Wall Street Journal
August 31, 2009
By LINGLING WEI and PETER GRANT
Federal Reserve and Treasury officials are scrambling to prevent the commercial-real-estate sector from delivering a roundhouse punch to the U.S. economy just as it struggles to get up off the mat.
Their efforts could be undermined by a surge in foreclosures of commercial property carrying mortgages that were packaged and sold by Wall Street as bonds. Similar mortgage-backed securities created out of home loans played a big role in undoing that sector and triggering the global economic recession. Now the $700 billion of commercial-mortgage-backed securities outstanding are being tested for the first time by a massive downturn, and the outcome so far hasn't been pretty.
The CMBS sector is suffering two kinds of pain, which, according to credit rater Realpoint LLC, sent its delinquency rate to 3.14% in July, more than six times the level a year earlier. One is simply the result of bad underwriting. In the era of looser credit, Wall Street's CMBS machine lent owners money on the assumption that occupancy and rents of their office buildings, hotels, stores or other commercial property would keep rising. In fact, the opposite has happened. The result is that a growing number of properties aren't generating enough cash to make principal and interest payments.
The other kind of hurt is coming from the inability of property owners to refinance loans bundled into CMBS when these loans mature. By the end of 2012, some $153 billion in loans that make up CMBS are coming due, and close to $100 billion of that will face difficulty getting refinanced, according to Deutsche Bank. Even though the cash flows of these properties are enough to pay interest and principal on the debt, their values have fallen so far that borrowers won't be able to extend existing mortgages or replace them with new debt. That means losses not only to the property owners but also to those who bought CMBS -- including hedge funds, pension funds, mutual funds and other financial institutions -- thus exacerbating the economic downturn.
A typical CMBS is stuffed with mortgages on a diverse group of properties, often fewer than 100, with loans ranging from a couple of million dollars to more than $100 million. A CMBS servicer, usually a big financial institution like Wachovia and Wells Fargo, collects monthly payments from the borrowers and passes the money on to the institutional investors that buy the securities.
CMBS, of course, aren't the only kind of commercial-real-estate debt suffering higher defaults. Banks hold $1.7 trillion of commercial mortgages and construction loans, and delinquencies on this debt already have played a role in the increase in bank failures this year.
But banks' losses from commercial mortgages have the potential to mount sharply, and the high foreclosure rate in the CMBS market could play a role in this. Until now, banks have been able to keep a lid on commercial-real-estate losses by extending debt when it has matured as long as the underlying properties are generating enough cash to pay debt service. Banks have had a strong incentive to refinance because relaxed accounting standards have enabled them to avoid marking the value of the loans down.
"There is no incentive for banks to realize losses" on their commercial-real-estate loans, says Jack Foster, head of real estate at Franklin Templeton Real Estate Advisors.
CMBS are held by scores of investors, and the servicers of CMBS loans have limited flexibility to extend or restructure troubled loans like banks do. Earlier this month, it was no coincidence that CMBS mortgages accounted for the debt on six of the seven Southern California office buildings that Maguire Properties Inc. said it was giving up. "During most of the evolution [of CMBS] no one ever thought all these loans would go into default," says Nelson Rising, Maguire's chief executive.
Indeed, many property developers and investors complain there is no way to identify the investors that hold their debt and that it is difficult to negotiate with CMBS servicers. In light of the complaints, the Treasury is considering guidance that would allow servicers to start talking about ways to avoid defaults and foreclosures sooner, according to people familiar with the matter. But investors in CMBS bonds argue that the servicers are ultimately bound contractually to the bondholders.
So Maguire will soon have a lot of company. In a study for The Wall Street Journal, Realpoint found that 281 CMBS loans valued at $6.3 billion weren't able to refinance when they matured in the past three month, even though 173 such loans worth $5.1 billion were throwing off more than enough cash to service their debt.
Mounting foreclosures in the CMBS sector would likely depress values even further as property is dumped on the market. And this would put pressure on banks to write down loans. "What's going on in the CMBS world is a precursor for what might be seen in banks' books," predicts Frank Innaurato, managing director at Realpoint.
The commercial-real-estate market could yet be salvaged by an improving economy and bailout programs coming out of Washington. In addition, capital markets are starting to ease for publicly traded real-estate investment trusts. Since March, more than two dozen REITs have managed to raise more than $13 billion by selling shares.
Still, most of the $6.7 trillion in commercial real estate is privately owned. Also, it is unlikely commercial real estate will benefit much from an early stage of an economic recovery. What landlords need is occupancy and rents to rise, and that means employers have to start hiring and consumers need to shop more. So far, there are few signs this is happening.
Monday, August 31, 2009
Rising Tides-Changing Title: Court to Mull Takings Issue
By John Nolon
New York Law Journal
August 19, 2009
The U.S. Supreme Court has granted certiorari in Walton County v. Stop the Beach Renourishment, Inc. This Florida case raises novel questions about coastal erosion due to storm events, the prospect of sea level rise, and the definition of constitutionally protected property rights of beachfront property owners. Lawyers who represent riparian land owners, title agencies, mortgage companies, equity investors, and land use regulators should pay close attention to the arguments before the Court in this case and the eventual decision. So should planners, citizens, and owners interested in the impacts of climate change which include storm surges, hurricanes, and the gradual landward movement of the tide.
The setting for the Walton County case is a five-mile stretch of beach along the Florida panhandle in Walton County that was critically eroded by several hurricanes. Much of the land adjacent to the beach is zoned for a variety of "pro-tourist" uses and is developed as high rise hotels, mid-rise condominiums and commercial properties, and a variety of lower density retail, tourist, and residential uses. Beach-related tourism in Walton County accounts for over $250 million in annual revenue and is a major reason for the government's commitment to rebuilding beaches when storm surges and hurricanes severely erode them. Some parts of the beach nearly disappeared after hurricane Opal; others were significantly narrowed, affecting the access that the public, including tourists, have to walk up and down the beach, sun bathe, and swim.
A variety of state grants, tax surpluses, bonds supported by future tax revenue, and other funds were accumulated by the Walton County Tourist Development Council. Altogether $16 million was raised to cover the cost of beach renourishment. The funds paid the costs of the beach rebuilding project, which was conducted under a Florida statute that requires two permits, detailed property surveys, and the protection of property rights as renourishment progresses. The plaintiffs objected to the prospect of rebuilding, argued against the issuance of the required permits at administrative hearings conducted by the Florida Department of Environmental Protection, and then challenged the statute in court as a regulatory taking. They won at the District Court level in Florida, but lost when the Florida Supreme Court reversed. They then successfully appealed for a writ of certiorari from the U.S. Supreme Court.
At first blush, it is hard to understand why property owners would object to having their beaches improved, widened, and protected by the State of Florida at the expense of the tourism industry and the taxpayer. The effect of the renourishment project, however, greatly expanded public access near their private lands. The project substantially widens the beach, expanding public access by adding, on average, 100 feet of beach seaward of the pre-project mean high water line. Constitutional arguments aside, these private owners object to the increased intensity of use by the public of the land in front of their properties. Demonstrating that opposition to the renourishment project was not limited to the six plaintiffs involved, an association with 150 members sought, but was denied, standing to sue.
The Impact of the Statute
The Beach and Shore Preservation Act was adopted by the state legislature in 19611 to discharge the state's duty under the Florida Constitution to protect natural resources,2 including coastal beaches. Under the public trust doctrine,3 the state owns legal title of the beach seaward of the mean high water line, which it holds on behalf of the public. Nearly 400 miles of 1,200 miles of shoreline in Florida is listed as "critically eroded" and in need of restoration under the act, including the five miles in question in Walton County.
The act authorizes state-sponsored renourishment projects and commits the state to maintain beaches restored and expanded by such projects. But for such projects, property owners gamble on the wiles of nature, accepting the risk of losing title to their land through erosion and gaining it through accretion: the gradual building up of the beach seaward of their property lines. Erosion and accretion occur gradually and unpredictably. As they transpire over the years, common law holds that the mean high water line is moved landward or seaward, and the boundary between public and private ownership shifts. When storm events occur and the land is suddenly altered, the law provides that the boundary between state and upland ownership is not changed. This is called avulsion. The doctrine allows both the state and the private owners affected by sudden shifts in land formation to take action to reclaim the land moved by avulsion. Case law in Florida clearly defines hurricanes as avulsive events.
Once a renourishment project is completed under the Beach and Shore Preservation Act, the statute provides that the property line is fixed at the pre-avulsion mean high water line. It denominates this surveyed line the Erosion Control Line (ECL) and requires it to be recorded on the land records. This statutory fixing of the property line takes away the risk of future erosion and the right to accretion. The statute provides, however, that if the state fails to maintain and protect the restored beach, the property line reverts to the common law mean high water line.
The plaintiff's primary claim is that fixing—rendering immoveable—the property line constitutes a regulatory taking of a recognized common law property right: the right to accretion. Normally, if the beach expanded through accretion, that new land would belong to the upland owner. The statute takes that right away, raising the issue of whether there exists a common law right to accretion under Florida law that is affected by the statute, and, if so, whether that amounts to a taking under the Constitution.
What is a Judicial Taking?
The plaintiffs' petition for certiorari claims that the Florida Supreme Court "invoked non-existent rules of state substantive law to reverse 100 years of uniform holdings that littoral rights are constitutionally protected." They call this a "judicial taking" and ask the U.S. Supreme Court to recognize this judicial redefinition of extant rights, combined with the working of the statute to fix their property line, as a compensable taking under the Fifth and Fourteenth Amendments.
More than 15 years ago, the Court denied certiorari in a similar case where beachfront owners argued that an Oregon statute constituted a taking where it prevented building sea walls on the "dry sand area" of their beaches. They lost when the Oregon Supreme Court held that the public had right to the dry sand area under the "doctrine of custom."4 Justice Scalia dissented from the denial of certiorari, writing that "the petitioners must be afforded an opportunity to make out their constitutional claim by demonstrating that the asserted custom is pretextual."5Among other statements, Justice Scalia indicated that the Oregon Supreme Court "appears to have misread Blackstone in applying the law of custom."6
Is this the role of the U.S. Supreme Court: to decide the wisdom or accuracy of a state court's determination of pre-existing state law? Perhaps one of the more interesting and important issues the Walton County case raises is whether matters of state common law, as determined by the highest state court, are reversible by the Court. Justice Scalia thinks so. "Our opinion in Lucas…would be a nullity if anything that a State court chooses to denominate 'background law'—regardless of whether it is really such—could eliminate property rights."7 The Court's Lucas case held that a regulation that takes all economic use of a petitioner's property is a taking unless, under the "background principles of the State's law,"8 the use that the regulation prohibits is "not part of his title to begin with."9
In Lucas, Justice Scalia, writing for the majority, referred to "our traditional resort to 'existing rules or understandings that stem from an independent source such as state law' to define the range of interests that qualify for protection as 'property' under the Fifth and Fourteenth Amendments."10 In Lucas, the Court stated, "Although it seems unlikely that common-law principles would have prevented the erection of any habitable or productive improvements on Lucas's land, this state-law question must be dealt with on remand."11 The Lucas decision also accommodates the notion that change in common law principles happens. "The fact that a particular use has long been engaged in by similarly situated owners ordinarily imports a lack of any common-law prohibition though changed circumstances or new knowledge may make what was previously permissible no longer so."12 In Phillips Petroleum, the Court held that "[s]tates have the authority to define the limits of lands held in public trust and to recognize private rights in such lands as they see fit."13
For devotees of regulatory takings doctrine, the Walton County case is not a Lucas type of case. There is no regulation at issue that takes the economic value of the parcel owned by the petitioners. Walton County is best described as a Loretto-style case, different a per se category of takings.14 The Walton County case raises the somewhat novel issue of whether the "appropriation" of a common law property right, such as the right to accretion, constitutes a compensable taking. The typical Loretto case involves a challenge to a governmental action that imposes an affirmative easement on private property where there is no application by the affected owner for a governmental permit.
Mrs. Loretto was simply told that she had to grant an easement to the cable company to allow them to install and maintain cables for the convenience of her tenants. Even though the intrusion was de minimis, the Court held that a taking of her fundamental right of exclusion occurred. Similarly, the beachfront owners in Walton County are told that their property lines will be fixed by the statute even though they are not before a public body for a building or development permit.
The Florida Supreme Court recognizes that a "governmental appropriation" of a discrete property right, one stick in the bundle of rights, can constitute a compensable taking. In Walton County, it refers to Lee County v. Kiesel, which held that riparian owners own a right to an unobstructed view of the water and that this right was violated by the construction of a bridge on government lands built at an angle to the water line that obstructed their view.15 The court, in Lee, held this to be a compensable taking. The Lee court cites two prior Florida cases for the proposition. It then held that the right to a view is not absolute, recognizing the government's right to obstruct it to a degree, but notes that the government action must not "substantially and materially obstruct the land owner's view of the channel."
The Lee court calls this a case by case analysis—a process of making an "equitable distribution" regarding the submerged lands between the upland and the Channel. This would seem to call for similar flexibility with regard to renourishment, rendering the other common law rights of the littoral owners less than absolute. In this sense, it differs from the absolutist view of imposing an affirmative easement as in Loretto under which even the slightest invasion is compensible.
The Florida Court's Ruling
Under Florida common law, the defendants own title landward of the mean high water line, while the state owns, in public trust, the land seaward of that line. The line is adjusted automatically every 19 years as tides change following historically predictable cycles that influence the tides. Littoral owners also own corollary rights including the rights of accretion, access to the water, use of the water, and an unobstructed view of the water. These are private property rights that cannot be taken from upland owners without just compensation.
The Supreme Court of Florida begins its opinion noting that prior court decisions have not dealt with many of the common law property right issues raised by beach renourishment. Curiously, this seems to be the situation in other prominent coastal states, including California and New York: the common law of littoral rights is poorly developed, despite the increasingly critical importance of coastal protection and property rights. The court also notes that it reviews matters of law of this type de novo and must be the arbiter of property law, giving deference to the legislature and presuming the constitutionality of its actions where possible. This is particularly so here, since the court treats the plaintiffs' challenge as a facial attack on the statute where it has to be shown that there exists no set of circumstances under which the statute would be valid.
The court notes that the statute preserves several of the corollary littoral rights: the right of access, use, and view, including the right of ingress and egress, after a renourishment project is completed. The lower court held that the common law rights of accretion and of contact with the water are taken by the statute. The Florida Supreme Court disagreed. It asserts that the lower court misunderstands the law of avulsion. Florida common law holds that when sudden loss or addition of land occurs—an avulsion—the property line does not move as it does with accretion; it remains fixed at the former mean high water line. Following such an event, both the state and the upland owner have a reasonable time to reclaim their lost lands. Prior case law establishes that hurricanes are avulsive events and that the loss of the sovereign's interest in the beach may be recovered by self-help on the part of the state. The court argues that the statute simply codifies the state's common law right to reclaim storm-ravaged lands by fixing the boundary line at the pre-event mean high water line.
Although the court recognizes the existence of a common law right of accretion, it notes that it is a contingent right, arising out of a rule of convenience and that the reasons for establishing the common law right of accretion do not apply to the statute. Florida common law established four reasons for recognizing the right of accretion; the court looks at each one and determines that none of them is implicated in the context of renourishment by the state of beaches seriously eroded by avulsive events. It goes through each of four underlying reasons for the doctrine and demonstrates why each does not apply.
It disagrees with the district court regarding the upland owner's right to contact with the water. It explains that this right is ancillary to the owner's right of access, which is preserved by the statute, quoting its prior decision in Board of Trustees v. Sand Key Associates.16 "We have never addressed whether littoral rights are unconstitutionally taken based solely upon the loss of an upland owner's direct contact with the water."17 Citing the statute's preservation of the right of access, the court concludes "at least facially, these provisions ensure that the upland owner's access to the water remains intact. Therefore, the rationale for the ancillary right to contact is satisfied."
Questions Raised
So many constitutional and practical issues are raised by the Walton County case. Will the Court use the Lucas concept of a total taking and apply it to the taking of a discrete stick from the bundle of property rights, or will it see Walton County as a Loretto-style case, but refine Loretto to include and explain how it should be used in a government appropriation case rather than its traditional use in invasion cases?
Did the Florida Supreme Court reinterpret common law as a pretext for validating the Beach and Shore Preservation Act? Is there any clear holding of a previous Florida Supreme Court decision in the context of beachfront erosion that was confused, reversed, or misinterpreted by the decision? If common law shifts gradually, like the mean high water line, should a "judicial taking" be found when a state court applies previous common law principles to emerging circumstances like coastal erosion in a time of climate change? What would the U.S. Supreme Court have to find wrong with the state court's analysis to justify reversal on the basis of state common law? By what powers of divination does the Court determine that a state court decision is motivated by a pretext?
This is clearly a case to watch.
John R. Nolon is professor of law at Pace University School of Law, counsel to its land Use Law Center, a visiting professor at the Yale School of Forestry and Environmental Studies. Pace Law School student Joe Edgar contributed to this article.
Endnotes:
1. FLA. STAT. §§161.011-161.45 (2005)
2. FLA. CONST. Art. II, §7(a).
3. Id. art. X, §11.
4. Stevens v. City of Cannon Beach, 854 P.2d 499 (Or. 1993).
5. Stevens v. City of Cannon Beach, 510 U.S. 1207, 1212 n.5 (1994).
6. Id.
7. Id. at 1212.
8. Lucas v. South Carolina Coastal Council, 505 U.S. 1003, 1029 (1992).
9. Id. at 1027.
10. See Lucas, 505 U.S. at 1030 (quoting Board of Regents of State Colleges v. Roth, 408 U.S. 564, 577 (1972)).
11. Lucas, 505 U.S. at 1031.
12. Id. (citing Restatement (Second) of Torts § 827 (1965)).
13. Phillips Petroleum Co. v. Mississippi, 484 U.S. 469, 479 (1988).
14. See Loretto v. Teleprompter Manhattan CATV Corp., 458 U.S. 419 (1982).
15. Lee County v. Kiesel, 705 So. 2d 1013 (1998).
16. Board of Trustees of the International Improvement Trust Fund v. Sand Key Associates, 512 So.2d 934 (Fla. 1987).
17. Id. at 936.
New York Law Journal
August 19, 2009
The U.S. Supreme Court has granted certiorari in Walton County v. Stop the Beach Renourishment, Inc. This Florida case raises novel questions about coastal erosion due to storm events, the prospect of sea level rise, and the definition of constitutionally protected property rights of beachfront property owners. Lawyers who represent riparian land owners, title agencies, mortgage companies, equity investors, and land use regulators should pay close attention to the arguments before the Court in this case and the eventual decision. So should planners, citizens, and owners interested in the impacts of climate change which include storm surges, hurricanes, and the gradual landward movement of the tide.
The setting for the Walton County case is a five-mile stretch of beach along the Florida panhandle in Walton County that was critically eroded by several hurricanes. Much of the land adjacent to the beach is zoned for a variety of "pro-tourist" uses and is developed as high rise hotels, mid-rise condominiums and commercial properties, and a variety of lower density retail, tourist, and residential uses. Beach-related tourism in Walton County accounts for over $250 million in annual revenue and is a major reason for the government's commitment to rebuilding beaches when storm surges and hurricanes severely erode them. Some parts of the beach nearly disappeared after hurricane Opal; others were significantly narrowed, affecting the access that the public, including tourists, have to walk up and down the beach, sun bathe, and swim.
A variety of state grants, tax surpluses, bonds supported by future tax revenue, and other funds were accumulated by the Walton County Tourist Development Council. Altogether $16 million was raised to cover the cost of beach renourishment. The funds paid the costs of the beach rebuilding project, which was conducted under a Florida statute that requires two permits, detailed property surveys, and the protection of property rights as renourishment progresses. The plaintiffs objected to the prospect of rebuilding, argued against the issuance of the required permits at administrative hearings conducted by the Florida Department of Environmental Protection, and then challenged the statute in court as a regulatory taking. They won at the District Court level in Florida, but lost when the Florida Supreme Court reversed. They then successfully appealed for a writ of certiorari from the U.S. Supreme Court.
At first blush, it is hard to understand why property owners would object to having their beaches improved, widened, and protected by the State of Florida at the expense of the tourism industry and the taxpayer. The effect of the renourishment project, however, greatly expanded public access near their private lands. The project substantially widens the beach, expanding public access by adding, on average, 100 feet of beach seaward of the pre-project mean high water line. Constitutional arguments aside, these private owners object to the increased intensity of use by the public of the land in front of their properties. Demonstrating that opposition to the renourishment project was not limited to the six plaintiffs involved, an association with 150 members sought, but was denied, standing to sue.
The Impact of the Statute
The Beach and Shore Preservation Act was adopted by the state legislature in 19611 to discharge the state's duty under the Florida Constitution to protect natural resources,2 including coastal beaches. Under the public trust doctrine,3 the state owns legal title of the beach seaward of the mean high water line, which it holds on behalf of the public. Nearly 400 miles of 1,200 miles of shoreline in Florida is listed as "critically eroded" and in need of restoration under the act, including the five miles in question in Walton County.
The act authorizes state-sponsored renourishment projects and commits the state to maintain beaches restored and expanded by such projects. But for such projects, property owners gamble on the wiles of nature, accepting the risk of losing title to their land through erosion and gaining it through accretion: the gradual building up of the beach seaward of their property lines. Erosion and accretion occur gradually and unpredictably. As they transpire over the years, common law holds that the mean high water line is moved landward or seaward, and the boundary between public and private ownership shifts. When storm events occur and the land is suddenly altered, the law provides that the boundary between state and upland ownership is not changed. This is called avulsion. The doctrine allows both the state and the private owners affected by sudden shifts in land formation to take action to reclaim the land moved by avulsion. Case law in Florida clearly defines hurricanes as avulsive events.
Once a renourishment project is completed under the Beach and Shore Preservation Act, the statute provides that the property line is fixed at the pre-avulsion mean high water line. It denominates this surveyed line the Erosion Control Line (ECL) and requires it to be recorded on the land records. This statutory fixing of the property line takes away the risk of future erosion and the right to accretion. The statute provides, however, that if the state fails to maintain and protect the restored beach, the property line reverts to the common law mean high water line.
The plaintiff's primary claim is that fixing—rendering immoveable—the property line constitutes a regulatory taking of a recognized common law property right: the right to accretion. Normally, if the beach expanded through accretion, that new land would belong to the upland owner. The statute takes that right away, raising the issue of whether there exists a common law right to accretion under Florida law that is affected by the statute, and, if so, whether that amounts to a taking under the Constitution.
What is a Judicial Taking?
The plaintiffs' petition for certiorari claims that the Florida Supreme Court "invoked non-existent rules of state substantive law to reverse 100 years of uniform holdings that littoral rights are constitutionally protected." They call this a "judicial taking" and ask the U.S. Supreme Court to recognize this judicial redefinition of extant rights, combined with the working of the statute to fix their property line, as a compensable taking under the Fifth and Fourteenth Amendments.
More than 15 years ago, the Court denied certiorari in a similar case where beachfront owners argued that an Oregon statute constituted a taking where it prevented building sea walls on the "dry sand area" of their beaches. They lost when the Oregon Supreme Court held that the public had right to the dry sand area under the "doctrine of custom."4 Justice Scalia dissented from the denial of certiorari, writing that "the petitioners must be afforded an opportunity to make out their constitutional claim by demonstrating that the asserted custom is pretextual."5Among other statements, Justice Scalia indicated that the Oregon Supreme Court "appears to have misread Blackstone in applying the law of custom."6
Is this the role of the U.S. Supreme Court: to decide the wisdom or accuracy of a state court's determination of pre-existing state law? Perhaps one of the more interesting and important issues the Walton County case raises is whether matters of state common law, as determined by the highest state court, are reversible by the Court. Justice Scalia thinks so. "Our opinion in Lucas…would be a nullity if anything that a State court chooses to denominate 'background law'—regardless of whether it is really such—could eliminate property rights."7 The Court's Lucas case held that a regulation that takes all economic use of a petitioner's property is a taking unless, under the "background principles of the State's law,"8 the use that the regulation prohibits is "not part of his title to begin with."9
In Lucas, Justice Scalia, writing for the majority, referred to "our traditional resort to 'existing rules or understandings that stem from an independent source such as state law' to define the range of interests that qualify for protection as 'property' under the Fifth and Fourteenth Amendments."10 In Lucas, the Court stated, "Although it seems unlikely that common-law principles would have prevented the erection of any habitable or productive improvements on Lucas's land, this state-law question must be dealt with on remand."11 The Lucas decision also accommodates the notion that change in common law principles happens. "The fact that a particular use has long been engaged in by similarly situated owners ordinarily imports a lack of any common-law prohibition though changed circumstances or new knowledge may make what was previously permissible no longer so."12 In Phillips Petroleum, the Court held that "[s]tates have the authority to define the limits of lands held in public trust and to recognize private rights in such lands as they see fit."13
For devotees of regulatory takings doctrine, the Walton County case is not a Lucas type of case. There is no regulation at issue that takes the economic value of the parcel owned by the petitioners. Walton County is best described as a Loretto-style case, different a per se category of takings.14 The Walton County case raises the somewhat novel issue of whether the "appropriation" of a common law property right, such as the right to accretion, constitutes a compensable taking. The typical Loretto case involves a challenge to a governmental action that imposes an affirmative easement on private property where there is no application by the affected owner for a governmental permit.
Mrs. Loretto was simply told that she had to grant an easement to the cable company to allow them to install and maintain cables for the convenience of her tenants. Even though the intrusion was de minimis, the Court held that a taking of her fundamental right of exclusion occurred. Similarly, the beachfront owners in Walton County are told that their property lines will be fixed by the statute even though they are not before a public body for a building or development permit.
The Florida Supreme Court recognizes that a "governmental appropriation" of a discrete property right, one stick in the bundle of rights, can constitute a compensable taking. In Walton County, it refers to Lee County v. Kiesel, which held that riparian owners own a right to an unobstructed view of the water and that this right was violated by the construction of a bridge on government lands built at an angle to the water line that obstructed their view.15 The court, in Lee, held this to be a compensable taking. The Lee court cites two prior Florida cases for the proposition. It then held that the right to a view is not absolute, recognizing the government's right to obstruct it to a degree, but notes that the government action must not "substantially and materially obstruct the land owner's view of the channel."
The Lee court calls this a case by case analysis—a process of making an "equitable distribution" regarding the submerged lands between the upland and the Channel. This would seem to call for similar flexibility with regard to renourishment, rendering the other common law rights of the littoral owners less than absolute. In this sense, it differs from the absolutist view of imposing an affirmative easement as in Loretto under which even the slightest invasion is compensible.
The Florida Court's Ruling
Under Florida common law, the defendants own title landward of the mean high water line, while the state owns, in public trust, the land seaward of that line. The line is adjusted automatically every 19 years as tides change following historically predictable cycles that influence the tides. Littoral owners also own corollary rights including the rights of accretion, access to the water, use of the water, and an unobstructed view of the water. These are private property rights that cannot be taken from upland owners without just compensation.
The Supreme Court of Florida begins its opinion noting that prior court decisions have not dealt with many of the common law property right issues raised by beach renourishment. Curiously, this seems to be the situation in other prominent coastal states, including California and New York: the common law of littoral rights is poorly developed, despite the increasingly critical importance of coastal protection and property rights. The court also notes that it reviews matters of law of this type de novo and must be the arbiter of property law, giving deference to the legislature and presuming the constitutionality of its actions where possible. This is particularly so here, since the court treats the plaintiffs' challenge as a facial attack on the statute where it has to be shown that there exists no set of circumstances under which the statute would be valid.
The court notes that the statute preserves several of the corollary littoral rights: the right of access, use, and view, including the right of ingress and egress, after a renourishment project is completed. The lower court held that the common law rights of accretion and of contact with the water are taken by the statute. The Florida Supreme Court disagreed. It asserts that the lower court misunderstands the law of avulsion. Florida common law holds that when sudden loss or addition of land occurs—an avulsion—the property line does not move as it does with accretion; it remains fixed at the former mean high water line. Following such an event, both the state and the upland owner have a reasonable time to reclaim their lost lands. Prior case law establishes that hurricanes are avulsive events and that the loss of the sovereign's interest in the beach may be recovered by self-help on the part of the state. The court argues that the statute simply codifies the state's common law right to reclaim storm-ravaged lands by fixing the boundary line at the pre-event mean high water line.
Although the court recognizes the existence of a common law right of accretion, it notes that it is a contingent right, arising out of a rule of convenience and that the reasons for establishing the common law right of accretion do not apply to the statute. Florida common law established four reasons for recognizing the right of accretion; the court looks at each one and determines that none of them is implicated in the context of renourishment by the state of beaches seriously eroded by avulsive events. It goes through each of four underlying reasons for the doctrine and demonstrates why each does not apply.
It disagrees with the district court regarding the upland owner's right to contact with the water. It explains that this right is ancillary to the owner's right of access, which is preserved by the statute, quoting its prior decision in Board of Trustees v. Sand Key Associates.16 "We have never addressed whether littoral rights are unconstitutionally taken based solely upon the loss of an upland owner's direct contact with the water."17 Citing the statute's preservation of the right of access, the court concludes "at least facially, these provisions ensure that the upland owner's access to the water remains intact. Therefore, the rationale for the ancillary right to contact is satisfied."
Questions Raised
So many constitutional and practical issues are raised by the Walton County case. Will the Court use the Lucas concept of a total taking and apply it to the taking of a discrete stick from the bundle of property rights, or will it see Walton County as a Loretto-style case, but refine Loretto to include and explain how it should be used in a government appropriation case rather than its traditional use in invasion cases?
Did the Florida Supreme Court reinterpret common law as a pretext for validating the Beach and Shore Preservation Act? Is there any clear holding of a previous Florida Supreme Court decision in the context of beachfront erosion that was confused, reversed, or misinterpreted by the decision? If common law shifts gradually, like the mean high water line, should a "judicial taking" be found when a state court applies previous common law principles to emerging circumstances like coastal erosion in a time of climate change? What would the U.S. Supreme Court have to find wrong with the state court's analysis to justify reversal on the basis of state common law? By what powers of divination does the Court determine that a state court decision is motivated by a pretext?
This is clearly a case to watch.
John R. Nolon is professor of law at Pace University School of Law, counsel to its land Use Law Center, a visiting professor at the Yale School of Forestry and Environmental Studies. Pace Law School student Joe Edgar contributed to this article.
Endnotes:
1. FLA. STAT. §§161.011-161.45 (2005)
2. FLA. CONST. Art. II, §7(a).
3. Id. art. X, §11.
4. Stevens v. City of Cannon Beach, 854 P.2d 499 (Or. 1993).
5. Stevens v. City of Cannon Beach, 510 U.S. 1207, 1212 n.5 (1994).
6. Id.
7. Id. at 1212.
8. Lucas v. South Carolina Coastal Council, 505 U.S. 1003, 1029 (1992).
9. Id. at 1027.
10. See Lucas, 505 U.S. at 1030 (quoting Board of Regents of State Colleges v. Roth, 408 U.S. 564, 577 (1972)).
11. Lucas, 505 U.S. at 1031.
12. Id. (citing Restatement (Second) of Torts § 827 (1965)).
13. Phillips Petroleum Co. v. Mississippi, 484 U.S. 469, 479 (1988).
14. See Loretto v. Teleprompter Manhattan CATV Corp., 458 U.S. 419 (1982).
15. Lee County v. Kiesel, 705 So. 2d 1013 (1998).
16. Board of Trustees of the International Improvement Trust Fund v. Sand Key Associates, 512 So.2d 934 (Fla. 1987).
17. Id. at 936.
Thursday, August 27, 2009
Power of Attorney Statutory Overhaul Set to Take Effect Changes to creation and use are significant.
By Benjamin Weinstock and Meeka Levin
New York Law Journal
August 24, 2009
New York state introduced the power of attorney (POA) in 1948 as a way to plan for the absence of servicemen and women in the armed forces during and after World War II.1 It turned out that acceptance of powers of attorney, including their use in real estate transactions, became far more widespread than the original proponents ever considered.2
A major overhaul of the POA law that will take effect on Sept. 1, 2009,3 dramatically changes how powers of attorney will be created and used. This article focuses on the POA changes that are most relevant to real estate practitioners.
The new statute, among other things, repeals General Obligation Law (NYGOL) §5-1501 and replaces it with new NYGOL §§5-1501, 5-1501A and 5-1501B. For the first time, the focus of the POA law is on the agent rather than the principal.4
The agent must now sign the POA and act with the standard of care of a prudent person dealing with the property of another.5 This comports with the overarching themes of consumer protection, accountability and the reduction of opportunities for fraud, all of which have gained increased notoriety. With the present state of the economy and the daily reports of unprecedented financial exploitation and scandal, this amendment arrives at an opportune time. It follows several other recent enactments to foster honesty and transparency in the marketplace, such as the Property Condition Disclosure Act, Home Equity Theft Prevention Act, predatory lending laws and the Foreclosure Prevention and Responsible Lending Act.
The POA has always been an attractive arrangement for real estate transactions, as a tool of convenience for both the client and attorney. Frequently, it is the only way a transaction can close.
Under the new law, a POA will be radically different in form and substance from what practitioners are used to. For example, the distinction between a durable and nondurable POA has been eliminated. Every POA created after Sept. 1, 2009, will be durable, meaning that the POA will be unaffected by the principal's incapacity, unless otherwise expressly provided.
Creating a Valid Power of Attorney
Powers of attorney validly executed prior to Sept. 1, 2009, continue to remain valid and may be used after that date.6 The new law applies only to powers of attorney executed on or after Sept. 1, 2009. However, if a new POA is executed after that date, even for a limited or specific purpose, all previous powers of attorney are automatically revoked.7
In order to create a valid POA after Sept. 1, 2009, the instrument must be typed or printed using a legible font at least 12 points in size.8 It must be signed and dated by the principal and the agent, with both signatures acknowledged in the manner prescribed for the acknowledgment of a conveyance of real property.9 The agent's signature, denoting acceptance of the appointment, is a prominent new requirement that creates a "cooling-off" period to give the principal more time to reflect upon the seriousness of granting such authority.
The principal and agent are not required to sign simultaneously or in the presence of each other, and a lapse of time between the acknowledgments of the signatures will not invalidate the POA. The statute does not state whether the order of the signatures has an impact on the validity of the document.
On one hand, one would think that the principal must sign first because the POA takes effect on "the date on which an agent's signature is acknowledged."10 How could the POA take effect on the acknowledgment of the agent's signature (attesting to the acceptance of the delegation of power) if the principal has not signed it first?
On the other hand, one could say that the statute really means that the POA is effective only when the agent's signature is acknowledged, provided that the principal also signs the POA. The better practice is to have the principal sign first, even if this sequence of execution may be more time consuming.
One is not required to use the new statutory short form POA set forth in NYGOL §5-1513.11 However, the statute is emphatic that every POA must "contain the exact wording" of paragraphs (a) and (n) of subdivision one of that section.12
Paragraph (a) warns the principal of the broad authority the document grants to the agent. It also expressly advises the principal of the right to revoke the POA.13
Paragraph (n) thoroughly explains the agent's function, fiduciary obligations and potential for liability for acting outside of the authority granted in the document.14
Paragraph (n) is the new centerpiece of the POA and it stands in sharp contrast to the current statute's silence about the agent's rights and responsibilities. No New York statute currently imposes a fiduciary duty on the agent for the benefit of the principal.15 If fiduciary obligations exist, they are solely common law duties.16 The drafters of the new law concluded that the common law responsibility of an agent was insufficient to prevent the recurring cases of abuse of power.17 Therefore, they legislated specific fiduciary duties that must be enumerated in every POA.
Major Gifts and Other Transfers
Current law does not differentiate powers of attorney on the basis of the value of the principal's assets or the agent's economic authority.
The new statute does. It provides for special treatment of powers of attorney involving "major gift transactions and other transfers."18 These include every transfer, except transfers customarily made to individuals and charitable organizations of up to $500 per year, per recipient.19 An agent may make a valid major gift or other transfer under a POA, only if the principal has executed a Statutory Major Gifts Rider (SMGR).20 Thus the basic POA has become an instrument of nominal value, and certainly not very useful in real estate transactions.
The mechanics for creating a valid SMGR are more rigorous than the requirements for creating a valid POA. The SMGR must be:
1. typed or printed in a legible font at least 12 points in size;21
2. accompanied by a statutory POA in which the principal initialed the language authorizing the agent to make major gifts and other transfers of property;22 and
3. signed and dated by the principal, with the signature of the principal acknowledged and witnessed by two subscribing witnesses, like a will.23
These demanding requirements are intended to ensure that the principal fully appreciates the serious nature of the decision to grant an agent "authority to take actions which could significantly reduce [your] property or change how [your] property is distributed at your death."24
Unlike the POA, the agent is not required to sign the SMGR. Rather, the new statute requires the POA and SMGR to be read together as a single instrument.25 The drafters apparently relied on the single instrument rule, and the requirement that the POA and SMGR be executed simultaneously, in order to ensure that the new fiduciary obligations placed on the agent in the POA would apply to the expanded authority granted in the SMGR.
SMGR Key for Real Estate Transactions
The new statute does not directly address the question of whether real estate transactions require a statutory major gifts rider. One might incorrectly think that a basic POA is sufficient because the basic form still includes a check-off box for real estate transactions. However, simply checking off the box in the basic POA is not adequate.
Under the new statute, an agent is not permitted to "create, change or terminate [other] property interests or rights of survivorship, and designate or change the beneficiary or beneficiaries therein" unless the authority is expressly granted in an SMGR or in a non-statutory POA that contains SMGR powers.26 Therefore, it is hard to imagine a real estate transaction that would be possible under a basic POA.
Executing and delivering a deed, granting an easement, and entering into mortgage and mezzanine loan financing all have the capacity to "create, change or terminate…property interests…."27 Accordingly, every real estate transaction, except those exempted by the customary $500 gift exception, may only be effectuated under a POA accompanied by an SMGR.
Include a Statement of Purpose?
Oddly, even though the new statute does not require the principal to include instructions or a statement of purpose in the "Modifications" section of the POA, under §5-1504 (1)(a)(9), title companies may refuse to recognize powers of attorney when such instructions or purpose are not included.28
Therefore, when an SMGR is used for real estate transactions, in addition to the execution requirements mentioned above, the principal should also insert specific instructions or a statement of purpose relating to the transaction in which the POA will be used.
Recording a Power of Attorney
RPL §294 authorizes the recording of a POA. Once recorded, there is constructive notice to all with respect to the agent's authority to act on behalf of the principal. Where a POA has been recorded, a written revocation pursuant to RPL §326 must be recorded to terminate the POA.29 As in the past, the revocation of the POA does not invalidate any exercise of the power prior to the recording of the revocation.
Surprisingly, however, even though one records an express revocation of the POA, the recording does not constitute constructive notice to third parties that the POA has been terminated.30 Unless and until a third party has actual notice of the revocation, the principal will be bound if the third party acted in good faith on the recorded POA.31
This strange construct seems to be antithetical to the guiding principles behind the new law and could lead to a situation where a principal may be bound by the acts of a rogue agent, even after the recording of a revocation.
Technical Amendments Underway
On June 15, 2009, an additional amendment to the POA law passed the Assembly.32 However, as of the press date of this article the Senate has not acted on the amendment.
Although it has been referred to as a "technical" amendment, it is really much more. Several important and logical changes will be implemented if this amendment is enacted, including:
(1) If a principal executes a new POA it will no longer automatically revoke a previous POA unless the principal gives written notice of its revocation to the agent named in the previous POA.33 Thus, one can have multiple powers of attorney extant simultaneously.
(2) The definition of the SMGR is clarified to indicate that it is used for "all" (not "major") gift transactions or other transfers except the $500 customary gift.34
(3) The $500 gift exclusion will become a yearly aggregate amount for the agent to disburse.35 Without this change, the exemption allows multiple gifts of up to $500 each to different donees without an annual aggregate limit.
Conclusion
The title of the new statute, "Statutory Short Form and Other Powers of Attorney for Financial Estate Planning," suggests that the true focus of this amendment is financial estate planning. However, the broad scope of the statute has the obvious potential to delay and complicate real estate transactions.
For assistance in making the transition to the new law, a checklist for powers of attorney to be used in real estate transactions can be downloaded from the authors' firm's Web site at http://www.ruskinmoscou.com/real_estate.htm.
Benjamin Weinstock is a partner at Ruskin Moscou Faltischek, where he serves as co-chair of the firm's real estate department. He can be reached at 516-663-6555 or bweinstock@rmfpc.com. Meeka Levin is an associate in the firm's real estate department and can be reached at 516-663-6657 or mlevin@rmfpc.com.
Endnotes:
1. The New York State Law Revision Commission. 2007 Recommendation on Proposed Revisions to the General Obligations Law Powers of Attorney. Page 8.
2. Id at 5 and 20.
3. 2009 N.Y. Laws ch. 4. S. 1728, A. 04392. Amends Chapter 644 of 2008. Originally, the effective date of the new POA law was scheduled for March 1, 2009. On Feb. 25, 2009, Governor Patterson signed into law a bill extending the effective date to Sept. 1, 2009. The justification for the extension was to provide the legal community with additional time to learn the new intricacies of the law. New York State Senate, Introducer's Memorandum in Support of A04392.
4. New York State Senate, Introducer's Memorandum in Support of S4996B.
5. The New York State Law Revision Commission. 2007 Recommendation on Proposed Revisions to the General Obligations Law Powers of Attorney. Page 26.
6. 2008 N.Y. Laws ch. 644 §21.
7. 2008 N.Y. Laws ch. 644 §19, 5-1511(6).
8. 2008 N.Y. Laws ch. 644 §2, 5-1501B(1)(a).
9. 2008 N.Y. Laws ch. 644 §2, 5-1501B(1)(b). See also N.Y. REAL PROP. LAW §§309, 309-a, and 309-b.
10. 2008 N.Y. Laws ch. 644 §2, 5-1501B(3)(a).
11. 2008 N.Y. Laws ch. 644 §2, 5-1501B(4).
12. 2008 N.Y. Laws ch. 644 §2, 5-1501B(1)(d).
13. 2008 N.Y. Laws ch. 644 §19, 5-1513(1)(a).
14. 2008 N.Y. Laws ch. 644 §19, 5-1513(1)(n).
15. The New York State Law Revision Commission. 2007 Recommendation on Proposed Revisions to the General Obligations Law Powers of Attorney. Pages 6, 15 and 24. New York State Senate, Introducer's Memorandum in Support of S4996B.
16. Id.
17. Id.
18. 2008 N.Y. Laws ch. 644 §2, 5-1501(13).
19. 2008 N.Y. Laws ch. 644 §19 5-1514(1). See also 2008 N.Y. Laws ch. 644 §10, 5-1502(I)(14).
20. 2008 N.Y. Laws ch. 644 §10, 5-1502(I)(14).
21. 2008 N.Y. Laws ch. 644 §19, 5-1514(9)(a).
22. 2008 N.Y. Laws ch. 644 §19, 5-1514(9)(c). The statute uses the term "initial" but we presume that the principal's signature instead of initials will be valid.
23. 2008 N.Y. Laws ch. 644 §19, 5-1514(9)(b). Unlike a statutory POA, the SMGR does have to be witnessed by two disinterested persons in the manner described in N.Y. EST. POWERS & TRUSTS LAW §3-2.1(a)(2). If one is using a non-statutory form, the POA may include the major gift powers if the POA is executed with the formalities of the SMGR.
24. 2008 N.Y. Laws ch. 644 §19, 5-1514(10).
25. 2008 N.Y. Laws ch. 644 §19, 5-1501(14) and (15). The SMGR also contains language indicating that it must be read with the POA as a single instrument.
26. 2008 N.Y. Laws ch. 644 §19, 5-1514(3)(c)(9).
27. Id.
28. 2008 N.Y. Laws ch. 644 §18, 5-1504 (1)(a)(9).
29. 2008 N.Y. Laws ch. 644 §19, 5-1511(4).
30. 2008 N.Y. Laws ch. 644 §19, 5-1511(5).
31. Id.
32. New York State Assembly Bill A08392.
33. Id at §2, 5-1511(6).
34. Id at §4, 5-1501(14).
35. Id at §5, 5-1513 (1)(f)(2)(I). If a principle appoints several agents, it appears that the annual limit is "per agent."
New York Law Journal
August 24, 2009
New York state introduced the power of attorney (POA) in 1948 as a way to plan for the absence of servicemen and women in the armed forces during and after World War II.1 It turned out that acceptance of powers of attorney, including their use in real estate transactions, became far more widespread than the original proponents ever considered.2
A major overhaul of the POA law that will take effect on Sept. 1, 2009,3 dramatically changes how powers of attorney will be created and used. This article focuses on the POA changes that are most relevant to real estate practitioners.
The new statute, among other things, repeals General Obligation Law (NYGOL) §5-1501 and replaces it with new NYGOL §§5-1501, 5-1501A and 5-1501B. For the first time, the focus of the POA law is on the agent rather than the principal.4
The agent must now sign the POA and act with the standard of care of a prudent person dealing with the property of another.5 This comports with the overarching themes of consumer protection, accountability and the reduction of opportunities for fraud, all of which have gained increased notoriety. With the present state of the economy and the daily reports of unprecedented financial exploitation and scandal, this amendment arrives at an opportune time. It follows several other recent enactments to foster honesty and transparency in the marketplace, such as the Property Condition Disclosure Act, Home Equity Theft Prevention Act, predatory lending laws and the Foreclosure Prevention and Responsible Lending Act.
The POA has always been an attractive arrangement for real estate transactions, as a tool of convenience for both the client and attorney. Frequently, it is the only way a transaction can close.
Under the new law, a POA will be radically different in form and substance from what practitioners are used to. For example, the distinction between a durable and nondurable POA has been eliminated. Every POA created after Sept. 1, 2009, will be durable, meaning that the POA will be unaffected by the principal's incapacity, unless otherwise expressly provided.
Creating a Valid Power of Attorney
Powers of attorney validly executed prior to Sept. 1, 2009, continue to remain valid and may be used after that date.6 The new law applies only to powers of attorney executed on or after Sept. 1, 2009. However, if a new POA is executed after that date, even for a limited or specific purpose, all previous powers of attorney are automatically revoked.7
In order to create a valid POA after Sept. 1, 2009, the instrument must be typed or printed using a legible font at least 12 points in size.8 It must be signed and dated by the principal and the agent, with both signatures acknowledged in the manner prescribed for the acknowledgment of a conveyance of real property.9 The agent's signature, denoting acceptance of the appointment, is a prominent new requirement that creates a "cooling-off" period to give the principal more time to reflect upon the seriousness of granting such authority.
The principal and agent are not required to sign simultaneously or in the presence of each other, and a lapse of time between the acknowledgments of the signatures will not invalidate the POA. The statute does not state whether the order of the signatures has an impact on the validity of the document.
On one hand, one would think that the principal must sign first because the POA takes effect on "the date on which an agent's signature is acknowledged."10 How could the POA take effect on the acknowledgment of the agent's signature (attesting to the acceptance of the delegation of power) if the principal has not signed it first?
On the other hand, one could say that the statute really means that the POA is effective only when the agent's signature is acknowledged, provided that the principal also signs the POA. The better practice is to have the principal sign first, even if this sequence of execution may be more time consuming.
One is not required to use the new statutory short form POA set forth in NYGOL §5-1513.11 However, the statute is emphatic that every POA must "contain the exact wording" of paragraphs (a) and (n) of subdivision one of that section.12
Paragraph (a) warns the principal of the broad authority the document grants to the agent. It also expressly advises the principal of the right to revoke the POA.13
Paragraph (n) thoroughly explains the agent's function, fiduciary obligations and potential for liability for acting outside of the authority granted in the document.14
Paragraph (n) is the new centerpiece of the POA and it stands in sharp contrast to the current statute's silence about the agent's rights and responsibilities. No New York statute currently imposes a fiduciary duty on the agent for the benefit of the principal.15 If fiduciary obligations exist, they are solely common law duties.16 The drafters of the new law concluded that the common law responsibility of an agent was insufficient to prevent the recurring cases of abuse of power.17 Therefore, they legislated specific fiduciary duties that must be enumerated in every POA.
Major Gifts and Other Transfers
Current law does not differentiate powers of attorney on the basis of the value of the principal's assets or the agent's economic authority.
The new statute does. It provides for special treatment of powers of attorney involving "major gift transactions and other transfers."18 These include every transfer, except transfers customarily made to individuals and charitable organizations of up to $500 per year, per recipient.19 An agent may make a valid major gift or other transfer under a POA, only if the principal has executed a Statutory Major Gifts Rider (SMGR).20 Thus the basic POA has become an instrument of nominal value, and certainly not very useful in real estate transactions.
The mechanics for creating a valid SMGR are more rigorous than the requirements for creating a valid POA. The SMGR must be:
1. typed or printed in a legible font at least 12 points in size;21
2. accompanied by a statutory POA in which the principal initialed the language authorizing the agent to make major gifts and other transfers of property;22 and
3. signed and dated by the principal, with the signature of the principal acknowledged and witnessed by two subscribing witnesses, like a will.23
These demanding requirements are intended to ensure that the principal fully appreciates the serious nature of the decision to grant an agent "authority to take actions which could significantly reduce [your] property or change how [your] property is distributed at your death."24
Unlike the POA, the agent is not required to sign the SMGR. Rather, the new statute requires the POA and SMGR to be read together as a single instrument.25 The drafters apparently relied on the single instrument rule, and the requirement that the POA and SMGR be executed simultaneously, in order to ensure that the new fiduciary obligations placed on the agent in the POA would apply to the expanded authority granted in the SMGR.
SMGR Key for Real Estate Transactions
The new statute does not directly address the question of whether real estate transactions require a statutory major gifts rider. One might incorrectly think that a basic POA is sufficient because the basic form still includes a check-off box for real estate transactions. However, simply checking off the box in the basic POA is not adequate.
Under the new statute, an agent is not permitted to "create, change or terminate [other] property interests or rights of survivorship, and designate or change the beneficiary or beneficiaries therein" unless the authority is expressly granted in an SMGR or in a non-statutory POA that contains SMGR powers.26 Therefore, it is hard to imagine a real estate transaction that would be possible under a basic POA.
Executing and delivering a deed, granting an easement, and entering into mortgage and mezzanine loan financing all have the capacity to "create, change or terminate…property interests…."27 Accordingly, every real estate transaction, except those exempted by the customary $500 gift exception, may only be effectuated under a POA accompanied by an SMGR.
Include a Statement of Purpose?
Oddly, even though the new statute does not require the principal to include instructions or a statement of purpose in the "Modifications" section of the POA, under §5-1504 (1)(a)(9), title companies may refuse to recognize powers of attorney when such instructions or purpose are not included.28
Therefore, when an SMGR is used for real estate transactions, in addition to the execution requirements mentioned above, the principal should also insert specific instructions or a statement of purpose relating to the transaction in which the POA will be used.
Recording a Power of Attorney
RPL §294 authorizes the recording of a POA. Once recorded, there is constructive notice to all with respect to the agent's authority to act on behalf of the principal. Where a POA has been recorded, a written revocation pursuant to RPL §326 must be recorded to terminate the POA.29 As in the past, the revocation of the POA does not invalidate any exercise of the power prior to the recording of the revocation.
Surprisingly, however, even though one records an express revocation of the POA, the recording does not constitute constructive notice to third parties that the POA has been terminated.30 Unless and until a third party has actual notice of the revocation, the principal will be bound if the third party acted in good faith on the recorded POA.31
This strange construct seems to be antithetical to the guiding principles behind the new law and could lead to a situation where a principal may be bound by the acts of a rogue agent, even after the recording of a revocation.
Technical Amendments Underway
On June 15, 2009, an additional amendment to the POA law passed the Assembly.32 However, as of the press date of this article the Senate has not acted on the amendment.
Although it has been referred to as a "technical" amendment, it is really much more. Several important and logical changes will be implemented if this amendment is enacted, including:
(1) If a principal executes a new POA it will no longer automatically revoke a previous POA unless the principal gives written notice of its revocation to the agent named in the previous POA.33 Thus, one can have multiple powers of attorney extant simultaneously.
(2) The definition of the SMGR is clarified to indicate that it is used for "all" (not "major") gift transactions or other transfers except the $500 customary gift.34
(3) The $500 gift exclusion will become a yearly aggregate amount for the agent to disburse.35 Without this change, the exemption allows multiple gifts of up to $500 each to different donees without an annual aggregate limit.
Conclusion
The title of the new statute, "Statutory Short Form and Other Powers of Attorney for Financial Estate Planning," suggests that the true focus of this amendment is financial estate planning. However, the broad scope of the statute has the obvious potential to delay and complicate real estate transactions.
For assistance in making the transition to the new law, a checklist for powers of attorney to be used in real estate transactions can be downloaded from the authors' firm's Web site at http://www.ruskinmoscou.com/real_estate.htm.
Benjamin Weinstock is a partner at Ruskin Moscou Faltischek, where he serves as co-chair of the firm's real estate department. He can be reached at 516-663-6555 or bweinstock@rmfpc.com. Meeka Levin is an associate in the firm's real estate department and can be reached at 516-663-6657 or mlevin@rmfpc.com.
Endnotes:
1. The New York State Law Revision Commission. 2007 Recommendation on Proposed Revisions to the General Obligations Law Powers of Attorney. Page 8.
2. Id at 5 and 20.
3. 2009 N.Y. Laws ch. 4. S. 1728, A. 04392. Amends Chapter 644 of 2008. Originally, the effective date of the new POA law was scheduled for March 1, 2009. On Feb. 25, 2009, Governor Patterson signed into law a bill extending the effective date to Sept. 1, 2009. The justification for the extension was to provide the legal community with additional time to learn the new intricacies of the law. New York State Senate, Introducer's Memorandum in Support of A04392.
4. New York State Senate, Introducer's Memorandum in Support of S4996B.
5. The New York State Law Revision Commission. 2007 Recommendation on Proposed Revisions to the General Obligations Law Powers of Attorney. Page 26.
6. 2008 N.Y. Laws ch. 644 §21.
7. 2008 N.Y. Laws ch. 644 §19, 5-1511(6).
8. 2008 N.Y. Laws ch. 644 §2, 5-1501B(1)(a).
9. 2008 N.Y. Laws ch. 644 §2, 5-1501B(1)(b). See also N.Y. REAL PROP. LAW §§309, 309-a, and 309-b.
10. 2008 N.Y. Laws ch. 644 §2, 5-1501B(3)(a).
11. 2008 N.Y. Laws ch. 644 §2, 5-1501B(4).
12. 2008 N.Y. Laws ch. 644 §2, 5-1501B(1)(d).
13. 2008 N.Y. Laws ch. 644 §19, 5-1513(1)(a).
14. 2008 N.Y. Laws ch. 644 §19, 5-1513(1)(n).
15. The New York State Law Revision Commission. 2007 Recommendation on Proposed Revisions to the General Obligations Law Powers of Attorney. Pages 6, 15 and 24. New York State Senate, Introducer's Memorandum in Support of S4996B.
16. Id.
17. Id.
18. 2008 N.Y. Laws ch. 644 §2, 5-1501(13).
19. 2008 N.Y. Laws ch. 644 §19 5-1514(1). See also 2008 N.Y. Laws ch. 644 §10, 5-1502(I)(14).
20. 2008 N.Y. Laws ch. 644 §10, 5-1502(I)(14).
21. 2008 N.Y. Laws ch. 644 §19, 5-1514(9)(a).
22. 2008 N.Y. Laws ch. 644 §19, 5-1514(9)(c). The statute uses the term "initial" but we presume that the principal's signature instead of initials will be valid.
23. 2008 N.Y. Laws ch. 644 §19, 5-1514(9)(b). Unlike a statutory POA, the SMGR does have to be witnessed by two disinterested persons in the manner described in N.Y. EST. POWERS & TRUSTS LAW §3-2.1(a)(2). If one is using a non-statutory form, the POA may include the major gift powers if the POA is executed with the formalities of the SMGR.
24. 2008 N.Y. Laws ch. 644 §19, 5-1514(10).
25. 2008 N.Y. Laws ch. 644 §19, 5-1501(14) and (15). The SMGR also contains language indicating that it must be read with the POA as a single instrument.
26. 2008 N.Y. Laws ch. 644 §19, 5-1514(3)(c)(9).
27. Id.
28. 2008 N.Y. Laws ch. 644 §18, 5-1504 (1)(a)(9).
29. 2008 N.Y. Laws ch. 644 §19, 5-1511(4).
30. 2008 N.Y. Laws ch. 644 §19, 5-1511(5).
31. Id.
32. New York State Assembly Bill A08392.
33. Id at §2, 5-1511(6).
34. Id at §4, 5-1501(14).
35. Id at §5, 5-1513 (1)(f)(2)(I). If a principle appoints several agents, it appears that the annual limit is "per agent."
Pre-Workout Agreements Are Today's Lender Essentials Put their protection in place before beginning borrower negotiations.
By David M. Stewart and Elizabeth Jaffe
New York Law Journal
August 24, 2009
How can a real estate-secured lender, faced with increasing defaults by borrowers and falling property values, protect itself during borrower negotiations pursuing a restructuring, or "workout," of the loan?
In the recent real estate downturn, lenders increasingly find themselves faced with defaults, or imminent defaults, by their borrowers. The defaults may be caused by decreasing cash flows generated by the properties as a result of the general national economic conditions (e.g., retail centers and hotels), may be caused by the tightening of the credit markets and borrowers' inability to refinance their loans, many of which include a significant balloon payment upon maturity, or may be caused simply by borrower mismanagement of the underlying asset and its cash flows.
To make matters more complex, lenders today may find that foreclosing on the mortgaged property is not the best defaulted loan strategy: Due to decreased property values and a lack of willing purchasers, the lender could still face a significant shortfall in the recovery of its loan, even if the property could be sold at foreclosure.
Many lenders (not to mention property owners and developers) may view a loan extension as the best option to obtain the greatest principal repayment, by waiting out the current environment and hopefully benefiting from a future economic turnaround. In comparison to pursuit of foreclosure or other loan remedies, workouts may avoid the need for balance sheet write-downs, and often just make sense, both in terms of time efficiency and in realizing the greatest possible return on the lender's investment.
However, extending the loan, or agreeing to any other type of restructuring in an environment that is vastly different from when the loan was originated, requires the parties to alter, sometimes significantly, the bargained-for deal made at the time of the loan's origination. In order to successfully restructure, the lender and borrower need to hold discussions, correspondence and negotiations, even while the existing loan remains distressed and perhaps already in default.
An effective pre-workout or pre-negotiation agreement between the lender and borrower can ease that process.
What does today's pre-workout agreement need to accomplish? At a minimum, a successful pre-workout agreement must maintain the status quo of the lender and the borrower during the workout discussions.
The essence of the pre-workout agreement is that the lender may consider and discuss with the borrower revising the loan terms, or renewing or extending the loan, without in any way prejudicing the rights the lender has already gained or will gain by virtue of the borrower's default, in the event the lender and borrower are unable to reach a definitive agreement to restructure the loan.
The Two Big Mistakes
The biggest mistake lenders make with respect to pre-workout agreements is not having them.
Some lenders fall into the trap of failing to put a pre-workout agreement in place simply because they could not anticipate a borrower default, or because the lender thought it could pursue its remedies or bully the borrower without a pre-workout agreement. In other cases, the lack of a pre-workout agreement results from a relationship between the borrower and the lender that is so troubled that the parties cannot even come to terms on the text of such an agreement.
However, regardless of the reason for not entering into a binding pre-workout agreement, in the absence of one, the lender runs the risk that its oral or written statements will be construed as default waivers on its part, or as a promise or acceptance of restructuring terms.
The biggest mistake lenders make in negotiating pre-workout agreements is being too tough on their borrowers.
Some lenders send borrowers a pre-workout agreement that tries to be comprehensive, a document that attempts not just to preserve the lender's rights, but also to strengthen them. Typically, the borrower will protest vociferously, and the lender and borrower may never finalize the agreement. In the meantime, the fruitless effort and time spent negotiating the unsigned pre-workout agreement runs in favor of the borrower, which ends up with a de facto waiver of its default during the time wasted on spurious negotiations. And as time progresses, the borrower gets a stronger and stronger argument that the lender has waived the borrower's defaults.
What Lenders Really Need
For this reason, lenders need to know their bottom line requirements for any pre-workout agreement, and need to finalize an agreement quickly. Here's what lenders really need:
• Avoid being bound inadvertently. The lender must know that it will not be bound by any possible oral agreements, correspondence, term sheets and draft agreements until the parties have come to a definitive agreement and both the lender and the borrower have signed a document memorializing their understanding. If the parties reach an interim understanding on a sub-issue but do not come to agreement on the overall terms of the loan restructuring, then the parties should not be bound by that agreement on the sub-issue, unless they mutually agree that the sub-agreement is acceptable in itself, and the parties formalize it in a written agreement.
To try to assure that discussions, letters, term sheets and drafts don't find their way into court, the pre-workout agreement should include a statement that all actions going forward will be in the nature of settlement discussions, and therefore will not be admissible as evidence in court or in arbitration, and that none of these materials can be construed as an admission by either party. Then, to be safe, when corresponding or meeting with the other side, each party should note at the outset that the discussions or written materials are subject to the pre-workout agreement.
• Don't waive existing rights. Every pre-workout agreement should contain a statement that explicitly preserves the status quo under the terms of the loan documents. The pre-workout agreement should confirm the parties' understanding that all negotiations or discussions undertaken pursuant to the pre-workout agreement will not constitute a waiver of any borrower defaults or of the lender's rights and remedies under the loan documents (and, in fact, the pre-workout agreement should expressly reserve such rights, especially when a default already exists).
The lender will in most cases want to keep the clock ticking against the borrower during the workout discussions. For this purpose, the pre-workout agreement may say that any default notices previously delivered remain in effect, and that the workout discussions will not toll, suspend or extend any borrower cure periods, notice periods or other time periods under the loan documents and applicable law.
Of course, many borrowers will be offended by the possibility that the lender could pursue its foreclosure or other remedies at the same time as the parties undertake the workout negotiations. The borrower may instead ask for a limited "standstill" period during which the lender will agree to suspend its enforcement actions. In considering whether to accept such an agreed deferral period, the lender must balance its need for speedy realization on its collateral against the likelihood and timing of an acceptable restructuring with the borrower.
• Leave the door open. The lender needs to be able to call it quits at any time. At some point, either of the parties may reach the decision that the discussions are simply not progressing, or that the value of pulling the plug on the loan is greater than the possible upside of consummating a restructuring. Therefore, either party should be able to call off the discussions at any time, simply by sending the other party a notice to that effect.
The pre-workout agreement must make it clear that either party has this right. An open-ended pre-workout agreement, with no explicit right to terminate the talk, may be worse than no agreement at all, because the workout discussions may establish a waiver, a "course of dealing," or an implication that the parties had made some kind of commitment, even though unwritten, to reach an agreement.
The pre-workout agreement should allow the parties to terminate with or without offering any justification to the other side. Of course, some cases in some jurisdictions imply a lender duty to negotiate in good faith. No one can guarantee that an explicit termination right in the pre-workout agreement would overcome that implied duty of good faith.
• Make it clear who pays. Some loan agreements require the borrower to pay all of the lender's costs of administering the loan; other loan agreements require the borrower to pay for the lender's costs of enforcement, only; still others are silent on costs, relying instead on the initial commitment letter.
If the workout discussions are an accommodation to the borrower, then the lender should attempt in the pre-workout agreement to require the borrower to pay the third-party costs (including legal fees) of those discussions, even if the parties don't eventually reach agreement on a restructuring, and even if it is the lender who ultimately withdraws from the discussions. Where the lender has leverage, it may even require the borrower to make an advance payment in respect of those expected costs. This payment is akin to an application fee. If the lender doesn't require that advance payment, then any promise by the borrower to pay the lender's costs may be of minimal value.
In instances where the lender has little leverage, if the loan is not in default or there is little pressure to restructure, the parties may agree to pay their own costs of negotiating the workout. Of course, under those circumstances, if the parties eventually finalize a deal, the lender could require payment of its legal fees as a precondition to the effectiveness of the definitive restructuring agreement.
• Pre-workout agreement as estoppel. In today's environment, a lender with negotiating strength may reasonably conclude that these minimum requirements are still not enough to bring it to the bargaining table. When a loan is in default, the lender-borrower relationship has been tense or uneasy, or the borrower has previously alleged that the lender may be in default or may be susceptible to lender liability, then the lender may want a pre-workout agreement that also functions much as an estoppel certificate against the borrower. Therefore, the lender may ask the borrower to acknowledge irrevocably in the pre-workout agreement the following items:
– a reaffirmation of all of the borrower's obligations under the loan documents in favor of lender;
– an acknowledgment that all the loan documents remain in full force and effect in accordance with their terms, and will remain in force until the parties have reached a definitive restructuring agreement;
– an acknowledgment that the loan is fully funded and the lender has no further duty to make advances or perform any other affirmative obligations;
– a statement that the borrower has no defenses to repayment of the loan and, ideally, that the borrower has no offsets, abatements or other defenses under any of the loan documents; and
– an acknowledgment that the lender is not in default or liable to the borrower.
This last acknowledgment is particularly valuable if the borrower has previously alleged that the lender has not acted in good faith, or if disputes have already arisen during administration of the loan. Some pre-workout agreements go further, making a detailed, explicit release of all lender liability a precondition to entering into the workout negotiations.
How Demanding Should Lenders Be?
At some point, even the most minimally advised borrower will refuse to sign a pre-workout agreement with provisions like those suggested above. The borrower will say that signing such an agreement has the opposite of the intended effect: Instead of preserving the status quo and maintaining each party's existing rights, such an agreement effectively requires the borrower to give up some of its rights, and to weaken its position, against the lender.
If the borrower balks, the lender must reevaluate its goals for the pre-workout agreement. Lenders should always appear tough, firm and decisive. Ultimately, though, lenders should be prepared to concede points on this language. Remember, even if the lender does not obtain these waivers and assurances in the pre-workout agreement, it will still have a chance to (and should) negotiate them into the definitive restructuring agreement.
David M. Stewart is a partner, and Elizabeth Jaffe is an associate, in the New York office of Latham & Watkins.
New York Law Journal
August 24, 2009
How can a real estate-secured lender, faced with increasing defaults by borrowers and falling property values, protect itself during borrower negotiations pursuing a restructuring, or "workout," of the loan?
In the recent real estate downturn, lenders increasingly find themselves faced with defaults, or imminent defaults, by their borrowers. The defaults may be caused by decreasing cash flows generated by the properties as a result of the general national economic conditions (e.g., retail centers and hotels), may be caused by the tightening of the credit markets and borrowers' inability to refinance their loans, many of which include a significant balloon payment upon maturity, or may be caused simply by borrower mismanagement of the underlying asset and its cash flows.
To make matters more complex, lenders today may find that foreclosing on the mortgaged property is not the best defaulted loan strategy: Due to decreased property values and a lack of willing purchasers, the lender could still face a significant shortfall in the recovery of its loan, even if the property could be sold at foreclosure.
Many lenders (not to mention property owners and developers) may view a loan extension as the best option to obtain the greatest principal repayment, by waiting out the current environment and hopefully benefiting from a future economic turnaround. In comparison to pursuit of foreclosure or other loan remedies, workouts may avoid the need for balance sheet write-downs, and often just make sense, both in terms of time efficiency and in realizing the greatest possible return on the lender's investment.
However, extending the loan, or agreeing to any other type of restructuring in an environment that is vastly different from when the loan was originated, requires the parties to alter, sometimes significantly, the bargained-for deal made at the time of the loan's origination. In order to successfully restructure, the lender and borrower need to hold discussions, correspondence and negotiations, even while the existing loan remains distressed and perhaps already in default.
An effective pre-workout or pre-negotiation agreement between the lender and borrower can ease that process.
What does today's pre-workout agreement need to accomplish? At a minimum, a successful pre-workout agreement must maintain the status quo of the lender and the borrower during the workout discussions.
The essence of the pre-workout agreement is that the lender may consider and discuss with the borrower revising the loan terms, or renewing or extending the loan, without in any way prejudicing the rights the lender has already gained or will gain by virtue of the borrower's default, in the event the lender and borrower are unable to reach a definitive agreement to restructure the loan.
The Two Big Mistakes
The biggest mistake lenders make with respect to pre-workout agreements is not having them.
Some lenders fall into the trap of failing to put a pre-workout agreement in place simply because they could not anticipate a borrower default, or because the lender thought it could pursue its remedies or bully the borrower without a pre-workout agreement. In other cases, the lack of a pre-workout agreement results from a relationship between the borrower and the lender that is so troubled that the parties cannot even come to terms on the text of such an agreement.
However, regardless of the reason for not entering into a binding pre-workout agreement, in the absence of one, the lender runs the risk that its oral or written statements will be construed as default waivers on its part, or as a promise or acceptance of restructuring terms.
The biggest mistake lenders make in negotiating pre-workout agreements is being too tough on their borrowers.
Some lenders send borrowers a pre-workout agreement that tries to be comprehensive, a document that attempts not just to preserve the lender's rights, but also to strengthen them. Typically, the borrower will protest vociferously, and the lender and borrower may never finalize the agreement. In the meantime, the fruitless effort and time spent negotiating the unsigned pre-workout agreement runs in favor of the borrower, which ends up with a de facto waiver of its default during the time wasted on spurious negotiations. And as time progresses, the borrower gets a stronger and stronger argument that the lender has waived the borrower's defaults.
What Lenders Really Need
For this reason, lenders need to know their bottom line requirements for any pre-workout agreement, and need to finalize an agreement quickly. Here's what lenders really need:
• Avoid being bound inadvertently. The lender must know that it will not be bound by any possible oral agreements, correspondence, term sheets and draft agreements until the parties have come to a definitive agreement and both the lender and the borrower have signed a document memorializing their understanding. If the parties reach an interim understanding on a sub-issue but do not come to agreement on the overall terms of the loan restructuring, then the parties should not be bound by that agreement on the sub-issue, unless they mutually agree that the sub-agreement is acceptable in itself, and the parties formalize it in a written agreement.
To try to assure that discussions, letters, term sheets and drafts don't find their way into court, the pre-workout agreement should include a statement that all actions going forward will be in the nature of settlement discussions, and therefore will not be admissible as evidence in court or in arbitration, and that none of these materials can be construed as an admission by either party. Then, to be safe, when corresponding or meeting with the other side, each party should note at the outset that the discussions or written materials are subject to the pre-workout agreement.
• Don't waive existing rights. Every pre-workout agreement should contain a statement that explicitly preserves the status quo under the terms of the loan documents. The pre-workout agreement should confirm the parties' understanding that all negotiations or discussions undertaken pursuant to the pre-workout agreement will not constitute a waiver of any borrower defaults or of the lender's rights and remedies under the loan documents (and, in fact, the pre-workout agreement should expressly reserve such rights, especially when a default already exists).
The lender will in most cases want to keep the clock ticking against the borrower during the workout discussions. For this purpose, the pre-workout agreement may say that any default notices previously delivered remain in effect, and that the workout discussions will not toll, suspend or extend any borrower cure periods, notice periods or other time periods under the loan documents and applicable law.
Of course, many borrowers will be offended by the possibility that the lender could pursue its foreclosure or other remedies at the same time as the parties undertake the workout negotiations. The borrower may instead ask for a limited "standstill" period during which the lender will agree to suspend its enforcement actions. In considering whether to accept such an agreed deferral period, the lender must balance its need for speedy realization on its collateral against the likelihood and timing of an acceptable restructuring with the borrower.
• Leave the door open. The lender needs to be able to call it quits at any time. At some point, either of the parties may reach the decision that the discussions are simply not progressing, or that the value of pulling the plug on the loan is greater than the possible upside of consummating a restructuring. Therefore, either party should be able to call off the discussions at any time, simply by sending the other party a notice to that effect.
The pre-workout agreement must make it clear that either party has this right. An open-ended pre-workout agreement, with no explicit right to terminate the talk, may be worse than no agreement at all, because the workout discussions may establish a waiver, a "course of dealing," or an implication that the parties had made some kind of commitment, even though unwritten, to reach an agreement.
The pre-workout agreement should allow the parties to terminate with or without offering any justification to the other side. Of course, some cases in some jurisdictions imply a lender duty to negotiate in good faith. No one can guarantee that an explicit termination right in the pre-workout agreement would overcome that implied duty of good faith.
• Make it clear who pays. Some loan agreements require the borrower to pay all of the lender's costs of administering the loan; other loan agreements require the borrower to pay for the lender's costs of enforcement, only; still others are silent on costs, relying instead on the initial commitment letter.
If the workout discussions are an accommodation to the borrower, then the lender should attempt in the pre-workout agreement to require the borrower to pay the third-party costs (including legal fees) of those discussions, even if the parties don't eventually reach agreement on a restructuring, and even if it is the lender who ultimately withdraws from the discussions. Where the lender has leverage, it may even require the borrower to make an advance payment in respect of those expected costs. This payment is akin to an application fee. If the lender doesn't require that advance payment, then any promise by the borrower to pay the lender's costs may be of minimal value.
In instances where the lender has little leverage, if the loan is not in default or there is little pressure to restructure, the parties may agree to pay their own costs of negotiating the workout. Of course, under those circumstances, if the parties eventually finalize a deal, the lender could require payment of its legal fees as a precondition to the effectiveness of the definitive restructuring agreement.
• Pre-workout agreement as estoppel. In today's environment, a lender with negotiating strength may reasonably conclude that these minimum requirements are still not enough to bring it to the bargaining table. When a loan is in default, the lender-borrower relationship has been tense or uneasy, or the borrower has previously alleged that the lender may be in default or may be susceptible to lender liability, then the lender may want a pre-workout agreement that also functions much as an estoppel certificate against the borrower. Therefore, the lender may ask the borrower to acknowledge irrevocably in the pre-workout agreement the following items:
– a reaffirmation of all of the borrower's obligations under the loan documents in favor of lender;
– an acknowledgment that all the loan documents remain in full force and effect in accordance with their terms, and will remain in force until the parties have reached a definitive restructuring agreement;
– an acknowledgment that the loan is fully funded and the lender has no further duty to make advances or perform any other affirmative obligations;
– a statement that the borrower has no defenses to repayment of the loan and, ideally, that the borrower has no offsets, abatements or other defenses under any of the loan documents; and
– an acknowledgment that the lender is not in default or liable to the borrower.
This last acknowledgment is particularly valuable if the borrower has previously alleged that the lender has not acted in good faith, or if disputes have already arisen during administration of the loan. Some pre-workout agreements go further, making a detailed, explicit release of all lender liability a precondition to entering into the workout negotiations.
How Demanding Should Lenders Be?
At some point, even the most minimally advised borrower will refuse to sign a pre-workout agreement with provisions like those suggested above. The borrower will say that signing such an agreement has the opposite of the intended effect: Instead of preserving the status quo and maintaining each party's existing rights, such an agreement effectively requires the borrower to give up some of its rights, and to weaken its position, against the lender.
If the borrower balks, the lender must reevaluate its goals for the pre-workout agreement. Lenders should always appear tough, firm and decisive. Ultimately, though, lenders should be prepared to concede points on this language. Remember, even if the lender does not obtain these waivers and assurances in the pre-workout agreement, it will still have a chance to (and should) negotiate them into the definitive restructuring agreement.
David M. Stewart is a partner, and Elizabeth Jaffe is an associate, in the New York office of Latham & Watkins.
Wednesday, August 26, 2009
Best Cities For A Housing Recovery
Forbes
By: Matthew Woolsey
08.13.09
Increased transactions and relatively low foreclosure resales spell good news for these markets.
In Depth: Best Cities For A Housing Recovery
The stock market is up 50% from its lows in March, and consumer spending increased in May, June and July. But when will housing turn around?
Even the wisest can't answer that, and experts caution against putting too much hope in rising home prices given the country's unemployment situation and high rate of mortgage defaults. But key measures indicate that some metros are more on their way to recovery than others.
Take Miami. Sales are up 27% over last year and only 3.5% of those are the result of foreclosure resales. In Lincoln, Neb., where sales are 15% higher this year than last, only 3.6% of them involved bank-owned properties Both top our list of markets on their way to health.
In Depth: Best Cities For A Housing Recovery
Behind The Numbers
In compiling our list, Forbes looked at 161 of the country's largest metropolitan statistical areas (or metros)--geographic entities defined by the U.S. Office of Management and Budget (OMB) for use by federal agencies in collecting, tabulating and publishing federal statistics--where sales activity had picked up over the last year, but where foreclosure sales, as a percentage of overall sales were the lowest. Our data came from Zillow.com, an online housing data firm based in Seattle, Wash. Our list doesn't profess to call the turnaround, but rather point out which cities are in the lead on the road to recovery.
To be sure, the national real estate picture remains grim. In Las Vegas and Madera, Calif., for example, respective sales are up 40% and 64% from a year ago. But 67% and 71% of those respective sales are from foreclosure resales.
The Rankings
10. San Jose, Calif.
9. Santa Barbara, Calif.
8. Redding, Calif.
7. Denver, Colo.
6. Bremerton, Wash.
5. San Luis Obispo, Calif.
4. Salem, Ore.
3. Colorado Springs, Colo.
2. Lincoln, Neb.
1. Miami-Ft. Lauderdale, Fla.
Other areas, however, are showing a spark at the very least and signs of bottoming at the very best.
Miami and Lincoln were followed by Colorado Springs, Colo., Salem, Ore. and San Luis Obispo, Calif. Here, sales have returned, but foreclosures are a relatively small percentage. In Colorado Springs, sales activity is up 14%, while transactions involving bank-owned properties made up one-fifth of them. While 20% is still a sizable chunk, it's relatively sound compared with areas like Bakersfield and Vallejo, Calif., and Phoenix, where over 50% of sales made up of foreclosures.
Because housing, like any asset, depends on supply and demand, the sales rate is an incredibly useful statistic in judging a recovery. However, an increased number of sales does not necessarily mean an imminent recovery.
"A bottom in sales volume is not the same thing as a bottom in home values," says Stan Humphries, chief economist at Zillow.com. "The former is a necessary precondition for the latter, but most economists expect prices to keep falling nationally through at least the early part of next year."
Courts Clarify Application of Passive Loss Rules to LLCs
New York Law Journal
By Ezra Dyckman and Seth Hagen
August 26, 2009
In two recent cases, the United States Tax Court and the United States Court of Federal Claims each ruled in favor of the taxpayer that certain interests in limited liability companies ("LLCs") would not constitute limited partnership interests for purposes of applying the passive activity loss limitation rules of Internal Revenue Code section 469. Generally, where an investor holds an interest in an activity through a limited partnership interest, the investor's involvement is presumed to be passive and losses from that activity may only be used to offset income from other passive sources. An investor may rebut this presumption only by satisfying one of three regulatory tests. By ruling that an investment through an LLC should not be treated as presumptively passive, the decisions effectively allow LLC members to establish their active involvement in the activity by meeting one of seven regulatory tests.
Passive Activity Loss Rules
In 1986, Congress enacted Internal Revenue Code section 469 to limit the losses and credits available to taxpayers from "passive" activities. Of motivating concern to Congress was the participation of taxpayers in certain tax shelters. These tax shelters afforded investors the opportunity to reduce or avoid tax liability with respect to their salary or other income items by making available deductions and credits potentially in excess of the real economic costs borne by the taxpayer. For example, high income individuals were investing in real estate activities unrelated to their occupations principally to reap tax benefits allotted to those industries. The typical tax shelter would provide these tax benefits to investors despite the fact that the investors lacked a significant interest in the economic performance of the actual activity and were not materially involved in the operations of the activity. To remedy the problem typified by the passive investment in business activities unrelated to the investor's principal occupation, the passive activity rules were enacted to prohibit the offset of deductions in excess of income (i.e., losses) from passive activities against income from other sources such as salary, interest, dividends, gains, and active business income.
Under Code section 469(a)(1), the deductibility of losses from certain passive activities of individual taxpayers (as opposed to, e.g., corporate taxpayers) are disallowed. Passive losses disallowed in one year generally may be carried forward to offset passive income in future years. Upon the ultimate disposition of a taxpayer's interest in a passive activity, previously disallowed losses are generally allowed. A "passive activity" is a trade or business in which the taxpayer does not "materially participate." A taxpayer is considered to "materially participate" in an activity only if the taxpayer is involved in the operations of the activity on a basis which is regular, continuous, and substantial. Generally, material participation may be established by the taxpayer by meeting one of seven alternative tests described in the Treasury Regulations. Under these alternative tests, an individual can demonstrate material participation if (1) the individual participates in the activity for more than 500 hours during the year, (2) the individual's participation in the activity for the year constitutes substantially all of the participation in such activity of all individuals for such year, (3) the individual participates in the activity for more than 100 hours during the year and such participation is not less than the participation of any other individual for the year, (4) the activity is a "significant participation activity" and the individual's aggregate participation in all significant participation activities for the year exceeds 500 hours, (5) the individual materially participated in the activity for any five years during the 10 preceding years, (6) the activity is a "personal service activity" and the individual materially participates in the activity for any three years preceding the current year, or (7) based on all the facts and circumstances, the individual participates in the activity on a regular, continuous and substantial basis during such year.1
The Limited Partner Rule
Certain onerous presumptions apply with respect to the passive loss rules. The focus of this article is on one such presumption whereby, except as otherwise provided by the Treasury Regulations, interests in an activity held in a limited partnership by a limited partner are not treated as interests with respect to which the taxpayer materially participates (the "limited partner rule").2 There are two exceptions to the limited partner rule. Under the "general partner exception," if the limited partner is also a general partner in the partnership at all times during the year, none of that partner's interest in the partnership is treated as a "limited partnership interest" for purposes of applying the limited partner rule.3 Under the other exception to the limited partner rule, a limited partner is allowed to demonstrate material participation under the alternative tests numbered 1, 5 or 6, described above. Generally, if a limited partner is involved in real estate activity, the partner may only demonstrate material participation by showing more than 500 hours of participation for the year or by showing material participation in five of the last 10 years. As there is typically no other cause for a limited partner in a real estate activity to track her time and activity, unless an individual is aware she must meet these tests, she may not keep records of her time and activity adequate to substantiate material participation under these tests.
For purposes of the limited partner rule, the Treasury Regulations treat a partnership interest as a limited partnership interest if
(A) Such interest is designated a limited partnership interests in the limited partnership agreement or the certificate of limited partnership, without regard to whether the liability of the holder of such interest for obligations of the partnership is limited under the applicable State law; or
(B) The liability of the holder of such interest for obligations of the partnership is limited, under the law of the State in which the partnership is organized, to a determinable fixed amount (for example, the sum of the holder's capital contributions to the partnership and contractual obligations to make additional capital contributions to the partnership.)
Recent Guidance
It had been unclear how limited liability companies (LLCs) treated as partnerships for federal tax purposes were treated for purposes of the limited partner rule. These entities offer liability protection to their members akin to a limited partnership but allow their members greater ability to participate in the management of the entity's business than a limited partnership allows to its limited partners. The two recent cases in the United States Tax Court and the United States Court of Federal Claims examine and shed light on this issue.
In the Tax Court case, Garnett v. Commissioner,4 the petitioners held interests in two LLCs. The LLC agreements provided for management by a manager to be selected by a majority vote of the members, but the petitioners were not managers of the LLCs. The IRS contended that losses from the activities performed by the LLCs were presumptively passive with respect to the petitioners because the petitioners' interests in the LLCs were "limited partnership interests" for purposes of the limited partner rule. Petitioners argued that the limited partner rule did not apply both because (i) none of the companies was a limited partnership and (ii) the petitioners should be considered general partners rather than limited partners.
The Tax Court in Garnett, while acknowledging that Congress in 1986 did not specifically contemplate LLCs (which then existed only in Wyoming) in drafting the limited partner rule, found to be too narrow the petitioners' argument that the rule could not apply to LLCs because an LLC was not, strictly speaking, a limited partnership. In examining the legislative history of the limited partner rule, the Tax Court found that Congress had considered that the secretary of the treasury would have regulatory authority to treat substantially equivalent entities as limited partnerships for purposes of the limited partner rule. The Tax Court determined that interests in an LLC may be substantially equivalent to an interest in a limited partnership. However, the Court also held that the petitioners' interests in the LLCs were not limited partnership interests because those interests qualified for the general partner exception. Neither the Code nor the Treasury Regulations defined or provided guidance as to what constitutes a "general partner" for purposes of the exception to the limited partner rule; accordingly, the Tax Court looked to the legislative history that set forth the special considerations pertinent to treating limited partnership interests as presumptively passive. One such special consideration was that a limited partner was generally precluded by state law from participating in the partnership's business. Participation in the partnership's business would cause the partner to lose his limited liability protection. Because limited partner status effectively prevents that partner from participating, Congress thought this circumstance precluded the need to examine the facts and circumstances to determine whether the partner materially participated. The Tax Court reasoned that because, in the case of an LLC, participation by a partner with limited liability did not impair the limited liability status of that member, the rationale for presuming the partner's interest to be passive was undercut. Accordingly, as the petitioners were not restricted from participating in the management of the LLCs, the court found the petitioners to be general partners rather than limited partners for purposes of applying the limited partner rule and general partner exception.
In Thompson v. United States,5 the Court of Federal Claims was asked to determine whether a member's interest in an LLC treated as a partnership for federal tax purposes was a limited partnership interest for purposes of the limited partner rule. The court found the fact that taxpayer was a manager and had an ability to control the company significant. In finding that the limited partner rule did not apply to the LLC, the court determined that an LLC is not substantially equivalent to a limited partnership because an LLC is designed to permit active involvement by their members in the management of the business and therefore it made "little sense" to extend the presumption concerning limited partners' lack of material participation to LLCs. The court went on to decide that even if an LLC were considered to be a limited partnership for purposes of the limited partner rule, the members would be treated as falling within the general partner exception.
Impact of the Decisions
The Garnett court held that although an interest in an LLC may constitute an interest in a limited partnership for purposes of the limited partner rule, the general partner exception applies to block the presumption that the partners' involvement in the entity's business is passive. The Thompson court held that an interest in an LLC is not an interest in a limited partnership for purposes of the limited partner rule, and, in any event, the members of an LLC qualify for the general partner exception. The courts have made it clear that limited liability is not the touchstone for the presumption of passive activity.
Significantly, the fact that the taxpayers in Garnett were not managers of the LLC did not prevent the court from finding that the taxpayers were not limited partners for purposes of applying the limited partner rule. The court apparently reasoned that the limited partner rule is a threshold test designed to stop unnecessary material participation analysis where material participation is not possible. The theoretical but not actual ability of an LLC member to participate in the activity is enough to step past the threshold of the limited partner rule.
At first blush, the holdings of Garnett and Thompson may seem significant, but before tax practitioners and real estate investors uncork the champagne, closer scrutiny of the cases' impact is warranted. The holdings simply allow LLC members to demonstrate material participation via any one of the seven regulatory tests, rather than via only the 500-hours test, the five-out-of-the-last-10-years test, or the personal services test. Garnett and Thompson do not hold that the LLC members were treated as materially participating; the cases merely open the avenues by which the taxpayers can establish this standard. For example, the Garnett and Thompson taxpayers may demonstrate material participation by showing that their activity constitutes substantially all of the participation for the activity for the year or by showing that they participated for more than 100 hours and no one else participated more. In addition, the investors may demonstrate material participation by demonstrating regular, continuous and substantial activity. In practice, these additional tests may offer some flexibility, but material participation will often remain an onerous standard to substantiate to the satisfaction of the IRS. In many instances, satisfaction of the 500-hours test, the typical test used for substantiation where the limited partner rule applies, will continue to be easiest to document.
Ezra Dyckman is a member and Seth Hagen is an associate of Roberts & Holland.
Endnotes:
1. Treasury Regulation section 1.469-5T(a).
2. Code section 469(h)(2).
3. Treasury Regulation section 1.469-5T(e)(3)(ii).
4. 132 T.C. 19 (2009).
5. 104 AFTR 2d, 2009-xxxx (Ct. Fed. Cl. 7/20/2009).
Subscribe to:
Posts (Atom)