Delaware courts often look to the Delaware General Corporation Law to decide cases involving alternative entities, such as limited liability companies and limited partnerships. Under 8 Del. C. Section 220, a corporate stockholder can seek books and records of a corporation if the stockholder can show a proper purpose that is reasonably related to such person’s interest as a stockholder.1 Delaware courts have long held that the scope of the demand must be “necessary and essential” to the proper purpose asserted.2
Borrowing from the familiar standards that govern demands for corporate books and records under 8 Del. C. Section 220, Delaware courts have consistently held that statutory demands for a limited partnership’s books and records under 6 Del. C. Section 17-305 (or under 6 Dec. C. Section 18-305 for limited liability companies) must be accompanied by a showing that each request is “necessary and essential” to the demanding party’s stated purpose.3 However, in Murfey, the Delaware Supreme Court held that the “necessary and essential” showing is not required—and no basis exists to infer that the showing should be required—where the inspection right is contractual and the partnership agreement does not expressly condition document inspection rights on satisfying the “necessary and essential” test.4
Background of the case
Murfey arose from a contractual books-and-records demand made by two limited partners of certain limited partnerships.5 As an initial matter, the language in the limited partnership agreements provided that limited partners could request (1) the partnership tax returns and (2) information related to the name, address, capital contributions, and partnership percentage of each limited partner.6 Although many of the books and records sought by the limited partners were produced, one category of documents – the Schedule K-1s attached to the partnerships’ tax returns – remained in dispute between the parties.7 The limited partners were provided with their own K-1s, but the limited partners specifically were seeking the K-1s of the other limited partners for the purposes of (1) valuing their ownership stake in the partnerships and (2) investigating possible mismanagement and wrongdoing.8
The Delaware Court of Chancery, based on its history of interpreting 6 Del. C. Section 17-305 in the same manner as 8 Del. C. Section 220, held that the K-1s were subject to the requirement that documents sought be “necessary and essential” to the investor’s stated purpose.9 Although the partnership agreements did not include the “necessary and essential” language, the Court of Chancery inserted the “necessary and essential” requirement into the contractual framework because it found that the partnership agreements incorporated the requirement applied in cases construing 6 Del. C. Section 17-305.10 The Court of Chancery held that the K-1s failed the “necessary and essential” test.11
On appeal, the Delaware Supreme Court reversed the Court of Chancery’s decision, holding that the limited partners had a contractual right to the K-1s (as part of the partnerships’ tax returns) under the plain language of the partnership agreements.12 The majority (over two dissenters) refused to import a “necessary and essential” condition into the partnership agreements.13 The court stressed Delaware’s “long-standing policy of respecting freedom of contract in the alternative entity context,” and explained that implying terms that the parties did not expressly agree to in a written contract, such as a partnership agreement, should be a “cautious enterprise.”14 The court also stressed that it has an obligation to enforce agreements as written to effectuate the parties’ intent rather than implying conditions that could have been, but were not, included.15 Implying terms that parties did not expressly agree to in a written contract “risks upsetting the economic balance of rights and obligations that the contracting parties bargained for in their agreement.”16 The same reasoning will likewise apply to limited liability companies.
Key Takeaways
- Unlike under the Delaware General Corporation Law, a court will not imply a “necessary and essential” condition absent a limited partnership agreement (expressly) conditioning the limited partner’s inspection rights on satisfying the “necessary and essential” test.
- The effect of Murfey is to recognize a broader reach in contractual language of partnerships than Delaware courts would permit under Section 220 of the Delaware General Corporation Law.
- The decision in Murfey reaffirms Delaware’s strong preference for freedom of contract, particularly in the alternative entity context.
- Murfey’s implications should similarly apply to other alternative entity types, including limited liability companies, and parties should carefully consider the intended scope of any contractual inspection right afforded to investors.
- See 8 Del. C. Section 220(b).
- See Wal-Mart Stores, Inc. v. Indiana Elec. Workers Pension Tr. Fund IBEW, 95 A.3d 1264, 1271 (Del. 2014) (“Documents are ‘necessary and essential’ pursuant to a Section 220 demand if they address the ‘crux of the shareholder’s purpose’ and if that information ‘is unavailable from another source.’”).
- See Murfey, 2020 WL 3957837, at *6 (citing Gotham Partners, L.P. v. Hallwood Realty Partners, L.P., 714 A.2d 96, 100-02 (Del. Ch. 1998)).
- See Murfey, 2020 WL 3957837, at *12.
- Id. at *1.
- Id. at *4.
- Id. at *1.
- Id.
- Id. at *5.
- Id.
- Id.
- Id. at *11.
- Id. at *10-11.
- Id. at *14-15 (“First, it is axiomatic that courts cannot rewrite contracts or supply omitted provisions. Doing so does not respect the parties’ freedom of contract.”).
- Id. at *15 (quoting Freeman Family LLC v. Park Ave. Landing LLC, 2019 WL 1966808, *4 (Del. Ch. Apr. 30, 2019)) (“[T]he court looks to the most objective indicia of [the parties’] intent: the words found in the written instrument”).
- See Murfey, 2020 WL 3957837, at *10.
Client Alert 2020-475
