Drummond Coal Sales, Inc. v. Norfolk Southern Railway Co.
Published Opinion (2021)
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Rule of Law:
A party breaches the implied covenant of good faith and fair dealing when it exercises its contractual discretion in a manner that, while not expressly forbidden, deprives the other party of the essential benefit of the bargain.
Facts:
- Drummond Coal Sales, Inc. (Drummond), a coal supplier, entered into an Agreement with Norfolk Southern Railway Company (Norfolk Southern) to obtain guaranteed shipping services at fixed rates.
- The primary purpose of the Agreement for Drummond was to know its shipping costs in advance, allowing it to offer a single 'one-stop-shop' contract for both coal and transportation to utility companies.
- In exchange for the fixed rates, Drummond promised to ship a minimum annual tonnage of coal with Norfolk Southern or pay shortfall fees.
- The Agreement expressly permitted Norfolk Southern to maintain and enter into separate shipping contracts with third-party utility companies.
- After the Agreement was made, Norfolk Southern entered into or amended confidential contracts with certain utilities that imposed millions of dollars in liquidated damages on those utilities if they shipped coal under Drummond's Agreement.
- From 2010 to 2014, Drummond did not ship any coal under the Agreement and paid Norfolk Southern the required shortfall fees.
- For the years 2015 and 2016, Drummond again did not ship any coal under the Agreement but refused to pay the associated shortfall fees.
Procedural Posture:
- Drummond filed suit against Norfolk Southern in the U.S. District Court for the Western District of Virginia, seeking a declaratory judgment.
- After a jury trial, the jury returned a special verdict finding that Norfolk Southern materially breached the Agreement, with the first breach occurring on July 1, 2010.
- Norfolk Southern filed a motion for judgment as a matter of law (Rule 50(b)), which the district court denied, finding sufficient evidence supported the jury's verdict.
- The district court entered a judgment that excused Drummond from paying future shortfall fees but denied its request for rescission and recoupment of fees paid between 2010 and 2014.
- Drummond filed a motion to alter or amend the judgment (Rule 59(e)) to obtain a full refund of past fees, which the district court also denied.
- Norfolk Southern, as appellant, appealed the district court's denial of its motion for judgment as a matter of law to the U.S. Court of Appeals for the Fourth Circuit.
- Drummond, as appellee and cross-appellant, cross-appealed the district court's denial of complete rescission.
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Issue:
Does a party to a shipping contract breach the implied covenant of good faith and fair dealing by exercising its contractual right to enter into third-party contracts in a way that penalizes customers for using the other party's services, thereby defeating the essential purpose of the agreement?
Opinions:
Majority - Judge Quattlebaum
Yes, a party breaches the implied covenant of good faith and fair dealing by exercising contractual discretion in bad faith to deprive the other party of the benefit of its bargain. While Norfolk Southern did not expressly breach the contract's rate provision because Drummond never shipped coal, a reasonable jury could find it breached the implied covenant of good faith and fair dealing. The essential benefit of the Agreement for Drummond was the ability to offer a viable one-stop-shop contract using the fixed rates. By imposing substantial liquidated damages on utilities that chose to ship under Drummond's Agreement, Norfolk Southern exercised its contractual discretion to enter third-party contracts in bad faith, effectively rendering Drummond's benefit valueless. The court also affirmed the district court's denial of full rescission, finding it would be inequitable to force Norfolk Southern to repay past shortfall fees because Drummond had made a business decision to sell coal in more lucrative overseas markets and Norfolk Southern had partially performed its obligations.
Analysis:
This decision reinforces the strength of the implied covenant of good faith and fair dealing as a check on the bad-faith exercise of contractual discretion. It establishes that a party cannot use a contractually permitted action, such as entering third-party agreements, as a tool to sabotage the core purpose of its agreement with another party. The case also clarifies the distinction between seeking declaratory relief as a defense ('a shield') versus a claim for damages ('a sword'), noting that the former does not necessarily require proof of causation and damages. This precedent will guide courts in evaluating claims where a party's technically permissible actions effectively nullify the other party's contractual benefits.
