Provident Bank v. DeChiaro Ltd. Partnership

BLOOM, Judge. The Circuit Court for Baltimore County consolidated for trial an action brought by Provident Bank of Maryland (Provident) against DeChiaro Limited Partnership (DLP) on a cog ⁵⁹⁹ novit note for one million dollars with an action brought by the Reverend Joseph A. Sellinger, J.S. (Fr. Sellinger), a trustee of the Ralph A. and Dorothy DeChiaro Trust Dated December 18, 1972 (the Trust), against Provident for a declaratory judgment as to the enforceability of that note and the underlying debt.

From a judgment in favor of DLP and a declaratory judgment that the one million dollar loan by Provident to DLP (in which the Trust held a ninety-nine percent interest as the limited partner) was null and void, Provident appeals, presenting the following issues: 1. Where Provident’s loan was made in good faith to DLP, and there was no misuse of DLP’s funds, did the trial court err in holding that the loan was made to the DeChiaro Trust in bad faith and was null and void? 2. Where Provident proffered evidence that showed extensive inter-entity loans in the DeChiaro-Rachuba Group, and such evidence supported Provident’s contention that there was no misuse of DLP’s funds and that Provident acted in good faith, did the trial court err in not admitting said evidence? 3. Where the DeChiaro Trust had no standing to sue, did the trial court err in granting it declaratory relief?

Asserting that the trial court erred in ruling against it on its action for damages for conspiracy, and in order to preserve that and other issues raised but not decided below, Fr. Sellinger cross-appeals, presenting five additional questions, phrased as follows: 1. Do the trial court’s findings of fact support its judgment under the terms of the Uniform Fiduciaries Act? 2. Is the judgment appealed from otherwise sustainable under the trial court’s findings of fact, pursuant to the provision of Maryland Annotated Code Trusts and Estates Article, § 14-105? 3.

Is the judgment appealed from otherwise sustainable under the trial court’s findings of fact pursuant to partnership law governing the power of a general partner to bind a limited partnership? ⁶⁰⁰ 4. Was a prima facie case made out before the trial court of civil conspiracy so as to provide alternative grounds for sustaining the judgment? 5. Does the Trustee have standing to participate in these proceedings? Responding to the issues raised by Provident, we hold that the circuit court did err (1) in treating Provident’s loan to the limited partnership as if it were a loan to the limited partner and in basing its judgment on that theory, (2) in excluding evidence of inter-entity loans within a conglomerate of which DLP was a member, and (3) in granting relief to the Trust, which had no standing to maintain an action against Provident.

By virtue of our holding that the Trust had no standing to sue Provident, it is not necessary for us to address the questions raised on the cross-appeal. Factual Background Throughout the entire period of time relevant to this case, DLP, which was formed under the Maryland Revised Limited Partnership Act, §§ 10-101 through 10-1105 of the Corporations and Associations Article of the Maryland Code (1975, 1993 RepLVol.), was one of sixteen privately held business entities that made up the DeChiaro-Rachuba Group, a prominent commercial and residential real estate development conglomerate. Lawrence R. Rachuba, the general partner, held one percent interest in DLP; the Ralph A. and Dorothy DeChiaro Trust held a ninety-nine percent interest in DLP as a limited partner. The DeChiaro Trust resulted from the 1987 merger of two trusts established by Ralph DeChiaro in 1963 and 1972 for the benefit of his three daughters, Carol Scheffenacker, Roberta Hucek, and Diane Rachuba.

Lawrence Rachuba, Ralph DeChiaro’s son-in-law, served as trustee of the DeChiaro Trust. Lawrence Rachuba was also the sole shareholder in Rachuba Enterprises, Inc. (REI), another real estate development company within the DeChiaro-Rachuba Group. ⁶⁰¹ In May of 1988, Provident issued a one million dollar unsecured “guidance” line of credit to DLP. The grant of approval for the line of credit limited the use of the funds to “capital expenditures on projects within the partnership.” This guidance line of credit was overseen by Parker Heckner, a vice president of Provident. Heckner previously had dealt with the DeChiaro-Rachuba Group when he was a loan officer for Signet Bank.

Lawrence Rachuba, the general partner of DLP, and Richard F. Melfa, the Director of Finance for DLP, executed the Partnership Borrowing Authority. Beginning on 18 May 1989, DLP, through Melfa, obtained four advances on the line of credit. Each advance was initiated by a letter from Melfa on DeChiaro-Rachuba Group stationery, requesting the amount of money needed and describing its intended use. With respect to two requests for advances, totaling $600,000, one on 18 May 1988 and one on 14 November 1988, Melfa stated in his correspondence, “These funds are to be used for our Thomas Run Project.” With respect to the other two requests, on 30 August 1988, and 22 December 1988, each for $200,000, Melfa stated, “These funds are to be used for our Pistorio Property.” Provident, that is, Heckner, knew that “Thomas Run” and “Pistorio Property” were projects of REI.

DLP executed a promissory note for each advance. After each request, Provident placed the funds in DLP’s account at Provident Bank. Melfa, on behalf of DLP, would then write a check on DLP’s account, payable to REI, noting on one of the check stubs that the money was a “loan.” These transactions were recorded in the financial books of the DeChiaro-Rachuba Group as loans from Provident Bank to DLP and as loans from DLP to REI. On 18 May 1989, DLP consolidated the credit line into one loan and extended the maturity date through 18 July 1989.

On 18 July 1989, Melfa executed a promissory note for DLP that extended the loan for an additional year, until 18 July 1990. REI made monthly interest payments directly to Provident through May 1990. DLP paid the June 1990 interest payment, but did not make the interest payment for 18 July 1990. On 30 July 1990 Provident obtained a judgment by ⁶⁰² confession against DLP pursuant to the authority contained in the promissory note signed by Melfa for DLP on 18 July 1989.

Meanwhile, beginning about June 1990, major changes in the makeup of the DeChiaro-Rachuba Group took place. Scheffenacker and Hucek had Lawrence Rachuba removed as trustee of the DeChiaro Trust, replacing him with Fr. Selling-er. Scheffenacker replaced Rachuba as general partner of DLP.

The DeChiaro-Rachuba Group reorganized into DeChiaro Properties, a new umbrella organization made up from the former DeChiaro-Rachuba entities, excluding REI. In. July 1990, Rachuba and REI filed petitions for bankruptcy under Chapter 11 of the Bankruptcy Code. Procedural Background After Provident obtained a judgment by confession against DLP in the Circuit Court for Baltimore County, DLP caused the case to be removed to the United States Bankruptcy Court for the District of Maryland.

DLP responded to the confessed judgment by filing a motion to vacate it. On or about 18 July 1991, the Bankruptcy Court remanded the case to the Circuit Court for Baltimore County. Fr. Sellinger, as Trustee for the DeChiaro Trust, brought a separate action against Provident, seeking a declaratory judgment that Provident’s claim against DLP was unenforceable, an injunction restraining Provident from pursuing its confessed judgment action, and damages against Provident for conspiring with Lawrence Rachuba to divert trust assets to Rachuba’s personal benefit.

The circuit court consolidated the two cases, and on 11 February 1992, the court granted DLP’s motion to vacate Provident’s judgment. Following a non-jury trial on the merits of the consolidated cases, the court entered judgment in favor of DLP in Provident’s confessed judgment action and granted Fr. Sellinger’s request for declaratory judgment that the Provident’s loan to DLP was null and void. The court found that Provident “did not exercise good faith when dealing with the DeChiaro Limited Partnership in Trust in the loan and advancement of funds to the Partnership ⁶⁰³ relating to the note of July 18, 1989 with full knowledge that the funds were not being used for partnership purposes.” I Appellee DLP asserts that there is substantial evidence to support the trial court’s findings of fact and that Provident is asking this Court to substitute its judgment on the facts for that of the trial court, referring to Rule 8 — 131(c), which provides that when an action has been tried without a jury, the appellate court will review the case on both the law and the evidence, but will not set aside the judgment of the trial court on the evidence unless clearly erroneous.

The “clearly erroneous” standard for appellate review set forth in Md.Rule 8-131(c) applies to findings of fact, not to a trial court’s determination of legal questions or conclusions of law based on findings of fact. Heat & Power Corp. v. Air Products & Chems., Inc., 320 Md. 584 , 578 A.2d 1202 (1990); Davis v. Davis, 280 Md. 119 , 372 A.2d 231 , cert. denied, 434 U.S. 939 , 98 S.Ct. 430 , 54 L.Ed.2d 299 (1977). We accept the trial court’s findings of fact that serve as the basis for its judgments, since there is substantial evidence to support them; we believe, however, that the court erred with respect to its conclusions of law based on those facts. II After hearing all the testimony and reviewing all the exhibits, the court rendered its judgment, which was accompanied by an extensive (twenty-one pages), comprehensive, and scholarly memorandum opinion, in which the court stated what it believed to be the issue before it, set forth its findings of facts, and expounded on the law it deemed to be applicable to the case.

Throughout that memorandum opinion, the court made it abundantly clear that it regarded the loan transaction as one between Provident Bank and the DeChiaro Trust, treating the limited partnership, DLP, and the Trust, as a limited partner with a ninety-nine percent interest in DLP, as if they were the same entity. It stated that the issue ⁶⁰⁴ is when and under what circumstances one may loan money to a Trust when it has actual knowledge that the money advanced is not to be used for trust purposes. The court also stated that the outline of consideration appeared to it to be (1) that Provident knew it was dealing with a trust, the limited partnership interest (99%) being in trust, wherefore Provident was charged with knowing that the trustee’s authority was limited by the Trust instrument and applicable law; (2) Provident knew that the $1,000,000 it advanced to the Trust was for purposes other than those related to Trust purposes; and (3) Provident did not exercise good faith and cannot collect on its $1,000,000 debt because the Trust had no capacity to contract for the diversion of its funds from a Trust purpose. In its discussion of the law, the court expounded at length on the common law regarding loans to a trustee who breached the trust and used the borrowed funds for other than trust purposes.

The court regarded as dispositive its finding that Provident knew that the borrowed money was being diverted from a trust purpose in that it was being used for the Thomas Run Project and the Pistorio Property development, two projects of REI, of which Lawrence Rachuba was the sole stockholder. Regarding the loan as if it had been made to the Trust, the court found that Provident did not act in good faith in transferring the loan proceeds to the Trustee, Lawrence Rachuba, in that it was aware that the loan proceeds were to be used for the benefit of Mr. Rachuba’s solely owned corporation, REI, instead of being used for Trust purposes. By reason of that lack of good faith, the court held, Provident was not entitled to the protection of Md.Code (1974, 1991 RepLVol.), § 15-202 of the Estates and Trusts Article (ET), and thus was liable under case law predating the Maryland Uniform Fiduciaries Act, Title 15, subtitle 2 of the Estates and Trust Article, of which ET § 15-202 is a part, for the defalcations of the fiduciary. ⁶⁰⁵ Basically, the Uniform Fiduciaries Act was enacted to protect those who deal in good faith with a fiduciary. ET § 15-202 provides: A person who in good faith pays or transfers to a fiduciary any money or other property which the fiduciary is authorized to receive is not responsible for the proper application of it by the fiduciary; and any right or title acquired from the fiduciary in consideration of payment or transfer is not invalid in consequence of a misapplication by the fiduciary.

Because the court found that Provident did not act in good faith under ET § 15-202, DLP, as did the trial court, relies on Duckett v. Mechanics’ Bank, 86 Md. 400 , 38 A. 983 (1897), as an example of the common law rule that was ameliorated by the Uniform Fiduciaries Act. In Duckett , a trustee received a check in payment of money belonging to the corpus of the trust estate. On the face of the check were the words “to deposit to the credit of Henry W. Clagett, trustee.” 86 Md. at 405 , 38 A. 983 . The proceeds of the check were placed in the trustee’s individual account by the bank, and the money was then misapplied.

The Court in Duckett said, If the bank knowingly aided and participated in Clagett’s breach of trust, then the bank is, beyond dispute, as responsible to the new trustees as is the defaulting trustee himself. This liability of the bank depends, however, altogether on the contingency that it knowingly aided the trustee, Clagett, to commit the default of which he was undeniably guilty. If without knowledge of Clagett’s misconduct, or without sufficient notice to put it on inquiry that would have enabled it to ascertain that Clagett was mingling with his individual deposits and using it as his own, money that the bank knew or had the means of knowing was trust money; or if the bank was merely the innocent agency through which, without fault or negligence on its part, Clagett depleted the trust estate, then it was not guilty of aiding him in misappropriating the trust fund and is not liable to restore it. In Whitney v. Citibank, N.A., 782 F.2d 1106 (2d Cir.1986), also relied on by DLP, Citibank was held liable when it ⁶⁰⁶ knowingly participated in misconduct of copartners when consideration was paid to a partner, rather than to the partnership, for property owned by a limited partnership.

Reliance on those cases is misapplied. Duckett involved, a trustee’s deposit of trust funds into his individual account; Whitney was a case of partnership proceeds being paid to individual co-partners instead of to the partnership. Neither of those situations exists in this case. Here, the trial court erred in treating the Provident loan as if it were a loan to the limited partner instead of to the partnership.

In so doing, the court actually coined the expression “Partnership in Trust” in referring to the borrower. Although the Trust, owning a ninety-nine percent interest in the limited partnership, is the entity that would actually bear the loss if Provident were to succeed in enforcing its cognovit note, it and the partnership are distinct entities, and there is no legal basis to treat them as one even though the same person acted as a fiduciary for both entities. 1 A limited partnership is a specialized business structure employed by sophisticated investors when special circumstances make other organizational forms less desirable. A limited partnership is a “creature of statute” designed to “permit a form of business enterprise, other than a corporation, in which persons may