Delaware Supreme Court Clarifies Elements of Disclosure Claims in Limited Partner Context
On June 23, 2020, the Delaware Supreme Court (the “Court”) in Dohmen v. Goodman, No. 403, 2019, reframed and answered in the negative two questions of law certified by the Court of Appeals for the Ninth Circuit: (a) whether, in a Delaware Limited Partnership context, a general partner’s request to a limited partner for a one-time capital contribution constituted a request for limited partner action triggering a fiduciary duty of disclosure, and (b) whether a claim for compensatory damages could be pursued for failure to disclose material information under the circumstances without proof of reliance/causation or actual (and not mere per se) damages. The decision provides important Delaware guidance regarding the scope of fiduciary duties a general partner assumes when it communicates with a limited partner, when such duties have not been disclaimed by agreement.
The action involved a hedge fund formed as a Delaware limited partnership (the “Fund”). Under the Fund’s limited partnership agreement, investors in the Fund became limited partners.
The Fund did not perform well. Accordingly, one of the limited partners sued, claiming misrepresentations by the Fund’s general partner in connection with a request to the limited partner for a capital contribution. Specifically, the limited partner alleged that the general partner misrepresented that the Fund would have other investors.
After a bench trial, the federal district court found for the limited partner with respect to his fiduciary duty claim, and held that because the general partner made a misrepresentation “when seeking [limited] partner action” the limited partner was not required to prove reliance or causation to recover damages in connection with his fiduciary duty claim. On appeal, the Ninth Circuit certified variants of the above described questions of law to the Court.
The limited partnership agreement at issue did not disclaim or modify fiduciary duties, as is permitted under Delaware law. Accordingly, and consistent with prior precedent, the Court noted that the general partner would be subjected to such fiduciary duties as are applicable in the Delaware corporate context, including the duty of loyalty.
In this case, the Court distinguished between the general partner’s request to the limited partner for a capital contribution to the Fund from a request for stockholder action that would trigger a duty of disclosure of all material facts relevant to the action. In particular, the Court held that the general partner’s request for a capital contribution from the limited partner was an individual transaction because the limited partner had direct access to the general partner, the limited partner had the Fund’s private placement memorandum, and the limited partner and general partner had direct email communications regarding the specifics of the limited partner’s contribution. The Court contrasted this type of transaction from one where a director seeks “collective” stockholder action, where it is difficult or impossible for each stockholder to ask and have answered by the corporation its own set of questions.
Having found that the requested limited partner capital contribution would not have imposed a duty to disclose all material facts within the general partner’s control without more, the Court nonetheless acknowledged that the general partner was still required to deal honestly with the limited partner, and that the general partner could breach its fiduciary duty of loyalty to the limited partner if it acted with scienter in disclosing false information.
Aside from requiring scienter on the part of the general partner, the Court also clarified that per se damages do not apply to this type of fraud-based disclosure claim where no duty of disclosure applies.
The Court’s decision clarifies further the fiduciary duties in the disclosure context owed by general partners to limited partners where those obligations are not modified or disclaimed by the operative limited partnership agreement. Specifically, the Court’s opinion underscores that disclosure obligations are defined by the context in which they are made, and that individual transactions between general and limited partners, as opposed to requests by the general partner for collective action, should not trigger an affirmative duty of disclosure on behalf of the general partner. Nevertheless, general partners must still deal honestly with limited partners, and can be liable for breach of fiduciary duty if they knowingly disseminate false information.