Category Archives: Real Estate

Establishing Fair Market Rent Through Arbitration

By Scott R. Lippert, Esq.
slippert@pashmanstein.com

In the commercial lease context, it can be difficult to reach an agreement concerning the methodology for arriving at the amount of base rent for any extensions of the term.  There are several different approaches:  there can be a stated, fixed amount; an amount derived by formula (e.g. CPI increases); or an amount derived by an appraisal process, frequently referred to as “fair rental value”.  In the first two instances, the drafting should be pretty straight-forward.  It is in the last instance where the parties have room to disagree about the process for resolving conflicting appraisals.

Frequently, the language in the lease will require either that the landlord propose the new base rent during the extended term, or that the landlord obtain an appraisal report from a qualified appraiser, stating the proposed rent.  The tenant would then be given the opportunity to dispute the landlord’s position with the tenant’s own appraisal.  The point of contention then becomes how to resolve the difference, if any, between the respective positions of landlord and tenant.

Some clauses provide for an averaging of the two positions if they are within a certain range, say within 5% or 10% of each other.  If not within that range, or if the parties prefer not to provide for averaging, generally a third appraisal is then required, which will be binding upon the parties.  The third appraiser may or may not be aware of the other appraisals. 

There is another approach, one which has been around for a while, which in my experience has recently come into vogue.  It is called “Baseball Arbitration”.  Baseball Arbitration requires each party to submit its number to a neutral, and the neutral’s charge is to pick one number or the other.  The neutral either comes up with his own figure without knowing the figures of the parties and the figure closer to the neutral’s figure will prevail (“night baseball arbitration”) or the neutral is made aware of each party’s figure and picks one or the other.  No averaging, nothing in between.  The theory is that, out of fear that the other side’s number will be chosen, the parties will each submit a reasonable number, within the midrange of possible outcomes.  There’s no point in submitting an outlier, since it is not likely to prevail, or at least so the thinking goes.

This, I believe, is risky business and it surprises me that business people are proponents of this device.  It is unlikely that the three appraiser process will lead to a result that is not within the range of reasonable outcomes.  In contrast, with baseball arbitration, one of the parties could really get hurt.  Chances are the parties will have done some negotiating before reaching an impasse and seeking arbitration.  If the parties are wildly far apart, baseball arbitration seems very risky, as they will likely be more entrenched at that point, in their respective positions.  To reduce the likelihood of a disastrous result, my advice is to stay away from baseball arbitration when establishing fair rental value.

Renewal Options in Commercial Real Estate Leases

By Louis Pashman, Esq.
lpashman@pashmanstein.com

Let’s assume you own a building.  You have a tenant with a written lease.  That lease contains an unambiguous clause that gives the tenant an option to renew the lease on terms set forth.  In order to exercise the option, the tenant must notify you in writing during a specified time period that he intends to exercise the option.  The tenant does notify you in writing but a bit outside the specified time period.

The general rule is that the exercise of an option is a “time of the essence” provision.  There are two cases, however, which have held that, when it comes to renewal options in a landlord-tenant relationship, that general rule is modified.

In the first case, thirty-nine days after the deadline for exercise, the tenant had not notified the landlord.  Landlord wrote to tenant informing him that he had to vacate because he, the landlord, was planning to expand into the tenant’s space.  Within a day or two of receiving that notice, the tenant wrote to landlord notifying him that he intended to exercise the option.  Tenant had been there for ten years and argues it would be unjust and inequitable to forfeit his lease.

The court agreed.  Finding that the tenant would suffer substantial harm if forced to relocate and that the landlord had not changed his position based on the non-exercise of the option, the court held that this “special circumstance” justified renewal of the option.

A decade later, another court reached the same conclusion in a case where the tenant had exercised the option prematurely.

From these two cases we know that a technically non-compliant exercise of the option will not work forfeiture when:

  1. Substantial harm would result to the tenant if forced to relocate;
  2. The landlord did not change his position in reliance on the delay;
  3. The failure by the tenant to give notice was based on an “honest mistake of fact;”
  4. The delay was “slight;”
  5. The loss to the landlord, if any, was “insignificant;”

Clearly, courts will not allow landlords to use “tactics” to avoid the option.  A landlord can, however, diminish the equitable argument a tenant might otherwise have if he reminds the tenant in advance of the approaching deadline or, if no notice is received, he takes significant action in reliance on his belief that he has no tenant.  From a tenant’s point of view, don’t rely on this exception to the general rule.  Be sure to comply completely with all requirements of the option clause.

Are We Ready for Virtual Malls?

By Scott Lippert, Esq.
slippert@pashmanstein.com

I recently read an article suggesting that new retail brands will be launched on-line, rather than in new stores.  This may well be the case, given the cost savings in creating a virtual store, rather than investing in multiple bricks and mortar locations.  The author predicted dire consequences for shopping malls.  I’m not ready to write them off just yet.  I am reminded of the prognostications of doom and gloom for the office sector that we heard some twenty years ago:  there would be no need to rent costly office space;  people would work from home and meet only when necessary via video-conferencing.  While some of that has occurred, it certainly hasn’t had a significant effect on the office market.

My own unscientific, purely anecdotal experience is that people like shopping malls too much to abandon them.  I may have a skewed view of this, having grown up in Paramus, the Mecca of shopping malls.  Paramus has no downtown.  If you want to go out and see your neighbors (in a climate controlled environment, no less), you go to the mall.  You may have no intention at all of buying anything.  On the other hand, once you’re there, you just might pick up a few things.

I see no impact of this purported trend at all on food and entertainment uses.  Clothing and gadgets might be another story, especially if your are able to try on or try out merchandise at a small sample store and then order the goods from a remote warehouse, which apparently is a very important feature of this new model.   But, I think people will still go to the mall just to go, and while there, may still want to purchase goods after going to a restaurant or seeing a movie.  It’s way too soon to anticipate the collapse of the retail real estate sector.  Or is it? After all, I read the article that I’m referring to on line and Newsweek just stopped publishing a print edition.

Permit Extension Act of 2008 Has Been Extended…

By Scott Lippert, Esq.
slippert@pashmanstein.com

On Friday, September 21, 2012, Governor Christie signed legislation further extending the effect of the Permit Extension Act of 2008.  Under the new legislation, the expiration date for many governmental approvals and permits for land development is further extended to December 31, 2014.  This is significant, because many developers have been deferring action on existing permits and approvals, due to the unfavorable economic conditions that have prevailed over the last four years or so.

The hope is that once the presidential election is behind us, and assuming we get past the “fiscal cliff”, conditions for development will improve and we’ll see an uptick in development activity.  It would have served no useful purpose to require developers to go back to the various boards and agencies to obtain extensions  of existing permits and approvals, or worse, to have to go back to square one and reapply.  Let’s hope the additional time will lead to more activity.

New Jersey Transitions to Partial Privatization of NJDEP Oversight

By Scott Lippert, Esq.
slippert@pashmanstein.com

The supervision of the remediation of contaminated property has essentially been privatized in New Jersey.  Effective May 2012, the party responsible for any clean-up will have to hire a Licensed Site Remediation Professional (“LSRP”) who will take care of the functions formerly performed by a case manager of the New Jersey Department of Environmental Protection (“NJDEP”).  NJDEP simply no longer has the staff or the funding to do its job in this area.  Environmental clean-up cases, especially “low-priority” cases have been languishing literally for years for lack of response from NJDEP.  We have one case in our office that has been pending for about 9 years.

It remains to be seen how effective the new LSRP program will be.  From a “green” perspective, concerns have been raised that these privately-paid professionals will not have the best interests of the state in mind when deciding whether or not to approve a particular clean-up plan.  On the other hand, there is no question that the new program will get remedial projects moving again.

Will some LSRPs seek to be perceived as business friendly and perhaps allow less comprehensive, less expensive plans to be implemented than might have occurred under NJDEP supervision?  Perhaps.  Another school of thought is that they will be so concerned with maintaining their licenses that they may in fact be more difficult to deal with than the case managers at NJDEP were.  We’ll just have to see what happens.

One thing to keep in mind when dealing with LSRPs is that they are agents of the state.  If they enter a site and find or suspect contamination, they must report it.  Therefore, an LSRP should never be used to conduct due diligence.  There will still be good old-fashioned environmental scientists who will not have LSRP licenses, who should be used for such investigations.  A seller of real property should make sure that the contract of sale has a provision expressly prohibiting the buyer from using an LSRP to conduct due diligence.

Developing Law on Commercial Mortgage-Backed Securities Loans

By Jennifer A. Lifschitz, Esq.
jlifschitz@pashmanstein.com

Beware of providing a personal guaranty for a seemingly non-recourse commercial mortgage-backed securities (“CMBS”) loan.  A recent opinion by the Court of Appeals of Michigan could potentially have a significant negative effect on guarantors of non-recourse CMBS loans if adopted by other jurisdictions.  The general intent behind CMBS loans is to limit recourse on the loan to the actual property securing the loan, while seeking recourse on the loan from guarantors only after specific and egregious “bad acts” of a borrower. In Wells Fargo Bank, NA v. Cherryland Mall Limited Partnership, the court concluded that a mortgage unambiguously required a borrower to remain solvent in order to maintain its single purpose entity (“SPE”) status. Lenders often require borrowers to maintain SPE status to protect the lender’s collateral from other potential creditors of the borrower. Having admittedly become insolvent due to its failure to make payments on the loan, the borrower violated the SPE requirements of the loan, and Wells Fargo sought repayment on the loan from the guarantor.  This is an issue that should be watched closely in and out of Michigan. As the law continues to develop on this matter, guarantors should be aware of the implications of guaranteeing a seemingly non-recourse CMBS loan and ensure that the terms of any non recourse carve-out guarantees securing such a loan are properly negotiated to protect their interests.

In October 2002, Cherryland obtained an $8.7 million non-recourse CMBS loan using property as collateral. David Schostak, a principal of Cherryland, acted as guarantor of the loan.  Wells Fargo eventually purchased the loan. In 2009, Cherryland failed to make a mortgage payment and Wells Fargo eventually commenced a foreclosure action and was the successful bidder.  There was a deficiency of about $2.1 million.  Wells Fargo filed litigation against Cherryland to enforce the loan documents and added Schostak as a defendant as the guarantor of the loan.  Wells Fargo filed a motion which sought judgment against Schostak as guarantor for the entire loan deficiency based on the fact that Cherryland’s insolvency was a failure to maintain its SPE status.  These actions seemed contrary to the intent of the CMBS loan which was to limit recourse on the loan to the property, absent extenuating “bad acts.”

The court’s willingness to allow a lender to enforce the insolvency requirement of the SPE provisions of a loan and seek repayment from a guarantor for the borrower’s “bad acts” is a troubling development for guarantors of CMBS loans.  In the current economic climate, it is not uncommon for borrowers to miss payments on a loan and be deemed insolvent. Lenders can too easily point to the “bad acts” of the borrower in failing to maintain SPE status and seek repayment from the guarantor for the balance of the loan.

In response to this troubling decision, the Michigan legislature passed the “Nonrecourse Mortgage Loan Act” (the “Act”) on March 29, 2012.  The Act prevents a post closing solvency covenant to be used as the basis for any claim or action against a borrower or any guarantor on a nonrecourse loan and thus invalidates the Cherryland decision discussed above. This is an issue to watch closely and to be aware of before undertaking to act as a guarantor in a CMBS loan.

Purchasing Distressed Assets

By Scott R. Lippert, Esq.
slippert@pashmanstein.com

Those of us who remember the 1987 stock market crash and its subsequent and long-lasting effect on an over-heated real estate market are starting to see some of the same signs of recovery that we began to see in the early 90’s.  One of those signs is the emergence of the entrepreneurial men and women who are willing to risk private capital to purchase distressed assets and turn them around.  In the commercial real estate arena, this frequently means purchasing the loans affecting over-leveraged properties at a substantial discount from the institutional lenders who would rather not engage in the workout/foreclosure/bankruptcy process that must occur in order to displace the defaulting ownership and acquire title.  It can be a difficult process, but a necessary one, creating an opportunity for substantial profits.

It goes without saying that there are risks accompanying those potential rewards, chief among them evaluating the purchase price.  To mitigate those risks, all of the due diligence that is standard to any acquisition must be performed, while having to work around an ownership that may be hostile to your presence.  In deciding how much to pay to acquire the loan, the careful purchaser will factor in the time and expense of ultimately obtaining title, whether by judicial process or by voluntary agreement of the debtor.

One of the ways to obtain title quickly is by having the debtor deliver a deed in lieu of foreclosure.  However, the New Jersey Division of Taxation has placed an obstacle in the way of completing such a transaction.

The Bulk Sales Act applies to transfers of interests in real estate and the Division requires the seller to place funds in escrow to secure payout of state taxes.  Of course, where a debtor is giving a deed in lieu of foreclosure, the likelihood is that the debtor will not be able to comply with this requirement.  After all, if the debtor had cash on hand, it probably would not be in default in the first place.  The same issue would apply if a lender agrees to permit a short sale.  The escrow requirement does not apply to a sheriff’s deed, so in these circumstances, completing a foreclosure may be the only way to obtain title.

The current marketplace affords many opportunities to acquire mortgage debt at substantial discounts.  This little nuance concerning bulk sales compliance is but one of many potential bumps in the road.  Careful execution of the transaction is essential.