The Delaware Supreme Court recently decided a case important to investors and developers of Low-Income Housing Tax Credit housing. The case (DV Realty Advisors LLC v. Policemen’s Annuity and Benefit Fund of Chicago, DEFAX Case No. D65838 {Del. 2013}), is important because it dealt with the circumstances under which a limited partner may remove a general partner from an operating partnership. The High Court affirmed a Delaware Chancery Court ruling that the limited partners in the case made a good faith determination when removing a general partner for the best interests of the limited partnership. The relevance of the case is enhanced by the recognition of Delaware business courts as being especially sophisticated in corporate and partnership issues.
The case originated when the public fund limited partners removed the general partner of DV Urban Realty Partners I, LP, a Delaware limited partnership (which invested in commercial and residential property in Chicago). The GP challenged the removal in the Chancery Court. The Court ruled that the fund could remove the GP, but the GP appealed, arguing that the Chancery Court improperly found that the investors had operated in “good faith” with the GP removal. The GP was removed for a pattern of excessively late delivery of required financial statements.
The Limited Partnership Agreement (LPA) stated that the limited partners holding in excess of 75% of the limited partnership interests could remove the GP, as long as such removal was done in “good faith” and was in the best interests of the limited partnership. The LPA did not define “good faith,” and thus both subjective and objective elements could be considered. The Chancery Court applied the Uniform Commercial Code (UCC) definition of good faith in determining that failure for three years to deliver required financial statements was adequate reason for removal and demonstrated “good faith.”
On appeal, the Delaware Supreme Court found that the Chancery Court did err in using the UCC definition of “good faith,” since the definition was not applicable to a limited partnership. Instead of “good faith” representing an objective reason for a decision, as outlined in the UCC definition, “good faith” in the context of a limited partnership is ensuring that the limited partners do not act in an arbitrary or capricious manner in removing a GP.
The High Court essentially defined “good faith” by defining its opposite – “bad faith.” In this case, the court applied common law as it relates to the business judgment rule. This rule is a principle intended to protect officers and directors from shareholders and third parties when the officers and directors use their experience and best judgment to make decisions, as long as such decisions are made in “good faith.” The type of action that would not be protected would be something “so far beyond the bounds of reasonable judgment that it seems essentially inexplicable on any ground other than bad faith.”
In this particular case, the GP had been more than six months late in the delivery of audited financial statements to the LPs for three consecutive years. The Court ruled that even using subjective criteria, removal of the GP in this case was not indicative of bad faith, and therefore was done in “good faith.”
This case is important for investors because it makes clear that substantiated reason for removal of a general partner is defensible, and unless specific reasons for removal are outlined in the LPA, limited partners has some latitude in this area. On the other hand, general partners are well advised to ensure that LPAs are as specific as possible in delineating acceptable reasons for removal.