The Sale-Leaseback Scenario

The “sale-leaseback” concept is not a new one, but it is one that is being utilized more and more in today’s economic climate as the financial and tax benefits can be numerous for both parties.  In its simplest form, a sale-leaseback is a transaction in which the owner of property sells the property and simultaneously leases it back from the purchaser. The purposes of a sale-leaseback are typically that of financing, accounting and/or tax.  

The benefits of a sale-leaseback can be quite substantial for both the seller/lessee and buyer/lessor. The primary benefits to (and thus motivation of) the seller/lessee in a normal sale-leaseback are typically as follows:

•    An immediate influx of cash while retaining the use of the property
•    The cash received is 100% of the fair market value (as compared to the 75%-80% of fair market value with conventional financing)
•    Improves the company balance sheet by increasing its current ratio
•    Tax deductible rental payments (as compared to conventional financing where only interest is deductible)
•    Deductible loss or offsetting gain on the sale of the property (depending on the gain or loss to be recognized on the sale and the need of the company)

Obviously, in order to induce a buyer/lessor to enter into such a transaction there needs to be substantial benefit to them as well.  Accordingly, the primary benefits to (and thus motivation of) the buyer/lessor in a normal sale-leaseback are typically as follows:

•    Higher rate of return (as compared to if it would simply loan money to the seller instead of purchasing the property)
•    A hedge against inflation since any appreciation in value accrues to the owner (this benefit is negated where the agreement allows the seller/lessee the option to repurchase)
•    Secured long-term investment requiring little or no ongoing management and providing a guaranteed return
•    Ability to take depreciation deductions where improved land is involved

It is apparent that a sale-leaseback transaction is one that can provide very real benefits to each party involved, but such an agreement needs to be properly structured in order to avoid certain risks associated with the IRS’s scrutiny of the transaction.  If not properly structured and orchestrated, the IRS may attempt to disallow deductions for such things as depreciation, rental payments, interest and investment tax credit by the parties to a putative sale-leaseback arrangement, on the grounds that the arrangement actually constituted a financing device or exchange of like-kind property.  To discuss the benefits, risks and requirements of a sale-leaseback arrangement please contact us and we can discuss the situation in greater detail. Each situation is unique and should be treated as such.

An Unwanted "Benefit" and Bill: A Recent Special Assessment Case

Gray v. City of Indianola [May 6, 2011]

In another recent case, the Iowa Supreme Court examined the fairness of special assessments levied upon certain property owners.  The district court had found that the property owners had been assessed in excess of the special benefits received from the project and reduced the assessments.  The city appealed the district court’s decision and the Supreme Court ultimately determined that the method, manner and amounts of the special assessment were (for the most part) proper, and upheld the bulk of the assessment.

In this case, several property owners sued the city of Indianola challenging the special assessments specifically levied for the paving a gravel road abutting their property and installing a side walk along the road.  The plaintiffs owned residential acreages on the west edge of Indianola along a gravel road.  The school board decided to build an elementary school along the road and the city council decided to pave it. Said paving project included expanding and paving the road, reconfiguring ditches, and installing sidewalks on both sides.  The city council’s decision to pave was based on the location of the school, and it may be worth noting that none of the owners of the residential acreages had requested that the road be paved. 

Iowa Code section 384.61 addresses the assessment of costs incurred by municipalities in the development of public improvements, and in pertinent part sets forth the following:. 

The total cost of a public improvement, except for paving that portion of a street lying between railroad tracks and one foot outside the tracks, or which is to be otherwise paid, must be assessed against all lots in the assessment district in accordance with the special benefits conferred upon the property, and not in excess of such benefits.  Iowa Code section 384.61

The Code states that a special assessment cannot exceed 25% of the value of the property.   The statutory scheme also provides limitations to “ensure that individual property owners are not subsidizing the general benefits enjoyed by the public resulting from the improvements, particularly when street improvements are at issue” Horak Prairie Farm, 748 N.W.2d at 507.  In this particular case, the controversy centered on whether the property owners were assessed in excess of the special benefits they received from the improvement.  Specifically, the plaintiffs contended that the city inappropriately relied on a purely mathematically formula (the Flint formula), to spread the costs of the street paving project among the abutting landowners resulting in assessments which were higher than the special benefit conferred upon their properties. The owners contended that the city should have engaged in an individualized assessment of each parcel to gauge the benefits conferred upon the property, to ensure that they were not subsidizing the general benefits enjoyed by the public resulting from the improvements. 

The court concluded that the substantial benefits derived by the general public from the paving project did not render the special assessment excessive, as the city did not assess the full cost of the project against the properties within the assessment district. Instead, (despite using the mathematical Flint formula as a starting point) at several points in the assessment process, the city reduced the assessment against the private landowners to balance the general benefits conferred upon the public with the special benefits conferred upon the abutting properties. The Supreme Court noted that property owners naturally are not happy about sharing the cost of public improvements through special assessments, particularly ones that they did not ask for. The court seems to marginalize the property owners’ arguments of detriment caused by the project when it quoted the previous case,  Chicago R.I. & P. Ry. V. City of Centerville, stating “it is natural for the average property owner to resent the burden thus laid upon him, and he easily persuades himself that the thing for which he is asked to pay is a detriment, rather than a benefit, to his land, and ordinarily it is not difficult for him to find plenty of sympathizing neighbors who will unite in supporting his contention.” 153 N.W. 106, 108 (1915). It should be noted that the court did however partially reduce the cost of the assessment for the sidewalk ruling that the assessments for the same failed to account for the significant public benefit occasioned by the sidewalks. 

Thus, you may not ask for it, but you may still very well be liable for a portion of the bill related to certain city improvements, as these costs and expenses are regularly assessed against the “benefitted” property owners. 

The Un-Neighborly Neighbor: A Recent Private Condemnation Case

Green v. Wilderness Ridge, L.L.C.  [May 11, 2011]

This recent Iowa Court of Appeals case involved a private condemnation action brought under Iowa Code Section 6A.4(2). Said code section provides for a private right of condemnation where property is not otherwise accessible by a public roadway, but requires the selection of the “nearest feasible route” in doing so. 

Wilderness Ridge, L.L.C. (“Wilderness”) purchased land in rural Dubuque County knowing that the property was not accessible by a public roadway, and thus instituted a private condemnation action to secure access through neighboring tracts, including farm land owned by a couple of brothers (the “Greens”). The Greens filed a petition in equity, arguing the route proposed by Wilderness was not the “nearest feasible route” to an existing public road as required under section 6A.4(2).  Specifically, the Greens asserted that Wilderness’ proposed route would have a devastating impact on their dairy and crop farming operations (i.e. inhibiting day-to-day farming operation due to moving cattle, decrease the value of the property, etc.).  The Greens were not necessarily challenging Wilderness’ right to a private condemnation, but were challenging the route proposed by Wilderness.

The court concluded that the harm to neighboring properties needs to be considered when determining the “nearest feasible route” in a private condemnation setting, and thus ordered the least harmful route to be used. In interpreting the phrase “nearest feasible route” in section 6A.4(2), the supreme court had previously emphasized the need for individualized determination “that extends beyond a mere determination of which route is the easiest to construct without consideration of land acquisition costs.”  It was ruled that in certain instances, determining the “nearest feasible route” of condemnation requires consideration of which route is easier to construct and which route will do less harm to the neighboring properties.  The courts are thus forcing “condemning” neighbors to be well…… neighborly in choosing the route to condemn.

Builders Beware: Home Construction Contracts Are Afforded Consumer Fraud Protections

In Scenic Builders vs. Peiffer and Peiffer, an Iowa Court of Appeals court recently was presented with the issue of whether contracts for the construction of personal residences are deemed “consumer merchandise” as contemplated under Iowa’s consumer fraud act.  Iowa Code Section 714H (the “Act”) is cited as the state’s "Private Right of Action for Consumer Frauds Act", and provides in pertinent part that “a consumer who suffers an ascertainable loss of money or property as the result of a prohibited practice or act…… may bring an action at law to recover actual damages.”  The Act goes on to list “prohibited practices” and “acts” as those relating to “the advertisement, sale, or lease of consumer merchandise.”

In Scenic Builders, homebuyers appealed the dismissal of their counterclaim that their contract for the construction of a personal residence with the builder entitled them to damages pursuant to the Act. The builder had previously filed a petition against the homebuyers alleging they breached a contract for new home construction. The homebuyers answered, claiming the document they signed was not a contract but instead a preliminary estimate.  They counterclaimed for damages under the Act, alleging that the builder engaged in unfair practices, false promises, and misrepresentation by altering the preliminary estimate and attempting to bind them to it.  The district court ruled that the consumer fraud Act did not apply to a contract for home construction, but the Court of Appeals now reverses that lower court determination.

The Court of Appeals reviewed the language of the Act, the legal definition of “real estate” and “services” as provided for in the Act, and also prior case law in determining that the plain language of the statute affords homebuyers the consumer protections contained in the Act. The court noted that the term “consumer merchandise” is defined in the Act as “merchandise offered for sale or lease, or sold or leased, primarily for personal, family, or household purposes.”  The court further noted that the Act utilizes a definition of “merchandise” that includes “any objects, wares, goods commodities, intangibles, securities, bonds, debentures, stocks, real estate or services.”

This ruling should put all home builders on notice as to the “prohibited practices” and “acts” in which they should seek to avoid in order to ensure that they do not incur liability to homebuyers under the Act. Conversely, all homebuyers should be aware of these consumer fraud protections when contracting with a builder for the construction of a personal residence.  If you have any questions regarding your consumer fraud rights or responsibilities under the Act and/or this recent ruling, please feel free to contact the firm.

Real Estate Rundown (Iowa Supreme Court)

On Friday the Iowa Supreme Court released its opinion in Duck Creek Tire Service, Inc. and Midwest Mexican Connection, Ltd. v. Goodyear Corners, L.C., and has therein issued a warning to landlords (and “sub”landlords alike). The warning is simple (and rather commonsensical):  If a landlord/lessor does not want to be held responsible for a breach of the covenant of quiet enjoyment caused by the actions of a paramount titleholder, the landlord/lessor should consider including such a provision in the lease. 

The case involved a deep and convoluted web of leases, subleases, and assignments of interests therein, all related to a particular commercial property. I won’t even dare attempt to explain the details of this web without the graphical flowchart provided by the court in the opinion (proof that everyone likes flowcharts).  Simply put, there was a primary lease for the property along with two additional subleases (not to mention the assignments of interests thereto).  The tenant/lessee under the primary lease defaulted and the landlord/lessor under said primary lease terminated the lease with notification being sent to all sublessees and sub-sublessees that they no longer had a right to possession of the property. The sub-sublessees claimed that the sub-sublessor breached the contractual covenant of quiet enjoyment when the paramount titleholder (the landlord/lessor under the primary lease) terminated the primary lease (and thus the right of possession of all tenants/lessees, sublessees and sub-sublessees).  Thus, the claim against the sub-sublessor was brought on only by the default of the lessee under the primary lease, which was really no fault of his own.  However, as alluded to earlier, the court ruled that the explicit covenant of quiet enjoyment contained in the sub-sublease can still be deemed breached despite no fault on the part of the sub-sublessor in a situation such as this. 

It is well known that there are many additional risks, concerns and issues related to subleasing arrangements (and even more so with sub-subleasing arrangements), and thus you should make sure you are aware of all risks, concerns and issues related thereto as either a sublessor or sublessee (or sub-sublessor or sub-sublessee) thereunder.  Feel free to contact the firm for additional information and assistance in properly protecting and safeguarding yourself in such situations. 

Update Re: Honey, Did You Sign the Mortgage?

The Iowa Court of Appeals, in the earlier unpublished decision Freedom Financial Bank v Estate of Boesen and Boesen (2010), came to the same conclusion set forth in JP Morgan Chase v Hawkins (concluding that a purchase money mortgage signed by only one spouse is a valid enforceable encumbrance).  However, in contrast, the Court of Appeals had previously ruled in Citimortgage, Inc. v. Danielson (2009) that a purchase money mortgage was invalid if not executed by both spouses (pursuant to the Iowa statutory homestead requirement). The hope was that the Iowa Supreme Court would take this issue under further review and offer some clarity, and it should be noted that the Supreme Court has in fact granted the application for further review in the Freedom Financial Bank v Estate of Boesen and Boesen case. 

Not to be outdone with regards to this issue, the state legislature has proposed an amendment to the homestead statute (Iowa Code § 561.13) as documented in Senate File 400.  The proposed amendment seeks to amend said Code section in pertinent part as follows:

“3.   A conveyance or encumbrance or a contract to convey or encumber the homestead is not invalid…if any of the following apply:
a.    The nonsigning spouse’s interest is terminated by a decree of dissolution of marriage or other order of the court.

b.    The nonsigning spouse’s right of recovery is barred by section 614.15 [Limitations of Actions].

c.    The encumbrance is a purchase money mortgage…   
d.    A court sitting in equity enters a decree holding that invalidating the conveyance or encumbrance or a contract to convey or encumber the homestead would, directly or indirectly, unjustly enrich the nonsigning spouse…”

This issue has become one of statewide debate following recently published news stories detailing the decision and underlying facts of Citimortgage, Inc. v. Danielson.  Again, in this case, a purchase money mortgage was deemed invalid due to the fact that the mortgagor’s spouse did not join in the execution of the mortgage.  Additionally, the mortgagor filed for bankruptcy thus leaving the lender with no other remedy and the mortgagor and his spouse remain in their home “free of charge”.

Often missing from the general public's discussion of this issue is the underlying purpose of this long standing requirement in the homestead statute. It should be noted that the statutory homestead joint spousal signature requirement exists for the purpose of protecting the ownership rights and interests of each spouse.  Hence where one spouse attempts to convey or encumber the homestead, such attempt is deemed invalid without the other spouse’s consent thereto.

Stay tuned for updates on this issue as it continues to be addressed by the state judiciary and legislature, and make sure to contact the firm with any related questions or concerns.
  


  

Honey, Did You Sign the Mortgage?

The Iowa Court of Appeals in JP Morgan Chase v Hawkins recently ruled that a purchase money mortgage does not fall under the statutory joint spousal signature requirement necessary for conveying or encumbering a homestead.  Iowa Code Section 561.13 provides in relevant part:

“A conveyance or encumbrance of, or contract to convey or encumber the homestead, if the owner is married, is not valid, unless and until the spouse of the owner executes the same or a like instrument, or a power of attorney for the execution of the same or a like instrument…”

Accordingly, up to this point in time and through a number of unpublished opinions, the Court of Appeals has stated that a mortgage, not signed by the spouse of the owner is void, as to both the owner and the spouse.  However, in JP Morgan Chase v Hawkins, the Court of Appeals ruled that if said mortgage is a purchase money mortgage (a mortgage that secures the unpaid purchase price of the mortgaged property) it arises prior to the acquisition of the homestead and thus does not fall under the prospective reach of the above homestead statute.  (The Court of Appeals in Freedom Financial Bank v Estate of Boesen and Boesen ruled the same in a similar factual situation). Thus a purchase money mortgage signed by only one half of married couple will still be deemed valid……. for now.  I would imagine this will be a matter the Iowa Supreme Court sees on appeal so stay tuned.