California’s Revised Uniform Limited Liability Company Act (RULCCA) sets out duties owed by managers or members of the LLC. While managers of manager-managed LLCs and members of member-managed LLCs both owe a duty of loyalty and care, all members and managers have a contractual obligation of good faith and fair dealing. However, unless terms are manifestly unreasonable, the LLC’s operating agreement affords the LLC an opportunity to edit these duties and responsibilities. This includes a modification of the duty of loyalty, duty of care, in addition to good faith and fair dealing. This begs the question: what is the manifestly unreasonable standard?
The National Conference of Commissioners on Uniform State Laws (NCCUSL) wrote RULLCA, on which California based their RULLCA. Thus, the NCCUSL’s description and commentary on the manifestly unreasonable standard should be understood by those looking to interpret an LLC’s operating agreement. This is especially true, given the little to no case law (in the entire nation) dealing with the manifestly unreasonable standard. According to NCCUSL, the manifestly unreasonable standard is fundamental to RULLCA because it protects an operating agreement. For example, if the concept of manifestly unreasonable were loosely applied, then the court would be able to alter the members’ agreement, something which RULLCA looks to prohibit. Furthermore, unlike in the commercial context, here manifestly unreasonable is to be applied to the individual business organization in its’ own context. Finally, it is important to note that when the manifestly unreasonable standard is used, the court’s determination is based off the date the term was adopted in the LLC’s operating agreement.
According to the NCCUSL, the party claiming that a term is manifestly unreasonable has the burden of proof. Furthermore, the court can only rule the term is manifestly unreasonable under certain circumstances. First, the court must first understand the purposes and activities of the LLC. Then, the court must apply their understanding to the term in question. The court can only find the term to be manifestly unreasonable if “it is readily apparent that (a) the objective term is unreasonable or (b) the term is an unreasonable means to achieve the provision’s objective.”
The court will obtain their understanding of the purpose/activities of the LLC by weighing factors like the sophistication of the parties, both parties’ interpretation of the manifestly unreasonable standard in addition to the overall bargain. If the LLC’s operating agreement results in unjust operations, regarding unfair dealing or “a situation outside of the reasonable expectations of the parties in in regard to fiduciary duties,” the court will likely revert the operating agreement to the default fiduciary duties provided in California’s RULLCA.