Now Tell Me Again: How Big Is That Property?

Bowen Zhu and Jain Yu contracted to buy a house in Harris County for $180,000. Seemingly, they intended to live there. But for this purpose it doesn’t matter.

The seller, listing agent, Harris County Appraisal District and Kai Lam all represented that the house had 2,722 square feet of living area. Kai Lam was the TREC-licensed broker representing Zhu and Yu. When Zhu and Yu initially viewed the property, Zhu told Lam that the house seemed smaller than 2,722 SF, but Lam assured Zhu that it only seemed smaller because it had an open floor plan.

On the day before closing Zhu told Lam he wanted to back out of the deal. Zhu claims that Lam told him he would get sued if he changed his mind. Lam gave Zhu a 1% purchase price rebate, and Lam persuaded the seller to discount the purchase price by $250 as a further inducement for Zhu to close.

After the closing and at Zhu’s request, the Harris County Appraisal Districted re-measured the house and found that its living area was only 1,967 square feet. The difference of 755 square feet is approximately 28% less than the square footage as represented to Zhu and Yu.

On a straight square footage basis, it is conceivable that Zhu and Yu paid $50,000 too much for the property.

The buyers sued Lam, Lam’s brokerage company Housesold Realty, Inc., the seller, the seller’s listing agent and others. All parties were dismissed (perhaps they settled?) but for Lam and HRI.

Finding no genuine issues of material fact, the trial court granted summary judgment for the broker Lam and his brokerage company HRI. Zhu and Yu appealed.

The buyers did not properly appeal the issue of monetary damages, and instead claimed that “damages are effectively presumed in this case.” Zhu and Yu’s testimony that the house had a value of $140,000 was given no probative value by the trial court. Also, it appears there was no expert testimony on this point, and so Zhu and Yu’s opinion of market value, without supporting comparables or other credible evidence, was merely conclusory, unsubstantiated and unreliable.

Since no authority was cited and since the buyers did not raise the argument in their response to Lam’s request for judgment in the trial court, the Court of Appeals had no choice but to forego awarding Zhu and Yu any compensation.

Buyers did, however, properly perfect their appeal regarding Lam’s and HRI’s breach of fiduciary duty owing to Zhu and Yu. To prevail under Texas law, the buyers must prove: (1) a fiduciary duty existed between Buyers and Lam; (2) Lam breached that duty; and (3) Buyers were damaged.

Lam and HRI defended the claim of breach of duty by asserting that Lam did not know the actual square footage, and that under Texas law Lam was neither required to measure nor investigate the size of the home.

Zhu and Yu were unable to prove that Lam knew or should have known the house was substantially smaller than 2,722 SF. Instead, the evidence seemed to show that Lam merely repeated what he was told from the seller and listing agent, and what he discovered by reviewing the HCAD website.

And Lam was correct on this point: unlike California and some other states, under 1992 Texas case law authority Lam had no duty to measure the property or further investigate.

The trial court’s Judgment was affirmed for Kai Lam and Housesold Realty, Inc. See Zhu v. Lam; No. 14-13-00368-CV, Texas Court of Appeals – Houston 14^th District, March 18, 2014. The broker won; the buyers lost; Lam did not breach his fiduciary duty to the Buyers by merely repeating information he had gained from the seller and public sources.

Lessons learned:

1.  Yes it is true that the broker was vindicated. However, a close reading of the appellate decision leads me to think this could have gone badly for the broker just as easily if the damages issue was properly presented.

2.  Don’t offer square footage representations. If you must do so, then clarify in writing that they are not your representations but rather come from the seller, appraiser, landlord, Central Appraisal District records or some other (hopefully public) source. And, that the buyers / tenants should independently verify the data before making any decisions.

3.  I don’t have a third lesson learned. It just felt a little, je ne sais quoi, empty without some text here.

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.

Power of Attorney!

In August 2002 Vinh Nguyen purchased property in Pflugerville Texas which was financed with a loan from Finance America. Finance America sold the loan to Wells Fargo. Wells appointed Ocwen Loan Servicing as Wells’ agent to collect loan payments, assure that the tax payments were timely made and that the property was insured.

 

In July 2003, the property was purchased by Francis Montenegro. Diem Thi Nguyen signed a Warranty Deed to Francis Montenegro as “Vinh Nguyen, by his attorney in fact, Diem Thi Nguyen.” Diem’s claim to be Vinh’s attorney-in-fact was supported by a Power of Attorney document signed by Vinh in June 2003.

 

The Warranty Deed was recorded with the Travis County Clerk about a week after closing. The Power of Attorney document was not recorded.

 

Montenegro made monthly payments to Vinh until April 2006; presumably Vinh was, in turn, supposed to pay Ocwen but Vinh failed to do so. In May 2006 Montenegro sent a letter to Ocwen requesting authority to make loan payments to Ocwen instead of Vinh.

 

Ocwen never expressly allowed Montenegro to make direct payments, but regardless Montenegro sent an $8128 payment to Ocwen to cure Vinh’s default. Thereafter Montenegro made monthly mortgage payments to Ocwen for one year.

 

In August 2007 Ocwen sent Vinh a Notice of Default and Intent to Accelerate. The notice was not sent to Montenegro. When the default was not cured, Ocwen sent a Notice of Acceleration and Notice of Foreclosure to both Vinh and Montenegro in October 2007.

 

Montenegro filed a lawsuit to stop the foreclosure sale. A temporary restraining order was granted, but Ocwen foreclosed anyway. So Montenegro sued Ocwen for wrongful foreclosure.

 

In February 2012 the trial court ruled for Ocwen. Montenegro appealed.

 

Montenegro claimed that Ocwen should have furnished Notice of Default and Intent to Accelerate to accelerate the loan to Montenegro, not solely to Vinhn. That analysis involves privity, or a legal connection between Ocwen and Montenegro.

 

In order to determine if Montenegro had privity with Ocwen, the Appellate Court had to review the 2003 transaction to determine its validity. If the Power of Attorney was ineffective, then so was the Deed. If that is true, then Montenegro would have no standing to contest Ocwen’s foreclosure.

 

The Appellate Court first turned its gun turrets towards that lonely piece of paper, the Warranty Deed transferring the Pflugerville property to Montenegro in July 2003, recorded in Travis County the week after. The Deed was signed by Diem Thi Nguyen, purportedly as attorney-in-fact for Vinh Nguyen. Vinh, you will recall, was the true property owner, having purchased the property in 2002.

 

The Deed appeared to be Ok, subject to the Power of Attorney provisions. So, next up was an evaluation of the POA document.

 

Texas law provides that Power of Attorney documents must be recorded if they will be used in real property transactions. There was no evidence to show that the Power of Attorney was recorded, at least not in the County that counts – Travis County.

 

Consequently, the Power of Attorney document failed.

 

Failure of the Power of Attorney meant that Diem did not have authority to convey Vinh’s title to Montenegro. In turn, that means that although Vinh could have properly contested Ocwen’s foreclosure despite the existence of a temporary restraining order, Montenegro did not have such standing as Montenegro was, at least in law, a stranger to the transaction.

 

Hopefully Montenegro received a title policy at the 2003 purchase (or after) so he would have recourse against a title underwriter if his ownership is later challenged. Otherwise, I suppose he might have recourse against Diem and Vinh, but it is unknown if either are solvent and doubtless both will raise statute of limitations and other defenses.

 

The trial court’s Judgment was affirmed for Ocwen Loan Servicing. Ocwen wins; Montenegro loses. See Montenegro v. Ocwen Loan Servicing, LLC; No. 07-12-00297-CV, Texas Court of Appeals – Amarillo, November 18, 2013.

 

Lessons learned:

 

1.      Power of Attorney documents are inherently risky business. Sometimes there is no alternative, as the Seller, Buyer, Lender, Landlord or Tenant is unavailable. In other situations such parties will execute a POA simply out of convenience. Avoid the issues presented in a POA by demanding signature of important documents by the real parties, not by their agents and attorneys-in-fact through a POA document.

 

2.      Of course title insurance is available in purchase and financed transactions, but did you know that title insurance is also available for leasing, easements and virtually every other estate in land? As a failsafe, always get title insurance. Title policies can insure the Buyer, Lender, Tenant, easement holder and a host of other holders of Texas estates in land.

 

3.      Always. Get. Title. Insurance. Or did I already write that?

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

Disclose More. Never Less.

In 2009 Shawn and Stephanie Holloway hired Jeremy Williams, a sales agent with Keller Williams Realty Northeast, to help them sell their existing home and find a new one. M/M Holloway were shown a home owned by Jennifer Blalock – another sales agent with Keller Williams Realty NE.

Following intermediary protocol, Keller Williams Realty NE engaged Tina Martin, also a sales agent with Keller Williams, to assist Jennifer Blalock. Meanwhile Jeremy Williams continued to represent M/M Holloway.

A Contract was signed for the purchase and sale of Blalock’s property. Keller Williams NE was designated as the broker for both seller and buyers. The Holloways were allowed a 10-day inspection period, and so they hired Clint Simon (referred to them by Jeremy Williams) for a termite inspection.

Simon found no visible evidence of active termite infestation or previous infestation, although Simon did disclose his finding of evidence of previous treatment for subterranean termites.

M/M Holloway closed the purchase and soon after closing the Holloways started renovating the property. The contractors discovered extensive termite damage – substantial enough to cause the Holloways to move out.

The Holloways filed a lawsuit against Blalock, Simon and Keller Williams NE. Blalock filed bankruptcy; Simon paid $200,000 to be released. That left Holloways vs. Keller Williams NE.

The trial jury found liability against Keller Williams NE based primarily on a theory of failure-to-disclose under the Texas Deceptive Trade Practices Act. The trial court then converted the jury’s findings into a Judgment.

Keller Williams NE appealed, claiming that the evidence was insufficient to support the jury findings. The point made by Keller Williams NE was that the only means for the jury to find it liable would have been due to the actions (possible failure to disclose) of Jennifer Blalock. And – that Jennifer Blalock was not an agent for Keller Williams NE, because Jennifer Blalock was acting only for herself.

Now of course Jennifer Blalock had signed an Independent Contractor’s Agreement with Keller Williams NE, to perform services as a real estate agent. However, in the Holloway deal Blalock was not acting in an agency capacity but rather as an owner and seller of the property. As such, the ICA was inapplicable and the actions (inactions) of Blalock did not bind Keller Williams NE as no principal-agency relationship was intended by this one, unique transaction.

So the argument went.

The Court of Appeals evaluated evidence that Blalock’s agent did “very little” and instead Blalock represented herself, offered the Property for sale herself, negotiated the sale herself, and sold the Property for her own account.

Thus, no agency relationship existed between Blalock and Keller Williams NE.

Then the Court turned its attention to the question of Keller Williams’ knowledge of the existence of unrepaired termite damage. Again, the evidence did not support the conclusion that Keller Williams knew of the issue, and failed to disclose.

The trial court’s Judgment was reversed in favor of the Keller Williams franchisee.

See Flutobo, Inc., dba Keller Williams Realty Northeast v. Holloway; Nos. 14-12-00104-CV and 14-12-00170-CV, December 16, 2013.

Lessons learned:

1.  If the non-disclosure is significant enough, there will be a claim. If the claim is not resolved, there will be a lawsuit. If there is a lawsuit, the only winners will be the lawyers as attorneys’ fees might eclipse the amount of any judgment. Particularly if there are appeals.

2.  This case is residential in context. But the same rules regarding disclosure and intermediary relationships apply to commercial transactions. There is no difference in Texas law, as TREC makes no distinction between the types of transactions relative to the disclosures that must be made although the DTPA applies only to “consumers.”

3.  Err on the side of disclosing too much, after of course you have obtained your principal’s written authorization. You might need to consider withdrawing if your principal refuses to furnish that consent. Better a blown commission than a lawsuit!

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

When a Guaranty Agreement Is Not

In early 1997 Border Patrol of Wisconsin, Inc. purchased nine Taco Bell franchises from Pepsico. In connection with financing the purchase, Scot Wederquist signed a Guaranty Agreement in favor of PFS, a division of Pepsico. At the time, Wederquist owned a 25% interest in Border Patrol and served as its Treasurer, and PFS supplied goods and services to Taco Bell franchisees.

PFS sold its assets including USA and Canadian operations to Ameriserve a few months later. And in January 2000, Ameriserve went bust and filed a Chapter 11 bankruptcy petition in Delaware. The Bankruptcy Court approved the sale of substantially all assets of Ameriserve to McLane Foodservice, Inc. in late 2000.

In June 2010 McLane contracted with Table Rock Restaurants to sell it food supplies and services. Wederquist owned 40% of Table Rock and also served as its Treasurer. Table Rock closed its doors in November 2010, owing McLane approximately $450,000.

In December 2010 McLane sued Table Rock and Wederquist to recover the delinquency. The trial court entered Judgment for McLane against Table Rock, but not against Wederquist, holding that he was not personally liable under the Guaranty Agreement he had signed 13 years before in the Border Patrol – Pepsico deal.

Probably sensing that a Judgment against Table Rock had limited collection value, McLane appealed.

It may have been a hint to the outcome of the case when the first substantive paragraph began with “A guarantor under Texas law is a so-called favorite of the law and as such, a guaranty agreement is construed strictly in [his] favor. . . Thus, where uncertainty exists as to the meaning of a contract of guaranty, its terms should be given a construction which is most favorable to the guarantor.”

The Federal District Court closely examined the language of the Guaranty Agreement. Section 1 of the Guaranty stated that Wederquist unconditionally guaranteed the punctual payment when due of the all indebtedness owing “. . . to Creditor” now or hereafter existing.” The preamble of the Guaranty Agreement defined “Creditor” as PFS and all affiliates of PFS.

McLane was of course not an affiliate of PFS but rather a purchaser of its assets. As such, McLane cited a provision in the Guaranty Agreement stating the Guaranty “. . . shall inure to the benefit of and be enforceable by Creditor and its successors, transferees and assigns.”

McLane argued that since it was a purchaser of PFS’s assets, McLane was also its successor, transferee and assign. And as such, McLane was entitled to the benefits of the Guaranty Agreement.

The Federal Court did not need to decide if McLane was a successor, transferee or assign. It wasn’t relevant to the decision. The definition of “Creditor” in the Guaranty Agreement applied only to PFS. Not McLane. If PFS and Wederquist had intended it to apply to others, then PFS and Wederquist could have easily expanded the definition, instead of limiting it to only PFS.

The US District Court Judgment is affirmed. Wederquist wins; McLane loses. The Guaranty Agreement is not binding.

See McLane Foodservice v. Table Rock Restaurants; No. 12-50980; U.S. Court of Appeals – 5^th Circuit, November 15, 2013.

Lessons learned:

1.      Sometimes Guaranty Agreements are, well, you know – Guaranty Agreements. But not always. Commercial Guaranty Agreements in the context of purchase and sale agreements, financing and leasing need to be carefully reviewed.

2.      Practice Tip: In my world there are all kinds and variations of Guaranty Agreements. Some are limited by time; others by amount. Others are “backup” only – recourse must be pursued against the primary debtor first, without success. Still others expire mid-term automatically if the debtor has not defaulted, while in other iterations the Guarantor might be bound to the original debt but to no further credit or time extensions. Many are joint and several such that a creditor has 100% recourse to all Guarantors, but others are only several and limited to each Guarantor’s pro-rata allocated amount.

3.      Don’t assume any Guaranty Agreement is lawful and binding. You might be unpleasantly surprised.

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

Non-Disclosure is Bad. Fraud is Worse.

Tukua Investments entered into a commercial listing agreement with Century 21 Charlotte Banks, to sell Tukua’s commercial property in Eagle Pass, Texas. The property was advertised as being benefited by a triple-net, licensed nursing and rehab center, with a Tenant paying base rental of $300,000 per year. The listed sales price was $2.75 million.

C-21 found a California buyer at the tail end of an IRS Section 1031 tax-deferred exchange. The Contract was prepared on August 16, 2007. In order to attain the benefits of IRS Section 1031, the buyer needed to identify exchange property candidates not later than October 1, 2007, and close not later than February 13, 2008.

The Contract was signed on September 12, 2007, and presumably Buyer timely identified the nursing / rehab center as a deferred exchange candidate. Buyer first learned of a problem with the new tenant, Signature Healthcare, one month later. At that time, it became evident that Signature was not going to fulfill the terms of the Lease.

As Buyer was exploring the reason and basis for the problem, Buyer inadvertently received a copy of a letter referring to an eviction notice from Tukua to Signature of August 8, 2007 – about one week before the first Contract was prepared and submitted to Tukua.

Since it was then too late for Buyer to designate new replacement property candidates, Buyer could only withdraw from the Contract and pay the gains generated from the sale of Buyer’s California property. The extra income tax bite was over $240,000.

Buyer filed a lawsuit for fraud and negligent misrepresentation against the Seller, Tukua. The jury found for Buyer on both counts, and the trial court converted the verdict into Judgment, awarding over $1.3 million to Buyer. Since the underlying damages were $240k, one might assume that a substantial part of the verdict and Judgment was composed of exemplary or punitive damages – the type that is reserved only for fraud cases.

Tukua appealed.

The Court of Appeals carefully analyzed all of the elements of fraud, Texas style. Buyer claimed that Tukua represented to Buyer that there was a valid 10 year lease. The Appellate Court found that Tukua’s representation was true when it was made. There was indeed a valid 10 year lease. The fact that Tukua claimed that Signature was in default did not affect the validity of the lease. That only gave Tukua the right to terminate the lease, evict Signature, or exercise other remedies.

Further, the Court allowed that the lease did not automatically terminate on default. In point of fact, even the delivery of an eviction notice does not serve to terminate the lease. Termination of rights of possession – yes; full-on lease termination; no.

On the fraud point the Appellate Court concluded that representations about future rents or income are typically statements of opinion. Not representations of fact. As such, there can be no actionable fraud claim.

The Buyer then claimed that Tukua had not truthfully represented the conditions, rights, benefits and validity of the lease and that there were serious issues existing with Signature Healthcare.

The Court of Appeals found an appellate decision from Dallas in 1961 stating “A company does not have a duty to disclose all of its financial difficulties while conducting business if it is actively working towards remedying the situation. Silence on the issue alone is not enough to constitute fraud.”

Standing alone it seems this position is subject to challenge, given the facts of this case. However, the Appellate Court then uses several pages to investigate further, and conclude that for an unknown reason this Buyer did not complete the normal due diligence of a typical commercial real estate purchaser. No one from the Buyer’s team really questioned Signature about why they weren’t paying rent. No one asked about unresolved licensing issues.

It seems possible that no Estoppel Statement (or equivalent) was requested of Signature by the Buyer and basically the Buyer just assumed that all was well. That leads me to think that perhaps Buyer was purchasing this parcel for cash, since normally a lender would insist on an Estoppel in this situation.

The Appeals Court overturned the lower court’s judgment. Tukua wins; Buyer loses.

See Tukua Investments, LLC v. Spenst; No. 08-11-00014-CV; Texas 8^th Court of Appeals, August 14, 2013.

Lessons learned:

1.  This case was decided on very narrow facts. Don’t count on getting the same results. Our rule of law, to avoid the courthouse, is unchanged: Disclose too much, not too little. Err on the side of over-communications.

2.  Доверяй, но проверяй. What’s the matter - your Russian a bit rusty? It’s from an old Russian proverb and rhyme – doveryai, no proveryai. Trust, but verify.

3.  Practice Tip: I live in the world of Tenant-Estoppels. We don’t obtain them in multi-family transactions because as a practical matter it is impossible. But we obtain them in every other commercial transaction involving tenants of a significant size. Even if a lender is not involved, commercial buyers need to receive updated, current Tenant Estoppel Certificates, signed by each Tenant. Not the kind that the Landlord signs through a lease-derived power-of-attorney paragraph.

 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.

Sick of Paying Excess CAM Charges?

In 1995, Garden Ridge leased space from Fiesta Mart. Fiesta Mart sold the shopping center to Clear Lake Center in 2003. Garden Ridge audited its allocated share of common area maintenance charges and sued its Landlord, Clear Lake Center.

This comprehensive commercial lease obligated the Landlord to operate, manage, maintain and repair the common areas, but Tenant was required to pay its prorate share of the expenses. The long list of allowable common area costs had virtually no limitations, although Landlord’s fee for “supervision” of the common areas was capped at 7.5% of the total of all CAM charges.

Evidently Garden Ridge had no issue with the CAM computations made by Fiesta Mart. However – Clear Lake added the 7.5% “supervision” fee to its CAM management fee. As well, Garden Ridge wasn’t pleased that both of such fees were paid to an affiliate of Clear Lake.

From 2003 to 2009 Garden Ridge paid $470,000 to Clear Lake for both management and supervisory fees. In 2009 Garden Ridge’s auditor concluded that Clear Lake charged an exorbitant amount.

So Garden Ridge sued Clear Lake in 2009 for breach of the Lease Agreement. The trial court awarded Garden Ridge $470,000 in damages and $530,000 in attorney’s fees, for an even $1 million dollar judgment. The judgment for $470,000 represented the full return of all management fees and supervision charges during that six year period.

Clear Lake appealed and, hoping to overturn the judgment, attempted to delineate between management fees and supervision fees.  As you would expect, Clear Lake mostly failed in that endeavor.

Clear Lake’s backup position was that even if the supervision fees were duplicative of the management fees, surely Garden Ridge was obligated to pay one or the other or some portion of both. And that even if Clear Lake had no right to upcharge the management fees with a 7.5% supervisory fee overlay, still Clear Lake paid honest expenses to operate, manage, maintain and repair the common areas and Garden Ridge should be responsible for its allocated share. Which share, if not $470,000, should have been something fairly close to it.

The Texas Court of Appeals agreed with Clear Lake. Clear Lake was not prohibited from contracting with a third party (although affiliated) for management of the common areas and passing on to Garden Ridge a pro rata share of those expenses. And if “supervision” fees were indeed separate from management expenses, then presumably Clear Lake could recover those too.

The Appellate Court sent the case back to the trial court to start over. The trial court can then determine what part of “management” fees are the same as “supervision” fees, if any, subtract such amount from $470,000 and enter a judgment accordingly.

Clear Lake wins, sort of. Garden Ridge also wins, sort of. I guess the lawyers in this litigation are the ones that really won.
See Clear Lake Center, L.P. v. Garden Ridge, L.P.; No. 14-12-00414-CV; Texas 14^th Court of Appeals, July 18, 2013.

Lessons learned:

1.      Garden Ridge, presumably a very sophisticated tenant, signed a Lease obligating it to pay both “management” and “supervision” fees. If those two terms are duplicative then Garden Ridge will win this case. Otherwise if Clear Lake can prove a meaningful distinction, then Clear Lake will win.

2.      CAM provisions, allocations and pro rata / sharing clauses are inherently difficult to comprehend and challenging to explain, particularly to 12 people sitting in a jury box or a judge who is unfamiliar with commercial leasing practices. From the Tenant’s perspective, capping controllable expenses (typically everything but taxes and insurance) and allowing only marginal annual increases will go a long way to preparing a meaningful expense budget. And keeping a Landlord from using CAM charges as a hidden profit center.

3.      Even with all the right verbiage in place, placing limits on the Landlord’s CAM charges is only as good as the Tenant’s investigation abilities, due diligence and audit. Without a meaningful way to review the Landlord’s books a lawsuit will be required. So – be sure you have both appropriate caps and limits as well as the right of Tenant to easily peek into the books and records of the Landlord, and force the Landlord to pay for the audit too if the overcharges are excessive.

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.