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What Does “Bad Faith” Mean In A Contract?

When businesses enter into contracts, they have an implied duty to act honestly, in good faith, and fairly. When they do not, they can be sued for a breach of this duty. Here, we discuss this duty of good faith and fair dealings and bad faith claims in the business context and the insurance context. 

What is the duty of good faith and fair dealing? 

Every contract contains an implied duty of good faith and fair dealing. This duty is implied, meaning it is not explicitly written into the contract. All parties are charged with acting honestly and fairly. They are expected to fulfill their duties by following the “spirit” of the contract, and if they do not, they can be sued. 

What is bad faith?

Contract law, particularly a document called the Restatement (Second) of Contracts, is where you will find the requirement of good faith and fair dealing, along with an explanation of what “good faith” means. The comments to the Restatement explain good faith in the negative; that is, what it does not include. It states that good faith “excludes a variety of types of conduct characterized as involving ‘bad faith’ because they violate community standards of decency, fairness or reasonableness.”

Good faith, therefore, is conduct that does not involve bad faith. This begs the question: what is “bad faith?” The Restatement explains that a “complete catalogue of types of bad faith is impossible” and instead chooses to give examples of bad faith. Bad faith includes the following acts: “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.”

In the paragraphs that follow, we will illustrate how this unfolds in two contexts: insurance claims and contractual disputes.

What is bad faith in an insurance context? 

Insurance companies owe a duty of good faith and fair dealing to those they insure. The implied covenant of good faith and fair dealing requires both the insurer and the insured to act in a way that does not interfere with the other party receiving benefits under the insurance agreement. If an insurance company does not act honestly and fairly in response to a claim by a policyholder, the policyholder might be able to bring a bad faith claim against the insurer. 

In North Carolina, bad faith cases can only be brought against a person’s own insurance company, not a negligent third party’s insurance company. Thus, only if your own insurance company has acted in bad faith can you bring a bad faith claim. 

How is bad faith different from breach of contract?

A breach of contract occurs when one party fails to uphold a specific requirement of the contract. A bad faith claim arises when one party acts in an unethical or deceptive manner. Unlike a breach of contract claim, a bad faith claim is not a violation of any specific provision of a contract but rather of the spirit of the agreement itself.

How is bad faith different from breach of contract in the insurance context?

In the insurance context, a breach of contract claim can be brought for any violation of the insurer’s specific duties under the insurance policy. A bad faith claim, on the other hand, is brought when the insurer breaches its implied duty of good faith and fair dealing. For example, based on the duty of good faith and fair dealing, an insurance company cannot interfere with the insured’s rights to receive benefits for covered risks and must use good faith when settling claims. When an insurance company denies a policyholder’s claim, while that denial might not have violated the terms of the policy itself, it could have been denied in bad faith. In a situation like this, if a plaintiff can show that the insurer’s denial, delay, or withholding of benefits was unreasonable, he may have a valid bad faith claim and may be able to recover damages.

What damages are available in a claim for bad faith?

Damages in bad faith cases against insurance companies can be complicated as they involve both traditional economic damages, as well as punitive damages (in some cases). In most personal injury cases, the court’s goal is to make the injured party whole again. In these cases, plaintiffs are often awarded economic and emotional damages to pay for items like medical bills, lost wages, property damage, attorneys’ fees, and emotional distress. 

Damages such as these, aimed to make a plaintiff whole again, are also available in a bad faith action. However, additional damages are potentially available as well when the insurance company acted particularly badly. Punitive damages are awarded to punish a party for its conduct, especially when the party engaged in extreme wrongdoing. Courts can and often do award punitive damages in bad faith cases. Punitive damages in bad faith cases can be very high, as they are also meant to deter the insurance company from acting in bad faith in the future. 

How can an attorney assist with a bad faith claim?

The implied duty of good faith and fair dealing requires parties to a contract to act reasonably and in good faith to fulfill their obligations. When one party does not uphold his duty and acts in bad faith, whether that party is an insurance company, individual, or corporation, the injured party may have the right to bring a bad faith claim. Our attorneys are experienced in all areas of civil litigation. If you believe your contractual rights have been violated by an act of bad faith, contact us today for a consultation and to review your case to determine the best course of action to recover the damages to which you are entitled.

Our firm proudly serves clients across North Carolina and helps them resolve their contractual disputes. To speak with a member of our firm, fill out our contact form, or call our Raleigh office (919-278-7453) or our Winston-Salem office (336-725-8688) to schedule a consultation with one of our employment law attorneys.

This article does not establish an attorney-client relationship and must not be construed as legal advice.