Law IRAC

Lach v. Man O’War,LLC

 

In 1986, Shirley Lach and her then husband, Lynwood Wiseman, formed Man O’War Limited Partnership for the purpose of leasing real property and developing and operating shopping centers. Robert Miller became a general partner along with Wiseman. Lach was one of eight limited partners. The partners’ ownership percentages were Miller, 1 percent, Wiseman, 32 percent, Lach, 27 percent, Jonathan Miller, 9 percent, Harry B. Miller, 12 percent, Harvey Morgan, 1 percent, Penny Miller, 3 percent, Jeffery Mullens, 1 percent, Jennifer Miller, 9 percent, and Sophie Wiseman, 5 percent. Wiseman, Lach, and Robert Miller also formed M.O.W. Place, Ltd., to lease a shopping center from the joint venture. In 1988, Wiseman and Lach were divorced, but continued in business together.

In the spring of 2002, Robert Miller became ill with cancer. With his approaching death, he met with Lach concerning the shopping center. Miller asked Lach to agree to naming Wiseman, Jeffery Mullens (brother-in-law of Robert Miller), and Jonathan Miller (son of Robert Miller), as the new general partners of the Partnership. Under the original Partnership agreement, new general partners could not be added without the consent of all the partners. Robert Miller also asked Lach to agree that when Wiseman died, the two remaining general partners will select a new general partner. Lach objected because it would allow the Miller family, which owned less than Lach’s individual interest, to manage and control the shopping center. The Millers’ would have two of the three general partners while Wiseman, who was then of advancing age, was alive. Upon his death, Jonathan Miller and Jeffery Mullens would then select the third general partner. Lach pro- posed substituting her daughter, Sherri McVay, an attorney, as a general partner in place of Jeffery Mullens. Her proposal was rejected.

Miller and Wiseman then sought to restructure the business form of the partnership to eliminate the need for Lach’s consent to the proposed management change. They formed a new business entity, Man O’War Limited Liability Company. When opera- tional, the LLC would be manager-managed and controlled only by a majority vote of the owners. The initial managers were to be Wiseman, Jonathan Miller, and Jeffery Mullens.

After forming the LLC, Robert Miller and Wiseman dissolved the Partnership, distributing its assets (the ownership of the LLC) to the partners in identical proportions to their previous ownership of the Partnership, that is—with one catch. Unless a partner signed the documents validating the restructuring, that partner would have no voting rights in the LLC. All the partners except Lach signed the agreement, leaving only Lach without any voting rights.

Lach then sued the LLC and Wiseman, among others. She asked the court to set aside the transfer of Partnership assets to the LLC on the grounds that the transfer and the Partnership’s subsequent termination was a violation of KRS 362.490 and a breach by the general partners of their fiduciary duty to the Partnership and Lach. The trial court found for the LLC and Wiseman, granting them summary judgment. The Kentucky appellate court affirmed the trial court’s decision. Lach appealed to the Supreme Court of Kentucky.

Scott, Justice

Lach argues that the restructuring of the Partnership business form was invalid without her consent for two reasons: (1) the restructuring was a conversion in violation of KRS 275.370, and (2) the restructuring made it impossible for the Partnership to carry on its business in violation of KRS 362.490.

KRS 275.370 provides, in pertinent part:

(1) A partnership or limited partnership may be converted to a limited liability company pursuant to this section.
(2) The terms and conditions of a conversion of a partnership or limited partnership to a limited liability company shall, in the case of a partnership, be approved by all the partners or by a number or percentage specified for conversion in the part- nership agreement or, in the case of a limited partnership, by all the partners, notwithstanding any provision to the contrary in the limited partnership agreement.

While conceding that the statute, in this instance, requires the approval of all the limited partners before a limited partner- ship can be converted into a limited liability company, the LLC and Wiseman argue that the transformation constituted a “reorganization,” not a “conversion” as envisioned under KRS 275.370(1). They illustrate their distinction of the word “con- version,” by pointing out that the statute envisions a limited partnership redesignating itself as a limited liability company, whereas, in this instance, the limited liability company was cre- ated separately and existed concurrently with the Partnership (albeit without any assets). Thus, the fact that the LLC acquired all the assets of the Partnership and the Partnership then dis- solved is simply immaterial.

KRS 275.375(1) acknowledges that “[a] partnership or limited partnership that has been converted pursuant to this chapter shall be for all purposes the same entity that existed

before the conversion.” KRS 275.375(2) recognizes that the property “ shall remain vested in the converted [business en- tity] . . . [and] [a]ll obligations of the converting . . . limited partnership shall continue as obligations of the converted [business entity].” (Emphasis added.) All of which seem to confirm the LLC and Wiseman’s argument that a “conver- sion” involves only one entity changing its legal form pursu- ant to statutory authorizations, rather than through interaction between two entities.

Looking at subsequent statutes for what light they cast on the question, we note that the Kentucky Legislature adopted the new Kentucky Uniform Limited Partnership Act in 2006. KRS 362.2-102, et. seq. This Act was adopted, with some changes, from the Uniform Limited Partnership Act (2001). The Act specifically provides “[i]n applying and construing this uniform act, consideration shall be given to the need to promote uniformity of the law with respect to its subject matter among states that enact it.” KRS 362.2-1201.

When the need for uniformity is acknowledged, courts may consider the “Official Comments” to a Uniform Act, even where they have not been officially adopted. Looking at the Official Comments to §1102 of the Uniform Limited Partner- ship Act, which, with changes, corresponds to KRS 362.2-1102, the Comment acknowledges, “[i]n contrast to a merger, which involves at least two entities, a conversion involves only one. The converting and converted organizations are the same en- tity.” Unif. Limited Partnership Act §1102–1105, GA U.L.A. 107 (2006).

Having thus considered the statutory scheme, its particular language, the subsequent statute and Official Comments, we an- swer the question that was presented to us—that the restructur- ing of the business form of the Partnership, to that of the LLC, in this instance, was not a conversion under, or subject to, KRS 275.370, for reasons that a conversion deals only with one en- tity. We have not been asked, nor have we considered, whether the restructuring of the Partnership into the LLC constituted a merger, pursuant to KRS 362.531.

Under Kentucky law, partners owe the utmost good faith to each and every other partner. The scope of the fiduciary duty has been variously defined as one requiring utter good faith or hon- esty, loyalty or obedience, as well as candor, due care, and fair dealing. Indeed, it has often been said, there is no relation of trust or confidence known to law that requires of the parties a higher degree of good faith than that of a partnership. Thus, the doing of an act proscribed by law is a breach of that duty.

KRS 362.490 provides, in pertinent part:

A general partner shall have all the rights and powers and be subject to all the restrictions and liabilities of a partner in a partnership without limited partners, except that without the written consent or ratification of the specific act by all the

limited partners, a general partner or all the general partners have no authority to

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(2) do any act which would make it impossible to carry on the ordinary business of the partnership.

The LCC and Wiseman argue that Miller and Wiseman had the authority to perform all the acts constituting the restructuring without Lach’s consent because they did not make it impossible to carry on the business of the partnership. They assert, it was the only act which made it possible to carry on the business of the partnership; suggesting that Lach would, by virtue of her right of rejection, have destroyed the partnership’s business, something she hadn’t done for the previous sixteen years. Moreover, the fact that a limited partner with significant ownership interests in a limited partnership would object to a transaction which would deprive her of her say in who might be able to successfully man- age her business interest as a general partner, in return for a mi- nority voting, or for that fact, a non-voting interest, in a limited liability company controlled by a majority vote, is not evidence that such limited partner has an interest in destroying the busi- ness, including the value of her interest therein.

They further argue that under the certificate of partnership and partnership agreement, the general partners had the absolute right to “(1) terminate the partnership, (2) execute documents agreements, contracts, leases, etc., on behalf of the partnership, and (3) to manage the partnership business in all aspects, which should include, but should not be limited to . . . take such other action, execute and deliver such other documents, and perform such other acts as the general partners may deem necessary, appropriate, or incidental to carrying out the business and af- fairs of the partnership.” In this regard, they seek to distinguish Mist Properties, Inc. v. Fitzsimmons Realty Co., 228 N.Y.S.2d 406 (Sup. Ct. 1962), in which the court approved the general partner’s transfer of title to property owned by the limited part- nership as against the claim of the receiver, because the limited partnership agreement allowed the general partners to do so.

Mist Properties, Inc., however, had a partnership agreement that gave the general partners the specific power to sell all of the partnership’s property, subject to written approval of sixty-five percent of the limited partners. “There clearly appears to have been no violation of the statute since the conveyance was not without the written consent of the limited partners but was spe- cifically contemplated and provided for by the agreement.” Id. at 410. As the court recognized therein, the agreement the part- ners had made with themselves through their partnership agree- ment controlled. “There is no intervening public policy which prevents persons dealing at arm’s length from entering into an agreement such as set forth above. It has been repeatedly held that where a limited partnership agreement has been entered into 

the partners cannot, inter se, set up that their rights are not gov- erned thereby. . . .” Id. at 410.

Simply put, we find that the general partners’ rights under the partnership agreement to (1) terminate the partnership at any time upon agreement of the general partners, and (2) to act upon behalf of the Partnership in matters that are “necessary, appropriate, or incidental to carry out its business,” can be not construed to allow them the power to transform the partnership into a limited liability company, in order to favor a majority of

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the partners in their selection, or substitution, of the general part- ners/managers of the business, without the approval of all the limited partners.

We therefore conclude that the transfer of the partnership assets to the LLC was in violation of KRS 362.490 and thus a breach of the ge

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