Whitley v. Klauber

51 N.Y.2d 555 | NY | 1980

Lead Opinion

OPINION OF THE COURT

Meyer, J.

When, as part of a plan to dispose of the assets of a limited partnership, all of the general and limited partners sell their interests in the partnership to a corporation in exchange for stock of the purchaser’s parent corporation, have the limited partners received a return of their partnership capital within the meaning of subdivision (4) of section 106 of the Partnership Law? If the answer to that question is affirmative, may a judgment creditor of the limited partnership who became a creditor prior to such sale recover from the former limited partners, to the extent of their respective capital contributions thus withdrawn, without relitigating the cause of action underlying the judgment against the partnership, even though the limited partners were not party to the action in which the judgment was obtained? The Appellate Division, reversing Special Term, answered both questions in the affirmative and directed entry of summary judgment against the appealing limited partners in the amount of the contribution of each, with interest. There should be an affirmance.

Presented by this appeal are not only the two issues concerning construction of the Partnership Law and the binding effect of the prior judgment outlined above, but subsidiary questions concerning whether plaintiff has failed to exhaust available remedies and whether he is barred by limitations and laches. The subsidiary questions are sufficiently answered in the Appellate Division opinion and will not be further considered here. As to the Partnership Law, six of us agree that the strong policy enunciated by section 106 permitting a creditor who was such when a limited partner’s capital was returned to him to recover from the limited partner to the extent of the capital returned, with interest, even though return of the capital was entirely proper, mandates the conclusion that a transaction or series of transactions in which all general and limited partners dispose of their interests in the limited partnership leaving a creditor unpaid constitutes a return of capital notwithstanding that in form it is the sale of the limited partners’ interests. On the question whether the judgment against the partnership binds the limited partners, five of us are agreed that it does, not on any theory of collateral estoppel but because the partnership, in whose right the creditor sues the limited partners to recover partnership assets (the capital, though rightfully returned), has already fully litigated its obligation to the creditor as such.

I

The facts upon which turn determination of the issues stated above are rather complex. Black Watch Farms was organized in 1962 as a limited partnership to manage and breed purebred Angus cattle as a tax shelter. Its principal general partner was BW Farms, Inc. (“BWF”), a New York corporation, whose president and principal shareholder, Jack Dick, was also Black Watch’s general manager. BWF was also a limited partner in Black Watch, owning 14% of the limited partnership interests. The other 86% of the $1,000,000 capital contributed to the partnership came from tax shelter investors who became limited partners.

In March, 1968, Black Watch entered into an exclusive agreement with plaintiff Whitley to pay him a finder’s fee if a sale of its assets were concluded with any of five prospects, including a corporation now known as Bermec Corporation. However, not long thereafter, having unsuccessfully attempted to persuade Whitley to relinquish his exclusive rights, Black Watch instructed him to cease all further contact with Bermec. In May, 1968, Bermec announced its intention to acquire Black Watch. On May 23, 1968, plaintiff Whitley’s attorneys informed both Black Watch and Bermec of his claim for a finder’s fee on the then proposed transaction. On June 21,1968, an agreement of sale was executed by BWF, Jack Dick, Bermec and Black Watch Farms, Inc. (“INC”), a wholly owned subsidiary of Bermec, pursuant to which BWF sold to INC for Bermec stock valued at $20,500,000 all of its assets, including its general and limited partnership interests in Black Watch. The agreement provided that INC was to be substituted for BWF as general partner of Black Watch and obligated Bermec itself to offer to purchase, for an aggregate of $10,500,000 in cash or Bermec stock less a finder’s fee to a company other than plaintiff, from each of the other Black Watch limited partners, the entire 86% of limited partnership interests in the same proportion as the individual partners’ interest in Black Watch bore to the 86% interest held by the limited partners other than BWF.

The offer was made by a prospectus which acknowledged that Bermec was obligated by the June 21, 1968 agreement to make the offer, stated that Bermec opted to offer stock rather than cash, set forth the amount of the finder’s fee to be deducted, and fixed an expiration date of January 7, 1969. All of the limited partners of Black Watch accepted the exchange offer. INC thus became the sole general and sole limited partner of Black Watch and distributed to itself all of Black Watch’s assets.

On August 21, 1968, no response having been received to his attorneys’ letter, Whitley began an action against both Black Watch and BWF, which resulted, some eight years later, after entry and vacation of two earlier judgments, in judgment against Black Watch and BWF in the amount of $1,552,034.50. On November 29,1977, the appeal by Black Watch and BWF from that judgment was dismissed for failure of prosecution. In the intervening years, however, Black Watch had been dissolved and its limited partnership certificate had been canceled on August 15, 1969, BWF had distributed its only asset (the Bermec stock received by it), Jack Dick had died, and Bermec and INC had both gone bankrupt. Whitley has realized on his judgment, therefore, only $20,983 paid to him as a creditor in the INC bankruptcy.

In April, 1978, Whitley began the action which is the basis of this appeal against the available former limited partners (other than BWF) of Black Watch. His complaint contained allegations establishing that his finder’s fee claim was an outstanding obligation of the limited partnership when the interests of the limited partners were acquired by Bermec as well as when the June 21, 1968 agreement was signed. By separate motions plaintiff moved for summary judgment against Daniel T. Alagna, Fania Friedman and Phemie Goldman (the “Alagna Group”). They and certain other defendants cross-moved for leave to amend their answers and all of the defendants cross-moved for summary judgment. Special Term denied plaintiff’s motions for summary judgment and granted defendants’ cross motions dismissing the complaint. It held that absent a showing of fraud the transfer of defendants’ limited partnership interests could not be equated with a return of capital to defendants. The Appellate Division reversed, granted summary judgment to plaintiff against the Alagna Group, and denied the cross motion of the other defendants for judgment dismissing the complaint. This appeal by the Alagna Group defendants followed.

II

Subdivision (4) of section 106 of the Partnership Law provides that: “When a contributor has rightfully received the return in whole or in part of the capital of his contribution, he is nevertheless liable to the partnership for any sum, not in excess of such return with interest, necessary to discharge its liabilities to all creditors who extended credit or whose claims arose before such return.” In determining the meaning of the words “return * * * of the capital of his contribution” ¹ one must look not only to those words but to the purpose of the provision and to its context as well (McKinney’s Cons Laws of NY, Book 1, Statutes, §§ 96, 97). That the purpose of the subdivision is the protection of creditors is crystal clear not only from the explicit reference to “creditors who extended credit or whose claims arose before such return” but also from the imposition of liability under its provision even though the contributor has “rightfully received the return.” It follows that primary in the determination whether a particular transaction constitutes a return of capital is not the limited partner’s purpose or intent or how the transaction is structured but its effect upon partnership creditors.

On the basis of that overriding purpose we and other courts have held limited partners liable under subdivision (4) of section 106 notwithstanding the absence of fraud, the fact that property other than cash is received by the limited partner or the fact that the transaction takes the form of a sale of the limited partners’ interests to a third person, rather than a distribution by the partnership itself. Thus, in Kittredge v Langley (252 NY 405)² we held that even though the assets remaining with the partnership at fair valuation were more than enough to discharge its liabilities to creditors who were such at the time a limited partner received back his contribution, the limited partner remained liable to the creditors. Though decided under preexisting law, the opinion in that case, by Chief Judge Cardozo, analyzed the Uniform Limited Partnership Act provisions which had been enacted after the repayment there in issue. In that opinion he noted that the provisions of article 8 of the Partnership Law “are declaratory of existing law” (252 NY, at p 421), and held that, notwithstanding the seemingly contrary language of section 105 (subd [1], par [a]) of the Partnership Law,³ a limited partner's “contribution, like the capital of a corporation and to a similar extent,⁴ is to be treated as a trust fund for the discharge of liabilities * * * He can gain nothing for himself out of the fund so created, except in subordination to the creditors, until the debts have been extinguished” (252 NY, at p 419). The “risk of change” in the situation of the partnership after such a distribution, he reasoned, is upon the limited partner rather than the creditors (252 NY, at p 420). Support for those conclusions was found in the priority for creditors over limited partners declared in section 112 of the Partnership Law (252 NY, at p 421).⁵

An analogous holding is to be found in Beers v Reynolds (11 NY 97), in which the limited partner sold his interest in the partnership to the general partner taking back a chattel mortgage on both partnership property and property of the general partner. The Trial Judge charged the jury that the limited partner was liable as a general partner (the result under the then existing statute when the partnership continued business after an alteration of its capital) irrespective of any design to defraud or injure creditors of the firm and without regard to the motives be-bind the sale of the limited partner’s interest or the intent with which it was made (accord Coffin’s Appeal, 106 Pa 280, 287).

Receipt by the limited partner of property (here Bermec stock) rather than cash does not change the result. While subdivision (3) of section 105 of the Partnership Law restricts a limited partner to receipt of cash for his contribution unless the partnership certificate states otherwise or all members consent, that provision has no bearing upon the interpretation of subdivision (4) of section 106, intended as it is to protect creditors. We have, moreover, held that a withdrawal occurred though the vehicle was not cash but the taking of title to partnership property in the name of both general and special partners (Madison County Bank v Gould, 5 Hill 309).

A closer question is whether the statute covers only a transfer, whether of cash or property, which comes from the partnership itself or includes as well a transaction which takes the form of a sale of the partnership interest and in which the consideration moves from a third person. While there are no New York cases in point, both Neal v United States (195 F2d 336) and Johns v Jaeb (518 SW2d 857 [Tex]) have held that it does. The Neal decision is of particular interest because in reaching its conclusion the Fifth Circuit Court of Appeals relied upon our Kittredge v Langley decision, and because it involved a factual situation akin to that of the present case.

In Neal the United States War Assets Administration had sold a lathe to a limited partnership composed of Neal and Nauts as special partners and Derrick as the general partner. The partnership being in need of new capital which Neil and Nauts declined to provide, Derrick formed a corporation which was to continue the business and sold interests in it in return for corporate stock. Derrick then used the cash thus obtained, plus his own personal assets and his own promissory notes, to pay out special partners Neal and Nauts, but the creditors, including the United States, received nothing. The court held the special partners liable, noting that the transaction was recorded on the partnership books as a return of capital and “taken as a whole, was simply a device to enable the special partners to withdraw their capital without first satisfying their creditors”, that “the court will look through form to substance” (195 F2d, at p 337), and that “The fact that the money was secured outside the partnership and followed an indirect route to the pockets of Neal and Nauts will not obscure the real purpose of the transaction, which was to preferentially return to Neal and Nauts their original capital investment in the partnership, without first satisfying partnership creditors, contrary to Art. 6128 of Vernon’s Texas Civil Statutes” (195 F2d, at p 338).⁶

Johns v Jaeb, supra, while not as closely in point, is of interest for its construction of the statute in question. The action was to recover penalties for usury. The issue was whether funds advanced by defendant to plaintiff were a loan or a contribution as limited partner to a limited partnership formed by plaintiff and defendant in which plaintiff was the general partner. Defendant’s contribution to the partnership was $5,000 and his share of the profits after a salary to plaintiff of not more than $1,000 a month was 99%. At the same time plaintiff agreed to purchase defendant’s partnership interest for $6,500 and gave a promissory note in that amount, payable in six monthly installments without interest, beginning one month thereafter. The Court of Civil Appeals held (518 SW2d, at p 860): “The difficulty of fitting this transaction into the limited partnership mold is demonstrated by its failure to comply with the Uniform Limited Partnership Act, Tex. Rev.Civ.Stat.Ann. art. 6132a (Vernon 1970). Section 17 of that Act provides that a limited partner shall not receive from a general partner any part of his contribution until all liabilties of the partnership, except liabilities to partners on account of their contributions, have been paid or sufficient property of the partnership remains to pay them. Here the general partner was unconditionally obligated to purchase the interest of the limited partner, and thus repay his contribution, in six monthly installments, regardless of whether the partnership could pay its obligations. This express prohibition of the Act may not be evaded by the simple device of labeling the transaction a sale of the limited partner’s interest.” (Emphasis supplied.)

Against the background of the strong statutory purpose to protect existing creditors and the cases analyzed above which, though not squarely in point, uniformly further the purpose of favoring such creditors over limited partners, we turn to analysis of the transactions underlying defendants’ receipt of Bermec stock for their limited partnership interest. That the ultimate purpose of the transactions was the termination of the business of Black Watch, the limited partnership of which defendants were members, is evidenced by plaintiff’s employment by Black Watch to “assist * * * in the sale of its assets” to named possible purchasers, including Bermec. The agreement of sale ultimately negotiated with Bermec provided for its immediate acquisition of BWF’s 57 % interest as a general and a limited partner in Black Watch (substantially all of BWF’s assets), but also obligated Bermec to offer to purchase from the remaining limited partners their interests for $10,500,000 in cash or stock. Since that sum equalled approximately $118,000 for each $10,000 unit of initial investment by the limited partners in Black Watch it was a foregone conclusion that the remaining limited partners would, as they all did, accept the exchange offer when made. Indeed, under article XVI of the limited partnership agreement, the general partner had the right, with the approval of only 51% of the limited partners, to cause the partnership to transfer its assets to a corporation, dissolve and distribute the stock received, in just such a series of transactions as in fact occurred. Though the actual distribution to limited partners was not completed until January 7,1969 and BWF was not in fact dissolved until August 15, 1969, there was, therefore, never any question that those steps would follow.

Notice of plaintiff’s claim was given to Black Watch prior to the execution of the contract, so it is clear that his claim arose before the limited partners received Bermec stock as a result of their acceptance of the offer,⁷ and plaintiff’s moving papers alleged and defendants have not denied that his is the only claim against Black Watch remaining unpaid. The end result of the transactions, therefore, was that the general and limited partners of Black Watch, none of whom retained any connection with Black Watch, have received the entire fair market value of the partnership assets, to the exclusion of its creditor, plaintiff.

Bearing in mind the purpose of the statutory provision in question to protect creditors even when a limited partner has rightfully received a return of his capital and looking to the effect of the transactions rather than to the form, we conclude that they resulted in a return to defendants of their capital within the meaning of subdivision (4) of section 106 and that, therefore, defendants are responsible to plaintiff to the extent of the capital contribution, thus withdrawn, plus interest.

Defendants and Judge Fuchsberg, dissenting, argue that creditors have no interest in the identity of a limited partner and that the statute should be liberally construed to protect limited partnership investors, who are intended to have the same limited liability that a corporate shareholder does. They contend further that there was no reduction in the assets of the limited partnership, nor any transfer of property from the partnership or from the general partner, that the limited partners took no part in the negotiations, and that the inevitable result of affirmance by us will be severely to limit use of limited partnerships since the transferability of limited partnership interests provided for in section 108 of the Partnership Law, will, as a practical matter, be impaired.

The liberal construction argument overlooks the statutory declaration in subdivision (7) of section 108 of the Partnership Law that transfer of a limited partner’s interest does not affect the transferring partner’s liability under section 106 of the same law, and the differences between the latter provision and section 629 of the Business Corporation Law. The declaration in subdivision (7) of section 108 seriously undermines, if it does not eradicate, the suggestion that a limited partner is immunized from the claim of an unpaid existing creditor simply because he took no part in negotiating the transactions and the return of his capital constitutes part of the consideration for the transfer of his partnership interest. As for the Business Corporation Law argument, there is a substantial (and here overriding) difference between its provisions which make liability turn on the solvency of the corporation at the time the stockholder transfers his shares and section 106 which continues a limited partner’s liability notwithstanding the partnership’s solvency at the time and the fact that the capital was “rightfully” returned.

Moreover, to the extent defendants rely upon Crehan v Megargel (234 NY 67, 80) and White v Eiseman (134 NY 101, 103), their argument ignores the facts that both cases antedate Kittredge and that both are clearly distinguishable. At issue in Crehan was whether a person who contributed to a trust which became a special partner could himself be held as a special partner. We concluded he could not, observing that a creditor had no direct interest in the identity of the partner “so long as he contributes his capital and observes all of the requirements of the statute” (emphasis supplied), which as the statute presently stands includes remaining liable to existing creditors when capital is withdrawn, even though rightfully withdrawn. Involved in White was whether a contribution made by a check certified before the partnership papers were filed was a contribution in “cash” as required by the statute. Overruling the contention that the special partners were liable as general partners, we held that, looking to substance rather than form, there had been substantial compliance with the statute.

The other contentions advanced are no more persuasive. The clear contemplation of the original agreement and its ultimate effect was the transfer of all Black Watch assets to INC, the Bermec subsidiary newly formed for that purpose, effectively reducing, unless a then existing creditor can succeed in an action such as this, the assets available to creditors. Nor should the sale of individual limited partnership interests be adversely affected by our holding in this case, predicated as it is upon the structuring of the transaction so as to result inevitably in the transfer of all limited partnership interests.

Ill

The binding effect in this action of the judgment holding the partnership liable to plantiff is likewise a function of the statute. Subdivision (4) of section 106 makes a limited partner who has received the return of his capital “nevertheless liable to the partnership for any sum * * * necessary to discharge its liabilities to all creditors * * * whose claims arose before such return” (emphasis supplied). As we held in Kittredge v Langley (252 NY 405, 420, supra), “The equity thereby established in favor of the partnership is one to which creditors succeed.” Plaintiff brings this action, therefore, not as a creditor seeking to hold a third person on his agreement guaranteeing partnership liabilities, but in the right of the partnership itself to recover the funds necessary to discharge its liability to plaintiff, a liability which has already been established by judgment. Were the action by the partnership rather than plaintiff, the limited partner could not defend on the ground that though the partnership’s liability to the creditor had been finally determined by judgment, it was in fact not liable to the creditor, for that would defeat the purpose of the statute. No more so can he be permitted to defend on such a ground when the creditor, as subrogee, sues in the right of the partnership.

What a limited partner will be permitted to contest in an action by a partnership against which a judgment establishing its liability to a creditor has been obtained is only whether he is in fact a limited partner, whether he received a return of capital, whether the judgment creditor was one whose claim arose before that return, and whether the amount sought by the partnership as return of capital was necessary to discharge the partnership liability (that is, whether the partnership had other means for discharging its liability). Only if the partnership’s liability to its creditor had not been determined by final judgment would a limited partner be at liberty to contest that liability when sued by the partnership, and no reason appears for holding otherwise when the action is by the creditor as successor in interest to the partnership.

The fallacy in Judge Gabrielli’s dissent on this question is in its suggestions that (at p 573) defendants’ “status as debtors' of the limited partnership is premised solely upon the proper resolution of the issues” presented in the prior lawsuit and that (at p 576) “the very existence of defendants’ obligation to the limited partnership turns upon the validity of plaintiff’s claim against the limited partnership.” ⁸ The partnership’s liability to plaintiff having been determined in an action in which the Special Term Judge found that the partnership had full opportunity to litigate the issues and did so fully and fairly, that liability is no longer open to question in any court. Like the stockholders of a corporation, limited partners are not proper parties to an action against the partnership unless the action is brought to enforce the limited partner’s liability to the partnership (Partnership Law, § 115). Like corporate shareholders, limited partners acquire their interests subject to the provisions of subdivision (.4) of section 106, know that by reason of that section they will be made to repay any capital returned if necessary to pay a partnership liability and are bound when the issue of liability has been previously litigated by the partnership (Patch Mfg. Co. v Capeless, 79 Vt 1, 8, 11; see Pope v Heckscher, 266 NY 114). Nor is there any due process infirmity in so holding (ibid.; Christopher v Brusselback, 302 US 500; Selig v Hamilton, 234 US 652, 662; see Hood v Guaranty Trust Co., 270 NY 17; Gottlieb, Res Judicata and Collateral Estoppel In The Law Of Partnership, 65 Cal L Rev 863, 881-885).

Furthermore, neither the Restatement comments referred to in the dissent nor Kittredge v Langley (supra), are to the contrary. The suggestion in Comment b to section 109 of the Restatement Second of Judgments (Tent Draft No. 4) that limited partners be treated as general partners who have not been served is, of course, correct with respect to most actions against the partnership but makes no reference to, and quite obviously was not written with respect to, the special situation created by section 106 of the Partnership Law. A further basis for distinction is that returned capital can quite properly be considered partnership property in possession of the limited partners to the extent needed to discharge plaintiff’s judgment against the partnership, and thus within Comment a to section 109 of the Restatement.

Nor is Kittredge authority for the contrary position. The basis for defendants’ argument that it is, is the statement (252 NY, at p 412) that “plaintiff might have been required, if the defendant had so chosen, to prove the debt anew without reference to the judgment.” It is not necessary to discuss at length the full history of the Kittredge litigation, which was before this court five different times (234 NY 501, 236 NY 375, 244 NY 168, 244 NY 182, 252 NY 405), to show that it is distinguishable on its facts. Though the special partner was joined in the original action, which was in tort not contract, the complaint was dismissed as to him because he was a special partner (252 NY, at p 409). The general partners Grannis and Lawrence were named as defendants, but only Lawrence was served, and in view of the nature of the action he appeared only as an individual and not in defense of Grannis’ interests. The judgment against the joint property of the firm was, therefore, modified at Grannis’ request to strike his name from it. The effect was that the original judgment was binding only upon Lawrence and neither upon any other partner, nor under then existing law upon the joint property of the partnership (Kittredge v Grannis, 244 NY 182, 194; Kittredge v Langley, 252 NY 405, 413), for when the Kittredge litigation was begun in 1914 partnerships were not regarded for purposes of suit as entities separate from the individual partners (see, generally, Gottlieb, op. cit., 65 Cal L Rev 863). Here plaintiff does have a judgment against the partnership and proceeds against defendants by way of subrogation to the right of the partnership against them.

For the foregoing reasons, plaintiff was entitled to summary judgment against the Alagna defendants and to denial of the cross motion of the other defendants for summary judgment. The order of the Appellate Division should, therefore, be affirmed, with costs.

1 . Section 106 of the Partnership Law is identical with section 17 of the Uniform Limited Partnership Act. The 1976 revision of that act deals in section 608 (6 ULA [1979 Supp], p 136) with the liability of a limited partner upon return of his contribution. Subdivision (c) of section 608 defines when a partner receives a return of his contribution and subdivision (a), which is derived from subdivision 4 of section 17 of the prior act, limits liability when return is not wrongful to a period of one year after return. However, the 1976 revision has not been adopted in New York (see 1980 Report of NY Law Rev Comm [Legis Doc No. 65], p 23), and therefore has no bearing on the instant case.

2 . Kittredge is annotated in 67 ALR 1096.

3 . “§105. Withdrawal or reduction of limited partner’s contribution

“(1) A limited partner shall not receive from a general partner or out of partnership property any part of his contribution until (a) All liabilities of the partnership, except liabilities to general partners and to limited partners on account of their contributions, have been paid or there remains property of the partnership sufficient to pay them.” (Emphasis supplied.)

4 . The words “to a similar extent” cannot be read literally for subdivision (4) of section 106 of the Partnership Law continues liability of a limited partner to all creditors who are such at the time his capital is returned without regard to solvency of the partnership whereas the corporation laws in existence when Kittredge was written imposed liability upon a stockholder who received corporate property after the corporation had refused to pay any obligation or when the corporation was insolvent or its insolvency was imminent (former Stock Corporation Law, § 15), or even if not insolvent, for wage claims (former Stock Corporation Law, §71).

5 . Additional support also exists in the provision of subdivision (7) of section 108 that a limited partner who assigns his interest is not released from liability to the partnership under section 106 by the substitution of his assignee as limited partner.

6 . Defendants argue that Neal is distinguishable because the statute referred to by the court dealt with transfers by the partnership while insolvent or in contemplation of insolvency, which was the case in Neal. However, the result would have been the same had the partnership not been insolvent since the Texas Limited Partnership Law (arts 6124, 6126) proscribed, without regard to insolvency, withdrawal of, or reduction of, the capital of a special partner.

7 . That defendants were not given notice is immaterial. The subdivision contains no such requirement and in any event notice to the partnership is binding on the limited partners, whether they had personal knowledge or not (cf. Wisner v Ocumpaugh, 71 NY 113, 116).

8 . A further fallacy is the equation (at p 577) of a stockholder’s right to litigate the.fact of his status as stockholder with a limited partner’s right to litigate his status as debtor to the partnership. The right of a limited partner paralleling the stockholder’s right to litigate his status as stockholder is the limited partner’s right to litigate his status as a limited partner.

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Dissenting Opinion

Gabrielli, J.

(dissenting). I dissent from so much of the majority decision as holds that former unserved limited partners are bound by the results of plaintiff’s prior lawsuit against the limited partnership. Since the former limited partners were not parties to the prior action and were not in a position to participate in or control it although their status as debtors of the limited partnership is premised solely upon the proper resolution of the issues presented in that suit, there exists no justification for deeming them to be bound by that decision. The unfortunate effect of the majority decision is to deprive defendants of their property without allowing them any opportunity to contest the validity of either plaintiff’s claim against the limited partnership or, more significantly, the partnership’s claim against defendants. I cannot concur in such a result, for I consider it to be utterly repugnant to basic principles of law and justice.

The majority reaches its conclusion by simply assuming without further discussion that limited partners “are bound when the issue of [the partnership’s] liability has previously been litigated by the partnership”, because they know that “they will be made to repay any capital returned if necessary to pay a partnership liability” (at pp 571-572). This rather facile formulation, however, begs the very question which we have been asked to decide. The difficulty with the majority’s analysis is that we are not here dealing with an attempt to recover known partnership assets in the hands of the former limited partners; rather, the limited partners are at most debtors of the partnership pursuant to subdivision (4) of section 106 of the Partnership Law. More importantly for these purposes, the debts are themselves contingent, depending as they do upon the validity of plaintiff’s claim against the limited partnership. This is so because these defendants are only indebted to the limited partnership if plaintiff actually has a valid claim against the limited partnership that arose at a time when these defendants were limited partners, and which the partnership is unable to satisfy due to its insolvency. Since the very existence of any obligation upon the part of defendants is founded upon the validity of plaintiff’s claim against the now insolvent partnership, these defendants may not be held liable as debtors of the partnership unless they have had a fair opportunity to contest the validity of plaintiff’s claim against the partnership. In other words, defendants may not be bound even under the majority’s formulation, because they have not yet had an opportunity to litigate an essential element of their claimed liability: whether repayment is “necessary” due to an outstanding partnership liability. Thus, inasmuch as there remains a disputed question of fact on this point, plaintiff is not entitled to summary judgment against these defendants.

Plaintiff’s claim against the former limited partners is based upon subdivision (4) of section 106 of the Partnership Law, which provides as follows: “When a contributor has rightfully received the return in whole or in part of the capital of his contribution, he is nevertheless liable to the partnership for any sum, not in excess of such return with interest, necessary to discharge its liabilities to all creditors who extended credit or whose claims arose before such return.” Pursuant to our decision in Kittredge v Langley (252 NY 405) it is now well settled that although the language of the statute refers only to the former limited partner’s liability to the partnership itself with respect to such unpaid partnership debts, the creditor of the partnership is nonetheless entitled to proceed directly against a limited partner if the limited partnership is unable to satisfy the debt. This does not mean, however, that a limited partner not made a party to the action against the limited partnership is bound by that determination of the validity of the creditor’s claim, for the limited partner is entitled to an opportunity to contest that claim. If he is not provided such an opportunity by being made a party to the prior action, he must be allowed to challenge it in the context of plaintiff’s subsequent attempt to enforce the claim directly against the limited partner. No contrary result is supported by principles of collateral estoppel or by the law of subrogation. Indeed, the conclusion reached by the majority clearly violates defendant’s constitutional right not to be deprived of property without due process of law. As the Supreme Court has recently reaffirmed, “[i]t is a violation of due process for a judgment to be binding on a litigant who was not a party or a privy and therefore has never had an opportunity to be heard” (Parklane Hosiery Co. v Shore, 439 US 322, 327, n 7; accord Blonder-Tongue v University Foundation, 402 US 313, 329; Hansberry v Lee, 311 US 32, 40).

Since due process is implicated by the use of a prior judgment to bind persons not parties to that prior action, it is always necessary to tread cautiously in the use of collateral estoppel in such cases. The majority’s conclusion that plaintiff is subrogated to whatever claim the partnership may have against defendants does not resolve the problem, since there is no connection between our recognition of plaintiff’s equitable right to seek to recover from the limited partners any valid claim he may have against the partnership, and the question whether these defendants are precluded from contesting the validity of plaintiff’s underlying claim against the partnership simply because plaintiff prevailed in the prior suit. For the reasons stated herein, I would hold that before the plaintiff may obtain a judgment against these former limited partners, they must be provided an opportunity to put plaintiff to his proof with respect to his claim against the partnership. To date, defendants have been accorded no such opportunity.

Initially, I note that defendants are in a somewhat unusual position. Plaintiff, as a judgment creditor of the limited partnership, is of course entitled to enforce his judgment against any debtors of the partnership. Such debtors, moreover, would not normally be able to contest the validity of the judgment plaintiff has obtained against the partnership, although they certainly could challenge the validity of their own obligation to the partnership. This is so because as debtors, their interest is limited to their own obligation, and usually does not extend to the validity of the plaintiff’s judgment against the partnership. Here, however, the very existence of defendants’ obligation to the limited partnership turns upon the validity of plaintiff’s claim against the limited partnership. If plaintiff’s claim against the partnership is not sound, then defendants are not liable to the partnership and thus there exists no debt enforceable by plaintiff. Because of this, the defendants have a very real property interest in the determination of the validity of plaintiff’s claim against the partnership. Hence, defendants cannot be bound by a prior decision which, if given conclusive effect, would establish the fact of their liability to the partnership without being accorded an opportunity to contest the issue (see New York Life Ins. Co. v Dunlevy, 241 US 518; see, also, Carr v Carr, 46 NY2d 270, 273, n 2).

Since defendants must be provided an opportunity to challenge plaintiff’s claim against the partnership, the determinative issue is whether the law of collateral estoppel allows a nonparty to be bound by a prior action under the circumstances presented on this appeal. Although there exists little law concerning the application of collateral estoppel principles to limited partners, the Restatement Second of Judgments suggests that limited partners should be treated for collateral estoppel purposes as general partners who have not been served (Restatement, Judgments 2d [Tent Draft No. 4], § 109, Comment b). As such, they are bound by a prior adverse judgment against the partnership only to the extent of partnership property in their possession (Restatement, Judgments 2d [Tent Draft No. 4], § 109, Comment a). This rule seems eminently reasonable and there exists no reason why it should not be adopted in this State. Indeed, such a rule appears to be supported by what little precedent does exist (see Kittredge v Langley, 252 NY 405, 412-415, supra). The cases cited by the majority (Pope v Heckscher, 266 NY 114; Hood v Guaranty Trust Co., 270 NY 17) are not to the contrary. While it was stated in those cases that a prior determination of the fact and amount of a corporation’s indebtedness would be binding upon shareholders, it was further stressed that the prior adjudication “would not operate to deprive the defendant of his right to litigate, in accordance with the requirements of due process, the fact of his status as stockholder and defenses personal to him” (Pope v Heckscher, supra, at p 118). In this case, the “fact” of the limited partners’ status as debtors to the partnership is predicated solely upon the existence of a debt owed by the partnership to plaintiff. Thus, although some superficial confusion may arise due to the coincidence of the issue of the partnership’s indebtedness to plaintiff and the concomitant issue of defendants’ indebtedness to the partnership, defendants must be afforded an opportunity to litigate the former issue consistent with due process.

The only real question is whether defendants’ contingent obligations to the partnership may validly be considered partnership assets. If so, to the extent of their returned capital defendants arguably may be deemed to be in possession of partnership assets and thus bound by the prior suit against the partnership. The difficulty in applying such an analysis to the instant case is the peculiarly contingent nature of defendants’ obligations to the limited partnership. As discussed above, the very existence of that obligation depends upon the validity of plaintiff’s underlying claim against the partnership. It is the circularity of the situation which creates a problem: if plaintiff does have a valid unsatisfied claim against the partnership, he is entitled to recover from defendants any partnership assets in their possession ; however, they in turn hold partnership assets only to the extent that plaintiff does have a valid claim against the partnership. Certainly the plaintiff must prove that the defendants do in fact possess partnership property, even if to do so requires plaintiff to relitigate against these defendants certain issues he has already successfully litigated with the partnership itself. Thus, for these purposes, defendants may not be considered bound by the prior judgment insofar as they were neither parties to that suit nor did or could they exercise control over that suit (see Restatement, Judgments 2d [Tent Draft No. 4], § 109, Comment d; see, also, Heavrin v Lack Malleable Iron Co., 153 KY 329; Dillard v McKnight, 34 Cal 2d 209). Such is the rule which normally applies to indemnitors (see Restatement, Judgments 2d [Tent Draft No. 3], § 107, Comment a) and guarantors (see 57 NY Jur, Suretyship and Guaranty, § 284; compare Adams v United States Fid. & Guar. Co., 239 App Div 525, aff’d 264 NY 550, with Blanding v Cohen, 101 App Div 442, aff’d 184 NY 538), and I see no justifiable reason to create a different rule of collateral estoppel for former limited partners who are called upon to satisfy a partnership obligation from properly returned capital contributions. The applicable considerations are truly similar, and thus I would apply similar principles of law.

In sum, I would hold that although the defendants have received a return on their capital for purposes of subdivision (4) of section 106 of the Partnership Law, they are entitled to put the plaintiff to his proof with respect to his claim against the partnership and are not bound by the prior judgment against the partnership. Accordingly, I vote to reverse the order appealed from and remit the case to Supreme Court for further proceedings upon the complaint.

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Dissenting Opinion

Fuchsberg, J.

(dissenting). Most respectfully, I suggest the result reached by the majority brooks legal and economic realty. In my view, it is premised on an unsound definition of what is a “return of capital”. Remove that erroneous assumption and the argument it advances collapses like a house of cards.

A few simple principles will point up my position. Essentially, the capital of a limited partnership, like that of a corporation, consists of the contributions subscribed or paid in, in the one case by its partners and in the other by its shareholders. The amounts for which either of these classes of investors is committed fix the limits of their exposure to creditors. To be distinguished are general partners who, by law, aside from their formal capital contributions, are personally responsible for the debts of the partnership.

A limited partnership’s creditors, therefore, have no right to look to anything but the capital contributed to the partnership and the personal liability of the general partners. For a limited partner’s interest, like that of a corporate shareholder, is nothing more than an undivided interest or, better yet, equity in the res of the partnership or corporation. That equity, subordinate of course to claims of general creditors, is a thing apart from the contribution of capital that gave rise to it. It therefore is basic that a sale or other transfer of that equity, so long as it does not directly or indirectly involve a withdrawal or impairment of the partnership capital itself, is, in fact as in form, not a return of capital, but merely the substitution of one owner of the limited partnership interest for another. It can be likened to a sale of corporate stock for a consideration which passes between the purchaser and seller of the shares in question; the corporation is no richer or poorer for the transaction.

Ignoring these basic tenets, the plaintiff in this now 12-year-old litigation hypothesizes that the defendants and the host of other limited members of the partnership in this case were participants in a plan whose purpose and effect was to put the capital of the partnership beyond the reach of creditors.¹ One trouble with the theory so postulated is that to carry it forward the plaintiff must soft-pedal the fact that the return of capital contemplated by subdivision (4) of section 106 of our Partnership Law speaks only of paid-in or subscribed partnership capital that is part of an investor’s “contribution”. The statute expressly limits any liability to such return of capital and not, as here, the consideration which owners of limited partnerships may have received for the sale of their limited partnerships from others than the partnership entity or its general partners, the only ones on whose credit those who deal with a partnership have a right to rely.

As revealed by the record, the simple and undisputed fact is that the partnership capital in this instance was as unimpaired and as fully available to creditors after the defem dants sold their limited partnerships as it had been before they did so.² In particular, the defendants, neither directly nor indirectly, nor in whole nor in part, received any consideration for their interests from the partnership or its general partners. Accordingly, there was no diminution of the assets of those who were the sole potential sources of satisfaction of any existing or future partnership obligations. To now foist personal responsibility on the limited partners for once again the amounts of their original contributions is, therefore, to ignore the fact that the form of their investments was intended by law to secure them, inter alia, precisely against such vulnerability. Moreover,, it would provide plaintiff with an economic windfall by way of additional debtors for whose personal liability he did not bargain. Perhaps most important, this misapplication of equitable creditors’ action principles bids fair to undermine the continued vitality of the limited partnership as a legislatively sanctioned device for conservative investment of capital.

Closer examination of the circumstances of the transfer of defendants’ interests confirms these propositions. It is not disputed that the appellants played no role initiating, negotiating or making the agreement under which the general partners, in June, 1968, agreed on their own to sell their interest, which included the right to manage the partnership, to Black Watch Farms, Inc. (INC), subsidiary of Bermec. Perhaps to meet the strictures of Federal securities laws (see, e.g., Perlman v Feldmann, 219 F2d 173; Ferraioli v Cantor, 281 F Supp 354), Bermec also undertook to offer cash or Bermec stock (the choice to rest with Bermec) to each of the nonmanagerial limited partners for their individual partnership interests. But the agreement was not conditioned on whether any or all of such offers were accepted. Self-standing, it was completely independent of whether the limited partners, each acting on his own, decided to sell.

Moreover, the general partners, who controlled the partnership’s assets but not the limited partners’ discrete right to dispose of their own unrealized equity in the partnership, were without power to compel the appellants to agree to sell, if and when Bermec made the offer. In fact, the offer was not made until sometime after the underlying agreement had been entered into, at which time, not surprisingly in light of the passive place of the limited partners,³ the defendants, on their own volition, decided to sell their limited partnership shares.^{4 5}In any event, the net effect of the acceptance by each limited partner of a certificate of Bermec stock in place of a certificate of limited partnership was not to diminish the capital of the Black Watch enterprise or of its general partners. Indeed, not one cent’s worth of Black Watch Farms’ money or any of its other assets was paid to the plaintiffs. Instead, the value of Black Watch Farms’ assets, which on June 30, 1968 were valued at $25,863,527, by June 30,1969, well after the plaintiffs were no longer partners, had increased to $42,155,642.®

On policy grounds, it also is relevant that this good faith transfer of limited partnership shares was nothing more than the exercise of another privilege which limited partners enjoy in common with corporate stockholders — the free transferability of interests (see Lichtyger v Franchard Cory., 18 NY2d 528, 536; Ruzicka v Rager, 305 NY 191, 197-198; Partnership Law, §§ 107, 108, subd [1]; Note, Sale of Limited Partnership Interests: Rivlin v. Levine, 14 Hastings LJ 176). No doubt this privilege is one of the chief reasons the limited partnership holds a favored position as a form of investment (see Haft and Fass, Tax Sheltered Investments, 4 Securities Law Series [rev ed, 1979], §§ 1.02, 5.02[2]).

Furthermore, the provision for the “return in whole or in part of the capital of his [limited partner’s] contribution” (Partnership Law, §§ 105, 106, subd [4]) does not look to the assets of the limited partner, but to those of the partnership and its general partners. It is illuminating, therefore, on examination of cases in which limited partners have been held to have received a return of capital, that each involved a dimunition of the capital of the partnership or a general partner.

For example, the Kittredge case, whatever its nostrums, was one in which a special partner was sued for the investment which had been returned to him out of partnership capital by two general partners in the course of dissolving the partnership (Kittredge v Langley, 252 NY 405, 408-409). Without question what was involved there was a “return of capital”.

In the same direction is Beers v Reynolds (11 NY 97). There the sale of a limited partner’s interest was to a general partner, who, in securing payment of the purchase price, gave the limited partner a chattel mortgage on both the partnership property and that of the general partner. Without more, at least in this circumstance, the mortgage was in effect the equivalent of a capital distribution in kind. Similarly, in Madison County Bank v Gould (5 Hill 309), title to partnership property was taken in the name of limited partners.

So, too, in Neal v United States (195 F2d 336) a general partner used cash obtained from third parties as well as his own personal assets and his own promissory notes to buy out his limited partners, a classic diminution of a creditor’s security. In like manner, in Johns v Jaeb (518 SW2d 857 [Tex]), a general partner undertook an unconditional personal obligation to purchase the interest of a limited partner ; again, we have a substantive, if not a formal, variant on the prohibited pattern of a payout of a limited partner at the expense of the security afforded creditors by the partnership-general partner nexus. In sharp contrast to either of these cases, in the present one the two former general partners did not pay the defendants anything via their own assets or those of the partnership.

Now turning back to the case at issue, unless an unwarranted cynicism is to govern — and there is not even a whisper of fraud, sharp dealing or preferential, intention — the defendants’ election to accept Bermec’s arm’s length offer to pay for the purchase of their limited partnerships in non-partnership and nonpartner assets did not run afoul of our statutory law. Having resorted to neither partnership nor general partners’ assets, how they disposed of their equity was their own affair.

Though the corporate stock the limited partners received ultimately became worthless, whether it represented an appreciation or depreciation of their investments at the time it was received was immaterial.⁶ The sale in no way affected the quantum of the partnership’s or general partners’ capital. The shares of Bermec stock for which the limited'partnerships were exchanged were not, and never had been, an asset of the partnership and therefore in no way were, or had been, available to discharge partnership obligations (see Mason, Fundamentals of Accounting, p 329). The substitution of new limited partners for the old ones had no bearing on a creditor circumstanced as was the plaintiff. The capital represented by each limited partnership remained intact.

Overall, the legitimate interest of a creditor is that the capital of a partnership shall be honestly represented and fully contributed and maintained as such. The defendants engaged in no acts constituting a departure from these requirements. Consequently, there is no more justification for imposing the respondent’s losses on the defendants than there would be for imposing those suffered by the plaintiff on the defendants.⁷

Finally, so far as collateral estoppel is concerned, I agree that as a general rule limited partners are bound by adjudications against a limited partnership, but only to the extent of the assets which they agreed to contribute. Estoppel therefore turns on whether the assets being pursued are those of the partnership. Since, for the reasons stated, the stock which the limited partners accepted for their partnership interests were not partnership assets, collateral estoppel does not not apply.

For all these reasons, I would reverse the order of the Appellate Division and reinstate the judgment at nisi prius.

Judges Jasen, Jones and Sweeney^* concur with Judge Meyer; Judge Gabrielli dissents and votes to reverse and remit the case for further proceedings in a separate opinion in which Chief Judge Cooke concurs; Judge Fuchsberg dissents and votes to reverse and reinstate the judgment of Supreme Court in a separate dissenting opinion.

Order affirmed.

1 . It is ironic that plaintiff’s underlying claim against the partnership was for a brokerage fee, presumably for his efforts to produce a deal akin to the one on which he now seeks to advantage himself.

2 . It has been authoritatively stated that, in the context of a partnership, capital means “the aggregate of the sums contributed by its members for the purpose of commencing or carrying on the partnership business, and intended to be risked by them in that business” (3 Lindley, Partnership [8th ed], p 382, quoted in M. & C. Creditors Corp. v Pratt, 172 Misc 695, 715, affd without opn 255 App Div 838, affd without opn 281 NY 804).

3 . Limited partners typically have less say over management than do corporate shareholders. They lack even the shareholders’ right to vote for a change in management. Rather, they can only inspect the firm’s books and, if warranted, force a judicial dissolution and account (Partnership Law, § 99).

4 . Since the option to pay in the form of Bermec stock or at the rate of $118,000 in cash for each $10,000 limited partnership interest rested with Bermec alone, the size of the cash payment, except for its impressive sound, was illusory. It could just as well have been 118 million instead of 118 thousand. As indicated, Bermec was not required to offer any cash and it never did. It appears obvious then that the function of the $118,000 was purely cosmetic, a dangling of a fictitious dollar value in order to induce the limited partners to sell. Thus, while the limited partners may have been the victims of high pressure sales tactics, possibly the “sheep” that were to be shorn, by not the wildest stretch of the imagination can it be said that they were engaged in a plot to divide the capital of the partnership.

5 . If anything, the assets available to creditors were enlarged. As the record indicates, when the newly formed INC took over the unimpaired partnership assets, it also assumed its liabilities, so that creditors became the obligees of both INC and the partnership rather than the partnership alone. While the plaintiff was not included on the list of partnership liabilities contained in the agreement between INC and the partnership, that was no doubt due to the fact that the managers of the partnership did not believe that the plaintiff, who did not commence his action against the partnership until two months later, was a creditor. Regardless of whether, under these circumstances, the plaintiff would have been treated like other creditors under the INC-BWF agreement (an academic matter in view of the fact that INC and BWF had both become insolvent by the time the plaintiff procured his eventual judgment against the partnership some eight years later), the creditors were certainly no worse off.

6 . Any gain or loss produced by such a sale, since it is the product of an asset of the partner rather than of the partnership, would be debited or credited for tax purposes to the limited partner alone (US Code, tit 26, § 741; Kinney v United States, 228 F Supp 656, affd 358 F2d 738).

7 . As a result of what, for aught that appears, were but the financial vicissitudes of private enterprise, the partnership, INC and Bermec each was to suffer insolvency in subsequent years. Concomitantly, the Bermec stock the limited partners received as consideration for their partnership interest became worthless.

Case Details

Case Name: Whitley v. Klauber

Court Name: New York Court of Appeals

Date Published: Nov 25, 1980

Citation: 51 N.Y.2d 555

Court Abbreviation: NY