Real Estate Legal Update : Global Corporate Real Estate Property and Planning Lawyer & Attorney : Reed Smith Law Firm

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.

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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.

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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.
 

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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 –

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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.”

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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.

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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.

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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.

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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.

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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:

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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.

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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? 

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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?

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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.

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