Monday, September 5, 2016

Limited Partnership Law: Should Tennessee Follow Delaware's Lead On Fiduciary Duty Private Ordering?

I originally was going to write about overconfidence today.  But I will reserve that post for a later date.  Instead, for today, I am sharing with you a Tennessee legislative drafting issue on which my voice (together with the voices of others) has been solicited and asking for your views and comments.

A committee of the Tennessee Bar Association has been working on proposed revisions to the Tennessee Revised Uniform Limited Partnership Act.  Several thorny issues remain for consideration and final decision making, among them, whether Tennessee law, like Delaware limited partnership and limited liability company law, should allow for the elimination of general partner fiduciary duties.  The committee soon will be voting on this issue, and we are circulating among us our current views (having earlier debated the matter in telephone conference calls).  I took a shot at writing down my views for the group and circulated them last night.  I am including the main substantive part of what I wrote here, minus some typos that I caught after the message was sent (and please forgive the disfluencies in places), and requesting comments from you:

 . . . I continue to believe in the value of a minimum level of mandatory fiduciary duties for managers in unincorporated business associations. I view the unincorporated business association as more than a mere contract between business venturers . . . [It is, rather], . . . an association that includes an inherent, underlying trust relationship that is only reinforced and legally enforceable through fiduciary duties. As such, fiduciary duty doctrine fills the gap between and among the structural and [additional] governance mandates of business associations law.

In its incorporation of mandatory fiduciary duties, business associations law takes from the common law principles of agency on which its central governance principles are founded. Agency is a fiduciary relationship, by definition. The common law fiduciary duty doctrine comprised in agency law encourages business principals (among others) to join together with others to act for them and on their behalf. Limited partners are similarly incentivized to invest in limited partnerships in which general partners act for and on behalf of the partnership and owe the partnership fiduciary duties. Lawyers and other agents acting for and on behalf of the partnership have legally enforceable fiduciary duties to the partnership that cannot be waived. Why should those authorized to act for and on behalf of the limited partnership every day be treated differently—be permitted to contract for agency without accompanying fiduciary duties?

As a former planner and drafter for business clients,  . . . [I must] note that mandatory fiduciary duties constrain management actions.  Mandatory fiduciary duties also introduce uncertainty and unpredictability into the equation when assertions are made that a transaction is invalid or otherwise legally flawed. I acknowledge these issues and take them into account in disfavoring the Delaware lead on the contractual elimination of limited partnership fiduciary duties.

I also acknowledge that fiduciary duties exist by default under the Delaware proposal. Thus, the partners and partnership would have to affirmatively and clearly contract out of those duties, requiring unanimous consent. This, of course, means that prospective partners may choose not to agree to the elimination of fiduciary duties through a partnership agreement waiver, if they so choose. Of course, this may mean that the dissenting partner[s] will have to forego (absent a change in the partnership agreement deleting the waiver of fiduciary duties) participation in the limited partnership altogether. What we know from Professor Manesh’s work on Delaware limited partnerships and limited liability companies (previously recommended by me [for review] in my May 18, 2016 message to the committee) is that almost all partnership agreements and limited liability company agreements, respectively, for publicly held limited partnerships and limited liability companies [organized] in Delaware do include provisions eliminating managerial fiduciary duties. It is hard to know how free and informed the partner . . . decisions were on those fiduciary duty waiver/elimination provisions.

 . . .

In closing, I should note that [if my point of view on this issue prevails,] I recognize that many lawyers in Tennessee will advise their clients to use Delaware limited partnerships or limited liability companies for their new businesses (as many now do), rather than Tennessee limited partnerships or limited liability companies. I am willing to live with that. Honestly, I am not sure that allowing for the elimination of fiduciary duties under TRULPA would change the advice of counsel in Tennessee such that they would then necessarily recommend Tennessee limited partnerships; but I may be wrong on that. There would seem to be little or no incentive, however, for a client to move outside Tennessee in organizing a limited partnership or limited liability company if the formation and maintenance costs as between the states are substantially similar, the client already uses Tennessee limited partnerships or limited liability companies in its business, and the client’s representatives in management are determined to act with care, in the best interests of the firm, and in good faith. The cost/benefit analysis on those facts would seem to favor the continued use of Tennessee limited partnerships or limited liability companies.

Do you disagree with my views, as expressed here?  If so, in what respects and why?  If not, did I miss a point that you would raise?  Regardless, have I mischaracterized or inaccurately described anything here (or omitted anything needed to make what I said not misleading)?  [That is the securities lawyer in me talking, obviously.  :>)]  I welcome your views and feedback and will pass everything relevant on to members of the committee as additional information for them to use in voting on this issue.

Business Associations, Joan Heminway, Legislation, Partnership | Permalink


Thanks for the shout out, Joan!

Unlike LLCs, LPs are largely tax-driven entities used for specialized purposes. LLCs, by contrast, are the go-to default choice of entity for small businesses of all types, involving participants with varying levels of business and legal expertise. Given this difference between the two entity types, I think any concerns regarding elimination of fiduciary duties are less grave in LPs, than in LLCs, because LPs are more likely to be utilized by sophisticated (or, at least, wealthy) business parties almost always aided by legal counsel.* Such parties are better able to fend for themselves when considering whether to contractually limit or eliminate fiduciary duties. With LLCs, this is less frequently the case.

Plus, as you aptly point out Joan, if Tennessee denies such parties the ability to contractually eliminate fiduciary duties in an Tennessee LP, those parties have the wherewithal and savvy to instead organize as a Delaware LP. (The decision to nonetheless organize as a Tennessee LP is more fraught than simply whether "management are determined to act with care, in the best interests of the firm, and in good faith". The question is whether a state judge or jury with perhaps limited expertise in the area would agree that management met such indeterminate standards.) Of course, the ability for parties to organize in Delaware could also be an argument to do nothing in Tennessee, as you suggest.

One additional argument against statutorily allowing the elimination of fiduciary duties in Tennessee LPs is the potentially confusing and costly complexity that would arise if LPs were permitted to eliminate such duties, but LLC were not. Worse yet (depending on your perspective), amending the LP statute might also eventually pave the way for similarly amending the LLC statute, which might be problematic if unsophisticated parties are using or investing in Tennessee LLCs.

*To be sure, as I've said in prior articles, none of this holds true for publicly traded LPs. For publicly traded LPs, it is harder to make the case for freedom of contract vis-a-vis fiduciary duties.

Posted by: Mohsen Manesh | Sep 5, 2016 9:19:01 PM

Thanks for these thoughts, Mohsen. Your views in this area are always welcomed—and duly respected. :>)

Of course, you are right that Tennessee limited partnerships are unlikely to be publicly traded and are mostly—although not necessarily exclusively—used in transactions involving sophisticated (or at least high-net-worth) investors as limited partners. Certainly, they are better able to fend for themselves than many, if not most, Tennessee LLC members. I agree that, for those and other reasons, I am more concerned about LLC fiduciary duty elimination/waivers. And I am afraid of the slippery slope that allowing this freedom of contract for limited partnerships will necessarily lead to the same freedom of contract for LLCs.

Having said that, I also am troubled by the notion that agents can completely and easily contract away the fiduciary duties that re-enforce trust in an agency relationship. The fiduciary duties of a common law agent can only be eliminated under agency law in specific circumstances subject to conditions of good faith, full disclosure, and fair dealing (under Section 8.06 of the Restatement (Third) of Agency). Why should it be easier for a general partner in a limited partnership, as an agent of the partnership in the ordinary course of its business, to eliminate his/her/its fiduciary duties to that partnership than it is for an employee or other agent of the limited to eliminate his or her or its fiduciary duties to the partnership?

I may be wrong, but it seems like even sophisticated and wealthy limited partnership investors may believe that they have more than a discrete contractual relationship when they enter into business with others. Why would they enter a business with a general partner and give the general partner authority to act on the firm’s behalf without being able to depend on the care and loyalty of the general partner—something more than what an implied covenant of good faith and fair dealing offers? Limited partners have little-to-no individual bargaining power to change the terms of a limited partnership agreement once a limited partnership offering is presented to them. The ability of limited partners to weigh the costs and benefits of that status or to bear the risk of loss may not adequately protect any interest limited partners may have in enforcing the trust relationship that fiduciary duties commonly support.

Of course, I agree that fiduciary duty standards can be indeterminate. And the plaintiffs’ bar does take advantage of indeterminacy and attempt to use it to their clients’ advantage. Having said that, the plaintiffs’ bar is creative and likely will find another promising cause of action to bring if fiduciary duties have been contractually eliminated and a general partner is grossly negligent or competes with or engages in unfair or unlawful transactions with or for the partnership. In the interests of time and space, I won’t belabor or extend that point further here.

At any rate, I am having trouble letting go of some threshold level of underlying duties that reinforce and allow for the enforcement of a trust relationship among co-venturers in limited partnerships and LLCs. The ability to eliminate general partner fiduciary duties seems to open a door for less-then-careful or unscrupulous general partner promoters to form, and solicit investors for, limited partnerships that are engineered, through well crafted limited partnership agreements, mainly for the benefit of those general partner promoters . . . . Only time will tell whether that is the case—in Delaware or in other states that allow for the elimination of managerial fiduciary duties in unincorporated business associations.

Posted by: joanheminway | Sep 5, 2016 10:38:48 PM

Professor Hemingway-

It is unclear from your post whether you are suggesting that the same fiduciary duties that apply to corporate managers should also apply to LLC/LP members and managers. As a practitioner, one of the primary advantages of the LLC and LP vehicles is their flexibility in organizing an entity in a manner that fits the needs of the relevant parties. If corporations, LLCs and LPs managers are all imposed with the same or similar fiduciary duties, it seems to significantly limit the non-tax benefits of an LLC/LP.

Posted by: Michael J. Moeddel | Sep 6, 2016 6:16:31 AM

Thanks for the question, Michael. My post actually does not address directly the nature of the fiduciary duties. The method we are following in Tennessee for the proposed revisions to the limited partnership statute is to use the RULPA as our primary drafting model but also look at what other states have done as a guide when Tennessee policy objectives may vary from the policies underlying the RULPA. So, my post assumes the fiduciary duties articulated in the RULPA would be the operative fiduciary duties by default and that they would be customizable as permitted under the RULPA. Several committee members have asked us to look at Delaware as a model instead of the RULPA, however. I am not convinced that the Delaware rule allowing for the elimination of fiduciary duties is the best rule for implementation in Tennessee. And so that is the subject of the post.

I hope this helps explain my position more completely. If not, fire back with another comment.

Posted by: joanheminway | Sep 6, 2016 10:52:15 AM

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