Don’t Leave It to a Court to Figure Out Contract Conditions

Parties often need to include conditions to the performance obligations of one or both parties in a contract. Common examples include conditions requiring that one party give consent before the other party’s rights may be exercised (e.g., “Tenant may not assign the lease without Landlord’s consent”) or that one party be “satisfied” with a product or performance before payment or other action is due (e.g., “Publisher will market Author’s text if Publisher is satisfied with its content”). But contract drafters should be wary—these conditions can be a source of much litigation.

You can increase the likelihood that conditions requiring consent or satisfaction will be enforced if you include a clear statement of the standard for consent or satisfaction in the agreement. Two common standards for determining satisfaction are

  1. the subjective, good faith test; and
  2. the objective, reasonable person test.

Under the good faith test, the party receiving performance is the sole judge of his or her satisfaction, but only if he or she acts in genuine good faith. Reasonableness isn’t required if the decision is made in good faith. Locke v Warner Bros., Inc. (1997) 57 CA4th 354, 363. In contrast, the reasonable person test allows dissatisfaction to excuse a party’s performance only if a reasonable person in the circumstances would also have been dissatisfied.

Which test applies depends on the parties’ intent as expressed in the contract, or, in the absence of any expressed intent, on the facts and circumstances of the case. See FEI Enters., Inc. v Yoon (2011) 194 CA4th 790, 800.

If you don’t specify a standard, the courts will impose one, and they prefer the reasonable person standard. However, if the condition of satisfaction involves matters of taste, fancy, or judgment, courts apply the good faith standard.

Unfortunately, whether a court will apply the reasonable person standard or the good faith standard isn’t predictable, so it’s best to specifify the standard in the contract.

Here are sample provisions you could include in a contract:

Subjective good faith standard:

The obligation of _ _[name of party]_ _ to _ _[describe performance that is conditional; e.g., finance production of Prototype A]_ _ is conditioned on its satisfaction with _ _[describe performance, characteristic, or event that must be satisfactory; e.g., Prototype A’s ability to perform the operations specified in Exhibit 1 to the Research and Development Agreement]_ _. _ _[Name of party]_ _ will make this determination in its sole discretion and according to its own standard of satisfaction with _ _[e.g., Prototype A’s performance]_ _, as long as _ _[name of party]_ _ acts in good faith.

 

Objective, reasonable person standard:

The obligation of _ _[name of party]_ _ to _ _[describe performance that is conditional; e.g., finance production of Prototype A]_ _ is conditioned on its satisfaction with _ _[describe performance, characteristic, or event that must be satisfactory; e.g., Prototype A’s ability to perform the operations specified in Exhibit 1 to the Research and Development Agreement]_ _. _ _[Name of party]_ _ will make this determination in good faith and as a reasonable person would under the circumstances.

Get more on different types of conditions and specific examples of their use in business agreements in CEB’s Drafting Business Contracts: Principles, Techniques and Forms, chap 10 , and California Law of Contracts, chap 6.

Other CEBblog™ posts you may find useful:

© The Regents of the University of California, 2018. Unauthorized use and/or duplication of this material without express and written permission from this blog’s author and/or owner is strictly prohibited.

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