§ 15.2 — Is Partnership Debt Contingent?

Revised: April 28, 2016

[1]

Only “noncontingent” debts (that are also “liquidated”1) are counted toward the Chapter 13 eligibility limits in 11 U.S.C. § 109(e).2 Chapter 13 debtors sometimes come into bankruptcy either doing business in partnership with others or having a partnership lurking in their past that owes somebody money. Debtors don’t always know they have been a partner—partnerships are implied by state law in many common situations in which the debtor and others engaged in some joint venture or shared enterprise to make money. The debt generated by that venture may be out of sight, but it returns to haunt the debtor in a Chapter 13 case in several ways.

[2]

The first issue is, did the partnership or joint venture have debt that could be a liability of the debtor? If so, the debtor must schedule all the debts of that partnership as contingent claims in an individual general partner’s schedules. Under the partnership law of every state, a general partner is personally liable for the debts of the partnership, and a general partner who files a Chapter 13 case must list all of the partnership debt.

[3]

But the proper characterization of partnership debt for eligibility purposes as contingent or not in a general partner’s Chapter 13 case is not so simple, dependent on state partnership law and individual facts. While in most states a creditor with a claim against a partnership must first satisfy its claim from the assets of the partnership before proceeding against individual partners, some states omit this requirement.3 It has been held that the precondition of exhaustion of partnership assets is a “future event” within the contemplation of the parties that renders partnership debt contingent in a partner’s Chapter 13 case.4

[4]

Several courts, also claiming reliance on state law, have concluded that a general partner is individually liable on all partnership debt, subject only to reduction in amount to reflect liquidation of partnership assets, and thus all partnership debt must be counted toward the eligibility limits in a partner’s Chapter 13 case.5 Under this analysis, all partnership debts would be noncontingent and would be counted against an individual partner’s Chapter 13 debt limits notwithstanding that partnership assets were undeniably sufficient to pay all partnership debts in full.

[5]

This split in the case law with respect to characterization of partnership debt demonstrates the difficulties of application of the definitions of noncontingent that have been offered by the courts.6 Under partnership law, a general partner has liability for the debts of the partnership in the sense that if the partnership does not pay and if the assets of the partnership are insufficient to pay its debts, the general partner can be sued directly by a creditor of the partnership to collect an unpaid partnership debt.7 Liability of this sort is a term of art under the Bankruptcy Code. “Debt” means “liability on a claim.”8 “Claim” means “right to payment.”9 Because of liability under state law, every partnership creditor has a claim in an individual partner’s Chapter 13 case. To give meaning to all of the words in the statute, contingent has to mean something different than liability. Here, contingent asks the question whether the right of a partnership creditor to collect its debt from the debtor is conditioned on an event other than merely the passage of time or entry of a judgment.

[6]

The liability of an individual partner for the debts of a partnership should be contingent for Chapter 13 eligibility purposes without regard to the definition of contingent one uses. Typically, state law does require triggering events or conditions precedent to collection from a general partner: failure of the partnership to pay, insufficiency of assets of the partnership upon liquidation and, sometimes, demand on the partner(s). These conditions or events were foreseeable at the time the debt arose—when the partnership became obligated to the creditor, a general partner’s personal responsibility for partnership debts was conditioned as provided by contract or state law. If the petition is filed before the conditions precedent are satisfied, future events render the claims of partnership creditors contingent in an individual partner’s Chapter 13 case. The contrary decisions seem to be confusing the existence of a right to payment—the predicate to having a claim in bankruptcy—with the existence of unfulfilled conditions to the enjoyment of that right—the gravamen of the concept of contingent claims that are not counted for Chapter 13 eligibility purposes.

[7]

This confusion may lie at the heart of the Ninth Circuit’s holding in United States v. Galletti (In re Galletti).10 The debtor was a general partner in a partnership that was assessed for unpaid employment taxes. The IRS did not assess the partner individually within the three-year limitations period in 26 U.S.C. § 6501. The Ninth Circuit found that the IRS did not have a claim in the partner’s Chapter 13 case notwithstanding the liability of partners for partnership debt under California law:

[A]lthough under [California] law each individual partner is liable for the debts of the partnership, a claim against the partnership does not automatically give rise to a right to collect against the individual partners. Instead, a creditor may collect a debt for which the partner is jointly and severally liable only by first obtaining a judgment against the partner. The IRS has obtained no judgment against Debtors. The time for doing so has expired.11
[8]

A unanimous Supreme Court reversed the Ninth Circuit. The Supreme Court held that assessment of the taxes against the partnership extended the three-year limitation on collection to 10 years. The individual partner admitted liability for the partnership debt, and nothing more was necessary to establish a claim for bankruptcy purposes under the broad definition of claim in 11 U.S.C. § 101(5). Neither California partnership law nor the Bankruptcy Code requires a prepetition judgment against the debtor to prove the existence of a claim in the Chapter 13 case.

[9]

The Supreme Court’s decision in Galletti is consistent with earlier Ninth Circuit authority such as Geary v. United States (In re Geary),12 which held that assessment of taxes before a bankruptcy petition was neither a precondition to the existence of a claim nor necessary to render the prepetition tax claim noncontingent for § 109(e) purposes. Several reported decisions in other contexts have concluded that a defense to collection of a debt—and the failure to assess partnership taxes within the three-year limitation in 26 U.S.C. § 6501 certainly looks like a defense—does not render the debt contingent or unliquidated for eligibility purposes in a Chapter 13 case.13

[10]

The financial condition of the partnership and the extent of efforts by partnership creditors to collect from the partnership may be relevant to determine the contingent or noncontingent nature of partnership claims in a partner’s Chapter 13 case.14 For example, it may make a difference whether the partner files Chapter 13 before or after liquidation of the partnership assets. The creditor that challenges eligibility of an individual partner may have to prove the insolvency of the partnership as part of its argument that the partnership claims are not contingent because collection from the partnership is not possible. The party challenging eligibility has been assigned the burden to prove the existence of a partnership to attribute partnership debt to an individual debtor.15

[11]

And what if state law permits a general partner to contractually waive some or all of the conditions or triggering events that unleash liability of a general partner for the debts of the partnership? One reported decision cites such a waiver in support of the holding that partnership debt was not contingent at the petition in a partner’s individual Chapter 13 case.16

[12]

That the partnership is a limited partnership and the debtor is a limited partner significantly affects characterization of partnership debt. Typically, the ability of creditors of a limited partnership to reach the income or assets of a limited partner is narrow or nonexistent under state law. Partnership debts are either not claims at all against a limited partner or, at most, are contingent claims in a limited partner’s Chapter 13 case. The precise terms of the partnership agreement could make a difference in the proper characterization.

[13]

The filing of Chapter 13 by a general partner may be an event of dissolution of the partnership under state law or under the partnership agreement.17 A party challenging eligibility of the individual partner may argue that dissolution requires examination of the assets and liabilities of the partnership to determine the residual of partnership debt that will flow through to an individual partner. Complicated proof may be necessary to demonstrate the extent of partnership debt, the insufficiency of partnership assets, and the amount of debt assessable under state law against an individual general partner. A sensible argument can be made that those complicated questions should not be entangled in the eligibility calculus but are best left for the more leisurely process of claims litigation.18


 

1  See § 14.1  Dollar Amounts and § 16.1  What Is a Liquidated Debt?.

 

2  See § 15.1  What Is Noncontingent Debt?.

 

3  See, e.g., In re Arriaga, Nos. 02-41989, 02-41686, 2003 WL 25273842 (Bankr. D. Idaho Feb. 6, 2003) (unpublished) (Pappas) (Under Idaho law, creditor of partnership can proceed directly against partner upon bankruptcy of partnership; no extrinsic act need occur before partner is liable for full amount due from partnership notwithstanding that assets of partnership have not been liquidated or distributed.).

 

4  Norman v. Norman, 32 B.R. 562 (Bankr. W.D. Mo. Aug. 22, 1983) (Pelofsy).

 

5  In re Anderson, 51 B.R. 532 (Bankr. D.S.D. Aug. 15, 1985) (Ecker); Miami Valley Prod. Credit Ass’n v. Tegtmeyer, 31 B.R. 555 (Bankr. S.D. Ohio July 21, 1983) (Anderson); In re Kelsey, 6 B.R. 114 (Bankr. S.D. Tex. Sept. 9, 1980) (Patton).

 

6  See § 15.1  What Is Noncontingent Debt?.

 

7  The secondary liability of a general partner for the debts of a partnership is recognized in the Chapter 7 context in 11 U.S.C. § 723(a), which provides that the Chapter 7 trustee has a claim against the general partner to collect any deficiency in the payment of claims from property of the estate. The Bankruptcy Reform Act of 1994 amended § 723(a) to limit the liability of a general partner in a partnership Chapter 7 case filed after October 22, 1994, such that the general partner is only liable for any deficiency that would be the general partner’s liability under applicable nonbankruptcy law. See 11 U.S.C. § 723(a), as amended by Bankruptcy Reform Act of 1994, Pub. L. No. 103-394, § 212, 108 Stat. 4106 (1994).

 

8  11 U.S.C. § 101(12) (emphasis added).

 

9  11 U.S.C. § 101(5).

 

10  298 F.3d 1107 (9th Cir. Aug. 8, 2002), as amended, 314 F.3d 336 (9th Cir. Nov. 20, 2002) (Kleinfeld, Graber, Bolton), rev’d, 541 U.S. 114, 124 S. Ct. 1548, 158 L. Ed. 2d 279 (Mar. 23, 2004).

 

11  United States v. Galletti (In re Galletti), 298 F.3d at 1114.

 

12  Nos. 02-55433, C.D. No. CV-01-03736-SVW, 2003 WL 68080 (9th Cir. Jan. 8, 2003) (unpublished) (Reinhardt, O’Scannlain, Paez).

 

13  See § 16.2  Effect of Defenses and Counterclaims.

 

14  See In re Arriaga, Nos. 02-41989, 02-41686, 2003 WL 25273842 (Bankr. D. Idaho Feb. 6, 2003) (unpublished) (Pappas) (Partnership debt is not contingent in partner’s Chapter 13 case because partnership filed separate Chapter 12 case and under Idaho law, creditor of partnership can proceed directly against partner upon bankruptcy of partnership; no extrinsic act need occur before partner is liable for full amount due from partnership notwithstanding that assets of partnership have not been liquidated or distributed.).

 

15  In re Ashline, 37 B.R. 136 (Bankr. N.D.N.Y. Feb. 3, 1984) (Marketos) (Partnership creditor has the burden of demonstrating the existence of a putative partnership to establish a claim against the individual debtor through that partnership.).

 

16  See In re Saunders, 440 B.R. 336 (Bankr. E.D. Pa. Sept. 7, 2006) (Fehling) (Confessed judgment on guaranty was not contingent notwithstanding absence of demand by creditor because contract waived all right to demand.).

 

17  See, e.g., In re Doddy, 164 B.R. 276, 279 (Bankr. S.D. Ohio Feb. 7, 1994) (Perlman) (Plan fails best-interests-of-creditors test because it fails to take into account the value of the debtor’s one-third interest in a real estate partnership. Applying Ohio law, the debtor’s interest in the partnership is personal property although the partnership property itself would be excluded from the debtor’s Chapter 13 estate. The filing of the Chapter 13 case dissolved the partnership, and only the “mechanical step” of winding up the partnership stands between the debtor and liquidation of the debtor’s interest in the partnership. “[The] debtor’s estate for purposes of liquidation analysis should include any distribution to which debtor will be entitled upon completion of that [winding up]. . . . The court thus must estimate the value of the surplus debtor will receive after liabilities to partnership creditors are paid, in order to determine whether the proposed plan meets the ‘best interests of creditors’ test set forth in § 1325(a)(4).”).

 

18  Some courts have defined “unliquidated” for eligibility purposes along these lines. See § 16.1  What Is a Liquidated Debt?.