In 1994, the Uniform Law Commissioners completed a top-to-bottom overhaul of the Uniform Partnership Act (UPA) of 1914. The 1994 version, which was further amended in 1997, has been adopted by a large majority of the states. New York is not one of them.
Under both the old and the new UPA, the death or withdrawal of a partner is or can be a dissolution event. One of the historical vestiges of the 1914 UPA, which the 1994 UPA eliminated, provides that when a partner retires or dies and the business is continued by the other partners,
he or his legal representative . . . shall receive as an ordinary creditor an amount equal to the value of his interest in the dissolved partnership with interest, or, at his option or at the option of his legal representative, in lieu of interest, the profits attributable to the use of his right in the property of the dissolved partnership.
The 1994 UPA ditched the election to receive a share of the profits. Instead, it provides only for the payment of interest on the valuation amount from the date of dissociation to the date of payment. I haven’t studied the history and commentary surrounding the change, but I’d wager the commissioners concluded that the calculation of interest inherently is simpler, faster and less prone to litigation than the determination of business profits.
If my wager is correct, there’s no better advertisement for the commissioners’ wisdom than Breidbart v. Wiesenthal, 2013 NY Slip Op 05040 (2d Dept July 3, 2013), decided earlier this month by the Brooklyn-based Appellate Division, Second Department. The case, which started in 2002 following the dissolution of a real estate partnership, over the years has generated countless motions, multiple hearings and no less than five decided appeals. This month’s ruling dealt with a question that would not exist under the 1994 UPA, namely, whether an election by an ex-partner to receive a share of profits in lieu of interest encompasses appreciation in value of partnership assets after the date of dissolution. The answer: No.
Breidbart involves a real estate business started in the 1920’s by Isadore Breidbart and Samuel Goldstein. In 1986, the ownership of five parcels of commercial realty was restructured into five partnerships each owned 50% by Breidbart’s testamentary trust and 50% by a partnership of Goldstein’s two children (the “Goldstein Partnership”).
The Breidbart trust terminated in April 2000 after the death of Breidbart’s daughter. The departing trustee’s final accounting directed a distribution to the Breidbart Remaindermen in the form of assignments of their proportionate interests in the trust’s real estate partnerships. The Breidbart Remaindermen sued in 2002, attacking the validity of the 1986 restructuring and seeking to enforce their ownership rights in the real properties. The Goldstein Partnership contended that the Breidbart Remaindermen were assignees of partnership interests entitled only to share in the partnership profits.
The Prior Appeals
In 2004, the Appellate Division, Second Department, set the stage for the next nine years of valuation disputes by ruling that the five realty partnerships terminated in April 2000 upon the death of Briedbart’s daughter, and that the trustee’s purported assignment of partnership interests had no effect. The court’s decision, reported at 10 AD3d 346, held that the Breidbart Remaindermen’s rights were governed by Partnership Law § 73, which tracks the above-quoted language of the 1914 UPA, entitling them to recover the value of their interest in the partnerships as of April 2000 plus, at their option, interest or post-dissolution profits.
A pair of additional appellate rulings in 2007 (read here and here) held that the Breidbart Remaindermen were not bound by the partnership values included in the trustee’s final account for purposes of determining his commission; ordered the lower court to appoint a real estate appraiser to value the partnership properties as of April 2000; ordered a valuation hearing; and ordered that the Breidbart Remaindermen were not required to elect between interest and profits under Partnership Law § 73 until after determination of the value of their interests in the dissolved partnerships.
In 2012, the Appellate Division decided another appeal, this time by the Goldstein Partnership, from a lower court order permitting the Breidbart Remaindermen to contest whether one of the five partnerships had been dissolved. The appellate court reversed the ruling below, holding that its 2007 order precluded re-opening the issue of dissolution. (Read decision here.)
The Latest Appeal: Is Appreciation Part of “Profits” Under § 73?
In late 2011 the parties stipulated to the appraised values of the partnership realty. This apparently occurred after the parcels of real estate owned by the partnerships were sold for amounts and gains not disclosed in the court decisions. The Breidbart Remaindermen then elected under Partnership Law § 73 to receive, in lieu of interest, their share of post-dissolution profits through the date of judgment. At the same time, they requested a ruling by the trial court declaring that the gain on the sale of the real estate parcels owned by the partnerships constitutes “profits” within the meaning of Partnership Law § 73.
In an unreported decision dated April 4, 2012, the trial court granted the request, prompting the latest appeal by the Goldstein Partnership.
The appellate court reversed, holding that the trial court erred by determining that “profits” under § 73 include the gain on the sale of the partnership’s realty. The court offered little analysis, other than its citation to a 1976 opinion by the Appellate Division, Fourth Department, in Harold J. Rosen Trust v. Rosen, 53 AD2d 342, aff’d, 43 NY2d 693 (1977).
In Rosen, the death of a partner in a real estate partnership that owned multiple properties triggered dissolution as of year-end 1964. In 1967, the estate of the deceased partner started what turned into a decade-long lawsuit against the surviving partners who neither had liquidated the partnership assets nor purchased the estate’s interest in the business. Ultimately the court determined that the estate’s rights were governed by Partnership Law § 73, and the estate elected to receive post-dissolution profits in lieu of interest.
One of the many issues the appellate court in Rosen dealt with was whether the referee properly included in his computation of post-dissolution profits the gain realized on the sale of one of the partnership properties in 1971. In holding that the referee erred, the court reasoned that post-dissolution appreciation in fair market value of partnership property does not bear on annual income or profits, and that permitting the electing partner to participate in post-dissolution appreciation is inconsistent with fixing the fair market value of the partnership interest as of the date of dissolution. Here’s the relevant portion of the court’s ruling:
We do, however, find error in the referee’s inclusion of the $95,681 gain realized on the 1971 sale of the Skokie, Illinois property in his determination of post-dissolution profits. In making its election as to the method of recovery, albeit after the referee’s determinations, plaintiff elected to receive its one-third interest in the partnership assets valued as of December 31, 1964 plus one third of the post-dissolution profits up to the date of the judgment. Implicit in this election is the right to receive a proportionate share of any increase in the fair market value, but only up to 1964. After that date subsequent increases would be reflected merely in the total net worth of the partnership and not in its annual income or profits. These subsequent increases would inure only to the benefit of the surviving partners upon the eventual sale of the properties.
The fact that such a sale occurred during the period of accounting should not, in our opinion, alter the basic rationale of the election. Although a “gain” was in fact realized on the sale of the Skokie, Illinois property, this gain is properly attributable to the increase in the fair market value of the property. Since plaintiff’s share of that fair market value was, pursuant to its election, immutably fixed at the December 31, 1964 valuation date, a share of this subsequent increase was not properly distributable to plaintiff and should not have been added to the post-dissolution profits.
It is, indeed, hard to argue with the court’s logic excluding post-dissolution appreciation from “profits” under § 73. Think of it this way: the sale of the income producing partnership realty at fair market value captures the present value of the property’s future income stream in perpetuity. A fair market value appraisal of the property as of a fixed valuation date (i.e., the dissolution date) does the same thing. Inclusion of post-dissolution appreciation therefore would give the partner whose interest is being valued a double-dip windfall.
One final observation: So long as § 73 remains the law, the election between interest and profits will be influenced by the spread between prevailing rates of return and the statutory interest rate which has been fixed at 9% in New York since 1981. In today’s economic climate, a risk-free 9% rate of return would be considered terrific.