The Fortuity Doctrine

            This is a bit complicated. But follow along until you see the words “The Fortuity Doctrine.” Доверяй, но проверяй.

Kernell and Stanley Thaw were married in 2001. In 2002 Stan Thaw and Leslie Schachar began operating a business together. When the business failed, Schachar paid business debts that were guaranteed by both Stanley and Schachar.

            Schachar sued Stanley in 2008 to recover Stanley’s share of the debt.

 

            While the lawsuit was pending, the Thaws contracted to purchase a home in Frisco Texas. In 2009 Schachar obtained a final judgment against Stanley, and Stanley appealed.

 

            While the appeal was in process, Schachar recorded an Abstract of Judgment in Collin County before any Deeds to the new home were recorded. Kernell and Stanley Thaw moved into their new home in 2010.

            In 2011 the Thaws paid off the mortgage debt and only then recorded a Deed in a transaction insured by Fidelity National Title. One month later the Texas Court of Appeals affirmed Schachar’s judgment, so Stanley countered by filing a bankruptcy petition near the end of 2011.

            Schachar filed a proof of claim in the bankruptcy for a $400,000 secured interest in the Frisco property. The bankruptcy court held that both the claim and lien were valid, finding that Schachar had recorded his Abstract of Judgment lien before the Thaws had made their new Frisco property their Texas homestead.

            As a consequence, when the Frisco property was sold in 2013 the Schachar lien attached to the net proceeds of the sale, approximately $500,000.

            In 2014 the bankruptcy Trustee as well as Stanley and Kernell Thaw made demand upon Fidelity for insurance benefits, as the title insurance policy insured title without exclusion for Schachar’s judgment. In 2016 the bankruptcy court approved a settlement in which Schachar received $444,000 from the net proceeds of the sale, in full satisfaction of his claim.

At that juncture the Trustee and Kernell Thaw determined they could recover the amount paid to Schachar from their title insurance carrier. As you likely guessed, Fidelity Title resisted and refused to pay.

            So Kernell and the Trustee sued Fidelity Title, arguing that Fidelity had breached its Policy by denying the claim. The bankruptcy court reviewed the policy and these unique facts, and issued an Order that coverage under Fidelity’s insurance policy was barred. The reasoning was partly due to application of the “Fortuity Doctrine.”

            The Trustee and Kernell Thaw appealed the bankruptcy court’s Order.

            The Fortuity Doctrine relieves insurers from covering some behaviors that the insured undertook prior to purchasing the insurance policy. Under this doctrine, the insured cannot obtain coverage for losses of which the insured had knowledge when the policy was bought, but failed to disclose to the insurance carrier.

            Kernell claimed that she had no actual knowledge that Schachar had recorded an Abstract of Judgment lien and further – she would not have understood the effect of such a filing if she had known of it.

            Evidently the Fortuity Doctrine covers this event, as it precludes insurance coverage when the insured is or should be aware of a known loss at the time the policy is purchased. Not understanding the legalities or process is not a great defense.

            The Court rationalized that even if Kernell had no knowledge of the recordation of the Abstract of Judgment, she knew or should have been aware that her husband’s failure to pay his debts resulted in a Judgment against him in 2009. And that due to appeals, the Judgment was uncollected at the time the Thaws purchased the Frisco property. And that the Judgment remained unpaid when the Thaws paid off the mortgage debt and purchased the title insurance policy in 2011.

            The Court reasoned that was a “loss in progress” and for that reason, Fidelity Title is not responsible for the claims asserted by Kernell Thaw and the Trustee.

            Fidelity Title wins; Kernell Thaw and the Trustee lose. See Christopher Moser and Kernell Thaw v. Fidelity National Title Insurance Company; US District Court; Eastern District of Texas; Case 4:17-CV-104; March 21, 2018; https://www.leagle.com/decision/infdco20180322h25

            Lessons Learned / Questions Asked:

1.      Now I know what the Fortuity Doctrine is!

2.      Insurance companies have abilities to defend that many of us (meaning: me) could never contemplate. This is one among many.

3.      This is my 99^th blog posting over a period of almost 10 years. Shouldn’t I get a watch, pen, or tuna sandwich? I mean, for the love of Pete it’s been fun but 99 blogs, really?

                                                                                                                            Stuart A. Lautin, Esq.*

 

* Board Certified, Commercial (1989) and Residential (1988) Real Estate Law,

Texas Board of Legal Specialization

 

Licensed in the States of Texas and New York

 

Reprinted with the permission of the North Texas Commercial Association of REALTORS®, Inc.

 

 

*

Fun with Percentage Rental Clauses

In 1993, Ralphs Grocery Company signed a 20-40 year lease with Midtown Shopping Center Associates for 53,000 square feet in a Los Angeles shopping center. Under the lease, Ralphs is required to pay an annual base rental rate of almost $1 million per year, plus 1.25% of gross sales over $31 million.

The lease defines “gross sales” as the amount of the sales price, whether or not for cash or upon credit, of all merchandise and goods, and the charges for services sold on or delivered from the shopping center property. The lease excludes 15 items from gross sales, including sales tax, deposits on returned items, refunds and credits for defective items, sales from other stores, interest and credit card charges, sales from lottery tickets and coin-operated devices, coupons, commercial sales of scrap materials and bulk sales consisting of inventory, fixtures and equipment.

Also excluded are “. . . discounts allowed to any customer pursuant to any customary and reasonable policy adopted by Ralphs . . .”

Ralphs created a Rewards program in 1997 intended to encourage and reward customer loyalty. In this program, Ralphs charges two prices for merchandise: (1) a higher price paid by customers who do not participate in the Rewards program; and (2) a lower price paid by customers who sign up for the customer loyalty program.
 
Paper transaction receipts generated at the check-out stand detail what Rewards customers would have been charged without the program discounts, and calculates their “savings.” The program has been quite successful: transactions by Rewards customers account for 97% of all transactions at Ralphs.

Ralphs provided Midtown yearly statements reflecting what it believed constituted “gross sales” from the Midtown store, using the amount Rewards customers actually paid rather than the amount they would have paid for the same items had they not participated in the loyalty program. When Midtown expressed its view that Ralphs was under-reporting “gross sales” by excluding the amounts Rewards customers could have been charged, Ralphs filed a lawsuit against Midtown.

The trial court concluded that “gross sales” was based on sales prices Rewards customers would have paid absent the program discounts. Accordingly, the court awarded Midtown $305,000.

Ralphs appealed.

The Court of Appeals determined that a reasonable, fair and just definition of “gross sales” is one that looks to the amounts Ralphs actually charges its customers, as opposed to the hypothetical amount Ralphs opts not to charge them.

The Court of Appeals also found that the Rewards program is a discount pursuant to a “customary and reasonable policy” adopted by Ralphs, as specifically contemplated by the lease even though it was created four years after the lease was signed.
        

The Judgment of the trial court is reversed. The term “gross sales” in the Ralphs – Midtown lease does not include amounts Ralphs never charged its Rewards customers. Consequently, Ralphs owes no additional rental.

See Ralphs Grocery Company v. Midtown Shopping Center Associates; No. B252292; California Court of Appeal, Second Appellate District, Division Two; June 17, 2015.

Lesson learned: It is difficult in commercial leasing to anticipate every issue that will occur over a 20 or 40 year lease term. Gross sales clauses are constantly being  probed and tested, as are CAM triple-net pass-through clauses of taxes since Texas franchise and margin taxes didn’t exist seven years ago. Be extra careful when you are addressing percentage-of-gross-sales and expense reimbursement provisions.

 

Reprinted with the permission of North Texas Commercial Association of REALTORS®, Inc.

Ipse Dixit!

DZM, Inc. leased retail space in a shopping mall to a tenant, to operate a poker room and social club. The tenant paid DZM rent from August 2005 to October 2005, but did not pay rental in November. So DZM changed the door locks.

Richie Garren asserted that he leased poker tables, chairs, poker supplies, electronics, decorations and other items to the social-club tenant for $1,000 per month. And that DZM effectively converted Garren’s property by changing door locks and refusing to return the items to Garren.

So Garren sued DZM. The jury determined that DZM had indeed converted Garren’s property, and awarded $12,500 in damages.

DZM appealed, not really to protest the issue of conversion, but instead to assert that the evidence was insufficient to prove an exact damages amount.

The appellate court found a recent Supreme Court case allowing a property owner to testify to its value. The owner in this unique situation doesn’t have to be a qualified expert to furnish an opinion. But rather the theory is that no one would know value better than the owner whose property was just wrongfully taken.

However, the owner’s testimony is judged by the same standards as expert testimony. States the court: “. . . an owner’s property valuation may not be based solely on the owner’s ipse dixit [emphasis in the original case opinion].”

Ipse dixit. Yes the court wrote that. You can’t make that up. My assumption is that all my loyal readers know the meaning. Well, for the one new reader who doesn’t (and yes I had to look it up too), I won’t keep you waiting: “he, himself, said it.”

That strikes yours truly as a rather arbitrary, dogmatic statement. Much like “well that’s just the way it has been so that’s the way it will be.” Sorta.

Anyway, back to the case. A property owner must provide the factual basis on which her / his opinion rests. It is not enough to simply claim “that’s what my stuff is worth because I just told you that’s why my stuff is worth."

Garren submitted some invoices and purchase receipts as indicia of fair market value. But this property was hardly new; it had been used by the poker room for some period of time. Evidently depreciation was not a factor, at least not to Garren anyway.

Because Garren was unable to furnish legally sufficient evidence that the property had any fair market value at the time of the conversion, the Judgment of the trial court was reversed. DZM, Inc. (real property landlord) wins; Richie Garren (personal property lessor) loses.

See DZM, Inc. v. Richie Garren; Cause No. 14-14-00040-CV; Texas Court of Appeals, 14th District - Houston; June 25, 2015.

Lessons learned:

1.  I offer much free advice at www.avvo.com. It’s my pro bono efforts. There are questions almost daily about property conversion. For those who have similar issues, this is an important case to understand that property valuations offered by the owner can be challenged.

2.  The NTCAR Expo is September 2 this year. I plan to make a new sign. Look for me there under the banner “IPSE DIXIT.”

3.  Practice Point: When you go home tonight, tell your spouse / significant other / dog IPSE DIXIT. Then send me an email and let me know how that went for you. I’m going to try it too. If there’s another Counsel Corner from me next month, I either lived or someone is ghost-writing.

4.  Bonus Lesson: ~ 10 years to litigate a case with a value of $12,500? Really?

Reprinted with the permission of North Texas Commercial Association of REALTORS®, Inc.

When Friends Become Business Partners

Carlo and Denise Bazan went into business with their long time friend, Luis Muoz, by opening a restaurant in Laredo called Vamp Ultra Lounge & Café. Two years later Luis sued Carlo and Denise, claiming they had wrongfully taken money from the café.

The partnership decision was made when Carlo, Denis and Luis were vacationing together in Cancun in 2008. A year later they signed a contract designating Denise as the Manager of their new enterprise. But as a matter of practicality, Denise delegated her management duties to Carlo.

According to the contract, the Bazans owned a 50% interest in the business, and Luis owned the remaining 50%. Initially, Luis contributed $80,000 to buy an existing nightclub, while Bazans contributed $15,000 which was used to remodel.

The business opened on October 31, 2009. Carlo collected cover charges at the door and installed cash controls in a point-of-sale system. It seems Luis may not have been consulted and expressed his displeasure about the cover charges, and his unhappiness was likely accelerated when Denise and Carlo started paying themselves a salary without Luis’ consent.

Record-keeping was poor or non-existent as cash receipts were counted at Denise’s residence. More often they were not counted at all. Distributions were made, also without Luis’ consent or participation, to Carlo and Denise.

The business did not make bank deposits for months, and as a consequence, bank accounts were frozen. When questioned, Carlo claimed that vendors, staff and DJs were paid by cash and that explained whey receipts were not deposited at the bank.

Finally, Luis asserted a lawsuit against Carlo and Denise. It seemed the business was making $60,000 to $70,000 a month, but the bank records only reflected deposits of $20,000 per month.

A jury found in favor of Luis on his claims for breach of contract, breach of fiduciary duty and fraud. The jury awarded Luis $120,000 and the trial court converted the jury award into Judgment.

Denise and Carlo appealed.

In a lengthy decision, the Court of Appeals found there was ample evidence of fraud committed by the Bazans’ failure to disclose information. Business partners owe fiduciary duties to each other – the same high standard that brokers and agents owe to their principals.

There was a special relationship of trust, confidence and loyalty in the café business. As such, Carlo and Denise had a duty to disclose material information to Luis.

Secretly taking money from the business breaches that duty, and supports the jury’s finding of fraud by nondisclosure.

The Appellate Court agreed with the Luis. Luis Muoz won and the Bazans lost. See Bazan v. Muoz; No. 04-13-00184-CV; Texas Court of Appeals; 4^th District; November 5, 2014.

Lessons learned:

1.      It’s not newsworthy to state that friends don’t always make good business partners. In fact, I see the opposite is also true: sometimes friends make the best business partners. But, be sure that the relationship is properly documented.

2.      This appellate decision states something we all know – the highest duties in law are imposed upon those who have a special relationship or duty of trust. Like brokers and agents. Breach of that duty means a lawsuit.

3.      Practice Point: All parties in a business venture should have their own separate lawyers. When that is not possible, at least be sure that the Contract has a provision where anyone who needs to exit can do so.

Reprinted with the permission of North Texas Commercial Association of REALTORS®, Inc.

Stop the Presses! [reboot]

Remember last month’s article? Well, evidently the same Texas appellate court came to an opposite conclusion just a few weeks ago. As Ricky Ricardo would say, "let me ‘splain."

Moody National Kirby Houston S, LLP, entered into a contract to sell a vacant lot in Houston to Capcor at KirbyMain, LLC. Seller and Buyer used TREC Form 9-10 “Unimproved Property Contract” for that purpose.

Capcor deposited $25k with Moody National Title Company, LP. Note the similarity in names? Both Moody Title Company and Moody Kirby were owned by Brett Moody.

On the day before closing Moody Title escrow agent Kay Street told Capcor’s lawyer that Moody Title needed to receive the purchase funds in the form of a wire transfer. Kay Street told Capcor’s principal, Josh Aruh, the same requirement when he arrived at the title agency offices the next morning to sign closing docs.

Capcor’s lender timely wired funds to Moody Title. Regardless, sometime after 5p.m. on the day of closing Capcor principal Avi Ron arrived at Moody Title with a cashier’s check.

Kay Street told Ron that she was leaving for the day and could not accept the check. Ron left it with her anyway. Capcor’s attorney offered to replace it the next day with a wire transfer. Moody Kirby however, sent notice that it was terminating the contract.

Capcor refused to sign a Release and instead sued Moody Kirby and Moody Title. Moody Kirby counterclaimed, demanding the earnest money and three times the amount of the earnest money, as provided by Section 18.D. of TREC Form 9-10.

Starting to sound familiar? See last month’s article if it doesn’t.

The jury found that Capcor had breached the contract and that Moody Kirby had the right to terminate the deal since Capcor had not timely performed its obligations. Paying for land with a check on the day of closing was not allowed when, the jury held, Kay Street had specifically told Capcor that Moody Title needed to receive all funds by wire.

The jury also found that Moody Title did not breach any fiduciary duties owing to Capcor. So the trial court entered judgment against Capcor, awarding Moody Kirby its attorney’s fees, escrowed funds, and earnest money plus liquidated damages equal to three times the amount of the earnest money.

Capcor appealed.

The Appellate Court first analyzed Moody Title’s obligations and whether or not they were properly discharged. They were. Then, the Court turned its attention to Moody Kirby’s right to terminate the deal because Capcor attempted to buy the land with a check when a wire was required and Capcor had been advised of that requirement.

Moody Kirby evidently had the right to terminate.

Strangely, there is nothing written about liquidated damages, other than to uphold the jury’s verdict and the trial court’s judgment. How interesting from the same Court that, barely eight months ago, invalidated TREC’s concept of “liquidated damages are always equal to three times the earnest money.”

The trial court’s Judgment was affirmed for Moody Title and Moody Kirby. See Capcor at KirbyMain, LLC v. Moody National Kirby Houston S, LLC; No. 01-13-00068-CV, Texas Court of Appeals – First District, March 13, 2014.

Lessons learned:

1.      In July 2013 the same Appellate Court reached the opposite conclusion regarding liquidated damages. Could it be that liquidated damages were not contested by Capcor in this appeal?

2.      Contact the title agent well before closing, so you will know their unique requirements and be prepared.

3.      I counsel my clients to avoid the situation where a party to a contract is also affiliated with the title agency. Although it appears that Kay Street was impartial in this case and should be commended for it, I am painfully aware of other circumstances where those who are connected receive more favorable treatment.

Reprinted with the permission of North Texas Commercial Association of REALTORS®, Inc.

Stop the Presses!

Your erstwhile reporter has found a biggy. At least I think it is. A BIGGY. Send me an email and tell me that you do or do not agree.

In 2008 Albert and Jennifer Magill entered into a contract to purchase real estate from The Estate of William H. Watson, Sr. The Magills deposited $8,000 in earnest money with the title company.

The Magills were unable to renovate / construct due to a truculent Property Owner’s Association. So the Magills terminated the deal by sending notice to the Estate. The Magills signed a Release Agreement providing for the return of all Earnest Money to them.

Instead of signing the Release, the Seller (well actually their assignee but no matter for this purpose) sent a notice to the Magills demanding the earnest money. When the Magills did not comply, the Seller filed a lawsuit against them alleging breach of contract.

The lawsuit requested not only the earnest money, but also three times that amount based on a damages provision in the Contract as follows:

"D. DAMAGES: Any party who wrongfully fails or refuses to sign a release acceptable to the escrow agent within 7 days of receipt of the request will be liable to the other party for liquidated damages in an amount equal to the sum of: (i) three times the amount of the earnest money; (ii) the earnest money; (iii) reasonable attorney's fees; and (iv) all costs of suit."

The case was tried to a jury, which found the Magills had breached the contract. Judgment was entered for the Seller (again, actually their assignee) for $32,000, representing the $8,000 earnest money amount plus liquidated damages of three times the earnest money, as well as attorneys fees, interests and costs.

The Magills appealed, contending that the liquidated damages clause is an unenforceable penalty.

And why is this interesting to us? Because this clause was written by the Texas Real Estate Commission and is presently contained in their on-line forms site, here: http://www.trec.state.tx.us/pdf/contracts/20-11.pdf.

But wait there’s more. Unless an exception exists, TREC licensees are mandated by law to use that exact form in residential transactions.

They. Have. No. Choice.

And – still more. Some users of commercial real estate contracts and leases in Texas (and outside of Texas too), taking their cue from TREC, have incorporated similar provisions.

The Texas Appellate Court reviewed the clause, and determined that it must be enforced if (1) the harm caused by the breach is incapable or difficult of estimation; and (2) the amount of liquidated damages is a reasonable forecast of just compensation. That follows the ruling given us by the Texas Supreme Court in 1991.

The Appellate Court found authority that if the amount stipulated in the liquidated damages clause is shown to be disproportionate to the actual damages, the clause is a penalty and will not be enforced.

The Court concluded that, because the contract simply takes the value of the earnest money and multiplies it times three, the provision is an unlawful penalty and does not attempt to forecast actual damages.

In fact, the Court used the TREC’s own commentary to defeat the TREC’s own contract: “This conclusion is supported by the comment promulgated by [TREC] . . . that the purpose of the clause was ‘to provide for additional incentives for prompt release of the earnest money.’ ”

WOW. Probably without intending to do so, Al and Jen Magill just gutted TREC’s most important contract, and similar provisions contained in commercial contracts and leases too. My surmise is that TREC is busy re-writing the statutorily-mandated sales contracts to comply with this ruling.

The trial court’s Judgment was reversed for the Magills; damages were reduced from $32,000 to $8,000. See Magill v. Watson; No. 01-12-00051-CV, Texas Court of Appeals – First District, July 9, 2013. I am not aware of any further appeals.

Lessons learned:

1.      Just because TREC wrote it – or it’s contained in a form – doesn’t make it enforceable!

2.      Liquidated damages clauses are inherently suspect and susceptible to challenge.

3.      This might be an opportune moment for you to closely examine your contracts and leases!

 Reprinted with the permission of North Texas Commercial Association of REALTORS®, Inc.

Hate It When This Happens

In June 2004 AGF Spring Creek / Coit II, Ltd. leased office space in Richardson Texas to Atrium Executive Business Centers Richardson, LLC

Later there were three Lease Amendments. Each was signed by Curtis for the tenant, as its President or CEO. The last Amendment extended the lease term into 2015.

Atrium, however, was never formed. Instead, Curtis formed “AEBC-Richardson, Inc.” After formation, AEBC occupied the leased premises and operated a business there for six years. Although AEBC offered executive suites at the leased premises to subtenants, it was Atrium that was shown as the tenant in the Lease and all Amendments, and Dawn Curtis signed each on behalf of Atrium, not AEBC.

In March 2010 Curtis sent an email to representatives of the Landlord stating that revenues were too low to continue in operations, and asking AGF to handle the details of the pending lease default. No further rent was paid and AGF terminated the Lease by written notice issued later that month.

In April 2010 AGF initiated a lawsuit against Dawn Curtis individually for breach of the 2004 Lease, as extended and amended. AGF contended that although Atrium was the named tenant, in fact (and in law) Atrium never existed as it was never formed. And consequently, Dawn Curtis was 100% liable as if she had signed an unconditional Guaranty.

The jury entered a verdict in favor of AGF in trial court, and the judge converted it into a Judgment. Curtis appealed.

On appeal Curtis acknowledged her mistake in failing to change the name of the tenant on the Lease, and her further mistakes in signing the Lease Amendments as President of an LLC that did not exist. She requested however that the Court overlook these mistakes and instead impose a lease agreement between AGF and AEBC through the action and conduct of the parties.

To support her argument, Curtis provided evidence that reimbursement of the tenant’s move-in expenses, all rental payments, fax transmissions, insurance policies, sales and use tax permits and subtenancy agreements with executive suite customers were all made in the name of AEBC rather than Atrium, and further – that Landlord was aware of these documents and payments.

However, Landlord refuted those arguments by stating that the Lease was unambiguous. Atrium Executive Business Centers Richardson, LLC was identified as the Tenant. Not AEBC-Richardson, Inc. The Lease also contained an “incorporation” clause providing that the Lease could not be altered, waived, amended or extended unless by written agreement.

Obviously changing the identity of one of the parties to the Lease is serious business and not easily accomplished without a written agreement between both parties.

Curtis’ lawyers found an interesting case from Fort Worth. An Appeals Court decided in 1997 that, in a similar situation as this case, “a promoter is relieved of personal liability only when the corporation subsequently adopts the contract either expressly or by accepting its benefits.”

But in our case the entity was never formed, and could not “subsequently adopt” the Lease. AEBC was ultimately formed. Not Atrium. And if Landlord had sued AEBC for breach of Lease, AEBC could have easily defended claiming it never signed the Lease or any of the modifications or anything else (such as a Lease Guaranty) leading to imposition of liability against AEBC.

Ultimately the Appeals Court overturned the lower court’s judgment, but due to entirely other issues: the jury had miscalculated the proper amount of the award. So while I must truthfully tell you that Curtis won this round, I must also conclude that if this case isn’t settled but instead is retried, Curtis will surely lose again.

See Curtis v. AGF Spring Creek / Coit II, Ltd.; No. 15-12-00429-CV; Texas 14^th Court of Appeals, August 28, 2013.

Lessons learned:

1.  Dawn Curtis made the cardinal mistake of signing an important legal document on behalf of an entity before the entity was formed. I see this problem daily. Ok daily is an exaggeration, but I see it very often.

2.  If a document is signed for a non-existent entity, personal liability is typically imposed upon the person signing. There is a way to finesse this when you know the entity has not yet been formed. Write in a special provision eliminating all personal liability once the entity has been formed and evidence of formation and adoption by the new entity is sent to the other parties who have signed the contract.

3.  Practice Tip: When I encounter an entity (whether as a client, adverse party, service provider, vendor, etc.) I check to be sure it is formed in its state of organization, and qualified to do business in Texas. Typically I start here. It’s a free search: https://ourcpa.cpa.state.tx.us/coa/Index.html. Then if it will be a client or adverse party, I’ll dig further, but be prepared to pay $1 per search: https://direct.sos.state.tx.us/acct/acct-login.asp.

Reprinted with the permission of North Texas Commercial Association of REALTORS®, Inc.

Indemnity Equals Guaranty

Michael Smuck and Edwin White wanted to purchase an apartment complex known as “The Falls,” located generally in the southeast quadrant of I-30 and Loop 820 in Fort Worth. They formed a special purpose entity (SPE) called MBS-The Falls, Ltd. for that purpose, and yet another SPE to serve as the general partner of MBS-The Falls.

To acquire the apartments, MBS-The Falls signed a $9 million note, deed of trust, security agreement and other loan docs pledging the real estate. Wells Fargo Bank became the owner of the loan docs through an assignment.

The loan provided for non-recourse financing. As such, the liability of MBS-The Falls was limited to its equity in the apartment complex, unless a non-recourse exception was triggered. The non-recourse exceptions that could impose liability upon MBS-The Falls were listed in the Note.

MBS-The Falls defaulted on the Note, and Wells Fargo foreclosed. Wells Fargo filed suit in Tarrant County alleging waste and that the owner allowed liens to be filed against the property, which impaired the value of Wells’ collateral.

At trial in Tarrant County, Wells Fargo obtained a judgment against MBS-The Falls for $10+ million. With that judgment in hand, Wells Fargo then sued Messrs. Smuck and White in Harris County for that amount. Wells Fargo claimed that Smuck and White were 100% liable for the judgment obtained in Tarrant County against the owner of the apartments.

The basis for Wells’ Harris County lawsuit is contained in a document signed personally by Smuck and White captioned “Non-Recourse Indemnification Agreement.” In that agreement both Smuck and White agreed to indemnify the lender for all losses incurred.

Smuck argued that he would be liable to Wells Fargo only if a third-party asserted a claim, and not merely if Wells Fargo had incurred losses.

White claimed that the judgment rendered in Tarrant County was not based on the non-recourse exceptions, and further that Wells Fargo failed to establish that any non-recourse exceptions had been triggered.

The Harris County court agreed with Smuck and White. Wells Fargo appealed.

The Harris County Court of Appeals first looked at the Indemnification Agreement. Despite the terminology of “Indemnity,” the Court had little problem concluding that it was essentially a “Guaranty,” for which Smuck and White were jointly and severally 100% liable for all losses suffered by Wells Fargo.

And from there it wasn’t difficult for the Court of Appeals to toss out all the secondary arguments used by Smuck and White.

The Harris County Court of Appeals reversed the trial court’s judgment. Wells Fargo won; Smuck and White lost.

See Wells Fargo Bank, N.A. v. Smuck and White; No. 14-12-00574-CV; Texas 14^th Court of Appeals, July 9, 2013.

Lessons learned:

1.   It’s easy to be lazy and not carefully read loan docs, leases and contracts; goodness knows they are as boring as watching a little league baseball game. In August. In Texas. With a 4p start time. The only surprise here is that Smuck and White were able to convince a trial court that the Indemnity Agreement they signed did not impose liability on them for Wells Fargo’s substantial losses.

2.  Don’t assume that non-recourse means no liability can be imposed. There is a new theory being used across the nation right now that even diminishment in value caused by recessionary market conditions can impose personal liability. Most of us don’t think that was the real purpose of non-recourse, “bad boy” or “carve out” provisions but at least some Courts do not agree.

3.  Come see me at the NTCAR Commercial Real Estate Expo on August 28 at the Sheraton in downtown Dallas, and tell me how I can approve these articles and what I should write about. I’ve got a booth!


Reprinted with the permission of North Texas Commercial Association of REALTORS®, Inc.

How a $50 Fine Became a $71,500 Debt

Dominion Estates Homeowners Association defended a lawsuit brought by Gabriele and Edward Duncan in Harris County. DEHA had asserted fines and penalties for violation of a Declaration and related Guidelines. The Duncans wanted clarification from the Court that DEHA was not entitled to receive either.

The Duncans owned a home in Dominion Estates. There were recorded restrictions which obligated each homeowner to “keep and maintain their lot, its yard and landscaping, and all improvements . . . in a well maintained, safe, clean and attractive condition.” As well, the DEHA’s Architectural Control Committee had adopted “Design Guidelines” which provided for fines for non-compliance.

In May 2007 DEHA sent the Duncans a letter stating that they had violated the Declaration and Guidelines, and needed to remove foil that had been wrapped around some exterior pipes. When M/M Duncan failed to comply, a second letter was issued to the same effect one month later.

At that time, a $50 fine was asserted with a statement that if the foil wasn’t removed within a few more weeks, an additional fine of $50 per week would be assessed.

Evidently M/M Duncan removed the foil, but replaced it with gray tape. So, a month later DEHA sent the Duncans a third letter instructing them to remove the tape from their pipes and to pay the $50 fine. When the fine was not paid, DEHA began to assess weekly fines of $50 caused by the Duncans’ failure to pay the initial $50 fine. As DEHA had promised / threatened to do.

In November 2007 the Duncans filed a lawsuit against DEHA alleging that neither the initial $50 fine nor the $50 weekly fines were authorized by the Declaration and Guidelines. M/M Duncan then challenged an additional $250 fine that was levied by DEHA against all homeowners as a special assessment for legal fees incurred by DEHA.

Later, as the Duncans attempted to sell their home they learned that DEHA had filed a Notice of Lis Pendens in the public records, effectively prohibiting them from selling their property. At that juncture DEHA believed that the Duncans owed $4800, and the fine was increasing $50 per week.

A trial was held in October 2009. The jury offered a conflicting verdict regarding the placement of foil and tape on exterior pipes. But regardless, the jury concluded that DEHA did not give M/M Duncan adequate notice of the implementation of the Design Guidelines before taking enforcement action. And also the jury stated that DEHA did not furnish the Duncans a reasonable amount of time to correct the alleged violations.

Further, the jury found that DEHA was not entitled to any unpaid fines and late charges.

The trial court rendered a Judgment that DEHA was not entitled to a recovery. Still, the Duncans appealed, claiming they should receive an award providing that DEHA breached the Declaration and Guidelines. It’s confusing but don’t forget that M/M Duncan brought this claim against DEHA. Usually it’s the opposite.

On August 11, 2011, the Harris County Appellate Court reversed the trial court’s judgment. In doing so the Appellate Court accepted the position asserted by the Duncans that they did not owe any money to DEHA. As well, the Appellate Court found that DEHA at least owed the Duncans the attorneys fees incurred by M/M Duncan to prove their point.

The Appellate Court instructed the trial court to hold a hearing and determine the amount of attorneys fees that should be paid by DEHA to M/M Duncan.

In the first week of May I learned that the jury in the 207th Judicial District Court had issued a verdict a few months prior allowing M/M Duncan to recover $68,000 in attorneys fees. In April the trial court added $3,500 in appellate fees for a grand total of $71,500 in attorneys fees to be paid by DEHA to the Duncans.

Not yet through with the Judgment, the trial court also tacked on an additional $25,000 for any additional appeals undertaken by DEHA. And I understand that DEHA is now considering its own appeal.

See Duncan v. Dominion Estates Homeowners Association; No 01-09-01086-CV; August 11, 2011. That’s where you will find the Appellate decision from two years ago, reversing the trial court’s judgment and providing for another hearing at the trial level. The results of the second hearing regarding attorneys fees that was just concluded, although public, is not located in a place that is easy to find on the web or in other reported services.

Lessons learned:

1.      I understand why DEHA took this action. And I understand why M/M Duncan defended their position and ultimately were forced to bring a lawsuit. All of the litigants had solid business and economic reasons.

2.      Even so, a $71,500 judgment based on an initial $50 fine is excessive. If DEHA isn’t insured for this loss, they may need to further specially assess their members or file bankruptcy. And don’t forget that in addition to the $71,500 judgment DEHA must now pay, DEHA must also pay its own attorneys whose fees may be comparable. And further, don’t lose sight that if DEHA appeals and loses, DEHA might owe another $25,000 as instructed by the trial court in the second hearing.

If that were to happen DEHA would owe the Duncans almost $100,000. All chasing a $50 fine.

3.      And you are doubtless asking – how does this relate to commercial brokerage? The connection is with late charges, lease compliance and fees. An overly aggressive landlord, property manager or agent might encounter the same type of defenses as asserted by M/M Duncan: inadequate notice; improper authorization of charges; unequal enforcement of rules, policies, procedures and guidelines.

The answer is that property owners, managers and agents must use discretion in enforcement obligations, or be potentially slapped by jurors and Courts. It’s not the slap that stings; it’s the attorneys fees that accompany it. Particularly when you may have to pay the fees incurred by both sides.

Reprinted with the permission of North Texas Commercial Association of REALTORS®, Inc.

Lease Mitigation

Mitchell Rudder Properties, LP sued GKG.Net, Inc. for breach of a commercial lease agreement. The jury awarded judgment to Rudder, and GKG appealed to the Houston Court of Appeals.

GKG had extended its lease until March 31, 2013. In 2006 GKG defaulted and Rudder took possession. At the time of the default GKG was paying $13.56 PSF per year.
Rudder quickly signed a replacement lease with World Savings Bank. World was later acquired by Wachovia. The replacement lease had a term through 2011, but World also reserved for itself a ‘kick-out’ or ‘knockout’ clause, where World could buy out of the last two years. Also, World reserved a five-year extension option.

Litigation was asserted by Rudder against GKG in 2006 for past due rents, diminished rents relative to the World lease, future rents for the unexpired original lease term (2011 World lease vs. 2013 GKG lease), and costs. Rudder was awarded damages in all categories requested, in addition to $314,123 for the two-year period of time after expiration of the World Lease.

GKG appealed only the $314k component, claiming that the jury improperly failed to grant an offset for the value of the lease during the two year period. Rudder’s property manager had testified in court that “. . . nobody that I know as an investor that would buy that tenth year – or year 11 and the last 3 months of 12 as an income stream for anything when they’d [World Savings] had already vacated the building. So we didn’t assign any value to that.”

The Houston Court of Appeals reviewed a pivotal 1997 Texas Supreme Court ruling, and more current case authority, and concluded that “. . . the reasonable cash market value of a lease for its unexpired term means the reasonable cash market value of the property – not the reasonable cash market value of the lease that has been breached.” Really the Court had little choice, because to do otherwise would mean that breaching tenants would never be entitled a fair market value offset for the balance of the lease term – that the remaining lease term is always worth zero.

In a further erosion of jury decisions, the Houston Court of Appeals therefore held that there is no evidence to support the jury’s decision that the reasonable cash market value for the remainder of GKG’s term is zero, and that Rudder was entitled to the full rental value of $314,123. The trial court’s judgment was reversed and the case returned to court for a new trial.

Lessons learned:

1. A really good lawyer is going to fight really hard for every penny due you.
2. The residual years of a long-term commercial lease have value.
3. It is the non-waivable duty of a Texas landlord to mitigate its losses for the entire duration of the lease term.

I don’t know what happened as I was not personally involved, but surely Rudder would have been more pleased to allow GKG some type of rental offset for the two-year gap period at the end of the term, then have to start over with a new trial.

Reprinted with the permission of North Texas Commercial Association of REALTORS®, Inc.

Commercial Lease Enforceability - Landlord v. Tenant

May a Landlord enforce a lease obligating the tenant to operate a nightclub or bar, when the tenant cannot obtain a liquor license? Merry Homes, Inc. thought so. Chi Hung Luu thought differently.

The Houston trial court entered a judgment declaring the commercial lease void for illegality, since Luu could not obtain a liquor license. Evidently the Bellaire site was too close to a school and hospital. The Houston trial court awarded Luu $6,000 for the security deposit, and $25,300 in attorneys fees. Merry Homes – the landlord – appealed.

In June 2005 Luu signed a 5-year Lease. The use clause provided that Luu may only use the premises to operate a nightclub or bar, and “for no other purpose.” The Lease also stated that Luu could not use the premises for any activity that violates laws.

Luu promptly submitted his liquor application to the City of Houston after the Lease was signed. The application was denied. The site was within 300 feet from a public school and a public hospital, and consequently, no nightclub / bar license would be issued. The City suggested that Luu might qualify under the “restaurant exception” rules, but Luu chose not to do so because of the expense of installing a full kitchen.

Luu requested the return of his deposit and termination of the Lease. Merry Homes refused.

Luu never occupied the premises. Instead he sued Merry Homes, requesting a judicial determination that the purpose of the Lease was impossibly frustrated, and therefore the Lease must be terminated.

The Houston Court of Appeals decided on February 19, 2010, that both the Houston trial court and Chi Hung Luu were correct. Mr. Luu could not legally perform his obligations in the Lease. A contract to fulfill an obligation which cannot be performed without violating law is void. The Lease was terminated by the Court.

Bottom line:
 
1.  Be careful with use clauses. It may have been better for the Landlord to offer some flexibility in that provision.
2.  The Landlord may have enjoyed a better position if it had clarified that rent was due regardless of Tenant’s use or non-use of the premises.
3.  A provision in a Lease stating that the Tenant has fully explored compliance with all laws and is satisfied might also have helped this Landlord.

Reprinted with the permission of North Texas Commercial Association of REALTORS®, Inc.