The Limits of Interposing a Limited Liability Entity as the General Partner of a Limited Partnership

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Limited liability entities (corporations, limited liability companies, and limited partnerships) are formed every day for the simple and legitimate purpose of shielding their owners, directors and officers from personal liability to third parties arising from the business conducted through those limited liability entities. And subject to certain exceptions related to personal participation by the owners, directors or officers in torts committed through those limited liability entities, and the limited circumstances when equitable veil piercing theories may be applicable,[1] the proper use of a limited liability entity generally accomplishes its intended result—shielding individual owners, officers and directors from liabilities to third parties otherwise attaching to that limited liability entity. But the sanctity of the statutory liability shield doesn’t work quite the same way when the liability sought to be imposed on the individual directors, officers or controlling owners of a limited liability entity is liability for breach of fiduciary duty to limited partners of a limited partnership of which the limited liability entity is the general partner.

Almost 30 years ago the Delaware Court of Chancery, in In re USACafes, L.P. Litigation, 600 A.2d 43 (Del. Ch. 1991), ruled that the individual directors and controlling owners of a corporate general partner of a limited partnership owe direct fiduciary duties to the limited partners of the limited partnership—i.e., the interposition of a limited liability entity as the actual general partner of a limited partnership does not in any way limit or shield the directors or controlling owners of that limited liability entity general partner from claims for breach of fiduciary duty by the limited partners. A recent Delaware Court of Chancery decision, Fannin v. UMTH Land Development, L.P., C.A. No. 12541-VCF, 2020 WL 4384230 (Del. Ch. July 31, 2020), reaffirms that principle and is a good reminder of one of the limits of the statutory liability shield available through the formation of a limited liability entity. According to Vice Chancellor Fioravanti, “[c]orporate practitioners and drafters of alternative entity agreements are [or should be] well advised of this precedent [USACafes] and the importance of it when drafting alternative entity agreements.”

If the potential imposition of direct liability to limited partners for breach of fiduciary duties is of concern to individual owners and directors of a limited liability entity general partner, the answer is not reliance upon the fact that the general partner is a limited liability entity but on Delaware’s “broad license to limit fiduciary duty protections in limited partnership agreements.” Indeed, as noted by the court, Section 1101(d) of the Delaware Revised Uniform Limited Partnership Act specifically provides that “drafters of limited partnership agreements may eliminate duties, including fiduciary duties, owed by ‘a partner or other person . . . 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.’” And some drafters of alternative entity agreements have specifically taken advantage of that statutory license and “have eliminated fiduciaries duties [, while] others have not,” by choice or otherwise. But if you fail to take advantage of Delaware’s liberal ability to eliminate (or limit) fiduciary duties in alternative entity agreements, don’t rely upon the general statutory liability shield otherwise available to protect individual directors or controlling owners of a limited liability entity from other types of liabilities to protect those individual directors and controlling owners from breach of fiduciary duty claims.

Corporate practitioners must first know the law in order to effectively negotiate and draft corporate agreements; indeed, drafting is often an exercise in avoiding contractually the consequences that the law imposes absent a provision opting out of that consequence (or at least understanding those consequences if you are unable to negotiate that opt out).[2] Make sure you are, or your counsel is, a corporate lawyer and not just a practitioner.

Endnotes

  1. We have previously outlined the means and manner of protecting private equity firms and their deal professionals from claims based upon these theories. See Glenn West, Protecting the Private Equity Firm and its Deal Professionals from the Obligations of its Acquisition Vehicles and Portfolio Companies, Weil Insights, Weil’s Global Private Equity Watch, May 23, 2016, available here.
  2. We have previously discussed the dangers of letting the “market” alone dictate the terms of your agreements. See Glenn West, Your Mother Was Right: Following Your Friends (or Market Studies) Off a Bridge is a Bad Idea, Weil Insights, Weil’s Global Private Equity Watch, January 28, 2020, available here.

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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