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In Re Cendant Corporation Securities Litigation

181 Fed. Appx. 206 (3rd Cir. 2006)

CONTRACTS; GOOD FAITH — The covenant of good faith and fair dealing arises from fundamental notions of fairness and is a judicial convention designed to protect the spirit of an agreement when, without violating an express term of the agreement, one side uses oppressive or underhanded tactics to deny the other side the fruits of the parties’ bargain.

While working for her company, an employee earned the right to buy company stock at a fixed price upon her departure. The rules governing those options were set forth in two plans, an option plan and a bonus plan. Under those documents, the employee’s resignation would trigger a four month deadline within which she could exercise her options. In the meantime, the company learned of accounting problems and retracted its financial statements from the SEC. The company further learned that federal law did not allow it to issue stock until it had filed new financial statements. Accordingly, the company imposed a temporary halt to the exercise of employee stock options and informed the employee that the company would not release shares of stock in response to her exercise request. When the blackout was lifted, the employee was allowed to exercise her options for as many days as she lost in the blackout period. The employee took advantage of this opportunity, but she earned substantially less than she would have if she had been able to acquire and sell her stock during the blackout.

The employee filed an action against the company alleging breach of contract and breach of the implied duty of good faith and fair dealing. The District Court granted the company’s motion for judgment on the pleadings. In considering the employee’s appeal, the Court of Appeals determined that it needed to decide two issues: whether the District Court erred in dismissing the employee’s breach of contract claim, and whether the District Court erred in dismissing the employee’s claim that the company breached an implied duty of good faith and fair dealing.

The employee argued that the company breached its contract with her in two ways: first, by not allowing her to exercise her options during the blackout period; and second, by extending the exercise term once the blackout period ended. As to the employee’s first argument, the Court found it to be without merit because the option plan authorized the company to bar a former employee from exercising duly acquired options. Further, allowing the employee to exercise her options would have required the company to violate federal law. As to the second argument, the Court was similarly not persuaded. It reasoned that because the four month period was interrupted by the company’s blackout, the extension period was reasonably regarded as part of the modified option term. Furthermore, the claim would have failed even if the Court held that the company breached the agreement because the employee would not have been able to prove damages.

Next, the Court considered the employee’s claim that the company breached its implied duty of good faith and fair dealing. The Court explained that the covenant of good faith and fair dealing arises from fundamental notions of fairness. It is a judicial convention designed to protect the spirit of an agreement when, without violating an express term of the agreement, one side uses oppressive or underhanded tactics to deny the other side the fruits of the parties’ bargain. The implied covenant may only be invoked where it is clear from what was expressly agreed upon that the parties who negotiated the express terms of the contract would have agreed to proscribe the act later complained of as a breach of their agreement had they thought to negotiate with respect to that matter. Where the subject at issue is expressly covered by the contract, the implied duty to perform in good faith does not come into play. First, the Court found that the employee did not point to any allegedly oppressive or underhanded tactics employed by the company to thwart the spirit of the agreement. Moreover, the Court noted that the course of action was indistinguishable from conduct that was expressly contemplated by the plan. Also, the subject at issue was expressly covered by the contract.
Accordingly, the Court of Appeals affirmed the judgment of the District Court.


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