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Yes … It Is Possible to Breach the Implied Covenant of Good Faith and Fair Dealing Implied in Every Contract

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  • Posted on: Sep 2 2016

When parties negotiate the terms of a contract, they cannot account for every contingency or event that may affect performance.  To be sure, they try.  But, it is simply not possible to account for every occurrence that might arise during the course of the contract.  This inability, therefore, gives the parties wide latitude in the performance and enforcement of their contractual obligations.  Underlying this discretion is the duty to act in good faith and with fair dealing.

As set forth in the Restatement (Second) of Contracts, “[e]very contract imposes upon each party a duty of good faith and fair dealing in its performance and its enforcement.” Restatement (Second) of Contracts § 205 (1981). A party to a contract breaches these duties when his/her conduct frustrates the purpose of the contract, e.g., by failing to perform the things necessary to carry out the purpose for which the contract was entered and to refrain from destroying or injuring the other party’s right to receive the fruits of the contract.  Such conduct is often described as bad faith, and is identified by, among other things, “evasion of the spirit of the bargain,” “abuse of a power to specify terms,” “interference with or failure to cooperate in the other party’s performance,” and willful rendering of imperfect performance. E.g., Restatement (Second) of Contracts § 205 cmt. d.

It is widely recognized that New York was the first jurisdiction to identify the duty of good faith and fair dealing as an implied covenant that made a contract enforceable. See Wood v. Lucy, Lady Duff – Gordon, 222 N.Y. 88 (1917).  Wood involved an endorsement and licensing agreement in which the parties agreed that the plaintiff could sell or license the defendant’s fashion designs in exchange for the payment of one half of all the profits and revenues generated under the agreement. A dispute arose and the defendant argued that there was no agreement between the parties.  The court rejected the defendant’s argument, stating:

The defendant insists, however, that it lacks the elements of a contract. She says that the plaintiff does not bind himself to anything. It is true that he does not promise in so many words that he will use reasonable efforts to place the defendant’s endorsements and market her designs. We think, however, that such a promise is fairly to be implied. The law has outgrown its primitive stage of formalism when the precise word was the sovereign talisman, and every slip was fatal. It takes a broader view today. A promise may be lacking, and yet the whole writing may be “instinct with an obligation,” imperfectly expressed. If that is so, there is a contract.

Id. at 90-91 (citations omitted).

New York Law:

In the 1933, the New York Court of Appeals expressed the duty found in Wood as an implied covenant of good faith and fair dealing.  In Kirk La Shelle Co. v. Paul Armstrong Co., a case involving a dispute between parties to a settled copyright litigation, the Court held that “in every contract there is an implied covenant that neither party shall do anything which will have the effect of destroying or injuring the right of the other party to receive the fruits of the contract, which means that in every contract there exists an implied covenant of good faith and fair dealing.” 263 N.Y. 79, 87 (N.Y. 1933).

Since Kirk La Shelle, the courts in New York have implied a covenant of good faith and fair dealing in the course of the performance of all contracts. See, e.g., Van Valkenburgh, Nooger & Neville v. Hayden Publ. Co., 30 N.Y.2d 34, 45 (N.Y.), cert. denied, 409 U.S. 875 (1972); Dalton v Educational Testing Serv., 87 N.Y.2d 384, 389 (N.Y. 1995). While the duties of good faith and fair dealing do not imply obligations “inconsistent with other terms of the contractual relationship” (Murphy v. American Home Prods. Corp., 58 N.Y.2d 293, 304 (N.Y. 1983)), they do include “any promises which a reasonable person in the position of the promisee would be justified in understanding were included.” Rowe v. Great Atl. & Pac. Tea Co., 46 N.Y.2d 62, 69 (N.Y. 1978) (citation omitted). When the contract contemplates the exercise of discretion by the parties, it includes a promise not to act arbitrarily or irrationally in exercising that discretion. Tedeschi v. Wagner Coll., 49 N.Y.2d 652, 659 (N.Y. 1980).

New York law does not, however, “recognize a separate cause of action for breach of the implied covenant of good faith and fair dealing when a breach of contract claim, based upon the same facts, is also pled.” Harris v. Provident Life and Acc. Ins. Co., 310 F. 3d 73, 81 (2d Cir. 2002). Therefore, when a complaint alleges both a breach of contract and a breach of the implied covenant of good faith and fair dealing based on the same facts and seeks the same relief, the latter claim will be dismissed as redundant. JFK Holding Co. LLC v. City of New York, 98 A.D.3d 273 (1st Dep’t 2012); MBIA Ins. Corp. v. Countrywide Home Loans, Inc., 87 A.D.3d 287 (1st Dep’t 2011); Logan Advisors, LLC v. Patriarch Partners, LLC, 63 A.D.3d 440, 443 (1st Dep’t 2009).

Rebecca Broadway L.P. v Hotton

Recently, the Appellate Division, First Department had the opportunity to once again consider the covenant of good faith and fair dealing. On August 16, 2016, the First Department decided Rebecca Broadway L.P. v Hotton, NY Slip op. 05839, a case that arose “from an unsuccessful effort to produce a Broadway musical about a ghost.” Id. at 1. As the New York Law Journal observed, the facts of the case “offer[ ] enough twists and turns to rival a stage play.” Jason Grant, Appellate Ruling Sets the Stage for Trial in Broadway Scandal, NYLJ, Aug. 18, 2016, available at http://www.newyorklawjournal.com/id=1202765487538/Appellate-Ruling-Sets-the-Stage-for-Trial-in-Broadway-Scandal.  Distilled to their essence, the facts of the case are as follows:

After it was reported that a major foreign investor in the production had died, it emerged that the supposedly deceased backer had never been more than a ghost himself —the man had never existed, except as a deceptive construct conjured up by a dishonest fundraiser, who has since been incarcerated for this wrongdoing. The publicity agent for the show, when he began to suspect the truth about the supposedly deceased foreign investor, expressed his concerns to the producer’s principal, who essentially told him to keep quiet about it. Apparently stung by this dismissive treatment, the publicity agent sent four anonymous emails to another potential investor (this one an actual, living person), who had wished to remain anonymous. The last of these emails, sent under a fictitious name, made various highly negative allegations about the producer and the show’s prospects, and urged the potential investor not to back the play. After receiving this email, the potential investor promptly withdrew from involvement in the production, preventing it from going forward.

Slip op. at 1-2.

The plaintiff, Rebecca Broadway Limited Partnership (“RBLP”), sued Marc Thibodeau (“Thibodeau”) a publicity agent for breach of contract, tortious interference with business relations and defamation. The motion court granted RBLP’s motion for summary judgment as to Thibodeau’s liability for breach of contract and denied RBLP’s summary judgment as to RBLP’s causes of actions for tortious interference with business relations and defamation.  The motion court also denied Thibodeau’s cross motion for summary judgment for, among other things, breach of contract. Thibodeau appealed the motion court’s order. The First Department affirmed.

“As to the breach of contract cause of action,” the First Department found that the motion court “properly granted RBLP summary judgment as to liability on that claim.” Slip op. at 4. The Court found that the “record establishe[d] that Thibodeau, without RBLP’s authorization, and using confidential information he had obtained as a result of his employment as RBLP’s press representative,” caused “a key potential investor” “to withdraw his financial commitment,” to the show, “which resulted in the cancellation of rehearsals and the play’s failure to open.”  Id. That sufficed to breach the terms of the agreement with RBLP.

The First Department noted that “[e]ven assuming that his conduct did not violate the express terms of his agreement to act as the play’s press representative, Thibodeau breached the implied duty of good faith and fair dealing by essentially defeating the purpose of the agreement by his actions.” Slip op. at 4 (citation omitted). In so holding, the Court found that

“Thibodeau was hired by RBLP to use his public relations skills to facilitate the production of a play; his actions, in which he made use of confidential information that RBLP had entrusted to him in the course of his employment, made it impossible for RBLP to produce the play as planned. It is difficult to imagine a plainer case of a party to a contract utterly defeating the purpose for which the other party had entered into that contract, or a more blatant example of an agent’s disloyalty to his principal.”

Id.

Having affirmed the motion court’s decision, the First Department turned to the denial of Thibodeau’s cross motion for summary judgment.

Thibodeau claimed that RBLP breached the covenant of good faith and fair dealing by instructing him to answer all questions about the project, notwithstanding the direction to refrain from discussing possible foreign investors. The First Department rejected this claim:

Although Thibodeau might well have felt uncomfortable in meeting the press while under orders not to give them the information they sought, RBLP did not breach the covenant of good faith and fair dealing by giving him those instructions. Again, while the record establishes that RBLP — as was its right — directed Thibodeau not to respond substantively to questions concerning the Abrams [i.e., foreign investor] issue, Thibodeau does not allege that RBLP ever directed him to respond falsely to press inquiries. He could have responded to questions about Abrams, both truthfully and consistent with RBLP’s directives, by stating that RBLP was investigating the matter. RBLP, as Thibodeau’s principal, was entitled to limit the subjects that Thibodeau, as RBLP’s agent, was authorized to discuss substantively with the press and public; if Thibodeau was uncomfortable with that limitation on his authority, he was free to resign.

Slip op. at 5.

The Court went on to observe that even if RBLP breached the covenant of good faith and fair dealing before Thibodeau breached his covenant, the result would remain unchanged.  As the Court noted, Thibodeau could have resigned and terminated the agreement with RBLP:

Even if RBLP could be deemed to have somehow breached its implied duty to Thibodeau of good faith and fair dealing before he committed his own breach of that covenant by sending the anonymous emails, we would not reach a different result. Any such material breach by RBLP, before the breach by Thibodeau, would have given Thibodeau grounds to suspend his own performance and, absent a timely cure by RBLP of its breach, to terminate his contract with RBLP (and then, perhaps, to seek damages for breach) …. But a first material breach of the parties’ agreement by RBLP, if there was one, would not have justified Thibodeau’s remaining in RBLP’s employ while using confidential information entrusted to him to sabotage the production. A party to a bilateral contract, when faced with a breach by the other party, must make an election between declaring a breach and terminating the contract or, alternatively, ignoring the breach and continuing to perform under the contract. Such a party has no right to represent himself as continuing to perform under the contract —and continuing to receive the other party’s performance in exchange — while at the same time surreptitiously breaching his own duty by flouting his own implied duty of good faith and fair dealing.

Slip op. at 5-6 (citations and quotations omitted).

Takeaway:

The implied duty of good faith and fair dealing has long been accepted as a judicial tool of contract analysis. It is aimed at ensuring that the parties to a contract do not interfere with the other party’s performance or destroy the other party’s expectations with respect to the benefits of the contract. Rebecca Broadway serves as a recent example of the duty and how it can serve as the basis for a separate cause of action.

Rebecca Broadway is also notable for its admonition to contracting parties about how to conduct themselves when there is a breach. In this regard, the Court made it clear that when a party to a contract breaches the agreement, the non-beaching party must make an election of remedies between declaring a breach and terminating the contract or, ignoring the breach and continuing to perform under the contract.

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