In the corporate setting, it has long been the case that a shareholder can assert a claim on behalf of the corporation when management of the entity refuses to do so – a so called derivative action. Under Pennsylvania’s limited partner statute, a partner (general or limited) can now do the same. A derivative action is one brought by a partner to assert a claim on behalf of the partnership where the general partner refuses to do so.
To bring a derivative action, unless the requirement to do so is excused, the limited partner must first make a demand that the general partner take steps to assert the partnership’s right. The demand must be in “record form” and “give notice with reasonable specificity of the essential facts relied upon to support each of the claims made in the demand.” As will be seen, it is important to carefully craft the demand, since the scope of the derivative claims that can be asserted is limited to those claims identified in the demand and because making the demand also temporarily tolls the statute of limitations on such claims.
After receipt of the demand, the general partner may choose to appoint a special litigation committee (SLC) to investigate the claims asserted in the demand and determine whether pursuing any of them is in the best interests of the partnership. The statute gives the general partner wide discretion to appoint members of the committee, so long as they are not interested in the claims and can exercise objective judgment. Indeed, other limited or general partners may be committee members.
The SLC is then charged with conducting an investigation. The scope of that investigation is limited by the claims set forth in the demand letter and is subject to the good faith requirements of the statute. Within these limitations, the investigation conducted is left to the committee.
Upon conclusion of the investigation, the SLC can make one of several recommendations authorized by the statute. These range from recommending that the claims not be brought (and if brought, discontinued) to recommending that the limited partnership itself assert them. The SLC has ultimate power over the claims as Court is bound to enforce its decision with judicial review limited to whether the members of the committee met the qualifications required under the statute  and whether the committee “conducted its investigation and made its recommendation in good faith, independently and with reasonable care.”
I recently used the SLC procedure in a case involving a limited partner who owed a large sum of money to the limited partnership. The general partner authorized a claim against the limited partner to collect the balance due.  The limited partner defended the case by asserting that the general partner was improperly appointed and therefore did not have authority to commence the collection action. The limited partner issued a demand for removal of the general partner under the act. I suggested that a special litigation committee be appointed. In this instance, I suggested that one committee member be a retired judge from the county in which the action was pending to defuse any argument that the SLC was not qualified or that it did not act in good faith and independently. As I represented the limited partnership, separate counsel was engaged to represent the general partner before the SLC.
In proceedings before the SLC, the limited partner’s counsel sought to expand the claims to include mismanagement and breaches of fiduciary duty alleged to have been committed by the general partner. Illustrating the importance of properly crafting the demand, the SLC refused to consider any of these expanded claims, holding that its review was limited to the issue raised in the demand – whether the general partner was validly appointed. .
Ultimately the SLC found that the general partner was validly appointed and directed that no claim be brought on this issue. As this claim had already been asserted, the limited partnership was preparing a motion to be filed with the Court to enforce the SLC’s determination when settlement negotiations, which had stalled over a year before, resumed, leading to a prompt settlement. The entire SLC process, from demand letter to decision, took four and one half months – a much quicker resolution, and at less cost, than fully litigating the issue.
The SLC procedure allows an independent review of the merits of derivative claims. If appropriate, such claims can be asserted on the partnership’s behalf or by the partnership itself. However, where such claims are found to be without merit, they can be summarily dismissed. The SLC is a powerful tool to address the merits of derivative claims on an expedited and reduced cost basis.

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People often ask, “What kind of lawyer are you?”  After my stock (and feeble) comedic response of “a good one”, I often say I am a “commercial litigator”.  I explain that our practice includes litigation of disputes which arise between businesses and business owners.  Commercial litigation includes a wide range of potential issues ranging from business torts to breach of contract, both internal to a business entity, and between two or more separate entities.  While there are a wide range of potential issues which must be considered, there are certain basic tenets which I always discuss with our clients before recommending litigation or taking on their representation.   

First, do you have an agreement which might apply to the situation and, if so, what does that agreement say about your position?  Agreements can come is various shapes and sizes, such as corporate by-laws, a formal shareholder agreement, a proposal combined with an acceptance or performance, or even a simple exchange of emails.  Documentary evidence is key, as a litigator is challenged to explain why the written word should not be impactful.       

Second, what is your goal? The kiss of death as to our representation is a client who says “it’s not about the money, it’s the principle”. When I was a young lawyer I had a mentor who gave sage advice when he communicated the firm’s policy that litigation was only appropriate when money was involved.  He would politely say, “we don’t litigate over principle”.  In many ways and in most situations that adage applies.  However, in the corporate setting, sometimes the connection to money is not readily evident or direct such as with regard to disputes over corporate control or enforcing a covenant not to compete.  In many situations, I caution stakeholders to take the long view and weigh the probable outcomes from a purely practical standpoint, taking care never to  lose sight of their long range business goals.   

Third, what is your capacity for litigation and business distraction?  Litigation not only costs money in terms of attorney fees, accountant fees, experts and costs, but participation also requires commitment of a leader’s most valuable commodity; time.  Business people are first and foremost concerned with business (daily operations, management and the bottom line).  Litigation invariably requires substantial client involvement in developing strategy, reviewing pleadings, searching for documents, reviewing documents produced by other parties and preparation for testimony.  I advise potential parties to litigation to think long and hard about the cost/benefit to the business of such an undertaking.

Fourth, what can you hope to recover or save; and what will it cost to do so?  While a corollary to litigation about money, it is not the same question.  The evaluation of potential cost is complex and issue dependent.   In a recent case, settlement discussions in a commercial litigation setting were driven by the anticipated six figure cost to translate thousands of pages of information from Chinese characters to English.  Costs of experts on any issue involving an opinion on issues ranging from the standard of care applicable to a corporate officer, to whether a machine functioned in the way represented, can rapidly accumulate.  Unless there is a provision in an agreement which provides for the recovery of attorney fees or such recovery is otherwise permitted under law, those fees and costs are not recoverable.

The above is not to discourage litigation of bona fide disputes; of which we handle many.  It is simply imperative that the lawyer and the client be on the same page as to expectations, risks and litigation management.  These questions can assist in forming the framework of a solid attorney client relationship in a commercial litigation setting, which goes a long way toward developing realistic expectations, reducing the stress inherent in the process,  and optimizing the chances of a successful outcome.

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The words “I’m calling my lawyer” as famously spoken on the big screen are intended to inspire fear and trepidation.  They often do; particularly where one side in litigation has a disproportionally strong legal position on a critical issue.  The threat of litigation is certainly a motivating factor in pre-suit settlement discussion.  Even before lawyers get involved in a dispute, the parties have often drawn their respective battle lines and prepared for the standoff.     

Sometimes litigation is absolutely necessary.  Where one party to a dispute unreasonably believes a legal position is infallible or is deluded by the grandeur of potential recovery, a third party, arbitrator, judge or jury may be necessary to convince that party otherwise.  An inability to assess risk often results in a failure to completely evaluate ramifications. In such cases, litigation is inevitable and the best available alternative.      

Under any circumstances, the parties must consider the impact of litigation.  In business, that impact is not only the expenditure associated with legal fees, but also the distraction litigation brings to the business.  Instead of pursuing the next lead, deal or development, the business can be dedicated to the completion of discovery, attendance at deposition or preparation for trial. 

A couple of practical considerations:

First, involvement in litigation invites intrusion into a business’s management, internal affairs and financial information.  Selecting appropriate individuals within your company who will be involved on a day to day basis and who have knowledge of the facts of the dispute can be a massive undertaking in and of itself, as the demands of producing needed information, data and research will inevitably interfere with that person or persons performing their normal duties and responsibilities for the business.   More importantly, in some cases, litigation results in exposure or threatened exposure of otherwise secret information.  Customer relationships can be impacted, particularly if those customers are forced to respond to subpoenas.  It is critical under such circumstances that business owners and managers make sure a plan is in place to manage internal and external communication.  

Other sensitive information may also be revealed.  In a classic case of “I did not realize that was important”, clients often omit material facts which may not bear directly on their claim but which may be implicitly revealed.  Tax issues are a prime example of such material facts.  Any time money changes hands, the manner in which such proceeds are recorded will be addressed in litigation and to the extent either party has sought an unsupportable tax advantage, that act or omission will be revealed.    

Undoubtedly, the party sued will seek retaliation and file counterclaims.  For example, a contractor performs work for a homeowner which the homeowner fails to pay for.  Contractor sues, only to have the homeowner raise counterclaims based on the Unfair Trade Practices and Consumer Protection law which provides for triple damages and attorney fees which can potentially dwarf the original claim. Now the contractor spends more defending the claim for treble damages than in pursuit of the recovery.    

Finally, there is the issue of cost.  Litigation is expensive.  At the end of the day, the parties must consider the cost of a particular course of action and whether the potential for recovery is simply outweighed by that cost. 

So before embarking down the road of litigation, be certain it is a path you wish to follow.  Be sure to consider the impacts, both intended and incidental, to ongoing business operations.  Be sure your house is in order and that the skeletons in the closets are not subject to reanimation.  Finally, be confident in the analysis that money spent in litigation is a good investment. 

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Reprinted with permission from the December 30, 2016 issue of The Legal Intelligencer. (c) 2016 ALM Media Properties. Further duplication without permission is prohibited.

Historically, the courts of the Commonwealth of Pennsylvania have been loathe to blur the distinction between tort and contract.  The gist of the action doctrine, well formed and frequently litigated, precludes  recasting contract claims as tort claims or claims of negligent performance of contractual duties.  The courts have specifically held that parties to business agreements such as partnership, shareholder or LLC operating agreements may contract away or severely limit fiduciary duties owed by partners, directors and managers.  Notwithstanding these long standing and often contested principles of law, the Pennsylvania Supreme Court is set to address an emergent trend toward the expansion of duties imposed by contract through the implication of the duty of good faith and fair dealing in the context of business relationships.  Specifically, the Court has granted allocator on the issue of whether “the implied covenant of good faith and fair dealing” applies to “all limited partnership agreements under Pennsylvania law.”  Assuming the Court answers the question in the affirmative, as have the Courts in neighboring Delaware in a similar cases involving business governance agreements, the bright line between tort and contract will dim.

The case of Hanaway v. Parkersburg Group, L.P. 132 A.3d. 461 (Pa. Super. 2015) arises out of a limited partnership agreement for the development and sale of real estate.  The complaint alleges various breaches of fiduciary duty, conversion and contract based on the general partner’s sale of real estate at below market value to a separate entity also controlled by the general partner and involving many of the same limited partners as had invested in the original limited partnership – to the exclusion of the plaintiffs.  All tort claims based on breach of fiduciary duty were found to be time barred.   Further, the trial court granted summary judgment on the contract claims.  On appeal to the Superior Court, plaintiffs argued that the trial court erred in granting summary judgment on breach of contract claims by finding that the provisions of the limited partnership agreement granting the general partner exclusive right to manage the business affairs of the partnership negated the duty of good faith and fair dealing.  Plaintiffs argued the covenant is implied in every contract and imposes on each party a duty of good faith and fair dealing in its performance and enforcement, notwithstanding the grant of exclusive management rights.  

The Superior Court held that the implied covenant of good faith and fair dealing imposed the duty to exercise a contractual obligation, even a contractual obligation expressly conferring the exercise of discretion, must be exercised in good faith.  “Good faith” was interpreted to mean “faithfulness to an agreed common purpose and consistency with the justified expectations of the other party; it excludes a variety of types of conduct characterized as involving bad faith because they violate community standards of decency, fairness or reasonableness”.  The Court went on to describe the implied duty as requiring “honesty in fact in the conduct of the transaction concerned”.   Thus, the Court concluded that the general partner’s sale of partnership assets at below market rate for its own benefit and the benefit of its like minded limited partners to the detriment of others may constitute a breach of the implied duty and an issue for trial which should not have been dismissed on summary judgment.   

The Pennsylvania Supreme Court’s impending decision will undoubtedly be guided by precedent from the Delaware Supreme Court and the statutory preservation of the duty of good faith and fair dealing even in the face of the right to contract including the right to limit other duties- even fiduciary duties.   Delaware has adopted both a Revised Uniform Limited Partnership Act and a Limited Liability Company Act which permit parties to business agreements within the scope of those Acts to limit fiduciary duties owed to each other and the business. The Limited Liability Company Act goes so far as to confirm the premise that managers in an LLC owe fiduciary duties to each other under law by default, but allows for modification of such duties in the  operating agreement. The Revised Uniform Partnership Act, while allowing for a contractual waiver of fiduciary duties, specifically rejects waiver of the covenant of good faith and fair dealing.  Accordingly, while the parties are free to modify the fiduciary relationship with regard to management of business entities traditionally governed by contract, the implied covenant of good faith and fair dealing remains.  That premise was confirmed by the Delaware Supreme Court in Gerber v. Enterprise Products Holdings, LLC 67 A.3d 400 (Del. 2013).    In Gerber, the Supreme Court explained that the implied covenant “seeks to enforce the parties’ contractual bargain by implying only those terms the parties would have agreed to during their original negotiations had they thought to address them”. Gerber, at 418.  

The blending of tort and contract in the Pennsylvania Superior Court’s analysis in Hanaway is clearly evident by the Court’s summary conclusion that the breach of contract claims should have been preserved for the jury.  Although directly addressing the breach of contract claim, the Court applied tort principles by finding that the evidence, if credited, could support a finding that the Defendant orchestrated the sale of partnership assets at a price below market value for its own benefit.  The Court then concluded  such sale could have constituted a breach of the contractual duty to exercise management of the limited partnership in “good faith”.  Hanaway, 132 A.3d at 476.

A Supreme Court opinion which imposes the duty of good faith and fair dealing to all agreements governing business relationships will have far reaching implications.  Clearly, if breach of contract can be successfully alleged in a business setting under circumstances described in Hanaway, the statute of limitations analysis is substantially modified.  Owners of a minority business interest may no longer be limited to a two year statute.  Business practitioners and drafters of organizational documents who once believed a disclaimer of fiduciary duty was sufficient must now reconsider the inclusion of a “good faith” definition.  For litigators, the permissible theories of damage claims in business disputes concerning internal governance documents are expanded.

Although the Hanaway Superior Court decision is at odds with many traditional notions of separation between tort and contract, any Supreme Court determination that excludes the principal of good faith and fair dealing from business agreements would be at odds with the overarching and recognized principle that the duty is “implied in every contract”.  Further, any such ruling would be at odds with recent precedent from the Supreme Court of Delaware. 

Tom Donnelly is a Partner of the firm. His practice focuses primarily on commercial litigation and transactions, employment disputes and personal injury.  To learn more about the firm or Tom Donnelly, visit www.ammlaw.com.
   
 

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