With apologies to the King James Bible, what the Manhattan real estate market giveth, a poorly conceived partnership agreement taketh away.
It’s the best explanation I can offer for three successive lawsuits lasting almost fifteen years and counting between two partners in a general partnership that owns a full-floor unit in a commercial co-op building in Manhattan’s Garment District and, since the death of one of the partners in 2011, between the deceased partner’s estate and the surviving partner.
The partnership, known as S-L Properties, acquired the unit in 1984. Its two partners, Robert Liss and Sage Systems, Inc., held 43.07% and 56.93% partnership interests, respectively. Under their agreement, the partners each took assigned portions of the unit for the use of their two, separate businesses. From what I can tell, the purchase price was around $250,000. For anyone familiar with Manhattan real estate values, that tells you right away that, whatever was paid for the unit in 1984, its value grew exponentially by the time litigation broke out in 2006, and super-exponentially at current market values. That’s the “giveth” part.
The partnership had a 40-year fixed term under its written partnership agreement, subject to early termination in the event of a partner’s death, upon which the surviving partner has an option to purchase the deceased partner’s interest for a fixed price essentially equal to the decedent’s cash contributions plus 6% interest from the date of each contribution. That’s the “taketh away” part.
The litigation unfolded in three acts:
- In Act One, Liss sought judicial dissolution of the partnership and liquidation of the partnership’s realty asset for Sage’s alleged violations of the proprietary lease’s subletting provisions.
- In Act Two, Liss filed a second lawsuit against Sage for an accounting. Following Liss’s death, Sage filed an amended countersuit to compel a buy-out of the Liss estate’s partnership interest at the fixed price under the partnership agreement.
- In Act Three, Sage sued Liss for contractual indemnification of its legal expenses defending the dissolution lawsuit.
Intrigued? Read on to find out what happened.
Act One: Liss Sues to Dissolve the Partnership
In 2006, Liss sued Sage for judicial dissolution of the partnership. His petition (read here) alleged that in 1984 the co-op, by letter from its president, consented to the partnership’s subleasing of assigned portions of the unit to Liss and Sage for use by their separate businesses; that the letter further consented to Liss’s and Sage’s sub-subleasing to third parties of their respective portions of the unit so long as one or more of the partners remained in occupancy of at least 51% of the entire premises; and that beginning in 2004, without the co-op’s consent, Sage sub-subleased an excessive share of its portion of the unit, thereby placing the partnership in violation of its proprietary lease and jeopardizing Liss’s use and occupancy of his portion of the unit.
In February 2009, the court granted summary judgment in favor of Sage dismissing the complaint. The court’s decision, which you can read here, found:
- first, that the 1984 letter from the co-op’s president upon which Liss relied did not constitute a condition of subletting under the proprietary lease because it never was approved by the co-op’s board;
- second, that Liss “has unclean hands with respect to his demand for the equitable relief of dissolution” based on his deposition testimony that the co-op board did not consider Liss’s own subleasing of 90% of his portion of the unit for terms of less than one year to be “real” leases, ergo Liss conceded that the alleged 51% retainage, even if required, was not breached; and
- third, Liss failed to proffer any evidence of “prejudice or lack of reasonable practicability of carrying out the partnership’s business that the sublets pose or that [Sage] has placed the Partnership in violation of any local or state building codes” that would justify dissolution under Partnership Law § 63.
Act Two: Liss Sues for an Accounting But Soon Afterward Dies, Triggering Sage’s Countersuit to Enforce a Fixed-Price Buy-Out
Having failed in his quest for judicial dissolution, in May 2010, Liss filed a new lawsuit against Sage asserting claims for an accounting and compensatory damages based on Sage’s alleged withholding of partnership books and records and misappropriation of $50,000 of partnership funds.
The case was just warming up when, in February 2011, Liss died, after which the case seemingly went into hibernation for over four years. In 2015, with Liss’s son as executor litigating on behalf of his father’s estate, Sage filed amended counterclaims alleging that following Liss’s death, it properly exercised its option under Section 12.02 of the partnership agreement (read here) to purchase Liss’s partnership interest for a fixed purchase price as formulated in Section 11.01 (a). Under the latter section, according to Sage, the purchase price totaled approximately $469,000 computed as 43.07% of the unit’s acquisition and renovation costs plus a 6% interest factor.
Following discovery both sides moved for summary judgment granting their own respective claims and dismissing each other’s claims. Liss’s estate argued that Sage failed to give proper and timely notice of its exercise of its option to purchase the estate’s interest and, assuming it properly exercised the option, that Sage miscalculated the purchase price by excluding Liss’s share of mortgage monthly interest payments over a 14-year period and his contributions toward the building mortgage.
In August 2018, New York County Supreme Court Justice Barbara Jaffe issued a Decision and Order (read here) in Sage’s favor on its claim for specific performance of the fixed-price buy-out. First, Justice Jaffe rejected the estate’s challenge to the sufficiency of Sage’s notice of its purchase-option exercise. Next, addressing the disputed purchase price, she also agreed with Sage that the formula excluded Liss’s payments toward the building mortgage, included within his pro rata share of monthly maintenance charges, because the payments were made to the co-op and not as contributions to the partnership as specified in Section 11.01 (a) of the partnership agreement. By the same reasoning, the court also held excludable from the fixed-price formula the principal and interest payments made by the partners directly to the holder of the unit mortgage.
The court subsequently entered a judgment requiring the estate to vacate its portion of the unit and terminating its partnership interest upon Sage’s tendering of the $469,000 fixed price for the estate’s interest.
The estate obtained a stay of enforcement of the judgment pending its appeal to the Appellate Division, First Department. In its ruling on the merits in September 2019 (read here), however, the appellate panel agreed with the lower court’s reasoning and affirmed the judgment.
Act Three: Sage Sues for Indemnification
In 2010, Sage filed its own action against Liss and, subsequently, against Liss’s estate, asserting a claim for indemnity under Section 13.02 (b) of the partnership agreement to recover its legal fees and expenses incurred defending itself in the dismissed dissolution action. Section 13.02 (b) provides:
The Partnership and the other Partners shall be indemnified and held harmless by each Partner from and against any and all claims, demands, liabilities, costs, damages, expenses and causes of action of any nature whatsoever arising out of or incident to any act performed by a Partner which is not performed in good faith or is not reasonably believed by such Partner to be in the best interests of the Partnership and within the scope of authority conferred upon such Partner under this Agreement, or which arises out of the fraud, bad faith, willful misconduct or negligence of such Partner.
Sage’s indemnity lawsuit, like Liss’s second lawsuit following his death, went into hibernation for over four years before substitution of the estate, resumption of discovery and, eventually, dueling motions for summary judgment.
In her Decision and Order issued last May (read here), Justice Jaffe ruled in Sage’s favor and entered an $80,000 judgment against Liss’s estate to indemnify Sage for its legal fees and expenses defending the dissolution action dismissed over 10 years before.
Justice Jaffe devoted the bulk of her analysis to the estate’s argument that Section 13.02 (b) did not satisfy the “unmistakably clear” standard established by the New York Court of Appeals’ 1989 decision in Hooper Associates v AGS Computers, Inc. for direct indemnity between parties to an agreement as opposed to third-party claims. Citing a number of intermediate appellate precedents, Justice Jaffe concluded that Section 13.02 (b), while containing “no reference to direct claims between the parties,” nonetheless satisfied Hooper because the provision uses
broad and inclusive language, i.e., “any and all claims,” the absence of a limit on the types of proceedings covered by the indemnity provision, and the absence of an impact that would render meaningless other provisions of the agreement at issue.
Justice Jaffe ultimately found that Liss filed his dissolution action in “bad faith” within the meaning of Section 13.02 (b), but not for the reason urged by Sage. Sage argued that Liss sought dissolution to secure a $66,000 commission on the post-dissolution sale of the unit to a potential buyer who, in 2005, made a $2.2 million purchase offer. Justice Jaffe considered the proffered motive too speculative and the projected commission too small to “warrant a finding that [Liss] commenced the dissolution action solely in order to obtain that sum of money.”
Instead, based on her own review of case precedent holding that an unclean hands defense requires a finding of bad faith, Justice Jaffe held that the court’s 2009 decision dismissing the dissolution action, in which it found that Liss “has unclean hands” and that his claims had no merit, “constitutes bad faith, thereby triggering [Liss’s] duty to indemnify [Sage] for its expenses incurred in defending itself in that action.”
Some Closing Thoughts
- Over a decade after Liss first filed suit, and eight years after his death, Liss got the partnership dissolution he wanted, but not in the manner he wanted and not for the money he wanted. I don’t know the unit’s market value as of last year when Sage tendered the $469,000 but I would hazard a guess that the amount doesn’t come anywhere close to 43% of market value. That’s without considering 15 years of Liss’s and his estate’s own legal fees and the $80,000 indemnity judgment against the estate.
- The litigation isn’t over! The estate is appealing Justice Jaffe’s May 2020 indemnity decision and judgment in Sage’s lawsuit. Meanwhile, Justice Jaffe’s 2018 decision and judgment in Liss’s second lawsuit did not dispose of all of the parties’ claims and counterclaims. In that action, the parties recently stipulated to extend the deadline for filing the note of issue, certifying that the remaining claims are trial-ready, due to the pendency of the just-mentioned appeal. At some point there’ll be a trial unless the parties at long last settle.
- A fixed price buy-sell provision for any interest in any business entity is a bad enough idea, but for an interest in a 40-year term partnership that owns Manhattan real estate, I daresay it’s reckless at best. In addition, even assuming Liss and Sage had their reasons for using a fixed-price formula predicated on a return of capital investment plus interest, why would they draft the provision in such a way as to exclude or include partner contributions to pay down balances on the building and unit mortgages depending whether the contributions were or were not funneled through the partnership? Perhaps they had other, tax-related reasons not to account for the payments as partnership contributions, but if so, were they cognizant of the negative impact on the fixed-price outcome?
- Finally, this is not the first time I’ve written about a case in which the Grim Reaper in midstream dramatically changed the course of business divorce litigation. At least the owner of Sage had the good sense to hold his partnership interest through his corporation.