Parking lots breed partnership disputes. I’ve litigated them and I’ve written about them, most notably the Kassab saga.
I suppose it’s the untapped development potential of parking lots, especially in flourishing downtown urban areas, that creates conditions ripe for dissension among co-owners with different investment goals and time horizons.
Such was the case in Blue Equity Holdings Kentucky, LLC v Cobalt Riverfront Properties, LLC, No. 2018-CA-001092-MR [Ky Ct App Aug. 30, 2019], in which a parking lot in downtown Louisville, Kentucky was the setting for a ruling by that state’s Court of Appeals in a judicial dissolution proceeding requiring it to construe the purpose clause of an LLC agreement.
Kentucky’s judicial dissolution statute for LLCs, like New York’s, requires a showing that it is “not reasonably practicable to carry on the business of the [LLC] in conformity with the operating agreement.” Relevant to the statutory standard under Kentucky law, as under New York law as articulated in 1545 Ocean Avenue, is whether the managing members of the LLC are unwilling to promote the LLC’s purposes as set forth in the operating agreement.
The Operating Agreement
The subject LLC in Blue Equity was organized by the Blues brothers — no, not those Blues Brothers — Johnathan (46.3%), Todd (46.3%), and Brent Blue (7.4%) to acquire a single piece of real property in downtown Louisville located close to a sports stadium and concert arena. The purpose clause of the LLC’s amended operating agreement provided in relevant part:
To purchase, acquire, invest in, own, improve, develop, maintain, lease, sell, exchange, and otherwise deal in and with respect to the property described on EXHIBIT A (the “Property”), including, without limitation, operating a parking lot, and holding and conducting corporate and other special events, such as concerts and sporting events, in, on and around the Property.
The Property was being used as a parking lot under lease to third parties at the time the operating agreement was entered into in 2004 and, apparently, in all subsequent years. The agreement designated Todd as sole managing member.
During a “Pre-Development Period” defined as “the period prior to the Sale or Development of the Property, including without limitation, the period during which the Property is operated as a parking lot,” the agreement entitled Todd to a “reasonable management fee” and to receive 92.6% of the LLC’s net income (i.e., his own and Johnathan’s pro rata shares) in exchange for managing the Property and absorbing 92.6% of the LLC’s expenses.
Johnathan’s Dissolution Petition
In 2017, Johnathan petitioned to dissolve the LLC claiming that it was not reasonably practicable to carry on its business in conformity with the operating agreement.
Specifically, Johnathan alleged that “it was always understood and intended that the Property would be developed, leased and sold” and that the LLC’s purpose was being frustrated by Todd who allegedly refused to take any steps to develop or sell the Property in order to continue receiving an annual management fee of $138,000 plus 92.6% of the profits from parking lot operations. According to Johnathan the Property had a market value of $40 million.
The LLC and Todd moved to dismiss the petition, arguing that the Property had been operated as a parking lot for 13 years and that such use was consistent with the LLC’s stated purpose as set forth in the operating agreement. They also stressed that the operating agreement vested all decision-making authority in Todd as the sole managing member.
The circuit court agreed and dismissed the petition. Johnathan appealed.
The Appellate Court’s 2-1 Affirmance
Over the dissent of one of the members of the three-judge panel, the Court of Appeals affirmed the lower court’s dismissal order.
The majority opinion quotes from Johnathan’s appellate brief where he argued that the operating agreement’s purpose clause is “ambiguous” and that:
In order to give to give effect to all parts and every word of the Amended Operating Agreement . . . [the LLC] cannot be prevented from operating the Property as a surface lot as long as it is also trying to develop, lease, and sell the Property.” [Emphasis in original.]
The majority disagreed, finding that the stated purposes of the LLC as set forth in the agreement “are clear and unambiguous” and that:
[the purpose clause] plainly sets forth myriad purposes, including to develop, to sell, and to operate a parking lot on the real property. Simply stated, [the purpose clause] envisions multiple purposes of [the LLC] directly related to the real property. These purposes specifically include operating a parking lot. And, under the Amended Operating Agreement, Todd Blue is the sole managing director, president, and CEO of [the LLC]. . . . The Amended Operating Agreement vests sole decision-making authority concerning [the LLC] in Todd Blue. So, Todd Blue possesses the discretion to utilize the real property in accordance with any of the stated purposes set forth in [the purpose clause], and the undisputed facts indicate that Todd Blue has done so by operating a parking lot thereupon.
The majority also rejected Johnathan’s argument that the defined Pre-Development Period “impliedly necessitates a development period when the real property would be developed or sold.” Rather, the majority wrote:
By providing for a pre-development period in connection with the real property, the Amended Operating Agreement merely addresses the rights and obligations of the parties during such a period; it is simply a thorough Amended Operating Agreement. And, we are unable to create an ambiguity where none exists or to add terms to an unambiguous contract. Therefore, we conclude that [Johnathan] has failed to demonstrate that [the LLC] is not pursuing its business in accordance with the purposes set forth in the Amended Operating Agreement. [Citations omitted.]
The dissenting judge would have reversed the lower court’s dismissal order, reasoning as follows:
The [dissolution] statute does not state if it is impossible for the business to be carried on in conformity with the operating agreement. The question posed by the statute is whether it is reasonably practical to do so. In this matter, the minority shareholder [sic] allegedly receives no benefit for its ownership of the property in question, a situation that may last forever. While it may be possible for the business to continue thusly, is it reasonably practical? The appellant was entitled to a hearing to determine that question.
Don’t Blame the Purpose Clause
Courts in New York, Kentucky, Delaware, and many other states have made the operating agreement’s purpose clause an analytic centerpiece of the judicial inquiry under dissolution statutes interpreted by the courts as requiring a showing that the LLC’s “stated purpose” has been frustrated.
The purpose clause in Blue Equity is less generic than some I’ve seen and written about for realty holding LLCs, and more generic than others. But overall, its choice of language, including its laundry list of options to operate, develop, lease, exchange, or sell the property, is typical of purpose clauses used in owner agreements for realty holding companies whether organized as partnerships, corporations, or LLCs.
For Johnathan Blue, the true problem was not the purpose clause. Rather, he found himself disempowered and unable to monetize his investment in the LLC because of other provisions in the operating agreement giving his brother Todd sole management authority and discretion in regard to the LLC’s business affairs, and transferring to Todd the lion’s share of parking lot income and profit.
Johnathan likewise was handicapped by the omission of any provisions in the operating agreement setting a timetable for developing or selling the realty or, alternatively, giving Johnathan buyout rights if the property was not developed or sold within a defined period.
The opinion doesn’t mention whether Johnathan had his own legal counsel advising him in the negotiation and drafting of the amended operating agreement. Given that the three members were brothers, my guess is he didn’t, which may be the ultimate lesson to be taken from Blue Equity.