Wednesday, January 27, 2016

No Fiduciary Obligations are Owed By General Partners to Members of LLC that is a Limited Partner

No Fiduciary Obligations are Owed By General Partners to
Members of LLC that is a Limited Partner


A decision rendered yesterday by the Delaware Supreme Court, it answering a certified question from the 11th Circuit Court of Appeals, held that the general partners of a limited partnership did not owe fiduciary duties to the members of an LLC that was one of the limited partners.  Culverhouse v. Paulson & Co, Inc., ___ A.3d ___. 2016 WL 304186 (Del. Jan. 26, 2016).

            Culvershouse was a member in HedgeForum Paulson Advantage Plus, LLC (the “Feeder Fund”), which collected funds from its members and in turn invested those funds in Paulson Advantage Plus, L.P. (the “Investment Fund”).  The Feeder Fund was a limited partner in the Investment Fund.  As explained by the Court:

As its name implies, a feeder fund collects investors to invest in the feeder fund, which in turn “feeds” such funds into a master fund, where the investment managers direct the investments in the master fund portfolio. The feeder/master fund structure, common to large or exclusive hedge funds, allows investors who cannot or choose not to meet the direct investment minimum capital requirements of the master fund to aggregate their smaller investments and gain access to the master fund.

The Investment Fund had made an investment of some $800 million in Sino-Forest Corporation, an investment that was ultimately liquidated for a less of $460 million after it came to light that Sino-Forest had overstated its timber holdings and engaged in questionable related party transactions.  Culverhouse then sought to bring suit against the Investment Fund’s general partners on grounds including breach of fiduciary duty  and gross negligence.  They responded (a) no fiduciary duty was owed Culverhouse, so there could be no breach of duty and (b) Culverhouse’s claims are derivative.  The trial court dismissed the suit on the basis that Culverhouse lacked standing as the claims were derivative, never addressing whether the alleged fiduciary duty existed.

On appeal to the 11th Circuit, it determined that whether or not Culverhouse was the beneficiary of a fiduciary duty was a necessary determination; if there was a fiduciary duty, under the decision rendered in Anglo American Security Fund, LP v. S.R. Global International Fund, L.P., 829 A.2d 143 (Del. Ch. 2003).  Alternatively, if no duty was owed, then the direct versus derivative test of Tooley v. Donaldson, Lufkin & Jenrette, 845 A.2d 1031 (Del. 2004), could be applied.

            The Delaware Supreme Court found that no fiduciary duty was owed to Culverhouse by virtue of his position as a member of an LLC that is itself a limited partner, writing:


Applying the undisputed facts to the certification request, we find that Culverhouse fails to meet both parts of the Tooley test. To the extent not waived by the terms of the agreements specific to each fund, the Investment Fund Managers owe fiduciary duties to the investors who invested directly in the Investment Fund, including the Feeder Fund.   But Culverhouse chose not to invest directly in the Investment Fund. Instead, Culverhouse invested in the Feeder Fund, which in turn invested in the Investment Fund. The alleged harm flowing from the Investment Fund’s losses would not in the first instance be suffered by Culverhouse. Culverhouse also would not in the first instance receive the benefit of any recovery. Under the Tooley test, Culverhouse’s claims are derivative.


The Court of Chancery’s decision in Anglo American is distinguishable based on its facts. In Anglo American, the limited partners did not invest through a feeder fund. They had a direct relationship with the investment fund and its manager. By contrast, Culverhouse and other Feeder Fund investors chose not to invest directly with the Investment Fund. Their legal relationship existed only with the Feeder Fund.


The separateness of the Feeder Fund and Investment Fund is not a detail to be disregarded simply because the Feeder Fund acts as a pass-through entity, and does not issue transferrable shares. “Delaware courts take the corporate form and corporate formalities very seriously....” Each fund has its own governing agreements spelling out the rights and obligations of the fund and its investors. To ignore these operative agreements would upset the contractual expectations of the investors and the managers of each fund. It would also unjustifiably call into question the vitality of the same type of foundational agreements in the established feeder/master fund investment model. Culverhouse and the class he purports to represent must look to the Feeder Fund and his contractual or fiduciary relationship with it and its managers, not the Investment Fund Managers, to address any dissatisfaction with investment losses by the Investment Fund.



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