Daily Development for Tuesday, April 29, 2003
by: Patrick A. Randolph, Jr.
Elmer F. Pierson Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin
Kansas City, Missouri
dirt@umkc.edu

BANKRUPTCY; "FREE AND CLEAR SALE;" LEASES:
Devastating Seventh Circuit case permits free and clear sale to wipe out all
lease rights under 365(h).  Precision Industries, Inc. v. Qualitech, 2003
U.S. App. LEXIS 7612 (7th Cir. April 23, 2003)

This case, in the editor's view, is a particularly troublesome one.  It is a
bombshell on the order of magnitude of Durrett and Fleet Factors, and
interested parties should seek to muster support for a petition for en banc
rehearing and, if necessary, a Supreme Court appeal.  It puts virtually all
long term leases and leasehold mortgages in mortal danger when the
landlord files for bankruptcy.

In a case of first impression,  the U.S. Seventh Circuit Court of Appeals has
held that under  363(f) of the Bankruptcy Code, the sale of the
lessor-debtor's real property "free and clear" of any "interest" trumps
365(h) of the Bankruptcy Code, which protects the rights of the lessee when
the lessor-debtor rejects a lease.  As a consequence, all property interests of
the lessee will be destroyed, leaving the lessee with a claim for damages
that may or may not have priority against the sale proceeds, and certainly
won't  satisfy the property expectations of the lessee, or its leasehold
mortgagee.

Section 363(f) provides that the trustee may sell property of the estate "free
and clear of any interest in such property of an entity other than the estate"
if [note the following are in the disjunctive]:  applicable nonbankruptcy law
permits such a sale; such entity consents; the interest is a lien and the sale
price is greater than the aggregate value of all liens against the property; the
interest is in bona fide dispute; or such entity could be compelled to accept
a money satisfaction of the interest.  The parties in this case conceded that
a 363 authorized a sale in this case. [More on this in the comments.]

The debtors (collectively, "Qualitech") owned and operated a steel mill in
Indiana. The lessees (collectively, "Precision") constructed a supply
warehouse at the property, for the sole purpose of providing supply services
for Qualitech. In 1998, Precision entered into a ten-year supply agreement
with Qualitech. If an early termination or default occurred under either
agreement, Precision had the right to remove all improvements and fixtures.
Otherwise, Qualitech could buy the improvements and fixtures for $1 at end
of term.  [Although, arguably, the special facts here tend to differentiate this
case from typical landlord bankruptcy cases, the court makes nothing of the
distinction and its interpretations of Bankruptcy law apply universally.)

Qualitech filed its Chapter 11 bankruptcy petition on March 22, 1999, and
on June 30, 1999, sold substantially all of its assets at auction pursuant to
a sale order "free and clear of all liens, claims, encumbrances, and interest"
under  363(f) of the Bankruptcy Code. The sale order approved the sale to
a group of pre-petition secured lenders for $180 million. Precision, which
had proper notice of the sale, did not object. The purchasers subsequently
transferred their interests in the property to a new entity, ("New Qualitech"),
which assumed the rights of the purchaser under the sale order and took title
to the property. The sale order also provided that the purchaser retained the
debtor's right to assume and assign executory contracts pursuant to  365 of
the Bankruptcy Code. Negotiations subsequently ensued with respect to
assumption of the lease, but were unsuccessful. The result, according to the
Seventh Circuit, was that "Precision's lease and supply agreement were de
facto rejected." By December 3, 1999, Precision had vacated and padlocked
the warehouse on the property. Shortly thereafter, New Qualitech, without
Precision's knowledge or approval, changed the locks on the building.

Precision then filed suit, claiming that its possessory interest in the leased
property, pursuant to  365(h), survived the bankruptcy sale. The
bankruptcy court held that, based on  363(f) and the fact that Precision's
lease was an "interest" under the sale order, New Qualitech had obtained
title to the property free and clear of Precision's leasehold interest. The
District Court reversed, ruling that the terms of   365(h) prevailed over
those of  363(f). The District Court reasoned that there was no statutory
basis for allowing the debtor-lessor to sell its property and terminate an
underlying lease, which would limit the lessee's post-rejection rights solely
to cases where the debtor-lessor retained title and possession of the
property.

The Seventh Circuit reversed the holding of the District Court, noting as a
threshold issue that Precision never objected to the sale order and that
"[s]ale orders are final, appealable orders," i.e., once the appeal period has
expired, res judicata precludes a subsequent lawsuit contesting the order.
The court then examined the meaning of the word "interest" in  363(f)
(which term is not defined in the Bankruptcy Code), and found that based
on applicable case law a leasehold estate was clearly an "interest" subject
to the provisions of   363(f). The court also noted that the parties never
disputed the fact that the conditions of  363(f) (which, standing alone,
authorized the sale of the bankruptcy estate's property, including any
"interest" therein, free and clear of the lessee's possessory interest), had
been complied with.

The court then turned its analysis to  365(h), and concluded that the terms
of this section did  not supersede those of  363(f). The court reasoned that
because  363(f) does not contain any cross-reference subordinating its
provisions to the lessee protections of   365(h), Congress did not intend
for   365(h) to limit  363(f). (According to the court, "Congress
authorized the sale of the estate property free and clear of 'any interest,' not
'any interest except a lessee's possessory interest.'" The court then held that
 365(h) applies only where the trustee (or debtor in possession) actually
rejects the lease, whereas in the present case a statutory sale of the property
(which was leased) had occurred. According to the court, "[t]he two
statutory provisions thus apply to distinct sets of circumstances.".

 Finally, the court ruled that  363(e) provides a mechanism for lessees to
protect their interests, i.e., it directs the bankruptcy court upon the request
of any party with an interest in the property to be sold or transferred, to
"prohibit or condition such . . . sale . . . as is necessary to provide adequate
protection of such interest."  The court reasoned that the lessee therefore
was not without an adequate remedy to protect its interests, and that while
it was not guaranteed continued possession of the property, it was entitled
to adequate protection and could seek to "be compensated for the value of
its leasehold interest --  typically from the proceeds of the sale." [but see
comments below about the inefficacy of this protection. Ed.]

The court also found, conversely, where the property is not sold and the
lessor-debtor remains in title and possession and rejects the lease, the lessee
is entitled to invoke its rights under   363(f) and remain in possession.
Thus, according to the court, both statutory provisions are given effect and
are not in conflict. The court also reasoned that its interpretation "is  . . .
consistent with the process of marshalling the estate's assets for the twin
purposes of maximizing creditor recovery and rehabilitating the debtor."

Comment 1: There is obviously a major philosophical disagreement
between the District Court and Appeals Court panel as to the proper
application of the relevant statutory provisions, with both camps claiming
that applicable case law (which, as the District Court noted, is divided on
the issue) and legislative history support their respective positions.

It is interesting that the Seventh Circuit's statement (in connection with its
ruling that that  363(f) trumps  365(h)) that, "Where the property is not
sold, and the debtor remains in possession thereof but chooses to reject the
lease, section 365(h) comes into play and the lessee retains the right to
possess the property," is exactly the reason that the District Court held that
 363(f) should not trump  365(h) ("There is no statutory basis for
allowing the debtor-lessor to terminate the lessee's possession by selling the
property out from under the lessee, and thus limiting a lessee's
post-rejection rights solely to cases where the debtor-lessor remains in
possession of the property."

Comment 2:  The court's holding that   365(h) applies only where the
trustee (or debtor in possession) actually rejects the lease, as opposed to the
situation where a statutory sale under  363(f) occurs with respect to leased
property, and its statement that "the two statutory provisions apply to
distinct sets of circumstances," appears to be a distinction without a
difference because the result is exactly the same in either scenario if, as the
Seventh Circuit ruled in this case,  363(f) trumps   365(h). This appears
to be a somewhat disingenuous attempt by the Seventh Circuit to shoehorn
the facts into the statutory interpretation the court desires in this case.

Comment 3: Read again the language of 363(f) set forth in the text above.
Which of those disjunctive conditions typically would apply to a lease?  The
editor proposes that none of them would.  Here, the tenant didn't object to
the sale, which gave the purchaser the right to avoid executory contracts
(which the court ultimately interprets to include avoidance of any 365(h)
rights of the tenant).  But it would appear to be possible to object in the next
case that 363(f) does not permit a sale free and clear of a lease because the
lease does not fit within any of the conditions supporting a free and clear
sale.  Note that, because of the problems discussed in the next comment, if
the judge disagrees, an appeal will be quite expensive.  It is vital that the
real estate community find a way to accomplish and win appeals of this
interpretation of 363(f) at an early stage.

Comment 4:   It is important to note that there is not really much good news
in  the court's suggestion that the lessee has the ability to avoid the terrible
consequences of the destruction of its lease by asking the bankruptcy court
to condition its sale so as to preserve the lease.

It is true that the lessee normally can get notice of the proposed sale.
Although outside of a bankruptcy case, the seller and purchaser generally
are free to keep a potential sale confidential, . In bankruptcy, the sale must
be made public by the filing of a motion in the bankruptcy court requesting
the court's approval of the sale. Notice of the sale must be provided to all
creditors, unless the court limits notice to appointed committees, such as the
unsecured creditors' committee and others who have formally requested
notice of all matters arising in the case.

It is further true that there is language in the Code that suggests that a lessee
can qualify for protection from a wipeout at the "free and clear sale."
Section  363(e) provides that upon request of any entity that has an interest
in such property, the court shall prohibit or condition such sale "as is
necessary to provide adequate protection of such interest."  But if the court
refuses to do this, and the sale proceeds, the sale is final.  When the
bankruptcy court has approves the sale of property of the estate by a trustee,
 363(f) provides that the buyer acquires title free and clear of all claims in
bankruptcy and the property may not be brought back into the estate in the
absence of fraud or collusion in the sale. Section 363(m) provides that the
reversal or modification on appeal of a sale authorized by the court does not
affect the validity of the sale to an entity that purchased the property in good
faith unless such authorization and sale were stayed pending appeal.  Thus,
unless the party appealing a sale order obtains a stay pending appeal, a
good-faith purchaser of assets is protected from reversal on appeal. The sale
order often will contain an express finding of good faith as well as language
similar to the following:

     Pursuant to 11 U.S.C.  363(m), absent a stay of this Order pending
     appeal, the reversal or modification on appeal of this Order, or any
     provision thereof, shall not affect the validity of any sale transaction
     approved hereby which is consummated prior to such stay, reversal
     of modification on appeal.

Under Rule 6004(g) of the Bankruptcy Rules, an order authorizing the use,
sale, or lease of property is automatically stayed until the expiration of 10
days after entry of the order, unless the court orders otherwise. The trustee
(and the purchaser) likely will seek to have the sale order contain specific
language that, notwithstanding Rule 6004(g), the order is effective
immediately (the same is true, under Rule 6006(d), for an order authorizing
the trustee to assign an executory contract or unexpired lease).

In order to stay the sale on appeal of the judge's order, a lessee have to post
an appeal bond.  The same judge who has already determined that it is in the
best interest of the estate to wipe out the lease is the one who decides the
amount of the bond.  In many "big ticket" bankruptcies these days, the
debtor's properties are packaged and sold in a single bundle, and many
lessees cannot afford to post a bond to block a $200 million sale in order to
protect their lease on a $10 million part of the package.

Reporter's Comment 5:  The liens and claims that are cut off in a 363(f) sale
attach to the proceeds of sale.  Thus, there is some chance for the sold out
lessee to recoup some damages with a priority claim other than as an
unsecured creditor.  But will there be any money to reach?  Secured
creditors will be feeding at the same trough, and remember that in a multi-
parcel sale it will be quite difficult for the sold out lessee to segregate
individual value from the parcel it occupied.  Further, how will the lessee
be able to prove damages?  Establishing the value of a prematurely
terminated long term lease has always been a major problem for state
courts.  Why will it be any different in bankruptcy?   The same goes for lost
business expectations.  And then there are the leasehold mortgagees, who
undoubtedly will be elbowing the tenant aside to get satisfaction of their
own mortgage debt (if they can).  They will be seeking big prepayment
premiums for the forced sale, based upon yield maintenance clauses that
will also drain any possible value from the tenant.

Reporter's Comment 6:    If we get to apply Section 365(h), there is indeed
protection for the lessee.  Although a lessor who files for reorganization
may seek approval to reject a lease,  the lessee then has the option to remain
in possession for the balance of the lease term and any renewal or extension.
Section 365(h)(1)(A)(ii) provides that the lessee may retain those rights in
the lease that are in or appurtenant to the real property, "including rights
such as those relating to the amount and timing of the payment of rent and
any right of use, possession, quiet enjoyment, subletting, assignment or
hypothecation," to the extent that such rights are enforceable under
applicable nonbankruptcy law.

BANKRUPTCY; LEASES; ASSUMPTION AND REJECTION;
ASSIGNMENT; RESTRICTIONS ON ASSIGNMENT; SHOPPING
CENTERS: Shopping Center landlord may not enforce use clause
restricting use to identified retail outlet and must demonstrate scheme of
integration of tenant uses into a viable "tenant mix" through its leasing
policies in order to argue that a change of use upon assignment is protected
by "tenant mix" considerations under Bankruptcy Code Section 365(b)(3).
LaSalle National Trust v. Trak Auto Corp., 288 B.R. 114, 2003 U.S. Dist.
LEXIS 6029 (1/10/03)

Bankrupt tenant was withdrawing from all its auto parts stores in a four
state region.  This included the store at tenant's retail center, which
consisted of twenty five "commercial locations," nearly all of which were
retail stores.  Tenant proposed to affirm the lease and assign it to a new
tenant who would operate a discount clothing operation.

Landlord objected on the grounds that the new tenant's use was inconsistent
with the use clause, which required that the store be operated as a "Trak
Auto Store," and in addition interfered with the tenant mix.  Landlord's
expert testified that the percentage of clothing stores in Landlord's center
already exceeded an optimal mix, and that committing the large floor space
of this store to clothing would be very harmful to the viability of the center.
Landlord's expert testified that the national average for clothing stores in
retail centers was 10%, while the percentage following the assignment in
this case in Landlord's center would increase to 20.8%.

Landlord's center was more like a "downtown shopping district" in that
there were nine other stores located in building contiguous to Landlords
stores that were virtually indistinguishable to customers from the stores
operated by Landlord.  Further, there were 28 more stores directly across the
street from Landlord's properties.  Landlord had no control, of course over
operations in any of these properties.   The Bankruptcy court had found that
the interests of "tenant mix" raised by Landlord were relevant only if
landlord operated a "shopping center" entitled to special protection against
assignment as set forth in 365(b)(3) of the Bankruptcy Code, and
Landlord's properties did not satisfy the test for a "shopping center."

The court here affirms the ruling of the Bankruptcy Court on the following
points:

1.  The use clause was an effective restraint on alienation of the lease and
could be avoided in bankruptcy.

2.  The special provisions of Section 365(b)(3) dealing with preservation of
landlord's interest in synergy in a shopping center may have been
applicable here even though landlord's space was not a true center.  The
trial court should have taken more evidence on the point.

3.  Nevertheless, even if this was a true center, landlord's arguments
concerning the negative impact of the increase in retail clothing space were
unfounded.

In determining that the use restriction operated as a de facto restriction on
assignment, the court relied heavily on In re Rickels Home Centers, Incl,
240 B.R. 826 (Bkrtcy. D. Del. 1998).  (The DIRT DD for 8/11/98) In
Rickels, the Delaware court held that restrictions on the purpose and size of
the store operations in a shopping center were de facto restrictions on
assignment and invalid under the Bankruptcy Code.

With respect to the specific provisions of the use clause, the court had little
problem with interpreting the clause, in context as a de facto restraint on
leasing.  Although the Bankruptcy court had  noted that the area was
saturated with auto stores and no prospective assignee would even bid on
the store as limited to that purpose, the court on appeal elected not to rely
upon that analysis.  Instead, it noted that the use limitation was not only to
auto parts stores, but to an auto store denominated "Trak Auto, " and that
this restrictions in effect prohibited leasing to anyone but the original
bankrupt tenant.  Clearly in the view of the court, this was a de facto
prohibition on leasing inconsistent with the policies of the Bankruptcy
Code.

Landlord relied upon a more recent Delaware Bankruptcy case, Sun TV &
Appliances, Inc., 234 B.R. 370 (Bkrtcy. D. Del. 1999), for the proposition
that a restriction on use would be upheld even when there was an impact on
assignability.  The court here cited to the Sun TV case a number of times,
but barely discussed it at all.  Indeed, it is a strong case for recognition of
the need for preservation of tenant mix.  It makes the point explicitly that
the value to the estate of assignment to a non-conforming assignee ought
not to matter at all if there is danger to the viability of the center.

Indeed, the specific language of 365(b)(3) seems to require rigid adherence
both to the requirements of a use clause and to recognition of tenant mix:

     (3) For the purposes of paragraph (1) of this subsection and
     paragraph (2)(B) of subsection (f), adequate assurance of future
     performance of a lease of real property in a shopping center includes
     adequate assurance--
     (A) of the source of rent and other consideration due under such
     lease, and in the case of an assignment, that the financial condition
     and operating performance of the proposed assignee and its
     guarantors, if any, shall be similar to the financial condition and
     operating performance of the debtor and its guarantors, if any, as of
     the time the debtor became the lessee under the lease; (B) that any
     percentage rent due under such lease will not decline substantially;
     (C) that assumption or assignment of such lease is subject to all the
     provisions thereof, including (but not limited to) provisions such as
     a radius, location, use, or exclusivity provision, and will not breach
     any such provision contained in any other lease, financing
     agreement, or master agreement relating to such shopping center;
     and  that assumption or assignment of such lease will not disrupt
     any tenant mix or balance in such shopping center.

The court here noted that other courts have construed this statute to require
that there actually be a designed tenant mix that deserves protection.  The
simple presence of a shopping center is not enough if there is no evidence
of an operating scheme to achieve tenant mix.  It is true that the Sun TV case
did emphasize the special integrated nature of the stores in that complex
(which also was not a classic "mall-type" center.  Although the lease in
question was not a percentage lease, many other stores in the center were,
and stores were expected to draw customers not only to their own location
but to others.

In the instant case, however, the court noted, first, that landlord had very
little control over tenant mix because there were so many other stores
nearby and that, second, most of the arguable objectives that could be
achieved by restricting the instant store to an auto parts outlet were not
proven.  Other stores in the center already sold auto parts, and there were
other tenants that drew male shoppers that were the primary anticipated
customers of an auto part store.  The court also noted that many of the other
leases in the center did not restrict the amount of space that could be
devoted to the sale of clothing, thus belying the landlord's claim that there
was a scheme that relied upon a limitation on the amount of space devoted
to such a purpose. In short, the landlord did not demonstrate that "the
alleged tenant mix was part of the bargained-for-exchange of its leases and
the leases of the other tenants."

Comment 1: The editor, and many commentators, viewed the Rickels case
as a disastrous mistake.  Its interpretation of space restrictions as
inconsistent with assignments basically gutted the essence of 365's special
protections for shopping centers.  On appeal, the holding in Rickels was not
exactly affirmed and not exactly reversed.  Instead, the appeals court got
caught up in procedural detail that operates to the disadvantage of the
landlord's making a case, but did not expressly find that 365(b)(3)  could
be so summarily ignored.   Indeed, the subsequent holding in Sun TV,
coming from the same judicial district, was a distinct ray of hope on the
Rickels issue.

This case does not go nearly as far as Rickels, although it is disconcerting
that it cites it with such approval.  Certainly a use restriction that says, in
effect, there can be no assignment to anyone who does not use the original
tenant's name is very, very restrictive.  Although the statute says expressly
that use provisions are to be protected, regardless, if there's a shopping
center, one can imagine a court concluding that the overall purpose of
permitting tenants to assign leases except when shopping center's business
synergy is endangered would be best served by bypassing such a provision.

The bottom line, then, is that landlords ought not to view tenant-specific use
clauses as likely to do them much good in a tenant bankruptcy.

Comment 2: Again, the court's conclusion that there really was no "tenant
mix" consideration to be taken into account here, since the landlord had not
made an adequate showing that it had developed a tenant mix concept, also
provides a good practice lesson.  To the extent possible, tenant mix
considerations should be made explicit.

Of course, competitive factors and available tenants will compel some
variation on tenant mix from time to time, but there could still be a kind of
"master business plan" that contemplates alterations and variations, and a
history could be kept of when and how these alterations and variations came
about.  As the court focusses upon whether tenant mix is a part of the
overall leasing bargain for the landlord and each tenant, this master plan
backdrop could be a very useful document.  Is it practical?  Who knows.
The editor is in the suggestion business, not the retail business!

Also see:  In re Paul Harris, 1992 Bankr. LEXIS 2418(U.S. Bktcy Ct., S.D.
Ind.) (assignment of a women's apparel store to a maternity store, despite
lease requiring that tenant operate under same name and for same purpose;
ct. held that such provision was "antiassignment"clause and invalid).

BANKRUPTCY; PROPERTY OF THE ESTATE; SINGLE MEMBER
LLC'S:  Efficacy of a single-member LLC as an asset-protection vehicle
thrown into doubt.  In re Ashley Albright, 2003 Bankr. LEXIS 291
(Bankr. D. Colo. April 4, 2003),

Debtor, who filed a Chapter 13 bankruptcy petition that was later converted
to a Chapter 7 liquidation, was the sole member and manager of a Colorado
LLC at the time of the filing. The LLC was not a debtor in bankruptcy. The
Chapter 7 trustee contended that because Debtor was the sole member and
manager at the time Debtor filed bankruptcy, the trustee now controlled the
LLC and could therefore sell the real property owned by the LLC and
distribute the net sales proceeds to the bankruptcy estate.

Debtor argued that the trustee acted only for Debtor's creditors and at most
was entitled to a statutory charging order (against distributions made on
account of Debtor's LLC membership interest) and could not assume
management of the LLC or sell its property.

The court, however, disagreed.  It  referred to the Colorado LLC statute,
under which Debtor's membership interest constituted the personal property
of the member. According to the court, "[b]ecause there are no other
members in the LLC, the entire membership interest passed to the
bankruptcy estate, and the trustee became a 'substituted member.'" The court
also stated that, "upon the Debtor's bankruptcy filing, the Trustee now
controls, directly or indirectly, all governance of that entity, including
decisions regarding liquidation of the entity's assets." The court reasoned
that because there were no other members in the LLC, no written
unanimous approval of the transfer was necessary, as would be the case
under Colorado law if there were other members - no matter how small such
other membership interests may be.

Colorado's LLC statute, similar to those in other states, provides that if the
unanimous consent of all members in a multi-member LLC is not obtained,
the bankruptcy estate is only entitled to receive the bankrupt member's share
of the profits or other compensation that the bankrupt member was
otherwise entitled to, and would not be entitled to any role in the voting or
governance of the LLC. However, in a footnote the court stated that this
statutory limitation "does not create an asset shelter for clever debtors.  To
the extent a debtor intends to hinder, delay or defraud creditors through a
multi-member LLC with 'peppercorn' co-members, bankruptcy avoidance
provisions and fraudulent transfer law would provide creditors or a
bankruptcy trustee with recourse.".

The court rejected Debtor's assertion that the trustee should be entitled only
to a charging order, finding that a charging order existed only to protect
other members of an LLC, and in a single-member LLC there were no
non-debtor members to protect. The court ruled that the trustee, as the sole
member of the LLC, therefore controlled the LLC and could cause the LLC
to sell its property and distribute the net proceeds to the bankruptcy estate,
or alternatively the trustee could elect to distribute the LLC's property to the
bankruptcy estate and then liquidate the property himself. However, the
court did permit Debtor to make a claim for her post-petition mortgage
payments to preserve the real property of the LLC, which was now an asset
of the bankruptcy estate.

Reporter's Comment 1:   Under most state LLC statutes if a member files
a bankruptcy case the LLC automatically dissolves (unless otherwise
specified in the operating agreement). Is this provision of a state LLC
statute overridden by the Bankruptcy Code because it constitutes an *ipso
facto* clause (i.e., a clause that modifies or eliminates a party's contractual
rights solely because of a bankruptcy filing) which is unenforceable under
sections 541(c)(1), 363(l) and 365(e) of the Bankruptcy Code?

The answer may depend on whether the articles of organization and
operating agreement are regarded as executory contracts (i.e., contracts on
which performance remains due to some extent on both sides). The question
then becomes whether these documents are "organic" governing documents
(as opposed to executory contracts) and whether a bankruptcy court, even
if it held the documents to be executory, would enforce the documents with
the sole exception of the bankruptcy-remote provisions if the agreements
were rejected, or permit such rejection to cause a dissolution of the LLC
without providing at least a "winding down"
period.

Reporter's Comment 2:   Because LLCs are still relatively new state-law
creations, the treatment of these entities in bankruptcy is uncertain, i.e., will
they be treated as partnerships or corporations for bankruptcy purposes?
See In re ICLNDS Notes Acquisition, LLC, 259 B.R. 289, 292 (Bankr. N.D.
Ohio 2001) ("an LLC is neither a corporation or a partnership, as those
terms are commonly understood. Instead, an LLC is a hybrid"). This
uncertainty is especially troublesome with respect to single-member LLCs.
This is because if an LLC is treated as a partnership, it could dissolve upon
the bankruptcy of its sole member and its assets distributed to creditors and
the bankrupt member (or, as in the Albright case, to the trustee of the
bankruptcy estate). If, on the other hand, the LLC were treated as a
corporation, it would not dissolve upon the bankruptcy of the last remaining
member, although the member's ownership interest could be transferred.

Some commentators believe that, at least under the Delaware Limited
Liability Company Act ("DLLC Act"), an LLC should be treated as a
corporation because the LLC operating agreement is similar to a certificate
of incorporation and a member's interest is analogous to a share of stock in
a corporation. See Larry E. Ribstein and Robert R. Keatings, Limited
Liability Companies,  14.04, at 14-18 (2000) ("[F]rom a policy standpoint,
LLCs probably should be considered corporations for bankruptcy purposes
because the special bankruptcy provisions that apply to partnerships
primarily relate to the general partner's duty to contribute to payment of the
firm's debts"); Carter G. Bishop and Daniel S. Kleinberger, Limited
Liability Companies Tax and Business Law, 1.04 (2)(a) (1999).

Reporter's Comment 3:   Since 1998, single-member LLCs have become
very popular in securitized and structured-financing transactions because of
their tax advantages, flexibility and low transaction costs. However, there
is a question as to whether a single-member LLC will continue to exist upon
the sole member's bankruptcy, death, or dissolution.  There is very little
legal precedent or case law on this issue.  The governing law must be
consulted to see if it allows for the continued existence of the LLC after the
sole member's bankruptcy or dissolution.  For example, the DLLC Act
(under which many LLCs are formed because of the favorable statutory
framework) specifically provides for the LLC's continued existence under
such circumstances, unless otherwise provided in the operating agreement.
See Del. Code Ann. tit. 6,
18-801 (a)(4). The DLLC Act also provides that by default an LLC's
existence is perpetual. Del. Code Ann. tit. 6,  18-801 (a) (1). A
single-member LLC, whose only member is the entity or individual in
question, requires the creation of only one entity, the LLC itself.  See Larry
E. Ribstein and Robert R. Keating, Ribstein and Keating on Limited
Liability Companies, Ch.
4, p.3 (1996) (Fall 2001 Update).

Reporter's Comment 4:   Bankruptcy courts generally look to state law to
determine whether dissolution occurs upon the bankruptcy of the sole
member of a single-member LLC.  Under the DLLC Act, for example, an
LLC whose member is in bankruptcy would be treated as if it were a
corporation with a bankrupt shareholder and the bankruptcy would not
cause a dissolution.  If a Delaware LLC agreement is properly drafted, under
Delaware law even the bankruptcy of the last remaining member will not,
by itself, cause the dissolution of the LLC.

Furthermore, under the DLLC Act, it is permissible to admit "springing
members," i.e., a person may be admitted as a member (including as the
sole member) without acquiring an interest in the LLC or being required to
make a capital contribution. See Del. Code Ann. tit. 6,  18-801(a)(4) and
(b); James G. Leyden Jr., A Key State's Approach to LLCs: Delaware Can
Be Different, 9-MAY Bus. L. Today 51, 63 (2000).

Reporter's Comment 5:    The single-member LLC operating agreement
should specifically provide for the continued existence of the LLC upon the
sole member's dissolution or the termination of its membership in the LLC.
The operating agreement also should condition the sole member's right to
withdraw on the existence of a succeeding member (or "springing" member)
who would be capable of continuing the operations and existence of the
LLC..   Typical "bankruptcy remote" provisions, which are promulgated by
rating agencies and appear in almost all LLC formative documents
involving securitized loan transactions, also would be applicable with
respect to single-member LLCs. Legal opinions as to the bankruptcy
remoteness of the borrowing entity (and perhaps its principals) are also
usually also required by the rating agencies, such as Moody's, Fitch, and
Standard & Poor's, in connection with securitized financing transactions to
provide support for a high rating. This is especially so in connection with
a single-member LLC, where the bankruptcy treatment of such a vehicle is
less clear. The enforceability of choice-of-law provisions in LLC documents
is also extremely important, because the ability of a single-member LLC to
continue in existence after the departure of the sole member is often
dependent on state law that enables the single-member LLC to continue in
existence.

Reporter's Comment 6:    The DLLC Act also specifically provides for the
exercise of a deceased or terminated member's rights by a personal
representative. Del. Code Ann. tit. 6,  18-705.  The DLLC Act also
provides for termination of an LLC without members, but contains a
mechanism to prevent the winding up the LLC.

The DLLC Act permits the admission of a personal representative of the
departed member within 90 days after such departure, if the representative
agrees in writing to be admitted or such representative is admitted pursuant
to a provision in the LLC agreement providing for such admission on the
departure of a member. See Del. Code Ann. tit. 6,  18-801(a)(4).

Reporter's Comment 7:   It has been suggested that the single-member LLC
operating agreement provide (where permitted) that a board of managers,
containing at least two "independent" members, would govern certain
management and operating decisions. The operating agreement would
provide that no bankruptcy filing or related action could occur without the
unanimous consent of all the board members. See Alexander Dill, Yaron
Ernst, Michael Kanef, and Adam Toft, Handle With Care: Single Member
LLCs in Structured Transactions, Special Report, Moody's Investor
Services, March 19, 1999. However, if the outside managers are not truly
independent and do not perform their fiduciary duty to the entity (and to all
creditors, including unsecured creditors), as opposed to specific third-party
creditors, the goal of bankruptcy-remoteness may not be achieved.

The inclusion, however, of such a "bankruptcy remote provision" in an LLC
operating agreement, especially one that requires approval of certain entity
actions by an independent director who is in actuality under the influence
of a major secured lender, may later be determined by a bankruptcy court
to run afoul of the Code's prohibition of provisions preventing an entity
from commencing a bankruptcy reorganization.

Also, several courts have held that as an entity approaches insolvency, i.e.,
becomes unable to pay its debts as they become due in the ordinary course
of business, the directors owe a fiduciary duty to all the creditors of the
company. See, e.g., In In re Kingston Square Associates, 214 B.R.
713, 735 (Bankr. S.D.N.Y. 1997). In this case, the debtor was unable to
obtain its board of directors' permission to file a voluntary bankruptcy
proceeding because of the refusal of the "independent director" to authorize
such a filing. The debtor then orchestrated an involuntary filing by certain
unsecured creditors (with the help of the debtor's limited partners). The
bankruptcy court found that such actions were not taken in bad faith and
that the debtor reasonably believed that the best course of action for the
entity was to file bankruptcy. The court further held that such actions were
necessary because the "independent director" had abdicated his fiduciary
duty to the debtors, creditors and limited partners in favor of the interests
of the mortgage lender. The court therefore refused to grant the secured
creditor's motion to dismiss the involuntary filing. The court also appointed
a Chapter 11 trustee, and held that the debtor's board of directors had
violated their fiduciary duties owed to the debtor, its limited partners and
its unsecured creditors and interest holders, in favor of the interests of the
mortgage lender. The court declined, however, to specifically nullify the
debtor corporation's bylaw provision containing the bankruptcy-proof
provisions as against public policy.

Reporter's Comment 8:   Another proposed method of enhancing the
bankruptcy-remoteness of a single-member LLC is to structure the entity so
that the sole member is itself a single-purpose bankruptcy-remote entity.
Unlike an individual, who can (and eventually will) die, the sole member
of a single-member LLC that is itself structured as a single-asset
bankruptcy-remote entity will have a perpetual existence. However,
borrowers may resist the imposition of such a requirement because they lose
some of the flexibility and cost-saving advantages, including direct personal
ownership, of single-member LLCs.

The Reporter for this item is Jack Murray of First American Title Insurance
Company.

BROKERS; LISTING AGREEMENTS; COMMISSION:   Although
a series of letters and other documents, taken together, may satisfy the
Statute of Frauds applicable to brokerage agreements, the requirement that
the writing set forth either a dollar amount or the rate of commission cannot
be satisfied by specifying or implying a "reasonable" commission.  C&J
Colonial Realty, Inc. v. Poughkeepsie Savings Bank,355 N.J. Super. 444,
810 A.2d 1086 (App. Div. 2002).

This lengthy case reads like a bad screenplay - "The Broker Who Wouldn't
Go Away."  I understand that there's an HBO special. . .

A bank, through its subsidiary, became the half-owner (with RTC) of an
abandoned and partially completed condominium development as a result
of foreclosure proceedings.  A real estate broker became aware of the
property and called the bank's contact person.  The bank told the broker that
the bank did not yet own the property free and clear and thus could not
convey title.  The broker also was advised that the bank was not going to list
the property with a broker "because the property had already elicited
substantial unsolicited interest from developers and the Bank had been
successful in selling properties directly."

The broker told the bank's officer "that he wanted to introduce the property
to some people he worked with on an ongoing basis ... [and the bank's
officer] said that would be fine but that the bank would 'not take a dime less
than three million dollars.'" The broker also understood that there would be
other financial requirements for any offer.  The bank's officer invited the
broker "to send him a letter with his business card requesting a sales
information package for the property," and when asked if the broker could
visit the site, he said, "sure, be my guest."

The bank never sent a package about the property.  Nonetheless, the broker
wrote to the bank saying, "I may be a principal in a group to buy the project
but failing that I will offer it out at 3 million plus my commission to
preserve the bank's net figures desired."  There was no response to this
letter.
The broker visited the site with his builders, but they were not interested or
able to meet the bank's cash requirements.  The broker then contacted
various developers and showed the property only to those people who
signed a "notice of showing" which stated that the broker "had the seller's
authorization to offer the property and that the seller would pay the
commission."  None of those notices were ever sent to the bank.
Eventually, after unsuccessful attempts to reach the bank's officer, the
broker wrote to the bank's president listing a number of people who had
been shown the property by the broker.  In each case, the broker had quoted
a purchase price, which after a ten percent commission would still net the
bank more than the minimum amount the bank had been seeking.

The bank's president responded by pointing out that the original bank
officer was "responsible for managing and marketing" the asset and pointing
out that the broker had never been given authorization "either verbally or in
writing to show this property to a prospective purchaser."  Even before the
broker received that letter, he arranged to show the property to two
individuals who had responded to the broker's newspaper advertisements
and signed a "notice of showing" indicating that they had visited the bank's
property.  The notice included an acknowledgment by the two individuals
that the broker had informed them that the broker would claim a ten percent
commission on the sale of the property and that the broker would be
specified as the procuring broker.  One of these two individuals then met
with the bank's original officer.

Another real estate developer became aware of the availability of the
property through a chain of contacts in the form of social contacts and the
like that began with one of the two individuals that the broker had
introduced to the property.  Eventually, it appeared that this developer
would be purchasing the property.  At that time, the bank's attorney wrote
to the real estate broker alleging that the broker, "without authority [had]
represented to certain potential purchasers that [it had] authority to show
this property."  It went on to say, "[y]ou have no listing agreement.  Without
such a listing, the owners are not obligated to pay you commission, no
matter how many telephone calls or letters your [sic] may sent [sic] to my
client alleging that such a listing exists."

The broker responded that it wanted either an exclusive listing or some
other form of authorization to offer the property for sale on an open-listing
basis.  The broker's letter reiterated that based upon its earliest discussions
with the bank's original officer, the broker believed that it had authorization
to offer the property to several potential buyers.  The bank instructed its
attorney to send the broker a "get-out-of-our-hair letter" saying, among
other things, that the broker had no authority to represent the bank.
Eventually, the property was sold and the buying entity did not include any
of the individuals that the broker had introduced to the property.  It did
include people that learned of the property through those individuals.  The
sales contract included a provision whereby the buyer agreed to indemnify
the bank for any commission claimed by the broker.  A separate agreement
between the buyer and one of the two individuals that the broker had
introduced to the property was executed, whereby the buyer paid that
individual on a monthly basis.  That agreement included a provision
whereby the individual agreed to indemnify the buyer against brokerage
commissions from the original broker.

The broker sued for its commission, and after a lengthy bench trial, the
lower court found in favor of the broker (yes, the broker!!) and awarded a
commission based on a five percent rate.  The bank and the buyer were held
to be jointly liable.  Each appealed and the broker appealed the application
of only a five percent commission.

As to the rate of commission, the bank had testified that the typical
commission paid by the bank was two percent or two and one-half percent
and the largest was four percent, which was warranted where there was a
low purchase price.  The bank also testified that it had used a broker on only
two or three of the ten or twelve sales it had accomplished in the prior two
years.  One of the buyers explained that he was accustomed to paying on a
sliding scale beginning with a five percent commission and running down
to about a two percent commission.  The broker argued that he first told the
bank that his commission "could be five or ten" percent and that the bank
responded "I don't care what you charge."  The broker asserted that the
commission on "raw land" was typically ten percent.  The Appellate
Division found the legal basis for the lower court's commission decision to
be less than clear.  It also found the factual basis for the lower court's
conclusions to be "somewhat contradictory."

The bank argued that the broker did not have an enforceable commission
agreement because it failed to satisfy any element of the Statute of Frauds.
The lower court had found that the Statute of Frauds was "fully satisfied by
the series of correspondence" because "[w]e don't need a single writing" and
even if there was a statutory failure, there was "no question" that the broker
was the efficient procuring cause of the purchase.

The Appellate Division carefully reviewed all of the correspondence and
found that there was never a clear and "uncontroverted" agreement
regarding the amount of the commission.  Further, despite the lower court's
finding that the authorization was based on the "series of correspondence,"
the lower court never discussed the ten percent commission figure, "finding
only that the Bank had agreed to pay a 'reasonable' commission."

The Statute of Frauds in force at the time in question required that the
writing state "either the amount or rate of commission."  In fact, "[t]o hold
that the specific statutory direction is satisfied   by an implied agreement to
pay a 'reasonable' commission renders that portion of the statute
meaningless and would be a violation of the basis statutory construction."
Further, "[a]n implied agreement to pay a 'reasonable' commission is fraught
with the risk of misunderstanding, misinterpretation and possible litigation,
the avoidance of which is the statute's purpose."

Consequently, the Court concluded that there was "no factual or legal basis
in support of the [lower court's] conclusion that [the critical broker's] letter
satisfied the written authorization requirement of the statute of frauds
entitling [the broker] to a 'reasonable' commission."  The Court then
analyzed all of the other correspondence and concluded that the lower
court's finding that the "parties' writing created an enforceable agreement
under the Statute of Frauds [was] unsupported by the record and the law,
and [that the lower court's] decision that [the broker] was entitled to a five
percent commission must be reversed."

Comment 1: Of course, we don't necessarily know "the truth and nothing
but the truth" about this deal.  The court's recitation of the facts, however,
is the basis for the opinion, and what we should assume to be the
controlling narrative.

The best case for the broker is that it notified the seller that it would show
the property and would expect a commission based upon a net listing.  The
seller never responded positively in writing  to this proposal, but later
acknowledged some responsibility with regard to several individuals to
whom the broker had introduced the property.

In the editor's view, there is a difference between an open listing, to which
the client apparently never agreed, and an acknowledgment that in one
instance the bank would be willing to negotiate a commission respecting a
certain prospect.  In the end, that prospect did not become a principal of the
ownership group.  Because that prospect had local connections, and there
was some bad blood, the ownership group elected to make some payments
to the prospect to "keep him happy."  (In return, he agreed to indemnify the
group for any exposure on commission to the broker.)

As a consequence of the above in the editor's mind there is no reason to talk
about the vagueness as to the commission amount.  There simply was no
listing.

Comment 2: The case is a good object lesson to those who lack experience
dealing with commercial brokers.  Although most are reputable and
straightforward professionals, some are in the business of ensnaring clients
in a web of half promises and uncertain representations, leading to a
colorable claim that can be used to extort a payoff.  Since we may not have
all the facts, the editor is not saying that the broker here actually fit that
description, but the court's narrative describes a set of events that illustrates
the problem.  The bottom line - authorize no behavior except what is set
forth in a clear and unambiguous listing agreement.

COMMUNITY ASSOCIATIONS;  DEVELOPER TRANSITION:  If
transition from a developer to a community or property owners' association
does not take formally take place because of the developer's bankruptcy, it
will be deemed to have taken place at the time of the bankruptcy if it was
clearly intended that the affected common elements were to be conveyed to
the association.  Poblette v. Towne of Historic Smithville Community
Association, Inc., 355 N.J. Super. 55, 809 A.2d 178 (App. Div. 2002).

The developer of a planned unit development created a nonprofit
corporation (Association) to maintain the development in accordance with
the provisions of a "Declaration."  The Declaration described "[a]n
easement for the present and future installation and maintenance of electric
service, master and/or cable TV service, telephone service, water (storm
water and a sanitary sewer), gas and drainage facilities and the necessary
appurtenances to the same" drawn in favor of the developer, the
Association, and others.  Each Association member's right to enjoyment and
use of the community facilities was subject to that easement.  The
Association had responsibility for the maintenance, governance, and
administration of common facilities as well as the responsibility for
maintenance of certain facilities, not owned by the Association, but known
as limited common facilities.

The development experienced a significant storm and some homeowners in
the development "suffered substantial damage to their homes from flooding
allegedly caused by the overflow of a detention basin on the Development
that was to form part of the storm water drainage system.  Significantly, the
developer had gone bankrupt well before the flood had occurred."  The
homeowners sued the Association and others on the theory that the
Association and the others were "under a duty to maintain and repair the
detention basin ... as the holder of an easement granting exclusive control
of said detention basis to [the Association]."

The lower court, on a motion for summary judgment, held that: (a)
transition of the development took place with respect to the storm water
system between the bankrupt developer and the Association; (b) the
Association had responsibility for the basin; (c) the Association, "as the
easement holder, was 'the owner' and 'operator' of the storm water basis";
and (d) the Association "had a duty by way of the easement created by the
[Declaration] to inspect, as an element of its maintenance obligations, the
storm water basin which [was] the subject of [the] litigation."  The failure
of the Association to inspect the storm water basin and discover and correct
the lack of an outflow mechanism and/or the lack of adequate depth of the
structure as the proximate cause of the flooding" was preserved for
determination at trial.  At trial, a jury found the Association and its
management company liable for damages.

On appeal, the Association argued that: "(1) no easement in favor of the
Association existed under the relevant provisions of [the Declaration]
because the detention basis [was] neither a 'Community Facility' nor a
'Limited Community Facility' as those terms were defined, and (2) even if
the basin did meet either definition, no easement was created because there
never was a 'transition' of the duty to maintain the detention basis from the
developer to the Association."

The Appellate Division rejected those arguments.  To the Court, it didn't
matter that the detention basis, by definition, did not fall exactly into either
the category of Community Facilities or Limited Community Facilities.
That was because the Court concluded "that whether or not the basin falls
within these definitions is not dispositive in determining whether the
Association held an easement to the basin in view of the broad language
contained" in the Declaration.  It then looked to easement language
reserving, to the Association, an easement for the "water [storm water and
sanitary sewer], ..., which easement shall run in favor of the ...
[Association]... ."  To the Court, the import of that language was that the
easement was not "circumscribed to cover only community and limited
community facilities, but to all property within the development."

As to the Association's argument that the easement to maintain the storm
basin "never attached to the Association because there had not been a
formal 'transition' of this responsibility from the developer to the
Association, the Court pointed out that although the Declaration did not
expressly discuss the concept of transition, this would not be the end of its
analysis.  The Court also recognized that New Jersey courts had never
"addressed the precise issue of when a transition has occurred in which the
developer cedes to a homeowner's association, or similarly empowered
organization, the rights and duties under an easement to maintain common
facilities for the benefit of the property owners in a planned development."

In light of the lack of controlling authority, the Court looked to the intent of
the developer "as to the existence, timing and scope" of such an easement.
In doing so, it examined the overall Declaration "and the circumstances
surrounding its adoption."  Here, the Court found that the intent of the
developer was "intertwined with the statutory provisions governing his
conduct in developing and offering for sale a community development."
Under that statutory scheme, a developer must create an association with the
obligation to manage the common elements of the facility.  The legislative
history explains that associations are required to be formed "to safeguard
the interests of the individual owners or occupants."  Further, a New Jersey
statute provides that "[t]he association shall exercise its powers and
discharge its functions in a manner that protects and furthers the health,
safety, and general welfare of the residents of the community."  To aid in its
analysis, the Court pointed out that when trying to determine the developer's
intent, it must recognize that, "at least in part, [such an attempt must have
been] to draft a declaration in compliance with the requirement of the Act
and the purpose underlying its provisions."  Against that "backdrop," the
Court needed to determine what would happen if a developer went bankrupt
before a "formal transition."

With the circumstances presented in this case, the Court found that the
transition of duties had actually occurred.  This was because "the detention
basis in question was constructed to serve the common interests of the
individual property owners of the development.  Hence, the detention basis
was intended to be a limited community facility as defined in the
Declaration."  More importantly, the Court found "it inconceivable that it
was the intent of the Legislature or of the developer upon drafting the
easement provision described above, that in the event of the developer's
bankruptcy, the easement in favor of the Association should not be given
effect.  To hold otherwise would allow the Association to disclaim any
responsibility as to the very duties it was almost exclusively formed to
assume simply because there was not a formal declaration that these duties
had been transferred to it by the developer."  As such, the Court concluded
that a de facto transfer to the Association "of those rights and obligations
under the easement provisions contained in the Declaration occurred."

The Court also pointed out the well established general rule that "absent a
contrary agreement, the holder of an easement has a duty to maintain and
repair the property/facility on a servient tenement subject to the easement."
Further, New Jersey case law has specifically held "that a duty to inspect
property subject to an easement exists as to the easement holder."  In
furtherance of that duty to inspect, the Court looked to County Development
Standards which stated "that detention and retention basis 'drainage systems'
must be inspected on a routine basis to ensure that they are functioning
properly."  According to the Court, had the Association conducted such
inspections, it would have seen that the drainage basin lacked sufficient
outlets.

Comment 1: Someone has got to be in control of these facilities, and it
clearly was the intent of the developer to transfer them at some time to the
Association.  But it does seem to be an unfortunate "gotcha" if the
Association lacked the awareness of its ownership and responsibility in this
case.

The court plays a little loose with the issue of developer's intent.  First, it
ought to be set that the intent ought to be mutual - in other words the
homeowners and the developer ought to agree upon or at least understand
the process by which the facilities are transferred.  Second, it is difficult to
say that either the developer or the owners, at the time the Declaration was
filed, had any intent other than to transfer the facilities at the appropriate
time provided for assuming no bankruptcy.  The developer didn't intend to
go bankrupt, and the homeowners also didn't expect the bankruptcy.
Consequently, and discussion as to what the partied "intended" in the event
of the developer's bankruptcy is nothing but castles in the air.

Comment 2: Let us assume, for instance, that the developer had a
considerable amount of work to do on the flood facilities themselves, but
went bankrupt before completing them.  Is it fair to say that the Association
really expected to be in charge of those facilities upon such bankruptcy?
Isn't another interpretation that the homeowners were entitled to wait and
see what would come out of the bankruptcy - whether the developer has a
successor?  Further, is it possible that the homeowners, in the event of the
developer's bankruptcy, might elect not to take over the responsibilities,
which, because of the bankruptcy and developer's other derelictions, might
be hugely expensive to complete and maintain - totally out of any rational
economic planning by the association?

In other words, does the Association have the obligation to a few owners to
complete expensive but uncompleted works that the developer originally
promised would be complete prior to transition?   In the editor's view, there
may be "changed circumstances" here that would preclude the operation of
the scheme set forth in the Declaration, preventing transition from occurring
and leaving the affected homeowners and the Association to negotiate a
new relationship in light of new realities.
BANKRUPTCY; COMMUNITY ASSOCIATIONS:  If transition from
a developer to a community or property owners' association does not take
formally take place because of the developer's bankruptcy, it will be deemed
to have taken place at the time of the bankruptcy if it was clearly intended
that the affected common elements were to be conveyed to the association.
Poblette v. Towne of Historic Smithville Community Association, Inc.,
355 N.J. Super. 55, 809 A.2d 17 (App. Div. 2002), discussed under the
heading: "Community Associations; Developer Transition."

BANKRUPTCY; LEASES; ASSUMPTION OR REJECTION;
RIGHTS OF SUBTENANTS:  Where master tenant files bankruptcy and
rejects master lease, subtenant's lease is terminated absent special language
in master lease or other agreement with master landlord guaranteeing non-
disturbance.   Syufy Enters., LP v City of Oakland, 128 CR2d 808 (Cal.
App. 2002) , discussed under the heading: "Landlord/tenant; Assignments
and Subleases; Subtenant's Rights; Master Tenant's Bankruptcy."

CONSTITUTIONAL LAW; DUE PROCESS; NOTICE; TAX
FORECLOSURES: New York Court of Appeals upholds tax foreclosure
where mailed notice was returned and county did not check "ordinary
sources" for alternative addresses.  Mosssafa v. Kleiman, 2003 WL 443797
(N.Y. 2/25/03)

As most real estate lawyers know, constitutional due process requires notice
and opportunity for a hearing before government can take away property,
even when the governmental action is a tax foreclosure.  Although there
hasn't been a lot of judicial discussion of what constitutes a proper
opportunity for a hearing in the tax foreclosure context, there has been some
important law on the question of notice.  In the noted U.S. Supreme Court
decision in Mennonite Board of Missionaries, 462 U.S.  791 (1983), the
Court ruled that the Mullane standard of constitutional notice applied -
"notice reasonably calculated, under the all circumstances, to apprise . . . ."

Here, when the property owner acquired the property, she registered an
address with the County.  The property owner later changed her address.
She claimed that she notified the County of the address change, but could
not produce the letter (not surprisingly) and in fact the County did not
change her address on its records.   The County continued to send the bills
to the address on its records, and indeed, in every year from 1983-1998,
property owner paid the taxes, except in 1996.  Several of the letters by
which the property owner paid her taxes had the correct address as the
return address, and the checks had the correct address.

In 1996, there was no tax payment.  This occasioned the County, in its 1998
tax bill, to put on the bill a warning that back taxes had not been paid and
that there was a risk of a foreclosure if payment was not made.  The 1998
taxes were paid, but there was no payment of the delinquent 1996 taxes.

The County initiated a tax foreclosure.  The applicable law required notice
of the foreclosure to be sent to owners whose property interest was a matter
of public record at the time of the delinquent taxes and "whose name and
address are reasonably ascertainable from the public record, including the
records in the office of the surrogate of the county."  The County sent notice
to the same address it had been using all along - that shown on its tax rolls.
This time the post office returned the notice with the notation: "not
deliverable as addressed unable to forward."

The County made no further search and obtained a default judgment of
foreclosure.  A purchaser bid $8000 at the auction, far in excess of the
$605.44 tax delinquency, and the County retained the surplus.   The
statutory redemption period ran, and thereafter the purchaser at the tax
foreclosure sale sought to quiet title, leading to this action.

Property owner (or, more accurately at this point, former property owner)
argued that when the County received back the returned letter indicating
that notice had not been effected, it had an obligation to take ordinary steps
to ascertain her correct address, such as to look in the telephone book or the
internet.

The New York Court of Appeals disagreed.  Although it acknowledged that,
by statute, the County had a duty to look at more than the tax rolls, it stated
that the property owner had not demonstrated that it would have found her
address in public records in the surrogate's office.  It rejected her claim that
the letters and checks by which she had paid earlier bills provided notice to
the County, since there was no requirement or expectation that the County
would use these for notice address verification and, indeed, the County did
not keep them.

The Court's critical ruling, of course, was on the question of whether the
County had a duty to go beyond the surrogate's office.  It rejected such a
proposition:

     "As an initial matter, we reject the view that the enforcing officer's
     obligation is always satisfied by sending the notice to the address
     listed in the tax role, even where the notice is returned as
     undeliverable.  In such cases, the enforcing officer is in no different
     position than if an initial examination of the roll had yielded no
     address.  Generally, when the notice is returned as undeliverable, the
     tax district should conduct a reasonable search of the public record.
     . . . A reasonable search of the public record, however, does not
     necessarily require searching the Internet, voting records, motor
     vehicle records, the telephone book or similar resource."

The court does not explain why it reach the somewhat surprising conclusion
that there is no duty even to look for the address in other readily available
public records not in the Surrogate's Office.  It admits that the County
cannot rely upon the notice of default that it appears likely that property
owner did receive.  This is not notice of foreclosure.  Nevertheless, the court
points to this notice, together with the fact that other notices sent to the
address in the record, both before and after the 1996 default notice,
apparently did reach property owner, since she regularly paid taxes billed
to that address.  The owner's carelessness in not changing the record
address, despite the fact that she in fact received many letters sent to the
wrong address, was a factor the court took into consideration:

     "While to an owner who has not abandoned his or her property,
     learning of its foreclosure is distressing - particularly when the tax
     due constituted a minuscule percentage of the market value of the
     property - the owner's interest must be balanced against the State's
     interest in collecting delinquent taxes, taking into account the status
     and conduct of the owner in determining whether notice was
     reasonable."   (emphasis added)

Later, the court expanded on this notion:

     "When th conduct of a party does not excuse the collecting officer
     from providing notice to those whose contact information is
     reasonably ascertainable, it is nevertheless relevant in determining
     whether the party's contact information was reasonably
     ascertainable."

Comment:   The Editor admits to being a person of tender sensibilities, but
the Editor is shocked by this result. The editor understands that there is an
argument for "mass due process" here.  Public agencies can't be required
to be overly punctilious at taxpayer's expense.  "Reasonable" is good
enough.  Therefore, it may be admitted that the County need not have
checked outside of the public records.  There are many phone books these
days and they are changed frequently, and if we required phone book
checking, we'd have to decide which phone book was sufficient.  Further,
the County need not be required to have an Internet adept on its foreclosure
staff.  But why is it all that great a burden to at least check the voting
records or other records that contained address at which public agencies
regularly had been able to reach the property owner?

The court qualifies its outcome, of course, by stressing the special
circumstances here - that there was evidence that other mail got through,
perhaps putting into doubt the bona fides of property owner's claim that the
foreclosure notice didn't in fact reach her.  But the blanket statement that
there is no requirement to go beyond the limited records available in one
public office when a potentially ruinous tax foreclosure is at hand
establishes precedent that difficult to distinguish away.  It seems to the
Editor that the court has overreached here.  Tax foreclosures aren't so
numerous that a little more caution isn't in order when the potential
consequences of an unnoticed foreclosure are so severe.
CONSTITUTIONAL LAW; FREE SPEECH; NOISE INJUNCTION:
Inunction that states that occupants of land may not "unreasonably disturb"
of neighboring tenants through excess noise is unconstitutional as an overly
vague restriction on free speech.  Howard Opera House Assoc. v. Urban
Outfitters, Inc., 322 F.3d 215 (2nd Cir. 2003), also discussed under the
heading: "Landlord/Tenant; Good Faith and Fair Dealing; Noise Nuisance."

 A city code section stated that it was unlawful to make or cause to be made
a any loud or unreasonable noise.  "Noise shall be deemed to be
unreasonable when it disturbs, injures or endangers the peace or health of
another . . .Any such noise shall be . . . a public nuisance."

Landlord and other tenants brought suit for nuisance.  The question of
whether there was a breach of the lease as well arose on landlord's claims
based upon breach of contract and breach of the implied warranty of good
faith and fair dealing.

The court entered an order requiring Urban Outfitters to refrain from
operating the sound system in the store in a manner "that substantially and
unreasonably interferes with the other tenants' use of their space."  The
court also, inexplicably ordered defendants affirmatively to operate the
sound system in a way that did not disturb the other tenants.  (Does the
defendant violate the second order if it doesn't operate the sound system at
all?  If not, why the two phrasings?)

The court commented that it is one thing for a noise ordinance to be broadly
worded so as to comprehend a variety of circumstances.  It is another for a
specific judicial order to have similar vagueness as this may tend  to inhibit
free speech.

The court commented that it appeared that there was ample evidence to
tailor the court's order more specifically to give the defendant direction as
to just how much noise was too much.  It stated that, in light of the free
speech ramifications involved, it was not too much to expect the trial court
to provide this level of detail.  It affirmed the finding of a public nuisance
but reversed the injunction and remanded.

EASEMENTS; SCOPE; ACCESS: An easement grant conveying "a 25
foot access and utility easement" may be used not only to serve the water
tower on adjacent property that was the original intent of the parties, but
also for general access to such adjacent property, including access to a
cellular tower later constructed there.  Bishop v. City of Fayetteville, 2003
WL 292119 (Ark. App. 2/12/03)

In 1987, Coveys granted to the City an easement in connection with a water
tower the City had built on adjacent land.  The easement stated that it
granted "the right of way and easement to construct, lay, remove, relay,
enlarge and operate a water and/or sewer pipeline or lines, manholes,
driveway and appurtenances thereto.  The deed described the easement as
"a permanent easement of 25 feet in width for the purposes of laying a water
line and an access driveway. . . " and described the specific metes and
bounds.  In the habendum clause, the deed stated that the right would last
so long as the "pipe line or lines, manholes, driveway and or appurtenances,
thereto shall be maintained" for the purpose of "inspecting, maintaining and
repairing said lines, manholes, driveway and appurtenance of Grantee . . .
and the removal, renewal and enlargement of such at will. . . ."

Subsequently, the city leased to Alltel the right to attach a cellular
transmission facility to the water tower, and Alltel used the easement to
access the tower for three years.  During this three years, Coveys transferred
the servient estate to plaintiffs.

After Plaintiffs obtained title, the city transferred to another cell company
the right to build a new cell tower on the city water tower parcel.
Plaintiffs sued to establish that the use of the easement to provide access to
the cell tower was a surcharge of the easement.  They lost.

The appeals court ruled that the deed was unambiguous in creating a
straight right of access to the City owned property, and that the right of
access was not limited to utility use.  The fact that the deed also created a
utility easement did not mean that this purpose modified the uses that could
be made of the road.  The court commented that the language in the deed
suggesting that the parties could come on the land for the "enlargement" of
the "lines drivew and appurtenance of Grantee"
indicated that the parties foresaw that the use of the right of way might
intensify over time.

The court had other evidence that a broad construction of the right of way
was what the parties intended, both in the implementing of a broader use by
Alltel and its continuation through the time of transfer to plaintiffs, and in
the testimony of Dr. Covey, who indicate that he intended a broad access
right.

Comment 1:   Congratulations to the Arkansas court for straightforwardly
interpreting the language of the deed and not getting lured by the available
extrinsic evidence into declaring the deed to be ambiguous.  It wasn't
ambiguous.  It said that it was providing an "access driveway."
Certainly if there is a general right of access to municipal property used as
a water tower, there is no surcharge when the access right is used for other
significant activities, including cell towers.
Comment 2:   The editor does have a cavil, however, with the court's
suggestion that the language in the habendum clause indicating that the
easement could be used for "enlargement" might mean that the roadway
could be enlarged.  Other parts of the deed unambiguously set forth the
precise dimensions of the roadway, and the "enlargement" language should
not be read as a license to exceed those dimensions, since it can also be read
to permit enlargement of the pipelines and other utility facilities, which
don't have precise dimensions.

Comment 3: As the editor has commented in the past, lawyers often are
careless in the drafting of easements, generally not anticipating what will
happen in the future.  This is true both of lawyers drafting on behalf of the
benefitted parties and those working for the burdened properties.
Each side should think into the future as to what value is really being
transferred and what is being retained.

Representing the burdened party, lawyers should  think of the easement as
a right to use the property for an identified use and only that use.  The
unique location and other characteristics of the property might make it
valuable for other uses that might come along in the future.  Since we can't
put a price on that value today, we shouldn't be  selling it for pottage due to
an overly broad description of permitted uses.

Representing the benefitted party, lawyers should try to get things as broad
and loose as they can, of course.  But if there is on the other side  a savvy
negotiator, who is trying to limit the uses, then the responsibility ought to
be to identify all potential future applications of the easement that the client
ought now to be able to foresee and conclude are worth purchasing.
Where these other uses are not particularly harmful to the burdened parcel,
and we're buying something today, many of these uses can be acquired more
cheaply now than when they are truly valuable later.  Cellular
telecommunications access, of course, is exhibit A.

DEEDS; BOUNDARIES: Description stating property is  "bounded . . . by
public road" does not convey any portion of the road and boundary was
right of way line of the road.  Lamson Petroleum v. Hallwood Petroleum,
824 So.2d 1194 (La.App. 3 Cir. 2001).

DEEDS; CAPACITY; PRESUMPTION: Properly executed deed has
presumption grantor was mentally competent at time of execution and clear
and convincing evidence is required to overcome this.  In re
Conservatorship of Moran, 821 So.2d 903 (Miss.App. 2002).

DEEDS; DELIVERY: Delivery of deed to attorney/escrow agent is
insufficient delivery to pass title where grantor conditions ultimate delivery
upon execution of note and mortgage by both grantees.  Smith v. Smith,
820 So.2d 64 (Ala. 2001).

DEEDS; DELIVERY:  Deed was not effectively delivered where it was
signed and handed to one grantee, but never recorded.  James v. Mabie, 819
So.2d 795 (Fla.App. 1 Dist. 2002).

This 2-1 decision tells an interesting tale, but appears to the editor to come
to the wrong conclusion.

Mabie, an experienced attorney, apparently had extensive dealings with
Urquardt and his company, Work Enterprises.  In 1992, Mabie handed
Urqhardt a deed to the property in which the company was located.  The
deed named Work as a 75% owner and one Eugene James as a 25% owner.
James also had dealings with Work.  Apparently it was Urquardt's intent to
pay for the property by retiring mortgages against the property, and indeed
Urquardt thereafter made some payments on the mortgages.

In 1993, Work Enterprises entered into a lease of the property.  In 1994, the
tenant discovered that Work did not have record title and contacted Mabie.
 Mabie then notified the tenant that he had taken over ownership of the
property and that the tenant should remit payments to him.    Later, Mabie
executed a separate lease with the tenant.   Urquardt knew of all of this and
apparently made no objection.  It should be noted that Urquardt and Work
had debt obligations to Mabie at this point.  Further, the tenant was not
getting along with Urquardt and preferred not to deal with him.

Apparently many people knew of the deed and urged Urquardt to record it,
but he never did.  Both Mabie and Urquardt passed away.  In 1997, Work,
which had extensive liabilities to Eugene James, the named cotenant,
quitclaimed its interest in the property to him.

A real estate broker present at the time the deed was handed over gave some
vague testimony about the fact that the parties did not expect title to pass
until Urquardt had paid the mortgage.  There was also evidence that
Urquardt wanted the deed in order to show it to some unnamed person.

Held: No intent to deliver - deed void.

Comment: The case is so "fact driven" that it likely establishes little
precedent.  But the notion that an experienced lawyer would execute a deed
to another person and leave it with that person without objection for more
than a year, during which time that person made mortgage payments on the
property, and that nevertheless the grantor had no delivery intent, strikes the
editor as absurd.  To pile on more data, the dissent indicates that Mabie
declared the gain on the sale of the property on his income tax return for
1993.  Further, the "star witness" - the realtor whose "uncontroverted"
testimony (he was the only one present still alive) was critical to the
majority view - also was the one who advertised the place for lease and who
delivered the potential tenant to Urquardt (and not to Mabie.)

All deed delivery cases are sui generis, but it does seem that when a
competent and knowledgeable party hands over a deed with no good
explanation, and the parties later behave in ways that suggest that ownership
has passed, then all presumptions should favor the conclusion that delivery
has occurred.  The later ambiguous dealing between Urquardt and Mabie
may suggest an informal "transfer back," but there apparently was never a
formal conveyance.  And in any event Urquardt's company owned only
75% of the property.

EMINENT DOMAIN; POLLUTED PROPERTY: Where a condemning
authority makes a price offer, but reserves the right to adjust it based upon
possible environmental contamination, its offer constitutes a bona fide
offer, rejection of which permits the condemning authority to file suit, and
the condemning authority still has the option of filing a separate clean-up
action.  The Housing Authority of the City of New Brunswick v. Suydam
Investors, L.L.C., 355 N.J. Super. 530, 810 A.2d 1137 (App. Div. 2002).

The primary issue presented by this appeal was "whether a condemnor may
consider the presence of environmental contamination in valuing the subject
property or must [it] value the property as if it were uncontaminated and
bring a separate action for costs of cleanup under applicable environmental
statutes."  The action involved three parcels of land located in a
municipality's downtown area.  The municipality's housing authority sought
to acquire the properties for a redevelopment project.  Before filing an
eminent domain action, it made an offer based upon its expert's appraisal.
The offer was "contingent on the satisfactory environmental status of the
property, as the appraisal does not take into account any environmental
problems that could affect value."  The property owner made a
counterdemand nearly two and one-half times the authority's offer.  A
condemnation action was filed with the Court and the property owner did
not oppose the taking.  In fact, it withdrew the amount that the authority had
deposited with the court.  Then, the authority sought to amend its complaint
for the purpose of "alleging the presence of environmental contamination
as a factor affecting the value of the property and reserving its right to
recover environmental cleanup costs" from the property owner.  The
property owner opposed the motion on the ground that the authority had
"unfairly withheld information concerning the alleged environmental
contamination on its property."  The Court granted the authority relief to file
an amended complaint and "also granted a six-month stay of the
commissioner's hearing to enable the Authority to 'attempt to complete its
environmental investigations and commence any action that it deemed
necessary and appropriate to resolve all issues relating to environmental