Joint Ventures—Development—Complaint Alleging Mismanagement of Real Estate Development Dismissed Based on Exculpatory Clauses in the Operating Agreements—Plaintiff Unsuccessfully Alleged Triple Derivative Claims—Court Noted That Large Manhattan Construction Projects Often Involve Stop Work Orders Due to Violations

Defendants moved, pursuant to CPLR 3211, to dismiss an amended complaint. The court granted the motion. The dispute involved a joint venture between the plaintiff and the defendant to develop luxury condominiums (project). In essence, the plaintiff and the defendant each had “a 50 percent stake in the project's profits.” The plaintiff alleged that the defendant, “who was responsible for the construction—did a shoddy job that caused delays and resulted in the project generating $30 million less profit than expected….”

The parties' operating agreements contain “classic exculpatory clauses for alleged malfeasance that amounts to mere negligence (as opposed,…, to gross negligence or intentional misconduct).” The court held that “the exculpatory clauses bar all of [the plaintiff's] claims for monetary damages” and the documentary evidence refuted the plaintiff's theory of the case.

The plaintiff alleged that the defendant “had an incentive to cause delay to generate more fees.” However, the court found that “[n]o such excess fees were obtained.” The alleged scheme “would reduce [the defendant's] own profit—the amount of which was identical to [the plaintiff's] share.” The court opined that the “obvious alignment of the parties' incentives, along with the…documentary evidence, leaves [the plaintiff] with nothing other than allegations of ordinary construction negligence” and “the…operating agreements' exculpatory clause mandates dismissal.” The plaintiff was in charge of, inter alia, “design, sales, and marketing.” The defendant was “in charge of construction.” The operating agreement provided:

A member exercising management powers or responsibilities…shall not have personal liability to the company or its members for damages for any breach of duty in such capacity, provided that nothing in this Section 2.3 shall eliminate or limit (a) the liability of any such member if a…final adjudication adverse to him or her establishes that…acts or omissions were in bad faith or involved intentional misconduct or a knowing violation of law, or that he or she acted without the unanimous consent of all members, or that he or she personally gained…a financial profit or other advantage to which he or she was not legally entitled….

Thus, the plaintiff had to establish that the defendant had either: “acted in bad faith,” “engaged in intentional misconduct or intentionally broke the law,” or “engaged in an ultra vires act….” The defendant's construction work was performed by a wholly owned affiliate (construction) and was governed by a construction management agreement (CMA). The court stated that the plaintiff's claims for breach of the CMA would be “a triple derivative claim.”

The plaintiff alleged that the construction “exhibited bad faith, intentional misconduct, and gross mismanagement throughout the duration of the project in breach of the [CMA]” by, inter alia, failing “to adhere to the project budget,” failing “to coordinate trades and consultants…, causing significant delays” and failing “to adhere to the project schedule.” construction allegedly failed to provide the plaintiff with “updated budgets, updated schedules, and monthly cost projections or forecasts,” failed to advise the plaintiff “of infractions at the project,” failed “to maintain sufficient personnel and staffing at the project” and failed to cause the work to comply “with all applicable laws.” The plaintiff emphasized that the Department of Building's “stop work orders” caused “over 350 days of delays at the project.”

The plaintiff asserted that the longer the project took, the more money that construction and other companies made a “financial windfall.” However, the court found that such theory was belied by the CMA, which provided, with one minor exception, that construction was only entitled to and only received reimbursement for its out-of-pocket costs. The court further noted that given the defendant's 50 percent ownership interest, the defendant would have also lost profits if the project was delayed.

Moreover, until the subject action was commenced, neither the plaintiff nor the lender, “who had oversight rights and an interest in completing the project in an efficient, cost-effective manner,” complained about “these purported problems.” After the work was substantially completed, the parties had agreed to “split” three remaining unsold units.

The plaintiff's breach of fiduciary claims were derivative, because the alleged harm the plaintiff “suffered is the diminished profit on the project…, which is a loss [the plaintiff] realized by virtue of its membership interests in the nominal defendant LLCs.” Here, Delaware law governed “whether a claim is direct or derivative.” “For a claim to be direct, '[t]he stockholder's claimed direct injury must be independent of any alleged injury to the corporation. The stockholder must demonstrate that the duty breached was owed to the stockholder and that he or she can prevail without showing an injury to the corporation.'” Since the plaintiff sought to recover the project's “lost profits,” its claims were derivative.

Additionally, the plaintiff's claims for breach of the CMA were “necessarily derivative because it is not a party to that contract. It is suing triple derivatively on behalf of the LLCs in which it has an interest….” Furthermore, the “derivative claims belong to the company, and,…stockholders lack standing to prosecute derivative claims absent demand or demand futility.”

The court found that, at most, the plaintiff's claims “amount to negligence claims for which defendants are exculpated from liability under the operating agreements.” The “defendants' demand futility and failure to state a claim arguments are predicated on virtually identical inquiries.” The court further explained “LLC members are free to disclaim most forms of liability, including breaches of fiduciary duty…. And while certain types of liability cannot be disclaimed (e.g., the duty of good faith and fair dealing and gross negligence) […], the negligence disclaimer in…the operating agreements is an example of a classic, enforceable exculpatory provision. Indeed, even under New York law applicable to construction contracts (such as the CMA), contractual negligence waivers are generally enforceable.”

Where there is an alleged 50-50 split in ownership, “demand futility exists if the 'board is evenly divided between compromised and non-compromised directors.'” The plaintiff argued that the defendant faced “personal consequences from the outcome of the litigation.” The plaintiff was required to make “particularized allegations” that allow “the conclusion that defendants face a 'credible threat of the imposition of liability.'” Here, the defendant would only face liability if the plaintiff had sufficiently pled a claim “for bad faith, gross negligence, or intentional wrongdoing” and the court had held that the plaintiff's allegations amounted to “mere negligence.”

The plaintiff cited, inter alia, the number of stop work orders, the failure to obtain certain necessary permits, a unilateral decision to relocate the elevators and delays based on a change of real estate brokers. The court held that those allegations and the alleged improper staff changes and allocation of personnel, did not constitute intentional misconduct. The court found such allegations to be “conclusory and implausible given the parties' equal stake in the project.” Moreover, some increases in the budget were attributable to “delays caused by ordinary negligence,” and did not constitute “evidence of intentional wrongdoing.” The court also reasoned that the defendant lacked an incentive to intentionally delay the project since any additional fees would have reduced the defendant's profit and therefore, the defendant “did not profit from delay.”

The court looked at the economic reality and observed that the plaintiff alleged that the defendant caused “$30 million in cost overruns and lost sales so that [construction] could collect one-seventeenth of that amount ($1.7 million) in 'general conditions.'” However, “under the governing documents, 'general conditions' payments did not and could not ever exceed the expenses [construction] actually incurred in connection with the project.” Moreover, the plaintiff was “a counseled, sophisticated business entity” that had “contracted away the right to disgorge such unrealized profits from [defendant] for ordinary negligence and did not contract for a cap on costs.”

The court further held that even if demand futility had been properly pled as to the alleged breach of the CMA, the claim was defective since damages were precluded by the CMA. The CMA waived “'consequential damages,' including damages for 'income and profit').” If the plaintiff had issues with how construction was performing, they should have raised such objections before the work was completed and the units sold. Here, the plaintiff never sought to terminate construction, first formally complained in the subject lawsuit and some of the delay arose from the plaintiff's own delay in producing architectural drawings.

The court concluded that the plaintiff had “not alleged conduct within the scope of the exculpatory clause, and, therefore,…failed to state a claim for relief under the operating agreements.” There was no evidence that the defendant faced “a credible threat of liability” and therefore, the plaintiff could not assert derivative claims. The court also held that there was “no need for an accounting at this juncture that could justify the burden of providing one.”

Comment: Interestingly, the court observed that, in its experience, “large construction projects in Manhattan often are affected by stop-work orders due to violations. Rarely does such a large project get completed without any delay.” Additionally, the court noted that “much of what [plaintiff] alleges is simply false.”

Madison Sullivan Partners v. PMG Sullivan St., Sup. Ct., N.Y. Co., Index No. 650930/2017, Kornreich, J.

Adverse Possession—Claim Denied

The plaintiffs had commenced an action pursuant to Real Property Actions and Proceedings Law (RPAPL) Art. 15, to determine claims to real property. The defendants moved for summary judgment dismissing the complaint. The plaintiffs cross moved to amend the complaint to add a cause of action “for precise location.” The court dismissed the complaint.

The plaintiffs purchased their property in 2005. Their backyard is adjacent to a property owned by the defendants. The defendants bought their property in Jan. 1988. “A chain-link fence” (fence) “existed on the strip of property that runs along the southern boundary of defendants' lot and close to portions of the northern boundary of plaintiffs' lot. The fence was located entirely on the defendant's property and was set back approximately ten feet.” The plaintiffs sought to acquire title “by adverse possession of the area of defendants' property between the…fence and the boundary line of plaintiffs' property, which covers approximately 800 feet” (disputed land). The plaintiffs contended that “between 2005 and 2015, they maintained the grass of the disputed land and planted a vegetable garden” and that a shed had been erected on the disputed land by their predecessor in interest.

A plaintiff testified, inter alia, in a deposition, that the plaintiffs had seen a fence on defendants' property and that “trees and shrubbery” were in front of the fence. The plaintiffs “never performed any maintenance or repairs to the…fence” and had never discussed the disputed land with the prior property owners. The maple trees on the disputed land had been there as long as plaintiffs owned the property. The plaintiffs did not know who had planted the maple trees. The plaintiffs asserted that a shed which had allegedly been erected by a prior owner of the plaintiffs' property, “existed in the backyard on the disputed land.” The plaintiffs acknowledged that between 2005 and 2010, they had not planted anything on the disputed land and had only “mowed the area and cleaned up any fallen branches.” In 2010, they allegedly hired a company “to take down pine trees and planted four arborvitaes on the disputed land. In the spring of 2011, plaintiffs planted a vegetable garden on the disputed land.” In 2015, the plaintiffs installed a pool in their backyard and “around that time, the defendants had removed the…fence.” The plaintiffs asserted that, after the removal of the fence, the plaintiffs lacked “a proper barrier around the pool and had to install a fence on their property.”

The plaintiffs' predecessor owner acquired the property in 1993 and erected an aluminum shed on the disputed property. He claimed that he tried to keep the shed on his own property and he thought that “the trees denoted the property line.” He intended to install the shed about a foot away from the property line. He had not done “any clean up, planting, or mowing of the disputed land.”

The defendants argued that there had been “no showing of exclusive occupancy by plaintiffs of the disputed land” and the fence was “a flimsy wire…fence and was not a substantial enclosure pursuant to RPAPL 522.2.” Although the plaintiffs claimed that part of the shed was built on the disputed land, the prior owner testified that “it was entirely within plaintiffs' property….” The defendants further argued that “mowing grass and cleaning branches are not adequate to put them on notice of adverse possession” and the plaintiffs had “not met the ten-year requirement for adverse possession, which, if at all, did not begin until 2010 when plaintiffs cleared the disputed land and planted a garden.”

The defendants also had argued that awarding the plaintiffs adverse possession would violate public policy, by reducing their plot size below that required by the applicable zoning ordinance.

The plaintiffs argued that defendants relied on hearsay, had failed to include authenticated exhibits and there were numerous issues of fact.

“To establish a claim of title to real property by adverse possession, a party must demonstrate, by clear and convincing evidence, that the possession was (1) hostile and under claim of right, (2) actual, (3) open and notorious, (4) exclusive, and (5) continuous for the statutory period of 10 years….” Parties who assert adverse possession claims may tack onto the time that “the party's predecessor adversely possessed the property,” if they demonstrate that the “predecessor 'intended to and actually turned over possession of the undescribed part with the portion of the land included in the deed.'” In 2008, the Legislature amended RPAPL 501 to include a “statutory definition of the 'claim of right.'” The 2008 amendments also defined “'permissive and non-adverse' actions that,…, were sufficient to obtain title by adverse possession.” RPAPL 543 provides:

1. Notwithstanding any other provision of this article, the existence of de minimus [de minimis] non-structural encroachments including, but not limited to, fences, hedges, shrubbery,…, sheds and non-structural walls, shall be deemed to be permissive and non-adverse.
2. Notwithstanding any other provision of this article, the acts of lawn mowing or similar maintenance across the boundary line of an adjoining landowner's property shall be deemed permissive and non-adverse.

The court held that the 2008 amendments are applicable to the subject action and that “[t]he plaintiffs had not possessed the disputed property for 10 years when the statute was enacted and their purported adverse possession did not vest prior to the enactment of the statute in 2008….”

The court stated that the plaintiff's clearing of “branches from the disputed land, mowing the lawn, or the existence of a shed on the disputed land are permissive and non-adverse” and “the permissive use of the property…'negates the element of hostility necessary to establish a claim of adverse possession.'” The plaintiffs had failed to raise an issue of fact as to whether the 10-year period could be met by tacking on periods of adverse possession or use by their predecessors, since “they offered no evidence that their predecessors intended to and actually turned over possession of the disputed property with the portion of the land included in the deed.” Accordingly, the court granted, inter alia, summary judgment to the defendants and dismissed the claim for adverse possession, nuisance, and injunctive relief.

Lorenz v. Soares, Sup. Ct., Westchester Co., Index No. 71204/2015, decided Jan. 10, 2018, Giacomo, J.

Scott E. Mollen is a partner at Herrick, Feinstein and an adjunct professor at St. John's University School of Law.