NYSBA SPRING 2002 | VOLUME 30 | NO. 2 N.Y. Real Property Law Journal A publication of the Real Property Law Section of the New York State Bar Association

A Message from the Section Chair

It is more attack on New York and indifference and the 9/11 attacks were not on than six months of people not wanting to deal with them. Many real estate lawyers are since the “day this problem. The second is the fear now involved in “work-outs” on of destruction” of being a “victim” by coming to hotels here in the city. The hotels and the effects New York City. Even in Manhattan have suffered and are badly in need of September 11 there are people that regard the prob- of relief and help in coping with the are still upon lems of lower Manhattan as remote loss of tourism that post 9/11 has us. September and not part of “our Manhattan.” created. Many of the commercial 11 has had a While many people have opened office buildings downtown are suf- huge effect on their hearts and pocketbooks to the fering also. The tenants have left; real estate, especially in the lower victims of 9/11, there are millions of many buildings were hurt by the part of New York State. The real people who do not want to know dust, flying concrete, steel, and glass estate market both in the commercial about the attack on the World Trade near Ground Zero and have not yet and residential area south of 14th Center but only deal with it as if reopened. Many tenants, including Street in Manhattan has been para- New York were a foreign country law firms both large and small, have lyzed. Commercial buildings have had prospective tenants leave and refuse to even look downtown. Lessees who have signed leases near Inside Ground Zero have defaulted and Habitability Issues at Ground Zero: Have Reports of the Death of the Duty elected to relocate to midtown Man- Reconsidering Real Property Law § 235-b to Mitigate in New York Been Greatly hattan. Residential tenants have in the Wake of September 11th 43 Exaggerated? A New Interpretation of entered into agreements to end their (Jay Berg) Holy Properties Ltd., L.P. v. Kenneth leases and have relocated. The reloca- Cole Productions, Inc. 77 Insurance Issues Resulting from the (Jason Kee Low) tion of these residential people have Attack on America— created in the suburbs—Westchester, September 11, 2001 51 Real Estate Developers: Rockland, Nassau and Suffolk Coun- (James E. Branigan) Don’t Buy the Farm! 82 (John D. Kern) ties, as well as nearby New Jersey—a City and State Rulings Open the Door tight market for homes and apart- for Synthetic Leases in New York 55 BERGMAN ON MORTGAGE FORECLOSURES: ments in these areas, thus already (Joshua Stein) Non-Judicial Foreclosure Renewed placing on a tight seller’s market a in New York 88 Federal Preemption of Real Estate lot of competition among home buy- (Bruce J. Bergman) Lending Activities of OTS Regulated ers. Statistics have shown that for- Lenders 59 New York State Bar Association eign and domestic tourists have (John G. Hall) Committee on Professional Ethics 89 stayed out of New York for two rea- (Peter Coffey) sons. The first is the “embarrassment Housing Cooperatives: Ownership by Trusts: A Retrospective and a Forecast 65 Bar Association Announces Web Site of the victims,” the populace not (Anita Rosenbloom and Richard Siegler) Redesign 91 wanting to know or be part of the (Michael J. Berey) relocated to midtown or other places. apartments. How do they obtain father, Eugene Morris, who received Many of the businesses have gone to title? How do they get breaks in pay- the Real Property Law Section Pro- nearby New Jersey, Westchester ment of loans or maintenance fessionalism Award. Gene richly County and even downtown Brook- charges because the “bread- deserves this award. lyn. This was especially true of law winner(s)” was killed? Problems in The Condominiums and Cooper- firms. Some, but only a few, have regard to the need for death certifi- ative Committee also had a CLE ses- returned to lower Manhattan. Many cates and how individuals can obtain sion; some of their speakers were Joel will never return. One large New death certificates were dealt with. Miller, Professor Paul Shupack, Terry York law firm that took a sub-lease in Contract rights—where people were Lewis and Com. John Lariviere, midtown immediately after is again buyers or sellers and the real estate speaking on the Uniform Commer- looking downtown for a large block was damaged by dust, etc., and even cial Code and Cooperatives. Ronald of space, even if the space is not where there was no physical dam- Kahn and Leatha Sturges spoke on ready for occupancy for some time. age—were also discussed. Problems the new cooperative contract now in The New York State Bar Association of landlords where their tenants wish use. The co-chairs, who did a terrific Real Property Law Section has tried to relocate were dealt with, including job, were David Berkey and Joseph to do its part in the post 9/11 circum- the inability to pay rent. Walsh. stances. Many of the firms in mid- All of our work has not been in town took in law firms from lower The Professionalism Subcommit- the 9/11 area. We have continued to Manhattan and gave them free space. tee had a CLE program chaired by oppose legislation where there were Some firms took in others having Co-chair Peter Coffey. The program no purposes for it and to promote nothing to do with the law. Some of was on “Can Attorney Professional- legislation that was badly needed. this available space was “matched” ism Survive?”, a discussion of the We have Section members working by the NYSBA. Qs and As for both pressures on today’s attorney. Co- in such areas as mortgage recording residential and commercial tenants chair Janet Stern was a participant in tax and consumer-oriented legisla- and owners were worked on by a setting up the program. Some of the tion. subcommittee chaired by Second speakers were John Blyth, John Hall, Vice-Chair Matthew Leeds. Partici- The January program held at the Hon. Justice Anthony V. Cardona, pants in that endeavor were Ed Baer, Marriott Marquis Hotel was a huge Melvyn Mitzner, Lorraine Power Joshua Stein, Harold Lubell, Karl success. First Vice-Chair John Privat- Tharp, Mark Solomon, Joseph Dulin, Holtzschue, John Hall, Jeffrey Chan- era put together an excellent pro- Isabel Franco, Mark Ochs and Mimi cas, Beatrice Lesser and David gram, which was well received and Netter. It was a very successful pro- Berkey. applauded. Those who spoke and gram. their topics were: Matthew Leeds, Some of the topics worked on by Another program that did well with a World Trade Center Report; the committee were real estate taxa- was the one on Attorney Opinion David Berkey, on Rights of Condo- tion in regard to diminishing value of Letters, successfully co-chaired by miniums and Cooperative Unit Own- real property and the inability to pay David Zinberg and Jill Myers. ers when access is denied; Steven real estate taxes. Mortgage payment Among the speakers were Stephen Baum, discussing the Sailors and Sol- relief in areas where there has been a MacDonald and David Portal. diers Relief Act; Leonard Sienko, on death of one of the parties at Law Firm Record Retention in the “ground zero” or on the airplanes Recently the need for “terrorism” 21st Century; Joseph Philip Forte, that went down or into the World insurance on large buildings has just discussing the Risk of Lost Collateral Trade Center. Questions about peo- about killed the sale and refinancing in the Securitized Market. Also ple’s rights as to title and possession of large trophy buildings in New speaking were James Branigan, who of real property because of a death at York City. However we are optimistic discussed the effect of 9/11 on the the World Trade Center, etc., were that a solution may be near. Hopeful- Real Property Insurance Market; discussed. What commercial tenants’ ly from the Congress; if not, maybe Edward Baer, on September 11th’s rights and obligations are because of from the insurance industry. ramifications on Residential Land damage caused because of proximity Commercial Leases; Karl Holtzschue, The Real Property Law Section to the World Trade Center were dis- discussing the Property Condition has been continuing its business even cussed and advice supplied. Ques- Disclosure Act, which went into after 9/11 and our help to the Bar tions as to liability on a commercial effect on March 1; and Sean Michael and all people has been well- lease were written about for Griffin, who spoke to us on Industri- received. We will continue to do instances where one of the parties to al Development Agency Matters. whatever is necessary to assist the the lease (i.e., tenant(s)) died at the Bar and public to recover. World Trade Center site. Many peo- At the Real Property Law Section ple had questions about cooperative luncheon, Dick Morris introduced his Melvyn Mitzner

42 NYSBA N.Y. Real Property Law Journal | Spring 2002 | Vol. 30 | No. 2 Habitability Issues at Ground Zero: Reconsidering Real Property Law § 235-b in the Wake of September 11th By Jay Berg

I. Introduction to the property owner and there was law such as civil rights, finally began some action that the owner could to catch up with the times.12 Indeed, Much has been written lately have taken that would have prevent- in a topical folk song from that era about whether residential tenants in ed or mitigated the ensuing damage. entitled “The Faucets are Dripping,” lower Manhattan whose apartments In no event should property owners the songwriter lambastes landlords and lives were turned upside-down be held strictly liable under the who would winter in Miami while as a result of the attacks on the umbrella of the implied warranty of their tenants are forced to make do World Trade Center can seek redress habitability, as some tenant advo- in substandard apartments in New from their landlords.1 The prevailing cates have suggested. York City.13 thought seems to be that they can.2 In particular, many tenants residing The first reported case in New in lower Manhattan who were forced York State in which a court held that to evacuate when the Twin Towers there is an implied warranty of hab- collapsed, and who returned weeks “. . . RPL § 235-b was not itability in every residential lease later to find their homes in disarray, enacted in order to hold was Amanuensis Ltd. v. Brown.14 are arguing that they are entitled to landlords strictly liable for Amanuensis Ltd. v. Brown involved a either a total or partial rent abate- the acts of third parties.” group of non-payment proceedings ment from their landlords. This brought by the owner against three argument is based on the theory that tenants at 310 West 18th Street. At the landlords are strictly liable for the time the owner had acquired the the conditions in the apartments II. The Implied Warranty of building, there existed numerous under what is called “the implied Habitability housing code violations which had warranty of habitability.”3 The been recorded against the property. implied warranty of habitability is A. The Common Law The owners did nothing, or virtually codified in New York as Real Proper- At common law, a lease was con- nothing, to correct those violations.15 ty Law § 235-b (RPL).4 Surprisingly, sidered a sale of property.6 Once the At the trial, the tenants acknowl- some law firms that primarily repre- landlord delivered “the goods” (i.e., edged that they had not paid rent for sent landlords have agreed.5 possession of the property), he ful- some time, arguing, inter alia, that filled his legal obligations to the ten- The purpose of this article is to the owner had breached a warranty ant.7 The tenant, like any other examine the implied warranty of of fitness for use and a warrant for buyer, took the property “as is,” with habitability to determine if indeed it quiet enjoyment. The trial court no recourse if it turned out that the is applicable in the wake of Septem- agreed, finding, inter alia, that “mod- premises were uninhabitable.8 The ber 11th. This article will demon- ern scholarship is unanimous in its rule was caveat emptor or caveat strate that RPL § 235-b was not outspoken condemnation of the lessee.9 Further, since the covenants enacted in order to hold landlords unfairness and harmful social conse- in the lease were considered inde- strictly liable for the acts of third quences of a doctrine that permits a pendent, the tenant was obligated to parties. The attacks of September landlord to recover rent and evict pay rent, even if conditions were 11th were acts of war. At a mini- tenants while defying the statutory deplorable.10 mum, they were the acts of crimi- requirement that he maintain the nals. If considered the former, then a These rules, which developed in premises in accordance with the private property owner should have medieval England, remained rela- law.”16 In reaching that conclusion, full, or at least qualified immunity tively unchanged for centuries.11 It the court relied on an article pub- for any losses suffered by a tenant as was not until the late 1960s and early lished in the Fordham Law Review in a result of the collateral damage 1970s, as the generation of Ameri- 1969 entitled “Law of Landlord-Ten- caused by the destruction of the cans that came of age after the Sec- ant: A Critical Evaluation of the Past World Trade Center. If deemed the ond World War began to challenge and Guidelines for the Future.”17 In latter, then an owner should only be the old notions of society, that land- that article, the authors had argued liable if the attacks were foreseeable lord-tenant law, like other areas of that:

NYSBA N.Y. Real Property Law Journal | Spring 2002 | Vol. 30 | No. 2 43 More often than not unjust rent with the court, claiming that the omitted]. Accordingly, it in its preference for the apartment was uninhabitable. Even- implies in every residential cause of the landlord [land- tually, the tenant vacated the apart- tenancy a warranty by the lord-tenant law] can only be ment, and the landlord sought landlord to maintain the described as outrageous release of the funds. The civil court apartment in a condition when applied to the poor found that as a result of the egre- suitable for decent living. tenant in the multi-family gious conditions of the apartment, Where there has been a sub- dwelling. There it views the landlord was entitled to only stantial failure by the land- with complacency the most one-half of the sum on deposit, with lord to maintain the apart- wretched living conditions, the remaining half to be returned to ment in a habitable littered and unlit hallways, the tenant. In particular, the court condition, the right to stairways with steps and noted the seriousness of the condi- receive rent is made subject banisters missing, walls and tions in the apartment. As the court to a defense comparable to ceilings with holes, exposed stated: that available in virtually wiring, broken windows, every part of our society to There persisted a severe lead pipes, stoves and refrig- one who does not receive roach and insect infestation, erators that do not work or that for which he agreed to with an almost total lack of work only now and then, pay.22 extermination service; virtu- and almost always the cock- ally non-existent janitorial roaches and the dread of It wasn’t long before the Appel- services; a nailed up back winter cold and uncertain late Division did take up the issue, in door, which prevented 23 heat.18 Tonetti v. Penati. In Tonetti v. Penati, egress; a front door that the Appellate Division, for the first The Amanuensis court then went could not be locked with time, determined that a warranty of on to hold that residential tenants knob that continuously fell habitability should be implied in the should be permitted to raise defens- off; a recurrent backing up of rental of premises for use as a resi- es to non-payment eviction proceed- a malodorous waters in the dence, and, for that reason, the com- ings in the following three situations: kitchen sink when the other mon-rule of caveat lessee should no tenants in the same line use longer be applied to residential leas- First, where the landlord has plumbing facilities; severe es. Interestingly, Tonetti v. Penati did not made a good faith effort leaks from the ceiling in the not involve an apartment in New to comply with the law and kitchen and foyer; and a York City. Rather, it involved the there have been substantial variety of other defects and lease of a five-bedroom private violations seriously affecting violations that need not be house in Palisades, New York. the habitability of the prem- detailed.21 ises. In Tonetti v. Penati, the conditions The court found that these viola- in the house were so unbearable that Second, where there are sub- tions violated the tenant’s implied the tenant moved out five days after stantial violations and code warranty of habitability. While he had moved in. The problems con- enforcement remedies have acknowledging that the doctrine of sisted of a terrible odor caused by been pursued and have been implied warranty of habitability had the former tenant keeping four or ineffective. not been “squarely passed upon by five dogs inside the house; another Third, where substantial vio- the appellate courts of this state,” the unbearable odor being emitted by lations exist and their contin- court nonetheless held that the doc- the furnace; and infestation by rats. uance is part of a purposeful trine was applicable. As the court In the ensuing litigation, the trial and illegal effort to force ten- stated: court held for the tenant. The trial ants to abandon their apart- The doctrine rests upon the court’s decision was affirmed by the ments.19 indisputable social reality Appellate Division, Second Depart- Another early New York case in that the apartment dweller, ment. The Appellate Division “rele- which the court found that there was in exchange for the rent he gate[d] to the limbo of history the an implied warranty of habitability pays expects not merely to orthodox view of caveat lessee and in every residential lease was Mor- occupy a certain amount of [held] that, unless expressly except- beth Realty Corp. v. Velez.20 In that space, but also a body of ed, there is an implied warranty of case, the tenant, in accordance with goods and services which habitability when a landlord leases Real Property Actions and Proceed- together make up the habit- premises for residential use.”24 As ings Law § 755, had deposited her able apartment [citations the court stated:

44 NYSBA N.Y. Real Property Law Journal | Spring 2002 | Vol. 30 | No. 2 It is evident that the ration- landlord or lessor shall be caveat lessee still prevails ale behind the common-law deemed to covenant and and requires the tenant to rule, which likened a lease to warrant that the premises so take the premises as they are the sale of a chattel and leased or rented and all and assume all risks as to therefore applied the ancient areas used in connection their condition.27 doctrine of caveat emptor, has therewith in common with no rational basis in a mod- other tenants or residents are The fact that the purpose of the ern, urban society. Realisti- fit for human habitation and law was to provide tenants with cally viewed, and fiction dis- for the uses reasonably basic amenities can be seen by exam- carded, a lease of residential intended by the parties and ining the Memorandum of Senator premises establishes a con- that the occupants of such H. Douglas Barclay. According to the tractual relationship with premises shall not be sub- Senator, the bill was designed to mutual obligations and is jected to any conditions meet minimal standards of habitabil- not intended to be treated as which would be dangerous, ity. As the Senator stated: a conveyance of an interest hazardous or detrimental to In this era of consumer-ori- in realty. The main concern their life, health or safety. ented legislation no provi- of today’s tenant is that he When any such condition sion has yet been made for acquire premises which he has been caused by the mis- those individuals who rent can enjoy for living purpos- conduct of the tenant or les- residential property to es; he is more mobile and see or persons on his direc- assure that the property they generally less skilled at tion or control, it shall not rent will be habitable. While maintenance than the land- constitute a breach of such the tenant has the covenant lord. Repairs are more costly covenants and warranties. to pay the rent, there is no in dwellings, with modern 2. Any agreement by a lessee corresponding covenant on plumbing and electrical or tenant of a dwelling waiv- the part of the landlord that facilities, and are more com- ing or modifying his rights the lease premises will meet plex. Thus, writers on the as set forth in this section the standard of livability. subject have supported the shall be void as contrary to The bill would encourage adoption of a rule of an landlords to maintain their public policy.26 implied warranty of habit- property in a safe and sani- ability (see, e.g., 38 Fordham The legislative history of RPL § tary condition and aid in the L. Rev, 225; 35 N.Y.U.L. Rev. 235-b demonstrates that it was sim- maintenance of housing 1279).25 ply the intention of the Legislature to stock.28 bring landlord-tenant law into the As these cases indicate, the 20th century by shifting the respon- The first major case construing courts were attempting to level the sibility for maintaining leased prem- section 235-b of the RPL was Park playing field by allowing tenants to 29 ises from the tenant to the landlord. West Management Corp. v. Mitchell. withhold rent in cases where the As stated by Governor Hugh L. In that case, the landlord was the conditions in the apartment were Carey in his Memorandum on § 235- owner of Park West Village, an abominable. Notably, in all of the b: apartment complex located on the cases cited, the conditions were upper west side of Manhattan. In caused by the acts or omissions of The bill represents a signifi- May 1976, the employees of Union the landlord, which invariably were cant beneficial change in the Local 32B went on strike. For the egregious. law of landlord and tenant. next 17 days, no maintenance or jani- With few exceptions, the torial staff member reported to work B. RPL § 235-b legal principles regulating at Park West Village. As a result, the Three months after Tonetti v. the rights of tenants to the tenants suffered extensive service Penati was decided, the Legislature safe, sound and habitable interruptions, which prompted some enacted RPL § 235-b. As originally housing accommodations of them to withhold rent. written, the statute provided as fol- are founded upon legal prin- lows: ciples that evolved during Park West Village commenced the Middle Ages. In the summary proceedings in the Civil § 235-b—Warranty of absence of an express provi- Court of the City of New York. As an Habitability sion in the lease, the land- affirmative defense, the tenants argued that Park West Village had 1. In every written or oral lord is not obligated to make breached its implied warranty of lease or rental agreement for necessary repairs. To a very habitability by not providing essen- residential premises the large extent, the doctrine of

NYSBA N.Y. Real Property Law Journal | Spring 2002 | Vol. 30 | No. 2 45 tial services. The Civil Court agreed a broad reading of RPL § 235-b. The the warranty of habitability. As the and found that the tenants were enti- Civil Court had held that the statute court stated: tled to a 10 percent rent abatement encompassed the level of services We agree that the language for the disruption in services. The and amenities tenants reasonably of warranty in § 235-b was Civil Court’s Order and Judgment expect to be provided under the adapted from the law of was affirmed by the Appellate Term, terms of the lease. The Court of sales, with its implied war- the Appellate Division and, ultimate- Appeals categorically rejected that ranty of fitness (UCC § 2- ly, the New York State Court of interpretation, finding that the 314), where it was the sub- Appeals. statute simply warrants that an ject of a well known legal apartment will be safe and habitable In pertinent part, the Court of development in which strict and that it does not cover expecta- Appeals held that “as the statute liability was imposed on tions arising from the terms of the places an unqualified obligation on those who manufacture or tenant’s lease. the landlord to keep the premises sell defective goods and habitable, conditions occasioned by products to the public. ordinary deterioration, work stop- “Nevertheless, the under- However, the section’s leg- pages by employees, acts of third par- lying principle of Park islative history makes it ties or natural disaster are within the quite improbable that the scope of the warranty as well.”30 West Village v. Mitchell, to the effect that landlords office contemplated exten- Notably, while holding the land- could be held liable for sion of the principle of strict lord accountable for the deteriora- liability to landlords for tion of services as a result of the san- breaches of the implied injuries and damages tradi- itation strike, the Court of Appeals warranty of habitability, tionally the subject of tort was unwilling to impose “across-the- even if those breaches liability.35 board” liability on landlords. The were caused by the acts Nevertheless, the underlying loss had to be substantial and direct- principle of Park West Village v. ly affect the habitability of the apart- of third parties, remained Mitchell, to the effect that landlords ment. As the Court stated: (and still remains) could be held liable for breaches of Petitioner maintains, and vibrant.” the implied warranty of habitability, rightfully so, that a landlord even if those breaches were caused is not a guarantor of every Further, the courts have consis- by the acts of third parties, remained amenity customarily ren- tently been unwilling to extend lia- (and still remains) vibrant. dered in the landlord-tenant bility under RPL § 235-b where the For example, in Sutton Fifty-Six relationship. The warranty tenant has a remedy under tort law. 36 of habitability was not leg- For example, in Curry v. New York Co. v. Fridecky, the Appellate Divi- islatively engrafted into resi- City Housing Authority,33 a tenant sion, First Department held that a dential leases for the pur- brought suit against her landlord for landlord was responsible for breach- pose of rendering landlord’s damages allegedly sustained when es of the warranty of habitability not absolute insurers of service, her two-year-old child fell out of the directly caused by its own actions. In which do not affect habit- window. Three causes of action were Sutton Fifty-Six Co. v. Fridecky, the ability. Rather, Section 235-b asserted, including a cause of action owner had constructed its building of the Real Property Law for breach of implied warranty of flush with the lot line, without any was designed to give rise to habitability embodied in RPL § 235- set back. This did not pose a prob- an implied promise on the b.34 Thereafter, the landlord moved lem until another building was con- part of the landlord that to dismiss the complaint. The structed on the adjacent lot, which both the demised premises Supreme Court granted the motion was also flush with the lot line. As a and the areas within the in part, but declined to dismiss the result, a brick wall was erected landlord’s control are fit for cause of action for breach of the immediately opposite the windows human habitation at the implied warranty of habitability. On in the first building, blocking out inception of the tenancy and appeal, the Appellate Division, First light, air and ventilation from the that they will remain so Department reversed and granted premises. throughout the lease term.31 the motion. In particular, the Appel- The affected tenants in those late Division found that RPL § 235-b apartments stopped paying their The Court of Appeals reaffirmed does not impose strict liability on a rent and the landlord commenced a this principle in Solow v. Wellner.32 In landlord for all injuries or damages series of non-payment proceedings.37 Solow, the Court of Appeals rejected suffered as a result of the violation of Citing Park West Management Corp. v.

46 NYSBA N.Y. Real Property Law Journal | Spring 2002 | Vol. 30 | No. 2 Mitchell, the Appellate Division, First any, to the landlord or lessor der,44 the court, in a footnote, also Department held that the fact that by reason of such strike or found that under certain circum- the breach was caused by the adja- labor dispute allocable to the stances, the acts of persons not cent land owner erecting its own tenants’ premises, provided, under a landlord’s control can be the building on the lot line did not however, that the landlord predicate for a breach of the warran- relieve the landlord of its obligations or lessor has made a good ty of habitability or a constructive under the statutory implied warran- faith attempt where practica- eviction. Likewise, in Nostrand Gar- ty of habitability. As the court stated: ble to cure the breach.40 dens Co-op. v. Howard, the Appellate Division upheld a 50 percent rent Nor is it controlling that the This amendment seems to sug- abatement given to a tenant for “culprit” is the adjacent gest that the Legislature, contrary to breach of the tenant’s implied war- landlord, since the statutory the views expressed by The Court of ranty of habitability.45 In Nostrand warranty of habitability can Appeals in Park West Village Corp. v. Gardens Co-op v. Howard, the tenant apply to conditions resulting Mitchell, did not intend to hold land- was subjected to constant yelling from events beyond the lords liable for a decrease in services and other loud noises coming from landlord’s control. Park West as a result of the acts of third parties the apartment above. Although the Management Corp. v. Mitchell, over whom the landlord had no con- co-op had argued that there was 47 N.Y.2d 316, 418 N.Y.S.2d trol. Whether the courts will follow nothing it could have done short of 310, 391 N.E.2d 1288, aff’g 62 the lead of the Legislature, and carve evicting the offending tenants (a A.D.2d 291, 404 N.Y.S.2d 115. out their own exceptions to RPL § daunting task considering that the Since the affirmative defense 235-b to cover the cases that are now tenants in question were an elderly alleging the breach of war- being brought as a result of the woman and her mentally-impaired ranty of habitability is a events of September 11, 2001, daughter), the Appellate Division viable defense that should remains to be seen.41 However, if still held that the co-op had breached have not been dismissed, the past performance is any indicator, it the respondent’s implied warranty counterclaim asserting the appears that the courts will continue of habitability. breach should have been to rely on Park West Management severed.38 Corp. v. Mitchell for the proposition Liability seems to depend on that the scope of the warranty of whether the landlord could have C. The Amendment to habitability does indeed encompass taken any measures to prevent the RPL § 235-b acts by third parties. occurrence, or least done something Two months after Sutton Fifty-Six to ameliorate the consequences. For For example, in 1996, the Appel- Co. v. Fridecky was decided, and in example, in Park West Village Corp. v. late Division, First Department, in direct response to Park West Manage- Mitchell, the landlord could have Elkman v. Southgate Owners Corp.,42 ment Corp. v. Mitchell,39 the Legisla- hired non-union help to haul away held that a landlord could be held ture, in the summer of 1983, amend- the garbage. Similarly, in Elkman v. liable for a breach of the warranty of ed section 235-b of the RPL, to create Southgate Owners Corp. and Nostrand habitability for conditions caused by an exception in cases of labor dis- Gardens Co-op. v. Howard, the land- an adjacent landowner. In Elkman v. putes. Specifically, the following pas- lord could have commenced actions Southgate Owners Corp., a tenant sued sage was added to the act: in nuisance against the offenders and his landlord claiming that noxious sought injunctions. Although these In determining the damages odors emanating from a retail fish alternatives were not explicitly sustained by a tenant as a store located in an adjacent building addressed by the courts in Park West result of a breach of the war- had breached his warranty of habit- Village Corp. v. Mitchell, Elkman v. ranty set forth in the section, ability. The landlord moved for sum- Southgate Owners Corp. and Nostrand the court shall, to the extent mary judgment dismissing that Gardens v. Howard, clearly the land- the warranty is breached or cause of action. The Supreme Court lord’s failure to take any action had cannot be cured by reason of denied the motion and the Appellate some bearing on the courts’ decision a strike or other labor dis- Division, First Department affirmed. to hold the landlords responsible for pute, which is not caused In particular, the Appellate Division the acts of the third parties. primarily by the individual found that the landlord could be landlord or lessor and such liable for the noxious odors emanat- Here, on the other hand, given damages are attributable to ing from the adjacent building, even the unprecedented nature of the such strike, exclude recovery though the landlord neither owned attacks on the World Trade Center, a to such extent, except to the nor controlled that building.43 Simi- court would be hard-pressed to hold extent of the net savings, if larly, in Palis Partners v. Vollenwei- a landlord liable for the collateral

NYSBA N.Y. Real Property Law Journal | Spring 2002 | Vol. 30 | No. 2 47 damage, unless it could be shown property damage, there is no reason which provided, inter alia, that “nei- that the landlord did not take ade- why the principle should not be ther . . . any individual . . . corpora- quate steps to ameliorate the prob- applied to private property owners tion . . . or any of the agents thereof, lem. Further, if the courts are made in the aftermath of September 11th. in good faith carrying out, comply- aware of the law with respect to Indeed, it is interesting to note that ing with or attempting to comply property damage caused by acts of there is actually a law on the books with any . . . Order . . . relating to war and crime, it may also lessen the in New York State that exempts Civil protection, shall be liable for likelihood that landlords will be held landowners from any liability for any injury . . . to persons . . . as the accountable under RPL § 235-b. injuries to persons or property suf- result of such activity.”54 As the fered as a result of an enemy attack, Court stated: III. Property Damaged as a where the person was using the Result of War owner’s property for sheltering pur- By the enactment, the legis- lature obviously intended to poses.51 Although the statute was It is well settled that property give immunity to owners of enacted at the height of the Cold War owners may not sue the government buildings complying or to provide immunity to landowners for damages caused by acts of war.46 attempting to comply in in the event of a nuclear attack,52 it As stated by the United States good faith with orders relat- nevertheless evinces an understand- Supreme Court in United States v. ing to civil protection. In ing that injury to person or property, Caltex,47 a case stemming from the view of the emergency con- as the result of an act of war should Second World War in which an oil ditions existing during not be compensable. company demanded compensation World War II, the act was a for losses it sustained when General valid exercise of the Police MacArthur, in his retreat from Mani- power. la in 1941, ordered the company’s “[G]iven the unprecedent- refining facilities in that city demol- ed nature of the attacks Just as in World War II, an emer- ished, on the World Trade gency condition exists in New York City as a result of the attacks on the The terse language of the Center, a court would be World Trade Center. The emergency Fifth Amendment is no com- hard-pressed to hold a is no less real now than it was then. prehensive promise that the landlord liable for the Indeed, it is more threatening today, United States will make collateral damage, unless what with the army guarding Grand whole all who suffer from Central and Pennsylvania Stations. every ravage and burden of it could be shown that the The Legislature granted absolute war. This Court has long rec- landlord did not take immunity to property owners in ognized that in war time, adequate steps to 1942 in recognition of the exigencies many losses may be attrib- ameliorate the problem.” of war. Should not the courts grant uted solely to the fortunes of the same absolute immunity to prop- war, and not to the sover- erty owners in 2002? eign.48 For example, in Field v. Manufac- At the very least, an owner Quoting from a case spawned by turer’s Trust Co.,53 a case that came should be entitled to qualified the Civil War,49 in which the Pacific out of World War II, a tenant sued immunity. That is, an owner should Railroad Company had sought com- his landlord for an injury sustained not be held liable for any breaches of pensation for 13 bridges that were during a citywide blackout in 1942. the implied warranty of habitability destroyed by the Union Army in Specifically, the tenant, who had as a result of the attacks on Septem- order to impede a Confederate been acting as an air-raid warden, ber 11th unless it can be shown that advance on St. Louis, the Supreme was seriously injured when he the owner unduly procrastinated in Court stated that: “The destruction stepped over a parapet on the roof of making the necessary repairs to the or injury of private property in bat- his building and fell to the yard tenant’s apartment. Such a rule tle, or in the bombardment of cities below. Following a bench trial, the would shield owners from liability and towns, and in many other ways court awarded the tenant judgment under RPL § 235-b for conditions it in the war, had to be borne by the in the sum of $40,000. The Appellate did not create, while protecting ten- sufferers alone, as one of its conse- Division, First Department reversed, ants from landlords who drag their quences.”50 and the Court of Appeals affirmed feet in making repairs. Certainly, it is the reversal. In particular, the Appel- While this precedent came out of more equitable than holding an late Division found that the landlord the Civil War, and involved govern- owner absolutely liable under the was immune from any liability mental immunity for war-related umbrella of the implied warranty of under the War Emergency Act, habitability.

48 NYSBA N.Y. Real Property Law Journal | Spring 2002 | Vol. 30 | No. 2 IV. Injury to Property Caused glar broke into some of the tenants’ Supreme Court. On appeal, the by Criminal Acts apartments and stole property val- Appellate Division, First Depart- ued at $1 million. The tenants ment, reversed and dismissed the The attacks of September 11th brought suit against the landlord, complaint. In particular, the Appel- can also be seen as criminal acts. alleging that the landlord had been late Division found that the Housing Indeed, the recent indictment of negligent in providing adequate Authority had no duty to protect the Zacarias Moussaoui for his role in security measures. The landlord boy from criminal acts of third par- the attacks reaffirms that fact. If such moved for summary judgment, ties committed on neighboring proper- an analysis is applied to the events claiming that it had taken reasonable ties, notwithstanding the fact that the of September 11th, then the property precautions to safeguard the apart- criminal act resulted in injury on owner should not be liable unless it ments during the renovation of the defendant’s property. The court fur- can be shown that the attack was building. The Supreme Court denied ther found that there was no evi- foreseeable to the property owner the motion and the landlord dence that the ongoing activities in and that the property owner appealed. The Appellate Division, the neighboring lot posed a risk of nonetheless took no precautions to First Department, unanimously danger to the building’s tenant suffi- avert it. As stated by Professor cient to create a duty on the land- Neisser in her 1990 St. John’s Law lord, as the building owner, to take Review article on this subject: “It thus appears that a precaution to protect its tenants from Traditionally, the implied colorable (if not persua- the results of those criminal acts. warranty of habitability did sive) argument can be Moreover, the fact that the court not apply to criminal acts of made that the implied found that the defendant could not third parties. The criminal warranty of habitability of have taken any precautionary meas- act was consistently held to ures on its own property to prevent be a superceding cause, RPL § 235-b should not the injuries, reinforced the conclu- against which one had no be applied to tenant sion that the shooting was an act of duty to protect another grievances caused by the violence by another not under the unless there was a special events of September landlord’s control. relationship between the The holdings in Martinez v. New parties. The relationship of 11th.” York City Housing Authority and landlord and tenant was not Roberts v. Jam Realty Co., while not considered to fit into this reversed, granted the motion for directly on point, should neverthe- category. . . .55 summary judgment, and dismissed less be given serious consideration the case. In particular, the Appellate by housing courts deciding habit- New York does not fully sub- Division found that while a landlord ability issues at Ground Zero. These scribe to this theory. Specifically, the has a duty to take minimal precau- cases provide valuable guidance as New York courts have held that a tions to safeguard the premises, that to a landlord’s liability with respect landlord’s failure to take adequate does not mean that the landlord can to the criminal acts of third parties, measures to protect its tenants from be held strictly liable for every crimi- and that, after all, is what the events criminal acts of third parties will, nal act of a third party As the court of September 11th are all about. under certain circumstances, consti- stated: “It is . . . well established that tute a breach of the implied warran- a landlord is not an insurer and, 56 V. Conclusion ty of habitability. However, in accordingly, that landlord’s duty to order to prove that there has been a offer protection against criminality It thus appears that a colorable breach of the implied warranty of on his or her premises arises only (if not persuasive) argument can be habitability, the tenant must show when the risk of such criminality is made that the implied warranty of that the criminal activity was fore- foreseeable. . . .”58 habitability of RPL § 235-b should seeable and that the landlord took no not be applied to tenant grievances steps to protect the tenant’s property. Martinez v. New York City Hous- caused by the events of September ing Authority is also instructive in 11th. The implied warranty of habit- For instance, in Roberts v. Jam this connection.59 In Martinez, a 14- ability is a concept that was devel- Realty Co.,57 a fire severely damaged year-old boy was shot in the head by oped to deal with recalcitrant land- a residential apartment building on a bullet that had entered through an lords who refused to provide basic East 25th Street. As a result, the ten- open bedroom window. Subsequent- amenities to their tenants. It was not ants of the building, like the tenants ly, the boy’s mother brought suit intended to apply to conditions over of lower Manhattan who lived at or against the landlord, the New York which the landlord had no control, near Ground Zero, were temporarily City Housing Authority. The land- such as those resulting from the forced to vacate their homes. While lord moved for summary judgment, attacks on the World Trade Center. the building was unoccupied, a bur- but the motion was denied by the

NYSBA N.Y. Real Property Law Journal | Spring 2002 | Vol. 30 | No. 2 49 While the implied warranty of rental obligations. Moreover, the tenant 42. 233 A.D.2d 104, 105, 649 N.Y.S.2d 138, habitability is no doubt a handy and had to have abandoned the premises, or 139 (1st Dep’t 1996). at least that portion of the premises that 43. Id. at 139. But see 56 Mac D., Inc. v. familiar friend to housing courts, it is Dave Herstein Co. v. was uninhabitable. Gravine, N.Y.L.J. Sept. 27, 2000, p. 26, col. not a proper tool in this instance. Columbia Pictures Corp., 4 N.Y.2d 117, 172 2 (tenant failed to substantiate allegation Rather than rely on the implied war- N.Y.S.2d 808 (1958). that recurring noxious odor from pizze- ranty of habitability we suggest that 13. Malvina Reynolds, “The Faucets are ria located directly below her apartment courts, confronted with habitability Dripping” (Schroeder Music Co, 1959), violated RPL § 235-b). Rise Up issues caused by the ramifications of reprinted with permission in 44. 173 Misc. 2d 8, 13, 660 N.Y.S.2d 272, 276 Singing: The Group Singing Songbook at 18 (Civ. Ct., N.Y. Co. 1997). the attacks on the World Trade Cen- (Peter Blood and Annie Patterson eds., ter, look to the laws relevant to 1988, 1992). 45. 221 A.D.2d 637, 634 N.Y.S.2d 505 (2d Dep’t 1995). national defense or criminal activity 14. 65 Misc. 2d 15, 318 N.Y.S.2d 11 (Civ. Ct., to find their answers to the problems N.Y. Co. 1971). 46. Corpus Juris Secundum, War and Nation- al Defense, § 15 (2001). posed by September 11th. 15. Id. at 14. 47. 344 U.S. 149, 73 S. Ct. 200 (1952). 16. Id. at 17. 48. Id. at 155. Endnotes 17. Thomas M. Quinn & Earl Philips, The Law of Landlord-Tenant: A Critical Evalua- 49. United States v. Pacific Railroad, 120 U.S. 1. Susan Saulany, Since Attack, More Land- tion of the Past with Guidelines for the 227, 7 S. Ct. 490, 30 L. Ed. 634 (1887). lord-Tenant Clashes Downtown, N.Y. Future, 38 Fordham L. Rev. 225 (1969). Times, Nov. 23, 2001, Sec. D, p. 6, col. 1. 50. 344 U.S. 149 at 153 (quoting Pacific Rail- Tom Perrotta, Landlords Sue Rent-Striking 18. Quinn & Phillips, id., at 225, quoted in road, 120 U.S. at 234, 7 S. Ct. at 493). Tenants, N.Y.L.J., Nov. 23, 2001, p. 1, col. Amanuensis Ltd. v. Brown, 65 Misc. 2d 15, 51. N.Y. Unconsol. Law § 9193 (McKinney’s 3. 318 N.Y.S.2d 11, 18 (N.Y. Civ. Ct., N.Y. 1974). Co. 1971). 2. Jack L. Lester, Testing the Warranty of 52. Report by the New York State Civil Habitability at Ground Zero, N.Y.L.J., Nov. 19. Amanuesis, 65 Misc. 2d at 19. Defense Commission to the New York 28, 2001, p. 1, 4, col. 1. 20. 73 Misc. 2d 996, 343 N.Y.S.2d 406 (Civ. State’s Defense Council Recommending 3. Id. Ct., N.Y. Co. 1973). a Shelter Policy for Adoption by the Defense Council, reprinted in 1952 N.Y. Id. 4. N.Y. Real Property Law § 235-b (McKin- 21. at 998. Laws XXXXX (McKinney) p. 1249 at ney’s 1989 & 2001 Supp.). 22. Id. at 999. 1253. 5. Warren A. Estis, Jeffrey Turkel & William 23. Tonetti v. Penati, 48 A.D.2d 25, 367 53. Field v. Manufacturer’s Trust Co., 271 A.D. J. Robbins, Landlord-Tenant Principles: Lit- N.Y.S.2d 804 (2d Dep’t 1975). 226, 62 N.Y.S.2d 716 (1st Dep’t 1946), igation Issues Will Likely be Guided by Well aff’d, 296 N.Y. 972 (1947). Established Laws, N.Y.L.J., Nov. 27, 2001, 24. Id. at 30. p. 6, col. 3 25. Id. at 29. 54. 62 N.Y.S.2d at 719. 6. Joan L. Neisser, The Tenant as Consumer: 26. 1975 N.Y. Laws ch. 597, § 235-b. 55. Neisser at p. 531. Applying Strict Liability Principles to Land- Carp v. Marcus, 27. Governor’s Memorandum, reprinted in 56. 112 A.D.2d 546, 491 lords, 64 St. John’s L. Rev. 527 (1990) See [1975] N.Y. Laws 1760–1761 (McKin- N.Y.S.2d 484, 485 (3d Dep’t 1985). (hereinafter “Neisser”). Mason v. U.E.S.S. Leasing Corp. ney’s). , 96 N.Y.2d 7. Steven W. Smollens, Landlord-Tenant Liti- 875, 730 N.Y.S.2d 770, 756 N.E.2d 58 28. Memorandum of Senator H. Douglas gation: Non-Payment Proceedings, includ- (2001). Barclay, reprinted in [1975] N.Y. Legis. ing the Warranty of Habitability, p. 20, Ann. 315. 57. 260 A.D.2d 230, 688 N.Y.S.2d 69 (1st 1989–1993 (unpublished manuscript on Dep’t 1999). file with the author) (hereinafter “Smol- 29. 47 N.Y.2d 316, 418 N.Y.S.2d 310, 391 58. 688 N.Y.S.2d at 71. lens”). N.E.2d 1288 (1979). 59. 238 A.D.2d 167, 655 N.Y.S.2d 523 (1st 8. Jesse Dukeminier & James E. Krier, 30. Id. at 327 (emphasis supplied). Dep’t 1997). Property 508, 521 (4th ed., Aspen Law & 31. Id. Business 1988). 32. 86 N.Y.2d 582, 535 N.Y.S.2d 132, 658 The author is an associate in the 9. Id. N.E.2d 1005 (1995). law firm of Belkin Burden Wenig 10. Smollens at 20. 33. 77 A.D.2d 534, 430 N.Y.S.2d 305 (1st and Goldman, LLP, which is located 11. Thomas M. Quinn & Earl Phillips, The Dep’t 1980). in New York City. The author Law of Landlord-Tenant: A Critical Evalua- 34. Id. at 534. wishes to express his gratitude to tion of the Past with Guidelines for the Future, 38 Fordham L. Rev. 225 (1969). 35. Id. at 535. Sherwin Belkin, Edward Baer and Martin Meltzer, partners in the 12. See Neisser at p. 531. That does not 36. 93 A.D.2d 720, 461 N.Y.S.2d 14 (1st Dep’t mean to say that the tenant was totally 1983). firm, for their valuable assistance in at the mercy of the landlord. The tenant 37. Id. at 15. the preparation of this article. In could always sue for breach of the 38. Id. at 16. addition, the author would like to covenant of quiet enjoyment of the lease. thank Joseph Burden, also a partner That remedy however, was neither prac- 39 Smollens at 22. in the firm, who suggested this arti- tical nor satisfactory. Under most stan- 40. RPL § 235-b, ch. 403, § 38, 1983 N.Y. dard leases, in order to assert a claim for Laws 729. cle, guided the author through the breach of the covenant of enjoyment, the writing, and encouraged its publi- 41. Estis, Turkel & Robbins, p. 6, col. 6. tenant must be current in his or her cation.

50 NYSBA N.Y. Real Property Law Journal | Spring 2002 | Vol. 30 | No. 2 Insurance Issues Resulting from the Attack on America— September 11, 2001 By James E. Branigan

This paper was prepared for presen- $50 billion. While many of the issues (replacement cost) and loss of busi- tation at the New York State Bar Associ- reviewed in this article may be appli- ness income/rental income until the ation Real Property Law Section, Annu- cable to any property loss, the premises are “with due diligence al Meeting in New York, January 24, emphasis is on loss caused by terror- and dispatch” restored to a condition 2002, and updated on February 5, 2002, ist acts. that existed prior to the loss. Those for publication in the New York Law properties not physically damaged, Journal. Terrorist Insurance Coverage but barred from use during the peri- od following the attack will likely Issues Introduction have their loss of business income limited to a sub-limit. Most property On September 11, 2001, the Unit- Definition insurance policies limit coverage to ed States was the target of an attack Most property insurance policies two weeks for prevention of ingress that in less than two hours resulted exclude losses from declared war or and egress. While longer periods and in the largest single insurable loss in losses caused by a uniformed inva- sub-limits for overall loss on a port- recent times. This horrific event has sion force or sovereign power. The folio of buildings has been observed, changed our world and that of the event that befell the WTC was nei- the most common coverage exten- insurance industry. Currently the ther; that is, it was not caused by a sion is two weeks. debate rages over such issues as the sovereign power, a uniformed inva- adequacy of insurable values, the sion force or an act of declared war. Firms with business income cov- number of terrorist acts on 9/11, the Thus, in the absence of a policy term, erage may have funds available to reserving practices of insurance and condition or exclusion that limits or continue their operations at a new reinsurance companies, and whether prevents coverage response, the Spe- location. Coverage for the additional insurers and reinsurers will be able cial Form (aka: so-called “All-Risk”) expense of doing business over and to meet their financial obligations to policy pays the loss. above normal operating expenses policyholders and each other. The can be insured by the inclusion of an impact will be felt for years to come extra expense endorsement. The con- Determination of Cause as underwriters and legal experts tingent business interruption define the rules and regulations Was the occurrence two hijacked endorsement may also cover busi- required for terrorist coverage. aircraft each crashing into one WTC ness interruption loss if an existing tower or was the occurrence one ter- supplier or customer is unable to When more than 50 percent of rorist plot that destroyed the WTC conduct business with the insured reinsurance treaties expired on Janu- towers? The answer, pending a deci- firm. ary 1, 2002, Congress had not yet sion by the U.S. District Court for the agreed on legislative measures to cap Southern District of New York, will Types of Insurance Coverage insurer and reinsurer liability have a significant outcome. If the Affected by 9/11/01 through some type of risk-sharing decision is one occurrence, insurers vehicle. The insurance industry has will be liable for the occurrence limit Some types of insurance cover- said its ability to continue to provide in their policy, which is reported to age affected by the 9/11 attacks coverage for the terrorist peril as be approximately $3.6 billion. If the include the following: provided in policies in effect on 9/11 decision is two occurrences, the • Property and Business Income is limited, and is lobbying to have insurers liability would double to coverage for direct damage to the the government provide a backstop approximately $7.2 billion. to its liability should another towers caused by the impact of unthinkable disaster reoccur. the aircraft and the resultant rain Collateral Damage of debris on buildings in the sur- This article focuses on property The damage around the towers rounding area. and business income insurance cov- caused by falling debris was sub- • Workers’ Compensation coverage erage issues solely as a result of the stantial. Those buildings directly terrorist attack on the World Trade for employees injured in the damaged likely will be covered for attack. Center (WTC). All losses from the physical restoration expense terrorist attack are estimated to be

NYSBA N.Y. Real Property Law Journal | Spring 2002 | Vol. 30 | No. 2 51 • Life Insurance payments to bene- WTC has been estimated to be as income, other losses covered in less ficiaries. much as five years, the necessary obvious policy extensions and spe- limits of insurance should be ade- cial endorsements may be of greater • Disability insurance coverage for quate to cover this time period. significance. Some examples include those unable to work following the following. the events of 9/11. Extended Period of Indemnity • Public Liability coverage for such Extended Period of Indemnity Prevention of Ingress & Egress and things as failure to provide ade- allows the landlord additional time Act of Civil Authority quate security or evacuation to find tenants. By the time recon- The inaccessibility of lower Man- instructions. struction is complete it is likely that hattan (below 14th Street) made it • Aviation Insurance to cover both most, if not all, tenants in the dam- impossible to gain access to build- the loss of life and loss of the air- aged and destroyed buildings will ings and business establishments for craft. have found other space. When the nearly two weeks, and in many cases premises are ready to be re-leased, longer. Prevention of Ingress & • Director’s and Officer’s Liability indemnity under the Business Inter- Egress and Act of Civil Authority is coverage for ensuing lawsuits ruption or Rental Income coverage an extension of coverage found in due to inadequate insurance or ends unless an Extended Period of nearly all property insurance poli- failure to provide adequate meas- Indemnity Endorsement has been cies; however, coverage is usually ures to assure continued business added to the business interruption limited to two weeks. Some savvy operations. and rental income coverage. The corporate risk managers have been Extended Period of Indemnity able to negotiate longer periods Property Insurance Issues Endorsement is purchased in 30-day and/or sub-limits for groups of increments. Most purchasers select a buildings. Property insurance policies pro- 180- or 360-day indemnity period. vide coverage for loss of property Coverage may be purchased for and are extended by endorsement to Contingent Business Interruption longer periods; however, more than cover loss of business income. Most two years is rare. Contingent Business Interrup- business policies contain a menu of tion endorsement pays the insured’s coverage and include some or all of business interruption loss if the dam- the following. Extra Expense Endorsement age is of the type insured in the poli- Extra Expense Endorsement is cy and prevents the insured from Direct Damage—Physical Loss an extension that pays for additional doing business due to loss at a cus- costs to the insured to continue oper- tomer or a supplier location. Service Property insurance policies pay ations as near normal as possible to providers, such as restaurants and a limit of insurance on a per occur- those existing prior to loss. Extra hotels, rarely purchase this type of rence basis. Other conditions that will Expense coverage is available under coverage. determine how a loss is paid, and on the Business Interruption & Rent what terms, include replacement cost Loss coverage forms (dollar for dol- or actual cash value, application of Law and Ordinance lar) to the extent that the payment co-insurance penalties and imposi- reduces the business or rental A significant extension of cover- tion of sub-limits and other terms income loss under the coverage part. age for rebuilding the destroyed and conditions that would potential- A separate Extra Expense Endorse- towers is “Law and Ordinance,” aka: ly limit a policy response. ment can provide coverage for sums “Demolition and Increased Cost of in excess of those saved under the Construction” (D&ICC). This Loss of Use Business Interruption & Rent Loss endorsement covers increased con- struction costs due to the enforce- Business and Rental Interruption form. Thus, if it costs a policyholder ment of laws requiring that build- Insurance are endorsements to the $1.25 to save $1.00 in lost business ings be reconstructed to standards property insurance policy and pro- income, the additional 25¢ is paid by higher than those that existed at the vide the insured with indemnifica- the Extra Expense Endorsement. time of loss. This coverage usually is tion for lost net profit and continu- subject to a sub-limit. ing fixed expenses from the time of Property Insurance Coverage the occurrences, until using “due Extensions diligence and dispatch” the premises Debris Removal While the loss of the towers and can be restored to a condition that A debris removal clause is a sub- their replacement is the basis of existed prior to loss. Given that the limit that could affect the availability direct property damage and business time necessary to reconstruct the of funds to reconstruct the WTC.

52 NYSBA N.Y. Real Property Law Journal | Spring 2002 | Vol. 30 | No. 2 This clause, contained in most poli- The following is an example of a companies, has filed a new terrorist cies, has a sub-limit equal to 10 per- Pre 9/11 Terrorist Exclusion. Note coverage endorsement in more than cent of the policy limit. This is an the condition in which the exclusion 40 states. The new Terrorist Cover- additional amount of insurance and applies and the exception to the age is complex and limits the insur- should the cleanup exceed this limit exclusion. ance industry’s exposure to cata- the cost to remove the debris would strophic loss by redefining A.) Hostile or warlike action in time of come from the reconstruction fund, occurrence and limiting loss for all peace or war, including action in thereby leaving a potential shortfall. insured losses, regardless of the hindering, combating or defending number of policies involved. against an actual, impending or Off Premises Service Interruption expected attack by any: Some states have accepted the Loss of business income caused new endorsement with reservation (i) Government or sovereign by lack of utility service is another and others, including New York and power (de jure or de facto); cause of ongoing business interrup- California, have rejected the filing. tion. “Off Premises Service Interrup- (ii) Military, naval or air force; or The new ISO endorsement is a tion” is an endorsement that can departure from traditional insurance cover this; however, it has many (iii) Agent or authority of any and requires review to gain an variations, including the number and party specified in (i) or (ii) understanding of the coverage. type of utilities covered, whether the above. When the total of all insured utilities are public or private, insur- Item (iii) of this exclusion does not losses reaches a threshold of $25 mil- able perils, and the distance of the apply to physical loss or damage lion per incident, all coverage is can- damaged utilities from the premises insured by this Policy done by ter- celed and void. This includes direct to which the coverage responds. rorists or done secretly by a foreign damage, resulting business income, enemy or agent of any government prevention of access and other exten- Leasehold Interest or sovereign power (de jure or de sions as well. An incident (not the A tenant can insure the financial facto), when not in connection with customary occurrence) is redefined loss associated with termination of a the operations of armed forces in or as all insured losses, within the Unit- favorable lease through the purchase against the country where the ed States and Canada, that occur of leasehold interest insurance. This Insured Location is situated. within a 72-hour period and appear endorsement pays the tenant if a loss B.) Discharge, explosion or use of any to emanate from a common source; destroys its premises and the lease is nuclear device, weapon or material these are considered one occurrence. canceled. The amount insured is the employing or involving nuclear fis- In addition, coverage is not provided difference between the remaining sion, fusion or radioactive force, for loss due to nuclear, chemical or lease payments and the market whether in time of peace or war and biological loss or damage. Liability rental today to replace the space regardless of who commits the act. forms reportedly contain similar destroyed, through the remaining clauses and add the coverage cancel- term and renewal option periods, C.) Insurrection, rebellion, revolution, ing condition where the incident discounted to present value. civil war, usurped power, or action causes the death of 50 or more peo- taken by governmental authority in ple. hindering, combating or defending Exclusions against such an event. Web sites with general informa- Exclusions that are the focus of tion regarding the National Associa- D.) Seizure or destruction under quar- attention with regard to insurance tion of Insurance Commissioners antine or custom regulation, or con- coverage for future terrorist acts (NAIC) and the details regarding the fiscation by order of any govern- involve the following: policy forms and state filing are as mental or public authority. follows: • Declared war is excluded from E.) Risks of contraband, or illegal coverage in most policies. • National Association of Insurance transportation or trade. Commissioners (see 12/21/01 • Terrorist acts are covered by an Press Release) exception to the exclusion; to be The New Terrorist Coverage excluded, the terrorist act must • Independent Insurance Agents of Endorsement typically be caused by a sover- America—policy form The Insurance Services Office eign power or uniformed inva- • Insurance Services Office—state (ISO), a service arm of insurance sion force. filings

NYSBA N.Y. Real Property Law Journal | Spring 2002 | Vol. 30 | No. 2 53 State of the Insurance action is left for retail insurers who Conclusion Market will not take on more risk than their While the insurance industry in-house capacity (the amount they This section covers the state of and legislators continue to search for keep without the benefit of reinsur- the insurance market Pre- and Post- a workable solution to cover terrorist ance)? The answer is to reduce the September 11, 2001. attacks, failure to find an acceptable overall policy limit to the amount of risk-sharing partner, even if only Prior to 9/11, the world insur- terrorist coverage they are willing to temporary, will continue to raise pre- ance markets were in the process of underwrite. This creates an overall mium levels and restrict coverage. rebounding from one of the longest capacity shortage, which drives rates Presently, insurance for terrorist risk soft insurance markets in history. up dramatically, and limits the cov- is available at substantial cost on a The competitive pricing of various erage extensions afforded to policy- restricted basis. One broker noted insurance products in recent years holders. One example is the reduc- that in a recent placement on a $200 lowered rates to levels never seen tion or elimination of Blanket Limits; million insurable value building in before. Premium increases in the a coverage enhancement often Europe, the additional cost to add year preceding 9/11 marked the afforded the insureds. Capacity is the terrorist coverage was $1 million. beginning of insurers’ efforts to once available amount of coverage. Lower again become profitable, and 9/11 supply and higher demand result in James Branigan is president & was a major disruption to that dramatic premium increases for the CEO of Omega Risk Management attempted recovery. insurance-buying public. LLC. His firm provides insurance Post 9/11, many property insur- consulting services to corporations ance renewals are experiencing sig- Lender Reaction and conducts due diligence reviews nificant rate increases ranging from Generally, lenders can be expect- for financial institutions originating 20 percent and in some cases more ed to be very cautious. They will large commercial loans throughout than 400 percent. In addition, insur- demand copies of the actual insur- the United States and Canada. Mr. ance coverage is being reduced and ance policies and will likely insist on Branigan has written several papers features such as Blanket Limits of terrorist insurance coverage on larg- on insurance in real estate finance Liability and Terrorist Coverage are er, well-known buildings. for the Practising Law Institute difficult, if not impossible, to obtain. (PLI) and co-authored a chapter on Some lenders are already taking insurance in Commercial Leasing, In the months following 9/11, a position that the lack of terrorist which will be published by the the chief executive officers of A I G insurance is an increased hazard and New York State Bar Association and Travelers Insurance companies may be an acceptable risk if borrow- later this year. He has served on the have discussed the need for a federal ers pay additional fees for their PLI faculty for three years, been a backstop or a reinsurance arrange- loans. Other lenders will require speaker for the NYSBA Committee ment. They propose that the govern- remotely located additional collateral on Leasing and was a panelist on ment provide coverage for 90 per- or personal guarantees from the bor- insurance in commercial leasing for cent of the loss in excess of the first rower’s principals. the NYC Dirt Lawyers. His most $10 billion in losses caused by terror- recent presentation was before the According to agencies like Stan- ist acts. They noted that the insur- NYSBA Real Property Law Section dard & Poor’s (S&P) that rate com- ance industry has a capacity to Annual Meeting. Mr. Branigan has mercial mortgage-backed securities absorb at most $130 billion and that delivered numerous insurance (CMBS), many are evaluating the exposure to yet a second loss of the training sessions for commercial exposure and need for coverage on a magnitude of the WTC would have lenders and law firms throughout case-by-case basis. Large target prop- serious effects on the industry. War- the U.S. Mr. Branigan attended the erties in major cities will likely be ren Buffet, chairman of Berkshire City and State University of New required to provide terrorist cover- Hathaway, proposed an FDIC-type York where he studied Fire Science age while a strip shopping center in system to provide a vehicle to fund and Business. He is licensed as an a rural area will likely not be and share risk among all commercial Insurance Broker and Insurance required to have terrorist coverage. insureds. Consultant by the State of New S&P may in some cases accept a ter- York and served in the United Reinsurers have refused to pro- rorist exclusion and will likely add a States Navy. James Branigan can be vide unlimited terrorist coverage to notation or subscript to the security contacted at (631) 692-9866 or retail insurance companies. What listing that coverage is not provided. [email protected].

54 NYSBA N.Y. Real Property Law Journal | Spring 2002 | Vol. 30 | No. 2 City and State Tax Rulings Open the Door for Synthetic Leases in New York By Joshua Stein

Until recently, commercial real able to do it by structuring the trans- thetic lease (the financial statement estate lawyers in New York were action as a “synthetic lease.” vanishing act) ends. The User must unsure of how the city and state then show the real estate on its In a synthetic lease transaction, would tax a real estate “synthetic financial statements, or figure out the User does not directly acquire lease” transaction. There was a gen- some other way to carry the invest- the desired asset. Instead, the User eral sense of dread, a sense that syn- ment. arranges to have a single-purpose thetic leases might attract so many entity (the “SPE”) acquire the asset Synthetic leases and some other state and city taxes that they were 5 financing structures are collectively probably not feasible in New York. directly from a third-party seller. The SPE then leases the asset to the called “off-balance-sheet financing” The New York State Department User. because the User in effect (and in of Taxation & Finance (the “State”) substance but not in form) borrows recently eliminated much of that fear The lease from the SPE to the money but the User’s financial state- by issuing a favorable Advisory User—the “synthetic lease”—gives ments don’t show it. Similar but the User the functional and econom- Opinion1 relating to a proposed syn- more aggressive techniques were ic equivalent of ownership, in virtu- thetic lease in Manhattan (the “Syn- widely used by Enron Corporation ally all respects, for all purposes thetic Lease Advisory Opinion”).2 and its various partnerships except the User’s financial state- (“Enron”).8 Enron did not appear to ments. If the lease satisfies a list of At about the same time, the New be involved in any way in the Syn- accounting criteria, the User need York City Department of Finance thetic Lease Advisory Opinion. Still, 3 not burden its financial statements (the “City”) issued a letter ruling Enron’s collapse and the resulting with ownership of the real estate, (the “City Letter Ruling”) that took a accounting issues will probably lead and those statements will show rent similarly favorable approach to syn- the public markets, securities regula- payments under the lease rather thetic leases for the City’s various tors, and the accounting profession 4 than interest (and indebtedness) and taxes. Together, the Synthetic Lease to change their view of all off-bal- depreciation expenses. This makes Advisory Opinion and the City Let- ance-sheet financing, including syn- the public markets and, hence, the ter Ruling make synthetic leases fea- thetic leases. If that is so, then the User happier. sible transactions in New York (at Synthetic Lease Advisory Opinion least as a matter of City and State To finance the acquisition and and the City Letter Ruling may have taxation). These pronouncements synthetic lease of the real estate been issued just in time to be represent a very welcome clarifica- asset, the User enlists some or all of prospectively irrelevant. tion of how the taxing authorities its regular bank lenders (the “Partici- will look at these transactions. Beyond the accounting, taxation, pants”) to make a loan to the SPE so and other issues that this article sug- the SPE can acquire the asset and A typical “synthetic lease” gests, synthetic leases raise a number lease it to the User. The SPE grants a begins when an operating company, of other issues in almost every area mortgage to the Participants (the often publicly traded (the “User”), of law and practice that real estate 6 wants to acquire or build a new facil- “Participants’ Mortgage”). The lawyers need to consider in any sub- ity, but also wants to keep that real “rent” payments under the lease will stantial transaction, including bank- estate off its balance sheet while exactly equal the debt service pay- ruptcy, conveyancing, corporate gov- retaining all the benefits and bur- ments under the Participants’ loan ernance, enforceability, income dens of ownership. This would plus some minor compensation for taxation, qualification to do business, 7 include the benefit of possible appre- the equityholders of the SPE. recharacterization, and title insur- ciation, as well as depreciation At the end of the lease term, ance.9 deductions for tax purposes, but not based on the terms and conditions of for financial statement purposes. At least for the synthetic lease the lease, the User will almost cer- under consideration,10 the Synthetic tainly exercise one of its options to Users very often want to achieve Lease Advisory Opinion establishes acquire the real estate from the SPE, all those goals, and all simultaneous- a very practical and reasonable struc- at which point the magic of the syn- ly. They have in recent years been ture to define the transfer tax and

NYSBA N.Y. Real Property Law Journal | Spring 2002 | Vol. 30 | No. 2 55 mortgage recording tax payable on ing implied by the synthetic The Synthetic Lease Advisory one of these transactions. The State lease exceeds the principal (tax- Opinion means that the State trans- adopted a “substance over form” paid) amount of the Participants’ fer and mortgage recording conse- approach that will facilitate synthetic Mortgage. The Deemed Mort- quences of a synthetic lease financ- leases in New York. gage will otherwise be exempt ing match those of a traditional fee under New York Tax Law sec- acquisition accompanied by a simul- Instead of imposing multiple tion 255.15 taneous fee mortgage. That is the transfer taxes on what is in sub- right result. It should facilitate the stance a financing transaction, the 5. Mortgage Recording Tax on Syn- use of synthetic leases in the State. State treats much of the transaction thetic Lease. The synthetic lease as just one taxable mortgage. The will be treated as part of the In the City Letter Ruling, the State deems any subsequent duplica- same mortgage financing City took a similar approach and tive mortgages to be merely “supple- described in “4” above. The treated the synthetic lease as a mental” to the first, hence taxable implied debt in that financing financing. The City said it would not only on the incremental indebted- would have been taxed when try to collect New York City Real ness that they secure. This approach the State taxed the Participants’ Property Transfer Tax on the various is far more practical and conducive Mortgage and the Deemed conveyances after the SPE’s initial to modern business transactions than Mortgage, as described above.16 acquisition of the asset. And, even the State’s approach in, for example, The State will collect that tax though the synthetic lease requires dealing with substantial commercial only once (on the Participants’ the User to pay “rent,” the City said revolving loans.11 Mortgage and the Deemed it would treat those payments as Mortgage) and will not collect it nontaxable debt service for the City’s Based on the Synthetic Lease a second time on the synthetic Commercial Rent and Occupancy Advisory Opinion, the State’s taxa- lease itself. Of course, if the Tax. tion of a synthetic lease transaction implied financing under the syn- can be summarized as follows: In reaching these very favorable thetic lease were to exceed the and practical conclusions, both the amount of the Deemed Mort- 1. Acquisition. For transfer tax pur- City and the State scrutinized the gage (very unlikely or impossi- poses, the State will treat the synthetic lease transaction structure, ble), then the State would collect SPE’s acquisition of the real and focused on a series of its charac- a mortgage recording tax, but estate in the first instance as if teristics. Although those characteris- 12 only on that excess. the User were acquiring it. tics mirrored those of many other 2. Recorded Mortgage. When the 6. Net Effect. As a result of the last synthetic lease transactions, they SPE records the Participants’ five steps, the mortgage record- gave the taxing authorities a road Mortgage, the State will collect a ing tax on all documents record- map to reach the right result. Any- single mortgage recording tax on ed to close a synthetic lease one who structures a synthetic lease the amount secured. transaction will reflect the maxi- in New York should try to create a mum total debt that those docu- similar road map. 3. Deemed Mortgage. The State will ments secure. It will, however, The following briefly summa- deem the User to have conveyed need to be paid only once. the real property to the SPE, but rizes the elements of the synthetic will treat this conveyance as a 7. Repurchase. Eventually, the User lease that supported the favorable mortgage (the “Deemed Mort- may (will?) exercise its option to treatment in the Synthetic Lease gage”), and not as a conveyance purchase or otherwise acquire Advisory Opinion and the City Let- subject to transfer tax.13 the real property. At that point, ter Ruling: when the SPE transfers title to • Parties’ Intentions. In all the syn- 4. Mortgage Tax on Deemed the real property to the User, thetic lease documents, the par- Mortgage. The State will treat the that conveyance will not be sub- ties consistently said they intend- Deemed Mortgage as being ject to transfer tax but will ed the synthetic lease be treated “supplemental” to the Partici- instead be deemed a nontaxable 14 as a financing for tax and other pants’ Mortgage. The State will “satisfaction” of the Deemed purposes18—everything except therefore impose a mortgage Mortgage.17 The Participants’ the User’s financial statements.19 recording tax on the Deemed Mortgage would remain in Mortgage only to the extent that place, and could be satisfied or • Control. The synthetic lease gives the principal amount of financ- refinanced. the User complete control over

56 NYSBA N.Y. Real Property Law Journal | Spring 2002 | Vol. 30 | No. 2 the real property. The User pays Except for the last point, virtual- helpful comments of Kim N.A. Boras, a all costs of ownership, giving the ly any synthetic lease transaction partner in the Los Angeles office of Lath- am & Watkins. SPE an absolutely “triple net” would have all the same characteris- rental income. The User has near- tics as this one, and hence would 2. N.Y. Dep’t Tax & Fin. Comm’r Adv. Op., N.Y. Tax Rep. (CCH) ¶ 404-004 (2001) ly total flexibility in its use, alter- probably qualify for the same favor- (hereinafter “Synthetic Lease Advisory ation, and (sub)leasing of the real able treatment. The parties to any Opinion”). The following discussion of property.20 such future transaction may, howev- the Synthetic Lease Advisory Opinion er, not want to rely on the Synthetic ignores some preliminary steps that occurred in the transaction before the • Debt-like Obligations. The User’s Lease Advisory Opinion and City obligations under the synthetic SPE took title to the real property, in this Letter Ruling.26 They might instead case a condominium unit. lease are much like those of a cor- want to obtain their own determina- porate borrower under a financ- 3. New York City Dep’t of Finance Letter tions. Ruling, April 19, 2001 (FLR-004773-721). ing agreement. The “rent” pay- A copy of the City Letter Ruling can be ments precisely equal the debt The Synthetic Lease Advisory found at: . The City Letter Ruling was also obtained by transaction relies in large part on implications if the User were to Carolyn Joy Lee of Roberts & Holland. the User’s credit rather than the grant a leasehold mortgage, as addi- 4. The City Letter Ruling considered the 21 real estate. tional security, either to the Partici- City’s Real Property Transfer Tax and pants or to the SPE. Based on the Commercial Rent and Occupancy Tax. It Development Controls • . A “Con- practicality displayed in the Synthet- did not address mortgage recording tax, struction Agency Agreement” ic Lease Advisory Opinion and the which the State generally administers, although the City sometimes publicly gave the User full control over City Letter Ruling, however, it may the construction and develop- disagrees with the State’s interpreta- be reasonable to expect the taxing tions. No such disagreement was appar- ment process and decisions, authorities to treat such a leasehold ent regarding the issues this article along with responsibility for all mortgage as being another “supple- describes. 22 related liabilities. mental” instrument, tax-exempt on 5. To comply with accounting standards the same basis as the other compo- for synthetic leases, the User cannot • Risk of Loss; Control of Appreci- already own the asset. The synthetic ation. Under the synthetic lease, nents of the transaction. Another lease is not a substitute for the tradition- the User bears the full risk of advisory opinion and another letter al “sale and leaseback.” casualty and condemnation and ruling may be necessary to reach that 6. The User may also mortgage its lease- receives the full benefit of future result, though. hold under the synthetic lease, but the appreciation.23 transaction described in the Synthetic In the meantime, the Synthetic Lease Advisory Opinion did not include Lease Advisory Opinion and the that element. Although the Participants • Future Purchase. The User has a might want the User to guaranty the variety of purchase options and City Letter Ruling certainly represent loan, any such guaranty would typically obligations. The User ultimately good news for synthetic lease trans- violate the accounting rules that synthet- bears most or all of any shortfall actions in New York. If the synthetic ic leases must satisfy. The User’s rental lease transaction survives as an stream under the synthetic lease does, in value (below the implied loan however, give the Participants much the balance) if the real property is accounting matter, it should now be same level of credit support for the loan. feasible in New York. Even if the sold to a third party or if an 7. The synthetic lease must comply with Event of Default occurs. As a synthetic lease does not survive, certain accounting criteria to be honored result of all these provisions con- though, these two pronouncements for accounting purposes, including mini- sidered together, the User is quite demonstrate a practical approach mum outside equity capitalization of the SPE. likely to acquire the real property that, if followed in other contexts, at the end of the lease term or may help facilitate other new and 8. Those partnerships were in many cases subject to the same minimum outside 24 creative transaction structures in possibly earlier. equity requirements that apply to any New York. synthetic lease SPE. • Corporate Headquarters. In the par- ticular transaction, the real prop- 9. For more on all these issues, the reader Endnotes should refer to the Web site operated by erty in question was to become John Murray, Vice President and Special the User’s world headquarters. 1. The Synthetic Lease Advisory Opinion Counsel, First American Title Insurance Therefore, external facts further was obtained by Carolyn Joy Lee of Co. Chicago National Commercial Divi- Roberts & Holland. Ms. Lee reviewed sion (Chicago). Mr. Murray, a nationally indicated that the User was likely this manuscript in draft, and her helpful recognized authority on synthetic leases, to acquire the real property at the comments and suggestions are very has posted on that site over a dozen of end of the synthetic lease.25 much appreciated. The author also his articles on many issues that synthetic acknowledges with thanks the very leases create. See http:

NYSBA N.Y. Real Property Law Journal | Spring 2002 | Vol. 30 | No. 2 57 .com/faf/html/cust/jm-articles.html>. merely overlap and secure the same 25. It is unclear how much weight the Mr. Murray’s articles do not fully obligation. In Florida, which suffers Department placed on this last fact. explore any accounting issues—issues from similar tax burdens (and has the Would a non-headquarters project create that collectively exceed in magnitude benefit of a statute to much the same a distinguishable set of facts entitled to and scope all the issues that Mr. Murray effect as the Synthetic Lease Advisory less favorable treatment? What if some does cover in his articles. See also articles Opinion), attorneys who close synthetic future User were less image-conscious by Evelyn D. Giaccio, Kim N.A. Boras lease transactions commonly ask the than this one? and Robert S. Bozarth in 456 Practising User to join in the Participants’ Mort- 26. State advisory opinions and City letter L. Inst.: Com. Real Est. Fin. 947–1079 gage, simply to bolster the argument rulings benefit only the taxpayer that (May 2000). that it secures the same indebtedness as requested them. Moreover, a future 10. An Advisory Opinion may not be relied the Deemed Mortgage. (The preceding transaction may be structured different- upon except by its addressees. See note was reported to the author by John Mur- ly, use words differently, and be distin- 26. ray, author of the Web site cited in note guishable in other ways from the trans- 9.) The User cannot, however, guaranty 11. See, e.g., Joshua Stein, A Simple Proposal action described in the Synthetic Lease the loan that the Participants’ Mortgage Advisory Opinion and the City Letter to Simplify New York’s Mortgage Recording secures. Tax, N.Y. Real Prop. L.J., vol. 25, no. 1, at Ruling. Those two documents therefore 26 (Winter, 1997); New York Mortgage 16. Synthetic Lease Advisory Opinion at 22. amount to helpful guidance but not See In re U-Need-a-Roll Off Recording Tax on Revolving Loans: The 17. Id. When the User exercises the purchase definitive law. Corp. Problem and a New Solution for Multistate option and takes title to the real estate, , TSB-H-84(16)S, N.Y. State Tax Rep. see also Transactions, NYSBA Real Prop. L. Sec- can the Participants’ Mortgage be (CCH) ¶ 251-000 (Jan. 20, 1984); tion Newsl., vol. 22, no. 1, at 13 (Winter assigned to a new lender to be “consoli- N.Y. Tax Law § 171, pt. “Twenty-fourth” 1994). dated” and “restated” to save future (McKinney 2001–2002 Interim Pocket Part). 12. The Synthetic Lease Advisory Opinion mortgage recording tax? The Synthetic Lease Advisory Opinion does not does not directly state this result because Joshua Stein, a real estate of certain unusual elements of the trans- answer that question. Presumably, action. Anyone structuring a synthetic instead of simply exercising the option, partner in the New York office of lease transaction should, however, and perpetrating a deemed “satisfac- Latham & Watkins and a member expect that a transfer tax will be due on tion” of the deemed mortgage, the User of the American College of Real will be able to figure out some way to the SPE’s acquisition of the real property Estate Lawyers, will be Secretary of from a third-party seller, unless that con- preserve and re-use the tax-paid Partici- veyance independently qualifies for pants’ Mortgage. the Real Property Law Section for some transfer tax exemption. 18. Synthetic Lease Advisory Opinion at the year starting June 1, 2002. This 13. Synthetic Lease Advisory Opinion at 3–4. article is an extract from his upcom- 21–22, 25. 19. In the post-Enron financial world, such ing book entitled New York Com- 14. The word “supplemental” triggers par- statements may be much less likely to be mercial Mortgage Transactions, tial or complete exemption from the made. which Aspen Law & Business will mortgage recording tax under N.Y. Tax 20. Synthetic Lease Advisory Opinion at 6. publish in July 2002. Other articles Law § 255 (McKinney 1999). 21. Id. at 7–8. by the author are available at 15. Synthetic Lease Advisory Opinion at 22. Id. at 5–6. www.real-estate-law.com. 26–28. In other words, the Participants’ Mortgage and the Deemed Mortgage 23. Id. at 8–9. Copyright © 2002 Joshua Stein. 24. Id. at 3, 9–12.

58 NYSBA N.Y. Real Property Law Journal | Spring 2002 | Vol. 30 | No. 2 Federal Preemption of Real Estate Lending Activities of OTS Regulated Lenders By John G. Hall

For a large part, the law of real (b) National Banks are regulated by legislation in that field. Implied pre- estate lending is the statutory and the National Bank Act, 12 U.S.C. emption occurs when a body of fed- case law of the state in which the section 21 et seq. eral law in a particular field or area real property is situated or where the is so pervasive that it leaves no loan is originated. Nevertheless, II. The Federal Regulatory doubt that Congress intended to pre- when the lender is a federally char- Structure empt state law (even though Con- tered institution such as a national Pursuant to the federal statutory gress has not specifically stated such bank, federal savings bank or federal scheme, the Office of Thrift Supervi- in the statute). savings association, state law is fre- sion (OTS—formerly the Federal Unfortunately, in actual practice, quently overridden and preempted Home Loan Bank Board), has enact- implied preemption seldom occurs by federal statutes or regulations. ed regulations impacting real estate in totally clear-cut circumstances. In The area is a complex area of the law lending. addition, Congress seldom articu- with many pitfalls. The purpose of lates a specific intent to totally pre- this article will be to familiarize the The Office of Thrift Supervision empt an entire field. In other cases real estate attorney with areas that regulates federal savings banks and Congress sometimes enacts in legis- have been the subject of some con- federal savings associations. Its regu- lation a savings clause permitting cern. lations are set forth in 12 CFR Part 500 et seq. It has a number of specific concomitant state regulations. I. Basic Constitutional and regulations that deal with preemp- The United States Supreme Statutory Provisions tion, such as: Court in Pennsylvania v. Nelson,1 Article VI, Section 2 of the Unit- 1. 12 CFR Part 560—Dealing with enunciated a three-prong test to ed States Constitution (the Suprema- Lending and Investment ascertain implied preemption param- cy Clause) provides: eters: 2. 12 CFR Part 590—Dealing with Clause 2. Supreme Law of Preemption of State Usury Laws 1. Pervasiveness of the federal reg- Land ulatory scheme. 3. 12 CFR Part 591—Dealing with This Constitution, and the Preemption of State Laws pro- 2. Federal occupation of the field Laws of the United States hibiting Due on Sale Laws as necessitated by the need for which shall be made in Pur- national uniformity. suance thereof; and all III. The Doctrine of 3. Danger of conflict between state Treaties made, or which shall Preemption laws and the administration of be made, under the Authori- When Congress enacts legisla- the federal program. ty of the United States, shall tion or a federal agency issues regu- be the supreme Law of the lations pursuant to congressional In areas where state law has not Land; and the Judges in enabling legislation, conflicting state been preempted, federal courts will every State shall be bound legislation may be challenged via the apply state law. thereby, any thing in the Preemption Doctrine. The doctrine Constitution or Laws of any The Director of the Office of establishes the rule that federal law State to the Contrary Thrift Supervision is authorized by overrides any inconsistent state law notwithstanding. federal statute to provide for the or regulation where there is an actual organization, incorporation, exami- In the area of real estate lending, conflict between the two sets of leg- nation, operation and regulation of the statutory scheme is embraced in islation such that both cannot associations (including federal sav- two acts. stand—e.g., where federal law pro- ings banks and federal savings asso- hibits an act which state law ciations) “under such regulations as (a) Federal Thrifts (Federal Savings requires. Preemption can be either the Director may provide. . . . “2 Pur- Associations and Federal Sav- express or implied. Express preemp- suant to such statutory authority ings Banks) are regulated by the tion occurs when a federal statute regulations were enacted by the Homeowners Loan Act, 12 specifically prohibits parallel state Director of the Office of Thrift Super- U.S.C. section 1462 et seq.

NYSBA N.Y. Real Property Law Journal | Spring 2002 | Vol. 30 | No. 2 59 vision, which provide in 12 CFR sec- section, “state law” includes (e.g., New Jersey Licensed Lender tion 560.2(a) and (c) as follows: any state statute, regulation, Act which provides that the doctrine ruling, order or judicial deci- of preemption applies to federal Section 560.2 Applicability of sion. institutions but would not apply to Law. * * * their operating subsidiaries) the (a) Occupation of field. Pur- Office of Thrift Supervision has (c) State laws that are not suant to sections 4(a) and taken the position that state laws preempted. State laws of the 5(a) of the HOLA, 12 U.S.C. that purport to regulate the activities following types are not pre- § 1463(a), 1464(a), OTS is of federal savings associations oper- empted to the extent that authorized to promulgate ating subsidiaries are preempted by they only incidentally affect regulations that preempt federal law to the same extent that the lending operations of state laws affecting the oper- federal law preempts the state law Federal savings associations ations of federal savings application to a federal savings asso- or are otherwise consistent associations when deemed ciation itself.4 The preemption appar- with the purposes of para- appropriate to facilitate the ently would not apply to service cor- graph (a) of this section: safe and sound operation of porations as opposed to operation federal savings associations, (1) Contract and commercial corporations.5 to enable federal savings law; associations to conduct their V. Specific Applications of the (2) Real property law; operations in accordance Doctrine of Preemption with the best practices of (3) Homestead laws speci- A. Prepayment Charges thrift institutions in the Unit- fied in 12 U.S.C. § 1462a(f); 6 ed States, or to further other Under New York law, prepay- purposes of the HOLA. To (4) Tort law; ment must be permitted if the prem- ises consist of a one- to six-family enhance safety and sound- (5) Criminal law; and ness and to enable federal residence and the interest rate is over savings associations to con- (6) Any other law that OTS, 6%. If prepayment is made after one duct their operations in upon review, finds: year it must be permitted without accordance with best prac- penalty. If prepaid within one year (i) Furthers a vital state tices (by efficiently deliver- such a prepayment penalty as is set interest; and (ii) either has ing low-cost credit to the forth in the loan contract may be col- only an incidental effect on public free from undue regu- lected. lending operations or is not latory duplication and bur- otherwise contrary to the Federal regulations applying to den), OTS hereby occupies the purposes expressed in para- federal thrifts state: entire field of lending regula- graph (a) of this section. tion for federal savings associa- Any prepayment on a real tions. [emphasis added] OTS It thus appears that the Director estate loan must be applied intends to give federal sav- of the Office of Thrift Supervision directly to reduce the princi- ings associations maximum clearly intended to exempt federal pal balance on the loan flexibility to exercise their savings associations from the appli- unless the loan contract or lending powers in accor- cability of state law for many real the borrower specifies other- dance with a uniform federal estate lending issues, such as pre- wise. Subject to the terms of scheme of regulation. payment or late charges. the loan contract, a Federal Accordingly, federal savings savings association may associations may extend As to the issue of whether or not impose a fee for any prepay- credit as authorized under OTS regulations could preempt state ment of a loan.7 federal law, including this statutes, the United States Supreme Court has held that they can.3 Turning to the Preemption Doc- part, without regard to state trine, the issue is whether in impos- laws purporting to regulate IV. Applicability of the ing a prepayment charge in its loan or otherwise affect their Doctrine of Preemption documents a federal association credit activities, except to the to Wholly Owned must comply with state law or may extent provided in para- go beyond state law. If the associa- graph (c) of this section or § Subsidiaries of Federal Lenders tion in its written contract complies 560.110 of this part [dealing with the state law, state law would with usury (explanation Although some states have not be in conflict with its federal reg- added)] For purposes of this attempted to take a different posture ulation. It would, however, limit the

60 NYSBA N.Y. Real Property Law Journal | Spring 2002 | Vol. 30 | No. 2 amount of prepayment which could ment of same, or a note rep- loan contract a provision be charged by a federal association. resenting a loan for the pur- authorizing the imposition In the one federal case which pose of financing the pur- of a late charge with respect addressed the issue,8 the Ninth Cir- chase of an ownership to the payment of any delin- cuit Court of Appeals affirmed the interest in, a proprietary quent periodic payment. lower court’s decision and held that lease from, a corporation or With respect to any loan “federal law preempts the field of partnership formed for the made after July 31, 1976, on prepayment of real estate loans to purpose of the cooperative the security of a home occu- federally chartered savings and loan ownership of residential real pied or to be occupied by the associations.” There, plaintiffs estate, contains a provision borrower, no late charge, brought suit against federally char- whereby the mortgagee or regardless of form, shall be tered banks in California and sought lender retains the right to assessed or collected by a a declaratory judgment that the collect a late charge on any Federal savings association, bank’s prepayment penalty was void installment which has unless any billing, coupon or as it was inconsistent with the Cali- become due and remains notice the Federal savings fornia state statute. The court held unpaid, such charge on any association may provide the prepayment penalty valid and such delinquent installment, regarding installment pay- stated that any state law in the area regardless of the period it ments due on the loan dis- is inapplicable to federal savings and remains in default, shall not closes the date after which loan associations operating within exceed and shall only be the charge may be assessed. the state. This premise has been con- enforced to the extent of two A Federal savings associa- firmed by the Office of Thrift Super- percent of such delinquent tion may not impose a late vision, which monitors federally installment; provided, how- charge more than one time chartered banks, in its opinion dated ever, that no charge shall be for late payment of the same July 13, 1993. The opinion states imposed on any installment installment, and any install- “that the exercise of the office’s paid within fifteen days after ment payment made by the authority is preemptive of any state the due date. No such late borrower shall be applied to law purporting to address the sub- charge shall be deducted the longest outstanding ject of the operations of a Federal from any regular installment installment due. A Federal savings association.” Thus, a federal- payment by the mortgagor savings association shall not ly chartered savings association, is or borrower, but shall be assess a late charge as to any exempt from General Obligations separately charged and col- payment received by it with- Law § 5-501 by 12 CFR § 560.34, lected by the mortgagee or in fifteen days after the due which allows the bank to impose a lender. In the absence of a date of such payment. No prepayment penalty charge. specific provision in a bond, form of such late charge per- note or mortgage no late mitted by this paragraph It thus appears that both the charge on any delinquent shall be considered as inter- court and the Office of Thrift Super- installment shall be assessed est to the Federal savings vision as stated in its letter of July or collected. The term association and the Federal 13, 1993, clearly feel that the area of “installment” shall include savings association shall not prepayment penalties has been com- amounts representing inter- deduct late charges from the pletely preempted by the federal reg- est, amortization of principal regular periodic installment ulation. and payments in respect of payments on the loan, but B. Late Charges insurance premiums, taxes must collect them as such and utility charges if the from the borrower. Section 254-b(1) of the Real Prop- bond, note or mortgage pro- Although the section provides erty Law of the State of New York vides for collection thereof no specific limit on late charges, the limits the amount of late charges. by the mortgagee. That statute provides: Office of Thrift Supervision has Late charges may be imposed by taken the position that a late charge If a bond or note, or the a federally chartered thrift in accor- cannot exceed 5% of the amount of mortgage on real property, dance with 12 CFR section 560.33, an overdue payment. heretofore or hereafter made, which provides: improved by a one to six Again, considering the Preemp- family residence occupied by A Federal savings associa- tion Doctrine9 is not necessarily in the owner, securing the pay- tion may include in a home conflict with section 254(b) of the

NYSBA N.Y. Real Property Law Journal | Spring 2002 | Vol. 30 | No. 2 61 New York Real Property Law but exercise of a due on sale clause by a statements disclosing specified could be harmonized with it—i.e., a federal thrift, despite a California information about the status of late charge could be charged but statute prohibiting it.11 The courts of the escrow account. only insofar as it complied with New New York have upheld the validity A similar determination had York law, i.e. at 2% and not 5%. of a due on sale clause where there been previously made in First Federal However, if the federal government was not a resulting prepayment Savings and Loan Association v. Green- intended to completely occupy the charge.12 The decision held that there wald13 in regards to a Massachusetts field section, section 254(b)(1) of the was not a conflict with Real Property statute. New York Real Property Law would Law section 254(a), which recognizes be preempted. the validity of a due on transfer but F. New York Real Property Law prohibits the levying of a prepay- No cases have been found deal- Section 274(a) and Payoff ment charge when the due on sale ing with the preemption issue inso- Statement Fax Charges transfer provision is implemented. far as it relates to late charges. Nev- Section 274(a) of the New York ertheless the Director of the Office of Indeed, the decision parallels the Real Property Law requires that Thrift Supervision as stated earlier present OTS regulation, which pro- under designated circumstances, the appears to have totally preempted vides in 12 CFR section 591.5(b)(2) mortgagee of certain residential real the area. that “a lender shall not impose a pre- property deliver within 30 days payment penalty or equivalent fee “mortgage-related” documents C. Lender’s Obligation to Pay when the lender or party acting on defined to include a loan payoff 1/4% of Mortgage Tax behalf of the lender (i) declares by statement. Section 274(a)(2) also pro- Section 253(1)(a) of the Tax Law written notice that the loan is due hibits the mortgagee from charging imposes an additional 1/4% mort- pursuant to a due on sale clause. borrowers for the mortgage-related gage tax to be paid by the mortgagee . . .” documents pursuant to an initial where the property consists of a one- request, but a mortgagee “may to six-family structure with separate E. Escrow Accounts for Real charge not more than twenty dollars cooking facilities for each unit and Estate Taxes, Etc. or such amount as may be fixed by the mortgagee is not a natural per- The New York State Legislature the banking board, for each subse- son. The statute also provides that in 1989 enacted title 3-A of the Real quent payoff statement provided.” this tax may not be passed through Property Tax Law (sections 953 to Although on its face, the statute to the borrower. 959), regulating tax escrow accounts. is not entirely clear that it would bar The law is applicable to “mortgage In Dime Savings Bank F.S.B. v. charging for the service of faxing a investing institutions” which by defi- State of New York,10 the Appellate payoff statement to the borrower, the nition include federal savings banks Division, Second Department in a Appellate Division, Second Depart- and federal savings and loan associa- 3–2 decision held that the anti-pass- ment held in Negrin v. Norwest Mort- tions (these are now known as “fed- through provision was preempted by gage, Inc.14 that a claim for charging eral savings associations,” although federal regulations. A federally char- for a payoff statement did state a the New York statute has not been tered lender could therefore pass- cause of action. amended). Although this area is a through the 1/4% to the borrower. fairly clear cut area of preemption, it When an inquiry was made as to Dime’s victory, however, was is clear that the New York Legisla- whether this statute would be appli- somewhat a pyrrhic victory. ture is trying to thwart preemption cable to a federally chartered institu- Although Dime won the right to in this area. tion, The Office of Thrift Supervision pass the tax along to the borrower, in a letter of its Chief Counsel, Car- In its opinion letter of January 3, competitively it could not do so olyn J. Buck, dated April 21, 2000 1991, the OTS held that New York because its borrowers would end up stated in part: Real Property Tax Law sections 953 paying a 1/4% more in closing costs et seq. were clearly preempted inso- OTS regulations are clear than they would at another lender far as they that federal law preempts which could not avail itself of pre- state laws that restrict loan emption. 1. Required the payment of interest related fees. Section on mortgage escrow accounts. D. Prohibition of Due on Sale 560.2(b)(5) expressly pro- Clauses 2. Prohibited the charging of fees vides that state laws pur- on escrow accounts. porting to impose require- The United States Supreme ments regarding loan related Court upheld the validity of the 3. Required that the lender provide fees are preempted . . . [a] to the borrower periodic written

62 NYSBA N.Y. Real Property Law Journal | Spring 2002 | Vol. 30 | No. 2 charge for faxing loan payoff VI. How Far Can the rate loan terms) as portions of the statements at the borrower’s Preemption Envelope regulations applicable to non-feder- request, is a loan related fee Be Pushed? ally chartered lenders. . . . therefore under Section As a result both in Virginia and 560.2(b)(5) [of 12 CFR], to the Recent litigation in other states New Jersey attacks on state prepay- extent Section 274(a)(2) has begun to push the preemption ment statutes were upheld and non- would prohibit [the lender] doctrine to new limits. In 1982 the federally chartered lenders were per- from charging a borrower Alternative Mortgage Transactions mitted to impose prepayment for faxing a loan payoff Parity Act, 12 U.S.C. section 380, et charges on adjustable rate loans statement requested by the seq., was enacted to extend the rights despite state statutes to the con- borrower, Section 274(a)(2) of non-federally chartered housing 16 does not apply. . . . creditors (such as mortgage compa- trary. In Black v. Financial Freedom nies) to make alternative mortgage Senior Funding Corp.,17 an action was Parenthetically it should be loans provided they were in accord brought against a mortgage lender noted that the statute by its terms in with federal regulations. asserting that a reverse mortgage defining “Banking Organization” violated various California laws states that it shall include any insti- The Office of Thrift Supervision against elder abuse, unlawful busi- tution chartered or licensed by the in response to the statute then enact- ness practices, fraudulent conceal- United States. This obviously would ed regulation 12 CFR section 560.220, ment and negligent misrepresenta- be of no effect if the statute is pre- which provides as follows: tion. The non-federally chartered empted. Section 560.220 Alternative lender defended, claiming that the Mortgage Parity Act. Parity Act preempted the plaintiff’s G. Preemption of State Usury claims. The appellate court held that Statutes Pursuant to 12 U.S.C. 3803, preemption was inapplicable since it Although General Obligations housing creditors that are only applied to specifically preempt- Law section 5-501 and Banking Law not commercial banks, credit ed laws such as those mentioned in section 14-a set the maximum rate of unions, or Federal savings section 560.220 of the regulations interest in New York at 16%, federal associations may make alter- (late charges, prepayment charges, law exempts certain lenders from native mortgage transactions adjustable rate loan terms). It further this limit. Pursuant to 12 U.S.C. sec- as defined by that section held that the California statutes tion 1735(f)(1)–(5) and (7), qualified and further defined and involved were not in conflict with creditors are exempt from the New described by applicable reg- other federal laws. York usury law. Qualified creditors ulations identified in this None of these decisions would include: section, notwithstanding any state constitution, law, or be applicable in New York because 1. a party which is insured by a regulation. In accordance New York opted out of the Alterna- federal agency. with section 807(b) of Public tive Mortgage Transactions Parity Law 97-320, 12 U.S.C. § 3801 Act.18 Nevertheless, the New York 2. a party which is regulated by a note, §§ 560.33, 560.34, attorney may deal with an out-of- federal agency. 560.35 and 560.210 of this state mortgage company (either 3. a party which makes or invests part are identified as appro- licensed or unlicensed in New York) in residential real estate loans priate and applicable to the which wrongfully attempts to apply aggregating more than $1 mil- exercise of this authority and the doctrine of preemption in these lion a year and is a regular all regulations not so identi- areas. extender of consumer credit fied are deemed inappropri- which is payable by agreement ate and inapplicable. Hous- VII. Additional Preemption in more than four installments ing creditors engaged in Issues in Other States or for which the payment of a credit sales should read the A. Pass-Through of Lender’s finance charge is or may be term “loan” as “credit sale” Legal Fees to Borrower required.15 wherever applicable. New Jersey, by statute,19 sought OTS has enacted regulations It identified section 560.33 (late to regulate the amount of legal fees dealing with the preemption of state charges); section 560.34 (prepayment that a lender could pass on to a bor- usury laws in 12 CFR Part 590. charges) and sections 560.35 and rower. The Supreme Court of New 560.210 (both dealing with adjustable Jersey held that where a lender was

NYSBA N.Y. Real Property Law Journal | Spring 2002 | Vol. 30 | No. 2 63 a federally chartered institution the 3. Fidelity Federal S&L v. de la Cuesta, Z., 458 17. 92 Cal. App. 4th 917, 112 Cal. Rptr. 2d state statute was preempted and the U.S. 141, 151 (1982). 445 (2001). fees could be passed along.20 4. See OTS Chief Counsel Opinion dated 18. See 12 U.S.C. § 3804(a); N.Y. Banking August 19, 1997. Law § 6-a. B. Licensing of Title Agent 5. See Spitz v. Goldome Realty Credit Corp., 19. N.J.S.A. 46:10A-6. aff’d Subsidiary of National Bank 569 N.E.2d 43, , 600 N.E.2d 1185 20. Turner v. First Union Nat’l Bank, 162 N.J. (1992). Title agents must be licensed in 75, 740 A.2d 1081 (1999). 6. General Obligations Law § 5-501(3). New Jersey. N.J.S.A. 17:46B-30.1 21. Valley National Bank v. La Vecchia, 59 F. 7. 12 CFR § 560.34. Supp. 2d 432 (Dist. N.J. 1999). specifically prohibits a bank, trust company or other lending institution 8. Meyers v. Beverly Hills Federal Savings & Loan Ass’n, 499 F.2d 1145 (1974). John G. Hall is a Partner in the from being licensed to sell title insur- 9. 12 CFR § 560.33. Staten Island law firm of Hall and ance or otherwise act as agent for the Hall. He is a Past Chair of the Real 10. 174 A.D.2d 173 (2d Dep’t 1992). sale of title insurance. Property Law Section. 11. Fidelity Federal v. de la Cuesta, supra, note The United States District Court 3. This article has been reprinted for New Jersey held that in the case 12. First Federal Savings & Loan Ass’n of of a national bank which is regulated Rochester v. Jenkins, 109 Misc. 2d 715 with permission from the Real Estate by the Office of the Comptroller of (1981). Finance Journal. It has been updated the Currency and not by the OTS, 13. 591 F.2d 417 (1st Cir. 1979). since its original publication. that the statute was preempted by 14. 263 A.D.2d 39 (2d Dep’t), 700 N.Y.S.2d Copyright 2002 West Group. section 92 of the National Bank Act.21 184 (1999). Originally published in Real Estate 15. 15 U.S.C. § 1602(F)(1); 12 U.S.C. § Finance Journal, Winter 2002, vol. 17, 5(b)(2)(D). Endnotes no. 3, and reprinted with permission 16. National Home Equity Mortgage Ass’n v. of West Group. It has been updated 1. 350 U.S. 497 (1956). Face, 64 F. Supp. 2d 584 (E.D. Va. 1999), since its original publication. 2. 12 U.S.C. § 1464(a). aff’d, 239 F.3d 633 (4th Cir.); Shinn v. Encore Mortgage Servs., 96 F. Supp. 2d 419.

SAVE THE DATES July 11th – 14th, 2002 Real Property Law Section SSuummmmeerr MMeeeettiinngg 22000022 Hyatt Regency Newport, Rhode Island

64 NYSBA N.Y. Real Property Law Journal | Spring 2002 | Vol. 30 | No. 2 Housing Cooperatives: Ownership by Trusts A Retrospective and a Forecast By Anita Rosenbloom and Richard Siegler

Seven years ago, we co-authored age, state of health, available gift tax tion-skipping tax rates are reduced an article discussing trust ownership exemption, anticipated estate tax from 55 percent to 50 percent. There- of cooperative and condominium exemption, projected taxable estate, after, the marginal estate, gift and apartments.1 We noted then an cost basis in the apartment, the value generation-skipping tax rates decline increase in the number of requests of the apartment and a consideration only an additional 5 percent during that co-op housing corporations of the client’s comfort level in part- the period from 2002 to 2009 before were receiving for permission to ing with ownership. It also may repeal of the estate and generation- transfer co-op apartments to trusts. depend upon his estate planning skipping taxes in 2010. The gift tax The increase was attributable in large counsel’s ability to predict the continues to apply in 2010 and there- part to the issuance in 1992 of final future—whether or not there ulti- after at a 35 percent rate. Further- Treasury Regulations blessing quali- mately will be a permanent repeal of more, the estate tax exemption does fied personal residence trusts the federal estate tax and a substitu- not increase to $1,500,000 until 2004, (QPRTs). The trend has continued tion of a modified carryover basis $2,000,000 until 2006 and jump to and we believe that it is likely to regime with respect to assets inherit- $3,500,000 until 2009, before repeal of continue, despite passage of the Eco- ed from a decedent. the tax in 2010. Repeal is not ever- nomic Growth and Tax Relief Recon- lasting. Repeal under EGTRRA ciliation Act of 2001 (EGTRRA). This would apply only for decedents article is intended to update the 1994 “Although taken as a dying during 2010. After that, the article to take account of new devel- whole, the pending “sunset” provisions of the 2001 Act opments and our experiences since changes under EGTRRA resurrect the estate, gift and genera- then in dealing with trust transfers tion-skipping taxes as they existed of co-op apartments. Condominium are very substantial, the before the 2001 Act was enacted. transfers to trusts are beyond the increase in the estate and Commencing on January 1, 2002, the scope of this article and should be generation-skipping tax gift tax exemption increases to dealt with separately. exemptions and drop in $1,000,000 but remains frozen at that level indefinitely. There remain two types of trusts the marginal estate, gift into which most transfers are pro- and generation-skipping The slow phase-in of the increase posed: the QPRT and the grantor in the estate and generation-skipping trust (also commonly referred to as a tax rates are phased in tax exemptions, uncertainty regard- “revocable trust” or a “living trust”). very gradually.” ing the ultimate repeal of the estate In the case of the grantor trust, and generation-skipping taxes and EGTRRA should have absolutely no continuation of the gift tax with the impact on the popularity of these Assessing the Impact of the exemption fixed at $1,000,000 make trusts, because these trusts are not Economic Growth and Tax it likely that older and very high net- designed to achieve any estate or gift Relief Reconciliation Act of worth individuals will continue to tax savings. Typically, they are find the QPRT an attractive vehicle 2001 includible in the grantor’s gross for leveraging the use of their estate for estate tax purposes.2 In Although taken as a whole, the $1,000,000 gift tax exemption contrast, as discussed below, the pending changes under EGTRRA are through its discount features. Indi- QPRT is a creature of the Internal very substantial, the increase in the viduals with more modest estates Revenue Code and generally the sole estate and generation-skipping tax may rethink the merits of putting reason for establishing it is to attain exemptions and drop in the marginal their apartment into a QPRT. A sin- gift and estate tax savings. Whether estate, gift and generation-skipping gle person who has a life expectancy it makes sense for an individual tax rates are phased in very gradual- beyond 2009 and projects a taxable client to transfer his co-op apartment ly. No changes occur until January 1, estate below $3,500,000 may have lit- to a QPRT in light of EGTRRA will 2002, when the estate and gift tax tle incentive to transfer his co-op to a depend upon an analysis of tradi- exemptions increase to $1,000,000, QPRT. A married couple can leave tional factors such as the person’s and the top estate, gift and genera- $7,000,000 to their heirs, free of estate

NYSBA N.Y. Real Property Law Journal | Spring 2002 | Vol. 30 | No. 2 65 tax under EGTRRA through proper value of the residence on the date of the gain.) Of course, the potential coordination of their wills and split the gift (increased by any gift tax capital gain may not be of great con- ownership of their assets, assuming paid on any unrealized apprecia- cern if it is anticipated that the that they both survive to 2009. If the tion).3 As a result, the built in gain is remainderman of the QPRT will con- couple’s combined assets are below passed along to the remainderman.4 tinue to own the residence for a the $7,000,000 threshold, they may lengthy period of time so that recog- pass on the QPRT. Yet another cou- Under EGTRRA, in tandem with nition of the gain is delayed, or that ple with comparable assets may be the estate tax repeal in 2010, the step- the remainderman will convert the inclined to transfer their co-op to a up in the basis of a decedent’s assets residence to his principal residence QPRT out of concern that their assets will be limited to the first $1,300,000 (with the consent of the co-op) and could appreciate beyond $7,000,000, of assets passing to anyone and an hold it for the requisite period to or that either might die prematurely additional $3,000,000 of assets pass- qualify for the $250,000 exclusion of or a feeling of uncertainty about the ing to the decedent’s surviving gain ($500,000 in the case of a mar- full phase-in of the estate tax exemp- spouse. The permitted basis increase ried couple) in his own right. For tion. would be allocated by the executor those individuals who reasonably on an asset-by-asset basis. The basis can expect to live until 2010 and of all assets acquired from a dece- have some level of confidence that dent exceeding the $1,300,000 and the estate tax will be repealed and “There is much speculation $3,000,000 figures will be equal to replaced by a modified carryover as to whether these the lesser of the decedent’s adjusted basis regime (which basically con- basis, or the fair market value of the onerous and complex verts the estate tax to an income tax assets at the decedent’s death. when the residence is sold), they will carryover basis rules will Although not technically part of the need to compare the potential gift ever become effective.” new carryover basis regime, EGTR- and estate tax savings produced by RA revises section 121 of the Internal the QPRT with the capital gain Revenue Code to allow the $250,000 which will be realized by the remain- exclusion of gain on the sale of a derman. The remainderman will not In each case, the potential gift principal residence to be claimed by be able to take advantage of the and estate tax savings that may be the decedent’s estate or $250,000 exclusion of gain which produced by the QPRT must be 5 beneficiaries. There is much specu- would be available if the residence is weighed against the loss of the step- lation as to whether these onerous the grantor’s personal residence and up in basis that would occur for a and complex carryover basis rules the grantor dies owning it after 2010. testamentary transfer occurring in will ever become effective. Similarly, there will be no opportuni- the next eight years. Of course, ty for the grantor’s executor to make where an individual has a relatively For individuals considering the basis allocation (up to $1,300,000 high cost basis in the residence, this transferring a residence with a low if the residence passes to anyone, will not be a factor. But for those cost basis to a QPRT, these with an additional $3,000,000 if it individuals with a low cost basis, the meandering and uncertain rules passes to the surviving spouse) that loss of the step-up should be careful- regarding basis should be consid- would be available if the grantor ly considered. Under current law, ered. Regrettably, this somewhat dis- dies after 2010 owning the residence, subject to certain limited exceptions, tasteful exercise forces the person to whether or not it is his principal resi- assets inherited from a decedent gen- contemplate their life expectancy, dence. erally receive a “stepped-up” basis since the rules that will apply will be equal to the fair market value of the dependent upon the year of death. Despite the complexity and assets on the date of the decedent’s An older client who is considering a uncertainty created by EGTRRA, it is death (or six month anniversary of short-term QPRT and has a life likely that very high net-worth indi- death if an alternate valuation date is expectancy of eight years or less, viduals still will perceive benefits in elected). This step-up in basis wipes must weigh the trade-off between transferring personal residences to out the taxable gain on any apprecia- the income tax on the capital gain QPRTs. Individuals with more mod- tion in the value of the residence that that will be incurred by the remain- est estates may be less inclined to do occurred prior to the decedent’s derman of the QPRT upon the sale of so. It therefore can be expected that death. In contrast, when an individ- the residence with the potential gift cooperative corporations will contin- ual gifts a residence to a QPRT, the and estate tax savings. (If the indi- ue to receive such requests from remainderman receives a carryover vidual refrains from transferring the their wealthier shareholders. Fur- basis equal to the lesser of the residence to the QPRT and dies thermore, the number of requests for donor’s basis or the fair market before 2010 owning the residence, transfers to grantor trusts should be the step-up in basis would wipeout undiminished.

66 NYSBA N.Y. Real Property Law Journal | Spring 2002 | Vol. 30 | No. 2 From time to time, cooperative cannot be emphasized enough that the residence for a fixed term, for corporations also may receive each trust instrument—and this example five years. The QPRT pro- requests for transfers of apartments means the entire instrument, not just vides that upon the expiration of the to a testamentary trust under the excerpts—must be reviewed by an term, the residence is to pass to des- will of a deceased shareholder (typi- attorney well-versed in trust issues. ignated beneficiaries or a follow-on cally to fund a credit by-pass trust) After review of the trust instrument, trust for such beneficiaries. The cre- or a request for a transfer to (or a counsel should advise the board of ation of the QPRT is a completed gift purchase by) an existing trust estab- the basic terms of the trust and any to the beneficiaries, but only in the lished by a third party other than the problematic provisions and should amount of the current actuarial value intended resident. It is likely that recommend documentation which of the remainder interest, which these types of requests also will con- may alleviate board concerns. Coun- passes to the designated beneficiar- tinue. Indeed, it is possible that there sel should conclude whether there is ies upon the expiration of the term will be an increase in the number of any legal reason why the transfer to for which the grantor has reserved requests to transfer co-op apartments the trust should not be approved. the use of the residence. For exam- to credit shelter trusts under a Ultimately, the final decision is with- ple, if an individual 60 years of age deceased shareholder’s will, as the in the discretion of the board. transfers a residence worth federal estate tax exemption expands $1,000,000 to a QPRT in October of It should be made clear to the over the next eight years and a larger 2001, retaining the use of the proper- shareholder seeking the transfer that portion of the estate will pass into ty for 10 years, the amount of the the fees of the co-op’s counsel for these trusts. taxable gift would be approximately review of the trust documents and $484,000.9 If the term of the QPRT is Since it is likely that cooperative advice to the co-op, as well as other extended, the taxable gift is reduced. corporations will continue to receive fees in connection with the transfer, On the other hand, if the term is requests for transfers to trusts, we will be borne by the shareholder shortened, the taxable gift would be will now discuss the ramifications of seeking the transfer, regardless of increased.10 Note that for the QPRT these transfers from the perspective whether the transfer is approved. to achieve estate tax savings, the of the co-op, with a view towards Legal fees can vary dramatically grantor must survive the fixed term facilitating shareholder requests.6 depending on the complexity of the for which he or she retains the right trust instrument and the extent of to use the residence. If the grantor modifications needed. Shareholders Role of Counsel dies within the term of the QPRT, the should be made aware of this before entire QPRT (including the resi- For those co-ops which have not the fees are incurred. already confronted the issue of trust dence) would be includible in his or ownership of an apartment, ideally her taxable estate. QPRTs they should seek the advice of coun- A QPRT will be established sel in advance to formulate a general The QPRT is a potentially highly under a trust agreement which will policy to deal with such requests so effective estate planning device for be irrevocable (to accomplish its gift that they are prepared to address an individual who owns a valuable and estate tax objectives), although them when they are received. When residence. Final Treasury some QPRTs may grant the trustees a a co-op board receives a request for a Regulations8 setting out the require- limited power to amend the QPRT to transfer to a trust, it should seek the ments for this form of trust were comply with requirements of the tax advice of counsel in reviewing the issued in 1992. A QPRT is a form of law. The QPRT is a form of grantor particular request. Counsel for the trust which can be used to remove a retained income trust, commonly co-op should understand that the residence from an individual’s gross referred to in estate planning circles decision whether to permit a transfer estate while making a taxable gift by the acronym “GRIT.” Thus, some to a trust is a policy matter invari- valued below that of the present of the transmittal papers provided ably within the discretion of the co- market value of the residence. The by the shareholder making the op board. If a board is inclined to residence may be a fee interest in a request may refer to the trust as a accommodate a request for a transfer house, a condominium or a co-op “GRIT.” In almost all cases, however, to a trust, co-op counsel should apartment, but it must be a personal the trust agreement is likely to make attempt to ensure that the co-op is at residence of the grantor as defined in a reference to a “QPRT.” Although no greater financial or other risk the applicable Treasury Regulations. most of the requests that co-ops are with a trust as a shareholder than The QPRT plan generally works likely to receive will involve a QPRT, with a natural person. as follows: An individual transfers a not all GRITs are QPRTs. In certain The first step in the process is to personal residence into an irrevoca- limited circumstances, it is possible review the trust instrument itself.7 It ble QPRT, retaining the right to use that the request will be to a GRIT which is not in the QPRT format. It

NYSBA N.Y. Real Property Law Journal | Spring 2002 | Vol. 30 | No. 2 67 also should be noted that while a nance and assessment charges apartment from the new owners QPRT may be a “grantor trust” for due pursuant to the proprietary at a fair market rent to avoid income tax purposes for a certain peri- lease and insurance costs. The potentially adverse gift and od of time, depending upon how the fact that the residence is subject estate tax consequences. If a co- trust instrument is drafted, its provi- to a mortgage does not jeopard- op board is willing to consent to sions will be substantially different ize the trust’s status as a QPRT the transfer of an apartment into from the revocable form of grantor under the Treasury Regulations, a QPRT, it also must decide trusts discussed below. but may impact the size of the whether it is willing at the time initial taxable gift and have fur- of the initial application to also In order to achieve its estate ther gift tax implications when consent to the subsequent trans- planning objectives, each QPRT must mortgage payments are made, fer of the apartment to the be drafted to comply with the depending upon whether the grantor’s children (or other ben- requirements imposed by Treasury debt is recourse or non- eficiaries) at the expiration of the Regulations. These require certain recourse.11 Hence, in the case of fixed term. language to be incorporated in the all QPRTs, it is incumbent on a trust agreement. Some issues to be If a board is reluctant to pre- co-op board to seek a personal considered by a co-op board in approve the transfer to the chil- guaranty of the proprietary lease reviewing transfer requests are set dren (or other beneficiaries) as obligations by the grantor, as forth below. owners, it could limit its there will be nominal funding of approval to the initial transfer of 1. The grantor (i.e., the sharehold- the trust other than with the res- the apartment into the QPRT. er) will reserve the right to use idence itself. Exhibit B is a sug- However, this may not fully the apartment for a fixed term of gested form of guaranty. accommodate the grantor’s years. Although the QPRT trust 3. Upon the expiration of the fixed wishes. It is likely that the agreement may restrict occupan- term for which the grantor has grantor will wish to continue to cy to the grantor during the reserved the use of the apart- occupy the apartment at the term for which he or she has ment, the trust principal (includ- expiration of the fixed term by reserved the use of the apart- ing the apartment) will pass to entering into a lease or similar ment, co-op boards nevertheless designated beneficiaries such as arrangement with his or her should seek an occupancy agree- children, other family members children (or other beneficiaries) ment executed by the grantor or even non-family members. In who will then become the new individually and the trustees of some cases, the trust agreement owners. For these reasons, the the trust, confirming that the will provide that the apartment grantor may desire that the co- grantor and the grantor’s family passes outright to the children or op board pre-approve the trans- will be the sole occupants of the other beneficiaries; in other cases fer to his or her children (or apartment throughout the term it will provide that it passes into other beneficiaries) at the expira- of the trust. Exhibit A is a sam- a trust for the particular benefi- tion of the fixed term. Although ple form of occupancy agree- ciaries. For example, it may pass this is rarely done, it is entirely a ment. into a combined discretionary policy decision to be made by 2. The trust agreement must pre- trust for the grantor’s issue and the board. A compromise is to clude the trustees from holding name a non-family trustee (who allow occupancy by the grantor. assets other than the subject co- is not one of the grantor’s issue) It may be possible to permit op apartment and cash to meet as the trustee. Some grantors feel other occupancies without a six months’ expenses for the res- that this gives them more assur- change in ownership, such as idence. While the trust agree- ance that their children (or other permitting occupancy by the ment may permit the infusion of beneficiaries) will not sell the immediate family of the grantor, cash from time to time to cover apartment while they remain in who by virtue of the proprietary six months of expenses, general- residence and that the trustee lease provisions would also be ly there will be no requirement will enter into a lease which will entitled to occupy an apartment. that such moneys be added to permit the grantor to continue to Note that a board’s refusal to the trust. Although not manda- occupy the apartment after the pre-approve the transfer to the tory under the Treasury Regula- expiration of the fixed term. If grantor’s children (or other ben- tions, many QPRTs may impose the grantor wishes to continue to eficiaries) may only delay the upon the grantor the obligation occupy the apartment following issue since, if the grantor sur- to meet all expenses relating to the expiration of the fixed term, vives the term of the QPRT and the apartment, such as mainte- he or she will have to lease the the apartment is not sold during

68 NYSBA N.Y. Real Property Law Journal | Spring 2002 | Vol. 30 | No. 2 the term, the board will most should not present a problem to 6. It is advisable to obtain an opin- likely receive a request at the the co-op since it is no different ion from the grantor’s counsel, expiration of the term for than if the grantor owned the admitted to practice in the state approval of the transfer of the apartment individually at the the laws of which govern the apartment to the beneficiaries. In time of death and disposed of it trust, addressed to the co-op, to addition, the board can expect a under the terms of a will. All the effect that: (a) the copy of the request for permission of the such transfers following the trust agreement furnished to the grantor to sublease the apart- death of the shareholder would co-op is a true and correct copy; ment from the new owner, require board approval pursuant (b) there have been no amend- which raises additional policy to the proprietary lease. ments to the trust agreement; (c) considerations. the trust is a valid and existing 5. There will be extensive provi- trust under the law of the partic- If a co-op board is unwilling to sions in the trust agreement ular state cited in the trust agree- pre-approve the transfer to the which deal with the possibility ment; (d) the trustees named in grantor’s children (or other ben- that the trust could cease to be a the trust agreement are the cur- eficiaries), it is important that QPRT, within the meaning of the rent trustees of the trust; (e) the board obtain a written con- Treasury Regulations. In general these individuals, in their capac- firmation from the grantor and terms, this could happen if the ities as trustees, have full the trustees that the board is apartment ceases to be used or authority to execute the propri- only approving the initial trans- held for use by the grantor as a etary lease and assume all of the fer of the apartment into the personal residence, if the apart- obligations thereunder, and to trust and that all further trans- ment is sold and a new resi- execute the occupancy agree- fers by the trustees, including dence is not purchased within a ment and letter agreement those to the beneficiaries upon two-year period or the apart- described above; and (f) the obli- the expiration of the fixed term ment is destroyed and the pro- gations under the proprietary or the grantor’s prior death, ceeds of insurance are received lease which are being assumed must be approved by the board and not used to purchase or con- by the trustees will be binding at such time. It is also recom- struct a new apartment within upon any successor trustees. mended that this letter agree- two years after the date of ment contain a general confir- receipt of such proceeds. In such mation from the grantor and the events, the trust agreement must Grantor Trusts trustees that, in the event of a provide that, within 30 days A grantor trust is a revocable, conflict between the terms of the after the date on which the trust amendable trust created primarily trust agreement and the propri- has ceased to be a QPRT, either for the benefit of the etary lease, the co-op’s by-laws (a) the trust be terminated and shareholder/grantor during his or or certificate of incorporation or the assets (i.e., the apartment) be her lifetime. Often, assets other than the occupancy agreement, the distributed to the grantor, (b) the a co-op apartment will be transferred provisions of the proprietary trust be converted to a qualified to a grantor trust. Typically, the lease, by-laws, certificate of annuity trust pursuant to which income and principal of the trust incorporation and occupancy the grantor is entitled to receive may be freely used by the trustee for agreement shall prevail. A sam- a qualified annuity interest (as the grantor’s benefit during the ple letter agreement can be defined by the applicable Trea- grantor’s lifetime. The grantor trust found in Exhibit C. sury Regulations) or (c) the is often used as a will substitute, trustees be given the option of 4. As noted above, if the grantor providing for the disposition of the complying with either (a) or (b). does not survive the fixed term, trust assets upon the death of the These provisions will appear in the trust fails as an estate plan- grantor, but does not result in estate all QPRTs, as they are required ning device and the trust agree- or gift tax benefits. There is a percep- by Treasury Regulations. How- ment typically will provide that tion that the grantor trust permits ever, these provisions ought not all of the trust assets (including the avoidance of probate proceed- to be of any concern to a co-op the apartment) are to be distrib- ings, saves expenses and facilitates board because the events which uted upon the grantor’s death as property transfers. However, these trigger them, such as the sale of the grantor may appoint pur- benefits may not actually material- the apartment or the rental of 12 suant to a testamentary power of ize. At the least, the grantor trust the apartment so that it ceases to appointment, to the executors of may be used to administer assets be a personal residence of the the grantor’s estate or perhaps where the grantor becomes disabled grantor, would require board to designated beneficiaries. This or incapacitated. approval in the regular course.

NYSBA N.Y. Real Property Law Journal | Spring 2002 | Vol. 30 | No. 2 69 The concerns raised by the shareholders such as trusts to own notice of the existence of these provi- grantor trust and the QPRT are an apartment, a transferee in these sions. To alleviate the concerns somewhat different. For example, in situations should be reviewed like raised by the presence of a spend- the case of a QPRT, the grantor may any other transferee, including a thrift provision, it is recommended likely be alive at the termination of review for financial stability. The that either (1) the trust agreement be the trust, giving rise to issues of trust instrument should be reviewed amended in such a manner as to occupancy and control of the co-op for troublesome issues, such as confirm that the spendthrift provi- apartment. Further, virtually the spendthrift provisions, discussed sions shall be of no force or effect only asset in a QPRT will be the co- below. Documentation similar to that against the co-op, and that any claim op apartment, while a grantor trust recommend for QPRTs and grantor that it may have against the grantor, is usually funded with other assets. trusts should be obtained. individually, or in his or her capacity Despite these differences, the docu- as trustee, or against any other mentation recommended to alleviate Spendthrift Provisions trustee, including but not limited to the concerns raised by both the claims arising out of a default under QPRT and the grantor trust are simi- While each trust instrument the proprietary lease, may be assert- lar. In a transfer to a grantor trust, as must be examined for problematic ed against and satisfied out of the with any transfer of a co-op apart- provisions, one particular trust pro- trust assets; or (2) the attorney’s ment to a non-individual, the occu- vision co-op boards should be aware opinion letter referred to above pancy of the apartment should be of is a “spendthrift” provision which includes a confirmation of the same. controlled by an occupancy agree- purports to protect the assets of the An amendment to the trust agree- ment similar to that found in Exhibit trust from the creditors of the benefi- ment would appear to be preferable A. A personal guaranty by the ciary and/or grantor. If a spendthrift as it would afford the co-op the grantor, similar to that in Exhibit B, provision is valid in the jurisdiction greatest protection and should be is advisable as a secondary source of governing the trust, it might pre- obtainable in the case of an amend- funds for maintenance and other clude a co-op from seeking satisfac- able grantor trust. Exhibit D is a sug- charges should the trustees fail to tion of any claims that it may have gested form of amendment. While pay the same. It should be con- against the grantor of the trust (or amending a QPRT may be problem- firmed, by the execution of a letter any other beneficiary of the trust) atic, the spendthrift issue arises less agreement similar to Exhibit C by out of the trust assets, such as claims frequently in QPRTs. This is so the grantor of the trust, the trustees arising out of a personal guaranty of because the transfer of a co-op apart- thereof, and any known beneficiar- the proprietary lease obligations. ment will be the sole reason for the ies, that no further transfer of the Spendthrift provisions are most com- QPRT, and co-op approval will apartment from the trust, either dur- mon and most troublesome in the invariably be sought before the ing the grantor’s lifetime or after his case of grantor trusts, because it is QPRT is created. Thus, any spend- or her death will be permitted with- likely that the grantor will have thrift provision can be deleted or out board approval, even if the transferred substantially all, or at revised in the drafting stage. transfer is to a named beneficiary of least a significant portion, of his or her assets into the trust. However, in the trust. Finally, the attorney opin- Conclusion ion referred to above should also be many jurisdictions, including New obtained. York, a spendthrift provision in a There appears to be no legal rea- grantor trust would not be binding son for a co-op board to reject pro- against the grantor’s creditors.13 posed transfers to QPRTs, grantor Testamentary Trusts and Trusts trusts, testamentary trusts or third- Created by Third Parties Regardless of whether as a mat- party trusts, provided that the partic- ter of law a spendthrift provision is In addition to what have become ular trust instrument does not con- binding against the grantor’s credi- routine requests for transfers to tain problematic provisions, tors, a co-op board ought to be wary QPRTs and grantor trusts, from time appropriate collateral documentation of permitting the transfer of an to time a co-op may receive a request is obtained and the particular cir- apartment to a trust which recites on for a transfer to a trust created under cumstances surrounding the pro- its face that the shares and propri- the will of a deceased shareholder, posed transfer do not otherwise raise etary lease (as well as all other assets usually to fund a credit by-pass independent concerns. Indeed, we of the shareholder placed in the trust, or a request for a transfer to, or would hope that most of these trust) would be beyond its reach a purchase by, an existing trust requests would be approved where should it seek to execute a judgment established by a party other than the the co-op can be adequately protect- against the grantor or other benefici- intended resident. Generally, if the ed, as most shareholder requests are aries, as the co-op would be on co-op policy permits non-individual motivated by a desire to facilitate estate planning.

70 NYSBA N.Y. Real Property Law Journal | Spring 2002 | Vol. 30 | No. 2 Unfortunately, we have seen agent with the various forms of entirely free from doubt. However, a instances where co-op boards have trusts and how readily the co-op can strong rebuttal to this position can be adhered to somewhat rigid poli- be insulated from any financial or based on a co-op’s absolute right to cies—not without cost to the share- other risk resulting from trust own- withhold consent to a trust transfer holder and his intended beneficiar- ership. As the use of trusts become for any reason, which implies the ies. For example, what could be a more commonplace in estate plans, right to impose any condition to more compelling set of circum- both for tax and non-tax reasons, such transfer. In rare cases, it may be stances than to permit the transfer of and co-op apartments increasingly appropriate for a co-op which per- an apartment to a credit by-pass represent a significant asset of share- mits transfers to trusts to consider trust under a will for the benefit of a holders’ estates, we would urge co- amending certain provisions of its surviving spouse, when there are op boards to consider these requests proprietary lease to reflect this form otherwise inadequate assets to fund with an open mind. Although few in of non-individual ownership. the trust. To deny the request would number, there are some buildings Co-op boards, with the advice of result in a waste of the decedent’s which have an absolute policy counsel, should carefully consider all estate tax exemption and higher against permitting trust ownership aspects of trust ownership and for- estate taxes when the spouse dies of apartments.14 We suggest that mulate a policy which is acceptable and the apartment is taxed as part of such boards review their general pol- and appropriate for the particular the second estate. icy for the benefit of their sharehold- building, balancing the desire to ers. accommodate shareholders and the In the end, the decision to permit duty to serve the co-op as a whole. “In the end, the decision a trust (or other non-natural individ- Over the past decade, in our experi- to permit a trust (or other ual) to own co-op shares and propri- ence with approximately 100 co-ops non-natural individual) to etary leases is a policy decision for which have confronted this issue co-op boards. Some co-op boards with our advice, virtually all have own co-op shares and have determined that non-individual permitted trust transfers. Moreover, proprietary leases is a ownership of co-op apartments is those that have allowed trust trans- policy decision for co-op inconsistent with the basic co-op fers to date have virtually never boards.” housing principle of owner-occupan- encountered problems resulting from cy.15 Most proprietary leases are trust ownership. Once trust transfers drafted presuming a natural person are permitted, it will be difficult for a as the lessee. They include provi- co-op board to deny this privilege to Another appealing case is where sions which do not make sense in other shareholders in good standing a request is made for the purchase of cases of non-individual ownership. who are willing to abide by the co- an apartment by a trust for the pri- For example, most proprietary leases op’s requirements for such transfers. mary benefit of the intended resident restrict occupancy to the named les- which was created by a third party, see and his or her family; obviously, Endnotes such as a parent or grandparent. The a trust lessee can have no family. trust (which is the proposed pur- Further, it can be argued that the co- 1. Richard Siegler & Anita Rosenbloom, Co- operatives, Condominiums: Ownership by chaser) may enjoy a tax-favored sta- op is at a greater risk of disputes Trusts, NYSBA Trusts and Estates Law tus, such as being exempt from the when actual ownership and benefi- Section Newsletter, Spring 1994, p. 5. generation-skipping tax and insulat- cial ownership are divided as 2. I.R.C. §§ 2036, 2038. ed from estate tax on the death of the between a trust, its trustees, its 3. I.R.C. § 1015(d). beneficiary. Permitting the purchase grantor and its beneficiaries. While 4. Until recently, it was possible through a by the trust may not only facilitate the foregoing concerns may be alle- clever maneuver to shield the remainder- the purchase, but insulate any appre- viated for some boards by the docu- man from the gain by having the grantor reacquire the residence from the QPRT ciation on the residence from estate mentation we have suggested, the just prior to expiration of the grantor’s and generation-skipping taxes. question may arise whether this doc- retained term. Under this “bait and umentation, which essentially modi- switch” technique, the remainderman Regrettably, we know of situa- fies certain terms of a proprietary would receive cash or other assets. Fur- tions where such requests have been ther, if the grantor retained the residence lease relating to occupancy and denied at a considerable cost to the until death, its basis would be stepped- transfers, is an amendment of the deceased shareholder’s heirs and the up. The Internal Revenue Service proprietary lease which is invalid responded by issuing Treasury Regula- beneficiaries of the third-party trust. without shareholder approval. Since tions, effective for trusts created after Sometimes the refusal of the request May 16, 1996, requiring that, in order to there is virtually no case law offering may be due to a lack of familiarity qualify as a QPRT, the trust instrument guidance on this issue, it is not by the co-op board or its managing must prohibit the trust from selling or

NYSBA N.Y. Real Property Law Journal | Spring 2002 | Vol. 30 | No. 2 71 transferring the residence, directly or grantor’s contingent reversionary interest In addition, most proprietary lease provi- indirectly, to the grantor, the grantor’s reduces the value of the gift. sions imposing a flip tax are triggered by spouse or an entity controlled by the 10. The amount of the taxable gift turns on a sale and payment of consideration, and grantor or the grantor’s spouse. Treas. five factors: (1) the interest rate used by as originally drafted do not expressly Reg. §§ 25.2702-5(c)(9). the Internal Revenue Service in its valua- cover a gift transfer to a trust. Therefore, 5. The estate or beneficiaries can only claim tion tables, (2) the value of the residence each flip tax provision should be the exclusion for a post-death sale of the on the date of the gift, (3) the grantor’s reviewed. If a board wishes to amend the decedent’s principal residence if the dece- age, (4) the length of the trust term and co-op’s proprietary lease to impose a fee dent used the property as such for at (5) whether the grantor has reserved a upon trust transfers, this almost always least two of the five years before the sale. contingent reversionary interest. requires shareholder approval. The period of occupancy by the decedent 11. Treas. Reg. § 25.2702–5(c)(2)(ii). Note that Anita Rosenbloom is a partner also can be added to the period of occu- shareholders with loans must generally pancy by an heir to determine if the heir obtain their lender’s consent to a transfer of Stroock & Stroock & Lavan LLP, meets the requirements for his or her to a trust. specializing in estate planning and a own $250,000 exclusion. 12. See Should I Create a Revocable Inter Vivos co-author of Manning on Estate 6. The Tax Reform Act of 1986 amended Trust?, 63 N.Y. St. B.J. 48 (Dec. 1991). Planning, published by Practising I.R.C. § 216 to include in the definition of “tenant-stockholder non-natural persons, 13. EPTL 7-3.1. Law Institute. including trusts, owning co-op shares.” 14. In the event that the cooperative corpora- Richard Siegler is a partner in tion refuses to consent to the proposed Richard Siegler, “Impact of Tax Reform the New York City law firm of on Co-op Housing,” N.Y.L.J., March 4, transfer to a QPRT, the IRS has confirmed 1987, p. 1, col. 1. that it nevertheless may recognize the Stroock & Stroock & Lavan LLP and transfer for transfer tax purposes. Priv. 7. Note that for various reasons, trusts are a member of the Committee on Con- established under the laws of different Ltr. Rul. 94-47-036 (Aug. 29, 1994); Priv. dominiums and Cooperatives of the states; just because the co-op apartment Ltr. Rul. 94-33-016 (May 18, 1994); Priv. Ltr. Rul. 92-49-014 (Sept. 4, 1992). In those Real Property Section of the New is located in New York does not mean the York State Bar Association. He is trust will be governed by New York law. cases, after the co-op board disapproved the request for transfer to the QPRTs, the also Adjunct Professor at New York 8. Treas. Reg. § 25.2702-5(c). donor assigned beneficial title to the co- Law School where he teaches a 9. If the transfer is made after November 1, op shares and the proprietary lease to the 2001, the figures may vary slightly. This QPRT and undertook as nominee to hold course on cooperative housing and is because the interest rate upon which legal title for the QPRT. We would not condominium law. the Internal Revenue Service’s valuation suggest this course of action as it would Reprinted from the Winter 2001 tables are based fluctuate from month to be a default under the proprietary lease. NYSBA Trusts and Estates Law Sec- month. The interest rate is equal to 120 15. Many proprietary leases provide that percent of the average yield on Treasury board consent is not required for a trans- tion Newsletter, vol. 34, no. 4 An ear- obligations with maturities between three fer of an apartment to the spouse of the lier version of this article appeared in and nine years. This example further shareholder and/or that board consent to a March 3, 1993 edition of the New assumes that the grantor has reserved a a transfer to a financially responsible York Law Journal. © 1993 NLPIP contingent reversionary interest in the member of the shareholder’s family may QPRT instrument providing that, if the not unreasonably be withheld. This raises Company. All rights reserved. Further grantor fails to survive the trust term, the the issue of whether a transfer to or by a duplication without permission is residence will pass to his estate or as he trust for the benefit of a grantor’s spouse prohibited. may appoint by a general testamentary or other family member should be subject power of appointment. The value of the to the same relaxed consent provisions.

72 NYSBA N.Y. Real Property Law Journal | Spring 2002 | Vol. 30 | No. 2 EXHIBIT A OCCUPANCY AGREEMENT [name of trustee] and [name of trustee], as Trustees (collectively, the “Trustees”) of the [name of settlor/grantor] Trust, dated ______between [name of settlor/grantor], as [Grantor][Settlor], and [name of trustee] and [name of trustee], as Trustees (the “Trust”), are the holders of the shares (the “Shares”) of (the “Corporation”) allocated to Apart- ment ___ (the “Apartment”) located at [address] and the proprietary lease appurtenant thereto (the “Lease”). The Trustees hereby agree with the Corporation that, notwithstanding any provisions of the Lease or any other document, they will not sublet or permit the occupancy of the apartment by any parties other than [name of settlor/grantor] and [her][his] immediate family (i.e., spouse, children and parents) residing with [her][him]. Any violation of this Agreement shall be considered a default by the Trustees, as lessee, under the provisions of the Lease. The occupant of the Apartment and Trustees shall be subject at all times to the Lease (including house rules) and the by-laws of the Corporation (the “By-laws”). The Trustees acknowledge and understand that the By-laws and Lease provide that the Shares are transferable only as an entirety and only to an assignee of the Lease approved in writing in accordance with the provisions of the Lease. The Trustees hereby represent that any transfer of the Shares or subletting of the Apartment made by them shall be done only in accordance with the provisions of the Lease and the By-laws. In the event of a conflict between the terms of the Trust and the terms of this Agreement, the Lease, the By-laws or the certificate of incorporation of the Corporation, as the same may be amended from time to time, the terms of this Agreement, the Lease, the By-laws and the certificate of incorporation of the Corporation, as the same may be amended from time to time, shall prevail. The Trustees recognize that the Corporation is relying upon the foregoing representation in permitting a transfer of the Shares of the Lease to the Trustees and that the Corporation would not otherwise consent to such transfer. The Trustees agree that any and all costs and expenses, including without limitation, reasonable attorneys fees and disbursements, incurred by the Corporation in connection with the enforcement of this Occupancy Agreement shall be deemed additional rent under the Lease. The Trustees consent to the jurisdiction of the New York courts and consent to the service of process on the Trust by certified mail addressed to the Apartment. This Agreement may be modified only by a written instrument signed by the Trustees and the Corporation. This Agreement shall be binding on the estates, heirs, executors, administrators, personal representatives, successors and assigns of each of the undersigned. This Agreement shall be governed by the internal laws of the State of New York, without giving effect to principles of conflicts of law. IN WITNESS WHEREOF, the undersigned have executed this Agreement as of the ___ day of ______, ____. [name of co-op corporation] By:______Name: Title: ______[name of trustee], as Trustee of the Trust ______[name of trustee], as Trustee of the Trust Accepted and Agreed to: ______[name of settlor/grantor], individually and as [Grantor] [Settlor] [ and as Trustee] of the Trust

NYSBA N.Y. Real Property Law Journal | Spring 2002 | Vol. 30 | No. 2 73 EXHIBIT B GUARANTY OF LEASE WHEREAS, by a certain Assignment of Proprietary Lease, dated ______, ______, [name of trustee] and [name of trustee], as Trustees under that certain Trust Agreement dated ______between [name of grantor/settlor], as [Grantor] [Settlor], and [name of trustee] and [name of trustee], as Trustees (such Trustees hereinafter collectively called “Assignee”), will acquire all of the lessee’s right, title and interest in and to a certain lease (the “Lease”) dated ______, between (“Lessor Corporation”), as lessor, and [name of grantor/settlor], or [her][his] predecessor in interest, as lessee, for apartment ___ (“Apartment”) in premises located at ______, New York, New York; and WHEREAS, by instrument dated ______(“Assumption of Lease”) Assignee will assume all of the obli- gations of [name of grantor/settlor], as lessee under the Lease, and is about to become the lessee of the Apartment by virtue of said instrument or the execution of a new lease. NOW, THEREFORE, in consideration of the premises and the consent of Lessor Corporation or its directors to the assignment of the Lease to Assignee and to the transfer to Assignee of the shares of Lessor Corporation which accompa- ny the Lease, [name of grantor/settlor] (“Guarantor”) hereby guarantees to Lessor Corporation the timely performance of all of Assignee’s obligations under the Lease, including, without limitation, the prompt payment by Assignee of all rent (maintenance charges) and any and all other charges or assessments payable under the Lease, as the same may be amended from time to time, accruing from and after the effective date of the Assumption of Lease. Guarantor agrees to reimburse the Lessor Corporation for all costs and expenses, including without limitation, rea- sonable attorneys fees and disbursements, incurred by the Lessor Corporation in connection with the enforcement of this Guaranty. In the event Assignee defaults or fails to pay any sum when due, Lessor Corporation may require Guarantor’s performance without first requiring that the Assignee perform. The obligations of Guarantor hereunder are direct and absolute. A separate cause of action or separate causes of action may be brought and prosecuted against any Guarantor without the necessity of joining Assignee or previously proceeding or exhausting any remedy against Assignee or any other person who might have become liable for the indebtedness of the Trust by assumption thereof. Notice of default or any extension of time to cure a default is hereby waived. This Guaranty shall remain in effect notwithstanding the modification of the Lease or the execution of a new lease by Assignee or any modification thereof. This Guaranty is an absolute and unconditional guaranty and may not be changed or terminated orally but only by an agreement in writing signed by the party against whom enforcement of such change or termination is sought. All rights and remedies under the Lease and this Guaranty are cumulative. This Guaranty and all of its provisions shall be binding on Guarantor and Guarantor’s estate, heirs, executors, administrators, personal representatives, successors and assigns. In any action on this Guaranty, guarantor waives trial by jury and the right to assert any counterclaim. This Guaranty shall be governed by the internal laws of the State of New York, without giving effect to principles of conflicts of law. New York, N.Y. Date: ______[name of grantor/settlor] State of New York ) : ss. County of New York ) On the _____ day of ______in the year ____, before me, the undersigned, personally appeared [NAME OF GRANTOR/SETTLOR], personally known to me or proved to me on the basis of satisfactory evidence to be the indi- vidual whose name is subscribed to the within instrument and acknowledged to me that (s)he executed the same in his/her signature on the instrument, the individual, or the person upon behalf of which the individual acted, executed the instrument. ______Notary Public

74 NYSBA N.Y. Real Property Law Journal | Spring 2002 | Vol. 30 | No. 2 EXHIBIT C

LETTER AGREEMENT

[name of trustee] and [name of trustee] Trustees of The [name of settlor/grantor] Trust ______New York, New York ______Date:______[name of co-op] Re: Transfer of Apartment Dear Sir/Madame: As a condition to your approval of the transfer of the shares of [name of co-op] (the “Shares”) and the proprietary lease (the “Lease”) allocated to Apartment ____ at, [address] New York, New York (the Shares and the Lease may be col- lectively referred to herein as the “Apartment”), to us, [name of trustee and [name of trustee], as Trustees of the [name of settlor/grantor] Trust, dated ______, ______, between [name of settlor/grantor], as [Grantor][Settlor], and us, as Trustees (the “Trust”), we, as Trustees of the Trust, [name of known beneficiary, if any, individually,] and [name of sett- lor/grantor], individually, hereby acknowledge and agree that, notwithstanding any purported disposition in the Trust Agreement, you shall retain and reserve the rights granted to you under the Lease, under your by-laws (the “By-laws”) and under your certificate of incorporation (the “Certificate”) to review and approve or reject in your sole discretion any further transfer of the Apartment by us, as Trustees, including, without limitation, any transfer which may take effect upon the death of [name of settlor/grantor] or the termination of the Trust, whether to a beneficiary of the Trust, to another trust or otherwise. We, [name of trustee] and [name of trustee], in our capacities as Trustees of the Trust, and [name of settler/grantor], individually and as [Grantor][Trustee] of the Trust, agree that we shall be jointly and severally liable for any and all costs and expenses, including without limitation, reasonable attorneys fees and disbursements, incurred by you in the enforce- ment of this Letter Agreement, and that such costs and expenses shall be deemed additional rent under the Lease. We, [name of beneficiary, if any ] and [name of settlor/grantor] hereby further acknowledge and agree that, in the event of a conflict between the terms of the Trust and this letter agreement, the Lease, the By-laws, the Certificate or the Occupancy Agreement of even date herewith, the terms of this letter agreement, the Lease, the By-laws, the Certificate and the Occupancy Agreement shall prevail. This letter agreement shall be binding on the estates, heirs, executors, administrators, personal representatives, suc- cessors and assigns of each of the undersigned. This letter agreement shall be governed by the internal laws of the State of New York, without giving effect to princi- ples of conflicts of law. Very truly yours, ______[name of trustee], as Trustee of the Trust ______[name of trustee], as Trustee of the Trust ACKNOWLEDGED AND AGREED TO: ______[name of settlor/grantor], individually [and as Trustee] of the Trust ______[name of beneficiary, if any, individually]

NYSBA N.Y. Real Property Law Journal | Spring 2002 | Vol. 30 | No. 2 75 EXHIBIT D

PROPOSED AMENDMENT OF SPENDTHRIFT PROVISIONS

“The Grantor hereby directs that the spendthrift provisions set forth in Paragraph _____ of said Trust Agreement shall be of no force or effect against [NAME OF CORPORATION], and hereby confirms that any claims [NAME OF CORPORATION], may have against the Grantor in her[his] individual capacity or against any other beneficiaries or Trustees of any trust established under this Trust, including but not limited to any claims arising out of the guarantee which the Grantor is making or arising out of a default under the lease, may be asserted against and satisfied out of the assets of any trust established under this Trust Agreement and subject to judgment, levy, execution, sequestration, attachment, bankruptcy proceedings or other legal or equitable process in connection therewith, whether such claims arise during the life of the Grantor or after her[his] death. The Grantor hereby directs that the provisions of this Amend- ment shall not be modified, amended or revoked without the prior consent of [NAME OF CORPORATION] and any such purported modification, amendment or revocation shall be ineffective against [NAME OF CORPORATION].”

76 NYSBA N.Y. Real Property Law Journal | Spring 2002 | Vol. 30 | No. 2 Have Reports of the Death of the Duty to Mitigate in New York Been Greatly Exaggerated?1 A New Interpretation of Holy Properties Ltd., L.P. v. Kenneth Cole Productions, Inc. By Jason Kee Low

I. Introduction New York cases recognize leases as II. The Modern Landlord- present transfers of estates in real In Holy Properties Ltd., L.P. v. Ken- Tenant Arrangement and property.8 neth Cole Productions, Inc.,2 the Court Policy Reasons for of Appeals is widely regarded as hav- Cole’s second principal argument Adopting a Mitigation Duty ing affirmatively held that the land- centered on the landlord’s termina- The traditional rule of no mitiga- lord-respondent had no duty to miti- tion of the landlord-tenant relation- tion, which regards leases as con- gate damages after an unjustifiable ship prior to commencing eviction veyances, conformed to the way the abandonment of the premises by the proceedings.9 Pursuant to the lease ancient farm lease operated.12 The tenant.3 However, the language in the agreement, the landlord exercised a land itself was the subject of the opinion dealing with the termination conditional limitation to terminate lease, and any structures on it were of the conveyance and lease agree- the lease upon the tenant’s default. incidental.13 The tenant did not ment may reasonably be interpreted This effectively ended the con- expect, nor was he provided with, to suggest otherwise. There potential- veyance, leaving only the contractual any services from the landlord.14 ly exists a duty to mitigate damages aspect of the lease. The tenant argued Since the landlord was absent from by a landlord, but subject to certain that, therefore, its liability was for the land, the tenant was better qualifications. contract damages only and that the equipped to make any repairs neces- landlord had a duty to mitigate in 15 At issue in Holy Properties was a sary and maintain the land. 10 lease provision that presumably accordance with contract law. Although the court acknowledged the While it may have been better relieved the landlord of liability for suited for agrarian societies, the tradi- failure to re-let the demised premises. conveyance had ended because of the eviction proceedings, it dispensed tional rule is dated and inconsistent The court interpreted the lease provi- with the contemporary landlord and sion as having with this argument, citing that the lease contract expressly provided that tenant framework, which involves 1) expressly relieved the landlord of the landlord was under no duty to mostly urban property.16 The modern any duty to mitigate damages mitigate damages.11 urban lease is not for land, but is typ- after abandonment by the tenant; ically for space or part of the space in and It is the court’s approach in a building.17 Such a lease necessarily rejecting Cole’s second principal includes a continuous flow of essen- 2) permitted the landlord to hold argument that might necessitate a tial services from the landlord to the the tenant liable for rent due lease provision specifying no duty to tenant, items that are not under the under the lease.4 mitigate before a landlord, who has tenant’s control.18 For instance, the terminated the lease, may assert such landlord controls a building’s access, The tenant-appellant’s (“Cole”) a claim. Accordingly, the primary heating, lighting, air conditioning, first principal argument urged the focus herein will be on the issue of elevator service, cleaning, and waste court to depart from the well-settled whether lease survival clauses are the removal. Although landlord or tenant New York approach5 and adopt the decisive factor in a court’s determina- may be responsible for maintenance contract rule of mitigation in the lease tion of whether to impose a duty to within the leased premises, neither damages context as other courts have mitigate upon a landlord after the expects the tenant to maintain the done.6 Nevertheless, the court predi- tenant defaults on the lease. If a lease building’s support structure, climate cated its decision partly on the survival clause is decisive, then there control, or electrical or plumbing sys- ground that in real property law is a duty to mitigate absent such a tems.19 The modern urban lease then, “established precedents are not light- clause where the landlord terminates “contemplates no single unilateral act ly to be set aside.”7 That is, venerable the lease. by landlord, but a continuous mutual

NYSBA N.Y. Real Property Law Journal | Spring 2002 | Vol. 30 | No. 2 77 exchange of consideration.”20 A lease disfavored penalty upon the premises prior to expiration of the can therefore be recognized as both a tenant.27 lease.33 The traditional no duty-to- conveyance and a contract, which mitigate rule is evinced in the first It follows from the above that the many courts and commentators have option—that the landlord could do modern contractual view of a lease done.21 nothing and collect the full rent due has been accepted as common wis- under the lease.34 Second, the land- Notwithstanding the contractual dom. However, it is notable that pro- lord could accept the tenant’s surren- nature of a lease, several policy rea- ponents of the modern view have der, re-enter the premises and re-let sons in favor of adopting a mitigation overlooked the protection a lease as a them for its own account.35 Third, the rule arguably outweigh the rationale conveyance affords a tenant if the landlord could notify the tenant that underlying the traditional rule.22 landlord becomes insolvent. If a lease it was entering and re-letting the First, a duty to mitigate requirement is regarded as a contract, the land- premises for the tenant’s benefit.36 would prevent landlords from need- lord’s insolvency could compromise Should the landlord undertake the lessly accumulating damages23 after a the tenant’s possessory interest in the third option, the rent collected would tenant’s breach of a lease agreement, leased premises—that is, the trustee be apportioned first to repay the and thereby encourage the produc- of an insolvent landlord’s estate may landlord’s expenses in re-entering tive use of land. Favoring a mitiga- reject any unexpired leases of real and re-letting and then to pay the tion duty for landlords upon a ten- property. Nonetheless, section tenant’s rent obligation.37 However, ant’s breach, the Colorado Supreme 365(h)28 of the Bankruptcy Code pro- the court noted, New York law per- Court stated, vides for such a contingency in two mitted the landlord to invoke the first ways: Under traditional property option to take no action and hold the law principles a landlord 1) by permitting the tenant to treat tenant liable for the rent for the entire could allow the property to the lease as terminated by the lease period.38 remain unoccupied while still rejection;29 and Although the court is perceived holding the abandoning ten- 2) if the term of the lease has com- to have affirmatively held that no ant liable for rent. This menced, by permitting the tenant duty to mitigate exists on the land- encourages both economic to retain its rights under the lease lord’s part because of the established and physical waste. In no and remain in possession of the rule mentioned above, a closer read- other context of which we are leased property.30 ing of the opinion with respect to the aware is an injured party per- lease provision may invoke a very mitted to sit idly by and suf- Additionally, the tenant is enti- different conclusion. The court clearly fer avoidable economic loss tled to enforce any renewal terms noted that “[a]lthough an eviction and thereafter to visit the full included in the balance of the lease terminates the landlord-tenant rela- adverse economic conse- 31 term. Accordingly, the tenant would tionship, the parties to a lease are not quences upon the party not be deprived of the estate for the foreclosed from contracting as they whose breach initiated the term which the tenant bargained for. please. If the lease provides that the chain of events causing the The tenant may also offset the rent tenant shall be liable for rent after loss.24 reserved under the lease against dam- eviction, the provision is enforce- Second, physical damage to leased ages caused by the rejection, but has able.”39 Given the court’s mindful property from vandalism or by acci- no other remedy if it elects to retain consideration of this lease provision 32 dent is less likely if the property is in its rights. in its analysis, it is reasonable to use.25 Third, the mitigation rule is In theory, therefore, section question whether the court would consistent with the trend disfavoring 365(h) of the Bankruptcy Code have found for the landlord-respon- contract penalties.26 regards an unexpired lease of an dent if not for this lease provision. insolvent landlord as a conveyance in Perhaps the parties to a commercial [A]llowing a landlord to order to preserve the tenant’s propri- lease in New York may not be subject leave property idle when it etary interest in the leased premises, to an absolute rule of no mitigation, could be profitably leased which would otherwise be trumped but they may be subject to what is and forcing an absent tenant by the landlord’s insolvency. essentially a default rule that a land- to pay rent for that idled lord has no duty to mitigate damages. property permits the land- III. The Court’s Holding and Its That is, after the landlord-tenant rela- lord to recover more dam- Potential Fallacy tionship terminates because the lessee ages than it may reasonably defaults and the landlord thereafter In its analysis, the court stated require to be compensated terminates the conveyance, the land- that the landlord had three options for the tenant’s breach. This lord will have a duty to minimize when the tenant abandoned the is analogous to imposing a damages, unless there is a lease pro-

78 NYSBA N.Y. Real Property Law Journal | Spring 2002 | Vol. 30 | No. 2 vision relieving the landlord of such a lease.47 The tenant argued that con- In cases where the lease expressly duty. tract law governs landlord-tenant provided that the landlord would leases and imposes a duty to mitigate have a mitigation duty if the premises A case directly on point with the on the non-breaching party.48 Howev- were abandoned or vacated, courts proposition that a landlord’s duty to er, the court reasoned that contract have held that the landlord is obligat- mitigate is conditioned upon the par- law provided no relief to the tenant ed to do so. In Harmon v. Callahan, the ties’ intentions in the lease agreement under the facts of that case, because Illinois Court of Appeals recognized is the Texas case of Metroplex Glass the 37-page lease agreement did not that a landlord generally has no duty Center, Inc. v. Vantage Properties, Inc.40 contain a provision compelling the to mitigate damages by re-letting the There, the lessee sought to appeal a landlord to mitigate its damages premises upon a tenant’s abandon- grant of summary judgment to the upon the tenant’s violation of the ment.51 In taking the position that a lessor for unpaid rentals due under a lease term. That said, the court went lease is an executed contract, the lease for commercial premises. The on to assert, court opined, lessee appealed on the ground that the question of mitigation of damages It is well established that, It would seem to be the law was not established as a matter of “the law will not imply a that where a lease is made, law.41 In response, the court specifi- contract different than that and subsequently the premis- cally stated, “With respect to the con- which the parties have es are abandoned by the ten- tention that mitigation of damages expressly adopted.” . . . This ant, and following that there was not established as a matter of rule is particularly apt when is merely a re-entry by the law, no duty exists to mitigate dam- reviewing a contract involv- landlord, the original con- ages unless that duty is imposed by ing two parties of relatively tract still stands and the ten- the lease.”42 Therefore, the court held, equal bargaining power, as is ant is liable on his promise to since the lease between the parties generally the case in a com- pay rent; that mere abandon- imposed no affirmative duty to re-let mercial lease setting. The ment and re-entry do not the premises upon the lessee’s aban- only exception to this rule is cancel the lease; and, further, donment, the lessor was under no when the inclusion or that, under such circum- obligation to mitigate damages by re- absence of a contract term stances, the mere abandon- letting the abandoned premises.43 would be violative of public ment of the premises by the Clearly, the court based its decision policy. . . . We find no such tenant and re-entry by the on the absence of a lease provision violation in this context, for landlord does not give rise to imposing the duty to mitigate, even the established law in Penn- an obligation on the landlord though Texas adhered to the tradi- sylvania does not require that to endeavor to re-rent. . . . tional no-mitigation rule at the time a landlord mitigate a tenant’s The tenant and the landlord of Metroplex.44 damages.49 (citations omit- fixed their obligations when ted). the lease was made, and no A similar inference may be subsequent ex parte conduct drawn from a 1996 Pennsylvania While the court acknowledged that on the part of the tenant and Superior Court opinion concluding several lower courts had imposed a mere re-entry by the land- that a landlord has no duty to miti- mitigation duty upon landlords in lord, which may be for the gate damages. Stonehedge Square Ltd. both residential and commercial lease necessary preservation of the Partnership v. Movie Merchants, Inc. contexts, the court still found for the premises, should increase the involved an action brought by a land- landlord because Pennsylvania fol- obligations of the landlord.52 lord to recover unpaid rents follow- lowed the traditional rule. Neverthe- ing the tenant’s breach of the lease.45 less, by having placed considerable However, the court duly noted that The tenant vacated the leased premis- emphasis on the lack of a lease provi- clause 7 of the lease expressly obligat- es in a shopping center prior to the sion for mitigation of damages and ed the landlord to re-let the premises expiration of the lease term. The trial the contractual nature of a commer- following the tenant’s abandonment. court initially found that the landlord cial lease, the court appears to have Therefore, the clause distinguished had no duty to mitigate damages, but subjected the traditional rule to a Harmon from cases involving simple reversed itself after granting the ten- qualification regarding lease clauses abandonment and re-entry. Under ant’s post-trial motion.46 On appeal, that dictate whether a landlord is that provision, the court held that the the landlord raised the question of required to mitigate damages. The landlord had a duty to re-let the whether Pennsylvania law imposes a Pennsylvania Supreme Court subse- premises with reasonable diligence. duty to mitigate on commercial quently affirmed, on appeal, the The court also stated, lessors when the lessee breaches the Superior Court’s holding in Stone- [A]fter re-entry, the landlord hedge.50 may by writing make himself

NYSBA N.Y. Real Property Law Journal | Spring 2002 | Vol. 30 | No. 2 79 liable to exercise diligence in terminate their duties under an exist- to a lease and may serve to reduce lit- re-renting, or he may re-enter ing contract, which constitutes a igation until the issue in New York is and relet and be chargeable rescission. “If any contractual right to definitively resolved by the Court of with the rents he actually further performance under the con- Appeals, the Appellate Division, or obtains. But, in the absence of tract or if any right to damages for a through legislative action. any such voluntary conduct, breach of the contract continues to mere abandonment and re- exist, there has been no complete Endnotes entry do not oblige the land- rescission. If all such rights have been 1. Cf. Samuel L. Clemens (a.k.a. Mark lord to endeavor, by affirma- discharged, there has been both Twain, 1835–1910), is often quoted as tive action, to decrease the ‘rescission’ and ‘accord and satisfac- having stated, “The reports of my death have been greatly exaggerated.” Brainy- 53 58 tenant’s liability. tion.’” By not imposing a duty to Media, BrainyQuote, Feb. 19 2002, at mitigate upon the landlord, however, . underscores the influence of lease stated that the contract was terminat- 2. 87 N.Y.2d 130, 661 N.E.2d 694, 637 survival clauses in a court’s determi- ed along with the conveyance, N.Y.S.2d 964 (1995). nation of any duty to mitigate on a instead of being breached. If that 3. See Whitehouse Estates v. Post, 173 Misc. 2d landlord’s part—even in 1919, when were the case, there would have been 558, 662 N.Y.S.2d 982 (Sup. Ct. App. T., the anti-mitigation rule was staunchly 1st Dep’t 1997); 342 Madison Ave. Assocs. no basis for holding Cole liable for followed by a majority of states.54 v. Suzuki Assocs., 187 Misc. 2d 488, 722 rent payments, since contracts are N.Y.S.2d 729 (Sup. Ct., N.Y. Co. 2001); IV. Conclusion based upon mutual obligations on the Duda v. Thompson, 169 Misc. 2d 649, 647 part of both parties.59 N.Y.S.2d 401 (Sup. Ct., Westchester Co. Rather than fully resolving the 1996); see also Robert E. Parella, Real Prop- confusion concerning a landlord’s Third, the court’s reliance upon erty, 1995-96 Survey of New York Law, 47 Syracuse L Rev. 681 (1997). duty to mitigate damages, the court’s Paragraph 18 of the lease in support of its holding is questionable. Para- 4. See Holy Properties, 87 N.Y.2d at 135, 661 opinion in Holy Properties tends to N.E.2d at 696, 637 N.Y.S.2d at 966. raise several key issues. graph 18 did not expressly abrogate the landlord’s duty to mitigate, but 5. Under New York law, if a tenant aban- First, Holy Properties involved dons the premises prior to the expiration only stated “Owner shall in no event of the lease, the landlord may do nothing parties to a commercial lease, and the be liable in any way whatsoever for and collect the full rent due under the court did not characterize the duty failure to re-let the demised premises. lease. See Becar v. Flues, 64 N.Y. 518 with respect to residential leases. . . .”60 Arguably, if the law in New (1876); Underhill v. Collins, 132 N.Y. 269, Remarkably, the court chose to not do 30 N.E. 576 (1892); In re Hevenor, 144 N.Y. York were indeed well-settled with 271, 39 N.E. 393 (1894). so even though the landlord-respon- respect to the issue of mitigation, the dent raised the issue in its brief and 6. See, e.g., Parkwood Realty Co. v. Marcano, court could have simply held that 77 Misc. 2d 690, 352 N.Y.S.2d 623 (N.Y.C. conceded that a mitigation duty was there was no duty to mitigate without Civ. Ct., Queens Co. 1974); Lefrak v. Lam- appropriate in the residential lease even discussing Paragraph 18. bert, 89 Misc. 2d 197, 390 N.Y.S.2d 959 context.55 Accordingly, it is possible (N.Y.C. Civ. Ct., Queens Co. 1976), modi- the holding in Holy Properties may Provisions in lease agreements fied, 93 Misc. 2d 632, 403 N.Y.S.2d 397 (Sup. Ct. App. T., 2d & 11th Dep’t 1978); only be applicable to commercial relieving a landlord of any duty to Forty Exchange Co. v. Cohen, 125 Misc. 2d leases;56 the court emphasized the mitigate may therefore be a necessary 475; Paragon Indus. v. Williams, 122 Misc. certainty of settled rules, particularly antecedent to a landlord’s position of 2d 628; Grays v. Brooks, 148 Misc. 2d 646; in business transactions.57 having no mitigation duty. As evi- Syndicate Bldg. Corp. v. Lorber, 128 A.D.2d denced by the aforementioned cases, 381, 512 N.Y.S.2d 674 (1st Dep’t 1987); Second, the court acknowledged Rubin v. Dondysh, 146 Misc. 2d 37, 549 lease survival clauses are apparently N.Y.S.2d 579 (N.Y.C. Civ. Ct., Queens Co. that the landlord-tenant relationship accorded greater consideration by 1989), reargument denied, 147 Misc. 2d 221, terminated when Holy Properties courts over the well-settled law in 555 N.Y.S.2d 1004 (N.Y.C. Civ. Ct., instituted summary eviction proceed- determining whether a landlord was Queens Co. 1990), rev’d, 153 Misc. 2d 657, ings, but still held the tenant was 588 N.Y.S.2d 504 (Sup. Ct. App. T., 2d & under a duty to mitigate. According- 11th Dep’t 1991); Douglas Manor House v. liable for rent due under the lease. To ly, parties to a lease in New York, Wohlfeld, 66 Misc. 2d 265 (Sup. Ct. App. reiterate, many courts and commenta- commercial or residential, should T., 1st Dep’t 1970). tors view leases as both conveyances insist on a lease provision that 7. Holy Properties, 87 N.Y.2d at 134, 661 and contracts, and in contract law, the expressly states in unequivocal terms N.E.2d at 696, 637 N.Y.S.2d at 966. non-breaching party has a duty to whether there exists a duty to miti- 8. See Becar v. Flues, 64 N.Y. 518 (1876); mitigate its damages. The duty dis- gate damages upon breach of the Reichart v. Spiess, 203 A.D. 134, 196 N.Y.S. solves upon mutual agreement 466 (2d Dep’t 1922); Centurian Dev. v. Ken- lease. At a minimum, such a provi- ford Co., 60 A.D.2d 96, 400 N.Y.S.2d 263 between the parties to discharge and sion would create certainty for parties (4th Dep’t 1977).

80 NYSBA N.Y. Real Property Law Journal | Spring 2002 | Vol. 30 | No. 2 9. See Holy Properties, 87 N.Y.2d at 135, 661 as would entitle the lessee to 43. See id. N.E.2d at 696, 637 N.Y.S.2d at 966. treat such lease as terminated by 44. The Texas Supreme Court explicitly 10. See id. virtue of its terms, applicable adopted a mitigation rule 14 years later nonbankruptcy law, or any agree- in Austin Hill, but consistent with its 11. See id. at 134, 661 N.E.2d at 696, 637 ment made by the lessee, then N.Y.S.2d at 966. view that a lease is both a conveyance the lessee under such lease may and a contract, indicated that the land- 12. See generally, Milton R. Friedman, Fried- treat such lease as terminated by lord and tenant may contract otherwise. man on Leases § 1.1 (4th ed. 1997). the rejection; or See Austin Hill, supra note 26, at 299. 13. See id. (ii) if the term of such lease has 45. 454 Pa. Super. 468, 685 A.2d 1019 (1996). commenced, the lessee may 14. See id. 46. See id. at 479–80, 685 A.2d at 1015. retain its rights under such lease 15. See id. (including rights such as those 47. See id. at 479, 685 A.2d at 1014. 16. See Edwin Smith, Jr., Comment, Extending relating to the amount and tim- 48. See id. the Contractual Duty to Mitigate Damages ing of payment of rent and other to Landlords When a Tenant Abandons the amounts payable by the lessee 49. Id. at 479–80. Lease, 42 Baylor L. Rev. 553, 554 (1990). and any right of use, possession, 50. 552 Pa. 412, 715 A.2d 1082 (1998). quiet enjoyment, subletting, See , supra . 17. Friedman note 12 assignment, or hypothecation) 51. 214 Ill. App. 104 (1919). 18. See id. that are in or appurtenant to the 52. Id. at 108, 109. real property for the balance of 19. See id. 53. Id. the term of such lease and for 20. Id. at 7. any renewal or extension of such 54. See id. 21. See Bernstein v. Seglin, 184 Neb. 673, 171 rights to the extent that such 55. The landlord-respondent asserted that, N.W.2d 247 (1969). Emphasizing the con- rights are enforceable under “[t]he dual concerns—shortage of hous- tractual aspects of the modern lease, the applicable nonbankruptcy law. ing and unequal bargaining power— court stated, “A modern lease of a busi- which fuel the engine of tenant protection in (B) If the lessee retains its rights ness building ordinarily involves multi- the residential sphere simply do not exist in under subparagraph (A)(ii), the ple and mutual running covenants the commercial context.” Respondent’s lessee may offset against the rent between lessor and lessee.” Similarly, in Brief at 50 (emphasis added). reserved under such lease for the Jackson v. Pepper Gasoline Co., 280 Ky. 226, balance of the term after the date 56. In Whitehouse Estates v. Post, 173 Misc. 2d 133 S.W.2d 91 (1939), the court stated, of the rejection of such lease and 558, 662 N.Y.S.2d 982 (Sup. Ct. App. T., “The lease from appellant to appellee is a for the term of any renewal or 1st Dep’t 1997), the court applied the bilateral contract, since there are mutual extension of such lease, the value anti-mitigation holding from Holy Proper- promises between the parties to the of any damage caused by the ties to a residential lease. However, other lease.” See also Robert Schoshinski, Amer- nonperformance after the date of lower New York courts not bound by the ican Law of Landlord and Tenant § 1.1 such rejection, of any obligation Appellate Term, First Department, could, (1980). of the debtor under such lease, theoretically, recognize the landlord’s 22. Schneiker v. Gordon, 732 P.2d 603 (Colo. but the lessee shall not have any duty to mitigate by distinguishing Holy 1987). other right against the estate or Properties from cases involving residential See Parkwood Realty Co. v. Marcano 23. The landlord’s damages in Holy Properties the debtor on account of any leases. ; Lefrak v. Lambert, supra amounted to $718,841.51. damage occurring after such date note 6. caused by such nonperformance. Holy Properties 24. Schneiker, 732 P.2d at 610. 57. , 87 N.Y.2d at 135, 661 29. See id. § 365(h)(1)(A)(i). N.E.2d at 696, 637 N.Y.S.2d at 966. 25. See id. 30. See id. § 365(h)(1)(A)(ii). 58. Arthur Corbin, Corbin on Contracts § 26. Austin Hill Country Realty v. Palisades 1236, at 533 (1964). Plaza, 948 S.W.2d at 293, 298, 40 Tex. Sup. 31. See id. 59. Cole argued that Paragraph 18 of the J. 924, 75 A.L.R.5th 647 (1997) (citing 32. See id. § 365(h)(1)(B). text). lease provided that tenant was liable for 33. See Holy Properties, 87 N.Y.2d at 135, 661 damages and not rent in the event the 27. Reid v. Mutual of Omaha Ins. Co., 776 P.2d N.E.2d at 696, 637 N.Y.S.2d at 966. lease was canceled as a result of re-entry 896, at 905–906. Note, however, that it or summary eviction proceedings by the may be unlikely that a landlord would 34. See id. landlord. Paragraph 18 stated the tenant deliberately act in this manner in the con- 35. See id. was liable for rent up until the landlord text of modern property realities; this is brought such actions. See Appellant’s 36. See id. especially applicable to residential prop- Brief at 26, 27. erty situations where rent control is a fac- 37. See id. Id tor. 60. . at 26. 38. See supra note 5. 28. 11 U.S.C. § 365(h) (2000) provides, in per- 39. Holy Properties, 87 N.Y.2d at 134, 661 Jason Kee Low is a third-year tinent part: N.E.2d at 696, 637 N.Y.S.2d at 966. law student at St. John’s University (h)(1)(A) If the trustee rejects an 40. 646 S.W.2d 263 (Tex. App. 5th Dist., 1983). School of Law. The author wishes to unexpired lease of real property under which the debtor is the les- 41. See id. sincerely thank Professor Robert M. sor and—(i) if the rejection by the 42. Id. at 265. Zinman for his guidance and trustee amounts to such a breach uncommon wisdom.

NYSBA N.Y. Real Property Law Journal | Spring 2002 | Vol. 30 | No. 2 81 Real Estate Developers: Don’t Buy the Farm! By John D. Kern

Farmland and open space in development rights, allow munici- flood plains can reduce the costs rural America is disappearing at an palities to acquire open spaces to associated with drainage projects.8 estimated rate of 35,000 acres per preserve the “character of the com- Along the same line, nearly one- week and roughly five million acres munity” and quality of life, and cre- third of all the irrigated farmland in yearly.1 As a result, many communi- ate conservation easements.5 This New York State is located in Suffolk ties have felt it necessary to pursue article will analyze the extent of County. This permits the state farm- legislative and legal venues to pro- intrusion that legislative initiatives ing industry to sustain itself in times tect their farmland and open spaces place on the ability of real estate of drought.9 Other industries are also from the marketplace of real estate developers to pursue their projects. dependent upon the farming indus- speculators and developers, and the Attorneys who have a better under- try. These include suppliers, mar- desire of property owners to sell standing of these zoning laws and keters, and, particularly in Suffolk their land to the highest bidder. Real statutes will better serve their clients. County, the tourist industry. Every estate developers should be aware of This will allow the developer to summer thousands of people flock to a growing number of legislative work well with the community, the area due to its particular rural incentives to protect agricultural establishing his goodwill, and and farming character. The Suffolk land that may adversely affect entre- paving the way for future projects. It County Planning Commission esti- preneurs. This has created palpable is a pre-requisite to have an under- mates that the tourist industry has tension between many local commu- standing as to why and how these grown into a $2 billion industry. This nities and real estate developers and lands can be preserved, the impor- would hardly be the case if the entire caused many headaches for attor- tance of doing so, and how attorneys area were turned into some sort of neys. and their clients can work within the east coast Malibu Beach. It is there- regulations. fore essential that people recognize One of the most prevalent exam- that preserving farmland and rural ples of this tension in New York character is necessary to preserve the State is in the area of Suffolk County, $2 billion tourist industry. There are Long Island. In Suffolk County, it is “The agricultural industry also other inter-related agricultural estimated that between 11,000 and provides both economic industries that depend on farming 15,000 acres of farmland a year are and environmental such as equipment sales and rentals, lost to development.2 Some feel this farm centers such as Agway stores, is reaching crisis proportions, espe- benefits to the local veterinary services and products, cially considering that agriculture in economy.” and seed fertilizers.10 Bearing these New York State produces in excess factors in mind, it is easy to see why of $3 billion gross income for the development in Suffolk County has state.3 The Importance of Preserving become a touchy subject. The Constitution of the State of Agricultural Land The agricultural industry pro- New York provides as a policy the While the farmer holds title to vides both economic and environ- preservation of natural resources and the land, actually, it belongs to mental benefits to the local economy. scenic beauty. Article XIV states: all the people because civiliza- Farmland works as a protection of “The policy of the state shall be to tion itself rests on the soil.6 wildlife habitat in that its use is com- conserve and protect its natural —Thomas Jefferson patible with wetland protection and resources and scenic beauty and stormwater filtering, thus saving the encourage the development and It is, first, important to under- state time and money in wildlife improvement of its agricultural land stand why communities want to pre- preservation projects and public for the production of food and other serve their farmlands and open works. This gives the legislature a agricultural products.”4 To carry out spaces, from an economic perspec- strong incentive to restrict develop- this policy, the Legislature has enact- tive. Farm, forest and, open lands ment. ed laws and statutes to address taxa- cost the local community an average tion issues, establish a farmland pro- However, suburban land values of $.37 per acre in community servic- tection trust fund, bar nuisance average 1,800 percent more when es, as opposed to $1.15 per acre for actions against farmers, sever and utilized for building purposes as residential development.7 Protecting sell development rights, transfer opposed to cultivation or grazing.11 farmland in critical areas such as

82 NYSBA N.Y. Real Property Law Journal | Spring 2002 | Vol. 30 | No. 2 In addition, New York farmers pay tive program such as a transfer of open space, and its current market the highest per-acre tax of any agri- development rights (TDR) or a pur- value.18 cultural state.12 The fact of the matter chase of development rights (PDR), In New York, a TDR program is is that farmland is readymade for explained later in this article. A con- governed by statute. A municipality development. It is flat, contiguous, servation easement can also be has the authority to designate the has proper drainage, and has already donated to a charitable organization various sending and receiving zones been cleared of vegetation and tree for significant tax benefits to the for the development rights as long as stumps. One of the purposes of landowner.14 it follows a “comprehensive plan.” many of the zoning techniques is to Further tax benefits are that the The zoning board must assure the continue to make farming an attrac- easement decreases the value of the fact that the area designated as a tive economic pursuit by protecting property, thereby decreasing the receiving zone to where the rights the farmer’s equity in his land, pro- amount of property and estate taxes will be transferred (1) has adequate viding tax incentives and a certain 15 facilities, (2) that there will not be an degree of judicial immunity, particu- that must be paid. The easement adverse environmental impact, and larly from nuisance suits. decreases the value of the land, thereby decreasing the amount of (3) that development is permissible estate taxes that the family must pay. within the district.19 There are vari- Techniques of Farmland This helps to keep the family farm in ous manners in which the develop- Preservation the family, and not force the benefici- ment rights are defined, based upon Having a working knowledge of aries to sell off some of the land to the methods in which development the various preservation techniques pay the taxes.16 is controlled. There may be floor-to- will allow an attorney to better area ratios (FAR), height allowances, understand how to work within the or lot size allowances. It is also zoning laws, saving both time and “The fact of the matter is important to look at the regulations clients’ money. It will also permit the that farmland is ready- within the particular district. The purchasing developer may not be attorney and the client to arrive at a made for development. meeting of the minds and a closing able to use all of his rights in one of the development deal in a more It is flat, contiguous, has district.20 The advantage of TDR pro- expeditious fashion or, as we shall proper drainage, and has grams is that they permit the see later, a transferring of the deal to already been cleared of landowner to benefit financially, an area where it is more needed. allow the developer to develop, and vegetation and tree at the same time preserve open space stumps.” and/or agricultural use of the land. Conservation Easements The farmer receives compensation, A conservation easement is a and an easement protecting the land A similar type of conservation voluntary restriction placed on a is in place without having to imple- easement is the transfer develop- landowner’s property for the pur- ment a regulatory scheme which ment rights or TDR program. The pose of providing for the conserva- might otherwise amount to a taking. concept behind the TDR program is tion, protection, and preservation of Zoning regulations do not necessari- that a landowner who is in a regulat- open space, natural, historic and cul- ly address the fairness issue for the ed area, the regulations of which tural resources.13 An agricultural landowner. Since TDR programs restrict development, may sell the conservation easement is defined as require the voluntary participation of development rights to a developer. a voluntary legally recorded agree- the landowner, the fairness problem The developer in turn will then use ment between the landowner and a is significantly resolved. qualified conservation organization these rights to build in an area where that restricts land to agriculture and such development is more appropri- A purchase of development open spaces. Landowners sell agri- ate and needed. When development rights program or PDR is similar to a cultural conservation easements to a rights are transferred from one piece TDR program, except that a govern- private conservation or government of property, the land is then restrict- ment body, as opposed to a private agency. This is also called a purchase ed with a permanent agricultural individual or business entity, pur- 17 of an agricultural conservation ease- conservation easement. The price chases the landowner’s development ment or “PACE” and is designed of the development rights is equal to rights creating a conservation ease- 21 specifically to protect farmland. Its the reduction in the market value of ment. This is also a voluntary pro- purpose is to limit the practice of the land resulting from the removal gram. It is much less of an economic subdividing and development. This of the development rights. This burden to the government entity is a very flexible tool and is usually would be the difference between the because it is only purchasing a part combined with another administra- value of the land for agricultural or of the land as opposed to purchasing

NYSBA N.Y. Real Property Law Journal | Spring 2002 | Vol. 30 | No. 2 83 the entire land for its full market still retains all other rights with the lease; likewise, however, the land is value. Unfortunately for the devel- exception that he cannot build on the only preserved for the time period of oper, once the government entity land. Some exceptions are allowed to the lease. In addition, if the munici- purchases the development rights permit farm-related structures on the pality cannot maintain its lease pay- they will not be sold to the develop- land.24 The PDR is also a more per- ments, the land returns to the farmer er. In New York State, preservation manent mechanism than zoning. along with the right to develop it.26 of open space is a statutorily permit- Zoning is often subject to the whims Knowing when these leases expire ted purpose, unless it can be shown of political pressure, and can change will allow an attorney to seize a that a statute was enacted for an at almost any time and for almost valuable business opportunity for a improper purpose.22 Therefore, if a any reason. client. developer’s attorney receives knowl- edge of a PDR about to occur, he Agricultural Districts should recognize it as an opportuni- “[I]f a developer’s attorney ty and start negotiating for a TDR in receives knowledge of a Agricultural districting is a plan his client’s favor. Municipalities are that is authorized at the state level open to this, as it shifts the economic PDR about to occur, he and enacted at the local level. It per- burden of land preservation to the should recognize it as an mits a landowner or group of private sector. opportunity and start landowners to take advantage of various land preservation techniques Suffolk County was the first negotiating for a TDR (such as PDRs and TDRs) by volun- local municipality to enact a PDR in his client’s favor. tarily designating their land as an program to protect its farmland.23 It Municipalities are open agricultural district, participating in is based upon New York General to this, as it shifts the the TDR or PDR program, and retir- Municipal Law § 247(2) which states: ing the land from development pos- economic burden of land sibilities. This is more advantageous The acquisition of interests preservation to the private than having regulations forced upon or rights in real property for them through zoning ordinances.27 the preservation of open sector.” Agricultural districts provide many spaces and areas shall consti- benefits to landowners. One such tute a public purpose for PDR programs are not without benefit is eligibility for differential which public funds may be their problems. Although cheaper tax assessments. This will allow for expended or advanced, and than buying all of the farmer’s land, lower tax assessments and may also any county, city, town or vil- funding is always a problem. The exempt the farmer from further spe- lage after due notice and results of the PDR programs (and cial tax assessments. Some districts public hearing may acquire TDR programs as well) often pro- require the landowners to sign an by purchase . . . develop- duce fragmented conservation ease- agreement that prohibits develop- ment right, easement, ments. This is to say the easements ment for the term of the enroll- covenant, or other contractu- are spread out sporadically and do ment.28 If the landowners break the al right necessary to achieve not follow a cohesive contiguous agreement, many districts impose the purposes of this chapter, plan.25 There has been some discus- severe financial penalties.29 New to land within such munici- sion in county legislatures of allow- York, for example, imposes a penalty pality. ing the sale of a PDR, but this is little of five times the tax saved in the last The statute gives local governments more than just talk. year in which the land benefited explicit authority to purchase inter- from the special agricultural assess- A relatively new solution is a ests in private land condemning it ment.30 lease of development rights program for the purpose of preserving farm- or “LDR.” In an LDR, the farmer A landowner wishing to partici- land for agriculture, or open spaces, gives up his right to develop on the pate must first apply to the local and restricting its nonagricultural land for a period of time in exchange government. The local government use. The restriction is a negative for a yearly lease. This helps spread then reviews and approves the appli- instrument in gross. It is then record- the costs of the easement for the cation. The application is then sent to ed with the property deed as a municipality. The farmer still has the the state government for final covenant that runs with the land. value of his equity in his land approval. State governments often The buyer (in this case a local gov- because the development rights are require that the local municipality ernment) then has the rights and not completely lost. They are merely already have a plan in place to pro- responsibility to prevent develop- suspended for the time period of the tect the agricultural land, such as a ment on the land. The landowner

84 NYSBA N.Y. Real Property Law Journal | Spring 2002 | Vol. 30 | No. 2 PDR or TDR, before the landowner more preferred use (i.e., residential) agricultural land to nonagricultural may file the application.31 If a devel- is not permitted in the lower catego- uses.40 oper feels he has found an opportu- ry (i.e., agricultural). All of the speci- The concern for communities in nity the viability must be cross- fied use of the zone is dedicated maintaining large blocks of farmland checked to see if the area is under an exclusively to the designated use. is to preserve what is called the criti- agricultural districting plan. If the Therefore, if the area is zoned for cal mass of agricultural land. This is developer unwittingly violates the agricultural use, the land can only be the threshold of land that must not district plan and the agreement there dedicated to agriculture and other be developed in order to ensure that will be severe monetary penalties closely related uses.34 In New York there will be enough farmland to incurred. Unless the developer is State, to overcome the zoning use, or support the local industries that willing to pick up the monetary to get a variance, a landowner must 41 penalties from violating the district establish practical difficulties of service it. A properly executed APZ plan and the agreement (in New unnecessary hardship or significant is a substantial hurdle for develop- ment in that it places a substantial York, five times the amount of tax economic injury.35 The records must restriction on the development saved in the last year) pursuing the show that: (1) the land in question potential of large tracts of land. opportunity would be an exercise in cannot yield a reasonable return if futility. The economic penalties are used only for the purpose allowed in simply too strong. that zone, (2) the plight of the owner Buffer Zones is due to unique circumstances and Buffer zones are also a common Agricultural Protection Zoning not to the general conditions in the zoning technique used in America neighborhood which may reflect the today. They are similar to the Euclid- In most states, agricultural pro- unreasonableness of the zoning ordi- tection zoning or (APZ) is imple- ean method in that their purpose is nance itself, and (3) the use to be to separate designated zoning areas mented at the county level. Howev- authorized by the variance will not er, towns and townships may also from one another by supplying a alter the essential character of the natural progression from one type of have APZ programs. Early agricul- locality.36 Some jurisdictions have tural zoning programs were based zoning to another. Certain types of held that the challenger must over- industrial commercial uses, or possi- on the traditional or Euclidean zon- come the presumption of the validity ing method. The Euclidean principle bly even high-rise residential build- by showing that there is no relation ings, are simply not appropriate for is governed by the concept that zon- to the public health, safety, or wel- ing extremes should be separated residential communities, and there- fare.37 Agricultural zoning has also fore need to be separated.42 from one another, if not by natural withstood Fifth Amendment chal- features or surface infrastructures, lenges as it has been considered a In cluster zoning, the purpose is then perhaps by intervening medi- valid exercise of police power for a to meet the maximum amount of 32 um-intensity zones. It is driven by governmental entity.38 density allowed on a particular tract both the aesthetic and the compati- of land. Improvements are also ble. This became known as cumula- Despite the appearance of dura- placed on the tract so as to allow the tive zoning. This meant that all high- bility, agricultural zoning has been preservation of open space or buffer er or more preferred uses are challenged and overcome through areas on certain borders. This way permitted in lower categories in petitions and political pressure. The the new development does not abut order to create the separation.33 Agri- controversy generally settles around the agricultural land. However, often cultural use was ranked at or near the issue of “downzoning.” When an this land is owned by the developers the bottom. Therefore, as was often APZ ordinance is enacted, it results or homeowners’ association.43 Prop- the case, residential or commercial in a reduction of permitted residen- erty owners may object to renting dwellings were erected in agricultur- tial densities in the new zone. This their open space to farming opera- ally zoned areas adjacent to farms reduction is called downzoning, and tions because of the various nui- despite their incompatibility. The invariably results in the reduction of sances with which farming is associ- result was often nuisance suits. This the market value of land.39 “Upzon- ated. Oftentimes the land itself is would in turn lead farmers, who ing” is the opposite. This is when simply not large enough for a farmer after finding that farming was no more residential dwellings are per- to support large commercial agricul- longer profitable or enjoyable, to sell mitted in the area. Petitions for tural operations.44 The end result is their farms to developers for the upzoning or rezoning of farmland often one which serves well to pre- higher uses. have been successful. APZs do, how- serve open spaces for the enjoyment ever, remain as the method most of the residents, but is not necessari- Today, zoning ordinances are commonly used in the United States more non-cumulative. The higher or ly an effective tool to preserve farm- for preventing the conversion of land.

NYSBA N.Y. Real Property Law Journal | Spring 2002 | Vol. 30 | No. 2 85 A technique similar to cluster any possible higher use. This would Appeals decision, Town of Lysander v. zoning is the planned unit develop- in turn require compensation from Paul Hafner,51 a farmer in Onondaga ment (PUD). The PUD allows for res- the local municipality, which many County was allowed to keep sin- idences in which people can live small communities can ill afford. glewide mobile home structures on combined with open spaces, recre- his property to house farm workers. Discouraging the development ational areas, and convenience, com- The Supreme Court and the Appel- of the land by affecting the market mercial, business and professional late Division had granted summary value is often done through a tech- buildings.45 This protects the adja- judgment to the town enjoining nique of large lot zoning. This is cent farmland from being developed Farmer Paul from using mobile done by establishing high minimum to support the various services nec- homes without building permits and lot acreage for development. In some essary for a community’s survival. certificates of occupancy. The lower cases, the lot size may be as high as Like cluster zoning, the buffered courts had held that section 305- 160 acres.49 Needless to say, this may areas that are not built upon can be a(1)(a) did not create an exemption also result in an adverse effect on the placed between the community of from local zoning authorities or ordi- market value of the land and bring residences and the nearby farmland. nances for all “farm operations,” and about a takings issue. This provides greater protection for that the statute did not provide any the farms and prevents any possible protection to “farm residential build- nuisance issues. The main opposition Accessory Uses ings,” including mobile homes.52 The to the PUD is that it conflicts with If a farmer is able to realize sig- Court of Appeals, however, reversed the traditional zoning of separation nificant economic benefits from his and granted Mr. Hafner summary of uses.46 It is still, however, land, he will be much less likely to judgment. The higher court looked embraced by many states and com- sell it to developers. Agriculture & to the legislative intent of section munities as a technique to permit Markets Law § 305-a(1)(a) states that 303, which gave county legislative proper and compatible use of land. It “local governments, when exercising bodies the power to create agricul- allows for preservation, while still their powers to enact and administer tural districts. The Court held that providing people with places to live comprehensive plans and local laws lands falling within those “agricul- and the services necessary to sustain . . . shall not unreasonably restrict or tural districts” may be entitled to a community. regulate farm operations within agri- various statutory protections and benefits. According to section For the PUD to work effectively, cultural districts in contravention of 301(11), buildings located on farms it must be combined with a floating the purposes of this article unless it may be considered part of farm zone program. This is to say that the can be shown that the public health operation. The legislative history zoning ordinance is held back to or safety is threatened.” Allowing a supports the view that the statute “float” until an appropriate use and farmer to use the land for something was amended in 1997 to strengthen, location for the development can be other than the specific use of farming not limit, the protections against figured out. Once the proper use is to realize economic gain may accom- unreasonably restrictive local laws defined, however, the ordinance is plish this benefit. This can be done and ordinances. The Town failed to then mapped. This could create through a policy of accessory uses. make any evidentiary showing that problems in a community, particular- Such accessory uses may include an absolute ban on singlewide ly if certain neighbors end up with a limited commercial uses such as mobile homes was needed because commercial or industrial use abut- opening shops or stands or farmers’ the public health or safety was ting their property. If the abutting markets. Permitting the farmer to threatened. The Court went on to use becomes significantly inconsis- use a dwelling for a bed and break- hold that “farmers rely on mobile tent, an issue of spot zoning may fast to take advantage of the tourist home housing for their farm laborers arise.47 industry is another possibility. Some municipalities have even permitted to accommodate the long work day, A result that often accompanies farmers to have low-level apartment seasonal housing needs and to cluster zoning and PUDs is open houses on their property which they address the real shortage of rental space zoning. The concept is that the may rent out to tenants.50 The housing in rural areas. Local govern- adjoining farmland or open space is advantage of this technique is that it ment prohibitions or restrictions on simply zoned as unavailable for permits the farmer to realize signifi- the use of mobile homes can signifi- development.48 This, however, is a cantly more economic gain in a more cantly impair the viability of farm very extreme measure, and invari- subtle way. It serves a dual purpose operations.”53 This is a big victory ably affects the market value of the of preserving the farmland while at for farmers, allowing them an acces- land. The end result may often be the same time addressing the pub- sory use that will facilitate their considered a taking if the landowner lic’s concern for the character of the industry. suddenly finds his land zoned out of community. In a recent Court of

86 NYSBA N.Y. Real Property Law Journal | Spring 2002 | Vol. 30 | No. 2 Whichever technique is used, the Endnotes 26. Id. municipality, landowner, and the 1. Julian Conrad. Juergensmeyer & Thomas 27. Id. developer must bear in mind that E. Roberts, Land Use Planning and Con- 28. American Farmland Trust, supra note 3. trol Law (1998) (hereinafter “Juergens- zoning is a valid excise of authority. 29. Id. The concept of property ownership meyer”). 30. Juergensmeyer, supra note 1 (citing N.Y. 2. Telephone interview with Kevin Mac- is one of a bundle of rights. Some Agric. & Mkts. Law § 306). Donald, Vice-President, The Group For rights belong to the property owner The South Fork, (Aug. 2, 2001) (here- 31. American Farmland Trust, supra note 3. and some to the municipality repre- inafter “MacDonald interview”). 32. David Callies, Robert H. Freilich & senting the community interests as a 3. American Farmland Trust, Agricultural and Thomas E. Roberts, Cases and Materials whole. Property owners are not per- Farmland Protection for New York, at on Land Use, 3d Edition (1999) (here- mitted simply to do as they see fit http://www.farmland.org (hereinafter inafter “Land Use”). with their land. Simply because an “American Farmland Trust”). 33. Juergensmeyer, supra note 1 at 618. individual purchased farmland at a 4. N.Y. Const. art. XIV, § 4. 34. Id. low price 30 years ago, does not 5. Sean F. Nolon & Cozata Solloway, Pre- 35. In re Doyle, 79 N.Y.2d 592, 597, 584 mean that he or she has the right to serving Our Heritage: Tools to Cultivate N.Y.S.2d 417 (1992). Agricultural Preservation in New York sell it to the highest bidder to build State, 17 Pace L. Rev. 591 (1997). 36. Mignon M. Otto v. Albert Steinhilber, 282 the East Quogue Trump Taj Mahal. N.Y. 71, 73 (1939). 6. Sam Sheronick, The Accretion of Cement and Steel onto Prime Iowa Farmland: A Pro- 37. William Weinstein, Zoning and Land posal for a Comprehensive State Agricultur- Use Control, Discrimination and Exclu- “Simply because an al Zoning Plan, 76 Iowa L. Rev. 583 sion in Zoning § 3.01 (2001). individual purchased (1991). 38. Id. farmland at a low price 30 7. American Farmland Trust, supra note 3. 39. American Farmland Trust, supra note 3. years ago, does not mean 8. David L. Szlanfucht, How to Save Ameri- 40. Nolon, supra note 5. ca’s Depleting Supply of Farmland, 4 Drake that he or she has the J. Agric. L.333 (1999). 41. American Farmland Trust, supra note 3. right to sell it to the 9. Agricultural & Farmland Protection 42. Village of Euclid et al. v. Amber Realty Co., Plan, Suffolk County, Executive Summa- 272 U.S. 365, 384 (1926). highest bidder to build the ry (1998). 43. Juergensmeyer, supra note 1 at 623. East Quogue Trump Taj 10. Nolon, supra note 5. 44. American Farmland Trust, supra note 3. Mahal.” 11. Juergensmeyer, supra note 1 at 597. 45. Juergensmeyer, supra note 1. 12. 17 Pace L. Rev. 591. 46. Id. 13. N.Y. Envtl. Conserv. Law § 49-0203(1)(3) 47. Land Use, supra note 32 at 136. Conclusion (McKinney 2001). 48. American Farmland Trust, supra note 3. 14. American Farmland Trust, supra note 3. Should one buy the farm for 49. Juergensmeyer, supra note 1 (citing Wil- development? One needs to be fully 15. Nolon, supra note 5. son v. County of McHenry, 92 Ill. App. 3d aware of what one is getting into. 16. Id. 997, 416 N.E.2d 426 (1981)). Zoning is a very strange animal. The 17. American Farmland Trust, supra note 3. 50. American Farmland Trust, supra note 3. attorney may even better serve his 18. Patricia Salkin, Zoning and Land Use 51. Town of Lysander v. Hafner, 96 N.Y.2d 558, client’s interest by enlisting local Control, Land Acquisition Programs § 733 N.Y.S.2d 358 (2001). counsel when attempting to deal 56.04 (2001). 52. See id. at 562–563. with zoning issues and trying to rec- 19. New York Town Law § 261-a(2)(a). 53. Id. at 564 (quoting the conclusions of the ognize opportunities at a local level. 20. Salkin § 56.04, supra note 18. Commissioner of Agriculture and Mar- Many a competent real estate or kets). 21. Id. transactional attorney who handles 22. North Shore Unitarian Universalist Society John D. Kern will receive his many diverse real estate matters for v. Incorporated Village of Upper Brookville, J.D degree from St. John’s Universi- a client has run into trouble when it 110 A.D.2d 123, 493 N.Y.S.2d 564, 565 (2d ty School of Law in June of 2002. comes to dealing with zoning boards Dep’t 1985). He is a student co-editor in chief of and municipalities. Being familiar 23. Mark R. Riely, Evaluating Farmland the New York Real Property Law with how to navigate through the Preservation Through Suffolk County, New Journal. This article is based on a sea of complex rules, political issues, York’s Purchase of Development Rights Pro- gram, 18 Pace Envtl. L. Rev. 197 (2000) term paper written for Professor and sometimes egos, will help an (citing Local Law 19-1974. Now codified Patrick J. Rohan, Dean Emeritus at attorney to better serve his client and as Local Law 16 in Chapter 8 of The Suf- St. John’s University School of Law, facilitate matters for the client in folk County Code). for his course in Land Use and future deals. 24. American Farmland Trust, supra note 3. Planning. 25. Riely, supra note 23.

NYSBA N.Y. Real Property Law Journal | Spring 2002 | Vol. 30 | No. 2 87 BERGMAN ON MORTGAGE FORECLOSURES Non-Judicial Foreclosure Renewed in New York By Bruce J. Bergman

Who was York has always been among the Number S.4784A (the 2001 extension waiting with most difficult states in the judicial of the statute until 2005), the pur- bated breath category. pose of the bill was recited as being for this one? “to extend the provisions of Article So, New York made an attempt Servicers of 14 of the Real Property Actions and in 1998 to ease the process. The commercial Procedures (sic) law, which provides details of why that effort did not loans, per- for the foreclosure of certain com- achieve expectations are too lengthy haps; ser- mercial mortgages by power of sale.” to address here, so reference will be vicers of resi- 1 Given the statute’s somewhat dential loans, made to a more expansive source. limited breadth, maybe all this is perhaps not. In short, though, a main problem small comfort. But at least for what it (May we with non-judicial foreclosure in New is worth, non-judicial foreclosure opine that it should be all mortgage York is that it is available only for continues to exist (although not lenders and attorneys who represent non-residential properties. Even as to thrive) in the Empire State. them?) But there is a value in know- commercial properties which are cov- ing that the procedure exists in New ered by the statute, there is much York—even to recognize that it may room for a borrower to thwart the Endnotes have limited application. procedures.2 In the end, probably the 1. See 1 Bergman on New York Mortgage Foreclosures, § 8.03, “Exceptions and To immediately address the first best use of non-judicial foreclosure is in consensual commercial cases. Impediments to Power of Sale Foreclo- point, non-judicial foreclosure came sure” (Matthew Bender & Co., Inc., rev. to New York (hallelujah) on July 7, The genesis of what became the 2002). 1998. It was to be effective, however, new Article 14 was the labor of a 2. Id. only until July 1, 2001. Not surpris- New York State Bar Association task © Copyright 2002 Bruce J. ingly, on June 29, 2001, the New York force intending to shortcut the time- Bergman State Legislature extended the consuming judicial foreclosure statute (RPAPL Article 14) to July 1, process generally in New York State. Mr. Bergman, author of the 2005. Although large commercial foreclo- three-volume treatise, Bergman on So, non-judicial foreclosure goes sures in particular tended perhaps to New York Mortgage Foreclosures, on in New York. How much does it suffer unduly from protracted Matthew Bender & Co., Inc. (rev. matter? delays, there was no intention by the 2002), is a partner with Certilman state bar to confine the prospective Balin in East Meadow, New York, Lenders who originate and serv- streamlined statute to commercial an Adjunct Associate Professor of ice mortgage loans throughout the cases and exclude residential foreclo- Real Estate with New York Univer- country are gleefully aware that in sures. When the state bar draft went sity’s Real Estate Institute where he almost half the states, speedy non- through the legislative process, how- teaches the mortgage foreclosure judicial or power of sale foreclosure ever, residential properties were course and a special lecturer on law is the preferred method. These excluded as subjects for non-judicial at Hofstra Law School. He is also a lenders are likewise, but painfully, foreclosure. Although the statute is member of the USFN and the aware that in a majority of states, not labeled as applying essentially to American College of Real Estate time-consuming and expensive judi- non-residential properties, such is its Lawyers. cial foreclosure is the path to enforce actuality. In the New York State Sen- a defaulted mortgage. And New ate Memorandum in Support of Bill

88 NYSBA N.Y. Real Property Law Journal | Spring 2002 | Vol. 30 | No. 2 New York State Bar Association Committee on Professional Ethics By Peter Coffey

On February 1, 2001, the New That being said, we can discuss in the sum of $200,000. The title com- York State Bar Association Commit- some escrow account issues both pany requires a check in the sum of tee on Professional Ethics issued inside and outside the scope of the $375,000—the payoff of seller’s mort- Opinion 737, establishing a bright opinion. Again, particularly noted is gage. In order for the closing to take line approach regarding the issuing that the Opinion speaks of writing place, either seller’s attorney or of escrow checks against “undeposit- escrow checks against checks bank’s attorney will have to process ed or uncleared client funds.” The received “in the form of a bank or certi- these checks through his or her Committee’s decision was as follows: fied check.” We are not talking about escrow account and issue an escrow “A lawyer may not issue a check putting a client’s personal check into check of $375,000 to satisfy the mort- from an attorney escrow account an escrow account and writing an gage. drawn against a bank or certified escrow check against that check. Many would think this is a sim- check that has not been deposited or That is simply impermissible and ple case and the answer is clear— has not cleared.” (Emphasis sup- will bring swift and certain disci- checks can only be written on col- plied). In my opinion the “or” should pline when the Lawyers’ Fund lected funds. However, the Opinion either read “and” or be omitted reports to the Ethics Committee that itself indicates the complexity entirely as the mention of a deposit the attorney has had a check involved. The Opinion cites five rea- is not crucial (checks cannot clear returned for insufficient funds. Fur- sons supporting the practice, and unless they are deposited!). In simple thermore, we are not speaking of while I believe the Committee articu- terms, the Committee requires that issuing checks against wired funds lately dismisses these reasons, the the check clear—i.e., that funds be in which have not been verified to be in fact that five well-reasoned opinions the account as a result of the negotia- the account. I am sure no one needs can be given for sustaining the prac- tion of the instrument. Surely the to be reminded that whether Ethics tice indicates the complexity of the Committee is not saying that simply are or are not involved liability is, situation. Furthermore, the Opinion depositing is sufficient. I do not and a returned check will have to be acknowledges that other states have believe the language really indicates made good. In this regard, failure to come to a different opinion. nor did the Committee in any way replace the checks with valid funds intend to have that sentence read will result in discipline. The Opinion cites three cases in “either/or.” However the use of the support of its opinion. All cases con- word “or” does give a potential tain in the parenthetical description reading to the sentence of that “There is nothing which of the case the words “inter alia.” nature. will excite the passions of Those two words are particularly appropriate to the three citations as RULE 1: There is nothing which Disciplinary Committee indeed there were a substantial num- will excite the passions of Discipli- attorneys more than a ber of other reasons why discipline nary Committee attorneys more than perceived problem with was imposed. I suggest that those a perceived problem with an escrow an escrow account.” cases do not support a finding of dis- account. In this discussion always cipline—certainly not discipline at remember Rule 1 and remember the Appellate Division level—for the Corollary 1 to Rule 1. In their excite- The Opinion singles out residen- sole reason that checks were issued ment disciplinary attorneys cannot tial closings as the setting in which against uncollected funds. The factu- restrain themselves to limiting exam- the issue arises most often. In addi- al descriptions point to different situ- ination or investigation to the prob- tion to the situation set forth in the ations; in the Abbatine case, the lem at hand. Examination of every Opinion, I would add another: The $10,000 deposit against which the conceivable aspect of your escrow purchase price is $500,000 and the $4,147.18 check was issued was not account activity for the entire length balance due on the seller’s mortgage made for 16 days; the Ferguson case of your practice is the desire of this is $375,000. The seller’s attorney involved the issuance of a check excited disciplinary attorney. (I un- receives an escrow check drawn on against “wired” funds not yet derstand the seven (7) year rule—not the escrow account of the bank’s received; in the Joyce case, the Appel- all the desires of even disciplinary attorney in the sum of $300,000 and late Division did indeed sustain a attorneys are fulfilled.) the purchaser delivers a bank check

NYSBA N.Y. Real Property Law Journal | Spring 2002 | Vol. 30 | No. 2 89 charge that “[o]n at least four occa- situation posed by the Opinion and available funds. If the checks were sions, the respondent issued checks the situation described in this article, written at closing and clearly not from his escrow account for a partic- what will happen to the attorney? against the available funds but the ular transaction in advance of The first complexity is whether or deposit was made immediately after depositing the subject funds into this not there were “available funds.” the closing and something happened escrow account, causing checks to (Remember again the discussion with the clearing of the checks or clear against the funds of other above—it is clearly the intent of this God forbid the checks actually blew clients or third parties.” However, Opinion that “deposit” is not the away, the lawyer would probably there were a host of other charges, operative event.) Oftentimes banks receive a letter not constituting disci- and the conduct cited first by the pline. (The second time is probably a court is abhorred by real estate prac- different matter.) titioners. Joyce represented a bank at “If you exercise good If you exercise good conserva- closing and held escrow monies for conservative judgment tive judgment and the worst hap- items to be completed on a new pens, you can, in my opinion, avoid home. He released the funds to the and the worst happens, discipline. building without obtaining the per- you can . . . avoid mission of the purchaser’s attorney. discipline.” Finally, I want to state that I am not nor is the Real Property Law Sec- Anytime a check is returned for tion of the New York State Bar Asso- insufficient funds and proper expla- will make funds available to the ciation advocating this practice. I am nation cannot be given to the bank attorney or law firm if the funds simply discussing what I believe are within five days, the bank is have been on deposit for one day. It the ethical consequences of an attor- required to report the matter to the is not inconceivable that in certain ney participating in such conduct— Lawyers’ Fund which in turn is cases funds will be made available which conduct is not simply com- required to report the matter to the immediately upon the deposit. I mon but is, in reality, all but appropriate Disciplinary Committee. know of at least one Committee mandatory for any attorney wishing Let us assume the worst. The matter which will not discipline an attorney to practice in this area. is reported to the Committee. In the who writes an escrow check against

Struggling with an ETHICS ISSUE?

NYSBA CAN HELP! E-mail: [email protected] or fax your question to: 518-487-5694.

90 NYSBA N.Y. Real Property Law Journal | Spring 2002 | Vol. 30 | No. 2 Bar Association Announces Web Site Redesign By Michael J. Berey

At the Annual Meeting of the Legal research by use of the Web New York State Bar Association held site will be enhanced for members in Manhattan in January of this year, through a new partnership with the Association’s Electronic Commu- Loislaw, a Division of Aspen Pub- nications Task Force announced that lishers. Loislaw will enable access, a redesigned, more dynamic Associa- without charge, to cases reported in tion Web site is expected to be rolled New York State courts and the Sec- out this May. ond Circuit Court of Appeals within On May1st, the immediately prior three years. The Web site, at , reports the activi- In addition, under the Associa- attorneys ties of 68 Committees and 23 Sec- tion’s arrangement with Loislaw, tions, including the Real Property representatives of the Real Property got a Law Section, in over 12,000 pages. Law Section can track for the Sec- Still, the Electronic Communications tion’s members newly reported cases powerful Task Force responded to a perceived which will be highlighted in the Sec- need to make the Web site easier to tion’s part of the Web site. This will new navigate and to have it always be be accomplished by directing the current in its content. Many of the Loislaw database to match certain . changes will be obvious only to key words, such as “condemnation” resource Association members, who have or “mortgage tax,” and to report • myNYSBA personalized home- complete access to what the site has cases with such terms in their text to page, customized based on to offer, but the redesign will also the Section. Articles published in the your interests and preferences suggest to visitors that there is value N.Y. Real Property Law Section Journal • free access to online legal in being a member of the Associa- will also be available through Lois- research, access to recent cases, tion. law, allowing the cases and statutes and legal alerts referenced in an article to be What are some of the services • legal updates delivered right to accessed through the use of hyper- the new Web site has to offer? Each your desktop links inserted in the text. member will be able to create a per- • myCLE credit tracker to man- sonal profile enabling ready access to The March/April issue of the age CLE credits content of particular interest. Regis- State Bar News details the scope of • citation-enhanced, searchable tration to the Association’s Continu- the Association’s redesigned Web ethics opinions ing Legal Education programs and site and provides instructions on • and much more . . . individualized CLE credit tracking how to access the new features. The will be available online. An electron- New York State Bar Association is ic bulletin board will be part of the taking steps to provide further value site, enabling discussion amongst to its members. The new members on issues of common inter- www.nysba.org est. Members will be notified of Michael J. Berey is Chair, Com- updates to the site by e-mail. mittee on Computerization and Technology, Real Property Law Sec- Easier location of substantive tion, New York State Bar Associa- material on the Association’s Web tion. site will be possible through an enhanced search function and the provision of an extensive table of contents. New York State Bar Association

NYSBA N.Y. Real Property Law Journal | Spring 2002 | Vol. 30 | No. 2 91 Real Estate Titles, Third Edition

An Essential Guide To The Many Complex Subjects Surrounding Real Estate Titles

—updated with new decisions, statues and regulations

• The Nature of Title and Estates in New York • Search and Examination of Title • Parties and Capacity to Buy and Sell • Federal Deposit Insurance Corporation • Devolution of Title by Death • Real Estate Descriptions Plottings, Sur- veys and Maps • Deeds • Mortgages • Liens and Encumbrances • and much more!

List Price: $160 (incls. $11.85 tax) Mmbr. Price: $130 (incls. $9.63 tax)

To order call 1-800-582-2452 or visit us online at www.nysba.org Product Number: 42101 Source Code: CL1539 New York State Bar Association

92 NYSBA N.Y. Real Property Law Journal | Spring 2002 | Vol. 30 | No. 2 Section Committees & Chairs The Real Property Law Section encourages members to participate in its programs and to volunteer to serve on the Committees listed below. Please contact the Section Officers or Committee Chairs for further information about the Committees.

Committee on Attorney Opinion Committee on Condemnation, Letters Certiorari & Real Estate Taxation John M. Wilson, II (Co-Chair) David J. Zinberg (Co-Chair) Robert L. Beebe (Co-Chair) 2400 Chase Square 250 Park Avenue 514 Vischers Ferry Road Rochester, NY 14604 New York, NY 10177 Clifton Park, NY 12065 (585) 232-5300 (212) 907-9601 (518) 373-1500 Fax: (585) 232-3528 Fax: (212) 907-9681 Fax: (518) 373-0030 E-Mail: [email protected] E-Mail: [email protected] E-Mail: [email protected] Committee on Land Use & Planning Jill M. Myers (Co-Chair) Jon N. Santemma (Co-Chair) Karl S. Essler (Co-Chair) 46 Prince Street 120 Mineola Boulevard, Suite 240 Two State Street, 14th Floor Rochester, NY 14607 Mineola, NY 11501 Rochester, NY 14614 (716) 697-0041 (516) 294-8081 (716) 232-1660 Fax: (716) 697-0043 Fax: (516) 294-8302 Fax: (716) 232-4791 E-Mail: E-Mail: [email protected] E-Mail: [email protected] [email protected] Committee on Condominiums & Carole S. Slater (Co-Chair) Committee on Awards Cooperatives 36 West 44th Street, Suite 712 John G. Hall (Chair) David L. Berkey (Co-Chair) New York, NY 10036 57 Beach Street 845 Third Avenue, 8th Floor (212) 391-8045 Staten Island, NY 10304 New York, NY 10022 Fax: (212) 391-8047 (718) 447-1962 (212) 935-3131 E-mail: [email protected] Fax: (718) 273-3090 Fax: (212) 935-4514 E-Mail:[email protected] E-Mail: [email protected] Committee on Landlord & Tenant Proceedings Committee on Commercial Leasing Joseph M. Walsh (Co-Chair) Edward G. Baer (Co-Chair) Austin J. Hoffman, II (Co-Chair) 42 Long Alley 342 Madison Avenue 4 Clinton Square Saratoga Springs, NY 12866 New York, NY 10173 Syracuse, NY 13202 (518) 583-0171 (212) 867-4466 (315) 422-7000 Fax: (518) 583-1025 Fax: (212) 867-0709 Fax: (315) 422-7019 E-Mail: [email protected] E-Mail: [email protected] E-Mail:[email protected] Committee on Continuing Legal Gerald Goldstein (Co-Chair) Joshua Stein (Co-Chair) Education 500 Old Country Road, Suite 107 885 Third Avenue, 10th Floor Terrence M. Gilbride (Co-Chair) Garden City, NY 11530 New York, NY 10022 One M&T Plaza, Suite 2000 (516) 248-6400 (212) 906-1342 Buffalo, NY 14203 Fax: (516) 248-6422 Fax: (212) 751-4864 (716) 848-1236 E-Mail: [email protected] E-Mail: [email protected] Fax: (716) 849-0349 E-Mail: [email protected] Committee on Legislation Task Force on Computerization & Robert W. Hoffman (Co-Chair) Technology Harold A. Lubell (Co-Chair) 1802 Eastern Parkway Michael J. Berey (Co-Chair) 1290 Avenue of the Americas Schenectady, NY 12309 633 Third Avenue, 16th Floor New York, NY 10104 (518) 370-4743 New York, NY 10017 (212) 541-2130 Fax: (518) 370-4870 (212) 850-0624 Fax: (212) 541-4630 E-Mail: [email protected] Fax: (212) 331-1511 E-Mail: [email protected] E-Mail: [email protected] Gary S. Litke (Co-Chair) Committee on Environmental Law 237 Park Avenue. 20th Floor Leonard E. Sienko, Jr. (Co-Chair) Joel H. Sachs (Co-Chair) New York, NY 10017 12 East Main Street 1 North Broadway, Suite 700 (212) 880-6190 Hancock, NY 13783 White Plains, NY 10601 Fax: (212) 682-0200 (607) 637-5400 (914) 946-4777 E-Mail: [email protected] Fax: (815) 361-2750 Fax: (914) 946-6868 E-Mail: [email protected] E-Mail: [email protected]

NYSBA N.Y. Real Property Law Journal | Spring 2002 | Vol. 30 | No. 2 93 Committee on Low Income & Janet Sandra Stern (Co-Chair) Committee on Real Estate Affordable Housing 1025 Old Country Road, Suite 205 Financing Jerrold I. Hirschen (Co-Chair) Westbury, NY 11590 Leon T. Sawyko (Chair) 36 West 44th Street, Room 712 (516) 876-1106 99 Garnsey Road New York, NY 10036 Fax: (516) 997-7876 Pittsford, NY 14534 (212) 819-1130 E-Mail: [email protected] (585) 419-8632 Fax: (212) 302-8536 Fax: (585) 419-8815 E-Mail: [email protected] Committee on Publications E-Mail: [email protected] William A. Colavito (Co-Chair) Brian E. Lawlor (Co-Chair) One Robin Hood Road Committee on Title & Transfer 38-40 State Street Bedford Hills, NY 10507 Karl B. Holtzschue (Co-Chair) Albany, NY 12207 (914) 666-4606 122 East 82nd Street, Apt. 3C (518) 486-6337 Fax: (914) 241-1881 New York, NY 10028 Fax: (518) 473-8206 E-Mail: [email protected] (212) 472-1421 E-Mail: [email protected] Fax: (212) 472-6712 Joseph D. DeSalvo (Co-Chair) E-Mail: [email protected] Committee on Membership 188 East Post Road, 4th Floor Richard S. Fries (Chair) White Plains, NY 10601 Samuel O. Tilton (Co-Chair) 405 Lexington Avenue (914) 286-6415 2 State Street New York, NY 10174 Fax: (212) 331-1455 700 Crossroads Building (212) 973-0111 E-Mail: [email protected] Rochester, NY 14614 Fax: (212) 891-9598 (585) 987-2841 E-Mail: [email protected] Harry G. Meyer (Co-Chair) Fax: (585) 454-3968 2000 M&T Plaza E-Mail: [email protected] Committee on Not-for-Profit Buffalo, NY 14203 Entities and Concerns E-Mail: [email protected] Committee on Unlawful Practice Anne Reynolds Copps (Co-Chair) of Law 126 State Street, 6th Floor Robert M. Zinman (Co-Chair) George R. Grasser (Co-Chair) Albany, NY 12207 St. John’s University School of Law 3400 HSBC Center (518) 436-4170 8000 Utopia Parkway Buffalo, NY 14203 Fax: (518) 436-1456 Jamaica, NY 11439 (716) 847-5490 E-Mail: [email protected] (718) 990-6646 Fax; (716) 852-6100 Fax: (718) 990-6649 E-Mail: [email protected] Mindy H. Stern (Co-Chair) E-Mail: [email protected] 60 East 42nd Street John G. Hall (Co-Chair) New York, NY 10165 Ad Hoc Committee on 57 Beach Street (212) 661-5030 Public Relations Staten Island, NY 10304 Fax: (212) 687-2123 Maureen Pilato Lamb (Co-Chair) (718) 447-1962 E-Mail: [email protected] 510 Wilder Building Fax: (718) 273-3090 One East Main Street E-Mail: [email protected] Committee on Professionalism Rochester, NY 14614 Peter V. Coffey (Co-Chair) (585) 325-6700 x220 224 State Street Fax: (585) 325-1372 P.O. Box 1092 E-Mail: [email protected] Schenectady, NY 12301 (518) 370-4645 Harold A. Lubell (Co-Chair) Fax: (518) 370-4979 1290 Avenue of the Americas E-Mail: [email protected] New York, NY 10104 (212) 541-2130 Fax: (212) 541-4630 E-Mail: [email protected]

94 NYSBA N.Y. Real Property Law Journal | Spring 2002 | Vol. 30 | No. 2 Real Estate Transactions— Commercial Property 2001 Edition

An Overview of the Major Issues and Practical Problem Solving Approaches - complete with practical guides and forms

• Overview of Commercial Real Estate Practice • Types of Commercial Property • Types of Transactions and Standard Documents • Role of Title Insurance • Closing List Price: $75 (incl. $5.56 tax) • Post-closing Mmbr. Price: $62 (incl. $4.59 tax) • plus, forms and exhibits…

Product Number: 40371

Real Estate Transactions— Residential Property 2001 Edition

A Practical Guide For Attorneys Representing Residential Purchasers or Sellers - an excellent reference for both new and experienced attorneys

• This latest edition includes coverage of the new Fannie Mae down payment requirement and new sections on: Recording of documents; Exemption from Form 1099S and Alternative Certifi- cation Requirements; Coverage of new Nassau County legisla- tion (Transfer Tax); and the revised notary acknowledgment List Price: $70 (incl. $5.19 tax) Yearly updates will make this a mainstay of your reference library Mmbr. Price: $55 (incl. $4.07 tax) for years to come! Product Number: 42141

These titles are also available as segments of the New York Lawyer's Deskbook and Formbook, a four-volume set that covers 24 areas of practice.

To order call 1-800-582-2452 or visit us online at www.nysba.org Source Code: CL1540 New York State Bar Association

NYSBA N.Y. Real Property Law Journal | Spring 2002 | Vol. 30 | No. 2 95 Publication of Articles N.Y. REAL PROPERTY LAW JOURNAL The Journal welcomes the submission of articles of timely Section Officers Co-Editors interest to members of the Section in addition to comments and Chair William A. Colavito suggestions for future issues. Articles should be submitted to One Robin Hood Road Melvyn Mitzner any one of the Co-editors whose names and addresses appear Bedford Hills, NY 10507 655 Third Avenue on this page. (914) 666-4606 New York, NY 10017 Fax: (914) 241-1881 For ease of publication, articles should be submitted on a (212) 973-6205 E-Mail: wcolavito@ 3½" floppy disk, preferably in Microsoft Word or WordPerfect Fax: (212) 883-6825 yahoo.com 5.1 and no longer than 8–10 pages. Please also include one E-Mail: mmitzner@ laser-printed copy. The Editors request that all submissions for landam.com Joseph DeSalvo consideration to be published in this Journal use gender neutral 188 East Post Road, 4th Fl. 1st Vice-Chair White Plains, NY 10601 terms where appropriate or, alternatively, the masculine and John J. Privitera (914) 286-6415 feminine forms may both be used. Please contact the Co- P.O. Box 459 Fax: (212) 331-1455 editors regarding further requirements for the submission of Albany, NY 12201 E-Mail:jdesalvo@ articles. (518) 447-3337 firstamny.com Unless stated to the contrary, all published articles repre- Fax: (518) 447-3368 Harry G. Meyer sent the viewpoint of the author and should not be regarded as E-Mail: [email protected] 2000 M&T Plaza Buffalo, NY 14203 representing the views of the Editors, Board of Editors or the 2nd Vice-Chair Section or substantive approval of the contents therein. E-Mail: hmeyer@ Matthew J. Leeds hodgsonruss.com 1290 Avenue of the Americas Student Editorial Assistance New York, NY 10104 Robert M. Zinman (212) 541-2290 St. John’s University St. John’s University, School of Law School of Law Fax: (212) 541-1390 Co-Editors in Chief 8000 Utopia Parkway E-Mail: [email protected] David Dunn Jamaica, NY 11439 John D. Kern Secretary (718) 990-6646 Dorothy H. Ferguson Fax: (718) 990-6649 Contributing Students 46 Prince Street E-Mail: zinmanr@ Catherine Biondo Harris Liolis Rochester, NY 14607 stjohns.edu Joseph Bozutti Stanley Liu (716) 697-0042 Melissa Carvalho Jason Kee Low Fax: (716) 697-0043 Cindy Chen Nancy Mahmoud E-Mail:dferguson@ferguson Suzanne Delio Jennifer Marinaccio andmyers.com Jake Derenthal Michael McCarthy Matthew Didora Jay Mower Board of Editors Matthew J. Leeds Ariel Gordon Michael Rosenberger Steven D. Bloom Harold A. Lubell Brian Graffeo Ross Schiller John K. Bouman James M. Pedowitz Thomas Horan George Schneider David Clurman Bernard M. Rifkin Alexandra Khasidova Patricia Wolfe Peter V. Coffey Joel H. Sachs Diana Lin Dorothy Ferguson Samuel O. Tilton John G. Hall Peter M. Wendt Robert W. Hoffman Mark Wright Correction Brian E. Lawlor Lawrence Zimmerman In our last issue we failed to list the name of John Kern as Co-Editor in Chief under the heading of Student Editorial Assistance, St. John’s This Journal is published for members of the Real Property University School of Law. John has worked as a student editor on Law Section of the New York State Bar Association. both our Winter and Spring 2002 issues. We reserve the right to reject any advertisement. The New York State Bar Association is not responsible for typographical or other errors in advertisements. Copyright 2002 by the New York State Bar Association. Cite as: N.Y. Real Prop. L.J. ISSN 1530-3918

Real Property Law Section NON-PROFIT New York State Bar Association U.S. POSTAGE One Elk Street PAID Albany, NY 12207-1002 ALBANY, N.Y. PERMIT NO. 155 ADDRESS SERVICE REQUESTED