general partners

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The Accounting Remedy – II

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Statutory Provisions under New York Law

As discussed in our last Blog post, the right to an accounting exists under common law and, in some instances, according to statute

The accounting remedy is codified in New York Partnership Law § 44 and New York Business Corporation Law § 720.  Section 44 of the Partnership Law provides that:

            Any partner shall have the right to a formal account as to partnership affairs:

1. If he is wrongfully excluded from the partnership business or possession of its property by his copartners,

2. If the right exists under the terms of any agreement,

3. As provided by section forty-three[1],

4. Whenever other circumstances render it just and reasonable.

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Rights of Limited Partners in the Face of a General Partner’s Self-Dealing

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Limited partnerships have in large measure been replaced by limited liability companies as the passive investment vehicles of choice.  But, they are still relevant because they are still sometimes used and there are many legacy limited partnerships that are still in existence.

On the surface, it appears limited partners have very few rights and protections.  They are not allowed to participate in management or to second guess the general partner’s actions.  However, while the law requires that they stay passive insofar as management is concerned, it does afford them a number of protections to assure that their financial interests are not abused.

"A limited partner is not in the hopeless position where he must only suffer in silence when an alleged wrong occurs. He has a right of full and free access to information contained in the partnership books, and of all things affecting the partnership, as well as a right to formal accounting." Millard v Newmark & Co., 24 AD2d 333, 336 (lst Dep' t, 1966).

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Fiduciary Duties in LLCs and Limited Partnerships

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It has long been a truism that partners in joint endeavors owe each other certain responsibilities to look out for one another. Justice Benjamin N. Cardozo stated the proposition as follows:

Joint adventurers, like copartners, owe to one another, while the enterprise continues, the duty of the finest loyalty. Many forms of conduct permissible in a workaday world for those acting at arm's length, are forbidden to those bound by fiduciary ties. A trustee is held to something stricter than the morals of the market place. Not honesty alone, but the punctilio of an honor the most sensitive, is then the standard of behavior.

Meinhard v Salmon, 249 NY 458 (1928). Although Justice Cardozo elucidated this rule over 90 years ago, it still rings true today. In Birnbaum v Birnbaum, the court reaffirmed this strong duty stating:

This is a sensitive and ‘inflexible’ rule of fidelity, barring not only blatant self-dealing, but also requiring avoidance of situations in which a fiduciary's personal interest possibly conflicts with the interest of those owed a fiduciary duty (Matter of Ryan, 291 N.Y. 376, 407). Included within this rule's broad scope is every situation in which a fiduciary, who is bound to single-mindedly pursue the interests of those to whom a duty of loyalty is owed, deals with a person "in such close relation [to the fiduciary] * * * that possible advantage to such other person might * * * consciously or unconsciously" influence the fiduciary's judgment.

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LLC and Limited Partnership Dissolution: When is it “not reasonably practicable to carry on the business in conformity with the [entity agreement]”?

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The New York and Delaware LLC and Limited Partnership Acts both provide that an LLC or limited partnership may be dissolved “whenever it is not reasonably practicable to carry on the business in conformity with the [LLC articles of organization, operating agreement or limited partnership agreement].” [1] This is the standard, but what does it mean?

When can an LLC member or limited partner seek dissolution, with some reasonable basis to believe that he will be successful?  These situations arise fairly frequently and there are no clear-cut rules.  Many courts have noted the dearth of case law which explicitly define the standard of what it means for it not to be “reasonably practicable” to carry on the business in conformity with the entity’s governing documents.[2]

The starting point for a “reasonably practicable” analysis is always what these documents say.  The documents take on great significance and small differences in their language can be decisive.  For example, entity documents with broad “purpose” clauses are likely to give the managers much greater latitude as to what they can do and make them more impervious to efforts to cause dissolution.  On the other hand, if the entitiy’s stated purpose  includes generating “cash flow” or “profits,” a failure to do so is much more likely to lead to dissolution that if the documents are silent on this point.

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Is a Limited Partnership Forever?

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Remedies for Aggrieved Limited Partners in New York

Before the advent of the limited liability company in the mid-1990s, limited partnerships were a preferred vehicle for the organization of pooled investments.  Most individuals who invested in limited partnerships did so with certain expectations, such as receiving tax benefits in the early years, profit distributions later on as the partnership assets cash flow increased, and a return of their investment plus a profit when the underlying assets were sold.

But, what if the investor has been a limited partner for many years and he or she has yet to receive any distributions and the general partner has shown no interest in selling the underlying assets?  What if the general partner has been able to take out whatever cash flow has been generated over the years in the form of management fees and other distributions?  What if the partnership has been managed for the benefit of the general partner, and not the investors?

Under these circumstances, what is a limited partner to do?  Without doubt, there will be many obstacles standing in the way of his or her ability to sell the partnership interest, even at a discount.  Finding a buyer will be difficult, since there is no public market for the interest.  Buyers are usually not looking for investments without a steady return and without any reasonable prospect of an exit.  Further, the limited partnership agreement will likely contain restrictions on both the limited’s right to transfer and on the rights of anyone who acquires the interest.