Friday, June 27, 2014

A Pair of Recent Equine Dispute Decisions Illuminate Principles of Contract, Agency and Fiduciary Duty Law

      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. 


            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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