Still Standing- The Ontario Court Of Appeal Holds A Limited Partner May Seek Leave To Commence A Derivative Action On Behalf Of The Partnership

The Ontario Court of Appeal ("ONCA") recently held that a limited partner may seek leave to commence a derivative action (a remedy typically reserved for corporations, rather than partnerships) where: (a) the general partner has refused to pursue a claim against a third party; (b) the limited partner is acting in good faith; and (c) the action appears to be in the best interests of the limited partnership.¹ However, leave to commence a derivative action will be denied where the limited partner may sue directly, such as for breaches of the limited partnership agreement, breaches of fiduciary duty, or other damage caused to the limited partner(s) by the general partner.²

Background: In this motion, the respondents (six siblings) sought leave to bring a derivative action on behalf of the limited partnership and four of its portfolio companies against the general partner (a corporation), a seventh sibling (Grant Anthony), and third parties (two corporations in which Mr. Anthony was the sole officer and director, and his romantic partner, Laura Colligan), for breach of fiduciary duty, breach of trust, breach of contract, breach of statutory duties, conversion, unjust enrichment and gross negligence, in connection with, among other things, misappropriation of partnership assets.

The limited partnership had been established by the siblings' deceased parents to hold most of the family's approximately $200 million in real estate holdings. At the time of the motion, Grant Anthony was the sole director of the general partner and the sole surviving trustee of the trust established to hold 100% of the shares of the general partner.

Motion judge's decision: The motion judge granted leave to bring the derivative action against the general partner and Mr. Anthony, but not against the two corporations and Ms. Colligan. The motion judge held that there was no statutory right to commence a derivative action under the Limited Partnerships Act (the "LPA"), but that a derivative action was available at common law under the narrow exceptions permitted to corporations (in this case, fraud) pursuant to the rule in Foss v Harbottle (1843), 67 E.R. 189 (Ch.).

The questions on appeal were:

1. Did the motion judge err in deciding that at common law, the respondents should be permitted to bring a derivative action in the name of and on behalf of the limited partnership against the general partner, and Mr. Anthony?
2. Did the motion judge err in refusing leave to bring a derivative action against Ms. Colligan and the two third-party corporations?

The Court of Appeal's Decision: The Court of Appeal allowed the appeal on both points. It held that the motion judge erred: (1) in granting the respondents leave to commence a derivative action against the general partner and Mr. Anthony; and (2) in failing to grant leave to bring a derivative action against the two corporations and Ms. Colligan.

As helpful background, the Court reiterated that partnerships, unlike corporations, are not distinct legal entities; rather, they are a relation between persons carrying on business together with a view to profit.³ However, they are treated as if they were a separate legal entity for certain purposes (e.g., they have the capacity to sue and be sued).

Limited partnerships, which are often used as a passive investment vehicle, are a special form of partnership in which the entitlements and liabilities of the limited partners are restricted compared to those of the general partner or partners, or partners in an ordinary partnership. Limited partnerships are governed by the common law and the Partnerships Act, R.S.O 1990, c. P. 5, except to the extent that these are superseded by the LPA. In a limited partnership, it is the general partner who is responsible for proceedings by and against the limited partnership.⁴

In this context, the Court held that, for the claims against the general partner and Mr. Anthony, a derivative action was not necessary, as the limited partners were entitled to sue these parties directly, for breaches of the limited partnership agreement, or breach of fiduciary duty. The Court also held that derivative actions are extraordinary, and leave may not be granted where other recourses exist.

The Court noted that a limited partner who seeks to enforce a general partner's obligations to the limited partners under their agreement is not presumed to be taking control of the business of the limited partnership, and therefore does not result in a loss of the limited partner protection.

By contrast, there was no direct cause of action by the limited partners against the third-party corporations and Ms. Colligan; as such, there was an equitable gap if these parties had harmed the partnership, but the general partner refused to take action.⁵

The Court held that, before granting leave to pursue a derivative action on behalf of and in the name of a limited partnership, a Court should be satisfied that:

• The general partner has refused to pursue a claim against a third party;
• The limited partner is acting in good faith; and
• It appears to be in the best interests of the limited partnership that the action be brought.⁶

The Court also held that a non-exhaustive list of factors a Court might consider in determining whether to grant leave include: whether the general partner's failure to act is unreasonable or in bad faith; the existence of any conflict of interest between the general partner and the proposed third-party defendant; the presence of a strong prima facie case against the third party; and alternative, non-derivative remedies that may be available to the limited partner.

In this case, the Court found that the respondents had met the test for leave, as the general partner had at least implicitly declined to take action against the third parties, the respondents appeared to be acting in good faith, and both the general partner and Mr. Anthony were in an apparent conflict of interest because Mr. Anthony was the sole director of the general partner, the sole officer, director, and shareholder of the proposed defendant corporations, and the alleged common law spouse of Ms. Colligan.

Key Takeaways:

• Leave to pursue a derivative action may be granted to a limited partner, where:
  • The general partner has refused to pursue a claim against a third party;
  • The limited partner is acting in good faith; and
  • It is in the limited partnership's best interest that the action is brought
• Derivative actions are extraordinary measures; leave may not be granted where the limited partner(s) have other remedies available, such as a direct claim against the general partner for breach of contract or the LPA or breach of fiduciary duty.

Footnotes

1. Binscarth Holdings LP v Grant Anthony, 2024 ONCA 522 at paras 99 to 104 [Binscarth].

2. Ibid at para 83.

3. Binscarth at para 51.

4. Binscarth at para 56.

5. Binscarth at para 100.

6. Binscarth at para 103.

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