Drafters love the phrase “in its sole discretion.” Put it next to a contractual right and you have told your client it can do the thing for any reason, or no reason, and no one can second-guess you.
You may have given really bad advice.
In 111 West 57th Investment LLC v. 111 W57 Mezz Investor LLC, the plaintiff was the largest equity investor — $65 million — in the venture to build 111 West 57th Street, the slender luxury tower on Billionaires’ Row. The project carried $725 million in debt, including a $325 million mezzanine loan held by Apollo entities. When that loan went into technical default, it was restructured into a $300 million senior piece and a $25 million junior piece. The junior loan was secured by the venture’s equity in the project — most of which was the plaintiff’s money.
What the plaintiff alleged happened next is the stuff of a business-school cautionary tale. Apollo, it claimed, assigned the $25 million junior loan to a new player, Spruce Capital, at face value — and Spruce promptly used a strict foreclosure under the Uniform Commercial Code to seize the venture’s equity and extinguish the loan. Financial models in the record reportedly showed roughly $600 million of equity value sitting on top of that $25 million loan. In a strict foreclosure, all of that collateral goes to the lender; in a public auction, any surplus above the debt would have flowed back to the venture. The plaintiff alleged that Apollo, Spruce, and the project’s sponsor had cooked up a “backroom deal” to wipe out its equity with the sponsor quietly keeping carried equity and staying on as developer.
The legal hook was the implied covenant of good faith and fair dealing — the promise, implicit in every contract, that neither side will do anything to destroy the other’s right to receive the fruits of the bargain. The catch was that the loan documents gave Apollo “sole discretion” over assignment. The intermediate appellate court had thrown out the implied-covenant claim on exactly that basis: if Apollo had an absolute right to assign, the reasoning went, the implied covenant could not be used to limit it.
The New York Court of Appeals disagreed. The holding is the part worth tattooing on the inside of every dealmaker’s eyelids: a party’s “sole discretion” over a contractual right does not exempt that party from the implied covenant with respect to that right. Even a discretionary right cannot be exercised in bad faith to frustrate the other side’s benefit of the bargain. The court reinstated the implied-covenant claim against Apollo and sent it back for further proceedings. (It left the dismissal of the plaintiff’s tortious-interference claims in place.)
But this ruling is not a license to attack every discretionary clause. The court was careful to preserve a separate, narrower rule: a party’s sole discretion to terminate a contract remains immune from the implied covenant. And it stressed that the specific words of the discretion grant, read together with the contract as a whole, define the scope of any implied duty. The covenant fills gaps consistent with the bargain; it does not rewrite the deal. The court also noted its approach lines up with Delaware law, which has long held that conferring discretion is a reason for the implied covenant to apply, not a reason to discard it.
What Obvious Lessons Did I Relearn?
“Sole discretion” is not a magic phrase that immunizes bad behavior. Build and keep a record of the legitimate business reasons for your decision. The difference between a defensible exercise of discretion and a breach of the implied covenant is often the difference between a documented rationale and a smoking gun email that crushes your case.
Parties who are subject to another party’s “sole discretion” may have more leverage than you may have assumed. A right exercised arbitrarily, irrationally, or as part of a scheme to strip you of your bargain can be challenged, even when the contract says the other side decides “in its sole discretion.” Preserve the communications and the financial models that show what the discretion was really being used to accomplish.
Regardless of which side of the table I am sitting on, I need to be precise or vague about what discretion means. The term “sole and absolute discretion” may be different than “sole discretion” depending upon the state law governing the contract.
A well-drafted operating agreement is the single most important document in a closely held business. Capicotto shows the flip side of that truth: the agreement will be enforced as written, including the parts you wish you had negotiated differently. The time to fix that is at the drafting table, not in an appellate brief.
David Seidman is the principal and founder of Seidman Law Group, LLC. He serves as outside general counsel for companies, which requires him to consider a diverse range of corporate, dispute resolution and avoidance, contract drafting and negotiation, real estate, and other issues. He can be reached at david@seidmanlawgroup.com or 312-399-7390.
This blog post is not legal advice. Please consult an experienced attorney to assist with your legal issues.
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