Does Texas Recognize a Duty of Good Faith in Business Contracts?

The general rule: no implied duty in ordinary contracts

Many states read a covenant of good faith and fair dealing into every contract. Texas does not. In English v. Fischer in 1983 the Texas Supreme Court refused to adopt a general implied duty, holding that it would let courts rewrite agreements the parties made and would make every breach of contract case a dispute about motive. The court has held that line since. A Texas business that performs exactly what the contract requires, for reasons the other side considers unfair, has not breached an implied duty, because there is none to breach.

The practical consequence is that Texas contract disputes are about the words. A counterparty that exercises a termination right the day before a bonus vests, that routes orders to an affiliate because the contract does not forbid it, or that refuses a discretionary approval the contract gives it the right to refuse, is usually within its rights. The remedy, if any, lies in a term that was breached, a representation that was false, or a relationship that carries duties of its own.

Exception one: special relationships

Texas recognizes a duty of good faith and fair dealing where a special relationship exists between the parties. The clearest example is the insurer and its insured, where the Texas Supreme Court imposed a common-law duty of good faith on insurers in handling claims because of the imbalance of power and the insured's dependence. Formal fiduciary relationships, such as partner and partner, trustee and beneficiary, or agent and principal, carry duties that include and exceed good faith. Texas courts have also found informal fiduciary or confidential relationships where one party justifiably relied on another over a long course of dealing that predated the contract, though they do that cautiously and not merely because the parties trusted each other in business.

Ordinary commercial relationships do not qualify. Courts have declined to find a special relationship between lender and borrower, franchisor and franchisee, employer and employee, supplier and distributor, or landlord and tenant, absent facts beyond the contract itself. Where partners or LLC members are involved, the analysis moves from good faith to fiduciary duty, covered in the fiduciary duties partners and LLC managers owe in Texas.

Exception two: sales of goods under the UCC

The Uniform Commercial Code brings its own rule. Business and Commerce Code section 1.304 provides that every contract or duty within the Code imposes an obligation of good faith in its performance and enforcement. Section 1.201(b)(20) defines good faith as honesty in fact and the observance of reasonable commercial standards of fair dealing. Section 1.302(b) makes the obligation non-waivable: the parties may not disclaim it, though they may set the standards by which it is measured if those standards are not manifestly unreasonable.

The Code also applies good faith to particular terms. Under section 2.305, a price that one party is to fix must be fixed in good faith. Under section 2.306, output and requirements contracts are measured by the quantity that occurs in good faith, with no quantity unreasonably disproportionate to stated estimates or prior dealings, and an exclusive dealing agreement imposes an obligation on the seller to use best efforts to supply the goods and on the buyer to use best efforts to promote their sale. A distributor or supplier of goods therefore has good faith arguments that a provider of services does not. The structure of goods cases is covered in how the UCC changes a sale of goods dispute in Texas.

Two limits apply even here. The UCC duty of good faith does not create new obligations; it governs how existing ones are performed. And Texas courts have generally held that it does not support an independent cause of action for breach of good faith; it is part of the breach of contract claim.

Exception three: the contract says so

Texas enforces what the parties wrote, and parties often write good faith into their agreements. A clause requiring a party to negotiate renewal in good faith, to use commercially reasonable efforts to obtain a permit, to use best efforts to market a product, or to act reasonably in granting an approval creates an express obligation that can be breached. The dispute then becomes what the chosen standard means. "Best efforts" is generally read as more demanding than "reasonable efforts," though Texas courts have required that the contract supply some objective goal or guideline against which effort can be measured; a bare promise of best efforts with no benchmark may be too indefinite to enforce. Clauses that make a party's discretion "sole" or "absolute" are enforced as written and are the drafting answer to the good faith argument.

What to plead instead

A business that feels it was dealt with in bad faith usually has a claim; it is just not called that. The candidates are:

• Breach of an express term. Read the contract for the obligation actually violated: an exclusivity clause, a notice requirement, a payment term, a confidentiality covenant. Most bad faith complaints turn out to be breaches of something specific.
• Fraud or fraudulent inducement. A false statement of fact that induced the contract, or a promise made with no intention of keeping it, is actionable in tort regardless of good faith doctrine. See fraudulent inducement in Texas.
• Breach of fiduciary duty. Where a partner, manager, agent or other fiduciary is involved, the duty of loyalty does the work the implied covenant does elsewhere.
• Tortious interference. Where the other party's conduct was aimed at your contracts with third parties, covered in tortious interference with contract in Texas.
• DTPA. A business consumer can sue for false, misleading or deceptive acts and unconscionable conduct without proving any implied duty.
• Prevention and waiver doctrines. A party that prevents the other side's performance cannot complain of it, and a party that hinders a condition cannot rely on its non-occurrence. These are contract doctrines, not good faith claims, but they reach much of the same conduct.

Example

Suppose a Dallas regional distributor has a five-year exclusive distribution agreement for a manufacturer's industrial fasteners, a sale of goods. The agreement sets minimum purchase quantities and says nothing about the manufacturer's pricing to other distributors or its direct sales. In year three the manufacturer begins selling directly to the distributor's largest customers at prices below the distributor's cost. The agreement has no term the manufacturer has literally violated. Because this is a contract for goods, section 2.306's exclusive dealing rule imposes on the manufacturer an obligation to use best efforts to supply and, read with section 1.304, to perform in good faith, and direct sales that hollow out an exclusive territory are a strong basis for a breach claim measured by the lost sales. Had the agreement been for exclusive marketing services rather than goods, the UCC would not apply, no duty would be implied, and the distributor would be left to argue that the exclusivity grant itself was breached by the direct sales, a contract argument about the meaning of "exclusive" rather than a good faith claim.

Why Texas keeps the rule

The Texas approach favors predictability. A party can read a contract and know what it is permitted to do without guessing how a jury will later judge its motives. The cost is that a party with superior bargaining power can draft a contract that gives it latitude the other side did not appreciate. The protection is at the drafting stage: define the standards, limit the discretion, and write the good faith or best efforts obligations you want, with benchmarks that make them enforceable. A litigator asked to evaluate a bad faith complaint will start by asking which express term, which relationship, and which statute can carry it. Tina Wysk represents Dallas businesses in contract disputes, including claims that a counterparty abused a contractual right or breached an express good faith or best efforts obligation, in state and federal court.