Posts about limited partnerships on this blog are far eclipsed by discussions on just about any other form of business entity because, as we’ve noted in the past, limited partnerships are generally on the decline.

So, I was pleased to debut my appearance here with what seemed to be an interesting case out of the Manhattan Commercial Division—Cline v Grodin, et al., Index No. 654095/2022—concerning an action commenced by a limited partner of a Delaware limited partnership alleging that the general partner (an LLC whose membership consists of the other two individual limited partners in the partnership) improperly distributed profits to those two limited partners, disguised as salaries for managerial duties the limited partners were never supposed to be paid for, without corresponding pro rata distributions to the aggrieved limited partner.

In Delaware (as in New York), a limited partnership is comprised of two classes of partner. General partners typically manage the business and affairs of the partnership. Limited partners, on the other hand, have limited liability (hence the name) because they are typically silent investors without a managerial role. A limited partner risks losing the benefit of limited liability if they participate in the control of the business (6 Del. C. § 17-303 [a]).

General partners may delegate management and control of the partnership’s business and affairs to agents, officers, and employees of the general partner or the partnership (6 Del. C. § 17-403 [c]).

What happens when the general partner delegates management and control of the partnership’s business and affairs to one or more of the limited partners? Can a “fee” paid to limited partners hired by the general partner (who is, itself, controlled by the same limited partners receiving the fee) be viewed as circumventing distributions to the other limited partners?

As it turned out, those are questions for another case on another day, because today’s case was resolved with the following finishing-blow delivered by Justice Jennifer G. Schecter, as recently affirmed by the First Department: “[T]he signed, amended, and restated limited partnership agreement that is dated as of October 1 of 2016 [] does utterly refute the claims that are in this complaint in every regard.” Ouch.

Let’s see what went wrong for our aggrieved limited partner, Cline.

Alcova Capital Management Limited Partnership

Formed in August 2016, Alcova Capital Management LP (“ACM”) is a small alternative asset management company headquartered in New York that provides “customized credit solutions (including bridge loans) for middle-market commercial real estate owners and developers.”

The three founding partners were Russell Diamond, Matthew Grodin and Bill Cline as limited partners, with Alcova Capital Management GP LLC (“ACMGP”) as general partner. ACMGP is a single purpose LLC in which Diamond, Grodin, and Cline were the only members (at least for a time).

Cline was the money guy, who provided much of the seed capital for the business (up to $20 million in 2017). Russell and Diamond were the boots on the ground, building and running the business of ACM.

Money, Money, Money

Cline claimed that in October 2016, the parties entered into an oral agreement for an ownership interest split of 40% to Grodin and 30% each to Cline and Diamond. Cline also claimed that the trio agreed that they would not take any salaries but would be compensated solely by their profit distributions.

In 2018, Cline agreed to transfer 10% of his interest to Diamond, as his investments were (or were soon-to-be) fully repaid, thereby reducing his interest in the partnership to 20%. From that point on, the ownership interest was split with Grodin and Diamond holding 40% each, and Cline holding 20%.

Amended and Restated Limited Partnership Agreement of ACM

In March 2019, Cline, Grodin, and Diamond executed an Amended and Restated Limited Partnership Agreement of Alcova Capital Management LP, effective as of October 1, 2016 (“LP Agreement”), amending the original off-the-shelf limited partnership agreement executed at the time of ACM’s formation.

• Section 5.1 concerns the management of ACM, providing, in part: “Except as otherwise expressly provided in this Agreement, the business and affairs of the Partnership shall be vested in the General Partner, subject to the express provisions of this Agreement. The General Partner shall make all day-to-day business decisions of the Partnership, conduct (or cause to be conducted under its supervision) the day-to-day business and affairs of the Partnership and carry out and implement the day-to-day affairs of the Partnership within the scope of authority granted pursuant to this Agreement.”
• Section 5.2 grants the General Partner the “full, exclusive, and complete discretion, power and authority, subject in all cases to the other provisions of this Agreement and the requirements of applicable law, to delegate the management, control, administration and operation of the business and affairs of the Partnership or the custody of the Partnership’s assets for all purposes stated in this Agreement.”

• Section 9.1 provides: “Except as otherwise set forth herein or agreed to by the Partners, the General Partner will perform its duties as general partner without compensation.”

• Section 9.2 provides: “The General Partner may cause or permit the Partnership to contract for the performance of services to the Partnership, any Partner or any Affiliate of a Partner; provided that the fees and expenses charged by such Affiliate are customary and reasonable, and the transaction otherwise complies with the Act.”

• Finally, Exhibit A to the LP Agreement lists the percentage interest of the partners as follows: ACMGP 0%; Diamond 40%, Grodin 40%, Cline 20%.

Cline’s Complaint

According to Cline, from 2016 to 2021, Grodin, Diamond, and Cline did not take salaries from ACM, instead receiving compensation in the form of their proportionate distributions per the parties’ 2016 oral agreement. But in late 2021, Grodin and Diamond excluded Cline from the operations of ACM and, starting in January 2022, Grodin and Diamond paid themselves distributions disguised as salaries, which were not shared with Cline. This, Cline claimed, was in breach of the 2016 oral agreement and of fiduciary duties owed to Cline.

But what about the fully executed LP Agreement, you may ask? Cline claimed that he “has no recollection of signing such an agreement” (but never alleged that he did not sign the agreement).

Cline, nevertheless, asserted a claim for a breach of the “alleged written agreement” claiming that ACMGP (which is comprised of Grodin and Diamond, having ousted Cline at some point) “is not permitted to utilize ACM funds to pay its own members (i.e., Grodin and Diamond) to perform the duties and responsibilities that ACMGP is required under the terms of the Alleged Written Agreement to perform without compensation.” Cline characterized the salaries to Grodin and Diamond as disguised distributions, for which ACM did not make a corresponding distribution to Cline.

Finally, Cline attempted to walk back the 10% ownership interest transfer made to Diamond in 2018, claiming that his own “unilateral promise” to Diamond was unenforceable.

Defendants moved to dismiss based on documentary evidence, namely the executed LP Agreement.

Oral Argument and Decision on Defendants’ Motion to Dismiss

Justice Schecter’s first question out the gate set the tone for the rest of the argument:

I really want to focus on the agreement that was signed… Why does that not utterly refute the plaintiff’s claims here in every single way?

Things went downhill for Cline from there.

Cline’s counsel (perhaps unwisely) spent the large majority of his time trying to convince the Court that the LP Agreement “was not signed” by Cline, an argument going nowhere fast. Pointing out the obvious, the Court asked: “How can you do that if the signature appears and he doesn’t contest the signature? That is exactly the type of allegation that would be refuted by this documentary evidence.”

Next up, Cline’s counsel offered a winding explanation why the LP Agreement should be interpreted to mean that ACMGP is not allowed to contract out its day-to-day management responsibilities unless it does so at its own cost, notwithstanding Section 9.2 which expressly allows the General Partner to “cause or permit the Partnership to contract for the performance of services to the Partnership, any Partner or any Affiliate of a Partner; provided that the fees and expenses charged by such Affiliate are customary and reasonable.”

Cline’s counsel argued that Section 5.1 (general partner will conduct the day-to-day business and affairs of the partnership) read together with Section 9.1 (general partner will perform its duties without compensation), results in a reading of the LP Agreement in which ACMGP can only contract out management responsibilities at its own cost, since the day-to-day management responsibilities are supposed to be performed by ACMGP without compensation. Counsel ignored the critical language in both 5.1 and 9.1 that says, Except as otherwise set forth in this Agreement. Counsel then acknowledged that Section 9.2 expressly permits contracting with limited partners (Grodin and Diamond), but argued that payment for these contracted services must be limited to non-management services only.

Justice Schecter, again, cut to the core: “That’s not what it says.”

As for Cline’s demand that he is entitled to a 30% ownership interest, the Court again noted the obvious: “And if I look at the end of the PDF that he sends back, it says that William Cline has a 20 percent interest on Exhibit A, which is consistent with the signed agreement. Everything here indicates that he acknowledges that he was at 20%.”

Unsurprisingly, the Court dismissed the complaint in its entirety.

First Department Affirmation

Cline appealed only that part of the dismissal for breach of the LP Agreement and corresponding breach of fiduciary duties, (wisely) dropping his claims stemming from an enforcement of the “oral agreement” and his walk-back of the 10% ownership transfer. Cline repeated his creative interpretation of the LP Agreement that was rejected by the trial court.

The First Department did not bite either. In a tidy, one-paragraph decision, the Appellate Court held:

The court properly dismissed the second cause of action for breach of a written limited partnership agreement and the third cause of action for breach of fiduciary duty. These causes of action are based entirely on plaintiff’s allegations that the amended limited partnership agreement prohibited the individual defendants from being hired by defendant general partner to manage the day-to-day operations of the limited partnership, and from getting paid out of the limited partnership’s proceeds. However, by its plain terms, the amended limited partnership agreement permitted the general partner to contract for services with the limited partners, and thus the court properly dismissed the claims.

Round 3 in the Works? I Hope Not, For Cline’s Sake.

Justice Schecter dismissed Cline’s complaint without prejudice to replead as derivative claims asserting corporate waste for excessive salaries or disguised distribution, which recovery would inure to ACM. Will Cline see more success if he takes Judge Schecter up on repleading? Probably not.

As far as partnership disputes go, the facts alleged in this case were pretty tame. Cline claimed promises that never made it into a writing. The agreement that was signed (even if he does not recall signing it) permitted the exact complained of acts. Cline never claimed that he was kept in the dark about any of the actions taken by ACM or ACMGP. Cline never complained that Grodin and Diamond’s compensation exceeded the work they performed for ACM, or even that Grodin and Diamond were doing a bad job. It appears that Cline was repaid his entire investment in ACM and has continued to receive his 20% distributions. By all tokens, it looks like ACM is thriving.

Unless there is more to this story, it is hard to see a case for corporate waste.

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