Delaware Law Updates
{ Banner Image }
PDF

Venhill Limited Partnership v. Hillman, C.A. No. 1866-VCS (Del. Ch. June 3, 2008)

June 3, 2008

The sole general partner of a partnership was found to have breached his duty of loyalty for causing the partnership to invest in and otherwise transfer money to an insolvent corporation of which the general partner was CEO, chairman and president. The court also found that the general partner was grossly negligent, and therefore liable under the partnership’s limited partnership agreement. The general partner was required to repay the principal amount plus a rate of interest approximate to what the partnership would have earned had it used the funds for alternative investments, as well as certain attorneys’ fees and expenses.

For more than a decade, the general partner made substantial investments in an insolvent corporation, Auto-Trol Technology Corporation (“Auto-Trol”), over the repeated objections of the limited partners. Auto-Trol had been insolvent since the early 1990’s, and the limited partners strenuously objected to the investment from as early as 1996; however, the general partner had sole discretion over the partnership’s investment decisions.  Substantial investments by the partnership continued until 2005 on terms set entirely by the general partner and that were far more favorable than Auto-Trol could have ever received in an arms-length transaction. To make the corporation appear solvent, the general partner recharacterized the corporation’s debt as equity and rolled various short-term notes into a single note maturing in 2020 that only would require interest payments on occasion and that earned interest at the Applicable Federal Rate. By the general partner’s own admission, Auto-Trol was a borrower that could not obtain debt or equity financing on any terms in the market. The partnership made 186 loans to Auto-Trol and invested tens of millions of dollars in Auto-Trol, and received very little in return. On the eve of his removal as general partner of the partnership, the general partner transferred another $2.3 million to Auto-Trol and transferred the majority equity interest of Auto-Trol from the partnership to an entity that the general partner personally controlled in exchange for no consideration (such transaction having been unwound by the general partner post-trial).

Because certain claims were time-barred, the plaintiffs agreed on the first day of trial to limit this cause of action to the three years prior to the filing of their complaint. Applying the entire fairness test (since the general partner was on both sides of the transactions as the general partner of the partnership and as an officer and director of Auto-Trol) for purposes of determining whether the transactions should be unwound, the court found that Auto-Trol had no “rational prospect of success”, and that no rational investor or lender would have lent money to Auto-Trol on any terms. The general partner did not exercise rational business judgment about how to invest the partnership’s funds. The investments were made on “grossly unfair” terms to the partnership. The general partner argued that the limited partners effectively ratified the general partner’s investment decisions by not removing the general partner prior to 2005. The court declined to adopt this theory: equity holders do not have a duty to remove a fiduciary if they disagree with
the fiduciary’s investment strategy, and failure to remove such fiduciary should not result in a lower standard of scrutiny. The court found that such a rule would effectively grant fiduciaries a “powerful and crudely overbroad immunity from liability”. The court also refused to mitigate damages based on the fact that the limited partners failed to remove the general partner before 2005. Each decision by the general partner to transfer funds to Auto-Trol was a breach, and mitigation only applies to damages occurring after a breach. The doctrines of acquiescence and ratification did not support the general partner’s defense. The doctrine of acquiescence is based on action or conduct which leads another party to believe that the act has been approved. The agency-derived doctrine of ratification requires action or conduct that justifies a “reasonable assumption that the person so consents”. Here, the limited partners actively opposed the transfers of money to Auto-Trol.

The court has broad discretion in determining the remedy for breach of fiduciary duties, guided in part by the policy in favor of generous awards to remedy breaches of the duty of loyalty. An award of attorneys’ fees, however, is limited to “unusually deplorable behavior” so as to not otherwise vitiate the American Rule.  Here, the court only found one part of the case justifying fee shifting: on the eve of his removal as general partner of the partnership, the general partner took control of Auto-Trol from the partnership and caused the partnership to pay Auto-Trol another $2.3 million. The general partner did not unwind this transaction until post-trial, and the parties and the court spent needless time addressing these issues.  Accordingly, the plaintiffs’ fees and expenses relating to that issue were ordered to be paid by the general partner. The remainder of the plaintiffs' request for attorneys' fees was denied.

The full opinion is available here