Opinion
Civil Action No. 3:02-CV-0636-N
January 27, 2003
ORDER
This matter is before the Court on appeal by Tomlin Properties and intervenor the United States of American from judgment rendered by the bankruptcy court in favor of Robert Milbank, Jr., Trustee for Debtor D.O. Tomlin, Jr. For the reasons stated below, the Court holds that the bankruptcy court erred as a matter of law in characterizing certain partnership transactions. The judgment below is therefore REVERSED and this matter is REMANDED for further proceedings.
I. BACKGROUND
A. Factual Background
Debtor Daniel O. Tomlin, Jr. and his father, Daniel O. Tomlin, Sr. each held a 50-percent interest in Tomlin Properties (the "Partnership"), a Texas general partnership. On April 29, 1984, Mr. Tomlin, Sr. died and his estate and widow each became a 25-percent partner in the Partnership. The business of the Partnership was promoting real estate development. In exchange for its services in promoting and managing real estate investment opportunities, the Partnership received interests in the investments, which were usually organized as joint ventures. In 1984, the Debtor organized Tomlin Properties, Inc. ("TPI"). From that point forward, TPI became the Debtor's operating entity, rather than the Partnership. After the death of the senior Mr. Tomlin, TPI took over the business assets of the Partnership and the right to receive certain commissions. Although the Partnership did not initiate new ventures after 1984, it continued to receive distributions from its previous investments.As TPI did business from 1984 forward, it incurred certain debts, which the Debtor personally guaranteed. When TPI began to experience economic difficulties, the Debtor used Partnership assets to satisfy some of TPI's obligations, thus relieving the Debtor from his liability on his guarantees. Three such transactions involving MBank, Bonham State Bank, and San Antonio Savings Association ("SASA") are at issue in this appeal. Also, when the Partnership received distributions from Grapevine Commercial JV and International Plaza JV, Debtor used his share of those funds to pay TPI payroll expenses. The Partnership reflected these four transactions as distributions to the Debtor's capital account. By the end of 1998, his capital account had a negative balance of $970,134.
B. Procedural Background
After Debtor commenced bankruptcy proceedings, the Partnership filed proofs of claims relating to Debtor's alleged negative capital account. The Trustee contested those claims in an adversary proceeding, seeking a declaratory judgment that the bankruptcy estate had a positive interest in the Partnership because he believed the Debtor's capital account actually had a positive balance. The United States intervened in its capacity as estate tax creditor for Mr. Tomlin, Sr's estate. The case was tried before the bankruptcy court over a period of four days. In extensive findings of fact and conclusions of law, the bankruptcy court found in favor of the Trustee. In particular, the court held that the partnership agreement for the Partnership did not permit unequal distributions or negative capital accounts and that some of the alleged transactions giving rise to the negative capital account did not happen. The result reflected the court's view that Debtor was engaged in a scheme to place his principal asset beyond the reach of his creditors, and that the paper trail supporting the negative capital account was thin and inconsistent.
The Partnership and the United States appeal to this Court, arguing that the bankruptcy court erred both legally and factually. This Court reviews the bankruptcy court's conclusions of law de novo, e.g., Beal Bank, S.S.B. v. Way Apartments, D. T., 201 B.R. 444, 449 (N.D. Tex. 1996), and reviews the bankruptcy court's factual findings under a clearly erroneous standard. E.g., In re Young, 995 F.2d 547, 548 (5th Cir. 1993). This Court holds that a fundamental legal error pervades the bankruptcy court's decision, and therefore remands for further proceedings.
II. THE BANKRUPTCY COURT ERRONEOUSLY DETERMINED THE PARTNERSHIP AGREEMENT WOULD NOT PERMIT A NEGATIVE CAPITAL ACCOUNT
The bankruptcy court determined that "[t]he alleged "disproportionate distributions' to the Debtor were not authorized by the Partnership Agreement and were therefore transfers for the benefit of all partners with their consent, or they were gifts or loans from his partners which would have been documented outside the partnership agreement. The alleged "disproportionate distributions' would have had an equal effect on all partners' capital accounts." Finding of Fact and Conclusions of Law ¶ 18.15 [hereinafter "FFCL"]. The error in this view is that if a partner does in fact improperly arrogate to himself an unfair share of partnership assets, his injured partners are left with no remedy; because the distribution was improper, the bankruptcy court concludes, we must indulge in the legal fiction that it was authorized or was a gift from the dispossessed partners. Neither the partnership agreement at issue here nor applicable state partnership law require that result.
The applicable statute is the Texas Uniform Partnership Act, TEX. REV. CIV. STAT. ANN. art. 6132b (Vernon 1970) [hereinafter "UPA"]. Under the UPA, a partner's capital account can be negative. See Park Cities Corp. v. Byrd, 534 S.W.2d 668, 673 (Tex. 1976) (holding negative capital account is asset of partnership that must be repaid upon dissolution). In this case, the partnership agreement also contemplated that any negative capital account would be repaid upon winding up of the partnership: "All of the assets of the Partnership, including . . . the repayment of any debit balance in a Partner's capital account shall be applied and distributed as follows. . . ." Partnership Agreement § 5.02D (R. 1452).
"The UPA was replaced by the Texas Revised Partnership Act, TEX. REV. CIV STAT. ANN. art. 6132b-1.01, et seq. (Vernon 2002). By its terms, the revised act did not apply to preexisting partnerships unless the partnership amended its agreement to make the revised act applicable. Id. art. 6132b-11.03. Accordingly the Court will rely on the UPA.
Thus, regardless of whether a disproportionate distribution was proper under the partnership agreement, if such a distribution did in fact occur, the proper outcome is to treat the resulting negative capital account as an asset of the Partnership, not to indulge in the legal fiction of consent or a gift. The bankruptcy court erred as a matter of law in concluding the opposite.
The bankruptcy court made similar errors in concluding the four transactions at issue did not occur. Those four determinations rested in part on the erroneous view that because such transfers were not proper under the partnership agreement, they could not have occurred. E.g., FFCL ¶¶ 6.8, 8.18, 9.11, 10.6, 11.12. As discussed above, however, the fact that the transactions may not have been proper does not mean the court should discount their existence; the result of those improper transactions, if they occurred, would be a negative capital account which would now be an asset of the Partnership. Similarly, the bankruptcy court appears to have been influenced in its findings by the fact that the transactions were not documented as required by the various joint venture agreements. Failure to obtain proper authorization or documentation does not indicate that the transactions did not occur. If assets left the Partnership in satisfaction of Debtor's guarantee obligations, then the transactions did occur, regardless of whether the paperwork was straight. The issue is not whether the transactions were proper under the partnership agreement, but rather whether they actually occurred and how they are characterized.
The bankruptcy court's characterization of the transactions also appears to be affected by that court's view that the transactions would be classified as bad debts for tax purposes under I.R.C. § 166. Although the full record is not before this Court, it appears that there is no evidence that the Partnership took part in the disputed transactions for profit. Absent a profit motive, those transactions would properly be considered under I.R.C. § 752.
Appellants raise numerous other claimed factual errors in the bankruptcy court's decision. That court's ultimate result is so colored by the legal error discussed above, however, this Court cannot tell if the bankruptcy court would have reached those same findings in the absence of that error. It is up to the bankruptcy court in the first instance to consider that issue in light of the full record. Accordingly, the judgment below is VACATED and this matter is REMANDED to the bankruptcy court for further proceedings consistent with this opinion.