The duty of good faith: to be or not to be?

By Roderick I’Anson Banks, Barrister, Partnership Counsel

The duty of good faith is the bedrock of the traditional partnership and underpins all of the rights and duties which partners acquire by entering into that relationship. Although it may be possible to amend or abrogate the duty, the consensus is that it cannot be excluded in its entirety. What is certain is that, while most well-drawn partnership agreements will contain an express duty of good faith, its omission will merely open the door to an implied duty.

For the management and members of an English limited liability partnership (LLP), the position is very different. There is a positive decision to be made which should not be allowed to go by default. It is all too easy to merely assume that an LLP is ‘just a different form of partnership’ to which the same regime must necessarily be applied.

LLPs: the default position

The starting point is the consultation process which led to the LLP Act 2000 when, despite concerted efforts, the DTI refused to accept that there should be an implied duty of good faith between LLP members.1 Hence the absence of any such duty in the LLP Regulations 2001, even though they do impose an express duty on each member to provide information to the others upon request.

No similar duty is owed to the LLP itself – presumably because the duty to provide information to the LLP is implicit in the agency relationship between the member and the LLP.

What is not in doubt is that, under the LLP Act 2000, the members of an LLP are its agents and, as such, owe an implied duty of good faith to the LLP. The existence of that duty will always oblige them to put the best interests of the LLP first. To that extent, there is no real distinction between the position of a member and that of a traditional partner.

Emerging trends

Two different trends are now emerging. The majority of firms, when converting to LLPs, have simply carried the express duty of good faith over from their partnership agreement into their LLP agreement, often with little conscious thought other than a general desire to retain the existing ‘partnership ethos’.

Other firms, either on conversion or, more often, subsequently, have taken a more considered and sceptical view and moved to an agreement where the only express duty of good faith is owed to the LLP and even, in some cases, to an agreement which expressly negates the existence of any such duty, express or implied, between the members.

Surprisingly, given the legislative history, this trend has not stopped members from seeking to argue that such a duty between members should be implied, albeit thus far without success.

What are the dangers?

An express duty of good faith between members can be a powerful weapon in the hands of a disgruntled member seeking to deploy the weapon of choice in LLP disputes, i.e. repudiation of the LLP agreement.

The stakes are high: a validly accepted repudiation will result in the LLP and all of its members being catapulted onto the default regime.

The effects of this can be far-reaching, including the total loss of all rights of removal and expulsion, agreed notice periods, restrictive covenants and management and remuneration structures. An unfair prejudice petition or damages claim may not be far behind; any exclusion of the Companies Act 2006, section 994 will fall with the agreement.

It is when approaching a downsizing operation that the duty of good faith will be at its most dangerous.

It is all too easy for management to inadvertently breach an express duty when canvassing views for the removal of a member on a ‘no fault’ basis by prematurely presenting a one-sided case for removal. When the decision is later taken to a vote, it may already be too late to offer the target member a genuinely fair hearing.

Ironically, in this area at least, the position may be little different if an express duty of good faith is omitted. Faced with an attempt to remove a member under an express power, it is overwhelmingly likely that a court or arbitrator will regard the rules of natural justice as applicable (as appears to have been accepted in Eaton v Caulfield [2011] EWHC 173 (Ch), at [52]). The type of conduct referred to in the last paragraph would just as much breach those rules as an express duty.

However, the duty is not only relevant in the case of removals but across a whole range of other powers and discretions in the LLP agreement. It is surprising how easy it is to identify a potential breach. Once that genie is out of the bottle, it may be too late to contain it. What price the partnership ethos then?

rciab@partnershipcounsel.co.uk

Endnote

1. See the Summary of Responses to the Consultation on the Regulatory Default Provisions Governing Relationship between Members (URN /00/865) in May 2000