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Miller v. HCP & Co. - No. 2017-0291-SG, 2018 Del. Ch. LEXIS 40 (Ch. Feb. 1, 2018)


The first step in evaluating an implied covenant claim is to determine whether the contract in fact contains a gap that must be filled. That is because the implied covenant applies only if the contract is silent as to the subject at issue. If the contract directly addresses the matter at hand, existing contract terms control, such that implied good faith cannot be used to circumvent the parties' bargain. If, on the other hand, the express terms of the contract do not address the subject at issue, the court must then consider whether implied contractual terms fill the gap. A court conducts that inquiry by asking whether it is clear from what was expressly agreed upon that the parties who negotiated the express terms of the contract would have agreed to proscribe the act later complained of as a breach of the implied covenant of good faith—had they thought to negotiate with respect to that matter. The court does not derive implied obligations from its own notions of justice or fairness. Instead, it asks what the parties themselves would have agreed to had they considered the issue in their original bargaining positions at the time of contracting. The implied covenant therefore operates only in that narrow band of cases where the contract as a whole speaks sufficiently to suggest an obligation and point to a result, but does not speak directly enough to provide an explicit answer. 


HCP & Company, together with its affiliates (collectively, the "HCP Entities"), were the largest holders of membership units in a company called Trumpet. The members executed the Second Amended and Restated Operating Agreement (the "OA"). Under the OA, Trumpet, cofounder of the LLC, created new "Class E" membership units, which, upon sale of Trumpet, would be entitled to a "first in line" payment of 200 percent of the holders' investment in the Class E units. One of the HCP Entities purchased approximately 80 percent of these new units, for a capital investment of just under $2 million. The HCP Entities also held nearly 90 percent of the existing "Class D" units; according to the OA, upon sale these units were next in line, also to receive 200 percent of the holders' investment. The HCP Entities had contributed around $12 million for the Class D units. Upon any sale, in other words, according to the waterfall provision of the OA, the HCP Entities were entitled to the bulk of the first $30 million, before sales proceeds would be available to holders of other classes of membership units. The HCP Entities held a majority of the membership units in Trumpet, and under the OA they were entitled to appoint four of the seven managers on the Trumpet Board. According to the OA, where the Board approved a sale of the company, every member was obligated to consent to the sale. The OA also gave the Board sole discretion as to the manner of any sale, conditioned only on the sale being to an unaffiliated third party. The members explicitly agreed, under the OA, to waive all fiduciary duties, to one another and from the managers to the members. The plaintiffs filed an action seeking relief under the implied covenant of good faith and fair dealing inhering to an LLC operating agreement. The defendants filed a motion to dismiss.


Should the court grant the motion to dismiss?




The Court held that a limited liability company agreement that eliminated fiduciary duties pursuant to Del. Code Ann. tit. 6, § 18-1101(c) and gave the board sole discretion to determine how to conduct a sale of the company, while requiring that any transaction be with an unaffiliated third party, indicated that the members had considered both the possibility of a sale through private negotiation and the implications of vesting discretion in a conflicted board. Thus, the implied covenant of good faith and fair dealing could not apply to require the board to conduct an open-market sale to achieve the highest value. The Court held that the parties easily could have anticipated a likelihood of self-interested conduct because of distribution waterfall provisions.

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