Bankruptcy Stay Prevents Removal of Limited Partnership’s General Partner
Under California’s Uniform Limited Partnership Act, a general partner’s bankruptcy filing causes the general partner’s automatic dissociation from the limited partnership and termination of management rights. (California Corporations Code sections 15906.03(f)(1) and 15906.05.)
But under the United States Bankruptcy Code, all interests of the debtor become property of the bankruptcy estate upon the filing of a bankruptcy petition notwithstanding any provision in an agreement or non-bankruptcy statute that is conditioned on the debtor’s bankruptcy filing and effects “a forfeiture, modification, or termination of the debtor’s interest in property.” (11 U.S.C. section 541(c)(1)(B).)
What happens when these two statutes collide? An opinion recently published by the United States Bankruptcy Appellate Panel of the Ninth Circuit — In re LeFever Mattson — addresses this issue.
Facts: general partner of a limited partnership declares bankruptcy; limited partners vote to confirm general partner’s removal and replacement.
Live Oak Investments, LP (“Live Oak”) was a California limited partnership formed to own an apartment complex known as Southwood. LeFever Mattson Inc. (“LFM”) owned a partial interest in Live Oak and was appointed as Live Oak’s General Partner pursuant to Live Oak’s Limited Partnership Agreement.
Years later, Southwood was sold and a dispute erupted over the sale proceeds. Live Oak’s Limited Partners contended that LFM breached the LPA and its fiduciary duties by pocketing most of the sale proceeds and failing to distribute any funds to the Limited Partners.
Shortly after the sale of Southwood, LFM filed bankruptcy petitions for itself and several of its affiliates including Live Oak. The related debtors’ cases were jointly administered and the bankruptcy court appointed an official Committee of unsecured creditors.
One year after the bankruptcy filings, Live Oak’s Limited Partners voted to remove LFM as General Partner of Live Oak and to appoint Limited Partner William Andrew as the new General Partner.
Bankruptcy Court: removal of General Partner after bankruptcy filing was void
The Committee of unsecured creditors filed a motion seeking an order declaring that the removal of LFM as General Partner of Live Oak was a violation of the bankruptcy automatic stay at 11 U.S.C. section 362(a)(3) and therefore void.
The bankruptcy court granted the motion. Mr. Andrew and the other Limited Partners appealed.
Appellate Panel of the Ninth Circuit: affirmed
The Bankruptcy Appellate Panel of the Ninth Circuit affirmed the bankruptcy court’s order.
The court first noted that LFM’s bankruptcy filing created a “bankruptcy estate” by operation of law, and property of the estate included “all legal and equitable interests of the debtor in property as of the commencement of the case.” Here, LFM’s bankruptcy estate included its general partnership interests in Live Oak.
Under California’s Uniform Limited Partnership Act, a general partner has “rights in the management and conduct of the limited partnership’s activities.” Beyond the statute, Live Oak’s Partnership Agreement also confirmed that Live Oak would be managed by its General Partner, LFM. The court stated: “Under California law, a partnership agreement is an enforceable contract, and a contract right is ‘property.'” As such, the court held: “LFM held management rights as General Partner of Live Oak LP when LFM filed its chapter 11 case, and those rights became property of its estate.”
The court next held that sections 15906.03 and 15906.05 of California’s Corporations Code “are preempted by the Bankruptcy Code.” The court noted that under section 541(c)(1)(B) of the Bankruptcy Code, the bankruptcy estate is vested with all of the debtor’s interest in property despite any contracts or nonbankruptcy laws purporting to terminate the debtor’s interest upon filing. Parties “cannot contract around what becomes estate property, and states cannot legislate estate property away.” The court held that Corporations Code sections 15906.03 and 15906.05 “effectuate an automatic ‘dissociation’ of a general partner from a limited partnership and terminate the general partner’s right to participate in the management of the limited partnership upon the general partner’s bankruptcy filing. Section 541(c)(1)(B) squarely precludes that result, and we hold that these ipso facto clauses are preempted by the Bankruptcy Code.”
As a result, the court held that the Live Oak Limited Partners’ removal of LFM as General Partner constituted an act “to exercise control over property of the estate” in violation of the automatic stay provisions in section 362 of the Bankruptcy Code.
Lesson
Under the LeFever Mattson opinion, the Bankruptcy Code preempts the provisions of California’s Uniform Limited Partnership Act that require the automatic termination of a General Partner’s management rights upon the General Partner’s bankruptcy filing. The General Partner’s managerial rights are considered part of the bankruptcy estate to be addressed through the bankruptcy proceedings.