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.

Limited Partnership Dissolved At the Request of Assignees of Limited Partners

Limited Partnership Dissolved At the Request of Assignees of Limited Partners

In a recent decision from Minnesota, a limited partnership was ordered to be dissolved in an action brought by the assignees of the limited partners. Storeland v. Nordic Townhomes Limited Partnership, A18-1564, 2019 WL 1983500 (Minn. Ct. App. May 6, 2019).

 

Nordic Townhomes was originally organized with three limited partners and three general partners. With the passage of time, all of the original limited partners died. No new limited partners were admitted, and the heirs of the various limited partners became transferees of their respective interests in the partnership. The partnership agreement of Nordic Townhomes and the present situation were summarized by the court as:

Once Nordic did not have any limited partners, the partnership was to dissolve, liquidate, and cease doing business. Despite the fact that Nordic does not have any limited partners, continue to exist as an entity and conduct business.

The plaintiffs, they being some of the assignees of now deceased limited partners, filed a complaint seeking that Nordic Townhomes wind up its business, satisfy its debts and obligations and distribute the net proceeds to those holding the economic rights in the partnership. The limited partnership responded by claiming that the plaintiffs did not have standing to seek either judicial or nonjudicial dissolution of the partnership on the basis that they were neither limited or general partners. The trial court granted the plaintiffs’ summary judgment, in effect finding that they could enforce the provision of the limited partnership agreement with respect to the partnership’s dissolution. This appeal followed.

Applying a “injury-in-fact” paradigm, the Court of Appeals found that the assignees of the limited partners had standing to enforce that provision of the limited partnership agreement directing that the partnership be dissolved upon having no limited partners:

Here, respondents suffered an injury-in-fact sufficient to give them standing to ask the district court to enforce the partnership agreement. The partnership agreement is clear: Nordic was to be dissolved when there were no longer any limited partners. That process involves liquidating assets, and respondents are entitled to their share of any profits remaining once partnership obligations are resolved. See Minn. Stat. § 321.0702(b)(2) (2018) (stating that “upon the dissolution and winding up of the limited partnership’s activities [a transferee is entitled to] the net amount otherwise distributable to the transferor”). Because respondents are entitled to their share of that money, and because Nordic refused to take steps to dissolve the partnership and liquidate assets, respondents suffered an injury-in-fact sufficient to confer standing.

2019 WL 1983500, *2.

Further rejecting the claim that the court was allowing a non-partner to move for judicial dissolution, the court observed that “respondents’ action is more properly characterized as seeking enforcement of the partnership agreement rather than seeking judicial dissolution of the partnership. And because we conclude that respondents have standing because they suffered an injury-in-fact, respondents do not need a statutory basis to have standing.” Id. (citation omitted). Still on that same point, the court would also write:

[T]he partnership agreement clearly states that Nordic was to be dissolved when there were no limited partners. Accordingly, as transferees, respondents had standing to ask the district court to enforce the partnership agreement and the district court correctly required Nordic to follow the partnership agreement’s mandate of dissolution and liquidation.

 

Finally, although our opinion rests on our application of the law, we observe that adopting Nordic’s position could effectively result in no one having standing to seek enforcement of the partnership agreement. We do not discern the Minnesota law leaves transferees like respondents without redress in cases where remaining general partners fail to abide by the partnership agreement.

Id.,*3 (footnote omitted).

For myself, I find this decision somewhat troubling. Yes, all the court is doing is enforcing the agreement. The court is, however, enforcing the agreement on behalf of persons who are not parties to it. As transferees of an economic interest in the limited partnership, the plaintiffs in this action have no right to participate in the management of the limited partnership. While the original limited partners may have been parties to the limited partnership agreement and in that role had the capacity to bring an action for its enforcement, that right did not devolve to the transferees upon the death of the limited partner. They are not parties to the limited partnership agreement, and for that reason an “injury-in-fact” paradigm fails; the failure of strict compliance with the limited partnership agreement gave no rise to an injury in the transferees as they were never parties to that agreement to begin with.  In effect, the court is allowing non-parties to an agreement to insist upon its enforcement. What about the requirement of privity before bringing an action for enforcement?

No Valuation Distinction Between a Mere Assignee and a Limited Partner

No Valuation Distinction Between a Mere Assignee and a Limited Partner

      In a recent decision from the Tax Court, it was held that an assignee and a limited partner would have the same valuation discounts. Estate of Streightoff v. Commissioner, T.C. Memo 2018-178 (October 24, 2018).

      The Tax Court was called upon to determine whether a donor had transferred the entirety of a limited partnership interest, or merely an assignee right therein. The court held, in this instance, that the donor had transferred the limited partnership interest, and not a mere assignee interest. The court went on to hold that, however, the distinction did not matter, and that the discount applied would be the same irrespective of whether a limited partnership interest or a mere assignee interest were conveyed. Both had the same right to distributions. While a limited partnership interest did convey a right to vote, that right existed only with respect to the removal of the general partner (thereby effectuating the partnership’s termination), and the limited partners had, to date, never held a vote.

Death and Conversion of a General Partner

Death and Conversion of a General Partner

      A recent decision from California addresses two changes with respect to general partners in limited partnerships. One of those situations was the death of a natural person, and the other was the conversion of the corporation into an LLC. Wong v. California Forefront, Inc., B281939, 2018 WL 4404148 (Ca. Ct. App. Second Dist. Sept. 17, 2018).

       Lily Wong was one of the two original general partners in Park Center Partnership. The other original general partner was California Forefront, Inc. An individual, Wyman Ip was the only limited partner. When Lily Wong died, her husband, as trustee of the Lily Y. Wong Family Trust, asserted that he was the successor general partner. In the alternative, it was asserted that when CFI, in 2010, converted from a corporation to a limited liability company, it was in effect disassociated as a general partner. Both of these assertions were rejected.

      While it was acknowledged that, upon the death of Lily Wong, her trust became the assignee of her economic interest in the partnership, applying the terms of this particular limited partnership agreement, which imposed specific limitations upon affiliates of existing partners, it was found that the trust could not be a successor general partner.

      With respect to the conversion of CFI from a corporation into a LLC, the court cited the applicable provision of the statute, it providing that upon conversion the converted entity is “the same entity that existed before the conversion.” That being the case, it was held that the conversion of a corporate general partner into the form of an LLC did not effect that corporation’s disassociation from the limited partnership or the alteration of its status as a general partner.

General Partner with Dementia Was Still a General Partner Able to Bind the Partnership

General Partner with Dementia Was Still a General Partner Able to Bind the Partnership

      In Mary Hubert Limited Partnership v. Hasselbring, 2018 Il. App.(3d) 160623-U 2018 WL 298293 (3^rd Dist., Ill App. Jan. 3, 2018), the court found that an elderly general partner, suffering from dementia, had not been dissociated as a general partner and therefore still had the ability to bind to the partnership. On other grounds, however, the lease that was the subject of the litigation was held unenforceable on grounds of unconscionability.