not been elucidated in any great detail, but it would be a view that is compatible with Markovits’s view of good faith.

Even understood narrowly, it seems that in Callow that the duty of honest performance problematically modifies the substantive terms relating to discretionary powers. The SCC specifies that the duty of honesty has “a limiting function on the exercise of an otherwise complete and clear right because the duty, irrespective of the intention of the parties, applies to the performance of all contracts and, by extension, to all contractual obligations and rights.”[39] The SCC inferred what was a reasonable expectation or what was only an expectation in the mind of one party, and subsequently thrusted a new obligation on both parties. Reasonable expectations may foresee something that is not explicitly mentioned in the wording, but it does not go contrary to the wording or spirit of the parties’ intentions. Trying to idealize the agreement strays away from the actual, imperfect intentions of the parties. In trying to perfect an imperfect contract ex post, courts violate the contract and does the party a disservice in constraining their freedom of contract. Good faith only “steps in to require contracting parties to respect each other’s contractual intentions even where they, preferring manipulation, are disinclined to do so.”[40] Even if it one party regrets what they contracted, they need to be held to their agreement and the court’s job is to enforce the actual intentions of freely entered contracts.

Critique of Markovits and the future of good faith in Canada

Despite the strengths of Markovits’s view, his account of remedies with respect to a breach of good faith is not convincing. On this front, I believe both Markovits and Bhasin get remedies wrong. There is a conceptual question as to the relationship between the duty of good faith and the corresponding remedy for a breach of good faith. Markovits understands expectation damages to be the proper remedy as it “vindicates the promisee’s reasonable contractual expectations.”[41] His gripes are with those who insist good faith implies specific performance and illustrates his point through the justification of efficient breach. He explains that, in cases of efficient breach, “it would be bad faith for a promisee to insist on specific performance, as this would give the promisee a benefit that he did not pay for and deprive the promisor of one of the benefits that the contract expressly gave her.”[42] This assumes that the expectation is for the value and that there is nothing beyond the fungible value contractual performance. Moreover, Markovits argues that it is implied in fact that a promisor has an ex ante entitlement to gains from efficient breach, and this possibility is priced into the agreement to the benefit of the promisee. As such, a promisee asking for specific performance ex post would be clawing back the value of what was previously negotiated. However, it is not clear that efficient breach is an implied in fact or implied in law, especially when dealing with non-sophisticated parties.

In Callow, the SCC was split on the measure of damages. Similar to the result in Bhasin, the majority awarded expectation damages.[43] However, the counterargument was that damages should be “measured against a defendant’s least onerous means of performance, the least onerous means of performance in this case would have been to correct the misrepresentation once Baycrest knew Callow had drawn a false inference.”[44] This measure would be reliance damages and the loss of Callow securing another contract for the winter. The non-majority judgments did not think expectation damages are appropriate. This can differ with the doctrinal subcategories of good faith, say, between a duty of honest performance and duty to exercise discretion in good faith.[45] For a duty of honest performance, there is argument that misleading conduct is independent of the termination provision and that reliance on the misleading conduct is the proper measure of damages.[46] The idea is that the defendant did not fail to perform the contract and defeated the plaintiff’s expectations, rather that the loss was due to a “dishonest extra-contractual misrepresentations concerning that performance, upon which the plaintiff relied to its detriment, and there is no “lost value of performance, but detrimental reliance on dishonest misrepresentations.”[47] There is a similar confusion amongst the SCC around what the appropriate remedy is for breaches of good faith.

At this point, we might question if the categories of common law damages can be the correct framework to address good faith. Awarding expectation damages would sometimes lead to a windfall, and perhaps then a better way to frame the damages is in terms of restitution or unjust enrichment. This question of remedies opens the door for a critique of Markovits’s view of good faith. In what follows, I offer a brief sketch of an alternative view to Markovits that largely draws on a promissory view of contracts.

Markovits understands the duty of good faith as inextricably embedded into the contractual obligations negotiated among parties at the formation of a contract. For the judge, the duty of good faith expands the scope of interpretating the contractual obligations of parties to capture exploitative behavior that is consistent with the reasonable expectations of the parties. Practically, acting in bad faith just means to breach contractual obligations and thereby giving the right to expectation damages to the innocent party. But this can sometimes lead to windfalls when performance is not at issue but there is a successfully claim of bad faith. We can see this in Callow whereby expectation damages were awarded because Baycrest failed to correct Callow’s impression that providing gratuitous services would lead to a renewal of their contract. It is hard to see how Baycrest’s bad faith and putative breach of an obligation is anyway related to a failure of performance on the part of Baycrest. Again, at the most, Callow is entitled to restitution on a quantum meruit basis. I take this absurd result of remedies to be a weakness in both the SCC and Markovits’s view.

There might be an alternative picture of good faith that makes better sense of good faith remedies. Instead of understanding good faith as an ex post interpretive tool to patch contractual obligations so it leaves bad faith actors with a breach of the original agreement, we might understand good faith to be an extra-legal or second-order obligation to not discharge contractual obligations in an exploitative manner. The theoretical backdrop to such a view would not be Markovit’s collaboration view, rather it would fit with a promissory view of contracts.[48] The justification for this view of good faith is that we are sensitive to the normative force of something above and beyond the words of the contract, namely a norm or duty not to use the institution of contract to undermine the spirit of a promise. Good faith is not only an attitude animating legal relations, it also has a constitutive role in creating promissory relations between strangers free from exploitation, deception, or coercion. Markovits is correct to identify contractual obligations as sui generis and not owed to anybody else other than the parties involved, but they do not arise out of a normative vacuum and contractual obligations carve out select norms from a landscape of extra-legal promissory norms between the parties. To be clear, reasonable expectations between parties are not objective in the sense that they refer to a community’s norms that are external to the parties. Rather, reasonable expectations must be relative to the norms set by the contracting parties but it remains objective in the sense it does not refer to the subjective mental states of one party. For example, sophisticated parties might find themselves in a community of commercial norms and thereby structure their contractual obligations within this commercial backdrop to allow, for example, efficient breach (whereas the norms of other communities may find efficient breach morally repugnant); yet, they may also set their own novel and granular contractual obligations, such as requiring specific performance in cases of a global pandemic. These extra-legal norms do not necessarily have to appeal to ideals of substantive fairness, but they can attend to background conditions of injustice and gives latitude to the judges to discern the entitlements of a wronged party.

Extra-legal obligations can impose new, ex post rights to remedies, similar to the remedial constructive trust. This obligation is triggered when first order contractual obligations are used to unjustly (i.e., through advantage taking that is contrary to the intention of the parties and undermines a party’s autonomy) deprive someone of a good. This view does not try to reinterpret the contractual obligations of the parties to infer that the intentions of the parties (ex ante) precluded the bad faith behavior; rather, it acknowledges the failure of the parties to foresee circumstances that are disadvantageous to one party and (ex post) corrects the entitlements of the disadvantaged party. We would then think that a breach of good faith is not a breach of a contractual obligation, yet it calls for some remedy. In this vein, good faith fits better with equitable doctrines such as unjust enrichment.

The difference between these views of good faith is mostly theoretical. However, I think my view better fits with moral intuitions. Extra-legal norms are important for understanding what kind of behavior should be legally prohibited, such as contracts for organs or other morally repugnant acts. Both Canadian and American jurisprudence seem sensitive to extra-legal norms: they understand the duty of good faith to prevent conduct “while consonant with the letter of a contract, exhibits dishonesty, ill will, improper motive or similar departures from reasonable business expectations.”[49] Consider, again, the doctrine of efficient breach. On my view, good faith may preclude some cases of efficient breach if they undermine the spirit of the promise, such as when parties negotiate against efficient breach or establish a reasonable expectation against it. To be clear and to address the more obvious objections, I take good faith to be important but not as a core contractual concept. I agree that it is morally important, but I think it is important to remain pluralistic for other contractual considerations, like efficiency. In this vein, I would think good faith is secondary to contractual obligations and good faith attaches to some types of contractual obligations, specifically obligations generated within promissory norms. In contrast, efficiency concerns or sophisticated parties like corporations may not follow the structures of promissory norms, and good faith may not be needed since everything should be explicitly spelled out in the contract (e.g., commercial contracts). Moreover, I concede that my appeal to promissory morality and extra-legal norms requires a larger justificatory story about contract law, but it is sufficient for my purposes to appeal to the shared intuitions of morality and the phenomenology of commonplace promissory practices.

Conclusion

Good faith is central to contractual relations and any analysis of good faith must say something about the nature of contractual relations. Much of the discussions of good faith here have been mostly explanatory in the sense that it tries to make sense of good faith rather than coming up with some legal test or defining the contours of the duty. This is no coincidence. The analysis of good faith reveals that it is conceptually thin, has strong commitments to formal equality, and it is a mistake to try to understand it as a substantive duty.

I have argued that good faith in Canada has gone awry since Bhasin. Markovits provides a view of good faith that is thin and essentially functions as an interpretive guide. Markovits’s view of good faith is consistent with Bhasin and makes sense of good faith better than the subsequent Canadian cases. Still, Markovits’s view of good faith has an odd view of remedies that I suggest is better understood by looking to extra-legal norms. The resultant view of good faith understands the remedial aspect as akin to equitable doctrines. More work is required to flesh out a view of good faith as a coherent equitable doctrine which fits into an account of the law of equity. For instance, it is not clear how rights-based theories of private law can accommodate good faith. By and large, the critique here of Markovits may be too ambitious and require a deeper analysis, but this paper can stand on its more modest thesis that Markovits offers a vindication of Bhasin and good faith in Canada.

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[1] (1777) 126 Eng. Rep. 160 (K.B.); 1 H. Bl. 273.

[2] 188 N.E. 163, 167 (N.Y. 1933).

[3] Uniform Commercial Code § 1-304 (2003)

[4] U.C.C. §§ 1-201, 2-103.

[5] U.C.C. § 2-311 cmt. 1.

[6] Restatement § 205 cmt.

[7] Restatement § 205 cmt. [a].

[8] Restatement § 205 cmt. [d].

[9] Sessions, Inc. v. Morton, 491 F.2d 854, 857 (9th Cir. 1974); Ryder Truck Rental, Inc. v. Cent. Packing Co., 341 F.2d 321, 323–4 (10th Cir. 1965); Perkins v. Standard Oil Co., 383 P.2d 107, 111–12 (Or. 1963) (en banc).

[10] Markovits, supra note 4, at 278.

[11] Ibid at 274.

[12] For example, a party seeking to terminate an agreement must give “reasonable notification” or “reasonable time to seek a substitute arrangement.” U.C.C. § 2-309 cmt. 8.

[13] Markovits, supra note 4, at 278.

[14] Ibid at 291.

[15] Mkt. St. Assocs. Ltd. P’ship v. Frey, 941 F.2d 588, 595 (7th Cir. 1991) at 594.

[16] Markovits, supra note 4, at 278.

[17] Ibid at 278.

[18] Ibid at 593.

[19] Daniel Markovits, “Contract and Collaboration” (2004) 113:7 Yale LJ 1417.

[20] Markovits, supra note 4, at 282.

[21] Ibid at 283.

[22] Ibid.

[23] Ibid.

[24] Ibid at 284.

[25] Ibid at 292.

[26] Ibid at 288.

[27] Ibid at 285.

[28] Ibid.

[29] Bhasin, supra note 1, at para 48.

[30] The trial judge understood the agreement between Can-Am and Bhasin as analogous to a franchise or employment agreement, so good faith was understood as an implied term. Good faith is built into the statutes for employment, franchise, and insurance contracts. The rationale is that Bhasin is in a position of inherent vulnerability to Can-Am. The trial judge noted that, in the alternative, good faith can be implied by the intentions of the party. Significantly, the contract contained an “entire agreement clause” stipulating that no other express or implied contracts applied to the parties’ agreement.

[31] Kirke La Shelle Co. v Paul Armstrong Co., 188 N.E. 163, 167 (N.Y. 1933).

[32] U.C.C. § 1-304 cmt.

[33] Markovits, supra note 4, at 277.

[34] Mkt. St. Assocs. Ltd. P’ship v. Frey, 941 F.2d 588, 595 (7th Cir. 1991) at 596.

[35] Markovits, supra note 4, at 281.

[36] Consider the analogy of a marriage. We might think that every marriage carries an objective obligation of mutual respect and care, and that each party to a marriage can reasonably expect this from their partner. However, this objective obligations of mutual respect and care is a thin and formal notion that acts as the scaffolding, and it is the parties in the marriage that actually build out the substantive norms of respect and care. For example, one marriage might establish that doing the laundry for their partner is an act of respect and care; for another marriage, they might establish this as an act of disrespect and grounds for divorce. What is important to note is that even if there is an objective standard of respect and care among all marriages, it is still important to look at the specific norms of each relationship. This analysis of marriage largely draws from Eric Rasmusen and Jeffrey Evans Stake. See Eric Rasmusen & Jeffrey Evans Stake, “Lifting the Veil of Ignorance: Personalizing

the Marriage Contract” (1998) 73:2 Ind LJ 453.

[37] Markovits, supra note 4, at 284.

[38] Bhasin, supra note 1, at para 52.

[39] Callow, supra note 3, at para 53.

[40] Markovits, supra note 4, at 276.

[41] Ibid at 281.

[42] Ibid.

[43] Callow, supra note 3, at para 107.

[44] Ibid at para 114.

[45] Ibid at para 181.

[46] Ibid at para 139.

[47] Ibid at para 142.

[48] Seana Valentine Shiffrin, “The Divergence of Contract and Promise” (2007) 120:3 Harv L Rev 708.

[49] Bhasin, supra note 1, at para 29.