Appeal from the Order of the Superior Court Entered June 26, 1986, at No. 148, Pittsburgh, 1985, Affirming the Order of the Court of Common Pleas of Allegheny County, Orphans' Court Division, Entered at No. 3224 of 1973, on January 11, 1985. Pa. Superior Ct. , A.2d (1986).
Leonard M. Mendelson, Jay D. Glasser, Andrea O. Griffith, Hollinshead and Mendelson, Pittsburgh, for appellants.
James P. McKenna, Jr., Arthur L. Schwarzwaelder, Pittsburgh, for Essex Square Corp., et al.
Harry S. Kalson, Pittsburgh, for Barry Hall.
Nix, C.j., and Larsen, Flaherty, McDermott, Zappala and Papadakos, JJ. Hutchinson, former J., did not participate in the consideration or decision of this case.
This case concerns various disputes related to two real estate investment limited partnerships. Appellants herein
are the Essex Square Corporation, the Green-Hill Lytle Corporation, Albert I. Raizman and Darryl Hall. The two corporations are the corporate general partners in two limited partnerships which were initially formed to finance, build, and operate, respectively, the Essex Square Apartments and the Green Hill-Lytle Apartments, both now constructed, and located in the City of Pittsburgh. The individual Appellants are the Administrators D.B.N., C.T.A. of the Estate of Charles Hall, who died on July 25, 1972. The Administrators now effectively control all of the stock in the two corporate general partners mentioned above. Charles Hall originally owned all of the stock in both corporations, and it passed to his estate at his death. Appellees are the two limited partnerships, Essex Square Partnership, Ltd., and Green Hill-Lytle Partnership, Ltd.; and the various limited partners therein, Herman Lipsitz, Morton and Carolyn Fiedler, Arizona Lipnob Estates, Inc., and Trading Corporations. Appellants will sometimes be referred to herein as the "general partner(s)" or as the "corporate general partner(s)." Appellees will sometimes be referred to as the "limited partner(s)" or as the "claimant(s)."
Appellees, the limited partners, asserted claims against the corporate general partners arising from the general partners' incurrence and assessment of management fees. Claims were also asserted on account of the Essex Square general partner's failure to pay interest on loans made to it by the limited partners during construction, and the Essex Square general partner's failure to maintain a life insurance policy on the life of Charles Hall. All of these claims were allowed in an opinion and order entered by the Orphans' Court Division of the Allegheny County Common Pleas Court (Ross, J.). Judge Ross's order was affirmed by the Allegheny County Common Pleas Court Orphans' Court Division sitting en banc, and by the Superior Court, 357 Pa. Super. 641, 513 A.2d 1080 (Cirillo, P.J., Del Sole and Beck, JJ.) in a memorandum opinion and order.
The underlying facts in this case, based on the findings of the trial court, are as follows. Charles Hall was an experienced and successful real estate developer. During 1970 and 1971, in order to raise the needed capital to build and develop the two apartment house projects involved in this case, Mr. Hall sought investors willing to put their money into such endeavors. He first approached claimant, Morton Fiedler, as to the Essex Square venture. Mr. Fiedler contacted claimant, Herman Lipsitz, an attorney as well as a prospective investor, and negotiations commenced. Preliminary estimates of the size, construction costs, capital investment needed, and projected cash flow were prepared by Mr. Hall and set forth in a " pro forma " for each project which was then presented to some of the claimants as an inducement to invest. The Green Hill-Lytle pro forma was introduced into evidence at trial. For each project, Mr. Hall formed a corporation of which he was the sole shareholder. These two corporations (Appellants, the Essex Square Corporation and the Green Hill-Lytle Corporation) were to become the general partners in the two real estate investment limited partnership agreements that were envisioned, while the various investors were to be the limited partners. The reasons for this somewhat complicated form of ownership structure include the following. In a limited partnership, the limited partners (the investors here) are ordinarily exposed to only limited liability should the venture fail, just like stockholders in a corporation. See, the Pennsylvania statutes on limited partnerships, now 59 Pa.C.S. § 501 et seq., and specifically 59 Pa.C.S. § 521, formerly 59 Pa.C.S. § 191. The general or managing partner in the limited partnership, on the other hand, is ordinarily exposed to unlimited personal liability for the debts of the partnership. See, Northampton Valley Constructors, Inc. v. Horne-Lang Associates, 310 Pa. Super. 559, 456 A.2d 1077 (1983). When, as here, the general partner is itself a corporation, this exposure to unlimited personal liability (here, Mr. Hall's) is avoided. Moreover, since the death of a general partner will ordinarily dissolve the partnership business, 59 Pa.C.S. § 534, formerly 59 Pa.C.S. § 204, and produce unfortunate
business and tax consequences, use of a corporate general partner avoids this problem as well since a corporation, for these purposes at least, does not "die." These advantages might also have been achieved by the simple forming of a corporation, but that form of ownership would typically not have produced the significant and perfectly legitimate tax shelter advantages available to a limited partnership under sections of the Internal Revenue Code applicable at the time the events relevant to this case occurred. See Internal Revenue Code of 1954, Sections 701, 702, 731 and 1372(e)(5).
Claimants began extensive negotiations with the Essex Square and Green Hill-Lytle Corporations through Charles Hall, their sole shareholder and agent, looking to the formation of the two limited partnerships that had been contemplated. The wording of each limited partnership agreement, along with supporting documents, was carefully scrutinized and the agreements were rewritten several times before becoming final. The agreements were prepared in Appellee-investor and attorney Herman Lipsitz's law office. The Essex Square agreement was finalized first in 1970, and served as a model for the second, the Green Hill-Lytle agreement, finalized in 1971.*fn1 The essence of these two limited partnership agreements was that the corporate general partner would see to it that all of the necessary construction work was completed and that the properties would be maintained and managed properly, whereas the limited partners were only obligated to contribute specific fixed amounts of capital, that is, financing. In return for rendering the services described above, the partnership agreements clearly provided that each of the corporate general partners received a fifty (50%) percent share of the rental income (R. 608e-609a, 681a). Neither corporate general partner was required to make any cash contribution to
the initial capital of either partnership. It is clear, incidentally, given each corporate general partner's fifty percent interest in what is now a successfully completed apartment project, that neither can properly be described as a shell corporation, or as a dummy corporation without assets. Through separate contemporaneous contracts, specifically the Essex Square corporate agreement and the Green Hill-Lytle corporate agreement (each fully set forth in the record), the corporate general partners each contracted with Charles Hall individually for his personal supervision of construction. Through separate pledge of stock agreements (both also fully set forth in the record), Mr. Hall agreed to release to the limited partners all of the shares of stock owned by him in the two corporate general partners in the event that he failed, during the construction period, to perform the services required of him. (See, R. 672a, 707a). Such stock could then be sold and the proceeds used to obtain substitute services. A careful review of these documents clearly demonstrates that great care was taken to protect the limited partners during the construction period in order to make certain that they received the benefit of Mr. Hall's expertise in the supervision of development and construction, or of comparable expertise should Mr. Hall falter for any reason. With respect to management of the projects after construction was completed, however, it is equally clear that scant attention was given in these documents to the problems that might develop during such later periods, particularly the problem of what would happen if Mr. Hall could not continue.
Construction was completed on the Green Hill-Lytle building first. Units were rented while Charles Hall was still alive and apparently no management fee was charged during his lifetime. Charles Hall died while construction on the Essex Square project was still on-going. All the stock in the two corporate general partners passed to Charles Hall's estate at his death since he was sole shareholder in both corporations. His son, Barry Hall, who was also a beneficiary under Mr. Hall's will, was named as Executor of the estate and, in that capacity, assumed effective control
of the two corporate general partners as a director-officer of each. Barry Hall ceased to act as Executor in 1980 and he was succeeded by Albert I. Raizman and Darryl Hall (another son of Charles Hall) acting as Administrators of the estate, D.B.N., C.T.A.
Shortly after the death of Charles Hall, each limited partnership was charged a management fee for the first time. Barry Hall, in control of each corporate general partner, effectuated a contract with his solely owned McQuarters Management Corporation which agreed to provide management services to the two apartment projects for a fee. McQuarters Management Corporation was later succeeded by McQuarters Realty Company, Inc., whose president and incorporator was Darryl Hall, and which entity currently manages the two properties. The trial court found that McQuarters Management made only small profits and sometimes lost money, but that Darryl Hall received a salary in 1980, and that Barry Hall received $25,260.00 in compensation in 1976. The limited partners were informed of the arrangement with McQuarters Management by letter dated December 16, 1974. The initial management fee was five (5%) percent of the gross rentals. This was increased to six (6%) percent for each building on May 1, 1978. Claimant-limited partners regularly objected to the management fee. They specifically asked that the practice cease by letter dated August 23, 1976, but this was unsuccessful. In this litigation, Claimants asked for reimbursement for these management fees, and said claims were allowed by the trial court. As of 1980, these claims against the two corporate general partners exceeded $330,000.00.
After construction loan commitments were made (during Mr. Hall's lifetime), construction began on both projects. The construction lender, Concord Liberty Savings and Loan Association, allowed the borrower to "draw down" upon each loan account as construction progressed, rather than take the full amount of the loan in one lump sum. The lender required that interest due on the loan be pre-paid. If
this interest was deducted from the "draw" or the full face amount of the loan up front, it would have reduced the total cash flow available to the borrower and hence diminished the amount available to pay bills. To avoid this problem, and also to provide claimants, the limited partners, with substantial tax benefits, the limited partners lent (or at least contributed) funds to the two corporate general partners so that they could pre-pay the interest on the bank loans attributable to the construction period. The uncontroverted testimony of Mr. Lipsitz's accountant established that these loans or advances were entirely voluntary on the part of the limited partners and were not mandated by either of the limited partnership agreements. The amount advanced by the limited partners to pre-pay interest on the Green Hill-Lytle construction loan was repaid to them in full and included repayment of both the principal amount advanced plus interest on that amount calculated at the prime rate of eight (8%) percent. An exhibit was offered into evidence which was asserted to be a calculation in the handwriting of Charles Hall showing that the amount of interest due on this advancement was eight (8%) percent as calculated over an eleven month period. The exhibit was at least in part written on the back side of a sheet of Mr. Lipsitz's stationery. (See, R. 633a-636a). It was not signed. In any event, it is clear that these advances on the Green Hill-Lytle project were, in fact, paid back with interest. The limited partners in the Essex Square project made advances to cover the prepaid interest on the construction loan on that building in the total amount of $155,000.00. The principal amount of these advances was repaid but no interest was paid to the limited partners on this amount. The Essex Square limited partners asserted a claim for this unpaid interest. This claim was allowed by the trial court over the objection of Appellants. As of February, 1981, this interest amounted to over $38,000.00.
Claimants also asserted that they were entitled to a credit on the Essex Square partnership account of $250,000.00 representing the proceeds of a life insurance policy on the life of Charles Hall which the Essex Square corporate
general partner had allowed to lapse for non-payment of premiums (obviously during the lifetime of Mr. Hall). The Essex Square partnership agreement at Article V, § 2(b) (R. 687a) expressly obligated the corporate general partner to secure such a policy. This claim was likewise allowed by the trial court.
The procedural history of this litigation includes the following. On April 17, 1980, two separate complaints in equity were filed in the Civil Division of the Court of Common Pleas of Allegheny County. (See R., 12a-54a, and 66a-73a). The two complaints separately raised claims with respect to the two partnerships. The plaintiffs in each case were essentially the Appellees herein, while defendants included Appellants, and in particular, the respective corporate general partners, along with the current administrators of the estate of Charles Hall. The complaint in the Essex Square matter was subsequently amended. (R. 74a-76a). Both complaints sought various forms of relief including appointment of a receiver to manage the properties, cancellation of the management contracts entered into by the corporate general partners, an accounting and auditing of the respective partnership records, and an award of compensation based thereon.
The estate of Charles Hall was named as a party defendant in these two cases. The administrators of the estate were named presumably because they exercised control over all of the stock in the two corporate general partners in their capacity as administrators. Whether, and in what capacity, they served as officers or directors in the two corporations is unclear. The two limited partnership entities themselves were curiously named as party plaintiffs rather than as party defendants. Neither the complaint in the Essex Square matter, nor the amendment thereof, pleads facts that in any way assert the claim that the insurance policy ...