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Real Estate Buyers Beware: Supreme Court opinion demonstrates importance for investors and developers to perform due dilligence before closing

14 Dec

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We’ve all heard the old adage: An ounce of prevention is worth a pound of cure. It surprises me how frequently I learn that clients or other savvy investors or businesspeople proceed to purchase real estate without receiving critical advice or performing adequate due diligence.

The Minnesota Supreme Court’s decision in Mattson Ridge, LLC v. Clear Rock Title, LLP, et al. demonstrates why, when purchasing land for investment, development, or even for personal enjoyment, due diligence is so important. The case involves Mattson Ridge, a real estate firm seeking investment opportunities in real estate, and presumably a savvy real estate investor in its own right. The company purchased 64 acres of farmland with the intent to hold it as an investment to sell to another party for future development.

Mattson Ridge read the market perfectly. It closed on its purchase of the property in September 2005 for $1.286 million and by the end of October 2005 had a purchase agreement in place to sell the property for $2.9 million. The sale was scheduled to close in May 2006, but a problem with the legal description of the property prevented the sale because it constituted a defect in the title to the property. In real estate terms, the seller was unable to provide “marketable title” to the property as of the date the buyer was ready, willing and able to close.

Mattson Ridge did take one step to protect itself that a surprising number of parties fail to do, which was to secure title insurance to protect against any title issues that might arise based on defects existing at the time it purchased the property. Unfortunately, that wasn’t enough to completely protect it. The limits under the title insurance policy were set at Mattson Ridge’s purchase price ($1.286 million), rather than at a higher figure that would have covered the full market value of the property (which the evidence suggests was $2.9 million, in light of the purchase agreement it entered into to sell the property).

In its opinion in the Mattson Ridge case, the Supreme Court held that the title to the property was defective, but that Mattson Ridge was not permitted to recover more on its insurance than the policy limits. This means Mattson Ridge is entitled to recovery $1.286 million, plus about $11,000 of out-of-pocket expenses, but it will not recover the profits it lost as a result of the failed closing; more than $1.6 million beyond those policy limits. An ounce of legal advice and assistance with due diligence in this matter would have prevented the need to seek more than a pound of cure -a cure that the buyer was denied because just buying title insurance was not enough.

What’s even more alarming than the $1.6 loss that wasn’t covered by insurance was that the case could have turned out even worse for Mattson Ridge. The Supreme Court declined to decide certain additional issues, which included whether a clause in the insurance policy called a “coinsurance provision” or “coinsurance clause” should reduce the coverage available to Mattson Ridge. A coinsurance provision in an insurance policy states that, if the insured purchases a policy with limits that are more than a certain percentage below the actual extent of potential loss that may arise (often 80 percent), the insured’s recovery may be reduced significantly. This issue did not affect Mattson Ridge because the title insurer did not raise it before the case reached the Supreme Court, but it certainly could have done so and if it had, the buyer could have lost even more money. This represents yet another reason to get advice and assistance when performing the proper due diligence required to make a sound real estate purchase.

Mattson Ridge ultimately was able to remedy the title defect, meaning it could be sold with a title that is now marketable (i.e., without the title defect that prevented its sale under the October 2005 purchase agreement). But the delays and defects that existed because the problem was not discovered prior to its own purchase means Mattson lost its opportunity to obtain a profit of more than $1.6 million in less than a year, and that kind of opportunity may not present itself again.

If you’re considering buying or selling real estate, or have a potential problem with providing or obtaining marketable title, consider taking a heavy dose of prevention and contact an attorney with Thomsen Nybeck. We have been assisting parties with real estate transactions and disputes for 40 years, and we can help you avoid the need for a painful cure that may never come. And, if need be, we can help administer the cure as well.

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Matt Drewes contributed this post.  Matt is a Shareholder with Thomsen Nybeck.  He is the head of the firm’s nine-member Community Association Representation Group and the firm’s Creditors’ Remedies Group. and practices in the areas of business and real estate litigation and transactions, employment law, construction litigation, community association law, debtor/creditor law and insurance. He has been included in the annual list of Minnesota’s Rising Stars for several years, and has been quoted on issues involving construction litigation, community associations and real property issues in the Minneapolis StarTribune, Minnesota Lawyer, Habitat Magazine, Yahoo!Finance.com, Bankrate.com, MSN.com, HOALeader.com, and elsewhere. He can be reached at mdrewes@tn-law.com or by phone at 952.835.7000.

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Minnesota Court of Appeals Holds Buyer Was Earnest About Real Estate Purchase Even Though It Didn’t Pay the Earnest Money Due Under the Purchase Agreement

7 Apr

In the case BOB Acres, LLC v. Schumacher Farms, LLC, decided on April 5, 2011, the Minnesota Court of Appeals held that, as long as the parties to a real estate purchase agreement clearly express the intent to buy and sell real property, the fact that the buyer did not provide the earnest money stated in the contract did not render the contract invalid.  Read it here.  It may at first seem remarkable that the Court of Appeals would hold that a party that did not provide the earnest money specified in the purchase agreement might still be able to enforce the agreement, but there were several factors involved.

The earnest money was a fairly nominal amount ($500 earnest money on a $70,000 contract for the purchase of 25 acres of undeveloped land).  This suggests that the earnest money was not a significant factor in the seller’s decision to sell the property to the buyer, but rather earnest money is provided simply to show the buyer’s good-faith intentions.

The Court also noted that the failure of a party to perform a material provision of the agreement could be a breach that permits the non-breaching party to discontinue performance, but the seller did not raise any objection to buyer’s failure to tender the earnest money until it had already announced that it no longer wished to be bound by the purchase agreement.  This resulted in a waiver by the seller of any right to object to certain breaches of the agreement by buyer, which might have allowed it not to go through with the sale if it hadn’t waived its rights.  The Court of Appeals explained that there is a difference between the issue of contract formation and contract performance.  As far as contract formation is concerned, the Court cited to a treatise on contract law (but apparently found no prior Minnesota case law on point) to hold that a promise is sufficient consideration for a promise.  In other words:  the buyer’s promise to buy the property (presumably for the purchase price stated in the agreement) was sufficient consideration for the seller’s promise to sell the property; the modest earnest money payment was simply incidental to the agreement.

Thomsen Nybeck represents both buyers and sellers, as well as lenders and other parties involved in real estate transactions of all types and sizes.  If you have a question about your next deal, contact one of our attorneys for advice about how to ensure you get the deal you intend.

Matt Drewes contributed to this post.  Matt is a Shareholder with Thomsen Nybeck.  He is the head of the firm’s nine-member Community Association Representation Group and the firm’s Creditors’ Remedies Group. and practices in the areas of business and real estate litigation and transactions, employment law, construction litigation, community association law, debtor/creditor law and insurance.  He has been included in Minneapolis/St. Paul Magazine’s list of Rising Stars for several years, and has been quoted on issues involving construction litigation, community associations and real property issues in the Minneapolis Star Tribune, Minnesota Lawyer, Yahoo!Finance.com, Bankrate.com, and elsewhere.  He can be reached at mdrewes@tn-law.com or by phone at 952.835.7000.

Minnesota Construction Warranty Claims: New Procedures for 2011

18 Jan

You may be familiar with (or at least aware of) the warranties provided to homeowners under Chapter 327A of Minnesota Statues.  These warranties include a one-year warranty on all workmanship and materials, a two-year warranty on plumbing, electrical or other mechanical systems, and a ten-year warranty against major construction defects.  These warranties apply to new or newly remodeled residential property (which can include single-family homes or community associations, such as condominiums or townhouses), and are binding against the builder (of a new home) or contractor (in the case of a remodeling project).  Throughout the rest of this article, I will refer to both as a “contractor”, though homeowners should appreciate there can be a difference.

For years, Chapter 327A has contained certain procedures that owners must follow to preserve a claim for a breach of one or more of these warranties.  Effective January 1, 2011, these procedures now have been revised, and new procedures have been added.  You can read the complete text of the new statute here.  The legislature’s goal in making these changes is to try to reduce the number of lawsuits that are necessary to resolve these warranty disputes, but as with any new process there will always be traps for the unwary and navigating the new procedures is bound to catch more than a few homeowners off guard.

The process still provides that written notice of an alleged defect must be provided to the contractor within six months of the discovery of the defect, with the new exception being where the owner can demonstrate the contractor had actual notice of the claimed defect. Of course, it’s best to provide timely written notice if you wish to rely on this statutory warranty.  Many owners falter by failing to provide this notice within six months of discovering the defect.

After this notice has been provided, the contractor has always been required to inspect the alleged defect within 30 days and propose a repair.  The new amendment now requires the owner to allow the contractor to conduct “invasive” testing to determine the extent of any damage or the proper type of repair, however.  Invasive testing may involve making test cuts in stucco or interior drywall and/or using a probe to test the moisture content of the wood framing members of the home, though the statute does not specify.  It is of course fair to permit the contractor a reasonable opportunity to understand fully the defect (if any) involved, and the contractor is required to place the property back into “pre-inspection condition” following any invasive procedures, but it is unclear how this restoration process will be measured or enforced in practice.

In the event the contractor inspects the property and the owner and contractor cannot agree on the proposed repair (and owners should carefully evaluate proposed repairs, preferably with the assistance of a trusted contractor, engineer or attorney), the homeowner must (yes, must) follow through with the new “home warranty dispute resolution process”.  The new dispute resolution process requires the selection of a “qualified neutral” from a list maintained by the Minnesota Department of Labor and Industry, which will charge aspiring neutrals a $200 fee to be listed.  There are rather short timeframes applicable to the steps for selecting a neutral, so homeowners should consult with an experienced member of the construction industry and/or their own construction attorney before submitting their claim to the commissioner of the Minnesota Department of Labor and Industry.  Otherwise they will find themselves with little time to make a decision about the neutrals from which they must choose to evaluate their case.

After a neutral has been selected, the parties must meet together with the neutral and each will submit its own reasons why its proposed repair is proper.  There is a fee of $25 per party for participation in the process, in addition to the hourly fees of the neutral third-party the parties select.  It also is possible the parties will use attorneys to represent them through this process, and contractors with insurance coverage almost certainly will have attorneys present to represent them, though homeowners presumably will not be required to do so.  According to the amendment, at the end of this process the neutral third party does not issue a binding decision (it simply is an evaluation). Moreover, this evaluation may not be used as evidence in any later litigation if the “unreasonable” party does not care to acknowledge that it is being unreasonable. The process does, however, provide the parties with perhaps some further understanding of the potential damages at stake and chances of a favorable (or unfavorable) result.

Barring certain exceptions, the parties must complete this process before litigation can be commenced.  However, there are four situations which owners may commence litigation earlier if the contractor is not engaging in the process in good faith:

1) The homeowner may sue the contractor immediately if:

a) the contractor fails to conduct an inspection within 30 days after the owner has provided written notice of the defect;

b) the contractor performs the inspection but fails to provide a written proposal to make a repair of the alleged defective condition within 15 days after the inspection is complete;

c) the contractor provides a proposed repair, to which the owner agrees, but the contractor does not perform the repair.

2) The homeowner may also sue the contractor following the expiration of 60 days from the owner’s receipt of the contractor’s repair proposal, whether or not the dispute resolution process is complete.

In the event the evaluation process is not successful in bringing the owner and contractor to a resolution, the new amendment also alters certain timing considerations applicable to a construction defect lawsuit. This is because there are numerous claims (or theories of recovery) applicable to construction defect cases. These can include not just a claim that the contractor breached one or more of the statutory warranties under Chapter 327A, but also that the contractor breached an applicable contract, or that the contractor was negligent. There are also other warranties that may apply, including warranties applicable to common interest communities (condominiums and townhouses) as well as warranties covering the sale of goods (such as windows, doors, shingles, etc.). Each of these claims has not only its own standards, but each also has an applicable limitations period (the period within which you must sue or your claim is barred) which may be different from the next. The amendments to 327A now provide that, for as long as an owner is following this statutory procedure, or for 180 days, whichever is longer, all of those claims will be “tolled” (meaning their expiration will be delayed). This is a useful provision for ensuring a homeowner does not lose the right to commence litigation as a result of participating in this mandatory dispute resolution process.

The new provisions of Chapter 327A certainly have created more opportunities for construction defect cases to reach resolution outside of court, in theory.  However, there is little likelihood that a contractor who was being unreasonable under the prior procedures failed to realize it was being unreasonable, and there is little consequence to a contractor that fails to reach a reasonable resolution even under this new scheme.  Therefore, until we have seen this process utilized a few times, we do not know whether it will provide aggrieved homeowners with a legitimate alternative to litigation, or just another hurdle to clear to obtain a recovery under Chapter 327A.  In the meantime, if you have any questions about whether this process applies to you and how to comply with its provisions, contact Matt Drewes or one of the other construction litigation attorneys at Thomsen Nybeck.

Matt Drewes contributed this post.  Matt is a Shareholder with Thomsen Nybeck.  He is the head of the firm’s 10-member Community Association Representation Group and co-leads the firm’s construction litigation group.  Matt practices in the areas of business and real estate litigation, construction litigation, community association law, debtor/creditor law, insurance and employment, has been included in Minneapolis/St. Paul Magazine’s list of Rising Stars for several years, and has been quoted on issues involving construction litigation, community associations and real property issues in the Minneapolis Star Tribune, Minnesota Lawyer, Yahoo!finance.com and Bankrate.com, and elsewhere.  He can be reached at mdrewes@tn-law.com or by phone at 952.835.7000.

Matt Drewes Quoted in Articles About Construction Defects Appearing at HOAleader.com

13 Mar

Matt Drewes recently contributed quotes for the following articles published at www.hoaleader.com, a national web-based publication focused on homeowners association and condominium board members and association management professionals: 

 

Matt Drewes is a Shareholder with Thomsen Nybeck.  He is the head of the firm’s 10-member Community Association Representation Group and co-leads the firm’s construction litigation group.  Matt practices in the areas of business and real estate litigation, construction litigation, community association law, debtor/creditor law, insurance and employment, and has been included in Minneapolis/St. Paul Magazine’s list of Rising Stars for several years.  He can be reached at mdrewes@tn-law.com.

Developer Beware: Land Use Issues When Two Governmental Agencies “Control”

13 Apr

The Minnesota Court of Appeals recently held that a party seeking to develop real property in an area regulated by both the Department of Natural Resources (DNR) and a city must carefully ensure compliance with the more restrictive reading of the two sets of rules – even where the DNR had previously declared the city’s ordinance in “substantial compliance” with its own rules.  Failure to do so, even in reliance upon past statements by the DNR, will not excuse non-compliance.


The case, In the Matter of the Denial of Certification of the Variance Granted to David Haslund by the City of St. Mary’s Point, resulted in a holding that when a municipality’s zoning ordinance conflicts with the DNR’s rules enacted under the Lower St. Croix Wild and Scenic River Act (the Act), the DNR’s rules control.  That case can be found here:  http://www.lawlibrary.state.mn.us/archive/ctappub/0901/opa080427-0127.pdf.  In it, the property owner (Owner) unsuccessfully challenged the Commissioner of Natural Resources’ refusal to certify a city’s decision to allow him to develop a parcel of land.


The City of Saint Mary’s Point (City) granted the owner a variance that would have allowed him to construct a residence on a parcel along the St. Croix River.  The parcel is subject to the City’s bluffland/shoreland management ordinance (BSM ordinance), which it passed pursuant to the Act.  That ordinance prohibited construction of a residence on a lot of less than 150 feet at the shoreline of the St. Croix River if the lot is “within a group of ‘contiguous platted lots under a single ownership.'”


The DNR also passed certain rules pursuant to the Act, including a rule that a lot which does not meet the requirements for development may not be developed separately from an adjacent lot if the two lots had ever been held in common ownership at any time since May 1, 1974.  This is inconsistent with, and more restrictive than, the City’s BSM ordinance which stated only that contiguous platted lots under the same ownership are prohibited from independent development.

The owner bought the lot in question in 1986, and came into ownership of a second, adjoining lot in 2000.  Both lots were narrower than 150 feet at the waterline, but neither had been platted and therefore it appeared under the BSM ordinance that either could be developed independently of the other pursuant to a City-approved variance.  The owner obtained the City’s variance permitting him to construct a dwelling on one lot and he sold the second lot.  Before granting the variance, the City’s mayor had consulted with the DNR, which indicated the variance should be okay.  The DNR’s comments regarding the request, however, were apparently made without the knowledge that the owner had title to the lot in question at the same time as he owned an adjoining lot.


Both the DNR’s rules and the City’s Ordinance had been passed pursuant to the Act.  The Act directed the DNR to develop a master plan for the development of the area in a manner consistent with the legislature’s goals of protecting the environments along the river.  Local government units, such as the city, were also instructed by the applicable state statute to adopt ordinances consistent with the DNR’s “guidelines and standards.”


The Minnesota Court of Appeals has held that the City was not permitted to grant a variance under its own ordinance that was inconsistent with the DNR’s rules without the approval of the Commissioner of Natural Resources.  The Court held that the statute expressly directed the city to adopt an ordinance that complied with the scheme established by the DNR, and by failing to enact an ordinance that was as restrictive as, or more restrictive than, the DNR’s rules, the ordinance in effect conflicted with state law.  A municipality may not enact local regulations that conflict with state law, which may include situations where the statute permits what the ordinance forbids, or where the ordinance forbids what the statute expressly permits.


The proposed variance granted by the City conflicted with the DNR’s rule by attempting to permit development that the rule forbids.  By not ensuring his proposal’s compliance with both the ordinance and the rule, the property owner was unaware until after he had sold his adjoining parcel that he could not build on the parcel in question.  Somewhat surprisingly, the owner was not spared by his reliance on the apparent consultation by the City’s mayor with the DNR before issuing its decision to grant a variance, or by the DNR’s prior determination that the City’s ordinance “substantially complied” with the DNR’s interpretation of the Act.  Had he consulted both authorities and applied the more restrictive reading of each, he could have been spared the unfortunate outcome of now holding an un-developable lot.  To avoid the same fate, parties seeking to develop land should ensure they are in compliance with all applicable ordinances and rules and have counsel ready to assist them in their interpretation and compliance.


Entry by Matt Drewes.  Matt is a shareholder at Thomsen & Nybeck, P.A. and head of the firm’s Community Association Representation Group.  He practices primarily in the areas of real estate litigation, townhome and condominium law, construction litigation, debtor/creditor law, insurance litigation and employment law.  For more information on our general real estate services, please visit: http://www.tn-law.com/CM/Real-Estate/Real-Estate-Law.asp, or visit this page for information about real estate litigation:  http://www.tn-law.com/CM/Custom/TOCLitigation.asp.


UPDATE:  04/29/10 -Minnesota Supreme Court overturns Minnesota Court of Appeals’ decision in In the Matter of the Denial of Certification of the Variance Granted to David Haslund by the City of St. Mary’s Point.  You can read the opinion here.  In it, the Minnesota Supreme Court held that the City’s BSM ordinance, even though not as restrictive as the DNR’s rules, was valid because it had been approved by the DNR pursuant to the Act.  In a concurring opinion, Justices Gildea and Anderson agreed with the result the majority reached, but opined that the DNR had no authority either to certify or to deny the variance issued by the city, regardless of its independent rulemaking powers.  As a result of this ruling, the development of the lot in question, separate from the neighboring tract, may proceed.

Understanding Community Association Budgets

24 Mar

Budget decisions for new community associations can be a minefield. Developers, owners, and board members often don’t realize all the financial considerations they’re supposed to take into account when making early budget decisions. An association should never start out “in the hole,” and there are measures that are required that can protect against an inability to perform necessary projects down the road. This article is to give those dealing with budget issues a brief overview of how to approach the budgeting process.

An association obtains funds through its assessments. The developer of the association (also known as the declarant) has control of the board of directors of a new association (or condominium conversion) until it turns over control to the unit owners. This gives the developer the power to set the amount of the monthly assessments during the period of declarant control. Assessments are comprised of two primary components: (1) The common expense assessments are for funds necessary to maintain and manage of the community; and (2) The reserve funds are those funds required for the replacement of anything the association is obligated to replace (this is found in the association’s governing documents, specifically the declaration – roofing and siding are frequent examples).

The Minnesota Common Interest Ownership Act, or “MCIOA,” found in Minnesota Statutes Chapter 515B, permits a developer to reserve the right to pay a 25% alternative assessment for each unit it owns that is not “substantially complete.” “Substantial completion” means the date on which a “certificate of occupancy” is issued, which is issued by the city in which the home is located following an inspection. A developer may therefore pass the first assessment early so homeowners start to pay a portion of the operating expenses, but delay “substantial completion” on unsold units to take advantage of the alternative assessment. Developers also may take advantage of potentially ambiguous language in MCIOA stating that assessment obligations do not begin until a unit is “created.”

It may sound unfair that a developer would pay only 25% of monthly assessments, but it’s not entirely that simple. Prior to the passage of the initial assessment the developer is required to pay all of the association’s operating expenses. Also, if there are any unpaid costs at the time control is transferred to the members, the developer must pay them within 60 days. The developer’s alternative assessment right is also limited to the common expense portion of the assessments. The developer has to pay 100% of the reserve assessment on the units it owns. Again, however, these assessments are not due until the unit itself or any building within the unit is “substantially complete,” which may lead a developer to delay the “substantial completion” of unsold units to avoid triggering this assessment.

All of this may tempt a developer to set assessments too low in order to minimize its own assessment contribution or to generate buyer interest. Nevertheless, the association’s budget is required by law to include an adequate reserve assessment to allow for the replacement of the required components of the development. The members of a board of directors who are appointed by a developer also owe a fiduciary duty to get this right. The developer and the board it appoints would therefore face liability if they leave the association with insufficient operating or reserve funds on hand. A developer would be wise to set a realistic budget or it and the board members it appointed will risk liability to the Association.

Similarly, it would be wise for individual owners elected as board members to review that budget right away, and each year thereafter. Consider whether a reserve study is necessary to ensure the reserves are adequate. A new association board should also make sure it has all the proper documentation for the construction, finances and operation of the association from the developer. These documents are often not turned over to the detriment of the unit owners going forward.

Assessment issues should be addressed proactively by all parties involved. Failing to discover a problem early can lead to significant financial consequences for all involved that will only worsen if not discovered. Accordingly, resolution of these problems is more likely if they are caught sooner, rather than later. Hopefully this article helps you to reach that goal.

Author:

This blog entry is written by Matt Drewes. Matt is a shareholder at Thomsen & Nybeck, P.A. and head of the firm’s Association Representation Group. He practices primarily in the areas of real estate litigation, townhome and condominium law, construction litigation, debtor/creditor law, insurance litigation and employment law.  For more information on townhome and condominium law, please visit: http://www.tn-law.com/CM/Real-Estate/Townhome-Condominium-Law.asp.

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