Bankruptcy Property Deal Devolves Into Mess of Contract and Fiduciary Duty Claims
The bankruptcy process is often straightforward: the debtor’s debts are discharged, creditors take a haircut of varying degrees, and life moves on. But some bankruptcy proceedings give birth to complicated agreements that can blow up, resulting in further court proceedings.
The latter type of bankruptcy was on display in a case recently filed by California’s Sixth Appellate District — Dorian v. San Jose Towers, LLC (slightly modified on rehearing here). While not published (and therefore not binding precedent), the case still provides a cautionary example.
Facts: development company files bankruptcy, giving rise to web of agreements
Briand Properties, LLC (“Briand”) was a real estate development company formed by Michael Dorian in 2006. Briand bought two lots in San Jose, but failed to develop them successfully, and ultimately filed for bankruptcy in 2016. The bankruptcy became a Chapter 7 liquidation.
A bankruptcy trustee was appointed, and a basic deal framework emerged. The trustee agreed to sell the lots to San Jose Towers, LLC (“SJT”), and entity that owned lots next to the Briand lots. SJT had three members — the family trusts of Gregory Bock and Arnold Kamrin, and Robert Johnston.
The deal gave rise to several agreements:
- The Preliminary Agreement (between Briand, Kamrin, and Johnston): This handwritten agreement stated that an investor group including Johnston, Bock, and another person to be named later (a group that would collectively later become SJT) would pay $3.6 million for the Briand lots; a new LLC would then be formed to hold title; membership in the new LLC would be 50/50 between Briand and the investor group; and profits would be split 45% Briand and 55% investor group. It also stated that in the event of any disagreements, decisions would be made by Arnold Kamrin.
- The Purchase Offer (signed by SJT, the bankruptcy trustee, Kamrin, Bock, and Johnston): This document repeated many of the terms of the Preliminary Agreement, and also included provisions concerning calculation of profits for the new LLC.
- The Purchase Agreement (between SJT as buyer and the bankruptcy trustee as seller): This agreement required SJT to pay $3.6 million for the Briand lots. The purchase price was to be used to satisfy Briand’s debts, with the excess paid to Dorian “who, subject to the terms of the new LLC, may be obligated to deliver the excess funds to the New LLC.” The Purchase Agreement contained an integration clause, and expressly prohibited third-party beneficiary claims. While Dorian was not a party to the Purchase Agreement, he signed it at the end indicating he approved its terms.
- The November Agreement (between SJT and Dorian): This agreement provided that: (1) the Preliminary Agreement was incorporated by reference, but references to Briand would be replaced by Dorian; (2) the Purchase Offer was incorporated by reference, again with references to Briand replaced by Dorian; and (3) Dorian “shall immediately turn over” to the new LLC all excess funds from the bankruptcy.
- The Second Street LLC Operating Agreement: The new LLC contemplated by the Purchase Agreement was formed as 545 South Second Street, LLC. It had two members — SJT and Dorian (through his trustee Al Haimson). The operating agreement repeated the prior agreements stating that ownership between the members was 50/50, and profits would be divided 45% to Dorian and 55% to SJT, and that Kamrin would have a tie-breaking vote. SJT was named the managing member. The agreement required SJT to make an initial contribution of the purchase price less excess funds received by Second Street LLC from the bankruptcy, and required Dorian to make an initial contribution of the excess funds.
Dorian never contributed the excess funds. Second Street eventually sold the Briand lots as part of a project involving several adjacent properties for a total of $22.5 million. The buyer paid $13.7 million in cash (which was used to pay off debts) and the remainder was reduced to a promissory note. Second Street claimed it received no profits and did not distribute any funds to Dorian.
Dorian sued SJT, Kamrin, Bock, Johnston, Haimson, and Second Street LLC, asserting various claims including breach of the Purchase Agreement (alleging he had standing as an “intended beneficiary” of that agreement) and breach of fiduciary duty (as a member of Second Street LLC). SJT asserted a cross-claim against Dorian for breach of the November Agreement.
Trial court: clean sweep for Dorian
The trial court (acting through a referee appointed under Code of Civil Procedure section 638) made several rulings:
- Dorian had standing to enforce the Purchase Agreement because he signed and approved it, and received benefits under its terms.
- SJT breached the Purchase Agreement by delaying actions required thereunder and by not distributing profits to Dorian.
- SJT, Kamrin, Bock , and Johnston owed fiduciary duties to Dorian, which they breached by not distributing profits to Dorian.
- Dorian was entitled to recover over $2.1 million in damages.
- SJT’s cross-claim failed because the November Agreement was unenforceable on the main ground that it “improperly attempted to modify the Purchase Agreement.”
Court of Appeal: mostly reversed due to multiple errors
The Court of Appeal held several of the trial court’s rulings were erroneous.
First, as to Dorian’s breach of contract claim based on the Purchase Agreement, the court held that Dorian lacked standing. He was not a party to the Purchase Agreement, which specifically precluded claims by third-party beneficiaries. The Purchase Agreement defined the parties as the Chapter 7 Trustee as seller and SJT as buyer. While Dorian unquestionably received benefits under the Purchase Agreement, the Agreement stated that the “Parties intend that no third-party beneficiary shall have any rights or claims by reason of this Agreement.” The fact that Dorian signed the Purchase Agreement was not enough to give him standing; his signature simply gave the Trustee “some assurance that Dorian, owner of the debtor, was satisfied with the Agreement and would not later challenge it.”
The court also reversed Dorian’s fiduciary duty judgment against Kamrin and Bock on the grounds that they were not members of the Second Street LLC and did not owe any fiduciary duty to Dorian. The court emphasized that absent any established relationship imposing fiduciary duties (like guardian and ward, trustee and beneficiary, principal and agent, or attorney and client), a fiduciary duty “may be imposed only upon persons who knowingly undertake to act on behalf and for the benefit of another.” And: it is “well-settled” that “contracts ordinarily do not create fiduciary relationships.”
SJT, however, owed Dorian fiduciary duties since SJT was the managing member of Second Street LLC. The court reviewed the trial court’s findings regarding SJT’s breaches of fiduciary duty, reversing some (on the grounds that the conduct occurred before Dorian became a member of the LLC and therefore before any fiduciary duties were owed), and affirming others (based on conduct after Dorian became a member, including the failure to distribute profits).
The court also concluded that the trial court miscalculated net profits. The court vacated the damage award and remanded to the trial court for further consideration.
Last, the court reversed the trial court’s judgment rejecting SJT’s cross-claim against Dorian for breach of the November Agreement. The November Agreement did not “improperly attempt to modify the Purchase Agreement,” as the trial court held. The Purchase Agreement was between SJT and the bankruptcy trustee. The November Agreement was between SJT and Dorian — not the bankruptcy trustee. “As a consequence, the November Agreement did not–and could not–modify the duties that SJT and the bankruptcy trustee owed to each other under the Purchase Agreement.” SJT’s cross-claim was remanded to the trial court for further evaluation.
Lesson
As illustrated by the Dorian opinion, complicated property deals involving purchase agreements and LLC operating agreements often devolve into litigation. The fact that the deals occur as part of the resolution of a bankruptcy case provides no assurance that battles will not erupt.