The first state to accept the common law implied-in-fact (good cause) contract exception

In this Section, I will examine to what extent private-sector employees can obtain just cause protection under the implied-in-fact (good cause) contract exception. Moreover, I wish to show that this exception is not as vague as presumed by the Reporters of the Third Draft. The latter held that

‘This Restatement does not adopt vague, conceptually ungrounded doctrines such as the “implied-in-fact” contract theory, which enjoyed support for a time in the California courts.’ ⁷⁷³

The implied-in-fact contract theory is still good law in California, and adopted among others in Kansas, New Mexico, Utah, Idaho, Connecticut and Arizona.⁷⁷⁴ The rationale behind the rejection of this exception by other states is that they believe that to accept this exception, this, in effect, would eliminate the requirement of mutuality of obligation – the exchange of independent consideration – under the contract.⁷⁷⁵

In examining the implied-in-fact (good cause) contract exception, I will take the decision of California’s Court of Appeal in the landmark case of Pugh (1981) as a starting point, because this Court was the first in the United States to hold that an implied-in-fact (good cause) contract could overcome the presumption of at will. In brief, it held that from the totality of circumstances it

773 ALI Employment Law Draft No. 3, Chapter 3, § 3.02, p. 6.

774 Morriss (Kan 1987); Kestenbaum (N.M. 1988); Berube (Utah 1989); Metcalf (Idaho 1989); Torosyan (Conn. 1995); Demasse (Ariz. 1999). See also Cameron 2001, p. 4.

775 See Berube (1989), 771 P.2d 1033, 1045.

may derive that an employer may discharge an employee with good cause only.

The California Supreme Court affirmed the decision of Pugh (1981) in Foley (1988).⁷⁷⁶

12.2 Pugh

12.2.1 Facts and holding

Wayne Pugh began working for See’s in 1941 as a dishwasher. In thirty-two years of employment with See’s, he worked his way up the corporate ladder from dishwasher to production manager, to vice-president in charge of production, and member of the Board of Directors. When Pugh started work for See’s in 1941, the President frequently told him that ‘if you are loyal and do a good job, your future is secure.’ His successors, too, had a practice of only terminating administrative personnel for good cause. During the entire period of his employment, there had been no formal or written criticism of Pugh’s work.

No complaints were voiced at the annual meetings preceding each holiday season, and he was never denied a raise or bonus. He neither received notice that there was a problem that needed correction, nor any warning that any disciplinary action was being contemplated. In 1973, in a meeting with the President, where he had been expected to be told of another promotion after being congratulated on the increased production in the 1973-edition of See’s newsletter, Pugh was dismissed without a reason. When Pugh asked the President for a reason, he was told that ‘he should look deep within himself to find the answer’. Pugh brought the case to trial before a jury. He alleged he had been dismissed in breach of contract and for reasons, which offended public policy. The employer filed for a motion for non-suit based on lack of sufficient evidence to establish a breach of contract or violation of public policy.⁷⁷⁷ The trial superior court granted the employer’s motion. Subsequently, Pugh went to the Court of Appeal, for which Justice Grodin wrote the decision.

The Court of Appeal held that it was error to grant the motion for non-suit with regard to breach of contract. The employee had presented sufficient evidence to justify that he could be terminated only for good cause. The Court of Appeal held that, if parties have agreed, expressly or impliedly, the employee could be terminated for good cause only, the employee had presented enough evidence. The Pugh Court held that in the case before it, there were facts in evidence from which the jury could determine the existence of an implied promise, deriving from the duration of plaintiff’s employment, the commendations and promotions he received, the apparent lack of any direct criticism of his work, the assurances had been given of continued employment and the employer’s acknowledged policies.⁷⁷⁸

776 For Foley (1988), see below under § 12.2.4. See also Estreicher and Robbins 1989, p. 2.

777 Black’s Law Dictionary defines a motion as a written or oral application requesting a court to make a specified ruling or order.

778 Pugh (1981), 116 Cal.App.3d 311, 316-319.

12.2.2 At-will rule: presumption

In building up its theory, the Pugh Court reviewed the legal history of the at-will rule. It held that, historically, the ancient law of master and servant did not provide an at-will rule. Based on the English Rule, the presumption was that employment was for a period of one year, which employment could be terminated for cause only.⁷⁷⁹ The law of master and servant in the United States, however, underwent remodeling into at-will employment in the nineteenth century. Contrary to most countries, which decided to enact just cause legislation to protect employees against the negative effects of the Industrial Revolution, the undergirding principle of employment contracts in the United States became the at-will rule.⁷⁸⁰ In effect, the superior bargaining power of the employer became a device for guaranteeing to management unilateral power to make rules and exercise discretion. This development brought with it a gradual weakening of the traditional presumption of the one year rule, to a rule that general hiring is prima facie a hiring at will as reflected in the California Labor Code Section 2922.⁷⁸¹

Still, the Pugh Court stressed, the at-will rule is a presumption only. In this respect, it pointed at just cause provisions in collective bargaining agreements, which had placed limitations on the employer’s unilateral right of termination, and the variety of statutory limitations established upon the employer’s power of dismissal.⁷⁸² Consequently, the Pugh Court held that the mere fact that a contract is terminable at will, does not give the employer the absolute right to terminate it in all cases.⁷⁸³ Consistently, it held that an implied-in-fact (good cause) contract can overcome the at-will presumption.⁷⁸⁴

12.2.3 Implied-in-fact (good cause) contract: circumstances of the case

In Pugh (1981), the California Court of Appeal held there was enough evidence to enable the jury to find the existence of an implied-in-fact promise that the employer would not discharge employees arbitrarily, based on the totality of circumstances, including the duration of employee’s employment, the commendations and promotions he had received, the apparent lack of any direct criticism of his work, the assurances he had been given, and the employer’s

779 Pugh (1981), 116 Cal.App.3d 311, 319. For the history of the one year rule and the at-will rule, see also above under § 10.2.

780 See also above under § 1.2.1.

781 Pugh (1981), 116 Cal.App.3d 311, 319 and 320. Section 2922 of the California Labor Code provides that ‘an employment, having no specified term, may be terminated at the will of either party on notice to the other. Employment for a specified term means an employment for a period greater than one month’.

782 Pugh (1981), 116 Cal.App.3d 311, 320.

783 Pugh (1981), 116 Cal.App.3d 311, 321 and 322.

784 See also Tully 1983, p. 5 and 6.

acknowledged policies.⁷⁸⁵ In this respect, the Pugh Court referred to a number of cases, relying on Cleary (1980) in particular.⁷⁸⁶ In Cleary (1980), the California Court of Appeal held that the longevity of service, and the expressed policy of the employer set forth in the regulation, justified an exception to the at-will rule.

More specifically, it held that an employer who dismissed an employee for alleged theft after eighteen years of satisfactory service, in violation of published company policy, which required a fair, impartial and objective hearing in such matters, had violated an implied covenant of good faith and fair dealing.⁷⁸⁷ Also, Pugh (1981) shows strong resemblance with Toussaint (1980), which is known and cited principally as Michigan’s equivalent of Pugh (1981). The Toussaint Court, too, adopted the rule that an implied-in-fact good cause term can limit the common law at-will employment rule.⁷⁸⁸

12.2.4 Pugh confirmed!

The California Supreme Court affirmed Pugh (1981) in Foley (1988).⁷⁸⁹ In the latter, an employee was hired in 1976 as a computer expert by Interactive Data Corporation, a subsidiary of Chase Manhattan Bank in California. At the time of hiring, Foley signed two agreements concerning non-competition and disclosure of proprietary information. In addition, the employer maintained written termination guidelines that set forth express grounds for discharge and a mandatory, seven-step procedure to follow leading up to discharge. After Foley had worked for the employer for almost seven years, receiving steady promotions and pay raises, he was suddenly discharged. He alleged that his supervisors repeatedly assured him that he had job security so long as his performance remained adequate. He also alleged that on the basis of the documents he signed and the termination procedure, he believed he would not be discharged except for good cause. Subsequently, Foley sued his employer for wrongful discharge.

In brief, Foley stated that in 1983, he had gone to his previous supervisor to tell him that he had learnt that his new supervisor was under investigation for embezzlement from his former employer, and that he was worried about the new supervisor’s suspected criminal conduct. The former supervisor had told Foley not to discuss rumors and to forget what he had heard.

Shortly thereafter, Foley’s supervisor informed him that the company had decided to replace him for ‘performance reasons’, but that he had an option to transfer from California to another position in Massachusetts. Two weeks later, Foley was abruptly discharged.⁷⁹⁰ The employer filed for a demurrer,⁷⁹¹ which

785 Winters 1985, p. 3; Linzer 1986, p. 10.

786 Pugh (1981), 116 Cal.App.3d 311, 327. See also Peck 1983, p.13; Hitchcock 1983, p. 2 and 4; Jung and Harkness 1989, p. 5.

787 Pugh (1981), 116 Cal.App.3d 311, 328.

788 Cotran (1998), 17 Cal.4th 93, 102.

789 Foley (1988), 47 Cal. 3d 654, 676 and 677. See also Barnhart 1998, p. 4.

790 Estreicher and Robbins 1989, p. 2.

the state Superior Court granted and which the California Court of Appeal affirmed. The California Supreme Court agreed to hear the Foley case in appeal.⁷⁹² The California Supreme Court addressed three questions in Foley (1988)

x when does discharge of an employee violates public policy so as to give rise to tort liability;

x when do promises in employment manuals and related documents create an implied-in-fact contract that an employee at will not be dismissed except for good cause; and

x what is the measure of damages for breach of the implied covenant of good faith and fair dealing?⁷⁹³

With regard to the breach of an implied-in-fact (good cause) contract – which is of interest in this thesis – Foley alleged that over the course of his nearly seven years of employment with the bank, the company’s own conduct and personnel policies gave rise to an oral contract not to dismiss him without good cause. In contrast, the employer in Foley (1988) urged the California Supreme Court to reverse the decision of Pugh (1981), and to hold that California law required an express contract provision, requiring good cause for termination, supported by independent consideration beyond work performance.⁷⁹⁴

The California Supreme Court held that the Pugh Court had correctly applied basic contract principles in the employment context, and that these principles were applicable to the employee’s employment agreement with the employer.⁷⁹⁵ First, it stressed that under the fundamental principle of freedom of contract, employers and employees are free to agree upon a contract terminable at will, or to agree upon a contract subject to limitations. Second, whereas the California Labor Code Section 2922 holds a presumption of at-will employment, this may be overcome by evidence, that despite the absence of a specified term, parties reached consensus on limiting the employer’s power to dismiss employees, for example, by a requirement that termination be based on good cause only.⁷⁹⁶

As regards the requirement of independent consideration, the Foley Court admitted that there may be some historical basis for imposing independent consideration beyond work performance.⁷⁹⁷ However, it stressed that any such basis has been eroded by the development of modern contract law and that

791 Black’s Law Dictionary defines a demurrer as a pleading stating that although the facts alleged in a complaint may be true, they are insufficient for the plaintiff to state a claim for relief and for the defendant to frame an answer.

792 Estreicher and Robbins 1989, p. 2; Burden 1989, p. 1.

793 Estreicher and Robbins 1989, p. 2.

794 Foley (1988), 47 Cal.3d 654, 671.

795 Foley (1988), 47 Cal.3d 654, 676. See also Cameron 2001, p.5.

796 Foley (1988), 47 Cal.3d 654, 677.

797 For case law, see Hitchcock 1983, p. 1and 2; Tully 1983, p. 4 and 6.

accordingly, it is inappropriate in the modern employment context. In citing Pugh (1981), the Foley Court held that there is no analytical reason why

x an employee’s promise to render services, or his actual rendition of services over time, may not support an employer’s promise both to pay wage and, for example, to refrain from arbitrary dismissal; and x in the employment context, factors apart from consideration and

express terms may not be used to ascertain the existence and content of an employment agreement, including the personnel policies or practices of the employer, the employee’s longevity of service, actions or communications by the employer reflecting assurances of continued employment, and the practices of the industry, in which the employee is engaged.⁷⁹⁸

12.3 Factors that determine the existence of good cause protection