What is “good faith”?

In law, the phrase “good faith” refers to a requirement to act honestly and to keep one’s promises without taking unfair advantage of others or holding others to an impossible standard.

Good faith is required in a wide range of situations, including contracts and business dealings, as well as during mediation, arbitration or settlement negotiations in a personal injury or similar tort case. The good faith requirement also appears in business law. The officers and directors of a corporation are obligated by their fiduciary duties to act in good faith when dealing on behalf of the corporation.

Although the phrase “good faith” may mean specific things in certain situations, most courts hold defendants to one of two separate standards when determining whether the defendant acted in good faith or in bad faith.

The first standard is based on reasonableness. A person or company may be liable for bad-faith dealing if they refuse to uphold their end of a contract or other bargain for no reason or for a reason that has little to do with the actual situation. For instance, suppose a plaintiff is injured in a car accident. His auto insurance covers medical bills for injuries caused by car accidents, so he files a claim with his insurance company. Instead of paying the benefits it owes him, however, his insurance company refuses to send a check and hangs up on the injured man whenever he calls them about it.

In this case, a court may find that the insurance company is liable for failing to act in good faith because its actions were not reasonable.  Not only did the company refuse to pay the benefits it owed the injured policyholder, but it also refused to give any reason why it would not pay.

The second standard also uses reasonableness to determine whether good faith exists, but it also asks about intent. Under this standard, a defendant may be liable for dealing in bad faith if he did not act reasonably and if he knew or should have known there was no reasonable basis to act the way he did.

For instance, in the example above, the insurance company was held liable for not dealing in good faith because it refused either to pay the benefits it owed or to explain why it would not pay them. Under this standard, the insurance company would only be liable for dealing in bad faith if it also knew that there was no reasonable way it could refuse to pay the injured plaintiff’s claims.

Officers and directors of a company are required to deal in good faith when representing the company to anyone, including the company’s own shareholders. However, shareholders who do not feel like the company’s officers or directors are acting in good faith must face an extra obstacle when bringing the directors or officers to court. Known as the business judgment rule, this obstacle states that courts presume a corporation’s officers and directors are acting in good faith, unless the plaintiff can show evidence that indicates they are not, or unless their actions were so unreasonable that no reasonable person would have done the same thing in that situation.

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