An Article on “Sole and Absolute Discretion”

Reader Steven Sholk told me about this article on the phrase sole and absolute discretion that appeared last week in the New York Law Journal. It focuses on New York caselaw.

Having written an article of my own on the implications of this phrase (available here), I was interested to see what the article had to say. But it doesn’t provide much guidance to contract drafters, presumably because it was written by two litigation partners.

Here’s how the article concludes:

Although all of the decisions discussed above recognized that implicit in every contract is a duty of good faith and fair dealing, courts seem more willing to find that the exercise of discretion may violate the good faith covenant where the party with discretion overreaches and exercises it in a way not reasonably contemplated by the parties. Where a party has sole and absolute discretion to terminate a contract, however, the decisions appear less likely to find that the implied covenant of good faith and fair dealing may constrain the exercise of that right.

The courts thus seem generally to recognize the fundamentally different nature of a party exercising discretion to monitor or approve the other party’s performance in an ongoing contractual relationship, and a party’s contractual right to terminate that relationship in its discretion, the former invoking notions of good faith implicit in an ongoing contractual relationship, and the latter recognizing that the notions of termination and good faith may by definition not be fully compatible.

But I’m not sure the distinction is that clear cut. For example, in one of the cases discussed in connection with ongoing contract relationships, the court applied the duty of good faith in the context of a bank declining to make a new loan. By contrast, in one of the cases cited in connection with terminating a contract, the court declined to apply the duty of good faith in the context of a bank electing not to make a new loan under an existing line of credit. Given the similar contexts, I’m not sure how convincing it is to explain away the differences by applying a “termination” label to the latter case.

So if you use the phrase sole and absolute discretion in a termination context on the assumption that a court would allow you to do an end-run around the duty of good faith, you’re rolling the dice.

Instead, address directly whatever issue might otherwise prompt you to use the phrase sole and absolute discretion. (It’s unlikely that you just want to make sure that you can behave unreasonably.) The more specific you are, the less likely it is that a court would hold that your discretion is constrained by the duty of good faith. See MSCD 2.120 for an example of how you can accomplish this.

Posted in Uncategorized | 5 Comments

  • Vance Koven

    I’m not entirely sure that your proposed solution really is one. What you recommend in MSCD is that the parties declare that one party may consult only its own interests in taking a specified action. However, a party doing that would just as surely be scrutinized for violating the duty of good faith as one who purported to reserve the right to act unreasonably (which is probably more prevalent a desire than you courteously suggest, or at least the desire is that no one be entitled to question whether the party has acted in good faith). The one case you cite to support your alternative was a SDNY case heard in Federal court on grounds of diversity of citizenship, which means it relied on state substantive law. New York state law has a singularly crabbed view of the duty of good faith, which it purports not to impose on all contracts. Why this should be is a matter of sociological interest, but suffice it to say that New York courts seem to tolerate a greater variety of economically sociopathic behavior than those of other states. In California, say, which does seem to have a robust view of good faith applicable to all contracts, would even a clause such as you advocate hold up against evidence that it was used to justify conduct prejudicial to the reasonable expectations of the counterparty?

    The point, then, is not how you phrase the contract but how the parties are actually behaving. After all, the reason the law even bothers to enforce private agreements is to provide stability of expectations within a framework of fundamental justice, so that people don’t go around prosecuting claims at gunpoint. Right? If one party, because of market power or other extraneous factors, were able to reserve the right to screw the other party at a whim, neither stability nor justice is effected.

    • http://www.koncision.com Ken Adams

      Vance: My point is that the more detail you provide in a contract regarding the discretion afforded a party in a given context, the less likely it is that a court will invoke the duty of good faith to circumscribe that discretion.

      The language I propose in MSCD was tailored to address the context in question; a different context might require a different approach.

      Regarding California, you might want to check out my article (the one I link to). It discusses a California case in which the court declined to apply the duty of good faith.

      More generally, I don’t want to adjust my contract language from jurisdiction to jurisdiction, in the hopes that a given jurisdiction will treat certain language more favorably. That way lies risk and chaos.

      Ken

      • Vance Koven

        I agree with your last point, and wasn’t suggesting that contract language be changed to suit the forum. Our disagreement goes to one aspect of your first point: contract language will probably not avail one way or another when the underlying conduct involves a breach of good faith, however the forum jurisdiction understands it. Or, at least, it shouldn’t.

        • http://www.koncision.com Ken Adams

          I think that by assuming a breach of good faith, your comment begs the question (in the original sense of that phrase). My point is that by explaining what your concern is, you can make it clear that you’re addressing a legitimate issue rather than looking to act unreasonably. That would make it less likely that a court would find a breach of the duty of good faith.

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