September 27, 2014

Is there a duty of good faith in negotiation? (Part 2)

Posted in Negotiation by Gene Killian |

I’ve read a lot of books on negotiation over the years, and attended a lot of seminars. And, of course, I’ve negotiated a lot of agreements myself. (Some seemed like a good idea at the time…) I think my favorite negotiation teacher ever is Professor Gerald Williams of Brigham Young University Law School.  Professor Williams has a dry sense of humor and emphasizes “game theory” in negotiations. His basic premise is that there are two types of negotiators in this world: aggressives (the “Rambo” crowd) and cooperatives (the “Getting to Yes” crowd).  

Aggressives play well with other aggressives, and cooperatives play well with other cooperatives. But, according to Professor Williams, these personality types don’t play well with each other. That’s because their mindset is so different.  Aggressives are most concerned with “winning” the negotiation, while cooperatives tend to focus on crafting what they consider to be a fair resolution for both sides. Since aggressives aren’t primarily concerned with fairness, cooperatives eventually tend to become quite unhappy with them, and negotiations tend to break down. Conversely, attempts at conciliation by cooperatives are viewed as silly signs of weakness by aggressives, to be exploited.

But is “fairness” ever a legal duty in negotiation? A recent decision from the federal court here in New Jersey discussed that concept. In West Palm Beach Hotel, LLC v. Atlanta Underground, LLC (D. N.J. Sept. 17, 2014), the parties entered into a letter of intent with respect to the potential sale of a hotel. The purchase price was set at $13,750,000, but the letter of intent stated that it was only “an indication as to the basic terms of the proposed transaction and…not a binding agreement.” West Palm (the eventual plaintiff) later sent an email to Atlanta (the eventual defendant) seeking to boost the purchase price to $14,250,000. But Atlanta contended that the original $13,750,000 price term was binding.

West Palm then proposed a mechanism to resolve the dispute, suggesting that the parties enter into a contract providing for a purchase price of $14.25 million, but also providing for the additional $500,000 in purchase price (over the $13.75 million that Atlanta contended was the binding price) to be placed in escrow. The parties would later engage in dispute resolution proceedings to determine whether Atlanta possessed an enforceable right to purchase the property for $13.75 million; if not, the escrowed amount would revert to Atlanta.

Atlanta said no to the (creative) proposal. West Palm then filed suit to declare the letter of intent null and void.

One of the issues in the suit was whether West Palm’s offer to resolve the dispute was an inadmissible settlement communication under Federal Rule of Evidence 408. (West Palm wanted to introduce the offer as evidence of its effort to negotiate in good faith.) The Court, applying a bit of judicial legerdemain, wrote that West Palm’s proposal to close title conditionally at a higher price was “not technically a settlement communication” because it “did not seek to resolve or compromise either side’s assertion of their rights, but instead sought to allow the parties to get the benefit of the [sale], while preserving the dispute over the purchase price.”  (Huh?)

As to Atlanta’s argument that West Palm had failed to negotiate in good faith, the Court first noted that “defining what type of conduct constitutes bad faith or good faith in the context of negotiating an agreement is a concept that defies precise definition.” Quoting a decision from the Seventh Circuit, the Court wrote: “’Good faith’ is no guide. In a business transaction both sides presumably try to get the best of the deal. That is the essence of bargaining and the free market. And in the context of this case, no legal rule bounds the run of business interest. So one cannot characterize self-interest as bad faith. No particular demand in negotiations could be termed dishonest, even if it seemed outrageous to the other party. The proper recourse is to walk away from the bargaining table, not to sue for ‘bad faith’ in negotiations.”

The Court wrote that, in any event, West Palm hadn’t acted in bad faith: “After Defendant objected to an increase in the purchase price, Plaintiff offered to finalize an agreement with the Defendant on terms that would have put $500,000 into escrow while the parties litigated their dispute over whether the parties were bound by the price term indicated in the LOI. Plaintiff was willing to put potential increased sale proceeds at risk, in the event of an adverse ruling, to finalize the sale agreement.”

A few observations about this case.

First, West Palm’s proposal certainly seems to have been a smart effort at trying to find resolution within the weeds of a dispute.  Always look for potential options to save a deal. You may succeed, and, if you don’t, you’ll be the cowboy wearing the white hat if ugliness later develops.  

Second, a problem with reading cases like this is that we’re constrained by the cold record. We obviously don’t know all of the moves that were made in the negotiation. What if Atlanta objected to the escrow arrangement, for example, but was willing to agree to pay an additional $500,000 in the event it lost the subsequent proceeding?  Would that have changed the tenor of the negotiation?

Third, while statements made in settlement negotiations are normally inadmissible under court under Federal Rule of Evidence 408 and its state court equivalents, you can never assume that a settlement communication will remain confidential. My former law partner used to call this the “New York Times” rule: If you wouldn’t want to see it on the front page of the New York Times, don’t say it.

You can read the West Palm case by clicking here.

-        Gene Killian