What Is The Implied Contractual Duty Of Good Faith And Fair Dealing?
In a previous post, I discussed the “two and a half duties” LLC members owe to other members, focusing primarily on the duties of loyalty and care. In this week’s installment, I attempt to identify some specifics about the slippery concept of the implied contractual duty of good faith and fair dealing (25.15.038(6)(b)). The context of this discussion arises out of a recent Washington Court of Appeals case: iCap NW Opportunity Fund (iCap) v. 134th Street Lofts II.
134th Street Lofts (I) and iCap formed an entity called 134th Street Lofts II (herein referred to as “Project Entity”). The purpose of Project Entity was to develop property into an apartment building in Clark County, WA. 134th Street Lofts served as the developer and obtained a construction loan from Parkview Financial on behalf of Project Entity to finance the construction of the apartment building. The terms of the construction loan prohibited further liens against the property.
After the project was underway, iCap alleged that 134th Street Lofts did not fulfill its contractual obligations and, in January of 2018, iCap and 134th Street Lofts entered into a settlement agreement (and amendment to the LLC Agreement) in which 134th Street Lofts and Project Entity promised to pay iCap $6 million by June 1st. More importantly, Project Entity gave iCap a promissory note for $1,850,000, secured by a deed of trust against the property.
Although iCap agreed their deed of trust was subordinate to Parkview Financial’s deed of trust, neither iCap nor 134th Street Lofts anticipated that Parkview Financial might object to iCap’s deed of trust. When Parkview Financial learned of iCap’s lien against the property, however, it refused to release further funds for construction unless iCap removed its deed of trust. 134th Street Lofts immediately requested iCap to remove its deed of trust but iCap did not do so until 3 weeks later.
During the 3-week period, contractors were not paid for their work and, as a result, they left the job site. By the time the funds were made available, the cost of restarting and completing the job had substantially increased. As a result, 134th Street Lofts was unable to adhere to its contractual budget and schedule requirements under the newly established Settlement Agreement.
134th Street Lofts filed suit against iCap for (among other things) breach of the implied covenant of good faith and fair dealing. The trial court granted summary judgment to iCap.
Good Faith and Fair Dealing
The appellate court identified three key legal principles about the covenant of good faith and fair dealing:
- The implied duty of good faith and fair dealing exists in every contract.
- The implied duty of good faith and fair dealing does not impose a “free-floating obligation, rather it must arise in relation to performance of a specific contract term.” The duty cannot add or contradict a contract’s express terms.
- The duties of good faith and fair dealing obligate both parties to cooperate with one another so that each party may obtain the full benefit of performance of the contract. It compels the parties to a contract to maintain ‘faithfulness to an agreed common purpose and consistency with the justified expectations of the other party’.
In applying the principles above, the Court found that the settlement agreement did not require iCap to reconvey the deed of trust. Without specific contract term to enforce, iCap did not breach its duty of good faith and fair dealing.
Delaware courts have further expanded on the implied duty. First, the Delaware courts distinguish between a contractual fiduciary duty of good faith and the implied covenant of good faith and fair dealing. The contractual fiduciary duty of good faith is very different from the good faith concept addressed by the implied covenant. In Gerber v. Enterprise Products Holding, LLC 67 A. 3d 400 (2013), the Delaware Supreme Court quoted with favor:
[T]he implied covenant is not a license to rewrite contractual language just because the plaintiff failed to negotiate for protections that, in hindsight, would have made the contract a better deal. Rather, a party may only invoke the protections of the covenant when it is clear from the underlying contract that “the contracting parties would have agreed to proscribe the act later complained of … had they thought to negotiate with respect to that matter.
In thinking about the above principles as applied to iCap, I cannot help but wonder if the outcome would have been different if the settlement agreement had required a release of the deed of trust if Parkview Financial were to object. Would a three-week delay have violated the duty of good faith and fair dealing? Did the Court conflate the duty of good faith and the implied covenant of good faith and fair dealing?
The concept of good faith is a slippery one. In next week’s post, we will continue to delve into the concept of good faith, particularly with respect to members and LLCs.
To learn more about the implied contractual duty of good faith and fair dealing, please contact Beresford Booth at email@example.com or by phone at (425) 776-4100.