Pennsylvania
Supreme Court Issues a Truly Bizarre Opinion on the Obligation of Good Faith
and Fair Dealing in Limited Partnership Agreements
Within every contract there
exist a non-waivable obligation of good faith and fair dealing. If you don’t
believe me, believe the Restatement (2nd) of Contracts, which at section
205 provides:
Every contract imposes upon each
party a duty of good faith and fair dealing in its performance and enforcement.
That
said, in a recent, and fairly described as truly bizarre, decision from the
Pennsylvania Supreme Court, it held that no obligation of good faith and fair
dealing arose in an agreement of limited partnership. Hanaway v. Parkersburg Group, No. 55 MAP 2016, __A.3d___,
2017 WL 3600580 (Pa. Aug. 22, 2017).
The Hanaways, plaintiffs in
this action, were among the limited partners of Sadsbury Associates, L.P., a
Pennsylvania limited partnership of which T. R. White, Inc. (“White”) served as
the general partner. The Sadsbury limited partnership was a financial success.
In light of that history, the same participants organized the Parksburg limited
partnership, largely devoted to the organization of a housing development. There
was transferred to Parksburg an option owned by White for what was referred to
as the “Davis Tract.” The subdivision plat as well included an adjacent quarry,
owned by the Hanaways and for which Parksburg held an option. The agreement of
limited partnership gave White broad discretion with respect to its management
and as well imposed ongoing capital contribution obligations upon the limited
partners.
Sometime after Parksburg began
the planning effort with respect to the subdivision, the Hanaways advised Parksburg
that the option to acquire the quarry had expired and would not be renewed, and
as well that they refused to contribute additional capital to the project.
These actions by the Hanaways led other limited partners to be unwilling to
contribute additional capital, and the project stalled. White informed the Hanaways
that the Davis Tract would be sold, as well as the option for an adjacent tract
upon which an option was held, for appraised fair market value to a newly
formed limited partnership, Park Mansion Partners (“PMP”). White served as the
general partner of PMP, and its limited partners were those persons who had
been limited partners in Parksburg, with the exception of the Hanaways. Some
two years later, the Hanaways would file suit, alleging the sale of the
properties to PMP for less than adequate consideration and below fair market
value, all “as part of the scheme to eliminate the Hanaways’ ownership interests.”
2017 WL 3600580, *3. In response to a motion for partial summary judgment based
upon the failure by the Hanaways to identify a specific term of the Parksburg limited
partnership agreement that had been breached, they contended that White had
breached the implied covenant of good faith and fair dealing. The trial court
granted partial summary judgment, holding, inter
alia, that the broad discretion afforded White in the agreement of limited
partnership could not be overridden by the implied covenant of good faith and
fair dealing. An intermediate court of appeals would reverse, holding that the
discharge of the contractually granted rights remained subject to the implied
covenant of good faith and fair dealing, and on that basis reversed the trial
court. Hanaway v. Parksburg Group, L.P., 132 A.3d 461 (Pa. Super. 2015).
In doing so, that intermediate court of appeals both adopted the Restatement
(2nd) of Contracts section 205 and, as characterized by the
Pennsylvania Supreme Court:
Perceived no reason to treat limited
partnership agreements differently than any other type of contract. The
majority also opined that the Hanaway’s breach of the covenant of good faith
and fair dealing claim was a breach of contract action, not an independent
action for breach of a duty of good faith. 2017 WL 3600580, *3.
The Pennsylvania Supreme Court
would reverse that determination, holding in effect that the obligation of good
faith and fair dealing does not apply and limited partnership agreements save
those organized under Pennsylvania’s new (2016) Limited Partnership Act, it
expressly providing for the obligation of good faith and fair dealing. There is
underlying political aspect of this determination. At the intermediate court of
appeals, then Judge Donahue, since transitioned to the Pennsylvania Supreme
Court, had in a dissenting opinion stated that the implied covenant of good
faith and fair dealing does not apply in limited partnerships because they are “creatures
of the legislature.” That are “governed, first and foremost” by the Limited Partnership
Act. 2017 WL 3600580, *4, quoting Hanaway,
132 A.3d at 477. This decision of the Pennsylvania Supreme Court would for all
interests and purposes adopt that dissent.
As described by the
Pennsylvania Supreme Court:
We granted allocatur to consider whether the implied covenant of good faith
and fair dealing applies to all limited partnership agreements formed in
Pennsylvania, and, if so, whether the implied duty of good faith and prayer
dealing can override the express terms of a limited partnership agreement. 2017
WL 3600580, *4.
I n response thereto, White
adopted the reasoning espoused by Donahue at the intermediate appellate level, “emphasizing
that limited partnership agreements are unique and ill-suited for application
of the implied covenant of good faith and fair dealing because they are
governed by statute.” 2017 WL 3600580 *5. He pointed out as well that under the
Uniform Limited Partnership Act (2001), adopted in Pennsylvania in 2016, there
is an express incorporation into the statute of the contractual obligation of
good faith and fair dealing, characterizing this as a “drastic change” and
reasoning that the obligation of good faith and fair dealing “did not exist at
the time that the parties formed Parkburg and entered into a limited
partnership agreement.” Id. In
contrast, the Hanaways argued that the implied covenant applies in all
contracts, including limited partnership agreements.
IMHO, the Pennsylvania Supreme Court could have easily resolved this dispute
without making any further examination of the obligation of good faith and fair
dealing. Specifically, it could have held, as a factual matter, that the
actions undertaken by White in the reorganization of the then failing Parksburg
limited partnership fell within the general partners authority and/or that the
plaintiffs had failed to adequately plead how White’s actions constituted a
breach of the limited partnership agreement. Had the court done so, the Hanaway
opinion would have been entirely
uninteresting. Unfortunately, that is not the way it went down.
The Pennsylvania Supreme Court
would hold that, except with respect to limited partnerships organized under
the Uniform Limited Partnership Act as adopted in Pennsylvania in 2016, the
implied covenant of good faith and prayer dealing does not apply with respect
to limited partnership agreements. After stating that “The Hanaways had the
opportunity to bargain for specific protections without having to rely upon
implicit concepts.” (2017 WL 3600580, *8), a statement that can only be made if
one entirely ignores the purpose of the implied covenant, the court went on to
hold that, under the applicable Limited Partnership Act “there was no duty of
good faith applicable to limited partnership agreements formed pursuant to
PRULPA.” 2017 WL 3600580, *9.
This decision was joined in by
three members of the six person court. Justice Donahue, who participated in the
decision at the intermediate appellate level, did not participate. There was a
dissenting opinion by two of the sitting justices, an opinion which would have
found that the contractual obligation of good faith and fair dealing applies to
any contract, and that the failure to reference the obligation in the prior
limited partnership act in no manner abrogated its existence. From there, the
dissent would have suggested a focus upon “whether the implied covenant of good
faith and fair dealing may impose duties that are inconsistent with the duties
imposed by the express terms of a limited partnership agreement,” suggesting
that:
It is illogical to conclude that,
had the limited partners considered this issue at the time of forming the
limited partnership, the limited partners would have authorized Parksburg (sic - White), as the general partner, to
exercise its discretion in bad faith to the detriment of either the Partnership
or the limited partners.
This is, at minimum, a
disturbing decision. First, for a state supreme court to suggest that because
limited partnership agreements are created pursuant to statute that the obligation
of good faith and fair dealing is somehow inapplicable is simply nonsensical. Under
that paradigm, to what degree of statutory involvement is necessary in order to
abrogate the application of section 205 of the Restatement (2nd) of Contracts
and the implied covenant? Partnership agreements are heavily influenced by
statute. LLC operating agreements are heavily influenced by statute.
Stockholder buy/sale-restriction agreements are heavily influenced by statute.
Security agreements are heavily influenced by statute. The list goes on. Is the implied covenant inapplicable in all of
them?
At least one member of the
Pennsylvania bar has suggested that this decision is not that important
because, with the application of the new Pennsylvania limited partnership act
to existing limited partnerships, they will all become subject to the new law’s
express incorporation of the implied covenant of good faith and fair dealing. I
can’t accept that. First, with respect to all of those legacy limited
partnerships, the implied covenant of good faith and fair dealing will not
apply retroactively to conduct and actions that accrued prior to the drag-in
effective date. Second, only a minority of the states have adopted the Uniform
Limited Partnership Act (2001). Litigants in other states, seeking to avoid the
application of the implied covenant of good faith and fair dealing, are going
to cite this decision of the Pennsylvania Supreme Court in support of the
notion that the covenant is somehow inapplicable. Hopefully those foreign
courts will undertake an appropriate analysis and an appreciation that the
implied covenant exist in every contract, and its reference in the Uniform
Limited Partnership Act (2001) is primarily in order to make clear that it
cannot be waived in an agreement, but the terms of its application may be
explained.
All in all, this is just a
bizarre decision.
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