Fiduciary Obligation of Partners | Annapolis, MD

Historically, the fiduciary obligation of partners was a defining characteristic of a partnership:

If nothing else could have been said with confidence about partnerships on the eve of promulgation of the UPA in 1914, it was that the relationship was fiduciary in character. Thus, regardless of the contractual structure to which the partners agreed, the foundation of the relationship was a matter of status, not contract. Simply by virtue of being partners, the participants owed each other certain general obligations of conduct: “The duty of each partner to exercise toward the others the highest integrity and good faith is the very basis of their mutual rights in all partnership matters.” Because the obligations were seen as arising by virtue of the status of the partners as partners, and not by their agreement, the remedy for breach of the basic obligations was in tort, not in contract.^{^[1]}

Because the fiduciary duty existed independent of the partnership agreement, it could override such an agreement. In an Illinois case,^{^[2]} for example, the limited partners claimed that the general partner “squeezed” them out by refusing to make sufficient distributions to cover the taxes generated from the investment, then buying them out at discount. The partnership involved a private placement promoted only to “wealthy and sophisticated investors.” The agreement gave the general partner “sole discretion” as to partnership distributions.[3] Nevertheless, the court held that the limited partners had a cause of action based on an intrinsic general fiduciary duty owed by the general partner that is separate from the terms of the agreement.[4]

[1] Vestal, “Fundamental Contractarian Error,” supra note 13, at 524-6.

[2] Labovitz v. Dolan, 189 Ill. App. 3d 403, 545 N.E. 2d 304 (Ill. App. Ct. 1989).

[3] Labovitz v. Dolan, 189 Ill. App. 3d 403, 406, 545 N.E. 2d 304, 306 (Ill. App. Ct. 1989). A provision, of course, can purporting to give the general partner absolute discretion as to partnership distributions can create gift tax issues. In Hackl v. Comm., 118 T.C. 279, aff’d. 335 F.3d 664 (7th Cir. 2003), the Tax Court held that a transfer of limited partnership units did not qualify as annual exclusion gifts because the gifts did not confer upon the donee-children immediate use, possession, or enjoyment of the transferred property. In part, the Tax Court based the decision on a distribution clause much like that in Labovitz. For the failure of a general fiduciary duty coming to the rescue, see Price v. Comm., T.C. Memo 2010-2, 7 (1/4/10) (“[P]etitioners contend that the general partner has a ‘strict fiduciary duty’ to make income distributions to the donees. We are not persuaded that such a fiduciary duty, if it exists, establishes a present interest…where the limited partner lacks withdrawal rights.”).

[4] See also, Wartski v. Bedford, 926 F.2d 11, 20 (C.A. 1st Mass. 1991) (“The fiduciary duty of partners is an integral part of the partnership agreement whether or not expressly set forth therein.”); BT-I v. Equitable Life Assur. Soc., 75 Cal. App. 4th 1406, 1412, 89 Cal. Rptr. 811, 816 (Cal. App. 4th 1999) (“We agree with several recent decisions holding that a limited partnership agreement cannot relieve the general partner of its fiduciary duties in matters fundamentally related to the partnership business.”).

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5.1.1 The Fiduciary Obligation of Partners

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