Generally, an “Operating Agreement” is an agreement amongst the members of a limited liability company (“LLC”). It sets forth the Member’s rights and duties. New Jersey’s Revised Uniform Limited Liability Act recognizes the members’ rights to freely contract amongst themselves with one exception: the operating agreement cannot contain terms and conditions that are “manifestly unreasonable.” In other words, if the operating agreement is not “manifestly unreasonable,” the members may agree to restrict or limit fiduciary duties or set forth measures of performance of the contractual obligation of “good faith and fair dealing.” The “manifestly unreasonable” standard allows Courts to intervene if they believe a term is so unfair to the members that the application of what is contained in the operating agreement is “manifestly unreasonable.” Unfortunately, the drafters of the Act did not specifically define what “manifestly unreasonable” means. In the next few years, I expect the Courts to provide more depth of what does and does not constitute terms that are “manifestly unreasonable.”
Generally, to assert a breach of the covenant of good faith and fair dealing, the complaining party must prove that the manager or member acted with no legitimate purpose with bad motives or intentions; engaged in deceptive; or evasion in the performance of terms and conditions set forth in the operating agreement. Moreover, they must prove that by engaging in such conduct they denied the complaining party of the bargain initially intended by the parties.
Because a Limited Liability Company is essence a contractual entity it has been widely recognized by many courts that the covenant of good faith and fair dealing already applied. Nevertheless, the Revised Uniform Limited Liability Act codifies the case driven application of the law. The codification gives even greater protections for members of an LLC. Of course, because a Limited Liability Company is a contractually based entity, the members may limit the covenant of good faith and fair dealing, so long as the limitation is not “manifestly unreasonable.” As I wrote in a previous blog post, because this law is in its infancy, it is unknown how Courts will define and apply the “manifestly unreasonable” standard. Of course, I will be diligently reading and analyzing those decisions over the course of the next few years.