The removal of a limited partnership’s general partner for malfeasance, under the court’s general powers of equity, is a rarely exercised judicial remedy. A court’s replacement of the expelled general partner with a limited partner is even rarer. But that’s just what happened last month in Garber v. Stevens, Decision & Order, Index No. 601917/05 (Sup Ct NY County June 6, 2012), decided by Manhattan Commercial Division Justice Eileen Bransten (pictured).

It figures that Garber involves a relatively old (1974) limited partnership formed to hold ownership of a Brooklyn apartment building. This once-popular form of realty ownership involving passive investors largely has been eclipsed since the mid-1990’s by use of the limited liability company form, which is governed by a comparatively sophisticated and more flexible set of statutory default rules that may be varied or eliminated by agreement of the members.

The Garber partnership’s vintage also indicates that it is governed by the original Uniform Limited Partnership Act (ULPA) adopted by New York in 1922, which remained largely unchanged until 1991 when New York adopted the Revised Uniform Limited Partnership Act (RULPA). ULPA makes no reference to the removal power, whereas RULPA includes a provision (§121-402[c]) for removal of a general partner “as may be provided in the partnership agreement.”

Kinpit Associates, L.P.

The subject limited partnership, known as Kinpit Associates, was formed pursuant to a Partnership Agreement dated July 1974 for the purpose of acquiring title to an apartment building in Brooklyn. The Agreement (view here) designates Troy Stevens and an entity he controls, known as Kinpit Realty Corp., as the two general partners, and eight individuals as limited partners.

The limited partners put up 100% of the initial capital contribution, and were entitled to a preferred return of almost $1.4 million. The Agreement provides a general partner/limited partners equity split of 5%/95% for the first 20 years, and 50%/50% thereafter.

The Agreement vests in the general partners the exclusive right to manage and control Kinpit Associates, and specifies in Section 15 that the limited partners

shall not participate in the management or control of the Partnership’s business nor shall they transact any business for the Partnership, nor shall they have the power to sign for or bind the Partnership, said powers being vested exclusively in the General Partners.

Section 14(c) of the Agreement lists several exceptions to the general partners’ plenary management powers, one of which is to sell, refinance or otherwise dispose of the partnership’s realty asset without the approval of 51% of the limited partners.

The Agreement’s sole provision contemplating the departure of a general partner is Section 18, which requires the termination and dissolution of Kinpit in the event of the bankruptcy, dissolution or other cessation to exist as a legal entity of any one of the general partners, unless the remaining general and limited partners unanimously agree to continue the partnership and to substitute a new general partner.

The Lawsuit

In 2005, the limited partners brought suit against the general partners asserting claims for breach of the Agreement and breach of fiduciary duty. The complaint (view here) alleges that Stevens refinanced the realty on multiple occasions without the limited partners’ knowledge or consent; failed to distribute any refinancing proceeds to the limited partners and diverted all such proceeds to himself; collected management fees in violation of the Agreement; and engaged in self-dealing.

In August 2011, Justice Bransten issued a decision (read here) granting the plaintiffs’ motion for summary judgment on liability against the general partners, and ordering a trial on damages. Defendants unsuccessfully appealed the decision, which was affirmed by the Appellate Division, First Department, in April 2012 (read here).

Meanwhile, in December 2011, the Court appointed a property receiver for the apartment building after plaintiffs learned that defendant Stevens had stopped paying the debt service on the mortgage encumbering the partnership’s property, thereby placing the mortgage in default.

The Motion to Remove and Replace the General Partners

In late March 2012, around when the mortgage lender filed a foreclosure action, the limited partners asked Justice Bransten to remove Stevens and Kinpit Realty as general partners and, in their stead, to designate a newly formed limited liability company, owned and controlled by the limited partners, as the sole general partner of Kinpit Associates. The application also was prompted by the receiver’s discovery that Stevens had transferred the partnership’s lockbox account with the mortgage lender to another bank, in violation of the mortgage agreement.

The limited partners, with the receiver’s support, argued that they would be unable to refinance the mortgage and/or cure the default so long as Stevens and Kinpit Realty remain as the general partners of Kinpit Associates, and that without such ability their investment in the partnership would be wiped out by foreclosure. The limited partners further supported their request to remove and replace the general partners with evidence that the latter had also brought about a default on a guarantee by the partnership of a $250,000 line of credit taken out in violation of the Agreement, and that Stevens was the target of an ongoing investigation by the IRS and HUD (which subsidizes 80% of the apartment building’s units) for ceasing to pay taxes on the partnership’s property.

The general partners based their factual opposition to the motion on the provisions of the Agreement. First, they argued that the Agreement’s silence on the removal of a general partner precludes the judicial power of removal. Second, they pointed to the Agreement’s express provisions prohibiting limited partner involvement in the management, control and business affairs of the partnership.

The Case Precedent

The limited partners relied primarily on two prior cases in support of their request to remove and replace the general partners: Drucker v. Mige Associates II, 225 AD2d 427 (1st Dept 1996), and Miltland Raleigh-Durham v. Myers, 807 F Supp 1025 (SDNY 1992).

In Drucker, the appellate court upheld the removal of one of multiple general partners of a limited partnership based on findings of malfeasance. The court, noting that the remedy of removal is “rarely invoked,” found it appropriate when “a partner’s breach of his fiduciary responsibility has rendered the partnership an entity that is no longer viable.”

In Miltland, the federal District Court held that the court has equitable power to remove a general partner and elevate a limited partner to general partner where the limited partners have shown that the general partner violated fiduciary duties to the partnership, and that removal is necessary to preserve the partnership.

The defendants argued that Drucker and Miltland are distinguishable, and that the court should instead be guided by Wolfson v. Rosenthal, 210 AD2d 47 (1st Dept 1994), and Dawson v. White & Case, 88 NY2d 666 (1996), standing for the proposition that, absent a mechanism in the partnership agreement for removal of a general partner, a general partner cannot be removed without causing the dissolution of the partnership.

Justice Bransten’s Ruling

Justice Bransten launches her analysis by rejecting the defendants’ argument that removal of a general partner necessitates dissolution. Here’s what she says:

The court finds that Wolfson and Dawson are here inapplicable. Both Wolfson and Dawson involve situations in which the partners removed or attempted to remove partners from the partnership outside of the judicial system. Wolfson and Dawson do not discuss the court’s power to remove a partner where that partner has been found to have breached his fiduciary duty to the other partners and where such removal is alleged to be necessary to preserve the sole asset of the partnership.

Justice Bransten next finds that the Agreement’s provisions barring limited partner participation in management of the partnership do not prohibit the court “from exercising its broad powers in equity by removing Defendants as General Partners and substituting the Limited Partners, via an LLC, as General Partners of the Partnership.” The court, she continues, “having obtained jurisdiction of the parties and subject matter in this action must adapt its relief to the exigencies of the case.”

Justice Bransten finds undisputed the limited partners’ contentions concerning the potentially catastrophic effects of the defendants’ failure to service the mortgage debt and other management breaches placing the partnership’s sole asset at risk of foreclosure. She explains:

The Partnership stands near-certain chance to be unable to cure the default on the mortgage by refinancing the loan or exploring other financing options. Lenders are alleged, and this court agrees, to be unwilling to do business with the Partnership while Stevens and Kinpit Realty are in place as General Partners. The court must thus do what is necessary to preserve the Partnership and the principal Partnership assets and remove Stevens and Kinpit Realty as General Partners.

Justice Bransten also disagrees with the defendants’ argument that the Drucker and Miltland cases do not authorize the removal and replacement of a general partner with a limited partner. The fact that in Drucker the court removed only one of multiple general partners, she writes,

does not mean that the court cannot here take a varying remedial action necessary to maintain the viability of the Partnership. The court finds it within its equitable power to substitute the Limited Partners, organized as an LLC, as the General Partner in Kinpit Associates. This will allow the Partnership to continue, provide a stronger chance of maintaining the Partnership’s asset in the Property, and will avoid the drastic measure of liquidating the Partnership.

Justice Bransten’s decision also cites Homburger v. Levitin, 130 AD2d 715 (2d Dept 1987), in which the appellate court affirmed the removal of a limited partnership’s sole general partner, and the elevation of the sole limited partner to general partner, in order to preserve the partnership’s sole leasehold asset.

Based on the undisputed facts and case precedents, the court removes Stevens and Kinpit Realty as general partners of the partnership and installs as the sole general partner the LLC wholly owned and controlled by the limited partners. Justice Bransten also clarifies that the defendants’ removal does not deprive them of their “equitable share” of the partnership to be determined after trial.

The right to “pick your partner” is a fundamental tenet of partnership law, which only underscores the magnitude of the remedy granted by the court in Garber, not only removing the general partners but installing an outside entity — albeit controlled by the existing limited partners — as general partner. Garber also highlights, as Justice Bransten observes, that “‘[t]he power of equity is as broad as equity and justice require'” (quoting Kaminsky v. Kahn, 23 AD2d 231, 237 (1st Dept 1965)).