Bernstein v. Nemeyer

• Decision Date: 13 February 1990
• Docket Number: No. 13823,13823
• Citation: 213 Conn. 665,570 A.2d 164
• Court: Connecticut Supreme Court
• Parties: Sidney R. BERNSTEIN, et al. v. Ronald J. NEMEYER, et al.

Page 164

570 A.2d 164

213 Conn. 665

Sidney R. BERNSTEIN, et al. v. Ronald J. NEMEYER, et al.

No. 13823.

Supreme Court of Connecticut.

Argued Dec. 6, 1989.

Decided Feb. 13, 1990.

Alan R. Spirer, with whom were Nathan C. Nasser, Westport and, on the brief, Karan Spirer, Wilton, for appellants (plaintiffs).

Richard P. Weinstein, West Hartford, for appellees (defendants).

Before PETERS, C.J., and SHEA, CALLAHAN, GLASS and COVELLO, JJ.

PETERS, Chief Justice.

The principal issue in this case is whether investors in a speculative real estate venture are entitled to rescission and restitution of their investments upon breach of a "negative cash flow guaranty" contained in their partnership agreement. The plaintiffs ¹ brought this action against the defendants Ronald J. Nemeyer and Cheshire Management Company, Inc., who are the general partners of CMC-Southwest Limited Partnership, to recover for the loss of the amounts that the plaintiffs, as limited partners, had contributed to the partnership. The complaint charged the defendants, in three counts, with breach of contract, willful misconduct and violation of the Connecticut Unfair Trade Practices Act, General Statutes § 42-110b. The defendants filed a number of special defenses, as well as a counterclaim for damages on a theory of indemnification. The trial court, after a hearing, ruled in the defendants' favor on the complaint, and in the plaintiffs' favor on the counterclaim. Only the plaintiffs have appealed, and their appeal challenges only the trial court's decision that they are not entitled to rescission and restitution on their claim of breach of contract. We find no reversible error in the judgment of the trial court.

The trial court found the following facts, which are undisputed. In 1983, the defendants and a group of investors known as the Class A limited partners formed the CMC-Southwest Limited Partnership (the partnership) to purchase and renovate two apartment complexes in Houston, Texas. During the summer of the following year, the defendants solicited the present plaintiffs, the Class B limited partners, to join the partnership. The plaintiffs were seeking an investment that would provide them with a source of capital growth as well as a tax deferral for sums generated by a takeover of the firm where they had been employed.

In their negotiations with the plaintiffs, the defendants described the objectives of the partnership as appreciation in the value of the Houston properties and federal income tax benefits in the form of deductions for the deferral of income. The defendants did not, however, conceal from the plaintiffs the risks of the partnership venture. The plaintiffs were on notice of the depressed state of the Houston real estate market in general. They were also informed of the particular vulnerability of the partnership properties to foreclosure, since the properties were fully leveraged, having been bought entirely with loans secured by mortgages. ²

In three different documents, which the defendants drafted in August, 1984, in order to procure the plaintiffs' agreement to participate as limited partners, the defendants undertook to give a so-called negative cash flow guaranty to the partnership at least until December 31, 1988. ³ The defendants expressly agreed to lend to the partnership the amount by which operating expenses, debt service and capital expenditures exceeded cash receipts from the normal operations of the partnership. ⁴ Such loans were to be recoverable either from operating income or from proceeds received upon disposition of the properties, but in the latter event only after all the plaintiffs had been repaid their capital contributions. ⁵

Although the plaintiffs invested $1,050,000 in the partnership, the partners' hopes for appreciation of the Houston properties did not materialize. The defendants lent $3,000,000 to the partnership by virtue of the negative cash flow guaranty but discontinued mortgage payments in November, 1985, in an unsuccessful effort to renegotiate the financial terms of the mortgages. The defendants' attempt thereafter to find shelter under the bankruptcy laws proved equally unsuccessful. The mortgagees foreclosed on the properties in the summer of 1987. Both the plaintiffs and the defendants lost their entire investments. This law suit ensued.

The trial court denied the plaintiffs' request for rescission and restitution of their $1,050,000 investment. The court found that the plaintiffs had bargained for the negative cash flow guaranty and that the defendants' failure to make mortgage payments in 1985 was a breach of that guaranty. ⁶ The court determined nonetheless that the plaintiffs could not recover for three reasons: (1) the guaranty was an incidental rather than a central term of the contract as a whole, and the defendants' nonperformance therefore was not a material breach warranting rescission; (2) the losses suffered by the plaintiffs resulted not from the defendants' breach but from the continued failure of the Houston real estate market; and (3) despite the defendants' breach, the plaintiffs had realized the tax benefits that were a central part of their bargain.

The plaintiffs' appeal challenges these adverse conclusions of the trial court and reasserts a right to rescission and restitution. We agree with the plaintiffs that the defendants' nonperformance of the negative cash flow guaranty was sufficiently material to the contract that the trial court erred in denying rescission to the plaintiffs on that ground. Because the remedy of restitution consequent to rescission requires a showing of unjust enrichment, however, the judgment of the trial court can be sustained on the alternate ground that the plaintiffs have failed to demonstrate unjust enrichment in this case. See Aetna Casualty & Surety Co. v. Murphy, 206 Conn. 409, 420, 538 A.2d 219 (1988); Favorite v. Miller, 176 Conn. 310, 317, 407 A.2d 974 (1978).

I

We first consider whether the trial court was mistaken in concluding that the plaintiffs were not entitled to rescission because they had failed to prove a material breach of the partnership agreement. This underpinning for the trial court's judgment cannot be sustained.

The trial court found that the defendants' breach of the negative cash flow guaranty was an incidental rather than a material breach. This finding was clearly erroneous in light of the evidence and the pleadings in the record as a whole. Practice Book § 4061; Pandolphe's Auto Parts, Inc. v. Manchester, 181 Conn. 217, 221, 435 A.2d 24 (1980). Several of the plaintiffs, as well as the named defendant, testified that the plaintiffs had bargained for the negative cash flow guaranty because of their concern about the quality of the Houston properties and the overall status of the Houston real estate market. ⁷ There was no testimony that the plaintiffs would have been willing to invest in the partnership in the absence of this guaranty. The various documents detailing the terms of the partnership agreement were all drafted by the defendants, and each contained such a guaranty. The terms of the guaranty differed, in the various documents, only insofar as there was some question about whether the guaranty extended beyond December 31, 1988. Since the defendants' breach occurred in November, 1985, this discrepancy was of minimal importance, and the trial court so found.

It is no answer to this unequivocal factual showing to point to the plaintiffs' interest in the partnership as a vehicle for tax deferral as well as for capital appreciation. The United States Supreme Court held, in Randall v. Loftsgaarden, 478 U.S. 647, 662-64, 106 S.Ct. 3143, 3152-53, 92 L.Ed.2d 525 (1986), that the receipt of tax benefits does not per se justify the denial of access to the remedy of rescission, when that remedy is otherwise warranted. Moreover, the prospects for both the tax deferral and the capital appreciation depended upon the partnership's viability over the long term, and that was precisely the object of the negative cash flow guaranty. There was no testimony to the contrary.

The trial court correctly looked to the multi-factor standards for materiality of breach contained in the Restatement (Second), Contracts § 241 (1981) ⁸ but failed to apply those standards correctly. In the circumstances of this case, the most important factors are that the defendants' breach deprived the plaintiffs of a substantial benefit for which they had clearly bargained and which they had every reason to expect, and that the defendants' breach was totally incurable, the partnership having lost all control over its Houston properties. That the defendants conducted the affairs of the partnership in good faith does not, on this record, make their breach immaterial or incidental.

II

The conclusion that the defendants' nonperformance of the negative cash flow guaranty was a material breach of the partnership agreement does not, however, end our inquiry. It follows from an uncured material failure of performance that the other party to the contract is discharged from any further duty to render performances yet to be exchanged. Vesce v. Lee, 185 Conn. 328, 334, 441 A.2d 556 (1981); Silliman Co. v. S. Ippolito & Sons, Inc., 1 Conn.App. 72, 75, 467 A.2d 1249 (1983), cert. denied, 192 Conn. 801, 470 A.2d 1218 (1984); Aiello Construction, Inc. v. Nationwide Tractor Trailer Training & Placement Corporation, 122 R.I. 861, 864-65, 413 A.2d 85 (1980); 2 Restatement (Second), Contracts § 237 (1981). ⁹ It does not follow that the party so discharged is automatically entitled to restitution rather than to a claim for damages. ¹⁰ We must still determine whether, in the circumstances of this case, the trial court correctly rendered judgment in favor of the defendants because the plaintiffs have failed to prove a right to restitution of the payments that they made to the partnership. We conclude that the record sustains the judgment of the...