PRIVILEGED AND CONFIDENTIAL — ATTORNEY-CLIENT COMMUNICATION / ATTORNEY WORK PRODUCT
CALDERWOOD & HARKNESS LLP 801 Brickell Avenue, Suite 2800 Miami, FL 33131
MEMORANDUM
TO: Dominic R. Pellegrino, Managing Member, Pellegrino Capital Group LLC Adriana Pellegrino-Voss, Senior Vice President of Investments, Pellegrino Capital Group LLC
FROM: Francesca Morano, Partner, Calderwood & Harkness LLP
DATE: April 18, 2023
RE: Initial Case Assessment — Meridian Shores Hospitality LLC v. Pellegrino Capital Group LLC, JAMS Ref. No. 1440032871
MATTER NO.: 1027-00003
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I. Executive Summary
Calderwood & Harkness LLP was engaged on March 22, 2023 to represent Pellegrino Capital Group LLC ("PCG") in connection with a buyout-valuation dispute initiated by Meridian Shores Hospitality LLC ("MSH"). This memorandum provides our initial case assessment based on our review to date of the governing Operating Agreement of Palmetto Grand Ventures LLC ("PGV"), the Whitfield and Beacon appraisals, the parties' arbitration filings, and our preliminary factual investigation.
On March 20, 2023, MSH filed a Demand for Arbitration with JAMS, alleging that PCG's exercise of its call option under Section 12.4 of the Operating Agreement of PGV materially understated the fair market value of the joint venture's assets. MSH asserts that PCG engaged in bad-faith conduct in selecting its appraiser and structuring the valuation, and seeks a total buyout price of $70.0 million for its 35% membership interest in PGV. PCG tendered $41.3 million to MSH on March 1, 2023 — a figure derived from the independent appraisal conducted by Whitfield Realty Advisors LLC. The resulting gap between the parties' positions is $28.7 million.
PCG filed its Response and Counterclaim on April 5, 2023, seeking declaratory relief that the $41.3 million tendered constitutes the proper buyout price under the Operating Agreement's prescribed valuation mechanism, or, alternatively, that fair market value should be determined through the neutral third-appraiser process contemplated by Section 12.4(c) without application of any bad-faith penalty.
The Honorable Margaret Liu Chen (Ret.) has been appointed as arbitrator, effective April 28, 2023, and a preliminary conference is expected to be scheduled for mid-May 2023.
This memorandum is organized as follows: (a) a summary of the factual background, including the formation of the joint venture, the hotel's financial performance, the key economic terms of the Operating Agreement, and the call-option exercise and tender; (b) an analysis of MSH's three principal claims; (c) an evaluation of PCG's affirmative defenses and counterclaim; (d) a risk-exposure assessment, including a probability-weighted analysis of likely outcomes; and (e) preliminary strategic recommendations regarding the arbitration, settlement posture, lender coordination, and privilege protection.
Our overall assessment is as follows: PCG possesses meritorious defenses against each of MSH's claims, particularly the bad-faith valuation claim, which faces a high evidentiary bar under Florida law. However, the magnitude of the valuation gap between the two party-appointed appraisals — a 28.4% divergence — and the potential for a bad-faith penalty award under Section 12.7 of the Operating Agreement counsel in favor of a litigation strategy that aggressively defends against the bad-faith allegation while preserving settlement optionality. The neutral third appraisal mandated by Section 12.4(c) will be the single most important determinant of the ultimate outcome, and PCG should prioritize the selection of a credible, well-qualified neutral appraiser at the earliest opportunity.
II. Background and Factual Summary
A. The Joint Venture and the Property
Palmetto Grand Ventures LLC ("PGV") was formed on June 15, 2017 as a limited liability company organized under the laws of the State of Florida. The Operating Agreement of PGV (the "Operating Agreement" or "OA") was executed and became effective on the same date. PGV is governed by the Florida Revised Limited Liability Company Act, Chapter 605 of the Florida Statutes (the "Act").
The stated purpose of PGV, as set forth in Article II of the Operating Agreement, is the acquisition, renovation, management, and operation of The Palmetto Grand Resort & Spa, a luxury beachfront hotel located at 650 Mandalay Avenue, Clearwater Beach, Florida 33767 (the "Property" or the "Hotel"). The joint venture was structured with two members: PCG, which holds a 65% membership interest and serves as the sole Manager of PGV, and MSH, which holds the remaining 35% membership interest and functions as a passive investor with specified consent rights.
The Hotel is a 312-room full-service luxury beachfront resort situated on Clearwater Beach in Pinellas County, Florida. The property includes 270 standard guest rooms and 42 suites, two full-service restaurants, a rooftop bar and lounge, an approximately 18,000-square-foot spa and wellness center, approximately 22,000 square feet of meeting and event space, and beachfront cabana service. The Hotel operates under a franchise agreement with Aurelian Hotels & Resorts Inc. (the "Franchise Agreement"), which was executed on July 15, 2017 and has a 20-year term expiring on July 14, 2037. Under the Franchise Agreement, PGV pays a franchise fee equal to 5% of gross room revenue plus a 2% contribution to the Aurelian Hotels marketing fund.
PGV acquired the Hotel on August 1, 2017 for a total purchase price of $87.5 million. The acquisition was financed with a $61.25 million commercial real estate loan from Gulf Atlantic National Bank (Loan No. CRE-2017-06284), representing a 70% loan-to-value ratio at origination. The loan originally bore interest at LIBOR plus 2.25%, which was converted to SOFR plus 2.25% in connection with the industry-wide LIBOR transition in 2022. The loan has a stated maturity date of August 1, 2027. Total equity required at acquisition, including approximately $2.3077 million in closing costs, was approximately $28.56 million.
At the time of formation, PCG made an initial capital contribution of $18.5625 million, and MSH made an initial capital contribution of $10.0 million. The agreed capital-contribution basis for each member is set forth in Section 4.1 of the Operating Agreement.
Following the acquisition, PGV undertook a comprehensive renovation of the Hotel during the period from 2017 through 2019, at a total cost of $24.3 million. The renovation was funded by additional capital contributions from both members in proportion to their respective membership interests: PCG contributed $15.795 million (65%) and MSH contributed $8.505 million (35%). The renovation encompassed upgrades to guest rooms and suites, the addition of the rooftop bar, expansion and modernization of the spa and wellness center, and improvements to common areas, meeting facilities, and the property's beachfront amenities.
MSH's total capital contributions to PGV aggregate to $18.505 million, consisting of its initial contribution of $10.0 million and its renovation-period contributions of $8.505 million. This figure is significant because it serves as the basis for calculating MSH's accrued preferred return under the Operating Agreement's distribution waterfall.
B. Hotel Financial Performance (2022)
The Hotel has performed well since the completion of the renovation, particularly in the post-pandemic recovery period. For the fiscal year ended December 31, 2022, the Hotel reported the following key performance metrics:
• Total Revenue: $62.8 million
• Revenue Per Available Room (RevPAR): $289
• Net Operating Income (NOI): $18.4 million
• Hotel-Level EBITDA: $19.7 million
These results reflect the Hotel's strong competitive position within the Clearwater Beach and broader Gulf Coast luxury resort market. The RevPAR of $289 places the Hotel among the top-performing luxury resorts in the Tampa Bay–Clearwater metropolitan area, and the NOI margin of approximately 29.3% is consistent with well-managed full-service luxury hotel operations.
As of December 31, 2022, the outstanding principal balance on the Gulf Atlantic National Bank loan was $48.6 million, having amortized from the original principal amount of $61.25 million over the approximately five-and-a-half-year period since origination. The debt service coverage ratio remained comfortably above the loan's 1.35x minimum covenant, which is relevant to the lender-coordination considerations discussed in Section VII.C below.
C. Operating Agreement — Key Economic Terms
The Operating Agreement contains several economic provisions that are directly relevant to the valuation dispute. The most pertinent terms are summarized below.
Preferred Return. Under Section 5.1 of the Operating Agreement, each member is entitled to a preferred return of 8% per annum on its unreturned capital contributions. The preferred return is cumulative and compounds annually. The preferred return accrues regardless of whether PGV generates sufficient distributable cash to pay it in any given period, and any unpaid preferred return accumulates and is added to the member's preferred-return balance.
Promote and Distribution Waterfall. The Operating Agreement establishes a tiered distribution waterfall under Section 5.2. Distributable cash is allocated first to the return of each member's unreturned capital contributions, then to the payment of each member's accrued and unpaid preferred return, and thereafter to profit distributions. After full return of capital and satisfaction of the 8% preferred return, profits are split 70% to PCG and 30% to MSH. Above a 15% internal rate of return threshold (as calculated under the methodology set forth in Section 5.2(d)), the profit split shifts to 75% to PCG and 25% to MSH, reflecting an enhanced promote structure for PCG.
MSH Accrued Preferred Return. Based on our preliminary calculations, MSH's accrued and unpaid preferred return through December 31, 2022 is approximately $17.01 million. This figure reflects 8% annual compounding on MSH's total capital contributions of $18.505 million over the relevant accrual periods, net of any distributions applied against the preferred return. We note that the precise calculation methodology under Section 5.2's distribution-reduction mechanics — which credits distributions first against preferred return and then against unreturned capital — requires verification with Grantham, Pryce & Associates CPAs, PGV's independent accounting firm. We have initiated that process and expect to have a confirmed figure within the next two to three weeks.
MSH Consent Rights. Section 7.3 of the Operating Agreement grants MSH certain consent rights over major decisions, including capital calls in excess of $2.0 million, dispositions of material assets, refinancing transactions, and the incurrence of new indebtedness. These consent rights are relevant to the deferred-maintenance claim discussed in Section III.C, as PCG may argue that any failure to undertake major capital improvements was constrained by the need to obtain MSH's consent to fund such expenditures.
D. Call-Option Exercise and Tender
Section 12.4 of the Operating Agreement grants PCG, as Manager, the right to exercise a call option to purchase MSH's entire membership interest in PGV at any time after the fifth anniversary of the date of the Operating Agreement — that is, at any time on or after June 15, 2022. The purchase price for the redeemed interest is to be the "Fair Market Value" of the redeemed interest, as determined in accordance with the valuation procedures set forth in Section 12.4.
Under Section 12.4(a), upon exercise of the call option, Fair Market Value is to be determined by an independent MAI-certified appraiser selected by PCG. The appraiser must be independent of both PCG and MSH and must hold the MAI designation from the Appraisal Institute.
PCG delivered its call-option exercise notice to MSH on January 9, 2023. In connection with the exercise, PCG retained Whitfield Realty Advisors LLC ("Whitfield") to conduct the required appraisal. Gerald K. Whitfield, MAI, is the principal of the firm and is based in Fort Lauderdale, Florida. Mr. Whitfield has over 25 years of experience in the valuation of hotel and hospitality assets throughout the southeastern United States and holds both the MAI designation and the MRICS (Member of the Royal Institution of Chartered Surveyors) credential.
Whitfield completed its appraisal on February 10, 2023. The appraisal concluded that the Fair Market Value of 100% of the PGV joint venture's real property and operating assets was $118.0 million as of December 31, 2022. Whitfield employed two recognized valuation methodologies:
(i) Income Approach: Whitfield applied both a direct capitalization analysis, using a capitalization rate of 9.5%, and a discounted cash flow ("DCF") analysis, using a discount rate of 10.75%. The two income-approach indicators were blended to arrive at the income-approach conclusion of value.
(ii) Sales Comparison Approach: Whitfield analyzed comparable hotel transactions in the Gulf Coast and broader Florida luxury resort market, making adjustments for location, property quality, size, and market conditions.
(iii) Weighting: Whitfield assigned a weighting of 40% to the income approach and 60% to the sales comparison approach in arriving at the final FMV conclusion of $118.0 million.
Based on the Whitfield appraisal, PCG derived the buyout price as follows:
PCG tendered $41.3 million to MSH on March 1, 2023, in accordance with the payment provisions of Section 12.4(b) of the Operating Agreement. MSH rejected the tender on March 10, 2023, asserting that the Whitfield appraisal materially understated the Fair Market Value of PGV's assets and that PCG had exercised the call option in bad faith.
E. MSH's Appraisal and Demand
Following its rejection of PCG's tender, MSH retained Beacon Valuation Group Inc. ("Beacon") to conduct an independent appraisal of PGV's assets. The Beacon appraisal was prepared by Dr. Priya Ramanathan, CFA, ASA, who is the firm's Managing Director and is based in Miami, Florida. Dr. Ramanathan is a Chartered Financial Analyst and holds the Accredited Senior Appraiser designation from the American Society of Appraisers. She has significant experience in hospitality-sector valuations, though we note that her primary credential is the CFA rather than the MAI designation.
Beacon completed its appraisal on April 14, 2023. The appraisal concluded that the Fair Market Value of 100% of PGV's real property and operating assets was $151.5 million as of December 31, 2022 — a figure $33.5 million, or 28.4%, above Whitfield's conclusion.
Beacon's methodology differs from Whitfield's in several material respects:
(i) Sole Reliance on Income Approach: Beacon employed only the income approach, using a DCF analysis with a discount rate of 8.5% and a terminal capitalization rate of 7.75%. Unlike Whitfield, Beacon did not perform a sales comparison analysis. The absence of a sales comparison approach is a notable methodological weakness that PCG should highlight in the arbitration proceedings.
(ii) Below-Market Franchise Agreement Adjustment: Beacon made an upward adjustment to FMV based on the theory that the Aurelian Hotels franchise agreement is "below market" — that is, that the 5% franchise fee plus 2% marketing contribution is favorable relative to current market franchise terms for luxury resort brands, and that this favorable contractual position has independent economic value that should be reflected in the property's FMV. Whitfield did not make any such adjustment.
(iii) Deferred-Maintenance Adjustment: Beacon included an upward adjustment of $8.2 million to FMV on the theory that the property would have been worth more had PCG, as Manager, properly maintained it. This adjustment is premised on MSH's contention that PCG breached its maintenance obligations under Section 8.3 of the Operating Agreement. Whitfield valued the property in its "as-is" condition and did not include any deferred-maintenance adjustment.
Based on the Beacon appraisal, MSH derived its demanded buyout price as follows:
We note that MSH's claimed bad-faith premium of $16,975,000 appears to represent approximately 32% of the sum of MSH's equity share ($36,015,000) and accrued preferred return ($17,010,000), or approximately $53,025,000. However, Section 12.7 of the Operating Agreement caps the bad-faith penalty at "up to 25% of the determined Fair Market Value of the redeemed interest." Even under Beacon's FMV conclusion, 25% of MSH's 35% equity share of $102.9 million (i.e., 25% of $36,015,000) would be $9,003,750 — substantially less than the $16,975,000 demanded. MSH's penalty calculation appears to either misapply the 25% cap or to apply it to a different base figure than the Operating Agreement contemplates. This is a potential basis for partial dismissal of the penalty claim as pled and should be raised at the earliest appropriate stage of the proceedings.
The divergence between the two appraisals is significant: |$151.5M − $118.0M| / $118.0M = 28.4%. This divergence exceeds the 10% threshold set forth in Section 12.4(c) of the Operating Agreement, which provides that if the FMV determined by the Manager's appraiser and the FMV determined by the redeeming member's appraiser differ by more than 10%, either party has the right to appoint a third, neutral MAI-certified appraiser, and the FMV shall be determined as the average of the two closest appraisals out of the three. The triggering of this mechanism is procedurally favorable to PCG, as discussed in the strategic recommendations below.
F. Procedural Status
The procedural history of the dispute is as follows:
• March 20, 2023: MSH filed its Demand for Arbitration with JAMS, Case No. 1440032871. The Demand asserts three claims: (1) bad-faith valuation under OA Section 12.7; (2) breach of fiduciary duty; and (3) breach of OA Section 8.3 (deferred-maintenance obligations). MSH seeks a total buyout price of $70.0 million, plus attorneys' fees and costs.
• April 5, 2023: PCG filed its Response and Counterclaim. The Response denies MSH's claims and asserts the affirmative defenses described in Section IV.A below. The Counterclaim seeks declaratory relief that $41.3 million is the proper FMV-based buyout price under OA Section 12.4, or alternatively, that FMV should be determined through the third-appraiser mechanism under Section 12.4(c) without application of any bad-faith penalty.
• April 28, 2023: The Honorable Margaret Liu Chen (Ret.) was appointed as the sole arbitrator. Judge Chen is a retired state court judge who served on the Eleventh Judicial Circuit of Florida for eighteen years, with substantial experience in complex commercial and real estate disputes. She is widely regarded as a thorough and well-prepared arbitrator with a reputation for pragmatism.
• Preliminary Conference: A preliminary conference has not yet been scheduled but is anticipated to occur in mid-May 2023. At the preliminary conference, we expect that the arbitrator will set a scheduling order for discovery, expert disclosures, and the final hearing.
MSH is represented by Hargrove, Dunlap & Castillo LLP, a Miami-based litigation firm. The lead attorneys are Victoria Castillo, Partner, and Ryan Matsuda, Senior Associate. Ms. Castillo has significant experience in partnership and joint-venture disputes and is known for an aggressive litigation style. We have worked opposite her firm in prior matters and have found them to be well-prepared and formidable adversaries.
III. Analysis of MSH's Claims
MSH's Demand for Arbitration asserts three principal claims, each of which is analyzed in turn below.
A. Claim 1: Bad-Faith Valuation Under OA Section 12.7
MSH's primary claim is that PCG exercised the call option in bad faith or with the intent to materially understate Fair Market Value, triggering the penalty provision set forth in Section 12.7 of the Operating Agreement.
The Contractual Standard. Section 12.7 provides, in relevant part, that if the Manager exercises the call option "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 25% of the determined Fair Market Value of the redeemed interest. This provision was clearly included in the Operating Agreement to deter the Manager from manipulating the valuation process to the detriment of the minority member. Importantly, the provision sets a ceiling — "up to 25%" — which confers discretion on the arbitrator to calibrate the penalty to the severity of any bad-faith conduct.
MSH's Allegations. MSH alleges that PCG engaged in bad-faith conduct in three respects. First, MSH contends that PCG selected Whitfield Realty Advisors LLC as its appraiser with the specific intent of obtaining a low valuation, implying that PCG either directed or influenced the outcome of the Whitfield appraisal. Second, MSH asserts that the Whitfield appraisal employed an inflated capitalization rate of 9.5% and an inflated discount rate of 10.75%, which MSH characterizes as inconsistent with then-prevailing market conditions for Gulf Coast luxury hotel assets. Third, MSH alleges that Whitfield deliberately excluded consideration of the economic value of the below-market Aurelian franchise agreement and failed to account for the impact of $8.2 million in deferred-maintenance obligations on the property's value.
MSH's Penalty Calculation. As noted in Section II.E above, MSH demands a bad-faith penalty of $16,975,000. This figure appears to apply a factor of approximately 32% to the sum of MSH's equity share and accrued preferred return — a calculation methodology that exceeds the 25% cap set forth in Section 12.7. This overreach in the penalty calculation is a potential basis for a motion to narrow or partially dismiss the penalty claim as pled. At a minimum, it undermines MSH's credibility on the bad-faith issue and suggests that MSH's litigation posture may be driven by an inflated damages theory rather than a measured assessment of PCG's conduct.
Assessment of Bad-Faith Risk. Under Florida law, a claim of "bad faith" requires more than a mere disagreement over valuation. Bad faith implies a dishonest purpose, moral obliquity, or a conscious doing of a wrong for some dishonest or sinister motive. See Ins. Co. of N. Am. v. Lexow, 937 So. 2d 228, 230 (Fla. 4th DCA 2006); Abruzzo v. Haller, 603 So. 2d 1338, 1340 (Fla. 1st DCA 1992). While the Operating Agreement defines the standard by reference to "bad faith or . . . intent to materially understate Fair Market Value," the arbitrator is likely to interpret these terms consistently with their established meaning under Florida contract law.
Several factors weigh strongly against a bad-faith finding in this case. PCG retained a qualified, independent, MAI-certified appraiser — Gerald K. Whitfield — who holds the gold-standard credential for real property appraisal and has extensive experience valuing hotel assets in the southeastern United States. The Whitfield appraisal employed two recognized valuation methodologies — the income approach and the sales comparison approach — and arrived at its FMV conclusion through a weighted blend of both. This dual-approach methodology is more comprehensive than Beacon's sole reliance on the income approach. The retention of a credentialed appraiser and the use of industry-standard methodologies are substantial evidence that PCG acted in good faith in exercising the call option.
However, certain factors present risk. The 28.4% divergence between the Whitfield and Beacon appraisals, while not dispositive of bad faith, is large enough that the arbitrator may infer that at least one of the appraisals falls outside a reasonable range. If the neutral third appraisal lands substantially above $118.0 million — for example, in the $135 million or higher range — the Whitfield appraisal will appear to be an outlier, which could lend support to MSH's narrative that PCG sought an aggressive, low-end valuation. Additionally, the specific components of Beacon's critique — the capitalization rate, the discount rate, and the exclusion of certain adjustments — are the types of granular valuation inputs that an arbitrator may examine closely for evidence of result-oriented assumptions.
Key Risk Factor. The single most significant risk factor on the bad-faith claim is the potential existence of internal PCG documents — including investment-committee memoranda, internal emails, financial models, or board presentations — that reflect PCG's awareness at the time of the call-option exercise that the Whitfield valuation was at the low end of a reasonable range, or that PCG had conducted its own internal analyses yielding a higher value. If such documents exist and are discoverable, they could be characterized by MSH as evidence that PCG intentionally structured the valuation to minimize the buyout price. We address privilege-protection strategies for such documents in Section VII.D below.
On balance, we assess the probability of a bad-faith finding at approximately 15–25%. The retention of an MAI appraiser and the dual-methodology approach provide substantial protection, but the magnitude of the appraisal divergence and the potential for damaging internal documents prevent us from assigning a lower probability.
B. Claim 2: Breach of Fiduciary Duty
MSH's second claim alleges that PCG, in its capacity as the sole Manager of PGV, owed fiduciary duties to MSH and breached those duties by exercising the call option at a price that PCG knew or should have known was below the fair market value of MSH's membership interest.
Governing Law. Under the Florida Revised Limited Liability Company Act, Chapter 605, the default fiduciary duties owed by a manager of a Florida LLC include the duties of loyalty and care. See Fla. Stat. § 605.04091. However, the Act expressly permits an LLC operating agreement to "expand, restrict, or eliminate" the duties (including fiduciary duties) of a manager. See Fla. Stat. § 605.0105(4)(b). Accordingly, the threshold question is whether the Operating Agreement modifies the default fiduciary duties that PCG owes to MSH.
Operating Agreement Provisions. Our review of the Operating Agreement reveals that Section 9.2 addresses the Manager's duties. Section 9.2(a) provides that the Manager shall manage the affairs of PGV "in good faith and in accordance with the terms of this Agreement." Section 9.2(b) states that "[t]he Manager's duties with respect to the valuation and redemption of Member interests under Article XII shall be governed exclusively by the procedures set forth in Article XII." While Section 9.2 does not contain an express elimination of fiduciary duties, the language of Section 9.2(b) — providing that the Manager's duties in the buyout context are "governed exclusively" by Article XII — can be read as an effective restriction of fiduciary duties with respect to the call-option process.
Interplay with the Section 12.7 Bad-Faith Claim. The fiduciary-duty claim largely overlaps with the bad-faith claim under Section 12.7, both factually and in terms of the relief sought. MSH will argue that the fiduciary-duty claim provides an independent basis for damages beyond the contractual penalty capped at 25% under Section 12.7. If the arbitrator finds an independent breach of fiduciary duty that is not subject to the Section 12.7 framework, MSH could potentially recover compensatory damages measured by the full difference between the "true" FMV and the tendered price, without the 25% cap. This makes the fiduciary-duty claim a potentially significant avenue for incremental exposure.
Assessment. We view this claim as moderately weak but not frivolous. The primary defense is that the Operating Agreement's valuation mechanism — including the party-appointed appraiser, the 10% divergence threshold, and the third-appraiser process under Section 12.4(c) — constitutes the exclusive contractual framework for resolving valuation disputes in connection with the call option, and that this framework supplants any extra-contractual fiduciary duty with respect to the call-option price. PCG will argue that it complied with the Operating Agreement's prescribed procedures and that MSH's remedy lies in the contractual mechanism, not in an overlay fiduciary-duty claim.
We note, however, that Florida law on the scope of manager fiduciary duties in the buyout context is still developing, and there is limited appellate authority directly addressing whether an LLC operating agreement's contractual valuation mechanism operates to preempt fiduciary-duty claims arising from the same transaction. The arbitrator may be reluctant to foreclose the fiduciary-duty claim entirely at the pleading stage and may instead defer the issue to the merits. For strategic purposes, we recommend preserving the preemption argument as both a motion-stage defense and a hearing defense.
C. Claim 3: Breach of OA Section 8.3 — Deferred Maintenance Obligations
MSH's third claim alleges that PCG, as Manager, breached Section 8.3 of the Operating Agreement by failing to maintain the Hotel in "first-class condition," resulting in $8.2 million in deferred-maintenance obligations that diminished the value of MSH's membership interest.
The Contractual Standard. Section 8.3 of the Operating Agreement provides that the Manager shall "maintain the Property in first-class condition, consistent with the standards of comparable luxury resort hotels in the Clearwater Beach and Gulf Coast market." This is a general maintenance obligation that does not specify a particular capital expenditure budget or reserve requirement.
MSH's Allegations and Beacon's Adjustment. MSH alleges that PCG failed to fund necessary maintenance and capital improvements during the period following the completion of the initial renovation in 2019. Specific items identified by MSH apparently include: (i) HVAC system upgrades, including replacement of aging rooftop units and ductwork in guest-room corridors; (ii) exterior façade and balcony restoration, including concrete spalling repairs and railing replacement; and (iii) spa facility refurbishment, including flooring replacement and treatment-room modernization.
Beacon's appraisal incorporated these deferred-maintenance items as an upward adjustment to FMV. Beacon's theory is that the property would have been worth $8.2 million more had PCG properly maintained it, and that the FMV calculation for purposes of the buyout should reflect the value of the property in the condition it should have been in, rather than its current "as-is" condition.
Assessment. This claim raises two distinct analytical questions. First, did PCG actually breach its maintenance obligations under Section 8.3? Second, even if there is some basis for a maintenance-related claim, is the proper remedy an adjustment to FMV in the valuation calculation (as Beacon contends) or a separate damages claim that is independent of the Section 12.4 buyout-price determination?
On the first question, PCG invested $24.3 million in the Hotel's renovation during 2017–2019, and we understand that PGV has continued to fund ongoing maintenance through its operating budget. The "first-class condition" standard in Section 8.3 is inherently subjective and will require expert testimony regarding industry maintenance norms, capital reserve practices, and the condition of comparable luxury hotel properties in the relevant market. We recommend commissioning a property-condition assessment from an independent engineering firm to document the current state of the Hotel and compare it against industry benchmarks.
On the second question, the distinction between a valuation adjustment and a separate damages claim has significant implications for the buyout-price calculation. If deferred-maintenance items are treated as a valuation adjustment — i.e., the property's FMV is determined based on what the property would have been worth absent the alleged maintenance failures — the adjustment inflates FMV and thereby increases MSH's 35% share. Under this approach, the deferred-maintenance claim is effectively embedded in the valuation dispute. Conversely, if the deferred-maintenance items are treated as a separate damages claim, they would be measured and awarded independently of the Section 12.4 buyout-price calculation.
Defense. PCG's primary defense is that the Whitfield appraisal correctly valued the property in its "as-is" condition, which is the proper FMV standard under Section 12.4. The Operating Agreement does not define "Fair Market Value" to mean the hypothetical value the property would have had under optimal maintenance conditions; rather, FMV refers to the value of the property as it exists at the valuation date. PCG will further argue that its maintenance expenditures during the period from 2019 to the present were reasonable and consistent with industry standards for a property of this type, and that the items identified by MSH as "deferred maintenance" represent discretionary capital improvements rather than mandatory maintenance obligations. We note that MSH's consent rights under Section 7.3 may also be relevant: to the extent that any of the identified maintenance items would have required capital calls in excess of $2.0 million, PCG may argue that it was constrained by the Operating Agreement's consent requirements.
IV. PCG's Defenses and Counterclaim
A. Affirmative Defenses
Based on our analysis of the claims and the governing documents, PCG intends to assert the following affirmative defenses:
1. Good-Faith Exercise of Call Option. PCG exercised its call option in strict compliance with the procedures set forth in Section 12.4 of the Operating Agreement. PCG retained a qualified, independent, MAI-certified appraiser — Gerald K. Whitfield — who employed recognized industry-standard valuation methodologies, including both the income approach and the sales comparison approach. The Whitfield appraisal was prepared in accordance with the Uniform Standards of Professional Appraisal Practice (USPAP) and represents the appraiser's independent professional judgment. PCG tendered the resulting buyout price of $41.3 million in accordance with the payment provisions of Section 12.4(b). There is no evidence that PCG directed, influenced, or manipulated the outcome of the Whitfield appraisal.
2. Contractual Compliance. PCG followed the Operating Agreement's prescribed valuation process in all material respects. The Operating Agreement establishes a multi-step mechanism for resolving valuation disputes, including the party-appointed appraiser process, the 10% divergence threshold, and the neutral third-appraiser mechanism under Section 12.4(c). This mechanism exists precisely for situations in which the party-appointed appraisals diverge, and its existence demonstrates that the contracting parties anticipated and provided for valuation disagreements. The pendency of a valuation dispute, standing alone, does not establish bad faith.
3. Section 12.7 Penalty Inapplicable. A reasonable divergence between two independent appraisals does not constitute "bad faith" or "intent to materially understate" Fair Market Value within the meaning of Section 12.7. The bad-faith standard requires more than a disagreement over valuation inputs or methodology; it requires proof of a dishonest purpose or conscious intent to deprive MSH of the fair value of its interest. Moreover, MSH's penalty calculation of $16,975,000 exceeds the 25% cap expressly provided in Section 12.7, and the penalty claim as pled should be reduced to conform to the contractual limitation.
4. Fiduciary Duty Claims Preempted by Operating Agreement. The Operating Agreement's valuation mechanism, set forth in Article XII, is the exclusive contractual framework for determining the buyout price in connection with the exercise of the call option. Section 9.2(b) of the Operating Agreement provides that the Manager's duties "with respect to the valuation and redemption of Member interests under Article XII shall be governed exclusively by the procedures set forth in Article XII." This provision operates to restrict and, in the buyout context, effectively displace any overlay fiduciary-duty claim arising from the same transaction.
5. Deferred Maintenance. PCG maintained the Hotel in a manner consistent with Section 8.3 of the Operating Agreement and with industry standards for comparable luxury resort properties. PGV invested $24.3 million in a comprehensive renovation during 2017–2019, and subsequent annual maintenance budgets were adequate and consistent with standard capital reserve practices for properties of this type and quality. The items identified by MSH as "deferred maintenance" represent either discretionary capital improvements or routine expenditures that were properly budgeted and prioritized within the context of PGV's overall capital plan.
6. Failure to Mitigate. MSH failed to exercise its own contractual remedies in a timely manner. The Operating Agreement provides MSH with specified rights and remedies with respect to capital expenditures, including consent rights over capital calls exceeding $2.0 million and the right to raise maintenance concerns through the consultative process set forth in Section 8.5. MSH did not exercise these rights or raise any formal objection to PGV's maintenance practices prior to its receipt of the call-option exercise notice. MSH's failure to timely invoke its contractual remedies should preclude or limit any recovery based on the deferred-maintenance claim.
B. Counterclaim for Declaratory Relief
PCG's counterclaim, filed on April 5, 2023, seeks declaratory relief on two alternative bases. First, PCG seeks a declaration that the $41.3 million tendered on March 1, 2023 constitutes the proper FMV-based buyout price for MSH's membership interest under Section 12.4 of the Operating Agreement. Alternatively, PCG seeks a declaration that FMV should be determined through the neutral third-appraiser mechanism set forth in Section 12.4(c), and that the resulting buyout price should be calculated in accordance with the methodology set forth in Section 12.4 without the application of any bad-faith penalty under Section 12.7.
The counterclaim serves an important strategic purpose. It frames PCG's position as one of seeking compliance with the Operating Agreement's contractual mechanism rather than resisting a fair outcome. By affirmatively invoking the third-appraiser process, PCG signals its confidence in the reasonableness of the Whitfield appraisal and its willingness to submit to an objective, independent determination of FMV. This framing is critical to countering MSH's narrative that PCG is attempting to deprive MSH of the fair value of its interest.
V. Risk Exposure Analysis
A. Maximum Exposure
PCG's maximum exposure in this arbitration is defined by MSH's full demand of $70.0 million. This figure consists of the following components:
If the arbitrator were to award $70.0 million — which we regard as an unlikely worst-case scenario — PCG's incremental exposure beyond the $41.3 million already tendered would be $28.7 million.
In addition to the incremental buyout-price exposure, PCG faces potential liability for MSH's attorneys' fees in the event of a bad-faith finding. Section 15.4 of the Operating Agreement provides for fee-shifting in favor of the "prevailing party" on claims arising under Section 12.7 (the bad-faith provision). If the arbitrator makes a bad-faith finding and MSH prevails on that claim, MSH would be entitled to recover its reasonable attorneys' fees and costs incurred in prosecuting the bad-faith claim. Based on the complexity of this matter and the anticipated duration of the proceedings, MSH's fees could be substantial — potentially in the range of $1.5 million to $3.0 million. PCG's own defense costs, regardless of outcome, are discussed further below.
B. Most Likely Range of Outcomes
Based on our preliminary analysis, we have identified the following range of potential outcomes:
Low End (PCG Prevails). The arbitrator determines FMV through the third-appraiser mechanism under Section 12.4(c), and the neutral appraiser's conclusion is at or near Whitfield's $118.0 million. No bad-faith finding is made. The buyout price remains at approximately $41.3 million, and PCG's only incremental costs are its defense costs. We assess the probability of this outcome at approximately 15–20%.
Midpoint (Moderate Adjustment). The neutral third appraiser concludes that FMV is in the range of $130 million to $140 million. No bad-faith penalty is imposed. Under this scenario, the buyout-price calculation yields a total buyout price in the range of approximately $45 million to $50 million, depending on the precise FMV determination. The incremental cost to PCG beyond the $41.3 million already tendered would be approximately $4 million to $9 million, plus defense costs. We assess the probability of an outcome in this general range at approximately 45–55%.
High End (Significant Adjustment and/or Partial Bad-Faith Finding). The arbitrator credits Beacon's valuation methodology or the neutral third appraiser arrives at a high FMV (above $140 million), and the arbitrator finds some basis for a partial bad-faith penalty under Section 12.7 — perhaps at a reduced percentage below the 25% cap. Under this scenario, the total buyout price could reach $55 million to $65 million. The incremental cost to PCG would be approximately $14 million to $24 million, plus defense costs and potentially MSH's attorneys' fees. We assess the probability of an outcome in this range at approximately 20–30%.
Worst Case (Full MSH Demand). The arbitrator fully credits Beacon's FMV of $151.5 million and imposes the maximum 25% bad-faith penalty. The total buyout price approaches or equals MSH's demand of $70.0 million, and PCG is liable for MSH's attorneys' fees. We assess the probability of this outcome at less than 5%.
It is important to note that if the appraisal divergence exceeds 10% — as it does here — Section 12.4(c) provides that FMV shall equal the average of the two closest appraisals out of the three (the two party-appointed appraisals and the neutral third appraisal). Accordingly, the neutral third appraiser's conclusion will be the single most important determinant of FMV. If the neutral appraiser's conclusion falls between $118.0 million and $151.5 million, FMV will equal the average of the neutral appraisal and whichever of the two party-appointed appraisals is closest to it. This mechanical feature of the Operating Agreement places tremendous weight on the neutral appraisal and underscores the importance of the third-appraiser selection process.
C. Probability-Weighted Assessment
Drawing on the foregoing analysis, we offer the following probability-weighted estimates:
Probability of Bad-Faith Finding: Low, estimated at 15–25%. PCG's retention of a qualified MAI-certified appraiser, use of a dual-methodology approach, and compliance with the Operating Agreement's procedural requirements provide substantial insulation against a bad-faith determination. However, the probability is not negligible, particularly if internal PCG documents reveal awareness of the low-end nature of the Whitfield valuation.
Probability That Final FMV Lands Above $130 Million: Moderate to high, estimated at 55–70%. This assessment reflects our view that Whitfield's capitalization rate of 9.5% and discount rate of 10.75% may be at the aggressive (i.e., high) end of the reasonable range for Gulf Coast luxury hotel assets as of the December 31, 2022 valuation date, particularly in light of the Hotel's strong 2022 financial performance and the favorable competitive dynamics of the Clearwater Beach market. A credible neutral appraiser applying mid-market assumptions is likely to conclude a FMV above $130 million.
Expected Range of Total Buyout Price (Probability-Weighted): Approximately $45 million to $55 million. This range reflects the likelihood that the neutral third appraisal will land above Whitfield but well below Beacon, and that no bad-faith penalty will be imposed.
Expected Incremental Cost to PCG Beyond $41.3 Million Tender: Approximately $4 million to $14 million, inclusive of the incremental buyout price and exclusive of PCG's defense costs. We estimate that PCG's defense costs through a final arbitration hearing will be in the range of $1.0 million to $2.0 million, depending on the duration and intensity of discovery and expert proceedings.
VI. Insurance Coverage
PCG has tendered the MSH claim to Atlantic Omnivrel Insurance Company ("Atlantic Fidelity") under its managers' liability and wrongful acts insurance policy, Policy No. AFML-2022-08745. The policy provides coverage for claims arising from "wrongful acts" committed by the insured in its capacity as a manager of a covered entity, subject to certain exclusions and conditions.
The policy limits are $10 million per occurrence and $10 million in the aggregate. The carrier acknowledged receipt of PCG's tender on March 30, 2023 and has issued a reservation-of-rights letter. Based on our initial review of the reservation-of-rights letter and our communications with Atlantic Fidelity's coverage counsel, we expect that the carrier will fund PCG's defense costs, subject to its reservation of rights. The reservation appears to be principally focused on the potential applicability of exclusions for (i) contractual liability, (ii) disgorgement or restitutionary relief, and (iii) punitive or penalty payments.
The coverage implications for the bad-faith penalty claim under Section 12.7 merit particular attention. If the arbitrator were to impose a bad-faith penalty, Atlantic Fidelity may contest coverage for the penalty component on the ground that it constitutes a "punitive or penalty payment" excluded under the policy. Whether a contractual penalty provision of this nature is insurable under Florida law is an unsettled question. PCG should preserve the argument that any penalty imposed under Section 12.7 is compensatory in nature — i.e., that it is designed to compensate MSH for the harm caused by PCG's alleged bad-faith conduct — rather than punitive. The characterization of the penalty will affect both the insurability of the award and the carrier's defense obligations with respect to that component of the claim.
We recommend that PCG continue to comply with all notice and cooperation requirements under the policy, maintain ongoing and transparent communication with the carrier and its coverage counsel, and preserve all arguments regarding the compensatory nature of any potential Section 12.7 penalty award. We further recommend that PCG avoid making any admissions or concessions in the arbitration proceedings that could be construed by Atlantic Fidelity as evidence that the penalty is punitive in character.
VII. Preliminary Strategic Recommendations
A. Arbitration Strategy
Based on our analysis of the claims, defenses, and risk exposure, we recommend the following arbitration strategy:
1. Response and Counterclaim. PCG filed its Response and Counterclaim on April 5, 2023, as described in Section IV.B above. No further action is required on this item.
2. Third-Appraiser Appointment. We recommend that PCG promptly initiate the process of jointly retaining a neutral, MAI-certified appraiser under OA Section 12.4(c). This is PCG's single most important procedural tool. The appointment of a credible, independent neutral appraiser shifts the focus of the proceeding from the bad-faith narrative — which is inherently subjective and unpredictable — to an objective, third-party valuation that will mechanically determine FMV under the Operating Agreement's formula. The sooner the neutral appraisal is underway, the sooner the parties (and the arbitrator) will have an objective anchor point for the dispute.
We recommend proposing Thomas Carraway of Linden Park Advisory LLC as the neutral appraiser. Mr. Carraway is a nationally recognized MAI-certified appraiser with deep expertise in luxury hospitality assets and a reputation for impartiality and rigor. Alternatively, we can propose several other similarly credentialed candidates for MSH's consideration. If the parties cannot agree on a neutral appraiser, Section 12.4(c) provides that the arbitrator shall select one from a list of candidates proposed by each party.
3. Discovery. We recommend conducting targeted discovery designed to achieve two objectives: (a) developing the factual record necessary to defend against the bad-faith claim, and (b) identifying weaknesses in MSH's appraisal and damages theories. Specific areas of focus include:
(a) MSH's communications with Beacon Valuation Group regarding valuation targets, assumptions, or desired outcomes;
(b) The factual and documentary basis for MSH's bad-faith allegations, including any internal MSH analyses, board minutes, or correspondence reflecting the basis for MSH's belief that PCG acted in bad faith;
(c) Beacon's workpapers, comparable-transaction data, and methodological assumptions, with particular emphasis on the basis for the 8.5% discount rate, the absence of a sales comparison approach, and the $8.2 million deferred-maintenance adjustment;
(d) MSH's communications regarding the timing of the arbitration demand relative to the call-option exercise, which may bear on the question of whether MSH had a pre-existing intent to challenge any call-option exercise regardless of the valuation.
PCG should be prepared to resist overbroad discovery requests from MSH, particularly requests targeting PCG's internal investment-committee memoranda, financial models, and strategic analyses. To the extent such documents reflect communications with legal counsel or were prepared in anticipation of litigation, they are protected by the attorney-client privilege and the work-product doctrine. We address privilege-protection measures in Section VII.D below.
4. Expert Preparation. We recommend working closely with Gerald K. Whitfield to strengthen the defensibility of the Whitfield appraisal in advance of the final hearing. Specifically, we recommend commissioning an independent market survey of capitalization rates and discount rates for Gulf Coast luxury hotel transactions closed during the 2021–2022 period. This survey will provide objective market data to contextualize Whitfield's assumptions against the range of rates observed in comparable transactions. If the survey demonstrates that Whitfield's rates fall within the mainstream of market observations — even if at the higher end of the range — it will be powerful evidence against a bad-faith finding.
Additionally, we should retain a supplemental expert to address the deferred-maintenance claim. An independent property-condition assessment from a qualified engineering or facilities-management firm will be necessary to evaluate the current condition of the Hotel, identify the specific items characterized by MSH as "deferred maintenance," and opine on whether those items represent actual deferred maintenance or discretionary capital improvements.
5. Deposition Strategy. We recommend depositions of the following individuals:
(a) Nathaniel Cordero — MSH's principal or authorized representative. We will seek testimony regarding Mr. Cordero's understanding of the Operating Agreement's valuation mechanism, MSH's expectations regarding the call option, and any pre-existing intent to challenge a call-option exercise. We will also explore MSH's own internal analyses of the Hotel's value and any communications with potential third-party acquirers that may bear on FMV.
(b) Dr. Priya Ramanathan — Beacon's appraiser. We will seek detailed testimony regarding Beacon's methodology, with particular emphasis on the following: (i) the decision to rely solely on the income approach without performing a sales comparison analysis; (ii) the basis for the 8.5% discount rate and the 7.75% terminal capitalization rate; (iii) the methodology and data supporting the below-market franchise agreement adjustment; and (iv) the basis for the $8.2 million deferred-maintenance adjustment, including whether Beacon performed an independent property inspection or relied on information provided by MSH.
B. Settlement Posture
Given the expected outcome range of approximately $45 million to $55 million and the likelihood that PCG's defense costs will exceed $1.0 million, early exploration of settlement may be economically rational. A resolution within or near the expected range would avoid the risk of a bad-faith finding, eliminate the potential for fee-shifting under Section 15.4, and provide certainty to both parties and to PGV's ongoing operations.
We recommend that PCG maintain a posture of settlement optionality — that is, PCG should not foreclose the possibility of settlement but should not initiate settlement discussions prematurely or from a position of weakness. The strongest negotiating position will be achieved after two milestones: (a) the completion of targeted discovery that demonstrates the weaknesses in MSH's bad-faith theory, and (b) the receipt of the neutral third appraiser's preliminary indication of value, which will provide an objective anchor for settlement negotiations.
We suggest a preliminary settlement authority range of approximately $48 million to $54 million, subject to refinement after receipt of the neutral appraisal. This range reflects a modest premium above the low end of our expected outcome range, recognizing the economic value of certainty and the avoidance of defense costs and bad-faith risk. Final settlement authority should be determined in consultation with the client after the neutral appraisal is available and the discovery record is more fully developed.
Mediation may be an effective mechanism for facilitating resolution. We recommend proposing mediation to be conducted after the neutral appraiser has issued a preliminary indication of value, as the neutral appraisal will serve as a natural anchor for the parties' expectations and may facilitate convergence. JAMS offers mediation services, and the arbitrator may be receptive to suggesting or ordering mediation at an appropriate stage of the proceedings.
C. Lender Coordination
Any resolution of this dispute that results in a total buyout price in excess of $41.3 million will require PCG to fund the incremental amount from its own liquidity, from PGV's operating cash, or from additional borrowings. Given the potential magnitude of the incremental payment — ranging from approximately $4 million to as much as $28.7 million in the worst case — PCG should proactively coordinate with Gulf Atlantic National Bank ("GANB") to assess the availability of incremental borrowing capacity.
We recommend that PCG initiate a consultation with Christine Delacroix at GANB — the relationship manager for the PGV credit facility — to address the following matters:
(a) Incremental Borrowing Capacity: Determine whether the existing loan documents (Loan No. CRE-2017-06284) permit PGV to draw additional funds or whether PCG has the ability to obtain supplemental financing, either at the PGV level or at the PCG holding-company level.
(b) Change-of-Ownership Consent: Assess whether the redemption of MSH's membership interest — which would result in PCG becoming the sole member of PGV — triggers any change-of-control, transfer, or consent provisions in the loan documents. Many commercial real estate loan agreements include provisions requiring lender consent for changes in the ownership structure of the borrowing entity.
(c) Loan Maturity and Refinancing Runway: The GANB loan matures on August 1, 2027, providing approximately four years of runway for post-redemption financial planning, including potential refinancing if needed to fund the incremental buyout cost.
Early engagement with the lender will ensure that PCG has a clear understanding of its financial options as the arbitration progresses and will avoid any surprises in the event that a resolution requires PCG to fund a significant incremental payment.
D. Privilege Protection
Maintaining the confidentiality of privileged communications is critical in this matter. MSH's bad-faith claim turns on PCG's subjective intent at the time of the call-option exercise, which means that MSH has a strong incentive to seek discovery of PCG's internal deliberations regarding the valuation, the timing of the call-option exercise, and PCG's assessment of the Hotel's value.
We recommend the following measures to protect privileged communications:
(a) Routing of Communications. All internal PCG communications regarding valuation strategy, settlement authority, litigation posture, and case assessment should be routed through or at the specific direction of Calderwood & Harkness LLP. Communications that reflect legal advice or were prepared in anticipation of litigation are protected by the attorney-client privilege and the work-product doctrine, respectively, but only if they satisfy the applicable legal standards. Communications that were prepared for business purposes — even if they later become relevant to litigation — may not qualify for protection.
(b) Investment-Committee Memoranda. We anticipate that MSH will specifically target PCG's internal investment-committee memoranda for discovery. To the extent such memoranda were prepared in the ordinary course of business without the involvement of legal counsel, they may not be privileged. Going forward, any PCG internal analysis of valuation issues, litigation risk, or settlement strategy should be prepared at the direction of counsel and should bear an appropriate privilege legend. For pre-existing memoranda that were not prepared at the direction of counsel, we will need to evaluate their content and context to determine whether any applicable privilege or protection applies.
(c) Litigation Hold. A litigation hold notice was issued on March 23, 2023, immediately after our engagement. The hold requires the preservation of all documents and electronically stored information potentially relevant to the dispute. We must confirm that all relevant PCG custodians are in compliance with the hold, particularly Dominic R. Pellegrino, Adriana Pellegrino-Voss, and Marcus Thiel (PCG's Vice President of Asset Management, who we understand was involved in the valuation process and the call-option exercise). Please confirm with each custodian that they have received the hold notice, understand its requirements, and have suspended any automatic deletion routines for email and other electronic communications.
VIII. Engagement Team and Next Steps
A. Engagement Team
The following Calderwood & Harkness LLP professionals are assigned to this matter:
All team members will be available to the client for questions, updates, and strategic consultations throughout the course of the engagement. Francesca Morano and Simone Laroche will serve as the primary client contacts and will attend all arbitration proceedings and substantive conferences.
B. Immediate Next Steps (April–May 2023)
The following action items require attention in the near term:
1. Prepare for Preliminary Arbitration Conference. The preliminary conference with Arbitrator Chen is anticipated for mid-May 2023. We will prepare a proposed scheduling order and brief on threshold procedural issues, including the timing of the third-appraiser appointment, the scope of permissible discovery, and any early dispositive motions.
2. Verify Accrued Preferred Return Calculation. Coordinate with Grantham, Pryce & Associates CPAs (Howard Grantham, engagement partner) to independently verify the $17.01 million accrued prefe