Labovitz v. Dolan
189 Ill. App. 3d 403, 136 Ill. Dec. 780, 545 N.E.2d 304 (1989)
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Rule of Law:
A general partner's contractually granted 'sole discretion' over partnership matters is limited by the overriding fiduciary duties of good faith, loyalty, and fairness. A general partner cannot exercise such discretion in a self-serving manner calculated to coerce limited partners into selling their interests at an unfair price.
Facts:
- Plaintiffs invested over $12 million as limited partners in a cable-vision partnership, Cablevision Programming Investments (CPI), with defendant Charles F. Dolan serving as the general partner.
- The partnership agreement granted Dolan 'sole discretion' to determine the availability of cash flow for distribution to partners.
- In 1985 and 1986, the partnership generated substantial earnings, creating significant personal income tax liability for each limited partner.
- Dolan elected to make only nominal cash distributions, forcing the limited partners to pay taxes on the partnership's large reported income from their own personal funds.
- During this time, the partnership loaned millions of dollars to other entities controlled by Dolan.
- In November 1986, Cablevision Systems Corporation (CSC), an affiliate owned and controlled by Dolan, offered to purchase all limited partnership interests for approximately two-thirds of their book value.
- The offer highlighted that by selling, partners could convert their large taxable income for 1986 into a sizable tax loss.
- Over 90% of the limited partners accepted the offer and sold their interests to Dolan's affiliate.
Procedural Posture:
- Plaintiffs, a group of former limited partners, filed a lawsuit against the general partner, Dolan, in the Illinois circuit court (a trial court of first instance) for breach of fiduciary duty.
- Defendants filed a motion to dismiss the complaint pursuant to section 2-619(a)(9) of the Illinois Code of Civil Procedure.
- The circuit court granted the defendants' motion and dismissed the complaint with prejudice.
- Plaintiffs (as appellants) appealed the dismissal to the Illinois Appellate Court.
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Issue:
Does a general partner's 'sole discretion' over partnership distributions, as granted in the partnership agreement, shield them from liability for breach of fiduciary duty when that discretion is allegedly used to create adverse tax consequences for limited partners to coerce them into selling their interests to the general partner's affiliate at a bargain price?
Opinions:
Majority - Justice Scariano
No. A general partner's contractually granted 'sole discretion' does not shield them from liability for breach of fiduciary duty. A fiduciary duty exists concurrently with the obligations in a partnership agreement and cannot be waived or contracted away. Despite the broad discretion granted in the Articles, Dolan still owed his limited partners a fiduciary duty encompassing good faith, honesty, and fairness. The court, citing Meinhard v. Salmon, emphasized that this is a high standard, particularly for a managing partner. The plaintiffs' allegations that Dolan deliberately withheld cash distributions to create tax pressure and force a 'squeeze-out' constitute a valid claim for breach of this duty. The language of 'sole discretion' is not an 'unrestricted license to engage in self-dealing.' Therefore, the burden shifts to the fiduciary, Dolan, to prove by clear and convincing evidence that his actions were equitable and just. The trial court erred in dismissing the complaint without allowing for a factual inquiry into the fairness of Dolan's actions and motivations.
Analysis:
This decision strongly affirms the principle that fiduciary duties are paramount in partnership law and cannot be easily contracted around. It establishes that even when a partnership agreement grants a general partner 'sole discretion,' courts will still scrutinize the exercise of that discretion for fairness and good faith. The case is significant for limiting a general partner's ability to engage in 'squeeze-out' maneuvers, where they manipulate partnership finances to create adverse conditions for limited partners to force a buyout on favorable terms. This ruling ensures that claims of bad faith and self-dealing will survive a motion to dismiss, requiring the fiduciary to prove the fairness of their actions at trial.
