David Shea
By David Shea, Goodell DeVries
So, you’re in a partnership or some form of corporate ownership that acts like one. Something is rotten in the State of Denmark: you think one of your fellow partners is doing something borderline unethical or maybe even illegal with assets that belong to the partnership. Do you have a legal duty to disclose that knowledge to the other partners? This article does not address potential criminal liability here (i.e. you’re alleged to be part of a conspiracy committing illegal or fraudulent acts against other partners). Instead, the question this article seeks to explore is whether there is a civil law duty to disclose material facts that may impact the partnership, particularly concerning misconduct of another partner or partners. The short answer is probably yes, at least hypothetically. But to parrot that annoying law-professor answer every lawyer has undoubtedly heard: it depends.
Whether viewing partnerships or other forms of corporate entities, a common thread runs through how courts interpret a “duty to disclose.” The law quite logically only imposes a strict and pointed disclosure duty to those who are part of the entity’s control group. After all, they are the ones most likely to be privy to material facts others don’t know and are best positioned to use that information for self-gain.
And that’s largely what the civil law world has concerned itself with: a duty to self-report conflicts of interest and other material information to stakeholders by those who pull the levers. It does NOT hold limited partners and stakeholders accountable for their potential silence in light of their control groups’ malfeasance. And that makes sense; to do otherwise would be to blame the potential victim of that malfeasance instead of, or in addition to, blaming the perpetrator.
So where does the duty to disclose begin and end? To fully understand the contours of such a duty, it is worth first looking at how it is understood within other entity structures and business relationships. In addition to the better-known duties of care, loyalty, and good faith, Maryland courts recognize that corporate directors have a distinct “duty to disclose” “all facts material” to specific “corporate transactions” to the corporation’s shareholders [and somewhat fictionally the “corporation” itself]. Storetrax.com, Inc. v. Gurland, 397 Md. 37, 58 (2007). Similarly, agency law requires that an agent has a “duty to disclose information material to the agency” to their principal. Plank v. Cherneski, 469 Md. 438, 578 (2020). This again makes logical sense. An agent doing business on behalf of a principal or a director conducting large corporation transactions are both likely in possession of information that could affect that business and need to keep the principal apprised of such information.
In the same way, Maryland common law recognizes a fiduciary duty and a “duty to disclose” that runs from a general partner (“GP”) to a limited partner (“LP” ). Forston v. Winstead, 961 F.2d 469 (1992) (finding no such duty to disclose existed for the law firm retained by the GP to the LPs where there was no fiduciary duty owed by the law firm to the LPs — whether in contract or otherwise). Indeed, just as in the corporate setting, in Maryland, an LP can statutorily seek recourse for the misdeeds and self-dealings of a GP in a “derivative” lawsuit (suing on behalf of the partnership itself). I & G Investors, LLC v. Dunn, 2013 U.S. Dist. LEXIS 149000, *28-29 (Oct. 16, 2013) (citing Md. Code Ann. Corps &Ass’ns § 10-1001).
The converse, however, does not appear to be true. To be sure, the prudent and conservative approach — would be to keep your partners apprised of material changes in events that might affect the partnership, even if you are an LP. But Maryland caselaw does not appear to explicitly state that limited partners owe any kind of duty to disclose to other LPs or the GP(s). It can arguably be inferred by one of the Maryland code sections governing partnerships as part of the sub-duties imposed by the duty of loyalty, although such a duty is far from self-evident from the text itself (emphasis added):
Md. Corps. and Ass’ns Code Ann. § 9A-404. General standards of partner’s conduct
(a) The only fiduciary duties a partner owes to the partnership and the other partners are the duty of loyalty and the duty of care set forth in subsections (b) and (c) of this section.
(b) A partner’s duty of loyalty to the partnership and the other partners is limited to the following:
(1) To account to the partnership and hold as trustee for it any property, profit, or benefit derived by the partner in the conduct and winding up of the partnership business or derived from a use by the partner of partnership property, including the appropriation of a partnership opportunity;
(2) To refrain from dealing with the partnership in the conduct or winding up of the partnership business as or on behalf of a party having an interest adverse to the partnership; and
(3) To refrain from competing with the partnership in the conduct of the partnership business before the dissolution of the partnership.
(c) A partner’s duty of care to the partnership and the other partners in the conduct and winding up of the partnership business is limited to refraining from engaging in grossly negligent or reckless conduct, intentional misconduct, or a knowing violation of law.
(d) A partner shall discharge the duties to the partnership and the other partners under this title or under the partnership agreement and exercise any rights consistently with the obligation of good faith and fair dealing.
(e) A partner does not violate a duty or obligation under this title or under the partnership agreement merely because the partner’s conduct furthers the partner’s own interest.
(f) A partner may lend money to and transact other business with the partnership, and as to each loan or transaction the rights and obligations of the partner are the same as those of a person who is not a partner, subject to other applicable law.
And even in other jurisdictions that explicitly recognize a general fiduciary duty owed amongst partners, the GP or GPs are said to owe a specialized and heightened duty to disclose. See, e.g., Alloy v. Wills Family Trust, 179 Md. App. 255, 288 (2008) (quoting J. William Callison & Maureen A. Sullivan, Partnership Law and Practice: General and Limited Partnerships § 22:7) (emphasis added) (discussing a general duty under D.C. partnership law requiring partners “to disclose [to each other] all material facts concerning the partnership business….” that falls under the duty of loyal but also noting that “[s]ince general partners in a limited partnership typically have the exclusive power and authority to control and manage the partnership, they owe the limited partners an even greater fiduciary duty than is imposed on general partnership in the typical general partnership”).
So, while it’s advisable to keep your fellow partners generally up to date on facts you learn that may impact the partnership, mere suspicion of malfeasance is not a material fact. Moreover, after investigating such suspicions (as any reasonable LP should do out of self-interest and on behalf of the partnership), if true and irrefutable misconduct is uncovered, it is the general partner who violated a fiduciary duty in his or her failure to disclose self-dealing, a conflict of interest, or outright fraud. A court is far less likely to find any kind of liability or fault with a limited partner who simply did not make enough noise about said general partner’s own breach of his or her fiduciary duty. Ultimately, if a limited partner finds themselves in such a position, they must weigh the costs and benefits of bringing suit against the general partner. If suit is brought, this accomplishes a dual purpose: 1) bringing transparency and a remedy for such malfeasance and 2) putting the other partners on notice of the same.
For assistance in understanding your duty to disclose suspected wrongdoing within a business partnership, please contact David Shea at [email protected]. David is an associate in Goodell DeVries’s Commercial and Business Tort Litigation and Risk Management, Investigations, and Compliance Practice Groups.
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