Relating to Real Estate
Relating to Real Estate - September 2011
- Contracts Don't Always Means What They Say
- HUD Issues New Forms for Multi-Family Mortgage Loans
- Claims for Refunds of Recordation Taxes
- Talking About Real Estate
- Franchisor Lease Addenda - Issues for Landlords
- Mortgage Lending: Challenge to Defective Affidavit of Consideration Fails
- When is a Statutory Trust or REIT a "Corporation?
Contracts Don't Always Mean What They Say
Contracts don’t always mean what they say. That’s what the Maryland Court of Appeals, Maryland’s highest court, held in two decisions in cases which involve the interpretation of agreements concerning real property. However, the significance of these cases is primarily a matter of contract law, not real estate law.
The first case is 600 N. Frederick Road LLC v. Burlington Coat Factory of Maryland LLC, 19 A.3d 837, 419 Md. 413 (2011). This matter involved three parcels of land located in the vicinity of Route 355 and Perry Parkway in Montgomery County. In 1981, the owner of all three parcels subjected them to a “Declaration of Easement and Covenant” (the “1981 Declaration”). It reserved certain rights of the original declarant prior to the conveyance of two of the three parcels to a third party. The development rights of the owner of parcel 2 required the consent of the owner of parcel 1. The 1981 Declaration provided that it could only be modified or cancelled by written instrument signed by the owners of the parcels. (Presumably meaning all three of the parcels). In 1984, when the owner of parcel 1 objected to certain proposed development work on parcel 2, the parcel 2 owner instituted litigation. Prior to the conclusion of the litigation, the parties came to agreement culminating in the execution and recording in 1992 of an “Amended and Restated Declaration of Easements and Covenants” (the “1992 Declaration”). The 1992 Declaration was signed by the owners of parcel 1 and parcel 2, but not the owner of parcel 3, a third party. In the 1981 Declaration, the ground lessee of parcel 1 was given the right of approval with regard to development of parcel 2. The 1992 Declaration similarly provided that proposed construction of parcel 2 was subject to the consent of the owner of parcel 1, but was more specific in the description of restrictions on development than was the 1981 Declaration.
When the ground lease assignee of parcel 1 (Burlington) refused to approve the development plans for parcel 2 of 600 N. Frederick, LLC, the new owner of parcels 1 and 2, 600 N. Frederick, instituted a complaint for declaratory relief, seeking a declaration that Burlington had no right to rely on the provisions of the 1992 Declaration because that Declaration was unenforceable, lacking the execution of the owner of all three parcels.
The Court of Appeals, upholding decisions of the trial court and the Court of Special Appeals, rejected 600 N. Frederick’s argument that the 1992 Declaration was invalid because the owner of parcel 3 did not join in its execution. The Court held that two parties to a three party agreement may modify the agreement without the joinder of the third party, as long as the modification does not prejudice the interests of the third party. Even though the 1981 Declaration required all parties to join in, the Court of Appeals focused on the freedom of parties to modify a contract or make a new agreement, as long as it does not adversely affect the rights of a party who does not join in.
The Court of Appeals remanded the case for a determination as to whether or not the 1992 Declaration was prejudicial to the owner of parcel 3.
The second case was decided by the Court of Appeals two months after its decision in 600 N. Federick Road. The case is Hovnanian Land Inv. Group, LLC v. Annapolis Towne Centre at Parole, LLC, -- A.3d --, -- Md. --, 2011 WL 2880627, 2011 Md. LEXIS 498 (July 20, 2011). In this case, Hovnanian had entered into a contract to purchase portions of a large mixed use development near Annapolis. The original contract between the parties required the seller/developer to record a declaration that would provide for annual assessments against the various components of the project. The contract also contained a typical non-waiver clause to the effect that the agreement could not be changed unless the change was in writing and signed by both parties, and that no purported or alleged waiver, unless in writing, would be binding.
Extensive interaction between the buyer and seller to bring the project to closing ensued. In the course of the communications, an alternate means of providing for the annual assessments was addressed by the parties. It involved the use of supplemental agreements among the various owners of properties in the development instead of a declaration. The original closing date was to be November 1, 2007. The purchaser paid $100,000 to extend that date to February 1, 2008.
In that period of time, the purchaser, in light of the economic challenges facing the housing industry, developed a serious case of buyer’s remorse. The purchaser sent the seller a letter attempting to terminate the contract, asserting that the seller had failed to satisfy the condition precedent of recording a declaration to deal with the annual assessments. The seller promptly filed suit in circuit court, seeking a declaratory judgment that the purchaser had breached the agreement. The circuit court held in favor of the seller, finding that the purchaser, through its actions subsequent to the execution of the contract, waived the requirement for the declaration concerning assessments. The Court of Special Appeals affirmed the finding of the trial court.
The Court of Appeals also affirmed. It held “that a party may waive, by its actions or statements, a condition precedent in a contract, even when that contract has a non-waiver clause.”
In arriving at its conclusion, the Court cited 600 N. Frederick Road for the proposition that the freedom to contract is not limited to the document as written. It includes the freedom to change the contract by subsequent behavior, even if contrary to the strict requirements of the written contract in question.
The Court of Appeals remanded the case to the trial court to determine if, under the facts of this case, the buyer had, indeed, waived the condition upon which it was relying. In providing guidance to the trial court, the Court of Appeals said “we do not mean to say that non-waiver clauses should be ignored altogether. Non-waiver clauses, although not favored by courts, must be considered by the trier of fact. The party alleging waiver must show an intent to waive both the contract provision at issue and the non-waiver clause.”
There are significant lessons to be derived from these two cases. One is that under certain circumstances, no matter how carefully a contract is drafted, the parties may be surprised as to how it is interpreted later. This leads to the second point. The way parties to a contract conduct themselves after it is executed but before it is consummated, can be determinative as to how it is interpreted. For that reason, it is important that clients communicate closely with counsel before taking action in the interim between contract and closing, to avoid surprises of the type experienced by the purchaser in the Hovnanian case.
Please contact Searle Mitnick if you have any questions.
HUD Issues New Forms For Multi-Family Mortgage Loans
The U.S. Department of Housing and Urban Development (HUD) has published revised loan documents for FHA-insured multifamily mortgage loans, including a new form of legal opinion letter from borrower's counsel. These new forms and application of revised regulations corresponding to the updated closing documents are required for all FHA-insured loans (other than loans for healthcare facilities) for which HUD issues a firm commitment for mortgage insurance on or after September 1, 2011. These replace the HUD loan forms issued in 2003. See 76 FR 24507 - HUD Multifamily Rental Project Closing Documents: Notice Announcing Final Approved Documents and Assignment of OMB Control Number, or Federal Register Volume 76, Issue 84 (May 2, 2011).
On January 21, 2010 (75 FR 3544), HUD published for public comment a notice advising that HUD was updating and revising a set of closing documents used in Federal Housing Administration (FHA) multifamily rental projects. This 60-day notice period started anew the process for updating the multifamily rental project closing documents, a process that had begun on August 2, 2004. On December 22, 2010 (75 FR 80517), HUD published a 30-day notice to complete the public comment process. HUD provided a detailed summary of the comments and HUD's responses to these comments in the January 21, 2010 notice accompanying the documents which were open for 60 days of comment.
Opinion practice in private sector transactions throughout the country has evolved significantly since 2003 when HUD issued its current approved form of borrower’s counsel opinion (which is called “Guide for Opinion of Borrower’s Counsel”). HUD has modified its form of legal opinion to reflect some changes in opinion practice, but it has also retained many of the features that historically have been a source of concern for borrower's counsel. See the webpage of the ABA’s Section of Real Property, Trust and Estate Law, Committee on Legal Opinions in Real Estate Transactions, Subcommittee on Opinions to Federal Agencies.
If you have questions about HUD-insured multi-family mortgage loans, please contact Searle Mitnick.
Claims For Refunds of Recordation Taxes
As we noted in a Real Estate Alert this past May, the Gordon, Feinblatt, Rothman, Hoffberger & Hollander, LLC real estate group has filed seven formal claims on behalf of five clients, including banks and real estate companies, for refunds of recordation taxes paid to Howard County, Maryland. The transactions underlying the claims involved financings employing indemnity deeds of trusts (“IDOTs”). The principal face amounts of these loans totaled more than $115 million, and the claims are for more than $575,000.
Each of the loans secured by the IDOTs went into default, and Howard County refused to record deeds for the properties in subsequent transactions until the recordation taxes on the IDOTs were paid. Our clients paid the recordation taxes to get their deeds recorded, and now we have filed claims seeking refunds.
Starting in July, 2009, Howard County’s method of collecting the tax has been different from the practices of Baltimore City and every other county in Maryland, including that of Howard County before then. This practice is also at variance from that prescribed in published opinions of the Maryland Attorney General.
Following the procedure set forth in the Tax-Property Article of the Maryland Code, this Spring we filed claims for refunds with the Howard County Director of Finance. Because it was the Director of Finance who directed the change in policy that caused the recordation tax to be collected, she denied our clients’ claims. We then filed petitions for appeal with the Maryland Tax Court in July, 2011, and Howard County has filed a Motion to Affirm the Denial Decisions. As of the date of this publication, no hearing date has been set.
If you have any questions about this matter, please contact Ed Levin or George Ritchie.
Talking About Real Estate
Franchisor Lease Addenda – Issues for Landlords
There are close to one million franchised business establishments, and this form of conducting business continues to expand annually. A shopping center trade organization estimates that approximately 40% of leases that are currently being signed are between landlords and franchisees. Many franchisors require that their franchisees obtain an addendum to their leases to grant the franchisor’s rights in the leased premises. Lease addenda required by a franchisor will typically have some provisions that landlords find attractive -- for example, the right of a franchisor to cure a lease default by a franchisee because it carries with it the implication that the franchisor will pay the rent when the franchisee does not. Conversely, franchisors customarily insert provisions in their standard lease addenda that can cause concerns to landlords. A few of these clauses are summarized below.
Notices of Defaults. Most franchisor lease addenda provide that the landlord must give the franchisor notice of any default by the tenant. This could be problematic for the landlord. Under the lease, there may be some defaults by the tenant that do not require that the landlord give notice to the tenant, such as non-payment of rent. If a landlord signs the standard franchisor lease addendum, the landlord may be obligating itself to give the franchisor notices that it is not required to give to the tenant. The notice clause in the franchisor lease addendum needs to be tailored to the notice requirements in the lease.
Cure of default. Many franchisor lease addenda provide the franchisor with the right to cure any default by the tenant, and frequently such provisions give the franchisor a cure period that is in addition to the cure period that might be provided to the tenant under the lease. Landlords need to consider how many times a franchisor will have a cure right as well as how long is reasonable for a cure period in light of cure rights given to the tenant.
Franchise Agreement Default. Commonly franchisors include a provision in their lease addenda by which a default under the franchise agreement would constitute a default under the lease. Landlords would not want technical defaults under a franchise agreement (e.g., reporting requirements) to trigger a lease termination. The landlord may want to require that the franchisor simply de-brand the location, but the landlord may not want to lose its tenant.
Assignment. Franchisor addenda frequently provide that the franchisor will have a right to take an assignment of the tenant’s interest under the lease (in the event of default or otherwise) and permit the franchisor to assign the tenant’s interest to a new franchisee. If the franchisor assumes the liabilities of the tenant, there is no significant detriment to the landlord; however, franchisors generally seek to avoid such obligations. Additionally, a landlord should have approval rights over any new franchisee to which a lease is assigned. These issues need to be negotiated.
Termination of Franchise Activities. Many franchisors include a provision in their standard lease addendum that enables the franchisor a period of time to remove all franchise marks and sell fixtures and equipment in the event that a franchise is terminated. Landlords need to consider whether such activities and “going out of business” sales are consistent with the shopping center’s character and are permitted under the lease.
- Silent provisions. Most franchisor lease addenda are relatively short – two or three pages in length – and do not contain many “boilerplate” provisions of the lease. If there is a waiver of jury trial provision in the lease, but not in the franchisor addendum, the landlord may find itself in a situation where it may be before a judge in a dispute with the tenant, but before a jury in a dispute with the franchisor. The failure to match lease provisions with the franchisor addendum can have adverse consequences to the landlord.
These are just a few of the issues that a landlord must consider when presented with a “standard” franchisor lease addendum. The landlord should not sign the “standard” franchisor lease addendum without considering the impact such addendum can have on the operations at the leased premises. Franchisor issues can generally be negotiated and resolved to the satisfaction of all parties – the landlord, the tenant/franchisee, and the franchisor. We suggest that the landlord discuss such issues with counsel.
If you have specific questions or concerns about a franchisor lease addendum, please contact Ed Levin.
Mortgage Lending: Challenge to Defective Affidavit of Consideration Fails
Maryland law requires that consumer loan mortgages and deeds of trust (security instruments) contain an affidavit that the consideration described in the security instrument is true and bona fide. If this affidavit of consideration is missing or defective, the security instrument will not be valid except as between the parties. Recognizing the potential harsh consequence of this law, the legislature enacted a “curative statute” which, simply stated provides that, failure to comply with the affidavit of consideration requirement is of no consequence unless it is challenged within 6 months after the security instrument is recorded.
Earlier this year, bankruptcy trustees challenged the validity of certain security instruments based on failings in the affidavits of consideration. These challenges were all brought after the 6-month period in the curative statute had ended. The bankruptcy court asked the Maryland Court of Appeals for guidance. On August 16, 2011, in Guttman, et al. v. Wells Fargo Bank, et al., the Court of Appeals answered the bankruptcy court’s certified questions, finding that the types of failings alleged by the bankruptcy trustees to invalidate the security instruments were cured by the curative statute.
While we of course encourage careful compliance with the formal requirements for security instruments imposed by Maryland law, we are comforted by the Court’s opinion. We note that this case does not overrule Ameriquest Mortgage Co. v. Paramount Mortgage Services, 415 Md. 656, 4A.2d 934 (2010), which held that a false affidavit of consideration or disbursement is not rectified by the “curative statute,” and this case does not deal with a challenge that is not made within six months of when a defective deed of trust or mortgage is recorded. Please contact Ed Levin if you have any questions.
When is a Statutory Trust or a REIT a "Corporation?
As a result of efforts of an ad hoc group that included Ed Levin of Gordon Feinblatt’s Real Estate Practice Group, and the chairs of three sections of the Maryland State Bar Association, the Maryland State Department of Assessments and Taxation (“SDAT”) stated in an e-mail dated August 10, 2011 that it would change its recent position and go back to treating statutory trusts as corporations for purposes of the Tax-Property Article of the Maryland Code.
This announcement was significant because statutory trusts and Maryland real estate investment trusts (REITs) are the preferred vehicles for people who acquire new commercial real estate in Maryland, and falling within the definition of “corporation” for recordation and transfer taxes purposes is important for these landowners. The exemptions for intra-group transfers of real estate between related corporations enable a parent or subsidiary to transfer real estate without incurring tax. Md. Code, Tax-Property (“TP”), §§ 12-108(p)(1) and (3) and 13 207(a)(9). Similarly, an exemption for transfers of real estate made as part of an income tax-free reorganization is available for mergers and acquisitions involving corporations. TP §§ 12-108(p)(2) and 13-207(a)(9).
There are, however, no similar exemptions available for transfers of real estate between related unincorporated entities. See generally TP § 12-108. Consequently, property owners that own multiple properties in different entities or intend to subdivide real property for different uses usually prefer entities treated as corporations for recordation and transfer tax purposes because they can transfer parcels from one entity to a related entity without incurring additional recordation and transfer taxes.
Earlier this summer, the SDAT stated that it was going to change its longstanding interpretation of the definition of “corporation” for the purposes of Maryland state and local recordation and transfer taxes so as to not include Maryland statutory trusts. Such a new interpretation would be contrary to opinions of the office of the Maryland Attorney General. It would also be inconsistent with the approach currently used by the clerks of court when a landowner files a deed. Additionally, it called into question whether the SDAT took a similar view with respect to REITs.
The relevant statutory language is “(1) ‘corporation’ includes an association or joint stock company.” TP § 1-101(f). At least since 1998, Maryland statutory trusts (which were formerly called business trusts) and REITs have both been viewed by the SDAT and the clerks of the circuit courts as associations taxable as corporations within the meaning of this statutory definition. See June 3, 1998 Tax Memo by David Lyons; June 11, 1998 Tax Letter by Julia Freit; and August 5, 2004 Letter and Memo to Clerks from Bruce Benshoof. The word “association” is a term of art that means an unincorporated business entity that has most of the characteristics of a corporation. Morrissey v. CIR, 296 U.S. 344 (1935) (a Massachusetts business trust is an “association” taxable as a corporation). The legislative history for the statutory predecessor of TP § 1-101(f) explicitly states that Massachusetts business trusts should be considered as within the definition of “corporation” for all Maryland real estate tax purposes. Maryland statutory trusts and REITs are codifications of the common law business trusts that were pioneered in Massachusetts. Therefore, the Maryland legislature specifically intended for these entities to be included within the definition of “corporation” for recordation and transfer taxes purposes.
For income tax purposes, Maryland statutory trusts and REITs are generally taxed as partnerships if there are two or more owners, and they are considered as disregarded entities if there is only one owner, unless the owners have made a valid election to be taxed as a corporation. See 26 CFR § 301.7701-3(a). Generally, property owners prefer to own real estate through a partnership or a disregarded entity instead of through a corporation because (a) there are fewer restrictions on the ability to deduct losses, (b) real estate owned by a partnership can be stepped up upon a sale of an ownership interest or death or an owner, (c) a partnership can generally liquidate without adverse income tax consequences, and (d) unincorporated entities are easier to govern.
Due to the work of the ad hoc group and the SDAT’s announcement that it will continue to treat statutory trusts as corporations, as a general matter, people who acquire new commercial real estate are well advised to continue taking title in a statutory trust or a REIT.
For questions contact Ed Levin.