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U.S. Small Business Administration v. Stratton

February 6, 2009

THE U.S. SMALL BUSINESS ADMINISTRATION, AS RECEIVER FOR ACORN TECHNOLOGY FUND, L.P., PLAINTIFF,
v.
SMITH STRATTON, WISE, HEHER & BRENNAN, LLP., ET AL., DEFENDANTS.



The opinion of the court was delivered by: Slomsky, J.

MEMORANDUM

I. Introduction

Before the Court is the Motion for Summary Judgment of Defendants Acorn Connecticut Investments, LP ("ACI"), Daniel P. Beharry, and Richard D. Propper, MD (collectively, "ACI Defendants"). ACI Defendants sought summary judgment dismissing Receiver's claims for unjust enrichment, negligence, breach of fiduciary duties and civil conspiracy, as well as four counts alleging aiding and abetting breach of fiduciary duties, gross negligence, wrongful conduct, and waste. For reasons that follow, the Court denies ACI Defendants' Motion for Summary Judgment.

II. General Background

In June 1998, the Acorn Technology Fund, L.P. ("Acorn") applied for a license from the Small Business Administration ("SBA") to operate as a Small Business Investment Company ("SBIC") pursuant to the Small Business Investment Act of 1958 ("the SBIC Act").*fn1 John Torkelsen, who is also a defendant in this case, founded Acorn and acted as Manager and President of Acorn's General Partner, Acorn Technology Partners, LLC ("ATP"). Defendant ACI was a Connecticut limited partnership formed by Daniel P. Beharry in January 1999 for the specific purpose of investing in Acorn, a New Jersey limited partnership and now-defunct capital venture fund.*fn2 Beharry was the general partner of ACI. Richard D. Propper, MD, was initially a limited partner of ACI, and then became a limited partner of Acorn.

Under the SBIC Act and SBA Regulations (the "Regulations"), the SBA provides federal funding to SBIC's to encourage them to invest in small business. An SBIC-licensed company is eligible to receive two dollars in federal matching funds (also called "Leverage") for every one dollar of private equity raised, subject to statutory maximums. In exchange, the SBA's investment is paid back first in the event of liquidation. Before a fund is eligible to receive an SBIC license and permission to leverage, it must typically have available ten million dollars ($10,000,000) to invest. 15 U.S.C. § 682(a)(1)(B); 13 C.F.R. § 107.210(a)(2). When Torkelsen met Propper in late 1998, he was considerably short of the ten million dollar floor. (Propper Dep., Receiver Ex. F at 37-38, 46).

The Acorn Fund, which received its license on June 25, 1999 to operate as an SBIC, was ultimately unsuccessful, which required the SBA to expend considerable sums to cover the loss. The essence of the Receiver's claims is that ACI Defendants were knowledgeable and active participants in a scheme to use Acorn to defraud the SBA out of $32 million and to divert money to themselves in a variety of ways.

The Receiver alleges that ACI Defendants, although nominally limited partners, actually participated in the management of Acorn and therefore became de facto general partners. As de facto general partners, they would owe fiduciary duties to Acorn, which they breached by engaging in conduct which caused Acorn to illegally apply for and obtain $32 million in federal funds from the SBA. Specifically, the Receiver alleges that they invested money in Acorn for purposes of meeting the threshold for SBA funding and increasing the amount of matching funds that could be obtained, with the understanding and agreement that the funding received from the SBA would be used to improperly finance companies in which they also had a financial stake. (See Rec. Compl. ¶¶ 61, 68-71, 73-76, 103, 108, 116-19).

In January 2003, the United States commenced suit against Acorn. U.S. v. Acorn Technology Fund, L.P., Civil Action No. 03-0070. On January 17, 2003, the Court (Giles, J.) placed Acorn in Receivership and appointed the SBA as Receiver for Acorn. This controversy arises in relation to the Receivership Order. On December 21, 2004, the SBA requested leave to lift the stay in the receivership in order to pursue claims against certain individuals for tortious conduct and for unjust enrichment. On January 14, 2005, the SBA commenced the present action.

III. The Summary Judgment Standard

Summary judgment is appropriate if "there is no genuine issue as to any material fact and . . . the moving party is entitled to judgment as a matter of law." Fed. R. Civ. P. 56(c). In examining Defendant's motion, we must view the facts in the light most favorable to the Plaintiff and draw all reasonable inferences in his favor. InterVest, Inc. v. Bloomberg, L.P., 340 F.3d 144, 159-60 (3d Cir. 2003).

The party moving for summary judgment bears the initial burden of demonstrating that there are no genuine issues of material fact. Fed. R. Civ. P. 56(c). Once the movant has done so, the opposing party cannot rest on the pleadings. To defeat summary judgment, the party must come forward with probative evidence establishing the prima facie elements of his claim. Celotex Corp. v. Catrett, 477 U.S. 317, 323-24 (1986). The non-movant must show more than the "mere existence of a scintilla of evidence" for elements on which he bears the burden of production. Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 252 (1986). An inference based upon speculation or conjecture does not create a material fact. Robertson v. Allied Signal, Inc., 914 F.2d 360, 382 n. 12 (3d Cir.1990).

IV. Discussion

The Receiver has asserted the following claims against the ACI Defendants: (1) negligence; (2) breach of fiduciary duties; (3) aiding and abetting breach of fiduciary duties; (4) civil conspiracy; (5) aiding and abetting gross negligence; (6) aiding and abetting wrongful conduct; (7) aiding and abetting waste; and (7) unjust enrichment. These claims will be discussed in turn.

A. Negligence and Breach of Fiduciary Duty

In order to succeed on its negligence and breach of fiduciary duty claims, the Receiver must show that (1) the ACI defendants owed duties to Acorn; and (2) the ACI Defendants breached those duties. McKelvey v. Pierce, 800 A.2d 840, 859-860 (N.J. 2002).

1. ACI Defendants Owed Duties to Acorn

ACI Defendants argue that limited partners do not owe fiduciary duties to a partnership, and that the Receiver cannot establish that ACI Defendants were de facto general partners of Acorn. The Court finds that there are material issues of disputed fact as to whether ACI Defendants became de facto general partners of Acorn.

N.J. Stat. Ann. 42:2A-27 outlines the liability of limited partners. Section (a) states that, subject to exceptions, "a limited partner is not liable for the obligations of the limited partnership unless he is also a general partner, or, in addition to the exercise of his rights and powers as a limited partner, he takes part in the control of the business." Therefore, the operative question is whether ACI Defendants became de facto general partners or took "part in the control of the business."

Subsection (b) of this statute describes certain "safe harbor" activities, which, if engaged in, do not subject limited partners to liability as a general partner. Subsection (b) provides in full as follows:

b. A limited partner does not participate in the control of the business within the meaning of subsection a. solely by doing one or more of the following:

(1) Being a contractor for or an agent or employee of the limited partnership or being a contractor, agent, employee, corporate officer, corporate ...


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