Scott E. Mollen
Scott E. Mollen ()

Temporary Receiver Appointed—Investor Dispute—Defendant Allegedly Reneged on Joint Venture—Allegations of Fraud and Mismanagement—Operation of Apartments as Illegal Hotel

The plaintiff moved for an order pursuant to CPLR 6301, enjoining defendants from “selling, transferring, or hypothecating” the subject premises (property) without the plaintiff’s consent and pursuant to CPLR 6401, appointing a temporary receiver during the pendency of the action. The court granted both motions.

“A,” the property owner, had commenced a Chapter 11 bankruptcy proceeding. “A’s” sole asset were “two…four-story mixed-use,…buildings and…unused development rights.” The Bankruptcy Court had approved a minimum bid for the property of $9 million. The plaintiff alleged that “B,” on behalf of “A,” had signed the bankruptcy proceeding petition and had represented that “he would be operating the…property during said proceeding.” “B” had signed an affidavit admitting that he is the sole member of “A.” The affidavit stated that the debtor “fell behind on mortgage payments following the 2008 economic crisis and cash flow problems.” “B” admitted that the property is burdened with an approximately $4 million first mortgage, “is subject to a foreclosure judgment” in favor of a second mortgagee in the amount of approximately $1.8 million, and “there is a third mortgage claim on the property in the amount of approximately $4 million.” “B” further swore that “he would be responsible for management of the property during the bankruptcy proceeding.”

Defendant “C” admitted that “more than 80 percent of the equity interest in the property belongs to him and his brother….” He also admitted that “[plaintiff] has some unquantified equity interest in the property.” The plaintiff’s documents, in support of his motion, included an “agreement of purchase and sale of company interest, the assignment and assumption agreement, and the irrevocable proxy agreement, all dated Nov. 5, 2015.” The court opined that such documents were “indicative of some suspicious transaction.” Moreover, text messages from the plaintiff to “B,” relating to the plaintiff’s “failed attempt to sell the property, indicate that ['B'] had some involvement in the management or ownership of the property despite [plaintiff's] intent to exclude ['B'] from the joint venture to purchase the property.”

In or about June 2013, “C” allegedly contacted the plaintiff “about jointly purchasing the property.” The parties disputed the terms of the contemplated purchase. An original proposal in a signed offer sheet provided that a limited liability company would be created to purchase the property. The offer sheet stated, inter alia, that the plaintiff would pay “$1.25 million for a 20 percent equity interest in the property.” “C” was to “advance at least $2.75 million as an equity contribution, be responsible for a $5 million mortgage on the…property, and have day-to-day management responsibilities.” The parties agreed that the funding to purchase the property would be as follows:

$760,000 due from [plaintiff] upon execution…as part of the downpayment towards the purchase price of the property pending acceptance by the [Bankruptcy] Court and closing….

“C” or an affiliate of “C” was to pay the balance of the purchase price and for the closing of a mortgage loan on the property in the amount of $5 million. All day to day management of the property was to be the sole responsibility of “C.” The offer sheet provided that each party would have a right of first offer and right of first refusal (ROFR). “C,” however, was permitted to transfer his interest among “family members and affiliated entities.”

The plaintiff claims that he insisted that “B” not have any involvement in the joint venture, “because of numerous lawsuits against him arising from failed real estate deals, including the fact that ['B'] had previously mismanaged the…property, forcing it into bankruptcy in the first place.” The court took judicial notice of other litigations wherein “B” is either currently or had been a defendant. Furthermore, “B” had “represented to the Bankruptcy Court that the purchaser of the property was a ‘non-insider unrelated to the debtor.’”

The plaintiff alleged that while the parties were negotiating terms of their agreement, he provided $1.1 million as an equity contribution towards purchasing the property and that the transaction was supposed to be “an all-cash deal.” He further stated that at an auction in August 2013, an entity owned and managed by “C,” purchased the property for $9.5 million, with “B,” “unbeknownst to him, allegedly operating behind the scenes to direct the purchase of the property.” The plaintiff asserted that “A” had given “a quitclaim deed for the property” to an entity under “C’s” exclusive control and that “C’s” entity had taken out an $8.5 million mortgage on the property (mortgage) “on that same day, securing the…property without his knowledge or consent.” The plaintiff alleged that the mortgage had been executed on behalf of “C’s” entity by an entity also within “C’s” exclusive control and the mortgage had been signed by “C’s” brother.

The plaintiff asserted that “the real world implications of ['C's'] reneging on the parties’ joint venture is that he is the only person who advanced funds in the transaction and that ['C'] essentially used [plaintiff's] money as leverage to secure the [mortgage], such that he is being wrongfully deprived of his ownership interest in the property.” The plaintiff reasoned that “because he ‘contributed 100 percent of the equity…to acquire the property, and then had his equity leveraged in order to acquire the mortgage, [plaintiff] is the one-hundred percent (100 percent) owner of the property, or the 100 percent membership interest holder’” of the ownership entity.

Additionally, the plaintiff alleged that “C” had “turned over day-to-day control of the property to ['B'] and his brother…, who operated the property as an illegal hotel,” that “the property…received numerous violations from the [NYC Department of Buildings (DOB)] and has incurred thousands of dollars in civil penalties that are still unpaid, none of which [plaintiff] had been informed.” The plaintiff also alleged that unbeknown to him, in November 2015, “C” entered into several agreements with “B’s” wife and “D,” an attorney who had recently been indicted “in a real estate scheme targeting the elderly and allegedly paid a fine for his role in a…mortgage relief scam in Florida.” Pursuant to such agreements, “C” had “allegedly sold a 49 percent equity interest in [the ownership entity] by an ‘irrevocable proxy’ to ['B's'] wife and ['D'] for approximately $1 million.”

The plaintiff further alleged that “C” represented to “B’s” wife and to “D” that the plaintiff’s “equity investment was an interest-free loan.” The plaintiff claimed that by reason of the foregoing improper agreements, “B’s” wife is “now the managing member of the entity that holds the property” and that the transfer of interest to “B’s” wife, “violated certain provisions of the mortgage on the property, resulting in a default.”

The plaintiff also claimed that in March 2016, he learned of a possible sale of the property. “B” and “C” had allegedly admitted that they had attempted to sell the property and had offered to return the plaintiff’s $1.1 million equity contribution, “depriving him of the proceeds of any such sale and his ownership interest in the property, despite the fact that his own equity interest was leveraged to obtain the $8.5 million mortgage to purchase the property in the first place.” The plaintiff also alleged that the DOB had continued to issue violations for construction or renovation work without required permits and for operating the property as an illegal hotel.

“C” acknowledged that the plaintiff contacted him and asked him to participate in acquisition of the property and that the parties had agreed to the terms in the signed offer sheet. Although “['C'] has handled dozens of real estate transactions,” he claimed that “he has never entered into an all-cash transaction…” and denied that he ever committed to the plaintiff that the property would be acquired on an all-cash basis. “C” asserted that since the plaintiff lacked management experience, the plaintiff wanted “C” to manage the property. He claimed that the plaintiff was “to be a ‘silent partner’” 20 percent minority investor and that “C,” or his affiliates, “would then have the 80 percent balance of the equity.”

“C” also contended, inter alia, that although the plaintiff had “provided ['C'] ‘with information as to the closing, its funding, costs and expenses,’” the plaintiff had “reneged on his promise to fund $1.25 million for the closing.” “C” allegedly had “to make up the balance” needed to close on the property. “C” claimed that he had raised “$1,223,314.90 along with being liable [with his brother] under the guarantee for the entire $8.5 million mortgage loan…making [them] solely responsible for more than 85 percent of the purchase price of the property.”

“C” further claimed that, “prior to and after the closing…, he provided [plaintiff] with a draft closing statement,” and other documents “relating to the funding, costs, and expenses for the purchase of the property.” “C” also asserted that “he ‘had much communication with plaintiff’s prior counsel,” and correspondence “made clear that plaintiff knew that ['C'] had procured a mortgage to purchase the property.” “C” further stated that the plaintiff had “‘never expressed to [him] any…objection with the mortgage financing’ and that if [plaintiff] ‘had an issue with this mortgage,’” he “would have raised it,’ but ‘[h]e did not.’” Additionally, “C” alleged that the plaintiff first questioned the mortgage financing, “nearly two and one-half years after the fact” and the plaintiff was “pleased that the sole guarantors of that mortgage were ['C'] and [his brother].”

“C” also claimed that “at all times relevant…, only he and his brother…were the majority equity investors in the property and…['B']” had “ no interest, equity or otherwise in the property.” He emphasized that the plaintiff had “‘never paid the balance of the funding he had promised’ nor made any additional capital contributions towards the property.” “C” claimed that he and his brother had paid all carrying costs of the property, and the plaintiff had been provided paperwork that documented the plaintiff “as a ‘preferred return member.’” “C” contended that the plaintiff had “disappeared and [did not] even communicate with [him]” for an extended period of time and that an amended operating agreement had been forwarded to the plaintiff, but had never been signed by the plaintiff. That amendment decreased the plaintiff’s member interest to 17.6 percent from the original 20 percent, allegedly due to the plaintiff’s “ default on his last payment.”

“C” further alleged that since neither the plaintiff nor “B” managed the property at the time, “he undertook management of the property” through entities he controls. “C” also claimed that it was the plaintiff who had the relationship with “B” and that he believed that plaintiff was “pleased and content with my management, leasing and day-to-day operation of the property for at least two straight years after the closing” and the plaintiff “only re-appeared” after he “heard that the property was being sold” and in fact, “no such sale ever took place.” “C” claimed that “the property is ‘not under contract or “on the verge”‘ of [being sold].”

In sum, “C” contends that the plaintiff’s allegations that “he contributed 100 percent of the equity,…the parties established an oral ‘joint venture,’…the purchase of the property would be an ‘all-cash deal,’…he is not in default of funding the entire amount of his commitment, and…a receiver is necessary, all ‘lack factual support, are contradicted by documentary evidence and fail to provide any basis for granting [plaintiff] the extraordinary relief of an injunction.” “C” further alleged that “[n]either [he] nor anyone associated with the property ever agreed to or discussed entering into a joint venture agreement, written or oral.”

The plaintiff had cited an email from “C” which stated that “the property required emergency funding” and settlement of litigation was “imperative.” That email cited outstanding debts and defaults. “C” purportedly had paid a “substantial amount of the outstanding bills owed on the property” and had entered into payment agreements with certain creditors.

The court found that a preliminary injunction and appointment of a temporary receiver was warranted since the plaintiff had demonstrated “a likelihood of success on the merits,” “irreparable injury absent the injunction,” and “a balancing of the equities in their favor.” The court opined that the plaintiff had demonstrated “C’s” “apparent failure to respect his equity interest in the property.” Although the court made “no quantification, at this juncture, as to what [plaintiff's] equity interest is in the property, it is evident that one exists.” The court observed that the defendants had “essentially conceded this point in court submissions.” The defendants had described the plaintiff’s interest as “solely being a non-interest bearing loan” and “the apparent transfer of a 49 percent equity interest to ['B's'] wife appears to be an attempt to dilute [plaintiff's] ownership interest, which constitutes irreparable harm.”

The court explained that “irreparable harm exists because mortgage covenants were violated and apartments in the property have been rented for transient use, resulting in the imposition of significant fines and requiring the city to commence nuisance abatement proceedings, including the existence of a fully litigated pending motion for contempt of court.” Additionally, the court found that “the balancing of the equities favors [plaintiff]…, since the appointment of a temporary receiver would merely preserve the status quo and prevent the property from being sold, as such a sale would result in a permanent loss of [plaintiff's] ownership and managerial rights of the property.”

The court explained that “a temporary receiver is appropriate ‘[u]pon motion of a person having an apparent interest in property which is the subject of an action…before or after service of summons and at any time prior to judgment…where there is danger that the property will be removed from the state, or lost, materially injured or destroyed. CPLR 6401(a).” A moving party must “make a clear and detailed evidentiary showing of the need to safeguard the property at issue and protect its interest in the subject property.” Here, the plaintiff had demonstrated that he has an interest in the property and “the property is in danger of being lost, materially injured, or destroyed through defendants’ actions” and that “appointment of a receiver [is thus] necessary to conserve the personal and real property and protect the parties’ interests, given the state of affairs between them.”

The court also noted that since the motion for a temporary receiver had been submitted, “the financial condition of the building has deteriorated.” The defendants had advised the plaintiff that the property was “in danger of a ‘mortgage default, jeopardizing current litigation, additional creditor litigation and foreclosure of the property.’” The court reasoned that “[t]he threat of the property being placed in foreclosure cannot be viewed as mere posturing given the purported transfer of 49 percent of the equity interest in the property to the wife of the individual who originally drove the property into bankruptcy.”

Furthermore, the “transfer of equity interest also constitutes a covenant default under the terms of the mortgage….” The court observed that “regardless of the [plaintiff's] equity interest, as an individual with an equity interest in the property, he has significant exposure to his investment based upon the potential accrual of statutory penalties of up to $1,000 per day for the defendants’ allegedly permitting an ongoing public nuisance to exist at the property in the form of renting apartments for illegal transient use.” Accordingly, the plaintiff had “adequately demonstrated an entitlement to have a temporary receiver appointed.”

The court required the plaintiff to post a preliminary injunction bond of $150,000 and appointed a temporary receiver who was authorized to, inter alia, take charge of and enter into possession of the properties.”

Disclosure: Although my firm played no role in the above litigation, I serve as a Special Master in an unrelated commercial litigation, wherein a defendant is a plaintiff.

Generally, courts know that the granting of an injunction and imposing a temporary receivership is a drastic remedy. Not only does a receivership involve additional costs and additional requirements for court approvals of, inter alia, significant transactions. For example, new long term leases, new financing and the sale of a property require the supervision and approval of the receiver and of the court. When potential lenders and purchasers hear that a receiver has been appointed, they assume that there may be a “fire sale” or substantial delays in obtaining approvals for important transactions. However, receiverships can work well when the receiver is experienced in dealing with the subject type of property, e.g., multi-family, office, retail or industrial and the receivership process. Moreover, many judges have substantial experience dealing with commercial matters and are very responsive when business decisions need to be promptly reviewed.

In the subject case, the court delineated in detail several reasons why it concluded that an injunction and a receivership was necessary in order to protect the property and the interests of the parties.

Lavi v. Assa, 651982/2016, NYLJ 1202792223487, at *1 (Sup., NY, Decided June 8, 2017), d’Auguste, J.