KE Property Management Inc. v. 275 Madison Management Corp.

Brief Fact Summary.

KE Property Management Inc. (KE Property) (Plaintiff), one of the general partners of 275 Madison Associates L.P., a limited partnership (the “Partnershipâ€), sought a declaratory judgment that the claimed removal of 275 Madison Management Corp. (275 Madison Corp.) (Defendant), the managing general partner of the Partnership, by KJ Capital Management, Inc. (KJ Capital), a limited partner and an affiliate of KE Property (Plaintiff), was effective.  It therefore sought to enjoin 275 Madison Corp. (Defendant) from claiming to act as the managing partner.

Synopsis of Rule of Law.

Fraud by the agent of a managing general partner of a limited partnership justifies removal of the managing general partner by a limited partner associated with a different general partner where the partnership agreement provides for removal by limited partners of a general partner who has damaged the partnership through fraud or willful misconduct.

Facts.

275 Madison Management Corp. (275 Madison Corp.) (Defendant) was the managing partner of 275 Madison Associates L.P., limited partnership (the “Partnershipâ€).  K.E. Property Management Inc. (KE Property) (Plaintiff) was a general partner, and its affiliate, KJ Capital Management, Inc. (KJ Capital), was a limited partner.  The Partnership’s original managing general partner, Skydell, who served as the president and part owner of Defendant, misappropriated $2 million of Partnership funds by diverting them from the Partnership’s bank accounts.  Skydell was able to divert the funds, as he was an authorized signatory on the accounts, in his capacity as a representative of Defendant.  Prior to Skydell’s fraud, the Partnership had borrowed $70 million from Kawasaki Leasing International, Inc. (Kawasaki Lender).  KJ Capital and KE Property were affiliated with the Kawasaki Lender.  The Partnership experienced financial hardship following the fraud and its finances were restructured with the Kawasaki Lender.  Afterwards, the Kawasaki Lender notified the Partnership that it was in default and risked foreclosure.  Defendant urged the Partnership to seek bankruptcy protection, but Plaintiff refused.  Defendant claimed Plaintiff was showing improper loyalty to the Kawasaki lender by their refusal, and therefore caused a breach of fiduciary duty to the other partners.  Approximately one month later, KJ Capital claimed to remove Defendant as a managing general partner, claiming under the Partnership Agreement, which provided that limited partners, under certain circumstances (which were met) could dismiss any general partner if the general partner had damaged the partnership as a result of fraud or willful misconduct in the performance of his duties as a general partner.  KJ Capital claimed that Skydell’s misappropriation of $2 million amounted to fraud or willful misconduct on the part of Defendant in its role as the managing general partner of the Partnership.  However, Defendant claimed that this was a pretext, instituted at the Kawasaki Lender’s directive, to prevent Defendant from filing for bankruptcy for the Partnership.  Nevertheless, two days after its alleged removal, Defendant proceeded to file.  Plaintiff then brought suit for a declaratory judgment that the alleged removal of Defendant was effective, and for an injunction to stop Defendant from acting on behalf of the Partnership.  Plaintiff sought summary judgment, which Defendant argued was improper because the Kawasaki affiliates had acted in bad faith to block the foreclosure of their loan by preventing the Partnership from entering bankruptcy.

Issue.

Does fraud by the agent of a managing general partner of a limited partnership justify removal of the managing general partner by a limited partner associated with a different general partner where the partnership agreement provides for removal by limited partners of a general partner who has damaged the partnership through fraud or willful misconduct?

Held.

(Hartnett, V. Chan.)  Yes.  Fraud by the agent of a managing general partner of a limited partnership justifies removal of the managing general partner by a limited partner associated with a different general partner where the partnership agreement provides for removal by limited partners of a general partner who has damaged the partnership through fraud or willful misconduct.  First, there is a presumption that the Kawasaki entities acted in “good faith†and Defendant bears the burden of showing “bad faith.â€Â  Also, Defendant’s allegation of “bad faith†is based upon KJ Capital having owed a fiduciary duty to its partner, in this case it was KJ Capital, a limited partner, that claimed to remove Defendant.  Nevertheless, even though the state’s Revised Uniform Limited Partnership Act (RULPA) does not specifically state that a limited partner owes a fiduciary duty to a general partner, it does so by referencing the state’s Uniform Partnership Act (UPA), which provides that all partners owe fiduciary obligations to one another.  Therefore, to the extent that a partnership agreement—as here—empowers a limited partner with discretion to take actions affecting the governance of the limited partnership, such as removing a general partner, the limited partner must act as a fiduciary, and is obligated to act in “good faith.â€Â  However, in this case, the Partnership Agreement does not give KJ Capital unlimited discretion in this regard.  Rather, removal can only occur upon “fraud or willful misconduct†that injures the Partnership.  Because Skydell’s fraudulent acts may be imputed to Defendant, it was guilty of the type of conduct permitting its removal by a limited partner.  The issue of “bad faith†is one of fact.  In this case, because 275 Madison Corp. (Defendant) bears the burden on this issue, and because it has not presented competent evidence to refute KJ Capital’s or the Kawasaki affiliates’ “good faith,†summary judgment is granted to KE Property (Plaintiff).

Discussion.

The court, in this case, imposes fiduciary duties on limited partners only when a partnership agreement empowers limited partners with discretion to take actions affecting the limited partnership’s governance, but not where the partnership agreement spells out the conditions under which the limited partners may act.  Therefore, with respect to KJ Capital, the court determines that KJ Capital did not owe fiduciary obligations to 275 Madison Corp. (Defendant).  Accordingly, the court reasoned that it did not need to reach the issue of whether KJ Capital owed such fiduciary obligations due to being controlled by the same entity that controlled KE Property (Plaintiff).