DV Realty Advisors LLC v. Policemen's Annuity & Benefit Fund of Chicago, et al.
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Defendant-appellant DV Realty Advisors LLC appealed a Court of Chancery declaratory judgment that plaintiffs-appellees properly removed DV Realty as the General Partner of Chicago-based Delaware limited partnership DV Urban Realty Partners I, L.P. In its two issues raised before the Supreme Court on appeal, DV Realty DV Realty argued: (1) the Court of Chancery improperly found that the Limited Partners believed in good faith that because of untimely delivered audited financial statements, removing DV Realty was necessary for the best interest of the partnership; and, (2) "Red Flag Issues" raised by an advisor were not sufficient to support a finding that the Limited Partners removed DV Realty in good faith. Upon review, the Supreme Court concluded that both of DV Realty's arguments were without merit.
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IN THE SUPREME COURT OF THE STATE OF DELAWARE
DV REALTY ADVISORS LLC,
§
§
Defendant Below,
§
Appellant,
§
§
v.
§
§
POLICEMEN’S ANNUITY AND
§
BENEFIT FUND OF CHICAGO,
§
ILLINOIS, MUNICIPAL
§
EMPLOYEES’ ANNUITY AND
§
BENEFIT FUND OF CHICAGO,
§
LABORERS’ AND RETIREMENT §
BOARD EMPLOYEES’ ANNUITY §
AND BENEFIT FUND OF
§
CHICAGO, RETIREMENT PLAN §
FOR CHICAGO TRANSIT
§
AUTHORITY EMPLOYEES’
§
TRUST, and PUBLIC SCHOOL
§
TEACHERS’ PENSION AND
§
RETIREMENT FUND OF
§
CHICAGO,
§
§
Plaintiffs Below,
§
Appellees.
§
No. 547, 2012
Court Below – Court of Chancery
of the State of Delaware
C.A. No. 7204
Submitted: June 4, 2013
Decided: August 26, 2013
Before STEELE, Chief Justice, HOLLAND, BERGER, JACOBS and
RIDGELY, Justices (constituting the Court en Banc).
Upon appeal from the Court of Chancery. AFFIRMED.
Richard L. Renck, Esquire and Andrew D. Cordo, Esquire, Ashby &
Geddes, Wilmington, Delaware, Edward T. Joyce, Esquire and Robert
Carroll, Esquire, Edward T. Joyce & Associates, P.C., Chicago, Illinois, for
appellant.
Bradley R. Aronstam, Esquire and S. Michael Sirkin, Esquire, Seitz,
Ross, Aronstam & Moritz, LLP, Wilmington, Delaware, and William Lynch
Schaller, Esquire, John M. Murphy, Esquire and Peter P. Tomczak, Esquire,
Baker & McKenzie, LLP, Chicago, Illinois, for appellees.
HOLLAND, Justice:
2
The defendant-appellant, DV Realty Advisors LLC (“DV Realty”),
appeals from the Court of Chancery’s declaratory judgment that the
plaintiffs-appellees1 properly removed DV Realty as the General Partner of
Chicago-based Delaware limited partnership DV Urban Realty Partners I
L.P. (the “Limited Partnership”).
DV Realty raises two issues on appeal:
first, that the Court of
Chancery improperly found that the Limited Partners believed in good faith
that, because of untimely delivered audited financial statements, removing
DV Realty was necessary for the best interest of the partnership; and,
second, that the “Red Flag Issues” raised by an advisor to the Limited
Partnership were not sufficient to support a finding that the Limited Partners
removed DV Realty in good faith.
We have concluded that both of DV Realty’s arguments are without
merit. Therefore, the judgment of the Court of Chancery must be affirmed.
1
The plaintiffs-appellees consist of Policemen’s Annuity and Benefit Fund of Chicago,
Illinois (“Policemen’s Fund”), Municipal Employees’ Annuity and Benefit Fund of
Chicago (“Municipal Fund”), Laborers’ and Retirement Board Employees’ Annuity and
Benefit Fund of Chicago (“Laborers’ Fund”), Retirement Plan for Chicago Transit
Authority Employees’ Trust (“CTA Fund”), and Public School Teachers’ Pension and
Retirement Fund of Chicago (“Teachers’ Fund”) (collectively the “Limited Partners”).
3
The Parties2
The Limited Partnership is a Chicago-based Delaware limited
partnership that invests in residential and commercial real estate in Chicago.
The Limited Partners, DV Realty, and Occam-DV, entered into the Limited
Partnership Agreement (“LPA”). The LPA provides the General Partners,
and the Managing Partner in particular, with broad discretion to manage the
everyday affairs of the Limited Partnership.
Managing Partner DV Realty, a General Partner of the Limited
Partnership since 2006, owns 4.9% of the Limited Partnership interests.
Jared Davis is the manager of JCJ Family LLC, which is the sole member of
DV Realty. Allison Davis, Jared Davis’ father, is active in the management
of JCJ Family LLC. Non-party Occam-DV was named a General Partner
alongside Managing Partner DV Realty. Robert Vanecko (“Vanecko”) was
the manager of Occam-DV.
The Limited Partners are all public pension funds located in Chicago,
Illinois.
Collectively, the Limited Partners own 95.1% of the Limited
Partnership interests. Among the Limited Partners are Policemen’s Fund,
with John Gallagher as Executive Director; Municipal Fund, with James
2
The relevant facts are not in dispute. Unless otherwise noted, the facts are drawn from
the Court of Chancery’s 2012 memorandum opinion, Policemen’s Annuity & Benefit
Fund of Chicago v. DV Realty Advisors LLC, 2012 WL 3548206 (Del. Ch. Aug. 16,
2012).
4
Mohler as Executive Director; Laborers’ Fund, with James Capasso as
Executive Director; CTA Fund, with John Kallianis as Executive Director;
and Teachers’ Fund, with Kevin Huber as Executive Director.
The LPA
This appeal necessitates our review of four sections of the LPA.
Under section 6.1 of the LPA, the General Partners are required to establish
an Advisory Committee. Pursuant to section 6.1 of the LPA, an Advisory
Committee was formed, which consisted of three members: Blake Eagle,
Tariq Malhance, and Steven Rogers. In July, 2007, Rogers resigned but was
never replaced. Under section 11.5 of the LPA, the General Partners are
also required to provide the Limited Partners with annual audited financial
statements. Section 3.2 of the LPA prohibits the use of placement or finder’s
fees with respect to any of the Limited Partnership’s investments. And,
section 3.10 specifies the mechanism through which the General Partners
can be removed.
The Limited Partners Become Concerned
Beginning in 2007 and continuing until the summer of 2009, certain
Chicago Sun-Times articles speculated that Vanecko had improperly used
his relationship with his uncle and former Chicago mayor Richard Daley to
induce the Limited Partners to invest in the Limited Partnership. A grand
5
jury in the United States District Court for the Northern District of Illinois
issued subpoenas to the Limited Partners. The subpoenas demanded “any
and all information relating to the investments and/or considerations of
investments made . . . [in the Limited Partnership].” At the time of trial, no
public information relating to the subject of the investigation had been
released.
In June, 2009, the General Partners—DV Realty and Occam-DV—
had not yet provided the Limited Partners with audited financial statements
for the Fiscal Year 2008 (the “2008 Statements”). These statements were
due by April 30, 2009.
The Executive Directors of the various Funds
constituting the Limited Partners—Gallagher, Mohler, Capasso, Kallianis,
and Huber (collectively “Executive Directors”)—met to discuss their
resulting frustration.
Mohler sent an e-mail to the Managing Partners on
behalf of the Limited Partners, telling the Managing Partners that under the
LPA, the 2008 Statements were due on April 30, 2009. Mohler requested
that the Managing Partners immediately notify the Limited Partners when
the 2008 Statements would be completed.
In a June 8, 2009 letter, the General Partners informed the Limited
Partners that Occam-DV and Vanecko would end their involvement in the
Limited Partnership.
Vanecko was withdrawing because of alleged
6
mischaracterizations in the press of his involvement with the Limited
Partnership.
Vanecko opined that his withdrawal would “further the
important work of the [Limited] Partnership while minimizing unwarranted
distractions from our core purpose.”
Despite Mohler’s June 5, 2009 e-mail, the 2008 Statements were not
completed by August of 2009. On August 25, 2009, four of the Executive
Directors sent DV Realty, now the sole General Partner, a letter requesting
the 2008 Statements and information relating to the terms of Vanecko’s
severance. The letter also requested that DV Realty cooperate with each of
the Limited Partner’s respective consulting firms. The letter warned that
continued failure to resolve these issues “may prompt the limited partners to
seek remedies available within the limited partnership agreement.”
In a September 9, 2009 letter, DV Realty responded to the Limited
Partner’s renewed request for the 2008 Statements. DV Realty explained
that the delay in providing the 2008 Statements centered on the near term
expiration of two loans. The Limited Partnership’s auditor, Deloitte &
Touche LLP (“Deloitte”), had insisted that “unless these loans were
extended, our audit would have a ‘going concern’ note which is not
desirable.”
DV Realty explained that since it was in the Limited
Partnership’s interest to not issue an audited statement containing a ‘going
7
concern’ note, the 2008 Statements had been delayed.
The letter also
explained that Vanecko was not paid in connection with his resignation. DV
Realty assured the Limited Partners that it would cooperate with the
consulting firms. On October 14, 2009, DV Realty provided the Limited
Partners with the 2008 Statements—173 days after the due date as required
by section 11.5 of the LPA.
The Advisory Committee, long defunct, stopped meeting in late 2009
or early 2010. Malhance resigned from the committee in 2010 and Eagle
resigned in 2011. Also in late 2009 or early 2010, Heitman LLC was
engaged by the Limited Partnership to provide economic advice.
In April, 2010, Michael Dudek filed suit against the Limited
Partnership, DV Realty, and all of the Limited Partners, alleging that he was
entitled to a finder’s fee because of the Limited Partners’ investment in the
Limited Partnership. The Limited Partners and the Limited Partnership were
dismissed from the suit, but as of the Court of Chancery’s 2012
Memorandum Opinion, the Dudek action was still pending against DV
Realty.
Dudek produced a written consulting agreement that Vanecko
executed and that purported to bind the General Partners to pay Dudek 2%
of capital raised from certain investments.
8
In May of 2010, the Limited Partners were concerned because the
2009 audited financial statements (the “2009 Statements”) had not yet been
completed. Pursuant to section 11.5 of the LPA, the 2009 Statements were
due April 30, 2010. Additionally, Heitman LLC had not yet begun its
analysis because DV Realty had yet to sign a confidentiality agreement. The
Limited Partners sent DV Realty a letter requesting that DV Realty complete
the 2009 Statements by June 14, 2010 and that DV Realty cooperate with
Heitman LLC by promptly signing a confidentiality agreement.
DV Realty then entered into a confidentiality agreement with Heitman
LLC. DV Realty also responded to the Limited Partners’ May letter, stating
that because of changes in the Financial Accounting Standards, debts that
mature within one year of the previous year’s audited financial statements
would be considered “going concerns.” DV Realty explained that three of
the Limited Partnership’s projects fit into this category, and that if they were
not extended or refinanced to provide for a later maturity date, the Limited
Partnership’s auditor (Deloitte) would include a “going concern” note in the
2009 Statements.
DV Realty stressed that if the 2009 Statements contained a “going
concern” note, this would alarm the Limited Partnership’s lenders and
creditors. DV Realty stated, “[o]ur goal is to have a ‘clean’ audit issued
9
which does not impair our relationship with you, our lenders, creditors, or
third parties.” DV Realty concluded by advising that after conferring with
Deloitte and Heitman LLC, they both agreed that August 1, 2010 would be a
realistic due date for the 2009 Statements.
As of September 14, 2010, DV Realty still had not completed the
2009 Statements.
DV Realty informed Mohler that the Limited
Partnership’s accountant, RSM McGladrey, Inc. (“RSM”), would prepare a
written statement outlining the status of the audit and the expected date of
completion.
The following day, each Limited Partner received a
memorandum from RSM, which explained that all work on the 2009
Statements had been completed except for the “going concern”
documentation.
According to RSM, DV Realty was waiting on loan extensions to be
completed so that the 2009 Statements could avoid including a “going
concern” note.
The RSM memorandum explained that Deloitte had
requested additional information from DV Realty.
The memorandum
required DV Realty to provide an updated Debt Assessment Summary, a
detailed property cash flow plan, and an assessment of agreements
implicating the assertion that the debt instruments do not have fund level
recourse or other “going concern” implications.
10
General Partner Removed
Concerned about the RSM letter, Huber asked Rob Kochis of the
Townsend Group Inc. (“Townsend”) to offer his “take” on the situation.
Townsend had already been retained by the Teachers’ Fund to help oversee
its real estate investments. Kochis prepared, but did not send, a letter that
recommended a change of management. At a September 27, 2010 meeting
of Townsend’s advisory investment committee, Kochis voiced his
recommendation that DV Realty be removed as General Partner of the
Limited Partnership. The minutes of the meeting state that Kochis “was
critical of [DV Realty’s] poor performance, misuse of leverage, lack of
transparency, etc.”
Kochis sent a letter to Huber that, while not explicitly recommending
removal of DV Realty, stated that Townsend believed there were sufficient
grounds to terminate DV Realty as General Partner. At trial, Huber denied
that he asked Kochis for a recommendation that DV Realty be removed.
Huber claims that he and Kochis were merely exploring options.
In November, 2010, Huber called a meeting of the Executive
Directors. At this meeting, Huber outlined the pros and cons of removing
DV Realty.
The Limited Partners collectively engaged Townsend to
evaluate the Limited Partnership and to review potential courses of action
11
with regard to DV Realty. Townsend’s mandate included searching for a
replacement manager to assume investment management responsibilities for
the Limited Partnership.
DV Realty completed the 2009 Statements on March 9, 2011—313
days after the due date mandated by section 11.5 of the LPA. Deloitte’s
notes to the 2009 Statements indicated that DV Realty had received a
$510,837 development fee in connection with a property that the Limited
Partnership never purchased. Townsend issued its final report in May, 2011,
which recommended that the Executive Directors of the Limited Partners
remove DV Realty as General Partner and appoint a successor. Townsend’s
final report recommended Lincoln Advisory Group Ltd. as a suitable
replacement.
Townsend based its recommendation for removal on the untimely
audited financial statements, and on several additional factors (the “Red Flag
Issues”). Townsend’s recommendation cited (1) the Limited Partnership’s
poor financial performance, (2) Vanecko’s resignation, (3) the dysfunction
of the Advisory Committee, (4) the Dudek lawsuit, and (5) DV Realty’s use
of recourse debt in violation of the LPA. Thereafter, each Limited Partner
12
approved the removal of DV Realty.3 The Limited Partners executed a
written consent for the removal of DV Realty. As of May, 2012, the audited
financial statements for 2010 and 2011 had yet to be completed.
The Limited Partners filed a complaint in the Court of Chancery
against DV Realty and against the Limited Partnership, as a nominal
defendant. The Limited Partners sought a declaratory judgment that they had
validly removed DV Realty. In addition, the Limited Partners requested an
award of attorney’s fees. DV Realty opposed the declaratory relief, arguing
that the removal procedures as set forth in the LPA had not been properly
observed.
On August 16, 2012, the Court of Chancery issued a Memorandum
Opinion, finding that the Limited Partners had properly removed DV Realty
but denied the request for attorney’s fees. This appeal followed.
Freedom of Contract
This opinion is the latest decision by this Court interpreting language
in limited partnership agreements.4
Although the limited partnership
agreements in all of these cases contain troublesome language, each decision
3
The Boards of Trustees of the Policemen’s Fund, the Teachers’ Fund, the Laborers’
Fund, and the Municipal Fund all approved removal. The Board of Trustees of the CTA
Fund delegated authority to Kallianis, who approved removal.
4
E.g., Allen v. Encore Energy Partners, L.P., ___ A.3d ___, 2013 WL 3803977 (Del.
July 22, 2013); Gerber v. Enter. Prods. Hldgs., LLC, 67 A.3d 400 (Del. 2013); Norton v.
K-Sea Transp. P’rs L.P., 67 A.3d 354 (Del. 2013); Brinckerhoff v. Enbridge Energy Co.,
67 A.3d 369 (Del. 2013).
13
was based upon significant nuanced substantive differences among each of
the specific limited partnership agreements at issue. That is not surprising,
because the Delaware Revised Uniform Limited Partnership Act is intended
to give “maximum effect to the principle of freedom of contract.”5
Accordingly, our analysis here must focus on, and examine, the precise
language of the LPA that is at issue in this case. Section 3.10(a)(ii) of the
LPA provides in pertinent part:
Both General Partners (and only both, not either General
Partner individually) may be removed without Cause by an
affirmative vote or consent of the Limited Partners holding in
excess of 75% of the [Limited] Partnership Interests then held
by all Limited Partners; provided that consenting Limited
Partners in good faith determine that such removal is necessary
for the best interest of the [Limited] Partnership. (emphasis
added).
Court of Chancery Decision
The Court of Chancery ruled that the Limited Partners bore the burden
of proof to demonstrate action in good faith under § 3.10(a)(ii). The Court
of Chancery noted that “The LPA . . . does not define good faith, and good
faith can sometimes include objective, as well as subjective, elements.”
Looking to the language of section 3.10(a)(ii), the Court of Chancery found
that the term “good faith” was ambiguous.
5
Allen v. Encore Energy Partners, L.P., ___ A.3d ___, 2013 WL 3803977, at *4 (Del.
July 22, 2013); Del. Code Ann. tit. 6, § 17-1101(c).
14
To resolve that ambiguity, the Court of Chancery turned to the
Uniform Commercial Code (“UCC”) definition of good faith found in title 6,
section 1-201(20) of the Delaware Code, which states: “‘Good faith’, except
as otherwise provided in Article 5 [which deals with letters of credit], means
honesty in fact and the observance of reasonable commercial standards of
fair dealing.” The Court of Chancery also examined the common law,
noting that good faith usually meant subjective good faith, but “there is
likely some conduct which is so unreasonable that [the Court of Chancery]
will necessarily determine that it could not have been undertaken in good
faith.”6 The Court of Chancery decided to use the UCC definition of “good
faith” because it was “at least” as broad as the common law definition.
The Court of Chancery then concluded that the Limited Partners
determined in good faith that the removal of DV Realty was “necessary for
the best interest of the Limited Partnership.” The court found that the
Limited Partners had removed DV Realty in subjective good faith:
Ultimately, the court determines that the Policemen’s Fund, the
Teachers’ Fund, the Laborers’ Fund, and the Municipal Fund
have shown that [DV Realty’s] continuous failure to have the
Limited Partnership’s audited [f]inancial statements completed
in the time prescribed by Section 11.5 provided them with a
good faith belief that [DV Realty] needed to be removed for the
best interest of the Limited Partnership.
6
See Guttman v. Huang, 823 A.2d 492, 506 n.34 (Del. Ch. 2003) (explaining that
conduct undertaken in subjective good faith may nonetheless be impermissible).
15
The Court of Chancery also found that it was objectively reasonable
for the Limited Partners to believe that it was necessary in the best interest
of the Limited Partnership for DV Realty to provide timely audited financial
statements. The court explained:
Annual audited financial statements provide significant value to
a business. Thus, when a limited partnership agreement places,
on a general partner, the duty of having the limited
partnership’s audited financials completed by a specific time,
and the general partner consistently fails to meet that duty, it is
objectively reasonable to believe that [it] is necessary in the
best interest of the limited partnership to replace that general
partner.
Thus, the Court of Chancery held the Limited Partners acted in good faith,
both subjectively and objectively, and therefore complied with the
requirements of section 3.10(a)(ii).
Standard of Review
DV Realty contends that, as a matter of law, its failure to provide
timely audited financial statements did not afford the Limited Partners a
good faith basis to believe that removing DV Realty was “necessary for the
best interest of the partnership.”
We review the Court of Chancery’s
conclusions of law de novo7 and its factual findings with a high level of
7
Stegemeier v. Magness, 728 A.2d 557, 561 (Del. 1999).
16
deference.8 We will not set aside a trial court’s factual findings “unless they
are clearly wrong and the doing of justice requires their overturn.”9
DV Realty contends “that the Court of Chancery misapplied [a] legal
standard when it ruled that the Limited Partners acted in good faith when
they determined that DV Realty’s late delivery of audited financial
statements made removal of DV Realty necessary for the best interest of the
Limited Partnership.” DV Realty argues that the relevant facts are not in
dispute, and that therefore, the Court of Chancery’s application of the term
“good faith” to the facts is a legal issue. Accordingly, DV Realty argues the
decision should be reviewed de novo,10 and points to Desert Equities, Inc. v.
Morgan Stanley Leveraged Equity Fund, II, L.P.11 in support of that
contention.
The Limited Partners respond that DV Realty has not identified any
question of law for review. The Limited Partners contend that the Court of
Chancery’s conclusion that the Limited Partners acted in good faith is
properly characterized as a factual finding, and cite Versata Enterprises, Inc.
8
Montgomery Cellular Hldg. Co. v. Dobler, 880 A.2d 206, 219 (Del. 2005).
Id. (citing Levitt v. Bouvier, 287 A.2d 671, 673 (Del. 1972)).
10
See Bank of N.Y. Mellon Trust Co., N.A., v. Liberty Media Corp., 29 A.3d 225, 236
(Del. 2011) (“Once the historical facts are established, the issue becomes whether the
trial court properly concluded that a rule of law is or is not violated. Appellate courts
review a trial court’s legal conclusions de novo.”).
11
Desert Equities, Inc. v. Morgan Stanley Leveraged Equity Fund, II, L.P., 624 A.2d
1199 (Del. 1993).
9
17
v. Selectica, Inc. for that proposition.12
The Limited Partners also cite
Corrado Brothers, Inc. v. Twin City Fire Insurance Co.13 in support of their
contention that determinations about whether parties acted in good faith are
factual in nature.
In our view, the cases cited by the Limited Partners and DV Realty all
consistently establish that the review of a conclusion of good faith involves a
mixed question of law and fact. The ultimate determination that a party
acted in good faith is a legal issue. The factual findings that provide the
basis for that determination will not be overturned unless they are clearly
erroneous. In Bank of N.Y. Mellon v. Liberty Media Corp., this Court
explained:
The legal issue in this case presents a mixed question of law
and fact. The applicable standards of appellate review are well
established. After a trial, findings of historical fact are subject
to the deferential “clearly erroneous” standard of review. That
deferential standard applies not only to historical facts that are
based upon credibility determinations but also to findings of
historical fact that are based on physical or documentary
evidence or inferences from other facts. Where there are two
permissible views of the evidence, the factfinder’s choice
between them cannot be clearly erroneous. Once the historical
facts are established, the issue becomes whether the trial court
properly concluded that a rule of law is or is not violated.
Appellate courts review a trial court’s legal conclusions de
novo.14
12
Versata Enterprises, Inc. v. Selectica, Inc., 5 A.3d 586, 589 (Del. 2010).
Corrado Bros., Inc. v. Twin City Fire Ins. Co., 562 A.2d 1188 (Del. 1989).
14
Bank of N.Y. Mellon Trust Co., N.A. v. Liberty Media Corp., 29 A.3d at 236.
13
18
Accordingly, the Court of Chancery’s factual findings will be
reviewed for “clear error” and its legal determination of good faith will be
reviewed by this Court de novo.
Contractual Good Faith
The LPA’s contractual duty encompasses a concept of “good faith”
that is different from the good faith concept addressed by the implied
covenant of good faith and fair dealing. In ASB Allegiance Real Estate Fund
v. Scion Breckenridge Managing Member, LLC, the Court of Chancery
articulated the important differences between the implied covenant and the
fiduciary duty concepts of good faith.15 In Gerber v. Enterprise Products
Holdings, LLC, this Court adopted that well-reasoned analysis as a correct
statement of our law.16
In Gerber, this Court examined a good faith claim within the context
of a contractual fiduciary duty. In analyzing that claim, we explained that,
like a common law fiduciary duty, a contractual duty to act in good faith
looks to “the parties as situated at the time of the wrong.”17 That temporal
criterion is important to our analysis in this case.
15
ASB Allegiance Real Estate Fund v. Scion Breckenridge Managing Member, LLC, 50
A.3d 434, 440-42 (Del. Ch. 2012), aff’d in part, rev’d in part on other grounds, 68 A.3d
665 (Del. 2013).
16
Gerber v. Enter. Prods. Hldgs., LLC, 67 A.3d 400, 418 (Del. 2013).
17
Id. (quoting ASB Allegiance Real Estate Fund v. Scion Breckenridge Managing
Member, LLC, 50 A.3d at 440).
19
Good Faith Undefined
The language of the LPA does not define good faith. For that reason,
the Court of Chancery decided to use the UCC definition of “good faith”
because it is “at least” as broad at the common law definition. This Court
has never held that the UCC definition of good faith applies to limited
partnership agreements.
The UCC applies to specific kinds of contracts, but not to limited
partnerships. If the parties wanted to use the UCC definition of good faith,
they could have so provided in the LPA or incorporated it as a defined term
by reference. Because neither alternative was chosen by the parties to the
LPA, the Court of Chancery inappropriately applied the UCC definition of
good faith to the LPA.
The “good faith” provision in LPA section 3.10(a)(ii) provides the
standard by which to measure the Limited Partners’ actions. The LPA’s
contractual duty requires the Limited Partners “in good faith [to] determine
that such removal is necessary for the best interest of the [Limited]
Partnership.” To determine whether the Limited Partners breached the
LPA’s contractual duty of good faith, we must first analyze what standard
the LPA imposes.
20
In Norton v. K-Sea Transportation Partners, L.P., we recently
considered a contractual good faith requirement and noted our “obligation to
construe the agreement’s ‘overall scheme.’”18 In Norton, we analyzed the
contractual duty of good faith in the context of the larger provision—or
value—it sought to protect.19 In the LPA before us, the use of the term
“good faith” is in the context of ensuring the Limited Partners do not
arbitrarily or capriciously remove the General Partner.
Good Faith/Bad Faith
Many centuries ago, Aristotle observed that we “often gain knowledge
of (a) a characteristic by the opposite characteristic, and (b) of characteristics
by those things in which they are exhibited.”20 It follows, Aristotle then
noted, that if one term in a pair of opposites is used in more than one sense,
the other term will also be used in more than one sense.21 Good faith and
bad faith are illustrative examples of opposite characteristics—as described
by Aristotle—in that each is used in more than one sense and thereby
18
Norton v. K-Sea Trans. P’rs, L.P., 67 A.3d 354, 360 (Del. 2013). Unlike the
contractual good faith duty in Norton v. K-Sea Transportation Partners L.P., this LPA
does not require a “reasonable belie[f].” Compare id. at 361 (emphasis omitted) (noting
that the limited partnership agreement permitted the general partner to make any decision
under the limited partnership agreement’s authority “so long as such action is reasonably
believed by [the general partner] to be in, or not inconsistent with, the best interests of the
[p]artnership”).
19
Id. at 362.
20
Nicomachean Ethics by Aristotle, Book V.
21
Id.
21
informs our understanding of each other. For example, in In re Walt Disney
Co. Derivative Litig.,22 this Court held that a failure to act in good faith may
be shown by “at least three different categories of fiduciary behavior [that]
are candidates for the ‘bad faith’ pejorative label.”23
In our recent opinion in Brinckerhoff v. Enbridge Energy Company,
Inc., we defined the characteristic of good faith by its opposite
characteristic—bad faith.24 We applied a traditional common law definition
of the business judgment rule to define a limited partnership agreement’s
good faith requirement. We used the formula describing conduct that falls
outside business judgment protection, namely, an action “so far beyond the
bounds of reasonable judgment that it seems essentially inexplicable on any
ground other than bad faith.”25 That definition of good faith, as set forth in
Brinckerhoff, is appropriately applied in this case as well.
22
In re Walt Disney Co. Derivative Litig., 906 A.2d 27 (Del. 2006).
Id. at 64.
24
Brinckerhoff v. Enbridge Energy Co., Inc., 67 A.3d 369, 373 (Del. 2013) (citing Parnes
v. Bally Entertainment Corp., 722 A.2d 1243, 1246 (Del. 1999)).
25
Id.
23
22
Record Supports Removal
Section 3.10(a)(ii) required the Limited Partners to determine in good
faith that the removal of DV Realty was “necessary in the best interest of the
Limited Partnership.”
Applying the definition in Brinckerhoff, that
determination will be considered to be in good faith unless the Limited
Partners went “so far beyond the bounds of reasonable judgment that it
seems essentially inexplicable on any ground other than bad faith.”26 The
record establishes that, as the Managing Partner, DV Realty had repeatedly
breached its obligation under section 11.5(a) of the LPA to deliver to the
Limited Partners audited financial statements on time—by April 30
following the close of each year. The audited financial statements for 2008
were delivered 173 days late (on October 20, 2009); the audited financial
statements for 2009 were delivered 303 days late (on March 9, 2011); and
the audited financial statements for 2010 were 337 days late as of the time
trial commenced (April 2, 2012).
Given these undisputed facts, the Court of Chancery correctly found
that the Limited Partners “have shown that the Managing Partner’s
continuous failure to have the Limited Partnership’s audited [f]inancial
statements completed in the time prescribed by section 11.5 provided them
26
Id.
23
with a good faith belief that the Managing Partner needed to be removed for
the best interest of the Limited Partnership.” As the Court of Chancery
explained, “when a limited partnership agreement places, on a general
partner, the duty of having the limited partnership’s audited financials
completed by a specific time, and the general partner consistently fails to
meet that duty, it is objectively reasonable to believe that [it] is necessary in
the best interest of the limited partnership to replace that general partner.”
The Court of Chancery also found DV Realty’s rebuttal—that the timely
issuance of audited financial statements would result in the auditor’s “going
concern” qualification—did not excuse DV Realty’s failure, as the
Managing Partner, to timely provide audited financial statements as the LPA
required.
The proper good faith standard called for by section 3.10(a)(ii) of the
LPA is purely subjective.
Therefore, the Court of Chancery ruled
incorrectly that “good faith” as used in the LPA, includes both subjective
good faith—“honesty in fact”—and an element of objectivity—“reasonable
commercial standards of fair dealing” as provided in the UCC. Nevertheless,
applying the subjective standard of good faith to the evidence in the record,
we hold that the Court of Chancery properly concluded that the Limited
Partners met the contractual standard for removal of the Managing Partner
24
“without Cause” set forth in section 3.10(a)(ii) of the LPA. That is, the
Limited Partners “in good faith determine[d] that such removal [was]
necessary for the best interest of the [Limited] Partnership.”
Red Flag Issues
The Court of Chancery held that “the principal basis for the Limited
Partners’ decision to remove [DV Realty] was [DV Realty’s] consistent
failure to have the Limited Partnership’s annual audited financial statements
completed on time.” The Court of Chancery also found that the Red Flag
Issues raised by the Final Townsend Report provided modest additional
support for the removal decision.
DV Realty claims that the Red Flag Issues are not sufficient to support
the removal decision, and that the Court of Chancery erred in giving them
any weight.
However, DV Realty also asserts “although the Court of
Chancery held that three of the ‘Red Flag Issues’ provided only slight
support for the Limited Partners’ removal decision, it is clear that without
the late audit issue, the Red Flag Issues are not enough to support the
removal decision. Thus, the principal issue on appeal is whether the Court
of Chancery’s ruling on the late audit issue was correct.” We agree with
those assertions. But, since we have concluded that DV Realty’s failure to
deliver timely audited financial statements independently provided the
25
Limited Partners with a sufficient good faith basis for removal of DV Realty
as the Managing Partner, it is unnecessary to address the Red Flag Issues.
Conclusion
The judgment of the Court of Chancery is affirmed.
26
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