Lease Renewals Save Otherwise Time-Barred Breach of Fiduciary Duty Claims in a Partnership

Posted by Jay McDaniel on March 13, 2012

The New Jersey Appellate Division affirmed a trial court decision holding that lease renewals would revive stale claims in a partnership dispute. In Munoz v. Perla, et al., A-5922-08T3, the Munoz brought claims, among others, for breach of fiduciary duty for his partners' failure to charge fair market rates in connection with the lease of the partnership's property. Despite that the rents were calculated and leases drawn up in 1994, the partnerships acts of renewing the leases in 2003 were found to be separate acts that revived the otherwise time-barred claims.

Formation of the Partnership

Munoz was one of three partners in a real estate venture called The Heritage Partnership. The three partners for started their business relationship in 1983 as principals of a professional engineering firm. Munoz was an inactive partner of Heritage and was not involved in the partnership's day-to-day operations. The purpose in forming Heritage was to "maintain, operate, manage, sell and/or lease" a commercial building. Each partner contributed capital to the venture and held a one-third ownership interest. The parties' partnership agreement provided that their rights and obligations were governed by the Uniform Partnership Act, N.J.S.A. 42:1A-1 to -56. 

In 1992, Heritage purchased a three-story office building and the parties decided to move the business operations of their engineering firm into the space. The parties did not consider a calculation of fair market value for rent for the engineering firm, but decided that the rent should cover the building's expenses. The engineering firm would also manage the building for Heritage a charge for the service.  In 1993, the parties incorporated a new business, which would also rent office space from Heritage. In 1994, Munoz received a letter from his partners outlining the rent calculations.

Munoz did not visit the building until 2005 and never requested to inspect the partnership's books and records during that time. Munoz did receive partnership tax returns and K-1 forms, but never read them thoroughly. The question of the fair market value of the rents that Heritage charged did not arise until Munoz sought to withdraw from Heritage in 2005. At that time, the rejection of Munoz's buyout offer led to the appraisal of the property and litigation ensued in 2007.

Statute of Limitations Defense

Munoz alleged in the complaint that his two partners breached their fiduciary duty to him in entering into leases that charge below fair market value rates. Defendants countered, as is expected, with the statute of limitations defense – stating that Munoz's claims expired 6 years after the leases were first executed. While both the trial court and Appellate Division agreed that Munoz possessed sufficient information that would prevent tolling of the statute of limitations, the claims were saved by lease renewals in 2003. The court found that the lease renewals, about which the partners failed to provide notice to Munoz, constituted separate acts and could be the basis for a breach of fiduciary duty. The court further found that the equitable defenses of estoppel, laches, and waiver also lacked merit.

The lesson in this case is that breaches of fiduciary duties may be continuous depending upon the parties' interactions. A prior breach may be revived by a later act long after the statute of limitations has passed. Despite Munoz's failure to keep himself informed about the partnership, the lease renewals created a new cause of action for breach of fiduciary duties for which the partners were found liable.

Bonnie C. Park, a principal of the firm, helped in the preparation of this post.

Fiduciary Duties Change With Time

Posted by Jay McDaniel on January 03, 2012

Partnership Failed to Keep Inactive Partner Informed

The fiduciary duties owed among partners can change with time and circumstances, and the disclosures that were appropriate when all of the partners worked together in the business may become inadequate when one of the partners has ceased to take an active role.

This is the lesson of Munoz v. Perla, Docket No. A-5922-08T3 (App. Div. Dec. 20, 2011) in which the Appellate Division affirmed a trial court decision holding that the members of a partnership had failed to make adequate disclosure of the terms of the leases held by the engineering firm, of which the parties had all once been partners.

Although the case involved the now-repealed Uniform Partnership Act, and thus not all of the holdings may be applicable to partnerships formed under later law, the decision is instructive as to how the fiduciary relationships between partners my evolve as time passes and circumstances change. (For another reason decision involving fiduciary duties among partners, see our blog post here.)

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Partnership Accounting Not Available from Deceased Partner's Heirs

Posted by Jay McDaniel on October 26, 2011

Uniform Partnership Act Limits Remedy

If a partner dies after having allegedly misappropriated partnership funds, do the other partners have a right to pursue his estate? The answer appears to be no, according to a recent Chancery Court decision.

The decision in In re Genet, Docket No.: ESX-C-44-11 (Oct. 13, 2011) was decided under the now repealed Uniform Partnership Act – yet another warning to partnerships formed before December 2000 that if they want the newer law to apply, they should amend the partnership agreement to say so.

In granting a motion to dismiss the claim of the surviving partner seeking to require his nieces to account for the misappropriations of their father, Chancery Judge Walter Koprowski held that the statutory language that created an obligation of the partnership to account to the estate of a deceased partner was not reciprocal. It did not create a similar obligation of the estate to account to the partnership for the wrongful acts of the deceased partner.

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Book Value is Not Fair Value in Partnership Buyout

Posted by Jay McDaniel on August 19, 2011

PartnerAgreement.jpgSocialite’s Family Partnership Interest

Book value can have a few different meanings. The best definition is simply the value of assets and liabilities that a company carries on its books. Is it different than the “fair value” standard applied in statutory buyouts?  Yes– a lot different.

There are many partnership agreements and corporate buy-sell agreements still in effect with a book value buyout provision. They tend to be older entities, often involving family businesses, and I cringe whenever I look at the agreement and see the term applied to the company’s value.

 

Book Value Used to Buy Socialite’s Interest

A recent decision involving the estate of socialite Claudia Cohen demonstrates why. Estate of Claudia Cohen v. Booth Computers, et al., Docket No. A-0319-09T2. Estate of Cohen App Div.pdf. (Thanks also to Peter Mahler’s NY Business Divorce blog for finding the trial decision. Cohen Chancery Div.pdf.) In that decision, the Cohen’s estate argued that the book value of a successful business was just less than 2 percent of its fair value – $ 178,000 as opposed to $11.526 million – and sought to reform the partnership agreement. The effort failed and the Appellate Division affirmed the trial court’s enforcement of the agreement. The disparity between book value and fair value was not, in the court’s opinion, reason to alter an otherwise unambiguous document.

The result was a windfall for the last surviving partner, Claudia’s bother James, and the same result is likely to occur in most agreements that set the value of the business at book value rather than fair value.

The Cohen case involved a partnership formed by the late Robert Cohen, an entrepreneur who amassed a considerable fortune through various entities including the Hudson News Group. He had three children – Claudia, Michael and James. Claudia, well known in Manhattan and Hamptons social circles, was also an editor of Page 6 of the New York Post and the ex-wife of entrepreneur Ronald Perelman. 

The estate, with Perelman as executor, brought suit against Booth Computers and Claudia’s brother, James, after Claudia’s interest in a family partnership was valued at a fraction of the fair value of the partnership’s holdings.

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Partnership Agreement Disclosure to Labor Union Pending Trial Court Decision

Posted by Jay McDaniel on January 28, 2011

In some circumstances, a business may be able to claim that its organizational documents are trade secrets. That seems to be the holding of a trial court decision insulating a partnership agreement from disclosure to a labor union.  

The case is interesting because non-management owners do not generally have fee access to all of the records of a business, but they do have a right of access to organizational documents. This case raises the prospect that a company that in turn enters into other ventures might classify those documents as proprietary or trade secrets and avoid disclosure to parties with an interest in their contents.

The dispute actually arose under New Jersey’s Open Public Meetings Act.  The lawsuit, Communications Workers of America and New Jersey Education Association v. John McCormac and Blackstone Capital Partners et al., L-3217-05 (2008), involved a complaint brought by several state workers’ groups against defendant public officials and private equity funds seeking documents which might reveal the investment strategy defendant private equity firms were utilizing to invest state worker pensions.  

In each circumstance, private equity firms drafted a partnership agreement between the state and themselves, along with other documents.  Only four individuals in the state have full access to these agreements.

The basis of plaintiffs’ claims were the Open Public Records Act and a common-law right to access for all contracts and proposed contracts the state had entered.  Plaintiffs first submitted correspondence simply requesting the information.  Of the thirteen documents identified, nine were withheld from disclosure because the contained “trade secret and proprietary . . . information which, if disclosed, would give an advantage to competitors or bidders; and the public need for confidentiality outweighs the interest in disclosure.”  Plaintiffs then filed suit.

 

Court Review

The court, after confidentially reviewing these documents, considered various theories brought by plaintiffs.  First, the court considered that the Open Public Records Act (or “OPRA”) generally demanded disclosure to the public of state government documents with some exceptions.  While noting exceptions must be construed “narrowly,” trade secrets were not considered government records.  In seeking instruction, the court looked to the equivalent federal law, the Freedom of Information Act (“FOIA”), and that the New Jersey legislature must have considered the expanse of FOIA when drafting OPRA more narrowly.  The court also noted that federal courts exempt from disclosure private commercial information under FOIA if disclosure would “impair the government’s ability to obtain such information in the future, or disclosure would cause substantial harm to the competitive position of the person from whom the information was obtained.”  

Noting that private equity firms would not accept investments from government entities if confidential information becomes subject to compelled government disclosure, the court agreed that the agreements in question should remain confidential.  Disclosure of the information would give competitor funds an advantage over those private equity funds that had done business with the state.  The court noted that private equity firms' defendants had gone to time and expense maintaining the information as a trade secret. 

The court also considered under the common law whether a cause of action could be brought.  Noting that disclosure of this information will do little to improve the financial outlook of individuals invested in the pensions, there was no common law right to access the information.  The court also considered that other states, including California had judicially ordered disclosure of similar information, and were not able after to find high-performing investment partners even with over $450 billion in assets.  California, Texas, and Michigan required amendments to their OPRA-equivalent laws to regain lucrative investment opportunities. 

 

Written Agreement Defeats Claimed Oral Partnership

Posted by Jay McDaniel on January 19, 2011

artwork Nadel v. Starkman revised.JPGOral agreements and even an extended course of dealing probably will be insufficient under New Jersey law to contradict the language of a written agreement, even if by all outward appearances a partnership existed.  An Appellate Division decision finding that no partnership between attorneys who practiced together for 11 years is a warning to make sure that the documents defining a business reflect its actual operations.

Raymond Nadel and Morris Starkman practiced together as Starkman & Nadel, shared profits and held each other and the firm out to the public as partners and even, it seemed, intended to be partnership.  Nonetheless, the Appellate Division decision, reversing a trial court decision that there was no partnership in contradiction of a written agreement.  See Nadel v. Starkman, 2010 N.J. Super. Unpub. LEXIS 2542 (App.Div. Oct. 20, 2010).  (Copy of Slip Opinion Here) The Appellate Division held that, notwithstanding ambiguity in an agreement, a court cannot use extrinsic evidence to vary the unambiguous terms of a contract.

The decision turned on an application of the extrinsic, or parol, evidence rule, which prohibits the introduction of extrinsic evidence to vary the terms of a written agreement.  Many trial courts see the rule as more of a suggestion and it sometimes seems that the exceptions to the rule make it meaningless.  The biggest exception in my view is that courts will accept evidence to prove that the written agreement was amended by an oral agreement, even if the contract has a provision that it can be amended only writing.  Perhaps the lesson here is that appellate courts look at such matters differently, or the plaintiff failed to argue that the original agreement had been amended orally or by the conduct of the parties.

In any event, the failure to find a partnership agreement resulted in the reversal of a verdict in excess of $500,000.  The fundamental issue in the case was whether Starkman was a partner or merely an employee, in which case he would not be entitled to a division of profits.  The Uniform Partnership Law N.J.S.A. 42:1-1 to -49, defines a partnership as “an association of two or more persons to carry on as co-owners a business for profit.”  N.J.S.A. 42:1-6(1).  It also provides that “receipt by a person of a share of the profits of a business is prima facie evidence that he is a partner in the business,” subject to exceptions, one being receipt of the share of the profits “[a]s wages of an employee.”

Nadel and Starkman, entered into a number of written agreements, beginning in 1987, outlining the rights and obligations of the parties regarding their practice of law together.  Important facts memorialized in the agreements were: (1) sharing of profits, but not losses; (2) reference to Nadel having an “interest in the practice;” (3) no reference in the agreement to a “partnership agreement;” (4) that Nadel is to be “an independent contractor” rather than a partner; (5) no evidence of a filed partnership tax return or reported income on a Schedule K-1; (6) that the practice would continue to be owned solely by Starkman; (7) no mention of a separate entity (partnership).

The lower court found for Nadel, concluding that the 1988 Agreement “was susceptible of different conclusions in terms of whether there was a partnership” and since Starkman drafted the agreement, the judge interpreted the agreement against him and found there to be a partnership.   The Appellate Division reversed, however, holding that because the 1988 Agreement “precluded [Nadel] from exercising important rights of a partner and was not required to undertake one of the key obligations of a partner” (obligation to share in the losses) and Nadel’s preclusion from any role in management, the agreement did not create a true partnership.  

The court went on to say that when there is ambiguity in a contract, extrinsic evidence may be used to clarify the ambiguity, but evidence cannot be used to change the unambiguous terms of a contract.  As applied here, the Appellate Division stated that the trial judge “. . . discounted very specific language of Paragraph 8 that Starkman continued to own the firm . . . .”

Despite an implied partnership claim, or ambiguity in a contract, when there is unambiguous language referencing key terms, extrinsic evidence may not be used to alter the terms, or the meaning of the contract.  Notwithstanding the conduct of the parties, there were key factual issues that could not be ignored, most specifically the disclaimer of any interest in the partnership by Nadel, the failure to issue K-1s instead of paying Nadel as an independent contractor.