Facts: A real estate investment trust (REIT) and an investor formed a partnership. The purpose of the partnership was to own and operate an existing nonresidential building by leasing it to a tenant who was an entity owned by the investor. The partnership and tenant signed a lease agreement in which the partnership agreed to make tenant improvements (TIs) and the tenant agreed to reimburse the partnership for their cost upon completion. The partnership commenced construction of the TIs.  Before completion of the TIs, both partners became aware the tenant had financial problems. When payment came due on completion of the TIs, the tenant filed for bankruptcy and the partnership recovered no part of the costs for the TIs.

Claim: The REIT made a demand on the investor for the losses incurred due to the tenant’s failure to pay for the TIs, claiming the investor, as owner of the tenant, violated his fiduciary duty owed to the REIT as a partner since he failed to disclose the tenant’s negative financial information.

Counter claim: The investor claimed he did not fail to disclose the tenant’s negative information since, even though he was the owner of the tenant, his knowledge of the tenant’s financial problems did not predate the formation of the partnership or the commencement of the TIs.

Holding: A California appeals court held the investor was not liable for his partner’s losses based on any failure of the investor to disclose the tenant’s negative financial information since the investor was unaware of the tenant’s financial problems prior to the formation of the partnership and commencement of construction of the TIs. [Mission West Properties, L.P. et al. v. Republic Properties Corporation, et al. (2011) 197 CA4th 707]

Editor’s note — While no amount of preemptive research may have been able to save the managing partner from suffering a loss in this case, his failure to thoroughly vet the tenant cannot be blamed on the passive partner who was the owner of the tenant. Every savvy landlord will thoroughly investigate a prospective tenant’s financial standing and other entanglements to avoid being sacked with a bankrupt tenant and the undesired cost of property improvements.

Related forms: Operating Agreement – LLC [See first tuesday Form 372], Tenant Lease Worksheet [See first tuesday Form 555] and Notice of Charges Due – Other than Monthly Rent Payment [See first tuesday Form 568].