Development Archives - Tennessee Real Estate Law

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.

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.