Do you really know what your liability is?
By: Tom R. Mounteer
Buyers, sellers, borrowers, and lenders frequently misperceive environmental liability risk in acquisitions and financings. These misperceptions make it difficult to identify, quantify, and apportion environmental risk appropriately between parties to a transaction. This article identifies — and debunks — 10 common myths about environmental liability that frequently arise in business transactions.
Follow this link to the article: Environmental Risk: 10 Myths
Tuesday, December 27, 2011
Thursday, October 27, 2011
Property acquisitions require a comprehensive approach to existing-lease due diligence.
Property acquisitions require a comprehensive approach to existing-lease due diligence.
by Crystal Lofing
Although commercial real estate investors often look at capitalization rates and replacement costs when considering an acquisition, the primary income stream — and therefore the primary pricing mechanism — is rent and operating expense recoveries paid by tenants. Comprehensive lease due diligence relating to the income stream or net operating income of a building is critical when acquiring a commercial property. In addition, a myriad of other lease provisions may have a material economic impact on the NOI.
Prior to undertaking lease due diligence, the buyer and its legal team should tailor the scope of the lease review to the size and type of the transaction and property. Considerations to review include financing, state-specific provisions, and buyer-specific considerations, such as risk tolerance, as well as corporate, tax, and accounting issues.
Significant Lease Provisions
In addition to identifying basic lease terms such as fixed rent, expense stops, and base years, and reviewing any specific, transaction–driven terms, such as subordination provisions in the context of a corresponding acquisition loan, there are certain lease provisions that should be identified and analyzed as part of every lease review due to their potential economic significance and ongoing property management implications. These provisions include rights to purchase or expand into other space at the property; lease term renewal, termination, and reduction rights; tenant obligations to reimburse landlord for capital expenditure costs; and state-specific issues, such as the presence of any Proposition 13 property tax protection in California leases.
In analyzing the above provisions, the event or date that triggers any expansion, purchase, renewal, or termination rights and the date by which such rights must be irrevocably exercised should be identified, as it assists the buyer in tracking future lease obligations and accordingly minimizes the risk of a future buyer default. It also alerts the buyer, particularly with respect to first refusal rights of tenants to expand their premises or purchase the property, and to any potential adverse side effects regarding its ability to lease or sell the property. For example, as a result of the waiting period imposed in connection with first refusal rights, a buyer, as owner, could experience a potential reduction in the pool of tenants or buyers and a corresponding reduction in the rent or purchase price that would be gained by a more competitive process.
Any potential economic impact on the rental stream should be analyzed as well. For example, an expansion, renewal, or purchase right may have an unfavorable rent or purchase price calculation. Depending on the circumstances, the impact could result from a deficient or discounted fair market formula or a dispute resolution process that favors the tenant. An expansion or renewal right also may require the landlord to provide certain tenant concessions, such as a construction build-out period.
A termination right that does not trigger a corresponding termination fee should be identified, as well as any deficiencies in the termination fee itself. For example, the termination fee may not contain a component attributable to downtime costs. A lease review also should identify if a tenant is not obligated to reimburse the landlord for market capital expenditure costs, such as operating expense-reducing costs or those required by law.
Any property tax protection granted to the tenant also should be described, together with any landlord rights to buy back the protection or reduce the protection over the lease term. For example, in California, full Proposition 13 protection prevents the buyer from receiving reimbursement for the applicable tenant's share of property taxes equal to the difference between the property taxes based on the current owner's purchase price (plus 2 percent annual increases) and the property taxes based on the purchase price to be paid by the buyer.
Additional Provisions
Additional lease provisions often are identified and analyzed by a buyer's legal team during the lease review process. Particularly for economically significant leases, these include the following plus other out-of-the-ordinary lease provisions that may have a material economic or accounting impact on the buyer:
unusual rent abatement or offset rights, including self-help rights;
significant restrictions on operating expense recoveries, such as an annual cap on increases in operating expenses;
audit rights, including a cut-off period to object to operating expenses or landlord obligation to pay for an audit;
security deposit or letter of credit provisions, including any burn-down or restrictions on application;
environmental representations and warranties or environmental indemnities made by the landlord;
pro-tenant landlord default provisions, such as offsets or an express right to terminate following a default by landlord; and
in-term lease concessions, such as a refurbishment allowance, or the ability of a tenant to convert an improvement allowance into a credit against rent.
These lease provisions are a starting point in determining the scope of the legal review of the lease component of an acquisition. They can be supplemented as appropriate by additional transaction-, state-, property-, and buyer-specific considerations.
Crystal Lofing is a real estate attorney in the Century City, Calif., office of Allen Matkins Leck Gamble Mallory & Natsis, a real estate, land use, and environmental law firm. Contact her at clofing@allenmatkins.com.
by Crystal Lofing
Although commercial real estate investors often look at capitalization rates and replacement costs when considering an acquisition, the primary income stream — and therefore the primary pricing mechanism — is rent and operating expense recoveries paid by tenants. Comprehensive lease due diligence relating to the income stream or net operating income of a building is critical when acquiring a commercial property. In addition, a myriad of other lease provisions may have a material economic impact on the NOI.
Prior to undertaking lease due diligence, the buyer and its legal team should tailor the scope of the lease review to the size and type of the transaction and property. Considerations to review include financing, state-specific provisions, and buyer-specific considerations, such as risk tolerance, as well as corporate, tax, and accounting issues.
Significant Lease Provisions
In addition to identifying basic lease terms such as fixed rent, expense stops, and base years, and reviewing any specific, transaction–driven terms, such as subordination provisions in the context of a corresponding acquisition loan, there are certain lease provisions that should be identified and analyzed as part of every lease review due to their potential economic significance and ongoing property management implications. These provisions include rights to purchase or expand into other space at the property; lease term renewal, termination, and reduction rights; tenant obligations to reimburse landlord for capital expenditure costs; and state-specific issues, such as the presence of any Proposition 13 property tax protection in California leases.
In analyzing the above provisions, the event or date that triggers any expansion, purchase, renewal, or termination rights and the date by which such rights must be irrevocably exercised should be identified, as it assists the buyer in tracking future lease obligations and accordingly minimizes the risk of a future buyer default. It also alerts the buyer, particularly with respect to first refusal rights of tenants to expand their premises or purchase the property, and to any potential adverse side effects regarding its ability to lease or sell the property. For example, as a result of the waiting period imposed in connection with first refusal rights, a buyer, as owner, could experience a potential reduction in the pool of tenants or buyers and a corresponding reduction in the rent or purchase price that would be gained by a more competitive process.
Any potential economic impact on the rental stream should be analyzed as well. For example, an expansion, renewal, or purchase right may have an unfavorable rent or purchase price calculation. Depending on the circumstances, the impact could result from a deficient or discounted fair market formula or a dispute resolution process that favors the tenant. An expansion or renewal right also may require the landlord to provide certain tenant concessions, such as a construction build-out period.
A termination right that does not trigger a corresponding termination fee should be identified, as well as any deficiencies in the termination fee itself. For example, the termination fee may not contain a component attributable to downtime costs. A lease review also should identify if a tenant is not obligated to reimburse the landlord for market capital expenditure costs, such as operating expense-reducing costs or those required by law.
Any property tax protection granted to the tenant also should be described, together with any landlord rights to buy back the protection or reduce the protection over the lease term. For example, in California, full Proposition 13 protection prevents the buyer from receiving reimbursement for the applicable tenant's share of property taxes equal to the difference between the property taxes based on the current owner's purchase price (plus 2 percent annual increases) and the property taxes based on the purchase price to be paid by the buyer.
Additional Provisions
Additional lease provisions often are identified and analyzed by a buyer's legal team during the lease review process. Particularly for economically significant leases, these include the following plus other out-of-the-ordinary lease provisions that may have a material economic or accounting impact on the buyer:
unusual rent abatement or offset rights, including self-help rights;
significant restrictions on operating expense recoveries, such as an annual cap on increases in operating expenses;
audit rights, including a cut-off period to object to operating expenses or landlord obligation to pay for an audit;
security deposit or letter of credit provisions, including any burn-down or restrictions on application;
environmental representations and warranties or environmental indemnities made by the landlord;
pro-tenant landlord default provisions, such as offsets or an express right to terminate following a default by landlord; and
in-term lease concessions, such as a refurbishment allowance, or the ability of a tenant to convert an improvement allowance into a credit against rent.
These lease provisions are a starting point in determining the scope of the legal review of the lease component of an acquisition. They can be supplemented as appropriate by additional transaction-, state-, property-, and buyer-specific considerations.
Crystal Lofing is a real estate attorney in the Century City, Calif., office of Allen Matkins Leck Gamble Mallory & Natsis, a real estate, land use, and environmental law firm. Contact her at clofing@allenmatkins.com.
Thursday, July 7, 2011
In NY Public Bidding Process, the term 'responsible' coupled with 'lowest bidder' now a slippery slope for governments.
July 8, 2011
By: Daniel Tartaglia
In a split decision, New York's Court of Appeals last month overruled the Appellate Division, Second Department and held that General Municipal Law Section 103 and Town Law Section 122 preclude a Town, in an open bidding process, from choosing a higher bid merely because it subjectively believes that a higher bidder is preferable and more responsible than a lower bidder based on criteria not specifically set forth in the bid proposal. (see: In the Matter of AAA Carting and Rubbish Removal, Inc. v. Town of Southeast, et al., 2011 NYSlipOp 04765).
The Court based its decision on a record that indicated the Town Board chose the second lowest bidder because in their opinion and business judgment it was "more responsible," than the lowest bidder. Using criteria not included in the bid specifications, the Town Board determined that it was in the best interests of the Town to choose the second lowest bidder over the lowest bidder.
In a sharply worded dissent, Justice Pigott argued that by holding "for the first time, that a contract subject to competitive bidding statutes must be awarded to the lowest bidder that meets the express bid specifications, regardless of whether the municipality, exercising discretion, considers it to be a responsible bidder," the majority's ruling was a "...mistake, defying precedent and good policy."
The lesson for Towns from now on, is to use carefully worded bid proposals and create a strong record before skipping over the lowest bidder.
By: Daniel Tartaglia
In a split decision, New York's Court of Appeals last month overruled the Appellate Division, Second Department and held that General Municipal Law Section 103 and Town Law Section 122 preclude a Town, in an open bidding process, from choosing a higher bid merely because it subjectively believes that a higher bidder is preferable and more responsible than a lower bidder based on criteria not specifically set forth in the bid proposal. (see: In the Matter of AAA Carting and Rubbish Removal, Inc. v. Town of Southeast, et al., 2011 NYSlipOp 04765).
The Court based its decision on a record that indicated the Town Board chose the second lowest bidder because in their opinion and business judgment it was "more responsible," than the lowest bidder. Using criteria not included in the bid specifications, the Town Board determined that it was in the best interests of the Town to choose the second lowest bidder over the lowest bidder.
In a sharply worded dissent, Justice Pigott argued that by holding "for the first time, that a contract subject to competitive bidding statutes must be awarded to the lowest bidder that meets the express bid specifications, regardless of whether the municipality, exercising discretion, considers it to be a responsible bidder," the majority's ruling was a "...mistake, defying precedent and good policy."
The lesson for Towns from now on, is to use carefully worded bid proposals and create a strong record before skipping over the lowest bidder.
Monday, June 20, 2011
Owner Friendly Modifications To Construction Forms
Kenneth M. Block and John-Patrick Curran
New York Law Journal June 15, 2011
The American Institute of Architects (AIA) publishes a multitude of contract forms for use on construction projects. While the AIA attempts to achieve a balance among the interests of owners, architects and contractors, there is a natural bias in favor of architects, which may also redound to the benefit of contractors. However, because of their widespread use, the forms are generally accepted by owners in order to avoid costly negotiations with architects and contractors.
While we endorse the use of AIA forms, we recommend fundamental modifications to protect the interests of the owner. In this article, we will suggest several modifications to the "Standard Form of Agreement Between Owner and Contractor for a Project of Limited Scope" (AIA Document A107-2007), which we believe will provide greater protections to the owner than exist under the form.
The Contract Sum
The 2007 version of A107 provides for three types of pricing: stipulated sum, cost of the work plus the contractor's fee, and cost of the work plus the contractor's fee with a guaranteed maximum price. For the purpose of this article, we will view A107 as a stipulated sum agreement, and reserve the discussion of "cost plus" and "cost plus with GMP" types of agreements.
Having agreed to a stipulated sum, which should be based upon a complete set of construction plans and specifications, the form should be modified to contain a representation that the contractor represents and warrants that the work can be completed for the stipulated sum. Increases in the stipulated sum should be permitted only when procedures related to "changes" are followed. While A107 lays out those procedures, additional language should be added confirming that no claim can be made for additional compensation unless a change order containing the actual cost of the change or a method for determining the cost is signed in advance by the owner and contractor. Provisions should also be made for the method to be used for determining the cost of the change (such as unit pricing) and the permissible markups for profit and overhead on account of the change.
In order to guard against the untimely submission of claims for changes, language should also be added confirming that late submission of claims constitutes a waiver by the contractor. Further, during the monthly requisition process, the contractor should represent, through its lien waiver, that only changes specifically identified in the waiver may be the subject of a claim. In the absence of listing the pending changes on the lien waiver, the contractor should be deemed to waive a claim for the change.
A107 has detailed procedures for periodic (usually monthly) applications for payment, but language should be added confirming that lien waivers must accompany the applications for payment and that the owner, as well as the architect, can assert grounds for withholding payments requested. While A107 gives full authority to the architect to approve applications for payment and issue certificates for payment, we add the caveat that the certificate is subject to the approval of the owner. This provides added protection in the event of a disagreement regarding amounts due between the owner and the architect.
Regarding final payment, additional language is necessary providing for final waivers and releases of lien from the contractor and the subcontractors as well as documentation specified by the owner and the architect, such as warranties and operating manuals, "as built" drawings in CADD format and other documentation which may be appropriate as a condition precedent to final payment.
The Work
Numerous provisions throughout A107 identify the work and establish requirements to be met by the contractor for the performance of the work. Several owner friendly modifications should be made to A107 in this regard. For example, the contractor should be obligated to:
• Perform all work not only expressly required by the contract documents but all work which is reasonably inferable therefrom.
• Perform all related work made necessary by a visual inspection of the project.
• Perform work in accordance with the manufacturer's instructions, industry standards and all applicable laws, rules and regulations where not expressly stated in the contract documents.
• Notify the architect and owner where the contractor identifies a conflict or ambiguity in the contract documents.
• Accept full responsibility for all conditions at the project that may affect its performance and warrant that the performance of the work will be in conformity with all applicable codes, rules, regulations and ordinances.
• Maintain a full time construction supervisor to coordinate and supervise the work and hold regularly scheduled job meetings to be attended by the contractor, the subcontractors, the owner and the architect.
In regard to subcontractors, A107 should be modified to provide for the conditional assignment of the subcontracts to the owner, which assignment may be exercised in the case of a contractor default. Additionally, the owner should be permitted to communicate with the subcontractors to verify that payments have been appropriately made. A107 should also be modified to provide that the contractor will comply with the provisions of the Prompt Payment Act (Article 35-E of the New York General Business Law) regarding the timeliness of payments to subcontractors.
While A107 has provisions relating to the correction of nonconforming work and provides for a one year warranty, the form should be modified to increase the warranty for a limited period of time following the performance of corrective work. It is also helpful to confirm that the one year warranty is not to the exclusion of the full six-year statute of limitations for the assertion of claims by the owner against the contractor for nonconforming work.
The Role of the Architect
As would be expected, A107 inserts the architect into the construction process in numerous ways and, in our view, goes too far. For example, the architect has the exclusive right to pass on amounts due the contractor under applications for payment. We modify these provisions by giving the owner the right of review and approval.
A107 also establishes the architect as the initial decision maker with respect to claims and disputes relating to the contract—-including those involving an error or omission by the architect. This places the architect in an obvious conflict of interest position and we remove the concept of the architect as the initial decision maker. We also eliminate the requirement that the architect "certify" that sufficient cause exists for the owner to terminate the contractor for cause.
Time and Scheduling
A107 contains dates for the commencement and substantial completion of the project; however, an essential element missing from the form is the requirement that the contractor "accelerate" the work in the event specific milestone dates (e.g., erecting steel, closing in building, completing plumbing) are not met, by adding additional personnel or working overtime—all at the cost of the contractor. Rather than waiting until the end of the projected time period for construction to see that the schedule has not been met (and fight over liquidated or other delays damages), delays should be addressed during the course of the project, and lost time made up to enable the project to return to the schedule.
The importance of an acceleration clause is highlighted by the mutual waiver of consequential damages contained in A107. Regarding the owner, damages for rental expenses, lost income and profit and financing costs are waived and the owner's best protection against delay damages is to prevent them by strictly enforcing the scheduling requirements. While the owner may seek to strike the waiver, most contractors and their counsel refuse to do so and, in certain cases, would prefer liquidated damages rather than be exposed to consequential damages. (Contractors also consider liquidated damages an anathema, leaving the owner with the protection of the acceleration clause and, of course, any actual damages incurred as a result of delay, such as additional fees to the architect because of the delay.)
Delays can also result from the actions or inactions of the owner or its architect, for whose acts the owner is responsible to the contractor. In order to guard against monetary claims for delay by the contractor against the owner, a "no damages for delay" provision should be included in the contract by limiting the contractor's remedy for delay exclusively to an extension of the contract time, not an increase in the contract sum. The mutual waiver of consequential damages also limits the contractor's ability to recover indirect expenses, such as home office overhead and lost profit as a result of owner delays.
Termination for Convenience
A107 contains a termination for convenience clause for the benefit of the owner, which eliminates the need to prove cause and allows for an amicable parting of the ways. Of course, if this clause is exercised, the owner will have no recourse against the contractor for defaults which may have occurred relating to nonperformance and it may be problematical to recover damages for defective work.
A107, however, allows the contractor to recover unearned profit and overhead on work not executed. We strike this clause and provide that the contractor is paid for work performed, calculated in accordance with the existing schedule values (in order to avoid claims of quantum meruit). Where appropriate, we may allow for the recovery of demobilization costs the contractor may incur in terminating operations.
Indemnity and Insurance
We depart entirely from A107 when it comes to indemnity and insurance by adding a separate rider. Regarding indemnity, we expand the provisions by including an indemnity covering economic losses arising from any breach of contract (which are not covered by insurance), such as fines, violations and mechanic's liens. We also provide for the recovery of attorney's fees incurred in connection with the enforcement of the indemnity.
Our insurance rider contains far more extensive provisions than recited in A107, including suggested coverages and limits and makes reference to current insurance industry forms. The rider, however, must be reviewed and approved by each owner's insurance consultant or broker, inasmuch as we believe counsel should not pass on final insurance coverage and limits required by an owner.
Conclusion
We have only touched on the major modifications to A107 but it should be apparent that, while A107 is a useful base, owners and their counsel should be prudent in its use.
Issues relating to cost, quality of work, time, the role of the architect, termination, and insurance and indemnity must be addressed in order to afford owners the greatest protection.
Kenneth M. Block and John-Patrick Curran are members of Tannenbaum Helpern Syracuse & Hirschtritt.
New York Law Journal June 15, 2011
The American Institute of Architects (AIA) publishes a multitude of contract forms for use on construction projects. While the AIA attempts to achieve a balance among the interests of owners, architects and contractors, there is a natural bias in favor of architects, which may also redound to the benefit of contractors. However, because of their widespread use, the forms are generally accepted by owners in order to avoid costly negotiations with architects and contractors.
While we endorse the use of AIA forms, we recommend fundamental modifications to protect the interests of the owner. In this article, we will suggest several modifications to the "Standard Form of Agreement Between Owner and Contractor for a Project of Limited Scope" (AIA Document A107-2007), which we believe will provide greater protections to the owner than exist under the form.
The Contract Sum
The 2007 version of A107 provides for three types of pricing: stipulated sum, cost of the work plus the contractor's fee, and cost of the work plus the contractor's fee with a guaranteed maximum price. For the purpose of this article, we will view A107 as a stipulated sum agreement, and reserve the discussion of "cost plus" and "cost plus with GMP" types of agreements.
Having agreed to a stipulated sum, which should be based upon a complete set of construction plans and specifications, the form should be modified to contain a representation that the contractor represents and warrants that the work can be completed for the stipulated sum. Increases in the stipulated sum should be permitted only when procedures related to "changes" are followed. While A107 lays out those procedures, additional language should be added confirming that no claim can be made for additional compensation unless a change order containing the actual cost of the change or a method for determining the cost is signed in advance by the owner and contractor. Provisions should also be made for the method to be used for determining the cost of the change (such as unit pricing) and the permissible markups for profit and overhead on account of the change.
In order to guard against the untimely submission of claims for changes, language should also be added confirming that late submission of claims constitutes a waiver by the contractor. Further, during the monthly requisition process, the contractor should represent, through its lien waiver, that only changes specifically identified in the waiver may be the subject of a claim. In the absence of listing the pending changes on the lien waiver, the contractor should be deemed to waive a claim for the change.
A107 has detailed procedures for periodic (usually monthly) applications for payment, but language should be added confirming that lien waivers must accompany the applications for payment and that the owner, as well as the architect, can assert grounds for withholding payments requested. While A107 gives full authority to the architect to approve applications for payment and issue certificates for payment, we add the caveat that the certificate is subject to the approval of the owner. This provides added protection in the event of a disagreement regarding amounts due between the owner and the architect.
Regarding final payment, additional language is necessary providing for final waivers and releases of lien from the contractor and the subcontractors as well as documentation specified by the owner and the architect, such as warranties and operating manuals, "as built" drawings in CADD format and other documentation which may be appropriate as a condition precedent to final payment.
The Work
Numerous provisions throughout A107 identify the work and establish requirements to be met by the contractor for the performance of the work. Several owner friendly modifications should be made to A107 in this regard. For example, the contractor should be obligated to:
• Perform all work not only expressly required by the contract documents but all work which is reasonably inferable therefrom.
• Perform all related work made necessary by a visual inspection of the project.
• Perform work in accordance with the manufacturer's instructions, industry standards and all applicable laws, rules and regulations where not expressly stated in the contract documents.
• Notify the architect and owner where the contractor identifies a conflict or ambiguity in the contract documents.
• Accept full responsibility for all conditions at the project that may affect its performance and warrant that the performance of the work will be in conformity with all applicable codes, rules, regulations and ordinances.
• Maintain a full time construction supervisor to coordinate and supervise the work and hold regularly scheduled job meetings to be attended by the contractor, the subcontractors, the owner and the architect.
In regard to subcontractors, A107 should be modified to provide for the conditional assignment of the subcontracts to the owner, which assignment may be exercised in the case of a contractor default. Additionally, the owner should be permitted to communicate with the subcontractors to verify that payments have been appropriately made. A107 should also be modified to provide that the contractor will comply with the provisions of the Prompt Payment Act (Article 35-E of the New York General Business Law) regarding the timeliness of payments to subcontractors.
While A107 has provisions relating to the correction of nonconforming work and provides for a one year warranty, the form should be modified to increase the warranty for a limited period of time following the performance of corrective work. It is also helpful to confirm that the one year warranty is not to the exclusion of the full six-year statute of limitations for the assertion of claims by the owner against the contractor for nonconforming work.
The Role of the Architect
As would be expected, A107 inserts the architect into the construction process in numerous ways and, in our view, goes too far. For example, the architect has the exclusive right to pass on amounts due the contractor under applications for payment. We modify these provisions by giving the owner the right of review and approval.
A107 also establishes the architect as the initial decision maker with respect to claims and disputes relating to the contract—-including those involving an error or omission by the architect. This places the architect in an obvious conflict of interest position and we remove the concept of the architect as the initial decision maker. We also eliminate the requirement that the architect "certify" that sufficient cause exists for the owner to terminate the contractor for cause.
Time and Scheduling
A107 contains dates for the commencement and substantial completion of the project; however, an essential element missing from the form is the requirement that the contractor "accelerate" the work in the event specific milestone dates (e.g., erecting steel, closing in building, completing plumbing) are not met, by adding additional personnel or working overtime—all at the cost of the contractor. Rather than waiting until the end of the projected time period for construction to see that the schedule has not been met (and fight over liquidated or other delays damages), delays should be addressed during the course of the project, and lost time made up to enable the project to return to the schedule.
The importance of an acceleration clause is highlighted by the mutual waiver of consequential damages contained in A107. Regarding the owner, damages for rental expenses, lost income and profit and financing costs are waived and the owner's best protection against delay damages is to prevent them by strictly enforcing the scheduling requirements. While the owner may seek to strike the waiver, most contractors and their counsel refuse to do so and, in certain cases, would prefer liquidated damages rather than be exposed to consequential damages. (Contractors also consider liquidated damages an anathema, leaving the owner with the protection of the acceleration clause and, of course, any actual damages incurred as a result of delay, such as additional fees to the architect because of the delay.)
Delays can also result from the actions or inactions of the owner or its architect, for whose acts the owner is responsible to the contractor. In order to guard against monetary claims for delay by the contractor against the owner, a "no damages for delay" provision should be included in the contract by limiting the contractor's remedy for delay exclusively to an extension of the contract time, not an increase in the contract sum. The mutual waiver of consequential damages also limits the contractor's ability to recover indirect expenses, such as home office overhead and lost profit as a result of owner delays.
Termination for Convenience
A107 contains a termination for convenience clause for the benefit of the owner, which eliminates the need to prove cause and allows for an amicable parting of the ways. Of course, if this clause is exercised, the owner will have no recourse against the contractor for defaults which may have occurred relating to nonperformance and it may be problematical to recover damages for defective work.
A107, however, allows the contractor to recover unearned profit and overhead on work not executed. We strike this clause and provide that the contractor is paid for work performed, calculated in accordance with the existing schedule values (in order to avoid claims of quantum meruit). Where appropriate, we may allow for the recovery of demobilization costs the contractor may incur in terminating operations.
Indemnity and Insurance
We depart entirely from A107 when it comes to indemnity and insurance by adding a separate rider. Regarding indemnity, we expand the provisions by including an indemnity covering economic losses arising from any breach of contract (which are not covered by insurance), such as fines, violations and mechanic's liens. We also provide for the recovery of attorney's fees incurred in connection with the enforcement of the indemnity.
Our insurance rider contains far more extensive provisions than recited in A107, including suggested coverages and limits and makes reference to current insurance industry forms. The rider, however, must be reviewed and approved by each owner's insurance consultant or broker, inasmuch as we believe counsel should not pass on final insurance coverage and limits required by an owner.
Conclusion
We have only touched on the major modifications to A107 but it should be apparent that, while A107 is a useful base, owners and their counsel should be prudent in its use.
Issues relating to cost, quality of work, time, the role of the architect, termination, and insurance and indemnity must be addressed in order to afford owners the greatest protection.
Kenneth M. Block and John-Patrick Curran are members of Tannenbaum Helpern Syracuse & Hirschtritt.
Monday, April 4, 2011
A message to NY Title Agencies - Make sure your closers call to verify payoff letters.
April 4, 2011
By: Daniel Tartaglia, Esq.
In a recent Nassau County case (United General Title Insurance Co. v. Meridian Abstract Corp., 30 Misc. 3d 1214) the defendant Meridian caused to be insured by plaintiff UGT a guaranty of "free and clear title" that was still encumbered by a mortgage for which payoff funds had not been secured at closing by defendant Meridian. The error resulted because a representative of Meridian relied on a "payoff letter" that contained false payoff figures to secure payoff funds that were insufficient to pay the full amount of the mortgage that encumbered the property. When payoff was attempted, the shortfall was $105,170.49.
In support of summary judgment, the plaintiff submitted the affidavit of a representative of the mortgagee, which avers that the company's computers log all incoming calls for each account and there is no record of a call to verify the payoff figures for the mortgage. The plaintiff also submitted telephone records which indicate that no call from Meridian's representative was placed to the mortgagee's toll free number as reflected on the payoff letters (including the letter with false figures). The plaintiff has also submitted expert testimony to establish that verification of inconsistent mortgage and payoff amounts was customary and necessary in the exercise of due diligence at real estate closings, as well as some company literature and bulletins which indicated that plaintiff's agents should always verify the payoff amounts. Finally, plaintiff submitted the inconsistent testimony of Meridian's representative, Kaplan, to indicate that Meridian had knowledge of the inconsistent figures but did not verify the payoff amount.
In response, the defendants submit that Meridian was entitled to rely on the payoff letter, and that in any case, its representative did verify the payoff figures by speaking with the mortgagee. In proof, defendant Meridian submits the affidavit of its representative, averring that he was the title closer at the transaction at issue, and that "[i]n every real estate closing in which I have acted as the title closer, I have always verified the amount of the payoff letter on the date of the closing. Thus, on May 1, I telephoned the mortgagee to verify the payoff amount set forth in the payout letter..." Defendants also submitted an affidavit by the sellers, averring that the payoff figures were correct as represented to the title closer.
The court was unconvinced by defendants and found that they utterly failed to come forward with their proof, available only to them, to verify the inconsistent and incredible allegations by Meridian's representative that he in fact verified the mortgage amounts or that he tried calling to verify the payoff amounts but his call was re-routed. The court found further that defendants did not produce any documentation or business records (as might be kept in the exercise of due diligence) which would indicate who their closer spoke to in order to verify the payoff figures; nor have they produced any telephone records which might indicate that Kaplan did attempt to reach a representative of the mortgagee.
Court's Conclusion
The plaintiffs proffer of proof and law created a prima facie case for judgment as a matter of law, as no genuine and triable issues of fact arose from the evidence. Defendants' proof failed to rebut the plaintiffs' entitlement to judgment as a matter of law and to raise any issues of fact which demand the resources of a trial. Plaintiff's motion is granted.
By: Daniel Tartaglia, Esq.
In a recent Nassau County case (United General Title Insurance Co. v. Meridian Abstract Corp., 30 Misc. 3d 1214) the defendant Meridian caused to be insured by plaintiff UGT a guaranty of "free and clear title" that was still encumbered by a mortgage for which payoff funds had not been secured at closing by defendant Meridian. The error resulted because a representative of Meridian relied on a "payoff letter" that contained false payoff figures to secure payoff funds that were insufficient to pay the full amount of the mortgage that encumbered the property. When payoff was attempted, the shortfall was $105,170.49.
In support of summary judgment, the plaintiff submitted the affidavit of a representative of the mortgagee, which avers that the company's computers log all incoming calls for each account and there is no record of a call to verify the payoff figures for the mortgage. The plaintiff also submitted telephone records which indicate that no call from Meridian's representative was placed to the mortgagee's toll free number as reflected on the payoff letters (including the letter with false figures). The plaintiff has also submitted expert testimony to establish that verification of inconsistent mortgage and payoff amounts was customary and necessary in the exercise of due diligence at real estate closings, as well as some company literature and bulletins which indicated that plaintiff's agents should always verify the payoff amounts. Finally, plaintiff submitted the inconsistent testimony of Meridian's representative, Kaplan, to indicate that Meridian had knowledge of the inconsistent figures but did not verify the payoff amount.
In response, the defendants submit that Meridian was entitled to rely on the payoff letter, and that in any case, its representative did verify the payoff figures by speaking with the mortgagee. In proof, defendant Meridian submits the affidavit of its representative, averring that he was the title closer at the transaction at issue, and that "[i]n every real estate closing in which I have acted as the title closer, I have always verified the amount of the payoff letter on the date of the closing. Thus, on May 1, I telephoned the mortgagee to verify the payoff amount set forth in the payout letter..." Defendants also submitted an affidavit by the sellers, averring that the payoff figures were correct as represented to the title closer.
The court was unconvinced by defendants and found that they utterly failed to come forward with their proof, available only to them, to verify the inconsistent and incredible allegations by Meridian's representative that he in fact verified the mortgage amounts or that he tried calling to verify the payoff amounts but his call was re-routed. The court found further that defendants did not produce any documentation or business records (as might be kept in the exercise of due diligence) which would indicate who their closer spoke to in order to verify the payoff figures; nor have they produced any telephone records which might indicate that Kaplan did attempt to reach a representative of the mortgagee.
Court's Conclusion
The plaintiffs proffer of proof and law created a prima facie case for judgment as a matter of law, as no genuine and triable issues of fact arose from the evidence. Defendants' proof failed to rebut the plaintiffs' entitlement to judgment as a matter of law and to raise any issues of fact which demand the resources of a trial. Plaintiff's motion is granted.
Friday, April 1, 2011
NY Statute of Frauds Satisfied by Email
By: Daniel Tartaglia, Esq.
You better think twice before hitting the send button on your next email. This is the lesson to be learned by reading a recent New York Appellate Court decision. In Naldi v Grunbger, 80 AD 3rd 1, October 5, 2010, the Appellate Division First Department held that an email sent by a broker in connection with a real estate transaction satisfied the New York statute of frauds (General Obligations Law § 5-703) for purposes of creating an enforceable contract. In an email to Buyer's broker the Seller's broker wrote (or should we say typed) that in connection with a $52 million purchase, the Buyer had a "...right of refusal on any legitimate, better offer during a 30 day period." In reliance on this the Buyer began performing costly due-diligence. Upon learning that the Seller was pursuing a sale to a third party in the amount of $50 million, the original Buyer sent the Seller a letter purporting to exercise the "right of first refusal" referenced in Seller's Broker's email. The Seller rejected the offer and sold the property to another buyer.
Although the Appellate Division ultimately sided with the Seller and rejected the Buyer's argument because it concluded that the parties had failed to reach an essential agreement on the purchase price, the Appellate Division held that an e-mail would have been sufficient to bind a seller had an agreement been reached on the purchase price.
In its reasoning, the Appellate Division first noted that the New York legislature had enacted the Electronic Signatures and Records Act (ESRA), which provided that:
[U]nless specifically provided otherwise by law, an electronic signature may be used by a person in lieu of a signature affixed by hand. The use of an electronic signature shall have the same validity and effect as the use of a signature affixed by hand. ESRA § 304[2]
After ESRA was enacted, Congress enacted the Electronic Signatures in Global and National Commerce Act (E-Sign) in 2000, which provided that:
(1) a signature, contract, or other record relating to such transaction may not be denied legal effect, validity, or enforceability solely because it is in electronic form; and that (2) a contract relating to such transaction may not be denied legal effect, validity, or enforceability solely because an electronic signature or electronic record was used in its formation.
In response, ESRA was amended in 2002 to conform the definition of the term "electronic signature" to E-Sign's definition of the same term.
Based on the foregoing, the Appellate Division held that "E-Sign's requirement that an electronically memorialized and subscribed contract be given the same legal effect as a contract memorialized and subscribed on paper is part of New York law..." and went on to state that "[e]ven in the absence of E-Sign and the 2002 statement of legislative intent, given the vast growth in the last decade and a half of the number of people and entities regularly using e-mail, we would conclude that the terms "writing" and "subscribed" in GOL § 5-703 should now be construed to include, respectively, records of electronic communications and electronic signatures..."
The import of the Naldi decision on real estate practitioners is clear:
• Any e-mail communication transmitting an offer, counteroffer, term sheet, contract, lease or other similar real estate related communication should be accompanied by an appropriate disclaimer to the effect that the e-mail in question may not form the basis of a binding agreement without the express written confirmation of the parties in a separate written agreement; and
• Any communication by a broker on behalf of its principal should require that the broker indicate on all e-mail communications that the broker is not authorized to bind the principal without the principal entering into a separate agreement with the counterparty to the e-mail.
Clients may find that, without appropriate safeguards, unscrupulous counsel and other parties may seek to use the Naldi decision to gain leverage over a counterparty embroiled in a contested real estate transaction by alleging that a binding agreement arose through an e-mail exchange.
You better think twice before hitting the send button on your next email. This is the lesson to be learned by reading a recent New York Appellate Court decision. In Naldi v Grunbger, 80 AD 3rd 1, October 5, 2010, the Appellate Division First Department held that an email sent by a broker in connection with a real estate transaction satisfied the New York statute of frauds (General Obligations Law § 5-703) for purposes of creating an enforceable contract. In an email to Buyer's broker the Seller's broker wrote (or should we say typed) that in connection with a $52 million purchase, the Buyer had a "...right of refusal on any legitimate, better offer during a 30 day period." In reliance on this the Buyer began performing costly due-diligence. Upon learning that the Seller was pursuing a sale to a third party in the amount of $50 million, the original Buyer sent the Seller a letter purporting to exercise the "right of first refusal" referenced in Seller's Broker's email. The Seller rejected the offer and sold the property to another buyer.
Although the Appellate Division ultimately sided with the Seller and rejected the Buyer's argument because it concluded that the parties had failed to reach an essential agreement on the purchase price, the Appellate Division held that an e-mail would have been sufficient to bind a seller had an agreement been reached on the purchase price.
In its reasoning, the Appellate Division first noted that the New York legislature had enacted the Electronic Signatures and Records Act (ESRA), which provided that:
[U]nless specifically provided otherwise by law, an electronic signature may be used by a person in lieu of a signature affixed by hand. The use of an electronic signature shall have the same validity and effect as the use of a signature affixed by hand. ESRA § 304[2]
After ESRA was enacted, Congress enacted the Electronic Signatures in Global and National Commerce Act (E-Sign) in 2000, which provided that:
(1) a signature, contract, or other record relating to such transaction may not be denied legal effect, validity, or enforceability solely because it is in electronic form; and that (2) a contract relating to such transaction may not be denied legal effect, validity, or enforceability solely because an electronic signature or electronic record was used in its formation.
In response, ESRA was amended in 2002 to conform the definition of the term "electronic signature" to E-Sign's definition of the same term.
Based on the foregoing, the Appellate Division held that "E-Sign's requirement that an electronically memorialized and subscribed contract be given the same legal effect as a contract memorialized and subscribed on paper is part of New York law..." and went on to state that "[e]ven in the absence of E-Sign and the 2002 statement of legislative intent, given the vast growth in the last decade and a half of the number of people and entities regularly using e-mail, we would conclude that the terms "writing" and "subscribed" in GOL § 5-703 should now be construed to include, respectively, records of electronic communications and electronic signatures..."
The import of the Naldi decision on real estate practitioners is clear:
• Any e-mail communication transmitting an offer, counteroffer, term sheet, contract, lease or other similar real estate related communication should be accompanied by an appropriate disclaimer to the effect that the e-mail in question may not form the basis of a binding agreement without the express written confirmation of the parties in a separate written agreement; and
• Any communication by a broker on behalf of its principal should require that the broker indicate on all e-mail communications that the broker is not authorized to bind the principal without the principal entering into a separate agreement with the counterparty to the e-mail.
Clients may find that, without appropriate safeguards, unscrupulous counsel and other parties may seek to use the Naldi decision to gain leverage over a counterparty embroiled in a contested real estate transaction by alleging that a binding agreement arose through an e-mail exchange.
Sunday, March 27, 2011
Before the Build-Out; Assessing tax consequences prior to leasehold improvements.
March, 2011
by Daniel Rowe, CPA, and John Vandaveer, CPA, CVA
In today’s competitive leasing market, build-outs or other capital improvements are good ways for property owners to retain current tenants or attract new ones. Creating more open floor plans or providing additional capacity for new technologies can adapt older office buildings to fit the changing needs of the occupants. The same is true for retail and industrial properties where new build-outs can attract new types of tenants to the space.
After deciding to make improvements, property owners must figure how to fund the construction costs. Three common methods provide funding for tenant improvements: a direct investment in the improvements by the property owner, a cash payment to the tenant to then make improvements, or a rent holiday for the tenant.
For landlords and tenants, the tax consequences vary based on the method, or combination of methods, used to fund improvements. Additionally, the intent of the parties and the specific language used in their agreements will directly affect the tax treatment of leasehold improvements. In all cases, both parties should consider the potential tax consequences when agreeing on how to provide for improvements to leased property.
Direct Investment
In a direct investment in the leasehold improvements, the property owner pays all of the construction costs, using its own money or borrowed funds. Retaining ownership of the improvements, the owner records them as assets on its books and receives a deduction for depreciation of the assets over their useful lives. There is no tax effect on the tenant as a result of a direct investment by the property owner.
Tenant Payment
When a property owner makes a payment directly to the tenant, the nature of the payment, as determined by the parties’ intent and the lease agreement, will influence the tax consequences. If the payment is considered a cash incentive for signing the lease, it will be treated as taxable income to the tenant and will be deducted by the landlord over the lease term. For example, if a $50,000 incentive is provided for a five-year lease, the tenant will have $50,000 of income in year one and the owner will deduct $10,000 of expense in each of years one through five. Once the tenant uses the money to make improvements, it will be able to depreciate them for tax purposes.
Contrast this with a payment that is considered to be a construction allowance. In this case, whether or not the tenant has income is based in large part on the lease agreement. If the lease is for retail space, is for 15 years or less, and the lease agreement expressly provides that the allowance is for the purpose of constructing or improving qualified long-term real property (not personal property), then the payment is not considered income to the tenant. The property owner would treat it as a direct investment, to be depreciated over 39 years. If the tenant does not use the allowance to pay for qualified real property, or the property does not revert to the owner at the termination of the lease, the tenant must consider construction allowance payments as taxable income. Therefore it is important to clearly establish what the allowance is to be used for and who retains the property at lease-end. Additionally if the lease is for nonretail space or the lease term exceeds 15 years, then the allowance is considered taxable income to the tenant.
Rent Holiday
Free rent is often the most tax-effective way for a property owner to adjust to market conditions and entice tenants to rent a property. The tenant is given a rent holiday for an agreed-upon number of months, with or without the holiday being explicitly tied to the tenant’s actual expenditures on improvements. The tenant then uses the money saved on rent to make any necessary improvements.
It is important for the lease agreement to state the terms of the rent holiday. The tax treatment of the transaction will be determined based on whether or not the improvements made by the tenant are considered to be in lieu of rent.
If the rent holiday explicitly is tied to tenant improvements or the improvements are considered a substitute for rent, the landlord will have both taxable income and depreciable assets (the improvements). For example, the agreement stipulates the tenant is to make $50,000 worth of improvements for the owner instead of paying rent. Then the owner would report $50,000 of taxable income despite not having received the rent. The owner would have $50,000 of assets to depreciate over their useful lives and the tenant would have a rent expense of $50,000.
On the other hand, if the rent holiday is not explicitly tied to improvements or the improvements are not made in lieu of rent, the owner should not have to recognize taxable income to the extent of the improvements made. The downside of this situation is that the owner has no tax basis in the assets. The tenant will have the tax basis and depreciation expense until the termination of the lease, at which time the tenant can write off any remaining assets.
Necessary building updates should not lead to unnecessary tax burdens. To fully examine the tax treatment of a specific situation, it is important establish who owns the improvements during the term of the lease and what happens to the property upon termination of the lease. The specific language of the lease agreement and examination of the facts and circumstances are also critical to establishing tax consequences. Owners and tenants should work with their tax advisers to ensure the intended results are achieved.
by Daniel Rowe, CPA, and John Vandaveer, CPA, CVA
In today’s competitive leasing market, build-outs or other capital improvements are good ways for property owners to retain current tenants or attract new ones. Creating more open floor plans or providing additional capacity for new technologies can adapt older office buildings to fit the changing needs of the occupants. The same is true for retail and industrial properties where new build-outs can attract new types of tenants to the space.
After deciding to make improvements, property owners must figure how to fund the construction costs. Three common methods provide funding for tenant improvements: a direct investment in the improvements by the property owner, a cash payment to the tenant to then make improvements, or a rent holiday for the tenant.
For landlords and tenants, the tax consequences vary based on the method, or combination of methods, used to fund improvements. Additionally, the intent of the parties and the specific language used in their agreements will directly affect the tax treatment of leasehold improvements. In all cases, both parties should consider the potential tax consequences when agreeing on how to provide for improvements to leased property.
Direct Investment
In a direct investment in the leasehold improvements, the property owner pays all of the construction costs, using its own money or borrowed funds. Retaining ownership of the improvements, the owner records them as assets on its books and receives a deduction for depreciation of the assets over their useful lives. There is no tax effect on the tenant as a result of a direct investment by the property owner.
Tenant Payment
When a property owner makes a payment directly to the tenant, the nature of the payment, as determined by the parties’ intent and the lease agreement, will influence the tax consequences. If the payment is considered a cash incentive for signing the lease, it will be treated as taxable income to the tenant and will be deducted by the landlord over the lease term. For example, if a $50,000 incentive is provided for a five-year lease, the tenant will have $50,000 of income in year one and the owner will deduct $10,000 of expense in each of years one through five. Once the tenant uses the money to make improvements, it will be able to depreciate them for tax purposes.
Contrast this with a payment that is considered to be a construction allowance. In this case, whether or not the tenant has income is based in large part on the lease agreement. If the lease is for retail space, is for 15 years or less, and the lease agreement expressly provides that the allowance is for the purpose of constructing or improving qualified long-term real property (not personal property), then the payment is not considered income to the tenant. The property owner would treat it as a direct investment, to be depreciated over 39 years. If the tenant does not use the allowance to pay for qualified real property, or the property does not revert to the owner at the termination of the lease, the tenant must consider construction allowance payments as taxable income. Therefore it is important to clearly establish what the allowance is to be used for and who retains the property at lease-end. Additionally if the lease is for nonretail space or the lease term exceeds 15 years, then the allowance is considered taxable income to the tenant.
Rent Holiday
Free rent is often the most tax-effective way for a property owner to adjust to market conditions and entice tenants to rent a property. The tenant is given a rent holiday for an agreed-upon number of months, with or without the holiday being explicitly tied to the tenant’s actual expenditures on improvements. The tenant then uses the money saved on rent to make any necessary improvements.
It is important for the lease agreement to state the terms of the rent holiday. The tax treatment of the transaction will be determined based on whether or not the improvements made by the tenant are considered to be in lieu of rent.
If the rent holiday explicitly is tied to tenant improvements or the improvements are considered a substitute for rent, the landlord will have both taxable income and depreciable assets (the improvements). For example, the agreement stipulates the tenant is to make $50,000 worth of improvements for the owner instead of paying rent. Then the owner would report $50,000 of taxable income despite not having received the rent. The owner would have $50,000 of assets to depreciate over their useful lives and the tenant would have a rent expense of $50,000.
On the other hand, if the rent holiday is not explicitly tied to improvements or the improvements are not made in lieu of rent, the owner should not have to recognize taxable income to the extent of the improvements made. The downside of this situation is that the owner has no tax basis in the assets. The tenant will have the tax basis and depreciation expense until the termination of the lease, at which time the tenant can write off any remaining assets.
Necessary building updates should not lead to unnecessary tax burdens. To fully examine the tax treatment of a specific situation, it is important establish who owns the improvements during the term of the lease and what happens to the property upon termination of the lease. The specific language of the lease agreement and examination of the facts and circumstances are also critical to establishing tax consequences. Owners and tenants should work with their tax advisers to ensure the intended results are achieved.
Thursday, February 17, 2011
The Interplay Of Property Insurance, Mutual Waivers And Waivers Of Subrogation In Commercial Leases
February 3, 2011
Article by William L. Nusbaum
There are few subjects in a commercial lease more intricately intertwined—and more misunderstood—than the trio of topics for this article. Because they are so interrelated in a well-drafted lease, they have been referred to as a "three-legged stool"1—all three legs are required for the stool to stand up. After a review of the issues, this article will conclude with a well-integrated, sample lease section addressing all three subjects.
The mutual goals of economic efficiency and cost-effectiveness dictate that landlords and tenants each assume responsibility for the risk of loss, and insuring against it, relative to their respective property. (Excluded from this discussion, of course, is the single-tenant building lease in which the tenant both obtains and pays for the insurance on both the landlord's building and the tenant's contents as part of a single insurance policy.) When this concept is elaborated into lease clauses dealing with property insurance, mutual waivers, and subrogation issues, the elements of the "three-legged stool" emerge:
1. Landlord and tenant each insure their own property against damage or loss by fire or other casualty, typically for the full replacement value.
2. Landlord and tenant each release the other for damage to their respective property caused by the other to the extent of the amount of property insurance required to be carried on that property under the lease (regardless of any negligence or even willful damage, and regardless of any self-insurance).
3. The mutual waiver by landlord and tenant extends to those who under common law or by statute would "step into the shoes" of the damaged party by reason of subrogation – typically the property insurers. In the commercial lease context, this takes the form of the parties each agreeing to obtain from its property insurer a waiver of the insurer's right of subrogation against the other, and if required under the policy, an approval of the mutual waiver in the preceding paragraph.2
One of the great challenges in negotiating the commercial real estate lease is to maintain internal consistency within the various provisions of the lease. This challenge manifests itself on several levels relative to property insurance, mutual waivers and waiver of subrogation: the lease negotiator must assure, first, that these three provisions are consistent with each other (are the three stool legs the same length?), and, second, that these three provisions are consistent with numerous other lease terms, such as liability for damages from various events (for example, a roof leak or a broken pipe), responsibility to perform various repairs, risk of loss, and surrender of the premises at the end of the lease.
A logical, but rarely utilized, way to increase the chances of keeping the property insurance, mutual waivers and waiver of subrogation sections of a lease consistent is simply to collect them in the same place in the lease, thereby subtly reinforcing their interrelation. In the typical lease, these three topics are dealt with in separate sections, usually scattered through the pages of the lease, enhancing the risk of an "out of sight, out of mind" error by the negotiators. By contrast, in the sample lease language attached at the end of this article (see Appendix A), they have been brought together in a logical order, which should facilitate assuring that all three legs of the stool still reach the floor once the lease negotiations have been concluded.
A LOOK AT THE ESSENTIAL LEASE PROVISIONS
Property Insurance. In a well-drafted commercial lease, the landlord insures the building components "at its own expense,"3 while the tenant insures its property at its own expense. In allocating what is to be insured by each party, attention should be paid to whether, elsewhere in the lease, tenant-installed improvements and fixtures become the landlord's property upon their installation or at some later time (such as lease expiration), or instead remain the property of the tenant and may be removed by the tenant, in the absence of default, at the time of lease expiration. So long as the tenant-installed improvements and fixtures remain the tenant's property, they should be insured by the tenant, but if the lease contains language making them the landlord's property, either immediately upon installation in the premises or at some intermediate time, then their insurance is properly the landlord's responsibility as soon as they become the landlord's property. Both the landlord and the tenant will be best served if their respective property insurance policies protect against all the perils included in a "Causes of Loss – Special Form" policy, and are in the amount of the full replacement cost, without deduction for depreciation, of the property insured.
Mutual Waiver and Release. The mutual waiver and release should be expansive, and extend to the usual laundry list of related parties (e.g., officers, directors, partners, members, managers, employees, agents, concessionaires, licensees and invitees, hereinafter the "Related Parties") to either a landlord or tenant. The waiver and release are limited, however, to loss or damage caused by risks covered by insurance; the right of recover for loss or damage from uninsured risks should not be released. The waiver and release paragraph is integrally related to the insurance coverage paragraph, because if the landlord's insurance will cover the landlord's loss or damage, even if caused by the tenant's negligent actions, then it would be inappropriate for the landlord to hold the tenant liable for the loss or damage, since it would result in a double recovery by the landlord. The same, of course, applies to loss or damage to tenant's property, caused by the landlord's negligence, but covered by tenant's insurance. Counsel should resist the temptation of giving in to opposing counsel's "parade of horribles," citing the most extreme and improbable cases of gross negligence or willful misconduct that ought to be carved out of the mutual waiver and release paragraph; if the loss or damage from the event is covered by insurance, it is proper for it to be waived and released.4 A loss not covered by insurance, however, would not be released.
Mutual Waiver of Subrogation. This lease clause may just be the one most likely to make a young real estate lawyer's eyes glaze over – especially when the other party's attorney starts renegotiating it, necessitating a thoughtful analysis and defense of the provision's intricate ties to the property insurance and mutual waiver and release sections. Conceptually, the mutual waiver of subrogation is a logical extension of the mutual waiver and release provision, as it extends the agreements made in the mutual waiver and release clause to apply to the parties' respective insurers who, by common law or by statute, "step into the shoes" of the injured party by applying the principle of subrogation. While the mutual waiver clause is designed to prevent a double recovery, this provision is instead designed to prevent the subversion of the lease's requirement that each party insure its own property against loss or damage, and that its own insurer assume the risk of loss.
Thus, a mutual waiver of subrogation provision will require each lease party to cause its own property insurance policy to include, either as an integral clause in the policy or in an endorsement, a waiver by the insurer of its right of subrogation, and all rights it may have by an assignment from its insured, against the other lease party and all its Related Parties. The Related Parties, incidentally, should be the same ones released in the mutual waiver paragraph, except that the landlord also may appropriately require any subtenant to secure a waiver of subrogation from its insurer.5 As some property insurance policies require the insurer to agree to the mutual waiver of subrogation, the lease should include the requirement to obtain such approval, if dictated by the terms of either party's policy.
OTHER LEASE PROVISIONS WHICH NEED TO BE CONFORMED
Repairs by Landlord or Tenant
This is where consistency often breaks down, as many lease negotiators punitively seek to foist the responsibility for repairing casualties caused by the other party (or its Related Parties) onto that party. Sometimes this is done explicitly, and other times implicitly by disclaimer (e.g., if tenant caused the damage to the roof, then landlord is not responsible for repairing the damage, inferring without expressly stating that if the landlord is not responsible, then the repair must be the tenant's duty), but regardless of whether it is explicit or implicit, if there is insurance coverage, then tying the repair duty to the causation of the loss or damage is inconsistent with the principles of mutual waiver and release and mutual waiver of subrogation. The farthest the parties should stretch the idea of a punitive allocation of the repair duty is to assign the repair duty to the causative party if and only if the casualty was not covered by the insurance carried by the party responsible for covering the damaged property. This is consistent with mutual waiver and release and mutual waiver of subrogation, because those concepts contemplate that the loss or damage was covered by insurance.
Similarly, provisions dealing with repairs made necessary by an Act of God or a mortal third party should only make a lease party (and which party it is should be consistent with the insurance and general repair obligations) liable for paying the portion of the repair cost, if any, which exceeds the proceeds received from insurance. Thus, if a fire is caused by a lightning strike or an electrical panel short, or a car crashes through a plate glass window, then the proceeds from the landlord's insurance (to the extent landlord's financing does not require that insurance be applied to pay down its loan) should pay to repair the building, while the proceeds from the tenant's insurance should be applied to the replacement of the tenant's trade fixtures, furnishings, equipment and inventory. The obligation to apply insurance proceeds to the repair or replacement of tenant improvements and fixtures, like the original obligation to insure them, should be allocated according to whether, under the terms of the lease, they had become the landlord's property by the time of the casualty.
Risk of Loss. Many leases contain a paragraph detailing what property within the premises the tenant is considered to own, and then continue to address tenant's sole risk of loss as to its own property in the event of a casualty. Some poorly drafted versions of this paragraph, however, conclude by carving out cases "where the loss is caused by the gross negligence or willful misconduct of the landlord." Such a proviso, making the landlord responsible for damage to the tenant's property, while doubtlessly tempting to tenant's counsel, is nevertheless at odds with the concept of mutual waiver and release detailed above, and should be excised from a lease which embraces the principles of the "three-legged stool."
Surrender of the Premises at Lease Expiration. Sometimes a landlord-friendly lease will require the tenant to surrender the premises simply "in good condition and repair." To be consistent with the insurance obligations and mutual waiver provisions discussed above, the provision should exclude the effects of ordinary wear and tear, casualty and condemnation, and situations to which the mutual waiver and release apply.
IMPLIED WAIVER OF SUBROGATION
We now turn from that well-crafted lease you have just drafted to the poorly drafted lease your just burned-out tenant client has just brought you to review for the first time. What do you do if your tenant's employee caused the fire, there is no mutual waiver of subrogation clause, and the landlord's insurer has paid the landlord's claim and is now seeking subrogation from your client, the tenant? You argue that the waiver of subrogation is implied from other terms in the tenant's lease. According to Friedman on Leases,6 courts have embraced three distinct approaches to the implied waiver of subrogation:
1. those cases – a growing majority – that are very receptive to inference of an implied waiver of subrogation, and set it as the general approach, except when special circumstances suggest otherwise;
2. those cases that refuse to find implied waivers in the "typical" case and will grant it only in the exceptional circumstance; and
3. those cases that adopt what might be called a "middle" position – generally open to the idea of implied waiver but insisting that the question must be resolved case-by-case on the particular equities of each situation.
The first approach, described by Friedman as "[t]he modern trend, which is rapidly being adopted as the more sound policy approach," treats tenants as equitably implied co-insureds solely for the purpose of inferring waiver of subrogation, regardless of whether the tenant is named as a co-insured under the landlord's property insurance policy. Implying the tenant is a co-insured under the landlord's policy defeats subrogation because there can be no right of subrogation by an insurer against its insured or co-insured. First enunciated in Sutton v. Jondahl, the Sutton doctrine provides that if the intent of the parties as to the allocation of the cost of insurance premiums is not explicitly stated in the lease, then the landlord's insurance is presumed to be for the mutual benefit of both landlord and tenant, and the tenant will be treated as a co-insured.7 Eighteen states have adopted this approach in residential leases (Sutton was a residential lease case), and thirteen of those states have extended the approach to commercial leases. (Alas for your burned-out tenant, however, Virginia is not among these states.) Among the facts which support these states in implying a waiver of subrogation (in some cases, only one such fact has sufficed) are:
• The landlord carried fire insurance for the entire premises, creating a presumption that negligently-caused fire damage is the main reason to obtain such coverage. Moreover, negligence is a standard factor in determining fire insurance premiums, and the premiums are taken into account in setting the tenant's rent.
• There is a public policy against waste, but allowing subrogation compels the tenant to obtain duplicative insurance coverage to protect itself against a subrogation claim. Also, more waste results if the insurer were allowed to collect twice – once by receiving its premiums and again by recovering its payouts by a subrogation claim against the negligent tenant.
• Language in the lease which exempts the tenant from responsibility for fire damage in some cases (e.g., excluding damage by fire from the surrender clause, landlord assumption of the responsibility to repair fire damage, options to terminate or continue a lease after a fire (especially if the landlord is responsible for repairs), and rent abatement during the repair period) is often cited to support an implied waiver of subrogation.
By contrast, six states, relying on the common law rule that a tenant should be responsible for its own negligence, require waiver of subrogation to be expressed "in unequivocal terms."8 Their position was colorfully summed up by Judge Fast of the New Jersey Superior Court, when he opined:
I find no binding case law or reason in common sense that would hold that where the landlord would have a claim against a tenant, the existence of insurance obtained by the landlord, paid for by landlord from landlord's own unrestricted funds, and for the benefit of the landlord should exculpate the tenant from the consequence of negligent conduct absent an express agreement to that effect. I find that proposition to fly in the face of common sense and the public policy of holding one responsible for the consequences of one's own negligence."9
Finally, thirteen states, including Virginia, Maryland and North Carolina, apply Friedman's so-called "middle approach," looking to the reasonable expectations of the parties as shown by their intent in the lease and the facts and surrounding circumstances. The Supreme Court of Virginia embraced this approach when it decided Monterey Corporation v. Hart, 216 Va. 843, 224 S.E.2d 142 (1976). In Monterey, Roanoke's Patrick Henry Hotel suffered $50,000 of damage in a fire negligently caused by Margaret Hart Barnes (since deceased), who, with her husband, had been renting an apartment in the hotel. The printed form lease provided by the landlord (and hence to be construed against it) made several references to the consequences of fire, including (1) excluding "damages by accidental fire" from tenants' obligation to surrender the premises in the condition leased to them, (2) the tenants' rent abatement during restoration or, if more than thirty days were required to restore the premises, the tenants' right to terminate the lease, all without imposing any obligation on the tenants to perform the restoration, and (3) obliging the tenants to not take any action that would cause landlord's fire insurance premiums to be increased.10 At the end of a thoughtful review of the case law on both sides, the Supreme Court of Virginia cited Rock Springs Realty, Inc. v. Waid, 392 S.W.2d 270, 277-78 (Mo. 1965):
Where it is clear that the parties contemplate insurance to be paid for by the lessor it is logical to conclude that they intend the lessee to pay for the insurance through rent payment. It would be an undue hardship to require a tenant to insure against his own negligence where he is paying for the fire insurance which covers the premises in favor of the lessor. The lessee should not be treated as a negligent third party subject to subrogation rights, but should have the benefit of the insurance policy. Such a policy [which] contemplates a potentially negligent occupant and a right of subrogation would be a windfall to the insurer.11
After considering the totality of the facts and circumstances in ascertaining the intent of the parties in entering into the lease, the MontereyCourt then concluded:
It is unreasonable to believe that the average layman contracting as a lessee of an apartment in a large multi-million dollar hotel would understand that a lease similar to the one signed by appellee's decedent would exempt him only for loss by fire not caused by his negligence. Logically, the lease agreement here should be interpreted to mean that appellee's decedent was exempted from liability for all fires normally insured against by the usual fire insurance policy.
It is our conclusion that the effect of the provisions of the lease was to absolve a tenant of any liability for damage to the building caused by a fire other than one attributable to the tenant's intentional and unlawful act.12
Recently, U.S. District Court Judge Conrad succinctly summarized Virginia's adoption of this "middle way" in Cincinnati Insurance Company v. Tienda La Mexicana, Inc., 2009 WL 4363450 (W.D. Va. 2009), where he characterized the holding in Monterey as follows:
Instead of establishing the implied co-insured doctrine as it is applied in other jurisdictions, the Court in Monterey held that, under Virginia law, an express provision in a lease freeing a tenant from his common law liability for fire loss due to his own negligence will control. In the absence of an express provision relieving a tenant of liability, a court must look at the lease as a whole to determine the intent and reasonable expectations of the parties.13
Judge Conrad proceeded to refer to the tenant's raising two lease provisions which other jurisdictions have found sufficient to imply the waiver of subrogation: "first, that the 'Landlord shall adequately insure the building and all public or common areas for fire' and second, that 'if said buildings [destroyed by fire] can with reasonable diligence be repaired within 60 days, said buildings shall be, by Landlord, repaired'" (emphasis in original). Instead, the court described the import of the two lease terms as "ambiguous at best," and ascribed much greater weight to the more explicit lease clause on insurance, which provided that "Tenant will be responsible for any damages to the premises by the following but not limited to: himself, customers, and/or delivery personnel." The court concluded that such language reaffirmed the original common law rule of tenant liability, and refused to relieve the tenant of responsibility to repair the fire damage under any theory of an implied co-insured or other basis for an implied waiver of subrogation.14
A similar conclusion had been reached three years earlier by the U.S. Fourth Circuit Court of Appeals in Allstate Insurance Company v. Fritz, 452 F.3d 316 (2006), which dealt with an apartment building fire negligently caused by the guest of two James Madison University student tenants. Where the lease expressly made the tenants liable for all costs of repairs resulting from the negligent actions or omissions of tenant or tenant's guests, the Court (reversing the District Court's opinion, which supported a waiver of subrogation) acknowledged the rule in Monterey, but pointedly noted that in this case, the lease clearly stated the parties' intent to place the liability on the tenants, and refused to disregard what it considered to be an unambiguous agreement by the landlord and tenants.15 Thus, the message is clear that while Virginia courts are willing to imply a co-insured status and waive the right of subrogation, they will not ignore the express intention or reasonable expectations of the parties in order to do so.
SAMPLE LEASE PROVISIONS
So, where does this leave the beleaguered real estate lawyer, faced with having to draft property insurance, mutual waiver and waiver of subrogation lease clauses which will both efficiently allocate risks and responsibilities and also be upheld in court? First, the lease should embrace the concepts of the "three-legged stool" with which this article opened. Second, all the other lease clauses which might give rise to inconsistent results should be carefully reviewed to make certain they are not at odds with the core terms of the "three-legged stool." While supplying samples of all of the relevant lease clauses rendered consistent with these three concepts goes beyond the scope of this article, I am pleased to conclude with sample commercial real estate lease clauses for achieving the desired consistency among the lease clauses for property insurance, mutual waiver and mutual waiver of subrogation. Found in Appendix A, these sample clauses are not intended to be heavily slanted to either the landlord's or the tenant's benefit, but they do assume the existence elsewhere in the lease of the typical lease clause that any leasehold improvements and fixtures installed by the tenant immediately become affixed to the fee and hence, the property of the landlord. As noted above, I believe it will promote the drafter's ability to resist the introduction on inconsistent modifications to these three provisions if they are presented as integrated clauses, all in a single section of the lease, as shown in Appendix A. Drafters, of course, will need to modify these sample clauses appropriately for use in a residential lease or a lease of space in a multi-tenant commercial building.
________________________________________
APPENDIX A
SAMPLE LEASE CLAUSES FOR PROPERTY INSURANCE, MUTUAL WAIVER AND MUTUAL WAIVER OF SUBROGATION
SECTION 10. PROPERTY INSURANCE; MUTUAL WAIVER; WAIVER OF SUBROGATION.
a. Landlord shall obtain and keep in force during the term of this lease a policy or policies of insurance covering loss or damage to the premises (but excluding items listed in Section 10.b, below), providing protection against all perils included in a Causes of Loss - Special Form policy (or its successor form), in the amount of their full replacement cost (i.e., the cost to replace without deduction for depreciation). Tenant shall pay during the term hereof, in addition to rent, the amount of the premiums for the insurance required under this subsection within thirty (30) days after receipt of a bill therefor from Landlord.
b. Tenant shall obtain and keep in force during the term of this lease a policy or policies of insurance covering loss or damage to Tenant's own property, inventory, trade fixtures and furniture, and personal property of others, providing protection against all perils included in a Causes of Loss - Special Form policy (or its successor form) in the amount of their full replacement cost (i.e., the cost to replace without deduction for depreciation). Landlord is not responsible for Tenant's property, inventory, trade fixtures and furniture, and personal property of others within the Tenant's care, custody or control.
c. Notwithstanding any other provision of this Lease to the contrary, neither party to this lease or its officers, directors, partners, members, managers, employees, agents, concessionaires, licensees and invitees shall be liable to the other for loss or damage caused by any risk covered by insurance required to be carried under this lease, and each party to this lease hereby waives any rights of recovery against the other and its officers, directors, partners, members, managers, employees, agents, concessionaires, licensees and invitees for injury or loss on account of such covered risks.
d. All policies of property insurance required to be carried by either party under this Section 10 shall include a clause or endorsement whereby such party's insurer waives all right of subrogation, and all rights based upon an assignment from its insured, against the other party, its officers, directors, partners, members, managers, employees, agents, concessionaires, licensees and invitees, and in the case of Tenant, its subtenants and their officers, directors, partners, members, managers, employees, agents, concessionaires, licensees and invitees, in connection with any loss or damage thereby insured against; provided that the foregoing reference shall not be deemed a consent by Landlord to any sublease of the premises. If any policy of insurance requires the agreement of a party's insurer as a condition to the effectiveness of this mutual waiver of subrogation, such party agrees to make a commercially reasonable effort to obtain such agreement.
Footnotes
1 Myles Hannan, Using Property Insurance, Mutual Waiver, and Waiver of Subrogation Clauses in Commercial Leases (with Model Clauses), THE PRACTICAL REAL ESTATE LAWYER, Mar. 2001, at 23.
2 Id. at 24.
3 Tenant's counsel will no doubt dispute that landlords ever do anything truly at their own expense; they just use the tenant's rent to pay for it. This, in fact, has given rise in some states to a theory of implied waiver of subrogation, the leading case for which is Sutton v. Jondahl, 532 P.2d 478 (Okla. Ct. App. 1975), where the court relied, inter alia, on the fact that the tenant pays for the landlord's insurance premium as part of the tenant's rent. Please take note that theories of implied waiver of subrogation are not accepted in all states. See the discussion, infra, of implied waiver of subrogation for more on this line of cases.
4 Self-insurance, incidentally, does not change the analysis, although opposing counsel may wish to set out minimum self-insurance requirements in the lease, or at least require periodic reporting by the self-insured party as to (1) the reserves it has set aside for its self-insurance plan and (2) what claims have been made by others against those reserves, to assure the other party that the self-insurance remains sufficient to cover its responsibilities with respect to a loss or damage.
5 If the subtenant is included in the tenant's waiver of subrogation, landlord's counsel should consider including a disclaimer, clarifying that the reference to "subtenant" does not mean the landlord is consenting to any subleases.
6 1 MILTON R. FRIEDMAN, FRIEDMAN ON LEASES § 9:11, at 9-91 to 9-112 (5th ed. 2010). The author leans heavily on, and refers the reader seeking greater detail to, FRIEDMAN ON LEASES, the gold standard among authorities on commercial leasing law, for this discussion of implied waiver of subrogation.
7Sutton v. Jondahl, 532 P.2d 478 (Okla. Ct. App. 1975).
8 FRIEDMAN ON LEASES, supra note 6, § 9:11.2, at 9-102.
9 Zoppi v. Traurig, 251 N.J. SUPER. 283, 288, 598 A.2d 19, 21 (1990).
10 Monterey Corp. v. Hart, 216 Va. 843, 845-46, 224 S.E.2d 142, 144 (1976).
11 Id. at 849-50, 224 S.E.2d at 146-47.
12 Id. at 851, 224 S.E.2d at 147.
13 Cincinnati Insurance Co. v. Tienda La Mexicana, Inc., 2009 WL 4363450, at *3 (W.D. Va. 2009).
14 Id. at *4.
15 Allstate Insurance Co. v. Fritz, 452 F.3d 316, 322-23 (2006).
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.
Article by William L. Nusbaum
There are few subjects in a commercial lease more intricately intertwined—and more misunderstood—than the trio of topics for this article. Because they are so interrelated in a well-drafted lease, they have been referred to as a "three-legged stool"1—all three legs are required for the stool to stand up. After a review of the issues, this article will conclude with a well-integrated, sample lease section addressing all three subjects.
The mutual goals of economic efficiency and cost-effectiveness dictate that landlords and tenants each assume responsibility for the risk of loss, and insuring against it, relative to their respective property. (Excluded from this discussion, of course, is the single-tenant building lease in which the tenant both obtains and pays for the insurance on both the landlord's building and the tenant's contents as part of a single insurance policy.) When this concept is elaborated into lease clauses dealing with property insurance, mutual waivers, and subrogation issues, the elements of the "three-legged stool" emerge:
1. Landlord and tenant each insure their own property against damage or loss by fire or other casualty, typically for the full replacement value.
2. Landlord and tenant each release the other for damage to their respective property caused by the other to the extent of the amount of property insurance required to be carried on that property under the lease (regardless of any negligence or even willful damage, and regardless of any self-insurance).
3. The mutual waiver by landlord and tenant extends to those who under common law or by statute would "step into the shoes" of the damaged party by reason of subrogation – typically the property insurers. In the commercial lease context, this takes the form of the parties each agreeing to obtain from its property insurer a waiver of the insurer's right of subrogation against the other, and if required under the policy, an approval of the mutual waiver in the preceding paragraph.2
One of the great challenges in negotiating the commercial real estate lease is to maintain internal consistency within the various provisions of the lease. This challenge manifests itself on several levels relative to property insurance, mutual waivers and waiver of subrogation: the lease negotiator must assure, first, that these three provisions are consistent with each other (are the three stool legs the same length?), and, second, that these three provisions are consistent with numerous other lease terms, such as liability for damages from various events (for example, a roof leak or a broken pipe), responsibility to perform various repairs, risk of loss, and surrender of the premises at the end of the lease.
A logical, but rarely utilized, way to increase the chances of keeping the property insurance, mutual waivers and waiver of subrogation sections of a lease consistent is simply to collect them in the same place in the lease, thereby subtly reinforcing their interrelation. In the typical lease, these three topics are dealt with in separate sections, usually scattered through the pages of the lease, enhancing the risk of an "out of sight, out of mind" error by the negotiators. By contrast, in the sample lease language attached at the end of this article (see Appendix A), they have been brought together in a logical order, which should facilitate assuring that all three legs of the stool still reach the floor once the lease negotiations have been concluded.
A LOOK AT THE ESSENTIAL LEASE PROVISIONS
Property Insurance. In a well-drafted commercial lease, the landlord insures the building components "at its own expense,"3 while the tenant insures its property at its own expense. In allocating what is to be insured by each party, attention should be paid to whether, elsewhere in the lease, tenant-installed improvements and fixtures become the landlord's property upon their installation or at some later time (such as lease expiration), or instead remain the property of the tenant and may be removed by the tenant, in the absence of default, at the time of lease expiration. So long as the tenant-installed improvements and fixtures remain the tenant's property, they should be insured by the tenant, but if the lease contains language making them the landlord's property, either immediately upon installation in the premises or at some intermediate time, then their insurance is properly the landlord's responsibility as soon as they become the landlord's property. Both the landlord and the tenant will be best served if their respective property insurance policies protect against all the perils included in a "Causes of Loss – Special Form" policy, and are in the amount of the full replacement cost, without deduction for depreciation, of the property insured.
Mutual Waiver and Release. The mutual waiver and release should be expansive, and extend to the usual laundry list of related parties (e.g., officers, directors, partners, members, managers, employees, agents, concessionaires, licensees and invitees, hereinafter the "Related Parties") to either a landlord or tenant. The waiver and release are limited, however, to loss or damage caused by risks covered by insurance; the right of recover for loss or damage from uninsured risks should not be released. The waiver and release paragraph is integrally related to the insurance coverage paragraph, because if the landlord's insurance will cover the landlord's loss or damage, even if caused by the tenant's negligent actions, then it would be inappropriate for the landlord to hold the tenant liable for the loss or damage, since it would result in a double recovery by the landlord. The same, of course, applies to loss or damage to tenant's property, caused by the landlord's negligence, but covered by tenant's insurance. Counsel should resist the temptation of giving in to opposing counsel's "parade of horribles," citing the most extreme and improbable cases of gross negligence or willful misconduct that ought to be carved out of the mutual waiver and release paragraph; if the loss or damage from the event is covered by insurance, it is proper for it to be waived and released.4 A loss not covered by insurance, however, would not be released.
Mutual Waiver of Subrogation. This lease clause may just be the one most likely to make a young real estate lawyer's eyes glaze over – especially when the other party's attorney starts renegotiating it, necessitating a thoughtful analysis and defense of the provision's intricate ties to the property insurance and mutual waiver and release sections. Conceptually, the mutual waiver of subrogation is a logical extension of the mutual waiver and release provision, as it extends the agreements made in the mutual waiver and release clause to apply to the parties' respective insurers who, by common law or by statute, "step into the shoes" of the injured party by applying the principle of subrogation. While the mutual waiver clause is designed to prevent a double recovery, this provision is instead designed to prevent the subversion of the lease's requirement that each party insure its own property against loss or damage, and that its own insurer assume the risk of loss.
Thus, a mutual waiver of subrogation provision will require each lease party to cause its own property insurance policy to include, either as an integral clause in the policy or in an endorsement, a waiver by the insurer of its right of subrogation, and all rights it may have by an assignment from its insured, against the other lease party and all its Related Parties. The Related Parties, incidentally, should be the same ones released in the mutual waiver paragraph, except that the landlord also may appropriately require any subtenant to secure a waiver of subrogation from its insurer.5 As some property insurance policies require the insurer to agree to the mutual waiver of subrogation, the lease should include the requirement to obtain such approval, if dictated by the terms of either party's policy.
OTHER LEASE PROVISIONS WHICH NEED TO BE CONFORMED
Repairs by Landlord or Tenant
This is where consistency often breaks down, as many lease negotiators punitively seek to foist the responsibility for repairing casualties caused by the other party (or its Related Parties) onto that party. Sometimes this is done explicitly, and other times implicitly by disclaimer (e.g., if tenant caused the damage to the roof, then landlord is not responsible for repairing the damage, inferring without expressly stating that if the landlord is not responsible, then the repair must be the tenant's duty), but regardless of whether it is explicit or implicit, if there is insurance coverage, then tying the repair duty to the causation of the loss or damage is inconsistent with the principles of mutual waiver and release and mutual waiver of subrogation. The farthest the parties should stretch the idea of a punitive allocation of the repair duty is to assign the repair duty to the causative party if and only if the casualty was not covered by the insurance carried by the party responsible for covering the damaged property. This is consistent with mutual waiver and release and mutual waiver of subrogation, because those concepts contemplate that the loss or damage was covered by insurance.
Similarly, provisions dealing with repairs made necessary by an Act of God or a mortal third party should only make a lease party (and which party it is should be consistent with the insurance and general repair obligations) liable for paying the portion of the repair cost, if any, which exceeds the proceeds received from insurance. Thus, if a fire is caused by a lightning strike or an electrical panel short, or a car crashes through a plate glass window, then the proceeds from the landlord's insurance (to the extent landlord's financing does not require that insurance be applied to pay down its loan) should pay to repair the building, while the proceeds from the tenant's insurance should be applied to the replacement of the tenant's trade fixtures, furnishings, equipment and inventory. The obligation to apply insurance proceeds to the repair or replacement of tenant improvements and fixtures, like the original obligation to insure them, should be allocated according to whether, under the terms of the lease, they had become the landlord's property by the time of the casualty.
Risk of Loss. Many leases contain a paragraph detailing what property within the premises the tenant is considered to own, and then continue to address tenant's sole risk of loss as to its own property in the event of a casualty. Some poorly drafted versions of this paragraph, however, conclude by carving out cases "where the loss is caused by the gross negligence or willful misconduct of the landlord." Such a proviso, making the landlord responsible for damage to the tenant's property, while doubtlessly tempting to tenant's counsel, is nevertheless at odds with the concept of mutual waiver and release detailed above, and should be excised from a lease which embraces the principles of the "three-legged stool."
Surrender of the Premises at Lease Expiration. Sometimes a landlord-friendly lease will require the tenant to surrender the premises simply "in good condition and repair." To be consistent with the insurance obligations and mutual waiver provisions discussed above, the provision should exclude the effects of ordinary wear and tear, casualty and condemnation, and situations to which the mutual waiver and release apply.
IMPLIED WAIVER OF SUBROGATION
We now turn from that well-crafted lease you have just drafted to the poorly drafted lease your just burned-out tenant client has just brought you to review for the first time. What do you do if your tenant's employee caused the fire, there is no mutual waiver of subrogation clause, and the landlord's insurer has paid the landlord's claim and is now seeking subrogation from your client, the tenant? You argue that the waiver of subrogation is implied from other terms in the tenant's lease. According to Friedman on Leases,6 courts have embraced three distinct approaches to the implied waiver of subrogation:
1. those cases – a growing majority – that are very receptive to inference of an implied waiver of subrogation, and set it as the general approach, except when special circumstances suggest otherwise;
2. those cases that refuse to find implied waivers in the "typical" case and will grant it only in the exceptional circumstance; and
3. those cases that adopt what might be called a "middle" position – generally open to the idea of implied waiver but insisting that the question must be resolved case-by-case on the particular equities of each situation.
The first approach, described by Friedman as "[t]he modern trend, which is rapidly being adopted as the more sound policy approach," treats tenants as equitably implied co-insureds solely for the purpose of inferring waiver of subrogation, regardless of whether the tenant is named as a co-insured under the landlord's property insurance policy. Implying the tenant is a co-insured under the landlord's policy defeats subrogation because there can be no right of subrogation by an insurer against its insured or co-insured. First enunciated in Sutton v. Jondahl, the Sutton doctrine provides that if the intent of the parties as to the allocation of the cost of insurance premiums is not explicitly stated in the lease, then the landlord's insurance is presumed to be for the mutual benefit of both landlord and tenant, and the tenant will be treated as a co-insured.7 Eighteen states have adopted this approach in residential leases (Sutton was a residential lease case), and thirteen of those states have extended the approach to commercial leases. (Alas for your burned-out tenant, however, Virginia is not among these states.) Among the facts which support these states in implying a waiver of subrogation (in some cases, only one such fact has sufficed) are:
• The landlord carried fire insurance for the entire premises, creating a presumption that negligently-caused fire damage is the main reason to obtain such coverage. Moreover, negligence is a standard factor in determining fire insurance premiums, and the premiums are taken into account in setting the tenant's rent.
• There is a public policy against waste, but allowing subrogation compels the tenant to obtain duplicative insurance coverage to protect itself against a subrogation claim. Also, more waste results if the insurer were allowed to collect twice – once by receiving its premiums and again by recovering its payouts by a subrogation claim against the negligent tenant.
• Language in the lease which exempts the tenant from responsibility for fire damage in some cases (e.g., excluding damage by fire from the surrender clause, landlord assumption of the responsibility to repair fire damage, options to terminate or continue a lease after a fire (especially if the landlord is responsible for repairs), and rent abatement during the repair period) is often cited to support an implied waiver of subrogation.
By contrast, six states, relying on the common law rule that a tenant should be responsible for its own negligence, require waiver of subrogation to be expressed "in unequivocal terms."8 Their position was colorfully summed up by Judge Fast of the New Jersey Superior Court, when he opined:
I find no binding case law or reason in common sense that would hold that where the landlord would have a claim against a tenant, the existence of insurance obtained by the landlord, paid for by landlord from landlord's own unrestricted funds, and for the benefit of the landlord should exculpate the tenant from the consequence of negligent conduct absent an express agreement to that effect. I find that proposition to fly in the face of common sense and the public policy of holding one responsible for the consequences of one's own negligence."9
Finally, thirteen states, including Virginia, Maryland and North Carolina, apply Friedman's so-called "middle approach," looking to the reasonable expectations of the parties as shown by their intent in the lease and the facts and surrounding circumstances. The Supreme Court of Virginia embraced this approach when it decided Monterey Corporation v. Hart, 216 Va. 843, 224 S.E.2d 142 (1976). In Monterey, Roanoke's Patrick Henry Hotel suffered $50,000 of damage in a fire negligently caused by Margaret Hart Barnes (since deceased), who, with her husband, had been renting an apartment in the hotel. The printed form lease provided by the landlord (and hence to be construed against it) made several references to the consequences of fire, including (1) excluding "damages by accidental fire" from tenants' obligation to surrender the premises in the condition leased to them, (2) the tenants' rent abatement during restoration or, if more than thirty days were required to restore the premises, the tenants' right to terminate the lease, all without imposing any obligation on the tenants to perform the restoration, and (3) obliging the tenants to not take any action that would cause landlord's fire insurance premiums to be increased.10 At the end of a thoughtful review of the case law on both sides, the Supreme Court of Virginia cited Rock Springs Realty, Inc. v. Waid, 392 S.W.2d 270, 277-78 (Mo. 1965):
Where it is clear that the parties contemplate insurance to be paid for by the lessor it is logical to conclude that they intend the lessee to pay for the insurance through rent payment. It would be an undue hardship to require a tenant to insure against his own negligence where he is paying for the fire insurance which covers the premises in favor of the lessor. The lessee should not be treated as a negligent third party subject to subrogation rights, but should have the benefit of the insurance policy. Such a policy [which] contemplates a potentially negligent occupant and a right of subrogation would be a windfall to the insurer.11
After considering the totality of the facts and circumstances in ascertaining the intent of the parties in entering into the lease, the MontereyCourt then concluded:
It is unreasonable to believe that the average layman contracting as a lessee of an apartment in a large multi-million dollar hotel would understand that a lease similar to the one signed by appellee's decedent would exempt him only for loss by fire not caused by his negligence. Logically, the lease agreement here should be interpreted to mean that appellee's decedent was exempted from liability for all fires normally insured against by the usual fire insurance policy.
It is our conclusion that the effect of the provisions of the lease was to absolve a tenant of any liability for damage to the building caused by a fire other than one attributable to the tenant's intentional and unlawful act.12
Recently, U.S. District Court Judge Conrad succinctly summarized Virginia's adoption of this "middle way" in Cincinnati Insurance Company v. Tienda La Mexicana, Inc., 2009 WL 4363450 (W.D. Va. 2009), where he characterized the holding in Monterey as follows:
Instead of establishing the implied co-insured doctrine as it is applied in other jurisdictions, the Court in Monterey held that, under Virginia law, an express provision in a lease freeing a tenant from his common law liability for fire loss due to his own negligence will control. In the absence of an express provision relieving a tenant of liability, a court must look at the lease as a whole to determine the intent and reasonable expectations of the parties.13
Judge Conrad proceeded to refer to the tenant's raising two lease provisions which other jurisdictions have found sufficient to imply the waiver of subrogation: "first, that the 'Landlord shall adequately insure the building and all public or common areas for fire' and second, that 'if said buildings [destroyed by fire] can with reasonable diligence be repaired within 60 days, said buildings shall be, by Landlord, repaired'" (emphasis in original). Instead, the court described the import of the two lease terms as "ambiguous at best," and ascribed much greater weight to the more explicit lease clause on insurance, which provided that "Tenant will be responsible for any damages to the premises by the following but not limited to: himself, customers, and/or delivery personnel." The court concluded that such language reaffirmed the original common law rule of tenant liability, and refused to relieve the tenant of responsibility to repair the fire damage under any theory of an implied co-insured or other basis for an implied waiver of subrogation.14
A similar conclusion had been reached three years earlier by the U.S. Fourth Circuit Court of Appeals in Allstate Insurance Company v. Fritz, 452 F.3d 316 (2006), which dealt with an apartment building fire negligently caused by the guest of two James Madison University student tenants. Where the lease expressly made the tenants liable for all costs of repairs resulting from the negligent actions or omissions of tenant or tenant's guests, the Court (reversing the District Court's opinion, which supported a waiver of subrogation) acknowledged the rule in Monterey, but pointedly noted that in this case, the lease clearly stated the parties' intent to place the liability on the tenants, and refused to disregard what it considered to be an unambiguous agreement by the landlord and tenants.15 Thus, the message is clear that while Virginia courts are willing to imply a co-insured status and waive the right of subrogation, they will not ignore the express intention or reasonable expectations of the parties in order to do so.
SAMPLE LEASE PROVISIONS
So, where does this leave the beleaguered real estate lawyer, faced with having to draft property insurance, mutual waiver and waiver of subrogation lease clauses which will both efficiently allocate risks and responsibilities and also be upheld in court? First, the lease should embrace the concepts of the "three-legged stool" with which this article opened. Second, all the other lease clauses which might give rise to inconsistent results should be carefully reviewed to make certain they are not at odds with the core terms of the "three-legged stool." While supplying samples of all of the relevant lease clauses rendered consistent with these three concepts goes beyond the scope of this article, I am pleased to conclude with sample commercial real estate lease clauses for achieving the desired consistency among the lease clauses for property insurance, mutual waiver and mutual waiver of subrogation. Found in Appendix A, these sample clauses are not intended to be heavily slanted to either the landlord's or the tenant's benefit, but they do assume the existence elsewhere in the lease of the typical lease clause that any leasehold improvements and fixtures installed by the tenant immediately become affixed to the fee and hence, the property of the landlord. As noted above, I believe it will promote the drafter's ability to resist the introduction on inconsistent modifications to these three provisions if they are presented as integrated clauses, all in a single section of the lease, as shown in Appendix A. Drafters, of course, will need to modify these sample clauses appropriately for use in a residential lease or a lease of space in a multi-tenant commercial building.
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APPENDIX A
SAMPLE LEASE CLAUSES FOR PROPERTY INSURANCE, MUTUAL WAIVER AND MUTUAL WAIVER OF SUBROGATION
SECTION 10. PROPERTY INSURANCE; MUTUAL WAIVER; WAIVER OF SUBROGATION.
a. Landlord shall obtain and keep in force during the term of this lease a policy or policies of insurance covering loss or damage to the premises (but excluding items listed in Section 10.b, below), providing protection against all perils included in a Causes of Loss - Special Form policy (or its successor form), in the amount of their full replacement cost (i.e., the cost to replace without deduction for depreciation). Tenant shall pay during the term hereof, in addition to rent, the amount of the premiums for the insurance required under this subsection within thirty (30) days after receipt of a bill therefor from Landlord.
b. Tenant shall obtain and keep in force during the term of this lease a policy or policies of insurance covering loss or damage to Tenant's own property, inventory, trade fixtures and furniture, and personal property of others, providing protection against all perils included in a Causes of Loss - Special Form policy (or its successor form) in the amount of their full replacement cost (i.e., the cost to replace without deduction for depreciation). Landlord is not responsible for Tenant's property, inventory, trade fixtures and furniture, and personal property of others within the Tenant's care, custody or control.
c. Notwithstanding any other provision of this Lease to the contrary, neither party to this lease or its officers, directors, partners, members, managers, employees, agents, concessionaires, licensees and invitees shall be liable to the other for loss or damage caused by any risk covered by insurance required to be carried under this lease, and each party to this lease hereby waives any rights of recovery against the other and its officers, directors, partners, members, managers, employees, agents, concessionaires, licensees and invitees for injury or loss on account of such covered risks.
d. All policies of property insurance required to be carried by either party under this Section 10 shall include a clause or endorsement whereby such party's insurer waives all right of subrogation, and all rights based upon an assignment from its insured, against the other party, its officers, directors, partners, members, managers, employees, agents, concessionaires, licensees and invitees, and in the case of Tenant, its subtenants and their officers, directors, partners, members, managers, employees, agents, concessionaires, licensees and invitees, in connection with any loss or damage thereby insured against; provided that the foregoing reference shall not be deemed a consent by Landlord to any sublease of the premises. If any policy of insurance requires the agreement of a party's insurer as a condition to the effectiveness of this mutual waiver of subrogation, such party agrees to make a commercially reasonable effort to obtain such agreement.
Footnotes
1 Myles Hannan, Using Property Insurance, Mutual Waiver, and Waiver of Subrogation Clauses in Commercial Leases (with Model Clauses), THE PRACTICAL REAL ESTATE LAWYER, Mar. 2001, at 23.
2 Id. at 24.
3 Tenant's counsel will no doubt dispute that landlords ever do anything truly at their own expense; they just use the tenant's rent to pay for it. This, in fact, has given rise in some states to a theory of implied waiver of subrogation, the leading case for which is Sutton v. Jondahl, 532 P.2d 478 (Okla. Ct. App. 1975), where the court relied, inter alia, on the fact that the tenant pays for the landlord's insurance premium as part of the tenant's rent. Please take note that theories of implied waiver of subrogation are not accepted in all states. See the discussion, infra, of implied waiver of subrogation for more on this line of cases.
4 Self-insurance, incidentally, does not change the analysis, although opposing counsel may wish to set out minimum self-insurance requirements in the lease, or at least require periodic reporting by the self-insured party as to (1) the reserves it has set aside for its self-insurance plan and (2) what claims have been made by others against those reserves, to assure the other party that the self-insurance remains sufficient to cover its responsibilities with respect to a loss or damage.
5 If the subtenant is included in the tenant's waiver of subrogation, landlord's counsel should consider including a disclaimer, clarifying that the reference to "subtenant" does not mean the landlord is consenting to any subleases.
6 1 MILTON R. FRIEDMAN, FRIEDMAN ON LEASES § 9:11, at 9-91 to 9-112 (5th ed. 2010). The author leans heavily on, and refers the reader seeking greater detail to, FRIEDMAN ON LEASES, the gold standard among authorities on commercial leasing law, for this discussion of implied waiver of subrogation.
7Sutton v. Jondahl, 532 P.2d 478 (Okla. Ct. App. 1975).
8 FRIEDMAN ON LEASES, supra note 6, § 9:11.2, at 9-102.
9 Zoppi v. Traurig, 251 N.J. SUPER. 283, 288, 598 A.2d 19, 21 (1990).
10 Monterey Corp. v. Hart, 216 Va. 843, 845-46, 224 S.E.2d 142, 144 (1976).
11 Id. at 849-50, 224 S.E.2d at 146-47.
12 Id. at 851, 224 S.E.2d at 147.
13 Cincinnati Insurance Co. v. Tienda La Mexicana, Inc., 2009 WL 4363450, at *3 (W.D. Va. 2009).
14 Id. at *4.
15 Allstate Insurance Co. v. Fritz, 452 F.3d 316, 322-23 (2006).
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.
Tuesday, February 15, 2011
The Latest on Adverse Possession in NY
2010 saw the chaos predicted for the 2008 amendments to New York's adverse possession law erupt into full flower. While the 2008 amendments were well intentioned and even made sense insofar as it took de minimis acts like mowing a piece of one's neighbor's lawn out of the doctrine of adverse possession, where they introduced a "reasonable basis for the belief that the property belongs to the adverse possessor" into the law of adverse possession, they transformed adverse possession law from purely objective to largely subjective. This is particularly dangerous for the title industry as the title of a person down the string of title now relies on what someone was thinking up the string of title, perhaps decades earlier.
One major controversy in 2010 in adverse possession was whether the 2008 amendments could consistent with constitutional due process clauses apply to facts which arose prior to the amendments. The courts first determined whether the adverse possession amendments were procedural or substantive rights. Rarely does one have a due process claim to a particular procedure, but they do attach to the property the procedure affects.
Franza v. Olin, 73 AD3d 44, 8897 NYS2d 804 (4th Dept. 2010), established that the 2008 amendments could not constitutionally be applied in 2010 to strip title by adverse possession from one whose rights had fully ripened under prior law. Thus the instabilities created under the 2008 amendments are mostly applicable to titles by adverse possession when the adverse act first occurred after 1998* because under the normal rules of adverse possession, it takes ten years to establish such a claim. However, for anything after 1998, the new unstable, untested, and hazardous rules control. Franza is being followed throughout the state.
See: Barra v. Norfolk Southern Railway Company, 75 AD3d 821, NYS2d (3d Dept. 2010)
* But see, Ziegler v. Serrano, 74 AD3d 1610, —NYS2d— (3d Dept. 2010) where, in dicta, the court left open the question of the propriety of applying the 2008 statute to older facts. Sawyer v. Prusky, 71 AD2d 1325, 896 NYS2d 536 (3d Dept. 2010) applied the 2008 law to older facts without hesitation, but it is questionable whether the Third Department in even this short span of time may not regard its own Sawyer decision as good law.
One major controversy in 2010 in adverse possession was whether the 2008 amendments could consistent with constitutional due process clauses apply to facts which arose prior to the amendments. The courts first determined whether the adverse possession amendments were procedural or substantive rights. Rarely does one have a due process claim to a particular procedure, but they do attach to the property the procedure affects.
Franza v. Olin, 73 AD3d 44, 8897 NYS2d 804 (4th Dept. 2010), established that the 2008 amendments could not constitutionally be applied in 2010 to strip title by adverse possession from one whose rights had fully ripened under prior law. Thus the instabilities created under the 2008 amendments are mostly applicable to titles by adverse possession when the adverse act first occurred after 1998* because under the normal rules of adverse possession, it takes ten years to establish such a claim. However, for anything after 1998, the new unstable, untested, and hazardous rules control. Franza is being followed throughout the state.
See: Barra v. Norfolk Southern Railway Company, 75 AD3d 821, NYS2d (3d Dept. 2010)
* But see, Ziegler v. Serrano, 74 AD3d 1610, —NYS2d— (3d Dept. 2010) where, in dicta, the court left open the question of the propriety of applying the 2008 statute to older facts. Sawyer v. Prusky, 71 AD2d 1325, 896 NYS2d 536 (3d Dept. 2010) applied the 2008 law to older facts without hesitation, but it is questionable whether the Third Department in even this short span of time may not regard its own Sawyer decision as good law.
Tuesday, February 8, 2011
How to Get a Refund from New York State for Mortgage Recording Tax Paid on Commercial Mortgages
For a tax year beginning on or after January 1, 2004, if you paid the special additional mortgage recording tax to record a mortgage on or after January 1, 2004 on real property located in New York State, you may qualify for a credit for the amount of special additional mortgage recording tax you paid. Partners in a partnership (including members of an LLC that is treated as a partnership for federal income tax purposes), estates and trusts, and beneficiaries of estates and trusts may also qualify for this credit if the partnership, estate or trust, in its tax year beginning on or after January 1, 2004, paid the tax to record a mortgage on or after January 1, 2004. This new credit does not apply to shareholders of New York S corporations. A New York S corporation will continue to claim a credit for this tax directly on its New York State S corporation return using Form CT-43, Claim for Special Additional Mortgage Recording Tax Credit.
This credit may be claimed by the lender or borrower, as the case may be, that paid the special additional mortgage recording tax. Except for loans made by a federal credit union and some loans made by a federal savings bank or by an exempt organization, in the case of a residential mortgage (defined below), the special additional mortgage recording tax is paid by the lender. In most other cases, the special additional mortgage recording tax is paid by the borrower. You should contact your lending institution or tax advisor to determine the amount, if any, of special additional mortgage recording tax you paid.
However, the tax credit is not allowed for the special additional mortgage recording tax paid on residential mortgages (defined below) if the real property is located in Erie county or any of the counties within the Metropolitan Commuter Transportation District (MCTD). The MCTD includes the counties of New York, Bronx, Queens, Kings, Richmond, Dutchess, Nassau, Orange, Putnam, Rockland, Suffolk, and Westchester.
A residential mortgage, for purposes of this credit means a mortgage on real property which is principally improved by one or more structures containing a total of not more than six residential dwelling units, each with its own separate cooking facilities.
If the amount of the special additional mortgage recording tax credit exceeds your tax for the tax year, you may carry over the amount of credit exceeding your tax to the following year or years, or you can elect to treat the unused amount of credit as an overpayment of tax to be credited or refunded, without interest.
If you qualify to claim this credit for a year after 2004 and have already filed your tax return for the year in which you made the payment without claiming the credit, you must amend your return to claim the credit. See the following instructions on how to amend your return.
IT-201 filers - File Form IT-201-X, Amended resident income tax return. Be sure to complete Form IT-256, Claim for special additional mortgage recording tax credit and attach it to Form IT-201-X.
IT-203 filers - File Form IT-203-X, Amended nonresident and part year resident income tax return. Be sure to complete Form IT-256, Claim for special additional mortgage recording tax credit, and attach it to Form IT-203-X.
IT-204 filers - Use a blank Form IT-204, Partnership return, and write Amended at the top. Include the amount of the special additional mortgage recording tax credit in the total for line 24. Be sure to complete Form IT-256, Claim for special additional mortgage recording tax credit, and attach it to your amended Form IT-204. In addition, each partner must file an amended return to claim his or her share of the credit. It is the responsibility of the partnership to inform each partner of his or her distributive share of the special additional mortgage recording tax credit.
IT-205 filers - Use a blank Form IT-205, Fiduciary return, and write Amended at the top. Be sure to complete Form IT-256 Claim for special additional mortgage recording tax credit, and attach it to the amended Form IT-205. In addition, each beneficiary must file an amended return to claim his or her share of the credit (if applicable). It is the responsibility of the estate or trust to inform each beneficiary of his or her share of the credit.
This credit may be claimed by the lender or borrower, as the case may be, that paid the special additional mortgage recording tax. Except for loans made by a federal credit union and some loans made by a federal savings bank or by an exempt organization, in the case of a residential mortgage (defined below), the special additional mortgage recording tax is paid by the lender. In most other cases, the special additional mortgage recording tax is paid by the borrower. You should contact your lending institution or tax advisor to determine the amount, if any, of special additional mortgage recording tax you paid.
However, the tax credit is not allowed for the special additional mortgage recording tax paid on residential mortgages (defined below) if the real property is located in Erie county or any of the counties within the Metropolitan Commuter Transportation District (MCTD). The MCTD includes the counties of New York, Bronx, Queens, Kings, Richmond, Dutchess, Nassau, Orange, Putnam, Rockland, Suffolk, and Westchester.
A residential mortgage, for purposes of this credit means a mortgage on real property which is principally improved by one or more structures containing a total of not more than six residential dwelling units, each with its own separate cooking facilities.
If the amount of the special additional mortgage recording tax credit exceeds your tax for the tax year, you may carry over the amount of credit exceeding your tax to the following year or years, or you can elect to treat the unused amount of credit as an overpayment of tax to be credited or refunded, without interest.
If you qualify to claim this credit for a year after 2004 and have already filed your tax return for the year in which you made the payment without claiming the credit, you must amend your return to claim the credit. See the following instructions on how to amend your return.
IT-201 filers - File Form IT-201-X, Amended resident income tax return. Be sure to complete Form IT-256, Claim for special additional mortgage recording tax credit and attach it to Form IT-201-X.
IT-203 filers - File Form IT-203-X, Amended nonresident and part year resident income tax return. Be sure to complete Form IT-256, Claim for special additional mortgage recording tax credit, and attach it to Form IT-203-X.
IT-204 filers - Use a blank Form IT-204, Partnership return, and write Amended at the top. Include the amount of the special additional mortgage recording tax credit in the total for line 24. Be sure to complete Form IT-256, Claim for special additional mortgage recording tax credit, and attach it to your amended Form IT-204. In addition, each partner must file an amended return to claim his or her share of the credit. It is the responsibility of the partnership to inform each partner of his or her distributive share of the special additional mortgage recording tax credit.
IT-205 filers - Use a blank Form IT-205, Fiduciary return, and write Amended at the top. Be sure to complete Form IT-256 Claim for special additional mortgage recording tax credit, and attach it to the amended Form IT-205. In addition, each beneficiary must file an amended return to claim his or her share of the credit (if applicable). It is the responsibility of the estate or trust to inform each beneficiary of his or her share of the credit.
Saturday, January 29, 2011
Deposit Disputes; How can transaction parties avoid earnest money conflicts?
by Andrew Maguire
Part of the toll of the ongoing commercial real estate slump is the high frequency of terminated deals. Scarcity of financing, valuation disconnects, and general economic concern all contribute to the “kill rate.” Of course, any time a deal is terminated, the earnest money deposit must be released by the escrow holder in accordance with the agreement of sale. But what happens if the agreement of sale does not clearly state which party should get the deposit?
Who Gets the Money?
Compared with residential deals, where consumer protection laws might trump the express language of the contract, courts are more likely to enforce the unambiguous agreement terms in commercial transactions. However, when a commercial transaction is terminated and the agreement is silent or ambiguous as to which party should get the deposit, the presiding judge is forced to make that decision.
In Wawa, Inc. v. Insnetvest Corp., a recent Philadelphia trial court case, the buyer and seller under a terminated purchase agreement each sought the entire $150,000 escrowed deposit. The purchase agreement gave the buyer the right to terminate if it could not obtain necessary conditional-use approvals at an “acceptable” cost. Although the buyer’s application for conditional-use approvals was approved — subject to the satisfaction of certain conditions — the buyer elected to terminate, maintaining that it was not cost effective to proceed to closing.
The purchase agreement between Wawa and Insnetvest did not state which party would get the deposit if the buyer terminated for cost-based reasons, leaving the trial judge to make that determination. The judge ruled that Wawa properly terminated the agreement of sale and held that the termination constituted a “rescission” of the contract. The object of rescission is to return the buyer and seller to the position that each occupied prior to signing the contract. Although the parties to a terminated agreement of sale can never truly return to their pre-contract positions (for example, how can the seller get back the time it lost while its property was under contract), the court determined that the buyer should recover its entire earnest money deposit.
Similarly, a 2010 California appeals court decision affirmed the rescission of an agreement of sale in Sharabianlou v. Karp. In that case, a prospective commercial property buyer brought an action to rescind the agreement after the transaction failed to close on time. After it found certain deposit release language in the agreement of sale to be ambiguously drafted, the Sharabianlou court awarded the full escrowed deposit to the buyer.
Practical Considerations
Transaction participants should heed the following guidelines to avoid deposit disputes.
Clear contract terms.
The purchase contract needs to clearly spell out what happens to the earnest money deposit upon termination on specific grounds. The contract, and any amendments to the contract, also must specify whether additional deposits are to be handled the same as the initial earnest money deposit if termination occurs.
Competent counsel.
Before entering into a commercial agreement of sale, even the most cost-conscious sellers and buyers should hire competent counsel — the alternative could end up being far more costly. In the Sharabianlou case, a commercial broker — not a lawyer — drafted the ambiguous amendment that led to the rescission of the agreement of sale and, ultimately, a lawsuit against the broker.
Generally worded termination letters.
As a rule of thumb, termination notices should broadly reference the rights of the terminating party to cancel the deal. If the termination letter gives one specific justification for termination (without citing other legitimate grounds for cancelation) and a court later rules the lone justification to be invalid, the terminating party might find itself bound under a contract that it could have otherwise properly terminated.
Unbiased escrow holder.
Deposit holders generally are regarded to have a fiduciary duty to both buyer and seller. However, neutrality can be compromised when the deposit is held by an attorney, broker, or other agent for one of the parties to the transaction. Typically, title companies work well as escrow holders, as long as the agreement of sale provides that the escrow-holding title agent must be acceptable to both buyer and seller. As a general rule, any deposit holder should require buyer and seller to sign an escrow agreement indemnifying the deposit holder.
Matters concerning contract termination and deposit release vary by state law and are highly fact-dependent. Any buyer or seller involved in a deposit release dispute should obtain appropriate representation.
Part of the toll of the ongoing commercial real estate slump is the high frequency of terminated deals. Scarcity of financing, valuation disconnects, and general economic concern all contribute to the “kill rate.” Of course, any time a deal is terminated, the earnest money deposit must be released by the escrow holder in accordance with the agreement of sale. But what happens if the agreement of sale does not clearly state which party should get the deposit?
Who Gets the Money?
Compared with residential deals, where consumer protection laws might trump the express language of the contract, courts are more likely to enforce the unambiguous agreement terms in commercial transactions. However, when a commercial transaction is terminated and the agreement is silent or ambiguous as to which party should get the deposit, the presiding judge is forced to make that decision.
In Wawa, Inc. v. Insnetvest Corp., a recent Philadelphia trial court case, the buyer and seller under a terminated purchase agreement each sought the entire $150,000 escrowed deposit. The purchase agreement gave the buyer the right to terminate if it could not obtain necessary conditional-use approvals at an “acceptable” cost. Although the buyer’s application for conditional-use approvals was approved — subject to the satisfaction of certain conditions — the buyer elected to terminate, maintaining that it was not cost effective to proceed to closing.
The purchase agreement between Wawa and Insnetvest did not state which party would get the deposit if the buyer terminated for cost-based reasons, leaving the trial judge to make that determination. The judge ruled that Wawa properly terminated the agreement of sale and held that the termination constituted a “rescission” of the contract. The object of rescission is to return the buyer and seller to the position that each occupied prior to signing the contract. Although the parties to a terminated agreement of sale can never truly return to their pre-contract positions (for example, how can the seller get back the time it lost while its property was under contract), the court determined that the buyer should recover its entire earnest money deposit.
Similarly, a 2010 California appeals court decision affirmed the rescission of an agreement of sale in Sharabianlou v. Karp. In that case, a prospective commercial property buyer brought an action to rescind the agreement after the transaction failed to close on time. After it found certain deposit release language in the agreement of sale to be ambiguously drafted, the Sharabianlou court awarded the full escrowed deposit to the buyer.
Practical Considerations
Transaction participants should heed the following guidelines to avoid deposit disputes.
Clear contract terms.
The purchase contract needs to clearly spell out what happens to the earnest money deposit upon termination on specific grounds. The contract, and any amendments to the contract, also must specify whether additional deposits are to be handled the same as the initial earnest money deposit if termination occurs.
Competent counsel.
Before entering into a commercial agreement of sale, even the most cost-conscious sellers and buyers should hire competent counsel — the alternative could end up being far more costly. In the Sharabianlou case, a commercial broker — not a lawyer — drafted the ambiguous amendment that led to the rescission of the agreement of sale and, ultimately, a lawsuit against the broker.
Generally worded termination letters.
As a rule of thumb, termination notices should broadly reference the rights of the terminating party to cancel the deal. If the termination letter gives one specific justification for termination (without citing other legitimate grounds for cancelation) and a court later rules the lone justification to be invalid, the terminating party might find itself bound under a contract that it could have otherwise properly terminated.
Unbiased escrow holder.
Deposit holders generally are regarded to have a fiduciary duty to both buyer and seller. However, neutrality can be compromised when the deposit is held by an attorney, broker, or other agent for one of the parties to the transaction. Typically, title companies work well as escrow holders, as long as the agreement of sale provides that the escrow-holding title agent must be acceptable to both buyer and seller. As a general rule, any deposit holder should require buyer and seller to sign an escrow agreement indemnifying the deposit holder.
Matters concerning contract termination and deposit release vary by state law and are highly fact-dependent. Any buyer or seller involved in a deposit release dispute should obtain appropriate representation.
Sunday, January 23, 2011
Paying the Handyman? The IRS Wants to Know
Article by John Compagno,
If you're the owner of even just a single unit of rental property, starting in 2011 you must begin tracking any vendor doing at least $600 worth of work for you, because you now have to send them an IRS 1099 Form for the 2011 tax year – or face stiff penalties.
The requirement to track vendors and issue the 1099 forms isn't new. It's something larger rental property owners already do. But last year, when the federal government enacted the Small Business Jobs and Credit Act of 2010 (H.R. 5297), it expanded the requirement to all property owners, no matter how small. In effect, even property owners just doing rental as a sideline – maybe as part of a family investment fund or as part of a retirement savings plan – are "conducting a trade or business," so the 1099 reporting requirement now applies to them.
That means you have a legal obligation to obtain certain information from your vendors (generally, their name, address and Social Security number or other Tax ID, plus the amount you pay them over the year), and then issue them the 1099 forms to reflect the income you paid them for the year. (Don't forget to keep a copy for yourself.) Since the requirement takes effect for the 2011 tax year, you should start tracking the payments you make to your vendors beginning in January 2011. After you've tracked your payments for the year, you'll send them the total in the 1099 form in early 2012.
There are some exceptions to the requirement:
• Burden: if gathering the information and issuing the forms would create a hardship
• Duration: if the property is only a temporary rental of your own residence
• Income: if your income from the rental doesn't meet minimal threshold requirements
Additional Guidance to Come
More guidance is forthcoming. The IRS will fill in the details on what constitutes a hardship or is considered "minimal" income, so you'll need to watch for that when it comes out.
On the vendor side, the requirement applies to all independent contractors or freelance workers that typically provide services in a rental real estate context. These include plumbers, electricians, painters, cleaning services, gardeners, landscapers, accountants and handymen – in short, virtually all service providers to the property that don't receive a W-2 form from you and who provide at least $600 in services for the year. It's a cumulative amount, so even if that painting job only costs you $400, you need to track it and add any other charges from that vendor to see if the total comes to more than $600, which triggers the requirement for sending that vendor the 1099 form.
How to Comply
To satisfy the requirement, you'll want to review your bookkeeping procedures (with your accountant if you work with one) to be confident you have a system in place to track your payments to your vendors. You'll want to set up your tracking procedure so that you can keep separate how you paid them: by credit card, debit card, check or cash.
The IRS will set forth the important dates for the 2011 tax year. You'll want to note those and be sure to comply, because late filing will be penalized. Indeed, penalties have been doubled under the new law.
The initial first-tier penalty has been increased from $15 to $30 (filing 1099 up to 30 days late), the second-tier penalty increased from $30 to $60 (more than 30 days late), and the third-tier penalty increased from $50 to $100 (filing after August 1). There's also a $250 penalty for the intentional failure to file.
As a general matter, you'll be able to request a 30-day extension for getting your forms to the IRS, but that won't apply to your deadline for getting the form to your vendors. Remember, they need to use those in preparing their tax returns.
For many owners, the new reporting requirement will come as a surprise. If you manage property for a small owner, make sure you let them know about it. If you're the owner, be sure to prepare to comply, which means tracking your payments starting this year.
A version of this article will be published in the January 2011 issue of REALTOR® magazine.
The Author is with the offices of Holland and Knight, San Francisco
If you're the owner of even just a single unit of rental property, starting in 2011 you must begin tracking any vendor doing at least $600 worth of work for you, because you now have to send them an IRS 1099 Form for the 2011 tax year – or face stiff penalties.
The requirement to track vendors and issue the 1099 forms isn't new. It's something larger rental property owners already do. But last year, when the federal government enacted the Small Business Jobs and Credit Act of 2010 (H.R. 5297), it expanded the requirement to all property owners, no matter how small. In effect, even property owners just doing rental as a sideline – maybe as part of a family investment fund or as part of a retirement savings plan – are "conducting a trade or business," so the 1099 reporting requirement now applies to them.
That means you have a legal obligation to obtain certain information from your vendors (generally, their name, address and Social Security number or other Tax ID, plus the amount you pay them over the year), and then issue them the 1099 forms to reflect the income you paid them for the year. (Don't forget to keep a copy for yourself.) Since the requirement takes effect for the 2011 tax year, you should start tracking the payments you make to your vendors beginning in January 2011. After you've tracked your payments for the year, you'll send them the total in the 1099 form in early 2012.
There are some exceptions to the requirement:
• Burden: if gathering the information and issuing the forms would create a hardship
• Duration: if the property is only a temporary rental of your own residence
• Income: if your income from the rental doesn't meet minimal threshold requirements
Additional Guidance to Come
More guidance is forthcoming. The IRS will fill in the details on what constitutes a hardship or is considered "minimal" income, so you'll need to watch for that when it comes out.
On the vendor side, the requirement applies to all independent contractors or freelance workers that typically provide services in a rental real estate context. These include plumbers, electricians, painters, cleaning services, gardeners, landscapers, accountants and handymen – in short, virtually all service providers to the property that don't receive a W-2 form from you and who provide at least $600 in services for the year. It's a cumulative amount, so even if that painting job only costs you $400, you need to track it and add any other charges from that vendor to see if the total comes to more than $600, which triggers the requirement for sending that vendor the 1099 form.
How to Comply
To satisfy the requirement, you'll want to review your bookkeeping procedures (with your accountant if you work with one) to be confident you have a system in place to track your payments to your vendors. You'll want to set up your tracking procedure so that you can keep separate how you paid them: by credit card, debit card, check or cash.
The IRS will set forth the important dates for the 2011 tax year. You'll want to note those and be sure to comply, because late filing will be penalized. Indeed, penalties have been doubled under the new law.
The initial first-tier penalty has been increased from $15 to $30 (filing 1099 up to 30 days late), the second-tier penalty increased from $30 to $60 (more than 30 days late), and the third-tier penalty increased from $50 to $100 (filing after August 1). There's also a $250 penalty for the intentional failure to file.
As a general matter, you'll be able to request a 30-day extension for getting your forms to the IRS, but that won't apply to your deadline for getting the form to your vendors. Remember, they need to use those in preparing their tax returns.
For many owners, the new reporting requirement will come as a surprise. If you manage property for a small owner, make sure you let them know about it. If you're the owner, be sure to prepare to comply, which means tracking your payments starting this year.
A version of this article will be published in the January 2011 issue of REALTOR® magazine.
The Author is with the offices of Holland and Knight, San Francisco
Saturday, January 8, 2011
The Ability to Expense Capital Costs (Section 179 Expensing) Now Includes Certain Real Property
By Paul J. Linstroth
For any tax year beginning in 2010 or 2011, a taxpayer may elect to treat up to $250,000 of qualified real property expenses as Section 179 property (subject to a phase-out). In other words, the taxpayer can take a current deduction for qualifying expenses as opposed to depreciating improvements over their useful life.
Qualified real property is:
(A) qualified leasehold improvement property (generally, improvements made pursuant to a lease by the lessor, lessee or sublessee, where the premises are occupied by the lessee or sublessee, and the improvements are made more than 3 years after the building was placed in service);
(B) qualified restaurant property (generally, a building or building improvements if more than 50% of the square footage is used for the preparation of, and seating for on-site consumption of, prepared meals); and
(C) qualified retail improvement property [generally, improvements to the interior of a building (excluding elevators, additions, structural framework modifications and common area improvements) used in a retail trade or business and such improvements are made more than 3 years after the building was placed in service].
The qualified property must be depreciable, acquired for use in the active conduct of a trade or business, and cannot be certain ineligible property (i.e., used for lodging, used outside the U.S., used by governmental units, foreign persons or entities, and certain tax-exempt organizations, air conditioning or heating units).
For purposes of applying the $500,000 expensing limitation for real and personal property, not more than $250,000 of the aggregate cost which is taken into account under Section 179 for any tax year can be attributable to qualified real property. The annual amount which may be expensed is reduced (but not below zero) by the amount by which the cost of qualifying property placed in service in tax years beginning in 2010 and 2011 exceeds $2,000,000. In addition, the expensing deduction is limited to the taxpayer's taxable income but can be carried over to a subsequent taxable year. Notwithstanding the general carryover rule for expensing deductions, no amount attributable to qualified real property can be carried over to a tax year beginning after 2011.
For any tax year beginning in 2010 or 2011, a taxpayer may elect to treat up to $250,000 of qualified real property expenses as Section 179 property (subject to a phase-out). In other words, the taxpayer can take a current deduction for qualifying expenses as opposed to depreciating improvements over their useful life.
Qualified real property is:
(A) qualified leasehold improvement property (generally, improvements made pursuant to a lease by the lessor, lessee or sublessee, where the premises are occupied by the lessee or sublessee, and the improvements are made more than 3 years after the building was placed in service);
(B) qualified restaurant property (generally, a building or building improvements if more than 50% of the square footage is used for the preparation of, and seating for on-site consumption of, prepared meals); and
(C) qualified retail improvement property [generally, improvements to the interior of a building (excluding elevators, additions, structural framework modifications and common area improvements) used in a retail trade or business and such improvements are made more than 3 years after the building was placed in service].
The qualified property must be depreciable, acquired for use in the active conduct of a trade or business, and cannot be certain ineligible property (i.e., used for lodging, used outside the U.S., used by governmental units, foreign persons or entities, and certain tax-exempt organizations, air conditioning or heating units).
For purposes of applying the $500,000 expensing limitation for real and personal property, not more than $250,000 of the aggregate cost which is taken into account under Section 179 for any tax year can be attributable to qualified real property. The annual amount which may be expensed is reduced (but not below zero) by the amount by which the cost of qualifying property placed in service in tax years beginning in 2010 and 2011 exceeds $2,000,000. In addition, the expensing deduction is limited to the taxpayer's taxable income but can be carried over to a subsequent taxable year. Notwithstanding the general carryover rule for expensing deductions, no amount attributable to qualified real property can be carried over to a tax year beginning after 2011.
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