The Covenant of Good Faith and Fair Dealing: The Contract Term You Never Wrote

Every California contract contains a term that neither side drafted, negotiated, or signed. It does not appear in the document, and it cannot be deleted from it. It is the implied covenant of good faith and fair dealing, and depending on the facts of your dispute it is either the claim that saves your case or the claim a judge strikes as clutter. Here is what the covenant actually is, when it applies, and how to decide whether it belongs in your lawsuit.

What the covenant is

California law implies in every contract a promise that neither party will do anything to unfairly interfere with the other party's right to receive the benefits of the agreement. That is the whole idea: you and I made a deal, and even where the written terms leave me room to maneuver, I may not use that room to deliberately deprive you of what the deal was supposed to give you.

Two boundaries keep the covenant from swallowing contract law. First, it is tethered to the contract. The covenant does not impose free-floating duties to be kind, generous, or reasonable in the abstract; it protects only the benefits the contract itself promises. Second, it cannot contradict the contract. The California Supreme Court made this clear in Carma Developers v. Marathon Development: conduct the contract expressly authorizes cannot be a breach of the implied covenant, even if it feels ruthless. If the lease says the landlord may recapture the space and pocket the appreciation, exercising that right is not bad faith. It is the bargain.

When it applies

The covenant exists in every California contract, but it earns its keep in a specific situation: when one party holds discretionary power under the agreement and uses that discretion in bad faith to strip the other side of the deal's value.

Think of the recurring patterns:

1. Discretionary approvals. A contract conditions payment or performance on one party's approval, satisfaction, or consent, and that party withholds it dishonestly to escape the deal rather than for any genuine business reason.
2. Contingent compensation. An employer terminates a salesperson weeks before a large commission vests, or a buyer structures a closing to dodge an earn-out. The written terms were technically followed; the timing and motive were engineered to defeat the payment.
3. Performance made impossible. One party quietly prevents the conditions of the other side's performance from occurring, then points to the failed condition as an excuse.
4. Starving the deal. A party with control over an ongoing relationship, a distributor, a licensee, a managing partner, runs the arrangement in a way calculated to make the other side's rights worthless.

In each case the defendant's defense is the same: "show me the clause I violated." And in each case the answer is the covenant: you violated the promise the law reads into every contract, that you would not use your position to gut the benefits you agreed to deliver.

Two important limits. In employment, the covenant cannot rewrite at-will status; the Supreme Court held in Guz v. Bechtel that the implied covenant cannot create job security the contract does not provide, though it can still protect earned compensation. And outside the insurance context, breach of the covenant is a contract claim with contract damages. Insurance bad faith is the famous exception, where the covenant sounds in tort and can support punitive damages. California courts have refused to extend that tort remedy to ordinary commercial contracts.

Should you plead it in your lawsuit?

This is where strategy matters, because the implied covenant claim is both overused and underused.

It is overused as a reflex. Many complaints plead breach of contract and then add an implied covenant claim that alleges the exact same conduct. California courts routinely strike those as superfluous: if the defendant's conduct breached an express term, the covenant claim adds nothing, and judges treat it as duplicative window dressing. A dismissed cause of action does not impress anyone, and cluttered complaints invite demurrers.

It is underused where it actually wins cases. The covenant claim earns its place when the defendant's conduct slipped between the express terms, when the contract gave them discretion, timing control, or gatekeeping power and they weaponized it. In those cases the covenant is not duplicative; it is the theory. Without it, you have a defendant smugly waving a contract they technically followed.

So the practical test before filing: ask what the defendant did, and whether an express clause squarely prohibits it.

• If yes, plead breach of contract and think hard before adding the covenant claim at all.
• If the conduct defeated the purpose of the deal without violating any specific clause, plead the implied covenant, and plead the facts that show bad faith: the timing, the pretext, the internal communications, the departure from how the parties actually operated.
• If you are chasing punitive damages on a commercial contract through a covenant claim, adjust expectations. Outside insurance, the remedy is contract damages: the value of the benefits you were denied.

One more drafting note: the covenant is also a defensive tool. Businesses accused of breaching it should look first at Carma Developers, because if the contract expressly authorized the conduct, the claim fails as a matter of law, and that argument can end a case at the pleading stage.

The Darvish Firm's approach

Our Los Angeles business litigation attorneys see the covenant from both sides: plaintiffs whose deals were hollowed out by a counterparty's engineered technicalities, and defendants accused of bad faith for doing what their contracts plainly allowed. The claim rewards careful pleading and punishes lazy pleading, and the difference is usually visible on the face of the complaint.

If a contract counterparty has used discretion, timing, or fine print to strip the value out of your agreement, or you have been accused of doing so, call (310) 677-3512 or request a consultation. Our breach of contract and business litigation teams handle these disputes across Southern California.

This article is general information about California law, not legal advice, and reading it does not create an attorney-client relationship. Every case depends on its facts. Consult an attorney about your specific situation.