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LLC Member Duties: The New Implied Contractual Duty of Good Faith and Fair Dealing, Part 1

In 2014, the Alabama Legislature passed the “Alabama Limited Liability Company Law of 2014” (the “Law”). The Law is very “contract-centric.” See Ala. Code § 10A-5A-1.06 (a) (“It is the policy of this chapter and this state to give maximum effect to the principles of freedom of contract and to the enforceability of limited liability company agreements.”). What this means is that the Law places an emphasis on the parties’ contractual agreement. Hence, the “LLC Agreement” (the “Agreement”), which is the agreement among the parties regarding the operation and management of the limited liability company, is generally paramount.

But, if the Agreement does not limit or restrict the members’ duties to the LLC or other members, then the provisions of the Law govern the duties of the members to the LLC and to each other. See Ala. Code § 10A-5A-1.08(a)(2) (“to the extent the limited liability company agreement does not otherwise provide for a matter described in subsection (a)(1), this chapter governs the matter.”). The Law differentiates between duties owed by those with “direction and oversight” over the LLC and those without such obligations. The parties could override this general rule in the Agreement, but if the parties do not override the rule then non-managing members are not subject to duties of loyalty and care which apply to persons with direction and oversight. Ala. Code § 10A-5A-4.08. Instead, “[o]ther than the implied contractual covenant of good faith and fair dealing, the only duty a member who does not have the authority to direct and oversee the activities and affairs of [the LLC] owes to [the LLC] or to the other members solely by reason of being a member is to not disclose or otherwise use information of the [LLC] to the detriment of the [LLC] or the other members.” Ala. Code § 10A-5A-4.08(g)(1).

We can easily understand the duty not to disclose or use information of the LLC to the LLC’s detriment. But what is this implied contractual covenant of good faith and fair dealing? There are no Alabama cases that include this exact phrase. The Commentary to § 10A-5A-1.08 explains:

The term “implied contractual covenant of good faith and fair dealing” as used in this Chapter is the same as that set forth in Delaware § 18-1101(c), (d), and (e), as that term was interpreted by the Delaware Supreme Court in Gerber v. Enterprise Products Holdings, LLC, 67 A.3d 400 (2013). The Alabama Supreme Court recognized this concept in Sellers v. Head, 73 So.2d 747 (Ala. 1954) (This implied covenant provides that if a contract fails to specify all of the duties and obligations intended to be assumed, “the law will imply an agreement to do those things according to reason and justice the parties should do in order to carry out the purpose for which the contract was made.”). Section 7-1-304, and cases construing the section such as, Tanner v. Church’s Fried Chicken, Inc., 582 So.2d 449, 452 (Ala. 1991) and Government Street Lumber Co., Inc. v. AmSouth Bank, NA, 553 So.2d 68 (1989) should not be utilized in interpreting the term “implied contractual covenant of good faith and fair dealing.” Consistent with the Alabama Supreme Court holding in Peninsular Life Ins. Co. v. Blackmon, 476 So.2d 87, 89 (Ala. 1985) the term “implied contractual covenant of good faith and fair dealing” does not create any new cause of action in tort for bad faith or any other tort.

Ala. Code § 10A-5A-1.08, Comment. Because the implied contractual covenant of good faith and fair dealing does not create any new right or cause of action there are many questions unanswered regarding the covenant. It is unclear whether the “implied contractual covenant of good faith and fair dealing” is merely a breach of contract action, or is another species of the duty of loyalty or care, or is another way of describing that the members must avoid “fraud in the inducement” in dealing with the Company and other members.

However, as the Commentary to § 10A-5A-1.08 notes, this issue has been addressed in Delaware. More on that in Part 2 (coming soon).