109 F. Supp.2d 66 (2000) | Cited 0 times | D. Rhode Island | August 8, 2000


This matter is before the Court on cross motions for summary judgment.This is abreach of contract case and the parties ask this Court to delve into therealm of the implied covenant of good faith and fair dealing.Specifically, in this matter the Court is confronted with the vexingquestion of whether and to what extent a term should be implied into awell-negotiated contract by utilizing the implied covenant of good faithand fair dealing. In Count I of the Amended Complaint plaintiff, RhodeIsland Charities Trust ("RICT"), asks this Court to interpret thecontract and seeks a declaration that defendant Engelhard Corporation("Engelhard") has violated the express terms of that agreement. In CountII, RICT alleges that even if the terms of the contract permit the actiontaken by Engelhard, such action is proscribed by the implied covenant ofgood faith and fair dealing. In Count III, plaintiff alleges thatEngelhard's conduct constitutes a breach of fiduciary duty owed toplaintiff. Plaintiff, RICT has moved for partial summary judgment pursuantto Fed.R.Civ.P. 56(d) on Count II seeking a declaration that Engelhardhas breached the covenant of good faith and fair dealing with respect tothe performance of the contract governing the relationship between theparties. Defendant has moved for summary judgment on all three Counts setforth in the Amended Complaint. For the reasons set forth below, thisCourt denies Engelhard's motion for summary judgment on Count II butgrants its motion for summary judgment on Count I and III. This Courtalso grants RICT's motion for partial summary judgment on Count II andmakes a declaration as to the proper interpretation of the contractapplying the implied covenant of good faith and fair dealing.

I. Background

The parties do not dispute the following recitation of the facts. In1937, RICT was formed for purposes of distributing money grants forcharitable causes. In 1948, RICT purchased Southern Clays, Inc., a kaolinmining and processing company located in middle Georgia. Kaolin is a clayutilized in many industries, but the principal use of the type of claymined and processed by Southern Clays was in the paper industry.

In 1963, RICT sold the assets of Southern Clays to Freeport SulphurCompany. At the time, the assets consisted of a modern processing plant,mining equipment, a laboratory and certain clay lands either owned bySouthern Clays or on which it held long-term mineral leases. In additionto the asset sale pursuant to an Asset Purchase Agreement, Southern Claysand Freeport entered into a ninety-nine year Indenture, whereby SouthernClays leased and assigned to Freeport its right to mine the clay on landsit owned (the "Fee Properties") and on land which it held the right tomine through various leases (the "Leased Properties") in exchange forroyalties. The Indenture involved a ninety-nine year lease oftwenty-three Fee Properties, and an assignment of sixteen LeasedProperties, with termination dates ranging from 1967 to 2023. SeeIndenture, §§ 22,23 and Defendant's Ex. E. The leases at the heart ofthis case, Nos. 5, 6, 7 and 8, as described in paragraph 23 of theIndenture (collectively, the "Veal leases"), all had termination dates ofMarch 23, 1995. Southern Clays then dissolved and RICT succeeded to allof its rights under the Indenture.

Pursuant to the Indenture, RICT received a one and one-half percent(1.5%) royalty on the sale of the clay and clay products. In 1985,Engelhard acquired Freeport and became successor in interest, as Lessee,under the Indenture.

The provisions of the Indenture detailing the calculation of theroyalties payable to RICT by Engelhard are as follows:

5. Royalties

(a) [Engelhard] agrees to pay [RICT] for each Royalty Period on (i) processed clay . . . (ii) unprocessed clay and — (iii) "mixed products" . . ., sold in such Royalty Period . . . as hereinafter provided in clauses (i), (ii) and (iii) . . .

(i) A royalty equal to one and one-half percent (1.5%) of [Engelhard's] Net Receipts from sales in such Royalty Period of each kind of process clay processed mineral . . . and each kind of unprocessed mineral . . . derived from the Properties.

(ii) . . . (1.5%) of the Net Receipts that would have been received by [Engelhard] in such Royalty Period if a number of tons of processed clay which could have been produced from the number of tons derived from the Properties of each kind of unprocessed clay sold in such Royalty Period.

See Indenture, § 5(a). The Indenture defines Properties as "all ofthe Fee Properties and Leased Properties collectively." Indenture, §1(a).

Of critical importance to this case is the fact that the Indenturepermits Engelhard to deduct from the one and one-half percent (1.5%)royalty any real estate taxes on the Fee Properties and, as to the LeasedProperties any advance royalties and production royalties payable to thelandowners. See Indenture, § 7(a)-(c). In subparagraph 7(a) of theIndenture, Engelhard, agrees to pay "(i) all real estate taxes imposed onor assessed against the fee properties," and "(ii) all payments (otherthan royalties based on production, provision for which is made insubparagraph (c) of this Paragraph 7) which the person named as lesseethereunder is required to make under the Leases." Subparagraph 7(b)allows Engelhard to deduct the payments made under 7(a) from theaggregate royalties otherwise payable to RICT pursuant to the Indenture.Finally, subparagraph 7(c) permits Engelhard to credit and deduct fromthe royalties owed to RICT any production royalties payable to thelandowners of the various Leases.

The deduction provisions of paragraph 7 read as follows:

(b) The aggregate amount of all payments made or payable by [Engelhard] for all Royalty Periods within any calendar year pursuant to subparagraph (a) of this Paragraph 7 shall be deducted from the aggregate royalties payable by [Engelhard] for such Royalty Periods pursuant to Paragraph 5 hereof.

(c) [Engelhard] also agrees to pay to the person entitled thereto all royalties based on production required to be paid under the Leases only so long as [Engelhard] remains an assignee thereof; provided, however, that [Engelhard] shall be entitled to a credit for any amounts paid or payable by it pursuant to this subparagraph (c) against royalties thereafter payable to [RICT] under the provisions of Paragraph 5 of this Agreement.

Indenture, §§ 7(b)-(c), Pl.'s Ex.A (emphasis added). As is evidentfrom the plain language of the contract, all payments, except forproduction royalties on the Leased Properties, made by Engelhard relatingto the Properties may be deducted from the aggregate royalties payable toRICT. In contrast, deductions for production royalty payments made to thelandowners of the Leased Properties are dealt with in a separatededuction provision which does not contain the word "aggregate."

At the time the Indenture was entered into in 1963, with a fewexceptions, the Lease durations were substantial and the Veal leases atissue in this case had upwards of 30 to 35 years to run. Productionroyalty obligations to landowners were between $0.10 and $0.20 per cubicyard. Although mining on the Leased Properties would have been profitableto RICT at then current prices, there was limited mining on theseproperties at that time. In the 1980s, however, mining began, and duringthe period of May, 1981 to May, 1995, RICT earned income from royaltieswhich ranged between $500,000 to $1,100,000 per year. See Plaintiff'sEx. H.

Among the assigned leases in the Indenture, and the leases at issue inthis case, were leases with the Veal families. The Veal leases were50-year leases that datedback to the 1930s. They were renegotiated in 1945 and 1970 and, as aresult, would have expired in 1995. Under the original leases, theproduction royalties payable to the Veals were $0.11 per cubic yard ofmined clay. In the 1980s the Veals demanded more money and threatenedlitigation. For that reason and others that are not relevant, the Vealproperties were not mined in the 1960s and 1970s.

Although Engelhard was uncertain of what it would do about the Vealleases in the mid 1980s, it was well aware that the Indenture didpermit, with limited restrictions, renegotiation of the assigned Leases.The pertinent provision of the Indenture reads as follows:

(e) It is expressly understood that [Engelhard] shall, without obtaining the consent of [RICT] (or any transferee or the Bank provided in Paragraph 8 hereof), be entitled to enter into any agreement to alter, modify (aside from complete termination), renew or extend any and all Leases and enter into new or additional leases or agreements with respect to any Leased Properties covered thereby, to such extent as [Engelhard] may deem desirable, provided, however, that [Engelhardl shall not make any alteration or modification of any Lease or other arrangement in connection with such Lease (other than alterations, modifications or arrangements contemplated by the terms of the Leases now in effect or which would result by reason of the provisions of any Lease now in effect from the exercise of any option contained therein) which with respect to the period prior to the normal termination date of such Lease would increase any fixed costs to be paid by [Engelhard] thereunder or would increase the amount of royalties payable by [Engelhard] thereunder with respect to any minerals, ores or substances permitted to be mined by [Engelhard] on the date hereof, unless [Engelhard] agrees to pay such increased fixed costs or additional royalties.

Indenture, § 2(e), Plaintiff's Ex. A. Thus, it is clear that theIndenture gives absolute discretion to Engelhard to amend and extend theLeases, provided, however, that Engelhard absorb any increased royaltiespayable to landowners as a result of the amendment through to the originaltermination date of the Leases. Paragraph 2(e) does not address thetreatment of increased royalty payments to the landowners after theoriginal expiration date of the amended and/or extended Leases. Yet,pursuant to § 5(c) of the Indenture, "any other rights" acquired byway of an extension on the Leases, made by Engelhard, are treated as"Leased Properties" and "royalties shall be payable in respect thereof."Indenture, § 5(c).

In the mid to late 1980s, Engelhard evaluated its options with respectto the Veal properties. It identified the following options: (1)accelerate mining on the Veal properties in order to extract as much clayas possible prior to the 1995 expiration date; (2) abandon the Vealleases and purchase replacement clay; or (3) renegotiate the Veal leasesto extend the time for mining and agree to increased payments to theVeals. See Defendant's memo., p. 14. At some point during either 1988 or1989, Engelhard decided it would be best to proceed with renegotiationsof the Veal leases. Initially, Engelhard was unaware that the Indenturecould be interpreted to permit the deduction of increased productionroyalties to the landowners under the amended leases from royaltiespayable to RICT. Thus, in its initial preparation of the amended Vealleases, Engelhard assumed it would have had to pay royalties to both theVeals and RICT.

On or around January 16, 1990, Engelhard and the Veals agreed thatproduction royalties would be increased to $3.00 per cubic yard on threeof the leases and $2.90 on one lease and that those leases would beextended for twenty years from the date of execution of the amendment.See Defendant's memo., p. 22 and McKenzie Aff., p. 17. This isapproximately a 3000percent increase in landowner payments under the Veal leases andcompletely wiped out the royalties of $1.21 per cubic yard that werepayable to RICT for mining the clay on these properties. See Plaintiff'smemo., p. 6 and Amended Complaint, § 22. The amendments to the Vealleases were conditioned upon approval by the Board of Directors ofEngelhard based in New Jersey. While the original version of the CapitalAuthorization Request ("CAR") prepared for presentation to the Board ofDirectors of Engelhard did not indicate an intent to deduct the increasedlandowner royalties, the final CAR Board letter, circulated on August 1,1990, was revised to include the following language: "After 1995 (theoriginal termination date of the Veal leases), the royalty payments tothe Veals can be deducted from royalties paid to RICT." See Defendant'smemo., p. 25 and Foote/McKenzie Dep., Ex. 44. Execution of the amendedVeal leases was approved by the Board of Directors of Engelhard on August9, 1990. See Foote/McKenzie Dep., Ex. 46.

Pursuant to paragraph 2(e) of the Indenture, from the time Engelhardentered into the amended Veal leases through the first half of 1995,Engelhard absorbed the increased payments to the landowners, whichtotaled $1,830,1691. See Davis Aff., p. 11 and Defendant's ExhibitsJ, K, L and M. In other words, these payments were not deducted from theroyalties paid to RICT during those years because of the expressprovision of § 2(e) of the Indenture. Consequently, the leaseamendments did not impact RICT until 1995. Upon expiration of theoriginal Veal lease terms in 1995, Engelhard began deducting theincreased Veal payments from the aggregate royalties payable to RICT.

The result was dramatic. Throughout the history of the royaltyarrangement, RICT received royalty payments every six months. Thesechecks usually exceeded $300,000. In contrast, the check for the last sixmonths of 1995 was $30,000. This trend continued in the years thatfollowed as Engelhard continued to deduct landowner royalties on theamended Veal leases from the total royalties payable to RICT.

As stated earlier, during the Veal lease amendment approval process in1990, Engelhard interpreted the Indenture to mean that the increasedlandowner royalties under the amended leases could be deducted from theaggregate royalties payable to RICT in the second half of 1995 andthereafter. However, it does not appear that Engelhard anticipated thatthose deductions due to production royalties payable under the amendedVeal leases would cause a reduction in the royalties payable to RICT fromother Leased and Fee Properties. See Plaintiff's memo., p. 7 andPlaintiff's Ex. S. But that has, in fact, occurred. In short, thedeductions from the royalties paid to RICT because of the amendments tothe Veal leases for the mining of Veal clay have eaten into the aggregateroyalties payable to RICT from mining non-Veal clay. See Plaintiff's Ex.S. Indeed, testament to this unexpected result can be gleaned from thefact that the Indenture did not expressly provide for such a scenario.Therefore, plaintiff is before this Court asking for a construction ofthe Indenture to prevent that from happening.

After realizing that the Veal lease amendments caused this drasticallyunprofitable result for RICT, Engelhard took the position that theIndenture authorized the action taken. It relied on § 2(e) of theIndenture, the provision granting authority to Engelhard to amend theLeases. RICT responded by filing this suit, claiming that Engelhardviolated the contract and the implied covenant of good faith and fairdealing in addition to its fiduciary duty to RICT by making thesedeductions from aggregate royalties payable to RICT. As stated earlier,RICT has moved for partialsummary judgment on Count II while Engelhard has filed a motion forsummary judgment on all three Counts.

II. Standard of Review

Rule 56(c) of the Federal Rules of Civil Procedure sets forth thestandard for ruling on a summary judgment motion:

The judgment sought shall be rendered forthwith if the pleadings, depositions, answers to interrogatories, and admissions on file, together with the affidavits, if any, show that there is no genuine issue as to any material fact and that the moving party is entitled to judgment as a matter of law.

Fed.R.Civ.P. 56(c). Thus, summary judgment may be granted when no"reasonable jury could return a verdict for the nonmoving party."Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 248, 106 S.Ct. 2505, 91L.Ed.2d 202 (1986). In determining whether summary judgment isappropriate, the Court must view the facts on the record and allinferences therefrom in the light most favorable to the nonmoving party.See Continental Cas. Co. v. Canadian Universal Ins. Co., 924 F.2d 370,373 (1991).

Plaintiff's motion is one for partial summary judgment pursuant toFed.R.Civ.P. 56(d). Partial summary judgment under Rule 56(d) isseparate and distinct from a motion for summary judgment under Rule 56(c). Rule 56(d) arms the court with a tool to "narrow the factual issuesfor trial." Rivera-Flores v. Puerto Rico Tel.Co., 64 F.3d 742, 747 (1stCir. 1995). The rule provides that when "judgment is not rendered uponthe whole case or for all the relief asked and a trial is necessary," thecourt may "ascertain what material facts are actually and in good faithcontroverted." Fed.R.Civ.P. 56(d). Based upon such an inquiry, the courtmay then devise an appropriate order "including the extent to which theamount of damages or other relief is not in controversy, and directingsuch further proceedings in the action as are just." Id.

The standard for ruling on a Rule 56(d) motion is "identical to thatdeployed when considering a summary judgment motion under Rule 56(c)."URI Cogeneration Partners, L.P. v. Board of Governors for Higher Ed.,915 F. Supp. 1267, 1279 (D.R.I. 1996) (citing Flanders & Medeiros, Inc.v. Bogosian, 868 F. Supp. 412, 417 (D.R.I, 1994), aff'd in part, rev'd inpart, 65 F.3d 198 (1st Cir. 1995)). A grant of summary judgment "is notappropriate merely because the facts offered by the nonmoving party seemmost plausible, or because the opponent is unlikely to prevail at trial."Gannon v. Narragansett Electric Co., 777 F. Supp. 167, 169 (D.R.I.1991). At the summary judgment stage, there is "no room for credibilitydeterminations, no room for the measured weighing of conflicting evidencesuch as the trial process entails, no room for the judge to superimposehis own ideas of probability or likelihood[.]" Greenburg v. Puerto RicoMaritime Shipping Auth., 835 F.2d 932, 936 (1st Cir. 1987). Summaryjudgment is only available when there is no dispute as to any materialfact and only questions of law remain. See Blackie v. Maine, 75 F.3d 716,721 (1st Cir. 1996). Additionally, the moving party bears the burden ofshowing that no evidence supports the nonmoving party's position. SeeCelotex v. Catrett, 477 U.S. 317, 325, 106 S.Ct. 2548, 91 L.Ed.2d 265(1986).

The coincidence that both parties move simultaneously for summaryjudgment does not relax the standards under Rule 56. See Blackie, 75 F.3dat 721. Barring special circumstances, a district court must considereach motion separately, drawing inferences against each movant in turn.See id. (quoting EEOC v. Steamship Clerks Union Local 1066, 48 F.3d 594,603 n. 8 (1st Cir.)), cert. denied, 516 U.S. 814, 116 S.Ct. 65, 133L.Ed.2d 27 (1995).

III. Discussion

As is evident from the factual background, this is a contractinterpretation case. Because the Indenture did not specifically providefor the events that transpiredsubsequent to the Veal lease amendments, this Court is required tointerpret the Indenture under recognized principles of contractconstruction. The issue to be decided is whether and to what extent underthe Indenture, landowner production royalties paid under the amendedleases can be deducted from aggregate royalties payable to RICT, once theoriginal lease expiration dates have been reached. For the reasonsoutlined in detail below, this Court holds that after the originalexpiration date of an assigned lease, production royalties payable to anylandowner under an amendment to that Lease may be deducted from royaltiesgenerated from clay mined on that Leased Property only. As discussedbelow, this interpretation of the Indenture results from use of theimplied covenant of good faith and fair dealing and is also based on afair reading of the Indenture as a whole utilizing accepted rules ofcontract construction in order to effectuate the intent of the parties.

As the parties do not dispute the application of Georgia law to thiscase, this Court will proceed by applying Georgia law since that is thejurisdiction chosen in the choice of law provision in the Indenture. SeeIndenture, § 19. Defendant is a New Jersey corporation but thecontract at issue relates to clay mining in Georgia and Freeport, itspredecessor, was Georgia based. As this Court has stated many times, underthe established law of Rhode Island, a choice of law provision in acontract is enforceable where the transaction bears a reasonablerelationship both to Rhode Island and another state. See Honey DewAssociates, Inc. v. M & K Food Corp., 81 F. Supp.2d 352 (D.R.I. 2000). Inthis case, there is a reasonable relationship between the transaction atissue and Georgia, therefore, the Court will apply the law of Georgia inconstruing the Indenture. See R.I. Gen.Laws § 6A-1-105; Providence &Worcester R.R. Co. v. Sargent Greenleaf Inc., 802 F. Supp. 680, 687(D.R.I. 1992) (holding that a choice of law provision in a contract isenforceable where the transaction bears a reasonable relationship both toRhode Island and another state).

A. The Implied Covenant of Good Faith and Fair Dealing

Plaintiff relies heavily upon the implied covenant of good faith andfair dealing in arguing that there should be an implied limitation uponthe discretion granted to Engelhard in the Indenture to amend the leasesand charge back the increased costs thereof to RICT. This Court agrees.Although it has been shrouded in mystery at times, the implied covenantof good faith and fair dealing is simply a residual gap-filling, defaultrule of contract law. In effect, it imposes limits upon one contractingparty's ability to adversely impact the contract's value to the otherparty. Therefore, it determines when a party to a contract may no longerpursue his or her own self-interest but rather must engage in cooperativebehavior by deferring to the other party's contractual interests. Seegenerally 3 Corbin on Contracts, § 507 (Supp. 1999) and 11 Willistonon Contracts, §§ 31:8, 32:2 (4th ed. 1999).

The implied covenant of good faith and fair dealing is usually employedin two situations, both of which apply to the situation in this case.First, it is utilized where the terms of the contract are ambiguous or donot cover the disputed conduct. See, e.g., Continental Bank, N.A. v.Everett, 964 F.2d 701, 705 (7th Cir.), cert. denied, 506 U.S. 1035, 113S.Ct. 816, 121 L.Ed.2d 688 (1992)(discussing how the obligation of goodfaith is another way to describe the effort made by the court to deviseterms to fill contractual gaps); Hubbard Chevrolet Co. v. General MotorsCorp., 873 F.2d 873, 876-77 (5th Cir.), cert. denied, 493 U.S. 978, 110S.Ct. 506, 107 L.Ed.2d 508 (1989). Secondly, the implied covenant is alsoused where the action at issue is taken pursuant to a grant of discretionin the contract and the scope of that discretion has not beendesignated. See, e.g., Chrysler Credit Corp. v. Marino, 63 F.3d 574, 579(7th Cir. 1995); Occusafe, Inc. v. EG & G Rocky Flats, Inc., 54 F.3d 618,624 (10th Cir. 1995) (holding that the court's inquiry focuses on whetherthe defendant's conduct affected the contracting parties' benefit of thebargain); Travellers Int'l v. Trans World Airlines, Inc., 41 F.3d 1570,1575 (2d Cir. 1994)(holding that where a contract confers discretion onone party, such discretion is limited by the obligation that it beexercised in good faith).

In Georgia, as in virtually all jurisdictions, the duty of good faithand fair dealing is implied into every contract. See West v. Koufman,259 Ga. 505, 506, 384 S.E.2d 664, 666 (1989)(quoting Restatement (Second)of Contracts § 231 ("Every contract imposes upon each party a duty ofgood faith and fair dealing in its performance and its enforcement."));see also Jackson Electric Membership Corp. v. Georgia Power Co.,257 Ga. 772, 364 S.E.2d 556 (1988). Indeed, this duty requires that eachparty to a contract act in furtherance of the other party's reasonableexpectations of the bargain. In the event that one party's actions are inconflict with or eviscerate the other party's reasonable expectations, acourt may be required "to look to the substance rather than to the formof the agreement, and to hold that substance controls over form." 3Corbin on Contracts, § 570, at 500 (Supp. 1999). Georgia courts havefollowed this rule by recognizing "the time honored rule that where adecision is left to the discretion of a designated entity, the questionis not whether it was in fact erroneous, but whether it was in badfaith, arbitrary or capricious so as to amount to an abuse of thatdiscretion." MacDougald Const. Co. v. State Hwy. Dept., 125 Ga. App. 591,593, 188 S.E.2d 405, 406 (1972). In other words, the question is whetherthe exercise of that discretion is consistent with the intent of theparties. See id.

In its brief, Engelhard avers that Georgia courts have resistedapplying the implied covenant of good faith and fair dealing in situationswhere one party to the contract simply does what the contract allows. Itprimarily relies upon the case of Automatic Sprinkler Corp. of America v.Anderson, 243 Ga. 867, 868, 257 S.E.2d 283, 284 (1979) to support thisargument. In Automatic Sprinkler, an employee voluntarily terminated hisemployment and sued claiming that the company owed him specific amountsof both deferred and non-deferred incentive compensation under thecompany's compensation plan. This contract provided in pertinent part:"The award of any direct incentive is entirely within the discretion ofthe corporation and nothing contained herein will be construed to thecontrary . . . With respect to those representatives whose employmentwith the corporation is terminated (for reasons other than theirdisability or retirement), the payment or nonpayment of all or any directincentive installments previously set aside but unpaid to them at thetime of their termination, will rest in the absolute and final discretionof the Compensation Committee of the Board of Directors." AutomaticSprinkler, 243 Ga. at 867, 257 S.E.2d at 284.

The Automatic Sprinkler Court held that "[t]here can be no breach of animplied covenant of good faith where a party to a contract has done whatthe provisions of the contract expressly give him the right to do." 243Ga. at 868, 257 S.E.2d at 284 (quoting MacDougald at 594, 188 S.E.2d at407 ("What the intent of the parties was in making the contract mustcontrol[.]")); see also Marathon U.S. Realties v. Kalb, 244 Ga. 390,392, 260 S.E.2d 85 (1979). In addition, the Court found that the terms ofthe contract "in this case are unambiguous." Id. at 869, 257 S.E.2d at285. Because the contract was unambiguous and, more importantly, becausethe exercise of the Board's discretion was consistent with the intent ofthe parties as expressed in the contract, the Court held that the duty ofgood faith was irrelevant in those circumstances. Id.

The holding in Automatic Sprinkler is reasonable and sound but it doesnot stand for the proposition that defendant proposes in this case.Defendant would have this Court decide that the implied covenant of goodfaith and fair dealing is inapplicable in all circumstances where oneparty to the contract exercises discretion granted to that party pursuantto the contract. That proposition is too broadly stated because anotherGeorgia case supports the view that the implied covenant of good faithand fair dealing can be applicable to conduct permitted under the termsof the contract. See Southern Business Machines of Savannah, Inc. v.Norwest Financial Leasing, Inc., 194 Ga. App. 253, 257, 390 S.E.2d 402,406 (1990). In Southern Business Machines, the contract at issueexpressly authorized Norwest, as assignee of certain leases, to contactthe lessees and to collect payment from the lessees under the leasesassigned to Norwest by Southern Business Machines. Southern BusinessMachines alleged that Norwest's exercise of this authority, expresslyconferred upon it by the contract, caused the lessees to cancel theleases. Citing the rule expressed in Automatic Sprinkler, the trial courtin Southern Business Machines found that Norwest's attempts to collectthe monies owing under the leases was "a legitimate exercise of [its]right to contact the lessees [under the contract]." Southern BusinessMachines, 194 Ga. App. at 257, 390 S.E.2d at 406. The Georgia Court ofAppeals reversed, holding that "[t]he provisions in the assignmentcontract purporting to authorize [Norwest] to contact lessees directlyand to collect payment from them, did not expressly or impliedlyauthorize [Norwest] to exercise this power in a manner constituting alack of good faith." Id.

Therefore, defendant's argument that there can never be a violation ofthe implied covenant of good faith and fair dealing when one partyexercises discretionary authority expressly granted to it under thecontract misses the mark. In rejecting an identical argument as that putforth by Engelhard, then Circuit Judge Scalia pointed out that "to saythat every expressly conferred contractual power is of this nature isvirtually to read the doctrine of good faith (or of implied contractualobligations and limitations) out of existence." Tymshare, Inc. v.Covell, 727 F.2d 1145, 1154 (D.C.Cir. 1984)(holding that although thecontract provided that increases could be made in management's solediscretion, that discretion was limited because there were some purposesfor which the expressly conferred power could not be employed).

The holding in Southern Business Machines follows the well settled rulethat, although courts are reluctant to rewrite contracts for theparties, they will imply promises or duties if justice so demands. SeeFisher v. Toombs County Nursing Home, 223 Ga. App. 842, 845,479 S.E.2d 180, 184 (1996) (quoting Higginbottom v. Thiele Kaolin Co.,251 Ga. 148, 149, 304 S.E.2d 365 (1983)). "What courts are doing here,whether calling the process `implication' of promises, or interpretingthe requirements of `good faith,' as the current fashion may be, is but arecognition that the parties occasionally have understandings orexpectations that were so fundamental that they did not need to negotiateabout those expectations." 3 Corbin on Contracts, § 507 at 500(Supp. 1999); see also 11 Williston on Contracts, §§ 31:8, 32:2 (4thed. 1999). Thus, the implied covenant of good faith and fair dealing isimplicated where one party fails to recognize that "its duty to thespirit of the bargain is higher than its duty to the technicalities of thelanguage [of the contract]." Id.

Furthermore, in discussing implied promises, or the doctrine of goodfaith, Corbin states that the covenant has a special application topromises to pay under a royalty agreement. "One who promises to pay aroyalty . . . proportional to his production or other performance hasoften been found to have promised by implication that he will usediligence and will neither wilfully nor negligently do anythingthat will prevent or reduce the sums to be paid." 3 Corbin on Contracts,§ 570 at 345 (1960). Such an application is to be expected becauseunder a royalty arrangement the only benefit of the bargain to one partyis the sum payable. Therefore, actions taken by one party that obstructsuch payments are often found to violate the implied promise to maintainthe royalties. In other words, it is the parties' intent to haveroyalties payable to one parties' that is paramount in the bargain.

Overall, it is fair to say that Georgia courts recognize that a partyto a contract is bound by the implied covenant of good faith and fairdealing in the exercise of discretionary authority expressly granted tothat party pursuant to the terms of the contract. This is because"whenever the co-operation of the promisee is necessary for theperformance of the promise, there is a condition implied that theco-operation will be given." 194 Ga. App. at 256, 390 S.E.2d at 405(quoting 17 Am. Jur.2d, Contracts, § 256). This rule flows from theconcept that one party's actions, whether or not carried out pursuant toan express provision in the contract, cannot be exercised so as todecimate the other party's reasonable expectations of the bargain. SeeFisher, 223 Ga. App. at 845-46, 479 S.E.2d at 184 ("`Good faith' is ashort hand way of saying substantial compliance with the spirit, and notmerely the letter, of a contract.")(citing Crooks v. Chapman Co.,124 Ga. App. 718, 185 S.E.2d 787 (1971)).

B. Interpreting the Indenture Using the Doctrine of Good Faith

In the case sub judice, this Court's inquiry into the application ofthe implied covenant of good faith and fair dealing will focus on two keyelements. First, whether the Indenture is ambiguous with respect to thededuction of production royalties payable to landowners after theexpiration of the original lease terms. Secondly, whether the action ofdefendant does violence to the intent of the parties to the Indenture.Finally, this Court will have to determine whether and to what extent aterm ought to be implied into the Indenture under the doctrine of goodfaith and fair dealing.

The rules for interpreting a contract in Georgia are similar to suchrules in other jurisdictions. Interpretation of a contract involves threesteps. First, the court decides if the contract language is unambiguous,and if so, the court enforces the clear terms of the contract. SeeLostocco v. D'Eramo, 238 Ga. App. 269, 518 S.E.2d 690, 695 (1999).Second, if the contract is ambiguous, the court must apply rules ofcontract construction to resolve the ambiguity. Id. The basic rule ofcontract construction in Georgia is to give effect to the intent of theparties by reading the contract as a whole. The intent of the parties isto be determined by looking at the "four corners" of the contract. SeeTumo Construction, Inc. v. Lasky, 158 Ga. App. 583, 584, 281 S.E.2d 325,327 (1981)(citing Stephens v. Parrino & Ware, 138 Ga. App. 634, 635,226 S.E.2d 809 (1976)). Third, if ambiguity remains after use of theconstruction rules, the meaning of the contract must be decided by ajury. See Lostocco, 238 Ga. App. 269, 518 S.E.2d 690, 695. In this case,application of the third step is unnecessary.

Application of the implied covenant of good faith and fair dealing isappropriate in this case for two reasons. First, the Indenture is silentwith respect to the challenged actions of Engelhard and that silencecreates an ambiguity in the document. Second, Engelhard's attempt todeduct the increased production royalties payable under the amendedleases from aggregate royalties payable to RICT contravenes the intent ofthe parties to the contract. This is why Engelhard's reliance onAutomatic Sprinkler is misplaced. There, the Court found that the impliedcovenant of good faith and fair dealing was inapplicable because thecontract at issue was unambiguous and the exercise of the Board'sdiscretion was consistent with the intent of the parties to thecontract. SeeAutomatic Sprinkler 243 Ga. at 868, 257 S.E.2d 283. This case is easilydistinguishable from Automatic Sprinkler because, as discussed in detailbelow, neither of the factors critical to the Court's holding in thatcase are present in this case.

Defendant contends that the Indenture is unambiguous with respect tothe deduction of production royalties under the amended Veal leases afterthe original expiration date of those leases. Defendant relies on §2(e) of the Indenture, which permits unilateral amendment of the Leases byEngelhard, to support its argument that any additional costs resultingfrom the amended leases should be deducted from aggregate royaltiespayable to RICT because that was intended by the parties. In short,defendant makes the preposterous argument that the parties contemplatedthat production royalties attributable to one amended Lease can be usedto wipe out the royalties generated from other Fee and LeasedProperties. Such a reading of the relevant provisions of the Indenturecannot be supported because that would be a clear violation of the intentof the contracting parties.

While it is clear that § 2(e) of the Indenture permits Engelhardto amend the Veal leases, it does not follow that this provision governsthe deduction of production royalties from aggregate royalties payable toRICT after the original termination date of the leases. With respect toincreased production royalties payable to landowners as a result of anamended lease, the Indenture provides "that [Engelhard] shall not makeany alteration or modification of any Lease . . . which with respect tothe period prior to the normal termination date of such Lease wouldincrease any fixed costs to be paid by [Engelhard] thereunder or wouldincrease the amount of royalties payable by [Engelhard] thereunder,unless [Engelhard] agrees to pay such increased fixed costs or additionalroyalties." Indenture, § 2(e). Thus, it is clear from the plainlanguage of the Indenture that any increase in production royaltiespayable to the Veals as a result of amending those leases, is to be borneby Engelhard prior to the normal termination date of such leases.However, § 2(e) does not expressly explain how an increase inproduction royalties under an amended lease is to be handled after thenormal termination date of such lease. The Indenture clearly is silent onthis issue and that is what creates the ambiguity in this case.

Engelhard argues that the production royalty payments have always beendeducted from aggregate royalties under the standard deduction provisionsin § 7 of the Indenture. Such an argument does not take into accountthe effect of Engelhard's exercise of absolute discretion in amending theleases and how that contravenes the intent of the parties in enteringinto a 99 year royalty arrangement. Section § 2(e) works as anexception to the standard deduction provision in § 7 by requiringEngelhard to bear any increased landowner costs that result from a leaseamendment or extension prior to the original termination date of suchlease. The parties could never have intended that after the normaltermination date of an amended lease increased landowner royalties couldbe used to wipe out royalties generated by the other Properties. At oralargument, when confronted with the Court's question of whether theIndenture should be read to allow the large cost increases resulting fromthe amended Veal leases to eat up all of the royalties payable to RICT,defendant's counsel responded by saying that such was an inherent risk inthe structure of the Indenture. See Transcript, p. 27. This Courtdisagrees.

It is clear that the Indenture is ambiguous with respect to productionroyalty deductions after the original expiration date of the amendedleases. Contrary to defendant's argument, the Indenture does notexpressly permit such deductions to be made against aggregate royalties.Although the Indenture expressly provides for the treatment of thesedeductions prior to the original termination date of theamended leases, it is silent on the treatment of such deductions afterthe original termination date. Thus, the Indenture must be viewed asbeing ambiguous on the subject. Therefore, this Court must construe theIndenture to give effect to the intent of the parties as evidenced by theIndenture as a whole under the doctrine of good faith.

In this case, the deduction of the increased production royalties paidby Engelhard to the Veals under the amended leases are eviscerating theaggregate royalties payable to RICT. The increased production royaltiespayable under the Veal leases are now so great that they are almostgreater than the Net Receipts generated from clay mined on all the LeasedProperties and are threatening the Net Receipts from clay mined on theFee Properties. It is unreasonable to think that RICT's predecessor wouldhave entered into a royalty arrangement for 99 years and intended thatits royalties could be devoured by the acts of defendant in amending afew leases.

The Court must consider the language contained within the four cornersof the Indenture. "In deciding whether to imply promises or duties to theterms of a contract, [t]he introduction of an implied term into thecontract of the parties . . . can only be justified when the implied termis not inconsistent with some express term of the contract and wherethere arises from the language of the contract itself, and thecircumstances under which it was entered into, an inference that it isabsolutely necessary to introduce the term to effectuate the intention ofthe parties." Fisher, 223 Ga. App. at 845, 479 S.E.2d 180 (quotingHigginbottom, 251 Ga. at 149(1), 304 S.E.2d 365). In this case, there isno express term which governs the deduction of the increased productionroyalties under the amended leases after the original termination datethereof. One thing is clear. If the increased production royalties underthe Veal leases are deducted from aggregate royalties payable to RICT,then those costs can wipe out all of the royalties payable to RICT thatare generated from clay mined on other Leased Properties as well as theroyalties generated from clay mined on the Fee Properties. In short, itis possible in the future that RICT will receive nothing under theIndenture and defendant will reap all the benefits of mining clay on theProperties owned by RICT. Such a result could not have been intended atthe time the Indenture was executed, therefore, Engelhard'sinterpretation of the Indenture cannot conceivably be what the partiesintended in entering into the royalty arrangement.

The Indenture provides that in return for the right to mine theProperties, Engelhard must pay RICT a royalty calculated by a percentageof the Net Receipts generated by the sale of clay or clay products. Quitesimply, that is the benefit bargained for by plaintiff in this contract.The intent of the parties would be destroyed if the increased productionroyalty deductions under a few amended leases were allowed to completelyeradicate the royalties payable to RICT from clay mining on all of theother Properties. This concept was so fundamental to the agreement thatthe parties need not have memorialized it expressly. It can reasonably beassumed that, with respect to the Leased Properties, RICT expectedreduced royalties after expiration thereof because they were to be net ofproduction royalty payments to the landowners. However, the parties couldnever have intended that production royalty payments to landowners wouldbe used to deplete all of the royalties payable to RICT under theIndenture. Consequently, the implied covenant of good faith and fairdealing should be utilized as a gap-filler in this case in order toeffectuate the intent of the parties.

Although courts are reluctant to rewrite a contract for the parties,they must imply terms or duties when justice, good faith, or fairness sodemand. See Fisher, 223 Ga. App. at 845, 479 S.E.2d 180. RICT's situationfits these criteria, and a limitation onthe deduction of the increased production royalty payments to the Vealsunder the amended leases should accordingly be implied in this contract.

This Court holds that the increased production royalty payments tolandowners under any amended lease will be deducted from the royaltiesgenerated by the mining of clay on that Leased Property only. Thus, theroyalty payments for mining on other Properties will not be affected byan amendment to or extension of any one lease negotiated by Engelhard.

This implied term follows the express language in the contract andeffectuates the intent of the parties without eviscerating the benefit ofthe royalty arrangement to RICT. At the end of the day, Engelhard willstill be able to mine the Properties and deduct its increased costs ofproduction royalties payable to landowners under an amended lease.However, such increased costs will be limited by Engelhard's good faithduty to preserve the royalties payable to RICT for mining on otherProperties under the Indenture. That is, Engelhard may amend any leaseand deduct the increased production royalty rates paid to landowners fromroyalties generated by that Leased Property, but it will not be allowedto have absolute discretionary power to amend leases and destroy thebenefit bargained for in this contract relating to other Leased and FeeProperties. Thus, after the implied term is inserted in bold type, therelevant portion of § 2(e) of the Indenture reads as follows:

[Engelhard] shall not make any alteration or modification of any Lease or other arrangement in connection with such Lease . . . which with respect to the period prior to the normal termination date of such Lease would increase any fixed costs to be paid by [Engelhard] thereunder or would increase the amount of royalties payable by [Engelhard] thereunder with respect to any minerals, ores or substances permitted to be mined by [Engelhard] on the date hereof, unless [Engelhard] agrees to pay such increased fixed costs or additional royalties. With respect to the period after the normal termination date of such Lease, any modification or alteration of any Lease or other arrangement in connection with such Lease which would increase any fixed cost to be paid by [Engelhard] thereunder or would increase the amount of royalties payable by [Engelhard] thereunder can be deducted from royalties payable to RICT generated from clay mined on such Leased Property only.

For the foregoing reasons, plaintiff's motion for partial summaryjudgment on Count II is granted and defendant's motion for summaryjudgment on Count II is denied.

C. Fiduciary Duty

Finally, this Court grants summary judgment for defendant on Count IIIsince there was no fiduciary relationship between RICT and Engelhard.Under Georgia law, a relationship is considered to be confidential "whereone party is so situated as to exercise a controlling influence over thewill, conduct, and interest of another or where, from a similarrelationship of mutual confidence, the law requires the utmost goodfaith." Ga.Code Ann, § 23-2-58 (1996). Although a confidentialrelationship between business people may arise, it is dependant upon thefacts. of each case. See Cochran v. Murrah, 235 Ga. 304, 307,219 S.E.2d 421 (1975). There can be no fiduciary relationship when theparties are engaged in a transaction with each other in an effort tofurther their own separate business objectives. See Parello v. Maio,268 Ga. 852, 853, 494 S.E.2d 331, 332 (1998) (citing Kienel v. Lanier,190 Ga. App. 201, 204, 378 S.E.2d 359 (1989)); see also Manning v.Engelhard Corp., 929 F. Supp. 1508, 1512 (M.D.Ga. 1996)(holding that noconfidential relationship is established in negotiation of mining leaseswhere the agreements were entered into at arm's length and between equalparties)(applying Georgia law).

In this case, the Indenture was negotiated at arm's length for over ayear betweenthe predecessors of these parties. See Sturges Depo., p. 169. It wasclear that both sides were furthering their own business interests duringthese negotiations. As the president of Freeport Sulphur stated, it wasclear that "Southern Clays, Inc. was a seller and a lessor dealing atarm's length with Freeport Sulphur Company as purchaser and lessee."Dufour Affidavit Motion, Def.'s Ex, O, p. 3. Plaintiff has put forth noevidence indicating the existence of a confidential relationship eitherat the time of entering into the Indenture or at some later date duringthe course of subsequent business dealings.

Therefore, plaintiff's contention, that there was a fiduciaryrelationship created as a result of business dealings through the years,is without merit. This is because the mere existence of a certain amountof trust and confidence between two people as the result of doingbusiness together for a number of years, is not, in and of itself,sufficient to find the existence of a confidential relationship. SeeParello, 268 Ga. at 853, 494 S.E.2d 331 (citing Kienel, 190 Ga. App. at203, 378 S.E.2d 359). As a result, there was never any fiduciaryrelationship created between the parties and, thus, no breach of such arelationship. For the foregoing reasons, defendant's motion for summaryjudgment on Count III is granted.


The contract at issue was negotiated for the sole purpose of payingroyalties to one party in return for the right to mine the Fee and LeasedProperties transferred to the other. Although the Indenture permitsamendment of the Leases, it does not explicitly deal with the deductionof increased production royalties under the Leases after the originalexpiration date of these Leases. Therefore, Engelhard's deduction ofthose increased costs from the aggregate royalties payable to RICT overthe last several years, was in violation of the implied covenant of goodfaith and fair dealing. Consequently, this Court has implied a term tolimit such deductions that is in the spirit of the royalty arrangementand is consistent with the intent of the parties to the Indenture. Underthis implied term, increased production royalties payable to a landowneras a result of an amended lease can only be deducted from royaltiesgenerated from clay mined on the particular Leased Property involved andcannot be used to reduce the royalties payable to RICT from mining onother Leased and Fee Properties. Therefore, plaintiff's motion forpartial summary judgment on Count II is granted and defendant's motion forsummary judgment on Count II is denied. Since Engelhard did not violatethe express terms of the Indenture and no fiduciary duty was involved, itis entitled to summary judgment on Counts I and III. It is clear that asa result of this decision, Engelhard has been underpaying RICT theroyalties due it for a number of years. The amount of those underpaymentsis the only issue remaining in this case. The Court will schedule ahearing and take evidence on this issue before entering judgment forplaintiff in this case on Count II. Defendant will be entitled to judgmenton Counts I and III but no judgments will enter until this final issue ofunderpayment is resolved.

It is so ordered.

1. Note that the lease with Vaughn Veron Veal and Howard Veal wascanceled in January, 1993 with the knowledge and concurrence of RICT.See McKenzie Aff., pp. 20-21.

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