The LPAC Strikes Back . . . When The Contract Says It Can

Many private equity partnerships utilize a limited partner advisory committee (“LPAC”) as a mechanism to approve certain transactions, particularly those where a potential conflict of interest could exist. While Delaware corporate law provides well defined rules for how a self-interested transaction can be cleansed by disinterested directors or shareholders in the context of a corporation, the rules are less well defined when it comes to conflicts of interest for partnerships including private equity funds established as limited partnerships. The decision from In re SunEdison, Inc. demonstrates that the LPAC’s role in approving conflicted transactions remains a case-by-case, contract specific analysis.

Background

The Delaware Revised Uniform Limited Partnership Act (“DRULPA”) establishes the rules for limited partnership formation and is intended to give “maximum effect to the principal of freedom of contract.” Limited partnership agreements can not only create an LPAC, but also can establish the specific responsibilities of that LPAC. The LPAC often acts as a decision-making body with respect to conflicts that may arise between the interests of the limited partners and the interests of the general partner. The role of an LPAC, however, can vary significantly; sometimes LPACs play a mere advisory role while others operate as a required review authority.

In re SunEdison, Inc.

In re SunEdison, Inc. involved the elimination of a limited partner’s partnership interest for failure to comply with a capital call required by the limited partnership agreement. The removed limited partner filed a lawsuit alleging breach of fiduciary duty. The limited partner argued that the general partner violated the partnership agreement by extinguishing the LP interest without first obtaining approval from the LPAC. The plaintiff alleged that LPAC approval was necessary because the elimination of a partnership interest resulted in an increase to the value of each remaining partnership interest including the general partners, and was therefore a conflict of interest transaction. The general partner defended the claim by arguing that the partnership agreement’s exculpation provision eliminated otherwise applicable fiduciary duties to the extent they were not specifically incorporated in the agreement. The court considered the arguments under the motion to dismiss standard.

A Delaware law claim for breach of fiduciary duty requires that a plaintiff establish two elements: the existence of a fiduciary duty and the defendant’s breach of that duty. But “DRULPA allows limited partnership agreement drafters to ‘disclaim’ fiduciary duties and replace them with contractual duties.” The SunEdison court found that the partnership agreement disclaimed all fiduciary duties, and as a result, the only duties that remained were the enumerated contractual duties and the implied covenants of good faith and fair dealing. Thus, the key inquiry was whether there was any material breach of the partnership agreement.

In determining there was no material breach, the court considered whether the agreement required LPAC approval before a partnership interest could be extinguished. The SunEdison partnership agreement contained an enumerated list that detailed what “conflict” transactions required advisory committee approval. This list included transactions with fund-affiliated companies. The court determined that eliminating a limited partnership interest did not match any of the enumerated conflicts and therefore LPAC approval was not necessary. As LPAC approval was not required, the court held there was no breach of the partnership agreement, and thus no material breach (“it is a stretch to assert even that there has been a contractual breach.”) Therefore, the court concluded the general partner had not breached its fiduciary duty.

Takeaways

• SunEdison is one of the few published cases addressing LPAC approval in the context of a private equity fund. It demonstrates that determining whether LPAC approval is required remains a case-by-case contract-specific inquiry.
• As DRULPA encourages maximum freedom of contract, conflicts of interest that may require LPAC approval will continue to vary between each partnership.
• When a limited partnership agreement defines what actions require LPAC approval, failure to receive that approval may result in general partner liability for either breach of contract or breach of fiduciary duty.

We note that the scope of the fiduciary duty of an adviser to a private fund under federal law, and the extent to which approval by an LPAC or investors of certain conflicts including principal transactions, may be necessary under the Investment Advisers Act of 1940,  is beyond the scope of this discussion.

This post is as of the posting date stated above. Sidley Austin LLP assumes no duty to update this post or post about any subsequent developments having a bearing on this post.