Minnesota Court Cases: Unenforceable Fiduciary Duty Limitations & Waivers

How Do Courts Interpret Fiduciary Duty Limitations and Waivers?

Courts take divergent approaches when interpreting partnership agreements that limit or waive fiduciary duties. Some enforce waivers between sophisticated parties; others refuse to give effect to provisions that would destroy the fiduciary character of the partnership. The outcome often depends on three threshold considerations.

First, before a court considers whether a partnership agreement limiting the right to disclosure or partnership opportunities should be given effect, the court will consider whether an opportunity actually belonged to the partnership. This is a threshold question because it determines what is within the scope of the partnership’s business. If information or opportunities do not relate to the partnership, a partner has no duty to present them to his partners. Minnesota statute frames the threshold the same way: a partner’s duty of loyalty is “limited to” accounting for benefits derived from the partnership business or property, “including the appropriation of a partnership opportunity.” Minn. Stat. § 323A.0404(b)(1). Because that duty attaches only to a partnership opportunity, an opportunity unrelated to the partnership’s business carries no duty to present it.

Second, partners often disagree regarding the scope of their business, so it is no surprise that parties have difficulty predicting how a court will define the scope of the partnership. This is an especially important point for attorneys drafting partnership agreements and assisting partnerships as the scope of the business is defined over time.

Third, courts appear more comfortable limiting fiduciary duties based on the scope of a partnership’s business than limiting fiduciary duties based on a partnership agreement that seeks to opt out of fiduciary duties. While this is an important lesson for partners seeking prospectively to have their fiduciary duty limitations enforced, it is difficult in practice. That is, in practice, a partner or attorney will have difficulty defining the scope of a partnership prospectively because the scope of a partnership evolves as the business progresses.

The following cases demonstrate courts’ diverse treatment of partners’ attempts to limit their duty to disclose and allow usurpation of partnership opportunities. The first Minnesota case represents the notion that the scope of a partnership may be so limited that the acquisition of an asset used by the partnership is not a usurpation of a partnership opportunity, nor does it violate a duty to disclose. The second Minnesota case firmly stands for the proposition that partners may not agree to limit their duty to disclose to merely the duty to disclose upon demand. Similarly, the First Circuit case stands for the notion that a partnership agreement allowing partners to compete will be given no effect if a partner fails to disclose an opportunity that relates to the heart of the partnership’s business.

These cases are contrasted by three other cases. The Fifth Circuit case stands for the notion that sophisticated partners may contractually limit their duty to disclose, subject to the non-waivable duty of good faith and fair dealing. Similarly, the two subsequent cases stand for the principle that parties may waive their fiduciary duties in their partnership agreement to such an extent that courts will treat the partners as though they are not partners.

What Do Minnesota Courts Say About Fiduciary Duty Waivers?

Lipinski v. Lipinski, 227 Minn. 511, 35 N.W.2d 708 (1949).

In a 1949 case, the Minnesota Supreme Court allowed a partner to buy a strip of land his partnership used, without disclosing the purchase at the time he made it, and then charge the partnership rent for its continued use.

In this case, the parties formed a partnership, subject to Minnesota’s version of the Uniform Partnership Act, to carry on commercial fishing on the waters of Lake Pepin, operating from leased shore property. Next to that property was a strip of land, owned by a third party, which the partners used for hauling the fish (the opinion calls it “the haul”). Martin, one of the partners, bought the strip for himself. He “did not say anything about acquiring this particular land from Bengtson at the time he signed the contract” with the other partners, and he later requested rent for the partnership’s use of it, which the other partners refused to pay for lack of funds. The other partners sued, asserting that Martin never disclosed his intent to purchase the land nor sought their consent.

The Minnesota Supreme Court held that Martin did not violate a fiduciary duty. The court did not rest that holding on any prior disclosure by Martin. It rested on the scope of the venture and the absence of any usurpation. The undertaking was “definitely that of a fishing enterprise and not one involving the acquisition, improvement, or development of real estate,” so acquiring real estate fell outside the partners’ shared business. The strip was not partnership property: the partners “had no right, title or interest in the disputed strip (called the haul), and they had made no plans to lease it, or buy it.” And Martin gained no advantage from the relationship in acquiring it: “He merely went up the hill and bought it. Any of the others could have done the same. He violated no confidence; he had no advantage in a race . . . .” The court recognized that partners owe one another “the highest standard of integrity and good faith in their dealings with each other,” but held that “[s]uch relationship and its obligations, however, were limited to the enterprise in which they were mutually engaged.” As the court framed the inquiry, “[i]n determining their respective obligations, a court should always keep in mind the purposes for which the participants were associated and the manner in which the association was organized.”

The “no advantage” language came from the trial court’s memorandum, which the Supreme Court adopted in affirming. As the trial court put it, “[t]he defendant did not buy the haul as the result of any information, priority, or advantageous position which he had obtained by virtue of the joint enterprise.” The court used the term “joint enterprise” (a fishing venture limited to a four-year term), not “partnership,” to describe the association whose scope defined the duty. A second, independent ground reinforced the result: the $200 Martin withdrew to buy the land was openly “charged to his account and deducted from his share of the profits,” so nothing was misappropriated. Together, these points mark the boundary between permissible individual acquisition and prohibited usurpation of a partnership opportunity: a partner may acquire property outside the venture’s scope so long as he did not exploit information, priority, or a position gained through the venture. Thus, this case stands for the notion that the scope of a partnership may be so limited that the acquisition of an asset used by the partnership is not a usurpation of a partnership opportunity, nor does it violate a duty to disclose.

Lipinski applied Minnesota’s original Uniform Partnership Act, which has since been replaced. Minnesota general partnerships are now governed by the Uniform Partnership Act of 1994 (RUPA), Minn. Stat. ch. 323A. Under RUPA the fiduciary duties are fixed by statute: “[t]he only fiduciary duties a partner owes to the partnership and the other partners are the duty of loyalty and the duty of care,” together with an overarching obligation of good faith and fair dealing. Minn. Stat. § 323A.0404. A partnership agreement may tailor those duties but may not eliminate them. Minn. Stat. § 323A.0103(b) sets a mandatory floor: the agreement may not eliminate the duty of loyalty, may not eliminate the obligation of good faith and fair dealing, and may not unreasonably reduce the duty of care. It may only identify categories of activity that do not violate the duty of loyalty if they are not manifestly unreasonable, or authorize or ratify a specific act after full disclosure of all material facts. Lipinski remains sound as history, but any question about whether Minnesota partners can waive or limit fiduciary duties today runs through chapter 323A.

Appletree Square I Ltd. Partnership v. Investmark, Inc., 494 N.W.2d 889 (Minn. App. 1993).

In a 1993 case, the Minnesota Court of Appeals would not give effect to a partnership agreement that replaced a partner’s duty to disclose all material information affecting the partnership with a duty to disclose such information only after another partner made a request.

In this case, sophisticated parties formed their partnership under the 1976 Uniform Limited Partnership Act as enacted in the Minnesota Statutes. The partners’ agreement limited the partners’ duty of disclosure by stating that the general partners would “provide the partners with all information that may reasonably be requested.”

The general partners sold their fifteen-story office building to the limited partners. Years after the sale, the limited partners learned that the building was contaminated with asbestos, which prompted this suit.

In considering the partners’ agreement to waive the duty to disclose without demand, the court acknowledged that “[p]artners may change their common law and statutory duties by incorporating such changes in their partnership agreement.” But the court then held that the general partners could not “replace their broad duty of disclosure with a narrow duty to render information upon demand” because that “would destroy the fiduciary character of their relationship, and it would also invite fraud.”

The court reasoned that “[u]nless partners knew what questions to ask, they would have no right to know material information about the business.” Further, it said, “where the major purpose of a contract clause is to shield wrongdoers from liability, the clause will be set aside as against public policy.” Thus, the court concluded that the provision limiting the duty to disclose would be given no effect.

The Appletree partnership was organized under Minnesota’s 1976 Uniform Limited Partnership Act, former Minn. Stat. ch. 322A. That act has since been superseded: Minnesota limited partnerships are now governed by the Uniform Limited Partnership Act (2001), Minn. Stat. ch. 321 (Laws 2004, ch. 199). The freedom-of-contract principle Appletree drew on survives. Under Minn. Stat. § 321.0110(a), the partnership agreement governs relations among the partners, so partners retain broad latitude to modify their default duties by agreement. But that latitude is expressly cabined by Minn. Stat. § 321.0110(b): the agreement may not eliminate the duty of loyalty, may not unreasonably reduce the duty of care, and may not eliminate the obligation of good faith and fair dealing. So the principle that partners may change their duties by agreement remains true, subject to these nonwaivable limits.

How Have Federal Circuit Courts Ruled on Fiduciary Duty Waivers?

Wartski v. Bedford, 926 F.2d 11, 14–20 (1st Cir. 1991).

In a 1991 decision very similar to the Triple Five decisions, the First Circuit refused to allow one partner to buy an interest in the partnership from other partners without disclosing the opportunity to the remaining partner, despite a provision in a partnership agreement expressly allowing the partners to compete.

In this case, an inventor and a businessman formed a limited partnership in 1981 under Massachusetts law to develop a device for motor vehicles. Both men were general partners with other limited partners. The partnership agreement provided that the “[g]eneral [p]artners shall not be prevented from engaging in other activities for profit, whether in research and development or otherwise, and whether or not competitive with the business of the partnership.” When the business appeared to fail, the businessman bought the limited partners’ interest in the partnership to obtain control of the business and the invention. The court found the businessman failed to disclose to the inventor his purchase of the limited partners’ interest in the partnership, which prevented the partner from participating in the purchase.

The court considered the provision allowing partners to engage in other profit-making activities “whether or not competitive with the business of the partnership.” First, the court doubted that the partners actually intended this language to include the “technology which was the heart and soul of the partnership venture and the brainchild of the other partner.” Second, the court declared that even if the provision included the heart and soul of the partnership, a partnership agreement “cannot nullify the fiduciary duty owed by [the businessman] to the partnership.” The court explained that “[t]he fiduciary duty of partners is an integral part of the partnership agreement whether or not expressly set forth therein . . . [which] cannot be negated by the words of the partnership agreement.” The court stated the governing rule plainly: a partner “has a fiduciary obligation to the partnership of the utmost good faith and loyalty and cannot divert a business opportunity for his own gain without first making a complete and unambiguous disclosure to the partnership.” Thus, this case stands for the notion that a partnership agreement allowing partners to compete will be given no effect if a partner fails to disclose an opportunity that relates to the heart of the partnership’s business.

Exxon Corp. v. Burglin, 4 F.3d 1294, 1299–1300 (5th Cir. 1993).

The Fifth Circuit decision in Exxon is contrary to both the Wartski and Triple Five decisions. Applying Alaska law, the Fifth Circuit held that a general partner was not liable for violating the duty to disclose information it kept secret from limited partners because the duty to disclose was limited in their agreement.

In Exxon, sophisticated parties formed their limited partnership expressly subject to Alaska law. Essentially, the partnership agreement provided that the general partner must furnish the limited partners with information necessary to evaluate their interests unless the general partner believed the information was confidential. The court noted that the partnership agreement was negotiated by highly sophisticated parties who bargained at arm’s length with the assistance of counsel, and that the limited partners received substantial sums of money for relinquishing their right to full disclosure.

The lawsuit arose because the general partner learned about the value of an oil field owned by the partnership but did not disclose this to the limited partners when the limited partners offered to sell their interests in the partnership to the general partner. The parties made the sale based on an agreement expressly stating that the limited partners were selling without knowing the future profit potential of the oil fields. The sale agreement also gave the limited partners an option to have an independent consultant examine the fairness of the offer, which they failed to do.

The court read the agreement’s confidentiality provision as recognizing “not only the partnership’s inherent need for secrecy to protect itself from outside competition but also the general partner’s individual need to protect its interests from the limited partners.” Accordingly, the court gave effect to the parties’ agreement, including the fiduciary duty limitations, and held that the general partner “was under no duty to disclose” the information that it deemed confidential. Even so, the court marked the outer limit of what such a waiver can accomplish: “the contractual abrogation of some fiduciary duties does not relieve the general partner from other basic fiduciary duties, such as the duty of good faith and fair dealing.” A validly bargained waiver of the disclosure duty did not extinguish that non-waivable duty. Thus, this case stands for the notion that sophisticated parties may contractually limit their duty to disclose, while the implied duty of good faith and fair dealing remains non-waivable.

When Have Courts Upheld Contractual Waivers of Fiduciary Duties?

Singer v. Singer, 634 P.2d 766, 768–73 (Okla. Civ. App. 1981).

In a 1981 case, the Oklahoma Court of Civil Appeals held that a partner in an oil production partnership did not violate a fiduciary duty when it purchased land within the area of the partnership’s interest because of a provision in the partners’ agreement:

Each partner shall be free to enter into business and other transactions for his or her own separate individual account, even though such business or other transaction may be in conflict with and/or competition with the business of this partnership. Neither the partnership nor any individual member of this partnership shall be entitled to claim or receive any part of or interest in such transactions, it being the intention and agreement that any partner will be free to deal on his or her own account to the same extent and with the same force and effect as if he or she were not and never had been members of this partnership.

The court explained that the defendants “had a contract right to do precisely what they did, namely, compete with the partners of Josaline and with Josaline itself ‘as if there never had been a partnership.’” It found that this provision (paragraph 8 of the agreement) “is designed to allow and is uniquely drafted to promote spirited, if not outright predatory competition between the partners.” The clause displaced the ordinary expectation of a noncompetitive relationship among partners.

The holding has an express limit. As the court put it, “the permissible boundaries of intra-partnership competition, under paragraph 8, are limited only after the threshold of actual partnership acquisition has been crossed.” The clause licensed competition for prospects and opportunities, but a partner still could not pirate an asset the partnership had already acquired.

Sonet v. Timber Co., 722 A.2d 319 (Del. Ch. 1998).

In 1998, a Delaware court held that general partners seeking to convert their limited partnership to a real estate investment trust, which benefited them but harmed a limited partner, were measured by their partnership agreement rather than by default common-law fiduciary duties. The court was careful not to hold that general partners categorically owe limited partners no fiduciary duties. It held that the traditional fiduciary duties among partners are defaults that a clear partnership agreement may modify or displace, so that where the agreement unambiguously gave the general partner discretion over such a transaction (checked by a two-thirds unitholder veto), the limited partner’s remedy lay in that veto rather than in a fiduciary-duty suit. The court explained that “principles of contract preempt fiduciary principles where the parties to a limited partnership have made their intentions to do so plain.”

Sonet also supplies the mechanics, not just the rule: “a claim of breach of fiduciary duty must first be analyzed in terms of the operative governing instrument” (the partnership agreement), “and only where that document is silent or ambiguous, or where principles of equity are implicated, will a Court begin to look for guidance from the statutory default rules” and other extrinsic sources. The partnership agreement is read first; the default duties supply the standard only where the agreement is silent or ambiguous.

While this case aligns with the others supporting the notion that partners may limit their fiduciary duties, it goes further by explicitly stating that contractual principles may override fiduciary duties in an unincorporated business entity. This “contractarian” view is consistent with many Delaware cases, and it rests on statute. Delaware’s Revised Uniform Limited Partnership Act declares the policy “to give maximum effect to the principle of freedom of contract,” Del. Code Ann. tit. 6, § 17-1101(c), and provides that fiduciary duties “may be expanded or restricted or eliminated by provisions in the partnership agreement; provided that the partnership agreement may not eliminate the implied contractual covenant of good faith and fair dealing,” id. § 17-1101(d). In Gotham Partners, L.P. v. Hallwood Realty Partners, L.P., 817 A.2d 160, 167–68 (Del. 2002), the Delaware Supreme Court questioned whether the statute then permitted a partnership agreement to eliminate fiduciary duties, noting that it provided only that a partner’s “duties and liabilities may be expanded or restricted by provisions in the partnership agreement,” and observing that there was no mention in the statute “that a limited partnership agreement may eliminate the fiduciary duties or liabilities of a general partner.” The word “eliminated” was later added to Section 17-1101(d) by a 2004 amendment.

Can These Conflicting Decisions Be Harmonized?

One attempt to harmonize these seemingly disparate decisions could be made by distinguishing a partner’s disclosure and competition with the partnership generally, from a partner’s disclosure and competition with another partner regarding the purchase of a partner’s interest. Under the first, a partner desires to compete in the same market as the partnership, such as by opening a restaurant in the same neighborhood as the partnership’s restaurant. It is easy to think of valid reasons for this, such as when the partners already own competing restaurants in the neighborhood and want to start another one together.

But when partners compete over the purchase of a third partner’s interest, the battle is only between partners. It is difficult to think of any good that could come from allowing partners to keep secrets and compete for ownership of the partnership. Based on this distinction, a partnership agreement should be allowed to override a duty not to compete with the partnership generally, but partners should not be allowed to modify their fiduciary duties when it comes to ownership interests in the partnership.

Thus, this attempt to harmonize these seemingly disparate decisions is appealing but, unfortunately, is unworkable with the cases here. First, Wartski v. Bedford held that partners may not buy an interest in the partnership from other partners without disclosing the opportunity to the remaining partner despite a provision in a partnership agreement expressly allowing the partners to compete. The Triple Five holding was similar. But Exxon Corp. v. Burglin in the Fifth Circuit gave effect to a contractual limitation on the duty to disclose, holding that the general partner had no duty to disclose confidential information when it acquired the limited partners’ interests. And Sonet v. Timber Co. in Delaware held that the traditional fiduciary duties among partners are contractual defaults that a partnership agreement may modify or displace. As a result, any attempt to harmonize these cases under this distinction appears unworkable.

What Do These Cases Mean for Partnership Agreements?

These cases present a wide range of outcomes. Some favor allowing parties to limit their fiduciary duties, while others favor applying fiduciary duties despite partnership agreements to the contrary.

These conflicting views create uncertainty in the law. As a result, partners may be discouraged from drafting partnership agreements that provide substantial limitations on fiduciary duties. Thus, some partners are stuck with an agreement that is less than they would like. This burden may decrease their profits and increase their transaction costs.

For example, profits are decreased if sophisticated companies who compete with each other cannot establish a partnership at all, because the law prevents them from eliminating their duty to disclose. Transaction costs are increased by hiring lawyers and accountants to form and operate new business entities, such as a Delaware LLC, that has a greater ability to limit fiduciary duties. Of course, those who seek to impose fiduciary duties despite contrary partnership agreements would argue that these costs are worthwhile to protect parties from abuse.

This post is also part of a series of posts on Unenforceable Fiduciary Duty Limitations.

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