Think Carefully Before Amending LLC and
Partnership Agreements: Understanding NextMedia
Mark V. Purpura and Joshua J. Novak
Special to the Delaware Business Court Insider | July 27, 2011
Purpura Novak
Under the Delaware Limited Liability Company Act and the Delaware Revised Uniform Limited Partnership
Act, if a limited liability company agreement or a limited partnership agreement "provides for the manner in
which it may be amended ... it may be amended only in that manner or as otherwise permitted by law."
In interpreting amendment provisions contained in LLC agreements and partnership agreements, Delaware
courts have historically ruled in favor of protecting nonmanaging investors. Despite this history, managers
and controlling members of limited liability companies and general partners of limited partnerships
frequently take advantage of amendment provisions contained in their LLC agreements and partnership
agreements that grant authority to amend such agreements unilaterally or with the consent of less than all
members or partners, so long as such an amendment does not have an "adverse effect" or "material
adverse effect" on a member or limited partner. Before doing so, however, such managers, controlling
members and general partners should carefully consider the Delaware Court of Chancery's decision in In re
NextMedia Investors LLC.
In In re NextMedia, the court was faced with the issue of whether a member's consent was needed to
amend the LLC agreement of NextMedia Investors LLC to extend the term of NextMedia and delay its
otherwise imminent dissolution. As the end of NextMedia's term approached, the United States was in the
middle of one of the greatest economic crises in its modern history, and NextMedia's board sought to extend
the dissolution date in hopes that NextMedia's assets would become more valuable once the economy
improved. NextMedia's LLC agreement provided that "without the consent of each member to be adversely
affected, the agreement shall not be amended so as to ... amend [the section of the LLC agreement
addressing dissolution] ... to affect adversely any member."
NextMedia's board sought the consent of all of NextMedia's members to amend the dissolution provision to
extend its term, and approximately 97 percent of the holders of NextMedia's Class A and Class C limited
liability company interests approved. The petitioners were among the 3 percent in interest of members that
objected and brought suit after the board proceeded to amend the LLC agreement to extend the term,
notwithstanding the objection.
The petitioners argued that unanimous consent of NextMedia's members was required in order to extend the
term because doing so would adversely affect all members. The court agreed, stating that whether a
member is adversely affected "is necessarily a before-the-fact question ... Thus, the question of who is
entitled to vote is best judged by who can be reasonably expected to be adversely affected."
In applying this test, the court found that "the ability to withdraw from an investment and take one's capital
elsewhere is an important one ... A reasonable investor would regard this guaranteed investment end point
that could not be changed without her consent to be a material economic provision of the LLC agreement."
In interpreting the amendment provision, the court found that the provision "gave investors greater
protection [than a class vote provision] by requiring the consent of 'each member' on an individual basis."
Noting that the petitioners had very few voting rights under NextMedia's LLC agreement, the court found
that "this suggests that the matters over which [they] do have voting rights are of particular importance."
As a result, because nothing in the LLC agreement provided otherwise, "the plain meaning of 'to adversely
affect' encompasses a situation where an investor will be adversely affected in the sense that a material
economic term of the LLC agreement is subject to alteration ... In other words, the obvious purpose of [the
amendment provision] was to allow individual investors to veto changes to specific, economically
substantive terms of the LLC agreement if they deem those changes inadvisable" (emphasis added). The
court held that because the petitioners did not consent to the amendment extending the term of NextMedia,
such amendment was not properly adopted and the petitioners were entitled to the dissolution of NextMedia.
Similar to NextMedia's LLC agreement, many LLC agreements and partnership agreements governing the
affairs of private equity funds and other types of limited liability companies and limited partnerships only
provide investors with limited voting rights, which often include the right to vote on certain amendments.
Many such agreements have, as a general amendment vote requirement, a provision requiring the consent
of a majority of the investors in order to amend the agreement. Many also contain provisions that allow a
general partner, manager or controlling member to amend the agreement without obtaining the consent of
any investor, so long as such provision does not "adversely affect" or "materially adversely affect" any
investor, as well as a provision similar to that at issue in In re NextMedia.
In light of In re NextMedia, it is important for general partners, managers and controlling members to
carefully navigate the amendment provisions of their LLC agreement or partnership agreement to analyze an
amendment's potential effect on an investor before proceeding with an amendment in certain circumstances,
including the following situations that we have experienced in our practice and that are fairly common in the
private equity fund context. (The following factual scenarios presume that the applicable fund agreement
has an amendment provision similar to that at issue in In re NextMedia and that such amendment provision
applies to the amendments discussed.)
INCREASING THE MAXIMUM AMOUNT OF CAPITAL COMMITMENTS
Many fund agreements place limits on how much capital may be committed to such funds. One effect of
such a provision is to provide a limit on how much an investor's interest in such fund may be diluted by
current or prospective investors subscribing for additional interests. Indeed, when an investor invests in a
fund that caps the amount of capital that may be committed to the fund, such investor has an expectation
that it will always maintain at least a minimum percentage interest in the fund. An investor would likely view
this limitation as an important provision, for when an investor's interest in a fund is diluted, amounts
distributable to such investor may similarly decrease, as might an investor's ability to influence key
decisions requiring the consent of investors.
Amending a fund agreement to increase a fund's maximum amount of capital commitments could be
contrary to the investors' expectations and may affect an investor's return on capital, thereby altering an
economic term of the fund agreement. Furthermore, as additional capital is committed to the fund beyond
the maximum amount originally agreed to by the investors, it stands to reason that any investor not
increasing its capital commitment to the fund could reasonably be expected to be adversely affected. Similar
to how a finite term in In re NextMedia provided investors therein with an "end point" for their investment, a
cap on how much capital may be committed to a fund provides investors with a bottom point below which
their percentage interest in the fund will not fall. As discussed above, having a diminished percentage
interest in a fund could have negative repercussions to an investor. Consequently, amendments that affect
the maximum amount of capital commitments to a fund should be carefully analyzed.
EXTENDING THE OUTSIDE DATE
Another provision commonly found in fund agreements is a limit on the amount of time during which
additional investors may be admitted or additional capital commitments may be made to such fund (an
outside date). Extending the outside date would allow additional time during which an investor's interest in
the fund could be diluted. Such a scenario raises similar analytical issues as altering the maximum amount
of capital that may be committed to a fund.
For example, if a fund agreement contains a limit on the maximum amount of capital commitments that
may be made to such fund (and such limit is not amended), even if the outside date is extended, the
minimum possible percentage interest that an investor could have in the fund, or the investor's "minimum
interest," would not change. If a fund agreement does not contain any limit on the maximum amount of
capital commitments that may be made, the investor would typically have no reasonable expectation of
maintaining a minimum interest in the fund. An investor's interest in a fund could be diluted (either to its
"minimum interest" or without limitation) prior to the outside date, and the investor arguably has no
reasonable expectation that such dilution would not occur. A general partner, manager or controlling
member may thus be able to argue that such lack of expectation dictates that the outside date is not a
material economic provision of the fund agreement, and therefore such an amendment could not reasonably
be expected to adversely affect the investors.
Conversely, an investor may argue that the outside date is analogous to the "end point" discussed in In re
NextMedia, and that amending such a provision would affect the investor's "minimum investment" as
discussed above (i.e., once the agreed-upon outside date passes, the investor is assured that its percentage
interest in the fund will remain at its then-current level). Therefore, an amendment affecting the outside
date could, in fact, alter a material economic term of the fund agreement.
INCREASING FIDUCIARY DUTIES
Amending a fund agreement to increase the fiduciary duties of a manager, controlling member or general
partner may not seem like it would implicate In re NextMedia. To the contrary, on its face, such an
amendment appears to positively impact investors. By increasing the manager's, controlling member's or
general partner's fiduciary duties, an investor may gain additional assurances that the manager, controlling
member or general partner would act in the investors' and the fund's best interests.
However, some investors may view a manager's, controlling member's or general partner's diminished or
eliminated fiduciary duties as beneficial. For example, if a fund agreement restricts or eliminates fiduciary
duties, the manager, controlling member or general partner may be able to take actions in its discretion (or
otherwise in compliance with such restricted duties), including actions that may involve added risk (which
could yield greater rewards), without fearing a lawsuit for breach of its fiduciary duties. Indeed, allowing
experienced managers, controlling members and general partners to exercise greater discretion and take
increased risks, with the lure of heightened returns, may help to induce an investor to invest in a particular
fund.
Such an investor may argue that increasing a general partner's, manager's or controlling member's fiduciary
duties may affect the amount of distributions the investor might otherwise receive and therefore could
reasonably be expected to have an adverse effect on the investors. While this scenario may seem less likely
than those previously discussed, it is illustrative of the lesson that careful consideration should be given to
the potential effect of an amendment when it is subject to the consent of "adversely affected" members or
limited partners.
Even though In re NextMedia is two years old, it is an important case that informs the analysis on
amendments to LLC agreements and partnership agreements that frequently occur. The court's analysis in
In re NextMedia should cause managers, controlling members and general partners to think carefully before
amending an LLC agreement or partnership agreement that contains an amendment provision similar to that
at issue in In re NextMedia.
Mark V. Purpura ([email protected]) is a director of Richards Layton & Finger. His practice includes
providing advice on limited liability company, partnership and statutory and common-law trust transactional
matters, as well as bank and trust company regulatory matters.
Joshua J. Novak ([email protected]), an associate at Richards Layton, focuses his practice on matters
involving Delaware limited liability companies and partnerships, including providing advice regarding private
equity fund, hedge fund and structured finance transactions. The views expressed in this article are those of
the authors and not necessarily those of Richards Layton & Finger or its clients.
Reprinted with permission from the July 27, 2011 issue of Delaware Business
Court Insider. © 2011 ALM Media Properties, LLC. Further duplication without
permission is prohibited. All rights reserved.
