In Drafting Contracts, the Grant of Discretion Usually Wins the Day

12 Min Read By: Steven H. Sholk

The folk rock group The Mamas and the Papas’ first hit and Grammy Hall of Fame song, “California Dreamin’,” expressed the hopes and dreams of leaving behind the cold of a winter’s day for the warmth of Los Angeles.[1] Under a recent decision of the California Court of Appeal that reversed the judgment of an L.A. trial court, whether a hit song means that the songwriter realizes the hopes and dreams of the warmth of financially sharing in the song’s success, or bears the cold of a winter’s day in not so sharing,[2] turns on the grant of discretion in the songwriter’s contract with the music publisher.


In Gilkyson v. Disney Enterprises, Inc.,[3] the children of the late songwriter Terry Gilkyson sued Disney Enterprises, Inc. and its music publishing subsidiary, Wonderland Music Company, Inc. (collectively, “Disney”), over royalties for the use of Gilkyson’s songs in the home entertainment releases of the 1967 animated film, The Jungle Book. One of the songs was “The Bare Necessities,” a song that has warmed the hearts of children around the world, whose laughter then warmed the hearts of their parents.

In 1963, Gilkyson entered into a contract with Disney that provided for a royalty equal to 50% of the net amount received by the Disney music publisher on account of licensing or other disposition of the mechanical reproduction right in and to material written by Gilkyson.

In another section of the contract, Disney reserved all revenue and receipts received by and paid to Disney by virtue of the exercise of grand, dramatic, television, and other performance rights, including the use of the material in motion pictures, photoplays, books, merchandising, television, radio, and endeavors of the same or similar nature.

Finally, another section of the contract provided that Gilkyson had no interest in any of the material other than his right to receive the royalties specifically set forth in the contract. In addition, nothing contained in the contract was to be construed as obligating Disney “to publish, release, exploit or otherwise distribute any of the material, and the same shall be always subject to [Disney’s] sole discretion.”

The jury returned a verdict of $350,000 in favor of the Gilkyson children for Disney’s breach of the contract. The trial judge then awarded an additional $699,316.40 as damages for the period after the date of the verdict through the duration of the songs’ copyrights.

Disney appealed the trial court’s judgment. The California Court of Appeal reversed and held that, under the language of the contract, Disney did not have any obligation to pay royalties to the Gilkyson children during the contract’s limitations period. Since the Disney music publisher was not paid for digital downloads of the motion picture or other audiovisual reproductions, it did not receive any amounts for which royalties were due.

Furthermore, nothing in the contract required Disney to exploit the mechanical reproduction rights at all or, if it elected to do so, exploit them in any particular manner. Rather, exploitation of these rights was in Disney’s sole discretion. Accordingly, the Disney music publisher had the right to permit its home entertainment affiliate to use the songs without charging an intercompany license fee and without incurring any liability to Gilkyson. The court keenly observed, “Had the parties intended that Disney would use its best efforts to exploit the mechanical reproduction rights in a manner that generated royalties for Gilkyson, the contracts would not have expressly granted Disney such unfettered discretion.”[4]

Since the trial court had denied the Gilkyson children’s motion for leave to file a second amended complaint that would have added a cause of action for breach of the implied covenant of good faith and fair dealing, and their appeal did not raise this issue, the covenant was not before the Court of Appeal. However, the Court of Appeal rejected the Gilkyson children’s argument that several general provisions of California law required the payment of royalties. Their argument would effectively require the court to rewrite the express language of the contract, which granted Disney the sole discretion on how to exploit the rights it obtained from Gilkyson and limited his right to royalties to Disney’s net receipts. The court was not authorized to engage in such an endeavor.


The reasoning of the court in Gilkyson is not unique to the jurisprudence of California. Delaware, the venerable bastion of corporate law, has used similar reasoning in its jurisprudence. In Oxbow Carbon & Minerals Holdings, Inc. v. Crestview-Oxbow Acquisition, LLC,[5] the Delaware Supreme Court’s most recent guidance on the implied covenant of good faith and fair dealing, the court rejected the use of the covenant in the face of a grant of discretion.

In Oxbow Carbon, two minority investors, Crestview Partners, L.P. and Load Line Capital LLC, became members (the “Minority Members”) of Oxbow Carbon LLC (“Oxbow”) in 2007. Oxbow was the leading third-party provider of marketing and logistics services to the global petroleum coke market. Crestview made a $190 million capital contribution in exchange for a 23.48% membership interest, and Load Line made a $75 million capital contribution in exchange for a 9.27% membership interest.

The majority investor, Oxbow Carbon & Minerals Holdings, Inc. (“Oxbow Holdings”), made a $483,038,499.86 capital contribution in exchange for an almost 60% membership interest. Oxbow and Oxbow Holdings were controlled by William I. Koch. Several of Koch’s family members and affiliates also invested in Oxbow, which meant that the Koch group owned a combined 67% of Oxbow’s equity.

The Minority Members bargained for the following exit rights. First, they received a put right that could be exercised after seven years. Second, if Oxbow rejected the put, the party exercising the put could force an exit sale of all of Oxbow’s equity interests. However, a member could not be forced to sell its equity interest unless it received total distributions from operations and the exit sale was equal to or greater than 1.5 times the member’s aggregate capital contribution (the “1.5x requirement”). The LLC agreement provided that all distributions were to be made pro rata in accordance with each member’s percentage interest and that any exit sale must be on equal terms and conditions for all members.

In 2011 and 2012, Oxbow admitted additional minority members, Ingraham Investments LLC and Oxbow Carbon Investment Company LLC (collectively, the “Small Holders”). The Small Holders received a combined 1.4% membership interest. The members of Ingraham were members of Koch’s family, and the members of Oxbow Carbon Investment Company were executives of a large sulfur trading company acquired by Oxbow. Ingraham made a $20 million capital contribution, and Oxbow Carbon Investment Company made a $15 million capital contribution. Oxbow distributed approximately $8.2 million to Crestview and $3.2 million to Load Line from these capital contributions.

The board of directors of Oxbow unanimously approved the admission of the Small Holders, including the directors appointed by Crestview and Load Line, who otherwise had the right to block their admission. Although their admission did not comply with the LLC operating agreement’s preemptive rights provisions and the special approval requirements for related party transactions,[6] and the Small Holders did not deliver signed counterpart signature pages, the Court of Chancery found that in their course of dealing, the parties treated the Small Holders as members.

On September 28, 2015, Crestview exercised its put. When Oxbow rejected the put, on January 20, 2016, Crestview exercised its right to an exit sale. However, at the price offered by the bidder, the sale proceeds were insufficient to distribute to the Small Holders an amount equal to or greater than the 1.5x requirement.

Litigation then ensued. The Court of Chancery held that although the 1.5x requirement prevented an exit sale, under the implied covenant of good faith and fair dealing, the exit sale should go forward. Since the board of directors did not expressly determine the rights, powers, and duties of Small Holders at the time of their admission, in particular whether the Small Holders would have the benefit of the 1.5x requirement, there was a gap in the contractual rights of the Minority Members and Small Holders. According to the Court of Chancery’s summary judgment opinion, had the Minority Members realized that the Small Holders would have the ability to block an exit sale due to the 1.5x requirement, the Minority Members would not have consented to their admission. In addition, had the parties recognized this gap, they most likely would have agreed that the Minority Members could satisfy the 1.5x requirement by making additional payments to the Small Holders from the proceeds the Minority Members received from the sale.

The Delaware Supreme Court reversed and held that there was no gap and the implied covenant of good faith and fair dealing did not apply. Therefore, under the plain language of the LLC operating agreement, the Small Holders had the benefit of the 1.5x requirement and could block the exit sale.

Under the LLC agreement, the terms of admission of new members were left to the discretion of the board of directors.[7] Since the board chose not to specify different rights for the Small Holders, the terms of the LLC agreement applied with equal force to them. The court would not imply new contract terms merely because the contract granted discretion to a board of directors.[8] Conferring discretion on the board was a contractual choice to grant authority to the board and not a gap. Although the grant of discretion did not relieve the board of its obligation to use that discretion consistent with the implied covenant of good faith and fair dealing, the Minority Members did not argue that the board exercised its discretion in bad faith in admitting the Small Holders.

The court found that in light of the absence of a gap, and since the admission of new members and its effect on the exit sale process could have been anticipated, the court would not apply the covenant. The court observed that the parties could have limited the 1.5x requirement to certain members, excluded subsequently admitted members, amended the exit sale right to permit distributions by Oxbow to the Small Holders to satisfy the 1.5x requirement before distributions were made pro rata to the members, or amended the exit sale right to permit the Minority Members to make payments to the Small Holders to satisfy the 1.5x requirement.

The court then described the limited use of the implied covenant of good faith and fair dealing. The covenant was a cautious enterprise best understood as a way of implying terms in a contract, whether employed to analyze unanticipated developments or to fill gaps in the contract. It was not an equitable remedy for rebalancing economic interests after events occurred that could have been anticipated but were not, which later adversely affected a party to the contract. Rather, the covenant was a limited and extraordinary legal remedy.

The covenant did not apply when the contract addressed the conduct at issue, but only when the contract was truly silent concerning the matter at hand. Even when the contract was silent, an interpreting court could not use an implied covenant to rewrite the parties’ agreement and should be most chary about applying a contractual protection when the contract could easily have been drafted to expressly provide for that protection.

Finally, the court pointed out the two situations in which the covenant generally would apply. First, a situation has arisen that was unforeseen by the parties, and the agreement’s express terms do not cover what should happen. Second, a party to the contract is given discretion to act as to a certain subject, and the discretion has been used in a way that is impliedly proscribed by the contract’s express terms.


The takeaway from Gilkyson and Oxbow Carbon is that in drafting contracts, the grant of discretion usually wins the day. If a party wants to avoid or lessen the risk of another party’s exercise of discretion to deprive it of a benefit, then to the extent that the party has the leverage, it should bargain for the contract to clearly set forth nondiscretionary obligations of the other party or well-defined parameters on the other party’s exercise of discretion. To rely on the implied covenant of good faith and fair dealing is likely no more than a vain hope and dream.

[1] The Mamas and the Papas, “California Dreamin’,” Music and lyrics by John E.A. Phillips and Michelle Gilliam Phillips, on If You Can Believe Your Eyes and Ears (Dunhill 1966).

[2] Cf. Gladys Knight & the Pips, “Midnight Train to Georgia,” Music and lyrics by Jim Weatherly, on Imagination (Buddah 1973) (“L.A. proved too much for the man (too much for the man, he couldn’t make it). So he’s leaving a life he’s come to know, ooh (he said he’s going). He said he’s going back to find (going back to find), ooh, what’s left of his world, the world he left behind not so long ago. . . . He kept dreaming (dreaming), ooh, that someday he’d be a star (a superstar, but he didn’t get far). But he sure found out the hard way that dreams don’t always come true, oh no, uh uh (dreams don’t always come true, uh uh, no, uh uh). So he pawned down his hopes (woo, woo, woo-woo), and even sold his old car (woo, woo, woo-woo). Bought a one way ticket back to the life he once knew, oh yes he did, he said he would.”).

[3] 2021 WL 3075699 (Cal. Ct. App. July 21, 2021).

[4] 2021 WL 3075699, at *11.

[5] 202 A.3d 482 (Del. 2019) (en banc) (Valihura, J.).

[6] The LLC operating agreement provided for the admission of new members “on such terms and conditions as the Directors may determine at the time of admission. The terms of admission may provide for the creation of different classes or series of Units having different rights, powers and duties.”

[7] See also Kenneth A. Adams, A Manual of Style for Contract Drafting 3.188 (ABA 4th ed. 2017) (“Discretion is primarily conveyed by means of may, which expresses permission or sanction.”).

[8] See also Mohsen Manesh, “Express Contract Terms and the Implied Contractual Covenant of Delaware Law,” 38 Delaware Journal of Corporate Law 1, 35 (2013) (“[W]hen the express terms of a contract unambiguously grant one party unfettered, sole, and absolute discretion, the court will readily construe the express terms to permit the discretion-exercising party to act under any circumstances and for any reason, free of judicial intervention. It is because the Implied Covenant notwithstanding, such language in the contract permits only that reasonable expectation.”) (footnote omitted).

By: Steven H. Sholk

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