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Drafting Around Good Faith EDITED BY BO LINKS SELF-STUDY mCLE Drafting Around Good Faith BY ALLEN B. GRODSKY Court has explained, the covenant discretion? Courts have addressed cannot be read “to prohibit a party this issue in a number of cases. from doing that which is expressly permitted by an agreement.” (Carma CASE LAW Developers, 2 Cal. 4th at 374.) How- Plaintiffs in three particular disputes ever, the courts are very particular tried unsuccessfully to invoke the about the specificity required for a implied covenant to impose a good contract to avoid the implied cov- faith limitation on conduct specifi- n California, every contract enant of good faith and fair dealing. cally described and expressly permit- Icontains an implied covenant of good faith ted by the contract. In one instance, and fair dealing, which prevents one party TWO-PRONGED TEST an employment contract provided from unfairly frustrating the other party’s In general, California courts will that when a Lockheed employee right to receive contractual benefits. The interpret a contract to allow a party created an invention during his implied covenant is particularly important to use its sole discretion—unlimited or her employment, the inven- in situations where an agreement invests one by the covenant of good faith and fair tion belonged to the company; the party with a discretionary power affecting the dealing—if two conditions are met. employee, however, could request rights of the other party; under the implied l The express purpose of the con- from Lockheed a “special invention covenant, such power must be exercised in tract is to grant unfettered discre- award” of up to $20,000. The con- good faith. (See Carma Developers (Califor- tion, and tract expressly stated that Lockheed nia), Inc. v. Marathon Development California, l The contract is otherwise sup- “may, but is not obligated to, grant” a Inc., 2 Cal. 4th 342, 372 (1992).) ported by adequate consideration. special invention award and that all MCLE But what if the parties intend to allow one (See Wolf v. Walt Disney Pictures & decisions “shall be final and conclu- party to exercise discretionary power with- Television, 162 Cal. App. 4th 1107, sive.” (Brandt v. Lockheed Missiles & out any good faith restriction? This is not an 1121 (2008).) Space Co., 154 Cal. App. 3d 1124, unusual situation. For example, record com- In such cases, one party’s ability 1128 (1984) (emphasis added).) panies often bargain for unlimited discretion as to use sole unfettered discretion is, The employee who brought the suit to whether and how to distribute albums that by definition, within the reasonable argued that the implied covenant of a musician records. Similarly, employers want expectation of the parties, and there- good faith and fair dealing required unlimited discretion to decide whether or not fore the exercise of discretion is not that Lockheed’s decision whether to award a bonus. In each of these cases, com- limited by the implied covenant. to grant a special award be made petent parties intend to “contract around” the In this context, how does one in good faith. The court of appeal implied covenant. But legally, can they do this? determine that the express purpose disagreed, finding that the language The answer is yes. As the California Supreme of a contract is to provide unfettered of the contract “could not be more clear and explicit.” (Brandt, 154 Cal. MCLE CREDIT CERTIFICATION App. 3d at 1130.) In other words, CLE CENTER Earn one hour of MCLE credit by The Daily Journal Corp., because the contract specified that You can now earn MCLE credit reading the article and answer- publisher of California Lawyer, ing the questions that follow. has been approved by the without leaving your computer. Go to Lockheed was not obligated to grant Mail your answers with a check State Bar of California as a www.callawyer.com and click on CLE for $35 to the address on the continuing legal education an award, the implied covenant Center for access to dozens of articles answer form. You will receive provider. This self-study could not impose a restriction on and tests on a range of topics. the correct answers with activity qualifies for Minimum EARN MCLE CREDIT explanations and a certificate Continuing Legal Education Lockheed to make such decisions within six weeks. Price subject credit in the amount of one only in good faith. GENERAL CREDIT to change without notice. hour of general credit. In another case, a commercial 38 JULY 2013 CALLAWYER.COM CONTRACTS lease provided that the landlord, within contract. But what if the contract is not prior dealings. The mortgage agreement 30 days of receiving notice that the ten- so precise? What if it provides broad dis- did not expressly state that the lender ant intended to sublet or assign the lease, cretion to one party but does not specifi- could absolutely refuse to grant exten- could terminate the rental agreement, cally address the conduct that another sions (unlike the language in the Brandt enter into its own lease with the intended party claims is restricted by principles of or Third Story Music cases). Nevertheless, sublessee or assignee, and keep all the good faith and fair dealing? Courts have the district court held that the contract’s profits realized on account of the termi- split dramatically on this issue. broad language provided unfettered dis- nation and reletting. (Carma Developers, On one side of this split is a case cretion inconsistent with the implied 2 Cal. 4th at 351–352.) The landlord did involving a contract that gave defendant covenant of good faith and fair dealing. exactly what the lease said it could, ter- Walt Disney Pictures & Television the (Symbolic Aviation, Inc. v. PNCEF, LLC, minating the lease after receiving notice discretion to assign or license rights to 2010 WL 3584509 (S.D. Cal).) of the intent to sublease and then nego- the plaintiff’s Roger Rabbit franchise as Also instructive is a franchise dispute tiating directly with the intended subles- Disney “saw fit.” The plaintiff argued in which the governing contract pro- see. The tenant argued that the implied that Disney breached the implied cove- vided that a franchisee could not change covenant of good faith and fair dealing nant by entering into licenses with third location without the franchisor’s written prevented the landlord from ending the parties in exchange for promotional consent. When the franchisor refused to lease unless its objection to the transfer considerations, without monetary allow the franchisee to move, the fran- was in good faith. The court of appeal compensation; this meant the plaintiff chisee sued, arguing that the implied agreed, concluding that as a matter of received no royalties. The court rejected covenant obligated the franchisor to act law the landlord’s termination of the the claim, holding that “recognizing only in good faith. Though the contract lease “solely to realize a profit” breached an implied term that would limit the did not specify that the franchisor could the implied covenant. But the Califor- unfettered discretion given to Disney to refrain from approving a move, the dis- nia Supreme Court reversed, holding license the characters as [Disney] saw trict court nevertheless held that because that the landlord’s “termination of the fit would be at odds with the express the agreement provided unfettered lease in order to claim for itself appre- terms of the agreement.” (Wolf, 162 discretion on the issue of relocation, ciated rental value of the premises was Cal. App. 4th at 599.) It did not mat- the court could not imply a covenant expressly permitted by the lease and was clearly within the parties’ reasonable MCLE expectations.” (Carma Developers, 2 The covenant of good faith and fair dealing Cal. 4th at 376 (emphasis added).) does not limit a party’s right to engage in Finally, an agreement with an enter- tainment production company gave conduct specifically permitted by a contract. Warner Communications the right to manufacture and distribute musician Tom Waits’s recordings—or to refrain ter that the contract failed to expressly of good faith and fair dealing. (Dos from these activities. The production state Disney could license the franchise Beaches, LLC v. Mail Boxes Etc., Inc., company wanted to release a new com- in exchange for only promotional con- 2012 WL 1903905 at *6 (S.D. Cal.).) pilation of the artist’s works, but Warner siderations. The court concluded that refused to distribute it because Waits— broad contractual language—as Disney ALTERNATE VIEW who had no legal right to object—was saw fit, to paraphrase the court—was But there is another side to the story. Two opposed to releasing the new compi- sufficient to establish the parties’ intent other courts have held that when a broad lation. The court sided with Warner to grant Disney unfettered discretion. discretionary clause does not specifically because the covenant of good faith and Two federal courts applying Cali- allow the challenged conduct, a party’s fair dealing would be directly at odds fornia law have reached the same con- conduct is restricted by the implied cov- with the express contractual grant of dis- clusion. One case involved a mortgage enant of good faith and fear dealing. cretionary power. (Third Story Music, Inc. agreement providing that a lender had The primary case for this proposi- v. Waits, 41 Cal. App. 4th 798 (1995).) “sole and absolute discretion” to extend tion involves a classic instance of bad the maturity date. After agreeing to one facts making bad law. (Locke v. War- VAGUE LANGUAGE extension, the lender balked and refused ner Bros., Inc., 57 Cal. App. 4th 354 The foregoing cases make clear that the to further extend the loan’s due date (1997).) The plaintiff, Sondra Locke, covenant of good faith and fair dealing without new payments.
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