Copyright 1990 by the Seton Hall University School of Law; Henry H. Perritt,Jr
Henry H. Perritt, Jr. [FNa]
INTRODUCTION
This article considers the implied covenant
of good faith and fair dealing as a common law wrongful dismissal theory. [FN1] This covenant
provided the framework for the earliest steps in modifying the employment-at-will
rule as a substantive limitation on employee recovery for wrongful dismissal.
The implied covenant theory is of major significance in wrongful dismissal law [FN2] because it represents a way to place employment tenure
beyond the employer's control and because it widens the spectrum of employer
conduct that may be considered to constitute a breach. [FN3]
The California Supreme Court's decision in
the case of Foley v. Interactive Data Corp. [FN4] has revived interest in the implied covenant theory. Foley
is most often regarded as a setback to the plaintiff bar because it rejected tort damages for breaches of the implied
covenant of good faith. But Foley could also have *685 adopted objective
restrictions on the implied covenant but failed to do so. Foley may therefore
be a boon to the plaintiff bar because it legitimatizes the basic theory which,
even under contract measures of damages, potentially permits hundreds of
thousands of dollars to be awarded in any individual case. This article takes a
fresh look at the implied covenant doctrine, noting where appropriate how the
Foley opinion impacts on case analysis and makes projections for the future.
This
article initially reviews two other major theories for wrongful dismissal: the
implied-in-fact contract and the public policy tort. In addition, this article
introduces the implied covenant as the third exception to the
employment-at-will rule. Part II reviews use of the implied covenant more
thoroughly, from its reception into contract law to its application in the
employment termination context. Part III considers the future of the implied
covenant, justifying externally imposed limitations on contract rights in
general, considering the role of the covenant in a relational view of
contracts, and then considering three possible interpretations of the covenant
as a limitation on employment terminations: (1) as a source of protection for
legitimate employee expectations; (2) as a source of an administrative law type
deferential review of employer decisions, and; (3) as a source of obligation to
dismiss only for good cause. Part IV explores a just cause interpretation of the covenant in greater detail, considering
practical application issues like the allocation of decisionmaking
responsibility in a dismissal controversy among employer, judge, and jury. Part
V considers jury instructions for a just cause interpretation and other more
deferential interpretations. Part V then observes that, based on a comparison
of jury instructions, there may not be a substantial difference between a just
cause interpretation and a more deferential interpretation. Part VI considers
damages theories, explaining that, even under Foley, large front pay awards are
conceptually available.
This article concludes in Part VII that, in
the absence of a comprehensive statutory reform, the implied covenant will most
likely be used to expand the substantive rights afforded at-will employees.
This article does not consider the impact of increased transaction costs on
employment practices or employment opportunities, except briefly in section
III, enumerating the disadvantages of a good cause limitation. Any externally
imposed legal standard that increases the opportunities for litigation over
employment decisions increases the average *686 transaction cost of each
potentially affected decision. Because resources must be made available to
cover these transaction costs, they are not available for employee compensation
or for job creation investment.
A. Other
Wrongful Dismissal Theories
The implied covenant of good faith and fair
dealing is one of three exceptions to the
employment-at-will rule, [FN5] which together constitute the universe of common law
wrongful dismissal theories. This section reviews the other two exceptions,
which are currently more influential.
1.
Implied-in-Fact Contract
Courts in virtually every state recognize an
implied-in-fact contract theory of wrongful dismissal. [FN6] The
implied-in-fact contract theory requires a plaintiff to plead and to prove the
following: (1) the employer made a promise of employment security; [FN7] (2) the employee gave consideration for the promise, in
the form of detrimental reliance by continuing employment or otherwise; [FN8] (3) the employer breached the promise by dismissing the
employee, and; (4) the employee suffered damages. [FN9] Under this theory the employment-at-will presumption can
be overcome by proof of an informal contract to dismiss only for certain
reasons or only through certain procedures.
The promise element can be established by
handbook provisions, personnel policies published for employees, or oral
assurances by persons authorized to speak for the employer. [FN10] There is growing
acceptance of the proposition that consideration for an informal employer
promise can be found in the employee's continuing to work and performing normal
duties after knowing of the employer's promise. The rationale is that the
continued performance of service is a
detriment suffered by the employee *687 which was bargained for by the
employer. [FN11] Even when the "bargained-for" aspect cannot be
met, the employer's promise can be enforced under the promissory estoppel
doctrine, contained in section 90 of the Restatement (Second) of Contracts, if
the employee acted in reasonable reliance on the promise and such conduct
should reasonably have been expected by the employer. [FN12]
Of course, employers are free to avoid promises
of employment tenure and may publish disclaimers to foreclose reliance on
informal promises. [FN13] The implied-in-fact contract theory thus is largely under
the control of the employer.
2. Public
Policy Tort
Courts in all but six states [FN14] recognize a private right of action for employee
dismissals that jeopardize a specific public policy interest of the state. This
category of tort liability is called the public policy tort. Intentional tort
principles permit a plaintiff to recover only by showing that a legally
protected right of the plaintiff was harmed by an act of the defendant and that
the defendant lacked justification for his act. [FN15] Until the public policy tort theory was accepted by the
courts, dismissed employees could recover in tort only if they could show that
their dismissals were accompanied by conduct
or a state of mind sufficient to satisfy traditional tort categories such as
intentional interference with contractual relations, intentional infliction of
emotional distress, fraudulent misrepresentation, defamation, or invasion of
privacy. None of these traditional theories permitted the employee *688
to recover for the dismissal itself. The newer public policy tort theory, a
specific application of the prima facie tort, [FN16] permits a
dismissed employee to recover for the dismissal itself, [FN17] when the dismissal violates a clear public policy of the
state.
Public policy tort cases require courts to
balance employee, employer, and societal interests under a formula presented in
section 870 of the Restatement (Second) of Torts. To win a public policy tort
case for wrongful dismissal, the employee must show: (1) the existence of a
clear public policy, manifested in a state or federal constitution, statute or
administrative regulation, or in the common law; (2) that dismissing employees
under circumstances like those involved in the plaintiff's dismissal would
jeopardize the public policy; (3) that the plaintiff's dismissal was motivated
by conduct related to the public policy, and; (4) that the employer lacked any
overriding legitimate business justification for the dismissal. [FN18]
Another way to understand the elements of
the public policy tort are to view steps one and two as embodying an inquiry
into whether the employee conduct was
protected, in the sense that section 7 of the National Labor Relations Act or
whistleblower statutes protect only certain conduct. [FN19] Under this
approach to the public policy tort, only employee conduct necessary to promote
the public policy is protected by the public policy tort concept. Implicit in
deciding whether public policy requires the protection of certain conduct are
two subordinate inquiries: identifying that public policy and deciding how it
would be jeopardized if the conduct in controversy were discouraged by the
threat of dismissal. Separating the clarity and jeopardy elements permits more
principled decision making as to what conduct is protected than an
undifferentiated protected conduct approach. In any event, a balancing process is
required.
The balancing process can be symbolized by
the scales of *689 justice. On the employee's side of these scales is an
obvious economic interest in employment. On the employer's side is an obvious
economic interest in running the business as the employer sees fit. If the
employee asserts no other interest, society places an additional interest on
the employer's side of the scales--the employment-at-will rule, representing
society's interest in market forces as the best way to promote efficient enterprise.
This is sufficient to tip the scales in favor of the employer and against the
employee. If, however, the employee can add a societal interest to his or her
side of the scales, the employee may win, depending on the weightiness of the
interest. Of course, the employer may assert
additional justification for the dismissal on the employer's side, which may
tilt the scales back in the employer's favor. Liability is imposed on the
employer whenever the interests of the terminated employee and the public
outweigh the interests of the employer.
Reasonably clear alternative rules have
emerged for the public policy tort concept. The majority rule, more favorable
to employees, involves a flexible interest balancing approach similar to that
outlined in the preceding paragraph. [FN20] The narrower approach, less favorable to employees, denies
recovery unless the employee can show that he was dismissed for exercising an
explicit statutory right, [FN21] or for refusing
to violate an explicit statutory prohibition. [FN22]
B. Role of
Implied Covenant
The implied covenant is a third common law
doctrine enabling an employee to recover for breach of contract [FN23] when the
employer has violated a "covenant of good faith and fair dealing," *690
implied in all contracts as a matter of law. [FN24] Conceptually,
the covenant requires that contract rights be exercised in a manner that does
not violate the covenant. Thus, even though an employer has the right to
terminate an at-will contract for any reason, good or bad, or for no reason at
all, the employer also has a duty not to exercise this right in bad faith or
unfairly.
Under the broadest view of the doctrine, a dismissed employee need only
show: (1) existence of an employment relationship; (2) termination of the
employment, and; (3) some aspect of the termination that was unfair or in bad
faith. Upon such a showing, a jury is entitled to decide, with only the most
general instructions, [FN25] whether the termination was fair and in good faith. Under
the implied covenant, external standards of fairness are used to scrutinize an
employer's decision to dismiss an employee and, logically, other employer
decisions.
The implied covenant doctrine enjoyed brief
popularity and was used by the courts that were the first to relax the
employment-at-will rule. But as the more traditional and circumscribed
implied-in-fact contract and public policy tort doctrines were developed, the
importance of the implied covenant doctrine declined. Now, California,
Massachusetts, and Montana are the only states that rely heavily on the implied
covenant as the primary wrongful dismissal doctrine. Further, California and
Massachusetts impose important limitations on its use. Quite recently, the
California Supreme Court, in Foley v. Interactive Data Corp., [FN26] held that tort
damages are not recoverable in implied covenant cases. The Montana courts have
been aggressive in using the implied covenant doctrine to impose something
close to a just cause requirement. [FN27] In Montana, an employer is burdened to show a "fair
and honest reason" for a dismissal to escape liability under the covenant.
[FN28]
The implied covenant of good faith and fair dealing is a special*691 implied-in-law promise. It is a substitute
for an express or implied-in-fact promise by the employer. [FN29] The implied
promise imposes a legally enforceable obligation not to exercise the otherwise
unlimited power of termination in bad faith or for reasons offending public
policy. This implied covenant concept resembles a tort theory more than a
contract theory because it tests the defendant's compliance with a duty imposed
through public policy rather than through a voluntary promise. This may explain
some of the confusion in early wrongful dismissal cases between contract and
tort. [FN30]
The implied covenant is the strongest
manifestation of the relational contract theory in employment law. Contract doctrine
applied to all kinds of transactions is becoming more relational in character. [FN31] Employment
contracts are not exempt from this trend, and the implied covenant idea is
certain to play an increasing role in deciding employment contract disputes.
Application of the implied covenant is not
always detrimental to employer interests. The implied covenant doctrine also
imposes the burden of proof on an employee-plaintiff to show bad faith or
ulterior motivation. This allocation of the burden of proof is significantly
more favorable to employers than that contained in the most recently enacted
federal legislation, the Americans with Disabilities Act, which burdens an
employer to prove the infeasibility of accommodating employee handicaps. [FN32]
The next part of this article explores the covenant in greater depth,
considering its genesis in contract doctrine generally, as well as considering
specific wrongful dismissal cases.
II. ORIGINS OF THE IMPLIED COVENANT DOCTRINE AND ITS APPLICATION
TO EMPLOYMENT
This part reviews use of the implied
covenant from its reception *692 into contract law to its application in
the employment termination context.
A. Role of
Good Faith in Contract Law
Section 205 of the Restatement (Second) of
Contracts provides: "Every contract imposes upon each party a duty of good
faith and fair dealing in its performance and its enforcement." [FN33] The commentary
to section 205 states:
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 have 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 power to specify
terms, and interference with or failure to
cooperate in the other party's performance. [FN34]
Earlier, Professor Corbin referred to a
standard of fairness and good faith in explaining how courts "prevent the
disappointment of expectations that the transaction aroused in one party, as
the other had reason to know." [FN35] To serve this goal, "courts find and enforce promises
that were not put into words . . . ." [FN36] There was,
however, no covenant of good faith provision in the Restatement (First) of
Contracts. [FN37]
Before its emergence in the employment-at-will
context, a good faith standard of contract performance or termination attracted
commentary and judicial attention primarily in connection with its inclusion in
the Uniform Commercial Code (UCC). Professor Farnsworth reviewed the history of
two UCC good faith obligations: good faith purchase and good faith performance.
[FN38] The former
originated in English merchant law as a way of importing commercial *693
morality into the law. [FN39] The latter was
neglected until its incorporation into the UCC. [FN40] Farnsworth opined that good faith performance should be
judged by "an objective standard based on the decency, fairness or
reasonableness of the community, commercial or otherwise, of which one is a
member." [FN41]
Professor Summers considered good faith as a
standard of contract performance in the context of the growing interest
"in devising legal standards of contractual morality," stimulated in
his view by the UCC's express obligation of
good faith. [FN42] He also noted
that good faith is applied as a standard in a wide variety of contractual
relationships, [FN43] and reviewed the
following types of conduct that have been limited by the good faith standard in
the context of contract performance: [FN44] (1) evading the
spirit of the deal; [FN45] (2) lack of
diligence and slacking off; [FN46] (3) willfully
rendering only "substantial" performance; [FN47] (4) abuse of a power to specify contract terms; [FN48] (5) abuse of a power to determine compliance; [FN49] (6) interfering with or failing to cooperate in the other
party's performance; [FN50] (7) conjuring up
a dispute; [FN51] (8) adopting overreaching or "weaseling"
interpretations and constructions of contract language; [FN52] (9) taking advantage of another to get a favorable
readjustment or settlement of a dispute; [FN53] (10) abuse of a
right to adequate assurances of future performance; [FN54] (11) wrongful refusal to accept the other's performance; [FN55] (12) willful failure to mitigate damages, [FN56] *694 and; (13) abuse of a power to terminate. [FN57]
Professor Summers argued that good faith is
best understood as an
"excluder"--a phrase which excludes heterogeneous forms of bad
faith, [FN58] specifically
including "arbitrarily and capriciously exercising a power to terminate a
contract." [FN59] Professor
Summers did not elaborate on the standards for termination under the covenant,
but simply cited Professor Gellhorn. [FN60]
B. History
of Application to Employment Contracts
Although section 205 of the Restatement
(Second) of Contracts and its commentary do not address employment contracts or
the exercise of the power to terminate an employment contract the section's
concept can be used to imply an employer obligation not to discharge employees
wrongfully. The 1959 California case of Petermann v. International Brotherhood
of Teamsters [FN61]
frequently is cited as the seminal case in the modern wrongful dismissal
revolution. [FN62] In Petermann, the plaintiff was employed by a union as a
business agent. He claimed that he was dismissed for refusing to commit perjury
before a committee of the state legislature. [FN63] The trial court
granted the defendant's motion for a judgment on the pleadings. [FN64]
The court of appeals noted that the
plaintiff's breach of contract cause of action was predicated on an employment
contract that did not contain any fixed period of duration. It quoted the usual
rule: "Generally, such a relationship is terminable at the *695
will of either party for any reason whatsoever." [FN65] However, the court noted that "the right to discharge
an employee under such contract may be limited by statute or by considerations
of public policy." [FN66] The court
acknowledged that the public policy concept is vague, but characterized it as
"that principle of law which holds that no citizen can lawfully do that
which has a tendency to be injurious to the public or against the public good." [FN67] The court easily concluded that allowing an employer to
dismiss an employee for refusing to commit perjury offends public policy. [FN68] Thus, in the absence of any factual evidence of an actual
promise of employment security, the court implied a promise not to dismiss for
policy-offensive reasons.
Monge v. Beebe Rubber Co. [FN69] was another
early case applying the covenant. The Supreme Court of New Hampshire considered
a jury verdict in favor of the plaintiff in a suit for breach of an employment
contract which was for an indefinite period of time. The court found sufficient
evidence for the jury to conclude that the plaintiff's dismissal was motivated
by her refusal to "go out with" her foreman. [FN70] After a brief discussion of the need to modify the
employment-at-will rule, the court held "that a termination by the
employer of a contract of employment at will which is motivated by bad faith or
malice or based on retaliation is not in the best interest of the economic
system or the public good and constitutes a breach of the employment
contract." [FN71] Again, the
promise of employment tenure was implied-in-law.
In Fortune v. National Cash Register Co., [FN72] the
Massachusetts Supreme Judicial Court held that a trial court committed no error
in submitting the issue of bad faith termination of an employment-at-will
contract to the jury. The plaintiff was employed under a written salesman's
contract which was terminable at-will, *696 without cause, by either
party on written notice. The defendant
apparently admitted the existence of a legally enforceable contract. The court
held that the plaintiff, in spite of the literal wording of the contract, was
entitled to a jury determination on his employer's motives in terminating him. [FN73] The premise for the employer's obligation not to discharge
in bad faith was a legally implied covenant. In support of its conclusion, the
court cited statutory provisions which required good faith in respect to
contracts under the UCC, under motor vehicle franchise contracts, and according
to a number of cases assuming or implying a requirement of good faith in
contract performance. [FN74] The
Massachusetts court also cited Monge v. Beebe Rubber Co. [FN75] and section 231 of the Restatement (Second) of Contracts. [FN76]
The California Court of Appeal observed, in
Cleary v. American Airlines, Inc., [FN77] that employment contracts, like all contracts, include an
implied covenant of good faith and fair dealing. Having concluded generally
that the plaintiff's contract included a covenant of good faith, the court
decided that an important factor in construing the covenant was the plaintiff's
eighteen years of service: "Termination of employment without legal cause
after such a period of time offends the implied-in-law covenant of good faith
and fair dealing." [FN78]
These early implied covenant cases suggested
no real limits to the scope of the implied covenant of good faith and fair
dealing. *697 Juries apparently were
to be allowed to decide for themselves what constituted good faith and to
decide if the employer's actions met the standard thus derived by them. [FN79] Under this approach, the implied covenant doctrine would
give employees very broad protection.
C.
Resistance to Covenant
Courts willing to relax the
employment-at-will rule began to raise doubts about the implied covenant theory
in the early 1980's. The New York Court of Appeals in Murphy v. American Home
Products Corp., [FN80]
opposed implying a promise in a breach of contract action that is inconsistent
with the manifest intent of the parties. The court reasoned that "it would
be incongruous to say that an inference may be drawn that the employer
impliedly agreed to a provision which would be destructive of his right of
termination." [FN81] The court
declined to imply such a covenant as a matter of law for the same reasons it
declined to recognize a public policy tort theory for wrongful dismissal--its
belief that the legislature was the appropriate branch of government to weigh
the policy factors involved. [FN82]
Increasingly, state supreme courts
confronted with the question have rejected the covenant, or at least have declined
to embrace it. [FN83] Some
courts have questioned the need for the *698 covenant theory now that
more traditional theories such as implied-in-fact contract and public policy
tort are recognized widely. [FN84] For example, in Thompson v. St. Regis Paper Co., [FN85] the Supreme Court of Washington, while adopting the
implied-in- fact contract theory and the public policy tort theory, refused to
adopt the implied covenant theory because its bad faith concept is
"amorphous," and because it might be internally inconsistent with
actual conduct or promises.
Other courts have used the covenant
grudgingly. The Wisconsin Supreme Court, in Brockmeyer v. Dun & Bradstreet,
[FN86] although
recognizing the implied covenant doctrine, limited it greatly. The Brockmeyer
court stressed that implied covenant recovery should be limited to dismissals
"contrary to a fundamental and well-defined public policy as evidenced by
existing law." [FN87] In effect, it used the implied covenant theory to limit
damages available under the public policy tort theory. [FN88] In Bertrand v. *699 Quincy Market Cold Storage
& Warehouse Co., [FN89] the United
States Court of Appeals for the First Circuit concluded that, under
Massachusetts law, an implied covenant of good faith and fair dealing is not
appropriate where collectively bargained arbitration exists as a remedy for
wrongful dismissal. The court reasoned that the collective agreement gave
greater protections against wrongful dismissal than the covenant, and
therefore, there was no reason to utilize the covenant. [FN90]
D. Recent
Use of Implied Covenant
As previously explained, the covenant declined in popularity as the more
conventional and circumscribed public policy tort and the implied-in-fact
contract theories matured. Nevertheless, the covenant continues to exist in
relatively strong form in California, [FN91] Arizona, Montana, and possibly Alaska. [FN92]
In Foley v. Interactive Data Corp., [FN93] the California
Supreme Court held that only contract damages are recoverable for breach of the
implied covenant. It did not embrace various restrictions on the covenant
developed by the intermediate appellate court, such as limiting the covenant to
employees with long service [FN94] *700
and/or to employees working in places where some kind of expectation reasonably
has arisen that dismissal will be only for certain reasons or will occur only
after following certain procedures. [FN95] Foley can thus be read as endorsing a broad substantive
view of the covenant, while limiting remedy theories.
The Foley court avoided defining what is
necessary to demonstrate a breach of the covenant. It noted that the covenant
initially was applied as "a kind of safety valve" to which judges
could turn to fill gaps and qualify or limit rights and duties otherwise
arising under rules of contract construction combined with explicit contract
language. [FN96] The court
reviewed some of the standards used by California courts, noting that they did
not provide a meaningful way to keep cases away from juries and did not prevent
the juries' tendency of ignoring the judge's
instructions in favor of using their own conceptions of fairness and good
faith. While not embracing the limitations summarized in the preceding
paragraph, the Foley court rejected using the covenant by itself to impose a
good cause requirement on terminable at-will employment contracts in the
context of whether tort damages should be available. [FN97] Moreover, the Ninth Circuit has interpreted California law
as permitting breach of the covenant to be shown by little more than absence of
good cause for termination. [FN98] It is not clear,
however, whether this precedent survives footnote thirty-nine in Foley. [FN99]
Montana has developed an interpretation of
the covenant that is only subtly distinguishable from a just cause
interpretation. [FN100] An
employer must show a "fair and honest reason" for a dismissal to
escape liability under the covenant. [FN101] In Gates v.
Life of Montana Insurance Co., [FN102] the Supreme
Court of Montana used an implied covenant of good faith and fair dealing to
obligate the employer to follow policies in its personnel handbook. [FN103] In Dare v.
Montana Petroleum Marketing Co., [FN104] the court
reversed summary judgment for the employer and held that the plaintiff was
entitled to a trial on questions of job security and improper reasons for
dismissal. The court ruled that the covenant of good faith protects reasonable
expectations of job security and that the covenant would be implied where there
are "objective manifestations" by the employer of job security which
were relied on by the employee. The
"objective manifestations" that would implicate the covenant are not
limited to promises made in a handbook. [FN105]
In Crenshaw v. Bozeman Deaconess Hospital, [FN106] the court
affirmed a jury verdict of compensatory and punitive damages for a respiratory
therapist discharged during a probationary period. The court in Niles v. Big
Sky Eyewear, [FN107] affirmed
judgment on a jury verdict of $470,000, based on breach of the covenant and
misrepresentation for false information given to law enforcement authorities
resulting in the plaintiff's arrest and termination. Further, the court
approved, by negative implication, a jury instruction that suggested a good
cause standard. [FN108] In Prout v. *702
Sears, Roebuck & Co., [FN109] the court held
that firing for a false reason breaches the covenant, even though the employer
would have been free to dismiss for no reason. [FN110] In Hobbs v. Pacific Hide & Fur Depot, [FN111] the Montana Supreme Court found reversible error in the
lower court's failure to instruct the jury that the covenant arises from
objective manifestations by an employer, leading to reasonable employee
expectations. [FN112] Significantly,
the court in Flanigan v. Prudential Federal Savings & Loan Association, [FN113] found that long term employment, by itself, was sufficient
to create the expectations protectable by the covenant. [FN114]
This line of cases suggests that the
covenant of good faith and fair dealing can be used to impute a promise of
employment tenure which cannot be proven from
the facts. Such use of the implied covenant theory is potentially more far-reaching
than either the implied-in-fact contract or the public policy tort doctrines. [FN115] The Montana
Supreme Court has held, however, that the implied covenant theory cannot be
utilized to enforce employer promises of promotions and salary increases. [FN116] It is available only to contest employment terminations.
E.
Limitations on Covenant
Outside California and Montana, the implied
covenant theory is hedged with various restrictions. [FN117] The supreme
courts of *703 Arizona, [FN118] Connecticut, [FN119] and North
Dakota [FN120] have expressly disavowed the notion that a breach of the
covenant can be established merely by proving dismissal without good cause.
Other recent cases also reject claims that the covenant is violated unless the
employer can demonstrate good cause. [FN121]
Four principal ways of limiting the
covenanthave evolved. First, a breach of the covenant can only be established
by showing that an employer failed to follow employer promulgated procedures,
upon proof of some other type of employer conduct, or by communication that has
led to reasonable expectations of employment security. [FN122] Other states
require a showing that the employer has violated some understanding about how
employees would be handled. [FN123] The Supreme Court of Montana, in Gates v. Life of Montana
Insurance Co., [FN124] found that an
implied covenant of good faith and fair dealing would be breached by the
employer's *704 failure to follow the policies in its personnel
handbook. [FN125] The Nevada Supreme Court used the covenant to permit both
contract and tort damages for a "bad faith" breach of a commitment to
pay retirement benefits. [FN126]
Second, a number of California intermediate
appellate cases suggest that the covenant is available only for employees with
long service. [FN127] In
Pugh v. See's Candies, Inc., [FN128] and Cancellier
v. Federated Department Stores, Inc., [FN129] the courts
found a breach of the implied covenant because a long-term employee was
discharged without notice or compliance with customary procedures. It is not
altogether clear from the case law whether dismissal after long service
suffices to establish a breach, or whether it must be accompanied by employer
conduct creating a legitimate expectation of employment security. Further,
while five years appears to be sufficient, it is not clear what qualifies as
long service. The California Supreme Court in Foley, however, has not adopted
these limitations.
The third mode of limiting the covenant is
to allow recovery only in cases where an employee was deprived of compensation
for past service. This approach, appearing mainly in Massachusetts decisions, [FN130] would
transform the covenant from wrongful *705 dismissal into a
quasi-contract doctrine. [FN131] Massachusetts
courts have suggested that a breach of the covenant can be shown only when the
employer has acted to deprive the employee of compensation that has been earned
by past performance. [FN132]
The fourth approach, reflected in the
decisions of a number of states, posits that breach of the covenant can be
shown only by a violation of a public policy. [FN133] This was, of
course, the factual context of Petermann v. International Brotherhood of
Teamsters, [FN134] which gave the implied covenant its start as a wrongful
dismissal doctrine. More recent decisions limit the implied covenant to
situations jeopardizing public policy. Borrowing a statutory age discrimination
standard to determine the boundaries of the contractual good faith obligation,
the United States District Court for the District of Massachusetts, in McKinney
v. National Dairy Council, [FN135] approved a
jury finding that the covenant of good faith was breached by a dismissal based
on age. [FN136] In Maddaloni v. Western Massachusetts Bus Lines, Inc., [FN137] a Massachusetts appeals court approved a jury finding of a
breach of the good faith covenant where the employee was terminated in orderfor
the employer to avoid payment of bonuses. [FN138] In Wisconsin,
the *706 covenant is used instead of the public policy tort in order to
limit damages. In Brockmeyer v. Dun & Bradstreet, Inc., [FN139] the Wisconsin Supreme Court held that the covenant of good
faith and fair dealing is violated when the discharge "is contrary to a
fundamental and well-defined public policy
as evidenced by existing law." [FN140] The New
Hampshire Supreme Court, in Howard v. Door Woolen Co., [FN141] similarly limited the scope of the implied covenant.
In Magnan v. Anaconda Industries, Inc., [FN142] the Supreme
Court of Connecticut hinted that a cause of action for breach of the implied
covenant is identical to a public policy tort, [FN143] while rejecting a claim of breach of the implied covenant
based solely upon a discharge without just cause. [FN144] Later, the court suggested that the implied covenant
overlaps both the public policy tort and the implied-in-fact contract theories.
[FN145]
Another stratagem for limiting the implied
covenant is to permit it only for fixed term employment contracts and not for
at-will or indefinite term contracts. [FN146] This approach is inconsistent with the Restatement
(Second) of Contracts which clearly contemplates the application of the covenant
to powers reserved to one party under the contract. Such reserved powers
conceptually include the power to terminate.
F. Waivers
and Disclaimers
Employers are free to avoid promises of
employment tenure *707 and to publish disclaimers to foreclose reliance
on informal promises. Disclaimers are express statements, typically found in
employment applications or employee handbooks,
that put employees on notice that general statements or conduct suggesting a
commitment of employment security should not be relied upon by the employees. [FN147] Only a handful
of cases have considered the effect of disclaimers on the implied covenant.
Most have held that the implied covenant cannot be disclaimed or waived. [FN148] This conclusion, while consistent with tort obligations,
is not consistent with contract obligations. If the implied covenant is a
contract term supplied by law in the absence of a contrary manifestation of
intent by the parties, it should be waivable. Consequently, the cases limiting
waiver of the covenant should be understood as treating the covenant as a tort
concept [FN149] or simply as wrongly decided.
III. THE FUTURE OF THE IMPLIED COVENANT AS A SOURCE OF EMPLOYER
OBLIGATION
The courts in most jurisdictions which have
accepted the implied covenant have not afforded definitive guidance as to the
limits of the implied covenant doctrine, cautiously adopting it in particular
cases. The covenant remains potentially available for egregious cases not
meeting the requirements of the implied-in-fact contract or the public policy
tort. The covenant might also evolve into a duty to dismiss only for good
cause.
One of the major problems with the implied
covenant theory is its vagueness. It is difficult to limit a jury to the
implication of specific criteria for employer
decisions. The same difficulty sends too many cases to the jury because there
are no real standards for dismissal of complaints or summary judgment.
Thissection considers the future of the
implied covenant, justifying externally imposed limitations on contract rights
in general and discussing the role of the covenant in a relational *708
view of contracts. This part will then consider three possible interpretations
of the covenant as a limitation on employment terminations: as a source of
protection for legitimate employee expectations; as a source of an
administrative law type deferential review of employer decisions, and; finally
as a source of an obligation to dismiss only for good cause.
A.
Theoretical Justification for Externally Imposed Obligations
Labor and employment law abounds with
limitations on the exercise of acknowledged contract rights. The implied
covenant of good faith and fair dealing may limit an employer's exercise of the
right to terminate an employee- at-will. Similarly, the National Labor
Relations Act and the Railway Labor Act limit the exercise of employer rights
under collective bargaining agreements and also limit original property
concepts when the exercise of those rights impedes collective bargaining. The
Employee Retirement Income Security Act of 1974 (ERISA) also imposes fiduciary
obligations on employee benefit plan administrators
who exercise discretionary authority. [FN150]
1.
Comparison with Fiduciary Obligations
While the standards of good faith and fair
dealing are not necessarily the same as fiduciary standards, the ideas are
similar in that contracting parties may not be able to escape from the
obligation by reserving rights in the contract. [FN151] Moreover, both
concepts are rooted to some degree in equity and fairness principles.
The examples of good faith given in the
Restatement (Second) of Contracts commentary to section 205 demonstrate the
overlap between the covenant and fiduciary duties. The covenant prohibits *709
a contracting party from interfering with the other party's performance, from
neglecting the contractual rights of performance and from acting inconsistently
with the purpose of the bargain. [FN152] These requirements are analogous to those embodied in
fiduciary duties. [FN153] The only
exception to the general similarity between good faith and fiduciary duties is
the duty of loyalty--in ERISA terms, the duty to act for the exclusive benefit
of the other parties (beneficiaries or participants). [FN154]
Generally, the common law trust fiduciary
obligations [FN155]
which are incorporated into a branch of labor and employment by ERISA [FN156] impose duties of loyalty to beneficiaries and duties of
care in administering the trust. [FN157] Derived from the duty of care is a duty to preserve and
maintain trust assets, including an obligation to discover and control the
location of trust property, as well as a duty to investigate the identity of
any uncertain beneficiaries and to notify beneficiaries of new gifts. [FN158] The duty of
care also includes a duty to supervise any agent the trustee may retain, such
as an administrator. [FN159]
*710 The fiduciary obligations under
ERISA are more demanding than the covenant of good faith in one important
respect. While the fiduciary obligation of loyalty requires that fiduciaries
act for the exclusive benefit of the promisee, [FN160] the implied
covenant of good faith and fair dealing only requires that the promisor act
without malice and withoutulterior motives which may be irrelevant or extrinsic
to the contractual relationship. There is, however, some similarity. In order
to pursue contract objectives faithfully, one must be loyal to the interests of
the other party recognized in the contract. Loyalty to the relationship is
therefore a must. Requiring loyalty to the interests of benefit plan
participants is not a requirement of loyalty to their interests in general,
only loyalty to their interests in the plan or relationship.
There are two ways to harmonize the covenant
with the fiduciary's duty of loyalty. One theory favorable to employees is to
conclude that contracts of employment are special relationships, and thus, are
equivalent to fiduciary relationships. Then
the contract party's implied covenant is a fiduciary obligation. The California
Supreme Court, however, rejected this approach in Foley. [FN161] The Foley
court was motivated by the desire to exclude tort damages for breaches of the
covenant. Therefore, the court's discussion of special relationship criteria is
not entirely convincing. Indeed, many of the criteria identified by the court
which led it to reject a special relationship finding appear to be met by most
employment relationships.
The four features identified by the Foley
court were: (1) one of the parties to the contract enjoys a superior position
in the formation of the contract to the extent that the party is able to
dictate the terms of the contract; (2) the weaker party does not *711
enter into the contract primarily for profit, but to secure an essential
service or product, financial security or piece of mind; (3) the relationship
that evolves is one in which the weaker party places its trust and confidence
in the larger entity, and; (4) the stronger party's conduct indicates an intent
to frustrate the weaker party's enjoyment of the contract rights. [FN162]
In most employment relationships the
employer enjoys a relatively stronger position which enables it to dictate the
terms of the employment contract. While the employee's purpose in entering into
an employment relationship generally is profit, the sought after benefit is not
usually of an entrepreneurial character. Rather, it is to enjoy minimal
financial security and well-being. In most
instances, the employee places trust and confidence in the employer, at least
to the extent of permitting this larger entity to adjust the terms of the
relationship. Further, employees allow employers to organize and direct the
fortunes of the enterprise, an organization in which both have a stake. The
presence of the final criterion, the employer's desire to deprive an employee
of benefits, varies depending on the motive behind the termination of
employment.
The Foley court concluded that these factors
do not exist in the usual employment relationship. [FN163] It did,
however, distinguish between insurance and employment relationships. The court
posited that an employee can turn to the marketplace in order to find other
work. Alternatively, an insured cannot turn to the marketplace to find another
source of reimbursement for a suffered loss. Further, it is likely that the
financial interests of the employer and the employee will converge, while that
of the insurer and the insured are fundamentally opposed. [FN164]
Interpreting the duty of loyalty broadly is
another means by which to close the gap between fiduciary duties and the
implied covenant on the duty of loyalty. Employers and employees share a common
goal in the success of the enterprise. An employer generally owes the employees
a certain duty of loyalty. This duty mandates that the employer run an
efficient enterprise, weeding out incompetent or misbehaving individual
employees. Thus, the duty of loyalty is akin
to the duty of loyalty in an employee benefit plan where the fiduciary serves
the interests of the beneficiaries *712 by rejecting certain individual
benefit claims. [FN165]
2.
Comparison with Prima Facie Tort
The scope of the implied covenant is similar
to the scope of the prima facie tort when applied to an employment
relationship. Both incorporate the idea that conduct that is not ordinarily
actionable can become actionable because of the state of mind of the actor.
Both the implied covenant and the prima facie tort allow employees to recover
damages when a dismissal was based on ulterior motives or accompanied by a
subjective intent to injure. [FN166] Under both theories, an employer can escape liability by
demonstrating a legitimate economic justification for the dismissal.
An analysis using a good faith or a
fiduciary standard to evaluate the defendant's conduct is difficult to
distinguish from the kind of inquiry involved in both a prima facie tort
analysis and an intentional interference with contract tort analyses. [FN167] When
confronted with either type of tort allegation, the court must determine if the
defendant was motivated by illegitimate considerations or used improper means.
This is done through a balancing of the interests of the plaintiff and the
defendant. This inquiry may be broader than the good faith inquiry depending on
whether the existence of ulterior motives
implies bad faith. A motive is ulterior whenever it is not legitimate. The
fiduciary standard is more demanding than either the propriety or good faith
standards because a simple showing of motive other than for the benefit of the
plaintiff is enough to establish a breach of *713 the requisite mental
state standard. [FN168]
The covenant of good faith need not be
viewed as a source of obligation fully external to the contract. Professor
Fried pointed out that the obligation to perform in good faith can be
interpreted as reinforcing the purposes of the contract and requiring the
parties to conduct themselves consistent with their bargain. [FN169] The covenant
of good faith thus can be understood as an aid to contract interpretation,
essentially reinforcing purpose, trade custom, and course of dealing pre-and
post-bargain as standards by which party performance can be judged. This is a
limited view of the covenant, within a classical or neoclassical view of
contract law. The covenant can be given wider sway, still within contract
rather than tort law, under a relational view of contract.
B.
Relational Contract Model
The implied covenant of good faith was noted
in the introduction as a prominent reflection of the relational contract
doctrine. In the relational contract school, "parties treat their
contracts more like marriages than like one-night stands." [FN170] Stewart
Macauley and Ian Macneil emphasized that parties
to real world transactions do not concern themselves with the traditional,
classical, model of contract formation and administration. Rather, they work
things out in order to maintain continuing relationships.
Obligations are not frozen in an initial
bargain. They evolve over time as circumstances change, guided by norms of the
particular community within which the relation exits. The object of contracting
is to establish and define a cooperative relationship, not merely to allocate
risk. If performance is neglected by either party, the other party is expected
to be accommodating rather than to insist on technical performance. The
sanction for unacceptable performance is to terminate the relationship and to
refuse to deal in the future. [FN171] The coercive power of the state, activated through breach-
of-contract litigation, existsas a means of changing bargaining power, but it
does not preoccupy the parties *714 in defining their relationship or in
seeking remedies for disappointment. [FN172]
Professor Macneil identified ten traditional
contract norms: (1) role integrity (requiring consistency, involving internal
conflict, and being inherently complex); (2) reciprocity (simply stated as the
principle of getting something back for something given); (3) implementation of
planning; (4) effectuation of consent; (5) flexibility; (6) contractual
solidarity; (7) the restitution, reliance, and expectation interest (the
linking norms); (8) creation and restraint of power (the power norm); (9)
propriety of means, and; (10) harmonization
with the social matrix. [FN173]
He also identified five significant norms in
established contractual relations: (1) role integrity; (2) preservation of the
relation; (3) harmonization of relational conflict; (4) propriety of means,
and; (5) supracontract norms. [FN174] These are the main relational contract norms. Professor
Macneil acknowledged that relational and discrete contract theories are not
entirely separate. [FN175] Significant
aspects of the contract-as- promise analysis acknowledge the relational
characteristics of modern contract law. [FN176]
Preservation of the relation is "an
intensification and expansion of the traditional norm of contractual
solidarity." [FN177] The preservation norm in relational contract theory
encompasses the reciprocity norm of traditional contract theory. This is so
because "contractual relations cannot continue without reciprocity." [FN178] Consideration is a manifestation of the reciprocity norm,
but it operates in the background of an ongoing contract relation. [FN179] Part III, F of this article reformulates some of these
relational theory value concepts into rules, at least in the form of rebuttable
presumptions.
Macneil identified labor and employment law
commentators Clyde Summers, Philip Selznick, and David Feller, among others, as
intellectual members of the relational contract school. [FN180] The Feller and
Cox formulations, for example, fit
comfortably into the Macneil formulation of relational contract. David Feller
noted the tendency of the United States Supreme Court to view collective
bargaining agreements as a kind of governmental code rather than as a contract,
[FN181] while acknowledging that some aspects of labor law
continue to embrace a contract notion. [FN182] He emphasized
that employers and unions do not write collective bargaining agreements
primarily as documents to be applied in court, [FN183] but rather to establish a system of ongoing rules to
govern the workplace. [FN184] Archibald Cox,
writing earlier, [FN185] agreed. [FN186] And, of
course, the Supreme Court's treatment of collective agreements as a kind of
"constitution" for the workplace in the Steelworkers Trilogy, [FN187] was a highly relational outlook.
Some anomalies in applying a classical
promise-based contract *716 theory to major employment contractual
controversies can be resolved by using the relational contract theory. For
example, an attractive feature of the relational theory for employment
contracts is the ease with which it accommodates the past practice concept in
interpreting collective bargaining agreements and statutory status quo
obligations under sections two and six, of the Railway Labor Act [FN188] and section
8(a)(5) of the National Labor Relations Act. [FN189] Under the
relational theory, the parties expect that the terms of their relationship will
evolve. There is no need for formalities to validate new practices to make them
part of the contract. If it is unobjectionable,
simply doing something becomes part of the contractual relationship and a
stronger obligation evolves the longer the action continues. The classical
contract-as-promise theory is able to accommodate this idea, but with more
difficulty. Classical and neoclassical theory use course-of-dealing and trade
usage as a means of interpreting the terms of pre-existing contracts. [FN190] The broad use of extrinsic evidence *717 is a
relational approach. [FN191] But this
interpretation approach has difficulty dealing with consensual practices that
deviate significantly from the express terms of the written instrument. It is
ironic to say that conduct "interprets" terms when it practically
rebuts express terms or dramatically changes them.
Consideration is obviously a reflection of
the reciprocity norm. The reciprocity norm in relational contracts is easily
satisfied. The fact that the parties deal with each other in the context of a
relationship is enough to give validity to the commitments they make to each
other.
The good faith and fiduciary obligation
concepts are an integral part of the relational theory, and therefore, they are
compatible. Under the relational theory, parties are obligated to behave in a
way that promotes the relationship, and in a way that is consistent with the
needs and expectations of both parties. This is a central concept of the
relational theory and a virtual restatement of the good faith idea. The
covenant idea is embodied in Macneil's preservation-of-the-relationship and
propriety-of-means norms. [FN192]
The author's main problem with the relational theory of contract is that it does not provide doctrinal rules to help decide cases. [FN193] In effect, the relational theory meshes the sharp distinctions of classical or neoclassical contract t