A pair of May, 2014 decisions,
while themselves not inter-related, provide a litany of useful direction on
numerous points of contract, agency and fiduciary duty law. Crestwood
Farm Bloodstock v. Everest Stables, Inc., __ F.3d __, 2014 WL 1856697 (6th
Cir. May 9, 2014); James T. Scatuorchio
Racing Stable, LLC v. Walmac Stud Management, LLC, 2014 WL 2116096 (E.D.
Ky. May 20, 2014). As a concession to
the brevity of life, this review will focus upon the legal rules explicated in
the decisions and skip their tortured factual background.
The Covenant of Good Faith and Fair Dealing
Every contract includes an
implied covenant of good faith and fair dealing, it imposing an affirmative
obligation “to do everything necessary to carry [the agreement] out.”, Ranier v. Mt. Sterling Nat. Bank, 812
S.W.2d 154, 156 (Ky. 1991); Ram Eng’g
& Constr., Inc. v. Uni. of Louisville, 127 S.W.3d 579, 585 (Ky. 2003),
and a negative burden to not act to “prevent [ ] the creation of the condition
under which payment would be due.” Oden Realty Co. v. Dyer, 45 S.W.2d 838,
840 (Ky. 1932). Crestwood Farm, 2014
WL 1856697, *8; Scatuorchio, 2014 WL
2113096, *8.
In the Crestwood case, Everest directed Crestwood to sell certain horses
at auction with no reserve. Crestwood
did so. Everest “planted a separate
agent at the auction (without Crestwood’s knowledge)” who sought to raise the
price by bidding against the unrelated bidders.
Effectively, Everest set a reserve on the auction. Crestwood
2014 WL 1856697, *1. Everest argued
that it did not violate the agreement in that it was Crestwood who was barred
from setting a reserve. Id. at *8. The Court found this conduct to violate the
obligation of good faith and fair dealing, consequent to which Crestwood was
entitled to $219,513.89, that being what would have been its share of the sale
proceeds of the failed high bid.
At the same time the implied
covenant will not supersede the express terms of the agreement.
But the “implied covenant of good
faith and fair dealing does not prevent a party from exercising its contractual
rights.” Farmers Bank & Trust Co. v. Willmott Hardwoods, Inc., 171
S.W.3d 4, 11 (Ky. 2005); see also Hunt
Enters. v. John Deere Indus. Equip. Co., 18 F.Supp.2d 697, 700 (W.D. Ky.
1997) (the covenant of good faith and fair dealing, “does not preclude a party
from enforcing the terms of the contract….
It is not ‘inequitable’ or a breach of good faith and fair dealing in a
commercial setting for one party to act according to the express terms of a contract
for which it bargained”). Put another
way, “a party’s acting according to the express terms of a contract cannot be
considered a breach of the duties of good faith and fair dealing.” Big
Yank Corp. v. Liberty Mut. Fire Ins. Co., 125 F.3d 308, 313 (6th
Cir. 1997).
Scatuorchio, 2014 WL
21113096, *8.
On that basis, the claim that a
fee determined in accordance with a formula in the subject agreement could not
be challenged a violating the implied covenant.
Rather, “the plaintiffs may not at this time re-write the unambiguous,
agreed-upon language of the SHLA under the guise of the implied covenant of
good faith and fair dealing.” Scatuorchio, 2014 WL 211096, *9.
Another important point is that
the implied covenant does not serve to preclude self-dealing conduct, but
rather only police it at the margins by protecting the express contracted
terms.
As to allegations that “constitute
self dealing,” a party may act in its own interest and not breach the covenant
of good faith and fair dealing, as long as its discretion is not used in a way
that is contrary to the spirit of the agreement.
Scaturochio, 2014 WL
2113096, *9.
Where, as in this case, the
plaintiff was unable to show the defendant “acted in bad faith, or in an
arbitrary, capricious, or unreasonable manner,” the use of contractually afforded
discretion would not be second-guessed.
Fiduciary Relationships
Both Courts highlighted the
necessary and high thresholds for the creation of a fiduciary relationship,
essentially the agreement by the fiduciary to act for the benefit of the other
even if doing so is to the detriment of the fiduciaries’ interest. In Crestwood
the plaintiffs sought to leverage facts including the principal’s failing
health and a long course of business into a fiduciary relationship. The Court disagreed, holding that:
That the two were friends, even
close friends, may well explain why they did business together. But that does not establish a fiduciary
relationship – that Crestwood was charged with putting Everest’s interests
above its own. Many friends do business
together. But not all friends are fiduciaries,
and in the world of arms-length commercial negotiations few are. See,
e.g., Sallee, 286 F.3d at 891-92 (“[T]he fact that the relationship has
been a cordial one, of long duration, [is not] evidence of a [fiduciary]
relationship.” (internal quotation marks
omitted)); 90 C.J.S. Trusts § 197 (“The mere existence of mutual respect and
confidence does not make a business relationship fiduciary.”)
Crestwood, 2014 WL
1856697, *5.
Setting forth a tour-de-force
recitation of the elements of a fiduciary relationship, the Scatuorchio Court, at 2014 WL 2113096, *12,
wrote:
Under
Kentucky law, to establish the existence of a fiduciary duty, a party must
demonstrate that: (i) the parties’ relationship existed prior to the
transaction that is subject of the claim; (ii) the reliance was not merely
subjective but reasonable; and (iii) the nature of the relationship imposed a
duty upon the fiduciary to act in the principal’s interest, even if such action
were to the detriment of the fiduriary. In re Salle, 286 F.3d at 892; Ballard v. 1400 Willow Council of Co-Owners,
Inc., No. 2010-SC-533-DG, 2013 Ky. LEXIS 579, at *33-35 (Ky. Nov. 21,
2013). A fiduciary duty requires more
than the generalized business obligation of good faith and fair dealing. See In
re Salle, 286 F.3d at 891; see also
Gresh v. Waste Servs. of Am., 311 F. App’x 766, 771 (6th Cir.
2009); Quadrille Bus. Sys. v. Ky.
Cattlemen’s Ass’n, 242 S.W.3d 359, 365 (Ky. Ct. App. 2007) (“An ordinary
business relationship or an agreement reached through arm’s length transactions
cannot be turned into a fiduciary one absent factors of mutual knowledge of
confidentiality or the undue exercise of power or influence.” (quotation marks and citation omitted)). “Only in rare commercial cases is it
reasonable to believe the other party will put your interests ahead of their
own.” In re Salle, 286 F.3d at 892.
Rather, “extraordinary facts are
necessary” to support such a believe. Id.; see
also Crestwood Farm Bloodstock v. Everest Stables, Nos. 13-5688/13-5689,
2014 U.S. App. LEXIS 8751, at * 14-15 (6th Cir. May 9, 2014).
Where “commercially
sophisticated parties enter into arm’s-length business agreements” that do not “expressly
or impliedly contain any provision supporting the creation of a fiduciary
relationship” or indicate that one party has agreed to act primarily in the
interest of others to its own detriment,” no fiduciary relationship will be
found.
The Principal-Agent Contract Controls
Everest alleged that Crestwood had
violated certain duties imposed by agency law by not maximizing the value of
the horses sold, including by not setting reserves. In that Crestwood was barred by the written
agreement from setting reserves, the Court found Everest’s objection to be without
merit.
Where
a contract exists defining the scope of the principal-agent relationship
... the existence and extent of the
agent’s duties are determined by the agreement between the parties.” Monumental
Life Ins. Co. v. Nationwide Retirement Solutions, Inc., 242 F.Supp.2d 438,
449 (W.D.Ky.2003) (applying Kentucky law); Restatement (Second) of Agency §
376.
Crestwood,
2014 WL 1856697, *6.
Takeaways
A few takeaways:
·
the implied covenant of
good faith and fair dealing with not alter express contractual obligations;
·
the obligations of an
agent to a principal are determined first by reference to their express
agreement and only thereafter by reference to general agency law; and
·
commercial
relationships will almost never be fiduciary in nature.
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