Henkels & McCoy, Inc. v. Adochio

138 F.3d 491 (3rd Cir. 1998)
  • Opinion Date: March 9, 1998

PARTNERSHIPS; DISTRIBUTIONS; LIABILITY—A limited partnership’s creditor is entitled to recover distributions to limited partners when made in violation of the partnership’s agreement and limited partnership law concerning the return of capital to partners.

A limited partnership (Red Hawk) entered into a partnership with Cedar Ridge Development Corporation (Cedar Ridge) for development and sale of homes. Red Hawk and Cedar Ridge were the general partners of the Chestnut Woods Partnership, for which Red Hawk suppled the funding and Cedar Ridge provided the land and acted as managing partner and general contractor. Cedar Ridge entered into a subcontract with Henkels & McCoy, Inc. (Henkels) to have it install the storm and sanitary sewer systems. When Chestnut Woods failed to pay for the completed work, Henkels obtained default judgments against Cedar Ridge and Red Hawk, trading as Chestnut Woods, and against G&A Development Corp. (G&A), a general partner of Red Hawk. Attorneys for all these entities informed Henkels that the defendants would be unable to satisfy the judgments. Henkels then brought suit against the individual limited partners of Red Hawk, seeking to compel replacement of certain capital distributions made to them by Red Hawk during the period that Cedar Ridge was obligated under its contract with Henkels. Henkels alleged that the return of capital to the limited partners was made in violation of Red Hawk’s limited partnership agreement (Agreement) and 42:2A-46(b) of the New Jersey Revised Uniform Limited Partnership Act (RULPA). The District Court held each limited partner liable for his proportionate share of the money owed to Henkels, because, despite knowledge of Red Hawk’s obligations in the Chestnut Woods Partnership, G&A failed to establish reserves as required by the Agreement.

The Third Circuit stated that whether Red Hawk and G&A breached the Agreement by failing to establish necessary reserves, and thus whether the partners received their distributions in violation of the Agreement, were questions of law and fact. The partners relied on section 42:2A-46(a) of RULPA in claiming they were not liable to Henkels. This section holds limited partners liable for one year after receiving a return of contributions. The Court stated that the partners mistakenly relied on this section of RULPA because Henkels sued under 42:2A-46(b), which is not dependent on subsection (a), and which does not require that Henkels be a creditor. Subsection (b) requires only that distributions be made in violation of a partnership agreement or RULPA. Furthermore, subsection (b) holds a limited partners liable for six years after “the return of any part of his contribution.”

The partners then argued that, at most, Henkels was only a creditor of Cedar Ridge, and not of Chestnut Woods or Red Hawk, because Cedar Ridge entered into the subcontract solely in its capacity as general contractor of Cedar Ridge. The partners reasoned that if this were true, the subcontract did not bind Chestnut Woods or Red Hawk in any way, and therefore, Red Hawk was not required to establish reserves; and therefore, the distributions were not in violation of the Agreement or RULPA. In support of this logic, the partners noted that the subcontract was only signed by Cedar Ridge, referred to Chestnut Woods only as the owner, and stated that Henkels was to be paid by Cedar Ridge. Additionally, Henkels acknowledged that the contract was only with Cedar Ridge, and that it had no knowledge that Cedar Ridge was a partner in any other entity. The Court found this “two hats” argument creative, but ultimately one of form over substance which ignored fundamental principles of agency and partnership law. The Court concluded that Cedar Ridge signed the subcontract, not only as the general contractor, but also as a partner, stating that it was “elementary” that every partner is an agent of the partnership, and any act on the part of a partner binds the partnership unless the partner has no authority in fact to act on the partnership’s behalf. N.J.S. 42:1-9(1). This notion holds true even when the principal is undisclosed and the agent signs in its individual capacity for the benefit of the partnership. The Third Circuit then stated that a third party creditor may hold the partnership principally liable, even if unaware of the agency relationship at the time credit was extended to the agent. Accordingly, the District Court properly ruled that a contractual relationship, and therefore a creditor relationship as well, existed between Red Hawk and Henkels based on the subcontract signed by Cedar Ridge.

The partners then claimed that even if there were a contractual relationship, they received their distributions before Henkels became a creditor of Red Hawk. The Court held that this was an erroneous view of both the definition of creditor and the contractual relationship with Henkels. The Court cited many statutes, the common law, and a legal dictionary for the broad definition of creditor, which includes unmatured payments of debt due under a contract. The contract was signed prior to the distributions to the partners, and the Court held this to be sufficient to establish Red Hawk’s obligation as partner of Chestnut Woods. The partners then argued that even if Red Hawk was a creditor at the time of the distributions, it was liable only contingently, as a guarantor of collection, not as a guarantor of payment. Under this theory, Henkels was not a creditor of Red Hawk until it obtained a judgment against Red Hawk, which was afer the distributions had already been properly made in accordance with the Agreement and RULPA. The Court dismissed this rationale, too, and held that the partners were contingently liable once the contract was signed by Cedar Ridge. The fact that their assets were not at risk, or that the amount was not yet fixed, was irrelevant.

The Third Circuit concluded by holding that, because Red Hawk failed to establish any reserves, it violated that portion of the Agreement requiring the establishment of “reasonable reserves,” and that the distributions also violated the Agreement. The Third Circuit upheld the District Court’s ruling and held each limited partner directly liable to Henkels.