REAL ESTATE TRANSACTIONS, FINANCE AND … ESTATE TRANSACTIONS, FINANCE, AND DEVELOPMENT Sixth Edition George Lefcoe Florine and Ervin Yoder Professor of Real Estate Law University

REAL ESTATETRANSACTIONS,

FINANCE, ANDDEVELOPMENT

Sixth Edition

0001 [ST: 1] [ED: m] [REL: 006] (Beg Group) Composed: Sun Mar 15 12:24:01 EDT 2009XPP 8.1C.1 Patch #5 FM000150 nllp 3097 [PW=540pt PD=720pt TW=360pt TD=612pt]

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Lenni B. BensonProfessor of Law & Associate Dean for Professional DevelopmentNew York Law School

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REAL ESTATETRANSACTIONS,FINANCE, ANDDEVELOPMENT

Sixth EditionGeorge LefcoeFlorine and Ervin Yoder Professor of Real Estate LawUniversity of Southern California Law School

0001 [ST: 1] [ED: m] [REL: 006] (Beg Group) Composed: Sun Mar 15 12:24:01 EDT 2009XPP 8.1C.1 Patch #5 FM000150 nllp 3097 [PW=540pt PD=720pt TW=360pt TD=612pt]


ISBN 978-1-4224-2986-0

Library of Congress Cataloging-in-Publication Data

Lefcoe, George.Real estate transactions, finance, and development / George Lefcoe. -- 6th ed.p. cm.Includes index.Rev. ed. of: Real estate transactions. 5th ed. 2005.ISBN 978-1-4224-2986-0 (hard cover)1. Vendors and purchasers--United States. 2. Real estate investment--Law and legislation--United States. 3. Real estatedevelopment--Law and legislation--United States. 4. Mortgages--United States. I. Lefcoe, George. Real estatetransactions. II. Title.KF665.L43 2009346.7304’37--dc22

2009006604

This publication is designed to provide accurate and authoritative information in regard to the subject mattercovered. It is sold with the understanding that the publisher is not engaged in rendering legal, accounting, orother professional services. If legal advice or other expert assistance is required, the services of a competentprofessional should be sought.LexisNexis and the Knowledge Burst logo are registered trademarks and Michie is a trademark of Reed ElsevierProperties Inc., used under license. Matthew Bender and the Matthew Bender Flame Design are registeredtrademarks of Matthew Bender Properties Inc.Copyright © 2009 Matthew Bender & Company, Inc., a member of the LexisNexis Group.All Rights Reserved.No copyright is claimed in the text of statutes, regulations, and excerpts from court opinions quoted within thiswork. Permission to copy material exceeding fair use, 17 U.S.C. § 107, may be licensed for a fee of 25¢ perpage per copy from the Copyright Clearance Center, 222 Rosewood Drive, Danvers, Mass. 01923, telephone(978) 750-8400.

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(2009–Pub.3097)



DEDICATION

To my family: Leon Chiu, my ideal and stalwart companion of 20 years; Edyth, mymother who led my way into real estate by her own good example; Judy, my belovedsister; and Howard and Ann, Scott and Kelly, my accomplished nephews and theirtalented, endearing wives.

iii





AcknowledgmentsThough I’ve never had a co-author for any of the editions of this textbook, I couldn’t

imagine completing this project with more supportive assistants than Bill Givens andKatherine Guevarra.

The USC law school continues to offer an ideal working environment, thanks to ourDeans Robert Rasmussen, Scott Altman and Greg Keating.

Our law librarians provide endless assistance not just in the usual types of research forwhich law librarians are admired but in forging relationships for me with outside vendorssuch as DataQuick, CoStar and other institutional providers of real estate research data.Thanks to Brian Raphael and Albert Brecht for this. A special thanks to our acquisitionslibrarian, Diana Jaque, for her persistence in finding texts, however obscure, for myresearch.

Student researchers worked energetically on this project and I am grateful to them fortheir unstinting efforts: David Aghaei, Mike Devlin, Molly Hage and Mike West and ourundergrad student worker, Anastasia Cooper.

Working with Lexis is a joy, thanks to Sean Caldwell, Keith Moore, Lisa Hughes,Kelli Eagle and all the others who encourage and support their authors so well–evenwhen an author tries their patience with endless changes and revisions in an alreadysubmitted text.

Many practicing lawyers and real estate professionals contributed, and their help isacknowledged in the specific chapters which they improved. But I owe an overarchingdebt of gratitude to Alex Jacobs, Leeanna Izuel, Bill Lindsay, Phil Nichols, and GlennSonnenberg.

Over the years many dedicated and talented law professors who adopted the textbookraised challenging questions and offered useful ideas for revisions. A heartfelt thanks toAndrew Berman, Ronald Brown, Barlow Burke, Marc Milhaly, Georgette Phillips, DavidReiss, Eileen Roberts, Alan Wayte, and Paul Zolan.

No one could have been more patient in tolerating my preference for early morningand other odd working hours, and helpful in showing me how to tap into and navigate online resources than my life partner, Leon Chiu. With a nod to Stevie Wonder’sunforgettable lyrics, Leon is the sunshine of my life.

Finally, I want to express my gratitude for the assistance I have received from othermembers of my family, starting with my mother who gave me not only the gift of life butmy entree into real estate by virtue of her own professional accomplishments in the field.My sister Judy has let me share each of her real estate transactions with her. My nephewScott is a constant wellspring of information about mortgage markets and finance and Ihave often benefitted from observations and transactions involving his wife, Kelly, mynephew Howard and his wife, Ann.

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TABLE OF CONTENTSChapter 1 BUYING AND SELLING REAL ESTATE IN THE UNITED

STATES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

I. REAL ESTATE SALES: A PROCESS IN THREE ACTS . . . . . . . . . . . . . 1

II. USEFUL DEFINITIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5

III. THE PLACE OF LAWYERS IN REAL ESTATE TRANSACTIONS . . . . 7

IV. PROFESSIONAL RESPONSIBILITIES OF THE REAL ESTATETRANSACTIONS LAWYER . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10

A. Attorney Liability for Aiding and Abetting A Client’s Bad Acts . . . . . . 10

B. Conflicts of Interests . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12

1. Attorneys Doing Business With their Clients . . . . . . . . . . . . . . . . . . 12

2. Representation of Multiple Parties in the Same Transaction . . . . . . . . 12

C. Engagement and Non-Engagement Letters . . . . . . . . . . . . . . . . . . . . . 15

QUESTIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16

Chapter 2 DECIDING TO BUY A HOME, FEDERAL TAX

CONSIDERATIONS AND NEGOTIATION POINTERS . 17

I. TO OWN OR RENT? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17

A. When is Leasing Office Space Better Than Owning It? . . . . . . . . . . . . . 17

B. The Case for Home Ownership . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18

C. The Case Against Home Ownership . . . . . . . . . . . . . . . . . . . . . . . . . . 19

II. FEDERAL INCOME TAX CONSEQUENCES OF HOMEOWNERSHIP . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20

A. The Tax Breaks Described . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20

B. More About the Home Mortgage Interest Deduction . . . . . . . . . . . . . . 21

III. THE NEGOTIATION PROCESS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22

A. Pricing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22

B. Should Buyers and Sellers Negotiate Directly, Through or With an

Agent? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23

C. Negotiation Pointers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24

QUESTIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27

Chapter 3 MARKETING RESIDENTIAL AND COMMERCIALREALTY: REAL ESTATE BROKERS, LISTINGAGREEMENTS AND SECURITIES LAWS . . . . . . . . . . . 29

I. COMPARING RESIDENTIAL AND COMMERCIAL BROKERS . . . . . 29

II. THE MULTIPLE LISTING SERVICE . . . . . . . . . . . . . . . . . . . . . . . . . 32

III. BROKER LICENSING REQUIREMENTS . . . . . . . . . . . . . . . . . . . . . . 34

A. State Licensing Laws . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34

B. Distinction Between Sales Agents and Brokers . . . . . . . . . . . . . . . . . . 35

vii



C. Exceptions to the Broker License Laws . . . . . . . . . . . . . . . . . . . . . . . . 36

1. Owners . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36

2. Finders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36

3. Attorneys . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37

IV. THE LISTING AGREEMENT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38

A. The Basics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38

1. Definition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38

2. Writing Requirement? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39

3. Contents of the Listing Agreement . . . . . . . . . . . . . . . . . . . . . . . . . 39

B. Types of Listings: Open Listing, Exclusive Agency, Exclusive Right to

Sell . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40

1. Open (Non-Exclusive) Listing . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40

2. Exclusive Agency . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41

3. Exclusive Right to Sell . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42

C. Amount of Commission . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43

D. Sellers’ Liability for Commissions on Deals That Never Close . . . . . . . 43

E. Limits on Seller’s Right to Revoke . . . . . . . . . . . . . . . . . . . . . . . . . . . 46

F. Specifying the Scope of the Broker’s Marketing Efforts . . . . . . . . . . . . 47

V. DEFINING THE LEGAL OBLIGATIONS OF BROKERS TO THEIRCLIENTS AND COUNTER PARTIES . . . . . . . . . . . . . . . . . . . . . . . . . 47

A. Fiduciaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 48

B. Sub-Agent . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50

C. Buyer’s Fiduciary Agent . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51

D. Dual Agent . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 53

E. Transaction Broker . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 56

VI. A CURSORY LOOK AT WHEN REAL ESTATE SALES COULD BEREGARDED AS SECURITIES OFFERINGS . . . . . . . . . . . . . . . . . . . . 57

A. Defining Security . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 57

B. Compliance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 58

QUESTIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60

Chapter 4 PURCHASE-AND-SALE AGREEMENTS: STATUTE OFFRAUDS AND PARTIES TO THE AGREEMENT . . . . . . 63

I. THREE QUESTIONS ANCILLARY TO DRAFTING A PURCHASE-AND-SALE CONTRACT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63

A. Why Bother Contracting? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63

B. Should Contract Provisions Be Included Which Reiterate the Default

Rules? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 64

C. Should the Parties Use a Letter of Intent? . . . . . . . . . . . . . . . . . . . . . . 65

II. THE STATUTE OF FRAUDS AND ELECTRONIC CONTRACTING . . 66

A. What It Takes for a Realty Contract to Satisfy the Statute of Frauds . . . . 66

B. Exceptions to the Statute of Frauds . . . . . . . . . . . . . . . . . . . . . . . . . . . 69

C. Electronic Contracts and the Statute of Frauds . . . . . . . . . . . . . . . . . . . 73

viii



III. THE PARTIES TO THE TRANSACTION . . . . . . . . . . . . . . . . . . . . . . 74

A. The Grantor . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 74

1. Identifying the True Owner . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 74

2. Buying From a Married Grantor . . . . . . . . . . . . . . . . . . . . . . . . . . . 74

3. Contracting to Acquire the Interest of One of Several Owners . . . . . . 75

4. Proper Authorization for Sale of Trust, Partnership, or Corporate

Property . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75

5. When Should the Owning Entity Be Sold Instead of the Realty? . . . . 76

B. The Grantee . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 77

1. Designating the Right Grantee . . . . . . . . . . . . . . . . . . . . . . . . . . . . 77

2. Undisclosed Principals and ‘Straws’ . . . . . . . . . . . . . . . . . . . . . . . . 78

C. Assignment of the Contract . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 80

1. The Default Rule Regarding Assignment . . . . . . . . . . . . . . . . . . . . . 80

2. Why Sellers May Not Welcome Assignees . . . . . . . . . . . . . . . . . . . 80

3. Assignment Provisions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 81

4. Avoiding The Sand Trap: “Purchaser or Nominee” . . . . . . . . . . . . . . 81

QUESTIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 81

Chapter 5 PURCHASE-AND-SALE AGREEMENTS: FOLLOWINGTHE MONEY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 85

I. THE PURCHASE PRICE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 85

A. How Do Buyers Know What Price Is Right for them? . . . . . . . . . . . . . 85

B. Closing Costs and Pro Rations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 86

1. Allocating the Cost of Settlement Services Between the Parties . . . . . 86

2. Pro Rations of Property Taxes, Casualty Insurance and Mortgage

Payments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 87

C. Formula Pricing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 87

II. THE INITIAL DEPOSIT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 89

III. THE COMPONENTS OF MORTGAGE DEBT . . . . . . . . . . . . . . . . . . . 90

A. The Determinants of the Mortgage Borrower’s Cost of Mortgage

Funds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90

B. Interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 91

C. Fixed or Adjustable Rate? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 92

D. Hybrids . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 94

E. Choosing Among Amortization Schedules . . . . . . . . . . . . . . . . . . . . . 95

F. Selecting the Loan Term . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 96

IV. FINANCING CONTINGENCIES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 97

A. The Default Rule Regarding Financing Contingencies . . . . . . . . . . . . . 97

B. Drafting a Financing Contingency . . . . . . . . . . . . . . . . . . . . . . . . . . . 98

1. Comparing Three Possible Financing Contingencies . . . . . . . . . . . . . 98

2. Contingencies Based on Application, Commitment, or Funding? . . . 100

C. Implementing Financing Contingencies . . . . . . . . . . . . . . . . . . . . . . . 101

1. Good Faith Effort to Procure Loan . . . . . . . . . . . . . . . . . . . . . . . . . 101

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2. The Financing Contingency Time Period . . . . . . . . . . . . . . . . . . . . 102

QUESTIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 103

Chapter 6 PURCHASE-AND-SALE AGREEMENTS: THE SUBJECT

PROPERTY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 105

I. INSPECTIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 105

A. Residential Physical Inspections . . . . . . . . . . . . . . . . . . . . . . . . . . . . 105

B. Commercial Realty Physical Inspections . . . . . . . . . . . . . . . . . . . . . . 107

C. Framing the Buyer’s Remedies Under an Inspection Contingency

Clause in a Purchase-and-Sale Contract . . . . . . . . . . . . . . . . . . . . . . . 108

1. Absolute Discretion or Reasonable Dissatisfaction? . . . . . . . . . . . . 108

2. Active or Passive Removal of Inspection Contingency? . . . . . . . . . . 109

3. ‘Take It or Leave It’ or Resolution Period Formats? . . . . . . . . . . . . 109

D. Why Sellers Should Contract for Their Own Physical Inspection Even

Though A Buyer Shouldn’t Rely on the Seller’s Inspection . . . . . . . . . 109

II. PREDICATES OF SELLER LIABILITY FOR DEFECTIVE PROPERTYCONDITIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 111

A. Caveat Emptor . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 111

B. Disclosure Obligations of Home Sellers . . . . . . . . . . . . . . . . . . . . . . 112

1. Seller Disclosure Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 112

2. Seller’s Common Law Disclosure Obligations . . . . . . . . . . . . . . . . 113

3. Buyer’s Remedies for Seller’s Failure to Disclose . . . . . . . . . . . . . . 114

C. Seller Representations and Warranties . . . . . . . . . . . . . . . . . . . . . . . 115

D. ‘As Is’ Clauses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 117

III. FIXTURES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 118

A. The Fixtures Default Rule . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 118

B. Practical Advice Regarding Fixtures . . . . . . . . . . . . . . . . . . . . . . . . . 120

IV. CASUALTY LOSSES DURING THE EXECUTORY PERIOD . . . . . . . 120

A. The Common Law Default Rule on Executory Period Risk of Loss . . . 120

B. The Uniform Vendor and Purchaser Risk Act (UVPRA) . . . . . . . . . . . 122

C. Contracting Out of Risk-of-Loss Default Rules . . . . . . . . . . . . . . . . . 123

QUESTIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 124

Chapter 7 PURCHASE-AND-SALE AGREEMENTS: THE QUALITYOF SELLER’S TITLE . . . . . . . . . . . . . . . . . . . . . . . . . . . 127

I. MARKETABLE TITLE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 127

A. The Default Title Standard . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 127

B. Identifying the Defects, Liens and Encumbrances That Could

Cause Title to Be Flawed . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 124

II. ALTERNATIVES TO THE MARKETABLE TITLE STANDARD . . . . 132

III. CONTRACT PROVISIONS REGARDING BUYER’S TITLEREVIEW . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 133

x



IV. WHEN BUILDING AND ZONING CODES MAKE TITLEUNMARKETABLE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 135

QUESTIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 139

Chapter 8 PURCHASE-AND-SALE AGREEMENTS: CONTRACT

PROVISIONS REGARDING THE TIME FOR

PERFORMANCE AND THE PRESUMPTION OF

MERGER . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 141

I. TIME FOR PERFORMANCE IN REALTY PURCHASE-AND-SALEAGREEMENTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 141

A. The Default Rule Regarding Time for Performance of Realty

Contracts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 141

B. Contracting for Time to Be of the Essence . . . . . . . . . . . . . . . . . . . . . 142

II. MARKING TIME . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 144

A. Critical Dates List . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 144

B. Counting the Days . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 145

III. DO THE SELLER’S PROMISES SURVIVE THE CLOSING? . . . . . . . 146

A. The Presumption of Merger . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 146

B. Contracting Out of the Presumption of Merger . . . . . . . . . . . . . . . . . . 149

QUESTIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 150

Chapter 9 TERMINATING REAL ESTATE CONTRACTS . . . . . . 153

I. MEDIATION AND ARBITRATION . . . . . . . . . . . . . . . . . . . . . . . . . 153

A. The Difference Between Mediation and Arbitration . . . . . . . . . . . . . . 153

B. Why Choose Mediation or Arbitration Over Litigation? . . . . . . . . . . . 153

C. Drafting Arbitration Clauses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 154

D. Critique of Mandatory Arbitration for Consumers . . . . . . . . . . . . . . . 155

E. Judicial Reference . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 156

II. SPECIFIC PERFORMANCE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 157

A. The Basics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 157

B. The Lis Pendens . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 158

III. LIQUIDATED DAMAGES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 159

A. The Case for Liquidated Damages . . . . . . . . . . . . . . . . . . . . . . . . . . 159

B. Limits to the Enforceability of Liquidated Damages in

Real Estate Purchase-and-Sale Contracts . . . . . . . . . . . . . . . . . . . . . . 161

QUESTIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 164

Chapter 10 RESIDENTIAL MORTGAGE LENDING . . . . . . . . . . . . 167

I. THE HOME MORTGAGE BORROWER’S TRAIL . . . . . . . . . . . . . . . 167

A. Comparative Shopping . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 167

B. The Loan Approval Process . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 169

1. Pre-Qualification, Pre-Approval and Loan Commitment . . . . . . . . . 169

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2. Rate Locks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 170

3. Enforcement of Written Loan Commitments . . . . . . . . . . . . . . . . . 170

4. The Enforceability of a Lender’s Oral Promise to Make a Loan . . . . 170

5. Borrower’s Obligation of Truthfulness in Loan Applications . . . . . . 171

II. A LENDER’S OUTLOOK ON RESIDENTIAL LENDING . . . . . . . . . 173

A. Underwriting: Capacity, Credit Reputation and Collateral . . . . . . . . . . 173

B. The Note and the Deed of Trust or Mortgage . . . . . . . . . . . . . . . . . . . 175

C. Securitization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 177

D. The Residential Mortgage Crisis of 2007 . . . . . . . . . . . . . . . . . . . . . . 180

III. REGULATIONS TO PROTECT HOME OWNERS FROM BADLOANS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 184

A. Two Approaches to Regulation: Disclosure and Product Control . . . . . 184

B. An Overview of the Real Estate Settlement Procedures Act (RESPA) . 185

C. The Truth-in-Lending Act (TILA) of 1968 . . . . . . . . . . . . . . . . . . . . 187

D. Should Mortgage Brokers or Lenders Be Liable to Borrowers for

Making Them ‘Unsuitable’ Loans? . . . . . . . . . . . . . . . . . . . . . . . . . . 190

QUESTIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 194

Chapter 11 COMMERCIAL MORTGAGE LENDING . . . . . . . . . . . 197

I. SIGNIFICANT DIFFERENCES BETWEEN COMMERCIAL ANDRESIDENTIAL MORTGAGE LENDING . . . . . . . . . . . . . . . . . . . . . . 197

A. The Distinction Between Debt and Equity . . . . . . . . . . . . . . . . . . . . . 197

B. Commercial Real Estate Financing Arrangements . . . . . . . . . . . . . . . 198

C. Underwriting Income Producing Property: The Debt Service

Coverage Ratio (DSCR) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 201

D. Key Loan Terms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 202

II. NEGOTIATING COMMERCIAL MORTGAGE PROVISIONS . . . . . . 203

A. Financial Covenants and Property Management . . . . . . . . . . . . . . . . . 203

B. Replacement Reserve Accounts . . . . . . . . . . . . . . . . . . . . . . . . . . . . 204

C. Non Recourse Loans and The Carve Outs . . . . . . . . . . . . . . . . . . . . . 205

D. Adjustable Rate Loans with Interest Rate Swaps or Caps . . . . . . . . . . 206

QUESTIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 207

Chapter 12 PREPAYMENT OF MORTGAGE LOANS . . . . . . . . . . . 209

I. UNDERSTANDING THE PREPAYMENT DECISION . . . . . . . . . . . . 209

A. Why Borrowers Sometimes Prepay . . . . . . . . . . . . . . . . . . . . . . . . . . 209

B. Why Lenders Care About Prepayments . . . . . . . . . . . . . . . . . . . . . . . 210

1. Why Lenders Welcome Prepayments . . . . . . . . . . . . . . . . . . . . . . . 210

2. Why Lenders Penalize or Bar Prepayments . . . . . . . . . . . . . . . . . . 211

II. TYPES OF PREPAYMENT DISINCENTIVES . . . . . . . . . . . . . . . . . . 212

III. PREPAYMENT LAW . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 217

A. The Default Rule . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 217

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B. Doctrinal Challenges to Prepayment Disincentives . . . . . . . . . . . . . . . 218

1. Challenges to Voluntary Prepayments . . . . . . . . . . . . . . . . . . . . . . 218

2. Challenges to Involuntary Prepayments . . . . . . . . . . . . . . . . . . . . . 221

QUESTIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 223

Chapter 13 WHEN THE BORROWER SELLS OR PLEDGESMORTGAGED PROPERTY . . . . . . . . . . . . . . . . . . . . . . 225

I. WHEN THE ORIGINAL DEBTOR SELLS MORTGAGEDPROPERTY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 225

A. The Due on Sale Clause: Why Owners Want the Option of Passing Their

Mortgage Loans to Their Buyers, and Their Lenders Want to Curb That

Option . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 225

B. The Difference Between a Buyer Assuming and Taking ‘Subject To’ the

Seller’s Mortgage Obligation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 227

C. How Buyers Prepare to Assume a Loan . . . . . . . . . . . . . . . . . . . . . . . 229

D. The Original Obligor’s Liability and Rights After Selling the Security

Property . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 231

E. Legal Issues Raised by Due on Sale Clauses . . . . . . . . . . . . . . . . . . . 232

II. THE RIGHT OF THE LENDER TO PREVENT THE BORROWER FROMFURTHER ENCUMBERING THE SECURITY PROPERTY . . . . . . . . 237

QUESTIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 240

Chapter 14 RECORDING ACTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . 243

I. THE SYSTEM OF PUBLIC LAND RECORDS . . . . . . . . . . . . . . . . . . 244

A. How the Public Land Records Function . . . . . . . . . . . . . . . . . . . . . . 244

B. Why Some Documents Go Unrecorded . . . . . . . . . . . . . . . . . . . . . . . 246

C. Searching the Public Records . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 246

D. Marketable Title Acts Shorten the Length of the Search . . . . . . . . . . . 254

E. Recordation and Validity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 257

II. THE COMMON LAW PRIORITY RULES . . . . . . . . . . . . . . . . . . . . . 258

III. TYPES OF RECORDING STATUTES COMPARED: NOTICE, RACE-NOTICE AND RACE STATUTES . . . . . . . . . . . . . . . . . . . . . . . . . . . 261

IV. QUALIFYING FOR BONA FIDE PURCHASER (BFP) STATUS . . . . . 264

A. Payment of Value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 264

1. Why Donees Should Record Even Though They Don’t Qualify as

Subsequent Purchasers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 264

2. When Do Unsecured Creditors Achieve the Same Status as BFPs? . . 265

3. The Doctrine of Shelter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 265

B. The Four Types of Notice . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 267

V. INTERESTS NOT ENTITLED TO THE PROTECTION OF THERECORDING ACTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 271

A. Interests Not Within the Statute . . . . . . . . . . . . . . . . . . . . . . . . . . . . 271

B. Unacknowledged Documents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 273

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C. Documents Filed for Record But Lost, Misindexed or Not

Indexed at All By the Recorder . . . . . . . . . . . . . . . . . . . . . . . . . . . . 274

D. Documents Outside the Chain of Title . . . . . . . . . . . . . . . . . . . . . . . . 276

1. Variations of Party’s Name . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 276

2. ‘Wild Deeds’: A Deed Is Outside the Grantor’s Chain of

Title Unless the Grantor Possesses Record Title . . . . . . . . . . . . . . . 278

3. Deeds Recorded by Grantors Before They Acquired Title May

Be Outside the Grantor’s Chain of Title . . . . . . . . . . . . . . . . . . . . . 279

4. Deeds and Other Interests Recorded by the Grantor After She Has

Relinquished Title May Be Regarded as Outside the

Grantor’s Legitimate Chain of Title . . . . . . . . . . . . . . . . . . . . . . . . 280

5. Land Use Restrictions Only Indexed as Affecting the Dominant

Tenement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 280

QUESTIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 282

Chapter 15 TITLE INSURANCE . . . . . . . . . . . . . . . . . . . . . . . . . . . . 287

I. THE TITLE INSURANCE PROCESS . . . . . . . . . . . . . . . . . . . . . . . . . 287

A. Comparing Title to Casualty Insurance . . . . . . . . . . . . . . . . . . . . . . . 287

B. Selecting A Title Company and a Title Insurer . . . . . . . . . . . . . . . . . . 288

C. What Title Insurance Replaced: The Abstract of Title and Attorney’s

Opinion Based on the Abstract . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 290

D. The Title Commitment or Preliminary Report . . . . . . . . . . . . . . . . . . 292

E. Is Title Insurer Liable for a Faulty Search or Erroneous Preliminary

Report? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 295

II. AN OVERVIEW OF THE TITLE POLICY . . . . . . . . . . . . . . . . . . . . . 297

A. The Three Parts of the Title Policy . . . . . . . . . . . . . . . . . . . . . . . . . . 297

B. Schedule A: What the Title Insurer Insures . . . . . . . . . . . . . . . . . . . . 297

1. Off-Record Risks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 297

2. Effective Date of Coverage . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 297

3. Access to a Public Road . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 298

C. Schedule B: Exclusions and Exceptions . . . . . . . . . . . . . . . . . . . . . . 299

1. The Exception for Defects ‘Created, Allowed or Agreed by

Insured’ . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 299

2. Unrecorded Defects Known to the Insured and Not Disclosed to the

Insurer . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 301

3. Defects Revealed by Inspection: The Exclusion for

Inquiry-Notice-From-Possession . . . . . . . . . . . . . . . . . . . . . . . . . . 301

4. The Exclusion for Defects Created by Public Laws . . . . . . . . . . . . . 302

5. Gratuitously Acquired Interests: The Exclusions for Losses

That Would Not Have Occurred ‘If the Purchaser Had Paid Value’ . 303

D. Conditions and Stipulations for Asserting Policy Claims . . . . . . . . . . . 304

1. The Insured Beneficiary of the Title Policy . . . . . . . . . . . . . . . . . . . 304

2. Notice of Claim . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 305

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3. Insured Amount . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 305

4. The Duty to Defend as Modified by the Policy Being One

of Indemnity, Not Warranty . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 305

5. No Right to Compensation Until Loss Occurs . . . . . . . . . . . . . . . . . 306

6. The Pro Tanto Clause . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 307

E. The Difference Between the Purchaser’s and the Lender’s Coverage . . 307

QUESTIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 308

Chapter 16 REAL ESTATE CLOSINGS AND ESCROWS . . . . . . . . 311

I. TWO TYPES OF CLOSINGS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 312

A. The New York-Style Closing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 312

B. The Escrow Closing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 314

1. The Process: An Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 314

2. Loan Closings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 315

II. THE ESCROW . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 316

A. Choosing an Escrow Agent . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 316

B. The Functions of an Escrow Agent . . . . . . . . . . . . . . . . . . . . . . . . . . 317

1. Opening and Terminating an Escrow . . . . . . . . . . . . . . . . . . . . . . . 317

2. Overview of the Escrow’s Limited Agency . . . . . . . . . . . . . . . . . . 318

3. The Escrow Agent’s Typical Check List of Things to Do . . . . . . . . . 319

4. Escrow Agent Do’s and Don’ts . . . . . . . . . . . . . . . . . . . . . . . . . . . 319

C. Escrow Instructions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 321

1. Escrow Instruction Formats . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 321

2. Notable General Provisions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 321

III. THE CLOSING STATEMENT: FOLLOWING THE MONEY . . . . . . . 324

A. The HUD-1 Form . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 324

B. Post-Closing Financial Issues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 324

1. Correcting Errors in the Closing Statement . . . . . . . . . . . . . . . . . . . 324

2. Unclaimed Funds Left in Escrow . . . . . . . . . . . . . . . . . . . . . . . . . 325

IV. ALLOCATING THE COSTS OF ESCROW AGENT EMBEZZLEMENTBETWEEN BUYER AND SELLER . . . . . . . . . . . . . . . . . . . . . . . . . . 325

V. THE REAL ESTATE SETTLEMENT PROCEDURES ACT (RESPA),KICKBACKS AND REFERRAL FEES . . . . . . . . . . . . . . . . . . . . . . . . 327

QUESTIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 331

Chapter 17 THE DEED . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 335

I. DEED FORMALITIES REQUISITE FOR VALIDITY ANDRECORDATION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 335

A. Identification and Signature of Grantor . . . . . . . . . . . . . . . . . . . . . . . 336

B. Acknowledgment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 340

C. Identification of New Owners (Grantee) . . . . . . . . . . . . . . . . . . . . . . 342

D. Acceptance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 342

E. ‘Valuable Consideration’ . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 343

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F. Words of Present Transfer . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 343

G. Legal Description . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 344

H. Exceptions and Reservations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 344

I. Documentary Transfer Tax Information . . . . . . . . . . . . . . . . . . . . . . 345

II. DELIVERY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 346

A. Definition and Probative Evidence of Delivery . . . . . . . . . . . . . . . . . 346

B. Dated Deed is Rebuttably Presumed to Have Been Delivered . . . . . . . 347

C. Validity of Deeds to be Delivered at Grantor’s Death . . . . . . . . . . . . . 347

III. TYPES OF DEEDS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 348

A. General Warranty . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 348

1. The Common Law Warranties . . . . . . . . . . . . . . . . . . . . . . . . . . . 348

2. Why Buyers Don’t Rely on Grantor Warranties as their Primary

Means of Title Assurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 351

B. Special Warranty, Limited or Grant Deed . . . . . . . . . . . . . . . . . . . . . 352

C. Quitclaim Deed . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 354

IV. LIABILITY RULES FOR BREACH OF DEED COVENANTS . . . . . . . 356

A. Distinguishing Future from Present Covenants . . . . . . . . . . . . . . . . . . 356

B. Enforcement of Deed Covenants by Remote Grantees . . . . . . . . . . . . 357

V. CORRECTIVE DEEDS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 358

QUESTIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 359

Chapter 18 SURVEYS, LAND DESCRIPTIONS AND BOUNDARYDISPUTES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 361

I. TYPES OF LAND DESCRIPTIONS . . . . . . . . . . . . . . . . . . . . . . . . . . 361

A. Metes and Bounds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 363

Robert G. Natelson, Modern Law of Deeds and Real Property . . . . 363

B. Subdivision Maps . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 366

C. U.S. Public Lands Survey System (PLSS) . . . . . . . . . . . . . . . . . . . . . 367

II. CONTRACTING FOR SURVEYS . . . . . . . . . . . . . . . . . . . . . . . . . . . 371

A. Three Possible Types of Survey Conditions for Buyers in

Purchase-and-Sale Contracts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 372

B. Ordering the Right Survey . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 372

C. Liability for Faulty Surveys . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 375

III. RESOLVING BOUNDARY DISPUTES AMONG NEIGHBORINGOWNERS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 377

A. Doctrines Applicable in Boundary Disputes . . . . . . . . . . . . . . . . . . . . 378

1. Adverse Possession . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 379

2. Prescriptive Easements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 381

3. Boundary by Agreement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 382

4. Boundary by Acquiescence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 383

5. Good Faith Improvers and the Doctrine of Relative Hardship . . . . . . 384

6. Trespass Statute of Limitations . . . . . . . . . . . . . . . . . . . . . . . . . . . 385

B. Title Insurance Coverage of Boundary Disputes . . . . . . . . . . . . . . . . . 385

xvi



QUESTIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 386

Chapter 19 THE MORTGAGEE’S INTEREST IN THE SECURITY

PROPERTY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 389

I. DEFINING SECURITY IMPAIRMENT: PARTIAL TAKINGS . . . . . . 390

II. WASTE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 392

III. RISK OF FORFEITURE OF SECURITY PROPERTY FORMORTGAGOR’S ILLEGAL ACTS . . . . . . . . . . . . . . . . . . . . . . . . . . 394

IV. MINIMIZING THE LENDER’S RISK OF ENVIRONMENTALLIABILITY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 397

A. Owners’ Limitless Liability for Environmental Clean Up Costs . . . . . . 397

B. Why Clean Up Exposure Worries Lenders and What They Do About

It . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 398

V. FIRE AND ‘OTHER HAZARD’ INSURANCE . . . . . . . . . . . . . . . . . . 400

A. Mortgagee’s Insurance Requirements . . . . . . . . . . . . . . . . . . . . . . . . 400

1. Insurable Interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 400

2. ‘All Perils’ Coverage . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 400

3. How Much Coverage? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 401

4. Mortgagee Clauses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 402

5. Credit Worthiness of Insurer . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 403

B. Allocating Proceeds in the Event of Loss . . . . . . . . . . . . . . . . . . . . . . 403

C. Force Place Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 405

QUESTIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 407

Chapter 20 MORTGAGEE’S RIGHT TO RENTS BEFORE AND AFTER

FORECLOSURE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 409

I. HOW AND WHY MORTGAGE LENDERS SEEK TO SAFEGUARD THERENT AS SECURITY BEFORE FORECLOSURE . . . . . . . . . . . . . . . 410

A. Why Lenders Seek to Control Rents Before the Borrower Defaults . . . 410

B. Default Rule Regarding the Right to Rent Before Foreclosure: The Title/

Lien Theory Distinction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 410

C. Assignments of Rent . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 412

1. Formats for Assignments of Rent . . . . . . . . . . . . . . . . . . . . . . . . . 412

2. The Enforceability of Mortgagors Assigning Rents to Mortgagees . . 413

II. THE STATUS OF A MORTGAGEE IN POSSESSION . . . . . . . . . . . . 415

A. What Is a Mortgagee in Possession? . . . . . . . . . . . . . . . . . . . . . . . . . 415

B. Obligations of a Mortgagee in Possession . . . . . . . . . . . . . . . . . . . . . 417

C. Advantages of Mortgagee in Possession Status for the Mortgagee . . . . 418

D. Criminal Trespassers Enter Where Lenders Fear to Tread . . . . . . . . . . 418

III. EQUITABLE RECEIVERSHIP . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 419

A. Definition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 419

B. Appointment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 419

xvii



IV. LESSEE’S STATUS FOLLOWING LANDLORD’S MORTGAGEDEFAULT AND FORECLOSURE . . . . . . . . . . . . . . . . . . . . . . . . . . . 420

A. The Tenant’s Dilemma When the Mortgagee Wants the Rent After the

Lessor Has Defaulted But Before Foreclosure . . . . . . . . . . . . . . . . . . 420

B. Prepaid Rents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 421

C. Tenant’s Rights After Foreclosure by Landlord’s Mortgagee . . . . . . . . 422

D. Adjusting the Lender-Lessee Relationship by Contract:

Subordination, Non-Disturbance, Attornment (SNDA) Agreements . . . 424

QUESTIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 426

Chapter 21 MORTGAGE FORECLOSURE . . . . . . . . . . . . . . . . . . . 429

I. HOW DEFAULTING DEBTORS AVERT FORECLOSURE . . . . . . . . 430

A. The Defaulting Borrower’s Menu of Choices . . . . . . . . . . . . . . . . . . . 430

B. Equitable Redemption . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 432

1. Evolution of the Equity of Redemption . . . . . . . . . . . . . . . . . . . . . 432

2. Strict Foreclosure: Origin and Definition . . . . . . . . . . . . . . . . . . . . 433

3. Clogs on the Equity of Redemption and the Concept of the Equitable

Mortgage . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 434

C. The Mortgagors’ Right to Cure . . . . . . . . . . . . . . . . . . . . . . . . . . . . 435

1. How Mortgagees Initiate the Foreclosure Process . . . . . . . . . . . . . . 435

2. Loan Provisions Allowing Cure and Reinstatement . . . . . . . . . . . . . 436

3. Reinstatement: ‘Arrearages’ Statutes . . . . . . . . . . . . . . . . . . . . . . . 437

4. Implications of Mortgagor’s Reinstatement Right for Foreclosing

Attorney . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 438

II. ACCELERATION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 438

A. Definition and Contents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 438

B. Consequences of Acceleration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 439

III. FORECLOSURE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 440

A. Differences Between Judicial and Power of Sale Foreclosure

Procedures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 440

B. Borrower Defenses in Judicial and Nonjudicial Proceedings . . . . . . . . 442

C. Buying Distress Property Before, At or After Foreclosure . . . . . . . . . . 445

1. The Formal Path to Foreclosure . . . . . . . . . . . . . . . . . . . . . . . . . . 445

2. The Distress Property Buyers’ Options . . . . . . . . . . . . . . . . . . . . . 447

IV. FORECLOSURE SALES OF REALTY SUBJECT TO MORETHAN ONE MORTGAGE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 452

A. Lien Priorities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 452

B. Impact of Failure to Join Junior Lienor in Senior Lienor’s Foreclosure

Sale . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 453

1. When Junior Lienors Aren’t Made Parties to a Judicial Foreclosure

Action . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 453

2. When Junior Lienors Aren’t Notified of Nonjudicial Sales . . . . . . . . 453

3. Resolving Claims of the Omitted Junior Lienor . . . . . . . . . . . . . . . 454

xviii



V. SETTING ASIDE FORECLOSURE SALES . . . . . . . . . . . . . . . . . . . . 454

A. Defects Rendering Void a BFP’s Foreclosure Sale Title . . . . . . . . . . . 454

B. For Gross Price Inadequacy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 455

C. For Procedural Irregularities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 456

VI. THE POST SALE (STATUTORY) REDEMPTION . . . . . . . . . . . . . . . 457

A. Definition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 457

B. The Policy Debate over the Efficacy of Statutory Redemption . . . . . . . 458

C. The Varying Terms of Statutory Redemption Statutes . . . . . . . . . . . . 458

1. Redemption Price . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 458

2. Redemption Time Periods . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 458

3. Type of Sale From Which Redemption is Possible . . . . . . . . . . . . . 459

4. Right to Possession During the Redemption Period . . . . . . . . . . . . . 459

5. Obligations of Mortgagor in Possession During Redemption Period . 459

6. Parties Entitled to Redeem . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 459

7. Effect of Mortgagor’s Redemption on Extinguished Junior Liens . . . 460

QUESTIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 460

Chapter 22 ALLOCATING FORECLOSURE SALE PROCEEDS ANDUNDERSTANDING ANTI-DEFICIENCYLEGISLATION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 463

I. ALLOCATING THE FORECLOSURE SALE SURPLUS . . . . . . . . . . . 463

A. Priorities of Lienors Senior and Junior to the Foreclosed Lien . . . . . . . 464

B. The Purchase Money Lien Priority . . . . . . . . . . . . . . . . . . . . . . . . . . 464

C. Easements Holders, Lessees, and Unsecured Creditors . . . . . . . . . . . . 465

II. ANTI-DEFICIENCY LAWS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 466

A. Why Lenders Care About Deficiency Claims . . . . . . . . . . . . . . . . . . . 466

B. Recourse and Non-Recourse Debt . . . . . . . . . . . . . . . . . . . . . . . . . . 466

C. Guarantors and Anti-deficiency Laws . . . . . . . . . . . . . . . . . . . . . . . . 467

1. Guarantors Don’t Ordinarily Enjoy the Right to Anti-Deficiency

Protection . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 467

2. If the Guarantor is Also the Debtor She Retains Her Rights Under the

Anti-Deficiency Laws . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 468

III. CALIFORNIA’S ANTI-DEFICIENCY QUARTET . . . . . . . . . . . . . . . 468

A. The Purchase Money Statute . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 468

The California Anti-Deficiency Statute: California Code of Civil

Procedure § 580b. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 469

B. Statutes Barring Deficiencies Following Power of Sale Foreclosures . . 473

C. ‘Fair Value’ Statutes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 474

D. ‘One Action’ Statutes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 476

1. The Two Meanings of the One Action Rule: One Proceeding

and ‘Security First’ . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 476

2. What Counts as an Action Under a One Action Statute? . . . . . . . . . 477

QUESTIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 478

xix



Chapter 23 ALTERNATIVES TO FORECLOSURE: WORKOUTS AND

DEEDS IN LIEU OF FORECLOSURE . . . . . . . . . . . . . . 481

I. UNDERSTANDING DEEDS IN LIEU AND WORKOUTS . . . . . . . . . 481

A. What Attracts and Repels Borrowers . . . . . . . . . . . . . . . . . . . . . . . . 481

1. About Deeds in Lieu . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 481

2. About Workouts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 482

B. What Attracts and Repels Lenders . . . . . . . . . . . . . . . . . . . . . . . . . . 482

1. About Deeds in Lieu . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 482

2. What Attracts and Repels Lenders About Workouts . . . . . . . . . . . . 483

II. HOW LENDERS PREPARE THEMSELVES . . . . . . . . . . . . . . . . . . . 484

A. For Deeds in Lieu . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 484

1. Due Diligence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 484

2. Appraisals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 484

3. Risk Assessment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 484

III. ANCILLARY AGREEMENTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 485

A. Settlement Agreements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 485

B. The Pre-Workout Agreement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 485

IV. LEGAL ISSUES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 485

A. Claims of Priority by the Borrower’s Other Creditors . . . . . . . . . . . . . 485

1. Dealing with Valid Third Party Claims . . . . . . . . . . . . . . . . . . . . . 485

2. Does Mortgage Merge in the Deed? . . . . . . . . . . . . . . . . . . . . . . . . 486

3. Fraudulent Conveyances, Bankruptcy and ‘Reasonably Equivalent

Value’ . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 487

4. Setting Aside Preferences If the Borrower Files Bankruptcy . . . . . . 488

B. Borrower’s Tax Liability for Debt Forgiveness . . . . . . . . . . . . . . . . . 488

C. When the Borrower Reclaims the Property . . . . . . . . . . . . . . . . . . . . 489

1. The Deed as an Equitable Mortgage . . . . . . . . . . . . . . . . . . . . . . . 489

2. Borrower’s Lender Liability Claims . . . . . . . . . . . . . . . . . . . . . . . 489

V. LENDER TACTICS AND STRATEGIES . . . . . . . . . . . . . . . . . . . . . . 490

A. Initiate Foreclosure? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 490

B. Buy Title Insurance? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 490

C. When Securitized Debt is Involved . . . . . . . . . . . . . . . . . . . . . . . . . . 491

1. The Role of Special Servicers When Securitized Loans Become

Delinquent . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 491

2. How REMICS Figure in Workout Decisions . . . . . . . . . . . . . . . . . 492

QUESTIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 493

Chapter 24 DEVELOPMENT AND CONSTRUCTIONFINANCING . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 495

I. AN OVERVIEW OF THE DEVELOPMENT GAME . . . . . . . . . . . . . . 495

A. The Land Developer . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 495

B. The Land Development Process . . . . . . . . . . . . . . . . . . . . . . . . . . . . 496

xx



1. The Tasks Required of Land Developers . . . . . . . . . . . . . . . . . . . . 496

2. How Developers Determine What They Can Afford to Pay for Land . 498

II. REAL ESTATE DEVELOPMENT FINANCING . . . . . . . . . . . . . . . . . 499

A. The Three Financing Phases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 499

B. Acquisition and Development Financing . . . . . . . . . . . . . . . . . . . . . . 500

1. The Risks and Rewards . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 500

2. Sources of A&D Funding . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 501

III. CONSTRUCTION LOANS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 502

A. Basics of Construction Financing . . . . . . . . . . . . . . . . . . . . . . . . . . . 502

1. Loan Terms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 502

2. Sources of Construction Funding . . . . . . . . . . . . . . . . . . . . . . . . . . 502

B. The Special Risks of Construction Lending and How Construction

Lenders Manage Them . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 503

IV. CONSTRUCTION LENDERS’ RISK MANAGEMENTTECHNIQUES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 504

A. Managing the Completion Risk . . . . . . . . . . . . . . . . . . . . . . . . . . . . 504

1. The Construction Loan Agreement . . . . . . . . . . . . . . . . . . . . . . . . 504

2. Retainage . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 504

3. Disbursement Controls . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 505

A Case Study of a Poorly Managed Loan . . . . . . . . . . . . . . . . . 506

4. ‘At Margin’ Provisions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 507

5. ‘Loan Balance’ Provisions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 508

6. Personal Guaranties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 508

7. Letters of Credit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 510

8. Performance and Payment Bonds . . . . . . . . . . . . . . . . . . . . . . . . . 511

9. Builder’s Risk Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 513

B. Managing the Value on Completion Risk . . . . . . . . . . . . . . . . . . . . . 513

1. Pre-Sales and Pre-Leasing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 513

2. The Permanent Lender’s Take-Out Commitment . . . . . . . . . . . . . . 514

V. PRIORITY DISPUTES: VENDOR’S AND VENDEE’S SECURITYINTERESTS v. THE CONSTRUCTION LENDER’S LIEN . . . . . . . . . 515

A. The Priority Rules . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 515

South Carolina Federal Savings Bank v. San-a-Bel Corporation . . 516

B. Subordination Agreements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 518

C. Partial Release Clauses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 520

QUESTIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 521

Chapter 25 CONSTRUCTION CONTRACTS . . . . . . . . . . . . . . . . . . 525

I. BUILDING CODES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 525

A. Building Code Goals and Limitations . . . . . . . . . . . . . . . . . . . . . . . . 525

B. The Code Compliance Process . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 527

C. Responsibility of Architects and Builders for Code Compliance . . . . . 529

II. OWNERS AND ARCHITECTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 530

xxi



A. The Owner-Architect Agreement . . . . . . . . . . . . . . . . . . . . . . . . . . . 530

B. The Respective Roles of Owner and Architect in Development

Planning . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 532

1. Owner’s Responsibilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 532

2. Scope of Architect’s Work . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 533

C. Four Owner-Architect Contract Issues . . . . . . . . . . . . . . . . . . . . . . . 535

1. Ownership of Plans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 535

2. The Architect’s Fee . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 537

3. Cost Conditions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 537

4. Indemnity Provisions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 539

III. THE OWNER-GENERAL CONTRACTOR AGREEMENT . . . . . . . . . 541

A. Construction Industry Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . 541

B. Criteria for a Legally Binding Construction Contract . . . . . . . . . . . . . 541

1. Must Construction Contracts be Written to be Enforceable? . . . . . . . 541

2. Contractor Licensing Laws . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 542

C. Sequencing Design and Construction . . . . . . . . . . . . . . . . . . . . . . . . 543

1. Design-Bid-Build . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 543

2. Design-Build . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 544

3. Fast Tracking . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 546

D. Structuring Construction Responsibilities . . . . . . . . . . . . . . . . . . . . . 547

1. Owner-Builder (a.k.a. Multi-prime Contracts) . . . . . . . . . . . . . . . . 547

2. Owner-General Contractor (GC) . . . . . . . . . . . . . . . . . . . . . . . . . . 547

3. Owner-Construction Manager (CM) . . . . . . . . . . . . . . . . . . . . . . . 548

4. Turnkey . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 548

E. Bidding Arrangements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 549

1. To Use Competitive Bidding or Not . . . . . . . . . . . . . . . . . . . . . . . 549

2. Selecting the General Contractor Early . . . . . . . . . . . . . . . . . . . . . 549

F. Pricing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 550

1. Stipulated Sum, Fixed Price . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 550

2. Cost of the Work Plus a Fee (a.k.a. ‘Cost-plus’ or Time and

Materials) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 551

3. Cost of Work Plus Fee With a Guaranteed Maximum Price

(a.k.a. G-MAX or GMP) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 551

G. Change Orders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 552

1. Why So Many Change Orders? . . . . . . . . . . . . . . . . . . . . . . . . . . . 552

2. Ordering and Pricing Changes . . . . . . . . . . . . . . . . . . . . . . . . . . . 552

3. Contractor’s Legal Burden of Proof for Extras Compensation . . . . . 554

4. Too Many Extras Vitiate the Original Contract . . . . . . . . . . . . . . . . 554

H. Timely Performance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 555

IV. SUBCONTRACTING . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 556

A. Why Subs? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 556

B. The Owner-Subcontractor Relationship . . . . . . . . . . . . . . . . . . . . . . . 557

QUESTIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 558

xxii



Chapter 26 MECHANICS’ (OR CONSTRUCTION) LIENS . . . . . . . 561

I. PURPOSES AND JUSTIFICATIONS . . . . . . . . . . . . . . . . . . . . . . . . . 561

II. ELIGIBLE LIENORS AND PERMISSIBLE CLAIMS . . . . . . . . . . . . . 563

A. Eligible Lien Claimants . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 563

B. Types of Goods and Services for Which Liens May Be Obtained . . . . . 563

C. Determining the Amount of the Lien . . . . . . . . . . . . . . . . . . . . . . . . . 564

III. THE MECHANICS’ LIEN CLAIM PROCESS . . . . . . . . . . . . . . . . . . 565

A. The Preliminary Notice . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 566

B. Recordation of a Mechanics’ Lien . . . . . . . . . . . . . . . . . . . . . . . . . . 567

C. Mechanics’ Lien Foreclosure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 568

1. Time Limits for Filing and Recording the Lien and Initiating the

Foreclosure Action . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 569

2. Foreclosure Suit Must Be Diligently Prosecuted . . . . . . . . . . . . . . . 570

IV. LIEN PRIORITIES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 570

A. ‘Relation Back to Visible Commencement’ Rule . . . . . . . . . . . . . . . . 570

B. Other Priorities Rules . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 573

V. OWNERS’ STRATEGIES TO PROTECT AGAINST MECHANICS’LIENS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 574

A. Select Contractors Carefully . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 574

B. Joint Checks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 574

C. Waivers and Lien Releases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 575

D. Retainage . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 575

E. Bonding . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 575

F. Clearing Owners’ Titles of Invalid Liens . . . . . . . . . . . . . . . . . . . . . . 575

VI. THE OWNERS’ OBLIGATIONS FOR IMPROVEMENTSORDERED BY TENANTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 576

A. Conflicting State Rules on Right of Tenant’s Contractor to

Lien Landlord’s Interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 576

B. Tenant Improvers’ Rights to Lien Lessors’ Interest in California . . . . . 577

VII. HOW MECHANICS’ LIENS RECORDED AGAINST THEIRSELLERS’ TITLES AFFECT PURCHASERS . . . . . . . . . . . . . . . . . . . 577

VIII. THE CONSTRUCTION LENDER AND THE MECHANICS’LIENOR . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 578

A. A Case depicting lien priorities between construction lenders and

mechanic’s lienors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 578

1st Choice Bank v. Fisher Mechanical Contractors, Inc. . . . . . . . . . 578

B. The Optional/Obligatory Distinction . . . . . . . . . . . . . . . . . . . . . . . . . 582

C. Risk Management Techniques for Construction Lenders . . . . . . . . . . . 585

D. The Stop Notice . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 587

QUESTIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 588

xxiii



Chapter 27 METHODS OF FINANCIAL ANALYSIS FOR REAL

ESTATE INVESTMENTS . . . . . . . . . . . . . . . . . . . . . . . . 591

I. ESTIMATING YIELDS ON REAL ESTATE INVESTMENTS . . . . . . . 592

A. Net Operating Income (NOI) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 592

1. Calculating Net Operating Income (NOI) . . . . . . . . . . . . . . . . . . . . 592

2. What NOI Excludes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 593

3. NOI After Debt Service = Before Tax Cash Flow . . . . . . . . . . . . . . 593

B. Net Present Value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 594

1. Calculating the Time Value of Money . . . . . . . . . . . . . . . . . . . . . . 595

2. Net Present Value Defined . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 595

C. Internal Rate of Return (IRR) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 596

1. Defining IRR . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 596

2. Comparing NPV and IRR . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 596

3. Using IRRs in Joint Venture Agreements To Calibrate the Promoter’s

Yield to the Investors’ Returns . . . . . . . . . . . . . . . . . . . . . . . . . . . 598

4. When Cash Trumps IRRs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 599

5. Drafting to Avoid IRR Ambiguities . . . . . . . . . . . . . . . . . . . . . . . . 600

6. Other IRR Limitations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 600

7. How the Calculations of Real Estate Investors Differ from Those of

Corporate Investors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 601

D. Protecting Investors from Wildly Unrealistic NPV and IRR

Calculations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 601

1. How the Business Judgment Rule Protects Promoters When Investors

Don’t Receive the Promised Yields . . . . . . . . . . . . . . . . . . . . . . . . 601

2. How Promoters’ Attorneys Can Become Liable to Disappointed

Investors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 603

E. Financial Leverage . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 604

1. The Impact of Leverage on Returns . . . . . . . . . . . . . . . . . . . . . . . . 604

2. Leverage Increases Risk and Volatility . . . . . . . . . . . . . . . . . . . . . 605

3. Reasons Other than Yield for Leveraging: Optimism, Portfolio

Diversification, Buying Bigger Projects, Tax Free Cash Outs . . . . . . 605

II. REAL ESTATE APPRAISALS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 606

A. When Appraisals Are Needed . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 606

B. Valuation Process . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 607

C. Approaches to Valuation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 608

1. Market Comparison Approach: Principle of Substitution . . . . . . . . . 608

2. Cost Approach: Principle of Contribution . . . . . . . . . . . . . . . . . . . . 609

3. Income Capitalization Approach: Principle of Anticipation . . . . . . . 611

D. Reconciliation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 615

1. Property Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 615

2. Property Tax Appraisals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 616

III. THE PRO FORMA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 617

QUESTIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 621

xxiv



Chapter 28 TAX MATTERS IN REAL ESTATE . . . . . . . . . . . . . . . . 623

I. INTRODUCTION: BASIC TAX RULES . . . . . . . . . . . . . . . . . . . . . . 623

A. Definitions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 623

1. Marginal and Average Tax Rates . . . . . . . . . . . . . . . . . . . . . . . . . 623

2. Basis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 624

B. Allowable Deductions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 624

1. Tax Treatment of Improvements and Repairs . . . . . . . . . . . . . . . . . 624

2. The Depreciation Deduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 626

C. Inclusion of Borrowed Funds in Basis . . . . . . . . . . . . . . . . . . . . . . . . 631

1. Components of Debt Service . . . . . . . . . . . . . . . . . . . . . . . . . . . . 632

2. Refinancing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 632

3. ‘At Risk’ and Qualified Non-Recourse Financing . . . . . . . . . . . . . . 632

4. Disallowance of the Deduction for Sham Transactions . . . . . . . . . . 633

5. When Depreciation Deduction is a Tax Shelter . . . . . . . . . . . . . . . . 634

D. Limitations on the Deductibility of Passive Activity Tax Losses . . . . . 635

II. CASH FLOW IMPLICATIONS OF TAX RULES FOR RENTALPROPERTY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 637

III. TAX IMPLICATIONS WHEN MORTGAGED COMMERCIALPROPERTY IS SOLD OR FORECLOSED . . . . . . . . . . . . . . . . . . . . . 641

IV. STRATEGIES FOR REDUCING OR DEFERRING TAXLIABILITY ON SALE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 644

A. Maneuvering to the Lower Rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . 644

B. Deferral of Tax on Gain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 645

C. The Like-Kind Exchange . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 646

QUESTIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 657

Chapter 29 SELECTING AN ENTITY FOR REAL ESTATEINVESTMENT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 661

I. A SURVEY OF THE ENTITY CHOICES FOR CLOSELY HELD REALESTATE VENTURES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 664

A. Sole Proprietorship . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 664

B. General Partnership . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 664

1. Formation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 664

2. Liability of Partners for Partnership Debt . . . . . . . . . . . . . . . . . . . . 665

3. Liability of Partnership for Personal Obligations of Individual

Partners . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 665

4. Tax Treatment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 666

5. Disposition of Partnership Interests . . . . . . . . . . . . . . . . . . . . . . . . 668

6. Disposition of Partnership Realty by Any General Partner . . . . . . . . 668

7. When One Partner Wants to Sell Out and the Other Does Not:

Dissolution, Damages and Buy/Sell Agreements . . . . . . . . . . . . . . . 669

C. C Corporation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 670

1. Formation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 670

xxv



2. Shareholder Limited Liability . . . . . . . . . . . . . . . . . . . . . . . . . . . . 670

3. Tax Treatment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 671

D. Tenancy-in-Common . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 673

1. Basic Characteristics of TIC Decision Making . . . . . . . . . . . . . . . . 673

2. The Right of Partition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 674

3. Limited Liability of Co-Tenants for Each Other’s Debts . . . . . . . . . 675

4. Tax Treatment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 675

E. Limited Partnership (LP) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 677

1. Basic Characteristics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 677

2. The Unlimited Liability of the General Partner . . . . . . . . . . . . . . . . 677

3. The Limited Liability of the Limited Partners . . . . . . . . . . . . . . . . . 678

4. Tax Treatment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 679

F. S Corporation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 679

1. The Advantages of an S Corp . . . . . . . . . . . . . . . . . . . . . . . . . . . . 679

2. Statutory Criteria for S Corp Status . . . . . . . . . . . . . . . . . . . . . . . . 679

3. Tax Drawbacks of S Corp Status . . . . . . . . . . . . . . . . . . . . . . . . . . 681

G. The Limited Liability Company (LLC) . . . . . . . . . . . . . . . . . . . . . . . 682

1. Member Limited Liability and Other Features . . . . . . . . . . . . . . . . 682

2. Tax Treatment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 683

II. THE REAL ESTATE INVESTMENT TRUST (REIT) . . . . . . . . . . . . . 683

A. The REIT Business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 683

B. Tax Code Limitations on REIT Ownership, Portfolio Composition and

Earnings Distributions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 684

C. Tax Treatment of REIT Shareholders . . . . . . . . . . . . . . . . . . . . . . . . 686

D. Comparing Investment in REIT Stock with Direct Acquisition of

Realty . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 686

QUESTIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 688

Chapter 30 ALTERNATIVES TO THE ‘PLAIN VANILLA’MORTGAGE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 691

I. MORTGAGES TO ACCOMMODATE THE BORROWERS’ PLACE INTHE LIFE CYCLE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 692

A. The Reverse Mortgage, A.K.A. the Home Equity Conversion Mortgage

(HECM) or Reverse Annuity Mortgage (RAM) . . . . . . . . . . . . . . . . . 692

B. The Graduated Payment Mortgage (GPM) . . . . . . . . . . . . . . . . . . . . . 695

II. ARRANGEMENTS FOR PROTECTING LENDERS AGAINSTINFLATION, INCLUDING ‘EQUITY KICKERS’ . . . . . . . . . . . . . . . . 695

A. The Price Level Adjusted Mortgage Plan (PLAM) . . . . . . . . . . . . . . . 695

B. The Shared Appreciation Mortgage (SAM) . . . . . . . . . . . . . . . . . . . . 696

C. The Participating Mortgage . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 699

1. Definition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 699

2. The Participating Mortgagor’s Position . . . . . . . . . . . . . . . . . . . . . 700

3. The Mortgagee’s Position . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 701

xxvi



4. Legal Risks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 701

D. The Convertible Commercial Mortgage . . . . . . . . . . . . . . . . . . . . . . 702

1. The Salient Features of a Convertible Mortgage . . . . . . . . . . . . . . . 702

2. The Legal Risk: Clogging the Equity of Redemption . . . . . . . . . . . . 704

E. The Wraparound Mortgage . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 705

1. How the WA Works . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 705

2. The WA Mortgagee’s Position . . . . . . . . . . . . . . . . . . . . . . . . . . . 707

3. Foreclosure of a WA Mortgage . . . . . . . . . . . . . . . . . . . . . . . . . . . 708

III. ARRANGEMENTS IN WHICH THE FINANCIER’S INVESTMENT ISSECURED BY AN INTEREST IN THE EQUITY . . . . . . . . . . . . . . . . 711

A. Installment Sale Contracts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 711

1. The Basic Arrangement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 711

2. Enforceability of Installment Sales Contracts . . . . . . . . . . . . . . . . . 712

B. Equity Sharing and the Internal Revenue Code . . . . . . . . . . . . . . . . . 713

C. Mezzanine Financing: Equity as Security . . . . . . . . . . . . . . . . . . . . . 717

1. Origin and Definition: The Influential Role of Credit Rating

Agencies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 717

2. The Special Purpose Entity (SPE) . . . . . . . . . . . . . . . . . . . . . . . . . 717

3. The Mezzanine Arrangement . . . . . . . . . . . . . . . . . . . . . . . . . . . . 718

QUESTIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 722

Chapter 31 THE LEASE AS FINANCING DEVICE . . . . . . . . . . . . . 725

I. GROUND LEASING . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 728

A. Defined . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 728

B. Key Players in Ground Lease Development . . . . . . . . . . . . . . . . . . . . 729

C. The Ground Lease and the Site Owner . . . . . . . . . . . . . . . . . . . . . . . 729

D. The Developer and the Ground Lease . . . . . . . . . . . . . . . . . . . . . . . . 730

Ground Leasing for Leverage: An Example . . . . . . . . . . . . . . . . . 731

E. Protecting the Leasehold Mortgagee Against Termination of the Ground

Lease . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 734

1. Five Potential Causes of Premature Lease Termination . . . . . . . . . . 735

2. Techniques Available to Leasehold Mortgagee for Mitigating the Harms

of Premature Lease Termination . . . . . . . . . . . . . . . . . . . . . . . . . . 737

F. The Sublessees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 740

II. SALE-LEASEBACK . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 741

A. Defined and Explained . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 741

B. Accounting Rules . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 742

1. Account Benefits and Limitations . . . . . . . . . . . . . . . . . . . . . . . . . 742

2. When is a Sale Leaseback a True Sale, Not a Disguised Mortgage? . 743

3. When Does a Sale Leaseback Create an Operating Lease, Not a

Capital Lease? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 744

C. Tax Rules . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 745

D. Re-Characterization of Sale-Leaseback as Equitable Mortgage . . . . . . 746

xxvii



1. Facts Relevant to Tax Re-Characterization . . . . . . . . . . . . . . . . . . . 746

2. The Mortgage Law Consequences of Re-Characterization . . . . . . . . 746

3. Title Insurance to Cover Re-Characterization Risk from Intervening

Lienors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 747

QUESTIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 748

Chapter 32 COMMERCIAL LEASING . . . . . . . . . . . . . . . . . . . . . . . 749

I. THE NEGOTIATING PROCESS . . . . . . . . . . . . . . . . . . . . . . . . . . . . 749

A. Negotiating a Lease . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 749

B. The Battle of the Forms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 750

II. THE PARTIES TO THE LEASE . . . . . . . . . . . . . . . . . . . . . . . . . . . . 751

A. Authority and Liability of the Parties . . . . . . . . . . . . . . . . . . . . . . . . 751

B. Liability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 751

C. Assignment and Subleasing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 752

1. Why Tenants May Wish to Transfer Their Leaseholds and

Landlords May Resist . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 752

2. Lease Provisions Regarding Assignment and Subletting . . . . . . . . . 753

3. California Law of Commercial Lease Assignments . . . . . . . . . . . . . 757

III. DEMISED SPACE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 759

A. Sizing up the Leased Space . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 759

B. Tenant Improvements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 761

1. ‘TI’ Allowances . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 761

2. Work Letter Issues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 762

C. Parking . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 762

1. Reserved or Open . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 763

2. Free or Pay . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 763

3. Does Lessor Have the Right to Change Parking Configuration

or Number of Spaces? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 764

4. Municipal Parking Requirements . . . . . . . . . . . . . . . . . . . . . . . . . 764

IV. THE LEASE TERM . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 765

A. Commencement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 765

1. Designating and Conditioning the Date for Commencement . . . . . . . 765

2. Delayed Commencement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 767

B. Selecting the Lease Term . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 767

C. Lease Renewals, Expansions and Cancellation Rights . . . . . . . . . . . . 768

1. Renewals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 768

2. Expansion Rights . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 768

3. Cancellation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 769

V. THE RENT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 769

A. Base Rent Adjustments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 769

B. Percentage Rent Formulas . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 770

1. Rationale for Percentage Rent . . . . . . . . . . . . . . . . . . . . . . . . . . . . 770

2. Percentage Rent Provisions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 771

xxviii



3. Implications of Percentage Rent Provision on Tenant’s Other Lease

Obligations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 773

C. Ways of Allocating Liability for CAM Expenses Between Landlord and

Tenant: Net, Gross and Expense Stop . . . . . . . . . . . . . . . . . . . . . . . . 774

1. Methods of Allocating Operating Expenses Between Landlords and

Tenants . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 774

2. Formulas for Allocating Common Area Maintenance Expenses Among

Tenants . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 776

VI. DEFINING THE SCOPE OF TENANT OPERATIONS: USE,EXCLUSIVES, RADIUS, CONTINUOUS USE AND CO-TENANCY . 780

A. Use Clauses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 780

1. The ‘Use’ Default Rule and Why it is Often Modified By Contract . . 780

2. Drafting ‘Use’ Clauses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 781

3. Use Restrictions and Government Imposed Land Use Controls . . . . 782

B. Exclusives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 783

1. Why Tenants Want Exclusives and Landlords Resist . . . . . . . . . . . . 783

2. Drafting Issues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 784

3. Exclusives and Anti-Trust Laws . . . . . . . . . . . . . . . . . . . . . . . . . . 785

C. Radius Clauses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 786

1. Radius Restrictions on Tenants . . . . . . . . . . . . . . . . . . . . . . . . . . . 786

2. Radius Clauses Against Landlords . . . . . . . . . . . . . . . . . . . . . . . . . 788

D. Continuous Use . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 788

1. Definition and Purpose . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 788

2. ‘Continuous Use’ Clauses are Seldom Implied . . . . . . . . . . . . . . . . 790

E. Co-Tenancy Clauses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 791

1. Drafting and Enforceability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 791

2. Arguments For and Against Co-Tenancy Provisions . . . . . . . . . . . . 792

QUESTIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 793

Chapter 33 OBTAINING ENTITLEMENTS FOR REAL ESTATEDEVELOPMENT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 795

I. ENTITLEMENTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 795

A. The Political Process . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 795

1. Entitlement Due Diligence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 795

2. The Official Players in the Land Use Entitlement Game . . . . . . . . . . 796

3. Unofficial Players . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 797

II. LEGAL CHALLENGES PRECIPITATED BY LAND USE DECISIONPROCESSES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 799

A. Disqualifying Public Officials . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 799

1. Pay to Play: Campaign Contributions Buy Access Lawfully . . . . . . 799

2. Bribes and Extortion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 800

3. Conflicts of Interest by Public Officials . . . . . . . . . . . . . . . . . . . . . 800

4. Legislative Privilege and the Exception for Official Animus as a Federal

xxix



Civil Rights Act Violation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 801

5. Due Process Limits on Local Government Land Use Decisions . . . . 802

B. Litigation Between Developers and Neighbors Arising from the Political

Process . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 803

1. Enforcement of Understandings Between the Developer and the

Neighbors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 803

2. Developer Lawsuits Against Project Opponents . . . . . . . . . . . . . . . 804

III. CONTROLLING SUBDIVISIONS THROUGH THE SUBDIVISION MAPACT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 805

A. The Contents of the Subdivision Map . . . . . . . . . . . . . . . . . . . . . . . . 805

B. The Map Approval Process . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 806

C. Standards for Denial . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 809

D. Developer Contributions to Infrastructure . . . . . . . . . . . . . . . . . . . . . 810

1. Impact Fees, Exactions, and Construction of Public Facilities . . . . . 810

2. Legal Challenges to Developer Exactions: The Constitutional

Dimension . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 811

3. Paying for Infrastructure Through Special Tax Districts Against Future

Home Buyers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 814

IV. THE LANGUAGE OF ZONING . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 815

A. Important Distinctions and Dichotomies . . . . . . . . . . . . . . . . . . . . . . 815

1. Distinguishing Between Use and Development Standards . . . . . . . . 816

2. The Difference Between ‘As of Right’ and Discretionary Zoning . . . 818

3. The Dichotomy Between Hierarchical and Non-Cumulative Zoning . 819

4. The Difference Between Single and Mixed Use Zones . . . . . . . . . . . 819

5. The Zoning Text and The Zoning Map . . . . . . . . . . . . . . . . . . . . . 820

B. Discretionary Controls . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 821

1. Special Uses, Special Exceptions or Conditional Uses; Definitions and

Applications . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 821

2. Variances . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 823

C. Density Controls . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 826

V. THE GENERAL, COMPREHENSIVE OR MASTER PLAN . . . . . . . . . 828

A. The Legal Status of State Planning Requirements in the U.S. . . . . . . . 828

B. Types of General Plans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 829

1. Growth Caps . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 829

2. Development Quality . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 829

3. Smart Growth . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 830

4. Urban Growth Boundaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 830

5. Planning for Sustainable Development to Reduce the Carbon

Footprint . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 831

6. Concurrency Requirements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 832

7. Consistency Planning . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 834

C. The General Plan as an Advocacy Tool . . . . . . . . . . . . . . . . . . . . . . . 835

IV. VESTED RIGHTS AND THE DEVELOPER . . . . . . . . . . . . . . . . . . . . 836

A. The Possible Times of Vesting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 836

xxx



1. The Majority Rule: Substantial Reliance on a Lawfully Issued Building

Permit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 836

2. Vesting at the Time of Land Purchase . . . . . . . . . . . . . . . . . . . . . . 838

3. Vesting Upon Submission of a Completed Building Permit or Tentative

Tract Map Application . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 838

4. Vesting When Owners Obtain Approval of Site Specific Permits . . . 839

5. Allocating the Entitlement Risk Between Sellers of Development Land

and Their Developer Buyers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 839

6. The Limits of Vesting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 839

B. Development Agreements Hedge the Retroactivity Risk . . . . . . . . . . . 841

VII. FEDERAL AND STATE ENVIRONMENTAL LAWS POTENTIALLYAFFECTING NEW DEVELOPMENT . . . . . . . . . . . . . . . . . . . . . . . . 842

A. The Clean Air Act . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 843

B. Wetlands, Dredging and Filling Navigable Waters of the United States:

The Clean Water Act . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 844

C. Coastal Zone Management Laws . . . . . . . . . . . . . . . . . . . . . . . . . . . 846

D. The Endangered Species Act . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 847

E. Environmental Impact Statements (EISs) and Environmental

Impact Reports (EIRs) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 851

QUESTIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 852

Chapter 34 PUBLIC/PRIVATE REAL ESTATE VENTURES . . . . . . 855

I. CITIES AS LAND DEVELOPERS . . . . . . . . . . . . . . . . . . . . . . . . . . . 856

A. Redevelopment to Achieve Planning Goals to Improve the Quality, Utility

and Livability of Urban Space . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 856

B. Redevelopment for Job Creation . . . . . . . . . . . . . . . . . . . . . . . . . . . . 859

C. Redevelopment to Augment the Local Government Tax Base . . . . . . . 862

II. TAX INCREMENT FINANCING (‘TIF’) . . . . . . . . . . . . . . . . . . . . . . 864

A. How Tax Increment is Determined . . . . . . . . . . . . . . . . . . . . . . . . . . 864

B. Bonding the Increment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 865

C. The Ideal Project for Producing TIF Dollars . . . . . . . . . . . . . . . . . . . 866

D. A TIF Case Study . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 867

E. The Impact of Redevelopment on Other Taxing Entities . . . . . . . . . . . 869

III. PUBLIC AGENCY DEALINGS WITH THE DEVELOPER . . . . . . . . . 871

A. Why Redevelopment Agencies Don’t Become Project

Owner/Builders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 871

B. The Agency-Developer Tango . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 871

IV. CHALLENGES TO REDEVELOPMENT RAISED BY THEOWNERS AND OCCUPANTS OF CONDEMNED LAND . . . . . . . . . 879

A. Pricing Public Acquisitions of Private Property . . . . . . . . . . . . . . . . . 879

B. ‘Public Use’ . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 886

QUESTIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 889

Table of Cases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . TC-1

xxxi



Table of Statutes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . TS-1

Index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . I-1

xxxii

