Death is Fatal to Limited Partner’s Derivative Action

Death is Fatal to Limited Partner’s Derivative Action

            Barring the narrowest of exceptions, a derivative action may be brought only by a shareholder, a limited partner or a member.  A non-shareholder does not have the right to on behalf of a corporation bring a derivative action, a non-limited partner does not have the right to on behalf of a limited partnership bring a derivative action, and a non-member does not have the right to on behalf of an LLC bring a derivative action.  A recent decision from New York applied these rules in the context of a limited partnership to hold the estate of a limited partner may not continue to prosecute a derivative action filed before death.  Weinstein v. RAS Prop. Mgmt. LLC, 67 Misc. 3d 240, 119 N.Y.S.3d 49 (N.Y. Sup. Ct. 2020).

The introductory paragraph of the opinion gave away the punch line:

The critical issue is whether a personal representative of an estate has standing to maintain a derivative lawsuit on behalf of a New York limited partnership that was commenced when the decedent was alive and was a partner. Because the court holds that a personal representative cannot, the motion for substitution must be denied.

The limited partnership at issue, Ninety-Five Madison Company LP, owned a sixteen-story in Manhattan.  Lois Weinstein was a limited partner in the partnership.  She had filed a derivative action seeking judicial dissolution, the appointment of a receiver, and sale of the building. After her death the executors of her estate sought to be substituted in the derivative action so that they could continue to prosecute the derivative action.  Here they would run into the terms of the limited partnership agreement.

To wit, Section 8.2 of the Partnership Agreement provides that the death of a limited partner “shall not terminate or dissolve the Partnership,” and that upon the death of such partner:

the executor, administrator, guardian, committee, trustee or other legal representative or successor in interest of such Partner shall have the rights of such Partner subject to the provisions of this Agreement. Such successor in interest shall not become a Substitute Partner except upon compliance with the provisions of Sections 8.3 and 8.4 hereof.

67 Misc. 3rd at 242 (emphasis by the court). The court went on to explain the distinction as to the rule in corporations, in which the heir is a shareholder and having received the shares by operating of law and as such may prosecute a derivative action pending at the time of death. Here, where the executors are not limited partners in place of the decedent without a separate admission, and that had not taken place, they lacked standing to continue the derivative action.

Postscript:

         I’ve been reminded that Peter Mahler, in his blog New York Business Divorce, prepared a review of this decision.  HERE IS A LINK to that review.  Peter raised the issue of whether the suit was properly characterized as derivative or direct, but observing as well that likely it does not matter.

        I agree with Peter that it probably does not matter whether the suit was a direct or a derivative action. If it was a derivative action, the decedent’s estate is not a limited partner (or in the case of an LLC a member) with the status required in order to prosecute the derivative action.  alternatively, if it is a direct action for breach of/seeking recovery for breach of the agreement of Limited Partnership, the decedent’s estate runs headlong into the privity problem; you cannot sue for breach of an agreement to which you are not a party.  While some might assert that the estate of a decedent is an intended third-party beneficiary of the agreement of Limited Partnership who should be able to continue the action for breach/recovery, that characterization is belied by the limited partnership act (and almost every limited partnership agreement) when it is provided that the estate is not substituted as a limited partner, but rather is a mere assignee absent admission, and the rights of a mere assignee preclude participation in management of the venture.

       In a postscript to Peter’s posting, Stuart Pachman pointed out the Louisiana decision Schauf v Schauf in which the court allowed the estate of a deceased member to continue to prosecute an action for judicial dissolution. HERE IS MY REVIEW of that decision.  I continue to be of the view that the Schauf decision is at best an outlier that is substantively in conflict with the proper treatment of an estate as a mere assignee.