Legal Strategies For 2009 -- Anticipating And Handling Litigation In Our Current Economic Climate

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CCN Client Alert

With the new year beginning and the credit crisis continuing to expand, many businesses are finding themselves confronting legal issues that are novel, unanticipated or simply not seen since the last economic downturn. Using our experience from prior real estate cycles and from addressing the emerging issues specific to this credit crisis, we offer some legal strategies for 2009 that we have used to help our clients better navigate through these new issues.

Lender Failure. As the credit crisis shows, lender failure has ramifications that are far-reaching and sometimes unanticipated. Borrowers are often left in the difficult position of having to address what to do when a lender ceases funding a loan, such as how to complete construction or satisfy obligations to other creditors (including mezzanine and junior lenders). In workout discussions with the lender it is important for the borrower to be mindful of the FDIC’s immunity upon a bank takeover, including a rule of law known as the D’Oench Duhme doctrine, which stands for the proposition that certain obligations of a lender may not be the obligations of the FDIC upon any takeover of a bank by the FDIC.

Defaulting Tenants. A sad consequence of the economic downturn is the increasing number of industrial and commercial tenants failing in their lease obligations, such as a failure to pay rent, maintain adequate insurance coverage and protect the owner against mechanics’ liens for work done on the tenant’s premises. Landlords should be aware of issues relating to acceptance of partial payments of rent as well as drawing down on letters of credit. Ultimately there also may be bankruptcy issues relating to automatic stays and statutory caps on lease payments. These, and issues like them, require deft negotiations and well thought out legal tactics.

Preventing Assets From Disappearing. There is often concern when starting new litigation that the party being sued will not have any assets to satisfy a judgment by the time the case makes its way through the court system. Additionally, plaintiffs want to resolve the dispute immediately and not have to wait several years for justice to prevail in court. There are numerous statutory and self help remedies available early in the litigation to make sure that known assets remain available to satisfy a judgment and, if obtained, will also encourage a defendant to settle the lawsuit early. The remedies include: (i) appointment of a receiver, (ii) recordation of a lis pendens as a lien against real property, (iii) injunctive relief barring or requiring certain acts, (iv) requiring third parties to deposit into court money or property held for the debtor but allegedly belonging to the plaintiff or (v) obtaining a writ of attachment on attachable assets of the debtor until a trial is held.

Bankruptcy. Whether you are the a creditor or debtor, bankruptcy disrupts the best laid plans. For a creditor, a borrower’s bankruptcy can stay enforcement of a debt indefinitely, including pending civil litigation, as the bankruptcy matter proceeds through the bankruptcy courts. For a debtor, bankruptcy can mean trying to reorganize your business within the strictures of bankruptcy law and under the oversight of the bankruptcy court, or if reorganization is not possible, liquidating your business. For certain real estate debtors, the “single asset real estate” (“SARE”) rules apply, imposing additional stringent requirements on the bankrupt judgment debtor.

Foreclosures. The foreclosure process, whether it be through power of sale or judicial order, is a complex path where patient and experienced guidance is needed. A commencement of foreclosure or the threat of a foreclosure is often a prelude to complex loan modification negotiations often in exchange for a limited loan forbearance period during which time the lender will not exercise its rights and remedies for the loan default in exchange for a fee or a release of any claims against the lender by the borrower. We advise careful consideration of all options before either filing a foreclosure or allowing a foreclosure to occur. The issues become particularly thorny for a junior or mezzanine lender.

Single Purpose Entity Issues. With the falling real estate prices and the rapidly increasing number of defaulted loans, lenders with loans to single purpose entities are examining whether they can reach assets of individuals or other entities under the doctrines of alter ego and piercing the corporate veil. Conversely, owners of SPE’s want to protect the integrity of the entity. We believe that with the downturn in the economy the number of challenges to the protections thought to be inherent in SPE’s will only increase.

Downsizing. Big or small, almost all employers are feeling the pinch in this economic downturn. If your company is forced to lay off employees, it is critical that your company follow the applicable laws so as to otherwise avoid costly employment litigation with the severed employees. For example, employers should be aware of the requirements of the federal WARN Act, California’s own “mini WARN Act,” and the federal Older Workers’ Benefit Protection Act. It is also important to review decisions about who will be laid off and who will be retained to avoid claims of discrimination in the layoff selection process.

Capital Calls and Disputes between Partners/Members. Business that find themselves in tight economic circumstances or facing an unanticipated liability may be required to make capital calls. Whether or to what extent capital calls may be made are generally contractually driven and requires careful consideration of other solutions, including reducing capital accounts, obtaining partnership loans and buying/selling or otherwise terminating a partner’s interest. Pervading the entire analysis has to be a thorough understanding of the law surrounding fiduciary obligations of partners among themselves. Too often we see the non-defaulting partners reacting without thought to the downstream effects.

Obtaining Property Tax Relief. Property taxes in California are levied based on an assessed value that is unilaterally set by the applicable county assessor’s office under the constrictions of Proposition 13. If that assessed value is greater than the fair market value due to a decline in real estate values, the taxpayer can apply for a reduction in the property tax assessment under Proposition 8 (adopted in 1978). We have found that property tax appeals involve a multitude of sometimes interrelated rules that must be understood clearly and navigated effectively. To the uninitiated, the process is at once arcane and impossibly complex. However, with guidance and experience, a property owner may be able to obtain tax relief.

Avoiding Mechanics Liens. The spiraling real estate downturn has seen a startling increase in the number of mechanic’s liens and stop notices. This is an area of the law that is misunderstood by most lawyers because the concept is completely statutory and unless the attorney works in the field regularly, the forest of statutes relating to stop notices, bonds, notices of completion and notices of nonresponsibility are simply too daunting and complex. Knowing your rights and defenses relating to liens and stop notices will help both owners and lenders avoid the statutory pitfalls.

D&O Insurance. In times of insolvency and declining values for business entities, management practices inevitably come under heightened scrutiny. In this climate, individual directors and officers can find themselves targeted for potential personal liability either due to their involvement in the business activities at issue or simply due to their position with the company. The analysis of the potential liability of directors and officers is cross-disciplinary involving transactional analysis, insurance coverage issues and litigation.

Preserving Entitlements and Renegotiating Conditions to Entitlement. With the market downturn, it may no longer be feasible to proceed with the same development and construction schedule previously contemplated. If a decision is made to put a project on hold, it is important to ensure, if at all possible, that the entitlements for the project do not expire. Indeed, the California legislature enacted a very important law regarding entitlements that was not even effective until July 15, 2008. We also see great use for other recent enactments (e.g., AB 2604) and existing statutory law, including the Subdivision Map Act, in dealing with this situation.

Decreased Demand for Residential Inventory. Builders and others in the residential construction industry who are facing a decreased demand for residential inventory may find themselves in control of the HOA board longer due to slow sales and excess inventory. A builder left in this position should seek legal guidance to properly understand its obligations and rights under the Department of Real Estate regulations and the CC&Rs and other governing documents for the project.

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