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Chancery Rejects Bid to Jettison USACafes and its Holding That, Absent Agreement to the Contrary, the Controllers of a Corporate General Partner Owe Fiduciary Duties

Fannin v. UMTH Land Development, L.P. (In re: United Development Funding III, L.P.), C.A. No. 12541-VCF (Del. Ch. Jul. 31, 2020).

The Court of Chancery has concluded that in certain situations, equity will, by default, impose fiduciary duties upon a corporate relationship. This decision rejects on stare decisis grounds an attempt to overturn longstanding precedent in this area.

Plaintiffs are limited partners of Nominal Defendant United Development Funding III, LP (UDF III), which is one of several related investment funds in the business of loaning capital for real estate development projects. Rather than carry out that purpose, Plaintiffs allege that in the wake of the 2007 collapse of the real estate markets, UDF III’s general partner and controllers breached their fiduciary duties and used UDF III’s resources to support earlier-formed related funds in a “Ponzi-like scheme” to conceal losses and maintain distributions. Defendants moved to dismiss on several grounds and asserted, inter alia, that Plaintiffs’ suit was untimely and failed to state a claim.

Much of the decision involved a fact-specific parsing of which claims were subject to equitable tolling (and thus, not barred by laches or statutes of limitations) and which claims were barred by the language of UDF III’s limited partnership agreement. Based on the pleadings-stage allegations, the Court found various of Plaintiffs’ claims to be timely and not barred.

More interesting, however, was Defendants’ attempt to convince the Court to depart from In re USACafes, L.P. Litigation, 600 A.2d 43 (Del. Ch.), appeal refused, 602 A.2d 1082 (Del. 1991), in which “then-Chancellor Allen held that directors and controllers of a corporate general partner owed fiduciary duties to the limited partnership and the limited partners.” Despite three decades of application, Defendants argued that USACafes “was wrongly decided” and “presents an irreconcilable conflict” with current alternative entity law. Thus, Defendants requested that the Court conclude that the director and controller Defendants owed Plaintiffs no fiduciary duties.

But the Court was not persuaded that USACafes was clearly erroneous or that there was an urgent reason to abandon its holding. Focusing on the case’s progeny and academic treatment, the Court saw no indication that USACafes was clearly wrong. To the contrary, while subsequent decisions debated the nature of the duties owed under USACafes, the Court has consistently followed USACafes for almost thirty years. At this point, jurists, practitioners and academics have accepted that directors and controllers of the general partner, at minimum, owe a duty not to use the partnership’s property to advantage themselves at the expense of the partnership.

Nor did the Court see any urgent reason to depart from USACafes. Since 2004, Section 17-1101(d) of the Delaware Revised Uniform Partnership Act has expressly permitted a limited partnership agreement to limit or eliminate duties owed by one partner to the others or to the partnership, and § 17-1101(f) has permitted the agreement to limit or eliminate liabilities for breach of such duties. Moreover, the Court of Chancery has enforced such limitations in numerous cases. And perhaps most notably, the drafters of UDF III’s partnership agreement could have eliminated such duties and liabilities, but chose not to do so.

Based upon all of this, the Court concluded that USACafes was entitled to deference under principles of stare decisis, and “[i]f USACafes is to be jettisoned, that is a determination for the Delaware Supreme Court.”

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