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Schuss v. Penfield Partners, L.P., Del. Ch. No. 3132, V.C. Parsons (June 13, 2008)

June 13, 2008

In this case, the Court of Chancery granted in part and denied in part the Defendant’s 12(b)(6) motion to dismiss for failure to state a claim. Plaintiffs, limited partners of Penfield Partners, L.P., a hedge fund (the “Partnership”), filed suit claiming breach of contract, breach of fiduciary duties of the Partnership’s general partner (the “General Partner”) and the General Partner’s general partner and seeking an accounting. Plaintiffs withdrew as limited partners of the Partnership as of December 31, 2006, and the Plaintiffs aggregate ending capital as of their withdrawal date (or retirement date, as such term is used in the partnership agreement of the Partnership (the “LP Agreement”)) was valued at $71,103,538. The Plaintiffs asked that their final capital distribution be made in kind and ratably. Pursuant to the LP Agreement, the Partnership had thirty days from the date of retirement to make a distribution to a withdrawing limited partner. On January 17, 2007, the General Partner made a final distribution of $58,631,876, reasoning that the securities chosen for distribution on the limited partners’ retirement date had decreased in value by the time of final distribution, and that the risk of decreased value fell on the withdrawing limited partners.

Plaintiffs’ first claim for breach of contract stated that the Partnership breached its contractual duty under the LP Agreement to make in kind distributions on a pro rata basis to the withdrawing partners. The Court, analyzing Section 17-605 of the Delaware Revised Uniform Limited Partnership Act and the LP Agreement, found that the Plaintiffs would not be successful on this particular breach of contract claim since the unambiguous language of the LP Agreement did not require such distributions to be ratable and granted the General Partner broad discretion in determining the manner in which such distributions were to be made. Plaintiffs’ second breach of contract claim centered on whether the withdrawing partners were “entitled to receive distribution of specific securities selected by the General Partner at or around the time of retirement...or of assets whose aggregated value equaled the withdrawing partners’ share of the [Partnership] as of the date of their retirement.” The Plaintiffs claimed that they were entitled to receive as a distribution the value of their capital accounts calculated on the withdrawal date, and that the Partnership bore the risk of the fluctuating market between the withdrawal date and the date of distribution. Because the LP Agreement “distinguishes between the date of withdrawal and the date of payment,” the Court found that the “Plaintiffs have at least a colorable argument that the plain language of the [LP Agreement] supports their interpretation of the [LP Agreement],” and applying the 12(b)(6) standard of review, denied the Defendants’ motion to dismiss with respect to this claim.

Plaintiffs also claimed that the Defendants violated their fiduciary duties to the limited partners by: “(a) distributing securities in kind in excess of their pro rata share; (b) shifting losses to Plaintiffs by distributing depreciated securities and valuing them based on inflated year-end prices; and (c) unreasonably delaying the final distribution to Plaintiffs in order to leverage them to accept less than their full [share of the Partnership].” The Court dismissed the first fiduciary duty count for failure to state a claim since, under the same reasoning used for the breach of contract claim, the Partnership was not required to make in kind distributions ratably. Defendants argued that they could not have breached their fiduciary duties because (i) the distributions were made in compliance with the LP Agreement, which in their interpretation vested the General Partner with broad discretion in selecting and valuing securities, and (ii) they were exculpated from liability under the terms of the LP Agreement, except for those claims which allege gross negligence, willful misconduct or violation of applicable laws. In ruling against the Defendants’ motion to dismiss, the Court looked to the reasonableness of the Defendants’ interpretation of the LP Agreement. The Court found that “[W]hile the [LP Agreement] expressly provides the General Partner with discretion to select which, if any, securities to include in a distribution, the [LP Agreement] does not explicitly support the remainder of the Defendants’ position” that the LP Agreement vested in the General Partner such broad discretion, and noted that the Defendants’ interpretation of the LP Agreement appeared[ed] strained.” Reasoning that the Plaintiffs could conceivably recover based on their interpretation of the LP Agreement, the Court denied the Defendants’ motion to dismiss with respect to rest of the fiduciary duty claims. The Court also found that the LP Agreement’s exculpation clause did not prevent the Plaintiffs from stating a cause of action because the Plaintiffs “conceivably could prove Defendants adopted their interpretation in bad faith or as a result of gross negligence or willful misconduct” falling within the exceptions to the exculpation clause contained in the LP Agreement.

Plaintiffs final claim sought an equitable accounting. The Court examined the following factors in determining whether an accounting was an appropriate remedy: (1) whether the partner was wrongfully excluded from the partnership; (2) whether there is a breach of fiduciary duty; and (3) other circumstances that would render an accounting just and reasonable. The Court found that, while the limited partners voluntarily withdrew from the Partnership, the allegations of the breach of fiduciary duties, coupled with the fact that determining how a monetary award could be equitably satisfied from the Partnership’s current assets could be complicated, would support a claim for an equitable accounting and therefore denied Defendants’ motion to dismiss.

The full opinion is available here