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Choice of Law and the Covenant of Good Faith and Fa

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Choice of Law and the Covenant of Good Faith and Fa RETAIL AND HOSPITALITY When—or Should We Say Where— Choice of Law and Is Compliance with a Contract also a Breach? the Covenant of By Leon Silver Good Faith and Fair Dealing Carelessness in drafting In my practice, my national and regional retail clients contract language can most often opt for the company’s headquarters’ home state result in your client’s as both the exclusive forum and the source for the control- company undertaking ling law in their master vendor agreements as well as any number of other contracts. While the prac- implies the duty of good faith and fair obligations and becoming tical realities of having to manage litigation dealing in every contract, and because the that could conceivably occur anywhere in states apply the duty differently, if you and exposed to liabilities the country make the forum choice a seem- your clients have not become aware of the ingly straightforward decision, I have often how the controlling jurisdiction treats the that the company never found that contract drafters do not give covenant of good faith and fair dealing, you the choice of law provision enough criti- can find your client’s sober and reasoned anticipated because the cal thought. This is particularly so because business decisions turned on their heads. the choice of controlling law may have the law implies duties that unintended and completely surprising con- Arizona: The Broadest View sequence of making conduct that complies Arizona sits at the broadest end of the good you cannot otherwise with the terms of a contract still actionable faith and fair dealing spectrum. We might for breach. almost, surprisingly, call Arizona “liberal” clearly define. This article examines how the covenant in this regard. Arizona, as most jurisdic- of good faith and fair dealing can create lia- tions, recognizes that the duty of good faith bility in some states but not others for the and fair dealing is implied in every con- exact same acts by a contracting party. Spe- tract. Rawlings v. Apodaca, 151 Ariz. 149, cifically, we will discuss how the covenant 163, 726 P.2d 565, 579 (Ariz. 1986). Ide- of good faith and fair dealing is viewed ally, this duty deters parties from acting to in six representative states: Arizona and impair the right of another party to receive Texas, reflecting the extremes, and Dela- the benefits that flow from the contract. See ware, New York, California, and Illinois, id. at 153–54, 726 P.2d at 569–70. providing a solid survey of the more mod- Arizona’s implied duty, however, encom- erate view. Since almost every state’s law passes nearly every action by a party. Any- ■ Leon Silver is a shareholder in the Phoenix office of Polsinelli Shughart. He handles complex commercial and real estate disputes for national retailers, restaurants, and manufacturers, sophisticated real estate investors, and developers. He has worked on a variety of finance, accounting, business fraud, and real estate related disputes. Mr. Silver is cofounder of Polsinelli Shughart’s retail and hospitality practice area and a member of the DRI Retail and Hospitality, Commercial Litigation, and Trial Tactics Committees. Nathan Kunz and Rebecca Lumley assisted in the research and preparation of this article. © 2013 DRI. All rights reserved. For The Defense ■ February 2013 ■ 25 RETAIL AND HOSPITALITY thing a party does that impairs or seems cretion either discretion expressly allowed Id. (emphasis added). to impair another party’s benefits that flow in the contract in a way not reasonably ex- The Arizona Supreme Court ruled it a from a contract can breach the implied pected or discretion not expressly excluded question of fact whether the bank “wrong- duty. Id. It does not matter whether the but still contrary to the other party’s reason- fully exercised contractual power for ‘a party’s action relates to an express term or ably expected benefits of the bargain. Bike reason beyond the risks’ that the Funds an area on which the contract is silent— Fashion, 202 Ariz. at ¶14, 46 P.3d at 434. assumed in the Triparty Agreement, or for either can breach the duty. Bike Fashion Wells Fargo Bank, 201 Ariz. 474, ¶60, 38 a reason inconsistent with the Funds’ justi- Crop. v. Kramer, 202 Ariz. 420, ¶14, 46 P.3d P.3d 12, 29 (Ariz. 2002), is perhaps Arizo- fied expectations.” 201 Ariz. at ¶67, 38 P.3d 431, 434 (Ariz. Ct. App. 2002). A party may na’s primary case regarding the implied at 30. Wells Fargo exemplifies potential lia- duty. The case began during Arizona’s late bility for failure to perform a condition not 1980s real estate crisis and included allega- in a contract. tions against the then- future governor J. Fife Another Arizona case exemplifies poten- Arizona law’s only Symington III who ultimately resigned dur- tial liability for “improperly” exercising ing his second term. 201 Ariz. at ¶2, 38 P.3d express, unfettered discretion. In Arizona consistent limitation on at 17–18. In 1988, Mr. Symington’s partner- Towing Profs., Inc. v. State, an unsuccess- ship secured interim funding from First ful bidder on a contract with the Arizona the duty of good faith Interstate Bank to build a commercial de- Department of Public Safety filed a pro- velopment in downtown Phoenix called The test. 196 Ariz. 73, ¶5, 993. P.2d 1037, 1038 is to prevent it from Mercado. Id. The permanent lenders, who (Ariz. Ct. App. 1999). Due to the protest, the were a collection of pension funds, were to department cancelled the bid—as it could “directly contradict[ing] an “take-out” the bank’s loan by June 1990. Id. under an express provision under the con- To that end, the bank, Mr. Symington, and tract: “the contracts… are cancelable for express contract term.” the funds entered a triparty agreement. The convenience on thirty (30) days’ notice.” triparty agreement did not require the bank Id. at ¶7, 993 P.2d at 1039. But the Arizona to provide any information to the funds. Id. Court of Appeals disagreed: “[The depart- breach the implied duty without breach- In 1989, the real estate market crashed. ment] did not act in good faith. It invoked ing an express term, and it may breach 201 Ariz. at ¶3, 38 P.3d at 18. Mr. Syming- the cancellation for convenience provision an express term without breaching the ton was unable to meet his obligations on a in an effort to render moot Shamrock’s implied duty. Wells Fargo Bank v. Arizona separate loan with the bank. Id. The bank, appeal of its original cancellation over the Laborers, 201 Ariz. 474, ¶60, 38 P.3d 12, 29 however, granted forbearances on that sep- bid protest.” Id. at ¶23, 993 P.2d at 1041. (Ariz. 2002). arate loan until mid-1990 when the funds Unbridled discretion would permit the The terms implied in the contract “are were to replace the bank on the loan. 201 department to avoid any appeals. Id. as much a part of the contract as are the Ariz. at ¶7, 38 P.3d at 19. Once the funds Arizona law’s only consistent limitation express terms.” Id. at ¶59, 38 P.3d at 28. met their obligation and paid the bank as on the duty of good faith is to prevent it Although the parties must be in privity, the promised, the bank held Mr. Symington’s from “directly contradict[ing] an express duty “arises by operation of law.” Id. There- other loan in default. Id. contract term.” Bike Fashion, 202 Ariz. at fore, breach of the duty is a claim distinct The funds sued the bank for failing to ¶14, 46 P.3d at 434. from breach of contract: “ because a party disclose Mr. Symington’s troubled finances. Under Arizona law, the results can be may be injured when the other party to a The funds alleged that the implied duty troubling. In one case handled by your au- contract manipulates bargaining power to required the bank to disclose Mr. Syming- thor, the court denied the opposing party’s its own advantage, a party may neverthe- ton’s financial difficulties. The bank- dis request for leave to amend its complaint to less breach its duty of good faith without agreed, arguing that it could not be liable add claims of a widespread and far- reaching actually breaching an express covenant in because “it did not breach any provision of alleged fraud. The party then sought to rely the contract.” Id. at ¶64, 38 P.3d at 29. Con- the Triparty Agreement.” 201 Ariz. at ¶63, on the same facts as part of its claim for versely, “[a] party may breach an express 38 P.3d at 29. breach of the duty of good faith and fair covenant of the contract without breach- The Arizona Supreme Court disagreed dealing. While the denial of the motion for ing the implied covenant of good faith and with the bank: leave limited the damages that could be fair dealing.” Id. The Bank relies too heavily on the literal claimed to contract damages, reliance on The breach of the duty may sound in text. The duty of good faith extends be- the good faith and fair dealing claim left contract or in tort. Id. at ¶61, 38 P.3d at 29 yond the written words of the contract…. the door open for discovery and introduc- (“When the remedy for breach of the cov- [A party] may breach an express cove- tion of what would have been, without the enant sounds in contract, it is not neces- nant of the contract without breaching good faith and fair dealing claim, inadmis- sary for the complaining party to establish the implied covenant” and conversely, “a sible, inflammatory evidence.
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