Real World; Real Problems—First Steps in Addressing Real Estate Partnership Disputes

On this Ropes & Gray podcast, real estate investments and transactions partner David Kaye and counsel Pete Scherer are joined by litigation partner Andrew Todres to discuss one of the more taboo topics in real estate investing: partnership disputes. Together, they explore the initial steps to take when facing a partnership dispute, the key considerations and remedies available, and the nuanced decision-making process between avoiding litigation and rushing to the courtroom. Whether you're a capital partner in a joint venture or simply interested in the complexities of real estate disputes, this episode provides valuable insights and practical advice.

---

Transcript:

Pete Scherer: Welcome to all of our listeners and thanks for joining us to discuss one of the more taboo topics in real estate investing: partnership disputes. My name is Pete Scherer, a counsel in our real estate investments and transactions group, and I’m joined here today by my colleagues, David Kaye, a partner in our real estate investments and transactions group, and Andrew Todres, a partner in our litigation group—and David’s and my first call when an investment starts to turn hairy.

Our goal today is to give you a sense of what your first steps should be in the event you find yourself facing a partnership dispute, and an appreciation of the factors and considerations to take into account should you find yourself in a dispute with one of your partners. With that background, let’s get started.

David, let’s start with you. Since we handle the documentation for an investment, we’ll typically field a client’s first call when issues start to emerge with an investment. What’s step one in your eyes when that call comes in?

David Kaye: It’s a great question, Pete, and hello to all of our listeners. The first step is just fact gathering and trying to begin formulating an initial analysis of the client’s contractual rights and remedies.

Pete Scherer: Okay, can you expand on that? Walk our listeners through what you view as the key objectives for that initial call from the client.

David Kaye: I want to leave that initial call with enough information to undertake productive next steps before speaking again with the client. What I mean by that is, I need to know what deal we’re talking about, what the fundamental commercial issue is, and who did (or didn’t) do something. I also need to know how exigent the issue is, and I need to have a sense of the conduct and conversations that have led up to the client reaching out to me about this potential issue. From there, I probably have enough information to review the relevant contracts and start outlining potential next steps and options for the client.

Pete Scherer: Focusing on the last thing you said, and bearing in mind we’re real estate lawyers, let’s assume your client is the capital partner in a joint venture (“JV”): What types of rights and remedies would you expect to see in the agreement?

David Kaye: The JV agreement will provide for different types of rights and remedies, which may depend on the nature of the breach, whether it’s a simple breach of contract claim, for example, failure of the general partner (“GP”) to request consent for a major decision, or failure to satisfy a performance standard, which could be not acting in the best interest of the asset or failing to demonstrate basic competency. Remedies could include removal “for cause,” which would involve a forfeiture of the promote and fees, loss of major decisions and operational control of the venture, and a corresponding indemnity from a credit-worthy affiliate. A capital partner might also be able to accelerate its exit from the transaction, which could be in the form of a forced sale of the asset or the JV, a put/call, or a combination of different remedies that might be available in law or in equity.

Pete Scherer: Okay, great. So, is the next step as simple as calling the client back and reading out those options or is it more nuanced than that? When does it go from a transactional lawyer issue to a litigator issue (when does Andrew get brought in)?

David Kaye: If it was only that simple. There’s a lot of nuanced analysis that ultimately goes into the right, and best, next step. Andrew is a key thought partner in performing that analysis. Andrew, let’s give you a chance to speak. Say I give you a call saying Client A is in a partnership dispute—I’ve taken a look at the JV, and I think we have X, Y, and Z options. What are your next questions for me?

Andrew Todres Thanks, David. So, before we go rushing into the courtroom, we’re going to have a lot of additional analysis to do on the litigation side. Often, the goal in a JV dispute is to try to avoid litigation if we can. But in order to inform the best strategy for resolving the dispute, we as litigators need to game out what a lawsuit would look like, what the pros and cons of litigating are, how likely litigation is to lead to the business objective, and how long litigation will take.

To start with, we usually evaluate four primary considerations:

1. What do the JV documents say about forum or venue. In layman’s terms, does litigation need to be filed in a specific court, or do you have more optionality as to where to file? And is there a mandatory arbitration provision that’s going to require you to arbitrate instead? These factors may impact what types of claims you can bring, and how long it will take to resolve them. Some courts move faster than others, and arbitration may move faster than litigating in court.
2. We need to think about what a successful exercise of remedies is going to look like, and what consequences might flow from those remedies. Are there material contracts with change of control provisions that might be triggered by removing the operating partner? Is it clear that, win or lose, the operating partner’s control rights will not be restored, or is there a potential for having to deal with a “fired” manager arguing that they should be reinstated if they win a removal dispute?
3. Are there other downsides to litigation or removal? You have to consider possible reputational costs; delays in the project; loss of “on the ground” relationships (maybe your operating partner had valuable relationships that you’re going to lose if you remove them). And as we all know, litigation can be distracting and time-consuming.
4. On the flipside, put yourself in the operating partner’s shoes. Some operating partners are in litigation all the time and unaffected by it. For others, being sued presents considerable reputational risks that they want to avoid. So, understanding how your potential adversary might be thinking about all of these factors will influence your judgment on whether and how to proceed with litigation.

Pete Scherer: Wow, a lot to unpack there, Andrew, and it makes me happy that I’m on the transactional side of things. One similarity I observe between what you do and the transactional side is, I think a key value add of all lawyers is helping clients think through the next steps and seeing around corners. When you’re emphasizing things like reputational costs, opportunity costs, and what happens if enforcements and remedies fail, those are all corollaries of things that we think through when we’re documenting a deal on the front end, before things go south.

As a follow-up question, just so I understand, is your recommendation that formal proceedings should always be avoided, or are there situations where you think there’s actually an imperative to rush to the courtroom to preserve rights or to seek some sort of equitable judgment? How do we help a client understand when it’s time to go slow and when it’s time to go fast?

Andrew Todres: That’s a great question, Pete. I’ve certainly seen plenty of urgent situations arise that require immediate litigation and intervention by a court. You can think of any number of examples: fraud, entering into some improper transaction that is about to close without your consent, and the list goes on.

In a more ordinary dispute, where the circumstances are not as exigent, it is often advisable to go through a process of trying to avoid litigation if you can, because once a case is filed, you lose some control over the process and over the outcome. A court might side with you, but not order the exact type of remedy that you want. A court might not understand how an agreement provision works and could rule against you.

Having said all of that, sometimes litigating is not that much of a gamble because you have a really strong claim or defense. And sometimes, if your partner won’t play ball or isn’t being reasonable, you have no choice but to litigate—and you can always continue to negotiate toward a resolution after a case has commenced.

Pete Scherer: That’s really helpful in helping me at least understand some of the nuances around when it’s time to do what you can to avoid the courtroom, and when it’s time to go to the mattresses, so to speak. One more follow-up question for you. Do you have a view more generally on whether arbitration, litigation, or even mediation is the better or best option, or is it always facts and circumstances dependent? If the latter, can you walk us through, if you have the choice, how you might weigh the pros and cons of, say, arbitration, versus litigation, versus mediation?

Andrew Todres: Sure. A lot of times in a JV, you’re stuck with whatever option is mandated by the agreement. But the advantages to arbitration are (i) it’s confidential, (ii) it’s usually more streamlined, and therefore, you can often get a result more quickly and more efficiently than in a full-blown lawsuit. That’s why a lot of times, JVAs will actually apply a mandatory arbitration provision to exigent removal issues while allowing other, more ordinary-course disputes to be litigated in court. Of course, if you have a forum selection clause that gets you into a court like the Delaware Court of Chancery or New York Commercial Division—courts that are very used to handling urgent disputes on an expedited basis—then that might weigh against arbitration and just going straight to court, because in court, especially if you have a better legal position, you might be more likely to get the result you’re looking for. I think judges are a little bit less likely than arbitrators to want to split the baby, and they’re just more focused on getting the right legal result. Mediation, on the other hand, is not typically binding on the parties in any way, so it can be used in conjunction with either arbitration or litigation (and it can even be used prior to the commencement of any litigation). A good mediator can be really effective at driving a resolution and helping to reduce litigation costs on the back end, so it’s always a step worth considering.

Pete Scherer: Got it. It’s really helpful to understand the pros and cons of the different dispute resolution options that might be on the table. Moving away from some of the more technical aspects of a dispute and which venue, process, or procedure to use, let’s say that we’re in a normal situation where you have reviewed the contracts associated with a given dispute, you’ve analyzed the claims, but there wasn’t an exigent circumstance requiring an immediate rush to the courtroom. What are the typical next steps? How do you signal to your counterparty that things are getting serious and that it’s time to stop messing around and get serious about working through the issue at hand?

Andrew Todres: There are a lot of different ways to stage it, but usually, we put together a demand or some sort of reservation of rights letter to try to help drive a negotiated resolution. That may be accompanied by some discussions at the business level or at the legal level.

As this is going on, we’d start to do our own homework and diligence, both from an offensive and defensive perspective. We want to assess what the documentary evidence would look like in litigation if the case goes to discovery. Do you have emails or other records that back up your claim or defense? Or are you complaining about some activity that the operating partner engaged in that you had, in fact, expressly approved in writing? So, it is important to get as clear an understanding of the facts and evidence as possible before we actually get into litigation so that we can take advantage of what is helpful to us and have a plan to minimize the effect of whatever might be harmful to us.

Then, separate from litigation planning, we need to do business planning around the desired result. You need to make sure the partnership dispute doesn’t impair asset value or critical timelines. It means getting ahead on things like satisfying any change of control requirements, and finding a replacement manager, which can be challenging.

And all this has to happen in parallel. In a time-sensitive or -critical matter, we would probably start drafting the litigation documents, too, to have those at the ready so that if we need to go into court on a moment’s notice, we can.

David Kaye: Lots of variables to balance, Andrew. I suspect you’ve had similar experience, but I’ve always found partnership disputes to be very dynamic and subject to rapid evolution with lots of things happening simultaneously. Lest we overwhelm our listeners, let’s suspend the discussion of strategies that go into resolving partnership disputes and assume for a moment that our client has decided they have a strong case and want to move forward to enforce formal remedies—let’s say, removal for cause of a JV manager. What happens next?

Andrew Todres: The answer will usually be spelled out in the removal provisions of the JV, which can vary, but in most cases, here is the process:

• First, you will issue a removal notice to the operating partner.
• Next, you’re going to need to provide notice to third parties as necessary and proceed with the business as though the partner has been removed (assuming the JV provides the capital partner the unilateral right to remove). That means bringing in a replacement manager; instructing the removed partner to hand over whatever documents, books, records, or other information is needed; providing access to the accounts, the JV property, keys, etc.; and then, you have to remove the removed partner’s personnel from being authorized signatories on behalf of the JV (including on the JV’s bank accounts).

Obviously, the second part doesn’t always work out in a cooperative manner if the JV partner challenges removal. Absent express language in the JV agreement to the contrary, courts may be inclined to preserve the status quo and keep them in as manager until the dispute is resolved. In fact, the Court of Chancery did just that in a recent case involving a removal dispute.

Some JVs resolve for this issue ahead of time by including requirements around books and records access during removal fights. The last thing you want is for the company to be unable to operate as a result of litigation.

David Kaye: That latter point, I think, is an important one. I know I always push to make it very clear that control transfers during the pendency of a dispute and that a fired manager can’t be reinstated (even if they get damages) to avoid a situation where my client, as the capital partner, can’t assume control of its investment where it feels doing so is imperative to avoiding value loss or where my client faces the risk of needing to “hand back” the keys to the manager that they just tried to fire.

Pete Scherer: Andrew, any final thoughts before we sign off?

Andrew Todres: I think my final thought is that there’s no one-size-fits-all approach here. Sometimes, you have a great case, but business considerations weigh against litigation. Sometimes, you have a really weak case, but litigation is your best option to force a positive result. A strategy that worked to resolve a dispute in Partnership A may not work to resolve a dispute in Partnership B, so you just have to take each case as it comes.

Pete Scherer: I know I speak on behalf of all of us when I say we’re happy to field any question that any listeners may have. And folks should feel free to reach out to any of their usual Ropes & Gray contacts if they have any questions about real estate partnership disputes. Thank you so much for listening. If you enjoyed today’s discussion, please subscribe and listen to this series on Apple or Spotify.