The hidden clause in every real estate contract

When you sign a real estate contract in Nevada, you promise not to engage in arbitrary, unfair acts that work to the disadvantage of the other party to the contract. This promise is implied, which means you won’t see it in the written contract when you read it before signing it. This legal principle is called the covenant (or duty) of good faith and fair dealing — CGFFD, for short — and may give rise to both contractual and tort remedies.

I’m routinely asked about conduct in relation to breach of a real estate contract. In my view, the CGFFD principle is both a shield and a sword: a shield, because it encourages fair conduct that may protect against disputes and messy/costly litigation; a sword, because it can be used to create disputes, perpetuate litigation and increase litigation costs. Here’s what you should know about the CGFFD:

1. It’s implied in every Nevada contract. A disclaimer or waiver of the CGFFD is likely unenforceable, and could be used against the disclaiming party to show bad faith and a violation of the CGFFD. Besides, who wants to enter into a contract with a party that wants to disclaim a promise to conduct itself fairly and in good faith in performing the contract’s objectives?

2. It applies to oral contracts, if an oral contract is found to exist and to be enforceable, i.e., not violating the statute of frauds (e.g., a lease of real property for more than one year and a sale of real property are void unless in writing and signed by the parties).

3. It applies in the performance and enforcement of the contract, not to the negotiation of the contract. That said, if you sign a letter of intent in advance of the final, definitive contract, the CGFFD will likely require the parties to negotiate the deal in good faith (versus arbitrarily or capriciously terminating negotiations) and to abide by the essential business terms of the letter of intent. This is the case even though you have identified the letter of intent as nonbinding and unenforceable. Further, if the letter of intent has terms that are intended to be binding, like confidentiality or exclusive dealing, then the CGFFD will apply in the context of those terms.

4. It may not be used to modify the terms of the contract or to imply into the contract a provision contradicted by the express terms of the contract. For example, if a contract requires a party to perform specific work on a specific portion of real estate, that party does not breach the CGFFD by failing to investigate or disclose wide-ranging structural issues with that real estate, since the contract did not require such investigation or disclosure. Similarly, if a contract did not contain a specific provision requiring the seller to make certain disclosures to the buyer, the seller’s failure to make those same disclosures may not constitute a breach of the CGFFD. Thus, an integration or merger clause – providing that the contract is the complete, full and final expression of the parties’ agreement – may operate to limit or negate a claim for breach of the CGFFD. That is because an integration clause will preclude reference to or reliance upon extraneous matters outside the four corners of the contract, thereby making it harder for a party to use those extraneous matters to support its claim for breach of the CGFFD.

5. It is most often used when the terms of a contract have been followed, but when a party to the contract deliberately contravenes the intention and spirit of the contract, that party can incur liability for breach of the CGFFD. For example, if a subcontractor waives all claims for damages based on delays in its ability to commence and perform its work arising from any reason, that subcontractor could still claim damages if the delays are so unreasonable so as to amount to project abandonment or caused by fraud, misrepresentation or similar conduct. In other words, regardless of how limited you think your contract is, if the court finds that you technically complied with the contract’s written terms but had the bad faith intent to prevent the contract’s purpose from coming to fruition, liability can arise.

6. It can result in contract and tort damages. The latter may result in materially increased damage liability because broader compensatory damages are available, as are punitive damages, for a tortious breach of the CGFFD (versus contractual breach). Tort damages are imposed in situations where a special or fiduciary relationship existed between the breaching party and the wronged party (i.e., the former was in a superior or entrusted position). This kind of relationship is more likely to be found in the areas of employment, insurance, partnerships and franchise arrangements than in arms-length real estate contracts (particularly if commercial in nature).

If you are uncertain about whether or not to engage in certain conduct or to make certain decisions in relation to contract rights or obligations, I suggest asking yourself whether the conduct or decision (1) complies with the literal terms of the contract, and (2) is in keeping with the spirit and intention of the contract. If, in good conscience, the answer to either of the questions is no, then it is time to step back, reassess the conduct or decision, and consult an attorney.

Elizabeth Fielder is an attorney with Fennemore Craig Jones Vargas in Reno. She can be reached at efielder@fclaw.com. Shannon Pierce, an attorney with Fennemore Craig Jones Vargas, provided research for this article. She can be reached at spierce@fclaw.com.