Skip to main content, L.L.C. v. Kids, Inc.

A-3391-06T2 (N.J. Super. App. Div. 2009) (Unpublished)

AGREEMENTS; GOOD FAITH — An implied covenant of good faith exists in every contract and a contracting party may not take actions that violate the other party’s reasonable contract expectations even if such actions do not contradict an express agreement of the parties.

In 2000, a retailer of toys and video games entered into an agreement with a internet “superstore” to launch a co-branded store on one of the superstore’s web pages. The agreement contained specific provisions granting the retailer the right to sell certain products exclusively, and to select products to be offered for sale in the “co-branded” virtual store. The agreement also prohibited the superstore from selling or permitting third parties from selling any “exclusive products” through the website. The retailer was required to maintain an agreed-upon inventory level to meet the anticipated demand. The agreement included several termination provisions and provided for a “post-termination transition period.”

Disagreements arose with respect to the agreement’s exclusivity provisions. The agreement was then amended to deal with a specific disagreement with a competitor of the retailer, but the parties’ interpretation of the exclusivity clause continued to be a problem. “Hot Links” on the superstore’s site directed customers directly to the retailer’s competitors and, if the exclusive products were out of stock, the superstore would reclassify the items as “non-exclusive,” and allow third-parties to sell those products. The retailer felt it was “sending customers to someone else to buy a product.” Then, the superstore introduced new technology for third-party sellers in the category of toys, games, and baby products resulting in thousands of what were otherwise exclusive products under the agreement being added to the superstore’s website by third-party vendors. The superstore’s website claimed it did not have the technologies in place to stop the addition of exclusive products by third-parties. The toy retailer sued the superstore, seeking injunctive and declaratory relief (for breach of contract), and damages. It also alleged that the superstore violated its covenant of good faith and fair dealing with respect to exclusivity rights.

The Chancery Division issued a temporary injunction restraining the superstore from implementing its new technology. It also issued an order enjoining the superstore from allowing third-parties to sell certain exclusive items on the superstore’s website.

On appeal, the Appellate Division vacated the preliminary injunction and restraints imposed by the lower court. At trial, the superstore website said it had used its “best efforts” to catch selected exclusive products from being offered by third parties and claimed that the toy retailer had “inventory shortcomings.” The retailer offered evidence that the website permitted the sale of exclusive items by third-party vendors. The lower court held that the superstore violated its implied covenant of good faith and fair dealing with respect to the exclusivity aspects of the agreement and directed that the agreement be terminated. It did not award any damages to either party. Both parties appealed.

The Appellate Division held that there was no technical breach of any specific provision of the agreement. Nevertheless, it ruled that the superstore’s failure to track and maintain sales, its creating new technology, and its altering the appearance of the site, cumulatively represented a material shift in the configuration of the partnership which neither an injunction or revision could reconcile. The Court believed that terminating the agreement was an equitable remedy because, to do otherwise, would be “inviting five years of continuing litigation.” Further, the Court believed that the superstore lacked the ability to police third-party sales effectively if the contract was allowed to survive.

The Court also held that the disagreement over the extent of the toy retailer’s exclusivity right concerned the very essence of the agreement and termination was thus appropriate under Delaware Law (which the parties agreed would be the applicable law under the agreement). Using Delaware Law, the Court found that an implied covenant of good faith exists in every contract (as is the case under New Jersey law). It ruled that, despite the plain language in the contract, extrinsic evidence showed that the superstore’s actions did not honor the toy retailer’s reasonable contract expectations to protect its exclusivity rights. Moreover, the Court held that the implied covenant of good faith did not contradict an express agreement of the parties. Here, the Court noted that it would have been difficult for the parties to have drafted the agreement in such a way as to comprehensively dispose of the exclusivity issue given all the post-agreement developments in the market and in technology. The Court also held that the web superstore’s implementation of new technology, without having a system in place to block third parties from selling exclusive products, was evidence that the superstore breached its implied covenant of good faith. Further, the Court held that the toy retailer’s failure to prove that the superstore explicitly breached the contract was due to the “insufficiency” of the data provided by the superstore and that the superstore, itself, had been less than forthcoming with documentation. The Court rejected the web superstore’s claim that the toy retailer failed to exercise efforts to ensure a minimum selection of top-selling products and keep them in stock.

Pursuant to Delaware law, a determination of commercial reasonableness is reached after a review of the specific facts of the case. Here, the Court held that the web superstore did not give the toy retailer a chance to cure the defect and never advised it as to what percentage of inventory was necessary to be maintained at any point in time. In addition, although the agreement stated that the toy retailer was to use “commercially reasonable efforts” to maintain inventory, that term was not specifically defined in the agreement. The Court also rejected the web superstore’s request to be paid fees during the wind-down period. It held that the agreement did not provide for payment of any such fees during this period and stated it would not rewrite the agreement for the web superstore to receive a better deal than it made for itself. It noted that the parties clearly intended to exclude these fees as they failed to include such payments in the section of the agreement dealing with items that “survive” termination. The Court also rejected the superstore’s argument that it should have been paid for honoring the toy retailer’s post-termination exclusivity rights. It held that such a duty was implicated by the superstore’s implied duty of good faith. Finally, inasmuch as the lower court found that the superstore had violated its implied duty of good faith, the retailer was entitled to damages for the difference between the exclusivity bargain it was promised and the compromised exclusivity which it actually received. Thus, the Court remanded for a determination by the lower court on this issue of damages.

66 Park Street • Montclair, New Jersey 07042
tel: 973-783-3000 • fax: 973-744-5757 •