Breach of Contract: The Duty of Good Faith and Fair Dealing in Commercial Contracts

The Tennessee Supreme Court recently addressed an important issue of first impression in Tennessee: whether the implied covenant of good faith and fair dealing applies to a silent consent provision regarding the assignability of a commercial contract. Dick Broadcasting Co., Inc. of Tennessee v. Oak Ridge FM, Inc., E2010-01685-SC-R11-CV (Tenn. Jan. 17, 2013).

In this case, the plaintiff, Dick Broadcasting Co., Inc., entered into three contracts with the defendants, Oak Ridge FM, Inc., ComCon Consultants and John W. Pirkle, relating to the programing of a radio station in Oak Ridge, Tennessee. Thereafter, the plaintiff decided to sell all of its assets to Citadel Broadcasting Company for $300 Million. As part of this transaction, the plaintiff sought to assign its contracts with the defendants to Citadel.  One of the contracts, a Right-of-First-Refusal Agreement, contained a so-called “silent consent clause.” In other words, the contract provided that consent to the assignment was required but the contract provided no standard or guidance as to the criteria for granting or denying consent. The provision at issue provided as follows: “No party may assign its rights, interests or obligations hereunder without the prior written consent of the other party.” The plaintiff formally notified the defendants of its intent to assign the contract to Citadel and requested consent for the assignment; however, the defendants refused to consent.

After the defendants refused to consent to the assignment, the plaintiff filed suit against the defendants for various causes of action sounding in contract. The plaintiff asserted that the actions of the defendants in refusing consent cost it millions of dollars in relation to the asset sale. Among other things, the plaintiff asked the trial court to find that it rightfully requested that the defendant consent to the assignment of one of the contracts and the defendant unreasonably withheld it. The plaintiff claimed that a duty of good faith and fair dealing applied and the defendant breached this duty in refusing consent to assignment. The defendants claimed that they refused consent because Citadel had no prior connection with the local radio community and were trying to protect the image and value of its radio station. On the other hand, the plaintiff claimed that the defendants refused to consent to the assignment solely to negotiate more money for themselves.

In the trial court, the parties filed competing summary judgment motions. Following a hearing, the court granted the defendants’ motion for summary judgment and dismissed the case. In doing so, the trial court found that the contract at issue was silent with regard to the circumstances under which consent to assignment could be withheld. The trial court determined that the general duty of good faith and fair dealing could not be imposed to the contract’s assignment provision, and that to impose such a duty would result in the addition of new terms to an otherwise unambiguous contract.

On appeal, the Tennessee Court of Appeals reversed the trial court’s grant of summary judgment, holding that “a silent consent clause should be interpreted consistent with the duty of good faith and fair dealing, requiring the parties to act in a commercially reasonable manner when deciding whether consent to a proposed assignment should be granted.”

The Tennessee Supreme Court granted review to answer the question of whether the implied covenant of good faith and fair dealing applies to a silent consent provision regarding the assignability of a commercial contract. The Court sided with the majority of other jurisdictions that have addressed this issue and upheld the ruling of the Court of Appeals. Accordingly, the Court has made it clear that when a contract does not provide the standard for withholding consent, a party may not withhold consent without a good faith and commercial basis for doing so. A breach of this obligation is a breach of the contract. While the common law in Tennessee has long imposed a duty of good faith and fair dealing in the performance of contracts generally; until now, such a duty has never been specifically applied to a silent consent assignment clause.

The Court noted that it was not creating a new contractual obligation between the parties; rather, it was inferring “a standard of conduct anticipated by the parties in carrying out the rights and liabilities provided for in the contract” that was otherwise silent in this regard. Obviously, if the language of the contract explicitly requires commercial reasonableness or provides other guidance as to the grounds for withholding or granting consent, there is no debate. The parties could have set forth any standard for withholding of consent; the parties could have agreed that consent could be withheld for good reason, bad reason or no reason at all. However, the contract in this case did not provide any standard, and therefore, the Court applied the implied covenant of good faith and fair dealing.

The Court’s decision seems to be the only reasonable outcome – how can the duty of duty of good faith in fair dealing generally apply to the performance of a contract, but not to certain provisions? If the contract fails to set forth the criteria for withholding consent, then it is only reasonable that the covenant of good faith and fair dealing should govern. This case is important as it will likely set precedent in the context of other commercial contractual disputes involving silent clauses. The Court stated that the outcome effectuates several desirable results:

(1) it is consistent with established precedent in Tennessee case law and a majority of other jurisdictions as cited and discussed         herein; (2) it establishes predictability, consistency, and bright-line clarity to contracting parties in the drafting and interpretation of agreements; (3) it guarantees full disclosure and clarity of understanding “on the front end” in reaching a deal if one or both parties want to retain complete and unfettered decision-making authority to provide or deny consent; and (4) it preserves and upholds the parties’ right to freedom of contract.

Justice Koch, agreeing the result of the Court’s opinion, wrote a separate concurring opinion to emphasize the potential dangers of courts enforcing implied obligations not set forth in written contracts. Justice Koch noted that the scope and application of the implied duty of good faith and fair dealing is “far from settled,” hinting that there may be instances that it would be improper impose such an obligation. Justice Koch warned that “courts should be cautious about imposing a set of morals on the commercial marketplace.”

This case demonstrates that there will likely be a trend in Tennessee to read into all contract provisions an obligation to act in a commercial reasonable manner and in good faith. It is also equally important to remember that parties have the freedom to contract, and therefore, the ability to negotiate and agree to the standards for which a party should act or the standard to judge conduct under a contract.