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Delaware Supreme Court Clarifies Implied Duty of Good Faith and Fair Dealing; Affirms Primacy of Contract Law

By Francis G.X. Pileggi

Nemec v. Shrader, Del. Supr. Nos. 305, 2009 and 309, 2009 (Del. Supr. Apr. 6, 2010), read opinion here.

This Delaware Supreme Court opinion features an unusual and vigorous dissent, but is especially noteworthy for its statement of Delaware law on the implied duty of good faith and fair dealing which is imposed on every Delaware contract by both statute and case law. The decision of the Court of Chancery, which was highlighted on this blog here, was affirmed by the majority in this opinion.

Background and Issues

The summary of the trial court opinion linked above includes more factual background, but the abbreviated factual setting of this case involves a complaint by two retiring shareholders that the directors of their company exercised the right to redeem their shares shortly before a merger which would have made the value of all shares of the company worth $60 million more. The Chancery Court dismissed claims that the timing of the redemption and the failure to allow the retiring shareholders to participate in an increased value of $60 million was a breach of the implied covenant of good faith and fair dealing. The trial court also dismissed claims of unjust enrichment and a breach of the fiduciary duty by the directors who made the decision. A majority of the Delaware Supreme Court affirmed the dismissal of all of those counts.

ANALYSIS

Implied Duty of Good Faith and Fair Dealing

For the latest iteration of Delaware law on the implied duty of good faith and fair dealing, pages 10 through 16 of the slip opinion in this matter are required reading. This claim is rarely successful and the truisms that the Court recites to support its reasoning include the following: 'We will only imply contract terms when the party asserting the implied covenant proves that the other party has acted arbitrarily or unreasonably, thereby frustrating the fruits of the bargain that the asserting party reasonably expected.' (Footnote 13) (emphasis added).

The majority emphasized that it is the intent of the parties at the time of contracting  that must be examined. (emphasis in original.) Delaware's High Court further reasoned that: 'Delaware's implied duty of good faith and fair dealing is not an equitable remedy for rebalancing economic interests after events that could have been anticipated, but were not, that later adversely affected one party to a contract. Rather the covenant is a limited and extraordinary legal remedy.'

Moreover, the Court added that: 'A party does not act in bad faith by relying on contract provisions for which that party bargained, where doing so simply limits advantages to another party. We cannot reform a contract because enforcement of the contract as written would raise 'moral questions.' See footnotes 26 and 27.

Primacy of Contract Bars Fiduciary Duty Claims

The Court recited the well-settled principle in Delaware that 'when a dispute arises from obligations that are expressly addressed by contract, that dispute will be treated as a breach of contract claim. In that specific context, any fiduciary claims arising out of the same facts that underlie the contract obligations would be foreclosed as superfluous.' See footnote 31. This 'primacy of contract' principle applied here to bar fiduciary duty claims that arose from a dispute relating to the exercise of a contractual right - - which was the right of the company to redeem the shares of the retiring shareholders. See footnote 31. Moreover, the Court rejected the argument that because the directors benefited from the redemption of the shares that prohibited the participation of the retiring shareholders in the additional $60 million compensation from the merger, because the directors received the same proportionate benefit as all the other non-retiring stockholders. Thus, the Court reasoned that they were making a rational business judgment to exercise a contractual right of the company that benefited all of the current stockholders rather than favoring retired stockholders. See footnotes 22 and 23.

Unjust Enrichment

The Court recited the five elements for a cause of action for unjust enrichment, and determined that the plaintiffs failed to demonstrate each required element. Moreover, the Court emphasized that a claim for unjust enrichment will not prevail when the alleged wrong arises from a relationship governed by contract. See footnotes 34 through 37
 

Full post as published by Delaware Corporate and Commercial Litigation Blog on April 07, 2010 (boomark / email).