Reasonableness and Good Faith in Contracts

In my recent post on moral turpitude, I noted that I found odd the phrase “its reasonable but good faith opinion.” I thought I should take a more general look at the relationship between those two concepts.

In this post, I considered a side issue—use of reasonable and reasonably. Now it’s time to address the main questions: When should you use a reasonableness standard and when should you use a good-faith standard? And does it make sense to use both in a given provision?

Whether to Use a Reasonableness Standard or a Good-Faith Standard

As a general matter, I prefer to have a reasonableness standard rather than a good-faith standard apply to the other side in a transaction. A reasonableness standard is objective—what would a reasonable person have done in the circumstances? By contrast, a good-faith standard is subjective—did the party in question think it was acting reasonably, regardless of whether it was or not when viewed from the perspective of a reasonable person? It seems counterproductive to give the other party room to act unreasonably but in good faith.

Of course, the difference between a reasonableness standard and a good-faith standard can be more apparent than real. Often it’s impossible to determine what a contract party was thinking when it acted a given way—either you have no evidence on that score, or the evidence you have is self-serving. So courts often end up deciding whether a party acted in good faith by considering how others have behaved in similar circumstances—in other words, by in effect applying a reasonableness standard. But I’d prefer to apply a reasonableness standard explicitly rather than have it applied by default.

So in the following extracts culled from EDGAR, I’d replace the good-faith standard with a reasonableness standard:

and shall make a good faith effort [read use reasonable efforts] to accommodate the Consultant’s reasonable scheduling needs in coordinating such cooperation

provided, however, that any such tax, assessment, charge or levy need not be paid if the validity thereof is being contested in good faith [read reasonably contested] by appropriate proceedings

unless the Company has in good faith [read reasonably] determined that the matters relating to such notice do not constitute material, nonpublic information

any written notice, instruction, instrument, statement, request or document that the Escrow Agent believes in good faith [read reasonably believes] to be genuine

But I can think of two contexts where a good-faith standard would be appropriate:

First, a good-faith standard is appropriate to qualify an obligation to negotiate. Because a good-faith standard is built into every contract through the implied duty of good faith (see MSCD 2.112), an explicit good-faith standard in this context should be redundant. But it’s standard, perhaps because (1) it reinforces the notion that you’re only required to negotiate as long as a meeting of the minds is possible and (2) it makes it clear that a reasonableness standard doesn’t apply—you can’t be forced to agree to something just because a reasonable person in your position would have done so.

And second, a good-faith standard is appropriate when you want to make it clear that the discretion granted a party in a given context is subject to an obligation to act in good faith. Courts in some jurisdictions have held that if Acme is authorized to do something and the provision uses “at its sole discretion” or comparable language, that discretion isn’t subject to the implied duty of good faith. For purposes of contracts governed by the laws of any of those jurisdictions, you should consider either (1) cutting back any grant of discretion that could be construed as particularly open-ended or (2) making it clear that it’s subject to a good-faith standard. (This is something that I’ll soon be writing about at greater length.)

And of course, if your client is the one subject to a given provision, you might want to use the less-exacting good-faith standard.

Using Both Standards Together

What about combining the two standards? I think it makes no sense to do so. If you meet the more exacting reasonableness standard, what could be the point of invoking good faith? Consider the following examples:

and it continues to actively employ, in good faith, all reasonable efforts to cause the applicable Registration Statement to become effective

the amount of all taxes paid … (as determined reasonably and in good faith by a Financial Officer)

makes it inappropriate in the reasonable good-faith judgment of the indemnified party for the same counsel to represent both the indemnified party and the indemnifying party

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Can you think of any exceptions to these two general recommendations (other than those I’ve noted)?

About the author

Ken Adams is the leading authority on how to say clearly whatever you want to say in a contract. He’s author of A Manual of Style for Contract Drafting, and he offers online and in-person training around the world. He’s also chief content officer of LegalSifter, Inc., a company that combines artificial intelligence and expertise to assist with review of contracts.