ESG Capital Partners v. Passport Special Opportunities Master Fund, C.A. No. 11053-VCL (Del. Ch. Dec. 16, 2015) (Laster, V.C.)

In this memorandum opinion, the Court of Chancery granted in part and denied in part defendants’ motion to dismiss a complaint seeking declaratory relief in which plaintiffs alleged that certain investors in ESG Capital Partners II, LP (the “Partnership”) received preferential transfers amounting to a breach of contract, wrongful conversion, and unjust enrichment.  The Court found that one of the defendants did not receive a preferential transfer and that plaintiffs sought redundant declaratory relief regarding the meaning of the partnership agreement, but that the complaint otherwise stated valid claims.

In 2011, non-party Timothy Burns formed the Partnership for the limited purpose of purchasing shares of stock of Facebook, Inc. prior to its initial public offering (“IPO”).  ESG Capital Partners GP, Inc. (the “Original GP”) served as the general partner of the Partnership.  The agreement governing the Partnership (the “Partnership Agreement”) divided the equity stake in the Partnership into “Units” and stated that any distribution would be made to all partners in proportion to their respective “Percentage Interest” in the partnership. 

Unbeknownst to the other limited partners, Defendant Passport Capital, the investment manager for defendant Passport Special Opportunities Master Fund, L.P. (the “Passport Fund”) and Burns entered in to a Side Letter in an attempt to secure preferential treatment for the Passport Fund.  The Passport Fund then acquired approximately 100,000 partnership Units.

The Partnership purchased 452,515 Facebook shares, prior to Facebook completing its IPO.  After the IPO, Burns misappropriated cash, shares, and other Partnership property.  Before the discovery of his wrongdoing, Burns caused the Partnership to transfer over 80% of the shares to the limited partners.  Burns distributed the shares disproportionately between the limited partners, with some receiving one share per unit (the “Favored LPs”) and others receiving less than one share per unit (the “Disfavored LPs), ostensibly in violation of the Percentage Interest as defined in the Partnership Agreement.  When Burns’ wrongdoing was discovered ESG Successor II, LLC (the “Successor GP”) became general partner of the Partnership and demanded return of the shares or payment at the current market value from the Favored LPs.  When the Favored LPs refused, the Disfavored LPs, the Successor GP, and the Partnership filed this suit.

The Court first analyzed whether the Favored LPs breached the Partnership Agreement by receiving the Facebook shares.  The Court found that the Complaint adequately alleged a breach of the distribution provision of the Partnership Agreement because the Favored LPs did not receive shares in accordance with their Percentage Interest.  The Court noted that the plain language of the Delaware Revised Uniform Limited Partnership Act (the “LP Act”) and the partnership documents made clear that no partner owned specific Partnership assets.  The Court noted that even though the number of shares received by the Favored LPs matched the number of Units they held, the preferential transfers were not the equivalent of a ratable distribution because Burns’ misappropriations reduced the number of Facebook shares below a one-for-one correspondence with the number of Units.

Analyzing whether Section 17-607 of the LP Act applied as the exclusive means for challenging a distribution, the Court found that the Section did not apply because the Partnership made a preferred transfer and not a distribution.  The Court concluded that Section 17-607(b) is not the exclusive means of challenging a distribution; rather the Section applies exclusively to a claim that a limited partnership violated Section 17-607(a), which functions as a statutory limitation on a limited partnership’s ability to make a distribution.  The Court recognized that there are additional protective measures against distributions that could be bargained for, such as a restriction in a partnership agreement, and that Delaware presumes those restrictions to be separate and independent of statutory rights.

The Court then analyzed whether the dispute resolution provision of the Partnership Agreement established a ten-day contractual limitations period for bringing claims, and found the provision to be too unclear to foreclose the lawsuit.  The Court stated that, although Delaware law does not have any bias against contractual clauses that shorten statutes of limitation, decisions follow the general principle that contractual limitation periods are valid if they are reasonable.  The Court then stated that it was possible that a ten-day limitations period could be deemed unreasonable, as it could force parties to rush into court without proper investigation. 

The Court addressed whether the Successor GP should be estopped from suing on the ground that it stood in the shoes of the Original GP, which could not challenge the preferential transfers because it made them.  The Court noted that estoppel is an affirmative defense that will turn on facts that had not yet been developed.  Moreover, even if estoppel might apply to the Successor GP, it would not be enough to dismiss the suit, as it would not apply to the Disfavored LPs.

The Court examined the Side Letter, which purported to provide that the Passport Fund held a specific number of Facebook shares, as a defense unique to the Passport Fund.  The Court rejected the Side Letter as void as a matter of law in light of an integration clause in the Limited Partnership Interest Subscription Agreement, executed after the Side Letter.  The Court further stated that, even if the Side Letter remained in effect, it could only bind the Partnership to the extent that the Original GP had the necessary authority to commit to its terms and that any rights contrary to the Partnership Agreement would require an amendment to the Partnership Agreement.

The Court noted that the Favored LPs asserted the same arguments in response to the claims of conversion and unjust enrichment as it had to the breach of contract claim, concluding that those arguments failed for the same reasons.  However, with respect to the conversion claim, the Court further noted that the Disfavored LPs had a property interest in the Facebook shares that were transferred to the Favored LPs, at least to the extent that the number of shares transferred exceeded each Favored LP’s respective Percentage Interest.  The Court then stated that had a proper distribution been made, the Facebook shares would have gone to the Disfavored LPs rather than the Favored LPs who treated them like their own.

Finally, the Court analyzed whether Passport Capital was a proper defendant, and found that receiving fees and incentive compensation based on the performance of the Passport Fund was different from being a party to the Partnership Agreement.  In dismissing the claims against Passport Capital, the Court noted that if the plaintiffs prevailed on the merits and the Passport Fund was unable to satisfy its liability, a remedy might then be available from Passport Capital.  The Court also noted that plaintiffs alleged that Passport Capital entered into the Letter Agreement and Limited Partnership Interest Subscription Agreement on behalf of the Passport Fund but failed to allege grounds for liability based on those acts. 

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