Commercial Real Estate Sales - Pitfalls to Avoid

by Thomas V. Bennett

Whenever someone decides to sell commercial real estate, there is always a financial plan and the timing of the receipt and expenditure of the proceeds of the sale (or refinancing) is often critical, be it a tax free exchange to purchase another property, the purchase of a retirement home or capital for another venture. It is important, therefore, that there be no unforeseen problems which could derail a sale or a purchase. Here are some of the legal issues that should be addressed to insure that the ultimate closing goes smoothly.
 

The record title. More and more frequently the sale or refinance of a commercial property is delayed because of record title problems. That happens frequently where the property has been owned for a long period of time and most often happens because a discharge of a mortgage has not been recorded. Although, generally, those problems are solvable, it does take time particularly if the holder of the mortgage was an individual or a small corporation. For generally about $300 you can have your title examined to be sure there are no record title issues that need resolution.
 

Zoning and permitting. When buildings are built there is the need for permits and sign-offs by town agencies. A recurring problem is Conservation Commission approvals which require a Certificate of Compliance after all of the work is completed and the recording of the Certificate of Compliance. Permits granted by town permit-granting boards for variances or special permits generally require that the decisions be recorded at the Registry of Deeds and sometimes there are not. The legal occupancy of a building is always a concern for a buyer or a lender and often times the records of a city or town are incomplete or nonexistent particularly, for older buildings. A request for the local building inspector to issue a certificate of occupancy may trigger some building compliance requirements, but the issuance of a certificate of occupancy will generally satisfy either a buyer or a lender that the uses of the property are in compliance with relevant zoning by-laws. Surveys are expensive but plot plan prepared by a surveyor generally costs about $350 and will uncover any problems that might come up in a survey obtained by a buyer. Smoke detectors and/or carbon monoxide certificates may be required for the sale and, if you check with the local fire department, you can find out what the requirements are and what you need to do in order to bring your property into compliance so that a certificate can be obtained at the appropriate time.
 

Environment. While the super priority lien under the hazardous waste law in Massachusetts does not apply to buildings where the majority use is residential, most buyers and lenders will require a so-called "Phase 1 Report" on any property that has a commercial use. It would make sense for a building owner to obtain their own Phase 1 Report prior to getting the property ready for sale to insure there are no environmental problems at the property. Generally, the licensed site professional that prepares the environmental report is willing to provide to the buyer and/or the lender a letter indicating that they may rely on the report. It costs some money but ultimately that cost can be reflected in the price. It is important to deal with that issue because if there is a problem it could be a deal breaker. If the property is serviced by a private sewerage disposal system, a Title V report by a licensed inspector will be required at the closing. It would be a good idea to find out if there is a problem in advance of a sale. If the water supply to the building is private, a test to determine that the water is potable would also be a good idea so, if there is a problem, it could be dealt with prior to the time the buyer decides to inspect the well water.
 

Leases. No buyer of a commercial building (or a buyer's lender) will be thrilled about all of the tenants being tenants at will, unless rents are below market and the building is tired and needs updating with an objective to upgrade the tenant population or convert it to condominiums. If the building has tenants with leases all expiring at the same time, that will raise a concern with the buyer since no one wants a vacant building unless the targeted buyer is a user. In any event, all leases should have a provision that the tenant's rights under the lease will be subordinate to the existing or any future mortgagee and that the tenants will sign a Subordination, Non-disturbance and Attornment Agreement (SNDA) which is an agreement amongst the tenant, the lessor and the lender that says if the bank ever forecloses, the tenant's rights will be honored but that the lease will be subordinate to the mortgage. If it is anticipated that an SNDA will be required, it would be a good idea to let your tenants know that you will expect them to sign one and to make sure they will be available to sign one when the time comes.
 

Every commercial property is different. The objectives of selling and buying may vary, but making sure that the legal components of the property are in order is as important as the mechanicals and the physical condition of the building and an audit, covering issues like the ones suggested above, may avoid unpleasant and expensive delays in the sale process.

Offer: Preliminary Step or Binding Contract?

by Thomas V. Bennett

The usual progression of a buyer of real estate is that a buyer makes an offer on a standard form to a seller containing the essential business terms and, once it is accepted, a purchase and sale agreement which sets forth more fully all of the rights and obligations of the parties is executed within ten or fifteen days thereafter. The closing follows after that generally thirty to ninety days. Sometimes the seller will have a change of heart after the seller has accepted the offer (usually motivated by more money from another offer) and the seller will try to wiggle out of the deal by not entering into the purchase and sale agreement.
 

In 1999 the Supreme Judicial Court of Massachusetts ruled that the intent of the parties controls and that if the parties agreed to all of the essential terms of the transaction in an offer, it reflected the parties' intention to be bound by that agreement and entering into a more formal purchase and sale agreement would not be a requirement for a law suit by the buyer to enforce that contract.
 

A recent Massachusetts Appeals Court decision may as a practical matter limit that right of a buyer to a single-family home or other relatively simple real estate transaction not involving permits, sophisticated financing and the like.
 

A recent case involved an offer that was contingent upon obtaining a curb cut, financingand the like in order to develop a parcel of real estate. Somewhere between the offer and the purchase and sale agreement the parties could not reach agreement and the seller entered into an agreement with a different party to sell the property. The first buyer brought suit to enforce the offer.
 

The court in analyzing the facts decided that it was not the intent of the parties to be bound by the offer because the buyer indicated the reason he had not proceeded to obtain the curb cut, financing and the like was because it would “cost thousands of dollars” and the buyer did not want to proceed until he knew he had a valid contract. The court found that because he failed to proceed so that he would be ready to close by the date required by the offer, he had demonstrated that it was not the intent of the parties to be bound by the offer since the buyer's conduct demonstrated that only a signed purchase and sale agreement would fill that role.
 

So, in any kind of a commercial transaction where the obligations of the buyer would be contingent upon obtaining zoning permits or financing or other costly items such as appraisals, engineering, lawyer's fees and the like, a buyer who seeks to enforce an offer will be forced to bear those expenses if the buyer wants a court to decide that it was the intention of the parties that the offer be controlling and run the risk of eating those costs if the buyer loses the law suit which may make it untenable for the buyer to pursue seeking to enforce the offer.

Protecting Real Estate Assets

by Thomas V. Bennett

The ownership or investment in real estate provides a number of choices with respect to how to hold title particularly if there are partners who own the real estate.
 

Real estate can be owned in the individual's name, or, if a couple, it can be owned as: tenants by the entirety for married persons either of the same or different gender; joint tenants which means that upon the death of either, the property will pass to the other by operation of law; as tenants in common under which on death the property would pass to the heirs or devisees of the deceased owner; or as tenants in partnership in which the deceased partner's interest would pass to the other partner by operation of law with the duty and obligation of the remaining partners to account to the heirs of the deceased partner as of the date of death as to the value of the deceased partner's interest in the real estate.
 

Ownership of real estate poses liability problems for negligence of the property owner which could result in personal injury to either the tenants or parties visiting the property. Real estate can also be attached for the debt of the owner. For those reasons, i.e. to limit liability and to make the interest in the real estate difficult to be attached, people very often own real estate in different entities.
 

For many years, trusts were a popular entity for holding title to real estate, particularly so-called “nominee trusts” which are really straw transactions where the trustee holds title for the benefit of the owners pursuant to a schedule of beneficiaries that is not recorded at the Registry of Deeds. The problem with that form of ownership is that during the dark real estate days of the 90's the FDIC was very aggressive in suing the trustees and the beneficiaries of nominee trusts on the basis of theories of law which hold that both the trustee and the beneficiaries as the agent and the principal can be held personally liable for the obligations of a note secured by a mortgage on real estate . Corporations were never really popular in the ownership of real estate because although they provide limited liability, they had adverse consequences in that a corporate tax would have to be paid, in addition to the individual tax.
 

Limited partnerships were used frequently where there were in fact investors and a general partner who would really run the real estate entity. Those, however, were cumbersome and expensive for the smaller commercial property owner and in order to again avoid liability, the general partner was generally a corporation which had to be more than a shell in order to pass muster under the tax code all of which added additional levels of cost for excise taxes, accounting and legal fees.
 

The limited liability company and the limited liability partnership have provided an ideal solution for protecting both against liability and allowing for partnership treatment for tax purposes similar to the use of the nominee trust and the limited partnership. There is an expense, however, since the annual filing fee for a limited liability company or a limited liability partnership is $500 per year.
 

No matter what form of entity is selected, there are still issues to deal with on what happens if one party wishes to sell their interest or becomes bankrupt or dies. The other concern is a creditor who seeks to “reach and apply” the interest of a party in such entity. The courts have held that a creditor may “reach and apply” a debtor's interest in intangible property that cannot otherwise be executed against in an action of law; i.e. a beneficial interest in a trust or a membership interest in a limited liability company or a limited liability partnership.
 

Although creditors may not “reach and apply” a debtor's interest in a trust that includes a “spendthrift” clause by which the creator of a trust forbids creditor attachments, special rules apply when the party creating the trust creates a trust for his or her own benefit and also attempts to immunize the trust from creditors' claims. In Massachusetts the courts have adopted a rule that provides that a creditor may reach the maximum amount that a trustee of a trust could pay to a beneficiary. This rule keeps the debtor from protecting “his property in such a way so he can still enjoy it but prevent his creditors from reaching it.” It is not necessary for the party to intend to defraud his creditors. The rule has special force in the case of nominee trusts where the beneficiary can control the trustee's actions but it applies even where the trustee has sole discretion. Even if there are anti-assignment clauses in the trust agreement or the operating agreement of the limited liability company, the court has ruled the reach and apply statute in Massachusetts is broadly written and contains no express reservation for cases in which an anti-assignment clause exists. The courts have found that a court can override a self-imposed non-assignment clause as readily as self-imposed clauses barring creditor attachment. The court can in applying the reach and apply statute impose equitable limitations if the court, due to operational provisions for example, felt that they would be important.
 

It is important, therefore, in any entity in which more than one individual is going to be involved that the entity take into account through its operating agreement or a joint venture agreement, if a trust, or any other operating document for its governance, the transfer of membership interest either voluntarily or involuntarily and how that will impact the operation of the entity and should also provide for possibilities of expulsion and the calculation of what the payment should be for the expulsion for the interest of the party being expelled and how it will be paid; for example, by note over a period of time at a favorable interest rate.
 

This is particularly of concern for so-called “high risk” professionals such as doctors, lawyers, chiropractors and others, as well people actively involved in businesses where they sign guarantees and otherwise incur personal liability.
 

Those folks who own real estate in a trust should consider, given recent court rulings involving trusts, a different form of entity to hold title to investment real estate and the provisions of the governance agreement among the members of that entity.
  

Know Your Tenancies

by Thomas V. Bennett

One of the first decisions a couple makes when they first buy real estate is how to take title. There are basically four ways that a couple can hold title. One is as tenants in common, the result of which is that if one of the parties dies, that party's interest in the real estate would pass to that party's heirs at law or whoever that party left it to under that party's will; if they take title as joint tenants and one of them should die, title would pass by operation of law to the other joint tenant; if they take as tenants in partnership and one of the partners dies, the other partner takes title to the real estate but has an obligation to account to the deceased partner's estate the value of the real estate obtained by the living partner; the final way to take title is tenancy by the entirety which is only available to husbands and wives.
 

With respect to the first three tenancies, any creditor of either of the couple could attach that person's interest in the real estate and if they were successful in the litigation and got an execution, they could then levy on the real estate, cause it to be sold at a sheriff's sale, and then after title ripened (a year after the sale), they could bring a suit in the Probate Court to partition the property which means they could force a sale and thereby obtain the interest of the party they sued.
 

A tenancy by the entirety had, prior to May 19, 2004, only been available to husband and wife. That tenancy's special provisions intended to make real estate less available to the creditors of the husband and wife. That interest of the husband and wife in a tenancy by the entirety could not be reached by a creditor with a levy with an execution although it could be attached unless the debt was owed by both the husband and wife or the debt was for “necessities.” Virtually all couples who purchased a home would take title in that manner because of those special protections.
 

The Supreme Judicial Court decision allowing gay marriage has now made tenancy by the entirety available to gay couples who are married.
 

All land in the Commonwealth is either recorded or registered land. Registered land is a system of title maintenance by the Land Court of the Commonwealth of Massachusetts which has statewide jurisdiction. On May 6, 2004, the Chief Examiner of the Land Court issued a memorandum to all of the registry districts with respect to tenancy by the entirety. The memorandum instructs the assistant registrars not to conduct any investigation or require any proof of marriage when accepting a deed of two individuals as “tenants by the entirety” and that is so whether or not the two individuals are or are not or appear from their names to be or not to be either of the same sex or of the opposite sex. Furthermore, the document establishing title need not refer to the two individuals as being married.
 

Accordingly, gay and homosexual couples who in the past had only the alternatives of joint tenants, tenancy in common or tenancy in partnership, now have (if they are married) another option and should consider, after marriage, changing their tenancy to a tenancy by the entirety.
 

This is another example of how the Supreme Judicial Court decision has helped gay and lesbian couples avoid discrimination that previously favored only straight couples.

Court Applies New Home Protection To Condominiums

by Thomas V. Bennett

The Supreme Judicial Court ruled that the sale of new residential condominiums by a builder-vendor carried with it an implied warranty of habitability and that the condominium association could bring a claim for breach of the implied warranty of habitability for latent defects in the common areas and facilities of the condominium that implicated habitability of individual units. This case not only is important because it applies the doctrine of implied warranty of habitability to the sale of new condominium units but also because it indicates who has the authority to bring such an action, i.e. the unit owner or the condominium association.
 

The Court observed that the ownership of a condominium unit is a hybrid form of interest in real estate entitling the owner to both exclusive ownership and possession of his or her unit and an undivided interest as a tenant in common together with the other unit owners in the common areas.
 

The Court further noted that condominium unit owners relinquish management and control of the common areas to the organization of unit owners which is the only party which may bring litigation relating to the common areas of the condominium development on their behalf.
 

The Court found that a claim for breach of implied warranty of habitability that attaches to the sale of a new residential condominium unit by a builder-vendor may be brought by an individual unit owner who can establish
 

1. He or she purchased a new residential condominium unit from the builder-vendor;
2. The condominium unit contained a latent defect;
3. The defect manifested itself to the purchaser only after purchase;
4. The defect was caused by the builder's improper design, material or workmanship; and
5. The defect created a substantial question of safety or made the condominium unit unfit for human habitation.
 

The Court further ruled that where the defects or other problems are in the common areas, the organization of unit owners has the exclusive right to seek a remedy.
 

In order for the condominium association to establish a claim for a breach of implied warranty of habitability in the common areas that would implicate the habitability of individual condominium units, the organization of unit owners must demonstrate that
 

1. It is an organization of unit owners as defined by the statute,
2. The common area of the condominium development contains a latent defect,
3. The latent defect manifested itself after construction of the common areas was substantially completed,
4. The defect was caused by the builder's improper design, material and workmanship, and
5. The defect created a substantial question of safety as to one or more individual units or made the units unfit for human habitation.
 

The Court further found that the actions, either by the unit owner or the condominium association must be brought within the three-year statute of limitation and the six-year statute of repose for tort actions arising from improvements to real property that begins to run at the earlier of the dates of (1) the opening of the improvement to use, or (2) substantial completion of the improvement and taking possession for occupancy by the owner.
 

The actual case involved a number of serious problems identified in the common areas of the condominium development, including problems with the sliding doors, chimneys, decks, and roofs which resulted in water leakage and damage to sheet rock and other materials inside the individual units.
 

In addition, outside decks were not constructed in accordance with the Code causing supporting columns to deteriorate and prematurely rot.
 

The litigation lasted many years due to the nature of the factual issues involved in the development of the condominium and the developer's acting as the trustee of the condominium trust and the subsequent turnover to the unit owners and subsequent amendment of the Master Deed of the condominium creating additional units.
 

The Court found that the exclusive right of the organization of unit owners to bring claims with respect to the common areas, combined with the unit owner's virtually nonexisting control over the common areas, may result in an incomplete remedy for unit owners against the builder whose improper design, material or workmanship is responsible for a defect in the common area which causes a unit(s) to be uninhabitable or unsafe. To insure that there is a complete remedy for a breach of implied warranty of habitability in the sale of new condominium units, the Court concluded that an organization of unit owners may bring a claim for a breach of implied warranty of habitability when there are latent defects in the common area that implicate the habitability of individual units.
 

The Court therefore, allowed both the unit owners and the condominium association to bring actions against a builder-vendor where, for instance, the association of unit owners may continue to be controlled by the developer. The case also dealt with the fiduciary obligation of the trustee which gives a second cause of action to a unit owner where the trustees fail to bring the appropriate action against the developer for latent defects in the common areas.

Supreme Judicial Court Protects New Home Buyers

by Thomas V. Bennett

The Legislature imposed gentrification in the rough and tumble world of commerce through the adoption of the Uniform Commercial Code in 1957 which imposes a certain code of conduct between business people and consumers and through M.G.L.A. c. 93A, the so-called "Mini FTC Act" which makes unfair and deceptive trade practices unlawful in the Commonwealth of Massachusetts adopted in 1967.
 

Against that backdrop of legislative conduct corrections, the laws dealing with the sale of real estate have been largely unchanged until now.
 

The Supreme Judicial Court in deciding a case of first impression,* held that the sale of a new home by a builder-vendor has an implied warranty of habitability, a concept that has been present in the Uniform Commercial Code, with respect to the sale of products, since its adoption.
 

The scope of the implied warranty of habitability that attaches to the sale of new homes by a builder-vendor is to be determined on a case-by-case basis as to whether or not the home is unsafe because it deviates from fundamental aspects of applicable building codes or is structurally unsound or fails to keep out elements because of defects in construction. The Court further found that the implied warranty of habitability is collateral to the covenant to convey and survives the passing of title and the taking of possession of real estate and it cannot be waived or disclaimed because to permit a disclaimer of the warranty protecting the purchaser from the consequences of latent defects would defeat the very purpose of the warranty.
 

At first blush this case may seem to cover basic flaws things like the plumbing not working; however, the suit, in fact, involved a home which had eleven fireplaces. The purchasers of the home had an express warranty but it expired after one year. The owners never used the fireplaces but found out, some three years after they had purchased the house, that the fireplaces were defective.
 

The Court surveyed cases of other jurisdictions in the country and determined there were a number of important policy considerations that had led other jurisdictions to adopt the type of implied warranty that the Court adopted in this case, including those policy considerations set forth in the Uniform Commercial Code. In order to establish a claim for breach of the implied warranty of habitability, a plaintiff would have to demonstrate that
 

1. they purchased a new home from the defendant builder-vendor;
2. the house contained a latent defect;
3. the defect manifested itself only after purchase;
4. the defect was caused by the builder's improper design, material or workmanship, and
5. the defect created a substantial question of safety or made the house unfit for human habitation.
 

In addition, the Court found that the claim must be made within the three-year statute of limitation and the six-year statute of repose set forth in M.G.L.A.c.260,§2B which provides, in pertinent part, that the action must be brought within three years next after the action accrues provided in no event should such actions be commenced more than six years after the earlier of the dates of (1) the opening of the improvement to use or (2) substantial completion of the improvement and the taking of possession for occupancy by the owner.
 

Since buying a simple appliance or electronic device carries warranties and implied warranties of merchantability, certainly this case is a major step for consumers whose home is generally the largest single purchase they will make in their lifetime.

Supreme Judicial Court Clarifies Brokerage Commission

by Thomas V. Bennett

The Massachusetts Supreme Judicial Court (SJC), the state's highest court of appeal, has clarified when a real estate broker is entitled to be paid a commission. (1)
 

The case involved a broker who sued for a real estate commission where the seller was unable to conclude the transaction due to the fact that there was hazardous waste located on the premises. The Trial Court judge found for the broker on the basis that the only reason why the closing did not occur was because of the seller's inability to back up the promise that the land was free of toxic materials such as gasoline. The Massachusetts Appeals Court reversed the judgment and the SJC granted the broker's application for further appellate review. The SJC in reviewing the applicable law noted that the cases have held that a broker earns a commission when: (a) he produces a purchaser ready, willing and able to buy on the terms fixed by the owner, (b) the purchaser enters into a binding contract with the owner to do so, and (c) the purchaser completes the transaction by closing the title in accordance with the provisions of the contract.
 

The SJC noted that the requirement that the sale actually be consummated is subject to an exception. The cases have held that a broker has an enforceable claim when the first two requirements are met, and the failure of completion of the contract results from the wrongful act or interference of the seller or where the seller wrongfully defaults.
 

The SJC upheld the Appeals Court reversal of the Trial Court's finding in favor of the broker holding that the seller's obligation to remove the hazardous materials from the property was a condition of the contract like a mortgage contingency which permitted the buyer to terminate the agreement. The SJC found it relevant that the agreement did not give the buyer a right to a claim for damages for willful default but only gave the buyer the right to terminate the contract. The SJC noted that the trial judge did not find, and that there was no basis of finding, that the failure of the sale was a product of any bad faith or wrongful interference by the owner.
 

There is a need to digress here for a moment. In the judicial system, just as in our system of government, there are two court systems. One is the state court system and one is the federal court system. On occasion when a federal court takes a case but the subject matter of the dispute involves state law, the federal court must apply state law. If that law is not clear then the federal court will interpret what it believes to be state law. The broker in the SJC case relied on such a federal case, (2) and the SJC took the opportunity in this case to state that the federal case was not correct.
 

In the federal case there was a dispute in which the broker brought a suit to recover against a seller where at the closing the parties discovered a defect in the title which no one knew of previous to the closing. The United States Court of Appeals for the First Circuit (the Federal Court) detected a "gray area" in Massachusetts law concerning a default by seller that did not amount to wrongful acts or interference. The Federal Court held the seller could be liable for broker's commission even if the seller's default was innocent concluding that the SJC would adopt that conclusion if it were faced with facts like those in the federal case. In so doing the Federal Court assumed that the SJC would prefer a "bright line rule" which would award the broker commission when the seller defaults on a binding purchase and sale agreement whether the default is innocent or motivated by bad faith.
 

The SJC stated that the Federal Court did not state Massachusetts law correctly. The SJC reiterated that the law in Massachusetts is that a broker is not entitled to a commission unless it appears that the closing is prevented by wrongful conduct on the seller's part. The SJC stated that it continued to believe that ordinarily when the owner of a property lists it with a broker for sale, the owner's expectation is that the money for the payment of the commission will come out of the proceeds of sale. The SJC acknowledged that brokers have legitimate expectations that if the broker brings the parties together on mutually acceptable terms that the broker expects a commission for his or her labor. Nonetheless, the SJC concluded that the broker is in a better position than the seller to protect those expectations by including in the brokerage contract a provision that the broker is entitled to its commission when it produces a ready, willing and able buyer whom the seller for whatever reason refuses to accept. The SJC stated in the absence of such a provision the burden is rightfully placed on the broker in light of the fact that many sellers, unlike brokers, are involved in real estate transactions infrequently and thus are unfamiliar with their legal rights.
 

1. Hillis v. Lake, 658 N.E.2d 687 (Mass. 1995)
2. Bennett v. McCabe, 808 F.2d 178 (1st Cir. 1987)