Whitley v. Alagna, 62 N.Y.2d 546 (1984)

When a limited partner receives a return of their capital contribution, they remain liable to partnership creditors whose claims arose before the return, even if the return was rightful and structured as a sale of partnership interests.

Summary

This case addresses whether limited partners are liable to a partnership’s judgment creditor after selling their partnership interests in exchange for stock. The New York Court of Appeals held that the sale constituted a return of capital under Partnership Law § 106(4), making the limited partners liable to the creditor to the extent of their withdrawn capital. The court reasoned that the statute’s purpose is to protect creditors, and the transaction’s effect, rather than its form, determines whether a return of capital occurred. The court further held that the prior judgment against the partnership binds the limited partners, precluding them from relitigating the underlying claim.

Facts

Black Watch Farms, a limited partnership, hired Whitley to find a buyer for its assets. Black Watch then circumvented Whitley’s exclusive agreement by negotiating a sale to Bermec Corporation. Bermec acquired the general partner’s interest and offered to purchase the limited partners’ interests in exchange for Bermec stock. All limited partners accepted the offer. Whitley sued Black Watch for his finder’s fee and obtained a judgment. However, Black Watch had been dissolved, and its assets distributed, and Bermec went bankrupt. Whitley then sued the former limited partners to recover his judgment.

Procedural History

Whitley initially sued Black Watch and BW Farms, Inc. and obtained a judgment. After attempts to collect on the judgment failed due to Black Watch’s dissolution and Bermec’s bankruptcy, Whitley sued the former limited partners (the Alagna Group) to recover the judgment. Special Term denied Whitley’s motion for summary judgment and dismissed the complaint, but the Appellate Division reversed and granted summary judgment to Whitley. The Alagna Group appealed to the New York Court of Appeals.

Issue(s)

1. Whether the sale of limited partnership interests in exchange for stock constitutes a return of capital under Partnership Law § 106(4)?

2. Whether a judgment against the partnership binds the limited partners, precluding them from relitigating the underlying claim?

Holding

1. Yes, because the effect of the transaction, rather than its form, determines whether a return of capital occurred, and the transaction resulted in the limited partners receiving the value of partnership assets to the exclusion of a creditor.

2. Yes, because the limited partners are liable to the partnership for sums necessary to discharge its liabilities, and the creditor, as subrogee, sues in the right of the partnership, which has already litigated its liability.

Court’s Reasoning

The court emphasized that the purpose of Partnership Law § 106(4) is to protect creditors. Even when a limited partner has rightfully received a return of capital, they remain liable to creditors whose claims arose before the return. The court stated, “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.” The court looked beyond the transaction’s form (a sale of interests) to its effect (a distribution of partnership value to the limited partners, leaving a creditor unpaid).

The court relied on Kittredge v. Langley, stating that “a limited partner’s ‘contribution, like the capital of a corporation and to a similar extent, 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.’” The court also cited Neal v. United States, which held that a transaction designed to allow special partners to withdraw capital without satisfying creditors would be disregarded, with the court looking to substance over form.

Regarding the binding effect of the judgment, the court reasoned that the creditor sues in the right of the partnership to recover funds necessary to discharge its liability. Since the partnership’s liability had already been established by judgment, the limited partners could not relitigate the claim. They can only contest whether they were limited partners, whether they received a return of capital, whether the creditor’s claim arose before the return, and whether the amount sought was necessary to discharge the partnership liability.

The court rejected arguments that limited partners should be treated like corporate shareholders, noting the differences between Partnership Law § 106 and the Business Corporation Law. It also distinguished prior cases, emphasizing that the statute in question includes remaining liable to existing creditors when capital is withdrawn, even though rightfully withdrawn.