Posted by Carrie B. Reyes | Feb 16, 2023 | Buyers and Sellers, Feature Articles, Laws and Regulations, Real Estate, Your Practice | 0

Reprinted from firsttuesday Journal  — P.O. Box 5707, Riverside, CA 92517

This article explains how a home inspection report (HIR) is used by a seller’s broker to shift the risks of non-disclosure liability in their mandatory use of a seller’s Transfer Disclosure Statement (TDS).

Transparency by design — don’t wait for the buyer to inquire

California’s recessionary housing market, which began in mid-2022, brings brokers and their agents face to face with a dramatic reversal away from the crass seller attitudes about dealing with buyers which developed in recent years of recovery and boom times.

Sellers prefer asymmetric property disclosures, which for agents as licensees is a deleterious path taken at their peril.

Consider that the position of an agent in any transaction — be it a sale, lease or a mortgage — is that of a facilitator. Agents have a duty to deliver discoverable information adversely affecting the value and use of a property to all participants, to document the negotiations, and to ultimately close the transaction as intended.

Today, a seller’s agent needs to inform their seller about the challenges of selling property in a recessionary housing market. A marketing plan of full disclosure — transparency by design — is needed to maintain the seller’s competitiveness in a market thin on prospective buyers and long on inventory.

Transactions in a recession differ from the boom phase of the market when prospective buyers prepare offers and willingly enter into purchase agreements without receiving sufficient (if any) information about material facts mandated for disclosure by a seller and their agent. Thus, sellers and their agents had a wholesale tendency to delay disclosing adverse property information — the Transfer Disclosure Statement (TDS) — until after entering into a purchase agreement. [See RPI Form 150]

Today’s recessionary housing market is demonstrably different. Sellers and their agents need to gather and package critical property information and deliver it as soon as practicable (ASAP) at the time a prospective buyer or their agent first asks for more property information.

A seller during a recession needs to listen and correct any preconceived boom-time notions they espouse about pricing and buyer behavior based on their real estate agent’s listing presentation.

Related article:

A property’s energy consumption: known and demanded in a recession: Part 1

 Transfer disclosure statement (TDS)

Before a sales agent agrees to take a seller’s listing, the agent first needs the seller to agree to prepare the mandated TDS. The agent provides the seller with a blank TDS form which the seller fills out based on their prior knowledge or suspicions of property defects. Disclosures are not limited to property conditions preprinted for comment on the statutory form mandated for use by the seller. [Calif. Civil Code §1102.8; see RPI Form 304]

The seller notes in the TDS any physical, environmental or neighborhood features which:

• adversely affect the property’s value; or
• interfere with a prospective buyer’s anticipated use of the property.

After the seller has prepared the TDS, the agent and seller meet to review its contents. Meanwhile, the agent schedules their mandatory visual inspection —and home inspection report (HIR) discussed below — of the seller’s property, noting on the TDS any defects observed by the agent which the seller did not note. [CC §2079]

Any seller objections to the mandatory inspection or defects the agent observes — or noted in the HIR — do not control the agent’s conduct regarding property disclosures. The seller’s agent owes a general duty to prospective buyers to conduct the inspection, observe defects affecting the property’s value and marketability and report them on the TDS prospective buyers are to receive.

However, while the agent owes a general duty to disclose adverse property conditions to buyers, they have no duty to further investigate property conditions or make comment on the consequences of the information disclosed.

Once the agent lists their findings in the TDS, both the seller and their agent sign the TDS. Thus, they both take responsibility for its content and delivery to prospective buyers as soon as practicable when a prospective buyer asks for additional information concerning the property.  Without the TDS, prospective buyers are unable to determine the property’s condition, value, and the price they are willing to pay for it. [Jue v. Smiser (1994) 23 CA4th 312]

First the disclosures, then the agreement to sell

Consider a purchase agreement entered into by a seller prior to the buyer receiving property disclosures. Before closing, the buyer becomes aware of property defects and demands corrections before funding for the reason they were unaware of the defects when they set the price they agreed to pay.

Here, the seller’s broker and their agent expose themselves to liability for non-delivery of the TDS prior to the time the buyer and seller entered into a purchase agreement. Presenting the TDS to buyers before contracting to buy is the first step the seller’s agent and their broker take to shield themselves from liability for non-disclosure of defects.

For a seller’s broker and their agent to best market a property to mitigate risks concerning non-disclosure of material facts to a buyer, a full disclosure package is prepared and presented to prospective buyers ASAP which contains these items:

• TDS or Condition of Property Disclosure Statement; [See RPI Form 304]
• home inspection report (HIR) attached to the TDS;
• Natural Hazards Disclosure (NHD) Statement; [See RPI Form 314]
• an occupancy certificate, when required by local ordinance;
• Home Energy Rating System (HERs) report on energy efficiency;
• Property Operating Expense Profile; [See RPI Form 306
• Residential Earthquake Hazards Report; [See RPI Form 315]
• structural pest control report (SPC);
• Seller’s Neighborhood Security Disclosure; [See RPI Form 321]
• Homeowners’ Association (HOA) addendum;
• Lead-Based Paint Disclosure; [See RPI Form 313]
• Disclosure of Sexual Predator Database; [See RPI Form 319]
• Local Ordinance Report; [See RPI Form 307]
• well water report, when applicable;
• septic tank report, when applicable; and
• Comparative Market Analysis (CMA) for setting values. [See RPI Form 200-1]

 The exacting Home Inspection Report

During the initial counseling session with the seller before accepting their listing of the property for sale, the agent needs to ask the seller to provide written authority to order a Home Inspection Report (HIR).

The HIR, together with the TDS, informs prospective buyers about the precise physical condition of the property so decisions can be made to prepare and submit an offer. An HIR notes any defects adversely affecting the:

• property’s desirability;
• property’s value; and
• buyer’s intended use.

A home inspector is a professional employed by a home inspection company to inspect and advise on the physical condition of property improvements in a home inspection report they prepare. The seller, the seller’s agent and the buyer may rely on an HIR as a warranty of the condition of improvements, except for defects known to the seller or their agents and not included in the HIR or TDS.

The home inspector who holds a professional license with the state as a general contractor, architect, pest control operator or engineer is deemed to be qualified, unless the agent knows of information to the contrary.

When hiring a home inspector, agents can look for qualifications such as the inspector’s:

• educational training in home inspection courses;
• length of time in the home inspection business or related property or building inspection employment;
• errors and omissions (E&O) insurance covering professional liability;
• professional and client references; and
• membership in the California Real Estate Inspection Association, the American Society of Home Inspectors or other nationally recognized professional home inspector associations with standards of practice and codes of ethics.

These material defects affect the property’s:

• market value;
• desirability as a dwelling;
• habitability from the elements; and
• safe usage as a dwelling.

Based on their observations, the home inspector may also recommend the need for further evaluations by other experts regarding defects they discover or perceive to exist.

To cure or not to cure defects  

On receipt of the HIR, the seller needs to decide whether they will cure some — or all — of the listed defects. The seller is not obligated to cure any of them unless they agree to make repairs. However, they are obligated to disclose the presence of known defects within the property to prospective buyers.

When the seller cures any of the defects noted in an HIR, an updated HIR is ordered. Either way, the seller signs the HIR and returns it to the agent. [See RPI Form 130]

During a recessionary market, buyers are more likely to demand the seller cures defects or accept a price reduction to cover the costs and efforts of the buyer to cure them after closing.

A TDS prepared to include defects noted in the HIR is the ultimate liability shield for agents and their brokers. An HIR used by the seller’s agent to prepare a TDS acts to mitigate their risk of liability for buyer claims in a transaction should the buyer discover defects not listed in the HIR or the TDS — before or after closing.

To be effective as a shield, the TDS and HIR disclosures need to have been handed to the buyer before the seller entered into a purchase agreement with the buyer.

However, the preparation and use of the HIR does not relieve the sales agent from conducting their mandatory visual inspection of the property. [CC §1102.4(a)]

Delivered to buyers, not to lookie loos

Once all third-party investigative reports for a property have been received, reviewed, and included within the marketing package, the seller’s agent is then prepared to locate prospective buyers and manage property disclosures the agent has a duty to deliver.

The seller’s agent need not provide the marketing package to every prospective buyer viewing the property. However, the seller’s agent does provide copies of the TDS and attached HIR to buyers and buyer’s agents when they request additional information on the property — but not to lookie loos who casually view the property with no indication they might submit an offer.

These inquiries for more information from the buyer or the buyer’s agent are evidence negotiations have started. It is negotiations which trigger the agent’s delivery of the TDS and HIR as part of the marketing package.

After receiving the TDS and HIR, the buyer’s agent reviews their contents. Unlike the seller’s agent, the buyer’s agent has no duty to inspect or confirm whether the contents of the TDS or HIR are complete.

On the outside chance the buyer’s agent observes an unlisted defect relating to the property’s components or the buyer’s intended use, they are to disclose this information to all participants.

An HIR as a relied-upon warranty

The HIR is not a confidential document, no matter who orders the report or pays for it. The HIR contains facts about a property’s conditions, and the preparer cannot limit who may rely on its contents. All buyers are entitled to information in an HIR and may rely on it to further their understanding of the property’s value and determine the price they might be willing to pay for it. [Leko v. Cornerstone Building Inspection Service (2001) 86 CA4th 1109]

Further, any provision in the home inspection contract attempting to waive or limit the inspector’s liability for a negligent investigation or preparation of the HIR is unenforceable. [Bus & Prof C §7198]

When the buyer discovers an error in the HIR after acquiring the property, they have four years from the date of the inspection to pursue any money losses they incur due to the undisclosed defects affecting the property’s value or desirability. [Bus & Prof C §7199]

Any defenses the home inspector asserts to limit the time period to less than four years for the buyer to make a claim are unenforceable. The four-year period is necessary to give buyers enough time to realize the home inspector produced a faulty HIR. [Moreno v. Sanchez (2003) 106 CA4th 1415]

By delivering the TDS and HIR to the buyer or the buyer’s agent upfront — before an offer or counter offer is accepted — the seller and their agent ensure the buyer has all the information needed on the property’s condition to set a price in their offer for their purchase of the property.

Related topics:
home inspection report (hir), material fact, recession, transfer disclosure statement (tds)

Posted by Amy Platero | Aug 18, 2023 | Economics, Laws and Regulations, Real Estate | 0

Reprinted from firsttuesday Journal  — P.O. Box 5707, Riverside, CA 92517

The California legislature introduced Senate Bill (SB) 35 in 2017 as part of a wave of housing bills meant to address the state’s low- and moderate-income housing shortage.

SB 35 allows eligible housing developments to go through a streamlined approval process — including bypassing a review under the California Environmental Quality Act (CEQA) — so long as projects meet local objective zoning and design standards, provide a minimum percentage of low-income units, and follow labor and wage requirements.

Since its implementation in 2018, SB 35 has:

• streamlined 18,000 new housing units across the state;
• made the approval process for new multifamily infill development faster and more certain;
• become a default approach for many low-income housing developers;
• mostly been used for 100% low-income housing developments; and
• been used to overcome local resistance to new housing, according to The Terner Center.

The number of completed SB 35 housing projects according to the California Department of Housing and Community Development (HCD) has been:

• 375 in 2018;
• 419 in 2019;
• 108 in 2020;
• 21 in 2021; and
• 39 in 2022.

Most SB 35 projects were built in the Bay Area and Los Angeles County, according to The Terner Center. However, use of SB 35 increased in other parts of the state after the first couple years of its implementation.

In 2022, the share of SB 35 projects completed by income level in California include:

• 33% that were very low income;
• 48% that were low income;
• 7% that were moderate income; and
• 12% that were above moderate income, according to the HCD.

Related article:

Attorney General files lawsuit against Elk Grove for violating state housing laws

Build up, not out

Suburban sprawl has proven to be a poor long-term housing and retail strategy, despite the appeal of a mythic stand-alone home on the prairie.

The suburban sprawl trend leads to higher construction costs and less desirable outcomes for homeowners, as they are forced into neighborhoods with fewer amenities and longer commutes.

Prompt action on the re-zoning of city center parcels will take advantage of vertical environment — build up, not out — to level out the next home price boom, expected around 2026, from turning into another market-killing pricing bubble.

Rising prices of existing single family residence (SFR) housing will be subdued when new units can be built at prices comparable to home resale prices. Critically, zoning is the pricing key to builder access and market stability.

Successful zoning laws keep demand for government services at a consistent level when builders are allowed to demolish obsolete and insufficient structures and construct high-density housing on existing blocks and parcels within city centers. Thus, the need to extend roads and utilities (which the cities will then be required to maintain) is avoided.

Encouraging builders to build in urban centers makes cities more favorably centralized. At the same time, center city improvements deliver the convenient apartments and condos the growing cultural flow of urban dwellers most desire. Given the choice, most prefer to live near to where they work.

Legislation like SB 35 makes the permitting and building process for low-income housing options and infill development within urban areas more accessible. It sidesteps the vocal not in my backyard (NIMBY) supporters of restrictive zoning who champion suburban sprawl and place pressure on local city councils to deliver more of the same.

Still, more needs to be done to reduce the costs and time required to develop new housing in California, which will allow housing to reflect the population and its needs.

SB 35 is scheduled to sunset in 2026 unless SB 423, which was introduced in early 2023, is passed. SB 423 seeks to extend and modify the streamlined approval process created under SB 35.

Stay updated on the latest California legislation affecting housing at our Legislative Gossip page and subscribe to the Quilix newsletter for the latest real estate news and market trends.

Related article:

New construction doesn’t always mean more homes to go around

Related topics:
california legislation, construction, housing shortage, low-income housing, zoning

Posted by Amy Platero | May 18, 2023 | first tuesday Local, Laws and Regulations, Real Estate, Sacramento | 0

Reprinted from firsttuesday Journal  — P.O. Box 5707, Riverside, CA 92517

The project and the lawsuit

The City of Elk Grove, located in Sacramento County, has denied the development of a 66-unit housing project called Oak Rose Apartments, aimed at providing permanent housing at rents affordable by homeless individuals. The project met low-income parameters and was subject to a streamlined, ministerial approval process under Senate Bill (SB) 35.

The city’s denial of the housing project resulted in a lawsuit filed against the city by the California Attorney General Rob Bonta and the California Department of Housing and Community Development (HCD).

The lawsuit, filed May 1, 2023, alleges the city’s denial of the project violates state laws, including:

• SB 35 as enacted into law;
• the Housing Accountability Act (HAA);
• the Nondiscrimination in Land Use Law; and
• the Affirmatively Furthering Fair Housing statute (AFFH).

The city denied the project claiming it did not meet zoning standards making it ineligible for SB 35 ministerial review and thus the issuance of a building permit. The Attorney General’s lawsuit sought injunctive relief requiring Elk Grove to approve the project and remain compliant with state law.

While on one hand the city denied the low-income housing project, they then approved a similarly situated, market-rate housing development located within the same neighborhood. This project did not have commercial uses on the ground floor, the main claim for denial of Oak Rose Apartments, but was approved without a low-income housing component.

The state agencies’ actions are a continued effort at supporting general population access to housing in California.

NIMBYism on display

California has the largest homeless population of any state, with 161,548 people experiencing homelessness as of January 2020, according to the U.S. Department of Housing and Urban Development (HUD).

California’s acute housing shortage stems solely because of the refusal of local governments to approve low-income housing to meet the needs of, well, lower skilled employed Californians, especially families of low and moderate income.

One key factor exacerbating the housing shortage is the local desire to enforce local ordinances which are archaic, if not racist single-family zoning in conflict with preempting state housing codes. Another is local vocal opposition to enlarging the availability of housing, evidenced primarily by the not-in-my-backyard (NIMBY) sentiment politically controlling local city councils.

These local factors make it particularly difficult for any developer or builder, and investors to develop new housing supportive of workers employed locally providing necessary low-income services.

Administratively, the objective is to set a standard for implementation which allows people to live where they work, the casita arrangement of accessory dwelling units (ADUs) being an example.

The Elk Grove planning commission and city council demonstrated NIMBY sentiments when they faulted the project in this neighborhood for not being in the “proper location.” They attempted to relocate the project to a possible alternative site, though the site suggested provided fewer resources for the future residents as remote from community services.

To combat this sort of forced housing shortage, California’s Department of Justice (DOJ) established a Housing Strike Force in 2021 aimed at advancing:

• access to housing;
• availability of priced right housing;
• environmentally sustainable housing; and
• equity in California’s housing market.

Related article:

California’s new housing strike force prepares for battle — with NIMBYs

State agencies are needed with their resources to battle it out against local political jurisdictions brazenly acting to skirt state housing laws and stifle low-income housing starts. The goal here is to take politics out of the permitting process for new housing which is administrative in nature, so real estate activity has commercial certainty of attaining objectives.

California since WWII has been increasingly committed to housing all levels of society unaffected by balkanized locals seeking to bar any equilibrium in the nature of the local population. We are a state in constant movement, with a few parochial enclaves remaining.

Subscribe to the weekly Quilix for more developments on California’s housing shortage sent straight to your inbox.

Related topics:
attorney general (ag), low-income housing, not in my backyard (nimby)

Posted by Carrie B. Reyes | Jul 7, 2023 | Fair Housing, Laws and Regulations, Property Management, Real Estate | 0

Reprinted from firsttuesday Journal  — P.O. Box 5707, Riverside, CA 92517

California has some of the most equality intense housing laws in the nation, partially brought about by the state’s high housing costs which has forced the majority of tenants into housing-burdened financial status. Meanwhile, landlords evict tenants or simply raise rents with conduct that is out of step with the state’s landlord-tenant laws.

From both the tenant’s and the landlord’s perspective, it is all about vying for money when housing is in very short supply. Construction starts is another method for leveling the pricing of rentals in contrast to rent control, a legislated zoning condition builders are settling into.

For four years and counting, 2019’s Tenant Protection Act (TPA) has provided the most comprehensive set of tenant-centered laws. However, the TPA got a late start with implementation and thus understanding, as pandemic-era tenant protections superseded the Act through much of 2022.

Now that the TPA is fully in effect, California’s Office of the Attorney General (OAG) as the enforcement agency is meeting resistance from landlords reluctant to follow — or simply unaware of — the rules.

Broadly, the TPA:

• caps annual rent increases at 5% plus the rate of inflation for much of California’s multi-unit residential properties; and
• requires “just cause” to evict tenants in place for 12 months or more.

The applicability of the TPA covers most multi-unit housing in California and those single family residential (SFR) units owned by a REIT, a corporation or an LLC with a corporate member. To complicate landlord compliance, numerous exemptions for multi-family units and conditions for SFRs exclude some properties.

Read more about who is exempt from the TPA.

TPA violations

Requiring a just cause for eviction creates another roadblock for landlords seeking to re-rent their properties to new tenants at a higher rate by evicting current tenants. Further, when a tenant is being evicted at no fault of their own, the landlord may be required to provide modest financial relocation assistance.

Still, while some landlords continue to work the loopholes in the TPA, others attempt to make their own loopholes.

Related article:

Lease renewals rise as housing options dwindle for California tenants

 

As one of the original authors of the TPA, the Attorney General has a special stake in making sure landlords are paying attention.

For example, the OAG recently made explicit that landlords renting to Section 8 recipients are not exempt from the TPA.

When landlords are guilty of violating the TPA, landlords may face consequences such as a:

• court trial;
• penalty fine; and
• jail term of one year or less.

For example, the OAG recently reached a settlement with a housing developer — Green Valley Corporation — for violating the TPA.

Green Valley Corporation unlawfully issued rent increases and eviction notices to its employee-tenants. Green Valley Corporation acted on the erroneous belief that the TPA did not apply to the tenants in their employ.

As part of the settlement, it will be required to pay $391,130, including:

• refunding 15 months of overpaid rent, totaling $331,130; and
• paying $60,000 in penalties to the state.

It will also return the units to the rental rates in place before the unlawful increases. Further, its staff is required to complete annual training on fair housing laws. The landlord will provide annual reports to the OAG regarding any rent increases, eviction notices and the annual training completed.

Related article:

California continues to crack down on landlords pursuing unjust evictions

Stay up to date with new housing laws and informed about laws being considered by the state legislature – follow the latest at firsttuesday’s Legislative Gossip page.

Related topics:
attorney general (ag), landlords and tenants, tenant protections

Posted by ft Editorial Staff | May 3, 2023 | Charts, Economics, Forecasts, Laws and Regulations, Market Watch, Recessions | 4

Reprinted from firsttuesday Journal  — P.O. Box 5707, Riverside, CA 92517

Bankruptcy filings began to inch higher during 2022, with 91,900 personal bankruptcies and 3,500 business bankruptcies filed nationwide in Q4 2022. Further, bankruptcies continue to increase in the first half of 2022, currently up 17% from a year earlier when filings were near a decades’ low.

With a below average filing share, California represents approximately 9% of the national filings versus 13% of the population.

Bankruptcies plummeted during the 2020-2021 pandemic period, despite the onset of the 2020 recession. Without pandemic interference, bankruptcies would have risen significantly, as in any recession. Businesses which otherwise would have folded found fuel in economic stimulus and rising inflation generated by the pandemic. Just 6,100 business bankruptcies were filed in California during 2021, a fraction of the 63,200 filings that were recorded during the 2011 peak of the 2008 recession. In 2022, this number increased to 6,800 business bankruptcies.

When it comes to recessions, bankruptcy numbers tend to be a lagging indicator. That is, many businesses hold on until they run out of cash, bleeding off market share as disruptors to a recovery while they exist as zombie businesses. Eventually they give in to market forces and throw in the towel. Compared to businesses, bankruptcy offers few benefits for individuals, though bankruptcy proceedings extend the foreclosure process by several months.

In 2023, the economy is rapidly contracting as the curtain opens on the second act of the 2020 recession. In 2020-2021, government stimulus bridged the pandemic gap for most individuals and businesses lacking the financial foundation to weather a recession — hence the artificially low bankruptcy numbers resulting in a buildup of bankruptcy candidates. But with the effects of stimulus now in the rearview, the recession — expected to officially arrive in the second half of 2023 — will deliver the killing blow for those lacking sufficient cash reserves or equity. The result will be a cyclically disproportionate rise in bankruptcy filings in the next three years.

For the housing market, the reduction in home sales volume which began dramatically in 2022 paced by rapidly doubling interest rates will see home values fall to wipe out the past four+ years of home price increases. Homeowners who see their home values diminish are more likely to go bankrupt when household financial stress occurs. As the struggle for ascertaining home values takes root and buyers simply wait for prices to bottom and hold, expect more personal and business bankruptcies to occur, expected to peak around 2026.

Updated May 3, 2023. Original copy released January 2010.

Chart update 05/03/23

Chart update 05/03/23

	Q4 2022	Q4 2021	Q4 2020
Personal Bankruptcies	91,900	88,300	107,400
Business Bankruptcies	3,500	3,200	5,000

Dashed lines are firsttuesday’s forecast. The number of bankruptcy filings has decreased each year since the end of the Great Recession. By the end of 2014, personal bankruptcy levels had fallen below the average levels seen during the 1990s and early 2000s, where they remain today. California districts with the highest number of bankruptcy filings in 2021 were:

• Central California, with 20,300 personal bankruptcies and 2,800 business filings;
• Los Angeles, with 8,500 personal bankruptcies and 3,300 business filings; and
• Riverside, with 6,000 personal bankruptcies and 700 business filings.

The majority of these personal bankruptcy filings were completed through Chapter 7.

Chart update 05/03/23

Two forms of bankruptcy

Two separate bankruptcy procedures exist, both governed by federal law.

Chapter 7 bankruptcy requires the insolvent homeowner in bankruptcy to repay their debt from whatever assets they possess, unless those assets are lower than state-allowed levels of assets and income. In Chapter 7 bankruptcy, a home without equity is counted among these assets, and foreclosed upon.

Chapter 13 bankruptcy, on the other hand, requires the homeowner to repay their delinquent debts over a longer period of time than contracted for, after deducting reasonable living expenses.

The Chapter 13 repayment plan can include the homesteaded sale of the owner’s home, if the home has any equity in the home. Bankruptcy law no longer permits a homeowner’s mortgage to be reduced by a bankruptcy court (a cramdown, or principal reduction). However, Chapter 7 bankruptcy voids any deficiency obligations on recourse mortgage refinancing, just as it voids all unsecured debt with a value exceeding the amount of the homeowner’s nonexempt assets.

In addition to putting an immediate stop to lender collection efforts, the process of filing bankruptcy allows a homeowner to pay delinquent mortgage payments over a three-to-five year period. Troubled homeowners often choose to file Chapter 13 Bankruptcy to discharge their non-mortgage (unsecured) personal debts, and then use the newly freed funds to make future payments on their mortgages.

Homestead exemption protections

Bankruptcy laws do enforce California homesteads. For positive equity homeowners, this exemption acts as an incentive to file bankruptcy to avoid unsecured debts and free up cash by making it available under the homestead.

On the other hand, the homestead exemption has no effect on the priority or payment of an owner’s mortgage. The bankruptcy process adversely affects lenders who have obtained involuntary liens (judgment liens) against the homeowner’s title.

In 2021, California homeowners qualify for a net equity homestead protection of:

• up to $300,000; or
• the median sale price for a single family residence (SFR) in the homeowner’s county in the calendar year prior to the year in which they claim the exemption, not to exceed $600,000 (adjusted annually for inflation). [CCP §704.730]

Related article:

California’s homestead exemption falls short of full protection for homeowners

Bankruptcy and foreclosure

The most important aspect of bankruptcy, from the point of view of mortgage lenders, is the “automatic stay” provision. This provision of bankruptcy law also delivers the most direct and immediate results for troubled homeowners. Any owner who files bankruptcy immediately places an automatic stay on all collection efforts, including foreclosure sales.

Lenders prefer to quickly move to a foreclosure sale, take title to the property or what proceeds they can and cut their losses, and are thus hamstrung by the automatic stay provision. They are forced to wait until a bankruptcy court allows them to proceed. The stay provision increases the lender’s costs of dealing with a homeowner who does not maintain their mortgage payments while in bankruptcy.

On average, filing Chapter 7 bankruptcy extends the foreclosure process from six months to a year. Chapter 13 delays the foreclosure sale even longer, often drawing it out to a year and a half. A homeowner who files bankruptcy without the ability to make payments on their mortgage merely extends the time before the eventual foreclosure sale. For the lender, the bankruptcy process increases the risk the home will be damaged or otherwise devalued before the sale takes place, increasing the lender’s eventual loss.

Lenders thus have a vested interest in government regulations that make it difficult for homeowners to obtain relief on their mortgages in bankruptcy, and they intend to keep their hard fought gain of a cramdown-free bankruptcy law intact. Lenders don’t want the threat of a bankruptcy judge endowed with the power to reset the loan balance at exactly the amount the security for the loan is worth (which, of course, is all the lender can expect to get from foreclosure anyway).

When bankruptcy is unavoidable, lenders want to get out of bankruptcy court as quickly as possible. Often they can be persuaded to agree to a short sale in order to hasten the process and cut their losses. Bankruptcy can thus be an effective way for homeowners to force the lender’s hand.

Costs and benefits of bankruptcy

So does filing bankruptcy, and thereby discharging unsecured debt and putting off a potential foreclosure sale, actually help homeowners pay their mortgages, or do the other costs of bankruptcy cancel out the benefits?

Evidence is mixed, but homeowners and their attorneys certainly seem to believe that bankruptcy can be beneficial. Troubled homeowners already make up the majority of those who file for Chapter 13 bankruptcy (studies in other states found that over 80% of filers were paying for homes with a loan to value ratio (LTV) over 90%).

Of the total number of homeowners who file bankruptcy, only about 33% successfully kept their homes, according to the Federal Reserve Bank of Philadelphia. It is certain that bankruptcy does, at least on occasion, have a positive effect for those desperate homeowners who turn to it as a last resort, and it is also sure that bankruptcy will almost always have a negative effect for lenders.

Equally important, homeowners who file for bankruptcy will find later that their past bankruptcy interferes with their future ability to qualify for mortgage financing.

Related topics:
bankruptcy, chapter 13 bankruptcy, chapter 7 bankruptcy, foreclosure, income, lien, mortgage, tenant

Posted by Carrie B. Reyes | Mar 23, 2023 | Laws and Regulations, Los Angeles-Santa Barbara-Ventura, Real Estate | 0

Reprinted from firsttuesday Journal  — P.O. Box 5707, Riverside, CA 92517

The fight over California’s housing density laws is just getting started. The newest saga features Huntington Beach, the coastal community known for its surfing competitions, conservative politics and now, their “no casitas allowed — ever” stance.

The City Council recently instructed the city to stop processing permit applications for accessory dwelling units (ADUs) and projects submitted under The HOME Act of 2021 – SB 9. At the same time, it directed the City Attorney to take legal action to challenge any and all “laws that permit ADUs.”

This came on the same day California’s Office of the Attorney General (OAG) and Department of Housing and Community Development (HCD) issued letters to the Council urging them to repeal their unlawful ADU moratorium ordinance.

The HOME Act aims to ease the process for homeowners to create a duplex or subdivide their single-family residential lot into up to four units. Now, as permitted by statewide zoning codes, homeowners may:

• split their lot into two parcels — each parcel may be no smaller than 1,200 square feet and no smaller than 40% of the original lot; or
• build duplexes — a project containing up to two dwelling units on each single-family parcel. [Government Code 66411.7 (a)]

However, as essentially an elimination of single family zoning, the HOME Act has met opposition from various conservative enclaves across the state, with Huntington Beach the latest bastion to willfully ignore state law.

But Huntington Beach wasn’t done.

Next, the City Council introduced an ordinance to unlawfully exempt the city from the Builder’s Remedy enacted by California’s Housing Accountability Act (HAA). The HAA streamlines approval for low- and moderate-income housing developments in cities which have not produced a compliant housing element to include sufficient low- and mid-tier housing for its residents (and, you guessed it, Huntington Beach does not have a housing element compliant with state laws).

Following the Council’s refusal to heed the OAG’s warning, the OAG sued the city, including a request for the court to issue a monetary fine on the Council members.

As the awareness that state codes really do preempt local ordinances, made clear by the OAG’s legal action, has quickly escalated, the Council is backpedaling. They are now considering a plan to reopen permit applications for ADUs and for parceling under the HOME Act, and amend its Housing Element to comply with state law.

For those counting, this is the second time the state has sued Huntington Beach over housing law violations, the first of which the city settled in 2020 after losing out on millions of dollars in state funding.

Related article:

Four units by the parceling of one

Strict zoning restricts fees

California’s housing crisis is ultimately the result of tight local zoning ordinances, which include restrictive:

• land use regulations;
• parking restrictions;
• lot size minimums;
• height limitations; and
• permitting costs and processing times.

With all these restrictions, builders looking for a “sure thing” tend to stick to single family residences (SFRs) on post-WWII lot sizes. With large lots restricted to a single unit on a parcel suitable in all ways for eight residential units, the inefficiencies created have resulted in a reduced housing supply. In fact, each year since 2018 there have been more SFRs constructed in California than multi-family units.

The end result is less housing — an intentional supply-and-demand imbalance — which has led to reduced homeownership, higher rents, and a lower quality of life for California’s owners and renters. Home sales have been in the doldrums for years, and that has hurt those servicing the housing market’s needs.

We need more housing units — not more occupants per unit.

Going forward, housing laws have now shifted from local control to a statewide housing policy. Legislation has focused on loosening zoning, seizing the reins from the hands of vocal not-in-my-backyard (NIMBY) advocates, and allowing private property owners to make their own choices to add an ADU or subdivide their lot — not the city fathers.

But when cities like Huntington Beach seek to sidestep the progress made by the state legislature for residents to live where the jobs are, our population’s housing preferences are artificially stifled.

Demand for more low- and moderate-income rentals is alive and well, even in today’s restrained housing environment which has seen sales volume and pricing plummet from their mid-2022 peak. Further, demand for low- and mid-tier for-sale inventory will rebound soon enough, likely around 2026 when prices will cyclically resume their upward trajectory after reaching a base-value price.

Related article:

The mean price trendline: the home price anchor

 

Real estate brokers understand the state’s anemic housing inventory has only held back transaction volume in recent years — and know that increasing the number of housing units will open up more opportunities for their fee-based brokerage services.

The housing shortage will be solved only when residential construction is allowed to rise to meet the level of demand for additional housing in every neighborhood – no matter its purported social status. This organic growth will gradually occur as California’s Home Act legislation allows builders to catch up — but only when local governments cooperate, voluntarily or by court order.

When city councils are not cooperative, the AG has the tools and the willingness to help homeowners become mini-landlords, free up builders from permit processes barricaded by city councils and allow employees to live where they work.

What’s more, the AG seems hungry for a fight.

Related article:

California’s new housing strike force prepares for battle — with NIMBYs

Related topics:
accessory dwelling unit, attorney general (ag), not in my backyard (nimby)

Posted by Carrie B. Reyes | Aug 18, 2023 | Laws and Regulations, Mortgages, Real Estate, Your Practice | 0

Reprinted from firsttuesday Journal  — P.O. Box 5707, Riverside, CA 92517

Economic stress has many real estate licensees considering how to connect with previously untapped clientele.

As part of their financial strategy to stay afloat despite reduced sales and leasing of property and origination of mortgages, brokers, agents and mortgage loan originators (MLOs) are doubling down on their solicitation efforts by FARMing past contacts — and others.

But in their rush to reach new and prior clients, these adaptive licensees may have missed an important step or two to comply with telemarketing and advertisement laws. The rules are simple and straightforward.

California’s attorney general recently announced a crackdown on illegal telemarketing, highlighting a number of lawsuits and court rulings against companies guilty of deceptive marketing practices.

Marketing and advertising are a fundamental part of a licensee’s ultimate business success. Potential clients need to be made aware of the licensee’s services. The telemarketing rules permit the achievement of this success while applying guardrails for reasonable conduct in disclosures and timing of calls to customers.

In application, MLOs who use phone calls as part of their marketing need to take note of and follow telemarketing rules.

We will explain.

Telemarketing rules for MLOs

Telemarketing by an MLO is any marketing campaign conducted by telephone to induce consumers to apply to originate a mortgage.

The conduct of an MLO’s telemarketing campaign is regulated and enforced by the Federal Trade Commission (FTC) under their Telemarketing Sales Rule. [16 Code of Federal Regulations §§310]

For starters, an MLO telemarketer must understand that deception is wrongheaded; they may not make false or misleading statements to induce the consumer they call to accept the mortgage the MLO is promoting. [16 CFR §310.3(a)(4)]

Further, the MLO placing a call must immediately, when the person called answers, orally disclose their:

• identity — name of the MLO and their employer;
• purpose of the call as soliciting a mortgage origination application; and
• nature of the particular type of mortgage origination offered on the call. [16 CFR §310.3(d)]

An MLO placing telemarketing calls must also — without first being asked — voluntarily disclose to the person they are calling:

• all costs incurred, directly or indirectly, to originate the specific type of mortgage offered;
• any restrictions or limitations on the use of the funds provided by the mortgage offered;
• conditions for processing the mortgage origination which alter the MLO’s or their employer’s ability to originate the offered mortgage without incurring greater costs, efforts and time;
• any affiliation of the MLO or their employer with any person or government agency including the mortgage lender or originator; and
• in a prize promotion, any conditions regarding receiving a prize, the odds of winning the prize, and that no mortgage origination is required to participate. [16 CFR §310.3(a)(2)]

Time of day avoids abusive call rule

A telemarketing call placed without prior consent is permitted by the Telemarketing Sales Rule. Permitted calls may only be made between 8:00 a.m. and 9:00 p.m. for the time at the location of the person receiving the call. A call placed at any other local time without prior consent constitutes a violation as abusive telemarketing. [16 CFR §310.3(c)]

Further, it’s not enough for an MLO to simply comply with FTC rules for acceptable telemarketing practices. Any MLO who knowingly supports or facilitates a violation of these rules by others — even the company they work for — is also in violation. [16 CFR §310.3(b)]

Related video:

Advertising rules for real estate licensees

Advertising introduces and fully identifies the licensee, their activities and services, and the message they want to convey to potential clients. Advertising is a form of communication which uses signs, symbols or actions to create brand awareness and promote a positive image of the licensee.

While telemarketing rules do not apply to material mailed by the MLO or their employer in marketing campaigns which intend to induce the recipient to call about their mortgage origination services when the mailing contains the physical business address of the MLO’s employer, there are additional rules that apply to these mailed advertisements.

When advertising on a website, in print or otherwise, real estate licensees are required to provide their:

• name;
• Department of Real Estate (DRE) license number;
• Nationwide Mortgage Licensing System (NMLS) ID number (when applicable); and
• responsible broker’s identity. [Calif. Business & Professions Code §10140.6]

Solicitation materials licensees use where these requirement apply include:

• business cards;
• stationary;
• websites owned and maintained by the soliciting real estate licensee;
• promotional and advertising flyers, brochures, postal mail, leaflets and FARM letters;
• advertisements in electronic media (including internet, email, radio, cinema and television);
• print advertising in any newspaper or periodical; and
• “for sale,” “for rent,” “for lease,” “open house,” and directional signs that display the name of the licensee. [DRE Regs. §2773]

Noncompliance by an agent or employing broker may result in:

• disciplinary action by the DRE;
• criminal prosecution; or
• both DRE disciplinary action and criminal prosecution.

For more information about advertisement compliance, see the DRE’s Real Estate Advertising Guidelines informational booklet DRE’s website. [See RE 27]

Related article:

Digital advertising: A compliance hot spot for brokers

Related topics:
advertising, mortgage loan originator (mlo)

Posted by Carrie B. Reyes | May 24, 2023 | Fair Housing, Property Management, Real Estate | 1

Reprinted from firsttuesday Journal  — P.O. Box 5707, Riverside, CA 92517

 

California’s Office of the Attorney General (OAG) is warning local governments about housing policies that conflict with state and federal anti-discrimination laws.

Several of the state’s local Crime-Free Housing Policies violate fair housing laws by targeting members of protected classes. The OAG is calling on local jurisdictions to either amend or repeal these policies, including any training programs or materials which unfairly target protected classes.

This guidance is a follow-up on a notice from the U.S. Department of Housing and Urban Development (HUD) which states that seemingly neutral Crime-Free Housing Policies can violate the federal Fair Housing Act (FHA) when they have a discriminatory effect and are “not supported by a legally sufficient justification.”

California’s fair housing law is more extensive than federal law in providing consumers equal status and protection. California prohibits discrimination in the sale or rental of housing accommodations based on an individual’s:

• race;
• color;
• religion;
• sex;
• gender;
• gender identity or expression;
• sexual orientation;
• familial or marital status;
• disability;
• genetic information;
• national origin;
• source of income;
• veteran or military status;
• ancestry;
• citizenship;
• primary language; or
• immigration status. [Calif. Government Code, §§ 12955; Calif. Civil Code §§51 et. seq.; Calif. Government Code §12955; DRE Reg. §2780 and §2781]

However, as noted by HUD and now the OAG, even when a landlord follows the letter of the law, discriminatory effects may occur when they selectively refuse to rent to a tenant based on their criminal history.

While a landlord may consider criminal activity in their screening of tenants, landlords are prohibited from enforcing blanket bans against prospective tenants or evicting tenants due to a criminal record.

Editor’s note — Assembly Bill 1418 is currently being considered in California’s legislature. This bill prohibits local governments from encouraging landlords with their crime-free housing policies to perform a criminal background check on a tenant or prospective tenant. Stay tuned for updates by following firsttuesday’s Legislative Gossip page.

Critically, landlords may not apply their crime-free policies in a discriminatory manner. For example, a landlord who only screens tenants for criminal history when they are a certain race, age, sex or other protected class is considered intentional discrimination.

Implicit discrimination is overtly discriminatory

Though tenants with a criminal history are not a protected class under fair housing laws, criminal record-based housing restrictions are used to disparately impact racial minorities — a protected group. Denying applicants who have any criminal record disproportionately impacts racial minority and low income groups which are convicted and incarcerated at higher rates — a discriminatory effect in violation of fair housing laws.

Thus, even when a landlord is not being explicitly discriminatory, housing restrictions based on a tenant’s criminal history are violations of California’s Fair Employment and Housing Act (FEHA) and the federal Fair Housing Act (FFHA), which separately expose a landlord to civil liability. This is a form of unintentional, or implicit discrimination everyone needs to learn to observe. [Gov C §12900, et seq.; 42 United States Code §3601, et seq.]

Further, landlords cannot refuse to rent to prospective tenants or evict existing tenants they suspect of having gang affiliations or who “appear” to be involved in criminal activity. Such a screening practice encourages arbitrary and unlawful housing discrimination on the basis of race, ethnicity, family composition, gender and appearance. [Castaneda v. Olsher (2007) 41 C4th 1205]

Editor’s note — The only exception to these guidelines occurs when a tenant has a conviction for the manufacturing or distribution of controlled substances. Here, a landlord may deny housing based on a conviction for drug manufacturing or distribution — though not based on a conviction for possession — without violating fair housing laws. [42 USC §3607(b)(4)]

Thus, landlords who impose blanket bans on applicants with any criminal record are subject to civil penalties and tenant money losses for housing discrimination.

Related article:

Landlord liability and criminal activity

Reporting suspected housing discrimination

California’s Civil Rights Department (previously the Fair Employment and Housing Department) is the agency which enforces anti-discrimination housing law. [Gov C §§12901, 12903, 12930, 12935]

Any individual who feels they have been discriminated against may file a complaint with the Department. The Department investigates the complaint to determine any wrongful conduct. When grounds exist, the Department then seeks to resolve the situation through discussions with the individual against whom the complaint is made. [Gov C §12980]

When the Department believes a discriminatory practice has occurred, it will first attempt to reach a resolution through the Department’s mandatory dispute resolution division. The dispute resolution is provided without charge to either party. However, when the dispute cannot be effectively resolved, the Department will file a civil action on behalf of the individual who was discriminated against in the county where the discriminatory conduct is alleged to have occurred. [Gov C §12981]

Read more in the RPI ebook: Implicit Bias, Office Management & Supervision, Agency, Fair Housing, Trust Funds, Ethics and Risk Management.

Related topics:
criminal activity, housing discrimination, implicit bias, landlords and tenants

Posted by Ashley Collins | Jan 16, 2023 | Laws and Regulations, Real Estate | 3

Reprinted from firsttuesday Journal  — P.O. Box 5707, Riverside, CA 92517

When it comes to California’s housing crisis, residents are saying enough is enough.

Last November, Californians voted on transformative housing measures in their cities amid a long-simmering statewide shortage. The 2022 midterm election highlighted voters’ growing displeasure with priced right housing, but the results also renew optimism as the state pivots its policies for 2023 and beyond.

Voters focused their ire on local zoning, tax and homelessness issues. Read on for the most critical housing-related measures passed in November 2022 across California’s major metros. Find your service area below for a breakdown of the changes impacting your practice.

In Los Angeles, residents voted “yes” on:

• Measure LH — earmarking public money to aid the development of an additional 5,000 low-income rental units per city council district;
• Measure EM — authorizing the rent control board to modify or reject annual rent adjustments during a state of emergency declared by the president, governor, LA public health officer, or city council;
• Measure H — enacting a rent control program limiting annual rent increases to 75% of consumer price index (CPI); and
• Measure RC — requiring residential landlords to intend occupancy for a minimum of two years, move in within 60 days of vacancy to evict a tenant, and reduce the rent increase cap to $70 per month.

In Orange County, voters approved:

• Measure K — allowing the city council in Costa Mesa to adopt publicly-reviewed land use plans to refresh areas, expand low- and mid-tier housing, and restrict building height.

In Riverside County:

• Measure K — passes the fee of 15 cents per building square foot on single-family residential (SFR)
  units, the authorization of bonds, and an appropriation limit of $39 million.

In San Diego County, voters secured:

• Measure B — ends free trash pick-up for single-family units; and
• Measure C — places a 30-ft. height limit on buildings in most areas west of Interstate 5, according to the San Diego Union-Tribune.

In Sacramento County, residents can look forward to:

• Measure D — allows the county to develop low-income housing equal to 1% of its existing housing, according to Sacramento County.

In San Francisco County:

• Proposition M — enforces a tax, at a rate between $2,500 and $5,000 per vacant unit, on owners of vacant residential units in buildings with three or more units when the units have been vacant for more than 182 days in a year.

Lastly, Santa Clara County voters said “yes” to:

• Measure M — imposes a parcel tax of $348 per parcel for 8 years to fund schools; and
• Measure A — adjusts zoning regulations to disallow construction with characteristics of new storage and distribution use.

Editor’s note — For an exhaustive roundup of California’s midterm election results, visit Ballotpedia.

Taken individually, these changes represent only incremental steps toward more priced right housing for low- and middle-income earners. But together, these policy changes reflect residents’ roiling frustration with cities to do something about housing costs. Perhaps the biggest mandate to emerge from the midterm’s results is on homelessness.

Related article:

California real estate: 2022 in review and a forecast for 2023

Measures for housing the unhoused

While homes prices and sales volume swelled during the pandemic, so too did the number of California’s unhoused. In fact, the state’s unhoused population rose by 22,500 between 2019 and 2022 — a conservative figure to be sure. But the passage of a few notable housing measures across the hardest-hit counties is turning compassion into legislative action.

To alleviate the homelessness crisis in their counties, voters passed:

• Measure ULA in Los Angeles, which raises nearly $1 billion annually for housing and homelessness efforts by taxing property sales of $5 million or more;
• Measure S in San Diego, which raises sales tax by one penny to aid the homelessness crisis;
• Measure O in Sacramento, a new homelessness policy that requires a minimum number of emergency shelter spaces based on number of unhoused individuals, prohibits encampments, and limits the city’s annual budget of $5 million;
• Measure B also in Sacramento, creating gross receipt tax from cannabis and hemp businesses to fund county homelessness services; and
• Proposition C in San Francisco, which creates a Homelessness Oversight Commission to oversee the Department of Homelessness and Supportive Housing and requires the city controller to conduct audits of services for people experiencing homelessness.

Though these measures ensure funding for vital homelessness programs and services, they do not directly address the root of the issue: California’s housing inventory shortage. The state is about 2 million units short of meeting demand, according to a landmark McKinsey & Company report.

Ultimately, only increasing housing inventory and production will make a long-term material impact in the prevalence of homelessness across California neighborhoods. This means clearing obstacles to construction starts, which are sluggish going into 2023.

At the local level, the housing bottleneck starts early — in the planning stage. Vocal not-in-my-backyard (NIMBY) advocates have long wielded outsized power in city council meeting, killing residential construction projects in their neighborhoods despite an urgent need for greater density.

Related article:

California’s new housing strike force prepares for battle — with NIMBYs

The market braces for impact

Though the state’s emergency response ended in 2022, the pandemic disruption will still ripple through 2023. Agents and brokers can expect inflation, mortgage interest rates, and evaporating sales volume to continue dominating 2023’s news cycle. It’s no surprise that many of the midterm’s housing measures were created in response to these forces.

Consider Measure EM and Measure H in Los Angeles. Both measures address rent control in response to housing price spikes fueling gentrification across the state. As home and rental prices spiked, many Californians lost their jobs and their ability to cover housing costs. This prompted a renewed push by YIMBY advocates to combat restrictive housing policies in desirable residential areas.

Housing policies informed by the pandemic’s economic lessons are finding their way into legislation as the state level as well. Senate Bill (SB) 6 and Assembly Bill (AB) 2011 encourage builders to transform office and retail commercial spaces into housing units for low- and middle-income earners.

Surviving (and thriving) during the 2023 recession means staying on top of shifting economic and legislative environments. Be the first on your team to pivot with California’s market and laws by subscribing to Quilix, the weekly firsttuesday real estate newsletter.

Related article:

Legislative steps toward more affordable housing

Related topics:
housing crisis, housing shortage, nimby, rent control

Posted by Carrie B. Reyes | Mar 2, 2023 | Buyers and Sellers, Feature Articles, Market Watch features, Real Estate, Your Practice | 0

Reprinted from firsttuesday Journal  — P.O. Box 5707, Riverside, CA 92517

This article explains when a buyer or seller is entitled to exercise their right to cancel a purchase agreement and escrow instructions, such as on a breach or failure of an event to occur or condition to be approved.

The recession wave of buyer cancellations

Over the past decade, home sellers — and their agents — have had the luxury of home sales being a virtual guarantee. If you list it, they will come. Easy.

That is, until 2022 when the bubble of buyer irrational enthusiasm — or fear — popped, and home sales volume and prices began what will be a prolonged crash.

In a falling price environment, the certainty of a quick and easy sale for real estate listings is a thing of the past. As buyers already in escrow see equivalent homes listed below their contract price, they are more likely to find reasons to back out. Likewise, willing buyers may succumb to job losses during the pending recession, losing access to funding.

What are the situations when a breach or failure of conditions in provisions of a purchase agreement entitles a buyer or seller to exercise their right to cancel?

Further, how can you distinguish a unilateral cancellation to terminate further performance under a purchase agreement from a bilateral rescission of a purchase contract — which restores the buyer and seller to their respective positions before entering into their purchase agreement?

Exercising the right to terminate the deal

Consider a seller who agrees to carry back a note secured by a trust deed junior to an existing mortgage the buyer will assume. The purchase agreement entered into with the buyer contains a further-approval contingency provision which grants the right to cancel the transaction to:

• the seller when the buyer’s creditworthiness is unacceptable to the seller [See RPI Form 150 §8.5]; and
• both the buyer and the seller when either one disapproves of the existing trust deed lender’s terms for an assumption of the mortgage by the buyer when the terms offered exceed the mortgage parameters agreed to in the purchase agreement. [See RPI Form 150 §8.6 and 10.3]

On the seller’s receipt of the buyer’s credit application form, the seller’s agent orders and receives a report on the buyer’s creditworthiness from a credit reporting agency. [See RPI Form 302]

Editor’s note – One such source of a comprehensive credit report is Tenant Screening Center. More information is available from their website.

The seller, on review of the credit report information with their agent, is concerned about the buyer’s payment history. The seller’s agent acts on these concerns by asking the buyer for financial statements including:

• a balance sheet listing assets and liabilities [See RPI Form 209-3] and
• an end-of-year financial statement on the buyer’s income and expenses for the past two calendar years.

The buyer promptly supplies the requested financial data. The seller notes the buyer is cash poor with insufficient cash on hand to make the down payment called for in the purchase agreement.

Meanwhile, the seller’s agent learns the buyer is going to use a line of credit at a bank to finance the down payment. This debt-leveraging information when known to the carryback seller might affect their decision to exercise their right to cancel the transaction under the credit approval contingency. Thus, the seller’s agent relays the information to the seller.

The seller now has all the relevant credit information readily available or known to the seller’s agent. The seller determines they have justification for exercising their option to cancel the purchase agreement and escrow instructions. However, the seller has not yet decided what to do about allowing the transaction to continue.

Related article:

Evaluating carryback sellers: secured and unsecured

Review data and respond timely

The seller’s agent is mindful of the upcoming expiration date of the seller’s right to cancel and of their duty to protect the interests of the seller. Seeing their client’s inaction, the agent advises the seller that when they do nothing to cancel before the expiration of their right, they will lose their ability to be excused from completing the transaction as agreed.

Thus, a choice is made through inaction.

The seller understands they need to serve the buyer with a notice of cancellation before the expiration date stated in the contingency provision. Otherwise, the period for cancellation will expire and they will need to proceed to close escrow. [See RPI Form 183]

By the expiration date of the seller’s right to cancel, the seller decides to do nothing. The seller is willing to undertake the additional risks, including the possible need to foreclose presented by the buyer’s insufficient creditworthiness to become owner of the property subject to the seller’s carryback mortgage.

Meanwhile, the existing mortgage lender processes the buyer’s application to assume the mortgage and forwards assumption documents to escrow for the buyer to sign and return. The terms for an assumption demanded by the lender include:

• a modification of the interest rate to current rates;
• a new payment schedule for amortization; and
• a fee extracted for allowing the assumption.

However, these terms exceed and are more financially burdensome than the mortgage assumption parameters agreed to in the purchase agreement.

Related article:

Structuring a no down payment carryback sale

Carryback seller’s refusal to subordinate

The buyer promptly signs the mortgage documents and returns them to escrow, along with the assumption fee demanded by the mortgage holder. Thus, the buyer, by conduct inconsistent with their right to cancel granted by the mortgage assumption contingency provision, waives their right to cancel the transaction.

The buyer now no longer has the authority to terminate the purchase agreement based on excessive financial demands by the mortgage holder to allow an assumption than agreed to in the purchase agreement. [See RPI Form 150 §10.3]

Meanwhile, the carryback seller determines the terms for assumption and modification of the existing mortgage are financially unacceptable and that they exceed the parameters of the mortgage assumption terms agreed to in the purchase agreement. The seller instructs their agent to prepare a notice of cancellation to terminate the transaction and escrow. The notice is immediately signed by the seller and delivered to the buyer and escrow, called a unilateral cancellation. [See RPI Form 183]

Here, the seller has a valid reason for refusing to subordinate. The risk of loss presented by the mortgage modification accompanying the assumption agreement is greater than the risks presented by the terms agreed to in the purchase agreement.

The seller’s notice of cancellation terminates the purchase agreement and escrow. Cancellation avoids any further performance of the purchase agreement or escrow instructions by the seller and buyer since all obligations to close escrow have been excused.

As authorized to cancel unilaterally

Unilateral cancellation of a real estate purchase agreement and escrow instructions may be initiated by a seller or buyer due to:

• a material breach of the agreement by the other participant; or
• the failure of an event to occur or a condition to be approved as called for in a contingency provision in the agreements.

Unilateral cancellation eliminates  whatever remains to be performed under the purchase agreement, called a termination of the contract. Thus, a cancellation abolishes any future enforcement of the agreement by either participant from the moment of cancellation.

Here, the purchase agreement is cancelled by a unilateral act since the cancellation is achieved by one participant acting alone.

Further, the cancellation of a purchase agreement does not alter the consequences of any liability for activities and events which precede the cancellation.

Conversely, a rescission of either an unexecuted purchase agreement (i.e., escrow has not yet closed) or of a completed real estate transaction (i.e., escrow has closed) is a bilateral agreement. As a bilateral rescission, both the buyer and seller act in concert to retroactively annul the purchase agreement as ineffective from the moment it was entered into.

Alternatively, a cancellation brings a purchase agreement and escrow instructions to a standstill. Only future obligations under the agreement are eliminated.

In contrast, a rescission returns the buyer and seller to the respective positions they held prior to entering into the purchase agreement. When a contract is rescinded, it is as though the participants had never agreed to the transaction. The retroactive return to their former, pre-contract positions is called restoration.

When both the buyer and seller enter into a rescission agreement, the buyer and seller are restored to their pre-purchase agreement positions. Thus, a rescission eliminates all claims they may have had against each other for conduct which occurred after entering into the purchase agreement and prior to its rescission.

A rescission is a mutual agreement, entered into voluntarily, which eliminates the purchase agreement, by a buyer and seller executing a release and waiver agreement. [See RPI Form 181]

Escrow instructions cancelled separately

Consider a buyer in escrow on a purchase agreement with a contingency provision for the origination of mortgage financing necessary to fund the purchase price. The provision contains no parameters for acceptable terms of the new funding.

When the mortgage lender forwards the note and trust deed documents for the buyer to sign and return before funding, the buyer rejects the mortgage terms. The interest rate and payment schedule set by the lender in the closing documents are greater than orally represented by the mortgage loan originator (MLO) and do not support the price the buyer agreed to pay.

The buyer instructs escrow to prepare instructions to cancel escrow and the purchase agreement and return all funds and documents – instruments – to the participant who deposited them with escrow. The seller refuses to cancel the purchase agreement or reduce the sales price, but agrees to cancel only the escrow instructions. The seller claims the buyer seeks to cancel the purchase agreement to avoid paying the agreed price since comparable properties are now selling for a lower price.

Here, the cancellation of a purchase agreement is distinguished from both a unilateral or mutual cancellation of the escrow instructions. The cancellation of only the escrow instructions does not cancel the purchase agreement which continues in effect.

Often, due to a dispute or failure of a contingency, escrow will not close. Here, escrow issues instructions calling for the return of funds and documents to the participants who deposited them in escrow, part of the provisions canceling escrow instructions.

These escrow cancellation instructions, signed by both the buyer and seller, need not but may provide for cancellation of the purchase agreement. When the purchase agreement is not referenced as cancelled, the cancellation instructions handed to escrow do not interfere with any rights the participants may have to enforce the purchase agreement. Thus, the purchase agreement remains intact to be enforced to buy, sell or recover money losses since it has not been cancelled or rescinded, just escrow. [Calif. Civil Code §1057.3(e)]

Negotiations by the transaction agent to resolve the misunderstandings or differences and close escrow might not be successful. When the purchase dispute is unresolvable, the agents need to consider advising the buyer and seller to terminate not only escrow, but the purchase agreement as well. On cancelling both documents, the property is released and placed back on the market by the seller — and the buyer is free of obligations to the seller.

When the buyer and seller terminate the transaction, it is in everyone’s best interest for the buyer and seller to also release each other, the brokers and escrow from any claims they may have against one another. They do so by entering into a cancellation, release and waiver agreement to put the transaction to rest forever. [See RPI Form 181]

Cancellation for a valid reason

A seller or buyer occasionally refuse or are unable to hand escrow the instruments (funds and documents) needed to close the transaction in compliance with escrow instructions. Unless their nonperformance is excused, they have breached the purchase agreement.

Nonperformance is excused and the refusal to act is not a breach of the purchase agreement, when:

• a contingency provision exists authorizing the buyer or seller benefitting from the contingency to terminate the purchase agreement on the failure of an event to occur or on disapproval of data, information, documents or reports;
• the event fails to occur or the condition reviewed is disapproved; and
• the person authorized or benefiting from the contingency provision acts to terminate the agreement by delivering a notice of cancellation prior to the expiration of their right to cancel. [See RPI Form 183]

When a valid reason exists which triggers the buyer’s or seller’s right to exercise their right to cancel and they choose not to timely serve a notice of cancellation on the other participant, their right to be excused from further enforcement of the transaction expires.

Related article:

Buyer breach of contract in a decreasing price environment: Seller remedies

Conduct less than disapproval

Consider a buyer who enters into a purchase agreement to acquire an income-producing property before a recovery from a recession has taken hold. A provision calls for the buyer to review and approve the operating income and expenses experienced by the property. The buyer is handed a property operating cost spreadsheet for review and approval, called an income and expense statement or an Annual Property Operating Data sheet (APOD). [See RPI Form 352]

The receipt of the data commences a period of review for the buyer to determine whether to exercise their right of approval.

The data tends to confirm the general information received by the buyer before making the offer. However, the breadth and depth in the detail of the information seems inadequate for a long-term investment, the price of which is based on the buyer’s capitalization (cap) rate.

The buyer’s agent asks the seller to supply additional data and information, including access by the buyer for a review of all supporting documents regarding the property’s operating history, including  leases, unit occupancy rates, expense records, list of contracted service providers — the works.

The seller claims the buyer’s request for more data and documents constitutes disapproval of the information and a cancellation of the agreement since the information already handed over sufficiently discloses the property’s operating history.

The seller claims the deal is dead – cancelled – and they are no longer required to perform. The seller has back-up offers at a higher price which the seller has accepted based on cancellation of this sale.

Has the buyer, by seeking additional information, disapproved of the condition of the income and expenses, and thus exercised their right to terminate the agreement?

No! The buyer’s request for additional data on the property’s operations is an expression of concern, not disapproval as clarification was sought. Implicit in a request for more information is the notion a decision of any type has not yet been made. Further, the seller has not fulfilled their obligation to deliver sufficient information to allow the buyer to complete their review and make an informed decision about the full nature and thus the acceptability of the property’s operations.

Termination of the agreement

Before an agreement is terminated by a buyer exercising a contingency provision, the buyer’s conduct needs to rise to the level of an unequivocal disapproval of the conditions presented by the data, information, documents and reports supplied by the seller.

For a termination of the purchase agreement to occur, the buyer needs to either:

• deliver a notice of cancellation, as called for to exercise the right granted to terminate the agreement; or
• otherwise communicate an unequivocal rejection of the disclosed condition to the seller.

The seller who fails to comply with a good faith request for more information to assist the buyer in the decision-making process of approval or disapproval of the condition under review has breached their obligation under the contingency provision to hand over data, information, documents, and reports.

Thus, the seller has defaulted on their obligations. This default is a breach which excuses the buyer’s further performance until the seller complies with the requests. Further, the seller’s breach of the provision allows the buyer to either cancel the agreement or pursue enforcement by a suit for specific performance.

Post-cancellation waiver attempt

Consider a prospective buyer of commercial property who includes a further-approval contingency provision in their purchase agreement offer calling for their approval of a survey to be furnished by the seller or cancellation by written notice. The seller accepts the offer, and a survey is conducted.

The surveyor’s observations are delivered to the buyer as agreed in the contingency provision. On the buyer’s review of the survey and accompanying report, the buyer discovers the location of structures does not conform to building permit requirements.

Thus, the buyer has a reasonable basis for exercising their right to cancel the transaction under the contingency provision.

However, the buyer’s agent does not prepare a notice of cancellation form for the buyer to sign and deliver to the seller as called for in the purchase agreement to terminate the transaction. Instead, the buyer advises the seller of their disapproval of the survey in letter form — but does not state they are cancelling the transaction due to their disapproval.

The seller does not respond to the buyer’s disapproval letter. At the same time, the market for income producing real estate is showing signs of a price recovery from recession levels.

The seller makes no effort to work out the discrepancies found in the survey so the buyer can approve the survey and waive the further-approval contingency.

Unequivocal disapproval terminates escrow

Prior to the date originally scheduled for escrow to close, the buyer’s agent prepares a notice of waiver of the further-approval contingency which the buyer signs. On the seller’s receipt of the notice of waiver, the seller has escrow prepare unilateral cancellation instructions which the seller signs and hands to escrow. The buyer then demands a conveyance of the property as agreed in the purchase agreement, which the seller rejects.

The seller claims the letter disapproving the survey terminated the transaction and excused the seller (and relatedly the buyer) from further performing on the purchase agreement or escrow.

The buyer believes their communication did not cancel the transaction, but merely disapproved of the survey without explicitly exercising the contingency provision which they now waived to allow the transaction to close.

Here, the buyer unequivocally disapproved the conditions disclosed by the survey. As a result, their rejection of the survey by the disapproval was itself an exercise of the buyer’s right under the contingency provision to terminate the purchase agreement and escrow. Thus, the disapproval is as effective as though they had signed a notice of cancellation and delivered it to the seller.

Here, the buyer is left without an enforceable contract, much less a right to cancel which they may later attempt to waive. [Beverly Way Associates v. Barham (1990) 226 CA3d 49]

Related topics:
breach of contract, cancellation, escrow

Posted by Amy Platero | Sep 5, 2023 | Fundamentals, Laws and Regulations, Licensing and Education, Real Estate, Your Practice | 0

Reprinted from firsttuesday Journal  — P.O. Box 5707, Riverside, CA 92517

This article is part of an ongoing series covering violations of real estate law. Here, the Department of Real Estate (DRE) revoked the real estate license of a broker who failed to report felony charges brought against them, advertised real estate services on their website while not in good legal standing with the Secretary of State, and failed to disclose required information in their website advertisements.  

In April 2023, the California Department of Real Estate (DRE) decided by default decision to revoke the license of Franco Tse-Hua Fang, a broker since 1995 operating out of San Gabriel, California. The decision became effective July 2023.

In January 2023, an indictment was filed against Fang under the United States District Court for the Northern District of California. The case alleged three felony counts of bank fraud against Fang.

Fang did not report the indictment charging a felony against her to the DRE within 30 days, a violation of real estate law. [Calif. Business and Professions Code §10186.2]

In February 2023, Fang filed a Certificate of Dissolution for the real estate corporation for which she managed as designated officer (DO), Golden Investments of America Inc. (GIAI) with the California Secretary of State (SOS). Thus, GIAI’s corporate status was terminated as of the date of the dissolution filing.

However, the DRE discovered GIAI maintained websites which solicited borrowers for mortgages and advertised itself as a licensed real estate corporation and a mortgage loan originator (MLO) with an MLO license endorsement. The website did this all while GIAI was not in good legal standing with the SOS, a violation of DRE regulations. [DRE Regulations §2742(c)]

Further, GIAI’s real estate websites lacked required disclosures. The websites failed to contain:

• GIAI’s real estate corporation ID number;
• GIAI’s Nationwide Multistate Licensing System (NMLS) ID number; or
• the required statement, “Real Estate Broker, California Department of Real Estate.”

Meanwhile, the site contained the names “DBestLoan.com DBA Golden Investments of America, Inc.” and “Mortgage Loan Solutions” which were not licensed as fictitious business names with the DRE.

Finally, Fang managed GIAI’s website as DO with broker supervision responsibilities imposed on her. She violated real estate laws and regulations with her oversight of the website by advertising without a valid business license and without providing the necessary disclosures. Thus, there was cause for the revocation of her real estate license and MLO license endorsement. [Bus & P C §§10166.051, 10177(h), 10177(g); DRE Regs. §2945.4]

Reporting felony charges, advertising and fictitious names

A felony charge involving fraud bares a substantial relationship to a broker’s real estate activities. Fraud has no place in a fiduciary’s dealings with the public.

The law requires a real estate licensee to timely report to the DRE:

• any criminal complaint, information, or indictment charging a felony against the licensee;
• the conviction of the licensee of any felony or misdemeanor; and
• any disciplinary action taken against the licensee by another licensing entity or authority of state or federal government. [Bus & P C §10186.2]

The licensee’s reporting is to be in writing and made within 30 days of the indictment, charge, conviction or disciplinary action. [Bus & P C §10186.2]

Failure to report is a cause for discipline against the licensee.

Related article:

DRE Hot Seat: DRE to be notified of disciplinary action by another licensing entity or authority of the state

Advertisement is a fundamental part of a licensee’s practice. [See RPI e-book Office Management and Supervision, Chapter 5]

Although real estate licensees may use different strategies in their advertisements, above everything else, the licensee’s advertising needs to be lawful.

When a licensee advertises on a website, in print or otherwise, they are required to provide their:

• name;
• DRE license number;
• NMLS ID number, when applicable; and
• responsible broker’s identity. [Bus & P C §10140.6]

Also, advertisements of mortgage products intended to solicit borrowers need to identify the licensing authority issuing the license, using the phrase, “Real estate broker, California Department of Real Estate.” [DRE Regs. §2847.3]

Finally, before using a fictitious business name when rendering real estate services requiring a license, a broker needs to first obtain an individual or corporate license from the DRE bearing the fictitious name.

A licensee may not use a fictitious name in the conduct of any activity for which a license is required unless the licensee is the holder of a license bearing the fictitious name. [DRE Regs. §2731]

Related video:

Want to learn more about real estate advertisement and marketing? Click the image below to download the RPI book cited in this article.

 

 

 

 

Related topics:
advertising, broker supervision, department of real estate (dre), fictitious business name, fraud, secretary of state

Posted by Guest Author Summer Goralik | Jan 12, 2023 | Laws and Regulations, Real Estate, Your Practice | 1

Reprinted from firsttuesday Journal  — P.O. Box 5707, Riverside, CA 92517

Real Estate Compliance Consultant and former California Department of Real Estate (DRE) Investigator, Summer Goralik, outlines the inherent risks real estate professionals face when handling trust funds, and how to counter them. Learn more by visiting her blog: Expert DRE Compliance. 

Compliance is a worthy challenge for many real estate brokers. Some brokers conquer it, while others struggle their way through it, and surprisingly, there are many that have yet to properly prioritize it. However, let’s put “baseline” real estate compliance aside for a minute. By baseline compliance, I mean, the laws and regulations that all real estate brokers and firms, regardless of their business models and activities, are subject to when they operate real estate businesses and supervise agents. The focus of this article is about a more rigorous and demanding type of compliance, and that is, the myriad requirements mandated under the California Real Estate law that only come into play when a real estate licensee receives or handles trust funds.

The engagement in trust fund handling requires a tireless commitment and strict adherence to the law, including precise accounting and meticulous record keeping. If real estate brokers are not 100% correct and compliant in their bookkeeping, then there is an actual chance that they may be disciplined by the California Department of Real Estate (DRE), or even worse, lose their real estate license. For this reason, it is my opinion that unless a real estate broker is extremely knowledgeable about trust fund handling requirements, and fully committed to satisfying them, they are officially operating in the danger zone of compliance, or as the title of this article reads, playing with fire.

Rather than cover a litany of trust fund handling requirements enforced by the DRE, which are lengthy, technical, and can just as easily be read in detail by referring to the Department’s website, this article will shine light on some straightforward and compelling facts that I believe tell a powerful story about trust fund handling and risk management. By the end of this piece, my hope is for brokers and salespeople, who handle trust funds in the course of licensed real estate activity, to better understand the critical importance of trust fund handling compliance and the inherent risks involved.

What are Trust Funds?

Before diving into the facts, let’s start at the beginning and understand the term, “trust funds,” and how it is used in the real estate industry. According to the DRE’s “Trust Funds” publication located on their website, trust funds are defined as “money or other things of value that are received by a broker or salesperson on behalf of a principal or any other person, which are held for the benefit of others in the performance of any acts for which a real estate license is required.”

Essentially, trust funds are monies belonging to principals, clients and/or the public, which are held and managed by a real estate broker, as trustee. The minute a licensee even “touches” trust funds, they trigger a world of regulatory requirements that have undoubtedly proven to be difficult for some brokerages to comply with. Such challenges can be gleaned by merely reviewing the Department’s annual reporting covering their government audits and findings which will be discussed below.

DRE Audits

One way to quickly digest the huge undertaking required of real estate brokers who engage in trust fund handling is to simply examine the Department’s audit history and statistics which are released to the public on an annual basis. According to the DRE’s latest Fall 2022 Real Estate Bulletin, the Department closed 440 audits in fiscal year (FY) 2021-2022, of which 166 were investigative audits and 274 were proactive. Notably, the DRE found trust fund shortages totaling $9.5 million, which the Real Estate Commissioner called “troubling.” It should be mentioned that out of the 440 audits closed, 330 of the audits covered property management brokers and 124 of them had shortages totaling $9,019,436. Interestingly enough, the DRE closed more audits in FY 2020-2021 (480) and discovered less trust fund shortages totaling $3.6 million.

According to the Department’s annual reporting, property management brokers are usually the subject of most DRE audit examinations and the evidence suggests that this pattern is not a coincidence. Property management is an area of real estate activity where numerous trust fund handling issues and shortages tend to occur. That said, mortgage loan brokers and broker-controlled escrows are certainly no stranger to DRE audits, and where a good share of trust fund handling violations are discovered. As such, if any real estate broker engages in these types of licensed activities (e.g., property management, broker-controlled escrows, mortgage loans), they would be wise to pay attention to these numbers and issues, and better yet, review the Department’s monthly enforcement actions which I will talk about below.

DRE Enforcement Actions and Common Violations

As a real estate compliance consultant and former DRE Investigator, I have witnessed plenty of licensees mishandle trust funds, both intentionally as well as inadvertently, and be subject to significant enforcement actions and financial penalties, including the suspension, restriction or revocation of their real estate licenses. But, you do not have to witness it to believe it — just review the DRE’s website and their monthly enforcement actions. One common denominator amongst the more serious disciplinary actions is often related to trust fund mishandling. Of course, that is not to say that other violations of law like misrepresentation, fraud or dishonest dealing, which are tied to transactional accusations, are not a problem, but only that trust fund non-compliance will surely lead to formal administrative discipline.

In my opinion, if a broker is thinking about engaging in an activity which requires the handling of trust funds, then one prerequisite to that activity should include the review of the Department’s summary of monthly enforcement actions, statistics and related disciplinary documents. It’s a valuable and practical education that one can obtain (for free!) in order to instructively learn about the types of activities and non-compliance that can lead to formal discipline; how the Department interprets and enforces the law (which is not always intuitive) and hopefully highlights the crucial mistakes being made by licensees and how to proactively avoid them.

It’s worth noting that the Department has also published an advisory, “Ten Most Common Violations Found In DRE Audits,” which is located on their website. Remarkably, out of the 10 violations cited, the majority are related to trust fund mishandling and non-compliance. In reading through the Department’s enforcement actions and public advisories, I believe the message is clear. If you are a real estate broker who avoids or disallows activities involving trust fund handling, you are engaging in a much “safer” activity when it comes to risk management and compliance. Conversely, if your brokerage handles trust funds, then your real estate world is more complicated as you have more technical requirements to contend with and get right, and a higher burden of compliance and risk to bear.

True compliance story

Putting numbers and regulatory advisories aside for a moment, there is another way to convey the risky nature of trust fund handling and how even unintentional acts could lead to formal discipline. In my line of work, I have countless stories and cautionary tales to share which exemplify what can go wrong when a real estate broker mishandles trust funds. The following illustration is just one example of trust fund mishandling and the high cost of non-compliance.

A few years ago, a real estate broker who had an in-house escrow division consulted with me after the DRE filed an accusation against their firm. For those who may not be aware, a “broker-controlled escrow” is when a real estate broker acts as both a broker on behalf of one party and also as the escrow holder on the same transaction. In this case, the escrow officer, who was an employee of the broker, accidentally and unknowingly deposited $150,000, representing a buyer’s final down payment, into the broker’s general operating account instead of the trust account. This error was the result of the escrow officer using a remote deposit scanner and selecting the wrong bank account when completing the deposit transaction. Subsequently, the escrow officer proceeded to close the subject escrow transaction without the benefit of this deposit which resulted in a major trust account shortage totaling $150,000.

Furthermore, this error was discovered by the responsible broker six days later and immediately corrected. Specifically, the broker transferred the $150,000 from the firm’s general operating account back into the trust account, curing the shortage in the subject escrow and trust account. Nevertheless, the damage was already done. In fact, the brokerage was in violation of the Real Estate law on several counts. It is important to note that the ratio from one non-compliant act to a violation of the law is NOT one-to-one. The non-compliant act of accidentally making one deposit of trust funds into the broker’s general account actually caused six violations of the law which I will summarize below:

• First, the broker was in violation of trust fund mishandling due to the fact that the trust account was short as a result of the deposit error and the disbursements that were made from the trust account in the amount of $150,000;
• Second, the broker violated the DRE’s commingling rule because trust funds were deposited into the broker’s general account and commingled with the broker’s funds;
• Third, the broker failed to maintain an accurate, complete and compliant control record in violation of the law. For example, the broker’s control record indicated that there had been a deposit of $150,000 into the trust account (when it was actually deposited into the broker’s operating account), and hence the control record and the daily running balance were not correct on the date of the deposit;
• Fourth, the broker failed to maintain an accurate and compliant separate beneficiary record relative to the subject escrow. It should be noted that if a broker’s control record is not accurate, then it is likely that their separate beneficiary records (in connection with individual escrow files) are not accurate either, and that was no different in this situation;
• Fifth, the broker failed to deposit trust funds received into the broker’s trust account by the next working day in violation of the Real Estate law. In this scenario, the funds received totaling $150,000 were first deposited into the broker’s general account, and were not deposited into the trust account until six days later; and
• Finally, the Department alleged lack of broker supervision against the responsible broker. This comes as no surprise because a “failure to supervise” charge is closely tied to violations involving trust fund mishandling. One of the primary responsibilities bestowed upon responsible brokers is to ensure that the brokerage engages in compliant trust fund handling and maintains complete and accurate trust account records in line with the DRE’s laws and regulations.

To recap, one mishap involving trust funds caused several violations of law. In my opinion,  this is a persuasive example of what can go wrong when handling trust funds, even when you are trying to do everything right. In this instance, there was no intentional motive on the part of the broker to violate the law, commingle or convert trust funds. Contrarily, the deposit into the broker’s operating account was a mere accident. Nonetheless, this error resulted in a formal accusation being filed against the real estate broker and eventually, administrative discipline.

With regards to discipline, the broker was fortunate in this case to receive a “public reproval,” the lowest level of formal discipline that may be rendered by the DRE against a real estate licensee. By “fortunate,” I am referring to the fact that the discipline did not include any suspension, restriction or revocation of their real estate license, which based upon my experience, is not always the norm. Additionally, the broker was required to pay the Department over $10,000 in audit and enforcement costs, and incurred costly legal fees in order to receive such a settlement.

Ultimately, the broker has formal disciplinary action on its real estate license record now, which can be reviewed by anyone on the DRE’s website. Therefore, the broker’s reputation has also been damaged and some may argue that this punishment far exceeds any fees paid or financial penalties rendered.

Broker Supervision

Admittedly, I know many brokers who have accidentally deposited trust funds into their general operating accounts versus their trust accounts. Sometimes this deposit error is discovered by the broker right away and prior to causing any shortages in their trust account. This timely discovery is usually by design and the result of appropriate policy and procedures in place, and an effective system of broker supervision, where daily controls exist in order to catch such trust account issues. On the other hand, a deposit error such as this one may go unnoticed for several days or much longer, causing trust account shortages, other violations of law, and an unforgiving paper trail evidencing lack of supervision and oversight by the responsible broker.

Sadly, it is not uncommon for some brokers to mistakenly engage in non-compliant trust account activities. While some of these brokers have managed to escape regulatory scrutiny, their fate can quickly change with just one DRE audit examination. Moreover, the primary point to take away here is that one unintentional accounting issue can potentially cause extensive regulatory repercussions.

Think Ahead

When a real estate broker decides to take on trust fund handling, they must fully commit to a new world of compliance which requires a “premeditated” or proactive game plan. This plan, which should be comprehensive and meaningful, should incorporate the following, without limitation:

• A review and understanding of the laws and regulations enforced by the DRE. If you do not understand the requirements or have questions, it is wise to seek outside help or assistance which may include a licensed real estate attorney, compliance consultant, or even contacting the DRE for clarification;
• Creation of, adherence to, and enforcement of sound policy and procedures which will enable the broker to fully satisfy and continually stay compliant with the DRE’s statutory expectations and rules;
• Establishment of a well-rounded and structured system of supervision which requires daily and monthly trust fund controls and maintenance, methods of review, spot-checking, brokerage reporting requirements, and risk management; and
• Supervision and oversight by the responsible broker which may also include reliance on some delegation of authority and supervisorial responsibility to other affiliated and trusted licensees.

The above outline of highlighted tasks serves as a high-level description of what needs to be done, and truthfully, it only gets harder and more complex as you iron out the critical details needed to make real compliance possible. Notwithstanding, the important thing to keep in mind is that without this type of wholehearted and robust course of action, complete with constructive controls, a broker will not have the necessary tools to actually carry out, achieve and monitor compliance, and their license, business and reputation will be at risk.

For those brokers already knee-deep in trust fund handling, they are not precluded from this exercise and overall discussion. Real estate brokers can always stop and re-evaluate their trust fund handling compliance and broker supervision, and ideally, before they are audited by the DRE. The self-evaluation and identification of non-compliance, as well as the correction of existing policy, procedures, systems and rules, in good faith by any broker, always has value and is strongly recommended no matter how compliant or non-compliant they may be.

Closing thoughts

The goal of this piece is not to scare or deter real estate licensees from engaging in trust fund handling, but to motivate them. If real estate licensees are going to handle trust funds, it would be wise to first adopt a multi-pronged approach to regulatory compliance. Without the execution of fundamental tasks as briefly touched on above, a broker is walking a tightrope that could cost them their real estate license if they lose their balance. As I like to preach, please do your homework, read and take steps to understand the law and requirements, ask questions, create solutions to potential problems (before they occur), hire outside help if you have to, and get the job done right the first time. Put another way, and more crudely perhaps, invest in trust fund compliance now or trust fund mishandling could be your reality and all the consequences that come along with it.

Author’s note: Any opinions, or recommendations contained in this article are based on my experience working for, and knowledge of the laws and regulations enforced by, the California Department of Real Estate, and must not be considered legal advice. Please consult with a licensed real estate attorney for legal support or clarification.

Related firsttuesday video:

Related topics:
audit, compliance, dre, supervision, trust funds

Posted by Guest Author Summer Goralik | Aug 10, 2023 | Fundamentals, Laws and Regulations, Real Estate, Your Practice | 0

Reprinted from firsttuesday Journal  — P.O. Box 5707, Riverside, CA 92517

Real Estate Compliance Consultant and former California Department of Real Estate (DRE) Investigator, Summer Goralik, reminds agents of the proper handling of termite inspection reports. Learn more by visiting the original post on her blog Expert DRE Compliance.

Disclosure of termite inspection reports in California

While the disclosure of structural pest control reports, also known as “termite inspection” reports, by licensees to purchasers of real property is an old staple on the regulatory radar of the California Department of Real Estate (DRE), this area of compliance is not typically gleaned as a hot enforcement topic among agents and brokers. Recently though, I encountered a situation that is not only worthy of an article, but should motivate licensees about the utmost importance of understanding and strictly complying with all of the DRE’s requirements covering termite inspection reports. Put another way, a compliance wake-up call for one brokerage or agent can fortunately serve as a valuable learning lesson for other real estate licensees in the industry.

Admittedly, the purpose of this piece is threefold: to remind licensees about the DRE’s rules involving the disclosure of termite inspection reports; to highlight some thoughtful considerations for agents and brokers when it comes to the handling and delivery of termite inspection reports to the parties of a sale; and finally, to warn responsible brokers who oversee agents about the necessary supervision and controls required.

Required compliance

First things first, let’s discuss what is actually required of California real estate licensees. Pursuant to Commissioner’s Regulation (Regulation) 2905 enforced by the DRE, “In a real estate transaction subject to the provisions of Section 1099 of the Civil Code, the real estate broker acting as agent for the seller in the transaction shall effect delivery of the inspection report, certification and the notice of work completed, if any, to the buyer in accordance with said section.”

The Regulation further states that “if more than one real estate broker licensee is acting as an agent of the seller in the transaction, the broker who has obtained the offer made by the buyer shall effect delivery of the required documents to the buyer unless the seller has given written directions to another real estate broker licensee acting as agent of the seller in the transaction to effect delivery.”

With regard to “responsible brokers,” the Regulation requires that the broker maintain a record of the action taken to effect compliance with this requirement, which is of course part of the broker’s statutory duty to ensure that all records obtain or executed in the course of licensed activity are retained.

It should be noted that unlike the Real Estate Transfer Disclosure Statement or Natural Hazard Disclosure, which are required by State law, a “structural pest control report” is not a mandatory disclosure. But, if and when a termite inspection report (e.g., inspection, re-inspection, supplemental, certification and notice of work completed) in connection with a property exists and/or has been ordered, then the broker and/or agent should be aware of their duties to disclose said report(s) to the buyer of real property. [See RPI Form 304 and 314]

While I believe most real estate licensees are generally aware of these basic requirements, because after all, this issue is part of a larger discussion regarding disclosure and an agent’s duty to disclose all facts materially affecting the value or desirability of real property, let’s hone in on some fundamental details that agents and brokers should consider when handling termite inspection reports.

Important considerations

The following are some important elements that real estate licensees would be prudent to consider when handling and delivering termite inspection reports to the parties of a sale, which essentially aim to help agents and brokers avoid transactional issues, non-compliance and potential complaints filed with, and investigated by, the DRE.

Disclose material information – no exceptions

While I do not want to cut any corners here, the focus of this piece is to highlight disclosure obligations bestowed upon an agent, representing the seller, who is aware of material information, namely, a termite inspection report, and their duty to disclose that information to the buyer’s agent or buyer. Specifically, let’s concentrate on the moment before a contract has been entered into between the parties, and the responsibility of the agent representing the seller who learns, or is in receipt of, a termite inspection report covering the subject property. This report may represent an inspection that took place before the property was listed for sale, or perhaps was ordered in connection with the listing. Either way, under these circumstances, the seller’s agent will have a duty to disclose and deliver this termite inspection report to the buyer.

To make matters more interesting, what if a seller has two termite inspection reports in their possession, issued by two different companies, and one inspection report reflects more or less damage than the other? The requirements don’t change here; any and all termite inspection reports need to be disclosed. In other words, the agent, or seller, does not get to pick and choose which termite inspection report will be disclosed to the buyer.

Conversely, when an agent representing a seller has material knowledge about a “second” termite inspection report, but fails to disclose it to the buyer, this frequently leads to the filing of a complaint with the DRE. In those cases, it is not uncommon for that undisclosed “second” termite inspection report to reveal more significant termite damage to the property than the termite inspection report that was disclosed to the buyer (and likely not by coincidence). More to come on this subject later.

The punchline on disclosure should be loud and clear: a real estate licensee must disclose all material information, which in this instance would mean all termite inspection reports, to the buyer.

Delivery of termite inspection report(s)

Another important aspect embedded in this area of compliance is how an agent delivers such reports to the buyer’s agent or buyer. This should be a thoughtful process, as opposed to haphazard or rushed. Meaning, as an agent representing the seller, when delivering material information regarding a property, as part of their duty to disclose all material information and facts, then they must make sure you handle and deliver this information with care. In other words, without proper delivery and written evidence or confirmation of receipt, it might be alleged that it never happened.

Nowadays, most agents deliver all documents, including material ones, to the parties of a real estate transaction by email. While this is generally fine and usually preferred, as it affords them the ability to have an automatic copy of what was sent, they must still ensure that the paper trail is clear and provides adequate proof of the actions that were taken.

Remember, everything a licensee does or says in the course of licensed real estate activity is, or will be, reviewed or evaluated by someone, whether it’s their client, the government, or the public. So, as I said before, take care in how material information is delivered to the parties. What a licensee says today, might be investigated a year later, and they will need to be able to clearly speak to the matter, explain information in detail and include supporting evidence.

Perhaps more important than the delivery of information, is the confirmation of receipt, which will be discussed below.

Obtain written receipt

As an agent delivering a termite inspection report (or any property report) to the buyer, especially in the case of multiple reports issued by different companies, it is imperative that their receipt of any and all reports be documented in writing. Without clear evidence of receipt, you have missed a crucial step. The reality is, a licensee’s failure to document receipt of material information not only puts their client at risk, but their real estate license too.

But let’s dig deeper on this one as the details actually matter. Because I used to work in the escrow industry, I know first-hand that a lot of buyers will be asked to only sign the first page of a termite inspection report, to signify that they received the entire subject report. Honestly, I did not like that practice then, back in the early 2000s, so as you might suspect, I am still not a fan of that practice now.

In my opinion, if an agent seeks the signature of a buyer on the physical termite inspection report, as written acknowledgment of their receipt, then they need to obtain their signature on each page of the report. Or, yet another way to evidence receipt, would be to have the buyer sign an acknowledgement or detailed receipt which clearly identifies the name of the termite company who issued the report, the date of the report, the type of the report issued, and the number of pages that the report contains.

Of course, I am well aware that brokers have policies (or at least I hope that most do) which specifically instruct agents on how to effect compliance in this area. The last thing that I want to do is interfere with that policy or instruction. Conversely, my point is simple: if a licensee doesn’t unequivocally obtain written receipt from the buyer evidencing delivery of a particular report, then it could come back to haunt them.

Broker supervision

A responsible broker operating under the DRE’s jurisdiction must ensure regulatory compliance by their brokerage and agents. Part of that job, which can be exhausting at times, is to make sure that their agents are well-trained regarding what is required of them when transacting with principals and clients in connection with the purchase or sale of real property.

In the case of termite inspection reports, it is absolutely tantamount to have policy and procedures in place, as well as training programs covering those policies, that educate and instruct agents to not only deliver and disclose all material information and reports to the buyer, and obtain their acknowledgment of all reports, but to make sure that this evidence is properly captured by the agent in writing and delivered to the broker.

In turn, when all documents are delivered to the broker, it is up to the responsible broker to ensure that their files are complete and in compliance before the closing of the sale, and that all transaction documents are retained in accordance with the Real Estate Law. If delivery of all material information and written receipt are sustained, and the paper trail clearly documents that process, then the agent and broker’s fulfilment of their statutory duties are memorialized.

The truth is, a broker and agent must work together. Regulatory compliance and success are the result of their concerted actions. Namely, the broker must make reasonable efforts to ensure that their agents are knowledgeable about the DRE’s requirements, their duties as an agent, and the broker’s policy covering the delivery and receipt of property reports. On the other hand, the agent needs to fulfill their end of the bargain by disclosing all material information as required, documenting proof of delivery and receipt, and submitting all transaction records to their broker.

It should be noted that even when an agent has made a mistake, some brokers, who have an effective and efficient system of supervision in place, may be able to catch the inadvertent error committed by their licensees, and correct or remedy the issue before any harm or risk is incurred. While I wish I could say I have witnessed more examples of that scenario, that is not the case. More commonly, it’s when policy and procedures are ignored by the agent, and/or not properly enforced by the responsible broker, and the process breaks down, that regulatory issues develop.

Breakdown, breakthrough

When it comes to real estate compliance, sometimes it takes a real-life enforcement story to drive the issue home in order to change minds or better yet, practices. I was recently involved in a case assisting a brokerage and their agent with an Accusation filed by the DRE. The alleged violations were the failure to deliver all termite inspection reports to a buyer, or more crudely put, the engagement in acts constituting misrepresentation, omission or concealment of materials facts, and essentially, dishonest dealing. Additionally, the designated officer of the brokerage was accused of lack of supervision.

Without going into all of the details, the crux of the case was that the agent, who represented the seller, was aware of and possessed two termite inspection reports, issued by two different companies. One report appeared to contain more extensive findings regarding termite damage than the other, and it was precisely this particular report that was not disclosed to and/or received by the buyer, or at least that was the allegation.

In this case, the agent emailed several documents and reports to the buyer’s agent, and claims that both termite inspection reports were attached to that email. It was later discovered that the agent was wrong, and that the “second” termite inspection report was not actually delivered to the buyer by email. Although the agent claimed that this second termite inspection report was also delivered in person to the buyer, there was no written evidence to support that claim. Needless to say, the buyer later experienced issues with the property and ended up filing a complaint with the Structural Pest Control Board. Through that investigation, the buyer learned of the second termite inspection report. Eventually, the buyer filed a complaint with the DRE.

As it turns out, the second termite inspection report was not delivered to the broker or uploaded into their transaction management software along with the other file documents. Therefore, the broker was only aware of one termite inspection report. It should be noted that, in this case, there was evidence that the brokerage and its designated officer performed reasonable supervision over the firm, its agents and their licensed activities. In addition to the establishment and enforcement of exemplar policy and procedures, as well as the employment of licensed file checkers to review all transaction files for compliance before closing, the broker also had training programs in place to educate agents about disclosure, transaction compliance, and DRE requirements.

Notwithstanding, the agent’s error, whether it was inadvertent or not, resulted in the formal filing of an Accusation by the DRE, with the brokerage, its designated officer, and additional licensed broker officers also named as Respondents. Hence, all parties were accused of wrongdoing and subject to potential discipline by the DRE.

Fast forward to the end, the real estate licensees were actually successful in their defense against the DRE’s Accusation, which I would argue is not a typical conclusion of a “failure to disclose” case. Keep in mind that this is my “drive through” version of the story and there were other facts, witnesses and circumstances which played a part in the resolution. More importantly, it should be pointed out that this result was only after an investigation was conducted, significant legal expenses were incurred, and an administrative hearing was held.

The real takeaways

Truthfully though, the core message to agents is that this whole ordeal could have been easily avoided. If the agent had properly ensured that all termite inspection reports were provided to the buyer and obtained a clear written receipt evidencing that both termite inspection reports were received by the buyer, then there would be no tale to tell here; no DRE complaint; no investigation and no legal proceeding.

The other part of the message speaks directly to responsible brokers: Broker supervision is critical. Without it, the firm, the responsible broker and agents are all at risk. To “say” that a responsible broker reasonably supervises their agents has no value. The real proof is the actual system of supervision in place. To that end, a responsible broker must be able to provide evidence to the DRE that they have appropriate supervisory controls in conjunction with established policy and procedures in all areas of requisite compliance.

With respect to the disclosure of termite inspection reports, and a situation like the one described in this piece, a responsible broker who is investigated by the DRE is tasked with the following: They must point the DRE to the policy and procedure that requires agents to disclose all material information to their principals and clients; to submit all documents to the broker; to make sure all reports have been delivered to the parties and that the buyer’s written receipt of all reports has been obtained; and to report to the broker when there are any disclosure, legal or compliance issues or questions, or when an agent is unable to effect compliance in this area.

Furthermore, a broker must illustrate to the DRE how and when transaction documents and files are reviewed for compliance, as well as who is responsible for this review and the procedure or system by which this process is monitored and supervised. Lastly, the broker would be wise to have some kind of training program or other method in place which educates agents about the broker’s requirements and how to satisfy them.

Moreover, returning again to my earlier message, when it comes to regulatory compliance, the broker and agent must work together. Each relies on the other to do their job, and to do it right. Without this partnership, there is potential risk.

Closing thoughts

When it comes to the disclosure of termite inspection reports, any property reports, and/or material information, agents should think twice before sending a text message or simply pressing “send” on a quick email containing a pertinent attachment. Handle material information carefully, ensure delivery of all documents and disclosure to the rightful parties, and obtain written receipt. Or, stated a bit differently, the execution of an agent’s statutory duties must be performed with extreme care and diligence.

If responsible brokers are reading this article, hopefully it’s incredibly obvious how integral their roles are to the regulatory success of their agents, transactions and firms, and how their personal licenses are undoubtedly on the hook when things go wrong.

Again, while the disclosure of termite inspection reports, or any material information, is a seemingly simple and straightforward task, let this article serve as “Exhibit A” on how the failure of an agent to correctly perform this function puts everyone at risk and may subject the brokerage to the full gamut of regulatory scrutiny.

NOTE: Any opinions, suggestions or recommendations contained in this article are based on Summer Goralik’s experience working for, and knowledge of the laws enforced by, the Department of Real Estate, and must not be considered legal advice. Please consult with a licensed real estate attorney for legal support or assistance.

Related article:

Brokerage Reminder: Timely termite inspections – eliminate the risk

Related topics:
broker supervision, property disclosures, termite inspection

Posted by David Swistock | Jun 26, 2023 | Buyers and Sellers, Real Estate, Recent Case Decisions | 0

Reprinted from firsttuesday Journal  — P.O. Box 5707, Riverside, CA 92517

Holt v. Brock

Facts: A co-owner of a property files a partition action to sell the property and distribute the proceeds to the individual owners.  The court appoints a broker to market and sell the property.  One of the co-owners submits an offer to purchase the property including a provision reducing the broker’s fee in the listing agreement, which the broker initially agrees to, but before court confirmation withdraws acceptance of the reduced fee.  Due to the co-owner’s intent to purchase the property, the court appoints a receiver to manage and approve the sale between co-owners. The co-owner submits an offer to purchase the second co-owner’s half interest in the property, and the second co-owner submits a higher offer to purchase the co-owner’s interest. The receiver accepts the second co-owner’s more competitive offer and the sale is closed. The bought-out co-owner makes a demand on the broker for money losses based on the greater price they would have received from the initial abandoned offer.

Claim: The bought-out co-owner claims the broker breached their fiduciary duties owed to the co-owner since the broker breached their agreement to accept a reduced fee in an offer to buy the property submitted by the co-owner which would have produced greater net proceeds.

Counterclaim: The broker claims they owe no fiduciary duties to the co-owner since the court is their client, not the co-owner.

Holding: A California appeals court holds the broker did not breach their fiduciary duties since they were acting as an agent for the court, not an agent for the co-owners, and the court receiver approved the sale. [Holt v. Brock (2022) 85 CA5th 611]

Holt v. Brock

 

Related Reading:

Legal Aspects of Real Estate Chapter 8: Listings as employment – Employed to act as an agent
Chapter 35: Forcing co-owners out

Watch:

Word-of-the-Week: Fiduciary duty

 

Related topics:
agency relationship, broker fees, fiduciary duty,

Posted by David Swistock | Jun 6, 2023 | Laws and Regulations, Real Estate, Recent Case Decisions | 0

Reprinted from firsttuesday Journal  — P.O. Box 5707, Riverside, CA 92517

Hobbs v. City of Pacific Grove

Facts: A city annually issues licenses permitting the operation of transient rentals in residential areas. The city restricts the number of licenses issued, a condition all transient rental licenses are subject to. After issuing licenses, the city determines they issued too many licenses. To correct the surplus of licenses issued, the city conducts a lottery to decide which licenses are ineligible for renewal. A license holder was selected for non-renewal following the license’s expiration.

Claim: The license holder seeks to compel the city to renew their transient rental license, claiming the city violated their procedural and substantive due process rights since they were not given an opportunity to be heard on the matter and the inability to renew is overly burdensome as an operator of transient occupancies.

Counterclaim: The city claims they had no obligation to extend licenses since issuance of the transient occupancy operator’s license was conditioned on a limited number to be annually renewed.

Holding: A California appeals court holds the holder of a license to operate transient rentals had no right to the renewal of their license since the license was conditional and the city’s restrictions on the issuance of transient licenses were reasonably related to the public interest for housing. [Ramirez v. PK I Plaza 580 SC LP (2022) 85 CA5th 252]

Hobbs v. City of Pacific Grove

 

 

Related Reading:

Legal Aspects of Real Estate — Chapter 6: Types of tenancies — Transient occupants and their removal

RPI Form 593 — Guest Occupancy Agreement – For Transient Occupancy Properties

 

 

Related topics:
city ordinances, license renewal, license revocation, short-term rentals (str)

Posted by David Swistock | Aug 14, 2023 | Bay Area, Laws and Regulations, Real Estate, Recent Case Decisions | 0

Reprinted from firsttuesday Journal  — P.O. Box 5707, Riverside, CA 92517

NCR Properties LP, v. City of Berkeley

Facts: An owner of two single family residences (SFRs) used as rooming housing with each having one uninhabitable floor converts the improvements on each lot into triplexes for a total of six separate dwelling units. Two of the six units were the previously uninhabitable floors. The properties are subject to rent control ordinances which exempt new construction. The city determines only the two units located in previously uninhabitable space are exempt from the rent control ordinance as new construction. The owner seeks to exempt all six of the units as new construction.

Claim: The owner claims all six renovated units are exempt from the ordinance since they are new construction, and the renovations increased the supply of available housing as more units were offered than before.

Counterclaim: The city claims four of the renovated units are not exempt from the rent control ordinance since they were conversions of space used for residential occupancy and not new construction.

Holding: A California appeals court holds the four converted units are not exempt from the rent control ordinance since the space in the existing structure now housing the four units was previously used for residential purposes. [NCR Properties LLC, v. City of Berkeley (2023) 89 CA5th 39]

NCR Properties LP, v. City of Berkeley

Related Reading:

Property Management: Chapter 58: Residential rent control

Legal Aspects : Chapter 16: Covenants, conditions and restrictions

 

Related topics:
conversion, home improvement, new construction, rent control, subdivision

Posted by Carrie B. Reyes | Apr 17, 2023 | Buyers and Sellers, Feature Articles, Real Estate, Your Practice | 0

Reprinted from firsttuesday Journal  — P.O. Box 5707, Riverside, CA 92517

This article explains how to avoid premature termination of a purchase agreement when objectives can be met by extending dates for events or activities to take place.

To read about when a buyer or seller may exercise their right to cancel the purchase agreement and terminate the transaction, see Part 1.

Foreseeable delays are ever present

Consider a buyer and seller who enter into a purchase agreement. They set a date to close escrow. Despite the buyer’s and all third parties’ diligence to clear all conditions leading up to closing, delays occur, making it impossible to close by the agreed-to deadline.

The alternatives for the seller are to cancel or agree to an extension of time to complete an activity or bring about an event. When permitted by provisions and activities establishing deadlines as essential to continuing the agreements, the seller may cancel the purchase agreement.

However, to meet the original objectives on entering into the purchase agreement, the seller has a discussion with the agents to determine whether to keep the transaction together. To proceed to closing, the additional time reasonably needed by the buyer, or others, to complete their performance is established.  An extension of time sufficient for the buyer to perform is prepared and entered into by the buyer and seller.

RPI does not publish a form to extend a transaction’s closing date. Formal extension are usually unnecessary when using an RPI purchase agreement and typical escrow instructions. [See RPI Form 150]

RPI forms are deliberately engineered to be simple. The goal is to fully avoid all inoperative and unneeded language typically appearing throughout forms distributed by other publishers. Further, RPI forms eliminate provisions that are contrary to the very intention for entering into an agreement.

Building on the objective of plain wording and a need to be functional, RPI forms do not include a time essence provision such as included in other publishers’ forms (like those released by the California Association of Realtors (CAR)). Thus, while a specific form extending the closing date is not needed except to establish an extension of time as essential for cancellation, you may use a general addendum to amend or extend an existing agreement, or simply ask escrow to draw up an amendment addressing the extension. [See RPI Form 250]

By design, terminating an agreement by cancellation is not an available remedy until time becomes material by a written extension. [See RPI Form 150 §10.2]

Time to close extended by notice

To establish the right to cancel when time is not stated or established in the provisions of a purchase agreement or escrow instructions as reason alone for canceling, the person in default needs to be placed on notice — given a heads up — that the date set as the “new deadline” will be strictly adhered to.

Further, the person in default needs to be allowed a realistic period of time following receipt of a notice to perform before any cancellation is considered effective. Continued nonperformance past the new deadline date noticed will be treated as a default, and escrow may immediately be canceled. [See RPI Form 181-1]

For example, a purchase agreement calls for a buyer to close escrow within 45 days after acceptance. No time-essence clause, cancellation provisions or agent authorization to extend performance dates exist. [See RPI Form 150 §12.2]

The seller agrees with the buyer’s request to extend the date for closing an additional 30 days during which the buyer is to complete their arrangements to close escrow. Two days after the extension period expires, the seller cancels the transaction.

Is the seller’s cancellation of the transaction effective?

Yes! The 30-day extension agreed to establish a reasonable amount of time for the buyer to perform before the seller exercised their right to cancel. A further unilateral extension of time is not needed for the cancellation to be reasonable and effective. [Fowler v. Ross (1983) 142 CA3d 472]

The seller is on notice

Consider a purchase agreement containing a simple time-essence clause. No provision grants the agents authority to extend performance dates. The transaction is taking place during a downward cycle in sales volume and property prices (as is occurring during 2023).

Consistent with the time-essence clause in the purchase agreement, the escrow instructions authorize escrow to close at any time after expiration of the escrow period, unless escrow first receives instructions calling for the return of documents and funds.

The date scheduled for performance proves to be an inadequate amount of time for the seller to complete or bring about all of their closing activities. The buyer discovers they can buy a comparable home at a price lower than the price the seller is to be paid by the buyer.

One day after the passing of the date scheduled for closing, the buyer cancels escrow. Twelve days later, the seller, using diligence at all times, is able to clear title and close.

The seller challenges the buyer’s cancellation as premature and ineffective. The seller claims the buyer is required to grant the additional time needed to close escrow before the buyer may cancel the transaction and thus forfeit the seller’s right to enforce the buyer’s promise to purchase the property.

Is the seller entitled to the additional time needed to close escrow?

No! The seller was on notice by the existence of the time-essence clause in the purchase agreement and the wording of the escrow instructions that the buyer had the right to cancel on failure of escrow to close by the date scheduled. No provision in any document expressed an intent which was contrary to the time-essence provision in the purchase agreement.

Thus, the buyer’s cancellation, one day after the appointed closing date, was in accordance with the intent stated in the purchase agreement and escrow instructions, i.e., that timely performance was essential to the continuation of the transaction.

More importantly, escrow instructions authorize escrow to return deposited money and instruments on the demand of either the buyer or seller when the closing does not occur on or before the date set. Thus, the buyer was not required to grant the additional time reasonably necessary for the seller to close the transaction. [Ward v. Downey (1950) 95 CA2d 680]

Related article:

Buyer breach of contract in a decreasing price environment: Seller remedies

Intent in conflict with time-essence clause

Consider the opposite situation: a sale taking place during a rising-price environment.

A provision in the purchase agreement authorizes the agents to extend the time for performance of any activity for a “period not to exceed one month.” The purchase agreement also includes a boilerplate provision stating “time is of the essence.”

Escrow is for a 60-day period, the end of which is the appointed date for closing the transaction. As usual, the escrow instructions state escrow may close at any time after the date scheduled for closing, unless instructions to the contrary have been received.

On the date scheduled for closing, escrow is not in a position to close due to the buyer’s inability to immediately record their purchase-assist mortgage which was necessary to fund the price to be paid. The seller (seeing an opportunity to cancel and re-list at a higher price) immediately cancels escrow to terminate the transaction, claiming time was of the essence by agreement.

Is the seller able to cancel without giving an extension of time when both a time-essence and an authority-to-extend provision exist?

No! The bargain struck by the conflicting provisions controlling performance dates did not contemplate time for the occurrence of activities or events by their appointed dates to be so essential that the transaction may be cancelled on the mere passing of the appointed date.

The use of a purchase agreement (or escrow instructions) containing wording that “time is of the essence” does not allow for the forfeiture of contract rights on a failure to perform within the agreed time period when other provisions express a contrary intent which is consistent with the common objectives on entering into the agreement.

Related article:

California tiered home pricing

Original bargain enforced

When logic permits, courts ignore boilerplate time-essence clauses and enforce the original bargain, if no financial harm results from the delay.

In the prior example, the purchase agreement (or escrow instructions) gave the agents the unconditional right to extend performance dates. Thus, being able to close by the date set for closing escrow is hardly considered crucial to the continued viability of the transaction. Also, the seller receives the full benefit they expected on entering into the agreement and incurs no loss on the delay.

Accordingly, the seller needs to give the buyer a reasonable amount of time to close escrow, i.e., the additional days needed to record the buyer’s loan before the buyer’s failure to perform justifies exercising the right to cancel. [See RPI Form 181-1]

When failure to fund is not a default

Before a buyer or seller may consider cancelling a transaction, the other person needs to have defaulted on their completion of an activity, or an event needs to have failed to occur.

On the date set for the close of escrow, buyers often have not deposited their down payment funds into escrow as called for in the purchase agreement and escrow instructions. When the deposit of closing funds or the lender’s wire of loan funds does not occur as scheduled, the buyer has not yet performed their obligation to close escrow. However, the failure to fund does not necessarily mean the buyer has defaulted on the purchase agreement, allowing the seller to cancel the transaction.

The question which arises for a seller who is attempting to cancel when agreed-to provisions state performance schedules are essential to the continuation of the transaction and the buyer or the buyer’s lender has not delivered closing funds, is whether the buyer is in default on the agreement, or is not yet obligated to deposit funds.

Escrow, as a matter of custom, will not call for a wire of closing funds from the mortgage lender or the buyer until escrow is in a position to close. Escrows, as an entirely practical matter, do not want closing funds sitting in an escrow which is not yet ready to close.

Specifically, before escrow will call for closing funds, the seller needs to have already fully performed by providing documents so the conveyance of title is able to be insured, and prorates and adjustments may be accounted for as called for in the escrow instructions. When the seller has not delivered instruments so escrow is in a position to close by the date scheduled for closing, escrow will not make a demand on the buyer or lender for funds.

Likewise, the buyer has no obligation to deposit further funds into escrow and is not in default before escrow requests funding. Until the buyer is in default due to a failure to timely respond to escrow’s request for funds, any attempt by the seller to cancel is premature and ineffective.

Escrow instructions usually state the buyer is to deposit funds for use by escrow provided the seller has performed. Thus, the obligation of the buyer to deposit closing funds is subject to the seller first performing, a condition precedent to the buyer’s performance. Therefore, the buyer’s “failure” to deposit funds before escrow is in a position to close is excused. [See RPI Form 150 §12.2]

Related article:

Time to perform as staging a cancellation

Consider a seller who is unable to convey title to a buyer and deliver a title insurance policy by the closing date called for in the purchase agreement and escrow instructions. The title company cannot issue a policy as ordered due to encumbrances affecting title which have not been released and the amounts needed for discharge and payoff have not yet been determined.

Here, the time for closing has arrived and the seller is not yet able to deliver marketable title as agreed. Thus, until the seller can obtain title insurance for their deed, the buyer is not in default for not yet depositing their funds.

Cancellation right waived by conduct

Even when the date scheduled for a buyer or seller to perform is stated as crucial, inconsistent conduct by the person entitled to cancel constitutes a waiver of their right to cancel. Once the right to immediately cancel has been waived, the person who failed to perform by the agreed deadline is no longer in default. Until the person who failed to perform is placed in default again, the right to cancel cannot be exercised.

For example, the date set for escrow to close arrives. The seller has not yet handed escrow clearances which are required before escrow may close.

A few days after escrow is scheduled to close, the seller deposits the clearances with escrow. The buyer deposits their closing funds on a call from escrow.

Two days later, the seller cancels escrow, claiming the buyer was in default since they failed to deposit their funds by the appointed date.

Here, the cancellation is ineffective and the buyer is entitled to close escrow. The seller waived their right to cancel, time having been of the essence, by conducting themselves without concern for the passing of the appointed date for closing. The seller failed to deliver documents or information sufficiently in advance for the buyer to meet the deadline. [Katemis v. Westerlind (1953) 120 CA2d 537]

Affirmative conduct and time as essential reinstated

A waiver by inaction does not occur simply because a person’s right to cancel the transaction is not immediately exercised on the failure of the other person to perform or an event to occur. Affirmative conduct inconsistent with enforcement of the performance deadline needs to occur by the person entitled to cancel, not just mere inaction, before the right to cancel in a time-essence situation is waived.

After a waiver of a date scheduled for approval of a condition or activity, time needs to be reinstated as crucial to the continuance of the transaction, or a reasonable, additional time period for performance must have passed after waiver of the right to cancel, before the transaction can be cancelled.

Time is best reinstated as essential to the continuation of the transaction by notifying the person who needs to perform that they are required to perform by the end of an additional period of time, set with sufficient duration as needed to provide them with a realistic opportunity to perform.

When performance is not forthcoming during the additional time period, the transaction may be promptly cancelled since strict compliance with the extension is now enforceable.

Related article:

Cancellation excuses further performance

Related topics:
cancellation, purchase agreement, rpi forms

Posted by Amy Platero | Sep 5, 2023 | Buyers and Sellers, Forms, Property Management, Real Estate | 0

Reprinted from firsttuesday Journal  — P.O. Box 5707, Riverside, CA 92517

An option to buy granted to a tenant

A landlord grants a tenant an option to purchase by entering into an irrevocable right to buy the property, called an option to buy.

The option to buy is typically evidenced by a separate agreement attached to the lease agreement. An option to buy includes the terms of purchase, none of which are related to the leasehold estate the tenant holds in the property. The option to buy is always referenced in the lease agreement and attached as an addendum. [See RPI e-book Real Estate Property Management, Chapter 6]

An option to buy contains all terms needed to form an enforceable purchase agreement for the acquisition of the real estate when the buyer exercises the option. [See RPI Form 161]

The tenant holding an option to buy has the discretionary right to buy or not to buy on the sales terms stated in the option. To exercise the option, the tenant does so within an agreed-to time period. No variations are allowed for enforcement.

Thus, the option is a purchase agreement offer irrevocably agreed to by the owner to sell, but the tenant has not agreed to buy. To agree to buy the property under an option, the tenant exercises their right to buy through an acceptance of the irrevocable offer to sell granted by the option.

The option agreement

Under an option to buy agreement, the tenant is not obligated to buy the leased property. The tenant is merely given the right to buy by a later timing exercise of the option. This is a type of call option. [See RPI Form 161]

For the option to be enforceable, the purchase price of the property and terms of payment on exercise of the option are included in the option agreement. The consideration given the owner by the tenant for the grant of the option is the tenant’s execution of the lease agreement. Option money is not also needed. [See RPI Form 161 §9]

When the dollar amount of the price is not set as a specific dollar amount in the option agreement, the purchase price may be stated as the fair market value (FMV) of the property at the time the option is exercised.

The right to buy is exercised by the tenant within a specified time period, called the option period. The option period typically runs until the lease expires or is terminated, including extensions/renewals. [See RPI Form 161 §4]

When the option is not exercised precisely as agreed during the option period, the option period expires of its own accord — no further notice or documentation is needed.

On expiration of the option, the option no longer exists, and the tenant is without an enforceable right to acquire the property. [Bekins Moving & Storage Co. v. Prudential Insurance Company of America (1985) 176 CA3d 245]

When options to renew or extend leasing periods are negotiated as part of the leasing arrangements, the expiration of the option to buy is tied by agreement to either:

• the expiration of the initial lease term; or
• the expiration of any renewal, extension or continuation of the tenant’s lawful possession.

Related article:

Form-of-the-Week: Option and Exercise of Option to Renew/Extend a Lease — Forms 565 and 566

A right of first refusal differs from an option to buy 

A right of first refusal is a contractual pre-emptive right held by a person to buy a property in the event the owner later decides to sell it.

The right of first refusal is often confused with an option to buy as they share similar characteristics.

Recall that an option to buy is an irrevocable right held by a person, typically a tenant, to purchase a property for an agreed-to price during a specified period of time.

In contrast, a right of first refusal, though similar, refers to an opportunity held by person, often a tenant, to purchase the property in the event the owner, such as the landlord, decides to sell it prior to the right expiring.

Further, when a third party offers to buy the property and the owner agrees to sell, a right of first refusal also provides the person holding the preemptive right with the ability to purchase the property on the same price and terms offered by the third party and accepted by the owner.

The right of first refusal is a short agreement with its provisions either included in the body of the lease agreement or by an addendum. Unlike the option to buy, the right of first refusal rarely contains any terms of a sale and does not need to for enforcement. [See RPI Form 579]

Related video:

Breaking down the irrevocable right to buy

A leasing or sales agent uses the Standard Option to Purchase — Irrevocable Right-to-Buy agreement published by Realty Publications, Inc. (RPI) when offers to rent or buy a property include a purchase option with a single time period for exercise. The form allows the leasing or sales agent to prepare an option as an irrevocable offer granted by the owner to sell a property at a price and on terms for payment exercisable during a single time period. The option form is attached as an addendum to a lease agreement or an offer to grant an option. [See RPI Form 161]

The Standard Option to Purchase — Irrevocable Right-to-Buy contains the following sections:

• Option money: a fee paid by the buyer as the optionee, to the seller as the optionor, in exchange for the exclusive right to purchase the property within the specified time period [See RPI Form 161 §1];
• Real property under option: the address or legal description of the real estate [See RPI Form 161 §2];
• Additional consideration: a checklist for selection of items the buyer is to obtain and deliver to the seller as further consideration for the grant of the option [See RPI Form 161 §3];
• Option period: the seller grants to the buyer an irrevocable option to purchase the seller’s right, title and interest in the property on the terms stated, for a period commencing with the acceptance of the option through its expiration [See RPI Form 161 §4];
• Exercise of option: the steps and methods the buyer is to use to exercise the option during the option period [See RPI Form 161 §5];
• Escrow contract: the escrow company to be used and how many days it will take escrow to close [See RPI Form 161 §6];
• Delivery of title: actions the seller needs to take for escrow to close [See RPI Form 161 §7];
• Brokerage fee: the amount and terms for payment of the broker’s earned fee [See RPI Form 161 §8];
• Sale terms: the real estate price and how it’s paid [See RPI Form 161 §9];
• General provisions: the mandated disclosures the seller is to provide to the buyer [See RPI Form 161 §10];
• Expiration of option: a specific date on which the option expires [See RPI Form 161 §11]; and
• Signatures of the seller, buyer, seller’s broker and buyer’s broker. [See RPI Form 161]

Breaking down the option to purchase with extensions to time for exercise

A buyer’s agent uses the Option to Purchase with Extensions — Irrevocable Right-to-Buy published by RPI when the buyer’s offer is for acquiring a purchase option with extensions for additional time to exercise. The form is used by an agent to prepare an option as an irrevocable offer to sell at a price and on terms for payment exercisable during an initial period or extensions of time, which is attached to an offer to grant an option. [See RPI Form 161-1]

The Option to Purchase with Extensions — Irrevocable Right-to-Buy contains the following sections:

• Option money: the dollar amount the seller will receive from the buyer as consideration for the option [See RPI Form 161-1 §1];
• Real property under option: an address and legal description of the real estate which is the subject of the option [See RPI Form 161-1 §2];
• First option period: the expiration of the extended option period [See RPI Form 161-1 §3];
• Second option period: a second option period commencing on expiration of the initial option period is granted on delivery of additional consideration [See RPI Form 161-1 §4];
• Third option period: a third option period commencing on expiration of the second option period is granted on delivery of additional consideration [See RPI Form 161-1 §5];
• Additional extensions: further monthly extensions following the third option period are granted on delivery of additional consideration [See RPI Form 161-1 §6];
• Exercise of option: the activities the buyer must perform to exercise the option [See RPI Form 161-1 §7];
• Escrow contract: the escrow company to be used and how many days it will take escrow to close [See RPI Form 161-1 §8];
• Delivery of title: actions the seller needs to take for escrow to close [See RPI Form 161-1 §9];
• Sale terms: the price of the real estate and the terms for payment of the price [See RPI Form 161-1 §10];
• General provisions: the disclosures the seller is to provide to the buyer [See RPI Form 161-1 §11];
• Expiration of option: the expiration date beyond which the option cannot be exercised [See RPI Form 161-1 §12];
• Brokerage fee: the amount and terms for payment of the broker’s earned fee [See RPI Form 161-1 §13]; and
• Signatures of the seller, buyer, seller’s broker and buyer’s broker. [See RPI Form 161-1]

Breaking down the assignment of option to buy

Agents and escrow officers handling the sale of an option to buy property, typically held by a tenant or a prospective buyer as the Optionee, use the Assignment of Option to Buy published by RPI to transfer the option rights when the Optionee sells their right to buy the property interest described in the option to another person, called the assignee who is acquiring the option rights.

The assignment form identifies the option to buy document by its date, the optionor who owns the property and granted the option, the optionee now selling their option rights to buy the property, the description of the property under option and any recording information related to the option to buy.

The form also identifies the participants to the assignment of the option as the Optionee assigning their rights to buy, and the Assignee who is acquiring the option rights to buy the property. [See RPI Form 161-2]

The Assignment of Option to Buy contains the following sections:

• Facts: the date of the option to buy, the Optionor who owns the property which is the subject of the option, Optionee who originally acquired the option rights, and a description of the property and any recording information [See RPI Form 161-2 §1];
• Agreement: the Optionee assigns their rights under the option to the Assignee acquiring the rights who agrees to perform all of the Optionee’s obligations under the option to buy [See RPI Form 161-2 §§2 and 3]; and
• Signatures of the seller and buyer. [See RPI Form 161-2]

The Assignment of Option to Buy needs to be notarized when the assignment is to be recorded. [See RPI Form 161-2]

Want to learn more about the option to buy? Click the image below to download the RPI book cited in this article.

Related topics:
california real estate forms, option agreement, option to buy, purchase option, right of first refusal

Posted by Ashley Collins | Mar 20, 2023 | Laws and Regulations, Real Estate | 1

Reprinted from firsttuesday Journal  — P.O. Box 5707, Riverside, CA 92517

The California HOME Act law from 2022 holds the power to end the housing shortage by splitting a single-family parcel in two lots and building three additional units.

On enactment of the Home Act, an estimated 700,000 units based on fourplex construction have the potential to overthrow the reigning housing shortage by building on single-family residence (SFR) parcels, according to Terner Center.

Property owners are now authorized to build three additional units for rent or resale on their SFR lots in response to the overflow of missing housing, by:

• splitting their lot into two parcels — each parcel may be no smaller than 1,200 square feet and no smaller than 40% of the original lot; or
• building duplexes — a project containing up to two dwelling units on a single-family parcel. [Government Code 66411.7 (a)]

Further, local agencies have been given strict rules for what they may and may not task an SFR owner with when the city administratively processes plans for the additional unit to fence off attacks by the not-in-my-backyard (NIMBY) action groups.

For example, plans submitted for a permit to add a residential unit on a property

within a single-family residential zone are to be considered without a discretionary review or hearing when the proposed housing development does not require demolition or alteration of low- or moderate-income housing. [Government Code §65852.21 (a)]

California builders have already been submitting plans to dive into the accessory dwelling unit (ADU) water with applications to split their lots in cities including:

• Los Angeles;
• Saratoga;
• Danville; and
• Sacramento.

However, in the same way that ADUs have historically faced a difficult approval process, the newly legislated process is turning out to be a similarly long timeline.

Related article:

Tiny homes join ADUs in the housing shortage fight

The Home Act needs an ADU update

The permit process for ADU construction has been simplified. Though it took a while for the ADU application process to be smoothed out, the Home Act for fourplex construction will benefit by adopting some of the ADU efforts.

The parceling and fourplex construction process has been a slow moving one due to the exacting standards of each local agency — and it needs some work.

Builders submitting applications for quad construction will benefit from the legislature:

• providing more standards for local zoning ordinances — such as the parameters for new units;
• creating clear instructions for the administration of local building permit procedures; and
• knocking down homeownership barriers — such as stifling infrastructure fees for small housing projects, according to the Terner Center.

It’s easier to build quads on larger lots when there’s clear instructions enabling homeowners to build. City councils are rather prone to set up obstacles to stop the permitting process with use-of-a-parcel type restrictions solely designed to interfere.

Builders and homeowners who take advantage of this new legislation have the opportunity to develop an extra source of income by building and renting residential units.

Agents and brokers need to have a conversation with their state legislator to suggest additional Home Act improvements. Also, to stay up to date on legislative updates, follow firsttuesday’s legislative gossip.

Related article:

How agents can get ahead of the mid-tier housing shortage

Related topics:
adu, california zoning, income, parcel

Posted by David Swistock | Jul 5, 2023 | Buyers and Sellers, Laws and Regulations, Recent Case Decisions, Tax | 0

Reprinted from firsttuesday Journal  — P.O. Box 5707, Riverside, CA 92517

290 Div. (EAT) v. City and County of San Francisco

Facts: A buyer purchases property from a city for a below-market price in a leaseback agreement with the city for city employees to use the property. As a change of ownership, the county assessor evaluated the property’s fair market value (FMV) at an amount greater than the purchase price the buyer paid for the property. The buyer seeks a FMV amount equal to the price paid to purchase the property and a refund for excess property taxes paid.

Claim: The buyer claims the FMV was incorrectly calculated by the county assessor since the assessor failed to recognize the leaseback with the city to use the property at a below-market rate.

Counterclaim: The county assessor claims the property was correctly valued since the city agreed to the provisions in the leaseback as a proprietor, rather than as a regulatory agency advancing public welfare.

Holding: A California appeals court holds the property was correctly valued by the county assessor at its FMV without concern for the leaseback agreement since the leaseback was an arms-length agreement entered into between a buyer and a city acting in its proprietary role, rather than advancing police powers related to public welfare. [290 Division (EAT), LLC v. City and County of San Francisco (2022) 86 CA5th 439]

290 Div. (EAT) v. City and County of San Francisco

Related Reading:
 Tax Benefits of Ownership: Chapter 32: Change of ownership and assessment of replacement home

Related Articles:
Brokerage Reminder: Property tax reassessment 101

Prop 13, explained

Related topics:
assessor, fair market value (fmv), property taxes, proposition 13 (prop 13), reassessment

Posted by David Swistock | Jul 24, 2023 | Laws and Regulations, Real Estate, Recent Case Decisions | 0

Reprinted from firsttuesday Journal  — P.O. Box 5707, Riverside, CA 92517

West Pueblo Partners, LLC v. Stone Brewing Co.

Facts: A commercial tenant’s lease agreement entered into with the landlord contains a force majeure provision. The tenant does not pay rent due to government closure orders during the COVID-19 pandemic which interfered with the tenant’s use of the property causing the tenant to operate at a loss. The tenant had funds available to pay rent at all times. The landlord seeks to evict the tenant in an unlawful detainer (UD) action based on a notice to pay rent or quit.

Claim: The tenant claims they are not delinquent in the payment of rent as they were excused from paying rent during the months their business was closed due to the pandemic, a force majeure event which triggered application of the provision.

Counterclaim: The landlord claims the force majeure provision does not apply since the tenant retained the financial resources to pay the delinquent rent and occupied the property throughout the period of delinquency.

Holding: A California appeals court holds the landlord is entitled to enforce the UD action since the force majeure provision does not apply as the tenant had the financial resources to pay the delinquent rent through the period of delinquency. [West Pueblo Partners, LLC v. Stone Brewing CO., LLC. (2023) 90 CA5th 1179]

West Pueblo Partners, LLC v. Stone Brewing Co.

Related Reading:

Real Estate Economics: Factor 25: Pandemic

Related Video:

Word of the Week: Force Majeure

Related topics:
commercial real estate, covid-19 pandemic, rent, unlawful detainer (ud)

Posted by David Swistock | Jul 24, 2023 | Laws and Regulations, Real Estate, Recent Case Decisions | 0

Reprinted from firsttuesday Journal  — P.O. Box 5707, Riverside, CA 92517

SVAP III Poway Crossings, LLC. v. Fitness International LLC.

Facts: A commercial tenant and the landlord enter into a lease agreement with a force majeure provision applicable only when the tenant’s failure to perform cannot be cured by the payment of money. The tenant ceases paying rent after an executive order based on the COVID-19 pandemic temporarily closes their business operations. The tenant was able to pay rent and they occupied the premises throughout the pandemic. The landlord seeks payment of delinquent rent, late charges and attorney fees.

Claim: The tenant claims they are excused from paying rent for the period the executive order closed their business since the COVID-19 pandemic constituted a force majeure event temporarily frustrating the purpose for occupying the premises.

Counterclaim: The landlord claims the tenant is obligated to pay rent since the tenant continued to occupy the premises and the force majeure provision is only operative when the tenant cannot pay the rent bargained for in exchange for occupancy, not for the right to operate a particular business.

Holding: A California appeals court holds the landlord is entitled to collect delinquent rent, late charges and attorney’s fees from the tenant since the purpose of the agreement was for the tenant to pay rent to the landlord in exchange for the right to occupy the premises, and the force majeure provision only applies when the default cannot be resolved by the payment of money. [SVAP III Poway Crossings, LLC v. Fitness International, Inc. (2023) 87 CA5th 882]

SVAP III Poway Crossings, LLC. v. Fitness International LLC.

Related Reading:

Real Estate Economics: Factor 25: Pandemic

Related Video:

Word of the Week: Force Majeure

Related topics:
commercial real estate, covid-19 pandemic, eviction moratorium, late payment fee, rent

Posted by David Swistock | Aug 28, 2023 | Appraisal, Laws and Regulations, Property Management, Real Estate, Recent Case Decisions | 0

Reprinted from firsttuesday Journal  — P.O. Box 5707, Riverside, CA 92517

Olympic and Georgia Partners, LLC v. County of Los Angeles

Facts: A developer enters into an agreement with a city to build a transient occupancy property for use as a hotel. The developer receives a subsidy from the city. On completion of construction, the developer enters into an agreement with a transient occupancy operator to occupy and manage the property under which the developer pays the operator a percentage of the revenues for their operations on the property. On assessing the property, the county assessor included the value of the subsidy and revenue from the developer’s agreement with the operator as income produced by the property. The developer seeks to exclude the value of the subsidy and the management contract from the property’s assessed fair market value (FMV).

Claim: The developer claims the assessor improperly included the values of the subsidy and the operator’s agreement in the property’s assessed FMV since they are intangibles, not real property.

Counterclaim: The county claims the assessor properly included the values of the subsidy and the operator’s agreement in the property’s assessed FMV since the subsidy and the operator’s agreement run with the ownership of the property.

Holding: A California appeals court holds the assessor improperly included the values of the subsidy and the operator’s agreement in the assessment since they are intangibles, not real property, as the property was built due to the subsidy and the operator’s business contributed to the property’s productive use. [Olympic and Georgia Partners LLC, v. County of Los Angeles (2023) 90 CA5th 100]

Olympic and Georgia Partners, LLC v. County of Los Angeles

Editor’s Note: The Supreme Court of California has granted a petition for review of this case. It is crucial to consider income flowing from a property to the owner, whether directly or indirectly, when determining its fair market value. Without ownership of the property, the income in this case – which is comparable to rental income from a net lease agreement – would not be received, and thus, it must be a factor in the evaluation process. The appellate court erred by not treating indirect income received solely due to ownership of the property as contributing to the worth of the property.

Stay tuned to the ft Journal for updates on the evaluation of income property in appraisals and broker price opinions (BPOs) this case will clarify.

Related Form:

Guest Occupancy Agreement – For Transient Occupancy Properties — RPI Form 593

Related Reading:

Tax Benefits of Ownership: Chapter 32: Change of ownership and assessment of replacement home

Related Video:

Three Appraisal Approaches: Income Approach

 

Related topics:
assessor, fair market value (fmv), property assessment

Posted by David Swistock | Jun 1, 2023 | Commercial, Laws and Regulations, Real Estate, Recent Case Decisions | 0

Reprinted from firsttuesday Journal  — P.O. Box 5707, Riverside, CA 92517

Ramirez v. PK I Plaza 580 SC LP

Facts: An independent contractor is hired by a commercial tenant to remove a sign from the roof of the leased premises as required by the lease agreement with the landlord. The lease agreement states the tenant is financially responsible for the sign’s removal, and makes no reference to hiring independent contractors to perform the removal.  The tenant hires an independent contractor to remove the sign, during which removal the contractor is injured in a fall. The independent contractor makes a demand on the landlord to recover their losses due to the injuries.

Claim: The independent contractor claims the landlord is liable since they were not employed by the landlord and the landlord did not authorize the tenant to hire an independent contractor.

Counterclaim: The landlord claims they are not liable for the injuries since the responsibility for the safety of the contractor is with the contractor, not the landlord or the tenant.

Holding: A California appeals court holds the landlord can be held liable for the independent contractor’s losses since the landlord does not have an employment relationship, directly or indirectly through authorization to the tenant, with the independent contractor. [Ramirez v. PK I Plaza 580 SC LP (2022) 85 CA5th 252]

Ramirez v. PK I Plaza 580 SC LP

Editor’s note – This case is decided on a narrow doctrine which is not the only theory the landlord may pursue to avoid liability. Stay tuned to the firsttuesday journal for updates to this case as it is brought before the California Supreme Court.

 

 

Related Reading:

Property Management Chapter 37: Care and maintenance of property

 

Related topics:
commercial property, independent contractor, landlords and tenants, liability

Posted by David Swistock | Jun 26, 2023 | Commercial, Laws and Regulations, Real Estate, Recent Case Decisions | 0

Reprinted from firsttuesday Journal  — P.O. Box 5707, Riverside, CA 92517

Tufeld Corp. v. Beverly Hills Gateway, L.P.

Facts: A tenant purchases a leasehold interest in a ground lease. The tenant enters into an amendment of the term of the lease with the landlord extending the term beyond 99 years. The tenant pays the landlord increased rent and an additional fee for the extension. Later, the landlord discovers the term lease as extended violates the rule against perpetuities. The landlord seeks to cancel the lease agreement as void.

Claim: The landlord claims the amended lease agreement, due to the extension beyond 99 years, is void since it exceeds the rule against perpetuities.

Counterclaim: The tenant claims the rule against perpetuities cannot be used by a landlord to void a lease agreement.

Holding: A California appeals court holds the tenant’s lease agreement is valid up to statutory 99-year limitation and awards the tenant a pro-rata portion of the fee paid to extend the lease term beyond 99 years, since the landlord was unable to agree to a remaining term of more than 99 years under the rule against perpetuities. [Tufeld Corp. v. Beverly Hills Gateway, L.P. (2022) 86 CA5th 12]

Tufeld Corp. v. Beverly Hills Gateway, L.P.

 

Related Reading:

Property Management: Chapter 48: Lease renewal and extension options – Future uncertainty

 

Related topics:
commercial property, void vs. voidable, voidable

Posted by David Swistock | Sep 11, 2023 | Laws and Regulations, Real Estate, Recent Case Decisions | 0

Reprinted from firsttuesday Journal  — P.O. Box 5707, Riverside, CA 92517

Starlight Cinemas, Inc. v. Mass. Bay Ins. Co.

Facts: An owner of commercial property holds an all risk commercial property and general liability insurance policy issued by an insurer. The policy covers loss caused by the suspension of commercial operations resulting from direct physical loss or damage to the building. The policy excludes coverage for any losses resulting from a virus. The owner’s commercial operations are suspended as a result of government closure orders due to the COVID-19 pandemic. No COVID-19 infections are reported on the property. The owner files a claim with their insurer to recover money losses suffered during the closure orders. The insurer denies the claim.

Claim: The owner claims the insurer breached their contract to cover money losses due to loss of functional use of the property caused by government closure orders since no viral infections were present on the property.

Counterclaim: The insurer claims the owner is not entitled to coverage for losses due to the physical loss of the use of their property since pandemic-related closure orders do not qualify as a physical alteration to the property to recover money losses caused by viruses as they are excluded from coverage.

Holding: A California appeals court holds the insurer did not breach the policy’s contract and the owner cannot recover losses since no physical loss to the property occurred and pandemic-related closures are not a physical alteration to the property, but an interruption of the commercial function of the property caused by a virus which is excluded from coverage. [Starlight Cinema Inc. v. Massachusetts Bay Insurance Company (2023) 91 CA5th 24]

Starlight Cinemas, Inc. v. Mass. Bay Ins. Co.

Related Reading:

Real Estate Economics: Realty Almanac 2022-2024 — Factor 23: Pandemic

Related Recent Case Decision:

Is an insurer liable for a loss of business income when operations are suspended due to the COVID-19 lockdown? — Apple Annie, Inc. v. Oregon Mutual Insurance Company

Related topics:
commercial property, covid-19 pandemic, insurance

Posted by David Swistock | May 22, 2023 | Laws and Regulations, Loan Products, Recent Case Decisions | 0

Reprinted from firsttuesday Journal  — P.O. Box 5707, Riverside, CA 92517

Barclay v. Boskoski

Facts: A creditor obtains a money judgment and records a lien against title to an owner’s principal residence. Years later, the owner files a petition for bankruptcy protection and claims an automatic California homestead exemption. When the judgment lien was recorded, the homestead exemption threshold was lower than the lien amount. When the owner filed the bankruptcy petition, the exemption had increased to an amount greater than the judgment lien.

Claim: The owner claims the full amount of their equity in the property is protected up to the increased amount of the current homestead exemption, since they are to receive the homestead exemption amount they are entitled to at the time of filing the bankruptcy petition.

Counterclaim: The creditor claims the owner is protected up to the amount of the exemption available when the lien was recorded since the maximum amount of the exemption available is based on the year the lien was created.

Holding: A federal appeals court for the 9th district covering California holds the homeowner’s equity is exempt from the creditor’s lien amount in the amount of the current homestead exemption since the exemption amount the owner receives is the exemption amount available on the date the bankruptcy petition was filed. [Barclay v. Boskoski (9^th Cir. 2022) 52 F4d 1172]

Barclay v. Boskoski

Related Reading:

Legal Aspects of Real Estate Chapter 33: Automatic and declared homesteads

Related topics:
automatic homestead, california homeownership, chapter 7 bankruptcy, homestead exemption, liens

Posted by David Swistock | Aug 29, 2023 | Appraisal, Bay Area, Laws and Regulations, Real Estate, Recent Case Decisions | 0

Reprinted from firsttuesday Journal  — P.O. Box 5707, Riverside, CA 92517

Joaquín Torres v. San Francisco Assessment Appeals Board No. 1

Facts: An owner’s property is rented out for sporting and other public events. The county assessor uses the replacement cost approach to determine the assessed value as the property’s fair market value (FMV). The county’s assessment appeals board excludes from the assessed value an allocation for future functional obsolescence. No current functional obsolescence exists for reducing the replacement cost. The assessor seeks to exclude from reduction of the assessed value an allocation for future functional obsolescence.

Claim: The assessor claims the board’s exclusion from assessed value of an allocation for depreciation due to future functional obsolescence was improper since all property owners face the same need to reserve a portion of the income generated by a property to cover functional obsolescence and replacement costs, and no current depreciation from functional obsolescence exists for reducing the replacement cost.

Counterclaim: The board claims the exclusion of the revenue generated by the property and reserved to prevent functional obsolescence is valid since the property’s unique use is more susceptible to depreciation from functional obsolescence which will reduce the amount a prudent buyer will pay to buy the property and thus deducting the present value of funding a reserve is proper under the cost method.

Holding: A California appeals court holds the board improperly excluded from the assessed value an allocation for future functional obsolescence since an exclusion for future obsolescence is improper under the cost method when no functional obsolescence exists on the property. [Joaquín Torres v. San Francisco Assessment Appeals Board No. 1 (2023) 89 CA5th 894]

Joaquín Torres v. San Francisco Assessment Appeals Board No. 1

Related Article:

Economic considerations in an evaluation: Part 1

Related Form:

Annual Property Operating Data Sheet (APOD) — RPI Form 352

Related Reading:

Real Estate Principles: Chapter 29: The appraisal report

Related Video:

Estimating Replacement Cost and Depreciation Under the Cost Approach

Three Appraisal Approaches: Cost Approach

Three Appraisal Approaches: Income Approach

Related topics:
assessor, fair market value (fmv), property assessment, reassessment

Posted by David Swistock | Jul 28, 2023 | Finance, Laws and Regulations, Real Estate, Recent Case Decisions | 1

Reprinted from firsttuesday Journal  — P.O. Box 5707, Riverside, CA 92517

In re: Jaswinder Singh Bhangoo

Facts: A creditor obtains a money judgment and records an abstract which places a lien on title to the judgment debtor’s residence. The debtor vacates the residence and leases the property to a tenant. The debtor files a petition for bankruptcy protection claiming an automatic homestead exemption. A month following their petition, the tenant vacates and the debtor moves back into the residence.

Claim: The debtor claims they are entitled to an automatic homestead exemption since their absence from the residence was temporary, and the debtor always intended on returning to the subject property.

Counterclaim: The creditor claims the debtor is not entitled to an automatic homestead exemption since the debtor or their family did not continuously occupy the property from the date the lien was recorded to the date of the bankruptcy petition, and the debtor’s absence was not temporary as they showed no intent to move back prior to the date of the bankruptcy petition.

Holding: A United States Bankruptcy Appellate court holds the debtor’s equity in the residential property is not protected by an automatic homestead exemption since the debtor’s absence was not temporary as the debtor showed no intent to move back before the date of the bankruptcy petition. [In re: Bhangoo (9^th Cir. BAP 2021) 634 BR 80]

In re: Jaswinder Singh Bhangoo

Related Reading:

Legal Aspects of Real Estate Chapter 33: Automatic and declared homesteads

Related Form:

Declaration of Homestead – RPI Form 465

Related topics:
automatic homestead, bankruptcy, chapter 7 bankruptcy, homestead exemption, personal property

Posted by David Swistock | Sep 14, 2023 | Laws and Regulations, Mortgages, Real Estate, Recent Case Decisions | 0

Reprinted from firsttuesday Journal  — P.O. Box 5707, Riverside, CA 92517

In re Guevarra

Facts: A debtor takes title to a family member’s home to cosign a mortgage to finance their purchase. The debtor does not financially contribute to the purchase of the property, receives no benefits from the funding, and never resides at the property. The debtor files a petition for bankruptcy protection. The creditor seeks to include the home as an asset of the debtor and force the sale of the property. The property is sold, and the debtor claims a wildcard exemption to exclude the sales proceeds from the bankruptcy.

Claim: The creditor claims the exemption is not valid since the debtor’s petition initially represented they held no interest in the property and did not claim the exemption until after the property was sold.

Counterclaim: The debtor claims the exemption is valid since the debtor is free to amend their bankruptcy schedules.

Holding: A United States Bankruptcy Appellate court holds the debtor may maintain a wild card exemption for the value of their interest in the property since debtors are free to amend their schedules and the debtor’s situation was changed by the sale of the property. [In re Guevarra (2022) 638 BR 120]

In re Guevarra

Related Reading:

Legal Aspects of Real Estate: Chapter 26: Tenants in common as a vesting

Related topics:
bankruptcy, california homeownership, mortgage,

Posted by David Swistock | Aug 14, 2023 | Laws and Regulations, Los Angeles-Santa Barbara-Ventura, Property Management, Real Estate, Recent Case Decisions | 0

Reprinted from firsttuesday Journal  — P.O. Box 5707, Riverside, CA 92517

Roxbury Lane LP, v. Benjamin Harris

Facts: A landlord rents a residential unit to a month-to-month tenant. A local rental control ordinance limits evictions to approved reasons. The tenant delivers a 30-day notice of intent to vacate to the landlord. On expiration of the notice, the tenant remains in possession of the property. The landlord files an unlawful detainer (UD) action to evict the tenant.

Claim: The tenant claims the landlord may not maintain a UD action since under the ordinance the tenant had a right to maintain possession after expiration of a notice of intent to vacate as expiration of an intent to vacate is not an approved reason for eviction.

Counterclaim: The landlord claims the tenant is not protected by the ordinance since the tenant failed to vacate before the expiration of the notice which converted the tenant into a tenant-at-sufferance to which the ordinance does not apply.

Holding: A California appeals court holds the landlord may not maintain a UD action based on the tenant’s continued occupancy after the expiration of the notice of intent to vacate since the ordinance protects a tenant’s right to possession on expiration of the tenant’s notice to vacate as their holdover is not a permitted reason for eviction. [Roxbury Lane LP, v. Harris (2023) 88 CA5th 9]

 

Roxbury Lane LP, v. Benjamin Harris

Related Reading:

Property Management: Chapter 22: Changing terms on a month-to-month tenancy

Real Estate Principles: Chapter 81: Notices to vacate — Rent control limitations on eviction

Related Form:

30-Day Notice to Vacate from tenant — RPI Form 572

 

Related topics:
city ordinances, eviction, holdover tenant, rent control, unlawful detainer (ud)

Posted by David Swistock | Aug 2, 2023 | Laws and Regulations, Property Management, Real Estate, Recent Case Decisions | 0

Reprinted from firsttuesday Journal  — P.O. Box 5707, Riverside, CA 92517

Sleep E-Z LLC., v. Lopez

Facts: A tenant and landlord enter into a lease agreement for occupancy of a residential property. The monthly rent includes a surcharge for an additional unnamed adult occupant to also reside in the property. Later, the tenant temporarily leaves to take care of a family member, leaving all their personal belongings. The unnamed occupant remains in possession and makes multiple rental payments then becomes delinquent.  When collecting the delinquent rent the landlord discovers the tenant is absent from the property. The landlord serves the tenant with a three-day notice to quit due to an assignment of their leasehold interest without permission. The tenant does not vacate the property and the landlord files an unlawful detainer (UD) action to evict the tenant and occupant.

Claim: The landlord claims the tenant breached the lease agreement by assigning their leasehold interest in the property to the unnamed occupant since the tenant vacated the residence leaving the occupant solely in possession without the consent of the landlord.

Counterclaim: The tenant claims their temporary leave was not an assignment of their leasehold interest to the unnamed occupant since the tenant did not remove their possessions and did not set up another permanent residence.

Holding: A California appeals court holds the landlord may not maintain a UD action based on a notice to quit for reason of an assignment of their leasehold interest since the tenant did not remove their personal possessions, did not set up another residence and the unnamed occupant’s possession and payment of rent did not constitute an assignment of the lease. [Sleep E-Z LLC. v. Lopez (2023) 88 CA5th 18]

Sleep E-Z LLC., v. Lopez

Related Reading:

Real Estate Principles: Chapter 80: Three-day notices to quit – Notice to quit; no alternatives

Property Management: Chapter 49: Lease assignments and subleases

Related Forms:

Three-Day Notice to Quit – Residential and Commercial — RPI Form 577

Three-Day Notice to Quit for Properties Subject to Just Cause Eviction Requirements – RPI Form 577-1

 

 

 

 

Related topics:
assignment, lease agreement, three-day notice, unlawful detainer (ud)

Posted by David Swistock | Jun 28, 2023 | Fair Housing, Laws and Regulations, Los Angeles-Santa Barbara-Ventura, Recent Case Decisions | 0

Reprinted from firsttuesday Journal  — P.O. Box 5707, Riverside, CA 92517

Frazier v. The Superior Court of Los Angeles County

Facts: A month-to-month tenant occupying a residential property located in a rent control community becomes delinquent on rent and the landlord serves a three-day notice to pay rent or quit. A local rent control ordinance mandates the landlord also submit a copy of the three-day notice to the rent control board to monitor rent increases. The landlord sends a copy of the three-day notice to the board after the period for its delivery expired. The tenant does not pay the delinquent rent nor vacate the premises within three days. The landlord files an unlawful detainer (UD) action to evict the tenant based on the three-day notice.

Claim: The tenant claims the landlord cannot maintain a UD action on the three-day notice since the landlord did not comply with the rent control ordinance calling for a copy of the three-day notice to be sent to the board prior to expiration of the time period for sending it.

Counterclaim: The landlord claims noncompliance with the local rent control ordinance does not bar them from maintaining a UD action based on a three-day notice since compliance with the ordinance is not required for a valid three-day notice.

Holding: A California appeals court holds the landlord may maintain a UD action on a three-day notice to quit without complying with the rent control ordinance since the ordinance is intended to put the rent control board on notice about rent increases in the eviction process. [Frazier v. Superior Court of Los Angeles County (2022) 86 CA5th 1]

 

Frazier v. The Superior Court of Los Angeles County

 

Related Reading:

Property Management: Chapter 58: Residential rent control

Related Forms:
RPI Form 575 — Three-Day Notice to Pay Rent or Quit – With Rent-Related Fees
RPI Form 575-1 — Three-Day Notice to Pay Rent or Quit — Without Rent-Related Fees

 

 

 

Related topics:
city ordinances, rent control, three-day notice to pay rent or quit, unlawful detainer (ud)

Posted by David Swistock | Aug 4, 2023 | Laws and Regulations, Loan Products, Mortgages, Real Estate, Recent Case Decisions | 0

Reprinted from firsttuesday Journal  — P.O. Box 5707, Riverside, CA 92517

In re: Gerald N. Reed

May a mortgage lender foreclose on the secured property to collect on a debt discharged by a bankruptcy court?

Facts: An owner of property executes a note and trust deed which encumbers the property. The owner defaults and the mortgage lender files a judicial foreclosure action. The lender is awarded a money judgment and order for the property to be sold and the lender paid the judgment amount out of the sales proceeds. The owner files a petition for Chapter 7 bankruptcy protection and receives a discharge of the debt owed on the trust deed note. Later, the lender completes the judicial foreclosure sale under the trust deed to satisfy the amount secured by the property.

Claim: The owner claims the mortgage lender was barred from selling the property at a foreclosure sale since the lender’s foreclosure judgment converted the trust deed note debt into a money judgment which was discharged by the bankruptcy court.

Counterclaim: The mortgage lender claims the judicial sale of the property was proper since the bankruptcy discharge has no effect on the lender’s ability to sell the property to collect on the debt secured by the trust deed.

Holding: A United States Bankruptcy Appellate court holds the mortgage lender’s judicial foreclosure sale under the trust deed lien was not barred by the bankruptcy discharge since the judgment did not transform the trust deed debt into a separate judicial money award against the owner. [In re: Reed (9^th Cir. BAP 2023) 640 932]

In re: Gerald N. Reed

Related Reading:

Real Estate Finance: Chapter 43: Judicial foreclosure

Word-of-the-Week: Judicial foreclosure

Related Videos:

Judicial Foreclosure and Pursuit of the Deficiency

Related Form:

Note Secured by Deed of Trust Installment – Interest Included – RPI Form 420

Note Secured by Deed of Trust Installment Note – Interest Extra – RPI Form 422

Note Secured by Deed of Trust Straight Note – RPI Form 423

 

 

Related topics:
chapter 7 bankruptcy, judicial foreclosure, liens, promissory note, trust deed

Posted by David Swistock | Jul 19, 2023 | Laws and Regulations, Real Estate, Recent Case Decisions | 0

Reprinted from firsttuesday Journal  — P.O. Box 5707, Riverside, CA 92517

Whitlach v. Premier Valley, Inc.

Facts: A real estate agent employed by a broker under an independent contractor agreement (ICA), also enters into a separate employment agreement as a sales manager with the employing broker. The agent is paid a percentage fee when performing real estate services for members of the public but is paid hourly when working as the sales manager. The broker fully pays and reimburses the agent’s sales manager activities as required by the Labor code. The agent is paid as agreed under the ICA for sharing fees on transactions. The agent seeks to invalidate their ICA and enforce civil penalties against the broker for violations of the Labor Code which protect employees other than Department of Real Estate (DRE) licensees employed under an ICA.

Claim: The agent claims they are entitled to be classified as an employee in all capacities to be timely paid minimum wages as well as receive all Labor Code protections offered to other employees since the ICA is an adhesion contract designed to deprive IC agents of protections afforded to other employees, which was cancelled when the agent became an employee under the sales manager agreement which is not an independently established trade.

Counterclaim: The broker claims the agent is an IC not entitled to Labor Code provisions for percentage fee-based employment since the sales manager employment did not cause a cancellation of the ICA and no Labor Code violations occurred when acting in the sales manager capacity.

Holding: A California appeals court holds the broker may classify the licensee as an IC regarding their agency duties and is not obligated to extend Labor Code protections offered to other employees when also employing the licensee as a sales manager since the ICA  contractually classified the licensee as an IC and the sales manager agreement did not cancel the ICA by novation and did not violate the labor code. [Whitlach v. Premier Valley, Inc. (2022) 86 CA5th 673]

Whitlach v. Premier Valley, Inc.

Related Reading:

Real Estate Practice Chapter 1: Brokerage activities: agent of the agent – The (not so) independent contractor

Related Form:

Independent Contractor Employment Agreement — For Sales Agents and Broker-Associates — RPI Form 506

Related Video:

Licensed Employees of the Broker

Related topics:
agent employment, agents and brokers, employment agreement, independent contractor, minimum wage

Posted by David Swistock | May 30, 2023 | Laws and Regulations, Property Management, Recent Case Decisions | 0

Reprinted from firsttuesday Journal  — P.O. Box 5707, Riverside, CA 92517

Group XIII Properties LP v. Stockman

Facts: A new owner of a residential rental property hires a property management company. The resident manager on the property posts a notice of the change of ownership and management notifying all existing tenants. The property management company later changes its name, and the resident manager posts a second notice. The second notice, unlike the prior notice, does not list the names and telephone numbers of any agent-for-service, manager or owner, or the office hours for service. A tenant delinquent in rent is served a three-day-notice to pay rent or quit and is evicted through an unlawful detainer (UD) action.

Claim: The tenant seeks to recover money losses resulting from the eviction claiming the owner was barred from evicting the tenant since the owner was not in strict compliance with notice procedures by failing to list the office hours or contact information for every agent authorized to manage the property within 15 calendar days of the effective name change.

Counterclaim: The owner claims the eviction was proper since they provided the tenant all required information between the two notices.

Holding: A California appeals court holds the residential tenant is entitled to recover their money losses due to an improper eviction since the owner needs to strictly comply with notices giving the names, phone numbers and addresses for all agents-for-service and managers within 15 calendar days every time there is a change to ownership or management before serving notices to pay or quit. [Group XIII Properties LP v. Stockman (2022) 85 CA5th Supp. 1]

Group XIII Properties LP v. Stockman

Editor’s note – Individuals authorized to enter into leases need to be diligent when attempting to evict tenants. Failure to strictly comply with statutory notification requirements on the change of ownership or management may temporarily prevent eviction.

Related Reading:

Legal Aspects of Real Estate Chapter 11: Identification of property manager or owner – Change in ownership and management

Related topics:
eviction, property manager, property owner, three-day notice to pay rent or quit, unlawful detainer (ud)

Posted by Carrie B. Reyes | Mar 13, 2023 | Buyers and Sellers, Feature Articles, Real Estate, Your Practice | 0

Reprinted from firsttuesday Journal  — P.O. Box 5707, Riverside, CA 92517

This article identifies natural hazards to be disclosed in all sales and explains how a seller’s broker avoids non-disclosure liability by the up-front use of a natural hazard expert.

A unified disclosure for all properties

Gone are the days, legislatively speaking, of minimal or delayed property disclosures. Or worse, none.

As boom times devolve into a recession, everyone’s behavior in real estate transactions changes. Buyers fast learn they have the right to demand delivery of the disclosures they are entitled to, voluntarily and upfront — included in the property’s marketing package prepared by the seller’s agent to profile the property.

In terms of the disclosure of natural hazards, hazards are more important than improvements. The hazards a buyer faces come with the location of a parcel of real estate. Unlike property improvements, which can be fixed or replaced, natural hazards run with the land, with little humans can do to alter their effect on property and humans.

Locations where a property’s location is likely to be subject to natural hazards include:

• special flood hazard areas, a federal designation;
• potential flooding and inundation areas;
• very high fire hazard severity zones;
• wildland fire areas;
• earthquake fault zones; and
• seismic hazard zones. [Calif. Civil Code §1103(c)]

The existence of a hazard due to the geographic location of a property affects its desirability, and thus its value — pricing — to prospective buyers. Hazards, by their nature, limit an owner’s ability to develop the property, obtain insurance or receive disaster relief.

Whether a seller lists the property for sale with a broker or markets the property themselves, it is the seller who is obligated to timely disclose to prospective buyers any natural hazards actually known to the seller and known as discoverable by a seller in a search of public records.

To unify and streamline the disclosure of natural hazards to a prospective buyer of a property, a statutory form was created entitled the Natural Hazard Disclosure Statement (NHD). [See RPI Form 314]

The NHD form for uniformity of disclosures

The NHD form is used by a seller and the seller’s agent, and when prepared by an NHD expert, on all types of real estate held out for sale. The form discloses natural hazard information known to the seller and seller’s agent (and the NHD expert) and readily available as shown on maps in the public records of the local planning department. [CC §1103.2; See RPI Form 314]

While use of the NHD Statement by sellers and their agents is mandated, specific classes of sellers (but not their agents) are excluded. Thus, the form — filled out and signed by the seller (unless excluded) and the seller’s agent (never excluded), or prepared by an NHD expert and signed by the seller and their agent — is included in marketing packages handed to prospective buyers when they initially seek additional information on a property.

Transactions when the seller’s use of the NHD Statement form is not mandated include:

• court-ordered transfers or sales;
• deed-in-lieu of foreclosures;
• trustee’s sales;
• lender resales after foreclosure or a deed-in-lieu;
• estates on death;
• transfers between co-owners;
• transfers to relatives/spouses; or
• transfers to or by governmental entities. [CC §1103.1(a)]

Sellers specifically excluded from using the form still need to make the disclosures referenced in the NHD. It is just that they do not need to use the statutory NHD Statement to make those disclosures. Thus, for excluded sellers, the NHD is the optional method for making the mandatory disclosure of natural hazard information to their buyers.

On the seller’s agent’s receipt of the NHD report, the agent:

• reviews the report with the seller;
• adds what they and the seller know about hazards which are not included in the expert’s report,
• signs the NHD statement accompanying the report;
• hands the entire NHD package to prospective buyers as part of the marketing package; and
• completes all these activities before an offer is accepted or a counteroffer submitted to a prospective buyer.

Editor’s note — Any attempt by a seller or seller’s agent to use an “as-is” provision or otherwise provide for the buyer to agree to waive their right to receive the mandatory seller’s NHD Statement is void as against public policy. [CC §1103(d)]

Related article:

Verify seller’s property disclosures: retain a home inspector

Mandated delivery of NHDs

Delivery of the information — whether disclosed by the use of one form or another — is not optional. A natural hazard disclosure is mandated when marketing any type of property for sale. [CC §1103.1(b)]

All sellers, and any seller’s or buyer’s agents involved, have a general duty owed to prospective buyers to disclose conditions on or about a property which are:

• known to them;
• might adversely affect the buyer’s willingness to buy; or
• might influence the buyer’s setting of the price and terms of payment they are willing to offer.

When a hazard is known to any agent (as well as the seller) or available in public records, it is to be disclosed to the prospective buyer before they enter into a purchase agreement on the property. When not disclosed, the buyer has the option to cancel the transaction, called termination, or continue to perform the agreement and close the transaction.

Further, when the transaction has closed escrow and the buyer discovers a hazard affecting the property’s value, the buyer may rescind the sale and be refunded their investment, called restoration. [Karoutas v. HomeFed Bank (1991) 232 CA3d 767] 

The NHD is delivered to prospective buyers as soon as practicable. The practical moment for delivery comes at the earliest opportunity and always before a buyer enters into a purchase agreement or otherwise sets the price and terms or conditions for its payment. [Calif. Attorney General Opinion 01-406 (August 24, 2001); CC §1103.3(a)(2)]

Related article:

A home inspection report: the liability shield for a seller’s broker

Investigating the existence of a hazard

Natural hazard information is obtained from the public records. When not retrieved by someone, the seller and seller’s agent have failed to gather the information and data needed to voluntarily make these compulsory disclosures to prospective buyers.

To obtain the natural hazard information, the seller and the seller’s agent exercise ordinary care in gathering the information. They may pull the information from public records themselves, or the seller may employ an NHD expert to gather information and prepare the NHD Statement.

When prepared by an NHD expert, the NHD report will also note whether the listed property is located within two miles of an existing or proposed airport, an environmental hazard zone called an airport influence area or airport referral area.

The buyer’s occupancy of property within the influence of an airport facility may be affected by noise and restrictions, now and later, imposed on the buyer’s use as set by the airport’s land-use commission. [CC §1103.4(c)]

Also, the expert’s report notes whether the property is located within the jurisdiction of the San Francisco Bay Conservation and Development Commission.

Avoiding liability for errors

The expert who prepares the NHD is liable for any errors it contains, not the seller or seller’s agent who rely on the report of a qualified expert they selected to fulfill their duty to check the public records. Neither the seller nor the seller’s agent need enter into an indemnification agreement with the natural hazard expert to avoid liability for errors made by the expert they selected.

However, an indemnity agreement entered into by the expert in favor of the seller’s broker covers the cost of any litigation which might unnecessarily haul the broker into court. [See RPI Form 131]

A word of caution about nondisclosure before acceptance: The seller’s agent’s tardy delivery of an expert’s NHD to the buyer or the buyer’s agent — after the offer or a counteroffer has been accepted — will not protect the broker from liability for the buyer’s lost property value.

Liability exposure due to delayed NHD disclosures includes:

• costs the buyer may incur to correct or remedy the undisclosed hazardous condition; and
• the portion of the agreed price which exceeds the property’s fair market value (FMV) based on the hazard undisclosed at the time the purchase agreement was entered into. [CC §1103.13]

Further, the agents, seller and expert are not exposed to liability from third parties to the sale who might receive their erroneous NHD Statement and rely on it to analyze the risk they undertake by their involvement. Third parties include insurance companies, lenders, governmental agencies and other providers who may become affiliated with the transaction. [CC §1103.2(g)]

Related article:

Form-of-the-Week: Authorization to Prepare a Home Inspection Report and a Natural Hazard Disclosure Report — Forms 130 and 131

Documenting compliance with NHD law

The seller and seller’s agent delivery of the NHD Statement to the buyer is documented by a provision in the purchase agreement. [See RPI Form 150 §11.5]

However, the seller is statutorily penalized by their agent’s failure to disclose natural hazards up front when purchase agreement provision calls for the seller’s agent to comply untimely with an “in escrow” disclosure.

The buyer on an in-escrow disclosure has the right to terminate the purchase agreement and avoid the transactions by exercising:

• a three-day right of cancellation after the NHD Statement is actually handed to the buyer; or
• a five-day right of cancellation when the NHD Statement is mailed to the buyer. [CC §1103.3(c)]

Further, buyer claims due to a late delivery of the NHD expose the seller and seller’s agent to liability, but not the buyer’s agent. The amount of liability exposure is the amount of money losses (including a lesser property value than the price paid) inflicted on the buyer by an untimely in-escrow disclosure when:

• the buyer chooses not to exercise their right to cancel; and
• proceeds with performance of the purchase agreement and closes escrow before demanding restitution. [CC §1103.13; Jue Smiser (1994) 23 CA4th 312]

Delivery of the NHD to the buyer

The buyer’s agent, on receiving the NHD form from the seller or seller’s agent, reviews it for any hazards which might affect the property’s value or its desirability for their buyer. [CC §1103.12(a)]

Further, the buyer’s agent counsels the buyer about their recommendations or explanations concerning the adverse consequences of any hazards it discloses. [CC §§1103.2, 1103.12]

When the buyer does not have a broker, the seller’s agent is responsible for delivering the NHD Statement to the prospective buyer. However, unlike the buyer’s agent, the seller’s agent has no duty to counsel or explain to the buyer the effect hazards have on the property or the buyer.

When the buyer is not represented by an agent, the buyer undertakes the duty to protect themselves and investigate the consequences of the NHD information handed to them.

Delivery of the NHD to a buyer may be in person or by mail. Delivery is considered to have been made when the NHD is received by the spouse of the buyer. [CC §1103.10]

Sellers occasionally engage in “For Sale by Owners” (FSBOs) transactions, negotiating a sale of their property directly with a buyer or the buyer’s agent. Here, the seller is responsible for preparing or obtaining an NHD statement and delivering the NHD Statement to the prospective buyer or their agent — and as always, prior to entering into the purchase agreement.

No warranty, just awareness by disclosure

A seller’s NHD Statement is not a warranty or guarantee by the seller or seller’s agent of the natural hazards affecting the property. Rather, the NHD Statement is a report prepared by the seller or the seller’s agent (or the NHD expert’s) of their actual knowledge together with information available in public records of any natural hazards affecting the property, called actual and constructive knowledge.

The NHD is intended to assist prospective buyers who rely on its content to make decisions as to whether they want to buy the property, and at what price and on what terms when deciding to prepare an offer to buy. To be meaningful, the buyer needs property information before the price and terms are set so the seller’s agent avoids misleading the buyer and their agent about conditions affecting the use of the property, called deceit. [AG Opin. 01-406]

Related article:

Form-of-the-Week: Lead-Based Paint Disclosure and Hazards Disclosure Booklets – Forms 313 and 316-1

Disclosures concerning the value and desirability of a property, such as an NHD Statement, are considered price-sensitive information. When not timely disclosed, the seller and seller’s agent subject themselves to money claims for price adjustments (offsets) which the buyer is entitled to make either before or after closing. Alternatively, the buyer may exercise their statutory right to cancel the purchase agreement and have their deposit fully refunded.

As good brokerage practice, the seller’s agent prepares and arranges to deliver the NHD for a property to prospective buyers before they submit an offer, and definitely before or as part of a counteroffer. From the first moment of a buyer’s inquiry for more information the property and until an acceptance takes place, the buyer is a prospective buyer entitled to disclosures. Disclosures are not to be delayed until the prospect has become the buyer under a purchase agreement.

As a matter of proper practice, the purchase agreement offer includes a copy of the seller’s NHD Statement as an addendum (along with all other disclosures), noting the transaction was entered into in compliance with NHD (and TDS/etc.) rules of licensee conduct.

An escrow officer handling a sales transaction where the seller’s agent has failed to deliver an NHD to the buyer or their agent prior to opening escrow, has no duty to prepare, order out or deliver the NHD (or the TDS or other reports) to the buyer. The obligation is imposed solely on the seller and seller’s agent. However, escrow may accept instructions to perform any of these activities, in which case escrow becomes obligated to act as instructed. [CC §1103.11]

Types of hazards disclosed

Sellers and seller’s agents of any type of real estate are to disclose whether the property is located in:

• an area of potential flooding;
• a very high fire hazard severity zone;
• a state fire responsibility area; • an earthquake fault zone; and
• a seismic hazard zone. [CC §1103.2]

Another flooding disclosure which needs to be made on the NHD Statement arises when the property is located in an area of potential flooding. [See RPI Form 314 §2]

An area of potential flooding is a location subject to partial flooding when sudden or total dam failure occurs. The inundation maps showing the areas of potential flooding due to dam failure are prepared by the California Office of Emergency Services. [Calif. Government Code §8589.5(a)]

Additional information concerning flood hazard areas is available in the Community Status Book. The book lists communities and counties participating in the NFIP and the effective dates of the current flood hazard maps available from FEMA.

Related article:

Residential landlords required to disclose flood hazard information

When a property is in an area where the financial responsibility for preventing or suppressing fires is primarily on the state, the real estate is located within a State Fire Responsibility Area. [Calif. Public Resources Code §4125(a)]

Notices identifying the location of the map designating State Fire Responsibility Areas are posted at the offices of the county recorder, county assessor and the county planning agency. [Pub Res C §4125(c)]

When the property is located within a wildland area exposed to substantial forest fire risks, the seller or the seller’s agent is to disclose this fact, as it requires maintenance by the owner to prevent fires.31 [See RPI Form 314 §4]

Additionally, the NHD Statement advises the prospective buyer of a home located in a wildland area that the state is not responsibile for providing fire protection services to the property, unless the Department of Forestry and Fire Protection has entered into a cooperative agreement with the local agency. [See RPI Form 314 §4]

A Seismic Hazard Zone map identifies areas exposed to earthquake hazards, such as:

• strong ground shaking;
• ground failure, such as liquefaction or landslides; [Pub Res C §2692(a)]
• tsunamis; [Pub Res C §2692.1] and
• dam failures. [Pub Res C §2692(c)]

When a property is susceptible to any of the earthquake (seismic) hazards, the seismic hazard zone disclosure on the NHD Statement is to be marked “Yes.” [See RPI Form 314 §6]

Seismic hazard maps are available at the California Department of Conservation.

Related article:

Manifestations of Seismic Hazards

Related topics:
disclosures, fire hazards, flood, natural hazard disclosure (nhd) statement, natural hazard expert

Posted by Amy Platero | Feb 3, 2023 | Laws and Regulations, Property Management, Real Estate | 0

Reprinted from firsttuesday Journal  — P.O. Box 5707, Riverside, CA 92517

In December 2022, a 6.4 magnitude earthquake struck Humboldt County, resulting in fatalities, injuries, power outages and damage to roads, bridges, buildings and utility lines. The governor immediately declared a state of emergency for the area.

Further, in December 2022 through January 2023, severe winter storms stretched across California, bringing prolonged rainfall, floods, fallen debris, power outages, damaged roads and levees and mandatory evacuations. In response, the governor announced a state of emergency throughout California.

These emergency conditions are deleterious, not just for their immediate effect on lives, land, buildings and infrastructure, but because they introduce a landlord’s ability to price gouge existing and new tenants for short term gain as demand for shelter temporarily soars.

Price gouging snares businesspeople who take unfair advantage of consumers disrupted in an emergency or disaster by greatly increasing prices, and thus profits, for essential consumer goods and services they provide in their ordinary course of business.

Businesses that reset pricing to levels that constitute price gouging include landlords

of rental housing.

Residential landlords may not raise rents by more than 10% during a state of emergency. As reminded by the Office of the Attorney General (OAG), residential landlords guilty of price gouging are subject to imprisonment of one year and a $10,000 fine. [Pen C §396(h)]

Resources for landlords and tenants

Rent gouging is not an issue until an emergency declaration is in effect for your area, which are noticed through the Office of Emergency Services.

Victims or witnesses of price gouging report these incidents online with the Attorney General.

A landlord rent gouging includes excessive increases or imposition of costs on residential tenants as additional fees for property services they offer, including for example:

• gardening services;
• cleaning services;
• utilities; and
• a shorter lease term.

For short-term rental housing advertised on a daily basis such as an AirBnB, the daily price may not be increased by more than 10% following an emergency proclamation for the area in which the property is located.

Further, landlords may not circumvent the price gouging restrictions by evicting a tenant and re-renting at a higher rate. [Pen C §396(f)]

However, tenants may still be evicted for lawful reasons during a state of emergency. [Pen C §396(m)]

Monetary penalties for price gouging were imposed on Santa Monica landlords in 2022 involved in tenant price gouging by raising a tenant’s rent in excess of 10% over prior market rents during a 2020 declared state of emergency related to wildfires. The landlords paid $35,000 to avoid criminal proceedings, according to the Santa Monica Daily Press.

Landlords need to be aware of the local requirements where their rental properties are located, including rental protections, rent stabilization and just cause eviction ordinances.

Related article:

Property Management 101

Related topics:
landlords and tenants, price gouging, state of emergency

Posted by Ashley Collins | May 26, 2023 | Fair Housing, Laws and Regulations, Real Estate | 0

Reprinted from firsttuesday Journal  — P.O. Box 5707, Riverside, CA 92517

As the primary gatekeepers for entry into real estate transactions, such as leases and sales, equal treatment by agents toward the public is crucial to success.

Everyone has an instant “feel” about an agent’s attitude. When their perception is other than getting fair treatment in their need for housing and financing, they become instant messengers of their negative encounter.

In 2021, a national total of 31,216 fair housing complaints became the highest amount of complaints since 2018. However, in the Pacific region, 7,814 fair housing complaints were reported — nearly a thousand less complaints in 2021 than the year prior, according to the National Fair Housing Alliance.

The national increase in fair housing complaints indicates implicit and explicit bias, and thus divisiveness is on the rise within the real estate industry outside the west coast — California. Consumers have had enough with rising adverse attitudes by filing their complaints.

Agents who are able to recognize and stop their discriminatory behaviors while counseling distressed clients, have trained themselves to behave for maximum success in serving consumers.

Discriminatory attitudes for agents to eliminate, include:

• advertisements using words and images targeting a group of people as preferential;
• inquiries into a potential or current tenant about their protected group status
  ;
• failure to reasonably accommodate a disability;
• sexual harassment in the process of handling a transaction;
• mortgage or insurance applications rejected based on the agent’s personal bias against a particular group of people, not legal reasoning; and
• refusal to rent, lease, mortgage, or sell housing by steering due to the consumer’s general classification.

Real estate agents need to voluntarily expose clients to opportunities available to view, rent, sell or finance property and leave it to the client to decide which suits their needs. The agent never decides what might be best for a client based on the client’s classification —that’s implicit bias. [DRE Reg. §2780(b)]

Real estate agents exercising personal discipline need to ask their clients legally permissible questions to enlighten the agents handling of a transaction, such as:

• about the presence of pets;
• how many tenants will occupy the property;
• how many parking spaces will be required;
• whether their present landlord will provide a favorable reference;
• whether any of the tenants smoke;
• the personal income of the tenant, credit references and credit rating; and
• whether any of the tenants intend to use a waterbed in the premises.

To ensure equal treatment, real estate agents need to ask all their clients the same list of standard questions. Additionally, agents ought to limit inquiries to matters that are directly applicable to the clients’ tenancy, finances for creditworthiness, or the care and maintenance of the property.

Related video:

Avoid Discrimination Risks in Rental Practices

How agencies handle discrimination complaints

Consider a residential landlord renting their apartment complex to tenants. The landlord enters occupied apartments without permission and refuses to let female tenants have male guests. Worse, the landlord has a pattern of sexually harassing female tenants. The tenants filed a complaint stating sexual discrimination against females. After a hearing, an order is entered, barring the landlord from future discriminatory practices — such as entering an apartment without a 48-hour notice — and compensation for the tenants at $100,000. [United States v. Claiborne (No. S-02-1099 DFL DAD) (E.D. Cal.)]

An individual who is a member of a protected class and believes another person has discriminated against them for that reason may file a complaint with the Secretary of Housing and Urban Development (HUD).  They have one year following the alleged discriminatory housing practice to file. To resolve the dispute, parties are encouraged to enter informal negotiations called mediation, at no expense to the individual.

When mediation fails to resolve the dispute, a judicial action before an administrative law judge may be initiated by HUD to resolve the dispute. Again, at no cost to the individual.

When a real estate broker subjected to a judicial action is found guilty of discriminatory housing practices, HUD is required to notify the California Department of Real Estate (DRE) and recommend disciplinary action.

When a court determines discriminatory housing practices occurred, actual and punitive amounts of money awards may be granted. Also, an order may be issued preventing the landlord or broker from engaging in discriminatory housing behavior.

Any individual with a discrimination complaint may elect to have the claims decided in a civil action in lieu of using an administrative law judge. [See RPI e-book Implicit Bias, Office Management & Supervision, Agency, Fair Housing, Trust Funds, Ethics and Risk Management Chapter 2]

To get on top of fair housing guidelines, take a look at our Implicit Bias, Office Management & Supervision, Agency, Fair Housing, Trust Funds, Ethics, and Risk Management e-book on Realtipedia.

Editor’s note – firsttuesday was the first to obtain DRE-approval for education by video presentation of the implicit bias training and expanded Fair Housing courses.

Related article:

State and Federal Fair Housing Laws: Identifying the Explicit and the Implicit, Pt II

Related topics:
complaints, discrimination, implicit bias, mediation

Posted by Amy Platero | Mar 10, 2023 | Fair Housing, first tuesday Local, Fundamentals, Laws and Regulations, Los Angeles-Santa Barbara-Ventura, Mortgages, Real Estate | 0

Reprinted from firsttuesday Journal  — P.O. Box 5707, Riverside, CA 92517

The complaint and allegations

The largest bank headquartered in Los Angeles, holding over $90 billion worth of assets and specializing in commercial, consumer, mortgage and wealth management banking services, just landed in hot water with the Department of Justice because of their unlawful redlining practices. They settled for an historic $31 million in January 2023.

The lender, City National Bank, avoided making mortgages and mortgage services available in majority-Black and Latino neighborhoods in Los Angeles from 2017 to 2020.

According to the Justice Department’s complaint, during 2017 through 2020, the bank:

• maintained only three of its 37 branches in minority neighborhoods;
• generated applications from their existing customers instead of marketing or advertising in minority neighborhoods;
• failed to provide adequate staff resources to serve the mortgage lending needs of residents from minority neighborhoods; and
• failed to act on internal reports indicating fair lending and redlining risk.

As a result of this conduct, the bank achieved disproportionately low numbers of mortgages and mortgage applications from minority areas compared to similarly situated lenders.

For example, City National received 8,593 mortgage applications within Los Angeles from 2017 through 2020. Of those applications, a mere 8% came from residents of majority-Black and Latino Census tracts. Meanwhile, peer lenders during the same period generated 46% of their applications from Black and Latino Census tracts.

These figures demonstrate a statistically significant failure by City National Bank, relative to its lender peers, to draw applications for mortgages and affirmatively provide mortgage services to residents from minority neighborhoods on a non-discriminatory basis.

The settlement and restitution

Under the Justice Department’s consent order filed with the U.S. District Court for the Central District of California, City National Bank has agreed to:

• provide at least $29.5 million for a loan subsidy fund for residents of majority-Black and Latino neighborhoods in Los Angeles;
• open one new branch in a majority-Black and Latino neighborhood and have at least four mortgage loan originators (MLOs) serving majority-Black and Latino neighborhoods; and
• conduct a research-based study identifying the financial needs for residents in majority-Black and Latino Census tracts within Los Angeles.

The settlement with City National Bank is the largest redlining settlement to ever be secured in the Justice Department’s history. City National is a subsidiary of Royal Bank of Canada, one of the world’s largest banks.

Related article:

Fannie Mae settles fair housing lawsuit for $50 million

Combatting redlining

While redlining

has become a catchall term for racist real estate practices, its precise definition and history is resurfacing to help real estate professionals combat the issue. Basically, redlining is about the improper allocation of our nation’s wealth among all the population, not just a pick-and-choose business choice for lenders as money is not a commodity, it is fiat created for everyone to have and to use. [Federal Reserve Bank of St. Louis]

Redlining is a failure to provide financing in specific communities based on demographics. The practice derives its name from the color-coded maps lenders used to grade the riskiness of mortgages in specific neighborhoods. In truth, the maps identified neighborhoods where minorities lived, allowing real estate professionals to further segregate homebuyers at underwriting for a mortgage origination.

Lawmakers outlawed the practice with the Housing Financial Discrimination Act of 1977 since it adversely affects the health, welfare and safety of residents. In fact, the California legislature views residents’ choice in housing opportunities within a free market as vital to the entire state’s economic health. [See RPI e-book Real Estate Principles, Chapter 9]

Substantively, a lender who denies mortgage applications based on the characteristics of a community discourages homeownership in that community. Thus, redlining leads to a decline in the quality and quantity of housing in areas where financing becomes generally unavailable.

Related article:

Redlining: its history and lasting impacts

Tearing down the legacy of redlining starts with real estate licensees. To become proactive, ask your clients whether they might want to file a claim with the California Business, Consumer Services and Housing Agency against a state-regulated lender when they express a belief their mortgage application was denied due to:

• their race, color, religion, sex, marital status, national origin, ancestry or any of the other applicable protected classifications; or
• trends, conditions or characteristics of the community where the real estate is located.

To further combat redlining and housing discrimination like the systemic disregard for providing equal access to mortgages levied against City National Bank, the California legislature recently imposed additional implicit bias training on real estate professionals for both continuing education (CE) and licensing courses.

The new CE course requirements apply to real estate agents and brokers with licenses expiring on or after January 1, 2023.

The new licensing course requirements apply to those who take the Department of Real Estate (DRE) State Exam after 2023. Anyone who is looking to apply in 2024 to take the DRE State Licensing Exam will need to complete a new Real Estate Practice course with the additional implicit bias and fair housing education.

Editor’s note — firsttuesday is expecting DRE approval soon for the new Real Estate Practice course needed in 2024. To enroll in firsttuesday’s two-hour Implicit Bias training for DRE license renewal CE, visit the order page.

Related article:

Implicit bias and fair housing soon required for licensing courses

Stay ahead of California real estate’s rapidly shifting legal landscape. Receive notice of this new course release in your inbox by subscribing to Quilix, the weekly firsttuesday newsletter for California real estate professionals.

Want to learn more about avoiding discriminatory housing practices? Click the image below to download the RPI book cited in this article.

 

 

 

 

 

Related topics:
discrimination, implicit bias, lenders, redlining

Posted by Amy Platero | Apr 6, 2023 | Appraisal, Fair Housing, Fundamentals, Laws and Regulations, Real Estate | 0

Reprinted from firsttuesday Journal  — P.O. Box 5707, Riverside, CA 92517

Multiple federal regulators in charge of enforcing the Federal Fair Housing Act (FFHA)

and Equal Credit Opportunity Act (ECOA) submitted a joint letter to The Appraisal Foundation, the private organization that sets appraisal standards.

The letter, signed by members of the Consumer Finance Protection Bureau (CFPB), Department of Housing and Urban Development (HUD), Department of Justice (DOJ) and Federal Housing Finance Agency (FHFA), urged The Appraisal Foundation to revise their latest draft of the Uniform Standards of Professional Appraisal Practice (USPAP).

Specifically, The Appraisal Foundation’s Ethics Rule found within the 2023 USPAP is what the federal regulators targeted.

The regulators pointed out the Ethics Rule uses the phrase, “An appraiser may not engage in unethical discrimination.” The statement implies an appraiser may engage in “ethical” discrimination — a concept foreign in existing legal codes and which creates unnecessary confusion between unethical discrimination and unlawful discrimination.

The regulators stress the importance for The Appraisal Foundation to provide appraisers clear and unambiguous statements about federal law requirements covering appraisal standards.

The Appraisal Foundation responded with a letter soon thereafter stating they will continue to work to clarify their Ethics Rule with an upcoming fifth draft of the USPAP.

The fifth draft USPAP was released on March 30, 2023.

Preventing discrimination in appraisals

To prevent discrimination during the appraisal process, licensees are prohibited from basing their appraisal on the basis of:

• race;
• color;
• religion;
• gender;
• gender expression;
• age;
• national origin;
• disability;
• marital status;
• source of income;
• sexual orientation;
• familial status;
• employment status; or
• military status. [Calif. Business and Professions Code §11424(a)]

This applies to all individuals who may be present or impacted by the appraisal, including the property’s prospective or current owners, any tenants, or occupants of neighboring properties. [Bus & P C §11424(a)]

To ensure compliance, as of January 1, 2022, the California Bureau of Real Estate Appraisers (BREA) is required to include a check box within their existing complaint form, asking the complainant whether they believe the appraisal to be below market value. Further, complainants will have the option to include their demographic information on the form. [Bus & P C §11310.3(b)]

The BREA is required to study this demographic information and provide a report of their findings to the state legislature before July 1, 2024. [Bus & P C §11310.3(e)]

Homeowners, buyers, sellers and agents who believe they have been the subject of appraiser discrimination may file an online complaint with the BREA.

Related article:

The votes are in: Appraiser discrimination is rare — here’s how to spot it

Related topics:
california bureau of real estate appraisers (brea), ethics, federal fair housing act, uspap

Posted by Carrie B. Reyes | May 15, 2023 | Buyers and Sellers, Feature Articles, Real Estate, Recessions, Your Practice | 0

Reprinted from firsttuesday Journal  — P.O. Box 5707, Riverside, CA 92517

This article advises agents on the need during a recessionary period in the real estate market to know the buyer’s liability exposure when the buyer breaches their purchase agreement. With this information, agents will be aware of the maximum dollar amount the seller is entitled to receive.

Windfall provisions, and liability limited to losses

A fundamental premise in law: when you wrongfully cause another person to lose money, you are responsible for repayment of the loss, and nothing more. This economic concept was codified for California real estate transactions in 1872 and remains intact today. [Calif. Civil Code §3307]

However, an equally fundamental and reciprocal premise holds that windfalls are abhorred by all since they are unearned and do not represent the loss.

These two legal precepts are disturbed by the inclusion of a liquidated damages provision (also called a forfeiture provision) in a purchase agreement (and, while we are at it, the inclusion of attorney fee provisions which we do not deal with here).

Use of a liquidated damages provision in a purchase agreement is an attempt to both:

• limit a buyer’s responsibility for payment of losses they inflict on a seller; and
• provide the seller with a windfall at the buyer’s expense.

The presence of a liquidated damages provision in agreements creates aberrations in the natural expectations logically held by individuals in a real estate transaction.

For an example of this distorted thinking: a seller expects to lose nothing of value in exchange for their receipt of the buyer’s good faith deposit when the buyer fails to close the transaction. However, the buyer expects a refund of their good faith deposit when they do not acquire the property as no one has lost or received anything.

A sellers agent needs to understand the financial nature of their seller’s position under a purchase agreement —with or without a liquidated damages provision. With a bit of knowledge, the agent may properly advise the seller when a buyer breaches the agreement negotiated by the agent.

When the buyer breaches and the seller cancels the purchase agreement, enabling the seller to market and resell the property, it is obvious the seller still owns the property. Further, the seller by cancelling has cleared the property of any claim by the buyer to acquire it. The seller has lost nothing, unless the property value was less at the time of breach or the buyer caused a loss of rental income or wrongfully interferes with the resale efforts. [See RPI Form 150]

Losses and resolving a breach

A buyer’s good faith deposit, even when released to the seller before closing after removal of all contingencies, remains the buyer’s money until:

• the buyer receives consideration (i.e., title to the property on close of escrow); or
• the deposit is offset to reimburse the seller for their actual money losses incurred due to a breach by the buyer.

The seller’s purported loss of prospective buyers and recent cyclical market synergies, or the infliction of seller inconvenience and frustration — all attributable to the buyer’s breach — are not money losses. Thus, these ancillary non-monetary conditions leave the seller with nothing in money losses to pursue or collect.

However, the sellers agent properly focuses on resolving a buyer’s breach and the failed sales transaction by immediately turning their attention to assisting their client to “clear out” the breached transaction so the property can be remarketed. Here, the sellers agent is still obligated to locate buyers under the seller’s Exclusive Right to Sell Agreement, unless it has expired. [See RPI Form 102]

To resell, cancellation instructions need to be given to escrow to cancel the breached purchase agreement and escrow instructions, unless the seller has reason to forego reselling the property and pursues a specific performance action to force the buyer to close escrow or simply decides to retain the property.

Related article:

The breaching buyer’s responsibilities: Part 1

 

Money losses reimbursed

What is the sellers agent to do about a buyer’s good faith deposit when the buyer breaches a purchase agreement?

While the agent’s knee-jerk reaction may be to call for release of the buyer’s deposit to the seller, the first reasonable step to take is to calculate the amount of money the seller lost.

The buyer owes the seller the seller’s actual money losses — expenditures which will not be reimbursed on a resale. Thus, the seller has a claim on the buyer’s good faith deposit as the primary source for recovery of money losses.

To the seller’s benefit, calculating the seller’s recoverable losses are quite straightforward for setting the amount of the demand to be made on the buyer.

Presuming, as a sellers agent must, the seller will not interfere with the listing and will allow the agent to locate a new prospective buyer, the property is likely to be resold in the near future when correctly priced. Again, a further price drop after the breach is not recoverable.

Accounting for income and expenses

Money losses recoverable by the seller include:

• increases in transactional costs on the resale over the costs the seller was to incur on the failed transaction; and
• any transactional costs actually incurred in the failed sale not reimbursed on the resale.

When the comparison of the net sheets on each transaction presents evidence the seller received less proceeds on the resale due to transactional costs differences, the seller has a factual basis for recovery. [See RPI Form 310]

The ongoing operating and carrying costs incurred during continued ownership are not recoverable expenses when the property remains rented or occupied by the owner prior to resale. The actual or implicit rent typically remains the same value, as do the operating expenses and carrying costs, after the breach until the closing of the resale.

However, when rents were decreased, units left vacant, or costs increased by agreement with the buyer and those conditions remain after the breach, the breaching buyer is liable for those amounts as losses foreseeably resulting from their breach.

Operating income and expenses and carrying costs of ownership – taxes, mortgage payments, assessments – are not typically altered by the terms of the purchase agreement. Thus, little (if any) loss exists for the seller to recover on their continued ownership of the property unless the value of the property declined below the agreed sales price at the time of the breach.

Related article:

Brokerage Reminder: Disbursement of funds when a transaction fails

Demands, challenges and limitations

When may the seller make the demand on the breaching buyer?

The seller may make a demand for all or a portion of the good faith deposit at either:

• the time of the breach; or
• after closing a resale of the property when a loss, if any, is known.

When a liquidated damages provision is included in the purchase agreement for one-to-four residential units and the buyer and seller both initial the provision, they have agreed that the buyer’s good faith deposit is to be forfeited to the seller on a breach by the buyer. But like all agreements, the provisions are subject to judicial enforcement based on contract law principles that then exist.

Here, liquidated damages provisions are enforceable by a seller, but only to set the limit of the buyer’s liability to the seller. Thus, the ceiling on the seller’s recovery is set at the amount agreed to be forfeited — typically the good faith deposit.

However, that is not where the analysis stops. When a breaching buyer demands the deposit be refunded, the seller becomes obligated to provide an accounting. When the accounting shows the seller’s losses equaled or exceeded the amount of the deposit, the seller is entitled to the entire deposit, but no more.

When the losses are less, the seller is entitled to recover only the amount of their actual money losses, not the entire deposit as actually worded in the liquidated damages provision. Here, the seller can recover the money they lost up to the total amount of the deposit referenced in the agreed liquidated damages provision and no more, no matter the amount of the deposit.

Related video:

Making a demand

When a liquidated damages provision exists, the proper initial reaction of the seller and the sellers agent is to make a demand on the buyer for the entire good faith deposit when it does not exceed 3% of the price. This percentage amount of forfeiture is presumed valid (though it may not be collectible) [CC §1675(c)]

Once the demand for the forfeiture has been made on the buyer — without concern for the actual money losses the seller has incurred or will experience on a resale — the seller merely waits for the buyer’s response. When it is positive and the funds are released to the seller, the seller has won without argument. Ideally (for the seller), the buyer will not later realize that the seller’s actual money losses were less than the amount released and then make a demand for a refund.

However, when the buyers agent and the buyer are well informed, the buyer will challenge any seller demand for the deposit under any type of liquidated damages provision. The buyer’s claim is that the validity presumption is voidable and demand a return of their deposit. In analysis, the provision’s validity is a rebuttable presumption giving the buyer the upper hand. Thus, the provision is a forfeiture and unenforceable as such.

Further, the total amount of the deposit — arbitrary for losses and coincidental to the price paid, not losses — has no legal relationship to the losses the seller may suffer on the buyer’s breach. Still, the deposit is the source of funds for the recovery of actual losses.

Calculating the seller’s losses

When a breaching buyer challenges any liquidated damages or forfeiture provision as voidable, the seller needs to itemize and calculate their losses on the resale, along with their permissible interim operating and carrying costs of vacant property prior to a resale, even when:

• no liquidated damages provision exists in the purchase agreement;
• the amount of the liquidated damages is more than 3% and thus presumed invalid;
• the liquidated damages or liability limitation provision places a ceiling on the buyer’s liability for the seller losses; or
• no provision limiting recovery existed in the purchase agreement restricting the seller’s right to recover all their losses.

Under any of the above scenarios, the seller is to itemize their money losses to include:

• any decline in the property’s value by the date of the buyer’s breach;
• the seller’s transactional costs incurred on the lost sale which are not recovered on a resale; and
• any increased operating costs or rent losses caused by the terms of the purchase agreement for the benefit of the buyer and incurred through the date of a resale.

Collecting from the buyer

The buyer is to cover these itemized losses from the good faith deposit up to any dollar limitation set by a liquidated damages or liability limitation provision in the purchase agreement.

Before the seller may recover losses caused by the breaching buyer when the buyer asserts their obligation to pay only the seller’s actual money losses, the seller needs to:

• promptly proceed to market, resell and close a resale of the property rather than retain the property;
• calculate the total amount of the price-to-value difference at the time of the buyer’s breach, lost transactional expenses on the breached sale and the loss of expenditures on non-value-adding improvements or repairs called for under the breached purchase agreement;
• make a demand on the buyer for the amount of the itemized money losses; and
• when not paid, pursue collection of the lost money and a release of the amount from the buyer’s deposit — subject to any agreed limitation on the dollar amount of the buyer’s liability for their breach.

Related video:

Challenging the validity-of-forfeiture presumption

When the seller demands the buyer’s good faith deposit, the buyer and buyers agent need to understand:

• the funds belong to the buyer until escrow closes, which will not occur due to the buyer’s breach;
• the seller has a claim against the deposit for recoverable losses; and
• the buyer is to make a demand on the seller for a statement of itemized losses before the buyer pays any compensable losses incurred by the seller.

Thus, when an initialed liquidated damages provision is included in a purchase agreement, the buyer’s demand for an itemization of the seller’s money losses constitutes a legal challenge. The demand rebuts the presumed validity of a forfeiture-of-deposit provision for deposit amounts not exceeding 3% of the purchase price.

Following the request of the seller for an accounting, when the seller fails to respond, they either did not incur a recoverable loss or waived any claim to recover their losses.

Limiting the breaching buyer’s liability

A seller is entitled to recover the entire amount of their money losses caused by the buyer’s breach when the purchase agreement does not contain a liquidated damages provision or contract liability limitation provision.

Conversely, the seller is limited in their recovery when the purchase agreement (for the sale of one-to- four residential units to a buyer-occupant) includes an initialed liquidated damages provision or a contract liability limitation provision.

In either case, when an accounting is sought by the buyer for the seller’s recoverable money losses, the seller needs to present an accounting to be reimbursed.

When an initialed liquidated damages provision is included in a purchase agreement, the breaching buyer avoids the forfeiture called for by challenging the presumed validity of any amount demanded by the seller up to 3% of the purchase price. [3 CC §1675(c)]

However, for the seller to enforce a forfeiture of any portion of a deposit exceeding 3% of the purchase agreement price, the seller challenges the presumed invalidity of the excess demand by demonstrating their losses on the sale exceeded 3% of the purchase price. [CC §1675(d)]

Thus, the liquidated damages provision has a “split-personality” — the responsibility of the buyer is to challenge the presumed validity of a forfeiture of 3% or less, while the responsibility for challenging the presumed invalidity of a forfeiture of more than 3% is the seller’s. Either way, the seller needs to account for losses.

In general, liquidated damages provisions, other than on the sale of one-to-four residential units to a buyer-occupant, are initially presumed to be valid. However, they are unenforceable when they do not represent an amount which bears some reasonably close relationship to the actual losses the seller will incur due to money lost resulting from the buyer’s default.

When the amount of the forfeiture exceeds the seller’s losses, the buyer can void the provision as unreasonable.

Liability ceiling or forfeiture

When a buyer and seller do not agree to either a liquidated damages provision or a contract liability limitation provision, the buyer who enters into such a purchase agreement and breaches is liable for an unlimited amount of losses incurred by the seller due to the buyer’s breach. In a stable resale market for property or one of rising prices, the buyer takes little risk when entering into a purchase agreement without a ceiling on their liability exposure.

Related chart:

California tiered home pricing

However, during a falling price environment, the buyers agent needs to be diligent in their protection of the buyer by explaining the need for a ceiling on liability exposure. Otherwise, when the value of the seller’s property has dropped below the sales price, the defaulting buyer may be liable for large seller losses.

In contrast, the sellers agent advises their seller in times of weak or weakening pricing power to avoid agreeing to a ceiling on the buyer’s liability and to obtain a larger deposit.

Seller’s refusal to refund is a breach

Consider a buyer of a single family residence (SFR) who has entered into a purchase agreement containing an initialed, liquidated damages provision.

Prior to closing, the buyer waives all contingencies and releases their good faith deposit to the seller in an amount in excess of 3% of the agreed price. At the time of closing, the buyer decides not to purchase of the property.

The seller promptly remarkets the property, accepts an offer and quickly closes a resale of the property, but at a slightly lower price. The buyer then makes a demand on the seller to return that portion of the deposit now held by the seller which exceeds the seller’s losses. The breaching buyer is willing to cover the seller’s loss in the amount of the reduced net proceeds on the resale (although the buyer is liable only for the decline in value which took place by the time of the buyer’s breach).

The seller rejects the buyer’s demand for a refund, claiming the funds released were option money which they are entitled to keep as consideration for their irrevocable offer to sell the property to the buyer, which the buyer did not exercise by closing escrow, a unilateral contract situation.

A bilateral agreement, or option to buy

In the previous example, the liquidated damages provision in the purchase agreement establishes the agreement is bilateral. The purchase agreement called for a forfeiture of the deposit when the buyer fails to close escrow, the antithesis of an option agreement which is unilateral and contains no forfeitures by its nature. Thus, the seller’s defense for keeping the buyer’s deposits as option money consideration for granting an option is without merit.

Further, the seller did not attempt to show that their losses caused by the buyer’s breach equaled or exceeded the buyer’s deposits. The seller did not produce closing statements for either the lost sale or the resale, lost transactional expenses, non-value-adding expenditures for repairs or maintenance, any recoverable operating costs for carrying the property or lost rental value until the close of the resale.

Here, the liquidated damages provision becomes a promise by the seller to refund — or release — that portion of the deposit which exceeds the seller’s recoverable losses, due to either:

• a buyer’s challenge of the forfeiture’s reasonableness; or
• the forfeiture amount being in excess of 3% of the purchase price.

Thus, the seller’s failure to refund (or release) the amount exceeding their losses is a breach by the seller of the liquidated damages provision and the purchase agreement. [Allen v. Smith (2002) 94 CA4th 1270]

Further, when the purchase agreement does not contain a liquidated damages provision or other contractual liabilities limitation, the seller is still limited to collecting no more than their actual losses. Thus, the excess amount of the buyer’s deposit over the seller’s losses is refunded by the seller or released from escrow to the buyer.

Related article:

Extending performance dates to attain purchase agreement objectives

Court-ordered forfeiture is also unenforceable

Consider a buyer and seller of a SFR property who enter into a court-ordered settlement agreement to resolve their dispute over their performance of the purchase agreement and agree to close escrow. The settlement agreement contains a forfeiture provision calling for the release of the buyer’s good faith deposit to the seller when the buyer does not complete the sale as agreed.

However, the buyer is unable to secure purchase-assist financing and cancels escrow, a breach of the settlement agreement since closing escrow was not contingent on their obtaining a mortgage.

The seller seeks to recover the total amount of the buyer’s good faith deposit. However, the seller incurred no loss due to the buyer’s failure to perform. The property is resold at a higher price.

The buyer claims the seller cannot enforce the forfeiture provision in the court-ordered settlement agreement since any provision agreeing to the forfeiture of the good faith deposit is limited by existing contract law to a provable loss.

The seller claims the forfeiture provision is enforceable without a proof of loss since the provision is contained in a court-ordered settlement agreement between the buyer and seller, not in a privately negotiated real estate purchase agreement.

Here, as in all forfeitures of money arising out of any real estate transaction, the seller may not enforce the forfeiture provision to recover the buyer’s good faith deposit unless they can show an actual money loss.

The court-approved settlement agreement is a contract agreed to by the buyer and seller, not an award determined by the court. Thus, as controlled by contract law, enforcement of liquidated damages provisions in a real estate purchase is prohibited, unless the seller incurs a loss. Even then, the recovery is limited to their money losses. [Timney v. Lin (2003) 106 CA4th 1121]

Related article:

The seller cancels the purchase agreement: now what?

Related topics:
buyers agent, good faith deposit, liability, purchase agreement

Posted by Carrie B. Reyes | Feb 20, 2023 | Buyers and Sellers, Feature Articles, Home Sales, Real Estate, Your Practice | 0

Reprinted from firsttuesday Journal  — P.O. Box 5707, Riverside, CA 92517

This article examines the risky business of pocket listings, and the drawbacks for sellers, buyers — and brokers.

The “Listing” of a secret double ends the fee

A pocket listing is an exclusive listing with an intentionally delayed release into the multiple listing service (MLS) environment of local brokers.

Pocket listings work as a marketing tool by manufacturing a sense of exclusivity among the few potential buyers exposed to the property solely by the seller’s agent.

Brokers who take on pocket listings find they essentially double their fees on a transaction by representing both buyer and seller (how nice). It also gains them the reputation of being well-connected and “in the know.”

This type of dual agent is a broker who simultaneously represents the best interest of opposing parties in a transaction, e.g., both the buyer and seller. This encompasses both the broker and the agents they employ. [See RPI Form 117]

Sellers who opt for pocket listing treatment do so to:

• skip the inconvenience of prepping their home for sale, including completing improvements and getting the home show-ready to open it to the MLS marketplace;
• limit interested buyers to the broker’s “vetted” shortlist of buyers to gain a veil of privacy (excluding the competitive “rabble” from viewing the home); and
• “test” the market for pricing before going to the effort of an MLS posted listing — a tactic selected during a housing market downturn when an illusionary seller is unlikely to receive their preconceived price.

For buyers, the motive to pursue a pocket listing is usually sheer desperation, sweetened by the knowledge they alone are worthy enough to view an off-market listing.

For example, pocket listings are most common during a seller’s market, characterized by:

• low MLS inventory;
• rising home prices; and
• high buyer demand and competition.

During these desperate times for buyers fueled by fear of missing out (FOMO), getting a chance at a property before the general public is like winning the lottery when notified of a pocket listing held off market by their broker.

Sounds like a win-win-win situation. But are pocket listings ever worth it for buyers — or sellers?

Sellers, buyers lose out with pocket listings

Sellers who allow their broker to float a pocket listing end up getting fewer views, meaning their home is likely to sell for a lower price with less favorable terms than had they opened it up to competition among all buyers of all brokers and agents.

The seller’s aim is to at least get fair market value (FMV), defined as the most probable price a property would bring on the open market, given prudent, knowledgeable and willing buyers and sellers. That is not capable when the property is not exposed to the market, as that is how FMV is established.

A pocket listing has no open market as the marketing of the home is not open — known — to the marketplace. Worse, the word is willing buyers — in the plural, as a single willing buyer alone does not establish market value.

On the other side of the transaction, buyers as a whole miss out when pocket listings take up a chunk of the market, as the majority of pocket listings are not available to them, resulting in a lower MLS inventory of housing options which distorts pricing in general.

Related article:

California’s for sale inventory: a symptom of homebuyer demand

 In 2021, the California Regional MLS (CRMLS) introduced a “Coming Soon” feature which sidestepped some of these concerns.

This feature allows agents to advertise their listings on the MLS for up to 21 days before the property is “officially” available in the market. Thus, persistent buyers who are unconnected to the broker are typically able to twist their way into a pre-listing showing (though, under CRMLS rules, performing tours and soliciting offers are prohibited during the Coming Soon phase).

Still, what’s to stop a broker with a Coming Soon property announcement from privately negotiating offers within their own personal network? An agent very well knows the 21-day Coming Soon period can be used to capture an unrepresented buyer — an in-house prospect — and double-end the transaction. Déjà vu.

The pocket listing environment is a bit like the Wild West. Rarefied oversight of pocket listings leaves relatively powerless buyers and sellers— who rarely possess the experience necessary to realize the advantages they lose with a pocket listing — to the devices of the gatekeepers for entry into property transactions with little to no protection. 

When the broker pushes a pocket listing

The real estate broker employed as the seller’s agent has, by agency law, taken on a fiduciary duty of utmost care, integrity, honesty and loyalty in dealings with the seller. [Calif. Civil Code §§2079 et seq.]

In a contradiction to this agency rule, a not uncommon activity of seller’s agents during times of high buyer demand and low availability of inventory is to delay the publication of a new exclusive listing on the MLS to stall exposure of the property to agents of potential buyers.

Unless instructed by the seller with a need to delay the listing’s release to the MLS, failure to use all readily available methods and media to promptly expose the property-for-sale to potential buyers is a breach of the seller’s agent’s fiduciary duty to take reasonable steps to locate a buyer — the stated purpose of the broker’s employment.

Occasionally, posting a listing to the MLS is reasonably postponed due to demands of the seller.

For example, the seller may want to make repairs or declutter the house prior to exposing it to the public — a legitimate financial reason accommodated by delaying its posting on the MLS. Under these maximizing-value circumstances, it is unlikely any buyer, including those potentially known to the seller’s agent, will have the opportunity to see the home until it is ready to view on the MLS. Thus, the term pocket listing does not apply in these reasonable circumstances for delaying the listing’s release.

However, some agents (and thus their brokers) will hoard a new listing for a week or a month or two, prior to placing it on the MLS for all to view. Leasing agents commonly use this strategy in developing recessions when warehousing becomes available, such as 2022 and 2023.

During this time, the agent pitches the property to other agents within their brokerage office, holds an open house or conducts other non-MLS sales promotion in an attempt for the office to “double end” the brokerage fees on the sale.  A for sale or lease sign is often set on the property advising users who drive by to call the seller’s agent.

Related article:

Dual agency explained

Here, the seller’s agent (and likely their broker) has prioritized their own needs for personal income enhancement over the needs of their client. This is an activity not in the best interest of their seller client for obtaining the highest price in the real estate market — a breach of their fiduciary duty to their client.

The seller’s agent owes the seller a duty of care to make a competent due diligence presentation of the property to attain the highest price for their property.

A pocket listing denies the seller access to the largest audience of competitive prospective buyers. In fact, it becomes impossible for a seller’s agent to meet their duty of care when subjecting a property under an exclusive employment to a pocket listing environment. As an agent, they have failed to make the property available to as many potential buyers ASAP. [CC § 2079.16]

The limitations of dual agency

While pocket listings may seem desirable to agents due to the possibility of a double-ended fee or to generate a second resale fee, these agents are in danger of breaking the cardinal rule: putting their individual interests above their client’s best interests. This stems from the issue of conflicts in dual agency, when a broker represents opposing principals in the same transaction.

Why is dual agency problematic? Though a dual agent needs to work diligently on behalf of both clients, they are prevented from fully negotiating on behalf of either client, unable to simultaneously negotiate the highest and best price for the seller, and the lowest and best price for the buyer.

Both the buyer and seller are clients of the dual agent. Thus, the dual agent (meaning the broker) owes a fiduciary duty to both principals they represent through their services or the services of their agents.

This dual agency naturally creates a conflict of interest, which the agent is mandated to promptly disclose to each client. The agent needs to obtain client approval before continuing negotiations on the clients’ behalf. [See RPI Form 117; CC §2079.17]

Further, the dual agency inherently limits the benefits obtainable by the principals. Though the dual agent is duty-bound to work diligently on behalf of both clients, the agent is prevented from actually achieving the full advantages of negotiations for either client.

Like the opposing ends of a teeter-totter, a natural inability exists to simultaneously negotiate the highest and best price for the seller, and the lowest and best price for the buyer.

Thus, clients of a dual agent generally do not receive the full range of benefits available from an agent who negotiates a purchase agreement as the exclusive agent of the client. It is for this reason the dual agency environment, even when handled properly, exposes the broker to breach-of-duty claims when a client becomes disgruntled with the results.

Related article:

Buyer breach of contract in a decreasing price environment: Seller remedies

Related topics:
dual agency, multiple listing service (mls), pocket listings, recession

Posted by Carrie B. Reyes | Apr 24, 2023 | Buyers and Sellers, Feature Articles, Market Watch features, Your Practice | 0

Reprinted from firsttuesday Journal  — P.O. Box 5707, Riverside, CA 92517

This article discusses buyer remedies when a seller breaches or cancels a purchase agreement.

The seller fails to act timely

On occasion, a buyer’s agent in a real estate sales transaction will be confronted with conduct by the seller which interferes with the close of escrow.

Examples of seller interference with a buyer’s acquisition of property include the seller’s failure to (timely):

• return escrow instructions;
• deliver closing documents;
• provide escrow with information on existing mortgages for requesting payoff demands, beneficiary statements or assumption papers;
• deliver seller identification information for title insurance purposes;
• eliminate defects as agreed to — or eliminate previously undisclosed property defects discovered after contracting to buy and found unacceptable to the buyer;
• arrange or permit property inspections by the buyer, appraiser, home inspector, city inspector, etc.; or
• close escrow as scheduled.

At the time of the seller’s interference, the buyer either has fully performed or is unable to proceed further toward closing. Thus, escrow cannot close due to an unexcused failure by the seller to perform an activity or cause an event to occur.

Seller remorse

Typically, the seller’s refusal or failure to timely act under the purchase agreement and close escrow arises during a recovery period characterized by dramatic increases in pricing for the type of property the seller has agreed to sell to the buyer.

In contrast, when property prices are falling (as began here in California in 2022), it is buyers who are more likely to back out of a purchase agreement in search of a better deal elsewhere.

Other reasons a seller may back out of a purchase agreement include:

• an inability to find or borrow mortgage funds to purchase a suitable replacement home, such as during times of low MLS inventory and fast rising property prices and mortgage rates;
• an unwillingness (or inability) to pay for or implement repairs demanded by the buyer following an untimely home inspection which reveals defects and needed repairs;
• the discovery during the title search of outstanding liens against the home; and
• a change in life circumstances which no longer requires the seller to move, such as a job loss.

Occasionally “seller remorse” sets in, manifested by the seller’s efforts to force the buyer to default on a scheduled activity or event which justifies the seller’s termination of the purchase agreement.

Faced with the failure of escrow to close due to the seller’s nonperformance or obstruction of the buyer’s efforts to proceed and close escrow — and the inability of the buyer and agents to induce the seller to voluntarily close escrow — the buyer is forced to make a pivotal decision regarding their bargained-for ownership of the property.

Buyer remedies

When the seller breaches the purchase agreement or escrow instructions, the decisions available to the buyer, called remedies, include:

• abandoning the transaction by entering into a mutual cancellation of the purchase agreement and escrow instructions with the seller, agreeing to do nothing further to enforce the right to purchase the property or seek a money recovery from the seller, other than a return of the buyer’s good faith deposit; [See RPI Form 181]
• acquiring the property by pursuing a specific performance action — enforcement — of the purchase agreement and escrow instructions;
• pursuing the recovery of money when the buyer cannot now acquire the property but due to the seller’s conveyance of the property for a measurably higher price to another person who was unaware of the pre-existing purchase rights held by the buyer; or
• pursuing the recovery of money when the buyer no longer wants to acquire the property, and the value of the property was measurably higher on the date the seller canceled escrow than the price the buyer agreed to pay — in this case, the losses are equal to the difference between the price the buyer contracted to pay and the value of the property at the time of the seller’s breach.

An unsuspecting buyer who acquires ownership of real estate without actual knowledge or recorded notice (constructive knowledge) of a pre-existing enforceable purchase agreement held by another buyer regarding the same property is referred to as a bona fide purchaser (BFP). As a BFP, the buyer pays consideration to acquire and take title to the property while having no knowledge of a claim to the property held by the other buyer. [Calif. Civil Code §3395]

Related article:

Buyer breach of contract in a decreasing price environment: Seller remedies

Misplaced reliance on an adverse party

Consider an owner of commercial real estate who lives out of the area. The absentee owner is solicited by a buyer’s agent seeking to locate properties suitable for their buyer. The owner responds indicating they will sell the property, but do not know its value. They ask for an indication of its value from the buyer’s agent.

The owner is capable of understanding that the buyer and the buyer’s agent are their adversaries in negotiations.

After exchanging information about the property, the buyer’s agent states they do not want to express an opinion of value on someone else’s property, but have shown their buyer similar properties offered at $2,000,000. The owner does not indicate what they believe the value of their property might be, but acknowledge they know the market value of nonresidential property is on the rise.

The buyer’s agent prepares a purchase agreement offer for a cash price of $2,500,000. The buyer signs the offer and it is submitted to the owner.

The owner accepts the offer and the buyer’s agent promptly dictates escrow instructions. A copy of the instructions and a grant deed for the transfer are sent to the seller. The buyer signs and returns the documents to escrow. On receiving, reviewing and approving the preliminary title report, the buyer advises escrow they will place the balance of the cash price into escrow when escrow calls for funds.

Seller’s discovery of property

The owner then visits the community where their property is located. For the first time, the owner inquires into the worth of their property by contacting local agents. The owner finds the property is worth considerably more than the price they agreed to.

Another buyer is located and a price of $7,500,000 is agreed to. Escrow is opened with the new buyer at a different escrow and title company and closed immediately.

Meanwhile, the original buyer is involved in a futile attempt to close their escrow with the owner. The owner claims the agreement they entered into with the buyer was never a binding contract due to the buyer’s misrepresentation of the property’s value and the owner’s reliance on the agent’s evaluation to set the sales price. Thus, they have no deal.

The original buyer decides they no longer want the property and will not pursue acquiring it since the new buyer is likely a BFP.

Related article:

Dual agency explained

The original buyer makes a demand on the owner for $5,000,000, the difference between the price agreed to and its worth on the owner’s breach based on the price the seller received on the resale of the property.

The owner refuses to pay the demand, claiming their refusal to close escrow at the agreed price was justified since the property’s value was known to the buyer and the buyer’s agent, but not to the owner. Thus, they took advantage of the owner’s ignorance of the property’s true value, called misrepresentation.

Here, the owner was a knowledgeable individual, fully aware of their choice to not inquire about the value of the property before agreeing to sell it to the original buyer at the price of $2.5 million. Thus, the owner owes the buyer the difference between the price agreed to with the buyer and the value of the property on the date the seller breached ($5,000,000). [Kahn v. Lischner (1954) 128 CA2d 480]

Recover money, not property

A buyer who seeks to recover money from a breaching seller, in lieu of ownership of the property, does so based on monetary claims within three categories of money losses:

• general damages, being money directly expended in the transaction or the monetary value lost in the transaction;
• special damages, also called consequential damages, being money collaterally lost due to the seller’s breach; and
• prejudgment interest on all monies recovered. [CC §3306]

General damages are monetary losses incurred by the buyer due to their expenditures and loss of value — greater market value at the time of seller breach. These money losses directly relate to their acquisition of the property which, due to the seller’s breach, they are no longer going to acquire, including:

• money advanced by the buyer toward the price of the property, such as deposits held by the agent or escrow, or previously released to the seller;
• expenses incurred examining title conditions, inspecting the property, verifying operating income and expenses, and obtaining financing, escrow services, engineering and improvement plans, etc., all called transactional expenses;
• move-in expenses incurred preparing the property to take possession; and
• the price-to-value difference between the price agreed to in the breached purchase agreement and the value of the property on the date of the seller’s breach.

Related article:

Market price influencers for a BPO report

Price-to-value difference on date of breach

Consider a buyer of real estate who enters into a purchase agreement to acquire one of two adjacent lots held by the owner. The purchase agreement contains a provision granting the buyer a right of first refusal to acquire the adjacent lot, also called a preemptive right to buy.

The right-of-first-refusal provision sets the price of the adjacent lot at $900,000, but does not state an expiration date for the right to buy it. A more formal documentation of the right of first refusal is not entered into and no memorandum of the right is recorded. The transaction closes.

Many years later, the owner conveys the adjacent lot to another person for $2,000,000. The person who acquires the adjacent lot has no knowledge of the outstanding right of first refusal. Thus, the person who acquired the adjacent lot is a BFP, barring any recovery of the lot by the buyer.

The buyer claims the owner has breached the right-of-first-refusal provision in their purchase agreement. Thus, the buyer makes a demand for the monetary value of the lost right to buy since they may no longer acquire the adjacent lot.

The buyer’s demand on the owner is $1,100,000, the difference between the price set in the right of first refusal provision and the value of the property on the date of the breach. The demand also includes interest at 10% (the legal rate) on the amount from the date of the breach until the demand is paid.

The owner refuses to pay the demand, claiming the right of first refusal they granted at the time of the purchase of the first lot expired prior to the owner’s sale of the lot since the provision did not contain an expiration date, and a reasonable period of time for the right to continue had passed.

Can the buyer recover money equal to the price-to-value difference several years later at the time of the sale of the lot covered by the right of first refusal?

Yes! The right of first refusal which the owner granted did not state a date for its expiration. Thus, the date of expiration becomes the date of the death of the owner who granted the right.

Editor’s note: A buyer who recovers money losses is also entitled to recover interest at the (legal) rate of 10%, commencing on the date of the seller’s breach, on amounts recovered for:

• the price-to-value difference;
• money paid toward the purchase price, whether held by the seller or as a deposit in escrow, until the date released to the buyer;
• funds expended on title examination and other transaction expenses incurred preparing to take title;
• expenses incurred while preparing to take possession of the property; and
• interest on consequential losses accruing from the date of their disbursement. [Al-Husry Nilsen Farms Mini-Market, Inc. (1994) 25 CA4th 641]

The notice of intent to sell

The period following the notice of the owner’s intent to sell controls the buyer’s actions. Until notice of intent, the buyer does nothing but wait to see if the owner ever decides to sell. The owner’s delivery of the notice to sell starts the running of the period during which the buyer may exercise their right to buy.

When this period for exercise is not stated in the right-of-first-refusal provision, it is limited to a reasonable period of time for acceptance/exercise which begins to run when the buyer receives notice from the owner of their decision to sell. [See RPI Form 162-2]

What expires is the period after the notice, not the grant of the preemptive right to buy, unless the right-of-first-refusal provision specifically limits the term of the grant.

Accordingly, the buyer’s money recovery of the lost opportunity to buy a property is the difference between:

• the value of the property on the date of the breach, here set by the price the owner received for the property on the resale (the event which triggered the right to buy); less
• the price agreed to in the right of first refusal provision as the amount the buyer was to pay for the property on exercise of the right to buy. [Mercer Lemmens (1964) 230 CA2d 167]

Preparing to take possession

Consider a buyer who enters into a purchase agreement with an owner-builder to construct a new home. The buyer purchases appliances and upgrades the fixtures, which the builder installs.

Later, the builder substantially alters the construction plans without the buyer’s approval. The buyer demands the builder complete construction under the plans and specifications as agreed. The builder refuses since they have prospective buyers for the property at a significantly higher price.

The buyer decides they no longer want the new home due to their conflict with the builder. Thus, they unilaterally cancel the purchase agreement since the builder has breached the agreement. The buyer now seeks to recover money — not the property — from the builder.

Here, the amount of money losses the buyer may recover from the builder include:

• funds advanced toward the purchase price, including good faith deposits and monies released to the seller;
• the price-to-value difference between the price the buyer agreed to pay in the purchase agreement and the resale value of the property at the time of the builder’s breach;
• expenses incurred to prepare the property for possession (to the extent they exceed the price-to-value difference), i.e., the expenditures made by the buyer for the additional appliances and upgraded fixtures; and
• interest from the date of the breach on all amounts of money recovered.

The buyer may recover expenditures incurred prior to a seller breach to prepare a property so they can take possession. However, the purchase agreement by its provisions needs to reflect the intention of the buyer to incur these expenditures. Recovery of construction costs advanced by a buyer for upgrades and additions gives the buyer the benefit of the bargain contemplated by both the buyer and seller when they entered into their agreement.

However, the buyer cannot enjoy a double recovery for the upgrades they paid for when the price-to-value increase exceeds the cost of the upgrades.

For instance, any expenditure a buyer may make to purchase furnishings before taking title to a new home is excluded from recovery. Here, money spent on furnishings is not related to the acquisition of real estate. Accordingly, it is prudent for a buyer to wait until escrow closes before actually buying furnishings for their use when in possession of the property.

Related article:

Extending performance dates to attain purchase agreement objectives

Special damages, a natural result

A buyer whose seller has breached their purchase agreement is also entitled to recover related expenses incurred by the buyer after the breach. These post-breach expenditures only qualify for recovery when they are the natural result of the seller’s breach, called special damages.

For the buyer to recover post-breach expenditures, the seller on entry into the agreement needs to know or be on notice the expenses will likely be incurred by the buyer as a natural and unavoidable result of the seller’s breach of the purchase agreement.

Consider a buyer who enters into an agreement to purchase a lot from a builder since the buyer needs a building to house their business. The builder agrees to complete the construction of improvements on the lot and convey the property by an agreed-to date.

Before the builder enters into the purchase agreement to sell and construct improvements on the property, the builder is informed of the adverse tax consequences the buyer will be subjected to when the construction is not completed and the property conveyed by the date scheduled for closing. Thus, time for performance by completion of construction and close of escrow is known by the builder on entering into the agreement as necessary for the buyer to qualify to avoid profit taxes on a prior sale of other property.

Recoverable special damages

The builder fails to complete construction and convey the property prior to the date set for closing. Here, due to the builder’s breach, the buyer is unable to avoid incurring and paying income taxes on the profit taken on their prior sale of their trade or business property (or investment property). The buyer is also forced to rent another property (and incur moving expenses) until the construction the builder promised is completed.

Here, the special damages recoverable by the buyer in the form of a money award include:

• the full amount of the profit tax the buyer paid;
• the rent paid for the temporary facilities until the improvements were completed (plus the cost of additional moving expenses); and
• interest at 10% from the date the amounts of rent and profit tax were paid by the buyer. [Walker Signal Companies, Inc. (1978) 84 CA3d 982]

Related article:

Time to perform as staging a cancellation

Losses you cannot recover

A buyer’s expenses and losses which are too remote and speculative to be foreseen by the seller as their obligation on their breach when agreeing to sell on the terms stated in the purchase agreement are not recoverable from the seller.

For example, a buyer enters into a purchase agreement to acquire an unimproved parcel of commercial property. The seller knows the buyer plans to develop the property. Before escrow closes, the seller determines a higher price can be had for the property from other prospective buyers and cancels escrow.

Here, the buyer can recover any increase in the value of the land on the date of breach over the agreed-to purchase price, as may be reflected by the seller’s resale of the property.

However, the buyer is not entitled to recover profits they might earn had they acquired the land and developed it. Lost profits from the anticipated development of the property the buyer does not acquire are unrelated to the sale. Worse, future operating profits are too speculative to be recovered by a buyer. [Stewart Development Co. v. Superior Court for County of Orange (1980) 108 CA3d 266]

This logic also applies to lost income from rents a buyer might receive when they acquired property subject to a long-term lease are not recoverable. The recovery of rents is barred on a different legal theory from consequential losses. Rents are related to the value of the property as it exists at the time of purchase, a capitalization issue.

Rent produced by income property is a factor used to establish the property’s present value — the price to be paid for the property. Allowing the buyer who does not buy the property to receive a money award for both the increase in the resale value and future rents from a breaching seller is a double recovery, i.e., present value of the future flow of rent, plus those future rents.

Further, interest serves the same economic function as rents. Both are a return on capital. Thus, when a buyer receives interest on the amount of their recovery, the further receipt of future rent is an impermissible double recovery. [Stevens Group Fund IV v. Sobrato Development Co. (1992) 1 CA4th 886]

Related article:

Seller interference with an earned fee

Related topics:
breach of contract, escrow, purchase agreement, seller

Posted by Carrie B. Reyes | Jun 16, 2023 | Feature Articles, Investment, Laws and Regulations, Real Estate | 0

Reprinted from firsttuesday Journal  — P.O. Box 5707, Riverside, CA 92517

This article describes how to use a limited liability company (LLC) as a shield to allow real estate vested in the LLC to remain undisturbed by creditors of members — and how the creditor of an individual LLC member may enforce a money judgment against the debtor member’s ownership interest in the LLC.

Liens against individuals

Consider a broker/owner of a real estate office. The broker employs several sales agents and has continuous access to real estate entering the market for sale. The broker manages the office and sales agents, and periodically meets with clients handled by agents. The broker also occasionally acquires property for their own account as a principal.

Due to the business activities of the sales agents employed by the broker, the broker has liability exposure for the professional errors and misconduct of the broker’s agents. Even though the broker has incorporated their real estate office operations and has errors and omissions (E&O) insurance coverage, their role as the designated officer exposes the broker to personal liability. The broker bears the responsibility for the constant supervision of the sales agents employed by the corporation.

The broker is cognizant of the need to personally maintain a low financial profile to avoid the appearance of a “deep pocket” which might itself trigger litigation. As a result, the broker vests all the real estate the broker personally acquires in separate limited liability companies (LLCs) the broker creates for vesting title to the property acquired.

The broker’s conflicting ownership interest between their brokerage office and any acquisitions handled in the office on behalf of the broker’s LLC vestings is fully disclosed to any seller or buyer with whom the broker or their sales agents have any relationship. [See RPI Form 527]

Related article:

DRE Hot Seat: Broker fails to supervise or disclose an overt conflict of interest

Potentially dangerous personal lawsuit

Later, one of the broker’s sales agents commits an error. The broker is faced with a potentially dangerous lawsuit arising out of the sales agent’s misconduct while acting on behalf of the broker, unrelated to any of the broker’s personal real estate acquisitions.

The broker needs assurance the pending litigation, which seeks a money judgment against the broker personally, will not interfere with their ability to manage, sell, mortgage or lease the real estate vested in the broker’s LLCs.

Will a money judgment or lien against an individual member who is an owner of an LLC interfere with the real estate vested in the LLC?

No! Ultimately, only the broker’s “off-record” ownership interest in the LLC can be affected, not the property vested in the LLC. Further, and importantly, the brokers interest as owner of the LLC is personal property, not real property. Thus, the recording of any liens or judgments against the broker will not affect the real estate vested in the LLC — only the broker’s interest as owner of the LLC and only when a charging order is issued by a court. [Calif. Corporations Code §17705.01]

A lien or money judgment against an individual who is a member or manager of an LLC is unrelated to the real estate vested in an LLC. Further, only after a judicial charging order is processed can a money judgment against an individual attach to the individual’s ownership interest as a member in an LLC. No attachments are automatic or permitted by recording of a document. [Corp C §17705.03]

Related video:

Interest in the LLC — not the real estate

An individual who is a member of an LLC has no interest in the real estate owned by the LLC. A member’s ownership interest in the LLC is thus classified as personal property. [Corp C §17300]

While a member has no interest in any LLC property, the member is entitled to their share of the LLC’s:

• operating income;
• sales proceeds; and
• assets in the event the LLC is dissolved. [Corp C § 17707.05]

Creditors, judgments and liens

A member in an LLC, such as an LLC solely owned by one individual like a broker, may have an outstanding debt they separately owe due to:

• a money judgment (i.e., lawsuit liability); or
• a local, state, or federal tax lien.

Once recorded, these money judgments or liens automatically attach to any real estate interests vested in the individual’s name or any trust arrangement they have established another person to hold title as a trustee for the true owner of the property. Remember, a trust is not an entity and is not separate from the beneficiary who retains all the rights and benefits of ownership to the property.

However, a money judgment against an LLC member which does not also name the member’s LLC entity as a judgment debtor can only be satisfied by foreclosing on the member’s ownership interest in the LLC — not the real estate owned by the LLC.

Thus, an LLC entity remains unaffected by a lawsuit against an individual member. The LLC, as a separate entity, carries on its normal business activities without interference from a member’s creditor seeking to enforce collection rights under a judgment. [Calif. Code of Civil Procedure §§708.310, 708.320]

Related article:

Are surplus funds from a trustee’s sale distributed in proportion to the co-ownership interests in a property?

 

Charging orders to attach a share

Through a money judgment against a member in an LLC, the member’s ownership interest in the LLC may, on discovery of its existence, be attached to satisfy the judgment. This procedure involves the use of a court-ordered judicial attachment device called a charging order. [CCP §708.310]

Under a charging order, a creditor must first locate the LLC interests held by a judgment debtor. Once discovered, the creditor then applies to the court for an order to charge (place a lien on) the ownership interest in the LLC held by the individual member for payment of the judgment. [Corp C §17302]

Notice of the hearing on the charging order is given to the debtor member and all other members of the LLC. [8 CCP §708.320]

A creditor of an individual member has two options to enforce a money judgment:

• appoint a receiver to receive the debtor member’s share of the income and profits generated by operations of the property vested in the name of the LLC; or
• foreclose under the charging order lien on the member’s interest in the LLC, and become the owner of the debtor’s interest. [Corp C §17302]

Under a charging order lien, the appointment of a receiver is restricted to accepting the benefit of the individual member’s interest in the LLC. The creditor acquires no greater rights than the debtor member had under the LLC Articles of Organization or the LLC Operating Agreement.  [Corp C §17705.02; See RPI Form 372]

A creditor with a judgment has the judicial means to go after a member’s economic interest only, not the property vested in the LLC. However, the reality of obtaining an individual member’s interest through further litigation is too often more of a hassle than it is worth.

The interest the creditor obtains from the debtor member is a nonvoting interest which prohibits interference with LLC activities requiring a vote. Accordingly, the creditor assumes no duty or liability owed to the LLC or its other members, but has no voice in management of the LLC. [See RPI ebook: Forming Real Estate Syndicates: Chapter 18]

Further, the LLC operating agreement typically provides for removal of the debtor member from the LLC when a charging order against the debtor member’s interest is not immediately removed. [See RPI Form 372 §6.2(d)]

Related article:

Placing title in trust to avoid recorded ownership

Buyout provisions triggered

One or all of the members in a LLC may terminate a debtor member’s interest in the LLC on the notice of a charging order without causing the LLC to be dissolved. This right is granted in the LLC operating agreement on terms in its buyout provisions. [See RPI Form 372 §7]

On termination of a member’s interest, the remaining members may buy the terminated member’s entire interest in the LLC. When more than one member exercises their option, those exercising will purchase their pro rata share based on their aggregate ownership interest. [See RPI Form 372 §7.1(b)]

Buyout provisions in an LLC agreement between members are the most common method used for the elimination of a debtor member and their judgment creditor. Additionally, the terms of buyout provisions are usually financially advantageous to the remaining members. [See RPI Form 372 §7]

Fraudulent conveyances by debtors

The transfer of property by an owner of real estate to evade a creditor is considered fraudulent when:

• the owner intends to defraud their creditors; [Calif. Civil Code §3439.04(a)(1)] or
• a reasonably equivalent value is not received by the owner in exchange for the property transferred, and the owner is or will be insolvent (i.e., debts exceed assets) on the transfer. [CC §3439.05]

Any property transfer made for the purpose of avoiding creditors may be invalidated as a fraudulent conveyance. 13

However, when the full value or a reasonably equivalent value is received by an owner for a transfer, the transaction cannot be invalidated. The creditor is then left to chase down and attach the proceeds received by the owner (debtor).

A fraudulent conveyance is indicated when an individual knows of pending litigation or claims against them, then transfers their real estate without receiving fair value.

Related article:

Form-of-the-Week: LLC Investment Circular and Operating Agreement — Forms 371 and 372

Fraudulent conveyance without fair value

Consider an LLC consisting of three members. Later, a judgment is obtained by a creditor against two of the members of the LLC in their individual capacities.

A creditor obtains a charging order against the members’ individual interests in the LLC. All three members receive notice of the proceedings.

Prior to the enforcement of the charging order, the members dissolve the LLC. The two debtor members each transfer their ownership interest to the third member, who is unnamed in the judgment, for a minimal sum, if any.

Here, the transfer is fraudulent since the third member was on notice of the charging order and did not pay a fair value for the transfer by the debtor members. When a transfer is made by an owner without a fair exchange of value to a “buyer” who knew the transfer diminishes the creditor’s claim, the “buyer” then becomes liable for the creditor’s losses. [Taylor v. S & M Lamp Co. (1961) 190 CA2d 700]

Thus, the fraudulent conveyance of a debtor’s “wealth” beyond the reach of a creditor will be subject to disciplinary action from the court.

Related article:

To syndicate or not: a securities risk (or not)

The LLC asset shield

The use of an LLC to hold real estate assets was neither designed nor intended to be employed as a place to hide an individual’s personal wealth. Rather, use of an LLC is a means to allow real estate vested in the LLC to remain undisturbed in the face of an individual member’s adversity, and vice versa. A shield, by definition, as the vesting forces the creditor to negotiate a better resolution.

Consider an owner who places their ownership of real estate into an LLC. The owner receives a percentage or all of the ownership interests in the LLC for the conveyance — fair value for the transfer since they became the owner of the LLC which now owns the real estate.

In this instance, the conveyance is not fraudulent. The owner has merely exchanged their interest in the real estate for an interest in the LLC of equal value. Full value is received, and no tax liability is incurred on the exchange. [26 United States Code §721]

In essence, the owner has substituted their real estate vesting for a position in the LLC. The owner still owns a value equal to the equity in the real estate they transferred, only in a different form. Thus, the value of the owner’s interest was not diminished since they received an equivalent value for the property. The nature of the owner’s ownership interest merely changes from one of real property to one of personal property.

However, this simple change in vesting inherently makes it far more difficult for creditors to locate and attach the debtor’s assets, much less collect. The individual owner (debtor) on a recorded abstract of judgment is not the vested owner of any real estate.

Further, the change in vesting makes the real estate, now the asset of an LLC, much more difficult for the creditor to reach due to:

• the charging order process;
• nonvoting status upon ownership by foreclosure; and
• the subject of buyout provisions in the LLC operating agreement at less than the current value.

As the creditor is attempting to locate and attach the debtor’s assets, the LLC continues its business of renting, selling, or encumbering the property. On attaching the member’s interest via a charging order and appointment of a receiver, the LLC distributes income proceeds the debtor member is entitled to receive to the judgment debtor who on foreclosure holds a nonvoting membership share in the LLC.

Related ebook:

Forming Real Estate Syndicates

Related topics:
liability, limited liability company (llc), real estate syndication