Contractual Duty of Good Faith and Fair Dealing in Construction Claims
By: Anthony J. Vanicek, Esq.
In Colorado, every contract that affords any discretion to one party comes with an implied duty (or covenant) of “good faith and fair dealing.” Colorado case law on the duty of good faith and fair dealing tends to focus on employment contracts (in particular when an employee gets to determine what constitutes “for cause” termination), and in the interpretation of “good faith” as used in the Uniform Commercial Code. But construction contracts are replete with instances in which one party is given discretion to determine scheduling, certain building specifications, or when one party seeks to process change orders as allowed under the contract.
Duty of Good Faith and Fair Dealing Generally
The duty of good faith is intended to give effect to the intentions of the parties and to honor their reasonable expectations. However, the duty of good faith and fair dealing cannot create new obligations, result in a material change in the terms of the contract, or cause either party to assume obligations that vary or contradict the contract’s express provisions. This puts courts in the difficult position of deciding whether to restrain one party’s exercise of discretion under the contract, while still honoring that party’s right to exercise discretion that it has bargained for under the terms of the contract. Most courts have tended to look towards a particular industry’s practices to determine what the party’s reasonable expectations may have been when they entered into a contract.
Some courts have been very careful to honor a party’s right to exercise their discretion, especially where the contract states that a party’s discretion shall be “unfettered” or “absolute”. In Big Horn Coal Co. v. Commonwealth Edison Co., 852 F.2d 1259, 1267 (10th Cir. 1988), the court explained that “it is possible to so draw a contract as to leave decisions absolutely to the uncontrolled discretion of one of the parties and in such a case the issue of good faith is irrelevant.” Id. But decisions like this should be contrasted with decisions such as Oberhamer v. Deep Rock Water Co., 2009 WL 1193737, (D. Colo. 2009) where a court held that in an employment contract that gave an employer discretion to determine what constituted “for cause” termination, “not applying a good faith requirement would render Deep Rock’s contractual obligations vis à vis severance pay illusory.” Id. at 10. In other words, if performance of a contract is at one party’s sole discretion, that contract may not be a contract at all, and the duty of good faith and fair dealing helps create an enforceable contract.
Abusive Failure or Refusal to Process Change Orders
Construction contracts almost always provide for a “change order” process to deal with unforeseen circumstances that require a change to the original plan. Typically, one party is given discretion as to whether they will accept or reject the change order. But while one party may have discretion to accept or reject change orders, not every rejection will withstand scrutiny in court.
For example, in Hamon Contractors, Inc. v. Carter & Burgess, Inc., 229 P.3d 282 (Colo. App. 2009), Carter & Burgess entered into a contract with the City of Denver which gave Carter & Burgess discretion to process change orders. Hamon Contractors Inc., (“Hammon”) experienced delays in its performance due to excessive water on the site causing the soil to become oversaturated. Id. at 287. Hamon submitted a change order for this stabilization work to C & B who denied the request for additional payment stating that Hamon could have taken ordinary and reasonably foreseeable drainage measures to prevent the issues. Id. at 287. The Court held that although Hamon had discretion as to whether to process change orders, the oversaturation of the soil was not foreseen by either party. The Court stated “[t]he implied covenant of good faith and fair dealing, which, under Colorado law, is implied in every contract, [citations omitted] limited [that] discretion. . . .”
Similarly in Dennis I. Spencer Contractor, Inc. v. City of Aurora, 884 P.2d 326 (Colo. 1994), a court held that a party has acted in bad faith where the refusal to process a change order or grant a time extension was proven to be connected to a retaliatory motive. See also Westec Const. Management Co. v. Postle Enterprises I, Inc., 68 P.3d 529 (Colo. App. 2002) (where refusal to process change order may constitute failure to mitigate damages). However, these cases should be contrasted with decisions such as A.A. & E. B. Jones Co v. Boucher, 530 P.2d 974 (Colo. App. 1974) where the court found that refusal to process change orders that constituted a dramatic change in price was not bad faith. This stands in harmony with the courts intention to give effect to the reasonable expectation of the parties.
Abusive Enforcement of Scheduling Demands
In Colorado, if the contracts states that “time is of the essence” courts will enforce damages for delays. Nevertheless, construction contracts are known for having unforeseen circumstances that require modifications to the initially agreed upon schedule. Where one party has discretion to change or not change a scheduling demand, the duty of good faith and fair dealing still comes into play. In New Design Constr. Co., Inc. v. Hamon Contractors, Inc., 215 P.3d 1172 (Colo. App. 2008), Hamon was responsible for developing and maintaining a schedule and New Design Construction Co. (“New Design”) was responsible for completing its work as directed by Hamon. Hamon’s initial phasing plan contemplated building five bridges sequentially, but later altered the plan so that all five bridges would be built simultaneously. Hamon did not provide notice to New Design in a timely manner and would later try to enforce the new scheduling demands in a strict manner. The court held that Hamon was responsible for developing and maintaining a schedule and NDCC was responsible for completing its work as directed by Hamon, but also that and Hamon was required not to abuse its discretion when directing NDCC to complete its work. Id. at 1182.
This case demonstrates that while contracts will be enforced in a way that gives effect to the intention of the parties (to include honoring one party’s right to exercise discretion), a court will restrain a party’s discretion if they are using it in a commercially unreasonable manner. In all contracts that confer discretion to one party courts will generally find a breach of good faith and fair dealing where one party uses discretion to act dishonestly or act outside of commercially accepted practices, where a party uses discretion for self-dealing, where discretion is used or the sole purpose of inflicting disadvantage upon the other party among many other scenarios.