LLP: “LIMITED INSPECTION PARTNERSHIPS”? AN EXAMINATION OF MANAGEMENT RIGHTS IN LIMITED LIABILITY PARTNERSHIPS
Author: Ross Wilson*, Senior Editor
Aside from partnerships, every legal entity form that provides a liability shield for its owners places some limitation on an owner’s right to access the entity’s business information, such as its books and records. For corporations, a corporate shareholder’s inspection rights are conditioned on being made in good faith, for a proper purpose, made with reasonable particularity, and directly connected with the shareholder’s purpose.[1] Likewise, a limited liability company (“LLC”) may impose reasonable restrictions and conditions on access to and use of LLC information on matters within the ordinary course of its activities[2] and the LLC agreement may also reasonably restrict a member or manager’s right to information.[3] Similarly, a limited partnership (“LP”) is authorized to impose restrictions on limited and general partners’ rights to information[4] and the partnership agreement may impose reasonable restrictions on the availability and use of information.[5] Notwithstanding this commonality among entity forms, it remains unclear whether a partner’s right to information may be subjected to reasonable restrictions in a limited liability partnership (“LLP”). What makes a partnership different in this regard than every other entity form? Should partnerships be able to restrict the right to information? How are courts likely to rule on this issue? Why do these questions matter to modern-day businesses?
General Partnerships vs. Limited Liability Partnerships
Partnership is the label that the law applies to a particular kind of business relationship:[6] “the association of two or more persons to carry on as co-owners a business for profit forms a partnership, whether or not the persons intend to form a partnership.”[7] The hallmark consequence of ordinary general partner status is that all partners are personally liable for all debts and other obligations of the partnership.[8] The liability is automatic, strict, and arises solely due to a person’s status as a partner.[9] By contrast, a limited liability partnership (“LLP”) is simply a general partnership that has invoked the limited liability partnership provisions of its governing general partnership statute by filing with a specific public official a specified document[10] thereby becoming a LLP and eliminating, partially or completely, depending on the state, the automatic personal liability of each partner for each partnership obligation.[11] Importantly, the act of becoming a LLP is equivalent to an amendment of the partnership agreement; where the partnership agreement is silent as to how it may be amended, conversion to an LLP requires the approval of every partner[12].
Co-ownership and co-management are two key attributes of the partnership form, each carrying significant implications for partners. A partner’s co-ownership in the partnership must be functional, meaning that each partner has the right to control use and disposition [of the partnership], and the right to benefit, or suffer, economically from the exercise of that right of control.[13] A partner’s co-management of a partnership is equally as important: each partner has a full panoply of management rights, meaning each partner has equal rights in the management and conduct of the partnership business.[14] This essential co-management right entitles a partner to access the partnership’s books and records[15] and is not conditioned on the partner’s proper purpose or motive, at least by default provision.[16] Additionally, the partnership agreement may not unreasonably restrict this right to information,[17] though reasonable restrictions are permissible.[18]
Should LLPs Restrict Management Rights?
One of the greatest advantages of the partnership form is its flexibility—almost every partnership with a formal partnership agreement varies the default management rules in some way.[19] However, such flexibility in amending statutory default provisions carries significant legal implications for those choosing to draft and enter into partnership agreements.[20] Consider the policy objective behind the unconditioned right to inspect and copy partnership books and records: a partner’s unlimited personal liability justifies an unqualified right of access to the partnership books and records.[21] Notice is the heart of the policy: because each partner faces unlimited exposure to personal liability, the drafters granted an unqualified right to access books and records to ensure that all partners have the means to keep themselves informed at all times with information relevant to the partnership, ultimately to preserve their ability to act on that information (such as withdrawing from the partnership). Those in inadvertent partnerships are protected because nothing in the Act obstructs their notice as their access right is unqualified. Notice is similarly protected when a partnership agreement imposes reasonable restrictions on information rights because each partner consents to the restriction in the partnership agreement. In general partnerships, therefore, the policy behind an unqualified access right proves sound.
However, nothing in the statutory text or its comments qualifies this [information] right when a partnership is a limited liability partnership.[22] In fact, no court has ever directly ruled on the issue. This is particularly interesting given that partners are shielded from automatic personal liability for partnership obligations in LLPs, suggesting that the policy concerns applicable to general partnerships are unnecessary in LLPs. Even more interesting is a comparison of this feature of LLPs to every other entity form providing a liability shield for its owners: the LLP is the only entity form whose statute does not specifically address whether restricting information access rights may be qualified.[23]
Notwithstanding the LLP’s uniqueness in this regard, it is worth noting that partnerships are different from the other liability shielding entities, in at least one significant way: ownership and management rights are intertwined in partnerships. Unlike limited partnerships, corporations, and LLCs, where economic and management rights are separated by role, partners share equally in the profits, have equal rights to manage the partnership and its business, and have the power to bind the partnership.[24] Of course many of the statutory default provisions are amendedable by partnership agreement, including the right of access to books and records, subject to a “reasonable” restriction standard.[25] However, agreements limiting a partner’s right to inspect and copy partnership books and records are subject to judicial review,[26] which begs the question: how is a court likely to rule on this issue?
Relevancy to Modern-day Partnerships
Although partnership law may vary somewhat between states, businesses often look to Delaware courts for guidance. In Murfey v. WHC Ventures, the Supreme Court of Delaware recently considered a case arising from a demand for books and records of certain limited partnerships by two of their limited partners.[27] Although Murfey involved limited partnerships, and not LLPs, Murfey highlights an extremely relevant consideration likely applicable to partnerships and LLPs: Delaware’s longstanding policy of respecting freedom of contract in the alternative entity context and the court’s corresponding obligation to enforce agreements as written to effectuate the parties’ intent rather than implying conditions that could have been, but were not, included.[28]
Applying Murfey’s “plain meaning” principle to the LLP context, courts may very well be willing to import a level of sophistication to partners in LLPs by granting them broad leeway in freedom to contract around default rules, such as restricting partner inspection rights. Modern-day partnerships would be well advised to carefully consider contractual language in partnership agreements concerning inspection rights and the extent to which these agreements deviate from the statutory rights. Modern-day partnerships outside of Delaware should likewise plan accordingly as courts outside of Delaware are likely to follow suit by inferring sophistication among partners in limited liability partnerships, granting them wide-ranging freedom to contract to reasonably restrict the right of access partnership books and records.
*The author, Ross Wilson, is a student at Salmon P. Chase College of Law and is a member of the Northern Kentucky Law Review.
[1] Model Bus. Corp. Act § 16.02(c)(1).
[2] Revised Unif. Ltd. Liab. Co. Act § 410(g) (2007).
[3] Revised Unif. Ltd. Liab. Co. Act § 110(c)(6) (2007).
[4] Unif. Ltd. P’ship Act § 304(b) (2001).
[5] Unif. Ltd. P’ship Act § 110(b)(4) (2001).
[6] Daniel S. Kleinberger, Agency, P’ships, and LLCs 250 (5th ed. 2017).
[7] Revised Unif. P’ship Act § 202(a) (1997).
[8] Revised Unif. P’ship Act § 306(a) (1997).
[9] Kleinberger, supra note 6, at 259.
[10] This document is often called a “statement of qualification.”
[11] Kleinberger, supra note 6, at 677.
[12] Revised Unif. P’ship Act § 1001(b) (1997).
[13] Kleinberger, supra note 6, at 256.
[14] Revised Unif. P’ship Act § 401(f) (1997).
[15] Revised Unif. P’ship Act § 403 cmt. 2 (1997).
[16] Id.; Compare Model Bus. Corp. Act § 16.02(c)(1) (shareholder must have proper purpose to inspect certain corporate records).
[17] Thus, to preserve a partner’s core information rights despite unequal bargaining power, an agreement limiting a partner’s right to inspect and copy partnership books and records is subject to judicial review. Id.
[18] Id.
[19] Kleinberger, supra note 6, at 323.
[20] Many of RUPA’s default provisions are intended to protect those in inadvertent partnerships (i.e. the legally unsavvy). For example, partners owe each other a fiduciary duty of loyalty meant to set a standard of acceptable behavior among partners, once articulated by Justice Cardozo as “the punctilio of honor most sensitive” (Meinhard v. Salmon, 164 N.E. 545 (N.Y. 1928)).
[21] Revised Unif. P’ship Act § 403 cmt. 2 (1997).
[22] Revised Unif. P’ship Act § 306(c) (1997).
[23] Supra, notes 1-5.
[24] See Revised Unif. P’ship Act §§ 401(f), 401(b), 301, and 305 (2013).
[25] See Revised Unif. P’ship Act §§ 103(a), 103(b) (1997).
[26] Revised Unif. P’ship Act, supra note 15.
[27] Murfey v. WHC Ventures, LLC, 236 A.3d. 337, 339 (Del. 2020),
[28] Id. at 356-57.