Relating to Real Estate

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Relating to Real Estate April 2016

In this issue:

Bad Boy (Guaranties), What You Gonna Do?

The IRS Appears to Change Established Practice Regarding Allocation of Nonrecourse Debt

On February 5, 2016, the Internal Revenue Service (the "Service") Office of Chief Counsel released Memorandum 201606027 (the "Memorandum"), which appears to be contrary to the generally-accepted view that nonrecourse debt will be allocated among all partners of a partnership, or members of a limited liability company ("LLC") that is treated as a partnership for tax purposes, in accordance with their profit-sharing percentages, even if the manager or key-principal gives a "bad boy" carve out guaranty.

Real estate acquisitions are often structured with one or more syndicators or active managers ("Manager") and multiple less-active or passive investors ("Investors"). In many such arrangements, a portion of the equity needed is provided by the Investors, and the Manager receives an ownership interest without investing its pro rata share of the investment. The remaining capital required is raised through financing. This financing is often done through a nonrecourse loan.

The lender making the loan will typically require that the Manager sign a "bad boy" guaranty that will make the Manager liable in the event of certain scenarios, which may include the following examples: (1) the borrower fails to obtain the lender's consent before obtaining subordinate financing, or transfer of the secured property, (2) the borrower files a voluntary bankruptcy petition, (3) a Manager files an involuntary bankruptcy petition against the borrower, (4) a Manager solicits other creditors to file an involuntary bankruptcy petition against the borrower, (5) a Manager consents to an involuntary bankruptcy, (6) a Manager consents to the appointment of a receiver or custodian of assets, or (7) a Manager makes an assignment for the benefit of creditors or admits in writing that the borrower is insolvent or unable to pay its debts as they come due.

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General Assembly Broadens and Clarifies Exemptions to Statute That Taxes Transfers of Controlling Interests

The Maryland General Assembly recently passed Senate Bill 597 and House Bill 1226, entitled Recordation and Transfer Taxes - Transfer of Controlling Interest – Exemption, which when signed by the Governor will revise the exemptions applicable to the taxation of transfers of controlling interests in Maryland real property entities.

Ed Levin and Jeff Spatz drafted these bills, and they worked with Tom Ballentine of NAIOP to promote this legislation. Ed testified before the House Ways and Means Committee on March 9 and before the Senate Budget and Finance Committee on March 11 about these bills.

This legislation will be useful to landowners and practitioners because the Maryland law involving transfers of controlling interests, §§12 117 and 13-103 of the Tax-Property Article of the Maryland Code ("TP"), was drafted with a wide net, and its exemptions did not reach certain transactions that should not have been subject to the tax. Specifically, Senate Bill 597 and House Bill 1226 will exempt transfers between affiliates that were not intended to trigger the tax but sometimes did. Also, the exemptions for transfers involving only corporations are now equally applicable to limited liability companies.

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Lease Termination May Be Avoided in Bankruptcy

When a commercial tenant is failing, the tenant and its landlord may enter into a lease termination agreement relieving the tenant from all or some of its obligations, and permitting the landlord to lease the space to a more viable tenant. Although the landlord may assume that the termination agreement has ended its relationship with the tenant, a recent decision of the U.S. Court of Appeals for the Seventh Circuit should change that assumption.

In In re Great Lakes Quick Lube LP, No. 15-2093, 2016 WL 930298 (7th Cir. March 11, 2016), the Seventh Circuit, in an opinion by noted jurist Richard Posner, reversed a bankruptcy court decision holding that a lease termination agreement could not be avoided under the Bankruptcy Code. Under the facts of the case, prior to bankruptcy, a landlord entered into an agreement terminating leases of several of the debtor's locations including two stores that were allegedly profitable. After the debtor filed for Chapter 11 bankruptcy, its creditors committee sued the landlord for the value of the leases of the two profitable stores on the basis that the termination of the leases was a preferential and/or fraudulent transfer. Under the Bankruptcy Code, a transfer of a debtor's property prior to bankruptcy may be avoided as a preference and/or fraudulent transfer if certain elements are established. The bankruptcy court held that neither lease termination was a "transfer" that could be avoided as a preference or fraudulent transfer.

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Bankruptcy Filing Upheld Despite Lender's Failure to Consent As "Special Member" of the Debtor

On April 5, 2016, the U.S. Bankruptcy Court for the Northern District of Illinois upheld a Chapter 11 filing by a limited liability company even though the LLC's operating agreement required the consent of the "Special Member" to the filing, and the Special Member did not consent. In re Lake Michigan Beach Pottawattamie Resort LLC, No. 15-bk-42427, 2016 WL 1359697 (Bankr. N.D. Ill., April 5, 2016).

In connection with the execution of a forbearance agreement on August 21, 2015, the LLC executed an amendment to its operating agreement which appointed its lender as a "Special Member" of the LLC with the right to approve or disapprove any "Material Action" including a filing for bankruptcy. The amendment also provided that the Special Member would owe "no duty or obligation to give any consideration to any interest of or factors affecting the Company or the Members." After the LLC defaulted under the forbearance agreement, the lender scheduled a foreclosure sale. Before the sale occurred, the LLC filed under Chapter 11 in order to stay the foreclosure. All of the LLC's members consented to the filing except for the lender, as the Special Member. The lender moved to dismiss the filing on the basis that it was not authorized by the LLC's operating agreement.

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Prince George's County Council Acts with Appellate Jurisdiction on Zoning Review; Must Defer to the Expertise of the Planning Board

County Council of Prince George's County, Sitting as the District Council v. Zimmer Development Company, 444 Md. 490 (2015), is a must read for anyone interested in Maryland zoning and planning procedure, and particularly for those concerned about real property located in Prince George's or Montgomery Counties. Judge Glenn Harrell handed down this decision on August 20, 2015, after he had retired as an active judge on the Court of Appeals; he was recalled for it. The case is 101 pages in length, the first 42 of which discuss the history of zoning and planning in Maryland from 1632 to the present. This is a fine gift for Judge Harrell to leave to the bench and bar.

The underlying facts in Zimmer involve the proposed development of 4.14 acres in Adelphi, Prince George's County, Maryland, known as the Edwards Property. Zimmer Development Company planned to build a retail center on the Edwards Property with a CVS pharmacy as its anchor. An application was filed in 2004 for a zoning map amendment of the Edwards Property to an L-A-C (Local Activity Zone), a floating zone, with a Basic Plan outlining how the property would be developed. The County Council of Prince George's County, sitting as the District Council, adopted a zoning ordinance granting the rezoning request subject to certain conditions.

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Value of a Federal Subsidized Lease Includes Considering the Tenant's Life Expectancy

In Kirk v. Hilltop Apartments, LP, 225 Md. App. 34 (2015), the Court of Special Appeals held that federal subsidized leases containing automatic renewal provisions are of indefinite length, and therefore to calculate the value of the lease the monthly rent is to be multiplied by the tenant's remaining expected life.

Hilltop Apartments sued LaShaun Kirk in district court to terminate her Section 8, federally subsidized lease, alleging numerous defaults. Kirk moved to have the case tried in circuit court, and there she prayed a jury trial. To do this, the amount in controversy must be more than $15,000.

Hilltop asked the circuit court to return the case to district court because the fair market value of the lease times the number of months until the end of the stated lease term was less than $15,000. The Circuit Court agreed, but on appeal the Court of Special Appeals reversed.

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Homestead Tax Credit Applies When Home Is Razed and Rebuilt, but Assessment Increases

In State Department of Assessments and Taxation v. Andrecs, 444 Md. 585 (2015), the Court of Appeals held that a homeowner who razes his home and rebuilds it is entitled to maintain the homestead tax credit he had before knocking down his house, but the value of improvements he made to the property must be included in the new tax assessment of the property.

This case addresses the tension between the homestead tax credit and the general rule that all real property in Maryland is to be uniformly assessed. When the homestead tax credit was originally enacted in 1977, if a homeowner substantially renovated his property he lost the benefit of the homestead tax credit. The legislature amended the homestead tax credit statute in 1991 and 2006 to provide that in such circumstances, the homeowner retains the existing tax credit, but the full value of the improvements are included for tax assessment purposes.

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Rent Under a Residential Lease Is Only the Basic Payment

The Court of Appeals held in Lockett v. Blue Ocean Bristol, LLC, 446 Md. 397 (2016), that under a residential lease, the term "rent" as used in the Real Property Article of the Maryland Code ("RP") only includes the basic payments under the lease. Therefore, a landlord could not exercise certain rights against a tenant who was in default with respect to other fees and charges under the lease.

Felicia Lockett was a tenant in an apartment building in Baltimore City and was active in the tenants association. This caused a difficult relationship to develop with the owner of the property, Blue Ocean Bristol, LLC, which elected not to renew Lockett's lease when it expired. When Lockett did not leave, Blue Ocean brought an action to dispossess her as a holdover.

Under Maryland law, a landlord may not retaliate against a tenant for certain activities, including activities with a tenants association. But the law only protects such tenants who are "current on the rent." See RP §8-208.1. Lockett was current with her payments of basic rent, but she was either in default or in a dispute with the landlord in connection with utility payments and other amounts that were deemed to be "rent" under the terms of her lease.

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Property Owners Abandoned Their Vested Right in a Permit After the Property Was Rezoned for Residential Use

In Sizemore v. Town of Chesapeake Beach, Maryland, 225 Md.App. 631 (2005), the Court of Special Appeals held that property owners could and did abandon their vested right in a zoning permit for a restaurant on their property after the property was rezoned residential and they stopped construction of improvements for extended periods of time.

In April 2000 Joyce and Stephanie Sizemore applied to the Town of Chesapeake Beach (the "Town") for a zoning permit for a restaurant on the 0.43-acre property where Joyce lived, and in 2003 they obtained a final zoning permit to construct a restaurant. In February 2004, as part of a comprehensive rezoning, the property was downzoned to a residential category.

The Sizemores started construction but did not proceed very far, and construction ceased entirely for long periods of time. After numerous warnings, in January 2009 the Town zoning administrator revoked the zoning permit for failure to complete or satisfactorily proceed with construction.

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Speaking of Real Estate

PRESENTATIONS

Ed Levin was a panelist at the meeting of the American College of Real Estate Lawyers (ACREL) in San Diego on "An Introduction to Local Counsel Opinion Letters in Real Estate Finance Transactions - A Supplement to the Real Estate Finance Opinion Report of 2012" on March 18, 2016. He also was a leader of two workshops at the ACREL meeting on the same topic on March 20, 2016.

Ed Levin will speak to the Commercial Real Estate Discussion Group of the Maryland State Bar Association's Section of Real Property, Planning and Zoning on May 10, 2016 on "Recent Maryland Real Estate Cases."

Ed Levin is program coordinator for and will be a panelist at the American Bar Association, Section of Real Property, Trust and Estate Law Symposia in Boston on May 12, 2016 on "Local Counsel Opinion Letters, A Revolutionary Supplement to the Real Estate Finance Opinion Report of 2012."

Ed Levin will be a panelist in the webinar sponsored by the ABA Section of Real Property, Trust and Estate Law on Legal Opinions in the series entitled "Fundamentals of Commercial Real Estate" on May 25, 2016.

LEGISLATION

Ed Levin and Jeff Spatz drafted Senate Bill 597 and House Bill 1226, entitled Recordation and Transfer Taxes - Transfer of Controlling Interest – Exemption, which was recently unanimously passed by the Maryland General Assembly. Ed testified before the House Ways and Means Committee on March 9, 2016, and before the Senate Budget and Finance Committee on March 11, 2016 about these bills. When signed by the Governor, these bills will revise the exemptions applicable to the taxation of transfers of controlling interests in Maryland real property entities. Ed, Jeff, Searle Mitnick, and Seth Rotenberg have worked on transactions involving change of control of real property entities, and they realized that the exemptions from recordation and transfer taxes in the original law were not well drafted to exempt transfers to related entities or to give all types of business entities the same exemptions that were afforded to corporations. An article about Senate Bill 597 and House Bill 1226 appears in this issue.