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Current Developments— Partnerships and LLCs 2003 |
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CURRENT DEVELOPMENTS IN CALIFORNIA LAW AFFECTING PARTNERSHIPS AND LIMITED LIABILITY COMPANIES - 2003
While things were relatively quiet on the legislative front, California courts grappled with some complex and interesting issues affecting partnerships and limited liability companies during the 2003 year.
Everest Investors 8 v. McNeil Partners One of the most important cases of the year, focusing on the distinction between partnership derivative versus individual actions, is . Plaintiffs in this case are a number of California LLC’s (together referred to as “Everest”) which held limited partnership interests in the McNeil Partnerships, a group of fourteen public real estate limited partnerships that owned more than 80 commercial, income and self storage properties. The litigation history between the parties is a long one. In 1995, a class action, known as the “Schofield” action, was filed by some of the McNeil Partnerships against the general partner and Robert McNeil alleging various breaches of fiduciary duties. A settlement was reached in the Schofield action, the terms of which included sale of the partnerships’ real estate assets. The settlement provided that class members could request exclusion from the class claims raised in that case, but could not opt out of that portion which settled derivative claims. This “opt out” provision set the stage for the current suit, which required the court to determine whether certain claims were derivative or individual. The partnership assets were sold to Whitehall Street Real Estate (Whitehall) for a price of $644,440,000. As structured, this transaction resulted in a merger of Whitehall and the McNeil partnerships, with the general partner retaining an equity interest in the new entity. The general partners continued to profit from the sale of the real estate when the new entity “flipped” some of the properties less than a year after the sale. This led the former limited partners to complain that they had been excluded from the profit participation, while their former general partners reaped a continued share of the profits. For example, the self storage properties, valued at $35 million in the acquisition, were resold by Whitehall within weeks for $42 million. Everest filed suit, with causes of action including breach of fiduciary duty, unfair competition and constructive fraud. The action included allegations that selling all of the properties together to one buyer failed to maximize the purchase price, that allocation of $35 million of the purchase price to Robert McNeil’s management company allowed the general partners to benefit at the expense of the investors, and that payment of an $18 million dollar “break up” fee, as well as a $2 million dollar “success” fees to company insiders, all served to discourage other bidders, thereby depressing price obtained for the properties, and give control to the McNeil controlled entities.
McNeil brought a summary judgment motion based upon its arguments that the claims were derivative in nature and therefore barred under the Schofield settlement, and further, that they were barred by application of the business judgment rule. The trial court granted McNeil’s summary judgement motion, and Everest appealed.
Everest’s opposition to McNeil’s summary judgment motion, and appeal of the trial court’s ruling, included the following arguments:
Its action was individual or direct and California law allows a limited partner to proceed directly against a general partner who breaches its fiduciary duty by misallocating proceeds among itself and the limited partners. In this situation, the action is direct and not derivative because the limited partners are harmed, but the general partner is not harmed . . . .,
Everest Investors 8 v. McNeil Partners, id, 114 Cal. App. 4th at 421 [arguing that the merger itself is a breach of fiduciary duty for its failure to maximize returns to the limited partners].
The Court of Appeal reversed and ordered the summary judgment in McNeils’ favor vacated. In its decision, the court followed the holding in the 1969 California Supreme Court the case known as Jones v. H. F. Ahmanson & Co. (1969) 1 Cal.3d 93, 108, 81 Cal. Rptr. 592, 460 P.2d 464 (“Jones”), in which the court stated that,
Self-dealing in whatever form it occurs should be handled with rough hands for what it is--dishonest dealing. And while it is often difficult to discover self-dealing in mergers, consolidations, sale of all the assets or dissolution and liquidation, the difficulty makes it even more imperative that the search be thorough and relentless.
Jones, id., 1 Cal. 3rd at 111. Jones involved self dealing by the majority shareholders of a savings and loan by creation of a holding company and transfer of shares into that company by the majority, a scheme that excluded minority shareholders, causing their shares to become worthless to anyone except the majority’s holding company. The minority’s claims in the Jones case were held to be individual, rather than derivative, as the plaintiffs were not seeking compensation for the corporation for injury to the company. Instead, the court found that the injuries complained had been suffered by the individual minority shareholders. The Court ruled that the plaintiff minority shareholder’s claims need not be unique in order to be individual, rather than derivative, rejecting the reasoning in the case of Shaw v. Empire Savings & Loan Assn. (1960) 186 Cal. App. 2d 401, 407, which stated that a unique injury was required to support an individual action. The Jones court further noted that Jones no special relationship between the complaining party and the wrongdoer was required to support such an individual claim, other than the stockholder relationship.
By Denise Olrich, Partner, Welch & Olrich, LLP
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