Monday, April 21, 2014

CMBS Litigation: The Guarantor Actually Wins One


On April 7, 2014, the US District Court in the Southern District of New York granted summary judgment in favor of the Guarantor in CP III Rincon Towers, Inc. (Plaintiff) v. Richard Cohen (Defendant) (No. 10 Civ. 4638 (DAB).   The substance of the court action revolved around a CMBS mortgage loan on property located in San Francisco, CA that had gone into default. The Plaintiff was attempting to recover the full outstanding amount owed under the loan from the Defendant alleging that the violation of certain “bad boy” provisions under the Guaranty executed by the Defendant triggered full recourse liability.

The borrower on this loan was delinquent on certain owner’s association fees, the amount of which it was disputing with the owner’s association. The borrower had also not paid certain contractor invoices due to a dispute over the work completed. These disputes, combined with nonpayment of the related invoices, resulted in liens being filed on the mortgaged property. 

The Plaintiff, in filing its action against the Defendant, alleged that the resulting liens on the property violated three full recourse provisions in the Guaranty: the “voluntary Lien, Indebtedness (without lender’s prior consent) and Transfer.”   The Defendant moved for summary judgment in its favor stating that the liens in question did not fall under either of these 3 provisions and therefore did not justify the Defendant being subject to full recourse liability.  

The Court agreed with the Defendant.  

In negotiating the Guaranty with the Plaintiff’s predecessor who negotiated the loan, the Defendant and his counsel were quite aggressive in pushing back on the form language in the agreement. Kudos to the Defendant’s counsel for doing his job well.  The takeaway for any would-be borrower or guarantor is to not blindly accept the CMBS loan documents and assume there is no room for negotiation. There is. The so-called bad boy provisions that trigger loss recourse and full recourse on the CMBS loans are broadly drafted and, from the perspective of a borrower or guarantor, need to be tightened up. Borrowers and guarantors who sign commitment letters and term sheets with these provisions already contained within the commitment document are acting foolishly, as they have pulled the rug out from under their lawyers and have undercut their ability to do their job.  

In this court action, the Plaintiff had attempted to argue that the actions or inactions of the borrower, by not paying invoices on time and/or disputing amounts, where voluntary choices and therefore the resulting liens should be categorized as “voluntary.”  The court didn’t buy into the Plaintiff’s argument, finding instead that mechanic’s liens arise by force of statute, not by an agreement of the parties. The court also held that judgment liens are imposed on the losing party and again, cannot be construed as voluntary. Strike one against the Plaintiff.  

Second, while both parties agreed that the resulting liens on the mortgaged property was properly viewed as indebtedness, the loan agreements clearly limited the full recourse trigger to indebtedness that was incurred without the lender’s prior written consent. The court interpreted this to mean it only addressed situations where a lender’s prior written consent is required before entering into the indebtedness, liability or obligation. The borrower did not need lender’s consent before starting construction or paying association fees, therefore the court held that the circumstances in this case did not fall under the full recourse provision.  

Finally, the Plaintiff argued that the liens on the property should be considered a “Transfer” which was broadly defined in the loan documents to include acts that “encumber” the mortgaged property. The court reviewed the interpretations argued by both parties and found the language to be ambiguous. It then looked outside the terms in the loan documents and revised the negotiations of borrower and lender prior to entering into the loan. Based on such external (i.e. “extrinsic evidence”), the court held that the parties clearly never intended these sorts of liens to trigger full recourse liability. 

The bottom line for parties on CMBS loans—Negotiate to protect your interests. It is important to clarify what will and will not trigger full recourse or loss recourse liability. From a borrower perspective, narrower, more specific provisions are better. A borrower also needs to review how these provisions might be unwittingly triggered by borrower’s standard operational procedures or even the simple desire to restructure ownership for estate planning purposes. Finally, work to ensure the language in the agreements clearly reflects everyone’s intentions. Otherwise, a court will interpret it for you.
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Monday, April 14, 2014

CLE Updates: Upcoming Real Estate Educational Seminars

In one sign that spring is here, the number of educational seminars on real estate topics is blooming.  Below is information regarding several upcoming seminars:
1.  The Ohio State Bar Association (OSBA) is sponsoring a Land Use and Zoning seminar on Wednesday, May 21, 2014 in Cleveland- live- (The Ritz Carlton, 1515 W. 3rd St., 44113) and in Columbus--live and via webcast on Wednesday May 14, 2014 (OSBA offices, 1700 Lake Shore Drive, 43204). Click here to access the OSBA's seminars.

2.  Sterling Education Services (SES) is sponsoring a seminar titled "Landlord-Tenant Law" on Friday, April 25, 2014 in Akron, Ohio (Holiday Inn Akron West, 4073 Medina Road; 330-666-4131).  Log on to www.sterlingeducation.com or call 715-835-5132 to register.

3.  National Business Institute (NBI) is sponsoring a seminar titled "Road and Easement Law from A to Z" on Monday, June 2, 2014 in Cleveland (Holiday Inn Independence, 6001 Rockside Road) . Order Now via the Web or Call: 800-930-6182.



+ Don’t Forget

4. Early-bird OSBA Convention registration discount extended to April 18
Register today and save $50 off full or $25 off single day registration.
The OSBA Annual Convention, April 30-May 2, at the Hyatt Regency Hotel in Columbus, continues to be one of the best CLE values available to Ohio lawyers.
In addition to being a great value, they have planned many new and exciting features for the 2014 Convention, including:
  • Special programming to celebrate and honor our military veterans for their service to our country;
  • A larger selection of CLE courses: 51 sessions, organized into 5 different tracks;
  • Shorter 60-90 minute CLE sessions;
  • Comprehensive programming designed specifically for the general practitioner; and
  • Sunrise and sunset CLE options to maximize your time at Convention.
Offer expires April 18. Log on to www.ohiobar.org/convention, or call their member service center at (800) 232-7124.
http://images.ohiobar.org/cle/Email_blasts/register.jpg

Monday, April 7, 2014

How the Right App Can Save the Day


This post is a little off topic for our blog but I wanted to share how one of the apps that I wrote about in January saved the day in a transaction closing. Recently, I attended a closing for a combined asset/commercial real estate transaction. In all acquisitions, whether a business or commercial real estate, certain closing conditions have to be met or waived, then the wires are initiated to fund the purchase. All lenders and title companies have a hard deadline in the afternoon by which the wire has to be initiated or it is postponed into the next business day.

 

In my transaction, we were running up against the wiring deadlines and risked not closing on time. To make matters worse, we were conducting the closing outside of my law office, at the business location being acquired. The scanning and faxing capabilities at the off-site location were inadequate and further complicated our ability to timely provide the lender with the items it needed before the wire transfers could be authorized. In a last ditch effort to meet out deadlines, I pulled out my iPhone and opened up my scanner app called JotNot Pro.  Using this application I was ability to ‘scan’ each document with my phone’s camera, convert the scans into pdf’s, including a multi-page pdf of the lease, and attach them to emails to the lender. We sucessfully funded and closed the acquisition with minutes to spare. Without this application I seriously doubt we would have closed our deal that day.

 
In real estate, I can visualize situations where having a scanner app on a smart phone or tablet would be immensely useful for professionals, such as real estate agents, who would benefit from being able to have purchase agreements and other documents signed and delivered immediately without having to wait until they back it back into their offices. I know that there are more than one such scanning app and highly recommend that people consider downloading one to try.   
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Monday, March 31, 2014

Don’t Let Your Contract Disappear (Merge) Into Your Deed

Other than the real estate purchase and sale agreement, the deed is the most important and often misunderstood document utilized in a real estate transaction. Like a certificate of title for an automobile, the deed is the document that actually transfers the title of real estate from one to another. Unlike a certificate of title for an automobile, however, the deed contains a specific legal description of the property; and may also contain warranties of title; reservations (e.g., right to reserve an easement over the property); and restrictive covenants (e.g., “this property may only be used for residential purposes”). Also unique to deeds vs. certificates of title (and bills of sale to transfer other personal property) the deed can, unwittingly erase protections or provisions in the real estate contract that the parties thought they would have after closing due to a principle of law entitled the “doctrine of merger by deed”.

The general doctrine of merger by deed holds that whenever a deed is delivered and accepted without qualification pursuant to a sales contract for real property, the contract becomes merged into the deed and no cause of action upon said prior agreement exists. The purchaser is limited to the express covenants of the deed only.

As with all general rules of law, of course there are exceptions to the rule. The first main exception is the “collateral exception”. “Provisions in the contract that are collateral to and therefore independent of the main purpose of the transaction are not merged in the deed. An agreement is collateral if it does not concern the title, occupancy, size, enjoyment, possession,or quantity of the parcel of land conveyed. If the agreements concern the use or enjoyment of the land, they are not collateral to the purchase agreement and are merged upon acceptance of the deed.” Westwinds Dev. Corp. v. Outcalt, 2009-Ohio-2948 (11th Dist. Ct. of App.).

Fraud and mutual mistake on the part of the original parties to an instrument are also exceptions to the doctrine of merger by deed. In such cases, the equitable remedy of reformation is available where it is shown that the written instrument does not express the true agreement entered into between the contracting parties by reason of fraud or mistake common to them. Equity, however, will not make a new contract for those who executed the writing sought to be reformed.

Two relatively recent cases in Ohio illustrate the need to make sure that deeds clearly mirror the intent of the parties contained in their real estate agreements.

In Wasserman v. Copsey, 2013-Ohio-1274 (6th Dist. Ct. of App.), the Wassermans purchased an agricultural strip of land from the Copseys at auction in 1988. The real estate contract described the land as “75 acres more or less”, and there were boundary flags placed at several points along the perimeter of the property, indicating an acre or so less than 75 total acres. The deed conveying the land, however, identified the parcel as being “75 total acres”. In 2009, in anticipation of selling the property, the Wassermans had the property surveyed, which survey showed 75 total acres and different boundaries than had been set out at the day of auction. The Wassermans then brought a “quiet title” action to seek court affirmation of their 75 acre parcel in congruence with the 2009 survey, and the doctrine of merger by deed. The Copseys appealed, claiming mutual mistake. The trial court agreed with the Wassermans, upholding the merger doctrine, and finding no admissible evidence of mutual mistake. The 6th District Court of Appeals affirmed, finding the trial court’s exclusion of evidence in the form of the boundary flags and contract language proper because “when a deed is delivered and accepted without qualification pursuant to a sales contract for real property, the contract becomes merged with the deed and no cause of action upon the prior agreement exists”.

In Mong v. Kovach Holdings, LLC, 2013-Ohio-882 (11th Dist. Ct. of App.), Joseph Mong sold land to Kovach Holdings in 2009, pursuant to a contract of sale which provided, among other things,  the following clause: “Gas + oil royalty reserved by present owner”. The deed, however, provided no specific reservation of royalties language. The deed merely stated that the property is subject to “conditions and restrictions of record.” Mr. Mong brought suit after he was denied the royalty payments he was seeking. He claimed the deed should be reformed to provide for the reservation of royalties, due to a mutual mistake. Kovach Holdings defended the law suit on the basis of the doctrine of merger, and that there was no mistake on their part. Kovach further stated that it knew of the expiring reservation of royalties made by Mr. Mong’s seller; the then “present owner of the royalties”, and it would not have bought the property if Mr. Mong was going to reserve the royalties after the prior reservation expired.

The trial court in Mong (affirmed by the 11th Dist. Ct. of App.) first established that the doctrine of merger by deed is alive and well in Ohio and most other jurisdictions. Further, reservation of mineral rights was not a collateral issue, and there was no reservation of royalties clause in the deed. The court then reasoned that there was no evidence of mutual mistake. Contrary to Mong’s position, the court explained that by its reading of the real estate documents, the contract of sale did not express an intent contrary to the terms of the warranty deed. The contract provided that oil and gas royalties were reserved by “the present owner.” The court took that to mean the present owner of the royalties (Mr. Mong’s predecessor in interest) vs. the present owner of the property. Since the predecessor’s (soon to expire) royalty agreement was of record, the court reasoned that the deed provision (subject to “conditions and restrictions of record”) actually mirrored the contract language.

What is the moral of this story? There are two morals to this doctrine of merger story. The first is a common theme articulated in a featured category of articles on this Blog: Watch your language. Namely, “Say what you mean precisely, or a judge will tell you what you meant”. Clearly, Mr. Mong should have reserved the royalties to himself, the Seller vs. an undefined “present owner”. Even more clearly, Mr. Mong should have inserted “survival language” in the contract to the effect: “the terms and conditions of this contract shall survive the closing, and not be merged into the deed”. Buyers and sellers can provide that all provisions survive, or negotiate which provisions survive and which do not, as well as negotiate survival periods.

The second moral to this story is to “respect the deed.” The deed should not be thought of as a mere formality. Buyers should request a draft of the deed prior to the end of diligence periods. Even better would be to attach a draft deed as an exhibit to the contract so buyers can be sure they are getting what they fought hard for at the contract stage.

In other words, don’t let your contract rights disappear (merge) into your deed.




Monday, March 24, 2014

Land Installment Contracts: An Overview


What is a land installment contract?

A land installment contract (also known as a land contract, a contract for deed or an installment sale agreement) is a contract between a seller and a buyer regarding real property in which the seller provides financing to the buyer at an agreed-upon price and other terms, and the buyer makes payments in regular installments. Under such contracts the  seller retains title to the property until payment is full is received, but the buyer takes possession of the property.
 
Why use a land contract?

 

Land installment contracts are used by buyers and sellers for many reasons but some of the common reasons are:

 

  • Buyer lacks sufficient down payment—short-term seller financing is provided with a large balloon payment at the end, with payments during term designed to provide for sufficient equity at the end allowing buyer to qualify at the end for conventional mortgage financing;
  • Buyer doesn’t qualify for conventional financing due to bad credit;
  • Seller wants to close quickly and there is not sufficient time for a buyer to arrange for traditional mortgage financing; or
  • Purchase price of the real property is so low that the costs associated with conventional financing doesn’t make sense.

 

What provisions must be included in a land contract?

 

Land installment contracts are subject to Chapter 5313 of the Ohio Revised Code. Section 5313.02 requires that every land contract must be executed in duplicate with each of buyer and seller receiving an original copy.  Section 5313.02 also lists a minimum of 16 provisions that must be included in a land installment contract. Besides the obvious inclusion of the identity of the parties, a legal description of the property and all of the economic terms, the contract must (i) disclose any encumbrances on the property, such as a current mortgage lien, and any pending order of a public agency against the property, (ii) require the seller to record a copy of the contract, and (iii) unless the buyer and seller expressly agree otherwise, require the buyer to pay the taxes, assessments and other charges assessed against the property from the date of the contract.

 

What are limitations or responsibilities are placed on a seller?

 

A seller cannot hold a mortgage on the property that exceeds the purchase price under the installment contract unless the mortgage covers more property than that sold to the buyer under the contract. If the latter is the case, the seller must disclose to the seller the amount of that mortgage and the release price, if any, that is attributable to the property that is subject to the contract.

 

Within 20 days after a land installment contract has been signed by the buyer and seller, the seller must cause a copy of the contract to be recorded and deliver a copy to the county auditor where the property is located. The installment contract must also conform to all legal formalities required by law for deeds and mortgages.

 

At least once a year (or, on demand of the buyer, no more often than twice each year), a seller must furnish a statement to the buyer that shows the amount credited to principal and interest based on buyer’s payments during that year and the balance due under the contract.


What happens if the buyer defaults?

 

Section 5313.05 of the Revised Code provides that a buyer’s interest may be forfeited under the contract only after the expiration of a 30 day cure period. After expiration of this 30 day period a seller can proceed to serve a notice on the buyer as described in Section 5313.06. 

 

If a contract has been in effect less than 5 years, and a buyer has paid less than 20% of the purchase price, then, in addition to any other remedies permitted under the law, a seller may bring an action for forfeiture of buyer’s rights in the contract and request restitution of the property under Chapter 1923 of the Revised Code.

 

However, if a contract has been in effect for 5 years or more, or a buyer has paid an amount equal to or greater than 20% of the total purchase price, then a seller may only recover possession of the property by initiating a foreclosure proceeding.

 

Terminating the land contract by forfeiture or foreclosure is a seller’s only remedy, subject to limited exceptions when a buyer has paid less than the fair rental value plus deterioration or destruction of the property caused by seller.  In such cases, a seller may also recover the difference between what seller paid on the contract and the fair rental value of the property plus an amount for the deterioration or destruction of the property causes by such seller’s use.

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Monday, March 17, 2014

Owner/User Buyers Making a Comeback

Banks Increasingly More Willing To Finance Sale/Leaseback, Build-to-Suits and Corporate Investments

Reprinted with permission from: Mark Heschmeyer, the CoStar Group

 Even well into a recovery, companies that own facilities have remained net sellers, raising cash by selling their property to investors and leasing back the space. 
Lately however, with increased financing options and a dwindling supply of large blocks of available space, more companies are warming up to the idea of owning their buildings once again.

"Owner/users are still net sellers, but there has been a pick-up in the amount volume of properties bought for occupancy," said Mark Gallagher, senior strategist in CBRE's Investment Strategy Services Group. "There are a number of owner buyers that have sufficient cash to either acquire or seek a developer of property in order to build-to-suit now that fewer large vacant floor spaces are available in strongest markets,” Gallagher said.
According to data from CoStar COMPs, while more corporate owner/users bought property last year valued at more than $500,000 than sold (5,577 buyers vs. 5,125 sellers.) However, the dollar volume of deals clearly weighed in favor of the sellers: $20.6 billion in properties sold vs. $16.8 billion bought.

“We're seeing a few things at play that are influencing corporate occupier decisions,” said Christian Beaudoin, director, Americas corporate research at Jones Lang LaSalle. “Among the majority of our clients, flexibility and agility seem to be key priorities, coming directly from the C-level. This is driving some very successful sale leasebacks, which give the occupier more flexibility and a huge gain on the value of their assets, while giving the buyer a stable credit tenant.”

Corporations are getting smarter about their real estate too, said Jones Lang LaSalle’s Rod “Lo” Loschiavo, a senior vice president in Fort Lauderdale.

“The most significant value creation in commercial real estate is in the lease as opposed to the bricks and mortar. A company with good credit could purchase a vacant building, execute a long-term lease and resell the property at a substantial profit,” Loschiavo said. “Often times, companies do not have the foresight to sell the property until it is no longer needed, resulting in a lower sale price down the road. But it appears as though more companies are selling these assets in the form of sale/leasebacks to maximize their return and take advantage of the premium investors are willing to pay today for the assets secured by the leases.”

Banks have re-entered the lending markets in a strong way last year after having sharply reduced the foreclosed properties and distressed loans in their portfolios as property values and the economy picked up. And owner-occupied loans are making up a big part of that lending increase.

“Certainly for 2013, commercial real estate term loans was an area of solid growth,” Andrew L. McDonald - chief credit officer and executive vice president of Columbia Bank in Tacoma, WA, told analysts last month. “Growth in commercial real estate term loans was centered primarily in owner-occupied properties, which accounts for approximately $25 million of the $31 million increase in this classification. Growth was centered in agricultural land, manufacturing facilities and warehouses.”

For the 12-months ended Sept. 30, 2013 (the last full quarter for which bank statistics are available), the nation’s banks increased the amount of owner-occupied CRE loans in their portfolios by $8.11 billion - a 1.7% increase to a total of $475.14 billion.

At the same time, borrowers are opting for shorter-term loans of from 3- to 5-years, which are right in banks’ wheelhouse.

“Banks have been pro owner-occupied lending for the past several years,” said Patrick Mahoney, principal, president and COO for NAI Realvest in Orlando. “The challenge until recently has been the financials of the underlying business. As the economy has improved businesses balance sheets are stronger and banks are more likely to look favorably on lending to them.”

Mahoney sees several factors tipping the buy vs. lease scale towards buyers.

“Property values were reset lower during the recession and if you couple that with the ability to get 90% leverage utilizing a combination of traditional and SBA loans, then owner-occupied real estate becomes a pretty good investment.”

Chris Crabtree, senior vice president, principal of Cassidy Turley in Pleasanton, CA, agrees that the owner/user buyer is making a comeback.

"As the economy strengthens, I’m finding that businesses are growing and they are beginning to feel more confident in taking risk so they are willing to consider an expansion," Mahoney said. For many small business owners, it makes sense to own as it is another tool, which is used to build wealth and spread risk."

Commercial real estate professionals look to CoStar for verified, continuously updated property information, market and asset analysis, and Internet marketing support. Today their suite of information, marketing and analytic services provides subscribers with the professional-grade tools they need to find, market and analyze properties with unsurpassed confidence. For more information, log on to: www.costar.com/

Keep up weekly on national news, trends and property leads with the Watch List Newsletter, a weekly pdf that includes other news and leads not found on the CoStar Group web news pages. Sign up for the Watch List E-Mail Alert. A new issue is published Monday mornings.




Monday, March 10, 2014

Protecting Claims for Indemnity Obligations When a Commercial Tenant Files Bankruptcy


As a landlord of commercial property, one of the more frustrating situations to endure is a tenant in bankruptcy. While the bankruptcy code provides more protections for commercial landlords than in the residential context, there are still many gray “no man lands” that can trap a landlord.

 

One area that can create issues for a landlord is the indemnity obligation a tenant may owe the landlord under a lease.  Consider a scenario where tenant signs a lease and proceeds to initiate a very expensive build out of the premises only to file bankruptcy before the construction is completed and the contractor paid.  Contractor proceeds to file a mechanics’ lien on the property. The landlord can be forced to spend significant amounts of money in litigation and settlement costs with the contractor to resolve and remove the lien, not to mention the litigation costs in bankruptcy court over the priority of its related indemnification claim against the tenant debtor.

 

This was the situation the landlord, WM Inland Adjacent LLC (MW Inland), found itself in after its tenant, Mervyn’s LLC (Mervyn) filed for relief under chapter 11 of the Bankruptcy Code.

 

MW Inland requested that its claim was entitled to priority treatment under section 365(d)(3) of the Bankruptcy Code while Mervyn objected claiming it should be treated as a general unsecured claim.  Section 365(d)(3) of the Bankruptcy Code provides that the debtor much timely perform all of its obligations under an unexpired lease until that lease is assumed or rejected.

 

Critical to the bankruptcy court’s decision in favor of MW Inland was the distinction of an “obligation,” which is “something one is legally required to perform under the terms of the lease” from a “claim,” which is “an unmatured right to payment.” (WM Inland Adjacent LLC v. Mervyn’s LLC (In re Mervyn’s Holdings LLC), No. 08-11586, Adv. Pro. No. 09-50920, 2013 WL 85169 (Bankr. D. Del. Jan. 8, 2013)) The court further found that the obligation arose when the contractor recorded the mechanics’ liens and sued WM Inland to foreclose upon the liens (prior to rejection of the lease), which entitled WM Inland’s claim to treatment as WM Inland had requested under section 365(d)(3).

 

The takeaway for a commercial landlord is to consult competent commercial bankruptcy counsel as soon as possible after a tenant files for relief in the bankruptcy court to develop a useful strategy for preserving pre-and post-petition claims it might have related to the tenant’s lease obligations.

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