High Energy -- New CAL Commercial Real Estate Disclosure Law

After several delays, CAL Assembly Bill 1103 Commercial Energy Disclosure went into effect on January 1, 2014. It requires the owners of all commercial buildings over 10,000 square feet which are being leased, sold, or refinanced to comply with the law. The final phase will go into effect on July 1, 2014, requiring the owners of all commercial buildings over 5,000 square feet to comply. The statute can be found at California Resources Code section 25402.10. What is the purpose of AB1103? The California legislature has set aggressive energy efficiency goals. The AB1103 Commercial Energy Disclosure program was created with the goal of making energy efficiency part of the discussion during a real estate transaction: the ultimate goal is to reduce energy waste in commercial buildings throughout California. The idea is also to benchmark buildings with similar features, allowing potential purchasers to easily shop around for more energy efficient buildings. Not only do energy efficient buildings help to reduce greenhouse gases, but they also usually translate into lower than average utility bills.

What does AB1103 require? Property owners who are going to sell, lease, or refinance an entire commercial building must upload one year’s worth of energy use data and space use attributes into the U.S. Environmental Protection Agency ENERGY STAR Portfolio Manager. This tool will process the building’s energy information and allow the property owner to generate a Data Verification Checklist disclosure form. The disclosure must be provided to the purchaser or lessee no later than 24 hours prior to the execution of the sales contract or lease agreement. In the case of a refinance, it must be provided to the lending institution no later than submittal of the loan application.

AB1103 also requires utility companies to provide the most recent 12 months of energy use data to property owners. The utility company will have the discretion to determine how to provide the energy use data information to the building owner. Currently, only the three major California utility companies (SoCal Gas, SCE and SDGE) are set up to provide the information directly through Portfolio Manager. It is anticipated that others will provide the information via a spreadsheet or similar means and the owner will then need to manually enter the information into Portfolio Manager in order to generate the disclosure form. The utility companies will also have the discretion to deal with confidentiality issues related to providing energy use data to owners when the bills are under the tenants’ names. Although AB1103 does not require any action to alter or update building systems on a property, AB1103 may encourage building owners to install energy efficient building systems to make their properties more marketable.

Who is exempt from AB1103? The most significant exemptions from AB1103 are factory, industrial, and residential properties. If the property in question is a mixed use property containing any of these exempt uses, then the entire building is exempt. Commercial buildings under 5,000 square feet are also exempt. It is also important to note that commercial buildings entering a contract before July 1, 2014 that are less than 10,000 square feet are also exempt. After July 1, 2014, all commercial buildings 5,000 square feet and larger will have to comply.

Who is enforcing AB1103? The property owner is required to release the disclosure report to the lessee, new property owner, lender, and the California Energy Commission (CEC). Enforcement for the law will be complaint driven and the hope from the CEC is that enforcement will be primarily market-driven.

The Buyer's Broker Has Commission Claim Upon Signing of Purchase Agreement

In August 2005, when the residential real estate market in downtown Los Angeles was still hot, Standard Pacific Corporation signed a purchase agreement to buy a condominium project near Union Station from Lincoln Property Co. During escrow, the market deteriorated to the point that Standard Pacific was willing to forfeit a $4 million deposit to cancel the deal. In August 2006, Standard Pacific and Lincoln signed a agreement to settle their differences. Lincoln later changed the name of the project and leased the condos instead of selling them.

Standard Pacific's broker, RC Royal Development and Realty Corporation (RC), was left out of the settlement and sued for a broker's commission under its written brokerage contract with the buyer. The trial court ruled in favor of Standard Pacific on a summary adjudication on the grounds that the close of escrow was a condition precedent to the obligation to pay a commission.

RC appealed and the Court of Appeal recently reversed the trial court in RC Royal Development and Realty Corporation v. Standard Pacific Corporation (2009) 177 Cal.App.4th 1410. It argued that its right to a commission ripened under the brokerage contract when Standard Pacific signed the purchase agreement with Lincoln. The brokerage contract provided that the broker would be entitled to a commission if buyer "purchased" the property and specifically defined "purchase" as "any and all acquisitions of any direct or indirect beneficial interest." The most interesting part of the published opinion is the Court of Appeal's discussion that the buyer acquired a "direct or indirect beneficial interest" in the property upon the signing of an executory contract -- in effect, there was a "purchase" of the property when the parties signed the buy-sell contract even though the escrow never closed. In the words of the Court of Appeal: ". . . [E]quitable title is a 'beneficial interest,' as it is one stick in the bundle of full legal rights to real property. Once Standard Pacific entered into a buy-sell contract containing all of the essential terms of purchase, it obtained equitable title."

If Standard Pacific had conditioned its obligation to pay a commission upon the close of escrow, the result probably would have been different. In that case it would not have been subject to the general rule of law that, "unless the contract provides otherwise, the broker earns his commission upon the principal's entry into a binding contract for a purchase subject to the brokerage contract regardless of whether the sale is consummated." (See, R.J. Kuhl Corp. v. Sullivan (1993) 13 Cal.App.4th 1589,1599-1600.

Sham Agreements -- They Will Not Take You Where You Need to Go

During the 1960's, Sam the Sham and the Pharaohs was a rock band which reached great heights considering that their big hit was "Wooly Bully." In a way, Sam was modest to call himself the Sham because no one could deliver "Wooly Bully" or "Little Red Riding Hood" like he and the Pharoahs.

Fast forward 40 years. The California Court of Appeal has rejected sham agreement prepared "solely for property tax purposes" -- to avoid the reassessment of a 50% interest in a shopping mall transferred several years earlier by the owner, Equitable Life, to a holding company and then to a LLC. The case is of interest to lawyers and accountants who advise clients how to use entities such as limited liability companies to structure the transfer of real estate without triggering a reassessment of the property under Proposition 13.


The Court reasoned that since the agreement that had no economic substance other than to avoid property tax liability, it was a sham document that could not be given effect. For a change in ownership to occur, there must be a transfer of legal title and of that transferor’s beneficial or equitable interests in that property. For purposes of property tax reassessment, a 100 percent change in ownership occurred when record title in property was transferred by Equitable Life to the holding company as its initial capital contribution. Even though Equitable Life was entitled to receive distributions if the holding company made a profit and had a right to participate in certain management decisions, those benefits and rights derived from Equitable Life’s membership interest in the holding company, not from ownership of the transferred property. Thus, the transferor did not retain a beneficial interest in the property itself. See, Fashion Valley Mall, LLC v. County of San Diego - filed August 17, 2009, Fourth District, Div.One, 2009 SOS 4956. To read the case, click here.

ESCROW EXTENSIONS -- BE REASONABLE!

It has been the law in California for some time that a Landlord must be reasonable in consenting to the assignment of a commercial lease. The California Court of Appeal has recently held that a seller of real property must act in an objectively reasonable manner when asked to extend the close of escrow.

In Peak-Las Positas Partners v. Bollag, the seller told the buyer he did not care how long it took the buyer to entitle a residential development project. But when the close of escrow approached, the seller refused to extend escrow. Imagine the buyers' surprise -- the buyer had already paid 98 percent of purchase price, had invested $5 million in project development costs and had diligently pursued the conditions for closing the sale.

The Court of Appeal held that the seller acted in an objectively unreasonable manner so the buyer would not forfeit the $465,000 it paid for the property and the $5 million in project costs.

A review of the facts demonstrates that the seller invented reasons late in the escrow to refuse the extension. First, the seller claimed he had landslide liability concerns. But the seller had observed soil failures on his property before purchase agreement was signed, and admitted he made no inquiries about insurance costs or availability. Second, the seller claimed the buyer failed to keep him informed about the entitlement processing. To the contrary, the buyer informed the seller about the progress of the land use application and the seller never complained that he lacked information. Even if the buyer had breached its obligation under the purchase agreement to keep the seller informed, the Court of Appeal said it would not constitute reasonable or good faith grounds for the seller to refuse the requested extension.

For guidance about what is objectively reasonable in a commercial real estate transaction, click here to read the opinion in Peak-Las Positas Partners v. Bollag.

2009 Trends in Environmental Law and Due Diligence

Environmental regulation has come a long way in the last 100 years. But environmental due diligence has been effected by the recent downturn in the commercial real estate market. In addition, there are some new laws that commercial real estate owners, lenders and brokers should be aware of. Joe Derhake is a environmental engineer and a principal at Partner Engineering and Science, Inc. based in El Segundo, California. Mr. Derhake is a friend of this Blog and its author. He was recently interviewed by Jessica Lillian of MortgageOrb.com, a blog for commercial real estate professionals. She asked Mr. Derhake about the effect of the lending slowdown on environmental due diligence on commercial properties, and about the trends in environmental law for commercial property in 2009. The interview is reprinted below.

Q: Have the more stringent lending and underwriting standards these days translated into more attention paid to the environmental component of the due diligence process?

Joe Derhake: The short answer is yes, we are definitely seeing a trend in that direction. Lending decisions are influenced by deal people and credit people, and as of late, the credit side is the more powerful group. For the environmental consultant, that means more thorough due diligence. Lenders are now more likely to order Phase I Environmental Site Assessments instead of limited products.

When contamination is found, however, the enthusiasm among lenders for quantifying the environmental problem and trying to underwrite around the problem is low. Lenders would prefer to pass on the deal.

Q: Vapor intrusion has received a lot of attention lately - though many in the lending community seemed somewhat unaware of it until recently. What emerging environmental issues are you seeing now?

Derhake: While the ASTM 2008 vapor intrusion standard created a lot of discussion in the environmental professional community, clients have been hesitant to use the new standard, instead relying heavily on the Phase I Environmental Site Assessment to address these environmental concerns.

An up-and-coming environmental issue is energy consumption, and California is leading the charge with Assembly Bill 1103, which mandates that all California nonresidential buildings participate in the Federal Energy Star program beginning in January 2009.

Benchmark data showing the building's relative energy consumption performance will be collected throughout 2009. After Jan. 1, 2010, building owners will be required to disclose these data to buyers, lessees and lenders. Energy Star will rate buildings against other buildings within the same class - adjusted for climate, but not age. Buildings within the top quartile are eligible to be recognized as an EPA Energy Star Building and can use the Energy Star label to communicate their energy efficiency to tenants, lenders and other stakeholders.

Not only will highly ranked buildings be more likely to capture a green premium when the property sells or rents, but analysis of these data will yield opportunities of energy savings and, ultimately, improvement of net operating income.

Will green buildings ever receive any sort of preferential treatment from lenders? Bank of America, Wells Fargo Bank and Citibank are among the national lenders that have committed themselves to billions of dollars of green lending.

To date, much of the green lending has focused on building green and LEED construction. However, Energy Star-rated buildings are gaining more and more attention, and with the data required by AB 1103 becoming available in the next year, lenders will have more objective standards to judge their collateral.

Lenders could easily aggregate their portfolio's Energy Star Rating and set goals to improve their portfolio over time. It is possible that other states will follow suit and implement similar building energy disclosure requirements in the future.

Q: What steps can cash-strapped financial institutions take to manage the costs involved with environmental assessments?

Derhake: Environmental policy can be thrifty and smart. To be thrifty, lenders should consider limited environmental products, such as environmental transaction screens and historical environmental reports. Historical environmental reports are inexpensive (typically under $500) and focus solely on the history of the property.

This is a perfect product for an asset that clearly has no issues, due to a benign use such as residential or office, and most reasonable concern is centered on what was there before the current development. If environmental concern is identified during the historic research, further due diligence can be conducted.

Q: What are the most common forms of contamination you are finding these days? Are there any recent technological advancements in remediation strategies?

Derhake: The types of contamination that we find are across the board. However, the type of contamination that is receiving greater scrutiny by regulators is volatile organic compounds, which include chemicals such as benzene (an additive in gasoline and an industrial solvent) and tetrachloroetheylene (PCE, a drycleaning solvent). These volatile chemicals are toxic and represent a vapor intrusion risk.

The concern that these chemicals will migrate up into buildings and create a cancer risk for occupants is driving cleanups. Many state regulators require soil vapor testing for all sites. To achieve closure, a property owner has to show that the levels of soil vapor are below action levels. Generally speaking, soil vapor-based action levels are more stringent than soil matrix-based action levels.

Volatile organic compounds have historically been remediated via soil vapor extraction and dual phase extraction. Each of these technologies involves more or less sucking the contamination out of the ground. We install vapor extraction wells, connect the wells to large blowers and pull. The toxic vapor stream extracted must then be treated.

In-Situ Chemical Oxidation (ISCO) is proving to be a significant alternative technology. ISCO involves injecting a reactive chemical into the ground, and the reactive chemical oxidizes the contaminant upon contact. This technology works very quickly, and for some contamination plumes, it is very cost-effective.

Q: What is the latest on the regulatory front for environmental compliance/liability issues? What might be on the horizon for 2009?

Derhake: California, Oregon and other states have published soil vapor action levels. When professionals are cleaning a site, the question becomes, "How clean is clean?" Environmental professionals compare our testing data to the action levels.

Historically, we collected soil samples and compared these data to soil matrix action levels. Lately, closure sampling must also consider soil vapor analysis, and we must compare these to far more stringent soil vapor action levels.

This shift is profound, as sometimes it means that the remedial system must run another year or more.

The Federal EPA has not yet pushed for any such soil vapor standards. With a new administration coming in 2009, we may see the Federal EPA addressing this issue. Commercial real estate owners do not benefit from stricter standards, as it likely will increase cleanup costs. However, greater uniformity from state to state makes environmental risk management easier.

To learn more about Joe Derhake's firm, Partner Engineering & Science, Inc., click here.

After the Fall -- What Now?

On December 26, 2006, I wrote a post entitled "'Creative' Financing -- The Slippery Slope in 2007."

On December 28, 2007, I wrote a post entitled "Non-Traditional Mortgage Products -- The Slippery Slope Became an Avalanche."

Now it is time for my third year end post. I read an insightful column in today's the Wall Street Journal about the global economic reversal. It is entitled, "The Economic News Isn't All Bleak" by Zachary Karabell. In the last paragraph of his column, Mr. Karabell observes:

"The rush to declare the future bleak has obscured the fact
that no one knows the outcome of an unprecedented event.
No one. The worst course in the face of uncertainty is blind
faith in conventional wisdom and past patterns. The best is
to stay humble in the face of the unknown, creative and
unideological about solutions, and open to the possibility
that as quickly as things turned sour they can reverse."

To the loyal readers of CalRealEstateLawBlog.com, watch out for wolves in sheeps' clothing and have a productive and healthy 2009!

The '08 Wildfires -- A Helping Handbook

Sadly, this is a repeat of a post from November 2007:

The recent wildfires have wreaked havoc on the lives of many families in Southern California. As a public service to those families, the Los Angeles County Bar Association and Morrison & Forester have published a "Helping Handbook" available on line. This handbook contains a compendium of California and Federal real estate and insurance law that will assist wildfire victims in the recovery process.

To read the Helping Handbook, click here.

ARBITRATION -- Revisited and Reviewed

This Blog recently criticized non- judicial arbitration because, among other problems, the arbitrator can render a binding award without following the applicable law. The California Supreme Court has ruled that the parties may agree by contract to avoid this pitfall.

In the recent case of Cable Connection Inc. v. DIRECTV, 2008 DJAR 13491, the Supreme Court held that parties to an arbitration agreement can agree in advance to judicial review of legal mistakes by the arbitrator. This is significant because many people sign arbitration provisions in this State unaware that arbitrators are not required to follow the law. For example, an arbitration provision is standard in the commonly used California Association of Realtor's form Purchase Agreement for residential real estate. If both parties initial the arbitration provision, they have agreed to binding arbitration without judicial review for legal mistakes.

Justice Carol Corrigan writing for the majority in Cable Connection Inc. v. DIRECTV explained that judicial review of an arbitrator's decision will still ease the pressure on California's trial courts. "The judicial system reaps little benefit from forcing parties to choose between the risk of an erroneous arbitration award and the burden of litigating their dispute entirely in court. Enforcing contract provisions for review of awards on the merits relieves pressure on congested trial court dockets."

What can you do to preserve the right to judicial review of an arbitrator's award. First, you must have appropriate language in the agreement to arbitrate. The provision in Cable Connection Inc. v. DIRECTV read: "The arbitrators shall not have the power to commit errors of law or legal reasoning, and the award may be vacated or corrected on appeal to a court of competent jurisdiction for such error."

Second, there must be a record made in the arbitration that is reviewable by a court. Often times awards in arbitrations merely something like, "Claimant is awarded $________ against respondent, plus costs." At the very least, a party should request a "reasoned decision" by the arbitrator in a form similar to a Statement of Decision that is issued by the Judge in a Superior Court trial. Because without a "reasoned decision" there may be nothing to review.

CONTRACTOR'S STATE LICENSE LAW -- When Is Ignorance Bliss?

A few months ago, I was retained to draft a construction contract by a client who is building a house in my area. During this assignment, I checked the website of the California Contractor's State License Board to see if the general contractor selected by my client was licensed. The contractor did not have a license in the name of his corporation and did not have worker's compensation insurance. My client selected another contractor who had a license and insurance.

A recent Court of Appeal case, Great West Contractors, Inc. v. WSS Industrial Construction, Inc. (2008 Cal. App. LEXIS 627) provides a good overview of the circumstances under which a licensed contractor can be denied any payment for its work. In that case a steel subcontractor sued the general contractor for labor and materials it provided for a school. The steel subcontractor ("WSS") was not licensed when it bid the job, did preliminary work under the subcontract (preparing plans and ordering materials), and began to invoice the general contractor. WSS became licensed before the subcontract was signed by both parties and before it did the lion's share of its work under the subcontract.

The Court of Appeal reversed a ruling by the trial court in favor of WSS, holding: "With one exception, the [Contractor's State License Law] forbids a contractor from recovery -- in law or equity -- on an otherwise valid claim for performance of any service for which a license is required if the contractor was unlicensed at any time during performance of the work." (Emphasis added.) This "bright line" test requires contractors to be licensed at the commencement of its services. If the contractor is aware of the problem and fixes it during the project, it is a case of "too little, too late."

But as the Court of Appeal said in that case, there is a statutory exception which is subject to interpretation by California courts. Under Business & Professions Code section 7031(e), a contractor can recover money in a civil action if it proves there has been "substantial compliance" with the licensure requirements: (1) the contractor had been duly licensed in this state prior to the contract or act; (2) it acted reasonably and in good faith to maintain proper licensure, (3) and did not know or reasonably should not have known that it was not licensed. This means that a contractor with an expired license can recover for work done without a license if a court finds that its ignorance of the law and the facts was excusable -- even if the excuse is a weak one. See, e.g., ICF Kaiser Engineers, Inc. v. Superior Court (1999) 75 Cal. App. 4th 226 (the appellate court excused Kaiser from compliance with the licensing law because it was a large company and could not be expected to keep abreast of developments that resulted in the suspension of its license). This is a case where ignorance was bliss.

But the owner who contracts with an unlicensed contractor is unlikely to achieve a state of bliss if a worker is injured on the job. Assuming the unlicensed contractor does not have worker's compensation insurance (a likely state of affairs), the injured worker may be deemed an employee of the owner. Labor Code section 2750.5. A possible consequence is that the unlicensed contractor who is injured on the job will make a worker's compensation or personal injury claim against the owner. This is a case where ignorance will not be bliss -- an owner should determine if a contractor is licensed and has worker's comp insurance before he or she signs a construction contract.

To read a recent Los Angeles Times article about the problems that can be created by hiring an unlicensed contractor, click here.

CAL. FIGHTS GLOBAL WARMING -- How to Turn Cow Manure into Greenbacks

In late 2006, the California Legislature passed AB 32, a law to reduce the emission of greenhouse gases. Now codified in California Health & Safety Code sections 38500, et seq., the "California Global Warming Solutions Act of 2006" will affect owners of commercial real estate throughout the state.

Under AB 32, the California Air Resources Board (CARB) has been empowered to develop regulations and market mechanisms to reduce California greenhouse gas emissions 25% by 2025. CARB is required to adopt a plan to accomplish this by 1/1/09 and a set of regulations that will be enforceable on 1/1/10. Battle lines are already being drawn over the plan by electric utilities that rely on the production of electricity by burning coal (example, the L.A. Dept. of Water & Power).

As AB 32 goes into effect, owners of real property such as office buildings, automobile dealerships, hotels and farms may be required to commission a study commonly referred to as a "carbon footprint" to determine the level of greenhouse gas emissions from their property. If the emissions are in excess of the acceptable limit for the property set by CARB, the owner will either have to reduce the emissions or buy "carbon credits" to offset the violation. This will be a big business.

Let's take the case of a dairy farmer in Southern California. Cow manure emits methane which is a greenhouse gas that is 23 more times harmful to the atmosphere than CO2. If the farmer can make the methane go away, he may turn manure into money. This will be done by constructing a biodigester that can turn the methane in electricity and the manure into fertilizer. If you think this is futuristic, it is already happening in Oregon and the Third World. Biodigesters will be sold at a cost millions of dollars to large dairy farmers with electric utilities and their customers picking up part of the tab. The dairy farmers will sell the electricity and fertilizer produced by the biodigesters and the carbon credits created by the reduction of emissions. Investment bankers are already getting into the business of brokering carbon credits; let's hope they do better than they did with the sale of pools of subprime mortgages.

Specific Performance -- The Good Old Days

A Court of Appeal opinion filed yesterday will leave some real estate investors longing for the good old days -- the days when speculators flipped property as readily as pancakes.

In Real Estate Analytics, LLC v. Vallas, filed February 26, 2008, Fourth District, Div. One (cite as 2008 SOS 1264), the trial court found that the defendant/seller breached his contract for the sale of a large parcel of coastal property in North San Diego County to a real estate investor. Despite the breach, the trial court refused to grant the buyer's request for specific performance ordering the sale of the property. The trial court concluded that money damages were an adequate remedy because the buyer's primary motivation was to quickly resell the property for a profit. Instead, the trial court awarded the plaintiff damages of $500,000 (the difference between the contract price and fair market value at the time of the breach) and attorneys' fees of $272,918.

The Court of Appeal held that the trial court erred by refusing to grant specific performance on the basis the property would quickly be resold for a profit: "The law generally presumes real property is unique and that the breach of an agreement to transfer property cannot be adequately relieved by pecuniary compensation. The seller did not overcome this presumption merely because the buyer's purpose in purchasing the property was to earn profits from developing and/or reselling the property."

With the downturn in the real estate market, this issue is unlikely to come up in the new cases. Instead, it is the seller who will consider suing the buyer for specific performance when a deal falls through. Seller's specific performance cases are generally unheard of in a rising market and require careful handling. There are some significant differences between a seller's and buyer's action for specific performance. As discussed above, damages are usually an inadequate remedy for a buyer of "unique" real property. Where the plaintiff is a seller, damages are generally considered the appropriate remedy and specific performance may only be available where the value of the property has remained more or less the same as the contract price (not likely in most parts of the country). This presents the seller/plaintiff with a paradox: if plaintiff alleges a basis for the recovery of damages, this will undermine the specific performance claim; and if plaintiff demonstrates an entitlement to specific performance this will negate a claim for general damages.

The '07 Wildfires -- A Helping Handbook

The recent wildfires have wreaked havoc on the lives of many families in Southern California. As a public service to those families, the Los Angeles County Bar Association and Morrison & Forester have published a "Helping Handbook" available on line. This handbook contains a compendium of California and Federal real estate and insurance law that will assist wildfire victims in the recovery process.

To read the Helping Handbook, click here.

Trade Secrets and Commercial Real Estate

Real estate and business litigation are first cousins. This fact is illustrated by the recent Court of Appeal opinion in San Jose Construction v. S.B.C.C., Inc. -- an action by one commercial construction company against another for misappropriation of trade secrets.

Plaintiff's former employee, a project manager, took confidential documents with him to his new job with a competitor. The documents were a compilation of information about the "design build" of more than a dozen projects that plaintiff used to emerge as the successful bidder on the projects. Using the confidential information, the former project manager sought to have the developers shift to his new employer.

The case contains a helpful summary of the law of trade secrets and unfair competition in CA. As in many trade secret cases, the defendant tried to "slice and dice" the information by claiming each bit of information by itself was not confidential. The plaintiff argued that it was the compilation of information (much like a secret recipe) that made it a trade secret. The Court of Appeal agreed by holding that plaintiff raised a triable issue of fact in opposition to defendant's motion for summary adjudication.

Trade secret cases are not uncommon in the real estate industry. Over the years, I have litigated cases involving proprietary building techniques used for factory built housing, customer lists in the mortgage business, and processes for originating specialized loans for multi-family housing.