802 F.2d 49 (2nd Cir. 1986), 1247, Luce v. Edelstein

Docket Nº:1247, Docket 86-7120.
Citation:802 F.2d 49
Party Name:, 6 Fed.R.Serv.3d 117 Henry LUCE III, Martin E. Messinger, Arthur Goldberg, Simon Akst, Marvin Bostin, Marshall Butler, Paul Caccia, John J. Colgan, Jr., Leslie Cooper, Joseph Cusenza, Thomas Despagni, James Foledy, Ariel Halpern, David Hunter, David Kaplan, Lawrence Linehan, Michael O'Daly, David Peleger, Robert Shapiro and Herbert Weller, Individ
Case Date:September 26, 1986
Court:United States Courts of Appeals, Court of Appeals for the Second Circuit
 
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802 F.2d 49 (2nd Cir. 1986)

, 6 Fed.R.Serv.3d 117

Henry LUCE III, Martin E. Messinger, Arthur Goldberg, Simon

Akst, Marvin Bostin, Marshall Butler, Paul Caccia, John J.

Colgan, Jr., Leslie Cooper, Joseph Cusenza, Thomas Despagni,

James Foledy, Ariel Halpern, David Hunter, David Kaplan,

Lawrence Linehan, Michael O'Daly, David Peleger, Robert

Shapiro and Herbert Weller, Individually and on behalf of

the limited partners of 583-587 Broadway Associates, and

derivatively on behalf of 583-587 Broadway Associates,

Plaintiffs-Appellants,

v.

Jonathan H. EDELSTEIN, Carol Kohlreiter Levy, George

Kazantzis, Leonard V. Gray, A. Michael Victory, HQZ

Enterprises, Inc., HQZ Fine Arts, Inc., Individually and as

general partners of 583-587 Broadway Associates, Cumberland

Investment Group, HQZ Development Corporation, HQZ Arts,

Inc., Petcap Development Corporation, Petra Capital

Corporation and 583-587 Broadway Associates, a New York

Limited Partnership, Defendants-Appellees.

No. 1247, Docket 86-7120.

United States Court of Appeals, Second Circuit

September 26, 1986

        Argued May 12, 1986.

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        Jonathan S. Gaynin, New York City (Melinda Socol and Maryanne Cunningham, of counsel), for plaintiffs-appellants.

        Jane W. Parver, New York City (Jay G. Strum, Peter C. Harvey, Kaye, Scholer, Fierman, Hays & Handler, of counsel), for defendants-appellees Jonathan H. Edelstein, George Kazantis, Leonard V. Gray, A. Michael Victory, HQZ Enterprises, Inc., HQZ Fine Arts, Inc., Cumberland Inv. Group, HQZ Development Corp., and HQZ Arts, Inc.

        Jules D. Zalon, New York City, for defendant-appellee Carol Kohlreiter Levy.

        Before MANSFIELD, CARDAMONE, and WINTER, Circuit Judges.

        WINTER, Circuit Judge:

        This case involves allegations of fraud in the solicitation of investors in an ill-fated real estate partnership. Judge Carter denied plaintiffs' request for preliminary injunctive relief and dismissed claims based on the Securities Act of 1933 and pendent state law claims on the basis of a forum-selection clause in the partnership agreement. He retained jurisdiction over the federal claims arising under Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. Sec. 78j(b) (1982), and Rule 10b-5 of the Securities and Exchange Commission, 17 C.F.R. Sec. 240.10b-5 (1986), but in a subsequent order dismissed the federal claims for failure to plead fraud with particularity. Fed.R.Civ.P. 9(b). Leave to amend was not granted. Plaintiffs appeal. We affirm the denial of injunctive relief and the dismissal of pendent state law claims. We reverse in part the dismissal of the federal claims, and remand with instructions that plaintiffs be given leave to amend their complaint.

        BACKGROUND

        The twenty named plaintiffs purport to represent a class of purchasers of limited partnership interests in 583-587 Broadway Associates ("Broadway Associates"). Defendants HQZ Enterprises, Inc. ("HQZ Enterprises") and HQZ Fine Arts, Inc. ("HQZ Fine Arts") are the general partners of Broadway Associates. Their affiliates are defendants Cumberland Investment Group

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("Cumberland"), a New York limited partnership; HQZ Development Corp. ("HQZ Development"), a New York corporation; Petra Capital Corp. ("Petra"), and its subsidiary, Petcap Development Corp. ("Petcap") both Delaware corporations; and HQZ Arts, Inc. ("HQZ Arts"), a New York corporation owned by Cumberland and Petcap. According to the complaint, HQZ Enterprises and HQZ Fine Arts are the "alter egos" of their affiliates, and the affiliates exercised complete direction and control over the partnership. All five of the individual defendants are past or present directors and officers of HQZ Enterprises and HQZ Fine Arts, and "some or all" of the individual defendants are the past or present officers or principals of Cumberland, Petra, Petcap, and HQZ Arts.

        Assuming as we must that the facts alleged in the complaint are true, the purportedly fraudulent scheme may be described as follows. HQZ Arts bought buildings located at 583-587 Broadway and 154 Mercer Street in late 1981, with the participation and/or funding of HQZ Development, Cumberland, Petra, and Petcap. Subsequently, Broadway Associates was established as a limited partnership with HQZ Enterprises and HQZ Fine Arts as general partners. Pursuant to a Private Placement Offering Memorandum ("Offering Memorandum") dated December 17, 1981, the general partners solicited limited partners to provide capital for a venture that would renovate the buildings and convert them into condominium units for artists and art-related businesses. The Offering Memorandum stated that 32 limited partnership interests would be sold to no more than 35 persons, each limited partnership requiring $22,344 in cash and a letter of credit for $103,125. The letters of credit would be used to secure a $3 million loan to the partnership from Morgan Guaranty Trust Company ("Morgan"). According to the Offering Memorandum, the full amount of the cash proceeds from the offering, plus the Morgan loan proceeds and a $385,000 contribution by the general partners, would be used as follows: (1) to repay loans to HQZ Arts and other affiliates; (2) to pay the balance of the purchase price on the properties; and (3) to provide working capital for Broadway Associates. The closing date for subscription to the offering and the Broadway Associates Limited Partnership Agreement (the "Partnership Agreement") was set for year-end 1981.

        HQZ Arts transferred the properties to Broadway Associates on December 30, 1981. However, only sixteen limited partnership interests had been purchased by that time, and the general partners issued a Supplement to Private Placement Memorandum ("Supplemental Memorandum") on December 31, stating that the Broadway Associates partnership had been formed with interests aggregating only $1,950,000, instead of $3,715,000. The Supplemental Memorandum also stated that the partnership had granted Petcap a first mortgage in the real estate in the amount of $1,352,932, and that HQZ Fine Arts had given Petcap a promissory note for $300,000 and agreed to deliver its preferred stock to Petcap on or before the note's due date of February 28, 1982.

        According to the complaint, very little went as expected in the renovation project. Instead of repaying the partnership's outstanding debts, defendants caused it to continue to borrow additional funds, including a construction loan of $2.2 million from Central Federal Savings Bank ("Central"). Further, HQZ Fine Arts neither repaid the promissory note to Petcap nor delivered the preferred stock. Defendants even failed to pay the real estate broker's commission on the acquired property, issuing instead another mortgage note. Defendants then assigned all the partnership's notes, except the $3 million loan from Morgan, to an "agent or employee," thereby consolidating the partnership's debts.

        The Offering Memorandum stated that construction would be completed and the condominium units sold by the end of 1982. Nevertheless, the project was far from complete when the complaint was filed in mid-1985, and the building is alleged to be a gutted shambles without windows, air conditioning, plumbing, fire alarms, security,

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or protection from the elements. Although defendants had caused the partnership to incur liabilities of about $10.2 million by November 30, 1984, only about $500,000 appeared to have been spent for construction work, and about $4 million more was still needed to complete the project. Moreover, despite representations in the Offering Memorandum that the property would be converted to artist-in-residence quarters, defendants knew that residential use was contrary to the zoning regulations and that a variance for such use had in fact been denied prior to the offering....

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