Monday, August 18, 2014

Defective Construction Claims: Are They Covered Under the CGL Policy or Not?

One area that is often argued are claims for defective construction under builders' commercial general liability insurance policies. This is an issue that equally affects a builder, a damaged party and the insurer, and how that issue is decided may depend on which state's law will control.

The issue involves whether defective construction constitutes an 'occurrence' under a CGL policy and if so, under what circumstances.

The Ohio Supreme Court addressed the issue in 2012 in Westfield Ins. Co. v. Custom Agri Systems, Inc. (2012 Ohio 4712) and held that faulty workmanship in and of itself is not enough to be considered an 'occurrence' under a CGL policy.  However, damage to property caused by the defective workmanship may be covered.

Ohio's approach is fairly strict compared to recent decisions in other states on this issue. A policyholder in Connecticut, Georgia, North Dakota or West Virginia might have better odds of making a successful claim given the more expansive interpretations that have come out of those state courts.

However, before policyholders start doing their happy dance...in all of these states, Ohio included, the rulings typically just addressed what constitutes an 'occurrence' under a CGL. Other exclusions or policy language may still preclude a claim.
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Monday, August 11, 2014

Pay Your Lawyer Now, or Pay Your Lawyer (a lot more) Later (to review a residential real estate contract)

Have you heard this one? A man/woman walks into a lawyer’s office (of, course, after he/she signs a contract and closes on a deal) and asks, “Can you help me?”

We hear it a lot, and unfortunately, the “punchline” is often not funny at all. All the old adages hold true- “an ounce of prevention is worth a pound of cure”, “you can pay me now, or pay me (a lot more) later”…In other words, the best time to evaluate your legal rights, responsibilities and potential liability is before you sign on the dotted line. And, by no means let the person on the other side of your transaction (or their broker/agent) convince you a lawyer is not necessary. Odds are they will be little help to you if/when something goes wrong in the deal later on.

The following presents a real life example that happens all too often in the residential real estate arena.

A buyer of a parcel of real estate (improved with a house and other improvements thereon) is presented with a broker form contract from the seller’s agent. The buyer asks, “Do I need a lawyer?” The answer given is, “No, they’ll just add time (theirs) and money (yours) to the equation. Anyway, the contract forms were drafted by lawyers. It is your choice, of course, but if you take all that extra time, you’ll probably lose the deal. There are a lot of interested buyers”.

So, buyer signs, without having a lawyer look over the contract. During the two months prior to Closing, things seem to go well; the inspections don’t reveal any problems and buyer’s financing goes through…Then, on the day of closing there is a stack of forms to sign; “all routine” according to the broker and the banker. Finally, about two weeks after closing, the buyer gets a package of documents from the title company including the deed and title insurance policy. The buyer then puts the documents in his safe, thinking he is.

The trouble begins about six (6) months later.  The neighbor writes the buyer a letter (with a copy of a survey) showing that some of buyer’s landscaping, retaining wall and driveway gate encroach upon the neighbor’s property, and demanding that buyer remove those items or the neighbor will sue. The buyer thinks the neighbor is crazy, but asks us to review everything. The buyer says this should be “a no brainer” because he has a survey, title insurance… everything he was advised to get when he bought the property.

Suffice to say, thing are not always what they seem. The buyer did get a survey, but not because the broker form called for a survey. Most broker forms do not contain survey provisions. Since the buyer got a loan, the bank ordered a “Mortgage Location Survey”.

The Mortgage Location Survey, however, did not show the landscaping, retaining wall (barely visible within the landscaping) or driveway gate. Mortgage Location Surveys in Ohio (and elsewhere) typically just show that the building(s) and/or other permanent improvements of the property are actually located on the land covered by the legal description in the mortgage.

Pursuant to Ohio law (Ohio Administrative Code Section 4733-38), there are minimum standards for a Mortgage Location Survey, but most of the same just require the surveyor to show: the boundary lines as cited in the legal description; major improvements (permanent structures; e.g., residence, garages, outbuildings with foundation); any visible utilities; apparent encroachments and the address posted on the building(s). Our buyer’s landscaping, wall and gate were not deemed permanent structures and were not apparent to the buyer’s surveyor.

Had the buyer procured an ALTA/ASCM Land Title Survey, odds are the surveyor would have noted the encroachments. The ALTA/ASCM Survey is the “Cadillac” of surveys. The Mortgage Location Survey is more like the “Mini Cooper”. An ALTA/ACSM Land Title Survey must adhere to a set of national standards put forth by the American Congress on Surveying and Mapping and adopted by the American Land Title Association. The ALTA/ACSM standards require much more detail than the typical border survey or Mortgage Location Survey including:

•           Easements benefitting or encumbering a property.
•           Encroachments across the boundary or easement.
•           Whether or not there is access to a public road.
•           Zoning setbacks.
•           Flood zones that may impact the property.
•           Evidence of any use by other parties.
•           Water boundaries within the property.
•           The names of the owners of the adjoining property.

The ALTA/ASCM survey is also held to very strict standards of accuracy. The allowable error in linear feet for urban property is approximately 1 foot in just less than 3 miles. In other words, for every 15,000 feet the survey can only be off by as much as 1 foot.

An equally important reason our buyer should have gone with an ALTA/ASCM survey is that the title insurance company would have (if asked) deleted its standard exception for survey matters. Many buyers don’t concern themselves with the “provisos” of title insurance, and believe that if they are getting a title insurance policy before closing, they are protected. They will be protected, but not from survey encroachments and other matters unless they request such protection, and have an ALTA/ASCM performed. Sometimes, in smaller residential deals the title company will even waive its survey exception with a Mortgage Location Survey. All you have to do is ask. With the survey exception deleted, all our buyer would need to do is send the neighbor’s letter to the title company. The title company’s lawyers would then work out a deal with the neighbor, and our buyer wouldn’t need to spend a dime.

Most broker form contracts, by the way do contain provisions for title insurance (to be provided at closing), but few include the right to receive a title commitment, prior to closing. To ensure that buyers get “good, marketable title” to property, as well as enough time to make that determination, buyers should insist upon (in the purchase agreement) a “title commitment” being delivered within a short time after signing the contract. The “title commitment” is a contract by the insurance company to enter into an insurance contract with the buyer, whereby the title insurance company will guarantee good title, subject to exceptions it finds upon a title search of the property (e.g., easements and liens having been filed against the property).

If buyers have an early chance to review these items (via a title commitment), they can evaluate whether or not same will adversely affect the property they are purchasing, and exercise a right to terminate the contract if there are items that will adversely affect the buyer’s use or value of the property.

While a title commitment (and corresponding right to terminate if the commitment shows liens, defects…) would not have helped the buyer on our facts, it will prevent many buyers from being unpleasantly surprised after they close with easements and other recorded rights against their property.

So, to recap, the buyer in our fact pattern has a survey, but is shows no encroachments. Our buyer has title insurance, but no coverage for survey matters.  Our buyer is essentially out of luck. While there may be an action against the surveyor, proving “apparent encroachments” of “permanent improvements” could end up costing more in legal fees than removing the encroachments. Can the buyer at least sue the seller? Sure, but in our fact pattern, the seller would probably prevail as it had a very common clause put in its deed (i.e., “subject to facts an accurate survey would disclose”).

What’s the moral of the story for buyers of real estate (residential and commercial)?
Have a real estate lawyer draft or review your contract, BEFORE you sign it, to ensure that you have: (1) the right to receive/procure a title commitment and survey, (2) the right to have the title insurance standard exceptions removed, (3) the right to review and object to adverse title/survey matters, (4) deed language that won’t effectively prevent an action against the seller; and (5) the right to terminate the contract if the seller won’t cure survey or title matters that adversely affect the use or value of the property you are buying.

Also, if your title company will not remove the survey exception without an ALTA/ASCM survey, make sure you procure the same. Further, for an additional premium, residential buyers can get even more protection with the ALTA Homeowner’s Policy. The ALTA Homeowner’s Policy (vs. the “Owner’s Policy”) provides coverage against losses from zoning violations, subdivision law violations, improvements that encroach into an easement, building permit violations, violations of covenants, conditions and restrictions, lack of vehicular and pedestrian access, supplemental assessments arising as a result of construction or transfer prior to the policy date and damage to the home caused by someone with easement rights.


A few extra “ounces of prevention” will always be worth the “pounds of cure”.

Default of Mortgage Loans Due to Death of a Borrower or Guarantor


While most people prefer not to think about it, the death of a borrower or guarantor on a mortgage loan has been known to occur and there can be significant consequences to the loan.

 

It is not uncommon, when an individual guarantees repayment of a loan, that the loan documents include a provision that the death of the guarantor results in a default of the loan. On commercial loans, lenders consider the involvement of a key owner/principal of a business borrower critical to the borrower’s ongoing ability to repay the loan. If that key owner/principal dies, the ability of the business borrower to continue operating at the same level and repay the loan is in doubt.  However, it is entirely possible that a suitable substitute guarantor is available; particularly if there are other principals in the business or relatives of the guarantors willing to step up and assume the guaranty.  If the guaranty doesn’t allow time for a suitable guarantor to be provided before the loan is defaulted, then that right needs to be negotiated into the loan documents. Most lenders will consider the inclusion of this provision and 90-120 days is the typical time frame negotiated for providing the new guarantor.

 

On the borrower side, it gets trickier.  If the borrower is an individual and that individual dies, the lender has a legitimate concern that the loan will not be repaid and may file an action to accelerate the balance due on the note and foreclose on the mortgage. Where it gets trickier is when the note includes both a husband and wife as co-borrowers or the note provides one borrower but the borrower’s spouse also signs the mortgage.  

 

Under Ohio law, it is not enough to establish that the note and mortgage were valid executed, the mortgage was properly recorded, the default occurred and the amount that is due to lender.  After determining that a default has occurred, the court must also address the equities of the situation to determinate if foreclosure is appropriate under the circumstances.

 

If the loan documents do not clearly define a payment default to include the death of a borrower, then the lender is pushing its luck to proceed with a foreclosure on that basis alone; particularly if timely payments are being made by the surviving spouse and that surviving spouse also signed the mortgage and is defined as a co-borrower under the mortgage. Just ask Third Federal Savings and Loan who lost its summary judgment and foreclosure order on appeal due to the default language in the note not clearly reflecting its default position and the trial court further failing to consider the equities of the situation. (see Third Fed. Sav. & Loan Assoc. of Cleveland v. Schlegel, 2013 Ohio 1978 (9th Dist. Ct. of App., Summit County)).

 

Words mean things, and each side needs to review the language in the loan documentation to ensure it correctly reflects the intent of the parties and what will and will not trigger a default and the right of a lender to proceed with foreclosure of the property.

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Monday, July 28, 2014

Due Diligence Review: A Critical Step When Buying Real Property


It astonishes me how many buyers will buy real property without conducting a thorough review of the property before closing. Most buyers will ensure a title search is ordered and buy title insurance. If a recent survey or phase I environmental review has been conducted, the buyer will typically ask for and receive a copy from the seller, but frequently will not order a new (or updated) survey and/or environmental review unless a mortgage lender is involved who will require it.   

 

Even taking this minimal diligence review into consideration, time needs to be negotiated into the LOI and purchase agreement to allow for more due diligence.  While not all-inclusive, and recognizing that certain types of property warrant a closer look than others (e.g., industrial property),  below a bullet point list of other items (besides title and survey) for buyers to consider in a real property review. Which items on the list warrant a higher level of attention would be dictated by each property’s unique characteristics; provided that purchase price should not be the only factor controlling that decision. A cheap piece of property can cause a very expensive headache later if adequate diligence was not conducted prior to closing on the sale.

 

  • Litigation—Have the local court dockets where the property is located, plus where the seller is headquartered, to ensure no litigation is pending that could hinder seller’s ability to close or buyer’s ability to obtain clear title.
  • Environmental—Besides the standard Phase I review, other items that may warrant investigation depending on what the buyer intends to do with the property after closing are conducting an asbestos review, wetlands study and flood plain review. I’ve encountered situations where minor dumping of non-regulated liquids from 50+ years ago still show up in soil samples today and delay (if not kill) the deals due to investigations and clean up required by a lender.
  • MEP—Conduct, or have an expert conduct, a review of the mechanical, electrical and plumbing (sewer) of the property.
  • Building Structure—Inspect the building structure. Will the roof need replacing in the near future? Does it currently leak? How about the foundation? Is the building in code compliance?
  • Safety—Review for safety issues that will need to be addressed. If the property is industrial, what about OSHA compliance?
  • Warranties—Depending on what equipment is included in the sale and the age of such equipment, a review of warranties may be warranted to ensure they can be transferred to the new owner.
  • Liens—If title work was ordered, then any liens encumbering the property will be disclosed in the title report. Otherwise, a lien search should be conducted.
  • Compliance with local building/zoning laws—If an ALTA survey was conducted, then legal requirements regarding number of stories, parking, setbacks, etc. are identified on the survey. Otherwise, a buyer needs to investigate these items. A zoning letter is often required by the lender as well.

 

The list above doesn’t cover the economic review that would be required if the acquisition involves a going concern, such as an office building or multi-family apartments. That may be the subject of another post.

 

Property buyers should take care not to be penny-wise and pound-foolish. A little more time and expense up front can often save a lot more time and larger expense later.

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Monday, July 21, 2014

Divide and Conquer: How Repair Regs Impact Your Property

Reprinted/posted with permission of Cohen & Company, Ltd. Original copyright “Taxonomics”, Spring, 2014

Just when you think you’ve figured out the rules of the game…

The IRS has adopted new regulations for business deductions on tangible property. It’s a sweeping
category covering everything from the purchase of computers to the repair and maintenance of buildings.

The process for adopting the new regulations was arduous, consisting of 10 years of hearings and public comments before final adoption this past September. As a result, the new regulations are complex. However, taxpayers may need to take a close look and assess the new rules to determine the potential impact.

The Parts are More than the Sum
While known in the industry as “repair regulations,” Cohen & Company Tax Partner Angelina Milo says, “these regulations really apply to the acquisition, production and improvement of tangible property.” Milo adds that although the regulations will impact all industries, they are significant to the real estate industry and to those who own real estate.

Prior to the new regulations, if your company owned a building and made substantial repairs or replaced parts of the facility, the decision to capitalize or deduct the cost was made primarily by comparing the cost of the improvements to that of the entire building. Other factors also came into play, such as the expected life of the property, overall value of the improvement, etc.

While other factors are still part of the equation under the new rules, the biggest change is that a building is no longer considered one unit of property, but is instead subdivided into separate “units of property.” Therefore, when a repair occurs, the cost of the improvement must be compared as it relates to the specific unit to which it belongs. The regulations identify nine building systems, each
as a separate unit of property: HVAC, plumbing, electrical, escalators, elevators, security systems, fire protection and alarms, gas systems and other structural components.

For example, a company owns an office building with a HVAC system that consists of 10 roof-mounted units. The company pays $75,000 for labor and materials to repair those units. The HVAC system, including the roof-mounted units and their components, comprise a unit of property under the new repair regulations. If the $75,000 in work done on the roof-mounted units is considered a significant improvement to the HVAC system, the $75,000 repair is treated as an improvement that should be capitalized. Whereas before these new regulations, the $75,000 compared to the cost of the entire building may have been insignificant enough to merely deduct the expense in the same year.

Safe Harbor Options
The regulations provide for a routine maintenance safe harbor, which looks at the frequency of the repair and maintenance. For a building, if the taxpayer reasonably expects to perform routine maintenance on a unit of property at least twice within 10 years, then the costs may be expensed. Milo says, additionally, taxpayers may now deduct the cost of acquiring an item under another new safe harbor provision; this safe harbor allows a taxpayer, with an applicable financial statement, to expense items costing $5,000 or less per invoice or item. (An applicable financial statement is one that is required to be filed with the SEC, is a certified audited financial statement that is accompanied by the report of an independent CPA, or is required to be provided to a federal or state government or agency other than the SEC or the IRS.)

The expense threshold changes to $500 per invoice or item for taxpayers without an applicable financial statement. So, if the cost to acquire a new HVAC unit was $5,000, then the cost could be expensed. Although unlikely for the purchase of HVAC units, this provision may be very helpful for less expensive items purchased.

Milo says to take advantage of the safe harbor provision for acquisitions, the taxpayer must have a written financial policy at the beginning of the tax year and must make an election with the taxpayer’s timely filed tax return. In addition, taxpayers may choose to have capitalization policies in place in excess of the safe harbor amounts. However, should the return be audited, the taxpayer will have to show that the amount in excess of the safe harbor is appropriate and clearly reflects income.

Out With the Old
In conjunction with the final repair regulations, regulations have also been proposed regarding the disposal of tangible property. Under the proposed rules, a taxpayer may elect to recognize a loss upon a partial disposition of tangible property. For example if the taxpayer replaced five of the 10 mounted HVAC units, a taxpayer will no longer need to dispose of an entire building to recognize a loss. The taxpayer would capitalize the costs of the new units while electing to deduct the remaining costs of the units replaced.

Looking Ahead
While compliance with repair regulations will be mandatory on 2014 returns, which by then could also include final regulations regarding the disposition of property, taxpayers have the option to voluntarily comply with both the repair and disposition regulations on their 2013 tax returns.

“Considering the expansive nature of these regulations, we have been meeting with clients so they understand the technical and practical application,” says Milo. “The ultimate impact will vary depending on each taxpayer’s existing policies and procedures.”

Ranked one of the top five accounting firms in northeast Ohio and top 100 nationally, Cohen and Company is a full service accounting firm with the following specialties: tax planning and compliance; accounting/auditing; business consulting; wealth management; transaction and litigation services; and corporate finance.

Angelina Milo, the author of this article is a partner with the firm, specializing in tax planning and general business consulting for individuals and closely held businesses. She is also experienced in assisting businesses through acquisitions, divestitures and succession planning. You can contact Angelina Milo of Cohen & Company for more information at amilo@cohencpa.com.



Monday, July 14, 2014

Owning Real Property as Tenants in Common


Owners of commercial property have increasing found benefit in owning their separate interests in the property as “tenants in common.”  Typically, if two or more parties wanted to jointly own a commercial property, the typical approach would be to form a limited liability company (LLC) to hold title to the property and the ownership interests of the LLC would be held in varying percentages by the parties. Most of the time, this will remain the preferred approach.


However, when one or more of the parties wants to use funds held in a 1031 exchange for the property purchase, holding title to the property as a tenants-in-common interest (TIC Interest) is a better option.


A TIC Interest is an undivided interest in the real property, which can be bought or sold separately from the other undivided interests in the property and can be separately mortgaged. 1031 exchange funds can be used to purchase a TIC Interest, but cannot be used to buy a partner’s equity interest in an LLC.


The parties that collectively own the TIC Interests a property will enter into a Tenants in Common Agreement (TIC Agreement) which sets out the terms and conditions upon which each will hold their respective TIC Interests and specifically elects to be excluded as a partnership under the Internal Revenue Code.


The TIC Agreement, will address property management, how income, expenses and liabilities of the property will be handled, and remedies that will be taken if a tenant in common doesn’t pay his or her proportional share of property expenses, and also identify other tenant in common obligations, such as compliance with loan obligations that affect the property as a whole.


If the property as a whole will be mortgaged, the lender may require additional provisions be added to the TIC Agreement for so long as the loan is outstanding, particularly if the loan will be a CMBS loan.


While TIC Agreements do not have to be lengthy or complicated, it is critical that the parties enter into such an agreement while the interests are held as TIC interests.  If even one of the tenants in common fails to cooperate or pay proportional expenses, then the other TIC owners need the ability to take action against the other owner.

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Monday, July 7, 2014

How to Spell Real Estate Tax Relief in Ohio-“ESOP”, “PTAP” “TOP”…

While paying taxes is still one of the “top 2 certainties” in our lives, and we can’t legally avoid them, there are a number of property tax deferral/loan/grant programs currently in place (or in process) in Ohio offering some relief.

Most counties in Ohio allow taxpayers to pay in installments.

In Cuyahoga County, the “EasyPay” program allows current taxpayers (or those on delinquent tax payment plans) to have their upcoming real estate tax payments automatically deducted from their checking or savings account:

 (i) Monthly - 1/6th of the taxpayer’s estimated future tax bill will be withdrawn from their account around the 5th of each month.  Each January and July the remaining balance due for the period will be withdrawn from their account on the last day of the collection period;

(ii) Semi-Annually - Withdrawals will occur twice a year on the last day of each collection period in January and July.  The taxpayer may elect to have the first payment made on the last business day of December instead of the collection closing date; or

(iii) Annually – The taxpayer’s full year tax amount will be withdrawn either on the last business day in December or the last day of the January tax collection.

Call (216) 443-7420 or log on to: http://treasurer.cuyahogacounty.us/en-US/easypay-plans.aspx  
for more information.

In Franklin County, the Budget Payment Program allows taxpayers to make monthly prepayments on their semi-annual tax bill. The money paid will be held in an escrow account in the taxpayers name and will automatically be applied to their semi-annual real estate tax bill when it comes due. Payments can be made by personal check, certified check, money order, cash, credit card, or direct debit.
By choosing the monthly direct debit from your checking or saving account the taxpayer can receive an interest credit towards future taxes.
  • The interest earned on the taxpayer’s escrow account is paid at the same rate of return as the Treasurer's investment portfolio.
  • Interest is calculated on all of the taxpayer’s monthly payments from their first direct debit until the tax due date.
  • The interest is credited to the taxpayer’s escrow account, which goes toward their taxes for the next billing cycle.
Should you have questions or require additional information please e-mail the Treasurer, call the Franklin County Budget Payment Unit at 614-525-3438 or log on to: https://treasurer.franklincountyohio.gov/payments/budget-pay

In Hamilton County, the Treasurer's Optional Payment (Top) Program allows
 residential and commercial  property owners to prepay their real estate taxes in five installments.
 It is similar to an escrow account with a financial institution. There is no service charge associated with the program.

  If interested in the “TOP Program”: Taxes must be current;  both residential and commercial properties qualify; and the Top Program cannot be used to pay taxes already owed.

 Once enrolled in the program, the taxpayer will be sent four prepayment coupons, representing their estimated tax payment. Each month they would mail their one-fifth payment, along with a coupon, to the treasurer's office.  The final statement will be the taxpayer’s tax bill, which will reflect all prepayments made and the final balance due.

 If you would like more information about this program, please call: 513/946-4788 or log on to: http://www.hamilton-co.org/treasurer/TOP2.html

Franklin County has a one-time emergency grant program-“PTAP”
.
The Senior Citizen Property Tax Assistance Program of Franklin County (PTAP) is a not-for-profit organization with an endowment fund through the Columbus Foundation which has as its purpose, the collection and distribution of funds to assist needy senior citizens and disabled individuals in the payment of their property taxes. These funds are to be provided for tax payments on an emergency basis only. The program is to assist eligible 60 plus year old senior citizens or disabled homeowners on a one-time basis (However, if applicant has a history of property tax delinquency, assistance will be determined on a case-by-case basis).

Income eligibility is to be based on 150% of the Federal Basic Needs Standard.  "Disabled" is defined as a person who is unable to engage in any substantial gainful employment or activity because of a physical or mental impairment that is expected to last for an extended period of time. The applicant should be receiving or has applied for disability payments such as SSI, SSD, VA etc.

If you would like more information about this program, log on to: https://treasurer.franklincountyohio.gov/tax-savings/property-tax-assistance-program

In Cuyahoga County, “ESOP” is about to unroll (August/September, 2014) its delinquent  property tax loan program

As reported by Sheryl Harris, Consumer Columnist with the Cleveland Plain Dealer in her article “ESOP Offers Loans to Seniors who Fall Behind on Property Taxes: Plain Dealing”, posted on June 27, 2014 (on Cleveland.com), eligible Cuyahoga County residents will soon be able to apply for loans to pay off their delinquent tax bills. According to Ms. Harris, “Sometime late this summer, Faith Community United Credit Union, which is administering the loans, will be taking applications from Cuyahoga County residents 55 and older [for 3 year, 10% loans]”. “ESOP refined the idea for the tax loan program with the help of the Clinton Global Initiative. Third Federal kicked in the $200,000 needed to cover the initial loans and associated costs.”

For the complete article by Ms. Harris, log on to: www.cleveland.com/consumeraffairs.com. Ms. Harris can be contacted at: 216-316-6832 (c) or sharris@plaind.com.

For additional information about the Senior Tax Delinquency Loan Program or ESOP's programs for homeowners, contact ESOP through www.esop-cleveland.org or call: 216-361-0718.