Provision Requiring Exercise of Reasonable Discretion Precludes Acting Arbitrarily, Irrationally, or Without Reasonable Basis

On July 18, 2018, the Second Department issued a decision in Grandfeld II, LLC v. Kohl's Department Stores, Inc., 2018 NY Slip Op. 05289, holding that a contract provision requiring a party to use reasonable discretion prevented that party from acting arbitrarily, irrationally, or without a reasonable basis, explaining:

When parties set down their agreement in a clear, complete document, their writing should be enforced according to its terms. This principle is particularly important in the context of real property transactions, where commercial certainty is a paramount concern, and where the instrument was negotiated between sophisticated, counseled business people negotiating at arm's length. A contract provision requiring the exercise of reasonable discretion includes a promise not to act arbitrarily, irrationally, or without reasonable basis.

In this case, it was unreasonable for the defendants to consider the DOT permit a governmental approval that had to be obtained for construction to commence, as it was not necessary until the near completion of construction. The defendants' contention that the DOT permit was a governmental approval within the meaning of the lease, since it was necessary for the operation of the building, would render meaningless the six-month time limitation to obtain such governmental approvals. A contract should be read as a whole, with every part interpreted with reference to the whole; if possible, the contract will be interpreted so as to give effect to its general purpose. Here, the general purpose of the lease was to set forth the chronological steps for the construction and operation of the store. Once the defendants obtained the governmental approvals necessary to commence construction, they could not terminate the lease on the ground that additional governmental approvals would be required in the future when construction was nearly complete. Thus, we agree with the Supreme Court's finding that the defendants breached the lease. If we accepted the defendants' contention that the governmental approvals necessary for construction and operation of the building include approvals that could be obtained at or near the time of an application for a certificate of occupancy, then the inability to obtain a certificate of occupancy—which can only be obtained after completion of construction—could be used as a basis for avoiding the defendants' responsibility to commence construction. Such an interpretation of the contract would be a plainly unreasonable result.

(Internal quotations and citations omitted).

Contract provisions requiring a party to exercise its discretion "reasonably" are common in commercial contracts. As this decision shows, courts will enforce the obligation of reasonableness. Contact Schlam Stone & Dolan partner John Lundin at jlundin@schlamstone.com if you or a client face a situation where you are unsure how to enforce rights you believe you have under a contract.