Wednesday, October 25, 2017

Pennsylvania Supreme Court Issues a Truly Bizarre Opinion on the Obligation of Good Faith and Fair Dealing in Limited Partnership Agreements


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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