## Facts

- Security Plans, Inc. (SPI) sold its credit-insurance business to CUNA Mutual Insurance Society (CUNA) for $3 million plus a contingent “earnout” payable after three years.
- The earnout formula depended on premiums and “loss ratios,” which incorporated claims and claim reserves set by CUNA.
- The agreement gave CUNA broad discretion to operate the business using its “best business judgment” and stated CUNA had no duty to maximize SPI’s earnout.
- During the earnout period, CUNA maintained unusually high claim reserves across its credit-insurance lines, which increased loss ratios and reduced the earnout calculated for SPI’s former book of business.
- After the earnout period, CUNA reduced reserves to more typical levels; SPI asserted the earlier reserve levels reflected an error that distorted the earnout.
- Record evidence included internal materials and testimony suggesting CUNA personnel recognized the reserve levels materially reduced SPI’s earnout and began, but did not complete, efforts to recalculate the earnout using different reserve figures.
- SPI sued, alleging (1) breach of the implied covenant of good faith and fair dealing based on CUNA’s discretionary earnout calculation and (2) separate express breach theories (including issues concerning experience refund deductions).
- The district court granted summary judgment to CUNA on all claims, reasoning the implied-covenant claim lacked evidence of bad faith; SPI appealed.

## Issues

1. Under New York law, can an implied-covenant claim proceed where the contract grants broad discretion and disclaims any duty to maximize an earnout, if evidence permits a finding that the discretion was exercised arbitrarily or irrationally?
2. Did SPI preserve and support its express breach of contract theories sufficiently to avoid summary judgment?

## Decision

- The court affirmed summary judgment for CUNA on SPI’s express breach of contract claims.
- The court vacated summary judgment for CUNA on the implied covenant of good faith and fair dealing claim and remanded.
- The court held that evidence of distorted reserve figures and CUNA’s incomplete corrective efforts created a genuine dispute as to whether CUNA acted arbitrarily in implementing the earnout formula.
- The court rejected the district court’s view that SPI had to show subjective bad faith or wrongful intent to reach a jury on the implied-covenant theory.

## Legal Principles

- New York law implies a covenant of good faith and fair dealing in every contract.
- When a contract grants a party discretion, that party must not exercise the discretion arbitrarily or irrationally, even if the contract gives broad operational latitude.
- Contract language disclaiming a duty to maximize an earnout does not eliminate the implied covenant’s constraint against arbitrary implementation of the agreed mechanism.
- A plaintiff may establish an implied-covenant breach without proving animus or dishonesty if the challenged conduct can be found arbitrary or irrational and inconsistent with the contract’s purpose.
- On summary judgment, courts must draw reasonable inferences for the nonmovant and ask whether a rational factfinder could find a breach.

## Conclusion

The Second Circuit held that SPI raised a triable issue that CUNA’s earnout calculation, driven by unusually high reserves and an abandoned recalculation effort, could constitute an arbitrary exercise of contractual discretion in violation of the implied covenant, while leaving intact summary judgment for CUNA on SPI’s separate express contract theories.


Security Plans, Inc. v. CUNA Mut. Ins. Soc'y, 769 F.3d 807 (2d Cir. 2014)