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Contractual Good Faith: Having Rights Doesn't Necessarily Mean You Can Use Them

It can be a painful lesson to learn: just because you have discretion to do something under a contract does not mean you can exercise those rights anytime you want. Why is that? The covenant of good faith and fair dealing, implied in every contract, requires that a party vested with discretion exercise it reasonably and not arbitrarily, capriciously or in a manner inconsistent with the reasonable expectations of the parties. The purpose of this duty is to ensure that parties do not take advantage of each other in a way that could not have been contemplated at the time the contract was drafted or do anything that would destroy the other party's right to receive the benefit of the contract.

The City of Woodstock learned this lesson the hard way in a recent Illinois Appellate Court decision. Reserve at Woodstock, LLC v. City of Woodstock, decided in September 2011, involved a 10-acre piece of property annexed to the City of Woodstock pursuant to a 1993 annexation agreement. In addition to zoning the property as residential (for 20 lots) and binding the parties for 20 years, the agreement contained a provision that no change could be made to any ordinance, code or regulation during the term of the agreement that would affect the zoning classification or uses permitted on the property. However, the agreement also gave Woodstock the right to re-zone the property for agricultural uses or de-annex the property if it was not developed within five years of annexation (i.e., the development window). Ultimately, the property was not developed within the specified period.

Reserve at Woodstock purchased the property from the original owner in 2005 and requested approval of a 20-lot plat in 2006. Woodstock's Plan Commission issued a report stating that the plat complied with both the annexation agreement and relevant city ordinances, and recommended approval of the plat. However, the Woodstock City Council denied approval despite the fact that Reserve had invested hundreds of thousands of dollars in connection with its efforts to get the plan approved, met all of the municipality's demands for impact studies and other assurances, and presented evidence that the plat was fully compliant.

Reserve sued the City of Woodstock, which responded by rezoning the property as agricultural and taking certain other steps that caused the property to be de-annexed. Although Woodstock had the right to take such action under the annexation agreement, the court nonetheless held that city's actions violated the implied covenant of good faith and fair dealing.

What does this mean for you and your business? First, bear in mind that this implied covenant exists in every private contract, as well as those involving a municipality. And discretion is common in certain types of contracts, such as in contracts for the purchase and sale of goods. Thus, if you have an agreement that gives you the right to perform within certain parameters or limits, the covenant of good faith and fair dealing should guide how you exercise that right.

Ask yourself whether your decision will deprive the other party of their expectations under the contract, and think twice before acting. Relying on the contract language may not be enough, so it is wise to discuss the matter with legal counsel. When it comes to contracts, an ounce of prevention is always better than a pound of cure.

© 2020 Much Shelist, P.C.National Law Review, Volume II, Number 51
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About this Author

Anthony C. Valiulis, Civil Trial Litigator, Much Shelist, Chicago Law Firm
Principal

Anthony C. Valiulis is an accomplished litigator with more than three decades of experience in a broad range of state and federal civil trial and appellate matters. A principal of the firm since 1979, Tony served as Chair of the Litigation & Dispute Resolution group for more than 20 years. His practice encompasses complex business and financial litigation, concentrating in four major areas: (1) business disputes, including non-compete agreements, (2) insurance coverage, (3) appeals and (4) class action defense. Tony represents individuals, privately held companies and publicly traded...

312-521-2691
Melinda J. Morales, Complex Commercial Litigator, Much Shelist Law firm
Principal

Melinda J. Morales is an accomplished litigator with 20 years of experience representing businesses and individuals in a broad range of complex class action and commercial litigation matters involving, the Employee Retirement Income Security Act (ERISA); the Fair Labor Standards Act (FLSA); the Fair and Accurate Credit Transactions Act (FACTA); the Truth in Lending Act (TILA); the Telephone Consumer Protection Act (TCPA); and related consumer protection statutes.

Having started her career working exclusively on class action litigation in the areas of securities, antitrust and...

312-521-2434
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