Are Officers of a Corporate General Partner Liable for Breach of Fiduciary Duties in a Texas Limited Partnership?
A very common business organization structure in Texas is the limited partnership, which permits many of the advantages of partnership--particularly the tax advantages--but limits the liability of investors in the same manner as a corporation. Texas limited partnerships are a favored vehicle for investments in real estate. A limited partnership is comprised of one or more general partners and one or more limited partners. The limited partnership general partners operate the business and are subject to liability in the same way as general partners in a general partnership. Each limited partnership general partner has the right to control and has unlimited liability for the debts and obligations of the partnership. The limited partners, however, have no right to control or manage the business and have no liability for the debts and obligations of the partnership. Limited partners risk only their investment capital, in the same way as shareholders of a corporation. General partners owe fiduciary duties to each other, to the partnership as an entity, and (although there is some confusion in the case law) to the limited partners. Generally speaking, limited partners owe no fiduciary duties to the partnership or to each other.
The conceptual difficulty comes when persons or entities involved in the limited partnership wear "different hats" and act in different roles. Typically, limited partnerships are set up with a corporate general partner that has few or no assets. A very common structure would be as follows: The promoter of the limited partnership investment vehicle organizes a limited partnership with the equity owned 99% by limited partners and 1% by a corporate general partner with no assets. Typically, the promoter would be the sole shareholder of the corporate general partner and its sole director and officer. The 99% interest would be sold to passive investors, and quite often the promoter would own a large amount of the limited partnership equity as a limited partner and thus individually exercise control over the limited partnership through his control over the corporate general partner. As to third parties, the promoter is completely shielded from liability. Only the general partner corporation bears unlimited liability for partnership obligations, but the corporation is judgment proof. As the sole director, officer, and shareholder of the corporate entity, the promoter is shielded individually from liability by the corporate veil. As a limited partner, the promoter has the same protection from individual liability as other limited partners.
While this structure makes sense with regard to third parties, who presumably can protect themselves by refusing to deal with the limited partnership without adequate security or personal guaranties, it becomes far more problematic when the rights of the other limited partners are in question. Because of his control over the limited partnership, the promoter has the ability to benefit himself at the expense of the other limited partners by misappropriation of assets or other self-dealing transactions that would constitute a breach of the duty of loyalty if the promoter individually were the general partner. While the corporate general partner owes fiduciary duties to the limited partners, the corporate general partner is judgment-proof. The promoter's duties as an officer and director of the corporation run only to the corporation. Therefore, unless the promoter is individually charged with the duties owed by the corporate general partner, the other limited partners would effectively have no remedy against the promoter who abuses his power to enrich himself.
A recent decision out of the Dallas Court of Appeals exemplifies this absurd result. In Rainier Income Fund I, Ltd. v. Gans, the plaintiffs were two investment funds that became limited partners in two Texas limited partnerships known as R-75, L.P. and R-75 II, L.P. The other limited partner was FNS Holding, L.P., an entity owned and controlled by the promoter, Fred Gans. The limited partnership General Partner was Star Creek Construction GP, Inc., another entity owned and controlled by Gans. The purpose of the two limited partnerships was to develop and lease two office buildings in Allen, Texas. Gans, individually, guaranteed certain partnership obligations to the limited partners, but the guaranty was triggered only by specific liquidation events. Things did not go well, and the assets of the limited partnership were foreclosed on by creditors and sold, resulting in a total loss to the plaintiffs.
The plaintiffs sued Gans on the guaranty and for breach of fiduciary duties. The trial court entered a judgment for the plaintiffs on the guaranty, but not on the fiduciary duties claim. The Dallas Court of Appeals reversed and rendered a take-nothing judgment against the plaintiffs. The Court of Appeals held that, while the guaranty would have been triggered if the limited partnership had sold the assets, a foreclosure sale by a creditor was not a sale "by the partnership," and that the guaranty did not apply according to its terms. The plaintiff's other theory was that Gans should have caused the limited partnership General Partner to declare a liquidation once all the assets were lost, which would have triggered the guaranty, and the failure to do so can only be explained by the desire of Gans to avoid personal liability to the remaining limited partners. This would seem to be a very solid breach of the fiduciary duty of loyaly claim. The difficulty is whether Gans, individually, owed such fiduciary duties to the limited partners. The claim would undoubtedly have been successful had it been asserted against the corporation, which was the limited partnership general partner; however, the claim was asserted only against Gans individually--presumably, because the corporate entity was judgment-proof. The Dallas Court of Appeals (without citation of any authority) held that Gans, individually, owed no fiduciary duties.
With respect to a formal relationship, Gans is not a partner in the partnership; he is an officer of the general partner. Although appellants cite several cases involving partners who owe duties, appellants do not cite any case for the proposition that an officer of the general partner of a partnership owes a fiduciary duty to the partnership. Instead, they argue Gans “cannot be distinguished from the entities he controls.” Appellants did not, however, allege that the corporate identity of Star Creek, the general partner, should be disregarded. Appellants have not shown a formal fiduciary relationship.
Rainier Income Fund I, Ltd. v. Gans, 501 S.W.3d 617, 624 (Tex. App.—Dallas 2016, pet. denied).
Individual Officers of Limited Partnership General Partner Can Be Held Responsible for Breach of Fiduciary Duties.
This is an absurd and unfair result. Unfortunately, the holding is inconsistent with other Texas cases, that apparently were not cited by the plaintiffs and not found by the Court of Appeals. Other Texas cases, including one tried by Fryar Law Firm that was recently affirmed, have refused to analyze limited partnership fiduciary duties in such a wooden fashion. Other courts have imposed fiduciary duties on individuals, including on limited partners, when the defendant wore several different hats and exercised control over the limited partnership. It is the exercise of control that creates the duty, and the concept is applied based on the principles of equity.
See the following authorities: McBeth v. Carpenter, 565 F.3d 171 (5th Cir. 2009); Strebel v. Wimberly, 371 S.W.3d 267 (Tex. App.—Houston [1st Dist.] 2012, pet. denied); Allen v. Devon Energy Holdings, L.L.C., 367 S.W.3d 355 (Tex. App.—Houston [1st Dist.] 2012).
Additionally, the fiduciary duties owed by a corporate entity that is the limited partnership general partner could have been extended to Gans individually under an "aiding and abetting" cause of action, or the "knowing participation" in a breach of fiduciary duty theory established by the Texas Supreme Court in the Kinzbach Tool case. Apparently, this theory was not pursued by the plaintiffs.