In Dunn v. Chappelle (In re Alta Mesa Res., Inc.), a bankruptcy trustee sued the officers and directors of a limited partnership and related entities for operating a drilling program despite having lower than expected results. No. 19-35133, 2022 Bankr. LEXIS 2928 (U.S. Bankr. Ct. October 13, 2022). The defendants filed a motion to dismiss. The court granted it in part and denied it in part. The court first analyzed the partnership agreement and held that officers of the partnership’s parent corporation did not owe fiduciary duties to the partnership:
The Agreement forms a limited partnership under the laws of Texas and specifically provides that Texas law will govern. Under Texas law, “except as provided by . . . a partnership agreement, a general partner of a limited partnership . . . has the liabilities of a partner in a partnership without limited partners.” Tex. Bus. Orgs. Code Ann. § 153.152 (2021). In other words, subject to the terms of a limited partnership agreement, the general partner of a limited partnership has the same duties of a partner in a general partnership. Those duties include the duty of loyalty and the duty of care. Tex. Bus. Orgs. Code Ann. § 152.204 (2021)… Only the general partner owes fiduciary duties to Alta Mesa. Nowhere does the Agreement state that directors or officers of AMR owe fiduciary duties to Alta Mesa. Similarly, the Texas Business Organizations Code does not impose such a duty on the directors of a parent corporation.
Id. The court then analyzed whether the officers of the general partner owed fiduciary duties to the limited partnership:
The Texas Business Organizations Code states that “a partnership may have elected or appointed officers.” Tex. Bus. Orgs. Code Ann. § 151.004 (2021). An officer “shall perform the duties in the management of the entity and has the authority as provided by the governing documents of the entity.” Tex. Bus. Orgs. Code Ann. § 3.103 (2021)…
Dunn argues that the defendants’ control over Alta Mesa means that they had fiduciary duties to Alta Mesa. While Texas law supports this theory, the issue is whether Dunn has sufficiently plead factual allegations to plausibly support it. The Fifth Circuit found in Harwood that “[A]n officer of a corporate general partner who is entrusted with the management of the limited partnership and who exercises control over the limited partnership . . . owes a fiduciary duty to the partnership . . . . We emphasize that it is not only the control that the officer actually exerts over the partnership, but also the confidence and trust placed in the hands of the controlling officer. . . .” FNFS, LTD. v. Harwood (In re Harwood), 637 F.3d 615, 622 (5th Cir. 2011).
Dunn pleads numerous factual allegations that demonstrate the high degree of control that Chappelle, Ellis, and Turner exercised over the operations of Alta Mesa. Dunn alleges that they were involved in the decision-making process at every stage of the drilling program from the testing that began before the merger to the decision to install ESPs when production fell below projected levels. They were charged with presenting information on the program to the board of AMR and to investors. There is no indication that the board did anything to interfere with the officers’ control until almost a year after they approved the drilling program. Unlike the defendant in Harwood, the defendants did far more than “hold themselves out” as officers of Alta Mesa. They actually were officers of Alta Mesa, and exercised power in that capacity. The totality of the circumstances, if proven, would support a finding of a fiduciary relationship. To clarify, the Court does not base its analysis on the directors’ positions or purported positions as officers of Alta Mesa GP. That fact is merely another marker of the control the defendants exercised over Alta Mesa in their capacity as officers of Alta Mesa directly. Dunn’s complaint sufficiently alleges facts to support the claim that Chappelle, Ellis, and Turner owed fiduciary duties, looking to the totality of the nature of their relationship to Alta Mesa.
The court then held that the trustee pleaded sufficient allegations of breach of the duty of loyalty by alleging that the officers provided insufficient information about the drilling program:
The Texas Business Organizations Code codifies the internal affairs doctrine and provides that Texas law “governs the formation and internal affairs of an entity” formed under a certificate filed under the laws of Texas. Tex. Bus. Orgs. Code Ann. § 1.101 (2021). Texas limited partnerships, as entities formed by filing certificates, are subject to the internal affairs doctrine. Tex. Bus. Orgs. Code Ann. § 152.802 (2021). Therefore, Texas law governs the dispute as to whether the officers of a Texas limited partnership breached fiduciary duties to the partnership. Herington v. Univar Solutions Inc., 2021 U.S. Dist. LEXIS 165986, 2021 WL 3828702, at *2 (S.D. Tex. May 20, 2021) (“The internal affairs doctrine applies to breach of fiduciary duty claims.”). The two primary fiduciary duties in Texas are the duty of care and the duty of loyalty. Gearhart Indus., Inc. v. Smith Int’l, Inc., 741 F.2d 707, 719 (5th Cir. 1984). In Texas, the business judgment rule is treated as a “rule of substantive law that requires a plaintiff . . . to plead and prove (1) that the conduct . . . was outside the exercise of judgment and discretion the rule is meant to protect, or (2) that the directors had a personal interest in the transactions complained of.” Resol. Tr. Corp. v. Norris, 830 F. Supp. 351, 356 (S.D. Tex. 1993). Therefore, Dunn must plead around the business judgment rule in alleging the officers breached either their duty of care or their duty of loyalty to survive dismissal….
To abide by the duty of care, directors generally must “inform themselves, before making a business decision, of all material information reasonably available to them.”… A poor decision that leads to a bad outcome is not a breach; failing to properly gather and analyze information while making that decision is a breach.
The Complaint indicates that Chappelle, Ellis, and Turner went to great effort to inform themselves and had intricate knowledge of how the wells were performing. They did not breach their duty of care simply because their decisions turned out poorly. Alternatively, Dunn alleges that having gathered and analyzed all the information necessary to make an informed business decision, Chappelle, Ellis, and Turner failed to disclose that information to the AMR directors and investors and even actively withheld and hid that information from the AMR directors. (ECF No. 50 at 39-43). Like Northstar, Dunn raises the issue of the duty of loyalty rather than the duty of care.
“The duty of loyalty dictates that a director must act in good faith and must not allow his personal interests to prevail over the interests of the corporation.” Gearhart, 741 F.2d at 719. The business judgment rule does not apply to self-dealing transactions. Northstar, 616 B.R. at 739. Because the duty of loyalty is most commonly called into question in instances involving self-dealing, the business judgment rule does not typically apply to the duty of loyalty. Here, there are no allegations that the officers were self-interested, and there is little case law addressing what constitutes “good faith” in this context. The duty of loyalty in Texas includes duties of candor and disclosure. Chapman v. Arfeen, No. 09-16-00272-CV, 2018 Tex. App. LEXIS 7132, 2018 WL 4139001, at *15 (Tex. App.—Beaumont Aug. 30, 2018, pet. denied); see also McBeth, 565 F.3d at 178 (reasoning that, as fiduciaries, partners in a limited partnership owe one another a duty of disclosure). Deciding whether to share specific information is itself a business decision. Schlumberger Tech. Corp. v. Swanson, 959 S.W.2d 171, 181 (1997). Because disclosure is a business decision, to the extent the allegations of breach of the duty to disclose do not allege self-dealing, the business judgement rule applies. A complaint successfully pleads around the business judgment rule where the facts support an inference that the officers acted dishonestly or deceptively in the withholding of information. Chapman, 2018 Tex. App. LEXIS 7132, 2018 WL 4139001, at *15 (citing Sneed v. Webre, 465 S.W.3d 169, 178 (Tex. 2015)).
Dunn alleges not only that Chappelle, Ellis, and Turner withheld information from the board, but further suggests they intentionally manipulated data presented to the AMR board and to investors to obscure the fact that the drilling program’s performance fell below projections. Specifically, the complaint alleges that Chappelle and Turner decided to present “cleaned up” data. They cut off a graph comparing well production to type curves right before the point where the graph showed actual production falling below the type curves. They also recalculated average production from the wells by removing the poorest performing wells from that calculation. Additionally, the complaint alleges that Ellis knew the patterns were underperforming and did not inform the board, and he participated in presentations of manipulated data to the investors and the board knowing the data had been similarly “cleaned up.” These factual allegations involve dishonesty and deception and call into question whether the officers acted in good faith or, as the trustee alleges, in an effort to save their jobs. Motive will be a matter for trial. But, the complaint sufficiently overcomes the business judgment rule’s presumption to plausibly plead a breach of the duty of loyalty with respect to defendants Chappelle, Ellis, and Turner.