Good Faith and Contract Interpretation: A Law and Economics Perspective
SIena Memos and Papers in Law & Economics - SIMPLE Paper No. 42/06
61 Pages Posted: 22 Jan 2008 Last revised: 15 Aug 2010
Date Written: August 13, 2010
The widespread acknowledgement of the implied contractual obligation of good faith is a relatively recent phenomenon in the American legal landscape. In the paper, I claim that the obligation of good faith in a contract should be a default rule that parties should include in their agreement only when it maximizes the ex-ante value of their contractual relationship. I discuss under what conditions the requirement of good faith proves efficient and propose a basic framework of reference for the parties' decision to include or exclude good faith in their contract. In this framework, the obligation of good faith is conceived as the rule of law that prohibits each contracting party from taking advantage of the contract's incompleteness to expropriate her counterparty's expected contractual benefits. However, I challenge the law-and-economics argument supporting the efficiency of good faith, claiming that parties themselves should decide whether to include or exclude good faith in their agreements. From a practical viewpoint, this means that the interpretative regime should be determined by private autonomy, rather than be a judicial decision based on a-priori assumptions.
In the good-faith regime I propose, therefore, parties are free to choose whether (i) to exclude good faith from their contracts and, thereby, opt for a literal interpretative regime in which the contract is the only evidentiary base courts should use in enforcing their agreement; or (ii) to include good faith and opt for a good-faith interpretative regime, giving courts indications on the evidentiary base that should be used to interpret the content of the good-faith obligation.
Keywords: contract law, good faith, incomplete contracts
JEL Classification: K0, K12
Suggested Citation: Suggested Citation