Today the California legal periodical The Recorder published my article Whittling Away at Duty of Good Faith. Go here for the copy on The Recorder’s website. To access it you’ll need to be a subscriber; for a humble text-only PDF version, go here.
Last year I submitted an amicus letter to the California Supreme Court in connection with this dispute. Since then the whole issue of allowing contract parties to do an end run around the implied duty of good faith has been bothering me—hence this article. If you use in your contracts the phrase at its sole and absolute discretion or some variation, or if you’ve wondered what the heck it’s meant to accomplish, this is the article for you.
But this article is different from my previous articles, in that it’s directed primarily at courts in California and any other jurisdiction with comparable caselaw. The Recorder’s limits on how long articles can be prevented me from including a section aimed at contract drafters, so I’ve included it below.
Contract drafters might be tempted to adjust, depending on the governing law of the contract, how they approach the implied duty of good faith, the notion being that it would be appropriate to include at its sole and absolute discretion, or some variation, if the contract is governed by the law of California or another jurisdiction that gives that language some teeth.
Or they might be inclined to include that language in all contracts—they know that courts in a given jurisdiction would disregard that language, but they keep it in, as it might have some in terrorem effect on the other party.
I recommend that instead you eliminate from your contracts any language that could be construed as effecting a waiver of the implied duty of good faith, even if it runs in favor of your client: doing so would reduce the likelihood of confusion or dispute.
Even in jurisdictions that unfortunately construe at its sole and absolute discretion as effecting an enforceable waiver of the implied duty of good faith, the certainty any such waiver aims to afford is more than offset by the potential mischief of an apparent endorsement of a party’s acting in bad faith. And the language used to articulate a waiver of the implied duty is sufficiently unclear that it could result in dispute. Furthermore, given the confused caselaw, it might be difficult to predict whether a court would hold that a given waiver is enforceable.
Instead, address directly whatever concern you might have been tempted to address by means of a waiver of the implied duty—after all, it’s unlikely that your client simply wants to ensure that it’s free to act in bad faith.
For example, imagine that Acme wants to purchase from Widgetco a number of stores that sell widgets. The parties have in mind that as part of the purchase price, Acme would pay commissions based on future net sales of the stores. But Acme wants to be able to close stores if it sees fit. Simply saying “Acme may at any time close any one or more Contract Stores” might allow Widgetco to claim that Acme was acting in bad faith if it ultimately were to decide to close any Contract Stores. And it would be reckless to assume that adding “at its sole and absolute discretion” would preclude that without risk of dispute.
You could make this language of discretion more specific by making Acme’s exercise of its discretion subject to conditions—for example, it may close a store only if that store fails to meet specified targets. But if Acme would prefer to avoid any meddling in its business decisions, a more promising approach would be to add specificity by having Widgetco acknowledge that certain potential adverse consequences will be irrelevant to Acme’s exercise of its discretion. That could be accomplished by 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 obligated to consider the effect of any such closure on Widgetco, including any reduction in commissions that Acme pays Widgetco under this agreement.
This approach should be palatable to the other party if circumstances suggest that the party with discretion would to some extent be constrained from acting in bad faith. In the above example, closing stores presumably involves some cost to Acme.
But in some contexts, neither of the two above approaches is likely to work. Consider the circumstances of the Cussler case: Assessing a screenplay is a highly subjective task, so it’s unlikely that either party would have agreed to make Cussler’s approval right subject to objective conditions. And Cussler’s rejection of Crusader’s screenplay wouldn’t require him to incur direct costs, so he had little to stop him from rejecting screenplays for any reason, however good or bad.
In such contexts, the prudent course of action would be to eliminate the problematic language of discretion. With respect to the Cussler case, dispute would have been avoided had the screenplay initially approved by the parties been the final screenplay, or if one or other party had been given unilateral control over revisions to the screenplay.