Two principals co-found a real estate investment firm. They raise their first fund together, close several acquisitions, and build a track record. The relationship works well enough when deals are performing. Then a portfolio property hits a rough patch. Expenses outrun the budget. One principal wants to hold and refinance. The other wants to sell. They disagree on whether a sale requires both of their consent under the operating agreement, and neither of them can find clean language in the document that resolves the question.
While they are still arguing about the sale, the property manager, an affiliate controlled by the principal who wants to hold, submits an invoice for fees the other principal believes were never authorized. Both principals now need to decide whether to call additional capital to cover a lender shortfall, and one of them says the capital call process requires their mutual approval while the other says it does not. Three disputes are running simultaneously, each of which traces directly to a provision in the GP operating agreement that was drafted ambiguously at formation and never tested until the relationship was already under stress.
That scenario, or some version of it, plays out routinely in real estate GP structures. The operating agreement that governs the sponsor side of a platform is the document that determines how economics are divided, who can make decisions, what happens when principals disagree, and how the relationship ends. Most of the disputes that arise under those agreements are not caused by exceptional circumstances. They are caused by ordinary business situations, a disagreement over a sale, an affiliate fee, a capital call, a departure, that the agreement addressed vaguely or not at all.
This post addresses the categories of dispute that appear most frequently in real estate GP operating agreements, what drafting conditions produce each category, and what the agreements must address specifically to reduce the probability that those disputes arise.
Economic Disputes: When the Numbers Were Never Actually Agreed
Economic disputes are the first category that partners tend to notice because they affect cash. The underlying cause is almost always the same: the parties agreed on a headline economics arrangement during the formation negotiation without specifying the mechanics with enough precision to administer it when actual distributions become available.
Waterfall and Promote Disputes
The promote, or carried interest, is the economic term that generates the most consequential disputes in real estate GP structures because it represents the largest source of upside for the principals, and its calculation involves layered formulas whose components can be interpreted differently without a clear set of agreed conventions. A waterfall that returns capital, pays a preferred return, provides a catch-up, and distributes a promote has at least four tiers that can each be disputed independently: when each tier is satisfied, whether the calculation is measured at the deal level or the venture level, how IRR is computed, and whether accrued but unpaid preferred return compounds before the catch-up begins.
The deal-by-deal versus whole-venture distinction is one of the most consequential choices in any real estate promote structure, and many agreements describe it imprecisely. In a deal-by-deal structure, the promote is calculated and potentially distributable on each asset as it is realized. In a whole-venture structure, the promote is measured across the portfolio as a whole, which means strong assets cannot produce a promote payment until weaker assets have been accounted for. Those two approaches can produce radically different timing outcomes even when the nominal promote percentage is identical. An agreement that does not specify which method applies, or that uses language from which both methods can be inferred, will produce a dispute at the first realization event.
Distribution Timing and Reserve Authority
Distribution timing disputes arise from a different mechanism than waterfall disputes. The economics are not contested; the question is when cash moves from the fund or venture to the principals. An agreement that requires distributions to be made from available cash without precisely defining available cash has delegated an enormous amount of discretion to the managing principal, who determines what reserves to maintain, what contingencies justify holding cash, and when a distribution is appropriate. The non-managing principal, who is often entitled to that cash for tax purposes regardless of whether it is distributed, may have a very different view of the appropriate reserve level.
Reserve authority is one of the most frequently litigated provisions in real estate operating agreements because it sits at the intersection of business judgment and cash access. A managing member who holds back distributions to fund platform overhead, personal compensation, or speculative future costs may be exercising the contractual reserve authority the agreement provides while simultaneously depriving the other members of cash they believe they are owed. Whether the conduct is a breach depends entirely on what the agreement says about reserve purposes, reserve amounts, and the process for approving reserve changes.
Fee Authorization and Affiliate Compensation
Fee disputes are particularly common in real estate firms because the platform model often involves multiple affiliated entities earning multiple categories of fees simultaneously: acquisition fees, asset management fees, construction management fees, financing fees, and disposition fees can all run through the sponsor group on the same property. As addressed in the prior post in this series on disclosure requirements for conflicts of interest, the Prime Group enforcement action confirmed that an affiliate compensation arrangement that was economically significant but not specifically disclosed in the fund documents produced a securities fraud finding under Section 17(a)(2) of the Securities Act, without requiring proof of intentional misconduct.
The private dispute version of that same problem is a managing principal who believes an affiliate fee was authorized by the general authority provisions in the operating agreement, and a non-managing principal who believes the fee was not authorized, was not disclosed, and was not approved through the conflict management procedure the agreement requires. When that dispute arises, the resolution turns entirely on whether the agreement specifically identifies the fee, the affiliated entity that receives it, the rate or calculation method, and the approval process that governs it. A general authorization to engage service providers at market rates is not specific enough to support an affiliated fee arrangement if the agreement’s conflicts provisions require individual approval of related-party transactions.
Governance Disputes: When Authority Is Defined by Dispute
Governance disputes are more damaging than economic disputes because they can stop the platform’s operations entirely. An unresolved disagreement about who controls a decision can prevent the fund from refinancing, leasing, selling assets, or responding to urgent portfolio situations. Those operational consequences can destroy value far exceeding the economic stakes of the underlying disagreement.
Authority Scope and Reserved Matters
The most common governance dispute in a real estate GP structure is the contest over whether a specific decision required the non-managing principal’s consent. The managing principal reads the agreement and concludes that the decision was within ordinary operating authority. The non-managing principal reads the same agreement and concludes that the decision was a major or material action requiring consent. The resulting dispute is about a list that many agreements describe in general terms rather than specific ones.
Phrases such as major decisions, material actions, extraordinary transactions, or actions outside the ordinary course of business are invitations to litigate. Each of those terms describes a category without defining its boundaries. A lease restructuring, a refinancing at different economic terms, a budget deviation above a threshold, or a settlement of a contractor dispute can each be characterized as within or outside ordinary course depending on the circumstances and the advocate’s perspective. An agreement that maps specific transaction types to specific approval requirements, with dollar thresholds and defined criteria where judgment calls are unavoidable, is an agreement whose authority provisions can actually be applied.
Deadlock and Its Consequences
Deadlock is the governance failure mode with the most destructive potential consequences. In a co-managed or co-controlled structure where both principals must agree on major decisions and neither can act unilaterally on contested matters, a genuine disagreement can freeze the platform at precisely the moment when urgent action is most necessary. A lender requiring a decision on a maturity extension, a tenant requiring a response on a renewal, or an insurance claim requiring documentation and authorization can all produce an operational crisis if the principals cannot agree.
Under Delaware law, judicial dissolution is available when it is no longer reasonably practicable to carry on the business in conformity with the LLC agreement, and Delaware courts have upheld dissolution in deadlock situations where the operating agreement did not provide a workable resolution mechanism. Dissolution is an expensive and disruptive outcome that serves neither party well, which is why the agreement should include a tiered dispute resolution framework that operates before the parties are at the point of seeking judicial intervention.
A functional deadlock framework typically involves an escalation step requiring the principals to involve more senior decision-makers or outside mediators before formal dispute resolution begins, a defined timeline after which unresolved deadlock produces a specific result, and a mechanism, often a buy-sell provision or a limited emergency authority grant, that allows the platform to continue operating on critical matters while the deadlock is being resolved. Each of those elements requires deliberate drafting choices made at formation, when the parties are still cooperative and the value of anticipating the hard scenario is obvious.
Removal and Transition Mechanics
Removal disputes rank among the most expensive and disruptive governance conflicts in real estate GP structures, not primarily because of the removal event itself but because of the downstream issues the removal produces. Most agreements distinguish between removal for cause, typically tied to specific events such as fraud, gross negligence, insolvency, or material breach, and removal without cause, which requires a higher vote threshold because it changes control without a finding of wrongdoing. That distinction is a reasonable starting point, but it is only the beginning of what the agreement needs to address.
After a removal, the parties must resolve whether management fees and asset management compensation continue during any transition period, whether the removed principal forfeits or retains promote on deals that were in progress at the time of removal, what obligation the removed principal has to cooperate with the transition and transfer records, whether any retained voting or approval rights survive the removal, and whether existing affiliate service arrangements can be terminated or must continue. An agreement that addresses removal without addressing any of those transition mechanics has solved one problem and left four others open for future litigation.
| 📌 The Provision That Appears in Every Agreement and Functions in Almost None Most real estate GP operating agreements include a provision that the managing member will manage the platform in a commercially reasonable manner consistent with the standards of a prudent real estate manager. That provision appears to create an accountability standard. In practice, it creates almost none. The problem is that commercially reasonable and prudent are standards rather than rules. They describe the quality of a decision without specifying what decisions must or must not be made. A managing member who makes a poor acquisition, misses a refinancing window, or agrees to unfavorable lease terms may have done so through a commercially reasonable process that happened to produce a bad outcome. The disappointed non-managing member’s claim that the conduct was unreasonable is not self-evidently correct, and the litigation required to test that claim is expensive. The agreements that generate fewer disputes in this area are the ones that supplement the general standard with specific procedural obligations: what information the managing member must provide before making major decisions, what approval process applies when decisions involve conflicts, what reporting is required on a scheduled basis, and what minimum standards of documentation apply to material transactions. Those specific obligations create measurable conduct standards rather than open-ended judgment questions, which means the dispute about whether the managing member acted appropriately is narrower and more tractable. The broader principle is that process obligations are generally more enforceable and less litigated than outcome standards. An agreement that requires the managing member to obtain three competitive bids before engaging an affiliate for construction management is easier to enforce than an agreement that requires the managing member to engage construction management at market rates, because compliance with the first provision is observable and the second requires a valuation dispute to adjudicate. |
Capital Contribution Disputes: When the Project Does Not Go as Planned
Real estate projects rarely unfold exactly as the financial model anticipated, which means the capital contribution framework in a GP operating agreement is tested precisely when the parties’ relationship is already under strain from project difficulties. A construction cost overrun, a lease-up delay, an unexpected tax liability, or a lender requirement for additional reserves can each produce a capital call at a moment when one or both principals may not have the liquidity to fund comfortably and may have different views about whether the contribution is justified by the circumstances.
Capital Call Authority and Validity
The first question in most capital call disputes is not whether the obligation was funded but whether the call was valid. An agreement that gives one principal unilateral authority to issue capital calls can produce a situation where the other principal believes the call was issued improperly, to fund expenditures that were not project-related, to create a default that would trigger dilution of the objecting principal’s interest, or to fund an expense that the issuing principal’s affiliate caused. The dispute about the validity of the call may be more heated than the dispute about the amount because the validity question carries an implication of bad faith.
The agreement should therefore specify who can issue a capital call, what expenses qualify as mandatory funding obligations, whether calls above a defined threshold require joint approval, and what documentation must accompany the call notice to support the expenditure basis. Those requirements prevent the capital call from being used as a tactical weapon and create a documented record that allows the parties to evaluate the call’s validity against objective criteria rather than competing characterizations.
Default Remedies and Their Enforceability
Capital contribution default remedies are among the most heavily negotiated provisions in real estate operating agreements because they can be severe and because they operate in the same difficult circumstances that produced the dispute in the first place. Dilution at a discounted valuation, high-interest default loans from the non-defaulting principal, buyout rights at a discount, and loss of voting or management rights are all commercially accepted remedies that appear in well-drafted agreements. Their severity reflects the genuine disruption a capital default creates for the non-defaulting partner and the project.
The enforceability question arises when the remedies are triggered and applied. Courts evaluating capital contribution default provisions in LLC agreements have examined whether the defaulting party received proper notice, whether the cure period was calculated correctly, whether the applicable interest rate was properly stated, and whether the dilution formula was applied as the agreement specifies. An error in any step of the process can produce an argument that the remedy was not properly triggered, which turns a straightforward default into a procedural dispute that extends the litigation and undermines the non-defaulting party’s position.
Guaranty Allocation and Reimbursement Disputes
In most real estate fund and joint venture structures, the fund’s financing requires one or more principals to provide a personal guaranty to the lender. The operating agreement should address how guaranty obligations are allocated among the principals, how the obligation is borne relative to ownership percentages, and how reimbursement or indemnification operates if a guarantor makes a payment that benefits another principal who has not contributed proportionately.
Guaranty disputes are among the most personally contentious in real estate GP structures because they involve personal financial exposure beyond the nominal investment. A principal who provides a guaranty and then watches the other principal fail to fund a required capital contribution, or fail to take steps that would have avoided a lender draw, will have a grievance that feels more personal than a promote calculation dispute. The agreement’s guaranty reimbursement and contribution provisions determine whether that grievance has a clean contractual remedy or must be litigated under implied contribution theories.
Fiduciary Duty, Self-Dealing, and the Delaware LLC Framework
Fiduciary duty disputes in real estate GP structures are complicated by a feature of Delaware LLC law that surprises many principals: the operating agreement can modify, limit, or even eliminate most fiduciary duties, leaving only the implied covenant of good faith and fair dealing as a non-waivable floor. That means the standard for holding a managing principal liable for self-dealing, opportunity diversion, or management misconduct depends entirely on what the operating agreement says, not on what the parties might assume about the general law of loyalty and care.
An operating agreement that broadly permits the managing member to engage in other real estate activities without offering opportunities to the entity, to engage affiliates for services without a specific conflict management process, and to make discretionary decisions without judicial review except for fraud or willful misconduct has substantially narrowed the non-managing member’s legal remedies. The non-managing member who signed that agreement without reading it carefully may feel strongly that the managing member has acted disloyally. The managing member may be contractually protected against all but the most extreme conduct.
That potential asymmetry is why the conflict management provisions in a real estate GP operating agreement deserve as much attention as the economic provisions. If the agreement does not specifically require the managing member to present affiliate service arrangements for approval, does not define the standard for evaluating related-party transactions, and does not specify a process for identifying and resolving conflicts of interest, the non-managing member’s protection against self-dealing is primarily the law’s implied covenant of good faith, which is a narrow protection in a well-drafted LLC agreement.
Exit and Transfer Disputes: When the Relationship Ends Before the Assets Do
Exit and transfer disputes are the category that most frequently produces the worst outcomes in real estate GP structures because they arise after the relationship has already deteriorated and because they involve questions that the parties, when they were optimistic at formation, had no incentive to think through carefully. The result is an agreement whose exit provisions were drafted as boilerplate and an exit dispute that the provisions cannot cleanly resolve.
Buy-Sell Provisions and Valuation
Buy-sell provisions are designed to provide a path out of a deadlocked or broken relationship without requiring judicial intervention. Their practical value depends on the quality of the valuation mechanism they employ. An agreement that requires the departing interest to be valued by appraisal without specifying the appraisal methodology, the treatment of contingent liabilities, the discount for minority or illiquid interests, or the inclusion of promote value in the valuation will produce an appraisal dispute that may be more costly than the original relationship dispute.
In real estate GP structures, the valuation question is particularly complex because the interest being valued includes not only the principal’s share of the underlying asset values but potentially also the promote or carried interest on those assets, the principal’s management company economics, and the value of the platform’s pipeline and relationships. A buy-sell provision that is based only on net asset value of the portfolio misses most of the value in the interest being transferred and will be contested by the party receiving that valuation as a basis for a forced sale.
Principal Departure, Death, and Succession
Every real estate GP operating agreement should address what happens when a principal is no longer able to perform their role, whether through voluntary departure, disability, death, or forced removal. The question is not hypothetical. It is a specific situation that will eventually arise in every long-lived platform, and the consequences of an inadequate answer are severe: a dispute between the surviving principals and the estate of the deceased principal, a governance crisis when the principal responsible for key institutional relationships is unexpectedly unavailable, or a promote dispute when the agreement does not specify how vested and unvested economics are treated upon death or departure.
The prior posts in this series on good leaver and bad leaver provisions, on vesting of promote interests, and on reallocation of economics after a GP member withdrawal addressed those specific questions in detail. The organizing principle those posts describe, that the departure economics should be documented at formation when the parties have shared incentives to design a fair system, rather than negotiated at departure when their incentives are maximally divergent, applies equally to the succession provisions in the operating agreement.
Transfer Restrictions and New Partner Admission
Transfer restrictions in a real estate GP operating agreement serve the same function as in any closely held entity: they prevent the involuntary introduction of new partners through assignment, foreclosure, or estate transfer, and they preserve the existing partners’ control over who participates in the platform. The disputes that arise under transfer restriction provisions typically involve whether a specific transfer was permitted by the agreement’s exceptions, whether the restriction was enforceable against the transferee, and whether a foreclosure or pledge enforcement by a lender constituted a transfer that triggered the restriction’s protective provisions.
Delaware’s LLC Act expressly separates economic rights from governance rights in the transfer context: an assignee of a membership interest receives the economic rights of the assigning member but does not automatically become a member with governance rights unless the operating agreement permits it or the existing members consent. That statutory framework gives the operating agreement substantial flexibility in structuring transfer restrictions, but it also means that an imprecise restriction provision may permit an economic transfer that the parties intended to block or block an economic transfer that the parties intended to permit.
| ⚠️ The Six Operating Agreement Provisions That Produce the Most Disputes in Real Estate GP Structures 1. Promote and waterfall mechanics without specified calculation conventions. The promote is the most valuable economic term in most GP operating agreements and the one most frequently described in terms that require additional interpretation to apply. Whether the calculation is deal-by-deal or whole-venture, how IRR compounds, and when each waterfall tier is satisfied must be specified in enough detail to administer without agreement between the parties. 2. Reserved matters defined by general category rather than specific action. Provisions requiring consent for major decisions, material actions, or extraordinary transactions delegate the classification question to whoever is arguing the dispute. A list of specific transaction types, with dollar thresholds and defined criteria for each, is administrable. A general category is not. 3. Deadlock provisions without a resolution mechanism. A co-controlled or co-managed structure that requires unanimous or supermajority approval for major decisions and provides no deadlock resolution mechanism is a structure that will eventually require judicial dissolution or an expensive negotiated resolution at the moment the parties are least able to cooperate. 4. Affiliate compensation authorized by general provisions rather than specifically described. An authorization to engage service providers at market rates does not authorize a specific affiliate fee arrangement. Related-party compensation must be specifically identified, the rate or calculation method stated, and the approval process described if the agreement’s conflict provisions are to provide any protection against the non-managing member’s later challenge. 5. Removal provisions without transition mechanics. Specifying when removal can occur without specifying what happens to management fees, promote, records, affiliate agreements, and retained governance rights after removal creates a second set of disputes that the removal was supposed to prevent. 6. Buy-sell and exit provisions without a complete valuation methodology. A buy-sell provision that relies on a general appraisal standard without specifying the methodology, the treatment of contingent liabilities, the discount convention for minority or illiquid interests, and the inclusion of promote value will produce a valuation dispute that may be as expensive as the underlying relationship dispute the provision was designed to resolve. |
The Agreement That Prevents Disputes Is the One That Was Designed to Handle Them
The opening scenario in this post involves three simultaneous disputes, about sale authority, an affiliate fee, and a capital call, each of which traces to a vague provision in the operating agreement rather than to exceptional or extraordinary circumstances. That accumulation of disputes is not coincidental. Vague provisions tend to cluster in agreements that were drafted to reach agreement at formation rather than to govern the relationship at its most difficult moments. The parties agreed on economics and governance in general terms when they were working toward a common goal. The specific questions their agreement left unanswered surfaced when their relationship was already under pressure.
Delaware law gives real estate GP structures broad contractual freedom to design precisely the governance, economics, and accountability framework they need. That freedom is not self-executing. An agreement that does not define the promote calculation with enough specificity to administer without agreement between the parties, does not distinguish between operational authority and reserved matters with enough precision to apply without litigation, and does not address removal transition mechanics, deadlock resolution, or departure economics has left the platform’s most important governance questions to be resolved after the dispute has already started.
The prevention strategy is not complicated to describe. The promote mechanics, waterfall conventions, reserved matter definitions, conflict approval procedures, capital call authority, deadlock resolution framework, removal and transition provisions, and exit and valuation methodology all need to be designed as a coherent system that answers the hard questions specifically and in advance. The cost of that design work at formation is predictable and manageable. The cost of litigating the questions it would have answered is neither.