Implied Terms and the Implied Covenant of Good Faith
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Implied Terms and the Implied Covenant of Good Faith
Definitions
Good Faith is a total absence of any intention to seek an unfair advantage or to defraud another party; an honest and sincere intention to fulfill one’s obligations
In the case of a merchant, good faith refers to honesty in fact and the observance of reasonable commercial standards of fair dealing in the trade. UCC §2-103(1)(b).
More generally, the term means “honesty in fact in the conduct or transaction concerned.” UCC §1-201(19).
The implied obligation of good faith and fair dealing originates in case law, but was given a major boost by its adoption in the UCC (Sec. 1-203; revised 1-304); this obligation was then generalized for all contracts by the 2nd Rst., Sec. 205.
CISG contains no clause requiring good faith in the international sale of goods by merchants but most European codes have clauses closely following Restatement 2d §205 which implies the duty of good faith and fair dealing in every contract.
Haines v. City of New York
Facts: Π was a developer that wanted to add a sewer system outside NYC in a town that had contracted with NYC in 1923 that “all costs of construction and subsequent operation maintenance and repair” shall be at the expense of NYC. The K also stated that it required NYC to extend the sewer lines when necessitated by future growth and building up of the communities. The sewer system is now at capacity, and further additions would be impossible without building a new plant.
Issue: K did not say for how long the K would be in effect, or what to do when it becomes impossible to add sewer lines. NYC argues it can terminate the K at will.
Analysis: Problems that arise due to silence in the contract are scope and duration.
Court holds City is NOT obligated under the terms of the 1924 contract to enlarge the existing sewage plant or build a new one to accommodate the present and future needs of the municipalities. (Scope issue)
By the agreement, the City obligated itself to build a specifically described disposal facility and to extend the lines of that facility to meet future increased demand. In providing for the extension of sewer lines, the contract does not obligate the city to provide sewage disposal services for properties in areas of municipalities not presently served or even to new properties in areas which are presently served where to do so would reasonably be expected to overload the system and result in its inability to properly treat sewage.
Court holds a contract calling for continuing performance is NOT perpetual in duration. (Duration issue)
Rule regarding duration: 2nd Rst., 230: In the absence of an express term fixing the duration of a contract, the courts may inquire into the intent of the parties and supply the missing term if a duration may be fairly and reasonably fixed by the surrounding circumstances and that parties’ intent.
Where the parties have not clearly expressed the duration of a contract, the courts will imply that they intended performance to continue for a reasonable time.
Held: The contract’s missing time term should be added to be the reasonable time required to perform the contract. NYC is obligated to maintain the existing plant, but not to expand it.
Missing Terms
When a term is missing, a reasonable term may be inserted by the court, i.e. reasonable time is implied when a temporal term is missing.
It is generally agreed that where a duration may be fairly and reasonably supplied by implication, a contract is not terminable at will. Restatement 2d §230.
A contract is not voided by conditions that arise outside the contemplation of the parties after execution.
Open Price Term UCC §2-305
Parties can write a contract without the price term settled.
At the time of delivery the price is a reasonable price if
nothing is said of price,
the price is left to be determined but the parties fail to agree
the price term is to be fixed to some 3rd party price index or market standard.
Good faith rules apply.
If the parties agree not to be bound without a price, there is no contract. Buyer must return all goods received or pay the reasonable value if unreasonable to return them. Seller must return prepaid money.
Centronics Corp. v. Genicom Corp.
Facts: Π agreed to sell biz assets to Δ. The purchase price was pegged at a value that arbitration was to determine. An escrow account held money from DD pending the results of the arbitration.
Issue: Π charged that Δ was breaching the implied covenant of good faith when Δ would not allow any money to be removed from the escrow before arbitration ended even though that money was going to be Π’s after arbitration and that Δ was belaboring the arbitration.
Analysis:
Common Rule: Under an agreement that appears by word or silence to invest one party with a degree of discretion in performance sufficient to deprive another party of a substantial proportion of the agreement’s value, the parties’ intent to be bound by an enforceable contract raises an implied obligation of good faith to observe reasonable limits in exercising that discretion, consistent with the parties’ purposes in contracting. Essentially, the party is not to frustrate the reasons why the parties entered into the agreement.
Thus a suit for violation of the implied covenant of good faith raises potentially four questions (which Prof points out, CB 299), beginning with (1) whether the agreement allows or confers upon the defendant a degree of discretion in performance tantamount to a power to deprive P of a substantial proportion of the agreement’s value.
In the instant case, the court says Genicom was NOT given the authority to deprive Centronics indefinitely of a portion of the agreed consideration for the business assets previously transferred. Justice Souter only gets to question (1).
“It is clear that what C claims to be G’s discretion over the timing of distribution is in reality a power that each party may exercise, but only jointly with the other, to agree to remove some or all of the escrowed funds from the ambit of the otherwise mandatory pay-out provisions.”
Burton identifies bad faith as a promisor’s discretionary action subjectively intended to recapture an economic opportunity intended to be bargained away by the promisor, which is essentially a refusal by the promisor to pay performance costs of the bargain.
Court says C would also fail under Burton’s view. Souter said the agreement is mutually beneficial and mutually deficient. It worked both ways, it was supposed to provide an incentive to both parties to settle quickly.
Furthermore, court finds that the parties never bargained away the right of either of them to condition any distribution on completing the arbitration of any disputes.
Held: Π had not asked for any clause in the K to allow them to pull any money out in the event of a long arbitration. Δ had good faith reasons to want to keep the money in escrow until the end of arbitration.
Note:
Summers: the obligation of good faith performance is better understood simply as excluding behavior inconsistent with common standards of decency, fairness, and reasonableness, and with the parties’ agreed-upon common purposes and justified expectations.
Burton: Bad faith is the exercise of discretion for the purpose of recapturing opportunities forgone or bargained away at the time of contracting, with the identification of such forgone opportunities depending on objective analysis of the parties’ expectations as they may be inferred from the express contract terms in light of the ordinary course of business.
Four Question Test
Does the agreement ostensibly allow to or confer upon Δ a degree of discretion in performance tantamount to a power to deprive the plaintiff of a substantial proportion of the agreement’s value?
If the ostensible discretion is of that requisite scope, does competent evidence indicate that the parties intended by their agreement to make a legally enforceable contract?
Assuming an intent to be bound, has Δ’s exercise of discretion exceeded the limits of reasonableness?
Is the cause of the damage complained of Δ’s abuse of discretion, or does it result from events beyond the control of either party, against which Δ has no obligation to protect Π?
Shell Oil Co. v. HRN, Inc.
Facts: Ps claim that D was setting the price too high because they wanted to run Ps out of business and that it would be more commercially advantageous for D to run their own company owned stations.
Reasoning: Court says that Shell’s posted price for gasoline under open price term contract was both commercially reasonable and fairly applied to gasoline dealers, and thus Shell did not breach duty of good faith in setting fuel prices under open price term contracts, even if Shell had intention to drive dealers out of business and replace them with producer-operated retailers; circumstantial evidence that price was too high for dealers to compete with other gasoline retailers was not evidence that producer lacked good faith when setting price.
Purpose of posted price presumption in open price term statute’s safe harbor provision is to preserve the practice of using sellers standard prices while seeking to avoid discriminatory prices. Allegations of dishonesty under open price term statute’s requirement of good faith in price fixing must have some basis in objective fact, which at a minimum requires some connection to the commercial realities of the case.
A relatively high yet commercially reasonable price is not evidence of bad faith in setting a price in an open price term contract. A “good-faith price” under open price term statute is not synonymous with a fair market price or the lowest price available. Evidence that different prices are available to different classes of trade is not evidence of bad faith in setting a price under statute allowing open price terms.
Held: There was NO requirement of “subjective” element of good faith under 2-305.
Reasoning to the contrary negates the effect of Comment 3’s “safe harbor” and effectively allows a jury to determine in every section 2-305(2) case whether there was any “improper motive animating the price-setter,” even if the prices charged were undisputedly within the range of those charged throughout the industry.
This result conflicts with the UCC drafters’ INTENT to eliminate litigation over prices that are nondiscriminatory and set in accordance with industry standards.
“Open price terms” are governed by 2-305 of the UCC, and the good faith requirement is specifically 2-305(2).
While “good faith” is defined elsewhere in the Code as “honesty in fact [subjective honesty] and the observance of reasonable commercial standards of fair dealing [objective standards]” the Court focuses specifically on the “safe harbor” provided by Comment 3 to 2-305: (Prof. points out this safe harbor)
Comment 3: “Subsection 2, dealing with the situation where the price is to be fixed by one party rejects the uncommercial idea that an agreement that the seller may fix the price means that he may fix any price he may wish by the express qualification that the price so fixed must be fixed in good faith. Good faith includes observance of reasonable commercial standards of fair dealing in the trade if the party is a merchant. (Section 2-103). But in the normal case a “posted price” or a future seller’s or buyer’s “given price,” “price in effect,” “market price,” or the like satisfies the good faith requirement.”
Donahue v. Federal Express Corp.
Facts: Π, a permanent employee, was a “whistleblower” at company Δ which then terminated him. Π appealed his termination with the Guaranteed Fair Treatment Procedure provided for in his K, which upheld the termination.
Issue: Π argues that Δ did not act in good faith in Π’s termination and that P supplied sufficient additional consideration to be classed differently than an at-will employee.
Analysis: “Good faith” with regard to at-will employment is sticky: the doctrine of good faith only exists insofar as a contract exists…but at-will employment is not contractual employment! The employee has to prove that, somehow, a contract has been incorporated into his employment. Which is why, in the instant case, the plaintiff attempts to incorporate the GFTP into his contract with the company.
Too bad for him, though, because the GFTP expressly says that the policies and procedures do not create contractual rights or otherwise; GFTP cannot provide a basis for a claim of breach of FedEx’s duty of good faith and fair treatment.
The cases cited by Donahue, Somers, Jacobs, and Baker simply provide that, in an at-will employment relationship, the duty of good faith and fair dealing applies to those contractual terms that exist BEYOND the at-will employment relationship
Held: As a matter of law, an employee cannot maintain action for breach of implied duty of good faith and fair dealing insofar as underlying claim is for termination of an at-will employment. Superior performance is not good enough to be classed differently than an at-will employee because that is what is expected.
Note:
An at-will employee can still be terminated at any time without a good faith duty for the employer to give a reason.
Most jurisdictions recognize a narrow “public policy” exception that must involve a public duty.
