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© Jack Lawter & Dianne Lawter, 2000 THE DYSFUNCTIONAL FAMILY LIMITED PARTNERSHIP: LITIGATION ISSUES RELATING TO FAMILY LIMITED PARTNERSHIPS PRESENTED BY: JACK W. LAWTER, JR. Lawter & Lawter, L.L.P. 5615 Kirby, Suite 930 Houston, Texas 77005 (713) 522-9400 WRITTEN BY: JACK W. LAWTER, JR. DIANNE W. LAWTER Lawter & Lawter, L.L.P. 5615 Kirby, Suite 930 Houston, Texas 77005 (713) 522-9400 14 Annual Wills & Probate Institute: th Focus on the Fundamentals Houston, Texas September 14-15, 2000 CHAPTER T

THE DYSFUNCTIONAL FAMILY LIMITED PARTNERSHIP: …...The Dysfunctional Family Limited Partnership: Chapter T Litigation Issues Relating to Family Limited Partnerships T - 1 T he Dysfunctional

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© Jack Lawter & Dianne Lawter, 2000

THE DYSFUNCTIONAL FAMILY LIMITED PARTNERSHIP:

LITIGATION ISSUES RELATING TO FAMILY

LIMITED PARTNERSHIPS

PRESENTED BY:

JACK W. LAWTER, JR.Lawter & Lawter, L.L.P.

5615 Kirby, Suite 930Houston, Texas 77005

(713) 522-9400

WRITTEN BY:

JACK W. LAWTER, JR.DIANNE W. LAWTER

Lawter & Lawter, L.L.P.5615 Kirby, Suite 930Houston, Texas 77005

(713) 522-9400

14 Annual Wills & Probate Institute: th

Focus on the Fundamentals

Houston, TexasSeptember 14-15, 2000

CHAPTER T

T - i

Table of Contents

I. Introduction. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

II. Financial Advantages of Family Limited Partnerships. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2A. The ability to transfer capital without killing the transferee's productivity and initiative.. . . . . . 2B. The pooling of partnership assets will lower operating costs and increase diversity.. . . . . . . . . . 2C. Simplify annual giving... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3D. Keep assets in the family.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3E. Provide some protection against future unforeseeable creditors.. . . . . . . . . . . . . . . . . . . . . . . . . . 3F. Protect assets against failed marriages.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4G. Partnership agreements are flexible... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4H. Business judgment rule offers flexibility in management.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4I. Arbitrate family disputes rather than litigate.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4J. Apply the "English" rule to disputes (loser pays).. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5K. Institutionalize communication on financial matters... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5L. Lower out-of-state probate costs.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5M. Indirectly allow trustee partners to follow modern portfolio theory.. . . . . . . . . . . . . . . . . . . . . . . 5N. A partnership has one level of income tax... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6O. In many jurisdictions there is no franchise tax or intangibles tax to pay with the use of

partnerships.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6

III. Additional Advantages of a Family Limited Partnership When Family Litigation is Expected. . . . . 6A. A temporary administrator or temporary guardian does not control the assets. . . . . . . . . . . . . . . 6B. No court control of assets or management... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6C. Disclosure is controlled by the partnership agreement.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6D. The partners can choose their partners.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7E. Control of the estate does not equate to control of money to fund litigation. . . . . . . . . . . . . . . . 7F. Business cannot be disrupted as easily.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7G. Potential contestants can be excluded from ownership of a partnership interest.. . . . . . . . . . . . . 7H. Community property concerns... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7I. Removal of general partner is difficult.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8J. Duties are owed only to partners.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8K. Becoming executor is not very attractive.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8L. It is more difficult for a contestant or litigant to force a partition, termination or distribution of

partnership assets.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9M. Arbitration clause with a loser pays provision can reduce the risk of frivolous cases.. . . . . . . . . 9

IV. The Family Limited Partnership to Avoid a Will Contest.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9A. No Contest Clauses.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9B. The use of the family limited partnership as an addition to or alternative to a no-contest clause

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9C. Structure of the family limited partnership as a substitute for a no-contest clause.. . . . . . . . . . . 10D. Example.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11

V. The Family Limited Partnership as a Substitute for a Prenuptial Agreement.. . . . . . . . . . . . . . . . . 12A. Prenuptial Agreements are Difficult to Use... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12B. A Family Limited Partnership As a Substitute for a Prenuptial Agreement.. . . . . . . . . . . . . . . . 12C. Example.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13

VI. Challenging or Defending the Validity of the Creation of a Family Limited Partnership. . . . . . . . 13A. Mental Capacity.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13B. Undue Influence... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14

T - ii

C. Duress.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14D. Fraud and Misrepresentation.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14E. Mistake... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15F. Agreement is Too Complicated to Understand.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15G. Comparison with Will Contest. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15

VII. Suing or Defending the General Partner of a Family Limited Partnership. . . . . . . . . . . . . . . . . . . . 16A. Texas Revised Limited Partnership Act §4.03. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16B. Duties of General Partner. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16C. Mismanagement.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16D. Self Dealing.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17

1. Texas Revised Limited Partnership Act §1.10. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 172. Case Law .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17

E. Lack of Disclosure.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18F. Exculpatory Clauses in Partnership Agreement.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19

VIII. Issues Relating to the Creation of a Family Limited Partnership by a Fiduciary.. . . . . . . . . . . . . . 20A. Fiduciary Relationships. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20

1. Guardian.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 202. Trustee. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 203. Executor/Administrator. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 204. Agent/Attorney-in-fact.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 215. Partnership or Joint Venture. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 216. Corporation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 217. Account - Client Relationship. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 218. Attorney-Client Relationship.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 219. Spouse. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2210. Relationship of Parties.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22

B. Fiduciary Issues. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 221. Fiduciary Duties.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 222. Loss of Value/Prudent Investment.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 223. Loss of Control/Delegation of Duties. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 224. Income Beneficiary vs. Remainderman. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 235. No Exit Strategy.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 236. Self Dealing. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 237. Diversification. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 238. Duty of Disclosure. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23

C. Example. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23D. Who Should Win?.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24

IX Psychological and Practical Problems which could lead to Litigation. . . . . . . . . . . . . . . . . . . . . . . 25A. The “Big Cheese” Syndrome. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25B. Sibling Jealousy and Rivalry. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25C. Too Complicated to Administer Properly.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25

The Dysfunctional Family Limited Partnership: Chapter T

Litigation Issues Relating to Family Limited Partnerships

T - 1

The Dysfunctional Family Limited Partnership:

Litigation Issues Relating to Family Limited PartnershipsBY: JACK W. LAWTER, JR. AND DIANNE W. LAWTER

LAWTER & LAWTER, LLP

I. Introduction

When bank robber, Willie Sutton, wascaptured, he was asked, "Why do you robbanks?" Willie answered, "That's where themoney is."

The location of the money is also thedriving force behind a recent increase inlitigation relating to family limitedpartnerships. This trend will likely continueas long as wealthy people can reduce transfertaxes by creating a family limited partnership.

The family limited partnership is one ofthe most effective and useful estate planningtools. More and more wealthy clients arecreating limited partnerships as more estateplanning lawyers include the family limitedpartnership as a part of their recommendedestate planning devices. In a happy family, alimited partnership can be great. However, wedo not yet know all of the potential problemswhich can arise when a family limitedpartnership is used in an unhappy or litigiousfamily. The authors believe that the familylimited partnership can be used as a tool toprevent litigation if careful thought is given tothe structure at the beginning.

As family limited partnerships becomemore common and more wealth is transferredto these entities, more litigation will ariserelating to these entities. For instance, asavvy, unscrupulous person may use undueinfluence or duress to force an elderly personto sign a family limited partnership instead ofa will. Many of the protections built into theprobate code and the law of wills do not existwith regard to a partnership agreement.

When a family limited partnership isused, instead of suing a negligent executor ortrustee, "beneficiaries" will be bringing suitagainst their general partner. Often when afamily limited partnership is created, theexecutor of an estate is holding little except apartnership interest. Many times, problems inthe family will be exacerbated if one person isgiven broad management authority after thedeath or incapacity of the patriarch ormatriarch. We will review the current statusof Texas law regarding suits against a generalpartner and actions to set aside or terminatepartnership agreements.

The driving force behind the move tofamily limited partnerships is the possibility ofsubstantial transfer tax savings. In thisenvironment, fiduciaries such as guardians,trustees, agents and executors will want toform family limited partnerships. We willexplore the issues relating to the creation of afamily limited partnership by a person who isserving as a fiduciary.

As more family limited partnerships arecreated by wealthy individuals, more familylitigation will move to the partnership arena.We will attempt to address the issues that arelikely to arise and attempt to make suggestionsto avoid some of the problems. Except inpassing, this outline does not deal with taxissues relating to family limited partnershipsor related tax litigation. This presentationdeals with Texas state law issues which mayarise in connection with a family limitedpartnership.

Chapter T The Dysfunctional Family Limited Partnership:

The Litigation Issues Relating to Family Limited Partnerships

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II. Financial Advantages of FamilyLimited Partnerships

A client can obtain numerous advantagesby creating a family limited partnership. Ofcourse, the primary advantage is transfer taxsavings. However, additional benefits can bederived from a family limited partnership.The following comprehensive list of financialadvantages of a family limited partnershipunrelated to transfer tax savings was set forthby S. Stacy Eastland in his outline "The Art ofMaking Uncle Sam Your Assignee Instead ofyour Senior Partner: The Use of Partnershipsin Estate Planning":1

A. The ability to transfer capital withoutkilling the transferee's productivity andinitiative.

Many successful clients fear thatsubstantial gifts to descendants may hindertheir productivity and initiative. In particular,clients with a substantial portfolio of stocksand bonds believe that giving a child orgrandchild a readily marketable asset wouldnot be doing that child any developmentalfavors. Most clients believe that no oneunderstands their children better than they do.By creating a family limited partnership andtransferring only a limited partnership interestto a descendant, a donor controls themarketability of the wealth transferredbecause the interest effectively cannot be soldand because the donor can reinvest thepartnership's cash flow rather than making

distributions to the partners. This retained,indirect power to affect the marketability ofthe transferred partnership interest does notsubject the transferred interest to estate taxeson the donor's death. By contrast, a retained2

power as trustee to determine the amount ofdistributions to trust beneficiaries may subjectthe trust assets to estate tax on the donor'sdeath

B. The pooling of partnership assets willlower operating costs and increasediversity.

Families often have many members, andoften several trusts have been created overtime in conjunction with prior gifts. Keepingup with investments for multiple parties canbe frustrating and expensive. Byconsolidating assets into one partnership,however, these problems over the long termare solved. It is easier and cheaper for apartnership to diversify investments becausethe size of the portfolio is larger. Likewise, itis easier and cheaper to diversify acrossseveral money managers because largeraccounts generally are less expensive on apercentage basis and because minimum sizerequirements are more easily met. This is whyunrelated individuals have used thepartnership form of ownership for their

The authors wish to express their appreciation to S.1

Stacy Eastland and John W. Porter of Baker & Botts,

L.L.P. for their assistance and permission to use their

descriptions of the financial advantages of a family

limited partnership. For an excellent outline on tax

court litigation relating to family limited partnerships,

see "Defending the Family Limited Partnership:

Litigation Perspective" by John W. Porter presented to

the Dallas Estate Planning Council on September 9,

1999.

See United States v. Byrum , 408 U.S. 125, 92 S.Ct.2

2382, 33 Led. 2d 238, 30 A.F.T.R.2d 72-5811, 72-2

USTC P. 12, 859 (U.S. Ohio, 1972). The Service held

in Tech. Adv. Mem. 91-31-006 (Apr. 30, 1991), citing

Byrum, that in a typical family limited partnership, the

managing partner will not be considered as having

retained an I.R.C. §2036(a)(2) or I.R.C. §2038 power

over the transferred limited partnership interest. See

also Rev. Rul. 81-15, 1981-1 C.B. 457; P.L.R. 94-15-

007 (Jan. 12, 1994); P.L.R. 93-10-039 (Dec. 16, 1992),

and P.L.R. 90-26-021 (Mar. 26, 1990); G.C.M. 38,984

(May 6, 1983); G.C.M. 38,375 (May 12, 1980).

The Dysfunctional Family Limited Partnership: Chapter T

Litigation Issues Relating to Family Limited Partnerships

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investment clubs. Related individuals also3

like forming "investment clubs". Thus, overtime, the pooling of assets will lead to greatervalue and wealth for all of the partners. Whenthe partners decide to terminate thepartnership agreement because of assetdiversity and cheaper per-unit operating costs,a significant comparative advantage couldexist for each partner in comparison to theirsituation if they had not pooled their assets.For investors who are not concerned withshort-term lack of control and marketability,and who wish to realize long-term growth oftheir assets for themselves and their family,the family partnership is an excellentinstitutional tool.

C. Simplify annual giving.

Many assets are extremely difficult tovalue and are not prone to gifts of undividedfractional interests. Good examples of suchassets are rural land and closely heldunincorporated businesses. Contributingthose assets to a family limited partnership,however, allows a donor to assign partnershipinterest to a descendant with the use of asimple form. A fractional interest is givenaway, yet there is no immediate risk ofpartition, and management of the assetremains consolidated. If a client wishes totransfer part of his limited partnership to hisissue, it generally will qualify for the annualexclusion.4

D. Keep assets in the family.

Family partnership agreements often aredrafted with certain buy-sell provisions to

ensure that the partnership's assets will stay inthe family. Under such provisions, if anypartner attempts to assign his or her interest inthe partnership to a person outside of thefamily, the other partners or the partnershipitself may acquire that interest on the sameterms, or, in the case of a gratuitous transfer,at its fair market value. Secondly, evenwithout buy-sell provisions, no outsider canhave any rights as a partner unless all of thepartners admit that outsider as a partner (andcan only be an assignee with limiteddistribution rights).

E. Provide some protection against futureunforeseeable creditors.

A family partnership can be a flexiblevehicle to provide some protection of anindividual's assets from future creditors. Theprincipal remedy of a partner's "outside"creditors, as distinguished from thepartnership's "inside" creditors, is to receive a"charging order" against the partner's interestin the partnership. Under many states' limitedpartnership laws, unless a partner has made afraudulent conveyance to the partnership or aconveyance deemed to be fraudulent, his orher creditors cannot reach the partnership'sassets. Instead, a creditor may obtain acharging order against the partner's interest inthe partnership, which does not give thecreditor any management rights but entitlesthe creditor only to the partner's share ofpartnership distributions (i.e., an assignee'sinterest). In addition, the partnershipagreement can be drafted so that aninvoluntary transfer of a partnership interest toa creditor or any other third party triggers buy-sell provisions which allow the other partnersor the partnership itself to purchase thatinterest at its fair market value. Since the fairmarket value of a limited partnership interestis usually much less than the underlying assetvalue the creditor effectively is paid with lessmoney, and the family assets are more likely

See Rev. Rul. 75-523, 1975-2 C.B. 257; Rev. Rul.3

75-525, 1975-2 C.B. 350.

See Tech. Adv. Mem. 91-31-006 (Apr. 30, 1991).4

But see Tech. Adv. Mem. 97-51-003 (August 28,

1997).

Chapter T The Dysfunctional Family Limited Partnership:

The Litigation Issues Relating to Family Limited Partnerships

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to survive the creditor's claims. Furthermore,partnership agreements can be drafted toprohibit the pledging of partnership interestsfor the debts of a partner.

F. Protect assets against failed marriages.

The risk of a gift to a descendant beingawarded to his or her spouse upon divorce canaffect an estate plan, and prenuptial orpostnuptial agreements may be distasteful orimpractical in many situations. In particular,stocks and bonds are very prone to beingcommingled with assets of the marriage and incommunity property states effectively mightbecome community property. Limitedpartnership agreements, however, can bedrafted so that gifts of limited partnershipinterests are protected from the risk ofdivorce. Many jurisdictions will not awardseparate property to a divorced spouse or willlimit that award. A partnership provides aconvenient means of segregating adescendant's separate property so thatcommingling is avoided. In addition, apartnership agreement can provide that aninvoluntary transfer of a partnership interestrequired by a divorce court will trigger buy-sell provisions under which the other partnersor the divorced partner can buy that interest atits fair market value. Because the fair marketvalue of the limited partnership interest isusually less than the underlying asset values,a divorced partner is protected even if a courtawards his or her interest to a former spouse.

G. Partnership agreements are flexible.

In comparison to an irrevocable,unamendable trust, a limited partnership is avery flexible arrangement. If all of thepartners agree, the partnership agreement maybe amended or the partnership may beterminated, and usually all of the partners arefamily members. By contrast, an irrevocabletrust generally may not be amended or

terminated without court participation andparticipation by a guardian or an attorney adlitem for certain beneficiaries. As comparedto corporations, a partnership requires fewerformalities and may be terminated without thepotential adverse tax consequences associatedwith the termination of a corporation.

H. Business judgment rule offersflexibility in management.

The "prudent man" rule applicable totrustees is a stricter standard than the businessjudgment rule applicable to the managingpartners of a partnership. Many financial5

investments, such as options andcommodities, and many business decisions,such as wildcat oil drilling, may be reasonablein terms of normal business judgment butcould be considered imprudent under trustlaw. Most families want to protect the familymember who is charged with theresponsibility of making investment decisions.In particular, families often want that familymember to be protected from the "20/20hindsight" of a court or jury.

I. Arbitrate family disputes rather thanlitigate.

Recent history is replete with examples ofhighly publicized intrafamily litigationinvolving the management of family assets. Itis extremely difficult to replace a trustbeneficiary's right to sue his trustee with acommitment to binding arbitration: the statelaw right of a beneficiary to sue his or hertrustee in many jurisdictions may not beremoved by a trust agreement. Because apartnership agreement is a mere contract,

Although the partnership agreement can provide5

that the business judgment rule is applicable, case

law applies a higher standard. See Section VII

Suing or Defending the General Partner of a

Family Limited Partnership, Supra.

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however, it can be written so that all of thepartners agree to settle disputes by arbitration.When compared to a jury trial, arbitration isusually preferable especially in the familycontext. The publicity associated with familydisputes can provide an unfair advantage tothe person bringing a lawsuit against thefamily's decision maker. With a well-draftedpartnership agreement, such publicity can beavoided through the arbitration process andenforced by a confidentiality provision. Inaddition, an experienced business person orfinancial advisor may serve as arbitrator andfact finder. Thus, where the client determinesthere is an advantage to arbitration, thepartnership vehicle is clearly superior to theuse of a trust in many jurisdictions.

J. Apply the "English" rule to disputes(loser pays).

Under the trust law, frivolous actions canbe difficult to prevent and may be brought bybeneficiaries just to provoke a resignation ordistribution by the trustee. It is difficult tocharge a trust beneficiary with the costsassociated with a legal action. Furthermore,even though a trustee may be reimbursed forlegal costs out of the trust's properties, theother beneficiaries of the trust suffer becauseof that reimbursement. By contrast, apartnership agreement can require a partnerwho brings an unsuccessful arbitration actionagainst the management of the partnership topay all of the costs associated with thearbitration. Thus, a family limited partnershipmore easily avoids frivolous claims andharassment actions.

K. Institutionalize communication onfinancial matters.

One of the more enjoyable aspects of afamily limited partnership is that it can serveto institutionalize the education of youngerfamily members on the family's wealth

management philosophies. Many people seenothing wrong with wealth per se, but fearthat it can be abused and therefore want tooversee the financial experiences of youngerfamily members. In addition, prudentinvestment can generate employment andserve other altruistic purposes. Thecollectivism provided by a partnershipagreement institutionalizes this educationalprocess.

L. Lower out-of-state probate costs.

Many people in our mobile society ownpassive real estate investments, includingvacation property, outside of their home state.Contributing that property to a family limitedpartnership avoids the costs associated without-of-state probate of those assets. Also, ifthe home state jurisdiction does not have abasic inheritance tax, the basic inheritance taxof the ancillary jurisdiction may be avoided incertain instances through the use of a familylimited partnership.

M. Indirectly allow trustee partners tofollow modern portfolio theory.

A trustee may have difficulty followingmodern portfolio theory because there is anatural conflict between the investmentphilosophies of income beneficiaries, whoprefer current income to growth, andremainder beneficiaries, who prefer growth tocurrent income. In general, modern portfolioor asset allocation theory teaches that rationalinvestors should seek to achieve the highestrate of return consistent with their tolerancefor risk, from whatever source. For example,sometimes stocks, may be preferred to bonds,and at other times the reverse is true. Onetype of trust, known as a "unitrust", payscurrent beneficiaries a percentage of the valueof the unitrust's assets, thus allowing thetrustee to follow modern portfolio theory;however most trusts are not unitrusts. A

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limited partnership, on the other hand, canserve as a "wrapper" around family assets andallow those assets to be managed like aunitrust. The managing partner can invest ina way that produces the highest rate of returnconsistent with his or her tolerance for risk,whether the source of that return isappreciated or current income. The managingpartner then may distribute the percentage ofthe partnership's assets that he or she deemsappropriate to the current "beneficiaries" (i.e.,partners) of the partnership.

N. A partnership has one level of incometax.

Partnerships are "pass through" entitiesthat do not pay income tax. Since the repealof the General Utilities Doctrine, "C"corporations and business trusts have becomevery inefficient tax entities because there willalways be two levels of income tax, even onunrealized gains.

O. In many jurisdictions there is nofranchise tax or intangibles tax to pay withthe use of partnerships.

III. Additional Advantages of a FamilyLimited Partnership When FamilyLitigation is Expected

A. A temporary administrator ortemporary guardian does not control theassets.

Often one of the biggest areas ofcontention when a will contest is filed is theappointment of a temporary administrator. Inmany cases, the temporary administrator willhave control of all of the assets of the estate.A similar struggle often occurs when atemporary guardianship is instituted. Inaddition to the possibility of a substantialcontest about the identity of the temporaryadministrator or a temporary guardian, a

family also faces the risk that the court willappoint an independent third party toadminister the Estate. This often results insubstantial fees and management by a personnot familiar with the property or business. Afamily limited partnership holding most or allof the assets of the client will usually avoidthe risk that a temporary administrator ortemporary guardian will have control of theassets.

B. No court control of assets ormanagement.

If assets are held in a family limitedpartnership, the court in which anadministration or guardianship is pending willnot have control over the assets. The familylimited partnership can continue to operatewithout control by the court in most instances.This can be important when litigation ispending because the contestant will not havea venue to express opinions aboutmanagement of the assets. This should alsomake it more difficult for the contestant tofrustrate his opponent by causing delays infinancial decisions or even preventing theimplementation of financial decisions byobjecting in court.

C. Disclosure is controlled by thepartnership agreement.

One of the problems faced by a familybusiness when litigation is pending is thedisclosure requirements in a litigation context.Often, contesting beneficiaries will makenumerous demands for documents andinformation. A partnership agreement may bedrafted to restrict the information which mustbe provided to partners. Arguably, non-partners would not be entitled to anyinformation based on an informal request.Obviously, subpoenas and other discoveryrequests can still be used by litigants, but thepartnership agreement should control informal

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requests for information and may have animpact on the court when it is considering theamount of information which must beproduced by a family partnership in discoveryand the confidentiality of financialinformation.

D. The partners can choose their partners.

One of the important aspects of apartnership is that the partners cannot beforced to be partners with someone.Consequently, a contestant or other litigantcannot be assured that victory in familylitigation will result in becoming a partner. Infact, litigation with other family members willprobably assure that the contestant will neverbecome a partner.

E. Control of the estate does not equate tocontrol of money to fund litigation.

When a client's property has been placedin a family limited partnership, the only assetheld in a probate or guardianship estate will bea limited partnership interest. The executor,administrator or guardian will not inherit anygeneral partnership management rights inmost instances. Consequently, therepresentative will not have the power tocompel distributions from the partnership.The general partner will continue to have thepower to decide when and if any distributionsare made.

F. Business cannot be disrupted as easily.

One of the biggest problems whenlitigation is filed is a disruption of familybusiness and investments. Even a claimwhich lacks merit can disrupt a familybusiness or a family investment strategy. If allof the family business and investment assetsare held in a family limited partnership, theimpact of a will contest or other litigation islessened.

G. Potential contestants can be excludedfrom ownership of a partnership interest.

A family limited partnership can bedrafted to prohibit ownership by potentialcontestants. The buy-sell provisions couldspecifically provide for a buy-out of apartnership interest which was assigned to aparticular family member. If the partnershipagreement is drafted carefully, the agreementcan limit or eliminate the upside potentialfrom a contest or other litigation. At the veryleast, the provision which prohibits ownershipby a particular person would cause thecontestant to have to set aside the provision ina trial or arbitration.

H. Community property concerns.

The family limited partnership can helpkeep separate property separate.Commingling of community and separateproperty is more difficult if separate propertyis placed in a family limited partnership. Theowner of the separate property whocontributes such property to a partnershipowns a partnership interest rather than theassets contributed to the partnership. It isdifficult to imagine how a partnership interestcould be commingled with communityproperty. This is in stark contrast to bankaccounts and brokerage accounts whichalmost always become commingled.Partnership income which is not distributed isgenerally not community property of thepartners.

The community or separate nature of eachpartner's interest in the partnership propertydepends on the source of the property. If amarried partner contributes communityproperty, then the interest is communityproperty. On the other hand, if a marriedpartner contributes separate property, hisinterest in the partnership is separate propertyto that extent, and any appreciation in its valueas a result of general economic conditions, as

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distinguished from labor and effort beyondthat required for preservation of the separateproperty, remains separate property. Smoot v.Smoot, 568 S.W. 2d 177 (Tex. Civ. App. -Dallas 1978, no writ). In Roach v. Roach, 672S.W.2d 524 (Tex. App. - Amarillo 1984, nowrit), the court held that where husbandconveyed his separate property to thepartnership without expressing any prior orcontemporaneous intention that the propertywould not be the partnerships property,husband and wife, as the only partners,became co-owners of the property holding astenants in partnership, but their rights in theproperty were not community property.

I. Removal of general partner is difficult.

One of the tactics frequently used infamily litigation is an action to remove anexecutor, trustee or guardian. A beneficiary ofan estate or trust has a substantial advantage ina removal action because of the fiduciaryduties owed by the fiduciary. In addition, theTexas probate code provides for recovery ofattorneys fees in a removal action. Attorneyfees also may be recoverable under the trustcode in an action to remove a trustee. To thecontrary, in most family limited partnerships,removal of the general partner is difficult.Removal of a general partner by a non-partnerwould be extremely difficult. In mostinstances, attorney's fees would not berecoverable in an action which attempted toremove a general partner.

J. Duties are owed only to partners.

If the potential contestant is not a partner(or is a partner with very limited rights), thegeneral partner will owe no duties or limitedduties to the potential contestant. One of thedifficult aspects of family litigation in anestate, trust or guardianship is that oftenfiduciary duties are owed to the personbringing the lawsuit. If the contestant is not a

partner, no duties will be owed to thecontestant, or only duties owed to an assigneeof a partnership interest will be owed. Theduties owed to an assignee of a partnershipinterest are limited under state law and can bedefined in the partnership agreement andlimited even further. An assignee of apartnership interest is generally entitled onlyto the assignee's share of any distributions if adistribution is made.

K. Becoming executor is not veryattractive.

After the death of the patriarch ormatriarch of the family, it is often veryimportant to have control of the estate iflitigation is probable. However, if all orsubstantially all of the assets of the estate areheld in a family limited partnership, theexecutorship is not very attractive. In thatinstance, the executor would own a valuablepartnership interest but would have no right tocompel distributions. Consequently, theexecutor would owe a large estate tax andwould have no way to fund administrationexpenses and the estate tax without thecooperation of the general partner or througha sale of the partnership interest. Of course,the other partners are the only realisticpurchasers of a partnership interest held by anestate. Thus, the role of executor is not asattractive when the assets are held in a familylimited partnership.

L. It is more difficult for a contestant orlitigant to force a partition, termination ordistribution of partnership assets.

The family limited partnership agreementwill control the termination, partition anddistribution of the partnership. A contestantcannot effectively bring suit to force apartition or distribution of a limitedpartnership in most instances. On the otherhand, actions can be brought to compel

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distributions or force a partition of the estatesand trusts. In some instances, a completetermination of a trust can be obtained throughcourt action.

M. Arbitration clause with a loser paysprovision can reduce the risk of frivolouscases.

As mentioned above, the partnershipagreement can be drafted to include aprovision requiring arbitration of all disputesrelated to the partnership. Arbitration clausesare generally enforceable in Texas. See e.g.,Prudential Securities Inc. v. Marshall, 909S.W. 2d 896 (Tex. 1995). Because the law ofcontract applies to a partnership agreement,the courts are likely to enforce the terms of thepartnership agreement. A provision whichrequires the loser to pay all expenses andattorney fees of an arbitration is a largedisincentive to any claim which is designedsolely to harass the opponent. This provisionalso tends to make both sides more reasonableon difficult issues because neither party willwant to go to an arbitration if a substantial riskexists that he or she will lose and will have topay all of the costs and fees.

IV. The Family Limited Partnership toAvoid a Will Contest.

A. No Contest Clauses.

A will with a no-contest clause is not avery satisfactory way to avoid familylitigation. Courts are extremely reluctant toenforce a forfeiture clause. The provisions arestrictly construed. Sheffield v. Scott, 662 S.W.2d 674, 676 (Tex. App. - Houston [14th Dist.]1983, writ ref'd n.r.e.] The courts createexceptions such as the policy of not enforcinga no-contest clause when a will contest orother litigation is brought in good faith andwith just cause. Calvery v. Calvery, 55 S.W.2d 527, 530 (Tex. 1932); See also, First

Methodist Episcopal Church South v.Anderson, 110 S.W. 2d 1177 (suit was not acontest but good faith/probable causeexception discussed with approval).Furthermore, the clause is only effective insituations in which the contestant has a greatdeal to lose. Finally, contestants are oftenable to use various other devices or causes ofaction to avoid the no-contest clause or tootherwise cause enough trouble and expenseto the rest of the family to cause the othermembers to settle even when thecircumstances do not justify a settlement.

B. The use of the family limitedpartnership as an addition to or alternativeto a no-contest clause.

In many situations, the client or the estateplanning attorney will know that litigation islikely. For instance, litigation is expectedwhen a wealthy client writes a will underwhich a child receives substantially less thanan equal share or the client excludes his or herchildren in favor of a second, third or fourthspouse. A better alternative to a will with ano-contest clause may be the use of a family limited partnership. Many of the problemswith no contest clauses could be avoided.

1. The case law relating to the strictinterpretation of no contest clauseswould not be applicable.

2. The reluctance of the courts to enforcea forfeiture provision could be avoidedthrough the use of mandatory bindingarbitration in the limited partnershipagreement.

3. The upside potential for the contestantcan be eliminated through the use ofprovisions relating to control of thepartnership and buy-sell provisions.

C. Structure of the family limitedpartnership as a substitute for a no-contest

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clause.

The following structure could beemployed to use a family limited partnershipas a substitute for (or addition to) a will witha no contest clause:

1. A family limited partnership would becreated holding substantially all of theassets of the client.

2. The client's intended primarybeneficiaries would be made class Apartners and perhaps general partnersalong with the client. The class Apartners would share in the profits andlosses of the partnership and would beentitled to distributions deemedappropriate by the general partner.

3. The partnership agreement wouldprovide that only the intended primarybeneficiaries, their descendants andcharities could ever own the class Ainterests in the partnership.

4. The partnership agreement wouldprovide for purchase of any interestassigned to the "contestant" at asubstantial discount or even a nominalprice. Alternatively, the partnershipcould provide that any attempt totransfer or assign an interest(voluntary or involuntary) to the"contestant" is void. The provisionswould need to provide for a defaultprovision stating that the ownership ofany attempted assignment to thecontestant would pass to the intendedprimary beneficiaries or a charity.

5. The contestant would be given a classB partnership interest which wouldprovide for guaranteed payments tothe contestant. The guaranteedpayments would be conditioned upon

no litigation being filed by thecontestant. The class B interest wouldhave very limited rights or access toinformation about the partnership andwould have no rights to enforce any ofthe partnership provisions other thanthe guaranteed payment. Theguaranteed payment could be as largeor as small as the client desires butshould be enough to cause thecontestant to hesitate before he or shesues.

6. The partnership agreement wouldcontain a provision which states thepartners intent that no litigation beinstituted in any proceeding by any ofthe limited partners against thepartnership, any of the general orlimited partners or the estate of any ofthe partners (including a will contest)and that any partner who files anaction forfeits his or her interest. Anexception can be made for actionsapproved by the general partners orapproved by all partners.

7. The partnership agreement wouldprovide for binding arbitration of anydisputes.

8. The partnership agreement wouldprovide that the loser pays theattorneys fees relating to any litigationor arbitration.

D. Example.

Mr. Jones has a $50 million estate and isinterested in a family limited partnership. Mr.Jones has two sons, his favorite son,Goldenboy Jones, and his other son,Blacksheep Jones. Mr. Jones would like toleave all or substantially all of his estate toGoldenboy Jones, but he is fearful that hisother son, Blacksheep, will sue after his death

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and will cause a great deal of trouble forGoldenboy. Mr. Jones is competent, in goodhealth and is willing to go to great lengths tosee that his intentions are followed after hisdeath. Mr. Jones comes to his lawyer, JoeEstateplan, and asks for advice. What shouldJoe suggest?

Joe suggests a limited partnership withtwo classes of partnership interests. Mr. Jonescontributes all or substantially all of his assetsto the partnership. Goldenboy and Mr. Jonesacquire all of the class A limited partnershipinterests in the partnership. The class Alimited partners participate in the profits andlosses of the partnership. In addition, Mr.Jones and Goldenboy Jones acquire thegeneral partnership interests. Mr. Jones alsoobtains the class B limited partnershipinterests in the partnership. The class Binterest is a $500,000 interest which pays an11% return annually by a guaranteed paymentas long as the class B interest holder does notbring any suit against the partnership, any ofits partners, or a partner's estate (including awill contest). The class B partners are entitledto no information about the partnershipbusiness as long as the annual guaranteedpayment is made. A small fraction of theclass B interest ($10,000 worth) is given toBlacksheep Jones by Mr. Jones when thepartnership is formed. The partnershipprovides that if any class A interest is acquiredby Blacksheep, the partnership may redeemthe interest for $1.00. The partnershipagreement also provides that if any partnerbrings suit against any other partner, apartner's estate or the partnership, such partnerforfeits his share of the partnership and suchforfeited share passes to the American RedCross. Mr. Jones also writes a will with a nocontest clause which leaves all of his generalpartnership interest and Class A interest toGoldenboy and his Class B interest toBlacksheep. The partnership agreement alsoprovides for arbitration of any disputes and

provides that the loser pays the cost of theproceeding and all attorney's fees. Finally thepartnership agreement provides that anassignee of a partner can never be admitted tothe partnership without the unanimous consentof all class A partners.

This structure should allow Goldenboy tocontrol the partnership after Mr. Jones' deathand should help prevent a will contest or otherlitigation by Blacksheep. If Blacksheep wereto prevail in a will contest or other litigationand be in a position to acquire an interest ineither a general partnership or class A interest,the provisions of the partnership would allowGoldenboy to enforce a forfeiture ofBlacksheep's share of the partnership. Thepartnership agreement would allow thepartnership to acquire any interest whichwould pass to Blacksheep for $1.00. Thedefault provision on the class B interest to theAmerican Red Cross will help make theforfeiture provision more palatable and wouldhelp avoid any adverse income taxconsequences from the forfeiture. The law ofcontract should control rather than the law ofwills. In addition, Goldenboy may be able toforce Blacksheep to arbitrate any dispute withthe threat of having to pay the winner'sattorneys' fees. If Blacksheep accepts the giftof the class B interest, Goldenboy should beable to assert an estoppel has arisen againstBlacksheep as to the validity of thepartnership. This arrangement has anadditional benefit for Goldenboy because theprovisions in the partnership agreementdesigned to prevent litigation are an excellentnon-tax business reason for the existence ofthe partnership. This should assist Goldenboyon an estate tax audit.

Query: Would Blacksheep have to facemost of the obstacles set forth above if Mr.Jones was not healthy and competent andthought he was John Hancock signing theDeclaration of Independence when the limited

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partnership agreement was executed? Theanswer should be no, but as a practical matter,it is likely that a court or arbitrator willenforce a partnership agreement until it is setaside. The risk of abuse is substantial.However, to borrow from the NRA,partnerships don't abuse people, people do.

V. The Family Limited Partnership as aSubstitute for a Prenuptial Agreement.

A. Prenuptial Agreements are Difficult toUse.

Although a valid prenuptial agreementcan be prepared, the agreements are difficultto use and difficult to enforce. Many clientswill not approach their future spouse about aprenuptial agreement. The entire subject isnot very romantic. In addition, to beenforceable, both future spouses need to berepresented by counsel and the negotiationsmay get the marriage off to a bad start.Sometimes the parties cannot reach anagreement but get married anyway. Finally,courts are reluctant to enforce prenuptialagreements and a substantial risk alwaysexists that an agreement will not be enforced.The spouse whose rights are limited by theprenuptial agreement often will be able toassert misrepresentation, duress or coercion asgrounds to set aside the prenuptial agreement.

B. A Family Limited Partnership As aSubstitute for a Prenuptial Agreement.

A family limited partnership created priorto marriage can serve many of the purposes ofa prenuptial agreement. Clearly, any propertycontributed to a partnership prior to marriageis separate property. Consequently, thepartnership interest received in exchange forthe contribution of assets to the partnership isseparate property. Property held in apartnership is partnership property rather thanthe property of any individual partner. Theentity nature of a limited partnership is now

well established. See Haney v. Fenley, Bate,Deaton and Porter, 618 S.W. 2d 541 (Tex.1981) and comments to Texas RevisedLimited Partnership Act, Art. 6132a-1.Consequently, the partnership property cannotbecome community property of any partner byadding income earned to a partnership accountor investing or reinvesting any of the funds.

Commingling of bank accounts andbrokerage accounts should not be a problem inmost cases. The spouse who contributes tothe partnership will own only a partnershipinterest which cannot be commingled withcommunity property. The banking andbrokerage activities of the partnership willhave no effect on the community property ofthe partners.

If the partner spouse receives a reasonablesalary for any time he or she spends on thepartnership business and business formalitiesare generally followed, the partnership interestshould remain the separate property of thepartner spouse. In most instances, this wouldinclude any retained income and appreciationin the partnership during marriage. The use ofa family limited partnership should keepseparate property separate, avoid the mostcommon commingling issues, provide avehicle for management of partnershipproperty and provide a vehicle to maketestamentary gifts to a spouse withoutdamaging the family business.

C. Example.

Mr. Stooge is 65 years old, single,healthy, competent and the owner of a $50million estate made up primarily ofmarketable securities. Mr. Stooge has threesons from a previous marriage, Mo, Larry andCurly. Mr. Stooge comes in to visit hisattorney Joe Estateplan and tells Joe that heplans to get married soon to a twenty-five yearold exotic dancer known as Boom Boom

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Johnson. Mr. Stooge is in love, but realizesthat the marriage may not work. He is alsoconcerned that Boom Boom may not get alongvery well with Mo, Larry and Curly. Mr.Stooge does not want to approach his bride-to-be about a prenuptial agreement and does notbelieve that Boom Boom would agree to aprenuptial agreement anyway. What shouldJoe suggest?

Joe Estateplan could suggest the creationof a family limited partnership with Mo, Larryand Curly. The partnership would be createdand completely funded prior to marriage withall of Mr. Stooge's assets except hishomestead. The partnership agreement wouldprovide for Mr. Stooge to be the generalpartner and Mr. Stooge and his sons the classA limited partners. The class A limitedpartners would share in all profits or losses ofthe partnership. The partnership agreementwould provide that no person could beadmitted as a Class A limited partner orgeneral partner without the approval of allClass A limited partners. A class B limitedpartnership interest also would be createdwith $5 million of capital and held by Mr.Stooge. The Class B interest would entitle theholder to a guaranteed payment of 9% per yearand would have very limited rights toinformation about the partnership.

Joe advises Mr. Stooge that this plan willavoid the risk of commingling his separateproperty investments with communityproperty. This will also assure that hisinvestments will be controlled by his sonsafter his death. The Class B interest willprovide Mr. Stooge and Boom Boom withcash flow during marriage and if the marriageworks Mr. Stooge can use the Class B interestto provide for his spouse in his will withouthaving to give her any management authority.If Mr. Stooge continues to be concerned aboutdisputes between Boom Boom and Mo, Larryand Curly, he can draft a widow's election will

which would require Boom Boom to electbetween a gift of the Class B partnershipinterest and her community property rights.

If the marriage does not work, the limitedpartnership should insulate the partnershipassets from community property claims byBoom Boom. Separate property is clearlyidentified and cannot be commingled if thepartnership is run properly. The guaranteedpayment to Mr. Stooge on the Class B interestshould avoid any claims that he has not beenproperly compensated for his time, toil andtalent. Although all of the risks of divorce arenot eliminated, Mr. Stooge has reduced hisrisks of a disastrous result.

VI. Challenging or Defending the Validityof the Creation of a Family LimitedPartnership

A. Mental Capacity.

With the more frequent use of apartnership to reduce transfer taxes, moreelderly people are forming limitedpartnerships. Traditionally, people in theirseventies or eighties would not be formingmany new business ventures, but in today'sworld, an elderly person is the most likelycandidate for a family limited partnership.The law of contracts applies to the creation ofa partnership. Park Cities Corp. v. Byrd, 534S.W. 2d 668, 672 (Tex. 1976). Consequently,a partner must have the capacity necessary toenter into a contract in order to form a validpartnership. A party has mental capacity tocontract if he appreciates the effect of what heis doing and understand the nature andconsequences of the acts and business beingtransacted. Mandell and Wright v. Thomas,441 S.W. 2d 841 (Tex. 1969).

B. Undue Influence.

A contract, including a partnership

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agreement, may be set aside because of undueinfluence. Undue influence in the executionof an instrument is present when dominionand control is exercised over the mind of theperson executing the instrument, under factsand circumstances then existing, to overcomehis free agency and free will and to substitutethe will of another so as to cause him to dowhat he would not otherwise have done butfor such dominion or control. Seymour v.American Engine & Grinding Co., 956 S.W.2d 49 (Tex. App. - Houston [14th Dist.] 1996,writ denied); Bailey v. Arlington Bank & TrustCo., 693 S.W. 2d 787 (Tex. App. - Fort Worth1985, no writ); B.A.L. v. Edna Gladney Home,677 S.W. 2d 826 (Tex. App. - Fort Worth1984, writ ref'd n.r.e.). "Overreaching" istricking, outwitting or cheating a person intodoing an act he would not have otherwisedone. B.A.L. v. Edna Gladney Home, supra.

C. Duress.

Duress or coercion are grounds to setaside or rescind a contract. To recover forduress or coercion, a party to a contract mustprove that the other party threatened to dosome act which it had no right to do, that thethreat was of such a character as to destroy thefree agency of the other party, that the threatovercame the free agency of the other partyand caused the other party to do that which itwas not otherwise legally bond to do, thatrestraint was imminent and that thecomplaining party had no means of protection.Tennessee Gas Pipeline Co. v. LenapeResources Corp., 870 S.W.2d 286 (Tex. App.- San Antonio 1993, affirmed in part, reversedin part by, 925 S.W.2d 565 (Tex. 1996)).Duress will invalidate a contract if undue orunjust advantage has been taken of anotherperson's economic distress or necessity tocoerce him into making an agreement. Brownv. Cain Chemical, Inc., 837 S.W.2d 239 (Tex.App. - Houston [1st Dist] 1992, writ denied).Intimidation may be sufficient to constitute

duress. Windham v. Alexander, Weston &Poehner, P.C., 887 S.W.2d 182 (Tex. App. -Texarkana 1994, writ denied).

D. Fraud and Misrepresentation.

As a general rule a party is not bound bya contract procured by fraud. FormosaPlastics Corp. U.S.A. v. Presidio Engineersand Contractors, Inc., 960 S.W.2d 41, 41 Tex.Sup. Ct. J. 289 (Tex. 1998). The legal dutynot to fraudulently procure a contract isseparate and independent from the dutiesestablished by the contract. Id. The law iswell settled that a person who has beeninduced to enter into a contract because ofmisrepresentations or concealments ofmaterial facts to his detriment, upon thediscovery of the fraud perpetrated upon him,has a choice of two remedies: 1) he mayaffirm the contract and sue for his damages; or2) he may rescind the contract. Dallas FarmMachinery Co. v. Reaves, 158 Tex. 1,207S.W. 2d 233 (1957).

E. Mistake.

A mutual mistake of fact will allowrescission of a contract. A partnershipagreement, like any other agreement orrelationship, may be rescinded when propergrounds exist. Volpe v. Schlobohn, 614 S.W.2d 615 (Tex. Civ. App. - Texarkana 1981, nowrit). When parties to an agreement havecontracted under a misconception or ignoranceof a material fact, the agreement will beavoided. Williams v. Glash, 789 S.W.2d 261(Tex. 1990). A mistake of law does notrelieve a party to a contract from being boundby its terms. Oak Hills Properties v. SagaRestaurants, Inc., 940 S.W.2d 243 (Tex. App.- San Antonio 1997, no writ). A unilateralmistake of fact will usually not be sufficient toset aside a contract unless the partycomplaining can show that the mistake was ofsuch great consequence that to enforce the

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contract would be unconscionable; themistake related to a material feature of thecontract; mistake was made regardless ofexercise of ordinary care and parties can bereturned to status quo such that rescission ofthe contract would not result in prejudice tothe other party except for the loss of thebargain. Seymour v. American Engine &Grinding Co., 956 S.W.2d 49 (Tex. App. -Houston [14th Dist.] 1996, writ denied).

F. Agreement is Too Complicated toUnderstand.

Family limited partnerships used in estateplanning are extremely complicated,sophisticated documents. It is likely thatparties will attempt to question whether thepartners (particularly elderly partners)understand the agreement. The law does notfavor this attack on a contract. A person ispresumed to know and understand thecontents of a contract. R. Conrad Moore &Associates, Inc. v. Lerma, 946 S.W.2d 90(Tex. App. - El Paso 1997, writ denied). Evenfailure to read the contract is not grounds foravoiding the contract. Estes v. Republic Nat.Bank of Dallas, 462 S.W.2d 273 (Tex. 1970).It appears that the complexity of theagreement cannot provide a defense unless itis combined with a more traditional defensesuch as lack of mental capacity or fraud.

G. Comparison with Will Contest.

1. No witnesses required for apartnership agreement.

2. Testamentary capacity is a slightlylower level than the capacity required to enterinto a contract.

3. The burden of proof is on the partyseeking to set aside the partnership agreement(the plaintiff) on all issues. In a will contestbefore a will has been admitted to probate, theproponent of the will has the burden oncapacity and lack of revocation.

4. Few formalities are required for apartnership agreement to be valid.

5. Undue influence and duress claims aresimilar in a will contest and an attack on apartnership.

6. Fraud claims are similar in a willcontest and an attack on a partnership.However, fraud and misrepresentation claimsmay arise more often in a partnership contextbecause the transaction involves businessmatters and mutual promises.

7. Registration with the state is requiredfor a limited partnership and is a publicrecord. See Article 2 of the Texas RevisedLimited Partnership Act. Tex. Rev. Civ. Stat.Ann. art. 6132a-1 (Vernon Supp. 1999). Awill is a private document (often privileged)document until submitted for probate.

8. Estoppel is available as a defense inboth types of action. A person who accepts apartnership interest or benefits from apartnership interest is estopped to challengethe validity of the partnership. Adams v.Petrade, Intern., Inc. 754 S.W. 2d 696 (Tex.App. - Houston [1st Dist.] 1988, writ denied).A similar defense is available in a will contest.

VII. Suing or Defending the GeneralPartner of a Family Limited Partnership

A. Texas Revised Limited Partnership Act§4.03

Sec. 4.03. (a) Except as provided by thisAct or a partnership agreement, a generalpartner of a limited partnership has the rightsand powers and is subject to the restrictions ofa partner in a partnership without limitedpartners.

(b) Except as provided by this Act,a general partner of a limited partnership hasthe liabilities of a partner in a partnershipwithout limited partners to persons other thanthe partnership and the other partners. Exceptas provided by this Act or in the partnershipagreement, a general partner of a limited

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partnership has the liabilities of a partner in apartnership without limited partners to thepartnership and to the other partners.

Tex. Rev. Civ. Stat. Ann. art. 6132a-1 Sec.4.03 (Vernon Supp. 1999)

B. Duties of General Partner

Although changes have been made to theTexas Revised Partnership Act in recent years,it appears that the courts will continue to treatthe relationships between the partners of apartnership as a relationship in the nature of afiduciary relationship. M.R. Champion, Inc. v.Mizell, 904 S.W.2d 617, 618 (Tex. 1995).Traditionally, in a limited partnership, thegeneral partner acting in complete controlstands in the same fiduciary capacity tolimited partners as a trustee stands tobeneficiaries of a trust. McLendon v.McLendon, 862 S.W.2d 662, 676 (Tex. App.,- Dallas 1993, writ denied). A managingpartner of a general partnership owes his co-partners the highest fiduciary duty recognizedby law. Huffington v. Upchurch, 532 S.W.2d576, 579 (Tex. 1976). Partners owe to eachother a fiduciary duty of (1) full disclosure ofall matters affecting partnership, (2)accounting for all partnership profits andproperty, i.e. refraining from self-dealing, and(3) refraining from competition withpartnership. Hawthorne v. Guenther, 917S.W. 2d 924 (Tex. App. - Beaumont 1996,writ denied). It appears that the courts willcontinue to treat the relationships betweenpartners as something like a fiduciaryrelationship in the absence of a provision inthe partnership agreement.

C. Mismanagement.

A managing partner has a duty toadminister the partnership affairs solely forthe benefit of the partnership. Crenshaw v.Swenson, 611 S.W. 2d 886, 890 (Tex. Civ.

App. - Austin 1980, writ ref'd n.r.e.). Includedin the fiduciary duty which the trustee (generalpartner) owes to the beneficiaries (limitedpartners) is the duty of loyalty. Not only is ithis duty to administer the partnership affairssolely for the benefit of the partnership, he isnot permitted to place himself in a positionwhere it would be for his own benefit toviolate this duty. Scott, Trusts (3d Ed.) Sec.170; Southern Trust & Mortgage Co. v.Daniel, 143 Tex. 321, 184 S.W.2d 465 (Tex.1944).

In Watson v. Limited Partners of WCKT,Ltd.; 570 S.W.2d 179 (Tex. Civ. App. - Austin1978, writ ref'd n.r.e.) the limited partnersbrought an action against the general partnerto recover their capital investment on thetheory that the general partner breached hisfiduciary duties by failing to properly managepartnership affairs. The court renderedjudgment that the limited partners recover theamount of their contributions to capital,together with interest, from the general partnerbecause the general partner failed to managethe affairs as a fiduciary resulting in loss ofthe limited partners' contributions to capital.

D. Self Dealing.

1. Texas Revised Limited Partnership Act§1.10

Sec. 1.10. Except as otherwise providedby the partnership agreement, a partner maylend money to and transact other business withthe limited partnership and, subject to otherapplicable law, has the same rights andobligations with respect to those matters as aperson who is not a partner.

Tex. Rev. Civ. Stat. Ann. art. 6132a-1 Sec.1.10 (Vernon Supp. 1999)

2. Case Law

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A managing partner may not placehimself in a position where it benefits him toviolate his duty to administer the partnershipaffairs solely for the benefit of the partnership.Crenshaw v. Swenson, 611 S.W. 2d 886, 890(Tex.App. - Austin 1980, writ ref'd n.r.e.).Public policy precludes a fiduciary fromlimiting his liability for (1) self-dealing; (2)bad faith; (3) intentional adverse acts; and (4)reckless indifference about the beneficiary andhis best interest. Grider v. Boston Co., Inc.,773 S.W. 2d 338, 343 (Tex.App. - Dallas1989, writ denied).

In McLendon v. McLendon, 862 S.W. 2d662 (Tex.App. - Dallas 1993, writ denied), thebeneficiaries sued the co-executors of theestate for mismanagement of the estate. Theco-executors were general partners of alimited partnership in which the estate was alimited partner. The co-executors and generalpartners amended the limited partnershipagreement as follows:

"Should any partner contest by legalaction, judicial proceeding or otherwise anymanagement decision or action made or takenby the managing partner [Bart] in his role assole and exclusive manager of the partnershipbusiness, then the managing partner may, bywritten notice to such partner (the "ExpulsionNotice"), expel such partner from thepartnership, such expulsion and thetermination of such partner's status as apartner in the partnership being effective as ofthe date of the Expulsion Notice. No suchexpulsion shall cause a dissolution andtermination of the Partnership and, upon anysuch event, no one shall have the right tocompel the termination and liquidation of thePartnership.

Upon expulsion, the expelled partnerreceives an amount equal to the book value ofhis or her partnership interest, payable by aten-year installment note."

McLendon v. McLendon, 862 S.W. 2d 662,666 (Tex.App. - Dallas 1993, writ denied).

The beneficiaries sued challenging the co-executors management of the estate andcontesting the validity of the amendment tothe partnership agreement. The beneficiariessought a declaratory judgment that thepartnership amendments were invalid basedon a breach of fiduciary duty and void asagainst public policy.

The beneficiaries presented experttestimony that after the amendments, thepartnership interest would have no value tothird-party buyers. The beneficiaries alsopresented expert testimony that theamendments removed the ability of anypartner to terminate the partnership andamounted to a removal of rights of partners.

The Executors presented expert testimonythat the value of the estate's interest in thepartnerships increased after the execution ofthe amendments. The expert testified thatbefore the execution of the amendments, theestate had an assignee interest and after theamendments the assignee interest was elevatedto a partnership interest. Therefore, the executors' expert concluded that theamendments benefitted the estate because apartnership interest is more valuable than anassignee interest.

While the trial court did not find that theamendments to the partnership agreementswere invalid, the jury found that the co-executors and general manager breached theirfiduciary duties and awarded actual damagesand exemplary damages. There was evidencethat the general manager and co-executorintentionally withheld partnership investmentreports from the beneficiaries without justcause, paid himself about $673,000 from thepartnerships over a four year period and thebeneficiaries received no distribution during

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that same period and took money from thepartnership to pay for renovations of a non-partnership property.

E. Lack of Disclosure.

Among the duties that a partner owes itsco-partners is the duty of "full disclosure of allmatters affecting the partnership". Hughes v.St. David's Support Corporation, 944 S.W. 2d423 (Tex.App. - Austin 1997, writ denied). Ina limited partnership, the general partner owesthe same duty of full disclosure to the limitedpartners. Huie v. Deshazo, 922 S.W. 2d 920,923 (Tex. 1996) ("Trustees and executors owebeneficiaries a fiduciary duty of full disclosureof all material facts known to them that mightaffect (the beneficiaries' rights.' ") (quotingMontgomery v. Kennedy, 669 S.W. 2d 309,311 (Tex. 1984).

In Hughes v. St. David's SupportCorporation, 944 S.W. 2d 423 (Tex. App. -Austin 1997, writ denied), the limited partnersbrought suit alleging that the general partnerbreached its fiduciary duty by not notifyingthem of a sale of the assets of an operatingpartnership. The Austin court of appeals heldthat even though the limited partner's interestwas small they were at least entitled to noticebefore the operating partnership assets weresold. The court of appeals concluded that thegeneral partner breached its fiduciary duty byfailing to give them prior notice of the sale.

In Johnson v. Buck, 540 S.W. 2d 393(Tex.Civ.App. - Corpus Christi 1976, writref'd n.r.e.), a partner sued the managingpartner to rescind a sale of the partner'sinterest to the managing partner. The partneralleged and the trial court found that themanaging partner made misrepresentationsand concealments of material facts whichinduced the co-partner to sell his interest inthe partnership properties for less than whatthey were actually worth and that but for such

misrepresentations and concealments the co-partner would not have sold same to themanaging partner at the agreed price. It is arule of long standing that each partner in apartnership business is a confidential agent ofthe other partner, and each is required to makefull disclosure of all material facts known tohim with respect to partnership affairs.Partners do not deal with each other at arm'slength, and in a sale by one partner to anotherof his interest in the partnership, an absoluteduty of full disclosure of all material facts andinformation to the buying partner is imposedupon the selling partner; such a sale, whenchallenged, will be sustained only when it ismade in good faith, for a fair considerationand on a full and complete disclosure of allinformation as to value. Johnson v. Peckham,132 Tex. 148, 120 S.W. 2d 786 (1938). TheCourt in Johnson v. Peckham also held thatthere was no legal duty on the part of the co-partner to make any investigation as to thetruth or falsity of the representations made tohim by the managing partner. Therefore, thestatute of limitations did not begin to run untilthe actual discovery of the fraud by the co-partner.

F. Exculpatory Clauses in PartnershipAgreement.

One of the basic tenets of contract lawand the Texas Revised Limited PartnershipAct is that the contract of the parties controls.Most modern family limited partnershipsprovide specifically what powers the generalpartners possess and limitations on the rightsof limited partners and assignees of limitedpartners to bring actions against the generalpartners. Generally, the partnershipagreement should control. However, onecould envision many scenarios in which acourt might be tempted to not enforce theprovision if a general partner takes actionswhich substantially prejudice the limitedpartners or unfairly benefits the general

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partner on the grounds of public policy.

Section 4.03 of the Texas RevisedLimited Partnership Act allows the partners tovary the liabilities of the general partner. Thepower to vary the liabilities is apparentlylimited only by public policy. The commentsto section 4.03 suggest that the limits onindemnification of a general partner set forthin section 11.02, 11.03 and 11.05 of the TexasRevised Limited Partnership Act may providesome guidance as to the public policy limits ofan exculpatory clause. Such sections provideas follows:

Sec. 11.02 If provided in a writtenpartnership agreement, a limited partnershipmay indemnify a person who was, is, or isthreatened to be made a named defendant orrespondent in a proceeding because the personis or was a general partner only if it isdetermined in accordance with Section 11.06of this Act that the person:

(1) acted in good faith;(2) reasonably believed:(A) in the case of conduct in the

person's official capacity as a general partnerof the limited partnership, that the person'sconduct was in the limited partnership's bestinterest; and

(B) in all other cases, that theperson's conduct was at least not opposed tothe limited partnership's best interests; and

(3) in the case of a criminalproceeding, had no reasonable cause tobelieve that the person's conduct wasunlawful.

Tex. Rev. Civ. Stat. Ann. art. 6132a-1 Sec.11.02 (Vernon Supp. 1999).

Sec. 11.03 Except to the extentpermitted by Section 11.05 of this Act, ageneral partner may not be indemnified underSection 11.02 of this Act with respect to aproceeding in which:

(1) the person is found liable onthe basis that the person improperly receivedpersonal benefit, whether or not the benefitresulted from an action taken in the person'sofficial capacity; or

(2) the person is found liable to thelimited partnership or the limited partners.Tex. Rev. Civ. Stat. Ann. art. 6132a-1 Sec.11.03 (Vernon Supp. - 1999).

Sec. 11.05 A general partner maybe indemnified under Section 11.02 of thisAct against judgments, penalties, includingexcise and similar taxes, fines, settlements,and reasonable expenses actually incurred bythe person in connection with the proceeding,except that if the person is found liable to thelimited partnership or the limited partners oris found liable on the basis that the personimproperly received personal benefit, theindemnification:

(1) is limited to reasonableexpenses actually incurred by the person inconnection with the proceeding; and

(2) shall not be made in relation toa proceeding in which the person has beenfound liable for wilful or intentionalmisconduct in the performance of the person'sduty to the limited partnership or the limitedpartners.

Tex. Rev. Civ. Stat. Ann. art. 6132a-1 Sec.11.05 (Vernon Supp. 1999)

VIII. Issues Relating to the Creation of aFamily Limited Partnership by a Fiduciary.

Now that it is well established thatcreation of a family limited partnership canresult in substantial transfer tax savings, manytimes family members want to form a familylimited partnership. Sometimes, the creationof the entity will be motivated by the otherconcerns such as a desire to consolidatevarious family investments or entities. Often,some or all of the assets to be contributed to

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the partnership are held in a business entity,trust, guardianship, estate or other entitygiving rise to a fiduciary duty. Difficult issuesarise when a fiduciary wishes to invest in afamily limited partnership unless every personwith an interest consents to the investment.

A. Fiduciary Relationships

Some of the more common fiduciaryrelationships in which issues relating to familylimited partnerships may arise are set forthbelow:

1. Guardian

A guardian owes a duty to his or her wardand generally cannot change the structure ofthe guardianship's investments without courtapproval. State v. Whitaker, 638 S.W. 2d 189(Tex. App. - Waco 1982, no writ). However,the Texas Probate Code provides for aprocedure for the establishment of an estateplan for the ward for the purpose ofminimizing taxes to the ward's estate. TexasProbate Code §865. Some of the requirementsof §865 may lead to substantial litigation in alitigious family, but approval of the estate planby the court after compliance with §865should help protect the fiduciary from claimsof breach of fiduciary duty for implementingthe approved estate plan.

2. Trustee

A trustee owes fiduciary duties to thebeneficiaries of the trust. Thigpen v. Locke,363 S.W. 2d 247 (Tex. 1963). The trustinstrument controls the rights and powers ofthe trustee. Most trust instruments give thetrustee the power to invest in a partnership,but usually do not provide specificauthorization to invest in a partnership with allof the attributes of a family limited partnershipused in estate planning. The beneficiaries mayrelease a trustee from a fiduciary obligation.

Texas Property Code 114.005.

3. Executor/Administrator

An executor or administrator owes dutiesto the beneficiaries of an estate and generallyowes the same fiduciary duties as a trustee. Humane Society v. Austin National Bank, 531S.W. 2d 574 (Tex. 1995), cert. Denied 425U.S. 976. The rights and powers of anexecutor will be determined by the will.Usually the powers are similar to those givento a trustee and may leave one with questionsas to whether a partnership with the attributesof a family limited partnership is anauthorized transaction. A fiduciary in adependent administration would merely needcourt approval of an investment in a limitedpartnership. An independent executor wouldneed to make the determination concerning aninvestment in a limited partnership withoutthe assistance (or protection) of the court. Adeclaratory judgment action would beavailable to an independent executor to havea court address any issues that are troublingthe independent executor.

4. Agent/Attorney-in-fact

An agent or attorney-in-fact owes dutiesto his or her principal. The powers of theagent or attorney-in-fact will be determined bythe document appointing the agent or attorney-in-fact. Usually, the document is a power ofattorney. Some powers of attorney used byestate planning lawyers are comprehensiveand authorize many types of estate planningtransactions. In the absence of specificauthority in the controlling instrument,difficult fiduciary liability issues may arise.

5. Partnership or Joint Venture

General partners and joint adventurersowe one another the same fiduciary dutiesowed by a trustee of a trust to a beneficiary.

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Johnson v. Peckham, 120 S.W. 2d 786 (Tex.1938). The sole general partner of a limitedpartnership owes fiduciary duties to thelimited partners. Watson v. Limited Partnersof WCKT, Ltd., 570 S.W. 2d 179 (Tex. App. -Austin 1978, writ ref’d n.r.e.). A decision toform a family limited partnership by a generalpartner will involve consideration of fiduciaryduties to the other partners in any existingpartnership. For example, a partner of abusiness partnership may want to form a newpartnership or invest in a new partnership toreduce estate taxes on the death of one of thepartners. Fiduciary duties would need to beconsidered.

6. Corporation

Certain parties in a corporate relationshipmay wish to form a family limited partnership.The officers and directors of a corporationowe fiduciary duties to the corporation.International Bankers Life Ins. Co. v.Holloway, 368 S.W. 2d 567 (Tex. 1963). Theofficers and directors owe a fiduciary duty tothe shareholders as a group. Faour v. Faour,789 S.W. 2d 620 (Tex. App. - Texarkana1990, writ denied). A majority shareholderowes a fiduciary duty to deal fairly withminority shareholders when the majorityshareholder deals with corporate assets.Thywissen v. Coron, 781 S.W. 2d 682 (Tex.App. - Houston [1 Dist.] 1989, writ denied).st

7. Account - Client Relationship

An accountant owes a fiduciary duty tohis or her client particularly when theaccountant has a financial interest in thetransaction. Dominguez v. Brackey Enter.,Inc., 756 S.W. 2d 788 (Tex. App. - El Paso1988, writ denied).

8. Attorney-Client Relationship

An attorney owes a fiduciary duty to his

or her client. Archer v. Griffith, 390 S.W. 2d735 (Tex. 1964). A business interest with aclient acquired during the course of theattorney-client relationship is presumed to befraudulent. Johnson v. Stickney, 152 S.W. 2d921 (Tex. App. - San Antonio 1941, no writ).

9. Spouse

In some instances, when dealing withcommunity property, a person may be foundto be a fiduciary for his or her spouse. SeeMiller v. Miller, 700 S.W. 2d 941 (Tex. App. -Dallas 1985, writ ref’d n.r.e.). Generally, aperson can make investment decisions withcommunity property under his or her controlwithout liability to the spouse. However,fraud issues could arise if a partnership is usedto harm the rights of a spouse in a divorceaction.

10. Relationship of Parties

Fiduciary relationships can arise from aclose, confidential relationship. Thigpen v.Locke, 363 S.W. 2d 247 (Tex. 1962).Fiduciary duties may be owed to personsinvolved in a family limited partnership evenwhen no formal fiduciary relationship exists.

B. Fiduciary Issues

When all of the interested parties in atransaction either cannot or will not agree tothe creation of a family limited partnershipand a court order approving the transaction isnot a viable option, the following issues mayarise:

1. Fiduciary Duties

The fiduciary duties which may come intothe consideration of an investment in a familylimited partnership include fiduciary dutiesrelating to investments by a fiduciary, the dutyof loyalty, the duty of disclosure to persons

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with a justiciable interest, the duty not todelegate discretionary decisions, the duty toavoid self-dealing and conflicts of interest, theduty to diversify investments and the duty totreat the income beneficiaries andremaindermen impartially.

2. Loss of Value/Prudent Investment

An investment in a family limitedpartnership almost always results in at least atemporary loss of value. In an estate planningcontext, the reduction in value is usuallydocumented through appraisals. The loss ofvalue occurs based on restrictions in thepartnership agreement and state law on thelimited partners rights to distributions andliquidation. The fiduciary may be criticizedfor making an imprudent investment. Atrustee has a duty to put trust funds to aproductive use and failure to do so can resultin personal liability. Langford v. Shamburger,417 S.W. 2d 438 (Tex. App - Fr. Worth 1967,writ ref’d n.r.e.). On the other hand, if a longterm view is taken, an argument can be madethat the investment increases the value of theproperty, reduces taxes and provides thefinancial advantages set forth at the beginningof this outline.

3. Loss of Control/Delegation of Duties

One of the attributes of a family limitedpartnership is a loss of control over the assetsinvested by the limited partners. A fiduciarymay be criticized for giving up control of theassets and delegating duties. This can beminimized if the fiduciary also serves asgeneral partner. An argument can be madethat virtually any investment in a businessenterprise involves a loss of control by theinvestor. However, many investments aremore liquid than an interest in a family limitedpartnership. Self-dealing issues may arise ifthe power or control of the fiduciary increasethrough the transaction.

4. Income Beneficiary vs. Remainderman

A family limited partnership is usually along-term investment. Depending on therights of the beneficiaries under the applicabledocument, issues may arise as to whether thefiduciary who invests in a limited partnershipis treating the beneficiaries impartially. Forinstance, many family limited partnershipagreements leave distributions entirely to thediscretion of the general partner. This willmean that the fiduciary who is a limitedpartner cannot be assured that income will bereceived to distribute to an incomebeneficiary. This can also be a problem in aguardianship if the guardian investssubstantial funds in a family limitedpartnership because many of the benefits ofthe planning may not accrue to the warddirectly.

5. No Exit Strategy

Most family limited partnerships offer nofavorable way to exit without the cooperationof the other partners. Creative exit strategiesare available, but a fiduciary may be criticizedfor making an investment which cannot beeasily liquidated. These disadvantages wouldneed to be weighed against the advantages ofthe investment.

6. Self Dealing

When an investment in a family limitedpartnership is being considered, the mostlikely people to be serving in fiduciarycapacities are other family members.Consequently, issues may arise as to whetherthe fiduciary receives a personal benefit fromthe investment or the fiduciary is a participantin another capacity. InterFirst Bank Dallas,N.A. V. Risser, 739 S.W. 2d 882 (Tex. App. -Texarkana 1987, no writ). Many wills andtrust instruments authorize self-dealing, but

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the issues should be carefully examined by thefiduciary before an investment is made in afamily limited partnership.

7. Diversification

To obtain the maximum benefit of afamily limited partnership for transfer taxpurposes, most or all of a client’s assets mustbe invested in the family limited partnership.Often, diversification of investments occurswithin the partnership, but issues of properdiversification may arise if a fiduciary investsall of the trust funds in one investment.

8. Duty of Disclosure

A fiduciary must fully disclose all factsand circumstances regarding his dealing’swith the trust. Failure to disclose suchinformation can result in a breach of fiduciaryduty. InterFirst Bank Dallas, N.A. v. Risser,739 S.W. 2d 882 (Tex. App. - Texarkana1987, no writ). An investment in a familylimited partnership is usually a significanttransaction and would need to be disclosed bythe fiduciary.

C. Example

Mr. Jones is elderly and has two adultchildren, his daughter, Plaintiff Jones, and hisson, Defendant Jones. Mr. Jones owns 80%of Jones.com Inc. a corporation managed byDefendant. Defendant and Plaintiff each own10% of Jones.com Inc. The company is worth$100 million. Defendant hears about theadvantages of a family limited partnership andhas the partnership documents prepared.Without consulting with his nosy sister,Defendant invests all of the assets ofJones.com Inc. in Jones.com, Ltd., a familylimited partnership designed to last for 50years and to be valued for estate tax purposesat $60 million. Mr. Jones consents to thetransfer, but it is questionable whether he has

capacity to make the decision. Defendant isnot worried though because he has a validpower of attorney for Mr. Jones and also signsthe documents in this capacity. Defendant isnamed as a general partner of the newpartnership and continues to run the businessand make money. Limited partnershipinterests are distributed to the three familymembers in proportion to their ownership ofthe corporation. Mr. Jones dies shortly afterthe creation of Jones.com, Ltd. with a willleaving his property equally to his twochildren. Plaintiff wants out of thepartnership, but Defendant tells her to read thepartnership agreement and take a hike.

If Plaintiff brings a lawsuit, what can theparties argue?

1. Plaintiff can argue:

a. Creation of the partnership was abreach of duty by Defendant aspresident of Jones.com, Inc.

b. Creation of the partnership was abreach of duty by Defendant as themajority shareholder (through hispower of attorney).

c. Creation of the partnership was a self-dealing transaction because of theadditional control given to Defendantin the partnership.

d. Creation of the partnership was abreach of Defendant’s duties to Mr.Jones under the power of attorney.

e. Plaintiff can claim she was damagedby the reduction in value of herinvestment and by the loss of controlof her assets.

f. Plaintiff can claim the Defendantbasically rewrote Mr. Jones’ will whenMr. Jones was no longer capable ofwriting a new will.

g. Plaintiff could assert a derivativeclaim on behalf of the corporationconcerning the investment.

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2. Defendant can argue:

a. He saved the estate $20 million intransfer taxes. Plaintiff should bethanking him instead of suing him.

b. The investment was prudent becauseof the tax savings and long termpotential of the investment.

c. Assuming that the partnershipagreement has an arbitration clause,the dispute would have to be decidedby arbitration.

d. Defendant can assert that Plaintiff isonly an assignee of a partnershipinterest and has very limited rights inthe partnership and limited standing tosue.

e. If Plaintiff has accepted any benefitsfrom the partnership, Defendant couldassert estoppel as a defense.

f. Defendant could challenge Plaintiff’sright to sue on behalf of their deceasedfather.

g. Defendant could also contest whetherhe owed a fiduciary duty to Plaintiff asa majority shareholder becauseDefendant only had a majority of thestock if you took into account Mr.Jones’ shares.

h. Defendant can contend that he was incharge of the company before thepartnership was created and thatPlaintiff has not been harmed by thetransaction.

D. Who Should Win?

It is difficult to say who should win. IfPlaintiff can establish a fiduciary relationshipwith regard to the creation of the partnershipand standing, the burden will be on Defendantto prove that the transaction was fair. In thisexample, Plaintiff will be able to show a hugereduction in value ($40 million), but an issueexists as to whether she has really suffered a

loss because the business has continued tomake money, the underlying assets are stillthere and she still has her pro rata share of thebusiness. Defendant’s lack of disclosure givesa slight edge to Plaintiff.

IX Psychological and Practical Problemswhich could lead to Litigation

A. The “Big Cheese” Syndrome

Many times a family limited partnershipis initially created and managed by the personwho made the money or started the business.We will call this person, “The Big Cheese”.In some families, the Big Cheese is female.Often, the partnership is formed for estateplanning purposes after the Big Cheese hasbeen running his business in another form formany years. The Big Cheese is used to doingwhat he wants whenever he wants. He oftenmixes business and personal pursuits. Heoften views anything he wants as anappropriate use of business funds. Thecreation of a family limited partnership willcreate duties and obligations that the BigCheese has never had to consider before.Several problems can arise from this situation.The Big Cheese may just ignore his duties tohis partners and continue to run things as ifthe partnership did not exist. This can lead toclaims of mismanagement by the partners.This type of conduct could also encourage theIRS or other creditors to make a claim that thepartnership is not a viable entity and should bedisregarded. The worst cases of the BigCheese syndrome can lead to claims of breachof fiduciary duty or fraud.

The best options for a lawyer when hespots the Big Cheese syndrome is todiscourage the use of a family limitedpartnership or to carefully inform the clientsabout the duties and obligations of a generalpartner. In the worst cases, neither of theseoptions will work and the family will be

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headed for trouble.

B. Sibling Jealousy and Rivalry

In many family limited partnerships, thegeneral partners are given extensive powers.Many times, as long as the matriarch orpatriarch holds the powers, the children willnot complain. However, problems arise whenless than all of the next generation are giventhe extensive powers. Nothing brings outsmouldering childhood problems quicker thanhaving a person’s brother or sister completelycontrol his or her inheritance in a entity whichcould last for a lifetime (or longer). Thesolutions are either shared control or adissolution of the partnership. Neither ofthese solutions are easily obtained inlitigation. Consequently, the litigation willoften take another form such as claims ofmismanagement or breach of fiduciary duty orattacks on the creation of the partnership.

C. Too Complicated to AdministerProperly

Family limited partnership agreements arecomplex. Great wealth does not alwayscoincide with great brains and managementskills. In some cases, the general partner maybe trying to do things properly, but just cannotmake good decisions about how to run thepartnership or just cannot understand thepartnership agreement. This can lead toclaims against the general partner formismanagement or breach of fiduciary duty.About the only solution is the replacement ofthe general partner or getting the confusedgeneral partner competent advice when he orshe needs it. The worst of these situationscould lead to a claim that the partnership isnot a viable entity.