Delaware Supreme Court Rules on “Necessary and Essential” Condition for LP Books and Records Demands
The Delaware Supreme Court recently decided the case of Murfey v. WHC Ventures, LLC, No. 294, 2019 (Del. July 13, 2020), which involved a dispute over whether the plaintiff limited partners were entitled to certain books and records under the partnership agreement in question. Specifically, plaintiffs sought the Schedule K-1s of the other limited partners in the partnership purportedly for the purpose of valuing their interests in the partnership.
The decision gives rise to several practice points for alternative entity practitioners and private fund managers, including the possible adoption of a “necessary and essential” condition for LPs’ books and records requests.
Synopsis of the Case
The Court of Chancery, C.A. No. 2018-0652 (Del. Ch. June 21, 2019), denied plaintiffs’ request for the K-1s, finding that although plaintiffs had stated a proper purpose, they had not shown that the K-1s were reasonably related to their stated purpose. In so finding, the Court applied the “necessary and essential” condition and concluded that the K-1s were not necessary and essential to satisfying the stated valuation purpose. The “necessary and essential” condition had initially been developed in cases applying Section 220 of the Delaware General Corporation Law, and it had been carried over by the Court of Chancery to cases applying Section 17-305 of the Delaware Revised Uniform Limited Partnership Act, 6 Del. C. § 17-101 et seq. (“DRULPA”), based on the common usage of the term “purpose reasonably related” to the person’s interest as a stockholder or limited partner.
The Court applied that standard to the partnership agreement provision in Murfey because the provision was based on Section 17-305. The Supreme Court reversed, finding that it was inappropriate to imply the “necessary and essential” condition to the provision in the partnership agreement.
While there has been considerable discussion of this case, it is likely that the information to which the Court of Chancery will give limited partners access under a Murfey type books and records provision will not change materially as a result of the Supreme Court’s decision (although, as discussed below, general partners of Delaware limited partnerships that have books and records provisions similar to the one at issue in Murfey should consider adopting appropriate standards on the information to which limited partners are entitled).
Key Points from the Decision
In assessing the effect of the Supreme Court decision, it is important to note several points.
- Both the Court of Chancery and the Supreme Court agreed that the plaintiffs’ purpose of valuing their interests was proper.
- It was undisputed that the K-1s constituted a part of the partnership’s tax returns to which the limited partners were entitled for a purpose reasonably related to their interest as limited partners.
- The general partner did not avail itself of its authority under the partnership agreement to establish reasonable standards for determining whether the purpose for the request was reasonably related to the limited partner’s interest as a limited partner.
- Both the Court of Chancery and the Supreme Court agreed that the requirement that the purpose be reasonably related to the limited partner’s interest as a limited partner performed a limiting function - that is, that the limited partner had to show a proper purpose and also had to connect that proper purpose to the information sought.
The point of disagreement between the Supreme Court and the Court of Chancery was whether the plaintiffs had to show that the information sought was “necessary and essential” to their proper purpose. Here, the Supreme Court held that the phrase “necessary and essential” performed a greater limiting role than the “for” any purpose reasonably related language and, therefore, was not the proper test. Further, where the Court of Chancery found that the K-1s would provide no type of information that would help the plaintiffs value their interests, the Supreme Court found that the K-1s were part of the partnership’s tax returns, which can “provide important information for Plaintiffs’ valuation purpose.”
Based on the foregoing, several important takeaways emerge from the Murfey case.
Revisit LP Books and Records Provisions
First, a general partner with a books and records provision similar to Murfey, which authorized the general partner to establish reasonable standards, “including standards for determining whether the purpose for the request is reasonably related to the Limited Partner’s interest as a Limited Partner”, should consider, in light of the nature of the partnership’s activities and the information to which the limited partners are permitted access under the applicable books and records provision, what reasonable standards should govern the limited partners’ access. In this regard, the language in the Murfey provision seems to lend itself to a determination by a general partner that the standard for determining whether a limited partner’s purpose is reasonably related to its interest could be whether the information sought is “necessary and essential” to the stated purpose. In all events, these provisions clearly give the general partner discretion to establish standards, and standards adopted on a so-called “clear day” may be given more deference than standards adopted in the heat of a battle over access to information.
Practical Application of a Books and Records Clause
Second, while it is clear that the Court of Chancery will not apply the “necessary and essential” condition to an information request under a Murfey-type provision (unless, perhaps, the general partner properly adopts a “necessary and essential” standard), the Court of Chancery will still require a limited partner to show that the information sought is reasonably related to a proper purpose. While under this standard the Court of Chancery may give the limited partner the benefit of the doubt on a close call, the type and range of information to which the Court of Chancery will permit limited partners access under a Murfey provision should not change materially.
Partnership Agreement Amendments to Restrict Access to Information
Third, to the extent the general partner cannot unilaterally adopt a restriction embodying the “necessary and essential” standard, it should consider whether such a standard could be adopted by amendment, particularly if a majority in interest of the limited partners (or whatever the applicable amendment standard is) would agree that certain information (such as individual limited partners’ K-1s) should not be made available to other limited partners. In this regard, Section 17-305(f) of DRULPA specifically authorizes an amendment to a partnership agreement to restrict the limited partners’ right to information.
Should you have any questions regarding the Murfey case, including as to potential standards that a general partner could adopt under a Murfey-type books and records provision, please feel free to contact any member of the Morris Nichols Delaware Alternative Entity Group.
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