Everest Investors 8 v. McNeil Partners

• Decision Date: 16 December 2003
• Docket Number: No. B159267.,B159267.
• Citation: 114 Cal.App.4th 411,8 Cal.Rptr.3d 31
• Court: California Court of Appeals Court of Appeals
• Parties: EVEREST INVESTORS 8 et al., Plaintiffs and Appellants, v. McNEIL PARTNERS et al., Defendants and Respondents.

8 Cal.Rptr.3d 31

114 Cal.App.4th 411

EVEREST INVESTORS 8 et al., Plaintiffs and Appellants, v. McNEIL PARTNERS et al., Defendants and Respondents.

No. B159267.

Court of Appeal, Second District, Division 1.

December 16, 2003.

Certified for Partial Publication.^*

Review Denied March 17, 2004.^**

Fainsbert Mase & Snyder, Dennis A. Kendig; Law Office of John A. Case, Jr., and John A. Case, Jr., Los Angeles, for Plaintiffs and Appellants.

Browne & Woods, Eric M. George and Miles J. Feldman, Beverly Hills, for Defendants and Respondents.

MALLANO, J.

A real estate limited partnership merges into a new entity, becoming a wholly owned subsidiary of the new entity. The interests of the limited partners are liquidated or cashed out, while the general partner retains an equity interest in the postmerger entity, which then sells the assets of the limited partnership to third parties for more than the assets were valued for purposes of the cash out and merger. Under those circumstances, we hold that a limited partner's claim against the general partner — that the merger transaction harms the limited partner by undervaluing its partnership interest or by depriving it of the future earnings and growth generated by the assets of the limited partnership — is individual in nature. The claim is not derivative because it is not based on any injury to the limited partnership or its assets, both of which survive the merger transaction intact.

Accordingly, we reverse the summary judgment in favor of defendants because the trial court erroneously determined that the claims asserted by plaintiffs limited partners are not individual but derivative in nature, and because triable issues of fact exist with respect to the defense of the business judgment rule.

FACTUAL AND PROCEDURAL BACKGROUND

Plaintiffs¹ (referred to as Everest) are five California limited liability companies which held limited partnership interests in 14 public real estate limited partnerships (referred to as the McNeil Partnerships).² The McNeil Partnerships were all controlled by a general partner, defendant McNeil Partners, L.P., and defendants related entities (referred to as "general partner" or McNeil).³ Together the McNeil Partnerships owned about 81 real estate holdings, including commercial property, apartment buildings, multi-family units and self-storage properties. The general partner owned a small percentage of the equity interests in the McNeil Partnerships; the limited partners together owned a 95 percent interest in McNeil Real Estate Funds IX, X, XI, and XII; the limited partners together owned a 99 percent interest in McNeil Real Estate Funds XIV, XV, XX, XXI, XXII, XXIII, XXIV, XXV, XXVI, and XXVII.

In 1991 and 1992 the McNeil Partnerships were restructured and the general partner agreed to commence a liquidation of the partnership properties seven years after the restructuring date and to use reasonable efforts to complete the liquidation and termination of the McNeil Partnerships by December 31, 1999. In 1995, some of the limited partners of some of the McNeil Partnerships filed a class action lawsuit against Robert McNeil and the general partner alleging that they breached their fiduciary duties to the limited partners in various ways, including rendering the limited partner units highly illiquid, artificially depressing the prices available for limited partner units in private sales, by charging excessive management fees and by not selling the real estate holdings and distributing the proceeds to the limited partners.

In September 1998, the parties to the class action lawsuit (referred to as the Schofield action) entered into a "Stipulation of Settlement" of all derivative and class claims pursuant to which the general partner would provide the limited partners with over $35 million in cash distributions and would purportedly implement a fair and impartial bidding process, overseen by PaineWebber, Inc., "designed to obtain the maximum value in connection with the sale, as part of one transaction, of the [McNeil Partnerships] and the management assets owned by certain defendants [i.e., McREMI]."

Before the execution of the Stipulation of Settlement, the general partner had solicited bids and was then pursuing negotiations with the three highest bidders in order to finalize a transaction with the highest value. The Stipulation of Settlement set out the procedures for the sale of the McNeil Partnerships and the allocation of the net proceeds from such sale to the limited partners. The procedures set out in the Stipulation of Settlement included the following requirements: (1) that the plans for allocation of net proceeds be based upon arms-length negotiations between the general partner and the limited partners, each side receiving advice and counsel from its own independent investment adviser; (2) that the limited partners retain an independent adviser to perform analyses of the partnership properties and management assets; and (3) that an independent investment adviser issue a fairness opinion that the proposed allocations are fair to the limited partners and the McNeil Partnerships from a financial point of view. The proposed plans for allocation of the proceeds of the sale were to be submitted to a vote of the limited partners of each McNeil Partnership.

In October 1998, the court in the Schofield action entered an order preliminarily approving the proposed settlement and providing that within a certain time period any member of the settlement class could "request exclusion from the class claims asserted in the Action," but that class members "cannot opt out of that portion of the Settlement which settles the derivative claims asserted in the Action." It is undisputed that Everest opted out of the class claims asserted in the Schofield action.

In March 1999, Whitehall Street Real Estate (Whitehall) sent to McNeil an outline of a proposed transaction, offering to "discuss an all cash purchase of the Commercial Properties by Whitehall directly." But McNeil refused to consider it, responding that "[a]n asset deal does not work for us" and that McNeil wanted "to share the proceeds of sales as partners."

Whitehall then made a "Total all-or-None Bid" for the McNeil Partnerships and McREMI in the total amount of $644,440,000, which PaineWebber deemed to be the highest bid. The general partner negotiated with Whitehall on the "possibility of the McNeil affiliates receiving an equity interest in the special purpose acquisition entity," namely the entity created to receive the assets of the McNeil Partnerships. The Whitehall transaction ultimately resulted in a merger of the McNeil Partnerships with Whitehall, pursuant to which the interests of Everest and all other limited partners in the McNeil Partnerships were liquidated. McNeil received an equity interest in the postmerger entity of about 46 percent, an increase from the 1or 5 percent interest which McNeil had owned in the McNeil Partnerships. According to the proxy statement prepared in connection with the merger, as a result of the transaction, "each participating McNeil Partnership will become a direct and/or indirect wholly owned subsidiary of WXI/McN Realty [the entity acquiring the McNeil Partnerships]...."

In May 1999, the general partner set up an "independent special committee," comprised of a single individual, Paul Fay, Jr., an "independent director" on the general partner's board of directors, to negotiate the final terms and conditions of the transaction with Whitehall. Because the general partner and other McNeil affiliates would be acquiring an equity interest in the new entity created by the proposed transaction, the general partner's board of directors "determined that an independent special committee was necessary in light of the actual or potential conflicts of interest created by the acquisition by [McNeil] of equity in WXI/McN Realty as a result of the proposed transaction" and that the special committee was "to evaluate the transaction on behalf of the limited partners of the McNeil Partnerships."

Eastdil Realty Company was retained as the special committee's financial advisor. The McNeil Partnerships had previously, in January 1998, retained the investment banking firm Robert A. Stanger & Co. (Stanger) to render opinions as to the fairness of the consideration to be received by each of the McNeil Partnerships pursuant to a sale transaction. McNeil hired its own investment adviser, Houlihan Lokey Howard & Zukin Capital (Houlihan), to negotiate the terms of the merger and the final formula for allocation of the proceeds of the transaction. The plaintiffs in the Schofield action, on behalf of the limited partners, retained the investment banking firm CFC Capital Corp. to review the analyses performed by Stanger and Houlihan and to advise Lawrence Kolker, counsel for the Schofield action plaintiffs, during the negotiation process. After several days of negotiations characterized by Kolker as "arms-length" and "difficult," the parties reached an agreement as to the material terms of the merger transaction. According to Kolker, "virtually every valuation and allocation dispute was resolved in favor of the [Schofield] Class [of limited partners]."

Under Stanger's analysis of the Whitehall transaction, the McNeil Partnerships' real estate assets had an aggregate value of approximately $601.5 million, and the value of McREMI was $35 million. Of the total consideration of $644.5 million generated by the transaction, the amount allocated to the limited partners' interests was $605.5 million. Stanger provided opinions that the following aspects of the merger transaction were fair and reasonable to the limited partners: (1) the aggregate consideration to be paid for McREMI, the limited partner interests and the general partner interests; (2) the allocation of the aggregate consideration between McREMI and the partnerships; (3) the per partnership allocated value; and (4)...