Management discretion granted solely and exclusively to a general partner in a limited partnership agreement is not without its constraints, as illustrated by the Illinois case of Labovitz v. Dolan.
Labovitz was one of the limited partners who invested over $12 million dollars in a cablevision programming limited partnership (the “Partnership”) sponsored and syndicated pursuant to a private placement memorandum by defendant general partner Dolan. In 1985, the Partnership reported earnings of over $34,000,000, and in 1986 it had earnings of just under $18,000,000. As a result, each of the limited partners was required to report his pro rata share of the earnings on his personal income tax returns for those years. The limited partners claimed that although the Partnership had cash available to fund the limited partners’ tax obligations, Dolan elected to make only a nominal distribution of cash to cover such liability. In 1985, each limited partner was required to report a taxable income of $415,331 per unit, while Dolan distributed only $12,000 per unit; and in 1986, the limited partners were required to report a taxable income of $216,750 per unit, while again receiving a distribution of only $12,000 per Partnership unit. As a result, the limited partners were forced to continuously invade their own resources in order to pay taxes on large earnings.
In late November 1986, Dolan offered to buy out the interests of the limited partners for approximately two-thirds of their book value. Over 90% of the limited partners accepted the offer, but simultaneously filed suit claiming Dolan’s tactics to be a breach of his fiduciary duty to them.
The circuit court dismissed the plaintiffs’ complaint with prejudice, holding that Dolan’s acts were within the broad discretion granted him under the terms of the Partnership agreement. Plaintiffs then appealed from that ruling.
The Articles of Limited Partnership (the “Articles”), which were bound as an exhibit to the private placement memorandum, provided that Dolan had “full responsibility and exclusive and complete discretion in the management and control of the business and affairs of the partnership”; that “Dolan in his sole discretion shall determine the availability of Cash Flow for distribution to partners”; that (the subscription documents including the private placement memorandum) “contain the entire understanding among the partners and supersede any prior understanding and/or written or oral agreements among them”; and that Dolan would be liable to the limited partners for his willful misconduct but not for “errors in judgment or for any acts or omissions that do not constitute willful misconduct.”
In their complaint, plaintiffs sought the imposition of a constructive trust upon those funds held by the Partnership not required to meet current obligations to maintain a sound financial position or establish reasonable reserves, an order that Dolan distribute these funds to plaintiffs, and that Dolan pay plaintiffs’ damages for breach of his fiduciary duty. The plaintiffs asserted Dolan’s discretion to withhold cash was not absolute – it was limited by an implied covenant of good faith and fair dealing implicit in every Illinois contract and by his fiduciary duty to his partners. In Illinois, plaintiffs argued, such a covenant is implied in every contract absent an express disavowal, and that it “has its most natural and common application to the situation where one party exercises discretionary authority in a manner that affects the rights and duties of the other party.” “Good faith between contracting parties requires that a party vested with contractual discretion must exercise his discretion reasonably and may not do so arbitrarily or capriciously.” Thus, plaintiffs argued, Dolan’s “discretion” to distribute cash flow was limited by his fiduciary duties to his partners.
Dolan responded that the Articles “unambiguously” supported the trial court’s conclusion that Dolan had the sole discretion to determine the availability of cash for distribution to the limited partners, and that the general partner’s specific authority to determine how partnership proceeds should be allocated was not inconsistent with any fiduciary duty owed by Dolan to the plaintiffs because partners have the right to establish among themselves, by a partnership agreement, their rights, duties and obligations. Dolan added that a limited partner who endows a general partner with certain powers to operate the partnership may not later complain that the general partner, by exercising those powers, has breached some fiduciary duty.
The court held that despite having such broad discretion, Dolan still owed his limited partners a fiduciary duty, which necessarily encompasses the duty of exercising good faith, honesty, and fairness in his dealings with them and the funds of the Partnership. The fiduciary duty exists concurrently with the obligations set forth in the Partnership agreement whether or not expressed therein. While “partners are free to vary many aspects of their relationship inter se . . . they are not free to destroy its fiduciary character.” Thus, the language in the Articles standing alone did not deprive plaintiffs of the trial they sought against Dolan for breach of fiduciary duty. Accordingly, the case was sent back to the trial court for trial to determine whether or not Dolan was serving his own interests or those of the Partnership in making various decisions.
In any fiduciary relationship in Illinois, the burden of proof shifts to the fiduciary to show by clear and convincing evidence that a transaction is equitable and just. Where there is a question of breach of a fiduciary duty by a managing partner, all doubts will be resolved against the managing partner and the managing partner has the burden of proving his innocence.
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