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Posts tagged with: investment

A PASSION FOR (REAL ESTATE) BUSINESS

Lawyers are like most other business professionals. We want your business and we want your referrals – we just don’t always know the best way to ask for either.

 

Take me for example. I’ve been handling commercial real estate transactions and business deals for nearly 40 years. I’ve loved (almost) every day of it, and I look forward to many more (knock on wood). My clients appreciate my insights and value the guidance I provide. Other attorneys respect what I do, and brokers and CPAs like working with me because I strive for practical solutions to efficiently and effectively get the job done. I pay close attention to learn my clients’ business objectives, then work diligently and negotiate hard to get my clients what they expect – when they expect it. That’s what lawyers do. Or at least what all lawyers should do. For any client hiring a lawyer, what else is there?  Achieving client objectives and getting the deal closed on time is why lawyers exist. Deals fail, for sure, but we can never be the reason they fail. Deals that fail are a waste of everyone’s time and money. Getting the deal done, if it can be done, is our value proposition.

 

Deals are my lifeblood – my passion. They’re why I wake up every morning and get out of bed. I love this stuff. I can’t explain exactly why that is – it just is.  Why do musicians practice their instruments and play? Why do scratch golfers golf? Why do competitive skiers ski?  It’s our passion. We don’t know exactly why – it comes from within. And we always need more.

 

Commercial real estate deals always come first for me, but in every commercial real estate project is a business. They go hand in hand. My preference for a good real estate deal over a good business deal is a matter of only slight degree. There’s not really a number one and a number two. It’s more like #1 and #1A.

 

So what’s the problem?

 

The problem is, a lot of people don’t know I’m available to represent them. I write books and articles on commercial real estate. I give seminars on how to structure and close business and real estate transactions. I publish a commercial real estate and business blog.  People think I’m busy, or that I only handle huge deals. The truth is, I am busy – but never too busy to handle another deal, large or small. In the words of the late, great Lucille Ball: “If you want something done, ask a busy person to do it.” We all loved Lucy!

 

The most shocking question I get from prospective clients is: “Would you (I) be willing to handle my (their) next business or commercial real estate deal?”  Are they kidding? My answer is always an emphatic “yes”! It’s my passion. It’s my love.  It’s what I live for.

 

To be sure, I’m a business professional, and I charge for what I do, but if you have a commercial real estate deal or business deal, and need representation, I’m in. Never be shy about calling me. We’ll work out the economics. The range of deals I handle is extraordinarily diverse. For a taste, look at my blog Harp-OnThis.com, or check out my latest book, Illinois Commercial Real Estate on Amazon.com or in your local public library. I love this stuff. I need this stuff. Of course I want to represent you. When can we get started?

 

So back to my initial point:  I do want your business and your business referrals. Like many other business professionals, I just don’t know the best way to go about asking for it. What do you suggest?

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THE CLIENT CONUNDRUM

A mistake lawyers make is treating all clients the same. It’s a mistake shared by other professions as well. They’re not all the same. The issues clients face, and the solutions they deserve, are as varied as life itself.

 

R. Kymn Harp
Robbins, Salomon & Patt, Ltd.

With the rise of technology and the commoditization of legal services, nuance can be lost. Precise solutions to particular problems may be neglected while cookie-cutter boilerplate is offered as a cheap substitute. Not that all boilerplate and technology is bad – they can provide huge benefits when applied correctly. But just as a mass-produced size 9 leather dress shoe may be ideal for some, it is of little comfort or use to an athlete with a size 10 foot.

 

Automation is a cost-saver, no doubt. But is it a reasonable substitute for thoughtful analysis and tailor-made solutions to client specific problems?

 

There may be areas of life where commoditized legal services represent a reasonable tradeoff. Perhaps consumers engaged in everyday transactions are adequately-served by inexpensive one-size fits all solutions. Even a consumer buying a home – often touted as the largest single transaction most consumers will make in their lifetime – may be well-served by inexpensive boilerplate solutions on most occasions. In the world of consumer transactions and consumer finance, there is a protective overlay of consumer protection laws and oversight that will often fill in the gaps left by a one-size fits all approach.

 

But what about most commercial transactions? Buying or starting a business? Investing in commercial or industrial real estate? Raising capital from third parties? Entering into a partnership agreement or limited liability company operating agreement for a commercial venture where someone else is in control, and uses or controls your money – or where you use or control someone else’s money? Are these circumstances where one-size solutions and documentation make sense?

 

How do you protect yourself if something goes wrong? Experience shows something can always go wrong. And when things go wrong in a commercial transaction, expensive lawsuits often follow.

 

Business people consider themselves to be intelligent, reasonable beings. When they invest in a business or real estate project they expect it will succeed. If they thought otherwise, they would not make the investment. That would be foolish, and they know for certain that they’re not foolish. If it fails, they conclude it had be someone’s fault – but it certainly wasn’t theirs.  They must have been duped. Information must have been withheld. They must have been lied to or cheated.  The other party must at least be incompetent if not downright crooked.

 

You may laugh, but that’s often how it happens. You may be one hundred percent competent and above-board. You may have understood and discussed the risks to the point where you are certain that your partners or investors understand the risks as well – but if you’re the promoter of the failed business or investment, or you’re in charge of making management decisions – you should expect to find yourself staring down the business end of a double-barreled lawsuit claiming the loss is your fault – even if you lost money as well, and even if nothing you did or could have done resulted in the loss. Changing economic circumstances, business and lifestyle trends, and other factors far beyond your control may be the reason for the loss, but you will be blamed. How do to protect yourself?

 

Suppose you’re on the other side. What if you’re the investor or partner asked to invest? What do you look for? What do you require? How do you protect yourself?

 

Clients are not all the same. Commercial transactions are not all the same. The risks and benefits of each investment and business venture are not all the same. The solutions and documentation of each transaction cannot, therefore, be all the same.

 

If clients are engaged in serious business, serious attention is required. Both the attorney and the client need to understand this. Once a deal goes bad, it’s too late to go back and redo what should have been done at the outset.

 

Will doing it right up front cost more?

 

Probably.

 

Will it be worth it if things go poorly?

 

You bet.

 

Should clients buy a size 9 shoe for their size 10 foot?

 

Thanks for listening. . .

Kymn

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Outside Investors and the Real Estate PPM – A Critical Step

RSP_LogoHD (3)It is not uncommon for commercial real estate investors to pool their funds for real estate investments. To obtain project financing, equity requirements remain relatively high. Loan to value ratios are in the 60% to 70% range in many circumstances. Even a modestly priced commercial project with a $5,000,000 price tag may require equity in the range of $1,500,000 to $2,000,000. The greater the price tag, the higher the equity requirement. A Real Estate PPM is an important tool when raising funds from outside investors for a real estate project.

TYPICAL INVESTMENT STRUCTURE

Private real estate investments are typically structured through a manager-managed limited liability company (LLC), with the project promoter or its affiliate named as the manager. Oftentimes, the business terms of the transaction will include a cumulative preferred return to equity investors, an attractive internal rate of return to equity investors until all capital is returned, and a waterfall that provides for a disproportionate percentage of distributable cash to be used toward repayment of the equity investment until it is repaid in full, followed by a permanent allocation of profits and losses based on percentage of ownership.

OUTSIDE INVESTORS – PROS AND CONS

The advantage to the promoter in raising capital from outside investors is that it places the promoter in a position to acquire and control more and larger real estate projects. A disadvantage to promoters is that they must give up a meaningful piece of project ownership and anticipated profits in return for using other people’s money.

 An advantage to outside investors is that they may realize high investment returns and certain tax advantages by participating in a real estate investment. A disadvantage is that they typically have little direct control over the project and must rely upon the knowledge, skill and efforts of the promoter to make money. Of course, if the outside investors don’t possess the knowledge and skill themselves, relying on an experienced real estate promoter may be their best bet for taking advantage of the opportunities real estate investment has to offer.

DUE DILIGENCE AND THE REAL ESTATE PPM

Whether investing in a stabilized real estate project, a project to be newly constructed, or a value-add project requiring redevelopment, renovation, or adaptive reuse, careful evaluation of the benefits and risks always require knowledgeable investigation using due diligence.

A good place for an outside investor to begin is by closely reading the investment PPM (private placement memorandum) which an outside investor should expect to receive from the promoter before making an investment. A well drafted Real Estate PPM will describe the project, the relevant history and experience of the promoter, sources of funds, uses of funds, material terms of the investment, including transfer restrictions, the exit strategy, and the identifiable risks of the investment and the project.

The Real Estate PPM, however, is only the beginning. A conscientious investor needs to go beyond the statements in the PPM to gain an understanding of the underlying real estate project itself, not unlike a conscientious lender would – but even more so, since the interest of an equity investor is subordinate to the interest of any secured lenders. If the prospective investor does not have the direct knowledge and expertise to evaluate and understand the underlying real estate project, it is highly advisable for the prospective investor to hire an advisor, attorney or consultant who has the skill-set to conduct the evaluation.

PPM – A DEFENSE DOCUMENT

Promoters sometimes resist preparing a fully developed PPM because they believe (naively) that it is an unnecessary burden and needless expense. Realistically, however, it is essential and its cost is a cost of raising money from outside investors.

Some promoters discount the value of a carefully prepared PPM because they think of it as a marketing brochure. With that belief, they conclude that their investors don’t need an expensive marketing brochure prepared by a lawyer. In truth, a PPM is not a marketing brochure. It is a critical defense document. Like insurance, it is only a waste of money if you never need it. Even the most well thought-out real estate project may not turn out as planned, or may not result in the impressive profits anticipated at the outset. In that case, believe it or not, there is a meaningful risk that the investors will sue – especially if they end up losing money.

Anytime a person is making a passive investment with the expectation that profits will be derived solely through the efforts of another, the investment is, by definition, an investment contract and, by extension, a security.  The party offering the security is required by law to make a whole host of disclosures to make sure the investor is fully informed of all material facts and risks. Failure to adequately describe the investment and disclose known and foreseeable risks exposes the promoter to serious potential liability under applicable securities laws and regulations.

When the investors sue, it will be for on a variety of theories, including breach of contract, fraud in the inducement, common law fraud, negligent misrepresentation, and violation of applicable securities laws. The investors will allege that the promoter made all kinds of promises and told the investor all kinds of things regarding the project and the investment, which the promoter knew, or should have known, were false.  The investor will also claim the promoter concealed or failed to disclose facts and risks known to the promoter which, if disclosed, would have caused the investors to decline making the investment. Since securities laws provide investment rescission rights and impose near strict liability on a broad range of promoters and persons controlling the investment, the promoter and its principal advocates can be exposed to significant personal liability absent an effective and reliable defense.

A well-crafted PPM can be highly effective in providing a strong defense by spelling out, in writing, all the material details and assumptions of the project and the investment, and all known and foreseeable risks inherent in the project and the investment. It will also limit the right of the investors to rely upon only the matters expressed in the PPM, and will clarify the distinction between statements of fact, and forward looking projections which constitute matters of opinion or belief which cannot reasonably be relied upon. As such, the Real Estate PPM is a powerful defense tool that no real estate promoter seeking investment from outsiders should go without. If things go poorly, it will be the firewall between the investors’ loss and the personal liability of the promoter.

INVESTOR RELIANCE ON PPM

From the investors’ perspective, the PPM is a valuable tool as well. If meticulously crafted, it will disclose the material details of the project and the investment, and will point out risks the investor should consider, even if they are risks the investor is willing to accept.   The investor will have the right to rely upon the facts and details set forth in the PPM unless expressly qualified or limited. If the PPM misstates the facts or omits to disclose known or knowable risks, the PPM can serve as a powerful piece of evidence in a claim against the promoter. It is precisely this evidentiary risk that impels promoters to dot the i’s and cross the t’s to make sure the PPM is complete and accurate – which makes it a valuable source of information for the prospective investor.

PROJECT DUE DILIGENCE BY INVESTOR

Even with the inclusion of necessary facts and disclosures in the Real Estate PPM, a detailed analysis and discussion of certain real estate fundamentals underlying the project may not fall within the purview of the PPM. If the disclosed risks are carefully crafted with broad language, in may be up to the prospective investor, in the exercise of due diligence, to evaluate the underlying project to confirm the suitability of the property for its envisioned use.

Due diligence by the investor is always appropriate. If the prospective investor does not have the knowledge on its own to understand real estate fundamentals, it is incumbent upon the investor to engage a real estate professional who possesses the necessary knowledge.  Regardless of whether a failure to adequately disclose and address gaps in the underlying project fundamentals is sufficient to expose the promoter to liability, imposing liability on the promoter is not the object of the investment. The object of the investment is to put the investor’s money to work in a profitable venture that will yield a favorable return – not a lawsuit.

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Whether raising money from outside investors, or considering an investment in a real estate project as a passive outside investor, a well-crafted Real Estate PPM is a vital component and critical step. Ignore it at your own peril.

Thanks for listening,

Kymn

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NEW BOOK – Illinois Commercial Real Estate

I’m happy to announce that the website for my new book, Illinois Commercial Real Estate is now live.  Visit www.Illinois-CRE.com for a book excerpt.

illinois-commercial-real-estate-book-coverIllinois Commercial Real Estate, Due Diligence to Closing, with Checklists, is intended as a practical handbook for investors, developers, brokers, lenders, attorneys and others interested in commercial real estate projects in Illinois. This book zeros-in on commercial real estate due diligence, and walks the reader through the due diligence process, from conception to closing, with a focus on making sure the commercial real estate project functions as intended after closing.  Checklists are provided as an aid to commercial real estate professionals to assist on evaluation of the property and the transaction on the path toward successful closing. As people in the real estate industry understand, if the deal doesn’t close, it doesn’t count.

I’d like to extend Special Thanks to:

My clients, whose passion for creative commercial development I share;

My partners and staff at Robbins, Salomon and Patt, Ltd., who work with me tirelessly to earn our client’s business every day.

Catherine A. Cooke and Emily C. Kaminski, attorneys at Robbins, Salomon & Patt, Ltd. who provided legal research, advice, counseling, and technical editing;

James M. Mainzer, tax partner at Robbins, Salomon & Patt, Ltd., for his insights and assistance on tax matters;

The editing staff at the Illinois Institute for Continuing Legal Education, for editing early versions of chapters 11, 12, 25, 27 and 28, which were first published in IICLE Practice Handbooks;

Dale V. Weaver, Illinois licensed surveyor, who was kind enough to convert my rough draft drawings into the diagrams included at chapter 25;

. . . and, of course, my friend and valuable resource, Linda Day Harrison, founder of theBrokerList, for her ongoing encouragement and support.

If you are buying, developing, financing, selling, leasing or otherwise dealing with commercial real estate in Illinois, I hope you will find Illinois Commercial Real Estate, Due Diligence to Closing, with Checklists to be a useful resource.

ENJOY!!!

R. Kymn Harp

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AIR RIGHTS DEVELOPMENT – Chicago, Illinois

WHY DEVELOP AIR RIGHTS?

Prime commercial land is limited. Prices per square foot can be astronomical. Demand for efficiency to maximize return on investment is growing. No wonder developers and property owners are looking to the sky, with varying degrees of success, to capture all the value they can from each urban parcel. Air rights development may be the solution you are looking for.

 

http://www.dreamstime.com/stock-image-chicago-skyline-image2898031Owners and developers, and people in general, are conditioned to think of potential development sites as flat surfaces with essentially two dimensions: north/south and east/west. They see only the surface of the land, and envision the building they will construct for the particular purpose they have in mind; a bank, a drugstore, a restaurant, a strip mall, a parking garage, an office building. If the parcel is larger than they need, they may envision subdividing the parcel to make two or more lots. In most cases, however, they think primarily in terms of land coverage for the type of building they need. They visualize only the two dimensional space depicted on their Site Plan or Plat of Survey.

 

In 30 out of 50 states, including Illinois and all other Mid-Western states, the “Rectangular Survey System” is in effect. The Rectangular Survey System was adopted in 1785 to meet the needs of the Federal Government as it faced the challenge of dividing vast areas of undeveloped land lying west of the original 13 colonies. The system, developed under the direction of Thomas Jefferson, essentially divides the United States into rectangles, measured in relation to lines known as Meridians and Base Lines.

 

Development lots are instinctively viewed as the two-dimensional surface of land visually representing a potential development parcel. Descriptions of a parcel typically refer to “a parcel of land X feet by Y feet” located in relation to an intersection or other identifiable landmark.

 

Once a parcel is “developed”, or designated for development, by construction of improvements on the land, it is natural to think of the parcel as being unavailable for further development (unless the existing improvements are to be demolished).

 

Classic examples of this are single story commercial buildings at prime commercial locations, a multi-deck parking garage or mid-rise building in a downtown development area, railroad tracks or spurs cutting across valuable urban land and, in some cases, roadways and alleys.

 

Each of these situations represent, potentially, under-utilization of valuable real estate. Finding a way to develop the “air” above these existing or planned improvements maximizes the economic utility of these parcels and can be like creating “money from thin air.”

 

The practice of finding ways to utilize the “space above” is often referred to as “air rights development”. Air rights development requires thinking in three dimensions, and requires serious design consideration and legal planning but, when land values are at a premium and zoning permits, the economic return may be dramatic.

 

Though often overlooked, virtually all of Chicago’s downtown business district is a “city in the air“. People tend to think of streets and street level entrances to buildings in the downtown Chicago “loop” as being at “ground level”. This is simply not the case. Most of what is thought of in the Chicago Loop as being at “ground level” is located 12 to 22 feet above the earth’s surface. This explains the vast network of “lower” streets and passageways in downtown Chicago, such as “Lower Wacker Drive”, “Lower Dearborn Street”, “Lower State Street”, etc. which most people seldom traverse. It also explains why, in 1992, the Chicago Loop business district was virtually shut down by “the Great Loop Flood of ’92”, but few people got wet or even saw any water as office and retail buildings were closed and workers were sent home because of “flooding”.

 

The point of these observations is to reveal that “development of air rights” is not new. It is also not “. . . some exotic legal manipulation of doubtful efficacy dreamed up by big city lawyers for use only in big cities”. Development of so-called “air rights” is little more than efficient use of a limited resource when use becomes economically feasible and beneficial.

 

WHAT ARE “AIR RIGHTS”?

“Air rights” are part of the “bundle of rights” constituting fee simple title to real estate. The term “air rights” generally refers to the right of the owner of fee simple title of a parcel of land to use the space above the land. If this right did not exist, it would not be possible to (more…)

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Illinois Condominium Deconversion

RSP_LogoHD (3)Condominium deconversion is growing in popularity to enhance the value of busted condominium projects. It is not unusual for condominium projects that entered the market in the bubble years immediately before the Great Recession to have ended up as a “busted condo” project. This is a term commonly used to described condominium projects that failed when developers were unable to sell a substantial portion of the condominium units.

 

In many cases this resulted in development loans going into default and foreclosure, with bulk purchasers acquiring the developer’s units and renting them out as individual rental units.  Other times, the developers themselves were able to modify their development financing and continue to hold and rent the units themselves.

 

In either case, with residential apartment projects becoming a favored investment vehicle for some investors, finding a way to deconvert busted condo projects by terminating their status as “condominiums” and turning the whole project into a single-owner apartment project has come into favor.  This often results in a substantial increase in value to investors.

 

Section 16 of the Illinois Condominium Property Act 765 ILCS 605/16 provides the mechanism for removing a condominium project from the provisions of the act, a term colloquially referred to as “condominium deconversion”.

 

A principal challenge for condominium deconversion is that, by statute, condominium deconversion requires action by all the unit owners and the consent of the holders of all liens affecting any of the units.   765 ILCS 605/16.  In any sizable condominium project, this is a difficult hurdle to overcome.

 

Fortunately, for bulk-owners of a substantial percentage of condominium units, getting to 100% participation by all units owners is not as difficult as it may at first seem. Instead of trying to convince 100% of all unit owners to go along, or trying to purchase units from hold-out unit owners who may demand a substantial premium over the objective fair market value of their unit, there is another alternative. Bulk-owners of a substantial percentage of units may chose, instead, to undertake a two-step process to enable condominium deconversion in a much more efficient way.

 

Two-Step Process to Condominium Deconversion:

 

1.     The first step is to acquire a sufficient number of condominium units in the project to be able to implement the “forced-sale” provisions of Section 15 of the Condominium Property Act. 765 ILCS 605/15. Unless the condominium declaration or bylaws require a greater percentage (which they seldom do in residential condominium projects), this means acquiring or gaining control of only 75% of the condominium units. Since many bulk-owners already own a substantial percentage of units, and sometimes have access to additional units at bargain prices through short-sale purchases or otherwise, getting to the 75% ownership threshold may not be an insurmountable challenge.

 

Once a bulk-owner owns or controls 75% of the units (unless a greater number is required by the declaration or bylaws), the bulk-owner can vote at a meeting of unit owners called for such purpose, to sell the property as a whole.  Pursuant to Section 15, such action is binding on all unit owners, and it is thereafter the duty of all unit owners to execute and deliver such instruments and to perform all acts necessary to effect the sale; provided that a unit owner that did not vote to approve the sale has the right, for 20 days, to file a written objection. If this occurs, the objecting unit owner is still obligated to execute all documents and take all actions to effect the sale, but will be entitled to receive an amount equivalent to the value of the unit owner’s interest as determined by fair appraisal, less any unpaid assessments or charges due from such unit owner. 765 ILCS 605/15.

 

2.     Upon satisfaction of the 75% threshold for approval to convey the entire property, and conveyance of the entire property to a single identified buyer, that buyer alone – provided it has the consent of all lienholders (which, in theory should be only the buyer’s mortgagee), has the power to elect to remove the property from the provisions of the Illinois Condominium Property Act pursuant to Section 16 of Act. 765 ILCS 605/16 – a so-called condominium deconversion.

 

The forced sale provision in Section 15 of the Act establishes a mandatory legal duty for all unit owners to participate in the conveyance and execute all instruments and take all actions to accomplish the conveyance. Still, it may be reasonable to expect that some unit owners may resist – particularly if the unit is their home, and/or if the mortgage indebtedness encumbering the unit exceeds the fair market value of the unit.  In light of this practical risk, when proceeding with a condominium deconversion through forced sale, it makes sense to budget for litigation expenses, and – though not legally required – to establish a settlement reserve to fund settlement buyouts when doing so makes practical business sense.

 

Condominium deconversion and sale is growing in popularity as a substantial value-add proposition for many busted condominium projects.  It can be tricky at times, but in the right circumstance, sophisticated investors are finding the financial rewards worth the added effort.

 

Do not hesitate to contact me if I can be of assistance.

 

Thanks for listening!

Kymn

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COOL PROJECTS – Real Estate

COOL PROJECTS
Real Estate Projects I Love to Work On.

I love cool real estate projects. Cool projects are why I became a lawyer. Cool projects are why I come to the office each day. Cool real estate projects are why I did not become an astrophysicist (well, one reason – although, that might have been cool too). Cool projects are the reason I live, smile, dance, breath, scour the earth for new deals, jump for joy.

And by “cool”, I don’t mean in a thermal sense – but rather in a “this project is so cool” sense. I am referring to real estate projects that are awesome. Real estate projects that are fun. Real estate projects that make you say “Wow – what a cool project!

R. Kymn Harp Robbins, Salomon & Patt, Ltd.

R. Kymn Harp
Robbins, Salomon & Patt, Ltd.

Cool projects don’t need to be costly projects in major urban centers – although those can be cool too. I’m talking about projects that are creative. Projects that require vision and imagination. Projects that take something mundane and turn it into something special.

Some people think I only like huge projects. To be honest, I do like huge projects, but largely because the huge projects I have worked on also happened to be cool projects.

Redevelopment of the commercial portions of Marina City in downtown Chicago was a cool project. Ground-up development of Sears Centre Arena in Hoffman Estates, Illinois was a cool project. Work on various mixed-use projects around the Midwest and upstate New York have been cool projects. But so has been the much smaller development of an 8,000 square foot microbrewery in the historic Motor Row District of Chicago using TIF financing; development of countless restaurant and entertainment venues throughout the Midwest; conversion of a multi-story industrial building into a high-tech office center; conversion of an outdated office building into a stylish, luxury hotel; adaptive reuse of outdated retail strip centers, bank buildings, city and suburban office buildings, bowling alleys, warehouses, industrial buildings, gas stations, and various small to medium sized special purpose buildings into modern, fully functional jewels – reinvented to provide much needed retail and service amenities for local neighborhoods and communities. It is not the size of the project that makes it cool – or the cost – it is the concept, imagination and creative challenge involved that makes the difference. At least for me.

Cool Projects Test

Here’s a test [call it the “Cool Projects Test”, if you will]:

Which of the following projects is more likely to end up on Kymn Harp’s list of cool projects? (more…)

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COMMERCIAL LANDLORD-TENANT – Part 2 – The Covenant of Quiet Enjoyment

R. Kymn Harp Robbins, Salomon & Patt, Ltd.

R. Kymn Harp
Robbins, Salomon & Patt, Ltd.

Catherine Cook Shareholder at Robbins, Salomon & Patt, Ltd.

Catherine A. Cooke
 Robbins, Salomon & Patt, Ltd.

This is Part 2 of a multi-part series of articles discussing the duties, rights and remedies of commercial real estate tenants in Illinois. Part 1, entitled “Getting It Right” discussed the importance of clarity in lease drafting, and the potential for unintended leasehold easements for parking, and other uses.

In March 2015, the Illinois Institute for Continuing Legal Education (“IICLE”) published its 2015 Edition practice handbook entitled: Commercial Landlord-Tenant Practice. To provide best-practice guidance to all Illinois attorneys, IICLE recruits experienced attorneys with relevant knowledge to write each handbook chapter. For the 2015 Edition, IICLE asked R. Kymn Harp and Catherine A. Cooke to write the chapter entitled Tenant’s Duties, Rights and Remedies. We were, of course, pleased to oblige. Although each of us represent commercial landlords at least as often as we represent commercial tenants, a clear understanding of the duties, rights and remedies of commercial real estate tenants is critical when representing either side of the commercial lease transaction.

The following is an excerpt (slightly edited) from our chapter in the 2015 Edition. We hope you find this excerpt, and the excerpts that will follow, informative and useful. Feel free to contact IICLE  directly to purchase the entire volume.

The COVENANT OF QUIET ENJOYMENT
What Is It? — General Principles

It has long been the law in Illinois that a covenant of quite enjoyment is implied in all lease agreements. Blue Cross Ass’n v. 666 N. Lake Shore Drive Associates, 100 Ill.App.3d 647, 427 N.E.2d 270, 273, 56 Ill.Dec. 290 (1st Dist. 1981); 64 East Walton, Inc. v. Chicago Title & Trust Co., 69 Ill.App.3d 635, 387 N.E.2d 751, 755, 25 Ill.Dec. 875 (1st Dist. 1979); Berrington v. Casey, 78 Ill. 317, 319 (1875); Wade v. Halligan, 16 Ill. 507, 511 (1855).

A covenant of quiet enjoyment “promises that the tenant shall enjoy the possession of the premises in peace and without disturbance.” [Emphasis in original.] Checkers, Simon & Rosner v. Lurie Co., No. 87 C 5405, 1987 WL 18930 at *3 (N.D.Ill. Oct. 20, 1987). This does not mean, however, that no breach of the covenant of quiet enjoyment may be found in a leasehold without a finding that the lessor intended to deprive the lessee of possession. Blue Cross Ass’n, supra, 427 N.E.2d at 27. It simply means that a tenant must actually be in possession of the premises to claim a breach of the covenant of quiet enjoyment. If the tenant has already vacated the premises before the disturbance has commenced, no breach of the covenant of quiet enjoyment occurs. Checkers, Simon & Rosner, supra, 1987 WL 18930 at *3.

RSP_LogoHD (3)An implied covenant of quiet enjoyment includes, “absent a lease clause to the contrary, the right to be free of the lessors’ intentional interference with full enjoyment and use of the leased premises.” Infinity Broadcasting Corporation of Illinois v. Prudential Insurance Company of America, No. 86 C 4207, 1987 WL 6624 at *5 (N.D.Ill. Feb. 9, 1987), aff’d, 869 F.2d 1073 (7th Cir. 1989), quoting American Dairy Queen Corp. v. Brown-Port Co., 621 F.2d 255, 258 (7th Cir. 1980).

If the landlord breaches the covenant of quiet enjoyment, the lessee may remain in possession and claim damages for breach of lease. In such case, the measure of damages is the difference between the rental value of the premises in light of the breached covenant of quiet enjoyment and the rent that the tenant agreed to pay under the lease, together with such special damages as may have been directly and necessarily incurred by the tenant in consequence of the landlord’s wrongful act. 64 East Walton, supra, 387 N.E.2d at 755.

Although Illinois cases defining the precise scope of a covenant of quiet enjoyment are rare, BLACK’S LAW DICTIONARY, pp. 1248 – 1249 (6th ed. 1993) defines “quiet enjoyment” in connection with the landlord-tenant relationship as “the tenant’s right to freedom from serious interferences with his or her tenancy. Manzaro v. McCann, 401 Mass. 880, 519 N.E.2d 1337, 1341. (Ringing for more than one day of smoke alarms in an apartment building could be sufficient interference with the tenants’ quite enjoyment of leased premises to justify relief against the landlord.).”

HOW THE COVENANT OF QUIET ENJOYMENT MAY APPLY— CASE LAW

In Blue Cross Ass’n v. 666 N. Lake Shore Drive Associates, 100 Ill.App.3d 647, 427 N.E.2d 270, 273, 56 Ill.Dec. 290 (1st Dist. 1981), the First District Appellate Court discussed the covenant of quiet enjoyment in the lease as granting the tenant a right of quiet and peaceful possession and enjoyment of the whole premises and equated a breach of quiet enjoyment under a lease to a private nuisance. “A private nuisance in a leasehold situation is ‘an individual wrong arising from an unreasonable, unwarranted or unlawful use of one’s property producing such material annoyance, inconvenience, discomfort, or hurt that the law will presume a consequent damage.’ ” Id., quoting Great Atlantic & Pacific Tea Co. v. LaSalle National Bank, 77 Ill.App.3d 478, 395 N.E.2d 1193, 1198, 32 Ill.Dec. 812 (1st Dist. 1979).

The tenant had entered into a five-year lease on August 22, 1978, with a five-year renewal option, for approximately 53,000 square feet of the (more…)

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Illinois LLCs – The Asset Protection Advantage

Illinois LLCs – The Asset Protection Advantage

A Technical Analysis

Among sophisticated investors and other high-asset/high-net worth individuals and businesses, the topic of “asset protection” is bound to arise. As many became painfully aware during the recent Great Recession, bad things can happen to good people. In my article Asset Protection – Lessons Learned, I discussed how properly structuring one’s holdings could have prevented, or at least mitigated, much of the financial devastation and anguish experienced by business owners, investors, real estate developers, doctors and others caught off-guard by the drastic economic collapse of 2007-2010.

RSP_LogoFull_2PMSOften, there is confusion about what the term asset protection really means. Some imagine a shadowy network of off-shore trusts and secret bank accounts in foreign lands set up by unscrupulous characters to cheat innocent creditors. This is simply not true. In this article I will not debate the claimed pros and cons of secret bank accounts and so-called off-shore asset protection trusts. I will say, however, that under most circumstances, they don’t work for U.S. citizens residing in the U.S.A.

Legitimate asset protection is nothing more or less than properly ordering one’s business and financial affairs in a way that does not unnecessarily expose all assets to claims of creditors.

The right of persons and businesses to limit their liability and exposure of their assets to claims of creditors is the well settled in the U.S.A. The United States of America, and each individual state, has a plethora of laws authorizing and recognizing the legitimacy of corporations and other limited liability entities as a means by which an investor can segregate assets and limit exposure to liability.

No person has a legal or moral obligation to structure his or her affairs in a way that makes it easy for a creditor of one business or professional enterprise to attach assets of the investor not committed to that enterprise. This protection may be impinged if the person or business engages in conduct tantamount to fraud, but actions explicitly authorized by applicable statute can hardly be characterized as being fraudulent. Fraud is an intentional tort requiring, among other elements, intentional breach of a duty owed to the person claimed to be harmed. If a statute expressly authorizes conduct, it implicitly, if not explicitly, negates any duty to act in a manner contrary to that authorized by the statute.

This article presents a technical analysis of certain asset protection attributes of an Illinois limited liability company expressly authorized by the Illinois Limited Liability Company Act, 805 ILCS 180/1-1 et seq (the “Illinois LLC Act”). The remarkably robust asset protection value of an Illinois limited liability company is measured by two key attributes:

1. The ability, expressly authorized by the Illinois LLC Act, to include in an LLC operating agreement provisions that protect the limited liability company and its business and assets from claims owed to others by members of the LLC – an attribute that creates a huge advantage vs. a corporation, as discussed in Part I, below; and

2. Enhanced protection of Members and Managers from liability for debts, contracts and torts incurred by the LLC, or resulting from acts or omissions of a Member or Manager while acting on behalf of the LLC, to an extent measurably greater than the protection afforded officers, directors and shareholders of a corporation.

Although one might reasonably expect that the order in which these key attributes are discussed would be reversed, the Part I discussion precedes the Part II discussion because the matters to be discussed in Part I are best considered at the outset, when the operating agreement is being drafted; while the matters discussed in Part II will most directly apply later, once a judgment creditor is seeking to enforce its judgment.

PART I: Key Statutory Provisions to Consider When Drafting the Operating Agreement

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STRATEGIES FOR ASSESSING COMMERCIAL TENANT CREDIT

David Resnick, Attorney Robbins, Salomon & Patt, Ltd.

David Resnick, Attorney
Robbins, Salomon & Patt, Ltd.

GUEST BLOG BY DAVID RESNICK of ROBBINS, SALOMON & PATT, LTD.

When considering a lease, tenants are usually focused on the location, size and quality of the leased space, and perform some minimal diligence on the landlord and property manager to ensure fair treatment over the course of the term. Landlords have a more difficult task,however. A prospective tenant, and most importantly, that tenant’s ability to pay rent, is often unknown to the landlord. In recent years, real estate professionals have witnessed expansion in the array of users of commercial space and at the same time, property owners have been compelled to seek out new types of tenants. Increasing numbers of start-ups and new ventures are seeking to lease space, many of which are backed by various types of equity financing. As a result of these changes, landlords should be particularly vigilant in understanding how their tenants make money, as well as the financial identities of the parties backstopping the obligations of those tenants.

Analyze Tenant Credit

Landlords should always analyze tenant credit in the context of the lease. After all, the success of leased real estate, as well as the property owner’s ability to borrow against that asset, is dependent upon the stability of its tenants. While rent is the primary economic factor in any lease transaction, other factors such as term (including rights of extension), area of the premises (including rights of expansion and rights of first refusal on additional space) and the scope of tenant improvements create the platform upon which a tenant’s credit can be evaluated. For example, substantial build-out (regardless of who pays for it) that may inhibit the re-letting the space following a default. Therefore, landlords should be mindful of the tenant’s capacity to pay its construction obligations, which capacity is usually encapsulated in the tenant’s credit and litigation history.

A proper underwriting of a tenant’s credit requires a thorough understanding of that tenant’s business. A prudent landlord will pay attention not only to the tenant’s sources of revenue, but to the market upon which the tenant relies and the business plan upon which the tenant charts its future success. What are the contours of the business model? Is the revenue sustainable? What is the plan for future growth? Has the tenant gone through restructuring or been forced to lay off personnel? Landlords can avoid doing business with troubled or unstable tenants by performing background, lien and litigation searches on the tenant parties as part of the underwriting process. This kind of diligence can usually be completed in a short time-frame at a reasonable cost, and may save substantial time and money if the landlord is forced to evict a tenant it should have known to be at increased risk of default.

Technology has given rise to new products which enhance the process of underwriting tenant credit. For example, the Chicago firm (RE)Meter has created the first “credit score” for commercial tenants, which captures and synthesizes proposed lease transaction terms and basic tenant financial information with exclusive data maintained by a number of federal agencies, including the U.S. Census Bureau, the Department of Labor and the Internal Revenue Service ((RE)Meter is the first firm to access IRS information in this context). The end product, called the TIL Report, can be completed in a mere 15 minutes and offers landlords a sector- and market-specific analysis of its prospective tenants, reflecting a number of detailed metrics including growth trends, profitability and rent per employee. Innovations like these have altered the landscape of tenant underwriting and will enable landlords to make more prudent decisions when marketing space and assessing the risk of potential tenants.

Tenant Credit Enhancements

Conventionally, several mechanisms exist to enhance the credit of a prospective tenant who fails on its own to meet the underwriting criteria of the landlord. The first and foremost of these is the security deposit, which is posted by the tenant in the form of cash or letter of credit and held by the landlord for all or part of the duration of the lease. The deposit may be applied by the landlord towards unpaid amounts payable under the lease like rent, proportionate common area expenses or taxes, or reimbursement of amounts expended to repair damage to the premises. A stronger credit tenant may receive the benefit of a return of all or part of the deposit held by landlord over time, provided the tenant has not defaulted.

Security Deposits

While cash security deposits have historically been the industry standard in commercial leasing, landlords are increasingly requiring letter of credit security deposits instead. For many landlords, the benefits of cash on hand are overshadowed by the security of an obligation issued by a third-party bank, particularly when the landlord is able to draw on the letter of credit following a default without notice to or consent by the tenant. Letters of credit also may bear advantages to the landlord following a bankruptcy by the tenant, as the obligation of the issuing bank to pay on the letter of credit is independent of the tenant’s obligations under the lease. However, some courts have found that letter of credit security deposits are part of the tenant’s bankruptcy estate and thus subject to the cap on a landlord’s claim for damages under Section 502(b)(6) of the United States Bankruptcy Code.

Lease Guaranties

Guaranties are a common alternative for securing the credit of a commercial tenant. In the context of commercial leasing, a guaranty is a legally enforceable undertaking by a third party to fulfill the payment or performance obligations of the tenant under a lease. A guaranty may be given by an entity, such as a corporate parent or affiliate, or an individual, such as a majority owner or other key principal of the tenant. To most effectively backstop the credit of the tenant, a guaranty should be a guaranty of payment as opposed to a guaranty of performance. This distinction ensures that the landlord will not be forced to exhaust its remedies against the tenant before pursuing enforcement of the guaranty. Rather, the landlord may pursue the tenant and guarantor simultaneously for unpaid amounts under the lease.

Once a landlord has determined that it will require a guaranty to secure the tenant’s obligations under the lease, what should the landlord look for in evaluating potential guarantors? The most straightforward factor, notwithstanding whether the proposed guarantor is an individual or an entity, is cash on hand and other liquid assets. In satisfaction of the landlord’s inquiry, an guarantors may produce income tax returns, bank statements, financial statements, balance sheets or other evidence of personal holdings. The review process for publicly traded companies is simplified in that pertinent financial information is publicly available. Of course, testing for liquidity has its flaws. There exists no iron-clad protection against fraud, and disclosures only present a snapshot of a party’s credit at the time of the test as opposed to a forecast of future liquidity and stability. A review of tenant and guarantor financial information, as well as credit reports for collections, pledging of material assets or opening of new lines of credit, should be performed at regular intervals throughout the term of the lease.

Financial Disclosure Challenges

Financial disclosures may be problematic or some privately-held concerns. Particularly in the modern era of start-up firms financed by venture capital and private equity interests, tenants and proposed guarantors may be limited by investor confidentiality. With this in mind, parties to a lease should clarify in the lease or guaranty the form of any future disclosures to be made. Tenants and guarantors may resist delivering full-fledged audited financial statements in favor of reduced balance sheets or nominal form of profit and loss statement. Depending on the profile of the market and building, landlords may be willing to accept less than full disclosure if the statements deliver a reasonable picture of the financial health of the party delivering them.

Tenant Stability and Performance Incentives

As lease term and the disclosure provisions are negotiated, tenants may push the landlord for a variety of concessions that effectively incentivize and reward tenant stability. Perhaps the most common examples of this request are limitations on the security deposit, pledged assets or the liability under or the term of the guaranty. Limitations like these can take a variety of forms, from a fixed term to a cap on the guarantor’s liability based upon a fixed dollar-figure or factor of rent payable under the lease, to an automatic reduction of either the security deposit or the cap on the guarantor’s liability over time. In each instance, the landlord should be cognizant of the hurdles the tenant party must overcome to receive the benefit of these limitations, none more important than the uninterrupted timely payment of rent without default.

Tenant Credit is a Key to Successful Lease Performance

In light of the crises our industry has withstood in recent years, a landlord’s exuberance in welcoming new tenants is understandable. But in the current era of increasing economic growth, landlords should adopt a cautious approach in understanding and monitoring the business of their tenants. No landlord can predict with certainty the success or failure of its tenants; however, perhaps now more than ever, a thorough and complete examination of tenant credit is essential to the financial success of any leased real estate.

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