Reynolds v. Coleman
| Decision Date | 01 August 1988 |
| Docket Number | No. 86-2035,86-2035 |
| Citation | 527 N.E.2d 897,123 Ill.Dec. 259,173 Ill.App.3d 585 |
| Parties | , 123 Ill.Dec. 259 Thomas A. REYNOLDS, Jr., Plaintiff-Appellee, v. John B. COLEMAN, Defendant-Appellant (Kenneth G. Pigott, Defendant-Appellee). |
| Court | United States Appellate Court of Illinois |
Foran, Wiss & Schultz, Chicago (Thomas A. Foran, Kenneth W. Sullivan, Christine S. McGoey, of counsel), for defendant-appellant.
Wildman, Harrold, Allen & Dixon, Chicago (Craig M. White, Dorothy A. Denniston, of counsel), for plaintiff-appellee Thomas A. Reynolds, Jr.
Patrick T. Driscoll, Jr., P.C., Chicago, for defendant-appellee Kenneth G. Pigott.
The present dispute arises out of a partnership agreement between John Coleman ("Coleman"), the defendant, and his former attorneys Thomas A. Reynolds, Jr. ("Reynolds"), the plaintiff, and Kenneth G. Pigott ("Pigott"), a nominal defendant, relating to the Whitehall Hotel ("Whitehall") located at 105 and 111 East Delaware Place in Chicago. After a bench trial, the trial court awarded Reynolds and Pigott each $953,465 for their respective shares in the partnership, and Coleman appeals challenging the court's construction of the partnership and its valuation of the partnership assets. For the following reasons, we reverse and remand.
The testimony and exhibits at trial reveal the following. In 1970, Coleman sought to purchase the Whitehall and develop it into a small luxury hotel. To finance his acquisition, Coleman entered into an agreement with Lex Hotels, an English corporation, in 1972, wherein Coleman would supply $6 million to fund the purchase and renovation of the Whitehall, while Lex would renovate and operate the hotel while paying $660,000 per year rent to Coleman. Reynolds and Pigott, attorneys with the firm Winston & Strawn, provided legal assistance to Coleman in concluding this deal.
Pursuant to the terms of the agreement with Lex, Coleman obtained the $6 million in interim financing from the First National Bank of Chicago, and in December 1972, he purchased the Whitehall for $2,300,000. Legal title to the real estate was held by LaSalle National Bank land trust number 41500 with Coleman as the sole beneficiary. Lex, as the tenant, paid rent to the trust.
In the latter part of 1973, Coleman purchased the Putnam Building immediately adjacent to the Whitehall, and transferred its title into the Whitehall land trust. Coleman then renegotiated his agreement with Lex, with the assistance of Pigott, to incorporate the Putnam Building into Lex's renovation program. Under the amended agreement, Lex's rent was increased to $1,100,000 per year, and Coleman agreed to provide the additional funds necessary for the extra renovations.
Subsequently, Coleman, Reynolds and Pigott entered into an agreement, memorialized in a letter dated March 4, 1975, confirming a prior oral agreement, "concerning [the] ownership, operation and management of The Whitehall" defined as "the real estate commonly known as 105 and 111 East Delaware Place, Chicago, Illinois." The letter, drafted by Reynolds, indicated that Coleman retained a 95% interest in the Whitehall while Reynolds and Pigott each held 2 1/2% interests in the hotel. The letter further recognized that title to the land was held in land trust number 41500 with LaSalle National Bank acting as trustee.
Lex began operating the Whitehall as a luxury hotel in June 1974, and continued to do so until October 31, 1980, at which time Coleman purchased the operations, leasehold and fixtures of the hotel through his wholly-owned corporation, W.M. Management Company, for approximately $2.2 million.
On March 30, 1984, Coleman entered into a complex financial arrangement structured by Integrated Resources, Inc., a publicly held financial services company, with Whitemont Associates Limited Partnership ("Whitemont") to raise cash towards the operations of the Whitehall and Tremont Hotel, another hotel owned by Coleman. The deal was characterized as a "sale" even though Coleman retained the right to manage the hotels and use their assets as collateral for future loans. He also remained obligated to pay all expenses, taxes, repairs, improvements and maintenance for the hotels, thus merely conveying their legal titles to Whitemont. The stated "purchase price" for the hotels under the transaction, based on an appraisal obtained from the firm of Cushman & Wakefield, was $70 million, 60% or $42 million allocable to the Whitehall and 40% or $28 million allocable to the Tremont. Coleman actually received for the Whitehall $38.64 million in purchase money notes and $9.66 million in cash, $6.3 million of which was prepayment interest on the Whitehall notes.
With the conveyance of the legal titles, Whitemont sold shares in the hotels to a syndicate of limited partners. The confidential offering memorandum for potential investors stated:
The return on a limited partner's investment came in the form of substantial tax losses. During the 15-year period, the limited partners could expect a tax loss at a ratio of $3.5 to $1 invested.
The trial court considered the Whitemont transaction as well as the testimony of five witnesses in arriving at its valuation of the partnership. Coleman submitted the testimony of William A. McCann and Neil King who are both professional real estate appraisers and licensed real estate brokers.
King and McCann testified that three recognized appraisal methods, the comparable sales approach, the economic or income approach, and the replacement or reproduction cost method, are taken into consideration in determining the fair market value of real estate. Under the comparable sales approach, the appraiser considers the sale price of similar properties to derive a unit for comparison which can be applied to the appraisal property. In the case of hotels, the appraiser attempts to derive a price per room unit of comparison by dividing the gross sales price of a comparable hotel by the number of rooms in a facility. A comparable hotel is one that is reasonably similar in location, use, physical construction and income production to the hotel subject to appraisal.
The economic or income approach requires the appraiser to multiply the actual fair rental value of the property by a reasonable capitalization rate to arrive at the total value for the property. The capitalization rate reflects the percentage rate of return an investor in the marketplace would expect to receive from the real estate.
Finally, under the reproduction approach, an appraiser adds the value of the land underlying the building to the cost to replace or reproduce the structure, plus or minus any accrued depreciation or appreciation. This appraisal method generally sets the high end of value for a property because the market assumes that a purchaser would not pay more for a used facility than he would to buy it new.
To give an appraisal of the Whitehall, McCann and King both visited the hotel and thoroughly inspected it. Their inspection revealed that the hotel is situated on a parcel of land that is approximately 18,266 square feet, about a half-block west of Michigan Avenue on the south side of Delaware Street in Chicago. Other hotels in the vicinity of the Whitehall include the Drake, the Mayfair Regent, the Ritz Carlton and the Inn of Chicago.
The Whitehall building itself is a 21-story, reinforced concrete structure with a face-brick finish built around 1928. The basement houses the original heating equipment, the boilers, and a laundry facility used for the hotel operations. On the first floor of the hotel is a 125-seat restaurant called "The Whitehall Club" which is operated as a private club as well as open to hotel guests. This floor also has a small lobby with a bar. Three elevators, two passenger and one freight, lead to the upper floors which contain approximately 223 guest rooms, including several suites on the top floors. The hotel structure is attached to the Putnam Building, a five-story complex used primarily for office space. A portion of the Whitehall Club extends into this building.
There is no parking available for guests of the Whitehall. Rather, the area behind the hotel is primarily used for commercial loading and unloading. This back parcel has no value to anyone other than the owner of the Whitehall or Tremont for expansion of those facilities.
King and McCann initially testified as to the value of the Whitehall real estate separate from the business of the hotel. After considering both the income and reproduction income approaches, King obtained fair market values of the real estate of $13 million and $17 million. King arrived at the $17 million reproduction figure by calculating the cost of the land underlying the Whitehall to be worth $5 million using a $250 to $300 per square foot rate. He then estimated the cost of replacing the building to be $115 per square foot times the 140,000 square foot area of the building for a total of $16 million. He added these two figures together and reduced the $21 million total by 25% for physical depreciation and functional obsolescence, resulting in $17 million.
In arriving at the $13 million income figure, King capitalized the $1.1 million per year rental income generated by the Lex lease by 9%, arriving at a total income of $12.2 million. He raised this $12.2 million to $13 million to account for the potential payment of "profit rent" as stated in the lease.
McCann valued the Whitehall, excluding the hotel business, between $11.9 and $20 million. He used reproduction cost figures similar to those of King to arrive at his $20 million total reproduction cost estimate. In arriving at the $11.9 million figure...
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