Many lenders are taking back half-built projects that are subject to the Colorado Common Interest Ownership Act (“CCIOA”).  CCIOA governs planned communities, condominiums and cooperatives in Colorado and contains many detailed provisions regarding the ongoing right of a developer (or a “Declarant”) to develop the community and control the board of directors.  These rights are referred to as “Special Declarant Rights” under CCIOA. 

When entertaining a possible deed in lieu transaction or a foreclosure, lenders need to be aware of any Special Declarant Rights that exist under the project documents and should evaluate whether those Special Declarant Rights might be valuable to a future purchaser of the property.  In doing so, a lender also needs to be aware of its possible successor liability if it takes over these Special Declarant Rights and how the lender might avoid such successor liability.

Generally, Special Declarant Rights may be transferred only in a signed and recorded document.  However, CCIOA recognizes that in a foreclosure, it may not be possible to get the borrower/original Declarant to execute an assignment of Special Declarant Rights.  As such, CCIOA allows a foreclosing lender to unilaterally record an assignment of Special Declarant Rights.  This unilateral right to record an assignment of Special Declarant Rights does not apply in a deed in lieu situation. 

If a lender takes an assignment of Special Declarant Rights from a borrower, it remains liable for the liabilities and obligations imposed on the borrower/old Declarant under CCIOA or the project declaration, except:

  • misrepresentations;
  • warranty obligations;
  • breach of fiduciary duties; or
  • any obligation that is imposed on the borrower/old Declarant after the date of the assignment.

In a foreclosure situation, a lender can avoid this successor liability if the unilaterally recorded document states that the lender is only taking these Special Declarant Rights for the purpose of transferring them to a third party (such as some future buyer of the property).  If that limitation is included, the lender can still exercise the rights to appoint board members, but cannot exercise any other Special Declarant Right.  While the lender’s liability will be limited under that approach, any future buyer who takes an assignment of the Special Declarant Rights will have the successor liability described above.  Because the unilateral right to record an assignment of Special Declarant Rights does not apply in a deed in lieu situation, lenders who take a deed in lieu do not have the ability to limit the effect of the assignment and thus limit their successor liability.

Because lenders are not in the development business, utilization of this procedure makes sense.  It allows a foreclosing lender to preserve the Special Declarant Rights for a future buyer of the remainder of the project, and doesn’t force a lender to take on liability.  It is important to remember that the right to unilaterally record an assignment document and limit liability does not apply in a deed in lieu transaction.  When a lender is deciding whether or not to foreclose or take a deed in lieu, this fact should be considered.

The two most common types of lease expansion options are rights of first refusal and rights of first offer.  When negotiating these expansion rights, landlords and tenants should understand the factors involved.

What’s the Difference?  A right of first refusal provides that when the landlord receives an acceptable offer from a third party for certain space, then the landlord must offer such space to the tenant on the same business terms.  A right of first of offer requires the landlord to offer any “available” space covered by the right to the tenant before the landlord offers the space to the market generally.

Some of the factors that are common to both types of rights are as follows: 

  • Both rights should cover a finite area, although it is possible to have these rights apply to an entire building or project.  The lease should specify what space is covered by the right. Use a diagram or other clear method of defining the space.  Beware that the configurations of a suite can change over time, so suite numbers can be problematic. 
  • Both types of rights are encumbrances on the landlord’s ability to lease the space.  Landlords need to track and monitor these rights carefully to avoid violations.  The landlord’s failure to honor a tenant’s right can result in the landlord incurring liability.
  • Landlords should try to protect the right to negotiate extensions of existing leases with other tenants of the encumbered space without triggering the right, even if those other tenants do not have a renewal right.
  • Once the landlord makes the offer to the tenant, and if the tenant declines, does the tenant have an ongoing right to further offers?  Or is it a one-time right?

Factors particular to rights of first refusal are:

  • Because there is a third‑party offer involved, the tenant can be reasonably assured that the business terms of the offer approximate the fair market value for the space. 
  • Because the landlord has to identify a prospective tenant and negotiate a deal before making an offer to the tenant, these rights are more cumbersome for the landlord’s management of its property.
  • Consider whether the existing tenant has to accept the agreed-upon deal, or does the tenant have the right to adjust the offer to be more similar to the terms of the tenant’s lease?  For instance, the term of the offer may be shortened or extended to be “coterminous” with the tenant’s lease term.  Landlord’s should try to avoid any requirement to modify the agreed-upon deal. 

Factors particular to rights of first offer are:

  • Rights of first offer are easier for the landlord to manage because it can offer the space to the existing tenant before negotiating with any other potential tenant.
  • A right of first offer is less attractive to tenants because it can be difficult to know if the landlord’s offer is fair.  On the other hand, the offer that can be easier to customize to the existing tenant’s needs, such as requiring a coterminous term or the same rental rate as the tenant’s existing space.
  • When is the space “available” and therefore subject to being offered by the landlord?  Is it available when the space is actually vacated? Or, when the occupant of the encumbered space is otherwise obligated to vacate the space?  Landlords will want to preserve flexibility in case the existing occupant wants to renew its lease, or if the occupant holds over in the encumbered space.
  • How can the tenant know the offer is fair?  One method is to require that the landlord “re-offer” the space to the tenant if the landlord actually offers materially more favorable terms to a third party (and the parties should agree on what the phrase “materially more favorable terms” means).  Also, if a certain period of time elapses after the offer and the landlord has not found a tenant, then the landlord may be required to re-offer the space.

Whatever the parties decide to do, they should be aware of the various issues involved in right of first refusal and right of first offer.

As Jamie C. Belgum reported in the Colorado Bar Association’s Business Law Newsletter, the Colorado Court of Appeals recently decided a case that gives broad interpretation to the Colorado Trust Fund Statute, C.R.S. § 38-22-127.

The Trust Fund Statute requires contractors to hold funds they receive for a project in trust for the payment of subcontractors.  That means if a contractor receives a disbursement from a construction loan or a payment from a home purchaser, the contractor has to use that money to pay subcontractors before paying any general business expenses.

construction - small.jpgThe question presented in AC Excavating, Inc. v. Yale is whether the Trust Fund Statute reaches a manager’s voluntary monetary contribution to his own construction company.  Mr. Yale loaned $157,500.00 to his construction company, Antelope Development, LLC, whose sole project was the construction of a retention pond for a golf course community.  Yale directed Antelope’s use of the funds to pay general business expenses, including interest on municipal bonds that secured Yale’s loan.  AC Excavating, a subcontractor, sued Yale under the Trust Fund Statute for misapplying the funds he himself contributed.

The Court took a broad reading of the statute saying that it reached all funds disbursed irrespective of the intent of the disburser.  The Court further held that since Antelope had only one bank account and one project it was clear that the funds were “for the construction project” for which AC Excavating did work.  Putting aside the question of whether the Court accurately interpreted the statutory language, there is still some hope for owners/managers seeking to recapitalize their construction company without subjecting themselves to trust fund liability:

  • Contractors should set up separate banking accounts for each project into which they can deposit disbursements made specifically for that project.  A subcontractor should only be paid from the account for the project for which that subcontractor did work.
  • A separate account should also be maintained for general business expenses (i.e., office materials, equipment leases, rent, pay-roll, and marketing).  Owners should deposit infusions of capital into the general business account when they plan on using such capital to pay general business expenses.
  • Any money left over in a project account after all subs have been paid can then be transferred to the general business account to pay general expenses and profits.

With cash flow tight it is easy to rationalize moving money around to help a struggling project, but to avoid liability under the Trust Fund Statute (which is often non-dischargeable in bankruptcy) contractors must maintain strict accounting practices.  Still, with ever broader interpretations of the Trust Fund Statute contractors can never be entirely safe from liability.

Photo from The Library of Congress (Flickr)

Last month the Town of Berthoud, Colorado approved a mixed use development known as PrairieStar.  The development is anticipated to contain residential housing, a school, a research and development facility, an equestrian center, retail and business components, and, most notably, a 25 acre solar farm.  Developers of the project, Scott Sarbaugh and partner Richard McCabe, anticipate that PrairieStar will ultimately reach “net-zero energy consumption” status as a result of the large solar component. solar.jpg

In addition to the solar farm, the PrairieStar development includes many additional green touches including a community garden, an irrigation system using nonpotable water and an energy center for recharging electric cars.

In negotiations between developers and local municipalities, this type of sustainable (and sustainably marketed) project is likely to shed a different light on the developer.  Not only does it appear that sustainable developments like PrairieStar are particularly marketable to the end user, but in the current green climate they should be appealing to the local jurisdiction for entitlement approval.

Photo by Foreign and Commonwealth Office (Flickr)

For landlords, a late or missed rent payment might be the first sign that one of its tenants’ businesses is struggling or even failing.  In this economy, a landlord facing this kind of situation should keep certain things in mind in order to minimize potential lost revenue and expense.  

Quick action is critical in this economyforrent.jpg

It is important for landlords to ensure that they understand the struggling tenant’s situation, and be able to quickly react.  If the tenant is in default for nonpayment of rent because its business is failing, a prompt eviction is typically appropriate.  Especially now, quick action in these cases is critical, since the passage of time may make it much more difficult for the landlord to recover its damages.  If the tenant’s business has failed, there will likely be little to recover from the tenant entity.  Additionally, if the only guarantors are the tenant’s principals, they will very likely also be facing precarious personal financial situations, making it difficult to recover from them.  Moreover, the longer the landlord waits to evict, the longer it will delay the landlord’s efforts to try to find a new, paying tenant.

Sometimes, eviction is not the best option

While it is appropriate in the case of a tenant with a failing (or failed) business for the landlord to quickly evict the tenant and attempt to re-let the premises, other situations may call for a more measured approach.  In some circumstances, the tenant’s business may simply be suffering a temporary setback, which the parties can often address through communication.  In other cases, the tenant’s business may be facing a permanent decrease in activity and resulting decrease in revenue.  Sometimes, this leaves a tenant unable to afford its rent payments. 

If the tenant’s business could remain viable if it were paying a lower rent, it may be in the landlord’s interest to consider restructuring the lease.  This is especially true for tenants with leases that were entered into prior to the economic downturn, since these leases may provide for a rental rate that is significantly higher than current market rates.  Considering that the tenant is “locked-in” at a high rent rate, some landlords may be inherently reluctant to even consider decreasing the tenant’s rent.  However, there are at least two reasons why it might be appropriate to restructure a lease for a tenant who, in absence of a rent reduction, will default and vacate the premises.  First, if the tenant is forced to vacate the premises, it may cause the tenant to fold completely, precluding it from generating any revenue.  This carries with it the risk that the landlord’s collection of damages will be very difficult.  Second, if a judgment based on the higher rate will be very difficult to collect, and if current market rates are significantly below what is provided for in the lease, the landlord may have little to lose by agreeing to decrease the lease rental rate to the current market rate.  Any new tenant would only be willing to pay current market rates, and keeping the existing tenant in place after restructuring the lease may allow the landlord to keep a paying tenant in the premises without having to go through a potentially long vacancy period.   

Obviously, the right approach will ultimately depend on the circumstances, and it is often helpful, even at the early stages, to involve an attorney with experience in landlord/tenant disputes and evictions to help the landlord best protect its interests.  For example, lease amendments and concessions should be carefully documented to ensure that the landlord does not inadvertently waive any of its rights, and it may be appropriate to address a number of contingencies when dealing with these situations. 

Regardless of the landlord’s chosen course of conduct, it is clear that, in the difficult leasing market we are currently experiencing, it is important for landlords to be very diligent at the first signs of problems with their tenants.  If a landlord does nothing in the face of months of unpaid rent, it may already be too late for the tenant’s business to survive, and the landlord will have missed out on months of time during which it could have marketed the premises to potential new tenants.   

This is the first part in a series in this blog on commercial/retail evictions.  In the next part, I will discuss the basic procedures for evictions under Colorado’s unlawful detainer statute. 

Photo courtesy of http://passionatephoto.com