Real Estate Syndication Disputes: Sponsors and Passive Investors

Why the interest is a security

Texas Government Code section 4001.068 lists a limited partner interest in a limited partnership as a security by name. A passive membership interest in a manager-managed LLC is treated the same way under the investment-contract test: investors put in money, the returns depend on the sponsor's acquisition, financing and management, and the investors do not run the property. The consequence is that the sponsor is a seller of securities. It needed an exemption from registration, nearly always Rule 506(b) or 506(c) of Regulation D, and it is liable under the Texas Securities Act for what it said and left unsaid in the raise. Whether a given structure is a security is covered in the guide on unregistered securities.

Dispute one: what the offering said

Syndication offering packages are heavy on projections: rent growth, occupancy, exit cap rate, internal rate of return. A projection that missed is not by itself a misstatement. The actionable problems are statements of present fact that were false when made, and omissions of facts the sponsor had to disclose. The recurring examples:

• The sponsor's track record, when prior deals that lost money or foreclosed were left out.
• The purchase price, the loan terms or the renovation budget, when the documents did not match the closing.
• Affiliate relationships, when the property manager, the contractor or the lender was owned by the sponsor and the fees were not disclosed.
• The status of due diligence, when a known roof, plumbing or environmental problem was omitted.
• The exemption itself, when a 506(b) deal was marketed publicly or sold to unverified non-accredited investors.

Under section 4008.052 the sponsor is liable to each buyer for a sale by means of an untrue statement of a material fact or a misleading omission, and the buyer may rescind and recover the price with legal interest less distributions, without proving intent. Section 4008.055 reaches the sponsor's principals as control persons and paid capital raisers as aiders. A raise that failed its exemption adds a registration claim under section 4008.051. The full mechanics are in the Texas Securities Act guide, and the remedies for a false memorandum in the offering memorandum guide.

Dispute two: how the deal was run

Most syndication fights are about the years after closing. The governing document is the limited partnership agreement or the LLC company agreement, and in Texas those documents carry great weight: the Business Organizations Code lets partners and members define the sponsor's duties and the mechanics of fees, distributions, capital calls and removal, within limits. The questions a litigator asks are these.

Fees and affiliate payments

Was each fee authorized by the agreement, in the amount charged, at the time charged? Acquisition, asset management, construction management, disposition and refinancing fees are typically enumerated; a fee not on the list, or paid to an affiliate at an above-market rate, is a breach of contract and often a breach of the duty of loyalty.

Fiduciary duties

A general partner of a Texas limited partnership has, under Business Organizations Code section 153.152, the liabilities of a partner in a general partnership, and a partner owes the partnership and the other partners duties of loyalty and care under section 152.204, to be discharged in good faith and in a manner the partner reasonably believes to be in the partnership's best interest. The agreement can shape those duties, and many syndication agreements do, but self-dealing without the disclosure and approval the agreement requires remains actionable. LLC manager duties follow the company agreement, with the same principle.

Capital calls, refinancing and sales

Did the agreement allow the capital call, with the notice and dilution consequences it provides? Did a cash-out refinancing require investor consent? Was a sale to an affiliate, or a sale that paid the sponsor a disposition fee while investors lost principal, permitted? These are contract questions first, and the answer is in the document, read against what actually happened.

Distributions and the waterfall

Preferred returns, catch-ups and promotes are arithmetic. An investor is entitled to have the waterfall applied as written, and a sponsor who pays itself a promote before the preferred return is current has breached the agreement whatever its cash position. The accounting is usually the first discovery request.

Example

Suppose sixty investors put $9 million into a Dallas-area apartment syndication in 2022. Distributions stop in 2025 with a letter blaming interest rates and announcing a capital call. The investors' records demand produces the general ledger, which shows a 3% construction management fee paid to the sponsor's affiliate that the agreement does not authorize, a loan assumption at closing on terms different from the offering summary, and a prior deal of the sponsor's that was foreclosed in 2021 and omitted from the track record. The omitted foreclosure and the loan terms support rescission claims under section 4008.052; the unauthorized fee is a contract claim and a loyalty claim; the capital call is tested against the agreement's notice and dilution provisions. The investors also hold the votes the agreement requires to remove the general partner, which changes the negotiation.

Removal, receivership and group action

Syndication agreements usually allow investors holding a stated percentage to remove the general partner or manager for cause, and sometimes without cause. Removal is a practical remedy that stops the bleeding without waiting for a judgment, but the procedure in the agreement must be followed exactly or the sponsor will contest it. Where the sponsor controls the bank accounts and will not step aside, a court can appoint a receiver for the entity, which is covered in the receivership guide. Investors in one syndication share documents and facts, so claims are typically pursued together; the first task is to find out who else has the same information and whether anyone has already signed a release or amendment the sponsor circulated.

Deadlines and forum

Texas Securities Act misstatement claims run three years from discovery and no more than five years from the sale; registration claims three years from the sale (section 4008.062). Fiduciary and fraud claims carry four years under Civil Practice and Remedies Code section 16.004; contract claims four years as well. Syndication agreements frequently contain arbitration clauses, jury waivers and choice-of-law provisions selecting the sponsor's home state, which can determine where and how the dispute is heard. The clause is checked before any demand goes out.

When to involve a litigator

When distributions stop without a clear explanation, when a capital call or refinancing is announced without a vote you believe the agreement requires, or when the records demand is refused. Early review often leads to a negotiated change of control or a corrected accounting rather than a lawsuit, and it protects rescission, which can be lost by continuing to act as a satisfied investor after learning the truth. Tina Wysk represents passive investors and sponsors in syndication disputes in Dallas state and federal courts and in arbitration; see securities and investment disputes.