Good Faith When Fiduciary Obligations are Waived by Contract?

This third and last post, based on noteworthy Delaware Court decisions during 2017 which I had not addressed in posts during the year, engages the seemingly technical question of what if any duties does a general partner owe to limited partners where the partnership agreement, not atypically, waives all fiduciary duties owed by the GP.

We are all aware of the waivers of duty obtained by sponsors of deals, allowing them to self-deal without running afoul of the fiduciary obligation owed by partners to each other under basic partnership law.  Recognizing that a GP cannot, however, contract with someone to permit that GP to steal from investors, often LLC and partnership agreements have mechanisms to protect the investors from what I will call in lay terms an “outrageous overreach,” typically drafted into sections that allow the controlling party to enter into transactions for his or her own account, or the account of his or her controlled entity, without facing some legal claim.

There is also in contract law (LLCs and partnerships are after all just contractual arrangements) an ill-defined but time-honored rule of construction that imposes on all parties an obligation to act with good faith and fair dealings with all other parties in the transaction.

In the January, 2017 Delaware Supreme Court Decision in  Dieckman v Regency, a GP undertook an interested party transaction and attempted to comply with both of the procedures set forth in that particular LP agreement.  He sought approval from a Conflicts Committee, which was allegedly tainted by self-interest.  He also sought a vote of the independent investors, but the complaint alleged that the materials given to the investors to induce approval for the transaction were false and misleading.

The Chancery Court below held that the complaint must be dismissed because all fiduciary obligations were waived in the contract and thus no argument could be made that misrepresentations violated such obligations.

The Supreme Court reversed and ruled that even where all fiduciary duties are waived, the implied covenant of good faith and fair dealing prevented the GP from misrepresenting to the investors to induce their approval.  In reaching this not-very-startling conclusion, the Court tripped over itself to explain that a waiver of fiduciary duty is not a license to lie and thus deprive the investors of their contractual right to approve or disapprove the transaction.  The covenant protects against action taken “arbitrarily or unreasonably, thereby frustrating the fruits of the bargain that the asserting party reasonably expected.”  What are these fruits of the bargain, as they are not expressly stated in the document; and indeed appear to have been waived?  Some “fruits” are so implicit that they need not be expressed, as their existence is “necessary to vindicate the apparent intentions and reasonable expectations of the parties.”  These fruits are “so obvious … that the drafter would not have need to include the conditions as express terms of the agreement.”

What then can we deduce as the legal meaning of the implied covenant of good faith and fair dealing?  “You cannot lie, cheat or steal.”  Not radical concepts, and it would be amazing if a Court could not find its way to so holding.  As for how the Court explains and relies upon the implied covenant — well, it seems to me that my articulation is more direct and understandable than the lawyerly and extensive explanatory efforts of the Supreme Court.

And if a GP is tempted to seek a waiver, in the partnership agreement, of any claims based on an implied covenant of good faith and fair dealing, thus meeting the covenant head-on?  One might expect the Court to void that waiver as against public policy, putting aside that even the most jaded of investors might blink at such a startling provision.

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