'GOOD FAITH' RESTRAINED RIGHT TO KILL CONTRACT

June 4, 2004

Steven P. Garmisa
Hoey & Farina Attorney
garmisa@hoeyfarina.com
1-888-425-1212

A real estate contract that appeared to give the seller an unfettered right to terminate the agreement did not really grant an absolute right to back out of a deal. The seller's right to walk away from the contract was fettered by the implied obligation of good faith and fair dealing. Schwinder v. Austin Bank of Chicago, 2004 WL 885197 (1st Dist., April 26).

The plaintiffs entered into a contract to buy a condominium unit. The closing was delayed because of a court order in a divorce case involving the beneficiary of the trust that held title to the property. But the plaintiffs obtained possession of the premises under a pre-closing agreement.

The order that stopped the closing was eventually lifted, but after the plaintiffs could not get the beneficiary to schedule a closing, they filed a lawsuit in Cook County Circuit Court for specific performance.

The sellers -- the trustee and the beneficiary, Marian Baginski -- responded by arguing that the real estate contract gave them an absolute right to terminate the deal, with their liability limited to a return of the earnest money.

Judge Robert V. Boharic ordered specific performance, and the sellers appealed. Affirming Boharic's ruling, the Appellate Court concluded that modification and estoppel barred the sellers from triggering the termination provision. Besides which, the sellers' right to terminate the contract was limited by the implied duty of good faith and fair dealing.

Here, with various omissions not noted in the quoted text, are some highlights of Justice Joseph Gordon's analysis of the duty of good faith.

"Initially, it must be noted that specific performance may only be granted where there is a valid and enforceable contract. Although neither party contends that the purchase contract is invalid, the defendants do contend that they have an unfettered right to terminate the purchase contract. This contention lends itself to the argument that the contract lacks mutuality of obligation and is thereby invalid.

"In its most elemental sense, the doctrine of mutuality of obligation means that unless both parties to a contract are bound by its terms, neither is bound. 'Mutuality of obligation in bilateral contracts is but another way of stating that consideration is essential.' 25 R. Lord, Williston on Contracts, section 67:42, at 332 (4th ed. 2002). The absence of mutuality of obligation could render the contract invalid and unenforceable. Such a mutuality of obligation issue arises when there is one party to a contract that has an unfettered right to terminate the contract.

"To counter that result, courts have found an implied covenant of good faith and fair dealing. Every contract contains this implied promise of good faith and fair dealing between the contracting parties. Restatement (Second) of Contracts, section 205 (1981). These promises limit the manner in which the party who is vested with discretion under the contract may exercise it by requiring that party to exercise that discretion reasonably and with proper motive, not arbitrarily, capriciously or in a manner inconsistent with the reasonable expectations of the parties.

" 'The phrase "good faith" is used in a variety of contexts, and its meaning varies somewhat with the context.' Restatement (Second) of Contracts [sec] 205, comment a, at 100. 'Good faith performance or enforcement of a contract emphasizes faithfulness to an agreed common purpose and consistency with the justified expectations of the other party; it excludes a variety of types of conduct characterized as involving "bad faith" because they violate community standards of decency, fairness or reasonableness.' Restatement (Second) of Contracts, section 205, comment a, at 100. The appropriate remedy for 'bad faith' or a breach of the duty of good faith varies with the circumstances. Restatement (Second) of Contracts, section 205, comment a, at 100.

"Furthermore, a contract should be construed as a whole to give effect to the intention of the parties. Great weight is to be given to the principal, apparent purpose and intention of the parties at the time that they entered into the contract. It follows that a contract should be construed so as to make the obligations imposed by its terms mutually binding upon the parties, unless such a construction is wholly negated by the language used.

"On the basis of the above-cited cases, we must interpret the disputed provisions of the present purchase contract, specifically paragraph 12, in such a manner as not to render meaningless the parties' obligations to one another. Paragraph 12, enumerated above, explicitly provided that '[i]f this contract is terminated without purchaser's fault, the earnest money shall be returned to purchaser.'

"In view of the covenants of good faith and fair dealing, the clause 'if this contract is terminated without purchasers fault,' should be construed as meaning that the seller, Baginski, should make every effort to ensure that the purchase contract is not terminated, but that if termination is due to circumstances beyond his control, plaintiffs could get their money back.

"Conversely, if we construed paragraph 12 to mean that the seller could, at will, terminate the purchase contract and return buyers' earnest money, this would impute bad faith, because the seller by returning the earnest money would be returned to his original position. Therefore, the seller would suffer no loss, and the buyers could do nothing to secure their position.

"The above interpretation of paragraph 12, which incorporates a duty of good faith and fair dealing, is supported by a large number of cases which hold that contractual language, that on its face, gives one or the other of the parties an unbridled right to cancel or terminate the contract must, if possible, be construed so as to sustain the validity of the contract in question.

"Similarly, the courts have imputed good faith and fair dealing in real estate purchase agreements. In Borys [v. Josada Builders, Inc., 110 Ill.App.3d 29, 32-33], a contract for the purchase of a condominium provided that failure or inability on the part of the seller to deliver title as a result of defects therein, which the buyer was unwilling to accept, would terminate the contract with the seller's liability limited to return of the buyer's deposit. The buyer contended that the seller's ability to control the quality of the title and its limited liability for breach of the agreement rendered the contract void for want of mutuality.

"The court held, however, that contractual clauses imposing an obligation on the seller to cause the unit to be sold and conveyed to the buyer, when read in view of the entire contract and construed in accordance with the implied contractual term requiring the parties to act in good faith, supported the conclusion that the sellers did not have the right to arbitrarily decide not to sell by providing an inadequate title and returning the buyers' earnest money.

"Applying Borys to the instant case would impose a duty of good faith and fair dealing on the provision granting the right to terminate the purchase contract and on the limitation of remedies available to plaintiffs, thereby imposing mutually binding obligations on both plaintiffs and defendants and rendering the purchase contract valid and enforceable."

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