§ 1.6.5 APPLICATION IN THE EMPLOYMENT CONTEXT.

• Jurisdiction: Arizona

§ 1.6.5 Application in the Employment Context. Courts began to recognize the covenant of good faith and fair dealing in a contract of employment at will in the 1970s. The seminal case, Monge v. Beebe Rubber Co.,¹⁸ relied on earlier public policy exception cases for its logic:

We hold that a termination by the employer of a contract of employment at will which is motivated by bad faith or malice or based on retaliation is not [in] the best interest of the economic system or the public good and constitutes a breach of the employment contract.¹⁹

As a consequence of this theory, employees terminated because of alleged malice or bad faith on the part of the employer could bring contract actions against the employer for breach of the implied covenant of good faith and fair dealing. Courts analyzed the whole employment relationship to determine whether the covenant might provide a remedy in a particular case. Factors considered by the courts in such an analysis included, but were not limited to: (1) extraordinary length of service; (2) good employee performance; (3) employer assurances that employment would continue; (4) employer practice of not terminating except for cause (whether based on oral or written policy); and (5) no prior warning that the employee's job was in jeopardy.²⁰ This broad approach was embraced by several states, including Montana²¹ and California.²² However, in Guz v. Bechtel National, Inc., the California Supreme Court narrowed this broad view of implied covenant claims, holding that, to the extent prior cases "suggest that the implied covenant may impose limits on an employer's termination rights beyond those either expressed or implied in fact in the employment contract itself," they are disapproved.²³

In Fortune v. National Cash Register Co.,²⁴ the Supreme Judicial Court of Massachusetts also applied a more restrictive interpretation of the covenant of good faith and fair dealing in the employment context. The contract at issue was a classic terminable at will employment contract. The contract itself reserved to the parties an explicit power to terminate the contract without cause on written notice. With respect to compensation, the contract provided for a weekly salary in a fixed amount plus a bonus for sales made within the territory assigned to the salesman. The bonus credit would be provided as follows: (1) 75% if the territory was assigned to the salesman at the date of the order, and (2) 25% if the territory was assigned to the salesman at the date of delivery and installation. On November 28th an order was placed within the salesman's territory for a purchase price of approximately $5,000,000. The salesman had participated in the sale. On January 6th he found an envelope on his desk at work that contained a termination notice dated December 2nd. Upon discussing the matter with his branch manager, the salesman was allowed to "stay on" to expedite delivery of the sale as well as to work on other accounts. He was, however, placed in a position entitled "sales support." He did receive 75% of the bonus commissions, but when he asked about the remaining 25%, he was told "to forget about it." Approximately 18 months after receiving his termination notice, the salesman was asked to retire. He refused and was fired.

Under the express terms of the contract, the salesman had received all the bonus commissions to which he was entitled. However, the plaintiff argued that he was entitled to a jury determination on the employer's motives in terminating his services under the contract and in finally terminating him. The court agreed. While recognizing the employer's need for control over its work force, the court held that where, as here, commissions are to be paid for work performed by the employee, the employer's decision to terminate an at-will employee should be made in good faith. The court held that when an employer seeks to deprive an employee of compensation by terminating the employment relationship on the brink of successfully earning a commission, the employer has acted in bad faith.²⁵ The employer's motivation, therefore, becomes a critical factor in determining the applicability of the implied covenant of good faith and fair dealing. Courts have applied the covenant to prevent overreaching by employers and the forfeiture by employees of benefits almost earned by the rendering of substantial services.²⁶

A later decision from the Massachusetts Supreme Court, explaining the rationale behind the rule enunciated in Fortune, stated: "[O]ur goal is and has been simply to deny [the employer] any readily definable financial windfall resulting from the denial to [the employee] of compensation for past services."²⁷ This approach to applying the covenant of good faith and fair dealing in the employment context has been approved by a number of other jurisdictions.²⁸ These jurisdictions appear to restrict recovery in that a discharged employee does not have the right to sue for backpay, frontpay, or reinstatement, but only for benefits due and compensation for services rendered prior to the date of termination.

The first Arizona employment law case to consider the theory of the implied covenant of good faith and fair dealing was Wagenseller v. Scottsdale Memorial Hospital.²⁹ While stating that the covenant of good faith and fair dealing existed in every contract, the court refused to follow the California decisions which applied it in the employment context as a broad exception to the employment at will presumption. The court reasoned that the very nature of the employment at will agreement precluded any claim for a prospective benefit such as the continuation of employment. Opining that the adoption of such a rule would tread perilously close to abolishing completely the at-will doctrine, and establish by judicial fiat the benefits which employees could and should get only through collective bargaining agreements or tenure provisions, the court expressly recognized that adopting such a rule would place undue restrictions on the employer's legitimate exercise of managerial discretion. The court held that the covenant of good faith and fair dealing did not create a duty for the employer to terminate the employee only for good cause.³⁰

Wagenseller did not, however, totally foreclose the application of the covenant of good faith and fair dealing in employment agreements. The court, citing the Fortune case with approval, stated that the covenant of good faith and fair dealing would be recognized as a protection against an employer's desire to avoid the payment of benefits already earned by the employee.

We do, however, recognize an implied covenant of good faith and fair dealing in the employment-at-will contract, although that covenant does not create a duty for the employer to terminate the employee only for good cause. The covenant does not protect the employee from a "no cause" termination because tenure was never a benefit inherent in the at-will agreement. The covenant does protect an employee from a discharge based on an employer's desire to avoid the payment of benefits already earned, such as . . . sales commissions . . . but not the tenure required to earn . . . pension and retirement benefits . . . [T]o the extent, however, that the benefits represent a claim for prospective employment, [the] claim must fail.³¹

Thus the court drew a distinction between those elements of an employment contract that were "bargained for" as part of the contract itself and those imposed judicially as a matter of equity. The implied-in-law covenant of good faith and fair dealing protects the right of the parties to an agreement to receive the benefits of the agreement into which they have entered. The denial of a party's right to those benefits, whatever they are, will breach the duty of good faith implicit in the contract. The relevant inquiry always will focus on the contract itself, to determine those terms to which the parties have agreed.³² Presumably then, the hindering of the performance of an employment contract for a term would give rise to an action based upon the covenant of good faith and fair dealing, because "tenure" was a benefit forming part of the bargain. Additionally, deceptive or obstructive actions on the part of an employer could constitute a breach of the implied covenants of the contract, even if they did not breach the literal terms of the contract.³³

The issue of the application of the covenant of good faith and fair dealing as it relates to an employment agreement for a term was addressed by the Arizona Court of Appeals in Lindsey v. University of Arizona.³⁴ In that case the court held that the mere fact that an employee is terminated before the full term of employment is completed does not entitle the employee to maintain an action both for breach of contract and breach of the covenant of good faith and fair dealing. Lindsey had signed a one-year...