Residential Foreclosures: Lenders Become Landlords

Featured Guest blogger at the National Law Review, W. Alexander Burnett of Williams Mullen provides great insight on the evolving role of certain lenders becoming landlords after foreclosures:  

 

Protecting Tenants at Foreclosure Act of 2009, Public Law 111-22

Introduction

On May 20, 2009, President Obama signed into law the Protecting Tenants at Foreclosure Act (the “PTFA” or the “Act”). The PTFA was part of the larger “Helping Families Save Their Homes Act of 2009.” The Act provides new protections to bona fide tenants in any federally-related mortgage loans or any residential real property. Before enactment of PTFA, a new owner of a foreclosed property could take immediate action to evict an existing tenant. The PTFA requires the foreclosing party to allow the tenant to remain in the premises through the end of the lease term, and it requires the foreclosing party to provide a bona fide tenant with at least 90 days notice to vacate. As a result, lenders and other parties who foreclose on residential rental property occupied by a tenant have no choice but to play the role of landlord until the expiration of the tenant’s lease. This article explains who is affected by the Act, the requirements under the Act, and the respective rights, remedies and obligations for both foreclosing parties and tenants who occupy the foreclosed properties.

The Basics

Who Is Affected by the PTFA?

The PTFA applies to any residential real property or any “federally-related mortgage loan” acquired through foreclosure. The only properties not covered by the Act are non-residential properties that were not foreclosed in connection with a federally-related mortgage loan. Note that one court in New York has held that the PTFA can only be enforced where “federally-related mortgage loans” are involved and that the enforcement of the PTFA in all residential loan situations “would extend federal control to arguably every area of human endeavor and vitiate the constitutional framers’ requirement that ‘federalism’ involves a limited universe of power and that the states retained all but expressly ceded powers.” Collado v. Boklari, 892 N.Y.S.2d 731 (N.Y. Dist. Ct. 2009). It is important to note, however, that this case has been distinguished by at least one other court, and that other courts have held that the PTFA applies in connection with non-federally-related mortgage loans.

The PTFA protects the rights of a “bona fide tenant,” which is defined by the Act as a person in possession of the property with or without a lease, provided that:

i. the tenant is not the mortgagor or the child, spouse, or parent of the mortgagor;

ii. the lease or tenancy was the result of an arms-length transaction; and

iii. the lease or tenancy requires the receipt of rent that is not substantially less than fair market rent for the property, or the rent is reduced or subsidized due to a federal, state, or local subsidy.

All three elements must be satisfied for a tenant to be a bona fide tenant.

The new restrictions in the PTFA are binding on any “immediate successor in interest” in the property. While the Act does not define “immediate successor in interest,” the term generally means the first party to take title to the property following the foreclosure. Note that the PTFA does not specifically address the situation involving a deed in lieu of foreclosure.

What Are the Effective Dates of the Act?

The PTFA became effective immediately upon enactment on May 20, 2009 and applies to all foreclosures that occur after enactment; pending foreclosures included. The provisions of the Act expire on December 31, 2012.

What Requirements Are Imposed on an Immediate Successor in Interest?

First, a successor must allow any existing tenants to remain in the premises until the end of the lease term. If, however, the property is sold to a purchaser who will occupy the property as a primary residence, then the new owner can give 90 days notice of the early termination of the lease. Second, if the lease has expired, is month-to-month or is terminable at will, the successor must give the tenant at least 90 days notice before requiring the tenant to vacate the property. The PTFA, therefore, places drastic new burdens on lenders and other foreclosing parties, especially when there is a significant amount of time remaining under a residential lease, because the lender must serve as a landlord throughout the duration of that lease.

The notice to vacate must be given to the tenant by the successor. Therefore, the successor can’t give notice prior to acquiring title to the property at the foreclosure sale. Accordingly, the notice of foreclosure sale cannot also serve as the 90-day notice to vacate. It is good practice to send the notice to vacate and any other notices to the tenant by Certified Mail, Return Receipt Requested, and to keep the receipts in case they are needed to prove to a court that proper notice was given.

Unfortunately, the PTFA does not give any details or set forth the rights or remedies of the successor during the time that the tenant is allowed to remain in the property. The Act merely states that successor assumes an interest in the property “subject to the rights of any bona fide tenant.” That likely means that the successor steps into the shoes of the former landlord and assumes both the rights and responsibilities of the landlord under the lease. This, of course, raises many questions which the Act does not answer.

Reading Between the Lines: The Details Behind the PTFA

What Responsibilities Do Tenants Owe to their New Landlords?

Presumably, a tenant must abide by all of the provisions in the lease. If the tenant defaults under the lease, the Act does not preempt a landlord from evicting the tenant without giving the 90 day notice under the Act. If a tenant has stopped paying rent, for example, the new landlord should follow applicable provisions under the lease and in the Landlord Tenant Act (Va. Code § 55-217, et seq.) or the Virginia Residential Landlord Tenant Act (Va. Code § 55-248.2, et seq.) to give proper notice of the default to the tenant and then to file an Unlawful Detainer suit to evict the tenant.

The Successor Has the Burden of Proving that an Occupant Is Not a Bona Fide Tenant.

In Bank of America v. Owens, the successor issued a 90 day notice to vacate immediately after foreclosure. 2010 NY Slip Op 20164, 2010 N.Y. Misc. LEXIS 954 (N.Y. City Ct. May 5, 2010). Along with the notice to vacate, the successor also issued a questionnaire to determine if the occupant was a bona fide tenant. The questionnaire stated that, if it was not returned to the successor within five days, the successor would commence eviction proceedings. When the questionnaire was not returned, the successor filed an eviction suit immediately and well before the expiration of the 90 day period. The court held that the new burden imposed by the questionnaire was impermissible and was not authorized by the PTFA. The court also held that the burden is on the successor to show that an occupant is not a bona fide tenant.

Can Tenants File Suit Against Successors For Violating the PTFA?

No. The PTFA does not create a private right of action. In Nativi v. Deutsche Bank National Trust Co., the Bank foreclosed on property and evicted the tenants one month later without giving 90 days notice. 2010 U.S. Dist. LEXIS 51697 (N.D. Cal. May 26, 2010). The tenants’ personal property was placed on the street where it was damaged or stolen. The tenants filed suit against the Bank seeking money damages for, among other causes of action, violations of the PTFA. The court held that the PTFA does not create a private cause of action and dismissed the PTFA count. See also, Fannie Mae v. Lemere, 2010 U.S. Dist. LEXIS 67005 (E.D. Cal. July 6, 2010) (“[F]ederal courts have held that the [PTFA] does not create a federal private right of action, but indeed provides directives to state courts.”) It is important to note, however, that these tenants may have had other valid causes of action against the bank, such as conversion or unlawful ouster. In addition, it is clear from the Bank of America v. Owens case that a tenant may use a violation of the PTFA as a defense in an eviction proceeding, even though it cannot be used as the basis for an affirmative claim for damages against a successor.

Is the New Landlord Responsible for the old Security Deposit?

This question is simply not answered by the Act, and there are no cases from the Virginia state or federal courts that interpret the Act. Generally speaking, however, under Virginia law a foreclosure wipes out the lease, which suggests that the new landlord is not responsible for the security deposit. In addition, the old landlord holds the security deposit in trust for the tenant. If the old landlord fails to transfer the security deposit to the new landlord, pursuant to Va. Code § 55-507, then the tenant would have a direct claim against the old landlord. The new landlord may not have any recourse against the old landlord. Furthermore, under the PTFA the new landlord steps into the shoes of the old landlord only with respect to the real property itself and not with respect to incidentals such as the security deposit. Nevertheless, it is possible that a court making a generous interpretation of the PTFA could find that the new landlord stepped into the same shoes of the old landlord and, therefore, is responsible for the old security deposit.

Can a Successor Terminate a Lease Early Using “Cash for Keys”?

Yes. “Cash for keys” is a program offered by many mortgage lenders where the tenant agrees to turn over the property in good condition and/or before the expiration of the tenant’s lease in exchange for a cash payment from the lender. It is no different than an agreement between a landlord and tenant to modify or terminate a lease early. There is no magic to it, and there is nothing in the PTFA that prevents a successor and a tenant from reaching such an agreement. It is important, however, to ensure that the transaction is arms-length, that it is agreed to voluntarily by both the successor and the tenant, and that the parties put the agreement in writing and sign it.

© 2011 WILLIAMS MULLEN ALL RIGHTS RESERVED

 

Foreclosure or Deed in Lieu: What’s Right for You?

This week’s featured bloggers at the National Law Review are from Williams Mullen.  Jamie Watkins Bruno details two options available in Virgina for defaulted loans secured by deeds:  

In Virginia, a lender holding a defaulted loan secured by a deed of trust has two primary means to enforce its remedies under that deed of trust: foreclosure by a trustee’s sale and conveyance by a deed in lieu of foreclosure. We’ve put together a brief primer summarizing the key strengths, weaknesses and procedural guidelines for each alternative to help you determine which option works best for your needs, timeline and budgetary constraints.

I. Trustee’s Sale.

The most common procedure for foreclosure is the sale of the property by a trustee, a non-judicial action. A trustee can act only in a manner authorized by the express or implied terms of the trust instrument or as authorized by statute. If the deed of trust does not provide otherwise, the provisions of the Virginia Code control as to the authority of the trustee. Foreclosure by a trustee’s sale can usually be completed within thirty (30) to forty-five (45) days after the expiration of any cure period provided by the loan documents for the default giving rise to the foreclosure, if the lender acts promptly.

A. The Trustee.

1. Duties and Obligations. A trustee is a fiduciary for both the debtor and the creditor. The trustee must not place himself in a position where the trustee’s personal interests conflict with the interests of the parties to whom he owes a fiduciary duty. A trustee who is counsel to or an employee of the noteholder must be sensitive to the obligation to discharge his fiduciary duties in an impartial manner. The mere fact that a trustee in a deed of trust securing a debt due to a corporation is a stockholder, member, employee, officer or director of, or counsel to, the corporation, however, does not disqualify him from exercising the powers conferred by the trust instrument. Trustees cannot act as purchasers, directly or indirectly, at their own sales; when a trustee buys directly or indirectly at his own sale, that constitutes constructive fraud, and the transaction is voidable. This rule also applies to a trustee who is named in a deed of trust but does not act.

2. Substitution of Trustee. If the person who is to conduct the foreclosure is not named in the deed of trust as trustee, a substitution of trustee is needed. When an instrument appointing a substitute trustee has been executed by the holders of more than fifty percent (50%) of the secured obligations, the substitute trustee can immediately execute all powers granted to the prior trustee.

    B. Initial Procedures.

    1. Documentation. A trustee should secure the proper documentation from the noteholder, which includes the deed of trust, the original note, title evidence (including title policies and surveys), copies of any correspondence between the noteholder and the debtor, copies of mortgage insurance or guaranty agreements, appraisal, written direction to proceed with the foreclosure and engagement letter. The trustee should verify that the noteholder has complied with all notice requirements set forth in the deed of trust.

    2. Diligence. A trustee should contact the local commissioner of accounts regarding fees charged for approving and examining accounts as well as any local requirements, including proper advertisement procedures. Though the trustee is only charged with selling the property encumbered by the deed of trust, the noteholder should consider any relevant diligence issues affecting the property prior to initiating foreclosure proceedings, including environmental matters, permits, insurance, utilities, leases, appraisal, physical condition and rights in fixtures. In addition, though there is no statutory right of redemption in Virginia, the debtor does have the right to pay off the secured indebtedness before the sale; some deeds of trust provide for reinstatement of the debt if the debtor cures all defaults and pays all expenses in the manner and time provided in such deeds of trust.

    3. Title. While the doctrine of caveat emptor applies in a foreclosure sale, a trustee must be aware of all liens and encumbrances affecting the property. A trustee cannot sell a greater interest in the property than the deed of trust gives him authority to sell, and any sale by the trustee will be subject to encumbrances having precedence over the deed of trust. A trustee must be aware of all encumbrances on the property, including federal tax liens, in order to properly notify all interested parties, to exercise proper discretion as to whether a fair sale can be had, and to make a lawful distribution of the proceeds of the sale. A trustee should order a title rundown of the property from the date of the original title policy, which can be obtained for approximately $100-$250.

      C. Notice.

      The trustee has no authority to exercise the power of sale or to obtain possession of the property until such time as the debtor defaults under the terms of the note and the trust instrument. The trustee must satisfy himself that the note and the deed of trust are actually in default before initiating foreclosure proceedings, including providing any pre-acceleration notice required by either document.

      1. Requirements; Timing. The present owner of the property must be given written notice of sale at his last known address as such address and owner’s name appear in the records of the secured party, which must be personally delivered or sent by registered or certified mail at least fourteen (14) days before the date of the foreclosure sale. It is a good idea to send a separate notice to each owner by regular mail. Each such must provide the date, time, and place of sale and is sufficient if it contains the same information set forth in the public advertisement of the sale. ‘Inadvertent’ failure to give notice imposes no liability on either the trustee or the secured party, and failure to comply with the notice requirements will not affect the validity of the sale. A purchaser for value will have no duty to ascertain whether proper notice was given. Actual receipt by the owner of the foreclosure notice is not required, and a defective statutory notice does not affect the validity of a foreclosure sale.

      2. Other Parties. Notice should also be given to any guarantors of the indebtedness, subordinate lienholders, private mortgage insurers, the United States (if a federal tax lien affects the property) and any government agencies that are involved with the secured loan. If a federal tax lien affects the property and has been filed for at least thirty (30) days before the date of the proposed sale, notice should be given to the United States at least twenty-five (25) days prior to such sale.

        D. Advertisement.

        A trustee must conform the advertising to the terms of the deed of trust, and any material departure will invalidate the sale. Substantial compliance, however, is sufficient as long as the rights of the parties are not materially affected. Section 55-62 of the Virginia Code provides a permissible form of notice that must include the time, place, and terms of sale, including the amount of any deposit required. The advertising provisions are mandatory and override the discretion of the trustee, regardless of the contractual agreement of the parties.

        1. Requirements; Timing. The advertisement must briefly describe the property to be sold by street address, if any, and, if there is no street address, the general location of the property with reference to routes, streets, and known landmarks. The tax map identification number of the property may be used but is not required. The advertisement must also include the name, address, and telephone number of the trustee and the secured party, or the secured party’s agent or attorney, to respond to inquiries from the public about the sale. Advertisement of the foreclosure must be made in a newspaper having a general circulation in the city or county where the property being sold or any portion thereof lies. The sale can be held no earlier than eight (8) days after the first advertisement and no later than thirty (30) days after the last advertisement.

        2. Number of Publications. If the deed of trust provides for the number of publications by using language such as “advertisement required,” then the direction of the deed of trust must be followed. In any event, if the newspaper advertisement is published on a weekly basis, it must be published not less than once a week for two weeks before the sale; and if published on a daily basis, it must be published not less than once a day for three days, which may be consecutive days. If the deed of trust does not provide for the number of publications, the Virginia Code requires that “the trustee shall advertise once a week for four successive weeks; provided, however, that if the property or some portion thereof is located in a city or in a county immediately contiguous to a city, publication of the advertisement five different days, which may be consecutive days, shall be deemed adequate.”

          E. The Sale.

          There are virtually no rules regarding bidding at a foreclosure sale, other than that the purchase price of the property must not be so low as to ‘shock the conscience’. The sale may take place “at the premises or at such other place in the city or county in which the property or the greater portion thereof lies, or in the corporate limits of any city surrounded by or contiguous to such county.” Most sales take place on the front steps of the city or county circuit court building. In the absence of specific direction in the trust instrument, the trustee is authorized to sell “upon such terms and conditions as the trustee may deem best.” This language has been interpreted to include the power to sell either for cash or on credit. The trustee must be present and either conduct or supervise the sale. In the absence of specific authority in the deed of trust, a trustee cannot, even with the consent of the lender, delegate the power to sell and be absent from the sale; the trustee may employ an auctioneer to cry out the sale. Prior to bidding, the trustee should announce the terms of sale and answer any general questions from the public. The trustee should disclose fully any known liens or encumbrances. A contract of sale between a trustee and a purchaser is complete when the trustee knocks down the property to the highest bidder and makes and signs a memorandum of the sale and its terms. The trustee may require a deposit, and a closing will be scheduled for approximately ten (10) to thirty (30) days after the sale, all as set forth in the advertisement. In the event that there was a federal tax lien on the property, the government has a right of redemption for a period of one hundred twenty (120) days, meaning that the government may take the property and reimburse the purchaser for the amount paid within this time frame. The trustee may request the waiver of such right upon the delivery of the notice of sale.

            F. Settlement and Accounting.

            A purchaser can only require a deed with special warranty of title from the trustee. The trustee is not responsible for conveying good title, because a trustee can sell only the interest conveyed to him under the deed of trust. Recordation tax to be paid upon recordation of the deed is the greater of the amount bid at the sale or the assessed value of the property. The trustee must receipt for the proceeds. Any proceeds from the sale must be applied in the following order: to discharge the expenses of executing the trust, including the trustee’s commission; to discharge all taxes, levies, and assessments, with costs and interest, including the due pro rata thereof for the current year; and to discharge in the order of their priority, if any, the remaining debts and obligations secured by the trust instrument, and any liens of record inferior to the trust instrument under which sale is made, with lawful interest. Any residual proceeds shall be paid to the debtor or his assigns. Within six months of the sale, the trustee must file an accounting of sale, including the original note, and all vouchers for his expenses with the local commissioner of accounts. The secured party may sue the debtor or any guarantor for any deficiency between the amount of the proceeds of the sale applied to the note and the amount of indebtedness outstanding thereunder.

              G. Advantages and Disadvantages.

              In Virginia, a trustee’s sale is a relatively quick and efficient means of foreclosing on real property. Once the sale has been completed, the purchaser will own the property free and clear of other junior encumbrances (provided that the junior lienholders were properly notified). However, the lender must be cognizant of the procedural and timing requirements in order to properly coordinate the trustee’s sale, and the foreclosure process can be more expensive than acquir4ing the property by a deed in lieu.

                II. Deed in Lieu of Foreclosure.

                With a deed in lieu of foreclosure, the grantor transfers the fee simple title to the property encumbered by the deed of trust to the lender under the deed of trust. The lender contemporaneously releases the lien of the deed of trust and forgives or stipulates the liability of the obligors under the obligations secured by the deed of trust.

                A. Advantages. Acquisition by a deed in lieu can be advantageous to a debtor, as the process minimizes damage to the debtor’s reputation and credit rating by avoiding a formal foreclosure and creates substantial savings in costs, expenses, attorneys’ fees and trustee’s fees. The lender may find significant benefits as well, such as efficiency and the ability to obtain quick control of the property to effect its completion, rental or sale to a third party.

                  B. Disadvantages. A lender should be aware of the potential disadvantages to obtaining property by a deed in lieu of foreclosure. The lender will own the property subject to junior encumbrances (which are normally extinguished by a foreclosure sale) and all obligations of the former owner (including building code violations and environmental responsibilities). The debtor’s creditors may attack the sale as a fraudulent or voluntary conveyance if the value of the property greatly exceeds the value of the loan forgiven; and any guarantor that did not consent to the transaction may assert that the guarantors and debtor are released from any deficiency claim.

                    © 2011 WILLIAMS MULLEN ALL RIGHTS RESERVED

                     

                     

                     

                    Extreme Makeover: Arts Edition Paducah, Kentucky

                    A postive story about urban redvelopment sparked by the arts from Sheppard, Mullin, Richter & Hampton LLP recently posted at the National Law Review

                    The notion that the arts make our culture “richer” is commonplace in our vernacular, but an undeniable trend has emerged giving an entirely new meaning to the phrase: across the board, the country’s nonprofit arts and culture industry has grown by twenty-four percent over the past five years, generating over $166 billion in economic activity a year. Art can be big business, and not just in cosmopolitan meccas like New York and Los Angeles. Across the United States, small and midsized cities are harnessing their creative energy to jumpstart their local economies, often with striking results. Cities that have taken heed of this trend have been rewarded in multiple ways—from the rehabilitation and development of uninhabitable areas of the city to the welcoming of tourists, businesses, and well-heeled residents to those very areas. One seminal example is New York’s Soho and Tribecca neighborhoods, which now exceed the famed Upper East Side and Central Park West neighborhoods in rental and real estate prices. It is a reversal of the commonly held notion that artists drain resources, rather than attract them. Perhaps no city has been more successful in exploiting the economic potential of the arts than Paducah, Kentucky, a town of 27,000 which got the Extreme Makeover formula just right when it implemented what has come to be known as an Artist Relocation Program.
                     

                    Ten years ago, artists were lured to the blighted downtown neighborhood of LowerTown by the prospect of free home ownership and creative autonomy in developing their properties. As a result, Paducah today has been transformed into a thriving community of galleries, shops, and cafes. It is just the kind of place that attracts visitors and tourism. Paducah’s tourist revenue has drastically increased from $66 million in 1991 to nearly $287 million in 2009. Since the Artist Relocation Program began, the city has attracted 234 new businesses, created over 1,000 jobs, raised over $52 million from private investors and invested nearly $50 million from public funds. Tom Barnett, Paducah’s former city planning director, boasted that for every dollar the city has put into the program, it has received $14 back—an extremely impressive return on its investment. Paducah has indeed become a national model for how a city can reinvent itself as a cultural destination.

                    Paducah is hardly different in its skeleton than countless cities across the country.  It suffered from both a loss of the economy that had helped it prosper (in this case, a uranium enrichment plant), and perhaps more substantially, from suburban flight.  LowerTown, which is the oldest neighborhood in the town, was once a thriving, self-contained neighborhood.  But as its older residents passed on, the next generation showed little interest in returning from their larger homes outside town.  LowerTown’s homes were gradually chopped up into apartments and largely neglected. It is a story repeated across the country. Now, many of these cities are mimicking the Paducah strategy.  Chattanooga, Tenn.Pawtucket, R.I., and Oil City, Pa., provide just three of many examples of smaller cities that are wholeheartedly embracing the idea of an Artist Relocation Program. 

                    When pursuing a rehabilitation process, city governments and planning committees begin by first consulting the current zoning laws and maps. Fortunately for Paducah, LowerTown was already designated as a mixed use zone, thus it did not have to drastically adjust the districts’ zoning laws. Mixed use zones accommodate multiple land uses in one zone, allowing a retail store to sit next to a single-family home or a restaurant to be housed on the first floor of a 100-unit condominium complex. On the other hand, conventional zoning, often referred to as Euclidean zoning, divides a city into specific and separate districts and assigns each district a permitted land use, such as residential, commercial, or industrial. To further complicate matters, Euclidean zoning also utilizes overlay zones to control land use, so for instance, a lot will be designated “commercial” and then in addition, the overlay rules will mandate that each lot be a minimum of 10,000 square feet. Zoning laws were originally written to be “as of right.” This means that by consulting the zoning ordinance governing their land, owners can determine what types of projects they are able to develop, subject only to the city’s verification that the owner’s plan complies with the applicable zoning laws. There has been a distinct trend over time to move towards discretionary zoning, which grants a city the right to review virtually all land use projects within a zone and determine whether the project will be approved, rejected or approved with additional conditions. Developers typically prefer ‘as of right’ zoning over discretionary zoning because discretionary zoning requires a public hearing, which often leads to increased costs and time. While most cities have employed discretionary zoning on mixed use zones, Paducah continued to utilize ‘as of right’ zoning in order to encourage growth and minimize expenditures for new developers.

                    Specifically tailored zoning ordinances allowed Paducah to effectively control both the aesthetic character of renovation projects and the intent of artists and businesses relocating to the city, in order to ensure the city’s rehabilitation project evolved into the community the city hoped to build. Further, Paducah took advantage of its mixed use zoning to enable artists to use their residences as both a home, studio, and sometimes even a gallery, leading to more affordable property values and rental costs. In addition, mixed use zones naturally lend themselves to more compact, close-knit communities that are organized to make walking and biking easier and more pleasant. This is helpful for an art community because it connects artists with the community while simultaneously providing the public easy access to artists’ works and galleries. It also leads to more “mom and pop” owned cafes and boutiques that serve as social hot spots for the local community.

                    In addition to offering mixed use real estate, Paducah provided qualifying artists with financial incentives to relocate to the city, as well as affordable properties to purchase in connection with a reimbursement program for artists who choose to restore their newly purchased property. For instance, Paducah offered relocating artists up to $2,500 in moving expenses, properties for $1 with an approved qualifying proposal, a $2,500 reimbursement for architectural and professional improvements and up to $5,000 for rehabilitation costs associated with the new property. In addition, the locally owned Paducah Bank offered artists long-term loans with generously fixed interest rates to finance the purchase and renovation costs of their homes. After approving these legislative measures, Paducah began actively seeking out artists via commercials and advertisements that portrayed Paducah as a quirky southern town which embraced the arts. The Artist Relocation Program and successful PR campaign have incentivized over 75 artists to relocate to LowerTown from across the country, helping to reduce the town’s crime rate and revive Paducah’s economy. 

                    Further, the significant twenty-four percent growth in the country’s nonprofit arts and culture industry can largely be attributed to the substantial amount of event-related spending by arts audiences. Art and cultural events generate economic activity for local businesses, including restaurants, hotels, retail stores and parking garages. Astutely realizing this potential, Paducah organizes large-scale events to entice tourists, such as the annual quilting convention that brings in nearly 40,000 tourists and the LowerTown music festival. During these events, the city’s “no vacancies” signs are lit, restaurants are hopping, and local boutiques are brimming with customers. In addition, Paducah plans local events to encourage residents to socialize and support one another. An example of this is Paducah’s “Live On Broadway” series that occurs every Saturday night in the summer. At these events, the city provides free live music, public art demonstrations, and horse-drawn carriage rides throughout the downtown district. Paducah residents are encouraged to support their community by shopping at local galleries and boutiques that remain open late into the evening exclusively for the event. Thus, Paducah effectively capitalizes on the arts’ economic potential by utilizing both large and small scale events to attract tourists and local residents.

                    Paducah’s future appears to be in good hands under the guidance of Mayor Bill Paxton, who explains, “As a Paducah native, I have watched the City grow and change. It’s always been known as a hub for river traffic and a regional destination for shopping, entertainment, employment, education, and medical facilities. But with the artist relocation program that revitalized LowerTown, the National Quilt Museum of the United States, and the Paducah School of Art, Paducah has become a nationally known cultural center. The City Commission and I are committed to making Paducah even better. We are working hard to bring new jobs to the area, revitalize more neighborhoods, and make the downtown and riverfront areas a destination for all. Everything we do is to improve the quality of life.”

                    As far as Extreme Makeovers go, one Paducah resident may have said it best when she stated that her city “makes you feel good to live here.” More importantly, Paducah and this overall national trend demonstrate how the arts can serve as an effective catalyst in reviving a community by paving the way for a richer city, both economically and culturally.

                    Copyright © 2011, Sheppard Mullin Richter & Hampton LLP. 

                     

                    New Alternatives to Condominium Structure for Florida Real Estate Developers

                    From featured bloggers at the National Law Review  Jeffrey R. Margolis and Barry D. Lapides of Duane Morris LLP – helpful information about what to look for in alternative non-condominium structure for certain real estate  projects in Florida.

                    Florida’s real estate market is showing signs of a turnaround. However, residential developers have appeared hesitant to construct new condominium projects. As an alternative to projects using a condominium form of ownership, new low-rise or “garden style” projects that would typically need to be structured as a residential condominium have recently been approved by several Florida local authorities, potentially paving the way for an alternative non-condominium structure for projects that otherwise would need to be structured as a condominium.

                    With the current perceived stigma of falling values for condominiums as well as the increased costs associated with forming condominiums and operating condominium associations, developers of proposed low-rise or “garden style” projects in Florida may want to consider a hybrid structure that allows the development of these projects as non-condominiums that permits the individual units to be conveyed as non-condominium homes operated through homeowners’ associations under Chapter 720 of the Florida Statutes.

                    With the proper documentation, including a declaration of covenants and restrictions, appropriate disclosures in homeowners’ association and sales documents, and necessary approvals from the applicable governmental authorities and lenders, homebuilders can now construct low-rise or “garden style” residential townhomes, with each unit having exclusive use of a garage, that can be structured to allow ownership as non-condominium units as opposed to condominiums.

                    With this structure—a sample floor plan is depicted below—all units have exclusive use and access to a garage, though certain units actually have no garages (“Non-Garage Homes”), and other units contain two garages (“Garage Homes”). To accommodate the Non-Garage Homes with use and access to a garage, an easement is provided in favor of a Non-Garage Home for the exclusive use of one of the garages. This structure may also be available for living areas other than a garage through the use of easements or other rights.

                    Floorplan

                    With this structure, the following may warrant consideration:

                    1. Easement. A recorded declaration of covenants and restrictions should include the necessary easements in favor of the Non-Garage Home, including a perpetual, exclusive easement for the use and enjoyment of the garage and the driveway appurtenant to the garage.
                       
                    2. Taxes. Fairness would dictate only that the owner of the Non-Garage Home pay the real estate taxes associated with the garage space over which it has exclusive use and enjoyment, although the garage is not part of the Non-Garage Home. Unless the local property appraiser agrees to assess each unit as if it has one garage, regardless of the legal description of the unit, a recorded declaration would have to provide a mechanism for the apportionment of real estate taxes.
                       
                    3. Homeowners’ Assessments. Depending on whether assessments are allocated to each unit based upon square footage or on an equal basis, a recorded declaration of covenants and restrictions should be drafted to account for any assessments allocated to the garage component.
                       
                    4. Utilities. Depending on how the utilities will be metered and billed, a recorded declaration would have to provide a mechanism so that utility costs related to the garage used by the Non-Garage Home are paid by the owner of the Non-Garage Home. In addition, issues relating to utility lines serving the garage component would have to be addressed.
                       
                    5. Insurance. Depending on whether the homeowners’ association obtains and maintains insurance coverage over all of the units in the community, the developer may want to consult with local insurance companies to determine whether coverage can be obtained so that the owner of the Non-Garage Home can obtain insurance, both casualty and general liability, covering the garage component.
                       
                    6. Casualty. Provisions should be set forth in a recorded declaration of restrictions and covenants to ensure that the garage used by the Non-Garage Home is reconstructed or repaired in the event of its damage or destruction.
                       
                    7. Maintenance. A recorded declaration should contain provisions to ensure that the owner of a Non-Garage Home maintains and safely uses the garage component used by the owner of the Non-Garage Home.
                       
                    8. Parking. The applicable governmental entity should confirm that applicable parking requirements are satisfied, notwithstanding the structure of this type of development.
                       
                    9. Disclosures. Appropriate and sufficient disclosures should be included in a recorded declaration of covenants and restrictions as well as sales documents advising purchasers and owners of the details of the structure, including the easements and issues relating to maintenance, taxes, insurance and property taxes.
                       
                    10. Other. A recorded declaration of covenants and restrictions should account for other issues, including provisions relating to liability and indemnification issues.

                    Duane Morris LLP & Affiliates. © 1998-2011 Duane Morris LLP.

                    Rise in Foreclosures + An Increase in Mortgage Fraud = More Homeowner Fires

                    A recent posting at the National Law Review by Rick Hammond of Johnson & Bell Ltd. highlights some of many problems related to mortgage fraud.  

                    According to recent reports, many insurers have experienced an increase in the number of fire claims since the onset of the subprime mortgage crisis.  Allegedly, many of these fires were intentionally set by homeowners facing foreclosure.  Not surprisingly, when homeowners’ monthly mortgage payments increase after their low introductory rates expire or when falling home values and stricter lending practices reduce the possibility of restructuring or refinancing loans, the natural result is an increase in the number of foreclosures and an increase in homeowner fires.

                    That’s not the only problem facing the insurance industry.  Insurers are also experiencing an increase in fires associated with the rise in mortgage fraud, which is also running rampant across the United States.  Mortgage fraud is generally defined as the intentional misstatement, misrepresentation, or omission by an applicant or other interested party relied on by a lender or underwriter to provide funding for a mortgage loan.

                    Victims of mortgage fraud include borrowers, mortgage industry entities, and those living in the neighborhoods affected by mortgage fraud. As properties affected by mortgage fraud are sold at artificially inflated prices, properties in surrounding neighborhoods also become artificially inflated. When property values are inflated, property taxes increase as well. Legitimate homeowners also find it difficult to sell their homes. When properties foreclose as a result of mortgage fraud, neighborhoods deteriorate and surrounding properties depreciate.

                    Legal Issues and Developing Law

                    • Insurable Interest by the Insured

                    The threshold question in many cases involving mortgage fraud and its effect on insurance coverage is whether the insured has an insurable interest in the property at the time of a loss.  An insurable interest at the time of loss is essential to the validity of an insurance policy.  Hawkeye Security Ins. Co. v. Reeg, 128 Ill. App. 3d 352, 470 N.E.2d 1103 (Ill. App. Ct. 1984).  Generally speaking, a person has an insurable interest in property whenever he or she would profit or gain some advantage by a property’s continued existence, and suffer loss or disadvantage by its destruction. Lieberman v. Hartford Fire Ins. Co., 6 Ill.App.3d 948, 287 N.E.2d 38 (Ill. App. Ct. 1972).

                    To determine whether an individual has an insurable interest in property, a court will usually examine whether an economic benefit or detriment inures to the named insured under any set of circumstances.  In cases involving a straw person, a close examination of the facts might reveal that in every conceivable manner an insured did not contribute a single cent towards the purchase of the insured property or its maintenance.  That is, an investigation might reveal that every payment towards the purchase or maintenance of the insured premises was made by a straw person, that is, the property’s unidentified buyer-in-fact.

                    Therefore, a proper investigation would seek to determine whether a buyer-in-fact paid for the insurance, paid the initial down payment, the mortgage payments, and for all upkeep and necessary expenses, and whether he or she paid for every attendant cost for the property.  In these cases, the actual insured will likely not incur economic loss due to the damage suffered by the insured premises, nor gain economically from any recoverable insurance proceeds.  Simply put, the primary question is whether there was an actual relationship between the insured and the insured premises, or whether the insured’s relationship to the insured premises is illusory.

                    • Mortgagee’s Duty to Notify Insurer of Foreclosure Proceedings

                    An insurer is often unaware of a pending foreclosure on property that it insures until after a fire has occurred.  Must a mortgagee, as a condition to receiving coverage, give notice to the insurer when that mortgagee initiates foreclosure?  A recent case in Tennessee is instructive in analyzing this question (See: U.S. Bank, N.A. v. Tennessee Farmers Mut. Ins. Co., 2007 WL 4463959).

                    In this case, a homeowner and insured fell behind on her monthly mortgage payments and the mortgagee, U. S. Bank, N.A., initiated foreclosure.  The bank sent a letter to the homeowner stating that it started foreclosure, but the bank neglected to give notice of the foreclosure to the property insurer, Tennessee Farmers Mutual Insurance Company.  Before the foreclosure process was completed, the homeowner and her husband filed for bankruptcy, which stayed the foreclosure proceedings.  Shortly thereafter, the house was destroyed by fire.

                    U.S. Bank filed a claim with the insurers, Tennessee Farmers, for the fire loss, but the insurer denied the claim because the bank had failed to notify Tennessee Farmers that a foreclosure had been initiated.  Tennessee Farmers stated that the foreclosure filing constituted an increase in hazard and, as such, the bank was required to notify the insurance company, and the bank’s failure to provide this notice was a breach of the policy’s mortgage clause, which stated:

                    We will:

                    (a)        protect the mortgagee’s interest in the insured building.  This protection will not be invalidated by any act or neglect of any insured person, breach of warranty, increase in hazard, change of ownership, or foreclosure if the mortgagee has no knowledge of these conditions

                    The trial court denied Tennessee Farmers’ motion for summary judgment and granted summary judgment to the bank.  The insurance company then filed an appeal.  On appeal, Tennessee Farmers argued that the foreclosure proceedings was an “increase in hazard” under the terms of the policy of insurance, and contended that the bank’s bad faith claim was unfounded.  On the other hand, U.S. Bank argued that commencing foreclosure proceedings did not constitute an increase in hazard, and asked the court to adopt the Kentucky’s court’s opinion in Anderson v. Kentucky Growers Ins. Co., Inc., 105 S.W.3d 462 (Ky. Ct. App. 2003).

                    In Anderson, the policy’s mortgage clause stated that the insurance company’s denial of the insured’s claim would not apply to a mortgagee’s claim if the mortgagee had notified the insurer of a “substantial change in risk of which the mortgagee becomes aware.”  In that case, the house was destroyed by fire, and the insurance company argued that the filing of foreclosure proceedings constituted a “substantial change in risk of which the mortgagee became aware.”

                    The court in Anderson ruled against the insurer, noting that insurance contracts are liberally construed in favor of the insured: “While we agree that the filing of foreclosure proceedings constitutes a ‘change of risk,’ we do not agree that such a change is necessarily ‘substantial.”  The court then concluded that the policy did not “clearly and unambiguously” require the mortgagee to give the insurer notice when foreclosure was initiated.  The court in Anderson further held that commencing foreclosure proceedings, while certainly a “change of risk,” did not constitute a “substantial change of risk” within the meaning of the mortgage clause.

                    The Tennessee Farmers’ court rejected the Anderson court’s analysis, noting that the mortgage clause in the Tennessee Farmer’s policy required notification of “any” increases in hazard, not just a “substantial” increase in hazard.  However, this issue remains a moving target.  Thus, after the Tennessee Court of Appeals agreed with the insurance company and reversed the trial court’s decision, U.S. Bank then appealed to the Tennessee Supreme Court.  The state’s high court held that the bank’s commencement of foreclosure proceedings was not an increase of hazard requiring notification to insurance company under the standard mortgage clause in a fire insurance policy, and the bank’s commencement of foreclosure proceedings was not an increase of hazard requiring statutory notification to insurance company.

                    • Mortgage Fraud and the Insurer’s Right of Rescission

                    By its very nature, mortgage fraud involves the intentional misstatement and misrepresentation of material information to a mortgagee.  Often, the same misrepresentations made to the mortgagee are also made to an insurer on an insurance application and give rise to a rescission action.  For an insurer to rescind a policy due to misrepresentation, the insured’s statement must be false, and the false statement must have been made with the intent to deceive ormaterially affect the acceptance of the risk or hazard by the insurer.  Illinois State Bar Assn. Mut. Ins. Co. v. Coregis Ins. Co., 335 Ill. App. 156, 821 N.E.2d 706 (Ill. App. Ct. 2004).  In such circumstances, an insurance policy becomes voidable, not void ab initio, and an insurer can waive its right to void if it does not invoke it promptly.

                    However, in some states an insurer has no general duty to investigate the truthfulness of answers to questions asked on an insurance application.  Those states have recognized that “an insurance company has the right to rely on the truthfulness of the answers given by an insurance applicant, and the insured has the corresponding duty to supply complete and accurate information to the insurer.”  Commercial Life Insurance v. Lone Star Life Insurance, 727 F. Supp. 467, 471 (N.D. Ill. 1989).

                    However, an insurer is generally estopped from voiding a policy for untrue representations in the application if the insured discloses facts to the agent and the agent, in filling out the application, does not state the facts as disclosed to him, but instead inserts conclusions of his own or answers inconsistent with the facts. See Boyles v. Freeman, 21 Ill. App. 3d 535, 539, 315 N.E.2d 899 (Ill. App. Ct. 1974). Typically, an insurer cannot rely on incorrectly recorded answers, even when the insured knows that the agent has entered answers different from the ones he or she provided, if the incorrect answers are entered under the agent’s advice, suggestion, or interpretation.  Loganv. Allstate Life Insurance Co., 19 Ill. App. 3d 656, 660, 312 N.E.2d 416 (Ill. App. Ct. 1974).

                    Thus, the agent’s knowledge of the truthfulness of the statements is imputed to the insurer.  Generally, only when an applicant has acted in bad faith, either on his or her own or in collusion with the insurer’s agent, will a court refuse to impute the agent’s knowledge to the insurance company.

                    Most laws that are enacted to regulate rescission actions are designed to prevent insurance companies from rescinding policies based on cursory or unintended misstatements by an insured.  However, in cases involving straw persons, an argument can be made that the buyers-in-fact act as puppet masters and typically arrange to have the insureds’ names placed on the mortgage and the insurance policies to shield him or herself from exposure, while still enjoying potential profits from sales or insurance proceeds.  In these cases, a court will likely recognize this deceptive arrangement, and that the buyer-in-fact elicited an insurance policy using the purported insured as a front.  Arguably, a court should order rescission of the insurance policy in these types of cases.

                    • Rescission of the Mortgagee’s Right of Recovery

                    Most policies’ mortgage clause does not address rescission of the contract, nor does it describe the mortgagee’s rights in the context of rescission, because these rights are, in fact, extinguished by rescission.  Therefore, a novel approach in cases involving fraud in the application for insurance is to file a declaratory judgment action seeking rescission and voiding of the policy, which will possibly render the mortgage clause inapplicable, and asking a court to bar the mortgagee from receiving any benefits of that clause.  Thus, rescission could potentially wipe the entire policy away, and the insurer would owe no contractual duties to either the insured or the mortgagee.  Assuming rescission is granted, in effect, the policy will have never legally existed, and all parties that had any putative rights under that policy would have none.

                    Importantly, some courts have held that an insurer’s right to rescind or deny coverage on the basis of fraud only applies to the claims of the insured, not to claims of innocent third-parties that are injured by the insured’s tortuous acts.  However, this argument is inapplicable here, since a mortgagee is not a third party but is tantamount to a first-party insured.  Moreover, contract law governs the alleged wrongful acts of the insured rather than tort law.

                    • Increasing the Effectiveness of an Insurance Claims Investigation

                    To conduct a more effective investigation when faced with mortgage fraud and foreclosure issues, the author encourages insurers, as part of their investigations, to check the sales history of the insured premises because several sales within a short period of time could indicate false, inflated values.  Also, it is advisable to conduct a title search, checking with the local tax assessment office or recorder of deeds, to analyze the property’s ownership history and to ensure that the insured owns the property.  Interviewing and completing background checks on the appraisers and real-estate brokers that were involved in a transaction are also advisable.

                    Finally, review information regarding recent comparable sales in the area, and other documents, such as tax assessments, to verify the property’s value.  Reviewing a title history can help determine if a property has been sold multiple times within a short period, which could indicate that the property has been “flipped” and that the value is falsely inflated.

                    ©2010 Johnson & Bell, Ltd. All Rights Reserved.

                    Assessing Your Current Leases for Implementation of LEED®

                    Recently featured on the National Law Review as a featured blogger Hannah Dowd McPhelin of Pepper Hamilton LLP reviews some things to look for in your company’s leases as related to LEED  implementation. 

                    If you are the owner of a multi-tenant commercial building and you are considering implementing LEED or another green building rating system, consider these four aspects of your existing leases before making the leap.

                    First, what costs associated with new sustainability efforts can be shared with the tenants?  A threshold issue in your decision to implement new measures will likely be cost and whether any of the cost can be shared with tenants.  Take stock of what expenses are permitted to be passed through to tenants under the current leases.  In particular, consider the treatment of capital expenditures and similar “big ticket” items.  A lease may allow at least some of the cost (perhaps on an amortized basis) of capital expenditures that are energy saving devices to be shared.

                    Second, what latitude do you have to impose new operational procedures on the current tenants?  A common example of a new operational procedure is a recycling program.  A good rules and regulations provision will be helpful here because it may allow you to stretch the four corners of the lease a bit to add new sustainability measures and ensure tenants’ compliance.  If you are planning to pursue certification or recognition through LEED or another green building rating system, then this will be an important consideration as the tenants’ compliance and cooperation may mean the difference between achieving certification and not.

                    Third, where will sustainability defaults fit into your leases’ current defaults and remedies provisions?  With respect to sustainability measures that are law, it is often appropriate for you to mandate tenants’ compliance.  For those measures that are not yet law, consider whether your tenants have an obligation to comply under the leases and when noncompliance becomes a default.  It is likely that any noncompliance would be a covenant default, which may be subject to a longer notice and cure period.  Practically, consider what remedies you are willing to exercise for noncompliance with sustainability measures.

                    Fourth, which party will reap the benefits of any rebates, credits or other incentives that accrue due to the new sustainability efforts?  Often, a standard lease form will not address the allocation of these items.  It is often assumed that the landlord receives the benefit but consider your tenants’ contributions to your sustainability efforts and also consider that for tax purposes and otherwise each party may benefit more from certain incentives.

                    Finally, and perhaps most importantly, you must communicate with your tenants and they must buy in to this process.  It will make the implementation of sustainability measures infinitely easier if your tenants are on board and enthusiastic – involve them early and often so they can share in the success of your building’s transformation.

                    Copyright © 2010 Pepper Hamilton LLP

                    About the Author:

                    Ms. McPhelin is an associate with Pepper Hamilton LLP, resident in the Philadelphia office. Ms. McPhelin concentrates her practice in real estate matters and other business transactions, including the acquisition and sale of commercial real estate properties and leasing of office, retail, warehouse and industrial space, representing both landlords and tenants. She is a LEED® (Leadership in Energy and Environmental Design) Accredited Professional and a member of the firm’s Sustainability, CleanTech and Climate Change Team.  215-981-4597 /www.pepperlaw.com