Limited Partners Held Personally Liable for Debts of Limited Partnership Where Limited Partnership Was Insolvent

In a case that demonstrates the danger of relying on complex corporate structures to avoid personal liability, a California Court of Appeal recently held two limited partners personally liable for the debts of their limited partnership to a third party.  Having found the limited partners to be alter egos of the limited partnership, the court concluded that the limited partnership's insolvency provided an inequitable result as a matter of law and did not require proof of a wrongful intent.  (Relentless Air Racing, LLC v. Airborne Turbine Ltd. Partnership ( 2013) 222 Cal.App.4th 811).

Relentless Air Racing, LLC ("Relentless") sued Airborne Turbine Ltd. Partnership ("Airborne") in a contract dispute involving the sale of an airplane.  Relentless prevailed and the trial court awarded it $174,374.95 in attorney fees and $6,640.91 in costs.  However, Relentless was unable to collect its judgment from Airborne because Airborne was insolvent.  In post-judgment debtor examinations of Wayne and Linda Fulton ("the Fultons"), Airborne Turbine, Inc. ("ATI"), and Paradise Aero, Inc. ("Paradise"), Relentless discovered that (1) the Fultons were Airborne's sole limited partners; (2) the Fultons were the sole officers and directors of ATI and Paradise; (3) ATI was Airborne's general partner until 2011, when Paradise became Airborne's general partner; (4) the Fultons changed general partners to keep ATI completely separate at the trial; (5) the entities operated from an office in the Fultons' house using equipment owned by the Fultons; (6) the Fultons made agreements among the entities, such as Airborne's agreement to pay ATI's utility bills in lieu of rent for the use of ATI's hanger; (7) the Fultons had Airborne partnership meetings, as many as five or six times a day, but only had written minutes of one meeting a year; (8) the Fultons took draws from Airborne in the amount to pay the Fultons' personal bills without holding a meeting to make a decision about a draw; (9) the last time Airborne had a significant amount of money was in January 2011, prior to the underlying trial; (10) in 2011 the Fultons withdrew $115,000 from Airborne; and (11) the Fultons are sole shareholders in the corporations and are the sole limited partners who controlled the underlying litigation. 

Having made these findings, the trial court found that the Fultons and their business entities were not separate entities.  However, the trial court found that there was not sufficient evidence to show that an unjust or inequitable result would occur if Airborne was treated as an entity separate from the Fultons and their other entities.  As a result, the trial court denied Relentless' motion to add the Fultons, ATI and Paradise as additional judgment debtors in Relentless' judgment against Airborne.

In reversing the trial court's decision, the Court of Appeal noted that a trial court is authorized to amend a judgment to add judgment debtors where a person or entity is the alter ego of the original judgment debtor.  To do so, a judgment creditor must show that (1) the parties to be added as judgment debtors had control of the underlying litigation and were virtually represented in that proceeding; (2) there is such a unity of interest and ownership that the separate personalities of the entity and the owners no longer exist; and (3) an inequitable result will follow if the acts are treated as those of the entity alone.  Both the trial court and appellate court found the two factors supported adding the judgment debtors in this case, but the trial court found the third factor did not support Relentless because Relentless did not prove that the Fulton's acted with a wrongful intent.

The appellate court explained that the law does not require proof of a wrongful intent.  Rather, Relentless was merely required to prove that the Fultons' acts caused an "inequitable result."  Thus, given the trial court's finding that the Fultons, Airborne, ATI, and Paradise were one and the same, it would be inequitable as a matter of law to preclude Relentless from collecting its judgment by treating Airborne as a separate entity.    

In seeking to avoid this result, the Fultons argued that Relentless should not be able to add judgment debtors after their original lawsuit where Relentless was aware of the alter ego relationship before the judgment was entered, and Relentless previously named and dismissed Wayne Fulton prior to trial.  In rejecting this argument, the appellate court found that there are good policy reasons not to force a plaintiff to litigate alter ego status in the underlying action.  Where a plaintiff reasonably believes an alter ego relationship exists, the complaint "should probably" include alter ego allegations.  However, "should probably" is not mandatory.  According to the court, "It makes no sense to deny Relentless a recovery because it did not engage in pretrial discovery and spend time litigating an alter ego allegation, when the entire matter might have been resolved simply by the Fulton parties paying the judgment."

What This Means To You

This case is a good reminder that corporate formalities must be followed to ensure that the benefits of these entities – limited liability – are actually enforced.  Here, the Fultons treated these entities as if they were their personal bank accounts, paying their personal debts and neglecting to hold regular, recorded partnership meetings.  By doing so, the Fultons exposed themselves to personal liability for the debts of their limited partnership, despite their limited partnership status. 

Topics:  Corporate Governance, Insolvency, Limited Partnerships, Personal Liability, Third-Party Risk

Published In: Bankruptcy Updates, Business Organization Updates, Civil Procedure Updates, General Business Updates

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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