Seventh Circuit Broadly Interprets Contractual Duty of Good Faith

In Wilson v. Career Education Corp. the plaintiff was a recruiter for a culinary school owned by the defendant. The school had an incentive plan which provided a monetary bonus to employees if a student that they recruited met certain milestones while the employee was still employed by the school. The plan (which the court interpreted under contract law principles) granted the school the right to modify or terminate the plan “for regulatory compliance purposes or for any other reason that CEC determines, in its sole discretion.”

In October of 2010, the Department of Education issued a regulation banning bonuses such as the one provided for in the program, effective July 1, 2011. The defendant terminated its bonus plan as of February 28, 2011, citing compliance with the new regulation as the reason. The plaintiff sued for lost bonuses for the period February 28 to July 1. Seeking class action status, the plaintiff claimed that if applied to all recruiters, the damages would total more than $5 million.

Reversing a lower court dismissal, the Seventh Circuit Court of Appeals held that the plaintiff could proceed with his suit. As explained by the court, despite the grant of broad discretion to terminate the plan “for any other reason” that the defendant determined in its sole discretion, the defendant was bound to exercise its discretion in good faith. In effect, the court found that the explanation given (compliance with regulations) made no sense, because the termination date was well in advance of the effective date of the regulations. The court held that the plan had to be interpreted in a manner consistent with the reasonable expectations of the parties, and that the early termination could be shown to defeat those expectations.

Illinois courts recognize that parties exercising discretion under a contract must do so in good faith. This means that a party cannot unfairly defeat the reasonable expectations of the other contracting party. So, parties in business dealings must tread carefully in exercising contractual discretion, even if the contract itself appears to leave such discretion virtually unfettered.

Although the duty of good faith and fair dealing governs the exercise of contractual discretion, it will not be used to re-write a contract. If a contract’s terms are clear and unambiguous and do not rely upon the exercise of discretion by any party, they will be strictly enforced by courts, even if the results are harsh for the other contracting party.