For a couple of years now, the phrase at its [or his or her] discretion has been at the back of my mind, and I’ve finally gotten around to giving it some thought. This post addresses use of at its discretion in language of discretion, as in Acme may at its discretion terminate this agreement. (I’ll deal with the other principal use in a future post.)
My conclusion? Using at its discretion in language of discretion is problematic, as it conveys that the party in question wants to be free to act unreasonably, a notion that a court could well frown on. Try instead to address directly the concern that you’d be trying to get at with at its discretion. (Even though in the following analysis I cite only U.S. case law, this recommendation should apply equally with respect to contracts governed by non-U.S. law.)
Discretion Limited by Good Faith
Language of discretion is language stating that a party has the discretion to take or not take a given action. Discretion is primarily conveyed by means of may, expressing permission. (See MSCD 3.52–53.) Using at its discretion in language of discretion suggests (1) that the language of discretion in question doesn’t grant complete discretion and (2) that tacking on at its discretion remedies this.
The first element of this proposition is correct—the discretion granted under a contract is limited, in that as a general matter any party to a contract would be under an obligation to exercise that discretion in good faith. Section 205 of the Restatement (Second) of Contracts states that “Every contract imposes upon each party a duty of good faith and fair dealing in its performance and its enforcement.” And section 1-304 of the Uniform Commercial Code provides that “Every contract or duty within [the Uniform Commercial Code] imposes an obligation of good faith in its performance and enforcement.” Cases invoking the duty of good faith “are legion.” 1-5 Murray on Contracts § 90 (2001).
And more specifically for our purposes, “where a party has contractual discretion to promote its own interest, the good faith requirement precludes action that would contravene the reasonable expectations of the other party.” 1-5 Murray on Contracts § 90; see also Williston on Contracts § 63:22 (stating that “even where a defendant is given absolute discretion, it must exercise that discretion in good faith”). For a case that stands for this proposition, see Gilson v. Rainin Instrument, LLC, 2005 U.S. Dist. LEXIS 16825 (W.D. Wis. Aug. 9, 2005) (stating that the implied covenant of good faith requires each party to an agreement “to exercise any discretion afforded it by the agreement in a manner consistent with the reasonable expectations of the other party”).
Attempting to Circumvent Good Faith
Adding at its discretion to language of discretion represents an attempt to nullify the obligation to exercise discretion in good faith. (This is why it’s pointless to embellish discretion by referring to reasonable discretion, good faith discretion, and the like—if you’re willing to have your discretion be subject to the obligation of good faith, you shouldn’t be messing with at its discretion.)
As a matter of semantics, the notion that at its discretion can circumvent good faith is a problematic one—if discretion as expressed by a verb such as may is subject to the duty of good faith, why should discretion as expressed by at its discretion be able to circumvent it?
But whatever the semantic shortcomings, the idea behind adding at its discretion is that a party may be unreasonable in exercising discretion if the parties agree that it may. I recently came upon an agreement that made this explicit by means of the following definition (I’ve resisted the urge to clean it up):
The terms “sole discretion” and “absolute discretion” with respect to any determination to be made a Party under this Agreement shall mean the sole and absolute discretion of such Party, without regard to any standard of reasonableness or other standard by which the determination of such Party might be challenged.
Some cases have held to be enforceable provisions that in effect state that a party may act unreasonably. For example, in Automatic Sprinkler Corp. of America v. Anderson, 257 S.E.2d 283 (Ga. 1979), the court considered “whether good faith is a prerequisite in the exercise of an absolute discretion to withhold incentive compensation.” The contract at issue stated that the decision whether to pay a terminated employee incentive compensation “will rest completely in the absolute and final discretion of the Compensation Committee of the Board of Directors.” The court held that the presence or absence of good faith was irrelevant.
But there are cases that hold the contrary. Consider for example A.W. Fiur Co. v. Ataka & Co., 422 N.Y.S.2d 419 (App. Div. 1979), in which the court noted that “Although the contract conferred upon [a wholly owned subsidiary of the defendant] the ‘absolute and exclusive right to reject any orders for any reason whatsoever’, such a contract does not import the right arbitrarily to refuse to accept orders.”
In the same vein, section 1-302 of the Uniform Commercial Code states that “The obligations of good faith, diligence, reasonableness, and care prescribed by [the Uniform Commercial Code] may not be disclaimed by agreement.” And in effect that’s what at its discretion attempts to accomplish.
An Alternative Approach
I recommend that instead of crossing your fingers and relying on at its discretion, you instead address more precisely whatever concern you’d be attempting to address through at its discretion. (After all, it’s unlikely that your client simply wants to ensure that it has the freedom to act in bad faith.)
Imagine that Acme wants to purchase from Widgetco a number of stores that sell replacement tires. The parties have in mind that as part of the purchase price, Acme would pay commissions based on future net sales of the stores. Acme, however, wants to be able to close stores if it sees fit. Simply saying “At any time Acme may close any one or more Contract Stores” might allow Widgetco to claim that Acme was acting in bad faith if it ultimately decided to close any Contract Stores. But if you were to say instead “At any time Acme may at its discretion close any one or more Contract Stores,” that could be regarded as an impermissible attempt to waive the obligation of good faith. You’d be better off saying something along the following lines:
Acme may close any one or more Contract Stores for any reason, and in doing so it may elect to consider only its own interests and will not be required to consider the effect of any such closure on Widgetco, including any reduction in commissions that Acme pays Widgetco under this agreement.
A court would be less likely to view an explicit provision of that sort as an impermissible attempt to waive of the obligation of good faith. For example, the above scenario is based on the facts in VTR, Inc. v. Goodyear Tire & Rubber Co., 303 F. Supp. 773 (S.D.N.Y. 1969). In that case, the courts said that “the parties may, by express provisions of the contract, grant the right to engage in the very acts and conduct which otherwise would have been forbidden by an implied covenant of good faith and fair dealing.”
Also relevant is this passage from 6-25 Corbin on Contracts § 525:
In any commercial agreement in which the compensation promised by one to the other is a percentage of profits or receipts, or is a royalty on goods sold, manufactured or mined, there will nearly always be found an implied promise of diligent and careful performance in good faith and of forbearance to make performance impossible by going out of business or otherwise. Such implications may, of course, be excluded by appropriate language in the agreement; it is excluded by language with which the proposed implication would be in conflict.
And section 1-302 of the U.C.C. states that although the obligations of good faith, diligence, reasonableness, and care may not be disclaimed by agreement, “The parties, by agreement, may determine the standards by which the performance of those obligations is to be measured if those standards are not manifestly unreasonable.”
If you’re unable or unwilling to craft explicit language of this sort, you could use at its discretion and warn the client that at its discretion may be ineffective as a means of ensuring unfettered discretion. Or you could simply omit it, on the grounds that it would be best to omit such an unstable phrase from one’s contracts, even if it means foreclosing the possibility, however questionable, of unfettered discretion. I’d be inclined to go with the latter approach.
Addendum on Wording
By the way, the phrase is indeed at its discretion. Anything beyond that—at its sole discretion, at its absolute discretion, at its uncontrolled discretion—is rhetorical emphasis. (Regarding rhetorical emphasis, see MSCD 13.37 and this blog post and this blog post.) One could instead use in its discretion, but I reserve that for what, in a contract, would constitute language of policy—It is in Acme’s discretion whether to exercise the Option. I wouldn’t use such language in a contract.