The implied contractual covenant of good faith and fair dealing (the “Implied Covenant”) is implicit in every type of contract, including LLC operating agreements, and it cannot be validly waived. Thus, it constantly looms as a wild card whenever disputes arise among LLC members and managers that are not clearly resolved in the provisions of the governing operating agreement, and you always have to be thinking about its possible impact when you’re planning, negotiating and drafting LLC operating agreements for your clients.
In general, under the Implied Covenant, the courts will decide a dispute of the kind described above by determining what the parties would reasonably have expected, despite their contractual silence, when they signed the agreement. With regard to the the LLC operating agreement in question in Fortis Advisors, decided on January 30, 2015, the Delaware Court of Chancery held, in effect, that a provision in the governing agreement that the parties would implement the agreement in a “commercially reasonable” manner overrode, effectively, the implied contractual covenant of good faith and fair dealing. You may find in many LLC deals that this “commercial reasonableness” standard may significantly reduce any Implied Covenant risk for your clients.
For a brief discussion of the Fortis Advisors case and a link to the text of the case, click here.
Many operating agreements for multi-member LLCs impose a duty on noncompetition on members and managers both while they are members and managers and for a specified period of time after they cease to be members or managers or members because of resignation or otherwise. Before you draft such an operating agreement provision, you need to make sure that it is consistent with the applicable noncompetition law both in your own home state and in every other state where the affected members and managers will conduct the LLC’s business. For a case that illustrates this need, click here.
If you have a fairly standard LLC formation practice, it will only very rarely be necessary for you to include “jerk insurance” clauses in operating agreements you negotiate or draft for your clients. However, you should at least be familiar with the concept. Click here to learn about jerk insurance clauses:
Here’s another recent Ken Adams post in his blog on contract drafting that applies powerfully to the drafting of LLC operating agreements: http://www.adamsdrafting.com/why-its-important-to-police-your-defined-terms/.
Here’s another good recent post by Ken Adam in his blog on contract drafting: http://www.adamsdrafting.com/clear-drafting-doesnt-involve-dumbing-down/. The post applies as much to LLC operating agreements as to all other types of contracts.
As I’ve written previously in posts to this listserv, by far the best blog I know of on how to draft legal prose, including contract prose, is Ken Adams’ blog. Here is a link to his recent post on a “may/shall/unless” conundrum that arises from time to time in drafting LLC operating agreements (and many other types of contracts): http://www.adamsdrafting.com/shall-not-unless-versus-may-only-if/.
About 70 percent of all LLCs are single-member LLCs owned by individual. About 25 percent are two-member LLCs. Only about 5% of all LLCs have three or more members.
The biggest risk for two-member LLCs are (i) deadlock between the members and (ii) serious misconduct by one of the members. The latter risk is addressed in this terrific recent blog post by Peter Mahler.
When you form two-member LLCs for your clients, you’ve got to address the above two risks forcefully in your clients’ operating agreements. Failure to do so would be a clear violation of the duty of competence under Rule 1.1 of the ABA Model Code of Professional Conduct as in effect in most states, and could lead to a well-deserved malpractice claim.
The Delaware Limited Liability Company Act is “everybody’s second choice” for LLCs with members from two or more different states, and it is the first choice for many sophisticated businesses. The Delaware Court of Chancery’s new decision in the Seaport Village case, summarized and cited in the attached post in the Delaware Business Litigation Report blog website, simply repeats the DLLC Act statutory rule that Delaware operating agreements may be valid even if the parties don’t sign them. If you form or ever will form Delaware LLCs, you should know this rule.
In the attached post in his “Business Divorce” blog, Peter Mahler lists what he believes to be the seven hottest current issues in business divorce law. As you’ll see if you visit his blog, the first four of these issues are LLC issues. Those of us who draft LLC operating agreements should draft them so as to address these issues. If you draft LLC operating agreements (or plan to in the future), read Peter’s post!