Good faith and fair dealing Delaware LLC requires parties to fulfill their contractual obligations in an ethical fashion. This principle, known as the implied covenant of good faith and fair dealing, exists within every contract.
While parties can include contractual provisions that mimic traditional fiduciary duties in their LLC operating agreements, this does not alter or negate the implied covenant of good faith and fair dealing.
What Does It Mean?
Delaware courts take seriously the implied covenant of good faith and fair dealing. But it can be tricky to interpret and implement in practice.
Example: It is well established that implied covenants cannot revive fiduciary duties that have been expressly waived by parties to their contract, yet its application in an LLC context remains uncertain.
Many LLC agreements are written to give management discretion in conducting ordinary operations and require member majority approval for certain major transactions, making a claim of breach of implied covenant more challenging than in previous cases. Under Nemec’s precedents, such claims might not stand up.
Nemec’s decision further narrows the scope of implied covenants to circumstances which were unforeseeable at formation, so members should exercise caution when placing too much reliance on this element to police manager misconduct based on discretionary acts.
What Can I Do?
Delaware contracts contain an implied covenant of good faith and fair dealing, even when disclaiming fiduciary duties such as in an LLC agreement. A claim for breach must demonstrate specific contractual obligations breached by the defendant, damages sustained to the plaintiff, as well as evidence that bad faith played a part in this breach.
This doctrine is vitally important to both controlling and minority investors alike, since many standard LLC agreements contain boilerplate management provisions that could compromise fiduciary duties-like duties implied by an implied covenant. When drafting such documents, investors should exercise care when drafting to avoid accidentally waiving any fiduciary duties-like duties implied by an implied covenant; it would also be wise for controlling members not to misuse its application against managers exercising discretionary acts – particularly where sale matters are concerned as recently the Court made clear that an implied covenant cannot force an LLC board into selling their company for the highest price available imposed by implied covenant imposed by implied covenant imposed imposed obligations against it by an implied covenant imposed through an implied covenant obligation upon an LLC board under pressure of an implied covenant imposing duties such as selling for maximum available price
What Can I Avoid?
One of the main duties imposed upon parties to an LLC agreement cannot be waived through contract; that duty exists under Delaware law and can be enforced in court.
Due to this risk, it is vital that businesses carefully consider whether adding an implied covenant provision into their LLC agreement makes sense for their business. Unfortunately, however, due to a recent decision of the Delaware Supreme Court in Nemec it will likely make it harder for plaintiffs to successfully bring breach of duty claims.
Nemec, former officers of government services firm Booz Allen claimed that its board of directors violated an implied covenant of good faith and fair dealing by failing to create a sales process which would ensure shareholders received maximum value when selling the company. However, the court dismissed their complaint on grounds that Booz Allen had every right to sell its shares at book value.
How Can I Get Help?
Controlling investors who seek to undermine a carefully drafted LLC agreement shouldn’t attempt to bypass it by alleging a breach of an implied covenant of good faith and fair dealing has occurred. While parties can include contractual standards in their operating agreement that parallel Delaware’s common law fiduciary duty of loyalty, those terms should stand on their own and cannot be subsumed under an implied covenant argument.
Miller v. HCP & Company presented the Court with this issue and rejected plaintiffs’ attempt to use an implied covenant of good faith and fair dealing to enforce a drag-along provision that waived fiduciary duties in an LLC agreement. This decision highlights why private equity funds and other controlling investors must thoroughly examine LLC agreements to ensure they effectively meet their desired business goals.
