Taylor Equipment, Inc. v. John Deere Co.

___________
No. 95-2937
No. 95-3000
___________
Taylor Equipment, Inc., *
doing business as Midcon *
Equipment Company, *
*
Plaintiff-Appellee/ *
Cross Appellant, * Appeal from the United States
* District Court for the
v. * District of South Dakota.
*
John Deere Company; John Deere *
Industrial Equipment Company, *
*
Defendants-Appellants/ *
Cross Appellees. *
___________
Submitted: June 12, 1996
Filed: October 18, 1996
___________
Before LOKEN, J. GIBSON, and HANSEN, Circuit Judges.
___________
LOKEN, Circuit Judge.
Deere & Company (formerly John Deere Co.) and its subsidiary, John
Deere Industrial Equipment Company (collectively, "Deere"), appeal a
judgment in favor of Deere's former industrial equipment dealer, Midcon
Equipment Company ("Midcon"). The judgment was entered after a jury found
that Deere breached the implied covenant of good faith and fair dealing
when it refused to approve Midcon's proposed assignment of its dealership
to a willing buyer, forcing Midcon's owners to sell the business to other
approved buyers for $1,715,000 less. The dealer contract provided that
Midcon could not assign its dealership "without the prior written consent
of [Deere]." Because the implied covenant cannot override this
express term of the contract, and because there was no proof that Deere
failed to exercise "honesty in fact," we reverse.
I. Factual Background.
Deere manufactures construction and industrial equipment which it
sells to independent dealers who sell or lease the equipment to end users.
Deere dealers buy and sell parts and used equipment and service customer
equipment. Because construction and industrial equipment is expensive,
Deere provides its dealers "floor plan" financing -- the dealer must take
title to a piece of equipment, such as a $100,000 road grader, upon its
delivery into inventory, but the dealer does not pay Deere until it sells
or leases the equipment, and it pays no interest on this credit transaction
for the first nine months after delivery. Given this financial stake in
its dealers, Deere screens prospective dealers for financial strength and
adequate capitalization.
Midcon was a long time Deere dealer in Sioux Falls, South Dakota, and
Sioux City, Iowa. This controversy began in 1990 when Deere discovered
that Midcon had sold $370,000 in equipment "out of trust" by failing to
timely pay Deere after the sales. The dealer contract between Deere and
Midcon provided that Deere could terminate immediately for cause (defined
to include defaults such as selling equipment out of trust), and that
either party could terminate without cause upon one hundred twenty days
written notice. Deere notified Midcon's owners, Paul and Cecelia Taylor,
that Midcon would be terminated because of these serious defaults.
However, in lieu of immediate termination, Deere advised that it would
allow Midcon to continue as a dealer in good standing for up to eighteen
months while the Taylors attempted to locate a buyer. The contract further
provided that it "cannot be assigned by the Dealer without prior written
consent of [Deere]."
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In the fall of 1991, Midcon entered into an "agreement in principle"
to sell nearly all its assets to Interstate Companies of Minnesota, Inc.
("Interstate"). This tentative agreement was subject to a number of
contingencies, including Deere's consent to the assignment of Midcon's
dealer rights to Interstate. Though Deere had approved Interstate's
acquisitions of Deere dealers in Montana and Des Moines, Iowa, in 1987 and
1989, Deere notified Interstate that it would not approve this assignment
unless Interstate enhanced its financial strength with additional equity
capital. Interstate declined to do so, Deere refused to approve the
assignment, and Midcon's sale to Interstate fell through. In 1992, with
Deere's approval of the purchasers as successor dealers, the Taylors sold
most of Midcon's Sioux Falls assets to Midwest Machinery, Inc. ("Midwest"),
and most of the Sioux City assets to Swaney Equipment Co. ("Swaney"), on
substantially less favorable terms than Interstate had previously offered.
II. Procedural History.
Midcon then commenced this action, alleging wrongful cancellation
under the South Dakota equipment dealer statute, S.D.C.L. §§ 37-5-3 and 4,
and breach of the implied covenant of good faith and fair dealing, when
Deere refused to approve the assignment to Interstate. Deere
counterclaimed, alleging that Midcon had fraudulently obtained government
customer discounts.
The district court summarily dismissed Midcon's wrongful cancellation
claim because the dealership was not cancelled, but it denied Deere summary
judgment on the breach of covenant claim. Prior to trial of that claim,
the court severed Deere's fraud counterclaim for separate trial. It also
granted Midcon's motion in limine to preclude evidence regarding Midcon's
sales out of trust and Deere's intended termination on the ground that this
evidence was irrelevant and unfairly prejudicial after dismissal of the
wrongful cancellation claim. The court ruled that the sole
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issue at trial would be whether Deere acted in good faith when it refused
to approve assignment of Midcon's contract to Interstate.
Although Deere had not told Paul Taylor why it refused to approve the
proposed assignment,1 discovery revealed Deere correspondence conditioning
approval on Interstate agreeing to enhance its equity capital. At trial,
Midcon's theory was that this demand was pretextual -- in fact, Deere had
forced Midcon to sell its businesses to two "key dealers," Midwest and
Swaney, to further Deere's secret plan to "rationalize" its dealer network
by eliminating fifty to one hundred small dealers during the 1990's. Deere
countered that the refusal was in fact based upon its good faith, rational
concern over Interstate's financial ability to expand in this fashion.
Midcon responded with evidence that Deere's equity capital demand was
unusual and unreasonable. The jury obviously credited Midcon's pretext
theory.2
1
When pressed by Taylor, Deere representatives told him to ask
Interstate why it was not approved. This was an appropriate
response since Deere's communications with Interstate had involved
that company's confidential financial information.
2
Early in the trial, Paul Taylor testified: "when Deere had
put a certain amount of pressure on me, I decided that I would sell
the business." Deere argued that Midcon thereby opened up the
issue of its sales out of trust, but the district court adhered to
its earlier motion in limine ruling. This ruling left the jury
free to infer that Deere "pressured" Taylor as part of its secret
plan to eliminate small dealers, not because Midcon had breached
its dealer contract. The ruling also precluded Deere from
explaining why Taylor did not have the option of refusing to sell
the business if he found the Midwest and Swaney purchase offers
unattractive. Finally, the ruling foreclosed Deere from putting
its own actions in context, which is critical when a party's
"honesty in fact" is at issue. Indeed, the district court even
barred Deere from introducing evidence of Interstate's later
financial troubles, evidence that would have substantiated the
concerns that Deere contended were the reason for its refusal to
approve assignment of the Midcon dealerships to Interstate. These
evidentiary rulings left Deere to defend a claim of bad faith with
one hand tied behind its back. Had we not concluded that Midcon's
breach of covenant claim fails as a matter of law, we would have
reversed and remanded for a new trial on this ground.
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The jury awarded Midcon $1,715,710 in compensatory damages. The
district court awarded $381,240.55 in prejudgment interest and denied
Deere's alternative motions for judgment as a matter of law or a new trial.
On appeal, Deere argues (1) it is entitled to judgment as a matter of law
on Midcon's implied covenant claim; (2) the district court erred in
excluding evidence of Midcon's sales out of trust and government discount
fraud, and Interstate's subsequent financial woes; (3) error in the jury
instruction on "good faith"; and (4) improper damages. In its conditional
cross-appeal, Midcon argues that we should reinstate the claim for wrongful
cancellation if we reverse the judgment for breach of the implied covenant.
Given our interpretation of controlling South Dakota law,3 we need only
address the first and last issues.
III. The Implied Covenant Claim.
The district court concluded that "the South Dakota Supreme Court
would impose on [Deere] a duty to act reasonably in deciding whether to
consent to a proposed dealership transfer." We review the court's
construction of state law de novo. See Pate v. National Fund Raising
Consultants, Inc., 20 F.3d 341 (8th Cir. 1994). Application of the implied
covenant is a matter of contract interpretation, Cambee's Furniture, Inc.
v. Doughboy Rec., Inc., 825 F. 2d 167, 175 (8th Cir. 1987) (applying South
Dakota law), a question we also review de novo. Dirks v. Sioux Valley
Empire Elec. Ass'n, Inc., 450 N.W.2d 426, 427-28 (S.D. 1990).
A.
The Supreme Court of South Dakota recently held that South Dakota law
implies a covenant of good faith and fair dealing into
3
Neither party challenges the district court's decision to
apply South Dakota law, and we do not examine that issue sua
sponte. See Kostelec v. State Farm Fire & Cas. Co., 64 F.3d 1220,
1224 (8th Cir. 1995).
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every contract. See Garrett v. BankWest, Inc., 459 N.W.2d 833, 841 & n.7
(S.D. 1990). This covenant affords only contract remedies; there is no
independent tort for its breach. Moreover, "good faith is not a limitless
duty or obligation. The implied obligation must arise from the language
used [in the contract] or it must be indispensable to effectuate the
intention of the parties." Id. at 841-42 (quotation omitted). The Court
in Garrett adopted for all contracts the definition of "good faith" found
in South Dakota's uniform commercial code -- "honesty in fact in the
conduct or transaction concerned." S.D.C.L. § 57A-1-201(19).
Though every contract includes the implied covenant, it does not
affect every contract term. The covenant is "a method to fill gaps" in a
contract. It has "nothing to do with the enforcement of terms actually
negotiated" and therefore cannot "block use of terms that actually appear
in the contract." Continental Bank, N.A. v. Everett, 964 F.2d 701, 705
(7th Cir.), cert. denied, 506 U.S. 1035 (1992). Where parties have
addressed an issue in the contract, "no occasion to divine their intent or
supply implied terms arises." Cambee's, 825 F.2d at 175 n.13.
In Garrett, the Court declined to apply the implied covenant to
compel a lender to extend credit when the contract's express terms did not
require such action. 459 N.W.2d at 847. Similarly, that Court has refused
to "transplant[] the covenant of good faith and fair dealing into the
foreign soil of the employment-at-will doctrine." Breen v. Dakota Gear &
Joint Co., 433 N.W.2d 221, 224 (S.D. 1988). A claim that an employee was
terminated in bad faith is fundamentally inconsistent with the concept of
at-will employment. Therefore, the implied covenant may not be used to
restrict the employer's freedom to terminate. See Poff v. Western Nat'l
Mut. Ins. Co., 13 F.3d 1189, 1191 (8th Cir. 1994) (applying the same
principle in Minnesota law).
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Applying similar reasoning, many courts have held that the implied
covenant may not be applied to limit a clear contractual provision allowing
termination of the contract without cause. See Grand Light & Supply Co.,
Inc. v. Honeywell, Inc., 771 F.2d 672, 675, 679 (2d Cir. 1985); Triangle
Min. Co. v. Stauffer Chem. Co., 753 F.2d 734, 739-40 (9th Cir. 1985);
Cardinal Stone Co. v. Rival Mfg. Co., 669 F.2d 395, 396 (6th Cir. 1982);
Corenswet, Inc. v. Amana Refrig., Inc., 594 F.2d 129, 138 (5th Cir.), cert.
denied, 444 U.S. 938 (1979); Blalock Mach. & Equip. Co. v. Iowa Mfg. Co.,
576 F. Supp. 774, 776-78 (N.D. Ga. 1983). See also General Aviation, Inc.
v. Cessna Aircraft Co., 703 F. Supp. 637, 644 (W.D. Mich. 1988) (implied
covenant may not restrict a party's right to refuse to renew an annual
dealer agreement), rev'd in part on other grounds, 915 F.2d 1038 (6th Cir.
1990). The Deere-Midcon dealer contract was terminable by either party
without cause. This suggests that Deere's right to disapprove an
assignment of the contract was intended to be absolute, because Deere in
any event would be free to terminate an unwanted successor without cause.4
This appeal involves a no-assignment-without-approval clause, rather
than a termination clause. However, courts have also been reluctant to
apply the implied covenant to block a party's exercise of its contractual
right to withhold approval. In James v. Whirlpool Corp., 806 F. Supp. 835,
839 (E.D. Mo. 1992), for example, the contract provided that "[n]one of the
rights or obligations under th[e] agreement shall be subject to assignment
. . . without the prior written consent of [the manufacturer]." The court
held that the implied covenant did not "override the express terms of the
agreement" which "unmistakably" granted an
4
In Cambee's, we held that a distributor contract silent as to
duration contained an implied covenant that the distributor would
not be terminated without cause "for a period sufficient to allow
[the distributor] to recoup its investment." 825 F.2d at 175.
However, the Deere-Midcon agreement was not silent as to duration.
Moreover, Midcon had many years as a Deere dealer in which to
recoup its initial investment.
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unlimited right to disapprove assignments. Id. at 843-44. See also In re
Bellanca Aircraft Corp., 850 F.2d 1275, 1285 (8th Cir. 1988) (U.C.C. good
faith obligation imposes no duty not to unreasonably withhold consent to
assign a contract right).
Similarly, in Hubbard Chevrolet Co. v. General Motors Corp., 873 F.2d
873, 877-78 (5th Cir.), cert. denied, 493 U.S. 978 (1989), the court held
that the implied covenant had "no role to play" in a dispute over the
manufacturer's refusal to approve a dealer's relocation. "[The contract]
gave GM the authority to approve or disapprove relocation for its own
reasons," the court explained; "we decline to allow a jury to reevaluate
the wisdom of the parties' choice to leave relocation decisions to GM." Id.
at 878. See also Tidmore Oil Co. v. BP Oil Co., 932 F.2d 1384, 1391 (11th
Cir.) (no breach of the implied covenant where supplier refused to approve
a jobber's expansion under a contract stating that the supplier "must
approve each outlet"), cert. denied, 502 U.S. 925 (1991).
Were the Supreme Court of South Dakota to apply the holdings in these
cases to this fact setting, it is clear that Midcon's implied covenant
claim would fail as a matter of law. The purpose of the implied covenant
is to honor the parties' justified expectations. Garrett, 459 N.W.2d at
846. Absent contractual limitation, Deere has an absolute right to choose
its equipment dealers. Midcon's dealer contract granted Deere an express,
unrestricted right to disapprove a proposed assignment of Midcon's contract
rights.5 This contract term gave Midcon no justified expectation that
Deere was agreeing to surrender its absolute right to choose Midcon's
successor. Instead, the no-assignment-without-
5
See Cunningham Implement Co. v. Deere & Co., No. C7-95-1148,
1995 WL 697555 (Minn. App., Nov. 28, 1995) (unpublished): "Deere
left nothing to implication . . . . [Denial of approval] was
Deere's contract right."
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Deere-approval term preserved that right.6 Cf. Massey v. Tandy Corp., 987
F.2d 1307, 1309-10 (8th Cir. 1993); Abbott v. Amoco Oil Co., 619 N.E.2d
789, 796 (Ill. App.) ("the dealers cannot complain when Amoco merely
exercises the discretion the dealers allowed Amoco to possess"), appeal
denied, 624 N.E.2d 804 (Ill. 1993).
B.
There is another line of cases that suggest some role, albeit a
limited role, for the implied covenant in a dispute involving exercise of
a contractual right to disapprove assignment of a dealer contract. In Kham
& Nate's Shoes No. 2, Inc. v. First Bank of Whiting, 908 F.2d 1351, 1357
(7th Cir. 1990), the court explained: "'Good faith' is a compact reference
to an implied undertaking not to take opportunistic advantage in a way that
could not have been contemplated at the time of [the contract's] drafting,
and which therefore was not resolved explicitly by the parties." The
Seventh Circuit further explained this concept in Original Great Amer.
Chocolate Chip Cookie Co. v. River Valley Cookies, Ltd., 970 F.2d 273, 280
(7th Cir. 1992):
Contract law imposes a duty, not to "be reasonable," but to
avoid taking advantage of gaps in a contract in order to
exploit the vulnerabilities that arise when contractual
performance is sequential rather than simultaneous. Suppose A
hires B to paint his portrait to his satisfaction, and B paints
it and A in fact is satisfied but says he is not in the hope of
chivvying down the agreed-upon price . . . . This . . . would
be bad faith, not because any provision of the contract was
6
The provision is consistent with general contract principles
in that it confirms the parties' understanding that Midcon's rights
as a Deere dealer fell within the broad class of contract rights
that are not assignable without the other party's consent because
"they are coupled with liabilities, or . . . involve a relationship
of personal credit and confidence." Green v. Camlin, 92 S.E.2d
125, 127 (S.C. 1956); see Berliner Foods Corp. v. Pillsbury Co.,
633 F. Supp. 557 (D. Md. 1986); Jennings v. Foremost Dairies, Inc.,
235 N.Y.S.2d 566, 573 (N.Y. Sup. Ct. 1962) (dealer contract).
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unreasonable and had to be reformed but because a provision had
been invoked dishonestly to achieve a purpose contrary to that
for which the contract had been made. The same would be true
here, we may assume, if . . . the Cookie Company had tried to
appropriate the value [the Sigels] had created by canceling the
franchise on a pretext . . . utterly trivial violations of the
contract that the company would have overlooked but for its
desire to take advantage of the Sigels' vulnerable position.
(Citations omitted.)
Under this interpretation of the implied covenant, Deere would be liable
if it dishonestly withheld approval of a proposed assignment, but not if
its decision was simply unreasonable. This interpretation is consistent
with Garrett's adoption of the U.C.C. standard, "honesty in fact." It is
inconsistent with the district court's imposition of a duty to act
"reasonably."7
We are frankly uncertain whether the Supreme Court of South Dakota
would hold that the implied covenant may not restrict an unlimited
contractual right of approval, following cases such as Grand Light & Supply
and James v. Whirlpool, or whether it would follow the above-quoted Seventh
Circuit decisions and hold that the implied covenant does bar dishonest
exercise of an otherwise absolute right to disapprove. But we need not
resolve that uncertainty in this case because Midcon presented no evidence
that Deere acted dishonestly when it disapproved the proposed assignment
to Interstate.
7
The district court instructed the jury that the implied
covenant required Deere "to act fairly and reasonably," and that
"[s]ubterfuge and evasions violate the obligation of good faith
. . . even though the actor believes its conduct to be justified."
These instructions erroneously expanded the implied covenant far
beyond "honesty in fact." In particular, the instruction regarding
"subterfuge and evasions" has no place in a case of this kind.
Deere's dealer strategies and its evaluation of Interstate's
financial statements involved sensitive business information. The
court should not have permitted the jury to find Deere guilty of
"subterfuge and evasions" because it failed to disclose such
information when it disapproved the assignment to Interstate.
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Midcon's case was built upon pretext and unreasonableness. Deere's
stated reason for disapproving -- Interstate's inadequate equity capital --
and the alleged secret reason -- a long term plan to consolidate
dealerships in the hands of key dealers -- are both legitimate business
reasons for not approving Interstate as Midcon's successor. Midcon had no
evidence of Deere's "dishonesty in fact" -- an intent to take
"opportunistic advantage" of Midcon's need to sell for any reason other
than Deere's business interests in choosing its dealers, interests
expressly protected in the contract. Thus, Deere is also entitled to
judgment as a matter of law under this interpretation of the implied
covenant.
C.
The district court relied upon Larese v. Creamland Dairies, Inc., 767
F.2d 716 (10th Cir. 1985), for its conclusion that the implied covenant
imposed a duty on Deere to act reasonably. In Larese, a franchise
agreement prohibited assignment "without the prior written consent of"
Creamland and declared any unapproved transfer "null and without effect."
Id. at 717. Applying Colorado law, the court held that the implied
covenant required that the franchisor not unreasonably withhold consent.
In a passage quoted approvingly by the district court, the court in Larese
opined that "the franchisor must bargain for a provision expressly granting
the right to withhold consent unreasonably, to insure that the franchisee
is put on notice." Id. at 718. We disagree.
The normal meaning of the approval clause in the Deere-Midcon
agreement is that Deere has an unrestricted right to withhold approval, at
least if it acts honestly. As review of any contract drafting treatise
will confirm, if the parties to a contract agree that the discretion
granted under such an approval clause should be more limited, their
draftsman will insert a provision stating that "consent to assignment shall
not be unreasonably withheld," like the contract at issue in Anheuser-
Busch, Inc. v. Natural Bev.
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Distribs., 69 F.3d 337, 345 (9th Cir. 1995). See generally R.A. Feldman,
Drafting Effective Contracts: A Practitioner's Guide § 5-J.2[a] (1996
Supp.). Unlike litigation, drafting a contract is a positive exercise
among parties contemplating beneficial, harmonious relations. No
experienced draftsman would think of inserting a provision to the effect
that "this clause permits Party A to act unreasonably." Thus, we decline
to follow Larese because it would impose an unrealistic drafting burden on
parties who intend to create an unrestricted approval clause whose exercise
will not be supplanted by a jury's notion of reasonableness.
"[I]n commercial transactions it does not in the end promote justice
to seek strained interpretations in aid of those who do not protect
themselves." James Baird Co. v. Gimbel Bros., Inc., 64 F.2d 344, 346 (2d
Cir. 1933) (L. Hand, J.). Paul Taylor was an experienced businessman who
had no justified expectation that Midcon's dealer contract would permit him
to second-guess Deere's choice of Midcon's successor. Accordingly,
Midcon's claim for breach of the implied covenant of good faith and fair
dealing fails as a matter of law under any reasonable application of the
implied covenant defined in Garrett.
III. The Wrongful Cancellation Claim.
Midcon argues that the district court erred in summarily dismissing,
without discovery, its claim that Deere cancelled the dealer contract in
violation of S.D.C.L. §§ 37-5-3 and 37-5-4. Section 37-5-3 provides that
a construction equipment manufacturer may not "unfairly, without due regard
to the equities of the dealer and without just provocation . . . cancel the
franchise of any dealer." Section 37-5-4 creates a cause of action for
damages resulting from a wrongful cancellation.
Midcon argues that Deere could be found to have constructively
cancelled the dealerships in early 1991 when Deere advised that
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Midcon was $370,000 out of trust and would be terminated if the dealerships
were not sold within eighteen months. However, Midcon's brief acknowledged
that it continued to be an active Deere dealer until June 1992 when the
businesses were sold to Midwest and Swaney.8 Indeed, Midcon could take no
other position if it wished to pursue its implied covenant claim because
termination of the dealerships would have destroyed Midcon's power to
assign them. The plain language of § 37-5-3 limits its scope to instances
of "unfair cancellation." In these circumstances, the district court
properly perceived the factual inconsistency in Midcon's claims and
dismissed a wrongful cancellation claim that was fundamentally at odds with
the events at issue.9
The judgment of the district court is reversed and the case is
remanded with instructions to enter a judgment in favor of defendants
dismissing all of Midcon's claims.
JOHN R. GIBSON, Circuit Judge, dissenting.
I respectfully dissent.
8
Midcon has no authority for its constructive cancellation
theory. It cites Groseth Int'l, Inc. v. Tenneco, Inc., 410 N.W.2d
159 (S.D. 1987), but there the dealer's franchise was in fact
cancelled. Unlike the dealer in Groseth, Midcon continued to serve
as a Deere dealer after the "constructive cancellation" and was
able to sell on-going businesses. See also Zeno Buick-GMC, Inc. v.
GMC Truck and Coach, 844 F. Supp. 1340, 1351 (E.D. Ark. 1992)
(Kansas statute does not apply to constructive franchise
terminations), aff'd, 9 F.3d 115 (8th Cir. 1993); Carlock v.
Pillsbury Co., 719 F. Supp. 791, 852 (D. Minn. 1989) (no
"constructive termination" claim under Washington Franchise
Investment Protection Act).
9
Midcon's reply brief asserts for the first time that Midcon
is entitled to pursue a claim that Deere violated S.D.C.L. § 37-5-2
by threatening cancellation. However, this claim was not pleaded
in Midcon's complaint nor raised in its notice of cross-appeal.
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I believe that the court today takes a far too narrow view of South
Dakota law with respect to Deere's refusal to approve the purchasers of
Midcon's business.
I must first say that were we considering adoption of a federal rule
with respect to the covenant of good faith, I would join much of the
court's opinion today with substantial enthusiasm. The issue, however, is
far more narrow; namely, a prediction of the rule that would be applied by
the South Dakota Supreme Court.
The two district judges involved in this case denied motions for
summary judgment with respect to the implied covenant of good faith issue.
The first such decision was articulated in open court after considerable
argument, relying on this court's earlier decision in Cambee's Furniture,
Inc. v. Doughboy Rec., Inc., 825 F.2d 167 (8th Cir. 1987), based on South
Dakota law.
The second judge, in a thoughtful and detailed analysis of several
South Dakota cases on the implied covenant of good faith undertaken by the
court, concluded:
In this case, the implied covenant of good faith and fair
dealing arises from the language of the assignment clause
expressly stated in the written dealership agreements. See
Nelson v. Web Water Dev. Ass'n, Inc., 507 N.W.2d 691, 698 (S.D.
1993) (reversing grant of summary judgment on issue of breach
of contractual good faith and fair dealing where high court
determined a valid employment contract existed). Cf. Garrett
[v. BankWest, Inc.,] 459 N.W.2d [833,] 844 [(S.D. 1990)],
(holding that no implied covenant arose because no contracts
existed). Although the South Dakota Supreme Court has not
decided a similar case, this Court concludes, based on Nelson,
Garrett and Groseth [Int'l, Inc. v. Tenneco, Inc., 410 N.W.2d
159 (S.D. 1987)], that, construing the contract language used
here, the South Dakota Supreme Court would impose on the
franchisor a duty to act reasonably in deciding whether to
consent to a proposed dealership transfer. See Larese, 767
F.2d [716,] 716-17 [(10th Cir. 1985)].
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The court continued, reasoning that there was no evidence that the
assignment clause resulted from arms-length negotiation between the
parties. In addition, Taylor testified in his deposition that long after
the agreements were reached, Deere executive, Gene Griffith, had told
Taylor "several times" that he would not be unreasonable about [approving
or disapproving transfer of the dealership agreements]. The district judge
stated:
[U]nder the contract language as written, the implied covenant
of good faith and fair dealing is necessary as an aid to
interpreting the assignment clause. Plaintiff Midcon had a
reasonable expectation that defendant would exercise good faith
and fair dealing in making its decision as to whether
dealership agreements could be transferred.
Later, in ruling on post-trial motions, the district judge referred
to the earlier order on the motion for summary judgment and ordered that
the judgment should stand. It rejected Deere's argument that the reasons
it gave for not approving Interstate as a purchaser presented questions of
law rather than questions of fact. The judge, viewing the evidence in the
light most favorable to the plaintiff, held there was sufficient evidence
from which the jury could find that Deere's actions were not reasonable.
The jury was instructed that the obligation of good faith and fair
dealing is implied in the expressed written terms of the contract, which
provided that Midcon could not transfer its dealership agreements to
another dealer "without the express written consent of Deere Industrial."
The instruction continued:
The implied obligation of good faith and fair dealing
required Deere Industrial to exercise good faith toward Midcon
and to act fairly and reasonably when Midcon requested Deere
Industrial's permission to assign its dealership agreements in
connection with the sale of Midcon to Interstate Companies.
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Good faith means honesty in fact in the conduct or
transaction concerned.
Subterfuges and evasions violate the obligation of good
faith in performance of a contract even though the actor
believes its conduct to be justified.
The jury was further instructed that Deere was entitled to exercise
its business judgment, and that error in business judgment was not
sufficient to establish lack of good faith and fair dealing.
The court's opinion today first makes reference to the Garrett case
and its adoption of the implied covenant of good faith, but then proceeds
to loose a volley of federal cases from other circuits and other districts
holding that the implied covenant did not restrict an employer's freedom
to terminate an employee at will, or to terminate a contract. Next, the
court's opinion refers to cases dealing with the no-assignment-without-
approval clauses that are based on law from states other than South Dakota.
Finally, the court considers two Seventh Circuit cases, Kham & Nate's
Shoes No. 2, Inc. v. First Bank of Whiting, 908 F.2d 1351 (7th Cir. 1990),
and Original Great American Chocolate Chip Cookie Co. v. River Valley
Cookies, Ltd., 970 F.2d 273 (7th Cir. 1992), slip. op. at 9, both based
upon Illinois law, that involve exercise of a contractual right to
disapprove assignment of a dealer contract. From Cookie, the court
reasons that the Seventh Circuit's interpretation of Illinois law would
point to liability if Deere dishonestly withheld approval of the proposed
assignment, but not if the withholding of approval was simply unreasonable.
It concludes that this interpretation is consistent with the adoption of
the U.C.C. standard in Garrett v. Bankwest, Inc., 459 N.W. 2d 833, 841
(S.D. 1990), which is "honesty in fact," but is inconsistent with the
district court's imposition of a duty to act reasonably. Because it
concludes that Midcon presented no evidence
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that Deere acted dishonestly when it disapproved the proposed assignment,
it reverses the district court.
Notably, the court treats Garrett in a most cursory fashion, paying
no heed to Garrett's discussion of the basis of the adoption of the good
faith rule, and in part coupling Garrett with reference to termination of
at-will employment, which is inapposite. By failing to carefully examine
the foundation on which Garrett sits, and by failing to consider other
relevant South Dakota precedent, however, the court fails to focus on the
central issue of the case -- whether the South Dakota courts would
interpret the covenant of good faith to incorporate acting reasonably.
The court today concedes that the South Dakota courts have not
provided a clear answer to the issue before us. Nonetheless, there is no
question but that in this diversity case we must apply the law of South
Dakota, and if the issue has not been decided by its courts, our obligation
is to predict the manner in which the issue will be decided.
The district court pointed to Garrett, which is the first decision
that explicitly adopted the implied covenant of good faith. Garrett
referred not only to the provisions of the U.C.C., § 1-203 as adopted by
South Dakota,10 but also made numerous references to the Restatement
(Second) of Contracts § 205 (1981). Garrett stated:
Good faith is derived from the transaction and conduct of the
parties. Its meaning varies with the context and emphasizes
faithfulness to an agreed common purpose and consistency with
the justified expectations of the other
10
"Every contract or duty within this title imposes an
obligation of good faith in its performance or enforcement." S.D.
Codified Laws § 57A-1-203 (1988). Good faith is defined as
"honesty in fact in the conduct or transaction concerned." S.D.
Codified Laws § 57A-1-201 (1988).
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party. Restatement (Second) of Contracts, [§ 205], Comment a.
But good faith is not a limitless duty or obligation. The
implied obligation "must arise from the language used or it
must be indispensable to effectuate the intention of the
parties." Sessions, Inc. v. Morton, 491 F.2d 854, 857 (9th
Cir. 1974).
459 N.W.2d at 841.
In its detailed analysis of the facts, Garrett quotes:
[G]ood faith is an ``excluder.' It is a phrase without general
meaning (or meanings) of its own and serves to exclude a wide
range of heterogeneous forms of bad faith. In a particular
context the phrase takes on specific meaning, but usually this
is only by way of contrast with the specific form of bad faith
actually or hypothetically ruled out.
Id. at 845 (quoting Robert S. Summers, Good Faith in General Contract Law
and the Sales Provision of the Uniform Commercial Code, 54 Va. L. Rev. 195,
201 (1968)). Garrett continues:
Professor Summers suggests some categories to identify bad
faith in performance of a contract including: evasion of the
spirit of the deal; abuse of power to determine compliance;
and, interference with or failure to cooperate in the other
party's performance. [Summers at 201.] Restatement (Second) of
Contracts, [§ 205] Comment e. And, as noted in Sessions, Inc.
v. Morton, supra, the good faith must arise from the language
used or be indispensable to effectuate the intention of the
parties.
Id. Garrett held that, though every contract contains an implied covenant
of good faith, there had been no violation of the covenant because there
had been no violation of the spirit of the contract or justified
expectations of the parties, and no abuse of power to determine compliance,
nor failure to cooperate in the performance. Id. at 846.
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Nelson v. Web Water Dev. Ass'n, 507 N.W.2d 691, 698 (S.D. 1993), is
further evidence that the South Dakota Supreme Court will continue to apply
the doctrine of implied good faith as it did in Garrett. Nelson directly
quoted Garrett's definition of the implied covenant of good faith and fair
dealing and again referred specifically to the Restatement of Contracts.
See 507 N.W.2d at 698. The district court referred to and relied on both
Nelson and Garrett in its determination that the reasonableness of Deere's
actions is a good faith issue.
Because of the Supreme Court of South Dakota's consistent reliance
on the Restatement (Second) of Contracts, I am persuaded that the court
would look further to the Restatement in ascertaining whether
reasonableness falls within the definition of good faith. The lengthy
definition given to good faith in Garrett was not considered to be all-
inclusive. Indeed, Garrett stated that the meaning of good faith "varies
with the context and emphasizes faithfulness to an agreed common purpose
and consistency with the justified expectations of the other party."
Garrett, 459 N.W.2d at 841. The Restatement of Contracts phrases the duty
as one of good faith and fair dealing in the performance and enforcement
of the contracts. Restatement § 205 comment a, in discussing the meaning
of good faith, refers to honesty in fact, but continues:
Good faith performance or enforcement of a contract emphasizes
faithfulness to an agreed common purpose and consistency with
the justified expectations of the other party; it excludes a
variety of types of conduct characterized as involving "bad
faith" because they violate community standards of decency,
fairness or reasonableness.
Restatement (Second) of Contracts § 205 cmt. a (emphasis added).
Comment e, specifically referred to in Garrett, further defines the
obligation of good faith in the enforcement of
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contracts. The obligation of good faith "also extends to dealing which is
candid but unfair, such as taking advantage of the necessitous
circumstances of the other party to extort a modification of a contract for
the sale of goods without legitimate commercial reason." Restatement
(Second) of Contracts § 205 cmt. e.
Finally, it must be observed that the court instructed the jury to
consider not only whether Deere had acted fairly and reasonably with Midcon
concerning permission to assign, but also that subterfuges and evasions
violate the obligation of good faith.
This instruction is directly supported by Comment d of the Restatement:
Subterfuges and evasions violate the obligation of good faith
in performance even though the actor believes his conduct to be
justified. But the obligation goes further; bad faith may be
overt or may consist of inaction, and fair dealing may require
more than honesty. A complete catalogue of types of bad faith
is impossible, but the following types are among those which
had been recognized in judicial decisions: evasion of the
spirit of the bargain, lack of diligence and slacking off,
willful rendering of imperfect performance, abuse of a power to
specify terms, and interference with or failure to cooperate in
the other party's performance.
Restatement (Second) of Contracts § 205 cmt. d.
I believe that the district court did not err in concluding from
Nelson and Garrett that their reliance on section 205 of the Restatement
of Contracts would support the conclusion that reasonableness, along with
subterfuges and evasions, all terms enumerated in the Restatement comments,
are issues properly to be considered by the jury in determining the issue
of good faith. Further, the district court's reliance on Garrett and
Nelson, and in turn the reference of those two cases to section 205 of the
Restatement of Contracts, supports the district court's reference
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to Larese, contrary to the extended arguments made by the court today.
While the court's comments today concerning the ruling on Midcon's
motion in limine to preclude evidence regarding Midcon's sales out of trust
and Deere's intended termination may be but dictum in view of its holding,
just a few words are in order to explain why I believe the court also errs
in this respect. Midcon's claim was pleaded in six counts. The district
court dismissed five of these counts, including that for wrongful
termination, at Deere's urging. At the hearing on this motion, Deere's
counsel argued that no cancellation of the franchise had been alleged, but
only "that Deere said you should find someone else to buy your business or
we will terminate. We never got to the we will terminate part, because he
did, in fact, find someone else to buy his businesses." Counsel continued
to advocate that what had happened in this case was the resignation of a
dealer after a buyer was found. Thus, the sole issue that was tried to the
jury was the question of the implied covenant of good faith on refusal to
approve the assignment. The district court explained that it excluded the
evidence because it was prejudicial in light of the fact that Midcon's
wrongful termination claim had been dismissed. In denying the post-trial
motion for new trial on this ground, the district court referred to this
order in the pretrial motions, and stated that Deere had provided no new
evidence or argument to justify a reversal of these rulings and therefore
denied relief. The trial judge has wide discretion in ruling on the
admissibility of evidence, and its decisions thereon will not be disturbed
unless there is a clear and prejudicial abuse of discretion. Robertson Oil
Co. v. Phillips Petroleum Co., 930 F.2d 1342, 1346 (8th Cir. 1991), cert.
denied, 114 S.Ct. 2120 (1994). I would not conclude that the district
court abused its discretion in this matter.
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I would affirm the judgment of the district court because I believe
it to be based firmly on South Dakota law and an accurate prediction as to
how South Dakota courts would decide the issue before us.
A true copy.
Attest:
CLERK, U. S. OF APPEALS, EIGHTH CIRCUIT.
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