A chapter 7 trustee sought to enjoin a bank from enforcing its security interest in rice and farming equipment that the trustee contended were assets of the bankruptcy estate. The bank, which had made loans to the chapter 7 debtors’ “joint venture,” claimed that the assets were owned by the joint venture not the individual debtors, and thus were not part of the bankruptcy estate. The bankruptcy court granted an injunction against the bank on the basis that the joint venture was not a separate entity. The district court affirmed and the bank appealed to the 8th Circuit.
The debtors (the Webbs) were spouses who jointly filed a chapter 7 bankruptcy. They listed ~225,000 barrels of rice and farm equipment in their bankruptcy schedules. Prior to bankruptcy, the Webbs had executed a joint venture agreement and operated their rice farming business under the name “Dudley R. Webb, Jr. Farms Joint Venture.”
The bank filed a request for relief from the automatic stay on the basis that it had a perfected security interest in these assets securing nine loans made to the joint venture. While the stay motion was pending, the chapter 7 trustee sought authorization to immediately sell the rice (to avoid infestation or spoliation) free and clear of liens, with liens transferring to proceeds. The bank responded with a letter to the trustee advising that it intended to proceed with liquidation of the assets because the rice was not property of the bankruptcy estate, but rather belonged to a separate entity – namely the joint venture. This led to the trustee’s request for an injunction.
The Bankruptcy Code defines the bankruptcy estate as “all of the debtor’s legal and equitable property interests that existed as of the time that the bankruptcy petition was filed.” Generally courts look to state law to determine property interests. Under applicable state law, assets of a partnership are not property of the individual partners. Thus if the joint venture was considered a partnership, the rice and equipment would not be part of the bankruptcy estate.
However, while a “joint venture” can be a partnership, that is not necessarily the case. The court identified potential differences between joint ventures and general partnerships as including “the ad hoc nature of joint ventures, or their concern with a single transaction or isolated enterprise, plus the fact that loss-sharing is not as essential to joint ventures as it may be for partnerships.”
Under state law, the issue of whether a partnership existed was primarily a question of intent of the parties. The bankruptcy court considered a number of facts in concluding that the joint venture was not a partnership:
- The joint venture agreement stated: “Nothing herein shall be construed to create a partnership of any kind.”
- The husband testified that he did not consider there to be any distinction between himself and the joint venture, and explained that it was created to establish his wife’s credit and to give her an equal interest in the farming operation.
- They did not file a partnership tax return, and instead showed farming income on their individual tax returns.
- There were no bills of sale transferring property from the Webbs to the joint venture at the time it was created.
- They listed the assets in question as individual assets on various loan applications.
- The joint venture was never registered as a separate entity with the Secretary of State.
The bank argued that the joint venture agreement was controlling and that it was error to consider the additional evidence. However, the court noted that even if paragraph 13 of the joint venture agreement was not dispositive (i.e., the joint venture was not a partnership), then other provisions (i.e., the parties “agreed to create an entity for purposes of a joint venture”) would have created an ambiguity justifying examination of evidence outside the four corners of the agreement.
The bank also argued that the Webbs should be estopped from claiming that the joint venture was not a separate entity because they held themselves out as a partnership. However, this argument was not raised in the lower courts, and was not a purely legal issue (since estoppel required a showing of reliance by the bank). Consequently the 8th Circuit concluded the argument was waived.
The bank also argued that public policy required a reversal in that the court’s ruling “will continue to negatively impact [the bank] and other creditors both in this case and in all other dealings with persons purporting to be operating a joint venture.” The court was not persuaded.
Consequently, the 8th Circuit affirmed. Because the “joint venture” was not a separate entity, the assets were owned by the individuals, and thus part of their bankruptcy estate.
In the heat of doing a deal it may not be apparent that there is any difference between consciously structuring a transaction as a “joint venture” as opposed to a partnership. However, as this case illustrates, if the joint venture is not structured as a separate entity, the bankruptcy of one of the joint venture parties can be even more disruptive to the transaction than the bankruptcy of a partner in a partnership.
Vicki R. Harding, Esq.