Chancery Sustains Founders’ Implied Covenant Claim For “Bad Faith” Termination To Deprive Them Of Contingent Compensation, Reasoning That Contracts Cannot Be Combined And Must Be Read On Their Own Terms, But The Implied Covenant May Provide Missing Terms

Morris James LLP

Servaas v. Ford Smart Mobility LLC, C.A. No. 2020-0909-LWW (Del. Ch. Aug. 25, 2021)

Delaware common law requires that contracts be read on their own terms.  Accordingly, contracts cannot be “combined” to supply missing terms.  However, the implied covenant and good faith and fair dealing can, in certain circumstances, supply these missing terms. 

Plaintiffs, founders of two companies providing computer-aided dispatch services for public transit systems, sold their companies to a subsidiary of Ford Motor Company. The transaction was structured through a series of agreements: a Stock Purchase Agreement (“SPA”), a Reallocation Agreement and Deferred Compensation Agreements (“DCA”) (together “Agreements”). Under each of the Agreements, the founder-plaintiffs were entitled to certain payments based, in part, on their continued employment in the post-transaction company. The DCAs further provided that if the founders’ termination was “for cause,” they would lose their entitlements. The SPA and Reallocation Agreement made no such distinction; they simply provided that the founders had to remain employees to receive payments. When each of the founders was terminated a month before they were owed additional compensation, they filed suit for, among other things, breaches of the Agreements and the implied covenant of good faith and fair dealing.

Plaintiffs argued their firings were a pretext to avoid the payments under the Agreements. The company moved to dismiss the breach of SPA and Reallocation Agreement claims because those agreements do not distinguish between termination for or without cause – if terminated, the founders lost their entitlements. Plaintiffs argued that all of the Agreements should be viewed as combined, and the “for cause” language from the DCAs modified the SPA and Reallocation Agreement. Following common law principles, the court held that all of the Agreements must be read on their own terms and could not be combined. The “for cause” language from the DCAs could not be read into the SPA or Reallocation Agreement. Under its gap-filling function, however, the implied covenant of good faith and fair dealing could imply terms into the SPA and Reallocation Agreement requiring that the founders’ termination not be in “bad faith.” Accordingly, the court dismissed the claims for breach of the express terms of the SPA and Reallocation Agreement, but it sustained claims for breaches of the implied covenant of good faith and fair dealing.

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