Recently in Contract Category

California Commercial Lease - How to Determine if Option to Renew is Not Enforceable


California commercial leases often include options for renewal of the lease beyond the initial term. Option terms can provide the duration of the renewal, and describe the future rent, or provide a mechanism for calculating the rent to be paid. But, frequently commercial lease attorneys encounter leases that are not so specific. They can describe the procedure for exercising the option, and the future term or terms, but only provide that the rent was to be as agreed upon. Lessors and landlords do this to provide some assurance to the potential tenant that they may be able to stay in the location for another tenant without committing themselves to rent terms, or even that this tenant. The tenant who has not consulted a real estate attorney enters the lease with the false comfort that they have the right to stay if they want. Such was the case in a Supreme Court decision where the tenant, who had made significant improvements to the property, learned that they did not have a right to stay.


ElDorado real estate and leasing attorney.jpgIn Ablett v. Clausen the Lease provided these option terms:
the lessees 'shall have the first right and a prior option to secure a lease upon said premises before the same are offered to any other person, firm or corporation for lease or rental and that said option shall contemplate a lease for a period of five (5) years upon terms to be then agreed upon.'
The landlord and tenant had some disputes about grading in the parking area of the property where the tenant had the 'Rite Spot' restaurant;, and the landlord's refusal to allow the tenant to remodel the restaurant. So, the landlord told the tenant that they would NOT renew the lease on expiration - the option was terminated. The tenant filed suit to have the court declare they were entitled to another five year rental, under the same terms and conditions.

The trial court ruled in favor of the tenants, so the landlord appealed. The tenant argued that the provision, 'first right and prior option', does not in any way qualify the right of renewal. The court first noted that terms as 'first privilege', and 'first right', and concluded that such provisions do not give the lessee an absolute right to a renewal, but one conditioned upon the lessor's leasing the property, in which case the lessee may have first refusal.

Sacramento real estate option attorney.jpgThe landlord argued that the option provision does not give even a conditional right to a renewal, but is too uncertain to be enforced; it is just an agreement to contract in the future, which is not enforceable. Here, the court noted that the rule is that where "either party by the terms of the promise may refuse to agree to anything to which the other party will agree, it is impossible for the law to affix any obligation to such a promise." There are some court decisions which find that when the only term of a lease which still requires the parties' agreement is the rent, there can be an exception allowing the court to determine a reasonable rent. But here, the Supreme Court found this permissible only where there are some ascertainable standards in the option for the court to decide the terms of the lease. That is not the case here. The original Lease was nine pages long, yet the only term provided by the option provision is how long the renewed lease would last. There is neither discussion of rent, nor a standard by which it may be calculated. Thus, the terms were not specific enough to be enforced.

This opinion takes a long time to get to what was really the obvious conclusion - where the option requires the parties to agree in the future, it is false comfort for the tenant to think they have a right to renew the lease.


Photos:
https://www.flickr.com/photos/tyle_r/7490093384/sizes/m/
https://www.flickr.com/photos/19779889@N00/4685142069/sizes/m/

The Option to Buy California Real Estate, and Escape Clauses - How Part Performance Made the Promise Binding


Sometimes possible real estate buyers do want to close the deal unless they can obtain certain benefits, such as a zoning change, or lot split. To lock up the property and make their investment worthwhile, they enter an option contract. An option is a unilateral contract under which a property owner, for consideration, agrees to sell its property to another (optionee) if, within a specified time period, the optionee elects to exercise the right to purchase. The owner has made an irrevocable offer to sell at the specified terms in return for the consideration. To be enforceable, the option contract must have consideration paid by the optionee, and sufficiently describe the purchase terms - parties considering such a deal may want to consult with a Sacramento real estate attorney to ensure its enforceability.

The optionee is not required to buy, but if they follow the terms for exercising the option, it becomes a simple purchase contract. Otherwise, it expires. In one court decision, the question arose of whether there was adequate consideration, or just an illusory promise that was not legally binding. the buyer had an escape clause that did not require him to do anything. The plaintiff who then decided not to sell was disappointed to learn that the buyer's part performance made the promise binding.

Sacramento option contract attorney.jpgIn Steiner v. Thaxton, Steiner entered a contract to buy 10 acres of bare land. However, the agreement provided that Steiner could cancel the deal at any time at his sole discretion. It states:

"It is expressly understood that [Steiner] may, at [his] absolute and sole discretion during this period, elect not to continue in this transaction and this purchase contract will become null and void."

He proceeded to seek county approval for a parcel split, and to obtain development permits, spending thousands of dollars. The seller then said he did not want to sell, and the buyer sued for specific performance of the contract.

The court first concluded that the contract was in fact an option. When the owner binds himself to sell on specified terms, and leaves it discretionary with the other party to the contract whether he will or will not buy, it constitutes simply an optional contract. Thus, the question arose as to whether there was consideration for the option.

Was There Consideration?

Civil Code section 1605 defines consideration as "Any benefit conferred, or agreed to be conferred, upon the promisor, by any other person...as an inducement to the promisor"

In our case the promisor is the owner of the land.

Thus, there is a 2-part test in order to find consideration:

1- The promisee must confer (or agree to confer) a benefit or must suffer (or agree to suffer) prejudice.

2- the benefit or prejudice must actually be bargained for as the exchange for the promise.

option contract attorney.jpgHere, part 1 was accomplished - the buyer/optionee's promise to seek a parcel split may have been illusory at the time the agreement was entered into, but he subsequently undertook substantial steps toward obtaining the parcel split and incurred significant expenses. The effort provided a benefit to the seller/optionor, and was a prejudice suffered by the buyer.

Secondly, part 2 was accomplished -the promise to obtain a parcel split was bargained for and induced the seller to enter the contract. There was evidence that the seller told the buyer that it was important to him that any potential buyer seeks to obtain a parcel split.

Thus, the court concluded that the buyer's part performance cured the illusory nature of the contract; thus there was sufficient consideration for the option, and that it was enforceable.

The steps that probably took place were a) the buyer tied up the property at a specific price, b) he signed a deal with another person to buy from him all or part of the finished product, with lot split and permits completed, and then c) he began the process of obtaining the development rights. There was a third party who interned in the lawsuit, because the buyer had assigned some of his rights.

Detailed terms of the purchase contract are set out in the footnotes of the opinion. But this begs the question - why did the parties not just enter an option contract? A nominal cash consideration could have been paid; after all, the seller has now tied up his property to some extent.


Photos:
https://www.flickr.com/photos/atomicbartbeans/71575328/sizes/s/
https://www.flickr.com/photos/therefore/276307074/sizes/n/

Conditions in California Real Estate Contracts - It makes a Difference if they are Dependent or Independent

A condition in a contract is a fact, the happening or nonhappening of which creates or extinguishes a duty on the part of the promisor. If the promisor makes an absolute or unconditional promise, he must perform when the time arrives. But if the promisor makes a conditional promise, he must perform only if the condition precedent occurs. The promise may be dependent upon the performance of another condition, in which case they would be dependant and concurrent conditions. In this case neither party is in default until one party performs or tenders performance. In the typical real estate contract seen by Sacramento real estate attorneys, delivery of the deed and payment of the purchase price are dependent and concurrent conditions. There must be performance or tender thereof by one party to put the other in default. In a recent decision, the court agreed with the swindled would-be buyer, who argued that return of their $3 million dollar deposit was an independent condition

Sacramento real estate contract attorney.jpgIn Rutherford Holdings, LLC v. Plaza Del Rey, Rutherford contracted to buy a mobile home park from Plaza, and provided a deposit of $3 million dollars. The agreement provided that the deposit was nonrefundable unless Plaza materially breached the purchase agreement or failed or refused to close.

Prior to the closing date, Plaza told the buyer that Plaza could reduce its property tax bill for the year if it was not in this contract for sale. The contract would increase the value that the tax was based on. If they did not close by the closing date, the tax would be based on a lesser value. Plaza promised the buyer that they would sell the property after the closing date, and after Plaza filed it tax returns. The buyer agreed! The closing date came and went and neither party performed; Plaza never tendered the deed to Rutherford, and Rutherford never tendered the full purchase price to Plaza. Plaza paid less in taxes, then said they would not sell the property to Rutherford, plus they were keeping the deposit, ha ha! This suit followed.

The court first noted that in a contract for the sale of real estate the delivery of the deed and the payment of the purchase price are dependent and concurrent conditions. Where the parties' contractual obligations constitute concurrent conditions, neither party is in default until one party performs or tenders performance. However, here, the buyer argued that the seller's obligation to return the deposit was independent of the Buyer's promise to pay the full purchase price. If the two covenants are independent, breach of one does not excuse performance of the other. The buyer's failure to place the money in escrow did not excuse Plaza's failure to return the deposit.

El Dorado real estate contract attorney.jpgIn this case the Court was looking at whether the Complaint sufficiently described a legitimate claim. Where an ambiguous contract is the basis of an action, the parties are expected to provide their own interpretation of its meaning. If their interpretation is not clearly incorrect, the court accepts as correct plaintiff's allegations as to the meaning of the agreement.

Here, the purchase agreement can be reasonably interpreted to mean what the Buyer has claimed. "While [that] interpretation ... ultimately may prove invalid," at the pleading stage, it is sufficient that the agreement is reasonably susceptible of this meaning." Thus, the Buyer had properly made the claim that return of the deposit was an independent condition, and should have been returned. It's too bad this buyer had to go through the appeal process at this stage of the lawsuit. The seller seems to be a real con artist, convincing the buyer to let the contract lapse with a promise to sell on the same terms, then keeping the $3 million dollar deposit.



Photos:
https://www.flickr.com/photos/look4u/2412200989/sizes/m/
https://www.flickr.com/photos/lynnfriedman/8909723865/sizes/n/

The Sham Guaranty in California - How to Avoid By Making Sure There is Separation Beween the Borrowower & Guarantor


I have written in the past about Sham Guaranties - this is a guaranty of a loan where the guarantor has such a close identity with the borrower that they are in effect providing a guaranty of their own loan. Such a sham guaranty is not enforceable. A typical scenario would be with a limited partnership. The general partner is fully liable for the debts of the limited partnership. If all the principals of the general partner sign the guaranty, the question arises of whether anything has been added by the guaranty. This is a sham especially when the lender takes a role in encouraging the formation of the entity, and only investigates the financial wherewithal of the individual guarantors. Business and real estate attorneys for lenders usually pay special attention to make sure they really will have an effective guaranty. In a recent decision. the guarantors were unhappy to learn that they were liable on the guaranty - there was too much separation between themselves and the borrowers, which they did on purpose so that they would not occur direct liability on the loan.


Sacramento real estate loan sham guaranty attorney.jpg In California Bank & Trust v. Lawlor, the bank loaned millions to Heritage Partners, secured by numerous real estate projects. Smith and Lawlor owned and controlled Covenant Management, which owned and controlled Heritage Capital, which was the general partner of the Heritage partnerships. They really tried to isolate themselves from the borrower to avoid personal liability. The lender required Smith and Lawlor to sign continuing guaranties. The borrower went into default, the lender foreclosed, and had a deficiency of $15 million dollars. California Bank and Trust brought this action to collect on the loan guaranties. Smith and Lawlor argued that the guaranties were sham guaranties and therefore they were actually the primary obligors on the loans, not true guarantors. As primary obligors, Smith and Lawlor claimed that they were entitled to the protection of California's antideficiency statutes. This should prohibit the lender from obtaining a judgment against them for the difference between the value of the security and the outstanding loan balances.

The antideficiency statutes strictly limit the right to recover deficiency judgments for the amount the debt exceeds the value of the security. The antideficiency laws promote several public policy objectives:
(1) to prevent a multiplicity of actions,
(2) to prevent an overvaluation of the security,
(3) to prevent the aggravation of an economic recession which would result if creditors lost their property and were also burdened with personal liability, and
(4) to prevent the creditor from making an unreasonably low bid at the foreclosure sale, acquire the asset below its value, and also recover a personal judgment against the debtor.

These protections are NOT provided to a true guarantor, however. The courts must decide whether the purported debtor is anything other than an instrumentality used by the individuals who guaranteed the debtor's obligation, and whether such instrumentality actually removed the individuals from their status and obligations as debtors.
The court surveyed numerous sham guaranty decisions, and noted that it would look to the purpose and effect of the parties' agreement to determine whether the guaranties constitute an attempt to circumvent the antideficiency law and recover deficiency judgments when those judgments otherwise would be prohibited. The test is to determine 1) whether the legal relationship between the guarantor and the purported primary obligor truly separated the guarantor from the principal underlying obligation, and 2) whether the lender required or structured the transaction in a manner designed to cast a primary obligor in the appearance of a guarantor.

Regarding the legal relationship, The Defendants are not the primary obligors on the loans because they did not enter into the business loan agreements or execute the promissory notes with the lender. Also, Cartwright Properties's and Heritage's (two of the borrowers) legal status as a limited liability company and a limited partnership provide legal separation between those entities as the primary obligors and Defendants as the guarantors. For the Heritage loans, there was an additional layer of separation existed between Smith and Lawlor and the primary obligors because there was both a limited partnership and a limited liability company between them and the primary obligors. Though the defendants owned and controlled these entities, there was no evidence that these were mere shells, which would allow the plaintiff to pierce the corporate veil ('ultra vires').

Sacramento loan guaranty attorney.jpgRegarding the lender's involvement, There was no evidence that the lender requested, required, or otherwise had any involvement in selecting the entities, or the form of the entities, that were the borrowers and primary obligors. Defendants offered no evidence showing Smith and Lawlor were the primary obligors on the loans or that the lender attempted to separate Defendants' interests in the loans by making Cartwright Properties and Heritage the borrowers while relegating Defendants to the position of guarantors.
These defendants did a great job structuring entities to shield themselves from personal liability. A property constructed LLC, corporation, or limited partnership can do that. The downside however, is that this level of protection eliminates the sham guaranty defense.

Photos:
https://www.flickr.com/photos/dcmaster/3399931333/sizes/n/
https://www.flickr.com/photos/charleshope/2560976779/sizes/n/

General reference of California disputes - How you can avoid a courthouse trial without having to deal with unpredictable arbitration


Parties can provide in their contracts that any dispute be resolved by "general reference." A general reference directs a referee to try all issues in the action. The hearing is conducted under the rules of evidence applicable to judicial proceedings. In a general reference, the referee prepares a statement of decision that stands as the decision of the court and is reviewable as if the court had rendered it. This results in a trial by a referee and not by a court or jury. "Judicial reference," on the other hand, differs in that in that it involves sending a pending trial court action to a referee for hearing, determination and a report back to the court. The BIG DIFFERENCE between reference and arbitration is that a judgment obtained by reference can be appealed, but an arbitrator's may not be appealed, regardless of how flawed it is. Sacramento real estate and business attorneys know that all the CAR forms have arbitration provisions, which are usually initialed by the parties without truly understanding them. I have railed before about how arbitrators are not held accountable for erroneous rulings.

The general referee's statement of decision "stands as the decision of the court," and once the statement of decision is final and filed by the referee, judgment must be entered thereon "in the same manner as if the action had been tried by the court." After judgment is entered, the losing party may make post-trial motions for a new trial, and/or to vacate the judgment. The judgment entered on the general referee's statement of decision may be appealed like any other judgment.

SACRAMENTO CONTRACT DISPUTE ATTORNEY.jpgIn a recent decision the court enforced a general reference provision that did not include an explicit waiver of a jury trial. In O'Donoghue v. Superior Court (Performing Arts LLC), a developer obtained a $20 million dollar construction loan for condos at 973 Market Street in San Francisco. Several individuals signed personal guarantees for the loan; the guaranty instrument had a general reference provision. Default occurred, a lawsuit filed, and the court enforced the reference, appointing a referee. The reference provision did not include a jury waiver; the guarantors appealed.

The court first noted that statute permitting agreement for a reference unambiguously results in a waiver of 'jury trial' without the need to use those words. Such a reference (like arbitration) entails dispensing with trial in the judicial forum, including jury trial. Also, in parallel, the California Supreme Court concluded that an agreement to arbitrate need not contain an express waiver of a jury trial.

sacramento loan guaranty attorney 2.jpgThe court reasoned that the provision must clearly and ambiguously show that a party has agreed to resolve disputes in a forum other than the judicial one, which is the only forum in which disputes are resolved by juries. The reference provision in this case satisfied that test. It contains the heading "Judicial Reference" and advises that all disputes "shall be heard by a single referee by consensual general reference pursuant to the provision of the California Code of Civil Procedure, Sections 638 et. seq." and that the referee "shall then try all issues, whether of fact or law, and report a statement of decision which either party may file with the clerk or judge and have judgment entered thereon." Further, it provides that "[t]he parties agree that the referee shall have the power to decide all issues of fact and law and report a statement of decision hereon, and to issue all legal and equitable relief appropriate under the circumstances before him or her."

This is a good result. Hopefully more California real estate and business attorneys will recommend reference to their clients instead of arbitration


Photos:
https://www.flickr.com/photos/dlytle/2228193416/sizes/n/

Catastrophic Damage to California Real Estate During a Purchase Transaction - How the Risk Is Allocated After Fire, Flood, Landslide,or other Disaster.

March 27, 2014

When California real estate is bought or sold, there is always a period of time between signing the purchase and sale contract, and when the title is transferred. With commercial properties the period could last for months, as the buyer completes their due diligence. But what happens if the building burns down in the interim? Does the buyer still pay full price? Is the contract cancelled? When it comes to allocation of this risk, The more detailed the sale contract, the better. Residential purchase agreements rarely provide for this issue, and rely on the California Civil Code. Commercial Sale agreements often contain provisions that covers the topic, and some in great detail. parties concerned about this issue should consult with a Sacramento and El Dorado real estate attorney to ensure that they are protected, as there are can be some surprises for both buyers and sellers.

Sacramento real estate catastrophe.jpgThe Civil Code

California Civil Code §1662 (the Uniform Vendor and Purchaser Risk Act, or "UVPA") provides that in sale contracts;
a) if neither title nor possession has been transferred, and a material part of the property is destroyed, the seller cannot enforce the contract, and the buyer gets a refund.
b) if either possession or title is transferred, the risk is on the buyer, and the contract is enforced to require full payment. The problem here is, what is material? That may become an area of dispute that prohibits easy resolution.

Contract Provisions

Many commercial purchase and sale contracts go the extra distance to define what "material" means. They do it in two ways:

1) Cost of Repair - this specifies that, if cost to repair exceeds a specified amount, than a material part of the property has been destroyed. If there are any aspects of the property that the buyer intends not to use or to demolish, such as an unattached garage or outbuilding, these should be excluded in calculating the cost to repair.
2) Diminution in Value -this is less desirable, as it would require appraisal, an expensive and time consuming affair.


Enforcement at a Reduced Price?

Civil Code §1662 subdivision (a), described above, does not state that the seller may terminate the contract; only that they cannot enforce it. It allows the Buyer to enforce it ("specific enforcement"). A 1983 court decision found that a buyer could not require enforcement of the contract with a reduction in the purchase price. In Dixon v. Salvation Army, Dixon was buying property with two buildings. Before possession or title passed to the Dixon, one of the buildings burned down. Dixon sued, seeking to enforce the contract at a reduced price to reflect that he was getting only one building.

Yolo purchase agreement.jpgThe court noted that subdivision (a) of 1662 applied, and the seller had the risk of loss. The seller could not enforce the contract., and the buyer could rescind. However, the statute did not say whether the buyer could enforce the contract at a reduced purchase price.

The court found that the equitable approach would be "to place the parties in their original position, free to make a new bargain. A rule that denies a vendor the ability to specifically enforce the sales agreement where the material part of the consideration is lost or destroyed calls out for the converse also to be applied. It would be grossly unfair to require either party to accept consideration less than the whole of what was bargained for under these circumstances."

Thus, the court ruled against the buyer, and did not order the sale at a reduced price. I think the court took the wrong approach to achieve the right result. The UVPA, by allowing the buyer to enforce, but being silent on a reduction, as a matter of statutory interpretation means that the buyer can enforce only the existing terms, without any change to the contract.

Photos: http://www.flickr.com/photos/bjohansson/2614591735/sizes/n/
http://www.flickr.com/photos/desk003/2244471856/sizes/m/

Liquidated Damages, Penalty, or a provision for Alternative Performance?

Liquidated damages provisions in California real estate contracts provide that the parties, at the time they enter into the contract, determine what the damages will be if there is a specified breach of the contract. It must represent a reasonable attempt to anticipate the losses to be suffered. It will not be enforced if it is primarily a penalty for punishing the party at fault. It must bear some relationship to what they parties may foresee as the actual damages that will occur. However, the parties could also have negotiated for alternative performance, where one side has a choice; Do things A & B, and you get paid something. Do just A, and you get paid something less.

A recent decision out of San Joaquin County shows how important it is to be clear in the contract, and one may need to consult a Sacramento real estate and business attorney for clarification. If the provision is not to be determined a penalty, you must actually have a reasonable basis for calculating the amount at the time of entering the contract, and also the contract must have language describing the parties agreement that the actual dollar amount has some relationship to the likely damages. If the number appears reasonable, it may qualify as both liquidated damages OR alternative performance. If it is not reasonable, the only hope is that if it is found to be alternative performance.


sacramento liqudated damages attorney.jpgIn Brian McGuire v. More-Gas Investments, LLC, McGuire had a contract to buy property to build a house. The property sold for over $1 million dollars, and was amongst vineyards in Acampo. The buyer wanted to make sure his view would be protected.

The Contract Provision
In the purchase contract the seller warranted that adjacent lots would not be permitted to construct any structure within nine hundred feet of the access road, in order to protect the buyer's view, by amending the CC&Rs. If the Seller was unable to amend the CC & Rs within two months from close of escrow, Seller was to refund to Buyers $80,000 from the purchase price under the Agreement. The CC&Rs were not amended, the Buyer refused to refund the money, and this lawsuit resulted.

At his deposition, the Buyer testified that he did not remember how that $80,000 figure was determined. He admitted plaintiffs did not do any market research to determine what the diminution in the value of the property would be in the absence of the building , and had not discussed damages.

The trial judge granted summary judgment, finding that the provision was an unenforceable penalty.
Yolo real estate sales contract attorney.jpg
Liquidated Damages

Civil Code section 1671 provides that a liquidated damages clause is "valid unless the party seeking to invalidate the provision establishes that the provision was unreasonable under the circumstances existing at the time the contract was made." (If the case involves a buyer failing to complete the purchase and facing forfeiture of the deposit, Civil Code sections 1675 - 1697 would apply)

An amount disproportionate to the anticipated damages is termed a "penalty." A contractual provision imposing a "penalty" is ineffective, and the wronged party can collect only the actual damages sustained. In this case the defendant shot himself in the foot in testifying that they did not really consider a way to arrive at the $80,000 figure, it was just a number. Thus, the court did not think it qualified as liquidated damages, and must be a penalty. The trial court did not consider whether it was for alternative performance.

Alternative Performance

A contract provision that first appears to be a liquidated damages clause or a penalty may, in fact be instead a provision that allows an alternative performance that does not impose damages and is not subject to section 1671 limitations. However, the court has to determine whether or not the alternative performance is merely a ruse to disguise a penalty. The judge looks at the substance, not the form, of the transaction. If it is in fact a contract contemplating but a single, definite performance with an additional charge contingent on the breach of that performance, the provision must be viewed under the rules for liquidated damages.

The Court in this case looked at cases covering alternative performance, in which a party was given the rational choice of which performance to tender: either the company could make the specified improvements to the property and an installment payment or the company could decline to make those improvements and forego the payment. In this case. More-Gas could either amend the CC & Rs and keep the $80,000 or decline to secure that amendment and refund the $80,000 to plaintiffs. Viewed in this manner, the purchase agreement for the Orchard property can be understood to contain an enforceable provision for alternative performance rather than an unenforceable penalty provision. Thus, it overruled the trial judge's finding that it was a penalty, and sent it back to determine if it was in fact a penalty or rather alternative performance.


Photos:
http://www.flickr.com/photos/76661041@N06/6876923335/sizes/n/
http://www.flickr.com/photos/21787777@N02/2705374485/sizes/n/

Option Agreements with other lease or purchase conract attached - when the binding contract is formed.

January 21, 2014

Option agreements for sale or lease of property often have a form of lease or purchase agreement attached, to be entered on exercising the option. The expectation is that, if the option is exercised, the attached contract will be signed by the parties and govern the transaction. Occasionally the option will contain all the terms, and not attach a form contract, and may or may not refer to entering an agreement. Sacramento and ElDorado real estate attorneys advise clients to prepare the Agreement and attach it to the option, otherwise there could be a dispute when the option was exercised. In pone such case, after the option to lease property was exercised, the property owner backed out. His legal argument was that the option was only a contract to enter a contract, and did not affect title to his property. The court said no, in this case, the option was sufficient as a lease.

In John Gavina v. Lon Smith, Plaintiff Gavina granted Defendant an option for an oil and gas lease on Gavina's property. The option stated all the details of the lease, (set out below), but also had an attached lease form that, on exercise of the option, was to be signed by the parties. Smith exercised the option and deposited the money in escrow. Gavina refused to accept the money from the escrow, did not sign the formal lease form, offered to give Smith the option fee back. Essentially, they told Smith to get lost. The lawsuit resulted.

sacramento lease attorney.jpgThe judge was not impressed by Gavina's conduct. Because of the nature of the suit (quiet title), it first addressed the question of whether the option itself created a contract, or was merely an executable contract to make a lease. It found the intent of the parties, as expressed in the option agreement, to set forth in both the option and the attached form of lease all the terms and conditions on which Gavina's offer to lease was made. By exercising the option, Smith accepted the offer and agreed to the lease on the those terms. The requirement of a written lease was satisfied. (Statute of Frauds) Nothing more was required to make a binding lease.

"Where the parties, however, have agreed in writing upon the essential terms of the lease, there is a binding lease, even though a formal instrument is to be prepared and signed later. The formal instrument may be more convenient for purposes of recordation and better designed to prevent misunderstanding than the other writings but it is not essential to the existence of the lease." Just because they expected to enter a written lease does not let them off the hook for a contract they already signed.

The decision had a caveat, though, to reign in its impact. "Since the execution of the formal contract would add nothing to what the parties had already agreed upon," there is no reason to say that the agreement they had made was not enforceable. The question raised is that, if the lease contract that was attached added any terms or conditions, would that make a difference? In this case, probably not. I think the court would have found an intent that the terms of the attached lease were incorporated into the option agreement. Thus, they were already agreed to.

But what if the lease agreement had not been attached, and the option indicated that it was subject to entering a formal lease agreement? This is the same language used at superior court settlement conferences in California, they are often "subject to entering a formal settlement agreement," or "formal documentation of releases," or something similar. The parties get the case 'settled,' so it is taken off the trial calendar, everybody sighs relief, and then the negotiating over the formal settlement agreement gets complicated, maybe even falling apart, and the parties go back to set a trial date.

Here are the Option terms:

-Rent was $1.00 per acre per year payable in advance.
-If drilling operations were not commenced within one year from the date of the lease, the lessee could extend the period of the lease for four years by paying $1.00 per acre for each year.
-Plaintiffs' royalty was to be one-eighth of all production.
-Surface rights were to be retained by plaintiffs for agricultural purposes.
The lessee was to pay for any injury to livestock, trees, crops and improvements
-On the exercise by defendant of the option and the payment in advance to plaintiffs of a rental of $1.00 per acre for one year, plaintiffs agreed to execute and deliver a completed oil and gas lease on the attached form.
-The money for the rental could be deposited in escrow with instructions that it be paid to the lessors upon receipt of the executed oil and gas lease.

photos:
http://www.flickr.com/photos/32834181@N00/2507125889/sizes/n/

Letters of Intent May Be Enforced in California - Steps to be Sure they Are Not Binding

January 16, 2014


Letters of Intent are often ambiguous documents in which parties set out certain key terms of a deal, usually with the intent there will be further negotiation and documentation. They may also be called a 'term sheet' or "memorandum of understanding," and are used extensively in California real estate transactions and Leases as well as in business contracts. The parties usually do not intend this document to be enforceable in court - rather, it is intended to guide further discussions and execution of a formal agreement or approval of a third party. A party entering such a letter should consult with a Sacramento business attorney for guidance in drafting it. However, as open ended as the parties may make them, occasionally they are surprised when a court finds such a letter creates enforceable obligations between the parties. It all depends on the court's view of the intentions and expectation of the parties. Among the issues considered are whether the parties agreed to the material terms, or left some for later agreement, making it an agreement to agree, and whether the parties intended not to be bound until preparation of a more formal agreement. The two decisions discussed below establish two important rules:

A. A Letter of Intent may be enforceable even if you plan to enter a formal contract. If the material terms of the deal are there, as well as intent, the Letter is enforceable; and,

B. A Letter of Intent may create a duty of the parties to negotiate in good faith, and failure to do so can result in damages.

Sacramento business attorney 5.jpgIn First National Mortgage Company V. Federal Realty Investment Trust, two sophisticated parties had been engaged in negotiations over several years regarding development of Santana Row in San Jose. They exchanged several proposals, including a "counter proposal" and a "revised proposal." Eventually they signed a document titled "Final Proposal," a one page document. Earlier proposals stated that they were non-binding; the final did not include this language. The Final stated that Federal Realty was to "prepare a legal agreement for First National's review to finalize the agreement." The effective date of the agreement was to be the "date of vacating premises." Finally, the last clause of the Final Proposal provides: "The above terms are hereby accepted by the parties subject only to approval of the terms and conditions of a formal agreement."

The court noted that an agreement is not unenforceable merely because it is subject to the approval of a formal contract. The Final Proposal clearly states that its terms "are hereby accepted by the parties subject only to approval of the terms and conditions of a formal agreement." Here, the circumstances demonstrate that the parties went from a "Counter Proposal," to a "Revised Proposal," to a "Final Proposal." In light of this, it cannot be said, as a matter of law, that the Final Proposal was not meant to be binding.

sacramento letter of intent attorney.jpgIn Copeland v. Baskin Robbins U.S.A., the parties were negotiating the sale of an ice cream plant. As part of the deal, Copeland, the buyer, wanted a co-packing agreement, in which the seller would agree to buy ice cream from Copeland. The parties signed a letter stating the terms of the deal, subject to a separate co-packing agreement and negotiated pricing. The parties negotiated another two months, then Baskin Robbins broke off, stating that the co-packing agreement was no longer "in alignment' with their strategy.

The Court found that Baskin Robbins failed to negotiate in good faith.
"A contract to negotiate the terms of an agreement is not, in form or substance, an "agreement to agree." If, despite their good faith efforts, the parties fail to reach ultimate agreement on the terms in issue the contract to negotiate is deemed performed and the parties are discharged from their obligations. Failure to agree is not, itself, a breach of the contract to negotiate. A party will be liable only if a failure to reach ultimate agreement resulted from a breach of that party's obligation to negotiate or to negotiate in good faith."

Thus , a letter of intent should include waivers of the implied covenant of good faith and fair dealing and reliance damages (as well as any other damages), as well as an affirmative statement that the non-binding letter of intent will not create an obligation to negotiate or be deemed a contract to negotiate.


Instead, to minimize the risk of a court deeming their letter of intent enforceable, negotiating parties should make sure to explicitly state in the letter of intent that it states that

1. It is non-binding on the parties, and that

2. no party shall be bound in any way until a final contract has been agreed to, executed and delivered by each party.

3. Moreover, all parties involved in the deal should avoid taking any actions that could imply that they intend to be bound by the letter of intent or believe that a binding contract exists, such as making public announcements that a deal has been reached.

4. language clearly denying the existence of a duty to negotiate in good faith and expressly stating that either party may terminate negotiations for any reason, or no reason, at any time prior to consummation of the contemplated final agreement.


Photos:
http://www.flickr.com/photos/jlunar/123555686/sizes/s/
http://www.flickr.com/photos/roboppy/3400967306/sizes/n/

Non - Refundable Deposits in California real estate contracts - not valid in rising market; The Alternative!

December 19, 2013

Standard in most form real estate contracts are provisions for liquidated damages. Not so common is the non-refundable deposit. A "liquidated damages" provision stipulates an estimate of what the damages would be in the event of a breach of a contract. It is generally valid, unless it can be shown that it was unreasonable under the circumstances at the time the contract was entered. A non - refundable deposit is generally not valid in a falling market. But there is an alternative!


nonrefundable deposit.jpgIn Bradford Kuish v. William W. Smith, Jr. There was a purchase contact for plaintiff to buy defendant's Laguna Beach house for $14 million dollars. The contract required a non-refundable deposit, initially of $800,000; after some amendments to the escrow instructions, the deposit was reduced to $620,000, which was paid by the buyer. The parties extended the escrow a couple of times. Finally the buyer asked that the escrow be cancelled; the seller agreed. They then turned to a backup up offer to sell the property for $15 million, one million more than the plaintiff would have paid. The seller refused to refund the buyer's $620,000 deposit, claiming that it was "non-refundable." The buyer sued to recover the deposit.

The court started with Civil Code 3307:

" The detriment caused by the breach of an agreement to
purchase an estate in real property is deemed to be the excess, if any,
of the amount which would have been due to the seller under the
contract over the value of the property to him or her, consequential
damages according to proof, and interest."

The seller's main measure of damages from a defaulting borrower is the difference between the contract price and the property's value at the time of the breach. In a rising market, as in this case, there are no longer any loss of bargain damages. There would be no damages here, so that presents a problem. The California Supreme Court has ruled, in a similar situation, that if the seller is allowed to retain the amount of the down payment in excess of its expenses in connection with the contract it will be enriched and plaintiff will suffer a penalty in excess of any damages he caused. (Freedman v. The Rector (1951) 37 Cal.2d 16). Here, where the buyer made the deposit, partially performing the contract, to allow the seller would be in effect punitive damages, and would be contrary to the laws regarding punitive damages and liquidated damages. Any provision by which money or property is forfeited without regard to the actual damages would be an unenforceable penalty.

Sacramento real estate deposit attorney.jpgThe Supreme Court also concluded that the provision allowing the seller to keep the deposit would not be enforceable even if it was construed as a liquidated damages provision. Although a liquidated damages provision in a real estate contract is presumptively valid, when as in this case it would not be impractical or extremely difficult to determine the actual damages (here there were none), such a provision may not be enforced as one for liquidated damages.

The Seller would have been able to retain the deposit in a FALLING market to the extent the seller was able to show actual damages under Civil Code section 3307. The deposit would be a fund from which to reimburse the seller, and the seller would have to refund the excess of the deposit over the amount of actual damages they could prove. This scenario gives the seller the advantage of shifting the burden to the buyer to show that seller is keeping more than the actual damages.

What can you do if you really want something like a non refundable deposit? Consult with an experienced Sacramento real estate attorney, and create an option contract, where the buyer pays a non-refundable fee for the right to buy the property under specified terms. An option agreement is a unilateral contract where, for consideration, the optionor promises not to revoke the offer in exchange for the act of the offeree of payment of the option consideration. If the buyer does not exercise the option, the seller keeps the fee.

Photos:
http://www.flickr.com/photos/nandf/293910393/sizes/m/
http://www.flickr.com/photos/niexecutive/8580308766/sizes/n/

Attorney fee provisions in California contracts can be restricted to contract claims, or expanded to cover any dispute. How the provision must be worded to do either

October 17, 2013


California generally goes by the American Rule for attorney fees- the parties are generally responsible for their own fees. In situations involving written contracts, however, they parties may provide for payment of attorney fees in the event on a dispute. I have written before regarding attorney provisions in:
--actions on commercial lease deposits;
--the CAR (California Association of Realtors) form & a failure to mediate; and
--Promissory Notes and the breach of the implied covenant of good faith and fair dealing.
Sacramento business and real estate attorneys are often asked about the impact of such a provision in a contract. This article addresses the language of an attorney fee provision in general, and whether it covers just actions on the contract, or are broader, encompassing tort (eg. Negligence or fraud).


attorney fee provision.jpgIn Catherine Maynard v. BTI Group, Inc., BTI acted as the broker for the sale of Maynard's business. The business was sold, but there was no security agreement securing the purchase price. The buyer later filed bankruptcy, and the balance of the purchase price was not paid. Maynard sued BTI for failing to get security for the deal.

The listing agreement, which was the contract between the parties, had the following attorney fee provision:

"All parties to this agreement agree to mediate, in good faith, any dispute prior to initiating arbitration or litigation. The prevailing party in the event of arbitration or litigation shall be entitled to costs and reasonable attorney fees except that any party found in those proceedings to have failed to mediate in good faith shall not be so entitled." (This is similar to the CAR form provisions, noted above)

The court awarded Maynard the balance of the purchase price, to be paid by BTI, so she sought attorney fees as she had a net judgment against BTI. But, she did not prevail on her contract cause of action, so BTI claimed that they were the prevailing party under Civil Code section 1717. This code section states:

"In any action on a contract, where the contract
specifically provides that attorney's fees and costs, which are
incurred to enforce that contract, shall be awarded either to one of
the parties or to the prevailing party, then the party who is
determined to be the party prevailing on the contract, whether he or
she is the party specified in the contract or not, shall be entitled
to reasonable attorney's fees in addition to other costs."

However, the court that you do not necessarily start with 1717. You must first look at section 1021, which states:
"Except as attorney's fees are specifically provided for by
statute, the measure and mode of compensation of attorneys and
counselors at law is left to the agreement, express or implied, of
the parties.."

If the contract limits attorney fees to the party that prevailed on the contract, then 1717 applies. But the provision does not need to be that restrictive- it can cover non-contract claims as well. If it does, then the prevailing party will usually be the one with the greater NET recovery.

The court noted a similar case, in which the attorney fee provision in a lease stated:

`If civil action is instituted in connection with this Agreement, the prevailing party shall be entitled to recover court costs and any reasonable attorney's fees.'

sacramento business attorney 3.jpgIn that case, the court found the provision was not limited to the breach of contract cause of action, and therefore the court did not have to restrict its analysis to the breach of contract, but also included the tort causes of action. And, in determining the attorney fee award, the court did not have to apportion between attorney fees incurred for the breach of contract claim and the tort claims- the lease contemplated recovery of fees for all claims in any action in connection with the lease.

The court pointed out that the problem arises when one confuses the idea of prevailing in the lawsuit with that of prevailing 'on the contract.' Here, the provision applies to fees occurred in 'any dispute.' It is similar to claims regarding provisions which call for fees "in connection with" a particular agreement; or to any action "arising out of" an agreement. These are not restricted to actions to enforce a contract. Those restricted to contract claims trigger application of 1717.

This decision is a good discussion of how to draft an attorney fee provision to do ewhat you want it to do; cover only contract claims, or to cover any kind of dispute.


photos:
http://www.flickr.com/photos/viriyincy/4644083734/sizes/n/in/photostream/
http://www.flickr.com/photos/caroslines/2361619710/sizes/n/in/photostream/

A California Option Which Was Illegal Because It Violated the Subdivision Map Act, Saved By an Amendment.

October 10, 2013

The Subdivision Map Act generally prohibits the sale of any parcel of real property for which a map is required, unless a map compliant with its provisions has been filed. Government Code section 66499.30. However, the Subdivision Map Act does not prohibit parties to offer or enter into contracts for the future sale of divided portions of land without first filing subdivision maps as long as such contracts are expressly conditioned on compliance with the SMA before the close of escrow. A recent decision regarding land in Danville involved an option to buy real estate for which a subdivision map had not been recorded, and the contract was not expressly conditioned on compliance with the Act. parties contemplating an option should consult with a real estate attorney to fully understand the ramifications of their agreement. Here, they amended the Option Agreement to make it expressly conditioned on compliance with the Subdivision Map Act, and the court said it was therefore Legal and enforceable.

option agreement enforceable.jpgAn an option is an offer by which a promisor binds himself in advance to make a contract if the optionee accepts upon the terms and within the time designated in the option. In Sidney Corrie, Jr., v Elizabeth Soloway, Corries bought in 1994 an option to buy 7 acres of Danville property, part of a 16 plus acre parcel. There was a nonrefundable option fee of $100,000, plus payments of $5,000 per month during the term of the option. The owner of the property wrote a letter to the planning director of Danville authorizing Corrie to apply for a tentative map and create a separate parcel consisting of the option property -so, the parties knew about the requirement for a map. In 2009 the parties entered an agreement that expressly stated that the exercise of the Option was conditioned on the approval and filing of a final subdivision map or parcel map. Things went well, things went bad, a lawsuit followed and the owner claimed that the Option Agreement was void and unenforceable at its inception because it was not conditional on compliance with the Subdivision Map Act. The trial court agreed. The Court of Appeals did not.

The Court first distinguished other decisions which held that later actions did not change the illegality of the contract. Here, the parties took action to correct the illegality of the initial option agreement. The court did not believe that allowing the parties to correct a technical violation by agreeing to an amendment to the option contract would allow the Subdivision Map Act to be circumvented. No public policy prohibits parties from abandoning a void, illegal contract for a new enforceable contract covering the same subject. There is no bright line rule that the parties' subsequent conduct cannot save their transaction from being illegal.

The court found that these facts met the criteria established in the decisions. First, no moral turpitude is implicated in this case. There is no evidence either party intended at any time to circumvent the law or that their transactions had an unlawful purpose. In fact, the parties first began the approval process for subdivision of the property before any contract of sale was formed, when the owner wrote a letter to the planning director in 2008 authorizing Corrie to proceed with a tentative parcel map application. The parties' failure to condition the original Option Agreement or the further option created by Amendment No. 1 on SMA compliance was nothing but a drafting oversight to which no moral opprobrium attached.

subdivision map act requirements.jpgAlso, the original agreement expired by its terms without being exercised. It is only the later amendment, which complied with the Map Act, is at stake. Lastly, neither side can be held guilty of greater moral fault than the other for the deficiency in the Option Agreement and Amendment No. 1. It was an error in drafting for which both sides are equally responsible.

This decision is a warning to comply with the Map Act in the first place. The decision does not really establish a hard and fast rule, so requires close reading


Photos: http://www.flickr.com/photos/gutbezahl/5121417494/sizes/m/in/photostream/
http://www.flickr.com/photos/colleen-lane/4351234863/sizes/m/in/photostream/

The Modern C.A.R. Real Estate Forms Allow the Seller to Cancel until Buyer's Contingencies Are Released in Writing

September 26, 2013

The California Association of Realtors has published a set of transaction forms ("CAR" forms) for nearly every potential real estate contract. These fill-in-the-blank forms are intended to allow agents to prepare standard contract documents without the risk of being accused of practicing law. They are routinely revised and often the changes are not obvious. Anyone with prior experience with the forms should be sure to check which edition they are currently using or interpreting, as the provisions may be different that what they are used to. If necessary, buyers and sellers of real estate should consult with a Sacramento real estate attorney be better understand what their contract language will mean in their deal. A common area of concern is the release of contingencies. If the sale is contingent on something, that something has to happen for the contract to be further enforceable. An example is a contingency to obtain a loan on certain terms. If the buyer cannot obtain it, then they can call the deal off. However, they can decide to accept a loan under different conditions, and waive the contingency.

Sacramento real estate lawyer.jpgThe C.A.R. forms used for residential purchase agreements since the October 2002 revision have eliminated the last vestige of "passive" removal of contingencies common in the older forms. The new forms all utilize "active" written removal of contingencies, such that satisfaction of the underlying condition is not enough; there must be a written removal before a contingency is, in fact, removed. If a party does not remove it in writing, it is incumbent on the other to serve a Notice to Perform. Until all contingencies are removed in writing, Sellers always have a right to cancel. Other than the risk of cancellation, there is no penalty to the holder of the contingency if the underlying event occurs but the contingency is not removed in writing. The older C.A.R. Purchase and Sale form copyrighted 1983-1985, is different.

Older C.A.R. Forms Allowed "Passive" Removal of Contingencies
The pre- October 2002 form provides for election of "Passive Removal." If the Buyer does not remove contingencies, or give notice of items disapproved, he is conclusively presumed to have waived all contingencies. Seller does not have a right to cancel. If the Buyer notified the Seller of items they did not approve, and Seller does not respond within the specified time, the Seller is deemed to have refused to correct the items, and the Buyer may cancel.

CAR form contingency.jpgOlder C.A.R. Forms, Where "Active" Removal Was Selected, Did Not Require a "Notice to Perform."

The pre- October 2002 form allows selection of "Active Removal" of contingencies. If the Buyer does not remove contingencies in writing within the specified time, the Seller may cancel without serving a Notice to Perform.

Current C.A.R. Forms Require "Active" Removal, Require Notice to Perform, And Maintain The Right To Cancel Until All Contingencies Are Removed In Writing.

The current C.A.R. forms are different, representing a change in philosophy of the forms, a result of the strong seller's market that had existed in California for several years. The forms give the parties a 17 day free look. Now, if a contingency is not removed in writing in the time specified, the other party must to serve a Notice to Perform to trigger their right to cancel. And if anyone's contingency is not removed in writing, the Seller always has a right to cancel. Thus, removal of a contingency in writing, as well as occurrence of the underlying event, are required to satisfy the Contract. The Purchase Contract and the Contingency are taken together as they are parts of one transaction. Civil Code §1642. The various provisions of the contract are reviewed together, "so as to give effect to every part, if reasonably practicable, each clause helping to interpret the other." Civil Code §1641. To interpret the contract otherwise would require pretending that the CAR forms were not changed.



photos:
http://www.flickr.com/photos/stonningtonhistorycentre/3591629134/sizes/s/in/photostream/
http://www.sxc.hu/photo/1007975

California Commercial Lease Negotiations - The Landlord's CAM Estimates May Need To Be Accurate, And The Landlord Cannot Raise The Percentage

September 12, 2013

Commercial tenants entering lease in California are usually required to pay their proportionate share of "common area maintenance,", or CAM charges. The CAM charges are always characterized as an estimate- at the end of the year the landlord determines the total costs incurred for the year, and then apportions them out to all the tenants. However, if it is a new development, sometimes not even built, the lessor must base the Common Area Maintenance charges on true estimates- what they predict will happen based on experience on other projects, or otherwise a best guess. At the end of the year, they figure out the real charges, and usually the tenant has to make up a big deficit. Sacramento and Placer real estate attorneys are frequently consulted regarding CAM charge disputes; often, there is a big jump in the charges, and the tenant can't believe they are justified. In a recent decision, the parties entered a letter of intent regarding an unbuilt project. Even though the CAM charges which were described were clearly described as an estimate, the landlord was surprise when the court said the landlord may be liable for fraud and breach of the covenant of good faith and fair dealing.

Sacramento commercial lease CAM.jpgIn Thrifty Payless Inc. V. The Americana at Brand, LLC, Thrifty entered a letter of intent to enter a lease of property from Americana. The project had not been built yet, but Thrifty had experience with Americana on other leases, and the CAM charges were reasonably accurate. The Letter of Intent ("LOI") Americana proposed stated three estimates- property taxes, insurance premium, and common are maintenance. The CAM estimate was $14.50. Thrifty crossed out $14.50 and wrote that a budget was to be presented to Thrifty. Americana responded with a budget, saying that Thrifty's pro rata share would be 2.2% of the budget, or $14.50. The parties entered the lease agreement. Of course, American ended up charging Thrifty much more for the three line items, including CAM charges at 5.67% of the total instead.

In the lawsuit, Thrifty alleged that Americana knew the representations were not true at the time they were made, or were made with no reasonable basis to believe that they were true. Thrifty alleged that its reliance was reasonable because of their prior experience with Americana. Citing other decisions, Thrifty claimed that estimates that the party should have known were inaccurate were grounds for misrepresentation. Thrifty found out that Americana was telling other potential tenants that Thrifty was paying a higher percentage that 2.2%, and that Americana had cut a deal with a theater to charge it less that its pro rata square footage rate. Great evidence!

Yolo commercial property.jpg
The Fraud Exception to the Parole Evidence Rule

Americana argued that the Lease has an integration clause, which it claimed barred evidence of the prior negotiations (called parole evidence). This is true, but an exception has arisen in fraud cases. It requires that evidence offered to prove fraud "must tend to establish some independent fact or representation, some fraud in the procurement of the instrument or some breach of confidence concerning its use, and not a promise directly at variance with the promise of the writing." Thus, here Thrifty can allege both intentional and negligent misrepresentations based upon Americana's grossly inaccurate estimates. In addition, the information Thrifty presented established that Americana knew or should have known the information was inaccurate--Americana told other prospective tenants that their pro rata shares would be substantially higher than the rates represented to Thrifty, and Americana cut a deal with a movie theater to charge it less than its pro rata share based on square footage.

Seems that Americana's conduct was not too trustworthy. It is rare that a commercial tenant gets this kind of evidence to fight the CAM charges, an expensive proposition.

photos: http://tinyurl.com/q956hur
http://www.flickr.com/photos/umjanedoan/497345293/sizes/s/in/photolist-KX2qR/

California Construction Contracts and Arbitration - When the Issue is whether the contractor was unlicensed, Courts Can Throw Away the Arbitrator's Decision.

I have written several times about the finality of Arbitration decisions, and haw they cannot be overturned even if the Arbitrator did not follow the law, or ignored the facts. Also discussed here has been the plight of the unlicensed contractor, and how he is not entitled to be paid, and has the give the money back, no matter how much work he did or how much he spent on the project. In both cases, parties should be sure to understand their situation, and may want to consult with a Sacramento and Yolo real estate and construction attorney. Both issues came together recently in a case were the arbitrator did not require the unlicensed contractor to disgorge his compensation. The court said the Arbitration Award was invalid.

arbitration award sacramento attorney.jpgIn Mouris Ahdout v. Majid Hekmatjah et.al., A Family Limited Partnership and Braum were the sole members and owners of a LLC. They formed the LLC to develop and sell a condominium project on property the had owned. The LLC Operating Agreement specified that the LLC would enter an agreement with BIDI (Braum Investment & Development, Inc.), general contractor, to execute contracts and purchase orders to develop the project. Braum, member of the LLC, owned BIDI. Braum was also designated the manager of the LLC. BIDI did not have a Class B Contractor's License, required under California law to build a commercial building.

The LLC operating agreement also said that BIDI was not to get any fees for acting as general contractor. However, the profit-sharing allocations under the Operating Agreement gave Braum an additional 25 percent allocation, so BIDI was actually getting paid for acting as general contractor.

There were numerous problems on the project- death of the architect, plan revisions required by the City Building Department, and construction delays, cost overruns, etc. The FLP owners were unhappy with the delays, costs, and also that there expectation of luxury condos turning out to be economy units. The parties had binding Arbitration Agreements, so the FLP started an arbitration action. Among other claims, they sought that BIDI disgorge all compensation for its contracting services as per Business and Professions Code section 7031 subdivision (b), because it worked as an unlicensed contractor.

From the evidence before the Arbitrator, it appears that the FLP knew BIDI was not licenced. City Building Dept. Accepted Braum, manager of the project, as owner, and the permit was issued to the owner/builder. The Arbitrator ruled for Braum and BIDI, that they were not required to disgorge, as they acted as consultant to the LLC and were not engaged in any work typically done by general contractors.

The FLP filed a petition in Court to throw out the Arbitration award because the Arbitrator exceeded his authority by allowing unlicensed contractors to keep their compensation. Additional evidence in the court proceeding was a bank loan application in which Braum declared under penalty of perjury that Braum Construction was the contractor; a similar declaration was submitted to the City. Preliminary Notices and invoices listed BIDI as contractor.


unlicensed contractor Yolo attorney.jpg ILLEGAL CONTRACT EXCEPTION

The Court of Appeal first considered the argument that this was an illegal contract, which provides an exception to reviewing an arbitration award. A claim arising out of an illegal transaction is not a proper subject matter for arbitration, and an arbitration award based on an illegal contract cannot be enforced. However, in this case, the illegality (paying an unlicensed contractor) did not "infect" the entire contract. Remember, the provision was in the LLC Operating Agreement, which covers a lot of ground. It was not just a construction contact between BIDI and the LLC. Therefore, the exception did not apply.

PUBLIC POLICY EXCEPTION

Numerous courts have found that an Arbitrator exceeds it powers within the meaning of Civil Code section 1286.2 by issuing an award that violates an explicit expression of public policy. If such a scenario applies, the court must set aside the Arbitrator's award. Here, the court found that section 7031 was just such an explicit expression of public policy.

In this case, the trial case should have reviewed all the evidence to determine whether disgorgement of compensation for BIDI's construction work was required by 7031. The Arbitrator's finding that BIDI was not the general contractor was not binding on the court. The judge must look at all evidence, regardless of whether the Arbitrator had reviewed it.


Photos: http://www.flickr.com/photos/atomische/4457224480/
http://www.flickr.com/photos/europedistrict/5200927638/