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11.340J Legal Issues in the Development Process

LEGAL ISSUES IN THE DEVELOPMENT PROCESS 1999 11.340J/15.658J M-W 8:30-10:00   Objective: The purpose of this course is to provide students with an understanding of the legal issues that arise in the course of acquiring, developing, managing, and disposing of real estate. The course adopts the perspective of the owner and examines the legal dimensions of issues regarding site control, the form of ownership of the real estate entity, the tax consequences of acquisition, operation and disposition of real estate, the public approval process, the financing, construction, and leasing of development projects and workouts. Classes are organized around analysis and understanding of fact situations and transactions which have been created as teaching vehicles. The course assumes no prior background or familiarity with the law. Enrollment is limited and is by permission of the instructor.   Organization: The course will meet twice a week with additional recitation sections scheduled as needed. Classes will be taught Socratically, and class participation will count towards the final grade. Students are expected to do the reading in advance of class and to come to class prepared to contribute to class discussion. The primary text for the course will be a two volume reader which is available for purchase from MIT Central Copy (room 11-004 in the basement of the main MIT building.) The reader contains four different types of readings: problems which serve to organize the major subjects covered in the course; articles that have been excerpted from journals and other publications; decisions of appellate courts that describe the relevant law governing particular issues; and documents which illustrate the types of agreements commonly encountered in real estate practice. The documents can be quite lengthy and tedious to read. In most cases you need only skim them. In a few instances we will want you to read them carefully and will so note in class. We have included these documents in your reader as a reference, and because we think all real estate practitioners should be somewhat familiar with them. The course aims to enhance your awareness of legal issues, not to train you as lawyers. As you will soon learn, successes and failures often turn on the meaning of small words in these documents.   Grading: Three written assignments will be distributed during the course of the semester. Each will count for 25% of the final grade. The remaining 25% will be determined by class partici-pation.   Instructors: Professor Lawrence S. Bacow, Room 10-200. 617-253-2004. Email bacow@mit.edu Office hours by appointment. Elliot M. Surkin, Esq. Lecturer. 617-428-3399. Email esurkin@hillbarlow.com Office hours by appointment. Instructor: Leigh A. Gilligan, Esq., Lecturer 617-345-7020. Email lgilligan@ghlaw.com Office hours by appointment.   LEGAL ISSUES IN THE DEVELOPMENT PROCESS   Syllabus 9/8 Introduction to the Course 1. Pierson v. Post, 3 Caines 175 (N.Y. Sup. Ct. 1805). A case that illustrates one of the major themes of the course: the relativity and divisibility of property rights. Handed out in first class. 2. Glossary of Real Estate Economic Terms. 9/13 Pre-Acquisition Due Diligence and Site Control I One of the first issues you are likely to confront is how to gain control of a property. In the first class on site control, we examine a number of common strategies for controlling sites including optioning the site, outright purchase, and leasing. The problem, Canton Shopping Center I, asks you to anticipate the issues that need to be addressed in a letter of intent for the purchase of a tired, old shopping center which you hope to redevelop into an enclosed mall. 1. Problem: CANTON SHOPPING CENTER I 2. "Note on Contracts." Throughout your careers, you will be encountering contracts -- contracts for the purchase or sale of property, contracts for architectural or construction services, brokerage contracts, employment contracts, etc. This note briefly summarizes the essential elements of a contract, as well as the legal concepts of breach and damages. The purpose of this note is to help you understand when a commitment becomes legally binding. 3. "Note on the Statute of Frauds." The Statute of Frauds provides that contracts for the sale of real estate must be in writing to be enforceable. This note describes a few cases where the parties were barred from asserting the affirmative defense of the Statute of Frauds. 4. Lawyers' Negotiation - a "short play" 5. Barry, "How to Negotiate Like a Slimeball," The Boston Globe, July 29, 1988. P. 66. 6. Documents: Standard Form Offer to Purchase, Letter of Intent 7. McCarthy v. Tobin, 419 Mass. 84 (1999) 8. Note on Letters of Intent 9. Confidentiality Agreement   9/15 Pre-Acquisition Due Diligence and Site Control II In the second class on site control, we examine the negotiation of the purchase and sale agreement. An essential part of this process is the due diligence associated with potential title and environmental problems. 1. Mack, "Negotiating and Drafting the Purchase and Sale Agreement." 2. Chesler, " Negotiating the Environmental Issues in Real Estate Contracts." 3. Johnstone, "Title Insurance," 66 Yale Law Review 492 (1957). 4. Hellman, "How They Assembled the Most Expensive Block in New York's History." A fascinating account of the land assembly for the Citicorp headquarters. Once you read this, you will understand why cities often take responsibility for assembling urban sites. 5. Documents: Purchase and Sale Agreement.   9/20 The Public Approval Process I In most developed parts of the world, land owners hold their land subject to regulation by the state. This regulation typically defines the conditions under which land subject to regulation can be developed. In the first class on the public approval process, we will explore the basic system of zoning used in most cities throughout North America and in many other parts of the world. 1. Wright, Land Use, 3rd. ed., pp. 172-209. 2. Euclid v. Ambler, 272 U.S. 365, (1926). 3. Massachusetts General Laws, Chapter 40A. 4. Parkview v. City of New York, 71 NY 2d 274, 519 NE 2d 1372 (NY 1988).   9/22 The Public Approval Process II Virtually all zoning schemes provide for exceptions to the general plan. In the second class on the approval process we will explore the discretionary powers vested in zoning authorities to grant exceptions, to amend the zoning ordinance, and to grant special permits both with and without conditions. We will also briefly look at the constitutional limits of the government's powers to regulate land use. 1. Dawe v. City of Scottsdale, 119 Ariz 486, 581 P.2d 1136 (1978). 2. Pearson Kent Corp. v. Bear, 28 NY 2d 396, 271 NE2d 218 (1971). 3. Dosman v. Area Plan Commission of St. Joseph County, 160 Ind. App. 605, 312 NE2d 880 (1974) 4. Otto v. Steinhilber, 282 NY 71 (1939). 5. Minnetonka Congregation of Jehovah's Witnesses, Inc. v. Svee, 303 Minn. 79 (1975). 6. Dolan v. City of Tigard, 114 S. Ct. 2309 (1994)   9/27 The Public Approval Process III Increasingly, environmental regulations also serve to regulate the develop-ment process. In the third class on the approval process, we examine just two state environmental statutes to illustrate their potential impact on the de-velopment process. 1. Frieden, The Environmental Protection Hustle, Chapter 7. 2. Problem: JOHN WINTHROP 3. Massachusetts Oil and Hazardous Material Release Prevention and Response Act, Mass. Gen. Laws, ch. 21E, §§ 2, 5, 13. 4. Massachusetts Wetlands Act, Mass. Gen. Laws, ch. 131, S40. 5. Buck, "Land Use and Environmental Due Diligence Checklist for Permitting Review" 6. Buck, "Land Use and Environmental Sample Report"   FIRST ASSIGNMENT HANDED OUT: DUE 10/12   9/29 Introduction to Federal Taxation of Real Estate The Federal Tax Code influences almost every aspect of real estate investment, operation, and finance. In order to understand how to structure real estate transactions efficiently, one must first understand how real estate is treated by our tax system. In this class, we review the basic structure of federal income taxation of real estate. For those of you who are familiar with the tax code, this class will be redundant and you may want to treat it as a review or to skip it altogether. Those of you from other countries may wonder why you should study our US system of taxation, especially given that you may never work in the US. The answer lies in the fact that unless you understand federal taxation of real estate, you will not understand the motivation of US institutions to invest in real estate in the US and abroad. Moreover, many of the more sophisticated financing strategies developed in the US in response to federal tax treatment of real estate are now being adopted abroad. 1. "Note on Taxation." Harvard Business School. 2. Grant, J., "Big Relief and Little Grief for Real Estate Under TRA '97," The Journal of Real Estate Taxation, Winter 1998, pp 99-118.   10/4 Taxation I: Acquisition and Operation of Real Estate The readings for this class review the tax issues most relevant in the early stages of property ownership and development. They supplement the Harvard Business School Note on Taxation. 1. Problem: VICTOR DEVELOPMENT. In this problem, you are asked to evaluate the impact of depreciation on the return to an investor in real estate. The problem asks you to evaluate what is depreciable, and who gets to depreciate it. It also explores limitations on deductibility of losses that are characterized as "passive" under the tax code. 2. Note on At Risk Limitation on Losses and Passive Loss Rules. 3. Lipton, "Further Development Concerning Passive Losses." 72 Taxes 136 (1994). 4. Property Subject to Depreciation a. Land and Improvements: Revenue Ruling 77-270 and notes. b. Property Subject to Lease: M. DeMatteo Construction Co. v. U.S., 433 F.2d 1263 (1st Cir. 1970). 5. Who Depreciates? a. Helvering v. Lazarus & Co., 308 US 252 (1939). b. Frank Lyon Company v. US, 435 US 561 (1978) This Supreme Court case is worth reading closely to appreciate how parties sometimes attempt to recharacterize transactions for tax and regulatory purposes. As you read the facts, try to understand why Lyon and Worthen structured the transaction in this particular way. Who really incurred the risks of ownership? What would happen in a foreclosure?   10/6 Taxation II: Acquisition and Operation of Real Estate, cont. In this class, we examine the tax incentives provided for rehabilitation of real estate. 1. Problem: VICTOR DEVELOPMENT II: In this version of the problem, we examine the tax incentives for rehabbing older buildings. 2. Note on Tax Treatment of Rehabilitation Expenses. 3. Webbe v. Commissioner, 54 TCM 281 (1987) and letter ruling 8917004. 4. Housing Rehabilitation - Confidential Private Offering Memorandum (Excerpt) 1999 -- GUEST: Stephen M. Nolan, Esq.   10/11 Holiday: Columbus Day . 10/12 Taxation III: Disposition Strategies Note: Tuesday class Eventually all property changes hands. This class reviews the tax consequences of disposition as well as the major strategies available for minimizing those consequences. 1. Problem: CASHING OUT JOHN SMITH: In this problem, we examine the options available for sheltering or deferring gain to someone who has owned a piece of real estate for a long term. 2. Nessen, Real Estate Finance and Taxation, pp 135-162. "The Seller's Perspective on Real Estate Finance." This reading provides a good overview of the basic strategies that are available to a seller to avoid recognition of gain. 3. Chirelstein, Federal Income Taxation, pp. 51-57.   10/13 Form of Ownership Entity I There are many ways to own real estate. You can take title to it in your own name, through a partnership, a limited partnership, a limited liability company, a corporation, a trust, or a REIT. Alternatively, your interest may be held as part of a co-op or a condominium. In this class, we explore the general business and tax issues involved in selecting the form of business entity. 1. Problem: CANTON SHOPPING CENTER II 2. Leibschutz, Waters, Welborn, Wilcomes, "Choice of Entity in Real Estate Transactions," American College of Real Estate Lawyers, 1995. This article is thorough, but a bit technical. Try to get through it, but if you are having trouble, focus on the scorecards on pages 13, 18, 24, 29, 32, 35, 38, and 42 along with Appendix A.   SECOND ASSIGNMENT HANDED OUT: DUE 10/25   10/18 Form of Ownership II 1. Problem: 501 STATE AVENUE. This problem deals with the development of a modest sized office building in which there is an opportunity for various project participants (developer, architect, engineer and tenants) to acquire a "piece of the action." We will review how to select and how to organize the ownership entity. 2. Schorr, "Limited Liability Companies: Features and Uses," The CPA Journal, December 1992. 3. Pillow, et. al., "Simplified Entity Classification Under the Final Check-the-Box Regulations," Journal of Taxation (April, 1997) p. 197. 4. Ely and Grissom, "State Taxation of LLCs and LLPs: an Update; Business Entities (March, April 1999) p. 24.   10/20 Form of Ownership III. The class will be divided into groups, each comprising representatives of the 501 State Avenue project participants. Class time will be reserved for each of the groups to negotiate and structure the 501 State Avenue ownership vehicle. 1. Surkin, "When Joint Venturers Can't Agree: The Buy-Sell Revisited".   10/25 Form of Ownership IV. 1. Group presentation and discussion of 501 State Avenue.   10/27 Financing I: The Basic Mortgage Documents Having organized your business entity and gained control of a property, your next task will be to finance your acquisition. This first set of readings describes the basic legal relationships between a borrower and the various lenders in a real estate transaction. 1. Note on Real Estate Financing. This note explains the terminology and basic principles involved in documenting the typical real estate loan. 2. W. Brueggeman and L. Stone, Real Estate Finance, pp 5-22. 3. Documents: Commitment Letter, Note, Mortgage, Closing Agenda for Permanent Financing.   11/1 Financing II: The Relationship between Permanent and Construction Financing Very few people build buildings without borrowing money. This class looks at the various forms of debt that are used in financing development projects. The emphasis is on the legal relationship between the permanent and the construction lender and the borrower. 1. Note: The Construction Loan Closing 2. TIAA v. Butler, 626 F. Supp. 1229 (SDNY, 1986) 3. Notes on Prepayment, Sharing of Risk, and Lender Liability. 4. Closing Agenda for Construction Loan   11/3 Financing III: Hybrid Instruments Mortgage financing has become very sophisticated in recent years. This class examines a series of mortgage instruments that are legally characterized as debt, but have many of the attributes of equity. 1. Nessen, Real Estate Finance and Taxation, pp 31-47. This excerpt describes the mechanics of a variety of hybrid mortgage instruments including participating, convertible, real return, and accrual mortgages. 2. Nessen, Real Estate Finance and Taxation, pp 77-102. This excerpt describes the legal issues raised in negotiation and execution of the above instruments. 3. Murray, "Filling the Gaps." Paper presented at the April 1997 meeting of the American College of Real Estate Lawyers. This article describes the status of the current market for mezzanine financing. 4. Documents: Participating note and mortgage. 5. Holson and Bagli, "Landing Without a Net: With Wall Street as its Banker, Real Estate Feels the World's Woes," The New York Times, November 1, 1998, Section 3, Page 1.   11/8 Financing IV: Financing Leasehold Interests This class explores so-called ground lease situations where the land and the building are owned by different persons. Ground leases are used for a variety of reasons. The financing process is complicated greatly if the borrower does not own the property in fee. This class reviews the legal issues posed by the existence of ground leases. 1. Madigan v. McCarthy, 108 Mass. 376 (1871). 2. Burford v. Burford, 396 NE2d 394 (1979). 3. Financing Provisions from a Ground Lease. 4. Model Leasehold Encumbrance Provisions. 5. American Bar Association Committee on Leases, Ground Leases and their Financing (1969). 6. Note on Tax Aspects of Leases. 7. "Ground Lease/Mortgage Relationships" Outline 8. Extract from Subordinated Ground Lease   11/10 Financing V: Public Sources of Capital GUEST: Gilbert Menna, Esq. Goodwin Procter & Hoar Increasingly, real estate capital is being raised from the public capital markets. In this class, we explore how Real Estate Investment Trusts are structured and priced in the marketplace. 1. Nessen, Structuring Complex Real Estate Transactions, pp. 182-197. 2. REIT Materials (to be distributed).   11/15 Commercial Leasing I The true economic asset in a real estate project may result from the leases rather than the building and land. In the section on commercial leasing, we will discuss how complex lease transactions work and will examine various leasing issues that may affect the security and quality of the cash flow. In the first class on leasing, we will analyze office building leasing discussing the Surkbac LLC's office deal . 1. Problem: THE SURKBAC OFFICE BUILDING 2. "A Practical Guide to Reviewing a Commercial Lease," 19 Real Property, Probate and Trust Journal 891 (1984). 3. Notes on Lease Related Points. 4. Document: Office Lease   11/17 Commercial Leasing II In the second class on leasing, we will focus on the interlocking issues that arise in negotiation of retail leases. Class discussion will be built around the Caredell retail kiosk lease transaction described in the materials. 1. Problem: THE CAREDELL LEASE. 2. "Reviewing a Shopping Center REA," 18 Real Property, Probate and Trust Journal 651 (1983). 3. Document: Shopping Center Lease (R. Goldberg)   11/22 Commercial Leasing III GUESTS: William B. Forbush, Esq., Hill & Barlow Raymond M. Kwasnick, Esq., Goulston & Storrs The final class on leasing will present a problem involving a major office lease transaction in a building that is not yet under construction. The class presentation will involve two lawyers negotiating the "special issues" in leasing space in a building that does not yet exist. Materials to be distributed. THIRD ASSIGNMENT HANDED OUT: DUE 12/6   11/24 Design and Construction I GUEST: Professor John Miller In a typical project, 60-70 percent of development costs are attributable to construction, yet the legal responsibilities of the architect and the contractor are often a mystery to the developer. In this class and the next class, we will examine the rights, duties, and obligations of the respective parties. General Concepts: Sources of Law, Parties to Development Related Disputes, Theories of Liability. Specific application of these principles to the nature of A/E liability, contract forms such as the AIA forms. Getting, and keeping your bearings on legal liability questions. Assignment: Be prepared to discuss the reading in class. Each student should be prepared also to present the factual background of each of the cases assigned to you.   Reading: Everyone: Scan the Powerpoint slides Read the article on A/E Liability (by Miller) Read the Klein v. Catalano Case Read the Waggoner Case Scan the B-141 AIA contract document   Plus: Last Name: A-M Read the Shea v. Bay State Gas Case N-Z Read Hollywood Barbecue Co. v. Morse, and N-Z Read Stone & Webster Eng Corp v. United   11/29 Design and Construction II GUEST: Professor John Miller Practical Applications to Typical Development Issues. Changes, Ambiguity (of Contract Language or Other Sources of Law Governing Contract Relationships), Differing Site Conditions, Statutes of Limitations. Assignment: Be prepared to discuss the reading in class. Each student should be prepared also to present the factual background of each of the cases assigned to you. Reading: Everyone: Read the "What do you do when" excerpts (Chs 3, 4, 5) Read the Duhame v. US case Read the Excerpt from the Restatement 2nd §205 Read the statute of limitations/repose   Plus: Last Name: A-M Read Milligan v. Tibbets and A-M King's Dept Stores v. Foley-Abrams Corp N-Z Montaup Elec. Co. v. Ohio Brass Corp   12/1 Workouts I Given the cyclicality of real estate markets, the long lead time for development projects, and the high degree of leverage available, virtually everyone who works in the real estate industry eventually must deal with a troubled property. This is equally true of developers, lenders, investors, contractors, designers, managers, and tenants. Pedagogically, workouts provide us with an opportunity to review each of the topics previously discussed because inevitably workouts raise questions of financing, taxation, partnership planning, contracting, approvals, and leasing. In the first class, we will try to identify the general issues that the case raises for the developer, the lender, the developer's partners, the contractor, and the tenants. 1. Problem: CORPORATE PLAZA 2. Lesser & Klug, "A Borrower's Guide to Real Estate Loan Workouts," Real Estate Finance, Summer 1990. 3. Eizenman, "Lender Liability: Minimizing Risk in Resolving Troubled Loans," Real Estate Finance, Summer 1990.   12/6 Workouts II. In the second workout class, we examine the potential liability of the borrower, the tax consequences of loan restructuring, as well as the impact of the bankruptcy statutes on the rights of the parties. 1. St. Claire, "Nonrecourse Debt Transactions: Limitations on Limitations of Liability." Real Estate Law Journal, Summer 1990. 2. Note on Bankruptcy Considerations in Real Estate. 3. 1993 CCH Standard Federal Tax Reporter, pp.20,031-20,043 12/8 Summary and Wrap-up.

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