Tuesday, August 31, 2021

Welcome to the ACREL News & Notes! It is published six times throughout the year and

features articles on substantive areas, noteworthy cases and hot topics, upcoming meetings,

ACRELive presentations and Fellow and local ACREL events.

We welcome your suggestions! Send ideas to David Gordon, dgordon@wilentz.com

--ACREL Communications Committee

As we go to press, summer is slowly winding down, Labor Day is less than one week away, and the

ACREL fall meeting in Nashville is less than 2 months away with more than 425 registered

Fellows and guests. Given our inability to meet in person for the past two years, the outstanding

CLE programs that line the Educational Agenda, the ACREL-only Sara Evans event at the

Country Music Hall of Fame, and the VIP seats at the Chris Stapleton concert, it is no wonder

that so many Fellows and their guests are looking forward to Nashville!

While we are continuing to receive new registrations weekly, we are hearing from time to

time from Fellows who are inquiring about health-related protocols for the Fall meeting. As I wrote

to you in a special email three weeks ago, the Executive Committee is acting deliberately to monitor

the situation so that we can provide Fellows and guests with a comfortable, yet prudent, meeting

experience. As I described in my email in early August, we are implementing a new seating plan

for the plenary sessions, all social events at the hotel will be held outdoors (this was the plan even

before COVID as the outdoor space at the JW Marriott is highly desirable), the Country Music Hall

of Fame allows for significant spacing including an outdoor terrace, and the JW Marriott, which is

only three years old and state-of-the-art in design, has implemented a number of COVID-related

upgrades and protocols. Please watch for additional announcements from the College as we move

into the fall.

* * * *

Looking ahead, I hope that you will join us for two special, first-of-a-kind ACREL events:

First-Ever ACREL Nominations Workshop. Leaders of the Member Development

Committee and the Membership Selection Committee are hosting the first-ever ACREL

Nominations Workshop at 2:00 p.m. eastern on September 9, 2021. Peggy Rolando, Marianne

Ajemian, Gail Mills and Bill Sklar will explain the nomination process and describe what makes

for a strong candidate and a successful nomination. The identification, nomination and admission

to ACREL of the country’s top real estate lawyers adds to the strength and vitality, and ensures the

long-term continuity, of the College. If you are thinking of nominating a prospective Fellow or

would just like to know more about the process, please attend the Nominations Workshop. There

will be ample time allotted for questions and answers. Please feel free to either raise your questions

during the program or to send them in advance to Peggy, Marianne, Gail or Bill.

Inaugural Meeting of the International Practice Group. I wrote in July of the

formation of the ACREL International Practice Group (IPG) led by Abe Schear. The IPG will

offer periodic programming with topics of interest for Fellows whose practices involve cross-border

transactions, whether inbound or outbound. I am pleased to announce the inaugural meeting of the

IPG, which will take place on September 23, 2021 at 1:00 p.m. eastern and will feature, as guest

speakers, Jane Helmstadter, of Bennett Jones in Toronto, and Richard Burgos, of Lavery in

Montreal. Please contact Abe if you have suggestions for future meetings and presentations, or if

you are interested in helping with the planning and coordination of the IPG. We are also planning

on an in-person strategy and brainstorming meeting of the IPG in Nashville so please watch for

further announcements prior to the fall meeting.

Please see the “What’s Happening This Week” email that you receive each Monday

from the College for more details and links to these presentations.

* * * *

In closing, I want to say a few words about one of our Fellows from the Class of 2021.

David Lust, from Rapid City, South Dakota, was approved for admission to the College by the

Board of Governors at its meeting in March of this year. David practiced law with the firm of

Gunderson, Palmer, Nelson & Ashmore and was a member for several years of the South Dakota

House of Representatives, including serving as Majority Leader. Many of us remember meeting

David virtually in March at the College’s inaugural New Fellows Council reception where we

welcomed our newest Fellows. I personally remember speaking with David, and I remember his

smile when I told him that Renee and I visited Rapid City last summer on a trip to Mount

Rushmore. Those of us on the Executive Committee were profoundly saddened and shocked when

we were notified by David’s firm in late July-- only four months after his admission to the College

and our Zoom meeting-- that David had passed away after suffering a cardiac event, leaving behind

his wife Rebecca and four children. At ACREL, all of our Fellows-- new and old-- are special and

very important to us. I have sent a card to David’s family on behalf of the College, and I extend

now my deepest condolences to those Fellows who knew David, including those who nominated or

seconded him for membership, and those who simply had the privilege of working with him.

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Call for 2022 Sponsors of ACREL

Do you know of a company that would benefit from being a sponsor to ACREL?

The Finance Committee is working hard to solicit sponsors for next year and

would love to hear from you if you have a contact or company in mind.

For more information, click here for the 2022 ACREL Sponsorship Brochure, or

email Julie Burgess.

Report of the ACREL Nominating Committee for 2022 Board of

Governors & Officers

We are pleased to release the report of the 2021 Nominating Committee, thanks to the

hard work and diligent efforts of this year's committee, led by Marilyn Maloney.

View Report

Fisher

Happy 85th Birthday to

Morty Fisher! Morty, an

ACREL Fellow since

1981 and Past President

of 1989, celebrated

among friends, including

Fellows and two ACREL

Past Presidents, Barry

Greenberg, Ray Truitt,

Roger Winston and Jay

Epstien.

Hagner

Congratulations to John

Hagner, from

Washington, D.C., on his

retirement from Womble

Bond after 44

years! John has been an

ACREL Fellow since

1987 and we wish him a

very happy retirement,

alongside his wife, Ellie.

Shierk

Kim Shierk has been

named to Michigan

Lawyers Weekly’s debut

list of “Go To Lawyers”

practicing in real estate

and condominium law.

One of the most

accomplished and

respected real property

and development

lawyers in Michigan,

Kim has blazed a trail

and broken new ground

for herself and other

women lawyers in a

world mainly comprised

of men. From small- to

large-scale residential

and commercial projects,

wireless communication

structures, and a host of

other real property

matters and initiatives,

Kim’s fingerprints–and

footprints–are all over

Michigan.

Lifetime Achievement Award Winners (Locke, Dysart)

Additional Awards Recipients (Love, Markel)

Presenters and Planning Team

The State Bar of Texas Advanced Real Estate Law Course was held July 7-10 at the

Hyatt Regency Hill Country Resort in San Antonio. Roland Love served as the

Course Director, and ACREL presenters included Art Anderson, Robert Bliss, David

Dickson, Diane Dillard, Sara Dysart, Roland Love, Marc Markel, Kent Newsome,

Katherine Tapley, David Weatherbie, Thomas Whelan, and Reid Wilson. The

Planning Committee also included Cary Barton and David Conoly.

Making up for the pandemic virtual year, awards and recognitions were made for 2019

through 2021. Recognition of ACREL Fellows included the following:

Lifetime Achievement Award: Bill Locke (2020) and Sara Dysart (2021)

The highest award and recognition made by the Real Estate Probate and Trust Law

Section

Best Speaker 2019: Roland Love and Marc Markel

Workhorse Award 2020/2021, Best Paper 2019: Roland Love

It is with great sorrow we inform you of the passing of the following Fellows of the College. Our thoughts are with their families, friends and colleagues.

John "Tim" Carssow Fort Worth, TX

1944-2020 ACREL Fellow since 1982

Join us in making a contribution in John's honor.

Warren J. "Bud" Daheim St. Paul, MN

1930-2020 ACREL Fellow since 1983

Join us in making a contribution in Warren's

honor.

Don L. Kortz Denver, CO

1940-2021 ACREL Fellow since 1983

Join us in making a contribution in Don's honor.

David E. Lust Rapid City, SD

1968-2021 ACREL Fellow since 2021

Join us in making a contribution in David's

honor.

John N. Patterson Santa Fe, NM

1943-2021 ACREL Fellow since 1987

Join us in making a contribution in John's honor.

Lawrence Rivkin New York, NY

1921-2021 ACREL Fellow since 1980

Join us in making a contribution in Lawrence's

honor.

ACREL Nominations Workshop

Thursday, September 9 @ 2 pm Eastern

Add to your calendar

2021 ACREL Annual Meeting

Nashville, TN

October 21 - 24

Register

ACREL News & Notes

August 2021

A Message from the Advocacy and Amicus Committee

Once again, we want to introduce the Advocacy and Amicus Committee to you. The

Committee is prepared to advocate for laws that will be beneficial to the real estate community.

In that advocacy, we will coordinate among others with the Uniform Law Commission which

adopts uniform acts or, in the case of acts which we think will act to the detriment of the real estate

community, we advocate to deny adoption. Recently, we successfully stopped the Uniform Drone

Act after our Committee found it overreaching and it modified certain common law principles

which should not have been modified. The work on this matter will probably continue until

eventually there will be a satisfactory Uniform Drone Act.

We are also focused on preparing Amicus briefs in cases of interest. A few years ago, we

filed a brief in the highest Court of New York and our brief was cited by the adoption in the Courts’

language with a result that our Committee achieved a successful confirmation of the lower Court’s

ruling.

Many issues of advocacies or amicus briefs create inherent conflicts among our Fellows.

However, we make every effort to directly take on those matters we believe will not impact our

Fellows or their clients. A case in point is that we were recently asked to file an amicus brief in a

pending case in which, in the judgment of the Committee, a lower Court made a grievous error.

We were unable to assist in this matter because College Fellows were involved in both sides of the

case.

Notwithstanding the potential conflicts, we are also available to assist in helping advocates

with a position on any side of a matter find other willing advocates without taking a Committee

position.

We look forward to seeing you in Nashville. If you have any suggestions, ideas, etc. for

the Committee, please stop any of the members listed below so that we may take up the topic.

See you in October!

ADVOCACY & AMICUS COMMITTEE

Barry B. Nekritz IL Chair

Thomas F. Kaufman DC Vice Chair

Calvert Chipchase HI

Joseph P. Forte NY

David R. Kuney DC

Cliff McKinney AK

Michael H. Rubin LA

James C. Wine IA

ACREL News & Notes

August 2021

Specialty Courts for Real Estate Disputes?

Carl J. Circo, Ben J. Altheimer, University of Arkansas School of Law, Fayettville, AR

Our judicial system features many specialty courts—juvenile, drug, and veterans courts

for the criminal arena, probate and bankruptcy courts on the civil side. The past three decades,

however, have seen an uptick in business and commercial courts. In addition to Delaware’s

famous Court of Chancery, dating from 1792, approximately half of U.S. states now have some

form of business court or distinct docket for business disputes.1

In some countries, business courts play more prominent roles than in the U.S. The United

Kingdom, which has several specialty courts for business disputes, established the tribunal now

known as the Technology and Construction Court (TCC) in 1873.2 Owing to my academic

interest in construction law, I find the TCC a particularly interesting example of specialization

geared to technical and complex disputes within a narrowly defined industry.

The TCC, a subdivision of the Queen’s Bench Division of the High Court of Justice,

hears a range of cases considered too technical for a generalist court and a jury, but its reputation

as a highly efficient and effective institution stems primarily from its history with construction

and engineering cases.3 The TCC has developed procedures to assure timely and high-quality

dispositions tailored to the construction industry context, including a “Pre-Action Protocol for

Construction and Engineering Disputes.”4 TCC judges have broad case management discretion

to engage in proactive steps to control costs, to encourage alternative dispute resolution, and to

resolve cases efficiently. Among several procedures governing experts and expert testimony is

an option for “the experts for all parties to be called to give concurrent evidence, colloquially

referred to as ‘hot-tubbing.’”5 Another procedure, not unique to the TCC but particularly

important in construction litigation, is the U.K.’s statutory adjudication option in which a neutral,

overseeing a highly abbreviated proceeding, renders a decision that is binding and almost

immediately enforceable, although still subject to a final, subsequent determination by the TCC.

In practice, many adjudication decisions conclude the case.6

A commercial court as specialized as the TCC (say one dedicated to construction industry

or real estate transactions) seems unlikely in the United States. Under our federal system, few, if

any, individual states would likely have sufficient caseloads to support a court specializing in

such targeted legal fields. Having no personal experience with business courts, I would be

interested in hearing from ACREL members who have war stories of real estate or construction

industry litigation in a business or commercial court.

1 See Lee Applebaum, et al., Through the Decades: The Development of Business Courts in the United States of

America, 75 Bus. LAW. 2053 (2020). 2 See https://www.gov.uk/government/publications/technology-and-construction-court-guide (TCC Guide). 3 See generally John Uff, Construction Law - the First 25 Years, 7 CONSTRUCTION L. INT'L 40 (2013). 4 See TCC Guide, § 2. 5 TCC Guide, § 13.8.2. 6 See Humphrey Lloyd, Adjudication & the British Courts, DISP. RESOL. J., July 2001, at 64.

ACREL News & Notes

August 2021

Towards a Hypothetical ACREL Shares 2.0

Justin L. Earley, First American Title Insurance Company, Santa Ana, CA

As you may know, this year the Innovation & Practice Committee is delighted to have the

support of a team of graduate students from the University of California, Irvine. These students

are completing master’s degrees in human-computer interaction design (often shortened to

“HCI”). What is HCI? In short, it’s the study of how to build computer systems that “just make

sense” to the people who use them. It’s one of the most important 21st century job fields, and it

has exploded in importance in the last decade. If you want to see what happens when software

isn’t usable, watch this.

One of ACREL’s key pieces of software is ACREL Shares. ACREL Shares is aptly described as

a “treasure trove” of collected legal knowledge, but the College is aware that Shares also has

some usability challenges. Working with graduate student experts in this space was a fantastic

opportunity to benefit the College. The team working on ACREL Shares consists of Alexandra

Eftimie, Isaac Sonnenburg, Karina Dandia, Maddy Thomas, and Melania Antillon, and I have

been meeting with them weekly since their project started in March. They are a great team and a

delight to work with.

A big “thank you!” goes out to all the Fellows who have generously given your time to our

student team as part of their research efforts. Through surveys, interviews, and observations, the

team has been able to distill key lessons that suggest ways for us to improve ACREL Shares.

This user-experience research is of immense value to the College, and we owe a big “thank

you!” to the student team as well.

The students’ project will be winding up late this summer, and they will be giving their final

report and recommendation to the Innovation & Practice Committee shortly before they graduate

in September. Between now and then, the student team is exploring and testing possible solutions

that will move us towards a hypothetical ACREL Shares 2.0. While we aren’t sure as I write this

text in July what a hypothetical Shares 2.0 might be, we do know that whatever it might be needs

to work for you. Your participation is key to creating a user-friendly system, so please be on the

lookout for more opportunities to support this project by offering feedback on possible solutions

that the students are exploring.

And for those who are as passionate about this subject as we are, please be sure to join the

Innovation & Practice Committee’s in-person meeting at the October convention in Nashville,

where we’ll be considering the next steps that derive from our graduate student partners’

research. Whatever ACREL Shares 2.0 may ultimately be, we’ll need robust support from the

Fellows to bring it to life!

ACREL News & Notes

August 2021

1 117862256v1

Homelessness is Still with Us, and ACREL is Still Involved

David H. Jones, Troutman Pepper, Charlotte, NC

Since its annual meeting in Los Angeles in 2017, ACREL has been investigating what it

might do, either institutionally or in support of its individual members, to address issues of

homelessness in our communities. This effort was sparked by our plenary session at that meeting

during which local officials and homelessness advocates presented the face of homelessness in

Los Angeles County and the steps being undertaken toward housing solutions.

Following that meeting, then in-coming president, Jay Epstien, asked Jane Smith to head

an ad hoc task force to determine whether there was a role for ACREL in addressing the problems

of the homeless. Jane recruited ACREL members to be involved and, since that time, has

facilitated countless meetings. Many ACREL members have been able to attend one or more

meetings and roughly 20 or so members have formed a core group that attend most, if not all, of

them. The group’s deliberations have continued to be supported by ACREL leadership as each of

the Presidents, since Jay, have been active champions of the effort, and both Jay and Marilyn

Maloney are core participants.

At first, the group was overwhelmed by the data and the issues and a bit daunted in trying

to determine how ACREL could be of use. Early on, we focused on gathering information about

homelessness: the number of victims and how they differed, the causes, and what local

communities were doing to address the issues. We felt we needed to learn as much as we could,

if we had any hope of making recommendations to ACREL.

The pandemic brought a new challenge. Dropped into what was already a domestic

humanitarian catastrophe was the prospect that hundreds of thousands of previously securely

housed families could find themselves on the streets due to quarantine induced economic

disruption. This disruption would lead to wage and job loss and which in turn would lead to rent

payment defaults. Quickly invoked eviction moratoria were put into place which stanched what

would have been an immediate flow of newly homeless people; however, it was apparent that not

all communities respected the moratoria and that in all events the moratoria would end at some

point.

For a while the committee narrowed its focus to the effect of the eviction moratoria and

the impact of their eventual end. Part of our deliberations centered on how the rental support

provisions of the federal and state relief packages were being administered. One of the revelations

to us was that most landlords who rent to the tenants most likely to be affected by the pandemic

related economic layoffs were smaller landlords who did not have the ability to absorb sustained

rental losses. To avoid foreclosure, they would be under the most pressure to evict tenants and try

to re-let those units.

The communities that were more efficient at getting the rental subsidy payments into the

hands of tenants and landlords were, as a result, the ones with lower pending eviction caseloads.

117862256v1

Drawing on what we learned, the committee prepared a white paper which contained a proposal

urging continued rent subsidy appropriations and listing some of the best practices we saw as to

how to get the money into the hands of landlords and tenants efficiently.

Through the good offices of ACREL member Lee Chilcote, an introduction was made to

an attorney with close ties to the new HUD Secretary, Marsha Fudge. Our paper was submitted to

HUD through this channel. While no direct action has come from HUD with respect to the paper,

we note, with some satisfaction, that a number of studies and articles that have been published

since that time have focused on the need to efficiently get rental subsidy payments into the hands

of smaller landlords as a key to avoiding additional increases in homelessness.

More recently, the task force has decided to refocus its efforts as to what role ACREL can

play to help reduce homelessness, more broadly. A smaller group is being asked to compile the

information we have gathered to date and the possible solutions that are under consideration by

advocacy groups and local governments. This small group hopes to report to the entire task force

later this year with a menu of policy options and individual actions where ACREL and its members

could bring their talents to bear in an effort to make safe and secure housing a realty for all.

ACREL News & Notes

August 2021

1

Amendments to Uniform Common Interest Ownership Act

and the Uniform Condominium Act

James C. Smith, University of Georgia School of Law, Athens, GA

The Uniform Law Commission approved amendments to the Uniform Common Interest

Ownership Act (UCIOA) at its July 2021 annual meeting held in Madison, Wisconsin. Parallel

amendments will be made to the Uniform Condominium Act. The most significant amendment

concerns the scope of UCIOA. The act since its inception in 1982 has generally applied only to

common interest communities created after the act’s effective date. Older communities are

grandfathered, regulated by preexisting state law, whether statutory (for condominiums) or largely

common law (for planned communities and cooperatives). The amendments apply UCIOA to all

common interest communities, regardless of time of creation, while retaining the act’s existing

exemptions for small cooperatives, small planned communities (“small” means 12 or fewer units),

and planned communities with small assessments. The change in scope responds to concerns that

grandfathering old communities, thus creating two sets of law based on the age of communities,

has created complex issues for the legal community and for residents. The administration of law

and practice within a state is considerably improved by uniformity, i.e., by making all communities

subject to the same law to the maximum extent feasible.

Other significant amendments include:

Emergency Powers. The amendments add a new section on emergency powers prompted

by challenges faced by common interest communities and their associations during the coronavirus

pandemic. The new section: (1) adds a definition of “emergency,” (2) relaxes the normal notice

rules to allow meetings and actions when notifying only persons “whom it is practicable to reach”

with notices given “in any practicable manner,” and (3) authorizes the executive board to take any

action it considers reasonably necessary to protect the unit owners and other persons during an

emergency.

Adverse Possession. Sometimes a unit owner makes long-term unauthorized use of a

common element, and when the association or neighboring owners object to the use, the unit owner

raises adverse possession or prescriptive easement as a defense. The amendments add a new

section that immunizes common elements from loss by unit owners’ claims of adverse possession

or prescriptive easement.

Termination of Common Interest Community. During the past decade, terminations of

common interest communities have become more frequent, triggered by older buildings becoming

obsolescent, by casualty destruction, and by the economic failure of new developments before

completion. The amendments make four important changes. First, the amendments prevent a

developer who owns many unsold units from forcing termination by requiring the approval of 80

percent of the sold units in addition to 80 percent of all units. Second, the existing text allows

termination by an 80-percent vote only for communities with multi-story dwelling units (stacked-

units), requiring unanimity (100 percent) when any non-stacked units are present. The amendments

apply the 80-percent vote for all communities, regardless of building type. Third, the amendments

ACREL News & Notes

August 2021

2

protect owners from low appraisals of their units by allowing an owner to obtain an independent

appraisal and to have an arbitral panel of three appraisers determines fair market value. Fourth, the

amendments add a new procedure for a “partial termination,” which allows the removal of some

but less than all of the units from a common interest community.

Master Associations. The existing act requires that delegations of powers to master

associations be set forth in the declaration. The amendments add flexibility by allowing the

executive board to delegate powers to a master association, subject to review by the unit owners.

The amendments also change the rules for the election of the executive board of a master

association to ensure that the unit owners of the sub-associations have effective voting power.

Limited Common Elements. The amendments make it easier to convert a common

element into a limited common element by allowing a conversion by approval of the executive

board of the association, subject to review by the unit owners.

Special Declarant Rights. Special declarant rights include rights of the declarant to make

changes to the community and to control the executive board. The draft reorganizes the rules and

defines special declarant rights as interests in real estate, appurtenant to all units owned by the

declarant and any real estate subject to a development right to create additional units.

Meetings and Voting. The amendments permit and facilitate electronic meetings of unit

owners, a topic that has become especially timely since the coronavirus pandemic. They authorize

unit owners to participate remotely at a meeting held at a geographic location and authorize “all-

electronic” meetings where there is no geographic location for in-person attendees.

Assessments. First, the amendments respond to the practice of executive boards, which

happens with increasing frequency, of assessing common expenses to one or a few unit owners

who are “benefitted” by the expense (usually a replacement or repair of a common element, such

as a door, porch deck, or skylight). The amendments modify the “benefitted” standard by

removing board discretion and by requiring the declaration to identify the common expense by

specific listing or category. Second, the amendments change for rules for assessing expenses based

on a unit owner’s “bad behavior” by (1) dropping the ability to do so for gross negligence, (2)

adding liability for a unit owner’s failure to comply with maintenance standards, and (3) protecting

unit owners by requiring that the association cover the loss by available insurance proceeds before

making an assessment against the unit owner.

ACREL News & Notes

August 2021

4849-4378-5459 v1

“Good as Gold or Fool’s Gold – What Does It Mean to an Owner for

a Contractor to be Licensed, Bonded, and Insured?”

Trippe Hawthorne, Kean Miller LLP, Baton Rouge, LA

Every property owner who has endeavored to undertake a construction, renovation, or repair

project has heard or seen the phrase “licensed, bonded, and insured”. But what does this mean,

and does it really matter? Like all good questions, the best answer is, “it depends”.

Licensing: Many but not all states require contractors to be licensed. If the project is in a state

where a contractor’s license is required, the importance of observing the licensing laws is

critical. Violations of state licensing law can have catastrophic consequences to the unlicensed

contractor and to the project. While owners do not typically have direct liability for a

contractor’s violation of state licensing law, a project employing unlicensed contractors is

subject to being shut down by licensing board investigators and authorities, which will

undoubtedly cost the owner significant time and money. Also, it is generally the case that where

a license is required for a particular type of work, a contract for such work with an unlicensed

person may be subject to nullification.

The licensing process varies from state to state, but it is generally structured to require proof that

a contractor has basic financial, business, and technical competency to perform the work for

which the license in a particular classification has been issued in a responsible way. Technical

competency is typically addressed through testing and/or required levels of experience in the

specific area for which the license is sought. Many states have a tiered or subdivided contractor

license system under which the state’s requirements for licensing are differentiated based on the

monetary value of the contractor’s contracts and/or the type of services the contractor offers.

Contractors that are licensed for large commercial construction contracts may hold a different

type of license than subcontractors who are not dealing directly with owners, or contractors that

only perform residential construction or home remodeling. Contractors and subcontractors

performing inherently dangerous work which can threaten life, health, and safety (such as

plumbing or electrical work) might need still other types of licenses.

Financial and business competency and viability is typically addressed through minimum asset

requirements, examination of basic financial records, and background checks. The background

checks may be for the licensed contractor and its key employees and agents, and will include

review for things like bankruptcies or unsatisfied judgments.

The structure and purpose of most state contractor licensing systems is to ensure basic

competency and basic levels of financial stability. State licensing requirements help create,

identify, and illuminate the channels available to customers, creditors, and the government to

hold a contractor accountable, particularly where there is a public threat to life, health, or safety.

Nevertheless, a contractor’s ability to obtain a license should not be overvalued, particularly with

regard to competency, and state licensing law is generally of little help to owners in the event of

a contractual dispute with a licensed contractor. A license (where required) is the bare minimum

that any responsible contractor needs before they begin to accept contracts.

ACREL News & Notes

August 2021

4849-4378-5459 v1

Bonded: While, as discussed below, traditional insurance is not intended to guarantee a

contractor’s performance under a construction contract, certain types of surety bonds are.

“Bonded” means that a surety will stand behind the contractor for some obligation owed by the

contractor. The surety guarantees some aspect of the contractor’s performance to someone. The

key questions then are “what performance has been guaranteed” and “to whom”?

Generally, when the words “licensed, bonded, and insured” are used in an advertisement for a

contractor, the word “bond” generally refers to a license and/or permit bond. This license and/or

permit bond guarantees that the contractor will abide by the terms of the license issued and/or the

permit they have pulled, protecting some or all of the licensing board, the public works

department, the owner, or the general public. The existence of and requirements for obtaining a

license and permit bond vary greatly by state, county, or municipality. In the event of a troubled

contractor, though, the proceeds of these bonds are likely to be claimed by a number of different

people, and the amount of the bond may not be likely to be sufficient to cover the contractor’s

liabilities. In other words, while it could be nice that a bond of general applicability exists,

owners should not place any reliance on such a bond in their decision-making process.

For a significant project, the owner will want to dictate the terms and conditions of the bond and

have it dedicated to the project and that particular owner. Typically this is done through a

“payment and performance bond” issued for a specific project. The payment bond guarantees

payment to subcontractors, material suppliers, laborers, and others that have worked on the

project, and who may have lien rights against the owner. The performance bond generally serves

as a guarantee by the surety to the owner that the contractor will perform the work pursuant to

the terms and conditions of the contract. The performance bond does not entitle the owner to

anything more than is owed under the construction contract, but does provide security that the

project will be completed for the contract sum, even if not by the contractor.

Insurance: Whether a contractor is “insured” may be the most important or least important part

of the trio, depending on the risk at issue. Insurance is the most valuable tool in protecting

against the risks to third parties created by a construction project, but is not particularly useful in

protecting the owner for its own damages caused by the contractor’s breach or bad work.

The most common risks addressed by a contractor’s liability insurance include property damage,

injuries, and workers’ compensation claims. Many states’ contractor licensing laws require a

minimum amount of general liability and workers’ compensation insurance in order to obtain

and maintain a license. Liability and worker’s compensation insurance is important to protect

owners from claims by third persons arising out of or related to their project, and insurance for

these claims is of critical importance if they arise. While an owner can ascertain and determine a

contractor’s available insurance through review of an insurance certificate supplied by the

contractor’s insurance agent, for more significant projects, the owner will want to be added as an

“additional named insured” to the contractor’s liability insurance policies and ensure that the

available insurance has appropriate coverage and limits for the work at issue, and will defend the

owner and contractor in the event of a claim.

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August 2021

4849-4378-5459 v1

While a contractor’s liability insurance may protect the contractor and even the property owner

from claims for damages to third parties arising out of the project, it is not intended to protect the

owner against breach of contract by the contractor or bad workmanship. In other words,

“insured” means that a contractor has insurance to protect against risks to people other than the

owner, and it is not likely to protect the owner from the owner’s own damages that may arise out

of or relate to the project.

Construction projects also typically involve different types of property insurance, ranging from

the owner’s property insurance policy or program to a builder’s risk policy, which protects the

project and the materials and component parts thereof while the work is incomplete.

It’s important to understand the difference between being bonded and insured. For a contractor,

one of the biggest differences between insurance and bonding is which entity takes on the risk;

an insurance policy transfers the risk to the insurer, while a bond ultimately keeps the risk with

the bonded contractor. For an owner, the main difference is in which types of circumstances are

covered by bonds versus which are covered by insurance. Bonds should generally be associated

with the Contractor’s performance of its obligations under the contract, whether to perform the

work, or to pay subcontractors and material suppliers. Insurance should be associated with

personal injury or property damage, typically to third parties.

The cost of licensing and insurance for a contractor is typically a general cost of doing business,

while the cost of a project specific bond is… project specific. So, for projects where cost is a

key factor (are there any where it is not?) many times, eliminating bonding requirements is a way

to reduce project costs.

Surety bonds protect the interests of the project owner and ensure that the projects are completed

correctly, securing the completion of the job and the security of the owner’s investment. Many

surety bond companies won’t issue a bond without having sufficient security from the contractor

and unless the contractor is sufficiently insured. If an incident occurred, causing property

damage or personal injury, the surety would want to be confident that the contractor’s insurance

would protect the continued viability of the contractor and its ability to complete the project,

which the surety has guaranteed.

From a planning perspective, knowing that a contractor is “licensed, bonded, and insured” is

certainly better than hiring a contractor that is not licensed, is not insured, and can’t get a bond,

but prudence will always suggest consideration of the requirements and ramifications of the

particular project, and at least some analysis of whether the protections offered by this contractor

for a particular project are appropriate and sufficient.

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August 2021

Why Is This So Complicated?

An Introduction to Common Tax Structures and

Considerations for Domestic and Foreign Investors in U.S.

Private Equity Real Estate Funds

John L. Mallinson1, AIG Global Real Estate Investment Corp, New York, NY

I. INTRODUCTION:

Interest in U.S. real estate as an investment asset class is robust amongst both foreign and

domestic investors. Not surprisingly, private equity real estate funds (“PERE Funds”),

which are a critical outlet for this demand, continue to attract significant levels of capital

and are becoming increasingly more important participants in the market. Despite their

ubiquity, forming and structuring a PERE Fund is a complex undertaking. This

complexity arises principally from the fact that a PERE Fund is often a Noah’s Ark of

varying international and domestic investor types each having their own tax and regulatory

sensitivities and requirements. The PERE Fund must address these sensitivities and

requirements not only on an individual investor basis but also within the context of an

overall investment structure that needs to work for all parties in the aggregate.

This article seeks to demystify some of the complexity surrounding PERE Fund structures

by providing an overview of some important categories of investors organized by tax

profile and examples of some structures through which they often invest. While there can

be many drivers behind a PERE Fund’s internal organizational complexity, very often the

most important driver is tax.2 For certain categories of investors in PERE Funds, the

failure to properly understand the tax impact of certain investment structures and to plan

accordingly can have significant economic consequences. This article endeavors to clear

some of the fog surrounding these structures by means of an introductory and necessarily

incomplete discussion of the topic. This article does not purport to provide tax or legal

advice and readers should consult their own professional tax advisors relative to any

particular tax question or circumstance. The structuring of a PERE Fund in actual practice

entails a myriad of additional important details, judgment calls, individual circumstances

and preferences, business drivers and other considerations producing a frequently bespoke

final product.

1 John L. Mallinson is the General Counsel of AIG Global Real Estate Investment Corp. Mr. Mallinson received his B.A. from

Binghamton University and a J.D. from New York University School of Law. Mr. Mallinson serves as the Chair of the Equity Investment Structures Committee of the American College of Real Estate Lawyers whose work on investment funds provided the impetus for this article. The author would like to thank Robert LeDuc of DLA Piper LLP, Dan Zygielbaum and Roger Singer of Gibson, Dunn & Crutcher LLP and Stevens Carey of Pircher, Nichols & Meeks LLP for their kind and thoughtful contributions to this article. 2 Even the use of a Delaware limited partnership as the standard PERE Fund entity is to a large extent the product of the tax

needs of prospective foreign investors despite the existence of the newer form LLC which may be considered superior in many respects. The U.S. treaty network typically requires a PERE Fund to be organized as a limited partnership if treaty benefits are to be claimed by foreign investors on dividends and/or interest passed through the PERE Fund, including dividends from a subsidiary REIT.

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August 2021

Part II of this Article provides a glossary of key terms used in the balance of this Article.

Part III provides a brief discussion on private REITs given their importance and prevalence

in PERE Fund structuring. Part IV lists the varying types of investors who typically invest

in a PERE Fund and some general statements about their tax profiles and typical approach

to achieving tax efficiency. Part V provides some concluding thoughts on PERE Fund

structuring.

II. KEY TERMS

Branch Profits Tax means a 30% branch profits tax on a foreign corporation’s

earnings and profits constituting ECI.3 The Branch Profits Tax may be reduced or

eliminated by treaty.

Blocker means a corporation or other entity, such as an LLC, electing to be taxed as a

corporation.4

Code means the U.S. Internal Revenue Code of 1986, as amended.

ECI means income effectively connected with the conduct of a U.S. trade or business

within the meaning of the Code.5 As a general matter income from operations or sale

of real estate in the U.S. constitutes ECI. A foreign investor who receives ECI from a

PERE Fund will be subject to U.S. federal (and potentially state) income tax and will

be obligated to file tax returns in the U.S., including potentially at the state level.

Leveraged Blocker means a Blocker that is capitalized with a combination of

shareholder loans and equity.

Non-REIT Qualifying Investment means assets within a PERE Fund which are

considered non-qualifying for various purposes of the REIT qualification tests.

REIT means a real estate investment trust as set forth within subchapter M of Chapter

1 of the Code.

REIT Qualifying Investment means assets within a PERE Fund which are considered

qualifying for various purposes of the REIT qualification tests.

QFPF means a qualified foreign pension fund within the meaning of Section 897(l) of

the Code.

3 I.R.C. Sec. 884(a).

4 In tax structuring parlance a “blocker” generally refers to an entity that is or elects to be opaque for tax purposes, as opposed

to a pass-through entity.

5 See I.R.C. Sec. 864(c).

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August 2021

Section 892 Investor means a “foreign government” investor, including a sovereign

wealth fund,6 within the meaning of Section 892 of the Code. Note that many foreign

pension funds are entitled to both Section 892 benefits and significant treaty benefits

and may also be QFPFs.

UBTI means unrelated business taxable income which is generally defined under the

Code as income that is unrelated to the exercise or performance of a U.S. tax-exempt’s

purpose or function but generally excludes dividends, interest and capital gains.7

USRPHC means a U.S. real property holding corporation within the meaning of

Section 897 of the Code.

III. PRIVATE REITs

While the general public is largely familiar with REITs that are listed on an exchange, a

REIT is not required to be publicly traded. REITs may be privately held and are fairly

common and well-established structures in the real estate investment world.8 REITs were

meant to provide access to the retail investor to larger real estate projects, the legislative

impression having been that such investment had been previously available as a practical

matter only to institutional investors and the wealthy.

The principal advantage of a REIT is that while it is a taxable entity, it is entitled to a

deduction for dividends paid.9 In circumstances where all or virtually all income is paid

out, the REIT should expect to owe little or no income tax.10 In order to receive various

tax benefits and otherwise qualify as a REIT, the REIT must meet various requirements

under the Code, including, generally speaking, annually distributing at least 90% of its net

taxable income (excluding net capital gains) and meeting certain asset tests such as that at

least 75% of the REIT’s total assets must be real estate assets, cash and government

securities at the close of each quarter of the calendar year. A REIT is required to (i) avoid

being more than 50% owned, by value, by five or fewer “individuals”, which can include

certain entities (the “5/50 Test”), and (ii) have at least 100 shareholders.11 Service firms

exist that source equity commitments from REIT investors and manage the relationship

with those investors.

As the number of requirements described above suggest, the utilization of private REITs

entails not insignificant administrative and formation costs and limitations on operational

6 For a definition of “sovereign wealth fund” see U.S. Department of the Treasury, Semiannual Report on International

Economic and Exchange Rate Policies, June 2007, at www.treas.gov/offices/international-affairs/economic-exchange-rates/pdf/2007_FXReport.pdf (March 3, 2008). 7 See Internal Revenue Service Tax on Unrelated Business Income of Exempt Organizations Publication 598 (Rev. March 2021)

8 For a discussion of the use of private REITs by PERE Funds see Michael Belotin, Why Private Investment Funds Are Using REITs

to Invest in Real Estate Tax Notes Federal 166-7 (February 17, 2020).

9 Note that private REITs can lose the deduction for dividends that are “preferential.” 10 Note that REITs will typically endeavor to distribute all of their income and net capital gain as undistributed amounts are

subject to income tax in the hands of the REIT.

11 Both of these ownership requirements have a limited grace period for newly formed REITs. The 5/50 Test takes into account

indirect and constructive ownership.

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August 2021

flexibility. Further, due to certain assets being Non-REIT Qualifying Investments, a REIT

will limit the appeal or add to the complexity of a PERE Fund investing in certain asset

types, such as hotels, residential condominiums, senior housing and horizontal

development of land lots. Additionally, sale of any property type within two years after it

is constructed could be considered a “prohibited transaction”12 if it does not fall within the

various safe harbor provisions of Section 857(b)(6)(C) of the Code; therefore the REIT

structure could impact a PERE Fund’s disposition and sale strategy relative to development

projects. Obviously, utilization of a REIT by a PERE Fund should reflect the view that the

prospective tax and regulatory benefits of the REIT outweigh the costs and limitations of

the REIT structure.

IV. INVESTOR TYPES BY TAX PROFILE

This Part provides a catalogue of investors organized by their tax profile and a discussion

of how an investor with such profile may often invest in a PERE Fund and some of the

benefits, trade-offs and considerations of such a structure. The structures outlined below

by no means exhaust the universe of potential structures.13 A typical PERE Fund will seek

to include a number of these structures within the PERE Fund or through one or more

alternative investment vehicles that invest alongside the fund.

U.S Investors:

Overview

U.S. investors can be broadly divided into two categories: taxable and tax-exempt. For

taxable investors, the investment structure in a PERE Fund organized in the U.S. is often

very straightforward. Investment structures for tax-exempt investors are often less straight

forward (unless the investor is a governmental pension fund in which case the structures

may be relatively simple). Two types of tax-exempt entities, corporate pension funds and

endowments, are critically important categories of PERE Fund investors; understanding

the rules applicable to them is essential in PERE Fund structuring.

U.S. Non-Tax Exempts (Corporations, Individuals) – Direct Investment Structure

These investors are generally going to be subject to U.S. federal income tax on their

allocable share of the Fund’s income and capital gains at the relevant current rates. Such

investors will typically invest as direct limited partners in the Fund or through vehicles

organized for purposes other than tax. These investors typically prefer structures that are

fully transparent and pass through from a tax perspective to avoid double taxation, although

some investors may prefer investing in a REIT to potentially reduce state tax filing and/or

payment obligations.

U.S., State and Local Pension Funds – Direct Investment Structure

12 I.R.C. Sec. 857(b)(6).

13 Despite the discussion below on Leveraged Blockers, for example, some if not many foreign investors for a variety of reasons

may opt to invest simply through a Blocker or directly into the PERE Fund itself.

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August 2021

These investors are known as “Super Exempt” organizations. Many of these government

pension investors14 take the position that they are not subject to federal or state income tax

on UBTI by virtue of Section 115 of the Code which excludes from the definition of gross

income any income derived, inter alia, from the “exercise of any essential governmental

function.”15 Based on such position, these investors may opt to enter the PERE Fund

directly as limited partners and not require REIT or other blocker structures.

Corporate Pensions and University/College Endowments – Single REIT Structure16

U.S. pension funds and endowments generally enjoy tax exempt status in the U.S. This

tax-exempt status, however, is not absolute. Congress did not, for instance, intend this

tax-exempt status to extend to activities that were not core to the mission of the

particular tax-exempt party. Income from such non-core activities is referred to in the

Code as “unrelated business taxable income” or “UBTI” and is subject to tax. Congress

has defined UBTI to include various items of income. Most notably income from real

estate with debt financing on it may, to a significant extent, be considered UBTI. The use

of mortgage financing is a core and a very traditional element of real estate investment.

Consequently, the inclusion of this income from debt financed properties as UBTI would

have a material impact if not addressed in some fashion. UBTI can also be generated by

properties or activities whose income may be viewed as more from business operations

than rent from real estate, such as hotels, and from “dealer” activities, such as the sale of

condominium units. Most tax planning for these tax-exempt investors will take into

account and seek to manage or eliminate UBTI.

Corporate pensions and endowments will typically invest directly in the PERE Fund but

will need the PERE Fund to have a subsidiary that is a REIT that in turn owns the individual

assets or invest in a fund that complies with the “Fractions Rule” in order to avoid the

adverse tax consequences of UBTI for leveraged investments. A discussion of the

Fractions Rule is outside the scope of this Article but suffice it to say that many investors

and sponsors prefer avoiding UBTI through utilization of a REIT rather than monitoring

and implementing a Fractions Rule compliant investment. Generally speaking, a REIT as

a corporate entity “blocks” 17 the attribution of income characterization as UBTI to

investors in the REIT.18 Care must be taken to avoid having the REIT be considered

“pension-held” or the UBTI blocking benefits could potentially be lost for certain pension

fund investors.19

14 Conversely, some government pension investors require UBTI blocking structures to eliminate any concern. 15 I.R.C. Sec. 115(1). 16 If the fund invests in Non-REIT Qualifying Investments a fund structure may include a separate and parallel blocker structure

to manage UBTI.

17 It should be noted that while the REIT structure blocks the imposition of UBTI to investors the REIT rules themselves

impose a set of restrictions on permissible income at the REIT not dissimilar to much of the UBTI regime. 18 See Mitchell Berg and Ian Tattenbaum, Using Private REITs to Minimize UBTI in Real Estate Investment Funds, Real Estate

Finance Journal (Winter 2003). 19 A REIT can be a “pension-held REIT” if either (i) at least one pension trust holds more than 25% of the value of the interests

in the REIT, or (ii) a group of pension trusts each individually holding more than 10% of the value of the REIT’s stock, collectively owns more than 50% of the value of the REIT’s stock, provided certain other factors are also present.

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August 2021

Not all assets in a PERE Fund are necessarily going to be REIT Qualifying Investments

entitled to preferential tax treatment. A residential condominium development project, for

instance, may be a Non-REIT Qualifying Investment. Corporate pensions and

endowments will want to avoid receiving income from Non-REIT Qualifying Investments

directly to avoid the need to file federal and perhaps state income tax returns. Accordingly,

many PERE Funds will employ either a Blocker or taxable REIT subsidiary (TRS)

ordinarily owned by a REIT to hold Non-REIT Qualifying Assets. Payment of tax and the

filing of tax returns will occur at the Blocker or TRS level, as applicable.

Foreign Investors:

Overview.

The enactment in 1980 of the Foreign Investment in Real Property Tax Act (“FIRPTA”)

was undertaken amidst legislative concerns about foreign ownership of, and investment in,

U.S. real estate. FIRPTA placed levels of taxation on those activities by most foreign

investors higher than those in respect of other investment classes. Accordingly, FIRPTA

has served as a headwind to foreign investment in real estate. Significantly, FIRPTA treats

gains from the sale of a “US real property interest” as ECI irrespective of whether they

would have otherwise constituted ECI. Subsequent amendments to FIRPTA and the

adoption of accepted tax planning strategies have alleviated some of these disincentives.

Even still, many foreign investors will be subject to substantive levels of U.S. tax and their

tax planning strategies will be to mitigate against even higher levels of tax.

In addition to the significant tax burdens applied to certain forms of investment under

FIRPTA, foreign investors may also subject themselves to the need to file a tax return in

the U.S. and perhaps various states and further subject themselves to the subpoena power

of the IRS relative to their other investment activities in the U.S. Tax planning for foreign

investors often leads to structures that avoid the need to file a U.S. tax return and its

resultant consequences.

Foreign Investor (QFPF) – Single REIT Structure

The 2015 PATH Act was designed to increase investment in U.S. real estate by certain

qualified foreign pension funds by exempting these entities from FIRPTA altogether. This

means that gains from the disposition of a USRPI, including capital gain dividends from a

REIT, are generally tax-free for QFPFs. 20 However, ordinary REIT dividends will

continue to be subject to withholding tax unless reduced or eliminated by a treaty or Section

892. Accordingly, a QFPF will generally invest directly in the PERE Fund but require a

REIT that is wholly owned by the PERE Fund to hold the underlying assets. The REIT

serves to block the creation of ECI and therefore the need to file a U.S. tax return.

However, a QFPF will be subject to withholding tax on ordinary dividends if and to the

20 Care must be taken to avoid having such gains be otherwise connected to a U.S. trade or business however, as this could

trigger U.S. taxation on such gains even for a QFPF. Accordingly, QFPF investors generally prefer to invest through REIT structures rather than pure passthrough structures.

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August 2021

extent not reduced or eliminated by an applicable treaty or unless the QFPF is owned by a

foreign government and falls within Section 892. Unlike a Section 892 Investor, a QFPF

may receive capital gain dividends that originate from sales of U.S. real estate without tax,

and without regard to how much of the REIT is owned by the QFPF.

Foreign Investor (Non-QFPF)- Leveraged Blocker Structure.21

Absent use of a Leveraged Blocker Structure, many foreign investors (other than QFPFs

and Section 892 Investors) could be subject to federal tax at a rate in excess of 44% and an

obligation to file federal tax returns with its attendant IRS audit and subpoena implications.

Accordingly, the Leveraged Blocker is a common structure inside PERE Funds. The

Leveraged Blocker Structure, however, is not a panacea as the foreign investor may still

pay, at least indirectly, a significant amount of tax. However, effective tax rates should

be expected to be brought down significantly in most cases.

Under this structure, the investor contributes equity to the Leveraged Blocker and makes a

shareholder loan to the Leveraged Blocker.22 The Leveraged Blocker is the investor in the

PERE Fund limited partnership. The Leveraged Blocker will generally obviate the need

for the investor to file a U.S. tax return because ECI will occur at the blocker level, unless

the investor disposes of its shares in the Leveraged Blocker while it is a USRPHC. There

may no withholding tax or a reduced rate on interest and dividends from the Leveraged

Blocker depending on applicable treaties and/or structuring the loans to qualify under the

“portfolio interest exemption.”23 However, the Leveraged Blocker will typically be subject

to state and Federal tax to the extent interest on the shareholder loans is not deductible.24

Care must be taken that the affiliated loan structure is respected as debt for federal tax

purposes. Among other matters, the loans must bear interest at an arms-length rate, have

appropriate loan to value ratios and not permit excessive deferral of interest.

Assuming the Leveraged Blocker is a U.S. entity (typically a Delaware C-Corp or a

Delaware LLC electing to be taxed as a corporation) the foreign investor should not be

subject to a Branch Profits Tax.

Federal and state income tax will be paid at the Leveraged Blocker level, net of allowed

deductions for interest on the shareholder loans and other allowable expenses. An investor

in the Leveraged Blocker will be entitled to receive a return of principal on its shareholder

loans, interest on its shareholder loans, a return of its capital contributions and profit on its

capital contributions. The amount of tax in respect of each of these will depend on a

variety of facts and circumstances, including applicable treaties and whether the investor

is a Section 892 Investor.

21 Other considerations for Leveraged Blockers are beyond the scope of this article. These considerations include the relatively

new Section 163(j) interest deduction limitations, the new Section 59A “base erosion” rules, the anti-hybrid rules of new Section 267A, and the repeal of Section 958(b)(4) which can frustrate certain portfolio interest planning.

22 Oftentimes a limited partnership (a “feeder partnership”) is interposed between the Leveraged Blocker and the investors.

23 I.R.C. Sec. 871(h) and 881(c). 24 The new Section 163(j) rules regarding interest deductibility must be considered carefully.

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August 2021

Foreign Investor (Non QFPF)- Multiple Leveraged Blocker Structure.

This is a variation of the Leveraged Blocker structure. In this variation, a Leveraged

Blocker is inserted into the fund structure with respect to each and every asset. Under

certain circumstances and subject to certain limitations, tax may not be payable by the

foreign investor on proceeds from a sale of an underlying asset if done in connection with

an ultimate liquidating distribution of the Leveraged Blocker. The Leveraged Blocker will

of course pay tax on its net income/gains to the extent not reduced by interest expense. A

liquidating distribution is generally not considered a dividend subject to withholding tax

and therefore is treated differently than dividends. A detriment of this structure is the

potential inability to offset losses of an investment made in one Leveraged Blocker against

gains made in another.

Foreign Investor (Non-QFPF) – Baby REIT Structure.

In a so-called “Baby-REIT” structure, the fund forms a Parent REIT that in turn owns all

or a substantial amount of the assets in the fund through special-purpose vehicles that are

REITs that own the individual properties. Sales of the individual properties occur through

a sale of shares of the property level REIT that owns the asset. Under FIRPTA, assuming

the applicable REIT in question is “domestically controlled” - meaning that foreign

ownership of the REIT is less than 50% during a specified testing period - then, generally

speaking, proceeds from such sale will be made free of federal income tax to the foreign

investor.25 The Parent REIT receives operating income and the REIT structure will

provide applicable tax benefits in respect of that income. Because the tax benefits are

significant, many foreign investors (other than QFPFs, which have been afforded alternate

means of obtaining tax efficiency) find the appeal of Baby-REIT structures quite strong.

A limitation of this structure is its practicality in a PERE Fund with many assets and

perhaps multiple asset level operating partners who may or may not wish to operate the

individual assets in a REIT structure or to limit the exit of the investment to a sale of REIT

shares. There is also the cost and complexity of operating this many REITs in a single

structure.26 Given these limitations, Baby-REIT structures are often employed in joint

venture arrangements as distinct from traditional PERE Fund structures or in PERE Funds

where the sponsor seeks out a large U.S. co-investor to take 51% of every deal on a deal-

by-deal basis with the PERE Fund investing the remaining 49%.

V. Conclusion

PERE Funds provide capital and liquidity to U.S. real estate markets and offer institutional

investors across the globe a means of achieving exposure to this important asset class.

25 If the Baby REIT is indirectly less than 50% owned by vote or value by a Section 892 Investor, and such Baby REIT is not

otherwise effectively controlled by the Section 892 Investor, similar results should obtain for such an investor even if the REIT is not domestically controlled.

26 In addition, sales of REIT equity in order to obtain the benefits of a domestically controlled REIT can require robust tax

indemnities and/or tax insurance to be obtained.

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August 2021

However, investment in U.S. real estate is often subject to special tax treatment under

FIRPTA, the REIT compliance regime, UBTI considerations and other important

requirements whose impact may vary from investor to investor. Harmonizing these

interests into a coherent and workable fund structure is the product of significant effort

supported by appropriate expertise.

ACREL News & Notes August 2021

P3 Projects: P3 Risks and Responsibilities

Wm. Cary Wright1, Carlton Fields, Tampa, FL

Public-Private Partnerships, generally referred to as “P3s,” are becoming increasingly more

common in the United States as the demand to update and provide new public infrastructure

facilities becomes overwhelming.1 Simplified, P3s are “contractual agreements between a public

agency and a private entity that allow for greater private participation in the delivery of projects.”2

However, P3s can be very complex and come in many different forms. P3s range from the

design-build method that transfers typical design and construction risks to the turnkey method

where there is a complete risk transfer.3 The in-between forms include “a variety of project delivery

approaches that add options by which public and private participants may tailor their respective

interest in sharing project risks and responsibilities across the entire scope of project services for

ownership design, construction, financing, operation and maintenance of the work.”4

The use of P3s spans across a range of infrastructure projects, including, but not limited to,

transportation, courthouses, prisons, water infrastructure, recreation, education, and hospitals.

Currently, the United States has relatively limited experience; nonetheless, interest continues to

grow at both the state and federal levels, as more legislation is being drafted and lessons are being

learned from recent projects. This Article discusses the general risks and responsibilities P3

projects present to assist public owners and private entities in deciding if a P3 delivery system is

appropriate for a project.

The decision to enter into a P3 cannot be made lightly. “Public agencies have to make

important and complicated decisions to develop effective P3 programs and projects, often under

intense public scrutiny.”5 An early identification of potential projects to be delivered as P3s is

integral to long-term success in performance and economics. The main characteristics of a project

that are indicative that a P3 delivery method is suitable for the project include “opportunities for

available revenue streams, risk transfer scalability, proper statutory authority, public vs. private

cost of financing and the long-term performance strategy for asset owners.”6

Risks & Responsibilites

How risks and responsibilities are treated in a P3 project is entirely different from how

risks and responsibilities are treated in private-sector projects. Who carries the risks and

responsibilities on the P3 project should be very clearly established in a P3 contract; this precludes

the parties from forming an agreement that is comparable to commercial “partnership,” in which

the “partners” owe fiduciary duties and share any profits, losses and liabilities of a business

venture.7 Specifically, negotiation of the P3 contract defines and restricts the P3 partnerships.

“Such a venture, although a contractual arrangement, differs from typical service contracting in

that the private-sector partner usually makes a substantial cash, at-risk, equity investment in the

project, and the public sector gains access to new revenue or service delivery capacity without

1 Wm. Cary Wright is a shareholder with Carlton Fields and chairs its Construction Practice Group. He would like to acknowledge the assistance of Monica S. Towarnicky, an associate at Carlton Fields, for her assistance in writing this article.

ACREL News & Notes August 2021

having to pay the private-sector partner.”8 This method of long-term contracting requires abundant

flexibility and trust on the part of both parties.

Not only is the treatment of risks different for P3s, but the potential risks differ from

traditional contractual relationships. These risks arise at all phases of the project: the development

phase, the construction phase, and the operation and maintenance phase. Risk identification is a

critical piece in the development of a P3.

Development Phase Risks

In order for a P3 to be successful, there must be strong governmental support.

Governmental support for P3s is often challenged by the political will of public officers and the

general public.9 “Manifestations of political risk include the outright cancellation of projects by

the public agency, the inability to reach an agreement between the public and private partners on

the project structure, and the failure to appropriate funds necessary for the proposed project.”10 As

with a lot of ventures in the government, public officers need to please their constituents. The

novelty of P3s can cause apprehension by the public, which in turn puts pressure on public officers

to avoid being in favor of the potential P3 project.11 The public can be uneasy about the private

sector, the implementation of new tolls, and the employment prospects and/or losses. This

apprehension can be eased by enhancing transparency and providing straightforward, simplistic

content to educate the public.12

To attract private entities to public P3 projects there needs to be a sufficient regulatory

framework. The long-term nature of P3s calls for clarity and flexibility in regulations to satisfy the

private entities, while also providing protection for the public.13 “Desirable provisions in P3

legislation include a requirement for clear procurement guidelines and decision criteria, flexible

project eligibility criteria, . . . the ability to revise toll rates [for transportation projects] over the

project’s life . . . limitations on leasing, [and] limitations on use of financing instruments. . . .”14

It is important to establish a framework for permitting. The responsibilities of permitting

can be given solely to the public agency or the private entity or it can be a shared responsibility. If

not clearly allocated or if governmental red-tape is not cleared for private entities, then a P3 project

can suffer significant delays.15

Complications can arise with procurement on P3 projects. There can be misunderstandings

on whether the P3 project is free from the constraints of federal and state procurement law, since

procurement laws usually apply when a project is government funded. Besides unclear legislation

regarding this issue, “procurement issues can arise from a lack of clarity in response requirements,

excessive financial commitment requirements, insufficient protection of design and proprietary

information, or a lack of transparency in the selection criteria.”16 Courts have interpreted P3

procurement by looking at whether the infrastructure was constructed for a public purpose and

with public funds.17

Construction Phase Risks

ACREL News & Notes August 2021

During the construction phase, the potential risks include design risk, construction cost

risk, including market risk, and latent defect risk. If not sufficiently negotiated and discussed at

the outset, the cost overruns, relief events and delays can become unnecessarily numerous.

Generally, the design risk falls to private entities in P3 projects. Constructability,

completeness and coordination of design and design documents can be allocated to an architect or

engineer, or shared across the private entities.18 The negative effects resulting from flawed design

work creates a myriad of issues, including delays and cost overruns, as well as safety issues in the

present and in the long-term.19

The long-term nature of P3s increases the construction cost risk, especially since there is

such a broad spectrum of items affecting construction costs — labor costs, delays, cost of

performance bonds, and material costs. At the core of P3 projects is the transfer of this highly

sensitive risk area to the private entities.20 “Construction costs are estimated during the design

phase and can be locked in through lump-sum turnkey contracts . . . which allow for fixed costs

and penalties in case of completion delays.”21 At the outset, the public agency should “produce as

clear and concise a set of output specifications as possible” to allow the project to be precisely

priced.22 Fluctuations in macroeconomic conditions may cause distress to material costs, labor

costs, and inflation rates.23 To protect from this, private entities should include inflation rate

considerations in the final bid. In contrast, public entities may chose a fixed priced contract.24

Latent defects are another risk that differs when entering into a P3. Given the length of P3

contracts, the responsibility for latent defects is more easily contracted for beyond the standard

statutory limitation period. Major defects that appear years after construction is complete may be

allocated as the responsibility of the private entity who may be responsible to operate and maintain

the completed project for forty to fifty years before it is returned to the public owner.25 This must

be taken into consideration as an incentive, not only when negotiating the contract, but also while

performing the work.

Operational and Maintenance Phase Risks

The major difference in risk allocation for P3s is found in the operational and maintenance

phase. “The operational knowledge and the need to maintain a cooperative relationship [between

the public agency and private entity] for the life of the contract” is unique.26 Once a private entity

becomes responsible for the operation and maintenance of the project for years after completion,

new and unfamiliar risks arise. The same amount of focus should be put on the operational and

maintenance phase that was put on the development and construction phases.

The first, and maybe most obvious, risk in this phase is the actual operation and

maintenance of the project. Risks here stem either from actual physical issues or the increase in

costs to operate and maintain. Properly forecasting increases in costs at the time of project

development is crucial.27 However, financial losses often occur because anticipation of cost

increase is not always accurate.28 Additionally, if not properly maintained, the project condition

can deteriorate leading to more expensive maintenance down the road.29

ACREL News & Notes August 2021

Traffic and tolls are also a post-construction risk private entities are not familiar with when

it comes to transportation P3 projects, which arise in P3s that provide the private entities with the

ability to manage toll services.30 “Traffic risk . . . refers to the risk that over the life of a project

actual traffic levels do not reach projected levels.”31 If traffic levels are low, the project’s cash

flows will be negatively impacted making the private entities unable to repay the debt and generate

profits.32 An increase in toll rates can also present problems as the public’s lack of information as

to where the money is going and why a toll is necessary can cause resistance.33 This type of public

resistance can lead to political opposition that can change the nature of the contract if public

officers yield to the constituents by removing any toll clause in the contract.34 For instance, a

project in California that was initially to be built as a toll-revenue P3 “faced strong public

opposition against tolls,” causing the contract to change “to availability payments because of

strong local political opposition . . . that killed the toll element.” 35

Another major risk is found in insurance coverage. “Before a contractor expands its role in

what would otherwise be a public project, the contractor should carefully identify any potentially

costly gaps in its insurance coverage.”36 The need for professional service liability insurance may

arise, when previously the private entity only needed CGL coverage.

The period of handback becomes a major risk for both private entities and public agencies.

There is always a possibility that the project was not properly maintained during the operation and

maintenance period, and the condition of the project is less than anticipated or contracted for.37

Including incentives in the contract and clearly specifying expectations can “encourage the private

partner to make the investments necessary to handback the facility to the public agency in suitable

condition.”38

Conclusion

As federal and state agencies become more comfortable and eager to use P3s, private

entities need to come prepared and knowledgeable. This Article provides just a general overview

of the risks and responsibilities each party may experience at the development, construction, and

operation and maintenance phases of the project life cycle. Understanding that the risks and

responsibilities of a P3 project are treated differently is a first step for both public agencies and

private entities. Learning and examining the unique risks and responsibilities will put each party

in a better position for a successful project.

1 NCSL P3 State Legislative Update: 2016-2018, NAT’L CONF. OF STATE LEGISLATURES (June 18, 2019), https://www.ncsl.org/research/transportation/ncsl-p3-update.aspx. 2 Build Am. Bureau, Public-Private Partnerships (P3), U.S. DEP’T OF TRANSP., https://www.transportation.gov/buildamerica/project-development/public-private-partnerships-p3/public-private-partnerships-p3 (Feb. 28, 2018). 3 PHILIP L. BRUNER & PATRICK J. O’CONNOR, JR., BRUNER AND O'CONNOR ON CONSTRUCTION LAW § 2:18 (2020). 4 Id. 5 FEDERAL HIGHWAY ADMINISTRATION, ESTABLISHING A PUBLIC-PRIVATE PARTNERSHIP PROGRAM: A PRIMER 5-1 (2012).

ACREL News & Notes August 2021

6 Building-Up: How States Utilize Public-Private Partnerships for Social & Vertical Infrastructure, NAT’L

CONF. OF STATE LEGISLATURES (Feb. 16, 2017), https://www.ncsl.org/research/transportation/building-up-how-states-utilize-public-private-partnerships-for-public-multi-sector-vertical-infrastructure.aspx. 7 See LaSalle Partners v. United States, 48 Fed. Cl. 797, 810-11 (Fed. Cl. 2001) (finding “no doubt that the agreement between [the private party] and the government never rose to the level of a legally-binding commercial partnership in which each side owes a fiduciary responsibility to the other”). 8 Id. at 810 (emphasis removed). 9 FEDERAL HIGHWAY ADMINISTRATION, RISK ASSESSMENT FOR PUBLIC-PRIVATE PARTNERSHIPS: A PRIMER 3-1 (2012). 10 Id. 11 See M. Julie Kim, Understanding and Mitigating Political Risks of Public-Private Partnerships in U.S. Infrastructure 54 (Jan. 2014), https://www.researchgate.net/publication/272242308. 12 See Id. at 10. 13 See FEDERAL HIGHWAY ADMINISTRATION, supra note 9, at 3-2. 14 Id. at 3-3. 15 See Id. 16 Id. at 3-4. 17 See Associated Subcontractors of Mass., Inc. v. Univ. of Mass. Bldg. Auth., 810 N.E.2d 1214, 1221 (Mass. 2004); Achen-Gardener, Inc. v. Superior Court, 809 P.2d 961, 967 (Ariz. Ct. App. 1990), vacated on other grounds, 839 P.2d 1093 (Ariz. 1992); Decker v. Kan. Dep't of Soc. Rehab. Servs., 942 P.2d 667, 669 (Kan. Ct. App. 1997). 18 See TIMOTHY J. MURPHY, STRUCTURING AND MANAGING CONSTRUCTION RISKS IN PUBLIC PRIVATE

PARTNERSHIPS 15 (2020). 19 See Id. at 15-16; FEDERAL HIGHWAY ADMINISTRATION, supra note 9, at 3-6. 20 See MURPHY, supra note 18, at 8. 21 FEDERAL HIGHWAY ADMINISTRATION, supra note 9, at 3-6. 22 MURPHY, supra note 18, at 10. 23 See FEDERAL HIGHWAY ADMINISTRATION, supra note 9, at 3-6. 24 See FEDERAL HIGHWAY ADMINISTRATION, supra note 9, at 3-7. 25 See Id. at 3-6. 26 Kim, supra note 11, at 10 (“[T]he crux of P3 contract management is in the operations phase.”). 27 See FEDERAL HIGHWAY ADMINISTRATION, supra note 9, at 3-8. 28 See Id. 29 See Id. 30 Id. at 3-7. 31 Id. 32 Id. 33 Kim, supra note 11, at 54. 34 Id. 35 Id. at 53 (“With availability payment-based concession, the public agency retains the traffic risk by making payments directly to the private sector partner based on the availability of the facility rather than on the number of vehicles.”). 36 P3 Considerations for Contractors, AGC, https://www.agc.org/p3-considerations-contractors (last visited June 23, 2021). 37 See FEDERAL HIGHWAY ADMINISTRATION, supra note 9, at 3-9. 38 Id.

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