Labovitz v. Dolan

Facts

LABOVITZ V. DOLAN

545 N.E.2d 304 (1989)

NATURE OF THE CASE: Labovitz (P), limited partners, appealed a judgment, which dismissed their complaint against Dolan (D), general partners, for the alleged use of economic coercion to cause them to sell their partnership interests at a bargain price.

FACTS: Ps invested over $12 million in a cablevision programming limited partnership sponsored and syndicated by D. When making their investments Ps were advised that their rights and obligations 'are governed by the Articles of Limited Partnership' (the Articles), which were bound as an exhibit. It was stated: The Partnership's intended policy is to make cash distributions to partners each year in an amount approximating the amount of taxable income reflected each year, after providing for adequate working capital requirements deemed necessary by the General Partners. There were significant contingencies relating to many factors which, from time to time, may prohibit any distributions, including, but not limited to cash, cash availability, general working capital requirements, lending restrictions, and revised costs and capital requirements. The Articles provided that D was to have 'full responsibility and exclusive and complete discretion in the management and control of the business and affairs of the partnership'; that 'D in his sole discretion shall determine the availability of Cash Flow for distribution to partners'; that they 'contain the entire understanding among the partners and supersede any prior understanding and/or written or oral agreements among them'; and that S would be liable to the limited partners for his willful misconduct but not for 'errors in judgment or for any acts or omissions that do not constitute willful misconduct.' In 1985, the partnership reported earnings of over $34 million, and in 1986, it had earnings of just under $18 million as a result of which each of the limited partners was required to report his pro rata share thereof on his personal income  tax returns for those years. D elected to make only a nominal distribution of cash. Ps were required to pay taxes almost entirely from their own funds on income retained by the partnership. Just by pure coincidence, an affiliate owned and controlled by D offered to buy out the interests of the limited partners for approximately two-thirds of their book value. D offered $271,870 per unit, payable $90,623 in cash and the remainder was to be paid either in 9% notes due on June 30, 1988, and June 30, 1989, or in CSC class A common stock. The offer disclosed that D  would derive substantial benefits in connection with the offer. D told Ps they would realize not only an added $71,870 per unit in cash profits on their initial investment in addition to the $24,000 previously distributed, but they could also convert their position in 1986 from that of having large taxable income to that of showing a sizable tax loss. Over 90% of the limited partners accepted the offer. But, they simultaneously filed suit claiming D's tactics to be a breach of his fiduciary duty to them. The court dismissed Ps' complaint holding that D's acts were within the broad discretion granted him under the terms of the partnership agreement. Ps appealed.

ISSUE: Even if a general partner is given sole discretion in financial matters with respect to limited partners, are those decisions made still subject to the general partner’s exercise of the highest degree of honesty, fairness and good faith?

RULE OF LAW: Even if a general partner is given sole discretion in financial matters with respect to limited partners, those decisions made are still subject to the general partner’s exercise of the highest degree of honesty, fairness and good faith.

HOLDING AND DECISION: (Scariano, J.) Even if a general partner is given sole discretion in financial matters with respect to limited partners, are those decisions made still subject to the general partner’s exercise of the highest degree of honesty, fairness and good faith? Yes.  Judge Cardozo's standard in Meinhard v. Salmon has been adopted by the courts of virtually every American jurisdiction, including our own. As between partners 'the heavier weight of duty' rests upon him who manages the affairs of the partnership. Ps argue that D , as general partner, owed the limited partners a duty of good faith and loyalty. Ps claim that partners owe each other the duty to exercise the highest degree of honesty, fairness and good faith in their dealings with one another and the handling of partnership assets. P's argue that D's discretion to withhold cash is limited by an implied covenant of good faith and fair dealing implicit in every Illinois contract and by his fiduciary duty to his partners. Ps argue, D made it clear in the deal agreements and paperwork that he intended to distribute cash flow annually when not required to meet current obligations; accordingly, his 'discretion' to distribute cash flow was limited by his fiduciary duties to his partners. D's claim that a limited partner who endows a general partner with certain powers to operate the partnership may not later complain that the general partner, by exercising those powers, has breached some fiduciary duty. D was granted rather wide latitude in deciding whether or  not to distribute cash to the limited partners. D has sole discretion. Despite having such broad discretion, D still owed his limited partners a fiduciary duty, which necessarily encompasses the duty of exercising good faith, honesty, and fairness in his dealings with them and the funds of the partnership. We agree with Ps that the trial court did not give due consideration to D's duty as general partner to exercise the highest degree of honesty and good faith in his handling of partnership assets, and instead treated the parties as arm's-length strangers. A financial analysis of both profits and cash flow reveal significant sums of money accumulating into the partnership’s accounts. For the year ending December 31, 1986, partnership net income was $17,658,000 and working capital increased by $10,220,000. D retained significant amounts of money within the partnership, which were loaned to 'related parties.' Our courts cannot allow a general partner to be the sole arbiter with respect to the flow that the cash of the enterprise takes, and thereby creates conditions favorable to his decision that the business is too good for them and contrives to appropriate it to himself, the articles of partnership constitute an impervious armor against any attack on the transaction short of actual fraud. Ps' complaint is that the general partner refused unreasonably to distribute cash and thereby forced Ps to continually dip into their own resources in order to pay heavy taxes on large earnings in a calculated effort to force them to sell their interests to an entity which D owned and controlled at prices well below at least the book value of those interests. Reversed and remanded. 

LEGAL ANALYSIS: Scrupulous adherence to fiduciary duties is normally expected. 

An excerpt from Dean’s Law Dictionary (www.deanslawdictionary.com): Delaware law is instructive. Six Del. C. Section 17-1101(d)(2) states: 'the partner's or other person's duties and liabilities may be expanded or restricted by provisions in the partnership agreement.' There is no mention in § 17-1101(d)(2), or elsewhere in DRULPA at 6 Del. C., ch. 17, that a limited partnership agreement may eliminate the fiduciary duties or liabilities of a general partner. Efforts by a fiduciary to escape a fiduciary duty, whether by a corporate director or officer or other type of trustee, should be scrutinized searchingly.

See McNeil v. McNeil, 798 A.2d 503 (Del. 2002) (discussing the fiduciary duties of trustees generally and holding that the trustees breached those duties); Cede & Co. v. Technicolor, Inc., 634 A.2d 345, 360 (Del. 1993) (stating that 'directors are charged with an unyielding fiduciary duty to protect the interests of the corporation and to act in the best interests of its shareholders'); Smith v. Van Gorkom, 488 A.2d 858, 872 (Del. 1985) ('In carrying out their managerial roles, directors are charged with an unyielding fiduciary duty to the corporation and its shareholders.'); Blum v. Kauffman, 297 A.2d 48, 49 (Del. 1972) (noting 'the policy of this Court to look with disfavor upon clauses which exonerate a party from the consequences of his own negligence or that of his agent'). [[08442]]A general partner owes the traditional fiduciary duties of loyalty and care to the limited partnership and its partners, but DRULPA § 17-1101(d)(2) 'expressly authorizes the ... modification, or enhancement of these fiduciary duties in the written agreement governing the limited partnership.' See also Boxer v. Husky Oil Co., 429 A.2d 995, 997 (Del. Ch. 1981) (stating that the general partner in a limited partnership is generally required 'to exercise the utmost good faith, fairness, and loyalty') (citing Meinhard v. Salmon, 249 N. Y. 458, 164 N.E. 545 (N. Y. 1928), aff'd 483 A.2d 633 (Del. 1984)).

By statute, the parties to a Delaware limited partnership have the power and discretion to form and operate a limited partnership 'in an environment of private ordering' according to the provisions in the limited partnership agreement. Codified at 6 Del. C. § 17-1101(d)(2) , reads: 'To the extent that, at law or equity, a partner or other person has duties (including fiduciary duties) and liabilities relating thereto to a limited partnership or to another partner or to another person that is a party to or is otherwise bound by a partnership agreement, ...(2) the partner's or other person's duties and liabilities may be expanded or restricted by provisions in the partnership agreement.' See also Elf Atochem North America, Inc. v. Jaffari, 727 A.2d 286, 287 (Del. 1999). The DRULPA embodies 'the policy of freedom of contract' Id. at 290. [See also Lubaroff & Altman, supra at n. 13 (noting that 'overarching principles reflected in [DRULPA]' include 'the principle of freedom of contract')]. and 'maximum flexibility.' Elf Atochem, 727 A.2d at 291 n. 27.

DRULPA's 'basic approach is to permit partners to have the broadest possible discretion in drafting their partnership agreements and to furnish answers only in situations where the partners have not expressly made provisions in their partnership agreement' Id. at 291. or 'where the agreement is inconsistent with mandatory statutory provisions.' Id. at 292. In those situations, a court will 'look for guidance from the statutory default rules, traditional notions of fiduciary duties, or other extrinsic evidence.' Sonet, 722 A.2d at 324.

But, if the limited partnership agreement unambiguously provides for fiduciary duties, any claim of a breach of a fiduciary duty must be analyzed generally in terms of the partnership agreement. See id. ('Under Delaware limited partnership law a claim of breach of fiduciary duty must first be analyzed in terms of the operating governing instrument- the partnership agreement- and only where that document is silent or ambiguous, or where the principles of equity are implicated, will a Court begin to look for guidance from the statutory default rules, traditional notions of fiduciary duties, or other extrinsic evidence.').

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