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Umbach v. Carrington Investment Partners (US), LP

United States Court of Appeals, Second Circuit

March 13, 2017

JOSEPH UMBACH, Plaintiff-Appellee,

          Argued: April 5, 2016

         Defendants appeal from a judgment entered in the United States District Court for the District of Connecticut, Jeffrey Alker Meyer, Judge, requiring them to pay plaintiff $1, 335, 137.55 in damages plus $529, 409.48 in prejudgment interest for breach of a limited partnership agreement ("Agreement") that, at the time it was entered into by the plaintiff limited partner, allowed such a partner to withdraw part or all of his interest in defendants' hedge fund. Defendants principally contend that the district court, Ellen Bree Burns, Judge, to whom the action was previously assigned, erred (1) in granting summary judgment against them on the ground that their acts to modify the Agreement--after plaintiff had given notice of withdrawal in conformity with the Agreement's terms-- to allow rejection of that notice constituted a breach, and (2) in calculating the dollar amount plaintiff would have received but for the breach. While we see no error in the court's ruling on liability, we conclude that there were factual issues to be tried as to the calculation of damages.

         Vacated and remanded for further proceedings as to damages.

          EDWARD TOPTANI, New York, New York, for Plaintiff-Appellee.

          LAURA K. LIN, Los Angeles, California (William D. Temko, Munger, Tolles & Olson, Los Angeles, California; Jeffrey R. Babbin, James O. Craven, Wiggin and Dana, New Haven Connecticut, on the brief), for Defendants-Appellants.

          Before: KEARSE, CABRANES, and CHIN, Circuit Judges.

          KEARSE, Circuit Judge:

         Defendants Carrington Investment Partners (US), LP, et al., a hedge fund and its managers (collectively "Carrington"), appeal from a judgment entered in the United States District Court for the District of Connecticut, Jeffrey Alker Meyer, Judge, requiring them to pay plaintiff Joseph Umbach, the indirect purchaser and assignee of a limited partnership interest in defendants' fund, $1, 335, 137.55 in damages plus $529, 409.48 in prejudgment interest for breach of the limited partnership agreement ("Agreement" or "LPA") which, at the time it was entered into by Umbach's assignor, allowed a limited partner under stated conditions, including 30 days' advance notice, to withdraw part or all of his interest in the hedge fund. The district court, Judge Ellen Bree Burns, to whom the action was previously assigned, granted Umbach's motion for summary judgment, ruling (1) that defendants' actions--after Umbach had given notice of withdrawal in conformity with the Agreement's terms--in causing the LPA to be modified, without the consent of all limited partners, to facilitate defendants' nullification of Umbach's notice of withdrawal constituted a breach of the Agreement, and (2) that Umbach was entitled to recover $1, 335, 137.55 in contract damages, representing his share of the fund's net asset value as of the date his interest, in accordance with the relevant Agreement, was entitled to be withdrawn. Defendants contend principally (1) that the court erred in its interpretation of the LPA and should have granted summary judgment in their favor on the issue of liability, and (2) that, in any event, permitting Umbach to withdraw from the fund would have precipitated a sale of fund assets at distressed prices, making it impossible for Umbach to receive more than a minuscule distribution, if any. For the reasons that follow, we reject defendants' challenges to the district court's ruling on the issue of liability, but we conclude that factual questions prevented the court from calculating as a matter of law the amount that Umbach would have received if his withdrawal request had been honored.

         I. BACKGROUND

         Defendant Carrington Investment Partners (US), LP (the "Fund"), was a hedge fund that invested in securities linked to single-family residential subprime mortgages. The Fund was structured as a limited partnership; the Fund's general partner was defendant Carrington Capital Management, LLC ("CCM" or "General Partner"); defendant Bruce Rose was the president and managing member of the General Partner. Umbach became a limited partner in May 2005, indirectly investing $1 million in the Fund; he eventually acquired direct ownership of that interest through assignment. For purposes of this opinion, we will, as did the district court, "refer to Umbach as the original investor and attribute any relevant action by [Umbach's investment surrogate] to Umbach" himself, Umbach v. Carrington Investment Partners (US), LP, No. 3:08-cv-484 (EBB), 2014 WL 10537157, *1 n.1 (D. Conn. Apr. 23, 2014) ("Umbach I"). As described in Umbach I, most of the facts are not in dispute.

         A. Relevant Provisions of the Limited Partnership Agreement

         We note, as did the district court, that although the limited partnership agreement that was in effect at the time of Umbach's 2005 investment was amended in 2006, the modifications did not change the LPA in any respect that is material to this action, and we too will refer to the 2006 version of the Agreement as the original agreement, see Umbach I, 2014 WL 10537157, at *1 n.2.

         Under Delaware law--which the Agreement provided would be applicable--prior to the dissolution and winding up of a limited partnership, a limited partner may withdraw from the partnership "in accordance with the partnership agreement." Del. Code Ann. Tit. 6, § 17-603 (2015). With exceptions not relevant here, the LPA's original § 3.9.1, titled "Total and/or Partial Withdrawals by Partners; Penalties, " provided, in pertinent part, that

a Limited Partner may not withdraw any portion of its Capital Account with respect to each of its Interests . . . unless such portion has been invested with the Partnership for a period of not less than 12 months (the "lock-up period"). The General Partner may waive the lock-up period, in its discretion. Following such lock-up period, a Limited Partner may, upon written request . . . withdraw all or a portion of his Interest as of the last Business Day of each quarter . . . . Written notice of such withdrawal in proper form must be received by the General Partner at least thirty (30) days prior to each Withdrawal Date, unless such notice is waived by the General Partner in its sole discretion. . . . In the event of a total or partial withdrawal of . . . an Interest, the General Partner will distribute 90% of the amount withdrawn, without interest, from the withdrawing Partner's Capital Account with respect to an Interest generally within twenty (20) Business Days after the Withdrawal Date, and the balance, if any, will be distributed, with interest, after the completion of an audit. . . . A Partner may revoke his notice of intent to withdraw on or prior to the Withdrawal Date by written instructions to the General Partner.

(Agreement § 3.9.1 (emphases added).)

         That section also made provision for certain "Hardships" that would allow the General Partner to partially postpone withdrawal distributions by "certify[ing] that extraordinary circumstances exist[ed], " such as "the General Partner's inability to liquidate positions as of [a] Withdrawal Date" (Agreement § 3.9.1). It stated that in the event the General Partner provided a Hardships certification, the Fund could

delay payment to Partners requesting withdrawal of the proportionate part of the value of withdrawn Interests represented by the sums which are the subject of such Hardships, in which event payment for withdrawal will be made to Partners as soon thereafter as is practicable following the end of such Hardships.


         Section 11 of the LPA provided, with some stated exclusions, that the "General Partner and Limited Partners holding at least two-thirds (66 2/3%) of the outstanding Interests"--sometimes referred to as a supermajority--"have the right to amend" the LPA. (Id. § 11.1.) However, in a section titled "Restrictions on General Partner's Authority, " the LPA provided that "[n]otwithstanding anything in this Agreement to the contrary, the General Partner may not, without the consent or ratification of the specific act by all the Limited Partners . . . do any act in contravention of this Agreement . . . ." (Id. § 5.3(a)(i) (emphases added).)

         B. Umbach's Notice of Withdrawal and Carrington's Response

         On July 11, 2007, more than a year after the end of his lock-up period, Umbach submitted to CCM a written request to withdraw his entire interest in the Fund. In accordance with § 3.9.1, he designated September 28, 2007, the last business day of the third quarter of 2007, as the withdrawal date.

          On August 30, 2007, Carrington proposed to the limited partners an Amendment of § 3.9.1 to be effective "September 30, 2007, " which added the following new first sentence:

Unless earlier declared by the General Partner . . . the next Withdrawal Date shall be September 30, 2008 . . . and Withdrawal Requests pending on or prior to the date hereof shall be deemed to be rescinded and of no further force or effect.

(Amendment No. 1, dated as of September 30, 2007, to [the original] Agreement of Limited Partnership 1-2.) The district court noted that, as thus proposed, the Amendment's literal "effective date [would have been] two days after Umbach's withdrawal request was to take effect, " Umbach I, 2014 WL 10537157, at *2 n.3 (emphasis added). However, because the effective date of the Amendment was not material to the resolution of Umbach's breach-of-contract claim, the court accepted, for purposes of considering Carrington's summary judgment motion, "Carrington['s] assert[ion] that the Amendment was actually meant to take effect on September 28, 2007." Id. (emphasis added).

         Umbach voted against the proposed Amendment, as did some other limited partners. However, the proposal was approved by more than two-thirds of the limited partners, and CCM deemed it adopted. Thus, the Amendment (1) imposed a new, not-previously-contemplated, 12-month lock-up period, and (2) retroactively rescinded pending withdrawal requests. CCM treated Umbach's withdrawal notice as rescinded and refused to pay him his interest in the Fund.

         C. The Present Action and the Cross-Motions for Summary Judgment

         Umbach commenced the present action against Carrington in 2008 and filed a First Amended Complaint in 2011 alleging, to the extent pertinent to this appeal, that defendants' rejection of his withdrawal request constituted a breach of the LPA. He alleged that Carrington's purported amendment of the Agreement was in contravention of the terms of the LPA and thus impermissible, and he principally requested rescission of the Agreement and restitution of his $1 million investment, plus interest. Defendants denied that there was any breach, and asserted, inter alia, that the Amendment of the LPA was duly authorized and that it nullified Umbach's withdrawal request. They also raised 18 affirmative defenses, including the assertion that if Umbach had suffered any damages he had failed to mitigate those damages.

         Following completion of discovery, both sides moved for summary judgment. As discussed in greater detail in Part II.B. below, defendants presented, inter alia, the declaration of CCM's Chief Strategy Officer, stating (a) that by early summer in 2007 the market for subprime-mortgage-backed securities "had completely shut down"; (b) that a substantial number of limited partners in addition to Umbach had sent Carrington requests to withdraw their interests as of September 28, 2007; and (c) that the Fund could not have satisfied more than a fraction of those requests with the cash it had on hand and would have had to sell securities at depressed prices to meet all of them. (Declaration of Darren A. Fulco dated November 4, 2013 ("Fulco Declaration" or "Fulco Decl."), ¶¶ 7-10.) Defendants claimed that the Amendment was necessary to avoid having to liquidate the Fund; they also stated that in proposing the Amendment and rejecting Umbach's withdrawal request, they had consulted with counsel and believed that those acts were within the authority conferred on them by the LPA. (See Fulco Decl. ¶¶ 20-24.) Defendants contended that § 5.5.1 of the LPA thus immunized CCM and Rose from an award of damages for those acts.

         Umbach argued that the purported amendment was ineffective because § 5.3 of the LPA expressly provided that notwithstanding any other provision in the LPA, the General Partner could not take any action in contravention of the LPA without the consent of all of the limited partners.

         1. Partial Summary Judgment as to Liability

         In Umbach I, the district court partially dealt with the issue of liability on Umbach's breach-of-contract claim. It stated that

[t]he singular question of law underlying . . . the breach of contract . . . claim[] is whether the retroactive rescission provision of the Amendment--while ostensibly having obtained a supermajority vote of the Limited Partners pursuant to Section 11.1--was null and void because it constituted an "act in contravention of [the LPA]" and did not have the required consent of all Limited Partners in accordance with Section 5.3.

Umbach I, 2014 WL 10537157, at *3. It noted that "neither party has argued that the LPA contains ambiguous terms pertaining to resolution of th[is] . . . claim[] . . . ." Id. at *3 n.5.

         While reserving decision on defendants' contention that the Agreement made CCM and Rose immune from a claim for damages, the district court concluded that defendants had breached the ...

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