Policemen's Annuity and Benefit Fund of Chicago, Illinois v. DV Realty Advisors LLC
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EFiled: Nov 27 2013 04:09PM EST
Transaction ID 54627709
Case No. 7204VCN
COURT OF CHANCERY
OF THE
STATE OF DELAWARE
JOHN W. NOBLE
VICE CHANCELLOR
417 SOUTH STATE STREET
DOVER, DELAWARE 19901
TELEPHONE: (302) 739-4397
F ACSIMILE: (302) 739-6179
November 27, 2013
Bradley R. Aronstam, Esquire
Seitz Ross Aronstam & Moritz LLP
100 South West Street, Suite 400
Wilmington, DE 19801
Andrew D. Cordo, Esquire
Ashby & Geddes
500 Delaware Avenue, 8th Fl.
Wilmington, DE 19801
Henry E. Gallagher, Jr., Esquire
Connolly Gallagher LLP
1000 West Street, Suite 1400
Wilmington, DE 19801
Re:
Policemen’s Annuity and Benefit Fund of Chicago, Illinois v.
DV Realty Advisors LLC
C.A. No. 7204-VCN
Date Submitted: August 26, 2013
Dear Counsel:
The Plaintiffs, five Chicago public employee pension plans and the limited
partners of Nominal Defendant DV Urban Realty Partners I L.P. (the
“Partnership”), removed Defendant DV Realty Advisors LLC (“DV Realty”) as
General Partner of the Partnership and then obtained the Court’s confirmation of
Policemen’s Annuity and Benefit Fund of Chicago, Illinois v.
DV Realty Advisors LLC
C.A. No. 7204-VCN
November 27, 2013
Page 2
the validity and effectiveness of their action.1 The Court reserved jurisdiction to
address follow-on matters.
The first of those issues is whether DV Realty’s
interest in the Partnership, as a general partnership interest, converted into a
limited partnership interest on its removal or, as the Plaintiffs call it, “a mere
economic interest.” The second issue involves valuation of DV Realty’s interest in
the Partnership or, to use the concepts of the limited partnership agreement, a
determination of its capital account.
A. DV Realty’s Status
Under
the
Delaware
Revised
Uniform
Limited
Partnership
Act
(“DRULPA”), unless the partnership agreement provides otherwise, a person may
be admitted to the partnership as a limited partner only upon the consent of all of
the limited partners. By Section 17-301(b)(1) of the DRULPA:
(b) After the formation of a limited partnership, a person is
admitted as a limited partner of the limited partnership:
(1) In the case of a person who is not an assignee of a
partnership interest, including a person acquiring a partnership interest
directly from the limited partnership and a person to be admitted as a
limited partner of the limited partnership without acquiring a
partnership interest in the limited partnership, at the time provided in
1
Policemen’s Annuity and Benefit Fund v. DV Realty Advisors LLC, 2012 WL 3548206 (Del.
Ch. Aug. 16, 2012), aff’d, 75 A.3d 101 (Del. 2013).
Policemen’s Annuity and Benefit Fund of Chicago, Illinois v.
DV Realty Advisors LLC
C.A. No. 7204-VCN
November 27, 2013
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and upon compliance with the partnership agreement or, if the
partnership agreement does not so provide, upon the consent of all
partners and when the person’s admission is reflected in the records of
the limited partnership; . . . .2
Because none of the existing limited partners consented to DV Realty’s becoming
a limited partner, it has no specific statutory claim to that status. Moreover,
nothing in DRULPA supports the claim that a removed general partner’s interest
somehow automatically converts into a limited partnership interest.3
Thus,
consideration of the Partnership’s limited partnership agreement is necessary.4
Partnership law generally embraces freedom of contract, and, through the
partnership agreement, the partners may provide different procedures for becoming
a limited partner. The LPA allows for the transfer of a limited partnership interest
to a “substitute Limited Partner.”5
Any such transfer of an interest in the
partnership requires approval of the General Partner, and that has not been
2
6 Del. C. § 17-301(b)(1). Section 17-101(8) defines a “limited partner” as “a person who is
admitted to a limited partnership as a limited partner as provided in § 17-301 . . . .”
3
See, e.g., Hillman v. Hillman, 910 A.2d 262 (Del. Ch. 2006).
4
DV Urban Realty Partners I L.P. Third Amended and Restated Agreement of Limited
Partnership (the “LPA”) appears as Exhibit A to Def. DV Realty Advisors LLC’s Combined
Resp. Br. Regarding its Status as a Limited Partner and Opening Br. in Supp. of its Mot. for a
Determination of its Capital Account.
5
LPA § 9.2.
Policemen’s Annuity and Benefit Fund of Chicago, Illinois v.
DV Realty Advisors LLC
C.A. No. 7204-VCN
November 27, 2013
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obtained.6
Thus, no provision of the LPA expressly establishes a process—
automatic or otherwise—by which DV Realty may claim to have achieved limited
partnership status.
The LPA addresses the rights of a removed General Partner:
In the event of the removal of a General Partner . . . such General
Partner . . . shall retain 100% of its Capital Account . . . with 50% of
such Capital Account . . . being maintained on the same basis as any
other Limited Partner’s Capital Account, while the other 50% of such
Capital Account . . . shall be distributed to such General Partner in
cash within 30 days of the date of removal.7
This paragraph confirms that the removed General Partner retains its Capital
Account (subject to the buy-back of half of it). DV Realty seeks solace in two
aspects of this provision. First, its Capital Account is to be “maintained on the
same basis as any other Limited Partner’s Capital Account.”
The language
requiring the treatment of a person on the same basis as any other limited partner
may be read to suggest that the person would also be a limited partner. Second,
“Capital Account” is defined as “an account maintained for each Partner.”8
6
LPA § 9.1(a).
LPA § 3.10(a)(iii)(B)(1).
8
LPA § 1.1, at 3.
7
Policemen’s Annuity and Benefit Fund of Chicago, Illinois v.
DV Realty Advisors LLC
C.A. No. 7204-VCN
November 27, 2013
Page 5
“Partner,” in turn, means “a Limited Partner or a General Partner.”9 If DV Realty
has a Capital Account—which it does—then, based on the definitions in the LPA,
one can conclude that it is either a general partner or a limited partner. Because
DV Realty is no longer a General Partner, then through the very simple process of
elimination, it must now be a limited partner. The logic of these arguments is
appealing but, ultimately, unavailing.
First, it is unlikely that such a major issue in partnership governance would
be handled through a maze of financial valuation or definitional provisions,
especially when the LPA has specific provisions addressing how one becomes a
limited partner. Second, the provisions upon which DV Realty relies generally
deal with economic rights. Third, the removed General Partner still carries the
title, even if its status has been modified, of General Partner. If the removed
General Partner had become a limited partner, then one would have expected that
the LPA would have acknowledged that. Fourth, the removed General Partner is
no longer obligated to honor capital calls. Nothing in the LPA supports the notion
that there are two types of limited partners: some who must make additional capital
9
LPA § 1.1, at 7.
Policemen’s Annuity and Benefit Fund of Chicago, Illinois v.
DV Realty Advisors LLC
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contributions and some who bear no such burden. Finally, there is a reasonable
drafting explanation. Someone who holds an interest (not yet liquidated) as a
former partner, under the revenue laws, must be treated the same as a partner for
tax purposes. Perhaps “any other” was an infelicitous choice of words, but those
words do not change the clear intent of the LPA or introduce that type of ambiguity
that may be resolved by reference to extrinsic evidence.
Representatives or advisors to the Plaintiffs have made statements reflecting
their understanding that a deposed general partner would become a limited partner.
Maybe that is a common understanding or expectation, but it is not what either the
law or the LPA provides.
The Plaintiffs are not bound by such speculative
mistakes because (1) they are questions of law which are for the Court to resolve
and (2) DV Realty did not rely upon any of the statements.
Accordingly, DV Realty is not a limited partner of the Partnership. Whether
it holds an “economic interest” or a “mere economic interest” is a question that the
Court does not need to address.
Policemen’s Annuity and Benefit Fund of Chicago, Illinois v.
DV Realty Advisors LLC
C.A. No. 7204-VCN
November 27, 2013
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B. The Capital Account
The Plaintiffs invested approximately $66.5 million for a 95.1% interest in
the Partnership while DV Realty invested approximately $3.4 million for a 4.9%
interest in the Partnership, which is now worth approximately $294,000. The
Partnership’s assets are now worth approximately $6 million. Under the LPA, the
Partnership must buy back half of DV Realty’s interest (i.e., 50% of its Capital
Account). Thus, if that interest is to be purchased at current fair market value, DV
Realty would receive approximately $150,000, a number that does not compare
favorably with $1.087 million, which is half of its tax basis capital account based
on its 2011 Schedule K-1. In contrast, if DV Realty were paid half of its initial
investment, or half of its tax basis capital account, in consideration of a 2.45%
interest (half of its interest), an outcome would result that would not please the
Plaintiffs.
The Partnership looks to the LPA to find a way to use a current fair market
valuation. By Section 5.14(b) of the LPA, “[t]he Managing Partner may make, or
refrain from making, any elections relating to or affecting the Partnership under the
Policemen’s Annuity and Benefit Fund of Chicago, Illinois v.
DV Realty Advisors LLC
C.A. No. 7204-VCN
November 27, 2013
Page 8
[Internal Revenue] Code [of 1986, as amended].”10 Treasury Regulations allow an
increase or decrease in the partners’ capital accounts based on the fair market value
of the Partnership’s assets when a distribution is being made to a partner:
“[a] partnership agreement may, upon the occurrence of certain events, increase or
decrease the capital accounts of the partners to reflect a revaluation of the
partnership property (including tangible assets such as goodwill) on the
partnership’s books.”11 In order to adjust capital accounts in compliance with the
Treasury Regulations, five criteria must be satisfied:
1.
Adjustments must be based “on the fair market value of
the Partnership property.”
2.
The adjustments must reflect how “unrealized income,
gain, loss, or deduction” is allocated among the partners.
3.
Each Capital Account must be adjusted in accordance
with Treasury Regulation § 1.704-1(b)(2)(iv)(g) with respect to
allocations of depreciation, depletion, amortization, and gain or loss.
4.
The partners’ distributive shares of depreciation,
depletion, amortization, and gain or loss for revalued property must
account for the variations between the adjusted tax bases and the book
value of the property following the directions of § 704(c).
10
Through this provision, the parties accorded substantial discretion to the General Partner. The
General Partner is “the Managing Partner or the Co-General Partner.” LPA § 1.1, at 5.
11
Treasury Regulations § 1.704-1(b)(2)(iv)(f).
Policemen’s Annuity and Benefit Fund of Chicago, Illinois v.
DV Realty Advisors LLC
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5.
The adjustments must be made principally for a non-tax
business purpose.12
These requirements have been satisfied.13 With that, the LPA allows the
General Partner to make elections under the Code, and the Code, as elaborated in
the Treasury Regulations, authorizes the Partnership to value Capital Accounts
based on the fair market value of the Partnership property in connection with the
distribution.
The LPA offers another means by which fair market value calculations may
be performed by the Managing Partner. Section 5.11 of the LPA provides:
For purposes of calculating Partnership Percentages, Capital Account
balances, calculating and allocating Partner Guaranteed Payments, the
allocation of income and loss and distributions, and for all other
purposes, all timely Capital Contributions shall be deemed to have
been made on the same day and the Managing Partner shall be
permitted to adopt reasonable conventions for such purposes and any
such determination by the Managing Partner shall be final and binding
12
See generally Treasury Regulations § 1.704-1(b)(2)(iv)(f)(1)-(5).
The current General Partner, TCB Urban LLC (“TCB”), took the following steps: It based its
adjustments on the fair market value of the Partnership’s property. It based its allocation upon
each partner’s proportionate share. The third requirement was satisfied by using the LPA’s
definitions of depreciation and of net profits and net losses. As for the fourth requirement, the
LPA, in Section 5.15, requires that the revaluation take into account any variations between the
property’s adjusted tax basis and its book value. Finally, the adjustments were taken for a nontax business purpose, more specifically, for the distribution to a former partner in payment for
part of its partnership interest.
13
Policemen’s Annuity and Benefit Fund of Chicago, Illinois v.
DV Realty Advisors LLC
C.A. No. 7204-VCN
November 27, 2013
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on the Partners. Capital Accounts will not be adjusted by de minimis
contributions or distributions of cash or other property.
Adjusting values to fair market value constitutes a reasonable convention. In light
of the steep drop in value of the Partnership assets, such a revaluation is especially
appropriate.
The date for valuing the Capital Account is yet another source of
disagreement. The Partnership looks to December 31, 2012, as the first valuation
following DV Realty’s removal.14 DV Realty, instead, wants to use the 2011
Capital Account balance appearing on its Schedule K-1. The debate, in practical
effect, is about whether the assets should be valued contemporaneously or
historically. One wonders if the positions would be different if the value had
escalated as dramatically as it has declined.
The removal process took some time. Although the Plaintiffs may have
started considering DV Realty’s removal earlier, they formally gave notice on
January 30, 2012. Litigation commenced in this Court on February 1, 2012, and
was resolved in the Supreme Court in August 2013. DV Realty remained as a
General Partner until September 20, 2012, when TCB was designated as the new
14
DV Realty has not challenged the 2012 valuation numbers.
Policemen’s Annuity and Benefit Fund of Chicago, Illinois v.
DV Realty Advisors LLC
C.A. No. 7204-VCN
November 27, 2013
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General Partner. The LPA provides no helpful, express guidance on the timing of
the valuation.
The valuation should be near the date of termination.
reasonable observation leads to other abstract considerations.
This
If the General
Partner had left when the termination notice was given, then the proper date would
be more apparent. Here, however, DV Realty did not go upon receiving notice.
Instead, the Plaintiffs concluded that this litigation should be commenced.
Thus, in these circumstances, with no clear basis for setting the date, the
focus must be on reasonableness. The end of tax (calendar) year 2012 date is the
better choice because it more accurately reflects the economic realities of the
Partnership. DV Realty seeks a partial cash-out from the Partnership at a value
that is much larger than its 2.45% of the Partnership’s current fair market
valuation.15 That outcome finds no support in either the text or the logic of the
LPA.
DV Realty wants to add to its Capital Account $2 million for a loan on
which it was a co-borrower and $985,000 for a guarantee provided by one of DV
Realty’s principals for a portion of a Partnership loan. The LPA provides an
15
The LPA does not prescribe a date that leads to an unreasonable valuation. Thus, it is not
necessary to avoid the parties’ agreement.
Policemen’s Annuity and Benefit Fund of Chicago, Illinois v.
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C.A. No. 7204-VCN
November 27, 2013
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explanation for why DV Realty is not entitled to what it seeks. A partner’s Capital
Account will be increased by “the amount of any Partnership liabilities . . .
assumed by such partner . . . .”16 DV Realty is a co-borrower on the loans, but DV
Realty is not “ultimately liable”17 because it is entitled to contribution from the
Partnership.18 As for the guarantee, it was not made by DV Realty; instead, it was
provided by one of DV Realty’s principals. As such, the guarantee does not
operate under the LPA to increase DV Realty’s Capital Account through its
principal’s personal and individual guarantee.
It should also be noted that DV Realty, while it was General Partner, made
no changes to its Capital Account for either of these reasons.
A somewhat technical argument by the Plaintiffs—one upon which the
Court need not rely—also supports this outcome. The LPA, in Section 6.1(f),
requires the Advisory Committee to approve any transaction involving the General
Partner. The Advisory Committee did not approve either of these transactions
(assuming that DV Realty’s principal somehow qualifies as a general partner for
16
LPA § 1.1, at 3.
See Treasury Regulations § 1.704-1(b)(2)(iv)(c).
18
This also applies to the $985,000 loan guaranteed by one of DV Realty’s principals.
17
Policemen’s Annuity and Benefit Fund of Chicago, Illinois v.
DV Realty Advisors LLC
C.A. No. 7204-VCN
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these purposes). Thus, no advantage may be gained by DV Realty for either the
$2 million as a co-borrower or for the guarantee of payment of $985,000 for
purposes of calculating its Capital Account.
Finally, there is debate about when the Partnership should have paid (or
should pay) DV Realty for 50% of its Capital Account. Until August 2013, DV
Realty was appealing this Court’s order confirming its removal as General Partner
and sought to be reinstated as a General Partner. The LPA provides that payment
should be made within thirty days of removal of the General Partner, but as long as
the General Partner contests its removal on appeal, there is no reason why the duty
to pay should not have been stayed in an effort to avoid the complications that
would ensue if the General Partner’s interests were, in part, paid and then it was
reinstated. Payment of half of its Capital Account was due DV Realty within thirty
days of the Supreme Court’s decision; interest will accrue on sums due DV Realty
thereafter.
Policemen’s Annuity and Benefit Fund of Chicago, Illinois v.
DV Realty Advisors LLC
C.A. No. 7204-VCN
November 27, 2013
Page 14
Counsel are requested to confer and to submit an implementing form of
order.
Very truly yours,
/s/ John W. Noble
JWN/cap
cc: Register in Chancery-K
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