Ninth Circuit BAP Holds That California Partnership Law Yields To The Bankruptcy Code On Management Rights, Rendering Void Attempts To Strip Estate Of Rights

Bottom line

The Ninth Circuit Bankruptcy Appellate Panel (BAP or Panel) addressed an issue of first impression and held that California state laws that automatically stripped a general partner of its management rights upon a bankruptcy filing were impermissible ipso facto clauses and not enforceable against the bankruptcy estate. As a result, a debtor’s prepetition management rights in a California limited partnership became property of its estate and any postpetition vote to remove those rights were void as a matter of law.

Background

LeFever Mattson Inc. (LFM) was a California corporation that controlled or held ownership interests in approximately 60 limited partnerships and limited liability companies. In re LeFever Mattson, BAP No. NC-25-1238-BCN, Bk. No. 24-10545 (Opinion). In 2015, in connection with the refinancing of an apartment complex known as Southwood, LFM and its founder, Kenneth Mattson, formed Live Oak Investments LP and prepared a limited partnership agreement (LPA) to govern the new entity. Opinion at 3. Participating investors transferred their individual ownership interests in Southwood to Live Oak in exchange for percentage interests in the partnership. Under the LPA, LFM was designated as general partner of Southwood, with the remaining investors, including Mr. William Andrew (Appellant) serving as limited partners. Id.

In August 2024, Southwood was sold for $10.8 million, with Live Oak entitled to almost $4 million of net proceeds. Opinion at 3. LFM was paid $2.3 million in net proceeds, which LFM maintained represented its 21.24% ownership interest and a 3% sale commission. Id. LFM distributed no sale proceeds to the limited partners; the limited partners alleged that this breached both the LPA and LFM’s fiduciary duties as general partner. Opinion at 4. 

Shortly after the Southwood sale, LFM filed Chapter 11 bankruptcy petitions for itself and its affiliates, including Live Oak (collectively, the LFM Debtors). Opinion at 4. The cases were jointly administered, and an official committee of unsecured creditors (Committee) was appointed for the LFM Debtors. Id. A year into the bankruptcy cases, the limited partners held a partnership meeting and authorized (1) the removal of LFM as general partner of Live Oak; (2) the appointment of the Appellant, a limited partner in Live Oak, as the new general partner and president; and (3) Live Oak to retain its own bankruptcy counsel. Id. 

The Committee had previously sought and obtained standing to prosecute claims on behalf of the LFM Debtors, and it moved for an order declaring the removal of LFM void as a violation of the automatic stay. Opinion at 4-5. The Committee argued that LFM’s right to participate in the management of Live Oak was property of LFM’s estate under Section 541(a)(1) and that the limited partners’ vote to oust LFM constituted an “act to exercise control over property of the estate” prohibited by Section 362(a)(3). Opinion at 2.

In response, the Limited Partners argued that under California's Uniform Limited Partnership Act, LFM had been automatically dissociated from Live Oak LP, losing all management rights, the moment it filed for bankruptcy. Opinion at 4. As a result, the management rights did not exist as of the bankruptcy filing and could not become estate property, and the automatic stay thus could not have been violated. The Committee countered that the relevant California state law provisions were impermissible ipso facto clauses that conflicted with Section 541(c)(1)(B) of the Bankruptcy Code and were therefore pre-empted by federal law under the Supremacy Clause. Id. at 5. The bankruptcy court agreed with the Committee and entered an order declaring the removal void. The limited partners, through the Appellant, timely appealed to the Ninth Circuit BAP.

Management rights are estate property 

The Panel began its analysis by noting that Section 541(a)(1) brings into the estate “all legal and equitable interests of the debtor in property as of the commencement of the case,” and the Supreme Court has made clear that this scope is broad. Opinion at 7 (citing United States v. Whiting Pools, Inc., 462 U.S. 198, 205 & n.9 (1983)). While state law defines the nature and extent of a debtor’s property interests, federal law determines whether those interests become part of the estate. Opinion at 7 (citing Butner v. United States, 440 U.S. 48, 55 (1979)).

Applying California law, the Panel found LFM’s management rights to be both statutory and contractual. Under California law, a partnership agreement is an enforceable contract, and a contract right constitutes “property.” Opinion at 9 (citing In re Altman, BAP No. CC-17-1277-KuLS, 2018 WL 3133164, at *5 (9th Cir. BAP June 26, 2018)).

The Panel rejected the limited partners’ argument that the property interest of a general partner is limited to its “transferable interest,” or the right to distributions under California state law. In doing so, the Panel held that “[j]ust because a general partner’s management rights are not ‘transferable’ does not mean that such rights do not exist or are not a property interest of that partner.” Opinion at 12.

Turning to whether applicable California state law constituted an ipso facto clause, the Panel noted that Section 541(c)(1)(B) provides that a debtor’s interest in property becomes property of the estate “notwithstanding any applicable nonbankruptcy law” that, conditioned on the commencement of a bankruptcy case, “effects or gives an option to effect a forfeiture, modification, or termination of the debtor’s interest in property…[P]arties cannot contract around what becomes estate property, and states cannot legislate estate property away.” Opinion at 11 (quoting In re Envision Healthcare Corp., 655 B.R. 701, 710 (Bankr. S.D. Tex. 2023)). The Panel found that the relevant California code sections did precisely that by providing for the automatic dissociation of a general partner upon becoming “a debtor in bankruptcy” and immediately terminating that partner’s right to participate in management. Accordingly, the Panel held that these provisions were impermissible ipso facto clauses squarely pre-empted by the Bankruptcy Code, an issue of first impression in the Ninth Circuit. Id. at 13-14. In doing so, the Panel rejected three cases relied on by the limited partners, finding that none of those decisions analyzed whether the California statutes were impermissible ipso facto clauses but made only “blanket statements on what apparently was an unopposed fact about a partner’s dissociation.” Id. at 14.

The Panel further rejected the limited partners’ arguments that existing precedent was inapplicable because it largely dealt with LLCs, not limited partnerships, as “a distinction without a difference.” Opinion at 14. Courts across the country have uniformly held that analogous state law provisions terminating an LLC member’s management rights upon a bankruptcy filing are pre-empted by Section 541(c)(1). Opinion at 11-12 (citing In re Envision Healthcare Corp., 655 B.R. at 710-11; In re Va. Broadband, LLC, 498 B.R. 90, 94-96 (Bankr. W.D. Va. 2013); In re Lahood, 437 B.R. 330, 334-36 (Bankr. C.D. Ill. 2010)). The Panel saw no reason why the result should differ in the limited partnership context.

Lastly, the Panel dispensed with the limited partners’ argument that because the LPA could not be assumed and assigned, its ipso facto clauses were enforceable under Sections 365(c)(1) and 365(e)(2). Controlling Ninth Circuit precedent has held that an executory contract, whether or not assumable or assignable, is property of the estate protected by the automatic stay. Opinion at 15 (citing Computer Communications, Inc. v. Codex Corp. (In re Computer Communications, Inc.), 824 F.2d 725, 729-31 (9th Cir. 1987)). To hold otherwise, the Panel reasoned, would allow parties rather than the bankruptcy court to define what rights become estate property.

As a result, the limited partners’ vote to remove LFM as the general partner and install the Appellant in its place violated the automatic stay and was void as a matter of law. Opinion at 16 (citing In re Schwartz, 954 F.2d 569, 571 (9th Cir. 1992)). 

Why this matters

The question of what happens to governance rights upon a bankruptcy filing is often fraught, and the BAP in LeFever provided clear guidance that state law ipso facto termination clauses cannot strip away a debtor’s governance rights. The decision reinforces that management rights in any California partnership or LLC are presumptively estate property and are protected by the automatic stay from the petition date, regardless of what state law or the governing agreement may provide.

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