Lach v. MAN O'WAR, LLC

256 S.W.3d 563, 2008 WL 746480

• Court: Kentucky Supreme Court
• Decided: March 31, 2008
• Docket: 2005-SC-001014-DG
• Status: Published

Opinions

Opinion of the Court by

Justice SCOTT.

We granted discretionary review of an opinion of the Court of Appeals affirming the Fayette Circuit Court’s grant of summary judgment against the Appellant, Shirley Lach (Lach). We now reverse and remand the matter to the trial court for further proceedings consistent with this opinion.

Facts

In 1986, Lach and her then husband, Lynwood Wiseman (Wiseman),¹ entered into a joint venture with other individuals to acquire a piece of real estate for development in Lexington, Kentucky. They also formed Man O’ War Limited Partnership (the Partnership) for the purpose of leasing real property, as well as the development and operation of shopping centers. Robert S. Miller (Miller), an attorney, provided assistance and became a participant. Miller and Wiseman became the general partners in the Partnership, while Lach was one of several limited partners. They also formed M.O.W. Place, Ltd., (LTD) to lease the shopping center from the joint venture. LTD was controlled and managed through the Partnership as LTD’s sole general partner until the occurrence of events in 2002 which are the subject matter of this litigation.

At all times, the Partnership’s general partners, and their ownership percentages were essentially, Miller (1.01802%) and Wiseman (32.48248%). The limited partners and their ownership percentages were essentially, Lach (27.02703%), Jonathan Miller (8.5%), Harry B. Miller (11.71171%), Harvey Morgan (1.08108%), Penny Miller (3.24324%), Jeffery Mullens (1.08108%), Jennifer Miller (8.5%), and Sophie Wiseman (5.40541%).

In 2002, the Partnership discovered that one of Wiseman’s non-partnership employees had over a period of years, stolen in excess of $200,000.00 from the Partnership. Lach had made several inquiries and complaints to the general partners regarding this possibility due to inconsistent entrees in its books and records. As a result, Wiseman paid the money back to the Partnership and a professional management company was retained to actively manage the Partnership and shopping center.

Later in the spring of 2002, Miller discovered he was gravely ill with cancer. With his approaching death, he contacted Lach in April 2002, and asked for a meeting concerning the shopping center. At the meeting, Miller asked Lach to sign a document he had prepared, which would name Wiseman, Jeffery Mullens, (brother-in-law of Robert Miller), and Jonathan Miller (son of Robert Miller), as the new general partners of the Partnership. Under the Partnership agreement, new general partners could not be added without the consent of all the partners. The document further provided that when Wiseman died, “the two remaining general partners will select a new general partner.” Lach objected as the proposal would permit the Miller family, which owned less than Lach’s individual interest, to manage and control the shopping center. The Millers’ would have two of the three general partners while Wiseman, who was then of advancing age, was alive. Upon his death, Jonathan Miller and Jeffery Mullens would then select the third general partner.

Believing it would be best if one of the three general partners controlling the shopping center was a person outside the Miller family, Lach responded with a proposal substituting her daughter, Sherri McVay, an attorney, as a general partner in lieu of Jeffery Mullens. Her proposal was rejected.

Miller and Wiseman then sought counsel in an effort to restructure the business form of the partnership so as to eliminate the necessity of acquiring Lach’s consent to the proposed management change. Upon advice of counsel, they formed a new business entity, Man 0’ War Limited Liability Company (the LLC). When operational, the LLC would be operated under the “manager form,” controlled only by a majority vote of the owners. The initial managers were to be Wiseman, Jonathan Miller, and Jeffery Mullens.

Once this was done, they transferred the Partnership’s interest as the sole general partner in LTD to the LLC, while the ownership of the LLC was transferred to the Partnership in return. After the transfer, Miller and Wiseman dissolved the Partnership, distributing its assets (the ownership of the LLC) to the partners in identical proportions to their previous ownership of the Partnership, that is— with one catch. Unless a partner signed the documents presented, which would necessarily validate the restructuring, that partner would have no voting rights in the LLC. As all the other partners signed the agreement, Lach was the only one left without any voting rights. Income, yes— any say in the management, no.

The fact that the Partnership’s restructuring was to avoid the required consent of Lach to the proposed changes in management is amply demonstrated. For example, billing on April 19, 2002, from counsel retained for the Partnership by Wiseman and Miller, was for “[ajttention to freeze out and letter to Sam Brown on requirements.” Billing on April 22, 2002, was for “[cjonference regarding change of limited partnership to limited liability company.” Billing on April 23, 2002, was for “[cjonference regarding non[-]exeeution of Operating Agreement by dissident limited partner.” Counsel’s letter of April 24, 2002, to the Partnership accountant, acknowledged, “[a]s we discussed earlier this week, we have been asked to consider a restructuring of [the Partnership] with the goal of eliminating the ability of any one limited partner ... to prevent any action of the [Partnership].... ”

Lach then brought this action in the Fayette Circuit Court alleging, among others, that (1) the restructuring (or conversion) of the business form of the Partnership without her consent was invalid, (2) the transfer of the assets of the Partnership to the LLC and the Partnership’s subsequent termination was a violation of KRS 362.490 and a breach by the general partners of their fiduciary duty to the Partnership and Lach. The trial court denied Appellant’s motions for partial summary judgment and granted summary judgment thereon, in favor of the Appel-lees. The trial court also denied her motion to compel the production of all communications between the Partnership, general partners and counsel regarding the reasons for the restructuring of the Partnership business. The Court of Appeals affirmed the trial court’s summary judgments, and as a consequence, found the discovery issues to be moot.

I. The standard of review

The standard of review for summary judgments is whether the trial court correctly determined that there were no genuine issues of material fact and that the moving party was entitled to judgment as a matter of law. Steelvest, Inc. v. Scansteel Serv. Ctr., Inc., 807 S.W.2d 476, 480 (Ky.1991). Where there are no material disputes of fact, the question is one of law and “may be reviewed de novo.” Bob Hook Chevrolet Isuzu, Inc. v. Com. Transp. Cabinet, 983 S.W.2d 488, 490 (Ky.1998).

II. The restructuring of the partnership business

Appellant argues that the restructuring of the Partnership business form was invalid without her consent for two reasons: (1) the restructuring was a conversion in violation of KRS 275.370, and (2) the restructuring made it impossible for the Partnership to carry on its business in violation of KRS 362.490. The Appellees on the other hand, argue that (1) the restructuring of the Partnership business into that of the LLC did not constitute a “conversion” subject to the mandates of KRS 275.370 and (2) the Partnership agreements gave the general partners authority to restructure as they did. Moreover, the restructuring did not make it impossible to carry on the Partnership’s ordinary business; rather, it made it possible to continue the business, given Lach’s objection to the proposed new general partners.

a. Conversions under KRS 275.370

KRS 275.370 provides, in pertinent part:

(1) A partnership or limited partnership may be converted to a limited liability company pursuant to this section.

(2) The terms and conditions of a conversion of a partnership or limited partnership to a limited liability company shall, in the case of a partnership, be approved by all the partners or by a number or percentage specified for conversion in the partnership agreement or, in the case of a limited partnership, by all the partners, notwithstanding any provision to the contrary in the limited partnership agreement.

While conceding that the statute, in this instance, requires the approval of all the limited partners before a limited partnership can be converted into a limited liability company, the Appellees argue that the transformation constituted a “reorganization,” not a “conversion” as envisioned under KRS 275.370(1). Thus, KRS 275.370(2), requiring the consent of all the limited partners, was not applicable. The Appellees illustrate their distinction of the word “conversion,” by pointing out that the statute envisions a limited partnership re-designating itself as a limited liability company, whereas, in this instance, the limited liability company was created separately and existed concurrently with the Partnership (albeit without any assets). Thus, the fact that the LLC acquired all the assets of the Partnership and the Partnership then dissolved is simply immaterial.

Appellant on the other hand, points to Mr. Miller’s statement in his deposition, “that there was a conversion from the partnership to an LLC,” and to the statement of their counsel, who in his letter of June 11, 2002, responding to an inquiry by Appellant’s counsel, acknowledged, “the general partners determined that a conversion to a Limited Liability Company (LLC) was in the best interest of the partnership. The reconstructing has been accomplished.” We must, however, analyze a transaction for what it is, not what someone says it is.

In resolving the dispute, we must follow common rules of statutory construction. Thus, “[a]ll statutes of this state shall be liberally construed with a view to promote their objects and carry out the intent of the legislature .... ” KRS 446.080(1). Moreover, “[a]ll words and phrases shall be construed according to the common and approved usage of language, but technical words and phrases, and such others as may have acquired a peculiar and appropriate meaning in the law, shall be construed according to such meaning.” KRS 446.080(4).

It is a well-known rule for the interpretation of statutes that the court should ascertain from their terms, as contained in the entire enactment, the intent and purpose of the Legislature, and to administer that intent and purpose. Furthermore ... words will be given their ordinary and usually understood meaning, unless a different or technical meaning, as gathered from the entire contents, was intended.

Seaboard Oil Co. v. Commonwealth, 193 Ky. 629, 237 S.W. 48, 49 (1922).

Moreover,

[i]f a thing contained in a subsequent statute be within the reason of a former statute it shall be taken to be within meaning of that statute, and, if it can be gathered from a subsequent statute in pari materia what meaning the Legislature attached to words of a former statute, this will amount to a legislative declaration of its meaning and will govern construction of first statute.

Miller v. Kirksey, 265 Ky. 106, 95 S.W.2d 1059,1061 (1936).

KRS 275.375(1) acknowledges that “[a] partnership or limited partnership that has been converted pursuant to this chapter shall be for all purposes the same entity that existed before the conversion.” KRS 275.375(2) recognizes that the property “shall remain vested in the converted [business entity] ... [and][a]ll obligations of the converting ... limited partnership shall continue as obligations of the converted [business entity].” (Emphasis added) All of which seem to confirm Appellant’s argument that a “conversion” involves only one entity changing its legal form pursuant to statutory authorizations, rather than through interaction between two entities.

Looking at subsequent statutes for what light they cast on the question, we note that the Kentucky Legislature adopted the new Kentucky Uniform Limited Partnership Act in 2006. KRS 362.2-102, et. seq. This Act was adopted, with some changes, from the Uniform Limited Partnership Act (2001). Unif. Limited Partnership Act § 1102-1105, 6A U.L.A. 106-109 (2006). The Act specifically provides “[i]n applying and construing this uniform act, consideration shall be given to the need to promote uniformity of the law with respect to its subject matter among states that enact it.” KRS 362.2-1201.

When the need for uniformity is acknowledged, courts may consider the “Official Comments” to a Uniform Act, even where they have not been officially adopted. Cf., White v. Winchester Land Dev. Corp., 584 S.W.2d 56, 60 (Ky.App.1979). Looking at the Official Comments to § 1102 of the Uniform Limited Partnership Act, which, with changes, corresponds to KRS 362.2-1102, the Comment acknowledges, “[i]n contrast to a merger, which involves at least two entities, a conversion involves only one. The converting and converted organizations are the same entity.” Unif. Limited Partnership Act § 1102-1105, GA U.L.A. 107 (2006).

Having thus considered the statutory scheme, its particular language, the subsequent statute and Official Comments, we answer the question that was presented to us — that the restructuring of the business form of the Partnership, to that of the LLC, in this instance, was not a conversion under, or subject to, KRS 275.370, for reasons that a conversion deals only with one entity. We have not been asked, nor have we considered, whether the restructuring of the Partnership into the LLC constituted a merger, pursuant to KRS 362.531.

b. Breach of partners’ fiduciary duty

Under Kentucky law, partners owe the utmost good faith to each and every other partner. See Axton v. Kentucky Bottlers Supply Co., 159 Ky. 51, 166 S.W. 776, 778 (1914). “The scope of the fiduciary duty has been variously defined as one requiring utter good faith or honesty, loyalty or obedience, as well as candor, due care, and fair dealing.” Anthony v. Padmar, Inc., 320 S.C. 436, 465 S.E.2d 745, 752 (App.1995). Indeed, it has often been said, “there is no relation of trust or confidence known to law that requires of the parties a higher degree of good faith than that of a partnership.” Van Hooser v. Keenon, 271 S.W.2d 270, 273 (Ky.1954). Thus, “the doing of an act proscribed by [law] is a breach of that duty.” Gundelach v. Gollehon, 42 Colo.App. 437, 598 P.2d 521, 523 (1979) (internal citations omitted).

Gundelach involved a sale of all a limited partnership’s assets under a statutory scheme and circumstances similar to the case at hand. The Colorado statute therein interpreted provided, in pertinent part:

(W)ithout the written consent or ratification of the specific act by All the limited partners, a general partner or all of the general partners have no authority to:

(b) Do any act which would make it impossible to carry on the ordinary business of the partnership.

Id. at 523.

Finding that all of the limited partners did not approve of the transfer of the limited partnership’s assets and noting the dissolution of the limited partnership after the transfer, the Court in Gundelach concluded, “that upon transfer of the sole asset of the limited partnership, it was no longer possible for the partnership to carry on its ordinary business within the meaning of [the statute].” Id.

Newburger, Loeb & Co., Inc. v. Gross, 563 F.2d 1057, 1074-1075 (2nd Cir.1977), also involved circumstances similar to the case at hand. Therein, the general partners and most of the limited partners desired to change the business from a limited partnership to that of a corporation. Over the objection of three of the limited partners, they transferred all the limited partnership’s property to the corporation and resumed the partnership’s business within the corporate structure. Both the Federal District Court for the Southern District of New York and the Second Circuit Court of Appeals held that, “the transfer of the Partnership assets without the consent of [the dissenting limited partners] was a violation of section 98 of New York Partnership Law.” Id. at 1074. Section 98(l)(b) provides that general partners may not, without the consent of all the limited partners, do any act which would make it impossible to carry on the ordinary business of the partnership. Id. at 1067. The court further noted, “[t]he February 11 transfer effectively terminated the Partnership and tunneled its assets into a new entity. It is difficult to conceive of an act that would make it more ‘impossible to carry on the ordinary business of the partnership.’ ” Id. at 1074.

KRS 362.490 provides, in pertinent part:

A general partner shall have all the rights and powers and be subject to all the restrictions and liabilities of a partner in a partnership without limited partners, except that without the written consent or ratification of the specific act by all the limited partners, a general partner or all the general partners have no authority to

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(2) do any act which would make it impossible to carry on the ordinary business of the partnership.²

Our statute thus mirrors the Colorado and New York statutes analyzed in Gunde-lach, supra, and Newburger, Loeb & Co., Inc., supra.

The Appellees, however, argue that Miller and Wiseman had the authority to perform all the acts constituting the restructuring without Lach’s consent because they did not make it impossible to carry on the business of the partnership. They assert, it was the only act which made it possible to carry on the business of the partnership; suggesting that Lach would, by virtue of her right of rejection, have destroyed the partnership’s business, something she hadn’t done for the previous sixteen years.³ Moreover, the fact that a limited partner with significant ownership interests in a limited partnership would object to a transaction which would deprive her of her say in who might be able to successfully manage her business interest as a general partner, in return for a minority voting, or for that fact, a nonvoting interest, in a limited liability company controlled by a majority vote, is not evidence that such limited partner has an interest in destroying the business, including the value of her interest therein.

They further argue that under the certificate of partnership and partnership agreement, the general partners had the absolute right to “(1) terminate the partnership, (2) execute documents agreements, contracts, leases, etc., on behalf of the partnership, and (3) to manage the partnership business in all aspects, which should include, but should not be limited to ... take such other action, execute and deliver such other documents, and perform such other acts as the general partners may deem necessary, appropriate, or incidental to carrying out the business and affairs of the partnership.” In this regard, they seek to distinguish Gundelach, supra, and Newburger, Loeb & Co., Inc., supra, through Mist Properties, Inc. v. Fitzsimmons Realty Co., 228 N.Y.S.2d 406, 410 (Sup.Ct.1962), in which the court approved the general partner’s transfer of title to property owned by the limited partnership as against the claim of the receiver, because the limited partnership agreement allowed the general partners to do so.

Mist Properties, Inc., supra, however, had a partnership agreement that gave the general partners the specific power to sell all of the partnership’s property, subject to written approval of sixty-five percent of the limited partners. “There clearly appears to have been no violation of the statute since the conveyance was not without the written consent of the limited partners but was specifically contemplated and provided for by the agreement.” Id. at 410. As the court recognized therein, the agreement the partners had made with themselves through their partnership agreement controlled. “There is no intervening public policy which prevents persons dealing at arm’s length from entering into an agreement such as set forth above. It has been repeatedly held that where a limited partnership agreement has been entered into the partners cannot, inter se, set up that their rights are not governed thereby....” Id. at 410.

Simply put, we find that the general partners’ rights under the partnership agreement to (1) terminate the partnership at any time upon agreement of the general partners, and (2) to act upon behalf of the Partnership in matters that are “necessary, appropriate, or incidental to carry out its business,” can be not construed to allow them the power to transform the partnership into a limited liability company, in order to favor a majority of the partners in their selection, or substitution, of the general partners/managers of the business,⁴ without the approval of all the limited partners.

“The obligations to do justice rest upon all persons, natural and artificial; if one obtains the money or property of others without authority, the law, independently of its expressed contract, will compel restitution or compensation.” Marshall’s Adm’r v. Webster, 287 Ky. 692, 155 S.W.2d 13, 18 (1941). “The law regards substance rather than form; the spirit and essence of a thing rather than the dry law. One may not do by indirection what he cannot do directly.” Id. at 19. We therefore conclude that the transfer of the partnership assets to the LLC was in violation of KRS 362.490 and thus a breach of the general partners’ fiduciary duty to the non-consenting limited partner.

Therefore, for the reasons as stated previously, the act of restructuring the business form from the Partnership to the LLC without the consent of all the limited partners was a breach of the general partners’ fiduciary duty to the non-consenting limited partner. As the trial court has yet to determine the remedy, or remedies for such breaches, we will not address same. In so concluding, we are not unmindful of Van Hooser v. Keenon, 271 S.W.2d 270 (Ky.1954), Axton v. Kentucky Bottlers Supply Co., 159 Ky. 51, 166 S.W. 776, 778 (1914), or Anthony v. Padmar, Inc., 320 S.C. 436, 465 S.E.2d 745 (App.1995), cited to the contrary by Justice Abramson in her dissent, yet we note that the transfer here does not involve the rights of innocent third party purchasers as occurred in the cases cited.

III. Discovery of communications between the partnerships, general partners and their counsel

As a consequence of its partial summary judgments, the trial court denied Appellant’s discovery motions regarding the full communications between the partnership, general partners and their counsel in regards to the discussion, planning and implementation of the restructuring of the partnership into the LLC. Neither did the Court of Appeals consider the issue, having regarded it as moot, given its affir-mance of the trial court’s summary judgment rulings.

Although the trial court in its opinion gave no reason for denying the production, the arguments and record suggest the basis was attorney-client privilege. This “privilege is generally considered to be absolute as to communications made by or to a person advising with an attorney as to past transactions and offenses.” Steelvest, 807 S.W.2d at 487. “However, the rule does not apply to future transactions when the person seeking the advice is contemplating ... the perpetration of a fraud.” Id. “We would presume to place the breach of fiduciary relationship on an equal par with fraud and deceit.” Id. “Accordingly, we determine, as a matter of law, that a breach of a fiduciary duty is equivalent to fraud.” Id.

Thus upon remand, we hold that the attorney-client privilege cannot be used to prevent discovery of the requested information to the extent the information requested deals with, assists, or furthers the breach of a fiduciary duty by the general partners or the Partnership.

IV. Conclusions

Having concluded as a matter of law that the restructuring of the limited partnership into a limited liability company without Lach’s approval was a breach of the general partners’ fiduciary duty to her, as was the transfer of the partnership’s assets to the limited liability company in violation of KRS 362.490(2), and that the attorney-client privilege cannot be used to defeat discovery of evidence connected with the breach of a partner’s fiduciary duty, we reverse the opinion of the Court of Appeals and remand this matter back to the Fayette Circuit Court with directions to grant partial summary judgment to the Appellant Lach, in regards to the general partners’ breaches of fiduciary duty to her as well as the transfer in violation of KRS 342.490, and to make such additional decisions and findings, and to conduct such other proceedings, as are necessary and consistent with this opinion.

LAMBERT, C.J.; CUNNINGHAM and SCHRODER, JJ., concur. ABRAMSON, J., dissents by separate opinion, with MINTON, J., joining that dissent. NOBLE, J., not sitting.

1 . Lach and Wiseman divorced in 1988, soon after the endeavor began.

2 . Pursuant to KRS 362.525, “[t]he repeal of any statutory provision by 1988 Acts Ch. 284, sec. 65, shall not impair, or otherwise affect, the organization or the continued existence of a limited partnership existing on July 15, 1988, nor does the repeal impair any contract or affect any right accrued before July 15, 1988.” KRS 362.521(1) provides, “[a] limited partnership formed under any statute of this state prior to the adoption of [the Kentucky Revised Uniform Partnership Act of 1988] until or unless it becomes a limited partnership under [the Act of 1988] shall continue to be governed by the provisions of the statute under which it was formed.”

3 . The argument ignores the business fact that she was elected Chief of the National Home Builders Association in 1989, and was the owner of various other businesses.

4 . The agreements of the parties obscure the question of whether majority control of an LLC is more valuable than control of a limited partnership, subject to the approval of all the limited partners.