Opinion ID: 1938746
Heading Depth: 2
Heading Rank: 1

Heading: Effect of Status as Debtor-in-Possession on Partnership Duties

Text: WMC acknowledges the bedrock principle that partners owe each other the duty of the utmost good faith in all that pertains to their relationship. Riss & Co. v. Feldman, 79 A.2d 566, 571 (D.C.1951). Contending, however, that the fundamental issue on this appeal concerns the rights and fiduciary obligations of a corporate general partner in a dissolved limited partnership upon its adjudication as a bankrupt under Chapter XI of the Federal Bankruptcy Act, WMC maintains that Judge Kessler erred in failing to recognize that its fiduciary duties to the partnership were extinguished by the filing of the bankruptcy petition and the new legal status of debtor-in-possession conferred on it by the bankruptcy judge. Because, WMC reasons, the bankruptcy dissolved the partnership and its new status made it solely a fiduciary of its estate owing fiduciary obligations to its creditors, under the supervision of the Bankruptcy Court, it could not be held liable under state law for alleged post-petition breaches of its `partnership fiduciary duties.' Its actions, therefore, in repaying AHS without providing a plan of protection for the other partners' interests, withholding Holle's distributive share, and not paying him interest on his share, while redressable in bankruptcy court, could not be the subject of a suit in Superior Court. Imaginative and studded with citations to federal bankruptcy law though this argument is, we conclude there is no authority for the counter-intuitive notion that Congress intended a partner-debtor's resort to bankruptcy protection to nullify its fiduciary duties to other partners during the remaining life of the partnership, including the winding up and termination. [10] Moreover, we note at the outset the artificial nature of appellants' argument as applied to this case. Much of the conduct that Judge Kessler found to be a breach of fiduciary duties occurred before WMC filed its bankruptcy petition. Moreover, WMC's conduct which formed the primary basis for the critical punitive damages award  withholding Holle's share and suing him in Superior Court  occurred after WMC had emerged from the chapter 11 proceedings. It is thus difficult to perceive the relevance of WMC's new entity theory to the bulk of the judgment in Holle's favor. We nevertheless proceed to address the argument on the merits. The term debtor-in-possession refers to a debtor in a chapter 11 case who is permitted to remain in possession of the bankruptcy estate and performs the functions and duties of a trustee in bankruptcy. 2 L. KING, COLLIER BANKRUPTCY MANUAL ¶ 1101.02 (1989). The legislative history of the Bankruptcy Reform Act of 1978 [11] explains: This section places a debtor in possession in the shoes of a trustee in every way. The debtor is given the rights and powers of a chapter 11 trustee. He is required to perform the functions and duties of a chapter 11 trustee (except the investigative duties). He is also subject to any limitations on a chapter 11 trustee, and to such other limitations as the court prescribes. S.REP. No. 989, 95th Cong., 2d Sess. 116, reprinted in 1978 U.S.CODE CONG. & ADMIN. NEWS 5787, 5902. Although assumption of the duties of a trustee for the benefit of creditors during reorganization affords the debtor-in-possession certain relief, such as discharge of all debts after confirmation of a reorganization plan, 11 U.S.C. § 1141(d)(1)(A) (1988), and the right to reject executory contracts and unexpired leases, 11 U.S.C. § 365, no new entity is formed by filing for reorganization under Chapter 11. Indeed, the distinguishing features of reorganization in bankruptcy, as opposed to liquidation, are that the debtor entity is permitted to continue business during the pendency of the proceeding, under the supervision of the court, and that it survives the proceeding without the necessity of liquidation and consequent termination of the enterprise. [12] Recognizing the fundamental purpose of reorganization, the United States Supreme Court recently rejected the contention that an employer's status as a debtor-in-possession made it a new entity, not party to a pre-petition collective bargaining agreement, and thus not subject to restrictions imposed by § 8(d) of the National Labor Relations Act (NLRA), 29 U.S.C. § 158(d) (1982), for mid-term modifications of collective bargaining agreements. N.L.R.B. v. Bildisco & Bildisco, 465 U.S. 513, 104 S.Ct. 1188, 79 L.Ed.2d 482 (1984) Justice Rehnquist, writing for the Court, concluded that the unilateral rejection of the contract by the debtor-in-possession prior to the bankruptcy court's approval did not constitute an unfair labor practice, deriving this conclusion from the strength of the policies reflected in the bankruptcy statute authorizing a debtor-in-possession to reject executory contracts. [13] Pertinent to our discussion, however, the Court expressly rejected the new entity rationale which the court of appeals had adopted: [14] Obviously, if the [debtor-in-possession] were a wholly new entity, it would be unnecessary for the Bankruptcy Code to allow it to reject executory contracts, since it would not be bound by such contracts in the first place. For our purposes, it is sensible to view the debtor-in-possession as the same entity which existed before the filing of the bankruptcy petition, but empowered by virtue of the Bankruptcy Code to deal with its contracts and property in a manner it could not have employed absent the bankruptcy filing. Id. at 528, 104 S.Ct. at 1197. While taking issue with the majority's balance of conflicting statutory policies, the dissenting Justices agreed that the new entity theory relied upon by the Third Circuit was untenable and properly rejected by the Court. Id. at 544, 104 S.Ct. at 1206 (Brennan, J., with whom White, Marshall and Blackmun, J.J., join, concurring in part and dissenting in part). [15] In light of Bildisco's rejection of the new entity theory, it is apparent that WMC's appointment as debtor-in-possession did not fundamentally change its status so as to terminate its duties as managing general partner of MHEC. WMC continued to exist and operate as a corporate entity during the pendency of the chapter 11 proceeding, and its operations included management of MHEC. Under the partnership agreement, the MHEC partnership dissolved upon WMC's filing of the petition in bankruptcy. Dissolution, however, is distinct from termination, and the partnership continued to exist until its business was wound up and a final accounting conducted. D.C.Code § 41-129 (1986); see Warren v. Chapman, 535 A.2d 856, 859 (D.C.1987). WMC's fiduciary duties as a partner continued throughout these latter two phases. See, e.g., D.C.Code § 41-120(a) (partner accountable as fiduciary for any benefit derived in any transaction connected with formation, conduct or liquidation of partnership); 2 A. BROMBERG & L. RIBSTEIN, BROMBERG AND RIBSTEIN ON PARTNERSHIP, § 7.08, at 7:87 (1988). [16] WMC erroneously suggests that its duties to the partnership somehow conflicted with its duties as trustee for the benefit of its creditors, and that the interests of the partners must therefore yield to those of the creditors. To the contrary, as will be seen, WMC's duties as bankruptcy trustee not only permitted but required it to protect the interests of the MHEC partners. A debtor-in-possession, in discharging its duties as a trustee, acts in a fiduciary capacity for the benefit of those with claims against the bankruptcy estate. Commodity Futures Trading Comm'n v. Weintraub, 471 U.S. 343, 355, 105 S.Ct. 1986, 1994, 85 L.Ed.2d 372 (1985); Wolf v. Weinstein, 372 U.S. 633, 649-51, 83 S.Ct. 969, 979-80, 10 L.Ed.2d 33 (1963); In re Woodson, 839 F.2d 610, 614 (9th Cir.1988); In re Technical Knockout Graphics, 833 F.2d 797, 802-03 (9th Cir.1987). The scope of these duties, however, is defined by the property interests comprising the estate. In re Technical Knockout, supra, 833 F.2d at 802. The bankruptcy estate consists of all legal or equitable interests of the debtor in property as of the commencement of the case. 11 U.S.C. § 541(a)(1). Here, the post-petition breaches of WMC's fiduciary duty to the partnership which Judge Kessler found arose from the manner in which WMC had handled the New Hampshire Avenue property. Judge Penn, in ruling on Holle's appeal from the denial of his motion to set aside WMC's Plan of Arrangement, concluded that the interests of the MHEC partners in the New Hampshire Avenue property were not part of the bankruptcy estate. He noted that WMC possessed only bare record title in the New Hampshire Avenue property, of which MHEC was the beneficial owner. He found that because WMC held the property in trust for the partnership, it had a duty to propose a means of adequately protecting the partners' interests in bankruptcy, see 11 U.S.C. §§ 361, 363(c), which it had failed to discharge. WMC argues that its failure to recognize the MHEC partners' interests in the sale of the property constituted only a breach of its duty under federal bankruptcy law to provide adequate protection, redressable in bankruptcy court, but not a breach of duty under District of Columbia partnership law. We disagree. Judge Penn's recognition of WMC's continuing trust duties to the partnership reflected the principle, now codified in 11 U.S.C. § 541(d), that only the debtor's interest in ... property becomes part of the estate. If the debtor holds bare legal title or holds property in trust for another, only those rights which the debtor would have otherwise had emanating from such interest pass to the estate.       To the extent such an interest is limited in the hands of the debtor, it is equally limited in the hands of the estate ... 124 CONG. REC. H11096, 11114 (Sept. 28, 1978). See also In re Auto-Train Corp., 258 U.S.App.D.C. 151, 154, 810 F.2d 270, 273 (1987). As this rule implies, a bankrupt fiduciary's status as debtor-in-possession does not necessarily extinguish its previous duty to handle property in its control in a manner consistent with fiduciary obligations. In circumstances where the debtor holds property in trust for another, as in this case, the trustee (or debtor-in-possession) must discharge the debtor's trust duty to turn over the property to the beneficial owner. See, e.g., 124 CONG. REC. S17413 (Oct. 6, 1978) (trustee of bankrupt mortgage seller with bare legal title to mortgages for servicing purposes must deliver mortgages to purchaser); In re B.I. Fin. Servs., 854 F.2d 351, 354 (9th Cir.1988) (courts generally hold that the debtor should turn the property over to the beneficial owner). Further indicating that Congress did not intend resort to bankruptcy protection to extinguish preexisting fiduciary duties, the Code provides that a discharge in bankruptcy does not absolve a debtor from any debt for fraud or defalcation while acting in a fiduciary capacity.... 11 U.S.C. § 523(a)(4). Any duty WMC had toward its creditors as debtor-in-possession related solely to its own property held in the bankruptcy estate. This property included its own partnership interest, but did not extend to the interests of the other MHEC partners in the New Hampshire Avenue property. See H. REP. No. 595, supra, at 199, 1978 U.S. CODE CONG. & ADMIN.NEWS at 6159 (When a partner is a debtor in a case under title 11, the partner's interest in the partnership ... is property of the partner's estate). The extent and nature of the debtor's interest in specific property is a question determined by reference to state law, not federal bankruptcy law. In re B.I. Fin. Servs., supra, 854 F.2d at 354; In re Auto-Train, supra, 258 U.S.App.D.C. at 154, 810 F.2d at 273. Because the realty at New Hampshire Avenue was partnership property, under the District of Columbia Partnership Act, WMC held the proceeds of its sale in trust for the benefit of MHEC. D.C.Code § 41-120(a). Consequently, WMC's use of the proceeds of the sale to satisfy its own creditors without adequately protecting the interests of the MHEC partners, in addition to constituting a breach of the statutory duty of adequate protection (as Judge Penn found), was conduct Judge Kessler could properly find to be self-dealing and a breach of the duty of loyalty imposed by District of Columbia partnership law. We conclude, therefore, that WMC's status as debtor-in-possession did not relieve it of the duty of good faith which it owed MHEC and Holle until winding up and termination of the partnership. [17]