Litman v. Prudential-Bache Properties, Inc.

• Decision Date: 10 February 1992
• Docket Number: PRUDENTIAL-BACHE,No. 12137,12137
• Parties: Doris and Sydney LITMAN and David and Lillian Zelitch, Plaintiffs, v.PROPERTIES, INC., Related Tax-Exempt Bond Associates, Inc., and Bache Group, Inc. a/k/a Prudential Securities Group, Inc., Defendants. Civ. A. . Date Submitted:
• Court: Court of Chancery of Delaware

Page 12

611 A.2d 12

Doris and Sydney LITMAN and David and Lillian Zelitch, Plaintiffs, v. PRUDENTIAL-BACHE PROPERTIES, INC., Related Tax-Exempt Bond

Associates, Inc., and Bache Group, Inc. a/k/a

Prudential Securities Group, Inc., Defendants.

Civ. A. No. 12137.

Court of Chancery of Delaware,

New Castle County.

Date Submitted: Feb. 10, 1992.

Date Decided: Feb. 13, 1992.

Carolyn D. Mack, and Robert J. Kriner, Jr., of Greenfield & Chimicles, Wilmington, and Michael J. Pucillo, of Greenfield & Chimicles, West Palm Beach, Fla., for plaintiffs.

Allen M. Terrell, Jr., Paul M. Altman, and Frederick L. Cottrell, III, of Richards, Layton & Finger, Wilmington, and Scott W. Muller, and Seth R. Lesser, of Davis Polk & Wardwell, New York City, for defendants Prudential-Bache Properties, Inc. and Bache-Group, Inc. a/k/a Prudential Securities, Inc.

James F. Burnett, of Potter, Anderson & Corroon, Wilmington, and Joel S. Weiss, of Esanu Katsky Korins & Siger, New York City, for defendant related Tax-Exempt Bond Associates, Inc.

OPINION

CHANDLER, Vice Chancellor.

Plaintiffs, Doris Litman, Sydney Litman, David Zelitch and Lillian Zelitch, have instituted this proceeding as a class action lawsuit against defendants for breaches of their fiduciary duties. Plaintiffs have named Prudential-Bache Properties, Inc. ("Pru-Bache Properties"), Related Tax Exempt Bond Associates, Inc. ("Bond Associates") and Bache Group, Inc. and its successor Prudential Securities Group, Inc. ("Bache Group") as defendants.

At this juncture, defendants have moved to dismiss plaintiffs' claim. This is my decision on the motion. Part I of my decision provides a brief factual history. Part II addresses the motion to dismiss standard that I must apply. Part III addresses the issue of the nature of plaintiffs' claim. Finally, part IV contains my conclusion.

I. FACTUAL HISTORY

Pru-Bache Properties and Bond Associates organized Summit Tax Exempt Bond Fund, L.P. ("Summit" or the "Partnership") under Delaware law pursuant to an Agreement of Limited Partnership (the "Partnership Agreement") dated December 18, 1985 and amended January 31, 1986. The Partnership Agreement named Pru-Bache Properties and Bond Associates as the general partners of the Partnership.

The Partnership Agreement provided that, as to the nature of the Partnership's business, "the Partnership shall invest in, hold, sell, dispose of and otherwise act with respect to first mortgage bonds secured by mortgage loans on various properties." (Complaint p 9.) The Partnership Agreement also provided that the general partners were responsible for the management of the Partnership's business. Finally, the Partnership Agreement authorized the general partners to issue beneficial units certificates ("Units") to the public, which represent limited partnership interests. According to plaintiffs, the Unitholders hold substantially the same rights as limited partners, including the right to sue on their own behalf or on behalf of the Partnership.

From February 19, 1986 until March 3, 1986, the Partnership commenced a public offering of Units. During that period, the general partners sold 7.9 million Units for $20 each. Plaintiffs Doris and Sydney Litman each purchased 5000 Units in the initial offering. Also, plaintiffs David and Lillian Zelitch together purchased 750 Units in the initial offering.

Pursuant to the Partnership Agreement's description of the nature of its business, the general partners invested in first mortgage bonds which are, in essence, mortgage loans secured by first mortgages on the properties being developed. Local or state governments issue these bonds generally on multi-family residential apartment projects which third party developers are to develop. The use of local or state government bonding enables the income from the bonds to be tax free. However, the local or state government agencies who issue the bonds have no obligation to stand behind the bonds since the project's cash flow provides the sole source of the principal and interest payments.

On or about the time of the offering, the Partnership either had invested in or identified for investment in the following projects:

                                                             Amount of
                Project            Location              First Mortgage Bond
                The Mansions       Independence, MO          $19,450,000
                Clarendon Hills    Hayward, CA                17,600,000
                Cypress Run        Tampa, FL                  15,750,000
                Thomas Lake Place  Eagan, MN                  12,975,000
                Greenway Manor     St. Louis, MO              12,850,000
                Tempo"Northridge   Atlanta, GA                12,400,000
                Sunset Terrace     Lancaster, CA              10,350,000
                Greenhill          Harrisburg, PA              8,900,000
                East Ridge         Mount Pleasant, SC          8,700,000
                Cedar Creek        McKinney, TX                8,100,000
                Martins Creek      Summerville, SC             7,300,000
                ----------
                

Indeed, within a year after the conclusion of the offering, the Partnership, in fact, had distributed the nearly $135 million in mortgage bond financing to these projects.

From this point, one can easily anticipate the tale. The real estate projects were riddled with cost overruns and construction delays. (See Complaint pp 28-53.) Further, the developers were delinquent in their payments of interest and principal which required the parties to restructure the terms of the bonds a number of times. (See id.) Ultimately, the delays, cost overruns and delinquencies resulted in a reduction of the Partnership's income, a reduction in the amount to be distributed to the limited partners and a reduction in the value of the Units. (See id. pp 33, 46, 50 and 53.)

III. MOTION TO DISMISS STANDARD

Defendants have moved to dismiss plaintiff's claim. Although defendants are ambiguous as to how they are making the motion, the circumstances indicate that their motion is a Chancery Court Rule 12(b)(6) motion to dismiss for failing to state a claim for which I can grant relief. ¹ In deciding a Rule 12(b)(6) motion to dismiss, a court must accept all well-pleaded allegations of the complaint as true, must construe all inferences in favor of the plaintiff and must not dismiss the complaint unless it appears that the plaintiff would not be entitled to relief under any set of facts which could be proved in support of his claim. See Grobow v. Perot, Del.Supr., 539 A.2d 180, 187 n. 6 (1988); Weinberger v. UOP, Inc., Del.Ch., 409 A.2d 1262, 1263-64 (1979) (citing Fish Eng'g Corp. v. Hutchinson, Del.Supr., 162 A.2d 722, 724 (1960)), rev'd on other grounds, Del.Supr., 457 A.2d 701 (1983).

III. THE NATURE OF PLAINTIFFS' CLAIM

Defendants argue that plaintiffs' claim is derivative. That is, plaintiffs bring this action on behalf of all persons other than defendants and those related to defendants who owned the Units between the commencement of the initial public offering on February 19, 1986 and the general partners' announcement that the Partnership's quarterly distribution would be reduced from $.35 per Unit to $.22 per unit on December 20, 1989. Defendants argue that the injury allegedly inflicted on the class by the conduct of the general partners was an injury to the Partnership itself. Thus, defendants argue, the conduct of defendants only injured the limited partners to the extent of their proportionate interest in the Partnership. ² Therefore, defendants contend, plaintiffs should have brought this suit as a derivative rather than a direct action. In fact, defendants argue, plaintiffs failure to bring their claim as a derivative suit requires me to dismiss their claim.

Plaintiffs contend that their claim is one properly brought as a direct rather than derivative action. That is, plaintiffs claim that defendants' misconduct directly injured their right to distributions from the Partnership. ³ Therefore, plaintiffs argue, they did not have to comply with the requirements of bringing a valid derivative suit. Accordingly, plaintiffs argue, I must deny defendants motion and not dismiss their claim.

Contrary to plaintiffs argument, see supra note 3, the determination of whether a fiduciary duty lawsuit is derivative or direct in nature is substantially the same for corporate cases as it is for limited partnership cases. That is, the duties of a general partner and a director are very similar. See Boxer v. Husky Oil, Del.Ch., 429 A.2d 995, 997 (1981); Hibou, Inc. v. Ramsing, Del.Super., 324 A.2d 777, 783 (1974). Therefore, it follows that the determination of the nature of the claims regarding a breach of those duties also should be very similar. See generally Strain v. Seven Hills Assocs., L.P., 75 A.D.2d 360, 429 N.Y.S.2d 424, 431-32 (1980) (after noting that stockholders and limited partners hold similar positions within their respective entities, the Court looked to corporate law for guidance in determining the nature of a suit by a limited partner); Field Enters. v. Gresser, 160 Wis.2d 45, 468 N.W.2d 30 (TABLE) (1990) (text in Westlaw, at 19) (the Court looked to the corporate standard contained in Bio-Scientific Laboratory, Inc. v. Todd, 149 Ill.App.3d 845, 103 Ill.Dec. 171, 174-75, 501 N.E.2d 192, 195-96 (1986) for the determination of whether a lawsuit was direct or derivative), appeal denied, Wis.Supr., 471 N.W.2d 509 (1991); 59A Am.Jur.2d Partnership § 1397 (1987) (author states that corporate law may be looked to for guidance in the determination of whether an action by a limited partner is derivative or direct). Therefore, throughout this decision, I rely on corporate as well as partnership case law for my determination of this lawsuit's nature.

"The distinction between derivative and individual actions rests upon the party being directly injured by the alleged wrongdoing." Kramer v. Western Pac. Indus., Inc., Del.Supr., 546 A.2d 348, 351 (1988) (emphasis in original). In a derivative suit, a shareholder sues on behalf of the corporation for harm done to the...