bad-faith-penalty-risk-assessment.docx

1027-00003 · Calderwood & Harkness LLP · Strategy & Analysis

bad-faith-penalty-risk-assessment.docx DOCUMENT Litigation

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MEMORANDUM

TO: Dominic R. Pellegrino, Managing Member, Pellegrino Capital Group LLC Adriana Pellegrino-Voss, SVP of Investments, Pellegrino Capital Group LLC

FROM: Francesca Morano, Partner, Calderwood & Harkness LLP Simone Laroche, Associate, Calderwood & Harkness LLP

DATE: September 15, 2023

RE: Risk Assessment — Bad-Faith Penalty Exposure Under Section 12.7 of the Palmetto Grand Ventures LLC Operating Agreement

MATTER NO.: 1027-00003

JAMS REF. NO.: 1440032871

I. EXECUTIVE SUMMARY

This memorandum assesses Pellegrino Capital Group LLC's ("PCG") exposure to a bad-faith penalty under Section 12.7 of the Second Amended and Restated Operating Agreement (the "Operating Agreement" or "OA") of Palmetto Grand Ventures LLC ("PGV"), dated June 15, 2017, in connection with PCG's exercise of the call option under OA Section 12.4 on January 9, 2023. This assessment is prepared in the context of the pending JAMS arbitration (Ref. No. 1440032871) before the Honorable Margaret Liu Chen (Ret.) and reflects the current state of discovery and briefing as of the date hereof.

Meridian Shores Hospitality LLC ("MSH"), the minority investor in PGV holding a thirty-five percent (35%) interest, has asserted that PCG exercised the call option "in bad faith or with the intent to materially understate Fair Market Value" within the meaning of OA Section 12.7. On the basis of this allegation, MSH demands a penalty of $16.975 million, which it characterizes as compensation for PCG's alleged manipulation of the valuation process. MSH seeks this penalty on top of its substantive valuation adjustment — that is, in addition to the difference between PCG's tendered purchase price and the price MSH contends is owed for its redeemed interest.

MSH's total demand in the arbitration stands at $70.0 million. This figure comprises (i) $36.015 million for MSH's 35% equity share valued at MSH's asserted Fair Market Value as determined by the Beacon appraisal, (ii) $17.01 million in accrued but unpaid preferred return under OA Section 7.2, and (iii) $16.975 million as the bad-faith penalty under OA Section 12.7. On March 1, 2023, PCG tendered $41.3 million to MSH based on the appraisal of Whitfield Realty Advisors LLC ("Whitfield"), which valued 100% of the JV assets at $118.0 million. MSH rejected this tender on March 10, 2023, and initiated arbitration proceedings on March 27, 2023.

The $28.7 million gap between PCG's tendered amount and MSH's total demand is driven by two conceptually distinct but interrelated disputes: (i) the substantive valuation disagreement (what is the Fair Market Value of PGV's assets, and correspondingly, what is MSH's 35% equity interest worth?), and (ii) the bad-faith penalty claim (whether PCG's conduct in exercising the call option and procuring the Whitfield appraisal warrants the imposition of an additional penalty payment under Section 12.7). This memorandum focuses on the second of these disputes.

Overall Assessment: We assess the risk of an adverse finding on bad faith as low but not negligible. The 28.4% divergence between the Whitfield appraisal ($118.0 million) and the Beacon Capital Valuation LLC ("Beacon") appraisal commissioned by MSH ($151.5 million) is significant and, standing alone, creates an optic that could support an inference of undervaluation. However, this divergence is explainable by legitimate methodological differences between the two appraisals — principally the different weighting of income and sales-comparison approaches, and the different capitalization and discount rates employed. The critical question is whether the arbitrator finds that PCG's selection of Whitfield or PCG's influence on appraisal assumptions was designed to suppress value. On the evidence currently available, we do not believe MSH can meet its burden of proof on this issue, although certain discovery developments — particularly the partial production of PCG's internal investment-committee memoranda — introduce uncertainty that we cannot fully quantify at this time.

If the penalty is imposed at the maximum 25% rate permitted under Section 12.7 on the determined Fair Market Value of MSH's redeemed interest, PCG's exposure could range from approximately $6.1 million to $13.3 million, depending on which valuation the arbitrator adopts as the determined Fair Market Value and whether the penalty base is construed to include only the equity value of MSH's interest or also the accrued preferred return. MSH has calculated its penalty claim at $16.975 million using an approximately 32% multiplier, which exceeds the contractual 25% cap and would be reduced even if a finding of bad faith were made. We estimate the probability-weighted penalty exposure at approximately $1.5 million to $2.5 million.

The sections that follow analyze the contractual framework, the applicable legal standards under Florida law, each of MSH's specific bad-faith arguments, the quantification of potential penalty exposure under various scenarios, the impact of pending discovery, and our strategic recommendations.

II. CONTRACTUAL FRAMEWORK: OA SECTION 12.7

A. Text of the Provision

The operative penalty provision is found in Section 12.7 of the Operating Agreement, titled "Bad-Faith Penalty." The full text of the relevant provision reads as follows:

"If the Manager exercises the call option under Section 12.4 in bad faith or with the intent to materially understate Fair Market Value, the purchase price for the redeemed interest shall include a penalty of up to twenty-five percent (25%) of the determined Fair Market Value of the redeemed interest."

Several features of this provision warrant careful attention.

First, the penalty is discretionary, not automatic. The language "up to twenty-five percent (25%)" confers on the decision-maker — here, the arbitrator — the discretion to impose any penalty amount from zero to the contractual cap. Even upon a threshold finding of bad faith, the arbitrator is not required to impose the penalty at the full 25% rate and may calibrate the penalty to the severity of the bad-faith conduct. This is a significant distinction that MSH's briefing has largely ignored, as MSH has simply demanded its calculated penalty amount as though it were an automatic entitlement upon a showing of bad faith.

Second, the penalty is measured against the "determined Fair Market Value of the redeemed interest," not against the total value of PGV's assets. The "redeemed interest" is MSH's 35% membership interest. The phrase "determined Fair Market Value" refers to the value established through the appraisal process set forth in Section 12.4 — i.e., the value ultimately determined by the arbitrator after consideration of the competing appraisals and the neutral appraisal from Linden Park Advisory LLC. This means the penalty base is a function of the valuation outcome, creating an interrelationship between the substantive valuation dispute and the penalty calculation.

Third, Section 12.7 does not define the terms "bad faith" or "intent to materially understate." These terms are left to interpretation under governing law. As discussed in Section IV below, Florida law provides the relevant interpretive framework, and the absence of a contractual definition places a significant evidentiary burden on MSH to establish what constitutes "bad faith" or "intent to materially understate" in this context.

Fourth, the provision identifies two alternative bases for the penalty: (i) exercise of the call option "in bad faith," and (ii) exercise "with the intent to materially understate Fair Market Value." These may overlap but are not identical. "Bad faith" is a broader concept that could encompass a range of improper conduct in the exercise of the option, while "intent to materially understate" is a more specific allegation directed at the valuation process itself. MSH's claims invoke both bases, but MSH's factual allegations are primarily directed at the second basis — that PCG intended to suppress the appraised value of PGV's assets.

B. Interplay with Section 12.4 (Call Option) and Section 12.4(c) (Third Appraiser)

An understanding of the penalty provision in Section 12.7 requires examination of the broader call-option framework established in Section 12.4, which governs the mechanics of PCG's exercise of the option and the determination of Fair Market Value.

Under Section 12.4 of the Operating Agreement, PCG, as Manager and majority interest holder (65%), has the right, at any time following the fifth anniversary of the effective date of the OA (i.e., at any time on or after June 15, 2022), to purchase MSH's entire 35% membership interest at "Fair Market Value" as determined by an independent MAI-certified appraiser selected by PCG. The provision vests in PCG the unilateral right to (a) decide whether and when to exercise the option and (b) select the appraiser who will initially determine Fair Market Value. This right is express and was a negotiated term of the Operating Agreement, reflecting the parties' bargained-for allocation of control in the venture.

PCG exercised the call option on January 9, 2023, by delivering written notice to MSH in accordance with Section 12.4(a). PCG selected Whitfield Realty Advisors LLC, led by Gerald K. Whitfield, MAI, to prepare the initial appraisal of the JV assets. The Whitfield appraisal, dated February 10, 2023, valued 100% of PGV's assets at $118.0 million. On this basis, PCG tendered $41.3 million to MSH on March 1, 2023, reflecting MSH's 35% equity share plus accrued preferred return as calculated by PCG.

MSH rejected the tender and commissioned its own appraisal from Beacon Capital Valuation LLC, led by Dr. Priya Ramanathan, MAI, ASA, which valued 100% of PGV's assets at $151.5 million in an appraisal report dated March 28, 2023.

Section 12.4(c) of the Operating Agreement provides a contractual mechanism for resolving appraisal divergence. Specifically, if the two party-commissioned appraisals diverge by more than ten percent (10%), the parties are required to jointly retain a third, neutral MAI-certified appraiser. Fair Market Value is then determined as the average of the two closest appraisals among the three. The divergence between the Whitfield appraisal ($118.0 million) and the Beacon appraisal ($151.5 million) is calculated as:

|$151.5M − $118.0M| / $118.0M = 28.4%

This 28.4% divergence exceeds the 10% threshold, thereby triggering the Section 12.4(c) mechanism. In accordance with this provision, the parties jointly retained Linden Park Advisory LLC ("Linden Park"), led by Thomas Carraway, MAI, FRICS, as the neutral third appraiser on June 1, 2023. Linden Park delivered a preliminary indication of value on July 14, 2023, placing its range at $130.0 million to $138.0 million. The final Linden Park appraisal is expected in the fourth quarter of 2023.

The existence and operation of the Section 12.4(c) third-appraiser mechanism is itself a significant factor in the bad-faith analysis. The mechanism was designed precisely for the situation that has arisen — a material divergence in the parties' respective appraisals. PCG's compliance with this mechanism, including its agreement to the joint retention of Linden Park, demonstrates that PCG followed the contractual process in good faith. The fact that the OA contemplates significant appraisal divergence and provides a contractual remedy for it undercuts MSH's argument that the divergence itself is evidence of bad faith. PCG did not resist the invocation of Section 12.4(c), did not attempt to circumvent the third-appraiser process, and has cooperated in providing access and information to Linden Park.

C. Relationship Between Penalty and Substantive Valuation

It is critical to maintain a clear analytical distinction between the substantive valuation dispute and the bad-faith penalty claim, notwithstanding MSH's apparent conflation of the two in its demand calculations.

The penalty provision in Section 12.7 operates as an additional payment on top of the determined Fair Market Value. That is, if the arbitrator determines that Fair Market Value is higher than the value reflected in PCG's tender, the purchase price is adjusted upward to reflect the determined Fair Market Value — and if, in addition, the arbitrator finds that PCG acted in bad faith or with intent to understate, a penalty of up to 25% of the determined Fair Market Value of the redeemed interest is added on top of the adjusted purchase price. The penalty and the valuation adjustment are conceptually and functionally distinct.

MSH has conflated its penalty demand ($16.975 million) with its valuation claim in a manner that obscures this distinction. MSH's total demand of $70.0 million includes both a full upward adjustment to MSH's preferred valuation and a penalty calculated on that adjusted basis. But the fact that the arbitrator may ultimately determine that Fair Market Value is higher than PCG's Whitfield-based tender does not, standing alone, establish bad faith. Many call-option exercises involve good-faith disagreements over valuation. The question under Section 12.7 is not whether PCG's appraisal was ultimately proven to be the most accurate, but whether PCG acted with wrongful intent or in bad faith in the manner of exercising the option and procuring the appraisal. This distinction is well-established in the case law discussed in Section IV below and will be a central theme of PCG's defense.

III. MSH'S THEORY OF BAD FAITH

A. Summary of MSH's Allegations (Per Demand for Arbitration and Subsequent Filings)

MSH, represented by Hargrove, Dunlap & Castillo LLP, with Victoria Castillo serving as lead counsel, has set forth its bad-faith theory in its Demand for Arbitration (filed March 27, 2023), its Statement of Claims (filed May 15, 2023), and its subsequent discovery motions and pre-hearing briefs. MSH's allegations can be grouped into five principal categories:

First, MSH alleges that PCG selected Whitfield Realty Advisors LLC knowing or intending that Whitfield would produce a below-market appraisal. MSH contends that PCG engaged in what it characterizes as "appraiser shopping" — soliciting indications of value from multiple appraisal firms and selecting Whitfield because it offered the most favorable (i.e., lowest) preliminary assessment. MSH asserts that PCG's choice of Whitfield was not driven by Whitfield's qualifications or expertise but by PCG's confidence that Whitfield would produce a valuation consistent with PCG's desired purchase price. MSH has not, as of the date of this memorandum, produced direct evidence of such "appraiser shopping," and this allegation appears to rest largely on inference.

Second, MSH alleges that PCG, in its capacity as sole Manager of PGV, influenced the Whitfield appraisal by providing selectively pessimistic operating projections and exaggerated capital expenditure requirements. Specifically, MSH contends that PCG furnished Whitfield with forward-looking financial projections that understated revenue growth prospects and overstated the capital expenditures required to maintain the Palmetto Grand resort property over the projection period. MSH asserts that these inputs were designed to reduce the appraised value under both the income approach and the discounted cash flow methodology employed by Whitfield. MSH has pointed to certain discrepancies between the projections provided to Whitfield and the projections included in PCG's 2022 investor presentation to its own limited partners, though the relevance and significance of these discrepancies is contested.

Third, MSH alleges that PCG deliberately deferred approximately $8.2 million in property maintenance and capital improvements in breach of its obligations under OA Section 8.3, which imposes on the Manager a duty to maintain the JV assets in "good condition and repair consistent with the property's classification and market positioning." MSH contends that PCG undertook this deferral strategically, beginning in approximately mid-2021, with the purpose of depressing the physical condition of the property and thereby reducing its appraised value in anticipation of exercising the call option after the fifth anniversary on June 15, 2022. MSH has retained a hospitality consulting firm, Harborstone Group LLC, to prepare a report quantifying the alleged maintenance deferral and its impact on property value. This allegation is the subject of a separate analysis being prepared by our team (cross-reference to Deferred Maintenance Claim Analysis Memorandum, expected October 2023).

Fourth, MSH alleges that PCG deliberately timed the exercise of the call option to occur shortly after the fifth anniversary — specifically, on January 9, 2023, only approximately seven months after the option became exercisable — in order to capture value before planned improvements and favorable market developments could be reflected in the property's financial performance. MSH suggests that PCG was aware of pending improvements, including a planned spa expansion and the anticipated opening of a new convention facility at an adjacent property, that would have increased the value of PGV's assets had the call option been exercised at a later date. MSH characterizes this timing as opportunistic and as evidence of PCG's intent to understate Fair Market Value.

Fifth, MSH argues that the 28.4% divergence between the Whitfield appraisal ($118.0 million) and the Beacon appraisal ($151.5 million) is itself circumstantial evidence that the Whitfield appraisal was the product of manipulation. MSH contends that a divergence of this magnitude cannot be explained solely by legitimate methodological differences and that it is consistent with an appraisal process that was influenced by PCG's desired outcome.

B. MSH's Calculation of the Penalty Amount

MSH's penalty demand of $16.975 million is calculated as follows, based on MSH's filings:

MSH appears to have applied an approximately 32% multiplier to the combined sum of its claimed equity share and accrued preferred return:

($36.015M + $17.01M) × 0.32 ≈ $16.968M, rounded by MSH to $16.975M

This calculation is deficient in at least two respects.

First, the 32% multiplier exceeds the contractual cap of 25% set forth in Section 12.7. MSH has not explained the basis for applying a multiplier that exceeds the express contractual maximum, and no provision of the OA or governing law supports recovery in excess of the 25% cap. MSH appears to have derived the 32% figure from an interest-based calculation that incorporates a time-value-of-money adjustment, but Section 12.7 does not authorize any such adjustment. The penalty is capped at 25% of the determined Fair Market Value of the redeemed interest, period.

Second, MSH's calculation of the penalty base appears to include the accrued preferred return ($17.01 million) in addition to the equity value ($36.015 million). Whether the "determined Fair Market Value of the redeemed interest" encompasses the accrued preferred return is an open question of contractual interpretation, as discussed further in Section VI below. If the penalty base is limited to the equity value of the redeemed interest (i.e., MSH's pro rata share of the net asset value), the penalty base would be significantly lower.

Even under MSH's own valuation assumptions and using the contractual 25% cap, the maximum penalty would be:

On equity share alone: 25% × $36.015M = $9.004 million

On equity share plus accrued preferred (if included in the base): 25% × ($36.015M + $17.01M) = 25% × $53.025M = $13.256 million

MSH's $16.975 million demand is thus overstated by any measure — by approximately $3.7 million to $8.0 million depending on the interpretation of the penalty base. This overstatement undermines the credibility of MSH's penalty claim and should be highlighted in PCG's responsive briefing.

IV. ANALYSIS OF BAD-FAITH STANDARD UNDER FLORIDA LAW

A. Florida's Implied Covenant of Good Faith and Fair Dealing

Under Florida law, every contract includes an implied covenant of good faith and fair dealing. This covenant is a foundational principle of Florida contract law, recognized by the Florida Supreme Court and consistently applied by Florida's appellate courts. See, e.g., Centurion Partners Holdings LLC v. Watermark Capital Group, 287 So. 3d 1145, 1152 (Fla. 4th DCA 2019) ("The implied covenant of good faith and fair dealing is an inherent part of every Florida contract and protects the reasonable expectations of the contracting parties."). The covenant prevents a party from exercising contractual discretion in a manner that deprives the other party of the benefit of the bargain, even where the party's conduct is technically within the literal terms of the contract.

Florida courts apply an objective standard in evaluating alleged breaches of the implied covenant: whether the challenged conduct frustrates the purpose of the contract or deprives the other party of reasonably expected benefits. See Riverview Capital Advisors Inc. v. Magellan Ventures LLC, 314 So. 3d 202, 211 (Fla. 3d DCA 2021) ("[T]he inquiry is whether, viewed objectively, the party's conduct was consistent with the reasonable expectations created by the contract, or whether it was designed to deprive the other party of the fruits of the agreement."). Importantly, the objective standard looks not only at the challenged party's subjective intent but also at whether the conduct, considered in context, was commercially reasonable and consistent with the parties' reasonable expectations at the time of contracting.

The Operating Agreement is governed by the Florida Revised LLC Act, Chapter 605, Florida Statutes, as specified in OA Section 15.2. Under Section 605.0409 of the Florida Revised LLC Act, the obligations of a manager in a manager-managed LLC are subject to the implied contractual covenant of good faith and fair dealing, which may not be entirely eliminated by the operating agreement. See Fla. Stat. § 605.0105(3)(e) (providing that an operating agreement may not "eliminate the implied contractual covenant of good faith and fair dealing"). This statutory provision reinforces the applicability of the good-faith standard to PCG's exercise of the call option in its capacity as Manager.

B. "Bad Faith" in Contractual Buyout / Valuation Contexts

The question presented in this arbitration — whether a controlling member's exercise of a contractual call option and procurement of a below-counterparty appraisal constitutes "bad faith" — is not one that Florida courts have addressed with great frequency, but several lines of authority provide useful guidance.

Mere valuation disagreement does not constitute bad faith. Florida courts have consistently held that a good-faith disagreement over the appropriate methodology, assumptions, or conclusions of a valuation exercise does not, without more, constitute bad faith or a breach of the implied covenant. In Bayside Marina Partners LLC v. Coastline Development Corp., 298 So. 3d 884, 893 (Fla. 2d DCA 2020), the court addressed a claim that a majority partner's retained appraiser had undervalued partnership real estate in connection with a buyout. The court held that "[a] divergence in appraisal conclusions, even a substantial one, is not by itself evidence of bad faith; it is the ordinary consequence of the exercise of professional judgment by different appraisers applying different, but reasonable, methodologies." The court noted that the partnership agreement, like the OA here, provided a mechanism for resolving appraisal divergence through a neutral third appraiser, and the invoking party's compliance with that mechanism "weigh[ed] heavily against a finding of bad faith."

Bad faith requires evidence of intentional deception, manipulation, or abuse. Courts have drawn a clear distinction between aggressive-but-good-faith valuation positions and conduct tainted by actual fraud, manipulation of appraisal inputs, or abuse of a controlling position to extract an unfair price. In Meridian Gulf Holdings Inc. v. Prestige Resorts International LLC, 331 So. 3d 45, 58 (Fla. 4th DCA 2021), the court held that a finding of bad faith in a contractual buyout context required "evidence that the controlling party engaged in conduct designed to corrupt the valuation process, such as directing the appraiser to reach a predetermined conclusion, withholding material information from the appraiser, or providing the appraiser with knowingly false data." The court emphasized that "the mere fact that the controlling party selected an appraiser who ultimately arrived at a favorable valuation does not establish bad faith, so long as the appraiser was independent and applied a professionally defensible methodology."

The existence of a professionally prepared appraisal by a credentialed appraiser strongly militates against bad faith. Where a party has retained a qualified, independent, MAI-certified appraiser, and the appraiser has applied a recognized valuation methodology and reached conclusions within the range of reasonable professional judgment, courts have been reluctant to find bad faith, even if the appraisal falls on the low end of the valuation spectrum. See Palmetto Bay Capital LLC v. Southeastern Equity Partners, 319 So. 3d 1101, 1114 (Fla. 3d DCA 2021) ("An appraisal that falls at the lower end of a range of professionally defensible values is not, without more, evidence of bad faith. Bad faith requires something beyond an unfavorable result."). The rationale is that the party's reliance on the professional judgment of an independent expert, even one selected by the party, reflects a good-faith effort to determine value through the contractually prescribed process.

Courts distinguish between "aggressive but good-faith" positions and those tainted by fraud or manipulation. This distinction is central to the analysis here. PCG's position is that it exercised a contractual right, retained an independent appraiser, and relied in good faith on that appraiser's professional conclusions. Even if the Whitfield appraisal is ultimately determined to be on the low side — as the Linden Park preliminary indication suggests it may be — this does not transform a legitimate valuation position into a bad-faith act. MSH must prove something more: that PCG corrupted the process, directed the outcome, or otherwise acted with the intent to deprive MSH of the value of its interest.

We also note that analogous Delaware case law on squeeze-out valuations and good-faith obligations in LLC buyouts is potentially relevant to this arbitration, even though the OA is governed by Florida law. MSH is organized as a Delaware LLC, and MSH's counsel may seek to import Delaware's robust body of fiduciary duty and good-faith jurisprudence into the analysis. Delaware courts have addressed analogous questions in the context of statutory appraisal proceedings and LLC disputes. See, e.g., In re Sterling Capital Advisors LLC, 2019 WL 2847302 (Del. Ch. 2019) (analyzing good-faith obligations in the context of an LLC buyout and finding that the controlling member's retention of a qualified appraiser and compliance with the operating agreement's buyout procedures was "strong evidence of good faith, even where the appraisal fell materially below the minority member's expectations"). While Delaware law is not controlling here, the arbitrator may find Delaware precedent persuasive to the extent it is consistent with Florida's good-faith framework.

Florida courts evaluating claims of bad faith in valuation contexts look to the totality of the circumstances, including but not limited to: (i) the process followed by the controlling party in exercising the contractual right, (ii) whether the retained appraiser was independent and free from undue influence, (iii) whether the controlling party influenced or manipulated the appraisal inputs in a manner designed to suppress value, and (iv) whether the contractual safeguards (such as the third-appraiser mechanism) were honored. See Bayside Marina Partners, 298 So. 3d at 894; Meridian Gulf Holdings, 331 So. 3d at 59. As discussed in Section V below, PCG's conduct fares favorably under each of these factors, though certain discovery-related uncertainties persist.

C. Burden of Proof

MSH bears the burden of proving bad faith under Section 12.7 of the Operating Agreement. This allocation of the burden follows from the general principle that the party asserting a claim must prove its essential elements, and from the specific structure of Section 12.7, which imposes the penalty only "[i]f" bad faith or intent to understate is established. MSH is the claimant with respect to the penalty claim and bears the burden of persuasion.

In this JAMS arbitration, the applicable standard of proof is the preponderance of the evidence — that is, MSH must prove that it is more likely than not that PCG exercised the call option in bad faith or with the intent to materially understate Fair Market Value. While this is a lower standard than the "clear and convincing evidence" standard that some jurisdictions apply to claims of fraud, it still requires affirmative proof of PCG's wrongful intent. Mere suspicion, speculation, or inference from a valuation gap is not sufficient to meet even a preponderance standard.

Bad faith is an inherently subjective inquiry in the sense that MSH must ultimately prove PCG's state of mind — that PCG intended to understate Fair Market Value or acted in bad faith. This is a difficult burden to carry, particularly where the challenged conduct (selecting an appraiser, exercising a contractual option) is facially consistent with the exercise of legitimate contractual rights. MSH's primary avenue for establishing intent is through documentary evidence of PCG's internal deliberations, which explains the significance of MSH's motion to compel production of PCG's internal investment-committee memoranda. That motion, filed November 6, 2023 and partially granted on November 30, 2023, appears to be MSH's principal strategy for obtaining direct evidence of PCG's state of mind. The implications of the compelled production are discussed further in Section VII below.

V. EVALUATION OF MSH'S SPECIFIC BAD-FAITH ARGUMENTS

We turn now to an evaluation of each of MSH's five principal bad-faith arguments, assessing the legal and factual strength of each and identifying the key risk factors that could affect the outcome.

A. Selection of Whitfield Realty Advisors LLC

MSH alleges that PCG's selection of Whitfield was an act of "appraiser shopping" designed to produce a below-market valuation. We assess this argument as posing low risk to PCG.

Section 12.4 of the Operating Agreement expressly grants PCG the right to select the appraiser who will initially determine Fair Market Value. This right is not subject to MSH's approval or consent and is not conditioned on any requirement that PCG select a particular type of appraiser, consult with MSH about the selection, or justify its choice. The sole contractual requirement is that the appraiser be "independent" and "MAI-certified." The exercise of a negotiated contractual right cannot, without more, constitute evidence of bad faith. See Meridian Gulf Holdings, 331 So. 3d at 57 ("A party does not act in bad faith by exercising a right that the contract expressly confers upon it, even if the exercise of that right is disadvantageous to the other party.").

Gerald K. Whitfield, MAI, is a credentialed and experienced appraiser with a demonstrated record of valuing hospitality assets in the Florida market. Mr. Whitfield has been practicing as an MAI-designated appraiser for over twenty years and has appraised in excess of 150 hotel and resort properties in Florida and the southeastern United States. He is a member of the Appraisal Institute and holds the MAI designation, which is the qualification specified in Section 12.4. There is no evidence of any prior improper relationship between Mr. Whitfield and PCG — no history of employment, financial dependence, or undisclosed conflicts. Mr. Whitfield has not previously been retained by PCG or any PCG-affiliated entity, and his retention for this engagement was an arm's-length transaction.

PCG's position is straightforward: it selected a competent, independent, credentialed appraiser in the exercise of its contractual right, and it relied in good faith on the professional conclusions of that appraiser. The fact that the Whitfield appraisal produced a valuation at the lower end of the range does not retroactively transform the selection of Whitfield into an act of bad faith.

Risk Factor: The principal risk on this issue arises from the possibility that MSH could develop evidence — through discovery or deposition testimony — that PCG solicited preliminary indications of value from multiple appraisal firms before selecting Whitfield. If it could be shown that PCG contacted, for example, three or four appraisers, received preliminary indications of value, and then selected Whitfield because Whitfield provided the lowest indicative value, this could undermine PCG's position. Such conduct could be characterized as "appraiser shopping" — i.e., the selection of an appraiser not for the appraiser's qualifications but for the favorability of the expected result. However, no evidence of such appraiser shopping has surfaced in discovery to date. Mr. Whitfield testified at his deposition on September 18, 2023 that he was contacted by PCG through a referral from a professional contact and that he was not aware of PCG having solicited indications from other appraisers. Unless contradictory evidence emerges, this factor should remain favorable to PCG.

Assessment: Low risk.

B. Alleged Manipulation of Appraisal Inputs

MSH's second argument — that PCG provided selectively pessimistic operating projections and exaggerated capital expenditure requirements to Whitfield in order to depress the appraised value — is a more serious allegation and presents low to moderate risk, depending on what the compelled discovery documents reveal.

As an initial matter, it is important to identify what Whitfield's appraisal actually relied upon. The Whitfield appraisal used the following actual 2022 financial data for the Palmetto Grand property:

These figures are derived from PGV's audited financial statements for the fiscal year ended December 31, 2022, as prepared by the venture's independent auditor. They are not projections or estimates; they are verified historical figures. MSH has not challenged the accuracy of these historical financials.

The methodological differences between the Whitfield and Beacon appraisals are significant and, in our view, account for the bulk of the valuation divergence:

Several observations are warranted. Whitfield employed a blended methodology, weighting the sales-comparison approach at 60% and the income approach (using direct capitalization) at 40%. The sales-comparison approach relies on comparable transactions in the Florida hospitality market and is less sensitive to forward-looking assumptions about revenue growth, occupancy, and operating margins. By contrast, Beacon relied exclusively on the income approach, using a discounted cash flow methodology with a significantly lower discount rate (8.5% vs. Whitfield's 10.75%) and an optimistic terminal capitalization rate (7.75%). The Beacon appraisal's lower discount rate implies a more favorable risk assessment of the property's future cash flows, while the lower terminal cap rate implies a higher exit valuation. These are matters of professional judgment on which reasonable appraisers can and do differ.

Critically, the Linden Park preliminary indication of value ($130.0 million to $138.0 million) falls closer to the Whitfield valuation than to the Beacon valuation. The Linden Park midpoint of approximately $134.0 million is $16.0 million above Whitfield and $17.5 million below Beacon. If the Linden Park final appraisal confirms this range, it would suggest that the Whitfield appraisal, while on the low side, is not so far outside the range of reasonable values as to support an inference of manipulation. It would also suggest that the Beacon appraisal may be the more aggressive of the two party-retained valuations — a point that PCG should emphasize in its briefing.

That said, the Whitfield appraisal's income-approach component did rely on forward-looking projections for capital expenditures, revenue growth, and operating margins. To the extent PCG, as Manager, provided Whitfield with operating projections that were selectively pessimistic or inconsistent with PCG's own internal forecasts, this could support MSH's manipulation theory. MSH has identified certain discrepancies between the capital expenditure projections furnished to Whitfield and the capital expenditure forecasts included in PCG's 2022 investor presentation to its limited partners. Specifically, MSH alleges that the projections provided to Whitfield assumed annual capital expenditures of approximately $4.8 million over the five-year projection period, whereas the investor presentation assumed approximately $3.2 million per year. If this discrepancy is substantiated and cannot be adequately explained, it could create an inference that PCG inflated capital expenditure assumptions to suppress the income-approach valuation.

Risk Factor: The content of the investment-committee memoranda compelled by the arbitrator's November 30, 2023 order will be pivotal on this issue. If those documents show that PCG's internal valuation analysis closely aligned with the assumptions provided to Whitfield and reflected a legitimate, good-faith assessment of the property's financial prospects, the risk decreases. Conversely, if the documents reveal that PCG's internal analysis valued the property materially higher than $118.0 million, or if they contain communications suggesting that PCG provided Whitfield with deliberately conservative assumptions, directed Whitfield toward a particular valuation target, or criticized draft appraisals as being "too high," the risk would increase significantly. We strongly recommend that Adriana Pellegrino-Voss and Marcus Thiel (PCG's Director of Asset Management) be consulted regarding the specific content of these documents before this assessment is finalized.

Assessment: Low to moderate risk, subject to revision based on compelled document production.

C. Deferred Maintenance Allegations (OA Section 8.3)

MSH's allegation that PCG deliberately deferred $8.2 million in property maintenance to depress the property's condition and appraised value is, in our assessment, MSH's strongest argument in support of the bad-faith penalty claim. We assess this argument as posing moderate risk.

The theory is as follows: PCG, as sole Manager, controls all capital expenditure and maintenance decisions for the PGV assets. OA Section 8.3 requires the Manager to maintain the JV assets in "good condition and repair consistent with the property's classification and market positioning." MSH contends that beginning in approximately mid-2021 — roughly one year before the call option became exercisable — PCG began deferring discretionary and non-discretionary maintenance expenditures, including HVAC system replacements, pool and spa renovations, exterior painting, and lobby and common-area renovations. MSH calculates the cumulative maintenance deferral at approximately $8.2 million and has retained Harborstone Group LLC to prepare an expert report quantifying the deferral and its impact on the property's physical condition and appraised value.

A separate, more detailed analysis of the deferred maintenance claim under OA Section 8.3 is being prepared by our team and is expected to be completed in October 2023. For purposes of this bad-faith risk assessment, we offer the following preliminary observations:

PCG invested a total of $24.3 million in renovation capital for the Palmetto Grand property during the initial renovation period from 2017 to 2019. This was a substantial capital investment that brought the property to its current luxury-resort standard. Subsequent annual capital budgets from 2020 through 2022 appear, at a preliminary level, to be consistent with industry norms for a property of this classification. The $8.2 million figure cited by MSH appears to include a number of items that are more properly characterized as discretionary capital improvements (e.g., a planned lobby redesign, a proposed spa expansion) rather than deferred maintenance in the traditional sense. The distinction matters because the Manager's obligation under Section 8.3 is to maintain the property in good condition and repair — it does not obligate the Manager to undertake every capital improvement that might enhance value.

Even if some maintenance was in fact deferred, deferred maintenance alone is generally not evidence of bad faith in a call-option context. Many factors influence capital expenditure decisions, including cash flow constraints, market conditions, seasonality, and the Manager's assessment of the optimal timing for various projects. To establish bad faith, MSH must show not merely that maintenance was deferred, but that the deferral was strategically motivated by PCG's intent to exercise the call option at a depressed price. This is a causal nexus that requires proof of PCG's subjective intent.

Risk Factor: This argument is MSH's strongest because it ties PCG's conduct as Manager (capital expenditure decisions) directly to the valuation outcome (a property in allegedly suboptimal condition is worth less than a well-maintained property). If MSH can produce documentary evidence — internal emails, investment committee minutes, board presentations — showing that PCG deliberately postponed or cancelled maintenance projects specifically in anticipation of exercising the call option after June 15, 2022, this would significantly bolster the bad-faith claim. The temporal nexus between the alleged onset of maintenance deferral (mid-2021) and the option eligibility date (June 15, 2022) is suggestive, and MSH will undoubtedly argue that this timing is not coincidental. PCG must be prepared to offer credible, contemporaneous explanations for its capital expenditure decisions during this period — for example, pandemic-related cash flow constraints, supply chain disruptions affecting construction materials, or the Manager's good-faith assessment that certain projects were not yet necessary.

Assessment: Moderate risk. This is the factor most likely to create a viable path for MSH's bad-faith claim, and PCG should devote significant attention to preparing its defense on this issue.

D. Timing of Call-Option Exercise

MSH argues that PCG's decision to exercise the call option on January 9, 2023 — approximately seven months after the option became exercisable on June 15, 2022 — was strategically timed to capture value before planned improvements and favorable market developments could be reflected in PGV's financials. We assess this argument as posing low risk.

The Operating Agreement grants PCG an unconditional right to exercise the call option at any time after the fifth anniversary. Section 12.4(a) requires only that PCG deliver "written notice to [MSH] of its election to exercise the call option," and it imposes no waiting period, no advance notice requirement, no obligation to consult with MSH about the timing, and no obligation to justify the timing of exercise. PCG's exercise on January 9, 2023, was fully within the scope of this contractual right.

MSH's argument that the timing was "strategically" chosen to precede value-enhancing events is speculative. The call option became exercisable in June 2022, and PCG exercised it in January 2023. A seven-month gap between eligibility and exercise is not, by any standard, unreasonably hasty. Moreover, MSH's argument proves too much: any exercise of a call option, by definition, captures value at a specific point in time. If the exercise occurs before a future improvement, the minority member might complain of strategic timing; if it occurs after a period of strong performance, the minority member might complain that the controlling party waited until its own value contribution was maximized. The OA resolves this issue by granting PCG discretion over timing, subject only to the good-faith obligation.

There is no evidence in the record that PCG's timing was driven by an intent to capture value before improvements. PCG has legitimate, documented business reasons for the timing of the exercise, including the desire to simplify PGV's ownership structure in anticipation of a potential refinancing of the property's senior debt facility with Southeastern Commerce Bank, which was under discussion in late 2022.

Assessment: Low risk. This argument is weak because the contractual right is unambiguous and because MSH has not identified any specific value-enhancing event that PCG was allegedly trying to precede.

E. The 28.4% Appraisal Divergence as Evidence of Bad Faith

MSH's final argument is that the 28.4% divergence between the Whitfield and Beacon appraisals is, in and of itself, circumstantial evidence that the Whitfield appraisal was the product of manipulation. We assess this argument as posing low risk.

Appraisal divergence is common in the hospitality sector, where different appraisers routinely apply different methodologies, use different comparable transactions, and employ different capitalization and discount rates. The divergence between Whitfield and Beacon is driven principally by: (i) Whitfield's use of a blended income/sales-comparison approach versus Beacon's exclusive reliance on the income approach, (ii) Whitfield's higher capitalization rate (9.5% vs. Beacon's implied rate), (iii) Whitfield's higher discount rate (10.75% vs. 8.5%), and (iv) the different weightings and comparable transactions selected. These are legitimate methodological choices on which competent professionals routinely disagree.

The Operating Agreement itself anticipated the possibility of significant divergence by including the 10% threshold in Section 12.4(c). If the drafters had intended that any divergence above a certain level would constitute per se evidence of bad faith, they would have said so. Instead, the contract provides a procedural safeguard — the neutral third appraiser — to resolve divergences. The fact that the parties bargained for this mechanism reflects the understanding that reasonable appraisals of a complex hospitality asset may differ materially. PCG honored this mechanism by agreeing to the joint retention of Linden Park, cooperating in the neutral appraisal process, and not attempting to obstruct or delay the third-appraiser procedure.

Moreover, as noted above, the Linden Park preliminary indication ($130.0–$138.0 million) falls closer to the Whitfield appraisal than to the Beacon appraisal. If the final Linden Park appraisal confirms this range, the "two closest" appraisals under Section 12.4(c) would be Whitfield and Linden Park — not Beacon and Linden Park. This outcome would further undermine MSH's narrative that the Whitfield appraisal was an outlier produced by manipulation.

Assessment: Low risk. Appraisal divergence alone, without evidence of intent or manipulation, is insufficient to establish bad faith.

VI. QUANTIFICATION OF POTENTIAL PENALTY EXPOSURE

A. Maximum Exposure Under Various Valuation Scenarios

We present below PCG's maximum penalty exposure under three valuation scenarios, reflecting the three appraisals that may inform the arbitrator's determination of Fair Market Value. In each scenario, we calculate the maximum 25% penalty on both (i) the equity value of MSH's 35% interest alone and (ii) the equity value plus the accrued preferred return, recognizing that the correct penalty base is an open interpretive question.

For all scenarios, we assume that PGV's outstanding senior debt to be deducted from gross asset value for purposes of determining net equity is $48.6 million, which reflects the outstanding principal balance of the Southeastern Commerce Bank credit facility as of the January 9, 2023 exercise date.

Scenario 1: Arbitrator Adopts Whitfield Value ($118.0M)

Gross asset value: $118.0M Less outstanding debt: ($48.6M) Net equity: $69.4M MSH 35% equity share: $69.4M × 0.35 = $24.29M

Maximum 25% penalty on equity interest alone: $24.29M × 0.25 = $6.07M Maximum 25% penalty on equity + accrued preferred: ($24.29M + $17.01M) × 0.25 = $41.30M × 0.25 = $10.325M

Scenario 2: Arbitrator Adopts Linden Park Midpoint ($134.0M)

Gross asset value: $134.0M Less outstanding debt: ($48.6M) Net equity: $85.4M MSH 35% equity share: $85.4M × 0.35 = $29.89M

Maximum 25% penalty on equity interest alone: $29.89M × 0.25 = $7.47M Maximum 25% penalty on equity + accrued preferred: ($29.89M + $17.01M) × 0.25 = $46.90M × 0.25 = $11.725M

Scenario 3: Arbitrator Adopts Beacon Value ($151.5M)

Gross asset value: $151.5M Less outstanding debt: ($48.6M) Net equity: $102.9M MSH 35% equity share: $102.9M × 0.35 = $36.015M

Maximum 25% penalty on equity interest alone: $36.015M × 0.25 = $9.004M Maximum 25% penalty on equity + accrued preferred: ($36.015M + $17.01M) × 0.25 = $53.025M × 0.25 = $13.256M

The following table summarizes the range of potential maximum penalty exposure:

In all three scenarios, MSH's $16.975 million penalty demand exceeds the contractual maximum. Even under the most adverse assumptions — the Beacon valuation plus inclusion of the preferred return in the penalty base — the maximum permissible penalty is $13.256 million, which is $3.719 million less than MSH's demand. MSH's 32% multiplier has no contractual basis and should be rejected.

Open Interpretation Issue: Whether the "Fair Market Value of the redeemed interest" in Section 12.7 includes only the equity value of MSH's interest or also the accrued but unpaid preferred return of $17.01 million is an issue of first impression under the Operating Agreement. The term "redeemed interest" is defined in Section 1.1 of the OA as "the Membership Interest of the Non-Manager Member that is the subject of the call option under Section 12.4." Section 7.2 addresses the preferred return separately, treating it as a distributional entitlement rather than a component of the membership interest's fair market value. On balance, we believe the better reading is that the penalty base is limited to the equity value of the redeemed interest and does not include the accrued preferred return, which is a separate contractual obligation. However, this is not free from doubt, and MSH will likely argue for the broader interpretation. The difference between the two interpretations is approximately $3.0 million to $4.3 million in penalty exposure, depending on the valuation scenario.

B. Discretionary Nature of the Penalty

Even if the arbitrator finds that PCG acted in bad faith, the penalty is not automatically imposed at the full 25% rate. Section 12.7 states "up to twenty-five percent" — this language confers discretion on the arbitrator to impose any penalty amount from zero to the 25% cap. The use of the phrase "up to" is universally understood in contract law to establish a ceiling, not a floor. See Landmark Capital Partners LLC v. Gulf States Realty Trust, 305 So. 3d 478, 489 (Fla. 1st DCA 2020) ("The phrase 'up to' in a contractual penalty provision establishes the maximum penalty; the decision-maker retains discretion to impose a lesser amount where the circumstances warrant.").

Even upon a finding of bad faith, the arbitrator will likely calibrate the penalty to the severity of the bad-faith conduct. If the bad faith is found to be limited — for example, if the arbitrator finds that PCG provided somewhat aggressive capital expenditure assumptions to Whitfield but did not engage in outright fraud or direct the appraisal conclusion — the penalty is likely to be imposed at a level well below the 25% cap. Analogous contractual penalty provisions under Florida law are subject to a general reasonableness inquiry, and courts and arbitrators routinely impose penalties well below the contractual maximum where the bad faith is not egregious. See Bayside Marina Partners, 298 So. 3d at 896 (approving a 10% penalty where the contractual cap was 20%, finding that "the controlling partner's conduct, while not exemplary, did not rise to the level of deliberate manipulation warranting the maximum penalty").

This discretionary aspect of the penalty provision provides an important layer of protection for PCG. Even in a worst-case finding of bad faith, the penalty would more likely be in the range of 10–15% rather than the full 25%, unless the arbitrator finds that PCG's conduct was egregious.

VII. IMPACT OF DISCOVERY ON BAD-FAITH RISK

A. Motion to Compel — Investment Committee Memoranda

On November 6, 2023, MSH filed a motion to compel production of PCG's internal investment-committee memoranda relating to the call-option exercise and the valuation of PGV's assets. The motion sought production of all investment committee minutes, memoranda, presentations, and related correspondence from January 2022 through March 2023, on the ground that these documents are directly relevant to PCG's intent and state of mind in exercising the call option and procuring the Whitfield appraisal.

The Honorable Margaret Liu Chen (Ret.) partially granted the motion on November 30, 2023. The order directed PCG to produce all non-privileged investment-committee memoranda and correspondence relating to (i) the decision to exercise the call option, (ii) the selection of the appraiser, and (iii) the valuation of PGV's assets during the relevant time period. The order permitted PCG to withhold documents protected by the attorney-client privilege or the work-product doctrine, subject to the production of a detailed privilege log.

PCG's supplemental production and privilege log, prepared in December 2023 (in progress as of this writing), identifies the responsive documents. A number of documents have been or will be produced; others have been withheld on privilege and work-product grounds. The privilege log identifies approximately twenty-two responsive documents, of which fourteen are being produced and eight are being withheld.

Critical Assessment: The content of the produced investment-committee memoranda will be the single most significant factor in determining the ultimate risk level on the bad-faith penalty claim. Two starkly different outcomes are possible:

Favorable scenario: The produced documents reflect a methodical, good-faith decision-making process. The investment committee memoranda discuss the call option as a strategic business decision (e.g., ownership simplification, refinancing preparation), the selection of Whitfield as a qualified appraiser, and reliance on Whitfield's independent judgment. The internal valuation analysis is broadly consistent with the assumptions provided to Whitfield, and there are no communications suggesting a target valuation or direction to suppress value. In this scenario, the documents would significantly reduce bad-faith risk and could be used affirmatively by PCG to demonstrate good faith.

Adverse scenario: The produced documents reveal internal communications suggesting that PCG's team was aware that the property was worth materially more than $118.0 million, or that PCG's internal valuation models produced estimates in the range of $130.0–$145.0 million. The documents contain statements by PCG personnel criticizing draft Whitfield appraisals as "too high" or suggesting a desired target valuation. Communications between PCG and Whitfield reveal that PCG pushed back on Whitfield's preliminary conclusions or directed Whitfield to adopt particular assumptions. In this scenario, the risk of a bad-faith finding would increase substantially, potentially to the moderate-to-high range.

We strongly recommend that Dominic Pellegrino, Adriana Pellegrino-Voss, and Marcus Thiel (PCG's Director of Asset Management, who prepared the capital expenditure projections furnished to Whitfield) be consulted on the content of the responsive documents before this risk assessment is finalized. If any of the produced documents contain problematic language or if any of the withheld documents present privilege vulnerabilities, we need to know immediately so that we can adjust our strategy accordingly.

B. Deposition Testimony

To date, four depositions have been taken that are directly relevant to the bad-faith penalty claim:

1. Gerald K. Whitfield (Whitfield Realty Advisors LLC) — Deposed September 18, 2023

2. Dr. Priya Ramanathan (Beacon Capital Valuation LLC) — Deposed September 18, 2023

3. Dominic R. Pellegrino (Managing Member, PCG) — Deposed October 10, 2023

4. Nathaniel Cordero (Managing Partner, MSH) — Deposed October 10, 2023

The key issues arising from these depositions, which should be assessed in conjunction with the complete deposition transcripts and testimony summaries being prepared separately by our team, include the following:

Whitfield deposition: Did Mr. Whitfield testify credibly about the independence of his engagement? Did he confirm that he was not directed by PCG to reach a particular valuation conclusion? Did he explain the methodological bases for his appraisal in a manner that supports the reasonableness of his conclusions? Were there any damaging admissions regarding PCG's influence on assumptions or inputs? Preliminary reports from the deposition suggest that Mr. Whitfield was a generally credible witness who defended the independence and methodology of his appraisal, but a complete review of the transcript is necessary.

Pellegrino deposition: Did Dominic Pellegrino's testimony reveal any problematic communications with Whitfield or any admissions suggesting that PCG sought to influence the appraisal outcome? Did Mr. Pellegrino articulate credible, good-faith business reasons for exercising the call option and for the timing of the exercise? Were there any inconsistencies between his testimony and the documentary record? This deposition is of particular concern because MSH's counsel, Victoria Castillo, is known to be an aggressive and skilled cross-examiner. Any statements by Mr. Pellegrino that can be construed as admissions of intent to suppress value would be damaging.

Cordero deposition: Did Nathaniel Cordero provide specific factual support for MSH's bad-faith allegations, or did he primarily rely on the valuation gap and general assertions of unfairness? If Cordero's testimony is largely conclusory and lacks specific factual grounding, it weakens MSH's case. If, on the other hand, Cordero identified specific communications or interactions with PCG that suggest bad faith — for example, statements by PCG personnel indicating an awareness that the property was worth more than the Whitfield value — this would be significant.

Dr. Ramanathan deposition: Did Dr. Ramanathan defend the methodology and conclusions of the Beacon appraisal credibly? Did the cross-examination reveal any weaknesses in the Beacon appraisal that could be exploited to argue that the Beacon valuation is the outlier, not the Whitfield valuation? Preliminary indications suggest that Dr. Ramanathan's exclusive reliance on the income approach (without a sales-comparison approach) and her use of an 8.5% discount rate — which is on the low end of the range for Florida luxury hospitality assets — may be vulnerable to challenge.

PRIVILEGED AND CONFIDENTIAL — ATTORNEY-CLIENT PRIVILEGED / ATTORNEY WORK PRODUCT This memorandum is protected by the attorney-client privilege and the work-product doctrine. It is prepared in anticipation of litigation and for the purpose of providing legal advice. Any disclosure to third parties may result in waiver of applicable privileges. Do not distribute, copy, or disclose without prior authorization from Calderwood & Harkness LLP.
MEMORANDUM
TO: Dominic R. Pellegrino, Managing Member, Pellegrino Capital Group LLC Adriana Pellegrino-Voss, SVP of Investments, Pellegrino Capital Group LLC
FROM: Francesca Morano, Partner, Calderwood & Harkness LLP Simone Laroche, Associate, Calderwood & Harkness LLP
DATE: September 15, 2023
RE: Risk Assessment — Bad-Faith Penalty Exposure Under Section 12.7 of the Palmetto Grand Ventures LLC Operating Agreement
MATTER NO.: 1027-00003
JAMS REF. NO.: 1440032871
I. EXECUTIVE SUMMARY
This memorandum assesses Pellegrino Capital Group LLC's ("PCG") exposure to a bad-faith penalty under Section 12.7 of the Second Amended and Restated Operating Agreement (the "Operating Agreement" or "OA") of Palmetto Grand Ventures LLC ("PGV"), dated June 15, 2017, in connection with PCG's exercise of the call option under OA Section 12.4 on January 9, 2023. This assessment is prepared in the context of the pending JAMS arbitration (Ref. No. 1440032871) before the Honorable Margaret Liu Chen (Ret.) and reflects the current state of discovery and briefing as of the date hereof.
Meridian Shores Hospitality LLC ("MSH"), the minority investor in PGV holding a thirty-five percent (35%) interest, has asserted that PCG exercised the call option "in bad faith or with the intent to materially understate Fair Market Value" within the meaning of OA Section 12.7. On the basis of this allegation, MSH demands a penalty of $16.975 million, which it characterizes as compensation for PCG's alleged manipulation of the valuation process. MSH seeks this penalty on top of its substantive valuation adjustment — that is, in addition to the difference between PCG's tendered purchase price and the price MSH contends is owed for its redeemed interest.
MSH's total demand in the arbitration stands at $70.0 million. This figure comprises (i) $36.015 million for MSH's 35% equity share valued at MSH's asserted Fair Market Value as determined by the Beacon appraisal, (ii) $17.01 million in accrued but unpaid preferred return under OA Section 7.2, and (iii) $16.975 million as the bad-faith penalty under OA Section 12.7. On March 1, 2023, PCG tendered $41.3 million to MSH based on the appraisal of Whitfield Realty Advisors LLC ("Whitfield"), which valued 100% of the JV assets at $118.0 million. MSH rejected this tender on March 10, 2023, and initiated arbitration proceedings on March 27, 2023.
The $28.7 million gap between PCG's tendered amount and MSH's total demand is driven by two conceptually distinct but interrelated disputes: (i) the substantive valuation disagreement (what is the Fair Market Value of PGV's assets, and correspondingly, what is MSH's 35% equity interest worth?), and (ii) the bad-faith penalty claim (whether PCG's conduct in exercising the call option and procuring the Whitfield appraisal warrants the imposition of an additional penalty payment under Section 12.7). This memorandum focuses on the second of these disputes.
Overall Assessment: We assess the risk of an adverse finding on bad faith as low but not negligible. The 28.4% divergence between the Whitfield appraisal ($118.0 million) and the Beacon Capital Valuation LLC ("Beacon") appraisal commissioned by MSH ($151.5 million) is significant and, standing alone, creates an optic that could support an inference of undervaluation. However, this divergence is explainable by legitimate methodological differences between the two appraisals — principally the different weighting of income and sales-comparison approaches, and the different capitalization and discount rates employed. The critical question is whether the arbitrator finds that PCG's selection of Whitfield or PCG's influence on appraisal assumptions was designed to suppress value. On the evidence currently available, we do not believe MSH can meet its burden of proof on this issue, although certain discovery developments — particularly the partial production of PCG's internal investment-committee memoranda — introduce uncertainty that we cannot fully quantify at this time.
If the penalty is imposed at the maximum 25% rate permitted under Section 12.7 on the determined Fair Market Value of MSH's redeemed interest, PCG's exposure could range from approximately $6.1 million to $13.3 million, depending on which valuation the arbitrator adopts as the determined Fair Market Value and whether the penalty base is construed to include only the equity value of MSH's interest or also the accrued preferred return. MSH has calculated its penalty claim at $16.975 million using an approximately 32% multiplier, which exceeds the contractual 25% cap and would be reduced even if a finding of bad faith were made. We estimate the probability-weighted penalty exposure at approximately $1.5 million to $2.5 million.
The sections that follow analyze the contractual framework, the applicable legal standards under Florida law, each of MSH's specific bad-faith arguments, the quantification of potential penalty exposure under various scenarios, the impact of pending discovery, and our strategic recommendations.
II. CONTRACTUAL FRAMEWORK: OA SECTION 12.7
A. Text of the Provision
The operative penalty provision is found in Section 12.7 of the Operating Agreement, titled "Bad-Faith Penalty." The full text of the relevant provision reads as follows:
"If the Manager exercises the call option under Section 12.4 in bad faith or with the intent to materially understate Fair Market Value, the purchase price for the redeemed interest shall include a penalty of up to twenty-five percent (25%) of the determined Fair Market Value of the redeemed interest."
Several features of this provision warrant careful attention.
First, the penalty is discretionary, not automatic. The language "up to twenty-five percent (25%)" confers on the decision-maker — here, the arbitrator — the discretion to impose any penalty amount from zero to the contractual cap. Even upon a threshold finding of bad faith, the arbitrator is not required to impose the penalty at the full 25% rate and may calibrate the penalty to the severity of the bad-faith conduct. This is a significant distinction that MSH's briefing has largely ignored, as MSH has simply demanded its calculated penalty amount as though it were an automatic entitlement upon a showing of bad faith.
Second, the penalty is measured against the "determined Fair Market Value of the redeemed interest," not against the total value of PGV's assets. The "redeemed interest" is MSH's 35% membership interest. The phrase "determined Fair Market Value" refers to the value established through the appraisal process set forth in Section 12.4 — i.e., the value ultimately determined by the arbitrator after consideration of the competing appraisals and the neutral appraisal from Linden Park Advisory LLC. This means the penalty base is a function of the valuation outcome, creating an interrelationship between the substantive valuation dispute and the penalty calculation.
Third, Section 12.7 does not define the terms "bad faith" or "intent to materially understate." These terms are left to interpretation under governing law. As discussed in Section IV below, Florida law provides the relevant interpretive framework, and the absence of a contractual definition places a significant evidentiary burden on MSH to establish what constitutes "bad faith" or "intent to materially understate" in this context.
Fourth, the provision identifies two alternative bases for the penalty: (i) exercise of the call option "in bad faith," and (ii) exercise "with the intent to materially understate Fair Market Value." These may overlap but are not identical. "Bad faith" is a broader concept that could encompass a range of improper conduct in the exercise of the option, while "intent to materially understate" is a more specific allegation directed at the valuation process itself. MSH's claims invoke both bases, but MSH's factual allegations are primarily directed at the second basis — that PCG intended to suppress the appraised value of PGV's assets.
B. Interplay with Section 12.4 (Call Option) and Section 12.4(c) (Third Appraiser)
An understanding of the penalty provision in Section 12.7 requires examination of the broader call-option framework established in Section 12.4, which governs the mechanics of PCG's exercise of the option and the determination of Fair Market Value.
Under Section 12.4 of the Operating Agreement, PCG, as Manager and majority interest holder (65%), has the right, at any time following the fifth anniversary of the effective date of the OA (i.e., at any time on or after June 15, 2022), to purchase MSH's entire 35% membership interest at "Fair Market Value" as determined by an independent MAI-certified appraiser selected by PCG. The provision vests in PCG the unilateral right to (a) decide whether and when to exercise the option and (b) select the appraiser who will initially determine Fair Market Value. This right is express and was a negotiated term of the Operating Agreement, reflecting the parties' bargained-for allocation of control in the venture.
PCG exercised the call option on January 9, 2023, by delivering written notice to MSH in accordance with Section 12.4(a). PCG selected Whitfield Realty Advisors LLC, led by Gerald K. Whitfield, MAI, to prepare the initial appraisal of the JV assets. The Whitfield appraisal, dated February 10, 2023, valued 100% of PGV's assets at $118.0 million. On this basis, PCG tendered $41.3 million to MSH on March 1, 2023, reflecting MSH's 35% equity share plus accrued preferred return as calculated by PCG.
MSH rejected the tender and commissioned its own appraisal from Beacon Capital Valuation LLC, led by Dr. Priya Ramanathan, MAI, ASA, which valued 100% of PGV's assets at $151.5 million in an appraisal report dated March 28, 2023.
Section 12.4(c) of the Operating Agreement provides a contractual mechanism for resolving appraisal divergence. Specifically, if the two party-commissioned appraisals diverge by more than ten percent (10%), the parties are required to jointly retain a third, neutral MAI-certified appraiser. Fair Market Value is then determined as the average of the two closest appraisals among the three. The divergence between the Whitfield appraisal ($118.0 million) and the Beacon appraisal ($151.5 million) is calculated as:
|$151.5M − $118.0M| / $118.0M = 28.4%
This 28.4% divergence exceeds the 10% threshold, thereby triggering the Section 12.4(c) mechanism. In accordance with this provision, the parties jointly retained Linden Park Advisory LLC ("Linden Park"), led by Thomas Carraway, MAI, FRICS, as the neutral third appraiser on June 1, 2023. Linden Park delivered a preliminary indication of value on July 14, 2023, placing its range at $130.0 million to $138.0 million. The final Linden Park appraisal is expected in the fourth quarter of 2023.
The existence and operation of the Section 12.4(c) third-appraiser mechanism is itself a significant factor in the bad-faith analysis. The mechanism was designed precisely for the situation that has arisen — a material divergence in the parties' respective appraisals. PCG's compliance with this mechanism, including its agreement to the joint retention of Linden Park, demonstrates that PCG followed the contractual process in good faith. The fact that the OA contemplates significant appraisal divergence and provides a contractual remedy for it undercuts MSH's argument that the divergence itself is evidence of bad faith. PCG did not resist the invocation of Section 12.4(c), did not attempt to circumvent the third-appraiser process, and has cooperated in providing access and information to Linden Park.
C. Relationship Between Penalty and Substantive Valuation
It is critical to maintain a clear analytical distinction between the substantive valuation dispute and the bad-faith penalty claim, notwithstanding MSH's apparent conflation of the two in its demand calculations.
The penalty provision in Section 12.7 operates as an additional payment on top of the determined Fair Market Value. That is, if the arbitrator determines that Fair Market Value is higher than the value reflected in PCG's tender, the purchase price is adjusted upward to reflect the determined Fair Market Value — and if, in addition, the arbitrator finds that PCG acted in bad faith or with intent to understate, a penalty of up to 25% of the determined Fair Market Value of the redeemed interest is added on top of the adjusted purchase price. The penalty and the valuation adjustment are conceptually and functionally distinct.
MSH has conflated its penalty demand ($16.975 million) with its valuation claim in a manner that obscures this distinction. MSH's total demand of $70.0 million includes both a full upward adjustment to MSH's preferred valuation and a penalty calculated on that adjusted basis. But the fact that the arbitrator may ultimately determine that Fair Market Value is higher than PCG's Whitfield-based tender does not, standing alone, establish bad faith. Many call-option exercises involve good-faith disagreements over valuation. The question under Section 12.7 is not whether PCG's appraisal was ultimately proven to be the most accurate, but whether PCG acted with wrongful intent or in bad faith in the manner of exercising the option and procuring the appraisal. This distinction is well-established in the case law discussed in Section IV below and will be a central theme of PCG's defense.
III. MSH'S THEORY OF BAD FAITH
A. Summary of MSH's Allegations (Per Demand for Arbitration and Subsequent Filings)
MSH, represented by Hargrove, Dunlap & Castillo LLP, with Victoria Castillo serving as lead counsel, has set forth its bad-faith theory in its Demand for Arbitration (filed March 27, 2023), its Statement of Claims (filed May 15, 2023), and its subsequent discovery motions and pre-hearing briefs. MSH's allegations can be grouped into five principal categories:
First, MSH alleges that PCG selected Whitfield Realty Advisors LLC knowing or intending that Whitfield would produce a below-market appraisal. MSH contends that PCG engaged in what it characterizes as "appraiser shopping" — soliciting indications of value from multiple appraisal firms and selecting Whitfield because it offered the most favorable (i.e., lowest) preliminary assessment. MSH asserts that PCG's choice of Whitfield was not driven by Whitfield's qualifications or expertise but by PCG's confidence that Whitfield would produce a valuation consistent with PCG's desired purchase price. MSH has not, as of the date of this memorandum, produced direct evidence of such "appraiser shopping," and this allegation appears to rest largely on inference.
Second, MSH alleges that PCG, in its capacity as sole Manager of PGV, influenced the Whitfield appraisal by providing selectively pessimistic operating projections and exaggerated capital expenditure requirements. Specifically, MSH contends that PCG furnished Whitfield with forward-looking financial projections that understated revenue growth prospects and overstated the capital expenditures required to maintain the Palmetto Grand resort property over the projection period. MSH asserts that these inputs were designed to reduce the appraised value under both the income approach and the discounted cash flow methodology employed by Whitfield. MSH has pointed to certain discrepancies between the projections provided to Whitfield and the projections included in PCG's 2022 investor presentation to its own limited partners, though the relevance and significance of these discrepancies is contested.
Third, MSH alleges that PCG deliberately deferred approximately $8.2 million in property maintenance and capital improvements in breach of its obligations under OA Section 8.3, which imposes on the Manager a duty to maintain the JV assets in "good condition and repair consistent with the property's classification and market positioning." MSH contends that PCG undertook this deferral strategically, beginning in approximately mid-2021, with the purpose of depressing the physical condition of the property and thereby reducing its appraised value in anticipation of exercising the call option after the fifth anniversary on June 15, 2022. MSH has retained a hospitality consulting firm, Harborstone Group LLC, to prepare a report quantifying the alleged maintenance deferral and its impact on property value. This allegation is the subject of a separate analysis being prepared by our team (cross-reference to Deferred Maintenance Claim Analysis Memorandum, expected October 2023).
Fourth, MSH alleges that PCG deliberately timed the exercise of the call option to occur shortly after the fifth anniversary — specifically, on January 9, 2023, only approximately seven months after the option became exercisable — in order to capture value before planned improvements and favorable market developments could be reflected in the property's financial performance. MSH suggests that PCG was aware of pending improvements, including a planned spa expansion and the anticipated opening of a new convention facility at an adjacent property, that would have increased the value of PGV's assets had the call option been exercised at a later date. MSH characterizes this timing as opportunistic and as evidence of PCG's intent to understate Fair Market Value.
Fifth, MSH argues that the 28.4% divergence between the Whitfield appraisal ($118.0 million) and the Beacon appraisal ($151.5 million) is itself circumstantial evidence that the Whitfield appraisal was the product of manipulation. MSH contends that a divergence of this magnitude cannot be explained solely by legitimate methodological differences and that it is consistent with an appraisal process that was influenced by PCG's desired outcome.
B. MSH's Calculation of the Penalty Amount
MSH's penalty demand of $16.975 million is calculated as follows, based on MSH's filings:
MSH appears to have applied an approximately 32% multiplier to the combined sum of its claimed equity share and accrued preferred return:
($36.015M + $17.01M) × 0.32 ≈ $16.968M, rounded by MSH to $16.975M
This calculation is deficient in at least two respects.
First, the 32% multiplier exceeds the contractual cap of 25% set forth in Section 12.7. MSH has not explained the basis for applying a multiplier that exceeds the express contractual maximum, and no provision of the OA or governing law supports recovery in excess of the 25% cap. MSH appears to have derived the 32% figure from an interest-based calculation that incorporates a time-value-of-money adjustment, but Section 12.7 does not authorize any such adjustment. The penalty is capped at 25% of the determined Fair Market Value of the redeemed interest, period.
Second, MSH's calculation of the penalty base appears to include the accrued preferred return ($17.01 million) in addition to the equity value ($36.015 million). Whether the "determined Fair Market Value of the redeemed interest" encompasses the accrued preferred return is an open question of contractual interpretation, as discussed further in Section VI below. If the penalty base is limited to the equity value of the redeemed interest (i.e., MSH's pro rata share of the net asset value), the penalty base would be significantly lower.
Even under MSH's own valuation assumptions and using the contractual 25% cap, the maximum penalty would be:
On equity share alone: 25% × $36.015M = $9.004 million
On equity share plus accrued preferred (if included in the base): 25% × ($36.015M + $17.01M) = 25% × $53.025M = $13.256 million
MSH's $16.975 million demand is thus overstated by any measure — by approximately $3.7 million to $8.0 million depending on the interpretation of the penalty base. This overstatement undermines the credibility of MSH's penalty claim and should be highlighted in PCG's responsive briefing.
IV. ANALYSIS OF BAD-FAITH STANDARD UNDER FLORIDA LAW
A. Florida's Implied Covenant of Good Faith and Fair Dealing
Under Florida law, every contract includes an implied covenant of good faith and fair dealing. This covenant is a foundational principle of Florida contract law, recognized by the Florida Supreme Court and consistently applied by Florida's appellate courts. See, e.g., Centurion Partners Holdings LLC v. Watermark Capital Group, 287 So. 3d 1145, 1152 (Fla. 4th DCA 2019) ("The implied covenant of good faith and fair dealing is an inherent part of every Florida contract and protects the reasonable expectations of the contracting parties."). The covenant prevents a party from exercising contractual discretion in a manner that deprives the other party of the benefit of the bargain, even where the party's conduct is technically within the literal terms of the contract.
Florida courts apply an objective standard in evaluating alleged breaches of the implied covenant: whether the challenged conduct frustrates the purpose of the contract or deprives the other party of reasonably expected benefits. See Riverview Capital Advisors Inc. v. Magellan Ventures LLC, 314 So. 3d 202, 211 (Fla. 3d DCA 2021) ("[T]he inquiry is whether, viewed objectively, the party's conduct was consistent with the reasonable expectations created by the contract, or whether it was designed to deprive the other party of the fruits of the agreement."). Importantly, the objective standard looks not only at the challenged party's subjective intent but also at whether the conduct, considered in context, was commercially reasonable and consistent with the parties' reasonable expectations at the time of contracting.
The Operating Agreement is governed by the Florida Revised LLC Act, Chapter 605, Florida Statutes, as specified in OA Section 15.2. Under Section 605.0409 of the Florida Revised LLC Act, the obligations of a manager in a manager-managed LLC are subject to the implied contractual covenant of good faith and fair dealing, which may not be entirely eliminated by the operating agreement. See Fla. Stat. § 605.0105(3)(e) (providing that an operating agreement may not "eliminate the implied contractual covenant of good faith and fair dealing"). This statutory provision reinforces the applicability of the good-faith standard to PCG's exercise of the call option in its capacity as Manager.
B. "Bad Faith" in Contractual Buyout / Valuation Contexts
The question presented in this arbitration — whether a controlling member's exercise of a contractual call option and procurement of a below-counterparty appraisal constitutes "bad faith" — is not one that Florida courts have addressed with great frequency, but several lines of authority provide useful guidance.
Mere valuation disagreement does not constitute bad faith. Florida courts have consistently held that a good-faith disagreement over the appropriate methodology, assumptions, or conclusions of a valuation exercise does not, without more, constitute bad faith or a breach of the implied covenant. In Bayside Marina Partners LLC v. Coastline Development Corp., 298 So. 3d 884, 893 (Fla. 2d DCA 2020), the court addressed a claim that a majority partner's retained appraiser had undervalued partnership real estate in connection with a buyout. The court held that "[a] divergence in appraisal conclusions, even a substantial one, is not by itself evidence of bad faith; it is the ordinary consequence of the exercise of professional judgment by different appraisers applying different, but reasonable, methodologies." The court noted that the partnership agreement, like the OA here, provided a mechanism for resolving appraisal divergence through a neutral third appraiser, and the invoking party's compliance with that mechanism "weigh[ed] heavily against a finding of bad faith."
Bad faith requires evidence of intentional deception, manipulation, or abuse. Courts have drawn a clear distinction between aggressive-but-good-faith valuation positions and conduct tainted by actual fraud, manipulation of appraisal inputs, or abuse of a controlling position to extract an unfair price. In Meridian Gulf Holdings Inc. v. Prestige Resorts International LLC, 331 So. 3d 45, 58 (Fla. 4th DCA 2021), the court held that a finding of bad faith in a contractual buyout context required "evidence that the controlling party engaged in conduct designed to corrupt the valuation process, such as directing the appraiser to reach a predetermined conclusion, withholding material information from the appraiser, or providing the appraiser with knowingly false data." The court emphasized that "the mere fact that the controlling party selected an appraiser who ultimately arrived at a favorable valuation does not establish bad faith, so long as the appraiser was independent and applied a professionally defensible methodology."
The existence of a professionally prepared appraisal by a credentialed appraiser strongly militates against bad faith. Where a party has retained a qualified, independent, MAI-certified appraiser, and the appraiser has applied a recognized valuation methodology and reached conclusions within the range of reasonable professional judgment, courts have been reluctant to find bad faith, even if the appraisal falls on the low end of the valuation spectrum. See Palmetto Bay Capital LLC v. Southeastern Equity Partners, 319 So. 3d 1101, 1114 (Fla. 3d DCA 2021) ("An appraisal that falls at the lower end of a range of professionally defensible values is not, without more, evidence of bad faith. Bad faith requires something beyond an unfavorable result."). The rationale is that the party's reliance on the professional judgment of an independent expert, even one selected by the party, reflects a good-faith effort to determine value through the contractually prescribed process.
Courts distinguish between "aggressive but good-faith" positions and those tainted by fraud or manipulation. This distinction is central to the analysis here. PCG's position is that it exercised a contractual right, retained an independent appraiser, and relied in good faith on that appraiser's professional conclusions. Even if the Whitfield appraisal is ultimately determined to be on the low side — as the Linden Park preliminary indication suggests it may be — this does not transform a legitimate valuation position into a bad-faith act. MSH must prove something more: that PCG corrupted the process, directed the outcome, or otherwise acted with the intent to deprive MSH of the value of its interest.
We also note that analogous Delaware case law on squeeze-out valuations and good-faith obligations in LLC buyouts is potentially relevant to this arbitration, even though the OA is governed by Florida law. MSH is organized as a Delaware LLC, and MSH's counsel may seek to import Delaware's robust body of fiduciary duty and good-faith jurisprudence into the analysis. Delaware courts have addressed analogous questions in the context of statutory appraisal proceedings and LLC disputes. See, e.g., In re Sterling Capital Advisors LLC, 2019 WL 2847302 (Del. Ch. 2019) (analyzing good-faith obligations in the context of an LLC buyout and finding that the controlling member's retention of a qualified appraiser and compliance with the operating agreement's buyout procedures was "strong evidence of good faith, even where the appraisal fell materially below the minority member's expectations"). While Delaware law is not controlling here, the arbitrator may find Delaware precedent persuasive to the extent it is consistent with Florida's good-faith framework.
Florida courts evaluating claims of bad faith in valuation contexts look to the totality of the circumstances, including but not limited to: (i) the process followed by the controlling party in exercising the contractual right, (ii) whether the retained appraiser was independent and free from undue influence, (iii) whether the controlling party influenced or manipulated the appraisal inputs in a manner designed to suppress value, and (iv) whether the contractual safeguards (such as the third-appraiser mechanism) were honored. See Bayside Marina Partners, 298 So. 3d at 894; Meridian Gulf Holdings, 331 So. 3d at 59. As discussed in Section V below, PCG's conduct fares favorably under each of these factors, though certain discovery-related uncertainties persist.
C. Burden of Proof
MSH bears the burden of proving bad faith under Section 12.7 of the Operating Agreement. This allocation of the burden follows from the general principle that the party asserting a claim must prove its essential elements, and from the specific structure of Section 12.7, which imposes the penalty only "[i]f" bad faith or intent to understate is established. MSH is the claimant with respect to the penalty claim and bears the burden of persuasion.
In this JAMS arbitration, the applicable standard of proof is the preponderance of the evidence — that is, MSH must prove that it is more likely than not that PCG exercised the call option in bad faith or with the intent to materially understate Fair Market Value. While this is a lower standard than the "clear and convincing evidence" standard that some jurisdictions apply to claims of fraud, it still requires affirmative proof of PCG's wrongful intent. Mere suspicion, speculation, or inference from a valuation gap is not sufficient to meet even a preponderance standard.
Bad faith is an inherently subjective inquiry in the sense that MSH must ultimately prove PCG's state of mind — that PCG intended to understate Fair Market Value or acted in bad faith. This is a difficult burden to carry, particularly where the challenged conduct (selecting an appraiser, exercising a contractual option) is facially consistent with the exercise of legitimate contractual rights. MSH's primary avenue for establishing intent is through documentary evidence of PCG's internal deliberations, which explains the significance of MSH's motion to compel production of PCG's internal investment-committee memoranda. That motion, filed November 6, 2023 and partially granted on November 30, 2023, appears to be MSH's principal strategy for obtaining direct evidence of PCG's state of mind. The implications of the compelled production are discussed further in Section VII below.
V. EVALUATION OF MSH'S SPECIFIC BAD-FAITH ARGUMENTS
We turn now to an evaluation of each of MSH's five principal bad-faith arguments, assessing the legal and factual strength of each and identifying the key risk factors that could affect the outcome.
A. Selection of Whitfield Realty Advisors LLC
MSH alleges that PCG's selection of Whitfield was an act of "appraiser shopping" designed to produce a below-market valuation. We assess this argument as posing low risk to PCG.
Section 12.4 of the Operating Agreement expressly grants PCG the right to select the appraiser who will initially determine Fair Market Value. This right is not subject to MSH's approval or consent and is not conditioned on any requirement that PCG select a particular type of appraiser, consult with MSH about the selection, or justify its choice. The sole contractual requirement is that the appraiser be "independent" and "MAI-certified." The exercise of a negotiated contractual right cannot, without more, constitute evidence of bad faith. See Meridian Gulf Holdings, 331 So. 3d at 57 ("A party does not act in bad faith by exercising a right that the contract expressly confers upon it, even if the exercise of that right is disadvantageous to the other party.").
Gerald K. Whitfield, MAI, is a credentialed and experienced appraiser with a demonstrated record of valuing hospitality assets in the Florida market. Mr. Whitfield has been practicing as an MAI-designated appraiser for over twenty years and has appraised in excess of 150 hotel and resort properties in Florida and the southeastern United States. He is a member of the Appraisal Institute and holds the MAI designation, which is the qualification specified in Section 12.4. There is no evidence of any prior improper relationship between Mr. Whitfield and PCG — no history of employment, financial dependence, or undisclosed conflicts. Mr. Whitfield has not previously been retained by PCG or any PCG-affiliated entity, and his retention for this engagement was an arm's-length transaction.
PCG's position is straightforward: it selected a competent, independent, credentialed appraiser in the exercise of its contractual right, and it relied in good faith on the professional conclusions of that appraiser. The fact that the Whitfield appraisal produced a valuation at the lower end of the range does not retroactively transform the selection of Whitfield into an act of bad faith.
Risk Factor: The principal risk on this issue arises from the possibility that MSH could develop evidence — through discovery or deposition testimony — that PCG solicited preliminary indications of value from multiple appraisal firms before selecting Whitfield. If it could be shown that PCG contacted, for example, three or four appraisers, received preliminary indications of value, and then selected Whitfield because Whitfield provided the lowest indicative value, this could undermine PCG's position. Such conduct could be characterized as "appraiser shopping" — i.e., the selection of an appraiser not for the appraiser's qualifications but for the favorability of the expected result. However, no evidence of such appraiser shopping has surfaced in discovery to date. Mr. Whitfield testified at his deposition on September 18, 2023 that he was contacted by PCG through a referral from a professional contact and that he was not aware of PCG having solicited indications from other appraisers. Unless contradictory evidence emerges, this factor should remain favorable to PCG.
Assessment: Low risk.
B. Alleged Manipulation of Appraisal Inputs
MSH's second argument — that PCG provided selectively pessimistic operating projections and exaggerated capital expenditure requirements to Whitfield in order to depress the appraised value — is a more serious allegation and presents low to moderate risk, depending on what the compelled discovery documents reveal.
As an initial matter, it is important to identify what Whitfield's appraisal actually relied upon. The Whitfield appraisal used the following actual 2022 financial data for the Palmetto Grand property:
These figures are derived from PGV's audited financial statements for the fiscal year ended December 31, 2022, as prepared by the venture's independent auditor. They are not projections or estimates; they are verified historical figures. MSH has not challenged the accuracy of these historical financials.
The methodological differences between the Whitfield and Beacon appraisals are significant and, in our view, account for the bulk of the valuation divergence:
Several observations are warranted. Whitfield employed a blended methodology, weighting the sales-comparison approach at 60% and the income approach (using direct capitalization) at 40%. The sales-comparison approach relies on comparable transactions in the Florida hospitality market and is less sensitive to forward-looking assumptions about revenue growth, occupancy, and operating margins. By contrast, Beacon relied exclusively on the income approach, using a discounted cash flow methodology with a significantly lower discount rate (8.5% vs. Whitfield's 10.75%) and an optimistic terminal capitalization rate (7.75%). The Beacon appraisal's lower discount rate implies a more favorable risk assessment of the property's future cash flows, while the lower terminal cap rate implies a higher exit valuation. These are matters of professional judgment on which reasonable appraisers can and do differ.
Critically, the Linden Park preliminary indication of value ($130.0 million to $138.0 million) falls closer to the Whitfield valuation than to the Beacon valuation. The Linden Park midpoint of approximately $134.0 million is $16.0 million above Whitfield and $17.5 million below Beacon. If the Linden Park final appraisal confirms this range, it would suggest that the Whitfield appraisal, while on the low side, is not so far outside the range of reasonable values as to support an inference of manipulation. It would also suggest that the Beacon appraisal may be the more aggressive of the two party-retained valuations — a point that PCG should emphasize in its briefing.
That said, the Whitfield appraisal's income-approach component did rely on forward-looking projections for capital expenditures, revenue growth, and operating margins. To the extent PCG, as Manager, provided Whitfield with operating projections that were selectively pessimistic or inconsistent with PCG's own internal forecasts, this could support MSH's manipulation theory. MSH has identified certain discrepancies between the capital expenditure projections furnished to Whitfield and the capital expenditure forecasts included in PCG's 2022 investor presentation to its limited partners. Specifically, MSH alleges that the projections provided to Whitfield assumed annual capital expenditures of approximately $4.8 million over the five-year projection period, whereas the investor presentation assumed approximately $3.2 million per year. If this discrepancy is substantiated and cannot be adequately explained, it could create an inference that PCG inflated capital expenditure assumptions to suppress the income-approach valuation.
Risk Factor: The content of the investment-committee memoranda compelled by the arbitrator's November 30, 2023 order will be pivotal on this issue. If those documents show that PCG's internal valuation analysis closely aligned with the assumptions provided to Whitfield and reflected a legitimate, good-faith assessment of the property's financial prospects, the risk decreases. Conversely, if the documents reveal that PCG's internal analysis valued the property materially higher than $118.0 million, or if they contain communications suggesting that PCG provided Whitfield with deliberately conservative assumptions, directed Whitfield toward a particular valuation target, or criticized draft appraisals as being "too high," the risk would increase significantly. We strongly recommend that Adriana Pellegrino-Voss and Marcus Thiel (PCG's Director of Asset Management) be consulted regarding the specific content of these documents before this assessment is finalized.
Assessment: Low to moderate risk, subject to revision based on compelled document production.
C. Deferred Maintenance Allegations (OA Section 8.3)
MSH's allegation that PCG deliberately deferred $8.2 million in property maintenance to depress the property's condition and appraised value is, in our assessment, MSH's strongest argument in support of the bad-faith penalty claim. We assess this argument as posing moderate risk.
The theory is as follows: PCG, as sole Manager, controls all capital expenditure and maintenance decisions for the PGV assets. OA Section 8.3 requires the Manager to maintain the JV assets in "good condition and repair consistent with the property's classification and market positioning." MSH contends that beginning in approximately mid-2021 — roughly one year before the call option became exercisable — PCG began deferring discretionary and non-discretionary maintenance expenditures, including HVAC system replacements, pool and spa renovations, exterior painting, and lobby and common-area renovations. MSH calculates the cumulative maintenance deferral at approximately $8.2 million and has retained Harborstone Group LLC to prepare an expert report quantifying the deferral and its impact on the property's physical condition and appraised value.
A separate, more detailed analysis of the deferred maintenance claim under OA Section 8.3 is being prepared by our team and is expected to be completed in October 2023. For purposes of this bad-faith risk assessment, we offer the following preliminary observations:
PCG invested a total of $24.3 million in renovation capital for the Palmetto Grand property during the initial renovation period from 2017 to 2019. This was a substantial capital investment that brought the property to its current luxury-resort standard. Subsequent annual capital budgets from 2020 through 2022 appear, at a preliminary level, to be consistent with industry norms for a property of this classification. The $8.2 million figure cited by MSH appears to include a number of items that are more properly characterized as discretionary capital improvements (e.g., a planned lobby redesign, a proposed spa expansion) rather than deferred maintenance in the traditional sense. The distinction matters because the Manager's obligation under Section 8.3 is to maintain the property in good condition and repair — it does not obligate the Manager to undertake every capital improvement that might enhance value.
Even if some maintenance was in fact deferred, deferred maintenance alone is generally not evidence of bad faith in a call-option context. Many factors influence capital expenditure decisions, including cash flow constraints, market conditions, seasonality, and the Manager's assessment of the optimal timing for various projects. To establish bad faith, MSH must show not merely that maintenance was deferred, but that the deferral was strategically motivated by PCG's intent to exercise the call option at a depressed price. This is a causal nexus that requires proof of PCG's subjective intent.
Risk Factor: This argument is MSH's strongest because it ties PCG's conduct as Manager (capital expenditure decisions) directly to the valuation outcome (a property in allegedly suboptimal condition is worth less than a well-maintained property). If MSH can produce documentary evidence — internal emails, investment committee minutes, board presentations — showing that PCG deliberately postponed or cancelled maintenance projects specifically in anticipation of exercising the call option after June 15, 2022, this would significantly bolster the bad-faith claim. The temporal nexus between the alleged onset of maintenance deferral (mid-2021) and the option eligibility date (June 15, 2022) is suggestive, and MSH will undoubtedly argue that this timing is not coincidental. PCG must be prepared to offer credible, contemporaneous explanations for its capital expenditure decisions during this period — for example, pandemic-related cash flow constraints, supply chain disruptions affecting construction materials, or the Manager's good-faith assessment that certain projects were not yet necessary.
Assessment: Moderate risk. This is the factor most likely to create a viable path for MSH's bad-faith claim, and PCG should devote significant attention to preparing its defense on this issue.
D. Timing of Call-Option Exercise
MSH argues that PCG's decision to exercise the call option on January 9, 2023 — approximately seven months after the option became exercisable on June 15, 2022 — was strategically timed to capture value before planned improvements and favorable market developments could be reflected in PGV's financials. We assess this argument as posing low risk.
The Operating Agreement grants PCG an unconditional right to exercise the call option at any time after the fifth anniversary. Section 12.4(a) requires only that PCG deliver "written notice to [MSH] of its election to exercise the call option," and it imposes no waiting period, no advance notice requirement, no obligation to consult with MSH about the timing, and no obligation to justify the timing of exercise. PCG's exercise on January 9, 2023, was fully within the scope of this contractual right.
MSH's argument that the timing was "strategically" chosen to precede value-enhancing events is speculative. The call option became exercisable in June 2022, and PCG exercised it in January 2023. A seven-month gap between eligibility and exercise is not, by any standard, unreasonably hasty. Moreover, MSH's argument proves too much: any exercise of a call option, by definition, captures value at a specific point in time. If the exercise occurs before a future improvement, the minority member might complain of strategic timing; if it occurs after a period of strong performance, the minority member might complain that the controlling party waited until its own value contribution was maximized. The OA resolves this issue by granting PCG discretion over timing, subject only to the good-faith obligation.
There is no evidence in the record that PCG's timing was driven by an intent to capture value before improvements. PCG has legitimate, documented business reasons for the timing of the exercise, including the desire to simplify PGV's ownership structure in anticipation of a potential refinancing of the property's senior debt facility with Southeastern Commerce Bank, which was under discussion in late 2022.
Assessment: Low risk. This argument is weak because the contractual right is unambiguous and because MSH has not identified any specific value-enhancing event that PCG was allegedly trying to precede.
E. The 28.4% Appraisal Divergence as Evidence of Bad Faith
MSH's final argument is that the 28.4% divergence between the Whitfield and Beacon appraisals is, in and of itself, circumstantial evidence that the Whitfield appraisal was the product of manipulation. We assess this argument as posing low risk.
Appraisal divergence is common in the hospitality sector, where different appraisers routinely apply different methodologies, use different comparable transactions, and employ different capitalization and discount rates. The divergence between Whitfield and Beacon is driven principally by: (i) Whitfield's use of a blended income/sales-comparison approach versus Beacon's exclusive reliance on the income approach, (ii) Whitfield's higher capitalization rate (9.5% vs. Beacon's implied rate), (iii) Whitfield's higher discount rate (10.75% vs. 8.5%), and (iv) the different weightings and comparable transactions selected. These are legitimate methodological choices on which competent professionals routinely disagree.
The Operating Agreement itself anticipated the possibility of significant divergence by including the 10% threshold in Section 12.4(c). If the drafters had intended that any divergence above a certain level would constitute per se evidence of bad faith, they would have said so. Instead, the contract provides a procedural safeguard — the neutral third appraiser — to resolve divergences. The fact that the parties bargained for this mechanism reflects the understanding that reasonable appraisals of a complex hospitality asset may differ materially. PCG honored this mechanism by agreeing to the joint retention of Linden Park, cooperating in the neutral appraisal process, and not attempting to obstruct or delay the third-appraiser procedure.
Moreover, as noted above, the Linden Park preliminary indication ($130.0–$138.0 million) falls closer to the Whitfield appraisal than to the Beacon appraisal. If the final Linden Park appraisal confirms this range, the "two closest" appraisals under Section 12.4(c) would be Whitfield and Linden Park — not Beacon and Linden Park. This outcome would further undermine MSH's narrative that the Whitfield appraisal was an outlier produced by manipulation.
Assessment: Low risk. Appraisal divergence alone, without evidence of intent or manipulation, is insufficient to establish bad faith.
VI. QUANTIFICATION OF POTENTIAL PENALTY EXPOSURE
A. Maximum Exposure Under Various Valuation Scenarios
We present below PCG's maximum penalty exposure under three valuation scenarios, reflecting the three appraisals that may inform the arbitrator's determination of Fair Market Value. In each scenario, we calculate the maximum 25% penalty on both (i) the equity value of MSH's 35% interest alone and (ii) the equity value plus the accrued preferred return, recognizing that the correct penalty base is an open interpretive question.
For all scenarios, we assume that PGV's outstanding senior debt to be deducted from gross asset value for purposes of determining net equity is $48.6 million, which reflects the outstanding principal balance of the Southeastern Commerce Bank credit facility as of the January 9, 2023 exercise date.
Scenario 1: Arbitrator Adopts Whitfield Value ($118.0M)
Gross asset value: $118.0M Less outstanding debt: ($48.6M) Net equity: $69.4M MSH 35% equity share: $69.4M × 0.35 = $24.29M
Maximum 25% penalty on equity interest alone: $24.29M × 0.25 = $6.07M Maximum 25% penalty on equity + accrued preferred: ($24.29M + $17.01M) × 0.25 = $41.30M × 0.25 = $10.325M
Scenario 2: Arbitrator Adopts Linden Park Midpoint ($134.0M)
Gross asset value: $134.0M Less outstanding debt: ($48.6M) Net equity: $85.4M MSH 35% equity share: $85.4M × 0.35 = $29.89M
Maximum 25% penalty on equity interest alone: $29.89M × 0.25 = $7.47M Maximum 25% penalty on equity + accrued preferred: ($29.89M + $17.01M) × 0.25 = $46.90M × 0.25 = $11.725M
Scenario 3: Arbitrator Adopts Beacon Value ($151.5M)
Gross asset value: $151.5M Less outstanding debt: ($48.6M) Net equity: $102.9M MSH 35% equity share: $102.9M × 0.35 = $36.015M
Maximum 25% penalty on equity interest alone: $36.015M × 0.25 = $9.004M Maximum 25% penalty on equity + accrued preferred: ($36.015M + $17.01M) × 0.25 = $53.025M × 0.25 = $13.256M
The following table summarizes the range of potential maximum penalty exposure:
In all three scenarios, MSH's $16.975 million penalty demand exceeds the contractual maximum. Even under the most adverse assumptions — the Beacon valuation plus inclusion of the preferred return in the penalty base — the maximum permissible penalty is $13.256 million, which is $3.719 million less than MSH's demand. MSH's 32% multiplier has no contractual basis and should be rejected.
Open Interpretation Issue: Whether the "Fair Market Value of the redeemed interest" in Section 12.7 includes only the equity value of MSH's interest or also the accrued but unpaid preferred return of $17.01 million is an issue of first impression under the Operating Agreement. The term "redeemed interest" is defined in Section 1.1 of the OA as "the Membership Interest of the Non-Manager Member that is the subject of the call option under Section 12.4." Section 7.2 addresses the preferred return separately, treating it as a distributional entitlement rather than a component of the membership interest's fair market value. On balance, we believe the better reading is that the penalty base is limited to the equity value of the redeemed interest and does not include the accrued preferred return, which is a separate contractual obligation. However, this is not free from doubt, and MSH will likely argue for the broader interpretation. The difference between the two interpretations is approximately $3.0 million to $4.3 million in penalty exposure, depending on the valuation scenario.
B. Discretionary Nature of the Penalty
Even if the arbitrator finds that PCG acted in bad faith, the penalty is not automatically imposed at the full 25% rate. Section 12.7 states "up to twenty-five percent" — this language confers discretion on the arbitrator to impose any penalty amount from zero to the 25% cap. The use of the phrase "up to" is universally understood in contract law to establish a ceiling, not a floor. See Landmark Capital Partners LLC v. Gulf States Realty Trust, 305 So. 3d 478, 489 (Fla. 1st DCA 2020) ("The phrase 'up to' in a contractual penalty provision establishes the maximum penalty; the decision-maker retains discretion to impose a lesser amount where the circumstances warrant.").
Even upon a finding of bad faith, the arbitrator will likely calibrate the penalty to the severity of the bad-faith conduct. If the bad faith is found to be limited — for example, if the arbitrator finds that PCG provided somewhat aggressive capital expenditure assumptions to Whitfield but did not engage in outright fraud or direct the appraisal conclusion — the penalty is likely to be imposed at a level well below the 25% cap. Analogous contractual penalty provisions under Florida law are subject to a general reasonableness inquiry, and courts and arbitrators routinely impose penalties well below the contractual maximum where the bad faith is not egregious. See Bayside Marina Partners, 298 So. 3d at 896 (approving a 10% penalty where the contractual cap was 20%, finding that "the controlling partner's conduct, while not exemplary, did not rise to the level of deliberate manipulation warranting the maximum penalty").
This discretionary aspect of the penalty provision provides an important layer of protection for PCG. Even in a worst-case finding of bad faith, the penalty would more likely be in the range of 10–15% rather than the full 25%, unless the arbitrator finds that PCG's conduct was egregious.
VII. IMPACT OF DISCOVERY ON BAD-FAITH RISK
A. Motion to Compel — Investment Committee Memoranda
On November 6, 2023, MSH filed a motion to compel production of PCG's internal investment-committee memoranda relating to the call-option exercise and the valuation of PGV's assets. The motion sought production of all investment committee minutes, memoranda, presentations, and related correspondence from January 2022 through March 2023, on the ground that these documents are directly relevant to PCG's intent and state of mind in exercising the call option and procuring the Whitfield appraisal.
The Honorable Margaret Liu Chen (Ret.) partially granted the motion on November 30, 2023. The order directed PCG to produce all non-privileged investment-committee memoranda and correspondence relating to (i) the decision to exercise the call option, (ii) the selection of the appraiser, and (iii) the valuation of PGV's assets during the relevant time period. The order permitted PCG to withhold documents protected by the attorney-client privilege or the work-product doctrine, subject to the production of a detailed privilege log.
PCG's supplemental production and privilege log, prepared in December 2023 (in progress as of this writing), identifies the responsive documents. A number of documents have been or will be produced; others have been withheld on privilege and work-product grounds. The privilege log identifies approximately twenty-two responsive documents, of which fourteen are being produced and eight are being withheld.
Critical Assessment: The content of the produced investment-committee memoranda will be the single most significant factor in determining the ultimate risk level on the bad-faith penalty claim. Two starkly different outcomes are possible:
Favorable scenario: The produced documents reflect a methodical, good-faith decision-making process. The investment committee memoranda discuss the call option as a strategic business decision (e.g., ownership simplification, refinancing preparation), the selection of Whitfield as a qualified appraiser, and reliance on Whitfield's independent judgment. The internal valuation analysis is broadly consistent with the assumptions provided to Whitfield, and there are no communications suggesting a target valuation or direction to suppress value. In this scenario, the documents would significantly reduce bad-faith risk and could be used affirmatively by PCG to demonstrate good faith.
Adverse scenario: The produced documents reveal internal communications suggesting that PCG's team was aware that the property was worth materially more than $118.0 million, or that PCG's internal valuation models produced estimates in the range of $130.0–$145.0 million. The documents contain statements by PCG personnel criticizing draft Whitfield appraisals as "too high" or suggesting a desired target valuation. Communications between PCG and Whitfield reveal that PCG pushed back on Whitfield's preliminary conclusions or directed Whitfield to adopt particular assumptions. In this scenario, the risk of a bad-faith finding would increase substantially, potentially to the moderate-to-high range.
We strongly recommend that Dominic Pellegrino, Adriana Pellegrino-Voss, and Marcus Thiel (PCG's Director of Asset Management, who prepared the capital expenditure projections furnished to Whitfield) be consulted on the content of the responsive documents before this risk assessment is finalized. If any of the produced documents contain problematic language or if any of the withheld documents present privilege vulnerabilities, we need to know immediately so that we can adjust our strategy accordingly.
B. Deposition Testimony
To date, four depositions have been taken that are directly relevant to the bad-faith penalty claim:
1. Gerald K. Whitfield (Whitfield Realty Advisors LLC) — Deposed September 18, 2023
2. Dr. Priya Ramanathan (Beacon Capital Valuation LLC) — Deposed September 18, 2023
3. Dominic R. Pellegrino (Managing Member, PCG) — Deposed October 10, 2023
4. Nathaniel Cordero (Managing Partner, MSH) — Deposed October 10, 2023
The key issues arising from these depositions, which should be assessed in conjunction with the complete deposition transcripts and testimony summaries being prepared separately by our team, include the following:
Whitfield deposition: Did Mr. Whitfield testify credibly about the independence of his engagement? Did he confirm that he was not directed by PCG to reach a particular valuation conclusion? Did he explain the methodological bases for his appraisal in a manner that supports the reasonableness of his conclusions? Were there any damaging admissions regarding PCG's influence on assumptions or inputs? Preliminary reports from the deposition suggest that Mr. Whitfield was a generally credible witness who defended the independence and methodology of his appraisal, but a complete review of the transcript is necessary.
Pellegrino deposition: Did Dominic Pellegrino's testimony reveal any problematic communications with Whitfield or any admissions suggesting that PCG sought to influence the appraisal outcome? Did Mr. Pellegrino articulate credible, good-faith business reasons for exercising the call option and for the timing of the exercise? Were there any inconsistencies between his testimony and the documentary record? This deposition is of particular concern because MSH's counsel, Victoria Castillo, is known to be an aggressive and skilled cross-examiner. Any statements by Mr. Pellegrino that can be construed as admissions of intent to suppress value would be damaging.
Cordero deposition: Did Nathaniel Cordero provide specific factual support for MSH's bad-faith allegations, or did he primarily rely on the valuation gap and general assertions of unfairness? If Cordero's testimony is largely conclusory and lacks specific factual grounding, it weakens MSH's case. If, on the other hand, Cordero identified specific communications or interactions with PCG that suggest bad faith — for example, statements by PCG personnel indicating an awareness that the property was worth more than the Whitfield value — this would be significant.
Dr. Ramanathan deposition: Did Dr. Ramanathan defend the methodology and conclusions of the Beacon appraisal credibly? Did the cross-examination reveal any weaknesses in the Beacon appraisal that could be exploited to argue that the Beacon valuation is the outlier, not the Whitfield valuation? Preliminary indications suggest that Dr. Ramanathan's exclusive reliance on the income approach (without a sales-comparison approach) and her use of an 8.5% discount rate — which is on the low end of the range for Florida luxury hospitality assets — may be vulnerable to challenge.