THE ARIZONA BUSINESS LAWYER
VOLUME 1
what’s inside
Can the Implied Covenant of Good
Faith and Fair Dealing Override
Express Contract Terms . . . . . . .1
Business Law Rocks! . . . . . . . . .3
From Software to Softwar . . . . . . .4
Business Law Section Executive
Council . . . . . . . . . . . . . . . . . . . .7
Letter from the Section Chair . . .12
Fundamentals of Business
Valuation and Their Application in
Legal Disputes - Part II . . . . . . .14
Legal Fees in Business Law
Controversies . . . . . . . . . . . . . .16
Author Biographies/Photos . . . .18
NOVEMBER 2002
No. 2
CAN THE IMPLIED COVENANT OF GOOD FAITH
AND FAIR DEALING
OVERRIDE EXPRESS CONTRACT TERMS?
By: Anne L. Kleindienst
T
he Arizona Court of Appeals in its recent opinion in Bike Fashion Corp. v. Kramer,
et al., 46 P.3d 431, 373 Ariz. Adv. Rep. 12 (Ariz. Apps. 2002), reflects on the "turbid" state of the law on the relationship between the express terms of a written contract and the implied covenant of good faith and fair dealing. 46 P.3d at 434. A very fitting
description for an area of law that is indeed confused and a bit cloudy. Following the lead of
the Arizona Supreme Court earlier this year in Wells Fargo Bank v. Arizona Laborers,
Teamsters and Cement Masons Local No. 395 Pension Trust Fund, et al., 201 Ariz. 474, 38
P.3d 12 (2002), the Court of Appeals in Bike Fashion Corp. nevertheless confirms that there
are circumstances when express terms of a written contract may be effectively overridden by
the implied covenant of good faith
and fair dealing.
It is well established in Arizona
that a covenant of good faith and
fair dealing is implied in every
contract. Wagenseller v. Scottsdale
Memorial Hospital, 147 Ariz. 370,
710 P.2d 1025 (1985); Rawlings v.
Apodaca, 151 Ariz. 149, 726 P.2d
565 (1986); see also Restatement
(Second) of Contracts § 205
(1981). The covenant is applied to
protect the rights of contracting
parties to receive the benefits of
their agreement. Hence, the
Arizona Supreme Court has recognized that the inquiry necessarily
must focus on the contract itself to determine the parties' agreement. Wagenseller v.
Scottsdale Memorial Hospital, 147 Ariz. at 385; Rawlings v. Apodaca, 151 Ariz. at 154.
With respect to the relationship between the implied covenant and a contract's express
terms, the Arizona courts have generally applied the rule that the implied covenant cannot
contradict an express contract term or, stated in another way, cannot require conduct inconsistent with the contract. Hence, the Supreme Court in Wagenseller held that the implied
covenant of good faith and fair dealing in an at-will employment contract did not create a
duty for the employer to terminate the employee only for good cause. 147 Ariz. at 385.
Similarly, the Supreme Court in Rawlings declined to apply the implied covenant of good
faith and fair dealing to an insurance contract to require the insurer to pay claims that were
expressly not covered by the contract. 151 Ariz. at 155.
In the more recent Wells Fargo case, the Arizona Supreme Court appears to have adopted
a more expansive view of the implied covenant's relationship with express contract terms.
Wells Fargo arose from the well-publicized Mercado Project involving Arizona's former
Governor, J. Fife Symington, III. At issue in Wells Fargo was a Triparty Agreement among
Mercado Developers, a partnership headed by Symington and the project’s developer; Wells
Fargo's predecessor, First Interstate Bank (the "Bank"), which provided interim construction
financing for the project; and various union pension funds (the "Funds"), which had commit-
“there are circumstances
when express terms of a
written contract may be
effectively overridden by
Editor-in-Chief, Paul J. Buser
paulbuserlaw@scottsdaleandphoenix.org
Phone: (480) 951-1222
Fax: (480) 951-2568
Contributing Editor, William D. Black
william@bblaw.com
This newsletter is published by
the Business Law Section
of the State Bar of Arizona
the implied covenant of
good faith and fair dealing.”
Continued on page 2
The Arizona Business Lawyer (Vol. I, #2) • November 2002
1
IMPLIED COVENANTS OF GOOD FAITH – CONTINUED FROM PAGE 1
ted to provide permanent financing for the
project. Under the Triparty Agreement, the
Funds could refuse to provide the permanent
financing necessary to take-out the Bank if
certain conditions were not met or if the
Funds were dissatisfied with Symington's
financial condition. Also, under the terms of
the Triparty Agreement, the Funds were entitled to receive from the Bank financial information on the status of the Mercado construction loan if requested by the Funds. The
Triparty Agreement expressly provided,
however, that the Bank "shall have no obligation to comply with any of the terms, conditions and provisions of Permanent
Commitment [of the Funds] but may, at its
election, satisfy such requirements on behalf
of Borrower". Wells Fargo v. Arizona
Laborers, Teamsters and Cement Masons
Local No. 395 Pension Trust Fund, 201
Ariz. at 480. Under the terms of the
Permanent Commitment, Symington was
expressly obligated to provide specific
financial information to the Funds.
The Funds complied with the terms of
the Permanent Commitment and, pursuant
to the Triparty Agreement, took out the
Bank on its interim construction loan on or
about June 30, 1990. Symington defaulted
on the permanent loan in 1992 and filed for
bankruptcy after the Funds obtained judgments against Symington personally in
1995. The Funds later claimed that the
Bank was guilty of wrongdoing during the
months leading up to the June 30, 1990
permanent commitment funding date,
allegedly taking actions in concert with
Symington which the Funds claimed were
intended to make Symington appear to be
financially strong and to deprive the Funds
of any reason to refuse to fund the
Permanent Commitment. The Bank then
filed a complaint seeking a declaratory
judgment that it had complied with and
performed all of its contractual obligations
under the Triparty Agreement. Included in
the Funds’ counterclaims was the allegation
that the Bank’s actions constituted a breach
of the covenant of good faith and fair dealing implied in the Triparty Agreement. The
trial court entered summary judgment for
the Bank on all claims finding that the
Bank, among other matters, owed no contractual duty to the Funds to disclose information about Symington's financial condition. The Court of Appeals affirmed.
The primary focus of the Supreme Court
in Wells Fargo when addressing the Funds’
implied covenant claim was on the Funds’
2
reasonable expectations. The fact that the
express terms of the Triparty Agreement
did not require the Bank to make disclosures to the Funds regarding Symington's
financial condition was not in dispute. But
the Court’s recognition of this fact did not
end the inquiry as to whether the Bank
breached the implied covenant of good
faith and fair dealing by failing to make
such disclosures to the Bank. As the
Supreme Court stated when reversing the
summary judgment in the Bank’s favor on
the Funds’ implied covenant claim, “[t]he
question is whether a jury might reasonably
find that the Bank wrongfully exercised a
contractual power for ‘a reason beyond the
risks’ that the Funds assumed in the
Triparty Agreement, or for a reason inconsistent with the Funds' justified expectations.” 201 Ariz. at 492.
It bears noting that the Wells Fargo case
involved more than merely non-disclosure
of information concerning Symington's
financial condition that the Bank had the
express contractual right not to disclose.
Rather, the facts suggested that the Bank
failed to take certain actions, including
declaring the interim construction loan in
default, which would have revealed
Symington's financial problems, actions
which the Funds could claim were within
their reasonable expectations. The case also
involved allegations that the Bank failed to
follow federal banking regulations and
report non-compliant activity, again actions
that the Funds could claim were within their
reasonable expectations. Nevertheless, the
Supreme Court's ruling on the implied
covenant claim raised the possibility that
the Funds would be able to recover on a
breach of contract claim for conduct that the
Bank, in the Triparty Agreement, expressly
stated it had no obligation to undertake.
The relationship between the implied
covenant of good faith and fair dealing and
express contract terms was addressed by
the Arizona Court of Appeals shortly after
the Supreme Court rendered its opinion in
Wells Fargo. Bike Fashion Corp. v. Kramer,
supra., involved claims brought by partners
of a general partnership seeking recovery
from other partners and their owners for,
among other theories, breach of the implied
covenant of good faith and fair dealing in
connection with the sale of real estate
owned by the partnership without the consent of 51% of the partners. The breach of
the implied covenant claim involved conduct that arguably did not conflict with the
express terms of the partnership agreement.
At issue on appeal was whether the partners were entitled to a new trial on the
grounds that the trial court incorrectly
instructed the jury that there could be no
breach of an implied contract provision if
there was an express written contract provision relating to the same subject. The Court
of Appeals held that the trial court erred in
giving such a jury instruction and reversed
the trial court's denial of the partners’
motion for a new trial.
The Court of Appeal’s holding in Bike
Fashion Corp. confirmed that the implied
covenant of good faith and fair dealing may
be breached even when the contract
includes express terms on the same subject.
As described by the court in Bike Fashion
Corp., the following two sets of circumstances could result in such a finding under
Arizona law: (1) a party’s exercise of discretion expressly granted by the contract
“in a way inconsistent with [the other]
party’s reasonable expectations,” or (2) a
party “acting in ways not expressly excluded by the contract’s terms but which nevertheless bear adversely on the [other] party’s
reasonably expected benefits of the bargain.” 46 P.3d at 435. As in Wells Fargo,
the focus in Bike Fashion Corp. was on a
determination of the reasonable expectations of the party claiming breach of the
implied covenant notwithstanding the existence of a written and unambiguous contract term on the same subject.
The recent decisions in Wells Fargo Bank
and Bike Fashion Corp. reflect the expanding scope of the implied covenant of good
faith and fair dealing in Arizona contract
law. Not unlike the reassessment required
following the Arizona Supreme Court's holding in Darner Motor Sales, Inc. v. Universal
Underwriters Ins. Co., 140 Ariz. 383, 682
P.2d 388 (1984), Arizona business lawyers
may want to re-examine whether specific
assumptions or qualifications addressing the
implied covenant of good faith and fair dealing may be warranted when opining as to
enforceability of written contracts governed
by Arizona law. Practitioners will also no
doubt want to consider whether a contracting party may expressly contract away the
implied covenant of good faith and fair dealing in order to bring more certainty to the
parties' contractual relations. Whether such a
contractual provision would be enforced by
the Arizona courts is perhaps an issue for
another day.
November 2002 • The Arizona Business Lawyer
Reprinted with permission of The Arizona Business Lawyer, an authorized on-line publication of the Arizona State Bar Association. Ms. Keindienst’s article originally appeared in
Vol. 1, #2 (November 2002) of The Arizona Business Lawyer.