Monthly Archives August 2012

Aug 222012

The Condo Hotel: The Worst of Both Markets

I stayed in a condo hotel this past weekend which you do not hear too much about anymore. Condo hotels tend to mainly be found near beach and mountain destinations. In Tennessee, they are primarily found near the Smoky Mountains in towns such as Gatlinburg, Pigeon Forge, and Sevierville.

In 2002, the Securities and Exchange Commission (SEC) issued a “no-action letter” which contained specific guidelines, or “safe harbors,” for how to market and sell a condo hotel product without engaging in the sale of a security under U.S. securities laws. Many developers viewed the letter as SEC guidelines on how to develop condo hotels and the result was an immediate boom in the industry. However, the condo hotel sector took a beating in the financial downturn (“the Pets.com of the real-estate bubble”) and it has been dormant ever since.

At first glance a condo hotel appears to represent the best of both the residential and commercial real estate markets. A buyer owns the specific condo unit and pays the property taxes, insurance, and maintenance fees for it, while a management company rents out the rooms and splits the revenue with the owners (typically around fifty percent). Even though the buyer owns the condo unit, they are limited on how often they can use the unit. With taxes, insurance, maintenance fees, tough financing, and rental market fluctuations, condo hotels are actually one of the more dangerous investments. Thus, many condo hotels were unable to close on unit sales when the real estate bubble burst and prospective buyers were faced with these tough economic challenges.

Although not specifically addressed by the Tennessee Condominium Act of 2008, the formation of a condo hotel is similar to that of a standard condominium regime. They are created by a Declaration and normally accompanied by a set of bylaws. They typically also require the approval of a shared facilities agreement, a rental management agreement, and a unit maintenance agreement. The structure of the agreements, and the advertisements and representations made in the sales process, are important because at some point the buyer is no longer just purchasing real estate but is instead investing in a business enterprise triggering U.S. securities laws.

Aug 152012

Tennessee Supreme Court: Tennessee’s Nonconforming Use Statute Applies Only to Zoning Change or Zoning Restriction

In the recent case of SNPCO, Inc. v. City of Jefferson City, 363 S.W.3d 467 (Tenn. 2012), the Tennessee Supreme Court analyzed Tennessee’s nonconforming use statute in the context of an annexation. The Court addressed the question of whether a city’s ordinance banning the sale of fireworks within its city limits implicates Tenn. Code Ann. § 13-7-208(b) which permits pre-existing nonconforming businesses to continue to operate despite a zoning change.

In November of 2003, Jefferson City banned the sale of fireworks within its city limits. In 2008, the city annexed property adjacent to its borders which included the property on which SNPCO, a fireworks retailer, was located. After the city annexed the property, the retailer asked the city for permission to continue selling fireworks as a pre-existing nonconforming use. The city refused and SNPCO filed suit.

The trial court dismissed SNPCO’s complaint finding that the combination of the fireworks ordinance and the annexation of the property was not an “unlawful taking” and that the fireworks ordinance was not a zoning ordinance subject to grandfathering protection under Tenn. Code Ann. § 13-7-208(b). SNPCO appealed. The Tennessee Court of Appeals affirmed concluding that the test mandated by Cherokee Country Club, Inc. v. City of Knoxville, 152 S.W.3d 466 (Tenn. 2004) did not apply to determinations of whether an ordinance was a “zoning restriction” for the purpose of Tenn. Code Ann. § 13-7-208(b).

Tenn. Code Ann. § 13-7-208(b) is a grandfather clause that allows businesses that may be adversely affected by changes in zoning codes after the business has already opened to remain open under certain circumstances. The statute provides a vehicle for avoiding the legal problems that can arise whenever a newly enacted zoning ordinance or an amendment to a zoning ordinance might otherwise force a property owner to discontinue an otherwise permissible use of the property. Property owners seeking to invoke this statute have the burden of proving it applies to their business.

The Tennessee Supreme Court concluded the retailer could not take advantage of the grandfather clause in § 13-7-208(b). The pivotal question was whether the combined effect of the city’s fireworks ordinance and its decision to annex the land on which the retailer’s business was located was tantamount to a “zoning restriction” or “zoning change.” The Court relied on the “substantial effects” test it adopted in Cherokee Country Club, Inc.; a two-part test that examines both the terms and the effects of the challenged ordinance. It requires the court to first determine whether the challenged ordinance relates to the city’s “general plan of zoning.” If the court determines that it does, then the second step is to ascertain whether the ordinance results in a substantial interference with the use of land. The Court notes that the fireworks ordinance was not related to the city’s general plan of zoning and could not be characterized as a zoning ordinance or a zoning restriction. The fireworks ordinance did not refer to land, zones, buildings, lot lines, or any other terms and concepts customarily associated with comprehensive zoning plans. The ordinance simply reflected the exercise of the city’s traditional, general police power. Thus, the Court held that because the ordinance was not a zoning ordinance, it was neither a “zoning change” nor a “zoning restriction” for the purpose of Tenn. Code Ann. § 13-7-208(b).

Aug 082012

Floods and Federal Temporary Takings

Counsel for the petitioner previewed arguments before the Supreme Court in Arkansas Game & Fish Commission v. United States, cert. granted, Apr. 2, 2012 (No. 11-597) during a panel on federal takings at the ABA 2012 Annual Meeting. The case asks the Supreme Court to consider whether temporary flooding constitutes a compensable taking and, more broadly, government takings liability for floodway management, when some lands are deliberately flooded to prevent greater damage elsewhere.

Background of the Case

The Fifth Amendment Takings Clause guarantees that private property shall not be taken for a public use without just compensation. This was designed to bar the Government from forcing some people alone to bear public burdens which should be borne by the public as a whole. In what appears to be a case of first impression, the issue before the Court in Arkansas Game & Fish Commission v. United States is whether the U. S. Government is liable under the Takings Clause for intermittently flooding timber lands owned by a state agency.

The Arkansas Game & Fish Commission owns and operates a 23,000-acre wildlife refuge and recreational preserve. Clearwater Dam, on Arkansas’ Black River, is a federal flood control project that lies 115 miles upstream from the refuge. Between 1993 and 2000, the U.S. Army Corps of Engineers released more water than authorized from the Clearwater Dam. As a result, the refuge subsequently suffered extensive property damage–primarily the death of numerous oak trees–which the Arkansas Game & Fish Commission attributed to the Corps’ intentional flooding of the property. In 2001, the U.S. Government acknowledged the substantial damage its flooding had caused on Arkansas Game & Fish Commission’s land and ceased deviations from the floodwater release plan.

After a lengthy trial in 2009, the U.S. Court of Federal Claims awarded $5,700,000 in favor of the Arkansas Game & Fish Commission finding that the Army Corps of Engineers’ actions in intermittently flooding petitioner’s property foreseeably destroyed or degraded the property, requiring just compensation to be paid pursuant to the Takings Clause. The Supreme Court granted cert after a divided panel of the U.S. Court of Appeals reversed the Court of Federal Claims award.

Blurring a Takings issue with a Damages issue

A temporary flooding scenario may be a case of first impression, but the Supreme Court has consistently recognized damage claims under the Takings Clause in temporary taking scenarios. To a certain degree the temporary issue is irrelevant; it happened once and injury occurred. Temporary flooding is no different than more permanent flooding that occurs in other inverse condemnation cases which regularly result in awards of compensation. Thus, the main issue should be whether the petitioner was damaged by the flooding for which compensation is due.

Ultimately, the Supreme Court will determine whether the temporary nature of intentional intermittent flooding acts constitutes a taking for which compensation is due. The respondent’s brief on the merits is due on August 27, 2012 and the case is set for argument on October 3, 2012.

Aug 062012

Tennessee Court of Appeals: Unlicensed Contractors and the Importance of Contract Review

The Devil is in the details. In Friday’s opinion of Anchor Pipe Company, Inc. v. Sweeney-Bronze Development, LLC et al., the Tennessee Court of Appeals reviewed the priority of two liens, a mechanic’s lien and a bank’s deed of trust, filed in connection with development of the Enoch Hill subdivision in Gallatin, Tennessee. The Circuit Court for Sumner County awarded summary judgment to the bank and granted it priority over the mechanic’s liens. The Court of Appeals disagreed.

The Court of Appeals first addressed whether a contractor who contracts for work above the monetary limit applicable to his license is an “unlicensed contractor” for purposes of the Contractors Licensing Act of 1994, Tenn. Code Ann. § 62-6-101 et seq. This act requires persons or entities performing activities defined as “contracting” to have a license, and makes it unlawful for a person or entity to engage in contracting without a license. Tenn. Code Ann. §§ 62-6-101, 62-6-103(a). An unlicensed contractor is only permitted to recover actual documented expenses upon a showing of clear and convincing proof.

Traditionally, a contractor is unlicensed for purposes of Tenn. Code Ann. § 62-6-103(b) if the contractor does not maintain a valid contractor’s license throughout the entire time contracting services are performed under the contract. Kyle v. Williams, 98 S.W.3d 661, 666 (Tenn. 2003). In the present case, the contractor had a contractor’s license throughout its work on the project and this license authorized it to perform the type of work it performed (underground piping, grading and drainage, and base and paving work). However, the monetary limit on the contractor’s license was only $750,000, whereas its bids exceeded two million dollars. Thus, the bank argued that the contractor was unlicensed because it bid on and performed work in excess of the limits of its license. The Court of Appeals disagreed and drew a distinction between contractors who are completely unlicensed and those who have complied with the licensing laws and may in some manner violate the provisions or limitations of their licenses.

Even if the Court had found that the contractor was unlicensed, outside the context of single-family residential construction, the fact that a contractor is unlicensed does not result in forfeiture of the contractor’s lien in Tennessee. See Tenn. Code Ann. § 62-6-128.

The final issues reviewed by the Court of Appeals touched on the importance proper document review and execution.

In the first avoidable error, the developer failed to properly establish a subordination agreement with the contractor. While working on the bank loan, the developer asked the contractor via e-mail if it would subordinate its lien to the bank’s lien rights. In its response, the contractor stated it would sign a release. However, a release was never finalized. An agreement to agree to something in the future is generally not enforceable. Thus, the e-mails alone were not sufficient to establish a contract and the contractor’s lien was never properly subordinated to the bank’s lien rights.

In the second avoidable error, the bank identified the wrong grantor of the bank’s deed of trust meaning the deed was void and the bank did not properly perfect its security interest. Although the identified grantor was a wholly owned subsidiary of the parent company (the correct grantor to the bank’s deed of trust), there was nothing in the record to suggest that the identified grantor had acted on behalf of the parent company in executing the bank’s deed of trust. When an agent fails to reveal his status, he alone is bound as principal. The bank later corrected this error and identified the correct grantor but only after the contractor’s date of visible commencement of operations had occurred. Thus, the contractor’s lien once again took priority over the bank’s lien rights.