Risk Management in Transactions

Virtually every transaction has some risk.  But the risk in most transactions is so small that we usually don’t even think about it.

For example, buying a candy bar at a convenience store usually has very little risk.  But no transaction is completely risk-free.  Years ago I knew a person who bought a package of candy-covered chocolates at a small store.  She put a handful in her mouth and broke a tooth.  The machine that made the candies had malfunctioned and put a hard piece of solid candy into the bag along with the chocolates. Expecting only soft chocolates, this person bit down hard and broke a tooth.

While there may not be much risk in buying candy, there can be much more risk in buying real estate.  Most real estate includes many systems which only work properly if they are correctly designed, constructed, and maintained.  A failure to correctly design, build, or maintain real estate can result in problems, and many of the problems seen in real estate can be traced to one of these causes.  In addition, there can be problems with title, easements, liens, and other issues concerning legal ownership or use of the property.  Fortunately, many transactions go smoothly with no problems, surprises, or disappointments. But when things go wrong, the time, cost, and frustration of setting things right can be significant.  The whole purpose of getting property inspections and professional advice before buying a property is to try to avoid surprise, expense and disappointment as much as possible.

Beachfront Property Complex

It’s been a busy end of the year – which means we haven’t seen as many Christmas DVDs this year as we might normally watch.  But some weeks ago, we did watch “Miracle on 34th Street.”  This is a charming movie from 1994 (which is actually a remake of a movie from 1947).  The movie concerns the reality of Santa Claus.  Richard Attenborough does a masterful job of portraying Kris Kringle in this heartwarming film about whether or not Santa Claus is real.  The climax of the movie occurs in a New York courtroom, where trial judge is called upon to determine whether or not Santa Claus actually does exist.  Following some fancy legal maneuvering, the trial judge makes a final decision, and there’s a happy ending all around.

It’s not every day that a lawyer gets to represent Santa Claus in court.  Dylan McDermott, who represents Kris Kringle in the film, does a great job of portraying the legal eagle who advocates Santa’s cause.  But what are the chances that most lawyers, or even any lawyer, would ever get a chance to represent the “Jolly Old Elf?”

The likelihood that any California lawyer might get a chance to represent Father Christmas in a legal matter may depend, at least in part, on how California Law views Santa Claus.  There are online legal databases that allow for word searches of all California cases.  So – if you were to do a word search of California legal cases, you’d find that the phrase “Santa Claus” actually does appear in a number of California cases. In one case, a police officer dressed up as Santa Claus and led a procession of motorcycles in a “pursuit for Kids Toy Ride.”  Amezcua v. Los Angels Harley Davidson (2011) 200 Cal. App. 4th 217.  In another case, a witness offered testimony at trial which the Court compared the testimony to a belief in Santa Claus.  People v. Moret (2009) 180 Cal. App. 4th 839.  And there’s even a case involving beachfront real estate – which is briefly described as follows.

The development of California’s coastal lands are regulated by law.  California beaches, or “tidelands,” are generally publicly owned.  This means that most tidelands and beaches are owned by the people of the State of California and not by private owners or investors.  However, there is a “line” where the beach “stops” and where private ownership of land begins.  This “line” is known as the “Mean High Tide Line.”  Land which is closer to the sea is “seaward” of the line and is owned by the public.  Land which is further from the sea is “landward” of the line, and such property can be owned by private individuals.  It’s very interesting to note that this property “line” does not stay a fixed location.  It changes over time with the level of the sea and the erosion or build-up of the shore.  It’s one of the very few property lines that can be constantly changing over time.

The California State Lands Commission is charged with the oversight of these beachfront lands.  The Commission adopted a policy which said that building, or development, is prohibited if it is any closer to the sea than position where the “Mean High Tide Line” has ever been.  In other words, if a parcel of land is presently located on the “landward” side of the line, but in the past it was located on the “seaward” side of the line, then the policy would prevent such landowner from ever building on such land.

In the case of Bollay v. California Office of Administrative Law (2011) 193 Cal. App. 4th 103, a landowner challenged the policy of the Commission.  Initially, the trial court held that the commission’s policy was valid and effective. But the Court of Appeal found that among other things, the policy would prohibit the development of land that is not now owned by the State of California and which may never in the future be owned by the State of California.  As a result, the Court of Appeal reversed the trial court and found that the Commission’s policy was invalid.

Notwithstanding this holding, the development of beachfront property involves complex legal considerations, and persons considering building, developing, or remodeling beachfront properties should consult appropriate legal counsel.

So how does such a case involve Santa Claus?  The beachfront property at issue was located on Santa Claus lane in Carpinteria.

Second Loan Interest Rate Reflects Higher Risk to Lenders

            Most homeowners are familiar with the concept of Homeowner’s insurance. This kind of insurance will typically insure the house against loss or damage.  If a home is damaged by fire or storm, most homeowners would know to call their insurer to report the damage and make a claim.

But some homeowners may not be familiar with mortgage insurance, also know as PMI.  This insurance typically provides coverage in the event of a mortgage default or foreclosure.  This insurance is typically designed to benefit lenders, but not homeowners. If a homeowner defaults on their loan, and their property is sold in foreclosure, then PMI mortgage insurance is designed to compensate the lender for the loss to the lender in the event the property sells for less than the amount of the loan.

Twenty years ago it seemed like many lenders were routinely requiring borrowers to purchase mortgage insurance. The PMI insurance payment was a monthly charge that borrowers paid in addition to their mortgage loan  payments of principal and interest.  In the event of a default or foreclosure, the borrower never received any payout from the insurer.  Instead, any payout went only to the lender.  In more recent years, it seems like lenders have often used a second loan to replace mortgage insurance.  Instead of requiring borrowers to purchase mortgage insurance, lenders often make two loans to borrowers.  The first loan, at a lower interest rate, often covers the majority of the house purchase price.  The second loan, at a higher interest rate, covers something like 10 to 20% of the price of the house.  If the market turns down, then this second loan is at a higher risk of not being repaid.  This increased risk is usually reflected in the higher interest rate charged by the lender.   Because the second loan is the one most at risk, such lenders have considered it unnecessary for borrowers to pay for PMI insurance when the property is purchased with two loans.

Church Properties Subject to Law

Most kids in High School take a class in Civics or U.S. History.  And most of those kids will learn about the United States Constitution.  They’ll learn that the Constitution was amended by the Bill of Rights, and they’ll learn that the Bill of Rights is the name of the first 10 amendments to the Constitution.  They’ll also learn that one of those amendments provides that Congress may not pass any law concerning the establishment of a religion.  This is formally known as the “establishment” clause.  It’s more commonly known as “separation between Church and state.”  Less know, but equally true, is the fact that the California Constitution also prohibits the California State Government from making any “establishment” of religion.  This is found in the California Constitution at Article I, section 4.

This separation is so firmly embedded in our perspective that the thought of having a church that is favored by the government is completely foreign to us.  But not every country takes this approach.  For example, some countries have supported a state-favored church with tax money.  This can obviously provide such churches with an enormous benefit with respect to operational costs.

In the United States, the separation between church and state is almost taken for granted.  Most people in this country never even think about how the establishment clause might affect their daily lives.  Yet the establishment clause can have a real effect on peoples lives right now.

Here’s an example.  Suppose a local congregation owns a church building on land that is also owned by the congregation.  But suppose the congregation encounters a disagreement over a point of church beliefs.  If this disagreement becomes severe enough, then it’s possible that the congregation may split.  Each side could claim it holds the correct beliefs.  If the dispute becomes sufficiently severe, there could literally be a separation of the congregation.  If this were to happen, each side might claim that it is entitled to the church-owned land and building.

What happens if the dispute becomes severe enough that the dispute ends up in Court?  The result can be surprising.  In such a situation, a court would literally be called on to make a decision as to which group is entitled to ownership rights as to church property.  However, the courts are governmental entities.  Even though a court isn’t a legislative body, it is still one of the branches of government and courts can actually create law where none existed before.  As a result, courts are subject to the establishment clause.  This means that the courts can’t take sides, nor can they favor one religion over another.  Where a “heierchal” church structure exists, then in appropriate circumstances a court may look to the decision of the church heierchary for determination as to which group represents the “true” church.  And once the “true” group is determined, then a court may award the church property to the “true” group.  In other cases, ownership of the church building and property may be determined by the bylaws of the church, the deeds to the property, and other key documents relating to church governance.   These principles are generally discussed in Metropolitan Phillip v. Steiger (2000) 82 Cal. App. 4th 923.

What can be done in advance?  Local congregations that own real property may be able to avoid later problems by deciding in advance how they are going to hold title to their church property, the nature of their relationship with a larger church organization, and how they plan to handle any potential disputes concerning ownership and handling of church property.

Short Sale Can Result in Surprise

California has a “Security First” rule.  This rule requires a lender to foreclose on a property before looking to a buyer’s other assets if a Buyer defaults on a loan.

The “Security First” rule can help borrowers who aren’t able to make the payments on their home.  But homeowners need to be cautious when getting involved in short sales, deeds in lieu of foreclosure, or other negotiations with their lender concerning loan modification or defaults. An uninformed borrower can actually damage their position if they get involved in a short sale without taking the necessary steps to protect themselves.

Here’s how it works.  Many borrowers today have two loans on their home.  If their home is “underwater” then such borrowers may elect to sell their home for less than the amount of the loans against their properties.  If the lenders agree to this, then such borrowers can use a “short sale” to get out of their underwater property.

But these days some lenders on a second loan are only agreeing to “release their lien” in a short sale.  This is very different from having such lenders release all claims against the buyer under the loan.  If the lender only releases its lien, then the lender may be only agreeing to release its mortgage lien so the homeowner can sell their property in a short sale.  Unless the lender releases all claims against the buyer under the loan, the lender could be planning to make a claim against the borrower for the unpaid loan balance following the short sale.

This could be a very unpleasant surprise for an unsuspecting homeowner following a short sale.  Such a homeowner might finish a short sale thinking that they are fully done with the property, only to find out later that their lender is making a claim against them.

Care must be used to avoid such situations.  Homeowners who want to avoid such surprises should get competent, qualified professional assistance in connection with their contemplated short sale or deed in lieu of foreclosure.

Short Sale Is Only One of Several Options

My wife and I bought our first home in 1989.  That was a banner year for real estate – in more ways than one.  The real estate market had experienced appreciation of close to 20% each year during the previous five years.  As a result, we paid almost exactly double the price that our seller had paid five years earlier.

This got my attention.  We’d paid more than we could afford at the time, and the monthly loan payments were a real challenge.  But given the rapid increase in prices I’d seen over the preceding years, I figured that if we needed to get out, then we’d sell at a profit.  Little did I anticipate that we’d hold the house for 7 years, do many improvements, and then sell at a loss.

For many years afterwards I’d mention to friends and acquaintances that we had lost money in the California real estate market.  Nobody could believe it.  All around us prices were escalating ever upwards, and the thought of losing money in real estate seemed like an impossibility.  I was the only person I knew of who had lost money in the California real estate market.

Fast forward to 2010.  I’ve been practicing real estate law now for over 20 years.  My first foreclosure matters were in 1987, and after that I hadn’t really worked on any for close to 15 years.  And then the market turned downwards.   I now consult on short sale and foreclosure matters on nearly a daily basis.  The white-hot appreciation of five years ago is gone, and homeowners are just trying to find out the best way to walk away from their homes – with most of them experiencing substantial loss.  It’s a difficult time.

It’s difficult to work on scraping together a down payment, then experience the excitement of moving into a new home, and make improvements only to find out years later that the home is worth half of what you paid for it.  Some homeowners choose to stay in their homes even in these situations.  But other homeowners are transferred in their jobs or they experience employment setbacks.  These owners have limited options with respect to their homes.

Many people are of the opinion that the best way to walk away from their home is through a short sale.  But that’s not always the case.  Liability issues can linger after a short sale – even though homeowners may believe that they are done with the property once it’s sold.

Mortgage, short sale and foreclosure law is complex.  These subjects involve complicated tax and liability issues.  Sometimes the best approach for a homeowner in distress is to short sale a property, but other times foreclosure is a far better option.  Bankruptcy is the best option for some owners.

Because of the complex issues and law involved, homeowners are prudent when they seek competent, qualified, experienced tax and legal advice.

Short Sales and Foreclosures Require Care

I recently had occasion to talk with one of the many servicing companies that do business in California.  These companies typically aren’t lenders.  Instead, they collect the monthly payments made by the borrowers, and then they transfer the monies collected to the owners of the loan.  These companies are often referred to as “loan servicers.”  To many borrowers, it feels like the loan servicer is the lender, but actually that’s not true.  The lender may never directly communicate with the borrower.  It’s the servicer that handles all of the payments, and often the servicer takes action when there’s a default in the loan payments.

The servicer I spoke with was handling a “short sale” for the lender.  A “short sale” occurs when the sales proceeds are not enough to pay off the balance due on the loan.  Lenders often agree to “short sales” when the property is worth less than the loan.  Lenders sometimes agree to these “short sales” because they’d rather have cash than another property.  Lenders can lend cash for a profit – they can’t (or they won’t) lend a property.

Lenders and servicers are in the business of generating profits.  They’re generally not in the business of helping borrowers.  If a lender agrees to help a borrower through modifying a loan, or reducing an interest rate, or agreeing to a short sale, then there’s often a business reason that benefits the lender.

There can be real benefits to sellers in conducting a short sale.   But even though there can be benefits, Sellers need to be cautious when they’re considering a short sale.  There can sometimes be unintended consequences from a short sale.

For example, Sellers can get ready to close a short sale only to find out that their lender won’t release them from personal liability on their loan.  New laws can make this illegal in some situations but it still happens.

So what’s a borrower to do when confronted with such decisions?  They should get competent, qualified, professional help.  It still surprises me sometimes when I hear of borrowers who would rather not pay a consulting fee than fully understand the considerations in these matters.  These decisions can make a difference of literally hundreds of thousands of dollars.  It just seems short-sighted to try to save several hundred dollars in a consultancy fee and possibly become unnecessarily exposed to a hundred thousand dollars or more in liability.  And the reality is that in some situations, lenders are in fact pursuing borrowers for deficiencies in their loans.  As a result, some borrowers who think their situation is over when the foreclosure or short sale is done can be in for a surprise.

 

Robert B. Jacobs practices Real Estate and Business Law throughout the San Francisco Bay Area and California.   The foregoing article is not a complete discussion of the subject addressed, and should not be relied on.  Readers with specific questions or issues should consult an attorney.

Soil Movement Can Be Dramatic

I well remember several lawsuits where homes were moving due to soils movement.  This may not sound like a problem.  If all parts of a house all move the same distance together at the same time and in the same direction, then there might not be a problem.  However, experience shows that house movement due to expansive soils is often not uniform.  Some parts of a house might move while other parts remain still.  This can create dramatic results.  When this happens, one part of a house may literally pull away from the rest of the house.  There can be visible evidence of such a separation.  Interior components can start separating, such as hardwood floors, or sheetrock may start to crack. Kitchen counters can pull away from the walls. Siding can start pulling away from the home.  Concrete may develop serious cracks.  Foundations can start to slowly move and buckle.  I’ve seen sheetrock crack so much that you could insert your arm in the wall all the way to your elbow.  It’s really dramatic.  And it’s really unpleasant for the homeowners.  They never envision such a thing when they buy their home.  When they purchased it, their home looked beautiful, undamaged, and attractive.  But their experiences with such homes can often be very different from their expectations.

Sometimes homeowners lie awake at night and listen to their house as the framing creaks and pops due to the movement.  Ultimately, some of these homeowners end up selling their homes for whatever they can get.  They aren’t able to withstand the process of seeing their homes literally coming apart at the seams.  Sometimes such homes can be fixed, and sometimes they can’t be.  But it’s often very expensive when foundation or soils repairs must be made.  In some situations the proposed repair is to literally separate the entire house from the foundation, jack the house up into the air, remove the entire foundation and replace it with a new one.  The house is then to be lowered back into place.

Fortunately, many houses never experience this kind of movement, and as a result many homeowners are completely oblivious to this kind of a situation.  But when situations of this nature arise, the effects can be really dramatic.

Soils Issues Can Be Significant for Homeowners

Most people don’t give much thought to dirt.  So long as soil stays outside, many homeowners don’t ever give it another thought.  If their soils are behaving properly, the biggest soils concern might be making sure that dirty footprints don’t get tracked across the living room floor.

But California and Bay Area soils are known for behaving poorly when they get wet.  If a hillside property is not properly drained and supported, then it can behave poorly when the soils get soaked with water.  Some soils can lose their strength when they get wet.  When this happens, these soils can lose their holding power, and there can be a “slump” or slide.

Evidence of these kinds of slides are visible on hillsides around the Bay Area.  I’ve seen several of them on hillsides adjoining Bay Area freeways.  When you know what to look for, you can see green hillsides where slumps of soil have pulled away from the hill.  There’s often a sharp dropoff at the top of the slump, and a small hill or pile of soil at the bottom.  You can tell that the soil has partially slipped down the hillside.

When these “slumps” happen on vacant land hillsides, there might not be much of a problem.  But there can be disastrous results when slumps or soils movement occurs in a subdivision with homes.  Modern engineering and construction methods can be used to address some issues with soils movement.  Retaining walls can be built to hold back a hillslope that would otherwise be unconfined.  And deep concrete piers can be drilled to address other concerns with soils movement.  Drains can be installed to carry away water that would otherwise penetrate the soil.  But some soil movements can be so severe that even modern design and construction methods may not be able to withstand them.  When this happens, a house can experience movement that can either be minor or significant.

Valuable Real Estate

The most valuable asset that most people will ever own will be their real estate.  Real estate is an investment.   Nearly everybody lives on some kind of real estate.  Most businesses operate out of some kind of real estate.  Real estate is everywhere, and in this day and age most people in the United States either own,  have owned, or will own some kind of real estate.  Those who don’t will undoubtedly lease some.

Real estate sales, purchases, and ownership can be complex.  When everything goes well, then nobody ever thinks twice about a real estate transaction.  But when things go poorly, people can remember their real estate headaches for a long, long time.

There is only so much land. We’re not making any more of it. And it seems like most buildings have been around for a long, long time.  So why should there be problems with real estate?  It almost seems like all of the kinks should have been worked out by now.  Buildings usually don’t move.  They seem stable.  And land generally stays in one place.  So why all the concern about real estate transactions?

Truth is, there are many, many aspects to real estate.  A smooth transaction, or a smooth construction project, will successfully address all of the potential issues.  But it doesn’t take much for something – anything – to go wrong in a real estate transaction, and when it does, the results can be both expensive and time-consuming.

What are some of the things that can go wrong in a real estate transaction?  Following are just a few.

Nonperformance.  Most real estate transactions have two (or more) parties.  If one of the parties doesn’t perform, then there may be no transaction.  If property is to be sold, the buyer must come up with the money, and the seller has to sign a deed.  If either side refuses to perform, then the transaction fails and someone is going to be disappointed.

Most litigation is filed because someone is surprised, disappointed or angry.  There is a lot of money at stake in a real estate transaction.  Sometimes people get cold feet.  Other times they find a better opportunity elsewhere.  Whatever the reason, non-performance can be a real headache.  And when non-performance occurs, people pick up the phone and call their lawyer.

            Construction Defects.  Modern buildings have many complex systems.  Soil must be properly graded and drained.  Foundations must be properly designed and reinforced.  Framing must be properly built.  Plumbing, heating, and electrical components must be properly installed.  And siding and roofing must be properly constructed.  There is much room for error in constructing any of these systems, and when errors occur the repairs can be expensive.

Real estate must also be maintained.  Roofs need to stay watertight.  Fixtures need to be replaced when they leak.  Termites and other pests need to be controlled.  If Real Estate isn’t properly maintained, the resulting damage can require expensive repairs.