PETER J. MESSITTE, District Judge.
The United States of America, on behalf of the Small Business Administration ("SBA"), filed a Complaint for Receivership and Injunction against ECC Partners L.P. ("ECC Partners"), a limited partnership licensed by the SBA as a Small Business Investment Company ("SBIC") pursuant to the Small Business Investment Act of 1958, as amended (the "Act"), 15 U.S.C. § 661 et seq., and its accompanying regulations, 13 C.F.R. § 107.20 et seq. (the "Regulations").
The Complaint alleged that ECC Partners was violating the Act and the Regulations in respect to capital requirements for SBICs of ECC Partners' type. Pursuant to 15 U.S.C. § 687c, the SBA sought preliminary and permanent injunctive relief
On October 7, 2009, the Court entered a Consent Order granting the requested relief and appointing the SBA as ECC Partners' Receiver.
ECentury Capital Corporation ("ECentury"), ECC Partners' former management company, filed a Motion in Opposition to the Receiver's Recommended Disposition of Claims, on which the Court heard oral argument. In an oral opinion issued from the bench at close of the argument, followed by a summary written Order dated January 14, 2011, the Court
The relevant facts are these:
The SBA operates programs that seek to encourage the growth of small businesses. Under the Act and the Regulations, the SBA is authorized to license SBICs.
In August of 2000, ECC Partners' predecessor interest, ECentury Capital Partners, L.P., was licensed by the SBA as a SBIC pursuant to Section 301(c) of the Act.
Among its responsibilities, the SBA monitors the operation of all SBICs, in the course of which it undertakes annual reviews of the SBIC's financial statements. In 2006, after receiving ECC Partners' financial statement for the quarter ending September 30, 2006, the SBA determined that ECC Partners had what it noted was a "capital impairment condition."
The letter further stated that: The Licensee may elect to defer the payment of that portion of the management fee contained in the Licensee's limited partnership agreement that exceeds that reduced amount. However, payment of all deferred fees in excess of the reduced amount must be subordinated to all amounts payable to SBA.
It is undisputed that ECC Partners did not cure the condition of capital impairment as directed by the SBA. Therefore, as of February 5, 2007, the SBA placed ECC Partners in Restricted Operation status
ECC Partners' condition of capital impairment persisted such that by letter dated February 4, 2008, the SBA notified ECC Partners that, effective January 29, 2008, it had been transferred from restricted operation status to liquidation status. Thereafter, in September 2008 the SBA and ECC Partners entered into a Wind-Down Agreement under which ECC Partners would be allowed to liquidate its assets, provided it met certain requirements established by the SBA. In September 2009, by which time the SBA had become concerned about the ability of ECC Partners to self-liquidate, the SBA, pursuant to 15 U.S.C. § 687c, sought appointment as liquidating Receiver of ECC Partners, which, as previously noted, the Court granted.
Following the claims procedure established by the Court, ECentury, ECC Partners' former management company, sought to recover $2,570,977 in unpaid management fees under its Investment Advisory Agreement with ECC Partners. The Receiver recommended that $84,139 of ECentury's claim be paid immediately and that $2,486,838 of the claim be deferred and subordinated until the leverage owed the SBA as a Preferred Limited Partner was satisfied. No objection has been taken with regard to the payment of the $84,139. As to the remaining $2,486,838, ECentury filed a timely Opposition asking the Court to approve payment of that amount prior to the SBA's preferred limited partnership interest.
The Court considers ECentury's claim.
ECentury alleges that neither ECC Partners nor ECentury ever agreed to subordinate payment of its management fees in excess of the Reduced Amount to amounts that might be owed to the SBA and further that the SBA lacks the authority to unilaterally subordinate ECentury's claim. ECentury therefore argues that its claim should be paid before SBA's PS
The SBA takes the position that, pursuant to both the Act and the Regulations, it possesses the authority to re-determine and subordinate the management fee of a SBIC where the SBA holds PS Leverage, as is it does in this case. In any event, the SBA argues that ECC Partners, through which ECentury's claim is derived, specifically accepted its offer to defer and subordinate management fees in excess of the Reduced Amount. ECC Partners' acceptance of this offer, says the SBA, is evidenced by ECC Partners' audited financial statements, including, for example, Form 468 for the period ending December 31, 2007, at Note 4 to the following effect:
A similar note is included in ECC Partners' Form 468 for the period ending December 31, 2008, in which the recorded contingent management fee for that period was $1,628,785. Accordingly, the SBA asks the Court to affirm its finding that ECentury's claim of unpaid management fees is subordinated to all amounts owed to the SBA as ECC Partners' Preferred Limited Partner.
"[A] receivership created under 15 U.S.C. § 687c is governed by principles applicable to federal equitable receivers generally." United States v. Royal Bus. Funds Corp., 724 F.2d 12, 16 (2d Cir.1983). "In a receivership proceeding, the district court has broad powers and wide discretion in crafting relief." Quilling v. Trade Partners, Inc., 572 F.3d 293, 298 (6th Cir. 2009) (citation omitted); see also United States v. Vanguard Inv. Co., 6 F.3d 222, 226-27 (4th Cir.1993) (discussing a district court's discretionary supervision of an equitable receivership). Where a petitioner seeks relief from a receivership, "`the receiver ordinarily has no power to adjudicate that claim. Instead, that authority lies within the sound discretion of the appointing court.'" United States v. Penny Lane Partners, L.P., No. 06-1894(GEB), 2010 WL 5796465, at *5 (D.N.J. Oct. 26, 2010) (quoting Barry Stuart Zisman, Banks and Thrifts: Government Enforcement and Receivership § 18.04[1] (2008)).
Here, the Receiver has concluded that ECentury's claim for unpaid management fees is subordinated to amounts owned to the SBA. The Court reviews that determination de novo.
ECentury first argues that the SBA lacks the authority to unilaterally subordinate a licensee's approved management expenses in favor of its own equity interest. The Court disagrees.
Under the Act, when a SBIC is licensed, the licensee agrees to abide by the provisions of the Act and the Regulations. The Regulations provide that, upon a determination by the SBA that there has been noncompliance by a licensee with their terms, including when a Restricted Operation Condition has occurred, some or all of the licensee's rights may be forfeited. The SBA has the right to impose certain remedies if a Restricted Operation Condition occurs and is not cured in timely fashion to the SBA's satisfaction. As set forth in the Regulations:
13 C.F.R. § 107.1820(f)(4). Among other things, a licensee is not allowed to have a condition of capital impairment greater than that allowed under 13 C.F.R. § 107.1830(c) and, if it does, the SBA indisputably has the right to re-determine the management fee. See 13 C.F.R. 107.1820(f)(4).
In this case, in the early part of 2007, the SBA made a determination that a Restricted Operation Condition had occurred with ECC Partners, namely, that it had a rate of capital impairment greater than the percentage allowed under the Regulations, 74% as opposed to 60%. The SBA's January 19, 2007 letter gave ECC Partners 15 days to cure the problem. When the condition was not cured, on or about February 5, 2007, the SBA placed ECC Partners in Restricted Operation status and, pursuant to 13 C.F.R. § 107.1820(f)(4), reduced ECentury's management fee to 50% of the previously approved amount. The January 19, 2007 letter, gave ECC Partners the option of deferring that portion of the management fee that exceeded the Reduced Amount, so long as the deferred portion would be subordinated to the SBA's claims. Although ECC Partners subsequently requested that the approved management fee be reduced by 34% rather than 50%, that proposal was rejected by the SBA after its review as of June of 2007 and ECC Partners accepted the 50% reduction.
The Court finds that the Regulations are explicit as to the SBA's authority; that when a licensee's financial condition becomes shaky, the SBA may take certain specific actions regarding the licensee's management fees and expenses. Indeed, it appears that the SBA would have the right to extinguish a licensee's management fee altogether. Be that as it may, it
ECentury also argues that to enforce the subordination clause, ECC Partners and/or ECentury would had to have separately consented to subordination of the management fee. The Court finds that, insofar as any consent was required, it was built into the Act and the Regulations. Beyond that, no consent was required.
Under the Partnership Agreement and the Investment Advisory Agreement, any rights that ECentury had were entirely derivative and limited by whatever rights and authority ECC Partners had. ECC Partners was and is subject to and its rights are limited by the Act and the Regulations. ECC Partners was not authorized to incur any expenses greater than what the Regulations and the SBA allowed. Among the possible restrictions accepted by ECC Partners when it was licensed as a SBIC was that, if a Restricted Operation Condition occurred and was not cured in timely fashion to the SBA's satisfaction, the SBA would have the right to impose certain remedies. 13 C.F.R. § 107.1820(f). These included SBA's right to reduce, even extinguish, the management fee it originally approved. When the SBA offered ECC Partners the more accommodating option of deferring and subordinating that portion of the management fee in excess of the Reduced Amount, ECC Partners had a decision to make. It could elect to defer and subordinate a portion of its management fee, or possibly see it eliminated altogether. The SBA did not need to obtain separate consent from ECC Partners or from ECentury to reduce the approved management fee to 50%, nor was it obliged to offer either entity the option of deferring and subordinating the portion of the management fees in excess of that amount.
In addition, except for asking that the management fee be reduced by 34% rather than by 50%, nothing in the record suggests that ECC Partners or ECentury ever lodged any objection to the subordination condition after receiving the SBA's January 19, 2007 letter. ECC partners' subsequent financial statements and accompanying notes clearly show that ECentury, ECC Partners, and their auditors operated under the assumption that payment of management fees in excess of the Reduced Amount would be deferred and subordinated to all amounts payable to the SBA as Preferred Limited Partner of ECC Partners. Indeed, it was Thomas Dann, on behalf of ECC Partners, through its General Partner, ECentury Capital LLC, who supplied the auditors with this information, signed off on the audited reports, and submitted them to the SBA. No one, therefore,—not ECentury, not ECC Partners, not Thomas Dann—can claim the least surprise at the SBA's insistence on the subordination term.
Alternatively, ECentury argues that the SBA reduced its management fee
First, SBA's, SBIC Program Standard Operating Procedure 10-06 (May 8, 2007), Chapter 8, Section 3(a) (What is the process for placing a SBIC into Restricted Operations?) ("SOP 10-06") which states:
Second, SBA's SBIC Liquidation Standard Operating Procedure 10-07-1 (Dec. 21, 2007), Chapter 3, Section 3(d) (How do you Develop a Liquidation Strategy for PS SBIC Cases?) ("SOP 10-07-1") which states:
The SBA's SOP 10-06 refers to the standard cure letter that it issues when it determines that a SBIC has a condition of capital impairment. The SBA's January 19, 2007 letter in this case was the standard cure letter, which clearly indicated that, unless ECC Partners cured the condition of capital impairment within 15 days, the approved management fee would be reduced by 50%.
As for SBA's SOP 10-07-1, the factors it lists refer to the analysis a SBA officer is expected to conduct "to reset" the management fee, "if appropriate," once a SBIC has been transferred from operation status to liquidation status as part of the liquidation strategy for that SBIC. In this case, ECC Partners' management fee had been reduced to 50% as of February 5, 2007, the date it was placed on Restricted Operation status. The fee was never reset as part of the liquidation strategy for ECC Partners, presumably because it was not deemed "appropriate" to do so. Strictly speaking, therefore, SOP 10-07-1 does not apply.
But in any event, different levels of review may be appropriate whether the SBA is deciding to reduce a management fee at the first sign of trouble or whether it is revisiting the situation later on. The later review may result in an adjustment of the fee, "if appropriate," or simply leaving the reduction in place. What level is "appropriate" is entirely fact-specific. If a SBIC's problem can be easily diagnosed and remedied from obvious facts, consideration of the full panoply of factors may be unnecessary. In such a situation, the SBA, like a doctor whose patient walks into his office bleeding profusely from a life-threatening open wound, does not need to verify whether the patient is maintaining
That, essentially, is the case here. The SBA received ECC Partners' 2006 balance sheets which showed significant capital impairment. The management fee was far and away the largest expense item and its reduction the clearest way to remediate the situation. Whatever analysis the SBA might have undertaken at that point, it in fact needed to undertake very little to be able to conclude with reason that immediate reduction of the management fee to 50% was an "appropriate" response to the critical condition of capital impairment. Nor would extensive analysis be required, under the circumstances, to deem it "appropriate" to keep the management fee at the reduced amount already in place when the same critical condition of capital impairment persisted weeks or months later. There is, in short, no basis for the Court to find that the SBA failed to appropriately "re-determine" the management fee.
The Court therefore affirms the Receiver's determination that ECentury's deferred management fee should be paid before the SBA's PS leverage.
For the foregoing reasons, the SBA's Recommended Disposition of Claims, as approved in the Court's Order Approving the Receiver's Recommended Disposition of Claims, Authorizing Payment of Approved Claims and Establishing Summary Disposition Procedures [Document No. 14], is
A Separate order has already issued.