Contract Term Allowing Defendant to Act in its Reasonable Judgment Required Defendant to Have a Reasonable Basis for its Actions

On November 8, 2019, the Fourth Department issued a decision in Scheer v Elam Sand & Gravel Corp., 2019 NY Slip Op. 08037, holding that a contract term allowing a defendant to act in its reasonable judgment required the defendant to have a reasonable basis for its actions, explaining:

Plaintiff leased land to defendant, a mining company, for a term of 20 years, subject to defendant's right to terminate the lease on six months' written notice "should [it] determine that there are insufficient recoverable [m]inerals from the [p]remises to permit [it] to make a profit." The lease also contained a provision allowing the prevailing party in any dispute to recover costs and attorney's fees. Defendant terminated the lease approximately 16 months after it was executed, claiming that there were insufficient recoverable minerals for it to make a profit. Plaintiff requested documentation supporting defendant's profitability determination. In response, defendant sent plaintiff a "resource evaluation" and the opinion of an accountant, both dated after defendant's termination notice. Plaintiff thereafter commenced this action asserting a single cause of action based on a breach of the implied covenant of good faith and fair dealing. Plaintiff alleged that the minerals were sufficient for defendant to make a profit, that defendant made its decision to terminate the lease before obtaining an expert analysis, and that defendant's experts ignored the presence of recoverable minerals on the premises.

Although a party has an absolute right to terminate a contract pursuant to an unconditional termination clause, the termination clause here was conditional inasmuch as defendant had the discretion to terminate the lease only if it made a determination prior to termination that there were insufficient minerals for it to make a profit. Because the lease contemplated an exercise of discretion, the implied covenant of good faith and fair dealing included a promise to exercise that discretion in good faith, not arbitrarily. The documentary evidence submitted by defendant did not conclusively establish that it acted in good faith when it terminated the lease.

We are mindful that the implied covenant of good faith and fair dealing is not without limits, and no obligation can be implied that would be inconsistent with other terms of the contractual relationship. Contrary to the court's conclusion, however, defendant's obligation to make a good faith profitability determination before terminating the lease is entirely consistent with the express language of the lease. The court accurately stated and defendant correctly asserts that the lease neither requires defendant to justify its profitability determination nor gives plaintiff the right to assess that determination and veto it. Nevertheless, the contract does require that defendant make a profitability determination in the first instance, which is consistent with an implied requirement that defendant make that determination in good faith.

(Internal quotations and citations omitted).

Part of the reason parties to commercial contracts choose to have those contracts governed by New York law is that New York courts typically enforce contracts as written. This decision shows that when a contract gives a party the right to act in its reasonable discretion, a court will enforce the requirement for reasonableness. Contact Schlam Stone & Dolan partner John Lundin at jlundin@schlamstone.com if you or a client have questions regarding the interpretation of a contract under New York law.