Unincorporated Business Law Prof Blog

Care in Contracting. BASF v. POSM II Properties Partnership LP (Del. Ch. 2009)

BASF Corp. v. POSM II Properties Partnership LP, C.A. No. 3608-VCS, (Del. Ch. March 3, 2009) (for opinion, see Delaware Corporate and Commercial Litigation blog), involved tiered limited partnerships.  BASF was a limited partner in POSM II Properties Partnership, LP formed to build and lease a facility to Lyondell's predecessor-in-interest, ARCO.  The partnership's general partner was POSM II Properties, the initial general partner of which was ARCO (later, Lyondell Chemical Company).  BASF's predecessor-in-interest, Mobil, had negotiated for a right to withdraw from the partnership if ARCO (or, now, Lyondell) or its affiliates no longer operated the facility.  After Basel AF S.C.A.acquired Lyondell, Lyondell became a wholly-owned subsidiary of LyondellBasel.  BASF claimed that, even though Lyondell was still operating the facility, the change in control of Lyondell triggered the withdrawal right.  Slip Op. at 3-4.

Vice Chancellor Strine, noted that the parties' agreement tied the withdrawal right to Lyondell's operation of the facility, and not to a change in control of Lyondell itself.  Id. at 4-7.  He declined to find a de facto change in control:

If the parties t... had reached a bargain to give [BASF] a right to walk away and be bought out upon a change of control of [Lyondell], one would have expected them to use the common technique and do that explicitly. In this regard, it is notable that change of control provisions often detail the precise scenarios that qualify, whereas, under BASF’s approach, the parties would either have to reach an after-the-fact accord on what corporate events qualified as an implied change in the operator or have a court do so. 

Delaware law does not invest judicial officers with the power to creatively rewrite unambiguous contracts in this manner.

Id. at 13  (footnote omitted).

Certainly, it's hard to imagine that major oil companies didn't know about acquisitions and mergers, and the effect of various structures used in acquisitions on the rights of the parties.

Hat tip, Francis G.X. Pileggi.

posted by Gary Rosin

Tangled Webs: Estate Taxes and Family UBEs (Stuart v. Oklahoma Tax Comm'n, 2008)

Stuart v. Oklahoma Tax Commission, 2008 Ok. Civ. App 85, 195 P.3rd 1280 (OK Civ. App. 2008) (cert. denied), involved the application of the Oklahoma estate tax to interests in a family LLC (organized in Oklahoma) which was itself owned by a family limited partnership. 

In the beginning, a retired rancher,then living in Texas, owned ranch land in Oklahoma, and used it to conduct a ranching business.  After that, the facts are not entirely clear, but it appears that

1. He formed an Oklahoma LLC (Ranch LLC), and transferred at least the ranching business to it, thereby becoming its sole member. 
2. He organized a revocable trust (Trust), and transferred to it his interest in the Ranch LLC, and his other property, which may have included the Oklahoma ranch land & buildings used in the ranching business.
3. The Trust then formed a corporation and became its sole shareholder.
4. The corporation became the general partner of a Texas limited partnership (Texas Family Partnership). The Trust transferred the entire ownership interest in the Ranch LLC to the Texas Family Partnership, became its sole limited partner.
5. Apparently the Trust retained ownership of the ranch land & buildings.

Id. at ¶¶ 2-6.  Oklahoma imposed its estate tax on the Trust's limited partnership interest in the Texas Family Partnership. Id. at ¶ 2.  On appeal, the court affirmed the imposition of the tax.

On seeing the West summary of the opinion, 195 P.3rd at 1280, I was expecting that the basis of the Court's ruling was that the limited partner owned the ranch land.  That was not case.  The Court recognized that an interest in a partnership is personal property (an intangible).  2008 Ok. Civ.. App. 85, at ¶ 10. Instead, the Court relied on Section 807(A)(7), which includes in the taxable estate of a nonresident decedent

the interest of such nonresident in a partnership the business of which is conducted in the state or the majority of assets of which are located in this state.

68 O.S. § 807(A)(7).  The Court reasoned that the Texas Family Partnership was conducting ranching business in Oklahoma.

The Court rejected the argument that the Texas Family Partnership was not conducting business in Oklahoma, but only owned an interest in Ranch LLC, which was conducting business in Oklahoma through a manager designated in the Operating Agreement.  2008 OK 85 at ¶ 12.  The Court reasoned that, as sole member of Ranch LLC, the Texas Family Partnership had the right to manage Ranch LLC's business directly:

Consequently, but for the appointment of Ms. Forst as the Ranch LLC's manager, the business of the LLC would be conducted by the Texas Family Partnership, and Oklahoma's authority to levy estate tax could not be questioned. Albeit through an Oklahoma LLC, the Texas Family partnership would, nonetheless, be conducting the business of Stuart Ranch in Oklahoma, and the terms of 68 O.S.2001 § 807(A)(7) would clearly apply.

Id. at ¶ 15.  So far as the Court was concerned, it was no Ranch LLC, but Texas Family Ranch, that appointed the LLC's manager:  "no other legal entity put pen to paper".  Id. at ¶ 18.  The Court further reasoned that:

Presumably, the Ranch LLC pays Oklahoma sales, property and income taxes no matter how far the Texas Family Partnership can distance itself from the Oklahoma operation. Nonetheless, one need not disregard the legal existence of that partnership [sic] to conclude that those taxes "come out of the pocket" of the Texas Family Partnership ....

Id. at ¶ 19.

The reasoning in both Paragraphs 18 and 19 clearly does disregard the status of Ranch LLC as an entity separate from its member.  The "no other legal entity put pen to paper" ignores the status of an Operating Agreement as a foundational document of the LLC itself.  See Elf Atochem North America, Inc. v. Jaffari, 727 A.2d 286 (Del. 1999).

The argument in Paragraph 15 that a managing member of an LLC with an Oklahoma-based business is conducting business in Oklahoma is more interesting.  As i recall the general rule, partners are considered to be doing business wherever the partnership is, which would also apply to general partners of limited partnerships.  But that reasoning is based on an aggregate view of partnerships.  Under an entity approach would a partner or a member be deemed to be doing business wherever the entity is doing business?  In my view, that might depend on whether the employees acting on behalf of the entity were different from other employees of the entity.  To the extent that an employee of the member is actively conducting LLC business in Oklahoma, it certainly can be argued that the member is also present.  Food for thought.

posted by Gary Rosin

Can Partners Steal Partnership Property?

In Commonwealth v. Giordano, the Massachusetts Superior Court reported dismissed a larceny indictment that charged a partner with larceny of partnership property, on the theory that the partner was a "co-owner" of partnership property.

The version of the UPA in force in Massachusetts is the original act, and not the RUPA.  Section 25(1) of the UPA clearly provides that partners are "co-owners" of specific partnership property, holding as tenants -in-partnership.  While Section 25(2)(a) gives a partner the right to possess specific partnership property, but only for partnership purposes (without the consent of the other partners).  Courts that take a pure aggregate conceptual approach to Section 25 often reach this result.  As an aside, the entire basis for federal income taxation of partnerships is based on that approach.

Even under a functional approach, a partner still has a right to possess.  Diversion of partnership property to non-partnership purposes might be another crime; I don't know the scope of "larceny under Massachusetts law.

Under the RUPA Section 201(a) a partnership is generally considered to be an entity, and Section 203 provides that partnership property belongs to the partnership, and not to the partners individually.  That might work a different result.  The qualification being whether a person rightfully in possession for limited purposes who diverts the property to other persons commits larceny, or some other property crime.

Hat tip to Prof,. Herbert N. Ramy (Suffolk).

posted by Gary Rosin

Partner Identity is not a Partnership Item in a TEFRA Proceeding (U.S. Ct. Claims 2008)

This from Prof. Bradley T. Borden (Washburn):

In Alpha I, L.P. v. U.S., Nos. 06-407 T, 06-408T, 06-409T, 06-410T, 06-411 T, 06-810T, 06-811T (consolidated) (U.S. Ct. Claims Oct. 9, 2008), the Court of Federal Claims held that the question of whether a person is a partner is not a partnership item in a TEFRA proceeding.  Thus, the court did not consider whether a transfer of partnership interest was a sham.  Consequently, the IRS was required to accept the listed partners as members of the partnership and could not make a claim in the TEFRA proceeding against a party it purported to be a partner.

posted by Gary Rosin

Standards for Implied Covenant of Good Fiath and Fair Dealing. Armisaleh v. Board of Trade (Del Ch. 2008)

In a recent case involving the implementation of a merger agreement, the Delaware Court of Chancery discussed the standards for determining whether a party had breached of the implied covenant of good faith and fair dealing.  Armisaleh v. Board of Trade, C.A. No. 2822-CC (Del. Ch. September 11, 2008) (Mem. Op.) (Chandler, C.).  The deadline for electing the form of compensation to be received in the merger was January 5, 2007, but the parties accepted late elections through January 17.  Plaintiff's election was received one day later, on January 18.  Because the parties chose to extend the deadline, the court treated the deadline as one to be set in the discretion of the parties.  The court found that there was a fact question as to the breach of the implied covenant, and denied a motion for summary judgment.

Chancellor began by noting the linkage between the inherent incompleteness of all contracts and the implied covenant:

No contract, regardless of how tightly or precisely drafted it may be, can wholly account for every possible contingency. In fact, contracting parties often explicitly defer key decisions when constructing their written agreement, and instead endow one side or the other with the discretion and authority to make those decisions during the course of performance. Such a course of action is undoubtedly a risk-shifting device, but the law presumes that parties never accept the risk that their counterparties will exercise their contractual discretion in bad faith. Consequently, in every contract there exists an implied covenant of good faith and fair dealing.

Id. at 1.  That said, Chancellor Chandler recognized that

While the existence and applicability of the implied covenant are well established, its substance and defining contours remain somewhat imprecise.

Id. at 19.  While both parties recognized that the question turned on denying another the benefit of the contract, Defendant argued that the use of "oppressive and underhanded tactics" was required, id., while plaintiff argued that only "arbitrary and unreasonable" conduct was required.  Id. at 20.

Chancellor Chandler indicated that the appropriate focus was whether a party

[A party's] conduct frustrate[d] the "overarching purpose’ of the contract by taking advantage of [its] position to control implementation of the agreement’s terms..."

Id.  at 23 (internal quotation marks and citations omitted).  That language seems to take a more objective approach to the breach of the covenant.  On the other hand, Chancellor Chandler noted that

there is a genuine issue of material fact as to whether [the partie’s] clandestine and unexplained decision to stop accepting late forms frustrated the purpose of the Merger Agreement’s election provision....

Id.  That language seems to shift the focus towards a more subjective, bad motive, approach.

It will be interesting to watch Armisaleh, and other Delaware opinions for further development of the contours of a breach of the implied covenant of good faith and fair dealing.

Hat tip to Francis G.X. Pileggi.

Obligation to Close Short Sale is a Section 752 Liability. Marriott Int'l Resorts v. U.S. (Ct. Claims)

     posted on behalf of Professor Bradley T. Borden (Washburn):

In Marriott International Resorts v. U.S., Nos. 01-256T & 01-257T (consolidated) (U.S. Ct. Claims Aug. 28, 2008), the Court of Federal Claims held that the obligation to close a short sale is a section 752 liability and must be considered in determining partners' outside basis of a partnership.  The case is significant because it represents another taxpayer defeat in a case involving a variation of the Son of Boss tax shelter.  From a precedential standpoint, it provides that the obligation to close a short sale is not a contingent liability, adding to the body of law defining liability for section 752 purposes.  The court used an entity concept (recognizing the effect partnership liabilities have on outside basis) to prevent the taxpayer's abusive use of an entity provision of partnership tax law (effect of contributed assets on outside basis).  Perhaps the court could have considered disallowing the taxpayer's abusive use of the entity provision.  For further discussion of the interplay of aggregate and entity provisions in partnership tax, see my article, The Aggregate-Plus Theory of Partnership Taxation.

Seinfeld v. Shakespeare. Clancy v. King (MD 2008)

     posted by Gary Rosin

The difference between the Maryland and the Delaware judiciaries?  Seinfeld and Shakespeare.  The recent opinion by Chancellor Chandler in R & R Capital, LLC v. Buck & Doe Run Valley Farms, LLC (discussed here and here) began and ended with references and quotations from Shakespeare.  The majority opinion by Justice Harrell of the Maryland Court of Appeals in Clancy v. King, No. 112/2007 (August 26, 2008) (slip op.) quoted from an episode of Seinfeld.  Id. at 28-29 n.27.  "Not that there's anything wrong with that [or that]."

Clancy v. King has so much going on that perhaps only a spy thriller could do it justice.  Start with the dramatis personae, which include the author Tom Clancy, his former wife, a limited partnership and a joint venture.  Add in provisions in the LP agreement allowing competition with the LP, and--surprise!--the application of the good faith standard. 

I'll have something to say about the opinion itself, but for now, the "brilliant" (perhaps I've been watching too much Doctor Who) use of what the Legal Profession Blog (Author! Author!) referred to as the "Wigmaster" episode, in which Seinfeld tries to return a suit "for spite."  According to the opinion by Justice Harrell, such an exercise would be in bad faith (not in good faith?).

There's a lot to be said about the Clancy v. King opinion, but let that be later.  For now, just reflect on a world of judicial references opened up by both the traditional and the contemporary.  Shakespeare and Seinfeld.  Though we may have to wait a bit for The Simpsons and South Park.

Lach v. Man O’ War LLC and what is a “Conversion”

Man O’ War Limited Partnership was organized in 1986 by Shirley Lach, her then husband, Lynwood Wiseman, and their attorney, Robert Miller.  Building upon additional facts recited in the dissent and in the opinion of the Court of Appeals, Man O’ War Limited Partnership served as the general partner of M.O.W. Place, Ltd., another limited partnership that is the lessee of the real property, itself owned by a joint venture whose ownership is never specified in any of the opinions.  Miller and Wiseman were the general partners in the Man O’ War Limited Partnership, while Lach was one of the limited partners.

     In 2002, Miller, one of the general partners, learned that he was gravely ill.  Wiseman, the other general partner, was as well of advancing years and had a stormy relationship with his prior spouse, Shirley Lach.  As such, upon Miller’s death, there was the possibility that the single largest limited partner would be at odds with the only remaining general partner and that, upon Wiseman’s death, there might exist lack of agreement as to a new general partner, thereby compelling the dissolution of the limited partnership.  In light of that, he contacted Lach and proposed to her an agreement providing that Wiseman (Lach’s ex-husband and already a general partner), Jeffery Mullens (the brother-in-law of Miller and a limited partner) and Jonathan Miller (Robert Miller’s son and a limited partner) as the new general partners of Man O’ War Limited Partnership.  That proposed document went on to provide that upon the death of Wiseman, the two remaining general partners (Jeffery Mullens and Jonathan Miller) would select a new general partner in Wiseman’s place.  Lach objected as the proposal, if put in place, would permit the Miller family to control the limited partnership, even though they, collectively, owned less of the limited partnership than did Lach individually.  Lach counter proposed that her daughter, Sherri McVay, become one of the new general partners in place of Jeffery Mullens, a proposal that was rejected. 

     Miller and Wiseman, the general partners of Man O’ War Limited Partnership, then sought counsel regarding how to restructure the partnership to achieve the management structure they sought but without the necessity of Lach’s consent - the partnership agreement at issue provided that a new general partner could not be added without the consent of all of the partners.    Following therefrom, a new limited liability company, “Man O’ War LLC” was organized as a manager-managed LLC of which the initial managers would be Wiseman, Jonathan Miller and Jeffery Mullens, the same persons that Robert Miller proposed be the new general partners.

     Once the LLC was organized, Man O’ War Limited Partnership transferred to it the sole general partnership unit in M.O.W. Place Ltd., receiving in return the membership interest in the LLC.  Thereafter, Man O’ War Limited Partnership was dissolved, and its assets, being now the membership interests in Man O’ War LLC, were distributed to the partners in-kind, but with the caveat that unless and until a partner executed the LLC’s operating agreement, they would have no voting rights in the successor LLC, being restricted to only the economic rights.

     Lach challenged the reorganization in Fayette Circuit Court, asserting that the restructuring was a de facto conversion for which her consent had not been given (under kentucky law, the conversion of a limited partnership to a LLC requires the consent of all partners, and that voting threshold is not subject to private ordering) .

Treatment of the “Conversion”

Lach asserted that the reorganization of the business was a de facto conversion for which her consent had not been given.  The Court reviewed statutory provisions governing the conversion of a limited partnership.  This limited partnership was organized in 1986 was governed by the

Kentucky

1970 adoption of the Uniform Limited Partnership Act (1916), but the Kentucky LLC Act permits such a LP to convert into an LLC.   The court determined that there was not a conversion in that the effect of the reorganization that was accomplished was not the same as is a conversion.  Notwithstanding some apparently unfortunate descriptions of the transaction by Robert Miller as a “conversion,” the court noting that “we must, however, analyze the transaction for what it is, not what someone says it is.”  2008 WL 746480 *3.  In a conversion there exists, at any moment in time, only a single business organization; in this instance both the limited partnership and the LLC existed at the same time.  On that basis, the transaction could not be treated as a de facto conversion. 

     The court specifically noted that it had not been asked nor had it considered whether the restructuring of the partnership into the LLC constituted a de facto merger pursuant to KRS § 362.531.   While the opinion is fairly careful in referencing the statutes governing this limited partnership, the Court’s reference to KRS § 362.531 is a mistake.  That provision, addressing limited partnership mergers, was added to the 1988 Limited Partnership Act in 1994 as part of the same bill that enacted the original Kentucky LLC Act.  This provision would not be available to the Man O’ War Limited Partnership unless and until it elected to be governed by the 1988 Limited Partnership Act, which it never did.

     The Ky Supreme Court had an opportunity to in this case visit the doctrine of independent legal significance - sadly that opportunity was missed.

Thomas E. Rutledge

Stoll Keenon Ogden PLLC

Louisville, Kentucky

DnD II? Red River Wings, Inc. v. Hoot, Inc. (ND 2008)

     posted Gary Rosin

Not Dungeons and Dragons, but drag 'n drop. 

The opinion in Red River Wings, Inc. v. Hoot, Inc., 2008 ND 117, 751 N.W.2d 206 (2008), is chockful of issues, including the imposition of fiduciary duties on a majority of the limited partners, who combined to remove the general partner, and to substitute as GP a business entity controlled by them (see discussion by Marc Ward, Iowa LLC blog). 

For now, I'd like to focus on drafting issues.  The limited partnership agreement provided for removal of the general partner by a majority of the limited partners, but did not address the appointment of a new general partner.  As a result, the purported appointment of a new general partner, and the continuation of business thereafter, were found to be wrongful.  This appointment of a new general partner could have been directly addressed in the limited partnership agreement.  For whatever reason, it was not, and the matter had to be litigated all the way to the North Dakota Supreme Court.

More later.

Suing Partnerships and Partners

     posted by Gary Rosin

In Kao Holdings, L.P. v. Young, No. 07-0197 (Tex. June 13, 2008)(slip opinion), the Texas Supreme Court recently held that, where a limited partnership is the only named defendant, judgment may not be entered against its general partner, even though service on the limited partnership was obtained by serving the general partner.  This result may seem straightforward under modern sensibilities grounded in the entity view of partnerships.  The court had to work its way through a minefield of statutes and rules, dating from the mid-1800s, designed to function in the context of the aggregate view of partnerships.

Under the aggregate view, a partnership was not considered to be a legal person (entity) separate from the partners composing the partnership.  Rather, a partnership was a collection of partners (joint owners) doing business under a common name.

Suing "a partnership" meant naming and serving all the persons doing business as partners.  In the mid-1800s, states began to adopt joint name  and common name statutes.  As applied to partnerships, these statutes allowed suits against all of the partners under partnership name, so long as at least one partner was served.  A judgment entered in such a suit could be entered against all partners--including those not served, but those partners who were not served were bound only to the extent of their interest in partnership assets (remember, no entity to hold title).  At least so far as explained up to here, partnership law was thus beginning to recognize the essence of entity--a segregated pool of assets and related liabilities. 

But wait, there's more!  Because a suit against a "partnership" was really a suit against the partners.  See, Kao Holdings, L.P. v. Young, at 3 n.8.  As a result, the judgment also be enforced against the separate property of partners who were served in the suit.  This is made clear by the 1858 Texas statute cited by the Texas Supreme Court:

Where suit is instituted against a partnership, service or process upon one of the partners shall be sufficient notice to all the members of the firm, except that the judgment rendered in case of such service, shall only be enforced against the partnership property, and the separate property of the partner who may have been served.

Id. at 3 n.8 (quoting from Act approved Feb. 5, 1858, 7th Leg., R.S., ch. 92, § 2, 1858 Tex. Gen. Laws 110)(emphasis added).

Historically, then, the general partner would have been directly liable on the judgment against "the partnership."  So how did the Texas Supreme Court reach its result?  I believe that, in large part, the Court could not fully escape modern sensibilities.  Under modern statutes, a partnership is a separate legal person, and the partnership name refers to that person, and not to the partners; if you want to have a judgment entered against them, you need to name and serve them.

One interesting note involves the interpretation of article 6132b--3.05(c) of the Texas Revised Partnership Act :

[a] judgment against a partnership is not by itself a judgment against a partner, but a judgment may be entered against a partner who has been served with process in a suit against the partnership.

Kao Holdings, L.P., at 2-3 (quoting statute).  The Court noted that the Texas Revised Partnership Act was based, in part, on a draft of the RUPA, which had almost identical language in Section 307(c).  Id. at 4.  The Court noted that the Official Comment to Section 307 indicated that a partner must be named and served before judgment against that partner.  Id. 

Again, the language of TRPA Sec. 3.05(c) does not expressly require that the partner be named, but only served.  Again, that probably traces back to the old joint name statutes.  Certainly, the Court's interpretation better suits modern times.  That said, the case makes a good cautionary tale for drafting statutes or contracts--if you mean something, say it.  And, for goodness sakes, beware incorporation of "legacy" language!

Alloy v. Wills Family Trust - Scope of Waiver of Partner's Duty of Loyalty; Limited Partner Squeeze Out Claim

      posted by Beth Miller

       In Alloy v. Wills Family Trust, 179 Md.App. 255, 944 A.2d 1234 (Md. App. 2008), the court recognized the contractual freedom of the partners of a limited partnership to modify the fiduciary duties of the general partners, but concluded that the breach of fiduciary duty claim of a limited partner against the general partners was viable notwithstanding a provision in the partnership agreement permitting the partners to engage in and possess other business ventures of any nature.  The provision did not protect the general partners from liability for secretly competing with the partnership because the clause did not relieve the general partners from the obligation to disclose such opportunities to the partnership.  The court also concluded that the limited partner plaintiff was entitled to pursue a squeeze out/oppression claim based on evidence of the general partners’ secret competition, discontinuance of what had been regular cash distributions, and sudden allocation to the limited partner of over one-half million dollars in taxable income.

       The limited partnership in issue was governed by District of Columbia partnership law, and the court applied the provisions of the D.C. Revised Uniform Partnership Act defining and authorizing modification of fiduciary duties.  The court noted that these provisions were applicable to general partners in a limited partnership by virtue of the D.C. Revised Uniform Limited Partnership Act provision that a general partner of a limited partnership has the rights and powers and is subject to the liabilities and restrictions of a general partner in a general partnership.

       The limited partnership agreement identified the limited partnership as a business venture relating to certain real property upon which were located warehouse buildings and stated that the business and purpose of the partnership was to own, develop, improve, operate and maintain the property.  The partnership agreement contained the following provision:

      The Partnership shall be a limited partnership only for the purposes specified in Article II hereof, and this Agreement shall not be deemed to create a partnership among the Partners with respect to any activities whatsoever other than the activities within the business purposes of the Partnership specified in Article II hereof.  Any of the Partners may engage in and possess any interest in other business or real estate ventures of any nature and description, independently or with others, including but not limited to, the ownership, financing, leasing, operating, managing and developing of real property; and neither the Partnership nor the other Partners shall have any rights in and to such independent ventures of the income or profits derived therefrom.

       For purposes of the appeal, the court of appeals assumed without deciding that (1) language explicitly authorizing partners to compete with the partnership business is not required to waive the duty not to compete, (2) the waiver is specific enough to unambiguously identify the purchase and offer of competing warehouses in the same neighborhood as “specific types or categories of activities that do not violate the duty of loyalty,” and (3) such a waiver of the duty of loyalty is not “manifestly unreasonable.”  Even with these assumptions, the court upheld the trial court’s decision to send the breach of fiduciary duty claim to the jury because the waiver did not dispense with the duty to disclose opportunities and conflicts, and there was testimony regarding a prior course of dealing of disclosure by the partners such that a reasonable juror could conclude that the partners agreed that prompt disclosure of opportunities and conflicts would be the measure of each partner’s good faith and loyalty in transactions that competed with the partnership.  The court also concluded that the breach of fiduciary duty claim was a viable claim upon which the plaintiff could recover nominal damages notwithstanding an absence of proof of monetary loss stemming from the breach.

      As an alternative ground for its breach of fiduciary duty claim, the plaintiff limited partner alleged that the general partners attempted to “squeeze out” the plaintiff.  The trial court did not permit the plaintiff to submit this claim to the jury.  The court of appeals discussed case law and commentary regarding squeeze outs and oppression in the partnership and close corporation context and reviewed the plaintiff’s evidence regarding the manner in which distributions and tax allocations had been made.  The court of appeals also found the evidence of secret competition relevant in this context, and the court determined that the evidence of secret competition, discontinuance of a regular pattern of distributions, and a sudden tax allocation to the plaintiff at a time when it was asserting its rights was sufficient to generate a jury question on the squeeze out claim. The court pointed out that there was also evidence from which a jury could conclude that the general partners had a legitimate and non-pretextual business basis for discontinuing cash distributions and belatedly allocating taxable income to the plaintiff, but the ultimate determination of whether the decisions were undertaken in bad faith for the purpose of squeezing out the plaintiff was for the jury.

Venhill, LP v. Hillman: Duty of Loyalty & Family Limited Partnerships

    posted by Gary Rosin

Venhill L.P. v. Hillman, C.A. No. 1866-VCS (Del. Ch. June 3, 2008) (slip opinion), is an interesting recent opinion by Judge Strine of the Delaware Chancery Court.  The case involved a limited partnership organized to streamline investments by a family trust, by concentrating power in one trustee, who made the general partner.  The opinion is full of interesting discussion of Delaware fiduciary law and private equity investment (see discussion on the Delaware Litigation blog).

For those interested in UBEs, the most interesting parts are the discussions, and conclusions, that

• the failure by the limited partners to remove to the general partner after the GP ignored objections to his investment policy did not waive a breach of fiduciary claim (pp. 20-21); and
• as applied, an exculpatory provision did not prevent entire fairness review of the GP's self-dealing (pp. 22-24, 29-30).

Hat tip to Francis X. Pilleggi.

Kuslansky Update

     posted by Gary Rosin

In my earlier post (after Ederer v. Gursky) on  Kuslansky v. Kuslansky, Robbins, Stechel and Cunningham, LLP, 2008 NY Slip Op. 04061 (NY App. Div. April 29, 2008), I indicated that the case involved yet another law-firm dispute.  I got that wrong--Kuslansky did involve a partnership among professionals, but it was a medical partnership. 

I would have corrected this earlier, but I was out-of-pocket for a while.  Plus, we reconfigured the blog, and earlier posts can longer be edited, and comments on them are now closed.

after Ederer v. Gursky...

posted by Gary Rosin

The first reported New York opinion to rely on Ederer v. Gursky is out:  Kuslansky v. Kuslansky, Robbins, Stechel and Cunningham, LLP, 2008 NY Slip Op. 04061 (NY App. Div. April 29, 2008).  Oddly enough, Kuslansky involves the break-up of another law partnership.  Kuslansky sued the partnership and the other partners for breach of contract by failing to pay him the value of his interest in the partnership, as required by the partnership agreement.  The trial court granted the individual partners' motion to dismiss on the grounds that the obligation was solely that of the LLP.  In a very brief opinion, the appellate court reversed, relying on Ederer:

The Court of Appeals recently made clear that the "liability shield" created by Partnership Law § 26(b) for general partners of a registered limited liability partnership only applies to "a partner's liability to third parties, and, in fact, is part of article 3 of the Partnership Law ( Relations of Partners to Persons Dealing with the Partnership'), not article 4 ( Relations of Partners to One Another')" (Ederer v. Gursky, 9 NY3d 514, 524). Thus, Partnership Law § 26(b) "does not shield a general partner in a registered limited liability partnership from personal liability for breaches of the partnership's or partners' obligations to each other" (Ederer v Gursky, 9 NY3d at 516).

2008 NY Slip Op. 04061, at *2.

As discussed earlier (Ederer v. Gursky  The Rest of the Story), the language used in the Ederer opinion was broader than necessary under the facts, which involved alleged wrongful acts by the partners.  The Kuslansky opinion is singularly unhelpful.  The court characterizes the complaint as a breach of the partnership agreement claim, but does not describe the agreement.

Prof. Alan Bromberg once attributed the pre-UPA confusion of Texas partnership law to "the garrulity of the courts in pronouncing needless dicta."  If anything, courts have become even more garrulous--except in providing facts!

Hat tip to Mike Frisch of the Legal Profession Blog.

Texas Appellate Court Finds No Partnership

In Torres v. Kelley, No. 13-04-313-CV, 2007 WL 528849 (Tex. App.-Corpus Christi Feb. 22, 2007), the parties Torres and Kelley had a business relationship. When the parties had a falling out, Kelley sued Torres, alleging that the parties had entered into a partnership and that Torres had wrongfully converted partnership assets for his own use and breached his duties of good faith and loyalty. The evidence showed that the parties had drafted a written partnership agreement that they never signed and which stated that a partnership would be created upon execution of the agreement. There was also evidence of some type of verbal, profit sharing arrangement, but it was undisputed that Torres did not have access to the business’s finances and he did not appear to share in the profits of the parties' relationship. Upon the parties’ falling out, Torres had taken some assets from the business and sold them under the name of a new company. The trial court found that the parties had entered into a verbal partnership and that Kelley was, therefore, entitled to recover for Torres’ conversion of partnership assets and that Torres breached the duties of loyalty and good faith.

On appeal, a Texas appellate court noted that before Kelley could recover for Torres's conduct, he had to show that the parties entered into a verbal partnership, that Torres converted partnership property, invoiced partnership customers for barrels sold under the name of a new company, collected funds for those invoices, and breached the duties of loyalty and good faith. The court applied the Texas Revised Partnership Act in determining whether the parties had entered into a partnership. The court held that Torres “did not act in an ownership or control capacity, receive profits, or establish any other factors tending to show the existence of a partnership.” Moreover, the parties never followed the procedures for winding up a partnership after their falling out, there was no agreement about capital contributions, there was no agreement about sharing of losses or liabilities, and no partnership tax forms were ever completed. The court observed that, at most, the parties had planned to enter into a written partnership agreement, but the agreement was never executed. The court noted that both parties had made conclusory statements regarding evidence of a partnership agreement, but that the “mere belief there may be a partnership is not probative evidence of a partnership.” Moreover, the court observed that Kelley had in fact admitted at trial that the business was going to be a partnership “when we signed the paperwork” and when Torres put up some capital for the business, but that neither of those events had ever occurred. The court noted, furthermore, that the mere fact that the parties had agreed to some split of the profits in their business did not necessarily prove that a partnership had existed. The court, thus, reversed the trial court’s judgment finding that Kelley was entitled to recovery. Although the court stated that it otherwise affirmed the trial court’s judgment, the court clearly found that no partnership existed. Thus, despite the language of the order, the court appears to have reversed the trial court in full.

[Gregory Duhl]

Washington State Appellate Court Holds That Jury Trial Not Required Under Language Of RUPA

In Schuetzle v. Lineberger, No. 57352-7-I, 2007 WL 575448 (Wash. App. Div. 1 Feb. 26, 2007) (unpublished), plaintiffs Jeffrey and Linda Schuetzle and defendants Robert and Cori Lineberger opened a fitness club together. The Linebergers put most of the money upfront to operate the club, the Schuetzles contributed significant labor to the club, and the parties split profits, although the methods varied. In 2001, the parties signed a written agreement, agreeing, among other things, to split the profits of the club 60/40. At some point during the alleged partnership, the Linebergers incorporated the fitness club. The Linebergers subsequently terminated the Schuetzles from the ownership of the club. The Schuetzles then sued the Linebergers, arguing that they had been partners in the fitness club and were entitled to an accounting of partnership assets. The evidence included testimony by several people who heard the Linebergers refer to the Schuetzles as their partners. The trial court found in favor of the Schuetzles. The Linebergers appealed, contending that the trial court erred in finding there was a partnership and furthermore that the court should have impaneled a jury to determine whether a partnership existed.

On appeal, a Washington appellate court held that substantial evidence supported the trial court’s finding that a partnership existed, despite that the Schuetzles had acted in certain ways that were not consistent with running a partnership, such as filing their income taxes as either independent contractors or employees of the fitness club and filing for unemployment after the Linebergers terminated them. The court noted the written agreement from 2001, signed by the Linebergers, in which the Linebergers agreed to share with the Schuetzles the profits and losses from running the fitness club on a 60/40 basis. The court also found that the fact that the Linebergers incorporated the fitness club after operating it for several years did not act to terminate the partnership, and the fact that the Schuetzles did not own a recorded ownership interest in the property did not mean that the Schuetzles were not partners, noting that a “partnership may be found to exist even though title to the alleged partnership property is held in the name of but one of the alleged partners.”

The court also found that the Linebergers had no right to a jury trial because an action requesting an accounting of partnership assets is an action in equity. The court noted prior case law in which courts had held that an action for determination of whether there is a partnership and the accounting of partnership assets is an action in equity that does not require a jury trial. The Linebergers had argued, however, that with Washington’s adoption of the Revised Uniform Partnership Act, a jury trial was required, but the court disagreed, noting that the Act states merely that a “partner may maintain an action . . . against another partner for legal or equitable relief.” The court observed that under the Act’s provision, a jury trial would be appropriate where a partner primarily seeks legal relief, but where the partner seeks primarily equitable relief, a jury trial is not required. The court further observed that although other courts in UPA jurisdictions have held that the issue of whether a partnership exists is for the jury, those cases involved actions at law—such as tort claims—rather than actions in equity—such as actions for accounting of the partnership assets.

Finally, the court upheld the trial court’s award of attorneys' fees to the Schuetzles, noting that under prior case law, a partner may be required to share the expense of the lawsuit when he breaches his fiduciary duty to the other partners. The court noted that since the trial court found that the Linebergers had breached their fiduciary duties to the Schuetzles, the award of attorneys’ fees was appropriate.

This case was a close call factually of whether there was a partnership. The court probably got it right that the Linebergers did not have a right to a jury trial because the court needed to determine whether a partnerhip existed to decide equitable issues. However, the court, like other courts, have mistakenly talked about the partners owing fiduciary duties to each other and not to the partnership.

[Gregory Duhl]

Federal District Court On Transfer Of Real Property To Limited Partnership

In Cendant Corp. v. Shelton, Civ. No. 3:06CV00854 (AWT), 2007 WL 419605 (D. Conn. Feb. 8, 2007), plaintiff Cendant Corporation (“Cendant”) sued defendant Kirk Shelton ("Shelton"), his wife Amy Shelton, and Robin D. Jackson (the “Trustee”), trustee of the Shelton Children Irrevocable Trust (the “Trust”), seeking a prejudgment remedy based on allegations that Shelton had made fraudulent transfers of his assets to shield his assets from creditors such as Cendant. Kirk Shelton had been president of a company called CUC, which merged with another company to form Cendant. In prior shareholder lawsuits, Shelton was accused of inflating his company’s earnings in fraudulent SEC reports. Cendant sought a prejudgment remedy against Shelton and the Trust in connection with, among other things,Shelton's alleged intentional/constructive fraudulent transfer of $7.5 million to the Trustee to fund the Trust. Plaintiff also brought a claim in connection with Shelton's alleged intentional/constructive fraudulent transfer to the Trustee of his interest in a condo in Vail. Plaintiff also alleged that Amy Shelton was unjustly enriched by Kirk Shelton's transfer to her of his interest in a home at 573 Middlesex Road in Darien, Connecticut and that the Trustee was also unjustly enriched by Kirk Shelton's transfer of certain real property located at 569 Middlesex Road in Darien, Connecticut to a limited partnership called SCIP Partners, L.P. (“SCIP”) and by the subsequent transfer by Kirk Shelton of his interest in SCIP to the Trustee.

The court granted the application for a pre-judgment remedy in part and denied it in part. With respect to the transfer of the real property located at 569 Middlesex Road in Darien, Connecticut to the limited partnership SCIP, the court found that since plaintiff had not named SCIP as a defendant, plaintiff could not obtain a prejudgment remedy with respect to transfer of the real property. The court noted that although the Trustee had a 99.9% interest in SCIP, SCIP and not the Trustee was the owner of the land. The court noted that plaintiff argued that it intended to attach the interest of SCIP by and through the Trustee, but the court observed that “it is not apparent how it will do this.” In finding as such, the court reiterated the principle that once a person transfers his or interest in real estate into a limited partnership, the owner of the real estate is the partnership. The transferor may retain an ownership interest in the partnership, but he is no longer the owner of the real property. The court found that SCIP was the owner of the real estate at issue, and the defendant Trustee had only a personal property interest in SCIP after Shelton transferred his interest in SCIP to the Trustee. Thus, plaintiff had no right to a prejudgment remedy with respect to the 569 Middlesex Road property. Finally, the court granted a prejudgment remedy with respect to Shelton’s transfer of his interest in SCIP to the Trustee, finding probable cause to believe that the transfer was for the purpose of shielding assets from claims by his creditors.

[Gregory Duhl]

Bankruptcy Court Reiterates That Property Acquired By Partnership Is Owned By Partnership, Not Individual Partners

In In re Lyle, 355 B.R. 161 (Bankr. D. Ariz. 2006), debtors owned a 100% interest in a limited partnership. The limited partnership, in turn, owned a 100% interest in a parcel of real property on which the debtors lived. When debtors filed Chapter 7 bankruptcy, they claimed a homestead exemption in the real property based on their right to possession of the property. The bankruptcy trustee objected, arguing that debtors had no ownership interest in the real property and that, in any event, any interest that they owned had to be capped under the Bankruptcy Abuse Prevention and Consumer Protection Act ("BAPCPA"). A bankruptcy court in Arizona held that the debtors had no interest in the real property and therefore could not claim a homestead exemption under the bankruptcy laws. As the court explained, although debtors were living on the property, they had no right to possession of the property simply by virtue of their personal property interest in the limited partnership. The court reiterated, as other courts have, the well-settled proposition that property acquired by a partnership is property of the partnership and not of the partners individually. Thus, although debtors had once owned the real property, their interest in the real property was extinguished when the debtors transferred their ownership interest in the real property to the limited partnership, and the debtors retained only a personal property interest in the limited partnership. The court further noted that debtors had produced no evidence to show that the limited partnership had ever granted debtors the legal right to possession of the real property. Therefore, debtors could not rely on the “right to possession” as a ground for claiming the homestead exemption. The court, therefore, sustained the trustee’s objection.

[Gregory Duhl]

New York Appellate Court On Liability Of Former Law Firm Partner Based On Acts Occurring After Withdrawal From Partnership

In Wright v. Shapiro, Slip Op. 00931, 2007 WL 294189 (N.Y.A.D. 4 Dept. Feb. 2, 2007), the mother of plaintiff Ricardo Wright contacted the law firm of Shapiro & Shapiro after plaintiff was injured while playing in a high school football game. At that time, Sidney Shapiro and James Shapiro were partners in the law firm. In November 1994, the law firm filed a notice of claim with the school district, alleging that the district was negligent for allowing plaintiff to play in the game. In April 1995, Sidney Shapiro withdrew as a partner in the law firm pursuant to a written “Agreement to Retire Partnership Interest.” Sidney Shapiro died sometime after withdrawing from the law firm. The law firm subsequently commenced an action against the school district in 1997. The lawsuit was dismissed in 2000 on a motion for summary judgment. Plaintiff subsequently filed a claim for malpractice against James Shapiro, James Shapiro, P.A., the fiduciary of Sidney Shapiro’s estate, each individually and doing business as the law firm. Plaintiff alleged that the 1994 notice of claim against the school district failed to include allegations of negligence based on the fact that the school district allowed plaintiff to play in the football game even though he had not attended enough practices to be eligible to play. A trial court denied a cross motion by the fiduciary of Sidney Shapiro’s estate on summary judgment.

On appeal, a New York appellate court reversed and entered judgment for the fiduciary of Sidney’s estate. The court first found that the notice of claim filed in November 1994, while Sidney Shapiro was still a partner in the firm, sufficiently encompassed the claim that plaintiff had not attended enough practices to be eligible to play in the game. The court, therefore, found that the malpractice claim against the fiduciary of Sidney’s estate did not accrue when the notice of claim was filed in 1994 or at any time before Sidney withdrew from the partnership. The court further stated that it rejected the notion that the fiduciary of Sidney Shapiro’s estate was liable for any legal malpractice occurring after Sidney withdrew as a partner. The court observed that a partner “is ordinarily individually liable for the tortious conduct of another member or employee of the firm only if such conduct occurred while that partner was a member of the firm.” The court, therefore, dismissed plaintiff’s action against the fiduciary of Sidney’s estate.

[Gregory Duhl]

Federal District Court On General Partner’s Counterclaims After Involuntary Removal As General Partner

In International Equity Investments, Inc. v. Opportunity Equity Partners Ltd., No. 05, Civ. 2745(LAK), 2007 WL 265170 (S.D.N.Y. Jan. 30, 2007), plaintiff International Equity Investments, Inc. (IEII) was a wholly owned subsidiary of Citibank. IEII was the limited partner in a limited partnership called CVC/Opportunity Equity Partners, L.P., known as the CVC Fund. Defendant Opportunity Equity Partners Ltd. was the general partner. The CVC Fund was a Cayman Islands exempt limited liability partnership. IEII was the sole limited partner and provided the entire $728 initial investment for the fund. The purpose of the fund was to “invest through publicly bid and privately negotiated equity and equity related investments in companies based and primarily operating in Brazil."

The relationship between the parties was governed by the Partnership Agreement, the Operating Agreement, and three other agreements. The Partnership Agreement was governed by Cayman Islands law and provided, among other things, that the general partner was responsible for management of the partnership funds. The Agreement also specifically imposed a fiduciary duty upon the general partner. The Operating Agreement was controlled by New York law and set forth a coordinated investment strategy for the CVC Fund, which included allowing for “side-by-side” investments with third parties. When relations between the parties soured, plaintiff removed defendant as the general partner and appointed a new general partner. Plaintiff then filed a lawsuit against defendant, alleging various claims related to defendant’s alleged mismanagement of the funds. Defendant counterclaimed against plaintiff and the new general partner, alleging that plaintiff conspired with other investors to deprive defendant of its share of its value of the CVC Fund. Plaintiff filed a motion to dismiss defendant’s counterclaims. A federal district court in New York granted the motion to dismiss in part and denied it in part.

As to defendant’s counterclaim for breach of fiduciary duty, defendant contended that plaintiff violated the language of the Partnership Agreement by taking control of management of the CVC Fund. Defendant contended that, as a result, a fiduciary duty arose flowing from plaintiff to defendant. The court noted that while Caymans exempt limited partnership law did not specifically address the issue, under common law limited partners that assume a management role in the partnership incur fiduciary duties owed to the other partners. The court found that the common law rule was consistent with Cayman partnership law. The court held that whether plaintiff assumed management control of the LLP so as to give rise to a fiduciary duty under the partnership agreement could not be resolved on a motion to dismiss and denied plaintiff’s motion to dismiss defendant’s counterclaim for breach of fiduciary duty.

The court next held that defendant general partner did not become a limited partner upon its removal under the Partnership Agreement and, therefore, the new general partner did not owe a fiduciary duty to defendant after defendant was removed as the general partner. The court noted that although language in the Partnership Agreement discussed the conversion of a general partner to a limited partner, defendant had admitted that it had not been designated as a limited partner upon its removal as a general partner; thus, the court granted the new general partner’s motion to dismiss defendant’s counterclaim for breach of fiduciary duty.

The court next held that the parties' side-by-side agreement did not create a joint venture among the parties that would give rise to fiduciary obligations as joint venturers. Thus, the court granted plaintiff’s motion to dismiss defendant’s counterclaim for breach of fiduciary duty arising out of plaintiff’s alleged role as a joint venturer. Next, as to defendant’s counterclaim for breach of the covenant of good faith arising out of plaintiff’s removal of defendant as the general partner, the court held that plaintiff’s removal of defendant as general partner did not violate an implied covenant of good faith under the Operating Agreement. The Partnership Agreement specifically gave the limited partner the right to remove the general partner with or without cause, so defendant had no bad faith counterclaim under the Operating Agreement. Thus, the court granted plaintiff’s motion to dismiss defendant’s counterclaim for breach of the covenant of good faith. The court also rejected defendant’s counterclaim for unjust enrichment, finding that the claims all arose under the parties’ contractual relationship. The court therefore granted plaintiff’s motion to dismiss defendant’s counterclaims in part and denied them in part.

Again, the problem with this opinion is that the court discusses the partners owing fiduciary duties to each other, not to the partnership.

[Gregory Duhl]