In re USACafes, L.P.

Brief Fact Summary.

The shareholders of a reorganized corporation filed breach of duty claims against the directors of the new corporation based on transactions that took place contrary to the interests of the shareholders as shown in the original prospectus.

Synopsis of Rule of Law.

In a limited liability corporation, the duty of loyalty includes directors of the corporation’s general partners sufficient to support a breach of duty claim by controlling shareholders.

Facts.

USACafes, L.P. (Defendant) was formed after the reorganization of a Nevada corporation, which included the creation of a general partner that was also named as a defendant in this case.  Metsa Acquisition Corp. (Metsa) moved to purchase substantially all of the assets of USACafes (Defendant), which triggered a breach of the duty of loyalty action against USACafes (Defendant) by the holders (Plaintiff) of the limited partnership.  The holders (Plaintiff) alleged that the sale of assets took place at a price favorable to Metsa, and that the directors of USACafes’ (Defendant) general partner received significant sie payments.  Also, the holders (Plaintiff) claimed that the directors of USACafes’ (Defendant) general partner were not adequately informed to make a valid business judgment on the sale.  Finally, the holders (Plaintiff) asserted a breach of duty claim on behalf of the shareholders of the original Nevada corporation based on the original shareholders’ belief that a sale of substantially all the assets of the reorganized corporation required an affirmative majority vote by all the shareholders.  In amending its complaint to include this assertion, the holders (Plaintiff) requested judicial recognition of the right to vote on the Metsa transaction, or a rescission of the transaction.

Issue.

In a limited liability corporation, does the duty of loyalty include directors of the corporation’s general partners sufficient to support a breach of duty claim by controlling shareholders?

Held.

(Allen, Chan.)  Yes.  In a limited liability corporation, the duty of loyalty includes directors of the corporation’s general partners sufficient to support a breach of duty claim by controlling shareholders.  The directors of USACafes’ (Defendant) general partner acknowledge that a fiduciary duty does exist between the limited partners and the general partner of the corporation, but that no such duties are owed by the directors of the general partner toward the limited partners.  In the court’s view, the directors’ (Defendant) claim of the independence of the corporate general partner from its directors is not correct.  There are no existing precedents to directly address the question that the directors of a corporate general partner owe fiduciary duties to a corporation and its general partners.  But, one who controls the property of another may not intentionally use that property to the detriment of the true owner without consent.  Therefore, corporate directors are regarded as fiduciaries for corporate stockholders.  Relevant authority extends the fiduciary duty of the general partner to a controlling shareholder.  Also, we recognize this duty in the directors of a general partner who are in control of the partnership’s property, more so than a controlling shareholder.  The directors (Defendant) have breached a fiduciary duty imposed upon them as directors of the general partner, therefore, the motion by the directors (Defendant) to dismiss the claim denied.

Discussion.

The court compared the role of a director owing fiduciary duties based on the control of property to that of a trustee.  The law of trusts requires that a fiduciary may not waste property, even when there is no self-interest involved.  Also, a fiduciary is required to exercise due care when controlling property for the benefit of another.  Eventually, courts of equity would extend these duties by analogy to corporate directors controlling the corporate enterprise.  Therefore, in this case, the court imposed a constructive trust, which is the appropriate remedy, requiring the return of the value of the property as held in trust by the directors on behalf of the shareholders.