On March 18, 2008, the New York Court of Appeals, which is New York’s highest court, decided Appleton Acquisition, LLC v. National Housing Partnership (read decision here).  The decision holds that a limited partner may not bring an action seeking damages or rescission based on allegations of fraud by the general partner in connection with a merger transaction, and that the statutory appraisal proceeding is the exclusive remedy for such claims.  As a result, the plaintiff in Appleton, which acquired partnership interests post-merger from limited partners who did not exercise appraisal rights, was out of court and out of luck.

The limited partnership known as Beautiful Village (“BV”) owned and managed a New York City apartment complex which received federal financing under HUD’s Section 8 affordable housing program.  By 2002, BV owed over $1.5 million to the corporate General Partner’s parent company.  Rather than foreclosing, the General Partner proposed that BV merge into a new limited partnership owned by the parent company, with each limited partner receiving $100 or 2.5 common units of the parent company for their BV shares.  The limited partners received proxy statements disclosing the conflict of interest between the General Partner and its parent company, and advising that rejection of the merger would likely lead to foreclosure resulting in adverse tax consequences for the limited partners.  The proxy also notified the limited partners of their alternative right to institute a judicial appraisal proceeding to receive the fair value of their partnership interests.  None of the limited partners exercised their appraisal rights.  In September 2002, the merger was approved and the limited partners’ interests in BV were extinguished.

Three years later, plaintiff Appleton Acquisitions, LLC (“Appleton”), which had no prior involvement with BV, purchased from the former BV limited partners their equitable or partnership shares together with any legal claims they had against BV, the General Partner and its parent company.  Appleton then filed a lawsuit against the latter entities asserting three causes of action for rescission of the merger and ancillary money damages on the grounds of fraud, breach of fiduciary duty and negligent misrepresentation.  Appleton alleged that the proxy statement contained false and misleading statements and that the General Partner had depressed the value of the BV partnership interests by failing to enroll in a certain HUD program that would have provided BV with additional Section 8 rent subsidies.  These allegations were also used to support two additional claims seeking monetary damages for breach of contract and aiding and abetting breach of fiduciary duty.

The seven judges of the Court of Appeals unanimously ruled that Appleton’s first three causes of action seeking to rescind the merger were barred by New York’s Revised Limited Partnership Act.  Sections 121-1102(b) and (c) of the Act permit a limited partner who dissents from a proposed merger or consolidation to be cashed out for the “fair value” of his or her partnership interest.  Section 121-1105 governs the procedure for payment and for the judicial determination of fair value absent agreement on the price to be paid.  Section 121-1102(d) closes the door on other remedies as follows:

A  limited partner of a constituent limited partnership who has a right under this article to demand payment for his partnership interest shall not have any right at law or in equity under this article to attack the validity of the merger or consolidation or to have the merger or consolidation set aside or rescinded, except in an action or contest with respect to compliance with the provisions of the partnership agreement or subdivision (a) of this section.

In so ruling, the Court contrasted Section 121-1102(d) with the counterpart dissenting shareholder provision in Section 623(k) of the Business Corporation Law.  The latter statute, enacted long before the Revised Limited Partnership Act, codifies a common-law exception based on fraud or illegality and expressly recognizes that a dissenting shareholder may “bring or maintain an appropriate action to obtain relief on the ground that [the merger] will be or is unlawful or fraudulent.”  The Court found dispositive the “intentional legislative omission” of a similar exception in the Revised Limited Partnership Act.

The Court went on to note that limited partners who claim that a merger is tainted by fraud are not without a remedy.  Under the appraisal statute, the court is to consider “the nature of the transaction giving rise to the [limited partner’s] right to receive payment . . . and all other relevant factors” in arriving at its fair value determination.  “This broad language”, the Court added, “allows a dissenting limited partner to raise the issue of fraud, illegality, breach of fiduciary responsibility or other deceitful acts by the general partner that may have resulted in less compensation than the limited partner should have received”.  In a footnote, the Court suggested that, had BV’s original limited partners exercised their cash-out appraisal rights, they could have utilized an expert appraiser to establish that the General Partner’s failure to obtain additional Section 8 subsidies “negatively affected the valuation of their shares in [BV]”.

The Court’s unanimity fell apart, however, when it came to Appleton’s two additional causes of action for monetary damages based on breach of contract and aiding and abetting breach of fiduciary duty.  A four-judge majority concluded that these claims also were barred by the statutory scheme, stating that “[a]cceptance of the Limited Partners’ argument would allow them to bypass the appraisal process even though they are asserting that the compensation they received for their shares was inadequate” and that the damages sought in lieu of rescission were “veiled attacks on the validity of the merger”.

The three dissenting judges argued that the “plain language” of Section 121-1102(d) does not “expressly prohibit the availability of the common law right of a limited partner to seek damages as a result of a breach of contract premised on a general partner’s alleged violation of a partnership agreement and the aiding and abetting of such breach by others”.  In their view, “[t]he Legislature surely did not intend section 121-1102 to insulate a general partner from an action for damages resulting from a breach of contract merely because the merger or consolidation was successfully completed”.

An intriguing aspect of Appleton‘s dueling opinions is the voting lineup and how both sides rely on another recent split decision by the Court of Appeals in Tzolis v. Wolff.  There, the Court held that members of LLCs have standing under common law to assert derivative claims notwithstanding the omission of any authorization in the LLC Law (see here for prior discussion of Tzolis) .  While the tenor of the arguments in both cases suggest that the dividing line is the degree of judicial deference to legislative will, the voting pattern suggests otherwise:  Judges Read and Graffeo were in the minority in Tzolis and the majority in Appleton; Judges Smith and Pigott were in the majority in both; and Chief Judge Kaye and Judge Ciparick were in the majority in Tzolis and in the minority in Appleton.  Go figure.