Lenz v. Associated Inns & Restaurants Co. of Am., 90 Civ. 3026 (KC).

Citation833 F. Supp. 362
Decision Date24 September 1993
Docket Number90 Civ. 3026 (KC).
PartiesGordon LENZ, individually and on behalf of Naples Tennis Resort, Ltd., Plaintiff, v. ASSOCIATED INNS AND RESTAURANTS COMPANY OF AMERICA, Aircoa Equity Interests Inc., TFC Investments Ltd., Realvest Inc., formerly known as Fracorp, Inc., Defendants.
CourtUnited States District Courts. 2nd Circuit. United States District Courts. 2nd Circuit. Southern District of New York

COPYRIGHT MATERIAL OMITTED

Jay Edmond Russ, Russ & Russ, Massapequa, NY, for plaintiff.

Michael Davies, Coudert Brothers, New York City, for defendants.

OPINION AND ORDER

CONBOY, District Judge:

This case involves a tax shelter that never stopped losing money. In the late 1970's and early 1980's, the United States experienced a rapid proliferation of real estate limited partnerships designed to shelter taxable income. These tax shelters constituted one stimulus for the Congressional overhaul of the federal tax laws in 1986, and reform significantly limited their appeal. The legal fallout from these shelters, however, continues to be felt at every level of the nation's adjudicative fora. Accusations of fraud and mismanagement have proven rampant where real estate tax shelters are concerned. Such an allegation is before the court in this case.

BACKGROUND
A. The Sale

In 1981, Gordon Lenz owned Conference Associates, an insurance company in Patchogue, New York specializing in health and other personal insurance plans for trade or professional associations, and in property and casualty insurance for businesses. His income had exceeded six figures for over five years, and in that time he had purchased several real estate investments, including two small apartment houses and a small office building. Lenz was in the 50% tax bracket and unhappy about it.

Lenz's discontent with his tax burden led him to respond enthusiastically to a call in March 1981 from his friend, Mark Rose, in which Rose stated that he had a golden opportunity for Lenz to shelter some of his income in a Florida real estate investment. In fact, Lenz was so enamored at the prospect that he left within the hour to examine the property with Rose. Based on his conversations with Rose by phone and then on the airplane, Lenz understood the investment to involve participation in a limited partnership formed to purchase a tennis club in Naples, Florida. He further understood that the driving force behind the investment was Frates Corporation, an organization in which Rose had indicated to Lenz that he (Rose) was a partner.

Upon their arrival in Naples, Lenz and Rose were met by Charles Holmes, who, Lenz was led to believe, represented the general partners of the project. Holmes then conducted a tour of both the Naples Bath and Tennis Club ("NBTC"), the assets of which were to constitute the assets of the limited partnership, and an adjacent condominium project. According to Lenz,1 Holmes offered a detailed description of the structure and administration of the limited partnership. Specifically, Holmes stated that the limited partnership would purchase NBTC for approximately $5,000,000 and the project was expected to lose money for two or three years, offering Lenz a writeoff of two times his annual investment during that time. The resort would begin to generate profits in the third year of operation and distributions of these profits would ultimately permit each limited partner to receive a cash return on their investment at or near the amount of his contribution prior to sale of the resort. These distributions were guaranteed, according to Holmes, to reach an annual rate of 10% of each limited partner's investment, and projected to rise as high as 15%. Holmes further indicated that the sale of the assets of the limited partnership for a profit was also guaranteed because a contract existed with the adjacent condominium association to purchase the project for $8,000,000 within any of the next five years and $11,000,000 during the sixth year or any year thereafter. Lenz was repeatedly told that the investment offered him a guaranteed "win-win" outcome (i.e., he could both shelter income through initial losses and gain a return on his investment through cash distributions and sale of the resort.) At the time of the tour, Lenz did not ask for or receive any financial or legal documents verifying Holmes's representations.

During the course of Lenz's overnight stay in Naples, Holmes suggested to Lenz that he could spread his investment over five years, contributing $50,000 in each year. Lenz indicated that this option represented an attractive income sheltering strategy for him. In response to his expression of interest, he received one week later the subscription agreement ("Subscription Agreement"), the signature page to the partnership agreement ("Partnership Agreement"), and a partnership summary ("Summary") for Naples Tennis Resort, Ltd. ("NTR" or "the Limited Partnership").

Lenz did not have expert advisors, attorney or accountants, review the documents. He himself reviewed the Subscription Agreement and the accounting projections contained in the Summary, which projected that the Limited Partnership would produce profits in its third year after providing initial tax shelter benefits. By signing the Subscription and Partnership Agreements on April 1, 1981, Lenz committed to purchase a 22.27% limited partnership interest in NTR for the sum of $245,000, comprised of $25,000 in cash and a $220,000 promissory note payable to NTR. The other limited partners were Mark Rose and M & R Equipment (a company controlled by Rose) owning together a 71.28% interest, and Kevin Bowler, who purchased a 4.45% interest.

B. The Subscription and Partnership Agreements

In signing the Subscription and Partnership Agreements, Lenz warranted that he understood: 1) The Limited Partnership constituted a risky and speculative enterprise; 2) He could withstand complete loss of his investment; 3) He and/or his advisors had sufficient investment sophistication to evaluate the merits of the project and had received all information necessary to do so; 4) He had not relied upon any assurances regarding the tax benefits of the investment or projections of its future profitability; 5) The sale of the project could yield significant tax liabilities; and 6) The other real estate activities of the general partners could lead to conflicts of interest with transactions involving the Limited Partnership. See, Subscription Agreement, §§ 4, 5; see also, XVI of the Partnership Agreement.2

Section 12.2 of the Partnership Agreement ceded to the General Partners "full, exclusive and complete discretion in the management and control of the affairs of the Partnership." This discretion included, among other powers, the capacity to enter into mortgages, borrow money, enter into leases, commit to and pay management fees, and sell all of the partnership's property at any price deemed satisfactory to the General Partners.

The Partnership Agreement also obligated the General Partners to certain procedures in distributing net proceeds from extraordinary events and making information available to the limited partners. Specifically, § 8.3 stated that:

All net proceeds received by the Partnership from extraordinary events (i.e., the net proceeds from any indebtedness, refinancing, sale ... or other disposition of all or any substantial part of the Partnership's property) ... shall be distributed in the following order:
(a) To the payment of all debts., liabilities, or obligations of the Partnership, other than in respect to those set forth in (b) through (f) below;
(b) Then, to the setting up of any reserves which the General Partners deem reasonably necessary to provide for all contingent or unforeseen liabilities ...
(d) Then, pro rata 1% to each of the General Partners and 98% to the Limited Partners in proportion to their respective Partnership Interests, until such time as 100% of the cash capital contribution of all Partners are returned ...
(f) Thereafter, pro rata 25% to each of the General Partners and 50% to the Limited Partners in Proportion to their respective Partnership interests.

Section 10 of the Partnership Agreement provided that the books and records of the Limited Partnership would be available for review, that each partner would be furnished with annual reports and tax information, and that any other information requested by a limited partner as to the partnership and its activities, would be provided to such limited partner.

Both the Subscription and Partnership Agreements provided that the Limited Partnership was to be governed by Oklahoma law.

C. Structure and Operation of the Limited Partnership

The original general partners of the Limited Partnership ("General Partners") were TFC Investments, Ltd. ("TFC") and Associated Inns and Restaurants Company of America ("Associated Inns"). In July 1984, Associated Inns' general partnership interest was transferred, by consent of all general and limited partners, to Aircoa Equity Interests, Inc. ("AEI"). Associated Inns later merged with another corporation, and the surviving entity was renamed Aircoa Hospitality Services, Inc. ("AHS").

The Limited Partnership acquired NBTC from a company affiliated with the general partners in a sale/leaseback transaction. The purchase price was $5 million, which included a 10% mortgage which "wrapped" an existing $3 million first mortgage on the property. Under the leaseback arrangement, the Limited Partnership leased the property back to the seller for an annual base rent of $480,000. The rental amount approximated the annual rent to be paid by the Limited Partnership on the $5 million mortgage. In addition, the Limited Partnership was to receive 90% of the tennis club's annual net profits before income taxes.

The Partnership Agreement also provided for various management fees and expenses, including: 1) 4% of gross revenues to general partner Associated Inns (later Aircoa) to manage the club facilities; 2) $25,000 per year to Frates...

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