Is New York ‘Reimagining’ the Implied Covenant of Good Faith and Fair Dealing?

This article is Part XII of the Musings on Contracts series by Glenn D. West, which explores the unique contract law issues the author has been contemplating, some focused on the specifics of M&A practice, and some just random.

New York courts have a justifiable reputation for enforcing sophisticated commercial agreements in accordance with their terms. As stated clearly by the New York Court of Appeals in 2019: “In keeping with New York’s status as the preeminent commercial center in the United States, if not the world, our courts have long deemed the enforcement of commercial contracts according to the terms adopted by the parties to be a pillar of the common law.”^[1] And as stated more recently by another New York court:

Freedom of contract, particularly between sophisticated commercial actors, dealing at arm’s length, is an important right, and, “[a]bsent some violation of law or transgression of a strong public policy, the parties to a [commercial] contract are basically free to make whatever agreement they wish, no matter how unwise it might appear to a third party.” . . . Where a contract was negotiated and relied upon by experienced, sophisticated business actors represented by counsel, the parties are entitled to the commercial certainty that flows from enforcing the plain meaning of their unambiguous agreement.^[2]

New York has also long recognized, however, that “in every contract there is an implied covenant that neither party shall do anything which will have the effect of destroying or injuring the right of the other party to receive the fruits of the contract, which means that in every contract there exists an implied covenant of good faith and fair dealing.”^[3]

But the implied covenant “is not without limits”; it operates solely “in aid and furtherance of other terms of the agreement,” and “it cannot be used to ‘imply obligations inconsistent with other terms of the contractual relationship.’”^[4] Equally importantly, a breach of the implied covenant is simply a breach of the underlying contract, not an independent tort claim.^[5]

Nevertheless, has a recent decision from the New York Court of Appeals (decided by a 4–3 majority), 111 West 57th Investment LLC v. 111 W57 Mezz Investor LLC,^[6] “reimagined” the implied covenant and cast doubt on New York’s historically reliable contractarian bent?

A Crack in New York’s Contractarianism?

According to New York Court of Appeals Judge Garcia, in his dissent in 111 West 57th Investment, the answer is decidedly yes:

Prior to today’s decision, a party in plaintiff’s situation seeking to invoke the implied covenant of good faith and fair dealing had a high bar to clear, as New York courts interfered with the freedom of contract between well-represented parties in complex commercial transactions only in the most extraordinary circumstances. No longer. Instead, the majority, analogizing the parties to the junior mezzanine financing agreement at issue here to a city agency hiring a painting company and a student signing up to take a standardized test, holds that the covenant may be used to rewrite the specific terms of a multi-million-dollar construction loan agreement contract based on a court’s notion of fair play. . .

This majority’s reimagining of New York law will disrupt the expectations of contracting commercial parties, making uncertain the rights and liabilities in billions of dollars of outstanding loan agreements, and may well affect whether similarly situated parties will choose to subject themselves to New York law.^[7]

Whoa! And two other judges joined in this dissent.

The majority opinion (written by Chief Judge Wilson and joined by three other judges) disagrees and suggests that its holding is in the mainstream of implied covenant jurisprudence when applied to discretionary acts—in this case, a lender’s decision to assign a portion of its outstanding loan to a third party, in circumstances alleged to have been in bad faith and designed to deprive one of the borrower’s major investors of its equity by inducing the borrower’s manager to acquiesce in a strict foreclosure. According to the majority, “[e]ven if [the lender] had the sole discretion to assign the junior mezzanine loan, doing so as part of an alleged backdoor deal to appropriate the value of plaintiff’s equity by conspiring with others to facilitate the scheme states a legally cognizable claim for breach of the implied covenant.”^[8]

It is important to note, however, that the alleged scheme here was not an alleged civil conspiracy, which requires an underlying tort claim;^[9] an alleged aiding and abetting of a breach of fiduciary duty (here, the applicable fiduciary duties appear to have been waived);^[10] or a tortious interference with contract, which had been dismissed because both the assigning lender and the assignee “had ‘a right to protect [their] own legal and financial stake in the breaching party’s business’ and plaintiff failed to alleged that either [the lender or the assignee] took actions that ‘were motivated by malice, fraud, or illegal means.’”^[11]

But let’s get into the alleged facts, or at least attempt to do so (the alleged facts in this matter are complex, have been the subject of several lawsuits against various defendants, and involve numerous claims).

Case Facts

Steinway Tower Ownership and Financing

The plaintiff in this case was 111 West 57th Investment LLC. The plaintiff was one of the principal equity investors in the development of 111 West 57th Street (also known as “Steinway Tower”), an ultra-luxury residential condominium in New York City (“Project”) and the skinniest skyscraper in the world. There were two other investors; one of the other investors (“Sponsor”) was “a special purpose vehicle by which the Project’s developers invested in and managed the Project.”^[12] The three investors formed a Delaware limited liability company, 111 West 57th Partners LLC (which the court referred to as the “Joint Venture”), and entered into an LLC agreement (which the court referred to as the “JVA”).^[13] Importantly, in the JVA, “Sponsor was designated the manager and was vested with ‘day-to-day authority to act for the Company,’ subject to certain ‘Major Decisions’ requiring plaintiff’s prior written consent, including ‘any financing or refinancing.’”^[14] And, “[t]he JVA also contained an expansive ‘Waiver of Fiduciary Duties’ clause.”^[15]

The Joint Venture borrowed $725 million to finance the Project, $325 million of which was provided as a nonrecourse junior mezzanine loan (“Mezz Loan”) by entities affiliated with Apollo (“Mezz Lenders”). The Mezz Loan was secured by a pledge of the equity interests in the entity owning the Project. The remaining $400 million was a traditional nonrecourse mortgage loan provided by a group of mortgage lenders (“Mortgage Lenders”) secured by the Project itself (“Mortgage Loan”).^[16]

To have some appreciation of what happened next, it is important to understand the ownership structure: The Joint Venture wholly owned a subsidiary called 111 West 57th Mezz 1 LLC (“Junior Mezz Borrower”),^[17] which in turn wholly owned 111 West 57th Holdings, LLC (“Senior Mezz Borrower”), which in turn wholly owned 111 West 57th Property Owner LLC (“Mortgage Borrower”). It appears that the Senior Mezz Borrower was the sole borrower on the original Mezz Loan, which was secured by a pledge of its equity in the Mortgage Borrower.

The Forbearance Agreement

As is common in construction projects, there were “budget overruns,” and the Mezz Loan apparently went into “technical default” by being “out of balance.”^[18] To get back into balance required an additional infusion of capital. What happened next is a bit fuzzy and will ultimately be the subject of a trial.

At some point, given the ongoing default resulting from the failure to contribute the additional funds needed to bring the Mezz Loan back into balance, the Sponsor, apparently exercising its authority as manager of the Joint Venture, entered into a forbearance agreement with the Mezz Lenders.^[19] Importantly, the default on the Mezz Loan was also a default under the Mortgage Loan—meaning the Mezz Lenders were at risk of the Mortgage Lenders foreclosing upon the Mortgage Loan, which, being senior to the Mezz Loan, could negatively affect the Mezz Lenders’ ultimate recovery on the Mezz Loan.^[20] And the sole means for the Mezz Lenders to recover the loan proceeds appears to have been the equity in the Project.

At the same time the forbearance agreement was being entered into, the Mezz Lenders appear to have “exercised [their] contractual right under the operative loan agreement to ‘modify, split and/or sever any portion of the Loan,’” by requiring that the Mezz Loan be split into two pieces: a $300 senior mezzanine loan (“Senior Mezz Loan”) and a $25 million junior mezzanine loan (“Junior Mezz Loan”).^[21]

The borrower of the Junior Mezz Loan then became the Junior Mezz Borrower, but the security for the Junior Mezz Loan now became a pledge of the Junior Mezz Borrower’s equity in the Senior Mezz Borrower (which, of course, structurally subordinated the Junior Mezz Loan to the Senior Mezz Loan). The borrower of the Senior Mezz Loan remained the Senior Mezz Borrower, and the Senior Mezz Loan continued to be secured by the Senior Mezz Borrower’s equity in the Mortgage Borrower.^[22] The individual owners of the Sponsor also entered into a guaranty “under which they would become personally liable to repay the Junior Mezzanine Loan if any of them attempted ‘in bad faith . . . to materially delay any foreclosure against the Collateral, or any other exercise by Lender of its remedies under the Loan Document.’”^[23]

Apparently, the Mortgage Loan and the intercreditor agreement between the Mortgage Lender and the Mezz Lenders were also amended in connection with the forbearance agreement. The amended intercreditor agreement restricted the Mezz Lenders’ ability to foreclose on their equity pledges unless they could “locate a new developer within sixty days of a foreclosure, and [] recommence construction under a new construction manager within thirty days of foreclosure.”^[24]

The amended intercreditor agreement also required the Mortgage Lender’s approval of the identities of the developers and construction managers and provided a list of those likely acceptable to the Mortgage Lenders, but that list did not include the Sponsor or its individual owners.^[25] But ultimately, the original developer did apparently come back into the deal.^[26]

The Alleged “Backroom Deal”

The plaintiff alleged that “during the forbearance period,” the Mezz Lenders, the Mortgage Lender, and the Sponsor “negotiated a secretive ‘backroom deal’” to bring in additional equity investors and “extinguish [p]laintiff’s equity.”^[27] The alleged plan was for new investors to invest in a new entity (“New Junior Mezz Lender”) that would acquire the Junior Mezz Loan from the Mezz Lenders (for its face amount of $25 million), which would then be strictly foreclosed upon and result in the New Junior Mezz Lender owning the Junior Mezz Borrower. As a result, all of the existing investors’ equity would be wiped out (which obviously included not only the plaintiff’s equity, but the Sponsor’s and all other existing investors’ equity as well), while the Senior Mezz Loan and the Mortgage Loan would remain in place.^[28] Apparently, the new investors were then expected to invest some additional capital beyond the amount required to purchase the Junior Mezz Loan. And there were allegedly projections provided by the Mezz Lenders indicating that the return on the new investors’ capital infusion would be significant.^[29] Presumably, these projections were based on a completed building and sales of the condominiums in that completed building, which apparently required additional capital to complete.

Shortly before the end of the forbearance period, the Mezz Lenders assigned the Junior Mezz Loan to the New Junior Mezz Lender, with the Mortgage Lender’s approval. Favorable amendments to the intercreditor agreement were also made. Within a short time after that, the New Junior Mezz Lender sent a notice of default and a strict foreclosure notice to the Junior Mezz Borrower pursuant to section 9-620 of New York’s Uniform Commercial Code.^[30] The Sponsor apparently provided the plaintiff with a copy of the notice. And, “[p]ursuant to UCC 9-620, the Junior Mezz Borrower had twenty days to object to the strict foreclosure.”^[31]

The plaintiff objected to the Sponsor acquiescing in the strict foreclosure as the manager of the Joint Venture, which was presumably the sole member of the Junior Mezz Borrower, and wanted the Sponsor to instead insist on a traditional foreclosure—the idea being that in a strict foreclosure, the New Junior Mezz Lender would receive the collateral in satisfaction of the Junior Mezz Loan, whereas in a traditional foreclosure, the New Junior Mezz Lender would conduct an actual foreclosure sale and any excess proceeds over the amount required to satisfy the Junior Mezz Loan might be paid to the Junior Mezz Borrower. The plaintiff claimed that this was a “Major Decision” requiring the plaintiff’s approval and, apparently, that the Sponsor was subject to an implied covenant not to acquiesce in the strict foreclosure in any event.^[32]

The Sponsor refused to object to the proposed strict foreclosure on behalf of the Junior Mezz Borrower, and the plaintiff filed an action to prevent it. But the trial court ruled that the plaintiff lacked standing, and the strict foreclosure proceeded, resulting in the New Junior Mezz Lender acquiring, in satisfaction of the $25 million Junior Mezz Loan, all of the equity of the Senior Mezz Borrower, subject to the Senior Mezz Loan and the Mortgage Loan. And sometime thereafter, additional investments were made in the Joint Venture or its subsidiaries, resulting in the original developers who owned the Sponsor once again having an ownership stake in the Project.^[33]

The Lawsuits

While the consummation of the strict foreclosure mooted the plaintiff’s effort to prevent it, the plaintiff amended its complaint to assert damage claims against the Sponsor, the Mezz Lenders, and the New Junior Mezz Lender. One of the plaintiff’s claims was that the Mezz Lenders and the New Junior Mezz Lender had tortiously interfered with the plaintiff’s rights under the JVA (by inducing the Sponsor not to object to the strict foreclosure). But the trial court dismissed that claim, apparently concluding that the decision not to object to the strict foreclosure was not a Major Decision and that, even if the Sponsor had an implied good faith obligation to object to the strict foreclosure, the Mezz Lenders and the New Junior Mezz Lender had “a right to protect [their] own legal and financial stake in the breaching party’s business” absent “a showing of either malice on the one hand, or fraudulent or illegal means on the other.”^[34] According to the trial court, “malice, fraud or illegal means go beyond allegations of intentional bad faith acts.”^[35]

Another of the plaintiff’s claims was that the Sponsor had breached its fiduciary duties to the plaintiff as the manager of the Joint Venture (and presumably that the Mezz Lenders or the New Junior Mezz Lender had participated in that breach). But that claim was dismissed because the JVA was a Delaware LLC, and Delaware law permits broad waivers of fiduciary duties in a limited liability agreement. Apparently, section 8.5 of the JVA did exactly that.^[36]

The plaintiff also filed a derivative claim on behalf of the Joint Venture against the New Junior Mezz Lender, asserting that it violated the covenant of good faith and fair dealing under the pledge agreement when exercising its “discretion” to strictly foreclose—allegedly having induced the Sponsor “into giving away the company’s right to a sale by auction, which gutted the value received by the company.”^[37] This claim is apparently still pending and was not involved in the Court of Appeals’ decision.^[38]

But the plaintiff additionally filed a derivative claim on behalf of the Joint Venture against the Mezz Lenders, asserting that the Mezz Lenders’ exercise of their discretion to assign the Junior Mezz Loan to the New Junior Mezz Lender violated the implied covenant of good faith and fair dealing as applied to the pledge and loan agreement governing the Junior Mezz Loan. Although this claim survived a motion to dismiss at the trial court, the Appellate Division disagreed, holding:

[T]he Apollo Lenders had the right to assign the Junior Mezzanine Loan. The relevant loan agreement and pledge agreement, when read together, conferred considerable discretion to the Apollo Lenders. Because Apollo had the absolute right to assign the Pledge Agreement in its sole discretion under the loan documents, there can be no implied covenant claim against them.^[39]

The Court of Appeals’ Approach to the Implied Covenant

The Appellate Division’s holding regarding the nonexistence of an implied covenant claim based on the exercise of the Mezz Lenders’ express contractual right to assign the Junior Mezz Loan was then appealed to the Court of Appeals, and this is where the fireworks occurred.

The majority opinion described the issue as follows:

[P]laintiff alleges that [the Mezz Lenders] violated the implied covenant under the Pledge Agreement by assigning the junior mezzanine loan to [the New Junior Mezz Lender] as a part of a “backroom deal” intended to push plaintiff out of the Project’s capital structure and benefit from the windfall of equity that would flow to [the New Junior Mezz Lender] (and others, including [the Mezz Lenders]) thereafter. Assuming without deciding that [the Mezz Lenders] had “sole discretion” to assign to the junior mezzanine loan under the terms of the Pledge Agreement and Loan Agreement, we disagree with the Appellate Division’s conclusion that such discretion exculpated [the Mezz Lenders] from the implied covenant. We instead hold that the second amended complaint sufficiently alleged a claim against [the Mezz Lenders] for breach of the implied covenant.^[40]

Acknowledging that there was a split in authority among the various Appellate Division departments on the issue of whether there can be a breach of the implied covenant if the contract grants a party “sole discretion,” the majority of the Court of Appeals held that merely using the term sole discretion does not eliminate the implied covenant:

Accordingly, the implied covenant obligates the party with discretion [to] act in good faith, and “not [] arbitrarily or irrationally,” when “exercising that discretion.” A promisor’s discretion may not be used to violate a promise that “a reasonable person in the position of the promisee would be justified in understanding w[as] included.”^[41]

The dissent did not disagree with the general principle that merely using the term sole discretion did not necessarily eliminate the possibility of an implied covenant constraining the unfettered exercise of that discretion. But Judge Garcia argued:

The relevant assignment clause permits [the Mezz Lenders], in [their] sole discretion, to assign the loan and reduce or eliminate risk, with certain bargained-for limits on that right. The parties negotiated two schedules of “prohibited transferees”; one effective prior to any default with a list of seven entities and one effective after any default that reduces that number to three.^[42]

And those bargained-for limits on the persons to whom the loan can be assigned are the bargained-for constraints on the implied covenant’s operation within the discretion granted to the Mezz Lenders to assign the Junior Mezz Loan.^[43] Thus, the Mezz Lenders’ “exercise of its discretion in assigning the loan to the [New Junior Mezz Lender], an entity not specifically prohibited from receiving the loan, did not deprive Borrower of the bargained-for limitations on transfer of the loan.”^[44]

The majority countered:

It does not matter if the parties already negotiated certain restrictions with respect to a party’s sole discretion because the implied covenant’s very purpose is to cover that which is not anticipated and yet incompatible with the object of the contract when viewed as a whole, regardless of that sole discretion.^[45] . . .

[T]he fact that the parties identified and agreed to certain entities to whom the loan could not be assigned does not suggest that the parties thereby authorized [the Mezz Lenders] to assign the loan to anyone else for a fraudulent purpose or in bad faith, which is what the plaintiff alleges.^[46]

The majority also argued that their position on the implied covenant’s application to a discretionary right was consistent with Delaware law.^[47]

New York Appears to Have a Broader Concept of the Implied Covenant Than Delaware

It is true that Delaware law similarly suggests that simply modifying the grant of discretionary authority with the word sole does not eliminate the implied covenant’s application to the exercise of that “sole discretion.”^[48] Instead, something more is required.^[49] “But ‘if the scope of discretion is specified, there is no gap in the contract as to the scope of the discretion, and there is no reason for the Court to look to the implied covenant to determine how discretion should be exercised.’”^[50]

And even when the implied covenant applies to a discretionary right, it simply prevents the holder of the right from acting maliciously to destroy the fruits of the bargain for its counterparty without any “contractually grounded” justification.^[51] “An obligation to act in the best interests of another party is a fiduciary duty, not a contractual one.”^[52] A party can exercise a discretionary contractual right to protect its own contractual interests, even if doing so is detrimental to the other party. But it cannot exercise those discretionary rights solely to harm the other party.^[53] In Delaware:

The implied covenant of good faith and fair dealing is the doctrine by which Delaware law cautiously supplies terms to fill gaps in the express provisions of a specific agreement. Despite the appearance in its name of the terms “good faith” and “fair dealing,” the covenant does not establish a free-floating requirement that a party act in some morally commendable sense. Nor does satisfying the implied covenant necessarily require that a party have acted in subjective good faith.^[54]

In 111 West 57th Investment, the assignment provision limiting to whom the loan could be assigned was clearly for the borrower’s benefit and set the limits of that restriction. But the general provision stating that an assignment to anyone else was permitted in the lender’s sole discretion was for the lender’s benefit, not the borrower’s benefit. For the borrower, the fruits of the pledge agreement were forbearance from foreclosure for a specified period, subject to bargained-for restrictions on the persons to whom the loan could be assigned. For the lender, the fruits of the pledge agreement were security for the repayment of the Junior Mezz Loan, which, except for the guaranty provided by the Sponsor’s owners, was nonrecourse. That was the bargain.

This assignment provision was not a clause granting the Mezz Lenders discretion over the borrower’s right to assign its obligations to a purchaser of the Project, where the issue of exercising that discretion reasonably would normally arise. Obviously, the Mezz Loan had been split into a smaller Junior Mezz Loan to provide flexibility for the Mezz Lenders in realizing on its sole collateral—the equity interests in the chain of companies that ultimately owned the Mortgage Borrower. And in the absence of the bargained-for restriction in favor of the borrower, the loan would have been freely assignable by the lender in any event.^[55] And even without the assignment, the Mezz Lenders had the right to initiate a strict foreclosure on the pledge securing the Junior Mezz Loan and to attempt to accomplish the objective that was in its best interest, given that the Mezz Lenders’ ability to recover on its loans was subject to the Mortgage Loan.

The sole issue on appeal was whether the plaintiff had stated a sufficient claim that the Mezz Lenders had breached the implied covenant in the pledge agreement securing the Junior Mezz Loan when the assignment was made to the New Junior Mezz Lender. It was not a question of whether the plaintiff had stated a sufficient claim against the Sponsor, alleging that the Sponsor had breached its implied covenant in the JVA by failing to object to the strict foreclosure. Nor whether the New Junior Mezz Lender had in fact induced the Sponsor to fail to object to the strict foreclosure in violation of the implied covenant applicable to the Sponsor’s discretionary powers as the manager of the JVA.^[56] Nonetheless, the majority stated that “[e]ven leaving the assignment aside, the complaint’s remaining allegations sufficiently allege a scheme to induce the [borrower’s manager] to refuse to object to the strict foreclosure, and sufficiently allege [the Mezz Lenders’] involvement in that scheme.”^[57]

But how can an alleged participation in an alleged scheme to induce a breach of an implied covenant (which is a contract claim, not a tort claim) be cognizable if such participation in such a scheme failed to qualify as tortious interference? After all, the majority “affirmed the dismissal of the tortious interference claims against both [the Mezz Lenders and the New Junior Mezz Lender] on the ground that they were insufficiently pleaded.”^[58]

And isn’t the induced breach of the implied covenant, as thus described by the majority, an implied covenant in the borrower’s Delaware law–governed LLC agreement, not the pledge agreement? If so, is that not a claim for tortious interference by the Mezz Lenders with the borrower’s LLC agreement (which has apparently been dismissed)? If not, is the majority’s formulation of the plaintiff’s claim a way of invoking the implied covenant as a repackaged version of an aiding and abetting of a breach of fiduciary claim (which was effectively waived under Delaware law)? Under Delaware law, “[r]especting the elimination of fiduciary duties requires that courts not bend an alternative and less powerful tool [i.e., the implied covenant] into a fiduciary substitute.”^[59]

The fact that New York’s LLC law is more limited in its statutory authority to permit parties to waive fiduciary duties in alternative entities^[60] does not change the fact that Delaware, the law under which the Joint Venture was established, broadly permits such waivers, subject only to an ongoing obligation of good faith and fair dealing.^[61] And the contours of that ongoing obligation of good faith and fair dealing respecting the “internal affairs” of a Delaware entity should be established based on Delaware’s approach to the implied covenant, not New York’s seemingly now-broader approach.^[62]

There appears to be ongoing litigation of other claims against other defendants that do not invoke the implied covenant in the potentially troubling context of a lender’s decision to assign its loan in a manner that did not violate the express terms of the loan and equity pledge agreement.

Let’s Ask Captain Obvious

The majority opinion suggests that its approach to the implied covenant, as applied to the exercise of discretionary rights to assign a pledge agreement, is consistent with Delaware law.^[63] But recent Delaware decisions have looked to English law and the “officious bystander test” as a convenient means of assessing whether the implied covenant should supply an implied term to fill a gap in the express terms of an agreement.^[64] And that includes gaps created by grants of discretionary rights (to the extent that this particular right of the Mezz Lenders to assign to anyone to whom an assignment was not expressly prohibited can even be categorized as a discretionary right).

While English law has not conceptually embraced the implied covenant of good faith and fair dealing, it does, when necessary, cautiously imply terms in a manner not dissimilar to the limited gap-filling approach that the Delaware courts use in applying the implied covenant. As described by a recent Delaware Chancery Court decision:

[U]nder English law, “a term should not be implied into a detailed commercial contract merely because it appears fair or merely because one considers that the parties would have agreed [to] it if it had been suggested to them.” The term must also “be so obvious as to go without saying or to be necessary for business efficacy.”^[65]

And English law also supplies a convenient approach to determining when a term is “so obvious as to go without saying”—the “officious bystander test.”^[66] That test asks whether “if, while the parties were making their bargain, an officious bystander were to suggest some express provision for it in their agreement, they would testily suppress him with a common ‘Oh, of course!’”^[67]

This officious bystander is the English equivalent of our “Captain Obvious”—i.e., the person who makes those ridiculously obvious statements that prompt those who hear them to reply unanimously with “Thank you, Captain Obvious,” or sometimes with an even more colorful phrase that begins with the word “no,” followed by a scatological reference, and ending with the name “Sherlock.”

So, if an officious bystander had suggested to the parties negotiating the pledge agreement securing the Junior Mezz Loan that there be an express provision prohibiting the Mezz Lenders from assigning the Junior Mezz Loan to a third party “as part of a backdoor deal to appropriate the value of plaintiff’s equity by conspiring with others to facilitate that scheme,” would the parties have unanimously answered “Oh, of course”? I think not.

While the Junior Mezz Borrower, acting through the Sponsor, may have been indifferent, the Mezz Lenders might well have replied:

Wait a minute. What does that even mean? Does a foreclosure constitute a scheme? Isn’t the whole idea behind a foreclosure of an equity pledge to appropriate the value associated with the pledged equity to ensure repayment of our loan? We have even negotiated a personal guaranty to ensure that the Sponsor’s owners are at risk if they interfere with a foreclosure. We are entitled to foreclose right now. The borrower is in default; we are junior to the Mortgage Loan, and they have demanded that we find a new developer to get the Project back on track. We are offering the borrower a forbearance to provide time to get the Project back on track. And we are exercising our rights to split the loan to provide us flexibility in any foreclosure scenario, and we will undoubtedly assign the Junior Mezz Loan to another party as part of using that flexibility to foreclose on only a portion of the Mezz Loan and leave the remaining portion outstanding in our favor, all while fulfilling the obligations we have now had to undertake to the Mortgage Lender. So, “No, of course not!”

Or, as one Delaware Court of Chancery decision suggested would be the result of a similar question regarding an implied term that a plaintiff alleged was required by the implied covenant, there would have been no “Oh, of course” response by the parties. Instead, “[a]t best, further negotiation would have ensued. It is therefore not reasonably conceivable that the implied covenant can support the implicit [rights suggested by the plaintiff].”^[68]

But the majority did not approach the implied covenant in this manner. Instead of asking what the parties to the pledge agreement (the Junior Mezz Borrower and the Mezz Lenders) would reasonably have understood the agreement might include by way of an implied term, the majority looked to what the plaintiff would have understood. The plaintiff, however, was not a party to the pledge agreement and would not have been there to hear the officious bystander offer the express term and be in a position to answer with the other negotiating parties, “Oh, of course.” Instead, looking to what a nonparty to the pledge agreement would have reasonably concluded, the majority held:

At bottom, accepting the second amended complaint’s allegations as true and making all reasonable inferences from those allegations in plaintiff’s favor, the pleading is sufficient to state a claim that Apollo breached the implied covenant in the Pledge Agreement. The purpose of the Pledge Agreement was to facilitate the forbearance of the original mezzanine loan from Apollo, such that the construction of the Project could continue and that the Joint Venture’s equity investment in the Project, including plaintiff’s $65 million investment, remained unimpaired. The Pledge Agreement and Loan Agreement were intertwined. As such, a reasonable party in plaintiff’s position would have understood that the Pledge Agreement included a promise by Apollo not to use its discretion under the Pledge Agreement to collude in a “backdoor deal” that stripped plaintiff of its position as an equity participant in the Project—the very equity the forbearance agreement was intended to protect. By implying such a promise, we recognize an obligation that was implicit in the Pledge Agreement. Allegations of this kind, which deprive parties of the benefits of the contract, are precisely what the implied covenant is intended to safeguard against.^[69]

The facts in this case are so complex and difficult to pin down that it is perhaps understandable that the majority wanted those facts more fully developed at trial and the case not decided simply on the pleadings. But the only claim here, it seems, was the implied covenant claim arising under the pledge agreement against the Mezz Lenders by virtue of the assignment of the Junior Mezz Loan to the New Junior Mezz Lender—not the implied covenant claim that also exists pursuant to Delaware law under the JVA. And the normal purpose of a pledge agreement is to secure a loan made, not to ensure that the pledged equity interests “remain unimpaired.”^[70]

Even if something untoward occurred here and the plaintiff suffered harm, it is important that a legally cognizable claim be used to address that harm.^[71] It is not clear that the pledge agreement itself is the place to find the implied covenant to address that presumed harm. And the implied covenant cannot be the means of redressing every alleged injury arising out of a contractual relationship that is not addressed by the express terms. To allow the wrong legal theory to address a perceived harm can have “ramifying consequences, like the rippling of the waters, without end.”^[72]

Concluding Thoughts

In a prior piece on the implied covenant,^[73] I suggested that Texas may have overreacted by rejecting the implied covenant of good faith and fair dealing outright.^[74] Specifically, I suggested that when the Texas Supreme Court declared that such a “novel concept . . . would . . . let each case be decided on what might seem ‘fair’ and in ‘good faith’ by each fact finder,”^[75] it was describing and rejecting the utopian vision of the implied covenant, not the more practical gap-filling version that simply implies obvious terms necessary to give business effect to the other express terms of an agreement—in other words, the version of the implied covenant that is applied in Delaware and that I believe was also applied in New York. But the dissent in 111 West 57th Investment noted Texas’s position and suggested that Texas’s position had, in fact, been unfounded until the majority decision in this case because the implied covenant had been so cautiously applied.^[76] But perhaps no more?^[77]

There are legitimate transactions structured every day that adhere to the express terms of written agreements governed by New York law, and, in connection with them, consideration is given to the implied covenant in its limited (and rarely used) role of implying gap-filling terms consistent with those express terms. Does this case add a new dimension to that exercise?^[78] And if so, are there discernible guidelines for navigating that new dimension?

1. 159 MP Corp. v. Redbridge Bedford, LLC, 128 N.E.3d 128, 132 (N.Y. 2019). ↑

2. Iberdrola Energy Projects v. Oaktree Cap. Mgmt. L.P., 216 N.Y.S.3d 124, 129–30 (N.Y. App. Div. 1st Dep’t 2024) (citations omitted). ↑

3. Kirk La Shelle Co. v. Paul Armstrong Co., 188 N.E. 163, 167 (N.Y. 1933). ↑

4. Singh v. City of New York, 217 N.E.3d 1, 5 (N.Y. 2023) (citations omitted). ↑

5. See Zormati v. Citibank, N.A., 2026 N.Y. slip op. 01821, 2026 WL 849365, at *2 (N.Y. App. Div. 2d Dep’t Mar. 25, 2026); see also Smile Train, Inc. v. Ferris Consulting Corp., 986 N.Y.S.2d 473, 475 (N.Y. App. Div. 1st Dep’t 2014) (“[B]reach of the implied covenant of good faith and fair dealing is not a tort; rather, it ‘is a contract claim.’”); Randall’s Island Aquatic Leisure, LLC v. City of New York, 938 N.Y.S.2d 62, 63 (N.Y. App. Div. 1st Dep’t 2012) (“There can be no claim of breach of the implied covenant of good faith and fair dealing without a contract.”). ↑

6. 111 W. 57th Inv. LLC v. 111 W57 Mezz Inv. LLC, No. 41, 2026 N.Y. slip op. 03376, 2026 WL 1502410 (N.Y. May 28, 2026) (NYCA). ↑

7. Id. at *9 (Garcia, J., dissenting in part) (emphasis added). ↑

8. Id. ↑

9. See Fisher v. Big Squeeze (N.Y.), Inc., 349 F. Supp. 2d 483, 489 (E.D.N.Y. 2004). ↑

10. 111 W. 57th Inv. (NYCA), 2026 WL 1502410, at *10 (Garcia, J., dissenting in part). The borrowing entity was a Delaware limited liability company. ↑

11. Id. at *11 n.1. ↑

12. Id. at *1 (majority decision). ↑

13. Id. ↑

14. Id. at *10 (Garcia, J., dissenting in part). ↑

15. Id. The Joint Venture was an LLC formed under Delaware law, and Delaware law permits broad waivers of fiduciary duties but not waivers of the implied covenant. 6 Del. C. § 18-1101(c) (“To the extent that, at law or in equity, a member or manager or other person has duties (including fiduciary duties) to a limited liability company or to another member or manager or to another person that is a party to or is otherwise bound by a limited liability company agreement, the member’s or manager’s or other person’s duties may be expanded or restricted or eliminated by provisions in the limited liability company agreement; provided, that the limited liability company agreement may not eliminate the implied contractual covenant of good faith and fair dealing.”). New York’s LLC statute is a more limited grant of authority to waive fiduciary duties. In New York, the waiver may not “eliminate or limit . . . the liability of any manager if a judgment or other final adjudication adverse to him or her establishes that his or her acts or omissions were in bad faith or involved intentional misconduct or a knowing violation of law or that he or she personally gained in fact a financial profit or other advantage to which he or she was not legally entitled. . . .”). N.Y. Ltd. Liab. Co. Law § 417(a)(1) (McKinney 2026). ↑

16. See 111 W. 57th Inv. LLC v. 111 W57 Mezz Investor LLC, 2022 N.Y. slip op. 34258(U), 2022 WL 17718682, at *2 (N.Y. Sup. Ct., N.Y. Cty. Dec. 15, 2022) (Trial Court). ↑

17. It is not clear whether the Junior Mezz Borrower was in the structure originally or only entered the structure as part of the subsequent forbearance agreement. ↑

18. 111 W. 57th Inv. (NYCA), 2026 WL 1502410, at *1. Apparently, the plaintiff alleged that the budget overruns exceeded the approved budget and that the plaintiff was not required to contribute its share of the shortfall and instead was entitled to trigger an equity put requiring that the Sponsor purchase the plaintiff’s equity. See Ambase Corp. v. Acrefi Mortg. Lending, LLC, 2019 N.Y. slip op. 33148(U), 2019 WL 5394498, at *1–3 (N.Y. Sup. Ct., N.Y. Cty. Oct. 22, 2019). The Sponsor disputed that and had apparently covered several capital contributions that the plaintiff had allegedly not funded. Moreover, the Sponsor had proposed a new financing to resolve the funding deficit, but the plaintiff had allegedly refused to approve the financing. See generally Ambase Corp. v. 111 W. 57th Sponsor LLC, 2018 N.Y. slip op. 30160(U), 2018 WL 587136, at *2–3 (N.Y. Sup. Ct., N.Y. Cty. Jan. 29, 2018); Iszo Cap. LLP v. Bianco, 2018 N.Y. slip op. 33384(U), 2018 WL 6809400, at *1 (N.Y. Sup. Ct., N.Y. Cty. Dec. 27, 2018). ↑

19. 111 W. 57th Inv. (Trial Court), 2022 WL 17718682, at *2. ↑

20. 111 W. 57th Inv. (NYCA), 2026 WL 1502410, at *10 (Garcia, J., dissenting in part). ↑

21. Id. ↑

22. Id. ↑

23. Id. ↑

24. See 111 W. 57th Inv. (Trial Court), 2022 WL 17718682, at *2. ↑

25. Id. ↑

26. 111 W. 57th Inv. LLC v. 111 W57 Mezz Inv. LLC, 2025 WL 2605958, at *2 (N.Y. Sup. Ct., N.Y. Cty. Sept. 9, 2025). ↑

27. 111 W. 57th Inv. (Trial Court), 2022 WL 17718682, at *3. ↑

28. Id. ↑

29. Id. ↑

30. Id. at *4. ↑

31. 111 W. 57th Inv. (NYCA), 2026 WL 1502410, at *2. ↑

32. 111 W. 57th Inv. (Trial Court), 2022 WL 17718682, at *4. ↑

33. Id. ↑

34. 111 W. 57th Inv. (NYCA), 2026 WL 1502410, at *11 (Garcia, J., dissenting in part); 111 W. 57th Inv. (Trial Court), 2022 WL 17718682, at *6. ↑

35. 111 W. 57th Inv. (Trial Court), 2022 WL 17718682, at *6. ↑

36. 111 W. 57th Inv. LLC v. 111 W57 Mezz Inv. LLC, 146 N.Y.S.3d 95, 98 (N.Y. App. Div. 1st Dep’t 2021). ↑

37. Id. at 99. ↑

38. 111 W. 57th Inv. (NYCA), 2026 WL 1502410, at *14 (Garcia, J., dissenting in part). ↑

39. 111 W. 57th Inv. LLC v. 111 W57 Mezz Inv. LLC, 198 N.Y.S.3d 521, 523 (N.Y. App. Div. 1st Dep’t 2023). ↑

40. 111 W. 57th Inv. (NYCA), 2026 WL 1502410, at *4. ↑

41. Id. at *5 (citations omitted). ↑

42. Id. at *11 (Garcia, J., dissenting in part). ↑

43. Id. at *13. ↑

44. Id. ↑

45. Id. at *5 (majority opinion). ↑

46. Id. ↑

47. Id. ↑

48. See Calumet Cap. P’rs LLC v. Victory Park Cap. Advisors, LLC, 353 A.3d 88, 126 (Del. Ch. 2026). ↑

49. See Glenn D. West, Musings on the Exercise of “Sole Discretion,” Weil Glob. Priv. Equity Watch (Aug. 29, 2022) (discussing caselaw that suggests “sole discretion” by itself does not eliminate the implied covenant); Paul M. Altman & Srinivas M. Raju, Delaware Alternative Entities and the Implied Contractual Covenant of Good Faith and Fair Dealing Under Delaware Law, 60 Bus. Law. 1469, 1484 (2005) (suggesting means of limiting the implied covenant in grants of discretion with language in addition to sole discretion). ↑

50. McKenzie v. BDO USA, P.C., 2026 WL 191010, at *5 (Del. Ch. Jan. 26, 2026) (citations omitted). ↑

51. See Guilbeau v. Footprint Int’l Holdco, Inc., 2026 WL 1180159, at *22 (Del. Ch. Apr. 30, 2026). ↑

52. Id. ↑

53. See id. ↑

54. Allen v. El Paso Pipeline GP Co., 113 A.3d 167, 182–83 (Del. Ch. 2014), aff’d, 2015 WL 803053 (Del. Feb. 26, 2015). ↑

55. See generally 29 Williston on Contracts § 74.10 (4th ed. May 2026 Update) (“Generally, all contract rights may be assigned in the absence of clear language expressly prohibiting the assignment, and unless the assignment would materially change the duty of the obligor or materially increase the obligor’s burden or risk under the contract or the contract involves obligations of a personal nature.”). ↑

56. See 111 W. 57th Inv. LLC v. 111 W57 Mezz Inv. LLC, 146 N.Y.S.3d 95, 99 (N.Y. App. Div. 1st Dep’t 2021) (“[T]he complaint states a derivative cause of action for breach of the duty of good faith and fair dealing by alleging that [the New Junior Mezz Lender], in which the pledge agreement vested discretion as to the exercise of UCC remedies, suborned insiders to allow it to exercise that discretion to plaintiff’s detriment.”). ↑

57. 111 W. 57th Inv. (NYCA), 2026 WL 1502410, at *10 n.10. ↑

58. Id. at *9. ↑

59. Lonergan v. EPE Holdings, LLC, 5 A.3d 1008, 1018–19 (Del. Ch. 2010). ↑

60. See N.Y. Ltd. Liab. Co. Law § 417(a)(1) (McKinney 2026) ( a waiver of fiduciary duties in New York may not “eliminate or limit . . . the liability of any manager if a judgment or other final adjudication adverse to him or her establishes that his or her acts or omissions were in bad faith or involved intentional misconduct or a knowing violation of law or that he or she personally gained in fact a financial profit or other advantage to which he or she was not legally entitled”). ↑

61. 6 Del. C. § 18-1101(c) (“To the extent that, at law or in equity, a member or manager or other person has duties (including fiduciary duties) to a limited liability company or to another member or manager or to another person that is a party to or is otherwise bound by a limited liability company agreement, the member’s or manager’s or other person’s duties may be expanded or restricted or eliminated by provisions in the limited liability company agreement; provided, that the limited liability company agreement may not eliminate the implied contractual covenant of good faith and fair dealing.”). ↑

62. See generally Eccles v. Shamrock Cap. Advisors, LLC, 245 N.E.3d 1110, 1121 (N.Y. 2024) (quoting Hart v. Gen. Motors Corp., 129 A.D.2d 179, 184, 517 N.Y.S.2d 490 (N.Y. App. Div. 1st Dep’t 1987)) (noting that “the internal affairs doctrine . . . protects the interests and expectations of shareholders by giving effect to their choice as to what jurisdiction’s laws will govern the corporation’s affairs”). ↑

63. 111 W. 57th Inv. (NYCA), 2026 WL 1502410, at *5. ↑

64. See Guilbeau v. Footprint Int’l Holdco, Inc., 2026 WL 1180159, at *14 (Del. Ch. Apr. 30, 2026); Zync, Inc. v. Porshe Inv. Mgmt., S.A., 2026 WL 1507812, at *21 (Del. Ch. May 29, 2026). ↑

65. Footprint Int’l, 2026 WL 1180159, at *14 (quoting Marks & Spencer PLC v. BNP Paribas Sec. Servs. Tr. Co. (Jersey) Ltd., [2015] UKSC 72, [2016] A.C. 742 [21], [23]). ↑

66. Id.; see also Glenn D. West, The ‘Officious Bystander’ and the Implied Covenant of Good Faith and Fair Dealing, Bus. L. Today (May 20, 2026). ↑

67. Id. (quoting Shirlaw v. S. Foundries (1926) Ltd., [1939] 2 K.B. 206, 227 (Eng.)). ↑

68. Footprint Int’l, 2026 WL 1180159, at *19. ↑

69. 111 W. 57th Inv. (NYCA), 2026 WL 1502410, at *8 (emphasis added). ↑

70. Id. It is also not clear that that is the primary purpose of a forbearance agreement is to ensure that a borrower’s equity interest “remain unimpaired.” ↑

71. There is a legal maxim that is worth recalling—damnum absque injuria (a “harm without injury in the legal sense, that is, without such breach of duty as is redressable by an action”). Black’s Law Dictionary (5th ed. 1979). ↑

72. Tobin v. Grossman, 249 N.E.2d 419, 424 (N.Y. 1969). ↑

73. West, supra note 66. ↑

74. Texas does recognize the implied covenant in the context of contracts subject to the Uniform Commercial Code and certain “special relationships,” such as an insurance contract. See Tex. Bus. & Com. Code §§ 1.201(b)(20), 1.304, 2.306; see also Natividad v. Alexsis, Inc., 875 S.W.2d 695, 697–98 (Tex. 1994) (“The duty of good faith and fair dealing emanates from the special relationship between the parties and not from the terms of the contract, therefore its breach gives rise to tort damages and not simply to contractual liability. However, the ‘special relationship’ exists only because the insured and the insurer are parties to a contract that is the result of unequal bargaining power, and by its nature allows unscrupulous insurers to take advantage of their insureds. Without such a contract there would be no ‘special relationship’ and hence, no duty of good faith and fair dealing.”). ↑

75. English v. Fischer, 660 S.W.2d 521, 522 (Tex. 1983). ↑

76. 111 W. 57th Inv. (NYCA), 2026 WL 1502410, at *12 n.2 (Garcia, J., dissenting in part). ↑

77. Unlike either New York or Delaware, Texas LLC agreements can completely eliminate fiduciary duties without any ongoing implied covenant of good faith and fair dealing overlay. See Tex. Bus. Orgs. Code § 101.401 (“The company agreement of a limited liability company may expand, restrict, or eliminate any duties, including fiduciary duties, and related liabilities that a member, manager, officer, or other person has to the company or to a member or manager of the company.”). ↑

78. As noted in my prior piece (West, supra note 66), I am working with coauthors on a more comprehensive law review article with the working title “Making Sense of the Implied Covenant of Good Faith and Fair Dealing.” This case has caused some rethinking, at least with respect to the “sense” of the doctrine in New York. ↑