Court Rules Houston Astros Cannot Strike Out Fiduciary Duties in Bankruptcy

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Introduction

One of the incentives that Delaware law offers founders of business entities is the ability to tinker with the fiduciary duties that the managers of the business owe. While the duties owed by corporate directors cannot be waived, the same is not true for partners of limited partnerships (“LPs”) or managers or managing members of limited liability companies (“LLCs”). While it has not previously been clear whether such disclaimers remain effective when the LP or LLC enters bankruptcy, a bankruptcy judge in Texas has just held that a disclaimer of fiduciary duties, valid under state law, ceases to be effective when the limited partner becomes a Chapter 11 debtor in possession.

Applicable State Law

Many states have laws that permit LPs and LLCs to expand or restrict, but not eliminate, the default set of fiduciary duties owed by partners to the partnership and/or other partners or by managers and members to the company and/or other members. In 2004, after the Delaware Supreme Court had ruled in Gotham Partners v. Hallwood Realty Partners, 817 A.2d 160, 167-68 (Del. 2002) that Delaware law had the same effect, the state legislature amended Delaware’s Limited Partnership Act (“LP Act”), Del. Code Ann. tit. 6, § 17-1101(d), and its Limited Liability Company Act (“LLC Act”), id. § 18-1101(c), to provide that LP agreements and LLC agreements can “eliminate[]” "fiduciary duties” owed to the partnership and/or other partners or to the company and/or other members (with exceptions dealing with bad faith). Alabama later joined Delaware in the very exclusive club of states that permit the virtually total waiver of fiduciary duties (although the default situation for a Delaware LP or LLC whose agreement is silent on the subject of fiduciary duties is, thanks to very recent legislation, that traditional fiduciary duties are owed). It is often the case that the entities creating an LP or LLC want to ensure that each limited partner or member, and its appointed manager or director, remains free to put its own interests ahead of the interests of the partnership or company as a whole, and the LP and LLC Acts permit them to do so. But the recent ruling, discussed below, provides that such freedom comes to an end when a bankruptcy petition is filed.

The Astros Case

One of the many Delaware LPs that availed themselves of the freedom contractually to eliminate fiduciary duties was Houston Regional Sports Network, L.P. (the “Network”). The Network was formed in 2003 to televise Houston Astros’ and Houston Rockets’ games and other sports programming on a cable channel in the Houston area. As of 2010, the partners that made up the Network were the Astros, the Rockets and a Comcast entity. The Network’s LP agreement provided that the Network was to be managed by its general partner, Houston Regional Sports Network, LLC, which is also owned by the Astros, Rockets and Comcast, and managed by four directors. The Astros and Rockets each appointed one director; the remaining two directors were selected by Comcast. The LP agreement further provided that the partners would not owe fiduciary duties to the Network or to each other and that each partner—and its appointed director—would be entitled to act in its own self interest in making decisions for the Network.

The Network’s principal assets were media rights agreements, providing it the exclusive rights to broadcast Astros and Rockets games in exchange for regular payments. These agreements could be terminated by the teams if the Network defaulted on its payment obligations. Significant decisions involving the media rights agreements required unanimity among the general partner’s four directors. 

The Network was not profitable and stopped making media rights payments in July 2013. In September 2013, several of its creditors—all Comcast affiliates—filed an involuntary Chapter 11 bankruptcy petition against the Network. Certain other creditors, including two Rockets-related entities, thereafter moved to join the petition. The Astros, on the other hand, moved to dismiss the petition based on (1) alleged bad faith on the part of the Comcast creditors, and (2) alleged futility of the Network’s reorganization. With respect to the latter argument, the Astros asserted that reorganization would be futile because, under the partnership agreement, its selected director would be entitled to, and likely would, veto any deal sought to be reached by the Network concerning the Astros’ media rights agreement. The veto would be intended to terminate the Astros’ media rights agreement with the Network, which the Astros contended paid less than most other baseball teams received for their media rights.

The Astros Court Decision

On February 12, 2014, the Bankruptcy Court denied the Astros’ motion to dismiss, ruling that the petition had not been brought in bad faith and that reorganization would not be futile. In re Houston Reg. Sports Network, L.P., No. 13-35998, 2014 WL 554824 (Bankr. S.D. Tex. Feb. 12, 2014). In reaching its decision, the Bankruptcy Court, among other things, ruled that despite the Network’s partnership agreement eliminating fiduciary duties and allowing the Astros and its appointed director to act in their own self interest, as permitted by state law, the Astros’ appointee director of the Network’s general partner owed fiduciary duties to the bankruptcy estate that could not be waived. Thus, the court ruled, the Astros-appointed director could not indiscriminately veto any and all proposals concerning the Astros’ media rights agreement because doing so would breach the fiduciary duties he owed to the estate (although the Astros as an entity would remain free to take any desired steps to oppose any such proposal). The court explained that fiduciary duties under bankruptcy law cannot be waived despite any contrary state laws effective outside of bankruptcy because otherwise, the estate would be left without any fiduciary. 

An Appeal is Pending

The Astros have appealed the decision, arguing, among other things, that (1) neither the Bankruptcy Code nor any legal precedent supports the court’s ruling that bankruptcy law revives fiduciary duties that were validly waived in governing documents under state law; (2) the court was wrong in reasoning that the estate would necessarily be left without a fiduciary because the court was always free to appoint a Chapter 11 trustee to replace the debtor in possession; and (3) the reason the court imposed fiduciary duties on the directors rather than appointing a trustee was that the appointment of a trustee would have permitted the Astros to refuse to consent to the trustee’s assumption of the Astros’ media rights agreement, thus terminating the agreement and leaving the estate without its most significant asset (although that is precisely what the parties intended).1 The appeal is not yet fully briefed.

Implications

The Bankruptcy Court’s ruling that a valid waiver of fiduciary duties under state law is unenforceable in bankruptcy, particularly if affirmed on appeal, has a number of important implications for partners, directors and managers of Chapter 11 debtors in possession. First, they should be aware that any right under state law to eliminate fiduciary duties in governing LLP (or LLC) documents is not absolute because fiduciary duties may arise automatically upon the filing of a bankruptcy petition. Second, the ruling suggests that bargained-for rights may be disregarded in bankruptcy when the court finds that doing so is in the best interest of the estate. Third, absent resignation, a director can be placed in the difficult position of having to act against the interests of the appointing entity, as the Astros-appointed director may have to do in this case.

Footnotes

1 This argument raises other complex bankruptcy law issues that are beyond the scope of this update.

 

Topics:  Breach of Duty, Commercial Bankruptcy, Fiduciary Duty, Limited Partnerships

Published In: Art, Entertainment & Sports Updates, Bankruptcy Updates, Business Organization Updates, Business Torts Updates, Civil Procedure Updates

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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