Austin v. Loftsgaarden
| Decision Date | 07 April 1982 |
| Docket Number | Nos. 80-1771,80-1874,s. 80-1771 |
| Citation | 675 F.2d 168 |
| Parties | Blue Sky L. Rep. P 71,731, Fed. Sec. L. Rep. P 98,628, 10 Fed. R. Evid. Serv. 252 Dr. Roger E. AUSTIN, Dr. Thomas W. Anderson, Dr. Myrel A. Neumann and Dr. William C. Randall, Plaintiffs, Appellees and Cross Appellants, v. B. J. LOFTSGAARDEN; Alotel Incorporated, a Minnesota Corporation; M. S. Noah; Lyman H. Coult; Property Development & Research Company, a Minnesota Corporation; and 2361 Building Corporation, a Minnesota Corporation, Defendants, Appellants and Cross Appellees. |
| Court | U.S. Court of Appeals — Eighth Circuit |
Fredrikson, Byron, Colborn, Bisbee & Hansen, John A. Grimstad, Terrence M. Fruth, Minneapolis, Minn., for Austin, Anderson and Neumann.
O'Connor & Hannon, Douglas M. McMillan, Robert A. Brunig, Minneapolis, Minn., for Randall.
Meagher, Geer, Markham, Anderson, Adamson, Flaskamp & Brennan, Clyde F. Anderson, Laura S. Underkuffler, Minneapolis, Minn., for defendants, appellants and cross appellees.
Before McMILLIAN and ARNOLD, Circuit Judges, and HANSON *, Senior District Judge.
Plaintiffs-appellees are four of twenty-two limited partners who invested in a development to build and operate a Ramada Inn motel in Rochester, Minnesota. In the district court they prevailed on various claims that they were defrauded by defendants-appellants B. J. Loftsgaarden and three of his closely-held corporations because of misrepresentations, half-truths, and omissions that were found to exist in the Offering Memorandum used to attract plaintiffs to the project. 1 A jury found Loftsgaarden and the corporate defendants (hereinafter Loftsgaarden) liable upon claims under § 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b); Rule 10b-5, 17 C.F.R. § 240.10b-5; the antifraud provisions of the Minnesota Securities Act, Minn.Stat. §§ 80A.01 et seq., 80A.23; and common law fraud. 2 The jury also rendered an advisory verdict-in which the district court concurred-that defendants were liable for violating § 12(2) of the Securities Act of 1933. 15 U.S.C. § 77l (2). 3 The district court applied a rescissory remedy, which resulted in an award to plaintiffs in the amount of the consideration that each had paid for his limited partnership unit or units, prejudgment interest from the date of purchase, and attorneys' fees for plaintiffs Randall and Neumann for a total judgment of $273,720. Defendants raise a number of issues on appeal mainly relating to the sufficiency of evidence on the essential elements of these claims and the measure of damages. Plaintiffs cross-appeal from the district court's denial of certain portions of their requested attorneys' fees. We affirm as to the finding of liability, but remand for further consideration on the issue of damages.
B. J. Loftsgaarden is an attorney and the president and sole shareholder of corporate defendants Alotel, Inc., Property Development and Research Company (PDRC), and 2361 Building Corporation. Through these corporations, Loftsgaarden intended to build and operate a Ramada Inn in Rochester, Minnesota. 4 To help finance the $3.5 million project, he organized a limited partnership, Alotel Associates, through which he expected to raise $1 million by selling 40 limited partnership units to not more than 20 investors for $25,000 per unit. The remainder of the money was to be obtained through a $2.31 million mortgage loan from Larwin Realty and Mortgage Trust 5 and a $240,000 furniture and fixtures loan from the First National Bank of Rochester. Loftsgaarden and Alotel, Inc., were to serve as the project's general partners.
In December 1971, Loftsgaarden prepared an offering memorandum through which he hoped to interest investors in the limited partnership units. The memorandum indicated that the partnership would "operate as a 'tax shelter' ", leading to "significantly greater returns for persons in relatively high income tax brackets." Accordingly, the memorandum outlined "Investor Suitability Standards" requiring that each investor have a net worth in excess of $200,000 excluding home and automobiles or that some portion of the investor's income was subject to federal and state income taxes at a rate of fifty percent or more. Paul Crawford, an investment advisor whom Loftsgaarden knew was not licensed to act as such, agreed to help Loftsgaarden find suitable high income investors.
The attraction of such an investment to high tax bracket individuals lies in the tax treatment of the partnership's income and losses. Because the partnership is not taxed as an entity, it serves as a conduit to the partners for all its taxable income and losses. I.R.C. §§ 701, 702. Each partner is permitted to take his or her share of the partnership's deductible losses "to the extent of the adjusted basis of such partner's interest in the partnership...." I.R.C. § 704(d). But in a real estate investment such as the one contemplated by Loftsgaarden, the limited partner's basis is not restricted to the amount of his actual investment (the amount "at risk"); rather, it may be increased by the partner's proportional share of any nonrecourse loans made to the partnership. See I.R.C. § 465(c)(3)(D). Against such an increased basis, a limited partner is able to receive from the partnership deductible losses far in excess of the amount he or she has at risk in the investment. By using accelerated methods of depreciation, prepaying interest on loans, renting instead of purchasing land, and other methods, the partnership is able artificially to generate large amounts of deductible losses and expenses in the early years of the venture which are passed on to the partners to use in offsetting other income on their individual tax returns. 6 The result is that a limited partner can often recoup his money in the year of his investment through tax savings. Generally the tax shelter serves only to defer taxation until the investment is liquidated and each partner receives his or her proportional share of the proceeds of the sale. Any gain realized will be taxed partly at capital gains rates (assuming the greater than one year holding period has been satisfied) and partly at ordinary income rates (to the extent that the accelerated depreciation taken exceeds the amount that would have been taken if a straight-line method were used). I.R.C. §§ 1231, 1250.
Under the terms of Loftsgaarden's offering memorandum, Alotel Associates planned to employ some of the above-described methods to provide immediate tax savings to the limited partners. The $2.31 million loan from Larwin would be a nonrecourse loan, thus serving to increase each limited partner's investment basis. In addition, rapid depreciation methods would be used to generate large deductible losses in the early years of the investment. Despite these features, only one person was willing to make the $50,000 minimum investment. This forced Loftsgaarden to terminate the offering and revise the project to further enhance the tax benefits and reduce the minimum price per investor. Instead of purchasing land as originally contemplated, the partnership would rent land thereby incurring another tax deductible expense. 7 Since capital was no longer required to purchase land, the amount of money Loftsgaarden needed to raise through the sale of limited partnership units was reduced from $1 million to $700,000. This also reduced the minimum investment per limited partner from $50,000 to $35,000 and the total number of units from 40 to 20.
In May 1973, Loftsgaarden revised the offering memorandum to reflect these changes. An accounting forecast included in the memorandum stated that the partnership would suffer losses resulting in income tax savings during its first three years; thereafter the business would begin to show a profit. Again Crawford aided Loftsgaarden in finding suitable high income investors. This time the offering proved successful. In the summer and fall of 1973, plaintiffs-Drs. Roger Austin, Thomas Anderson, Myrel Neumann, and William Randall-were among those who purchased units. 8 The jury found that plaintiffs bought their units in reliance on the representations made in Loftsgaarden's offering memorandum and upon the advice of either Crawford 9 or their own financial advisors who in turn relied on the memorandum.
Among other matters, the offering memorandum represented that Loftsgaarden could obtain interim construction financing for the motel at an interest rate of nine and one-half percent; that the construction loan interest would amount to $130,000; that the land lease would run for forty years with renewal and purchase options; that construction of the motel would begin in May 1973 and be completed seven months later in December 1973; that the developer and the construction company (i.e., Loftsgaarden and 2361) would receive $103,000 for "overhead and profit"; that the $240,000 furniture and fixtures loan from the Rochester bank would be at an interest rate of eight percent; and that Alotel Associates had procured a firm commitment for long term financing 10 from Larwin. Findings of Fact, Conclusions of Law, and Order for Judgment, Designated Record (D.R.) 445-59. 11
These representations were found to be false. In fact, Loftsgaarden had not obtained either the interim construction loan or the furniture and fixtures loan at the stated fixed interest rates, but rather at interest rates that floated four and three percent respectively above the prime lending rate. The land lease was for fifteen years with a fifteen-year renewal option instead of forty years with renewal and purchase options. Loftsgaarden knowingly underestimated the construction time by five months, thus the memorandum's estimate that construction loan interest would amount to $130,000 was too low because it was based on a lower interest rate and a shorter construction time than actually expected. It was also not true...
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