In Good Faith, Would Your Agreements Say That A Party Can Act In Bad Faith?

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Would you write that a tenant’s or landlord’s consent was required but that consent could be withheld in bad faith? We don’t think so. We’ve never seen such. We doubt we ever will.

There is no need for a contract, such as a lease or mortgage, to say that the parties will act in good faith. The obligation to act in good faith and deal fairly with the other party or parties is implied by law into every agreement. As such, it is a contractual obligation, not a fiduciary duty. So, we think that, as a contractual obligation, it can be negated by a voluntary and knowing agreement between the parties to an agreement. That’s what expressly allowing one party or the other to act in bad faith would do.

Admittedly, we haven’t done any legal research that would support or undermine our thinking. That’s because we strongly doubt anyone ever included a “bad faith allowed” provision in their agreement. If any reader knows otherwise, let us and other readers know through the comment feature of this blog site.

Now, we (and all of you) have seen many agreements where “consent” is required before one of the contracting parties can take specified actions. Though the most common formulation is: “which consent may not be unreasonably withheld (, delayed or conditioned),” there are certain contracting parties who don’t want to be reasonable. Yes, it is permitted not to be reasonable, though no one we’ve ever met has had the temerity to write: “which consent may be unreasonably withheld.” But, what we and all readers have seen are formulations such as: “which consent may be exercised in its sole (unfettered) discretion” or “which consent may be withheld for any reason or no reason at all.”

Are those (and similar) formulations the functional equivalent of “which consent may be unreasonably withheld”? No, they are not. The reason goes back to that ever-present (implied) covenant of good faith and fair dealing. Yes, even “sole discretion” and “no reason at all” are “conditioned” by the obligation to act in good faith. A recent example of that principle comes to us by way of a United States District Court decision dealing with a “no-build” provision in a Declaration of Restrictions and Grant of Easements governing an Oregon shopping center.

Let’s set the scene. The shopping center consisted of two adjacent parcels. The parcels were owned by separate entities. One of the center’s tenants, the “disruptor” in this story, was a chain drugstore. The two parcels were governed by a “Declaration” of Restrictions and Grant of Easements. Under the Declaration, buildings could not be placed within what were defined as “Common Areas.” Those areas were the ones at the shopping center that were to be used exclusively for “vehicular driving, parking …, pedestrian traffic, directional signs, sidewalks, walkways, and landscaping.” The Declaration was not immutable. It had a “Modification Provision” that permitted amendment. It read as follows:

This Declaration may not be modified in any respect whatsoever or rescinded, in whole or in part, except with the consent of the Prime Lessees and the owners of the Parcels containing ninety percent (90%) of the total square footage of existing buildings in the Shopping Center at the time of such modification or rescission, and then only by written instrument duly executed and acknowledged by all of the required owners and Prime Lessees, duly recorded in the office of the Recorder of Marion County, Oregon.

The drug store was a Prime Lessee.

The owner of one of the parcels had a letter of intent for a long-term ground lease from a national quick service restaurant tenant. To go forward, the owner needed to get land use approvals and get the Declaration modified (because the ground lease would be for a portion of the common areas). The City approved the development plans. All identified parties, but for the drug store tenant, approved the needed change to the Declaration. According to the court, the drug store was “correct that the Declaration unambiguously grant[ed] it the right to deny a proposed modification.” Case over? No. Read on.

It seems this dispute spanned “years of efforts by [the parcel owner] to adequately address any reasonable concerns” raised by the drug store tenant. The parcel owner hired a third-party engineering firm and a third-party architectural firm to analyze the drug store tenant’s concerns. Each “concluded that the development of the Proposed Building Area would not materially impact [the tenant’s] parking utilization, driveway operations, or visibility.”

Well, that should square up the issue. Given the seemingly uncontroverted testimony from third-party experts, did the drug store tenant have the right it asserted in court, the: “absolute right to prevent [its landlord from] building a restaurant in the shopping center”?

In Oregon and everywhere else we know of in the United States (using the court’s words):

The law imposes a duty of good faith and fair dealing in the performance and enforcement of every contract.

The purpose of this duty is to prohibit improper behavior [and] ensure that the parties will refrain from any act that would have the effect of destroying or injuring the right of the other party to receive the fruits of the contract.

The good faith doctrine is therefore designed to “effectuate the reasonable contractual expectations of the parties.

However, the obligation of good faith does not vary the substantive terms of the bargain . . . nor does it provide a remedy for an unpleasantly motivated act that is expressly permitted by contract.

As a result, a duty of good faith and fair dealing may be implied as to a disputed issue only if the parties have not agreed to an express term that governs that issue.

Whether one calls those “rules of law,” “strong suggestions” or mere platitudes, they can’t be ignored. Over the past (almost) six years, we’ve plucked similar statements from court decisions all over the country. You can find those blog postings by searching for “good faith” using the blog site’s search feature. Applying the principles in the list above and with respect to all of the similar ones we’ve presented over the years is not a simple task. Like most principles, they can easily be applied at the outer ends of a spectrum of facts, in situations where the answer is clearly a breach of the duty of good faith or where there clearly is not such a breach. Otherwise, it appears to be a balancing act. It is a breach of “good faith” to deny consent when the denier derives no benefit and the requestor is harmed by the denial. It appears to be a denial in “good faith” where the denier has a valid non-pretextual business reason and the requestor is only slightly harmed. That leaves a big range in the middle.

To add to the “big middle” situation, courts appear to be timid when applying the universally accepted covenant of good faith and fair dealing. It would be an understatement to say that courts in Oregon “have reached varied results concerning the exercise of discretion in this context.” Let’s translate that ‘observation” made by the federal court about this “tension in Oregon law” – “courts are all over the place on this principle.”

Ruminations has read a lot of the cases that give rise to this alleged “tension” and has concluded that the “tension” is more about the kind of agreement in front of a court and less about whether the covenant of good faith is a real one. We would urge that readers neither fear nor take comfort in any “reluctance” on the part of a court to apply the good faith requirement, especially when it comes to leases and slightly less so when it comes to purchase and similar agreements. On the other hand, it would appear that lenders are less often held to a high standard of :good faith” in loan agreements, though it may just be that when it comes to pure issues of “money,” courts believe that every lender’s decision involves the lender’s legitimate business interests. We suggest that any reader searching for a law review article topic think about our hypothesis.

Though we don’t feel the rest of the story is as important as what we’ve already written, Ruminations owes readers some sort of ending to the story. To some, the ending may be a little disappointing. To others, the ending may be a warning and a behavior-changing lesson. Frankly, to say “ending” is somewhat inaccurate because the court only framed the issue so that the drug store tenant and its landlord could proceed to argue the “facts” before a trial court. Nonetheless, we say “ending” because it is unlikely we’ll ever know how the dispute gets resolved because once the court said that there is not an absolute right to deny consent, settlement becomes attractive.

So, back to how did the implied covenant impact the tenant’s “unambiguous” right to deny consent to use of the common areas for a new restaurant building? In what manner could the tenant’s right be exercised? The Declaration was silent. So, according to the court, “[b]ecause there [was] no express contractual term to the contrary, [the tenant] was required to act in good faith and deal fairly when exercising its discretion.” [Note: the court would seem to be saying that had the Declaration expressly permitted a bad faith denial, if anyone would dare negotiate to put that in an agreement, good faith would not have been required.]

In answering the question about whether the tenant’s denial was compatible with “the reasonable expectations of the parties,” the court made the following observations. Even though the landlord, in its lawsuit, never “explicitly allege[d] its reasonable contractual expectations and how [its tenant, the drug store] has violated those expectations by its arbitrary and unreasonable refusal to consent to modifying the declaration … the Declaration itself provide[d] some guidance.” In that regard, “[t]he only explicitly stated purpose of the Declaration [was] to facilitate commercial activities ‘for the mutual benefit of all real property in the Shopping Center’ [and] the Declaration provide[d] a mechanism through which its terms, including the preclusion relating to construction in Common Areas, [could] be changed.” Further, as is common in other jurisdictions [but, be careful, the extent to which this is true varies], “Oregon law requires that consent not be unreasonably withheld absent an express contractual term to the contrary.”

So, with all of that in mind, “it was objectively reasonable for [the landlord] to expect [its tenant] to negotiate, reasonably and in good faith, concerning any proposed amendment that [was] potentially beneficial to [the shopping center] generally, and not materially [emphasis ours] to [the tenant’s] specific financial and/or business interests.” For that reason, this dispute would continue through a trial unless the parties reached a consensual agreement.

[To see the court’s actual decision, click: HERE.]

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Comments

  1. Bob Dilling says:

    Just so you know I often see lenders put in the miscellaneous section of a loan agreement an affirmative statement that’s says when their consent or approval is required unless the standard expressly states otherwise the lender is under no duty to act in good faith and that the lender can act or refuse to act in its sole and absolute discretion- I am not certain a court would enforce such a provision but I think it is good practice to remove this language and incorporate the UCC standard of commercial reasonableness and good faith-

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