Interpretation of Limited Partnership and Limited Liability Company Agreements Under Delaware Law

Copyright© 1998 Martin I. Lubaroff

All rights reserved.

Delaware courts will apply general rules of contract interpretation when interpreting a limited partnership agreement. This approach reflects the freedom of contract principles which pervade the Delaware Revised Uniform Limited Partnership Act, 6 Del. C. §17-101 et seq. (the "Limited Partnership Act"). Specifically, Section 17-1101(c) of the Limited Partnership Act provides that "[i]t is the policy of this chapter to give maximum effect to the principle of freedom of contract and to the enforceability of partnership agreements." 6 Del. C. § 17-1101(c).

Various cases have established Delaware courts' willingness to apply general rules of contract interpretation to limited partnership agreements. In Arvida/JMB Partners, L.P. v. Vanderbilt Income and Growth Associates, L.L.C. and Raleigh Capitol Associates, L.P., C.A. No. 15238-NC (Del. Ch. May 23, 1997), aff'd No. 428, 1997 (Del. June 9, 1998), the Court of Chancery interpreted a limited partnership agreement and additional assignment documents (namely a master assignment agreement and individual instruments of assignment) in order to determine whether a subsequent assignee of limited partnership interests in the partnership had voting rights or a right to become a limited partner. Neither the partnership agreement, nor the assignment documents explicitly addressed the voting rights issue. Vice Chancellor Balick indicated that "[c]onsistent with the policy of the [Limited Partnership Act], the controlling agreements must be interpreted in accordance with the rules for construing contracts." Id., slip op. at 6; see also Star Cellular Telephone Co. Inc. v. Baton Rouge CGSA, Inc., C.A. No. 12507, slip op. at 8 (Del. Ch. July 30, 1993), aff'd 647 A.2d 382 (Del. 1994) ("[T]he court must analyze [partnership agreement] Section 13.1's antitransfer clause in light of applicable contract principles."). By employing general rules of contract interpretation, the Court of Chancery in Arvida found that the subsequent assignee had voting rights. Arvida, C.A. No. 15238-NC, slip op. at 10.

In Katell v. Morgan Stanley Group, et al., C.A. No. 12343 (Del. Ch. June 8, 1993), the Court of Chancery was presented with the task of interpreting a limited partnership agreement in order to determine general partners' rights to form unilaterally an independent committee to assume control of legal action brought in a derivative suit. As no provision in the Limited Partnership Act explicitly addressed the issue, the Court of Chancery noted that Section 17-1101(c) of the Limited Partnership Act mandated that "the specific rights and responsibilities of parties in a general or limited partnership are determined by the parties' particular partnership agreement." Id., slip op. at 4. Further, the Court of Chancery noted that such agreements are to be interpreted according to "classic rules of contract construction." Id., slip op. at 9. In looking to "classic rules of contract construction" to interpret the ambiguous limited partnership agreement, Vice Chancellor Chandler reasoned that "any ambiguities in the Partnership Agreement should be resolved against the general partners who drafted the contract." Id. (citing Graham v. State Town Mut. Auto Inc., Co., 565 A.2d 908, 912 (Del. 1989))(for a more expansive explanation of this proposition, see Section II C). The Vice Chancellor also reasoned that "[u]nder well settled rules of construction, specific language in a contract controls over general language . . . [m]oreover, unequivocal language controls over qualified language." Id., slip op. at 7.

With respect to the issue of contract interpretation in the limited partnership area, it is noteworthy that Delaware courts have referred to breach of limited partnership agreement claims as breach of contract claims and have applied general contract principles when interpreting such limited partnership agreements. See Desert Equities Inc. v. Morgan Stanley Leveraged Equity Fund II, L.P. et al., C.A. No. 12449, slip op. at 2 (Del. Ch. July 28, 1992), rev'd on other grounds, 624 A.2d1199 (Del. 1993); Boesky v. CX Partners, L.P., C.A. Nos. 9739, 9744, 9748 (Del. Ch. Apr. 28, 1988).

As seen in the foregoing authorities, Delaware courts are employing general contract principles when interpreting limited partnership agreements.

Delaware courts will not interpret a contract absent a finding that the instrument's language is ambiguous and subject to multiple interpretations. Generally, Delaware courts interpreting contract provisions first attempt to ascertain the clear meaning of an agreement. See, e.g., US West, Inc. v. Time Warner, Inc., C.A. No. 14555, 1996 WL 307445 at *9 (Del. Ch. June 6, 1996) (describing steps in contractual interpretation, beginning with clear meaning). Extrinsic evidence is employed only upon finding an ambiguity. Id. See also, Cincinnati SMSA Limited Partnership v. Cincinnati Bell Cellular Systems Co., C.A. No. 15388 (Del Ch. August 13, 1997) (stating that Delaware law "precludes (the Court of Chancery) from considering extrinsic evidence to interpret the terms of a contract without first determining that the contract is ambiguous."); Eagle Industries, Inc. v. DeVilbiss Health Care, Inc., 702 A.2d 1228, 1232 (Del. 1997) (" If a contract is unambiguous, extrinsic evidence may not be used to interpret the intent of the parties, to vary the terms of the contract or to create an ambiguity.") This approach is consistent with general contract interpretation principles.

Several Delaware cases support the notion that a finding of ambiguity is necessary to allow judicial interpretation of a limited partnership agreement. An ambiguity in a limited partnership agreement was found to exist in Star Cellular, C.A. No. 12507, slip op. at 8, whereby the Court of Chancery then proceeded to interpret the limited partnership agreement to determine whether the scope of the term "transfer" of interest was sufficient to encompass merger by the partnership. The Court of Chancery noted that its determination was governed by the common meaning of the parties. Further, the Court of Chancery stated that where a writing is clear and unambiguous on its face, that meaning is controlled by the writing itself and "there is no room for interpretation, construction, or a search for the intent of the parties." Id. (quoting Klair v. Reese, 531 A.2d 219, 223 (Del. 1987)). An agreement may be considered clear and unambiguous on its face only when a disputed term has a "plain or generally prevailing meaning". Star Cellular, C.A. No. 12507, slip op. at 8. In Star Cellular, the term "transfer" was found not to have a generally prevailing meaning, and was thus considered to be ambiguous. Accordingly, the Court of Chancery proceeded to interpret the limited partnership agreement under general contract principles.

As noted above, Delaware courts are not likely to interpret provisions in a limited partnership agreement that are clear and unambiguous. In James River-Pennington, Inc. v. CRSS Capital, Inc., C.A. No. 13870, 1995 WL 106554 (Del. Ch. March 6, 1995), partners in a limited partnership objected to the exercise of a call provision which entitled other limited partners to purchase their interests in the partnership. Although the limited partnership agreement expressly allowed for such action, the plaintiff partners contended that the applicable provision failed to reflect accurately the parties' true intent regarding the matter, as evidenced by proffered oral agreements. The Court of Chancery, however, found that the limited partnership agreement was clear and unambiguous on its face and thus enforced the challenged provision, noting that it "will not use prior antecedent agreements to interpret or contradict the clear language of the disputed provisions." Id. at *5; see also Davenport Group MG, L.P. v. Strategic Investment Partners, Inc., et al., 685 A.2d 715, 719 (Del. Ch. 1996) ("I find the language of the Limited Partnership Agreement . . . clear and unambiguous. A Delaware court should give the terms of the contract their plain meaning."); Cincinnati SMSA Limited Partnership v. Cincinnati Bell Cellular Systems Co., C.A. No. 15388 (Del. Ch. August 13, 1997) (stating that when the "words of an agreement are not subject to different interpretations and when the words do not otherwise create ambiguity when viewed in the light of other contractual provisions, (the Court of Chancery) will not consider extrinsic evidence to interpret the meaning of the agreement.").

In Desert Equities, C.A. No. 12449, the Court of Chancery again declined to interpret an unambiguous limited partnership agreement. In that case, the parties disputed whether a provision in the limited partnership agreement entitled the general partner to exclude a limited partner from participating in an investment. The Court of Chancery found that the agreement "clearly and unambiguously" allowed such an action "as a matter of law" and, therefore, did not interpret the limited partnership agreement. Id., slip op. at 5.

As is apparent from the above analysis, the approach used by Delaware courts in deciding whether to interpret limited partnership agreements is analogous to the standard applied in those cases outside of the limited partnership area, and reflects the application of general contract interpretation principles. As noted in part above, these general principles are that the parties' intentions form the touchstone of any contract interpretation. E.I. du Pont de Nemours & Co. v. Shell Oil Co., 498 A.2d 1108, 1113 (Del. 1985); Demetree v. Commonwealth Trust Co., C.A. No. 14354, slip op. at 7 (Del. Ch. Aug. 27, 1996). Moreover, contract language serves as the primary factor in determining a clear meaning. Watkins v. Beatrice Cos. Inc., 560 A.2d 1016, 1021 (Del. 1989). In addition, if the writing is plain and clear on its face, then it alone provides the sole source for interpreting the parties' intent. Moreover, Delaware courts have stated that "[o]nly when there are ambiguities may a court look to collateral circumstances. The language of the Agreement must . . . be the starting point." Kapoor v. Fujisawa Pharmaceutical Co., C.A. No. 93C-06-50, slip op. at 11 (Del. Ch. May 10, 1994) (citing City Investing Co. v. Continental Cas. Co., 624 A.2d 1191, 1198 (Del. 1993)); See Citadel Holding Corp. v. Roven, 603 A.2d 818, 822 (Del. 1992).

Accordingly, Delaware courts interpreting a limited partnership agreement will first determine whether an ambiguity exists, and only after finding an ambiguity will parol or extrinsic evidence be considered. This approach is consistent with general contract interpretation principles. See Citadel Holding, 603 A.2d at 822; Pellaton v. Bank of New York, 592 A.2d 473, 478 (Del. 1991).

When a limited partnership agreement is a negotiated bilateral agreement (a "negotiated agreement"), Delaware courts will consider extrinsic or parole evidence to interpret an ambiguous provision in such an agreement. See Star Cellular, C.A. No. 12507, slip op. at 8. Where terms in a negotiated agreement are susceptible to multiple interpretations, extrinsic evidence serves as the principle means for a court to ascertain the parties' intent:

Id. (citations omitted).

Again, this position reflects the principles inherent in general contract interpretation. If a contract's language is ambiguous, then extrinsic or parol evidence may be admissible to clarify the provision's meaning. In Kaiser Aluminum, the Delaware Supreme Court noted that "[w]hen a contract is ambiguous, a court normally relies upon extrinsic evidence of the parties' intent." 681 A.2d at 397; see also Klair, 531 A.2dat 223; Mesa Partners v. Phillips Petroleum Co., 488 A.2d107 (Del. Ch. 1984); Sundlun v. Executive Jet Aviation, 273 A.2d 282, 285 (Del. Ch. 1970) ("[I]f the meaning of the words is not plain and unambiguous, then the court will look to the surrounding circumstances"). This analysis applies when such limited partnership agreement is a negotiated bilateral agreement (but see, 6 II C below).

Once a Delaware court determines that an ambiguity exists in a negotiated agreement, it will then consider extrinsic evidence. In such a situation, the court will look to a variety of sources, including antecedent agreements, communications and acts of the parties, business context, prior dealings, and business customs and usage in the industry. See Eagle Industries,

702 A.2d at 1233; Bell Atlantic Meridian Sys. v. Octel Comm. Corp., C.A. No. 14348, slip op. at 13-14 (Del. Ch. Nov. 28, 1995); see also US West, C.A. No. 14555, slip op. at 21-22; Demetree, C.A. No. 14354, slip op. at 9 n.9. Such extrinsic evidence may include letters, memoranda, or other material written prior to the transaction at issue, where such evidence is probative of the circumstances surrounding the transaction. See Continental Airlines v. American Gen. Corp., 575 A.2d 1160, 1165 (Del. 1990), cert. dismissed, 498 U.S. 953 (1990); see also US West, C.A. No. 14555, slip op. at 28, n.10; Bell Atlantic Meridian Sys., C.A. No. 14348, slip op. at 17-18; cf. DuPont v. Wilmington Trust Co., 45 A.2d 510, 517 (Del. Ch. 1946) (considering explanatory circumstances). Affidavits of draftsmen or other parties are also admissible. See Klair, 531 A.2d at 223; Cities Service Co. v. Gardinier, Inc., 344 A.2d 254, 258 (Del. Super. Ct. 1975), appeal dismissed, 349 A.2d 744 (Del. 1975).

Before the recent Delaware Supreme Court decision in of SI Management L.P. v Wininger, 707 A.2d 37 (Del. 1998), several Delaware courts had looked to extrinsic evidence when interpreting limited partnership agreements and related documents in limited partnership litigation. In Arvida, C.A. No. 14283-NC, the Court of Chancery referred to the offering prospectus when analyzing the meaning of terms contained in the limited partnership agreement and the assignment documents. Id., slip op. at 10-11. An early version of the prospectus contained language restricting the voting rights sought by the plaintiff, a subsequent assignee, while a later version of the prospectus omitted such restrictive language. The Court of Chancery noted that the earlier language in the prospectus may have constituted extrinsic evidence of JMB Realty Corporation's (an affiliate of various defendants) subjective intent to limit voting rights to those who purchased interests in the partnership through the public offering and not through a subsequent assignment. Id., slip op. at 11. The Court of Chancery noted, however, that even if such extrinsic evidence (i.e., the prospectus) was considered, it "could, at most, serve as an aid in interpreting the language of the controlling agreements." Id.

In Star Cellular, C.A. No. 12507, the Court of Chancery allowed for the possibility that an FCC application and documents executed contemporaneously with a challenged merger, and relevant letters could serve as credible extrinsic evidence. Id., slip op. at 13. Similarly, in Desert Equities, C.A. No. 12449, the Court of Chancery examined letters sent from a defendant general partner to the plaintiffs in order to establish the proper context in which to interpret the limited partnership agreement. Id., slip op. at 6.

In addition, various Delaware cases outside of the limited partnership area provide further guidance as to the types of extrinsic evidence that may be relied upon by Delaware courts in resolving contractual ambiguities. For instance, in Klair, Chief Justice Christie stated that "the court must consider the statements of the parties concerning the meaning of the writing as well as evidence such as trade usage or course of dealing." 531 A.2d at 223.

In Cities Service Co., the Superior Court relied on the affidavit of an officer of plaintiff Cities Service Company in examining an ambiguity in a sales contract, and consequently denied defendant's motion for summary judgment. 344 A.2d at 254. In analyzing the dispute over a pricing formula contained in the sales contract entered into between the parties, the Superior Court found that the defined term "Direct Cost" was ambiguous as used in the contract. As a result, the Superior Court considered the affidavit of one of plaintiff's officers, reasoning that "even where a term is defined in a contract, the definition may, itself, be so worded as to require extrinsic evidence to determine its meaning and application." Id. at 258. Ruling that the affidavit raised a question of fact, the Superior Court denied defendant's motion for summary judgment. Id.; see also Patten Corp. v. Ass'n of Property Owners of Sleepy Hollow Lake, Inc., 568 N.Y.S.2d 970, 972 (N.Y. App. Div., 3d Dept. 1991) (suggesting that affidavits are admissible extrinsic evidence when ambiguity in a written instrument exists, but further suggesting that the most helpful affidavits in interpreting written notes on filed subdivision maps would be affidavits of the original draftsman of the documents or the corporate subdivider of the property).

In Continental Airlines, the Supreme Court looked to letters, memoranda, and a bulletin written prior to the transaction at issue in order to determine the parties' intent. 575 A.2d at 1160. At issue in Continental Airlines, was whether an employee stock option (the "Option") was merger consideration. Since the Option was not mentioned in the merger agreement, the Vice Chancellor "correctly examined the surrounding circumstances, examining the meaning and purpose of the transaction." Id. at 1165 (citing Klair, 531 A.2dat 223). The Supreme Court looked to statements made by agents of the majority stockholder indicating that the Option was part of the merger transaction. Id. First, the Supreme Court relied upon a letter sent before the merger from counsel for the majority stockholder to the American Stock Exchange. Id. at 1166. In that letter, counsel referred to the Option as "an important part of the merger proposal." Id. The Supreme Court also relied upon characterizations of the merger transaction in memoranda authored by the majority stockholders' general counsel. Id. In addition, the Supreme Court noted that in a bulletin sent by Continental to its employees, the Option was characterized as merger consideration. Id. The Supreme Court concluded that "[c]ontrary to [the majority stockholder's] assertion, these statements, and others similar to them, cannot be described as 'non-contractual scraps.'" Id. Rather, the statements were held to be relevant in determining whether the majority stockholder intended for the Option to be merger consideration, since the issue was not resolved by the merger agreement. Id.

Negotiation documents have also served as significant extrinsic evidence. In Sellon v. General Motors Corporation, 521 F. Supp. 978 (D. Del. 1981), the District Court considered extrinsic evidence when interpreting an ambiguous provision in a release of claims entered into by parties involved in an automobile accident. The District Court considered "documents reflecting [contract] negotiations." Id. at 985. "Both parties offer[ed] affidavits to fill out the factual record of intent behind the release." Id. The affidavits considered by the District Court included affidavits of an attorney involved in the negotiations. Id. The District Court also considered a draft of the contract at issue and correspondence sent during the negotiations by counsel concerning the draft. Id.

Finally, in Gluckman v. Holtzman, 51 A.2d487, 491 (Del. Ch. 1947), the Court of Chancery heard oral testimony to ascertain the parties' intent as expressed by the language used in the agreement.

From the foregoing, it can be seen that Delaware courts are likely to rely upon a wide range of extrinsic evidence when interpreting ambiguous terms in a negotiated agreement. Furthermore, recent Delaware cases suggest that a similar or identical approach to contract interpretation will be employed by Delaware courts when interpreting negotiated agreements as that used when interpreting other types of contracts.

In the recent Delaware Supreme Court case of SI Management L.P. v Wininger, 707 A.2d 37 (Del. 1998), the Supreme Court announced a new test regarding how to construe an ambiguity once an ambiguity is found to exist in a limited partnership agreement. In SI Management, the general partner, SI Management L.P. ("SI"), had entered into a partnership agreement with approximately 1,850 investors who became limited partners of the partnership. Subsequently, SI decided to propose a plan of withdrawal of limited partner interests and dissolution of the limited partnership, whereby a limited partner would be able to either (1) exchange all or a portion of its limited partner interest for cash through a public offering of stock or (2) receive a proportionate interest in shares of the company of which the partnership was majority owner. However, in order to implement the plan, the partnership agreement would have to be amended to eliminate restrictions concerning the withdrawal and distribution of partnership interests. Id. at 38-39.

SI began to solicit proxies from the limited partners in order to obtain the requisite vote needed to implement the plan and amend the agreement. A limited partner of the partnership petitioned the Court of Chancery to enjoin the implementation of the plan because the limited partner claimed the amendment process being conducted by SI was in violation of the partnership agreement. The Court of Chancery agreed and granted a preliminary injunction. SI filed an interlocutory appeal with the Supreme Court protesting the preliminary injunction.

The Supreme Court affirmed the preliminary injunction. The Supreme Court stated that the important issue presented was one of first impression in Delaware. The issue is, assuming an ambiguity is found in a partnership agreement, should such ambiguity be construed against the general partner of the partnership without resort to any extrinsic evidence when the partnership agreement containing such ambiguity was unilaterally drafted by the general partner and the 1850 limited partners who executed the agreement did so without having any input or negotiation as to the terms of the partnership agreement.

The first step in answering the issue presented was for the Supreme Court to decide if there was an ambiguity in the partnership agreement. The Supreme Court 's analysis in this area was the same as discussed in Section II above and SI Management does not have any affect on prior decisions or reasoning of Delaware courts. The Supreme Court found that the partnership agreement was, at best, ambiguous on the issue of whether or not an opinion of special counsel relating to the legality of an amendment was needed in all instances before an amendment could be effectuated.

Because the Supreme Court found the provision in question to be ambiguous, it next turned to the issue of first impression presented by the case, namely how to construe such an ambiguity in a situation in which the limited partners of the partnership had no input regarding the drafting of the partnership agreement.

The Supreme Court began its analysis by analogizing the situation to the comparable situation of ambiguous provisions in contracts of insurance. The Supreme Court stated that in Delaware, such contracts are construed against the drafter (contra proferentem). The Supreme Court , citing Penn Mutual Life Ins. Co. v. Ogelsby, 695 A.2d 1146 (Del. 1997), stated that the policy behind the contra proferentem principle in insurance contracts is that the insurer is the entity in control of the process of articulating the terms of the contract. Id. at 1149. " Therefore, it is incumbent upon the dominant party to make the terms clear." Id. at 1150. The Supreme Court also mentioned that the same contra proferentem principle applies to certain corporate documents.

The Supreme Court then held that when a limited partnership agreement is entered into by 1850 investors who had no part in drafting the agreement and, in fact, appeared to be faced with a "take it or leave it" proposal by the general partner, then the principal of contra proferentem applies and ambiguous terms in the partnership agreement should be construed against the general partner as the "entity solely responsible for the articulation of those terms." SI Management, 707 A.2d at 43. The Supreme Court went on to state that extrinsic evidence in such a case would be irrelevant to the intent of the parties at the time they entered into the agreement. Id. at 44. The Supreme Court remanded the case to the Court of Chancery to determine if the limited partners actually did engage in negotiations with the general partner on the issues in question in the case.

Consistent with the foregoing, once an ambiguity is found to exist in a limited partnership agreement, then a court must next decide whether the limited partnership agreement is a negotiated bilateral agreement or an agreement with respect to which the general partner is solely responsible for the articulation of the terms of the agreement. If it is found to be the former, then extrinsic evidence will be considered to help the court construe an ambiguity. If it is the latter, however, the court will not normally consider extrinsic evidence, and will construe an ambiguous term against the general partner as the drafter (note Kaiser Aluminum, supra, a case cited approvingly in SI Management, in which the Supreme Court stated that an ambiguous provision must be construed to adhere to the reasonable expectations of the investors who purchased the securities and thereby subjected themselves to the terms of the contract). Left unresolved is the question of how Delaware courts will deal with ambiguities in limited partnership agreements involving situations falling between the two extremes of agreements that are fully negotiated or not negotiated at all (e.g., a situation in which only certain terms of an agreement are negotiated, a situation in which, while a limited partner has an opportunity to negotiate all terms of an agreement, it chooses to negotiate only some or none of the terms, or a situation in which some, but not all, of the limited partners of a limited partnership are involved in the negotiation of the terms of a limited partnership agreement).

LIMITED LIABILITY COMPANY AGREEMENTS

Although there has not yet been a limited liability company decision rendered in this area, the same analysis referred to in Section I above, regarding the interpretation of limited partnership agreements, would likely apply to the interpretation of limited liability company agreements. Similar to Section 17-1101(c) of the Limited Partnership Act, Section 18-1101(b) of the Delaware Limited Liability Company Act, 6 Del. C. § 18-101 et seq., states that, "[i]t is the policy of this chapter to give the maximum effect to the principle of freedom of contract and to the enforceability of limited liability company agreements." 6 Del. C. § 18-1101(b).

Once again, as there has not yet been any limited liability company litigation in this area, the same analysis set forth in Section II above, regarding ambiguity and the use of extrinsic evidence when interpreting limited partnership agreements, would likely apply to the interpretation of limited liability company agreements.