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Usury lawsuit names Harvard, Princeton, and Yale endowments

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Bloomberg News / November 22, 2007

Harvard, Yale, and Princeton universities' endowments are being accused of backing a loan with 42 percent interest, twice the legal limit, according to a lawsuit filed by a developer who borrowed the money.

The three Ivy League schools, along with three other universities and two foundations, are named in a civil complaint in state court in Boston alleging they violated a law aimed in part at loan sharks, who make loans with excessive interest rates backed by threats of violence. Fred Fahey, a Dracut developer who filed the suit, planned to build a golf course community with money borrowed from Realty Financial Partners, a firm in which the schools invested.

The lawsuit is a window into the rarely disclosed money management tactics endowments use. Nonprofit funds last year allocated 39 percent of their assets to alternative investments - including real estate, private equity, commodities, and hedge funds - up from 23 percent in 2000, according to the Commonfund Institute, in Wilton, Conn. Yale's endowment gained 28 percent in the 12 months ended June 30, Princeton's 25 percent, and Harvard's 23 percent.

In a case of charging 42 percent interest, "you have to ask if there's an inconsistency between the public purpose" of universities "and this type of financial transaction," said Peter Kinder, the president of KLD Research & Analytics Inc. in Boston, which advises nonprofit endowments and pension funds. "It's a hell of a burden to put on someone."

Fahey's Meadow Creek LLC planned to build a 186-home community and golf course in Dracut.

Fahey sought financing from Realty Financial Partners, based in Wellesley. The schools and foundations were limited partners in Realty Financial Partners V LP, which in turn was a limited partner in LR5-A LP, the actual lender.

Fahey received two loans from LR5-A totaling $10.1 million; the interest rate of 42 percent was applied to one of the loans for $6.7 million.

Fahey's lawsuit may be trying to get around the legal protection usually afforded limited partners, said Mark Budnitz, a professor at Georgia State University College of Law in Atlanta and author of a book on lender liability. Courts are reluctant to hold limited partners liable, believing it may discourage investment, he said. The foreclosures and losses triggered in recent months by subprime mortgages may lead to a more expansive view of liability, he said.

Massachusetts forbids loans with more than 20 percent annual interest. It allows lenders to charge more if they file a notice every two years with the state attorney general.

LR5-A LP did file notices with the attorney general, one on May 8, 2001, and another on Aug. 20 that year. Fahey's suit alleges that the first notice came too soon, before the lending partnership was formed, and the second too late, after the loan was made.

David Rich, 36, the lawyer representing Realty Financial Partners, said the timing of the lender's notices was valid.

Besides the Ivy league schools, the suit names the University of Notre Dame, Oberlin College in Ohio, Spelman College in Atlanta, the Carnegie Corp. of New York, and the John D. and Catherine T. MacArthur Foundation of Chicago, all also represented by Rich.

The defendants argue in court papers that the usury law's requirements don't apply to them because they had no involvement in managing the Meadow Creek investment, and that state law shields limited partners from such claims. The law was aimed at organized crime and loan-sharking, the three Ivy League schools said in a filing, not at limited partners of a lender.

Joshua Mintz, general counsel for the MacArthur foundation, said in a statement there was no basis for including the organization in the suit. Spokesmen for the other defendants declined to comment on the lawsuit.

Fahey, 46, first sought a loan in March 2001 from Realty Financial Partners, a lender that has raised almost $1 billion from investors, including the Ivy League universities, since 1994, according to its website. Rich said Fahey knew the terms of the loan 2 1/2 months before the closing and was represented by an experienced real estate lawyer.

Fahey said he accepted the terms because he expected to get development approvals within three to six months, allowing him to refinance with a bank. When he couldn't do so and failed to meet the required payments, the lending partnership eventually foreclosed on his property, triggering an auction. The lending partnership reassigned its winning bid on the development to another entity it owns, Rich said.

Fahey is asking the court to declare the loans illegal and is seeking more than $20 million in damages, the amount he claims he could have earned on the project. A mid-December hearing on a motion to dismiss the complaint against the schools and foundations has been requested, said Fahey's attorney, Richard Briansky.

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