In JV Partnerships, Mind the Punctilios!
- May 04, 2016
By Brian Hochleutner
How do you know whether you or a joint venture partner has breached a fiduciary duty? Is your joint venture agreement clear enough for that question to be answered?
Fiduciary duties often arise in joint ventures, regardless of whether the parties intend them to exist. They are created by statute or common law based on the existence of a relationship in which one party is deemed to have placed special trust in another or to have relied upon that other party’s judgement. In other words, a manager, general partner or controlling member in a joint venture can have fiduciary duties, even if the parties make no mention of such duties in their agreements.
The scope of such duties can be uncertain. A fiduciary is considered to have heightened duties of care and loyalty, but what does that mean in the real world? For example, the duty of loyalty requires avoidance of conflicts of interest. Is that duty breached if a limited-liability company owns real property and its manager (or the manager’s affiliate) also manages other potentially competing properties? This is just an example of the kind of uncertainty that can make fiduciary duties susceptible to disputes.
The classic fiduciary duty case is Meinhard v. Salmon, 164 N.E. 545 (N.Y. 1928), which involved a joint venture that owned a 20-year lease. When the lease and venture ended, one partner made a new deal with the property’s landlord. The other partner sued, alleging breach of fiduciary duty. The New York Court of Appeals ruled that a breach of duty had indeed occurred. Chief Judge Benjamin Cardozo famously wrote in the court’s majority opinion that a fiduciary must abide by “the punctilio of an honor most sensitive,” which he called “something stricter than the morals of the market place.”
Punctilios and morals are not great guideposts for behavior in modern commercial transactions, and while more recent case law and statutes give additional benchmarks, considerable uncertainty remains. It is therefore particularly important that parties to commercial real estate joint ventures take care to address and define the scope of their fiduciary duties. Generally speaking, parties can choose: (1) traditional/default fiduciary obligations, express or implied; (2) waiver of fiduciary obligations to the extent permitted by law; or (3) modification/clarification of fiduciary duties (e.g., limiting such duties to particular circumstances, such as in the handling of money or other critical assets).
Mind the details
In defining fiduciary obligations, the relative leverage of the parties, the scope of anticipated reliance and potential for conflicts will be critical factors. The following should also be considered:
- Form of entity. The type of joint venture vehicle matters. Formation of general partnerships, trusts and corporations trigger fiduciary obligations that generally cannot be waived. The same is not true for limited liability companies and limited partnerships, where waiver or limitation of fiduciary duties is often permitted. Choice of entity is driven by many factors, including tax considerations, but fiduciary rules should certainly be part of the analysis.
- Default rules; partial waiver and modification. State laws vary regarding default rules and the extent to which they can be waived or modified. The leading approach, based on the Uniform Limited Liability Company Act and Uniform Limited Partnership Act and used in Delaware, New York and other states, can be summed up as follows: (1) As a default rule (unless an LLC or LP agreement says otherwise), fiduciary duties are imposed on general partners, managers and/or controlling members; and (2) parties can change the default and contractually expand, restrict or eliminate fiduciary duties, provided that any waivers are appropriately documented and that the implied covenant of good faith and fair dealing cannot be eliminated.
Details of laws governing fiduciary duties vary by state and must be carefully considered. California, for example, imposes duties of loyalty, care, and good faith and fair dealing, and allows modifications only (a) if not “unreasonable” as to the duty of care, and (b) if not “manifestly unreasonable” in other cases. (Beware: there is little case law on the “manifestly unreasonable” standard.)
- Replacement provisions. In connection with any contractual waiver or modification of fiduciary obligations, appropriate modified duties should be considered, including through contractual provisions addressed to standards of care, transactions by affiliates and other potential conflicts of interest.
Parties to a real estate joint venture are in a special relationship, and in that context it is important to consider fiduciary duties. Rather than lurking in the background, such duties should be squarely addressed through thoughtful consideration of risks and goals, attention to applicable law and careful drafting. These critical steps can help manage the potential risks and rewards associated with fiduciary duties.
Brian Hochleutner is a real estate associate in DLA Piper’s Boston office. His practice focuses on real estate development, joint ventures, finance, leasing, acquisition and sales.