The influential Delaware Court of Chancery recently discussed the contractual legal requirement of "good faith and fair dealing" in the context of a limited partnership agreement (Allen v. El Paso Pipeline GP Company). In essence, a contract's language and the purposes of the contracting parties control any implied terms that a court might impose. Abstract moral concepts of fairness do not apply.
The Court first considered specific language contained in this case's limited partnership agreement. This agreement stated that "good faith" required that the person undertaking an action "must believe that the determinations or other action is in the best interests of the partnership." While a "belief" is subjective, the Court noted that a trial judge cannot read minds and must rely upon objective facts to infer the subjective belief of an individual. The "best interest of the partnership" requirement allows the interests of many constituents to be considered and not just those of the limited partners. The objective facts of this case indicate compliance with this stated requirement.
The Court next considered a general implicit requirement (implied covenant) in contracts of "good faith and fair dealing." The Court wrote that Delaware courts use this doctrine to cautiously fill gaps in a specific agreement. "Good faith" in this broad usage does not depend upon a mental state of a person but simply means "faithfulness to the scope, purpose and terms of the parties' contract." "Fair dealing" means consistency with the parties' agreement and its purpose. Neither concept turns on "a court's belief about what was morally or equitably appropriate under the circumstances" but rather "on the contract itself and what the parties would have agreed upon had the issue arisen when they were bargaining originally." If the contract specifically addresses an issue or the parties had considered and rejected the inclusion of certain terms, an implied requirement cannot contradict or modify the contract. The implied requirement merely "protects the spirit of the agreement" when the contract is "truly silent" on an issue.
The Court additionally wrote that implied covenants cannot be used to rewrite a contract or give a party protections that that were not secured through bargaining. Parties make bad deals that the law enforces. However, since human knowledge is imperfect, parties cannot contractually address every possible future state of the world. Also, the parties may possess un-negotiated fundamental understandings. In these situations a Court may cautiously and occasionally imply contract terms in order to fulfill the reasonable expectations of the parties. The Court may not "introduce its own notions of what is fair and reasonable" but only provisions that the parties would have created if they had considered them. Contractual terms are not implied under an abstract standard of "reasonableness."
Another interesting aspect of this decision is the Court's determination that Delaware law allows limited partnership agreements to eliminate all common law duties, including fiduciary (utmost good faith and fair dealing) duties. Applying this rule, the Court concluded that the limited partnership agreement in the present case establishes a contractual standard that eliminates all fiduciary duties.
This case contains several lessons. First, the plain language of a Delaware limited partnership agreement is enforced as written. Second, a Delaware court will not use abstract moral concepts to rewrite a contract. Consequently, the burden is on the parties to make their contractual intentions clear. One way to do this is to have an introductory section in a contract that discusses the purposes and goals of the agreement. Clarity and completeness is key. For this reason, always involve an experienced attorney in creating a business entity, such as a limited partnership, and in creating business contracts generally.