Real Estate Law

Palo Alto Residential Leasing: The Mandatory Mediation Ordinance (Part I)

By Blog, Real Estate Law

Palo Alto’s Mandatory Mediation Ordinance is premised on the notion that fostering communication between landlords and tenants is key to a positive residential housing environment. The highlight of the Ordinance is the requirement that all landlords and tenants of covered properties (most residential rental properties are covered) must participate in the conciliation and mediation process outlined in the Ordinance.

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Real Estate Purchase Options in California: Steiner v. Thexton

By Blog, Real Estate Law

As noted in my last blog post, the California Supreme Court just reversed the appellate court decision in the case of Steiner v. Thexton, Ca. Sup. Ct., 03-18-2010, 10
C.D.O.S. 3391
.  This is good news for developers and other buyers of real property in California, although there are still some traps that will catch the unwary.

Real property purchase agreements in California are often drafted with broad due diligence or feasibility provisions that allow the buyer to terminate the agreement, and get the deposit back, for any reason in the buyer’s sole discretion.  These “free look” provisions are valuable to prevent disputes over whether a buyer is entitled to terminate the agreement.  The buyer simply has the right to terminate for any reason or no reason, as long as notice of termination is given within a specified period.

As made clear in the Steiner case, under California law such agreements are not purchase agreements at all, despite what they are often called.  Instead, these are actually option agreements, with the seller obligated to hold open its offer to sell on the stated terms of the agreement, and the buyer holding the power to accept or reject the offer.  And for an option agreement to be irrevocable, so that the seller cannot retract his offer, the buyer needs to have given the seller legal consideration for the option to purchase the property.  If there is no option consideration given by the buyer, then the option can be revoked by the seller at any time until it is unconditionally accepted by the buyer.  This is where the court of appeals and the Supreme Court parted ways in the Steiner case.  Even though Steiner had expended substantial sums of money in reliance upon his “contract” to buy the property, the appellate court held that Steiner had given no consideration for his option, and so therefore the seller, Thexton, could unilaterally terminate the agreement.  The Supreme Court disagreed, and held that Steiner’s actions in seeking a parcel split that was required before the property could be sold was sufficient to render his option irrevocable, particularly since that was an important component of the deal to Thexton.

The Supreme Court’s decision, while good for developers and other buyers, raises many issues that will need to be resolved in subsequent cases.  In the meantime, however, buyers should be sure that their purchase agreements are drafted to avoid inadvertently creating a revocable option. To do so, buyers need to either (i) pay actual consideration for the option, or (ii) undertake a clear affirmative obligation to do something that confers a benefit on the seller or imposes a burden on the buyer.  Since one of the underlying advantages to a broad due diligence clause is avoiding disputes, buyers may want to avoid committing to affirmative legal obligations.  Our advice is to use a clause similar to the following, which provides for a portion of the deposit to be retained by the seller if the buyer decides not to go forward with the transaction:

“In the event the sale of the Property as contemplated hereunder is consummated, the Deposit shall be credited towards the Purchase Price.  In the event the sale of the Property is not consummated because of the failure of any condition or any other reason other than a default under this Agreement on the part of Buyer, the Deposit (less the amount of $__________ (the “Contract Consideration”)) shall be returned to Buyer and, notwithstanding anything to the contrary contained in this Agreement, the Contract Consideration shall be paid to and retained by Seller for and in consideration of Seller’s entering into this Agreement.  Buyer and Seller agree that the Contract Consideration together with the mutual covenants and agreements herein set forth are adequate to prevent this agreement from constituting a revocable option to purchase the Property.”

The amount of the "Contract Consideration" need not be large, but should be more than nominal.

Thomas B. Jacob, Real Estate Group

California Supreme Court Overturns Steiner v. Thexton

By Blog, Real Estate Law

In Steiner v. Thexton (2008) 163 Cal. App 4th 359, the California Court of Appeal held that a document entitled “Real Estate Purchase Contract” was not in fact an agreement for the purchase and sale of real property.  Instead, the court held it was an option agreement that was not enforceable by the buyer.  Since the “buyer” could terminate the agreement at any time prior to closing, the court felt that the option was not supported by the required consideration.  The seller was thus allowed to terminate the agreement after the buyer had expended time and money
This ruling caused much concern in the California development community, since many California purchase agreements drafted by developers provide for an unrestricted right of the developer to terminate the agreement if he or she determines that development is not feasible.
Today, the California Supreme Court overturned the Court of Appeals, in Steiner v. Thexton, Ca. Sup. Ct., 03-18-2010, 10 C.D.O.S. 3391.  The Supreme Court held that while the agreement in question was indeed an option, it was enforceable by the buyer because the buyer’s actions were sufficient to provide the necessary legal consideration for a binding contract.
We will post an analysis of the new decision shortly.
Thomas B. Jacob, Real Estate Group

California Legislation Threatens Tax-Free Exchanges

By Blog, Business Law, Real Estate Law

California’s anticipated $20 billion budget shortfall is well-known and legislators are understandably scrambling for solutions.  Newly proposed AB 2640 was introduced in the California Assembly on February 19 and would raise revenues immediately.  In fact, its terms are retroactive to January 1, 2010.
Among other provisions, AB 2640 would tax gain from certain exchanges that are tax-free under federal law.
For example, Section 1031 of federal tax law provides that no gain or loss is recognized when business or investment property is exchanged for property of a “like kind.”  California has long-respected this non-recognition provision, but AB 2640 would require that those gains, exempt from federal tax, be taxed in California.  While 1031 exchanges apply to many types of property, they are most commonly used for real estate, allowing gains from the sale of one investment property to be rolled over into another investment property so long as the entire proceeds of the sale of the original property are used for the purchase of new property.  If AB 2640 is enacted into law, gain on the transaction will be taxed at California’s rates and, in order to qualify for the full federal tax exclusion, anyone wishing to complete a 1031 exchange will have to pay the California taxes from funds other than the proceeds of the sale of the original property.
AB 2640 also takes aim at two valuable corporate non-recognition provisions.  Currently, when a corporation issues its stock, whether in a public or private offering, it does not recognize gain or loss.  Section 1045 of the Internal Revenue Code also allows gain to be rolled over if a taxpayer sells “qualified small business” stock and rolls over the proceeds to another “qualified small business” stock within 60 days of the sale.  These two provisions allow corporations to effectively raise capital and favor investment in small businesses.  Both of these provisions will be eliminated with AB 2640, causing corporations to pay tax on stock issuances and discouraging additional investment in small businesses.
There are a number of other exclusions AB 2640 would eliminate, including the exclusion of gain on transfers between spouses when they are divorcing, non-recognition provisions that apply if property is destroyed or condemned and other provisions that relate to exchanges of insurance policies and corporate securities.
It seems unlikely that AB 2640 will become law with its sweeping changes.  It will, however, only require a majority vote in the California legislature to enact it.  The bill does not create any new taxes (which would require a 2/3 majority to enact), it simply removes some existing exemptions and exclusions.  It would certainly generate current revenues and alleviate the present budget crisis.  Over the long term, however, it does not increase overall revenues but accelerates them to the present.  The Legislative Counsel of the State of California allows you to track the bill’s progress at by entering “AB 2640” into the search line.
Anne E. Senti-Willis, Business Group

Green Construction Contract Checklist

By Blog, Real Estate Law

Implementing a sustainable, energy efficient construction project involves many considerations encompassing the full range of development activities: site selection, design, construction, operation, maintenance and demolition. Every owner must consider a wide variety of implications, including cost, availability of materials, schedule and quality. Among the first issues to be addressed is the content of
the design and construction contracts. What follows is a checklist of issues to consider when negotiating and drafting contracts with architects, contractors and others involved in the project.

1. Should a certified green professional be retained? A design professional who has obtained accreditation in green design and construction will be recognized as an “Accredited Professional.”

2. If a specified standard of construction is required, be sure it is specified clearly, and with reference to the revision date of the applicable standard. A number
of organizations offer certification standards and ratings, including the LEED Green Building Rating System, Living Building, Green Globes, Green Point Rated and the National Association of Home Builder’s Green Building Program.

3. Be aware of changes in the law, especially local ordinances, relating to the requirements for any element of green design and construction.

4. Plan for extra time, and potentially extra cost, for delivery of materials.

5. Incorporate any applicable “performance” standards for the project, such as energy savings, air and water quality, water usage and recycling.

6. Watch for exculpatory provisions and disclaimers of responsibility at every stage. For example, a particular material requirement may draw a disclaimer of liability from an architect or contractor, who might not have confidence in the product. This may lead to extended negotiations over indemnities
and damage waivers.

7. Watch for, or give thought to clauses that require a particular standard of care that might be higher than customary. Such clauses may trigger insurance exclusions, thereby negating coverage from professional liability insurance or complicate bonding.

8. Consider extending any payment retention until the required certification is obtained. In addition, require that all documents related to the green requirements are created, maintained and turned over as part of the certification.

9. Reexamine how the green requirements may impact standard construction clauses, including such matters as delay, indemnities, consequential damage waivers, change
orders, insurance and substitutions.

10. Implement job-site recycling/waste
management requirements, if not already contemplated by a particular standard that is applicable.

Some of the standard forms of design and construction contracts include provisions that promote consideration of sustainability issues, but typically those are general and not mandatory. As with any contract, the parties need to identify exactly what their expectations are and specifically provide for the accomplishment of those goals in the contract.

Stephen C. Gerrish, Real Estate Group