“Modern contract law has generally recognized an implied covenant to the effect that each party to a contract will act with good faith towards the other with respect to the subject matter of the contract.” Katz v. Oak Indus. Inc., 508 A.2d 873, 880 (Del. Ch. 1986). Accordingly, in Delaware as well as other US jurisdictions, it is now accepted that “the implied covenant of good faith and fair dealing … inheres in every contract.” Gotham Partners, L.P. v. Hallwood Realty Partners, L.P., 817 A.2d 160, 168 (Del. 2002).
The implied covenant of good faith and fair dealing (hereinafter ICGF) comes up at several points in my corporate law courses. And every time it does, I find myself asking: What’s the point? What work does the damned thing do?
Consider, for example, Delaware Supreme Court Chief Justice Leo Strine’s recent opinion in Nationwide Emerging Managers LLC v. Northpointe Holdings LLC, No. 441, 2014 (March 18,2015). The invaluable Francis Pileggi explains that:
This Delaware Supreme Court opinion is notable for at least the following reasons:
(i) it provides the latest iteration of Delaware law on the amorphous but important contract provision imposed by law on every Delaware contract: the implied covenant of good faith and fair dealing. This 32-page opinion reversed the trial court’s finding that the implied covenant did apply to the contract at issue in this case. The Supreme Court’s reversal is another reminder of how challenging it is to make a successful claim based on the implied covenant;
(ii) many basic contract interpretation principles are explained in this opinion, but one that I found especially notable is that before the court can “fix a typographical error” in a contract, it must first satisfy the exacting prerequisites that would entitle one to the remedy of reformation of a contract, just as if it were a material term apparently.
There is much more to commend this opinion for its scholarly analysis and interesting facts, including the backstory of the buyer of an investment advisory firm who thought it was entitled to millions of dollars in damages because it did not think the seller gave it everything that it thought it was buying. That is not an uncommon complaint, but I still find it interesting that it remains such a common allegation.
Indeed. The inherent wimpiness of the ICGF is nicely illustrated by Strine’s statement that:
When a court implies a term in a contract, much less one as detailed as the Purchase Agreement, it must be very careful.
The supporting footnotes explains that:
See Nemec, 991 A.2d at 1125 (“The implied covenant of good faith and fair dealing involves a cautious enterprise, inferring contractual terms to handle developments or contractual gaps that the asserting party pleads neither party anticipated. . . . We will only imply contract terms when the party asserting the implied covenant proves that the other party has acted arbitrarily or unreasonably, thereby frustrating the fruits of the bargain that the asserting party reasonably expected. When conducting this analysis, we must assess the parties’ reasonable expectations at the time of contracting and not rewrite the contract to appease a party who later wishes to rewrite a contract he now believes to have been a bad deal. Parties have a right to enter into good and bad contracts, the law enforces both.”) (internal quotations omitted); Cincinnati SMSA Ltd. P’ship, 708 A.2d at 992 (noting that use of the implied covenant of good faith and fair dealing should be “rare and fact-intensive, turning on issues of compelling fairness”); Allen v. El Paso Pipeline GP Co., 2014 WL 2819005, *11 (Del. Ch. 2014) (noting that the Delaware Supreme Court has “admonish[ed] against a free-wheeling approach” to invoking the implied covenant of good faith and fair dealing), aff’d, 2015 WL 803053 (Del. 2015).
A doctrine that is to be applied cautiously, rarely, and so on is not a doctrine that’s going to do a lot of work.
We see this reluctance in other contexts, as well. In the labor low area, for example, the Third Circuit has noted that “Delaware courts have been reluctant to recognize a broad application of the implied covenant of good faith and fair dealing out of concern that the covenant ‘could swallow the doctrine of employment at will.’” Murphy v. Bancroft Constr. Co., 135 F. App'x 515, 518 (3d Cir. 2005).
The problem is inherent in the test applied by Delaware courts:
Delaware courts often state the test for breach of the implied covenant as follows: “‘is it clear from what was expressly agreed upon that the parties who negotiated the express terms of the contract would have agreed to proscribe the act later complained of as a breach of the implied covenant of good faith-had they thought to negotiate with respect to the matter?'" Allied Capital Corp. v. GC–Sun Holdings, L.P., 910 A.2d 1020, 1032 (Del.Ch.2006). Therefore, resort to the implied covenant is only appropriate when the contract is truly silent with respect to the matter at hand, and when the expectations of the parties were so fundamental it is clear that they did not feel it was necessary to negotiate them.
Langley v. Chase Bank USA, N.A., No. 3:10-CV-587-O, 2010 WL 8266202, at *2 (N.D. Tex. Aug. 18, 2010) aff'd sub nom. Langley v. Chase Bank USA NA, 430 F. App'x 312 (5th Cir. 2011).
With all due deference, that test makes no fraking sense. How do you know whether the contract is silent because the parties failed to discuss the issue or because they discussed it and decided to leave the contract silent? This is especially problematic when you consider that Delaware law states that “the implied covenant inquiry initially focuses on the four corners of the contact itself, and parol evidence is only admissible once an ambiguity arises from the text.” Allied Capital Corp. v. GC-Sun Holdings, L.P., 910 A.2d 1020, 1033 (Del. Ch. 2006).
Second, if the issue really was so important to the parties, wouldn't you have expected them to address it? If so, isn't silence itself proof that their expectations on the relevant points were not fundamental ex ante?
Third, Delaware law makes clear that the ICGF cannot be used to add terms to the contract. See Aspen Advisors LLC v. United Artists Theatre Co., 843 A.2d 697, 707 (Del.Ch.2004) (holding that "the implied covenant should not be used to give plaintiffs “contractual protections that they failed to secure for themselves at the bargaining table"). So what good is it? If the express terms don't solve the problem and you can't add terms to solve the problem, does't the problem remain unsolved?
In sum, I have come to believe that the ICGF is a judicially created tax on transactions for the benefit of lawyers. It generates a lot of litigation, but rarely changes outcomes, so it does the parties no good, while costing them huge legal fees. And, of course, the risk of ICGF litigation justifies ex ante lawyering by transactional lawyers.
Kill it. Kill it now.
