On occasion, I have heard investors who had invested in a limited partnership believe that the General Partner (and its principals) have mismanaged the partnership. One such occasion is when the General Partner effectuated an investment by the partnership to invest in a different category of asset than what had been proposed. The issue is that an investor that is a limited partner will have a tough time if they wish to sue to recover their investment in the partnership. The scenario illustrates why investors must do their due diligence by examining the partnership agreement closely, especially if the partnership agreement is governed by Delaware law.
Waiver of fiduciary duties:
Delaware law permits parties to a limited partnership agreement to disclaim all fiduciary duties based on the principle of freedom of contract. Frequently, a limited partnership agreement will do so, though most provide exceptions in cases involving fraud, bad faith, or gross negligence. LPAs also generally provide broad exculpation and indemnification provisions for the general partner and its officers and affiliates. Delaware courts will enforce these provisions according to their terms.
The only duty that may not be disclaimed under Delaware law is the covenant of good faith and fair dealing, which is implied in Delaware contracts. But the Delaware Supreme Court has stated that this implied covenant is not a remedy for rebalancing economic interests after events that could have been anticipated but were not. See Nemec v. Shrader, 991 A.2d 1120, 1128 (Del. 2010). In other words, the implied covenant does not apply when the contract addresses the conduct at issue and will not allow an investor to get around an unfavorable, but enforceable, contract provision.
Conflict-of-interest transactions:
Transactions between a general partner and an affiliate necessarily pose a conflict of interest, thereby implicating the duty of loyalty. However, since fiduciary duties can be waived in limited partnership agreements, LPAs regularly permit the general partner to engage in these transactions subject to an approval process. Frequently, this approval process requires approval by either a percentage of the disinterested limited partners or approval by a committee appointed to address these transactions. Provided the process outlined in the LPA is followed in good faith, Delaware courts will not generally set aside an interested transaction.
Use of investor funds:
Delaware LPAs usually provide the general partner with sole discretion regarding how funds should be invested. When a partnership fails, investors often want to sue the general partner and its principals on the basis that they were told their funds would be invested in one type of asset when they were, in fact, invested elsewhere. While an LPA that provides wide latitude to the general partner on investment decisions is not an ironclad defense against a lawsuit for securities fraud or fraudulent inducement, it does make prevailing in a lawsuit much more difficult for the investor. Further, all LPAs contain a merger clause, which states that the investor is not relying on any representations not expressly contained in the LPA.
Access to books and records:
Section 17-305(f) of the Delaware Revised Uniform Limited Partnership Act allows a partnership agreement to expand or restrict limited partners’ access to books and records. Based on this statute, LPAs often severely restrict or even eliminate a limited partner’s access to information. While the enforceability of a provision that completely eliminates access to information is an unsettled issue in Delaware, the cautious investor should assume that these provisions would be enforced.
Moral of the story:
The diligent limited partnership investor will read the LPA carefully. If possible, provisions that provide a general partner with unacceptable leverage should be renegotiated. For high-demand investments, the general partner will usually refuse to renegotiate. In those situations, the investor should understand that the LPA means what it says.
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