Corporate Governance

Limited Partnership Units As Securities: Liberty Property Trust v. Republic Properties Corp.

By Drew Reitman

In Liberty Property Trust v. Republic Properties Corporation, 2009 U.S. App. LEXIS 18880  (D.C. Cir. Aug. 21, 2009), plaintiffs sued Republic Properties Corporation and its only two shareholders, Grigg and Kramer, alleging securities fraud under Rule 10b-5, control person liability, and various infractions under state law.  The court held that the limited partnership units at issue were 'securities' for purposes of the Securities Exchange Act of 1934.

Grigg and Kramer were real estate developers and jointly owned Republic Properties Corporation ('Corporation').  In October 2004, the Corporation entered into a $100 million mixed-use development agreement ('Agreement') with the City of West Palm Beach, Florida, that included representations that the Corporation did not use bribery to secure the contract.  The next month, the Corporation hired Liberti, a West Palm Beach commissioner, as a paid consultant.  Liberti later voted to approve and amend the Agreement to the benefit of the Corporation.

In July 2005, Grigg and Kramer, formed, and appointed themselves as trustees in, Republic Property Trust (the 'Trust'), a real estate investment trust (REIT).  The Trust established Republic Property Limited Partnership ('Limited Partnership').  The Trust owned 88% of the Limited Partnership and was its sole general partner.  As part of the Trust's IPO, the Corporation sold rights in the Agreement to the Limited Partnership in exchange for 100,234 limited partnership units, valued at $1.2 million.

On May 5, 2005, Liberti was indicted on unrelated bribery charges and subsequently pled guilty.  Subsequently, the City of West Palm Beach notified the Corporation of its intent to terminate the Agreement and end the project.

The Limited Partnership's successors in interest brought suit in the District Court for the District of Columbia, alleging that defendants failed to disclose the relationship between Liberti and the Corporation before transferring the Agreement in exchange for limited partnership units.  As part of the claim, plaintiffs asserted that the Limited Partnership interests were securities under § 10(b) of the Exchange Act.  The district court disagreed, finding that the Limited Partnership units were not securities because Grigg and Kramer were on both sides of the transaction.    

The Court of Appeals for the District of Columbia, in a split decision, reversed.  In analyzing the issue, the court looked to the definiton of 'investment contract' in the Securities Exchange Act.  The Supreme Court in SEC v. W.J. Howey, 328 U.S. 293 (1946) defined the phrase as an investment of money in a common enterprise with the expectation of profits from the efforts of the promoter or third party.  The defendants argued that they controlled both the Corporation that assigned the Agreement and the Trust that, as the General Partner for the Limited Partnership, signed the Contribution Agreement.  As such, any profits from the Limited Partnership interests would come from the the Trust that they controlled and not from the efforts of others.   

The majority declined to find the absence of a security solely because defendants controlled both entities.  As the opinion noted:  "Such an approach required the court to disregard both entities.   And the appellees point to no cases where defendants have avoided liability--under the securities laws or elsewhere--on the basis of their own control, pervasive or otherwise. We see no reason to pioneer a new application of that limited doctrine on the facts before us."  The court instead emphasized that the Limited Partnership and the Corporation were separate and distinct entities and served independent purposes; thus, a transaction could occur that benefited the Corporation at the expense of the Limited Partnership, requiring the protection of securities laws.  

Nor did the majority find the argument that Griggs and Kramer controlled the Trust persuasive.  They collectively owned only 9% of the Trust.  Moreover, although they served as trustees, they held only two of the six positions on the Board of Trustees.  The court acknowledged that the Board had only three Trustees at the time the Contribution Agreement was executed.  Nonetheless, to the extent both expected other Trustees to join the Board, they were expecting profits to be generated from the efforts of others.    

Judge Randolph, in his dissent, argued that the majority should have limited its analysis to Howey's focus on economic reality, rather than relying on the use of the corporate form.  Arguing that Grigg and Kramer did control the Limited Partnership, the Judge opined that because they controlled the purchase of the partnership units, they could not have been relying on anyone else to make a profit, and thus the limited partnership units were not securities.

The primary materials for this post are available on the DU Corporate Governance website.

Full post as published by The Race to the Bottom on September 23, 2009 (boomark / email).