Real Estate Joint Venture and Investor Disputes

Why the venture agreement decides almost everything

Real estate ventures in Texas are nearly always organized as a limited liability company or a limited partnership, with a sponsor or operating partner who runs the project and capital partners who fund it. Texas lets the parties write their own rules. For an LLC, Business Organizations Code § 101.052 provides that the company agreement governs the relations among members, managers and the company and the company's internal affairs, and that the Code applies only where the agreement is silent. Section 101.401 goes further: the company agreement may expand or restrict any duties, including fiduciary duties, that a member or manager owes to the company or the other members, along with the related liabilities. For a limited partnership, chapter 153 and the general partnership rules in chapter 152 play the same role, subject to the partnership agreement.

So the first question in every one of these disputes is not what is fair. It is what the signed agreement says about this exact situation, and whether the sponsor followed it. Investors who skipped the agreement and relied on the offering deck or on conversations are often surprised by what they agreed to.

The disputes that come up most

Capital calls

The agreement says whether capital calls are mandatory or voluntary, who may issue them, for what purposes, and what happens to a partner who does not fund. Typical remedies for a defaulting partner are dilution of its interest, often at a penalty ratio, conversion of the shortfall into a loan from the funding partners at a high rate, loss of voting rights, or a forced sale of the interest. Fights arise when a capital call is issued for a purpose the agreement does not permit, when the sponsor uses a call to dilute a partner it wants out, or when the dilution formula is applied incorrectly. Because dilution is permanent, a partner who believes a call is improper should object in writing before the funding deadline rather than after.

Promote and waterfall

The distribution waterfall sets the order in which cash goes out: return of capital, a preferred return, then a split that gives the sponsor a disproportionate share, the promote, once investors hit a hurdle. Disputes center on how the hurdle is calculated (compounded or simple, from what date, on what capital), whether refinancing proceeds run through the same waterfall as sale proceeds, whether a clawback applies if early distributions turn out to exceed what the final numbers justify, and whether the sponsor's fees were paid before or after the investors' preferred return. These are accounting cases as much as legal ones. The agreement's definitions and the actual bank records decide them.

Fees and related-party dealings

Sponsors commonly earn acquisition, asset management, construction management, leasing and disposition fees, often through affiliates. The agreement usually authorizes specific fees at specific rates. Anything beyond that list, any affiliate contract at above-market terms, and any use of venture funds for the sponsor's other projects raises a self-dealing claim. The general principles are set out in self-dealing by a partner or manager.

Removal of the sponsor

Most agreements let the investors remove the managing member or general partner for cause, and define cause: fraud, gross negligence, willful misconduct, an uncured material breach, a bankruptcy, or a key-person event. Some allow removal without cause by a supermajority. The fight is usually over whether cause existed and whether the removal procedure (notice, cure period, vote) was followed. For a limited partnership, § 153.155 of the Business Organizations Code lists the events on which a person ceases to be a general partner, including removal in accordance with the partnership agreement, so the agreement's procedure controls. Removal also triggers questions about the removed sponsor's economic interest, its guaranties on the project loan, and consents the lender may require.

Sale, refinance and exit

When one side wants to sell and the other wants to hold, the agreement's major-decision list, buy-sell clause, drag-along and tag-along rights and forced-sale provisions govern. A buy-sell clause, where one partner names a price and the other must buy or sell at it, is enforced as written and is often the fastest way out of a deadlock.

The duties the sponsor owes

By default, Texas partnership law makes each partner owe the partnership and the other partners a duty of loyalty and a duty of care, to be discharged in good faith and in a manner the partner reasonably believes to be in the best interest of the partnership (Business Organizations Code § 152.204). The same section says a partner does not breach a duty merely because its conduct also furthers its own interest, and that a partner is not held to the standards of a trustee. For LLCs, the Code does not spell out the duties in the same way, and courts look to the company agreement first and to general fiduciary principles where it is silent. A managing member who controls the money is commonly held to owe duties to the company it manages.

The venture agreement can narrow these duties, waive conflicts of interest, approve categories of affiliate transactions in advance and replace the fiduciary standard with a contractual one. It cannot authorize fraud, and Texas courts read waivers of fiduciary duty closely. A sponsor who hid information, falsified reports or diverted funds will not be saved by a general exculpation clause. The elements and remedies of a breach are covered in what fiduciary duties partners and LLC managers owe in Texas.

Who can sue, and for what

Many investor claims belong to the venture, not the investor. A sponsor that overpaid itself fees or wasted venture money injured the company, and the claim to recover it is derivative: brought by a member on the company's behalf, subject to the demand and standing rules in the Business Organizations Code and any procedure in the agreement. Claims that belong to the investor individually include breach of the agreement's promises to that investor, fraud in inducing the investment, and failure to make a distribution the agreement required. The difference matters for who gets the recovery and for whether the investor must first make a demand on the company.

When the interests were sold to passive investors through an offering, securities law adds a second layer. Misstatements in the offering materials, sales by unregistered persons and undisclosed conflicts can support claims under the Texas Securities Act and federal law, which are covered in real estate syndication disputes between sponsors and passive investors. Those claims have their own, shorter deadlines.

Example

Suppose four investors fund 90 percent of the equity for a value-add apartment project in Fort Worth through an LLC managed by the sponsor, which contributes 10 percent and earns a 20 percent promote above an 8 percent preferred return. Two years in, distributions stop. The investors request the books and find that the sponsor paid its affiliate a construction management fee the agreement does not list, took a refinancing fee on a loan the agreement treats as a major decision requiring investor consent, and issued a capital call to cover the resulting shortfall with a dilution penalty for anyone who did not fund. The investors' claims divide into three: the unauthorized fees are a derivative claim for breach of the agreement and of the duties the agreement preserved; the refinance without consent is a breach of the agreement's major-decision clause; and the capital call, issued to cure the sponsor's own breach, is challenged as outside the permitted purposes, which would undo the dilution. Whether the investors can remove the sponsor depends on whether these events fit the agreement's definition of cause and whether they follow its notice and cure steps exactly.

Evidence that decides these cases

• The signed company or partnership agreement with every amendment, side letter and consent.
• The offering memorandum, subscription documents and investor presentations.
• Bank statements and the general ledger for the venture and any affiliate that touched its money.
• Every capital call notice, distribution notice and investor report, with the dates sent.
• Loan documents, including guaranties and any lender consents, since removal and sale usually require them.
• Communications among the partners about the disputed decisions, especially anything showing consent or objection.

Investors have information rights under the agreement and the Code, and using them before suing is usually the right order; the records request is explained in an LLC member's right to records in Texas.

What is at stake for the business

A venture dispute threatens the asset itself. Lenders treat sponsor removal, litigation among members and unfunded capital calls as default events or at least as grounds to refuse an extension. Tenants, contractors and brokers hear about the fight. A receiver, if one side asks for and obtains one, takes control from everyone. These pressures push most venture disputes toward a negotiated restructuring: a buyout at an agreed valuation, a replacement manager, a revised waterfall or an orderly sale with the disputed amounts escrowed. Litigation then serves to set the terms rather than to run the project.

When to involve a litigator

Before responding to a capital call you believe is improper, before voting on removal, and before signing any amendment or consent the sponsor circulates while the dispute is live. Each of those steps can waive a claim or lock in a dilution. Tina Wysk represents sponsors and investors in real estate venture, partnership and fiduciary disputes in Dallas state and federal courts and in arbitration, through the firm's real estate litigation practice.