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Posts from December 2013.

As a real estate finance lawyer, I often review bank loan documents and shake my head over the extreme measures taken to protect the rights, prerogatives and leverage of banks. Lenders are given every conceivable remedy as against the borrowers, and borrowers and loan guarantors are required to waive all statutory, equitable and common law defenses and rights. Once in a while this approach backfires.

Standard loan documents used by many commercial banks have included a provision which said the deed of trust not only secures the obligation to repay the indebtedness, but also secures performance of “any and all obligations under the note, the related documents and the deed of trust.” “Related documents” is defined as including any “guaranties”.

At the same time, there is a general rule in Washington State and in most states that prevents lenders from obtaining deficiency judgments against borrowers and guarantors after non-judicial foreclosure of a deed of trust securing a loan. RCW 61.24.100. There are exceptions to that rule, including the provision of RCW 61.24.100(10) which allows a lender to sue a commercial loan guarantor for a deficiency if the guaranty was not secured by the foreclosed deed of trust. It is the interaction of the “related documents” language common to bank loan documents and the limited exception to the general rule prohibiting deficiency judgments which was examined by Division II of the Washington Court of Appeals in First-Citizens Bank & Trust Company v. Cornerstone Homes & Development, LLC, No. 43619-1 (Wash. Ct. App. 2013).

In First-Citizens Bank, the lender non-judicially foreclosed on a number of borrower’s properties after a series of commercial construction loans went into default. Because the amounts bid at the trustee’s sales did not fully repay the amounts owed under the loans, the bank then brought a lawsuit seeking a deficiency judgment against the loan guarantors. However the guarantors argued that because the guaranties were “related documents” which were secured by the deed of trust foreclosed, the general anti-deficiency rule of RCW 61.24.100 barred the lawsuit against them.

The bank and the amici (Washington Bankers Association) argued that the bank did not intend to secure the specific Commercial Guaranty signed by the guarantors, not withstanding the language that the “related documents” secured included “guaranties”. They also argued that the guarantors waived their right to raise the “anti-deficiency” defense in their guaranty, among the laundry list of rights and remedies which a guarantor ostensibly waives in the bank’s form guaranties.

In the first decision by an appellate court which I could find in the United States, Division II of the Court of Appeals agreed with the guarantors, that the bank was barred from seeking a deficiency judgment against them in this context. The Court ruled that the deeds of trust in question secured performance of the guaranties. While the bank may not have intended the effect of its explicit language, it drafted the instruments and is bound by the express language. To the extent the language may not have been clear, ambiguities are construed against the drafter and in favor of the guarantors. Because the guaranties were secured by the deed of trust non-judicially foreclosed, RCW 61.24.100 barred a deficiency judgment against the guarantors thereafter. It also cited recent Supreme Court precedent strongly disfavoring waivers of statutory requirements governing non-judicial foreclosures in rejecting the bank argument that the guarantors waived the anti-deficiency defense.

In a fashion which is typical in bank loan documents, the lender tried to overreach in providing protection for its prerogatives and expansive rights and remedies. This case confirmed that in this context, banks’ over-zealous efforts to provide maximum security for loan documents can backfire. Usually us lawyers representing lenders are more effective in enlarging a lender’s hammer in a way which does not harm its position. The “related documents” dragnet went too far.

As the Court noted, the bank had other approaches which would have preserved its right to sue the guarantors. But the bank chose to first conduct a Trustee’s Sale. There are at least ten cases pending in the Superior Courts of Washington or on appeal with a similar fact pattern. For commercial loan guarantors swept up in the real estate downturn of the last five years, this drafting and procedural misstep by many banks makes Christmas a little cheerier!

Several of the blogs we have posted have addressed different aspects of the law of condemnation (read here, here, and here).  This law addresses the power of eminent domain – the ability of the government to take private property.  Although the government has this right, it is qualified by, among other things, both the Oregon Constitution Article I, Section 18 and the U.S. Constitution’s Fifth Amendment, which provide that the government may exercise this right only upon paying “just compensation” for the property being taken.

Typically the traditional purpose of condemnation is to acquire property for public projects like roads and sewers.  However, it has also been used in a not so traditional way to acquire property that the condemning government may convey – i.e. “flip” – to private developers for purposes of redeveloping property.  Many of the urban renewal efforts have used the power of eminent domain to acquire “blighted” properties in order to include them in economic redevelopment projects.  This approach to economic development has been used for generations, but for many it was under the radar until it was addressed in the U.S. Supreme Court case of Kelo v. City of New London.  In Kelo, the facts aligned where the taking was of property owned by an elderly lady who had no interest in selling her property and wished to live out her days in her home.  However, the City of New London, Connecticut had a different plan for her property – it should be redeveloped along with other properties in order to boost the economic development of that area of the city.  Since the owner was unwilling to sell to the developer, the city would use its eminent domain powers to acquire her property and then convey it to the developer to be included in the larger redevelopment project.  Although this was nothing new, when the U.S. Supreme Court ruled the city was well within its authority to use its powers in this fashion there was public outrage across the country and many states passed legislation under public pressure that would not allow a government to use condemnation to acquire property that would then be conveyed to a private developer.  In Oregon the issue was placed on the ballot by an initiative which passed by a large margin, resulting in the ORS 35.015 prohibition that a public body may not use its power of eminent domain to acquire private property which it intends to convey to another private party.

CondemnationYou might think the backlash to Kelo would cause public agencies to be more discrete and conservative in utilizing condemnation for non-traditional purposes.  But that isn’t the case, at least in a couple of California jurisdictions, where they have considered using condemnation to acquire not real property itself, but interests in real property in the form of “underwater mortgages.”  This concept was apparently first floated in a Cornell Law School Legal Studies Research Paper authored by Professor Robert C. Hockett.  The idea of these “Mortgage Condemnations” is to condemn underwater mortgages secured by private deeds of trusts.  Only that interest in the property, i.e., the financial instrument, would be condemned, not the property itself.  The beneficiary of the deed of trust, generally a bank, would be paid less than the face value of the performing loan, reflecting the possibility that the property owner would eventually stop paying if the property value remains less than what is owed.  Once the deed of trust was acquired, the condemner would convey this interest in the property to a private entity that would offer the property owners an opportunity to refinance their mortgage for a lower principal amount and more favorable terms, increasing the chance they will stay in their home. 

This proposed approach may have a populist appeal in that it addresses the impact on homeowners of the declining value of residential property.  The concept is that, once the underwater mortgage was acquired, the owner’s loan could then be restructured in a way to allow the owner to stay in their home.  However, it is not necessarily entirely altruistic.  A primary advocate for mortgage condemnations is a private group of investors located in San Francisco, Mortgage Resolution Partners (MRP).  Purportedly MRP would provide to the condemning authority the funds necessary to acquire the underwater mortgage.  The acquired underwater mortgages would be transferred to MRP (or a similar private party), which would then renegotiate terms more favorable to the owner and manage the account.  As with any investor, it is assumed that MRP will get a return on its investment and efforts.

The use of condemnation to acquire underwater mortgages is fraught with issues, primarily the issue of whether it is constitutional.  To see the Points – Counterpoints view of this use of eminent domain, you can visit the web pages of Mortgage Resolution Partners (pro) and the Securities Industry and Financial Market Association (con).  There are also interesting issues concerning how the just compensation would be determined – i.e., what is the fair market value of an underwater mortgage?  However, the constitutional and other legal issues aside, at least in Oregon, given the ORS 35.015 prohibition on the use of eminent domain to acquire private property which is intended to be conveyed to another private party, it is unlikely this use of eminent domain is going to happen.

There is a certain irony that a populist response to the use of eminent domain in Kelo resulted in many cases of restrictions being legislatively imposed on condemnation, while a populist response to the housing crisis is the basis for likely the most “creative” expansion of the use of eminent domain authority since...well...since it was first used to acquire property to be turned over to private parties for redevelopment.

By Edward J. Sullivan and Carrie A. Richter

In Koontz v. St. Johns River Water Management District, the US Supreme Court held that monetary exactions, like requirements to dedicate real property, are subject to the “nexus” and rough proportionality requirements of its Nollan and Dolan decisions.  In those cases, the court required a connection (“nexus”) and a rough proportionality between the obligation imposed by the government and the impacts resulting from a proposed development.  The Koontz decision addressed how far those requirements go.  Rather than focus on the nature of the exaction involved, whether a real property interest, a monetary obligation, or something else, the Koontz court found that the mere fact that a landowner seeks development approval from the government places limits on the imposition of excessive demands. The court did not provide further guidance on the types of condition-imposed obligations that would be subject to the Nollan and Dolan tests, other than noting that the payment of money is subject to those tests.  Thus, we are left to speculate about the level of scrutiny to apply to obligations such as a requirement to improve an intersection or to offset the loss of a wetland.

In a thoughtful article “Koontz Redux: Where We Are and What’s Left,” Professor David Callies identifies the various types of development fees that would likely fall within the nexus and rough-proportionality ambit.  Those fees likely include:  mitigation fees, fees imposed to offset impacts to identified natural resources, fees charged in-lieu of requiring the dedication of land to accommodate a particular public improvement, impact fees and fees charged to pay for public facilities such a schools or wastewater treatment facilities.  All of these obligations presumably involve the payment of money to recover the cost of public infrastructure, services or resources resulting from the development.

Things get even more complicated in other situations, such as where the government imposes conditions that do not directly require the payment of money or when the regulation at issue is more closely connected with furthering the governmental police power to protect for the health, safety and welfare than in recovering for some direct cost imposed by development.  For example, many states require developments to contain below-market rate housing units or that fees be paid in-lieu of a set-aside for workforce housing.

Recently, in Sterling Park, L.P. v. City of Palo Alto, the California Supreme Court found that the Mitigation Fee Act, a state statute that requires rough proportionality for exactions, includes within its scope obligations to provide below-market rate housing units, options for government purchase or for the developer to pay a fee-in-lieu for such housing elsewhere.  The Sterling Park case dealt with the timing for pursuing such a challenge rather than what obligations are subject to scrutiny, but necessarily implicated the latter.  The question was whether a developer could, in fact, challenge the obligation after the permits were obtained and construction had started.    The Court’s ruling relied on the language of the Act itself, which defined its subject as any “fee, tax, assessment, dedication, reservation, or other exaction.”  That language may well be broader than the 5th Amendment limitation identified in Koontz.   Interestingly, the Sterling Park court distinguished the various conditions based on whether they divest the developer of money or whether they impact the use of the property.  The court explains that use limitations such as limiting the number of units that could be built, how large each unit can be, or the proposed use are obligations that fall outside the scope of a fee or “other exaction” under the Mitigation Act.  Possibly oversimplifying, the court reasons that “obviously” these obligations, such as the number of units or the size of the units, do not lend themselves to being built now and litigated at a later date.  The court expressly declined to consider whether forcing the developer to sell some units below market value, by itself, would constitute an exaction.

Whether a condition lends itself to compliance under protest and a later challenge cannot be the sole distinguishing factor between an exaction and a use regulation.  Consider, for example, legislatively imposed setback standards, where construction could proceed notwithstanding setback requirements and presumably an addition to the building added after a successful challenge.  Although the US Supreme Court has previously held that setbacks do not give rise to a taking, an obligation to set a building back from a property line to allow for the possibility of government acquisition of a portion of the property to accommodate a sidewalk may not be distinguishable from requiring that a developer give the government an option to purchase units at below-market rates.  In both cases, development is limited for a police power purpose of regulating a use that is not necessarily directly tied to the direct impacts resulting from a proposed development.

This same may be true for legislatively-imposed design standards requiring particular number of stories, fenestration patterns or particular exterior finishes.  Some design decisions must be decided early-on in the process.  However, determining whether a particular exterior siding was necessary could, theoretically, occur later depending on outcome of a successful challenge.  Presumably some rough proportionality findings weighing the enhanced livability or increased property values resulting from setbacks or other aesthetic considerations could be made both at the time of approval as well as at the time of imposition of more specific conditions. Whether such findings would be sufficient is still unknown.

Happy Holidays from the GSB Land Law Team. We look forward to working with you in 2014!

Carrie, Ed, Bill, Jennifer, John, Joe, Rob, Paul, Cynthia, and Julia

 

 

On December 4, 2013, the Oregon Court of Appeals issued a decision in Greenfield v. Multnomah County that lays down new rules about farm stands in exclusive farm use zones.  The clarity will be welcome, but may cause some farm stands to reconsider their operations.

The case began with enforcement issues regarding Bella Farms, a farm stand located in the Sauvie Island area.  In order to resolve the enforcement issues, Bella applied to modify its permit to allow it to conduct a variety of fee-based activities, including farm-to-plate dinners, harvest festivals and small scale gatherings, such as birthday parties, picnics and similar activities.  Bella also sought to use food carts, tents, ticket kiosks and other temporary structures for those activities.

The application was heard before the county hearings officer and several opponents testified against the application.  Ultimately, the hearings officer approved some of the proposed activities, but limited others.  Specifically, she allowed 22 farm-to-plate dinners, limited to 75 guests, 24 harvest festivals (including the use of food carts) and unlimited small gatherings.  The hearings officer denied the use of tents and other temporary structures.  Both the applicant and an opponent appealed the County’s decision to the Land Use Board of Appeals (LUBA).  LUBA affirmed in part and reversed in part and all three parties – the applicant, the opponents and the County – appealed to the Court of Appeals.

Veggies at Farm StandThe issues on appeal all involved the interpretation of the farm stand statute, ORS 215.283(1)(o), which authorizes farm stands as an outright allowed use in the exclusive farm use zone.  The statute also authorizes the sale of retail incidental items and fee-based promotional activities, but with language that created significant ambiguities.  The court used its standard statutory construction approach set out in PGE v. Bureau of Labor and Industries, 317 Or 606, 610-12, 859 P2d 1143 (1993), and State v. Gaines, 346 Or 160, 171-73, 206 P3d 1042 (2009), which require a review of the text and context of the statute, as well as any legislative history that may be proffered.

Thus the court, relying significantly on the legislative history of the bill, concluded that, as originally adopted in 1993, the farm stand statute “pertained exclusively to the use and design of the farm stand structure” and allowed the sale of farm products and limited amounts of incidental items.  Promotional activities were not allowed as part of a farm stand.  However, the statute was amended in 2001 to “add to the uses allowed by the statute – to authorize promotional activities, outside of a farm stand structure, as part of the farm stand permit.”  The court concluded that the clause is not limited to allowing sales or promotional activities only inside farm stand structures, but the “legislative concern was to avoid the placement of commercial structures on farmland that were related to farm marketing.” 

Based on its reading of the statute, the Court first found that the farm-to-plate dinners are permitted at farm stands; however, it remanded the issues to consider additional procedural issues related to the farm-to-plate dinners.  Next, the court agreed with LUBA that any structure on the farm stand cannot be used “solely for promotional use and the sale of retail incidental items.”  In other words, the predominant use of any structure must be for the sale of farm crops or livestock.  The court interpreted the term “structure” broadly to include tents, canopies, viewing structures, ticket kiosks and, specifically, food carts.  Finally, the Court agreed with LUBA that birthday parties and other small-scale activities could be considered “primarily [to] promote the sale of products at the farm stand” if they are properly conditioned to result in the contemporaneous sale of farm crops.

The Court of Appeals remanded the decision to LUBA, and possibly the County, to resolve several procedural issues and to determine whether certain structures, e.g., food carts, can be considered “designed and used for the sale of farm crops or livestock grown on the farm operation.

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We regularly update clients about changes in real estate law and on industry trends. This includes briefing clients on legislative proposals in the federal tax, housing and other legal areas affecting their businesses. Staying current enables you to anticipate and prevent legal problems as well as capitalize on new developments.
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