Who’s the buyer? – Real estate attorney liability in transactions with LLCs

Instead of looking at due diligence issues that potential buyers need to investigate in real estate transactions, this post will look at the due diligence that real estate brokers and attorneys may have to do on their own clients.

If you’re reading this blog, you’re probably familiar with the New York Time’s story that came out over the weekend looking at foreign investment in New York real estate and the use of LLC’s to hide the identity of the buyers. If you’re not familiar with it, it is an interesting article and well worth a read.

The practice of using a limited liability company in a real estate transaction has taken off in recent years. The use of LLCs in real estate purchases is perfectly legal and can protect anonymity and the liability of the client. However, they can also be used to hide illicit funds from victims of fraud or from a foreign government who has a legitimate claim on them.

The issue isn’t with run of the mill purchasers who would like to keep their names out of publicly available records. The issue instead is with people using high-end real estate to launder money or to hide proceeds of corruption – things that are possible with apartment sales in excess of $100 million. Banks are required to “take all reasonable steps to ensure that they do not knowingly or unwittingly assist in hiding or moving the proceeds of corruption.”

While real estate brokers and attorneys currently do not have any compliance responsibilities, it is a distinct possibility that they will be required to perform due diligence investigations of their customers in the future. What would those investigations look like? If it looks like the investigations banks have to perform, would real estate brokers or attorneys have the same sort of liability as banks? While it is unclear what actions will be taken, if any, to limit the amount anonymous money flowing in to the US through real estate transactions, it bears watching because it could major effects on real estate attorneys.

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A Delicate Balance – Environmental liability in commercial leases

A recent court case highlights how seemingly innocuous decisions, rather than the more obvious overstating square footage, in real estate transactions can create major liabilities. The case looked to see whether a lessee was responsible for a share of the commercial property owner’s remediation costs after the sublessee’s dry cleaning machine leaked chemicals into the ground during a fire. The federal court ruled that the lessee would not be held liable unless there were sufficient indicia of ownership.

The Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA) creates liability for owners of contaminated property, among other classes. While a lessee that only subleases the property is generally not an “owner,” the lessee can be liable if it acts as a de facto owner.

The factors that create the “indicia of ownership” are:

  • The length of the lease and the control the owner retains over the property use
  • Whether the owner can terminate the lease before the term ends
  • Whether the lessee can sublease the property without owner notice or approval
  • Whether the lessee pays property costs (taxes, insurance, operation and maintenance costs, etc.)
  • Whether the lessee makes structural repairs on the property

As a result of the short lease term (20 years) and the property owner retaining traditional rights of ownership, limiting property uses, having termination right, paying some taxes, and making structural repairs, the District Court found the lessee was not a de facto owner of the property. Interestingly, the lessee’s right to sublease the property without notice to the owner did not shift any of the liability, but a lease term of 99 years may have.

Rather than simply protecting sublessors from environmental liability caused by sublessees, this decision highlights just how imperative it is to completely understand what is at stake in real estate transactions. When a lessee decides to move its operations and sublease the space to save money, the difference between environmental liability and none may be a longer lease term and no ability for the owner to terminate the lease. For a property owner, allowing sublease without requiring prior approval may result in far more environmental liability than anticipated.

Square Footage – That’s not what I paid for!

After reading a recent New York Times article about discrepancies between advertised and actual square feet in real estate deals, I began to wonder who is really responsible for accurate measurements and what possible remedies a buyer could have.

The article details the sale of a mansion in Malibu, California that was advertised as having over 15,000 square feet. The documents filed with county indicate that the mansion is less than 10,000 square feet. The difference between what was advertised and the actual square footage of the house may come, in part at least, from different measuring methods. While county records may only include square footage of the house itself, a real estate agent or architect may include the square footage of guesthouses, garages, or covered outdoor spaces.

While this is an extreme example of differences between advertised and actual square footages, smaller differences can lead to litigation as well. In New York, a difference of less than 100 square feet resulted in a lawsuit against the real estate broker for breaching his duty to the buyer.

Similar occurrences are not uncommon in commercial real estate, however. In New York City, commercial landlords continue to find new ways to measure spaces. For example, One World Trade Center “grew” by almost half a million square feet when it was remeasured in 2010. In fact, the inflation of usable square feet into rentable square feet has become a standardized practice through the “loss factor.”

With the relatively common practice of inflating or manipulating the square footage of commercial real estate, why are residential buyers still being surprised by square footage differences? Is this an attorney or broker due diligence failure? Besides suing the broker for breaching his duty to the buyer, what other remedies exist? It seems unlikely that real estate attorneys would not be involved in multi-million dollar home purchases, so what is their potential liability?

While the potential remedies for a buyer are unclear, real estate attorneys and brokers should discuss how the square footage of a home or commercial space is measured with their clients.