United States v. Acorn Technology Fund, L.P. Leonard Barrack and Lynne Barrack

Citations: 429 F.3d 438; 2005 U.S. App. LEXIS 24029; 2005 WL 2979230Docket: 04-3663

Court: Court of Appeals for the Third Circuit; November 7, 2005; Federal Appellate Court

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An interlocutory appeal was filed by Leonard and Lynne Barrack challenging the denial of their motion to lift a stay of litigation imposed by a receivership order. The Barracks allege they were fraudulently induced to invest in Acorn Technology Fund, L.P. and incurred losses due to mismanagement and lack of disclosure. The U.S. District Court for the Eastern District of Pennsylvania denied their motion, concluding that their claims failed as a matter of law. The appeal was heard by the Third Circuit, which affirmed the lower court's decision, adopting the standard from SEC v. Wencke. 

Acorn Technology Fund, established in New Jersey in 1999 as a Small Business Investment Company under the Small Business Investment Act, had its general partner, Acorn Technology Partners, L.L.C., managed by John Torkelsen. The Barracks were solicited to invest, initially committing $1 million through a Subscription Agreement in April 1998, with a provision allowing them to pay in installments and waiving potential penalties for incomplete payments. They made partial payments totaling $750,000 but later exercised their right to discontinue further investment without penalty. 

Separately, in January 2003, the U.S. initiated a lawsuit against Torkelsen and others for alleged misuse of Acorn to divert federal funds, further complicating the Barracks' situation.

On January 7, 2003, the U.S. initiated a lawsuit to place Acorn in receivership due to violations of the Small Business Investment Act (SBIA). The District Court appointed the Small Business Administration (SBA) as receiver on January 17, 2003, and imposed a stay on all civil litigation involving Acorn and its affiliates, unless permitted by the court. The SBA, acting as receiver, subsequently filed a suit against the Barracks for $750,000 owed on Subscription Agreements. The Barracks sought to lift the stay to file counterclaims, but the District Court denied their motion on August 12, 2004, leading to an appeal.

The District Court had jurisdiction under various sections of the SBIA and the Small Business Act. The appellate court has jurisdiction over the interlocutory appeal and will review the District Court's legal applications de novo, while reviewing procedural choices for abuse of discretion.

The appellate court has not previously established a standard for lifting receivership stays. Both parties requested the adoption of the standard from the Ninth Circuit's Wencke cases, which outlines factors for a District Court to consider when deciding to lift a stay. The Wencke standard includes evaluating whether maintaining the stay preserves the status quo or causes substantial harm to the moving party, the timing of the motion relative to the receivership, and the merits of the underlying claim.

The Ninth Circuit reviewed a district court's refusal to lift a receivership stay on litigation, reaffirming the three Wencke factors which differ from standard preliminary injunction criteria. The court emphasized the need for a district court to balance the broad interests of the Receiver, which include protecting the receivership assets and defrauded investors, against the interests of the moving party. The purpose of a stay is to allow the Receiver to manage and untangle a company’s assets without constant litigation pressure, while also recognizing that potential litigants should be able to petition the court to sue, especially if they risk harm from inaction.

The court noted that the merit of claims should not be judged too early in the receivership; rather, the district court should only assess whether claims are colorable enough to warrant lifting the stay. If a claim appears meritless, it may conclude the inquiry; however, if it has potential merit that requires factual development, the district court must consider the Wencke factors. The court referenced experiences from other Circuits that have adopted the Wencke standard, including a Maryland case where a stay was partially lifted for a foreclosure action due to substantial merits and potential harm to the movant, despite the receivership being relatively young.

A New York district court indicated it would have assessed the interests of both the receiver and the moving party regarding a partial lifting of a stay but deemed it unnecessary due to the receiver’s lack of objection. In a related case from Illinois, the court denied a motion to lift a stay of litigation, citing the short duration of the receivership, the complexity of the estate's finances, and the movants’ failure to demonstrate substantial injury without the ability to sue. This court relied on the first two Wencke factors, suggesting the claim might have merit. Ninth Circuit courts have continued to apply the Wencke standard, which balances a litigant's right to timely court access with the objectives of a receivership stay.

The decision to adopt the Wencke standard for lifting a receivership stay will involve an abuse of discretion review for district court decisions, similar to other procedural choices in receivership proceedings. The current case determined that the Barracks’ claims against the SBA are likely to fail as a matter of law, thus negating the need to remand for Wencke consideration. The court acknowledged an error by the district court in classifying the Barracks’ fraud claim as derivative but found the record sufficient to apply the Wencke standard directly to that claim. The Barracks sought to bring two types of claims against the SBA: one for alleged breach of fiduciary duties as co-limited partners and another for breach of statutory duties as a regulator of Acorn. The district court ruled that these claims lacked legal merit, justifying the continuation of the stay.

Claims against the Small Business Administration (SBA) are affirmed as being barred under the Federal Tort Claims Act (FTCA), which serves as the exclusive avenue for tort claims against federal agencies. The discretionary function exception outlined in 28 U.S.C. 2680(a) precludes claims based on government employees' actions when exercising due care in the execution of statutes or regulations, regardless of their validity or whether discretion was abused. The Barracks' assertions that the SBA breached statutory and regulatory duties are deemed to fall within this exception. 

The Barracks argue that their claims stem from the SBA's role as a preferred limited partner and investor in Acorn, alleging that the SBA failed to inform other investors about mismanagement by the Torkelsens and did not impose sanctions. However, this claim lacks support, as it fundamentally links back to the SBA's regulatory role, which grants it informational advantages over other investors. 

The SBA's actions, including decisions on sanctions and management fees, are characterized as discretionary, reflecting elements of judgment or choice. The District Court found these actions to be committed to the agency's discretion, aligning with the statute's social, economic, or political goals. Consequently, the FTCA bars the suit based on these discretionary decisions, affirming that the claims against the SBA cannot be maintained.

The Barracks are attempting to sue the SBA regarding its decisions as a regulator of Acorn, which is prohibited by the Federal Tort Claims Act (FTCA) due to the discretionary function bar. Consequently, the District Court's refusal to lift the stay on these claims is affirmed, as they cannot be considered colorably meritorious under the Wencke standard. Regarding mismanagement claims against Acorn and Acorn Partners, the Barracks argue they would not have invested had they known of the mismanagement by Torkelsen. However, the District Court determined that these claims must be brought as a derivative suit by the SBA, as the Barracks did not suffer a unique injury but rather a collective one with other investors due to the management's alleged misconduct. This positions the claims within the framework of the Revised Uniform Limited Partnership Act, which the state has adopted, leading to the conclusion that the Barracks cannot pursue these claims individually.

In contrast, the Barracks also seek to assert claims of fraud in the inducement against Acorn and Acorn Partners based on a waiver provided by Torkelsen. The District Court initially classified these claims as derivative and therefore legally invalid. However, while acknowledging that fraud in the inducement generally constitutes individual claims, the District Court mistakenly equated the Barracks’ damages solely with the loss in investment value. The Barracks may have a valid independent claim for fraud based on the waiver, indicating that the District Court prematurely dismissed the potential for an individual claim. Thus, while the individual claims can be pursued, their merit remains to be evaluated.

Fraud in New Jersey is established by five elements: 1) a material misrepresentation of a present or past fact; 2) the defendant's knowledge of its falsity; 3) intent for the other party to rely on it; 4) reasonable reliance by the other party; and 5) resulting damages. The District Court found the waiver invalid and deemed the Barracks' reliance on it unreasonable as a matter of law, which was considered premature. Torkelsen's letters, as head of Acorn's general partner, indicated a waiver of penalties for future capital contributions under a subscription agreement. However, Section 3.4.2 of the Limited Partnership Agreement allows the General Partner to reduce a limited partner's commitment with SBA's consent. The District Court stated there was no evidence of such consent; however, the Agreement allows for consent by silence if the SBA does not object within thirty days of notice regarding legal actions related to capital contributions. This issue of consent was not addressed by the District Court. If consent by silence occurred, the Barracks’ reliance on the waiver could be considered reasonable, potentially supporting a fraudulent inducement claim. The SBA acknowledged that the Barracks' claims might have merit, warranting further examination of the remaining factors from the Wencke test. The Barracks assert that the SBA has disrupted the status quo by pursuing recovery on the Subscription Agreements; however, the SBA's actions as a receiver aim to manage the estate's assets, which does not equate to disturbing the status quo. Unlike previous cases, the SBA is not preparing for asset distribution in this situation.

The Barracks argue that they would face significant harm if a stay is not lifted, as it could prevent them from asserting future claims. This argument is dismissed for two reasons. First, the SBA allows the Barracks to obtain discovery in the original SBA-Barrack suit, which could clarify the waiver's validity. The potential success of their waiver claim would discharge their payment obligations, meaning that not lifting the stay would not cause substantial injury. Second, although the Barracks wish to seek rescission of Subscription Agreements and recover $750,000 if the waiver is invalid, this does not demonstrate substantial injury if they must wait for the receivership to be resolved. Previous cases where stays were lifted involved much more severe injuries, such as significant personal hardships or imminent asset distributions.

Regarding the second Wencke factor, the timing of the motion to lift the stay, the court clarifies that the SBA's filing of a suit does not imply consent for the Barracks to assert counterclaims. The receivership had been active for only ten months when the initial request was made, and it has since persisted for 30-36 months. The court emphasizes that each case has unique circumstances, and the relatively young age of the receivership (two years) does not favor lifting the stay. Prior cases illustrate varied outcomes based on timing and the emergence of new facts. Ultimately, while the Barracks' claims may have merit, the overall considerations do not support lifting the stay at this time, and the court finds that the Barracks have not met their burden of proof to justify such action.

The District Court incorrectly ruled that the Appellants' fraud in the inducement claims could only be pursued derivatively and were legally meritless. Despite this error, the Court's decision to maintain the stay on these claims was upheld based on an analysis of the Wencke factors used to evaluate whether to lift stays in receivership proceedings. The refusal to lift the stay was also affirmed regarding claims of mismanagement against Acorn or Acorn Partners and any claims against the SBA, as these claims were deemed non-colorable. The excerpt references the Wencke case, where the SEC sought a receiver for companies involved in fraudulent activities, resulting in a court injunction preventing further legal proceedings without permission. Additionally, it notes that the Barracks' claims related to fiduciary duties and a waiver agreement were not addressed due to the conclusion that such claims were barred, although the SBA acknowledged their potential merit during arguments.