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Lawyers, other representatives, expert(s), tribunal’s secretary

Final Award

[1].
This Final Award is issued pursuant to Rule 24 of the JAMS Comprehensive Arbitration Rules & Procedures.
[2].
Claimant Camilleri 2015 Family LLC Camilleri ("Claimant") is represented by Donald N. David, Esq., and David F. Bayne, Esq., Akerman LLP, 666 Fifth Avenue, 20th Floor, New York, NY 10103. Respondent 236 West 24th Chelsea LLC ("Chelsea") is represented by Jay S. Hellman, Esq., Silverman Acampora LLP, 100 Jericho Quadrangle, Suite 300, Jericho, NY 11753.
[3].
The agreement to arbitrate is contained in a Stipulation Adjourning Order to Show Cause, dated July 17, 2015, and Section 5.1.6 of the July 31, 2012 Operating Agreement for 236 West 24th LLC ("236 West 24th LLC" or the "Company") (the "Operating Agreement"), the Members of which are David Camilleri ("Camilleri") and Chelsea. Claimant’s Exhibit (CX) 4. On June 22, 2015, Camilleri transferred his interest in the Company to Claimant. CX 62.
[4].
An evidentiary hearing was held on December 7, 8 and 9, 2015. Oral argument was heard on December 18, 2015.
[5].
The sole issue presented in this arbitration is whether Camilleri may remove Chelsea as the Managing Member of pursuant to Section 5.1.6 of the Operating Agreement, which provides in pertinent part:

5.1.6. Removal of Managing Member. If any one or more of the following events (a "Managing Member Default") occurs as determined after expedited arbitration * * *, David Camilleri may remove the Managing Member and, thereupon, he shall become the sole Managing Member:

5.1.6.1. the Managing Member’s willful or intentional violation or reckless disregard of the Managing Member’s duties to the company; or

* * *

5.1.6.3. the Managing Member’s material breach of this Agreement without cure after twenty days notice thereof;

5.1.6.4. any act of * * * willful misconduct or gross negligence by the Managing Member in the performance of his obligations under this Agreement * * *.

[6].
For the reasons set forth below, I find that Claimant has established a Managing Member Default pursuant to Section 5.1.6.1 of the Operating Agreement, and may remove Chelsea as the Managing Member.1

EVIDENCE PRESENTED AT THE HEARING

[7].
Claimant offered the testimony of Kevin Smith ("Smith"), and expert witness Jerome Haims. Respondent offered the testimony of Camilleri, Kenneth Hart ("Hart") and Sean Heaphy ("Heaphy"). The parties stipulated to the testimony of Respondent’s expert, Brock Emmetsberger of Cushman & Wakefield. Both parties submitted voluminous documentary evidence.
[8].
The following evidence is substantially undisputed, except as specifically noted. This arbitration concerns real property located at 236 West 24th Street, New York, New York (the "Property").
[9].
On June 9, 2011, Camilleri ("Owner") entered into a Joint Venture Agreement (the "JV Agreement") with Hart and Smith (together, the "Developer") (CX 1).
[10].
Paragraph 2 of the Joint Venture Agreement provides:

Owner and Developer intend as soon as practicable after execution and delivery of this Agreement jointly to construct on Premises [236 West 24th Street] certain improvements substantially similar in quality and design to 124 West 15th Street, New York, NY, for sale as market rate condominiums (the "Improvements," and together with the conversion of the premises to a condominium and marketing and sale of the condominium units, the "Project").

CX 1 (bold in original). 124 West 15th Street is a property previously developed by Hart as condominium apartments, which the parties agreed would be a model for the development of 236 West 24th Street.

[11].
Pursuant to the Joint Venture Agreement, Camilleri transferred ownership of 236 West 24th Street to the Company on June 27, 2012, which was his capital contribution to the project.
[12].
On July 30, 2012, Smith and KEH Owner LLC (owned by Hart) entered into an operating agreement for Chelsea ("Chelsea Operating Agreement") (CX 3), with each being equal members.
[13].
On July 31, 2012, Camilleri and Chelsea entered into the Operating Agreement (CX 4), pursuant to which Chelsea was admitted as a member to the Company. Claimant owns a 50.1% membership interest in the Company and Respondent owns 49.9%. Chelsea is the Managing Member of the Company.
[14].
Section 2.3 of the Operating Agreement provides:

2.3. Purpose. The sole purpose of the company shall be, directly or as a member, partner or other participant, of another entity, to acquire, own, lease, develop, construct, renovate rehabilitate and operate, convert to a condominium form ownership and sell or otherwise dispose of, the Property, for the production of a profit and carrying on any and all activities related thereto (including, without limitation, entering into, making and performing all contracts and other undertakings necessary or advisable to the carrying out of the foregoing purposes).

[15].
Chelsea proceeded to rebuild 236 West 24th Street into a five-unit apartment building. Funding for the project was provided by Smith, Hart and Hart’s business associate Heaphy, who was not a member of Chelsea (or of 236 West 24th LLC), but who participated in the project in a variety of capacities pursuant to an informal, unwritten agreement with Hart. Heaphy’s financial role in the project was not disclosed to Camilleri. The parties consulted with the real estate brokerage firm of Douglas Elliman (represented by Michael Graves) with respect to marketing strategy and pricing (CX 7), and Douglas Elliman was retained in September 2013 as the exclusive sales broker for the five condominium units ("Exclusive Sales Agreement"). CX 75. The parties prepared and submitted on May 23, 2014, a Condominium Offering Plan ("Offering Plan") for approval by the New York State Attorney General’s Office. CX 17. Schedule A to the Offering Plan contains information about each of the units in the building including their asking prices, which were agreed upon by Camilleri and Respondent. CX 17, Schedule A at 21. The JV Agreement, Operating Agreement and Offering Plan all reflect the intention and expectation of Camilleri and Respondent that the Property would be developed for sale as five individual condominium units. A Certificate of Occupancy was issued on December 14, 2014. CX 31. At no time did the parties discuss or agree on an "exit strategy" in which the apartments would be leased and the Property sold to an investor as a going concern.

ALLEGATIONS OF MANAGING MEMBER DEFAULT

[16].
The question of managing member default is complicated by the fact that there is currently a dispute between the members of Chelsea (effectively Hart and Smith), which has resulted in a separate pending litigation between them. Essentially, Hart contends that he is the majority interest owner and sole managing member of Chelsea due to KEH Owner LLC’s additional capital contributions over and above those of Smith, and that Smith was removed as a manager of Chelsea at what Hart asserts was a lawfully noticed and convened meeting of Chelsea. Accordingly, since at least February 2015, Hart has asserted the authority to act unilaterally on behalf of Chelsea as the Managing Member of the Company.

Refusal to Sell Condominium Units

[17].
The principal ground of Claimant’s assertion of Managing Member Default is Chelsea’s (Hart’s) refusal to sell certain condominium units notwithstanding the receipt of offers at or above the asking price specified in the Offering Plan.
[18].
Hart’s position and conduct regarding the sale of the apartments has changed over time.
[19].
The apartments were put on the market in late summer or early fall of 2014 at the asking prices set forth in the Offering Plan. Units #2 and #3, which were the lowest-priced apartments at $2,050,000 and $2,250,000, quickly generated full-asking-price offers. CX 20, 24. There was little or no interest in the garden apartment (priced at $3.75 million) or the penthouse (priced at $6.95 million), each of which had been deliberately priced at $1 million above the sales price that the parties were prepared to accept. Although Graves expressed confidence that the sale of the three middle units would generate interest in and sale of the garden and penthouse apartments, Hart’s view that Units #3 and #3 were overpriced eventually led him to refuse to approve the sale of any of the condominiums, unless and until all parties agreed to raise the asking prices for Units #2 and #3 (which would require amendment of the Offering Plan), and until Camilleri and Smith agreed to contribute additional capital..
[20].
Initially, however, Hart’s approach to the perceived underpricing was to offer in October 2014 to purchase Unit #3 at the full asking price, as a result of which Graves turned down a recently-received all-cash, full-asking-price offer for that Unit. CX 23. A month later, Heaphy offered to purchase Unit #4 for $2.4 million--less than the full asking price of $2.75 million. (Chelsea (Hart) agreed to a reduction in price for Unit #4 over Smith’s objection.) On November 6, 2014, the attorney for the Company sent to Hart and Heaphy’s counsel Purchase Agreements in the form specified in the Offering Plan. CX 103, 104. They were returned over a month later with proposed changes favorable to Hart and Heaphy that the Company’s attorney rejected as "unauthorized" and "unacceptable," including a substantially reduced down payment, extension of the closing date from 30 days to 180 days after contract, and deletion of a clause prohibiting assignment of the Purchase Agreement (the deletion of this prohibition would allow the buyer to "flip" the contract to another buyer without having to close). CX 30, 34, 106. On December 9, 2014, Camilleri demanded that the apartments be placed back on the market "ASAP." CX 35.
[21].
Meanwhile, in December 2014, Heaphy was permitted by Hart to reside in Unit #4 without paying rent (a separate basis for removal of the Managing Member discussed below), which effectively precluded showing that apartment. In January 2015, Hart issued capital calls to the members of the Company, which Smith and Camilleri believed to be unauthorized and refused to pay. CX 37. Shortly thereafter Chelsea’s counsel directed the attorney for the Company not to proceed with a proposed contract for the sale of Unit #3 (at full asking price), because Hart believed the sale of the apartment "is not in the best interest of the joint venture/seller and does not consent to such sale." CX 45. Then, on February 13, 2015, in connection a scheduled closing on the sale of Unit #2 (for full asking price), which was delayed by a dispute with the purchaser, Hart’s attorney announced that Hart would refuse to give the purchaser any extensions and would cancel the contract because the price was "insufficient," and that he would also "oppose the sale of any other units until the members of the Joint Venture can come to terms on price and all required capital for the proper functioning of the Joint Venture is contributed." CX 43, 44. At no time did Chelsea (Hart) prepare or submit an application to amend to the Offering Plan to permit a price increase.
[22].
Camilleri’s attorney responded the same day that Chelsea "is clearly in default of its obligations (including its fiduciary obligations) under the Company’s agreement," asserting that Hart had "sabotaged all efforts by the broker to sell units in the condominium. He has allowed someone to occupy one of the units in the building who doesn’t even pay rent, which makes that unit unmarketable. A market rent would provide all the funds needed by the Company to pay operating expenses. He refuses to permit the existing sale to go forward. This one sale also would solve all the Company’s cash flow problems." CX 46.
[23].
At some point, Hart unilaterally began to explore the option of leasing the apartments and selling the building as a going concern, which Hart suggested as a way to avoid paying capital gains taxes on the sale of the apartments as individual condominiums. Hart did not ask Smith or Camilleri if they would realize any tax benefit from this strategy, which arguably required a vote of 2/3 of the interests in the company. See Operating Agreement, Section 5.1.3.4 (CX 4). Both Smith and Camilleri opposed leasing the apartments. Hart asked Douglas Elliman to prepare a rental analysis, but did not request an appraisal of the value of the building if frilly leased.
[24].
On April 23, 2015, Camilleri’s attorney demanded the removal of Chelsea as Managing Member of the Company pursuant to Section 5.1.6 of the Operating Agreement. CX 55. The parties have been unable to resolve their disputes. Hart continues to maintain that he is the sole Managing Member of the Company, and that in that capacity he has the exclusive right to make all decisions regarding the Property, regardless of the wishes of Camilleri and Smith. He has refused to approve the sale of any of the apartments (including rejecting full or above-asking-price offers for Units #2 and #3), leading to the litigation between Smith and Hart, and to this arbitration. There was testimony at the arbitration hearing that the protracted delay in marketing the apartments has diminished their value.

Failure to Maintain and/or Provide Financial Reports and Records

[25].
Article VIII of the Operating Agreement ("Books, Records, Accounting and Tax Elections") requires "the Members" to deposit all funds of the Company in designated bank accounts, to maintain and make available for examination accurate books and records of the Company, including supporting documentation, and to prepare certain financial reports, including an "annual compilation report" prepared by the company’s independent accountants in accordance with standards issued by the American Institute of Certified Public Accountants, and tax information necessary for the preparation of Interest Holder’s income tax returns. CX 4, Sections 8.1, 8.2 and 8.4.
[26].
It is undisputed that Hart was solely responsible for the preparation and maintenance of the financial records of the Company, and the only member in a position to engage an accountant and prepare and issue the required financial reports. Camilleri acknowledges that prior to April 2015, he made no request to examine the books and records of the company, and did not request any annual compilation reports or tax information (neither annual compilation reports nor tax information had ever been prepared prior to the arbitration hearing). On April 10, 2015, Camilleri’s attorney sent Chelsea a Notice of Default for failing to comply with Sections 8.1, 8.2 and 8.4 of the Operating Agreement. CX 53. Camilleri’s attorney also requested an opportunity to examine the books and records of the Company on April 21, 2015. By letter dated April 20, 2015, Chelsea’s counsel responded that the books and records would not be available for examination on April 21 because "the controller who manages the Company’s books and records is going away on April 23 and is immersed in preparing to be away," and requested that Camilleri’s counsel contact him to schedule a date after the controller returns for your client to examine the 236 W. 24 LLC books and records." CX 54. Camilleri acknowledged at the arbitration hearing that he never attempted to re-schedule an examination of the books and records.

Permitting Heaphy to Occupy Unit #4 Without Paying Rent

[27].
In or about December 2014, Heaphy began residing in Unit # 4 (the apartment that Heaphy had previously sought to purchase at a reduced price) without paying rent. Heaphy paid for over $100,000 in "upgrades" to the apartment. At this point Heaphy (according to records maintained by Hart) had contributed approximately $1.8 million to the project on behalf of KEH Owner LLC and Hart. Hart and Heaphy testified that Heaphy was installed in Unit #4 to provide incidental maintenance tasks and security services for the otherwise unoccupied property. There is no written agreement regarding Heaphy’s occupancy of Unit #4. During Heaphy’s occupancy, there has also been a part-time superintendent paid personally by Smith, and between January and November 2015, Smith also personally engaged and paid a management company known as Tri-Star Equities to oversee the day-to-day needs of the property. CX 36. Notably, the Offering Plan states that the only building staff required for the property is "one part time porter who will perform janitorial services," estimated to cost $9,600 per year. CX 17 at 18, 26. It is undisputed that Heaphy’s occupancy has devalued Unit #4 because it can no longer be marketed as "new construction."

DISCUSSION

[28].
Under Section 5.1.6.1 of the Operating Agreement, the Managing Member may be removed upon the occurrence of "the Managing Member’s willful or intentional violation or reckless disregard of the Managing Member’s duties to the company."
[29].
It is well-established under New York law that a managing member of a limited liability company owes a fiduciary duty to the company and to the non-managing members. Nathanson v. Nathanson, 20 A.D.3d 403, 404 (2d Dep’t 2005). A manager of a New York LLC has "a statutory duty to perform his duties 'in good faith and with that degree of care that an ordinarily prudent person in a like position would use under similar circumstances’." Id., quoting Limited Liability Company Law § 409[a]). The managing member "owes a duty of undivided and undiluted loyalty to those whose interests the fiduciary is to protect" and this is a "'sensitive and inflexible rule of fidelity, barring not only blatant self-dealing, but also requiring avoidance of situations in which a fiduciary’s personal interest possibly conflicts with the interest of those owed a fiduciary duty.’" Pokoik v. Pokoik, 115 A.D.3d 428, 429 (1st Dep’t 2014) (quoting Birnbaum v. Birnbaum, 73 N.Y.2d 461, 466 (1989)). The fiduciary is mandated to "single-mindedly pursue the interests of those to whom a duty of loyalty is owed." Birnbaum, 73 N.Y.2d at 466. In addition, a managing member owes the non-managing member a duty to make full disclosure of all material facts. Sam v. Feldstein, 20 A.D.3d 469, 470 (2d Dep’t 2005).
[30].
Based upon the above evidence, I find that Chelsea (Hart) has breached its fiduciary duty to the company and has therefore willfully and intentionally violated its duties to the Company as Managing Member pursuant to Section 5.1.6.1 of the Operating Agreement, by refusing to approve the sale of apartments and by permitting Heaphy to occupy Unit #4 without paying rent.2
[31].
Chelsea (Hart) asserts that its actions are protected by the "business judgment" rule, which "bars judicial inquiry into actions of corporate directors taken in good faith and in the exercise of honest judgment in the lawful and legitimate furtherance of corporate purposes." Auerbach v. Bennett, 47 N.Y.2d 619, 629 (1979).3 Chelsea argues that "Hart, as an experienced developer in the New York city/Metropolitan area, has knowledge of the marketplace and in his experienced view, the most effective way to exit this investment, and the vest avenue to achieve investor profit, is to lease the Unites and then sell the entire building." Chelsea Pre-Hearing Memorandum at 7-8. Thus, "in light of the broad authority granted to Chelsea under the Operating Agreement, it is clearly within Chelsea’s business judgment to either sell or lease the Units." Id. at 7. Chelsea further asserts that permitting Heaphy to occupy Unit #4 without paying rent benefitted the Company by making the Property more secure.
[32].
I disagree.
[33].
The undisputed evidence establishes that that Chelsea (Hart) has acted contrary to the best interest of the company in order to obtain maximum return on his personal investment and/or force Smith and Camilleri to assume a greater share of the costs and expenses incurred in developing the Property. Plainly, the decision to refuse to accept full-asking-price offers was not made in the exercise of "honest judgment," as Hart candidly and tellingly acknowledged at the hearing that (contrary to the position taken in Chelsea’s pre-hearing memorandum), leasing the Units is not the highest and best use of the asset. Accordingly, the intentional derailing of the profitable sale of condominium units cannot be economically justified and defeats the object of the parties in entering into the JV Agreement and the Operating Agreement. Rather than benefitting all members, Hart’s actions appears to be part of an attempt to gain leverage in his efforts to obtain additional financial contributions from Smith and Camilleri. Hart’s use of his assertedly unfettered discretion in a manner that frustrates the basic purpose of the parties’ agreements and deprives Camilleri of the benefits of those agreements is a violation of his duty of loyalty, as well as a violation of the implied obligation of good faith and fair dealing found in every contract. Hirsch v. Food Res., Inc., 24 A.D.3d 293, 296 (1st Dep’t 2005).
[34].
Moreover, I find that the decision to permit Heaphy to reside in Unit #4 without paying rent, was clearly made to provide Heaphy with a benefit for his financial support of Hart rather than to save the Company the expense of engaging a security firm. Not only was security and maintenance being provided by a superintendent and a management company, but Hart’s testimony that Heaphy’s occupancy was solely to provide security at the property is belied by the fact that Heaphy’s investment of $100,000 in upgrades (not coincidentally in the same apartment he had previously attempted to buy). This decision was not only affected by inherent conflict of interest, but also constituted an act of self-dealing by Hart (using a corporate asset for personal advantage).

CONCLUSION

[35].
For the reasons set forth above, I find that Claimant has established a Managing Member Default pursuant to Section 5.1.6.1 of the Operating Agreement, and may remove Chelsea as the Managing Member of 236 West 24th LLC.4

SO ORDERED:

January 13, 2016

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