Implied Duty of Good Faith and Fair Dealing Does Not Impose a Confidentiality Obligation on Delaware LLC Members
Many limited liability company agreements do not include confidentiality provisions. That may be because the company expects to have agreements with its employees and consultants that include confidentiality obligations. Or it may be that the parties and their lawyers simply don’t address it in the formation of the LLC. In any event, members who invest in an LLC but don’t work for it are in many cases bound only by an LLC agreement with no confidentiality restrictions.
LLC managers are sometimes surprised to discover that their LLC agreement does not obligate the company’s members to hold the LLC’s information in confidence. This may become an issue when there is a dispute with a member and the member requests information from the company. Many state LLC statutes give members the right to obtain certain records and information from the LLC, and the state acts don’t usually require that the member keep the information confidential. E.g., Del. Code Ann. tit. 6, § 305; Wash. Rev. Code § 25.15.135.
A canny LLC manager might logically ask, “Isn’t there any sort ofimplied obligation that the member keep company information confidential?” Many states imply a duty of good faith and fair dealing in contracts, either by statute or as part of the state’s common law. E.g., Del. Code Ann. tit. 6, § 18-1101(e) ( limited liability company agreement may not limit or eliminate liability for any act or omission that constitutes a bad faith violation of the implied contractual covenant of good faith and fair dealing); Badgett v. Sec. State Bank, 116 Wn.2d 563, 569, 807 P.2d 356 (1991) (there is in every contract an implied duty of good faith and fair dealing).
Earlier this year the Delaware Court of Chancery dealt with a claim that the implied covenant of good faith and fair dealing imposed confidentiality obligations on an LLC member. Kuroda v. SPJS Holdings, L.L.C., No. 4030-CC, 2010 Del. Ch. LEXIS 57 (Del. Ch. Mar. 16, 2010). The case was complex. As the court said:
This is round two of a bout between sophisticated, experienced parties who have woven a complex web of overlapping contracts, agreements, and duties that the Court must now untangle and interpret in order to make sense of who among these sophisticated parties owes whom what. Plaintiff seeks money he alleges defendants owe to him pursuant to a limited liability company agreement.
The counterclaims include misappropriation of trade secrets, breach of fiduciary duty, breach of the implied covenant of good faith and fair dealing, and breach of contract.
Kuroda, 2010 Del. Ch. LEXIS 57, at *1, 2.
Kuroda provided consulting services to an investment firm LLC in which he was a non-managing member. He later left the company, started a competing investment firm, and allegedly used investor lists and market strategies from the first company in his own business. Francis Pileggi has provided a compete synopsis of the case here, and Larry Ribstein has commented on the court’s treatment of the fiduciary duty elements of the case here.
Kuroda was a party to a consulting agreement with the LLC containing confidentiality provisions. The defendants, however, did not base their trade secret misappropriation claim on the consulting agreement because it would have required arbitration in Japan. The defendants instead argued that the LLC agreement’s implied covenant of good faith and fair dealing imposed a confidentiality obligation on Kuroda.
The court described the implied covenant of good faith and fair dealing as inhering in every contract, and requiring a contract party to refrain from arbitrary or unreasonable conduct that would prevent the other party to the contract from receiving the “fruits of the bargain.” Kuroda, 2010 Del. Ch. LEXIS 57, at *39. The court noted that the implied covenant does not constitute a free-floating duty on contracting parties, but instead is used to ensure that the parties’ reasonable expectations are fulfilled. The implied covenant has a narrow purpose and is therefore only rarely invoked successfully. Kuroda, 2010 Del. Ch. LEXIS 57, at *39, 40.
The court refused to invoke the implied covenant of good faith and fair dealing to create a confidentiality obligation in the LLC agreement. Noting that the defendants used confidentiality provisions in other documents related to the LLC, but not in the LLC agreement itself, the court said “any use of the implied covenant to insert a contractual duty of confidentiality into the LLC Agreement would be an override of the express terms of that agreement.” Kuroda, 2010 Del. Ch. LEXIS 57, at *40, 41.
An LLC manager seeking to prevent a member from disclosing or using the LLC’s information might wonder whether state trade secret law would impose a duty of confidentiality on the member. In most states the Uniform Trade Secrets Act (USTA) will apply. (According to the National Conference of Commissioners on Uniform State Laws, 47 states have adopted the USTA.)
Business people often think that any private or semi-private information about an LLC, its members or its business is legally protected. The USTA does not reach that far, however. For there to be an actionable misappropriation under the USTA, the member must have acquired the information by improper means, or acquired the information under circumstances giving rise to a duty to maintain its secrecy or limit its use. Del. Code Ann. tit. 6, § 2001. A non-managing LLC member may have been legitimately exposed to the LLC’s information, or may have obtained the information from the LLC by making a request under the state statute, and without a contractual commitment there will not be a duty. The result is different if the member is a manager, because then the manager’s fiduciary obligations will create a duty to not disclose the LLC’s information.
Even if the member is a managing member, not all LLC information will be a protectable trade secret. To be a trade secret under the USTA, the information must derive independent economic value from not being generally known to, and not being readily ascertainable by proper means by, other persons who can obtain economic value from its disclosure or use. It must also be the subject of efforts that are reasonable under the circumstance to maintain its secrecy. Id.
So, trade secret law may not protect the LLC’s information unless the members have a contractual obligation not to disclose or use the information. And the Kuroda case underscores the need for express confidentiality provisions in the LLC agreement. Lawyers who assist clients in the formation of LLCs should consider adding confidentiality provisions to their LLC checklists and form agreements.