Buyer Beware: Always Check Vesting Deeds

In February 2006 Summit Electric Supply Co., Inc. agreed to sell a five-acre parcel of property located at Manana Drive and IH-35 in Dallas to Saeed Mahboubi. Those of us who live or work in Dallas might guess the highest and best use for that property just by the location. Nonetheless, the Contract of Purchase and Sale prohibited use of the property as a sexually oriented business.

Mahboubi assigned the Contract to Semira Rezaie. Rezaie then entered into a Contract to flip the parcel to Jerry Spencer, LP.

The first closing was on August 4, 2006. Summit signed a Deed conveying the property to Rezaie. The Deed contained a clause restricting use of the property as a SOB. Because the first Deed failed to contain a proper legal description, the corrected Deed was not recorded until August 25, 2006, three weeks after closing.

The second closing was also on August 4. At that closing, Rezaie conveyed the property to Spencer, without exceptions or restrictions. The second Deed was recorded on August 7, 2006 – 18 days before the first Deed.

Spencer leased the property to 2327 Manana, LLC, who posted a notice on the front door announcing its intent to operate a SOB. Then the litigation started.

Spencer and Manana argued in trial court that they could not be held responsible for compliance with the SOB restriction, because the Deed containing that restriction was not recorded in Dallas County until weeks after they had completed their purchase and lease. Since the Deed from Rezaie did not contain the restriction, they argued, then surely Texas law would not / could not stop them from operating a SOB at the site.

Spencer and Manana lost. They appealed.

On June 25, 2010, the Dallas Court of Appeals affirmed the trial court’s judgment. The Court of Appeals had little trouble concluding that a real estate purchaser is bound by every matter contained in or disclosed by any instrument which forms an essential link in the chain of title, even though Spencer and Manana had never read the documents. Essentially, if Spencer and Manana closed their transaction without reviewing the immediately preceding deed in the chain – the ‘vesting deed’ – then Spencer and Manana did so at their own peril.

Not addressed in the case due to procedural matters were the claims against the broker who represented all of the buyers, and possibly failed to disclose the inclusion of the restrictive clause in the first deed. Also not addressed were possible claims against the title company, who may have insured the secondary transaction without reference to the restrictive covenant contained in the Summit / Rezaie deed.

Bottom line:

1.  Demand to see the Vesting Deed. Check it for restrictions. Particularly in flip transactions where closings are occurring quickly.

2.  If possible, get representations and indemnities in Contracts and Leases, obligating the Seller / Landlord to certify that the property can be used as the Purchaser / Tenant requires.

3.  If you have actual knowledge about a latent defect or material condition, immediately disclose it to your principal in writing.

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

Move Your Residence or Business Near the Airport at Your Own Peril

83 Houston residents near Bush Intercontinental Airport sued the City of Houston. A new runway resulted in increased airplane traffic and the owners determined that living near the airport was untenable. So the owners argued that their properties had been taken by “inverse condemnation,” and they should be compensated for their loss.

The City won the case in trial court. The homeowners appealed.

The Houston Court of Appeals used a 1946 United States Supreme Court case to guide them. In that case, the property owners operated a chicken ranch but were forced to close their business when military planes were flying only 63 feet about the barn. Six to 10 chickens were killed daily by flying into the walls from fright. Egg production suffered. The owners were unable to sleep and became nervous and frightened, and were entitled to compensation.

Our Texas Supreme Court decided a case in 2002 where the plaintiff owned commercial property near the Austin-Bergstrom International Airport, and intended to use it as a landfill, but was unable to do so because of airplane traffic. The plaintiff sued the City of Austin for taking-by-overflight. The trial court awarded a judgment to the plaintiff, but the Texas Supreme Court reversed it because the property could maintain its use as a landfill.

The Texas Supreme Court focused on the concept of “unsuitability” in their 2002 decision. A mere impairment does not necessarily equate to unsuitability. Landfills, subject to zoning and other laws, can be anywhere.

The 83 Houston residents had not claimed that their residences were uninhabitable. Instead, they stated that conversations were impossible, TV reception was bad, sleep was interrupted, children and pets were frightened, nervous and irritable, and it was difficult to entertain friends or speak on the phone.

But the residents did not relocate. This could have been because no one would buy their properties, but that sidebar issue was not addressed in the Houston case.

And so the Houston Court of Appeals had no choice but to follow Texas Supreme Court precedent in the April 2010 case of Alewine v. City of Houston. Since the properties were still capable of use as residences, the plaintiffs must lose. Expect an appeal to the Supreme Court.

Bottom line:

1. If you move your residence or business near an airport, don’t expect to be compensated by the government when the airport expands.

2. If you are asking the government for compensation anyway, tell your lawyer to use the “unsuitable” word in the lawsuit.

3. Let’s just use the KISS principle here: don’t move near an airport.

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

Beware the ROFR

Cecil Hicks gave Tim Castille a right of first refusal (“ROFR”) to buy a four acre parcel of land in Wheeler County, Texas. A small portion of the four acres was leased to American Tower. To trigger Castille’s ROFR, Hicks sent Castille a letter providing that Hicks intended to sell only the small portion of the property that was leased to American Tower for $50,000.

Castille did not exercise his ROFR, but instead brought a lawsuit claiming that Hicks had no right to subdivide the four-acre parcel and sell pieces. Instead, Castille argued, the ROFR applied to all four acres. Predictably, Hicks did not read the RFOR in that manner.

The Wheeler County trial court agreed with Castille and refused to allow Hicks to subdivide his acreage. So Hicks appealed.

The Amarillo Court of Appeals reviewed Texas cases that generally disfavor restraints against a property owner’s ability to mortgage, lease or sell it. As well there was no language in the ROFR prohibiting Hicks from partitioning his property or otherwise permitting Castille to require a sale of all four acres and nothing less.

Simply put, the ROFR did not address the issue.

On April 14, 2010, the Amarillo Court of Appeals reversed the decision of the Wheeler County court, holding that Hicks had the right to sell all or less than all four acres, as Hicks determined was appropriate, provided the third party (American Tower’s) offer was: (a) commercially reasonable; (b) submitted in good faith; and (c) not designed specifically to defeat Castille’s ROFR.

Bottom line:

1. ROFRs, purchase and lease options, right of first offers ("ROFO"s) and similar provisions can be (and usually are!) difficult to properly draft.

2. Texas Courts are reluctant to overly burden property owners.

3. Sometimes commercial brokers are accused of finding a “straw” buyer or tenant to feign an interest in property, so that a ROFR, option or ROFO is triggered and the option holder is forced to buy or lease. If the offer of the “straw” buyer or tenant is not legitimate or does not meet the three-part test described in this case, then the ROFR, option or ROFO may not be properly triggered.

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

Real Estate Fraud

William Myre engaged an engineer to prepare a plat for Hunt County property he owned. Although there were no drainage plans as required by county regulators, Hunt County approved it anyway and the property became Cole Estates. Thereafter, Craig Development, Inc. purchased Cole Estates from Myre.

Carl Meletio and others bought some Cole Estates lots from Craig Development, Inc. (“CDI”) between 2000 and 2002. Cole Estates became a residential subdivision.

Some of the properties in Cole Estates flooded during significant rainstorms between 2002 and 2006. Meletio sued CDI and Myre. The jury determined that Myre had committed fraud by failing to disclose to Meletio and others that Cole Estates might be inundated by floodwaters. Judgment was rendered for Meletio, and Myre appealed.

In the appeal Myre claimed that he could not have committed fraud, since he did not owe a duty of disclosure to the individuals to whom he did not sell property. Myre reminded the appellate court that he sold the property to CDI, not Meletio. Myre served only as the developer, and claimed that Myre’s duties were owed only to CDI. Therefore, if the property owners were damaged their recourse should be directed against CDI, not Myre.

The 5th District Court of Appeals ratified Texas law that “. . . a seller is under a duty to disclose materials facts that would not be discoverable by the exercise of ordinary care and due diligence by the purchaser, or that a reasonable investigation and inquiry would not uncover.” The Court cited a case providing that a party cannot be guilty of fraudulently concealing facts of which he is not aware.

Finding that Myre had no relationship with any of the plaintiffs and therefore Myre had no duty of disclosure to them, the Court concluded that Myre could not be liable for fraud. The fraud portion of the judgment was reversed. See Myre v. Meletio, 05-08-00576, Fifth District Court of Appeals, Dallas Division; judgment rendered February 26, 2010.

Bottom line:
 
1. Real estate disclosure duties are typically owed to property purchasers and tenants by their immediate sellers and landlords.
 
2. Disclosure duties are also owed by brokers and agents to their principals and to their opposing parties as well.
 
3. It is surprising that real estate brokers and agents were not sued. If CDI’s broker and agent were sued in this case, both the trial court and appellate court could have asserted liability against them if they had knowledge of the flooding issue, and failed to disclose.

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.

Commercial Foreclosures and Correction Deeds

It is rare that The Supremes review a real estate case. But in December 2009 the Texas Supreme Court decided Myrad Properties vs. LaSalle Bank. The case was about a timely subject – Texas foreclosure.

Myrad financed two apartment communities in Killeen with LaSalle Bank NA’s predecessor. Myrad signed a $1 million note and a deed of trust. The deed of trust was recorded in Bell County. The deed of trust contained separate property descriptions for both the Casa Grande Apartments and La Casa Apartments.

Myrad defaulted. LaSalle Bank posted a notice of foreclosure upon only the Casa Grande property. At the foreclosure auction in Bell County, the substitute trustee read only the property description for Casa Grande. LaSalle was the only bidder, offering almost $1 million.

LaSalle received and recorded a substitute trustee’s deed for the Casa Grande property.

Two days later Myrad sued LaSalle, to keep it from filing a correction deed covering the La Casa property. When LaSalle filed it anyway, Myrad asserted that LaSalle owned only the Casa Grande property, while Myrad retained ownership of La Casa free of LaSalle’s deed of trust lien.

Both the trial court and court of appeals held that LaSalle’s correction deed was effective to transfer ownership of both Casa Grande and La Casa to LaSalle.

The Texas Supreme Court reviewed the history of correction deeds and determined that such deeds can be used to correct minor defects and imperfections. However, correction deeds cannot be used to convey additional, separate properties. The correction deed filed by LaSalle was void.

Bottom line:
1. Foreclosures are risky business.
2. Purchasers at foreclosure auctions sometimes make mistakes. So do lenders. Trustees too.
3. Be wary of correction deeds.


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

Forming New Entities as Commercial Tenant or Buyer

Typically forming a new entity to serve as a commercial tenant or buyer is a good idea. But not always.

In 1986 Dick’s Last Resort, as tenant, signed a Lease for Dallas property located in the West End District. In 1999 the Landlord allowed Dick’s Last Resort to use a newly formed, related entity (Dick’s West End) to replace the old one and serve as the new tenant.

Presumably the Landlord did not recognize the Tenant’s intentions.

In 2005 the restaurant relocated without the Landlord’s consent and rent payments ceased. The Landlord sued Dick’s West End for breach of the lease, but also alleged that Dick’s Last Resort was liable under a little-used legal theory called “piercing the corporate veil.” That theory imposes liability by ignoring the corporate structure, when the corporate form has been used as part of an unfair device to achieve an inequitable result. Typical allegations include fraud and evasion of existing legal obligations.

The 44^th Judicial District Court of Dallas, in a jury trial, awarded Judgment to the Landlord against all defendants. Dick’s Last Resort, Dick’s West End and various other defendants appealed.

Testimony from a Dick’s principal indicated that Dick’s West End was purposefully formed as a no-asset company, so that it could close the restaurant and leave the Landlord with the remedy of pursuing an insolvent tenant. The jury, after receiving evidence that Dick’s: (i) moved the restaurant only three blocks away, (ii) was paying rent at half the cost of the initial Lease, and (iii) was in continual operation with the same employees, equipment and operating company from the date of the relocation through the date of trial, concluded that Dick’s Last Resort had perpetrated a fraud. The jury would not let Dick’s Last Resort escape liability by forming a shell entity and transferring to it the tenant’s interest in the Lease.

The Judgment of the trial court was upheld in a recent appellate decision.

Bottom line:
1.  Be careful when you form a new entity for a singular purpose.
2.  Be careful when you give deposition testimony, written statements or Court testimony.
3.  Juries and Judges do not favor escaping liability by playing the entity shell game.

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