When businesses enter into contracts, they generally focus on the express terms: price, deliverables, timelines, and remedies. But every contract in Texas also carries with it an implied obligation that does not appear in the written text. This is the duty of good faith and fair dealing, and understanding how it operates can be the difference between winning and losing a contract dispute.
A Houston breach of contract lawyer will tell you that the implied covenant of good faith is one of the most frequently invoked and frequently misunderstood concepts in Texas contract law. This article explains what it means in practice for businesses throughout Houston, Sugar Land, The Woodlands, Katy, Spring, Missouri City, and Richmond.
What Is the Implied Covenant of Good Faith and Fair Dealing?
The implied covenant of good faith and fair dealing is a legal doctrine that imposes on each party to a contract an obligation to act honestly and in a manner that does not undermine the other party’s ability to receive the benefit of their bargain. In simple terms, it means that even when a contract gives a party certain rights, those rights cannot be exercised in a way that is arbitrary, capricious, dishonest, or designed to deprive the other party of what they were supposed to receive from the deal.
How Texas Courts Apply the Good Faith Doctrine
Texas courts take a somewhat narrow view of the implied covenant of good faith and fair dealing compared to courts in some other states. Texas follows the rule that the implied covenant does not create independent tort liability in most commercial contexts. This means that if someone breaches the duty of good faith, the remedy is generally a breach of contract claim, not a separate tort claim that might entitle the injured party to additional damages such as mental anguish or punitive damages.
There is an important exception: the Texas Supreme Court has recognized that in certain “special relationships” characterized by an imbalance of power and the entrustment of one party’s interests to another, a breach of the duty of good faith can give rise to a tort claim. The clearest example is the relationship between an insurer and its insured.
Outside of these special relationships, Texas generally does not recognize a standalone bad faith tort claim between ordinary commercial parties. This does not mean good faith is irrelevant to your dispute, but it does define the limits of the doctrine and what remedies you can realistically pursue.
What Good Faith Requires in Practice
Even within these limits, the implied covenant has real teeth. Courts apply it in a variety of ways that can determine the outcome of contract disputes.
Discretionary Contract Provisions
Many contracts give one party discretion over certain decisions. For example, a contract might allow a party to set prices within a certain range, to approve or reject deliverables based on their “satisfaction,” or to determine the timing of performance. The implied covenant of good faith governs how that discretion is exercised. A party who has discretion under a contract must exercise it honestly and not in a way that is designed to deprive the other party of the benefit of the bargain.
Requirements and Output Contracts
Under the Texas UCC, parties to requirements and output contracts have express good faith obligations. A buyer under a requirements contract cannot, in bad faith, reduce their requirements to zero to deprive the seller of expected business. Similarly, a seller cannot manipulate their output to favor other customers at the contract buyer’s expense.
Termination Rights
Many contracts include broad termination rights that allow either party to end the agreement with or without cause. Courts in Texas have generally upheld these rights, but the manner in which termination is executed can still be subject to good faith scrutiny. If a party uses a termination right pretextually to avoid obligations they have already incurred, or in a way designed to harm the other party beyond simply ending the relationship, that may give rise to a good faith claim.
What Good Faith Does NOT Require
Understanding what good faith does not require is just as important as understanding what it does require.
Good faith does not require a party to forego rights they are clearly entitled to under the contract. If the contract gives you the right to terminate on 30 days’ notice, you are not required to give more notice simply because doing so would be more considerate. If the contract allows you to charge a penalty for late payment, you are not acting in bad faith by enforcing that penalty.
Good faith also does not require you to accept modifications to the contract simply because circumstances have changed and the other party is struggling to perform. Texas courts are generally reluctant to use the good faith doctrine to rewrite contracts after the fact. The doctrine governs how parties exercise rights and perform obligations; it does not give courts license to impose new obligations that the parties did not agree to.
Clients occasionally come to a Houston contract attorney expecting that a court will help them out of a bad deal simply because the other party is holding them to strict contractual terms. That is not what good faith and fair dealing requires. It prevents dishonest and abusive conduct, but it does not save parties from agreements they simply wish they had not made.
Good Faith in Contract Negotiations
One area where Texas courts are particularly cautious is applying good faith to pre-contract negotiations. Unlike some states, Texas does not generally impose a duty of good faith during contract negotiations. Parties are free to negotiate aggressively, walk away from deals, and keep information to themselves without automatically violating any legal duty.
The exception is fraud. If one party makes affirmative misrepresentations during negotiations that induce the other party to enter into a contract, that may give rise to a fraud claim and potentially a right to rescind the contract. But simply negotiating hard or failing to disclose information, without more, does not generally violate a good faith duty in Texas.
Practical Implications for Houston Businesses
If you are involved in a contract dispute in Houston or the surrounding areas, the good faith doctrine may be relevant in several ways:
If you believe the other party is using contractual discretion in a way that seems designed to prevent you from receiving what you bargained for, that is worth discussing with a Houston breach of contract lawyer. Courts can and do provide relief in these situations.
If you are drafting or reviewing a contract, consider whether any discretionary provisions could be exercised against you in ways that would be harmful. Adding objective standards or criteria for the exercise of discretion can reduce ambiguity and help both parties understand exactly what is expected.
If you are considering refusing to perform or exercising a termination right, be thoughtful about your motivations and the manner in which you proceed. Document your legitimate business reasons. Acting in ways that appear pretextual or deliberately harmful could expose you to a good faith claim even if your technical right to act is clear.
How Our Houston Contract Attorneys Can Help
Good faith issues arise in a wide variety of contract disputes, from commercial lease disagreements to vendor disputes to business partnership breakdowns. Our team of Houston business lawyers helps clients throughout Sugar Land, The Woodlands, Katy, Spring, Missouri City, Richmond, and the greater Houston area navigate these complex issues. Our business law solutions include contract drafting and review, dispute resolution, and litigation when required.