The plight of the bare naked assignee.

Author:Kleinberger, Daniel S.
 
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  1. INTRODUCTION AND IRONY (2)

    In 1975, the Massachusetts Supreme Judicial Court decided what has since become an iconic case of the law of closely held corporations, Donahue v. Rodd Electrotype Company of New England, Inc. (3) The company, Rodd Electrotype, had been founded by two men. One had died, leaving his stock essentially to his widow. The other founder, getting on in years, sought to have the company buy out his holding to the ultimate advantage of his adult children.

    Not surprisingly, the widow of the deceased founder saw no reason why company money should redeem the stock of one founder while leaving her to take whatever fate (or that founder's children) might have in store for her. (4) She sued, and the Supreme Judicial Court ruled in her favor. In doing so, the court made a historic characterization and announced a rule of law that have together remained at the core of the law of closely held corporations for more than thirty years:

    Because of the fundamental resemblance of the close corporation to the partnership, the trust and confidence which are essential to this scale and manner of enterprise, and the inherent danger to minority interests in the close corporation, we hold that stockholders in the close corporation owe one another substantially the same fiduciary duty in the operation of the enterprise that partners owe to one another. (5) For those who study the law of limited liability companies, this famous passage is full of irony, as is the Donahue case itself. If Rodd Electrotype had been founded in the LLC era, then absent a contrary agreement among the founding "members," Mrs. Donahue's claim would have been DOA. Her husband's death would have effected his dissociation from the LLC, which would have stripped him and his estate of any governance rights. The estate and any heirs would have been confined to the role of "bare naked assignee" (6)--with neither management nor voting rights, no rights to information, and no rights even to complain. (7)

    Thus, what the Donahue court wrote of minority shareholders in a closely held corporation would apply in spades to the assignee of an LLC member: "Although the [entity] form provides ... advantages for the [owners] (limited liability, perpetuity, and so forth), it also supplies an opportunity for [those in control] to oppress or disadvantage" (8) those without power. Certainly, member upon-member oppression occurs within limited liability companies (9) (like shareholder-upon-shareholder oppression within close corporations), but the LLC form gives rise to something more. A new and separate opportunity for oppression exists because LLC law purports to (1) recognize a species of persons holding legal rights vis-a-vis the LLC (assignees) while (2) denying those persons any remedies whatsoever in connection with those rights. This article addresses the conceptual mechanics, history, and ultimate instability of that denial. The article also considers a note of irony--namely, that the plight of the "bare naked assignee" derives from a construct, the organization as "aggregate," that LLC law has in all other respects emphatically transcended.

    To understand the plight of the assignee of an LLC interest, one must first understand a bit of partnership law and history. Part II provides that necessary foundation, acknowledging that assignee vulnerability is a built-in aspect of partnership law. Part III examines how partnership law and even the original Uniform Limited Liability Company Act (ULLCA) limited that vulnerability, at least theoretically, and how the notion of a partnership with a perpetual term eliminated even that theoretical limit.

    Part IV describes and characterizes the state of affairs for assignees under LLC law, explains the countervailing practical concerns ("freeze the deal" versus "oppression unlimited"), and shows how the drafters of the newest uniform LLC Act (Re-ULLCA) chose to "punt" to "other law." (10) Part V provides two different conceptual approaches for use by "other law." One approach assumes that under LLC law a member's assignment of rights constitutes an assignment of contractual rights under the operating agreement. The other approach assumes that the assignment is merely a transfer of property rights vis-a-vis the LLC. In its own way, each approach could equip courts with sufficient authority in "extreme and sufficiently harsh circumstances ... to protect [assignees] against expropriation." (11) Part VI provides an account of an unreported trial court decision, in which the judge fashioned a remedial approach worth considering and concludes with the author's suggestion for further refining that approach.

  2. THE "PICK YOUR PARTNER" PRINCIPLE AND ASSIGNEE VULNERABILITY

    The "pick your partner" principle has always been at the core of U.S. partnership law. "Absent the consent of fellow partners, a partner simply lacks the power to convey to any outsider any role in the partnership's management or governance...." (12) Partnership is a voluntary association, resting on a contract (express or implied) to co-own a business. That contract co-exists with, and the business depends on, a relationship of trust and confidence among the co-owners who choose to co-associate.

    As a matter of basic definition, "voluntary association" entails the power to pick one's associates, and partnership statutes have always protected that power. Absent a contrary agreement, (13) partnership law requires unanimous consent to admit a new partner, and therefore a partner's right to alienate his, her, or its ownership interest is necessarily strictly limited. Economic rights are freely transferable. Governance rights are not.

    In the original 1914 Uniform Partnership Act (UPA), the "admission" requirement is stated simply, but the transfer restrictions are not. UPA [section] 18(g) provides, "No person can become a member of a partnership without the consent of all the partners." (14) In contrast, UPA [section][section] 26 and 27 must be read together to understand that the law bifurcates a partner's ownership interest into (1) economic rights and (2) rights to participate in, manage, and have information about the partnership.

    Section 26 states, "A partner's interest in the partnership is his share of the profits and surplus, and the same is personal property." (15) Section 27, captioned "Assignment of Partner's Interest" expresses no restriction on such a transfer, but does however strictly delimit a transfer's effect. Per subsection (1),

    A conveyance by a partner of his interest in the partnership does not ... as against the other partners in the absence of agreement, entitle the assignee, during the continuance of the partnership, to interfere in the management or administration of the partnership business or affairs, or to require any information or account of partnership transactions, or to inspect the partnership books; but it merely entitles the assignee to receive in accordance with his contract the profits to which the assigning partner would otherwise be entitled. (16) The Revised Uniform Limited Partnership Act (RULPA) takes essentially the same approach, although moving the crucially limited definition of "partnership interest" to the statute's definition section (17) and expressly providing for that interest's assignability. (18) The result is the same: "An assignment of a partnership interest does not ... entitle the assignee to become or to exercise any rights of a partner. An assignment entitles the assignee to receive, to the extent assigned, only the distribution to which the assignor would be entitled." (19)

    Beginning with the Revised Uniform Partnership Act (RUPA), the Uniform Law Commissioners have sought to state the matter more directly and to use the more inclusive term "transfer" rather than "assign." The construct, however, has remained essentially the same. The "pick your partner" principle controls a partner's power to transfer rights relative to the partnership.

    In fact, the RUPA formulation emphasizes that point even further by stating, "The only transferable interest of a partner in the partnership is the partner's share of the profits and losses of the partnership and the partner's right to receive distributions." (20) Moreover, while transfer of these economic rights "is permissible," (21) the transfer of economic rights occurs naked of any governance role. (22)

    In theory, at least, if a transferee obtains rights from a person who remains a partner, the transferee may shelter under the rights of the transferor. If, for example, the transferee suspects that a new contract between the partnership and an affiliate of one of the other partners is bleeding profits out of the company (and thereby away from the transferee), the transferee can push the transferor partner to demand information and, as appropriate, take further action. (23) When, however, the transferor ceases to be a partner, the assignee is left naked--owning potentially valuable economic interests but by statute stripped bare of any means to protect those interests.

    Dame v. Williams (24) illustrates the point succinctly. The case concerned a general partnership whose "stated purpose was the acquisition, development and management of real property investment opportunities." (25) The original managing partner had that role for fifteen years, until health problems caused him to resign that position while remaining a partner. He died two years later, and in due course his widow, acting as his executor, brought suit against the successor managing partner. The court rejected her claims essentially out of hand (i.e., for failing to state a claim) because the estate was nothing but a bare naked assignee. The court quoted New York Partnership Law [section] 51 (equivalent to UPA [section] 26), which expressly precludes an assignee from asserting management or informational rights, and then stated,

    As can be seen, the various provisions of the Partnership Law...

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