It’s no accident this blog has featured dozens of posts involving disputed capital calls. It’s a common scenario in the world of closely held firms, not always but sometimes pitting the interests of the passive owners in maintaining their equity slice and getting the biggest bang from the fewest bucks, versus the interests of the active owners — not that they don’t share the same profit motive — in having sufficient capital to operate and build the business or, in the case of real estate development projects, to finance and build the building.

The challenges to capital calls generally fall into familiar categories singly or in combination: the passive owner claims an improper squeeze-out motive, or an improper dilution motive, or manipulation of a future waterfall, or lack of authority or procedural non-compliance under the governing agreement.

In two decisions issued on the same day last week by the Manhattan-based Appellate Division, First Department, both involving real estate projects, the court addressed challenges of the latter type, that is, claims by the passive owners that capital calls issued by the controllers were unauthorized by governing agreements.

In one decision, the appellate panel unanimously reversed the motion court’s construction of dueling “notwithstanding” provisions in the operating agreement, holding that the capital call was authorized and the passive owner who failed to meet the call lost its consent power concerning the project’s development budget.

In the other, the panel unanimously affirmed the motion court’s decision green lighting a passive owner’s lawsuit to invalidate capital calls and rejecting the controlling owner’s argument that it was not required to seek third-party loans before making the calls.

HNA Holdings

This is my second run at the HNA Holdings case entangling parties to a Delaware limited partnership agreement. Last year I wrote about the motion court’s decision requiring it to reconcile the LPA’s mandatory capital call provision and a major decisions provision, each of which was preceded by close variants of the ubiquitous phrase, “Notwithstanding anything herein to the contrary.” Rather than repeat the case background, I urge you to detour to my earlier post before continuing here.

For those who don’t, I’ll simply show truncated versions of the dueling provisions:

• Section 3.02(e) (“Mandatory Capital Contributions”) provides, “Notwithstanding anything herein to the contrary,” any party that fails to make its share of a required capital contribution “shall permanently lose all of its rights . . . to vote on or approve any matters that would otherwise require its approval pursuant to this Agreement . . ..”

• Section 6.01(e) (“Management”) provides, “Notwithstanding anything to the contrary contained in this Agreement,” TSCE cannot cause the LP to proceed with any Major Decision without HNA’s prior written consent.

Acknowledging that the two provisions “appear to be in conflict (or at least in tension),” among several other linguistic nuances the court read the capital call provision’s use of “herein” as limited to Article 3 of the agreement and therefore subordinate to the major decision provision’s indefinite “contained in this Agreement,” i.e., the broader, more indefinite term trumps the narrower, more definite term.

As noted above, the Appellate Division’s decision last week reversed. Parting ways with the motion court, the panel cited Delaware law for the proposition that “herein” refers to the entire agreement, not just its Article containing the capital call provision. As the court wrote:

The language of the [capital call] penalty provision is indisputably broad, with the phrase “approve any matters” unambiguously encompassing plaintiffs’ major decision “consent” rights in the major decisions provision. If the parties had wished to limit the broad scope of the penalty provision, they could have done so explicitly.

The panel further explained:

While “notwithstanding” language can sometimes evince an intent that the clause it modifies will outrank all other contractual terms (see e.g. Estate of Crist, 863 A2d 255, 258 [Del Ch 2004], affd 879 A2d 602 [Del 2005]), this is not the case here. General “notwithstanding” language is used repeatedly throughout this LPA (and indeed prefaces both of the relevant provisions at issue), which was likely a product of inartful drafting rather than a specific intent to prevail over other contractual provisions. [Emphasis added.]

Nor is there anything specifically “contrary” to the major decisions provision in the penalty provision. The purpose of the major decisions provision is generally to bestow rights to plaintiffs; the purpose of the penalty provision is to take them away upon a party’s default, which indisputably occurred here. It is well settled that the “more specific provisions [in a contract] will generally prevail over” and “qualify the meaning of the general ones” (Reybold Venture Group XVI LLC v Furniture Servs. Unlimited, LLC, 2014 WL 7010757, *5, 2014 Del Super LEXIS 623, *13-14 [Del Super, Nov. 16, 2014, C.A. No. N10C-05-078 RRC], affd 115 A3d 1215 [Del 2015]).

The real estate joint venture in HNA Holdings involves a nine-figure development project at the site of the former Macy’s department store in downtown Brooklyn. We can safely assume highly sophisticated lawyers negotiated and drew up the LPA, which makes the court’s reference to the “inartful drafting” all the more ouch-worthy.

I won’t pretend there’s a hard and fast lesson to be drawn from the panel’s decision, other than to use notwithstanding clauses with greater precision. Construing “herein” and “contained in this Agreement” as equivalents by itself doesn’t provide especially meaningful guidance. The same holds true for the court’s observation that contracts can always state the parties’ intent more explicitly. What’s left? That given two provisions with equal canceling force, the provision taking away party rights prevails over the provision granting party rights? Doubtful. Makes me glad to be a litigator rather than a contract lawyer.

Capitol Hill

Having noted the HNA Holdings court’s ouch-worthy comment about inartful drafting in a case that resulted in an appellate reversal, it’s only right and proper to begin my discussion of the Capitol Hill case, which garnered an appellate affirmance, by noting the motion court’s reference to the “well drafted Operating Agreement” in that case.

The case involves a real estate joint venture formed to acquire a hotel in Washington D.C. To that end the parties formed a Delaware LLC — I always scratch my head when I see this in Delaware company agreements — with a New York choice-of-law provision.

The controversy stemmed from a series of capital calls made by the defendant managing member during and in the aftermath of the COVID pandemic, totaling about $34 million. The plaintiff non-managing member balked at the calls, subsequently claiming that they could not be made under the operating agreement’s terms unless and until the defendant sought third-party financing, which it did not do, and that the calls were designed to dilute the plaintiff.

The agreement’s critical provisions include:

• Section 3.3.1 authorizes the managing member to issue a capital call if it determines the LLC requires additional capital that cannot otherwise be obtained from any “Third-Party Loan.”
• “Third-Party Loan” is defined as a “loan provided to the Company or Property Owner by a Third-Party Lender.”
• “Third-Party Lender” is defined as “any third-party lender (i.e., any lender other than a Member or any Affiliate of a Member) providing financing to the Company or Property Owner. As of the date hereof, initial Lender is a Third Party Lender.”

The plaintiff sued for a judgment declaring that the disputed capital calls were issued in violation of the operating agreement and that any distributions for the improper capital call amounts paid by the managing member come after the initial and secondary capital contributions paid by the parties. The motion court denied the managing member’s dismissal motion.

The managing member appealed, arguing that the venture’s existing mortgage financing contractually could not be enlarged and that the operating agreement excludes potential new loans from other lenders by using past tense in its definition of Third-Party Loan (a “loan provided to the Company”) and present tense in its definition of Third-Party Lender (a lender “providing financing to the Company”).

The managing member also argued that the plaintiff’s and motion court’s interpretation would lead to commercially unreasonable results by forcing the company to spend an indeterminate amount of time seeking loans from an unspecified number of lenders when funds are required to meet immediate needs.

The Appellate Division wasn’t buying it, writing:

The court properly denied defendants’ motion to dismiss the second amended complaint because Section 3.3.1 may be interpreted to mean that a “Third-Party Lender” be any lender, not simply the existing lender – and that Section 3.3.1 required [managing member] to seek a loan, or a modification or forbearance under its existing loan, or show that it could not obtain Additional Capital before issuing its capital calls.

With the caveat that I’ve not taken a deep dive into the court record, I gather the parties in Capitol Hill acquired a fully operational hotel, encumbered by an $87 million mortgage, about six months before the COVID pandemic hit. To that extent, maybe a little understanding is due the managing member for keeping the hotel liquid during a difficult time for the hospitality industry and credit markets.