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THE PLACE OF LAWYERS IN REAL ESTATE TRANSACTIONS New Jersey Supreme Court [T]he record does not contain

proof that, in the aggregate, the damage that has occurred in South Jersey [where lawyers are seldom involved in residential closings] exceeds that experienced elsewhere [in North Jersey where lawyers typically preside over residential closings.] In this case, the absence of proof is particularly impressive, for the dispute between the realtors and the bar is of long duration, with the parties and their counsel singularly able and highly motivated to supply such proof as may exist. The South Jersey practice also appears to save money. For the record demonstrates what is obvious, that sellers and buyers without counsel save counsel fees. We believe, given this record, that the parties must continue to have the right to decide whether those savings are worth the risks of not having lawyers to advise them in what is almost always the most important transaction they wrn ever undertake, We realize this conclusion means that throughout the transaction, sellers and buyers may not have the benefit of their own counsel but will look to brokers and title officers, often with conflicting interests, for practical guidance and advice. Lawyers owe a duty of loyalty to their clients that is paramount to all other considerations. This loyalty often results in cost savings to a client in the thousands of dollars. Commercial Closings Lawyers may be asked to negotiate, draft contracts, review documents and actually process the closing.

Aspects of Modern Real Estate Practice Residential real estate markets are no longer local. Rather than having countless individual local markets for real estate transactions, we now have a fully integrated market operating at the super-regional, national and international levels. This transformation away from local and toward a more fully integrated national market has enhanced the profitability of real estate related activities and has raised important implications for the practice of law. In particular, with respect to the standard applied to the quality of professional legal services, it has shifted the frame of reference for determining a minimal level of competence for the exercise of professional judgment.

The driving forces behind this change were the sudden availability of new investment vehicles--which offered traditional household savers far higher returns than regulated passbook savings accounts--and the development of the legal and technical infrastructure needed to support a modern secondary mortgage market for indirect investment in residential real estate activities.

The modern secondary mortgage market has been responsible for reviving the financial health of many lending institutions. keeping residential real estate markets liquid reducing mortgage costs, and reviving the financial health of many lending institutions

Most significantly, real property and mortgage laws have been pushed toward greater uniformity as lenders have turned their attention to the demands of distant and wealthy mortgage market investors, and away from the particular concerns of local borrowers. Simply stated, the real estate business is no longer local because the money is no longer local. The client will expect the attorney to understand and explain the roles of these professionals, as well as confer, and where necessary, negotiate with them while diligently protecting the buyer's expectations. In sum, the lawyer must be the one person in the transaction who, at every step, is completely committed to the buyer's interests. The Role of the Lawyer The lawyer's job involves understanding the consequences of the law, the role of legal institutions, and the dynamic context in which legal transactions take place. The Role of the Lawyer Where possible, the lawyer should act to eliminate or reduce the risk of an unexpected contingency or potential loss. The Role of the Lawyer Even when certain risks cannot be eliminated, the lawyer must use the law to minimize potential future risks to the client. This may include bringing in professionals like building inspectors or surveyors to prepare opinions on the property, or it may involve arranging for insurance to cover known, or knowable, risks such as potential losses due to fire or earthquakes. 2

The Role of the Lawyer It also involves making use of contract contingencies, representations and warranties, indemnification agreements, subordinations, and a variety of other legal tools. The Role of the Lawyer All real estate transactions involve risks, and the primary reason for hiring a lawyer is to engage a professional who is competent in the understanding, identification, and proper management of the risks involved. The Role of the Lawyer the attorney in a commercial real estate sale is requested to perform legal due diligence The Role of the Lawyer This type of due diligence is a two-step process: first, the attorney collects every piece of paper relevant to the deal, including leases, notes, mortgages, easements, franchise agreements, environmental reports, government records pertaining to the property, and applicable statutes.

The Role of the Lawyer Second, the attorney scrutinizes each one of these documents to make sure the client is receiving exactly what was promised. To do this, the attorney needs to know the clients expectations. For example, the attorney representing a buyer purchasing an incomeproducing property such as an office building or shopping center will carefully match the projected rents as described in the promotional material with the provisions in all existing leases. Lease clauses for review: 3

Are there lease termination or rent abatement rights Are there guaranties for the leases With shopping centers are there operating hours obligations and going dark provisions Are there security deposits and are they held as specified in the leases. Are there any outstanding brokerage commissions due Utilities Rights to assign or sublet. Residential issues Stabilized tenants Controlled tenants Dhcr complaints

Lease clauses for review contd: Are there lease termination or rent abatement rights Are there guaranties for the leases With shopping centers are there operating hours obligations and going dark provisions Are there security deposits and are they held as specified in the leases. Are there any outstanding brokerage commissions due Utilities Rights to assign or sublet. Residential issues Stabilized tenants Controlled tenants Dhcr complaints 4

PROFESSIONAL RESPONSIBILITIES OF THE REAL ESTATE TRANSACTIONS LAWYER Engagement Letters Non Engagement Letters New Court Rule Requires Lawyers to Provide Letters of Engagement to Clients lawyers are required to provide many clients with a "letter of engagement." The purpose of the rule, as explained by the New York State Office of Court Administration, which initially proposed the rule in June 2001, is "to ensure that there is a memorialized meeting of the minds with regard to the basic terms of the engagement." There are three basic components to the letter: (1) explaining the scope of legal services to be performed; (2) explaining the fees and expenses to be charged, along with the lawyers billing practices; and (3) noting that the client may have a right to arbitration of any fee dispute that may arise under Lawyers who choose not. to use engagement letters, however, are asking for trouble. Without an express agreement about the representation, the agreement between the attorney and client may be implied. In the course of implying the existence and terms of the agreement, all contested matters are likely to be resolved against the attorney, who should have known better than to enter a professional relationship without specifying its parameters in an engagement letter. John M. Bur,nan, Ethical Considerations When Representing Organizations, 3 WYO. L. Rev, 581, 585-86 (2003). The ABA Model Rules of Professional Conduct require a lawyer to: (1) (2) (3) Provide competent representation; Abide by the clients decisions as to the scope and objectives of the representation; Act with reasonable diligence;

(4)Keep the client informed; (5) (6) (7) (8) Avoid overcharging the client; Avoid revealing confidences; Avoid conflicts of interest; Avoid business relationships with or adverse to clients; and 5


Hold the property of others with the care of a fiduciary.

Attorney Representation of Multiple Parties The American Bar Association favors separate counsel so that conflicts of interests between lawyer and client can be avoided and conflicts between purchaser and vendor can be anticipated and clearly resolved. *T+he prevailing ethical model of a partisan advocate acting zealously with absolute loyalty to a single client frowns upon a lawyer with divided loyalties since no man may serve two masters. Model Rules of Professional Conduct Client-Lawyer Relationship Rule 1.8 Conflict Of Interest: Current Clients: Specific Rules Rule 1.8 Conflict Of Interest: Current Clients: Specific Rules (a) A lawyer shall not enter into a business transaction with a client or knowingly acquire an ownership, possessory, security or other pecuniary interest adverse to a client unless: (1) the transaction and terms on which the lawyer acquires the interest are fair and reasonable to the client and are fully disclosed and transmitted in writing in a manner that can be reasonably understood by the client; (2) the client is advised in writing of the desirability of seeking and is given a reasonable opportunity to seek the advice of independent legal counsel on the transaction; and (3) the client gives informed consent, in a writing signed by the client, to the essential terms of the transaction and the lawyer's role in the transaction, including whether the lawyer is representing the client in the transaction.

Rule 1.7 Conflict Of Interest: Current Clients (a) Except as provided in paragraph (b), a lawyer shall not represent a client if the representation involves a concurrent conflict of interest. A concurrent conflict of interest exists if: (1) the representation of one client will be directly adverse to another client; or (2) there is a significant risk that the representation of one or more clients will be materially limited by the lawyer's responsibilities to another client, a former client or a third person or by a personal interest of the lawyer.

(b) Notwithstanding the existence of a concurrent conflict of interest under paragraph (a), a lawyer may represent a client if:

(1) the lawyer reasonably believes that the lawyer will be able to provide competent and diligent representation to each affected client; (2) the representation is not prohibited by law; (3) the representation does not involve the assertion of a claim by one client against another client represented by the lawyer in the same litigation or other proceeding before a tribunal; and (4) each affected client gives informed consent, confirmed in writing.

Under what circumstances is a lawyer permitted to represent multiple clients in the same or substantially similar matters? A lawyer may represent multiple clients in the same or substantially similar matters provided that the lawyer's conduct conforms to DR 5-105 of the Lawyer's Code of Professional Responsibility, as amended June 30, 1999. See 22 NYCRR ? 1200.24. DR 5-105(A) and (B) provide, respectively, that a lawyer shall decline proffered employment or shall not continue multiple employment, "if the exercise of independent professional judgment in behalf of a client will be or is likely to be adversely affected by the [multiple representation], if it would be likely to involve the lawyer in representing differing interests, except to the extent permitted under DR 5-105(C)." The Definitions section of the Lawyer's Code defines "differing interests" as "includ[ing] every interest that will adversely affect either the judgment or the loyalty of a lawyer to a client, whether it be a conflicting, inconsistent, diverse, or other interest." Multiple representation can cause serious hardship to one or more clients if a lawyer is forced to withdraw after having performed significant legal services. DR 5-105(C) permits multiple representation in the situations covered by DR 5-105(A) and (B) "if a disinterested lawyer would believe that the lawyer can competently represent the interest of each and if each consents to the representation after full disclosure of the implications of the simultaneous representation and the advantages and risks involved."

The lawyer, before engaging in a dual representation, should prepare for both parties a comprehensive explanation of potential areas of disagreement that could arise.8 Until being shown a lucid depiction of potential areas of conflict, most clients wont be in a position to grant meaningful consent. The Scrivener Exception. Some courts have allowed a lawyer to represent both parties when acting primarily as a scrivener, implementing an agreement the parties have already negotiated between themselves. 7

Duty of Confidentiality to the Client. Acutely aware of the confidentiality rule, attorneys in their initial meetings caution potential clients not to reveal confidential information until they have worked out the terms of a mutually acceptable engagement agreement because, until then, the client may not be entitled to the benefit of the lawyer. client privilege.) Attorneys Duty to Unrepresented Party. when an attorney represents one of the parties to a real estate deal, and the other is unrepresented, does the attorney owe any duty of professional care to the unrepresented party? Generally speaking, under current case law, an attorney may be liable to a non-client if the client intended the attorneys services to benefit the non-client, or the attorney knew or should have known that the non-client would rely on the attorneys actions. [A]ttorneys may owe a duty of care to non-clients when the attorneys know, or should know, that non-clients will rely on the attorney's representations and the non-clients are not too remote from the attorneys to be entitled to protection ... [A] lawyer's duty may run to third parties who forseeably rely on the lawyer's opinion or other legal services. Petrillo, 139 N.J. at 483-84, 485, 655 A.2d 1354

An attorney is under an ethical obligation to do two things. First, the attorney must explain to the unrepresented opposing party the fact that the attorney is representing an adverse interest. Second, the attorney must explain the material terms of the documents that the attorney has drafted for the client so that the opposing party fully understands their actual effect. When the transaction is as one-sided as that in the present case, counsel preparing the documents is under an ethical duty to make sure that an unrepresented party understands the possible detrimental effect of the transaction *emphasis added+ and the fact that the attorneys loyalty lies with the client alone.


SOURCES OF DATA ABOUT PROPERTIES AND NEIGHBORHOODS Brokers Neighbors Local Periodicals THE NEGOTIATION PROCESS SHOULD YOU NEGOTIATE DIRECTLY, THROUGH OR WITH AN AGENT? For one thing, brokers seldom actually negotiate. They calmly carry offers and counteroffers back and forth passively between the parties. Because they depend on sales commissions for a living, brokers are motivated to conclude deals quickly, not necessarily the best thing for the principals. METHODS OF FINANCIAL ANALYSIS FOR REAL ESTATE INVESTMENTS STANDARD METHODS OF VALUING REAL ESTATE comparing rates of return on potential investments, and displaying estimated yields. ESTIMATING YIELDS ON REAL ESTATE INVESTMENTS The investor buying income producing realty anticipates contributing capital at the outset and possibly being called upon to invest additional capital during the life of the project, as planned or needed. In return, the investor anticipates three sources of gain: (1) annual cash flow from rents, (2) equity appreciation from eventual sale, and (3) federal income tax benefits. CURRENT YIELD/CASH ON CASH RETURN Example: an investor buys land for $5,000,000 and 9

sells it for $6,000,000 a year later. To simplify further, assume the investor has no holding costs (no property taxes or insurance premiums to pay) and no selling costs (brokerage fees, legal, title and escrow charges). The investors net profit is $1,000,000a 20% cash on cash return on its $5,000,000 investment. Cash on cash/current yield has significant drawbacks in failing to account for variations in the timing of income and expenses and producing a single number representing the rate of return on the investment. To depict the impact of timing, investors use annualized spreadsheets to calculate their current yield for multi-year Investments. Example: An investor buys an apartment building for $10,000,000, paying $3,000,000 in cash, and borrowing the balance. The gross rental income in the first normal year of operation is $1,550,000. Annual operating expenses are $500,000. Subtract gross income from operating expenses to derive net operating income (NOl), in this case, $1,050,000. Annual debt service is $600,000. Subtract these two numbers from gross income to derive cash flow after debt service$450,000. In the first year of this investment, the investors cash on cash return, the return on equity, is 15%450,000/3,000,000. Suppose rents and operating expenses increase annually, rents more rapidly than expenses in absolute terms though not in percentage terms. Here is how a five-year analysis might look: PRESENT VALUE Because the timing of inputs and returns from each realty asset is unique, analyzing an individual investment or comparing one investment with another, requires a reliable technique for placing a time value on money, a method sensitive to the varying time value preferences of each investor.


Present value represents the sum a person would pay today for an amount to be received in the future and represents a search for the payees indifference pointthe least sum acceptable to a particular individual for the deferred payment. . NET PRESENT VALUE AND INTERNAL RATE OF RETURN Net Present Value (NPV) compares the value of a dollar today versus the value of that same dollar in the future. It represents the dollar amount by which a particular investment outperforms or underperforms an investors benchmark rate, or desired discount rate. The NPV formula takes into account the amount of cash the investor will receive each year, including the residual value upon sale, and the timing of income and expenses, by summing the present value of all the outflows (expenses) a project or improvement requires, with all the inflows (income) the project or investment is expected to yield. the Internal Rate of Return is the percentage rate that would make the cash flows plus residual value equal to the current market value of the investment. Internal in IRR means that the formula only includes returns on capital earned while still invested in the project. Once capital has been withdrawn from the project, returns on that capital no longer count towards project IRR. Conversely, the IRR formula presumes that the investor earns interest on accrued interest left in the deal. Interest is usually compounded annually but IRR formulas exist to account for compounding at any interval: daily weekly, monthly, quarterly, or continuously.

When Investors Dont Receive Promised Yields, Is the Promoter Liable to Them? Even if the investors had actually relied upon those numbers in deciding to place their funds with the developer and even if the developer had intended for the investors to rely on the projected numbers, the court would have regarded that investor reliance as patently unreasonable. Here, plaintiffs could easily have obtained background information about the anticipated state of the Harlem real estate market by consulting the legal and financial advisors who had guided their previous investment decisions. Plaintiffs could also have requested supporting 11

documentation for the project summaries, investigated the project site and its existing leases, reviewed the construction contract and asked for more information about theY terms and success rate of *the developer+s other real estate development ventures. In any event, the business judgment rule shielded the promoter from liability to the investors since they ould come up with no hard evidence of bad faith, conflict of interest or personal bias Johnston v Norton The claim that withstood the defendants multiple motions for summary dismissal was the attorneys breach of a fiduiary relationship for the unauthorized release of escrowed funds entrusted to them. APPROACHES TO VALUATION Market Comparison Approach: Principle of Substitution APPROACHES TO VALUATION Cost Approach: Principle of Contribution. The cost approach values property with a five-step process. (1) The appraiser values the land. (2) The cost of improvements is added, usually based on replacement cost. (3) The appraiser deducts the depreciation caused by curable and incurable physical deterioration, functional deficiencies and obsolescence, adverse economic influences, and changes in market preferences. (4) The appraiser deducts the accrued depreciation from the reproduction cost of improvements to arrive at the depreciated cost estimate. (5) The appraiser adds the estimated land value to the depreciated cost estimate to arrive at a value estimate for the property or site. APPROACHES TO VALUATION Income capitalization Approach: Principle of Anticipation The appraiser considers: (1) historical operating expenses such as energy bifis, maintenance contracts, etc.; (2) historical building management forecasts; (3) existing leases and billed escalation rates; (4) must-take space, rights of first refusal and/or options given to 12

existing tenants; (5) market rents in light of existing supply and demand, future construction, proposed buildings, building moratoria, and zoing adjustments; (6) existing financing; . (7) repair history and estimated life of major building systems such as heating, ventilation, air conditioning, roofing, etc.; (8) commissions to leasing brokers in the area and tenant improvement allowances given to attract tenants in the market place; (9) proposed renovations, possible expansions, and mandatory retrofitting such as asbestos removal, fire sprinklers, etc; and (10) economic factors such as job growth and inflation. The next step is to select a discount rate for the project. The discount rate, or required rate of return, reflects the risk level .of the project, inflationary expectations, market expectations, interest rates, and duration of the project. Using this discount rate, the appraiser values the project cash flow for each year of the investment, adds these figures together, and subtracts the initial investment to determine th present value of the property. THE PRO FORMA The financial feasibility package contains the pro forma, which describes the projects estimated income and expenses.


OBTAINING ENTITLEMENTS FOR REAL ESTATE DEVELOPMENT Zoning and Land Use An Introduction to Zoning Terminology New York City is divided into three basic zoning districts: residential (R), commercial (C) and manufacturing (M). http://nyc.gov/html/dcp/pdf/zone/map16c.pdf The three basic categories are further subdivided by the intensity of use, whether for retail or manufacturing categories, parking, building bulk or residential density. Each zoning district regulates permitted uses; the size (bulk) of the building permitted in relation to the size of the lot; the required open space for residential uses on the lot or the maximum amount of building coverage allowed on the lot; the number of dwelling units permitted on the lot; the distance between the building and the street; the distance between the building and the lot line; the amount of parking required; and other requirements applicable to specific residential, commercial or manufacturing activities, including the size and placement of signs. AS-OF-RIGHT DEVELOPMENT


This means that a developer may build a structure "as-of-right" if the Department of Buildings is satisfied that the structure complies with the provisions of the Zoning Resolution and the Building Code. No action is required by the City Planning Commission under such circumstances. The developer simply files plans with the Department of Buildings and can begin construction upon issuance of a building permit. BUILDING SIZE The maximum size (or bulk) of a building on a lot is determined by the floor area ratio (FAR) assigned in the Zoning Resolution to each zoning district A building can contain floor area equal to the lot area multiplied by the floor area ratio (FAR) of the district in which the lot is located DENSITY Applying only to residential developments, density refers to the number of people living in a certain area, generally expressed in terms of the number of families, households or housing units per acre. Density controls, one of several ways used to control the intensity of development, permit the city to plan in an orderly way for new schools, utilities and transit. DISCRETIONARY ACTIONS Special Permits Some development is allowed only by special permit granted either by the City Planning Commission with City Council review or by the Board of Standards and Appeals. There are two types of special permits: modifications of the use regulations and modifications of the bulk or parking regulations. In general, projects that have greater land use impacts or involve significant planning issues are under the jurisdiction of the City Planning Commission; localized issues are reviewed by the Board of Standards and Appeals Authorizations At its discretion, the City Planning Commission, by resolution at a public meeting, may modify certain zoning requirements provided that specific findings set forth in the Zoning Resolution have been satisfied. Unlike the procedure for special permits, a public hearing is not required. Certifications For some as-of-right development, the City Planning Commission or the Chairperson of the City Planning Commission is required to administratively certify to the Department of Buildings that certain specified conditions set forth in the Zoning Resolution have been satisfied before a building permit may be issued 15

Appendix A Index of Uses When a district associated with a given #use# is designated in the Index with an asterisk (*), the #use# is permitted in such district only by special permit of the Board of Standards andAppeals, as set forth in the applicable portions of this Resolution. When a district associated with a given #use# is designated in the Index with a double asterisk (**), the #use# is permitted in such district only by special permit of the City Planning Commission, as set forth in the applicable portions of this Resolution. #Uses# listed in Use Group 11A, 16, 17, or 18 as permitted #uses# in C8 or #Manufacturing Districts# must also meet the applicable performance standards for these districts. #Uses# listed in Use Group 18 are permitted in M1 or M2 Districts if they can comply with the applicable performance standards for those districts. Variances Sometimes the peculiar shape or unusual topography of a parcel would cause unnecessary hardship were the owner required to comply with all the applicable regulations of the Zoning Resolution. In such cases, the Board of Standards and Appeals may grant variances from the use and bulk provisions of the Resolution to the extent necessary to permit a reasonable use of the parcel. OPEN SPACE / OPEN SPACE RATIO In some districts, the amount of open space required is determined by the open space ratio (OSR) which expresses the percentage of total floor area of a building that must be provided as open space on a development parcel. PARKING Zoning laws also require the provision of off-street parking for most new developments. Parking on the site of a new development helps eliminate congestion on nearby streets. USE GROUPS The uses permitted in each zoning district are found in one or more of eighteen use groups set forth in the Zoning Resolution. The uses listed in each use group have common functional or nuisance characteristics. The use groups start with residential and community facility uses (Use Groups 1-4) and work their way up from local retail and service uses (Use Groups 5-9) to regional shopping centers/amusement uses (Use Groups 10-12), waterfront/recreation uses (Use Groups 13-15), 16

heavy automotive service (Use Group 16) and manufacturing uses (Use Groups 17 and l8). The text identifies which use groups are permitted in each zoning district. THE ULURP PROCESS Actions Requiring ULURP Changes to the City Map Mapping of subdivisions or platting of land into streets, avenues or Public Places Designation or change of zoning districts Special Permits within the Zoning Resolution requiring approval of the City Planning Commission (CPC Contd Site selection for capital projects Revocable consents, requests for proposals and other solicitations or franchises, and major concessions Housing and urban renewal plans and project pursuant to city, state and federal laws Disposition of city owned property Acquisition of real property by the city ULURP Review Process Filing of Application Certification.

Community Board Review Borough President Review City Planning Commission Review. City Council Review Mayoral Review THE OFFICIAL PLAYERS IN THE LAND USE ENTITLEMENT GAME (1) elected local officials (2) planning boards or commissions 17

(3) the planning staff of the local government, (4) staff members of other agencies (5) area residents (6) other unofficial players Elected Officials Control Zone changes, general plan amendments and the environmental documentation accompanying them. Planning Boards or Commissions the first official say on many matters headed for the local legislature. (e.g., zoning, plan amendments): In many communities they also have the last word on administrative or quasi.judicial . matters (subdivision approvals, HI variances, conditional use permits, planneA unit developments) unless the city council or board of supervisors accepts an appeal on the decision First Steps in Performing Entitlement Due Diligence (1) talking with earlier applicants, (2) studying the transcripts and files of similar cases (3) auditing public hearings on planning and zoning matters; (4) reading local newspaper accounts of past planning controversies; (5) reading the public conflict-of-interest disclosure forms where required of local officials; and (6) meeting with officials to discuss the specific project application or their views on land use issues generally Pay to Play . Developers donations purchase access, by which they mean the opportunity to discuss their problems privately with the officials whose campaigns they helped finance lawyers with political connections to the leadership were more successful in obtaining rezonings than lawyers without traceable connections MANAGING A LAND USE CONTEST Public Hearings 18

Petitions Developer Strategy Opposition Tactics Developer Rebuttal Appeal By the Opposition DEALING WITH NEIGHBORS The Influence of Neighboring Homeowners Homeowners lack a legal entitlement to prevent zoning changes or new subdivisions, but nonetheless often strongly influence the officials making those decisions Legal Limits on Delegation of Public Authority to Homeowners Groups Advance Meetings with Neighboring Owners: the Pros and Cons Local elected officials appreciate and sometimes mandate developer efforts to defuse potentially, explosive planning decisions. Even if efforts at compromise fail, the developer learns the basis of complaints neighbors will likely air when the developer s case goes before the planning commission or city council. Bruce Ratner's challenge Reaching Enforceable Understandings Between the Developer and the Neighbors Written Contracts and Deed Restrictions for the Benefit of the Neighbors Contract and Tort Enforcement of Developers Unwritten Promises Community Benefits Agreements Community Benefit Agreements (CBAs) deals between developers and coalitions of community organizations, addressing a broad range of community needs are safeguards to ensure that affected residents share in the benefits of major developments. They allow community groups to have a voice in shaping a project, to press for community benefits that are tailored to their particular needs, and to enforce developers promises. Community Benefits Agreements Making Development Projects Accountable published by Good Jobs First and the California Partnership for Working Families, As local governments grapple with their responsibility to shape development and land use patterns, a new movement has emerged to challenge conventional thinking and offer a broader 19

vision. This movement is centered on the concept of community benefitsthe simple proposition that the main purpose of economic development is to bring measurable, permanent improvements to the lives of affected residents, particularly those in low-income neighborhoods. This new movement is pressuring the public sector to play a more strategic role in land use planning and urban growth, in order to leverage its multibillion dollar investment in the private sector toward creation of good jobs, affordable housing, and neighborhood services that improve the quality of life for all residents. Conditional Zoning The concessions agreed to by the developer can become specific conditions attached to the developers rezoning, Planned Unit Development, Specific Plan, Conditional Use Permit or Speda1Exception. Development Agreements Local governments may enter development agreements either by authority of state statute or through aggressive use of their zoning powers. Developer Lawsuits Against Project Opponents Strategic Lawsuits Against Public Participation (SLAPP) Four criteria have been suggested for classifying an action as a SLAPP suit: (1) commencement of an action or interposing a counterclaim seeking monetary damages or injunctive relief; (2) filed against non-governmental individuals or groups; (3) as a consequence of communication to a governmental entity or the public; (4) on an issue of public interest.[ New York Law JUDGE DISMISSES ACTION, FINDS DEVELOPER SOUGHT TO CURB PUBLIC COMMENT 1/7/2009 N.Y.L.J. 1, (col. 3) Citing Civil Rights Law 70-a, 76-a, which says a plaintiff in a SLAPP suit must meet a heightened burden of proof to avoid summary judgment dismissing the action, the judge noted a plaintiff must demonstrate that its action has a substantial basis in fact or law or is supported by a substantial argument for an extension, modification or reversal of existing law. Private Nuisance Actions Against Uses Allowed by Zoning 20

Once the project is underway, or even after it has been completed, disgruntled neighbors can initiate private nuisance claims for interference or disturbance of the use and enjoyment of their homesteads. CONTROLLING SUBDIVISIONS THROUGH THE SUBDIVISION MAP ACT S Subdivision regulations are land use controls that. govern the division of land into two or more lots, parcels, or sites for building The Approval Process 1. when the developer completes an application for a tentative map and submits it to the appropriate local government agency. A tentative map (sometimes called a preliminary plat) is a drawing detailing the design of project 2. Local governments can condition approval on the construction of roads, sewers and water connectionsconditions which must be met before a final map can be recorded and sales begin. PAYING FOR PUBLICLY REQUIRED INFRASTRUCTURE IN NEW SUBDIVISIONS THE FOUR WAYS TO FINANCE PUBLIC INFRASTRUCTURE The Government Pays The Developer Pays Owners of Benefited Property Pay Future Home Owners Pay DEVELOPER EXACTIONS IMPACT FEES are charges against new developments to defray a portion of the cost of basic services and facilities local government provides to its citizens. Specifically, they take the form of cash assessments, usually paid at the time a building permit is issued, to finance off-site capital improvements such as roads, sewers, parks or schools necessitated by the new development. IMPACT FEES: OVERVIEW OF NEW YORK LAW 2/5/90 NYLJ 1, (col. 1) In Nollan v. California Coastal Commission,58 the U.S. Suprme Court restricted government authority to impose conditions in the course of grantrng discretionary permits such as those required to subdivide land;


The Court affirmed a rule already widely applied by state courts, that th government demonstrate a rational nexus between the condition or dedication requirement and the harm likely to result from the proposed project without condition or dedication.


CHOICE OF ENTITY WHAT FACTORS WILL PARTIES CONSIDER IN SELECTING A BUSINESS ENTITY? The primary factors include protection of the owners of the business from debts, obligations and liabilities of the business, and

achieving favorable tax treatment.

Secondary factors include items such as flexibility of management, control, simplicity, cost, transferability of interests, and ease of raising capital.

WHAT ARE THE SPECIFIC CONSIDERATIONS IN REAL ESTATE TRANSACTIONS? 1.The nature of the particular real estate interest 2.The reasons for the acquisition of the real estate 3.The reasonable expectation that business objectives could change 4.The parties 5.The financial resources of the respective parties 6.The type of entity the parties are currently using and the possibility of conversion to another form with or without adverse tax consequences 7.The importance of limited personal liability to one or more of the parties. 8.The particular tax status and tax objectives of the respective parties 9.The jurisdiction or jurisdictions in which the entity will operate.


Requirements to form and maintain the entity. How difficult and expensive is it to form and maintain such entity? If the entity will do business in more than one state, what additional costs are involved?

Will the entity require formal annual meetings? Will there be periodic reporting and/or security laws compliance requirements? Extent of owner/investor liability.


To what extent are each of the owners/investors prepared to have or share in personal liability for the obligations of the entity?

3. Management and control. Who is to exercise day-to-day management responsibilities?

Who is to have ultimate control?

For instance, will borrowing money require investor approval?

Will this responsibility or authority change at various stages of the project?

4. Transferability of interest. How desirable will it be to limit or facilitate transferability of ownership interests? 5. Legal flexibility.

To what extent are the activities and agreements of the owners governed by statutory provisions? Can the owners contract around these statutory provisions, and can the form of entity be easily converted to another?

6. Continuity of life. 24

How important is it to the owners and/or managers that the entity have continuity of life?

7. Methods to get money out. One of the most important factors to many owners is how they will be able to withdraw the profits returned on their investment and/or their principal 8. Tax considerations.

Last, but by no means least, what is the tax treatment of the entity? Because of the desirability of avoiding double taxation, pass-through status is normally the preference. Other tax concerns include the issue of whether and to what extent selfemployment taxes will be payable. sole proprietorship sole proprietorship is a business owned and operated by a single person. Formation. A sole proprietorship comes into existence when the proprietor first uses property or offers services in the conduct of a trade or business. no formal requirements to form a sole proprietorship, and no annual filings are required. Tax Treatment. A sole proprietorship is not a separate entity for tax purposes. The proprietor reports all items of income, gain, loss, deduction and credit on Schedule C of his or her personal income tax return. Liability. The owner is entitled to all of the profits and, likewise, is responsible for all of the debts. Notably, the sole proprietor has unlimited personal liability for acts of employees and obligations of the business. Tenancy In Common Tenancy In Common A tenancy in common is not a partnership, nor are other forms of joint ownership of property, such as joint tenancy and tenancy by the entireties. F.S. 620.8202(3)(a). is a specific type of concurrent, or simultaneous, ownership of real property by two or more parties. All tenants in common hold an individual, undivided ownership interest in the property. This means that each party has the right to alienate, or transfer the ownership of, her ownership interest. This can be done by deed, will, or other conveyance. tenants in common may hold unequal interests. General Partnership 25

A general partnership is an organization composed of two or more persons formed for the purpose of conducting a business for profit. Formation. The partnership may be organized by an agreement that is written, oral, or implied. It is possible to inadvertently form a partnership. Interstitial Statutes In the absence of written partnership agreement, the general partnership is governed by statute. Tax Treatment. Although a partnership is not a separate legal taxpaying entity, it nevertheless files a tax return for informational purposes to report its income or losses, and to report each partner's share of partnership income and deductions. Liability. Each partner is jointly and severally liable for all debt and obligations of the partnership. On dissolution of a partnership, a creditor of the partnership whose claim is not satisfied in full can sue any or all of the partners to obtain satisfaction of the claim. LIMITED PARTNERSHIPS A limited partnership is a partnership comprised of one or more general partners who operate and manage the business, and one or more limited partners who do not actively participate in the operation or management of the business and do not have personal liability for the obligations of the partnership (except in respect of certain distributions from the partnership and situations where the limited partner manages). Formation A limited partnership is formed by filing Articles of Limited Partnership with the state. The rights of the partners with respect to management and financial matters may, but need not, be set forth in a partnership agreement.

Aspects of the relationship not covered by the partnership agreement are prescribed by statute.

Formation contd The name of a limited partnership must contain the words "limited partnership," "limited," "L.P.," or "Ltd."


A limited partnership must file an annual report in order to remain in good standing.

The limited partnership automatically dissolves upon death, bankruptcy or withdrawal of a partner, unless continued by a vote of the remaining partners; its duration is limited to a fixed number of years. Thus, formation can be costly and technical depending upon the arrangements of the parties.

Formation Contd A limited partnership can exist for any term, F.S. 620.108(1)(e), but the death, withdrawal, or incapacity of an individual general partner or dissolution of a corporate general partner dissolves the partnership unless the remaining general partners, if any, continue the business under a right to do so as provided in the agreement, or all remaining partners agree in writing to the continuation of the business. The Florida statute provides for a 90-day period within which all partners may agree in writing to continue the business of the limited partnership and to appoint one or more additional general partners as necessary or desired. F.S. 620.157(4). A corporation, on the other hand, is not dissolved by the death or retirement of its officers or directors.

Tax Treatment. The tax treatment of a limited partnership is essentially the same as the tax treatment of a general partnership. The parties may create classes of capital with varying characteristics and create complicated provisions for the allocation of profit and loss. Liability. As long as limited partners do not take part in the management of the business, they will not be personally liable for the debts and obligations of the limited partnership. General partners in a limited partnership are jointly and severally liable for all debts and obligations of the limited partnership, just as general partners in a general partnership. LIMITED LIABILITY PARTNERSHIP. The limited liability partnership is a general partnership that combines the flexibility of a traditional partnership with limited liability for partners similar to a limited liability company. Formation


Formation. A limited liability partnership is formed by an oral or written agreement among the partners, and by filing a registration. A limited liability partnership must comply with certain statutory registration and disclosure requirements. The most likely use of a limited liability partnership will be in the professional service area when professional corporations or limited liability companies are not available or desirable. Formation contd The registration statement that must be filed with the Department of State sets forth specified information about the partnership and its partners.

Annual reports must be filed. The name of a limited liability partnership must include the name "limited liability partnership" or must contain the initials "L.L.P." or "LLP."

Tax Treatment. A limited liability partnership is basically a general partnership and is therefore taxed the same as a general partnership.

Liability As long as the statutory filings are made, the partners of a limited liability partnership are not personally liable for the partnership's debts or obligations. However, a partner in a limited liability partnership providing professional services may still be personally liable with respect to such services, but will not be liable for the professional services rendered by a fellow partner.

Corporations A corporation is formed by filing the articles of incorporation with the Secretary of State, paying the charter tax and filing fee, issuing stock, adopting bylaws, and electing directors and officers. The corporation has a separate existence from its shareholders. Interests are readily transferable.

Shareholders have limited liability.


The corporation is taxed as an entity.

The corporation has perpetual existence (i.e., the death of a shareholder does not terminate the corporation's existence).

Corporate management is centralized. C CORPORATION A corporation is a legal entity for and pursuant to state statute that exists separately from, and independent of, its owners. A corporation has most of the same powers, rights and duties as a natural person. The corporation is the most common form of doing business. Formation A corporation is formed by filing Articles of Incorporation with the Department of State.

The Articles of Incorporation set forth specified information about the corporation and about the stock it is authorized to issue.

The management structure and financial and voting rights of the shareholders are typically embodied in bylaws or shareholder agreements. Formation contd Management of a corporation is centralized in a board of directors elected by the shareholders. Officers are appointed by the board of directors in accordance with the bylaws of the corporation. The organizers should consider if a shareholder agreement is advisable. SHAREHOLDER AGREEMENT such as restrictions on transferability of stock; voting of stock;


arbitration of disputes;

buyout of stock on death,

incompetence, or

withdrawal of a shareholder from the business; or

purchase of life insurance to fund a buyout. Tax Treatment A regular or C corporation is subject to federal and state income tax as a taxable entity separate and apart from its owners (i.e., shareholders). The net income of a C corporation is therefore taxed twice. Items of income and deduction do not flow through a C corporation to the shareholders. Liability Neither the shareholders nor the officers or members of the board of directors of a corporation are personally liable for the corporation's debts or obligations, unless they have personally guaranteed those obligations or unless the corporate "veil" can be "pierced." Piercing the Corporate Veil First, if there is such a unity of interest and ownership that the separate personalities of the corporation and the individual no longer exist. That is, if the corporation is in fact the "alter ego" of one or a few individuals.

Second, if the observances of the corporation as a separate legal entity would sanction a fraud, promote injustice or if an inequitable result would follow. Piercing the Corporate Veil contd Some of the factors that will be examined to determine whether there is a unity of interest and ownership between the corporation and the individual include


whether corporate formalities were observed, whether corporate assets were used for the personal benefit of the individual, whether corporate and personal funds were intermingled, and whether the individual respected the corporation as a separate legal entity.

SUBCHAPTER S CORPORATION An S corporation is a corporation that has filed a Form 2553 with the Internal Revenue Service (IRS) and has otherwise satisfied the requirements to be taxed under subchapter S of the Internal Revenue Code. A subchapter S corporation is a corporation that, by complying with certain requirements of the Internal Revenue Code, avoids the double taxation problem of regular corporations, and is taxed more like a partnership than like a regular corporation. FORMATION A subchapter S corporation is created the same way that a regular C corporation is created.

In addition, the corporation must file with the Internal Revenue Service a completed Form 2553, Election by a Small Business Corporation. All shareholders of the corporation must consent in writing to the subchapter S election.

The election, together with written shareholder consents, must be filed with the Internal Revenue Service on or before the 15th day of the third month of a taxable year in order for the election to be effective during that tax year. If the election is not timely filed, or if the corporation did not meet all of the requirements for being a subchapter S corporation at all times during the year for which the election is filed, the election would not be effective, although it might be effective for the following tax year if the corporation then qualifies.

The subchapter S is effective until it is terminated or until a disqualifying event occurs.

Generally, a subchapter S corporation Must be an eligible entity (a domestic corporation, or a limited liability company which has elected to be taxed as a corporation). 31

Must have only one class of stock. Must not have more than 100 shareholders.[Shareholders must be U.S. citizens or residents, and must be natural persons, so corporate shareholders and partnerships are generally excluded. However, certain trusts, estates, and tax-exempt corporations, notably 501(c)(3) corporations, are permitted to be shareholders. Profits and losses must be allocated to shareholders proportionately to each one's interest in the business. Some states such as New York and New Jersey require a separate state-level S election in order for the corporation to be treated, for state tax purposes, as an S corporation. Furthermore, if more than 25% of a S-corporation's gross receipts consists of passive income for three consecutive years when the corporation has accumulated earnings and profits, the S corporation will automatically lose its subchapter S status and revert to being a regular C corporation. Tax Treatment The subchapter S corporation files an information tax return, and each shareholder separately accounts for his or her allocated share of items of income and deduction. Distributions to shareholders are generally nontaxable unless the corporation has accumulated earnings or profits from a pre-election period.

A shareholder's proportionate share of flow through losses can only be used to offset income from other sources to the extent of the shareholder's basis in his or her stock. LIABILITY Shareholders of a subchapter S corporation enjoy the same protection from liability for the debts and obligations of the corporation as shareholders of a regular C corporation. LIMITED LIABILITY COMPANY LIMITED LIABILITY COMPANY A limited liability company (LLC) combines some of the features of a partnership with some features of a corporation. An LLC has the tax advantages and operational flexibility of a general partnership, together with the limited liability protection of a corporation. The LLC is a separate legal entity which is organized by two or more persons. Formation


A limited liability company is formed by filing Articles of Organization with the Department of State.

The Articles of Organization are very similar to Articles of Incorporation filed to create a corporation. The limited liability company also must adopt an operating agreement, which have a function similar to the bylaws of a corporation or the terms of a partnership agreement. The owners of a limited liability company are called "members." An annual report must be filed each year with the Division of Corporations and Commercial Code.

Fewer formalities are required to set up and operate a limited liability company than a corporation. Although company minutes and resolutions are not required by statute, they are, nevertheless, a good idea.

Unless otherwise provided in the articles or the regulations, management of the limited liability company is vested in the members in proportion to their contributions to capital. if so provided in the articles, the limited liability company may be managed by one or more managers elected annually by the members in a manner prescribed by the articles or regulations. Like subscribers to stock in a corporation, the members' contributions to capital of a limited liability company may be in cash or property, a promise to contribute cash or property, past services rendered, or future services to be rendered. The interest of a member in a limited liability company is personal property. A member's interest, however, is not freely transferable without the consent of all other members unless transfer is allowed by the articles or regulations. The death, bankruptcy, or dissolution of a member, or the occurrence of any event terminating the continued membership of a member under the regulations or operating agreement, dissolves the limited liability company, unless all of the remaining members consent to the continuation or a right to continue is stated in the articles of organization. Tax Treatment


A limited liability company is taxed like a general partnership. Items of income and deduction flow through to the members, and may be specially allocated by agreement among the members. Liability Neither the members nor the managers of a limited liability company are personally liable for the debts or obligations of the company. However, the limited liability may not be recognized with respect to transactions in states not yet recognizing limited liability companies, or in states whose limited liability statutes differ. Unless otherwise provided in the Articles of Organization, any member has the power to bind the company. Because the liability protection of members is conferred by statute, and because fewer formalities are required with a limited liability company than with a corporation, it is arguably more difficult to "pierce the veil" of the limited liability company to hold members personally liable. business trust is an unincorporated association created by a governing instrument under which property is held, managed, administered, controlled, invested, reinvested and/or operated, or business or professional activities for profit are carried on, by a trustee for the benefit of such persons who are entitled to a beneficial interest in the trust property. The beneficiaries of a business trust should have limited liability. joint venture A joint venture is a general partnership organized to carry out a limited or specific purpose. Allocations of profits and losses, duties of the co-venturers, and other elements of the venture should be spelled out in the joint venture agreement. WHAT IS A REIT? REIT stands for Real Estate Investment Trust. A REIT is a company that owns and usually manages income-producing real estate property such as apartments, offices, and industrial space. Along with meeting additional criteria, to qualify as a REIT in the United States, the company must: Be structured as Corporation, business trust, or similar association Be managed by a board of directors or trustees Have shares that need to be fully transferable pay at least 90% of its taxable income to its shareholders every year. 34

have at least 100 shareholders. invest at least 75% of its total assets in real estate. derive at least 75% of its income from rent or mortgage interest from properties in its portfolio. No more than 50 percent of the shares can be held by five or fewer individuals during the last half of each taxable year By having REIT status, a company avoids corporate income tax. A regular corporation makes a profit and pays taxes on the entire profits, and then decides how to allocate its after-tax profits between dividends and reinvestment; an REIT simply distributes all or almost all of its profits and gets to skip the taxation. Types of REITs MORTGAGE REITS Fewer than 10% of REITs fall into a special class called mortgage REITs. These REITs make loans secured by real estate, but they do not generally own or operate real estate EQUITY REIT Equity REITs tend to specialize in owning certain building types such as apartments, regional malls, office buildings or lodging facilities. Some are diversified and some are specialized Hybrid REITs Hybrid REITs combine the investment strategies of equity REITs and mortgage REITs by investing in both properties and mortgages.


The Acquisition Contract Real Estate Transaction Time Line Pre-contract negotiations Executory Contract Closing Post-closing

The Pre-Contract Stage: -- The Preventive Lawyering Stage What information should the attorney be gathering? 101 West 55th Street C6-6 Letters of Intent What are they? What are the dangers of a Letter of Intent? What are the dangers of a Letter of Intent? In short, the court is looking at the actions of the parties leading up to the writings. If it is clear from the writing that the essential elements of the deal have been reached but may not be artfully written; and that there is no express written statement that material elements remain which must be formalized in a final written contract, then the writing will be sufficient. The Executory Contract Stage The Executory Period Time is a problematic element in this transaction. The longer the time horizon on a transaction, the more difficult it is to assess the potential value of the end deal. Time creates contingencies: Macro-economy Discovery of environmental problems or the creation of the problem Changes consumer tastes and desires Death or bankruptcy of a partner to a transaction Property damage 36

The Closing or Settlement The Post-Closing Period The deed must be recorded, title insurance policies must be received and closing documents collected What issues need to be addressed in the Contract What are the elements of a contract? I. 2. 3. 4. 5. A promise by a person with legal capacity to act, Two or more parties, Manifestation of mutual assent to terms and consideration, Sufficient consideration, and An agreement that is not void by statute or common law.

What is necessary to satisfy the statute of frauds? GENERAL OBLIGATIONS LAW 5-703 disclose the names of the parties who are parties to the contract, adequately describe the land or property to be sold, provide the essential terms of the agreement, and It must be executed by the party against whom the contract is to be enforced or by an agent authorized by that party. essential terms 1. The price, or a formula that can be used in determining the price (for example, appraised value); 2. The closing date or specific conditions precedent after the satisfaction of which closing will occur; and 3. The method of payment (for example, cash, seller financing, the assumption of existing debt, and so forth). There must be a grantor and grantee. How do you know both exist? What is required when dealing with a corporation or partnership? copy of the corporate charter


a certificate of good standing evidence of authority to do business in the state current certification of the authority of the officers to buy and sell property corporate resolutions regarding this transaction

A correct description of the purchasing entity is important

Is this acceptable? PURCHASE AND SALE AGREEMENT This Purchase and Sale Agreement (this Agreement), dated ____________, ____, 200, by and between ABC, LTD., a Florida limited partnership (Seller), and Z (Buyer).

LEGAL CAPACITY how do we determine that the person signing on behalf of the entity has the authority to bind the entity? Finally, how do we determine that the entity entering the contract as the seller is, in fact, the owner of the property? Procedural steps First, a title report should be ordered right away Second, the seller should supply copies of its organizational documents Third, if an agent purports to act for the seller or the buyer, the agent should have a written agency agreement that specifically authorizes it to bind the seller or buyer. Fourth, the buyers attorney should check the state laws for statutory requirements governing asset sales. Finally, individuals who have been declared incompetent and individuals or entities that are in bankruptcy or reorganization proceedings3 cannot act without court authority The recital in the contract, signed by the foregoing officers, that the corporation executed an instrument pursuant to its bylaws or pursuant to a resolution of its board of directors, is prima facie evidence of authority and conclusive evidence in favor of a bona fide buyer. Cal. Corp. Code 1190 (West 1981). Property Description How do you describe the property?


Whats missing? 2.1 Property. Subject to and upon the terms and conditions of this Agreement, Seller shall sell to Buyer and Buyer shall purchase from Seller all of the following (collectively, the Property) at the price set forth in this Agreement: (a) (b) (c) (d) (e) the Land; the Improvements; the Appurtenances; the Personal Property; and the Leasehold Property.

Property Description the property should be as accurately described as possible, either by legal description or by reference to a plat that can be attached to the contract. Describing the property What is the role of the survey? Who should demand the survey? Who can rely on the survey? Who wants the title search? Describing the property Multiple Properties In contracts involving the purchase of multiple properties in a single transaction, whether the purchase and sale agreement is set forth in one contract or in multiple contracts, the drafter should consider the effect of voluntary or involuntary termination of the contract as to some, but not all, of the properties. Are the properties contiguous?

What are strips and gores? A strip is a long narrow piece of land, and a gore is a triangular piece of land. Condition of the Property 2.2 As Is Condition. Seller agrees to deliver and Buyer agrees to take (without reduction of the Purchase Price) title to the Property on the Closing Date in its as is condition on the date hereof, ordinary wear, tear and deterioration between the date hereof and the Closing Date 39

excepted. Buyer represents to Seller that Buyer is a knowledgeable buyer of real estate properties. Buyer has previously reviewed and considered the nature of this transaction and the Due Diligence Period will enable Buyer to thoroughly investigate the Property and all aspects of the transaction. In electing to proceed with this transaction, Buyer shall have determined that the Property is satisfactory to Buyer in all respects and is purchasing the Property in as-is, where-is condition with all faults. Buyer has relied and will rely solely on Buyers own independent investigations and inspections, and Buyer has not relied and will not rely on: (i) any representation of Seller other than as expressly set forth in this Agreement (and provided that Buyer understands and agrees that none of the representations of Seller shall survive the Closing nor are intended to be relied upon by Buyer after Closing except as expressly provided herein), or (ii) any information, representations and/or warranties contained in any marketing materials or offering memoranda for the Property (including, without limitation, any such information, materials or memoranda delivered or provided by MMM. Buyer further acknowledges and agrees that, except for the specific representations made by Seller in this Agreement, Seller has made no representations, express or implied, is not willing to make any representations, nor held out any inducements to Buyer other than those (if any) exclusively set forth in this Agreement; and Seller is not and shall not be liable or bound in any manner by any express or implied warranties, guaranties, statements, representations or information pertaining to the Property, except as may be specifically set forth in this Agreement. Notwithstanding anything to the contrary contained in this Agreement, the provisions of this paragraph shall survive the Closing and any cancellation or termination of this Agreement. What are the issues with this provision regarding the condition of the property? Condition of the Property Primarily this is an issue of soundness of improvements, the environmental safety of improvement to the land and impacts from neighboring land, and the availability of amenities and utilities and access Express Allocations of Risk of Quality An as is provision ordinarily bars the admissibility of any evidence regarding quality unless it is to show fraud. To do this the plaintiff must show by clear and convincing evidence that: A representation has been made The representation is false The representation is material The speaker knows that it is false 40

The speaker intends for the hearer to rely on the false statement The hear could reasonably anticipate to rely on the statement Consequent injury

Express Allocations of Risk of Quality Impact of a merger clause The general rule is that the vendor has no duty to disclose unless there are hidden defects which he knows or should have known which may present an unreasonable risk of harm to persons on the premises which he may anticipate that the vendee will not discover. Disclosing Inaccurate Information Material Defects and Duty to Disclose The Court in found in COPELAND v NATHANIEL 164 Misc.2d 507, 624 N.Y.S.2d 514 (1995) that in New York, a party has duty to speak in three situations: One where the party has made a partial or ambiguous statement on the theory that once a party has undertaken to mention a relevant fact to the other party and can not give a half truth; Two the party stand in a fiduciary or confidential relationship with each other; Three where one party superior knowledge no readily available to the other and knows that the anther is acting on the basis of mistaken knowledge.

Statutory Duties to Disclose Interstate Land Sales Full Disclosure Act Implied Duty to Disclose General rule is that there is no duty to disclose material facts about the subject matter of a sale unless a specific exception exists. The law has developed that latent defects do give rise to a duty on the part of the seller to make disclosure. More especially, when latent defects are combined with misrepresentations or concealment, then there can be a recovery for fraud. Fraudulent concealment exists where a vendor fails to disclose sources of peril of which he is aware, if such a source is not discoverable to the vendee. What should the buyer seek to obtain in a commercial real estate transaction? The seller should be required to deliver within a specified period of time: 41

Title leases, agreements, surveys, plats, site plans, zoning documents, and any other information that may be relevant to the buyers decision to purchase the property.

Inspections The buyer should have the right to enter onto the property for purposes of undertaking tests and inspections The Sellers perspective From the sellers standpoint, the contract should clearly delineate the extent of the investigation that the buyer will undertake. The seller may be willing to allow a potential buyer to undertake environmental testing or even to attempt to secure financing, but may be unwilling to let the buyer tie up the property without any commitment to at, least spend money on advancing the deal. Duration of the inspection period Zoning Due Diligence The zoning classification will therefore control the height, density, and use to which the building can be put. The zoning statute will establish standards for parking, storm water management, grading, landscaping,

The certificate of occupancy 42

Building Operations - Leases The buyer wants to know that the leases are in effect, that there has been no prepayment of rent, that other monetary obligations of the landlord/seller are complete, and that the landlord/seller is not in default in its obligations to the tenants.

ESTOPPEL CERTIFICATES 7.2 Conditions Precedent to Buyers Obligation to Close

(d) On or before the Closing Date, Seller shall have furnished a Tenant Estoppel Certificate from each tenant of the Property, each dated no earlier than thirty (30) days prior to the Closing Date; ARTICLE 8. SELLERS REPRESENTATIONS AND WARRANTIES. Seller makes the following representations and warranties for the benefit of Buyer: .

8.2 Leases. To the best of Sellers knowledge, Schedule 1 is an accurate and complete list of all leases and amendments thereto which have been executed by Landlord on the date hereof and all other agreements by Landlord with the tenants relating to the occupancy of the premises including tenant improvements agreements; and to the best of Sellers knowledge the information contained in Schedule 1 is accurate and complete as of the date hereof, and to the best of Sellers knowledge, each of the Leases is in full force and effect, and neither Seller nor. to the best knowledge of Seller, any of the tenants are in default of any of their obligations under any of the Leases, except as set forth in Schedule 1. SNDAs subordination, nondisturbance, and attornment agreements Building Operations Employment Agreements employment agreements, union contracts, bonuses, 43

profit sharing, retirement, vacation benefits, or hospital insurance plans with respect to past or present employees. Building Operations - Equipment Building Conditions - Commitments to Third Parties It is therefore typical to include in a contract a representation that the property and the seller (with respect to the property) are subject only to specified contractual commitments that are listed on an exhibit to the contract and that there are no defaults under any agreements, contracts, or commitments. Building Conditions - Fire and Building Code Violations ARTICLE 8. SELLERS REPRESENTATIONS AND WARRANTIES. Seller makes the following representations and warranties for the benefit of Buyer: 8.1 Ordinances. To the best of Sellers knowledge, Seller has not received any written notices of outstanding violations of any applicable laws, ordinances, rules, regulations or orders relating to the Property. Building Conditions - Environmental Conditions Title ARTICLE 6. TITLE. 6.1 Conveyance of Title. At the Closing, Seller shall convey and Buyer shall accept fee simple title to the Property (except the Appurtenances) free and clear of all liens and encumbrances except the Permitted Exceptions. Seller shall convey and Buyer shall accept any and all right, title and interest of Seller in the Appurtenances in accordance with the terms and conditions of Section 12.2(b). Title Marketable Title The starting point is that the purchaser wants marketable title:


title with the quality of indefeasibility One free from encumbrances and from any reasonable doubt as to its validity. One that may be freely made the subject of resale. Title to real property that is readily saleable to an interested, reasonable, prudent, intelligent buyer at market value.

WHO DETERMINES QUALITY OF TITLE THAT PURCHASER MUST ACCEPT? Title It is common to provide in the contract that the seller shall convey at closing fee simple title to the property, marketable and good of record and in fact, and insurable as such at standard rates by a title insurance company acceptable to the buyer. Title must be free and clear of any liens, encumbrances, or restrictions except for the lien of real estate taxes that are not yet due and payable and title objections that have been approved in accordance with the procedures set forth in the contract. Title Insurance The extent of coverage that the title insurance company provides is not necessarily cast in stone. Title insurance companies may be willing to issue special endorsements to cover particular concerns of the buyer or the buyers lender. Obviously, the company will be more willing to negotiate the coverage when the amount of the policy is very large. Title Objections 6.3 Title Objections.

(a) If any title defects or encumbrances appear in the Commitment or the Survey, other than the Permitted Exceptions (Title Objections), Buyer may reject title by giving notice of such rejection to Seller (Buyers Rejection Notice) on or before the Inspection Deadline Date, which notice shall specify the alleged Title Objections. Buyers failure to timely give such notice shall be deemed an election by Buyer to waive such alleged Title Objections, and Buyer shall thereupon take and accept title to the Property as is. If Buyer shall so reject title, Seller shall have the right in Sellers sole and absolute discretion subject to Section 6.3(g) below, upon notice to Buyer given not more than ten (10) business days after receipt of Buyers Rejection Notice, either to cancel and terminate this Agreement, in which event both parties shall be relieved of all obligations hereunder except for Buyers obligations under Article 5 or to adjourn the Closing for a period or periods not exceeding ninety (90) days in the aggregate, during which time Seller may endeavor to cure such Title Objections. Title Objections


If there is a title objection that the seller refuses to cure, the buyer will contend that the buyer should have the option of Correcting the title objection if the title objection can be corrected by the payment of money and proceeding to closing, with a deduction from the purchase price in the amount required to cure the objection, Accepting the title as it is (assuming that the objection cannot be cured with a payment), or Terminating the Agreement The buyer would also like the seller to be obliged to litigate if necessary to clear title.

Need for a Survey? 6.2 Title Commitment and Survey. Buyer shall after the date hereof order a commitment (the Commitment) for an ALTA Owners Policy of Title Insurance for the Property from the Title Company and shall deliver the same to Seller within seven (7) business days after the date hereof. Buyer shall order a survey of the Property certified to Seller, Buyer, any mortgage lender selected by Buyer (provided Buyers obligations under this Agreement are not in any way subject to Buyers receipt of financing), and the Title Company (Survey), and shall cause copies thereof to be delivered to Seller within five (5) days after receipt thereof by Buyer or its attorneys and in any event no later than the Inspection Deadline Date. Why a survey? The existence of the property. Is the property a mathematically closed figure? The relationship of the property to adjoining properties. Are the property lines clear or do they overlap. The relationship of the occupied lines to the record lines. Do the fences overlap onto a neighbors property? Does the garden overlap. The locations of physical improvements. Unrecorded easement and other facts not recorded What Is a Survey? What Is a Survey? a graphical representation of the opinion of the surveyor as to the location of the boundary line of the property surveyed. In other words, it is a map of the property.


A ROAD MAP FOR LAWYERS ABOUT SURVEY COVERAGE SUBJECT OFTEN SHROUDED IN MYSTERY By Paul J. Prinzivalli 11/10/97 N.Y.L.J. S3, (col. Why a survey? Where a contract of sale has been made subject to any state of facts an accurate survey may show, the buyer has been held to be required to take title despite encroachments or variations that were found. If other words are added, "which do not render title unmarketable," the opposite result is usually found. Remedies after Inspections Recission Price Adjustment The Undertaking to Sell and Buy 2.1 Property. Subject to and upon the terms and conditions of this Agreement, Seller shall sell to Buyer and Buyer shall purchase from Seller all of the following (collectively, the Property) at the price set forth in this Agreement: The Undertaking to Sell and Buy the undertaking by the seller to sell and the buyer to buy the property on the terms of the contract, the purchase price and method of payment, and the deposit. The method of payment and the deposit are discussed here. Method of Payment The cash portion of the purchase price is typically payable in good funds by wire transfer of federal funds or by delivery of a cashiers check or certified check.

Formula Pricing A home-builder might purchase acreage for an agreed sum per buildable lot.defining buiidable as the number of lots the local government allows in approving the builders subdivision map Formula for Pricing in gross or by the acre 47

ARTICLE 3. PURCHASE PRICE. 3.1 Amount. The full purchase price (the Purchase Price) for the Property shall be, and Buyer shall pay to Seller subject to the terms and conditions herein, Three Million Fifty Thousand United States Dollars (U.S.$3,050,000.00) payable at the Closing in Acceptable Funds The Deposit Deposit. The Purchase Price shall be payable as follows: (a) Simultaneously with the execution of this Agreement by Buyer, Buyer shall deposit into escrow with Escrowee in Acceptable Funds the amount of One Hundred Thousand United States Dollars (U.S. $100,000.00) as a deposit against the Purchase Price (the Deposit), such Deposit (i) to be held and disbursed by Escrowee pursuant to the terms and conditions of Article 4 and (ii) shall be deemed nonrefundable in the event Buyer fails to timely deliver a Termination Notice to Seller in accordance with the terms and conditions of Article 5 subject, however to satisfaction or waiver by Buyer of all of the conditions precedent set forth in Section 7.2; and The Deposit held in an interest-bearing account Cash or a letter of credit The Letter of Credit The Deposit and the Escrow Agent the escrow agent should certify that it has received the deposit and that it agrees to hold the deposit in accordance with the terms of the contracts. Attorneys as Escrow Agents The attorney, who is supposedly acting as a neutral stakeholder, may have a conflict of interest if there is a dispute as to the deposit. The contract should also provide that, in the event of a dispute, the escrow agent is entitled to deliver the deposit to the clerk of the local court or to another escrow agent chosen by the stakeholder so that the law firm can continue to represent its client. Financing Condition In the absence of a financing condition the transaction is assumed to be an all cash transaction What are the relevant conditions?


Basic Financing Terms Principal Interest Points Monthly payment Amortization Financing issues include the amount financed, the interest, the terms of the loan and even the form of the mortgage Three Possible Financing Contingencies A financing contingency may be quite specific in identifying the terms of the loan the buyer would be obligated to accept. It could leave those terms subject to Buyer obtaining satisfactory financing. It could call for the buyer to accept available financing The Contingency Risk When does the Seller bear the risk? When does the Buyer bear the risk? Good Faith Effort to Procure Loan Buyers are legally obligated to make the effort of applying in good faith for a loan at a reasonable number of lenders and completing the required applications for financing. BLASK v MILLER 186 A.D.2d 958, 588 N.Y.S.2d 940 (1992) absent an express promise to apply to a particular bank or to make a specified number of loan applications, a mortgage contingency clause only requires a good faith attempt to procure a loan in the amount specified. If a contract says diligent efforts as this contract did then something more than good faith is required. Two key contingencies 49

property appraisal and

credit check The Financing Contingency Time Period CASUALTY LOSSES DURING THE EXECUTORY PERIOD What happens if the property burns to the ground? Risk of Loss THE DEFAULT RULE DERIVED FROM THE DOCTRINE OF EQUITABLE CONVERSION What is equitable conversion? Equitable conversion splits title to the property between the seller and the buyer at the moment that the contract is signed. It means that the buyer has an interest in the property even thought the contract has not been fully performed. Both parties have the right to deal with their respective interests, that is to buy sell assign pledge mortgage devise insure Usual principle is that the party in possession bears the risk. Uniform Vendor and Purchaser Risk Act found in the General Obligations Law 5-713(11). CONTRACTING OUT OF RISK-OF-LOSS DEFAULT RULES (1) What risks are covered? (2) (3) What remedies does each party have in the event of loss? When must they make their choice of remedy clear?


(4) Does the remedy prescribed in the clause depend on whether the seller caused or could have prevented the loss? CONTRACTING OUT OF RISK-OF-LOSS DEFAULT RULES contd (5) Does the buyer have the option of taking the property in its damaged condition with a price abatement equal to the diniinution in value or repair cost? (6) If the seller is over-insured, does the buyer have the option of taking the property as is along with the insurance proceeds? (7) Are material and immaterial or substantial and insubstantial losses treated the same? How are material or substantial defined? The Closing The Seller The Buyer The Lender


THE LEASE AS FINANCING DEVICE What is a Lease? What is a lease? A contract by which a rightful possessor of real property conveys the right to use and occupy the property in exchange for consideration, usu. rent. The lease term can be for life, for a fixed period, or for a period terminable at will. A lease agreement is a contract between a lessee and a lessor for the use of a building, property or other asset. It allows the lessee to use the asset for a specified rent and period of time. A lease agreement formalizes the duration of the lease, identifies the assets under lease, includes the names of the two parties and specifies the payment method (periodic or lump sum). What is an operating lease? Operating Lease A lease of property (esp. equipment) for a term that is shorter than the property's useful life. Under an operating lease, the lessor is typically responsible for paying taxes and other expenses on the property. Cf. lease-purchase agreement. Operating leases, also called service leases, are agreements between two parties in which one provides rent to the other for using an asset. In an operating lease, the borrower uses an asset for only a fixed portion of the assets life. The owner of the asset is responsible for all maintenance costs and other operating costs associated with the leased asset. What is a capital lease? Capital Lease Also called a lease-purchase agreement. A rent-to-own purchase plan under which the buyer takes possession of the goods with the first payment and takes ownership with the final payment; a lease of property (esp. equipment) by which ownership of the property is transferred to the lessee at the end of the lease term. Such a lease is usually treated as an installment sale. Under a capital lease, the lessee is responsible for paying taxes and other expenses on the property. Also termed lease-to-purchase agreement; hire-purchase agreement; capital lease. Cf. operating lease under LEASE Capital leases, also called finance leases, are those in which the borrower has full control over the use of the asset(s) during its lease period, is responsible for all maintenance and other associated costs and is directly affected by its associated advantages and disadvantages.


Difference between Operating Lease and finance lease? Difference between Operating Lease and finance lease? An operating lease does not transfer the risks and rewards to the lessee at the end of the lease period where a finance lease does. So in affect the operating lease can be thought of as renting the asset while a finance lease can be seen as a finance option to own the asset. What is a synthetic lease Synthetic Lease A method for financing the purchase of real estate, whereby the lender creates a specialpurpose entity that buys the property and then leases it to the ultimate user (usu. a corporation). A synthetic lease is treated as a loan for tax purposes and as an operating lease for accounting purposes, so that the lessee can deduct the property's depreciation and the loan's interest yet keep both the asset and the debt off its balance sheet. The synthetic lease combines features of an operating lease with those of a mortgage. Long used as a form of capital financing by corporations to acquire costly inventory and equipment, such as airplanes and automobiles, corporations now use the synthetic lease Ground Leases and Sale-leasebacks What is Common to both the ground lease and the sale-leaseback? What is a Ground Lease Ground Lease Blacks Law Dictionary defines a ground lease as a lease of vacant land, or land exclusive of any buildings on it, or unimproved real property Usually a net lease.

What is a net lease? A Net Lease is a . 'lease in which provision is made for the lessee to pay, in addition to rent, the taxes, insurance and maintenance charges. 53

The net lease The net, net lease The net, net, net lease Common Element the fee simple title is split into two distinct estatesa term of years and a reversionary interest. Three Elements That Make A Genuine Ground Lease (a) Land Three Elements That Make A Genuine Ground Lease (b) Long Term Three Elements That Make A Genuine Ground Lease (c) Net Rent Ground leases are net to the lessor, which means the ground lessee is primarily responsible for taxes, insurance, utffities and maintenance.

Default on a normal operating lease may leave the lessor responsible for all of these spiraling expenses. However, a default on a ground lease usually leaves the lessor with a freely improved lot.and more than enough rent to cover any rising expenses. The developer who defaults on the rent and is evicted, forfeits the value of the building to the landlord KEY PLAYERS IN GROUND LEASE DEVELOPMENT KEY PLAYERS IN GROUND LEASE DEVELOPMENT The ground lease begins with

a landowner (player one) and a long-term. tenant (player two), called a ground lessee. 54

The tenants lender (player three), called a leasehold mortgagee, secures the funds with a mortgage on the developer/tenants interest in a long-term lease. If the ground lessee doesnt personally need the space it builds, it sublets to player four, occupants who do need the space, often known. simply as subtenants. The landowner may create a fifth player by mortgaging her fee interest to a -fee or freehold mortgagee.

OBJECTIVES OF THE PARTIES Ground Landlord (a) Economic Factors (b) Tax Factors THE GROUND LEASE AND THE SITE OWNER To understand the point of ground leasing, compare it to the other choices an owner has for getting cash from a vacant site: sell, mortgage the site, or sell and take back a purchase money mortgage.

Why would any owner NOT prefer the ground lease to an outright sale? Ground Tenant the ground tenant's key objective is maximum freedom to make decisions regarding the property. The ground tenant may also seek the ability to subdivide the land and to make future improvements. This would require drafting provisions to release portions of the property from the original lease and establishing new "severance leases" for each such parcel, which gives the ground tenant greater flexibility to sell individual parcels.


For tax purposes, the ground tenant wants to be the owner of the improvements to be legally entitled to depreciate the cost of those improvements and thus lower its current cash tax burden. The ground tenant's rationale for retaining such ownership is that it is obligated to pay for the improvements to be built on the land. An analogue in space leases is the provision that allows the tenant to retain ownership of trade fixtures and remove them on lease termination. THE DEVELOPER AND THE GROUND LEASE For developers, ground leasing provides a form of highly leveraged equity financing. Due Diligence The ground lease transaction above, is more akin to a purchase and sale of property than to a typical space lease.

. Allocating Residual Value to the Optimal Recipient Why Some Developers Avoid Ground Leases Why Some Developers Avoid Ground Leases (1) Ground leases are costly and complicated to administer (2) Most sellers want to cash out and have no interest in becoming landlords to a developer (3) Most developers don t wish to take on an amateur partner, the site owner.

(4) Many lenders wont finance ground lease deals, and those who do charge a premium for becoming involved in them. One reason is that as the lease term


winds down, the lenders exit strategies are diminished as a re financing or sale of the leasehold becomes more difficult Why Some Developers Avoid Ground Leases (5) Potential tenants and investors perceive the leasehold as adding needless complexity and risk.

(6) Many potential buyers wont consider purchasing the developers interest because it is a leasehold estate, not full ownership. Buyers pay a lot less to acquire a leasehold than a fee and typically purchase leaseholds at a cap rate higher by two to three percent than comparable fee interests.

(7) Eventually, the developers project may turn obsolete and need to be refurbished or replaced, with not enough time remaining on the lease to amortize the new investment

Although the developer may get along famously with the original lessor, after many decades, the developer or its assignees will almost certainly not be dealing with the original lessor but with the lessors heirs or assigns

Critical Terms Term and Rent Rental Variable Rent Critical Terms contd

Operational Provisions Use Construction of the Building Critical Terms contd GENERAL LEASE TERMS 1. Covenants that the landlord expects the tenant to performevent of a default by the tenant.


Provisions which recognize the institutional lender as the third participant to the ground lease transaction and are designed to make the ground lease 'mortgageable' Critical Terms contd Ownership of Improvements Alterations Casualty Eminent Domain Transfer of Ground Tenant Interest Encumbrances The Ground Lessees Purchase Option The last two problems On the above list can be mitigated somewhat by the ground lessee reserving an option to purchase the fee at fair market value PROTECTING THE SECURITY INTEREST OF THE LEASEHOLD MORTGAGEE Problem: As security for development financing, a ground lessee will pledge to its leasehold mortgagee the ownership of the improvements and an assignment of its leasehold interest. Because ground lessees are seldom personally liable to their mortgagees, the leasehold mortgagee depends entirely.. on collateralthe tenants interest in the ground lease But if the ground lesse defaults on its lease, the leasehold mortgagee runs the risk, that the ground lessor will terminate the lease and evict the ground lessee. Solutions: (a) Notice and Opportunity to Cure. (b) A New Lease For Leasehold Mortgagee on Termination of the Old (c) Subordination. Ways of Achieving Subordination Subordination can be accomplished by the landowner signing a mortgage of the fee for the benefit of the leasehold mortgagee or signing the leasehold mortgage itself. Under either format mortgages such as these are called accommodation mortgages because they secure the obligation of another person. In no event would the landowner become personally liable for the mortgage debt beyond the value of the property, not having co-signed the note. When is the period of greatest risk of default on the leasehold mortgage? 58

When is the period of greatest risk of default on the leasehold mortgage? The subordinating lessors chance of losing the land through foreclosure is greatest before completion of the project. Incomplete projects yield no income and can end up costing more to finish than they are worth. Especially if the site generates a steady income from pre existing buildings, the lessor will want tangible financial assurances that the better building will be completed withina reasonable time before allowing the lessee to proceed with demolition 23

Protecting the Leasehold Mortgagee When the Lessee Purchases the Ground Lease Does the Leasehold Mortgage Survive a Bankrupt Leasehold Mortgagees Rejection of the Ground Lease? Leasehold mortgagees hope to avoid dependency on Courts leeping leases in place after rejection by the ground lessees bankruptcy trustee. They insist upon a ground lease clause allowing theth the option of assuming the lease if the lessee defaults.

Avoiding the Possibility of Termination of the Leasehold Estate by the Lessors Mortgagee THE SUBLESSEES The value of the ground lessees interest is the difference between the ground rent and the fair rental value of the improved site. That value will depend on the developer successfully subleasing space to operating tenants (the sublessees), who provide the income source for the payment of rent on the ground lease and repayment of the leasehold mortgage.

The leasehold mortgagee, ground lessor and sublessees all expect to be reciprocally protected from modifications, defaults, and terminations of the ground lease. If the developer defaults on the ground lease, the ground lessor would want to keep the performing sublessees in place THE SUBLESSEES Non-disturbance, Sublease Recognition and New Lease Clauses. Ground Lease Assignees Obligation to Pay Rent After the Giound Lease Terminates. SALE-LEASEBACK As its name suggests, the simple sale-leaseback involves a transfer of an interest in property and a simultaneous lease back to the transferor of a lesser interest (namely, a leasehold estate) in 59

the same property. In other words, the seller-lessee retains a possessory estate and the buyerlessor the reversionary interest in the same property. Countless variations on this basic theme have been devised. SALE-LEASEBACK an alternative to conventional mortgage financing The sale-leaseback arrangement is highly flexible. Under a great many circumstances, it can be beneficial to both the seller-lessee and the buyer-lessor. The bulk of these benefits are tax related; however, there are also considerable, tax-independent business and legal reasons for entering into a sale-leaseback. A number of tax and nontax benefits are described below. SALE-LEASEBACK Had the seller obtained a mortgage loan, its loan to value ratio it would probably have been in the range of 60-80% of the fair market value of the realty serving as security for the loan. In a sale, the lender/buyer can pay 100% of fair market value of the property acquired, the equivalent of 100% financing for the seller. Residual Value Insurance What to do if, on the date the lease expires and the loan falls due, more money will be owed on the loan than a sale of the property would produce, making it difficult for illiquid borrowers to retire the debt through conventional means of sale or refinance?

The Structure of the Leveraged Sale Leaseback

A leveraged lease transaction involves, at a minimum, the following parties: a lessor, a lessee and one or more lenders. Also, in certain situations where the lessee is not a strong credit, a credit provider may be involved to support the lessee's obligations.

The Structure The lessee selects an asset which will meet its requirements. The lessee negotiates the price and either purchases the asset directly from a manufacturer and subsequently sells it to the lessor The lessor then leases the asset back to the lessee on a "net lease basis" for a term which is less than the useful life of the equipment. 60

The lease payments cover costs, interest and profit for the lessor.

The lessor acquires the asset with a combination of its own funds and with funds borrowed from lenders on a nonrecourse basis. The lessor's funds come from its own capital or from recourse borrowings.

Tax Advantages of the Sale-Leaseback for the Seller-Lessee

increased access to liquid capital tax savings and accounting reporting advantages e.g. enhance corporate financial ratios. Deductibility of Rental Payments Loss or Gain on Sale Tax Advantages for the Buyer-Lessor Depreciation Mortgage Interest Deduction Income Stream Leveling Business and Financial Advantages for the Seller-Lessee Working Capital and Financing Expansion 100 Percent Financing Improved Balance Sheet and creditworthiness Unavailability of Conventional Financing Legal or Contractual Restrictions on Company Indebtedness

Business and Financial Advantages for the Buyer-Lessor Higher Rate of Return Management-Free Investments 61

Stable Investment Inflation Hedge Remedies of Landlord Rather Than Mortgagee Leverage

RE-CHARACTERIZATION OF SALE-LEASEBACK AS EQUITABLE MORTGAGE: RE-CHARACTERIZATION Usually, the debtor seeks re-characterization as a means of capturing the lost reversionary value and resisting summary eviction. In bankruptcy, the debtor and other creditors benefit from re-characterization because the value of the fee would become an asset of the debtors estate. The Internal Revenue Service seeks to re-characterize as conditional sales those sale-leaseback transactions structured solely to avoid taxes with no other economic purpose. To avoid re-characterization: the property will have: a remaining useful life of not less than 20 percent of its total expected economic life; and

a residual value without adjustment for inflation or deflation of not less than 20 percent of the lessor's cost. (These dual 20 percent tests are generally satisfied through an appraisal.)

Frank Lyon Company v. United States, 435 U.S. 561 (1978), Under the Frank Lyon test, petitioners must show not only that their participation in the sale-leaseback was not motivated or shaped solely by tax avoidance features that have meaningless labels attached, but also that there is economic substance to the transaction independent of the apparent tax shelter potential.

The Consequences of Re-characterization Tax. 62

Mortgage. Bankruptcy CERCLA Avoidance

Key Provisions in Sale-Leaseback Documentation

1. Initial sales price 2. Terms of sale Key Provisions in Sale-Leaseback Documentation 3. Repurchase option 4. Term Key Provisions in Sale-Leaseback Documentation 5. Rents 6. Net Lease Key Provisions in Sale-Leaseback Documentation 7. Default 8. Casualty Key Provisions in Sale-Leaseback Documentation 9. Condemnation 10. Financing

Traditional Lessor Status--Incidents of Ownership The greater the buyer-lessor's commitment to the costs of ownership and operation of the property, the stronger the inference of true ownership; likewise, the greater the benefits of the property that inure to the buyer- lessor (cash flow, depreciation deductions, appreciation in value, etc.), the more readily demonstrable is its ownership.


Financing for Real Estate Development Risks Associated with Financing People are experiencing losses because of : excessive debt service requirements from loans which have no flexibility in prepayment, subordinate financing, or due on sale clauses. In addition, these terms prevent a potential sale because the property cannot be refinanced in the current marketplace. Using Mortgage Brokers or Mortgage Bankers the Mortgage Broker finds financing for a percentage of the loan. A mortgage banker is an individual or company that can originate and service the mortgage loan. Mortgage Bankers A mortgage banker is an individual or firm which underwrites, closes, or services loans in their own name and then sell the loans to the secondary mortgage market. Many mortgage bankers will act as a correspondent The Use of Leverage The majority of real estate developers will look to increase their potential investment return by using Other Peoples Money (OPM). The majority of developers cannot afford to pay all cash for their developments. Even if they could, they would be limited to the number of purchases that could be made. By financing property, the developer can structure a loan to suit his needs. Depending upon the availability of the developers cash and the current market rates for loans, the developer can structure the overall investment needs by borrowing more or less. FINANCING FOR THE DEVELOPMENT PHASE In the first phase of the development process, the developer must obtain financing to acquire the land,


construct the site improvements, and construct the building. Sources of Development Loans Commercial Banks Savings and Loans Local Development and Housing Authorities Small Business Administration (SBA) Insurance Companies Pension Funds Mortgage Real Estate Investment Trusts (REIT) Types of Development Loans Land Acquisition Loan Construction Loan Factors affecting the availability of Construction Loans When making a construction loan, most lenders will require that the borrower have a source of permanent financing secured, before agreeing to provide this financing. Providing Assurance to the Construction Lender Piggyback Mortgage Standby or Take-Out Loan Forward Commitment Buy-Sell Agreement In order for the construction lender to gain comfort that he will indeed be taken out by the new permanent lender, he might require that this new lender enter into a Buy-Sell Agreement Buy-Sell Agreement A buy-sell agreement is a 3-party agreement in which the construction lender,


the permanent lender, and the developer all agree that when all parties have met their predetermined obligations, the permanent lender will buy the loan from the construction lender. Gap Loan If the developer is not able to obtain a construction loan for all the hard and soft costs, he might seek funding for this shortfall rather than picking up the cost himself Bridge Loan The term bridge is used because the loan does just that. It bridges from one loan to another. An example would be from construction which is short-term to permanent which is long-term. It is another tool which the developer can use to buy time while searching for better terms. The bridge loan could be used to pay off the construction financing, and the permanent loan would be used to pay off the bridge loan. Loan Participation the lender may assemble a syndication of other lenders to fund the construction loan. Construction Loan Issues Type of property you need on which financing is needed Location of the property Magnitude of loans which lender normally provides Lenders quoted interest rate Construction Loan Issues contd If you can interest a lender based on the foregoing then the following factors enter into consideration: Percentage of total development cost on which financing Funding of development fees Terms of the construction loan Rate for the construction loan

Construction Loan Issues contd


Interest payment schedule Construction loan personal liability Prepayment penalty Points to be charged for the construction loan Estimate of loan closing costs

Construction Loan Issues contd Reimbursement of predevelopment costs at closing Construction loan closing attorney Time for underwriting the loan Time funding the loan Submissions necessary for the underwriting of this loan

Construction Loan Issues contd Construction draw schedule Stored materials funding schedule Any holdback? Letters of credit or bonding of contractor Inspecting architect fees and schedule of visits

Construction Loan Issues contd Phasing of property funding Approved appraisers Will all loans for building, site costs, or land costs be funded together? Loan extensions costs and terms Equity required

Construction Loan Issues contd Can a letter of credit be used instead of cash?


Can the borrower get a sample copy of the loan documents prior to closing the loan?

Construction Loan Commitment Gentlemen: We are pleased to advise you that we have approved your application for a $xxxxxxxxxx loan subject to all of the terms and conditions which follow herein.

Construction Loan Commitment Purpose: The proceeds of the loan shall be used to pay the costs of constructing, fixturing, and equipping a xxx,xxx square foot xxx story office building all in accordance with plans and specifications to be approved by Bank. Construction Loan Commitment Security: First Deed to Secure Debt on xxxxxxxx acres of land which will be developed with xxxxxxxxx square foot building. A true legal description to be provided by the closing attorney. Completion Date: (xx) months from the date of initial disbursement of the loan funds.

Construction Loan Commitment Maturity: (xx) months from the date of the initial disbursement of the loan funds. Borrower shall have the option to extend the loan for an additional xxxx months upon payment of a __% fee Construction Loan Commitment Conversion to the Permanent Loan: The permanent loan will close within 30 days after the execution of the Certificate of Completion (signed by the approved Architect). Construction Loan Commitment Mechanics and material man's liens Easements Hazard Insurance Liability Insurance and Workers Compensation Insurance


Loss of Rents Insurance Construction Loan Commitment Appraisal Authority to Borrow Due-on-Sale Clause Current Survey Building Permits Construction Loan Commitment Independent Consultant Construction Contracts Architectural Contracts Costs and Contracts Construction Loan Commitment General Contractors Completion Bond Certificate of Completion Certificate of Occupancy Plans and Specification-Assignment Thereof Compliance with Governmental Regulations Construction Loan Commitment Pre-leasing Requirement Assignment of Leases Tenant Estoppel Certificates Subordination of Leases Construction Loan Commitment Signage and Publicity


Secondary Financing Further Encumbrances Financial Statements Construction Loan Commitment Legal Opinions The Borrower shall deliver to the Bank an opinion of counsel for the Borrower to the effect that: 1. The Security Property as improved and to be improved for its use conforms with the applicable zoning ordinances, and that it has not discovered any federal, state, or municipal laws, restrictions, regulations, or requirements including, but not limited to, those relating to environmental matters which would be violated by the Security Property as improved or to be improved and its use. 2. The Borrower and all Guarantors have full power and authority to enter into this Loan, to execute and deliver all documents related thereto, and to carry out all the terms and conditions of the Loan. 3. The Note, the Deed to Secure Debt, and other loan documents constitute the valid and legally binding obligation of the borrower and Guarantors and, upon the filing and recording of the Deed to Secure Debt and other documents related thereto, the Bank will have a fully perfected first lien and security interest in the Security Property. The Legal Opinion The borrowing entity exists and has the right to carry on its business and enter this transaction. The borrower is not in violation of any securities laws. The loan documents will be fully enforceable according to their provisions. The deed of trust, when recorded, will be a valid lien on the property.

The financing statement, when recorded, will perfect a security interest in the personal property identified therein. The borrower has obtained all of the legal permits and licenses required to carry on their business and the operation of the property. The property may be used for the purposes which it is being used.

Any provisions of any agreements between the borrower and lender do not violate any known law. 70

There are no pending legal matters which may adversely affect the lenders interest in the borrowers property or inhibit the ability of the borrower to repay the funds. No form of rent control, or proposed rent control, is in effect or is pending.

Loan Disbursement Procedure 1. Advances shall be conditioned upon requisitions submitted by the Borrower stating the costs of materials in place and the labor performed, with such requisitions to be properly certified and executed by the contractor, architect, and Borrower. At the Banks request, all such costs shall be verified by paid receipts, invoices, and lien waivers. 2. Advances shall not exceed the amount projected in each category as submitted, by the Borrower and approved by the Bank pursuant to the cost breakdown required above. Any excess funds in any costs category may be transferred to another category only at the Banks option. Any costs or anticipated costs in excess of the amount projected in each cost category must be immediately paid in cash into the project by the Borrower at the Banks request. In no event shall the aggregate amount of all advances exceed the loan amount. 3. No advances will be made for stored materials except at the sole and absolute discretion of the Bank. 4. Advances shall be made no more than _________ times per month. All inspection fees shall be paid by the Borrower. 5. Prior to each advance, the title to the Security Property shall be examined to the date of each advance and the Bank shall be furnished with an endorsement to its mortgage title insurance increasing the amount of insurance thereunder to the cumulative total of all advances, including the advance made at the date of the endorsement, with no change in the status of the title. Loan Disbursement Procedure 6. The Bank may withhold payment of any requisition or any part thereof on account of:

A. Defective work or work not performed in a good and workmanlike fashion in strict accordance with the approved plans and specifications B. Claims or liens filed or evidence indicating the probable filing of claims or liens

C. Failure or inability of the contractor to make payments to subcontractors for materials or labor


D. In the sole and absolute opinion of the Bank, the improvements as described herein cannot be fully completed and all projected related expenses paid with the funds committed but not yet advanced hereunder. Items to Be Signed by the Borrower at Closing Construction (permanent, if applicable) note and deed to secure debt The borrower will guarantee (personally or corporately) the Note Assignment of lease agreement Assignment of additional collateral (if applicable) Uniform Commercial Code Financing statement Signed closing statement

Items Required by the Lender Copy of a title insurance policy acceptable to the lender

Copy of a letter that parking, ingress and egress, and any other easements necessary are in place for the benefit of the property Copy of a paid hazard insurance policy Copy of the general liability insurance policy with limits approved by the lender

Copy of a Workmans Compensation insurance policy for all contractors within the statutory coverage limits required by law Copy of a rent loss insurance policy (if applicable) in an amount determined by the lender Copy of a current appraisal completed by an approved MAI Appaiser

Copy of a letter that the borrower (if applicable) has the authority to borrow for the corporate entity Copy of a current survey Copy of a soils report

Copy of a letter from the zoning department that the property can accommodate the necessary parking as required by law Copy of the development and building permits


Copy of all construction documents: plans, specifications, cost breakdowns, schedules Copy of all architectural and engineering agreements and final working drawings Copy of the general contractor completion bond or letter of credit

Copy of all utility letters from the proper authorities: gas, electricity, water, sewer, telephone, cable TV Copy of a letter from the zoning department stating that the proposed development meets all local zoning regulations Copies of all signed leases and credit file (if applicable) Copies of all tenant estoppel certificates (if applicable)

Copies of all environmental letters that state that the property does not violate any local, state, or federal environmental laws Clauses to Be Inserted into the Documents Permanent Loan Take-Out Requirements Interest Payment Clause Reimbursable Items at Closing Clause Line Item Expense Clause Draw Request Clause Clauses General Contractor Holdback Clause Tenant Improvement Holdback Clause Contingency Account Clause 73 Copies of all major subcontractors contracts Copies of all geo-technical studies Copies of the construction contract Copy of the lender approval letter of the general contractor Copy of the architectural contract

Plans and Specification Clause Final Disbursement Clause Clauses Default and Acceleration Clause Release of Personal Liability Clause Subordination of Leases Clause Signage Clause Clauses Default Clause Secondary Financing Clause Further Encumbrance Clause Financial Statement Clause No Adverse Change Clause Clauses Lenders Right to Waive Clause Warranties by the Bank Clause Representations of the Borrower Clause Assignment or Modification Clause Acceptance of Commitment Clause Termination of Commitment Clause FUNDING THE PERMANENT LOAN Sources of Permanent Financing Credit Companies Mortgage Limited Partnerships Charitable Foundations 74

Religious and Fraternal Associations Individual Investors Securities Sold by Wall Street Brokerage Firms Mortgage-Backed Securities A certificate that evidences ownership of an interest in a mortgage loan or pool of mortgage loans An obligation that is secured by a mortgage loan or a pool of mortgage loans Collateralized Mortgage Obligations CMOs use the cash flow from the various types of underlying securities to repay the bond classes in the order of their priority. Because each bond class has a different maturity date, the cash flow can be structured to pay out at the stated maturity date of that particular bond class. Secondary Mortgage Markets Federal National Mortgage Association (FNMA): Federal Home Loan Mortgage Corporation (FHLMC Government National Mortgage Association (GNMA) Types of Permanent Loans There are three basic types of permanent loans. 1. 2. 3. Fixed payment mortgage Variable rate mortgage Participating mortgage

Fixed Payment Mortgages Self-Amortizing or Level Payment Mortgage Fixed Payment Rate with an Accrual Pledged Account Mortgage (PAM Variable Rate Mortgages Base pay rate Periodic interest rate cap 75

Lifetime interest rate cap Ability to convert to a fixed-rate loan TYPES OF VARIABLE RATE LOANS Adjustable Rate Negative or Accelerated Amortization Mortgage Graduated Payment Mortgage Growing Equity Mortgage Reverse Annuity Mortgage Interest Only Mortgage Participating Mortgages Shared Appreciation Mortgage Convertible Mortgage Miscellaneous Types of Mortgages Mini-Permanent (Bullet or Balloon) Mortgage Blanket Mortgage Leasehold Mortgage Chattel Mortgage Buy Down Mortgage Permanent Loan Questions and Issues Will the lender finance this type of property?...in this location? . at the amount needed?

Will the lenders interest rate work within your projected economics? Will the lender lend on a percentage of the appraised value or on a certain debt service coverage ratio? Debt coverage ratio to be used Permanent Loan Questions and Issues


Rates to be used (fixed or tied to an index) Are interest only loans available? Loan term Loan amortization period Loan extensions Points charged at commitment Points charged at closing Who pays closing costs? What are the closing costs? Permanent Loan Questions and Issues Appraisals required? By whom? Approved appraisers Loan funding date Prepayment of loan Loan lock-in period Prepayment penalty Are any personal guarantees required for this loan?

Can these guarantees be for less than the total amount of the loan, and can they be released based on the property performance? Permanent Loan Questions and Issues Escrows for taxes and insurance Borrowers interest on escrow funds Assignment at resale Transfer fee at loan assumption Will the loan rate or terms change upon resale? Will the new borrower have to qualify for the loan? Price for buying down the rate 77

Does the loan require any cash flow or future resale profit participation by the lender?

Permanent Loan Questions and Issues Response time for a firm commitment Commitment extensions and cost Can the borrower obtain a copy of the loan documents prior to closing? Requirements for monthly, quarterly, or yearly operating statements

Permanent Loan Clauses Due-on-Sale Clause Right-to-Transfer Clause Acceleration Clause Lock-In Clause Prepayment Clause Escrow Clause Permanent Loan Clauses Foreclosure and Right of Redemption Clause Defeasance Clause Subordination Clause Release Clause Exculpatory Clause Dragnet Clause Permanent Loan Clauses Cross-Default Clause Default Clauses



Mortgage Theories VIF GAGE MORT GAGE LAW DAY EQUITY OF REDEMPTION CLOGGING DEVICES UNCLOGGING THE CLOGGING DEVICES 1. "Once a mortgage, always a mortgage." Chancery courts rejected anything in a mortgage agreement that would limit the borrower's right of redemption. A mortgage cannot be made irredeemable.

2. "A mortgage shall not contain a collateral advantage." A collateral advantage is a right of the lender to receive something besides the interest and principal.

3. The doctrine of "fettering" that invalidates any bargain binding the mortgaged land beyond the redemption period. Once the borrower has repaid the principal and interest, he or she must be given an unfettered right to the collateral. The word "fettering" derives from "fetters," a synonym for shackles or handcuffs.

Modern Mortgage Theories Mortgage conveys fee title to the lender Mortgage give a lien interest Intermediate or Hybrid Theory 79

Deed of Trust and Mortgage the deed of trust creates a third party the trustee who is to act as a neutral party to foreclose and conduct a private sale of the property in case of default. In theory, it protects all interests but usually the trustee is the nominee of the lender. Mortgage Obligations The Mortgage Note The life of the mortgage is contingent upon the life of the debt. If there is no debt, there is no mortgage.

The essential elements of a valid mortgage note are: 3-106. UNCONDITIONAL PROMISE OR ORDER. A writing An obligor with contractual capacity An obligee with contractual capacity A promise or covenant by obligor to pay a specific sum Terms of payment Default clause, including mortgage covenants by reference Proper execution Voluntary delivery and acceptance

(a) Except as provided in this section, for the purposes of Section 3-104(a), a promise or order is unconditional unless it states (i) an express condition to payment, (ii) that the promise or order is subject to or governed by another record, or (iii) that rights or obligations with respect to the promise or order are stated in another record. A reference to another record does not of itself make the promise or order conditional.


(b) A promise or order is not made conditional (i) by a reference to another record for a statement of rights with respect to collateral, prepayment, or acceleration, or (ii) because payment is limited to resort to a particular fund or source. Note consists of four divisions: Acknowledgement of the debt Note consists of four divisions: A promise to pay Note consists of four divisions: Provision for default. Note consists of four divisions: Execution

Elements of a Valid Mortgage Contract A mortgage is a security device and need not be of any prescribed form. In title states, it usually takes the form of a deed of conveyance with a defeasance clause.

In lien states, a form is used wherein there is merely a mortgaging clause that "the mortgagor hereby mortgages to the mortgagee." In still other states, the usual form employed is the deed of trust that conveys the legal title to the trustee With a power of sale in the event of a default.

The elements of the mortgage contract are as follows: A mortgagee 81 A mortgagor with contractual capacity A writing

Voluntary delivery and acceptance. Identification of the parties and the instrument The title of the document usually framed as an indenture tells us what it is and then the name of the borrower and lender in that order. Proper execution Mortgagors statutory covenants and clauses Description of the premises The pledge that is the agreement that this is to secure payment of a debt or obligation A mortgaging statement An interest in the real property that may be mortgaged

The pledge Framed as That to secure the payment of an indebtedness and then a reference to the note. The obligation should refer to the amount borrowed the interest terms, the payment terms and the date of repayment.

It should be identical as a discrepancy can create a problem. Mortgaging Statement 82

This is an essential statement of the purpose of the instrument, which is to mortgage the property to the mortgagee. Because this is a transaction in real property, the property must be described as in a deed. The property is now conditionally granted to the mortgagee. This provision may also incorporate personal property into the security. In that event, in foreclosure they will be sold.

Covenants and Clauses That the mortgagor will pay the indebtedness as hereinbefore provided. Covenants and Clauses That the mortgagor will keep the buildings on the premises insured against loss by fire for the benefit of the mortgagee; that he will assign and deliver the policies to the mortgagee: and that he will reimburse the mortgagee for any premiums paid for insurance made by the mortgagee on the mortgagor's default in so insuring the buildings or in so assigning and delivering the policies.

Covenants and Clauses That no building on the premises shall be removed or demolished without the consent of the mortgagee. Covenants and Clauses ACCELERATION: That the whole of said principal shall and interest shall become due at the option of the mortgagee: after default in the payment of any installment of principal or of interest for . days; or after default in the payment of any tax, water rate or assessment for . . days after notice and demand; or after default after notice and demand either in assigning and delivering the policies insuring the buildings against loss by fire or in reimbursing the mortgagee for premiums paid on such insurance, as hereinbefore provided; or after default upon request in furnishing a statement of the amount due on the mortgage and whether any offsets or defenses exist against the mortgage debt, as hereinafter provided.

Covenants and Clauses That the holder of this mortgage, in any action to foreclose it, shall be entitled to the appointment of a receiver. Covenants and Clauses


That the mortgagor will pay all taxes, assessments, or water rates, and in default thereof, the mortgagee may pay the same. Covenants and Clauses That the mortgagor within . .. . days upon request in person or within .... . days upon request by mail will furnish a written statement duly acknowledged of the amount due on this mortgage and whether any offsets or written defenses exist against the mortgage debt. See RPL 254 (7) Covenants and Clauses That notice and demand or request may be in writing and may be served in person or by mail. Covenants and Clauses That the mortgagor warrants the title to the premises. RPL 254 (5) Covenants and Clauses That the whole of said principal sum shall become due at the option of the mortgagee after default for ___ days after notice and demand, in the payment of any installment of any assessment for local improvements heretofore or hereafter laid, which is or mav become payable in annual installments and which has affected, now affects or hereafter may affect the said premises, notwithstanding that such installment be not due and payable at the time of such notice and demand.

Covenants and Clauses That the whole of said principal sum shall become due at the option of the mortgagee, if the buildings on said premises are not maintained in reasonably good repair or upon the failure of any owner of said premises to comply with the requirements of any department of the State, County or City within three months after an order making such requirement has been issued by any State, County or City Department. Covenants and Clauses The whole of principal sum shall immediately become due at the Option of the mortgagee if the mortgagor shall assign the rents or any part of the _____ of the mortgaged premises without first obtaining the written consent of the Mortgagee to such an assignment, or upon the actual or _____________or removal of any building erected. or to be erected upon the premises.

Special Clauses 84

One usually addresses special assessments and the right of the mortgagor to challenge them. First they must be paid.

Mortgagor obligates himself to keep the property in good repair and not allow someone like the city to do it.

Assignment of the rents to the mortgagee is usual so that the mortgagee is secured. Sometimes they will take it to pay the obligation and then give the excess to the owner. See net tenancies.

The usual assignment of rents clause in mortgage on realty, even though it gives mortgagee right of entry on mortgagor's default, does not constitute absolute "assignment" as of time of default, but becomes effective only after mortgagee asserts his right thereto by appointment of receiver in foreclosure action or becomes mortgagee in possession with express or implied consent of owner of equity of redemption. Dime Sav. Bank of Brooklyn v. Lubart, 1942, 38 N.Y.S.2d 252.

Agreement by the owner to use funds from the property first to maintain the property before anything else.

A sale in one parcel provision may also be added when the property consists of several parcels. Thus, each parcel is sold until the obligation is extinguished. The mortgagor may keep any other parcels. If on the other hand, the individual lots do not bring in sufficient funds then the bank can sell them as a single unit.

A provision that the owner will pay a fair market rent in case of default otherwise there is no duty to pay any rent by the owner although tenants have a continuing obligation. Clauses in Junior Mortgages Default in prior mortgage provision if the mortgagee defaults on prior mortgage, the mortgagee may pay the defaulted amounts and add it to the principal. It allows him to prevent the default.


Subordination. - This provision fixes the second mortgage behind the first mortgage. /

AN INTRODUCTION TO MORTGAGE MARKETS Access to Mortgage Markets Primary Mortgage Markets The mortgage market is composed of four general segments Savings by households and others Lending by organizations and institutions Borrowing by households and others Selling mortgages and notes in the secondary market.


The Construction Process The following is a list of reasons why developments suffer because of a poor construction process.

Problems due to casualty, delays, or even problems with unions and governmental agencies

Cost overruns on the construction side of the equation can affect marketing by reducing the contingencies available for negative cash flows during the lease-up period.

Schedule overruns can prevent tenant construction and delays for which penalties in space leases may be enormous.

Poor workmanship in systems and finishes can haunt a development for years and cause additional expenditures.

The project can be fined or shut down due to failure to comply with codes and ordinances. The confidence of lenders can be lost preventing financing of further transactions. Wasted time will be expended in selecting another contractor. Litigation from actions due to construction can consume time and resources.

The typical construction project consists of four stages: planning, design, 87

construction, and litigation.

THE NETWORK OF CONSTRUCTION RELATIONSHIPS Owner Architect Owner Engineer Owner Contractor Owner Multiple Contractors General Contractor-Architect There are seldom direct contracts between general contractors and architects although each depends on the other for the successful completion of the project. Any emergent legal claims arising from the poor performance. of the general contractor or architect to each other - are resolved by reference to tort law. Some courts express reluctance to. hold contractors and architects liable to each other to avoid compromising th prim acy of the owner-contractor and owner-architect relationships. Construction Lender-Architect/General Contractor If the owner is relying on outside funding to cover its payments to the architect, the agreement should: define the payment arrangements clearly and fully. The architect and general contractor may both be relying on the construction loan proceeds for payment. THE DEVELOPER-ARCHITECT AGREEMENT Architects translate the owner s objectives into buildable plans and construction documents, assist owners in obtaining bids and negotiating with contracts; and advise the owner on the progress and quality of construction.


THE RESPECTIVE ROLES OF OWNER AND ARCHITECT Owners Responsibilities Many owners believe that hiring an architect and providing the project financing are their only responsibilities. the owner is responsible for paying the bills but the owners duties go far beyond that. The owner also has a responsibility to the architect to formulate clearly her program goals, provide information about the site that would not be apparent by the architects casual inspection, and obtain all land use and environmental permits other than the building permit. THE RESPECTIVE ROLES OF OWNER AND ARCHITECT The Program the owner furnishes the architect a written program which answers such questions as why the client wants to build, the intended use of the new space, scheduling issues, the estimated budget, and: special criteria, including space requirements and special equipment needs THE RESPECTIVE ROLES OF OWNER AND ARCHITECT Site Information. Information about the site can be grouped into one of three types: information readily observable from a casual inspection, such as vegetation or access; information available from public sources such as recorded easements and zoning ordinances; and concealed information, such as subsurface conditions or invisible pollutants, neither visible diretly nor t. contained in public documents.

THE RESPECTIVE ROLES OF OWNER AND ARCHITECT Owners are burdened with the obligation of furnishing a full legal description and a detailed survey of the site showing all easements, utilities, zoning, deed restrictions, existing structures, boundaries i and contours. 89

They are also responsible for describing unusual site conditions to the architect and general contractor hiring experts as needed, such as soils engineers

Scope of Architects Work The first phase is called schematic design, the conceptual design of the Project illustrating the scale and relationship of the Project components. Scope of Architects Work In the second phase, called design development, the architect refines the scheme into threedimensional specifics and prepares drawings complete enough to describe the project size and shape, with all structural and mechanical elements identified along with the type of construction contemplated. Scope of Architects Work The third phase is the preparation of construction documents and drawings, sufficiently detailed so that contractors may bid on them, knowing what materials and labor will be required to build theproject. Scope of Architects Work Architects Role in the Bidding Process. After the design effort prodtcs formal set of agreed plans, the architect assists the owner in identifying potential bidders, soliciting bids, preparing a project manual descrIbing construction contract conditions, evaluating bids received, and once the owner selects a general contractor, informing the winner and losing bidders. Scope of Architects Work Architects Role During Construction. Most owners will need to rely on someone other than the architect to keep tabs on the general contractors performance. the architect only ascertains periodically that the project conforms generally to the design The AlA forms are written to shrink the architect s role during construction from one of being the owner s supervising inspector to that of a helpful occasional observer at the site The architect s legal liability as an occasional observer is far less than it would be if the architect agreed to supervise construction on behalf of the owner. Some architects flatly reject mere site observer status and the assumption that this is the best way to limit their liability for construction defects They believe the best way to limit their liability is not by distancing themselves from the job site but instead by keeping a very close eye on it. Scope of Architects Work Under the AIA form, during construction, the architect issues Certificates of Payment to honor the contractors Applications for Payment when justified bi the progress of the work. 90

Once the work reaches a phase of completion where the project is ready for use or occupancy, the architect certifies substantial completion and works with the owner to develop a list of unfinished items, called a punchlist. Final completion is attained when the punchlist items are satisfactorily corrected.

FIVE OWNER-ARCHITECT CONTRACT ISSUES Ownership of Plans The Architects Fee Implied Cost Conditions. The Architects Role in Dispute Resolution Consequential Damages ARCHITECTS TORT LIABILITY Two possible negligence standards apply. Under the standard most frequently applied, the architects performance is compared to what other architects would have done under similar circumstances, and whether the challenged architect demonstrated skills and abilities matching those ordinarily and reasonably provided by their peers. The competing standard holds architects accountable for the product the client could reasonably have expected, not what other architects would have done. THE CONSTRUCTION PROCESS Construction is a process by which an owner of real property identifies, dedicates, and expends various resourceslabor, materials, technology, expertise, and investment capital to enhance the value of the real property.

A construction contract governs and shapes a relationship, not merely a transaction.



Variety of Structures Available Single Prime Contractor Multiple Prime Contractors Construction Management Design/Build Single Prime Contractor

MULTIPLE PRIMES structural, electrical, mechanical, and finish all become prime contractors, in direct contractual privity with the owner.

MULTIPLE PRIMES Construction Management As with the multiple prime contractors approach, pure construction management places the various trade contractors in direct contractual privity with the owner. The fundamental difference between the two methods is that here the owner employs a construction manager to perform many of the functions traditionally performed by the general contractor, such as coordination and scheduling Construction Management Design/Build The design/build construction method is different from the preceding three in that the responsibilities for the design and construction of the project are combined and contractually delegated to one entity. That entity, typically a contractor, then provides or purchases the design services, well as the construction materials and services. Design/Build



The general contractor will be an asset to the development process because of his experience, his purchasing power for labor and materials, his organization, and ability to guarantee the construction costs. Building and Lease-Up Once mobilized, the contractor becomes the general officer who is responsible for all activities on the site. He will hire subcontractors of all types, assemble a staff, organize on-site offices, and coordinate with all local authorities for utilities and permits. He must consider rain delays and plan contingencies to overcome them. He must be prepared for material delays in shipping and must make sure that the project is built per the quality specified. Everything which goes under and within the physical product of the development will bear his mark. His failure will become the developers challenge.

The following is a list of key items which must be addressed. Operating manuals giving operating instructions for various installed systems and their maintenance (normally provided in a bound notebook at completion) Warranties, which are normally included in the purchase of various equipment and systems (normally provided in a bound notebook at completion) Mechanical equipmentcomplete with flow arrows, tags and control schematics, chillers charged and operable, test and balance reports, and air handling units cleaned with permanent filters Electrical equipmenttransformers and primary cables complete and signed off by utility companies, labeled panels, labeled circuiting, and all fixtures installed Fire safety equipment complete, tested and approved by local fire marshal

All site work complete including sanitary and storm sewers, domestic water, site lighting, paving, and parking lot stripping. All quality assurance/quality control test inspections are complete and work approvedmore on this subject is found later in this chapter 93

Generally all surfaces cleaned and all debris removed

CONTRACT FORMS AND PROVISIONS Fast TrackGuaranteed Maximum Negotiated Contract The contractor, based on pricing drawings produced by the architect and other designers, using his experience provides a guaranteed maximum/not to exceed price which the developer can use in his project economics. Armed with this price and the contractors agreement, the developer can obtain financing. The design and construction team fast track the process by finishing designs, drawings, specification for long lead items first as schematics, then gradually adding the missing pieces until the total set of drawings is complete. The big difference with this process and the bid award process is that the building is 50 percent complete before the drawings are complete. In the bid award process all the drawings are complete before the contractor begins. Needless to say, this process requires mature and experienced contractors and architects working closely with a schedule consultant and a developer who has a bias for action in decision making.

Cost -Plus Contract The contractor performs for a set fee regardless of how much the project finally costs, but he bills the developer for the costs plus this fee. When the bid-award or contract fixes the total price, whereas the unit price method will fix the price of specified items. The total contract is determined by multiplying the unit pricing by the quantity of items used. This method can be used effectively for tenant development work. Lump-Sum with Escalation Contract This method is used to eliminate any unwarranted price increases to cover contingencies in the general contractors bid.

Fixed Price Incentive Contract

This method allows the fee portion of the price to be adjusted either upward or downward depending on certain factors which are controlled by the general contractor. This price adjustment is typically based on actual construction costs incurred by the general contractor during the work. The following factors are agreed upon by both parties:

Target cost of the work 94

Target fee for the work Target price (cost plus fee) Ceiling price that will limit the owners responsibility for any cost overruns Formula for establishing the final general contractors fee


The scope of work will describe the work which the general contractor will be performing, by referring to the plans and specifications.

Start Date of Construction

This section will specify how the notice to proceed with construction will be given.

Construction Scheduling

This section will outline the schedule which will be followed during construction.

Construction Completion Date

This section will specify the time when construction must be complete.

ELEMENTS contd Cost Saving Split


Depending on the type of contract which was negotiated, a savings in any construction costs may be split between both parties.

ELEMENTS contd Method of Payment a lump sum or fixed price; This section will specify the procedures for draw requests Draw Schedule This section will state exactly what guarantees the general contractor is making Guarantees This section will detail the procedures to be used for any change orders required. Change Orders

the cost of the work plus a fee (fixed or percentage), with or without a guaranteed maximum price; and

unit prices.

Standard contract provisions typically provide for monthly payments based on a percentage of the work completed, with the owner withholding a fixed percentage (retainage) to ensure satisfactory completion of the project.5 96

ELEMENTS contd Performance standards should be clearly spelled out in the contract, especially if the desire is for a higher than average quality or a standard of performance different from that which is ordinary and customary in the industry. In the absence of a specific standard or level of quality, a performance level based on industry standards and common construction practice will generally be implied.

In determining whether the contractor has performed in accordance with the contract, form construction contracts frequently give the architect or engineer the power to accept or reject the contractors work. ELEMENTS contd Rain Days Extension

This section will specify the definition of a rain day and how construction duration may be altered.

Bonus and Penalty Fee Clause

This clause determines the bonus and penalty. The formula for these items will be based on scheduling of construction. Since the interest charges increase the longer it takes to build the project, the general contractor should pay a penalty for not performing per the agreed upon time schedule. On the other hand, if the general contractor delivers the project early he should share in the reduction of the interest costs. This fee is usually based on the daily interest costs for the development.

Backcharges During the course of the construction project, it may be necessary for the developer to contract for certain work operations performed by others. In these instances, the developer will backcharge the general contractor for the cost of this work.

ELEMENTS contd 97

Reserve This section will outline the composition of the construction reserve and when it will be released to the general contractor.

This section will detail which lien waivers will be required by the general contractor from the subcontractors and material suppliers prior to funding draw requests. Lien Waivers

This section will define the procedure for the final punch-out of the property. A specified time period will be agreed upon to complete these punch out items. If after this time period expires and the work is not complete, the developer should be able to have this work completed by others and then reduce the contractors reserve (or sometimes called retainage). Punch Out

This section will define the warranties of construction which the general contractor will give to the developer. Warranty

98 Staging of Phases This section will define how the project is turned over to the developer. ELEMENTS contd Broom Clean Condition

If the development consists of more than one development phase, the contract should spell out the construction timing of each phase.

Arbitration or Litigation Clause

The contract should include a clause which sets procedures for disputes between both parties. ELEMENTS contd Finally, a construction contract, like any other agreement, should provide some procedure for termination of the agreement under certain specified circumstances

Implied Contractual Obligations

a duty of the contractor to perform the work in a workmanlike manner. Other significant obligations that may be found by implication in a construction contract are the owners implied warranty of the sufficiency of the plans and specifications the duty of each party to cooperate and not to hinder or delay the other party and an obligation of more recent vintage that appears destined for wider application, the duty of the parties to deal in good faith with one another .

Implied Warranty of the Plans and Specifications The party who furnishes plans and specifications legally warrants the adequacy and sufficiency of those documents.

Duty to Cooperate and Not to Hinder or Delay

In construction law, an owner has the following implied obligations:


2. Not knowingly to delay unreasonably the performance of duties assured under the contract; and 1. Not to do anything to hinder or obstruct performance by the contractor;

Duty to Deal in Good Faith 3. To furnish information that will not mislead prospective bidders.2


Mutual Waiver of Consequential Damages

Perhaps the most controversial new concept introduced in the 1997 edition of AlA Document A20l is the addition of a provision whereby both the owner and the contractor waive any claims against the other for consequential damages. The new subparagraph 4.3.10 expressly waives any claims for damages incurred by the owner for rental expenses, lost income, financing costs, damage to business and reputation, and lost productivity. On the other side of the coin, it also expressly waives any claims by the contractor for damages relating to principal office expenses, financing costs, damage to business and reputation, and lost profits (other than anticipated profit arising directly from the work that is the subject of that contract).


Correction of Work Under new subparagraph AIA, the owner waives its right to require the contractor to correct defects or to assert a claim for breach of warranty if the owner fails to notify the 100

contractor and give the contractor an opportunity to make the necessary corrections during the one-year correction period. An example of the potential ambiguity that remains, however, is the uncertain meaning of the phrase opportunity to make the corrections. New subparagraph AIA states that, when the contractor does perform corrective work during the one-year period, the performance of this corrective work does not extend the correction period. Hazardous Materials The 1997 edition also requires a licensed testing laboratory to verify both the presence and the remediation of hazardous materials encountered on the site. The owners indemnity obligations are also broadened with respect to hazardous materials to require the owner to indemnify the contractor even when the owner was not negligent. Killer Clauses One of the basic principles of good management is that responsibility should be commensurate with authority. Applying this fundamental principle to the construction process would suggest that the party best able to identify, manage, and control a particular risk should bear responsibility for it. Yet this basic tenet is violated, to one degree or another, in many, and perhaps most, construction contracts.

One way this violation occurs is through the frequent inclusion in construction contracts of a variety of common risk-shifting, risk avoidance, or exculpatory clauses. Killer Clauses 1. No damages-for-delay clauses;


Subsurface disclaimers;


Stringent (and sometimes unreasonable and/or punitive) notice provisions;


Waiver of lien rights;


Pay when paid clauses (in subcontracts); and 101

2. The owner failed to have the construction site prepared on time for the contractors performance; 6. DELAY 1. The owner failed to deliver materials as called for under the contract; Waivers of, or limitations on recovery of, various types of costs or damages.

7. The owner failed to coordinate the work of parallel prime contractors properly, resulting in delay; 6. The owner failed to make timely payments to the contractor; 5. The owners defective specifications caused delays; 4. The owner failed to provide timely and sufficient access to the construction site; 3. The owner failed to relocate utilities;

10. Certain actions of the owner caused labor unrest, resulting in delays to the contractor. 9. The owner failed to approve shop drawings within a reasonable period of time; and 8. The owner refused to give written orders for extra work, resulting in delay;

Recovery for delay has been allowed when the delay was 102

Of a kind not contemplated by the parties as being covered by the clause; Tantamount to abandonment of the contract; The result of fraud, bad faith, or arbitrary action; The result of active interference with the contractors work by the owner; The delays were caused by the owners bad faith or its willful, malicious, or grossly negligent conduct; The delays were uncontemplated; The delays resulted from breach by the owner of a fundamental obligation of the contract. Contractors faced with a no damages for delay provision may be forced to include a contingency in their price to cover the risk of owner-caused delay.


ENVIRONMENTAL LAW ISSUES National Environmental Policy Act The National Environmental Policy Act (NEPA) is the basic national charter for protection of the environment. NEPA establishes policy, sets goals, provides means for carrying out policy, and contains provisions to ensure that federal agencies act according to the letter and spirit of the Act. The National Environmental Policy Act (NEPA or the Act) requires federal administrative agencies to factor environmental considerations into their decision-making. The Act directs that federal agencies implement, to the fullest extent possible, methods and procedures designed to accord environmental factors appropriate consideration.2 NEPA Producing environmental documentation is often called the NEPA process. These procedures ensure that environmental information is available to public officials and citizens before decisions are made and before actions are taken. Accurate scientific analysis, comments from expert agencies, and public scrutiny are essential to implementing NEPA. Ultimately, the NEPA process is intended to help public officials make decisions that are based on an understanding of environmental consequences. The President, federal agencies and courts share responsibility for enforcing NEPA. Most important, NEPA documents must concentrate on the issues that are truly significant to the action in question, rather than amassing needless detail. Neither an EIS nor NEPA itself, however, dictates any particular result. NEPA is essentially a procedural statute; it establishes procedural steps, such as the preparation of an EIS, which, once satisfied, do not dictate any particular substantive decision, or even require the elevation of environmental concerns over the pertinent considerations.6 However, no decision on a proposed action subject to NEPA can be made until full compliance with the Acts requirements is achieved. Thus, the key to compliance with NEPA is satisfaction of its procedural mandates. The Definition of Environment Effects While NEPA is addressed primarily to physical effects, the term human environment goes beyond impacts on earth, air and water. The CEQ regulations provide a very broad definition of the term human environment, which encompasses impacts on the quality of urban life. Effects not only include direct impacts of an action, but also indirect (or secondary) impacts those which are later in time or farther removed in distance from the proposal, but which nevertheless are reasonably attributable to it and reasonably foreseeable in time. 104

This landmark legislation, enacted in 1969, was the progenitor of the little NEPAs in other states, including the New York State Environmental Quality Review Act (SEQRA). Consequently, many of the procedural aspects of NEPA and SEQRA are similar, and developments in the application and interpretation of NEPA are likely to be germane to SEQRA. State Environmental Quality Review Act ( SEQRA ) the New York State Environmental Quality Review Act (commonly referred to as SEQRA or occasionally as SEQR) is perhaps the most pervasive and far-reaching in fostering public awareness of local environmental concerns and enabling the public and the government to protect a broad range of environmental values. SEQRA must be followed by all state and local agencies. N.Y. Envtl. Conserv. Law (ECL) article 8,secs. 8-0101 to 8-0117 (McKinney 1984) SEQRA was fashioned after the National Environmental Policy Act of 1969 (NEPA) The basic purpose of SEQRA is to incorporate the consideration of environmental factors into agency planning, review and decision-making so that social, economic and environmental factors are considered together in reaching decisions on proposed activities.

SEQRA achieves its purpose through a process which assures the identification and evaluation of potentially significant adverse environmental impacts that may arise from actions which are directly undertaken, funded or approved by governmental agencies at either the state or local level and identification and evaluation of alternatives to these actions which might mitigate or reduce the identified impacts. The vehicle through which these potential impacts are evaluated is the environmental impact statement (EIS), which undergoes an extensive governmental and public review process. The EIS and its review process have been described as an alarm bell: which can alert the public and decision-makers to the potential for adverse environmental harm arising from a proposal prior to it becoming a fixed reality. SEQRA is an unusual regulatory process, inasmuch as no specific governmental agency is charged with ensuring compliance with the statute SEQRA Definitions 105

Actions Governed by SEQRA The SEQRA process applies to any action directly undertaken by a governmental agency, funded by a governmental agency or approved by a governmental agency.

Governmental agencies subject to the provisions of SEQRA are broadly defined. These include: state agencies and authorities and all local municipal and county boards and agencies, villages and cities in both a legislative and an administrative capacity. However, actions of the New York State Legislature and New York courts are specifically exempt from the provisions of SEQRA.

Actions are broadly defined as including: projects or activities directly undertaken by any agency; or projects or activities supported in whole or in part through contracts, grants, subsidies, loans, or other forms of funding assistance from one or more agencies; or projects or activities involving the issuance to a person ofa lease, permit, license, certificate or other entitlement for use or permission to act by one or more agencies;. . . policy, regulations and procedure-making

Permit or licensing actions include any form of government approval, permission or authority to conduct an action (e.g., issuance of a variance or special permit by a zoning board of appeals), site plan approval by a planning board and issuance of a permit to fill a wetland, alter a stream, construct a landfill or discharge industrial wastewater. Type I and Unlisted Actions There are two broad categories of actions or projects which are specifically subject to SEQRAs procedural requirements. These two categories are Type I and unlisted actions. Type I actions are those actions or projects determined to be more likely to require the preparation of an EIS than those not so listed. Examples of Type I actions taken from the statewide list adopted by the DEC. set forth in 6 N.Y.C.R.R. sec. 617.12, are identified below: The adoption of changes in the allowable uses within any zoning district, affecting 25 or more acres of the district; The acquisition, sale, lease, annexation or other transfer of 100 or more contiguous acres of land by a State or local agency; Construction of new residential units which meet or exceed certain thresholds:


Activities, other than the construction of residential facilities, which meet or exceed certain thresholds; Any structure exceeding 100 feet above original ground level in a locality without any zoning regulation pertaining to height Unlisted actions are simply that vast category of activities which are not included on either the Type I list or the Type II list of exempt actions . Actions Not Subject to SEQRA The SEQRA regulations define three categories of actions which are not subject to SEQR.A. These are excluded exempt and Type II actions Excluded actions are those actions which were undertaken, approved or funded prior to the effective date SEQ The second category of such actions is called exempt actions. These actionsinclude: (1) civil or criminal enforcement proceedings, whether administrative or judicial, including a particular course of action specifically required to be undertaken pursuant to a judgment or order, or the exercise of prosecutonal discretion; (2) official acts of ministerial nature, involving no exercise of discretion;

(3) maintenance or repair involving no substantial changes in an existing structure or facility; (4) emergency actions which are immediately necessary on a limited and temporary basis for the protection or preservation of life, health, property or natural resources, provided that such actions are directly related to the emergency and are performed to cause the least change or disturbance, practicable under the circumstances, to the environment. Any decision to fund, approve or directly undertake other activities after the emergency has expired is fully subject to the review procedures of this Part; and (5) actions of the Legislature of the State of New York or of any court. Actions of local legislative bodies are not exempt.33 Type II actions are those actions which the DEC has determined will not have a significant adverse effect on the environment under any circumstance. Examples include: the granting of individual setback and lot line variances; installation of traffic control devices on existing streets, roads and highways;


purchase or sale of surplus government property other than land, radioactive material, pesticides, herbicides or other hazardous materials; purchase of furnishings, equipment, or supplies license, lease and permit renewals, or transfers of ownership thereof where there will be no material change in permit conditions or the scope of permitted activities.37

Agencies Responsible for Compliance with SEQRA Involved Agencies Those agencies with a discretionary approval or which are directly undertaking or funding an action are referred to in the SEQRA regulations as involved agencies.4 An agency is an involved agency even though it may not be called upon to consider an action and issue an approval until much later in time than some of the other agencies.4 Lead Agency The agency which will be principally responsible for carrying out the procedural requirements of the SEQRA regulations is referred to as the lead agency. The SEQRA regulations provide guidance concerning which agency should be the lead agency where there is more than one involved agency SEQRA states that the following criteria, in order of importance, shall be used to designate the lead agency: (i) Whether the anticipated impacts of the action being considered are primarily of statewide, regional or local significance, (i.e., if such impacts are of primarily local significance, all other considerations being equal, the local agency involved shall be lead agency); (ii) which agency has the broadest governmental powers for investigation of the impact of the proposed action; and (iii) which agency has the greatest capability for providing the most thorough environmental assessment of the proposed action The responsibilities of the lead agency include determining the environmental significance of the action and issuance of either a positive or negative declaration; causing all the required notices to be properly filed, circulated and published; review and acceptance of a DEIS, if one is required; providing for public review and comment on the DEIS, 108

including a public hearing, where warranted; causing an FEIS to be prepared; and issuing the SEQRA findings prior to decision-making SEQRA Procedures The regulations provide that whenever any agency receives an application for funding or approval or proposes to undertake an action, it must do the following: determine whether the action is subject to SEQRA; determine whether the action involves a federal agency; determine whether the action involves one or more other agencies;

make a preliminary classification of an action as Type I or unlisted, using the information available and comparing it with the thresholds set forth in sec. 617.12. Such preliminary classification will assist in determining whether a full EAF and coordinated review is necessary; for all actions subject to SEQRA, determine whether a full or short EAF will be required

Preliminary Agency Review of the Action If the action is a Type I or unlisted action and involves activities of a federal agency, SEQRA provides that the federal agencys compliance with NEPA shall be coordinated with the state and local agencies compliance with SEQRA.5 Under the regulations, if a DEIS and FEIS have been prepared under NEPA, a state or local agency has no obligation to prepare an additional EIS under the SEQRA regulations; however, the state and local agency may not undertake or approve the action until the federal FEIS has been completed and SEQRA findings have been made On the other hand, if the federal equivalent of a negative declaration has been issued by the federal agency, such determination does not constitute compliance with SEQRA, and state and local agencies remain responsible for compliance with the provisions of SEQRA which includes making a new determination of significance. Determining the Significance of an Action Criteria for Negative and Positive Declarations and Conditioned Negative Declarations The lead agency must determine whether the proposed action (1) will not have a potentially significant environmental effect on the environment (a negative determination of significance or negative declaration, commonly referred to as Neg-Dec) or(2) may have a potentially 109

significant impact on the environment (positive determination of significance or positive declaration) The criteria contained in 6 N.Y.C.R.R. sec. 617.11 (1987) provide the yardstick against which an agency must measure an actions potential for significant environmental effects. (a)(l) a substantial adverse change in existing air quality, ground or surface water quality or quantity, traffic or noise levels; a substantial increase in solid waste production; a substantial increase in potential for erosion, flooding, leaching or drainage problems; the removal or destruction of large quantities of vegetation or fauna; substantial interference with the movement of any resident or migratory fish or wildlife species; impacts on a significant habitat area; substantial adverse effects on a threatened or endangered species of animal or plant, or the habitat of such a species; or other significant adverse effects to natural resources; (3) the encouraging or attracting of a large number of people to a place or places for more than a few days, compared to the number of people who would come to such place absent the action; (4) the creation of a material conflict with a communitys current plans or goals as officially approved or adopted; (5) the impairment of the character or quality of important historical, archeological, architectural or aesthetic resources or of existing community or neighborhood character; (6) (7) a major change in the use of either the quantity or type of energy; the creation of a hazard to human health;

(8) a substantial change in the use, or intensity of use, of land including agricultural, open space or recreational resources, or in its capacity to support existing uses; (9) thecreation of a material demand for other actions which would result in one of the above consequences; (10) changes in two or more elements of the environment, no one of which has a significant effect on the environment, but which when considered together result in a substantial adverse impact on the environment; or (11) two or more related actions undertaken, funded or approved by an agency, none of which has or would have a significant effect on the environment, but when considered cumulatively, would meet one or more of the criteria in this section.


For the purpose of determining whether an action will cause one of the foregoing consequences, the lead agency must consider reasonably related long-term, short-term and cumulative effects, including other simultaneous or subsequent actions which are: (1) (2) (3) included in any long-range plan of which the action under consideration is a part; likely to be undertaken as a result thereof; or dependent thereon.

The significance of a likely consequence (i.e., whether it is material, substantial, large or important) should be assessed in connection with: (1) (2) (3) (4) (5) (6) (7) its setting (i.e., urban or rural); its probability of occurrence; its duration; its irreversibility; its geographic scope; its magnitude; and the number of people affected.

It is important to emphasize that the threshold for requiring preparation of an EIS under SEQRA is when the action may have a significant effect on the environment. The threshold under SEQRA for preparation of an EIS is a lower standard than applicable to federal agency actions under NEPA. As a consequence of the applicability of the SEQRA process to agency actions, many project proponents, in both the governmental and private sectors, plan and design projects so as to reduce a projects potential for adverse environmental effect below the significance threshold which would necessitate preparation of a DEIS. Where mitigation measures have been incorporated into the design of the proposed project and can be said to eliminate the potential for significant environmental impact, issuance of a negative declaration is appropriate, notwithstanding the size or complexity of the project.65 In such a case, the goals of the statute have been achieved with a minimum of procedural delay. Form and Content of the Negative Declaration In order to be upheld on judicial review, the negative declaration prepared by the lead agency concerning an action must satisfy a three-part test. The negative declaration must show that the lead agency 111

adequately identified the areas of potential adverse environmental impacts; took a hard look at the potential impacts; and

-- made a reasoned written elaboration of the basis for its negative determination.67 Once a negative declaration has been issued, the SEQRA regulations provide that certain notice and circulation requirements must be followed depending upon whether the action is a Type I or an unlisted action.~ Generally speaking, for Type I actions, filing of the negative declaration with various listed agencies is required, whereas negative declarations for unlisted actions need only be filed in the lead agencys own records.73 Upon issuance and filing of the negative declaration by the lead agency, the lead agencys SEQRA responsibilities end, and the lead agency and other involved agencies may proceed to exercise their underlying authority concerning the action.74 A conditioned negative declaration is a form of a negative declaration for certain unlisted actions that may have potentially significant environmental impacts which can be eliminated or sufficiently mitigated through the imposition of conditions by a lead agency. As a consequence, no significant adverse environmental impacts will result from the action. Any conditions imposed must be practicable and reasonably related to impacts identified in the full EAF and the conditioned negative declaration completed by the lead agency. . Form and Content of a Positive Declaration The issuance of a positive declaration means that a DEIS will have to be prepared concerning the action and all decision-making concerning the action postponed until the EIS procedures, discussed in detail below, are completed. Issuance of a positive declaration can cause an applicant to make significant financial commitments, by virtue of the costs associated with preparation of a DEIS and the time required for compliance with SEQRAs remaining procedural requirements. Thus, while the positive declaration may not be the final82 action under SEQRA, the positive declaration may nevertheless be ripe for judicial review. Notice of Completion and Public Review of the DEIS Once the DEIS has been prepared and is found by the lead agency to be satisfactory with respect to its scope, content and adequacy, the lead agency must prepare a notice of completion of the DEIS. The content of the notice of completion is described in sec. 617.10(c) of the SEQRA regulations The most important elements which must be contained in a notice of completion of the DEIS are: 112

1. a brief and precise description of the action covered by the statement, and the location and nature of its potential environmental impacts and effects; 2. a statement indicating where and how copies of the DEIS can be obtained from the lead agency; and 3. a statement that comments are requested and will be received and considered by the agency at a given address for a stated period oftime (not less than 30 calendar days from the first filing and circulation of the notice of completion, or not less than 10 calendar days following a public hearing at which the environmental impacts of the proposed action are considered, whichever is later). 4. be analytical and not encyclopedic;

5. be clearly and concisely written in plain language that can be read and understood by the public; 6. address in detail only those specific adverse or beneficial environmental impacts which can be reasonably anticipated and/or that have been identified in the scoping process 7. contain no more detail than is appropriate considering the nature and magnitude of the proposed action and the significance of its potential impacts; and 8. summarize highly technical material.7

A practical difficulty which often arises in the case of controversial projects is that the costs of reproducing a voluminous DEIS are quite high. Section 617.10(d) states that copies of the DEIS shall be filed with the DEC and all agencies and with persons requesting it. Roles of Involved and Interested Agencies to cooperate and make available to the preparer any information contained in their files relevant to the EIS Scoping is a process to aid in the identification of relevant issues to be addressed in a DEIS Hearings on the DEIS are discretionary and generally to be based on the extent of controversy over the environmental effects of the proposal (as opposed, at least in theory, to controversy over the project itself).7 After the publication and circulation of the DEIS and the closing of any hearing, a final EIS (FEIS) is prepared. The FEIS must respond to all substantive comments on the DEIS . The Draft EIS (DEIS) DEISs must contain the following:


1. A concise description of the proposed action, its purpose, public need and benefits, including social and economic considerations; 2. A concise description of the environmental setting of the areas to be affected, sufficient to understand the effects of the proposed action and alternatives; 3. A statement and evaluation of the environmental impacts of the proposed action, including the reasonably related short- and long-term effects, cumulative effects, and other associated environmental effects; 4. An identification and brief discussion of any adverse environmental impacts which cannot be avoided or adequately mitigated if the proposed action is implemented; 5. A description and evaluation of the range of reasonable alternatives to the action which are feasible, considering the objectives and capabilities of the project sponsor. The description and evaluation of each alternative should be at a level of detail sufficient to permit a comparative assessment of the alternatives discussed. The range of alternatives must include the no-action alternative and may include, as appropriate, alternative a. b. c. d. e. f. g. sites; technology; scale or magnitude; design; timing; use; and type of action.

6. An identification of any irreversible and irretrievable action should it be implemented; commitments of resources which would be associated with the proposed A description of mitigation measures to minimize the adverse environmental impacts;


8. A descijption of any growth-inducing aspects of the proposed action, where applicable and significant; 9. A discussion of the effects of the proposed action on the use and conservation of energy, if applicable and significant; 10. For state agency actions in the coastal area:

a. when the action is not in an approved local waterfront revitalization program area, an identification of the applicable coastal policies of Executive Law article 42 as contained in 19 114

N.Y.C.R.R. sec. 600.5, and a discussion of the effects of the proposed action on, and their consistency with, such policies; b. when the action is in an approved local waterfront revitalization program area and the action is one identified by the Secretary of State pursuant to sec. 916(1)(a) of the Executive Law, an identification of the applicable policies of the local program and a discussion of the effects of the proposed action on such policies; and 11. A list of any underlying studies, reports and other information obtained and considered in preparing the statement. The Final EIS (FEIS) Within the later to occur of (a) 45 days from the close of the public hearing on the DEIS or (b) 60 days after issuance of the Notice of Completion of the DEIS, the FEIS must be prepared.3 These times may be extended where additional time is needed to prepare the FEIS adequately where problems with the proposed action requiring material reconsideration or modification have arisen.32 An FEIS must consist ofthe following: (a) the DEIS, including any revisions or supplements to it (the DEIS may be incorporated by reference or directly incorporated into the FEIS); (b) copies or a summary of the substantive comments received on the DEIS during the public comment period or at the public hearing and their source; and (c) the lead agencys response to all substantive comments.~ The Supplemental EIS (SEIS) The DEC SEQRA regulations provide for the preparation of a supplemental draft or final EIS (SEIS), limited to specific issues not addressed or inadequately addressed in the EIS in the following circumstances: (a) changes are proposed for the project which may result in a significant adverse environmental effect; (b) newly discovered information arises about significant adverse effects which was not previously addressed; or (c) a change in circumstances arises which may result in a significant adverse environmental effect. Judicial Review


Most courts apply the arbitrary and capricious standard to an agencys determination not to prepare an EIS, although a minority of the circuits apply the reasonableness criterion. An ElS must have been prepared with objective good faith and have taken a hard look at environmental consequences and alternatives To sustain a challenge to an EIS, a plaintiff must prove a fundamental flaw; the identification of numerous small errorsflyspecking the EISwil not be sufficient) The already difficult burden placed upon a party challenging the adequacy of an EIS is usually exacerbated by the submission of the voluminous agency record which invariably accompanies EIS preparation.


ENVIRONMENTAL LAW ISSUES II Environmental liabilities can dramatically increase the business risk of a transaction. Liability for on-site and off-site cleanup costs and third-party toxic torts easily can translate into sums far in excess of the transaction investment. Federal Laws The most significant federal legislation is the Comprehensive Environmental Response, Compensation, and Liability Act, commonly referred to as CERCLA or Superfund. CERCLA impacts a property transfer in two main ways. First, individuals and entities that acquire contaminated property, regardless of whether by deed or lease, may be liable for cleanup costs. Second, CERCLA permits the government to place a lien on property in order that the government can recoup its cleanup costs.

The Resource Conservation and Recovery Act (RCRA) regulates the day-to-day handling and disposal of hazardous wastes. Although RCRA is relevant to the way IN which certain business operators handle hazardous wastesfor example, the storage of dry cleaning solvents by a dry cleaning establishmentthe laws primary focus is on the manner in which hazardous wastes are stored, treated, and disposed of by owners and operators of hazardous waste treatment, storage, and disposal facilities The Federal Underground Storage Tank Law imposes liability upon owners and operators of regulated underground storage tanks for failure to properly register or operate those tanks and for discharges from those tanks. Like RCRA, the federal Water Pollution Control Act3 and the federal Air Pollution Prevention and Control Act4 will have greater significance in a stock or asset sale than in a real estate transaction, since these laws generally are designed to regulate discharges through a permitting program State Laws Common Law remember that liability for environmental conditions may be imposed under a number of common law tort theories, such as nuisance, trespass, negligence, and strict liability



THE COMPREHENSIVE ENVIRONMENTAL RESPONSE,COMPENSATION, AND LIABILITY ACT There are four classes of responsible parties: 1. The present owner(s) and operator(s); 2. The owner(s) and operator(s) at the time of disposal;

3. The person who arranges for the disposal or treatment of hazardous substances or arranges with a transporter for the transporting of hazardous substances for disposal or treatment; and 4. The person who accepts hazardous substances for transportation to disposal or treatment facilities at which there is a release. Liability under CERCLA is strict, joint, and several Generally speaking, responsible parties under CERCLA may be sued by the federal Environmental Protection Agency (EPA) and private parties, and held liable for costs of removal and remedial action, response costs, and damages to natural resources. In addition, fines and penalties of up to $25,000 per day may be assessed for violation of the Act,7 and the government may impose a lien on the real estate of any responsible party that is the subject of a cleanup action. A current owner will be liable under CERCLA, regardless of whether that party caused the discharge.

When there has been a discharge during ownership, ownership liability will attach, no matter how brief the period of ownership, and may be predicated on the passage of equitable title as opposed to legal as well as an assignment of a lease. Also, corporate officials who actively participate in the operations of a facility, parent corporations that exert control over a subsidiarys facility, and developers who move contaminated soil from one section of a parcel to another may be held liable as an operator for cleanup costs. An otherwise responsible party will not be liable under CERCLA if a showing can be made that the release of hazardous substances and the resulting damages were solely the result of 1. An act of God;



An act of war; or

3. An act or omission of a third party other than the responsible partys employee or agent or one whose act or omission occurs in connection with a contractual relationship so long as the responsible party establishes that (i) he or she exercised due care with respect to the hazardous substance concerned and (ii) he or she took precautions against foreseeable acts or omissions of any such third party and the consequences that could foreseeably result from such acts or omissions.

THE INNOCENT PURCHASER DEFENSE the party must show that, when the real estate was acquired, the party undertook all appropriate inquiry into the previous ownership and uses of the property consistent with good commercial or customary practice. .. . In determining what constitutes good commercial or customary practice, courts are directed by the statute to take into account the following factors: The specialized knowledge and experience of the party; Whether the purchase price and the property value match;

Information that is commonly known or is reasonably ascertainable about the real estate; Whether the existence of contamination is obvious; and

Whether the existence of contamination can be determined by appropriate inspection. CONTRACTUAL REALLOCATION OF LIABILITY Although CERCLA does not permit private parties to shift CERCLA liability from one private party to another vis--vis the government, CERCLA expressly recognizes the ability and enforceability of agreements to reallocate CERCLA responsibility between the contracting parties. A threshold determination must therefore be made in every sale transaction whether liability for preexisting environmental contamination will shift to the new owner. IMPACT OF AS IS Traditionally, sellers have sought refuge in the doctrine of caveat emptor and included an as is provision in the sale document to shift the risks of property ownership to the buyer.


In the environmental arena, however, real property sold on an as is basis will not necessarily preclude a claim brought by a buyer against its seller under CERCLA. To preclude recovery against a seller under CERCLA, there must be an express provision allocating the risk between the parties and a clear and intended waiver or release of the right to bring the particular claim in the future. It is therefore incumbent upon the contract drafter to make certain that the contract terms are clear, unambiguous, and broad enough to address all statutory and common law theories of relief and anticipate potential future conditions, and to be familiar with the law of the state in which the property is located, since the court will look to the state law to determine when and if the agreement will shift environmental responsibility. ACHIEVING COMPLETE RELEASE FOR A SELLER the release will fall short of insulating a seller against liability to subsequent owners and operators, since there is no privily of contract between the seller and such parties. Consequently, sellers real estate counsel should give consideration to expanding the release and indemnification from a contract provision to a covenant within the deed of conveyance and expressly providing in the conveyance instrument that the covenant will run with the land and bind successors in title and interest.

DUE DILIGENCE The courts have held that a buyer that knows of the operations conducted on a site and that knows those operations contributed contamination to a site cannot satisfy the CERCLA innocent purchaser defense. The courts have also held that some on-site inspection is required to meet the innocent purchaser defense. While the innocent purchase defense is available to both prior and current owners of real estate, an innocent owner of real estate that learns of a discharge and fails to disclose that discharge to a subsequent purchaser will lose the innocent purchaser defense. CERCLA does not establish a safe harbor by specifically delineating what constitutes appropriate inquiry. In fact, the standard is rather elusive, since satisfaction will be determined based on the buyers level of sophistication and the circumstances of the purchase. Generally speaking, however, to satisfy the innocent purchaser defense, a buyer must undertake due diligence. The aim of any due diligence project must be to establish, through a properly designed system of inquiries, that, in light of the particular transaction circumstances, the buyer did not know and had no reason to know of any contamination. Three components of due diligence 120

1. Contract due diligence in the form of representations, warranties, and covenants by a seller; 2. 3. Federal, state, and local file reviews; and An on-site environmental audit.

Representations, Warranties, and Covenants Representations, warranties, and covenants should establish a baseline of a sellers knowledge of the environmental condition of the property. The goal of contract due diligence is to educate a buyer in the sense of informing a buyer about what a seller knows concerning the environmental condition of the property.

Generally speaking, representations and warranties should address the following: Whether the real estate is in compliance with environmental laws. There should be included within the contract a covenant that, at closing, the seller will deliver the real estate in compliance with environmental laws. Whether the seller has been ordered to clean up any property that the seller may own or operate, including the property that is the subject of the sale. CERCLA authorizes the government to impose a lien to recoup cleanup costs. Many states have lien and superlien statutes that permit a lien to attach to all property of a discharger, not just the property that is the subject of the cleanup.4~ Consequently, even if the property that is being sold is not the subject of an ordered cleanup, it may be the subject of a lien. Whether there has been any notice issued to the seller alleging a violation of environmental laws. A seller may not disclose a notice of violation if only asked to represent about violations of environmental laws, since the alleged violation may be subject to a defense and has not yet been determined to be a violation. Also, a buyer with knowledge of the alleged violation will be able to properly focus its on-site investigation in order to make its own independent determination of whether there, in fact, is a violation. Whether the seller has received an informational request from the federal EPA pursuant to 104(e) of CERCLA. Section 104(e) of CERCLA grants investigative powers to the EPA. In the event such an informational request has been issued to a seller, a buyer should be made aware of that fact in order to properly focus its on-site investigation and should insist on receiving a copy of the sellers response to the informational request. In addition, depending upon the particular jurisdiction, a representation and warranty should be added concerning any notices received by a seller regarding potential citizen suits under local environmental rights acts.47


Whether the seller has all environmental licenses and permits necessary to own and operate the property and whether any tenant occupying the property has all environmental licenses and permits necessary to operate the business conducted at the property. Whether there are any underground storage tanks on the property, and if not, whether preexisting tanks were properly removed and their contents disposed of pursuant to all applicable laws and regulations. In the event underground storage tanks are located on the property, then further representations should be considered to address underground storage tank law compliance requirements, and a buyer should investigate environmental issues that may be associated with the underground storage tanks Whether any asbestos or asbestos-containing material exists on the property and whether any transformers or capacitors containing polychlorinated biphenyls are located on the property Whether the property has been used as a sanitary landfill or a facility for disposal of hazardous materials in a manner that would make the property a sanitary landfill as defined by law or require certain disclosures based on state law. REPS AND WARRANTIES A buyer will want to provide that the representations and warranties continue to be true at closing and survive closing and will want to impose upon a seller the responsibility for indemnifying the buyer in the event of a misrepresentation or false warranty. In addition to the representations and warranties, a buyers contract due diligence should include covenants obligating a seller to deliver to the buyer all environmental documentation in the sellers possession or control concerning the property, a narrative description of all current and prior operations at the property, and a copy of all permits and licenses used in connection with the operation of the property Federal, State, and Local Records Review The appropriate regional office of the federal EPA; The state environmental protection agency; The local building department; The local engineering department; The local fire department; The local health department; and Applicable regional and county offices. 122

Right of Entry for On-Site Inspection Once a buyer has negotiated the representations, warranties, and covenants with a seller, received the documentation in the possession or control of the seller concerning the environmental condition of the property, and undertaken its governmental file reviews, the buyer is then in a position to commence the third prong of its environmental due diligence: an on-site inspection. Even if a buyer has a contract with strong representations and warranties and a financially capable seller to back up any misrepresentation or false warranty, the buyer should still undertake an on-site inspection of the property. Phase I Study The Phase I Study is intended by ASTM to define good commercial and customary practice in the United States of America for conducting an environmental site assessment of a parcel of commercial real estate with respect to the range of contaminants within the scope of Comprehensive Environmental Response, Compensation and Liability Act (CERCLA) and petroleum products. The goal of this practice is to enable a buyer to identify potential areas of environmental concern. The Phase I Study consists of four components: (1)a review of governmental records; (2) an on-site inspection; (3) interviews with current owners and occupants of the property, as well as local governmental officials; and (4) preparation of a report.

PHASE II A Phase II environmental assessment is an investigation that includes tests performed at the site to confirm the location and identity of environmental hazards. The assessment includes preparation of a report that includes recommendations for cleanup alternatives. Phase II assessments also are commonly referred to as site investigations. Buyers Right of EntrySellers Concerns A seller should limit the time frame of the buyers due diligence and impose a confidentiality requirement to ensure that the results of the investigation are, to the extent permitted by law, not reported to any governmental authority or other third party. 123

Also, to ensure against triggering statutory reporting requirements, the contract should provide that the results of the investigation will be disclosed to the seller only upon the sellers request. A seller may wish to consider giving a buyer very broad due diligence rights. In this manner, if a buyer terminates the transaction after its due diligence, the seller will not be charged with constructive knowledge of an environmental condition, since the buyers right of termination is not limited to environmental issues. However, real estate counsel must examine local laws to evaluate local reporting requirements when structuring the agreement.57 A seller should also insist upon a buyer indemnifying the seller in the event of any damage or injury arising during an inspection and require appropriate insurance naming the seller as an additional insured, since the buyers indemnity will be only as valuable as the financial net worth of the buyer.

UNDERGROUND STORAGE TANK LAW In 1984, Congress enacted Title VI of the RCRA Reauthorization Act, which established a new Subtitle Ito RCRA titled Regulation of-Underground Storage Tanks. Subtitle I established a federal program to regulate certain underground storage tanks and required the federal EPA to adopt regulations to implement the statute. When a seller is aware of the existence of underground storage tanks, the most conservative approach on the part of the seller will be to have the buyer acknowledge the existence of those tanks of which the seller is aware, to accept the tanks as is, and to release the seller of all liability with respect to all known and unknown tanks. A buyer will want to undertake integrity testing, sampling, or both, and reserve the right to void the transaction if the results reveal a discharge of a regulated substance. As an alternative to voiding the sale, a patient buyer may wish to require a seller to remove the tanks and perform any necessary cleanup prior to the closing of title. A seller, on the other hand, will want to reserve the right to void the transaction if a leak is found and the cleanup costs are high, unless the buyer agrees to remove the leaking tank and clean up the discharge at the buyers own expense or agrees to an acceptable cost-sharing arrangement.


COMMERCIAL LEASING Factors in Retail Leasing The difference between the leasing of retail space and other forms of commercial leasing is based upon the importance of location to the retail tenant, the need on the part of landlords and tenants to develop legal protection from competition while preserving the synergy arising from the co-existence of retail tenants, and the need to use the space to enhance the business of the tenant, rather than to provide housing. In addition, the landlords objective is to derive profit from the tenants ability to maximize its business.

THE OFFICE TENANTS QUESTIONS What are the premises that it is getting? When does the lease begin? What does the lease cost? When does its lease end? NEGOTIATING A LEASE The term sheet: Duration Rent Demised premises Use Signage Additional rent/taxes Extensions



Parties prefer their own forms for many reasons. subtleties neglect to include provisions of importance to their clients. squander valuable negotiating leverage persuading the other party to delete or modify clearly outrageous provisions buried deep within the other party's form Any firm administering a large numbers of leases, whether as landlord or tenant, will benefit from all of its leases being the same. THE PARTIES TO THE LEASE

AUTHORITY AND LIABILITY OF THE PARTIES Landlords and tenants tend to do business in entities specially formed for each location. LIABILITY

ASSIGNMENT AND SUBLEASING Why Tenants May Wish to Transfer Their Leaseholds and Landlords May Resist How the Tenant Sees It

Why Tenants May Wish to Transfer Their Leaseholds and Landlords May Resist The Landlord's Vantage Point. 126

. Lease Provisions Regarding Assignment and Subletting Some leases restate the predominant default rule by allowing the tenant the right freely to assign. Some leases bar assignment without the lessor's prior consent which may be withheld in the lessor's sole and absolute discretion, or absolutely prohibit tenants from assigning. Some leases allow assignment with the prior consent of the lessor, specifying no standard for the exercise of that consent. Some leases require the lessor's prior written consent which "shall not be unreasonably withheld. Some leases permit free assignability, but with the proviso that the lessor will share in or keep any rent increase imposed on the assignee. Landlord may condition its consent to any transfer upon satisfaction of all or any of the following conditions: (b) the net assets of the assignee, licensee, sublessee, or other transferee or permittee (collectively transferee) immediately prior to the transfer shall not be less than the greater of the net assets of Tenant immediately prior to the transfer or the net assets of Tenant at the time of the signing of this Lease; (C) such transfer shall not adversely affect the quality and type of business operation that Tenant has conducted theretofore;

(d) such transferee shall possess qualifications for the Tenant business substantially equivalent to those of Tenant and shaU have demonstrated recognized experience in successfully operating such a business, including, without limitation, experience in successfully operating a similar quality business in first-class shopping centers; (e) such transferee shall continue to operate the business conducted in the Premises under the same Tenant Trade Name, in the same manner as Tenant and pursuant to all of the provisions of this Lease; (f) such transferee shall assume in writing, in a form acceptable to Landlord, all of Tenants obligations hereunder and Tenant shall provide Landlord with a copy of such assumption/transfer document; (g) Tenant shall pay to Landlord a transfer fee of One Thousand Dollars ($1 ,000.OO) prior to the effective date of the transfer in order to reimburse Landlord for all of its internal costs and expenses incurred with respect to the transfer, including, without 127

limitation, costs incurred in connection with the review of financial materials, meetings with representatives of transferor and/or transferee and preparation, review, approval, and execution of the required transfer documentation, and, in addition, Tenant shall reimburse Landlord for any out-of-pocket costs and expenses incurred with respect to such transfer; (h) as of the effective date of the transfer and continuing throughout the remainder of the Term, the Annual Basic Rental shall be the greater of (A) the Annual Basic Rental set forth in Section hereof, or (B) the sum of all Annual Basic Rental and all Annual Percentage Rental payable by Tenant during the twelve (12) calendar months preceding the transfer; (i) Tenant to which the Premises were initially leased shall continue to remain liable under this Lease for the performance of all terms, including, but not limited to, payment of Rental due under this Lease; (j) Tenants guarantor, if any, shall continue to remain liable under the terms of the Guaranty of this Lease and, if Landlord deems it necessary, such guarantor shall execute such documents necessary to insure the continuation of its guaranty;

Limiting Tenant Remedies When Landlords Unreasonably Withhold Consent. DEMISED SPACE Consider the office building occupant. She leaves her car in the parking lot on the third floor of the building, enters the building lobby, awaits the elevator at the elevator lobby, takes the elevator to her floor, visits the womens room, and walks down the corridor (past the janitorial supply room) to the door to her office. This tenant may feel that she is paying only for the area inside her office. She is wrong. Office building tenants pay for almost every part of the building. In some cases, they pay for more than every part of the building. DEMISED SPACE SIZING UP THE LEASED SPACE DEMISED SPACE - Described 1. Existing premises may be identified by suite number (for example, Suite 2720).

2. Premises that are to be built may be assigned a suite number, but are also described by an approximate number of square feet on a particular floor (for example, approximately 5,280 square feet on the sixth floor) or simply by the approximate dimensions and floor.


3. Full-floor premises (whether or not already built) are identified by floor number, although elevators, shafts, stairwells, and other common areas of the building are usually expressly excluded from the premises. For office tenants, space falls into one of three categories. Usable Rentable Common Areas The Demised Premise Appurtenances in an Office Building parking; means of access to the building (for example, bridges, footpaths); building doors and entries to the building; the lobby; the directory; corridors; elevators; signs in the elevators that announce the tenants floors (common in Manhattan); directories on each of the floors; bathrooms; stairways; telephone, telecommunication, and utility connections (not visible); and the basement.

Verifying the Dimensions of the Chosen Base Lessors who rent on the basis of a lump sum instead of 'per square foot' avoid having to remeasure the space and possibly decrease the rent due to an earlier miscalculation: "For purposes of this lease, the square footage of the space rented to T shall conclusively be deemed to be 10,000 square feet, whether the tenant's space is actually 10,000 square feet or not.


TENANT IMPROVEMENTS Tenant Allowances accept the premises 'as is.' A coherent agreement regarding tenant improvements (TIs) resolves these fundamental issues: (1) which party will be responsible for selecting the designer and the contractor and overseeing the work, (2) how will costs be allocated between landlord and tenant, and (3) who will own the improvements during and at the end of the lease term?

Work Letter Issues The TI work letter explains how TI allowance funds are to be used. Tenants desiring an amenity level above what the TI allowance can cover will have to finance it themselves. The landlords goals in the workletter are prompt commencement of rent; control of the design and construction process; timely completion of lienfree work and commencement of rent at the least possible cost to it; preservation of the integrity of the building and its systems, including heating, ventilating, and air conditioning, fire and life safety, security, and central mechanical and electrical systems, and structure; control of the common areas on multitenant floors; payment for its supervision of any work that the tenant does; allocation of the tenant improvement allowance (which is discussed in this section) to improvements, that is, hard costs (bricks and mortar, as the saying goes), because one tenants improvements may be used for the next one, instead of soft costs (such as planning, design, or moving expenses) that are lost forever; insurance against damage and liability to third parties; and premises that can be prepared cheaply for reuse by another tenant. PARKING Reserved or Open 130

Free or Pay Do Tenants Share in Parking Revenues?

Does Lessor Have the Right to Change Parking Configuration or Number of Spaces? Municipal Parking Requirements THE LEASE TERM A. Commencement Designating and Conditioning the Date for Commencement Usually, the premises must be prepared for the tenant, and its occupancy occurs weeks or months after signature. The means by which the premises are prepared is the workietter.

Delayed Commencement Damages for Delay

SELECTING THE LEASE TERM Amortization of Tenant Improvements. Credit Leases Used to Secure Long-term Financing. Short-Term/Long-Term Lease Trade-offs for Landlord and Tenant. LEASE RENEWALS, EXPANSIONS AND CANCELLATION RIGHTS Renewals Tenants often negotiate for the option to extend the term of the lease. Renewal option clauses specify when and how the option is to be exercised, the renewal term, the conditions precedent for the tenant to have the right to extend the initial lease term and the future rent

Option to Extend Right of First Negotiation 131

Right of First Offer Right of First Refusal to Lease Additional Space Expansion Rights Expansion options constrict the landlord's ability to market the optioned space. Landlords can avoid having to hold space in reserve by restricting the tenant's expansion option to a right of first refusal as space becomes available. If the option to expand is not exercised, it is irretrievably lost, Mandatory Relocation . Sometimes, tenants agree to allow their landlords to relocate them to make room for new or expanding tenants. Tenants usually insist on ample advance warning and full compensation for the disruption and other costs of the move

Cancellation Tenants on a long term lease sometimes negotiate the right to cancel the lease after a few years. THE RENT BASE RENT ADJUSTMENTS Rent bumps are rent increases built into the lease. This is an easily administered way of compensating the landlord for increases in the rate of inflation and the market value of the property over time. Alternately, landlords unwilling to bet that they can guess the rate of inflation years in advance could elect to link periodic rent increases to CPI Percentage Rent Although the backbone of the rental structure in the retail lease is the minimum or basic rent charged by the landlord, the percentage rent forms an important component. Percentage rent affords the landlord protection against inflation. Percentage Rent Defined in the Lease Minimum and percentage rent can be expressed in the retail lease either in the alternative or with percentage rent being payable after a defined break point is achieved. The computation of 132

the break point is based on a capitalization formula, with the minimum rent being divided by the percentage rent Percentage Rent Selecting the Percentage Percentage Rent Payment The typical lease clause provides for payment of percentage rent on a monthly basis, with percentage rent computed against a monthly break point. This permits the landlord to collect percentage rent in an accelerated fashion, with an adjustment period at the end of the lease year. Percentage Rent Percentage rent is typically calculated on a tenants gross sales, with certain permitted exclusions. The theory behind the gross sales calculation is that, while the landlord shares in the tenants success, the landlord does not desire to share the total risk of a business enterprise with the tenant. Percentage Rent Gross Sales. A. Gross Sales Defined. The term Gross Sales means the gross amount received by Tenant (including for this purpose only the amount received from any Concessionaire, as defined in Section ) from all sales, both for cash and on credit, made or rendered in, upon or from the Premises (and in cases of sales on credit whether or not payment be actually made therefor) and including the gross amount received by Tenant for merchandise sold pursuant to orders received in the Premises although filled elsewhere. Percentage Rent Landlords usually reserve the right to audit tenants sales records to ensure the proper payment of percentage rent

Implications of Percentage Rent Provision on Tenant's Other Lease Obligations Tenants Can't Lawfully Steer Consumers from One Location to Another to Avoid Percentage Rent But Can Place Merchandise to Reduce Percentage Rent Payments Continuous Operation Hours of Operation


Common Area Maintenance Charges Common area maintenance payments (CAM) have become the most heavily negotiated payment clause. The concept is that the landlord, in an attempt to keep its minimum and percentage rent free from the vagaries of the expense side of the equation, includes in its lease many separate recovery sections that include CAM and other expense recoveries that will be discussed later, such as utilities, taxes, and costs of advertising and promoting the shopping center. CAM Office Lease Unless discussed elsewhere in the lease, office services may include utilities (gas, water, electricity, heating, ventilating, and air conditioning), parking, landscaping, cleaning, trash removal, security, and elevator service.

Landlords Operating Costs includes, but is not limited to, all costs and expenses of operating, maintaining, repairing, lighting, signing, cleaning, painting, striping, policing and security of the Common Areas (including the cost of uniforms, equipment, and employment taxes); alarm and life safety systems; insurance, including, without limitation, liability insurance for personal injury, death, and property damage, all-risks casualty insurance (including coverage against fire, flood, theft, or other casualties), workers compensation insurance or similar insurance covering personnel, fidelity bonds for personnel, insurance against liability for assault and battery, defamation and claims of false arrest occurring on and about the Common Areas, plate glass insurance for glass exclusively serving the Common Areas; the costs and expenses of maintenance of all exterior glass; 134

maintenance of sprinkler systems; removal of water, snow, ice, trash, and debris; regulation of traffic; surcharges levied upon or assessed against parking spaces or areas by governmental or quasigovernmental authorities, payments toward mass transit or car pooling facilities or otherwise as required by governmental or quasi-governmental authorities ; costs and expenses in connection with maintaining federal, state, or local governmental ambient air and environmental standards; the cost of all materials, supplies, and services purchased or hired therefor; operation of public toilets; installing and renting of signs; fire protection; maintenance, repair, and replacement of utility systems serving the Common Areas, including, but not limited to, water, sanitary sewer and storm water lines, and other utility lines, pipe, and conduits;

CAM Apportioning CAM Expenses Based on Tenant Usage. Location Use Number of customers Type of business

Potential for CAM Overcharges Utilities 135


Capital Costs

Fixed CAMS Fixed CAM means that the tenant pays a fixed dollar amount, rather than an amount based on the tenant's prorated share of [the landlord's] actual CAM costs."" Lease provisions for fixed CAMS usually call for annual increases, based on a dollar amount, a set percentage, an index (such as the Consumer Price Index) or a fixed percentage above an index. Limiting CAM Charges Tenants have also negotiated clauses that provide that certain CAM expenditures will be recoverable on an amortized basis over the useful life of the improvement or over its tax life. The goal of these tenants is to restrict landlords in both the scope and the amount of costs for repair and replacement of capital items imposed in any one year. Another important trend in the world of CAM payments is the development of maximum CAM increases, better known as caps. Utilities Landlords include clauses in retail leases that require tenants to pay all utility charges incurred by them directly to the utility providers. These include electric, gas, water, trash, and other similar services. In mall settings, however, landlords often have an opportunity to provide utilities t) their tenants as a middleman or distributor and gain a profit by taking advantage of the rate differential that is present in most utility company rate schedules. Utilities Office Lease It may want the right to contract directly with the utility providers. The landlord should have the responsibility for replacing bulbs and worn-out building-standard lighting fixtures. The tenant has responsibility for its own fixtures. HVAC The tenant may want the system to maintain a stated range of inside temperatures or stated inside temperatures at various outside temperatures. The ability of the system to maintain those temperatures is, of course, dependent upon the number of occupants of the space because body heat will make demands upon the system. That is why landlords often limit the number of occupants of the space. Taxes Retail leases typically provide that real property taxes assessed against the shopping center are paid by the tenants in accordance with their proportionate share. 136

Office Leases discuss: Base Year or Base Amount Definition of Taxes exclusions include the following: I. 2. 3. 4. 5. 6. 7. 8. Inheritance taxes Gift taxes Transfer taxes Franchise taxes Excise taxes Net income taxes Profit taxes Capital levies

Advertising and Promotion Mall leases will provide for tenants to pay toward the expense of running mallwide promotion and advertising efforts. MERCHANTS ASSOCIATION AGREEMENT DEFINING THE SCOPE OF TENANT OPERATIONS: USE, EXCLUSIVES, RADIUS, CONTINUOUS USE AND CO-TENANCY Use A 'use' clause describes, permits, mandates or prohibits the goods and services the tenant offers from the leased premises. Use An 'exclusive' grants one tenant a mini-monopoly over the sale of specified goods or services in the center Use A 'radius' clause blocks the landlord or tenant from opening a competing facility within a designated radius of the property subject to the lease. Use 137

A 'continuous use' clause requires the tenant to remain open for business during certain prescribed hours and days. Use Through a 'co-tenancy' provision, a tenant reserves the right to modify or terminate its lease if certain tenants exit the project, identified by name, type of business or square footage 'Use' Default Rule and Why it is Often Modified By Contract No Use Restriction = No Limitation on Use. When Use Clauses Matter Greatly to Landlords and When They Don't "'Restriction on use' means a provision in a lease that restricts the use of leased property by a tenant, whether by limiting use to a specified purpose, mandating use for a specified purpose, prohibiting use for a specified purpose, limiting or prohibiting a change in use, or otherwise." Cal Civ Code 1997.20. 'Restriction on use Shopping center landlords care deeply about `uses.' Without carefully drafted, restrictive use clauses, the overall performance of the center could disappoint. Even owners of free-standing retail space may be sensitive to the significant status and operating differences between a five star restaurant and, say, an `adult' bookstore. Drafting `Use' Clauses "Merely stating that a use is permitted does not prohibit the tenant from engaging in other uses. If the lease contains no limitations on `uses,' and the tenant assigns or subleases, the landlord may be in for some unpleasant surprises Use' Limitations and the Tenant's Right to Assign. Use Restrictions and Government Imposed Land Use Controls Landlord imposed EXCLUSIVES Why Tenants Want Exclusives and Landlords Resist Shopping malls Street front offices


EXCLUSIVES Drafting Issues Tenants desiring an exclusive should not rely on courts to imply one. They should extract an explicit promise from the landlord, worded to protect against competition from prior and later tenants alike.'" On the other hand, lessors seeking to ward off any implied exclusives should provide that "nothing in the lease restricts the landlord from renting space to other tenants with the same, similar or competing uses." EXCLUSIVES Enforcement Leases should specify whether the lessor owes either absolute liability for one tenant's breach of another's exclusive or, alternatively, only a duty to use `best' or `good faith' efforts to cure the breach, such as by notifying the offender and, if necessary, seeking a court order to stop the violation. EXCLUSIVES Applicability of Exclusives to Expanded Centers EXCLUSIVES Each shopping center has a distinct radius of impact. The neighborhood shopping center obviously attracts a small group of people generally located within the same neighborhood. The community shopping center usually serves a larger area and can have a radius of impact of several miles from its borders. The regional, super-regional, and power centers will typically have a significant impact based on a driving time of 20 minutes or more from its borders and will affect a population of hundreds of thousands of people.

EXCLUSIVES RADIUS CLAUSES Radius Restrictions on Tenants The landlord is often in the difficult position when it has to enforce the exclusive on behalf of a tenant. The tenant will require the landlord to bring suit against other tenants that are violating its exclusive. The landlord must be the enforcing party, since tenants typically do not have privity of contract between one another in their 139

shopping center leases and the violation of an exclusive may not give rise to a tort that would permit the tenant to bring the action directly. EXCLUSIVES RADIUS CLAUSES Radius Clauses Against Landlords

CONTINUOUS USE Lessors who expect tenants to operate a business continuously at the leased space need to provide for that through lease covenants.' The landlord's best defense against tenants 'going dark' is a continuous use clause. "If landlords abhor darkness and prefer light, let them put it in the leaser"' A well drafted `continuous use' clause sets a lease commencement date after which the tenant is to be 'open for business continuously, actively and diligently,' `solely for the use' permitted under the lease, at specified hours and days of the week, fully outfitted, stocked and staffed, using the lessee's trade name and occupying the entire premises. CONTINUOUS USE Enforcement Issues. A landlord might well seek injunctive relief to prevent the tenant from going dark or cutting back on staff, merchandise, advertising, or hours of operation. Because courts are more comfortable ordering a continuation of the status quo than trying to reverse the facts on the ground, landlords should file suit before the tenant's closure has become a fait accompli. CONTINUOUS USE Continuous Use' Clauses are Seldom Implied CO-TENANCY CLAUSES With a co-tenancy clause, a tenant in a shopping center conditions its obligation to perform on there being certain other designated merchants open for business in the center. In regional malls, the 'anchors,' usually department stores, are the specified co-tenants. In life style malls anchored by movie theaters and high end specialty retailers, all of these will be sought after as designated cotenants. Co-tenancy provisions are uniformly upheld though courts will seldom infer a co-tenancy clause in a lease without one.'" "All tenants in shopping center want cotenancy rights; who gets them depends on a tenant's leverage with the landlord.s Remedies for Breach of a Co-tenancy Provision. For infringements of an opening co-tenancy, a protected retailer might reserve the right to delay its opening, or pay a reduced rent for a period of time or until the co-tenancy breach is cured. 140

With an operating co-tenancy, the protected retailer might be entitled to an abated rent, a partial release from its continuous operations covenant and the right to close its doors during what would otherwise be normal mall operating hours unless other tenants remain open. The protected retailer might negotiate for the freedom to go dark if the absent tenant isn't replaced within a set time.

LANDLORDS RIGHTS TO CONTROL FUTURE DEVELOPMENT AND APPEARANCE In the case of enclosed mall shopping centers and larger community centers, it is important that the landlord maintain control over the common areas of the shopping center, maintain its ability to relocate certain common facilities in order to prevent an expansion or renovation of the center, and maintain control over the appearance of the shopping center. A number of clauses in shopping center leases facilitate this control.

Control of the Common Areas; Changes and Additions to the Shopping Center The landlord desires to have complete right to relocate common facilities and make changes or revisions to the site plan for the shopping center, including the rights to add new buildings, common facilities, and parking areas and to make other changes to existing buildings and roadways. Additionally, the landlord desires the right to use the roof and walls in order to facilitate development:

Relocation Clauses Powerful landlords will often attempt to reserve the right to relocate tenants from the location bargained for to another location in order to effectuate an expansion of the shopping center or, indeed, to replace a less successful tenant with a more successful tenant. Office Lease Issues Access


Elevator service is commonly omitted from the landlords description of its services because elevator service is a necessary component of most office buildings. The tenant will want to be certain that use of an elevator is available at all times outside of business hours and at no cost. When a standard is prescribed, it is usually comparable buildings. The tenant will also want to be certain that a freight elevator is available to it during its move-in and move-out and for delivery of large items during the term. The cost of the freight elevator service must be stated; usually, it is free for moving in and moving out and at cost during the term. Office Lease Issues The janitorial services provision usually describes the number of times per week that the premises are cleaned. Many tenants append janitorial specifications stating the jobs, such as interior window-cleaning, and the frequency for all aspects of the janitorial services. Tenants on a multitenant floor should insist on a specification for the cleaning of the common areas, including the bathrooms. Office Lease Issues After-Hours Services Quite commonly, office tenants will want heating, ventilating, and air conditioning (HVAC) service outside of normal business hours. They will usually ask for it and get it, at a price equal to the landlords cost. However, the landlords cost may have an overhead factor included that is supposed to compensate it for the additional wear and tear on the system or for its administrative personnel, who are probably not putting in any extra time in order to run the system after hours. ALTERATIONS When alterations are proposed, the landlord has many bona fide concerns that must be addressed. The landlord will want assurances that the floor loads will not be exceeded, the building systems will not be affected, the neighboring tenants will not be disturbed, the cost of janitorial service will not increase, and the work will be done in a workmanlike manner without liens.

ALTERATIONS Of great importance to the tenant is the landlords requirement for removal of proposed alterations. 142

Interruption of Services The tenant wants its services and does not want to pay rent without them. After all, it believes that is the bargain that it struck. On the other hand, the landlord feels it loses money because of interruptions caused by accidents; the making of changes, upgrades, or repairs to the premises or the project; or blackouts and government curtailment (such as an energy conservation program