Death of Limited Partner Disarms Derivative Action

Farrell Fritz, P.C.

I’ve yet to see him make a court appearance, and hope I never do, but the Grim Reaper sure has a knack for disrupting business divorce litigation involving LLCs and limited partnerships.

To begin with, the statutory default rules for New York limited partnerships and limited liability companies essentially are the same for transfer of ownership interests and rights of the estate of a deceased partner or member. This is no coincidence. Many provisions in the LLC Law enacted in 1994 are modeled on the Revised Limited Partnership Act (RLPA) enacted several years earlier.

Death. Under the default rules governing the estate’s rights upon the death of a partner in a limited partnership or an LLC member (RLPA § 121-706; LLC Law § 608), the decedent’s executor or other legal representative may exercise all of the partner’s/member’s rights “for the purpose of settling his or her estate or administering his or her property,” including  any power under the partnership or operating agreement of an assignee to become a limited partner or member.

Assignment. Unlike shares in corporations, which generally are freely transferable and convey the entire package of economic, voting, and other rights associated with the shares, and except as otherwise provided by agreement, the assignment of LP and LLC interests conveys only the assignor’s rights to receive distributions and profit/loss allocation (RLPA § 121-702LLC Law § 603). The assignee can become a partner or member only if the partnership or operating agreement so provides, or if the other partners or members give their consent (RLPA § 121-704; LLC Law § 604).

When the Grim Reaper strikes, the combined effect of the default rules can block an estate representative from commencing a derivative action against the entity’s controllers, or from stepping into the shoes of a decedent in a pending suit brought by the decedent while alive. The same holds true for actions seeking judicial dissolution and to inspect books and records, both of which statutorily condition standing on the petitioner being a partner or member.

This blog previously featured the Budis v Skoutelas and Pappas v 38-40 LLC cases in which courts held that the express terms of operating agreements, providing that the “successor in interest” of a deceased LLC member shall succeed to the decedent’s economic rights but shall not acquire member status, deprived the decedents’ executors of standing to bring derivative actions against the LLC’s controlling members.

A first-impression decision last week by Manhattan Commercial Division Justice Andrew Borrok in Weinstein v RAS Property Management, LLC, 2020 NY Slip Op 20028 [Sup Ct NY County Feb. 5, 2020], makes it official: estate representatives of deceased limited partners get the same treatment.

A Family-Owned Limited Partnership

Weinstein involves a third-generation, family-owned limited partnership that owns and manages a 16-story commercial building in Manhattan. In June 2019, Lois Weinstein as limited partner sued her half-sister Rita Sklar as general partner, alleging what the petition describes as “an absolutely shocking record of fraud, tax fraud, deceit, breach of fiduciary duties, gross negligence and incompetence, oppressive and unfair dealings toward the other limited partners.” Did I mention the petition suggests that Sklar has “dementia or another mental disorder”? So much for sisterly love.

Weinstein’s 118-paragraph petition, the caption of which styles her as suing “individually and on behalf of the Partners” of the LP — notice it does not say, on behalf of the LP; I’ll come back to that later — does not identify any specific cause of action. Its final demand for relief seeks judicial dissolution of the LP under RLPA § 121-802, the discharge of Sklar as the LP’s “manager,” the appointment of a receiver to sell the realty, and an accounting.

Enter the Grim Reaper

Weinstein died five months after filing her petition, in November 2019. Her death automatically stayed the proceedings.

After the Manhattan Surrogate issued preliminary letters testamentary to two friends of Weinstein named as her executors, Weinstein’s counsel, now acting as counsel to the estate representatives, moved by order to show cause to substitute them as petitioners in the proceeding.

Counsel’s six-paragraph affirmation in support cited as the basis for his motion the above-mentioned RLPA § 121-706 providing that an executor or other legal representative may exercise all of the deceased partner’s rights “for the purpose of settling his or her estate or administering his or her property.” Counsel’s affirmation also relied on and quoted a portion of Section 8.2.B of the governing Limited Partnership Agreement (“Death or Disability of the Limited Partner”) stating that upon a limited partner’s death, the executor “shall have the rights of such Partner subject to the provisions of this Agreement.”

Counsel’s quotation omitted the section’s final sentence which essentially tracks RLPA § 121-702, stating:

Such successor in interest shall not become a Substitute Partner except upon compliance with the provisions of Section 8.3 and 8.4 hereof.

Sections 8.3 and 8.4 likewise follow the scheme of RLPA § 121-702, providing that an assignee of a partnership interest has no right “to substitute . . . as a Partner in his place without the prior written permission of the other Partner” and that an assignee who is not substituted as a partner “shall have the right to receive the same share of the profits and losses and distributions of the Partnership to which his Assignor would have been entitled.”

Sklar opposed the motion to substitute, characterizing Weinstein’s petition as a “derivative action” which the estate representatives lack standing to maintain as a non-partner both under Sections 8.2, 8.3, and 8.4 of the LP Agreement and under RLPA § 1002 (b) (“Limited Partners’ Derivative Action”) which provides:

In a derivative action, at least one plaintiff must be a limited partner at the time of bringing the action and (i) at the time of the transaction of which he complains, or (ii) his status as a limited partner had devolved upon him by operation of law or in accordance with the terms of the partnership agreement from a person who was a partner at the time of the transaction of which he complains.

In regard to subdivision “(ii)” of the statute, Sklar argued that Weinstein’s partnership interest “devolved upon” her legal representatives neither in accordance with the LP Agreement nor “by operation of law” given that, under Weinstein’s will, the representatives had no present or prospective ownership interest in Weinstein’s partnership interest which, ironically or not, her will left to Sklar’s two children (Weinstein was childless).

The Court Denies Substitution

The first paragraph of Justice Borrok’s decision succinctly frames the issue and announces the outcome:

The critical issue is whether a personal representative of an estate has standing to maintain a derivative lawsuit on behalf of a New York limited partnership that was commenced when the decedent was alive and was a partner. Because the court holds that a personal representative cannot, the motion for substitution must be denied.

In reaching its conclusion, the decision summarizes the LP Agreement’s provisions addressing the death of a partner and the circumstances under which a successor in interest is treated as a mere holder of an economic interest versus a substitute partner.

Justice Borrok’s analysis then turns to case precedent, finding “instructive” two cases involving suits brought by estate representatives of deceased LLC members:

  • In Pappas v 38-40 LLC, involving a New York LLC, the court dismissed derivative claims for lack of standing based on the operating agreement’s express provision that upon a member’s death, the personal representative of the estate is a successor in interest only and is entitled only to allocations and distributions but does not automatically become a member of the LLC.
  • In Estate of Calderwood, involving a Delaware LLC, the court dismissed a suit brought by the estate representative of a deceased LLC member seeking a declaration that the estate had stepped into the shoes of the decedent and succeeded to all of the rights and privileges of a member under the operating agreement, an accounting, the imposition of a constructive trust, and to inspect company books and records. The court held that the under the LLC’s operating agreement, the estate was a successor-in-interest only, with rights to distributions, but was not a member and did not obtain the rights previously possessed by the decedent.

Even though they involve LLCs and not limited partnerships, Justice Borrok finds that the “principles” underlying the Pappas and Calderwood cases “compel” the conclusion that the Weinstein estate representatives lack standing to pursue a derivative lawsuit. As he further explains:

Here, like in Pappas and in Estate of Calderwood, . . . pursuant to the terms of the governing documents of the company, the personal representative succeeds to owning the equity interest in the business without becoming a substitute limited partner in the partnership. It is of no moment that [Weinstein’s legal representatives] acquired their interest in the partnership by operation of law (cf. Pessin v Chris-Craft Indus., Inc., 181 AD2d 66 [1st Dept 1992] [finding contemporaneous ownership requirement under BCL § 626 satisfied where plaintiff acquired shares by operation of law]). In this respect, this action is not analogous to a corporate stockholder derivative suit where the issue of contemporaneous ownership may be satisfied through, e.g., a will (e.g., Singer v State Laundry, 188 Misc 583, 586 [Special Term, NY Cnty 1947]). Put another way, unlike in a corporation where the estate becomes a stockholder by operation of law, the personal representative in the limited partnership may never become a successor limited partner under the terms of the Partnership Agreement. As such, [Weinstein’s legal representatives] simply lack standing to maintain this lawsuit and cannot be substituted for Ms. Weinstein. [Emphases in original.]

Is It a Derivative Action, and Does it Matter?

Justice Borrok’s decision appears to accept as a given Sklar’s characterization, in her papers opposing the substitution motion, of Weinstein’s lawsuit as a derivative action. Because he moved by order show cause, Weinstein’s counsel did not have the opportunity to file reply papers challenging that characterization or any other aspects of Sklar’s opposing arguments.

I’m not convinced the characterization fits. The petition is not styled as a derivative action. Its caption identifies Weinstein as suing individually and on behalf of the partners of the LP, not on behalf of the LP. The petition does not allege demand or demand futility as required in a derivative action. Most importantly, its demand for relief does not seek any recovery on behalf of the LP. What it seeks is judicial dissolution and relief ancillary to dissolution.

But I’m also not convinced it matters to the outcome of the case. RLPA § 121-802 authorizes a petition for judicial dissolution “[o]n application by or for a partner.” Weinstein unquestionably had standing to sue for judicial dissolution of the LP when she filed the case in June 2019. Following her death five months later, can the estate representatives continue prosecuting the dissolution action as within their powers granted under RLPA § 121-706 to “exercise all of the partner’s rights for the purpose of settling his estate or administering his  property”?

A “yes” answer to the question faces significant hurdles, namely, explaining why the statute’s reference to “partner’s rights” does not implicate the LP Agreement’s provisions depriving the estate representatives of partner status and thereby defeating their standing to seek dissolution under RLPA § 121-802. The same would hold true applying LLC Law §§ 608 and 702 if we were looking at an LLC whose operating agreement had restrictive transfer-upon-death provisions similar to those in the LP Agreement in Weinstein.

I’ve not seen any case law providing the answer, so we’ll just have to wait for the Grim Reaper’s next intervention in a pending LLC or LP dissolution case.

[View source.]

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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