This is a final follow up on my recent posts, Fannie and Freddie: The NWS and the Implied Covenant of Good Faith and Fair Dealing and Some Further Thoughts on the Implied Covenant.
(Yes, I get three swings at a pitch.)
I want to spend just a little more time on the comment by Francis G. X. Pileggi in his Delaware Corporate & Commercial Litigation Blog, that I highlighted previously:
“…claims predicated on the implied covenant may survive dismissal where well-pled factual allegations support a reasonable inference that a contracting party has, in exercising otherwise-legitimate contractual rights, taken actions to undermine express contractual rights of the other party. This is especially so where the offending actions were such that explicitly proscribing them in the contract would have been too obvious or provocative.”
(Of course at trial, those “well-pled factual allegations” if proved can support a verdict that vindicates the implied covenant claim.)
The context for this situation also follows up on the distinction, with respect to reasonable investment expectations, that I highlighted previously between a privately negotiated investment and an investment in a publicly offered junior preferred security.
I have negotiated many private investment contracts and participated in many public securities offerings…they couldn’t be more different with respect to the extent to which the investor can specify in advance the investor’s desired contractual terms…and this is precisely the context with respect to which a court applies the implied covenant of good faith and fair dealing.
There is a dance that an investor, the other contracting party and their respective counsel engage in during a private investment negotiation. The investor wishes to protect itself from various risks, including moral hazard by the other contracting party. As counsel for the investor, you engage in a premortem, in which you try to envisage all of the adverse developments and risks that might arise, and then set forth contractual provisions that protect your client (the investor) from them.
Except counsel for the other contracting partner pushes back often during the negotiation, whether because opposing counsel believes a specified risk should in fact be borne by your client, or your request is thought to be unreasonable (though likely not so unreasonable that opposing counsel wouldn’t be making the same request if in your shoes), or simply because your request is provocative…which is to say, it is beneath dignity to entertain the notion that the contracting party would do such a thing as you, counsel for the investor, seek protection against.
There is, of course, no opportunity for this in connection with a publicly offered junior preferred stock. It would be provocative (and insulting) for counsel for the underwriters to insist on a provision in the junior preferred certificate of designations that the issuer may only issue senior preferred stock, or amend its terms, in connection with the receipt of funds or other valuable consideration by the issuer.
So the request is never made by counsel for the underwriters, and that contracting term is never incorporated into the junior preferred certificate of designations. This is precisely the reason the implied covenant exists…to prevent a contracting party from pursuing a course of action in bad faith that is not proscribed by the express terms of the security, simply because no investor should be required to specifically contract against all possible instances of bad faith that an issuer might engage in…especially in the context of a public security, where the ambit of contractual negotiation is de minimus.
Thanks for all your insightful analysis. What do you think the remedy would likely be if the shareholders win this case? Would it be paid to the companies or to the shareholders directly? Would it be equal to (or based on) how much the government has been overpaid as a result of the Third Amendment relative to the original deal with a 10/12% dividend rate? Would there likely be a discount/haircut to that? Or would it be based on something else?
ROLG - thanks for that explanation regarding the reasoning behind the existence of the implied covenant. I admittedly have read many contracts over the years and don't believe I've received as good of an explanation!
I do have a question regarding the GSE litigation that I would appreciate your insight, if you are so inclined. I think I recall in some context earlier in the Lamberth related case a pleading or ruling that essentially spoke to, either implied or expressly stated, that a shareholder of the GSEs should have known or at least contemplated that ownership of the GSE shares was "different" (than say owning Apple) given the nature of the GSEs (that the charters provide or come along with a public policy or mission). I may be wrong, but I took that as saying 'you as an owner of the junior preferreds' need to recognize that this publicly traded security (that has a special charter to carry out a public mission) may incur certain conditions that require or warrant appointment of a conservator or receiver which represents additional inherent risk.
My questions is the following: Let’s assume a prospective buyer of the preferreds was aware of the risk that a conservator (or receiver) could be appointed under certain conditions that may or would negatively impact their interest, BUT a ruling by Scotus (in Collins on the APA) essentially broadened/re-defined/expanded (not sure the right word there) THIS conservator's powers beyond any previously appointed conservator in U.S. history, how was one to have contemplated that prior to purchase of the securities? In what context or litigation would that kind of 'argument' apply with the GSEs, if at all? I may likely be way off base, but it has been something I've been thinking about post the Scotus Collins ruling. I feel as if a prospective investor was being asked to understand the "definition" of the powers and latitudes of a conservator, but they have now changed/expanded the definition after the fact. Thank you, Jack