Partition of land In-Kind (by splitting the property) is Preferred to Sale in California

February 19, 2015

When co-owners of property cannot agree on what to do with it, a solution is a legal action for partition. In a partition the judge will order the property 'partitioned'; that is, either divided in-kind between them or sold and the money divided between the owners. Under California law Partition in-kind is favored "since this does not disturb the existing form of inheritance or compel a person to sell his property against his will. Forced sales are strongly disfavored." However, in modern times, Sacramento real estate attorneys see the bulk of these disputes concerning developed properties with an individual home or commercial building. You can't split a house down the middle, so the property is ordered sold and the judge splits the cash accordingly. But larger properties are different, and the preference is division in kind. One co-owner who really only wanted a sale so that he could buy out the other owner was disappointed when the court caught on and cut-up the property for division in kind.

Sacramento partition attorney.jpgIn Butte Creek Island Ranch v. William Crim, The parties each owned one half of a waterfowl hunting ranch in Butte County. The property consisted of two separate parcels Parcel A was primarily used for a sleep house, dining building, garage and barn. Parcel B, which is much larger, is where the hunting occurs. Butte Creek (a partnership) wanted to buy Crim. When Crim said no, this Partition action was filed.

The parties stipulated to the appointment of a receiver (CCP section 873.040). The referee concluded that the proper course was division in kind- to divide Parcel A & B into 2 parcels each and then each party would get part of A and part of B. He thought that division by sale would leave the parties less than whole in two respects:

"First, capital gains taxes would have to be paid, leaving insufficient funds to purchase a similar property. Secondly, and more important, the extreme scarcity of properties similar to the subject with respect to location, use, and general amenities, would effectively preclude acquisition of a replacement."

The plaintiff did not like this result, and opposed confirmation of the referee's report. The court first noted the two types of evidence that may justify partition by sale.

Two Types of Evidence

The first is evidence that the property is so situated that a division into subparcels of equal value cannot be made. This requires proving that the land cannot be divided equally. An example is a property where the major value was a water well, without which the land would not have much value. The well could not be split; one party would get it, the other would not. That's not equal. It would not matter if the well property was a third acre and the other was 10 acres; they would not have equal value.

The second type of evidence which supports a partition sale rather than physical division is economic evidence to the effect that, due to the particular situation of the land, the division of the land would substantially diminish the value of each party's interest. This would mean that a cotenant would receive a share of land that was worth significantly less than the share of the cash the cotenant would receive if the entire parcel was sold.

Sacramento partition lawsuit attorney.jpgThe plaintiff did not present either type of evidence. They introduced no evidence whatsoever to establish that the aggregate economic value of the land would be diminished through physical division. no evidence towards proving that the land cannot be equally divided or that the aggregate economic value of the land would be diminished through division.

The court was not amused by the plaintiff. "Plaintiff had and has no intention of yielding up physical possession of the land. It sought a forced sale of the land in order to acquire defendant's interest which he did not desire to sell. This is nothing short of the private condemnation of private land for private purposes, a result which is abhorrent to the rights of defendant as a freeholder."


Disputed Property Lines and the Importance of the Surveyor's Decisions in Retracing Ancient Deeds

February 12, 2015

Real estate title in more rural or agricultural areas of California are often reliant on ancient surveys, sometimes handwritten, relying on monuments that are gone or have changed, and less accurate survey instruments. When disputes arise, the parties must rely on their surveyors to convince a judge that they are correct. Real estate attorneys can find themselves in a battle of surveyors, disputing whether the other side's approach is reliable or not. This problem arose in a recent decision near Healdsburg regarding a property line between a vineyard property and the new owners of an adjacent winery. The surveyor's approach, as well as testimony of some old-timers who lived on the properties, made life difficult for the new winery owners.

Sacramento title attorney lg.jpgIn Belle Terre Ranch, Inc. v. Wilson, new owners bought the Soda Rock Winery in 2000. The Soda Rock winery building backed up to the vineyard of Belle Terre Ranch, with a pathway in between. A line of ancient oaks ran behind the building, within 2-4 feet of the building wall. The new Soda Rock owners began reconstructing the winery, and the owners used the pathway for deliveries to the back of the building, as well as for heavy equipment access. Ron, the 70 year old President of Belle Terre, had lived on the property all his life. He testified that he did not complaint about use of the pathway during the initial reconstruction because he wanted to be neighborly.

Soda Rock applied to the county for permits to complete the renovation, and Belle Terre complained to the county about a need for the survey, and that there had been some trespassing. The owners spoke with each other, agreeing that a survey should be done. Ron apparently agreed to accommodate access to the rear of the winery for reconstruction, so as to be a good neighbor.

Two surveys were conducted. Both surveyors agreed that the property description ran back to 1870, when the public highway (now Hwy 128) was a narrow, single lane, straight dirt road used buy horses and wagons. The problem was locating the centerline of that road, since it has been replaced by a 2 lane paved highway.

Belle Terre commissioned Brunner, who concluded that the line was 2.5 to 3 feet behind the building, and corresponded with the line of oak trees. He found that the public highway was not lost, and that the only verifiable change was a layer of asphalt pavement. He determined what the centerline was as of 1870, and took his measurements from there.

Soda Rock commissioned Story, who found that the boundary line was 12 to 13 feet behind the winery building. Story did not believe the original highway centerline could be established from the monuments. He used for his starting point a pasture fence described in 1870; he believed it was in the same location because it appeared ancient. Running the line to where it crossed the Trimble property line, and along the Trimble line more than 1672 feet to locate the Northeast corner of the Soda Rock Property. The Trimble description was from a 1885 handwritten survey.

Sacramento surveyor attorney lg.jpgBrunner found the Trimble survey had an unacceptable degree of error believing it was unreliable. His testimony was that the surveying instruments and measurements from 1885 were not reliable enough. Another surveyor testified as an expert, agreeing that the Trimble survey was unreliable, and that Brunner used the more reliable evidence. Ron and David, a witness who had grown up on the Soda Rock property, both testified that as kids in the 1940's they believed the line was a cattle fence that ran along the line of oak trees. David said that the back doors of the winery opened inward and had only been used for ventilation, not for deliveries.


The court thought the Brunner survey was more reliable than Story's. It found "the Brunner survey most closely aligns with the language contained in the original Deed creating the subject parcel and, as such, most closely follows the original intent of the parties." It noted that Brunner's location of the property line corresponded closely with the location of the cattle fence that had once existed along the line of oak trees. And it found "very little evidence, if any, ... to indicate that the actual centers of the historic route of Highway 128 and the current route of Highway 128, at least as of the time of the 1988 Survey, differ in any significant detail." It quieted title to the disputed are in favor of Belle Terre.


Soda Rock also claimed that it had established a prescriptive easement in the area behind the winery. The court disagreed.

Remember that an element of establishing a prescriptive right is that the use be adverse and hostile to the true owner's title. If the true owner had permitted the use, the claim is groundless. Here, Ron had testified that he did not complaint about use of the pathway during the initial reconstruction because he wanted to be neighborly. Also, when owners spoke with each other, agreeing that a survey should be done, Ron apparently agreed to accommodate access to the rear of the winery for reconstruction, so as to be a good neighbor. That testimony was enough; Soda Rock had nothing that could contradict the permissiveness of the use. The court noted that, prior to 2008, there was no evidence the Soda Rock owners had ever made a statement to Belle Terre claiming ownership of or a right to use the disputed strip of land, nor was there evidence that they had "cared for or maintained the territory (avenue) in dispute."


Title Insurance does not protect against a Notice of an Abatement Action, which is not a lien, encumbrance, or defect of title; and preliminary reports can't get no respect.

February 5, 2015

When California lenders and buyers seek title insurance, they want to be sure that the title to the property that they are receiving, or the security for their loan, is what they expect it to be. In the case of the lender, they want to be sure that they are in first place, so that if they need to foreclose, the property will be unburdened by any senior lien or liability, and they can get their money out of it. A preliminary title report, the precursor to the policy, is an offer to sell an insurance policy, but not like any other kind of offer to make a contract. If I offer to sell you my "used Buick, which has 20,000 miles on it, for $12,000," and you accept, when you discover that it really has 97,000 miles on it, you have a claim against me for breach of contract and fraud. But Sacramento & Yolo commercial real estate attorneys are often faced with explaining to clients that the preliminary report cannot be relied on in the same way. That was the answer some mortgage investors got from the court, when the preliminary report stated that the title company would get a full release of a notice of abatement action before issuing a policy.

Sacramento title insurance policy attorney.jpgIn Stockton Mortgage Inc. v Tope, the plaintiff Lender loan $315,000 to Tope to buy and rehab a Stockton property. The lender obtained title insurance from Alliance Title Company, underwritten by First American. The preliminary report had the standard language stating"

"[T]his Company ... is prepared to issue, or cause to be issued, as of the date hereof, a Policy or Policies of Title Insurance ... insuring against loss which may be sustained by reason of any defect, lien or encumbrance not shown or referred to as an Exception herein or not excluded from coverage pursuant to the printed Schedules, Conditions and Stipulations of said Policy forms."

One of the exceptions was a Notice of Abatement Action, along with the statement "Prior to close of Escrow Alliance Title Company will require that a FULL RELEASE be obtained." However, the Notice of Abatement was NOT included in the final title insurance policy.

The title company contacted the County and made a payoff demand. The County responded that they could not release the abatement action until all the deficiencies were cured. The problems were not fixed, the borrower defaulted, the property was foreclosed, and the loan investors (who had been assigned the lender's rights) took title. They sued the title company, claiming that the release of the abatement action was a condition of making the loan.

Breach of Contract - The title insurance policy

The lender argued that the notice of abatement was a lien or encumbrance, covered by the policy (a written contract), because it accrued penalties and other assessments. The court first considered the definition of encumbrance, which is 'any right to, or interest in, land which may subsist in another to the diminution of its value, but consistent with the passing of the fee, including taxes, assessments, and all liens upon real property.' But here, the Notice of abatement action informed the owner of a duty, and raised only the possibility of future enforcement, which could included assessing costs which could become a lien. The court found that the policy did not insure against future events; thus the possibility of a lien did not equal being an insurable lien. The recording of the notice itself is merely notice of the physical condition of the property, for which there is no coverage. (Actually, in this case Alliance did pay all outstanding enforcement costs at close of escrow).

Breach of Contract - the Preliminary Report

Sacramento lenders title insurance attorney.jpgThe lender also claimed that the title company breached the terms of the preliminary report, because the prelim stated that Alliance would require a full release of the Notice. However, it is fundamental that an application for title insurance and is an offer to issue a title insurance policy. (Ins.Code, § 12340.11.) It did not create any liability on behalf of the title company. Huh? In this case, it sure looks like it was a term of the offer - we will not insure title UNTIL we get a full release! Nonetheless, courts don't look at prelims that way. Title companies always win on this argument.


The lender also claimed that the title company represented it would obtain releases for the Notice, and having so agreed, was bound to exercise ordinary care in doing so. The court said no; we already explained that you lost on the contract action, thus reliance on the prelim or title report, was misplaced.

The lender went further, arguing that the prelim represented that they would obtain a release of the Notice, and in the insurance policy that no notice existed. Having failed to do so, Alliance made a misrepresentation. The court didn't hesitate. A misrepresentation must be about past or existing facts. A false promise to perform in the future, as this could be construed to be, can support a claim for intentional misrepresentation, not negligent misrepresentation. The statement that it would obtain a release was a statement of future performance. And, in fact, Alliance did attempt to obtain a release, so there is no claim for intentional misrepresentation.

Lastly, the lender claimed that the title company's inclusion of the Notice in the prelim, and failing to include it in the insurance policy, was an "implied representation' that it had been release. No dice, said the court- negligent misrepresentation requires a positive assertion and does not apply to implied misrepresentations.

Gus & Britney Spears -

Adhesion and Unconscionability in Commercial Leases - The Cotenancy Provision, Part 2.

January 28, 2015

Last week I discussed a cotenancy provision in a California commercial lease, where the court found that the rent abatement aspect - if the specified cotenant was not operating, the tenant's rent is reduced or eliminated - was found to be an unenforceable penalty. That court also looked at whether the provision was unconscionable, and thus unenforceable. Unconscionability (codified at Civil 1670.5) has no specific legal definition, but generally means extreme unfairness. Business and real estate attorneys often see a situation where one party gets a really bad deal, but that alone does not make it unenforceable. California courts have developed an analysis requiring two elements, "Procedural," and "Substantive." In the decision being addressed here, the court found that Procedural element was not fulfilled so the cotenancy provision was not unconscionable.

Sacramento commercial lease unconscionable attorney.jpgIn Grand Prospect Partners, LP, v Ross Dress for Less Inc., Ross entered a lease in a commercial center in Porterville, CA. The lease required that Mervyn's be open when the Ross store opened, and Mervyn's was to remain in operation for the term of the Ross lease. If Mervyn's was not operating, Ross could cease paying rent, and also terminate the lease. Mervyn's filed for bankruptcy before opening in this center, so the cotenancy requirement was unfulfilled, and Ross declined paying rent. In the ensuing lawsuit, the Landlord claimed that the cotenancy provision was unconscionable, and thus should not be enforced.

Procedural Unconscionability.

The procedural element involves the circumstances of contract formation. It addresses oppression and surprise due to unequal bargaining power that results in little negotiation and no meaningful choice. This can be shown in two ways - either by showing that it is a contract of adhesion, or by the totality of the circumstances surrounding the contract.

A. Adhesion

The California Supreme Court has defined the term "contract of adhesion" to mean (1) a standardized contract (2) imposed and drafted by the party of superior bargaining strength (3) that provides the subscribing party only the opportunity to adhere to the contract or reject it.

Here, the lease in its entirety was not a preprinted form. There were extensive negotiations, including five versions of the lease. Thus the lease itself did not qualify as one of adhesion.

The landlord argued that the cotenancy requirement requiring a Mervyn's itself was a clause of adhesion. "Procedural unconscionability focuses on the manner in which the disputed clause is presented to the party in the weaker bargaining position. When the weaker party is presented the clause and told to 'take it or leave it' without the opportunity for meaningful negotiation, oppression, and therefore procedural unconscionability, are present." (Szetala (2002) 97 CalApp 4th 1094, 1100)

Sacramento commercial lease adhesion attorney.jpgThe court disagreed in this case. When, as here, when the relatively stronger party insists on including a provision in an otherwise enforceable contract, it does not turn the entire contract into an unenforceable one of adhesion. This differs from the situation where, for example, a clause is added to and existing contract by amendment, on a take it or terminate the contract basis (like a bank giving you the choice to accept the amendment or close your account.)

B. Totality of The Circumstances

The court noted several relevant circumstances for this element:
- Sophistication of the parties,
- Time Pressure,
- Economic Pressure,
- Pressure from Coercion or Threats,
- Relative Bargaining Power, and
- Meaningful Choices.

In this case, the landlord had 33 years in the real estate industry, was sophisticated real estate manager, and understood cotenancy provisions. Ross did not exert any time pressure; the negotiations went from 2005 through 2008. The landlord was not economically vulnerable, as there was no evidence it was having problems paying its debts nor had a balloon payment coming due. There were no threats. Ross was the larger company and may have greater bargaining power but there were still legitimate negotiations and the landlord had meaningful choices. Ross may have absolutely demanded a cotenancy provision, but the terms of that provision were subject to negotiation. Lastly, the landlord had other prospective tenants to fill the space, and the landlord had actually approached Ross in the first place.
Based on this analysis, the court concluded that there were real negotiations between the parties, and that the landlord was given meaningful choices. The court concluded that there was no procedural unconscionablity here. California law requires establishing both the Procedural & Substantive elements; with one missing, unconscionability was not grounds for invalidating the cotenancy requirement.

California Commercial Lease Cotenancy Provisions: When they Can Be Unconscionable or an Invalid Penalty

January 22, 2015

Cotenancy provisions are often required by larger retail tenants in shopping centers of all sizes. They require other specified stores in the center to be open and operating, on the assumption that these other stores will draw the desired mix of potential customers. They come in two flavors; opening requirements, meaning that the requirement is fulfilled before the tenant is required to open; and Operating requirements, meaning that the tenant's obligations continunue only so long as the named tenants remain in business. Parties to a commercial lease may need to consult with a Sacramento real estate attorney to clearly define the cotenancy requirements in their lease, so that they do not face any surprises, as one tenant faced in a recent decision when their cotenancy provision was found to be an unenforceable penalty because the tenant had never really considered what its harm would be if the named store did not open.

Sacramento commercial lease attorney.jpgIn Grand Prospect Partners, LP, v Ross Dress for Less Inc., Ross was negotiating with a shopping center owner Porterville, in Tulare County. Ross wanted a cotenancy provision that required a Mervyn's to opening and running before Ross was required to open. If Mervyn's did not open, or ceased operating, Ross would not owe rent, and did not have to open a store. (The terms of the lease are more fully set out below). Two months after the parties signed the lease; Mervyn's filed bankruptcy, and never opened its store in the Portville center. Eventually Ross notified the landlord that it was going to terminate the lease under the cotenancy provision. This lawsuit ensued, with Grand Prospect, the landlord, claiming that the lease was unconscionable, and the cotenancy rent abatement provision was an unenforceable penalty.

Under California law, an unenforceable penalty lacks a proportional relationship between the forfeiture compelled and the damages or harm that might actually flow from the failure to perform a covenant or satisfy a condition. The test requires a comparison of

(1) the value of the money or property forfeited or transferred to the party protected by the condition to

(2) the range of harm or damages anticipated to be caused that party by the failure of the condition. If the forfeiture or transfer bears no reasonable relationship to the range of anticipated harm, the condition will be deemed an unenforceable penalty.

Here, the lease rental payments (plus CAM charges) which were to be abated were $39,000 per month. However, in negotiating for this provision, the evidenced showed that Ross did no study or analysis to see what the impact of Mervyn's traffic would have on the profits of a Ross store sales. Ross was unable to say whether the closure of Mervyn's stores in other centers where Ross was located impacted Ross sales. Thus, the trial court found that Ross anticipated that it would not have any losses due to Mervyn's absence. When the 1) value of money forfeited, $39,000/month, was compared with the damages anticipated by Ross, $0.00, the Court concluded that the rent abatement provision was an unenforceable penalty.
It is surprising to me that a retailer as large as Ross did not have any analysis of the harm closure of other stores in centers which Ross had a presence. This case is a clear lesson, in any rent abatement situation, for a tenant to determine (before signing the lease) what harm it may actually incur if there is to be a rent abatement.

Commencement Date Requirement: Mervyn's was to occupy no less than 76,000 square feet of leasable floor area, on Ross's commencement date.
"Commencement Date Reduced Occupancy Period" was defined as beginning with the failure of one of the required tenants to be open for business on the commencement date of the Lease and continuing until cured. Ross was not required to open its store for business. That section also stated that, "regardless of whether [Ross] opens for business in the Store, no Rent shall be due or payable whatsoever until and unless the Commencement Date Reduced Occupancy Period is cured."

Ross also had an option to terminate the Lease conditioned upon (1) the Commencement Date Reduced Occupancy Period continuing for 12 months and (2) Ross giving 30 days' notice of termination prior to the expiration of the Commencement Date Reduced Occupancy Period.


Reassessment of California Property Where Entities Are Involved - How To Do The Math

January 16, 2015

California real estate sellers and buyers are rightly concerned about reassessment of the property on sale. A parcel held for many years is assessed, and taxed, based on the purchase price long ago. Prop 13 provides that, real property generally is taxed based on its value at the time of acquisition, not its current value. A sale today would trigger reassessment and an increase in property tax. A problem can arise with ownership of entities such as LLCs or corporations Generally, the transfer of an ownership interest in an entity such as an LLC or corporation is not a change in ownership of the real property held by that entity. However, if one person or entity acquires more than 50%, it is deemed a change of ownership; if you are facing this problem, you may want to consult a Sacramento real estate attorney. In a recent decision the County assessor claimed that more than 50% changed hands; however, the court, demonstrating the math to determine ownership, showed that the assessor was dead wrong, and at risk of paying over $200,000 in attorney fees.

Sacramento property assessment lawyer.jpgIn Ocean Avenue LLC v. County of Los Angeles (227 Cal App 4th 344), Ocean LLC owned the Fairmont Miramar Hotel in Santa Monica. Ocean entered a contract to sell it, but that contract was terminated. On the same day of the termination they contracted to sell ownership of the LLC to a group of three entities; a Trust, MSD Portfolio, and Hotel Investor LLC. Staff for the County assessor reviewed the ownership interests and determined that no one had more than 50% ownership. Ignoring staff, the Assessor re-assessed the hotel. The owners paid the tax, then filed suit.

California Code provides that there can be reassessment when there is a change of ownership in real property, "[w]hen any corporation, partnership, limited liability company, Massachusetts business trust or similar trust, other legal entity or any person... obtains through multi-tiering, reorganization, or any transfer direct or indirect ownership of more than 50 percent of the total interest in [the limited liability company's] capital and more than 50 percent of the total interest in [its] profits[.]" (Cal. Code. Regs., tit. 18, § 462.180, subd. (d)(1)(B).) The Assessor claimed that Michael Dell (that may be his name on the computer you are using) controlled more than 50% of the capital invested by the new owners.

1. The County Failed to Do the Math, So the Court Showed Them How -
The Change of Ownership Theory.

The Court pointed out that the Assessor did not do the multiply-through test, so the court did it for the Assessor Dell owns:

A) 99.99 percent of the capital of MSD Portfolio, which owns 42.5 percent of the Hotel. 0.9999 x 42.5 = 42.49575%

B) 93.3333 percent of Blue Fin and Michelangelo, and those two entities, collectively, own 73.065 percent of Hotel Investor, which owns 8.5 percent of the Hotel.
0.933333 x 73.065 = 68.194%

0.68194 x 8.5 = 5.79649%

Total percentage controlled by Michael Dell : 42.49575% + 5.79649% = 48.29224%

No matter what the Assessor says, the numbers do not add up.

Sacramento real estate assessment attorney.jpg2. The Equitable Conversion Theory.

The Assessor next argued that under the initial contract, which was terminated, the hotel changed ownership under the equitable conversion theory, which provides that in unconditional contract for the sale of land, of which specific performance would be decreed, the purchaser is granted equitable title, and equity considers him the owner. However, there is no equitable conversion when the contracting parties demonstrate an intent to the contrary (here, they terminated it), or the contract terms were never satisfied (here, the buyer never paid). Thus, the Assessor losses again.

It is fair to guess that the buyers knew about reassessment, and carefully structured the transaction so that reassessment would not happen. The County Assessor was not so smart, and assumed they would just pay up and go away. It pays to do the math.


Title Insurance - Only Insures Against Claims Alleging a Defect, Lien or Encumbrance Against Title - The Preliminary Report Is Not A Contract Guarantying The State of Title

January 8, 2015

Title Insurance - Only Insures Against Claims Alleging a Defect, Lien or Encumbrance Against Title - The Preliminary Report Is Not A Contract Guarantying The State of Title

Buyers of real estate in California routinely buy a policy of title insurance. This insurance is triggered when there is a claim or lien against the property which the title company did not initially identify and point out to the buyer in the Preliminary Report. The Preliminary Report is a report prepared by a title company before issuing a title insurance policy, indicating the conditions under which the insurance company will issue title insurance. Buyers often have misunderstandings about the preliminary report and how it should be looked at, and may wish to consult a Sacramento real estate attorney for assistance. Often people incorrectly view the Prelim as a contract guaranteeing that the title is in such a condition. But that is not the case, as was recently made clear in a Federal Court decision following California law in which alota money was at stake.

Sacramento Title insurance attorney.jpgIn Feduniak v. Old Republic National Title Company (2014 WL 6603253), the plaintiffs bought a $13 million dollar home on 17 mile drive in Pebble Beach. They bought title insurance from Old Republic title Company. The title company missed something - namely, an easement in favor of the California Costal Commission. The easement required that at least 86% of the property be maintained as native dune habitat. At the time the property was purchased, it contained a golf course, violating the native dune requirement. Old Republic Title Company missed the easement; it was not listed as an exception to the title policy. The owner filed a claim with Old Republic. The title company wanted to hire an appraiser to determine the diminishment in value of the property due to the easement, but the owners had them negotiate with the Coastal Commission instead, to remove the easement. The negotiations were unsuccessful, other than to tip off the Coastal Commission that the easement was being violated. The Commission went after the owners, and Old Republic defended them. The Commission issued a cease & desist order, requiring them to submit a fix-it plan. They went back & forth on plans, and the commission filed suit for violation of the Cease & Desist order. They eventually agreed on a rehab plan, but the Commission did not dismiss the suit- it went to trial for over $25 million in penalties, exemplary damages, attorney fees and costs. The owners then sued the title company.

Breach of Contract

The owners claimed that the preliminary report and insurance policy were a contract which was breached by the failure to discover the easement. However, under California law, a preliminary title report is not, a representation as to the condition of title to real property, but is a statement of the terms and conditions upon which the issuer is willing to issue its title policy. The policy also provides that claims of loss whether or not based on negligence, and which arises out of the status of the title to the property covered by the policy, are be restricted to this policy. Thus, there is no claim for breach of contract.

Sacramento real estate title attorney.jpgIndemnification for Defense Costs

The owners claimed that the title company should pay their defense costs in the action in which the Commission sued for violation of the cease and desist order. Old republic had rejected this claim as it had no duty to defend this action. Old Republic pointed to paragraph 4(a) of the Policy, which is set out in full below. It provides that the insurer will provide a defense to any claim which alleges a claim, lien, or defect in the title to the property. But the Coastal Commission action sought civil penalties for the owners' failure to rehabilitate the property; they instead continued to water and maintain the golf course. This was not a claim, lien, or defect in the title. This conduct arose after issuance of the policy, and clearly was not covered.

I guess the owners really wanted a golf course on their property, as the matter got convoluted in their efforts to provide off-site mitigation while maintaining the golf course. This route lasted a couple of years, but the Coastal Commission finally got fed up.

The Standard Title Policy language:
4. Defense and Prosecution of Action; Duty of Insured Claimant to Cooperate.
(a) Upon written request by an insured and subject to the options contained in Section 6 of these Conditions and Stipulations, the Company, at its own cost and without unreasonable delay, shall provide for the defense of such insured in litigation in which any third party asserts a claim adverse to the title or interest as insured, but only as to those stated causes of action alleging a defect, lien or encumbrance or other matter insured against by this policy. The Company shall have the right to select counsel of its choice (subject to the right of such insured to object for reasonable cause) to represent the insured as to those stated causes of action and shall not be liable for and will not pay the fees of any other counsel. The Company will not pay any fees, costs or expenses incurred by an insured in the defense of those causes of action which allege matters not insured against by this policy.


Deeds in Lieu of Foreclosure - The Rule for Determining When The Transfer Causes a Merger, Allowing Junior Liens to Survive.

December 23, 2014

A deed in lieu of foreclosure is occasionally used as an alternative to a foreclosure sale. The borrower merely deeds the property back to the lender "in lieu of foreclosure." The lender does not have to go through the time and expense of a foreclosure, and the borrower/owner gets the process over with more quickly. However, there is some risk for the lender in this situation. Title conveyed by a trustee's deed after a foreclosure sale relates back in time to the date on which the deed of trust was executed. The trustee's deed therefore passes the title held by the trustor (the borrower; remember the 'trustor' is 'poor') as of that earlier time, rather than the title that the trustor held on the date of the foreclosure sale. Liens that attached after the deed of trust was recorded are 'sold out' or eliminated. However, a deed in lieu of foreclosure (as opposed to a foreclosure deed) passes title to the transferee subject to all existing liens. Whether concerned about deeds in lieu or lien priority in general, it is best to consult with a Sacramento real estate lawyer. Hopefully, you can avoid the problem recently faced by a lender when the trial judge didn't follow the law regarding merger. They had to get the court of appeals to set things right.

Sacramento merger attorney.jpgIn Decon Group, Inc. v. Prudential Mortgage Capital Company LLC, the owner of a commercial property had a mortgage with Prudential. They hired Decon to renovate the property, but did not pay the bills, so Decon recorded a mechanic's lien for $437,000, and filed suit to foreclose the lien. The owner was in default on the loan, so the lender took back a deed in lieu of foreclosure from the owner. The lender then conducted a trustee's sale, and took title to the property. In the action to foreclose the mechanic's lien, the judge ruled that, on taking back the deed of lieu, the two interests, as beneficiary under the deed of trust and as grantee under the deed in lieu merged, destroying the senior lien. Thus, the junior mechanic's lien was not eliminated by the foreclosure. The court ordered that the property be sold at auction. The lender appealed.

The court of appeal reversed the lower court, finding that no merger had occurred. It first noted that, under ordinary circumstances, where the holder of a mortgage acquires the estate of the mortgagor (debtor), the mortgage interest is merged in the fee and the mortgage is extinguished.... But this rule is never applied where there is an intervening lien on the property, and where there is no evidence of an express intention to extinguish the first mortgage and hold subject only to the second.

The Supreme Court articulated the rule as follows: " 'Merger is always a question of intent when the question is as to whether a mortgage lien is merged in the fee, upon both being united in the same person. Equity will keep the legal title and the mortgagee's interest separate. If there is an intervening mortgage the acquirement of the title will not operate as a merger.

Sacramento deed in lieu attorney.jpgThus, where it benefits the holder of the first to eliminate all junior liens, the court assumes that the intent was that there not be a merger on the transfer by deed in lieu. The senior lien remains in place. In this case, even more clearly, was the language in the deed of lieu that expressly stated that there was no merger:

"[t]he Indebtedness shall remain in full force and effect after the date hereof. The interest of Grantee in the Property upon effectuation of the transfers, assignments or conveyances as provided in this Grant Deed shall not merge with the interest of Lender pursuant to the Loan Documents, but shall be and remain at all times separate and distinct, and the Loan Documents shall be and remain at all times valid and continuous liens on the Property."

Here the intent was clear to everyone except the trial judge. Unfortunately for the lender, they would have had to post an appeal bond for much more that the $437,000 mechanic's lien to prevent the sale from occurring pending the decision.


A California Easement for Ingress Means Just That - to Enter and Leave Your Property

December 16, 2014

The proper use of an easement is often the subject of disputes in California. An easement is a restricted right to a definable use or activity on someone's property, and it must be less than the full right of ownership. Real estate attorneys are often consulted when someone interferes with use of an easement; if legal action is pursued, the judge must interpret the language of the grant of easement to determine what the original parties intended. In a recent decision, a developer had an easement over other property for ingress and egress. Being a bonehead, he did much more that use it to access the property, and then lost the development to Bank in foreclosure. The Bank, which then inherited the dispute, had to make a ridiculous argument to the court to avoid a judgment that misuse of the easement subjected it to damages.

sacramento easement scope attorney.jpgIn Schmidt v. Bank of America, N.A., Parks owned two adjacent properties in La Mesa, California. She conveyed the western parcel to Schmidt, reserving to herself an easement for ingress and egress for public road purposes along the eastern 40 feet. She later sold the adjoining property (the dominant tenement), along with the easement over the eastern property. Time goes by, and eventually the owner of the eastern parcel began construction of a condominium project. In doing so, he built features on, under, and around the easement area. It was graded for use as a private roadway, a locked gate was added. He installed sewer pipes, and storm drains under the easement area. The developer went belly up, and defendant Bank of America foreclosed. The Bank ended up owned the condominium property, including the features on and under the easement. The eastern owner, Schmidt, sued for trespass, nuisance, and other relief.

In the lawsuit the Bank argued that the scope of the easement covered the structures and improvements affecting the easement. The Schmidts countered that the grant was for only a right of ingress and egress that allowed the Bank to use only the surface of the easement. The phrase "for public road purposes" did not create a public right of way.

The court first focused on the deed language to determine the extent of the easement granted, interpreting it like any other contract. The language:

"RESERVING to the grantor, her successors, assigns and/or heirs, the right of ingress and egress for public road purposes, and incidental purposes, over the Easterly 40 feet of the following described land..."

sacramento easement use attorney.jpgThe court found that the grant was limited to the right of ingress and egress, and that the phrase "for public road purposes," was a limitation on the right of ingress and egress, not an expansion. For 'public road purposes' means to allow one to reach a public road. The language did not create a public easement, but a private easement that vested use rights only in the neighboring property.

The Bank argued that "for incidental purposes" meant that the easement should be interpreted broadly and include any use incidental to a public road. But the court said no; incidental purposes are those incidental to the main purposes of the easement - ingress and egress.

Next, having interpreted the easement language, the court looked at the uses complained of in this case. Whether a particular use of an easement by either the servient or dominant owner unreasonably interferes with the rights of the other owner is a question of fact. The court needed to determine if the facts indicate that the a actual use of the easement was withing the terms of the grant of easement. The Bank claimed that the uses were compatible with a public roadway easement. The Supreme Court has established that "[t]he establishment of a public highway practically divests the owner of a fee to the land upon which it is laid out...." If a public right, Schmidt did not have any rights in the property. However, the court has already concluded that the easement was for private right of ingress and egress, a much more restrictive grant of easement. This granted the Bank unobstructed passage, but no other use.


Altered Deeds In California - Sometimes They Are Void, But When They Are Not Somebody Loses

December 9, 2014

Altered or forged deeds are subject to some specific rules in California. In some cases, where it is altered by a party to the deed, they may be declared void, and of no effect. If it is altered by a third party, it is not entirely void - it is still valid as between the original parties. In a recent decision, The person who should have been an owner of property did not consult a Sacramento real estate attorney, and misunderstood what a deed actually said. When it was improperly altered before recording, the result did not change the effect of the conveyance - she had no interest in the property.

Sacramento altered deed attorney.jpgIn Lin v. Coronado, Lin pooled her $150,000 with $100k provided by River LLC and Elevation LLC to buy a residential property at a trustee's sale. The property was bought by the LLCs for $250,000. The original deed from the trustee was to "Cal-Western Reconveyance Corporation (herein called trustee) does hereby grant and convey, but without covenant or warranty, express or implied to RIVER FOREST FINANCIAL LLC 75%, ELEVATION INVESTMENTS 25% HELEN LIN." However, the deed that was recorded states "Cal-Western Reconveyance Corporation (herein called trustee) does hereby grant and convey, but without covenant or warranty, express or implied to RIVER FOREST FINANCIAL LLC 75%, ELEVATION INVESTMENTS 25%." Lin was not named in the recorded deed. River LLC and Elevation sold the property to Coronado, the defendant in this appeal.

Lin filed suit against River & Elevation for fraud, and also against Coronado, the buyer, to quiet title. Regarding the quiet title, she claimed that the deed was altered after it was executed, it was void, and thus did not convey title. The buyer claimed that Lin never had an interest in the title in the first place, so they were a bona fide purchaser for value, and the claim failed. The Court agreed with the buyer.

Altered Deeds

When a deed is altered or changed by someone other than the grantor before it is delivered or recorded, and the alteration is without the grantor's knowledge or consent, the deed is void and no title vests in the grantee or subsequent purchasers, even bona fide purchasers for value; and if the deed is altered after delivery by the grantee before recordation, the deed is void and conveys no title to the grantee.

sacramento forged deed attorney.jpgHowever, the court found that in this case"...the only alterations which will affect the validity of an instrument are those which are material; that is, alterations which change the legal effect of the instrument." The test for determining the materiality of an alteration is "not whether the liability of either of the parties is increased or decreased or reduced as a result but whether the instrument has the same legal effect after the alteration as it had before."

Here, in the original declaration of trustee's sale, Lin had no percentage interest in the property. Recording a deed without her name on it had no legal effect. Thus, the alteration - removing Lin's name from the deed - was not sufficiently material to render the deed void. Lin had no claim against the title to the property. Lin also tried to have the court reform the deed to reflect her interest. But the court could not do that because it was not shown to be void. Civil Code section 3399 allows reformation "so far as it can be done without prejudice to rights acquired by third persons in good faith and for value." Here, Coronado was a good faith purchaser, and reformation would prejudice her rights.


A Full Credit Bid on California Property Prevents a Lender From Recovering Insurance Proceeds; the Simple Solution

December 2, 2014

When a foreclosure sale occurs, the lender often bids at the sale the entire amount due on the loan. If no one bids higher, they obtain the property. But are they entitled to then collect insurance for pre-foreclosure damage? Sometimes insurers obtain their own insurance policy, which covers them for all damage to the property. However, commercial lenders often are insured through their borrower's policy, which only covers the value of the debt. There is an important difference if the lender forecloses, and parities in this situation may need to consult with a real estate attorney. In a recent case, the lender discovered that making a full credit bid at the foreclosure sale was a mistake, and lost its chance to collect on the policy.

sacramento credit bid attorney.jpg In Najah v. Scottsdale Insurance Company, the plaintiff sold a commercial property taking back a note for $2.5 million secured by a 2nd deed of trust. The first loan was for $2 million. There was a structure on the property, and the terms of the Notes required that the buyer not remove or destroy the building, and to repair any damage that occurred. The Note required the buyer to provide an all risk insurance policy insuring the seller, which the buyer obtained.
The Buyer went into default and the first lender pursued foreclosure. The seller, holder of the second, bought the interest of the first lender for the balance due on the first loan, $1.75 million. The Seller was also assigned the first deed of trust. The seller then foreclosed on its 2nd deed of trust. At the foreclosure sale, the Seller made a full credit bid - that is, it bid the full amount due on the 2nd Note.

The Seller took possession of the property, and discovered that the prior owner had trashed the building. They had taken out the HVAC equipment, water heater, commercial laundry, kitchen appliances, etc. Also there was damage throughout. The Seller, now again the owner, made a claim against the insurance policy that had been required by the promissory note. The insurer denied the claim, and suit ensued.

The Insurance Policy and the "Standard Mortgage Clause"

The policy included a provision stating that even if the insurer denied a claim for "covered loss of or damage to buildings or structures" due to "[the buyer's] acts" or because the Buyer "failed to comply with the terms of this Coverage Part," the "mortgageholders" would "still have the right to receive loss payment," so long as certain conditions were met. This is called the 'standard mortgage clause.' It operates as an independent contract of insurance between the insurer and the lender/mortgagee, the same as a separate policy would provide. However, the amount payable to the mortgagee under the policy is limited to the amount necessary to satisfy the debt, even if it is less than would be required to repair the physical damage to the property, and once the debt is satisfied, "[the lienholder] ha[s] no further claim on any insurance proceeds."

full credit bid attorney.jpg

The Full Credit Bid Rule

When the lender obtains a property at a foreclosure sale by making a full credit bid--bidding an amount equal to the unpaid debt, including interest, costs, fees, and other expenses of foreclosure--"it is precluded for purposes of collecting its debt from later claiming that the property was actually worth less than the bid. This is called the full credit bid rule. Because a full credit bid extinguishes the mortgage debt, the lender is not entitled to insurance proceeds for preforeclosure damage to the property.
Here, the lender argued that this rule did not apply in this case, because they held two deeds of trust securing two separate debts. Thus, they should have the same remedy as a third party who owned a senior, unforeclosed deed of trust. However, the buyer in a foreclosure on a junior deed of trust takes the property subject to the more senior deeds of trust. Thus, a full credit bid is presumed to establish the value of the total indebtedness - what was bid (the junior) and what the property is still subject to (the senior). In other words, the total of their bid plus the outstanding lien. Thus, a full credit bid "conclusively established the value of the property as being equal to the [total] indebtedness secured by the property." Because the insurance covered only the amount of the debt, they were not entitled to any insurance proceeds for preforeclosure damage.

The Solution

The lender could have avoided this problem by underbidding their security interest at the foreclosure sale. Underbidding has risk, in that a third person may bid higher and obtain the property, but this can be avoided through the instructions to the trustee, or attending the sale to observe the bid and raise to a full credit bid if necessary. By underbidding, the lender would then have a deficiency balance, which could be recovered by a claim on the insurance policy.


The Security First Rule - how a lender with multiple California properties as security for its loan must protect itself when releasing one of the properties from the deed of trust, and still get a deficiency judgment.

November 18, 2014

The security first rule is one of the numerous anti-deficiency protects provided to borrowers under California law. "Security first" means that a creditor must first exhaust all real property security through judicial process in the "one form of action" authorized by Code of Civil Procedure section 726--that is, a judicial foreclosure. The rule is violated if the lender attempts to obtain a personal judgment against the debtor before first exhausting all the real property in a judicial foreclosure lawsuit. This can be a serious penalty in the case of commercial properties, and lenders and borrowers should consult with a real estate attorney to be sure of their options. If the creditor violates the security first rule, it loses its chance to get a deficiency judgment, which holds the borrower personally liable for the balance of the debt above the value of the property.

If the borrower raises the security first rule as an affirmative defense, there are four ways the case may proceed:
1. The lender may amend the judicial foreclosure to include the omitted security;
2. The lender may prove that the borrower waived their protections under section 726;
3. The lender may prove that an exception to the antideficiency protections apply;
4. If none of the above, the lender may proceed with judicial foreclosure without obtaining a deficiency judgment, but if that is the case, it would be quicker and cheaper to just conduct a trustee's sale.
In a recent decision, the lender needed to prove #2 applied- that a borrower waived the protection. They did not, at great cost.

security first rule sacramento attorney.jpgIn First California Bank v. MacDonald, Sally and John borrowed over 1 million dollars secured by property in Wasco, Ca. As additional security, they also signed a deed of trust against a parcel in Safter which was owned by Sally as her sole and separate property. Sally sold the Shafter property by agreement with the Lender in which it agreed to the sale, the lender would receive all the net proceeds of the sale, and the Borrowers would not be released of liability. Apparently, John did not sign the agreement. John died, the note went into default, and bank filed a lawsuit for judicial foreclosure of the Wasco property. The trial Court issued a decree ordering sale of the Wasco parcel, finding that a deficiency judgment could be entered against John's estate (Sally had filed bankruptcy and discharged her personal liability).

The Court of Appeals said no. The first sentence of section 726 states that there "can be but one form of action for the recovery of any debt or the enforcement of any right secured by mortgage upon real property..." A component of the one form of action requirement is the security first rule, which requires the lender to proceed first against all the real property security first in a judicial foreclosure before further enforcing the underlying debt.

Code of Civil Procedure section 726(b)) provides that the decree for the foreclosure of a deed of trust "shall declare the amount of the indebtedness or right so secured and, unless judgment for any deficiency ... is waived by the judgment creditor ..., shall determine the personal liability of any defendant for the payment of the debt secured by the mortgage or deed of trust and shall name the defendants against whom a deficiency judgment may be ordered following the proceedings prescribed in this section."

Sacramento one form of action attorney.jpgHere, the lender had not shown that John had agreed to Sally's sale of the Shafter property. As it was her sole and separate property, they probably dealt only with her. While common sense may indicate that John was aware of his wife's plan to sell the property, and should have spoken up if he objected, but that was for the Lender to prove to the court, but they did not do so. All they needed was John's signature on such an arrangement, in which he made a knowing waiver of his rights.


Aiding and abetting breach of fiduciary duty - the two ways the aider may become liable.

November 13, 2014

Parties such as corporate directors, partners and managers of LLC's owe each other a fiduciary duty, which is a duty of loyalty and a duty of care. These are legal duties to act solely in another party's interests, and not profit from their relationship with their principals unless they have the principals' express informed consent. Violating this duty can result in liability. But, even if you do not owe someone a fiduciary duty, you can be found liable for aiding and abetting someone else in breaching such a duty, something to be aware of in any any transaction.. Under California Law, liability may be imposed on one who aids and abets the commission of an intentional tort if the person-

(a) knows the other's conduct constitutes a breach of duty and gives substantial assistance or encouragement to the other to so act, or

(b) gives substantial assistance to the other in accomplishing a tortious result and the person's own conduct, separately considered, constitutes a breach of duty to the third person.

Aiding-abetting focuses on whether a defendant knowingly gave 'substantial assistance' to someone who performed wrongful conduct, not on whether the defendant agreed to join the wrongful conduct. An aider and abettor does not 'adopt as his or her own' the tort of the primary violator. Rather, the act of aiding and abetting is distinct from the primary violation; liability attaches because the aider and abettor behaves in a manner that enables the primary violator to commit the underlying tort. In a recent California decision, just such an aider and abettor was found liable, which may result in millions in damages.

fiduciary duty sacramento attorney.jpgIn American Master Lease LL v. Idanta Partners Ltd. AML was an LLC formed to own real estate. (Hold on, the facts take some explaining) Roberts, the founder, designed it for people who did not want to individually manage their real estate investments. They could convey the property to AMC, and receive in return membership interests in the LLC. All members of the LLC would be "tenants in common," in that they all owned interests in the same LLC, but no interest in the real estate. Roberts and his family were the majority owners of the LLC, and Roberts was the Manager. Several others also joined. Defendant Idanta Partners was a venture capital firm, 80% owned by the Bass family of Texas.

Roberts, the manager, and other members entered into a management agreement with AML. Roberts remained the managing member, but under the agreement the other members became the Operating Group. AML needed a new financing partner, and the Operating Group proposed Idanta. Roberts objected, and presented an amendment to the Operating Agreement which prohibited that no deals could be done without majority approval. Roberts wanted to make all the decisions. Roberts told the others that he controlled the company. The Operating Group said screw you, and formed a new company, FPI which would partner with Idanta. The Operating Group gave the new company a license to use AML's business method. Roberts objected several times that the license agreement was not authorized. He claimed that the Operating Group was in breach of the operating agreement, which contains a non-compete, and any income from the new venture belonged to AML. The lawsuit began alleging a cause of action for aiding and abetting breach of fiduciary duty.

Sacramento real estate management attorney.jpgHere, the court found liability under test (b) above. Idanta gave substantial assistance to the other in accomplishing a tortious result and Idanta's own conduct, separately considered, constitutes a breach of duty to the third person. AML proved that Idanta had actual knowledge of the fiduciary duties that the Operating Group owed to AML as managers of AML. Idanta made a conscious decision to aid the Operating Group in performing a wrongful act; here, it was improperly acquiring rights to the AML business methods, and hiring the Operating Group to execute those methods.

Mixed Collateral Security - What the Lender Must Do to Be Sure It Avoids The California Antideficiency Rules

November 4, 2014

When the same debt is secured by liens on both real property and personal property, the lender has options as to how they are allowed to enforce their security interest. They can enforce against the real property under real property law, against personal property under the Commercial Code, or both. There are specifics under both areas of law which must be observed, or the lender may lose their security, and a party in this situation may want to consult with a business and real estate attorney. Otherwise, they may run into the problem faced by a lender recently when they failed to adequately describe the personal property in the deed of trust. The Court of Appeals found that the deed of trust did not successfully describe personal property as additional security, and thus any further recourse for the lender would be contrary to the purpose of the antideficiency laws.

mixed collateral attorney sm.jpgIn Thoryk v. San Diego Gas and Electric Company, the owner of an avocado ranch in San Diego County wanted to subdivide it into two-acre homesites. The owner borrowed $1 and ½ million from Highland for this purpose. There was a wildfire which did extensive damage to the property, and the project stopped. Highland foreclosed and obtained title to the property. The owner believed that San Diego Gas and Electric was at fault and sued for damages. Highland joined the suit, claiming that its deed of trust was secured by more than just the property, and extended to any of the owner's recovery of damages caused to the property; i.e. it was also secured by personal property. Highland argued that it was entitled to a judicially imposed lien under the terms of its deed of trust and related note.
The owner argued that he was protected by the antideficiency laws, which prohibits collecting money from the owner after a trustee's sale. However, where there are liens established upon both personal and real property in the subject transaction, a foreclosing lienholder using the power of sale may continue to pursue remedies against the former property owner/borrower. The creditor is not seeking a personal judgment for the unpaid balance of a loan, but instead seeks to enforce additional security secondarily liable for the principal loan.

The Court noted that where additional collateral was created for an obligation, a debtor-creditor relationship may survive a nonjudicial foreclosure, if the proceeds of the sale were insufficient to pay the debt, by showing that the language of the trust deed and note created additional collateral, beyond the real property security that it took under power of sale. It looked at the terms of the deed of trust. There, "real property" was defined to also include all fixtures, easements, water rights, plans or engineering reports, permits, entitlements, "and all money held on deposit for any of the foregoing or otherwise related to the Real Property; and all other rights, royalties, and profits relating to the real property, including without limitation all minerals...."

deed of trust attorney.jpgAlso provided was that it "shall constitute a Security Agreement to the extent any of the Property constitutes fixtures or other personal property, and Lender shall have all of the rights of a secured party...
with regard to the personal property, such as fixtures, the lender is given all the rights of a secured party, "including without limitation the right to recover any deficiency in the manner and to the full extent provided by California law."

Here, there was no express provision in the deed of trust that assigned any tort claims for injury to the real property as "additional security" for the mortgage debt. Without more specific language, the court refused to find that the deed of trust language included in the "personal property" defined by the trust deed as money "related to the Real Property. Thus, the lender was restricted to the real property alone. A better description in the deed of trust was required.


Collecting A Judgment against a Bankrupt LLC - When You Can Hold The Members Liable.

October 16, 2014

Individuals create LLCs, same with corporations, for ownership and investment purposes primarily to enjoy limited liability. If you invest $10 in an LLC and someone gets a huge judgment against the LLC, the most you could lose is your investment -the $10. The judgment creditor would not be able to come after you personally to collect the balance of their judgment. However, not all LLCs or corporations have assets from which a judgment may be collected. Sacramento area business and real estate attorneys are occasionally asked by clients withe judgments what can be done to go after the members, managers, directors or shareholders. As one group of LLC members recently discovered, if the LLC's distributions to them leaves the LLC penniless and essentially dissolved, the creditor may collect from the members.

Yolo LLC attorney.jpgIn CB RICHARD ELLIS, INC. v. TERRA NOSTRA CONSULTANTS, the real estate broker was seeking their commission on sale of 38 acres in Murrieta for $11.8 million. While the broker had the property listed, the buyer made an offer. Before closing, either the listing ended or the LLC which owned the property fired the broker, it was not clear. The sale closed. A few days after the cash went from escrow to the seller LLC's bank account, it all left the account and was distributed to the members. The broker arbitrated its dispute with the LLC (because there was an arbitration provision in the listing agreement) and obtained a judgment against the LLC. But, of course, the LLC had no money.

The broker than filed suit against the members. Its argument was in the Corporations code, which provides for liability in the event the entity has been dissolved. Applicable was the old Section 17350 (which was replaced by the equivalent section 17707.07) provides:

(a) (1) Causes of action against a dissolved limited liability company, whether arising before or after the dissolution of the limited liability company, may be enforced against any of the following:

(A) Against the dissolved limited liability company, to the extent of its undistributed assets, including, without limitation, any insurance assets held by the limited liability company that may be available to satisfy claims.

(B) If any of the assets of the dissolved limited liability company have been distributed to members, against members of the dissolved limited liability company to the extent of the limited liability company assets distributed to them upon dissolution of the limited liability company.

sacramento broker commission attorney.jpgIt was subsection (B) that the broker was looking at -over $11 million was distributed to the members. But, argued the members, this code section only applies when the corporation had been dissolved. Another section of the corporations code (old 17355, now replaced by 17707.1 ), states that an LLC shall be dissolved when it provides so in the operating agreement, when the members vote to dissolve, or a court issues a decree of judicial dissolution. None of these formal steps had occurred!

The Court of appeal said get lost. The purpose of section 17350 was designed to prevent unjust enrichment of LLC members, when the members have received assets which the LLC needs to pay creditors. Here, there was a de facto dissolution, and the broker could make the claim against the creditors. Otherwise, an LLC could be free to distribute all its assets, and then the next day vote to dissolve, with the members escaping free and clear.