Good faith: what it means and how to draft it

What a good faith clause does

A good faith clause states expressly a duty that courts in most states already read into a contract: the implied covenant of good faith and fair dealing. The clause signals that each party will perform and enforce the agreement honestly, will not evade the spirit of the deal, and will not use technical compliance to defeat the other party’s reasonable expectations.

The covenant works mainly as a standard of conduct and as a gap-filler. It does not add substantive obligations that contradict the written terms, and it does not give a court license to rewrite the bargain. Instead, it governs the manner of performance, especially where the contract grants one party discretion: setting a price under an index, approving a deliverable, deciding output or requirements volumes, or exercising a right to terminate. Where the agreement is silent on how that discretion must be used, good faith supplies the missing standard, so the discretion is exercised reasonably and consistently with the parties’ justified expectations, not arbitrarily and not to recapture an opportunity the party gave up when it signed.

A good faith clause is therefore less about creating new duties and more about naming and reinforcing an existing one, so both sides read the contract with the same baseline of honest, cooperative performance.

Drafting example

“Each party shall act in good faith and deal fairly with the other in performing and enforcing this Agreement. Where this Agreement grants a party discretion, that party shall exercise that discretion reasonably and in good faith, and shall not exercise it in a manner that deprives the other party of the benefits it is entitled to receive under this Agreement. This Section does not create any obligation inconsistent with the express terms of this Agreement.”

The first sentence fixes the general standard, honesty and fair dealing, and ties it to both performance and enforcement, mirroring the Restatement. The second sentence targets the highest-risk area, discretionary rights, and requires that discretion serve the contract rather than undermine it. The final sentence is a guardrail: it confirms the clause supplements, and does not override, the express terms, which reduces the risk that a counterparty later argues good faith trumps a right you negotiated.

What US law says

The baseline is broad. The Restatement (Second) of Contracts Section 205 states that every contract imposes on each party a duty of good faith and fair dealing in its performance and enforcement. For sales of goods, the Uniform Commercial Code Section 1-304 imposes an obligation of good faith in the performance and enforcement of every contract within its scope, and Section 1-201(b)(20) defines good faith as honesty in fact and the observance of reasonable commercial standards of fair dealing.

Two features matter for drafting. First, the duty generally cannot be disclaimed: under UCC Section 1-302(b), the parties may not waive the obligations of good faith, diligence, reasonableness, and care, although they may by agreement set the standards by which performance of those obligations is measured, provided the standards are not manifestly unreasonable. Second, the covenant is a shield for the bargain, not a sword to remake it. Courts frequently hold that it cannot create obligations that contradict the contract’s express terms and cannot be used to override a clearly reserved right.

State law varies in important ways. New York courts recognize an implied covenant that neither party will do anything to destroy the other’s right to receive the fruits of the contract, but decline to use it to imply terms inconsistent with the writing. California recognizes the implied covenant in every contract and, in the narrow insurance context, allows a bad-faith breach to sound in tort with broader damages. Delaware treats the implied covenant as a cautious, gap-filling doctrine of last resort, especially for LLC and limited partnership agreements. Because whether a breach sounds in contract or in tort, and what remedies follow, depends on the jurisdiction and the subject matter, the governing-law choice and the specific facts should be confirmed for each deal.

Common mistakes to avoid

The most common error is treating good faith as a substitute for clear drafting. The covenant fills gaps; it does not cure vague price, scope, or termination language, and leaning on it invites disputes. A second mistake is trying to disclaim the duty outright, which is generally ineffective and can signal bad intent; the better move is to define reasonable standards for measuring discretionary performance. A third is assuming good faith will override an express right, such as an unqualified right to terminate for convenience; many courts will enforce the clear right and refuse to let the covenant swallow it. Teams also blur good faith with best efforts, though the two are different: good faith sets a standard of honesty and fair dealing, while a best-efforts or commercially reasonable efforts clause sets an affirmative level of diligence. Finally, parties often ignore state-law differences, drafting a single clause for a fifty-state footprint without checking how the governing state treats the covenant and its remedies.

When it matters most

Good faith carries the most weight in relational and long-term contracts, where cooperation over time cannot be fully specified in advance: supply and distribution agreements, franchises, joint ventures, and long-dated services deals. It is decisive wherever a contract hands one party open-ended discretion, including requirements and output contracts under UCC Section 2-306, index-based or cost-plus pricing, approval and acceptance rights, earn-outs, exclusivity and most-favored-customer terms, and termination-for-convenience clauses. In exclusive dealing arrangements, the UCC reads in a duty to use best efforts, which good faith reinforces. In each of these settings, the party holding discretion should document its reasoning, because a clear, contemporaneous record of an honest, commercially reasonable decision is the strongest answer to a later claim that discretion was abused.

Good faith is easy to state and hard to police, which is why it rewards disciplined contract management. Capturing every good faith and discretion clause in a searchable repository, applying consistent drafting rules through compliance playbooks, and flagging one-sided or risky discretion with PactAI risk scoring lets a team hold the same standard across a whole portfolio rather than one contract at a time. Pactolane can also surface conflicts between agreements and preserve a full audit trail of how discretionary rights are exercised, turning an abstract duty into something a business can actually monitor, evidence, and defend.