Henkels & McCoy, Inc. v. Adochio

Opinions of the United
1998 Decisions States Court of Appeals
for the Third Circuit
3-9-1998
Henkels & McCoy Inc v. Adochio
Precedential or Non-Precedential:
Docket 97-1170
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Filed March 9, 1998
UNITED STATES COURT OF APPEALS
FOR THE THIRD CIRCUIT
No. 97-1170
HENKELS & McCOY, INC.
v.
ROBERT ADOCHIO, RALPH ANDERSON, ROBERT
BADER, RALPH BARUCH, JOHN BUCK, ALAN
GOLDBERG, FRED GREEN, LEONARD C. GREEN,
C. BRUCE JOHNSTONE, HERBERT KAUFER, BILL
LUCAS, WILLIAM MILLER, ARTHUR ROTHLEIN, EDWARD
ROWAN, JOSEPH SCUTELLARO, CONRAD STRUDLER,
BARRY WAGENBERG, ARTHUR WELLMAN, JAMES R.
WILLING, and CHESTER DAVIS
Ralph Anderson, Robert Bader, Ralph Baruch, John Buck,
Fred Green, Leonard C. Green, C. Bruce Johnstone,
Herbert Kaufer, Bill Lucas, Arthur Rothlein, Edward
Rowan, Joseph Scutellaro, Barry Wagenberg, Arthur
Wellman, James R. Willing and Chester Davis,
Appellants
An Appeal from the United States District Court
for the Eastern District of Pennsylvania
D.C. No. 94-cv-03958
Argued: October 15, 1997
Before: STAPLETON, ALITO, and ROSENN, Circuit Judges.
(Opinion Filed March 9, 1998)
Robert J. Stern
Stradley, Ronon, Stevens & Young
2600 One Commerce Square
Philadelphia, PA 19103
Counsel for Appellee
Roger B. Kaplan
Wilentz, Goldman & Spitzer
90 Woodbridge Center Drive
P.O. Box 10
Woodbridge, NJ 07095
Counsel for Appellants
OPINION OF THE COURT
ROSENN, Circuit Judge.
This appeal presents an important question pertaining to
the obligation of limited partners to return capital
contributions distributed to them in violation of their
partnership agreement which required that they establish
reasonably necessary reserves. The issue is rendered
complex by an interrelated maze of corporations and
partnerships devised by the limited partners and the
general partner in their efforts to develop two separate real
estate projects. One of these, Timber Knolls, was aborted
shortly after conception, and the other, Chestnut Woods,
became the genesis of protracted litigation and of this
appeal.
The defendants-appellants are limited partners of Red
Hawk North Associates, L.P. (Red Hawk) L.P., a New Jersey
limited partnership. G&A Development Corporation (G&A)
is the general partner of Red Hawk. Cedar Ridge
Development Corporation (Cedar Ridge), a New Jersey
corporation, and Red Hawk entered into a joint venture
agreement, the Chestnut Woods Partnership (Chestnut), to
develop, construct, and market residential homes in Bucks
County, Pennsylvania. Red Hawk and Cedar Ridge are both
general partners of Chestnut Woods. Under the joint
venture agreement, Red Hawk would provide the funding
and Cedar Ridge would provide the land which it previously
2
had agreed to purchase. Cedar Ridge would act as the
managing partner and general contractor.
On December 29, 1989, Cedar Ridge, as general
contractor for Chestnut Woods, entered into a written
subcontract with Henkels & McCoy, Inc. (Henkels), the
plaintiff herein, to have it furnish the labor, materials, and
equipment for the installation of the storm and sanitary
sewer systems for the project. Cedar Ridge agreed to pay
Henkels a fixed-price of $300,270 under the contract.
Henkels completed the installation of the storm and sewer
systems but Chestnut Woods defaulted in making the
payments due under the contract. Henkels, a Pennsylvania
corporation, then filed three actions in the United States
District Court for the Eastern District of Pennsylvania;
Henkels filed the first in December 1990 against Cedar
Ridge and Red Hawk, trading as Chestnut Woods, for the
balance due on the contract plus interest. The court
entered a default judgment which was not satisfied in
whole or part.
Henkels then filed suit against G&A in its capacity as a
general partner of Red Hawk and obtained a default
judgment in the same amount as it had obtained against
Cedar Ridge and Red Hawk. Efforts to obtain payment on
this judgment also proved fruitless and counsel for the
defendants advised plaintiff 's counsel by letter dated
October 26, 1993 that Red Hawk was worthless. Henkels'
counsel also had been advised that G&A was unable to pay
the judgment out of its assets.
Henkels finally brought this suit against the nineteen
limited partners of Red Hawk (the Partners), standing in the
shoes of the Red Hawk limited partnership; sixteen of the
partners are parties to this appeal. Henkels sought, inter
alia, to compel replacement of certain capital distributions
made by Red Hawk to the limited partners aggregating
$492,000 during the period that Cedar Ridge was obligated
under its contract with Henkels to pay Henkels $300,270.
Henkels alleged that the capital distributions were made in
violation of the Red Hawk limited partnership agreement
and S 42:2A-46(b) of the New Jersey Uniform Limited
Partnership Law of 1976 (New Jersey ULPL).
3
After the district court denied both Henkels's and the
Partners' motions for summary judgment,1 it conducted a
bench trial and on January 6, 1997, entered judgment in
favor of Henkels. The court held each limited partner of Red
Hawk liable to Henkels for his proportionate share of
liability in the total amount of $371,101.84 plus interest to
the date of payment of any judgment. The Partners
appealed. We affirm.2
I.
The following facts are undisputed and are based upon
the stipulation of the parties and the findings of fact made
by the district court. The Red Hawk partnership, consisting
of 20 (1 deceased)3 limited partners and one corporate
general partner, G&A, was formed in 1986. Pursuant to
their partnership agreement, the Partners contributed $3.5
million in capital which ultimately they allocated to two
distinct partnership projects, Timber Knolls and Chestnut
Woods.
In 1987, Red Hawk and Cedar Ridge entered into a joint
venture agreement forming the Chestnut Woods
Partnership, with both Red Hawk and Cedar Ridge as
general partners. Under the joint venture agreement, Red
Hawk would provide the capital funds for the project and
Cedar Ridge would provide the general management and
assign its contract for the purchase of the land. Red Hawk
funded the Partnership with an initial capital contribution
of $650,000 (and an additional contribution of $200,000 in
1988). Cedar Ridge agreed to act as both the managing
partner and the general contractor of the Chestnut Woods
project. In addition, Cedar Ridge had the right to incur
_________________________________________________________________
1. Henkels & McCoy, Inc. v. Adochio, 906 F. Supp. 244 (E.D. Pa. 1995).
2. The district court had jurisdiction over this matter pursuant to 28
U.S.C. S 1332, as it is a civil action involving parties of diverse
citizenship and the amount in controversy at the time the suit was filed
in 1994 was in excess of the then existing $50,000 jurisdictional
amount. This Court has appellate jurisdiction of the district court's
final
order pursuant to 28 U.S.C. S1291.
3. Conrad Strudler, a limited partner, died before trial and was no longer
a defendant.
4
liabilities on behalf of the partnership in connection with
the partnership's reasonable and legitimate business,
borrow money in the name of the partnership, and incur
reasonable and legitimate expenses related to the Chestnut
Woods property. Work on the Chestnut Woods project
subsequently commenced.
In 1988, Red Hawk and Cedar Ridge entered into a
second and distinct joint venture agreement to form the
Timber Knolls partnership, under which both Red Hawk
and Cedar Ridge were also general Partners. Red Hawk
contributed $2.3 million to the Timber Knolls partnership
and Cedar Ridge again agreed to act as both the managing
partner and the general contractor of the project. Unlike the
Chestnut Woods project, the Timber Knolls project never
commenced operations. Therefore, in 1988, the Red Hawk
Partners entered into an agreement with Cedar Ridge
requiring the latter to return Red Hawk's $2.3 million
capital contribution. As evidence of this obligation, Cedar
Ridge executed promissory notes aggregating $2.3 million
with interest and principal payable quarterly.4 Cedar Ridge
made quarterly payments to Red Hawk on the notes, and
G&A distributed these payments to the individual Red
Hawk Partners, as follows:
Payments by Distributions by
Cedar Ridge G&A to the
to Red Hawk Red Hawk
Date On the Notes Partners
(1) Jan. 1989 $ 78,750 $ 76,200
(2) April 1989 $215,000 $207,900
(3) July 1989 $215,000 $207,900
Totals $508,750 $492,000
Meanwhile, on December 29, 1988, Cedar Ridge, in its
role as general contractor of Chestnut Woods, bound itself
to a $300,270 fixed-price contract with Henkels, under
which Henkels agreed to furnish and install storm and
_________________________________________________________________
4. Each note initially called for quarterly interest of $78,750 only, with
balloon payments of principal due on the third quarter of each year. In
addition, the $2.3 million due was subsequently reduced to $2.1 million,
with $200,000 transferred to Red Hawk's stake in Chestnut Woods,
thereby increasing its investment to $850,000.
5
sanitary sewer systems for the Chestnut Woods
development. The contract identified Cedar Ridge as the
"General Contractor," Henkels as the "Subcontractor," and
Chestnut Woods as the "Property Owner." The contract did
not mention the relationship between Cedar Ridge and the
Chestnut Woods Partnership, and made no reference to Red
Hawk. It provided that the General Contractor, Cedar
Ridge, was obligated to pay Henkels, payments to be made
against billed invoices 30 days after approved inspection. At
that time, Henkels was unaware that Cedar Ridge and Red
Hawk were partners in Chestnut Woods.
On January 16, 1989, Henkels commenced the
installation of the Chestnut Woods storm and sewer
systems and completed the work according to the contract
in late 1989. Under the contract, Cedar Ridge was required
to pay Henkels in progress payments as invoiced.
Accordingly, Henkels invoiced Cedar Ridge and received
payments as follows:
Invoice Invoice
Date Amount Invoice Status
(1) Feb. 24, 1989 $ 37,632 paid in full 4/4/89
(2) May 24, 1989 $ 33,421 paid in full 7/6/89
(3) Aug. 14, 1989 $215,175 only $25,000 paid on 10/19/89
(4) Sept. 28, 1989 $ 37,183 no payment
(5) Nov. 9, 1989 $ 10,586 no payment
$333,996 Total amount paid = $ 96,053
Total amount unpaid = $237,943
Thus, Henkels received a partial payment in October on
its August invoice and no payments on its September and
November invoices, leaving a total unpaid balance of
$237,943. G&A, the general partner for Red Hawk, failed to
establish any reserves from the cash receipts of the limited
partnership.
On March 16, 1990, Cedar Ridge sold its assets to Red
Hawk. Shortly thereafter, in April 1990, G&A agreed with
Henkels to pay Cedar Ridge's outstanding obligations to it,
including accrued interest. However, Cedar Ridge paid only
two small payments aggregating $8,000.
On December 19, 1990, Henkels sued Cedar Ridge and
Red Hawk, trading as Chestnut Woods, claiming breach of
6
the installation contract and the April 1990 agreement,
unjust enrichment, and conspiracy to defraud. Henkels
obtained judgment against Cedar Ridge and Red Hawk in
the amount of $282,421.55, including interest. Cedar Ridge
and Red Hawk were unable to satisfy this judgment, in
whole or in part.
In June 1992, Henkels sued G&A in its capacity as
general partner of Red Hawk for the amount of the
judgment previously obtained against Cedar Ridge and Red
Hawk. On August 12, 1992, the Henkels obtained a default
judgment against G&A in the sum of $282,424.55 plus
interest at 6% per annum from October 15, 1991. When
Henkels learned that G&A was unable to satisfy this
judgment in whole or in part, it filed the instant suit
seeking to have the Partners return to Red Hawk the cash
capital distributions they received in 1989 as limited
partners so that Red Hawk could satisfy the judgment
obtained by Henkels against it.
The parties stipulated in the district court that the
distributions made to the Red Hawk limited partners
constituted a return of capital and that the distributions
did not violate the New Jersey Limited Partnership Act. The
district court concluded, however, in a careful and
thorough opinion, that Paragraph 12(a) of the Red Hawk
agreement of limited partnership governed the distribution
of all cash receipts, except those derived from the operation
of the property, and found that the payments on the
promissory note from Cedar Ridge to Red Hawk did not
constitute cash receipts derived from operations. It
therefore held that the general partner was obligated to
follow the mandate of Paragraph 12(a)(iv) of the partnership
agreement which required the establishment of reasonable
reserves prior to distributing cash receipts to the limited
partners.
The district court found that the general partner in Red
Hawk failed to establish any reserves and that Red Hawk
had knowledge of its contingent obligations in the Chestnut
Woods project and knew or should have known of the
strong potential that the assets of Chestnut Woods would
not cover the expenses it continued to incur for site
improvements by Henkels and for which Red Hawk was
7
ultimately responsible. Accordingly, it held that Red Hawk
violated the partnership agreement by failing to establish
reasonable reserves to cover the cost of the site
improvements made by Henkels.
The court accordingly entered a verdict in favor of
Henkels and against the Partners individually for their
proportionate share of liability in accordance with the
monetary sums set forth in its conclusions of law in the
total amount of $371,101.84 to date plus interest to the
date of payment of any judgment.
The Partners appealed.
II.
On appeal, the Partners contend that the district court
erred in holding that at the times of the distributions by
Red Hawk to its limited partners, Henkels was a creditor of
Red Hawk and that the distributions were made in violation
of the partnership agreement. They also argue that even if
Henkels were a creditor of Chestnut Woods, Red Hawk, as
a Chestnut Woods partner, was not jointly and severally
liable for the partnership debts (as a guarantor of payment)
but rather only contingently liable as a guarantor of
collection, and then only in the event Henkels obtained a
judgment against the Chestnut Woods Partnership and
failed to collect on such judgment.
This Court reviews a district court's construction and
application of the New Jersey Uniform Limited Partnership
Law de novo. See Salve Regina College v. Russell, 499 U.S.
225, 231 (1991); Schreiber v. Kellogg, 50 F.3d 264, 266 (3d
Cir. 1995). However, whether Red Hawk and G&A breached
the Red Hawk limited partnership agreement by failing to
establish reasonably necessary reserves, and thus the
Partners ultimately received the distributions in violation of
the agreement, is a mixed question of law and fact.
Accordingly, this Court exercises plenary review of the legal
operation of the partnership agreement, but will vacate the
district court's contract interpretations and subsidiary
factual findings only if they are clearly erroneous. See
Cooper Lab., Inc. v. International Surplus Lines Ins. Co., 802
F.2d 667, 671 (3d Cir. 1986); Ram Constr. Co., Inc. v.
8
American States Ins. Co., 749 F.2d 1049, 1053 (3d Cir.
1984).
As a preliminary matter, we must first address the Red
Hawk Partners' argument that Henkels was not a creditor
who had extended credit to Red Hawk at the time of the
1989 capital distributions, and therefore the Partners were
not liable to Henkels. The Partners base their argument on
Section 42:2A-46(a) of New Jersey's ULPL, entitled "Liability
upon return of contribution," which provides
a. If a limited partner has received the return of any
part of his contribution without violation of the
partnership agreement or this chapter, he is liable to
the limited partnership for a period of one year
thereafter for the amount of the returned contribution,
but only to the extent necessary to discharge the
limited partnership's liabilities to creditors who
extended credit to the limited partnership during the
period the contribution was held by the partnership.
N.J. Stat. Ann. S 42:2A-46(a) (emphasis added). The
Partners' reliance on this section is, however, misguided for
several reasons: first, and most importantly, Henkels
brought suit under Section 42:2A-46(b) not (a); second,
subsection (b) is not in any way dependent upon nor does
it even make cross reference to subsection (a); third,
subsection (b) does not require that Henkels have extended
credit or have been a creditor, nor does it even mention the
word "creditor." Finally, subsection (b) addresses an entirely
different concern than subsection (a): contributions made
in violation of a partnership agreement or the New Jersey
ULPL as opposed to distributions made without such
violations but to the prejudice of creditors. Accordingly,
Section 42:2A-46(a) is irrelevant to the issues raised on this
appeal.
Our analysis does not end with this conclusion, however,
because as just mentioned, Henkels does allege that the
distributions made by G&A to the Partners were illegal
under Section 42:2A-46(b) of the New Jersey ULPL. Henkels
specifically alleges that the distributions violated the New
Jersey ULPL because they were made in violation of the Red
Hawk partnership agreement. Accordingly, we confine our
9
analysis to the relevant sections of the partnership
agreement in conjunction with Section 42:2A-46(b) which,
in its entirety, reads as follows:
b. If a limited partner has received the return of any
part of his contribution in violation of the partnership
agreement or this chapter, he is liable to the limited
partnership for a period of six years thereafter for the
amount of the contribution wrongfully returned.
(emphasis added). Section 12(a) of the Red Hawk
partnership agreement specifically provided that cash
receipts be used for the establishment of reasonable
reserves (for creditors) before such receipts be distributed
to the Partners.5 The Partners contend that the
distributions were not made in violation of the partnership
agreement because Henkels, under the sewer subcontract,
at most was a creditor of only Cedar Ridge, not of either
Chestnut Woods or Red Hawk. Thus Red Hawk, they argue,
was not required to establish reserves. Pursuant to this
reasoning, the Partners assert that because Henkels was
not a creditor, they did not receive the 1989 distributions
in violation of the partnership agreement and thus did not
violate the New Jersey ULPL.
The district court, however, committed no error when it
found that Henkels was a creditor of Red Hawk even
though Henkels was not in direct contractual privity with
either Chestnut Woods or Red Hawk. The Partners contend
that this was in error and that they could not be liable to
Henkels because Cedar Ridge was acting solely in its
capacity as general contractor and not as a partner in
Chestnut Ridge when it entered into the contract with
Henkels. Thus they contend that the contract did not bind
Chestnut Woods or Red Hawk in any way.
_________________________________________________________________
5. Section 12, in pertinent part, provides that:
(a) Application of Cash Receipts. Cash receipts shall be applied
in the following order of priority:
. . .
(iv) to the establishment of such reserves as the General Partner
shall reasonably deem necessary; and
(v) to distributions to the Partners . . .
10
In support of their argument, the Partners note that the
Subcontract Agreement with Henkels identifies Cedar Ridge
as the "General Contractor," Henkels as the
"Subcontractor," makes no mention of Red Hawk, and
merely lists the Chestnut Woods Partnership as the
"Property Owner." The contract, signed only by Henkels and
Cedar Ridge, also states that Henkels shall invoice and be
paid by Cedar Ridge, and provides that the Chestnut Woods
property shall not serve as security for payment or be
subjected to liens. The Partners also consider significant
that Henkels acknowledged that the contract was with
Cedar Ridge only and that Henkels had no knowledge that
Cedar Ridge or Red Hawk were partners in Chestnut
Woods. The Partners argue that these facts conclusively
establish that Cedar Ridge entered into the contract solely
in its capacity as general contractor, not as a general
partner of Chestnut Woods, and therefore Cedar Ridge is
solely liable under the contract.6
This "two hats" argument, although creative, is merely
one of form over substance, ignoring the essence of the
Chestnut Woods partnership agreement as well as
fundamental principles of agency and partnership law
which largely control the outcome of this case. First, the
essence of the Chestnut Woods partnership agreement was
that Red Hawk would "fund the PARTNERSHIP" by
providing the capital with which to develop the property,
while Cedar Ridge would contribute its development
expertise by "act[ing] as the MANAGING PARTNER and
GENERAL CONTRACTOR." (App. 76a, "Joint Venture
Agreement, Chestnut Woods Partnership"). Thus, when
Cedar Ridge signed the contract with Henkels as General
Contractor, it simultaneously also was acting as a partner
in the joint venture pursuant to its express authority to
_________________________________________________________________
6. The Partners cite in their brief, In Re Moserbeth Assoc., 128 B.R. 716
(E.D. Pa. 1991), as support for this argument. Moserbeth, however, is
inapposite. In Moserbeth, the general contractor was not itself a partner
in the limited partnership, but instead was a separate and distinct
corporation owned 100% by a partner in the partnership. This separate
and distinct corporate identity was critical to the Moserbeth court
holding that the partnership was not liable for the debts of the general
contractor.
11
"act as the . . . GENERAL CONTRACTOR" as provided in
the Chestnut Woods partnership / joint venture agreement.
Second, it is elementary that "[e]very partner is an agent of
the partnership for the purpose of its business, and the act
of every partner . . . binds the partnership, unless the
partner so acting has in fact no authority to act for the
partnership in the particular matter." N.J. Stat. Ann.
S 42:1-9(1); see also Eule v. Eule Motor Sales, 170 A.2d 241,
243 (N.J. 1961); Restatement (Second) of AgencySS 12, 140
(1958). This principle holds true even when, as here, the
principal is undisclosed and the agent signs the contract in
his individual capacity for the benefit of the partnership.
But when a third party creditor ascertains an agency
relationship, it may hold the partnership as principal liable
(and ultimately the individual partners) even though the
creditor was unaware of the agency relationship at the time
that he extended the credit to the agent. See Looman Realty
Corp. v. Broad St. Nat'l Bank of Trenton, 161 A.2d 247, 255-
56 (N.J. 1960) ("The principal, if discovered, may also be a
party to the contract."); Levy v. Iavarone, 154 A. 527 (N.J.
1931) (seller can recover from partner, although seller did
not know at the time credit was extended to the partner's
agent that a partnership relationship existed between the
partner and the agent); Yates v. Repetto, 47 A. 632, 633
(N.J. 1900) (when credit is given to an agent, and the
principal is unknown, the creditor may elect upon
disclosure of the principal, to hold either the agent or the
principal liable); Moss v. Jones, 225 A.2d 369, 371 (N.J.
Super. Ct. App. Div. 1966) ("If the existence of the principal
is not known until after [a judgment against the agent goes
unsatisfied], then the undisclosed principal may be sued,
notwithstanding the judgment against the agent.");
Restatement (Second) of Agency SS 186, 190, 194, 195
(1958).
Here, it is undisputed that Red Hawk was a partner with
Cedar Ridge in the Chestnut Woods Partnership, that Cedar
Ridge had actual authority to enter into the contract with
Henkels,7 that the sewer systems were being installed for
_________________________________________________________________
7. Paragraph 13.1(b) of the Chestnut Woods partnership agreement
delegated to the managing partner, Cedar Ridge, general management
12
the benefit of the Chestnut Woods Partnership, and that
Cedar Ridge was entitled to reimbursement from Chestnut
Woods for all monies paid by Cedar Ridge to Henkels.
Accordingly, the district court committed no error when it
ruled that, although indirect, a creditor relationship existed
between Red Hawk and Henkels based on the contract
signed by Red Hawk's partner in the Chestnut Woods
Partnership, Cedar Ridge.
The Partners also argue that the district court erred in
finding that Henkels was a creditor of Red Hawk, because,
even assuming arguendo that a contractual relationship
existed between Red Hawk and Henkels, Henkels had not
extended any credit to Cedar Ridge, Chestnut Woods, or
Red Hawk. The unpaid invoices at issue here are from
August, September, and November 1989, whereas the
distributions to the Red Hawk Partners were made prior, in
January, April, and July 1989. Therefore, the Partners
claim that this is in itself prima facie proof that Henkels
was not a creditor -- i.e., Henkels was not owed any money
at the time of the distributions. These arguments, however,
take a very narrow and ultimately erroneous legal view of
the contractual relationship with Henkels and even a more
constricted view of the definition of creditor.
Although the term creditor is undefined in the New
Jersey ULPL and there is no New Jersey case law
interpreting the term in this context, the term creditor is
not foreign to New Jersey law. For instance, many New
Jersey statutes define creditor very broadly to include "the
holder of any claim, of whatever character, . . . whether
_________________________________________________________________
authority and decision making power, including: "[t]he right to incur
liabilities on behalf of the [Chestnut Woods Partnership] in connection
with the reasonable and legitimate business of the [Chestnut Woods
Partnership]." In addition, Paragraph 13.1(n) delegated the right and
power "to enter into such contracts or agreements deemed necessary or
appropriate on behalf of the [Chestnut Woods Partnership]." It is
significant that these provisions, unlike paragraphs 13.1(d), (g), (j),
(l), &
(m), allowed Cedar Ridge to incur "on behalf of the [Chestnut Woods
Partnership]," and did not require that it incur liabilities and enter
contracts only "in the name of the [Chestnut Woods Partnership]."
(emphasis added).
13
secured or unsecured, matured or unmatured, liquidated or
unliquidated, absolute or contingent." See N.J. Stat. Ann.
S 14A:14-1(b) (Business Corporation Act); N.J. Stat. Ann.
S 15A:12-18(c) (Nonprofit Corporation Act); and N.J. Stat.
Ann. S 25:2-7 (Uniform Fraudulent Conveyance Act)
(repealed), & N.J. Stat. Ann. S 12A:6-109 cmt. (UCC Bulk
Transfers) (repealed). Cf. City of Philadelphia v. Stepan
Chem. Co., 713 F. Supp. 1491, 1493 n.3 (E.D. Pa. 1989) (to
qualify as creditor, a party's claim must be based on "some
legal foundation, such as an underlying debt, a contract, or
a lawsuit"). Also, the statute is remedial in nature,
"designed to protect creditors and should be interpreted
with this purpose in mind." Henkels & McCoy, Inc., 906 F.
Supp. at 252-53. In addition, the generic common law
definition of creditor is very broad and
includes every one having [the] right to require the
performance of any legal obligation [or] contract, . . . or
a legal right to damages growing out of [a] contract or
tort, and includes not merely the holder of a fixed and
certain present debt, but every one having a right to
require the performance of any legal obligation [or]
contract, . . . or a legal right to damages growing out
of [a] contract or tort.
Black's Law Dictionary 368 (6th ed. 1990) (emphasis
added). Finally, the failure of the statute to define creditor
is indicative of the New Jersey legislature's intent that the
term "creditor" be construed consistent with the New Jersey
ULPL's broad remedial purpose and its common usage. See
N.J. Stat. Ann. S 1:1-1 (General rules of construction). The
district court cited many of these reasons and found them
sufficiently persuasive, as do we, to adopt a broad
definition of creditor which includes unmatured payments
of a debt upon performance under a contract such as
Henkels's.
Pursuant to the subcontract agreement, Henkels had a
claim to payment for a fixed contract price to be paid in
installments upon progressive completion of the sewer
work. Although the Partners argue that Henkels did not
have a claim at the time of the 1989 distributions, the
contract between Henkels and Cedar Ridge was entered
into on December 29, 1988. Thus Henkels and Cedar Ridge
14
had definite obligations to each other under the contract
over a week prior to the first distribution by the general
partner to the Red Hawk limited partners. Those obligations
required Henkels to make the site improvements and Cedar
Ridge to make scheduled payments as performance was
rendered. In addition, G&A made the bulk of the
distributions after Henkels had commenced work and was
incurring costs and expenses in fulfilling its commitments
under the contract. Thus Chestnut Woods and Red Hawk
had incurred liability as early as December 29, 1988,
although the bulk of the payment matured the month after
the last distribution by Red Hawk to the Partners. The
Partners' overly narrow definition of creditor is inconsistent
with the obvious financial realities that existed at the time,
the generally accepted common law meaning of the term,
the broad definition used in other New Jersey statutory
contexts, and the broad remedial purpose of the statute.
Accordingly, we hold that under this broad definition and
consistent with the principles of agency and partnership
law previously discussed, Henkels was not only a creditor
of Cedar Ridge, but of Chestnut Woods, and thus Red
Hawk and its partners.
The Partners further argue that even if we conclude that
Henkels was a creditor of Chestnut Woods, Red Hawk was
not "jointly and severally" liable for the partnership's debts,
but only "jointly" liable, as it was only a partner in
Chestnut Woods. The Partners find this significant and
contend that as a partner Red Hawk was only contingently
liable as a guarantor of collection, not as a guarantor of
payment. Furthermore, the Partners contend that even then
Red Hawk was not liable until Henkels had obtained a
judgment against the Chestnut Woods partnership, was
unable to collect, and then sought payment from Chestnut
Woods's partner, Red Hawk. Therefore, the Partners
conclude, Henkels was not a creditor of Red Hawk until
this eventuality ultimately did occur in October 1991--
more than two years after the distributions. Thus, they
assert there was no violation of Section 42:2A-46(b) or the
partnership agreement. Although the Partners make much
of the distinction between "joint" and "joint and several
liability," and between "guarantor of collection" and
15
"guarantor of payment," the distinctions between these
terms are illusory here and are not dispositive.
Under the New Jersey ULPL, partners are only jointly
liable for contract obligations of the partnership, and thus
a contract creditor of the partnership must first exhaust
the partnership's assets before it can pursue the assets of
the individual partners. See N.J. Stat. Ann. S 42:1-15(b).
The Partners dwell on their argument that joint liability
means that partners are merely guarantors of collection
rather than guarantors of payment, citing Seventy-Three
Land, Inc. v. Maxlaw Partners, 637 A.2d 202 (N.J. Super.
Ct. App. Div. 1994). They contend that this distinction
means that Henkels was not a creditor of Red Hawk until
after it obtained a judgment against Red Hawk's assets in
October 1991, "long after the distributions to the limited
partners were made."
This argument is without merit, however, because the
Partners overly emphasize the distinction between
guarantor of collection and guarantor of payment by
ignoring the sentence in Seventy-Three Land, Inc.
immediately preceding the courts' discussion of this
distinction; that sentence actually supports an opposite
conclusion. The court in Seventy-Three Land, Inc. merely
stated that "[p]artners are liable for partnership contract
debts, but their assets are not at risk until it is shown that
the partnership cannot discharge the debt." Id. at 204
(emphasis added). This language, consistent with the broad
definition of creditor previously discussed, clearly
demonstrates that jointly liable partners such as Red Hawk
do have a present liability. The significance to the Red
Hawk Partners is that payment of that liability out of their
individual assets is contingent, rather than fixed, until the
partnership's assets are first exhausted. Although the
Partners' individual assets were only contingently at risk,
the Partners nonetheless were liable to Henkels from the
time the contract was signed and, as ultimately did happen,
their assets did become available when the Red Hawk
partnership's assets proved insufficient to meet its debt
with Henkels.
Accordingly, we hold that the district court's finding that
Henkels was a creditor of Red Hawk was correct. See
16
Henkels & McCoy, 906 F. Supp. at 252-53. At the time of
the 1989 distributions, Henkels was a creditor of Red Hawk
and the individual Red Hawk partners were liable for that
debt.8
III.
Although Henkels was a creditor of Red Hawk, the 1989
distributions were in violation of the partnership agreement
only if, as Henkels argues, Red Hawk's distributions
constituted a failure to abide by the partnership
agreement's requirement to establish reasonably necessary
reserves. The Partners, however, contend that the district
court made several errors in interpreting the Red Hawk
partnership agreement which resulted in its finding that
the distributions were in violation of the agreement by
failing to establish such reasonable reserves.
Section 9(b) of the partnership agreement grants the
general partner, G&A, certain rights and powers, including,
under subsection (ix), the power "to establish reasonable
reserve funds from income derived from the Partnership's
operations to provide for future . . . debt service or similar
requirements." The Partners argue that this subsection is
the only subsection of the agreement that permits or
authorizes the general partner to reserve funds. Thus,
according to the Partners, all reserves had to be (1)
authorized by this subsection, (2) taken from income
derived from operations, and (3) used for debt service.
Therefore, had G&A reserved funds against the Henkels
_________________________________________________________________
8. The dissent would extend our holding far beyond its limit. It concludes
that the majority holds "by necessary implication. . . that a distribution
could not be made to Red Hawk partners unless cash reserves had been
established to fund the payment of all anticipated future liabilities of
the
joint venture partnerships (owned in part by others) that might accrue
over some unspecified period of time . . . ." Dissent at p. 30. We are not
called upon in this case to decide whether reserves are required for "all
anticipated future liabilities" and therefore the majority does not decide
that question, either directly or by implication. The focus of our holding
is merely that when there is clear liability under an existing contract,
the
equity partners cannot ignore that liability, recapture their capital
investments, and leave the creditor spinning in the wind.
17
contract, the Partners contend that such reserves would
have been taken in violation of this subsection of the
partnership agreement because the funds would not have
been derived from operations but from distributions of
capital.
The Partners' argument fails, however, because it
selectively presents the language of Sections 9 and 12 and
omits other relevant language which demonstrates that the
Partners greatly overemphasize the significance of
subsection (ix). First, the express language of Section 9(b)
provides that the general partner possess all "rights and
powers required for or appropriate to its management of the
partnership's business which, by way of illustration but not
by way of limitation, shall include the following: . . . (ix) to
establish reasonable reserve funds from income derived
from the partnership's operations to provide for future . . .
debt service or similar requirements." This unambiguous
language demonstrates that G&A had the right and power
to establish reserves, even if not expressly authorized under
subsection (ix), if it deemed them required or appropriate
for the management of Red Hawk's business. The list of
rights and powers in subsection (ix) is merely illustrative
and is not an exclusive limitation on the general partner's
rights and powers.
Equally important, as the district court properly found,
the distributions at issue here were not taken from income
derived from operations, but were merely returns of capital
of the aborted Timber Knolls partnership, which, as Red
Hawk admits, "never got off the ground." Income from
"operations," as used in this subsection, refers to income
derived from the active, normal, on-going activities of the
partnership. Timber Knolls never functioned, and thus
there never was any income from operations. Therefore,
subsection (ix) is not applicable to the distributions at issue
here.9 It is completely irrelevant because the distributions
_________________________________________________________________
9. This point is significant in interpreting Section 12(a) as well.
Following
the order of priority for the distributions of cash receipts in Section
12(a)(i)-(v) is a provision which prohibits the general partner from
"retain[ing] and invest[ing] any Cash Receipts derived from the operations
of the Property, except . . . (2) for investments of reserves permitted to
be established under clause (ix) of Paragraph 9(b)." (emphasis added).
Because the cash receipts used to fund the distributions were not
derived from income from operations of Red Hawk property, this
prohibition is not relevant to this appeal.
18
constituted capital funds retrieved by Red Hawk from its
abandoned project, Timber Knolls. Although the Partners
emphasize that the funds were derived from the Timber
Knolls project, Subsection (ix) only addresses the reserving
of funds derived from operations; the germinating project is
immaterial.
Finally, as previously discussed, Henkels qualified as a
creditor of Red Hawk at the time the distributions were
made. Therefore, pursuant to Section 12(a) of the Red Hawk
limited partnership agreement governing the distribution of
all cash receipts, the Red Hawk general partner was
required to establish reasonable reserves from the cash
received on the Timber Knolls promissory notes to meet its
ongoing liability before distributing such cash to the
individual limited partners. We, therefore, turn to the issue
as to what would constitute a "reasonable" reserve to meet
the outstanding liability under the Henkels subcontract.
Although neither party provided the district court with
any case law or treatise defining reasonable reserves, the
court used the Black's Law Dictionary definition of
"reasonable" and of "reserves" in the insurance context to
define reasonable reserves in the business context before
us. We agree with them that the insurance context is
inappropriate for analysis because the nature of the
insurance business differs significantly from that of an
ordinary business partnership. Unlike an ordinary business
partnership, an insurance company essentially is required
to meet future, contingent obligations, and these reserves
are required. The Partners instead propose that the highly
deferential corporate "business judgment" standard is the
appropriate standard. However, as Henkels correctly
argues, the business judgment rule also is inapposite in the
partnership context because it is a function of a unique
corporate setting. See 3A William Meade Fletcher et al.,
Fletcher Cyclopedia of the Law of Private Corporations
SS1036-37 (perm. ed. rev. vol. 1994).
Although the New Jersey courts have not yet addressed
the issue of what constitutes reasonable reserves, we do not
need to expressly define reasonable reserves in the context
of this case because it is unnecessary to the disposition of
this appeal. See Rush v. Scott Specialty Gases, Inc., 113
19
F.3d 476, 486 (3d Cir. 1997) (declining to decide issues
unnecessary to the appeal); Georgine v. Amchem Products,
Inc., 83 F.3d 610, 623 (3d Cir. 1996) ("[W]e believe it
prudent not to decide issues unnecessary to the disposition
of the case."). Regardless of what standard the New Jersey
courts will ultimately adopt, under any standard and using
any definition of reasonable reserves, the Red Hawk general
partner's failure to establish any reserves in the face of the
fixed obligation and imminent payments due under the
contract with Henkels and the operations of the Chestnut
Woods development was callous and not reasonable.
It is undisputed that of the approximately $500,000
monies received by Red Hawk in 1989, the Red Hawk
general partner (G&A) did not set aside any of these funds
to establish reserves, even in the face of a contracted
liability. Red Hawk argues, however, that this was not
unreasonable because (1) the Red Hawk partnership had no
liabilities and $3 million in assets at the time of the
distributions; (2) Henkels had not yet invoiced Chestnut
Woods; (3) the financial outlook of Red Hawk (& Chestnut
Woods) was healthy; and (4) the express terms of the
partnership agreement prohibited the taking of such
reserves. Each of these contentions is without merit.
First, the $3 million of assets included on Red Hawk's
January 1, 1989 balance sheet is somewhat illusory. Of the
$3 million in assets, a scant $22,000 was in the form of
cash or other liquid assets. The remaining were almost
exclusively illiquid: the $800,000 investment in the
Chestnut Woods project itself which consisted of land and
infrastructure and the $2.1 million Timber Knolls notes
receivable from Cedar Ridge -- which were substantially
distributed to the limited partners. Neither of these assets
were readily available to satisfy Red Hawk obligations,
especially not after the payments on the notes were
distributed to the partners. Moreover, Red Hawk repeatedly
left almost no money in its checking account after each
distribution to the Partners, other than several thousand
dollars to cover incidental operating expenses. Additionally,
the absence of any formal liabilities from its balance sheet
and the failure of Henkels to physically invoice Cedar Ridge
did not mean that Red Hawk had no liabilities; it simply
20
was an "off-balance sheet" liability. In the accounting
profession, an "off-balance sheet" liability is a financial
obligation that is not formally recognized in an entity's
accounting statements because no "accounting" obligation
arises until the exchange transactions is completed;
nonetheless, they do have real current and future cash flow
consequences. See Accountant's Handbook, 10.29 (7th ed.
1991). Under the broad definition of creditor established
above, Red Hawk had an unmatured, fixed, off-balance
sheet liability to Henkels.
Although by itself this may be not determinative, more
telling is the Partners' failure to identify any other source of
funds from which the Red Hawk Partnership would be able
to meet its obligations, including its contract obligation to
Henkels. The Timber Knolls project never got off the
ground, literally and figuratively, and based on the record,
Chestnut Woods generated no earnings during the 1989 tax
year and Red Hawk generated none during both 1988 and
1989. Because the Chestnut Woods property was under
development at the time, Chestnut Woods reported a loss
during 1989 and Red Hawk reported losses on both its
1988 and 1989 tax returns, and both Chestnut Woods and
Red Hawk appear to have had negative cash flows during
these years. Without any other source of cash or liquid
assets, short of liquidating the Chestnut Woods property
itself, it clearly was unreasonable for G&A to distribute to
the Partners Red Hawk's only available source of payment
without setting aside any reserves to meet the Henkels debt.10
_________________________________________________________________
10. As we noted above, see supra p. 10, under the New Jersey
partnership statute and fundamental principles of agency law, every
partner is an agent of the partnership and the act of every partner binds
the partnership for the purpose of its business. Accordingly, the
liability
of the Red Hawk partnership to Henkels was committed by written
contract between Henkels and Red Hawk's partner, Cedar Ridge, in
December 1988, before any retrieval by the Partners of their capital
investment in Timber Knolls. In addition, Red Hawk's project, Chestnut
Woods, had current liabilities as of January 1, 1989, according to its tax
returns, which disclosed debts of over $1.7 million. These liabilities
also
were in place prior to the retrieval of the Partners' investments in Red
Hawk. Nevertheless, the dissent would relieve the Partners of any
liability under the contract to creditor Henkels on the theory that from
January to August 1989, Red Hawk "had no significant liabilities of any
kind." Dissent at p. 29.
21
Second, and equally telling, G&A knew, or at least had
ample notice, that the financial outlook of Red Hawk and
Chestnut Woods was not as rosy at the time of the
distributions as the Partners attempt to assert now. 11 For
example, the Partners fail to mention or accurately state
many of the following facts: (1) Red Hawk and G&A, in
December 1988, received notification from Cedar Ridge that
four separate and distinct types of delays in the Chestnut
Woods project were resulting in additional financial
burdens to it; (2) Cedar Ridge also informed Red Hawk that
these financial burdens were worrisome given the decline
already experienced in the housing market; (3) Red Hawk
had a scant $22,000 in cash or other liquid assets on hand
as of January 1, 1989; (4) Chestnut Woods had an equally
scant $12,000 in cash or other liquid assets on hand as of
January 1, 1989; (5) Chestnut Woods' January 1, 1989
balance sheet showed over $1.7 million in current
liabilities, with the land and construction in progress of
Chestnut Woods comprising over 90% of its $2.4 million in
assets, leaving meager resources available to pay for the
planned 1989 site improvements, such as the $300,000 of
sewer systems from Henkels;12 (6) as of March 7, 1989, Red
Hawk had, at a minimum, imputed knowledge from its
bank's written notice that interest on the Chestnut Woods
mortgage would no longer be paid out of the interest
reserve fund and that Cedar Ridge was responsible to pay
_________________________________________________________________
11. Even assuming arguendo that Red Hawk and G&A did not have
actual notice or knowledge of the precarious financial condition of
Chestnut Woods, "[t]here are many cases stating the general rule that
knowledge of one partner [(Cedar Ridge)] will be imputed to the others."
Harold Gill Reuschlein & William A. Gregory, The Law of Agency and
Partnership S200 at 304 (1990); see also N.J. Stat. Ann. S 42:1-12
("Knowledge to any partner of any matter relating to partnership affairs
. . . operate[s] as notice to or knowledge of the partnership . . . .");
Claflin
v. Wolff, 96 A. 73, 79 (N.J. 1915) ("If any of [the partners] had notice
or
knowledge . . . they would all be affected by it.").
12. Red Hawk states, and its 1989 tax return shows, that Chestnut
Woods' assets were $2.4 million, not $1.8 million. Although the district
court found the number to be $1.8 million, this difference is
inconsequential; either amount consisted almost exclusively of the
project's land and work-in-progress -- i.e., illiquid assets, leaving next
to
nothing to pay its $1.7 million in current liabilities.
22
interest out of its own funds due to "the past unfortunate
circumstances [which] caused slower than expected
[progress on the Chestnut Woods project,]" and which
caused the remaining interest reserve to become
substantially depleted and potentially "insufficient to carry
this loan;" and (7) the August 1989 $2.7 million appraisal
of the Chestnut Woods project was merely a potential future
retail estimate and contained the express caveat that this
"value estimate[ ] assume[s] that all site improvements will
be completed in a workmanlike manner and within a
reasonable period of time."13
Finally, as previously discussed, the Red Hawk
partnership agreement did not prohibit G&A from reserving
funds for the payment of Henkels. Section 9(b)(ix) is merely
an illustration of G&A's rights and powers and, because the
funds at issue were not derived from operations, ultimately
was irrelevant to the funds at issue. More importantly,
Section 12(a) expressly required that the available cash
funds be used to establish reserves before they were
distributed to the Partners.
_________________________________________________________________
13. The dissent ignores the foregoing realities of Red Hawk's and
Chestnut Woods' financial straits while the Chestnut Woods project was
still under development, and already beset by a negative cash flow in the
project, while at the same time the Partners were retrieving all of their
total capital investments in the Timber Knolls project. The dissent,
again, would permit the Partners to escape liability in the face of
Henkels' 1988 contract on the infirm premise that at the end of August
1989, when all partner contributions had been repaid, Chestnut Woods
had the project appraised at $2.7 million and Red Hawk "had significant
net worth throughout this period." Dissent at p. 30. In the first place,
the appraisal obtained by Chestnut Woods was merely an optimistic,
potential, retail figure dependent on the market price for the lots, when
and if sold, and the completion of the project "in a workmanlike manner
and within a reasonable period of time." Second, even if the appraisal of
the project were accurate, the frozen nature of the real estate -- not yet
marketable -- provided no liquid source for payment of ongoing
obligations. To illustrate, it could not meet the payment due of $215,175
for the August delivery by Henkels. Further significant, Red Hawk and
Chestnut Woods both reported losses during 1989, and both appear to
have had negative cash flows. Both had meager sums of cash on hand,
and Chestnut Woods had significant current liabilities with 90% of its
assets frozen.
23
Although neither Henkels nor the district court attempted
to determine what level of reserves was reasonable, no
determination was needed because Red Hawk and G&A
failed to establish any reserves. It is patently obvious that
at least some level of reserves was reasonably necessary,
and that the general partners' distributions and failure to
reserve any money for the Henkels contract obligation, in
light of Chestnut Woods' and Red Hawk's precarious
financial condition, was unreasonable. Thus, the district
court did not need to determine what level of reserves was
reasonable; it clearly had an ample factual basis upon
which to determine that the complete failure to establish
any reserves was a violation of the Red Hawk partnership
agreement's requirement that G&A establish some level of
reserves before making distributions to the Partners.
Accordingly, we hold that Red Hawk's failure to establish
any reserves in light of both partnerships' then existing
financial condition was not reasonable.
IV.
In conclusion, we find no merit to appellants'
contentions. We see no error in the district court's
conclusion that Henkels was a creditor of Red Hawk, and
therefore the 1989 capital distributions to the Partners and
failure to establish any reserves to fund its contract
obligation to Henkels was a violation of the Red Hawk
partnership agreement. The Partners are therefore obligated
to return the improper capital distributions to Red Hawk.
Because the plaintiff stands in the shoes of Red Hawk for
the purpose of recovering these funds on behalf of the
partnership, In re: Sharps Run Associates, 157 B.R. 766,
772-73 (D.N.J. 1993), and because of the multiple suits it
already has been compelled to undergo to enforce collection
of its debt, judicial resources will be conserved and
economies of time and expenses effectuated, to hold the
Partners directly liable to Henkels.
Accordingly, the judgment of the district court will be
affirmed. Costs taxed against the appellants.
24
STAPLETON, Circuit Judge, Dissenting:
The critical issue posed by this appeal is one of intent -
the intent of the Red Hawk partners when they negotiated
their partnership agreement. Given the text of that
agreement and the context in which it was executed, I
believe the district court clearly erred when it interpreted
Section 12(a)(iv) as precluding the three challenged
payments to Red Hawk's limited partners.
The relevant facts are documented and undisputed. Red
Hawk is a limited partnership organized under the New
Jersey Uniformed Limited Partnership Law to facilitate the
investment of its corporate general partner and its
individual limited partners in two specific real estate
developments. The sole declared purpose of the partnership
was to participate in two joint ventures pursuant to
identified, previously executed joint venture agreements,
each of which would independently develop a parcel of real
estate in Bucks County, Pennsylvania. The Timber Knoll
joint venture was to develop the Timber Knoll property; the
Chestnut Woods joint venture was to develop the Chestnut
Woods property. In each instance, management of the joint
venture was placed in the hands of an unrelated
corporation with experience in the business of real estate
development, the Cedar Ridge Development Corporation.
The partners of Red Hawk contributed to it capital of $3.5
million. Of this capital, $2.3 million was committed to the
Timber Knoll joint venture, and $850,000 was committed to
the Chestnut Woods joint venture. It was understood that
Cedar Ridge would be simultaneously involved in other real
estate development projects in New Jersey, Pennsylvania,
and other states.
Under the Chestnut Woods joint venture agreement,
Cedar Ridge, as the "Managing Partner," was authorized to
borrow money and to mortgage and sell assets. Red Hawk
was to receive a Preferred Minimum Return on Capital prior
to any distribution of profits to Cedar Ridge. The preferred
return was equal to 15% "per annum based on simple
interest payable quarterly on the amount of capital
outstanding and not returned." J.A. at 91. However, "in the
event the net cash working reserve of the [joint venture fell]
below $500,000, the quarterly preferred return [could] be
25
deferred by the MANAGING PARTNER until the net cash
working reserve has sufficient cash in excess of $500,000
to pay the unpaid preferred return." J.A. at 91-92. The
agreement further provided that no partners would have
"the right to compel a distribution of profits or cash, unless
the [joint venture] has accumulated an unwarranted
amount of cash not reasonably needed for future business
activities." J.A. at 93-94. Red Hawk's capital contribution
was to be returned at the minimum rate of $12,400 per lot
sold after the sale of the first 20 lots. In addition, the
managing partner committed itself to "make a good faith
effort to make minimum annual cash distributions equal to
thirty-five percent (35%) of the distributive share of profits
allocated to each PARTNER" for tax purposes. J.A. at 94.
Distributions could be made in cash or property.
It was in the context of this joint venture agreement and
the similar Timber Knoll joint venture agreement that the
Red Hawk Partnership Agreement was negotiated. Since the
Red Hawk partners understood that cash flow would be
coming to Red Hawk from the managing partner of the joint
ventures only after Cedar Ridge had established reserves to
service the only business operations in which Red Hawk
would ever have an interest, the Red Hawk limited partners
understandably sought assurance that joint venture profits
and return of capital would not be accumulated in the Red
Hawk partnership by its general partner, G&A.
The Red Hawk Partnership Agreement thus provided for
a mandatory pass-through of cash receipts, whether
generated by the joint ventures in the regular course of
business or otherwise, after the general partner had paid all
of the currently due debt obligations of Red Hawk and had
set aside specifically limited reserves. Any reserves were
expressly limited to such revenue from operations as the
general partner, in its discretion, considered appropriate for
the purpose of paying anticipated administrative expenses
and, in the event of the distribution of joint venture
property in kind, anticipated property management
expenses. Section 12(a) of the agreement thus provided:
(a) Application of Cash Receipts. Cash Receipts shall
be applied in the following order of priority:
26
(i) to the extent required, to the creditors of the
Partnership, except to any Partner or any
Affiliate thereof;
(ii) to the extend required, to the payment of any
debts or liabilities to any Partner or any
Affiliate thereof (other than a loan to the
Partnership by the Partner);
(iii) to the payment in full of any loans to the
Partnership by a Partner;
(iv) to the establishment of such reserves as the
General Partner shall reasonably deem
necessary; and
(v) to distributions to the Partners in accordance
with Paragraphs 12(b) and (c) hereof.
Notwithstanding the foregoing, the General Partner
shall not retain and invest any Cash Receipts derived
from the operations of the Property, except (1) to defray
expenditures for any repair or improvement to any
Property, which it, in its sole discretion, deems
appropriate or (2) for investments of reserves permitted
to be established under clause (ix) of Paragraph 9(b)
hereof, nor shall the General Partner invest the net
proceeds derived and retained by the Partnership from
the sale or other disposition of any Property (including
any total condemnation or destruction of any portion of
the Property) except as otherwise provided herein.
J.A. at 274.
The term "Property" is defined in the Red Hawk
Agreement to mean "the Buildings and Land in Bucks
County, Pennsylvania." J.A. at 261. "Cash Receipts" means
"all cash receipts of the Partnership from whatever source
derived." J.A. at 259. Section 9 of that Agreement is entitled
"Rights and Duties of the General Partner." It imposes no
duty on the General Partner to set aside reserves for any
purpose. In subsection (b)(ix), the subsection referenced in
Section 12(a), the general partner is given the authority "to
establish reasonable reserve funds from income derived
from the Partnership's operations to provide for future
27
maintenance, repair, replacement, debt service or similar
requirements." J.A. at 265.
Read in the context of the Agreement and the
expectations of the Partners, it is apparent that the
dominant portion of Sections 12(a) is the paragraph
commencing with the clause "Notwithstanding the
foregoing." Indeed, that lead clause requires that this
paragraph be given controlling significance over the
preceding text. It mandates disbursement to the partners of
all cash whether received by Red Hawk in the course of the
normal operations of the joint venture properties or
whether received by it from dispositions of joint venture
property other than in the course of its regular business
operations. The two exceptions recognize that the General
Partner, in its sole discretion, should have the ability to
retain cash derived from operations to establish reasonable
reserves for property repairs and improvement, debt
service, and other operating expenses.
The subordinate portion of Section 12(a) that precedes
the "notwithstanding" clause establishes the priorities
among various interests that may compete for distributions
of cash receipts. The purpose of subsection 12(a)(iv), in
particular, is (1) to recognize the possibility that the
General Partner may wish to withhold some funds
pursuant to the two express exceptions from theflow
through mandate; and (2) to emphasize that the General
Partner's authority to do so is limited to such reserves as it
might "reasonably deem necessary." Thus, subsection 12(a)
is designed both to recognize the possibility of retention of
cash receipts for authorized reserves at the discretion of the
General Partner and, at the same time, to assure the
limited partners that there will be no accumulation of even
funds for reserves when the general partner, in the exercise
of business judgment, could not reasonably regard them as
necessary for the designated purposes.
The Timber Knoll project never got off the ground. The
requisite governmental approvals for development were not
obtained by the owner of the Timber Knoll site, and the
property was never purchased by the joint venture. When it
appeared that the objective of the joint venture would have
to be abandoned, an amendment to the joint venture
28
agreement was executed that called for the conversion of
Red Hawk's $2.3 million capital contribution into
promissory notes of Cedar Ridge. Pursuant to these notes,
payments were received by Red Hawk in January 1989,
April 1989, and July 1989. These payments represented a
return of the capital contribution made by Red Hawk to the
Timber Knoll joint venture and interest accrued thereon
after the conversion.
The Chestnut Woods project did get underway in late
1988. Cedar Ridge served the Chestnut Woods joint venture
not only as managing partner, but also as "general
contractor" for the site improvements. The site
improvements were to be financed, at least in part, through
bank borrowing. Among these improvements were, of
course, storm and sanitary sewer systems. Cedar Ridge, in
its capacity as "general contractor," contracted with plaintiff
Henkels & McCoy in December of 1988. Henkels
commenced its work at the Chestnut Woods site on
January 16, 1989, shortly after Red Hawk received the first
payment on the return of its capital contribution to the
Timber Knoll joint venture.
In January, April and July of 1989, Red Hawk's general
partner made the decisions that gave rise to this lawsuit.
When each return of capital from the Timber Knoll project
was received, G&A decided to deposit a few thousand
dollars in Red Hawk's checking account to cover
anticipated administrative expenses and to return the
remainder to the limited partners. Henkels seeks to compel
return of those distributions to Red Hawk for application to
a default judgment it later obtained against Red Hawk.
During the period from January to August 1989, Red
Hawk had satisfied its entire capital commitment to the
Chestnut Woods joint venture, and it had no significant
liabilities of any kind. It was receiving reports from Cedar
Ridge that site improvements, after some initial delays,
were progressing. Cedar Ridge estimated at the start of this
period (i.e., December 1988) that, even without
improvements, the entire property could be sold for
approximately $78,000 per lot, i.e., $1.8 million. At the end
of this period (i.e., August 1989), the Chestnut Woods
29
project was appraised at $2.7 million. It is undisputed that
Red Hawk had significant net worth throughout this period.
The district court found it significant that Red Hawk and
its partners understood that site improvements were on-
going during the period from January to July 1989 and
that the Chestnut Woods joint venture was, accordingly,
incurring liabilities. It did not find, however, that this joint
venture was insolvent during this period. To the contrary,
the record relevant to this period indicates that the
liabilities of the Chestnut Woods joint venture did not
exceed $1.7 million, that it thus remained solvent, and that
trade creditors were being paid on a current basis. In
particular, all invoices that were submitted to Cedar Ridge
by Henkels during this period were paid in full.
New Jersey's Uniform Limited Partnership Law provides
that a partner may not receive a distribution from a limited
partnership "to the extent that, after giving effect to the
distribution, all liabilities of the limited partnership, other
than liabilities to partners on account of their partnership
interests, exceed the fair value of the partnership assets."
N.J. Stat. Ann. S 42:2A-45. This is the sole mandatory
restriction in the law for the benefit of partnership creditors
on distributions to partners. Any additional restriction for
the benefit of creditors must thus be one voluntarily
undertaken by the Red Hawk partners in their partnership
agreement.
Our court today holds that the Red Hawk partners,
although mandating a pass-through to themselves of cash
receipts, intended in Section 12(a) of their partnership
agreement voluntarily to impose on themselves a very
significant restriction for the benefit of joint venture
creditors. This voluntary restriction, the court holds by
necessary implication, was intended to be sufficiently broad
that a distribution could not be made to Red Hawk partners
unless cash reserves had been established to fund the
payment of all anticipated future liabilities of the joint
venture partnerships (owned in part by others) that might
accrue over some unspecified period of time, even though
those other partnerships were expected to pay their own
liabilities with their own or borrowed funds. The record
suggests no reason, however, why the partners, when
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setting up the Red Hawk partnership, would have imposed
such an unnecessary and ill-defined burden on themselves,
and the text of Section 12(a) does not require such a
conclusion that they did.
The court resolves the central issue in this appeal in one
sentence: Section 12(a)(iv) "of the Red Hawk partnership
agreement specifically provided that cash receipts be used
for the establishment of reasonable reserves (for creditors)
before such receipts be distributed to the [limited
partners]." Slip opinion at 10. Because Red Hawk's general
partner had reason to believe that Henkels might submit
invoices in the future for site improvement work, the court
accordingly concludes that the three challenged
distributions violated Section 12(a)(iv).
In my view, the court errs for at least five reasons: (1) In
context, Section 12(a)(iv) was intended for the protection of
the limited partners, not as a creditor protection device
even for creditors of Red Hawk; (2) Section 12(a)(iv), even if
viewed as a creditor protection provision, was not intended
for the protection of joint venture creditors for whom the
joint ventures were to make other provision; (3) the
challenged distributions were a return of capital that the
partners had agreed to devote to an abandoned venture,
and it is not reasonable to find an intent in Section 12(a)(iv)
to commit that capital contribution to the creditors of a
different, fully capitalized venture; (4) Section 12(a)(iv)
permits the general partner to retain reserves only from
"Cash Receipts derived from the operations of the Property"
and the challenged distributions did not come from funds
generated by operations;1 and (5) even if Section 12(a)(iv)
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1. The district court correctly found that the three payments
representing a return of the capital committed to the Timber Knoll joint
venture did not constitute a "cash receipt from the operations of the
Property." It inexplicably concluded from this, however, that the general
partner was thus "plainly obligated" to follow the terms of Section
12(a)(iv) and establish a reserve for anticipated future liabilities to
Henkels. At the time the Red Hawk partnership agreement was
negotiated, the parties were not, of course, anticipating the
abandonment of the Timber Knoll venture, and the"notwithstanding"
clause does not literally read as applying to a return of capital that
does
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could reasonably be read to require Red Hawk's general
partner to set aside funds for creditors in Henkels' position
whenever a reasonable general partner exercising business
judgment would do so, this record provides no basis for a
conclusion that the failure of Red Hawk's general partner to
set aside funds for Henkels in January through July of
1989 was a decision beyond the bounds of business
judgment.
I would reverse and remand with instructions to enter
judgment for the defendants.
A True Copy:
Teste:
Clerk of the United States Court of Appeals
for the Third Circuit
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not result from a sale of the joint venture property. Nevertheless, I
believe the intent behind the provision governing such sales, and the
provisions strictly limiting the objectives of the partnership to
participation in specified joint ventures with specified capitalization,
required a pass-through of the payments from the Timber Knoll joint
venture. But whether or not this is the case, Ifind no authority in the
agreement for the establishment of reserves other than out of operating
revenues.
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