Thursday, February 25, 2010

With Discharged Indebtedness IRS accords Mezzanine Debt Status of Qualified Indebtedness

New York Law Journal

February 24, 2010

In today's real estate market, lenders in many cases have agreed to forgive a portion of real estate debt. While this discharge of indebtedness would normally result in taxable income for the real estate owner in the year of the discharge, the Internal Revenue Code generally allows an individual to exclude this income if the debt is "qualified real property business indebtedness," i.e., certain debt which is secured by real property used in a trade or business. In a recent private letter ruling, the IRS considered whether mezzanine financing, where debt is secured by interests in an entity that owns real property but not by the real property itself, can be qualified real property business indebtedness.

Background

If a lender cancels all or a portion of a borrower's indebtedness, the borrower generally has taxable income equal to the amount of the discharge. However, section 108 allows certain taxpayers (e.g., if the taxpayer is insolvent or in bankruptcy) to exclude discharge of indebtedness income (cancellation of indebtedness or "COD" income), generally in exchange for a reduction in basis or other tax attributes of the taxpayer.

The economic downturn of the early 1990s resulted in a significant amount of real estate being "underwater." Under the Code that was then in effect, the discharge of a portion of the debt on underwater property would generally result in COD income unless the taxpayer was insolvent or in bankruptcy proceedings. Further, in the case of partnership indebtedness, even if the partnership was insolvent or in bankruptcy, each partner could benefit from the insolvency or bankruptcy exclusions of COD income only if the partner itself was insolvent or in bankruptcy. Congress responded by enacting section 108(c) to provide for the exclusion of COD income resulting from the discharge of qualified real property business indebtedness ("QRPBI").

Qualified Indebtedness

Under section 108(c), COD income of a taxpayer other than a C corporation is excluded from gross income as QRPBI if (1) the debt was incurred or assumed by the taxpayer in connection with real property used in a trade or business and "is secured by such real property," (2) the debt was incurred or assumed to acquire, construct, reconstruct, or substantially improve such property (or was incurred or assumed before Jan. 1, 1993), and (3) the taxpayer elects for the debt to be QRPBI. The amount excluded from gross income as QRPBI is generally limited to the excess of the outstanding principal amount of the debt over the fair market value of the property at the time of discharge. In the case of partnership indebtedness, the election for the debt to be QRPBI is made at the partner level.

In exchange for the exclusion of COD income resulting from the discharge of QRPBI, a taxpayer electing for debt to be QRPBI must reduce the basis of his or her depreciable real property by the amount of the exclusion (and the amount of COD income which is excluded from gross income as QRPBI may not exceed the aggregate basis of depreciable real property held by the taxpayer immediately before the discharge). Thus, section 108 allows for the exclusion of COD income resulting from the discharge of QRPBI at the cost of lost depreciation deductions and, if the property is sold before being fully depreciated, increased gain upon sale of the property.

For the 2009 and 2010 taxable years, section 108(i) provides taxpayers with an opportunity to defer certain COD income and recognize it ratably over the five-year period beginning in 2014. Still, it is often more advantageous for a taxpayer to elect for debt to be QRPBI. To illustrate, suppose that, in 2010, a lender agrees to cancel a portion of a taxpayer's debt which is secured by real property with a remaining depreciable life of 35 years. Excluding this COD income as QRPBI and reducing the property's basis would cause the taxpayer to lose depreciation deductions in the amount of the deferred COD income ratably over the 35-year period (assuming that the property is not sold), which generally would have the effect of spreading out the taxpayer's COD income over those 35 years. In contrast, if the taxpayer were to elect for the COD income to be deferred under section 108(i), the taxpayer would recognize all of the COD income by 2018, a less advantageous result. Further, COD income which is deferred under section 108(i) must be recognized in full upon the death of the taxpayer, while a taxpayer's death does not affect the recognition of COD income that is excluded as QRPBI. In addition, section 108(i) is in effect only with respect to COD income arising through Dec. 31, 2010.

Mezzanine Debt

Real estate is often financed through mezzanine debt, which is secured by interests in an entity that owns real property but not directly by the real property itself. Until recently, there has been an absence of guidance regarding whether mezzanine debt meets the requirement that QRPBI be "secured by such real property." On the one hand, if an entity owns real property and no other significant assets, it would appear to be a meaningless distinction whether the lender upon default receives the real property directly or receives the interests in the entity that owns the property. On the other hand, one could argue that, based on a technical reading of the statute, mezzanine debt is not "secured by such real property" and therefore cannot be QRPBI.

Ruling 200953005

In a recent private letter ruling (PLR),1 the IRS ruled that mezzanine debt, collateralized by a 100 percent ownership interest in a limited liability company that owned real property, met the requirement that QRPBI be "secured by such real property." The ruling involved a taxpayer that, through a series of wholly-owned limited liability company subsidiaries, indirectly owned real estate used in a trade or business. As part of a refinancing, the taxpayer had received a mezzanine loan that was secured by 100 percent of the ownership interests in the limited liability company that owned the property ("Owner LLC"), but not by the property itself. As a result of a decline in the value of the property, the taxpayer anticipated that a portion of the mezzanine debt would be discharged and requested a ruling that the debt would be considered to be secured by the property for purposes of being QRPBI under section 108(c).

In support of its conclusion that the mezzanine debt was "secured by such real property," the well-reasoned ruling noted that the creditor would obtain a 100 percent ownership interest in Owner LLC upon default, which would result in it acquiring full ownership of the property. Therefore, the only difference between the creditor's security interest in this property and a mortgage is the method of foreclosure, a distinction that the IRS did not find to be relevant for purposes of determining whether the property can be QRPBI. The ruling further explained that the statute could have explicitly required that QRPBI be secured by a mortgage, but instead used the broader phrase "secured by such real property," which suggests that Congress intended for QRPBI to include security interests other than mortgages on real property. In addition, the ruling also observed that, in other areas of the Code (e.g., provisions regarding real estate investment trusts), the IRS has ruled that debt which is secured indirectly by real property that the lender could acquire upon default is considered to be secured by real property. It is particularly noteworthy that the favorable authority in the real estate investment trust context exists despite the more restrictive statutory standard of "mortgages on real property" that applies in that area.

Impact of the Decision

Since this ruling is a PLR, it may be formally relied upon only by the taxpayer to whom it was issued. However, PLRs generally indicate positions that the IRS is likely to take in the future. In using this PLR to anticipate future IRS rulings, though, it potentially could be relevant that the PLR notes that Owner LLC was a disregarded entity for federal income tax purposes and suggests that it would be "incongruent" to give significance to it for purposes of determining whether the debt was secured by the property while disregarding it for all other purposes. However, none of the ruling's other arguments in support of the property being considered to be secured by the debt are dependent on Owner LLC being a disregarded entity, and the ruling gives no indication that its conclusion would be different had the property not been owned through a disregarded entity. Thus, it appears that the ruling's conclusion was not dependent on the fact that the property was owned by a disregarded entity.

It is on the business plan for the Treasury to address the definition of "secured by such real property" under section 108(c). Hopefully, a Treasury regulation or a revenue ruling will be adopted to embody the conclusion of PLR 200953005 and clarify that it is not limited to real property owned by a disregarded entity. In the meantime, the PLR provides real estate owners with an indication that the IRS will consider mezzanine debt to meet the requirement that QRPBI must be "secured by such real property."

Ezra Dyckman is a partner in, and Daniel W. Stahl is an associate of, the law firm of Roberts & Holland.

Endnotes:

1. Priv. Ltr. Rul. 200953005 (Jan. 4, 2010).

Tuesday, February 23, 2010

Buyers Rely on 1968 Federal Law to Terminate Contracts

New York Law Journal

February 17, 2010

In this recessed economy, where real estate prices and sales have plummeted, it should come as no surprise to developers that purchasers do not want to close on properties they contracted to buy when the market was hot. In new construction deals, it is common for a buyer to sign a contract as much as two years prior to closing, and in today's market, that could mean a substantial decrease in the value of the property from when the buyer originally signed the deal.

Although many developers were not worried about the decline in values with respect to properties that were under valid and enforceable contracts, some purchasers decided to just walk away from the deal and forfeit their deposits since the loss of deposit monies was far less than the loss in a property's current value.

Other creative purchasers, or shall we say those with creative attorneys, have turned to the Interstate Land Sales Full Disclosure Act of 1968 (15 U.S.C. §1701, et seq.), and the federal regulations promulgated thereto (24 C.F.R. 1710.1, et seq.) to get out of new construction contracts. The act was enacted in 1968 to protect purchasers who were buying land in another state that was advertised as a tremendous development opportunity. At that time, buyers would not typically visit a property until after the closing and would arrive to find a swamp or other worthless type of property. The act is still in effect today to protect buyers. It continues to impose certain obligations on developers who utilize state commerce and in today's technologically advanced world, any developer that offers properties for sale through the use of e-mail or a site dedicated to the project could subject themselves to the interstate land law.

The act requires developers to register subdivisions of 100 or more lots (including condominium units) with the Secretary of Housing and Urban Development (HUD) and to deliver to each purchaser a disclosure document (called a property report) prior to signing the purchase agreement. Section 1702 of the act does contain certain exemptions from the requirements. For instance, if under a contract of sale a developer obligates itself to complete construction of a unit within two years, then the act will not apply to that contract.

As many practitioners know, it is a rare occasion that a developer will obligate itself, in writing, to complete a project within a specific time frame. As such, many new developments in New York City with 100 units or more would not be exempt from the requirements imposed under the act.

There are a significant number of cases pending in the U.S. District Court in the Southern District and other federal courts in New York, Florida and other states throughout the country whereby the plaintiff purchasers are seeking return of their deposits claiming they had a right to rescind their purchase contracts based upon the developers' failure to comply with a number of requirements of the act, including the failure to register with HUD, to deliver the required property report, and/or to provide a seven day right of rescission disclosure. Some buyers have also argued that developers have violated the act by failing to deliver a deed for the property within 180 days after the contract was signed in cases where the purchase agreement did not include an identifiable description of the property, as required under the act (§1703(d)).

Violations of the act entitle an aggrieved party to certain rights and remedies including, without limitation, revocation of the purchase contract. The act provides, in relevant part, as follows:

In the case of any contract or agreement for the sale or lease of a lot for which a property is required by this chapter and the property report has not been given to the purchaser or lessee in advance of his or her signing such contract or agreement, such contract or agreement may be revoked at the option of the purchaser or lessee within two years from the date of such signing, and such contract or agreement shall clearly provide this right. (See 15 U.S.C. §1703(c)).

In addition to the right to terminate the contract, §1709 authorizes a purchaser to bring an action, at law or in equity, against a developer who violated §1703(a). Section 1709 provides that the "court may order damages, specific performance or such other relief as the court deems fair, just and equitable."

It appears that many developers chose to take the risk of not registering with HUD because, during the real estate boom, the benefits seemed to far outweigh the risks. In this new post-Madoff and federal bailout economy, this is no longer the case. Coincidentally (or not), since these lawsuits have been filed, there appear to be a number of registration applications recently filed with HUD by developers whose status is listed with HUD as "pending."

The Interstate Land Sales Full Disclosure Act seems clear: if a developer does not fall under any of the exemptions provided for in §1702, then it must register with HUD and comply with the requirements under the act. As of the date of this article, to our knowledge, none of the New York federal cases have been decided. Depending upon the outcome of those cases, the flood gates could open up to a significantly larger number of purchasers looking to terminate their contracts and seek the return of their deposits.

Allison Lissner is a member and Tara Duggan Ryan is an associate in Cole, Schotz, Meisel, Forman & Leonard in Manhattan.


Thursday, February 11, 2010

Special District Taxes in NY: What Is Benefited?

Mark D. Lansing

New York Law Journal

January 12, 2010

Real Property Tax Law (RPTL) and Town Law permit municipalities to create special districts. Special districts include ambulance, fire, sewer, garbage, lighting, highway and others.1 Many special districts benefit all residents (e.g., highways, ambulance service, fire services). However, other special districts only provide a direct benefit to specific parcels of real property (e.g., garbage, sewer). When real property is not benefited by the special district's services, it cannot be assessed for that special district's tax.2

This article reviews challenging a special district assessment, the meaning of "benefited," the different standards applied to utility and railroad properties, and the appropriate application of recent case law addressing special district assessments. Are you paying for a service that you are not receiving?

Challenging the Assessment

To challenge a special district assessment, the taxpayer commences a plenary action in the Supreme Court of the county in which the real property is located. See Civil Practice Law and Rules Article 78 and/or Section 3001 (declaratory judgment action). A plenary action asserts that the municipality lacks statutory authority to designate the taxpayer's real property as being benefited by the special district.3 The taxpayer does not have to meet the statutory conditions precedent of or follow the procedures set forth in the Real Property Tax Law.4 Niagara Mohawk Power Corp. v. City School Dist., 59 N.Y.2d 262, 269 (1983). The taxpayer does not contest the town's right to create or maintain the challenged special district, but solely whether their real property is benefited by the services that the special district provides.

The period of limitations to commence this plenary action is four months from the date of the final determination by the taxing authority that the real property is benefited for that tax year.5 The running of the four-month period may arise from the filing date of the final assessment rolls of the town or receipt of the special district's tax bill. The preferable and more conservative time period is based on the filing of the final assessment rolls.6

In addressing a special district challenge, a court must first address the nature of the district—i.e., whether its tax or special assessment constitutes a "special ad valorem levy" or a general tax.7 The distinction between a general tax and a special levy or special ad valorem levy has had a long history in New York law. Special levies reflect taxes that finance a service providing a specific benefit to a particular property, or group of properties.8 The Real Property Tax Law §102(14) codified this distinction in its definition of "special ad valorem levy" as:

…a charge imposed upon benefitted real property in the same manner and at the same time as taxes for municipal purposes to defray the cost, including operation and maintenance, of a special district improvement or service, but not including any charge imposed by or on behalf of a city of village.

In Tuckahoe Housing Authority v. City of Eastchester, 208 A.D.2d 521, 522 (2d Dept. 1994), the court observed:

The Legislature has expressly excluded such levies and special assessments from the definition of tax under the RPTL (see RPTL 102[20]).

Once the special district tax is shown to be a special ad valorem tax, the only remaining inquiry is whether the real property is benefited. The necessity for the property to receive a benefit was concisely stated by the Court of Appeals as follows: "[b]ecause plaintiffs do not receive the pertinent benefit, no basis exists in these circumstances for the imposition of this ad valorem garbage collection levy." Applebaum v. Town of Oyster Bay, supra, 81 N.Y.2d at 736.9

Two Lines of Inquiry

The necessity that the property be benefited requires an understanding of the term "benefited." The Court of Appeals has defined benefited parcels as follows:

In determining whether a property is benefited—i.e., whether it is capable of receiving the municipal service funded by the special ad valorem levy—we look to the innate features and legally permissible uses of the property, not the particularities of its owners or occupants or the state of the property at a fixed point in time. Asa class of property, telephone poles can never produce or require municipal garbage collection. For the purposes of a special ad valorem levy to finance garbage collection, they therefore are not benefited.

Id, 4 N.Y.3d at 394. In applying this definition of benefit, the Court of Appeals established, in essence, two classes of special district real property and the standard to be applied for each class. The two classes are: (1) undeveloped or developed land that can or could use the service (presently or in the future) due to the land's innate character; and (2) utility and railroad property, whose innate characteristics determine whether they are capable of receiving a direct benefit from the special district services.10

Non-utility Vacant or Developed Land. Vacant land situated in a sewer or garbage district cannot avoid their special district levy merely because the land presently cannot use the service.11 The land's value is enhanced by the presence of either district (in particular, if its development would likely result in installing a sewer lateral or be subject to garbage pick-up). Similarly, neither vacant nor developed land can avoid the special district assessment merely because another option is available to the taxpayer (e.g., septic tanks and wells do relieve the taxpayer of paying sewer or water special district assessments). However, if the town refuses to perform the garbage pick-up request, or its rules preclude such pick-up (e.g., weight restrictions, content restrictions, etc.), the property is not benefited and, thereby, cannot be assessed.12

The Court of Appeals summarized this line of cases, as follows:

By contrast, a lot that is vacant, but otherwise amenable to development, would be "benefited." Although undeveloped, there is no legal or practical disability to the lot's one day receiving garbage collection. Likewise, a hypothetical home whose owners never produced refuse or garbage of any kind would, for the purposes of RPTL §102(14), be directly benefited by municipal garbage collection. By the same token, home or business owners could not opt out of a special ad valorem levy funding the local sewer or water district simply by virtue of having a septic tank or well on their properties. The same logic would apply to others who would seek to avoid special ad valorem levies under analogous circumstances. In determining whether a property is capable of receiving a benefit, our focus is on the innate characteristics of an individual property as representative of a species of property (in our last example, homes), not the conditions or proclivities of individual owners.

New York Telephone Co., supra, 4 N.Y.3d at 394.

Utility and Railroad Real Property. The second line of cases involves utility and railroad property. Here, to be subject to a special district assessment, the utility or railroad improvements must be directly benefited by the special district services. See New York Telephone Company v. Supervisor of Oyster Bay, supra.13 In addressing utility improvements, the courts recognize that the innate characteristics of those improvements, as a matter of law, preclude any possible use of certain special district services. For example, a utility pole or wire cannot defecate, urinate or produce solid refuse to use a town's sewer system or garbage district service. Long Is. Light. Co. v. Office of Supervisor, 233 A.D.2d 300, 301 (2d Dept. 1996).14

The Court of Appeals also found that "indirect" benefits are not sufficient when addressing utility improvements:

If an indirect benefit is sufficient for the purposes of RPTL §102(14), every conceivable species of real property could be said to benefit from garbage removal, or any other municipal service.… The Legislature's use of the modifier "benefited" plainly implies that there is some class of property that is not benefited.

New York Telephone Co., supra, 4 N.Y.3d at 392.

Similarly, railroad improvements and their fee-owned corridors must be shown to be directly benefited. In People ex rel. New York Central Railroad Company v. Limburg, 283 N.Y. 344 (1940), the Court of Appeals upheld the striking of a town's assessment for a sewer system, as it was "legally unavailable for the disposal of storm water or surface water which may collect along the relator's right of way." See also, Matter of Long Island R.R. Co. v. Ryan, 240 N.Y. 199, 208 (1925). Both the railroad improvements and fee-owned land comprising the corridor were found not to be benefited.

Finding land not to be benefited (when the improvements are not benefited) is consistent with the Court of Appeals' integrated plant rule, which focuses on the primary function of the property comprising the integrated plant. Thus, a proper application of the theory precludes taxing any component of the integrated plant or system, even if such component were otherwise individually taxable. When the primary property of the system is utility or railroad improvements and those improvements are not directly benefited by the special district, neither is the fee-owned land underlying those improvements. People ex rel. New York Central Railroad Company v. Limburg, supra; Long Island Lighting Company, supra.15

Recent Cases

The recent case of Niagara Mohawk Power Corporation v. Town of Watertown, 6 N.Y.3d 744 (2005), has sometimes been relied upon by municipalities for the proposition that these two lines of special district tax cases were blurred when dealing with fee-owned land of electric transmission corridors. Such an interpretation is erroneous.

In remanding the case, the Court of Appeals sought to develop the taxing authorities' argument that storm water drainage systems "benefited" utility lines by reducing flooding. The contention was that sewer district systems included storm water drainage systems. In reality, storm water drainage systems are, generally, required to be separately maintained and financed by a taxing authority's highway department, not sewer department. See, e.g., Town Law §§202-a, 231 (et seq); Highway Law §§46, 218(4). Cf. General Municipal Law Article 14-f. In fact, storm water drainage and sewer systems are now required to be separate to preclude cross contamination.

Another argument misconstruing Watertown is that mere ownership of land in fee by a utility makes the utility improvements and fee-owned land subject to the special district tax, as a matter of law. In fact, the case law is contrary. In Long Island Lighting Company, supra, and People ex rel. New York Central Railroad Company v. Limburg, supra, the Court of Appeals previously held that when the improvements were not benefited, the land was also not benefited. In both cases, the land was owned in fee by the utility company and the railroad.16

While in any particular municipality, special district assessments may appear to be insignificant, for taxpayers having multiple sites over numerous and different municipalities, special district assessments become costly. Thus, in these times of over-taxation of real property, management of these costs is necessary to ensure that owners are paying only their equitable share of the taxes. Taxpayers should review their special district assessments, analyzing whether their property is benefited.

Mark D. Lansing is a partner at Hiscock & Barclay, in the real property tax and condemnation, and energy and utilities practice groups.

Endnotes:

1. See Town Law §54, 190.

2. See RPTL §102(14). New York Telephone Company v. Supervisor of Town of Oyster Bay, 4 N.Y.3d 387 (2005); Long Island Lighting Co. v. Office of Supervisor, 233 A.D.2d 300, 649 N.Y.S.2d 717 (2d Dept. 1996).

3. See also, Kahal Bnei Emunim v. Town of Fallsburg, 78 N.Y.2d 194, 205 (1991); Averback v. Board of Assessors of the Town of Delhi, 176 A.D.2d 1151 (3d Dept. 1991).

4. New York Telephone Company v. Supervisor of Town of Oyster Bay, supra.

5. Kahal Bnei Emunim v. Town of Fallsburg, supra, 78 N.Y.2d at 205; Averback v. Board of Assessors of the Town of Delhi, 176 A.D.2d 1151 (3d Dept. 1991).

6. Caveat: make sure that the town has not created separate special district assessment rolls, as the filing of these special district assessment rolls will control.

7. See also, Matter of Crandall Pub. Lib. v. City of Glens Falls, 216 A.D.2d 814, 815 (3d Dept. 1995); Matter of L.P.A. Associates v. Daby, 231 A.D.2d 827, 829 (3d Dept. 1996).

8. See Hassan v. City of Rochester, 67 N.Y. 528, 533 (1876); Roosevelt Hospital v. City of New York, 84 N.Y. 108, 112 (1881). Also, whether the boundary of the special district is coterminous with the town boundary is not determinative or a factor as to whether the special district tax or assessment is either a special ad valorem levy or a general tax. See, e.g., RPTL §102(14/15). The sole inquiry is whether the subject real property receives a benefit from the special district services.

9. In Applebaum, supra, no benefit was found where the homeowner agreed to avail itself solely of private garbage service to obtain favorable zoning consideration by the town. In Landmark Colony at Oyster Bay, supra, no benefit was found when property owner was required to forgo town garbage services to obtain condominium construction approval. In Matter of Sperry Rand Corp., supra, no benefit conferred on large industrial plant, as town's limit on the volume of garbage and rubbish that could be collected, precluded that plant's use of the town's garbage service.

10. N.Y. Tel. Co., supra, 4 N.Y.3d at 393-95, so summarizes. One must disregard the subsequently issued opinions of the New York State Office of Real Property Services, as they lack sound legal analysis and can lead a municipality to an unenviable litigation. See, e.g., NYSORPS Memorandum of Law, dated April 25, 2006.

11. N.Y. Tel. Co., supra.

12. Applebaum, supra; Landmark Colony at Oyster Bay, supra; Matter of Sperry Rand Corp., supra. Cf. Niagara Mohawk Power Corporation v. Town of Tonawanda, 17 A.D.3d 1090 (4th Dept. 2004), aff'd, Niagara Mohawk Power Corporation v. Town of Watertown, 6 N.Y.3d 744 (2005).

13. Only the Real Property Tax Law defines real property that can be assessed. Herkimer County Light & Power Co. v. Johnson, 37 A.D. 257 (4th Dept. 1899).

14. The courts have uniformly focused on the existing use of the property, and the direct benefit that the special district's service provided to that parcel. This focus comports with the fundamental Real Property Tax Law principle that value and benefit of a real property parcel are determined as the property exists on the statutorily defined valuation and condition dates. See Kalski v. Fitzgerald, 25 A.D.2d 573 (3d Dept. 1966); Addis Co. v. Srogi, 79 A.D.2d 856 (4th Dept. 1980).

15 Cf., Niagara Mohawk Power Corporation v. Wanamaker, 286 A.D. 446, 449 (4th Dept. 1955), aff'd, 2 N.Y.2d 764 (1956); Jackson v. State of New York, 213 N.Y. 34 (1914); Hasnas v. Hasnas, 91 A.D.2d 1058 (2d Dept. 1983); Glen & Mohawk Milk Association Inc. v. State, 2 A.D.2d 95 (3d Dept. 1956).

16. Niagara Mohawk Power Corporation v. Town of Tonawanda, supra, is not contrary, as the Fourth Department failed to address the prior utility and railroad cases dealing with land, or the integrated property rule. The Fourth Department also failed to consider the wholesale absence of benefit to the improvements, as distinct from the theoretical benefit found with respect to the land.

Monday, February 8, 2010

Numerous NY Statutes Outline Street Demapping Standards

Anthony S. Guardino
New York Law Journal
January 27, 2010

Local governments, and developers and other property owners, as well as their counsel, routinely face the challenge of "demapping" or discontinuing unimproved "paper streets" contained on a subdivision map. Less often, they also must consider demapping improved streets. The reasons for demapping can be quite varied, ranging from urban renewal and construction or property development to public safety.

Numerous sections of New York law make reference to the different standards that apply to demapping streets in counties, towns, and cities. Authority for discontinuing streets is found in Highway Law §131-b(1) for counties, General City Law §§20(7) and 29 for cities, Second Class Cities Law §101 for second class cities, the Administrative Code of the City of New York §5-432(a) for New York City, Highway Law §§171(2) and 205(1) for towns, and Village Law §§6-612 and 6-614 for villages. These various statutes were enacted at different times and do not reflect uniform standards or procedures. A county may discontinue a highway, for instance, by merely determining that the "interest of the county will be promoted thereby,"1 whereas a town may discontinue a highway only if it has become "useless"2 or "abandoned."3

For villages, Village Law §6-612 simply provides that, "[t]he board of trustees may by resolution provide for laying out, altering, widening, narrowing, discontinuing or accepting the dedication of a street in the village." Village Law §6-614 requires notice to the public of any resolution under consideration for discontinuing a street.

Village Law §§6-612 and 6-614 set forth no legal standard for determining whether a village may discontinue a street. However, it has been held that the discontinuance of a village street requires a finding that the street has become "useless as a right-of-way to the general public."4

In one case,5 Bass Building Corp. owned a tract of land that was under development as Wesley Hill Estates in the Village of Wesley Hills, contiguous to the Village of Pomona. A single road, Hidden Valley Drive, extended from within the Village of Pomona into the Village of Wesley Hills, where it intersected Bass Building's land at the border. After a hearing, the board of trustees of the Village of Pomona passed a resolution that the roadway on its side of the border be discontinued as it was useless to Pomona.

Bass Building brought suit, alleging that the Pomona resolution was designed to prevent the development of Wesley Hills Estates by leaving it with only one means of ingress and egress. Bass Building moved for a preliminary injunction, and the defendants moved to dismiss the complaint. The Supreme Court, Rockland County, denied both applications, and the parties appealed.

In its decision, the Appellate Division, Second Department, explained that municipalities hold fee title to streets in trust for the general public. Here, the Second Department continued, Bass Building's interest as a member of the public in the continued existence of Hidden Valley Drive was within the zone of interests to be protected.

The Second Department then held that Bass Building was entitled to a preliminary injunction because, among other things, the street on the Pomona side of the border provided a means of ingress to and egress from the Bass Building tract on the Wesley Hills side of the border. It was in this context that the appellate court held that the "useless" test governed the discontinuance of village streets under Village Law §§6-612 and 6-614, adding that Pomona had not established, and had not even attempted to establish at its public hearing, that the discontinued portion of Hidden Valley Drive had become useless as a right-of-way to the general public.

Eminent Domain

A number of years ago, a town sought advice from the New York State Attorney General on its ability to rely on eminent domain to close a town highway to enlarge its watershed area. The attorney general opined that the town could not do so, explaining that, instead, the "present statutory authority governing abandonment or discontinuance of a town or county highway or a substantial portion of a town or county highway set forth the conditions which must be met for such action."6

The Appellate Division, Second Department, subsequently relied on that opinion in Matter of E&J Holding Corp.7 In this case, the town board of Babylon determined that closing a section of Gleam Street was necessary to join parcels of town property and create a site for the construction of a new resource recovery facility. DeMatteo Salvage Co. Inc., which operated a waste salvage business on Gleam Street, asked the Second Department to overturn the town's resolution.

The Second Department explained that, to close this portion of the highway to the public, the town was required to follow the specific statutory mandate of the Highway Law, which provides for the closing of town highways "under very limited circumstances," or obtain other clear and express legislative authorization. Because Gleam Street apparently was still in "active use," the Second Department granted the petition and annulled the town's resolution.

Interestingly, the Second Department also found that the "prior public use" doctrine applied in this case. That doctrine provides that property that has been taken or acquired for public use cannot be taken for another public use if such other public use would interfere with or destroy the first public use, unless the intention of the legislature that such property should be so taken is shown by express terms or necessary implication. The Second Department found that the prior public use doctrine was pertinent, "when the land sought to be condemned is a public highway." Simply put, the Second Department declared that property used for a highway "cannot be appropriated for another public use, absent specific legislative authorization."

SEQRA

A Second Department decision this past December, in Matter of Baker v. Village of Elmsford,8 reinforces the rules applicable to demapping streets, while also highlighting the need to consider the state's environmental laws in these circumstances.

This case arose after the Village of Elmsford agreed to purchase property located on Vreeland Avenue for $1,550,000 from Brookfield Automotive Exporting Corp. A rider to the contract conditioned the sale upon the village demapping portions of Vreeland Avenue and River Street and transferring title to the demapped property to Brookfield in exchange for a credit to the village of $200,000 against the contract price at closing.

The village prepared Short Environmental Assessment Forms ("EAFs") for each road pursuant to the State Environmental Quality Review Act ("SEQRA"), indicating, among other things, that the proposed demapping of Vreeland Avenue and River Street would not affect the area's air quality, surface and ground water, noise levels, traffic patterns, waste disposal, erosion, drainage, or flooding problems. At the public hearing, the village heard from a variety of municipal officials, including its assessor, fire and police chiefs, and building inspector.

One witness at the public hearing advised that during episodes of flooding, Vreeland Avenue and River Street were used as an egress to Routes 9A and 119. A demapping of the roads, he argued, would landlock property owners and tenants and "negate access that ha[d] been used continuously." This witness' counsel took issue with the portion of the EAFs and the representations of municipal officials that the roads had never been improved or traveled, noting that improvements had been made to the roads as conditions of an earlier building permit and a certificate of occupancy. At the conclusion of the hearing, the board adopted two resolutions that discontinued portions of Vreeland Avenue and River Street.

William and Ronald Baker sought review of the resolutions. The Bakers owned two properties contiguous to the streets the village intended to demap. The Bakers alleged that Vreeland Avenue had always been open and accessible to public traffic and for parking, and that both Vreeland Avenue and River Street had been specifically used for vehicular access and parking by their buildings' tenants and their employees. They contended that the roadways were not useless, and that the village had failed to take the requisite "hard look" at the environmental impact of the discontinuances as required by SEQRA. The Bakers argued that the demapped roads were used during flooding, which occurred at least six times per year, as the sole means of ingress to and egress from the area when an alternate route via Havens Avenue was flooded.

The Supreme Court, Westchester County, held that the village had acted within its authority, had a rational basis for the demapping, and had complied with the "hard look" requirements of SEQRA. The Bakers appealed, and the Second Department reversed.

In its decision, the appellate court observed that once a street was established, its continued existence was presumed, and that municipalities may close a street only if acting under proper statutory authority in doing so. It noted that under the "useless" test, if a street afforded a means of ingress or egress and was used as such to any degree more than a mere token use, the street was not useless.

The Second Department explained that the village had compiled significant information at the public hearing that the discontinuance of portions of Vreeland Avenue and River Street would have no negative effect on the area's market values, fire protection, law enforcement, water, sanitation, and other environmental factors. On this basis, the village passed resolutions that the relevant portions of Vreeland Avenue and River Street no longer served any public use and therefore were no longer needed as a thoroughfare for public vehicular or pedestrian traffic or access, i.e., the streets had become useless. However, the Second Department pointed out, in passing its resolutions, the village "wholly ignored" information that the streets had previously been improved at the village's insistence as conditions of a building permit and a certificate of occupancy, and that the streets were actively used by area building owners, tenants, and employees at various times each year as a means of ingress and egress during recurrent flooding.

The Second Department then ruled that the village's determination that portions of Vreeland Avenue and River Street had become useless as a thoroughfare was arbitrary and irrational given that the streets had undergone improvements at the insistence of the village and were repeatedly used for vehicular travel during times of periodic floods. The roads were not, in fact, useless, but served "a highly useful, though perhaps sporadic, emergent purpose."

In addition, the Second Department rejected the village's argument that the Bakers had no need for the discontinued portions of Vreeland Avenue or River Street, even in times of flooding, as a paved driveway through the premises at 17 Hayes Ave. connects the Bakers' properties to Hayes Avenue. The appellate court ruled that even if access from a private driveway was possible, the fact remained that the demapped portions of Vreeland Avenue and River Street had been used, and remain useful, as a thoroughfare to members of the public. "The private driveway of 17 Hayes Avenue is not a public means of access to or from the Bakers' premises at 12 River Street," and if the 17 Hayes Ave. was sold and its new owner were to deny through access to or from River Street, the discontinuance of Vreeland Avenue and the flooding of the alternative Hayes Avenue route "would choke off all ingress to or egress from 12 River Street."9

The Second Department also agreed with the Bakers that the village had not complied with SEQRA. It noted that the EAFs stated that the road discontinuances would not cause any adverse effects associated with, among other things, existing traffic patterns or flooding. However, the Second Department stated, the "Reasons Supporting This Determination" sections of the negative declaration pages of the EAFs contained an attachment "that merely restated that there would be no adverse effects related to traffic or flooding." The central basis for questioning the discontinuance of the streets, relating to their use during times of periodic flooding, "was apparently not considered when the Short Form EAFs were prepared," and the Second Department ruled that the negative declarations were "merely conclusory." Under these circumstances, the Second Department held, the village's look at the potential adverse effect of the discontinuances upon local traffic and safety did not represent the "hard look" with "reasoned elaboration" mandated by SEQRA. Accordingly, it reversed the Supreme Court's judgment, granted the Bakers' petition, and annulled the resolutions.

Conclusion

Demapping raises a host of other issues, including whether a party may be entitled to damages from the closing of a street.10 A municipality is more likely to succeed in demapping when an unimproved street is involved, but an unused, improved street can be demapped under appropriate circumstances. The law is, perhaps surprisingly, rather extensive in this area, and practitioners should be familiar with it when advising their clients about this subject.

Anthony S. Guardino is a partner with Farrell Fritz.

Endnotes:

1. Highway Law §131-b(1).

2. Highway Law §171(2).

3. Highway Law §205(1).

4. Bass Bldg. Corp. v. Village of Pomona, 142 A.D.2d 657 (2d Dep't 1988).

5. Id.

6. 1968 Opns Atty Gen 93.

7. 126 A.D.2d 641 (2d Dep't 1987).

8.2009 N.Y. Slip Op. 9220 (2d Dep't 2009).

9. The Second Department distinguished cases relied upon by the village to the effect that a public road may be discontinued when there is an alternative means of access, noting that the alternatives in those cases consisted of, or directly accessed, public rights-of-way rather than private driveways. See, e.g., Reis v. City of New York, 113 A.D. 464, aff'd 188 N.Y. 58 (1907).

10. See, e.g., Gengarelly v. Glen Cove Urban Renewal Agency, 69 A.D.2d 524 (2d Dep't 1979).