Don't Bet the Business

The following could be a real make or break point for the contracts into which one enters. Michigan law provides that every contract imposes upon each party a duty of good faith in its performance and enforcement. 

This “good faith” duty requires that “neither party shall do anything which will have the effect of destroying or injuring the right of the other party to receive the fruits of the contract.” Hammond v United of Oakland, Inc, 193 Mich App 146, 152; 483 NW2d 652 (1992). 

As typically applied, the phrase “good faith” is “a standard [of] measuring the state of mind, perceptions, honest beliefs, and intentions of the parties.” Miller v Riverwood Recreation Ctr, Inc, 215 Mich App 561, 570; 546 NW2d 684 (1996). To act in “good faith” means to conduct oneself with “an honest belief, the absence of malice and the absence of design to defraud or to seek an unconscionable advantage.” Id. at 571. 

“Bad faith” could simply be viewed as the absence of “good faith,” but the courts typically refer to “bad faith” as an “arbitrary, reckless, indifferent, or intentional disregard of the interests of the person owed a duty,” involving something more than honest errors of judgment. Id. at 571.

So to give this “good faith / bad faith” measure some context, suppose you had a contract in which you agreed to indemnify another party for losses the other party incurred due to third-party claims. Suppose further that the other party settled a third-party claim for its face value and then sought complete indemnification from you for the amount paid, including attorney fees. Lastly, assume further that you felt the third-party claim lacked merit and should have been contested or at least should not have been paid in full. Are you liable under the indemnity agreement? Maybe.

In this example, the indemnitee party that paid the third-party claim may be shown to have paid the claim in “bad faith.” For example, the facts might show that the indemnitee paid the claim without questioning its legitimacy and conducting a reasonable factual review of the merits simply knowing that it had you as a collectible indemnitor.

Keep in mind that claims of bad faith must be based on more than just an error in business judgement. Rather, proof must be brought to show that the third-party claim was paid arbitrarily, recklessly, indifferently, or with an intentional disregard of your interests as the indemnitor.   

Be advised that some indemnity agreements attempt to deal with this issue of good faith by providing that the payment of a claim is deemed “prima facie” evidence of the indemnitor’s liability. Prima facie evidence is evidence that is enough to prove liability if it is not rebutted by other competent evidence. The legal effect of designating payment prima facie evidence is that it shifts the burden of proof to the indemnitor to prove that the indemnitee acted in bad faith. In other words, you, as the indemnitor, would be required to offer sufficient evidence to rebut the presumption of payor’s good faith in settling the third-party’s claim.

If you face potential liability under an indemnity agreement, or if you want to create one to fit your business needs, call us and let us help. We will walk you through it so that you are protected, or at least so that you understand what your rights and duties include.