Opinion ID: 718701
Heading Depth: 2
Heading Rank: 2

Heading: Mr. Sender's Claims

Text: 19 Mr. Sender contends the defendants received payments, as limited partners of HSA L.P., 6 in violation of CULPA. CULPA applies to all limited partnerships formed on or after November 1, 1981, Colo.Rev.Stat. § 7-62-1101, and therefore applies to HSA L.P., which was formed in December 1984. Mr. Sender's claims against Mr. Simon and the Baker Partnership rely specifically on Colo.Rev.Stat. § 7-62-608(2), which provides: 20 If a partner has received the return of any part of his contribution in violation of the partnership agreement or this article, he is liable to the limited partnership for a period of six years thereafter for the amount of the contribution wrongfully returned. 21 Mr. Sender contends the defendants received wrongfully returned contributions under § 608(2) in both senses contemplated by the section. First, he claims Mr. Simon and the Baker Partnership received payments in violation of the partnership agreement. 7 Second, Mr. Sender claims the defendants received payments in violation of § 607 of CULPA. See Colo.Rev.Stat. § 7-62-607. 8 22 Mr. Simon and the Baker Partnership offer several alternative reasons why they should not be held liable on Mr. Sender's claims. First, Mr. Simon and the Baker Partnership invoke the defense of fraud and argue the Partnership Agreement was void ab initio and unenforceable. Second, the defendants contend they were never limited partners in HSA L.P. and are therefore not subject to claims under CULPA. Third, they claim that even if they are subject to claims brought under CULPA, they nevertheless, as a matter of law, cannot be found liable under § 608(2) of that act. Fourth, Mr. Simon and the Baker Partnership assert that if they are liable on the claims brought by Mr. Sender they are nevertheless entitled to recoupment or setoff. 23 The district court granted the defendants' motion for summary judgment on the basis of their fraud defense. According to the district court, the limited partnership Mr. Simon and the Baker Partnership purportedly joined was merely a fraudulent arrangement used to carry on a Ponzi scheme. The putative partnership never represented a legitimate contract between consenting parties and therefore a valid partnership never existed to give rise to the provisions of CULPA. 24 For slightly different reasons than those relied on by the district court, we reach the same result. Before embarking upon our analysis, it is important to emphasize two points on which we have already touched. First, Mr. Sender relies exclusively on provisions in CULPA; he has pursued no other legal or equitable claims that might be available under Colorado law. Accordingly, the success of his claims depends on a threshold demonstration that Mr. Simon and the Baker Partnership entered into valid and enforceable partnership agreements that give rise to CULPA's provisions. Second, in his capacity as a bankruptcy trustee bringing causes of action pursuant to 11 U.S.C. § 541, Mr. Sender stands in the shoes of the bankrupt partnership and has no greater rights than the partnership had as of the bankruptcy filing. 11 U.S.C. § 541(a)(1) (limiting estate to the debtor's interests in property as of the commencement of the case); Hays & Co., 885 F.2d at 1154 n. 7. With these principles in mind, we turn to Mr. Sender's claims against the defendants. 25 As other courts have recognized in the context of Ponzi schemes, courts generally will not enforce an illegal contract based upon  'the elementary principle that one who has himself participated in a violation of law cannot be permitted to assert in a court of justice any right founded upon or growing out of the illegal transaction.'  Merrill v. Abbott, 77 B.R. at 857 (quoting Gibbs & Sterrett Mfg. Co. v. Brucker, 111 U.S. 597, 601, 4 S.Ct. 572, 574, 28 L.Ed. 534 (1884)); Martino v. Edison Worldwide Capital (In re Randy), 189 B.R. 425, 441 (Bankr.N.D.Ill.1995) (same quote). This rule is not reserved for contracts that are illegal on the basis of their subject matter, e.g., a contract to manufacture illicit narcotics. 26 A bargain may be illegal by reason of the wrongful purpose of one or both of the parties making it. This is true even though the performances bargained for are not in themselves illegal and even though in the absence of the illegal purpose the bargain would be valid and enforceable. A party who makes such a bargain in furtherance of his wrongful purpose can not enforce it.... 27 Tri-Q, Inc. v. Sta-Hi Corp., 63 Cal.2d 199, 45 Cal.Rptr. 878, 890, 404 P.2d 486, 498 (1965) (quoting 6A Corbin on Contracts § 1518, at 744 (1962)). 28 As Mr. Sender has conceded, Mr. Donahue operated an illegal Ponzi scheme and was sentenced to federal prison upon being convicted of securities fraud. Though it is not clear whether Mr. Donahue intended to run a Ponzi scheme from the moment he began Hedged Investments in the late 1970s, Mr. Sender concedes the operation never made the returns it reported and would have collapsed absent new funds being invested. Neither does Mr. Sender dispute that Mr. Donahue created the Debtor Partnerships as vehicles for persons to invest with him. According to the conclusions of Mr. Sender's accounting expert, [t]he purported annual returns set forth in ... the partnership tax returns as filed were completely fictitious. Notwithstanding the representations made to investors, the Debtor Partnerships were insolvent as of 1982. 29 Though the Debtor Partnerships were not illegal per se, it is beyond peradventure they were created and operated in furtherance of a fraudulent and illegal investment scheme. To the extent HSA L.P. was created as a vehicle to further the Ponzi scheme and utilized to give the scheme a veneer of legitimacy, it was in utter complicity with Mr. Donahue's fraud. HSA L.P., acting through Mr. Donahue and HIA Inc., fraudulently induced the participation of Mr. Simon and the Baker Partnership in the scheme by misrepresenting both the true nature of the Hedged Investments fund and the partnership's role in perpetuation of the fraud. In other words, with regard to its interactions with Mr. Simon and the Baker Partnership, HSA L.P.'s purpose was an illegal one. It furthered this illegal purpose by fraudulently inducing Mr. Simon and the Baker Partnership to execute the partnership agreements. 30 Mr. Sender, standing in the shoes of HSA L.P., now seeks to enforce the partnership agreements against Mr. Simon and the Baker Partnership. Following the suggestions of our fellow jurists, this court will not aid in the enforcement of an agreement that was fraudulently procured in furtherance of an illegal purpose. See Merrill, 77 B.R. at 857; Tri-Q, 45 Cal.Rptr. at 890, 404 P.2d at 498. That Mr. Sender acts as a trustee in bankruptcy cannot lend strength to the partnership's position. The question is whether the partnership could have succeeded on its claims before it entered bankruptcy, and the answer to that question is clearly no. 31 Mr. Sender contends HSA L.P. was not an illegal partnership, and in support of this contention points us to the language of the partnership agreement. Mr. Sender correctly observes: There is nothing in the stated purposes of the Partnership Agreement which violates any statute or the common law, there was no failure to obtain a required license and further there is nothing on the face of the Partnership Agreement reflecting that the partnership is to be operated as a fraud. Mr. Sender insists that since an options trading business is not an unlawful enterprise, HSA L.P., which was created for the putative purpose of running such a business, cannot be an illegal partnership. Mr. Sender's argument ignores the reality of HSA L.P.'s existence. Obviously, the language of the agreement did not indicate the partnership actually operated as a vehicle for fraud. That is the point; the partnership and its agreement helped endow the scheme with a facade of legitimacy. As we have already established, a bargain may be illegal by reason of the wrongful purpose of one or both of the parties making it. This axiom is true even though the performances bargained for are not in themselves illegal and even though in the absence of the illegal purpose the bargain would be valid and enforceable. Such is the case with HSA L.P. 32 Mr. Sender also tries to immunize HSA L.P. from illegality by contending Mr. Donahue's illegal acts and purposes cannot be attributed to the partnership. He argues a limited partnership may not be held responsible or liable for the wrongful conduct of a general partner unless the conduct is within the ordinary course of the partnership's business or is done with the authority of the other partners. In support of this contention, Mr. Sender cites Colo.Rev.Stat. § 7-60-113, which provides: 33 Partner's wrongful acts--liability. 34 Where, by any wrongful act or omission of any partner acting in the ordinary course of the business of the partnership or with the authority of his partners, loss or injury is caused to any person, not being a partner in the partnership, or any penalty is incurred, the partnership is liable therefor to the same extent as the partner so acting or omitting to act. 35 As the language of this statute makes clear, the rule on which Mr. Sender relies applies only when loss or injury is caused to any person, not being a partner in the partnership. (Emphasis added.) Also, the cases he cites in support of his position each involve injury to third parties, not other partners. See, e.g., Courts of the Phoenix v. Charter Oak Fire Ins. Co., 560 F.Supp. 858 (N.D.Ill.1983); Wales v. Roll, 769 P.2d 899 (Wyo.1989); see also Williams v. Burns, 463 F.Supp. 1278 (D.Colo.1979). They do not involve the situation where a limited partnership, acting through its managing general partner, has fraudulently induced an innocent investor to participate in a Ponzi scheme. In our case, HSA L.P. held itself out to Mr. Simon and the Baker Partnership as a legitimate component of a legitimate investment opportunity. Once Mr. Simon and the Baker Partnership joined HSA L.P. as limited partners, the partnership encouraged them to remain partners by reporting fictitious earnings. When, by prudence or luck, they sought to leave the partnership, HSA L.P. continued the fiction by paying them unrealized profits. To say the fraudulent intent originated in Mr. Donahue merely recognizes that HSA L.P. acted exclusively through Mr. Donahue as sole shareholder of HIA Inc., HSA L.P.'s managing general partner. Focusing on Mr. Donahue as the source of wrongdoing does nothing to change the fact that fraud and illegality permeated every aspect of HSA L.P.'s relationship with Mr. Simon and the Baker Partnership. Mr. Sender now asks us to brush aside the pervasive illegality of HSA L.P.'s relationship with Mr. Simon and the Baker Partnership and focus on the facially valid partnership agreements. We refuse. 36 In conclusion, this court will not aid the effort of a fraudulent entity that used the trappings of legal formality to lure its victims to turn around and try to hold its victims accountable under those same legal formalities. Though our reasoning parallels that of the district court in certain respects, we would like to emphasize that, unlike the district court, we are not declaring the partnership agreements void ab initio. As one court explained: 37 While it is frequently asserted that an illegal bargain is void, meaning thereby, presumably, that the situation is just as if no contract had been made, this is not strictly so. What the courts really have done, in such cases, in the absence of a statute specifying otherwise, is to take the view merely that the judicial machinery is not available for use to one who has participated in an illegal transaction. 38 Kermath Mfg. Co. v. Brownell, 222 F.2d 577, 580 (6th Cir.) (quoting Grismore's Law of Contracts § 290), cert. denied, 350 U.S. 843, 76 S.Ct. 84, 100 L.Ed. 752 (1955); see also Smithy Braedon Co. v. Hadid, 825 F.2d 787, 790 n. 4 (4th Cir.1987) (noting with approval Williston's and Corbin's efforts to inter the proposition that illegal contracts are 'void' ab initio). 39 We would also like to make clear that nothing we say in this opinion should be seen as affecting the rights of trustees like Mr. Sender who bring actions under other theories of state law. We understand Mr. Sender is only trying to maximize the value of the debtor entities in the interest of mitigating other investors' losses. Though his goals and zeal are laudable, we cannot endorse his means. 40 The district court's grant of summary judgment in favor of Mr. Simon and the Baker Partnership is AFFIRMED.