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.
Drafting Recommendations
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.
We don’t have a general contractual duty of good faith in English law, but the point seems to be very similar to the duties of a director to a company (or other types of fiduciary duty), and the same language is often used to attempt to waive those duties.
You are probably right that many contractual parties are unaware that such language is used to waive this kind of duty, and I agree that the language has become a convention used by lawyers – and courts – to achieve something that is not obvious from the language used and which (as in this case) can lead to disputes. I think I would look at the issue slightly differently though: “Sole and absolute discretion” probably does mean, to a layman, that the party with the discretion has to take no regard of anyone else or any other factor – it is the duty of good faith itself that would catch out a layman, because it is not stated in the contract.
The question, at heart, is why the duty should apply if the contract says “Party A may change the document” but not if it says “Party A may change the document in its sole and absolute discretion”. If the duty is waivable (and it currently is), the answer should be based on whether the intention of the parties to waive the duty can be implied from “in its sole and absolute discretion”. Courts usually feel that it can be – because that is the convention.
There is a slightly maddening circularity to it, but I think that the lawyers on each side, certainly, will see that language as performing that function. I don’t believe that Crusader’s lawyers will have been under any illusion about that when they signed the contract, and I expect it will have been negotiated by both parties on that basis.
So my conclusion is that the drafting convention is not a good one – I agree with your general point that, if it ends up in court, it is flawed. But I think the court made the right decision based on the law as it stands.
W: My most basic point is that if you acknowledge the implied duty of good faith, then it doesn’t enhance the contract process to recognize waivers of the implied duty, thereby giving contract parties the discretion to behave in bad faith. Ken
Ken,
Are you saying that as a matter of public policy, there should be an unwaivable implied duty of good faith in every contract? Or are you saying that in jurisdictions in which there is such an implied duty, it does not make sense to allow contracting parties to waive this duty?
Paul: The latter. And the idea of waiver is problematic not only as a matter of policy but also as a matter of contract logic. That much is suggested by the confused California caselaw. Ken
Ken:
In your proposed language, I would strike the words “elect to” and replace “obligated” with “required.” I believe that’s what MCSD would require, though I don’t have it at hand. (I’d actually replace “will not be obligated to” with “need not,” but that’s not MCSD-approved.)
It seems that your analysis would apply equally to a termination provision that read, “Either party may terminate this agreement by giving notice to the other party at least 30 days before termination.” Without more, the implied duty could constrain a party’s ability to exercise this termination right. One approach might be to add “for its convenience” after “agreement.” But there could be problems even so. Suppose that the evidence showed that termination was not convenient for the terminating party, but was part of some tactical gamesmanship intended to get a new deal with more favorable terms. I doubt that would pass muster under the implied duty, even with the “for its convenience” language. So, now I’m thinking of adding language like yours to my standard termination for convenience provisions.
Chris
Chris: I can’t sneak anything by you! For purposes of MSCD § 2.142, I have in mind changing is not required to to is not obligated to, simply because on reflection, the former seems unnecessary elegant variation.
You’ll know from MSCD § 12.370 that I’m not a fan of the phrase for convenience. How about for any reason? (See MSCD § 12.378.)
Ken
Ken:
“For any reason” has the same problem as “for convenience” in this context. When paired with the implied duty, it probably means “for any good-faith reason.”
Further, in many contexts, people use the phrase “for cause” or “with reason” to mean “for good cause” or “with good reason.” That makes me a little leery of “for any reason” without further qualification. In fact, many contracts have a provision that allows for termination “for cause” and another “for convenience.” That’s shoddy drafting, but it sets the mental context for many readers.
What I think this gets back to is that, if you want to ensure that the implied duty of good faith does not prevent you excercising your option to terminate with notice, then you need language like the language you suggested. If you pair that language with “for any reason,” you pretty much eliminate the possibility that it was intended to mean “forany good reason.”
Chris
Chris: I think that for any reason is better than for convenience, but I agree that it would be safest to use the approach suggested in this post. Ken
Ken:
In your proposed language, I would strike the words “elect to” and replace “obligated” with “required.” I believe that’s what MCSD would require, though I don’t have it at hand. (I’d actually replace “will not be obligated to” with “need not,” but that’s not MCSD-approved.)
It seems that your analysis would apply equally to a termination provision that read, “Either party may terminate this agreement by giving notice to the other party at least 30 days before termination.” Without more, the implied duty could constrain a party’s ability to exercise this termination right. One approach might be to add “for its convenience” after “agreement.” But there could be problems even so. Suppose that the evidence showed that termination was not convenient for the terminating party, but was part of some tactical gamesmanship intended to get a new deal with more favorable terms. I doubt that would pass muster under the implied duty, even with the “for its convenience” language. So, now I’m thinking of adding language like yours to my standard termination for convenience provisions.
Chris
I’ve sometimes defined the term discretion along the following lines:
–snip–
IF:
This Agreement commits a decision, determination, or action to a person’s discretion; THEN: That decision,
determination, or action may be taken with a mind solely to the person’s own interests and desires, and without reference to any putative standard of reasonableness,
good faith, or fair dealing.
–snip–