Family Cash Pooled to Build $23M Mixed-Use Condominium in Flushing: Court Determines Interests of Parties in Absence of Definitive Paperwork

This was originally posted on the SGR Blog.

New York real property development disputes often require the Court to navigate hundreds of pages of lengthy and dense contracts, agreements, or understandings that are the source of contention despite having been drafted by experienced attorneys and signed by sophisticated investors. But, as a recent case illustrates, matters become even more contentious where family members informally invest large sums of money with little concomitant paperwork.

Chun You Cheng (“Cheng”) and Chiu Ming Yan Cheng (“Chiu-Ming”) brought a derivative action against family members and other entities (“defendants”) seeking a judgment declaring the ownership interests of the investors (or their successors or assigns) in Garden View LTD (“GVL”). The Court held a 10-day “bench” (non-jury) trial over several months.

GVL was a real estate holding and management corporation managed by Hsiu-Lan Yang (“Tracy”), with the assistance of her son, Roger Yang (“Roger”).

Cheng is a Taiwanese citizen and resident. Cheng’s wife, Chiu-Ming, is also a Taiwanese citizen and resident. Chiu-Ming is also the younger sister of decedent Mu-Chiao Yang a/k/a Mark Yang (“Mark”).

Tracy, a citizen and resident of Queens County, is Mark’s widow. Roger, the son of Mark and Tracy, was sued in his capacity as the Administrator of Mark’s Estate. AJ Chan (“AJ”) is Tracy’s father, Roger’s grandfather, and was Mark’s father-in-law. AJ resides in Taiwan.

Dahlia Realty is a real estate brokerage company formed in 2004. Until his death, Mark, a licensed real estate broker, was the sole owner of Dahlia. Ju Yi is a limited liability company that owns two commercial spaces purchased from GVL. Ju Yi is owned by non-parties to this litigation, all siblings of Tracy.

In 1998 Mark Cheng and Cheng’s brother, Chun Kung Cheng (“Kung”), orally agreed to pool their money to build and operate a hotel in Flushing, Queens. After locating land overlooking the Queens Botanical Gardens, the men formed GVL as a vehicle to hold title to the land and construct and operate their hotel. The corporation was authorized to issue 200 shares of no par value stock. But no stock was ever issued as provided for in the corporate bylaws. And no other corporate formalities of any kind were ever followed. The three men contemplated equal 1/3 ownership interests in GVL and orally agreed that ownership percentages would ultimately be determined upon the hotel’s completion based upon the actual amount of capital each person contributed. The three men further agreed that, because of his experience in and familiarity with real estate development, the hotel industry, and the United States, Mark would manage the joint venture hotel Project and maintain its books and records, including construction expenses and tax returns.

The parcel of land for the hotel was located across the street from the Queens Botanical Gardens. At closing on June 22, 1998, the land was purchased for approximately $2.3 Million, with Cheng and Kung signing the initial contract for the purchase and providing the initial capital for the purchase of the land.

In early 2000, Kung decided to leave the project. At the time of Kung’s departure, Kung, Yang, and Cheng calculated the exact amount that had been contributed by the two brothers. At the time of Kung’s departure, the two brothers had contributed $3,516,964, of which $16,964 was returned to Kung in a check, making the combined contribution of Kung and Cheng in June 2000 $3.5 Million. Of this $3.5 Million, it was agreed that $1 Million represented Kung’s equity investment that would be divided equally among the two remaining investors in the hotel venture. Cheng and Yang agreed that they would divide responsibility for the return of Kung’s $1 Million equity investment equally amongst themselves and that each would ultimately invest one-half of the capital necessary as equal partners to construct the hotel.

As with the first oral agreement, although Cheng and Mark Yang contemplated equal 50% ownership interests in GVL upon completion of the hotel, they again agreed that ownership percentages would ultimately be determined based upon the actual amount of capital each person contributed.

Shortly after the second oral agreement, the entire hotel project, and the reason for the joint venture/partnership, fell apart. In July 2000, the New York City Building Department unexpectedly revoked the building permit for the hotel as the result of a zoning issue. Construction halted between July 2000 and April 2001, while Mark sought out and ultimately retained a new architect, Michael Kang, R.A., who submitted new building plans for the construction and development of a mixed-use residential and commercial building that could be developed and thereafter managed as a condominium.

In September 2000, Cheng expressed to Mark his desire to have his investment returned and that he had no interest in owning condominiums, and that he needed his $3 Million back to repay his creditors. Cheng nevertheless agreed with the plans to move forward with the condominium because funds were not available in GVL to repay him. On May 11, 2001, new plans were filed which specified that the building would become a 14-story “mixed-use” condominium apartment building, with five retail stores on the ground floor. In addition, the number of stories changed from ten to fourteen.

In 2003, GVL obtained a construction loan from Industrial and Commercial Bank of China, Ltd., in the face amount of $8 Million. Mark, Tracy, Cheng, and Chiu-Ming all personally guaranteed the loan. The loan proceeds were delivered in tranches, as the funds were needed by GVL. The construction loan was insufficient to cover GVL’s construction expenses in connection with the condominium project. Accordingly, AJ Chan invested approximately $4.5 Million from May of 2000 through June of 2005. Mark promised AJ an equity interest in the property.

Construction of the building was substantially completed in 2004. A certificate of occupancy was issued on July 15, 2004. In November 2004, GVL filed a First Amendment to the Offering Plan, substituting Dahlia as the selling broker for GVL. Mark Yang, through Dahlia, began marketing condominiums and Dahlia began receiving commissions for closed sales. Dahlia acted as the selling broker for all transactions not involving Tracy’s family members. Commissions on arms-length sales to non-family members totaled $741,410, which represented 5.2% of the sold units’ total purchase price. Of this amount, $230,063 was paid to Li Jeng Chen, a real estate agent/broker.

Cheng returned to New York on June 27, 2005, and stayed for over one week at the time the first closings on the initial sales of units were taking place. He again returned to New York on September 29, 2005, and remained until October 20, 2005. During that time period, Cheng was meeting with Mark and asking for his money back. During those visits, Mark informed Cheng that the cost for the construction of the building totaled $23 Million, as established by a faxed letter from Cheng to Mark.

Cheng initially objected to AJ being made an equity member but acquiesced. And, on October 10, 2005, Cheng and Mark executed a memorandum regarding profit sharing. It stated: “AS PER OUR AGREEMENT, THE PROFIT SHARING FROM GARDEN VIEW LTD., FOR CHUN YOU CHENG & CHIU MING YANG CHENG HAS BEEN CHANGED FROM ORIGINAL 1/2 TO 1/3.”

Cheng received payments from GVL which amounted to $3,954,121. Cheng also received payments from other parties which amounted to $713,000. In addition, Cheng received the use of an apartment that was held off the market for him to use when he visited New York. The rental value of this apartment was $578,880.

Defendants received payments from GVL in the amount of $1,959,382. During the time period from June 2005 through November 2011, 7 condo units were transferred to the defendants’ family members at a discount of $281,176.00.

Defendants created Dahlia Realty to market and sell the condos. Dahlia received commissions in the amount of $741,410.00, and, of those commissions, $230,063.00 was paid to Li Jeng Chen, a third-party broker. The remainder, $511,176.00, was paid to Dahlia. However, Dahlia charged GVL a commission of 5% rather than the market rate of 3%. Thus, Dahlia was paid excess commissions in the amount of $204,539.

Defendants provided four rent-free units to family members that deprived GVL of income in the amount of $1,908,000.00.

GVL also made donations on behalf of defendants in the amount of $208,415.00 and repaid non-business-related expenses on behalf of defendants in the amount of 434,062.00.

On behalf of the defendants, GVL made pension and life insurance payments in the amount of 1,693,960.00.

To the extent that Cheng and others had knowledge of those payments, they acquiesced to them as part of the defendants’ share of the profits because all parties still expected to arrive at an amicable resolution.

The parties invested millions of dollars in the construction of a multi-story building. However, they did so with less paperwork than would accompany the sale of a single-family home and a complete disregard of corporate formalities. Thus, the first question before the Court was to determine the scope of the parties’ agreement.

Here, the Court found that there was undoubtedly an intent to be bound. However, many essential terms of the contract were unstated, and the certainty of an agreement was replaced by trust arising out of the familial relationship. However, the trust dissipated upon the death of Mark,

The crux of this case was who owned what percentage of GVL. The sixth cause of action in the complaint sought a declaratory judgment of the parties’ ownership percentages.

The agreement was that the ownership percentages would ultimately be determined based upon the actual amount of capital each person contributed. Consistent with that agreement, and the evidence of contributions, the October 10, 2005 memorandum was executed. Thus, Cheng and Chiu-Ming were one-third owners, AJ Chan was one-third owner. And Hsiu-Lan Yang and Roger Yang, as Administrators of the Estate of Mu-Chiao Yang was one-third owners.

Having determined the ownership, the payments made to the parties were accounted for. Defendants believed that the payments made to the Chengs were part of a buyout and that the various payments and benefits that defendants received were made in lieu of formal distributions to avoid taxes. However, there was no meeting of the minds on a buyout or dissolution. Accordingly, as a matter of equity, the Court treated those payments as constructive dividends to the parties.

A constructive dividend arises where an entity confers an economic benefit on a party without the expectation of repayment even though neither the entity nor the party intended a dividend. The crucial concept in a finding that there was a constructive dividend was that the entity conferred a benefit on the party in order to distribute available earnings and profits without expectation of repayment. Although the subject usually arises when the recipient fails to pay tax on the constructive dividend, the concepts also apply when one party reaps a benefit to the detriment of the others.

Constructive dividends may consist of compensation paid to a party in excess of what is considered reasonable; the use of entity-owned property if the value of such usage was not repaid or was not included in a party’s salary or wages; or the bargain purchases of entity property by a party. Benefits paid or given to a family member may also constitute constructive dividends.

Thus, the Court found that the payments made to the parties here must be treated as constructive dividends. Accordingly, the Chengs received dividends and constructive dividends in the amount of $5,246,001, representing $3,954,121 in payments from GVL; $713,000 directly from defendants; and $578,880 in imputed rent for the apartment held off the market for their use.

Defendants received dividends and constructive dividends in the amount of $6,689,534, representing $1,959,382 in payments from GVL; $1,693,960 in pension and life insurance premiums; $208,415 in donations made by GVL on defendants’ behalf; $434,062 in non-business expenses reimbursed by GVL; $281,176 in lost profits from the below-market sale of units to family members; $204,539 in excess commissions to Dahlia; and $1,908,000 in imputed rent for the units used by defendants. Accordingly, defendants were found to have received distributions and imputed distributions in the amount of $6,689,534.

Thus, the Chengs received dividends and constructive dividends in the amount of $5,246,001. Defendants received dividends and constructive dividends, less a credit for monies paid to the Chengs, in the amount of $6,689,534. Because Roger Yang, as Administrator of the Estate of Mu-Chiao Yang, Hsiu-Lan Yang, and, A.J. Chan own twice the Chengs’ share, defendants were entitled to an additional dividend of $3,802,486 ($5,246,001 × 2 = $10,492,002 – $6,689,534 = $3,802,486).

Defendants argued that the classification of some of those payments as constructive dividends was barred by the statute of limitations. However, the Chengs acquiesced to those payments because the parties agreed that they would be made in lieu of dividends to avoid taxes. Accordingly, the classification was not barred by the statute of limitations.

The first cause of action alleged corporate waste. The essence of a waste claim is the diversion of corporate assets for improper or unnecessary purposes. Waste occurs when assets were utilized improperly or unnecessarily in breach of fiduciary duty. The Court found that the Chengs had proven corporate waste, which was remedied by the reclassification of wasted assets as constructive dividends.

The second cause of action alleged that defendants should be jointly and severally held to account for all monies and property looted, wasted, squandered, and misappropriated and all losses and damages sustained by GVL by reason of the acts of corporate waste. To the extent that the cause of action sought relief against the individual defendants, it was duplicative of the first cause of action. And the Chengs failed to prove any wrongdoing by Ju Yi Garden LLC and Dahlia Realty Inc. Accordingly, the Court found for those defendants on the accounting cause of action.

The third cause of action requested that Ju Yi and Dahlia jointly and severally post-security in such amount as the court may require to indemnify GVL against any future losses, expenses, and damages arising by reason of the actions outlined in this complaint. The Chengs failed to prove any future losses. Accordingly, the Court found for defendants on that cause of action.

The fourth cause of action sought a permanent injunction enjoining defendants from self-dealing. To establish, prima facie, entitlement to a permanent injunction, a plaintiff must demonstrate: (a) that there was a violation of a right presently occurring, or threatened and imminent; (b) that he or she had no adequate remedy at law; (c) that serious and irreparable harm would result absent the injunction; and (d) that the equities were balanced in his or her favor. However, the allegations of self-dealing arose from the complete disregard of corporate governance by all parties. The percentages of ownership having been determined, the rules of corporate governance provided an adequate remedy at law. Accordingly, the Chengs failed to prove their cause of action for a permanent injunction.

The fifth cause of action sought to impose a constructive trust on the shares of GVL owned by the defendants. To obtain the remedy of a constructive trust, a party is generally required to establish four factors, or elements, by clear and convincing evidence: (1) a confidential or fiduciary relationship; (2) a promise;(3) a transfer in reliance thereon; and (4) unjust enrichment flowing from the breach of the promise. Here, the Chengs failed to prove that shares were transferred to defendants in reliance on a promise arising from a fiduciary relationship. Accordingly, the Chengs failed to prove their cause of action for a constructive trust.

The seventh cause of action sought an award of reasonable attorneys’ fees. Section 626 of New York’s Business Corporation Law provides the mechanism for bringing a shareholder derivative action. It requires the plaintiff in such an action to be a shareholder at the time the action is brought, and at the time of the transaction implicated in the lawsuit, and it further requires that “the complaint shall set forth with particularity the efforts of the plaintiff to secure the initiation of such action by the board or the reasons for not making such effort”.

BCL Section 626(e) provides that “If the action on behalf of the corporation was successful, in whole or in part, or if anything was received by the plaintiff or plaintiffs or a claimant or claimants as the result of a judgment, compromise or settlement of an action or claim, the court may award the plaintiff or plaintiffs, claimant or claimants, reasonable expenses, including reasonable attorney’s fees, and shall direct him or them to account to the corporation for the remainder of the proceeds so received by him or them.” As a general rule, a fee award is appropriate if the plaintiff achieved a substantial benefit for the corporation.

In this case, there was no board of directors, so the demand did not apply. Furthermore, the action achieved a substantial benefit to the corporation because the reclassification of free rent, below-market sales, pension, and life insurance payments, commissions, non-business expenses, and donations, into distributions, constituted the recoupment of monies that would have been wasted. Thus, the Chengs were entitled to a legal fee award.

The eighth cause of action, which sought a preliminary injunction pending the trial, was moot.

The ninth cause of action sought exemplary damages. Recovery of exemplary or punitive damages in a common-law action required a showing of conscious disregard of the rights of others or conduct so reckless as to amount to such disregard. The Chengs failed to prove the conscious disregard of the rights of others or conduct so reckless as to amount to such disregard.

The Chengs also moved to conform the pleadings to the proof to add a cause of action for an accounting. In order to enlist the aid of a court of equity in vindicating the right to an accounting, a plaintiff must show a demand for an accounting and a failure or refusal by the partner with the books, records, profits, or other assets of the partnership in his possession to account to the other partner or partners. Here, the discovery in this action yielded complete disclosure of the books and records of GVL. Accordingly, the Chengs’ motion was denied.

The Chengs also sought to conform the pleadings to the proof to add a cause of action for breach of fiduciary duty. However, allowing that claim would not result in any relief not already awarded pursuant to the first cause of action. Accordingly, the motion was denied.

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