Business partnerships are built on the trust and loyalty of their participants. Without mutual coordination and honesty among all involved, tensions will inevitably arise that could derail a partnership’s success. The resulting fallout could be costly in several ways, as lost profits, ruined business opportunities, protracted litigation, and busted personal relationships would surely follow.
Given the dark clouds that quickly form overhead as tensions increase among partners in a partnership, one would assume it would make good business sense, if not common sense, for those partners to look out for each other.
It certainly would make legal sense to do so because partners in a partnership, and, generally speaking, co-owners of all businesses, will typically be deemed to owe a fiduciary duty to each other. At its core, a fiduciary duty is the legal duty of a fiduciary (i.e., one business owner) to act at all times in the best interests of the beneficiary (i.e., the other owner(s) of a business). This requires partners in a partnership to act loyally toward each other, with care, with good faith and fair dealing, and to disclose material information to each other.
In most instances, the interests of partners in a partnership will be aligned with each other and with those of their business. Presumably, the co-owners will be unified in their desires to maximize their business’s profits and value and their own salaries and distributions, and minimize their and their business’s tax burdens.
But what happens when a partner lies to their partners about sales transactions, withholds material information about key business opportunities, and engages in self-serving transactions that did not consider the wishes of other partners? Sounds like a recipe for a breach of fiduciary duty lawsuit, right?
Now consider if it is still a breach of fiduciary duty if the partner in question’s actions not only complied with the agreement governing the partnership but also benefited the other partners?
Would the partner’s actions still constitute a breach of fiduciary duty?
The Pennsylvania Superior Court recently tackled this question, issuing a decision that has implications for business partnerships where the partners are given autonomy to act unilaterally on behalf of their partnerships.
A series of unilateral moves by a partner passes legal muster—at first
In Slomowitz v. Kessler, 2021 Pa. Super. 230 (2021), the namesake plaintiff, Marvin Slomowitz, served as a general partner with two of his colleagues, Stuart Kessler and John Rosenthal, in three limited partnerships that ran and maintained Section 8 apartment buildings for elderly and low-income tenants. All three partnerships were established in the 1970s. Rosenthal actively managed all three partnerships from their establishment until his death in 2008.
After Rosenthal’s death, as the remaining partners grappled with their responsibilities, disputes arose between Slomowitz and Kessler regarding their respective roles. Slomowitz believed the governing partnership agreements allowed him to act unilaterally on behalf of the partnerships without securing any other partner’s approval. Kessler, on the other hand, believed he and Slomowitz were general partners on equal footing. Therefore, Kessler believed any decisions made on the partnerships’ behalf required the consent of both him and Slomowitz to move forward and bind the partnerships.
Naturally, this tension led to substantial friction between Slomowitz and Kessler. In the ensuing years, Slomowitz engaged in actions that he felt were necessary to maintain or increase the profitability of the partnerships. Many of those actions, however, were taken against Kessler’s wishes. Some actions Slomowitz took included:
- Excluding and failing to communicate with Kessler about critical partnership matters and transactions he knew Kessler would have quashed;
- Securing necessary approvals from limited partners to sell off all partnership real estate assets without Kessler’s knowledge or consent;
- Misleading Rosenthal’s estate into believing that the sale of a specific partnership property was the only option available to consider, without raising or discussing Kessler’s preferred option of refinancing the property; and
- Knowingly misleading a limited partner into moving forward with the sale of a partnership property by misrepresenting to that partner that Rosenthal’s estate supported a sale when it was merely open to considering the idea absent other options.
The trial court, the Court of Common Pleas of Luzerne County, acknowledged that Slomowitz’s conduct “may have been repugnant,” as well as “offensive and un-businesslike.” However, the court noted that all three of the partnership agreements that governed Slomowitz’s activities granted each general partner the individual and complete authority to execute documents and other instruments on a partnership’s behalf. It further found that no partner needed to secure mutual consent in the process.
Therefore, the trial court concluded, based on its interpretation of the partnership agreements and Pennsylvania’s statute governing partnerships, that Slomowitz acted within his authority as a general partner and that nothing appeared wrong with the disputed transactions. Thus, he did not breach his fiduciary duty to Kessler.
The Pa. Superior Court sees things differently
As was to be expected, Kessler appealed the trial court’s ruling. On appeal, the Pa. Superior Court disagreed with several aspects of the trial court’s ruling.
Although the Superior Court acknowledged that all three governing partnership agreements gave each general partner unfettered authority to act unilaterally on behalf of each partnership, the court noted the specific language in the agreements requiring the general partners to exercise their responsibilities in a “fiduciary capacity” at all times to maximize relevant tax advantages. Since none of the partnership agreements defined what the term “fiduciary capacity” meant, the court determined that the fiduciary duties owed by Slomowitz under the partnership agreements were actually a combination of duties provided for by (i) Pennsylvania statutes, (ii) the partnership agreements, and (iii) common law by application of agency principles, i.e., the duty of loyalty, care, good faith and fair dealing, and the duty to disclose.
The court found that under the statutes that govern Pennsylvania partnerships, “a partner must account to the partnership for any benefit and hold as trustee for it any profits derived by him without the consent of the other partners.” Even more critically, the court noted that at least one of these statutes simultaneously subjects partners’ fiduciary duties to Pennsylvania agency law.
As for the applicable partnership agreements, the court noted that, as set forth in the agreements, Slomowitz owed a fiduciary duty to Kessler because he was required to perform actions under the agreement in a “fiduciary capacity.”
And finally, under agency law principles, the court noted each partner is considered an agent of the partnership. Thus, each partner owes duties of loyalty and care to their fellow partners. Additionally, each partner also owes a duty to act in good faith and fair dealing and disclose material information.
Underlying the court’s discussion of partners’ fiduciary duties under Pennsylvania law was Meinhard v. Salmon, a 1928 New York State Court of Appeals decision written by then-Chief Judge Benjamin N. Cardozo (four years before he joined the U.S. Supreme Court) that the Supreme Court of Pennsylvania followed and adopted in a 1970 decision. In Meinhard, Judge Cardozo wrote that
A [co-owner of a business] is held to something stricter than the morals of the marketplace. Not honesty alone, but the punctilio of an honor the most sensitive, is then the standard of behavior. As to this there has developed a tradition that is unbending and inveterate. Uncompromising rigidity has been the attitude of courts of equity when petitioned to undermine the rule of undivided loyalty by the ‘disintegrating erosion’ of particular exceptions. * * * Only thus has the level of conduct for fiduciaries been kept at a level higher than that trodden by the crowd. It will not consciously be lowered by any judgment of this court.
The Superior Court observed that this duty was not grounded in contract or in statute, but in a more elementary basis: trust.
Guided by the applicable statutes, language in the partnership agreements, and Meinhard’s tenets, the court found Slomowitz’s acts did not rise to the fiduciary standard he needed to satisfy, as he should have been more forthright, honest, and transparent with Kessler and his other partners. Notably, Slomowitz’s actions may have caused Kessler to incur more tax liability than if Slomowitz pursued an alternative option that Kessler preferred—thus contradicting one of the goals of the partnership agreements to maximize tax advantages. The court, therefore, remanded the case back to the trial court to make findings regarding damages stemming from Slomowitz’s breach of fiduciary duty.
What Slomowitz means for partners in Pa. partnerships moving forward
The Superior Court’s decision here does not break new ground as much as it reminds partners in business partnerships that the fiduciary duties they owe to each other will not allow favorable business results to excuse the “repugnant,” “offensive[,] and un-businesslike” actions that led to those results. That Slomowitz might have unilaterally engaged in actions that benefited the partnerships did not, in the court’s eyes, mean that he could avoid complying with his fiduciary duty to Kessler.
Going one step further, the court appears to honor the “Spider-Man Rule”: With great power comes great responsibility. The trial court focused on Slomowitz’s full, exclusive, and complete right under the applicable partnership agreements to directly control the business of a partnership in holding that he didn’t breach his fiduciary duty to Kessler. After all, the trial court presumably believed if Slomowitz had the right to do whatever he wanted, he could do whatever he wanted without concern about how it would affect Kessler.
The Superior Court, however, made clear that because Slomowitz had to act in a fiduciary capacity under the partnerships’ agreements, he still had a responsibility to rein in his unilateral powers and employ them in a way that did not breach his fiduciary duty to Kessler.