On December 19, 2022, Justice Chan of the New York County Commercial Division issued a decision in MLCJR, LLC v. PDP Group, Inc., 2022 NY Slip Op. 34345(U), holding that even when a contract grants a party absolute discretion, that discretion may not be exercised arbitrarily or irrationally, explaining:
The starting point for analyzing the likelihood of Plaintiffs’ success on the merits, is paragraph 3 of the GAI, which provides that:
Upon Surety’s [i.e. Defendants’] written demand, Indemnitors [i.e; Plaintiffs] shall promptly deposit with Surety a clean, irrevocable letter of credit on a form and from a bank acceptable to Surety, or shall provide another form of collateral acceptable to Surety … in the amount of any reserve Surety establishes for any existing liability or claim, and or any expenses associated therewith, whether or not any assertion or payment of such liability, claim, or expense has been made at the time of the Surety’s demand. Further, Indemnitors expressly and specifically agree that Surety in its sole discretion and for any reason may, by written demand, require Indemnitors to provide the Surety within ten (10) days collateral, as defined herein, in the amount representing the total of any undischarged liability under the Bond as determined by the Surety in its sole discretion. In the event of any increases in Surety’s undischarged liability, Indemnitors shall supplement the Collateral to match the increase. * * * * To the fullest extent allowed by law, lndemnitors waive any and all defenses or challenges to the provision of collateral pursuant to this Agreement. Indemnitors further expressly stipulate and agree that Surety will have no adequate remedy at law should Indemnitore fail to post any collateral required herein, and agree that Surety is entitled to specific performance of the obligation .to post collateral.
There is no dispute that collateral security provisions are enforceable under applicable New York law. At issue is whether the
amount demanded for collateral security must be reasonable notwithstanding the language of the GAI requiring that Plaintiffs post collateral in the Surety’s “sole discretion and for any reason” [and] “in the amount representing the total of any undischarged liability under the. Bond as determined by the Surety in its sole discretion.”Defendants argue that based on the plain language of the Collateral Provision no reasonableness requirement can be inferred and that cases relied on by Plaintiffs are not the contrary as they involved different factual circumstances – specifically involving when the demand for collateral was made pursuant to provision related to the surety’s potential liability for claims in pending or
anticipated litigation. Contrary to Defendants’ argument, under New York law, the principles underlying the reasonableness requirement are not limited to circumstances where a surety seeks collateral for claims related to pending or potential litigation. Instead, the precedent broadly holds that equitable remedy of specific performance of collateral security provision depends on the reasonableness of a demand. In this regard, because a grant of specific performance is discretionary, despite the language of the GAI stating that Plaintiffs will post collateral in the full amount of the Bond, Defendants are not automatically entitled to specific performance of this obligation.As for the claim for breach of the implied duty of good faith and fair dealing, under New York law, every contract implies a covenant of good faith and fair dealing in the course of performance. This covenant embraces a pledge that neither party shall do anything which will have the effect of destroying or injuring the right of the other party to receive the fruits of the contract. Moreover, as noted by Plaintiffs, when, as here, the contract contemplates the exercise of discretion, this pledge includes a promise not to act arbitrarily or irrationally in exercise of discretion.
Although the reasonable standard applies to Defendants’ demand for collateral under the GAI and the amount of the demand cannot be arbitrary and irrational, Plaintiffs have not established that they will succeed on the merits of their claims for breach of contract and breach of the implied duty of good faith and fair dealing. Specifically, it cannot be said on this record that Defendants’ demand for amount of the entire exposure under the Bonds was unreasonable or lacked a good faith basis. Thus, to the extent Plaintiffs could show that the waiver provision does not apply to a challenge to the amount of collateral sought, they have not demonstrated likelihood of success on the merits.
(Internal quotations and citations omitted).