Management fees. Administrative fees. Performance fees. To a promoter of real estate investments, such fees reduce risk and pay for the work involved in putting together and managing real estate deals. To an investor, on the other hand, these charges can cut too deeply into profits, even if the services themselves are necessary.
Such fees are usually agreed to by the promoter and the investors, but sometimes they can result in breaches of fiduciary duties and lawsuits. In a recent case, the two active partners in a New Jersey office building were accused by a third partner of taking excessive fees and charging themselves below-market rent. The court took evidence from appraisers, awarded damages to the third partner, and ordered the rent increased to fair market rent and the fees reduced to reasonable market rates.
As told by the appeals court, the story began in 1992, when the three partners, as Heritage Partnership, bought the building and decided to manage it through RPMS Consulting Engineers, of which they were owners. They relocated RPMS to their new building, but rather than set fair market rent they charged Heritage with the expenses of the building. In 1993, RPMS started to charge Heritage for management services at a 35% markup over costs.
Then things began to change. One partner, Orlando Munoz, retired and was bought out of RPMS. He retained his interest in Heritage (and Foam Technology, Inc., another company owned by the same threesome), but moved away, took no active part in the activities of Heritage, and didn’t pay thorough attention to its affairs. In 1994, the rent being paid by RPMS to Heritage was reduced and remained constant through 2012.
In 2005, Mr. Munoz sought to withdraw from Heritage, but rejected the amount of his partners’ buyout offer. Munoz brought suit, alleging that his partners, Robert Perla and Robert Steiger, breached their fiduciary duties and the partnership agreement and other wrongful acts. The trial court threw out some of the claims, but reviewed each side’s appraisals and ordered that the payments be changed to reflect market rent and reasonable fees.
The appeals court upheld the trial court, noting that Mr. Perla and Mr. Steiger had the duty to keep Munoz informed about the lease renewals and fees and that the amounts were not reasonable. The appeals court ruled that as agents for Heritage, Perla and Steiger were obligated to seek maximum value for the leased space, but that after Munoz withdrew from RPMS and Foam, the leases unfairly favored Perla and Steiger. The appeals court also upheld the trial judge’s ruling, based on the appraisals, that a reasonable amount for the fees should have been 4 to 6 percent of gross rents.
This case illustrates some of the risks and conflicting pressures involved in setting rents and fees. The fiduciary duties of those in control generally require that they exercise reasonable skill and care and not put their self-interest ahead of that of the business as a whole. Another point to bear in mind about fees: in some states they may be subject to sales and use tax.
Legal brief. The case discussed is Munoz v. Perla, et al. (N.J. Super. Ct. App. Div. December 20, 2011). Cross-appeals after bench trial resulted in reformation of leases, reduction of fees and damages assessed due to breaches of fiduciary duty and partnership agreement. Held, affirmed. Majority owners had fiduciary, statutory and contractual duties to minority including keeping him informed about business, seeking maximum value for leased space and limiting fees to reasonable amount. Reformation of leases was proper remedy for violation of fiduciary duty. Defendants’ assertion of estoppel, waiver and laches due to plaintiff’s conduct rejected.