The Journal of The DuPage County Bar Association

Back Issues > Vol. 16 (2003-04)

The Application of the Implied Covenant of Good Faith and Fair Dealing in Contract Cases
By Ronald B. Kowalczyk and Melissa Piwowar

The implied covenant of good faith and fair dealing has been, and continues to be, a hotly litigated issue in Illinois courts. Generally speaking, the implied covenant requires that parties to a contract use "good faith and fair dealing in its performance and its enforcement" of the contract.1 The Second Restatement of Contracts provides that "Good faith performance or enforcement of a contract emphasizes faithfulness to an agreed common purpose and consistency with the justified expectations of the other party; it excludes a variety of types of conduct characterized as involving ‘bad faith’ because they violate community standards of decency, fairness or reasonableness."2 The decision in Ledingham v. Blue Cross Plan for Hospital Care of Hospital Service Corp.,3 gave rise to debate over whether a cause of action in tort should be permitted, notwithstanding its place as an "implied covenant" in every agreement. Thus, while the concept of good faith may seem fairly straightforward on its face, Illinois courts have struggled in its application.

A. Independent Causes of Action in Contract for Breaches of Implied Duty of Good Faith and Fair Dealing.

Illinois recognizes and implies a covenant of good faith and fair dealing in every contract absent a specific provision or disavowal to the contrary.4 This principle ensures that parties do not try to take advantage of each other in a way that could not have been contemplated at the time the contract was drafted or to do anything that will destroy the other party’s right to receive the benefit of the contract.5 Nonetheless, the courts in Illinois remain largely divided over whether an independent cause of action for breach of contract can arise out of a breach of the implied duty of good faith and fair dealing.6

Generally, the covenant has been treated, not so much as an independent source of duty imposed upon the parties as a matter of law but, instead, as a guide for the construction of explicit terms in an agreement.7 In Martindel v. Lake Shore National Bankl, the Illinois Supreme Court announced the principle as follows:

Every contract implies good faith and fair dealing between the parties to it, and where an instrument is susceptible of two conflicting constructions, one which imputes bad faith to one of the parties and the other does not, the latter construction should be adopted.8

Since then, courts have found that the covenant may give rise to a breach of contract claim when the contractual obligations of one party are contingent upon a condition peculiarly within the power of that party.9 Implied covenants, in this regard, are generally implicated where one party to a contract is given broad discretion in performance.10 Thus, "The doctrine of good faith …requires the party vested with contractual discretion to exercise that discretion reasonably and with proper motive, not arbitrarily, capriciously, or in a manner inconsistent with the reasonable expectations of the parties.’"11 In summary, the courts are split as to whether a breach of the covenant alone constitutes sufficient grounds to warrant a breach of contract action and apparently will remain divided until the Supreme Court more clearly defines the requirements of such a cause of action, should there exist one based for this type breach.

B. Recognizing a Cause of Action in Tort: Ledingham v. Blue Cross Plan for Hospital Care of Hospital Service Corp.12

While the various jurisdictions apparently remain divided on the contract claim issue, the Illinois Supreme Court has weighed in on the issue with respect to tort claims.

Historically, a cause of action in tort for breach of the duty of good faith and fair dealing had been contemplated in only certain areas of the law including, most notably, insurance coverage. Specifically, the issue of good faith and fair dealing arose in Ledingham v. Blue Cross Plan for Hospital Care of Hospital Service Corp.13 There, the Court was asked to consider whether punitive damages could properly be awarded in an action brought by a health plan policyholder, where the insurer had allegedly wrongfully denied benefits to the insured on the basis of a preexisting illness exclusion in the policy. The insurance company contended that Illinois law did not allow punitive damages in a suit on a contract. The Court found that, while punitive damages are generally not awarded in an action on a contract, a breach of the contract itself may constitute an unusual case where an independent willful tort will be found. Further, in the life and health insurer-insured relationship, both parties have an implied duty act in good faith and fair dealing with the other. A breach of this duty is both a breach of contract and a tort.14

Thus, by the decision of Ledingham, a breach of the implied covenant rose to the status of an independent tort.15 The Illinois Supreme Court, however, would limit this opinion in Cramer v. Insurance Exchange Agency.16

C. The Supreme Court’s Decision in Cramer v. Insurance Exchange Agency.

In Cramer, the Court was asked to decide whether a separate and independent tort action for bad faith existed in Illinois. The insurer had asserted that Section 155 of the Illinois Insurance Code preempted a common law fraud action against it for the company’s alleged unreasonably conduct in denying an insurance claim. In ruling in favor of the insurer, the Court declined to recognize such causes of action, stating that a claim would be proper only in the narrow context of cases involving an insurer’s obligation to settle with a third party who had sued the policy holder.

The Court began its analysis by examining Section 155 of the Insurance Code. Section 155 provides in part that:

In any action by or against a company wherein there is in issue the liability of a company on a policy or policies of insurance or the amount of the loss payable thereunder, or for an unreasonable delay in settling a claim, and it appears to the court that such action or delay is vexatious and unreasonable, the court may allow as part of the taxable costs in the action reasonable attorney fees, other costs, plus an amount not to exceed any one of the following amounts: (a) 25% of the amount which the court or jury finds such party is entitled to recover against the company, exclusive of all costs; (b) $ 25,000; (c) the excess of the amount which the court or jury finds such party is entitled to recover, exclusive of costs, over the amount, if any, which the company offered to pay in settlement of the claim prior to the action.17

The Court thus found that the statute provides an extra-contractual remedy to a policyholder whose insurer acts vexatiously and unreasonably in its refusal to recognize liability and pay a claim under a policy. The Court went on to conclude that the application of this statute was relatively routine until Ledingham. Thus, the Court concluded in Cramer, Ledingham was in error inasmuch as the appellate court had failed to consider the impact of Section 155 when deciding whether to permit recovery under a new tort theory for breach of the implied covenant. Indeed, the Ledingham court’s failure to reconcile its analysis fostered considerable discussion and confusion amongst the appellate and federal courts.18

In Cramer, the Court went on to find that, although Section 155 provides an extra-contractual remedy, it is silent as to tort liability, leaving open the question of whether recovery in tort might be available in some cases.

The Cramer court agreed with the decision in Ledingham inasmuch as it acknowledged that a defendant may engage in conduct that both breaches a contract and constitutes a separate and independent tort. The Court also found, however, that tort actions such as common law fraud require proof of elements different than vexatious and unreasonable behavior and remedy a different type of harm. Since such torts address misconduct other than that addressed by the statute, therefore, the Court concluded that "the statute was not intended to insulate an insurer from such tort actions."19 The question thus remained whether the Court should recognize an independent tort action for bad faith in Illinois.

The Ledingham court derived the tort of good faith and fair dealing from contract law. In distancing itself from this reasoning, the Cramer Court held that "[t]his good-faith principle, however, is used only as a construction aid in determining the intent of contracting parties . . . This contractual covenant is not generally recognized as an independent source of duties giving rise to a cause of action in tort."20 Put simply, the Court held that as a general rule, there existed no tort recovery for breaches of the implied duty of good faith and fair dealing in contract cases. But the Court then went on to carve out an exception to this rule.

Specifically, the Court held that a separate action in tort is available when an insurer breaches its duty to settle an action brought against the policyholder by a third party. "The ‘duty to settle’ arises because the policyholder has relinquished defense of the suit to the insurer. The policyholder depends upon the insurer to conduct the defense properly. In these cases, the policyholder has no contractual remedy because the policy does not specifically define the liability insurer’s duty when responding to settlement offers."21 This reasoning, however, does not apply to claims made by a policyholder against the insurer. "The policyholder does not need a new cause of action to protect him from insurer misconduct where an insurer refuses to pay. The policyholder has an explicit contractual remedy. He can sue for the proceeds due under the policy."22

With respect to the cap on recovery in breach of contract cases, the Court found that:

The legislature has recognized that the contractual remedy may not be sufficient and has provided for the award of an extra-contractual remedy. The primary benefit of the tort theory developed in Ledingham is that it permits insured parties to collect an extra-contractual award in what essentially are breach of contract actions, where attorney fees and punitive damages are usually unavailable. [Citation omitted] The legislature, however, specifically enacted section 155 to deal with this lack of an extra-contractual remedy. The remedy provided by section 155 allows an extra-contractual award and specifically defines the limits of this award.23

The Court concluded by stating that while "an insurer’s conduct may give rise to both a breach of contract action and a separate and independent tort action," in order to bring such an action for insurer misconduct a plaintiff must allege and prove the elements of a separate tort; mere allegations of bad faith or unreasonable and vexatious conduct are insufficient.

D. Voyles v. Sandia: the Supreme Court Curtails the Availability of a Cause of Action in Tort.

After the decision in Cramer, and until the appellate court’s decision in Voyles v. Sandia Mortgage Company, Illinois courts consistently refused to recognize independent tort actions based on a breach of good faith and fair dealing except in "duty-to-settle" cases.

In Voyles, the Second District Appellate Court recognized an independent cause of action in tort for the alleged breach of good faith and fair dealing arising from a contract when it distinguished the case before it from Cramer.24 The court reasoned that the Supreme Court in Cramer had denied the availability of a tort claim in that case because Section 155 provided an available extra-contractual remedy for the plaintiffs. Thus, according to the court in Voyles, "The [Cramer] court emphasized that it would not create a common-law tort where the legislature had acted to provide a limited remedy and where that remedy had been regularly updated by the legislature."25

The court also concluded in Voyles, however, that in the case before it, the legislature had not intervened with lenders in the home mortgage field. Moreover, the court found it significant that the opinion in Cramer dealt merely with bad faith claims against insurers, not in other contexts such as financial lending. Accordingly, the appellate court ruled that the Cramer decision did not control the outcome of the case before it.

The Illinois Supreme Court disagreed.

Although Cramer involved section 155 of the Insurance Code [citation omitted], the opinion’s rationale was not confined to that context. The court’s description of the covenant of good faith and fair dealing as a rule of construction, rather than an independent source of tort liability, was not limited to the area of insurance law, and is as apt here as it is in other circumstances. Moreover, this court’s analysis in Cramer made clear that, irrespective of a statutory remedy, the existence of a contractual remedy would have made the tort theory unnecessary.26

The Supreme Court thus found that, since Voyles had recourse to both the specific remedies available to her under the parties’ contract and traditional tort remedies, a cause of action for violation of the duty of good faith and fair dealing would add little, if anything to her case. The Court thus declined to recognize a cause of action for violation of the duty of good faith and fair dealing under the facts of the case before it.

E. Conclusion

In summary, the general rule in Illinois is that plaintiffs may not recover in tort for alleged breaches of good faith and fair dealing in contract cases. The Supreme Court in Cramer, however, carved out a single exception to this rule for "duty-to-settle" cases. More importantly, however, the Supreme Court in the very same case apparently left open the possibility of other exceptions. In the "duty-to-settle" context, where a third party seeks recovery from a policyholder, the insurer has a duty to defend. Thus, the policyholder depends on the insurer to conduct the defense properly. In these cases, the policyholder has no contractual remedy against the insurer for claim settlement abuses. As such, the Supreme Court permitted recovery in these type cases because the policyholder lacks any recourse under the insurance policy. Accordingly, it seems reasonable to conclude that should other situations exist where a contract fails to provide recourse for a party, other exceptions could be carved. However, until that time, tort recovery for breaches of good faith and fair dealing in contract cases will only be permissible in "duty-to-settle" scenarios.

1 Restatement (Second) of Contracts 205 (1981).

2 Id. Comments and Illustrations.

3 29 Ill. App. 3d 339, 330 N.E.2d 540 (5th Dist. 1975) rev’d on other grounds, 64 Ill.2d 338, 356 N.E.2d 75 (1976).

4 Kipnis v. Mandel Metals., Inc., 318 Ill. App. 3d 498, 506, 741 N.E.2d 1033 (1st Dist. 2000).

5 Vincent v. Doebert, 183 Ill.App.3d 1081, 1090, 539 N.E.2d 856 (2d Dist. 1989).

6 See Pierce Packing Company, Inc. v. Atlas Copco Wagner, Inc., 2003 U.S. Dist. LEXIS 17503, *2-3 (N.D. Ill., October 2, 2003)citing generally Honorable Howard L. Fink, The Splintering of the Implied Covenant of Good Faith and Fair Dealing in Illinois, 30 Loy,U.Chi.L.J. 247 (1999).

7 Beraha v. Baxter Health Care Corp., 956 F.2d 1436, 1443 (7th Cir. 1992) (applying Illinois law).

8 Martindell v. Lake Shore Nat’l Bank, 15 Ill. 2d 272, 154 N.E.2d 683, 690 (1958) (citation omitted).

9 Pierce Packing, at *3 citing Beraha, 956 F.2d at 1444.

10 Bass v. Innovative Consultants, Inc., 328 Ill. App. 3d 492, 765 N.E.2d 1079 (1st Dist. 2002) citing Perez v. Citicorp. Mortgage, Inc., 301 Ill. App. 3d 413, 703 N.E.2d 518 (1st Dist. 1998).

11 Id. quoting Resolution Trust Corp. v. Holtzman, 248 Ill. App. 3d 105, 112; 618 N.E.2d 418 (1st Dist. 1993).

12 29 Ill. App. 3d 339, 330 N.E.2d 540 (5th Dist.

1975) rev’d on other grounds, 64 Ill.2d 338, 356 N.E.2d 75 (1976).

13 Id.

14 Id. at 350, 330 N.E.2d at 548.

15 Id..

16 Cramer v. Insurance Exchange Agency, 174 Ill.2d 513, 522, 675 N.E.2d 897, 901-902 (1996).

17 Id. at 519-520 citing 215 ILCS 5/155 (West 1994). This provision has been amended effective January 1, 2004.

18 Id. at 522-533. According to the opinion, some courts "rejected Ledingham and the tort of bad faith entirely (citations omitted)," recognized the tort and concluded that only punitive damages were preempted (citations omitted), held that that the statute does not preempt a tort action of any kind and a plaintiff may also seek punitive damages (citations omitted) and some held that "the statute preempts a tort action, regardless of the specific legal theory asserted, if the complaint alleges nothing more than unreasonable and vexatious conduct (citations omitted) .

19 Id. at 524.

20 Id. at 524 (citations omitted).

21 Id. at 526.

22 Id.

23 Id. at 527.

24 311 Ill. App. 3d 649, 724 N.E.2d 1276 (2d Dist. 2000).

25 Id.

26 Voyles v. Sandia Mortgage Corp., 196 Ill.2d 288, 297, 751 N.E.2d 1126 (2001) citing Cramer, 174 Ill. 2d at 526-27.

Ronald B. Kowalczyk is a partner at Kowalczyk & Bell, P.C., where his practice concentrates in the areas of corporate civil litigation, insurance premium fraud litigation, class action antitrust litigation, and toxic tort cases. In addition to his practice at Kowalczyk & Bell, Mr. Kowalczyk is general counsel to the Chicago Cobras Woman’s Soccer Team and works of counsel to Fenech, Pachulski & Welgat, P.C. Mr. Kowalczyk received his B.A. from Stetson University in 1990, his M.S. in Public Affairs from American University in 1994 and his J.D. from DePaul University in 2000.

Mr. Kowalczyk has authored a number of law review articles including Section 12.03 of the New York Arts and Cultural Affairs Law: Civil By Association and Supreme Court Slams the Door on the Press: Media ARide-Along@ Found Unconstitutional in Wilson v. Layne. Currently, he teaches legal writing, torts and litigation for paralegals at Elgin Community College and acts as the Chairman of the Volunteer Attorney Panel at the Center for Disability and Elder Law in Chicago.

Melissa Piwowar is a full-time paralegal student at Elgin Community College with over ten years of experience in sales and management. She plans to continue her studies on through law school. Ms. Piwowar was the recipient of the 2003 Elgin Community College Trustee Leadership Scholarship and Judge Ernest W. Akemann Scholarship. She is a member of the National Association of Legal Assistants, the Illinois Paralegal Association and has been nominated for membership in the Phi Theta Kappa National Honor Society.

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