Co-authored by Dean N. Razavi.
The Delaware Court of Chancery granted a motion to certify a class of investor plaintiffs in a limited liability company, dismissing a claim raised by the defendant manager that there was a conflict of interest among class members.
The plaintiffs, former limited partners in Zon Capital Partners, L.P., filed claims for breach of fiduciary duties, breach of contract, negligent misrepresentation, and unjust enrichment against the former general partner of the LP entity. The complaint alleged that the defendant effectuated a self-interested conversion in which Zon Capital Partners, L.P. was converted into Zon Capital Partners, LLC. As a result of the conversion, the plaintiffs alleged, the distribution hierarchy was altered such that the general partner (now owner of Class C shares in the LLC) would receive payment on its carried interest calculated before payments made to the former limited partners (now owners of Class B shares). In contrast, under the LP structure the general partner (Class C owner) was paid carried interest calculated only after payments were made to the limited partners (Class B owners).
Defendants objected to including within the plaintiff class any Class B owner who also was an owner of Class A shares. At the time of the conversion, the general manager offered limited partners the opportunity to make additional capital contributions in the new LLC entity, with such new investments to be held as Class A shares (in addition to having their existing LP interests converted to Class B shares). According to the defendants, investors who in the new LLC structure were both Class A and Class B owners had a conflict with those who were only Class B owners because the Class A/B owners might be inclined to support the conversion in order to encourage the general partner (Class C) owner to continue its service as manager of the LLC entity.
The court rejected the defendants’ argument as speculative and unsupported, concluding that the litigation sought only to take benefits away from the general partner (Class C owner) and transfer them to the Class B owners (with no potential conflict between Class A and Class B owners).
Garrett v. Zon Capital Partners, L.P., No. 5607-CS (Del. Ch. Nov. 10, 2011).