Delaware Contemplates Allowing Discretion Unfettered by Good Faith

I admit that my first inclination when someone shares a case from Delaware state courts with me is to wince. They tend to be important. They tend to be long. Most of the facts involve transactions with a lot of moving parts that make them hard to blog about.

McKenzie v. BDO USA, P.C., decided by the Court of Chancery in January, is a short opinion, and the legal issues are straightforward. It makes me wince for different reasons, the kind of reasons that made Cicero cry out when he spoke of the Catiline Conspiracy.

Jason McKenzie was a partner in BDO USA, P.C. (BDO). After he announced his resignation, BDO reclassified his equity interest from variable to fixed shares, reducing his payout. He sued, alleging breaches of contract, the implied covenant of good faith and fair dealing, and fiduciary duties.

Mr. McKenzie was a partner in an accounting firm that BDO acquired in 2016. When he joined BDO, Mr. McKenzie signed its Partnership Agreement, which gave BDO broad discretion to designate partners, at any time, as either equity partners a/k/a Variable Share Partners (“VSPs”), or non-equity partners, a/k/a Fixed Share Partners (“FSPs”). The designation was not fixed, in that BDO could change its partners’ status and the allocation of partnership units in its sole discretion. A formula in Article 12 of the Partnership Agreement provided the mechanism for allocating shares to departing partners, provided they gave six months’ notice required in Article 11. Mr. McKenzie gave over a year’s notice.

Upon receiving that notice, BDO converted Mr. McKenzie’s VSPs to FSPs. Mr. McKenzie objected and was given what he reasonably construed as assurances that no transaction was contemplated that would make the change material. The next day, BDO announced that it was converting from a partnership into a professional corporation, a change in entity form that apparently had a negative impact on Mr. McKenzie’s compensation.

Mr. McKenzie filed his suit in March 2025. BDO filed its motion to dismiss in May. Vice Chancellor Will heard oral argument in October and issued her opinion in January 2026. Vice Chancellor Will made short work of the breach of contract claim. Everything that BDO did was within its rights under the Partnership Agreement. We don’t need to sweat the details, as what really concerns me in this post is the implied covenant. 

Vice Chancellor Will acknowledges that the duty of good faith is a part of every contract. However, citing a couple of Chancery Court opinions, she noted that “if the scope of discretion is specified, there is no gap in the contract as to the scope of the discretion, and there is no reason for the Court to look to the implied covenant to determine how discretion should be exercised.” Moreover, the Delaware Supreme Court noted in Nemec v. Schrader that the implied covenant “is not an equitable remedy for rebalancing economic interests after events that could have been anticipated, but were not.”

Here, BDO’s board exercised discretion in ways that Mr. McKenzie did not anticipate but which were permitted under the Partnership Agreement. In so doing, Vice Chancellor Will says, “the Board comported with the parties’ reasonable expectations embodied in the contract’s text.” 

I find this all astonishing. In my view, the implied covenant dwells in a space between breach of contract and equitable remedies. It is not a remedy available for all events that could have been anticipated but weren’t. It is a remedy for sharp practices against one’s contractual counterparties as well as a doctrinal mechanism that prevents contracts involving discretion from being rendered illusory. While the words of the Partnership Agreement permit the BDO board’s conduct, that conduct was still not foreseeable, because the implied covenant is, as its name suggests, an implied term. Mr. McKenzie was entitled to assume that the board would not strip him of an earned benefit once he had done the firm the courtesy of ample notice of his resignation. From that perspective, the board’s conduct did not comport with reasonable expectations. Mr. McKenzie did not expect such conduct, and in my view, his surprise at the conduct was justified.

As to Mr. McKenzie’s fiduciary duty claims, Vice Chancellor Will finds them duplicative of the breach of contract claim. Mr. McKenzie had not pleaded self-dealing here, in the Vice Chancellor’s view, because the conversion of his VSPs to FSPs would not have enriched the defendants any more than it enriched BDO’s other equity partners. Given that the reallocation would be shared among all equity partners, the benefit to any individual defendant would be de minimis. More alarmingly, Vice Chancellor concluded that BDO’s board owed him fiduciary no duties. Rather the Delaware Revised Uniform Partnership Act provides that the board’s duties run only to the partnership and the partners collectively. That is really a matter of Delaware entity law and so not the prime focus on this Blog.

I find unconvincing the Vice Chancellor’s finding that the fiduciary and contracts claims are duplicative De minimis non curat lex is a fine slogan, but it does not fit these facts. We are talking about a breach of a fiduciary duty. Cardozo said it best (of course), “Not honesty alone, but the punctilio of an honor the most sensitive is then the standard of behavior.” That being the case, I don’t think we care by how much the defendants enriched themselves. They cannot enrich themselves at all at the expense of a party to whom they owe fiduciary duties.

You would not know if from reading the Court of Chancery opinion, but Mr. McKenzie alleged that he was fired in retaliation for whistleblowing. Those facts come out in oral argument before the Supreme Court, discussed below. Perhaps the Vice Chancellor did not think those facts relevant, but Mr. McKenzie’s counsel on appeal gives them a lot of weight, arguing that these concrete allegations of an improper purpose distinguish this case from Nemec.

Mr. McKenzie took an appeal to the Delaware Supreme Court. You can watch the oral argument here. In the oral argument, counsel did not take up my argument about de minimis breaches of fiduciary duty. Rather, Nemec v. Schrader took center stage.

Mr. McKenzie’s attorney laid out the issues very clearly:

Mr. McKenzie’s counsel urged the Supreme Court to reverse the Vice Chancellor’s decision because her rulings on each of these two fundamental issues were incorrect. She pointed out that even absolute discretion does not allow a board to act in bad faith or in retaliation. Even if the board had discretion to strip a party of their status as an equity partner, and the Partnership Agreement does not say that, it could not do so in bad faith. She called the notion that board owe no fiduciary duty to individual partners “staggering.”

She distinguishes this case Nemec in that Mr. McKenzie was acting as a whistleblower, and the board retaliated against him for that reason. Plaintiffs in Nemec alleged only that they were harmed by a board decision, and they had no independent claims of bad faith.

As to the question of whether boards owe fiduciary duties to individual stockholders or equity holders, such as Mr. McKenzie, Mr. McKenzie’s counsel conceded that there is no general fiduciary duty to equity holders. However, there is a duty to them qua equity holders. She explained:

This language gestures towards an unconscionability argument, and one of the Justices seemed interested in that possibility. He asked whether Mr. McKenzie had a hand in negotiating the Partnership Agreement. His counsel did not know the answer. I suspect that the answer is no, but even were that the case, I’m not sure that fact is relevant to either of the issues before the Court. If the implied covenant is as impotent as the Vice Chancellor thinks it is, unconscionability doctrine might have to be stretched to fill the gap, but it is too late in the game for that to matter for this case.

As expected, BDO’s counsel defended the Vice Chancellor’s decision. He described Nemec very differently, claiming that there were allegations of bad faith conduct in that case as well, in that the board members benefited from the deprivation of benefits to plaintiffs. BDO took the hard line that Nemec stands for the proposition that the implied covenant is not a limitation on the board’s exercise discretion, so long as the board’s conduct is consistent with contractual terms. If that’s what Nemec says, that is indeed staggering. Mr. McKenzie’s counsel countered on rebuttal that there were allegations of bad faith in Nemec but they were naked allegations that amounted to nothing more than being deprived of a benefit. They did not allege retaliation for whistleblowing or any other independent misconduct by the board.

As to the board’s duties, I remember covering scenarios when I was teaching where a board took actions that hurt some shareholders. That is perfectly permissible if there is an argument that the transaction benefits the entity as a whole, but that requires some inquiry. Here, the board could easily justify its grounds for changing the entity from a limited partnership to a professional corporation, but it’s decision to change Mr. McKenzie’s status is more challenging. And because they personally benefited from that change, even if they only benefitted to the same degree as all the other equity partners, we have an interested transaction and the usual business judgment rule would not apply, or so I would think.

We’ll see how it goes.

Thanks to Mitu Gulati for sharing this case with me and thereby weakening, ever so slightly, my already faltering faith in humanity.