Everest Properties II v. Prometheus Development Co., Inc., A114305 (Cal. App. 9/27/2007)
| Decision Date | 27 September 2007 |
| Docket Number | A114305 |
| Court | California Court of Appeals Court of Appeals |
| Parties | EVEREST PROPERTIES II et al., Plaintiffs and Respondents, v. PROMETHEUS DEVELOPMENT CO., INC., et al., Defendants and Appellants. |
Appeal from the San Mateo County Super. Ct. No. CIV-436873.
The trial court found that appellants breached fiduciary duties to respondents in connection with a merger transaction and liquidation of a partnership. Compensatory damages were awarded to respondents, along with prejudgment interest, and equitable relief was granted in the form of a constructive trust and equitable lien on the partnership units. In this appeal, appellants complain of the trial court's evidentiary rulings, challenge the evidence to support the judgment, assert they were improperly denied a new trial before a jury to assert the defense of collateral estoppel, and contest various aspects of the relief granted to respondents by the trial court. We conclude that the imposition of a constructive trust and equitable lien must be reversed, and the award of prejudgment interest must be modified. We further conclude that no other prejudicial errors occurred and the evidence supports both the finding of breach of fiduciary duties and the compensatory damages awarded to respondents. We therefore affirm the judgment in all other respects.
Prometheus Income Partners (PIP) was a limited partnership created pursuant to a partnership agreement in 1985 to own, construct, and ultimately sell two apartment buildings located in Santa Clara, California, known as the Alderwood and Timberleaf apartments. Defendant and appellant Prometheus Development Co., Inc. (PDC), a California corporation, was the sole corporate general partner of PIP; defendant and appellant Sanford N. Diller (Diller) was an officer, director and, through family trusts, the sole shareholder of PDC.1 PIP issued nearly 19,000 limited partnership interest units at a cost of $1,000 per unit to finance the development of the Alderwood and Timberleaf apartments.
In June of 1996, construction defects were discovered in the hardboard siding, flashing, and to a lesser extent the roofing installed in both the Alderwood and Timberleaf apartment buildings. Investigation revealed that necessary remedial measures would include removal and restoration of "the skin of the building" in each complex, along with replacement of the defective waterproofing and repair of structural damages. Estimates were received for the cost of the repairs. PIP also created a reserve account as required by the lender to cover the estimated cost of repair of the construction defects. The reserve was supplemented with an additional amount that in the "business judgment" of PIP management was necessary to "cover contingencies" that may occur with the repairs. The "cash flow" from the projects was used to fund the reserve accounts, so quarterly distributions to the limited partners were suspended between 1996 and 2002. By the end of March 2002, the total amount in the reserve accounts was around $10.2 million. PIP also filed two "construction defects" lawsuits against the general contractor and several subcontractors.
As estimates and plans for repairs of the properties proceeded, respondent Everest Properties II LLC, a company which invests in real estate limited partnerships, and its affiliate Everest Management, LLC (collectively Everest or respondents), undertook an analysis of the PIP limited partnership interest units. According to an internal tender offer analysis dated June of 2000, Everest placed a liquidation value on the PIP partnership units of "at least $1200" per unit, based on "conservative estimates" which included the repair costs. Everest then began to acquire PIP units through tender offers to existing limited partners at $650 to $800 per unit.
By 2000, the limited partners increasingly complained about the impact of the construction defects and litigation, the lack of distributions, the failure of the properties to appreciate, and the illiquidity of the market for the units. PDC explored options for achieving liquidity for the limited partners. PDC decided not to place the Alderwood and Timberleaf apartments for sale on the open market without completion of repairs. PDC management determined that the "known defects" in construction made "marketing the property problematic" due to the "uncertainties" of the cost of repair which would result in fewer potential buyers and sale of the property at less than an optimum price. The alternative of repairing the construction defects first, then selling the properties and distributing the proceeds upon liquidation of the partnership, was also considered but rejected in favor of a merger transaction with an "affiliate organized by Diller" which was willing to purchase the properties with known defects. PDC was aware that structuring the transaction as a merger rather than a sale would result in a tax advantage to Diller and his affiliates — although not to the unaffiliated limited partners.
In January of 2000, PDC investigated and then proposed a merger whereby PIP Acquisition, LLC, would purchase essentially all of the outstanding shares of PIP from the existing unaffiliated limited partners, then merge into PDC. PIP Partners — General LLC (PIP Partners) owned PIP Acquisition LLC, and also then owned approximately 18 percent of the units of the limited partnership. Ninety-nine percent of the interests in PIP Partners was owned by Diller and managed by an entity controlled by appellants. Thus after the merger, entities controlled by Diller would own essentially the entire partnership, and the unaffiliated partners would no longer have any interest in the partnership units. In May of 2000, a merger value of $1,200 was fixed for each unit to be offered to the limited partners, based upon the estimated market value of the partnership properties of approximately $55.1 million and the potential financial impact of the still-pending construction defects litigation.
PDC was aware that the proposed merger was an affiliate transaction rather than an "arm's length transaction" with an independent third party. Thus, PDC, as an entity with "public reporting responsibilities," filed a preliminary proxy statement and related disclosure materials on the transaction with the SEC in June and September of 2000 that placed a value of $1,200 on each of the units. The same amount per unit was paid by PDC for the acquisition of some partnership units in June of 2000. The SEC responded with comments, which in turn resulted in proxy statement amendments filed by PDC.
In October of 2000, Everest prepared a further analysis of the PIP units that took into account the proxy statement filed by appellants and the pending litigation over the construction defects in the apartment buildings. A value of $1,355 to $1,359 was placed on the units in Everest's analysis.
After PDC reviewed the partnership's most recent favorable financial performance in October 2000, and received an independent appraisal that placed an increased value on the properties of $68.9 million in December 2000, the proposed merger transaction was reevaluated. The proxy solicitation was then modified to provide for the consideration to be based on liquidation value of the property of a minimum of $1,200 per unit, plus a contingent payment dependent upon the recovery in the construction defect litigation, less the cost of repairs. Shortly thereafter Everest expressed to PDC an interest in submitting a competitive bid on the partnership properties, but no offer was made.
The SEC declined to grant approval of the proposed merger transaction with the contingent payment as described in the preliminary proxy solicitation. By its terms, the revised merger proposal terminated without clearance from the SEC at the end of August 2001.
In September of 2001, while PDC continued to evaluate a restructuring of the merger transaction, an independent appraisal placed a reduced market value of $53.2 million on the Alderwood and Timberleaf apartments. The lower appraised value was due primarily to a decline in net operating income from the apartments caused by a deflated rental market. The appraisal also subtracted the amount of the deferred maintenance costs for the repair of the roof and siding on the buildings, stated by PDC as $3,079,654. Everest, which by that time owned a total of just under 5 percent of the outstanding PIP units, did not have an objection to the merger proposal as it was then constituted with payments of $1,200 per unit plus additional compensation dependent upon the outcome of the construction defects dispute, and so advised its source of financing, Blackacre.
In October of 2001, final settlement of the construction litigation resulted in a net recovery by PIP of $10.8 million, after deduction of expenses and legal fees.2 PIP also retained the amount of $10.2 million previously accumulated in the reserve account to fund the repairs. The estimate given by PIP of the cost to accomplish the repairs was between $12.5 and $14.6 million.
Soon after settlement of the construction litigation, PDC decided to proceed with a revised version of the proposed merger, and so notified the limited partners by letter. Based upon the most recent property appraisal and the cash assets held by the limited partnership as of December 31, 2001, PDC set the merger consideration at $1,714 per unit.
As advised by counsel, in October of 2001 PIP engaged the investment banking firm of Houlihan Lokey Howard & Zukin Financial Advisors, Inc. (Houlihan) to prepare a "fairness opinion" on the proposed merger as amended.3 In the opinion dated March 6, 2002, Houlihan found that given the decline in real estate values, the appraisal of September of 2001 remained a reasonable substitute for the enterprise value of the partnership, specified to be in the...
To continue reading
Request your trial