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In re UTSA Apartments 8, L.L.C.

United States Court of Appeals, Fifth Circuit

March 27, 2018

In the Matter of: UTSA APARTMENTS 8, L.L.C. Debtor
v.
UTSA APARTMENTS 8, L.L.C.; UTSA APARTMENTS 5, L.L.C.; UTSA APARTMENTS 9, L.L.C.; UTSA APARTMENTS 12, L.L.C.; UTSA APARTMENTS 13, L.L.C.; UTSA APARTMENTS 19, L.L.C.; UTSA APARTMENTS 23, L.L.C.; UTSA APARTMENTS 24, L.L.C.; UTSA APARTMENTS 25, L.L.C.; UTSA APARTMENTS 27, L.L.C.; UTSA APARTMENTS 28, L.L.C.; UTSA APARTMENTS 30, L.L.C.; UTSA APARTMENTS 34, L.L.C.; UTSA APARTMENTS 1, L.L.C.; UTSA APARTMENTS 4, L.L.C.; UTSA APARTMENTS 6, L.L.C.; UTSA APARTMENTS 15, L.L.C.; UTSA APARTMENTS 16, L.L.C.; UTSA APARTMETS 18, L.L.C., Appellees UTSA APARTMENTS, L.L.C.; WOODLARK UTSA APARTMENTS, L.L.C., Appellants UTSA APARTMENTS, L.L.C.; WOODLARK UTSA APARTMENTS, L.L.C., Appellants
v.
UTSA APARTMENTS 8, L.L.C.; UTSA APARTMENTS 5, L.L.C.; UTSA APARTMENTS 9, L.L.C.; UTSA APARTMENTS 12, L.L.C.; UTSA APARTMENTS 13, L.L.C.; UTSA APARTMENTS 19, L.L.C.; UTSA APARTMENTS 23, L.L.C.; UTSA APARTMENTS 24, L.L.C.; UTSA APARTMENTS 25, L.L.C.; UTSA APARTMENTS 27, L.L.C.; UTSA APARTMENTS 28, L.L.C.; UTSA APARTMENTS 30, L.L.C.; UTSA APARTMENTS 34, L.L.C., Appellees UTSA APARTMENTS, L.L.C.; WOODLARK UTSA APARTMENTS, L.L.C., Appellants
v.
UTSA APARTMENTS 8, L.L.C.; UTSA APARTMENTS 5, L.L.C.; UTSA APARTMENTS 9, L.L.C.; UTSA APARTMENTS 12, L.L.C.; UTSA APARTMENTS 13, L.L.C.; UTSA APARTMENTS 19, L.L.C.; UTSA APARTMENTS 23, L.L.C.; UTSA APARTMENTS 24, L.L.C.; UTSA APARTMENTS 25, L.L.C.; UTSA APARTMENTS 27, L.L.C.; UTSA APARTMENTS 28, L.L.C.; UTSA APARTMENTS 30, L.L.C.; UTSA APARTMENTS 34, L.L.C., Appellees

          Appeal from the United States District Court for the Western District of Texas

          Before HIGGINBOTHAM, PRADO, and HIGGINSON, Circuit Judges.

          EDWARD C. PRADO, CIRCUIT JUDGE.

         This is a consolidated appeal stemming from the bankruptcy of nineteen companies that were tenants-in-common of a student housing development in San Antonio, Texas, called The Reserve. Appellants are Woodlark UTSA Apartments, LLC ("Woodlark"), who was The Reserve's asset and property manager, and a related entity, UTSA Apartments, LLC ("UTSA"), [1] which also owned an interest in The Reserve. This Court is asked to address the propriety of two rulings by the bankruptcy court concerning: (1) UTSA's share of net proceeds stemming from the sale of The Reserve to a third party during the bankruptcy proceedings, and (2) Woodlark's proof of claims against the bankruptcy estate. Appellants raise several issues involving the Bankruptcy Code and Texas fiduciary law. For the following reasons, we REVERSE the bankruptcy court's reduction of UTSA's share of net proceeds, but AFFIRM the bankruptcy court's reduction of Woodlark's proof of claims.

         I. BACKGROUND

         A. The Parties

         Appellees are nineteen Delaware limited liability companies ("Debtor TICs")[2] that-with Appellant UTSA and other limited liability companies that are not parties to this appeal ("Non-Debtor TICs")-owned undivided tenancy-in-common interests ("TICs") in The Reserve, an off-campus student housing project in San Antonio, Texas (the "Property"). Appellant Woodlark was the Property's asset manager. In addition, Woodlark was the Property's property manager, except for the period from February 2012 to April 2015.[3] Woodlark and UTSA are separate LLCs, but they are commonly owned by Harold Rosenblum through Woodlark Capital, LLC.

         B. The Reserve Project and Governing Documents

         In 2008, the TICs (the Debtor TICs, Non-Debtor TICs, and UTSA) purchased undivided tenancy-in-common interests in the Property for approximately $45 million. The Property was governed by three agreements: (1) the Declaration of Tenants in Common Agreement (the "Declaration"), (2)the Asset Management Agreement (the "AMA"), and (3) the Declaration of Call Agreement (the "Call Agreement"). While Woodlark, the Debtor TICs, and Non-Debtor TICs, signed and executed all three agreements, UTSA only signed and executed the Declaration and AMA. Despite being listed as a party to the Call Agreement, UTSA did not sign the Call Agreement.

         In conjunction with the AMA, the Declaration made Woodlark, as asset manager, "the agent of the [TICs] with respect to overseeing and supervising the management, operation, maintenance and leasing of the Property, and for purposes of interfacing with the Lender." The Declaration also permitted Woodlark to "employ a Third Party Property Manager, " as its agent "pursuant to the [AMA], to manage, operate, maintain and lease the Property."

         Additionally, in the Declaration, each of the TICs agreed to be responsible for paying their pro rata share of "Property Expenses"[4] to be determined by Woodlark as asset manager. The Declaration provided a process for Woodlark to notify TICs that payment of pro rata expenses was due through payment requests, also known as cash calls. If payment was not made in response to a cash call as specified in the Declaration, "the other Tenants in Common and [Woodlark] [had] the right to purchase the Delinquent Tenant in Common's interest in the Property in accordance with the terms of the Call Agreement."

         The Call Agreement governed the terms under which the Delinquent Tenant in Common's interest in the Property could be purchased through "Call Rights, " which could "be exercised only by the Asset Manager [Woodlark]." Once exercised, however, the other TICs (the non-delinquent and non-dissenting TICs) had the option of purchasing a portion of the delinquent or dissenting TIC's interest "on a pro rata basis according to their Interests" after providing the required notice. Any interest of the defaulting or dissenting TIC not purchased by the other TICs could "be purchased by the Asset Manager [Woodlark]."

         C. Turmoil at The Reserve

         As both Appellants and Appellees concede, Woodlark and the TICs had a very contentious and adversarial relationship. After informing the TICs of the Property's deteriorating financial performance on December 3, 2014, Woodlark sent the first of three requests for funds, or cash calls, to the TICs on December 15, 2014, pursuant to the terms of the Declaration. Woodlark made a second cash call on February 4, 2015, and a third cash call on July 15, 2015. Only two of the TICs, UTSA and TIC11, responded to all three cash calls.

         On September 22, 2015, Woodlark sent the TICs another request for funds within two business days pursuant to paragraph 4.2(b) of the Declaration. In this cash call, Woodlark sought payment for both the projected cash shortfall and delinquent funds. One week later, on September 29, 2015, Woodlark informed the non-paying TICs that their "failure to pay [their] corresponding pro-rata share of deficit in expenses" in response to the July and September cash calls had rendered them "Defaulting" TICs, also known as "Selling" TICs. Further, Woodlark stated that it was exercising its "Call Rights" pursuant to the Call Agreement and that it intended to purchase the TICs' ownership interests in the Property. As prescribed by the Call Agreement, any non-defaulting TIC that also intended to purchase the Defaulting TICs' interests was given 30 days to notify Woodlark of its intention to purchase the Defaulting TICs' interests.

         Only UTSA provided written notice of its intent to purchase the interests of the Defaulting TICs. On November 4, 2015, Woodlark notified the TICs that only UTSA had provided notice of intent to purchase the Defaulting TICs' interests and that UTSA had "opted to purchase the entire interests in default" (the "November 4th Letter"). Pursuant to the Call Agreement's provisions for determining the value of selling interests, Woodlark computed that the value of each of the Defaulting TICs' interests was "less than zero" with a deficiency owed to Woodlark. Furthermore, Woodlark stated that "[t]he fair market value of the Property . . . based on an appraisal performed a few days ago by a prospective capital partner" was $28.1 million (the "CBRE Appraisal"). Given this appraisal, the outstanding loan balance, the Property's payables balance, and the total amount of loans/advances provided by Woodlark, Woodlark maintained that no further payment was due to the Defaulting TICs for their ownership interests. Woodlark stated that the closing would take place on November 20, 2015. If the Selling TICs refused to execute the deed transferring ownership, Woodlark made clear that it would exercise the Call Agreement's "power of attorney" provision[5] to execute the deeds on their behalf, transferring ownership to UTSA.

         D. State Court Proceedings

         On November 19, 2015, several resisting TICs[6] filed suit in the 150th Judicial District Court of Bexar County, Texas against Woodlark ("State Court Suit"). The TICs sued Woodlark for (1) breach of fiduciary duty, (2) negligence, and (3) breach of contract. Additionally, the TICs sought a temporary restraining order and permanent injunction prohibiting Woodlark from conveying the TICs' interests to itself via UTSA. The state court granted the TICs' request for a temporary restraining order precluding Woodlark from exercising its power of attorney.

         In response to the State Court Suit, Woodlark filed a motion to compel arbitration, and Woodlark and UTSA jointly filed a demand for arbitration against all the TICs with the American Arbitration Association. Additionally, Woodlark and UTSA filed a separate petition to compel arbitration against several TICs[7] in the 288th Judicial District Court of Bexar County, Texas. Ultimately, seven[8] of the TICs either arbitrated their claims or settled with Woodlark and UTSA.

         E. Bankruptcy Court Proceedings

         1. Petitions for Bankruptcy

         On December 2, 2015, fifteen[9] of the TICs filed voluntary petitions for Chapter 11 bankruptcy. Subsequently, four additional TICs joined. The now nineteen cases (corresponding to each of the Debtor TICs) were jointly administered before the United States Bankruptcy Court for the Western District of Texas under Case No. 15-52941. The same day, the Debtor TICs removed the State Court Suit, which included their contract, negligence, and breach of fiduciary duty claims against Woodlark, to the bankruptcy court, which was docketed as Adv. No. 15-5093 ("Breach of Duty Adversary").

         2. Sale of The Reserve

         During this time, the Debtor TICs began seeking a buyer for the Property. While several offers were secured for well above the $28.1 million valuation Woodlark asserted in the November 4th Letter, [10] both UTSA and Woodlark opposed the sale of the Property. After two unsuccessful attempts to sell the Property via motion, the Debtor TICs filed Adversary Proceeding No. 16-5047 ("Sale Adversary") seeking to sell the Property over Woodlark's objections pursuant to 11 U.S.C. § 363(h).[11] In the Sale Adversary, the Debtor TICs also objected to Woodlark's proofs of claim, specifically its claim for payment of cash advances, deferred management fees, and a disposition fee of approximately $1.485 million.

         On September 14, 2016, following an agreement by the parties, the bankruptcy court issued an order authorizing the sale of the Property to Arris Reserve San Antonio, LLC ("Arris") for a sales price of $33.5 million and gross amount worth $35 million (the "Sale Order"). Under the Sale Order, all of the TICs' interests, including UTSA's interest, would be transferred to Arris, free and clear of all liens, claims, encumbrances, and interests. As to the sale's net proceeds, the Sale Order provided that they would be held by an escrow agent "pending final resolution of all the Claims against the Debtors' bankruptcy estates and payment of same and by further orders of the Court." Because the Debtor TICs' objections to Woodlark's proof of claims remained unresolved, they were severed and separately docketed as Adversary Proceeding No. 16-5070 ("Claims Adversary"). Finally, on November 21, 2016, the sale to Arris closed.

         3. The Parties Seek Distribution of the Sales Proceeds

         After the sale, the parties filed three separate motions for distribution of the sales proceeds. First, Woodlark filed a motion to distribute funds attributable to the Non-Debtor TICs, [12] which the bankruptcy court granted on December 16, 2016. Second, Woodlark and UTSA jointly filed a motion to distribute funds attributable to UTSA ("UTSA Motion to Distribute"), which the Debtor TICs opposed. Finally, the Debtor TICs filed a motion to surcharge Woodlark and UTSA "for the fees and costs that benefitted UTSA and Woodlark in connection with the sale of the [Debtor TICs'] assets" ("Debtor TIC Surcharge Motion"), which Woodlark and UTSA jointly opposed.

         4. The Trial and Ruling

         The bankruptcy court set the following matters for a consolidated bench trial to begin in January of 2017: (1) the Breach of Duty Adversary, (2) the Claims Adversary, (3) the UTSA Distribution Motion, and (4) the Debtor TIC Surcharge Motion. On January 23-26 and February 7, 2017, the bankruptcy court held a trial and considered testimony and evidence regarding these four matters.

         After the trial, but prior to the bankruptcy court's ruling, the Debtor TICs, UTSA, and Woodlark agreed to move forward with a reorganization plan, which culminated in the bankruptcy court's confirmation order on February 23, 2017. The confirmation order, to which all parties consented, provided that the Debtor TICs' remaining claims would be determined the bankruptcy court, which retained jurisdiction pursuant to the reorganization plan.

         On March 8, 2017, the bankruptcy court orally issued its findings of fact and conclusions of law regarding the four matters contested at trial. The court began with a basic factual chronology of the project, the TICs' purchase of the Property for $45 million, and the financial issues giving rise to the dispute between the TICs and Woodlark. The court found that by entering into the various agreements with the TICs "fiduciary duties were created and imposed upon Woodlark, because the investors, the TICs, were relying on Woodlark to manage the property and protect their investment." As a result of the financial crisis beginning in 2008, the court explained that the Property did not perform as well as had been anticipated, and Woodlark issued various cash calls to the TICs. The court noted that the relationship between Woodlark and the TICs was "adversarial" because the TICs "were very unhappy on many management issues." However, the court found that the TICs could not remove Woodlark as asset manager because one of the TICs was UTSA, a Woodlark affiliate, and Woodlark made it clear that UTSA would oppose any effort to remove Woodlark as asset manager. The court noted that the relationship between Woodlark and the TICs continued to deteriorate, with the TICs requesting audits that were never provided and the Property continuing to financially decline. Ultimately, Woodlark, citing the CBRE Appraisal of the Property valuing it at $28.1 million, demanded that the TICs tender their ownership to Woodlark under the Call Agreement "for zero dollars." However, the court found that the CBRE Appraisal was flawed in two primary respects. First, the court found that the CBRE Appraisal omitted ad valorem tax refunds, stemming from tax litigation and protests which Woodlark had not kept up with despite its fiduciary duty to do so. Second, the court found that the CBRE Appraisal had not properly taken into account the value of vacant land that was part of the Property. Had the CBRE Appraisal taken into account these two items, the court found that the Property would have been worth at least $33 million, a valuation that was ultimately "proven" by the actual $33.5 million sales price.

         Turning to the instant bankruptcy litigation, the court observed that the Debtor TICs had been attempting to market and sell the Property over the course of the case with "Woodlark . . . resisting and objecting every step of the way." With the sale completed without "very much help from Woodlark, " the court summarized the parties' opposing positions with respect to the approximately $2.1 million net sale proceeds. On the one hand, Woodlark sought the entire $2.1 million, which included all of its cash advances to the Property, all unpaid management fees, and a 4.5% transaction fee stemming from the sale of the Property. On the other hand, the Debtor TICs claimed that Woodlark should receive nothing and that they should receive the full $2.1 million as a result of their breach of contract and breach of fiduciary duty claims, which should bar Woodlark's recovery of cash advances, management fees, and transaction fees. In addition, the court noted the Debtor TICs' request for actual and punitive damages.

         The court announced that it would allow Woodlark to recover its actual cash advances to the Property and the Debtor TICs, but it would disallow the property management fees, asset management fees, and transaction fee. The court held that Woodlark "and its affiliated entity" UTSA would not be given credit for the 19% ownership interest that was transferred to UTSA under Woodlark's demand. Instead, the court stated that the 19% would be shared pro rata among the remaining TIC owners. Thus, the court held that, following the reimbursement of Woodlark's cash advances, UTSA's share of the net proceeds would be 3.14%, and the Debtor TICs' share would be 96.86%.

         As to the Debtor TICs' breach of contract and breach of fiduciary duty claims, the court began by describing the duties of a fiduciary and noted that the "burden of proof is on the fiduciary to show fairness of the transaction." The court opined that "Woodlark treated the relationship as a typical contractual agreement in which both parties look out for their own financial interests first, [but that] this was not such a contract." The court found that Woodlark used the CBRE Appraisal "as a cudgel to force the TICs to pay up or forfeit their interests." Quoting Justice Cardozo's seminal opinion in Meinhard v. Salmon, 164 N.E. 545 (N.Y. 1928), the court held that Woodlark's actions violated its fiduciary duties to the TICs requiring "the punctilio of an honor the most sensitive" and holding Woodlark to "something stricter than the morals of the marketplace." Accordingly, in light of Woodlark's breach of the contract and breach of fiduciary duties, the court held that Woodlark must forfeit the unpaid asset management fees, unpaid property management fees, and the 4.5% transaction fee.

         As to Woodlark's proof of claims, the court granted Woodlark's actual cash advances, totaling $410, 097.78, and disallowed the remainder of its claims. The court stated that remaining net proceeds would be divided by UTSA and the Debtor TICs, with UTSA receiving 3.14%-its share having been reduced from 21.17%-and the Debtor TICs receiving 96.86%. The court declined to grant any further damages, attorneys' fees, or surcharges, and denied all other relief. Upon further questioning by Woodlark and UTSA's counsel, the court gave two reasons for reducing UTSA's share to 3.14%. First, the court explained that UTSA did not sign the Call Agreement. Second, the court explained that it did not believe that "they[13] should profit from this action, which I felt like was a breach of fiduciary duty, to try to force the TICs to surrender their interest for no consideration when the property was worth more."

         Following the trial, the court entered final judgment in the bankruptcy case disallowing all of Woodlark's claims against the Debtor TICs and the bankruptcy estate, except for $410, 097.78 representing "cash advances made by [Woodlark] pre-petition." The judgment also provided that the Debtor TICs would be awarded a distribution of 96.86% of the net remaining amount of the estate and UTSA would be awarded a distribution of 3.14% of the net remaining amount. Additionally, consistent with its oral rulings, the court entered an ...


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