Today we are going to begin in depth exploration of a topic we've already come across a few times. The duty of good faith. We're going to start by discussing Centronics Corp v Genicom Corp. A case decided by the Supreme Court of New Hampshire in 1989. The case concerned a rather complicated transaction for financial assets. Centronics agreed to sell and Genicom agreed to purchase certain business assets. The parties agreed that the purchase price of the assets would be pegged to the asset's value at closing. Because the price value couldn't be known at the time that the contract was formed, the parties agreed that disputes over the ultimate purchase price would be referred to an accounting firm for arbitration. The parties also agreed that pending final valuation of the assets, Genicom would deposit a portion of the purchase price into escrow. The parties did indeed disagree about the value of the assets at closing, and so began arbitration. The arbitration process apparently was taking longer than the parties anticipated, and while arbitration was still on going Centronics requested that Genicom release from escrow the portion of the funds that were not in dispute. Genicom refused to do so and Centronics sued, arguing that Genicom had breached an implied obligation of good faith. Genicom moved for summary judgment, which the trial court granted. The New Hampshire Supreme Court, in an opinion by then judge and now, former Supreme Court Justice David Souter affirmed. Souter did not deny that an obligation of good faith existed, rather his opinion focused on what good faith requires. Souter outlined three categories of cases in which good faith disputes might arise. Cases dealing with standards of conduct in contract formation, that's the first category. The second is cases concerning at will termination of employment contracts. And the third is limits on discretion in contractual performance. These three categories correspond to three different times of a contract's existence. Its formation, its termination, and what happens in between. The good faith requirement can always be seen as limiting discretionary behavior. Souter saw that the limits on discretion, though, differ depending on whether we're talking about a contractors discretion in forming or termination a contract, or in exercising discretion during a contract. That is how to perform a contract when there is some discretion granted one side or the other. Under category one, concerning good faith and formation, good faith is tantamount to the traditional duties of care to refrain from misrepresentation and to correct subsequently discovered error insofar as any representation is intended to induce and is material to another parties decision to enter into a contract In justifiable reliance upon it. Basically, Souter is saying that you have to be honest both explicitly and implicitly, when dealing at arms length in negotiating the possible formation of a contract. Under category two, concerning at will termination of a contract. The good faith obligation limits an employers power to fire an up will employee. Good faith is violated when the employer fires and that one employee quote, out of malice or bad faith in retaliation for action taken, or refused by the employee in consonance with public policy, end quote. Combing through precedent, the court determined that good faith in the third category of cases into which the instant dispute fell, requires, quote, an implied obligation of good faith to observe reasonable limits in exercising that discretion, consistent with parties purpose or purposes in contracting, unquote. The court further broke down the analysis required for category three discretionary performance cases into four questions. First, whether the contracting question allowed or conferred upon the defendant a degree of discretion in performance that was tantamount to a power to deprive the plaintiff of a substantial proportion of the agreement's value. Second, if it did, whether the evidence suggested that the parties intended to make a legally enforceable contract. Third, if so whether the defendant's exercise of discretion exceeded the limits of reasonableness. A question that required identifying the purpose of the contract. And forth whether the the damage complained of resulted from events beyond the control of either party. But the court didn't need to run through each of these four questions because it determined the decision in answering the very first question. That the contract it found did not confer discretion upon Genicom to deprive Centronics of a substantial proportion of the agreement's value. The court examined the contractual provisions governing release of the funds from Escrow. The Escrow Agreement provided that quote, in accordance with section 2.07 of the Purchase Agreement, the Escrow Agent shall hold the escrow funds in its possession until instructed in writing, unquote, by the parties' lawyers. Quote, to distribute the same, or some portion thereof to Centronics or Genicom as the case may be. Section 2.07 of the purchase agreement, entitled Final Payment of Purchase Price stated, quote final settlement and payment of the purchase price shall be made not later than ten days after determination of the closing value and computation of the purchase price whether by agreement of the parties or decision of the arbitrator. These provisions were in the court's words express and unequivocal, they gave Genicom no discretion to withhold payout for approval beyond that time or to affect the timing of the arbitration itself. Because of this, the court concluded that Genicom was not given discretion such that it could deprive Centronics indefinitely of a portion of the agreed consideration for the business assets previously transferred. The court addressed discretion beyond the timeline specified in the agreement. What about before that timeline? Does Genicom have discretion to release the funds before ten days after determination of closing value? The court believes the text of the agreement supported the claim that the parties intended the escrow agent to leave the fund intact until the point of the final payment, if any. That would be due to Centronics ten days after the final price determination. Good faith did not require Gencom to do something inconsistent with the terms of the agreement. And here I'm quoting, what Centronics claims to be Genecoms discretion over the timing of distribution, is in reality a power that each party may exercise but only jointly with the other, to agree to remove some or all of the escrowed funds from the ambit of the otherwise mandatory payout provision, unquote. The opinion further agreed with the trial court that it wasn't the judge's duty to quote, insert a provision in the contract for partial payments where such provision does not exist. The court will not renegotiate the contract between the parties to obtain this result. In determining how to approach the good faith question Souter discussed two scholars, Summers and Burton. And their different understandings of the meaning of good faith. Summers, adheres to an excluder analysis. He defines good faith as anything that isn't bad faith. He denied that certain words or phrases have a general positive meaning of their own but instead quote, function to rule out various things according to context, unquote. One example he offered is the word voluntary in criminal law. Quoting a philosopher, Summers argued that when we say someone acted voluntarily, the word serves to exclude heterogeneous range of cases such as physical compulsion, coercion by threats, accidents, mistakes, etc. Voluntary itself didn't designate a specific mental state. Summers believes that good faith is similar. It functions as an excluder to rule out a wide range of heterogeneous forms of bad faith. Such forms of bad faith include evading the spirit of bargain and abuse of power to define specific terms. Burton, by contrast, advocates what he calls a recapture theory. He explained that parties give up certain opportunities at the time that they contract. He termed this the expected cost of performance. A party acted in bad faith. Burton argued, quote, precisely when discretion is used to recapture opportunities foregone upon contracting when the discretion exercising party refuses to pay the expected cost of performance. For the purposes of analyzing good faith and discretion during a contract performance of this third category, Souter said that he found Summers' analysis more in line with the New Hampshire precedent. Nevertheless, the four question test he set out reads especially with its emphasis on contract's purpose, somewhat like an implementation of Burton's recapture theory. In any case, Souter explicitly attempted to analyze the case in recapture terms and determine that even by those terms Genicom's actions wouldn't constitute bad faith. This was because, first Genincom's refusal to consent to distribution from escrow, quote neither recaptures nor gains Genincom anything. In and of itself, the refusal removes no issue from the contingencies of arbitration, and gives Genincom no present or future rights to the money it wishes to obtain, unquote. More significantly, the court emphasized that to Burton's parties, expected cost depend upon objective analysis of the party's expectation as they may be inferred from the expressed contract terms in light of the ordinary course of business and customary practice. The court's objective analysis found that the parties expected the escrow to remain intact during the arbitration. The parties thus, quote, never bargained away the right of either of them to condition any distribution on completing the arbitration of any disputes. Genicom by insisting arbitration be completed before releasing escrow funds then was not trying to recapture a foregone opportunity. I'm not assured that Genicom had not, by default, bargained away the right to resist releasing escrow abounds not at risk. Would rational parties give Genicom this power of insistence? It gives Genicom bargaining power to possibly get Centronics to agree to less than the arbitrator would ultimately give. Judge Souter seems to think this bargaining power was what Centronics signed up for. So Genicom wasn't using its transgression to get anything extra. But a contrary ruling that was explicitly a default might not have been contracted around by many parties. Then again, this bargaining power might have also affected the initial sale price that was offered, knowing that there would be difficulty negotiating in its shadow. More generally, how should the court think about a use of discretion that gives defendant very little and cause the plaintiff a lot. If choosing X instead of Y gains the defendant a penny, but costs the plaintiff a $100, is that bad faith? If it gains the defendant $99 but costs the plaintiff a $100, is that small inefficiency bad faith? If it gains the defendant $100, but costs the plaintiff a $100, and it's just a transfer of wealth, can that ever be bad faith? I'd be attracted to saying that using discretion, even discretion in refusing to modify a contract should be bad faith if it creates massive inefficiency. Imagine though that Genicom were found to have acted in bad faith in performing the contract. Is that a separate cause of action? Well, some jurisdictions do recognize a separate cause of action for failure to perform or enforce in good faith. But most do not, instead construing the failure to perform specific contractual terms in good faith as a breach of contract. Restatement section 205 says that the appropriate remedies In breach of good faith cases, can vary according to context. Centronics is a pretty packed case, there's a lot to take away from it. The primary take-away, the one most relevant to the dispute between Centronics and Genecom was that good faith and contractual performance arises only in the context of the party's exercise of discretion. But beyond that we talked about Souter's classification of different good faith scenarios and corresponding understandings of what good faith entails. We also discussed two influential and very different understandings of good faith. The excluder theory espoused by Summers. And the expected cost, or recapture theory, championed by Burton. Think about which of these you find more persuasive.
