INVOLUNTARY DEED RESTRICTION WAIVER

             McDaniel Homes owned real estate in Houston. The Meyerland Community Improvement Association was in charge of enforcing deed restrictions. One of the restrictions allowed stairs, steps, and ramps to be located up to five feet outside of the front building setback line. 

            McDaniel sought a declaratory judgment that the restriction had been waived through abandonment. 

            The POA denied the allegations, and filed a motion to dismiss, asserting that McDaniel’s claims have no basis in fact or law. The trial court granted the motion of the POA and dismissed McDaniel’s claim. 

            McDaniel Homes appealed. 

            The Court of Appeals reviewed McDaniel’s assertions that: (a) the POA has not enforced restrictions consistently; (b) there are dozens of properties throughout the neighborhood that violate the restrictions; and (c) the POA has decided to selectively enforce the restrictions against McDaniels and no other developers or property owners. 

            This yielded an analysis of the facts required under Texas law to conclude that restrictions have been abandoned, and enforcement waived. To successfully establish this position, the Court of Appeals determined that the litmus test is: “violations of the covenant then existing are so great as to lead the mind of the average person to reasonably conclude that the restriction in question has been abandoned and its enforcement waived.” 

            To make that evaluation, the Court must consider the number, nature, and severity of existing violations, any prior enforcement of the restriction, and whether it is still possible to realize to a substantial degree the benefits of the restriction despite the violations. 

            The Court of Appeals decided that the facts presented have a basis in law, and cannot be dismissed as overly broad or vague, or improperly fail to allege a claim. The Court refused to rule for McDaniel based on the facts claimed, but presumably if McDaniel can prove the facts alleged in trial court, then the restrictions will fail. 

            The trial court’s judgment is reversed and the case returned for a full trial to allow a jury or judge to evaluate the facts McDaniels alleges. McDaniel wins this round. See McDaniel Homes v Meyerland Community Improvement Association; Case Number 14-22-00854-CV; Texas 14^th Court of Appeals; May 23, 2024: https://scholar.google.com/scholar_case?case=12496832388846844844&q=mcdaniel+homes+llc+v.+meyerland+cmty.+improvement+ass%27n&hl=en&as_sdt=6,44&as_vis=1. 

            Questions / Issues / Comments: 

1.      Am I the only one looking for a timing requirement – at least a suggestion – to support the conclusion that deed restrictions have been abandoned or waived? I find it compelling that timing of the acts leading to the alleged waiver or abandonment was not addressed by this Court of Appeals. Was that omission purposeful? 

2.      Can restrictions be waived or abandoned this easily, and if so, are POA and HOA directors, lenders, developers, tenants, and property owners aware? 

3.      If McDaniels ultimately receives a final Judgment in support of McDaniels’ position, will that be sufficient to cause a title insurance underwriter to remove or amend the exception in an Owner’s Policy and Lender’s Policy related to recorded restrictions at least with respect to stairs, steps, and ramps? 

                                                                        Stuart A. Lautin, Esq.*

* Board Certified, Commercial (1989) and Residential (1988) Real Estate Law, Texas Board of Legal Specialization

Licensed in the States of Texas and New York

  

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

HOW NOT TO RELEASE A MORTGAGE

             Starting in 2010, Jerome Cohen and Shaun Cohen, through their entities EquityBuild, Inc. and EquityBuild Finance, LLC, sold promissory notes to investors. Each note represented a fractional interest in a specific real estate property. Investors were assured returns ranging from 12% to 20%. 

            Separate mortgages on underdeveloped areas of Chicagoland secured the notes. 

            The Cohens had each investor sign a contract granting to EquityBuild the right to service the loans. Consequently, the mortgages were structured so that EquityBuild was the borrower and individual investors were the lenders, “in care of” EquityBuild. 

            The contracts authorized EquityBuild to issue monthly statements and payoff demands, and collect loan payments. The contracts also limited EquityBuild’s power, by requiring written instructions from investors before foreclosure, amendment, or termination of the mortgage debt. 

            However, separately and in addition to the contract, many investors also signed a document providing EquityBuild with the authority to receive payments and issue mortgage releases. 

            In 2017, BC57 loaned $5.3 million to EquityBuild, in exchange for a first mortgage on five properties located on the south side of Chicago. Those five properties were already owned by EquityBuild, and were already subject to preexisting mortgage liens securing individual investors. 

            To deal with the problem of competing first-lien security interests, EquityBuild provided payoff letters and Releases to BC57 and the escrow agent at closing, purporting to pay and discharge the existing loans. The Releases were executed by EquityBuild, with Shaun Cohen signing as the manager of EquityBuild. 

            Individual investors did not sign the Releases. Neither did individual investors receive any monies from BD57’s payment. 

            All of this collapsed in 2018, when the Cohens admitted to the US Securities and Exchange Commission that EquityBuild had funded investor interest payments with later investments. The SEC filed a lawsuit, obtained a temporary restraining order, and the district court authorized the appointment of a Receiver to liquidate the assets of EquityBuild. 

            With approval from the district court, the Receiver sold the five Chicagoland properties and recovered $3 million. The individual investors asserted a claim to those proceeds, arguing that they never received payment or released their mortgages. 

            BC57 disagreed and asserted it had priority. 

            The district court ultimately awarded the funds to the individual investors, concluding that the mortgage releases were defective and that EquityBuild lacked the authority to execute them. 

            BC57 appealed, claiming that its $5.3 million payment was made in exchange for first-lien mortgages. And that the lien positions of the individual investors had been discharged through full payment of their mortgages. 

            The baseline rule, as determined by the Appellate Court, is that payment of a debt secured by a mortgage automatically extinguishes the security interest. BC57 contends that this rule yields the inescapable conclusion that BC57 is entitled to all net funds recovered by the court’s Receiver. 

            In reviewing other appellate decisions, the Court found that there can be circumstances when payment alone does not extinguish a debt. To cause a mortgage debt to be fully discharged, a properly executed, valid Release instrument, is also required. 

            The Releases that were tendered contained fundamental errors. As the most glaring example, the Releases list EquityBuild as the party issuing the releases, even though EquityBuild was the borrower – not the lender or the lender’s agent. 

            BC57’s response is that discrepancies do not invalidate the Releases, because they fall under the legal doctrine of mutual mistake. In reviewing that position, the Appellate Court approved the district court’s decision concluding the opposite. There was no mutual mistake here, rather all of this pertains directly to the Cohens’ business model operated to purposefully obscure legal responsibility and asset ownership. 

            The Releases were facially invalid. Mortgage payment alone does not extinguish a preexisting security interest without a valid Release. Individual investors win; BC57 loses. See SEC v. EquityBuild; US Court of Appeals 7^th Circuit, Case No. 23-1870, May 6, 2024: https://media.ca7.uscourts.gov/cgi-bin/OpinionsWeb/processWebInputExternal.pl?Submit=Display&Path=Y2024/D05-06/C:23-1870:J:St__Eve:aut:T:fnOp:N:3206589:S:0. 

            Questions / Issues / Comments: 

1.      Title insurance for the individual investors and BC57 is not mentioned in this case. My conclusion is that all of this occurred without such coverage. I could be wrong – perhaps there are separate claims against escrow agents and title underwriters – but if so then presumably it all would have been consolidated here, for judicial economy. 

2.      Even if lender title insurance policies had been issued, the same claims and defenses would still have been asserted. But at least one or more “deep-pocket” insurance companies could possibly have been induced to pay claims. 

3.      Putting aside title insurance, the underlying issue is the legal effect of Lien Release documents. It is my impression that not enough real estate lawyers, title agents, underwriters, and escrow officers review these documents other than possibly to verify that the Property description and recording data are correct. The assumption is that mortgage payment equals mortgage release. That will now (should!) change, based on this case. 

                                                                       Stuart A. Lautin, Esq.*

 * Board Certified, Commercial (1989) and Residential (1988) Real Estate Law, Texas Board of Legal Specialization

Licensed in the States of Texas and New York

  

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

ARBITRATION, ROUND NEXT

             Mohammad Rafiei bought a new house from Lennar Homes in 2018. Three years after purchase, Rafiei alleges that the garbage disposal exploded, injuring him. 

            Rafiei sued Lennar for damages over $1 million. The lawsuit was asserted in a Texas District Court. 

            The contract executed between Lennar and Rafiei required that all disputes be submitted to arbitration, including claims of personal injury and issues regarding the enforceability and validity of the arbitration provision. The arbitrator was vested with sole authority to decide everything. 

            The provision incorporated the rules and procedures of the AAA, following its construction industry regulations. If claimed damages exceed $250,000, three arbitrators must resolve the dispute. 

            Each party is required to pay its own costs and expenses of arbitration. 

            Lennar requested that the trial court stop the litigation proceedings, and instead require arbitration as provided in the contract. Rafiei opposed Lennar’s motion, arguing that the arbitration provisions are unconscionable because arbitration costs are prohibitively expensive. 

            To support his response Rafiei submitted evidence that arbitration would cost him $8,025. And that all he could afford was $6,000. If Rafiei is required to use only arbitration he would effectively be precluded from pursuing his claim. 

            The trial court denied Lennar’s motion to stop the lawsuit and instead, require arbitration. Lennar appealed. 

            The court of appeals analyzed the situation and concluded that the trial court was correct. It is unconscionable that Rafiei was forced to use a dispute-resolution forum that he could not afford. This meant that, on a practical basis, he had no access to justice as he could not pay the fees and costs. 

            The court of appeals affirmed in 2022. Lennar again appealed. 

            The Supreme Court considered the concept of unconscionability. A contract is unconscionable and unenforceable when a transaction is so one-sided, with so gross a disparity in values exchanged, that no rational contracting party would have entered it. When a court applies an unconscionability standard to arbitration, the critical issue is whether arbitration is an adequate and accessible substitute for litigation. 

            To be enforceable, the alternative to litigation must be a forum where parties can effectively vindicate their rights. Anything less fails. 

            At trial, Rafiei presented no evidence that he sought a waiver or reduction of AAA arbitration fees and related costs. The court transcripts indicated that Rafiei failed to include a comparison of costs between litigation and arbitration. Further, Rafiei offered no testimony regarding his ability to afford litigation, but not arbitration. 

            Lacking submittals from Rafiei regarding costs between both alternatives other than the conclusion of Rafiei’s lawyers that arbitration costs are “astronomically higher” than litigation, out-of-pocket expenses in litigation are “minimal,” and litigation hearings and trials are “free,” the Supreme Court concluded that Rafiei failed to establish that he could afford litigation but not arbitration. 

            The Judgments of the trial court and court of appeals are reversed. Lennar wins this round but Mohammad Rafiei will have another chance to present evidence that arbitration costs preclude him from seeking justice. The case is sent back to the trial court for further proceedings consistent with the Opinion of the Supreme Court. 

            See Lennar Homes of Texas v. Rafiei; Texas Supreme Court; Case 22-0830, April 5, 2024: https://scholar.google.com/scholar_case?case=3185182584592779686&hl=en&as_sdt=6&as_vis=1&oi=scholarr. 

Questions / Issues / Comments: 

1.      It seems basic that Rafiei would furnish evidence of the cost disparity between litigation and arbitration, and his ability to afford only litigation. Could this have been a trial strategy, hoping Lennar would settle instead of appealing to the Supreme Court? Because if this had gone poorly for Lennar, it could mean that all of its contracts containing arbitration procedures are subject to challenge. 

2.      I am not a trial lawyer. But I am constantly discussing trial and arbitration strategies with litigators in my Firm. It feels like corporate America prefers arbitration for reasons of privacy and the perceived inability of a claimant to present facts to a jury, hoping to receive punitive and exemplary damages. And that plaintiffs typically prefer litigation, wanting to avoid the situation where a win in arbitration results in merely a Decree, which still requires conversion to Judgment via litigation to be capable of court-ordered enforcement. 

3.      In general, Courts find a way to uphold the enforceability of arbitration provisions. Builders, engineers, architects, surveyors, and construction contractors continue to insist on adding arbitration into their contracts. Mandatory arbitration provisions are difficult to challenge. 

                                                                        Stuart A. Lautin, Esq.*

 * Board Certified, Commercial (1989) and Residential (1988) Real Estate Law, Texas Board of Legal Specialization

Licensed in the States of Texas and New York

  

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

CAN YOU RELATE TO CONSTRUCTION LIENS?

             S&H Holdings purchased commercial real estate in 2014. In 2018, S&H engaged Integrated Construction Management Service to construct a new Burger King at the site. 

            ICMS contracted with Nore Electric to furnish materials and services in the construction of the BK. Ultimately, ICMS failed to pay Nore and other subcontractors. 

            S&H sold the BK site to Realty Income Properties, and the deal closed on January 18, 2019. The warranty deed was recorded with the County Clerk two weeks later. 

            In March and April 2019, Nore and other subcontractors recorded construction liens against the BK site. Since neither S&H nor RIP were willing to pay the subcontractors, Nore Electric asserted a lawsuit to enforce its liens. 

            The district court concluded that Nore’s liens were valid and properly attached to the BK site, placing RIP at risk of losing its ownership interest if the liens were foreclosed. The court issued a decree of foreclosure, holding that the transfer from S&H to RIP did not cause the liens to lapse or the subcontractors to waive their lien rights. 

            S&H and RIP appealed. 

            S&H and RIP contend that construction liens can only attach to the contracting owner’s real estate. The appellants further argued that because S&H incurred the debts, but the liens were not recorded until after RIP had become the owner, the liens must fail. 

            The Supreme Court disagreed and found that construction liens relate back to the time work began at the site. Construction liens are considered “inchoate” or “hidden” liens. Consequently, one who buys property within the time a contractor is allowed to perfect the lien takes title subject to construction liens recorded after the date of closing. 

            As a result, even though the liens were not recorded at the time of the sale from S&H to RIP, Realty Income Properties could not be a “bona fide” purchaser. 

            The Supreme Court determined that the ability of a contracting owner’s interest to be subjected to future construction liens passes to the next owner. Perfection of construction liens that relate back in time may lawfully occur following the recordation of a Deed. Or a Mortgage. Security Agreement. Deed of Trust. Financing Statement. Assignment of Rents. UCC-1. &tc. 

            The liens filed by Nore Electric and other subcontractors are valid, and are superior to RIP’s Deed, even though the liens were filed after the date the Deed was recorded. The foreclosure decree is affirmed. The Judgment of the district court is also affirmed; Nore wins; S&H and RIP lose. 

            See Nore Electric v. S&H Holdings; Nebraska Supreme Court; Case Number S-23-282; March 15, 2024: https://casetext.com/case/nore-elec-v-s-h-holdings-llc. 

            Questions / Issues / Comments: 

1.      You are a buyer. Or lender. Maybe even a tenant. You checked title and there is nothing untoward. How do you protect yourself from this anomaly? Obtain affidavits from the seller and borrower. Conduct site inspections to determine if the property has been recently repaired or improved. Obtain construction escrows and holdback accounts, to secure the need to later pay the contractors. Get all-bills-paid affidavits from all major contractors and subcontractors. And of course, purchase the best title insurance policy with extended endorsements. 

2.      This is not an issue unique to Nebraska. It is my impression that most States have a similar process. The lien power of contractors, subcontractors, laborers, material providers, architects, surveyors, engineers, and similar labor and service providers, can be derived from States’ constitutions and supplemented by statutes. Perhaps this is a reflection of our agrarian-based USA societies from 200+ years ago, and the desires of those State legislators who wrote the constitutions and statutes to support the workers and laborers who were (and still are) pivotal to our economic success. 

3.      Conversely, you are a contractor, engineer, architect, laborer, surveyor, custom manufacturer, or material provider, and you haven’t been paid? Happy news, you may not be too late to assert your rights, even if the real estate has been sold. Mortgaged. Leased. Foreclosed by others. 

                                                                        Stuart A. Lautin, Esq.* 

 * Board Certified, Commercial (1989) and Residential (1988) Real Estate Law, Texas Board of Legal Specialization

Licensed in the States of Texas and New York

  

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

IS PROCURING CAUSE [STILL] A THING?

            Catalyst Strategic is a consulting firm that advises companies regarding mergers, acquisitions, and similar. Three Diamond Capital is an equipment rental company based in Houston. Three Diamond engaged Catalyst to help with a sale of its company, and executed a contract accordingly. But in October 2018, Three Diamond decided to stop pursuing a sale and ended the agreement. 

            Still, the two companies continued a working relationship. And in 2019, Three Diamond again sought a buyer and executed another engagement agreement with Catalyst. That agreement stated that Three Diamond would pay Catalyst $25k per calendar quarter, plus a commission upon the sale of Three Diamond. The commission was payable if the deal was concluded from the date of the agreement through the 18^th month following the date of termination of the agreement. 

            Due to the onset of COVID-19, Three Diamond terminated its contract with Catalyst in March 2020. 

            The rental industry recovered, so the CEO of Three Diamond contacted the CEO of Herc Rentals. Herc had initially been sourced through the efforts of Catalyst during the term of the agreement. This time Herc agreed to purchase Three Diamond for $190 million; the deal closed in August 2021. 

            Three Diamond refused to pay Catalyst the separate fee, even though the transaction took place within 18 months after Three Diamond terminated the contract with Catalyst. So Catalyst sued Three Diamond for breach of contract. 

            The trial court determined that Catalyst substantially performed its obligations, and granted judgment for Catalyst. Three Diamond filed a motion for reconsideration, premised on the ‘procuring cause’ doctrine in Texas. The trial court, unmoved by Three Diamond’s request, awarded Catalyst close to $4 million, plus interest. 

            Three Diamond appealed. 

            The Appellate Court reminded us that the procuring cause doctrine is a ‘settled and plain’ rule in Texas, as announced in a Texas Supreme Court case of 2022. Its function is to credit a broker or agent for a commission-generating sale when a buyer is produced through the efforts of a broker or agent. As a consequence, the commission entitlement vests at the moment of procurement, not when the deal closes. 

            The theory of ‘procuring cause’ is only operational when there is no contract that governs how to handle post-termination commissions. Contractual silence, however, leaves the procuring cause doctrine intact. 

            In this situation, the Catalyst contract contained a ‘robust accounting’ of fees, interim fees, completion fees, and post-termination commissions; there is no claim that the agreement was silent on these points. 

            So, although the procuring cause doctrine is indeed still very much a thing, at least in Texas, it is inapplicable here as the contract is crystal clear. 

            Catalyst must win; Three Diamond will lose. See Catalyst Strategic Advisors LLC v Three Diamond Capital SBC LLC; US 5^th Circuit Court of Appeals No. 23-20030; February 22, 2024: https://casetext.com/case/catalyst-strategic-advisors-llc-v-three-diamond-capital-sbc-llc. 

Questions / Issues: 

1.      Be careful. Although the ‘procuring cause’ doctrine may be alive and well, there are statutes that supplant it. As just one example, it is not enough for a real estate broker or sales agent to be the procuring cause of a deal in many States; strict licensure and other requirements must be met before the agent or broker may assert a lawful claim for commission entitlement. 

2.      Further, and although not addressed in this Opinion because there was no need to do so, most States have adopted statutes of fraud that generally preclude oral agreements above a minimum threshold amount, like $500. Do not make the mistake of concluding that a solid argument for a ‘procuring cause’ entitlement means that a written contract is not needed. 

                                                                        Stuart A. Lautin, Esq.*

 * Board Certified, Commercial (1989) and Residential (1988) Real Estate Law, Texas Board of Legal Specialization

Licensed in the States of Texas and New York

  

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

DEFECTIVE ACKNOWLEDGMENT MEANS DEFECTIVE DEED?

             In August 1990 John and Virginia Turcato created separate Living Trusts. John and Virginia each conveyed one-half of their home to each Trust so that title to the residence was owned 50% by John’s Trust and 50% by Virginia’s Trust. 

            John died in 2009. In 2020 Virginia was 94 years old and continued to live at the residence. Virginia wanted to transfer 100% of the home to Darrell Turcato and Robbin Wilkins, two of the grantors’ four children, in recognition of the physical and financial assistance they provided her. 

            A Deed was prepared conveying the home from both Trusts to Darrell and Robbin. Robbin, acting as a Co-Trustee, signed the Deed before a notary. Virginia’s signature was also required, but evidently Virginia signed the Deed out of the presence of a notary since Robbin did not want to take her mother out in public due to COVID and her mother’s frail health. 

            The notary who witnessed Robbin’s signature also acknowledged the deed for Virginia, as the notary had known the family for 20+ years and had previously notarized Virginia’s signature. 

            Virginia died in 2020. Jan Frady and Larry Turcato, the two remaining children of John and Virginia, sought a judicial declaration that the transfer of the home to their siblings was invalid based on the defective acknowledgment and for other reasons. The trial court granted their petition, ruling that the Deed failed and consequently Jan and Larry would become part owners of the property, as provided in the Trusts. 

            Darrel and Robbin appealed, claiming that the Deed was valid and consequently, Jan and Larry have no interest in the residence. 

            To start, the Appellate Court reviewed statutes which require that all deeds must be acknowledged before any notarial officer. Failure to have the instrument properly acknowledged prevents the document from being recorded. And, failure to record it means there is no public record of the transfer. The result is that third parties are unaware of the previous transfer. 

            However, this issue has been litigated previously in many States, as an imperfect acknowledgment or failure to obtain execution by proper witnesses is common. As are other administrative and mechanical errors. 

Consequently, some States have concluded that the failure of parties to follow a statutory requirement like notarization does not always render ineffective a deed or other transfer document as between those who know of its existence, presumably the parties identified in the document. 

            And, depending on the circumstances, perhaps other parties too. 

            The trial court Judgment is reversed; Darrell and Robbin own this property by virtue of the deed signed by all those who are required to sign it, even without a valid notary acknowledgment. See Turcato v. Frady; Wyoming Supreme Court; Case 2024 WY 8; January 23, 2024: https://casetext.com/case/turcato-v-frady. 

Questions / Issues: 

1.      This outcome may be a surprise to some of my loyal readers. And for fair reasons, as who can say for sure which parties to an unrecorded instrument know of its existence, except only for those who signed it. And to that point, absent notary acknowledgments and witnesses, all signatures are subject to challenge as forgeries. 

2.      This must be another place where State legislatures responded to a common problem – failure to dot each i and cross each t – but in making it easier to mortgage and transfer properties perhaps worse problems were created. 

3.      If you were a member of your State’s legislature, would you vote for a law that rendered void all important documents (deeds, mortgages, deeds of trust, ground leases, easements, deed restrictions, wills, trusts, oil and gas reservations, &tc) unless those instruments are either witnessed or signed before a notary? Or is this one of the situations where there is no middle ground and any resolution is imperfect because people will always make inadvertent, ministerial mistakes. 

                                                                        Stuart A. Lautin, Esq.*

 * Board Certified, Commercial (1989) and Residential (1988) Real Estate Law, Texas Board of Legal Specialization

Licensed in the States of Texas and New York

  

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