Family-owned enterprises often place real estate assets and operating businesses into separate entities, with the real estate company leasing space to the operating company. In such instances, the owners or managers need to agree upon what rent the operating business will pay to the real estate company. The rental amount will then affect the funds available for use or distribution at each company level. Without agreement on the proper amount of rent, or without equal ownership and involvement at each company level, disputes can arise as to the fairness of the rent that is charged or paid.
A recent case from New York – Boriello v. Loconte (N.Y. App. Div. Mar. 25, 2020) – illustrates some of the issues that can arise with rent payments between family-owned companies. According to the Court’s decision, Boriello and her three siblings owned both a food distribution business (Jersey Lynne Farms, Inc. (“JLF”)) and a real estate business (Caterina Realty, LLC). Caterina leased a warehouse to JLF. The siblings terminated Boriello and her husband from JLF and removed her as a director of that company. Counsel for both companies thereafter advised the siblings to amend the lease between JLF and Caterina to ensure JLF was paying fair-market rent. Counsel also advised that the siblings obtain an independent certified appraisal to determine that rent.
The siblings engaged a valuation firm their family had previously used and adopted that firm’s fair-market rent valuation. Boriello objected both to using that firm and to the firm’s valuation. She further claimed that the fair-market rental value was much higher and that the lease should be a triple-net lease. Essentially, Boriello complained that JLF would be paying too little and Caterina could have and should have received more in rent and payment of expenses. Boriello was given the opportunity to perform her own rent appraisal but she did not do so because the siblings would not authorize Caterina to pay for that appraisal. The siblings, on Caterina’s behalf, voted to enter a new lease with JLF at the annual rent proposed by their valuation firm.
Boriello then sued the siblings for breaches of their fiduciary duties to Caterina based on their conduct and decisions in connection with the rent in the new lease. At trial, both sides presented testimony of rental appraisers. Following the conclusion of Boriello’s case as plaintiff, the siblings moved for a directed verdict. The trial court allowed that motion, concluding, based on the evidence presented at that point, that “no trier of fact could find that the defendants breached their fiduciary duties as members and managers of Caterina.” The trial court then dismissed Boriello’s complaint and entered judgment in the siblings’ favor.
Boriello appealed the judgment. The Appeals Court determined that the trial court improperly considered and relied upon the siblings’ appraisal expert’s testimony in dismissing the case. Specifically, the siblings’ expert testimony had been presented “out of order” (likely due to the witness’s scheduling conflict) during Boriello’s evidence and before she rested. Boriello thus did not have a chance to present rebuttal evidence in response to the siblings’ appraiser during the presentation of their defense. The trial court nonetheless placed more weight on the siblings’ expert than on Boriello’s expert in deciding to dismiss the claims.
The Appeals Court reversed the dismissal, ruling that the trial court should not have weighed the competing evidence in deciding the directed verdict motion. Instead, the determination of weight and credibility of witnesses should have been presented to the fact-finder after both parties had rested following all of their evidence. The Appeals Court then reinstated Boriello’s complaint and remanded the case to the trial court for a new trial. At this point, it remains to be seen what will happen with the parties’ claims and defenses on remand. Assuming the parties continue to litigate, however, the further proceedings will add to an already lengthy and presumably expensive process of resolving this dispute.
The Boriello case highlights several important considerations when evaluating and drafting the terms of leases between family-owned entities.
First, parties should ensure that the leases are fair to both the lessor and the tenant and do not provide unwarranted benefits to or concessions by either party. Second, when engaging an appraiser to determine rent, it would be best if the appraiser is independent or at least agreed-to by all stakeholders. Third, if there are to be arguably non-market terms in favor of one of the parties, the decision-makers should evaluate whether any owner, either directly or on a company’s behalf, could assert a viable claim for damages due to alleged lost income, excess expenses or receipt of other improper benefits. Finally, if there is an objection to the terms of a proposed lease, the decision-makers promoting the lease terms should consider early attempts to resolve those objections. Upfront consideration of these issues could both better ensure a beneficial economic arrangement between the family-owned real estate and operating company and allow the stakeholders to avoid the effort, expense, and disruption that could accompany years of litigation over allegedly unfair lease terms.