West Coast Real Estate Update: April 2016

by Holland & Knight LLP

Residential Communities: Calderon Process for HOAs Likely to Be Extended Again

The California Assembly Committee on Judiciary in early April unanimously passed Assembly Bill (AB) 1963 to extend the pre-litigation procedures for homeowners associations (HOAs) that wish to file construction defect claims contained in the Davis-Stirling Common Interest Development Act for another seven years, through July 1, 2024. Under such law, prior to filing a complaint for damages against a builder, developer or general contractor of a common interest development, an owners association must first follow a specific pre-litigation process known as the "Calderon Process." This statutory procedure, set to sunset on July 1, 2017, was first established in 1995, revised and expanded in 2001, and has been reauthorized several times.

Under the Calderon Process, prior to filing a construction defect complaint, an HOA must, among other things, notify the developer or other pertinent party of the defect claim and provide the party the opportunity to informally meet with the HOA in an attempt to resolve the defect, and if not so resolved, then participate in mandatory mediation.

While the necessity and effectiveness of the Calderon Process have been debated and there have been calls for change, no advocacy group has proposed revisions to the existing law and there is no registered opposition to the contemplated extension. The bill is sponsored by the California Building Industry Association (CBIA), the original sponsor of the law in 1995, and supported by the California Professional Association of Specialty Contractors (CALPASC).

The CBIA advised the Assembly that the law allows parties to discuss a claim prior to an action to avoid costly and time-consuming litigation, but still preserves the right to legal action. The Consumer Attorneys of California (CAOC) have expressed concerns that the law creates delays for resolution of homeowner construction defects claims, as it overlaps with the state's Right to Repair Act (California Civil Code Sec. 895 et seq.), which went into effect in 2003, and have offered to assist in amending the law, but at this time remain neutral on the proposed bill. Absent any unexpected delay, it is anticipated that AB 1963 will move smoothly through the legislative process.

Lease Terminations May Be Voidable in Bankruptcy

The U.S. Court of Appeals for the Seventh Circuit ruled last month that an agreement entered into between a landlord and a tenant to terminate the lease was a "preferential transfer" and, therefore, when the tenant subsequently filed for bankruptcy protection, the termination was ruled to be voidable. See In re Great Lakes Quick Lube LP, 2016 WL 930298, at *2 (7th Cir. March 11, 2016).

In the case, the tenant voluntarily terminated its leases for five stores. At the time the leases were terminated, two of the stores were profitable and three were not, and significantly, the tenant was experiencing serious financial trouble. Fifty-two days later, the tenant filed for bankruptcy protection.

The landlord understandably believed that an agreement to terminate the lease, when voluntarily agreed to by both parties, was an enforceable contract. The bankruptcy court agreed, ruling that a lease termination does not constitute a "transfer," and even if it did, Section 365(c)(3) of the Bankruptcy Court expressly provides that a lease that has been validly terminated prior to the bankruptcy filing cannot be assumed or assigned. The Court of Appeals reversed, ruling that the terminations constituted either fraudulent conveyances or preferential transfers of the value of the leases and, therefore, were voidable.

The court did not reinstate the terminated leases or require the eviction of new tenants in the vacated space. Instead, it ruled that the value of the terminated leases would need to be paid by the landlord to the creditors, and it remanded the matter to the bankruptcy court to determine the value of the terminated leases.

The ruling has broad implications for commercial landlords who are approached by financially distressed tenants about terminating their leases. In such situations, landlords may need to take into account the possibility that, if a bankruptcy occurs within the relevant period of time, they may face liability for the value of the remainder of the tenant's leasehold estate (presumably after deducting the value of the tenant's obligations that are being released by the lease termination).

Does Sustainability Pay Off?

The National Real Estate Investor reports that investors and tenants alike prefer retail properties with sustainability measures in place. Studies of the office market indicate that green office buildings trade at a 13 percent premium, on average, nationwide when compared to non-green buildings, and rental rates are 3 percent higher, on average, at green buildings than non-green buildings. The retail sector has been slower to improve the sustainability of malls and other shopping centers, but the trend nonetheless pushes those owners forward and creates an emphasis on sustainability.

City and state governments are also increasingly concerned about the energy usage of commercial properties. Energy benchmarking laws mandating energy scorecards for commercial buildings have passed in states such as California and Washington, as well as a number of local governments: Atlanta; Austin, Texas; Berkeley, Calif.; Boston; Boulder, Colo.; Cambridge, Mass.; Chicago; Kansas City, Mo.; Minneapolis; Montgomery County, Md.; New York; Philadelphia; Portland, Ore.; San Francisco; Seattle; and Washington, D.C.

In January 2014, the International Council of Shopping Centers (ICSC) established a property efficiency scorecard to help retail landlords compare property efficiency in terms of controllable costs (energy, water and waste consumption) and green operating practices across their portfolios and to identify shopping centers where energy efficiency could result in cost savings. Since the launch of the ICSC scorecard, owners and investors are becoming more focused on the efficiency of their shopping centers.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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