August 12, 2010

Real Estate Newsletter (Summer 2010)

Arnold & Porter Advisory

By Kenneth A. Neale

There have been a number of interesting court decisions and other developments in real estate law over the past few months which may be of interest to the real estate owner or professional. Some of the more significant developments are described below.

Earnest Money Deposits: When are they truly non-refundable? The recent case of Kuish v. Smith involved a dispute over a $620,000 earnest money deposit made pursuant to a residential purchase agreement for a $14 million ocean-front home located in Laguna Beach, California. Without cause, the buyer elected to terminate the contract. The seller then immediately sold the property for $15 million. The original buyer sought to recover its earnest money deposit, but the seller refused claiming it was entitled to retain the deposit as nonrefundable consideration for the extension of the closing date under the purchase agreement. In the absence of a valid liquidated damages provision, the court held that the seller could not show damages and thus had to return the deposit to the buyer. This case illustrates the importance of complying strictly with California Civil Code Section 1677 regarding liquidated damages if the parties intend that the deposit should be retained by the seller in the event of a default by the buyer. Without a valid liquidated damages provision, the seller had to prove that the property was worth less than $14 million to obtain damages, which the seller, of course, could not do.

Brokerage Agreements: Are commissions still payable if the buyer backs out? In RC Royal Development and Realty Corporation v. Standard Pacific Corporation, the California Court of Appeal held that the broker earned its commission at the time the buyer entered into the purchase agreement and that the close of escrow was not a condition precedent to the right of a commission. In a surprising result, the court concluded that the mere signing of a purchase agreement — even though close of escrow may be subject to conditions and may never occur — could nonetheless result in the buyer or seller having to pay a broker a large commission. This case highlights the importance of conducting a careful legal review of all brokerage agreements before signing. Although this case turned on broad language contained in the brokerage agreement defining the word "purchase," in our experience, many brokerage contracts contain similar broad language.

Professional Liability: Can a professional be required to defend even if not required to indemnify? UDC-Universal Development v. CH2M Hill serves as a reminder that the duty to indemnify is different from the duty to defend and that there can be a duty to defend even where there is no duty to indemnify. This case reinforced the California Supreme Court's ruling in Crawford v. Weather Shield Mfg., (2008) 44 Cal4th 541, holding that an environmental consultant was required to defend its client with regard to certain claims even though there was no showing or allegation that the consultant was negligent because the duty to defend was broader than the duty to indemnify. This should be a major concern for professional service providers because professional liability insurance may not cover defense costs (which can be quite substantial) without a finding of negligence. Thus, even if the provider is ultimately found to not have been negligent, it may still have to pay hundreds of thousands of dollars in defense costs which may not be recoverable through insurance. In order to address this issue, many professional service providers expressly exclude the duty to defend from any indemnity for professional negligence. Instead, they may include the obligation to reimburse attorneys' fees if ultimately found to be negligent. One other point to be wary of — even if the word "defend" is not included in an indemnity clause, §2278(4) of the California Civil Code would require the indemnifying party to provide a defense.

Title Insurance: The disappearance of creditor's rights protection. In obtaining title insurance, it is typical for an owner of lender to ask for a creditors rights endorsement. The purpose of such coverage is to protect the insured against loss from a judicial finding that the transfer of the property was a fraudulent conveyance or preferential transfer which could result in the transaction being unwound. Typically, this coverage is provided by the ALTA 21 (Creditor's Rights) endorsement. Recently, several national title companies (including First American Title Insurance Company, Fidelity National Title and Chicago Title Insurance Company) have decided that they will no longer issue this endorsement. This is a risk when purchasing property from a distressed seller where the purchase price may be less than its fair value. In order to protect itself from a fraudulent transfer or similar claim, a buyer or lender should consider investigating the financial condition of the property owner and obtaining a current appraisal of the property.

AB 1103: Disclosure of energy data will soon be required for commercial buildings. Proposed rules under Assembly Bill 1103 passed in 2007 would require, effective January 1, 2011, that a commercial building owner disclose Energy Star Portfolio Manager benchmarking data and ratings for the most recent 12 month period to prospective tenants, buyers and lenders. The benchmarking data include an energy performance rating and other information about energy use at the building. The purpose behind the rules is to allow buyers, renters and lenders of commercial real estate to value the energy efficiency of a building. Thus, for example, a prospective buyer of a commercial building might pay more for a building with a higher energy performance rating.

If you have questions about any of the issues raised in this article, contact Kenneth A. Neale at 415.677.6322 or your usual Howard Rice attorney.

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