THE CONTRACTUAL DUTY OF “GOOD FAITH” – AN UNRESOLVABLE ENIGMA IN THE ABO WORLD

CJ Steele

Chief Justice Myron T. Steele

The inaugural Ruby R. Vale Distinguished Speaker Series, held on October 28, featured Chief Justice Myron T. Steele of the Delaware Supreme Court.  Chief Justice Steele lectured on what he characterized as an unresolvable issue within Alternative Business Organizations (“ABO”) – the contractual duty of “good faith” in LLC and limited partnership agreements.

The rapid growth of ABOs since 2003 has made this a critical topic in Delaware law.  Between 2003 and 2013 there has been an 81% increase in business organizations chartered in Delaware.  Remarkably, although there has been such a dramatic increase in chartered businesses, Delaware corporations are down 8%. That decline has been offset, however, by a 174% increase in ABO’s.  Facing a tidal wave of newly formed ABOs, Chief Justice Steele opined that transactional lawyers have the heavy burden to prevent unnecessary litigation.  As he recommended, lawyers need to clearly define the fiduciary duties of members and managers, if the agreements don’t eliminate those duties.  The Chief Justice warned attorneys that if a court cannot ascertain the intent of the parties at the time the agreement was made, then the meaning of the terms would be left to the “fiat” of the court.

The lecture then turned to the Delaware Limited Liability Company Act and the “maximum effect to the principle of freedom of contract” that is to be given to LLC agreements.  To this end, Chief Justice Steele discussed the difficulty that courts have in promoting this principle if the LLC agreement’s terms are not explicitly defined.  Since that statute permits the the LLC agreement to expand, restrict, or eliminate a member or manager’s fiduciary duties as long as it does not eliminate the implied covenant of good faith and fair dealing, the terms of a member or manager’s fiduciary duties must be clear.  He then asked a rhetorical question: should a judge impose an equitable doctrine to decide a dispute within the LLC, or should the judge look solely to the terms of the contract?

Of particular concern to the Chief Justice was the definition of good faith in company agreements.  The Chief Justice reviewed the history of Delaware’s jurisprudence on implied good faith and fair dealing.  He acknowledged the unsettled jurisprudence that the bench and bar have continued to wrestle with since the 1960’s.  After acknowledging that the recent addition of 18 Del. C. § 1104 establishes that the rules of fiduciary duties apply by default, the Chief Justice puzzled over the archaic term within the statute, “the law merchant.”

Tying together the struggle to define good faith and fair dealing for over 50 years and the attempts by the General Assembly to provide a framework for guidance within ABOs, Chief Justice Steele turned to the case law addressing the “Gordian knot” of provisions of ABO agreements that attempt to define or limit the role of good faith.  Case law has focused on safe harbor provisions, where Delaware courts have struggled to determine the parties’ intent.  Recent Supreme Court cases have found good faith provisions are failing to provide for an objective or subjective standard when reviewing manager conduct.  Moreover, safe harbor provisions conflict with other fiduciary duties within the agreement causing confusion as what standard applies to particular manager actions.

To round out his message, Chief Justice Steele reminded the audience that he his retiring from the bench, so now it is the bar’s responsibility to navigate the murky waters.  Essentially, transactional attorneys have the burden to prevent opportunistic litigators from invoking ambiguous contractual good faith provisions.

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Randy MacTough

J.D. Candidate, Class of 2014

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