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THE MAGAZINE OF THE LOS ANGELES COUNTY BAR ASSOCIATION
JANUARY 2018 / $5
Los Angeles lawyer Ashley B. Jordan providesan overview of the key insurance issues inrecent state and federal court decisionsconcerning construction defect liabilitypage 20
Finger onthe Trigger
BankruptcyProperty Rightspage 12
SeawallPolicypage 15
BUYING ANDSELLING CONTAMINATEDPROPERTIESpage 27
ATTORNEYFEE
LIENSpage 34
EARN MCLE CREDIT PLUS
33RD ANNUAL
REAL ESTATE
LAW ISSUE
20 Finger on the Trigger BY ASHLEY B. JORDAN
Both state and federal courts have recently addressed certain key issues indeciding latent construction defect liability cases
27 A Clean Bill of SaleBY GARY A. MEYER
Given the ubiquitous potential for contamination in Southern California, purchasing, selling, and leasing real estate in the region require a strategy fordealing with possible environmental liabilitiesPlus: Earn MCLE credit. MCLE Test No. 274 appears on page 29.
34 Promises to PayRENA E. KREITENBERG
Bankruptcy case authority is in conflict on whether a promise to perform futurelegal services may be considered reasonably equivalent value
F EATU RE S
Los Angeles Lawyer
the magazine of
the Los Angeles County
Bar Association
January 2018
Volume 40, No. 10
COVER PHOTO: TOM KELLER
01.18
11 Barristers TipsLACBA's Immigration Legal AssistanceProject aids Dreamers BY VICTORIA M. MCLAUGHLIN
12 Practice TipsOwner vs. tenant rights in a property inbankruptcyBY GARY F. TORRELL
15 Practice TipsLynch v. California Coastal Commissionand California's seawall policyBY ANGELA HOWE
40 Closing ArgumentCalifornia's new affordable housingefforts may be in jeopardyBY TED M. HANDEL
DE PARTM E NTS
LOS ANGELES LAWYER (ISSN 0162-2900) is publishedmonthly, except for a combined issue in July/August, by theLos Angeles County Bar Association, 1055 West 7th Street,Suite 2700, Los Angeles, CA 90017 (213) 896-6503. Period -icals postage paid at Los Angeles, CA and additional mailingoffices. Annual subscription price of $14 included in theAssociation membership dues. Nonmember subscriptions:$38 annually; single copy price: $5 plus handling. Addresschanges must be submitted six weeks in advance of nextissue date. POSTMASTER: Address Service Requested. Sendaddress changes to Los Angeles Lawyer, P. O. Box 55020,Los Angeles CA 90055.
REAL ESTATE LAW ISSUE
4 Los Angeles Lawyer January 2018
VISIT US ON THE INTERNET AT WWW.LACBA.ORG/LALAWYERE-MAIL CAN BE SENT TO [email protected]
EDITORIAL BOARD
ChairJOHN C. KEITH
Articles CoordinatorSANDRA MENDELL
Assistant Articles CoordinatorTYNA ORREN
SecretaryRENA KREITENBERG
Immediate Past ChairTED M. HANDEL
JERROLD ABELES (PAST CHAIR)
SCOTT BOYER
CHAD C. COOMBS (PAST CHAIR)
THOMAS J. DALY
GORDON K. ENG
DONNA FORD (PAST CHAIR)
STUART R. FRAENKEL
MICHAEL A. GEIBELSON (PAST CHAIR)
SHARON GLANCZ
GABRIEL G. GREEN
STEVEN HECHT (PAST CHAIR)
DENNIS F. HERNANDEZ
JUSTIN KARCZAG
MARY E. KELLY (PAST CHAIR)
KATHERINE KINSEY
JENNIFER W. LELAND
CAROLINE SONG LLOYD
PAUL S. MARKS (PAST CHAIR)
COMM’R ELIZABETH MUNISOGLU
CARMELA PAGAY
GREGG A. RAPOPORT
JACQUELINE M. REAL-SALAS (PAST CHAIR)
LACEY STRACHAN
YHEZEL ARMANDO VARGAS
THOMAS H. VIDAL
STAFF
Editor-in-ChiefSUSAN PETTIT
Senior EditorJOHN LOWE
Art DirectorLES SECHLER
Director of Design and ProductionPATRICE HUGHES
Advertising DirectorLINDA BEKAS
Senior ManagerMELISSA ALGAZE
Administrative CoordinatorMATTY JALLOW BABY
Copyright © 2018 by the Los Angeles County Bar Association. Allrights reserved. Reproduction in whole or in part without permissionis pro hibited. Printed by R. R. Donnelley, Liberty, MO. MemberBusiness Publications Audit of Circulation (BPA).
The opinions and positions stated in signed material are thoseof the authors and not by the fact of publication necessarily those ofthe Association or its members. All manuscripts are carefullyconsidered by the Editorial Board. Letters to the editor are subject toediting.
6 Los Angeles Lawyer January 2018
LOS ANGELES LAWYER IS THE OFFICIAL PUBLICATIONOF THE LOS ANGELES COUNTY BAR ASSOCIATION
1055 West 7th Street, Suite 2700, Los Angeles CA 90017-2553Telephone 213.627.2727 / www.lacba.org
LACBA EXECUTIVE COMMITTEE
PresidentMICHAEL E. MEYER
President-ElectBRIAN S. KABATECK
Senior Vice PresidentTAMILA C. JENSEN
Vice PresidentPHILIP H. LAM
Assistant Vice PresidentJESSE A. CRIPPS
Assistant Vice PresidentJO-ANN W. GRACE
TreasurerJOHN F. HARTIGAN
Immediate Past PresidentMARGARET P. STEVENS
Barristers PresidentJEANNE NISHIMOTO
Barristers President-Elect JESSICA GORDON
Chief Financial & Administrative OfficerBRUCE BERRA
BOARD OF TRUSTEES
KRISTIN ADRIAN
HON. SHERI A. BLUEBOND
SUSAN J. BOOTH
RONALD F. BROT
TANYA FORSHEIT
JENNIFER W. LELAND
MATTHEW W. MCMURTREY
F. FAYE NIA
BRADLEY S. PAULEY
ANGELA REDDOCK
DIANA K. RODGERS
MARC L. SALLUS
MICHAEL R. SOHIGIAN
EDWIN C. SUMMERS III
KENDRA THOMAS
KEVIN L. VICK
WILLIAM L. WINSLOW
FELIX WOO
AFFILIATED BAR ASSOCIATIONS
BEVERLY HILLS BAR ASSOCIATION
CENTURY CITY BAR ASSOCIATION
CONSUMER ATTORNEYS ASSOCIATION OF LOS ANGELES
CULVER MARINA BAR ASSOCIATION
GLENDALE BAR ASSOCIATION
IRANIAN AMERICAN LAWYERS ASSOCIATION
ITALIAN AMERICAN LAWYERS ASSOCIATION
JAPANESE AMERICAN BAR ASSOCIATION
JOHN M. LANGSTON BAR ASSOCIATION
THE LGBT BAR ASSOCIATION OF LOS ANGELES
MEXICAN AMERICAN BAR ASSOCIATION
PASADENA BAR ASSOCIATION
SAN FERNANDO VALLEY BAR ASSOCIATION
SANTA MONICA BAR ASSOCIATION
SOUTH BAY BAR ASSOCIATION
SOUTHEAST DISTRICT BAR ASSOCIATION
SOUTHERN CALIFORNIA CHINESE LAWYERS ASSOCIATION
WOMEN LAWYERS ASSOCIATION OF LOS ANGELES
8 Los Angeles Lawyer January 2018
Ted M. Handel is the chief executive officer of Decro Corporation, a nonprofit housing devel -oper that develops and manages affordable multifamily projects for low-income familiesand seniors. Paul S. Marks is a partner with the Neufeld Marks law firm in Los Angeles. Theyare the coordinating editors for Los Angeles Lawyer’s special issue on real estate law andboth are former chairs of the Los Angeles Lawyer Editorial Board.
in a bankruptcy proceeding is the focus of Gary F. Torrell’s article. In a recentcase, the Ninth Circuit reconciled two seemingly contradictory provisions inthe Bankruptcy Code: One statute allows tenants to remain in possession ifthey satisfy the lease obligations while another allows a landlord or trustee tosell property free and clear of all liens and interests, including leases. Althoughthe court upheld the trustee’s sale of the affected land free and clear of thetenants’ leases, the tenants could have mitigated their losses had they assertedtheir rights to “adequate protection,” which they failed to do.
Preservation of California’s pristine beaches is covered in Angela Howe’sarticle on the California Supreme Court’s decision in Lynch v. California CoastalCommission. This opinion may be more significant for the issue the court didnot address than the one it decided. The justices narrowly focused their unanimousopinion on actions taken by bluff-top homeowners in rejecting their objectionsto the Coastal Commission’s approval of a seawall. Unlike the court of appeals,the supreme court did not cover the more significant environmental issuespresented by the homeowners’ challenge to the Commission’s permit conditions.
Construction and insurance law attorneys will find Ashley B. Jordan’s articleto be instructive on coverage issues for latent construction defect claims arisingunder commercial general liability (CGL) policy terms. Jordan reviews recentfederal and state decisions on whether faulty work constitutes an “occurrence”within the terms of current CGL policies, how courts have interpreted the phrase“trigger of coverage” despite the absence of this phrase in CGL policies or theInsurance Code and insurers’ response to that interpretation, and whether“business risk” or “ongoing operations” work exclusions constitute groundsfor insurers to deny coverage.
Author Gary A. Meyer notes that Southern California commercial andindustrial properties have frequently been used for various operations that resultin these properties’ becoming contaminated with chemicals now regulated bystrict environmental laws. Meyer examines the regulatory issues sellers andbuyers may encounter in the purchase and sale of contaminated land, the resourcesavailable to determine the source and level of contamination, and whether anyremediation has occurred. He then recommends strategies each side can followin protecting their interests when environmental conditions arise. Landlords andtenants are also provided a similar analysis.
Finally, Rena E. Kreitenberg covers a topic potentially affecting any attorney:whether obtaining security from a client for future payment of legal fees, such asa real property lien, is voidable as a fraudulent transfer when the client subsequentlyfiles for bankruptcy. As Kreitenberg explains, attorneys can retain this securityif their fee arrangements satisfy certain criteria. n
Because real estate plays a key role in our community,Los Angeles Lawyer follows its 33-year-old traditionof dedicating the first issue of the new year to matters
affecting those practicing in this field. The tug of war thatcan occur between landlords and tenants over property rights
Los Angeles Lawyer January 2018 11
OCTOBER 5, 2017, WAS THE DEADLINE FOR DREAMERS—undocu-mented immigrants brought to the United States as children—to apply for work-permit renewals under the Deferred Actionfor Child hood Arrivals program (DACA). One demonstratortold news reporters, “[We are] fighting for our right to behuman.”1 At the intersection of Wilshire Boulevard and VeteranAvenue in the Westwood neighborhood of Los Angeles, thedemonstrator continued, “We’re here as refugees from all differentparts of the world.”
An unassuming reception area lies on the third floor of theFederal Building at 300 North Los Angeles Street downtown.Children’s drawings decorate the walls. A girl from Belize drewherself on a donkey, and a boy from Egypt drew a heart. Inother pictures, a girl from Italy created the American and Italianflags, and a boy from Cambodia depicted a house on stilts nextto a palm tree and a dog, dark storm clouds gathering overhead.I walked into the Los Angeles County Bar Association (LACBA)Immigration Legal Assistance Project one Monday morning inSeptember to learn ways in which new and young attorneysmight contribute to the work of the project. The recent announce-ment by the Trump administration regarding the phaseout ofDACA had directed my attention to immigration issues and theways in which young lawyers might provide legal assistance.
Before the morning was through, I had witnessed eight con-sultations—eight individuals or families who had found theirway to the project for immigration help. No two cases were thesame, but all contained one common thread: the clients neededthe assistance of the Immigration Legal Assistance Project inorder to receive legal services for which they had a pressing need.
When a client walks into the Immigration Legal AssistanceProject (no appointment necessary), he or she pays only a $20consultation fee.2 LACBA’s charitable arm, Counsel for Justice,supports the Im migration Legal Assistance Project and threeothers: the Domestic Violence Legal Services Project, VeteransLegal Services Project, and AIDS Legal Services Project.
The projects work together on crossover issues that arise,funneling clients to the proper places. For example, a client inneed of a U visa—a nonimmigrant visa set aside for victims ofcrime who assist law enforcement—might seek out the ImmigrationLegal Assistance Project, which would ultimately direct them tothe Domestic Violence Project.
2016 Statistics
In 2016, 663 volunteers (including attorneys, law students, para-legals, interpreters, and mediators) allowed LACBA’s projects tohelp 17,790 clients, providing $3,764,025 in pro bono legal ser-vices (over 14,975 hours of pro bono legal services).3
The Immigration Legal Assistance Project provides legal assis-tance and counsel to all categories of low-income persons fornominal fees. It uses its resources to 1) provide immigration legal
advice for U.S. citizens, immigrants, and aliens; 2) prepare immi-gration and naturalization forms; 3) translate, certify, notarize,and copy documents; 4) tie in lawyer referral service and allappropriate social service agencies; and 5) train law students,attorneys, and volunteers in all aspects of immigration law andprocedures.
The Immigration Legal Assistance Project relies heavily on itscommitted volunteers, five each day of the week. Volunteers neednot have specific immigration law knowledge to volunteer forthe project; however, the volunteer must commit to volunteeringfor at least one day per week for a 12-week period. In so doing,the Immigration Legal Assistance Project is able to train volunteersto efficiently and effectively provide pro bono immigration legalservices.
On January 1, 2016, the project received a grant from theState of California to provide free legal assistance for Dreamers,either renewing or applying for DACA, as well as DACA appli-cants seeking advance parole, family petitions, or adjustment ofstatus. However, on September 5, 2017, when the Departmentof Homeland Security initiated the orderly phaseout of DACA,it provided a limited, six-month window during which it wouldconsider certain requests for DACA and applications for workauthorization, under specific parameters.
As a result, I witnessed a consultation in which the future ofone Dreamer was painfully unclear, although the ImmigrationLegal Assistance Project did educate her as to all alternatives shemight pursue. New and young attorneys are equipped to contributeto the project and make a meaningful difference in clients’ lives.
Although not everyone could be helped as he or she desired—I feel particularly haunted by a girl who was set to lose her DACAstatus—when I walked out of the Immigration Legal AssistanceProject, past a drawing of a flower by Lucas of France, age five,the value of this project was clear: not only are legal services ren-dered, but a spirit of hope and safety also pervade within thosewalls—it is a place in which we all can feel human.
To find out more about the project or to volunteer, please visit the project’s website (https://www.lacba.org/give-back/immigration-legal-assistance-project/immigration-legal-assistance-project-volunteer-form) or contact Project Director Mary Muchaat (213) 485-0143 or [email protected]. n
1 9 in custody at pro-DACA immigration protest in West wood, L.A. DAILY NEWS,Oct. 5, 2017, http://www.dailynews.com.2 This is waived in some cases.3 Impact 2016, Counsel for Justice, http://www.lacba.org/docs/default-source -/counsel-for-justice/who-we-help-and-infographics-page/2016-combined-report.pdf(last viewed Dec. 5, 2017).
barristers tips BY VICTORIA M. MCLAUGHLIN
LACBA’s Immigration Legal Assistance Project Aids Dreamers
Victoria M. McLaughlin is an attorney at the Law Offices of William E. Crockett.She is the vice president of the LACBA Barristers Section and sits on theboard of governors of the Women Lawyers Association of Los Angeles.
12 Los Angeles Lawyer January 2018
RENTAL PROPERTY OWNERS IN BANKRUPTCY and bankruptcytrustees want to sell properties free of leases to maximize saleproceeds. Tenants, however, want bankrupt landlords to honorthe leases to avoid disrupting, if not terminating, their businesses.On its face, the U.S. Bankruptcy Code seems to take two con-tradictory approaches to reconciling these conflicting interests.One code provision says tenants of bankrupt owners can stay inpossession for the term of their lease if they pay rent when dueand honor other lease terms.1 However, another provision allowsa bankrupt owner or trustee to sell property free and clear of allliens and interests.2 Many bankruptcy courts interpret the latterstatute to allow a tenant’s leasehold interest to be extinguishedin approving a sale.
The U.S. Court of Appeals for the Ninth Circuit recentlyinterpreted these statutes to determine if a conflict truly existedbetween them.3 This decision involved related debtors, the primarybeing Spanish Peaks Holdings, LLC, which owned Big Sky Resort,a 5,700-acre property in Big Sky, Montana. James J. Dolan ranSpanish Peaks Holdings, and Spanish Peaks Holdings signed twolong-term leases with related company tenants at monthly rentsbelow market. Dolan also was an officer of both tenants andsigned the leases for both the landlord and two tenants. TheNinth Circuit ruled the chapter 7 trustee could sell the realproperty free and clear of the lease interests over the tenants’objections.
As developer of the resort property, Dolan planned to builda ski and golf resort, restaurant, and other facilities. One lease,for restaurant space, was made in 2006 between Spanish PeaksHoldings as landlord and Spanish Peaks Development, LLC, withrent charged at $1,000 per month. A year later, the parties replacedthe lease with a new version between Spanish Peaks Holdingsand an entity called the Pinnacle Restaurant at Big Sky, LLC(Pinnacle), a company that Dolan controlled, for a term of 99years and with the rent reduced to $1,000 per year. The resort’sgeneral manager later told the bankruptcy court he had negotiatednumerous leases and that he believed a fair market rent for therestaurant was $40,000 to $100,000 per year. Dolan also signeda 60-year lease with Montana Opticom, LLC (Opticom), ofwhich he was the sole officer, for three cellphone tower locations,with the rent being only $1,285 per year.
In October 2011, facing multiple lawsuits and unable to sellthe resort, Spanish Peaks Holdings and two related companiesalso controlled by Dolan—The Club at Spanish Peaks, whichmanaged the resort facilities, and Spanish Peaks Lodge, LLC,which managed real estate sales—filed chapter 7 bankruptcy inDelaware. The cases were consolidated a few months later and,at the request of certain parties, the Delaware court transferredthe cases to the bankruptcy court in Montana. The bankruptcycourt appointed a trustee that, with the agreement of the seniorlender holding a mortgage totaling more than $122 million,
retained a real estate agent to find qualified buyers for the resort.The trustee prepared a term sheet for the proposed sale, which
provided that, “Pursuant to Section 363(f) of the BankruptcyCode, all of the Debtors’ right, title and interest in and to theProperty will be transferred free and clear of all liens, claims,encumbrances and other interests in the Property,” other thansome permitted encumbrances. In addition, it said, “Any otherperfected, enforceable, valid liens, claims, interests and encum-brances (if any) will be discharged by the order approving thesale.”4
The bankruptcy court commented that “[t]hroughout the salesprocess, the Trustee did not give a lot of thought” to the restaurantand cell tower leases, because the trustee’s financial advisor felt“the status of the Leases” made them immaterial to the sale.5
In response to the auction sale, Pinnacle and Opticom (alongwith Spanish Peaks Holdings acting for the tenants) asked thebankruptcy court to affirm that they “could avail themselves,by separate motion, to any rights they might have under 11U.S.C. § 365(h)” to remain in possession of the leased properties.The court denied their motion without explanation. The trusteethen filed a motion rejecting the restaurant and cell tower leasesbecause “the estate no longer possesses the property that is thesubject of the Leases.” The debtor and two tenants did notrespond, and the court granted the motion.6
By failing to respond, the tenants made a critical mistakebecause they did not exercise their right under Bankruptcy CodeSection 363 to request “adequate protection”7 of their leaseholdinterests in connection with (and prior to the court’s approvalof), the sale of the resort.8
After the bankruptcy court approved the sale, the court con-ducted a hearing on what rights, if any, the two tenants retained.The court applied what it called a “case-by-case, fact-intensive,totality of the circumstances, approach,”9 and relied on severalfactors in making its determination on these rights. First, therestaurant tenant had not operated the restaurant for over sixyears.10 Second, the rent was far below fair market.11 Third, theleases were signed at a time when the landlord and both tenantswere controlled by the same person. Fourth, the leases weresubject to a bona fide dispute. Finally, under state law if thebank with a lien on the property foreclosed, it would wipe outthe leases (created after the bank’s lien), and the trustee coulduse such state law in bankruptcy to avoid the leases when sellingthe property.12
Based upon these findings, the bankruptcy court ruled thesale could proceed free and clear of the leases.13 The U.S. DistrictCourt affirmed the bankruptcy judge’s rulings and this decisionwas appealed to the Ninth Circuit.
practice tips BY GARY F. TORRELL
Owner vs. Tenant Rights in a Property in Bankruptcy
Gary F. Torrell is a partner at Valensi Rose, PLC, where he leads the firm’sBusiness and Finance, Real Estate, and Creditors’ Rights practice groups.
Los Angeles Lawyer January 2018 13
The appellate court acknowledged thepotential tension between Bankruptcy CodeSection 363, which authorizes a trustee to sell property free and clear of all liensand interests, and Section 365(h) whichsupposedly protects a tenant when a bank-rupt landlord “rejects” the lease and givesthe tenant an option to remain in posses-sion of the leased premises for the balanceof the lease term.
The Ninth Circuit noted a “majority”of courts, when trying to reconcile the ap -parent conflict between these two statutes,ruled a tenant’s rights under Section 365supersede those conferred on a trustee ordebtor under Section 363 to sell propertyfree and clear of leases. The appellate courtstated “several bankruptcy courts haveheld that sections 363 and 365 conflictwhen they overlap,” because “each pro-vision seems to provide an exclusive rightthat when invoked would override theinterest of the other.”14
The Ninth Circuit judges also com-mented that several courts that have decidedthe issue have applied “the canon of statu-tory construction that ‘the specific prevailsover the general’”15 and, thus, Section 365takes precedence over Section 363. In addi-tion, the majority reasoned that “the leg-islative history regarding section 365 evincesa clear intent on the part of Congress to
protect a tenant’s estate when the landlordfiles bankruptcy.”16
Despite these precedents, the NinthCircuit decided to follow a different legalanalysis from the U.S. Court of Appeals forthe Seventh Circuit, which ruled in PrecisionIndustries, Inc. v. Qualitech Steel SBQ,LLC, that Sections 363 and 365 “themselvesdo not suggest that one supersedes or limitsthe other.”17 Section 363, the Seventh Circuitreasoned, confers a right to sell propertyfree and clear of “any interest,” includingleases entitled to protections under Section365.18 In contrast, it noted that Section 365has a more “limited scope.” Specifically,Section 365(h) “focuses on a specific typeof event—the rejection of an executory con-tract by the trustee or debtor-in-posses-sion—and spells out the rights of partiesaffected by that event. It says nothing aboutsales of estate property, which are theprovince of section 363.”19
As the Seventh Circuit pointed out,Section 363(e) entitles tenants to seek “ade-quate protection,” in connection with asale of the underlying property. This meanstenants “are therefore not without recoursein the event of a sale free and clear of theirinterests,” because they have the right toseek protection under Section 363(e),” andif they do so, “the bankruptcy court isobligated to ensure that their interests are
adequately protected.”20
If the property is not sold and the trusteeor debtor (acting for the bankruptcy estate)retains ownership but chooses to rejectthe lease, Section 365(h) gives the tenantthe right to remain in possession underthe terms of its lease. Understood this way,the Seventh Circuit said, “both provisionsmay be given full effect without cominginto conflict with one another and withoutdisregarding the rights of lessees.”21
The Ninth Circuit noted that even withthe analysis provided by the Seventh Cir -cuit, a significant issue remains; that is,whether a trustee has “rejected” the lease.The Ninth Circuit acknowledged that theBankruptcy Code does not define a “rejec-tion,” but said the term “is universallyunderstood as an affirmative declarationby the trustee that the estate will not takeon the obligations of a lease or contractmade by the debtor.”22 A sale of propertyfree and clear of a lease “may be an effec-tive rejection of the lease in some everydaysense,” but it is “not the same thing asthe ‘rejection’ contemplated by section365.”23
The Ninth Circuit’s interpretation ofthe statutes was that “section 363 governsthe sale of estate property, while section365 governs the formal rejection of a lease.Where there is a sale, but no rejection (or
a rejection, but no sale), there is no con-flict.”24 However, circumstances exist whena trustee’s failure to act would be consid-ered a rejection. For example, failing toassume or reject a residential lease within60 days in a chapter 7 liquidation, orwithin 120 days for a nonresidential leaseif the debtor is the lessee, is deemed to bea rejection.25 However, in In re SpanishPeaks Holdings II, LLC, all parties agreedthe restaurant and cell tower leases werenot formally rejected prior to sale of theunderlying real property. Because no leaseshad been formally rejected, the NinthCircuit reasoned that Section 365 was nottriggered.26
In addition to the Seventh Circuit’sanalysis of the statutory language, theNinth Circuit identified other reasons whySections 363 and 365 do not necessarilyconflict: “First, we note the mandatorylanguage of section 363(e). A bankruptcycourt must provide adequate protectionfor an interest that will be terminated bya sale if the holder of the interest requestsit.”27 The term “adequate protection” caninclude any relief (other than compensationas an administrative expense) that will“result in the realization by such entity ofthe indubitable equivalent” of the interestthat will be terminated.28
Because the tenants in Spanish Peaksfailed to request adequate protection beforethe property was sold, the Ninth Circuitwas not required to decide what “adequateprotection” the bankruptcy court couldor should have awarded to them. “Still,”the Ninth Circuit said, “we think it worthmentioning that the broad definition ofadequate protection makes it a powerfulcheck on potential abuses of free-and-clearsales.”29 In addition, the Ninth Circuitsaid, “[We] emphasize that section 363(f)authorizes free-and-clear sales only in cer-tain circumstances.” One of these circum-stances is that “applicable nonbankruptcylaw permits sale of such property free andclear of such interest.”30
The Ninth Circuit acknowledged thatunder Montana law, if a lender with a lienon real property forecloses and the lien isrecorded before the leases were created,the foreclosure would terminate the leasesand all other junior liens or property inter-ests.31 A trustee in bankruptcy can use thisstate law—even when the lender does notforeclose—to sell property free and clearof junior liens and leases, driving up thesale price since any prospective buyerswould prefer acquiring real property unen-cumbered by two long-term and below-market leases.
The court said that while Section 365(h)is designed to protect tenant rights in the
property owner’s bankruptcy, it is notdesigned to enhance those rights beyondwhat the tenant retains under state law.32
Therefore, the Spanish Peaks bankruptcy“proceeded, practically speaking, like aforeclosure sale,” the Ninth Circuit said,which is not surprising since the largestcreditor was the holder of the mortgageon the property.33 “Indeed, had SPH [Span -ish Peaks Holdings] not declared bank-ruptcy, we can confidently say that therewould have been an actual foreclosuresale,” the court stated, and this sale wouldhave terminated the leases.34
The Ninth Circuit cited the Dishi &Sons case in which the U.S. District Courtfor the Southern District of New York heldthat Section 363(f)(1) “refers not to fore-closure sales, but rather only to situationswhere the owner of the asset may, undernonbankruptcy law, sell an asset free andclear of an interest in such asset.”35 TheNinth Circuit said that Section 365 rec-ognizes rights conferred by a lease “to theextent that such rights are enforceableunder applicable nonbankruptcy law,”which would include the law governingforeclosure sales. The court concluded thatthe “clear intent” of the statute is “to pro-tect lessees’ rights outside of bankruptcy,not an intent to enhance them.”36
The Ninth Circuit noted that its analy-sis “highlights a limitation inherent in the ‘majority’ approach taken by othercourts.”37 Section 365 reflects the intent ofCongress to protect lessees. “But that intentis not absolute; it exists alongside otherpurposes and sometimes conflicts withthem,” the court said.38 In some circum-stances, protecting a lessee can reduce thevalue of the estate if the terms of a leasefavorable to that lessee makes the propertyless desirable to a buyer. That would becontrary to the goal of “maximizing creditorrecovery,” which is a key objective of theBankruptcy Code, it noted.39 “The statutorytext is the best assurance we have that weare balancing competing purposes in theway Congress intended,” it added.40
For tenants of a bankrupt landlord, thelesson to be learned here is to aggressivelypursue and protect one’s rights and request“adequate protection” under BankruptcyCode Section 363 when any sale of theunderlying real property is proposed freeand clear of the tenant’s lease. (Most bank-ruptcy sales are structured to offer the prop-erty free and clear of all encumbrances toincrease the sale price.) On the other hand,more bankrupt companies and trustees mayuse the holding in Spanish Peaks to sellrental property free and clear of leases andthereby increase the sale proceeds. These“sold out” tenants may file a claim for
damages, but the recovery can be little andworth far less than the right to continueusing the rental property. Ten ants facingthese circumstances should consult withexperienced bankruptcy counsel and dis-cuss various forms of “adequate protec-tion” they should request as a conditionto a court’s approval of a trustee (or chap-ter 11 debtor’s) request to sell propertyfree and clear of the tenant leases. n
1 11 U.S.C. §362.2 11 U.S.C. §363.3 In re Spanish Peaks Holdings II, LLC, 862 F. 3d1148 (9th Cir. 2017).4 In re Spanish Peaks Holdings II LLC, 2014 Bankr.LEXIS 913 (Bankr. D. Mont., Mar. 10, 2014).5 Id. at 21.6 Id. 7 As explained in Pinnacle Rest. at Big Sky, LLC v.CH SP Acquisitions, LLC (In re Spanish PeaksHoldings), 862 F. 3d 1148, 1156 (9th Cir. 2017),amended by 872 F. 3d 892 (9th Cir. 2017), “[a] bank-ruptcy court must provide adequate protection for aninterest that will be terminated by a sale if the holderof the interest requests it. Moreover, “adequate pro-tection” includes any relief—other than compensationas an administrative expense—that will “result in therealization by such entity of the indubitable equivalent”of the terminated interest. 11 U.S.C. §361(3).”8 Pinnacle Rest., 862 F. 3d at 1153. 9 Id.10 Id. at 1152.11 Id. at 1153.12 Id.13 Id. at 1151.14 Id. at 1154 (citing In re Churchill Props., 197 B.R.283, 286 (Bankr. N.D. Ill. 1996); In re Haskell, L.P.,321 B.R. 1, 8–9 (Bankr. D. Mass. 2005); In re Taylor,198 B.R. 142, 164–66 (Bankr. D.S.C. 1996); and Inre LHD Realty Corp., 20 B.R. 717, 719 (Bankr. S.D.Ind. 1982)). 15 Pinnacle Rest., 862 F. 3d at 1154-55 (quoting In reChurchill Props., 197 B.R. at 288). 16 Pinnacle Rest., 862 F. 3d at 1155 (quoting In reTaylor, 198 B.R. at 165). 17 Precision Ind., Inc. v. Qualitech Steel SBQ, LLC (Inre Qualitech Steel Corp. & Qualitech Steel HoldingsCorp.), 327 F. 3d 537, 547 (7th Cir. 2003).18 Id. 19 Id. 20 Pinnacle Rest., 862 F. 3d at 1155 (quoting PrecisionInd., 327 F. at 548). 21 Id.22 Pinnacle Rest., 862 F. 3d at 1155-56.23 Id. at 1156.24 Id.25 Id.26 Id.27 Id.28 11 U.S.C. § 361(3).29 Pinnacle Rest., 862 F. 3d at 1156.30 Id.31 Id.32 Id. at 1157.33 Id. at 1156.34 Id. at 1157.35 Dishi & Sons v. Bay Condos, LLC, 510 B.R. 696,704 (S.D. N.Y. 2014).36 Pinnacle Rest., 862 F. 3d at 1157.37 Id.38 Id.39 Id.40 Id.
14 Los Angeles Lawyer January 2018
Los Angeles Lawyer January 2018 15
RICK
EW
ING
ENCINITAS IS A HIP LITTLE BEACH TOWN in North County SanDiego, home to beautiful beaches, crowded coffee shops, and allthe charms of coastal living. Unfortunately, it is also home tocontroversy surrounding the very asset that defines it: the coastline.The sandy beach in Encinitas is disappearing due to erosion andrising sea levels. In the face of rising seas, natural coastlineswould normally migrate inland and use sand from bluff resourcesto restore the beach; however, a hardened structure, e.g., a wallthat is intended to stabilize a bluff or protect it from oncomingwaves, essentially fixes the back of the beach in a certain spotthus disrupting the natural shoreline processes.1 Expert geologistswarn that dry beach width is consistently and significantlynarrower where a wall or hardened structure exists.2 Becausesandy beaches are being enveloped with water from the seawardside, while also being deprived of sand from the landward side,seawalls ultimately force the shoreline to migrate inland, reducingthe width of the beach in front of the seawall and eventuallyleading to total loss of the sandy beach. A rise in sea level alsoexacerbates this process.3
Bluff stabilization seawalls remain a primary means of pro-tecting existing structures situated on an eroding coastline. Localmunicipalities and the California Coastal Commission have beenaddressing the issue of seawalls and other forms of coastalarmoring or reinforcement through Local Coastal Programs(LCPs) and guidance documents. These entities also must decideon individual permits for coastal armoring projects and incorporatethoughtful coastal management provisions in this permittingprocess.
Lynch Seawall Case
Encinitas homeowners and neighbors Barbara Lynch and ThomasFrick own adjacent properties that sit on a bluff and cascadesteeply down to the beach and shoreline. These bluff-top home-owners share a seawall and a private staircase. The 100-footlong seawall was meant to stabilize the bluff upon which thehomes are built, and the staircase provides private access to thebeach. The seawall and staircase both have a long history of reg-ulation by the Coastal Commission. The original staircase wasconstructed prior to enactment of the California Coastal Act of1976.4 When the staircase collapsed in 1973, the CoastalCommission (established by Prop osition 20 and the CaliforniaCoastal Zone Conservation Act of 19725) determined that recon-struction was exempt from state permitting requirements. Theseawall and a mid-bluff retention structure were built in 1986,and in 1989, the Coastal Com mission issued a coastal developmentpermit (CDP) allowing the structures to remain in place. Theoriginal seawall structure was comprised of 20-foot wooden polesembedded in the sandy beach and cabled to the bluff with railroadties anchoring the mid-bluff structure. In 2003, the bluff-tophomeowners applied for a CDP with the City of Encinitas to
replace the wooden erosion control structure with a texturedconcrete seawall system and remove and replace the lower sectionof the staircase.
Six years later, in 2009, the City of Encinitas approved theproject based on a finding that it would not adversely affect thecity’s general plan or its municipal code. However, the city con-ditioned its approval on the bluff-top homeowners obtaining afinal permit from the Coastal Commission. The commissionapproved the permit but imposed the following conditions: 1)the private staircase could not be reconstructed, 2) the seawallpermit would expire 20 years from the date of approval, and 3)prior to the 20-year expiration period, the owners would haveto submit an application for another CDP to remove, change, orextend the seawall. The CDP also required that Lynch and Frick
practice tips BY ANGELA HOWE
Lynch v. California Coastal Commission and California’s Seawall Policy
Angela Howe is the legal director for the Surfrider Foundation headquarteredin San Clemente, California. In leading the organization’s legal strategy,she fights for sustainable solutions to environmental challenges and protectionof coastal resources and beach access rights throughout the nation.
record a deed restriction evidencing theiragreement with the permit conditions. Thebluff-top homeowners recorded the deedrestrictions, which acknowledged that thespecial conditions of the permit were bind-ing and restrictive covenants thus limitingtheir use and enjoyment of the properties.The CDP was then issued and construc-tion began on the seawall. Meanwhile,Lynch and Frick also sued the CoastalCom mission seeking a writ of mandatedirecting the commission to remove theconditions from the CDP. They challengedthe commission’s conditions arguing thatthere could be no 20-year “sunset clause”or expiration date on the seawall permit,nor could the commission deny a permitto repair the staircase. Further, the bluff-top homeowners argued the new technol-ogy used in rebuilding the seawall wasexpected to last for 75 years. In addition,they argued that the permit term limit con-stituted an unconstitutional taking underthe U.S. Supreme Court’s holdings inNollan v. California Coastal Commission6
and Dolan v. City of Tigard.7 They usedthis case law and its progeny to argue thata government agency that imposes permitconditions without any “nexus” and“rough proportionality” to the impact ofthe proposed project is constitutionallyimpermissible.8
In response to the staircase issue, theCoastal Commission argued that the city’sLCP prohibited construction of private stair-ways on a bluff, thus, the staircase consti-tuted a structural nonconformity. The stair-way would have to be removed or turnedinto a public access way. The commissioncited Encinitas Municipal Code Section30.76.50, which only allows for repair andmaintenance of a structural nonconformity,not replacement. It then argued that theexemption for natural disasters underMunicipal Code Section 30.80.050 did notapply for replacement of a structure de -stroyed by an act of God. The com mis -sion’s staff report stated that the staircase’scollapse was deemed not to be caused by anatural disaster and further found that evenif it was a natural disaster, the staircase wasstill impermissible since the constructionhad to comply with the LCP and become apublic stairway if it continued to exist.
Life of a Seawall
With regard to the seawall, the CoastalCommission argued the 20-year permitterm was necessary to ensure the seawallremained safe in light of sand erosion, bluffchanges, and rising sea levels that mightundercut the support system after such along period of time. Generally, this periodcorresponds to what coastal engineers
assume for the life of a seawall. In addition,the National Oceanic and AtmosphericAdministration makes boundary determi-nations for the mean high tide line every18.6 years, which is used by the CaliforniaState Lands Commission.9 If the seawallwere located below the mean high tideline, it could end up on public property oraffect public property. The commissionalso cited the collapse of the old seawallafter 20 years as a rationale for this timeframe. Essentially, the coastal managerswanted the opportunity to reexamine theseawall’s effects on the coastline after twodecades in order to note the new locationand potentially impose additional mitiga-tion measures.
In March 2013, San Diego CountySuperior Court Judge Earl H. Maas IIIissued the writ of mandamus sought byLynch and Frick and directed the com -mission to remove these conditions. JudgeMaas held the staircase simply neededrepair rather than replacement. The courtalso found the LCP’s prohibition on thesestructures did not apply because it refersonly to new structures as private accessways and not existing structures. Further,the court sided with the bluff-top home-owners stating the Coastal Commissionwould retain the power to force repair orchange if the seawall ever became unsafeso the agency’s concerns could be addressedwithout the “sunset clause.” Finally, thelower court did not directly speak to thetakings claim.
Rulings on Appeal
Since the seawall permitting issue is centralto the Coastal Commission’s authority tomanage the coast in the face of rising sealevel, the agency appealed the decision.The California Court of Appeal, FourthDistrict, reversed Judge Maas’s decision.The appellate court addressed whether 1)the permit conditions were waived by thebluff-top homeowners’ actions in signingand recording documents, agreeing to thestated conditions and then accepting thebenefit of the permit by completing theirproject, and 2) the Coastal Commission’sconditions were valid and supported bysubstantial evidence. The appellate courtheld that Lynch and Frick waived theirright to challenge the permit conditions byaccepting the benefits of the permit andthen went on to rule on the validity ofthose permit conditions. With a split deci-sion at the appellate court in the commis-sion’s favor, the issue generated numerousamicus briefs, including coastal propertyowner groups, planning and realtor asso-ciations, and coastal protection organiza-tions. For instance, the Surfrider Found -
ation described the science behind howseawalls cause gradual elimination of thesandy beach and the detrimental impactsof coastal armoring to the public trustresources located at the intertidal zone.
Waiver Issue
The California Supreme Court affirmedthe appellate court on the waiver issue butdeclined to address the issue related tovalidity of the permits. Writing for a unan-imous court, Justice Carol A. Corriganconcluded the bluff-top homeowners for-feited their right to challenge the permitconditions when they accepted the permitand proceeded to build the seawall autho-rized by the commission.10
The court asked why a property ownershould be allowed to accept the benefitsof a permit (i.e., the right to build a seawall)without accepting its burdens (i.e., the 20-year duration). The bluff-top homeownersargued these conditions were severable andthat California Civil Code section 1094.5allows this type of relief; however, no caselaw exists on this issue. If the court ruledacceptance of the permit allowances did,in fact, include simultaneous acceptanceof the permit conditions, the bluff-tophomeowners would have waived their rightto pursue a substantive challenge to thepermit conditions under the Coastal Actand on constitutional grounds. CitingPfeiffer v. City of La Mesa on this issue:“If every owner who disagrees with theconditions of a permit could unilaterallydecide to comply with them under protest,do the work, and file an action…completechaos would result in the administrationof this important aspect of municipalaffairs.”11
According to the California SupremeCourt, if the condition was invalidated afterthe seawall was built, the Coastal Com -mission could not require alternative miti-gation measures such as directing the seawallbe located farther inland “to account forsand loss beyond 20 years” or altering itssize or design. As a matter of equity, thebluff-top homeowners should have negoti-ated or challenged the Coastal Commission’sconditions before proceeding with construc-tion. After all, the court stated, “[t]helandowner is in the best position to knowhow strongly he objects to a particular con-dition.”12 Generally, a property owner mayobject to an allegedly unreasonable permitcondition by refusing to comply with thecondition and challenging the entire permit.This rule stems from the equitable maximof jurisprudence, “He who takes the benefitmust bear the burden.”13
By ruling on the waiver issue, the statesupreme court issued a decision in favor
16 Los Angeles Lawyer January 2018
of the Coastal Commission and rejectedthe bluff-top homeowners’ claim that per-mit conditions imposed by the commissiontriggered a regulatory taking of their privateproperty.14 As for the merits of the CoastalCommission permit, the supreme courtdecided: “We granted review. Because wedetermine plaintiffs’ claims have been for-feited, we do not decide the legality of thechallenged conditions.”15
One may wonder why the bluff-tophomeowners did not contend that they hadan immediate need to build their seawallbecause of the existence of an emergency.In arguing before the supreme court, thebluff-top homeowners’ counsel took painsto avoid arguing an “emergency” conditionfor the seawall, knowing that this argumentwould lead to the rebuttal that the home-owners should have applied for an emer-gency permit versus the full Coastal Dev -elopment Permit.16 While the Calif orniaCourt of Appeal decision may lack prece-dential value, it nevertheless provides in -sights and guidance on the permit condi-tions issue and others that will eventuallyneed to be recognized and addressed bythe California Supreme Court. Further,published authority already exists to sup-port the Coastal Commission’s authorityto mitigate the impact of seawalls.17
Duration of the Permit
Lynch and Frick argued the conditions lim-iting the duration of the permit to 20 yearswere invalid because they had no nexusto the seawall’s impacts and the commissionhad no other authority to impose them.The commission responded that the bluff-top homeowners waived any challenges tothe conditions by accepting the benefits ofthe permit and building the seawall andthat the conditions were valid and sup-ported by substantial evidence. On thisissue, the appellate court found the 20-year term was reasonable because, in part,“the seawall will likely need augmentation,replacement, or substantial changes within20 years because of sea level rise and theseawall’s location in a high hazard area.”18
The court concluded that:Since the Commission imposed theconditions limiting the permit’s dura-tion to ensure the seawall’s long-term impacts do not extend beyondthe time period for which the sea-wall’s existence can be reasonablyjustified to protect respondents’existing homes, we conclude the con-ditions fell within the Commission’sdiscretion and were valid.19
Lynch and Frick also argued thereshould be an “under protest” exceptionfor permit applicants who oppose non-fee
conditions. The appellate court rejectedthis for several reasons: 1) this type ofexception would effectively swallow thegeneral rule since many permittees areasked to accept permit conditions that theyconsider unfavorable in order to obtainpermit approval for the overall project, 2)allowing challenges of the burdens of apermit while accepting the benefits wouldfoster litigation and create uncertainty inland use planning, and 3) a non-fee provi-sion that would be deemed invalid is noteasily quantified or remedied by the per-mitting agency after the fact when othercomparable remedies may not be availableanymore.20
Finally, with regard to the deed restric-tions constituting covenants running withthe land, the court stated, “Absent clear,supporting authority,…we are unwillingto condone deliberate subterfuge in re -corded documents as doing so would sub-vert the documents’ noticing function.”21
Here, the subterfuge would have been thebluff-top homeowners’ accepting the deedrestrictions by recording them and thensubsequently challenging the validity ofthese restrictions in court.
A definitive California Supreme Courtdecision on the permit condition issuewould have provided guidance not onlyto the Coastal Commission but also otherlocal municipalities in developing andenforcing LCPs. Specifically, it would haveenabled the latter to be able to reconcileprivate property rights with protection ofthe public trust resources in the face of ris-ing sea levels and adopting needed adap-tation strategies. For the time being,California courts agree that property own-ers can either receive a permit and proceedto build a project or file suit to challengea permit decision, but they cannot do both.
Long-Term Effects
The Coastal Commission imposed the con-tested 20-year permit term in preparationfor the anticipated long-term effects ofintensifying coastal storms and projectedrising sea levels on the California coast. Aneffective rising sea level adaptation policyallows for flexible land use decisions inlight of the changing shoreline environmentand increased knowledge about the on-the-ground projected impacts of climatechange.22 For the 20-year permit term,the court of appeal found it reasonablebecause, in part, “the seawall will likelyneed augmentation, replacement, or sub-stantial changes within 20 years becauseof sea level rise and the seawall’s locationin a high hazard area.”23 Since the com-mission imposed the conditions limitingthe permit’s duration to ensure the seawall’s
long-term impacts do not extend unrea-sonably, the court of appeal concluded theconditions fell within the commission’s dis-cretion and thus were valid.24 The com-mission relied on the Ocean Harbor Housecase to defend its discretion to adopt mea-sures that provide for mitigation of all sig-nificant impacts that a seawall projectmight have.25
The Stairway
The Coastal Commission argued that thiswould be the fourth time the stairway wouldhave to be rebuilt. Since this type of con-struction is harmful to the bluff, the com-mission decided to deny it. As the CoastalCommission points out, the city’s coastalbluff overlay regulations, which are alsopart of the city’s LCP, effectively implementthese policies by allowing only public accessfacilities on coastal bluffs.26 Because thereconstruction of the lower stairway wasinconsistent with both the general planpolicies and the coastal bluff overlay reg-ulations, the court of appeal agreed thatpermit condition disallowing the stairwellwas valid.27 The state supreme court, how-ever, declined to address the substantiveissue of the stairway modification andwhether the Coastal Com mission couldimpose this permit condition.
The California Supreme Court’s oppor-tunity to weigh in on coastal managementissues in the face of rising sea levels cameand went as quickly as an ocean wave.The court passed on an opportunity toaffirm or deny the policies and decisionsof the Coastal Commission as well asmunicipalities and their LCPs while theyare attempting to deal with the impact ofrising sea levels and climate change onexisting residential structures and otherforms of coastal development that markthe California coast.
This proliferation of coastal develop-ment and threat to beach access and othercoastal resources is one reason Proposition20 and the California Coastal Act wereadopted decades ago and why a strongcoastal policy to protect and manage thoseresources is needed now more than ever.Controversies like the one over the Lynchand Frick seawall in Encin itas will onlybecome more prevalent. Hopefully, withthe next go-round in seawall litigation,coastal property owners and the beach-going public will be afforded more certaintyabout coastal armoring policy and thefuture of one of California’s most belovedassets: the beach. n
1 Molly L. Melius & Margaret R. Caldwell, 2015California Coastal Armoring Report: Managing CoastalArmoring and Climate Change Adaptation in the 21st
18 Los Angeles Lawyer January 2018
Century, STANFORD LAW SCHOOL 8 (June 2015), avail-able at http://law.stanford.edu/wp-content/uploads/2015/07/CalCoastArmor-FULL-REPORT-6.17.15.pdf(hereinafter Melius); see also Meg Caldwell & CraigHolt Segall, No Day at the Beach: Sea Level Rise,Ecosystem Loss, and Public Access Along the CaliforniaCoast, 34 ECOLOGY L.Q. 534, 534 (2007).2 Melius, supra note 1, at 8.3 As sea levels rise, the current elevation beach will beswallowed by the higher ocean water. Sandy beachesthat are not constantly nourished and cannot migrateinland because of a seawall will eventually be squeezedout and lost between the rising tides and the inlandbackstop of coastal armoring. CALIFORNIA COASTAL
COM MISSION STATEWIDE SEA LEVEL RISE VULNERABIL ITY
ASSESSMENT (Dec. 31, 2016), available at https://documents.coastal.ca.gov/assets/climate/slr/vulnerability/FINAL_Statewide_Report.pdf.4 PUB. RES. CODE §§30000 et seq.5 California Coastal Zone Conservation Act of 1972(“Proposition 20”) as amended by Chapters 28 and1014 (1973), available at https://www.coastal.ca.gov/legal/proposition-20.pdf.6 Nollan v. California Coastal Comm’n, 483 U.S. 825(1987).7 Dolan v. City of Tigard, 512 U.S. 374 (1994).8 Nollan and Dolan constitute two seminal cases intakings jurisprudence. In Nollan, a case involving adevelopment permit for a beachfront house in Ventura,California, the U.S. Supreme Court established that agovernment agency can require an easement as a con-dition for a permit, if that exaction substantiallyadvanced the government interest that was affectedby the granting of the permit. In Dolan, a case involvinga store expansion in Oregon, the regulatory takingsdoctrine was further refined with the holding thatthere must be “rough proportionality” between thecity’s public interest and the proposed infringementon the property owner’s rights.9 Tidal Datums, NAOO Tides & Currents, U.S. Dep’tof Commerce, https://tidesandcurrents.noaa.gov (lastviewed Nov. 22, 2017).10 Lynch v. California Coastal Comm’n, _Cal. 5th_,No. S221980, 2017 WL 2871762 (Cal. July 6, 2017).11 Lynch, 2017 WL 287176, at *9 (Cal. Ct. App. July6, 2017), quoting Pfeiffer v. City of La Mesa, 69 Cal.App. 3d 7, 78 (1977).12 Lynch, 2017 WL 287176, at *11.13 CIV. CODE §3521.14 See Lynch, 2017 WL 287176. While ruling solelyon the waiver issue, the court did not find the argumentof regulatory takings to be relevant.15 Id. at *4.16 See PUB. RES. CODE §§30624, 30600 et seq.17 Ocean Harbor House Homeowners Ass’n. v. Calif -ornia Coastal Comm’n, 69 Cal. App. 3d 74, 242(1977). 18 Lynch v. California Coastal Comm’n, No. D064120,at 12 (Cal. App. 4th Sept. 9, 2014).19 Id. at 13.20 Id. at 8.21 Id. at 9.22 See California Coastal Commission Sea Level RisePolicy Guidance: Interpretive Guidelines for AddressingSea Level Rise in Local Coastal Programs and CoastalDevelopment Permits, Cal. Coastal Comm’n (Aug. 12,2015), available at https://www.coastal.ca.gov/climate/slrguidance.html.23 Lynch, No. D064120, at 12.24 Id. at 13.25 Ocean Harbor House Homeowners Ass’n. v. Calif -ornia Coastal Comm’n, 69 Cal. App. 3d 74, 241-422(1977).26 ENCINITAS MUN. CODE §30.34.020(B)(2)(a).27 Lynch, No. D064120, at 18.
Los Angeles Lawyer January 2018 19
BARRY ROSS, ESQ., MBA818.840.0950
www.ROSSmediation.com
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Waronzof Associates, Incorporated 400 Continental Boulevard, Sixth Floor El Segundo, CA 90245
ASSOCIATES WARONZOF Timothy R. Lowe, MAI, CRE, FRICS
310.322.7744 T 424.285.5380 F [email protected]
www.waronzof.com
REAL ESTATE DISPUTE CONSULTING
20 Los Angeles Lawyer January 2018
KEN
CO
RRA
L
or not insurance willprovide a defense and
indemnity in a construction defect lawsuit presentsone of the more complicated legal questions faced by insurance and construction law practitioners alike.The coverage issues are highly fact-dependent, thecontract clauses vary from construction project toconstruction project, and the law is constantly in astate of flux. Moreover, add to these factors cases inwhich discovery of the defects only takes place severalyears after project completion—so-called “latentdefects”—and the coverage question becomes evenmore complex. Fortunately, recent California stateand federal decisions have addressed and informedseveral key coverage issues in the context of commercialgeneral liability (CGL) policies, viz., whether faultywork constitutes an “occurrence,” the “trigger” ofcoverage, and the applicability of several standardbusiness risk exclusions.
The insuring agreements of post-1986 CGL policyforms promulgated by the Insurance Services Office(ISO) provide that, in order for “bodily injury” or“property damage” to be covered, the harm must becaused by an “occurrence.”1 CGL policies define“occurrence” as “an accident, including continuous
or repeated exposure to substantially the same generalharmful conditions.”2 Carriers and policyholders oftendispute whether faulty construction work qualifies asan occurrence under CGL policies because the Calif -ornia Supreme Court has yet to squarely address thequestion.
The two principal areas of contention are as follows:1) whether the event giving rise to the loss was “acci-dental”—itself an undefined term in the policies, and2) whether the type of damage sustained is covered(i.e., is there only damage to the insured’s work or isthere economic loss?). There is much confusion inCalifornia jurisprudence on the former question. Somecourts have interpreted the term “accident” to encom-pass unintended property damage resulting fromintended but negligently performed acts.3 Others,however, have applied a narrow definition, focusingon the insured’s conduct rather than any unintendedconsequences.4
Recent Cases
For example, Navigators Specialty Insurance Companyv. Moorefield Construction, Inc.5 involved a suit byan insurer seeking a declaration it had no duty todefend or indemnify its insured in a construction
Ashley B. Jordan is of counsel with Ver Ploeg & Lumpkin, P.A., specializing in the representation of individuals and corporate policyholders in complex insurance coverage and bad faith disputes with insurance companies.
REAL ESTATE LAW ISSUE
FINGER ON THETRIGGERCalifornia law holds that occurrence-based commercialgeneral liability policies are triggered at the time damagetakes place
BY ASHLEY B. JORDAN
WHETHER
defect lawsuit. The property owner suedMoorefield, the general contractor for thebuilding, claiming the flooring had faileddue to faulty construction. Navigatorsdefended Moore field in that lawsuit, sub-ject to a reservation of rights; the case ulti-mately settled with a policy limits paymentby the insurer.
Navigators then sought reimbursementfrom the contractor, arguing the damageto the flooring did not qualify as an occur-rence under the CGL policies because itwas not the result of an accident. The poli-cies contained the standard ISO definitionof occurrence.6 The trial court enteredjudgment in Navigators’ favor and requiredMoorefield to reimburse Navigators itssettlement payment. The trial court foundthere was no occurrence because Moore -field directed the flooring subcontractorto install the flooring, despite knowingthat moisture vapor emission from theconcrete slab exceeded specifications. Inother words, this was not an accident.Rather, it was the result of intentional con-duct. Moorefield appealed.
The appellate court affirmed, determin-ing Navigators had no duty to indemnifybecause the flooring failure did not con-stitute an occurrence, since there was noaccident: “Under California law, the word‘accident’…refers to the conduct of theinsured for which liability is sought to beimposed on the insured…; where theinsured intended all of the acts that resultedin the victim’s injury, the event may not bedeemed an ‘accident’ merely because theinsured did not intend to cause injury.”7
It was undisputed that Moorefielddirected its subcontractor to install theflooring on the concrete slab. The evidenceat trial also established that the subcon-tractor and the insured knew tests hadshown the moisture vapor emission ratefrom the concrete slab exceeded specifi-cations. Further, Moorefield’s project man-ager discussed the moisture vapor emissionrate results with the developer and owner,and the decision was made, based on acost-benefit analysis, to install the flooring.Indeed, the subcontractor performing thework anticipated problems from the highmoisture levels and refused to install theflooring unless Moorefield first releasedit from warranty claims. The trial courtfound the flooring failed due to excessiveconcrete slab moisture present during theoriginal construction. The court concludedthe insured’s deliberate act produced thedamage. There was no accident and thusno occurrence.
Notwithstanding the moisture testresults, the insured and its project managerbelieved there was little or no risk to
installing the flooring. The court statedthat even if true, they ended up beingmistaken, and “[a]n insured’s mistake offact or law does not transform an inten-tional act into an accident.”8 The courtcontinued:
Navigators proved that Moorefieldknew about and intended to per-form defective work with the hopeor mistaken belief the defect wouldnot cause property damage. Al -though there was no evidence thatMoore field intended to cause prop-erty damage, under Calif ornia law,[t]he insured’s subjective intent isirrelevant.9
The lesson of Navigators v. Moorefieldis that knowledge of potential defects plusintent to perform the work is unlikely toequal an “accidental” occurrence. How -ever, what if the contractor had not knownin advance about the moisture tests andhad not instructed the subcontractor toperform the defective work? Could cov-erage have been required under that hypo-thetical, since the harm was caused by anaccident?
The California Supreme Court maysoon provide further guidance on this ques-tion. In October 2016, the court grantedthe Ninth Circuit’s request for certificationof the following question of Californialaw: “Whether there is an ‘occurrence’under an employer’s [CGL] policy whenan injured third party brings claims againstthe employer for the negligent hiring, reten-tion, and supervision of the employee whointentionally injured the third party.”10
The case, Liberty Surplus Insurance Cor -poration v. Ledesma & Meyer Cons truc -tion Company, Inc.,11 is fully briefed andawaiting oral argument before the Calif -ornia Supreme Court.
In Liberty Surplus, the contractor(L&M) performed construction work ata middle school. Sadly, an L&M employeeallegedly committed sexual acts against astudent at the school. L&M’s carriers suedfor a declaration that they had no duty todefend or indemnify with respect to theunderlying action, and were entitled toreimbursement of the fees and costsexpended to defend the underlying lawsuit.The CGL policy contained the standardISO definition of “occurrence.”12
The parties filed cross-motions for sum-mary judgment. The district court grantedthe insurers’ motion, determining L&Mwas obligated to reimburse its carriers forfees and costs expended to defend L&M.The court reasoned the alleged injurieswere not caused by an occurrence:
L&M’s alleged negligent hiring,retention and supervision were acts
antec edent to the sexual molestationthat caused injury to [the claimant].While they set in motion and createdthe potential for injury, they weretoo attenuated from the injury-caus-ing conduct committed by [the in -sured’s employee]. Moreover, evenif one argued that L&M’s conductof supervision and retention werenot ante cedent, but rather simulta-neous, to the molestation…the super-vision and retention are still not theinjury-causing acts.13
The court also noted that “courts haverejected the argument that the insured’sintentional acts of hiring, supervising, andretaining are accidents, simply because theinsured did not intend for the injury tooccur.”14
L&M appealed. The Ninth Circuit cer-tified the question outlined above to theCal ifornia Supreme Court, noting the issuewas an unsettled matter of insurance lawin California. The Ninth Circuit declaredthat “resolution of this question will extendbeyond the employment context, affectingmany insured entities and persons,” and“[g]iven the ubiquity of insurance policiesthat cover ‘occurrences’ in California, thiscertified question presents an issue of sig-nificant precedential and public policyimportance.”15 Oral argument and a deci-sion on this important issue are expectedsometime in 2018.
Trigger of Coverage
Another common dispute between policy-holders and insurers is the thorny questionof “trigger of coverage.” The term “trigger”is neither found in CGL policies nor definedby the California Insurance Code. Triggerof coverage refers to “that which, underthe specific terms of an insurance policy,must happen in the policy period in orderfor the potential of coverage to arise.”16
When property damage happens over anextended period of time (i.e., due to alatent defect), the question becomes whichpolicy or policies will respond? Will it bethose in effect at the time of construction,the time the defect first manifested itself,the time the resulting damages to the struc-ture occurred, or some other time?
The insuring agreement of 1986 andlater ISO occurrence-based policies statesas follows: “The insurance applies only to‘bodily injury’ and ‘property damage’ whichoccurs during the policy period.”17 Cal -ifornia law thus holds that occurrence-based CGL policies are “triggered” at thetime the damage takes place.18
The California Supreme Court laid thefoundation for this principle in MontroseChemical Corporation v. Admiral In sur -
22 Los Angeles Lawyer January 2018
ance Company19 There, the court con-cluded the “continuous injury” triggerapplies to third-party liability cases involv-ing continuous or progressively deterio-rating losses. The court noted nothingabout the standard ISO insuring agreementsuggests the trigger occurs only upon man-ifestation of the harm. Mon trose also ex -plained the policy language only requiresthe injury or damage, rather than thecausative event, happen during the policyperiod. The court stated, “the date of dis-covery of the damage or injury” is not
controlling; “It is only the effect—theoccurrence of bodily injury or propertydamage during the policy period…—thattriggers potential liability coverage.”20
Montrose, however, left some questionsunanswered. The court in Tidwell En -ter prises, Inc., et al. v. Financial PacificIn sur ance Com pany, Inc.21 recently ad -dres sed the trigger issue in the latent con - struction defect context. The insurer,Financial Pacific, refused to defend itsinsured, Tidwell, against a constructiondefect action under a series of CGL poli -cies.22 Tidwell had installed a fireplace sys-tem in a home that was later damaged by fire. Tidwell sued Financial Pacific,alleging the carrier owed it a defense.
Financial Pacific moved for summaryjudgment on the coverage issue. The trialcourt granted the carrier’s motion, reasoningthe fire occurred after the expiration of thelast Financial Pacific policy. The appellatecourt reversed, concluding there was a pos-sibility the damages were covered, as theymay have been caused by physical injuryto the house predating the fire. It explainedthe allegations and known facts indicatedas follows:
Tidwell might have negligently in -stalled a custom top on the chimneyin the [] house that restricted theflow of air in the chimney, which inturn might have resulted in excessiveheat in the chimney every time a firewas burned in the fireplace from thetime the house was built, which inturn (through the process of pyrol-ysis) might have altered the chemicalcomposition of the wood framingthe chimney chase, thereby reducingthe temperature at which it wouldignite, until eventually, on Nov ember11, 2011, the wood framing the
chimney chase did ignite, which inturn resulted in the fire that damaged[the] house, for which [the home-owner’s insurer] was obligated toin demnify [the homeowner] as [thehomeowner’s] insurer.23
The court of appeal stated such allega-tions and facts triggered the insurer’s poten-tial liability because “the repeated exposureof the wood framing the chimney chaseto the excessive heat in the chimney, forwhich Tidwell was responsible, may havecaused physical injury to the wood (by
altering its chemical composition andreducing its ignition point) during one ormore policy periods” and “that physicalinjury would have caused Tidwell’s legalobligation to pay damages for the fire thatresulted (at least in part) from the damagedwood.”24
That the damage alleged in the under-lying complaint was for a fire that occurredafter the policies expired, the court ex -plained, “does not preclude the possibilityof coverage because of the causal role thatthe degradation of the wood during oneor more policy periods may have playedin causing the fire for which [the home-owner’s carrier] sought to recover dam-ages.”25 Specifically, “an initial causativeevent constituting an ‘occurrence’—namely,the repeated exposure of the wood framingthe chimney chase to excessive heat in thechimney—may have resulted in propertydamage over a period of years—namely,the physical degradation of that wood—which in turn may have led ultimately tothe fire in November 2011.”26 The injuryto the wood resulting from the initial causalevent, the court determined, may have con-stituted a further causal event in the chainbetween Tidwell’s negligent installationand the fire.
Modification of the Trigger
In response to evolving case law, insurershave drafted endorsements and nonstan-dard language modifying the trigger foroccurrence-based CGL policies. Practit -ioners and corporate counsel need to beon the lookout for policy provisions requir-ing that the occurrence happen within thepolicy period, or mandating applicationof the so-called “manifestation” trigger.
One of these policy provisions was re -cently enforced in Bankers Insurance Com -
pa ny v. A-1 Air Conditioning & Heat ing,et al.27 There, the CGL policies containedan endorsement requiring the oc currenceto take place during the policy periods.The endorsement modified the definitionof occurrence, in relevant part, as follows:
“Occurrence” means an accidentwhich results in “bodily injury” or“property damage” that first occursduring the policy period and is nei-ther expected nor intended by aninsured. “Bodily injury” or “prop-erty damage” first occurs during the
policy period only if: a. The “bodilyinjury” or “property damage” isfirst sustained by a person or entityduring the policy period….28
The insureds installed a stove in a res-idence that was subsequently destroyedby fire, and thus sought insurance cover-age. Upon receipt of its insureds’ tender,the carrier filed a declaratory judgmentaction regarding its defense and indemnityobligations.
The court granted the insurer’s motionfor summary judgment, determining theendorsement unambiguously stated thatboth the accident and property damagemust occur during the policy period. Itwas undisputed that the fire (the occur-rence) and resulting damage (the propertydamage) occurred after expiration of thepolicies. The court thus concluded theendorsement precluded the potential forcoverage.29
At issue in St. Paul Fire & Marine In -surance Company v. Insurance Companyof the State of Pennsylvania, et al.,30 werepolicies containing endorsements modifyingthe trigger mandated by California law.There, the insurer sought reimbursementfrom other carriers for its settlement pay-ments in a construction defect action. Onecarrier, St. Paul Fire and Marine InsuranceCompany, moved for summary judgment,arguing there was no evidence any damagesoccurred during its policy period. The St.Paul CGL policy defined “property dam-age” in a rather folksy way, as “[p]hysicaldamage to tangible property of others,including all resulting loss of use of thatproperty. We’ll consider all physical damageto tangible property of others to happenat the time that it is first manifested.”31
The policy defined the phrase “first man-ifested” to mean “first known, or first in
Los Angeles Lawyer January 2018 23
The injury to the wood resulting from the initial causal event,...may have
constituted a further causal event in the chain between Tidwell’s negligent
installation and the fire.
a condition where it reasonably shouldhave been known, by [the insured].”32
The court granted St. Paul’s motion,concluding there was no evidence that thedamage “first manifested” during the St.Paul policy period. While there was experttestimony showing damage had startedoccurring during the St. Paul policy period,nothing proved the insured knew or hadreason to know the damage was occurringat that time, as re quired by the policyendorsement.
Policyholder and corporate counselshould be aware of these nonstandardendorsements and provisions, as well astheir potential implications, since they maysignificantly impact coverage available forlatent construction defect damages. Counselshould consider advising clients to discussthese endorsements/provisions with theirbrokers and, if possible, remove the limitinglanguage.
Business Risk Exclusions
To deny coverage for construction defectclaims, insurance carriers also frequentlycite Exclusions j(5) and j(6), known as“business risk” or “ongoing operations”work exclusions. Exclusion j(5) in the1986 and later ISO CGL policies reads inrelevant part as follows: “This insurancedoes not apply to: ‘Property damage’ to:…That particular part of real property onwhich you or any contractor or subcon-tractor working directly or indirectly onyour behalf are performing operations, ifthe ‘property damage’ arises out of theseoperations….”33
Exclusion j(6) in the 1986 and laterISO CGL policies provides in pertinentpart: “This insurance does not apply to…‘Property damage’ to:…(6) That particularpart of any property that must be restored,repaired or replaced because ‘your work’was incorrectly performed on it….”34 Anexception to the exclusion states: “Para -graph (6) of this exclusion does not applyto ‘property damage’ included in the ‘prod-ucts-completed operations hazard.’”35
The term “your work” is defined as“(a) Work or operations performed by youor on your behalf; and (b) Materials, partsor equipment furnished in connection withsuch work or operations. ‘Your work’includes warranties or representationsmade at any time with respect to fitness,quality, durability or performance of anyof the items included in a. or b. above.”36
These “business risk” exclusions applyto property damage arising while theinsured is still performing operations. Whendamage arises after the insured has con-cluded its operations, exclusions j(5) andj(6) will not preclude coverage.37 Disputes
with respect to these exclusions generallyinvolve fact-intensive inquiries: 1) the mean-ing of the phrase “that particular part”(i.e., the entire contractual undertaking ver-sus the immediate area of the work wherethe property damage arose); and 2) whenthe work performed by the insured, or onthe insured’s behalf, was complete.
A California federal court recently ana-lyzed the applicability of these exclusionsin the context of a carrier’s duty to defendin Tokio Marine Specialty Insurance Co.v. Thompson Brooks, Inc.38 The contrac-tor, Thompson Brooks (TBI), had beenengaged as a general contractor to demol-ish and rebuild a house. Tokio Marineissued consecutive CGL policies to TBIthat contained the standard ISO j(5) andj(6) exclusions.39 With regard to the cov-erage dispute, the court denied the insurer’smotion for summary judgment, concludingTokio Marine owed a defense because dis-puted issues of material fact remained,thus implicating potential coverage. Theseissues were “how ‘complete’ the Projectwas at the time of termination (or aban-donment)” and “whose work caused theproperty damage and which parts of theProject were damaged….”40
As to Exclusion j(5), the court statedfactual issues remained as to 1) whetherthe alleged damage arose out of TBI’s oper-ations or third parties not under TBI’s con-trol, 2) the time and location of damage,and 3) the scope of and likely cause of dam-age. As to Exclusion j(6), factual issuesremained as to 1) whether the alleged dam-age arose out of TBI’s operations or thirdparties not under TBI’s control, 2) the timeof damage, and 3) whether the work wasabandoned or completed, which would trig-ger the exception to the exclusion. The courtthus ruled neither exclusion precluded TokioMarine’s duty to defend.
In another recent federal decision,Archer Western Contractors, Ltd. v. Nat -ional Union Fire Insurance Co. of Pitts -burgh, Pen nsyl vania,41 Exclusions j(5) andj(6) were found to preclude an insurer’sduty to indemnify for a defective worklawsuit settlement. A construction defectlawsuit had been filed against ArcherWestern with respect to its work on anemergency water storage pro ject. NationalUnion denied coverage, citing standard IS0j(5) and j(6) exclusions in its commercialumbrella liability policy.42
The district court granted NationalUnion’s summary judgment motion, rulingthe exclusions precluded the insurer’s dutyto indemnify. With respect to exclusionj(5) (labeled “e(5)” in National Union’spolicy), the court stated “[i]n the case ofa general contractor…the ‘particular part
of the property’ is the entire project.”43
Archer Western was the general contractorresponsible for construction of the pumphouse and installation of the turbine gen-erators, and all the alleged property damagewas to those components. The court thusdetermined the “particular part of the prop-erty” on which the general contractor wasworking encompassed both the pump houseand the turbine/generators. The court alsodetermined, construing the term “arisingout of” broadly, the alleged property dam-age arose out of Archer West ern’s work.The trial court reasoned that Exclusion j(6)(“e(6)” in National Union’s policy) pre-cluded coverage because the damages arosesolely from the contractor’s defective workduring the course of construction, includingconstruction of the pump house and instal-lation of the turbine/generators.
Archer Western appealed. The NinthCir cuit affirmed, explaining that “Calif -ornia courts have consistently adoptedbroad interpretations of the phrases ‘thatparticular part’ and ‘arises out of’ whenapplied to a general contractor.”44 Thecourt noted that California courts andfederal courts interpreting Calif ornia law“have construed ‘that particular part’ toencompass the entire project on which ageneral contractor is performing opera-tions.”45 The Ninth Circuit concluded thedistrict court’s decision was proper because“the alleged property damage was to thepump house and turbine generators, dis-crete portions of the property for which[Archer Western] was partially if not fullyresponsible, and the damage flowed fromits allegedly defective work on the prop-erty.”46 The court also rejected the in -sured’s argument that the exclusions wereambiguous.
Defenses to Exclusions
As has been seen, exclusions j(5) and j(6)sometimes provide carriers with powerfuldefenses to coverage. Although an insured’sbest response to these exclusions is not tohave them in the policy in the first place,policyholders still have a number of gen-erally applicable defenses at their disposal.The extent to which these defenses applywill, naturally, depend on the precise policylanguage and facts presented.
First, it is a basic rule of California lawthat “exclusionary clauses are interpreted nar rowly against the insurer.”47 Second,“[p]rovisions which purport to excludecoverage or substantially limit liabilitymust be set forth in plain, clear and con-spicuous language.”48 In addition, Ex -clusions j(5) and j(6) may not preclude acarrier’s defense obligation in many cases.An insurer’s duty to defend is greater than
24 Los Angeles Lawyer January 2018
its duty to cover, and the duty to defendis interpreted broadly under Californialaw. In most cases, the pleadings areunlikely to eliminate the potential thatalleged property damage arose after theinsured completed its work, or to resolvethe questions of the scope and likely causeof the property damage.
An insurer must defend its insuredagainst claims creating even a potential forindem nity.49 The duty to defend is excusedonly when “the third party complaint canby no conceivable theory raise a single issuewhich could bring it within the policy cov-erage.”50 Moreover, the entire action mustbe defended if there is any potentially cov-ered claim.51 “The determination whetherthe insurer owes a duty to defend usuallyis made in the first instance by comparingthe allegations of the complaint with theterms of the policy.”52 Extrinsic evidencemay defeat the duty to defend only if “suchevidence presents undisputed facts whichconclusively eliminate a potential for lia-bility.”53 Allegations in the complaint are“liberally construed” toward potential cov-erage.54 Finally, “[a]ny doubt as to whetherthe facts establish the existence of the defenseduty must be resolved in the insured’sfavor.”55 Thus, while these exclusions workto deny coverage in some cases, insureds
retain potent avenues for finding coverageand a duty to defend. n
1 SCOTT C. TURNER, INSURANCE COVERAGE OF CON -STRUCTION DISPUTES §6:56 (2d ed. 2017) [hereinafterTURNER].2 Id.3 See, e.g., McGranahan v. Insurance Corp. of N.Y.,544 F. Supp. 2d 1052, 1059 (E.D. Cal. 2008); LegacyPartners, Inc. v. Clarendon Am. Ins. Co., No. 08CV920BTM (CAB), 2008 WL 4482298, at *2 (S.D. Cal. Oct.2, 2008); Anthem Elecs., Inc. v. Pacific Employ ers Ins.Co., et al., 302 F. 3d 1049, 1055-56 (9th Cir. 2002);Hogan v. Midland Nat’l Ins. Co., 3 Cal. 3d 553, 559(Cal. 1970); Geddes & Smith, Inc. v. St. Paul MercuryIndem. Co., 51 Cal. 2d 558, 563-64 (Cal. 1959);Economy Lumber Co. v. Insurance Co. of N. Am., 157Cal. App. 3d 641, 647-48 (Cal. Ct. App. 1984).4 See JOHN K. DIMUGNO & PAUL E.B. GLAD, CAL IF -ORNIA INSURANCE LAW HANDBOOK §44:35 (2017).5 Navigators Specialty Ins. Co. v. Moorefield Constr.,Inc., 6 Cal. App. 5th 1258 (Cal. Ct. App. 2016).6 Id. at 1264-65.7 Id. at 1275 (citations omitted).8 Id. at 1277 (citation omitted). The court also notedthe trial court could have disbelieved them or discountedtheir testimony. See id.9 Id. at 1278 (citation omitted).10 See Liberty Surplus Ins. Corp. v. Ledesma & MeyerConstr. Co., Inc., 834 F. 3d 998, 1000 (9th Cir. 2016);Liberty Surplus Ins. Corp. v. Ledesma & Meyer Constr.Co., Inc., No. S236765 (Cal. Aug. 23, 2016).11 Liberty Surplus Ins. Corp. v. Ledesma & MeyerConstr. Co., Inc., No. CV 12-00900-RGK (SPx), 2013WL 12143958 (C.D. Cal. Jan. 23, 2013).12 Id. at *2.
13 Id. at *3.14 Id. (citations omitted).15 Ledesma & Meyer, 834 F. 3d at 1002.16 State of Cal. v. Continental Ins. Co., et al., 55 Cal.4th 186, 196 (Cal. 2012) (quotation omitted).17 TURNER, supra note 1, at §6:44.18 See Montrose Chem. Corp. v. Admiral Ins. Co., 10Cal. 4th 645, 668-69 (Cal. 1995); Armstrong WorldIndus., Inc. v. Aetna Cas. & Sur. Co., et al., 45 Cal.App. 4th 1, 39-40 (Cal. Ct. App. 1996) (collectingcases). Note the trigger for the loss of use form of“property damage” is subject to special treatment. SeeTURNER, supra note 1, at §6:44.19 Montrose, 10 Cal. 4th 645. 20 Id. at 675 (emphasis in original).21 Tidwell Enters., Inc., et al. v. Financial Pac. Ins.Co., Inc., 6 Cal. App. 5th 100 (Cal. Ct. App. 2016).22 Id. at 103.23 Id. at 108.24 Id.25 Id. at 111 (emphasis in original).26 Id.27 Bankers Ins. Co. v. A-1 Air Conditioning & Heating,et al., No. 2:16-cv-00177-JAM-CKD, 2017 WL1093930 (E.D. Cal. Mar. 23, 2017).28 Id. at *4.29 See also City of San Buenaventura v. Ins. Co. of theState of Pa., 719 F. 3d 1115 (9th Cir. 2013); PMACapital Ins. Co. v. American Safety Indem. Co., 695F. Supp. 2d 1124, 1127 (E.D. Cal. 2010); PennsylvaniaGen. Ins. Co. v. American Safety Indem. Co., et al.,185 Cal. App. 4th 1515 (Cal. Ct. App. 2010).30 St. Paul Fire & Marine Ins. Co. v. Insurance Co. ofthe State of Pa., et al., No. 15-CV-02744-LHK, 2017WL 897437 (N.D. Cal. Mar. 7, 2017).31 Id. at *31.32 Id.33 TURNER, supra note 1, at §29:1.34 Id. at §32:1.35 Id.36 Id.37 See PHILIP L. BRUNER & PATRICK J. O’CONNOR, JR.,BRUNER & O’CONNOR ON CONSTRUCTION LAW
§§11:256, 11:257 (2016). 38 Tokio Marine Specialty Ins. Co. v. ThompsonBrooks, Inc., No. 17–cv–00514–WHO, 2017 WL1489281 (N.D. Cal. Apr. 26, 2017).39 See id. at *3.40 See id. at *5.41 Archer W. Contractors, Ltd. v. National Union FireIns. Co. of Pittsburgh, Pa., No. 15-55648, 2017 WL816891 (9th Cir. Mar. 2, 2017).42 See Archer W. Contractors, Ltd. v. Liberty Mut.Fire Ins. Co. & Nat’l Union Fire Ins. Co., No. CV 14-3041 DMG (MANx), 2015 WL 11004493, at *2(C.D. Cal. Mar. 31, 2015).43 Id. at *8.44 Archer W. Contractors, 2017 WL 816891, at *1.45 Id. at *1-2.46 Id. at *2.47 MacKinnon v. Truck Ins. Exch., 31 Cal. 4th 635,648 (Cal. Ct. App. 2003).48 Thompson v. Occidental Life Ins. Co., 9 Cal. 3d904, 921 (Cal. Ct. App. 1973) (citation omitted).49 See Align Tech, Inc. v. Fed. Ins. Co., 673 F. Supp.2d 957, 967 (N.D. Cal. 2009).50 Montrose Chemical Corp. v. Superior Ct., 6 Cal.4th 287, 300 (Cal. 1993). 51 See Horace Mann Ins. Co. v. Barbara B., 4 Cal. 4th1076, 1081 (Cal. 1993).52 Horace Mann Ins. Co. v. Barbara B., 846 P. 2d792, 795 (Cal. 1993).53 Montrose Chem., 6 Cal. 4th at 298.54 Church Mut. Ins. Co. v. U.S. Liab. Ins. Co., 347 F.Supp. 2d 880, 887 (S.D. Cal. 2004).55 Montrose Chem., 861 P. 2d at 1160.
26 Los Angeles Lawyer January 2018
Los Angeles Lawyer January 2018 27
and prior use of com-mercial and industrial
properties in Southern California, including the region’s numerousand vast oil fields (and related operations like refineries, tankfarms, and gas stations), the aerospace industry, metal platingoperations, circuit board manufacturing, and defense-relatedoperations and manufacturing, means that contaminated sitesare often the rule here, not the exception.1 Few commercial orindustrial properties—including manufacturers, dry cleaners, hos-pitals, gas stations, office buildings, and even undeveloped prop-erties—are immune from being impacted by contaminationwhether from an on-site or off-site source. At the same time, fed-eral2 and state3 environmental statutes have broad reach, coveringpast and present owners of contaminated real property, as wellas lessors, lessees, and operators.4
The potential, and often actual, liabilities involving contami-nated properties, while sometimes not obvious, can result intremendous cleanup costs, long delays in the property’s reuse ordevelopment, decreased value or use of the property, and claimsfrom employees, lessees, and adjacent property owners. A primeexample of such damages and liabilities can and often haveresulted from a dry cleaner shop that is part of a strip mall.Long-term operational spills or leaks of the chemicals often usedin the dry cleaning process can migrate into the soil and ground-water, spreading throughout the property and onto adjacentproperties. This can result in expensive site assessment and reme-
diation costs as well as expose the operator of the business andthe property owner to toxic tort claims from individuals—includingemployees—who allege adverse impacts from the chemical vapors.Such contamination can also adversely impact the value and mar-ketability of the parcel on which the dry cleaner store is located.Thus, it is incumbent to recognize the environmental liabilitiesthat may arise in purchasing, selling, developing, and leasing realproperty, and to develop a strategy to avoid, or at least minimize,these liabilities.
Thorough due diligence is essential in any real estate transaction.Many sources exist to obtain information and documentation onthe environmental condition and history of a given property. Theseinclude Internet-accessible databases like the State Regional WaterResources Control Board’s GeoTracker5 database that tracks andarchives compliance data on waste discharges to land and ground-water and releases of hazardous substances from undergroundstorage tanks. EnviroStor,6 the California Department of ToxicSubstances Control’s (DTSC) data management system, tracksDTSC cleanup, permitting, enforcement, and investigative actionsinto hazardous waste facilities and sites with known contamination.Aerial photographs may also help reveal evidence of past operationsor spills. Phase I environmental reports that the current or priorowner, operator, or lessee may have had prepared are anothersource. A Phase I Environmental Site Assessment is designed toidentify recognized environmental conditions based upon a reviewof available public records, interviews and visual inspections but
Gary A. Meyer is a principal of the law firm of Parker, Milliken, Clark, O’Hara & Samuelian and the founding chair of his firm’s environmental law department.He was recently selected as Environ mental Attorney of the Year by the Los Angeles Business Journal.
REAL ESTATE LAW ISSUE
A CLEANBILL OF SALEProspective real estate purchasers can use various governmentresources to assist in managing hazardous waste disposal
BY GARY A. MEYER
MCLE ARTICLE AND SELF-ASSESSMENT TEST
By reading this article and answering the accompanying test questions, you can earn one MCLE credit.
To apply for credit, please follow the instructions on the test answer sheet on page 29.
THE HISTORY
does not include sampling or testing.Because contamination does not respect
property boundaries, it is also prudent to obtain information about the environ-mental condition of adjacent propertiesthrough GeoTracker, EnviroStor, or othersources. For example, if a neighboring sitehas a soil or groundwater problem, it isvaluable to know if this contamination mayhave migrated onto or under the subjectsite. This contamination may have numerousimpacts on a client’s property, includinggroundwater contamination flowing towardthe property or soil vapor contaminationarising from the subsurface into buildings,thus posing a potential health threat.
Site Testing
A prospective buyer, lessee, or developershould consider conducting tests on theproperty. The nature and scope of envi-ronmental testing will depend on manyvariables, including the buyer’s willingnessto incur this expense, an owner’s cooper-ation in allowing the testing, and the par-ties’ negotiation on the time granted forthis investigation. Generally, conductingand completing environmental due diligencetesting exceeds initial estimates. Accord -ingly, parties are advised to allow a suffi-cient due diligence period and provideoptions to extend the closing date so thebuyer may thoroughly evaluate the testdata and conduct further testing as needed.Assuming the owner permits a buyer, lessee,or developer to proceed with an environ-mental investigation, several important fac-tors must be determined and evaluated.
First, what are the types and charac-teristics of contaminants impacting theproperty? Are these impacts limited to thesoil or does it extend to indoor air orgroundwater or both? A buyer may en -counter a vast range of contamination con-ditions from those that are manageable asto time and money to those that are long-term, high risk, and expensive to remediate.For example, environmental agencies oftenconsider soil contaminated by low levelsof total petroleum hydrocarbons (i.e., gaso-line-related contamination) as posing a“low threat”7 to human health and theenvironment; therefore, these agencies areusually amenable to relatively inexpensiveremedial options such as natural attenua-tion, excavation, and soil vapor extraction.By contrast, chlorinated solvents such astetrachloroethylene (PCE) or trichloroeth-ylene (TCE)8—chemicals commonly asso-ciated with dry cleaners, circuit board pro-duction, and metal plating opera tions—often result in contamination to soil, soilvapor, and groundwater. Reme diation ofsolvent contamination often takes several
years, is very expensive, and may posehealth risks to on-site employees due tosoil vapors migrating onto the property orthe indoor air of on-site buildings or both.9
Accordingly, a determination that propertyis “contaminated” is a wholly in sufficientevaluation of its environmental condition.Knowledge and understanding of the chem-icals impacting the property, the media(i.e., soil, soil vapor, air, or groundwater)which may be or is affected, the cost andtime of remediation options, and the healthrisk factors to on-site employees or off-site neighbors are important factors to beconsidered.
Second, integral to determining whatchemicals may be present on the propertyis learning the nature and extent of bothpast and current operations conducted onit. “Out of sight, out of mind” is not agood strategy. This investigation shouldinclude evaluating if there were or still areany subsurface “buried treasures” at theproperty. Underground structures such astanks, sumps, clarifiers, and their attendantpiping that were or are on-site must beidentified. Were any underground structuresabandoned in place or were they removed?What chemicals—gasoline products orpotentially more problematic solvents—were stored or used in these tanks? Doesdocumentation exist, e.g., disposal recordsor removal permits? An investigation ofenvironmental operations, both those con-ducted below and above ground, must bemade. Did the facility have storage areas,whether inside the building or out in the“back forty” near a fence line, where drumsor other waste products may have beenstored? Are there indicia of past spillagefrom drums or leaks from vehicles such asforklifts that may have been operated on-site? Is there evidence of chemical releasesfrom or near the site’s manufacturing areasor equipment? Is there any evidence of pastfires or flooding that may have caused orexacerbated an environmental condition?
Examining the building itself is some-times overlooked in investigations. Whendealing with older, pre-1980 buildings,testing for asbestos-containing buildingmaterials (ACMs) should be done in theroof, ceiling, flooring, dry wall, or insula-tion areas. Any ACMs in good conditionshould not pose a problem but those inpoor condition can cause exposure to fri-able asbestos, especially during remodeling,building construction, or demolition. AllACMs require special handling when beingremoved from the property.10 Older build-ings may also contain other potentiallyhazardous materials or chemicals like leador polychlorinated biphenyls (PCBs)11 thatwill require similar treatment.
Third, agency actions relating to theproperty must be researched. Has the localregional water quality control board, theDTSC, the South Coast Air Quality Man -age ment District, a local hazardous mate-rial agency, a certified unified programagency,12 or the U.S. Environmental Pro -tection Agency (EPA) been involved withthe site by issuing a permit, a cleanup andabatement or compliance order, or noticeof violation? Has a closure or no furtheraction letter been issued regarding the prop-erty? The issuance of either letter is bene-ficial but the scope and protection offeredby it must also be evaluated and completelyunderstood. Some prospective buyers mayincorrectly assume that a closure letter13
necessarily covers the entire site and, thus,no further environmental due diligence isrequired. This assumption can be a bigmistake because a closure letter may onlyapply to one aspect of a past operationlike underground tanks but may not coverothers with different environmental impli-cations at other locations on the property.
Alternatively, a closure letter may onlyapply to soil contamination and notground water contamination. Further, a letter issued by a local agency may not berecognized by a state agency that has takenover as the site’s lead agency. Also, mostclosure letters contain “re-opener” lan-guage allowing an agency to seek moretesting or additional remediation if newinformation becomes available or if clean-up standards applicable to the relevantcontaminants change. For example, be -cause of the recent focus by many agencieson vapor intrusion inside buildings, whichresults from volatile chemicals emittinggases upward from below surface soil or groundwater, it is now not uncommonfor a closure letter to be reopened by anagency to require testing for indoor vaporintrusion.
A thorough environmental assessmentshould include establishing a baseline of aproperty’s contamination levels before atransaction closes. Important risk and lia-bility allocations can often depend on thisenvironmental baseline. For example, if alessee demonstrates through a baselinereport that it never used a certain chemicalor product in its operations that has nowbecome the focus of an environmentalinvestigation or cleanup order, the lesseemay avoid liability to the government ora third party seeking redress due to a chem-ical used by the lessee’s predecessor.Similarly, a former owner may be able torely on an environmental baseline reportas evidence that that owner never handleda chemical that is now the subject of acleanup order or lawsuit by an adjacent
28 Los Angeles Lawyer January 2018
Los Angeles Lawyer January 2018 29
MCLE Answer Sheet #274
A CLEAN BILL OF SALE
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INSTRUCTIONS FOR OBTAINING MCLE CREDITS
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2. Answer the test questions opposite by markingthe appropriate boxes below. Each questionhas only one answer. Photocopies of thisanswer sheet may be submitted; however, thisform should not be enlarged or reduced.
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Make checks payable to Los Angeles Lawyer.
4. Within six weeks, Los Angeles Lawyer willreturn your test with the correct answers, arationale for the correct answers, and acertificate verifying the MCLE credit you earnedthrough this self-study activity.
5. For future reference, please retain the MCLEtest materials returned to you.
ANSWERS
Mark your answers to the test by checking theappropriate boxes below. Each question has onlyone answer.
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MCLE Test No. 274The Los Angeles County Bar Association certifies that this activity has been approved for Minimum ContinuingLegal Education credit by the State Bar of California in the amount of 1 hour. You may take tests from backissues online at http://www.lacba.org/mcleselftests.
1. Contaminated sites throughout Southern Californiaare primarily a result of the pervasiveness of gasstations in the region.True.False.
2. Federal and state environmental statutes can holdresponsible current owners, past owners, lessees, andoperators.True.False.
3. Environmental agencies such as the California StateRegional Water Quality Control Board do not makeaccessible online database information about contam-inated sites they regulate.True.False.
4. A Phase I report identifies environmental conditionsand also includes site sampling for contaminants.True.False.
5. A seller of property is obligated to allow a prospectivebuyer to conduct site testing for contamination.True.False.
6. It is more likely for petroleum-related contaminationto be determined to pose a low threat to human healththan contamination from chlorinated solvents.True.False.
7. Operations that use PCE or TCE, e.g., dry cleaners,can often result in contamination to soil, soil vapor,and groundwater.True.False.
8.When considering the purchase of a commercial orindustrial building, it is not necessary to inspect anyof the building materials themselves for potentiallyhazardous materials.True.False.
9. A closure or no further action letter may be “re-opened” by an agency.True.False.
10. The recent focus of environmental agencies on theissue of indoor vapor intrusion has led to closed sitesbeing reopened for further testing.True.False.
11. Allowing for preclose environmental testing by theprospective buyer is always a good idea for the sellerbecause it will help to close the transaction.True.False.
12. It is prudent for a seller and buyer to enter into asite access agreement before a buyer conducts testingon the seller's property.True.False.
13. Environmental indemnifications between a buyerand seller can be tailored as to scope of time and spe-cific contaminants and chemicals that are included orexcluded within the indemnification.True.False.
14. Insurance policies from the early 1980s are nomore valuable than recent policies with regard to pro-viding protection from environmental claims.True.False.
15. It is a good idea for an owner to conduct an envi-ronmental prescreen of a prospective tenant's operationand chemical usage because an owner may be heldliable for its tenant's contamination.True.False.
16. It is prudent for a lessor to establish an environ-mental baseline of the condition of its property andpast chemical usage before the commencement of alease.True.False.
17. Certain environmental agencies offer a cost oversiteagreement whereby an owner can have the agencyreview and approve its remediation plans for a cost.True.False.
18. Cleanup standards do not vary between commercialuses and residential or school uses.True.False.
19. If a seller is aware of its property's contamination,it need not disclose it to the buyer if the deal is an"as-is" transaction.True.False.
20. The California Land Reuse and Revitalization Actprovides bona fide purchasers and innocent landownersa process to conduct site assessment and implementa cleanup action in exchange for being provided withgovernmental immunity against agency action.True.False.
landowner. Thus, in litigation among var-ious parties (i.e. between and among pastand current owners and operators) involv-ing the allocation of responsibility forcleanup costs, a strong defense can oftenturn on a party’s ability to produce evidencethat during its ownership or operation itdid not use those chemicals that causedthe contamination. Detailed record-keep-ing and past environmental reports can bean important part of such an evidentiaryshowing.
Owner/Seller Perspective
An owner of contaminated property hascertain options to limit its liability whenselling or leasing the property. A buyerwill likely want to do a thorough environ-mental investigation, including conductingon-site testing of the soils or groundwateror both. The owner has the right and dis-cretion to allow or disallow this request.If prior testing has already been conducted,the owner may ask the buyer to rely onthat test data by providing a copy of theexisting environmental report or other doc-umentation in the owner’s possession.Indeed, even in an “as is” transaction, anowner who knows or has reasonable causeto believe hazardous substances have beenreleased on its property may be obligatedstatutorily to disclose this condition to thebuyer.14
Allowing the prospective buyer to con-duct testing has both rewards and risks.The former is new test data that may beobtained showing no new or unforeseencontamination. In turn, this new databecomes an important part of the property’senvironmental baseline. In addition, thebaseline may enable the seller to refutefuture claims that erroneously allege certaincontamination existed when the transactionoccurred. Perhaps most beneficial of all,allowing the buyer to conduct preclosingtesting provides an incentive to move for-ward with the transaction. In contrast, arisk of permitting preclosing testing is thatadditional contamination will be discov-ered, resulting in the buyer’s seeking toreduce the purchase price or terminatingthe deal altogether. Also, the owner maythen face the prospect of incurring unan-ticipated cleanup costs for a property thathas now become less valuable or evenunmarketable. Finally, the owner will haveto disclose this new contamination infor-mation to the next buyer.
If an owner permits preclosing testing,a well-drafted access agreement is beneficial.An access agreement can allocate liabilityto the buyer for damage caused by its test-ing, including exacerbating any existingenvironmental conditions. Second, the
buyer must return the property to its pre -testing condition. Third, the buyer mustengage an environmental consultant whois experienced in these investigations andholds any required licenses while main-taining certain mutually agreed upon insur-ance coverage. The owner should requestto be named as an additional insured andthat the consultant’s insurance coveragenot be limited to the cost of the subjecttesting. Fourth, the owner may want torequest splits of the testing samples todecide whether to retain its own environ-mental consultant to check the test datafor any discrepancies or false positives.Alternatively, the owner may request thatthe buyer conduct the testing and ask thebuyer not to share the test results with theowner so the latter remains unaware offacts that it would have to later discloseto other prospective buyers if the transac-tion does not close. Further, the ownershould also carefully review and approvethe scope of testing being requested bybuyer. Subsurface testing may be viewedas overly intrusive (i.e., inside the buildingor underneath the building’s foundationor surrounding property). Also, a reason-able deadline by when the buyer must com-plete testing needs to be set. Test resultscan be inconclusive thus leading to requestsfor more testing. One consideration to mit-igate time delays and test result uncertaintyis to ask the buyer to make agreed uponnonrefundable payments for due diligencetime extensions or for other inconveniencesor delays due to preclosing testing.
Mitigation Strategies
An owner also has other risk mitigationstrategies that can be followed. On oneend of the spectrum, the seller can marketthe transaction as is and request the buyerindemnify the owner for any new conta-mination caused by the buyer or its suc-cessors after they take possession of theproperty. An as-is transaction, however,will likely result in the buyer’s getting aless-than-market-value purchase price offerbecause the buyer is assuming the risk ifthe property is contaminated. Althoughan as-is transaction for contaminated prop-erties is the exception, it should not besummarily ruled out under the right cir-cumstances. For example, a sophisticatedbuyer may want a contaminated site dueto its location, size, infrastructure, or otherfactors and will have the resources to makea reasonably accurate evaluation of theproperty’s environmental condition and,thus, may be willing to assume certain risksin obtaining that site.
In lieu of an as-is deal, the owner mayseek to minimize future liability by nego -
ti ating that the indemnification providedto the buyer be restricted in scope or by time or restricted to a certain dollaramount. In dem nification can be tailoredso if an environmental claim arises withinfive years of the closing date, the ownerwould bear the entire responsibility forany claims or losses. However, the owner’sliability could be reduced, for example, to75 percent at seven years and then to 50percent at 10 years, and so on. If—basedon the property’s environmental baselinereport prepared during the transaction—it is determined the owner’s operationsonly included contaminants referred to as“heavy metals” such as lead, nickel, copper,or cadmium, indemnification may be lim-ited only to cover future claims related tothose contaminants. In lieu of a completeindemnity, an owner can offer to assignits rights under any comprehensive generalliability insurance policies that the ownerheld during its ownership if a third partyclaim later materialized. This could beespecially favorable to a buyer for policiesfrom 1986 or before since these policiesdid not contain the absolute pollutionexclusion language that is included in morerecent policies. An insurance assignmentcan be offered as an alternative to othermonetary concessions that the seller mayotherwise need to provide to the buyer.Similarly, an owner may offer to assign itsrights to claims it may have against priorproperty owners or operators in the chainof title. This assignment of an owner’sinsurance rights or its claims against itspredecessors can replace offering morestringent indemnification language to thebuyer.
If the buyer’s plan to redevelop the prop-erty includes excavating for subterraneanparking in areas in which there is knowncontamination, the owner may consideran agreement whereby its responsibility islimited to the incremental costs the buyerincurs in treating, remediating, handling,transporting, and disposing of the conta-minated soil or groundwater. This limitsseller’s future costs to the differential be -tween the cost of excavating and handling,including treating, remediating, transport-ing, and disposing of, contaminated mate-rials and the cost that the buyer wouldotherwise incur for excavating and handlingthe same materials if not contaminated.This is an equitable allocation formula forboth buyer and seller.
Lessors’ Minimization Strategies
A lessor of commercial or industrial prop-erty must become fully aware of the busi-ness operations that a prospective tenantor its subtenants intend to conduct, espe-
30 Los Angeles Lawyer January 2018
cially their potential environmental impacts.The tenant should be asked if its businessuses or generates hazardous waste as a by-product of its operations. Will the tenantuse or install underground storage tankson the property or emit air pollutants?Will chemicals be used, stored, treated, orotherwise handled as a part of the tenant’sbusiness? An affirmative answer to any ofthese questions raises a distinct possibilityof significant risk or exposure. A good ten -ant prescreening device is to require all ten-ants to complete a prelease comprehensiveenvironmental checklist that requires themto disclose detailed information on the mate-rials that they plan to use in waste man-agement practices, a past environment alcompliance history, and insurance inform -ation and claims history. In addition, ten ants need to provide copies of any envi-ronmental permits they have or applicationsfor permits needed to operate on the prop-erty. Too many red flags or uncertaintiesrevealed in this prelease checklist may pro-vide a valid reason to pass on certain pro -spective tenants. Obtaining this type of in -formation is good protocol for large andsmall tenants alike. Indeed, “mom and pop”operations such as dry cleaners or smalltooling shops can create large environmentalproblems because of the chemicals used,and these tenants usually do not have theassets necessary to remediate the environ-mental problems their operations may cause.
Lease provisions related to environmen-tal issues also must be reviewed carefully.What may seem like an otherwise favorable,lessor-oriented lease may leave a lessorwide open to environmental liabilities forthe tenant’s activities. Some standard com-mercial and industrial leases still do notinclude language specifically referring toissues and liabilities related to hazardouswaste and hazardous materials. Ac cord -ingly, it is important to include specificlanguage in the lease that addresses theseissues. However, even if the tenant is con-sidered responsible for environmental lia-bilities under the lease, these assurancesmay be of little moment if the tenant isfinancially incapable of assuming the lia-bilities. An extra month’s rental depositwill not begin to cover the expense of acleanup. Thus, a landlord should considerrequiring the tenant provide some alter-native form of financial assurance demon-strating it will have the resources to actuallyindemnify the lessor if an environmentalproblem arises. This is especially importantsince a lessor/owner can be held liable forthe tenant’s contamination just based onownership status.15
Just as in the purchase and sale context,a lessor should establish an environmen -
tal baseline detailing the condition of the property and past chemicals at the lease’sinception. Contested proceedings involvingwhich party is responsible for any conta-mination are often ultimately determinedby evidence of what party used what chem-icals and when.
Buyer’s Perspective
A first and fundamental step in managingand limiting liability is to undertake a thor-ough environmental due diligence of theproperty and its environs. Information anddocumentation can and should be obtainedfrom a number of sources, including theagency websites GeoTracker and Enviro -Stor, aerial photographs, and a review ofprior environmental reports regarding theproperty and of neighboring properties. Inaddition, testing the soil and groundwaterto determine the current status of the prop-erty is advisable. Based on this collectionof information, which should be carefullyreviewed by an experienced environmental
consultant and environmental attorney, aprospective buyer will be in a better positionto determine the risk and rewards of mov-ing forward with the purchase of a conta-minated property.
Among the factors to determine is thenature of the existing contamination. Thebuyer should evaluate the time and expenselikely needed to remediate the problem.What are the remediation options—exca-vation, soil vapor extraction, chemicalinjection to neutralize the contamination,natural attention—or a combination ofthese options? A determination should alsobe made as to whether use of the propertyor its redevelopment can proceed whileremediation is ongoing, or whether thebuyer’s plans will have to be put on holdor scaled back during remediation.
Another important factor to consideris whether existing contamination posesan actual or potential health risk to em -ployees or tenants at the site. Specifically,a determination should be made as to
Los Angeles Lawyer January 2018 31
Summary of the Prospective Purchaser Agreement Fact Sheet1
1. The site falls under jurisdiction of the California Department of Toxic Substances Control (DTSC)because an actual hazardous substance release exists.2. The prospective purchaser offers to enter into an agreement with the DTSC whereby thatpurchaser will pay the DTSC for oversight costs and commits to ensure the response action willcompletely remediate the site or will make significant progress toward complete remediation.3. Unauthorized disposal of hazardous waste is not currently occurring at the site.4. The prospective purchaser is not a responsible party or affiliate of a responsible party withrespect to the hazardous substance release(s) when the time the agreement is executed.5. A Preliminary Endangerment Assessment (PEA)2 or equivalent has been performed and providedto the DTSC identifying the hazardous substance releases at the site.6. The hazardous substance release site is not the subject of an active enforcement action oragreement with another agency with jurisdiction over the remediation unless that agency transfersoversight to the DTSC.7. The public will receive a substantial benefit from the PPA that would not otherwise be available(e.g., potential environmental benefits, significant progress towards site remediation, value tothe community in terms of additional jobs, an increased tax base, or opportunities for disadvantagedgroups).8. The continued operation at the site or new site development, with the exercise of due care, willnot exacerbate or contribute to the existing contamination or interfere with the investigation ofthe extent, source, and nature of the hazardous substance releases(s) or the implementation ofremedial or removal actions.9. The effect of continued operation or new development on the site will not result in health risksto those persons likely to be present at the site.10. The prospective purchaser is financially viable and willing to provide financial assurancesand has sufficient funds to complete the investigation and remedial action.11. The prospective purchaser is a “bona fide prospective purchaser” (i.e., a person or entity pur-chasing all or part interest in real property, but is not affiliated with any person potentially liablefor response actions at a site). The bona fide prospective purchaser must provide evidence ofthese conditions to the DTSC.
1 Data derived from Fact Sheet, Prospective Purchaser Policy, Cal. Dept. Toxic Substances Control (April 1998, revised 5/01),http://www.dtsc.ca.gov.2 The PEA is an initial step into the investigation of a site and provides basic information to help determine if there has beena release of a hazardous substance that presents a risk to human health or the environment. See Preliminary EndangermentAssessment Guidance Manual, Cal. Dept. Toxic Substances Control, (Jan. 1994, revised Oct. 2015) available at http://www.dtsc.ca.gov.
whether vapor intrusion exists at the siteor in any construction at the site. A relateddetermination is whether the risk of sub-surface vapors can be managed by installingvapor barriers or other on-site engineeringmechanisms. The cost of doing this canthen be factored into the purchase price.If the buyer recognizes that some post-pur-chase remediation will likely need to occur,consideration should be given to what thecleanup levels will need to be based on theproperty’s intended use. If the property isintended for a mixed residential-commercialuse, cleanup levels will likely need to con-form to more stringent residential reme-diation standards.16
The buyer should also determine if aparticular environmental agency has pre-viously been involved with the propertybased on prior events at the site. If so, thebuyer should conduct due diligence on thatagency’s remediation requirements, its gen-eral time frames for reviewing remediationplans, and the agency’s protocols for itsissuance of closure letters. Some agenciesoffer a cost oversite option whereby a prop-erty owner or operator can enter into anagreement for the agency to review reme-diation plans and closure letter requests,for a cost.17
A buyer needs to be mindful of whetherand to what extent adjacent properties mayhave been impacted by the subject site ormay be impacting the subject site. For exam-ple, if the subject property has groundwatercontamination that is migrating off-site, itis important to determine not just that factbut whether any off-site properties impactedinclude areas zoned residential, for schooluse, or for recreational/open space. Agenciesconsider these types of properties to be“sensitive receptors” so if remediation ofthese sites is required, the cleanup standardsmay be more stringent than for the subjectproperty. Similarly, it is advisable to knowif an off-site property has contaminationthat is migrating onto the subject site and,if so, if an agency has already ordered theoff-site owner or operator to engage inremediation. This fact could make less likelythe subject property owner’s being nameda responsible party. Moreover, it is importantto learn if the migrating contamination maylead to the placement of monitoring wellsor other remediation equipment on the sub-ject site. In addition, the prospective buyershould try to determine if the off-site cont-amination does or may pose an actual orpotential risk to the subject property.
The purchase and sales agreement fora contaminated site should contain detailedprovisions directed to the property’s envi-ronmental condition. For the buyer’s pro-tection, the seller should provide environ-
mental representations and warrantiesrelated to the site’s contamination; currentand past operator’s use of and identity ofchemicals; the status of activities undertakenby the seller or past operators or both tocomply with all applicable federal, state,and local environmental statutory and reg-ulatory requirements; whether there arepending environmental investigations,notice of violations, cleanup, and abatementorders or other environmental civil, crim-inal, or administrative proceedings relatedto the property; the identity and status ofany and all environmental permits; andthe seller’s compliance status regardingthese permits. If the buyer intends to con-tinue with the same business or operationsconducted by the seller, determinationshould be made if the seller’s environmentalpermits are transferable, and, if so, thebuyer should become familiar with thetime frame required for such transfers tobecome operative.
In addition to the parties’ representa-tions and warranties, the scope of indem-nification being provided is perhaps themost actively negotiated and importantprovision in a purchase and sales agree-ment. The indemnification that a buyercan or should obtain will depend on thedetails of each transaction and the parties’respective bargaining power as well as risktolerance levels. Sales of contaminatedproperties can run the gamut from as-istransactions to a full and complete indem-nification whereby the seller agrees todefend, save, indemnify, and hold harmlessthe buyer from and against any and alllosses, claims, and lawsuits resulting fromor arising out of the environmental con -dition of the property. Indemnification may be limited by time, dollar amounts,the types of contamination included, andwhether, for example, the indemnity in -cludes soil only, groundwater only, onlyon-site contamination, all contaminationon, to, or from the property.
If a known environmental conditionexists at the property that requires reme-diation, but the parties do not want todelay closing until remediation has beencompleted, one option is for the seller tocommit to completing the remediationthrough its receipt of a no-further-actionletter and holding back a portion of thepurchase price until this letter is receivedfrom the lead agency.
A buyer may also seek protection undervarious government programs related topurchase of contaminated sites. For exam-ple, the California Land Reuse and Revit -alization Act (CLRRA) of 2004 promotesthe cleanup and redevelopment of blightedcontaminated properties by providing lia-
bility protection to bona fide purchasers,innocent landowners, and contiguous prop-erty. 18 It establishes a process for eligibleproperty owners to conduct a site assess-ment and implement a response action, ifnecessary, to ensure the property is readyfor reuse. In return, property owners willreceive governmental immunity againstagency actions. This act has been extendedto include prospective purchasers and bonafide ground tenants with a lease term ofat least 25 years.19
Similar to CLRRA, DTSC makes avail-able a prospective purchaser agreement(PPA) to certain qualifying buyers of con-taminated properties, including a covenantnot to sue from the DTSC. A PPA is limitedto certain circumstances and requirements,which have been delineated in a fact sheeton the PPA compiled by the DTSC. (SeeSummary of the Prospective PurchaserAgreement Fact Sheet on page 31.)
The EPA offers programs for qualifiedpurchasers of contaminated sites, includingits Brownfields and Land RevitalizationPrograms, which are designed to empowerstates, communities, and other stakeholdersin economic redevelopment to collaborateto prevent, assess, safely clean up, and sus-tainably reuse brownfields.20 Under theseprograms, the EPA offers funding andgrants to local governmental entities andprivate parties for site assessments andcleanup activities. These programs seek toencourage private redevelopment, public-private redevelopment and public-led rede-velopment.
All parties involved in real estate trans-actions related to commercial and industrialproperties must be conscious of contami-nation issues. Obtaining information re -garding the property’s environmental con-dition and understanding the nature andextent of the contamination that is or maybe impacting the site is an important stepin developing a strategy to best protect aparty’s interests. Also, establishing an envi-ronmental baseline of the property’s envi-ronmental condition before a transactionis completed is important so it is clear whatthe nature of the contamination is beforea deal closes.
Inclusion of indemnification and rep-resentation and warranties language in atransaction document, determining theexistence and/or applicability of environ-mental insurance, and the pursuit of immu-nity protections offered under statutoryprovisions such as CLRRA are among theother devices a party can use to minimizeits liabilities. n
1 The State Water Resources Control Board’s Geo -Tracker database includes records relating to over
32 Los Angeles Lawyer January 2018
15,000 cleanup sites in the County of Los Angelesalone.2 See e.g., Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA), 42 U.S.C.§§9601 et seq., and Resource Conservation andRecovery Act (RCRA), 42 U.S.C. §§6901 et seq.3 See, e.g., HEALTH & SAFETY CODE §§25100–25259(Hazardous Waste Control); Carpenter-Presley-TannerHazardous Substance Account Act (2015), amendingHEALTH & SAFETY CODE §§25360.4, 25363, 25366.5;and Porter-Cologne Water Quality Control Act (2017)WATER CODE, Div. 7. 4 See e.g., 42 U.S.C. §9607(a); HEALTH & SAFETY
CODE §25323.5(a).5 GeoTracker, State Water Resources Control Bd.,https://geotracker.waterboards.ca.gov.6 Envirostar, Dep’t Toxic Substances Control, https://www.envirostor.dtsc.ca.gov/public.7 See, e.g., Low-Threat Underground Storage Tank CaseClosure Policy, available at https://www.waterboards.ca.gov/board_decisions/adopted_orders/resolutions/2012/rs2012_0016atta.pdf (last viewed Nov. 16,2017).8 Fact sheets relating to many toxic chemicals, includingPCE and TCE, can be found at ATSDR Toxic Sub -stances Portal, Agency for Toxic Substances and DiseaseRegistry, available at https://www.atsdr.cd.gov/substances/index.asp.9 See generally Fact Sheet on Chlorinated Solvents andother Volatile Organic Compounds Pollution inCalifornia Groundwater and Associated State WaterBoard Cleanup Programs, Cal. Water Boards (June12, 2014), available at https://www.waterboards.ca.gov/ust/docs/ust_site_cleanup_program_fs.pdf.10 See, e.g., 40 C.F.R. I(C)(61)(M), and CAL. CODE
REGS., tit. 8, §1529.11 For more information on PCBs, which have beenused as coolants and lubricants in transformers,capacitors, and other electrical equipment, see Poly -chlorin ated Biphenyls - ToxFAQs™, Agency for ToxicSubstances and Disease Registry, available at https://www.atsdr.cdc.gov/toxfaqs/tfacts17.pdf (last viewedNov. 16, 2017).12 Certified unified program agencies are local agenciescertified by the DTSC to enforce state regulations. Seegenerally HEALTH & SAFETY CODE §§25404–25404.9.13 Governmental oversight agencies often issue “nofurther action” or closure letter after the owner, oper-ator, or other responsible party has met the agencies’corrective action requirements. See, e.g., the discussionrelating to case closure procedures as part of theUnderground Storage Tank Cleanup (UST) Programat UST Program–Cleanup, State Water ResourcesControl Board, https://www.waterboards.ca.gov (lastviewed Nov. 17, 2107).14 See HEALTH & SAFETY CODE §25359.7.15 By way of example, any person who at the time ofdisposal of any hazardous substance owned any facilityat which such hazardous substances were disposedmay be a responsible party under CERCLA. See 42U.S.C. §9607(a).16 See, e.g., California Human Health Screening Levels,Cal. Office of Environmental Health Hazard Assess -ment, https://oehha.ca.gov (last viewed Nov. 17, 2107).17 See, e.g., information relating to the DTSC’s Vol -un tary Cleanup Program, which is available at Brown - fields Voluntary Program, Cal. Dep’t toxic Sub stancesCon trol, ttp://www.dtsc.ca.gov/SiteCleanup/Brownfields/BrownfieldsVoluntaryProgram.cfm (last viewed Nov.17, 2107).18 HEALTH & SAFETY CODE Ch. 6.82, 6.83.19 See HEALTH & SAFETY CODE §25395.104.20 Overview of the Brownfields Program, U.S. Envtl.Prot. Agency, https://www.epa.gov (last viewed Nov.17, 2017).
Los Angeles Lawyer January 2018 33
For More Information Call 213-617-7775Or visit us on the web at www.hmlinc.com
Business litigation is increasingly complex. That is why we believe valuationissues must be addressed with the same meticulous careas legal issues. Analysis must be clear. Opinions must bedefensible. Expert testimony must be thorough andarticulate. HML has extensive trial experience and canprovide legal counsel with a powerful resource for experttestimony and litigation support.
ConfidenceAtThe Courthouse.
BUSINESS VALUATION • LOSS OF GOODWILL • ECONOMIC DAMAGES • LOST PROFITS
34 Los Angeles Lawyer January 2018
HA
DI F
ARA
HA
NI
becomes more costly,attorneys are increas-
ingly faced with clients who find themselves short of cash tofund the litigation process. When this happens, attorneys areput in the position of either abandoning the client or, in the caseof a client with assets but cash flow issues, to obtain security forthe future payment of fees, such as a real property lien. But evenwhen an attorney carefully documents the transaction and complieswith the ethical rules involving lien transactions, the attorneymay still end up out in the cold: what happens if the client filesfor bankruptcy? The answer depends on the laws of fraudulenttransfer and preferences.
Once the client files for bankruptcy, the trustee in bankruptcywill have broad powers to grow the bankruptcy estate by, amongother things, clawing back money previously paid by the debtorto a creditor. The trustee’s goal is to treat creditors fairly and toprevent the debtor from preferring a favored creditor over anothercreditor prior to bankruptcy. The trustee’s powers include thepower to set aside and avoid liens securing payment of debt,
including attorney fee liens or deeds of trust securing future pay-ment for services previously performed or for services to be per-formed in the future. The two legal avenues available to thebankruptcy trustee are fraudulent transfer actions and preferenceactions under the Bankruptcy Code.
Fraudulent transfer actions—even if brought in the bankruptcycourts—require application of the California version of theUniform Voidable Transactions Act (UVTA) formerly known asthe Uniform Fraudulent Transfer Act. Under the UVTA, CaliforniaCivil Code Section 3439.04 authorizes claims based on actualand constructive fraudulent transfer. Actual fraudulent transferrequires proof that the transfer was made “[w]ith actual intentto hinder, delay, or defraud any creditor of the debtor.1 Con - structive fraudulent transfer is a transfer “[w]ithout receiving areasonably equivalent value in exchange for the transfer or oblig-ation and the debtor either was engaged or was about to engagein a business or a transaction for which the remaining assets ofthe debtor were unreasonably small in relation to the businessor transaction,” and the debtor “[i]ntended to incur, or believed
Rena E. Kreitenberg is a partner in the Los Angeles law firm of Mesisca Riley & Kreitenberg LLP where her practice focuses on civil litigation and appeals,emphasizing real estate, negligence, and employment actions. She also serves as a member of the Los Angeles Lawyer Editorial Board.
REAL ESTATE LAW ISSUE
PROMISESTO PAYWhile cases of actual fraud emphasize the transferor's intent, claims of constructive fraudulent transfer focus on the good faith ofthe transferee
BY RENA E. KREITENBERG
AS LITIGATION
or reasonably should have believed thathe or she would incur, debts beyond hisor her ability to pay as they became due.”2
Section 3439.04 has been amended toadd the burden of proof for the elementsas follows: “A creditor making a claim forrelief under subdivision (a) has the burdenof proving the elements of the claim forrelief by a preponderance of the evidence.”“Under both the UVTA and 11 U.S.C.§548 of the Bank ruptcy Code, the Trusteehas the burden of proving the elements ofa fraudulent transfer by a preponderanceof the evidence.”3
Constructive fraudulent transfer underthe U.S. Bankruptcy Code requires proofthat a debtor “received less than a reason-ably equivalent value in exchange for suchtransfer or obligation; and…was insolventon the date that such transfer was madeor such obligation was incurred….”4 AChapter 7 trustee’s power to avoid liens isprovided in 11 USC Section 544. To avoidtransfers pursuant to Section 544(b) of theBankruptcy Code, the trustee steps intothe shoes of an unsecured creditor who“‘had a viable claim against [the] debtorat the time the bankruptcy petition wasfiled.’”5 “One creditor of any amount willsuffice for the purposes of § 544(b).”6 Thetrustee is subject to any defenses that canbe asserted against the creditor.7 “If thecreditor is estopped or barred from recoveryfor some…reason, so is the trustee.”8
A trustee in bankruptcy steps into theshoes of the creditor as of the time of thechallenged transfer. The idea is that thecreditor has been harmed by the debtorbecause the debtor left the creditor unpaidwhile taking care of another creditor andthen filing bankruptcy. Critical to the analy-sis is whether the creditor had the legalright to void the transfer when the transferwas made. Thus, when an attorney recordsa deed of trust to secure unpaid legal feesand the client files for bankruptcy, thequestion is whether, at the time of thetransfer, the creditor into whose shoes thetrustee steps could have avoided the lienas a fraudulent transfer.
Wyzard v. Goller
California case authority is scant onwhether a lien obtained by an attorney tosecure payment of attorneys’ fees is sub -ject to a claim of fraudulent transfer. InWyzard v. Goller, the California Court ofAppeal held that a transfer by a debtor tohis attorney in the form of a promissorynote and deed of trust for payment of legalfees rendered in litigation was not a fraud-ulent transfer as a matter of law.9 InWyzard, both the debtor and his counselknew the litigation would result in a judg-
ment against the debtor, and the prefer-ential transfer of a deed of trust to theattorney for payment of legal fees wouldresult in the debtor’s inability to pay theplaintiff-creditor. Nonetheless, the courtof appeal held that the transfer to theattorney was not a fraudulent transferbecause the preference of one creditorover another—something that may wellbe voidable by a bankruptcy trustee—isnot a fraudulent con veyance under theCalifornia UVTA.10 It has also been heldthat the fact a preference hinders or delaysother creditors in the collection of theirclaims does not automatically render itvoid, “nor does the fact that the preferredcreditor had knowledge that such conse-quence would follow the preference.”11
The Wyzard case, however, specificallydealt with legal services that had alreadybeen performed. The analysis becomes lessclear when an attorney enters into a writtenagreement with a client for services to beprovided in the future and obtains securityfor those services that is potentially detri-mental to other creditors. What happensto a lien securing legal fees for services tobe performed in the future when the lienis challenged by an unpaid creditor?
Badges of Fraud
The trustee bears the burden of proof toestablish that a transfer was made with“actual intent to hinder, delay, or defraudany creditor of the debtor….”12 Becausethere is usually no direct evidence demon-strating actual intent, courts generally inferactual fraudulent intent from the circum-stances surrounding the transaction—theso-called “badges of fraud.”13 In order toaid the fact finder in determining whetheractual fraudulent intent exists, the Calif -ornia UVTA sets forth these “badges offraud” in a nonexclusive, 11-factor testfor determining whether a transfer wasmade with an actual intent to hinder, delay,or defraud a creditor.14
Similarly, federal law has provided thatproof of certain objective facts such as a“transfer to a close relative, a secret trans-fer, a transfer of title without transfer ofpossession, or grossly inadequate consid-eration would raise a rebuttable presump-tion of actual fraudulent intent.”15 Thestate of mind of the transferor is generallythe focus of the analysis.16
The Wyzard court found that “the presence of one or more [badges of fraud]does not create a presumption of fraud,but ‘is merely evidence from which aninference of fraudulent intent may bedrawn.’”17 As a result, the court in Wyzardheld that even though some of the 11badges of fraud were present, they did
not raise a triable issue of fact in that casebecause “[i]t was established and concededthat [the attorney] had rendered the ser-vices he claimed to have rendered, andthus, had earned the fee secured by theencumbrances.”18
But when there is only a promise offuture services given in consideration forthe transfer, the more badges of fraud pre-sent, the more likely a fraudulent transferwill be found. If the trustee can presentevidence that, for example, the lien wassecretly entered into without notice toother creditors or that the considerationpaid for the prom ised services was inade-quate and the transferred interest was forsubstantially all of the debtor’s assets, thetransfer could well be found to be fraud-ulent. On the other hand, when the lienis recorded, the attorney creditor has per-formed substantial services and continuedto represent the debtor until the filing ofbankruptcy, the badges-of-fraud analysisis less compelling.
Both federal and state authority appearto hold that even if an attorney is awarethat the transfer will prevent other creditorsfrom collecting on his or her debt, if thetransfer is for payment of legitimate attor-neys’ fees incurred by the debtor, there isno basis for a finding of actual fraudulenttransfer. The Wyzard court expressly foundthat a transfer made in payment of legiti-mate legal services is not fraudulent, evenif made in anticipation of possible liabilityand “with recognition that the transferwill effectively prevent another creditorfrom collecting on his debt.”19
In the unreported Northern DistrictBank ruptcy Court case In re Guzman, sim-ilar facts were considered, and the courtconcluded the evidence established noactual fraudulent transfer:
The evidence demonstrates that Pinchretained Duffy & Guenther to rep-resent him in the damages phase ofthe Monterey County Superior Courtaction, and that the law firm, notsurprisingly, required a substantialre tainer. The evidence also establishedthat Pinch did not believe that Plain -tiffs were entitled to compensatoryor punitive damages, and that heretained the law firm to vigorouslydefend himself in the damages phaseof the litigation. If Pinch did notbelieve that the Plaintiffs were enti-tled to any damages, why would apayment to these attorneys indicatethat he intended to hinder, delay ordefraud their yet to be determineddamages award?20
While the focus for actual fraud is theintent of the transferor, in claims of con-
36 Los Angeles Lawyer January 2018
structive fraudulent transfer the focus isthe good faith of the transferee and whetherreasonably equivalent value for the lienwas received by the debtor. Both state andfederal law provide that a transferee isentitled to keep the transfer if the trans -fer ee can show that he or she “took ingood faith and for a reasonably equivalentvalue.”21 A transferee lacks good faith if he or she “(1) colludes with the debtoror otherwise actively participates in thedebtor’s fraudulent scheme, or (2) has
actual knowledge of facts which wouldsuggest to a reasonable person that thetransfer was fraudulent.”22
Therefore, it may be argued that whenthe lien was executed in order to providea client with needed legitimate legal rep-resentation and the fee agreement anddeed of trust were entered into in anarm’s-length transaction for which thedebtor consulted independent counsel,the transaction should be viewed as oneentered into in good faith and for fairvalue. The more detailed the fee agreementis concerning how the attorney calculatedthe hourly rate and anticipated time esti-mated for the handling of the matter, themore likely the attorney will be able toshow that fair value was exchanged forthe transfer. Naturally, evidence that feeswere inflated, whether as a result of attor-ney-client collusion or otherwise, can beconstrued as evidence of lack of goodfaith and fair value.
Reasonably Equivalent
Under Section 548(a)(1)(A) and Cal i forniaCivil Code Section 3439.04, the trusteebears the burden of proving that thedebtor failed to receive reasonably equiv-alent value in exchange for the lien.23
However, the phrase “reasonably equiv-alent value” is not defined in the Calif -ornia Civil Code or the Bank ruptcy Code.As the court explained in In re Kemmer,defining reasonably equivalent value hasbeen left to the courts: “There is no hardand fast rule in the Ninth Circuit as towhat constitutes ‘reasonably equivalentvalue.’ The concept of ‘reasonable equiv-alence’ is not wholly synonymous with‘market value’ even though market valueis an extremely important factor to be
used in the court’s analysis.”24
The test for determining whether rea-sonably equivalent value was given requirescourts to “determine the value of whatwas transferred and to compare it to whatwas received.”25 The factors a court mayconsider include “the fair market value ofwhat was transferred and received, whetherthe transaction took place at arm’s length,and the good faith of the transferee.”26
The value of the transfer must be estab-lished as of the date of the transfer.27 In
other words, evidence must be presentedat trial by the trustee establishing thevalue of the services promised at the timeof the transfer. Without such evidence, itwould be impossible for a court to evalu -ate whether the fee agreed to by the debtorwas or was not reasonably equivalent tothe services the attorney was obligated toprovide under the fee agreement.28
What constitutes reasonably equivalentvalue is a fact-intensive inquiry based upon“market realities.”29 There is no minimumpercentage or amount necessary to consti-tute reasonably equivalent value, and theexchange of value need not be dollar fordollar.30 It does, however, require a com-parison of values—the value of what thedebtor received to the value of what thedebtor transferred, or, in the case of anattorney fee lien, the amount secured andthe market value of the specified servicesagreed to be performed by the attorney.31
The issue boils down to one of inter-pretation of the scope of “value.” Bank -ruptcy Code Section 548(d)(2)(A) defines“value” for purposes of fraudulent transferas “property, or satisfaction or securingof a present or antecedent debt of thedebtor, but does not include an unper-formed promise to furnish support to thedebtor or to a relative of the debtor.”32 Itis this language that has led courts to ana-lyze whether a promise for future, unper-formed services can constitute value in afraudulent transfer analysis. But bank-ruptcy case authority is in conflict onwhether a promise to perform future legalservices may be considered value. In thecase In re Dixon, for example, the North -ern District of Texas Bankruptcy Courtheld that a promise of future performancecannot serve as “reasonably equivalent
value.”33 But there are contrary cases andtreatises that discuss in great detail whetherunder federal bankruptcy law an “execu-tory promise” can serve as “reasonablyequivalent value.” In In re Treasure ValleyOpportunities, Inc., the Idaho BankruptcyCourt pointed out a number of publishedopinions that held an executory promisecould constitute value.34 The BankruptcyCourt in In re Treasure also pointed outthat the cases that concluded a promiseto provide future services could not con-
stitute reasonably equivalent value reliedon the bankruptcy treatise Collier on Bank -ruptcy; however, the Idaho court foundthat Collier had been misconstrued bythose authorities and pointed out that evenCollier acknowledged that an executorypromise could constitute value “especiallywhen the promise has been partially ortotally fulfilled in good faith….”35
The Ninth Circuit in In re Bigelow indi-rectly addressed whether a promise to per-form future services is sufficient consider-ation to support a prepaid fee for futureservices. The bankruptcy appellate panelfor the Ninth Circuit addressed whethera prepaid nonrefundable fee constituted abreach of the attorney’s fiduciary duty tohis client within the meaning of the dis-charge exception under 11 USC Section523(a)(4).36 In Bigelow, the Ninth Circuitwas called on to interpret Washington statelaw that permitted a nonrefundable retain -er for services not yet performed. The for-mer client filed an adversary proceedingfor return of the fee paid, alleging that itwas a breach of fiduciary duty for theattorney not to refund the money. Relyingon the Ohio Bankruptcy Court opinionIn re National Magazine Publishing Com -pany, The Ninth Circuit found that theattorney’s “promise to represent [the client]was the consideration for the prepaidfee.”37 The decision held that in a classiclegal fee retainer situation the considerationis the present promise of the attorney torepresent the client on a given matter.38
Relative Value
The courts have also looked at the relativevalue of the lien and the value of the secu-rity for the lien in determining whetherreasonably equivalent value was given. In
Los Angeles Lawyer January 2018 37
The more detailed the fee agreement is concerning how the attorney
calculated the hourly rate and anticipated time estimated for the handling
of the matter, the more likely the attorney will be able to show that
fair value was exchanged for the transfer.
Calif ornia, the Second District Court ofAppeal in the recent unpublished decisionStoltenberg v. Sheppard, Mullin, Richter,& Hampton, LLP, approved a law firm’sfiling of a lien on its client’s multimilliondollar art collection. The lien secured pay-ment of accrued, but unpaid, legal feesincurred in litigation in an amount lessthan $1 million dollars—in other words,an amount much lower than the amountof the lien. Due in part to the existenceof the lien, the plaintiffs in that litigationwere unable to satisfy the judgmentagainst the losing defendants, so theysued the law firm to set aside the lien,alleging actual and constructive fraud.39
In addressing the constructive fraud claim,the Second District noted that althoughthe amount of the debt was substantiallyless than the value of the security, therewas nonetheless proof of reasonably equiv-alent value. The court of appeal held thatthe Sheppard Mullin lien “was coextensivewith the debt, not the security,” and that“the premise of the [UVTA] is that thevalue of the interest transferred for securityis measured by, and thus correspondsexactly to, the debt secured.”40
It may very well be that a public policyargument wins the day. In the unreportedcase NAMA Holdings, LLC v. Dorsey &Whitney LLP, the Second District asserted
public policy in connection with attorneyliens for payment of fees even when othercreditors might be prejudiced:
Attorneys must be free to put forththeir best efforts in representing sucha client and attempting to securefindings in the client’s favor. It wouldplace an undue burden on attorneysand clients to require attorneys toevaluate the likelihood of potentialclients prevailing in a case-in-chiefand the contractual indemnity the-ories before ever agreeing to repre-sent a client under threat of at somepoint being found to have engagedin a fraudulent transfer merely foraccepting payment of their fees. Thatcannot be what the Legislature con-templated when it provided in CivilCode section 3439.08, subdivision(a), that a transfer that would oth-erwise be voidable (such as whenthe debtor made the transfer withactual intent to defraud anothercreditor) is not voidable against onewho took in good faith for a rea-sonably equivalent value.41
The Second District in Stoltenberg alsoreasserted the “sound public policy”behind the holding in the Wyzard case:“Without the ‘Wyzard rule,’ attorneys willhave less incentive to represent clients
who cannot pay adverse judgments, par-ticularly if entering into a security trans-action like the one here exposes them tolawsuits seeking to void the preference.”42
But what is even more compelling, theNAMA court stated plainly the definitionfor reasonably equivalent value in casesinvolving a lien securing payment of attor-neys’ fees: “[T]he definition of ‘reasonablyequivalent value’ is more straightforward:whether the value of the legal services…provided…was worth what [was] chargedfor those services.”43
Based on the current state of the law,there is no definitive answer to the ques-tion whether a lien given in exchange fora promise of future legal representationwill survive a fraudulent transfer attack.Never theless, based on the public policyrecently reaffirmed by the California Courtof Appeal, the case auth ority that an execu-tory promise can serve as value, long-standing case authority that the value ofthe transfer must be evaluated at the timeof the transfer when the promise is madeand the rationale of Wyzard, it can besafely inferred that so long as the amountcharged by the attorney for the services isreasonably equivalent to the services actu-ally contemplated to be performed, andthe promise to perform is genuine, suchliens will be defensible in both state andbankruptcy forums. Not with standing theforegoing, a trustee could consider such atransfer as a voidable preference under theBankruptcy Code—but that is a topic foranother article. n
1 CIV. CODE §3439.04(a)(1).2 CIV. CODE §3439.04(a)(2).3 In re 3dfx Interactive, Inc., 389 B.R. 842, 863 (Bankr.N.D. Cal. 2008), subsequently aff’d sub nom. In re3DFX Interactive, Inc., 585 F. App’x 626 (9th Cir.2014).4 11 U.S.C. §548(a)(1)(B).5 In re Acequia, 34 F. 3d 800, 807 (9th Cir.1994),quoting Karnes v. McDowell 87 B.R. 554, 558 (Bankr.S.D. Ill. 1988).6 In re AFI Holding, Inc., 525 F. 3d 700, 703 (9thCir. 2008).7 In re Verco Indus., 704 F. 2d 1134, 1137-39 (9thCir. 1983).8 In re Marlar, 252 B.R. 743, 754 (8th Cir. BAP 2000),citing Brent Explorations, Inc. v. Karst Enters., Inc.(In re Brent Explorations, Inc.) 31 B.R. 745, 748(Bankr. D. Colo. 1983), aff’d Williams v. Marlar (Inre Marlar), 267 F. 3d 749 (8th Cir.2001).9 Wyzard v. Goller, 23 Cal. App. 4th 1183 (1994).10 Id. at 1190.11 United States Fid. & Guar. Co. v. Postel, 64 Cal.App. 2d 567, 572 (1944).12 In re Acequia, 34 F. 3d 800, 807, 805–806 (9thCir.1994).13 Id.14 The 11 factors are: 1) whether the transfer or oblig-ation was to an insider; 2) whether the debtor retainedpossession or control of the property transferred afterthe transfer; 3) whether the transfer or obligation wasdisclosed or concealed; 4) whether before the transfer
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was made or obligation was incurred, the debtor hadbeen sued or threatened with suit; 5) whether thetransfer was of substantially all of the debtor’s assets;6) whether the debtor ab sconded; 7) whether thedebtor removed or concealed assets; 8) whether thevalue of the consideration received by the debtor wasreasonably equivalent to the value of the asset trans-ferred or the amount of the obligation incurred; 9)whether the debtor was insolvent or became insolventshortly after the transfer was made or the obligationwas incurred; 10) whether the transfer occurred shortlybefore or after a substantial debt was incurred; and11) whether the debtor transferred the essential assetsof the business to a lienholder who transferred theassets to an insider of the debtor.15 BFP v. Resolution Trust Corp., 511 U.S. 531, 541(1994).16 In re Cohen, 199 B.R.709, 716-17 (9th Cir. BAP1996).17 Id. at 1190.18 Wyzard v. Goller, 23 Cal. App. 4th 1183, 1192(1994).19 Id. at 1189.20 In re Guzman, No. 05-51833, WL 478978, at *4(Bankr. N.D. Cal., Feb. 4, 2011). 21 CIV. CODE §3439.08; see also In re Century CityDoctors Hosp., LLC, No. 2:08-bk-23318-PC, WL7637255, at *11 (Bankr. C.D. Cal., Nov. 2, 2011). 22 Cybermedia, Inc. v. Symantec Corporation, 19 F.Supp. 2d 1070, 1075 (N.D. Cal.1998).23 In re Brobeck, Phleger & Harrison LLP, 408 B.R.318, 347 (Bankr. N.D. Cal. 2009).24 In re Kemmer, 265 B.R. 224, 323 (Bankr. E.D. Cal.2001); In re 3dfx Interactive, Inc., 389 B.R. 842, 863(Bankr. N.D. Cal. 2008).25 In re Fatoorehci, 546 B.R. 786, 793 (Bankr. N.D.Ill. 2016), quoting Barber v. Golden Seed Co., Inc.,
129 F. 3d 382, 387 (7th Cir. 1997).26 In re Fatoorehci, 546 B.R. at 793, quoting Smith v.SIPI, LLC and Midwest Capital Investments, LLC (Inre Smith) 811 F. 3d 228, 240 (7th Cir. 2016).27 In re Maddalena, 176 B.R. 551, 553 (Bankr. C.D.Cal. 1995).28 See, e.g., O’Toole v. Karnani (In re Trinsium Grp.),460 B.R. 379, 393 (Bankr. S.D. N.Y. 2011) (“Thenotes were executed in exchange for the repurchaseof company stock, but there are no facts in the pleadingregarding how much the stock was worth at the timethe transfers took place or how many shares of stockwere transferred with respect to each promissory note.Without evidence of how much certain stock wasworth in a fraudulent conveyance action to avoid thetransfer of stock in exchange for notes, it was “impos-sible for the Court to reasonably infer whether thetransfer was for less than reasonably equivalent value.”);see also Garcia v. Garcia (In re Garcia), 494 B.R. 799,815 (Bankr. E.D. N.Y. 2013) (“[A]s a threshold matter,the Complaint must be dismissed because it fails toplead any facts concerning the value of…membershipinterests as compared to the consideration received inexchange for them.”)29 Kaler v. Able Debt Settlement, Inc., 440 B.R. 526,533 (8th Cir. BAP 2010); In re Calvillo, 263 B.R. 214(W.D. Tex. 2000). See also BFP v. Resolution TrustCorp., 511 U.S. 531, 548 (1994).30 In re Calvillo, 263 B.R. 214 (W.D. Tex. 2000) (deter-mination of reasonably equivalent value is inherentlyfact-laden and turns on case specific circumstances).31 In re First Commercial Mgmt Group, Inc., 279 B.R.230 (Bankr. N.D. Ill. 2002).32 11 U.S.C. §548(d)(2)(A)33 In re Dixon, 143 B.R. 671, 681 (Bankr. N.D. Tex.1992).34 In re Treasure Valley Opportunities, Inc., 166 B.R.
701, 705 (Bankr. D. Idaho 1994), citing Freitag v.The Strand of Atlantic City, 205 F. 2d 778, 784 (3dCir. 1953) (holding executory promise may be propertyand “fair consideration” within the terms of theUniform Fraudulent Conveyance Act). 35 In re Treasure Valley Opportunities, Inc., 166 B.R.at 705: “…the authorities noted by the trustee basetheir conclusion that executory promises cannot befair value on statements to that effect in Collier onBankruptcy.… Even Collier qualifies this broad-sweep-ing language:
When the thing promised cannot benefit thecreditors, an executory promise is certainly tobe condemned. When, however, the promisoris solvent and the promise is enforceable, unlessit is a mere promise of support, a transfer tohim in exchange for his promise should notbe held necessarily and automatically to haveno value, especially when the promise has beenpartially or totally fulfilled in good faith andthe creditors have profited by a reduction oftheir debtor’s obligations after the transferwas made.”
36 In re Bigelow, 271 B.R. 178, 189 (B.A.P. 9th Cir.2001).37 In re Nat’l Magazine Pub. Co., 172 B.R. 237 (Bankr.N.D. Ohio 1994).38 Id.39 Stoltenberg v. Sheppard, Mullin, Richter, &Hampton, LLPWL 2644646 at *1 , (Cal. Ct. App.,June 20, 2017), review denied (Sept. 27, 2017).40 Id. at *6.41 NAMA Holdings, LLC v. Dorsey & Whitney LLP,No. B238449, WL 4034358 at *8 (Cal. Ct. App.,Aug. 7, 2013).42 Id.43 Id.
40 Los Angeles Lawyer January 2018
WHEN GOVERNOR JERRY BROWN SIGNED a record 15 affordablehousing bills into law last September, renters, developers, publicagencies, lenders, and tax credit investors had ample reason tocelebrate. California now will have a dedicated source of fundingthat could raise $200 million to $300 million annually in multi-family housing developments for the homeless initially and,eventually, low-income families and seniors as well. In addition,voters will have the opportunity to approve a $4 billion housingbond measure in November, of which $3 billion is earmarkedto subsidize affordable housing projects and support home own-ership and $1 billion is allocated to the CalVet Home Loansprogram.
The critical shortage of affordable rental housing throughoutCalifornia, including Los Angeles County, was the catalyst forthese legislative initiatives. According to a May 2017 study bythe nonprofit California Housing Partnership Corporation(CHPC), Los Angeles County needs more than 551,807 rentalunits “to meet the needs of its lowest-income renters.” The CHPCalso found the county’s “inflation-adjusted median rent increased32 percent while median renter income decreased 3 percent from2000 to 2015.” Finally, the study said “renters need to earn 4times [the] local minimum wage to afford the median askingrent of $2,499” in the county.
As housing demand and rents skyrocketed, availability offederal and state funds to build or preserve units declined dra-matically, especially after the governor and state legislature abol-ished community redevelopment agencies several years ago. Since2008, the CHPC said, investment in affordable housing productionin Los Angeles County has been reduced by nearly $457 millionannually. In late 2016, an encouraging turnaround in fundingbegan to occur. In November of that year, more than 77 percentof voters in the City of Los Angeles approved Measure HHHauthorizing $1.2 billion in bonds over the next 10 years todevelop approximately 10,000 homeless housing units. LastMarch, Los Angeles County voters approved a quarter-cent salestax increase that could eventually generate $355 million annuallyto fund housing, rent subsidies, and services for the homeless.
Leveraging financing is key to developing affordable housing.In California, developers traditionally have relied on debt in theform of a private first mortgage and loans from one or morepublic agencies, together with equity generated from the “sale”or syndication of federal low-income housing tax credits (LIHTCs)to provide permanent financing for developments. The new stateand local housing initiatives will contribute funds for loans thatdevelopers can use in this leveraging process. LIHTCs are anequally essential component in this equation. Congress createdthe LIHTC program under the 1986 Tax Reform Act to promoteprivate investment in multifamily housing. The credit is calculatedbased on a percentage of eligible development costs and takenby investors over a 10-year period. LIHTCs come in two forms:
a 9-percent credit allocated competitively by each state and a 4-percent credit awarded with the issuance of private activitybonds. Since its inception, the National Multifamily HousingCouncil reports LIHTCs have helped finance nearly three millionapartment units.
California’s housing initiatives could suffer a serious, if notdevastating, impact from purported tax reform legislation beingconsidered by Congress. In mid-November, the U.S. House ofRepresentatives approved H.R. 1, the Tax Cuts and Jobs Act.One change in tax law made by this bill—eliminating the taxexemption for private activity bonds—would have an adverseimpact on affordable housing production. Without this exemption,affordable housing developers would lose access to 4-percentLIHTCs. According to California State Treasurer John Chiang’soffice, California used $6 billion in private activity bonds (PABs)in 2016 to finance affordable housing projects that resulted inan allocation of $2.2 billion in LIHTCs. Collectively, this helpedbuild or preserve 20,600 housing units.
A month later, the Senate by a two-vote margin passed itsversion of a tax reform bill. Unlike the House, the Senate preservedthe status quo for PABs. However, both tax bills reduce the cor-porate tax rate from 35 percent to 20 percent. Lower tax ratesmean corporations have less appetite for tax credits, includingLIHTCs, which translates to lower credit prices and reducedequity for projects. The Senate also adopted a Base Erosion andAnti-Abuse Tax (BEAT).… As one website explains, "BEAT tar-gets…large companies with foreign operations…[that]…reducetheir tax bills through cross-border payments they can deduct inthe U.S. According to CHPC, BEAT “means that banks withsignificant foreign operations such as Union Bank, could losetheir interest in purchasing housing credits, disqualifying banksand other investors that account for 10 to 25 percent of thecapital invested in the housing credit market.”
The tax reform bill is touted as a jobs creation measure; how-ever, in the context of rental housing construction, the bill accom-plishes precisely the opposite. Novogradac & Company, anaccounting firm, reports more than 1.1 million jobs would belost under the House tax bill over the next 10 years, including296,180 jobs in California. Equally important, when people canafford housing and have a stable living environment, it allowsthem to seek work and retain those jobs.
For families and individuals struggling to find or keep a safe,clean, affordable place to live, LIHTCs, PABs, and BEAT have nomeaning. Depending on how Congress acts on tax reform, theseobscure acronyms could suddenly have a very real and lastingimpact as these people try to keep a roof over themselves. n
closing argument BY TED M. HANDEL
California's New Affordable Housing Efforts May Be in Jeopardy
Ted M. Handel is chief executive officer of Decro Corporation, a nonprofithousing developer that develops and manages affordable multifamily projects.He is a member and former chair of the Los Angeles Lawyer Editorial Board.
