On May 28, 2026, the Court of Appeals issued a decision in 111 W. 57th Inv. LLC v. 111 W57 Mezz Inv. LLC, 2026 NY Slip Op. 03376, holding that even where a contract gives a party the right to act in its sole discretion, it still must exercise that discretion in good faith, explaining:
Every contract contains an implied covenant of good faith and fair dealing. The implied covenant of good faith and fair dealing 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. Said simply, the covenant requires the parties to perform under the contract in a reasonable way. Even where a contract contemplates the exercise of discretion, the implied covenant includes a promise not to act arbitrarily or irrationally in exercising that discretion.
However, the implied covenant is not without limits. Courts will imply a covenant only in aid and furtherance of other terms of the agreement of the parties. It is a heavy burden to succeed on such a claim, because the plaintiff eventually must prove that the particular unexpressed promise sought to be enforced is in fact implicit in the agreement when viewed as a whole. In evaluating such a claim, the Court looks to what the parties would have expected under the contract: the Court will infer that contracts include any promises which a reasonable person in the position of the promisee would be justified in understanding were included at the time the contract was made.
In this case, plaintiff alleges that Apollo violated the implied covenant under the Pledge Agreement by assigning the junior mezzanine loan to Spruce as a part of a backroom deal intended to push plaintiff out of the Project’s capital structure and benefit from the windfall of equity that would flow to Spruce (and others, including Apollo) thereafter. Assuming without deciding that Apollo had sole discretion to assign to the junior mezzanine loan under the terms of the Pledge Agreement and Loan Agreement, we disagree with the Appellate Division’s conclusion that such discretion exculpated Apollo from the implied covenant. We instead hold that the second amended complaint sufficiently alleged a claim against Apollo for breach of the implied covenant.
The Appellate Division’s dismissal of the implied covenant claim against Apollo rested on that Court’s view that Apollo’s absolute discretion to assign the junior mezzanine loan negated any implied covenant with respect to assignment of the junior mezzanine loan. Its decision relied on First Department cases that are in tension not only with other First Department decisions, but also with the general consensus among the other Departments, which instead hold a party cannot exercise discretion in a way that frustrates another party’s rights under the contract.
We concur with the prevailing view among the Appellate Division departments—that a party’s sole discretion with respect to a right does not exculpate that party from complying with the implied covenant with respect to that right. Although parties to a contract are basically free to make whatever agreement they wish, no matter how unwise it might appear to a third party there exists an unavoidable tension between the concept of freedom to contract and the equally fundamental belief that an enlightened society must to some extent protect its members from the potentially harsh effects of an unchecked free market system. In light of those competing interests, rightly or wrongly, society has chosen to intervene in various ways in the dealings between private parties, for example by mandating the express or implicit inclusion of certain substantive or procedural provisions in various types of contracts. Indeed, one of those implicit substantive provisions is the implied covenant, which has the primary purpose of ensuring 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, when that conduct is inconsistent with the other terms of the contractual relationship,” and yet not negotiated for in advance.
This doctrine is even more important where a contract contemplates the exercise of discretion, or in other words awards one party the freedom to act in ways the contract may not directly foresee. Accordingly, the implied covenant obligates the party with discretion act in good faith, and not arbitrarily or irrationally, when exercising that discretion. A promisor’s discretion may not be used to violate a promise that a reasonable person in the position of the promisee would be justified in understanding was included.
Finally, our decision is consistent with Delaware law, which has repeatedly held that the implied covenant imposes a good faith and fair dealing obligation when a contract confers discretion on a party.
(Internal quotations and citations omitted).