Real Estate Legal Update

Michigan Court Denies Transfer Tax Exemption to Fannie Mae & Freddie Mac: A Sweet Result for Michigan That Could Cost the Feds Millions

Jennifer C. Waryjas — Fri, 11 May 2012 09:44:32 -0800

While those with a sweet tooth may think of Fannie May as the Chicago-based chocolate company, Fannie Mae has only brought heartburn to Michigan as Fannie and Freddie Mac claimed a federal exemption from the Michigan real estate transfer tax as to the sale of foreclosed properties – costing Michigan millions of dollars in lost tax revenues. Michigan challenged the validity of these claimed exemptions, and a recent federal District Court decision, Oakland County v. Federal Housing Finance Agency, produced a sweet result in its favor – holding that Fannie and Freddie are not exempt from the type of taxation imposed by the Michigan real estate transfer tax.

In Michigan, as in most states, when real estate is transferred, a transfer tax (based on the value of the property) is imposed on the transaction. Fannie and Freddie (as well as the Federal Housing Finance Agency (FHFA) as conservator) routinely claimed a federal exemption from the Michigan tax because their federal charters exempted them from “all taxation” imposed by any state or county. Oakland County filed suit against Fannie and Freddie, asserting that this claim of exemption from state transfer tax was erroneous because the Michigan transfer tax is not the type of tax intended to be covered by the federal exemption. And the federal District Court agreed!

In its analysis, the court considered the intended scope of the federal exemption. Although the federal charters of Fannie Mae and Freddie Mac provide for an exemption from all “taxation” by states and counties, the court determined that this exemption applied only to “direct” taxes, and not excise taxes. Because, per Michigan law, the real estate transfer tax is an excise tax levied on the conveyance of property – and not a direct tax – the court concluded that the federal exemption granted to Fannie and Freddie in the charters did not apply to the transfer taxes.

The court also rejected an argument that the Feds didn’t even make. Oakland County sought a ruling on whether Fannie and Freddie were exempt from the transfer tax as federal instrumentalities under a Michigan statute. The Feds argued that the court need not address the issue, because they were exempt under the federal exemption. The court, however, citing a recent federal court decision from the District of Nevada (Nevada v. Countrywide Home Loans), held that Fannie and Freddie are not exempt under the Michigan law either, because they are not federal instrumentalities.

Given the tremendous number of sales of foreclosed properties by Fannie and Freddie nationwide, this decision has implications well beyond a single state. Michigan is only one of many states plagued by the foreclosure crisis and is desperately in need of tax revenues to balance stressed budgets; according to RealtyTrac, nationally there were foreclosure filings on almost 2 million properties in 2011. This decision is likely to grow legs as state and local governments around the country realize their potential to realize on the transfer tax.

Chicago Wins the Latest Round: In a Longstanding Battle, Court Upholds Chicago Landmarks Ordinance Against Constitutional-Vagueness Challenge by Property Owners

Daniel J. Slattery — Tue, 08 May 2012 11:47:55 -0800

The City of Chicago has prevailed in the latest round of a “no holds barred” battle with local property owners over the constitutionality of The Chicago Landmarks Ordinance. In a decision dated May 2, 2012 by the Circuit Court of Cook County, the property owners’ claims that the Landmarks Ordinance was unconstitutionally vague and violated due process were rejected, and the court upheld the Ordinance. Hanna and Mrowka v. City of Chicago. No. 06 CH 19422. The landowners had previously won a highly favorable ruling at the appellate court level (in 2009), which raised the prospect of the invalidation of the Ordinance (as reported in a previous Reed Smith Client Alert) – a result that would have sent shockwaves through the historic preservation community nationwide. With the case remanded to it for decision, the trial court considered the due process vagueness issue in detail, including as to the clarity of the Ordinance’s criteria for landmark status; but it was not persuaded by the property owners’ arguments, and found that they did not meet their burden of rebutting the presumption of the constitutionality of the legislation, thus upholding the Ordinance.

In essence, the trial court was not convinced that the criteria and standards set out in the Landmarks Ordinance were vague, especially when viewed in the context of the issues and concerns that the Ordinance seeks to address. “[T]he challenged words of the criteria,” wrote Judge Sophia H. Hall, “must be read in the context of the whole criterion, and not in isolation. It is nearly always possible to take a few words here and there from an ordinance and argue how the word could be unclear . . . [W]hen the criteria are viewed in the context of the Ordinance and its expressed purposes as a whole, the criteria provide sufficient guidance for the [Landmarks] Commission to select and choose among that which represents the heritage and character of the City.”

The Ordinance sets out criteria that are to provide guidance to the Landmarks Commission in making its recommendations to the legislative body – the Chicago City Council – as to whether a property should be designated a City landmark. Among the criteria are: “Important Architecture,” “Distinctive Theme as a District” and “Unique Visual Feature.” The property owners challenged words such as “important,” “distinctive” and “unique” as being so vague in meaning as to allow for arbitrary application – in violation of constitutional due process guarantees. In rejecting this argument, the court pointed to a number of decisions in other states -- as well as a federal decision applying Illinois law – which upheld similar ordinances and statutes, and found the reasoning in them persuasive. The court noted that these decisions pointed to “guideposts” in the laws that informed the decision-making and acted against arbitrariness – specifically, the history and character of the area, the purposes of the ordinance and the criteria used in context, and the applicable procedures.

News reports have already indicated that the property owners are likely to appeal, and given that the case has been fought tenaciously over many years, this ruling is not likely to be the last word on this subject. It would not be surprising if the case made its way ultimately to the Illinois Supreme Court. In the meantime, historic preservationists all over the country are breathing a little easier, especially in the Windy City.

EPCs - Be Prepared

Siobhan Hayes — Fri, 20 Apr 2012 07:41:16 -0800

As a result of Government concerns that Energy Performance Certificates (EPCs) were not being provided soon enough, changes to the regulations relating to EPCs require them to be provided earlier than previously. The changes came into effect 6 April 2012 Agents need to know that they have direct liability under the new Regulations and that the EPC must now be commissioned before marketing.

More important, though, are the changes that will mean that in the future, buildings with the lowest grading of EPC will no longer be lettable.

Here we summarise the immediate and longer-term changes to the EPC regulations.

Remember, not all buildings need an EPC as the Regulations only apply to buildings with heating, ventilation or air conditioning.

For those buildings that do require an EPC, the new Regulations require that –

The EPC is commissioned before marketing
The owner of the building uses reasonable endeavours to obtain the EPC within seven days of the property being put on the market
The particulars of the property include the first page of the EPC (not just the asset rating), which means that the main recommendations for improvements to energy efficiency will show up in the particulars
A full copy of the EPC must be provided to the buyer or tenant as early as possible, and the Regulations no longer provide the comfort that in any event this may be just before the sale/lease

Agents beware! Agents for the property owner will be liable themselves for any breach of the Regulations and have a duty to check before marketing that the property owner has commissioned the EPC. The Government guidance states that agents should satisfy themselves that the EPC is available or has been commissioned before they start marketing.

If the EPC is not available within the seven-day period, there is a 21-day period to try to obtain the EPC. The breach of the Regulations occurs if no EPC has been obtained within 28 days of the property going on to the market.

The penalty regime remains unchanged, so for commercial real estate, the minimum penalty is £500 and the maximum is £5,000, and enforcement is by way of a Trading Standards Officer’s penalty notice. The hassle resulting from non-compliance may, however, be worse than the financial consequences.

Good news - if your building was on the market before 6 April, then you are still operating under the old regime and not the new.

Of long-term significance is the change set up by the Energy Act 2011. From April 2018, it will be unlawful to rent out a residential or business property that does not reach a minimum energy efficiency standard (expected to be EPC rating 'E'). The building will still be capable of being sold, but this change will provide a commercial incentive to make the EPC rating and the recommendations for improvements more significant. Landlords have time to review their EPC ratings and schedule upgrades before new lettings are required, but forward planning will be needed to avoid issues relating to value and marketability over the next five years or so.

The Non-Recourse CMBS Loan: Apparently Not All It's Carved Out To Be

Alex Braden — Fri, 30 Mar 2012 05:43:42 -0800

In the world of securitized commercial mortgages, non-recourse carveout guaranties have long been a matter of standard practice. For CMBS lenders, they offer a critical backstop against fiscal mischief by borrowers, and for responsible borrowers they provide access to real estate financing without fear of personal ruin. Nevertheless, two recent court decisions have thrown the non-recourse concept into turmoil and may spell big trouble for the entire commercial real estate lending industry.

In 51382 Gratiot Avenue Holdings, Inc. v. Chesterfield Development Company (Chesterfield), a single purpose entity borrower defaulted on a $17 million mortgage loan; the lender foreclosed on the mortgaged property but then sued the borrower’s guarantor for the $12 million deficiency based on a provision in the loan documents rendering the non-recourse clause void in the event that the borrower should “become insolvent or fail to pay its debts and liabilities from its assets as the same shall become due.” The defendant borrower (correctly) contended that by characterizing the mere inability to pay down its mortgage debt as a recourse-invoking default, the entire loan would be post facto transformed into a full recourse obligation. Nevertheless, the court held in favor of the lender.

In Wells Fargo Bank, N.A. v. Cherryland Mall (Cherryland), the action hinged on a loan document provision making the loan fully recourse in the event that the borrower “fails to maintain its status as a single purpose entity as required by, and in accordance with the terms and provisions of the Mortgage.” Here, the mortgage contained a section with the heading “Single Purpose Entity/Separateness,” which section in turn contained a covenant that the borrower “is and will remain solvent and [borrower] will pay its debts and liabilities . . . from its assets as the same shall become due.” Although the borrower argued that the solvency covenant fell under “Separateness” and not “Single Purpose Entity,” the court disregarded the distinction, and full recourse liability was imposed against the guarantor.

If other courts follow Chesterfield and Cherryland, the potentially catastrophic implications for borrowers and their sponsors are obvious, but these decisions portend grave consequences for CMBS lenders and investors as well. More to the point, it can be assumed that a large number of borrower sponsors have delivered guaranties on multiple loans. If a lender were to enforce even one such guaranty, the sponsor’s assets could be all but wiped out, creating a disastrous ripple effect for borrowers and lenders alike throughout the CMBS space.

There is some consolation here, given that both of these cases are being appealed and are constrained to Michigan, where, in fact, the state legislature has quickly passed a bill that would effectively overturn the decisions. What’s more, loan originators and their counsel can and well should regard Chesterfield/Cherryland as a cautionary tale, taking heed to pay special attention when drafting non-recourse carveout language in new loan documents. Still, what seems to be quite evident is that if these cases prove influential, the already-troubled CMBS market should brace itself for more dark days ahead.

National Planning Policy Framework

Siobhan Hayes — Tue, 27 Mar 2012 09:28:34 -0800

This post was written by Siobhan Hayes and Catrin Phillips

The Government has today published the new National Planning Policy Framework and here is a link . This comes into effect immediately and is part of the Government’s drive to simplify planning in the UK to promote growth. Government sources today called it ‘unashamedly pro-growth.’ Last summer’s draft of the NPPF got a lot of criticism particularly from environmental, heritage and sustainability groups and it has been revised significantly.

Those involved in property development might like to note the following key points –

The NPPF is just a policy document. It should not be forgotten that the overriding statutory requirement is still that all planning decisions should be made in accordance with the development plan, unless material considerations (of which the NPPF is but one) dictate otherwise. So the starting point should still be the relevant local development plan.
The NPPF states that the purpose of planning is to achieve sustainable development. This is a definition that has changed significantly since the first draft of the NPPF and has three limbs - economic, social and environmental. The document refers to the UN’s definition of sustainable development meeting the needs of today without compromising the ability of future generations to do so.
Top down planning is a thing of the past, and where an application is submitted for a development that accords with an up to date local development plan then consent should be granted. We have seen recent statistics saying that over half the local authorities do not have their up to date plans in place but, no doubt, now the NPPF has been published it will be easier for them to progress their local plans.
Green belt land remains protected and the protection overrides the general presumption in favour of sustainable development.
Similar protection is stated for heritage assets.
The re-use of brownfield land is encouraged.
Town centres are to be recognised as being at the heart of the community and there will be a sequential test for planning applications for developments for ‘main town centre uses.’
When local planning authorities assess applications for retail, leisure and office development outside town centres which are not in accordance with up to date local plans they will require impact assessments to understand the impact on existing, committed and planned public and private investment in the area and on the town centre's vitality and viability. Smaller developments will escape this requirement.

It remains to be seen if the bodies which objected last summer still find this version of the NPPF quite as controversial as they did. Even more importantly, it remains to be seen if it will improve the process for developers in obtaining planning permission.

Financing Contingencies and Earnest Money Deposits: If I Can't Get My Loan, I Get My Deposit Back, Right?

Daniel J. Slattery — Wed, 22 Feb 2012 12:25:44 -0800

Real estate purchasers whose contract permits the return of the earnest money deposit if financing cannot be obtained must be extremely careful in how this contingency is worded in the purchase contract, or a purchaser may get an unwelcome surprise, and be forced to forfeit the earnest money when financing cannot be obtained.

Typically, when a purchaser needs bank financing to purchase real estate, it will make its obligation to purchase contingent upon obtaining that financing. In this type of transaction, the deal is premised upon the purchaser having the lender’s funds available at closing to apply towards the purchase price. At the same time, a real estate purchaser generally puts up some of its own money at the time of contract - as an earnest money deposit - to provide assurance to the seller of performance under the contract, and also to provide a possible fund for seller’s liquidated damages in the event of a default by purchaser. The deposit, however, is usually refundable in the event of a termination of the contract without purchaser’s fault.

So, if there is a financing contingency in a contract, and the purchaser does not obtain that financing, it follows that a termination of the contract based on the failure of that contingency would result in the return of the earnest money deposit to the purchaser. Right?

Not necessarily according to the Illinois courts. In a recent decision, Triple R Development, LLC v. Golfview Apartments I, L.P., an Illinois appellate court held that a financing contingency did not require a refund to the purchaser of the earnest money deposit when the purchaser failed to obtain the necessary financing to close. The court interpreted the contract’s financing contingency to require only a determination of the purchaser’s “eligibility” for financing - and not the obtaining of a commitment for funding or the funding itself. Because it found that the purchaser was in fact “eligible” for financing, the court held that the contingency was satisfied, even though the purchaser did not actually obtain the financing.

The Triple R Development court focused on the language of the contingency -- which did not refer to financing in general - but rather to the purchaser’s “determination of eligibility” to receive certain tax credits necessary in connection with the financing. Although elsewhere in the agreement there were references to the need of the purchaser to “obtain the financing” to be able to close, the court chose not to read those provisions in combination with the specific contingency language, to create a more general financing contingency.

Accordingly, the court upheld the lower court’s determination that the contingency was satisfied, that the purchaser was in default due to its failure to consummate the transaction, and that the seller was entitled to the payment of purchaser’s earnest money deposit ($230,000) to cover its damages. The court was not persuaded by the general legal principle that forfeitures in contracts are not favored, instead focusing on the function of the earnest money deposit to assure purchaser performance, and asking rhetorically, “[w]hat is the purpose of a deposit if it is to be returned to the buyer whenever the buyer chooses not to proceed?”

This decision underscores the importance of the precise language of financing contingencies in real estate contracts, and how they must be written and understood based on the level of comfort or certainty required by the purchaser as to the ability to obtain financing – as evidenced by loan eligibility, loan commitment, loan closing, or receipt of loan proceeds. The court was not willing to interpret the contingency language beyond the loan “eligibility” language to avoid a forfeiture. The decision also reflects the tension between real estate contract financing contingencies - which are designed to give a purchaser an “out” - and earnest money deposits - which are given to protect a seller from a “walk.”

Chicago's Vacant Building Ordinance Addresses Some Serious Problems - and Creates Some of Its Own, Too

Daniel J. Slattery — Tue, 24 Jan 2012 08:39:06 -0800

Chicago’s Vacant Building Ordinance, which imposes substantial and unprecedented duties on mortgagees of residential real estate located in the city of Chicago, continues to generate controversy – and lawsuits.

The Ordinance was amended in July 2011 to impose, for the first time, duties on mortgagees to register and maintain vacant buildings located in the city of Chicago (as reported in Reed Smith Client Alert No. 2011-206. As we noted in the Client Alert, the Ordinance represents the city’s attempt to address some serious problems resulting from the significant increase in vacant buildings throughout the city, including public safety and crime concerns, and adverse property value impacts. A recent GAO report entitled Vacant Properties: Growing Number Increases Communities’ Costs and Challenges details the myriad ills that can be tied to vacant buildings throughout the country – including the millions of dollars spent by budget-challenged cities to secure or demolish them.

After the financial industry voiced serious concerns as to the fairness and legality of the Ordinance, the city went back to the drawing board and retooled the Ordinance. In November 2011, apparently after obtaining the input of some major financial institutions, the city adopted an amended Ordinance which retains the obligations of mortgagees to register and maintain vacant buildings, but reduces the extent of the obligations and allows mortgagees certain affirmative defenses. The Ordinance still requires mortgagees to register vacant residential buildings prior to assuming ownership or filing for foreclosure, and to maintain the building – both the exterior and the interior. The affirmative defenses now available include the assertion of rights by the fee owner in a foreclosure proceeding, and the existence of an automatic stay in a related bankruptcy proceeding.

This “tweaking” of the Ordinance was not enough to mollify the federal government, in the form of the Federal Housing Finance Agency (FHFA), which sued the city in mid-December in federal district court in Chicago. The complaint alleges that the Ordinance is preempted by federal law and regulations governing Fannie Mae (Federal National Mortgage Association) and Freddie Mac (Federal Home Loan Mortgage Corporation). As stated in the complaint:

The City of Chicago seeks to regulate and supervise the Conservator [FHFA], Fannie Mae and Freddie Mac in their capacity as mortgage investors and mortgagees – that is, as holders of the indebtedness secured by real estate that has not (emphasis in original) been foreclosed upon. The City has enacted an [Ordinance] that imposes a registration and regulatory scheme – replete with taxes, fines, penalties, and ongoing supervision by the Chicago Department of Buildings – on the FHFA and [Fannie and Freddie] in violation of federal law.

The Feds have filed a motion for summary judgment and are seeking an expedited ruling on the case.

This lawsuit, though pertaining to the Chicago Ordinance only, is of national import; as noted by the GAO report, communities throughout the country grapple with the same problems that Chicago faces – large inventories of vacant buildings, property owners unable or unwilling to maintain them, and significant and ongoing expenses to secure and remediate them. Other municipalities, including Las Vegas, Nevada, Charlotte County, Florida and Cook County, Illinois, have adopted their own vacant building ordinances, with registration and maintenance requirements similar to Chicago’s approach. The local press accounts describe similar motivations and concerns as to those raised in relation to the Chicago ordinance, as indicated by the press coverage in Nevada. We anticipate that nationwide these ordinances will continue to face federal preemption challenges along the lines of the FHFA lawsuit filed in Chicago, as well as challenges based on conflicts with state foreclosure and property laws, which recognize the superior rights of fee owners in these circumstances.

We will continue to monitor the progress of this Chicago ordinance and lawsuit and provide updates in the Blog on this important topic.

Unbroken Leases

Siobhan Hayes — Fri, 13 Jan 2012 04:53:19 -0800

This post was written by Siobhan Hayes and Katherine Campbell

Break clauses are currently one of the hot topics in real estate litigation. This is unsurprising given the state of the market. A High Court case reported this week shows how difficult it can be for tenants to operate a conditional break clause in a lease. In this case, the lease contained a condition that for the break to operate there must be no overdue payments by the break date. Around £130 of default rate interest was overdue at the break date. The tenant paid rent due the day before the break by way of cheque, but did not pay any interest. The default interest had not been demanded by the landlord but the tenant was found to have failed to satisfy the pre-conditions to the break and the lease now continues for five years.

For tenants this looks like a tough decision.

Tenants note

Unless the lease specifies otherwise the default rate interest does not have to be demanded and you are just as capable as the landlord of calculating what is due.
You can only make payments by cheque for money due under the lease if there is an agreement between you and the landlord that cheques are acceptable. The agreement can be implied. If cheques have been accepted previously without objection that will suffice.
When agreeing future leases make it clear that break rights are unconditional because the landlord is not disadvantaged as it can still claim damages for any breaches of the lease that existed at the break date after the lease has come to an end. This should be dealt with at the heads of terms stage.
Tenants with conditional break rights will need legal advice at the earliest stage possible where they are thinking about exercising a conditional break. Please see our previous posting about disputes under break notices.
For any tenants interested in the technical arguments please see our longer posting explaining the landlord’s position.

Legal Break Clauses

Siobhan Hayes — Fri, 13 Jan 2012 04:32:27 -0800

This post was written by Siobhan Hayes and Katherine Campbell

A High Court case reported this week shows how difficult it can be for tenants to operate a conditional break clause in a lease. On the face of it, this looks like a good decision for landlords. In this case, around £130 of default rate interest was overdue at the break date. The lease was clearly stipulated that the break notice would be ineffective if any payments due under the lease had not been paid by the break date. It is always of interest to landlords to see a robust interpretation of a break clause but the landlord’s ‘win’ in this case did depend upon the facts so this makes the outcome of similar cases difficult to predict.

The case is Avocet Industrial Estates LLP v Merol Ltd and Tudor Rose International Ltd and it raises a number of points which will be of interest to investors and those managing investment property.

Payments by cheque

There was an implied agreement that payment could be made by cheque because some payments had been made by cheque (although recent payments were made by BACS). Implied agreements like these will depend on the actions of the parties.
There was no requirement for the landlord to be paid in cleared funds so the cheque did not have to have cleared by the break date as long as the cheque cleared in due course.
The landlord accepted the cheque by not rejecting it in the two days it had to do so (being the break date and the day before it). In the Avocet case the cheque was not returned by the landlord until three weeks had passed.

Default interest – do landlords have to notify their tenants and demand it for it to fall due?

The lease did not expressly require a formal demand (which is very common) and it was held that default interest was due on a daily basis even if the landlord had not made a demand for the default interest. The tenant, who frequently paid rent late, was just as capable of calculating the amount of default interest due.

Estoppel – this is always a worry to transactional real estate lawyers as it blurs the black letter of the contract especially when you consider that it is possible for silence to create an estoppel!

The landlord received the tenant’s cheque with a letter stating that no sums were outstanding the day before the break date. This was in error (default interest being due) but the landlord did not know of the tenant’s mistake until after it had taken legal advice (after the break date) so there was no estoppel for the tenant to rely on.

In conclusion

Landlords who have made their break clauses conditional on the payment of all outstanding sums may be able to rely on default rate interest due from past arrears to defeat the operation of a break clause.
Landlords receiving cheques in similar situations need to react very quickly and return them if they do not want to be found to have accepted payment.
As ever, everything will turn on the facts of each case.

SEC Targets Key Mortgage REITs Exemption

Steven M. Regan — Wed, 14 Dec 2011 07:51:41 -0800

SEC Action Threatens Already Shaky Housing Market

Mortgage real estate investment trusts (“MREITs”), which provide much needed liquidity to a capital starved real estate market, are at risk of losing a key exemption under the Investment Company Act of 1940 (the “Act”). MREITs are currently exempt from the Act and its limits of the amount of leverage a fund can use to acquire assets. The exemption currently allows MREITs to use high levels of leverage to boost returns. Many MREITs use low-rate, short-term bonds to finance bond purchases. If MREITs become subject to the Act, an important source of liquidity for the housing and real estate markets could be lost.

On August 31, 2011, the Securities and Exchange Commission issued concept release IC-29778 (PDF) seeking comments from the public as to whether MREITs, should remain exempt from the Investment Company Act of 1940 (the “Act”) pursuant to Section 3(c)(5)(C) of the Act. The public comment period for the concept release ended on November 7, 2011.

The SEC’s stated goals in issuing the concept release (PDF) are to: “(1) be consistent with Congressional intent underlying the exclusion from the Act provided by Section 3(c)(5)(C); (2) ensure that the exclusion is administered in a manner that is consistent with the purposes and policies underlying the Act, the public interest, and the protection of investors; (3) provide greater clarity, consistency and regulatory certainty in this area, and (4) facilitate capital formation.”

Under Section 3(c)(5)(C) of the Act, any person “not engaged in the business of issuing redeemable securities, face-amount certificates of the installment type or periodic payment plan certificates and who is primarily engaged in one or more of the following businesses . . . (C) purchasing or otherwise acquiring mortgages and other liens on and interests in real estate” is not an investment company for purposes of the Act. MREITs have little in common with traditional property REITs aside from satisfying REIT requirements that 75% of the MREIT assets be real estate related and 90% of taxable income is returned to investors as dividends.

According to the National Association of Real Estate Investment Trusts (“NAREIT”), there were 29 publicly traded MREITs with a combined equity market capitalization of $43 billion. MREITs provide critical financing and liquidity in the real estate capital markets by funding mortgage related residential and commercial loans, originating mortgages and mortgage related loans. (See NAREIT comments to SEC.) As we have seen, credit markets have tightened significantly since the financial crisis and the burst of the housing bubble. FannieMae and FreddieMac have required billions in taxpayer bailout dollars to remain marginally solvent while many in Washington call for the winding down of all government sponsored entities. According to the Mortgage Bankers Association (“MBA”), MREITs have stepped in to fill a portion of the credit void. MREITs have “raised over $30 billion of capital in 88 initial public offerings and secondary offerings since 2008” and have raised another “$11 billion in the first part of 2011 alone which translates into $71 billion of mortgage demand out of a net supply of $203 billion.” (See MBA Comments to SEC).

The SEC’s focus on the leverage that MREITs use to acquire assets seems terribly misplaced. With an average leverage of 8-1, MREITs can lock in spreads of 200 basis points and produce yields in the mid-teens. When compared to mortgages held by banks, the 8-1 leverage is tame in comparison. When a bank holds a mortgage that is not guaranteed by FannieMae or Freddie Mac, the bank is required to hold 8% capital in reserve, or an 11.5 to 1 leverage. When those mortgages are guaranteed by Fannie and Freddie, the credit reserve requirement is cut by 80% resulting in a more than 60-1 leverage. At a time when the real estate market, particularly housing, is starved for capital, freezing out an important player is ill-advised and inconsistent with the SEC’s stated goals in issuing the concept release.

A tale of two hotels - Part II

Siobhan Hayes — Tue, 06 Dec 2011 06:17:00 -0800

This post was written by Siobhan Hayes and Catrin Phillips.

Almost exactly a year ago we posted a blog on the High Court case of London Tara Hotel Limited v Kensington Close Hotel Limited, where it was decided that a personal licence to use a roadway granted to the previous owner of the Kensington Close Hotel did not prevent the current owner from acquiring an easement based on over 20 years’ continuous use. The Court of Appeal has upheld the High Court decision and made a couple of interesting comments in the process:

The High Court had decided that the original licence was personal to the previous owner of the Kensington Close Hotel (‘Kensington’). The owners of the Tara Hotel (‘Tara’) argued they had granted a licence to Kensington (which they could then terminate), to try and defeat Kensington’s claim that they had the benefit of an easement. The Court of Appeal confirmed that there could not be an implied licence or permission to the successor owner of the Kensington simply by inaction or tolerance on the part of Tara.
In order to acquire the easement based on continuous use, the owners of the Kensington had to show that the use was ‘open’, i.e. not hidden or secret. The owners of the Tara claimed that as they were not informed of the change in identity of the owners of the Kensington, the use was ‘secret’. The Court of Appeal dismissed this argument – there was no intention to keep the change in ownership of the Kensington quiet, and the use was in every ordinary sense of the word ‘open’.

Our advice therefore stands – those managing property interests should take steps to monitor the nature of any rights they have granted. As the Court of Appeal pointed out, it only means checking the position once every 18 or 19 years, which is not onerous!

The First CRC Performance League Table

Siobhan Hayes — Fri, 25 Nov 2011 02:04:20 -0800

The Environment Agency published the first Performance League Table under the Carbon Reduction Commitment (Energy Efficiency) Scheme (‘CRC’) earlier this month . One of the ideas behind the CRC is that organisations will be motivated to improve their energy efficiency (and therefore their carbon emissions) not only because they will reduce their energy costs but also because they will want to be well placed in the CRC performance league table. The league table is said to rank the energy efficiencies of each of the participants. It is debatable whether it reveals anything really significant this year, although it is possible that it may do so over time.

This post was written by Siobhan Hayes

The Environment Agency (EA) run the CRC and compiles the league table. This year the rankings are based only on two specific early actions that each participant could have taken to improve their energy efficiencies. The first is the installation of automatic metering and the second is how much each participant’s emissions are covered by the Carbon Trust Standard (which certifies organisations that achieve reductions in carbon emissions and commit to reduce them further in future) or another equivalent and EA approved carbon reduction scheme.

Critics would say that these are very simplistic measures and would not take into account any other energy efficiency measures which had already been put into place. They also point to the fact that those who took their actions too early get no credit for them in this league table. Organisations generating electricity from renewable sources for their own use whilst potentially very ‘green’ don’t count in the league table rankings (and are dealt with in a complex way for CRC reporting and buying allowances).

The league table gets a bit more interesting next year when, in addition to the metering and carbon reduction scheme standards, the ranking in the league table will be affected by:

the participants’ percentage change in their CRC emissions when compared to the first CRC year’s emissions; and
the percentage change in annual CRC emissions per unit of turnover (or revenue) which will recognise organisations that are growing sustainably.

The Government has said that it may revise the reputational element of the CRC when it sees how it operates in the first few years. A number of organisations have been critical of the league tables. The British Retail Consortium has called for them to be scrapped . Many others are critical. They certainly serve far less purpose now that there is no repayment to participants based on their position in the table.

There are some interesting facts and figures in the table though. We noticed that :

The Ministry of Defence were the biggest emitters of CRC measured CO2 (1,754,541 tonnes) and if their emissions remain the same for year 2 of the CRC their bill for allowances will be just over £21 million (at the likely fixed price of £12 per tonne)
The Charity Commission emitted 382 CRC tonnes of CO2 and would, if nothing changes, spend £4,584 on allowances

The first time the obligation to buy allowances to cover CO2 emissions will apply is 2012. When costs have to be budgeted and paid for we expect companies will be more motivated than before to take steps to reduce costs, even if these are long term plans that don’t immediately show up as a higher position in the CRC league table.

The Ostrich in the Room? Competition Law in Land Agreements - Anchor Tenant

Siobhan Hayes — Tue, 15 Nov 2011 05:56:35 -0800

This post was written by Siobhan Hayes and Marjorie Holmes.

Have those involved in property development buried their heads in the sand over the question of competition law applying to land agreements? How many carefully drafted exclusivity arrangements for anchor and major tenants could be unenforceable because of the Competition Act which now applies fully to land agreements?

The answer from the heads of terms that we are seeing is that many negotiations seem to take place without regard for competition law. Clients work on the assumption that the exclusivity agreed will be binding, so the legal process where this is questioned must be coming as an unwelcome interruption to getting the deal done.

The Problem with Exclusivity

Exclusivity is common in new retail and leisure developments (and used in many others). In competition terms, the problem with this is that it creates a barrier preventing an outsider from entering that market. When an agreement has as its purpose or effect the prevention, restriction or distortion of competition in the UK then the parties to it are at risk of being in breach of the Competition Act. Whilst we have not seen many exclusivity provisions for new developments that are entered into for the purpose of distorting competition, the question is are they having that effect, and is that effect appreciable?

In the end the question always returns to ‘what is the market’? Tenants will be used to considering this in appraising their decision to locate in a new development. However, it is not just the tenant’s market which is relevant, the developer’s market also needs to be considered. It will be necessary to consider the market for land that is suitable for the contemplated use. Out of town developments are more vulnerable to breaches of competition law. That is because if I am walking round a shopping centre looking for a cup of coffee and a coffee shop tenant has been granted exclusivity for coffee in that centre, I have to pay the price demanded or not have the coffee at all. Similarly, if I drive 30 minutes to get to my nearest out of town retail outlet to buy a new TV, and the choice is poor or they all seem expensive am I experiencing the impact of the exclusivity granted to a retailer who is exploiting the customers? Apart from, perhaps, indulging in a bit of internet shopping at home, I am unlikely to make an hour’s drive from the retail outlet to the nearest town centre as part of the same outing.

So, why agree exclusivity arrangements between developer and tenant in heads of terms which may not be enforceable? A tenant who has invested millions in a fit out (basing its decision on having a number of years with a secure return and no local competitors) may suffer if the landlord reviews all the exclusivity agreements on competition law grounds. This is not too far fetched as landlords sell on after completing the development and come under pressure to let voids. Our advice is that it is best to know the market and understand the potential restriction on competition at an early stage. That way it may be possible to see if the exclusivity agreed can be tailored to fall within the exemption, which applies if it -

provides an economic benefit to the consumers;
improves distribution or choice;
does not impose more than the bare minimum of restrictions necessary to achieve that consumer benefit; and
does not eliminate competition for a substantial part of the products in question.

We are seeing the largest tenant operators with significant fit out costs who need exclusivity to justify the decision to invest, take a thorough approach to competition law at the outset. They commission the necessary reports and research to be able to show impact on the market and evidence their claim for the exemption. Smaller tenants seem to be agreeing terms as they always did before the Competition Act was made to apply to land agreements.

Most importantly, however, it seems that in regular real estate development we will have to get used to the fact that it is unlikely that a restriction that applies for over 5 years will ever be seen as legitimate. It is now possible for developer and tenant to seek a short form opinion from the OFT as to the legitimacy of their arrangements. This may enable them to present a case for their anti-competitive provisions to continue for over five years if they can show that they are a special case. So far the OFT have not received a request for a short form opinion on land agreements but they are expected.

As well as anti-competitive provisions being unenforceable, the consequences of a breach of the Act are:

investigations by the OFT who have the power to impose fines (a percentage of the group’s global turnover);
anybody who has suffered as a result of the restrictive provision can sue for damages or an injunction;
ultimately, for the most hardcore offences, there is the risk of criminal liability and director’s disqualification.

What can be learnt from other sectors:

The grocery sector was subjected to very detailed scrutiny by the OFT and is now controlled by the Groceries Market Investigation (Controlled Land) Order 2010. Large grocery retailers are now unable to enter into any new exclusivity arrangements that restrict grocery retailing for more than 5 years from the first opening of the store. Their ability to impose restrictive covenants is restricted and some existing covenants and exclusivity agreements are unenforceable.

Those involved in industries that have always been subject to competition, like telecoms, have simply welcomed us to their world of understanding and analysing exclusive and potentially anti-competitive arrangements on a regular basis.

The future:

We can already see that the biggest developers and tenants understand their markets and their potential impact. They retain economic evidence for a future investigation or justification. Many other tenants who understand their market well may need to develop a rule of thumb about their own impact on the market, even if they do not always fully understand the developer’s position. They should probably assume that exclusivity applying for more than five years is at risk of being unenforceable. Smaller developers are starting to explore the issues. Some day soon we hope there will be an interesting OFT short form opinion on land agreements to review.

Administration Rents - Goldacre prevails for the time being...

Siobhan Hayes — Mon, 14 Nov 2011 07:51:07 -0800

We have previously posted on the impact of the 2009 Goldacre case (Goldacre (Offices) Limited v Nortel Networks UK which ruled that landlords of tenants in administration are able to claim rent as an expense of the administration when the administrators use leasehold property for the benefit of the tenant’s creditors.

Is this really as good as it seems?

On the face of it, this was a good result for landlords. However, the precedent set by the Goldacre case has meant that only rent falling due for payment after the appointment of administrators can be claimed by landlords under this special category. This has resulted in an increasing trend towards administrations starting just after a rent payment day, forcing landlords to wait until the next rent payment day (usually a full quarter) before making such a claim. Naturally, this has left some landlords substantially out of pocket and so it was no surprise to hear of a group of landlords challenging the current position.

Legal action launched by landlords against the administrators of TJ Hughes, the discount department store retailer, sought to challenge the Goldacre case and establish whether rent that had fallen due for payment prior to the appointment of administrators should also be paid as an administration expense. TJ Hughes collapsed into administration on 30 June 2011, six days after the June quarter day. As a result of the Goldacre case, the administrators were not legally obliged to pay the June quarter’s rent, despite trading from a number of the premises.

Rather unhelpfully to the rest of us, this action was settled out of Court, leaving landlords still facing this uncertainty. However, the fact that a settlement has been reached at least indicates that the precedent set by the Goldacre case is open to challenge.

There is a clear need for further clarity on the Goldacre case. Given the current economic climate which is proving difficult for retailers, it seems likely that fresh administrations will lead to similar claims, particularly following the December quarter day. To that end, we anticipate a further post in the not too distant future.

Rights of way: never straight forward!

Siobhan Hayes — Tue, 25 Oct 2011 05:21:49 -0800

This post was written by Brigid North and Emma Parsons.

In this post we revisit private rights of way from the perspective of a development site – looking at how they are created, varied, and how they can be extinguished.

Q1: ‘I recently purchased a large estate. At the time of purchase, my lawyers reported that the area close to one boundary was subject to a right of way contained in a 19^th century deed. There is no evidence that anyone has used it for a long time. I want to redevelop my land: can I build over the right of way?’

A1: No. The right of way still exists and you are not permitted to obstruct or interfere with it, unless the deed says you can. In one case, a right of way which had not been used in over 175 years was still technically in existence! Lack of use of a formal right of way is insufficient to show it has been abandoned. To be able to prove abandonment, the evidence has to be so overwhelming as to show that the person with the right of way has permanently given it up. Each case will be determined on its facts. For example:

(a) a vehicular right of way over a lane was abandoned when the beneficiary allowed the public use of the lane as a footpath. The lane was exceptionally narrow and it was established that there was not enough room for both vehicular and pedestrian use; but

(b) a right of way over a canal was not abandoned when the beneficiary sold off that part of the property which abutted the canal. It was decided that the benefit remained as the parcel of land could have been purchased again.

Q2: ‘Would it make a difference if the right of way had been acquired by use without a deed?’

A2: No. Once a right of way has been established by continuous use of twenty years it does not have to go on being used consistently. The rights obtained are the same as if the right was granted by deed and known as prescriptive rights.

Q3: ‘The owner of the adjoining property which has the benefit of this right of way is planning to redevelop his property which will increase the amount of traffic using the right of way. Can he do this?’

A3: Maybe. Again, we need to look to the deed as a whole or where there is no deed the circumstances in which the right was acquired by prescription. The context of the right is important.

Even if the deed does not limit the right of way – for example if it simply states it can be used ‘with or without carriages’ – then the amount of traffic using it may not be increased if there are other provisions in the deed that are inconsistent with this (e.g. a covenant limiting the use of the property for residential purposes).

In addition, if the rights were acquired by prescription, a change of use could result in the right being lost. For example, if the right was acquired to access a single residential property and that residential property is redeveloped for commercial purposes, it is unlikely that the right of way will be valid for the new use.

Property owners should monitor the exercise of any rights of way over their land; and those exercising a right of way need to be aware of the context in which the right arose and the limits on its use.

Finally, it should be remembered that rights can also be acquired by the public in general. The rules governing the acquisition of such rights are different and that is the subject of another blog.

Act now to influence changing asbestos regulations

Siobhan Hayes — Tue, 11 Oct 2011 06:04:38 -0800

This post was written by Hayley Steel, Christopher Parrott and Siobhan Hayes

Marks & Spencer and its contractors had unwelcome press recently when convicted and fined more than £1.15m for putting members of the public, staff and construction workers at risk of exposure to asbestos. The risks arose as a result of the removal of asbestos-containing materials from two stores during refurbishment works. Any owner or occupier carrying out refurbishments where such materials are present could face similar prosecution if the process of removal is not properly managed and carried out in accordance with the legislation. To make life more complicated, that legislation is about to change, so keeping up to date is vital.

As a result of the European Commission taking legal action against the UK Government over the existing asbestos regulations, the Health and Safety Executive (HSE) is proposing brand new Control of Asbestos Regulations. The effect of them will be to cover a wider range of employers and situations than the existing regulations, and there will be fewer exemptions for low risk works.
The new regulations will create a new category of work which is notifiable to the authorities but does not require a licence before it can be undertaken. The new category of non-licensed work, “Notifiable Non-Licensed Work” (NNLW), will require an employer to :

have arrangements to deal with accidents, incidents, and emergencies;
designate asbestos areas;
notify work with asbestos to the relevant authority;
carry out medical examinations; and
maintain health records.

Non compliance with the new provisions may lead to prosecution. In addition to concerns for employees and the public, the reputational issues as well as the fines are not something any company wants to face.

Those involved in the industry may want to comment on the HSE proposals, in particular the types of asbestos-containing materials and work activities that should be categorised as NNLW. You have until 4 November 2011 and the Consultative Document and how to respond can be viewed and downloaded from the HSE website. We will be monitoring developments.

The UK's Construction Act gets a face-lift

Siobhan Hayes — Tue, 06 Sep 2011 04:49:19 -0800

This post was written by Christopher Parrott.

Changes to construction legislation coming into force on 1 October 2011 (1 November 2011 in Scotland) will incorporate revisions to the fair payment and adjudication provisions required to be included in construction contracts. Unless developers are careful about updating their construction contracts, they may unwittingly find that the provisions they believe to be agreed are replaced with something stricter.

The changes include an overhaul of the payment procedure, with the “withholding notice” process replaced by a new “pay less notice” system. Contractors’ and consultants’ remedies following suspension for non-payment have been widened. The provisions now also apply to contracts which are not in writing.

Unless developers entering into construction contracts specifically address the changes in their bespoke contracts, or use updated standard form contracts, they run the risk that the statutory regime takes precedence. Updated JCT contracts which are compliant with these changes will be published in the next couple of weeks.

Unfortunately the legislation is not particularly well drafted and the proposed changes are difficult to interpret. For those of you concerned about the impact on your construction contracts, our experts Christopher Parrott, Jonathan Stone, and Elinor Crowther have prepared a detailed alert covering the changes to the Act which can be accessed if you follow this link.

Non-domiciles - tax-free investments in UK commercial property

Siobhan Hayes — Mon, 22 Aug 2011 09:11:03 -0800

This post was written by Annette Beresford and Siobhan Hayes.

Next year could bring some interesting changes for non-UK domiciled developers and investors in UK property. Businesses that undertake the development of commercial or residential property or the letting of commercial property may gain the tax-free use of offshore income and gains in the UK. The Government is consulting on a proposal to allow this from 6 April 2012.

The key points of the proposal are -

To qualify for tax-free treatment, the investment must be made through a company which is UK resident or has a permanent establishment in the UK. The Government is considering whether to include listed companies.
Investments in a company that develops commercial or residential property as its trade will be permitted as well as investments in certain types of residential property such as nursing homes or hospitals where a commercial trade is carried on. However, the letting of residential property will not qualify.
An investment may be made through subscribing for or acquiring share or loan capital in the company (or a mixture). There will be no restriction on the size of the investment. The investment may be made directly by the non-domiciled person or through any kind of offshore investment vehicle or trust.
There will be anti-avoidance provisions to prevent abuse of the relief which will include the making of non-commercial payments (such as inflated salaries or non-commercial loans) to ‘leak out’ the value of the investment to the individual. Non-domiciles will be prevented from selling a business they already own to a new company funded by overseas income.
If the investment is disposed of, the proceeds must be taken out of the country within two weeks or be reinvested in another qualifying business within two weeks. If this is not done, the offshore income and gains originally invested will become subject to UK tax in accordance with normal rules.

The proposal may change as a result of the consultation and if it does we will post an update.

Telecom Agreements - Beware of the Electronic Communications Code!

Siobhan Hayes — Tue, 16 Aug 2011 04:55:27 -0800

This post was written by Laura Peasnell and Siobhan Hayes.

Telecom masts can be a welcome source of income but can also pose problems when you want to redevelop a property. The Law Commission has just announced that it is going to review the Electronic Communications Code which may be good news for property owners. The review process will take until Spring 2013, so it will continue to be important for owners to exercise caution when telecoms operators want to place equipment on their land. Given this week’s news about increasing broadband speeds for parts of the country that are badly served at present, more electronic communications sites will be needed by the operators.

During the last two decades, landowners took advantage of the race run by telecoms companies to improve network coverage across the country by allowing mobile phone masts and other telecoms equipment to be put on their land for a rent or a licence fee. However, the decision to enter into these agreements - often without taking legal advice - can cause a costly and troublesome barrier to the removal of equipment when the original agreements have ended or a redevelopment is planned.

The big problem is that a landowner can only force the removal or alteration of telecoms apparatus installed on their land by following a statutory procedure. Whether they realised it or not, they are bound by the Electronic Communications Code and, unlike the Landlord & Tenant Act 1954 provisions, it is not possible to contract out of it.

Statutory Procedure

When the landowner wants an alteration to the equipment or wants his land back (or does not want the equipment there in the first place) they have to serve a notice on the operator requiring the removal of the telecoms equipment. If the operator objects he can go to Court to get an order to stay without any agreement. The trouble is that there is no case law establishing principles that could be relied on to interpret the Code.

Our Market Experience

To date, operators have managed to reach settlements with landowners without needing to have their day in Court. Currently we are seeing a pattern of industry consolidation where operators ‘buddy up’ and share telecoms space under existing arrangements with landowners. We are also seeing operators now threatening litigation although so far their actions have remained at the threat stage. Obviously it is not in the operator’s commercial interests to alienate the property industry and they should generally still be motivated to negotiate.

Conclusion

The potential difficulty and costs involved in obtaining vacant possession at the end of an agreement may well outweigh the short-term financial gains! Therefore, landowners should carefully consider the long-term implications of agreements with operators, no matter how innocuous the proposed arrangements may appear. Restrictions on the operators on their use of the equipment on the land may be tough to negotiate but will prove invaluable. Our experience allows us to suggest a number of ways in which landowners can protect themselves against the threat of enforcement of the Code – please contact one of the authors of this blog or your usual Reed Smith contact.

Submissions

Submissions to the Law Commission are not currently required until September 2012. This post will be updated then to discuss potential submissions on the proposals set out in the consultation paper.

News on Guarantees

Siobhan Hayes — Thu, 28 Jul 2011 04:18:29 -0800

This post was written by Jon Pike, Richard Perkins and Siobhan Hayes.

Last spring we posted on the difficulties facing landlords and tenants as a result of the High Court decision in Good Harvest. Yesterday we had some good news as the Court of Appeal has reconsidered the point and introduced some commercial common sense into the law.

The case in question is K/S Victoria Street v House of Fraser and the contract provisions that were being examined in detail were unusual. We are not commenting on those. It is the Court’s remarks about guarantees that are of interest rather than their decision on the very specific facts of the case. We now know that with the right wording a tenant’s guarantor can guarantee the tenant’s obligations given in an authorised guarantee agreement (AGA) when a lease is being assigned.

The practical implications for investors are –

On the grant of a new lease best practice for landlords will be –

to require the valuable company to be the tenant company and not just a guarantor
to prohibit assignments intra-group so as to retain control
to impose a pre-condition to any assignment that any guarantor of the outgoing tenant guarantees their obligations in the AGA

When a tenant wants to assign a lease

landlords can require that the original guarantor guarantees the outgoing tenant’s obligations being given in the authorised guarantee agreement
no direct guarantee of the assignee’s liabilities will be enforceable even if given voluntarily by the original guarantor

When an investment acquisition is taking place check early if there are any guarantees with significant covenant strength where the relevant lease has been assigned. Assume any direct guarantee of an assignee will be unenforceable and factor that into any valuation.