## Facts

- A New Jersey limited partnership, Red Hawk North Associates, L.P. (Red Hawk), participated (with Cedar Ridge Development Corp.) as a general partner in Chestnut Woods Partnership, a residential development in Pennsylvania.
- In December 1988, Cedar Ridge, acting for the development, subcontracted with Henkels & McCoy, Inc. (Henkels) to perform construction work.
- Henkels completed its work but was not fully paid; it obtained default judgments against Cedar Ridge and Red Hawk (as Chestnut Woods) and later against Red Hawk’s general partner (G&A Development Corp.), all of which remained unsatisfied due to lack of assets.
- In 1989, after an unrelated venture (Timber Knolls) was discontinued, Red Hawk received returned capital and distributed about $492,000 to its limited partners.
- Red Hawk’s limited partnership agreement required the general partner to establish reasonable reserves for partnership debts before making cash distributions to limited partners.
- No reserves were set aside from the Timber Knolls proceeds before the 1989 distributions, despite evidence that the partnership and project were experiencing serious financial difficulty.
- Henkels sued nineteen limited partners to recover the distributions under N.J. Stat. Ann. § 42:2A-46(b), seeking return of the amounts necessary to satisfy its unpaid judgments.

## Issues

1. Whether distributions to limited partners were made “in violation of the partnership agreement” under N.J. Stat. Ann. § 42:2A-46(b) when the general partner failed to create contractually required reserves for partnership debts.
2. Whether limited partners may be required to return distributions derived from an unrelated venture when those funds became partnership assets and the partnership later could not satisfy a creditor’s claim.
3. Whether imposing pro rata repayment limited to amounts received is consistent with limited partner protections under New Jersey limited partnership law.

## Decision

- The Third Circuit affirmed judgment for Henkels.
- New Jersey law governed because Red Hawk was a New Jersey limited partnership, and partner rights and liabilities are determined by the law of the state of organization.
- The reserve clause in the partnership agreement was enforceable and defined when distributions were permissible; distributing cash without establishing reasonable reserves constituted a violation of the agreement.
- The Timber Knolls source did not exempt the distributions because returned capital became a partnership asset available for creditor protection and subject to the agreement’s reserve requirement.
- The limited partners were required to return the 1989 distributions on a pro rata basis, limited to what each received, to the extent necessary to satisfy the partnership’s obligation to Henkels.

## Legal Principles

- Under N.J. Stat. Ann. § 42:2A-46(b), a limited partner who receives a distribution made in violation of the partnership agreement or statute may be liable to return the distribution, up to the amount necessary to discharge partnership obligations to creditors.
- A partnership agreement clause requiring “reasonable reserves” for debts is a substantive condition on distributions; failure to create reserves can render distributions improper and recoverable.
- Restitutionary “clawback” liability for improper distributions differs from general personal liability for partnership debts and is limited to the amount actually distributed to the limited partner.
- Funds returned to a partnership from a separate venture become partnership assets and may be subject to statutory and contractual restrictions designed to protect partnership creditors.
- Repayment may be allocated proportionately among limited partners based on amounts received, ensuring no partner pays more than the improper distribution received.

## Conclusion

The court held that when a general partner makes cash distributions without establishing contractually required reserves, those distributions violate the partnership agreement and trigger limited partners’ statutory obligation to return amounts received, pro rata and limited to the distribution, to satisfy unpaid partnership creditor claims.


Henkels & McCoy, Inc. v. Adochio, 138 F.3d 491 (3d Cir. 1998)