Tuesday, December 28, 2010

Business Breakups; Preparation pays off when partnerships dissolve

by Cara Lowe

Given commercial real estate’s protracted downturn, brokerage arrangements, investment groups, and client partnerships may be on shaky footing these days. While breaking up is hard to do, learning how to do it successfully can help all business participants to pick up the pieces, pack up, and get on with their lives.

Asking the Right Questions
To avoid a long, exhausting battle, partners should consider the following questions.

Is there a prenuptial agreement?
Well-advised business owners create a buy-sell agreement — at the start of their partnership — that outlines situations in which the parties can part ways. The “four D’s” — death, disability, disagreement among the parties, or personal divorce — are typical triggers, but an effective buy-sell agreement addresses issues specific to the parties or the project that might trigger a buyout. The agreement also outlines how the parties can fairly and accurately price the bought-out interest and clearly articulates the payment terms.

If the buy-sell terms fall short or become stale, the parties have to negotiate new terms outside of the agreement, which may be difficult if relationships sour. If all else fails, they can consider a voluntary or involuntary dissolution of the company under applicable corporate or partnership law.

For operating businesses, such as real estate development, management, and brokerage companies, the standard buy-sell provisions discussed above should be located in the owners’ shareholder agreement for the operating company. Different provisions might exist in the partnership or operating agreement prepared for the separate partnership or LLC entity in which investors participate. Typically investors have few, if any, rights to withdraw their capital from a private or non-public investment.

In contrast, a joint venture between a service partner, such as a developer, and a finance partner, such as an institutional or lead investor, usually sets forth detailed scenarios — based on performance milestones, budgetary thresholds, and other objective metrics — in which the service partner’s interest can terminate or the finance partner’s interest can be “put” to the company.

In addition, real estate entities likely are subject to various bank and other third-party covenants or restrictions that limit the options available to the parties. Thus, those contractual obligations require consideration in order to avoid a technical breach under those agreements.

How do you value the buyout?
When preparing a buy-sell agreement or negotiating the terms of the buyout, the parties need a valuation mechanism that they mutually accept as realistic, relatively accurate, and fair. With an operating company, the owners themselves usually are best equipped to select the appropriate valuation process, with support and input from the company’s accountants, third-party appraisers, or other industry experts. However, valuation is complex and involves weighing all factors that could impact the company’s bottom line, including current and future revenues and liabilities. Further complicating the process is the fact that the value of development projects and investments is uncertain until completion.

The downturn has caused property values to erode significantly in many markets, but buy-sell provisions might still apply. For example, the buy-sell might provide for a put option, where the investor can force the company to liquidate its interest, or a call option, where the company can force the investor to sell its interest. If no viable options exist, then the owners have to consider remaining together, negotiating a buyout, or selling the underlying asset.

Regardless of how the buyout surfaces, the parties need to consider the tax consequences to the company, the departing party, and the remaining parties. These include any income recognition related to a departing party’s negative capital account or any potential transfer tax or property reassessments that might be triggered by the change in beneficial ownership interests in the underlying real estate assets.

When can you tell the “kids” (your team and staff)?
Often one party pulls the plug suddenly, forcing the others to scramble to retain key talent and develop a communication plan. Express nonsolicitation covenants may prohibit the departing owner from soliciting employees and clients before and after departure. In the absence of such contracts, fiduciary duties under state partnership, corporate, and LLC law may forbid officers, directors, partners, and majority shareholders from soliciting other employees, owners, and clients prior to the departing party’s effective resignation and ownership interest termination.

When can the parties start dating?
Many buy-sells include noncompetition covenants that restrict the departing party from competing with the company and/or soliciting clients. Most states enforce reasonable restrictive covenants. In a few jurisdictions, such as California, noncompetes are unenforceable unless the situation falls within a statutory exception.

Can the parties walk away with a clean slate?
Whenever a buyout comes into play, the parties need to consider granting a mutual general release, where both sides release each other from all claims.
In real estate companies and ventures, a general release might not be appropriate if misconduct is suspected or personal guaranties of third-party liabilities remain in place after the parties part ways. The parties need to take into account all of the liabilities and risk that exist or could arise after the breakup. Any termination agreement that memorializes the parties’ breakup could contain expansive representations and warranties about those issues and other relevant facts. In that event, the parties could give mutual general releases and still have recourse against a party that breaches the representations and warranties given to the other party.

How do you announce the change to the outside world?
The parties should establish “game rules” at the start of negotiations, including an agreement to keep the breakup, negotiations, and all terms confidential until they sign a written settlement agreement. To encourage fair play after they part ways, the parties also might consider adding a nondisparagement covenant to their termination agreement.

Saturday, December 18, 2010

Who's Square Feet? The Ugly Truth About Measuring Condos and Coops


Who's Square Feet?

New York Times - Saturday, December 18, 2010

The tape measure does not lie.

But when it comes to measuring the square footage of New York City apartments, the tale told by the tape can be exaggerated, massaged, misrepresented and manipulated.
There are willful — and legal — tactics to make a space appear bigger on paper, like including common spaces and elevator shafts in the calculation of an apartment’s size. There are also honest mistakes that derive from historical inaccuracies, differences in how condominiums and co-ops are measured, advances in measuring technology, changes in measuring standards, and unusual layouts. Then there are outright misrepresentations.

It can all add up to confusion or worse.

Buyers may be saddled with an apartment that the bank finds to be less valuable than assumed, because it is smaller than was thought. Deals can be delayed or even denied if lenders calculate a square footage different from the one listed, which can lower the appraised value. And developers who grossly overestimate square footage in an offering plan may find themselves being sued or losing deposits if the attorney general finds they acted in bad faith.

“There is an implied precision,” said Jonathan J. Miller, the president of the Miller Samuel appraisal firm. He prepares the quarterly market reports for Prudential Douglas Elliman, which track prices per square foot, among other indicators. In reality, he said, the measurements are anything but precise.
Mr. Miller, who said he had calculated square footage for more than 7,000 New York City apartments, estimates that measurements vary by about 10 percent industry-wide. Dimensions are generally taken with a laser device, the latest in a long line of tools used to gauge the size of apartments. But the laser is only as good as the person wielding it. And sometimes the stated square footage is a willful exaggeration.

“I remember seeing a condo unit and being told it was 600 square feet,” Mr. Miller said. “And I immediately thought, if this is 600 feet, I am blind.”
Brokers are often accused of overestimating. Bank assessors, on the other hand, are widely thought to underestimate. Even when estimates are in agreement, owners are likely to resist any change that will decrease the size, and therefore the value, of an apartment.

Official oversight of square footage measurements is limited, real estate lawyers said. Condo developments are required to say how they calculate square footage in their offering plans, which are filed with the state Office of the Attorney General. But there is no similar requirement for co-ops. And even in newer condos, as the property changes hands over the years, small inflations may morph into architectural tall tales.

Brokers are often careful to say they take no responsibility for listed square footage, and owners may honestly not know how large their home is. So, often, there is no obviously responsible party when discrepancies are found.

Steven Wagner, a real estate lawyer, says he encourages anyone thinking about buying an apartment in a new building to hire a lawyer to read the offering plan closely in order to determine whether the square footage measurements include common space like elevator shafts and hallways — adding them in is legal in some cases, but that is not common knowledge. He said buyers of resales would be wise to have an architect or engineer measure the place before any contract is signed.
Mr. Wagner said it was more than two decades ago, when many buildings were being converted to co-ops, that he began noticing that the square footage numbers were being cooked.

“Some of the sponsors converting the buildings started measuring not from the interior wall, but from the exterior wall,” he said. “Of course, that does not work very well unless you plan on living inside the brick wall itself.”

While a certain amount of variation is tolerated, Mr. Wagner said, “the standard for fraud is a misrepresentation of material fact.”

“There comes a point where it is not O.K.,” he said. “But I can’t tell you whether it is 2 percent or 20 percent.”

One buyer, Glenn Evans, a senior vice president of Estée Lauder, is sure that he was defrauded. When Mr. Evans and his partner, Calvin Poon, moved back to New York from Shanghai in 2009, they told their broker that they wanted a place with more than 2,000 square feet.

“I must have showed them 40 or 50 apartments,” said Robert Beacham, a broker at the Real Estate Group of New York.

But it was not until they walked into a two-bedroom co-op apartment at 1200 Broadway, a former hotel built just after the Civil War, that they knew they had found their new home. The building’s mansard roof, ornate windows and high ceilings were all part of the draw. But so was the price per square foot. Mr. Evans said that the apartment was listed at 2,170 square feet.

“We did all our calculations based on the price per square foot,” he said. At the time, the broker representing the seller — who could not be reached recently for comment — insisted that the price per square foot was well below market value.

The seller was asking for $1.749 million, and Mr. Evans countered with an offer of $1.65 million, which was accepted. But as part of the loan-approval process, the bank did two appraisals, both of which flabbergasted Mr. Evans. The bank found that the apartment was either 1,634 square feet or 1,741 square feet. Admittedly, the place has an odd layout that makes it difficult to measure. But nobody was coming up with anything near 2,170 square feet. Mr. Evans hired an architect to check again. The third measurement came in at nearly 1,800 square feet, convincing him that he had been deceived.

When Mr. Evans tried to negotiate a lower price based on the bank’s assessment, the seller refused. Mr. Evans said he was told he would lose his 10 percent deposit if he backed out.

He sued the seller and the brokerage firm, Prudential Douglas Elliman. Mr. Evans claimed that the selling broker knew the apartment was not 2,170 square feet — a size given in past transactions — but continued to use the inflated figure.
“We just felt we were misled,” he said. “There was a deliberate, coordinated action by these people to rip us off.”

The case against the seller was dismissed when a judge determined that the seller had had nothing to do with the marketing of the apartment. Prudential Douglas Elliman contested the suit, which Mr. Evans recently dropped because it would have been too costly to continue, he said. A spokeswoman for Prudential Douglas Elliman said it never comments on litigation involving the company.

Mr. Evans and Mr. Poon went through with the deal. Although they say they love the apartment, they are still bitter about the experience.

“They were fighting this like a class-action suit,” Mr. Evans said of the brokerage. “It would open a whole Pandora’s box of liability.”
Because brokers are generally careful to list square footage as an “estimate” or “approximation,” there is often little recourse for buyers.

For that and other reasons it is unwise to place too much emphasis on square feet as a basis for comparison, said Douglas Heddings, the president of the Heddings Property Group.

“First and foremost,” Mr. Heddings said, “I think all the weight that is put on price per square foot, especially in Manhattan, is ludicrous.” He is particularly skeptical of comparing apartments in different buildings based on their listed square footage.

“Very rarely can you compare two units unless they are units that are in the same building and were measured using the same standards,” he said.

Frances Katzen, an executive vice president of Elliman, said a number of her clients had bought apartments that turned out to be smaller than they had been told. She counsels her clients to focus not on square footage, but on what similar properties in the same building have sold for in the past.

She is currently showing a duplex apartment at 468 West 23rd Street. The owners, who have moved to Australia, bought the place several years ago without the help of a broker. They paid $2.1 million, thinking that the apartment had 2,100 square feet. The size estimate included the 700-square-foot backyard.

When they went to sell, Ms. Katzen said, the owners were disappointed to learn that outdoor space is not typically counted as part of overall square footage. So instead of 2,100 square feet, the apartment is listed at 1,400 square feet, and priced at $1.85 million.

Renters are often swayed by square-footage figures, said Clifford Finn, the managing director for new developments at CitiHabitats.

“Renters don’t necessarily calculate the rent based on price per square foot,” he said. “But often, they will come in with a very specific idea of how much square footage they need.” However, more often than not, neither the renter nor the landlord in older buildings has any idea of the true size of an apartment.

“In more than half the walk-up apartments in Manhattan,” he said, “no one knows the true square footage. And renters will come in saying they cannot live in less than 750 square feet, but will have no idea what 750 square feet is. You show them something that is 640 feet and they are like, ‘This is great.’ ”

Even for professionals, square footage can still hold surprises.
Pamela Liebman, the chief executive of the Corcoran Group, said that when her company was renewing its lease on office space in SoHo, the landlord came to her with unexpected news.

“We were paying rent based on 12,000 square feet,” Ms. Liebman recalled. “He said, ‘Your space is now measured at 14,000 square feet.’ ”

The landlord wanted to charge more based on the new calculation. Ms. Liebman replied that the space had not magically grown 2,000 feet overnight.
“We had a war over it,” she said. The landlord eventually relented.
Although it was commercial real estate — which has a different set of rules when it comes to measuring square footage, as well as its own, often more egregious, variations in measurements — it offered a reminder of just how unreliable size estimates can be.

“I think we have all become too obsessed with dollars per square foot,” Ms. Liebman said. “Smart buyers should look carefully at the offering plans or have the apartment measured themselves.” And, she added, always keep in mind that “everyone seems to have a different tape measure.”

Wednesday, December 8, 2010

Dashing Through the Snow: Fleeting Holiday Pop-Up Stores Plow Into New Legal Territory

December 3, 2010
Article by Amy Armond - Holland and Knight

If you live in a metropolitan area, chances are that this holiday season you will notice more than just lights and festive decorations appearing around town: pop-up stores are a growing trend in retail that appears to be here to stay. If you're not particularly attuned to the retail scene, you may ask "What is a pop-up store?" Broadly, the term "pop-up store" is used to describe a retail venture of a temporary nature. If you're vaguely familiar with the pop-up store concept, you may be picturing a seasonal store – perhaps one in a mostly-vacant strip mall with a large plastic orange and black "Halloween" banner announcing its arrival.

In the past few years, however, the pop-up store has evolved from the typical seasonal store to a sophisticated and carefully calculated business tool – one that can take on any incarnation marketers can imagine. Retailers (and companies touting products that are not typically conceived of as falling within the "retail shopping" category) are using pop-up stores as vehicles for testing locations and markets, launching new products, and, most notably, for promoting and fostering brand identity. The fleeting nature of a pop-up store leads to the store's presence becoming newsworthy, thus creating buzz about the featured brand or product and planting urgency in consumers' minds to visit the store before it's too late.

Modern Pop-Up Stores Hope To Make the Season Bright

One example of a modern pop-up store is the temporary store that Pop-Tarts opened in Times Square in August 2010, which has been featured in numerous news stories over the past several months. In the store, consumers can not only consume Pop-Tarts (including special limited edition flavors) at the in-store cafe, but also participate in interactive features, such as an oversized vending machine-type display that allows consumers to create personalized "variety packs" of Pop-Tarts. The lease for the store reportedly runs through January 2011. Other pop-up stores planned for this holiday season include Toys-R-Us, which plans to open 350 "Holiday Express" toy locations across the country. Best Buy plans to open approximately 50 mobile outlets to accommodate holiday demand for its products. And Harry & David plans to open 16 pop-up "orchards" in major cities, where the fruit and gift retailer hopes to not only increase its sales but also revamp its image among urban consumers.

Need for Legal Guidance

For building and shopping center owners approached by retailers seeking to use space for pop-up stores, these temporary ventures may seem like the perfect solution to ongoing retail vacancies related to the recession and a useful tool for increasing traffic to shopping centers during the holiday season. Unfortunately, the temporary nature of pop-up stores may create the perception on both parties' ends that liabilities are limited, legal concerns are insignificant, or quick negotiation is paramount to consideration of details. Before simply following the pop-up store trend in merry measure, property owners and retailers should seek legal guidance to ensure that there exists an agreement which encompasses both parties' business goals and legal concerns.

Considerations for Landlords

Before entering into a pop-up store agreement, a building or property owner needs to consider carefully the impact that the store may have on the subject property. Aside from the obvious need for insurance coverage and indemnity provisions to provide protection from the potential liabilities that may arise due to the store's presence, an owner who is negotiating a lease or license agreement with a pop-up retailer needs to anticipate the effect that the store will have on the property and ensure that its attorney understands the myriad of issues that may need to be addressed in the agreement.

• One of the first considerations is whether the agreement should be structured as a lease or a license. The answer depends on the length of the term of the agreement, the potential for conversion to a long-term arrangement, and the extent to which a property owner is willing to grant an interest in (and allow an encumbrance on) the property.

• Another critical provision in a pop-up store agreement is the "use" language. From the landlord's viewpoint, such language needs to be crafted narrowly to avoid unexpected and undesired activities on the property. A shopping center landlord also needs to ensure that the pop-up retailer's proposed use will not violate any "exclusives" in favor of existing tenants. For a shopping center owner who desires flexibility to enter into pop-up store agreements in the future, it may be worthwhile to consider updating the lease form used for the property to except temporary uses from the exclusives granted to future long-term tenants.

• A landlord will also want to protect the marketability of the subject property to long-term tenants by including limitations on alterations and permanent fixtures, as well as language allowing the landlord entry to show the premises to potential future tenants. In addition, any landlord who has plans for future use of the property may wish to instruct its attorney to prepare particularly strict holdover provisions to avoid (or be compensated for) any detrimental effects of a pop-up tenant failing to vacate its space within the time frame provided for under the lease or license.

• There are also several practical considerations which might be missed by a property owner entering into a pop-up store agreement in haste: Should the agreement include terms relating to special events, media presence, crowd control, parking, safety issues, equipment and inventory loading and storage, or signage? Will the retailer be required to pay utility and maintenance costs? Should the retailer be permitted to assign the agreement?

• Lastly, a landlord will want to retain some modicum of control over its property, including the ability to impose rules and regulations to address safety issues and prevent any adverse effects that the presence of the pop-up store may have on other tenants.

To sum up, a property owner should not enter into a pop-up store agreement without thinking through the ramifications and consulting with an attorney who is aware of the issues surrounding these types of agreements. The aim is to ensure that the risk of any potential negative effects is sufficiently mitigated.

Considerations for Tenants

The primary concern for a retailer planning on opening a pop-up store will be protecting the valuable investment made in the store and ensuring its success, both in terms of sales and brand identity. Retailers can of course obtain business loss and liability insurance coverage to protect themselves when opening a pop-up store, but without a skillfully negotiated pop-up store agreement, a retailer may find that the business purposes of inducing sales and creating brand loyalty are thwarted by an agreement that is inflexible or fails to incorporate novel ideas to accommodate the special purpose of the business arrangement with the property owner.

• A tenant should first consider whether the agreement needs to be crafted to allow for extension of the term or transition to a permanent lease if the location proves highly successful. Including such options in a pop-up store agreement may streamline the negotiation of a more permanent deal in the future (if this is something the retailer is contemplating).

• Landlords generally contribute minimal build-out funds to pop-up tenants and demand that leases or license agreements state that the property is being taken "as-is." Even if aware of the implications of these business terms, a retailer should have its attorney attempt to incorporate as many protections as possible into the pop-up store agreement. For example, will the landlord at least warrant that the HVAC will function properly during the term of the agreement?

• Typical retail lease agreements may not address terms that are critical to a pop-up retailer's plans. For example, does the retailer need to be open beyond normal shopping center business hours to accommodate its customers or host special events? For a very short-term pop-up store, should the agreement include "back-up" dates if unforeseen circumstances prevent the store from opening on the planned dates?

• Apart from the agreement itself, a retailer seeking to open a pop-up store in a shopping center may wish to have its attorneys review any reciprocal easement agreements, exclusives or covenants affecting the shopping center to lessen the risk of the pop-up store's operations being challenged by permanent tenants of the center. In addition, a retailer should ensure that it is aware of all laws, regulations and codes that may apply to operation of the pop-up store. Are special permits needed? Does the locality in which the store will be located impose special sales or use taxes of which the retailer needs to be aware?

Do You See What I See?: Coming to Terms and Finalizing the Agreement

In navigating all of the issues outlined above, and in negotiating basic terms such as rent, the landlord and the tenant should each consider its rationale for entering the deal and ensure that its attorneys effectuate the desired business arrangements adequately and efficiently. Pop-up store agreements memorialize specialized business terms which may require an attorney to draw from several types of agreements as precedent and creatively construct a new document to comport to the particular deal at hand. Nonetheless, property owners and retailers can both achieve their business goals and increase the odds of a harmonious relationship (whether during the holidays or any other time of year) by using thoughtfully negotiated and competently drafted legal agreements.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
Specific Questions relating to this article should be addressed directly to the author.