Wednesday, October 8, 2014

Expression is the Better Part of Valor: Discretion and Good Faith in Entertainment Contracts

By Professor F. Jay Dougherty

It is not unusual for contracts in the entertainment industry to contain provisions leaving performance of an act to one party’s discretion. Often the other party’s attorney will request that such a provision also expressly require good faith. Sometimes, “good faith” is expressly added to the contractual language—after all, the client will act honestly in exercising its discretion. In the past, however, negotiators might reject the request, arguing that good faith and fair dealing is implied in all contracts anyway. In recent years, some courts have moved away from implying an obligation of good faith in a matter left to a party’s discretion. Other courts have implied the good faith obligation, even where a matter of subjective creative judgement is involved. Volatility and uncertainty in connection with implied covenants of good faith suggest that attorneys should be careful to draft such provisions clearly, leaving no ambiguity as to the intent of the parties.

In Third Story Music v. Waits[1], the plaintiff (“TSM”) had entered into an exclusive recording artist agreement with acclaimed singer-songwriter Tom Waits in the 1970’s, and had later transferred its rights under that agreement to Elektra/Asylum Records, a label in the Warner Communications family of record companies (“Warner”). Under the agreements, TSM would produce Waits’ records, and Warner would have the exclusive right to exploit and license those records. The agreement between TSM and Warner also specifically said that Warner “may at [Warner’s] election refrain from any or all of the foregoing.” TSM was to receive a percentage of amounts earned by Warner from the records, and a substantial advance for each album.

In 1993, an affiliate of TSM attempted to obtain a license from Warner to compile and exploit an album of some of the Waits recordings. Warner itself had no objection, but before it would agree to issue the license, it sought Waits’ approval, which he refused to give (assertedly to maximize the value of his later recordings made after the expiration of his agreement with TSM). When Warner refused to issue the license, TSM sued for damages for breach of the implied convenant of good faith and fair dealing. Warner demurred, asserting that the contract language expressly permitting it to refrain from licensing precluded application of the implied covenant. The demurrer was sustained, and affirmed on appeal.

In the appellate decision, the court attempted to reconcile the conflicting ideas that “a covenant of good faith should be applied to restrict exercise of a discretionary power”[2] but that “an implied covenant must never vary the express terms of the parties’ agreement.”[3] In doing so, the court applied the strict test for implying covenants, permitting such implication only only where (1) the implication arises “from the language used or is indispensable to effectuate the intention of the parties,” (2) it appears from the language used that the implication was “so clearly within the contemplation of the parties that they deemed it unnecessary to express it,” (3) the implication can be “justified on the grounds of legal necessity,” (4) “it can be rightfully assumed that [the implied promise] would have been made if attention had been called to it,” and (5) “the subject is [not] completely covered by the contract.”[4]

After reviewing precedents, the court concluded that: “[C]ourts are not at liberty to imply a covenant directly at odds with a contract’s express grant of discretionary poser except in those relatively rare instances when reading the provision literally would, contrary to the parties’ clear intention, result in an unenforceable illusory agreement. In all other situations where the contract is unambiguous, the express language is to govern…”[5] Because the TSM-Warner agreement guaranteed minimum compensation regardless of Warner’s efforts, it was not necessary to imply an undertaking to exploit the recordings in order to find consideration to support the contract. Hence, the court refused to imply a promise to actually exploit the records in good faith and issue licenses.

In its decision, the court recognized that judges routinely imply convenants to use good faith or even “best efforts” where a license grants exclusive rights in exchange for a royalty or a percentage of profits, but the licensee does not expressly promise to do anything.[6] In discussing this scenario, the court cited Zilg v. Prentice-Hall[7], without mentioning that it reached an arguably contradictory result to that reached here. In Zilg, an author had written a book highly critical of the Dupont family. The defendant publisher had been granted exclusive rights, but the contract expressly left to Prentice-Hall’s discretion printing and advertising decisions. The author’s compensation was a royalty, but the publisher had also agreed to pay an advance. Hence, the agreement was supported by consideration and was enforceable without implying an obligation to exploit in good faith. Still, the court found an implied obligation to make certain efforts in publishing the book; namely, “a good faith effort to promote the book including a first printing and advertising budget adequate to give the book a reasonable chance of achieving market success in light of the subject matter and likely audience…”[8] Although the publisher had greatly reduced the advertising budget and the size of the printing of the book after it received some pressure from the Duponts and the book was deleted from an expected book club, the court still found that Prentice-Hall had satisfied its obligation to use its good faith business judgement.

Indeed, the Waits court could have followed the Zilg approach and yet reached the same result. That is, it could have found that there was an implied convenant of good faith in the TSM-Warner contract, but that Warner’s efforts to exploit Waits’ albums had been adequate to satisfy good faith requirements and, perhaps, that Warner had exercised good faith business judgement when it nurtured its relationship with Waits by seeking his approval, even when not contractually required to do so. Instead, the Waits court took a very restrictive view of the circumstances in which a covenant of good faith will be implied.

In Locke v. Warner Bros.,[9] another California appellate court distinguished Waits and applied the more liberal approach to assessing when to imply a covenant of good faith where the decision of whether to exploit intellectual property is left to the discretion of one party. In that case, Warner had entered into a nonexclusive “first look” deal with Sandra Locke in connection with a settlement of a dispute between Locke and Clint Eastwood, her former lover. Warner failed to accept any projects for development under that deal, and Locke sued, alleging breach of the implied covenant of good faith a fair dealing, among other claims. The lower court granted summary judgement and Locke appealed.

The first look agreement apparently left to Warner’s discretion the decision whether or not to acquire Locke’s proposed projects, but did not expressly give Warner the right to refrain from working with Locke at all. The contract provided for a substantial payment to Locke and the provision of an office and an assistant. Hence, there was clearly consideration for the agreement and it was not necessary to imply an obligation to accept and exploit a project in order to preserve the enforceability of the agreement. Still, the appellate court reversed the grant of summary judgement, finding that there was an implied covenant of good faith and there were disputed issues of material fact as to whether Warner breached that covenant. The court said that “The trial court’s ruling missed the mark by failing to distinguish between Warner’s right to make a subjective creative decision, which is not reviewable for reasonableness, and the requirement the dissatisfaction be bona fide or genuine.”[10] Rather than limiting the convenant of good faith to those situations where it is necessary to preserve enforceability of a contract, the court took the broader view, “[W]here a contract confers on one party a discretionary power affecting the rights of the other, a duty is imposed to exercise that discretion in good faith and in accordance with fair dealing.”[11]

The Locke court did not ignore the conflict between the general rule that contract terms will not be implied to contradict the express language of a contract. Indeed, it observed that, “As to acts and conduct authorized by the express provisions of the contract, no covenant of good faith and fair dealing can be implied which forbids such acts and conduct.”[12] It distinguished the Waits decision, since in that case, “the agreement expressly provided Warner Communications had the right to refrain from marketing the Waits recordings, [so] the implied covenant of good faith and fair dealing did not limit the discretion given to Warner Communications in that regard.”[13]

The history of contract law reflects a tension between conflicting values. On the one hand, contract law respects the autonomy of the parties to agree on whatever they desire, so long as the objective is legal. This goal is reflected in the “plain meaning” rule of contract interpretation: the language of the contract is the primary expression of their agreement, and if that language is clear and unambiguous, the plain meaning of the language prevails. On the other hand, modern contract law reflects certain social and commercial norms, including an expectation of honesty and fairness in transactions. The imposition of a duty of good faith and fair dealing in contracts is an example of that goal. The Restatement (Second) of Contracts[14] and the Uniform Commercial Code[15] each include a statement that “every contract” imposes a duty or obligation of good faith. Courts are increasingly caught in the conflict between those values, with a trend towards emphasizing the express language of the parties and reluctance to imply a covenant of good faith to limit the exercise of discretion by one party when such discretion is clearly and expressly permitted by the terms of the contract.[16] Still, the best way to resolve uncertainty and reduce the likelihood of expensive litigation in this area is to take special care to be clear about intention in the drafting of the contract. Accordingly, where the intention is that discretion will be exercised in good faith, such a term should be expressly included. By contrast, where discretion is not to be so limited, that intent should be clearly indicated in the contractual language, for example by use of terms such as “sole and unfettered discretion” and by stating expressly that the promissor will have the right to refrain from doing the act which is left to its discretion.

[1] 41 Cal.App.4th 798 (Ct.App. 2d Dist., 1996).
[2] 41 Cal.App.4th 798, 804.
[3] Id.
[4] Id.
[5] 41 Cal.App.4th 798, 808.
[6] 41 Cal.App.4th 798, 805. The classic case recognizing this is Wood v. Lucy, Lady Duff-Gordon, 222 N.Y. 88 (1917).
[7] 717 F.2d 671 (2d Cir., 1983).
[8] 717 F.2d 671 ____.
[9] 57 Cal.App.4th 354 (Cal.App.2d Dist., 1997).
[10] 57 Cal.App.4th 354, 363.
[11] Id.
[12] 57 Cal.App.4th 354, 366 (emphasis in original, citations and internal quotations omitted).
[13] Id. (emphasis in original).
[15] Cal. Comm. Code §1203.
[16] See Michael P. Van Alstine, OF TEXTUALISM, PARTY AUTOMNOMY, AND GOOD FAITH, 40 Wm. & Mary L.Rev. 1223 (1999)(criticizing that trend and arguing that the obligation of good faith should always be presumed, even where a matter is expressly left to one party’s discretion, unless the contrary is both clearly expressed and the opposing party’s attention is directed to that expression).

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