Daily Development for Thursday, November 18, 1999

Daily Development for Thursday, November 4, 1999

By: Patrick A. Randolph, Jr.
Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin
Kansas City, Missouri
randolphp@umkc.edu

VENDOR/PURCHASER; GOOD FAITH AND FAIR DEALING; LETTERS OF INTENT: Letter of intent can become a binding contract by estoppel, and conduct in "shopping" transaction to others during pendency of letter of intent can constitute breach of duty of good faith and fair dealing, leading to punitive damages.

GMH Assoc., Inc. v. Prudential Realty Group, 38 D&C 4th 225 (C.P. Del. 1998)

The comments in this report are based upon a report of the case by Harris Ominsky of the Blank, Rome law firm in Philadelphia. This case has been discussed widely in east coast real estate circles, but has never been aired in this forum. It is a lower court case, but the substantial damage award ($30,000,000), including punitive damages, and the good faith and fair dealing aspects of the case make it particularly noteworthy. Although a Delaware decision, it applies Pennsylvania law.

Seller executed a letter of intent with Buyer stating that either party could terminate negotiations with notice at any time. Verbally, however, Seller told Buyer that the properties were "off the market" during the negotiations and that buyer has an "exclusive look."

The court found that, instead of giving Buyer an "exclusive look," Seller in fact actively negotiated with another potential buyer while continuing negotiations with Buyer under the letter of intent. In addition, the court found that Seller denied that these parallel negotiations existed and actively concealed from Buyer information about them. Ultimately Seller sold the property to the other buyer.

The court held that the Seller had breached a contract, formed by the letter of intent and oral modifications, and had done so with a bad faith motive or, at the very least, with reckless indifference to [Buyer's] rights," and awarded $20 million actual damages and $10 million punitive damages. Significantly, the court found a verbal modification of the letter of intent notwithstanding the fact that the letter of intent contained provisions stating that it could only be modified in writing. The court found that an oral agreement can modify a written agreement and can act as a waiver of a provision barring such oral modifications.

In addition to the breach of contract claim, the court also found that Seller breached a "duty to negotiate in good faith." The court noted that this duty to negotiate is independent of the existence of the binding contract of sale. The court cites other federal authority applying Pennsylvania law to support the existence of this special duty: Flight Systems, Inc. v. Electronic Data Systems Corp., 112 F.3d 124, 130 (3rd Cir. 1997); Channel Home Centers v. Grossman, 795 F.2d 291, 299 (3d Cir. 1986).

Comment: This lower court case undoubtedly will be appealed. Veterans have seen these cases wax at the trial court and then wane on appeal. One thinks of the famous punitive damages judgment against a noted Washington, D.C. law firm in a case involving the Penthouse resort project in Atlantic City. The stinging rebuke delivered to the lawyers by the trial court was outdone only by the stinging rebuke delivered to the trial judge in the appeals court decision that reversed him.

Nevertheless, the new fashion for "good faith and fair dealing" is proving particularly problematic for parties engaged in the traditional rough and tumble world of real estate negotiations.

If your client signs a document that ways it can be modified only by a writing, and later your client tells you that it has received verbal assurances from the other side, you likely would advise (or would have, prior to this case) that these assurances are not worth the air they are written on and the client should "get it in writing." The reason for a requirement for written changes is to avoid misunderstanding and the inevitable puffery concerning verbal commitments that arise in the course of disputes over such misunderstandings. To permit a formal written understanding with a "no written amendments" provision to be amended verbally is to deny the parties the protection of contract, and ultimately to injure, and not promote, the cause of a fair and efficient marketplace.

Comment 2: Leaving aside the contract, the court's recognition here of a "duty to negotiate in good faith" must be put in the appropriate context. The duty arose because of assurances by the Seller that in fact it would continue to negotiate with the Seller until it withdrew formally from those negotiations. It is certainly a possible reading of such an undertaking that the Seller also agreed implicitly that these negotiations would be exclusive, or at least that any competing negotiations would be disclosed, at least when they were reaching final stages. In fact, in this case, the Seller lied about the existence and later the status of the competing negotiations even after they had been completed, when the Seller told Buyer that the other deal had "just come up."

In the bulk of the cases in which it arises, the duty of good faith and fair dealing is nothing more than a restatement of the established judicial doctrine that courts have a function to play in interpreting both the stated and unstated understandings in every agreement. If we required every last application of the written agreement to be spelled out in writing, every contract would be an encyclopedia. There are always unstated understandings that clearly are part of the agreement. Imposing contract responsibilities to carry out such unstated understandings is neither revolutionary nor improper.

Unfortunately, when courts started calling such a responsibility a "duty of good faith and fair dealing," a few commentators and a few courts began to read in to this label a separate, far more extensive and, frankly, pernicious concept that courts have a function to play in making after the fact judgments about the general fairness of a party's actions in negotiating and performing a contract. This can be very dangerous in a system in which parties generally understand that the contract limits their liability. The instant case should be limited in its application to a simple statement that where parties agree to negotiate until formal withdrawal from negotiations, a court necessarily must interpret what the parties mean by "negotiate" in this context. So limited, the case is consistent with precedent and with good sense.

Readers are urged to respond, comment, and argue with the daily development or the editor's comments about it.

Items in the Daily Development section generally are extracted from the Quarterly Report on Developments in Real Estate Law, published by the ABA Section on Real Property, Probate & Trust Law. Subscriptions to the Quarterly Report are available to Section members only. The cost is nominal. For the last six years, these Reports have been collated, updated, indexed and bound into an Annual Survey of Developments in Real Estate Law, volumes 1‑6, published by the ABA Press. The Annual Survey volumes are available for sale to the public. For the Report or the Survey, contact Maria Tabor at the ABA. (312) 988 5590 or mtabor@staff.abanet.org

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