Wednesday, October 31, 2012

Part Two: Do Non-Representation Provisions Really Work?

Matlock Place Apartments, LP (it’s in Arlington Texas) was controlled by Hagop Kofdarali. Druce Properties, LLC purchased the apartments in 2004. Both were fairly sophisticated owner / operators, with at least some level of experience in managing  multi-family properties.
When Hagop’s sister initially purchased the property in 2002 the occupancy rate was only 40% - 50%. In 2002 and 2003 Hagop spent more than $500,000 in repair and remodel expenses, possibly as a condition to a $1.8 million loan.
Hagop then listed the property with a national brokerage firm. The firm prepared and distributed to Druce a marketing brochure which provided for a 93% occupancy rate and claimed “Major Rehab Just Completed.” Hagop, however, testified at trial that occupancy could fluctuate monthly anywhere from 80% - 93%, and that the rehabilitation was incomplete because the roof repairs and unit-interiors still required work.
Druce and Hagop signed a letter of intent for $2.4 million, which provided a 21-day inspection period as well as a $100,000 credit at closing for “repairs and maintenance.” Druce testified that he personally inspected the property and viewed 10 of the 99 units. He was satisfied with what he saw, and continued with the analysis.
After the contract was signed Druce received 1,500 – 2,000 pages of documents from the property manager. Included within the package were disclosures regarding delinquent rentals and serious criminal activities. Druce claims he did not notice them, since they were “buried” in the pile of paper.
Druce and Hagop closed the deal in July 2004. Druce evidently visited the property a few days before closing and noticed that it looked deserted. During that visit he also learned from an Arlington police officer that the area was well known for drug dealers, addicts and prostitutes. But he bought it anyway, claiming he was financially and emotionally invested in it, thinking that the income stream would be “gigantic.”
After closing the occupancy rate was between 58% and 78%. Druce spent $800,000 to rehabilitate the property, all in an effort to merely break even.
Druce, claiming he relied on Hagop’s representations as contained in the marketing piece and that such reps were untrue, brought a lawsuit seeking damages. The trial court entered Judgment against Hagop for approximately $2.4 million, finding that Hagop committed fraud by failure to disclose.
Hagop’s appeal was primarily centered around the theory that Druce could not have relied on anything that Hagop (or his broker) did or did not say or represent, because of the full-blown “as is, where is, non-reliance” clause in bold, upper case type in the Contract.
The Texas Court of Appeals in Fort Worth agreed with Hagop. Judgment reversed. Hagop wins. Druce loses. A properly worded “as is, where is, non-reliance” clause may still be effective in Texas.
See Matlock Place Apartments v. Druce; No. 02-09-00130; Court of Appeals, Second District of Texas; January 17, 2012.
Lessons learned:
1.      Recently, my son published an article evaluating the continuing effectiveness of “non-reliance” clauses in commercial real estate. Recent Texas Supreme Court authority indicated that such clauses are almost extinct. This Fort Worth Court, however, has a different view.
2.      Sellers should check their Contract forms to be sure they track the language of the “non-reliance” clause in this case as close as possible.
3.      Buyers should check their Contract forms to be sure they track the language of the Italian Cowboys case my son wrote about.

Reprinted with the permission of North Texas Commercial Association of REALTORS®, Inc.

Wednesday, October 17, 2012

Do Non-Representation Provisions Really Work?

My son Jon Lautin is in law school at Boston University. He wrote this, and it is reprinted here with his permission.

Fraud is bad, and courts don’t like it.

Franceso Secchi and his wife Jane Secchi opened a restaurant called Italian Cowboy in Keystone Shopping Center, in Dallas. The land and building was owned by Prudential Insurance Company and had been previously leased to Hudson’s Grill. Evidently Hudson’s struggled to pay rent, and vacated.

The lease contained two clauses relevant to a claim later asserted by M/M Secchi: the first stated that the Secchis did not rely on any representations by Prudential except those stated in the lease (a “Merger” clause). The second contained an “Entire Agreement” clause stating that the lease constitutes the entire agreement and no changes are binding unless signed by both parties.

Before signing the lease the Secchis were assured by agents of the landlord that the building was new, had no problems, was in “perfect condition” and that the previous tenant had no issues with the building. However, immediately after moving in the Secchis noticed that there was a sewer stink permeating the building. After some investigating they discovered that the grease trap was improperly installed which caused the terrible smell.

Both the Secchis and Prudential attempted to fix the problem but were unsuccessful. Before Italian Cowboy was scheduled to open for business, the Secchis realized that the smell prevented the possibility of a successful restaurant. They stopped paying rent and sued Prudential for fraud and negligent misrepresentation. Prudential counterclaimed for breach of contract since the Secchis stopped paying rent.

Numerous facts allowed the Secchis to win approximately $600,000 in damages in trial court. The previous tenants of the building, also owners of a restaurant, notified Prudential of the foul smell long before the Secchis started lease negotiations. Nonetheless, the defendants claimed that they were not aware of the stench when confronted by the Secchis. Prudential reassured the Secchis numerous times before signing the lease that the building was in perfect condition. These statements, determined to be false in the trial court, were enough to prove fraud and negligent misrepresentation.

Or so the Secchis thought.

The Texas Court of Appeals disagreed and held that the lease barred claims for fraud and negligent misrepresentation. The Court of Appeals stated that not all “Representation” clauses bar fraud and negligent misrepresentation claims unless it is clear that both parties intend the clause to be binding. Reverting back to a fundamental principal of American contract law, the Court of Appeals decided that both the plaintiff and defendant had a “meeting of the minds” to bar all fraud claims. Furthermore, the Appellate Court held that there could be no fraud and negligent misrepresentation because the parties were experienced businesspeople and they had competent attorneys negotiating the contract. Therefore, the merger clause is binding since the evidence suggests the parties meant it to be binding.

Or so Prudential thought.

The Supreme Court of Texas reversed the Court of Appeals’ decision. The Supreme Court held that the language of the “Representation” and “Merger” clauses did not show intent to bar allegations of fraud and negligent misrepresentation. The Court further explained that even if the parties intended to release all claims of fraud, the clauses in the contract did not contain “clear and unequivocal language” to that effect.

The ruling in this case may indicate a change in direction for the Supreme Court of Texas. In a landmark case in 1997, Schulumberger Technology Corp. v. Swanson, the Court held that a particular contract with a similar “Representation” clause effectively barred all claims of fraud. While there are differences between the facts of the two cases, the Texas Supreme Court’s willingness to hear the Italian Cowboy case and its decision that fraud was not barred could show that Texas is following other states and taking a hard-line stance on fraud.

See Italian Cowboy Partners, Ltd. v. The Prudential Insurance Company of America; No. 08-0989; Supreme Court of Texas; April 15, 2011.

Lessons learned:

1.      Courts will usually allow a party to stop performing their obligations under a contract if that party was fraudulently induced into entering the contract.

2.      Including clauses that appear to bar fraud claims may not be sufficient to bar fraud claims.

3.      Courts, like juries, can be unpredictable.

Reprinted with the permission of North Texas Commercial Association of REALTORS®, Inc.

Thursday, October 4, 2012

For Sale Cheap – 545 Acres in Wood County

In November 2003 William Earl Norris and Martha Sue Norris decided to sell their farm to Eleanor Fox Davis. William and Martha signed not one, not two, but three – count ‘em three – contracts, all with Eleanor.

In the first contract M/M Norris agreed to sell 215 acres to Ms. Davis. Davis also had the right to acquire more acreage from M/M Norris, being the remainder of the 545-acre farm. In the second, Davis agreed to purchase 10 acres from Norris. The third contract was for approximately 210 acres. The parties closed on the second and third contracts, but left the first pending.

In 2006 Davis sent M/M Norris a letter announcing her intention to exercise the option in the first contract. Counsel for the Norris’ did not agree that Davis was entitled to purchase more property, and consequently M/M Norris did not appear at the time and place designated by Davis for closing.

Davis sued M/M Norris for specific performance or damages. Davis lost. Davis appealed.

The Texarkana Court of Appeals first stated that options must be clearly drafted and the purchaser must strictly comply. The Appellate Court concluded that the contract was unclear as to what, exactly, is required to exercise the option. This conclusion was based primarily on the handwritten statement in the contract that: “SELLER WILL HAVE 9 MONTHS NOTICE BEFORE BUYER WILL CLOSE,” coupled with some additional unclear provisions.

The handwritten clause followed a provision granting Davis “. . . an Option and First Right of Refusal until January 1, 2007 to purchase [the property].” But what is the correlation between the January 1, 2007 deadline and the 9-month notice provision? Must nine-month notice be issued before January 1, 2007, or must the closing be completed by January 1, 2007?

At the trial court M/M Norris won a summary judgment based on the single theory that Davis did not timely exercise the option. The Court of Appeals reversed the decision of the trial court, and remanded the case back to Wood County to figure out what the parties had contemplated to properly and timely exercise the purchase option.

See Davis v. Norris, 06-10-00093-CV, 6th Court of Appeals, Texarkana; October 27, 2011.

Lessons learned:

1.  It appears that no brokers were involved. Thank goodness, since clearly all brokers and agents would have been sued.

2.  Option contracts are tricky. Do not draft option contracts, rights of first refusal, rights of first offer or anything similar, in contracts or leases. Or anywhere else for that matter. Even seasoned lawyers often make mistakes in this area.

3.  Review option language closely. Everything in an option provision must be spelled out with great particularity – timing, property description, pricing, review and due diligence periods, earnest monies or additional deposits, means by which notice must be furnished, title companies, closing documents, prorations, taxes, etc. Tricky stuff. Seriously.

Reprinted with the permission of North Texas Commercial Association of REALTORS®, Inc.