Last year Chancellor Strine said “[t]he implied covenant of good faith and fair dealing is not a license for a court to make stuff up ….” But two recent Chancery Court decisions are reminders that can still happen.
In JPMorgan Chase & Co. v. American Century Companies, Inc. (2012 Del. Ch. LEXIS 89 (Del.Ch. 2012)). Vice Chancellor Noble held that JPMorgan Chase & Co. (“JPMC”) adequately stated a claim for breach of the implied covenant of good faith and fair dealing, denying a motion to dismiss that claim by American Century Companies, Inc. (“ACC”).
JPMC held a 45% interest in closely-held ACC, and ACC had an option to buy any number of its shares held by JPMC at “fair market value” as determined by periodic valuation reports of ACC’s financial advisor, Duff & Phelps (“D&P”). In July 2011, ACC exercised its option, and shortly after that won a $373 million award in a separate arbitration against JPMC. JPMC thought D&P should have, but did not, assign a value to the arbitration claim in the valuation used for the shares purchased by ACC and, as a result, ACC paid JPMC less than it should have to buy the shares.
JPMC claimed both breach of contract and breach of the implied covenant of good faith and fair dealing. Both claims were based among other things on ACC failing to give D&P sufficient information for it to value ACC’s arbitration claims against JPMC for purposes of the share valuation. The court dismissed the breach of contract claim because the option agreement did not expressly require ACC to give D&P information about the arbitration claims. But the court held that JPMC adequately pled a claim for breach of the implied covenant of good faith and fair dealing. That is, an implied contractual obligation for ACC to provide D&P with sufficient information to value the shares accurately.
In Blaustein v. Lord Baltimore Capital Corp. (2012 Del. Ch. LEXIS 126 (Del. Ch. 2012)). Vice Chancellor Noble again held that the plaintiff adequately stated a claim for breach of one of the many covenants she wanted the court to imply in a shareholders’ agreement.
Delaware Implied Covenant of Good Faith and Fair Dealing
The implied covenant of good faith and fair dealing is imposed on all Delaware contracts. It allows Delaware courts to imply terms into a contract in order to address unforeseen events or contractual gaps. Contract terms will be implied only where the party asserting the implied covenant shows “the other party has acted arbitrarily or unreasonably, thereby frustrating the fruits of the bargain that the asserting party reasonably expected.” Contract terms generally will not be implied if the conduct is permitted under the agreement. The implied covenant does not apply to events the parties failed to consider during negotiations, only events that could not have been anticipated by the parties during negotiations. The Delaware Supreme Court has called it a “limited and extraordinary legal remedy.” In order to plead successfully a breach of the implied covenant, the plaintiff must allege a specific implied contractual obligation, a breach of that obligation, and resulting damage to the plaintiff.
In this case, Blaustein represented a group of investors that collectively owned approximately 17.59% of Lord Baltimore Capital Corp. (“LBCC”), a closely held corporation formed to hold various investments of several wealthy families. Blaustein’s claims for breach of implied covenants all related to her desire for LBCC to repurchase her stock at a price she considered reasonable, rather than the discounted prices that LBCC management proposed over the years.
The court dismissed most of the implied covenant claims on the basis that they were inconsistent with the terms of the shareholders’ agreement. But the court held that Blaustein had adequately alleged that there might be an implied covenant requiring repurchase proposals to be presented to LBCC’s board of directors, and if there was, that implied covenant had been breached because LBCC’s management had never presented Blaustein’s repurchase proposals to the LBCC board. So that count of the complaint was not dismissed, even though the Vice Chancellor thought board consideration of the plaintiff’s repurchase proposals “may provide her with little benefit.”
A claim for breach of the implied covenant of good faith and fair dealing is often included in contract dispute cases that go to court in Delaware. Reported decisions suggest that claim generally has not been successful in cases that were not settled. For example, we surveyed reported Delaware decisions since 2009 involving commercial transactions (our survey excluded employment termination and insurance coverage disputes) with implied covenant claims and found that out of the 44 case sample:
- 31 cases (70%) were dismissed on summary judgment motions before trial, and
- no post-trial decisions upheld a damage claim based on a breach of the implied covenant of good faith and fair dealing.
But these two cases make clear that Delaware courts may still fill contract gaps.
Chadbourne Summer Associate Eric Kamerman assisted in the research for this article.