Nemec v. Shrader
991 A.2d 1120, 2010 WL 1320918 (2010)
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Rule of Law:
The implied covenant of good faith and fair dealing cannot be used to override the express terms of a contract. A party does not breach the covenant by exercising a clear and unambiguous contractual right, even if the timing is financially advantageous to that party and disadvantageous to the counterparty.
Facts:
- Joseph Nemec and Gerd Wittkemper were officers at Booz Allen and participated in the company's Stock Rights Plan.
- The Stock Plan provided that after an officer retired, they had a two-year 'put' right to sell their shares back to the company at book value.
- The Plan also gave Booz Allen the right to redeem a retired officer's stock at book value at any time after this two-year period expired.
- Nemec and Wittkemper retired on March 31, 2006, making their two-year put rights expire on March 31, 2008.
- In 2007, Booz Allen began negotiations to sell its government business division to The Carlyle Group for $2.54 billion.
- By early 2008, it was known that the sale would generate a price per share significantly higher than the book value.
- In April 2008, immediately after Nemec's and Wittkemper's put rights expired and while the Carlyle transaction was pending, Booz Allen exercised its contractual right to redeem their shares at the lower book value of approximately $162.46 per share.
- The sale to The Carlyle Group, which resulted in a value of over $700 per share, closed on July 31, 2008.
Procedural Posture:
- Joseph Nemec and Gerd Wittkemper filed consolidated actions against Booz Allen and its directors in the Delaware Court of Chancery.
- The defendants filed a motion to dismiss the complaint for failure to state a claim upon which relief could be granted.
- The Chancellor of the Court of Chancery granted the defendants' motion and dismissed the complaint in its entirety.
- The plaintiffs, Nemec and Wittkemper, appealed the dismissal to the Supreme Court of Delaware.
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Issue:
Does a company breach the implied covenant of good faith and fair dealing by exercising an express, unconditional contractual right to redeem a former employee's stock, even if the timing of the redemption is strategically advantageous to the company and prevents the former employee from sharing in the profits of a pending, lucrative corporate transaction?
Opinions:
Majority - Steele, Chief Justice
No. A company does not breach the implied covenant of good faith and fair dealing by exercising an express contractual right. The implied covenant is a limited legal remedy used to infer terms for developments or gaps that neither party anticipated; it cannot be used to override or rewrite express, bargained-for contract provisions. Nemec and Wittkemper received exactly what the Stock Plan entitled them to: the redemption of their shares at book value after their put rights expired. A party does not act in bad faith by relying on contract provisions for its own advantage. The court cannot reform a contract to rebalance economic interests, even if the outcome raises 'moral questions.' Furthermore, any fiduciary duty or unjust enrichment claims are foreclosed because the dispute arises from obligations expressly addressed by the contract.
Dissenting - Jacobs, Justice
Yes. A company can breach the implied covenant of good faith and fair dealing even when exercising an express contractual right if it does so arbitrarily or unreasonably. The exercise of a contractual right must further a legitimate interest of the party exercising it. Here, the complaint alleges that the redemption served no legitimate interest of Booz Allen as a corporate entity; its sole effect was to transfer approximately $60 million in value from the retired stockholders to the remaining working stockholders. Timing the redemption to occur just before the lucrative transaction closed, when waiting would have caused no prejudice to the company, was an arbitrary and unreasonable exercise of a contractual power, thus stating a cognizable claim for breach of the implied covenant.
Analysis:
This decision reinforces the narrow scope of the implied covenant of good faith and fair dealing in Delaware contract law, emphasizing its function as a gap-filler for unanticipated events rather than a tool for equitable reformation. It provides corporate actors with significant certainty that clearly drafted contractual rights, such as redemption clauses in stock plans, will be enforced as written, even if exercised opportunistically. The ruling solidifies the principle that where a contract governs a dispute, contract-based claims will take precedence, often foreclosing tort-based claims like breach of fiduciary duty that arise from the same set of facts.
