When are demand letters and other communications useable as a defense to a lawsuit?

When your lawyer is really creative. Or not. A recent court of appeal decision held that correspondence from one partner to another in which the first partner tries to talk the second partner out of selling the second partner’s interest to a third party are not, necessarily, privileged. Thus, when the third party had to pay more for the second partner’s interest, the first partner had the chance to became liable to the buyer for the increase in purchase price! When sued for that difference, the first partner tried to characterize the letters and emails as communications “in anticipation of litigation” and thus privileged, under the Anti-SLAPP rules. Not so, said the court.

Reference: Haneline Pacific Properties v. May (2008, DJDAR 15330)

Need some polish for your “Corporate Shield?”

Many brokers (agents too) have set up corporations for themselves to protect against claims. Then they forget about the annual “formalities” or use the “company” money for personal expenses – which allows a plaintiff to “pierce the corporate veil” and go after their personal assets.

“The seller told me – so it must be true.” Don’t bet on it. At least not without checking first.

President Reagan wasn’t the only one to say, “Trust; but verify.” Under California law, a real estate broker has an obligation to independently verify information passed on to a client OR, advise a client of the fact that information being passed on by the broker has not been independently verified by the broker (when it hasn’t been) and to also advise the principal to independently verify the information if it is material. If the agent doesn’t make that advisory statement and the information passed on is proven false, even if the agent didn’t know it at the time, the agent has liability to the principal for any damage the principal suffers.

Corporations are business entities separate and apart from their individual shareholders.

Corporations

Corporations are business entities separate and apart from their individual shareholders. Where corporate formalities are followed (among so so many other things), the corporation’s shareholders, directors and officers are generally protected from the claims against the corporation. A shareholder’s liability is usually limited to the amount of his or her investment in the business, and no more.  If, however, anyone is deemed to have behaved badly within the corporation, that person can always be held personally liable for his or her actions.  Recent examples of this include, on a larger scale, the executives of Enron. “C-corporations” are corporations that have not elected to be taxed as a “small business” for state and federal tax purposes (see below).

S Corporations

Under certain conditions a corporation and its shareholders may elect to have the corporation treated as a “small business” corporation for the purpose of federal income taxes. This election permits the taxable income of a corporation making the election to be taxed to the shareholders, rather than the corporation.

There are numerous requirements which must be satisfied to qualify a corporation and its shareholders to make an election to be taxed in this fashion. The officers of the corporation should consult with the corporation’s counsel and accountant to determine whether the corporation is eligible to make such an election and to consider the consequences, advantages or disadvantages of making the election. The election typically must be made and filed within 75 days from incorporation.

Partnerships

A partnership is defined as an association of 2 or more persons to carry on as co-owners a business for profit. In California, there are general partnerships, limited partnerships, and LLCs electing to be treated as partnerships. S Corporations are also treated in most ways like a partnership for tax purposes. Typical of partnerships is the characteristic that the tax benefits (and, gulp, corresponding burdens) flow-through to the individual taxpayers, typically in proportion to their percentage of interest in the profits, but not always. And frequently two people find themselves in a partnership without even knowing it. As a result, they find themselves obligated to each other, and taxing authorities, in ways that are frequently a shock to them.

In a general partnership, each partner, and that partner’s personal assets, is liable for the partnership’s liabilities, and for each other partners’ liabilities incurred on behalf of the partnership. Limited partnerships, on the other hand, limit the liability of the limited partners up to each of their investments. Members of a limited liability company are generally treated the same as limited partners. Of course, anything a partner does personally that is, well, bad, will likely expose that partner to personal liability.

Every entity has its purpose and usefulness. General partnerships should be used when there’s more than one person in the enterprise, partners trust (ahem) each other, and there is little concern about being sued. However, if you can think of an enterprise in today’s economic and political climate where being sued is not likely, please call us.

Limited partnerships are very useful in ventures where there is a desire to have one corporation or person managing an enterprise, and the rest of the participants desire to be passive investors, or “silent” partners. However, LLCs are being used more and more for this purpose, including in the area of real estate investments.

LLC

An LLC, or limited liability company, is a recent invention, combining the limited liability of a corporation, with the pass-through taxation characteristics of a partnership. It is formed, and its existence commences, when articles of organization are filed with the California Secretary of State. Typically, the management and operation of a limited liability company is governed by an “operating agreement”. This is the equivalent of a partnership agreement and the bylaws of a corporation. An LLC can have 1 or more members.

Typically people like to use, and we recommend using, an LLC, almost whenever possible. Compliance with corporate-like characteristics is optional. However, LLCs can not be used for most professional business enterprises, and there are certain tax disadvantages to LLCs.

Articles of Incorporation

The articles of incorporation are contained in one document which, when filed with the Secretary of State (for a nominal fee), bring a corporation to life. Prior to the articles being filed, the corporation is not a corporation at all, but merely an enterprise, or a corporation “in formation”. The articles define the name of the corporation, and certain other required and optional information about the corporation, which information can only be changed by following certain statutory formalities.

The SS-4

Every new business, including a new corporation, must obtain an Employer Identification Number from the Internal Revenue Service. The number must be used on all federal tax returns and related documents. The corporation’s accountant or counsel can assist in filing Form SS-4 to obtain this number. One of the few times this may not be necessary is when forming a single-member LLC without any employees.

25102(f)

Corporate shares, LLC memberships, and partnership interests are considered securities for purposes of federal securities laws and, generally, will be a security under California securities laws. Under California securities laws, any “offer” or “sale” of “securities” must be qualified with a permit from the California Department of Corporations, unless either the security or the transaction is exempt under the California Securities Law or preempted by federal law.

Section 25012(f) of the California Corporations Code provides a limited offering transaction exemption for offers and sales of securities to up to 35 purchasers within or outside of California. Huh? This exemption means that, if certain guidelines are followed, there is no need to comply with the voluminous (literally) state and Federal securities laws. There are a number of exemption requirements. One of them is the filing of the form named after the statute, the 25102(f) Notice of Transaction Form. This form is filed with the Department of Corporations, must be done online, and must be accompanied with the appropriate filing fee.

Some businesses don’t file one, and though not filing one is acceptable, the fee for filing will go up dramatically if, for some reason, the Department of Corporations makes a demand for such filing.

Close Corporations

Close corporations, or closely-held corporations, are corporations which have chosen to be governed by certain statutory rules. Typically these are chosen by people who do not want to have to deal with the ongoing corporate book maintenance issues of minutes and such, but who aren’t aware of the corresponding downsides and obligations, or these are chosen by people who simply thing that if there are a few shareholders, that it’s good to be “close”.

Generally speaking, we do not recommend this type of entity, unless it is under some very specific circumstances. Shareholders in close corporations are required to enter into an agreement for purposes of governing corporate operations and share restriction. And though we recommend this anyway for all corporations, it is required here. In addition, there are some other rules which restrict the day-to-day governance and decision-making process. Typically it involves the ongoing participation of all shareholders, whether majority or minority. And though that might work for some, generally we find that having one person in charge makes life easier, and subjecting that person to the typical corporate scrutiny of fellow shareholders or directors.

In Closing

Starting a new business, or growing one, can be very exciting, and daunting. Do not let the plethora of information in this article, or otherwise available to you, overwhelm you. You’ve already done the right thing by reading this article. When it comes to your business, you can never know too much.

“Puffing” is an art; but where’s the line from “puff” — to problem?

You want to get attention focused on your listing, as opposed to the swarm of others out there. You’re under obligation to the client is to make the property sound as attractive as possible – from a buyer’s perspective; whether it’s the sunny kitchen, or the stream of rental income. “Puffing” is an art; but where’s the line from “puff” — to problem?

In a recent case we handled, the agent described a property as having “legal duplex” in an MLS listing. The MLS also said “Check w/ City.” The Transfer Disclosure Statement said: “Property was purchased at a trustee’s sale…, and is being sold strictly for profit, tax records show the property as a duplex, however property is being used as a triplex, sellers have not checked county records to see whether or not work was done w/permits.”

When checking with the County tax assessor, the property was assessed as having two units, and when checking with the City, we found there were two, separate-address, permit files for the property, each for an individual unit – one commercial, one residential.

After the close of escrow, the buyer began working on the property, without getting a permit. The City red-tagged the job, and while conducting inspections, discovered the bootlegged 3rd unit in the residential building, and required its removal. The buyer never used or rented the commercial part of the property, and later, it was torn down – thus converting the property into a single family dwelling (SFD).

The buyer then sued the seller, and the seller’s agent for fraud – claiming the misrepresentation in the MLS induced him into buying a property he thought was a “duplex” when it was in fact only a SFD. An arbitration followed. The seller won, but the listing agent lost and was required to pay the buyer $45,000!

The arbitrator held that Civil Code § 1088, which provides that any agent who places a listing or other information in an MLS shall be responsible for the truth of those statements, created a duty between the listing agent and the buyer. (This was not otherwise a “dual agency” relationship.) Since the buyer claimed (without any other evidence than his mere statement to this effect) that he relied on the representation of “legal duplex” in the MLS and since the buyer took that to mean “two residential units” – the arbitrator found the listing agent liable.

This is a cautionary tale on two counts:

First, be careful about what you place in an MLS.
Second, do NOT agree to binding arbitration, ever.

This buyer could not speak English, and when asked to read the errant MLS, did not read or understand the word “duplex.” In addition, the buyer made a profit when he re-sold the property. The buyer also stated in the arbitration that he would have been satisfied with 2 units, of any kind, not just residential units. The listing agent should have been cleared of liability because the buyer could not have “relied” on an MLS statement he couldn’t read, there were no damages since he made a profit, and there was no “material” negligent misrepresentation because the buyer was satisfied with any kind of units, so long as there were two. Yet in this case, the arbitrator found against the uninsured (!) listing agent, for $45,000.

Arbitrators can be arbitrary. And an arbitration has no right to appeal.

It’s right there in paragraph 24 (or 16, or 32): “Time is of the essence.” So what?

Many agents will tell a client “It’s just the boilerplate.” Or, even worse, “It doesn’t really mean anything, as long as you close close to the closing date.” (Say that three times really fast.)

This “boilerplate” means something. (As does all the other “boilerplate.”) “Time is of the essence” means that you must perform within the time specified or the contract is breached. There is no “slippage” allowed. “Close” is only good enough for hand grenades. Some of you already understand exactly what I’m talking about. And have the horror stories to go along with it. Other are saying, “Wait a minute, I’ve been in hundreds of deals where the close of escrow gets bumped because of one reason or another. It’s never been a problem.” Wrong! Very wrong.

The California Courts have addressed this issue in Jeffrey Pittman v. Lily Canham, (2 Cal. App. 4th 556), where the court ruled that the failure of both parties to perform concurrent conditions did not leave the contract open for an indefinite period so that either party could tender performance at his or her leisure. The failure of both parties to perform concurrent conditions during the time for performance results in a discharge of both parties’ duty to perform. Thus, where the parties have made time the essence of the contract, at the expiration of time, without tender by either party, both parties are discharged. (See also, Corbin on Contracts (1960) § 663, p. 181.)

But, like most things in the law, there are exceptions. You can waive the “time” provision in a contract.

Waiver of the “time is of the essence” clause can occur whenever the seller acquiesces in a delay, or otherwise affirmatively agrees, either by modification of the contract in a writing, or by conduct, such as accepting payment or otherwise signaling approval of a delay.¹

A case on point, is Galdjie v. Darwish (2003) 113 Cal.App.4th 1331 (7 Cal.Rptr.3d 178), in which Galdjie submitted a purchase offer on an apartment building located in Santa Monica. The seller, Barbara Darwish, penned a counteroffer which Galdji readily accepted. Id. at 1334.

The purchase agreement contained a “time is of the essence” clause and the parties agreed that escrow was to close on April 9, 1998. On April 1, 1998, in connection with faxing respondent some information needed by a prospective lender, Darwish wrote a note to Galdjie stating that the contract would not be extended beyond April 9th. In May, Darwish cancelled escrow and Galdjie filed suit seeking specific performance under the purchase agreement.

Galdjie prevailed in trial court and was affirmed on appeal. The appellate court recognized that “the trial court found that Barbara Darwish waived the time provisions by continuing to deal with respondent after the dates specified in the contract. The court found that Barbara Darwish’s statement in her April 1 letter that time would not be extended past April 9 was contradicted by her actions in staying in communication with respondent and approving and assisting his efforts to locate a willing lender. Thereafter, she did not reestablish time conditions by giving notice that the deal must close by a certain date. Instead, she simply cancelled escrow without informing respondent or the realtor just as respondent finally obtained a firm loan commitment.” Id. at 1340.

1 The court in Leiter v. Handelsman (1954) 125 Cal. App. 2d 243,251 suggests that waiver includes inaction after the passing of the original closing date. The court stated, “there is language in some cases, notably Chan [citation omitted] suggesting that after a waiver or when the date originally provided for performance has passed without decisive decision action, a definitive notice demanding performance by another reasonable and specific date is required.”

In 1998 Alanna Spencer, a first-time home buyer, bought a two-bedroom condominium in Hayward, California. Later, Spencer became delinquent on her mortgage payments to her lender. The lender recorded a notice of default to begin foreclosure proceedings in November 2002. Spencer filed a Chapter 13 Bankruptcy petition in January 2003. The automatic stay provided upon filing this bankruptcy halted the foreclosure proceedings.

One year into the bankruptcy, the lender on Spencer’s mortgage filed a motion with the bankruptcy court seeking relief from the automatic stay so that it could proceed with its foreclosure against Spencer. While this motion was pending, Spencer signed a contract to sell her home for $220,000, less than its appraised value of $290,000, to Ryan Marshall, a licensed real estate broker doing business in Alameda County, California. Spencer at the same time signed an agreement to lease her home back from Marshall and also signed an option agreement which allowed Spencer to repurchase her home from Marshall at a price of $260,000, within one year after the sale to Marshall.

The sale of the condominium by Spencer to Marshall was approved by the Chapter 13 Bankruptcy Trustee for Spencer’s bankruptcy, but was not submitted to the bankruptcy court itself for approval. This procedure for approval of the sale was set forth in the bankruptcy court’s order approving Spencer’s Chapter 13 plan, and was a common procedure in use in the U.S. Bankruptcy Court in Oakland, California at that time.

In September 2004 the escrow for the sale by Spencer closed, and the proceeds were used to pay off Spencer’s creditors in the Chapter 13. The Bankruptcy Court then issued an order discharging Spencer’s debts in the bankruptcy. Soon after the close of the sale, title to the property was transferred to a corporation partly owned by Marshall; this transfer of title was made without the consent of Spencer.

Spencer continued to reside in the condominium under the leaseback, but she was unable to repurchase the home from Marshall’s assignee by the deadline of September 2005. Upon the expiration of the one-year leaseback, Spencer was served with a 60-day notice to terminate her tenancy.

In December 2005 Spencer sued Marshall and related entities. Among other things, Spencer alleged that the terms of the contracts between Spencer and Marshall violated the terms of the Home Equity Sales Contract Act (HESCA).¹

HESCA seeks to regulate transactions between an equity purchaser and an equity seller resulting in the sale of residential real property in foreclosure. At the heart of the statutory scheme is the requirement that the agreement between buyer and seller be in writing, with specific terms aimed at protecting the homeowner.² The contract must include the total consideration given, terms of payment and terms of any rental agreement; a conspicuous statement of the right to cancel within five business days or until 8 a.m. on the day scheduled for foreclosure, with an attached notice of cancellation; and a conspicuous notice that until the right to cancel has ended, the equity purchaser cannot ask the seller to sign a deed or any other document.³ The equity purchaser must provide, and complete, the contract in conformity with these terms.⁴

During the “cooling off” period, the equity purchaser cannot take title to the property by written instrument; cannot transfer or encumber any interest in the property; or pay the seller any consideration.⁵ Moreover, the purchaser cannot make untrue or misleading statements about the value of the property, any foreclosure proceeds, or the terms of sale.⁶ Additionally, when the seller grants the residence by an instrument purporting to be an absolute conveyance such as a deed, but reserves or is given an option to repurchase the residence, the equity purchaser cannot grant any interest in the property to another without the written consent of the equity seller.⁷ Finally, it is unlawful to take unconscionable advantage of the property owner in foreclosure.⁸ Depending on the nature of the violation, the aggrieved seller may be entitled to rescission, other equitable relief or damages, including punitive damages.⁹

At the time of trial, it was found that Spencer’s home was in foreclosure at the time of the sale to Marshall; the foreclosure proceeding started by Spencer’s lender had been halted by the bankruptcy filing, but had not been finally terminated. There was also no dispute that the contract documents used by Marshall did not comply with the formal requirements of HESCA. It was also found that Marshall had improperly transferred the title to the property without Spencer’s consent (which was required because she held an option to repurchase. Marshall was found liable for damages of $280,000, including $210,000 in punitive damages, reduced by $27,300 for unpaid rent.

On appeal, Marshall contended that he was exempt from the requirements of HESCA, citing a provision that a purchaser is exempt from the requirements of HESCA when the purchaser acquires title “At any sale of property authorized by statute.”¹⁰ Marshall contended that a The 11 case reviewed is Spencer v. Marshall (2008) 168 Cal.App.4th 783. provision of the U.S. Bankruptcy Code which states that the bankruptcy trustee, after notice and a hearing, may sell property of the bankrupt’s estate (such as the condominium). Marshall contended that because the sale of the property was approved by Spencer’s bankruptcy trustee under the procedure established by the local rule in the Oakland bankruptcy court, this amounted to a sale “authorized by statute.

Marshall also contended that a second exemption in HESCA applied: that a purchaser who acquires title “by order or judgment of any court” is exempt.

The appeal court rejected these arguments, finding that Marshall did not purchase the property “at” a sale authorized by statute, such as a purchase of a property at a government sale for unpaid taxes, and that the first exception cited by Marshall therefore did not apply. The court also found that no court order or transfer ever directed that the sale to Marshall take place; that the only scrutiny of the sale was by the bankruptcy trustee, and not the court itself, and that the bankruptcy trustee had no interest in ensuring that the terms of the sale were fair to Spencer, but only the creditors in the bankruptcy were fairly treated.

The appeal court also found that HESCA was enacted to protect homeowners in foreclosure from fraud, deception and unfair dealing, and that the trial court had not been wrong in finding that Marshall had engaged in the type of abuse prohibited by HESCA. The trial court had found Spencer’s version of what happened more credible than Marshall’s rendition. Spencer stated that she saw Marshall’s offer as the only way she could remain in her home and testified that Marshall misled her into believing that, by selling the property to him and getting out of bankruptcy, she could afford, with his help in obtaining financing, to buy back her home within a year. The court concluded that Spencer was especially vulnerable to Marshall’s predatory tactics. The appeal court concluded that the record amply supported the trial court’s findings that Spencer was vulnerable and susceptible to Marshall’s promises that he could help her.

This case gives clear warning to all persons, including real estate brokers and agents, that in dealing with owners of residences that are in foreclosure, great care must be exercised to ensure that the requirements of HESCA are complied with in connection with any sale of the property by the homeowner. It is imperative that the documents used in any such sale be reviewed by someone with specific expertise in the area of home equity sales. It is also critical that the substantive terms of the transaction be fair to the home equity seller, and that the procedures outlined in the contract documents concerning options to repurchase be followed exactly, taking care that no transfer of title or encumbrance of the property takes place within the term of any option to repurchase held by the equity seller.11

1 California Civil Code §§1695 et seq.
2 California Civil Code §§1695.2, 1695.3, 1695.5
3 California Civil Code §§1695.3 – 1695.5
4 California Civil Code §§1695.6(a)
5 California Civil Code §§1695.6(b)
6 California Civil Code §§1695.6(d)
7 California Civil Code §§1695.6(e)
8 California Civil Code §§1695.13
9 California Civil Code §§1695.7, 1695.14
10 California Civil Code §§1695.1(a)(4)