NY, Delaware Contract Provisions Require Close Study to Navigate

Both New York and Delaware—the two dominant jurisdictions for sophisticated commercial agreements—recognize the implied covenant of good faith and fair dealing.

In New York, the doctrine traces back to Kirke La Shelle Co. v. Paul Armstrong Co., which held that neither party may act to destroy the other’s right to receive the “fruits of the contract.” The Delaware Court of Chancery similarly recognized in Wagner v. BRP Group, Inc. that the covenant “inheres in every contract governed by Delaware law and cannot be eliminated.”

But when a contract grants one party “sole discretion,” the jurisdictions diverge. There are critical distinctions between these jurisdictions, and it’s important to ensure discretionary provisions can withstand judicial scrutiny.

Delaware Doctrine

In Delaware, the covenant arises in two scenarios.

It can “gap fill” when an unforeseen development threatens the parties’ bargained-for expectations and the contract is silent. Where a contract confers discretion, Delaware courts require such discretion to be exercised “reasonably and in good faith,” consistent with what reasonable parties would have agreed at signing.

Parties in Delaware can’t eliminate the covenant of good faith and fair dealing in their contract. “Existing contract terms control, however, such that implied good faith cannot be used to circumvent the parties’ bargain,” as the Delaware Supreme Court stated in Dunlap v. State Farm Fire & Cas. Co. Put simply, the covenant can’t be used to “rewrite the contract to appease a party who later wishes to rewrite a contract it now believes to have been a bad deal.”

New York Contractual Deference

While New York doesn’t use Delaware’s explicit “gap-filling” terminology, the covenant operates similarly in practice when conduct falls outside express contractual terms but frustrates the agreement’s core purpose. New York courts also enforce the covenant where contractual discretion is applied to deprive another party of its rights.

In Richbell Information Services v. Jupiter Partners, the First Department upheld a good faith and fair dealing claim where the complaint alleged the defendant exercised its contractual power to veto an initial public offering “for an illegitimate purpose and in bad faith.”

Nevertheless, in New York, the covenant “cannot negate express provisions of the agreement” and isn’t “violated where the contract terms unambiguously afford [a party] the right to exercise its absolute discretion.” Where the contract explicitly authorizes the conduct, the actor’s motive is generally irrelevant.

This principle has been applied to protect a lender with authority to deny funding requests “in its sole and absolute discretion” and for “any other reason determined by [Capital One] in its sole and absolute discretion.” Similarly, New York courts have enforced termination rights exercisable “for any reason whatsoever” or “no reason at all.”

The 2020 decision in Seeking Valhalla Trust v. Deane provides helpful guidance for sponsors and managers drafting New York-governed LLC agreements that provide them with discretion over income allocation.

There, an LLC operating agreement granted one manager “express sole discretion to reallocate sharing ratios, even down to zero, at any time.” Plaintiffs—beneficiaries of a trust holding membership interests—challenged the manager’s decision to reallocate their sharing ratios to zero, alleging breach of the operating agreement, breach of the implied covenant of good faith and fair dealing, and breach of fiduciary duty.

The First Department affirmed dismissal of all claims, holding that the manager “did not breach the operating agreement or the covenant of good faith and fair dealing by exercising her express sole discretion to reallocate sharing ratios, even down to zero, at any time.” The court found the discretionary language “unambiguous” and concluded the manager “merely exercised the very power given to her by the operating agreement.”

New York’s approach is permissive—but it isn’t unlimited. Courts will invoke the implied covenant when necessary to avoid rendering a contractual promise illusory.

In Southern Telecom Inc. v. ThreeSixty Brands Grp., LLC, a federal court applying New York law examined a licensing agreement that granted the licensor “sole and absolute discretion” over product approvals. The court distinguished between discretion to evaluate applications and discretion to reject applications without any consideration.

Even with “sole and absolute discretion” language, the covenant required the licensor to conduct a good-faith review of applications rather than “simply to refuse to consider STI’s submissions because they came from STI.” To hold otherwise “would be to deprive STI of the fruits of its contract and render the agreement illusory.”

Thus, a litigant must rely on more than the phrase “sole discretion” to contract around the covenant of good faith and fair dealing.

Delaware’s ‘Sole Discretion’

In Delaware, “the mere vesting of ‘sole discretion’ [does] not relieve the [holder] of its obligation to use that discretion consistently with the implied covenant of good faith and fair dealing.” The Court of Chancery has observed that when a contract grants “sole discretion,” that may provide more reason—not less—for the implied covenant to apply.

Though case law in Delaware is less certain, helpful guidance has emerged. For example, while an LLC agreement may eliminate fiduciary duties, Delaware courts have held that the implied covenant remains available, though they are reluctant to use it to “re-introduce fiduciary review through the backdoor.”

The Delaware Supreme Court has also implied that parties seeking to narrow the scope of the implied covenant should consider adding language that the discretion holder may “consider only such interests and factors as it desires, including its own interests,” and has no “duty or obligation to give any consideration to any interest of or factors affecting the entity or its investors.”

As long as the parties use careful drafting, it appears likely that a Delaware court would enforce a contractual provision that confers discretion to a party to do something self-interested.

Practical Drafting Considerations

In New York, explicit “sole and absolute discretion” language, combined with broad authority to act for “any reason” and without good faith qualifiers, can effectively override covenant obligations. Clarity and comprehensiveness in granting unfettered authority is key. Effective New York clauses should:

• Include “sole and absolute discretion” language
• Explicitly authorize action “for any reason whatsoever or no reason at all”
• Detail the scope of discretionary authority
• Omit good-faith qualifiers that appear elsewhere in the agreement
• Demonstrate intentional drafting by contrasting provisions that are subject to express good-faith standards
• Ensure the counterparty retains some non-illusory contractual benefit

Delaware courts have required more sophisticated drafting to achieve similar results. Effective Delaware strategies should:

• Include unambiguous language waiving all fiduciary duties
• Detail the scope of discretionary authority
• Specify permissible considerations, including express authorization to consider the decision-maker’s own interests
• Allocate economic risks explicitly, especially around exits, waterfalls, earnouts, and capital events
• Address foreseeable contingencies to avoid judicial gap-filling

The goal is to leave the covenant no meaningful role to play. Contractual discretion is economic power. Whether that power survives litigation depends on jurisdiction and drafting precision.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law, Bloomberg Tax, and Bloomberg Government, or its owners.

Author Information

Jennifer Fiorica Delgado is a partner at Lowenstein Sandler in the commercial litigation practice.

Gavin J. Rooney is a partner at Lowenstein Sandler and chair of the business and class action litigation practice.

Write for Us: Author Guidelines