Article

Factual Summary: Developer agreed with Contractor to sell a portion of property to be developed in the future in exchange for the construction of roads and sewer, water, electric, and gas lines and conduits on it. Because of a hold on connections with the local sewer system of which both had been unaware imposed by the local governmental authority, the parties modified their agreement, providing that in the event that a permit for building the sewers was not issued within the agreed time frame, the sum of US$300,000 would be paid by Contractor. In that case, Developer would itself build the sewers when a permit became available in the future.

Payment of the US$300,000 was to be assured by means of a standby LC issued to a title company acting as the Escrow Agent who would draw on the LC and pay the proceeds to Developer on certification by Developer that no permit had been issued after an agreed amount of time or release the standby if it had.

Subsequently, the city imposed a formal moratorium until greater capacity was made available. There were limited exceptions to this moratorium, but Developer did not qualify for them. Developer did not request an exception since it did not currently intend to develop the property and could not supply required information. Nor did Contractor request that the Developer apply for a permit. The city later indicated a starting date for expansion, stating that it would take 18 months to complete, well after the agreed time frame had ended.

When Developer certified to Escrow Agent after the requisite time that no permits had been issued, Contractor sought and obtained a temporary restraining order, asserting that Developer had failed to make a good faith effort as required by the underlying contract to procure an exemption. After a trial, a permanent injunction was issued against Issuer, Beneficiary, and Developer. On appeal, reversed and remanded for entry of judgment in favor of Developer.

Legal Analysis:

1. Duty of Good Faith and Fair Dealing: In entering permanent injunctive relief, the trial court concluded that Developer had violated its contractual duty of good faith and fair dealing in the underlying contract by not applying for the sewer permit.

The appellate court, however, noted that the purpose of the subsequent modification of the agreement to provide for issuance of a standby was to allocate the risk of delay in the expansion of sewer capacity, an event which would happen at an unknown date in the future.

The court rejected Contractor's arguments that some permits had been granted, noting that they were for relatively small parcels and that there was no indication that the relevant authority would exercise its discretion in favor of Developer. The appellate court, instead, focused on limitations of the duty of good faith and fair dealing, noting that it "does not extend beyond the agreed upon terms of the contract and the reasonable contractual expectations of the parties."

The court concluded that Contractor "could have no reasonable contractual expectation that Seller had any obligation to apply for a permit before the work on the sewer main was completed."

2. Windfall: The trial court had concluded that were Developer paid the proceeds of the standby, it would receive a windfall. The appellate court rejected this conclusion, noting that the payment was the sum agreed to by the parties in an arms length agreement as to the value of the sewer installation.

3. Attorney's Fees: Developer claimed entitlement to attorney's fees from Contractor as a result of a clause in the contract awarding attorney's fees to the prevailing party. Noting that the trial court had failed to assess such fees because of "its erroneous disposition" of the case, the appellate court instructed the trial court on remand to receive evidence of reasonable attorney's fees incurred by Developer.

Comments:

1. The appellate court's reversal turned on a point of contract law, that the standby constituted a risk allocation that should not be disturbed and that a drawing on it did not constitute a breach of the common law duty of good faith and fair dealing. This point is valid and represents an important and useful insight that is often overlooked by courts.

2. What is troubling about the disposition of this case is the unanswered question of whether a breach of this contractual duty of good faith and fair dealing would have justified an injunction against a drawing on the standby. Put another way, the question that lurks behind this decision is whether or not such a breach of contract constitutes a material fraud within the scope of Revised UCC Section 5-109 which was effective in Missouri at the time of the events of this case. Interestingly, the appellate court did not mention this statutory test.

3. Despite the insights of the appellate court, it appears that its analysis started at the wrong point. Instead of asking, as it did, whether or not the conduct of the developer constituted a breach of the underlying contract (or of related common law duties), the court should have examined this conduct in light of the material fraud test of Section 5-109. While the answer in this case may have been the same (i.e. no breech of good faith covenant and no material fraud), it is possible that there may be a breach of the covenant by conduct that does not rise to the level of material fraud.

4. It may be that under the approach taken by this appellate court, no such result could have been obtained because the provision for a standby would always allocate the risk that it would be drawn on. If so, however, the contractual analysis is unnecessary at best and potentially confusing at worst.

5. Similarly puzzling is the court's approach to attorney's fees. Missouri's version of Section 5-111(e) is similar to the Model Code. One is left to wonder whether the court concluded that attorney's fees in this action for injunctive relief were not within the scope of the provision or whether the court ignored the statute for whatever reason. Its approach also leaves one to wonder whether an action for injunction on the standby falls within the scope of the underlying contract's boilerplate attorney fee provision as between the developer and the contractor. Apparently the court concluded that it did.

6. The appellate court's reasoning on the contract point, that there was no breach of Developer's common law duty of good faith and fair dealing is flawless. As it understood the facts, there was no indication that a request would have been granted and, more significantly to the court, no reasonable expectation that the Developer would have applied for an exemption.

[JEB/ees]

COPYRIGHT OF THE INSTITUTE OF INTERNATIONAL BANKING LAW & PRACTICE

The views expressed in this Case Summary are those of the Institute of International Banking Law and Practice and not necessarily those of ICC or the other partners in DC-PRO.