Loan guaranty waivers cannot be used to shield a bank from misconduct

A guarantor’s general waiver of defenses cannot be used to shield a lender from the lender’s willful breach of a loan agreement.

A guarantor’s waiver of defenses is limited to legal and statutory defenses expressly set out in the agreement, a California appellate court held in California Bank & Trust v. Thomas Del Ponti.  A waiver of statutory defenses is not deemed to waive all defenses, especially equitable defenses, where to enforce the guaranty would allow the lender to profit from its own wrongful conduct.

The facts of the case were straightforward.  A developer obtained a construction loan from Vineyard Bank to develop a 70-unit townhome project with guaranties from two of the principals.  The developer contracted with a general contractor to build the project in two phases.  The project was on schedule for the first 18 months.  However, when the first phase of the project was nearly complete, the bank stopped funding approved payment applications, preventing completion and sale of the first phase units.  As a result, the developer defaulted under the loan.

The bank eventually reached an agreement with the developer, requiring the general contractor to finish the first phase so the units could be sold at auction.  The bank promised to pay the subcontractors unless they discounted their bills and released any liens.  The general contractor paid the subs out of its own pocket to keep the project lien free so the auction could proceed.  Nevertheless, the bank foreclosed against the developer.  In response, the general contractor filed an unbonded stop notice.  The bank (through its assignee California Bank & Trust) sued the developer and the guarantors under various theories for the deficiency following a trustee’s sale of the property.  The general contractor sued the developer and the bank for restitution and breach of contract.

In a consolidated case, the court found that bank breached the assigned construction contract and found that the bank breached the loan agreement with the developer, exonerating the guarantors.  The bank appealed, claiming that the guarantors had waived all defenses under the guaranty agreements.

The appellate court rejected the bank’s argument.  A pre-default waiver of the Bank’s own misconduct was not expressly waived in the guaranty agreement.  California Civil Code section 2856 permits a guarantor to waive certain legal and statutory defenses.  However, that section does not permit a lender to enforce pre-default waivers beyond those specified where to do so would result in the lender’s unjust enrichment and allow the lender to profit from its own fraudulent conduct.

In all suretyship and guaranty contracts in California, the creditor owes the surety a duty of continuous good faith and fair dealing. The court reasoned that it would be a violation of public policy to enforce the guarantors’ waivers of defenses to payment of the note where the bank willfully breached the loan agreement, causing the default.

New ADA and Energy Use Disclosure Requirements for Commercial Property Owners

Beginning July 1, 2013, owners of commercial property in California will need to comply with new disclosure requirements when entering a new lease, amending a lease, or when owners sell or finance a commercial building.  The first disclosure requirement relates to disability access and the other requirement relates to a building’s energy use and consumption.

Certified Access Specialist Disclosure

Under California SB 1186, commercial property owners must include a disclosure in all commercial leases or lease amendments stating whether the property has been inspected by a certified access specialist and, if so, whether the property is in compliance with construction-related accessibility standards.   A certified access specialist (also known as a “CASp”) is a professional certified by the State of California to assess commercial properties and their compliance with federal and state disability-related laws and regulations.  After an inspection, the specialist issues a report which identifies areas of non-compliance with accessibility standards.  The report can be used by property owners to create a practical and financially reasonable plan for fixing problems in advance of litigation.

While the CASp disclosure in leases and lease amendments is mandatory, property owners are not required obtain such inspections.  The new law provides incentives, however, to having the building inspected.  Property owners who timely correct ADA violations identified in a CASp report or have had their property inspected by an approved inspector prior to being served with a complaint by an ADA plaintiff can be eligible for reduced statutory damages or a 90 day stay of proceedings in the event of a lawsuit.   The stay is granted to give the owner the opportunity to correct accessibility issues and dismiss the lawsuit.

Energy Use Reporting

Another California law, known as AB 1103, provides that prior to the leasing, sale or financing of an entire commercial building of more than 50,000 square feet (the requirement hits smaller buildings in 2014 – all the way down to 5,000 square feet on July 1, 2014!), the landlord, seller or borrower is required to disclose energy use data for the building for the prior 12 months, together with information regarding the building’s operating characteristics and ENERGY STAR Energy Performance Score.  To comply, building owners are required to open an account for the building at the ENERGY STAR Portfolio Manager Website, operated by the US EPA, no later than 30 days prior to the date the disclosure is required.  Under the law, once an account is opened, utility companies are required to provide energy data within 30 days of the date of the request.   Then, the owner must log back in to the account, complete a compliance report, and download certain Energy Use Materials for disclosure to the prospective tenant, purchaser or lender.   The disclosure requirement applies to virtually all commercial building use types.

The ENERGY STAR Portfolio Manager is a free online software tool that allows property owners to track and evaluate energy consumption in light of the occupancy of the building in specified land use categories.  A building is given a score on a scale of 1 to 100.  A rating of 50 means that the building performs at the midpoint when compared with similar buildings.  The Portfolio Manager uses national weather data to compare buildings in similar climates, so that buildings in locations that have snow in the winter and high humidity in the summer are not are scored against buildings in temperate climates. A building that scores 75 or above qualifies for an ENERGY STAR certification.  Because the consequences of having a poor score can have consequences in attracting tenants that have green building requirements, it is important for property owners to retain knowledgeable staff or consultants to handle the inputs into the ENERGY STAR database.  Even small mistakes can affect an overall score considerably in the wrong direction.

The new law will allow tenants, buyers and lenders to compare a building’s  performance with other similar buildings.  In addition, the disclosure requirement provides more information than a disclosure of monthly utility bills, as is typical when tenants evaluate utility pass through expenses, buyers estimate future operating costs in their pro formas, or when lenders evaluate which assets have a better ability to maintain profitability and support loan repayment.  On the other hand, the cost and expense of complying with the law’s new disclosure requirement is an added cost of doing business as a commercial property owner in California.

Park District Need Not Comply with CEQA Prior to Taking Private Property

A local government agency may start the process for condemning private property without first complying with the California Environmental Quality Act (“CEQA”), a California appellate court has held. Golden Gate Land Holdings, LLC v. East Bay Regional Park District (1st Dist. 2013).

The East Bay Park District (the “District”) proposed to take 2.88 acres of private property in fee title and a 4.88 acre perpetual, non-exclusive easement “. . . in order to construct, operate, and maintain a recreational trail . . . to be used by the general public for hiking, bicycling and equestrian use and other related uses.” The District authorized its special counsel to commence the proceedings necessary to acquire the property in the District’s name. The District filed a notice of exemption under CEQA stating that the District “has approved this project and found it to be exempt from CEQA.” The notice of exemption provided: “The subject parcels are being acquired for the purpose of open space protection and future public access.” As for the stated reasons why the project was exempt from CEQA: “This project consists of the acquisition of land in order to protect open space and to secure future public access to [Eastshore Park] and the . . . Bay Trail. . . . Any development of this property and land use changes would be subject to future CEQA review.”

The property owner filed a court action, asserting that the District had violated CEQA and the eminent domain law. The trial court found that the District had approved a CEQA “project” — which consisted of both the proposed acquisition and the proposed trail improvements. For CEQA purposes, addressing the two parts separately would be improper piecemealing of the project, the court reasoned. The proposed improvements are sufficiently definite given the District considered three options for a trail site, selected one, has a design and price estimate for the improvements, and is now initiating the condominium proceeding. Nevertheless, the court determined that a public agency is permitted to initiate condemnation proceedings with “actual acquisition” conditioned on CEQA compliance. As a result, the court allowed the District to proceed with its eminent domain action before complying with CEQA, requiring the District to vacate only that portion of its resolution that provided that the project was exempt from CEQA.

The court of appeal turned quickly to the essential question: “when an EIR must be prepared in a case where CEQA and eminent domain law intersect.” Some California authorities suggest that CEQA review must be completed before a condemnation proceeding is started. However, the appellate court declined to follow those authorities. Instead, the appellate court held that a trial court did not have to vacate the entire resolution of necessity (a first step in an eminent domain proceeding) but could order a lesser remedy and vacate only a part of the District’s action. The appellate court relied on state statutes and equitable principles to give the trial court flexibility to fashion an appropriate remedy. Also, the court found “no evidence that, by continuing its eminent domain proceedings, the District was going to be prejudiced in its ‘consideration or implementation of particular mitigation measures or alternatives to the [proposed improvements].”

The District dodged a bullet in this case. When the appellate court agreed with the trial court that the District did not comply with CEQA, it should have been “game over” — particularly when the trial court found that the acquisition of the property was part of the CEQA “project”! Even so, court of appeal held that the condemnation proceeding could continue. In my view, once the case was framed as whether a trial court had power and authority to fashion a narrowly tailored remedy, the property owner had an uphill battle. Courts are generally reluctant to limit their powers, particularly when the power that is being limited is one that allows a trial court to fashion a remedy that looks like judicial restraint. Nevertheless, CEQA played a big role in this case and it is a warning to local governments. Counsel for landowners will argue that this case continues the trend: public agencies must comply with CEQA before fully implementing a public project, even one that may have an “environmental benefit” like a park or trail. Counsel for local governments may be tempted to see this case as providing an “escape hatch” in litigation, arguing that a court can fashion a narrowly tailored remedy that allows “a portion of the action” to move forward while the local government complies with CEQA on an after-the-fact basis. Of course, CEQA requires analysis of “the whole of an action” and defines a “project” in that manner. When the “portion of an action” is something other than the eminent domain power and its well-developed statutory procedures and rich history in the case law, CEQA may very well require a different result.

Nonprofit medical facilities and California real estate transfer taxes

Owners of nonprofit health care facilities in California should be careful not to assume that because their organization is exempt from regular property tax assessments, they need not pay real estate transfer taxes when the real property is purchased or sold.

Even though a nonprofit health care facility may qualify for California’s “welfare” exemption for property tax assessment purposes, the nonprofit corporation owner may still be subject to a real property transfer tax at the time real property is transferred.  This tax can be a significant sum and can be negotiated as part of the transaction. 

California law authorizes each county and some cities to impose a transfer tax in connection with the transfer of real property within the state.   

Counties may impose a tax on instruments transferring real property at a rate of 55 cents for each $500 of the value of the property.  (California Revenue and Taxation Code section 11911(a).) 

As for cities, the applicability of the transfer tax depends on whether the city is a “general law” city or a “charter city.”  If the city is “general law,” the city may not impose a transfer tax on the sale of real property.  (California Government Code section 53725, enacted as Proposition 62 on November 4, 1986).  If the City is a “charter city,” the city may impose a transfer tax.  (Fielder v. City of Los Angeles (1993) 14 Cal.App.4th 137.)  The tax is applicable to “realty sold,” but California courts have construed that phrase to include a “change in ownership” too, not just a conveyance of title. 

Transfer taxes vary among charter cities and can be substantial.  For example, as of this writing, the transfer tax rate in the City of Oakland is $15.00 per $1,000 of property value and the transfer tax rate in the City of San Diego is $1.10 per $1,000 of property value.  Therefore, in a $50,000,000 medical office building sale, transfer taxes can be $750,000 in Oakland or $55,000 in San Diego.  (Note: Due to the budgetary challenges currently faced by many cities, there is growing pressure to increase transfer tax rates, especially in those charter cities where the transfer tax rate is low.)

During the negotiation of a purchase and sale agreement, buyers and sellers will often discuss who will be responsible for the payment of transfer taxes.  Nonprofits should not assume that they are exempt from the payment of the tax because they otherwise may qualify for an exemption from the payment of ordinary “property taxes.”  Nonprofits should also be careful not to fall automatically into the trap of the county “custom” in the payment of transfer taxes.  Allocating the responsibility for payment of transfer taxes is fully negotiable in the purchase and sale agreement. 

There is a short list of exemptions to the application of the transfer tax.  While none of the exemptions are similar to the broader “welfare” exemption available to nonprofits for regular property taxes, counsel should be consulted to determine whether any of those exemptions might apply in your given situation.