Monday, September 26, 2016

RUPA § 404(e) Confusion

    Every year I teach RUPA (1997) § 404(e), and every year I am confused.  That section states that “[a] partner does not violate a duty or obligation under this [Act] or under the partnership agreement merely because the partner’s conduct furthers the partner’s own interest.”  The comment makes the following observations (emphasis added):

    Subsection (e) is new and deals expressly with a very basic issue on which the UPA is silent.  A partner as such is not a trustee and is not held to the same standards as a trustee.  Subsection (e) makes clear that a partner’s conduct is not deemed to be improper merely because it serves the partner’s own individual interest.

    That admonition has particular application to the duty of loyalty and the obligation of good faith and fair dealing.  It underscores the partner’s rights as an owner and principal in the enterprise, which must always be balanced against his duties and obligations as an agent and fiduciary.  For example, a partner who, with consent, owns a shopping center may, under subsection (e), legitimately vote against a proposal by the partnership to open a competing shopping center.

 I have always found this shopping center example to be puzzling.  Assume that the partner believes that it would be beneficial for the partnership to open a shopping center, but harmful to the partner’s individual interest (because it will compete with his personal shopping center).  In other words, the partner is voting against a proposal not because the partner believes that it is in the partnership’s interest to do so, but solely because the partner believes that it is the right decision for him personally.  Is § 404(e) conveying that voting in such a manner is not a breach of the partner’s duty of loyalty or the implied covenant?

    Under the “cabining in” language of RUPA (1997), the action has to fit within § 404(b) to be considered a breach of the duty of loyalty.  Section 404(b)(1) prevents the “appropriation of a partnership opportunity.”  When a partner attempts to block the partnership from taking an opportunity to protect the partner’s own related business, can it be argued that the partner is, at least indirectly, seeking to appropriate the opportunity for himself?

    Alternatively, might the partner’s vote violate the § 404(b)(3) obligation to “refrain from competing with the partnership”?  While the partners have consented to the partner owning his own shopping center, that consent presumably does not extend to self-interested conduct designed to foil the partnership’s effort to open its own shopping center.  When a partner votes against what he believes would benefit the partnership solely to protect his own competing business, isn’t that a form of competition with the partnership?

    Might the vote violate the implied contractual covenant of good faith and fair dealing?  One could argue that the partnership agreement assumes that partner voting will be based on what the partner thinks is good for the partnership.  Surely the spirit of the agreement is that a partner has to consider the partnership’s interests, and not solely the partner’s personal interests, when voting.

    Is the answer simply that voting is always protected by § 404(e)?  A partner’s vote can never give rise to a breach of fiduciary duty or implied covenant claim?  Cf. Thorpe v. CERBCO, Inc., 676 A.2d 436, 444 (Del. 1996) (noting that the controlling shareholders “were entitled to pursue their own interests in voting their shares,” and acknowledging “their entitlement as shareholders to act in their self-interest”); see also Jedwab v. MGM Grand Hotels, Inc., 509 A.2d 584, 598 (Del. 1986) (observing that the law “does not … require … controlling shareholders [to] sacrifice their own financial interest in the enterprise for the sake of the corporation or its minority shareholders”); Willard v. Moneta Bldg. Supply, Inc., 515 S.E.2d 277, 288 (Va. 1999) (concluding that majority stockholders are entitled to vote their shares as they see fit absent illegal, oppressive, or fraudulent conduct).

    I welcome your thoughts.

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The Hillman/Weidner/Donn treatise on RUPA details three alternative interpretations of 404(e). My personal view is that it sanctions a self-interested vote (ie, in voting, a partner is not bound by an obligation to look out for the best interests of the partnership or the other partners).

Posted by: Tom Rutledge | Sep 26, 2016 8:20:01 AM

I also have been confused by this provision. I think that one might argue that the shopping center example is overstated, and that "merely" is the key term. I do not know if that argument would be right. As with all fiduciary things, all depends on context. If the only benefit for a particular vote is to the partner, and the vote is to the clear detriment of the partnership, hard to see how the section trumps all other duties and obligations.

Posted by: Bill Callison | Sep 26, 2016 8:49:48 AM

I believe the section reflects the basic notion that, Meinhard v. Salmon notwithstanding, partnership is a business relationship, and the whole point of a business relationship is to make money for the party entering the relationship. It's not guardian-ward or trustee-beneficiary. Thus, a partner should not be held to breach a fiduciary duty when, for example, she votes not to admit new partners because she is worried about her slice of the partnership pie decreasing. She is entitled to threaten to leave the partnership unless they pay her more money, even if the partnership as a whole would be better off if she made less. Partners are free to specify that they may have no other business interests outside the partnership, or that they may not own any interest in any business that might conflict with the partnership. But that's a matter for agreement among consenting business people, not for imposition of a duty designed to protect hapless wards from depredations by their guardians. We're talking about statutory minimum standards. So, yes, a partner is entitled to pursue her own interests in voting her partnership interest, unless there's some agreement to the contrary.

Posted by: Frank Snyder | Sep 26, 2016 8:50:29 AM

Look at Welch v Via Christi Health Partners, 133 P.3d 122 (2006), which I believe states a balancing requirement. Also Peretta, 520 F3d 1039 (9th Cir 2008) (which may have been withdrawn) (question is not whether partner is benefitted but whether partnership is harmed by self interested transaction) and Enea, 34 Cal Rptr 513 (2005) (partners only excused for incidental benefits obtained without detriment to partnership). There may be more, but these come from quick look at section of my partnership law treatise. Bill Callison

Posted by: Bill Callison | Sep 26, 2016 9:36:25 AM

Thanks to all of you. The idea, as Tom suggests, that voting in a self-interested manner is not a breach of fiduciary duty, even if that vote is detrimental to the partnership, is interesting. That argument is easier made in a "cabined-in" jurisdiction, but now that harmonized RUPA has "uncabined" fiduciary duty, it would not surprise me if a purely self-interested vote that was detrimental to the partnership was held to be a breach of duty. Although, as Bill points out, context matters, and I agree with Frank that his examples do not seem problematic. But when I vote to, for example, block the partnership from raising the rent on a property that I originally leased several years ago from the partnership (and with the partnership's permission), it is hard for me to understand why that vote should not be considered a breach of duty.

Posted by: Douglas Moll | Sep 26, 2016 2:56:03 PM

This is a great issue. Thanks for provoking such a rich discussion, Doug. I will ask my students to read the post and the comments--after their oral midterms next week! :>)

Posted by: joanheminway | Sep 26, 2016 10:06:54 PM

On Doug's last hypo, what's the difference between that and blocking a proposal by your partners to reduce your partnership points and thus give you less money? Let's flip it. Would it be a breach of duty for the other partners to raise the rent and thereby cause their partner to suffer economic harm? IOW, if the partner with the lease has some fiduciary obligation to help his partners make more money, why don't the co-partners owe him a duty to enable him to make more money? Fiduciary duties are important when dealing with one who is entrusted with other people's money. But when it's your own property, I believe you ought generally to be able to do with it as you please. Shareholders generally don't owe fiduciary duties to fellow shareholders. Why should partners?

I agree with Joan -- great conversation. I haven't really touched on RUPA 404 in class before, but I certainly will this year.

Posted by: Frank Snyder | Sep 27, 2016 3:07:26 PM

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