A Narrow Lane: Navigating Claims for Breach of the Duty of Good Faith and Fair Dealing
Courts quick to dismiss except under certain circumstances.
By Adrienne B. Koch
New York Law Journal
(November 16, 2020)
It is a settled principle of New York law that “all contracts imply a covenant of good faith and fair dealing in the course of performance.” 511 W. 232nd Owners Corp. v. Jennifer Realty Co., 98 N.Y.2d 144, 153 (2002) (collecting cases). Courts have described this covenant as a duty “encompassing any promises which a reasonable person in the position of the promisee would be justified in understanding were included and which are not inconsistent with the contract.” This duty “is breached when a party acts in a manner that, although not expressly forbidden by any contractual provision, would deprive the other party of the right to receive the benefits under their agreement.” Twinkle Play Corp. v. Alimar Properties, Ltd., __ A.D.3d ___, 2020 WL 5540060, *1 (2d Dept. Sept. 16, 2020) (collecting cases; citations and internal quotations omitted).
It is tempting to invoke this duty liberally. After all, most plaintiffs probably believe that the defendant did not act in good faith and/or that the result was unfair. But contract law is all about allowing parties to agree on how their business relationships will be ordered, and courts are loath to make rulings that might vary the terms to which the parties agreed. A party’s conduct either breaches the terms of the agreement or it does not; if it does not, that is generally the end of the line for a breach of contract claim. A party seeking to impose an additional duty on the ground that it is “implied” bears a heavy burden.
In short, claims for breach of the duty of good faith and fair dealing fail far more often than they succeed. This article explores some of the nuances that make such claims particularly thorny.
What The Duty Is Not
An explanation of those nuances must begin with what the duty of good faith and fair dealing is not. Despite its name, it is not an obligation to deal in subjective good faith. To the contrary, “[t]he law encourages ‘efficient breaches’”; that is, breaches committed based on the breaching party’s calculated determination that it “will still profit after compensating the other party for that party’s expectancy interest.” 28A N.Y. Prac. Contract Law § 23.2. Absent a specific provision in the contract that requires good faith, a “bad faith breach” is no different from any other.
The duty of good faith and fair dealing does not change this. In fact, although a claim for breach of the duty of good faith and fair dealing requires that the parties have a valid contract (and will be dismissed if they do not – see Veneto Hotel & Casino, S.A. v. German American Capital Corp., 160 A.D.3d 451, 452 (1st Dept. 2018)), such a claim will fail if it is based on the same alleged conduct that forms the basis for a cause of action for breach of the contract’s express terms. See Kim v. Francis, 184 A.D.3d 413, 414 (1st Dept. 2020).
By the same token, the duty of good faith and fair dealing cannot be invoked to create rights not actually contemplated by the contract – even where to do so would be more “fair.” See, e.g., Rapson Investments LLC v. 48 East 22nd Street Property LLC, 2019 WL 1179438, *9 (Sup. Ct. N.Y. Co. Mar. 11, 2019) (duty could not be invoked to relieve a breaching party of the consequences of its default), aff’d, 180 A.D.3d 614 (1st Dept. 2020). Thus, for example, where a contract gives a party absolute discretion with respect to a particular matter, an exercise of that discretion cannot constitute a breach of the duty of good faith and fair dealing – no matter how unfair the result may seem. See, e.g., Veneto Hotel & Casino, supra, 160 A.D.3d at 451-52.
What The Duty Is: Two Illustrations
So what does constitute a breach of the duty of good faith and fair dealing? Two recent cases provide illustrations. In Twinkle Play, supra, the parties had a commercial lease pursuant to which “the plaintiff was to open and operate a children’s play and party space on the ground floor of a building owned by the defendant.” 2020 WL 5540060 at *1. The plaintiff claimed that the defendant “had refused to sign certain paperwork required by the New York City Department of Buildings” to allow the plaintiff “to legally operate its business.” Id. The lower court granted the defendant’s pre-answer motion to dismiss the plaintiff’s claim for breach of contract, because the parties’ lease did not expressly require the defendant to sign that paperwork.
The Appellate Division, however, reversed. Accepting the plaintiff’s allegations as true, the court held, “there was an implied understanding that the defendant would cooperate with the plaintiff’s efforts to legally change the usage of the rental space, which would require approval by the [Department of Buildings], and, therefore, the defendant’s failure to cooperate in legalizing the premises constituted a breach of contract.” Id. The absence of an express duty in the lease was of no consequence: because the defendant’s alleged actions had the effect of depriving the plaintiff of the right to receive the benefit specifically contemplated by the lease (that is, the ability to operate a children’s play and party space in the premises), if proven they would constitute a breach of the duty of good faith and fair dealing. Id.
Similarly, in Howard v. Pooler, 184 A.D.3d 1160, 126 N.Y.S.3d 824 (4th Dept. 2020), the parties formed a limited liability company (LLC) for the purpose of developing a certain residential subdivision. Their operating agreement provided that the plaintiff would be primarily responsible for sales of lots in the subdivision, and that its company would be the exclusive agent for such sales for as long as they continued at a certain minimum. The defendant, however, took various actions that obstructed the plaintiff’s sales efforts. As a result, the plaintiff was unable to meet the stated quota. The court had no difficulty affirming the lower court’s finding that this constituted a breach of the duty of good faith and fair dealing: although the defendant’s conduct was “not expressly forbidden” by any provision of the operating agreement, it had the effect of depriving the plaintiff of the benefits contemplated by that agreement. 126 N.Y.S.2d at 829-30.
Finding The Narrow Lane
Although the lane in which a claim for breach of the duty of good faith and fair dealing might succeed is narrow, two common threads in Twinkle Play and Howard point the way down that lane. First, in each of those cases the plaintiff complained that the defendant did something that essentially rendered the contract (or an important part of the contract) worthless to the plaintiff. Second, in each one the defendant’s alleged conduct was inconsistent with the contract’s express purpose, even though it was not specifically prohibited. Conduct that meets both of these criteria is rare. But its presence in each of these cases made the claim for breach of the duty of good faith and fair dealing viable.
There is another important caveat to bear in mind. Although the duty of good faith and fair dealing is considered a matter of black-letter law (see Restatement (Second) of Contracts § 205 (“Every contract imposes upon each party a duty of good faith and fair dealing in its performance and its enforcement.”)), it may mean different things depending on which state’s law governs the contract. Some states appear to treat the duty similarly to New York. See, e.g., A.D.E. Systems, Inc. v. Energy Labs, Inc., 183 A.D.3d 791 (2d Dept. 2020) (discussing California law). Others, however, view the duty somewhat differently. Under Delaware law, for example, a claim for breach of the duty of good faith and fair dealing requires a showing that the parties’ agreement contains a “gap” that “neither party could have anticipated.” See Pilot Air Freight, LLC v. Manna Freight Systems, Inc., 2020 WL 5588671, *18-19 (Del. Ch. Sept. 18, 2020) (collecting cases; citations and internal quotations omitted). This is arguably an even narrower interpretation than what New York law permits. See Kuroda v. SPJS Holdings, L.L.C., 971 A.2d 872, 888 (Del. Ch. 2009) (duty of good faith and fair dealing is “only rarely invoked successfully” under Delaware law). It is important to understand these distinctions if the operative contract is governed by a law other than New York’s.
The temptation to invoke the duty of good faith and fair dealing is understandable. Before yielding to that temptation, counsel should step back and think carefully: courts that are accustomed to seeing claims for breach of this duty are primed to recognize their overuse. Nevertheless, if the conduct at issue is of the rare type that fits within the narrow lane illustrated by Twinkle Play and Howard, then with careful pleading the claim may succeed.
Adrienne B. Koch is a litigation partner with Katsky Korins in New York.
Reprinted with permission from the November 16, 2020 edition of the “New York Law Journal” © 2020 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited. ALMReprints.com – 877-257-3382 – firstname.lastname@example.org.