Labels Can Be Misleading: General Partnership Interests As Securities

lee lashway headshotby Lee Lashway

In a previous article titled “Are Membership Interests in LLCs Securities Under Oregon Law?”, we considered the application of investment contract theory to determine whether interests in member-managed limited liability companies (“LLCs”) could be considered securities and therefore subject to securities law compliance requirements.

Interests in manager-managed LLCs are typically investment contracts, and, as a result, are subject to securities regulation. They are similar to limited partnership interests, under which limited partners have no legal authority to participate in the entity management.

On the other hand, interests in member-managed LLCs are usually analogous to general partnership interests. General partners have legal authority to participate in the management and control of the general partnership, subject to limitations that might be included in the general partnership agreement. For that reason, general partnership interests enjoy a rebuttable presumption that they are not securities.

A “rebuttable presumption” is just that, however. In a recent case from the Tenth Circuit Court of Appeals (SEC v. Shields, No. 12-1438, 2014 U.S.App. LEXIS 3369 (10th Cir. Feb. 24, 2014)), the Court reversed a District Court decision in favor of the defendants’ motion to dismiss. The Court held that the complaint alleged facts sufficient to rebut the presumption that the challenged investments in oil and gas exploration and drilling opportunities, labeled as general partnership interests, were not a security.

As a result, the case was remanded to the federal District Court in Colorado with direction to look beyond the form and label of the agreements with investors to the economic and factual realities underlying the agreements. Shields had raised over $5 million from 60 investors in 28 states using so-called “joint venture agreements” that purportedly provided investors with the rights of general partners. In fact, however, the investment opportunities were marketed to individuals with little or no experience in the oil and gas business. Additionally, the agreements contained provisions that substantially limited the practical ability of investors to exercise rights truly analogous to those typically found in general partnership arrangements.

The Shields Court joined several other federal circuit courts in applying the approach of Williamson v. Tucker, 645 F.2d 404 (5th Cir. 1981), to set aside the presumption. The Williamson Court set forth examples of non-exclusive factors that could be applied to rebut the presumption that a general partnership interest was not a security: the agreements left the investors with powers more akin to those of limited partners; the partners lacked the experience and knowledge sufficient to actually exercise their powers as general partners; or the partners were in fact dependent on the unique entrepreneurial or managerial ability of the promoter for success. The Court found that the SEC had alleged sufficient facts that some or all of these factors could rebut the presumption that the purported general partnership interests were not securities.

What are the take-aways from this case?

The rationale of the Williamson case is alive and well. A purported general partnership interest can be subject to the same analysis as an interest in a member-managed LLC to determine whether the interest might constitute a security as an investment contract. Extra scrutiny is warranted for any arrangement in which some “partners” are not especially sophisticated in business; are not practically able to exercise general partner authority purportedly granted to them; or in which the success of the venture is substantially dependent on the unique skills or knowledge of the promoters.


Please contact Lee Lashway if you wish to discuss this issue further.

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