Caparos v. Morton ( 2006 )

FIFTH DIVISION
March 3, 2006
No. 1-04-2354
CONSTANTIN CAPAROS; DESPINA CAPAROS; ) Appeal from the
CHARLES ALEXANDER; SHELDON H. CLOOBECK; ) Circuit Court of
JOHN P. CULHANE; TREASUREX FINANCIAL LTD., ) Cook County
assignee of Paul M. Daugerdas and Paul M. Daugerdas Jr.; )
PETER D=AGOSTINO; DRINK INVESTORS, Ralph E. )
Lowenberg TTE Allen Kohl 1974 Trust, General Partner; )
DUANE ERICKSON; ETT, INC; ELIZA KAUFMAN )
FLYNN; BRUCE FRANKENBERG, RALPH S. GERBIE; )
GERBIE PROFIT SHARING PLAN; JAY HARRIS; IRA )
KAUFMAN; JOHN KAUFMAN; STEPHEN KAUFMAN; )
JAMES H. KOULOS; SHELDON KREITMAN, D.P.M.; )
ALFREDO LOPEZ; MANSUR INVESTMENT III, LP; )
ROBERT PINKERT; ROBERT L. PLUMMER, Jr.; )
JAMES D. POHL; RICK ROEHM; MAURICE )
SANDERMAN; BENJAMIN B. SARMAS; DAVID H. )
SHULMAN; MARK SMITH; SHEPARD SWIFT; )
MELODY SWINK; JEFFREY TESSIATORE; BARRY )
WEINSTEIN; DANIEL WHITE; and ROBERT ZENDER, )
)
Plaintiffs-Appellees, )
)
)
v. )
)
)
MICHAEL MORTON, SCOTT DEGRAFF and LATE )
NIGHT LAS VEGAS, INC., ) Honorable
) Nancy J. Arnold,
Defendants-Appellants. ) Judge Presiding.
PRESIDING JUSTICE GALLAGHER delivered the opinion of the court:
Defendants Michael Morton, Scott DeGraff and Late Night Las Vegas, Inc., appeal the
trial court=s judgment in an action brought by numerous limited partners for breach of fiduciary
duty, a constructive trust and an accounting. We hold that although the limited partnership could
have been named as a party defendant, the partnership=s interests were not prejudiced by its
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absence from the proceedings in the trial court, and we therefore affirm.
In the early 1990s, Morton and DeGraff developed and opened Drink, a restaurant and
nightclub, in Chicago. Late Night Las Vegas, Inc., a Nevada corporation, was formed to build
and operate a similar Drink club in Las Vegas. The approximately 35 limited partners who are
plaintiffs in this case represent 55 % of the Late Night Las Vegas Limited Partnership, a Nevada
limited partnership with its principal offices in Chicago. Late Night Las Vegas, Inc., was the
corporate general partner of the limited partnership.
In January 1994, Late Night Las Vegas entered into a 10-year lease of a corner lot near
the Las Vegas strip, on which Drink was constructed. The land was owned by Air Storage, Inc.
Under the lease, Morton and DeGraff had a purchase option to buy the land from Air Storage at
any time during the first five years of the lease. The option allowed Morton and DeGraff to sell
the land to a third party without the limited partnership=s involvement and with the limited
partners having no rights to future development. Fifty limited partnership interests in Drink
were offered for $50,000 each, to raise a total of $2.5 million. Plaintiffs each purchased an
interest. Morton and DeGraff=s option to purchase the land from Air Storage was disclosed to
plaintiffs. Under the partnership agreement, the cash flow received from Drink=s operations
would be applied to partnership expenses and then be distributed 99 % to the limited partners
and 1 % to the general partner until the limited partners received an amount equal to their
original contributions, after which the limited partners and the general partner each would
receive 50 % of the income from Drink.
The club opened in May 1995 and was initially profitable, although it encountered
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operational difficulties and cost overruns that are described in great detail in the parties= briefs
but are of little importance here. In October 1997, Morton and DeGraff called a meeting of the
limited partners and presented a proposal to relocate Drink to another Las Vegas site. The
suggested relocation was prompted by an offer from Grand Plaza, which owned 33 acres of land
contiguous to the Drink site. Morton and DeGraff informed the limited partners that Grand
Plaza offered to buy the Drink site and the surrounding land for $15 million and sell it to a hotel
casino developer. The limited partners voted to approve the transaction and relocate Drink.
Following that vote, Morton and DeGraff entered into a purchase agreement with Grand
Plaza in November 1997 which provided that they would buy the Drink land from Air Storage
under their purchase option and then sell the land to Grand Plaza. Under the agreement, Grand
Plaza was to pay defendants $250,000 of refundable earnest money and an escrow deposit of $3
million. In December 1997, Morton and DeGraff bought the Drink land from Air Storage,
thereby becoming the partnership=s landlord.
In March 1999, after numerous extensions of the closing date, Grand Plaza cancelled its
agreement with Morton and DeGraff. In July 2000, after Morton and DeGraff informed the
limited partners that Drink was losing money and that they had been unsuccessful in finding a
buyer, Morton and DeGraff told the limited partners that Drink would close on July 31, 2000,
which it did. To that point, each limited partner had received about $35,000 back on a $50,000
investment, or a similar percentage on a smaller investment. (Some limited partnership interests
were purchased by investors pooling funds to purchase a single interest.)
On August 28, 2000, Morton and DeGraff wrote to the limited partners that the lease of
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the Drink property from Air Storage was Ain default for the nonpayment of rent@ and that the
partnership=s lease of the property was terminated on July 31, 2000. The letter stated that a third
party had offered to buy the partnership=s assets (the building, equipment and inventory) for
$450,000. Morton and DeGraff asked the partners to vote on the potential sale.
Morton and DeGraff contend that when several limited partners demanded that they
reinstate the Drink lease, they offered to do so if the partnership approved a capital call (through
which the partnership seeks additional money from the limited partners to pay partnership debts),
to which the partners did not respond. However, plaintiffs assert that after Drink closed, Morton
and DeGraff continued to lease the Drink property from Air Storage and subleased it to a
promoter who operated it as Club Utopia for about a year. Plaintiffs state that in August 2003,
Morton and DeGraff leased the property to another venture that opened a club called Ice.
Plaintiffs contend that Morton and DeGraff, freed of the partnership=s lease of the
property, profited from the sublease arrangements even though the former Drink building,
equipment and inventory belonged to the partnership. Morton and DeGraff maintain that they
Acarried the property@ and that no profit was made. In October 2000, plaintiffs filed suit for
breach of fiduciary duty, a constructive trust, and an accounting, seeking their Apro rata@ share of
the value of the lease with Air Storage. The limited partnership was not a party to the
complaint. Plaintiffs later amended the complaint to add counts of conversion and unjust
enrichment.
Defendants counterclaimed for unpaid management fees, and the counterclaim did not
name the limited partnership as a party. Plaintiffs moved to dismiss the counterclaim, referring
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to themselves as Aa group of individuals representing some of the Limited Partners in the Limited
Partnership@ and contending that to obtain a judgment against the limited partnership, defendants
must name the limited partnership as a party. The trial court granted plaintiffs= motion to dismiss
defendants= counterclaim.
As to plaintiffs= amended complaint, defendants moved for judgment on the pleadings,
asserting that plaintiffs alleged no injuries distinct from those sustained by the partnership.
Defendants contended that plaintiffs could only prevail in a derivative action to which the
partnership was a necessary party, and defendants pointed to plaintiffs= position in their motion
to dismiss that they represented only some of the limited partners and not the partnership.
The court allowed plaintiffs to bring a second amended complaint and ordered defendants
to answer the complaint, barring them from moving to dismiss it. In the second amended
complaint, plaintiffs brought their claims Aboth as individuals and derivatively pursuant to 805
ILCS 210/1001,@ a section of the Revised Uniform Limited Partnership Act as adopted in Illinois
(the Illinois Act) (805 ILCS 210/100 et seq. (West 2000)). Plaintiffs alleged that Morton and
DeGraff terminated the lease with Air Storage to allow them to sell the property and Awrongfully
reap a multimillion dollar profit for themselves.@ They alleged that by retaining the option to
purchase the land, Morton and DeGraff had a conflict of interest with the partnership and the
limited partners because the two men effectively became the partnership=s landlord, which the
complaint alleged was in conflict with Morton and DeGraff=s Apersonal desires to maximize their
investment in the Property.@ The five-count complaint alleged that although Morton and
DeGraff blamed Drink=s demise on an increasingly competitive nightclub scene in Las Vegas,
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they pursued further investment opportunities there, including three new nightclubs and one
Arestaurant venture.@ DeGraff testified at trial that he had interests in four clubs that opened
between 2000 and 2002.
Count I of plaintiffs= second amended complaint alleged that defendants owed the limited
partners a fiduciary duty to disclose all material facts concerning the partnership=s business and
act in its best interests. Plaintiffs alleged that they and the other limited partners should receive
pro rata shares of the profits and assets converted by Morton and DeGraff. Count II alleged that
Morton and DeGraff converted property that belonged to the limited partnership, including
$900,000 in Aextension fees@ that Grand Plaza paid them under the purchase agreement to extend
the closing date. Count III alleged that Morton and DeGraff were unjustly enriched by retaining
Aassets and property interests of the Partnership and Plaintiffs to which they are not entitled.@ As
relief under those two counts, plaintiffs requested compensatory damages of not less than $3.75
million and punitive damages of twice that amount. In counts IV and V, plaintiffs sought the
imposition of a constructive trust on partnership assets and property in defendants= control and
requested an accounting of the partnership=s assets and liabilities. Defendants raised as
affirmative defenses, inter alia, that the limited partnership was a necessary and indispensable
party and that plaintiffs did not allege any personal injury and thus had no standing to sue
individually.
Following a two-week bench trial, the court dismissed plaintiffs= claims for conversion
and unjust enrichment but found that Morton and DeGraff breached their fiduciary duty to the
limited partners by not disclosing how they would benefit from their deal with Grand Plaza. The
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court found that defendants did not fully account to the limited partners for expenses and ordered
defendants to return about $833,000 in management fees to the partnership. The court imposed a
constructive trust against $900,000 in extension fees that defendants received under the contract
with Grand Plaza and ordered defendants to Ahold that sum as trustee for the benefit of the
limited partnership.@ The court also imposed a constructive trust equaling the value that
defendants received from the $3.25 million in earnest money that defendants received from
Grand Plaza and that they used to buy the Drink land. In addition, the court awarded the
partnership $1 million in punitive damages.
ANALYSIS
On appeal, defendants contend that plaintiffs, who represented 55 % of the limited
partners, sought relief for all of the limited partners and therefore were required to bring a
derivative cause of action naming the limited partnership as a party. Without the limited
partnership represented, defendants assert that the trial court adjudicated the rights of a party that
was not before it and therefore could not have resolved all interests in one judgment. For those
reasons, defendants argue that the judgment for plaintiffs must be reversed.
Plaintiffs respond that they were not required to bring a derivative action because they
sustained unique and personal losses. They contend that in a derivative suit brought for the
partnership, defendants, as the general partners, would have benefitted from any recovery.
Although plaintiffs acknowledge their injuries are the same as those sustained by the other
limited partners, they contend their claims differed from those sustained by Morton and DeGraff
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as the general partners and thus were individual. Plaintiffs further assert that even if their
injuries were not individual and they were required to seek relief for the limited partnership, they
properly brought their action as a derivative suit. Plaintiffs contend they did not need to name
the limited partnership as a party because they adequately represented the interests of both the
partnership and the absent limited partners.
Because the parties have presented issues of law, our standard of review is de novo.
Eden Retirement Center, Inc. v. Department of Revenue, 213 Ill. 2d 273, 284, 821 N.E.2d 240,
246 (2004). Before addressing the arguments, we note that Late Night Las Vegas, Inc., and Late
Night Las Vegas Limited Partnership were business organizations created in Nevada and are
thus governed by that state=s laws. See 805 ILCS 210/901 (West 2000) (Athe laws of the state or
other jurisdiction under which a foreign limited partnership is formed govern its formation and
internal affairs and the liability of its limited partners@). However, the pertinent provisions of the
Nevada statute governing derivative actions in limited partnership situations are substantially the
same as the corresponding Illinois act, with the statutes of both states modeled on the uniform
act. Compare Nev. Rev. Stat. Ann. ' 88.610 et seq. (Michie=s 2004); 805 ILCS 210/1001 et seq.
(West 2000). In their briefs to this court, the parties cite to the Illinois statute and do not contend
that it differs from the relevant Nevada law. For that reason, though we are cognizant of the
Nevada statute, we refer to the pertinent Illinois code sections in discussing the parties=
arguments, as the parties themselves do.
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I. Did Plaintiffs State an Individual or a Derivative Claim Against Defendants?
Plaintiffs indicated in their second amended complaint that their claims were made Aboth
as individuals and derivatively pursuant to 805 ILCS 210/1001.@ To the extent that plaintiffs
argue that phrase defines the legal adequacy of the claims made in their complaint, the court, in
determining whether an individual or derivative claim is stated, is not bound by the designations
used by the parties but instead considers the nature of the alleged injury. Hamilton v. Conley,
356 Ill. App. 3d 1048, 1054, 827 N.E.2d 949, 955 (2005); Sturm v. Marriott Marquis Corp., 85
F. Supp. 2d 1356, 1374 (N.D. Ga. 2000).
When a limited partner seeks to recover for a breach of fiduciary duty by general partners
in a partnership, three types of claims are possible. Lenz v. Associated Inns & Restaurants Co. of
America, 833 F. Supp. 362, 378 (S.D.N.Y. 1993). A limited partner can pursue an individual
claim directly against the general partners for harm specific to that limited partner. In the other
two kinds of relief, the plaintiff limited partner represents not just itself: the plaintiff can bring a
direct claim against the general partners in a class action suit on behalf of all limited partners, or
the plaintiff can allege a derivative suit on behalf of the partnership against the general partners.
Lenz, 833 F. Supp. at 378.
In a derivative action by a corporate shareholder, the suit is brought on behalf of the
corporation for harm done to it for which the corporation either cannot assert or refuses to assert
its own right. Goldberg v. Michael, 328 Ill. App. 3d 593, 599, 766 N.E.2d 246, 251 (2002). In a
direct claim, the shareholder seeks recovery for injuries sustained individually or by a class of
shareholders. M.D. Building Material Co. v. 910 Construction Venture, 219 Ill. App. 3d 509,
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515, 579 N.E.2d 1059, 1062 (1991). To bring a direct claim, the plaintiff must allege an injury
separate and distinct from that suffered by other shareholders, or an injury that involves a
contractual right, such as the right to vote or the right of majority control, that exists
independently of any right of the corporation. Goldberg, 328 Ill. App. 3d at 599, 766 N.E.2d at
251; Spillyards v. Abboud, 278 Ill. App. 3d 663, 670-71, 662 N.E.2d 1358, 1363 (1996).
Courts have treated limited partners similarly to corporate shareholders in this respect.
Northern Trust Co. v. VIII South Michigan Associates, 276 Ill. App. 3d 355, 363, 657 N.E.2d
1095, 1101 (1995); see also Arndt v. First Interstate Bank of Utah, N.A., 991 P.2d 584, 588-89
(Utah 1999) (discussing uniform act and citing Northern Trust, among other decisions). Limited
partners are investors to whom ownership is spread via their financial interests in the venture;
however, they lack control over its operations by the inherent structure of a limited partnership.
M.D. Building Material, 219 Ill. App. 3d at 515, 579 N.E.2d at 1062-63 (noting that the Apassive
nature of the limited partners= role has often resulted in mismanagement and self-dealing by
general partners@).
Limited partners seeking redress for the decreased value of their shares in the limited
partnership must do so in a derivative action. LID Associates v. Dolan, 324 Ill. App. 3d 1047,
1069, 756 N.E.2d 866, 885 (2001). A derivative lawsuit is intended to protect the rights of the
partnership, not the rights of the limited partners. Moore v. Simon Enterprises, Inc., 919 F.
Supp. 1007, 1009-10 (N.D. Texas 1995). AThe purpose of a limited partner=s derivative action is
to enforce a claim which the limited partnership possesses against others [such as the general
partners] but which the partnership refuses to enforce.@ Wallner v. Parry Professional Building
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Ltd., 22 Cal. App. 4th 1446, 1449, 27 Cal. Rptr. 2d 834, 836 (1994). For example, a claim that
the general partners= misconduct resulted in diminished income to the partnership and a decrease
in the value of the limited partners= interests in the venture states a derivative claim. Litman v.
Prudential-Bache Properties, Inc., 611 A.2d 12, 15-16 (Del. 1992). Proper derivative actions
include claims for a general partner=s mismanagement, negligence, diversion of assets, action
beyond authority, and failure to perform elements of an agreement. Partnership Equities, Inc. v.
Marten, 15 Mass. App. 42, 50, 443 N.E.2d 134, 138 (1982).
Plaintiffs assert that their second amended complaint stated both a derivative claim on
behalf of the partnership and a claim for their individual injuries. (Plaintiffs= contention that they
can proceed on both of these theories simultaneously is discussed later in this opinion.) In the
complaint, plaintiffs alleged breach of fiduciary duty, conversion and unjust enrichment.
Plaintiffs also sought the imposition of a constructive trust on partnership assets and property
and an accounting of the partnership=s assets and liabilities, and they requested that any funds
recovered be Adistributed pro rata to the limited partners, including plaintiffs.@
Plaintiffs argue that they stated an individual action because their losses were distinct
from those suffered by the partnership as a whole. They argue that Morton and DeGraff, as the
general partners, were not injured as the limited partners were; rather, plaintiffs contend that
Morton and DeGraff profited from the transaction Ato the exclusion and detriment of the limited
partners.@ Plaintiffs contrast their situation with that of the general partners in contending that
their injuries differ from those sustained by the other members of the partnership.
Plaintiffs= main theory of relief is that Morton and DeGraff breached their fiduciary duty
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to the limited partners. The nature of such an allegation is that the general partners have not
sustained the same losses as the limited partners, but, rather, have gained from their wrongdoing
at the expense of the limited partners and the partnership as a whole. Plaintiffs concede that their
injuries are the same as those sustained by the limited partners who were not parties to the suit.
Indeed, the second amended complaint sought recovery for all limited partners Aincluding
plaintiffs.@
Plaintiffs= complaint therefore did not state a claim for direct or individual harm. In
pleading that defendants breached their fiduciary duty to the partnership, plaintiffs brought a
derivative action on the partnership=s behalf. See LID Associates, 324 Ill. App. 3d at 1069-70,
756 N.E.2d at 885, citing Frank v. Hadesman & Frank, Inc., 83 F.3d 158, 160 (7th Cir. 1996)
(interpreting Illinois law). Plaintiffs admit that all limited partners were similarly harmed by
defendants= conduct. When investors sustain a common injury, they must act collectively.
Frank, 83 F.3d at 160. Plaintiffs alleged no distinct individual harm that was not also borne by
the other limited partners. Plaintiffs= claim that Morton and DeGraff converted partnership
assets and profits and that plaintiffs= damages include the loss of those funds is derivative in
nature. See Litman, 611 A.2d at 15-16.
We next address whether individual claims and derivative claims are mutually exclusive
and if a single complaint can include each type of claim. Plaintiffs argue they were injured by
defendants= breach of fiduciary duty to the partnership and also were Apersonally damaged.@
Plaintiffs couch the allegations of their complaint in terms of both direct harm and derivative
harm (e.g., A[d]efendants *** owed the Partnership and each of the plaintiffs a fiduciary duty@).
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Direct and derivative claims can arise from the same nucleus of facts, and it certainly is
possible for plaintiffs to bring, in one complaint, a direct claim for their individual damages and
a derivative claim on behalf of the partnership, provided that sufficient facts are alleged in
support of each theory. As we have discussed, whether an action is derivative or direct turns on
whether the partnership or the individual partner has been injured. See Sterling Radio Stations,
Inc. v. Weinstine, 328 Ill. App. 3d 58, 62, 765 N.E.2d 56, 60 (2002) (applying rule in analogous
corporate setting). This court has recognized, in a case involving corporate shareholders, that
both a direct and a derivative action can be stated under one set of facts:
AIn Illinois, a shareholder may bring a derivative action and an individual
claim at the same time if he has suffered a different injury from his fellow
shareholders. Thus, >where the wrongful acts are not only against the corporation
but are also violations of a duty *** owed directly by the wrongdoer to the
stockholders,= a stockholder may sue both derivatively and individually to obtain
redress for these wrongs.@ (Emphasis added.) Levy v. Markal Sales Corp., 268
Ill. App. 3d 355, 371, 643 N.E.2d 1206, 1218 (1994), quoting Zokoych v.
Spalding, 36 Ill. App. 3d 654, 663, 344 N.E.2d 805 (1976).
Plaintiffs have alleged that defendants harmed the partnership and that they, as limited
partners, were damaged as a result. Plaintiffs= injuries were the same as those sustained by the
other limited partners, and plaintiffs did not allege any individual harm that would support a
direct action against defendants, in addition to their derivative claim.
As a final note, we address the statute=s demand requirement. Section 1001 of the Illinois
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act permits derivative actions by limited partners or assignees only when Ageneral partners with
authority to do so have refused to bring the action or unless an effort to cause those general
partners to bring the action is not likely to succeed.@ 805 ILCS 210/1001 (West 2000). Section
1003, as with the corresponding Nevada statute, requires the complaint to indicate that the
plaintiffs attempted to have a general partner initiate the legal action or explain why no such
attempt was made. 805 ILCS 210/1003 (West 2000); Nev. Rev. Stat. Ann. ' 88.610 et seq.
(Michie=s 2004). Here, defendants raised as an affirmative defense that plaintiffs did not comply
with section 1003 and thus Adeprived Defendants of their chance to resolve Plaintiffs= claims
within the Limited Partnership or to test such allegation in a timely manner.@
Plaintiffs stated in their complaint that any effort to cause a general partner, i.e., Morton
or DeGraff, to bring the action was not likely to succeed. Although the complaint did not
contain plaintiffs= reasoning for failing to make such a demand, section 1001 is meant to address
situations such as this. It would have been futile for plaintiffs to have requested that Morton or
DeGraff sue themselves and the corporate general partner, Late Night Las Vegas, Inc. See
Hirsch v. Jones Intercable, Inc., 984 P.2d 629, 635-36 (Colo. 1999) (demand requirement futile
when made of those who committed alleged breach). But see Cabaniss v. Deutsche Bank
Securities, Inc., 170 N.C. App. 180, 183, 611 S.E.2d 878, 881 (N.C. 2005) (potential futility of
asking managers to bring action against themselves is insufficient excuse for failure to make
demand under section 1001 when partnership agreement disclosed conflicts of interest or self-
dealing).
In summary, plaintiffs= theory of direct relief against defendants is unsuccessful because
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plaintiffs suffered no harm distinct from that sustained by the limited partners who were not
parties to the lawsuit. Instead, the complaint adequately set out a derivative action on behalf of
the Late Night Las Vegas Limited Partnership for damages to the partnership. However, even if
plaintiffs= complaint sufficiently stated a derivative claim, we must consider defendants=
contention that the trial court=s judgment must be reversed because plaintiffs failed to join the
partnership as a party to their action.
II. Was the Limited Partnership a Necessary Party to Plaintiffs= Derivative Claim?
Plaintiffs= complaint alleged a derivative claim on behalf of the Late Night Las Vegas
Limited Partnership. Defendants argue that because plaintiffs failed to join the partnership as a
party, this court must reverse the trial court=s judgment.
The absence of a necessary party may be raised at any time. Allied American Insurance
Co. v. Ayala, 247 Ill. App. 3d 538, 543-44, 616 N.E.2d 1349, 1355 (1993). The record reveals
that the trial court did not decide the limited partnership=s status as a necessary party before trial
because the court barred defendants from moving to dismiss plaintiffs= second amended
complaint. Notably, defendants= motion was made on the eve of trial. After that ruling by the
trial court, defendants answered the complaint and raised as an affirmative defense, among other
theories, that the limited partnership was a necessary and indispensable party to the suit. In its
judgment, the trial court ruled that plaintiffs adequately represented the limited partnership=s
interests and that the partnership was not a necessary party.
On appeal, plaintiffs first contend that the applicable statute does not require that the
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limited partnership be a party to a derivative claim by a limited partner. Plaintiffs refer to
section 1002 of the Illinois Act, titled AProper Plaintiff,@ which states, in pertinent part:
ANo action shall be brought by a partner[] or assignee *** in the right of a
limited partnership unless, at the time of bringing the action, the plaintiff was a
partner or assignee ***.@ 805 ILCS 210/1002 (West 2000).
Plaintiffs argue that by defining the Aproper plaintiff@ in a derivative action as a Apartner
or assignee,@ the legislature necessarily indicated, by omission, that the limited partnership was
not a necessary party. Plaintiffs contend that because section 1002 states that an action shall be
brought Ain the right of a limited partnership,@ the partnership is represented in the derivative suit
by the limited partner or partners and thus is not a necessary party. Plaintiffs also assert that in a
successful derivative action, a prevailing plaintiff is to remit the proceeds of the suit to the
partnership, less reasonable expenses and attorney fees. 805 ILCS 210/1004 (West 2000).
Plaintiffs contend that provision further eliminates the need to make the limited partnership a
party to a derivative action because any recovery from such a suit is returned to the partnership.
We note that the trial court agreed with these arguments in its written ruling; however,
our review of this legal question is de novo. Eden Retirement Center, 213 Ill. 2d at 284, 821
N.E.2d at 246. First addressing plaintiffs= contentions based on section 1002, we interpret that
section to refer to the proper plaintiff to bring a derivative action and to indicate that the plaintiff
in a derivative suit must be someone with a financial interest in the partnership, i.e., a partner or
a partner=s assignee. We further interpret the language specifying the derivative nature of the
partner=s claim B Ain the right of a limited partnership@ B to denote the statute=s applicability to a
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derivative action, as opposed to a direct action. Thus, this section does not eliminate the need to
name a limited partnership where it is a necessary party.
Furthermore, because plaintiffs= arguments involve a uniform act, and given the dearth of
Illinois cases interpreting the statute, we note the decisions of other states= courts on this point.
The 11th Circuit Court of Appeals, interpreting Florida=s statute, has considered and rejected an
argument similar to that raised by plaintiffs in Bivens Gardens Office Building, Inc. v. Barnett
Banks of Florida, Inc., 140 F.3d 898, 909-10 (11th Cir. 1998). 1 In that case, the appeals court
considered whether the federal district court properly dismissed a limited partner=s derivative
claim because the partnership was an indispensable party. The limited partner argued that the
partnership need not be named as a party because the Florida statute did not Aexpressly require
it.@ Bivens Gardens, 140 F.3d at 910. Rejecting that contention, the appeals court stated that the
limited partner Awas required to name [the partnership] in order to plead a proper derivative
action even absent a statutory requirement.@ Bivens Gardens, 140 F.3d at 910.
As we have observed, derivative actions in limited partnership situations arose from the
advent of corporate shareholders= derivative suits. See M.D. Building Material, 219 Ill. App. 3d
at 515, 579 N.E.2d at 1062. The United States Supreme Court, in the case of a shareholder
1
The Florida statutes at issue in Bivens Gardens are equivalent to sections 1001 and
1002 of the Illinois act. See Fla. Stat. Ann. '' 620.163, 620.164 (West 2001).
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derivative suit, has stated:
AThe claim pressed by the stockholder against directors or third parties >is not his
own but the corporation=s.= [Citation.] The corporation is a necessary party to the
action; without it the case cannot proceed. Although named as a defendant, [the
corporation] is the real party in interest, the stockholder being at best the nominal
plaintiff.@ Ross v. Bernhard, 396 U.S. 531, 538, 24 L. Ed. 2d 729, 736, 90 S. Ct.
733, 738 (1970).
Illinois courts have reached the same conclusion in corporate cases. Feen v. Ray, 109 Ill.
2d 339, 344-45, 487 N.E.2d 619, 621 (1985); Kalabogias v. Georgou, 254 Ill. App. 3d 740, 747,
627 N.E.2d 51, 56-57 (1993) (corporation is necessary party to shareholder derivative action;
recovery runs to it and not to shareholders); Bingham v. Ditzler, 320 Ill. App. 88, 92, 49 N.E.2d
812, 813 (1943) (stockholder commences suit on behalf of corporation, which is Aindispensably
necessary party@ (emphasis omitted)).
Extending that reasoning to cases involving partnerships, several federal courts have held
that a limited partnership is a necessary party to a derivative action brought by a limited partner.
See New York Life Insurance Co. v. Ramco Holding Corp., 938 F. Supp. 754, 755-56 (N.D.
Okla. 1996); Moore, 919 F. Supp. at 1009-10; Wallner, 22 Cal. App. 4th at 1449, 27 Cal. Rptr.
2d at 836; Lenz, 833 F. Supp. at 378.
The Wallner court explained:
ALike a shareholder=s derivative action, a limited partner=s derivative suit is filed
in the name of the limited partner, and the partnership is named as a defendant.
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Although a limited partner is named as the plaintiff, it is the limited partnership
which derives the benefits of the action.@ Wallner, 22 Cal. App. 4th at 1449, 27
Cal. Rptr. 2d at 836.
Also, in Smith v. Bader, 458 F. Supp. 1184, 1187 (S.D.N.Y. 1978), the United States
District Court for the Southern District of New York ordered the plaintiff limited partners to join
the partnership to a derivative suit, stating:
AThe Partnership is an indispensable party to this action for reasons analogous to a
corporation being an indispensable party in a shareholders= derivative action
[citing United States Supreme Court=s opinion in Ross]. If the general partner has
converted the corporate assets or opportunities of the Partnership, it is the
Partnership which has the primary interest; the limited partner has no property
interest in the assets of the partnership, but only a right to share in the profits.
[Citation.] Furthermore, much of the relief sought by the plaintiffs would have a
direct effect on the Partnership and its assets: e.g., rescission of the sale of the
limited partnership units and the appointment of a receiver to operate the business
of the Partnership. The protection of such interests may be impeded in the
Partnership=s absence from this action since both the plaintiffs and defendants are
necessarily primarily concerned with protecting their own interests, which may
not, in all instances, coincide with those of the Partnership. In addition, the
defendants [who in Smith included the general partner] may be open to double,
multiple or otherwise inconsistent obligations since plaintiffs do not represent all
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the limited partnership interests. The addition of the Partnership to this action
would effectively eliminate this possibility. Since it is alleged that the
Partnership is in antagonistic hands, it should properly be added as a party
defendant to this action.@
These cases illustrate the prevailing opinion that a limited partnership should be named
as a party defendant to a derivative action brought by one or more limited partners. However,
we observe that one federal appeals court has reached the opposite conclusion, reversing a
district court=s judgment that the partnership was an indispensable party and holding that because
all limited partners were before the court, it was not necessary for the partnership to be joined:
A[A partnership=s] interests must ultimately derive from the interests of the human
beings that are its members ***. A partnership=s interests as an entity consist of
an aggregation of those interests of each of the individual partners that are
relevant to the purpose of the partnership. Thus, at least in certain cases, it is
possible that a partnership=s interests can be effectively represented in litigation
by participation of its partners.@ HB General Corp. v. Manchester Partners, L.P.,
95 F.3d 1185, 1193 (3rd Cir. 1996).
In the instant case, defendants contend the partnership was a necessary party because
only it could represent the rights of all the limited partners and bind them to a settlement.
Defendants argue that the trial court could not cure plaintiffs= failure to name the partnership as a
party by granting it relief in its absence, e.g., ordering defendants to return management fees to
the partnership.
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Plaintiffs respond that the partnership was not a necessary party because as a group of
limited partners, they adequately represented the partnership=s interests. Plaintiffs cite the cases
on which the trial court relied, most prominently Cales v. Dressler, 315 Ill. 142, 149, 146 N.E.
162, 165 (1924), in which the Illinois Supreme Court stated, in the context of a will dispute, that
A[w]here parties are effectively represented they need not be made parties.@ Plaintiffs argue that
by seeking damages for defendants= breach of fiduciary duty, they, as individual limited partners,
sought relief for the benefit of the partnership.
Illinois courts have defined a necessary party as one with a legal or beneficial interest in
the litigation that will be affected by the court=s actions. Boyd Electric v. Dee, 356 Ill. App. 3d
851, 859, 826 N.E.2d 493, 500 (2005), quoting Holzer v. Motorola Lighting, Inc., 295 Ill. App.
3d 963, 970, 693 N.E.2d 446 (1998). A party is necessary when its presence is required for one
of three reasons: (1) to protect an interest in the controversy that would be materially affected by
a judgment entered in its absence; (2) to protect the interests of those who are before the court; or
(3) to enable the court to make a complete determination of the controversy. Boyd Electric, 356
Ill. App. 3d at 859, 826 N.E.2d at 500. Fundamental principles of due process prevent the entry
of a judgment that affects a right or interest of a party not before the court. Feen, 109 Ill. 2d at
344, 487 N.E.2d at 621-22; Tsuetaki v. Novicky, 158 Ill. App. 3d 505, 513, 509 N.E.2d 1019,
1026 (1983).
Having considered the three potential reasons for the necessity of the limited
partnership=s presence in this action, we conclude that none of those reasons warrants reversal of
the trial court=s judgment for the failure to join the limited partnership as a party. As to whether
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the limited partnership=s interest in the suit was materially affected by the judgment entered
without it as a party or whether the limited partnership=s presence was necessary to protect the
interests of those before the court, the trial court granted relief to the limited partnership by
ordering the general partners to return management fees to the limited partnership and also by
imposing a constructive trust on certain funds for the benefit of the limited partnership. The
party to be compensated in a derivative action is the partnership, with the limited partners who
bring the suit acting as the nominal plaintiffs. See Ross, 396 U.S. at 538, 24 L. Ed. 2d at 736, 90
S. Ct. at 738; Wallner, 22 Cal. App. 4th at 1449-50, 27 Cal. Rptr. 2d at 836. As the cases
discussed above illustrate, even though the partnership=s interests often are aligned with those of
the plaintiff limited partners, the partnership is named as a defendant. Although the limited
partnership was not named as a party defendant in plaintiffs= complaint, the defendant general
partners, against whom the judgment was entered, were afforded due process. Defendants were
given notice of the action against them and were fully represented in the court proceedings. For
this court to negate the substantial work of the trial court based on the absence of the limited
partnership as a party would elevate form over substance.
Moreover, the limited partnership=s absence did not prevent the court from engaging in a
complete determination of the controversy. Defendants= argument to the contrary is based on the
positions of the absent limited partners, and defendants momentarily contend in their reply brief
that those limited partners also were necessary party plaintiffs to this action. However,
defendants do not appear to argue that the absent partners should be named as parties but rather
that if the partnership was made a party, the remaining partners would be represented via the
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partnership=s presence in the suit.
We conclude that the absent limited partners were adequately represented, albeit under a
different theory than that offered by defendants. Under the doctrine of representation, absent
parties need not be joined when their interests are effectively protected by those in the suit.
Holzer, 295 Ill. App. 3d at 972, 693 N.E.2d at 453. In bringing a derivative action, plaintiffs
sought to protect the financial interests of all of the limited partners, and privity exists between
parties who adequately represent the same legal interests. See Schnitzer v. O=Connor, 274 Ill.
App. 3d 314, 326, 653 N.E.2d 825, 833 (1995) (plaintiffs in shareholder derivative action had
same interest as separate group of plaintiff shareholders, i.e., recovery to the corporation and its
shareholders for the defendant directors= breach of their duties). The absent limited partners
share the same interest in this derivative suit as plaintiffs, who sought recovery for the
partnership. Therefore, the absent limited partners are not necessary parties to the derivative
action brought by plaintiffs. Moreover, the failure to name the partnership as a party defendant
did not prevent the court from fully resolving the case.
III. The Trial Court=s Additional Rulings
A. Management Fees
Defendants next argue that the trial court erred in ordering them to return $833,190 in
management fees to the limited partnership to compensate for funds that Morton and DeGraff
earned as general partners between 1997 and 2000, the period when the trial court found
defendants to be in breach of their fiduciary duty to the partnership. Defendants assert that
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although preliminary discussions with Grand Plaza occurred in September 1997, defendants
could not have breached their duty to plaintiffs until October 14, 1997, when they informed the
limited partners of the proposed transaction. Plaintiffs respond that the award of management
fees was not manifestly erroneous, and they argue that defendants= actions in September and
October 1997 were not the sole basis for the trial court=s finding of a breach of fiduciary duty.
As the trial court observed in its opinion, and as defendants do not dispute, a breach of
fiduciary duty requires the complete forfeiture of all compensation during the period of the
breach, and the appropriate remedy for such a breach is left to the equitable discretion of the trial
court. See LID Associates, 324 Ill. App. 3d at 1071, 756 N.E.2d at 886. The trial court stated
that defendants= breach of fiduciary duty Aextended through the period 1997-2000@ during which
defendants took $833,190 as Amanagement fees.@
Defendants acknowledge that a trial court=s findings of fact are to be disturbed on review
only if they are against the manifest weight of the evidence, meaning when the findings appear to
be arbitrary or not based on the evidence, leaving the opposite conclusion apparent. See Corral
v. Mervis Industries, Inc., 217 Ill. 2d 144, 154-55, 839 N.E.2d 524, 530-31 (2005). That
standard reflects the role of a reviewing court, which is to not substitute its judgment for that of
the trier of fact. Corral, 217 Ill. 2d at 155, 839 N.E.2d at 531. In the case at bar, the evidence
does not contradict the trial court=s ruling that defendants were not entitled to management fees
for the period of 1997 through 2000. The court based its finding that defendants breached their
fiduciary duty to plaintiffs, in part, on defendants= failure to disclose their deal with Grand Plaza
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to the limited partners at the meeting on October 14, 1997. The court also cited the $900,000 in
extension fees that defendants received from Grand Plaza as further evidence of a breach.
Defendants argue that they were entitled to keep management fees that they earned in
1997 until October 14, and defendants contend the trial court did not state that defendants should
forfeit all management fees received in that calendar year. However, the failure to disclose the
terms of the Grand Plaza deal to the limited partners at the October 1997 meeting did not mark
the point of defendants= breach of their fiduciary duty to the partnership. The discussions that
preceded the formal agreement with Grand Plaza necessarily occurred before the October 1997
meeting with the limited partners. Indeed, the record includes an affidavit in which Morton and
DeGraff state that they were Aapproached@ by Grand Plaza in the spring of 1997 about a potential
property deal. The trial court=s decision to deny defendants management fees for the entire 1997
calendar year was not contrary to the manifest weight of the evidence.
B. Punitive Damages
Defendants= final contention on appeal is that the trial court erred in granting plaintiffs $1
million in punitive damages. Punitive damages can be awarded when a tort is committed with
fraud, actual malice or deliberate violence or oppression, or when the defendant or defendants
act willfully or with such gross negligence as to display a wanton disregard for others. Lowe
Excavating Co. v. International Union of Operating Engineers Local No. 150, 358 Ill. App. 3d
1034, 1039, 832 N.E.2d 495, 500 (2005). Because punitive damages are not favored in the law
and due to their penal nature, courts must ensure that punitive damages are not awarded
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improperly or without consideration. Lowe Excavating, 358 Ill. App. 3d at 1039, 832 N.E.2d at
501; Franz v. Calaco Development Corp., 352 Ill. App. 3d 1129, 1137, 818 N.E.2d 357, 366
(2004).
In reviewing a trial court=s decision to award punitive damages, this court takes a three-
step approach, considering: (1) whether punitive damages are available for the particular cause
of action, using a de novo standard; (2) whether, under a manifest weight of the evidence
standard, the defendant or defendants acted fraudulently, maliciously or in a manner that
warrants such damages; and (3) whether the trial court abused its discretion in imposing punitive
damages. Lowe Excavating, 358 Ill. App. 3d at 1039, 832 N.E.2d at 501. As to the first
consideration, it is undisputed that punitive damages are appropriate to punish and deter the
conduct of a defendant who has intentionally breached a fiduciary duty, particularly when in a
position of trust and confidence. Dowd & Dowd, Ltd., v. Gleason, 352 Ill. App. 3d 365, 387-88,
816 N.E.2d 754, 773 (2004).
Turning to the second factor, we review the trial court=s reasons for imposing punitive
damages to determine if its judgment that defendants acted fraudulently, maliciously or in a
manner warranting punitive damages was contrary to the manifest weight of the evidence. The
trial court stated in its order that Morton and DeGraff did not tell the limited partners Aabout the
parts of the [Grand Plaza] deal they were keeping for themselves.@
Defendants first assert, however, that they disclosed to the limited partners the terms of
the transaction with Grand Plaza, including the extension fees that Morton and DeGraff would
retain. Defendants argue that they reasonably believed the extension fees were rightfully theirs
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and were not intended for the partnership. Defendants further maintain that because the Grand
Plaza deal was never consummated, the partnership did not sustain a Aloss.@ They argued that, to
the contrary, Drink continued to operate to the partnership=s benefit until the changing Las Vegas
club scene led to its financial losses and eventual demise.
The trial court also stated that Morton and DeGraff concealed their use of $3 million in
earnest money in the Grand Plaza deal. In an affidavit included in the record, Morton and
DeGraff attest that they Adid not use earnest money from Grand Plaza to purchase the [Drink
land] but rather obtained a loan.@ Defendants contend they did not hide from the partnership
their use of the $3 million earnest money from Grand Plaza to exercise the option with Air
Storage and buy the Drink land. Plaintiffs respond that defendants attempt to maintain two
inconsistent facts: (1) the limited partners knew that defendants used the $3 million to purchase
the Drink property; and (2) defendants truthfully stated in their affidavit that they did not use the
earnest money to buy the land.
The trial court made the following findings of fact. Morton and DeGraff personally
owned the option to purchase the Drink land and had acquired that option before the partnership
was formed. The partnership owned the leasehold on the Drink property and was required to
relinquish that leasehold for the Grand Plaza deal to be completed. Defendants received $3.25
million from Grand Plaza upon executing the purchase agreement, which the agreement called a
Aloan.@ Defendants argue that the money was a loan because when the purchase agreement was
cancelled, the money was refunded to Grand Plaza.
AThe fiduciary nature of the partnership relation requires at all times the highest degree of
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good faith, and precludes any secret profit, benefit or advantage of any kind.@ 1 S. Rowley,
Rowley on Partnership ' 21.0, at 515 (1960). Whether the partnership sustained a measurable
loss, and whether or not the limited partners were aware of such a loss, is not the test of whether
defendants breached their fiduciary duty to the partnership. Such a breach occurred if
defendants took for themselves money that properly belonged to the partnership, even if no
Aloss@ was apparent to the limited partners.
Another reason the trial court expressed for granting punitive damages involved
defendants= statements to the limited partners about legal representation for the partnership in the
negotiations with Grand Plaza. The trial court found that Morton and DeGraff falsely told the
limited partners that the attorney negotiating with Grand Plaza represented the limited
partnership; the attorney actually represented Morton and DeGraff as the general partners. The
trial court found that contrary to Morton and DeGraff=s representations, the limited partnership
was unrepresented in the talks with Grand Plaza.
Defendants attempt to downplay their conduct by arguing that several limited partners
retained one attorney to represent their interests in the Grand Plaza transaction and that the
majority of the limited partners voted to proceed with the deal because it was potentially
lucrative. Defendants further contend that counsel for the partnership Amight have been
important@ if the limited partners were asked to Agive something up@ in the Grand Plaza
transaction. However, defendants do not contest that they told the limited partners that the
limited partnership was represented in the talks with Grand Plaza when that was not the case.
The trial court=s award of punitive damages on this basis was not against the manifest weight of
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the evidence.
Lastly, under the third step set out in Lowe, we do not find that the trial court abused its
discretion in assessing punitive damages in this case. A trial court does not abuse its discretion
unless no reasonable person could assume its view. Franz, 352 Ill. App. 3d at 1148, 818 N.E.2d
at 375. The trial court correctly noted in its judgment that the purposes of a punitive damages
award are retribution against the wrongdoer and deterrence of similar conduct by that party and
by others in general, and the court stated that its order against defendants served those needs.
The court also found substantial damages were necessary in this case due to the amount of
money involved in the transactions. The court did not abuse its discretion in awarding $1
million in punitive damages against defendants. Therefore, based on the three-step test set out in
Lowe, we affirm the trial court=s award of punitive damages.
IV. Modification of Compensatory and Punitive Damages Awards
Plaintiffs ask this court to amend the compensatory and punitive damages awards,
pursuant to Supreme Court Rule 366(a) (155 Ill. 2d R. 366(a)), to exclude defendants from
receiving any part of the awards as the partnership=s general partners. Plaintiffs assert that if the
court=s judgment is not modified to prevent defendants from sharing in the proceeds, defendants
will benefit from their own wrongdoing. Plaintiffs request that we amend the trial court=s order
to state that the award should be distributed only to the limited partners.
Defendants respond that plaintiffs waived this request by failing to seek relief in the trial
court via a posttrial motion to modify the judgment, and they argue that the trial court=s order did
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not address the distribution of the award to the partnership aside from the issue of the
approximately $833,000 in management fees.
Nevertheless, even if plaintiffs did not bring this issue to the trial court=s attention, waiver
is customarily considered an admonition to the parties and not a hindrance to a reviewing court=s
ability to address issues of law. See, e.g., Demos v. Ferris-Shell Oil Co., 317 Ill. App. 3d 41, 48,
740 N.E.2d 9, 14-15 (2000). This approach is particularly appropriate when the argument
involves Rule 366(a), which allows this court numerous general discretionary powers, including
the ability to address certain matters sua sponte. 155 Ill. 2d R. 366(a). Defendants offer no
substantive response to the doctrine that a fiduciary should not benefit from its own wrongdoing.
Accordingly, the trial court=s order is modified to state that defendants are to receive no part of
the compensatory and punitive damages awarded to the partnership.
CONCLUSION
In summary, plaintiffs= second amended complaint alleged a derivative, not a direct,
action against defendants on behalf of the Late Night Las Vegas Limited Partnership. Although
the limited partnership was a necessary party to plaintiffs= derivative claim, we conclude that the
due process rights of the partnership were not prejudiced by plaintiffs= failure to name the
partnership and that no practical purpose would be served by reversing the trial court=s ruling
simply to allow plaintiffs to name the limited partnership as a party defendant. Thus, the
judgment of the trial court is affirmed. Furthermore, the trial court=s ruling as to the management
fees retained by Morton and DeGraff and the court=s assessment of $1 million in punitive
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damages were not contrary to the manifest weight of the evidence and are therefore affirmed. In
addition, the trial court=s order is modified to state that defendants are to receive no part of the
compensatory and punitive damages awarded to the partnership.
Affirmed as modified.
O'BRIEN and NEVILLE, JJ., concur.
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