In Paige Capital Management, LLC v. Lerner Capital Fund, LLC, C.A. No. 5502-CS (Del. Ch. Aug. 8, 2011), the Delaware Court of Chancery, in a post-trial opinion, ordered a hedge fund to return the seed money provided by an heir to the Lerner fortune, with interest. That “seed investment” comprised 99.9% of the hedge fund started in 2006 by Michele Paige, who shared management of the fund with her husband.

In some respects this is a simple contract case. In other ways it is a novella-length drama about people behaving badly and those in business relationships who cannot get along. Bloomberg has an article on the opinion here, with links to background on some of the personalities involved. Read the 101-page opinion here. My overview of the (much shorter) prior Chancery decision in this case is available here.

Why it’s noteworthy: This decision is must-reading for those who would invest in a hedge fund or those who would create or manage one. The two Yale Law School-trained lawyers who created and managed the hedge fund in this case lost their bet that the controlling agreements (that they provided to the investor) would prevent the seed investor from withdrawing his money.

Why it may be interesting to others: This business litigation ruling reads, from one perspective, like a sit-com. The opinion contains references to salacious emails among Lerner and his office-mates which the Court describes as indicative of a frat house atmosphere–as well as more incisive descriptions. (They most certainly never expected their “locker room style emails” to be referenced in a published opinion). There are also aspects of the Court’s ruling that could be part of a doctoral dissertation for a joint Ph.D. degree in sociology and psychology along with a mini-thesis on “realities of the modern business world.” For example, despite the academic success of the creators of the fund, the Court observed that one reason they may not have been able to attract more investors to their fund was due to their less than exemplary presentation and communication skills–highlighted by the Court’s reference to them as more “professorial than professional”. This might be an example applicable to other arenas in which mere brilliance is not enough to succeed. One needs “the whole package”, including, for example, interpersonal skills.

Selected Legal Aspects of Decision

There is no effective manner to “do justice” in a short blog post to a decision of over 100-pages. We may supplement this short blurb at a later date but for the time-being, we whet the appetite for serious readers who will want to read the whole magnum opus at the above link, with two holdings:

First, it was a breach of the relevant agreement(s) for the hedge fund not to return the money.

Second, it was  breach of fiduciary duty (duty of loyalty) to refuse to exercise authority to return the money based on the selfish reason of wanting to continue to collect management fees. See generally footnote 95 for reference to the venerable principle that a fiduciary’s actions are twice tested. That is, in addition to being legally possible, they must be equitably appropriate.

Selected Money Quotes

Referring to the Chancery decision of In re USACafes, L.P. Litigation,  600 A.2d 43 (Del. Ch. 1991), the Court explained that:

That case and its progeny have established that a director, member, or officer of a corporate entity serving as the general partner of a limited partnership, like Michele Paige, who exercises control over the partnership’s property owes fiduciary duties directly to the partnership and its limited partners.

 See footnote 186. The Court continues by observing the tension created in USACafes, and questions why investors in a limited partnership would not be required, “in the absence of a reason for veil piercing, to look solely to the entity they knew was their fiduciary for relief”.  In this case, fiduciary duties tempered the sole discretion given to Michele Paige in the agreements. See footnotes 195 and 196.

Regarding the statutory defense that allows one to rely in good faith on the provisions of a partnership agreement as a defense to a fiduciary duty claim, the Court reasoned that:

Section 17-1101(e) is not a license to exculpate fiduciaries for self-serving interpretations of governing instruments. It is best read as ensuring that fiduciaries who take action to advance a proper partnership purpose but do so based on a good faith misreading of the agreement are not tagged for liability for a breach of fiduciary duty. To exculpate a fiduciary for breach of fiduciary duty for making a good faith, but erroneous, determination that the partnership agreement allowed the fiduciary to advance its self-interest over the best interests of the investors would seem to extend the statute’s reach beyond its sensible borders.

There are many other paradigmatic “money quotes” in this tome, but paying clients await.

Supplement: Reuters has a story by Alison Frankel here about the case, with links to transcript rulings here and here involving pre-trial motions to compel and fee-shifting on those motions–which is becoming “less and less uncommon” in Chancery.