Legally Speaking
Parting Ways with Your General Partner
By David M. Abromowitz
6 min read
Succession is not just a challenge of the C-suite. With most affordable housing developments owned by limited partnerships (the older ones) or limited liability companies (the newer ones), the competence of the general partner (or manager) is of critical importance. In the vast majority of situations, the GP performs well, or at least well enough for the limited partners to have no reason to seek ouster. But what happens if the GP fails to live up to the partnership agreement?
If the GP has proven to not be competent or has breached its duty to act in the best interests of the partnership, it may be time to remove them and put in a GP who can do the job. While that sounds simple, in practice, the path to successfully remove a GP can be rocky. As with most partnership issues, the starting point for figuring out a removal strategy is a close reading of the partnership or operating agreement. As a broad generalization, the oldest partnership agreements, such as those from early Department of Housing and Urban Development deals in the late 1970s and early 1980s, tended to be general partner-friendly, with limited, if any, explicit grounds for the removal of a GP. Early-era tax credit deals, with a single limited partner investor or fund, beefed up removal provisions.
Current practice is for the agreement to detail a number of Events of Default that give rise to a right to remove. The list will almost always include breach of fiduciary duties, gross negligence, fraud, misappropriation or intentional misconduct but can grow quite long – including violations of law that materially adversely affect the property, uncured defaults under loan documents, material breaches of the partnership or operating agreement in general (including taking actions without getting any necessary limited partner consents or violating transfer restrictions), and in tax credit deals any actions or omissions that could trigger recapture. The key for the limited partner(s) is to be detailed and precise in citing the breach, as the first step in the removal process is to give notice of the reasons for removal to the GP.
Depending on how closely drafted these provisions are, there may be a window of time during which the notice must be delivered in order for it to be effective. Any failure to follow the notice provisions to the letter, or to give clear reasons for removal, amounts to an invitation to the general partner to block the process in court.
Most well-drafted agreements will give the GP a short period of time to cure an Event of Default if it is curable. If the default has not been cured within the applicable time period (or cannot be cured), the removal is typically deemed effective without any further action by the limited partner(s). Rarely, however, does the GP sit quietly by and let the time slip away. Instead, most GPs threatened with removal will sprint to court and seek a restraining order blocking the effort. Such efforts to block removal are often won or lost on procedural grounds (Was proper notice given? Did the notice spell out the basis for removal and give the GP a chance to cure, if the agreement provided for a cure?), or by challenging the underlying facts of the alleged breach of the partnership agreement.
In one of the most significant cases involving removal in recent years, the Delaware Chancery Court (where many of the disputes end up due to many partnerships being formed under the Delaware Revised Uniform Limited Partnership Act) rejected the limited partner’s claim that the GP breached its fiduciary duty. This complicated and technical case, part of the long-running saga over Year-15 Right of First Refusal exercises by nonprofits acquiring Low Income Housing Tax Credit properties over objections by certain profit-maximizing investors, turned on the Court interpreting fiduciary duties as narrowly tied to the purpose of the partnership. In this case, and greatly simplifying, the Court found the purpose of the fund partnership was to invest in projects for tax credits, and not to “pursu[e] other sources of value from the Property.”
Nevertheless, even some vaguely worded language may provide a limited basis for removal. For example, in a case involving a (non-LIHTC) partnership agreement, investors holding at least 75 percent of the limited partner interests could remove the GP without cause provided they acted “in good faith” and removal was for “the best interest” of the partnership based on the terms of the partnership agreement.
Successfully removing the GP is only halfway to the goal. When a limited partnership ceases to have at least one GP, it typically triggers a “dissolution” that requires winding up the affairs of the partnership. Worse yet, the entity ceases to be a “limited” partnership and, under state law, may be a general partnership going forward, exposing the remaining partners (as GPs) to direct liability for claims against and debts of the partnership. Accordingly, it is critical to have a plan to replace the GP being removed before initiating a removal, or the former limited partners could find themselves facing both personal liability and a forced disposition of the property. Hardly the desired outcome.
Continuing the limited partnership can be accomplished if the agreement has a provision allowing the limited partners the right to vote to continue the affairs of the partnership and appoint one or more substitute GPs, or if the governing statute, like Delaware’s, allows 50 percent of the remaining partners to do so. In most cases, this election must happen within 90 days of the effective date of removal.
The risk of forced dissolution and winding up can also be triggered by the death of a human GP, or by the “corporate death” of an entity GP. These eventualities typically fall under the term “event of withdrawal,” which can be defined by statute, the partnership agreement or both. For example, the filing for bankruptcy by a GP is typically an automatic “event of withdrawal.” As with removal initiated by the limited partner(s), it is critical that the remaining partners have a plan in place to continue the partnership and admit a substitute GP to avoid dissolution.
