Filed: February 9, 2011
Opinion by Judge James R. Eyler
Held: A claim brought by partners in a general partnership or members of an LLC against a managing partner or managing member will survive a motion to dismiss if they sufficiently allege they suffered harm directly and the managing partner or managing member violated duties owed to the partners or members.
Facts: Plaintiffs are partners in five real estate investment general partnerships and two real estate investment LLCs. Defendants are Mr. Kay, an individual that is the managing member or de facto managing member or partner of the partnerships and LLCs, and Kay Management Company, Inc. and Kay Investment Group, LLC, two entities controlled by Kay. Plaintiffs alleged Defendant took money from the partnerships and LLCs and invested the money with Kay Investment through Kay Management. In turn, Kay Investment invested the money with the Bernard Madoff entities. Plaintiffs brought suit following the Madoff ponzi scheme collapse.
The complaint set forth thirteen counts, including, among others, fraud, breach of fiduciary duties, conversion, civil conspiracy and negligence. The Circuit Court granted Defendant's motion to dismiss because none of the claims were individual, the derivative claims involving the partnerships were not agreed to by a majority of the partnership, and the failure to make demand on behalf of the LLCs was unexcused.
After a lengthy discussion of corporations, general partnerships and LLCs, the Court framed the principal issues on appeal as (1) whether Plaintiffs may assert individual claims against Kay and (2) whether Plaintiffs may bring derivative claims on behalf of the partnerships and LLCs against Kay.
(1) Individual Claims
Applying logic from Shenker v. Laureate Education, Inc., which permitted a shareholder to bring a direct action when the shareholder suffers the harm directly or duties owed to the shareholder have been violated, the Court extended the rationale to the law of partnerships and LLCs. The Court then concluded Plaintiffs sufficiently alleged (a) they suffered harm directly and (b) Kay violated duties owed directly to the Plaintiffs.
Plaintiffs alleged Kay took funds that were required to have been distributed. He also took funds required to be held in reserve, further injuring Plaintiffs by forcing them to replace the removed reserves.
Under the Revised Uniform Partnership Act, general partners owe each other, not just the partnership, fiduciary duties. Section 9A-405(b) of the RUPA "clearly provides a mechanism through which partners can sue other partners directly for breach of those obligations and others." However, there is no statute in Maryland expressly addressing LLC members' fiduciary duties. The Court, after finding managing members to be "agents for the LLC and each of the members, which is a fiduciary position under common law," again applied rationale from Shenker, to state where no statute precludes or limits fiduciary duties under common law, the underlying duties apply. Accordingly, the Court found Kay's fiduciary duties as the managing partner/member to run to the partnerships, the LLCs, the partners and the members.
(2) Derivative Claims
The Court found the term "derivative" inappropriate in a general partnership context. Derivative actions are necessary in a corporate and limited partnership context because shareholders and limited partners have no management rights. "Unlike shareholders and limited partners, however, general partners all have the ability to act on behalf of the partnership, and all have management rights." Accordingly, no need for a derivative action exists. The Court turned to whether minority general partners can bring claims against other partners. The Court cited many sections of RUPA to conclude all partners have equal ability to enforce rights involving partnership property. While section 9A-405(j) of RUPA requires unanimous consent of all the partners, the Court felt it should be tempered "when non-plaintiff partners have conflicts of interest." Instead, "the unanimity requirement should not apply to defendant partners and other interested partners."
However, based on the facts, the Court found a suit on behalf of the partnerships unnecessary because Plaintiffs adequately alleged an individual direct injury. If Plaintiff's prove the allegations, complete relief will be afforded. The derivative claims on behalf of the LLC were rejected for the same reason.
Note: In discussing fiduciary duties in the LLC context, the Court, citing section 4A-402(a) of the Maryland Limited Liability Company Act, notes that "one Maryland statute governing LLC operating agreements does suggest that provisions within operating agreements could alter existing duties or create other duties..." However, no such provisions were alleged in the case.
The full opinion is available in pdf.