Waivers of fiduciary duty have gone to extremes in recent limited partnership agreements.
They have even gone so far as to waive fiduciary duty as in a partnership, or limited liability company, as well as the limited partners, the investments, the lenders or any other parties.
The goal is that the general partner or manager would have no fiduciary duty to anyone.
Almost all pension funds and other asset owners invest with external managers that have the authority to select and dispose of investments as well as serve as fiduciaries. Many investments — particularly in private equity, venture capital, real estate and hedge funds — are done through investment limited partnerships.
In 2004, Delaware — the state in which most such partnerships or similar limited liability companies are formed — amended its laws to allow the general partner and the limited partners to contractually modify duties, including fiduciary duties, that 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.” That amendment is in Delaware Revised Uniform Limited Partnership Act. Essentially the same change applies to limited liability companies as well under the Delaware Limited Liability Company Act.
Delaware has moved away from the principles of fiduciary duty and the common law of agency — that is, case law that has developed to deal with the relationship between a principal and someone authorized to act on his behalf — to become a forum of statutory contract law. This move makes sense for corporations with operating businesses but not for plan sponsors, and it runs counter to the long-established practice of permissible delegation.
If the fiduciary institutional investor delegates, but then waives, fiduciary duty for the general partner or investment manager and/or provides substantial other exculpation and indemnification protection as to create a de facto elimination of fiduciary duty, there is no one left with any fiduciary duty at all. This waiver could be seen by a court as a backdoor method for eliminating the entire fiduciary duty of the plan sponsor or trustees, which might be in violation of state or federal law and public policy. What are being bargained away, indeed if there is any bargaining at all, are fundamental fiduciary principles. Prospective limited partners, especially large institutional ones, negotiate many terms in the limited partnership agreement but rarely seem to negotiate these important terms, as they see them as just legalese.
The Employee Retirement Income Security Act provides that a trustee can delegate to an investment manager the power to invest and dispose of assets, and errors of the investment manager will not create a liability for the trustee. However, an investment manager has to be a registered investment adviser, acknowledging in writing that it is a fiduciary with respect to the plan. It follows that a waiver of fiduciary duty would disqualify the prospective manager.
The Uniform Prudent Investor Act provides that a fiduciary trustee may delegate the investment function to an “agent.” The agent becomes subject to the laws and jurisdiction of the state of the institutional investor, which may create additional uncertainty for choice of law provisions in agreements. Would the waiver remove the safe-harbor protection of the fiduciary trustee and expose the fiduciary trustee to personal liability for unreasonable delegation, but also for the direct acts of the investment manager to which it delegated?
The UPIA Committee comments are telling:
“The trustee's duty of care, skill, and caution in framing the terms of the delegation should protect the beneficiary against overbroad delegation. For example, the trustee could not prudently agree to an investment management agreement containing an exculpation clause that leaves the trust without recourse against reckless management. Leaving one's beneficiaries remediless against willful wrongdoing is inconsistent with the duty to use care and caution in formulating the terms of the delegation. This sense that it is imprudent to expose beneficiaries to broad exculpation clauses.”
Under the Uniform Prudent Management of Institutional Funds Act, the standard of delegation is that of an “ordinarily prudent person” and the relationship is again that of “agent” that submits to personal jurisdiction in the institutional investor's state, as with the Uniform Prudent Investor Act.
However, the LPA is an agreement between the general partner and the limited partners only and therefore does not bind other parties. The LPs might unwittingly take on the liability for breach of fiduciary duty claims that arise from any of any number of parties against the GP. It is unlikely that a court would find that no one is liable for third-party fiduciary breach claims simply because of a private agreement between the GP and LP. So which of the two is likely to be holding the liability bag?
The 2004 Delaware law is intended for consensual business relationships that prefer to follow a contract law format. The main statutory frameworks defining plan sponsor and investment manager relationships contemplate the common law of agency. Waiver of fiduciary duty runs counter to the long-established practice of permissible delegation. Can — and importantly should — an institutional fiduciary, e.g., an LP, simply eradicate the traditional agency relationship with the stroke of a pen? Indeed, is it even legally possible?
And what is liability for lawyers representing the LPs, who are supposed to have read, understood and advised their client? Are there malpractice claims lurking, too?
This are issues fiduciaries have consider as they continue to invest through limited partnerships or similar structures.
Jeffrey E. Horvitz is vice chairman of Moreland Management Co., Beverly Farms, Mass.