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Debtors' Joint Venture Not Separate Legal Entity; Rice Grain Part of Bankruptcy Estate

Wednesday, February 19, 2014
By Diane Davis

Feb. 12 --A bankruptcy court did not err in holding that a debtor had not created a separate legal entity with its joint venture agreement and that the rice grain was part of the debtor's individual bankruptcy estate, the U.S. Court of Appeals for the Eighth Circuit held Feb. 6 (Bank of England v. Rice (In re Webb), 2014 BL 31787, 8th Cir., No. 13-1495, 2/6/14).

Affirming the judgment of the bankruptcy court, Judge Diana E. Murphy concluded that the debtors' joint venture agreement supports the bankruptcy court's determination that the debtors had not intended to create a separate entity.

If the court were to conclude that the language of the agreement were not dispositive, the court correctly considered evidence outside the four corners of the agreement. The court's reference to the lack of entity registration also served as further evidence of the debtors' intent, the court said.

The question of whether the debtors' entity was a partnership was a core proceeding necessary to determine if the rice was part of the bankruptcy estate, the court said, citing 28 U.S.C. § 157(b)(2)(A). If property is determined to be part of the bankruptcy estate, the bankruptcy court may authorize the trustee to sell it, the court said.

Joint Venture Agreement
Debtors Dudley R. and his wife Peggy J. Webb executed a joint venture agreement in January 2003 to operate a rice farming business under the name “Dudley R. Webb, Jr. Farms Joint Venture.” The agreement stated that each of them would have a 50 percent interest in the business and that “during the duration of this partnership” both parties “shall … exercise their utmost skill, effort, and endeavor for the furtherance of the interests, profits, benefits and advantage of this joint venture.” Paragraph 13 of the agreement provided that “[n]othing herein shall be construed to create a partnership of any kind.”

During the operation of the business, the debtors borrowed money from the Bank of England and from the U.S. Department of Agriculture Commodity Credit Corporation. Many of these loan agreements were executed in the name of the joint venture.

Chapter 7 Filing
The debtors filed for Chapter 7 protection in February 2012. On their schedules they listed an ownership interest in an estimated 105,000 bushels of rice located in grain bins, an estimated 117,000 bushels of rice located at the Federal Dryer and Storage Company, and certain vehicles, rolling stock, and farm equipment.

The Bank of England filed a motion for relief from the automatic stay imposed under Bankruptcy Code Section 362, arguing that it had a perfected security interest in the rice equipment arising out of nine unpaid loans made by the bank to the joint venture.

Trustee Seeks to Sell Rice Grain
Trustee M. Randy Rice filed a complaint seeking an order authorizing him to sell all of the debtors' remaining rice grain free and clear of liens, claims, and encumbrances. According to the trustee, they needed to sell the grain to avoid infestation or spoliation, and he requested that all liens, claims, and encumbrances attach to the proceeds from the sale for the determination of the parties' rights at a later time.

The next day, the trustee received a letter from the bank indicating that it intended to liquidate the rice and equipment immediately because the rice bushels are not property of the debtors' bankruptcy estate but belong to a separate entity, Dudley R. Webb Jr. Farms Joint Venture.

In response to the letter, the trustee filed a motion for a temporary restraining order, preliminary injunction, and emergency hearing. The bankruptcy court issued a temporary restraining order and set the case for an emergency hearing.

Emergency Hearing
At the hearing, the bankruptcy court heard testimony from Dudley Webb, bank representative Joey Adams, and the trustee, and reviewed more than 70 exhibits. Dudley Webb testified that he did not differentiate joint venture property from his individual property, but treated assets “all one in the same.” The debtors created the joint venture to ensure that his wife had an interest in the farming operations and to help her establish credit.

According to documents submitted at the hearing, the debtors reported their income from the farming operations on Schedule F of their Form 1040 individual tax returns rather than on a Form 1065 partnership return. Webb also testified that he never prepared any bills of sale to transfer property to the joint venture at the time it was created. Neither party produced evidence that the joint venture was registered as a separate entity with the Arkansas Secretary of State's office.

Not a General Partnership
The bankruptcy court determined that the joint venture created by the debtors was not a general partnership or other separate legal entity. Thus, the rice grain and equipment listed in the name of the debtors' joint venture was owned by the debtors individually and should not be included in the bankruptcy estate, the court said.

The bankruptcy court then entered a permanent injunction enjoining the Bank of England from taking control of the assets and ordered that the trustee sell the contested rice grain and hold the proceeds from the sale in an estate account pending the determination of the various parties' rights.

Appeals
The Bank of England appealed to the district court, which affirmed that the record indicated that the debtors had not intended to form a partnership. The district court also concluded that the bankruptcy court had jurisdiction to determine whether the rice grain was part of the debtors' bankruptcy estate.

The Bank of England appealed to the Eighth Circuit, arguing that the debtors' joint venture was a partnership under Arkansas law and that the rice grain and equipment should be excluded from the couple's bankruptcy estate.

Debtors' Bankruptcy Estate
The bankruptcy estate is comprised of “all of the debtor's legal and equitable property interests that existed as of the time that the bankruptcy petition is filed,” the court said, citing Section 541(a)(1). Bankruptcy courts look to state law to determine the nature and extent of a debtor's interest in particular property because “[p]roperty interests are created and defined by state law,” the court said. Under Arkansas law, partnership assets are not the property of an individual partner's bankruptcy estate under Section 541, the court said, citing In re Burnett, 241 B.R. 438 (Bankr. E.D. Ark. 1999).

While a joint venture can be a partnership if it fits the definition of such an entity, an association is not classified as a partnership simply because it is called a “joint venture,” the court said, citing Uniform Law Comment 2 to Ark. Code Ann. § 4-46-202. According to the court, joint ventures differ from general partnerships in the “ad hoc nature of joint ventures” or their concern with a single transaction or isolated enterprise, plus the loss-sharing is not as essential to joint ventures as it may be for partnerships. Under Arkansas law, the question of whether a partnership exists depends primarily on the intent of the parties to form and operate a partnership, which is a question of fact, the court said.

No Intention to Create Separate Entity
Looking at the language of the joint venture agreement, the appeals court found that paragraph 13 of the joint venture agreement supports the bankruptcy court's determination that the debtors had not intended to create a separate entity. If the contract is ambiguous, the court said, the trial court may consider evidence outside the four corners of the agreement. After considering the testimony of Dudley Webb that he treated his property “all one in the same” and never transferred property to the joint venture or executed a bill of sale, and the debtors claimed the property on their individual tax forms, the bankruptcy court did not err in its determination that the debtors did not intend to create a separate entity, the court said.

The appeals court rejected the Bank's argument that public policy compelled reversal because while the condition that influenced the bankruptcy court's decision is no longer a concern, the court's ruling will negatively impact the bank and other creditors in this case and in all other dealings with persons purporting to be operating a joint venture. According to the court, only those issues in the adversary proceeding are before the court and the trustee sought an injunction directly in response to the Bank's attempt to exercise authority over the disputed rice grain without awaiting a ruling from the bankruptcy court. Further, the trustee requested a hearing on both his complaint and the Bank's motion for relief from stay, the court said. Thus, public policy does not compel a reversal, the court said.

Evidence of Debtors' Intent
Finally, the court rejected the Bank's argument that the bankruptcy court erred by applying a “separate entity” test as part of its decision because Arkansas law does not mandate the registration of a general partnership in order for it to be legally formed and valid. According to the court, the bankruptcy court did not consider the lack of entity registration to be determinative of whether the debtors formed a partnership. The bankruptcy court's reference to the lack of entity registration merely served as further evidence of the debtors' intent, the court said.

Judges James B. Loken and Lavenski R. Smith joined the opinion.

To contact the reporter on this story: Diane Davis in Washington at ddavis@bna.com

To contact the editor responsible for this story: Jay Horowitz at jhorowitz@bna.com

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