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MENKE v. GLASS

September 20, 1995

FRANK MENKE, et al., Plaintiffs, against DANIEL GLASS, individually, and MIGDAL, TENNEY, GLASS & POLLACK, a Partnership, Defendants.


The opinion of the court was delivered by: DENNY CHIN

 CHIN, D.J.

 This is a case brought by a group of investors in a limited partnership against one of the general partners, Daniel Glass, and Mr. Glass's law firm, Migdal, Tenney, Glass & Pollack. Plaintiffs allege that defendants defrauded them and breached their fiduciary duties with respect to the purchase of a motion picture. Defendants move for summary judgment, on the basis that plaintiffs' claims are barred by the applicable statutes of limitations. For the reasons stated below, the motion is denied.

 FACTS

 The purchase price for the movie was $ 11.875 million, which was to be comprised of $ 100,000 cash at the closing, $ 1.4 million payable on February 1, 1982, a recourse purchase money note in the amount of $ 6.025 million (the "Recourse Note"), and a non-recourse purchase money note in the amount of $ 4.35 million (the "Non-Recourse Note"). Both notes matured on January 10, 1990. Each partner purchased a unit (or share of a unit) costing $ 176,000, $ 61,000 to be paid in cash with the balance guaranteed by personal notes on a letter of credit due on January 10, 1982 and January 10, 1983. By purchasing the film, the partners received the right to claim certain tax deductions and credits and the right to receive license fees measured by varying percentages of the adjusted gross receipts made by the movie. Following the purchase, the partnership immediately leased the movie back to Orion for promotion and distribution. The arrangement was intended as a profit-making vehicle and as a tax-shelter for the limited partnership; Orion would benefit because it would be given ready cash to finance the movie.

 Prior to purchasing the film, the limited partners were given a Private Offering Memorandum ("POM") and a Notice of Availability ("NOA"). Both documents warned that the investment posed a high degree of risk and that there was no assurance that the gross receipts would cover the amounts that were to become due on the Recourse Note or return a profit. The documents also stated that the IRS would likely challenge any tax deductions or credits taken. In addition, the POM required that each partner have a net worth of at least $ 400,000, an adjusted gross income that would place the partner in a 50% tax bracket, and the ability to afford a total loss on the investment.

 Pursuant to a Distribution Agreement between Orion and Prince Associates, Orion was obligated to spend $ 11.875 million by December 31, 1982 in advertising the film, $ 4 million of which would be provided by the partnership. According to the POM and paragraph 14 of the Distribution Agreement (which was not attached to the POM), if Orion spent more than $ 4 million but less than $ 11.875 million advertising the film, it was obligated to pay the partnership whatever amount in excess of $ 4 million (up to a maximum of $ 7.875 million) was not used by January 10, 1990, the same day that the notes became due (the "Excess Advertising Funds"). *fn1" As it turned out, Orion spent only slightly more than $ 4 million in advertising the movie. Hence, under the AEDP, Orion was obligated to repay the partnership the Excess Advertising Funds.

 With respect to repaying the Recourse Note, the Purchase Agreement and the Distribution Agreement provided that Prince Associates' share of the gross receipts from the movie would be applied to reduce the unpaid principal balance of the Recourse Note The parties also agreed that the partners' share of the gross receipts to be credited against the amount due on the Recourse Note would be "multiplied up" and capped by the outstanding principal balance on the Recourse Note on its maturity date. (POM at 4). Under this multiplication formula, which was contained in P 3-1 of Appendix A to the Distribution Agreement, the Recourse Note would be satisfied if the picture grossed about $ 1.5 million. In fact, on January 10, 1990, when the Recourse Note became due, the "multiplied receipts" were sufficient to satisfy the Recourse Note.

 Paragraph 3-1 also contained language that apparently contradicts the AEDP and that is at the heart of this dispute. It provided that "the aggregate of (i) the proceeds and sums remitted or remittable to [Prince Associates] and applied or applicable to the reduction of said principal and interest and (ii) the amount payable to [Prince Associates] pursuant to this Paragraph 3-1 shall not exceed the then unpaid principal amount of the Appendix A Note [Recourse Note] and the Appendix B Note [Non-Recourse Note] and the interest on said Notes." This provision was later cited by Orion to support its refusal to reimburse Prince Associates for the Excess Advertising Funds. Orion was of the view that under this provision, if there were no amounts due on the Recourse Note (because the "multiplied receipts" were sufficient to satisfy the Recourse Note), then Orion would not be obligated to pay Prince Associates any sums under the AEDP, no matter how little of the $ 7.875 million it had actually spent advertising the film. *fn2"

 The deal closed on August 19, 1981, the same day that the picture was released. The movie, despite generally favorable reviews, failed at the box office, and on February 25, 1982, the partnership was advised of the loss. The limited partners were also advised that the general partners were considering suing Orion. The general partners did retain a law firm, but ultimately decided against a lawsuit. Clearly unhappy with the way the investment turned out, one of the plaintiffs, Richard Scobey, wrote to defendant Glass in December 1982 criticizing the general partners' handling of the partnership. Scobey also wrote to the limited partners seeking funds for a possible lawsuit against the general partners.

 On February 24, 1983, defendant Glass notified the limited partners of an impending tax audit concerning the partnership. In 1984, the Internal Revenue Service informed the partnership of its decision to disallow any deductions and credits. Litigation between Prince Associates and the IRS ensued in the Tax Court during October and November 1986. The AEDP was not mentioned during the course of the trial but was raised in Prince Associates' post-trial reply brief in response to the IRS' contention that tax benefits were not available to the partnership since the AEDP guaranteed the return of the limited partners' investments regardless of the box office success of the movie. The partnership's counsel argued that, in actuality, the AEDP, together with any other funds to which the partnership was entitled, was limited to the amount outstanding on the Recourse Note, i.e., that the partnership's cash contribution could not be recouped by Orion's failure to spend its full advertising budget.

 In 1989, the Tax Court rejected Prince Associates' argument and held that since Orion was obligated to pay Prince Associates the Excess Advertising Funds, the partners were not at risk in their investment and consequently were not entitled to any tax deductions or credits. Represented by new counsel, the partnership appealed to the Eighth Circuit and in its brief argued that the AEDP was capped at the balance, if any, outstanding on the Recourse Note. The Eighth Circuit, however, was not convinced, and affirmed the Tax Court in January 1991. Upham v. Commissioner, 923 F.2d 1328, 1337-38 (8th Cir. 1991). The limited partners were informed of each stage of the Tax Court trial and of the appeal to the Eighth Circuit.

 On August 15, 1988, while the lawsuit with the IRS was pending, plaintiff Menke wrote to the limited partners advising them of his intention to dissolve the partnership; by letter dated October 24, 1988, Menke informed the partners that he proposed to file a final tax return and make a final distribution to the partners of all funds to which they were entitled before dissolving the partnership. Accompanying this letter was a report by an accounting firm that listed the partnership's assets as $ 111,000, apparently excluding any entitlement to ...


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