The Implied Covenant of Good Faith and Fair Dealing in California
By Matthew W. Reiser | Last reviewed October 1, 2026
In California, every contract contains an implied promise that neither party will unfairly frustrate the other's right to receive the benefits of the deal. The covenant is a powerful tool when one side uses discretion under a contract to take away what the other side bargained for. It is also narrow: it cannot add obligations the contract does not contain, it cannot override express terms, and outside insurance it usually supports only contract damages, not tort damages.
What the covenant is
The California Supreme Court has long held that "[t]here is an implied covenant of good faith and fair dealing in every contract that neither party will do anything which will injure the right of the other to receive the benefits of the agreement." Comunale v. Traders & Gen. Ins. Co., 50 Cal. 2d 654, 658 (1958).
The court later defined its limits. The covenant "exists merely to prevent one contracting party from unfairly frustrating the other party's right to receive the benefits of the agreement actually made," and "cannot impose substantive duties or limits on the contracting parties beyond those incorporated in the specific terms of their agreement." Guz v. Bechtel Nat'l, Inc., 24 Cal. 4th 317, 349-50 (2000).
Where it matters most: discretionary power
The covenant does its most important work when a contract gives one party discretion that affects the other. "The covenant of good faith finds particular application in situations where one party is invested with a discretionary power affecting the rights of another. Such power must be exercised in good faith." Carma Developers (Cal.), Inc. v. Marathon Dev. Cal., Inc., 2 Cal. 4th 342, 372 (1992).
Business contracts are full of discretion:
- An operating agreement lets the manager decide when to make distributions.
- An acquisition agreement ties an earnout to performance the buyer controls.
- A lease requires the landlord's consent to an assignment.
- A distribution agreement lets the supplier allocate product or territory.
- A founder's stock agreement lets the board decide whether a termination was for cause.
When the party holding that discretion uses it to deprive the other of the benefit of the bargain, rather than for the legitimate purposes the contract contemplates, the covenant can supply a claim.
What the covenant cannot do
It cannot contradict the contract. The Supreme Court was "aware of no reported case in which a court has held the covenant of good faith may be read to prohibit a party from doing that which is expressly permitted by an agreement," and explained that "implied terms should never be read to vary express terms." Carma, 2 Cal. 4th at 374. If a defendant "did what it was expressly given the right to do, there can be no breach." Wolf v. Walt Disney Pictures & Television, 162 Cal. App. 4th 1107, 1120 (2008). For the same reason, courts will not imply a covenant that directly conflicts with a contract's express grant of discretionary power. Id. at 1122.
It cannot create new obligations. The covenant is "read into contracts in order to protect the express covenants or promises of the contract." Racine & Laramie, Ltd. v. Dep't of Parks & Recreation, 11 Cal. App. 4th 1026, 1031 (1992) (quoting Foley v. Interactive Data Corp., 47 Cal. 3d 654, 690 (1988)). It "is limited to assuring compliance with the express terms of the contract, and cannot be extended to create obligations not contemplated in the contract." Id. at 1032.
It is not a second breach of contract claim. If the allegations "do not go beyond the statement of a mere contract breach and, relying on the same alleged acts, simply seek the same damages or other relief already claimed in a companion contract cause of action, they may be disregarded as superfluous." Careau & Co. v. Sec. Pac. Bus. Credit, Inc., 222 Cal. App. 3d 1371, 1395 (1990). A covenant claim earns its place when it targets conduct the express terms do not reach, such as a bad-faith use of discretion that technically complies with the contract's words.
Contract damages, not tort damages
Outside insurance, a breach of the implied covenant is a breach of contract. In the employment context, the Supreme Court held that "tort remedies are not available for breach of the implied covenant in an employment contract to employees who allege they have been discharged in violation of the covenant." Foley, 47 Cal. 3d at 700. The court later extended the principle to commercial contracts generally, overruling its earlier decision in Seaman's "in favor of a general rule precluding tort recovery for noninsurance contract breach, at least in the absence of violation of 'an independent duty arising from principles of tort law.'" Freeman & Mills, Inc. v. Belcher Oil Co., 11 Cal. 4th 85, 102 (1995).
Insurance is the main exception. When an insurer "fails to deal fairly and in good faith with its insured by refusing, without proper cause, to compensate its insured for a loss covered by the policy, such conduct may give rise to a cause of action in tort for breach of an implied covenant of good faith and fair dealing." Gruenberg v. Aetna Ins. Co., 9 Cal. 3d 566, 574 (1973). In a business dispute between commercial parties, plaintiffs should plan on contract damages, and on tort damages only if an independent tort, such as fraud, is also present.
Practical points for business disputes
- Read the discretion clause first. The strongest covenant claims attack how discretion was used, not whether it existed. If the contract grants "sole and absolute" discretion, the claim is much harder.
- Build the purpose record. Evidence of why the contract gave the defendant discretion, and what both sides expected, helps show that the defendant used it for an improper purpose.
- Plead it distinctly. Identify the conduct that complied with the letter of the contract but defeated its purpose. Otherwise the claim may be dismissed as duplicative.
- Check the fee clause. Because the claim sounds in contract, a contractual attorney's fee provision may apply, which raises the stakes for both sides.
- Consider the defense side. For a party accused of bad faith, the express terms are the first line of defense. Showing that the challenged conduct was expressly permitted usually defeats the claim.
How we handle these claims
Reiser Law represents plaintiffs and defendants in California contract disputes, including disputes among co-owners, founders and investors, where discretion under an agreement is often at the center of the case. Read more about partnership, LLC and shareholder disputes and co-founder and startup disputes, or contact our San Francisco Bay Area office.
This article is general information, not legal advice, and reading it does not create an attorney-client relationship. The law changes, and its application depends on the facts of each case. Attorney advertising.