In the world of real estate, legal battles are a reality. Join Matt Clarke, a seasoned litigator with over 20 years of experience, as he navigates the challenges faced by property owners, operators, and syndicators. From vendor payment disputes to partner disagreements, he provides practical advice on communication, insurance, and clear contracts. Get ready for an informative journey through the complexities of real estate law.

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Matt, having been a litigator as you have for well over 20 plus years, touch briefly on what some of the hot point issues in the litigation arena are with respect to operators, syndicators, sponsors, people that actually own real property around the United States. What are some of the issues that you’re seeing right now on the litigation forefront that people should be watching out for?

The Most Common Litigation Issue for Property Owners

I’d say the number one most common litigation issue is vendors suing to get paid for work they’ve done. Those come up all the time. The amounts at issue range from $10,000 to $600,000, and that’s either like property managers or people doing rehab at value-add multifamily properties or any other potentially independent contractor relationships.

So, what do you do if you’re a sponsor, an operator, and you’re faced with the idea of, ‘I don’t have enough money to actually pay the monthly nut with my bank and also pay the person doing the work at the property, and I don’t want to be involved in a lawsuit?’ What’s the most likely outcome or solution to that scenario?

First Step to Avoiding Getting Sued as a Property Owner

So, I would say the number one fastest way to get sued is to ignore people. And so, if you have a vendor and they’re asking to be paid, communicate with them. At the very, very, very least, communicate to them, tell them the situation, and if you can at all give them some amount of money. The worst thing to do is to ignore them, pay them nothing, and they think you’re ungrateful and you don’t care what they did to improve your property, and then they’ll sue you.

It’s very sound advice. Should clients or sponsors actually own properties that have leverage leans, mortgages, deeds of trust that are attached to their property, where they have a senior lender, should they be concerned with the loan covenants with respect to potential leans that might be filed on their property?

Do You Need to Be Concerned with Loan Covenants and Liens on Your Property?

Absolutely. I mean, it’s a loan-by-loan basis, but I could say with pretty high confidence that you’re going to be violating a covenant if you have a lien against your property. And the reason is that liens allow lien holders to foreclose. But if you do have a lien, I think both of us would agree that the best thing for you to do is obviously communicate with the person that’s placed the lien on your property, potentially work out some sort of payment plan with them to avoid the placement of the lien or, worst case, you’re going to actually contest the lien, right? So, that the lender knows that you’re not agreeing that this is a legitimate lien on your property. So, the key there is before they put a lien on your property, deal with it, because once there’s a lien on your property, that vendor has a hook in you, and they will not let it go without full payment of the lien. So, that’s why the emphasis is on dealing with a problem before it becomes a real problem.

Okay, let’s switch topics briefly. So, we’ve talked about liens. What about things by third parties like crimes? So, there seems to be, my impression, an uptick in lawsuits, plaintiffs’ attorneys seeking to get big judgments or big settlements out of property owners and multifamily where a crime has taken place. Have you seen that type of scenario?

How to Mitigate the Risk of Being Sued when a Crime Has Taken Place on Your Property

We have a handful of those cases, and they arise in high crime areas where some tragedy has happened at the hands of a murderer or a rapist or whatever violent criminal does something on your property, and the victim can’t look to the perpetrator, right? Because they don’t have any money. And so, a creative lawyer will say, ‘Well, let’s sue the property owner,’ and they’ll come up with a theory of liability that the property owner made it easier for the crime to occur because of various factors of the property.

That seems to me that can seem terribly unfair. If I was a property owner to think that you own a property, you’re not involved in the criminal activity, and yet you’re being sued for monetary damages, sometimes in the millions of dollars. What can a property owner do to potentially mitigate that risk or lessen the likelihood of being sued in the future?

So, if you own a multifamily property in a high crime area, and if it’s a high crime area, you probably know that. Yeah. And there’s resources you can look to if you don’t know it. And first of all, the thing to do is to make sure you have insurance that will cover it. The typical commercial general liability policy will exclude any kind of bodily injury, claim based upon firearms. See, why? That’s a huge exclusion. So, if anybody gets shot, there’s no coverage. The other one is criminal activity. And so, if any criminal activity occurs and somebody sues you for it, there’s not going to be coverage. So, go to your broker, go to your agent and say, ‘What can you do to get me coverage for this?’ If you’re in a high crime area, you’re just a matter of when, not if.

But you would think that most people that are looking to buy or acquire those assets, whether a straight acquisition or an assumption of a loan of a property in those types of areas, that should be on the forefront of when they’re talking with their insurance broker during the acquisition phase because not after the crime has occurred and the lawsuit has been filed. Right.

It’s happened many times where people have said, ‘Oh my gosh, I got sued because there was a murder, and the victim’s family has sued me.’ And I inquire whether there was coverage, and they said, ‘Oh no, I turned that coverage down because it was kind of expensive.’ So, imagine the savings they could have had if they had the right kind of coverage and still, proverb, penny wise and a pound foolish, right?

Exactly. And so, if you have a major lawsuit against the property and there’s no insurance, you’re going to be paying your own lawyers out of your own money. And if there’s a judgment or a settlement, you’re have to pay that too. And it can be in the six figures, easily.

Preventative Measures to Lower the Risk of Being Sued as a Property Owner

There’s an uptick throughout the United States with the filing of lawsuits alleging premises liability for crimes that actually take place on your property. So, when you have tenants on your property, if they are the victims of a crime, you might be facing a potential lawsuit.

Some of the things that you can potentially do to lower the risk or mitigate the aspect of being sued are things dealing with safety like bulbs, cameras, security guards, working locks, those types of issues that you’re faced with. And so, you don’t want to be penny wise, pound foolish. You really want to evaluate it, especially if your property is in what has historically been a high crime area. You want to make sure that you can actually protect not only yourself or the hard work that you’ve gone into it but also your investors. So, many of you that own properties, you’ve raised passive money, you’ve raised equity from passive investors, and that is how you purchase the property. So, you want to protect your investment. So, I would say some of those things are very important.

Unpacking Earnest Money Disputes

One of the other issues that we get presented as litigators all the time is this idea that there’s going to be an earnest money fight, right? So, whether you’re the seller or the buyer, it’s pretty apparent that given the volatility and the capital markets, it’s not uncommon to have earnest money disputes where the seller is trying to allege that the earnest money is hard and non-refundable and the buyer is trying to say the earnest money is actually refundable because of some condition that has occurred at the property, whether that condition is a seller breach, whether there’s a casualty or condemnation event, whether there’s some sort of title survey or environmental event. Those are the standard exceptions to be able to make earnest money that is theoretically hard, non-refundable, refundable, and usually the tension exists between the seller saying that condition that the buyer is saying occurred did not occur. And that is often what you’re going to need a lawyer to essentially evaluate and assist you with.

Refundable vs Non-refundable Earnest Money

So, one of the things that you want to do going into those contracts, whether you’re a seller or a buyer, it doesn’t matter which, you’re going to want to make sure that the contract clearly spells out what exact carve-out conditions will make earnest money hard, meaning non-refundable, to something that is refundable and under what set of circumstances could you expect both as a buyer to receive that money back or as a seller to receive that money. And just remember, most of these transactions occur using the use of a third-party escrow company like a title company, and the reality is if you don’t voluntarily agree as the buyer for the release of that earnest money and the seller doesn’t voluntarily agree, the title company will not release that money. So, I can’t tell you the number of times that I’ve had clients try to say, ‘Well, it’s just not fair what they’re saying on the other side,’ whether you’re a buyer or seller, is not true. And they’re only saying that because they want the earnest money, and the title company should see that and make a decision. And I always want to tell you, doesn’t matter if your property is in California, Rhode Island, or Timbuktu or anywhere in between, the title company is not allowed by law to release the earnest money absent express representation by both parties. So, you want to make sure that you understand that when going into the earnest money aspect.

Due Diligence Timeline with Earnest Money Disputes

Another thing that you’re going to want in dealing with earnest money potential disputes is make sure that the due diligence period. So, with the capital markets are volatile, which they are presently, that typically changes from a seller’s market to a buyer’s market, which means that maybe in a couple years ago, you were having to put hard money down to win the beauty contest to actually win the contract on the buyer side, and now you’re not having to do that. But you want to make sure that if you’re still competing with other groups for possibly getting that property under contract and you’re shortening that due diligence period to where your earnest money is going to become hard, you want to make sure that you have sufficient time to actually assess the business viability of your plan as well as the use of the property. So, does your due diligence period give you sufficient time to be able to get environmental reports back, property condition report, appraisal, the historic thirds reports? Does it give you additional time or enough time for you to do a professional lease audit? If the answer to that is no, then you probably need additional time in your due diligence period; otherwise, you’re going to be faced with the possibility of a dispute with the seller, and you’re going to be saying, ‘I didn’t get this report back,’ and the seller is going to be saying, ‘Holding you to that 7-day, 14-day, 21-day, or 30-day due diligence period.’ So, you want to keep an eye out for all of that.

Know the Risks Associated with Earnest Money

And then you just want to make sure that you totally understand the risks. If you’re the buyer or the seller, it doesn’t matter which side you’re on, you really want to know the risks associated with those earnest money, and it most likely will should be explicit in your purchase and sale agreement.

What Happens in a Partnership Dispute?

The last thing that I want to talk to you about is how do you get out a partner? What happens in the event of a partnership dispute between general partners or the managers of an entity? What are you going to do? Well, often there will be provisions in your operating agreement, and if you haven’t ever taken the chance or the time to review your operating agreement, I suggest that you do so because more likely than not, there’s probably a provision in there that will lay out what’s for cause, meaning typically there’s not a without cause removal of a general partner or a manager in one of these structures. But there’s typically a for cause removal. And so, don’t be surprised if you see a conviction for a felony, some sort of financial crime, or an act of moral turpitude. That’s kind of fancy lawyer language for saying you’re doing something dishonest or unethical or something that violates the spirit of the agreement or the terms that you’ve reached as partners. There should be something in your operating agreement. If there’s nothing in your operating agreement, then the default provisions of the state where the property is located is most likely going to be controlling on you. So, most states will have a limited liability company act if you’re doing a limited liability company or a limited partnership act. Or many states will have a revised limited liability company act or a uniform company act. So, you want to make sure that you understand those provisions, and you actually seek legal counsel in the event that you’re going to have a dispute with one of your partners.

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