U.S. v. Acorn Technology Fund, L.P.

• Decision Date: 08 November 2005
• Docket Number: No. 04-3663.,04-3663.
• Citation: 429 F.3d 438
• Parties: UNITED STATES OF AMERICA v. ACORN TECHNOLOGY FUND, L.P. Leonard Barrack and Lynne Barrack Appellants.
• Court: U.S. Court of Appeals — Third Circuit

429 F.3d 438 UNITED STATES OF AMERICA
v.
ACORN TECHNOLOGY FUND, L.P. Leonard Barrack and Lynne Barrack Appellants. No. 04-3663. United States Court of Appeals, Third Circuit. Argued October 18, 2005. Filed November 8, 2005.

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Paul G. Shapiro (Argued), Office of the United States Attorney, Philadelphia, PA, Patrick K. McCoyd, Tracey R. Seraydarian, Post & Schell, P.C., Philadelphia, PA, for the Government, on behalf of the Small Business Administration.

Eric Kraeutler (Argued), G. Jeffrey Boujoukos, Catharine E. Gillespie, Morgan, Lewis & Bockius LLP, Philadelphia, PA, for Movants-Appellants Leonard and Lynne Barrack.

Before VAN ANTWERPEN, ALDISERT and COWEN, Circuit Judges.

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VAN ANTWERPEN, Circuit Judge.

Before us is an interlocutory appeal from an order denying Appellants' motion to lift a stay of litigation which was entered pursuant to a receivership order. Appellants Leonard and Lynne Barrack ("the Barracks") are attempting to bring claims against Acorn Technology Fund, L.P. ("Acorn"), Acorn Technology Partners, L.L.C. ("Acorn Partners"), and the Small Business Administration ("SBA"). The claims allege that the Barracks were fraudulently induced to invest in Acorn, and subsequently lost money, due to mismanagement and lack of disclosure. The United States District Court for the Eastern District of Pennsylvania denied the Barracks' motion to lift the receivership stay after determining that all their possible claims failed as a matter of law. We will affirm the District Court's refusal to lift the stay, and in so doing, we will adopt the standard of SEC v. Wencke, 742 F.2d 1230 (9th Cir.1984).

I. FACTUAL BACKGROUND AND PROCEDURAL HISTORY

Acorn Technology Fund, L.P. was formed in New Jersey in 1999 as a Small Business Investment Company ("SBIC") under section 301(c) of the Small Business Investment Act ("SBIA") of 1958, 15 U.S.C. § 681(c), which is administered by the SBA. Acorn's general partner was Acorn Technology Partners, L.L.C., a New Jersey company run by John Torkelsen. In early 1998, Torkelsen convinced the Barracks to invest in Acorn beginning with a $1,000,000 Subscription Agreement ("Subscription 1") executed on April 7, 1998. As part of the solicitation, on March 24, 1998, Torkelsen sent a letter to the Barracks indicating that he was willing to do two things to "make it easier for you to subscribe": 1) allow them to pay only $250,000 upon signing a Subscription Agreement, followed by $250,000 annually over the next three years; and 2) waive any penalties which would be imposed by the SBA if the Barracks failed to fully pay the balance on their Subscription Agreement. The Barracks returned a signed Subscription Agreement on April 9, 1998, along with a check for $250,000 and a letter reciting that "You [Acorn Partners] have agreed that if I choose to discontinue investing I will maintain my existing position without penalty." The Barracks also signed a Limited Partnership Agreement, section 3.4.2 of which permitted the general partner, with the consent of the SBA, to reduce a defaulting limited partner's partnership share to the amount of capital actually contributed.

The Barracks timely paid the first two installments of Subscription 1, bringing their paid capital investment to $750,000. On September 15, 2000, they signed a second Subscription Agreement ("Subscription 2") and promised an additional $500,000. In 2001, though, the Barracks decided to exercise their right-allegedly granted in the waiver letter-to discontinue investing without penalty, and froze their total investment at $750,000.

In a matter initially unrelated to the Barracks, the United States brought suit in the United States District Court for the Eastern District of Pennsylvania on January 6, 2003, against Torkelsen, his wife and son, and his business associate, under the Mail Fraud Injunction Act, 18 U.S.C. § 1345, et seq. United States v. Torkelson et al., No. 03-CV-0060 (E.D.Pa. Jan. 6, 2003). The suit alleges that the Torkelsens used Acorn to obtain $32 million in federal funds from the SBA, then invested the money in companies they controlled and ultimately diverted it into their own accounts. On January 7, 2003, the United States filed the instant suit to have Acorn placed in receivership based on violations

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of the SBIA. The District Court appointed the SBA receiver on January 17, 2003, as authorized by 15 U.S.C. § 687c. As part of the receivership order, the District Court imposed a stay on all civil litigation "involving Acorn, the Receiver, or any of Acorn's past or present officers, directors, managers, agents or general or limited partners," unless specifically permitted by the court. Order for Operating Receivership, United States v. Acorn Technology Fund, L.P., No. 03-cv-0070 (E.D.Pa. Jan. 17, 2003) ("Receivership Order").

The SBA, acting as receiver, filed suit against the Barracks to force them to pay the $750,000 still outstanding on the two Subscription Agreements. United States Small Bus. Admin., as Receiver for Acorn Tech. Fund, L.P. v. Barrack, No. 03-cv-5992 (E.D.Pa. Oct. 29, 2003). The Barracks responded by filing a motion with the receivership court which sought to have the stay of litigation lifted, for the purpose of asserting, in the SBA's suit, counterclaims against the SBA, Acorn, and Acorn Partners. On August 12, 2004, the District Court denied the Barracks' motion in full and refused to lift the stay of litigation. This appeal followed.

II. JURISDICTION AND STANDARD OF REVIEW

The District Court had jurisdiction over the receivership action pursuant to section 308 of the SBIA, 15 U.S.C. § 687(d); section 311 of the SBIA, 15 U.S.C. § 687c(a); and section 2(5)(b) of the Small Business Act, 15 U.S.C. § 634(b)(1). This Court has jurisdiction over this interlocutory appeal pursuant to 28 U.S.C. § 1292(a)(1). We review de novo the District Court's application of law in receivership proceedings. SEC v. Black, 163 F.3d 188, 195 (3d Cir.1998). We exercise plenary review over applications of the Federal Tort Claims Act's discretionary function exception. Mitchell v. United States, 225 F.3d 361 (3d Cir.2000). We review for abuse of discretion the procedures the District Court chooses to follow in connection with the receivership proceedings, including decisions to grant, deny, or modify an injunction. See Black, 163 F.3d at 195; see also Am. Tel. & Tel. Co. v. Winback & Conserve Program, Inc., 42 F.3d 1421, 1427 (3d Cir.1994).

III. ANALYSIS

In this Circuit we have not yet addressed the standard for a District Court to use when considering whether to lift a receivership stay of litigation. Both parties have urged this Court to adopt the standard laid out by the Ninth Circuit in SEC v. Wencke, 622 F.2d 1363 (9th Cir.1980) ("Wencke I"), and SEC v. Wencke, 742 F.2d 1230 (9th Cir.1984) ("Wencke II") (collectively, "Wencke"). For the reasons set forth below, we accept this invitation.

A. Wencke Standard

In a trilogy of cases in the early 1980s, the Ninth Circuit laid out factors a District Court should consider when deciding whether to partially or wholly lift a stay of litigation entered pursuant to a receivership order. The court in Wencke I affirmed the inherent power of a District Court to enter a valid stay of litigation effective even against nonparties to the receivership action. 622 F.2d at 1369.¹

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The court then addressed, somewhat abstractly, the relevant issues presented when deciding whether to exempt a party from the litigation bar. Id. at 1373-74. The Wencke II court, faced with an appeal of the district court's refusal to lift the same stay of litigation, set forth a three-part test to be used by a District Court:

"(1) [W]hether refusing to lift the stay genuinely preserves the status quo or whether the moving party will suffer substantial injury if not permitted to proceed; (2) the time in the course of the receivership at which the motion for relief from the stay is made; and (3) the merit of the moving party's underlying claim."

Wencke II, 742 F.2d at 1231.

In reviewing a district court's refusal to lift a different receivership stay of litigation, the Ninth Circuit reaffirmed the three Wencke factors and clarified that they differ from the normal criteria used by courts for preliminary injunctions. SEC v. Universal Fin., 760 F.2d 1034, 1038 (9th Cir.1985). The test "simply requires the district court to balance the interests of the Receiver and the moving party.... [T]he interests of the Receiver are very broad and include not only protection of the receivership res, but also protection of defrauded investors and considerations of judicial economy." Id.

We agree. Given how rare non-bankruptcy receiverships are, it is not surprising that we have not yet faced this exact issue²-or that few courts around the country have done so. The purposes of a receivership are varied, but the purpose of imposing a stay of litigation is clear. A receiver must be given a chance to do the important job of marshaling and untangling a company's assets without being forced into court by every investor or claimant. Nevertheless, an appropriate escape valve, which allows potential litigants to petition the court for permission to sue, is necessary so that litigants are not denied a day in court during a lengthy stay.

A district court should give appropriately substantial weight to the receiver's need to proceed unhindered by litigation, and the very real danger of litigation expenses diminishing the receivership estate. At the same time, we agree with the Wencke courts that the interests of litigants also need to be considered. Far into a receivership, if a litigant demonstrates that harm will result from not being able to pursue a colorably meritorious claim, we do not see why a receiver should continue to be protected from suit. Cf. Wencke II, 742 F.2d at 1232 (reversing the district court's refusal to lift the stay,...