The problem I identified in LLC Company Agreements in the prior part of this series — here — applies likewise to private partnerships and sometimes, although not as frequently, to private corporations when it comes to private company proxy issues.
Example of Proxy Gap in Limited Partnership Agreement
Here is a typical definition of "Partnership Interest" in a Texas Limited Partnership Agreement (LPA):
the percentage interest of a partner in the Partnership at any particular time as set forth herein … and specifically includes the right of that partner to any and all benefits to which that Partner may be entitled as provided in this Agreement and in the Act, together with all obligations of that partner to comply with all the terms and provisions of this Agreement and the Act.
Exactly like the LLC Company Agreement's definition of membership interest, the LPA's definition of partnership interest includes the management participation right although the applicable statutory definition of that term is limited to the economic rights only and expressly provides that the term "does not include a partner's right to participate in management."
Similar to the LLC Company Agreement's restrictions against transfer of membership interests, the LPA states that a "purported transfer of a Limited Partner's Partnership Interest not in conformance with [this Article governing transferability] shall be null and void and of no effect."
So, a purported transfer of the right to participate in management, or vote, will be invalid unless effected in compliance with the LPA's section on transferability conditions? No. That section clearly focuses upon economic transfers and says nothing about assignments of voting powers by way of proxies.
And like the LLC Company Agreement, the LPA's own language confirms that interpretation in the provisions on meetings of partners: "A Partner may vote by proxy."
Proxy Gap in Corporation's Shareholders Agreement
The problem is less often present in the shareholders agreements or voting agreements among a privately held corporation's shareholders. That is because, I think, the issue is plainly visible when a voting agreement is negotiated and drafted. The sole purpose of a voting agreement being to bind the owners to vote together, as a block, on the matters identified in the voting agreement, it would be surprising if the agreement only bound the shareholders with respect to votes cast in person at a shareholders' meeting but ignored or excluded voting by way of consent. For the same reason, it would be surprising — and like an omission regarding actions by consent, it would frustrate the essential purpose of the voting agreement — if the agreement did not cover casting votes by proxy.
But where shareholders enter into a shareholders agreement instrument only and not a separate voting agreement instrument also, they sometimes omit to include a voting agreement as part of the shareholders agreement. I believe this happens largely for the same reason that proxy voting is rarely considered in Company Agreements for LLCs and LPAs for partnerships — the parties and their attorneys become so focused on what they consider to be the primary purpose of the shareholders agreement (restricting the sale, gift, pledge or other change or potential change in ownership of the shares) that they simply forget about a shareholder's capability to transfer his voting power to an outsider.
How to Fill the Gap
For privately held LLCs and partnerships, at least two basic approaches are available for correcting this common omission in Company Agreements and LPAs (and general partnership agreements).
First Alternative — JUST SAY NO
The first method is the simpler, but is the more problematic in practice. Unlike corporation statutes, the statutes governing LLCs and partnerships (as I have shown) grant the owners nearly unfettered authority and power to establish by their own agreement such restrictions (or absence of restrictions) on ownership transferability and management participation rights (voting) as those parties desire. This is absolutely true of proxies, which is why the simpler method would be to outlaw voting by proxy. Members and partners would be contractually allowed to vote or consent only in person and not by proxy or agent.
The bright line rule of a flat prohibition is very easy to draft, but frankly not pragmatic in practice. Where the private company is owned by a very small number of owners who at the same time are all active in its management, then obviously all the owners interact in person on a regular basis; the idea of acting through a third person proxy would normally be unusual.
In other privately held companies — such as real estate investment partnerships — the managers and the owners are often different persons. This is basically the same problem/opportunity that exists in publicly held companies, with the real difference between the two categories being whether or not there exists a readily available market for the sale and purchase of the ownership interests.
And like public companies, all of the owners of such privately held companies do not regularly attend member and partner meetings of the company and do not not routinely take active roles in reviewing the company's activities and monitoring its management. Those "semi-absent" owners just want the company to be profitable and to distribute the monies from those profits among the owners. And those owners often do not want to expend their time interacting in person with other owners — many of whom they do not actually know — or other management. (I can attest from experience that management frequently wants to limit its time communicating with and otherwise interacting with those owners.)
Second Alternative — Limit Who Can Serve as Proxy Holder
It would be self-defeating, offensive and pointless to attempt to bar owners from exercising their statutory rights to grant proxies, BUT as with restrictions on transferability of economic interests, it would be defensible and valid to impose reasonable conditions upon the exercise of proxy use.
The Delaware and Texas statutes governing LLCs and partnerships expressly permit owners to modify the statutory default provisions on proxies.
A prudent modification of those default provisions could include imposing restrictions similar to the economic transferability restrictions. For example, proxy grants to other members or partners might be permitted while grants to third persons could be prohibited or be subject to prior discretionary approval by management (or a committee of owners) to insure that the proxy holder will act merely as the agent of the granting owner and not in the proxy holder's own interest. To expedite the approval process, owners might be allowed to request preclearance for specific individuals, whose background, relationship with the owner and company, and potential conflicts of interest with the company could be fully vetted well before the casting of critical votes; and to afford adequate time to conduct a proper vetting, owners wanting the convenience to act through a proxy holder might be required to submit the proxy holder's name some time prior (perhaps 45 days) to any vote or consent.
More thoughtful drafting of private company governing documents can close the proxy loophole. Principals of the private company will have to be persuasive in explaining to potential investors why their agreeing to limitations on proxy voting will protect the integrity of the company, in much the same way management of public companies have to persuade their owners why staggered boards, poison pills, and other devices preserve and promote the company's stability and future growth and earnings.
And like their public company counterparts, private company principals will have to be ready to give a strong defense against accusations that placing limits on the use of proxies is not actually a way to entrench management and disenfranchise the company's owners.