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Brown-Hill Morgan, LLC v. Hehrer

August 12, 2010


On appeal from Superior Court of New Jersey, Chancery Division, Hudson County, Nos. C-206-05 and C-211-05.

Per curiam.


Argued March 9, 2010

Before Judges Wefing, Grall and LeWinn.

Defendants J.C. Morgan Realty, LLC ("JC Morgan"); M. Robert Lehrer ("Lehrer"); and 350 Warren, LP ("350 Warren") appeal from a judgment entered by the trial court. Brown-Hill Morgan, LLC ("Brown-Hill"); Morgan Jersey Development, LLC ("Morgan Jersey"); and Jeffrey M. Brown ("Brown") cross-appeal from that same judgment. After reviewing the record in light of the contentions advanced on appeal, we affirm in part.


The dispute between the parties arises out of a failed real estate development venture in downtown Jersey City. Defendant Lehrer, through a limited partnership, 350 Warren, in which he was the sole general partner, owned an eight-story building located at 350 Warren Street. It had been built in 1906 for use as a warehouse and had been vacant for a number of years. Lehrer hoped to redevelop the property into a mixed-use structure, with underground parking, retail shops on the ground floor and luxury apartments on the upper floors. He approached Brown to solicit his participation in the project. Brown had extensive experience in construction and construction management and had been involved in the construction of several large projects in Jersey City but had not previously been involved in developing any projects in the city. Brown was interested in the concept, and the two men ultimately agreed to form a joint venture, Morgan Jersey, to pursue the project. They did not form this joint venture directly; rather, Brown formed Brown-Hill, and Lehrer formed JC Morgan, and Brown-Hill and JC Morgan, in turn, created the joint venture Morgan Jersey. Lehrer explained to Brown that for tax reasons, he would not have a direct ownership interest in JC Morgan; instead, it would be owned by his son Eric Lehrer and his nephew Kevin Lehrer. Because this arrangement had no direct impact upon him, it was satisfactory to Brown.

The building was located in a section of the city known as the Powerhouse Arts District, an area that had been designated both as a historic preservation district and to foster a growing arts community within the city. With respect to the latter, the city had adopted a redevelopment plan for the area that required ten percent of the apartments in a development to be "work/live" units for artists. Because of the historic preservation designation, approval of the Historic Preservation Commission was required before there could be any changes to the building's façade.

For the project to be viable in the modern real estate market, Lehrer and Brown both understood that it would be necessary to replace all the windows in the building, which were significantly smaller than current buyers would accept. Since the building had an estimated one thousand windows and the walls of the building were up to twenty-eight inches thick, planning and implementing their replacement was a complex endeavor. In addition, financial viability of the project necessitated relief from the requirement for a ten percent set aside for artists. Lehrer proposed seeking an exemption from this requirement through setting aside certain of the building's retail space as gallery and studio space. Brown said that Lehrer represented to him that getting these exemptions would not be a problem in light of the relationships Lehrer had developed with the individuals in charge of that process for the city. During their discussions and in the various documents they executed, the parties referred to the needed variances and approvals as "entitlements." We shall continue that terminology for the purposes of this opinion.

The parties executed a variety of documents to give form to their agreements. On March 24, 2005, Brown-Hill and JC Morgan executed the operating agreement for Morgan Realty. Certain provisions of that operating agreement are pertinent to the issues on this appeal. Under the operating agreement, Brown-Hill was responsible for designing the project and preparing a development and construction schedule. It was also responsible for preparing the final budget, subject to the approval of JC Morgan, and securing construction financing. If, within twelve months of the signing of the operating agreement, Brown-Hill had not located construction financing that was reasonably acceptable to JC Morgan, Brown-Hill had the right to extend the financing period for another six months. If the election had not been made, JC Morgan could terminate the agreement. If it elected that extension and had not secured such financing at the end of that six-month period, JC Morgan had the right to terminate the operating agreement. In addition, with the approval of JC Morgan, Brown-Hill would hire the architect, engineer and other professionals needed to complete the project.

The operating agreement provided for Brown-Hill to make capital contributions to the project of up to $500,000 through the date when Morgan Realty closed on purchase of the building. It also provided for Brown-Hill to inform JC Morgan of its capital contributions. Further, the operating agreement capped Brown-Hill's capital contribution at $500,000 until that closing occurred or one year had passed. If one year had passed and JC Morgan determined that additional capital contributions were required, Brown-Hill was obligated to make such additional contributions as JC Morgan reasonably determined were necessary. Paragraph 3.6 of the operating agreement provided:

Except (i) upon dissolution of the Company; or (ii) as may be expressly set forth in this Agreement, no Member shall have the right to demand or receive the return of any of its aggregate Capital Contributions or any part of its Capital Account or be entitled to receive any interest on its Capital Contributions or its outstanding Capital Account balance.

Paragraph 3.9 of the operating agreement provided in pertinent part:

Notwithstanding anything to the contrary contained in this Agreement, if the Entitlements for the Project are not obtained on or before the date which is the six month anniversary of the date hereof (the "Outside Date"), and this Agreement is consequently terminated pursuant to this Section 3.9, then the JB Member [Brown-Hill] shall be responsible for up to $100,000.00 of Project Costs. To the extent the JB Member has paid its Capital Contribution of up to $500,000.00 and any additional Capital Contributions, the excess of its Capital Contributions over $100,000.00 (the "Excess"), shall be reimbursed by the Lehrer Member [JC Morgan] within 120 days after this Agreement is terminated. This reimbursement shall be guaranteed by the Lehrer Member.

Although Brown-Hill was responsible for preparing the final budget for the project, JC Morgan had the right to approve that final budget, including any material modifications or deviations from the preliminary budget that was attached to the operating agreement.

JC Morgan was responsible for obtaining the necessary entitlements. The operating agreement provided a six-month window for JC Morgan to obtain these entitlements. If its efforts were not successful within six months, Brown-Hill could either waive that deadline or declare the agreement terminated. In the event of such termination for failure to obtain the necessary entitlements within that time frame, Brown-Hill would be responsible for up to $100,000 of the project costs, and JC Morgan would reimburse Brown-Hill for any excess capital contributions "[n]otwithstanding anything to the contrary contained" within the operating agreement.

The preliminary budget that was attached to this operating agreement estimated total project costs of $116,305,929. Of that amount, $60 million was allocated for construction costs. Brown testified that figure was just an estimate because at the time the preliminary budget was prepared, Brown-Hill had not determined the full scope of the project and had not conducted any structural assessment of the building or its systems.

Brown also testified that Lehrer had repeatedly assured him that the inherent value of the building stood behind the provision in the operating agreement to reimburse Brown-Hill. Lehrer denied ever making such a statement, and Brown admitted that nothing within any of the documents that were executed gave him the right to impose a lien on the building to secure his claim for reimbursement.

On that same date, March 24, 2005, 350 Warren, and Morgan Jersey executed a contract of sale for the building, the terms of which incorporated the operating agreement between Brown-Hill and JC Morgan governing their joint venture. The purchase price had three elements: a fixed sum of $7.238 million, plus an additional $100 per "Net Saleable Square Foot" plus 40% of the taxable income on the sale of residential units within the building. Closing was to occur on the date construction financing was in place.

Paragraph 12.3 of that contract provided the following:

Notwithstanding anything to the contrary, Purchaser [Morgan Jersey] agrees to pay from and after the date hereof, the costs of operating the Property, which costs include real estate taxes, insurance, water charges, sewer rents, assessments, employee salaries and utilities. Schedule 12.3 attached hereto and made a part hereof sets forth the current month's operating expenses for the Property. Seller [350 Warren] acknowledges that Purchaser is relying on Schedule 12.3 as a reasonable estimate of monthly operating expenses for the Property. If this Contract is terminated, Seller shall cause the Lehrer Member to reimburse Purchaser in accordance with the terms of the Operating Agreement. Nothing in this Paragraph 12.3 shall otherwise alter the obligations of the parties hereto. The provisions of this Paragraph 12.3 shall survive the Closing, or the sooner termination of this Contract.

Additionally, Morgan Jersey executed a construction management agreement with Jeffrey M. Brown Associates, Inc. ("Associates"). This agreement provided for Associates to receive a guaranteed maximum price and set forth the procedure for setting that figure. Both Brown and Lehrer agreed in their testimony that at some point that price was increased by one percent in return for Brown's agreement to hire Lehrer's son and nephew, the nominal principals of JC Morgan, during the project to help them learn real estate development. The construction management agreement also referred to certain "preconstruction phase" work to be performed but provided no breakdown for responsibility for those tasks between Associates and Brown-Hill.

The parties needed interim financing to carry the project until construction financing was in place, and in February 2005 JDI Loans, L.L.C. ("JDI") provided a construction loan in which $11.9 million was disbursed to Morgan Jersey, at an interest rate of 10.5%. Obtaining this loan required the payment of a loan origination fee of $117,000 to JDI; Brown-Hill advanced those funds. The loan agreement provided that in December 2005, the interest rate would be the greater of prime plus five percent or 10.5%; it also provided that in the event of default, the interest rate would increase to twenty percent. The loan could be extended at the end of the one-year period upon payment of one percent of the outstanding principle and deposit of six months future interest. Of the loan proceeds of $11.9 million, $2.65 million was used to satisfy the two outstanding mortgages on the property and $7.5 million was used to buy out a third-party's development rights to the property. This latter figure was greater than originally anticipated; the reasons for this increase are not entirely clear from the record.

Following the closing of this interim loan and execution of the relevant documents, the parties set about their respective tasks. The record before us contains minutes of the various design development meetings that were held, as well as e-mails that were exchanged among the various participants in the project. These minutes and e-mails chronicle the slowly deteriorating relationship between Lehrer and Brown as various delays were experienced, both in finalizing the project's design elements and in securing the requisite entitlements from the city.

Based upon Lehrer's recommendation, Morgan Jersey retained an attorney to represent it in its efforts to obtain the needed variances and approvals from the city. As time went on, Brown became increasingly concerned that the attorney, who had done prior work for Lehrer, viewed Lehrer as his client on this project, rather than the joint venture, Morgan Jersey. The attorney informed Morgan Jersey that although the Historic Commission and the Planning Board apparently came to view the project favorably, both entities preferred to have the city revise its zoning ordinance to minimize the potential for challenges to any approvals they might grant the project. The attorney advised withholding formal submission for approvals until this question was clarified. These discussions, involving multiple parties, had the inevitable effect of delaying the project.

It was not until the end of July 2005 that a formal application was submitted to the Historic Commission for approval to enlarge the windows in the structure. The attorney was advised that the Commission might take up the application at its September meeting, but for reasons that are not clear from the record, it was not included on the Commission's September agenda; there is a reference to the application being misplaced. The developers were unwilling to proceed with replacing the windows on the basis that the application had been pending for more than forty-five days, N.J.S.A. 40A:12A-7(e), for fear of antagonizing city officials and jeopardizing any future applications before the Planning Board.

In addition, the project went through certain evolutions in design. The number of penthouses to be built increased and Lehrer, for instance, wished to enlarge certain aspects of the approximately 4,000 square foot penthouse unit that, under the operating agreement, would be conveyed to him. These changes, of necessity, required changes in design to the remaining elements.

While the parties waited for municipal approval and debated the various design questions, Brown-Hill did perform certain work at the site and advanced funds for expenses, including those for architectural and engineering services necessary to determine the structural integrity of the building and the soil composition of the site. The building, for instance, was built entirely with wooden beams; the condition of these beams had to be determined and whether they were capable of supporting the extra weight that would be engendered by the project. Brown-Hill provided Morgan Realty with periodic reports of the progress on these fronts and received no comments in response.

Brown-Hill also explored various possibilities for obtaining construction financing. Details of this financing, however, could not be completed until the designs were finalized and approvals were in place. Brown received, for instance, one proposal for construction financing based upon a proposed budget of approximately $176 million, including construction costs of $83 million. Brown testified that budget was merely conceptual in light of the many details which remained to be finalized and "costs that were unsubstantiated."

Brown testified that he met with Lehrer on September 22, 2005, and that Lehrer "told me we finally had a deal with the city and that the Mayor had approved," as did the heads of relevant departments. Lehrer gave him a sheet outlining the concessions he had to make for approval. It contained a revised description of the project with gallery/studio space in the proposed building, together with six affordable rental units for artists in a building on one of Lehrer's nearby parcels, and community parking on a lot next to the project site that Lehrer had hoped to use for a high-rise. Brown was satisfied that the project could proceed. Lehrer testified that the ...

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