Partnership Negotiation Exercise
Background
Bonnie Broker, a real estate broker in Salt Lake City, sees an opportunity for a profitable investment in purchasing, renovating and reselling older private homes in the Central City. She comes to you for advice. You are representing Ms. Broker, as the promoter, but in light of the small size of the project, you will also represent the project itself and any investors in it. If at any point you feel that this represents a conflict, of course, you will take appropriate action.
Ms. Broker's idea is as follows: She and ten friends will each contribute $1500 in capital. She will then identify a dilapidated home and arrange to purchase it from its owner, with owner-supplied financing. After the building has been purchased, she and her friends (many of whom have renovation or home building expertise) will renovate it. While they will purchase materials from outsiders, they intend to supply virtually all the labor themselves, with each of the investors supervising the area of renovation in which he or she has expertise. After the restoration is complete, Ms. Broker will list the building and sell it. She expects that the net proceeds of the sale of the renovated building will be at least 50% higher than the sum of the purchase price (including the financed portion) and the out-of-pocket renovation costs.
Ms. Broker tells you that she intends that each of the 11 investors will contribute the same dollar amount to the project ($1500) and that profits will be divided equally. In addition, because Ms. Broker will arrange and manage the project without any compensation, she will have the right to be the sole broker for both the purchase and the sale of the house. She will charge her normal fee for that work and it will be considered an expense of the project (that is, it will reduce the profits that are to be distributed equally). Each of the investors, including Ms. Broker, will be expected to contribute time and expertise to the renovation and will not be compensated for that.
While Ms. Broker thinks that losses are inconceivable, she intends that they be divided equally among all the investors.
If the project is successful, Ms. Broker anticipates repeating it several more times with different buildings. She would like to make it easy for the investors to simply reinvest their profits from the last project into the next project. On the other hand, the future projects are fairly speculative: she has only thought out the first one in detail and wants to be able to decide about future projects after she sees how this one works out. She also wants investors to be able to evaluate each project individually and to withdraw when they wish.
Possible Assignment I: Prepare to meet with Ms. Broker in class. In preparation, consider at least the following issues:
A. What form of business organization would you recommend for Ms. Broker? Why?
B. Would you recommend a written agreement? If so, why?
C. What terms would you recommend in a written agreement?
D. What issues would you recommend Ms. Broker consider?
E. If, despite your advice, Ms. Broker proceeds with no further thought and no agreement beyond the terms outlined above, what are the consequences in each of the following circumstances? Which of those results could have been varied by proper planning? Which ones would you want to vary (remember your client)?
a. Ms. Broker finds a wreck with enormous potential and persuades the seller to sell it for $1.50. Suddenly she realizes that with such a low purchase price, she has enough capital to do the renovation on her own. What if she does?
b. George Palumbo, one of her co-investors, is a plumber. In his business, he charges $125 per hour for his time. The plumbing work on the renovation turns out to be extraordinarily difficult -- indeed, it is so complex that George is unable to make much use of the other investors' labor and ends up doing most of the work himself. Then it turns out that almost no other work is needed -- Mr. Palumbo has done virtually the entire renovation by himself. What rights does he have? What if he found it necessary to bring in his expert assistant to do the work, for whom Mr. Palumbo normally charges $100 per hour (the assistant earns a salary, not an hourly wage, but the salary is roughly equivalent to $20 per hour most years)? What if Mr. Palumbo could have done the work himself, but just decided to refer it to his business in order to be able to spend some time with his family on the weekends? Does it matter whether Mr. Palumbo makes this decision himself or whether he merely makes a recommendation which is adopted?
c. Sally, another co-investor, has a very busy life and, through unavoidable circumstances, it turns out that she is never available to help on the particular days when the renovation work is done. Even though her reasons for being unavailable have often seemed perfectly reasonable (indeed, on the most important day, she was hospitalized with a sudden relapse of a genetic disease she has been valiantly fighting all her life, and on another occasion she said she was attending her mother's funeral) and she has always made at least some attempt to reschedule, the fact remains that everyone else has contributed five weekends each of hard labor and she has not. George Palumbo objects to Sally receiving an equal share of the proceeds.
d. Mr. Schlemiel, an investor who is a roofer by trade, takes charge of repairing the roof. Mr. Schlmazel, another investor, is working up there when something falls from above, causing Schlmazel to fall off and sustain serious injuries with a settlement value exceeding $1 million. There is some evidence that the falling object was Schlemiel's hammer, but the facts are unclear and a jury could go either way. The homeowners' insurance which the investors took out had a specific exclusion for work performed by the owner. Who is liable for Schlmazel's injuries?
e. Frank is a furnace repairman and can obtain furnaces wholesale through his connections in the business. He does not routinely sell furnaces as part of his business. He has agreed to supply a furnace, but there was no discussion regarding the terms. Under the agreement, may Frank consider the difference between the wholesale price and the usual retail price to be part of his $1500 contribution? What if Frank's business is not furnace repair, but retail furnace sales: he makes his living from the mark-up?
f. The real estate market collapses. After completing the renovation, the building cannot be sold for enough to repay the loan from the original seller. Who is liable? What if the investors had all agreed that Mr. Palumbo had supplied so much labor that they would waive his $1500 contribution? What if the agreement had always been that Mr. Palumbo would do the plumbing work and receive an equal share of the proceeds but contribute no money? Sally never paid the last $500 of her share. How much does she owe?
g. The renovation takes far longer than expected. Nellie gets nervous, or needy, and wants out. What are her rights? What change to the agreement might you recommend to better regulate this contingency?
h. The investment is very successful and the investors wish to expand -- which means adding additional investors. Under the agreement as outlined above, who has what rights? What changes might you recommend?
i. During the course of the renovation, a gas pipe explodes, severely damaging a neighbor's house. The neighbor sues and is able to establish that the renovators were negligent.
Possible Assignment II
A. Draft an appropriate agreement to govern the proposed enterprise. This project is to be done in groups of 4.
B. Give your proposed agreement to another group, as assigned. Critique the proposed agreement you have received.