We May Have a Legal System – Whether We Have A Justice is Up for Debate
The path to a financially successful golf course starts with financing. Nothing begins until capital is committed. With equity invested as seed capital, debt instruments are often required
The complexity of raising funds is increased if the golf course is to be located within a real estate development where lots are created, roads are to be built, sewer installed, water provided, and lights mounted.
Add to this puzzle the idiosyncrasies of humans working in partnership, the odds of success become daunting.
I attended a two-week jury trial regarding a development: $7.5 million in equity funding with $71.5 million in debt that went through two bankruptcies. Five years after emerging from bankruptcy, the original developer and those who provided debtor in possession (DIP) financing found themselves in a heated battle in court. It was believed that the project had the potential to generate $20 million in profits from the sale of 243 lots and the operation of an exclusive private country club.
Note that after the golf course development emerged from bankruptcy, the individual who provided DIP financing received 80.1% of the corporation with the developer receiving 19.9%.
That allocation is stipulated in bankruptcy also. Also, know that the developer orally represented that he had personally invested $7 million in the project from 1998 until the bankruptcy was filed in 2012. The eight other original investors in 1998 had their investment flushed in the bankruptcy.
The original developer remained as managing member of the emerged bankrupt operating company from May 2013 until September 2014 when he was terminated for non-performance as he dissipated $8.5 million without achieving additional lot sales or the construction of a clubhouse with restaurants, pools, wine cellar, fitness center, and spa.
The DIP financier was designated as the principal manager of the newly formed parent company that owned 100% of the subsidiary real estate and golf course operating company the original developer managed.
In 2017, the DIP financier sued for fraudulent misrepresentation. The developer counter-sued for malfeasance in management, contesting additional loans made, the need for the construction of the clubhouse, the failure to distribute profits (there were none), etc.
The cost of the litigation exceed $1 million, including each side spending over $100,000 for a two-week trial. Go figure.
There is one caveat to this story. It should be recognized, that in the absence of the will of the parties to cooperate, there is no agreement that can or will provide the clarity and direction necessary to ensure any conflicts can be successfully settled without litigation.
Hence, there are valuable lessons for every golf course operator.
- The emotion and passion of the original developer and the individual who provided DIP financing (a homeowner in the development) clouded their financial judgment. An individual’s distaste for another human being colors sound and reasonable thoughts concerning compliance with the terms of the agreement.
- Never create a windfall provision for distribution of profits that differs from the equity structure of the company that emerges from bankruptcy.
An operating agreement was created where the original developer was to receive first from profits the $7 million he invested and then 55% of all remaining profits. The individual who provided DIP financing was to receive, after than $7 million was paid to the developer, their DIP investment next. Then, profits would be split 55% to the developer and 45% to the DIP investor.
- Never sue an original developer for fraud based on the oral representations they may have regarding their original investment. While oral representations are affirmative statements that can be interpreted as fraud, there are seven thresholds that must be achieved for a claim of fraud to be enforceable.
The representation has to be (1) false, (2) material, (3) knowingly made to be false; (4) made with the intent to deceive, (5) was relied on by the aggrieved (6) the reliance was justifiable, and (7) damages occurred.
- Never sue to contest a profits distribution clause, i.e., damages, if such would occur only if the development were successful, which at this time, is debatable as the clubhouse has yet to be constructed.
- Never sue based on an oral representation of the developer and then use the fact as a DIP financier you didn’t sign the loan collateral guarantee agreements in which both parties pledged additional assets for a subsequent loan.
It was necessary to secure $10 million in financing upon emerging from bankruptcy. The original developer, the DIP financier, and eight others posted personal collateral to guarantee the loan. They were to receive 5% of their pledged collateral annually with a deferred payment provision of 12%.
After several years of paying the 5% interest to all those who guaranteed the loan, when the representation that the developer invested $7 million was learned to be false in 2016 on which the windfall was created, payments to the original developer on the loan guarantee were suspended three years later in 2019.
Making payments for three years then asserting the agreement is not enforceable is a strategy built on a thin thread.
- Guarantee payment agreements for collateral provided for loans should be based on a single, not a tiered interest rate that is not dependent upon some future event.
- The legal boilerplate of representations and warranties in an operating agreement are never read and certainly never fully understood. This is a huge mistake. These provisions, which are often very broad in scope, have to be closely examined, narrowed in scope, and fully understood.
- Upon termination of the developer, an amended operating agreement was created with the windfall provisions inserted, and a separate mutual release was executed. Such agreements should be integrated. A mutual release, when drafted, should be narrow in scope and specifically state that which it does not include, i.e., fraud, malfeasance, etc.
The mutual release, in this case, did not contain limitations in scope.
- Know that the process of introducing evidence into a case, even if its reliance is intuitively obvious, can be a tedious process that often precludes the admission of material facts if the foundation is not probably established by the lawyer.
Before an exhibit can be offered into evidence in court, a foundation must be laid for its admission. The first foundation that must be laid is that the article is authentic. The “hearsay” rules come into play as to the admissibility of evidence. Materials facts can be precluded from entered into court if the foundation is not properly set.
A final document of a contract may be insufficient to be admitted as evidence unless the underlying red-lined iterations of the draft are also included as to show the intent of the parties.
- Understand that lawyers are not accountants or salesman and will get so immersed in presenting the details to a jury that they may fail to present the strategic points to the case.
Lawyers are largely inept in presenting financial information in a simple matter than can easily be understood by the jury. The focus on the minutiae masks the broader picture of revenues, expenses, net operating income, and key balance sheet items, i.e., loans.
While cases often turn on small points and consistency in the evidence presented, creating a simplified highlight of the underlying issues of the case is essential for the jury to comprehend.
We observed five hours of testimony focusing on individual transactions contesting advances and loans made by the managing member of the newly formed parent to keep the struggling enterprise afloat rather than merely showing the net operating loss for two years was $2.8 million that the managing member of the parent personally funded to ensure continued operations. The point be made could have been presented in five minutes.
Note that when such advances and loans are made, they should be fully described on the balance sheet as loans with the stipulated interest and maturity date specified. The managing member of the parent company labeled such as accrued liabilities, consistent with historical practices. This categorization led to the representation that the developer was being intentionally deceived as to the activities of the project for which they had a continuing carried interest.
- It is a bad idea that if loans are advanced by an individual to an operating company, and such debt is satisfied through the transfer of lots, reduction of member dues, etc. A check for the loan payment should be written and a separate check tendered for the purchase of the lot or the payment of club dues. Offsetting liabilities by the transfer of assets creates the impression of impropriety.
- Cash flow forecast should be prepared at four levels: worst case presuming the project’s failure, realistic, possible, optimistic. Never publish an optimistic forecast. Present the range of forecasts that the entity may achieve – not a single projection for that will be used as what your intent was. While you want to obtain the financing, the risk of future litigation outweighs the short-term benefit of inflated projections.
- The more complicated the case, the less you want a jury trial. Juries pick up astutely on the inconsistencies in witness’ statements almost to the exclusion of looking at the principal substance and equity of the issues being presented.
- Many people rely on client-attorney privilege. If you and your attorney have a conversation that includes a third independent person, i.e., a broker to raise capital for the project, that conversation is not protected under the client-attorney privilege.
- Where the client-attorney privilege is enforce, the client can unilaterally waive such privilege. The attorney can not.
- What you do, say, write or forecast, presume that it will be reviewed by an attorney who will twist, contort, discredit and misrepresent the intent of the agreement.
- Lawyers may take a case and represent a client to argue one’s case if the assertions even if the probability of success is unlikely. Their priority is to their fees.
- As a spectator, whoever is presenting, you form the impression that they are likely to win the case.
Note: This blog is not intended in any way, shape, or form to communicate any legal advice or to be relied on. It is solely based on the opinions formed by the author, a lay person, from the evidence seen and the statement made in a court proceeding.
The conclusion drawn is if one had the option of investing $8 million in golf course and $20 million in a clubhouse vs. investing in a certificate of deposit that pays 4%, take the CD.