Is a Limited Partnership Forever?

Remedies for Aggrieved Limited Partners in New York

Before the advent of the limited liability company in the mid-1990s, limited partnerships were a preferred vehicle for the organization of pooled investments.  Most individuals who invested in limited partnerships did so with certain expectations, such as receiving tax benefits in the early years, profit distributions later on as the partnership assets cash flow increased, and a return of their investment plus a profit when the underlying assets were sold.

But, what if the investor has been a limited partner for many years and he or she has yet to receive any distributions and the general partner has shown no interest in selling the underlying assets?  What if the general partner has been able to take out whatever cash flow has been generated over the years in the form of management fees and other distributions?  What if the partnership has been managed for the benefit of the general partner, and not the investors?

Under these circumstances, what is a limited partner to do?  Without doubt, there will be many obstacles standing in the way of his or her ability to sell the partnership interest, even at a discount.  Finding a buyer will be difficult, since there is no public market for the interest.  Buyers are usually not looking for investments without a steady return and without any reasonable prospect of an exit.  Further, the limited partnership agreement will likely contain restrictions on both the limited’s right to transfer and on the rights of anyone who acquires the interest.  

So, is the limited partner stuck forever in this untenable situation?  Not necessarily. 

The recent case of Garber v. Stevens, 94 A.D.3d 426, 941 N.Y.S.2d 127 (App. Div., 1st Dept. 2012), is instructive in several respects.  In that case, the Limited Partnership Agreement (“LPA”) precluded the general partners from (a) employing the partnership’s credit or capital for any purpose other than partnership business; (b) refinancing the property without the approval of 51% of the limited partners; and (c) receiving compensation for services rendered to the partnership.  The LPA also required that any payment of proceeds go first to the limited partners.  The Appellate Division upheld a summary judgment ruling in favor of the limited partners’ breach of contract and breach of fiduciary duties claims, stating that:

It is undisputed that the general partner defendants refinanced the property six times without prior approval from plaintiffs; paid defendant Stevens proceeds from those refinancings, presumably for loans he had made for property renovations; did not pay any of the loan monies to the limited partners; and paid themselves management fees for services provided to the partnership.

While the appeal was pending, the general partners ceased paying the debt service on the partnership’s property and the mortgage lender moved for foreclosure.  It is possible that the general partner let the mortgage go into default to create leverage over the limited partners; however, the move backfired.  The limited partners moved to replace the general partners with a limited liability company that they had formed for the purpose of taking over management of the partnership.  The Court decided that it had the equitable power to replace the general partners with this entity, even though the Partnership Agreement did not provide such a right and even though it expressly prohibited the limited partners’ involvement in the management of the entity.  Garber v. Stevens, 2012 WL 2091186 (N.Y. Sup. June 6, 2012). 

Critical to the Court’s reasoning were its findings that the general partners had been found to have breached their fiduciary duties and that their removal was necessary to preserve the partnership’s sole asset.  The Court noted that it found credible the assertion that the lenders would not be willing to forbear so long as the general partner defendants remained in control of the partnership. 

The Court rejected the defendants’ arguments that replacing them with an entity controlled by the limited partners violated the Partnership Agreement, stating:

The power of equity is as broad as equity and justice require.  It is a familiar principle that a court of equity having obtained jurisdiction of the parties and the subject matter of the action will adapt its relief to the exigencies of the case.

The court went on to describe these powers in the context of the Garber facts:

A court has the power to remove a general partner as general partner from a partnership and elevate a limited partner to general partner where the limited partners have shown that (i) the general partner violated his fiduciary duties to the partnership and that (ii) removal is necessary to preserve the partnership.  Where a partner’s breach of his fiduciary responsibility has rendered the partnership into an entity that is no longer viable, a court may take remedial action, including discharging such partner or liquidating the partnership.  A court has discretion to remove a general partner and elevate a limited partner to the status of general partner as necessary to protect the principal asset of the partnership.