This en banc decision is the latest opinion by the Delaware Supreme Court interpreting language in limited partnership agreements. The Court here affirmed the Court of Chancery’s decision granting declaratory judgment in favor of the limited partners (the “Limited Partners”) of DV Urban Realty Partners I L.P., a Delaware limited partnership (the “Partnership”), that the Limited Partners properly removed DV Realty Advisors LLC (the “General Partner”) as general partner of the Partnership. The Court rejected, however, the Court of Chancery’s application of both subjective and objective standards of “good faith,” as provided in the Delaware Uniform Commercial Code (the “UCC”), in interpreting the term “good faith” as used in the Partnership’s Limited Partnership Agreement (the “LPA”). Rather, the Court held that the LPA imposed a purely subjective good faith standard. With guidance from Aristotle, the Court defined that subjective standard and held that the Limited Partners acted in good faith in removing the General Partner without cause.
Under the LPA, the Limited Partners could remove the General Partner “without Cause by an affirmative vote or consent of the Limited Partners . . . ; provided that consenting Limited Partners in good faith determine that such removal is necessary for the best interest of the . . . Partnership” (emphasis in original). The LPA did not define good faith.
The Court of Chancery had stated, “good faith can sometimes include objective, as well as subjective, elements,” and had found the term “good faith” as used in the LPA ambiguous. To resolve that ambiguity, the Court of Chancery examined the common law, noting that good faith usually meant subjective good faith, but also that “there is likely some conduct which is so unreasonable that [the Court of Chancery] will necessarily determine that it could not have been undertaken in good faith.” In addition, the Court of Chancery turned to Section 1-201(20) of the UCC, which defines good faith generally to mean “honesty in fact and the observance of reasonable commercial standards of fair dealing.” Applying the UCC’s definition of good faith, the Court of Chancery determined that the General Partner’s failure to have the Partnership’s audited financial statements timely completed provided the Limited Partners with a subjective good faith belief that the General Partner needed to be removed for the best interest of the Partnership. In addition, the Court of Chancery found that it was objectively reasonable for the Limited Partners to believe it was necessary in the best interest of the Partnership that the General Partner provide timely audited financial statements.
On appeal, the Supreme Court recognized that the LPA did not define “good faith,” and relying on its decision in Gerber v. Enterprise Products Holdings, LLC, stated that “[t]he LPA’s contractual duty encompasses a concept of ‘good faith’ that is different from the good faith concept addressed by the implied covenant of good faith and fair dealing” because it looks to the parties as situated at the time of the wrong. Although the UCC supplies a definition of good faith, the Court indicated that it does not apply generally to partnership agreements and held that it did not apply to the LPA. According to the Court, “[i]f the parties wanted to use the UCC definition of good faith, they could have so provided in the LPA or incorporated it as a defined term by reference.” Instead, the Court determined to analyze the contractual duty of good faith in the context of its purpose in the LPA “of ensuring the Limited Partners do not arbitrarily or capriciously remove the General Partner.” In doing so, it held that the LPA called for a purely subjective standard of good faith.
In defining this subjective standard, the Court drew on Aristotle's Nicomachean Ethics, Book V: “Aristotle observed that we ‘often gain knowledge of (a) a characteristic by the opposite characteristic, and (b) of characteristics by those things in which they are exhibited.’ It follows, Aristotle then noted, that if one term in a pair of opposites is used in more than one sense, the other term will also be used in more than one sense. Good faith and bad faith are illustrative examples of opposite characteristics—as described by Aristotle—in that each is used in more than one sense and thereby informs our understanding of each other.” Noting that in Brinkerhoff v. Enbridge Energy Company the Court had “defined the characteristic of good faith by its opposite characteristic—bad faith,” the Court evaluated whether the Limited Partners’ removal of the General Partner “went ‘so far beyond the bounds of reasonable judgment that it seems essentially inexplicable on any ground other than bad faith.’” Based on the General Partner’s repeated failure to deliver audited financial statements on time, the Court held that the Court of Chancery properly concluded that the Limited Partners met the contractual standard for removal of the General Partner without cause under the LPA.
The full opinion is available here.