Saraiya v. Patel

Decision Date31 October 2013
Docket NumberCV 13 812206
PartiesRAJESH N. SARAIYA, et al., Plaintiffs, v. ATUL PATEL, et al., Defendants
CourtCourt of Common Pleas of Ohio

JOURNAL ENTRY DENYING MOTION FOR PRELIMINARY INJUNCTION

John P. O'Donnell, J.

The plaintiffs claim they are members of a limited liability company formed to acquire and operate a hotel. They allege that two of the defendants, Atul Patel and CLENYJ Hospitality, LLC are acting as managing members when they are, in fact, not members at all. The plaintiffs have asked the court to preliminarily enjoin Atul Patel and CLENYJ from acting as managing members. This entry follows a five-day hearing on that motion.

STATEMENT OF THE FACTS

On November 19, 2011, defendant Cleveland West 150th Street, LLC entered into an agreement with Cleveland Hotel, LLC for an option to purchase the Holiday Inn hotel at 4181 West 150 Street in Cleveland.[1] The gist of the contract is that Cleveland West would acquire the hotel by an initial payment of $750, 000 and the payment of $1, 150, 000 -- secured by a promissory note -- over five years in $230, 000 annual installments. (Cleveland West was also obligated to assume the seller's payment of about $25, 000 per month on a $3.3 million Small Business Administration mortgage loan and pay the hotel's monthly franchise fee -- a percentage of gross receipts -- to franchisor International Hotel Group.) Defendant Atul Patel personally guaranteed the $1.15 million promissory note. At the same time, Cleveland West and Cleveland Hotel entered into a management agreement that allowed Cleveland West to take over the operation of the hotel and keep all of its profits (or incur its losses).[2] Immediately, Cleveland West then made its own management agreement with defendant CLENYJ under which CLENYJ would manage the hotel for 5% of the gross revenue.

Cleveland West is a limited liability company formed for the specific purpose of acquiring the Holiday Inn. Its operating agreement is also dated November 19, 2011. The operating agreement identifies the members, and their percentage of ownership of the membership units, as Atul Patel with 50%, Fred Hanania, 25%, CLENYJ, 10%, and Kaku USA Hotel, LLC, 15%.[3]

The large majority of the down payment came from plaintiffs Rajesh Saraiya, Jayshree Saraiya and Sudha Patel.[4] The Saraiyas contributed $325, 000 and Sudha Patel put in another $325, 000. The plaintiffs were brought to the transaction when Ashwani Adya introduced them to Atul Patel, the self-described promoter of the hotel acquisition. In exchange for their total contribution of $650, 000, Atul Patel gave them a security agreement.

The security agreement was made by Atul Patel personally and refers to the plaintiffs as " Investors." It begins with recitals that include the following:

WHEREAS, A. Patel has arranged for the purchase of certain real property known as the Cleveland Holiday Inn located at 4181 W. 150th St., Cleveland, Ohio (hereinafter " the Property"); and
WHEREAS, Investors are desirous of providing certain funds for the acquisition of the Property; and
WHEREAS an Ohio limited liability company known as Cleveland West 150th Street, (" the LLC") has been formed to take title to the Property; and
WHEREAS, A. Patel intends to take title to a membership interest in the LLC for the benefit of Investors who are jointly providing funds for the acquisition and operation of the property[.]

The security agreement was signed on the same date as, but separate from, the operating agreement of Cleveland West and the option. The security agreement does not expressly refer to the " acquisition of the Property" to mean acquiring an option to buy it, and Rajesh Saraiya testified that he and the other plaintiffs were not told before signing the security agreement that the underlying transaction was actually for an option contract and not an outright purchase of the hotel. The three plaintiffs were also not shown Cleveland West's operating agreement before signing, but Atul Patel did assure Rajesh Saraiya in a November 10, 2011, email that the plaintiffs would have half the interest in the " Asset LLC, " i.e. Cleveland West.

The security agreement goes on to say that the plaintiffs' $650, 000 will be " contributed to the LLC through Patel for the acquisition and operation of the property." Since the money is deemed as contributed through Patel he will " receive title to a 50% membership interest in the LLC" but will hold such title " for the benefit of" the three plaintiffs, and will transfer legal title to the units to them upon request. He also agreed to hold in trust for the plaintiffs all distributions that he would be entitled to as a member of Cleveland West. In addition, Patel promised the plaintiffs a 10% annual return, payable in quarterly installments of $8, 125 each, plus a share of any profit in excess of 10%. Finally, Atul Patel warranted that the plaintiffs " shall have no personal liability for the debts or obligations of the LLC."

Cleveland West's operating agreement reserves the management of the company to the managing members and names Atul Patel, Hanania and CLENYJ as managing members and Kaku as a non-managing member. The agreement contemplates the admission of other members but makes clear that no member, other than a managing member, has " any right to approve, vote on or otherwise consent to any matter relating to the business, affairs or assets" of Cleveland West. But the agreement goes on to provide that no member -- managing or otherwise -- will be required to undertake personal liability for any loan or similar obligation of the company. In other words, the risk to the managing members was the same as the risk to any other member: the extent of any capital contribution.

According to the contract, the initial members were to make capital contributions totaling $1, 300, 000 on the date it was executed. The importance of making the specified capital contributions at the outset was highlighted by section 11.17(b) of the operating agreement, which declares that any member not contributing capital right away " shall be deemed to have immediately and automatically withdrawn as a Member under this agreement and shall have no further rights whatsoever under either this Agreement or the Property Management Agreement ( sic )."

The hearing evidence showed that Atul Patel never made a capital contribution of his own and CLENYJ never made its required capital contribution of $130, 000, although its three members did pay a total of $150, 000 to the seller in January 2013 to cover Cleveland West's November 2012 annual payment to the seller on the promissory note. The evidence also showed that Kaku paid some capital when the contract closed but did not pay all of its required contribution until January 2013. The parties to the lawsuit agree that Hanania made his entire contribution at the required time.

Additional capital contributions may be sought from members but they cannot be required to comply with any such cash calls. If they don't, however, the ownership interests of any member not contributing additional capital will be diluted in proportion to the additional contributions made by other members.

As for the transferability of membership units, section 9 of the operating agreement allows unconditional transfers from a member to a person in the member's family, but gives a right of first refusal to Cleveland West -- and a right of second refusal to the other members -- when a member proposes to " sell or in any other way transfer his interest." The agreement also provides that a member " shall not pledge, cause a lien to be placed against or encumber his interest in any way."

Cleveland West, through the management agreement with CLENYJ, has operated the hotel since November 2011 and the plaintiffs have received their quarterly 10% payments. They have not received distributions exceeding 10%. In early 2012 and again in 2013, Cleveland West issued Internal Revenue Service Schedule K-1s to the plaintiffs showing all three plaintiffs as members of the limited liability company, with the Saraiyas' total share at 25% and Sudha Patel's share at 25%. No K-1s were ever issued to Atul Patel. On April 15, 2012, Atul Patel, for Cleveland West, issued separate certificates to the three plaintiffs that evidenced their ownership of a total of 50 membership units in Cleveland West. He testified that these certificates were issued not to show that the plaintiffs are members but merely as collateral in connection with the security agreement.

Soon after the entire transaction, around early 2012, Rajesh Saraiya learned to his surprise that the deal was for an option and that he and the other two plaintiffs were not named as members of Cleveland West. He began to make frequent requests of Atul Patel for information showing the financial performance of the hotel. Rajesh Saraiya testified that he was never able to get everything he asked for and even the documents he did get were extracted from Atul Patel with difficulty. Nevertheless, he continued to receive his 10% return while CLENYJ forwent its management fee over several months when cash flow was light.

Tension between the plaintiffs and Atul Patel remained through the middle of 2013. Before that time, Rajesh Saraiya found out that the annual $230, 000 installment on the promissory note had been paid two months late and he knew that the hotel, despite a profitable 71% occupancy rate, was not paying all of its bills. Then he was forwarded a July 15, 2013, email from Rehan Murad of Cleveland Hotel to Atul Patel threatening an imminent default on the option agreement if a proposed alternative agreed payoff of the loan was not finalized. Murad said:

If [the negotiated early payoff] is not received by [July 26, 2013] we will have no choice, but to enforce all remedies available to us under the existing agreement including but not limited to talking possession of the hotel and applying for
...

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