CREJ - Journal

Page 16 —

COLORADO REAL ESTATE JOURNAL

— July 1-July 14, 2015

experience

perspective

BKD National Construction & Real Estate Group

What are you reflecting on?

Expanding your footprint? New

revenue sources? In an industry where each project is unique, your

list is likely a long one. You need guidance.

BKD brings 90 years

of experience to the table,

and the advisors of BKD National

Construction & Real Estate Group possess the perspective to help

you manage change, make wise decisions and stay compliant.

Experience how

our expertise can give you a better vantage point.

years

Colorado Springs

719.471.4290

Denver

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Law & Accounting

t is not uncommon for real

estate investors to invest

both money and services

as equity in a multiparty entity.

The entity pools the money, uti-

lizes the services and acquires

more than the individual could

have on his, her or its own. The

investors use the entity to act on

the collective behalf of the equity

holders. The entity itself is gov-

erned under various rules set

by contract, statute or case law,

with the opportunity for signifi-

cant deviation and tailoring to

the desires of the participants.

Inevitably, however, conflicts

arise among investors, and often

one party elects to bring the

dispute to court for resolution.

These conflicts bring into focus

the respective rights, duties and

remedies of the majority ver-

sus the minority equity holders.

Colorado follows the model of

most states by adding an addi-

tional requirement for conflict

resolution that is unfamiliar

even to many attorneys: a stat-

utorily mandated out-of-court

process to evaluate “derivative

claims” and determine if they

proceed in court at all.

Conflicts among investors

arise when real estate invest-

ments either fail or underper-

form and disgruntled investors

look for recourse from their

fellow investors. Typically, an

investor with a “minority” posi-

tion, i.e., the inability to dictate

decisions within the entity, finds

fault with the decision making

of the majority and/or the man-

agement. It is not uncommon

for the majority and manage-

ment to be aligned, or even to be

the same parties. The minority

interest holder runs into a road-

block in resolution if the major-

ity or management will not do

what the minority wants done.

The issue becomes even more

problematic when the entity

can no longer operate because

equity holders begin using veto

rights as leverage to try to com-

pel the noncomplying equity

holders to take actions they do

not want to take. While busi-

ness divorces between disagree-

ing partners often make perfect

sense, as frequently occurs with

marriage divorces, the issue

then devolves into the question

of money. In the chasm between

rights and desires, one disagree-

able party with a willingness

to go to court

is all it takes

to transform

a voluntarily

joined enter-

prise into a

litigious war

of attrition.

Howeve r,

by joining in

the enterprise

as equity hold-

ers, investors

r e l i n q u i s h

certain claims

that

may

seem very personal to them. If

an officer, director or manager

breaches a contractual obliga-

tion or a fiduciary duty, gener-

ally the claim belongs to the

entity itself and not the indi-

vidual equity holder. Unless the

equity holder can demonstrate

unique damages, distinct from

damages suffered by the other

equity holders, any claim that

the actions of management or

the actions of the other equity

holder harmed the enterprise

belong only to the entity itself.

These are called “derivative

claims.” While the individual

equity holder can assert the

claim on behalf of the entity,

such as when an officer/direc-

tor/manager refuses to sue

him or herself, the claim itself

remains property of the entity.

There are a variety of busi-

ness structures available for real

estate investment, but principal

among themare the corporation,

partnership and limited liability

company. Each of these distinct

entity types provides different

levels of rights and remedies for

the equity investor. However,

within Colorado, each has a sim-

ilar – but not identical – process

for evaluating the propriety of a

derivative claim asserted by an

equity holder. For corporations,

Colo. Rev. Stat. § 7–107–402 sets

forth the process for evaluating

derivative claims. In a limited

partnership, Colo. Rev. Stat. §

7–62–1001 provides a similar

process. With respect to limited

liability companies, Colo. Rev.

Stat. § 7-80-716 provides for

the appointment of a “panel”

to determine if the derivative

claims should proceed. The stat-

ute makes clear that “panel” can

be “one or more persons.” Colo.

Rev. Stat. § 7-80-716(b). Once

the panel reviews the claims,

the panel makes a recommen-

dation to the court regarding

whether the claim should pro-

ceed. If the panel, after “con-

ducting an inquiry” determines

in “good faith” that the proceed-

ing should be dismissed, the

court must dismiss the deriva-

tive proceeding.

There is a scarcity of published

cases addressing these issues in

the context of limited liability

companies. Young v. Bush, 277

P.3d 916 (Colo. Ct. App. 2012)

provides the most detailed over-

view of the issues in play. Most

significantly, the case confirms

that the court has no discretion

to disagree with the recommen-

dation of the panel regarding

whether to dismiss or continue

the action if the court determines

that the panel made the decision

in “good faith” and after “con-

ducting an inquiry.” The Court

of Appeals in Young v. Bush

makes clear that independence

of the panel, i.e., whether the

reviewing panel has an econom-

ic stake in determining whether

to proceed with the claim, is a

relevant inquiry into the good

faith question.

In a litigious real estate busi-

ness environment, where

grouchy investors may be dis-

satisfied by the limitations of

their rights, reason or even the

facts, the law in Colorado strives

to provide a balanced process

to evaluate whether an equity

investor asserting derivative

claims should be allowed to

proceed on behalf of the non-

consenting management or

other equity holders. In instanc-

es where management or the

nonconsenting equity holders

disagree with their demands,

the derivative claims evalu-

ation process provides a wel-

come opportunity to have an

independent, disinterested third

party evaluate the claims and

determine if they should pro-

ceed, without all the expense

and restrictions of a civil court

proceeding. Where one party

has been attempting to use the

claims as a sword against man-

agement or the other equity

holders, the out-of-court evalu-

ation process provides a wel-

come shield to put an end to an

unwarranted attack.

Who owns a claim in a multiparty real estate investment entity?

Lars H. Fuller

Counsel,

BakerHostetler,

Denver

Our national real estate practice

is focused on the evolving

needs of clients.

We advise on current positions,

opportunities, and complex

transactions in:

• Acquisition

• Development

• Financing

• Leasing

For more information, please call

Beverly Quail at 303.292.2400

Built on a Reputation of Excellence and Integrity

Real Estate Development ◊ Commercial Lending

Commercial Leases ◊ Forclosures ◊ PropertyTax Appeals

Commercial Litigation ◊Venture Capital Investments

BERENBAUM WEINSHIENK PC

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Denver, Colorado 80202

Telephone: 303.825.0800

Facsimile: 303.629.7610

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