Probate & Property - July/August 2024, Vol. 38, No. 4

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DEATH AND TAXES: DYNASTY TRUSTS AND WEALTH IN AMERICA

ACCELERATING AND DE-ACCELERATING THE MORTGAGE NOTE

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EDITORIAL BOARD

Editor

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Articles Editor, Real Property

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Articles Editor, Trust and Estate

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Senior Associate Articles Editors

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Associate Articles Editors

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Melvin O. Shaw

Bruce A. Tannahill

Departments Editor

James C. Smith

Associate Departments Editor Soo Yeon Lee

Editorial Policy: Probate & Property is designed to assist lawyers practicing in the areas of real estate, wills, trusts, and estates by providing articles and editorial matter written in a readable and informative style. The articles, other editorial content, and advertisements are intended to give up-to-date, practical information that will aid lawyers in giving their clients accurate, prompt, and efficient service.

The materials contained herein represent the opinions of the authors and editors and should not be construed to be those of either the American Bar Association or the Section of Real Property, Trust and Estate Law unless adopted pursuant to the bylaws of the Association. Nothing contained herein is to be considered the rendering of legal or ethical advice for specific cases, and readers are responsible for obtaining such advice from their own legal counsel. These materials and any forms and agreements herein are intended for educational and informational purposes only.

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The price of an annual subscription for members of the Section of Real Property, Trust and Estate Law is included in their dues and is not deductible therefrom. Any member of the ABA may become a member of the Section of Real Property, Trust and Estate Law by sending annual dues of $95 and an application addressed to the Section; ABA membership is a prerequisite to Section membership. Individuals and institutions not eligible for ABA membership may subscribe to Probate & Property for $150 per year. Requests for subscriptions or back issues should be addressed to: ABA Service Center, American Bar Association, 321 N. Clark Street, Chicago, IL 60654-7598, (800) 285-2221, fax (312) 988-5528, or email orders@americanbar.org.

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UNIFORM LAWS UPDATE

Successes and Future Prospects for the Uniform Partition of Heirs Property Act

The Uniform Partition of Heirs Property Act (UPHPA), approved by the Uniform Law Commission (ULC) in 2010, has been passed in 22 states, the District of Columbia, and the US Virgin Islands. Over half of the US population is covered by the UPHPA, which gives owners of heirs’ property substantive and procedural protections in a partition action. “Heirs property” consists of property held by tenants in common, a minimum percentage of which are relatives who have not entered into an express agreement regulating partition of the property. The UPHPA protections include mandatory notice to heirs, posting a sign on the property if any heirs are unlocatable, an independent appraisal, a right for the heirs who did not request partition by sale to buy out the heirs who filed for partition, an enhanced preference for partition in kind, and an open-market sale procedure to ensure the highest possible return if the court orders a partition sale. The procedures established by the UPHPA are designed to allow owners of heirs’ property to keep their property within the family whenever possible and to ensure that they receive fair market value for their asset when sale is necessary.

The UPHPA’s most recent enactments include Arizona in 2024, Washington state and the District of Columbia in 2023, Maryland and Utah in 2022, and California in 2021. Additionally, as of press time, versions of the UPHPA are currently under

Uniform Laws Update Co-Editor: Jane Sternecky, Legislative Counsel, Uniform Law Commission, 111 N. Wabash Avenue, Suite 1010, Chicago, IL 60602.

Uniform Laws Update provides information on uniform and model state laws in development as they apply to property, trust, and estate matters. The editors of Probate & Property welcome information and suggestions from readers.

consideration in the legislatures of Kansas, Massachusetts, Michigan, New Jersey, and North Carolina.

Notably, Maryland, Virginia, California, and the District of Columbia expanded the UPHPA to apply to all partition actions, regardless of whether the property is “heirs property” as defined in the uniform act. This expansion is a testament to the efficacy of the court procedures established by the UPHPA, and evidence of these states’ dedication to ensuring that partition can no longer be used as a tool for property developers to acquire any cotenant-owned property for pennies on the dollar.

The UPHPA’s widespread incorporation into United States’ property law would not have been feasible without the assistance of a network of heirs’ property organizations. The drafting committee for the UPHPA included observers from the Land Loss Prevention Project, the Heirs’ Property Law Center, the Heirs’ Property Retention Coalition, and other key organizations focused on protecting the rights of these vulnerable landowners. Many of these organizations have supported the ULC’s enactment efforts through legislative advocacy and by sharing the stories

of heirs’ property owners who were harmed by their states’ lack of protection. These organizations have helped the ULC to demonstrate the scale of the problem of land loss through abusive partition actions involving heirs’ property, both nationally and at the level of individual states and communities.

Additionally, news organizations and the real property bar have played a key role in the UPHPA’s success, particularly in New York. In March 2019, a New York regional television news channel, NY1, produced and published an extensively researched piece that highlighted heirs’ property issues in Brooklyn and Queens. The NY1 piece brought attention to the plight of two property owners who were forced out of their homes by real estate speculators. With the assistance of the New York City Bar Association’s advocacy team, New York’s legislature took quick action to pass the UPHPA, closing the loophole that allowed heirs’ property to be acquired for far less than market value.

Another key component of the UPHPA’s success is the 2018 federal Farm Bill, which modified certain United States Department of Agriculture (USDA) programs. One of those programs creates a path for owners of heirs’ property to obtain a loan to resolve outstanding issues with title, while the second key provision of the Farm Bill allows heirs’ property farm owners to obtain a farm number, a necessary prerequisite for participating in USDA programs, even when they do not have clear title. Through cooperative federalism, Congress created this additional incentive for states to pass the UPHPA and gained the support of state farm bureaus in several states.

An Iowa Supreme Court decision on an heirs’ property issue served as a

catalyst for the UPHPA’s passage in that state. In Newhall v. Roll, 888 N.W.2d 636 (Iowa 2016), the court determined that Iowa’s then-existing partition law required partition in kind only if it was “equitable and practicable.” In this case, a family farm owned by a brother and sister was ordered sold after the brother filed for partition, even though the sister requested partition in kind and was willing to pay her brother for some of

the land in order to ensure the division was equitable.

After the Newhall case was decided, Iowa farmers grew increasingly concerned about the lack of protection provided to family farms under the state’s existing partition statute. This decision laid the groundwork for a successful introduction of the UPHPA, which Iowa passed in 2018.

A study by the USDA’s Forest Service

estimates that there are at least 168,000 parcels of heirs’ property in the 29 states that have not yet enacted the UPHPA. Without the additional protections offered by the UPHPA, these heirs’ property owners remain vulnerable to losing their property through forced sales. During the years to come, the ULC will continue to advocate for this important piece of uniform legislation in the remaining state legislatures. n

AN ESTATE PLANNER’S GUIDE TO QUALIFIED RETIREMENT PLAN BENEFITS SIXTH EDITION

By Louis A. Mezzullo

This ABA bestseller has helped thousands of estate planners understand the complex rules and regulations governing qualified retirement plan distributions and IRAs. Now newly updated and including the SECURE Act and SECURE 2.0, An Estate Planner’s Guide to Qualified Retirement Benefits provides expert and current guidance for structuring benefits from qualified retirement plans and IRAs, consistently relating key distribution issues to current estate planning practice. Topics covered include:

• The different types of qualified plans and the tax and non-tax rules relating to them;

• The forms of distribution and the situations in which they need to be considered;

• Penalty taxes;

• Distribution requirements and how to calculate them;

• Income taxation and handling rollovers;

• Transfer taxes;

• Spousal rights, QDROs, and community property considerations;

• Estate and trust administration issues;

• Practical planning strategies to avoid penalty and excise taxes on distributions while incurring the lowest income tax, and more.

Includes appendices on tax consequences and hypothetical retirement plan scenarios, sample forms, and revenue rulings, private letter rulings, IRS news releases and notices.

PROTECTING AGAINST COMPETITION Exclusive Use Clauses and Radius Restrictions in Commercial Leases

By Alvin C. Miester III and Jonathan B. Cerise

When drafting a commercial lease, both the landlord and the tenant should consider how future competition will affect the new lease. For the tenant, the concern typically is competition from third parties—the landlord may lease space in its shopping center to a new tenant that engages in the same or a similar business that will negatively impact the tenant’s sales. For example, if Home Depot leases space in a center, it would want to take proactive measures to ensure that, as long as Home Depot is operating in the center, the landlord will not also lease space to Lowe’s or any other home improvement store competitor. This may be accomplished by negotiating certain exclusivity rights into the lease.

The landlord’s competition concerns are slightly different. For example, in a lease where the tenant is paying percentage rent, that tenant’s sales (and, correspondingly, the percentage of those sales paid to the landlord as rent) likely would suffer if the tenant opens another store just down the street. The landlord’s interests are best served by including restrictions in the lease that would prevent the tenant from competing with itself.

Exclusive Use Provisions

What Is an Exclusive Use Provision?

Although many use provisions aim to limit the behavior of the tenant, an exclusive use provision is provided for the benefit of the tenant and limits the landlord’s ability to lease

other space in the shopping center to a competitor or other business that may be undesirable, in the tenant’s view. For big-box anchor tenants, obtaining exclusive use rights is usually a prerequisite to the tenant’s agreeing to enter into lease negotiations for space in a particular shopping center. Because of the immense bargaining power, economic importance (including an influx of people coming to the shopping center), and expansive variety of products offered by major tenants, exclusive use provisions may need to include carveouts or exceptions to ensure that the exclusive is not too broad or overly restrictive for the landlord’s future leasing opportunities in the shopping center.

Exclusive use provisions also may give small business tenants the necessary protection to successfully conduct their operations. These businesses often have small margins or limited cash flow, and the emergence of a competitor within the same shopping center (especially a large, big-box competitor or national chain) may produce dire consequences, including rendering the tenant unable to generate sufficient sales to meet its rent obligations. Unfortunately for these smaller tenants, they frequently have less bargaining power in lease negotiations and often must concede on carveouts or limitations required by the landlord for any exclusive.

What Concerns Should a Landlord Have in Agreeing to Exclusive Use Provisions?

Granting any tenant exclusive use rights will restrict the pool of additional potential tenants for other spaces available in the landlord’s center. In most cases, however, landlords recognize that a successful shopping center should have a well-balanced mix of retail tenants. A good tenant mix attracts more customers to the center, bolsters the tenants’ financial stability, and increases the landlord’s percentage

Alvin C. Miester III and Jonathan B. Cerise are members at Sher Garner Cahill Richter Klein & Hilbert, L.L.C. in New Orleans, Louisiana.

Courts generally favor the unfettered and unrestricted use of real property, so a provision that unreasonably or too thoroughly limits potential tenants or types of businesses may be invalidated by a court.

rental income. Rather than refusing to grant exclusive uses, most landlords will strive to ensure that any exclu sive use granted is narrowly tailored to avoid unintended consequences. An exclusive use provision that is not carefully drafted may lead to confusion about what type of business is allowed or restricted. This, in turn, may lead to disputes over an alleged breach, including costly injunctive hearings and

For example, an unwary landlord leasing space to a cookie shop might agree to an exclusive use provision in the tenant’s lease restricting the landlord from leasing other space in the center for the sale of “baked goods.” That landlord may have expected the exclusive language to be narrowly interpreted to only prevent leases to other tenants primarily engaged in the sale of cookies. The cookie shop tenant would be well within its rights to claim—much to the unwary landlord’s surprise and chagrin—that its exclusive use has been violated even if the landlord signs a new lease with a bakery specializing in the sale of bread and breakfast pastries. The landlord would have been better served by negotiating exclusive use language that aligned directly with the tenant’s business and only restricted future leases to other cookie shops. Similarly, landlords should ensure

that reasonable restrictions and carve outs are included in any exclusive use clause. For example, it might appear reasonable for a coffee shop tenant to request an exclusive use clause pro hibiting other tenants from engaging in the sale of coffee products; however, because most restaurants offer cof fee on their menus, this exclusion may prohibit the landlord from entering into a future lease with any restaurant selling coffee. A better drafted exclu sive use clause for a coffee shop tenant would limit future leasing to tenants engaged primarily or exclusively in the sale of coffee products (i.e., other coffee houses) or carve out sit-down restau rants that happen to offer coffee on their menus.

First, an exclusive use provision may be drafted using a specific list of competitors to whom the landlord is restricted from leasing. This level of specificity ensures that the exclusive use provision is not subject to judicial scrutiny or considered too ambiguous, which could lead to it being interpreted more broadly or narrowly than the parties intended. The downside, however, is that any potential competitor not named in the list is likely “fair game” for the landlord to engage in negotiations for a new lease within the shopping center. Attorneys therefore should be as thorough as possible when drafting lists of named competitors.

An exclusive use provision may also include prohibited categories of business. This allows a broader range of businesses to be excluded, and tenants do not have to worry about a missed party in their descriptive list. Tenants and potential tenants, however, run the risk of the categories being too broad, creating ambiguity, and increasing the risk of litigation. Alternatively, the landlord runs the risk of excluding a much wider swath of potential future tenants.

When drafting exclusive use provi sions, landlords must also confirm that their pre-existing leases are protected from the new use restriction so as not to automatically trigger a breach of the new lease. This exclusion should also address the renewal of any of these pre-existing leases, the relocation of a tenant to a different building within the premises, and the replacement of a tenant in the case of a default.

How to Draft an Exclusive Use Clause?

Generally, there are three ways to draft exclusive use provisions.

Finally, parties may choose to draft an exclusive use provision by the “belt and suspenders” method. This strategy uses a combination of the specific list and prohibited categories methods to allow for both precision and broader protection. Because courts generally favor the unfettered and unrestricted use of real property, a provision that unreasonably or too thoroughly limits potential tenants or types of businesses may be invalidated by a court. To minimize this risk, parties should consider including a percent revenue requirement in the definition of prohibited categories when defining potential prohibited competitors or activities. Returning to the coffee shop example, if the tenant wishes to prohibit other coffee shops from leasing space in the shopping center (but not all restaurants that serve coffee), the exclusive may include a restriction that the landlord may not lease to any business that derives more than 15 percent of its revenue from the sale of coffee.

What Are Common Remedies in Exclusive Use Provisions?

Rent Abatement

One of the most common remedies for a violation of exclusive use provisions is the abatement of rent. Abatement occurs during the period that the restriction was breached. Rent may be diminished completely or by a set percentage. Additional rent such as common area maintenance (CAM) charges and real property taxes usually are not abated. Landlords often seek to include notice and cure provisions in the agreements to allow time to remedy the violation and avoid the rent abatement. Tenants should push back against this because a violation of an exclusive use clause produces immediate harm to the tenant’s business.

Termination

Also common in these provisions is the tenant’s ability to terminate the lease. This right is usually triggered if the violation continues for an extended period of time.

Liquidated Damages

The parties may set liquidated damages in the case of a breach by the landlord of an exclusive use restriction. This gives the landlord a predictable amount of liability yet ensures the tenant does not have to expend substantial resources in the difficult endeavor to prove lost profits.

Rogue Tenant Exceptions

The existence of exclusive use provisions may require the landlord to constantly monitor business activities of its tenants, both to ensure that the provision has not been violated and to ensure that the exclusive use tenant has not waived a potential claim to enforce the provision. To avoid this constant policing of all tenants’ activities, the landlord could include carveouts in the new lease for activities by “rogue tenants” (tenants who, without prior consent or without the landlord’s knowledge, start selling prohibited products or using their premises for prohibited uses). Specifically, the

landlord can require that the tenant not pursue any remedies for exclusive use violations by rogue tenants as long as the landlord uses commercially reason able efforts to cause the rogue tenant to cease violating the restrictions. If an exception for rogue tenants is included, the landlord need only attach to all future leases an exhibit listing all exclu sive uses in the shopping center and include language in the lease restricting any tenant from violating such exclu sive uses.

What Happens after the Exclusive Use Is Agreed Upon and the Lease Is Signed?

Once the tenant and landlord reach an agreement on the exclusive use lan guage and the lease is executed, the tenant should ensure that the exclusive use language is included in its recorded memorandum of lease. Recording the restriction provides future tenants with constructive notice of the restrictions.

How Are Exclusive Use Provisions Waived?

Waiver often occurs when the tenant is not using the property as originally intended by its lease. At that point, the need for the exclusive use ceases. Inac tion over a sufficient period of time may trigger this waiver. As good prac tice, landlords also should seek waivers whenever existing tenants change their business model where the new business concept conflicts with an exclusive use provision.

How Do Courts Interpret Exclusive Use Clauses?

If the meaning of an exclusive use pro vision is not adequately defined and litigation ensues, courts analyze these provisions narrowly, favoring unrestricted use of the real property. Courts may not expand the scope of an exclusive use provision “beyond that clearly indicated by its language and shown to have been intended by the parties.” Bookman v. Cavalier Court, 198 Va.183 (1956) (citing 51 C.J.S. Landlord and Tenant § 238, p. 865). As a result, a provision may be pared down for being too broad with its categories of prohibited

uses and products. On the other hand, a

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A well-drafted provision will define exactly where the radius’s centerpoint is located, thus helping avoid ambiguity and potential litigation for stores opened on the fringes of the radius.

agreement should reflect a legitimate business interest that the landlord seeks to protect. The restriction should not be overly broad in either geographic scope or duration. The determination of what constitutes an overly broad geographical restriction has varied widely among courts. However, parties should aim to draft radius restrictions such that they do not extend farther than a few miles in nonurban areas or more than one mile in cities. Establishing boundaries that extend beyond these distances increases the likelihood that the restriction will be declared unenforceable by a court.

a specified radius of the leased premises during the term of the lease. Landlords often seek radius restrictions in lease agreements when rent is based on a per centage of the tenant’s gross sales from the premises.

What Are the Benefits of Radius Restrictions?

Radius restrictions provide the landlord with a sense of financial security. When leases are calculated based on a percentage of gross sales from a specific location, a radius restriction helps ensure that the tenant will not open another loca tion near the leased premises that may diminish the tenant’s sales. Additionally, landlords can employ radius restrictions to ensure vibrancy in their shopping centers. Having the only branch of a store within a certain geographic area in your shopping center means more customers entering your center, increasing sales for that tenant and other tenants in the center. Radius restrictions also may help prevent potential tenant defaults because of reduced sales and customer diversion.

of a larger business plan. Most national retail tenants meticulously scout and choose potential locations based on a variety of factors. They examine the sales performance of their existing loca tions (compared to the terms of their lease), identify “underperforming” loca tions, aim to improve net sales, and propose new locations based on the amount of working capital they have in a given year. The potential restriction of a retail tenant’s ability to freely execute its business plan may deter that tenant from leasing space in a landlord’s center.

What Are the Main Factors in a Well-Drafted Radius Restriction Provision?

Another important question when assessing geographic boundaries is where the radius begins. Landlords may prefer that the radius begin from the outer boundaries of the shopping center itself, but tenants will prefer that the calculation begin from the outer walls of their individual premises. A well-drafted provision will define exactly where the radius’s centerpoint is located, thus helping avoid ambiguity and potential litigation for stores opened on the fringes of the radius.

The Parties Affected by the Radius Restriction

Lawyers drafting a radius restriction provision in a lease agreement should consider the below factors:

The Geographic Boundaries of the Radius Restriction

What Are Some Downsides of Radius Restrictions?

Many tenants view radius restrictions as an obstacle to the development of their business. If the tenant is a major retailer or chain, it will not value its particular lease individually, but as a part

Establishing the centerpoint and extent of a radius restriction is the essential first step in drafting these provisions. Parties must establish a geographic limitation that properly protects against a tenant opening a new location in such close proximity to the existing location that it cannibalizes sales from the premises yet not unreasonably hinder the tenant’s plans for future expansion. The boundaries established in the

A well-drafted radius restriction should also adequately identify the parties subject to the restriction. Many retail and chain-restaurant tenants are not merely single-purpose entities but are part of much larger affiliated groups. They do not exist to open and operate just one location. As a result, lawyers should be careful to include all relevant affiliated parties in the restriction. This includes the tenant, its affiliates, and its owners. Failure to include such affiliates may prompt the parent company to form a new single-purpose entity to open and operate the chain within the boundaries of the radius, free from the restrictions. By contrast, tenants should seek to limit the restriction only to those affiliated entities that conduct substantially similar operations.

Remedies Available to the Landlord

A common remedy for breaches of radius restrictions is the landlord’s

inclusion of gross sales from the violating location in the calculation of gross sales for the original premises. This remedy typically is used in leases with percentage rent clauses. Implementing this remedy eliminates the burden to the landlord of proving actual damages in litigation and deters tenants from violating the terms of the radius restriction. Alternatively, the landlord may provide for liquidated damages for each day the violating location remains open for business. In the absence of adequate monetary remedies or stipulated damages, a landlord may petition to enjoin the operations that violate the radius restriction.

The tenant also may request advance notice of any violation of a radius restriction and reasonable time to cure before the landlord may exercise any remedies. Note, however, that notice and cure periods for a breach of a radius restrictions may not always be helpful to the tenant. To cure this breach, the tenant would have to shut down operations at the violating location, which could be costly.

What Are Some General Exceptions to Radius Restrictions?

Generally, radius restrictions provide carveouts in two scenarios.

First, a carveout usually is included by a tenant or its parent or affiliate. If, during the lease negotiations, the tenant is considering purchasing a chain, the provision likely will include an exception for the operation of that new chain in the restricted area.

Additionally, radius restrictions often provide exceptions for existing stores. Tenants should ensure that the radius restriction language does not suggest that a renewal of an existing lease for a store operating within the restricted area would violate the radius restriction.

When Should Radius Restrictions Be Waived?

Radius restrictions may be waived for many reasons. These restrictions often are waived when a tenant has a new, noncompeting concept that would not infringe on its sales at the premises and would pose no actual

threat of economic harm to the landlord. Additionally, radius restrictions may be waived when a landlord owns an adjoining development within the radius and wants to expand the potential number of new tenants. By waiving the radius restriction, the landlord may attract a wider array of businesses, including those affiliated with the restricted tenant.

Final Considerations

Thoughtful and well-negotiated exclusive use clauses and radius restrictions protect both the landlord’s and tenant’s financial interests and increase the appeal of a shopping center, without placing onerous burdens on either the landlord’s future leasing flexibility or a retail tenant’s future development plans. It is essential for both parties to consider the long-term effects of these clauses and carefully craft the language both to survive judicial scrutiny and to avoid unanticipated effects on either party’s business. n

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KEEPING CURRENT PROPERTY

CASES

CONDOMINIUMS: Termination agreement must provide for sale of all units. The condominium, consisting of 96 units, was established in 2007. Only six units were sold to individual purchasers. In 2018, the plaintiffs bought one of those units, and a year later, the condominium association held a meeting to discuss termination. The declaration set forth procedures for terminating the condominium, which were consistent with the termination provisions of the Arizona condominium act and required approval by at least 90 percent of the unit owners. At the time, a purchaser from the developer, PFP Dorsey, owned 90 units and cast its votes in favor of termination. The termination agreement provided for the sale of all units and other interests in the condominium not already owned by PFP Dorsey to PFP Dorsey. The agreement called for the payment of fair market value for the units and contained a mechanism for obtaining an independent appraisal. After the condominium association recorded a warranty deed transferring title to plaintiffs’ unit, PFP Dorsey took possession, changed the locks, and disposed of the plaintiffs’ personal property. Thereafter, the plaintiffs filed a claim against the condominium association and PFP Dorsey, seeking ejectment, the imposition of a constructive trust, and quiet title. They argued that the sale violated the condominium act procedures for terminating the condominium and alternatively that the termination procedures were unconstitutional because they authorized the taking of private

Keeping Current—Property Editor: Prof. Shelby D. Green, Elisabeth Haub School of Law at Pace University, White Plains, NY 10603, sgreen@law.pace.edu. Contributor: Prof. Darryl C. Wilson.

Keeping Current—Property offers a look at selected recent cases, literature, and legislation. The editors of Probate & Property welcome suggestions and contributions from readers.

property for private use. The trial court granted defendants’ motion to dismiss, and the appellate court reversed in part, finding that an earlier version of the Arizona condominium act applied, which contained different appraisal rights. The supreme court reversed. It first ruled that the termination procedures were not unconstitutional because the plaintiffs as purchasers had agreed to be bound by them. The termination, however, did not comply with the act. In plain terms, the act requires that “all the common elements and units … be sold.” Ariz. Code § 33-1228(C). “All” means the whole amount, and not just those not held by the developer or its successor. Cao v. PFP Dorsey Invs., LLC, 545 P.3d 459 (Ariz. 2024).

used by public absent express or implied acceptance of a dedication. Property owners of Lakefront Subdivision sought to require Sumter County to repair roads in their subdivision. In 2010, the county signed an easement agreement with the subdivision for the sole purpose of road maintenance. The county maintained the roads from 2010 through 2019, but there was no evidence that it ever expressly accepted the roads; at two county board meetings the board discussed the roads without accepting them. The property owners filed for a writ of mandamus to require the county to repair the roads and to declare that the roads were public roads. The trial court held the county did not own the roads and was not required to repair or maintain them. The appellate court vacated and remanded for the trial court to consider whether there was evidence of recognition of the roads as a public road or implied acceptance of dedication. The supreme court reversed and remanded. The court reaffirmed the long-standing precedent that public recognition of a road alone does not obligate a county to repair and maintain a road used by the public. Instead, there must be some acceptance, either express or implied. The appellate court erred to the extent it suggested that mere public use is sufficient. The supreme court, however, remanded the case to determine whether there was an implied acceptance. Sumter County v. Morris, 896 S.E.2d 571 (Ga. 2023).

DEDICATION: Government does not have to repair or maintain road

DEEDS: Building code violation does not breach covenant against encumbrances. In 2017, Poon sold a condominium unit to Galvan, conveying by a warranty deed that included a statutory covenant against

The condominium unit owned by plaintiffs in Cao v. PFP Dorsey Investments. Photo courtesy of Attorney Eric M. Fraser, Osborn Maledon, Phoenix, Arizona.

encumbrances. Previously, reconstruction work converted the building into three condominium townhouse units, separated by interior walls that failed to include fire barriers, as required by the city building code. Galvan learned of the building code violation when he began to renovate his unit. In 2018, the city sued Galvan and his two neighbors to enforce the code. Galvan paid significant sums for the violation and for professional remediation of the issue, and he also incurred expenses for living elsewhere while construction took place on his unit. Galvan filed suit, asserting various claims including breach of the deed covenants. The trial court granted a directed verdict for Poon, but the appellate court reversed, finding a breach of the covenant against encumbrances because the violation subjected Galvan to the threat of litigation and made the home unmarketable and uninhabitable. The supreme court reversed. The court discussed the history of the covenant since the nineteenth century, concluding that an encumbrance relates to rights or interests in the land rather than the condition of the property. Governmental regulations, standing alone, do not constitute an encumbrance because they are primarily concerned with use of the land. A contrary interpretation would make sellers warrant matters of which ordinary citizens generally lack knowledge. Other jurisdictions are split on whether violations of government regulations are encumbrances. Absent governmental enforcement actions, almost none holds that violations of building codes, as opposed to other types of regulations like zoning laws, are encumbrances. This is because building or housing code violations usually involve obscure or technical details that are not apparent to individuals engaged in normal title searches or property inspections. Galvan v. Poon, 999 N.W.2d 351 (Mich. 2023).

EASEMENTS: Easements implied from prior use can be exclusive. In the 1940s, the Cutlers purchased two adjacent parcels of land and built a home on one (the 643 Property) and

later installed a driveway, a brick garden planter, and a chain-link fence that encroached by eight feet onto their neighboring parcel (the 651 Property) for a total area of 1300 square feet, about 13 percent of the parcel. In 1986, the Cutlers conveyed the 651 Property to their son Bevon, who built a house on it to sell for profit. Before the conveyance, the Cutlers applied to the city to adjust the boundary between the two lots to the line marked by the chain-link fence, but the process was never completed, and the legal boundary line remained unchanged. In 2014, Romero bought the 651 Property and Shih bought the 643 Property. Years later, a survey revealed the encroachment and Romero sued Shih to have the encroachments removed or for damages. The trial court found that Shih had an implied easement. When the Cutlers sold the 651 Property in 1986, the parties intended that the encroachments would continue because they were reasonably necessary for the enjoyment of the 651 Property; otherwise, the driveway would be too narrow. The intermediate appellate court reversed in part, stating that California law did not recognize an exclusive implied easement. The supreme court in turn reversed. Giving a tutorial on the mechanics and policy underlying implied easements, the court stated that under California law, easements can arise both in favor of the grantor and grantee by implication based on the intention of the parties as manifested by the facts and circumstances of the transaction. Although California has codified the doctrine of implied easements, Cal. Civ. Code § 1104, the cases make clear that the law of implied easements is broader than the statutory language would suggest. Nonetheless, implied easements are not favored because they deprive the servient owner of the exclusive use of the property, and courts do not lightly infer that the parties intended to create one. The supreme court framed the issue as whether an implied easement can be exclusive because Shih’s claimed easement effectively excluded Romero from making any use of the area. Any

reasonable person observing the two properties in 1986, when the Cutlers divided them, would have assumed that the owner of the 643 Property retained some continuing interest in the disputed strip of land. The court rejected Romero’s argument that the recognition of exclusive implied easements undermines a buyer’s ability to rely on the legal descriptions in recorded instruments, the concern being outweighed by the interest in protecting reasonable expectations of parties to transactions by giving effect to what they “must have intended,” given the “obvious and apparently permanent nature of the pre-existing use.” Romero v. Shih, 541 P.3d 1112 (Cal. 2024). The court went on to discuss the trial court’s findings on what the Cutlers’ successors might have noticed at the time of their purchases. Ordinarily, implied easements from prior use are based on uses existing at the time of severance, and once established, their burdens and benefits run to successors. In many states, Shih would have prevailed on a claim of title by adverse possession, rather than the exclusive easement theory.

FAIR HOUSING: Evidence that city’s property tax assessment scheme disproportionately raises taxes in communities of color may violate fair housing laws. Tax Equity Now N.Y. LLC, a tax equity advocacy group, sued the City and State of New York challenging the city’s property tax system. It alleged staggering inequities in tax bills in violation of the New York Real Property Tax Law (RPTL) § 305(2) and the Fair Housing Act (FHA), 42 U.S.C. § 3601. The lower court dismissed the complaint for failure to state a claim, but the court of appeals reversed the dismissal against the City. RPTL § 305(2) requires the assessment of all property in each assessing unit at a uniform percentage of value. The court found that the plaintiff introduced sufficient facts to avoid dismissal. It claimed that properties within the same borough were assessed at vastly different rates— one community being assessed at over triple the rate of that in a comparable fasterappreciating community. The plaintiff’s

complaint included a graphic depiction of great disparities of assessed value to market value for the property class consisting of 1-to-4-unit homes. In addition, the plaintiff complained that the tax assessments for coops, 98 percent of which were built before 1974, were too low because the city compared them to rental properties subject to rent stabilization. On the FHA claim, the plaintiff alleged that the tax policy favored owner-occupied housing over rental housing and the disparities fell disproportionately on minorities, who are disproportionately renters bearing the burden of taxes passed through by landlords. This cohort, the plaintiff claimed, was over-assessed by $1.9 billion and over-taxed by $376 million annually. The court concluded that vastly higher rates (as much as 275 percent) resulting from government policy could operate to make housing “otherwise unavailable” within the prohibition of the FHA by increasing the cost of purchase, exacerbating housing shortages, and perpetuating segregation. The plaintiff relied on an array of public documents, studies, and statements by government officials as to the disparities in tax rates and assessments. Whether or not the allegations would stand up at trial, the court did not opine, ruling only that they were sufficient to withstand a motion to dismiss. Tax Equity Now N.Y. LLC v. City of New York, 2024 N.Y. LEXIS 298, 2024 WL 1160498 (March 19, 2024).

LANDLORD-TENANT: Violation of fair housing act is affirmative defense in forcible entry and detainer action. The parties entered into an oral lease under which the tenant agreed to do pet care and light housekeeping in lieu of paying rent. Soon after she took possession, she claimed that the landlord repeatedly demanded that she engage in sex with him. Her refusals were met a notice to quit from the landlord. When she refused to vacate, the landlord commenced a forcible entry and detainer (FED) action. At trial, the tenant asserted a violation of the state fair housing law as an affirmative defense to eviction. The district court ordered

eviction, stating that a landlord may file a notice to quit for no reason or any reason and concluding that a claim of a discriminatory or retaliatory eviction under the fair housing law is not a defense to an FED action. The court stated that a tenant had recourse by pursuing a civil remedy against the landlord in a separately filed action. The supreme court reversed. Under the Colorado Fair Housing Act, the first state-wide legislation in the nation to prohibit discrimination in housing, enacted in 1959, it is unlawful to discriminate in the renting of housing because of impermissible factors. Colo. Stat. § 24-34-502(1)(a)(I) (later amended to cover sex). The court stated that that the landlord did not dispute the tenant’s allegation that the landlord sought to evict the tenant in retaliation for her refusal to have sex with him. This, the court held, amounts to discrimination on the basis of sex in violation of the act. Even so, it remained to be decided whether a landlord’s statutory violation can be asserted defensively in an FED action, or whether a tenant is limited to pursuing affirmative relief (meaning damages), as the district court concluded. The court adopted the former position. Although Colorado has long recognized that a landlord has a right to decline to renew a lease for any reason, that right is not absolute. Instead, the state act and its federal analogue protect renters not only from eviction, but also from discriminatory actions that would lead to eviction. If a statutory violation is not a cognizable defense in a FED action, the act would wholly fail to fulfill its purpose of preventing discriminatory or retaliatory evictions. Requiring a tenant first to suffer a wrongful eviction and then pursue a separate action to vindicate her statutory right undermines the effectiveness of the statutory scheme, even if recognizing affirmative defenses causes some delay in FED actions. Miller v. Amos, 543 P.3d 393 (Colo. 2024).

LANDLORD-TENANT: Punitive damages are constitutionally excessive when award equals thirtythree times tenant’s compensatory

damages. The plaintiff suffered a serious knee injury at his apartment complex when his leg punched through a section of elevated walkway that had been weakened by dry rot. The owners and managers of the apartment complex knew that the walkway and other structures at the complex had deteriorated to the point that they required “life safety” repairs but chose not to repair the walkway. The plaintiff sued the defendants for negligence and violation of the state’s residential landlord-tenant statute, which requires safe and habitable dwellings. The jury awarded $296,000 in damages for medical expenses and pain and emotional distress. The jury also awarded punitive damages of $10 million against each defendant. On a post-verdict review of the punitive-damages verdict, the trial court concluded that the evidence permitted the jury to find the defendants liable for some amount of punitive damages, but that imposing $10 million in punitive damages would violate the defendants’ due process rights. Instead, the trial court determined that the maximum amount to be nine times the amount of compensatory damages and, accordingly reduced the award to $2.7 million. On appeal, both the intermediate appellate court and the supreme court affirmed. By statute, punitive damages are unavailable unless it is proven by clear and convincing evidence that the defendant has acted with malice or has shown a reckless and outrageous indifference to a highly unreasonable risk of harm and has acted with a conscious indifference to the health, safety, and welfare of others. Ore. Rev. Stat. §31.730(1).

The court explained that federal law alone governs the question whether an award of punitive damage is constitutionally excessive because there is “no state law excessiveness challenge under the Oregon Constitution.” Although the US Supreme Court has not set any constitutional “rigid benchmark” to limit punitive damages, it has articulated three guideposts: “the degree of reprehensibility of the defendant’s misconduct; the disparity or ratio between the actual or potential harm suffered

by the plaintiff and the punitive damages award; and the difference between the punitive damages awarded by the jury and the civil penalties authorized or imposed in comparable cases.” Here, two of the guideposts—reprehensibility and comparable civil sanctions—support a significant punitive damages award. But the amount exceeded the approximately $300,000 in actual compensatory damages by a ratio of 33 to 1. There was no evidentiary basis for increasing the second term of the ratio by inferring significantly greater “potential harm” to the plaintiff. The disparity was dramatically greater than the “single-digit ratio” that the Supreme Court has suggested is—except in extraordinary circumstances—the limit of what due process will permit, no matter what the tort. Trebelhorn v. Prime Wimbledon SPE, LLC, 544 P.3d 342 (Ore. 2024).

LEGAL DESCRIPTIONS: Government survey that describes lot as riparian determines its boundary with neighboring lot. The plaintiff, owner of Government Lot 1, sued her neighbors, owners of Government Lot 7, to determine the boundary between their lots. A US government survey recorded in 1867 created the lots. The survey showed Lot 1 and Lot 7 as containing 53 acres and 33 acres, respectively, separated by the Loup River. Over the past 150 years, the river gradually moved to the east and uncovered new land on the defendants’ west side of the river. The plaintiff claimed ownership of land on both the east and west sides of the river and asked the court to confirm her proposed boundaries in metes and bounds. The defendants filed a counterclaim seeking a declaration that the eastern boundary of Lot 1 be established as the thread (that is, the center) of the river. Both parties sought summary judgment and agreed that judicial determination of Lot 1 would resolve all claims and counterclaims. The trial court granted summary judgment for defendants, finding that Lot 1 was riparian property, whose boundaries are fixed by the river. The supreme court affirmed. The court first noted that for land to be riparian, it must have a stream flowing over it

or along its border. If Lot 1 was riparian when first surveyed, the boundary between the two lots is the thread of the river. What controls are the government corners fixed by the government survey and when appropriate the field notes, including plats, at the time of the original survey. When lands are granted according to an official plat of the survey of such lands, the plat itself, with all its notes, lines, descriptions, and landmarks, becomes as much a part of the grant or deed by which the lands are conveyed. Here, the survey and field notes showed Lot 1 to be riparian. The plat did not depict anything other than a riparian tract. Nothing in the field notes otherwise supported the plaintiff’s argument for a metes and bounds description. Puncochar v. Rudolf, 999 N.W.2d 127 (Neb. 2024).

MORTGAGES: Bankruptcy discharge does not accelerate promissory note to start running of statute of limitations. A homeowner defaulted on his Nevada mortgage loan and subsequently obtained a discharge in bankruptcy of his mortgage debt. Later in 2014, a default in payment of dues to the homeowners’ association resulted in a nonjudicial foreclosure sale of the property to SFR Investments Pool. Bank of New York Mellon, the holder of the promissory note for the home mortgage loan, brought a judicial foreclosure action against SFR, arguing that its deed of trust survived the foreclosure sale. At trial, SFR argued that the bankruptcy discharge automatically accelerated the due date of the promissory note, therefore barring the bank’s action under Nevada’s six-year limitations period. Nev. Rev. Stat. § 104.3118(1). The district court ruled that the bank’s judicial-foreclosure claim against SFR was not time-barred. The Ninth Circuit affirmed. Under the Nevada statute of limitations, an action to enforce the obligation to pay a note accrues within six years after the due date or, if a due date is accelerated, within six years after the accelerated due date. The borrower’s bankruptcy discharge did not make the loan due for several reasons. First, the statute listed only two

documents that determine when a loan becomes “wholly due” for purposes of triggering the limitations period— the mortgage or deed of trust and any recorded written extensions. SFR failed to identify any provision in the promissory note, deed of trust, or other written instrument that indicated a bankruptcy discharge automatically accelerated the due date on the promissory note. Second, a debtor’s bankruptcy discharge excuses only a personal obligation on the loan secured by the deed of trust. Nothing in a discharge extinguishes a lender’s right to foreclose on the mortgage after bankruptcy. Third, acceleration is seldom implied, and courts usually require that a lender accelerate in a manner so clear and unequivocal that it leaves no doubt as to its intention. Bank of N.Y. Mellon v. SFR Inv. Pool, 2024 U.S. App. LEXIS 3840, 2024 WL 687627 (9th Cir. Feb. 20, 2024).

PUBLIC ACCOMMODATIONS:

Exclusion of disabled child from hockey team and ice arena may violate state human rights act. In 2019, a minor child (M.U.) signed up to play hockey on a girls’ team run by Team Illinois Hockey Club. Team Illinois leased and operated the Seven Bridges Ice Arena. During the hockey season M.U. began treatment for various psychological issues, including suicidal thoughts, and her mother shared that information with M.U.’s team coach. Shortly thereafter, the coach banned M.U. from all Team Illinois activities until she fully recovered and sent emails to other team members’ families, instructing them to have no contact with her. Through her parents, M.U. filed suit against Seven Bridges and Team Illinois, alleging discrimination on the basis of disability in violation of the Illinois Human Rights Act, 775 Ill. Consol. Stat. § 5/5-102(A). The trial court granted the defendants’ motion to dismiss on the ground that Team Illinois was not a physical place and thus not a place of public accommodation. The appellate court reversed, finding persuasive a US Supreme Court decision interpreting the analogous provisions of the Americans with Disabilities Act, to hold that professional

golf association tours and qualifying rounds are public accommodations because the events occurred at public golf courses, which are covered by the federal act. PGA Tour, Inc. v. Martin, 532 U.S. 661 (2001). The state supreme court affirmed and remanded. The court found the plain language of the state statute clear and unambiguous. First, a person under the act includes a corporation and an organization, both of which apply to Team Illinois. Second, the ice rink fits within the definition of a public place of accommodation as a place of exercise or recreation. M.U. v. Team Illinois Hockey Club, Inc., 2024 Ill. LEXIS 146 (Ill. Mar. 8, 2024).

LITERATURE

DEEDS: In Title Theft, 81 Wash. & Lee L. Rev. Online 161, Prof. Stewart Sterk analyzes one of the scams affecting a small but growing number of property owners across the country—title theft. Although his article does not explore the origins of title theft or discuss its widespread coverage in popular media coverage, one may infer that much of the current malaise results from the confluence of our aging population and the rapid growth of technology, often leading to negative outcomes. Title theft generally involves several individuals acting in concert who prepare fake documents purporting to sell property to unwary buyers or offering refinancing to actual property owners in financial distress. In other instances, they use the stolen title to secure equity loans unbeknownst to the property owners, often leaving them with insurmountable losses. Prof. Sterk provides an updated review of the common-law rules that guard owners’ titles and comments on modern expansive options currently available or being proposed to protect owners. Prof. Sterk notes the well-established foundational rule that a forged deed is void. Thus, in instances of title theft the law has routinely protected those victimized by forgery. Similarly, the law of fraud has protected consumers, albeit somewhat to a lesser extent. In some instances,

fraud “in factum” is treated the same as forgery, although fraud “in inducement” is not. Forgery and fraud are also viable statutory options for criminal actions throughout the country. For the victimized, however, civil and criminal relief, although available in principle, are realistic only for victims with access to sophisticated knowledge bases and substantial financial resources. Title Theft examines many options proposed nationally and in Prof. Sterk’s home state of New York, concluding that none is satisfactory in addressing the financial burdens faced by the victims of the transgressors. Those options include county programs that notify individuals whenever a document is recorded involving their property, expanding potential criminal options, reforming notary procedures, and delaying court procedures involving title disputes. Prof. Sterk focuses on insurance as the best potential resource to possibly deter theft activity or at least compensate victims of title theft. He notes the plethora of entities currently marketing title and identity theft protection in a variety of questionable forms, some of which have triggered state action in jurisdictions investigating whether those companies are involved in fraud as well. In comparing the standard title insurance policies that homeowners usually secure, he indicates that they are inadequate for title theft protection since they do not cover post-policy fraud or forgery. He proposes new legislation to require post-policy protection, although he does not specify exactly what it should look like. He does somewhat acknowledge the existence of cost v. benefit concerns associated with mandatory insurance for both the title insurance industry as well as consumers who must pay higher premiums for greater protection. Prof. Sterk believes such legislation would build upon the knowledge and resources of title insurance companies who already monitor property records and that forcible expansion of their coverage would incentivize them to use their expertise to provide greater help to consumers facing title theft.

LAND USE: Who owns the sidewalks? Is it owners of abutting property? The vendors selling food and wares? The restaurants for their outdoor dining? The neighborhood for its block parties? In Sidewalk Government, 122 Mich. L. Rev. 613 (2023), Prof. Michael C. Pollack suggests that the answer is neither required by established legal principles nor intuitive. In probing the issue, he begins by recounting the myriad users (residents, businesses, the government) and uses (dining, festivals, Christmas tree sales) that occur on space nominally said to be public, the sidewalk. He goes on to show that inevitably there are conflicts among users and uses—pedestrians want easy passage without having to dodge scaffolding and sandwich boards, and neighbors want quiet and fresh air. Then there is the question of who is responsible for maintaining sidewalks. He believes that the usual methods for mediating conflicts—property law, public regulations, social norms, or a mix of these—are inadequate, revealing a fragmented web with both siloed and interdependent authority and out of sync. Prof. Pollack proposes a new paradigm, called Sidewalk Law, governed by a Department of Sidewalks, which would coordinate all facets of sidewalk life, including the private obligations of maintenance and snow removal, responsibility for trees, over food carts, and delivery robots. An appointed commissioner would be accountable for the state of the sidewalks. Although the notion of a single regulatory body for managing common space is a good idea, there remain the many thorny issues of assigning priority over uses—al fresco dining versus pedestrian passage?

TAKINGS: The Supreme Court decision in Cedar Point Nursery v. Hassid, 141 S. Ct. 2063 (2021), seems to have struck fear in the hearts of so many about so much—from rent regulation to historic preservation. In Cedar Point Nursery v. Hassid and Customary Use: Protecting the Public’s Right to Recreate on Dry Sand Beaches, 35 Colo. Nat. Res. Energy & Envtl. L. Rev. 1 (2024),

Anna A. Schmelzle speaks about beach access. She sees the holding in Cedar Point —that a government-authorized physical invasion of property need not be permanent to qualify as a per se taking — as a departure from half a century of the Court’s takings jurisprudence. In challenges to customary use statutes, property owners attempt to restrict public access to dry sand beaches and claim that the statutes constitute a per se taking by allowing the public to access private beach property. Nonetheless, she believes that states’ customary use statutes, founded upon ancient principles, can withstand a takings challenge under the expanded takings law of Cedar Point. The doctrine of customary use, dating back to the time of Blackstone, protects the public’s ancient, reasonable, and continuous use of dry sand for dancing, playing games, and using dry fishing nets on certain land. In modern times, courts and legislatures have recognized the public’s customary use of dry sand beaches in state statutes, constitutions, and common law to cover sunbathing and picnicking. Customary use statutes fall within the Court’s exception to a taking as a background principle. This is so because the public’s interest in dry sand property predated the government’s property interest, which means that the government’s initial transfer of dry sand property to private owners never included the right to limit public beach access. Thus, the right to exclude the public from dry sand beaches never inhered in the title held by current owners. Another reason she offers for protecting beach access pertains to the Court’s recognition of the government’s inherent power to legislate and abate public nuisances—here, conduct by property owners that interferes with public beach access rights. State statutes may prohibit actions that unreasonably interfere with a right common to the general public without effecting a taking. Beaches provide a variety of societal benefits, including improving overall health and well-being, supporting tourism, and increasing local property values. Customary use statutes

abate what can be seen as public nuisances in property owners’ interference with the public’s right to use, enjoy, and recreate on the dry sand. Although the assertion of Cedar Point in this context might seem doubtful to many, the author makes a convincing case for protecting public beach rights from takings challenges.

LEGISLATION

COLORADO provides immunity to landowners from liability for injuries to persons crossing land with notice of danger. An owner posting a sign with prescribed warnings is not liable to a person who enters the land at a primary access point and is injured or killed on the land by a known dangerous condition, use, structure, or activity. 2024 Colo. Ch. 27.

FLORIDA adopts law to enable quick removal of unlawful occupants from residential real property. The law is aimed at recent concerns about squatters. A property owner may request, on a prescribed form, that the sheriff remove a person unlawfully occupying a residential dwelling so long as (1) the person unlawfully entered and remained on the property, (2) the property was not open to the public, (3) the property owner directed the unauthorized person to leave the property, (4) the person is not a current or former tenant, (5) the person is not an immediate family member of the property owner, and (6) there is no pending litigation related to the property between the property owner and any known unauthorized person. The unlawful occupant is subject to criminal penalties. 2024 Fla. Laws ch. 44.

INDIANA prohibits land ownership by citizens of foreign adversaries. The law applies to agricultural land and prohibits all forms of acquisition of title and lesser interests in the land by citizens of China, Iran, North Korea, Russia, or a country designated as a threat to critical infrastructure by the governor. 2024 Ind. Acts 168.

INDIANA limits enforceability of long-term residential real estate service agreements. Agreements under which a service provider promises to provide services in connection with the maintenance, purchase, or sale of residential real estate and that are not to be performed in their entirety within one year after the agreement is entered are not recordable, do not create a lien on any property, and do not bind bona fide purchasers. The act applies to agreements made after March 14, 2024. 2024 Ind. Acts 62.

SOUTH DAKOTA requires sellers to disclose facts concerning homeowners’ associations. A seller must inform the buyer about the homeowners’ association, provide a copy of its governing documents, and a statement about required assessments. 2024 S.D. SB 217.

SOUTH DAKOTA prohibits homeowners’ associations from including or enforcing provisions on firearms. Governing documents may not prohibit or restrict the lawful possession, transportation, storage, or discharge of firearms or ammunition. 2024 S.D. SB 39.

SOUTH DAKOTA places restrictions on foreign ownership of agricultural land. The restrictions apply to persons and entities from the People’s Republic of China, the Republic of Cuba, the Islamic Republic of Iran, the Democratic People’s Republic of Korea, the Russian Federation, and the Bolivarian Republic of Venezuela. The act limits the amount of land that can be acquired. 2024 S.D. HB 1231.

UTAH adopts provisions for recorder of deeds to alert property owners of recordings against their property. Notices are sent electronically. 2024 Utah SB 165. n

Fiduciary Considerations in ESG Investing

By Laurel R.S. Blair

ESG (environmental, social, and governance) investing has evolved from what some regarded as a well-intentioned, virtue-signaling, and marketing tactic into a risk-laden minefield for fiduciaries. ESG investing is a trend that warrants consideration. In the trust context, however, the ESG investing option should be given rigorous analysis and vetting by fiduciaries and counsel to determine whether it is appropriate in each specific situation. This article examines the challenges and fiduciary considerations associated with ESG investing in the trust administration context.

ESG investing is somewhat similar to the concepts of impact investing, socially responsible investing (SRI), and sustainable investing. There is no universal consensus on precisely what “ESG investing” means. The concept can encompass a range of issues. It is subjective (meaning different things to different people), it is sometimes politicized, and it is an evolving trend. It tends to be interpreted as investing for subjective “social good”—which may or may

Laurel R.S. Blair is a partner at Womble Bond Dickinson (US) LLP in Charleston, South Carolina. The views expressed herein are those of the author and not necessarily those of Womble Bond Dickinson (US) LLP.

not necessarily maximize quantifiable investment returns.

Challenges presented by the ESG investing trend include:

1. ESG is not just another investment whose performance is easily measured by objective, quantifiable investment returns. It may involve more subjective, less objectively quantifiable concepts of “doing good.” That said, certain ESG investments (such as Tesla) have generated favorable, quantifiable investment performance and profits.

2. Trust documents and law may be the same, but social trends have changed. Beneficiary (or grantor) demands for fiduciary ESG investing, where old trust language, purposes, or existing law don’t allow for it, may result in a breach of fiduciary duty situation or trustee resignation or removal.

3. Beneficiaries tend to be better informed, more activist investors. Beneficiaries are demanding that trustees alter existing investment portfolios to incorporate ESG investments and eliminate what they deem to be “unfavorable” investments (such as fossil fuels), even if those existing investments are generating acceptable returns

and have long provided financial support to family members.

4. The traditional objective, quantifiable measurement of investment performance (safer for fiduciaries) is easier for beneficiaries and courts to understand than a subjective “social good” standard.

5. Due diligence and vetting of ESG options is difficult for fiduciaries, given inconsistencies between, and inaccuracies associated with, ESG investment ratings firms and given “greenwashing” (third-party mischaracterization of investments as “green” or sustainable to attract principal). The subjectivity of ESG ratings is illustrated by the fact that different rating services have ranked Tesla at the top and bottom.

6. There is a lack of clear regulatory guidance indicating what ESG investing means and requires.

7. There may be intergenerational beneficiary disputes (because of differences in social mores) over whether ESG investing is appropriate.

The plain language of the specific trust instrument at issue (i.e., evidence of settlor or grantor intent and trust purposes) principally governs a fiduciary’s administration of that trust. Applicable state law, such as a trust code, supplements the trust instrument language (fiduciary duties and powers) in guiding the trustee during the course of trust administration. Reconciling a relatively new ESG investing concept with pre-existing trust document language and pre-existing state law, which do not take ESG into consideration, presents a challenge for fiduciaries in trust administration and for trusts and estates counsel.

Generally, within the context of trust administration, particularly private and charitable trusts, well-established fiduciary duties have not materially changed over time. Article 8 of the Uniform Trust Code, as adopted by most states, sets forth (1) the duty to administer the trust (§ 801) in accordance with its terms, (2) the duty of loyalty (§ 802) to administer the trust solely in the beneficiaries’ interests, (3) the duty of impartiality (§ 803),

and (4) the duty of prudent administration (§ 804), considering the purposes, terms, distributional requirements, and other circumstances of the trust; exercising reasonable care, skill, and caution. The Uniform Prudent Investor Act (UPIA), codified in most states, also governs fiduciary duty of care in asset management, with total return and prudent investor concepts. Although UPIA § 2(c)(8) allows a trustee to consider an asset’s special relationship to purposes of the trust or to beneficiaries, it was not designed for ESG investing and it deals with existing relationships rather than a beneficiary desire for a new ESG investment approach.

Some states (including Delaware, Georgia, New Hampshire, Illinois, and Oregon) recently changed their laws in an effort to allow for ESG investing and resolve inconsistency between their prudent investor statutes and ESG investing. See Del. Code Ann. tit. 12, § 3302(a) (2021); Ga. Code Ann. § 53-12340(D) (2021); N.H. Rev. Stat. Ann. § 564-B:9-902(c) (2021); 760 Ill. Comp. Stat. 3/902(c)(7)-(8) (2021); Or. Rev. Stat. § 130.755(3)(i)–(j) (2021). Their approaches differ; however, their legislative changes have generally included amendment of their prudent investor law to allow for trustee consideration of beneficiary preferences or values and desire for ESG and sustainable investing. The new laws apply to both existing trusts and new trusts. These changes in law may give rise to new potential issues, such as what weight should be given to beneficiary preference versus trust settlor or grantor trust provisions and purposes, or how inconsistent beliefs and values among multiple beneficiaries should be addressed.

ESG investing does not warrant any exemption or exception from established fiduciary principles and law. It does raise the issue of whether a trustee of a private trust, who is required by the duty of loyalty to act only in the sole interests of the beneficiary without regard to the interests of anyone else, including the fiduciary, should make an ESG investment serving the “social good.” Restated, is it possible for a trustee to consider ESG investments relating to unrelated social

issues that have benefits to others, in addition to their financial return for the trust beneficiary? There is thought leadership in support of the proposition that ESG investing is permissible for a trustee of a trust under American fiduciary law (consistent with the duty of loyalty and prudent investor rule) if (1) the trustee reasonably concludes the ESG investment will benefit the beneficiary directly by improving risk-adjusted return and (2) the trustee’s exclusive motive for adopting the ESG investment program is to obtain that direct benefit. See Max M. Schanzenbach & Robert H. Sitkoff, Reconciling Fiduciary Duty and Social Conscience: The Law and Economics of ESG Investing by a Trustee, 72 Stan. L. Rev. 381 (2020). Relevant in that analysis are the trustee’s compliance with the prudent investor rule (due diligence and process in exercise of discretion; the trustee’s application of an overall investment strategy with risk and return objectives reasonably suited to the trust, and conclusion that the ESG investment strategy would provide better returns and the same or less risk than other options, continued monitoring to address changes in circumstances, and adequate contemporaneous documentation).

Unlike a private trust for the benefit of designated ascertainable beneficiaries, a charitable trust is established for the benefit of a charitable purpose, and its trustee must act solely in furtherance of that charitable purpose. See Restatement of Charitable Nonprofit Organizations §§ 1.01(a)–(b), 1.02 cmt. b (Am. L. Inst., Tentative Draft No. 1 (2016)); 3 Restatement (Third) of Trusts § 78(1) (Am. L. Inst. 2007). Investing assets of a charitable endowment to obtain third-party benefits is permissible if those benefits fall within the charitable purpose. If a charity acquires an ESG asset with a dual

purpose (as an investment for return and as a vehicle to carry out its mission), then the charity is complying with its duty of loyalty even if the acquisition does not generate as much return as another. IRS Notice 2015-62 (applicable to private foundations) was issued in response to questions about mission-related investing. See I.R.S. Notice 2015-62, 2015-39 I.R.B. 411 (Sept. 28, 2015). It provides that an investment made to both further charity purposes and produce financial returns is not a breach of fiduciary duty, even if investment returns are lower than expected.

Determining whether ESG investing is a wise and appropriate option from a fiduciary standpoint in executing a fiduciary investment strategy may involve a consideration of several factors, including but not limited to the following:

1. Whether there is an existing trust (drafted before the existence of the ESG investing concept) or a newly drafted trust with specific language of settlor or donor intent, and purposes authorizing ESG investing. An existing trust may (or may not) have powers and purposes language giving the fiduciary sufficiently broad powers to allow for ESG investing consistent with trust purposes. Judicial document construction may be necessary if trust language is unclear or ambiguous, or if there is disagreement on interpretation. “Family legacy” positions addressed in settlor intent or trust language (legacy positions such as heirloom stock, interests in oil companies, fossil fuels) may also influence whether ESG investing is possible. If the trust’s purpose is to financially support generations of family, any ESG investment considered should generate sufficient financial returns to do so (in addition to having more subjective benefits). The trustee in the exercise of discretion should honor and implement grantor intent and trust purposes as they are stated in the trust instrument plain language. Fiduciary prudence is about thoughtful, documented process

2. Whether applicable state law allows ESG investing in the context of trust administration. The fiduciary duties of prudence, impartiality, and loyalty in assessing potential ESG investment (as with any other investment) must be observed.

3. Beneficiary interests and preferences. Under the UPIA § 6 (Impartiality) adopted by most states, if a trust has two or more beneficiaries, the trustee shall act impartially in investing and managing the trust assets, taking into account any differing interests of the beneficiaries. The best interests of a beneficiary may not be the same as what the beneficiary wants.

4. Trustee process and protocol (independent, contemporaneous, well-documented, careful due diligence, consistent monitoring, vetting, and exercise of fiduciary discretion in trust administration over time to implement settlor intent and trust purposes in compliance with fiduciary duty).

Trustee options and tools to address ESG issues may include the following:

1. Court orders and consent orders (e.g., trust modification or equitable deviation to allow ESG investing, if the existing trust language does not provide for it; declaratory judgment to determine legal rights of various parties (such as whether a beneficiary has rights to invade trustee powers to determine how trust assets are invested); guidance or instruction to trustee on specific issues; document construction) may assist in providing protection and certainty to trustees and beneficiaries.

2. Beneficiary consent, release, and ratification of trust ESG investment. Under well-established trust law, a beneficiary may consent to in advance or subsequently ratify or release trustee conduct that would otherwise constitute a breach of trust (neutralizing

trustee liability exposure). See 4 Restatement (Third) of Trusts § 97 (Am. L. Inst. 2012).

3. Division of trust for multiple beneficiaries into separate trusts for each beneficiary (allowing for investment strategy customized for each beneficiary). ESG investing would not necessarily be the sole reason for this option.

4. Nonjudicial settlement agreements (be careful; they provide less certainty than a court order).

5. Facilitated meeting between trustee and beneficiaries. Mediator obtains beneficiary input and reminds them of trust terms. This is useful to defuse intergenerational beneficiary disputes over ESG issues and remind beneficiaries of trust purposes and settlor intent, that the trustee is neutral, etc.

6. Family values statement. This is a tool to define beneficiary values and priorities re: ESG issues. This is more an expression of principle than an enforceable agreement and may require updates as beneficiary positions change over time. Family values statements do not alter the terms of a trust or the trustee’s duties or powers.

All that taken into consideration, issues such as ESG investing powers are best addressed in the estate planning stage, in consultation with the expected trustee, who will likely have preferred language to suggest. The strategic decision of whether to draft broadly with respect to grantor intent and fiduciary powers (which may encompass the ESG investing trend and those after it)—or to draft with a more specific approach—is nothing new.

There is recent indication that the general ESG investing trend may be losing popularity. In 2022, multiple state attorneys general warned BlackRock CEO Laurence Fink that ESG polices violate the sole interest rule, which requires fiduciaries to maximize financial returns rather than promote social or political objectives. Others warned state pension boards that ESG investing is likely a violation of fiduciary duty. In 2023,

certain large-asset management firms scaled back their support of ESG initiatives and 14 states passed anti-ESG legislation restricting investors from considering ESG factors when investing public funds. Economic headwinds in 2024 and geopolitical conflict also have made ESG less appealing in comparison to more traditional options. See Jon Solorzano, Sarah Morgan & Matt Dobbins, ESG Is Over—as We Know It, 39 Westlaw J. Corp. Officers & Dir. Liab., no. 14, Jan. 11, 2024. ESG-related enforcement has also increased. See Madison Guerinot, How Will an Increased Focus on ESG by the SEC and Investors Impact Transactions?, 61 Hous. Law., no. 6, May/June 2023, at 18. The Securities and Exchange Commission launched the Climate and ESG Task Force in 2021 with respect to ESG reporting. In 2022, the SEC charged BNY Mellon Investment Advisor, Inc., for misstatements and omissions about ESG considerations (including lack of ESG quality review scores at the time of investment) in making investment decisions for certain mutual funds it managed, resulting in a $1.5 million penalty. In September 2023, the SEC adopted changes to the “Name Rule,” including changes designed to discourage greenwashing and other deceptive or misleading marketing practices by US investment funds. See Douglas Gillison & Michelle Price, US Cracks Down on Funds “Greenwashing” with New Investment Requirement, Reuters, Sept. 20, 2023. The existing rule required investments with names suggesting a focus on a particular type of investment to have 80 percent of the assets invested in accordance with the suggestion of the name. The new rule extends that 80 percent requirement to funds with names suggesting a focus on investments with “particular characteristics” (an undefined term) and used ESG as an example of a term that would trigger the new requirement. Funds with names such as “ESG” or “sustainable” must consistently invest in appropriate assets or risk a “materially deceptive” or “misleading” finding. Perhaps such enforcement may result in a more accurate and reliable due diligence and vetting process for fiduciaries considering potential ESG investing. n

KEEPING CURRENT PROBATE

CASES

ADVANCE DIRECTIVES: Standard for revocation is clear and convincing proof. The Oklahoma Supreme Court in In Re Guardianship of L.A.C , No. 120500, 2024 WL 442442 (Okla. Feb. 6, 2024), held that under the express language of the statute governing revocation of advance health care directives, an incompetent or incapacitated person retains the right to revoke or modify his or her advance directive and that given the policy of the statute to allow persons to control their own health care, the standard of proof required is clear and convincing evidence. The Chief Justice dissented on the grounds that the policy issues require the standard to be only a preponderance of the evidence.

CONDITIONAL WILLS: Language referring to survival of surgery creates conditional will. In Estate of Rick, NO. 2023-CA-0391, 2024 WL 412253 (La. Ct. App. Feb. 5, 2024), the Louisiana intermediate appellate court held that a holographic will beginning “If I don’t make it through this open hea[r]t surgery . . . .” creates a conditional will (a “suspensive condition” in Louisiana terms) and is not entitled to probate because the testator survived the surgery and died 18 months later.

CONTRACTS: Continued cohabitation is sufficient consideration for enforcement of contracts to make gifts at death. The decedent and the decedent’s unmarried partner (the couple was engaged for more than 10 years before decedent’s death but never married) executed a series of agreements

Keeping Current—Probate Editor: Prof. Gerry W. Beyer, Texas Tech University School of Law, Lubbock, TX 79409; gwb@ ProfessorBeyer.com. Contributors: Julia Koert, Paula Moore, Prof. William P. LaPiana, and Jake W. Villanueva.

Keeping Current—Probate offers a look at selected recent cases, tax rulings and regulations, literature, and legislation. The editors of Probate & Property welcome suggestions and contributions from readers.

in which the decedent promised that the partner would receive designated property at the decedent’s death. The decedent died intestate, and the surviving partner brought an action to enforce the agreements. In Tremblay v. Bald, No. 2023-0022, 2024 WL 332101 (N.H. Jan. 30, 2024), the Supreme Court of New Hampshire held that continued cohabitation was sufficient consideration to create binding contracts.

ELECTIVE SHARE: Probate property poured over to existing trust is subject to spouse’s elective share rights. The decedent’s will poured over the probate estate to the decedent’s unfunded revocable trust. The will made no provision for the decedent’s surviving spouse, but the surviving spouse is entitled to more than the elective share entitlement as a beneficiary of the trust. The surviving spouse asserted the elective share right, which the probate court granted. On appeal by the estate, the Supreme Court of Wyoming affirmed in Matter of Estate of Tokowitz, 541 P.3d 446 (Wyo. 2024). The court held that the surviving spouse’s interest as a beneficiary of the trust has no relevance to the entitlement to the elective share and that the property passing to the trust is disposed of by will and thus subject to the elective share right.

NEGATIVE WILLS: Limited gift in will prevents taking by intestacy. The decedent devised $5 to the decedent’s daughter, stating it was the decedent’s

desire that “this is all she is to receive from me.” The will also made a specific devise of all tangible personal property to decedent’s spouse but lacked a residuary clause. In In re Estate of Bebout, No. 584 MDA 2023, 2024 WL 47939 (Pa. Supr. Ct. Jan. 4, 2024), the court held that under 20 Pa. Cons. Stat. § 2101(b), a decedent may make a negative will and that the language of the decedent’s will shows that the decedent intended the daughter to receive nothing more than the devise of $5, thereby preventing the daughter from sharing in the partially intestate estate.

TRUST AMENDMENT: Substantial compliance does not excuse failure to deliver amendment to trustee. Florida law allows an amendment or revocation of a revocable trust by substantial compliance with the method specified in the trust terms. In Grassfield v. Grassfield, 381 So. 3d 628 (Fla. Dist. Ct. App. 2023), the Florida intermediate appellate court held that where the trust terms require the delivery to the trustee of an amendment executed and acknowledged by the settlor, substantial compliance is not accomplished where the amendment is not delivered to the person who is co-trustee with the settlor. Unlike the Uniform Trust Code, the Florida statute does not allow amendment by any method showing the settlor’s intent where the specified method is not made “exclusive.”

TRUST CONTESTS: Time bar applies to actions not directly contesting trust amendments. California law bars actions by beneficiaries to contest trusts brought more than 120 days after the beneficiaries receive the statutory notice required on the happening of certain events such as a revocable trust’s becoming irrevocable. The California intermediate appellate court in Hamilton v. Green, 316 Cal. Rptr. 3d 632 (Cal. Ct. App. 2023), held that the

time-bar applies to actions for tortious interference, conversion, breach of fiduciary duty, and accounting where the plaintiffs would have no interest in the trust unless a trust amendment were invalidated and where they received proper notice.

TRUST

JURISDICTION: No personal jurisdiction over out-of-state trustee where administration is not in forum state. In Luongo v. Luongo, 306 A.3d 610 (Me. 2023), the Maine Supreme Judicial Court affirmed the dismissal of claims against a non-resident co-trustee for lack of personal jurisdiction. Maine’s statute governing personal jurisdiction over a trustee, 18-B Me. Rev. Stat. § 202(1), (2) (identical to U.T.C. § 202(a), (b)), provides that a trustee is subject to personal jurisdiction if the trustee accepts the trusteeship of a trust having its principal place of administration in the state or moves the principal place of administration to the state. The trust in question was governed by Massachusetts law and the principal place of administration has always been there. The long-time residence in Maine of the settlor and the other co-trustee is irrelevant.

TAX CASES, RULINGS, AND REGULATIONS

SHAM TRUSTS: Couple incarcerated for criminal tax crimes does not escape civil fraud penalties or deficiencies in income tax. The taxpayers created a complex system of purported trusts and transferred all their business and personal property to the multiple trusts. The husband held himself out as an expert in trusts and the taxation of trusts and marketed similar arrangements to others. The couple filed joint tax returns for the years at issue, but of the many years the numerous trusts existed and on one occasion, only one trust filed a tax return. The federal district court convicted the couple of filing false tax returns and aiding and abetting the filing of false tax returns. Following the criminal investigation, the IRS issued a notice of deficiency in the couple’s federal income tax and civil

fraud penalties. The taxpayers challenged the deficiency in Tax Court. In Aldridge v. Commissioner, T.C. Memo 2024-24 (2024), the court sustained the determination of deficiencies and fraud penalties. The court held the income from the trusts attributable to the petitioners. The court noted that the trusts lacked economic substance and that the taxpayers’ relationship with their property did not differ in any material way before and after they created the trusts. With respect to the fraud penalties, the court noted the taxpayers were college educated, aware of their obligations under the tax law, and possessed the financial knowledge and business background to understand and comply with their obligations. Instead of complying with their tax obligations, they established a bogus trust arrangement to hide their assets, did not report the income they received from the trusts, and even claimed the earned income credit intended to assist low-income taxpayers.

TRUSTS:

A delinquent taxpayer does not have to possess title to a piece of property for a nominee lien to attach. The taxpayer’s parents transferred a shopping mall to a trust for one dollar during the taxpayer’s divorce proceedings and after the IRS filed several multi-million-dollar federal tax liens against the taxpayer. The Third Circuit in United States v. Hovnanian, 133 A.F.T.R.2d 2024-673 (3d Cir. 2024), upheld the federal district court’s order of sale of the mall to satisfy a thirdparty nominee lien. A review of the state law regarding third-party nominees showed that the factors weighed heavily against the taxpayer. First, the trust paid nominal consideration. Second, the timing of the transfer suggests the parties meant to circumvent tax liabilities and provide funds to the taxpayer. Third, the taxpayer had a close relationship with the trust, as he was co-trustee from the time the property was transferred to the trust and his children were named beneficiaries. Finally, although the taxpayer never held title to the property, he exercised substantial control over it after it was transferred

to the trust. The tenants considered the taxpayer their landlord. He made decisions about the property’s expenses, usually without input from his cotrustee, he used his personal account to pay the property’s expenses, and he comingled profits with his personal assets and used them to pay his personal expenses.

LITERATURE

CHARITABLE GIFTS: In Strings Are Attached: Shining a Spotlight on the Hidden Subsidy for Perpetual Donor Limits on Gifts, 56 Loy. L. A. L. Rev. 1169 (2023), Roger Colinvaux explains how donor limits can harm charitable gifts. He reveals that 66 percent of the $525 billion net assets of the top 100 charities in the United States are subject to these limits, leaving charities with only 34 percent control over their assets. This lack of control leads to various harms, including imposing compliance costs and undermining public interest, charitable autonomy, and operational funding. Colinvaux suggests tax reforms that enable donors to retain limits on their gifts yet allieviate the burden on charities and the community caused by dead-hand control.

DIGITAL PROPERTY: In Estate Planning for Cyber Property—Electronic Communications, Cryptocurrency, NonFungible Tokens, and the Metaverse, 16 Est. Plan. & Cmty. Prop. L. J. 1 (2023), Gerry W. Beyer and Kerri Nipp explore the growing significance of digital assets as a category of personal property within estate planning. The authors aim to educate estate planning professionals about the importance of planning for administering digital assets so that fiduciaries can locate, access, and properly dispose of them. Further, the authors explain how the Revised Uniform Fiduciary Access to Digital Assets Act operates and provide guidance on planning techniques, including sample forms for incorporation into estate planning documents.

GUARDIANSHIP: In #FreeBritney: The Importance of Public Access to the

Guardianship System, 30 Cardozo Arts & Ent. L. J. 245 (2022), Cecily D’Amore highlights how the #FreeBritney movement has spotlighted much-needed attention on the guardianship practice. Britney Spears’s case has raised awareness about exploitation under conservatorships, but many individuals who lack fame face similar risks. The lack of public information about guardianship has hindered progress in reform efforts. D’Amore suggests that each state should publicly disclose its guardianship cases and establish guardianship databases. States can promote accountability through these measures and have the necessary data for meaningful guardianship reform.

HEIRS PROPERTY: In Beyond Institutions: Analyzing Heirs Property Legal Issues and Remedies through a Black History Lens, 22 U. Md. L.J. Race, Religion, Gender & Class 148 (2022), Heidi Kurniawan delves into the loss of Blackowned land in the South. She frames her article around a powerful exposé in 2019 of Melvin Davis and Licurtis Reels of North Carolina, who faced imprisonment for resisting eviction from land inherited without a will. This heartbreaking story highlights how heirs property, with deep roots in Black history, disproportionately affects Black and low-income Americans, contributing to the loss of millions of acres of land over decades. Considering the historical challenges these marginalized landowners face, Kurniawan emphasizes the need for thoughtful legislative reform.

HEIRS PROPERTY: In Property Rich and Money Poor: An Analysis of the Uniform Partition of Heirs Property Act and Discussion of Its Benefits Through a Nationwide Implementation, 24 Loy. J. Pub. Int. L. 63 (2023), Elise Gibbens examines the Uniform Partition of Heirs Property Act (UPHPA), to help families who inherit land over generations but do not have clear ownership titles. The lack of a clear title makes the landowners vulnerable to losing their land because of legal disputes. Though the UPHPA has proven benefits in states

where it has been adopted, Gibbens advocates for nationwide adoption as the optimal solution.

HEIRS PROPERTY: In The Anticommons Intersection of Heirs Property and Gentrification, 76 Vand. L. Rev. 1561 (2023), Emma White explores the pressures on Black landowners that have often resulted in fragmented ownership through heirs property. This division of ownership has often left minority neighborhoods vulnerable to gentrification and eventual loss of land. White points out problems in the Uniform Partition of Heirs’ Property Act (UPHPA) and suggests reforms to address the root cause of property fragmentation. She proposes a new uniform act that combines principles of the UPHPA and solutions to the tragedy of the anticommons to prevent the involuntary displacement of these communities.

HEIRS PROPERTY: In The Heirs Property Dilemma: How Stronger Federal Policies Can Help Narrow the Racial Wealth Gap, 27 N.C. Banking Inst. 320 (2023), Kendall Bargeman delves into how the lack of a clear title, particularly in Black communities, inhibits access to financial assistance after environmental disasters like flooding. FEMA has broadened documentation requirements, but challenges persist, leaving heirs property owners with limited access to aid. Bargeman argues that FEMA’s current approach is insufficient and proposes alternative solutions to resolve heirs property challenges before disaster strikes.

IOWA—INSANE SLAYER: In Avoid a Fight over Blood Money: The Iowa Legislature Should Take Action to Amend Its Slayer Statute to Ensure That Even the Insane Slayer Does Not Inherit, 109 Iowa L. Rev. 439 (2023), Natalie Risse explores the legal issues that arise when slayer statutes lack provisions for cases involving legally insane perpetrators. In a recent federal court case in Iowa, the court allowed an insane perpetrator to inherit under the slayer statute. Risse advocates that amending the

slayer statute is crucial to upholding its rationale, honoring the victims, and respecting surviving families, friends, and other beneficiaries of the victim.

PRISONER FEES: In Get Out of Jail Free? A Survey of Pay-to-Stay-Statutes Through a Constitutional Lens, 16 Est. Plan. & Cmty. Prop. L. J. 219 (2024), Sarah McClure investigates the long-standing practice of states imposing pay-to-stay fees to cover prison expenses, highlighting how these fees have often left released prisoners with significant debt. Further, she explores how proper estate planning is rarely a solution to protect inmates from these fees, often leaving families in a cycle of poverty. Ultimately, McClure argues that the pay-to-stay fees violate the excessive fines clause of the Eighth Amendment and that a total repeal of these fees could facilitate smoother prisoner reentry into society and reduce recidivism.

SOUTH CAROLINA—IRREVOCA-

BLE TRUSTS: In What Do You Mean “Irrevocable?,” 35 Mar S.C. L. 40 (2024), Meagan MacBean explores “irrevocable” trusts, traditionally understood as trusts that cannot be altered. The South Carolina Trust Code, however, allows for modifying trusts to accommodate legal changes or family dynamics, providing flexibility for settlors, beneficiaries, and trustees. This evolution is generally beneficial, but MacBean recommends that attorneys inform their clients about the potential of modification and whether they would like to draft against future modification preemptively.

TEXAS—DEPORTATION TRUST: In The Texas Deportation Trust: Protecting the Equity of Immigrants Working Towards the American Dream, 16 Est. Plan. & Cmty. Prop. L. J. 265 (2024), Orlando Oropez explores the historical context of immigration, the deportation process, and the impact of deportation on immigrants’ property rights. He contends that noncitizens who have established themselves in the United States and accrued assets deserve the opportunity to safeguard their wealth

while pursuing the process of becoming a naturalized citizen. Oropez advocates for implementing a deportation trust in Texas with potential recommendations to facilitate its effective use.

TEXAS—FORCED OWNERSHIP:

In Forced Ownership: Enough to Make a Texas “Laughing Heir” Cry, 16 Est. Plan. & Cmty. Prop. L. J. 165 (2023), Bradford Yock explores the effect of forced ownership and the current interpretation of the “passage of title upon intestacy.” Current laws disclaiming inheritance are unsatisfactory, so Yock highlights the need for lawmakers to change the rules and clarify that heirs shouldn’t be forced into ownership without first having the right to renounce.

TEXAS—FOSTER CARE: Homeless, Hopeless, and Helpless: How Attorneys Ad Litem Can Help Foster Youth Aging Out of the System, 16 Est. Plan. & Cmty. Prop. L. J. 303 (2024), Maddie Royal advocates for an amendment to the role of attorney ad litem and proposes assigning additional responsibilities to ensure foster youth receive proper support and advocacy. The aim is to improve foster youth transition out of the system and decrease negative outcomes such as homelessness and incarceration. Through a comprehensive examination of the foster care system, personal stories, and proposed solutions, Royal explains how attorney ad litems could fill the critical need for foster youth aging out of the system.

TEXAS—TRUSTEES: In Trustees’ Ability to Retain and Compensate Attorneys in Texas, 16 Est. Plan. & Cmty. Prop. L. J. 97 (2024), David Johnson offers practical advice for trustees navigating the process of retaining and compensating attorneys for trust administration, helping them understand their rights and available options.

UNCLAIMED DIGITAL

ASSETS:

In Unclaimed (Unowned) Digital Assets: Addressing the Legal Implications of Absent or Unknown Ownership, 16 Elon L. Rev. 221 (2024), Vladimir Troitsky explains a growing issue of unclaimed

digital assets with estimated millions of dollars’ worth of cryptocurrencies sitting in dormant crypto wallets. These unclaimed digital assets present a variety of complex issues in determining ownership and intellectual property rights. Troitsky examines the applicability of existing legal concepts for unowned assets and specific problems when applying these conventional legal concepts to digital assets. Finally, he offers potential solutions that address the challenges of digital assets without an owner.

UNDUE INFLUENCE: In The New Undue Influence, 2024 Utah L. Rev. 231 (2024), David Horton and Reid Weisbord explore a rising trend of “probate attorneys general” combating elder abuse by arguing a “new undue influence.” The authors thoroughly assess this phenomenon by analyzing nearly 7,000 probate and trust cases from California, leading the way in this emerging movement. Through their analysis, they saw a higher success rate for challengers but also a heightened risk of duplicative litigation and procedural inconsistencies. Therefore, Weisbord and Horton ultimately recommend reforms that could help policymakers harness the benefits of the new undue influence while minimizing the costs.

LEGISLATION

INDIANA requires insurance on property subject to a transfer-on-death-deed to remain effective after the named insured dies for (1) a maximum period of 60 days following the transfer, (2) a minimum period of 30 days if the insurance policy had an expiration date less than 60 days following the death of the insured, or (3) until the transferee obtains an insurance policy for the transferred property. 2024 Ind. Legis. Serv. Pl. 2-2024.

MICHIGAN provides for a cost of living adjustment for determining the intestate share of a surviving spouse, the homestead allowance, exempt household property, the family allowance, the amount qualifying for the small estate

administration, and other amounts as specified in the legislation. 2024 Mich. Legis. Serv. P.A. 1.

NEBRASKA enacts the Uniform Community Property Disposition at Death Act. 2024 Nebr. Laws L.B. 83.

NEW HAMPSHIRE adopts the Uniform Real Property Transfer on Death Act. 2024 N.H. Laws Ch. 1.

NEW JERSEY grants partners in a civil union the right to inherit in the same manner as a spouse. Additionally, (1) a surviving spouse will not be entitled to an elective share of a decedent’s estate where either the decedent or the surviving spouse has filed an action for divorce and (2) where one of the parties to a divorce action dies during the pendency of the action, a court will maintain the jurisdiction to render an equitable distribution of the property between spouses. 2023 N.J. Sess. Law Serv. Ch. 238.

SOUTH DAKOTA makes provisions for electronic and remote notarizations. 2024 S.D. Laws SB 211. n

PRESENT DAY LOAN WORKOUTS

By Manuel Farach

These materials present the mortgage lender’s point of view to assist real estate lawyers with a workout of distressed real estate, whether or not the workout may involve litigation or bankruptcy.

First Steps

Analyze Your Case

What Is the Client’s Objective? The first step in either a workout or litigation recovery of distressed property is to ask the client whether it has specific objectives it wants to pursue. The client can, of course, sell the loan to a third

party, agree to a discounted loan payoff, agree to a workout of some sort with either the present arrangement in place or changed parties, or decide to proceed with litigation, foreclosure, or the possible bankruptcy of the borrower. Having a clear plan in place from the start makes the process more efficient.

Manuel Farach is a shareholder in the West Palm Beach office of Mrachek Law. He is the former Chair of the Real Property Litigation Group of the American Bar Association. This article is based on a presentation for the American College of Real Estate Lawyers.

Chapter 11 Benchmark. No matter which course of action the client directs, the lawyer should conduct a worst-case analysis by examining the likelihood of the creditor or guarantors declaring bankruptcy. At the least, counsel should analyze who will benefit (and how) from a Chapter 11 proceeding and who has the staying power and negotiating leverage to force desired outcomes. Analysis should also be conducted of the possibility of plan confirmation over creditor objections through a cram-down, i.e., a court-ordered modification of a secured claim (such as a mortgage) over the objection of a secured claimant. And in light of the growing popularity of Subchapter

V bankruptcy plans, practitioners should note that a cram-down over the objection of secured creditors is not required to confirm a plan under Subchapter V of the Bankruptcy Act. The financial health of any guarantor (nonrecourse carveout or full recourse) should be assessed to determine if a bankruptcy filing would be toxic to the guarantor.

Conduct

Your Own Due Diligence. Consider the workout a form of reverse closing and conduct your due diligence as if you were closing a deal. The three primary things to consider during your due diligence are document review, collateral review, and party review. Document review is straightforward: Review all documents necessary to enforce the loan and determine what is needed to enforce those instruments in court. Be sure to review your documents to see if there are gaps in recordation, signatures, or other details that might affect enforcement. Also consider the contents of any notices or correspondence that might be

construed as an agreement of forbearance. Although not necessary, it is helpful to have litigation counsel, especially bankruptcy counsel, participate at this stage. Litigation counsel should be able to give real estate counsel a rough estimate of the time required to recover the collateral through litigation and, if necessary, through bankruptcy proceedings. This estimate of time will be important in determining property value down the road and in the client’s decision of what avenue to pursue.

Collateral review is also straightforward: How do collateral values affect how the lender proceeds? This is especially important with regard to the carrying costs of the project and the overall value of the project. Again, having litigation counsel available at this stage would be helpful as litigation over these issues has become the domain of expert witnesses, and their testimony may affect the ability to enforce loan documents. Location of and interviews with expert witnesses are advised if it is believed that collateral value is in dispute and will play a role in the workout.

Just as important is analysis of the players involved in the case. Some counsel focus solely on the lender, the borrower, and the guarantor, but a cautious lawyer should expand the analysis to include third parties such as vendors, customers, ground lessors, tenants, employees, regulators, government agencies, and, not least of all, the media. These third parties may affect the workout, the litigation, or the bankruptcy case in different ways. Analysis should also be conducted of the management teams of the lender and borrower, especially their respective commitments to the loan or project and their staying power.

Title Search. Counsel sometimes wait to conduct a title search until the process reaches the litigation stage, but recall the process is like a reverse closing and conduct your title search early. The title search should focus on the players needed to obtain marketable title should litigation be necessary. At this stage, assistance from a sophisticated title company is important, and counsel should inquire whether the title company can prepare a “foreclosure certificate” or other form of

report that identifies the parties that must be joined in litigation to achieve marketable title. Investigate whether there will be difficulty in serving or prevailing over the parties listed in the report. New exceptions to a title policy such as construction liens or certified judgments may not directly threaten priority of the client’s first mortgage but will have to be cleared if the workout goal is an outright sale without judicial foreclosure, and this may slow down recovery. The matters that appear on a title policy also may shed light on potential “bad boy acts” versus blameless operational challenges.

Analyze the Market

Having conducted your initial due diligence, the next step is to analyze the market. Considering the present instability of certain market segments, it is helpful to have input from brokers and appraisers as to the possible value of the property today and at a targeted liquidation date in the future. Special attention should be given to the property classification for that locale.

Analyze the State Law

There are two parts to this analysis. First, consider the organic law of the state where the collateral lies because local law may affect lien priority or remedies. For example, in a “one action” state such as California, which requires all claims on the promissory notes and security agreements to be filed in one suit. Also, research the issues important to the case and the client. For example, is a jury trial or lien marshaling waiver effective in the state? Second, the loan instruments should be analyzed to see whether the law of another state is set forth as controlling that particular instrument. If so, the law of both states must be reviewed under conflict of laws analysis to determine the law applicable to that instrument and to the client’s preferred remedies.

Analyze Issues on Portfolio Loans

Some states such as Florida grant creditors the ability to split causes of action between the mortgage and the promissory note, i.e., allow one suit on the debt instruments and a different suit on the security and mortgage instruments. Counsel

should analyze these issues to consider the best options for the client. The guarantor in a portfolio loan situation may risk more exposure with loan documents written to foster a single judgment. How long the process will take is another factor to consider against a consensual workout. Of course, the lender can decide to dispose of the note and mortgage via assignment or sale to a third party or seek nonjudicial remedies to obtain the collateral. Be cautious of the effect a potential remedy may have on guaranties and the concept of marshaling of assets.

Analyze the Possible Defenses

Key to both the lender and the borrower is an accurate analysis of the possible defenses. Analysis of possible defenses is beyond the scope of this article but can include defenses based on failure to follow trustee’s sale procedures for deed of trust states and, contractually, statute of limitations, unconscionability, estoppel, waiver, failure of consideration, and usury.

Opening Salvos

Pre-Negotiation Letter

Perhaps the most important instrument, especially from the lender’s perspective, is the Pre-Negotiation Letter or Agreement (PNA). This instrument opens the discussion between the parties and may provide early insight into the goals of the parties. This letter or agreement gives an early indication of the borrower’s position. Failure to agree to a PNA or objections on key points might be a “tell” of the other party’s position on that issue. If the borrower is unwilling to sign an agreement as to the facts, the lender should be wary that the workout will not materialize. The PNA can also help to clear up hazy facts not clear from the audit and may disclose liens that need to be perfected, transfers, and the like. A form of PNA follows this article.

Key to the lender’s requests in a PNA is an estoppel covenant that the loan is in effect and there are no offsets or defenses. Some pushback on this issue is to be expected, but a complete rejection is an indication the borrower is not serious about a consensual workout. On the other side of the coin, refusal of the lender to discuss softening of some of its requests

may indicate to the borrower that the lender intends to take a hard line on negotiations and possible litigation. It would be useful for both parties to agree on the floor value of the property at this point to possibly avoid unnecessary squabbling over the value in later proceedings. Typically, the parties agree in a PNA that there is no binding agreement until a final resolution is worked out between the parties. Sometimes the parties agree on certain issues but not others, which results in a binding resolution of the agreed upon issues. The lender can also use the negotiation to clear up any potential lender liability issues, and the borrower can request that the PNA walk back some acts of default as a path to a workout. An aggressive ask that should be made cautiously is a request by the lender for the borrower’s plans for the project because doing so may convince the borrower that the lender seeks the property and not a workout, but the time during a workout and before the initiation of litigation might be the best time to ask, i.e., while the parties are still talking. The PNA can also set forth requirements of both parties pending a workout such as the lender agreeing to continue funding under some conditions and the borrower agreeing to maintain insurance and governmental permits on the project. Again, the objectives of the clients and their beliefs of the relative strengths (or weaknesses) of their cases often determine the items requested in a PNA and how hard one side may want to push on those issues.

Nonlitigation Discovery

Litigation will provide a great deal of discovery from the other side but is expensive and time-consuming. The internet and other nonlitigation sources can provide a good deal of information to answer the questions parties may have, including those of the opposing party. For loans where the amount in controversy is substantial, parties are well advised to create a portfolio on the opposing party for analysis of key points and issues that may be raised during negotiation, and possibly litigation.

Notices of Default and Acceleration?

The knee-jerk reaction is yes, of course

Lenders should strongly consider exercising an assignment of rents provision in order to limit the ability of a borrower to use cash collateral during a bankruptcy.

accelerate all instruments and obligations right away. Acceleration of an obligation, however, may have unintended consequences such as tying a party to a particular course of action that may not be strategically advantageous or that creates cross defaults and further erodes the borrower’s ability to work through the default in an orderly process. Carefully examine the question of acceleration with litigation counsel before exercising this right.

Demands for Rents

Many states have statutes providing for assignment of rents by agreement. Examine your instruments to see if you have that right and, if so, what is required under state law to exercise it. Also, state law will determine if the security interest in rents is perfected by notice, lockbox control, or some other process or event. Some state statutes require a form of notification and a period of time before the assignment becomes effective, so plan in advance and determine when the best time is, strategically, to send the notice. Lenders should strongly consider exercising an assignment of rents provision in order to limit the ability of a borrower to use cash collateral during a bankruptcy.

Insurance Coverage?

One of the areas often overlooked during workouts is whether insurance coverage remains in effect. Be sure to examine the insurance coverage issues and consider whether it is necessary to obtain force-placed coverage or fund premium

payments for the insurance while negotiations are ongoing.

Tax Liability Concerns

Another area that is easily overlooked during a workout is whether taxes, including personal property taxes, are current or are in arrears. Investigate whether taxes have been paid and do not rely on the possibility that notification was given to lenders through a statutory process. This is both a collateral preservation issue and a possible negotiating tactic if one party has failed to comply with contractual requirements.

Lender Liability Concerns

Another risk to be wary of is extending the lender’s reach too far into the borrower’s business. Recall that excessive lender control of a borrower is a classic element of a lender liability claim, so lender’s counsel should be cautious on issues regarding control of the borrower. Both parties should keep in mind possible environmental, control, negligence, RICO, good faith, and interference issues.

Other Lenders

The lender considering a workout must consider the positions of other lenders on the property, including senior, junior, mezzanine, vendor, and construction, to see what effect a workout or foreclosure would have on their positions. Communication and coordination with these other lenders are key to avoiding a slowdown of a workout or foreclosure. An intercreditor agreement is common in these situations and a model intercreditor agreement form is discussed in Comm. on Com. Fin., ABA Sec. of Bus. Law, Report of the Model First Lien/Second Lien Intercreditor Agreement Task Force, 65 Bus. Law. 809 (2010).

Draft Workout or Complaint?

Having collected all this information, the lender and the borrower are in a position to decide whether to work out the loan or proceed to litigation, foreclosure, and possibly bankruptcy.

The Workout

Non-CMBS Loans

The team a borrower will face in a nonCMBS (commercial mortgage-backed security) loan depends on the amount of the

loan and the sophistication of the lender. Workout specialists, whether in-house at the lender or hired from an outside company, have become common. Often the final call will come down to the decisions of the credit committee of, and for large loans, the Board of Directors of the lender.

CMBS Loans

Because it relies on the capital markets and is a tax-driven structure, a CMBS loan is a dramatically different animal. Moreover, a CMBS loan has more moving parts than a non-CMBS loan. The players involved include the following.

1. The Master Servicer. The master servicer interacts with the borrower and manages payments on the loans. Unless there is a default, the master servicer services the loan for the entire life of the loan. If there is a default or an imminent risk of default, the master servicer will transfer the loan to the special servicer for further handling.

2. The Special Servicer. After a transfer, the special servicer takes over and typically attempts to resolve the default through some form of loan modification. The special servicer is contractually obligated to protect the interests of the investors in the real estate mortgage investment conduit (REMIC), not the borrowers.

3. The Directing Certificate Holder. The directing certificate holder is the party that directs and approves the actions of the special servicer. The “B-Piece” owners of the riskier tranches are subject to more risk and are sometimes called the “First Loss Class,” but they can have special rights such as appointment of the special servicer. The Pooling and Servicing Agreement (PSA) governing the REMIC will also set forth and control the conditions under which appraisal rights are exercised. This will often determine who controls the special servicer.

4. Companion and Mezzanine Loan Issues. The capital stack of many loans also contains a mezzanine loan. This loan is a complicating factor because a mezzanine lender can, upon default, take over the

stock of the borrower through a UCC sale (not a real estate foreclosure). These concerns are typically addressed in an intercreditor agreement.

5. CMBS-Specific Issues That Limit Flexibility in CMBS Workouts. CMBS loan pools are a legal structure known as a REMIC and are pass-through entities organized as trusts that do not pay income taxes. The pass-through component of a REMIC, and, accordingly, a CMBS loan, is crucial to the structure. Accordingly, the tax laws applicable to REMICs limit the ability to make certain decisions.

6. REMIC Issues—“Qualified Mortgages” and “Significant Modifications.”

• Significant Modification. The CMBS tax rules give a significant tax advantage, i.e., the passthrough capability, to REMICs that hold CMBS loans. But the rules require the REMICs to be passive, i.e., that they not engage in the business of buying and selling mortgages. Modification of mortgage terms could be interpreted to draw the REMIC into the “active business” sphere and thus constitute a “significant modification.” Special rules exist to allow workouts without the workouts being deemed a significant modification. A significant modification under REMIC regulations will result in a taxable event to borrowers, REMIC residual holders, and grantor trust investors, an undesirable outcome to be avoided.

• Reasonably Foreseeable Default. One of the exceptions to taxation upon modification is where there is a “reasonably foreseeable default.” This requires an actual belief that default is foreseeable, the master or special servicer has begun to take actions to reduce risk of default (which may be internal), and there currently exist circumstances where a material nonpayment default will occur with the passage of time or if the value of collateral securing the mortgage

is significantly below the outstanding principal amount of the mortgage loan.

• Safe Harbors. Safe harbors from taxation exist for assumptions, waiver of due on sale, changes in recourse, and changes in collateral, guaranty, or credit enhancement as long as principally secured by real property. Conditions for safe harbors include modifications with unconditional payment requirements and no more than five years or 50 percent of the original term remaining, changes of yield by 25 basis points or 5 percent of annual yield, and changes in covenants or forbearances for up to two years. There is a 100 percent tax, however, on “prohibited transactions,” i.e., transactions that violate the REMIC restrictions.

7. PSA Issues “Servicing Standard” vs. Servicer Compensation Issues.

• “Servicing Standard” vs. Servicer Compensation Issues. Servicers are bound by a “servicing standard” imposed under the PSA and must avoid conflicts of interest, employ a standard of care higher for the pooled loans than its own loans, take into account the interests of all certificate holders (including B-Note holders and pari passu holders), and seek timely recovery on a net present value basis.

• Hot Buttons for Trusts—Size of Defaulting Loan in Relation to the Specific Trust Portfolio. Trusts will be concerned with P&I, out of pocket expenses, yield maintenance, and interim occupancy agreements, which allow a buyer to occupy the property either before or after a sale.

• Hot Buttons for Servicer. On the other hand, servicers will be concerned with default interest, servicing fees, and workout fees.

Types of Workouts

1. Forbearance. Forms of forbearance can include reserve waivers;

Published in Probate & Property, Volume 38, No 4 © 2024 by the American Bar Association. Reproduced with permission. All rights reserved. This information or any portion thereof may not be copied or disseminated in any form or by any means or stored in an electronic database or retrieval system without the express written consent of the American Bar Association.

deferred payments of interest, principal, and reserves; or conditional agreements not to exercise remedies for a period of time not to exceed two years. A form of forbearance agreement follows this article.

2. Reinstatement. Reinstatement entails resolution of the default and immediate reinstatement of the loan to performing status.

3. Modification. Modification entails permanent relief or major changes to the loan instruments.

4. Lender Exit. The lender may want to exit the relationship and, if so, the lender has at its disposal various methods, including sale of the loan instruments, deeds in lieu of foreclosure, consensual receiverships, a receivership sale (in some states, prejudgment receivership sales are permitted), and a friendly foreclosure.

5. Borrower Exit. Borrowers also have exit strategies they may wish to employ, including assumption, a discounted payoff, a short sale, and defeasance.

Workout Strategies

Lenders and Decision Makers

What type of loan—i.e., CMBS or nonCMBS loan—is in distress? Recall that CMBS loans have REMIC strict guidelines to follow, so the PSA will need to be consulted and counsel must determine who (special servicer, directing certificate holder, mezz lender, companion noteholder, trustee) needs to consent.

Collateral Status

Just as complicated is the question of the status of the collateral. The types of issues that affect workouts include:

a. Type (classification) of property.

b. Physical and financial condition of the property.

c. Fair market value of the property compared to outstanding loan amount.

d. Underlying major tenant default (i.e., “it is not borrower’s fault”).

e. Can current income support

operations?

f. Maturity default?

g. Are there deferred maintenance issues?

h. Types of guaranty agreements and current financial condition of guarantor.

i. What dark clouds loom in the near future for this type of property?

j. Are there any positive factors for a workout?

How Did the Default Happen?

Both sides have to understand how the default happened. Was it caused by the fault or neglect of the borrower? What are general market conditions (e.g., rising interest rates, no interest rate cap, lack of insurance, changing market demographics)? Is this a single major tenant insolvency or an asset class issue such as a dying regional mall or office building in a struggling downtown area? The reason the property went into default will determine workout possibilities and choices.

Who Is in Charge?

Having determined how the default happened, the next question is who is in charge of the property at present. If the person now in charge was in charge when the default occurred, the lender will want to know whether a change of control is necessary (without exercising excessive lender control), what the quality and reputation of the sponsor are, and whether the property is self- or third-party managed. The lender will also ask whether it makes sense to put a receiver in charge or otherwise find a method to dispossess the borrower.

Are There Borrower or Guarantor Issues That Need to Be Resolved?

The lender will want to know if there are disputes among the ownership groups and the reputation of the ownership group. The lender will also want to know if a workout creates any publicity concerns.

How Realistic Are the Borrower’s Asks?

A borrower may need to give to get and the lender will want to know what the

sponsor’s commitment is to the property. The borrower will also need to know that extension without investment in capital expenditures to address deferred or unperformed maintenance might leave the lender in a worse situation and is not appealing to a lender. The ultimate question here will be whether the borrower is realistic with the property asset class position in the current market.

Suit

Despite the best efforts of the parties, or sometimes as the result of a lack of best efforts, a workout may not be fruitful and litigation becomes necessary. But litigation can be a workout by other means. At this point, the interests of the parties are completely adverse because the lender may seek to dispossess the borrower and interrupt the flow of money yet the borrower wants to maintain ownership and use its ownership to continue to receive funds while fighting the lender or stalling the process while looking for a white knight.

Discovery

It is hoped that the parties were forthright with each other during the workout phase, but court-based discovery forces parties to be more honest than they might have actually been. The lender will probably be forced to admit gaps in loan instruments and perhaps weaknesses in loan administration, and the borrower may need to admit poor planning or execution in the project or, worse yet, situations that call into play the “bad boy” acts that bring a recourse carveout guaranty into play. These discovery disclosures can and often do shift the leverage between the parties and may create a new opportunity for resolution.

Receivers and Interim Relief

Another point that may affect the relative leverage between the parties is the possible appointment of a receiver or other interim relief. The appointment of a receiver will deal a significant blow to a belligerent borrower as it will probably lose the income stream that was funding the fight against the lender. The

appointment of a receiver, however, is not all rosy for the lender because the receiver will take direction from the court, not the lender, and the lender will have to pay for the receiver. Appointment of a receiver may be a two-edged sword for the lender. In some states, the receiver enjoys a “super priority” lien similar to DIP (bankruptcy debtor in possession) financing that primes all other lenders and claims. Likewise, the receiver may be directed by the court to spend funds to protect the collateral or the tenants, which may work to the detriment of the lender.

Assignments of Rent

Another pressure point is the possibility of the court permitting the lender to enforce an assignment of rents provision. This is a form of a “Goldilocks” pre-trial remedy for the lender because it gets to redirect the stream of income away from the borrower without having to pay for a receiver and without having to worry whether a receiver will take a direction not desired by the lender. Often these assignments are collateral assignments that were agreed to in the loan documents, a fact that makes it difficult for the borrower to contest the enforceability of the assignment. Although a borrower need not cease its defenses upon the granting of an order enforcing an assignment of rents, the borrower’s tasks will certainly be more difficult and will require funding from alternative resources, either the borrower’s reserves or contributions from the owners.

Pursuit of Guaranty

Another pressure point is a possible claim against the guarantors. This course of action, however, is difficult for the lender unless there is clear evidence bringing the guaranty into play. A failed attempt by the lender to bring the guaranty into play may embolden the borrower and shift leverage back to the borrower.

Judgment

Unless significant appeal issues exist, a final judgment against the borrower will end the litigation and may give the parties another opportunity to work out the loan. Unless the lender has no desire or ability to take over the property, a final judgment shifts the leverage to the lender. But

a lender not willing or able to take over the property without an ability to pursue the guarantor may have won a Pyrrhic victory as the borrower may just walk away from the property.

Post-Judgment Proceedings

Post-judgment proceedings absent a guaranty are limited and probably won’t lead to a workout. But post-judgment discovery of assets may disclose fraudulent conveyances and possible courses of action against third parties. Again, this may shift the leverage to the creditor.

Bankruptcy

Bankruptcy may be the ultimate form of workout because many real estate projects are single-asset entities and bankruptcy proceedings in a single-asset case are often resolved quickly and geared toward consensual resolution. Various points in the process offer a great opportunity for workouts, and the lender that has been involved in the workout process from the start, especially if it already has conducted a Chapter 11 analysis, has an advantage over other creditors and can use the bankruptcy process to its advantage.

Pre-Packs

“Pre-packs” (i.e., pre-packaged bankruptcies) have become more common and favor the lender who has worked with the borrower toward a possible resolution.

A pre-pack essentially takes a workout resolution agreed to by the lender and the borrower and has it approved by the bankruptcy court, often to the advantage of the lender and the borrower and the disadvantage of the other creditors.

Section 362 Relief

Another point in the bankruptcy process that offers an opportunity for a workout is the filing of a motion for relief from the automatic stay. Some borrowers file bankruptcy to seek an alternative forum to the litigation that did not work to its favor. If so, an order granting relief from stay under Section 362 of the Bankruptcy Code sends the case back to the prior litigation forum. As to be expected, this shifts leverage for a possible workout back to the lender.

Section 363 Sale

The Bankruptcy Code offers another opportunity for lenders because the bankruptcy court can, over the objection of the debtor, order a Section 363 lease or sale of the property. This again dispossesses the borrower and sells the property, shifting the leverage back to the lender. The prospect of a Section 363 order may cause the recalcitrant borrower to reconsider a workout.

Modification Through Chapter 11 Plan

The final method by which a workout can be accomplished during the bankruptcy process is through confirmation of a Chapter 11 plan of reorganization, which includes the agreed-upon terms of the workout. The lender typically is secured and, as a result, has the ability to control the process to a certain extent through its vote on a proposed plan of reorganization. Practitioners should note, however, that a plan of reorganization can be confirmed over the objection of objecting creditors, i.e., a cramdown, and Subchapter V debtors can confirm a plan over creditor objections without a cramdown order.

Conclusion

There are many opportunities for workouts of a loan as it works its way through the process, with leverage going back and forth between lenders and borrowers. n

Re: Agreement to Enter into Workout Discussions of Debt Dated ____________ Arising from Loan Instruments Dated __________

Dear _________________:

It was a pleasure speaking with you concerning the above matter. Per our conversation, this letter reflects the current status of the above matter as well as a discussion about resolution of the debt owed by Borrower to Lender.

Upon the execution of this letter, interested parties will not be bound by any subsequent discussions, irrespective of the scope or complexity, until the terms and provisions of any proposed agreement have been reduced to a formal, written agreement fully approved and executed by all necessary parties, i.e., a “definitive agreement,” or either party terminates the discussions. A definitive agreement may be in the form of forbearance agreements, a waiver or consent document, or any other documents that comprise the agreement of the parties. The parties agree that evidence of the conduct and the discussions between the parties are inadmissible as evidence in any further proceedings but that this letter is admissible without objection by either party. Otherwise, all proceedings, communications, and items regarding the discussions are confidential and are not to be disclosed to any third parties without consent of all parties to this agreement, which confidentiality covenant is enforceable by injunction without the necessity of a bond.

All parties executing this letter agree that our discussions regarding this matter are voluntary and may be terminated by either party at any time and that only written agreements signed by all necessary parties will modify the loan documents. If our discussions fail to lead to a formal resolution, modification, or forbearance agreement, Lender may exercise its remedies and the Borrower may employ those defenses it deems appropriate except as limited herein.

The parties anticipate that they may receive “Confidential Information” of the other party. “Confidential Information” is defined to include all information supplied by one party to the other party; any information relating to customers (past, current and prospective); any loans; this agreement; accounts; vendors; marketing activities or plans; business plans; employees; pricing; financial matters; financial statements; the financial condition of the parties; any information revealed to third parties under any confidentiality agreement, understanding, or duty; any information generally regarded as confidential in the consumer and commercial credit industries; and any information treated as confidential information or nonpublic personal information under the Gramm-Leach-Bliley Act, related regulations, and state privacy laws. The parties further agree that they shall not disclose any Confidential Information obtained as part of these discussions to any person who is not an employee or agent of their organization, and that they shall restrict the disclosure of Confidential Information only to their employees, officers, or agents who have a need to know the Confidential Information. Each party shall use any Confidential Information only in connection with the purposes of this Agreement. Upon the termination of this agreement, each party shall, whether requested or not, return all materials, data, forms, discs, charts, spreadsheets, and all other materials and information provided by the other party or any designee of the party. The parties agree that any and all Confidential Information, including verbal statements, obtained during the discussions that constitute furnishing, promising, offering, accepting, promising to accept, or offering to accept a valuable consideration in compromising or attempting to compromise the Debt or conduct or statements made during the discussions about the Debt are not permitted to be used in court proceedings.

Borrower acknowledges its current obligations and has no information and does not claim that the Loan Instruments are not enforceable, and accordingly, the Borrower does not claim that the Debt owed to the Lender is not due.

Borrower confirms that there is currently outstanding a Debt due to Lender in the amount of ______________ and that there are no offsets, abatements, or other defenses of Borrower to Borrower’s obligation to pay the Debt, and that there is no obligation of Lender to provide any more funds to Borrower in any manner, shape, or form.

As a courtesy to Borrower, Lender is not presently seeking to enforce its rights with regard to the Debt. But Lender has not agreed to forbear the Debt while the discussions are ongoing, and Lender retains its ability to exercise any available right or remedy, including, but not limited to, issuing additional default notices or commencing actions at any time during the negotiations. The parties agree and understand that neither of them waives any of their rights, remedies, or obligations with regard to this matter except as expressly set forth herein.

As an inducement for Lender to enter into these discussions, Borrower agrees that it will not assert any claim, action, or cause of action, suit, or defense against Lender as a result of any action taken or not taken, and irrevocably and unconditionally releases and discharges Lender and its respective directors, officers, attorneys, employees, and agents from any claims, actions, or causes of action, suits, or damages caused by or arising out of the actions in any way related to the Debt and also with regard to the proceedings regarding the Debt obligation.

Borrower recognizes that Lender will not agree to any proposed amendment or resolution of the claims on the Debt without first obtaining appropriate written approval of various parties, and that Lender will seek same with regard to any possible consensual resolution reached through the discussions. Borrower further recognizes that Lender may decline to enter into any binding agreements unless and until it first obtains that approval.

Borrower further agrees that it will provide that financial information necessary for Lender to review its options with regard to this particular agreement and the status of the Debt and possible resolution of the Debt. All parties recognize the negotiation process may take time to reach a mutually agreeable resolution, and Borrower is permitted to operate and maintain possession of its property during the negotiation process in a manner it sees fit so long as Borrower does not, without the prior written permission of Lender, sell or encumber any assets outside of the ordinary course of business, including, but not limited to, refinancing, selling, leasing, or otherwise disposing of any assets of Borrower that may constitute potential loan collateral for reimbursement or payment of the Debt. Borrower accordingly agrees that it will not sell or encumber any assets outside of the ordinary course of business, including, but not limited to, refinancing, sale, lease, or other disposition of any assets of Borrower that may constitute potential loan collateral for any further agreement without the prior written permission of Lender.

Borrower represents and warrants it is represented by legal counsel of its choice (or has chosen not to obtain representation by legal counsel) and is fully aware of the terms contained in this agreement and has voluntarily and without coercion or duress of any kind entered into this agreement. If any party hereto is not represented by legal counsel, each such party acknowledges and represents that it has been advised by Lender to obtain its own independent legal representation, and it has voluntarily chosen not to obtain independent legal representation.

By signing below, the parties acknowledge that they are the authorized representatives of their principals and the respective parties, and are authorized to enter into this agreement and bind their represented party.

Sincerely yours,

Manuel Farach

FORBEARANCE AGREEMENT

This FORBEARANCE AGREEMENT is made as of [_____ ___, 20___], by [__________], a [__________] (“Borrower”), and [__________], a [__________] (“Lender”).

A. Lender has made a loan to Borrower (the “Loan”) in the original principal amount of [$_____] (the “Loan Amount”).

B. To evidence the Loan, Borrower executed and delivered to Lender a Promissory Note dated [_____ ___, 20__], in the Loan Amount (the “Note”).

C. The Note is secured by, among other things, a [Deed of Trust, Assignment of Rents and Security Agreement], dated [_____ ___, 20__] (the “Deed of Trust”), executed by Borrower, as trustor, to [__________], as trustee, for the benefit of Lender, as beneficiary, recorded on [_____ ___, 20__], in the real property records of [__________] (the “Records”), in Book [_____], as Instrument Number [_____]. The Deed of Trust encumbers real property known as [__________] (the “Property”).

D. The Note, the Deed of Trust, and all other documents or instruments related to the Loan, as amended, are the “Loan Documents.” Each capitalized term used but not otherwise defined in this Agreement has the meaning given to it in the Deed of Trust.

E. Lender has determined that Borrower has violated paragraph [_____] of the Deed of Trust and is in default under the Loan Documents (the “Existing Default”).

F. Borrower has requested that Lender forbear in the exercise of Lender’s remedies related to the Existing Default in order to _______________________. Although Lender is under no obligation to actually agree to do so, Lender has agreed to forbear from exercising Lender’s remedies, subject to this Agreement.

Accordingly, the parties agree:

1. Reaffirmation of Loan Documents. Borrower acknowledges that the Loan and Loan Documents are in full force and effect, that the obligations of Borrower under the Loan Documents are not subject to any defenses and that the execution and delivery of this Agreement does not, except as expressly provided in it, change the Loan Documents.

2. Existing Default. Borrower acknowledges and agrees that:

a. Borrower is currently in default of its obligations under the Loan Documents as a result of the occurrence of the Existing Default.

b. But for the temporary forbearance in this Agreement, Lender (without the need for further notice to anyone) would be entitled to exercise its rights under the Loan Documents against Borrower and the Property.

c. To the extent any of the Loan Documents requires any notice by Lender to anyone regarding the Existing Default, an opportunity to cure it, or any other matter, such notice has been properly given by Lender, or has been waived by Borrower.

d. No defenses, set-offs, counterclaims, or claims of recoupment exist with respect to the enforcement by Lender of its rights under the Loan Documents and applicable law.

e. Neither this Forbearance Agreement, nor any actions taken pursuant it, shall cure the Existing Default or any other event of default that may exist, or be a waiver by Lender of (i) the Existing Default or any other event of default that may exist or (ii) except as provided in paragraph 3, any rights or remedies of Lender in connection with the Existing Default or any other event of default.

f. As of [_____ ___, 20__], the outstanding principal balance of the Loan (exclusive of accrued interest, default interest, late fee charges, and foreclosure costs) is [$_____]. Upon the Effective Date (defined in paragraph 6), the outstanding principal balance will be reduced under the terms of paragraph 4 below.

g. No agreement and no amendment to, and no assignment or assumption of, the Loan Documents (including with out limitation, with respect to the rights and remedies of Lender) shall be binding against Lender unless set forth in a writing executed and delivered by Lender.

h. Lender is under no obligation to advance any additional proceeds under the Loan.

3. Compliance with Cure Periods and Notice Requirements. Borrower acknowledges that the Loan Documents may contain various periods with regard to the determination of whether an event of default has occurred under the Loan Documents and whether Lender is permitted to exercise remedies under them. Borrower agrees that, with respect to the Existing Default, all of such notices (if any were required) have been duly given and received and that all applicable grace periods or cure periods, if any, with respect to the Existing Default have lapsed or are hereby waived.

4. Forbearance. Except as provided in this Agreement, Lender agrees to forbear from exercising the remedies available to IT under the Loan Documents as a result of the Existing Default during the period (the “Forbearance Period”) commencing on the date hereof and ending on the earlier of:

a. [_____ ___, 20__];

b. The occurrence of an event of default under the Loan Documents other than the Existing Default; or

c. The occurrence of a breach or default by Borrower of any of ITS agreements or obligations under this Agreement or

any document executed in connection with this Agreement or a breach of any representation made by Borrower. d. The forbearance in this Paragraph is granted provided that (i) such forbearance shall be without prejudice to the exercise of Lender’s remedies as provided in this Agreement or the Loan Documents; (ii) Lender does not waive any of Lender’s remedies, and does not grant any additional rights to notice or to an opportunity to cure other than as set forth in the Loan Documents; (iii) Lender does not waive the Existing Default, any other event of default existing under the Loan Docu ments, or any future defaults that may occur under the Loan Documents; and (iv) Lender does not agree to amend or mod ify any of the Loan Documents except as set forth in this Agreement.

5. Modified and Additional Loan Documents. Lender may, in its sole discretion, provide written amendments to the existing Loan Documents that reflect this Agreement (the “Modified Loan Documents”) or additional loan documents that reflect this Agreement (the “Additional Loan Documents” and collectively the “Modified and Additional Loan Documents”), the execution of which will be required as a condition to the forbearance in this Agreement. Lender’s election not to prepare or deliver any Modified and Additional Loan Documents shall not affect the terms of this Agreement or be deemed to impair the modifications to the Loan Documents effectuated by this Agreement.

6. Effective Date. This Agreement shall only become effective on the “Effective Date,” which shall be the date that a counterpart of this Agreement is duly executed and delivered by Lender and Borrower. Borrower agrees that until the Effective Date, Lender shall not be bound by the terms and conditions of this Agreement and Borrower specifically and irrevocably waives any claim that would enforce the terms of this Agreement upon Lender prior to the Effective Date.

7. No Waiver of Rights. This Agreement (a) shall not constitute a waiver or release by Lender of any event of default that may now or hereafter exist under the Loan Documents nor grant Borrower any additional rights to receive notice or to have an opportunity to cure other than as set forth in the Loan Documents and (b) shall be without prejudice to, and is not a waiver or release of, Lender’s rights at any time in the future to exercise any and all of Lender’s Remedies, including, without limitation, the right to accelerate all indebtedness, obligations, and liabilities under the Note and the Loan Documents; institute foreclosure proceedings; exercise its rights under the Uniform Commercial Code or other applicable laws; or institute collection proceedings against Borrower.

8. Borrower’s Representations and Warranties. Borrower represents and warrants to Lender that:

a. The recitals are true.

b. The Loan Documents are enforceable against Borrower in accordance with their terms.

c. The execution and delivery of this Agreement and the performance of the Loan Documents have been duly authorized by all requisite action by or on behalf of Borrower.

d. Borrower has been represented by counsel of its choosing or has made a decision not to be so represented by counsel. Bor rower has read and understood this Agreement and executed this Agreement willingly and with no obligation or compul sion from Lender or any Lender Parties (as defined below).

9. Default. In addition to acts of default under the Loan Documents, any of the following constitutes an event of default under this Agreement and the Loan Documents:

a. Any representation or warranty made by Borrower under this Agreement is false or misleading.

b. The occurrence of any default under this Agreement or the occurrence of any additional event of default under the Loan Documents, as modified by this Agreement.

c. Commencement by Borrower or Borrower’s Principal (as defined in the Loan Documents) of any case under the Bank ruptcy Code, Title 11 of the United States Code, or commencement of any similar proceeding under any law by or against Borrower or Borrower’s Principal.

d. Borrower takes any action to repudiate this Agreement or this Agreement ceases to be in full force and effect other than in accordance with its terms.

10. Remedies Upon Default. Upon the occurrence of an event of default under this Agreement or the Loan Documents, and without demand for performance or any other notice of any kind to Borrower, Lender’s agreement to forbear under this Agreement shall automatically terminate and Lender may exercise Lender’s Remedies under the Loan Documents and this Agreement including, without limitation, the institution and completion of foreclosure proceedings against the Property, without further notice of any kind, all of which are waived by Borrower. No failure to exercise and no delay in exercising, on the part of Lender, any right, remedy, power, or privilege under this Agreement or under the Loan Documents shall operate as a waiver of it; nor shall any single or partial exercise of any right under this Agreement or under the Loan Documents preclude any other or further exercise of any other right by Lender. The rights under this Agreement are cumulative and are not exclusive of any rights under the Loan Documents.

11. Additional Actions. Borrower agrees, at Lender’s request, to take such actions and execute and deliver to Lender such documents as Lender shall reasonably request to effectuate the purpose of this Agreement.

12. Stay Relief. Borrower agrees that if Borrower files a petition with any bankruptcy court or is subject to any petition under Title 11 of the United States Code (the “Bankruptcy Code”) or is subject to any order for relief issued under the Bankruptcy Code or is the subject of any petition seeking reorganization, arrangement, composition, readjustment, liquidation, dissolution, or

similar relief under any present or future law relating to relief for debtors, or seeks or consents to or acquiesces in the appointment of any trustee, receiver, conservator, or liquidator, or is the subject of any order entered by any court involving a petition filed against Borrower for relief under any[A4] , Lender shall be entitled to relief from the automatic stay pursuant to section 362(d) of the Bankruptcy Code, or any other stay otherwise imposed by law under a comparable provision, on or against the exercise of the rights available to Lender under the Loan Documents or under this Agreement. Borrower shall consent to any motion for relief from the automatic stay filed by Lender to exercise its rights as a creditor or mortgagor under the Loan Documents and this Agreement. Borrower acknowledges that Lender is not adequately protected with respect to the obligations under the Loan Documents and this Agreement and that Borrower cannot provide adequate protection to Lender, thus entitling Lender to relief from the automatic stay.

13. Release of Claims. Borrower releases Lender, and its officers, directors, employees, servicers, agents, successors, and assigns (collectively the “Lender Parties”), from any and all claims of any nature whatsoever, which occurred or was initiated at any time prior to the Effective Date arising out of the Loan or the Loan Documents.

14. Forbearance Negotiations. Except as provided in this Agreement, there are no agreements concerning the forbearance of rights arising under the Loan Documents or any existing or future breach or event of default under this Agreement or under any Loan Documents. No agreement concerning the forbearance of rights, or any other matter related to them, shall be binding or enforceable and may be relied upon unless reduced to writing and signed by the person against whom enforcement is sought. All negotiations related to this Agreement shall be deemed compromise negotiations and shall be inadmissible in evidence pursuant to Rule 408 of the Federal Rules of Evidence and any similar state rule or statute.

15. Miscellaneous

a. No Third Party Beneficiaries. This Agreement is made for the sole benefit of Lender and Borrower and is not intended to inure to the benefit any third party.

b. Governing Law. This Agreement shall be enforced in accordance with the laws of the State of [_____] without regard to its conflicts of law principles.

c. Severability. No provision of this Agreement that is unenforceable invalidates the remaining provisions of this Agreement.

d. Construction. All references in this Agreement to the singular shall be deemed to include the plural if the context so requires and vice versa. References in the collective or conjunctive shall also include the disjunctive unless the context otherwise clearly requires a different interpretation.

e. Waiver of Jury Trial. Each party irrevocably waives, to the fullest extent permitted by applicable law, any right it may have to a trial by jury in any legal proceeding directly or indirectly arising out of or relating to this agreement or any other loan document or the transactions contemplated by them (whether based on contract, tort, or any other theory). Each party (a) certifies that no representative, agent, or attorney of any other person has represented that such other person would not, in the event of litigation, seek to enforce the foregoing waiver and (b) acknowledges that it and the other parties hereto have been induced to enter into this agreement and the other loan documents by, among other things, the mutual waivers and certifications in this section.

f. Integration. This Agreement constitutes the entire agreement between the parties concerning its subject matter and may not be amended except by written agreement signed by them. All prior and contemporaneous agreements concerning the subject matter of this Agreement, other than the Loan Documents, are merged in this Agreement.

g. Time. Time is of the essence of this Agreement.

h. Counterpart Execution. This Agreement may be executed in one or more counterparts, each of which shall be deemed an original and all of which together shall constitute the same document. Signature pages may be detached from their coun terparts and attached to a single copy of this Agreement to form one document.

i. Notices. All notices, requests, and demands to be made under this, or to be made in accordance with any of the Loan Doc uments, shall be in writing and shall be delivered in the manner set forth in the Deed of Trust or the other Loan Docu ments, as applicable, as the same have been modified pursuant to this Agreement.

The parties hereto have executed this Agreement as of its date.

DATED: BORROWER:[____________________]

By: _________________________________

Name: _______________________________

Its: __________________________________

DATED: LENDER: [____________________]

By: _________________________________

Name: _______________________________ Its: __________________________________

Long-term irrevocable trusts may need to be fixed at some point because of poor design, sloppy implementation, negligent maintenance, changes in tax laws, changes in beneficiaries, improvements in drafting techniques, changes in the grantor’s family or financial situation, or changes in a beneficiary’s circumstances. In addition to the normal difficulties associated with irrevocable trusts, irrevocable life insurance trusts (ILITs) have special problems related to the fact that the primary trust asset is life insurance. ILITs are most likely to incur damage and need fixing regarding (i) Crummey withdrawal rights, (ii) generation-skipping transfer tax (GSTT) matters, (iii) changes in the tax laws, and (iv) life insurance policy issues. This article will explore different techniques that an attorney can use to fix some of these ailments and will provide a checklist to avoid certain problems before they occur.

How to Deal with Ignored or Neglected Crummey Withdrawal Right Notices

Upon discovering that Crummey notice requirements have been neglected or ignored, do not assume that nothing can be done and that the gift tax annual exclusion is lost. Instead, consider the following.

Fixing Damaged ILITs (Plus

Checklist to Avoid Problems)

By Robert J. Adler and Michael J. Hausman

Robert J. Adler is a member of the New York firm of Adler & Adler, PLLC. Michael J. Hausman is a shareholder in the Hausman Law Group, PC.

Was Any Notice Provided? What about Oral Notice?

If a beneficiary received oral notice, have the beneficiary acknowledge in writing that he received oral notice for the “missing” years. The fact that this is done prior to any challenge from the IRS would show that it was in fact done in good faith and not in response to an audit. To document oral notice, consider having the beneficiary sign a written statement confirming the date of each gift, the withdrawal right associated with each gift, and the beneficiary’s action with respect to that withdrawal right.

File a Late Gift Tax Return Reflecting the Gifts

Consider filing a late US gift tax return (assuming a gift tax return was not previously filed for the tax year in question), detailing the reasons that the annual gift tax exclusions are allowable. Under Treas. Reg. § 301.6501(c)-1(f), the statute of limitations will close three years after filing of the US gift tax return with respect to the issue if it is adequately disclosed. On the chance that the gift tax return is selected for audit, it is still better to be dealing with the IRS while memories are fresh and the donor is alive, rather than waiting decades until the federal estate tax audit.

Create Crummey Withdrawal Right in Letters of Gift Transmission

A possible method of securing a gift tax annual exclusion where the ILIT does not contain Crummey withdrawal rights is to create Crummey withdrawal rights in a letter of gift transmission to the ILIT trustee. The gift letter would inform the trustee of the gift being made, the terms of the gift, which trust beneficiaries have withdrawal rights, the amount of the withdrawal right, the time period in which a withdrawal right lapses, etc. See Pvt. Ltr. Rul. 8445004, where this technique was used to increase an annual withdrawal right from $3,000 to $10,000.

I’m

Involved in an Estate Tax Audit— What Now? Consider the Position

That No Notice Is Required

The emphasis in Crummey v. Commissioner, 397 F.2d 82 (9th Cir. 1968), was on the possession of the right of

withdrawal—not notice. The existence of the withdrawal right was itself sufficient to confer a present interest status on a contribution to an irrevocable trust. The court in Crummey never required that written notice, verbal notice, or other notice be given to the beneficiaries. In fact, the court in Crummey acknowledged that it was unlikely that certain beneficiaries would ever know of the contributions. Said the court, “[I]t is likely that some, if not all, of the beneficiaries did not even know that they had any right to demand funds from the trust. They probably did not know when contributions were made to the trust or in what amounts.” A similar distinction between possession of a right of withdrawal versus notice or knowledge of the right to withdraw is found in Estate of Holland v. Commissioner, 1997 T.C.M. (CCH) 3236.

To buttress the position that no notice is required, consider analogizing to Internal Revenue Code (I.R.C.) §§ 2041(a), 2056(b)(5), and 2503(c)(2). I.R.C. § 2041(a) provides for inclusion in a decedent’s gross estate of the value of all property with respect to which the decedent possesses a general power of appointment. “General power of appointment” is defined by I.R.C. § 2041(b)(1) as a power exercisable in favor of the holder, his estate, his creditors, or the creditors of his estate. It is established that the mere possession of a general power of appointment triggers inclusion under I.R.C. § 2041(a), regardless of whether the holder was ever competent to exercise the power. See, e.g., William R. Boeving v. United States, 650 F.2d 493 (8th Cir. 1981); Estate of Nancy E. Rosenblatt v. Commissioner, 633 F.2d 176 (10th Cir. 1980); Estate of Anna Lora Gilchrist v. Commissioner, 630 F.2d 340 (5th Cir. 1980); Estate of Fannie Alperstein v. Commissioner, 613 F.2d 1213 (2d Cir. 1979), cert. denied, 446 U.S. 918 (1980); Clarence Blagen Fish v. United States, 432 F.2d 1278 (9th Cir. 1970). I.R.C. § 2056(b) is the general power of appointment marital deduction provision. If the surviving spouse is given the requisite income interest in the property, coupled with a general power of appointment, the inability of the surviving spouse to exercise the power of appointment because of incapacity

or a lack of knowledge of the power will not disqualify the interest for the marital deduction. See Estate of Frank E. Tingley v. Commissioner, 22 T.C. 402 (1954), aff’d sub nom. T. Everett Starrett v. Commissioner, 223 F.2d 163 (1st Cir. 1955); Rev. Rul. 75-350, 1975-2 C.B. 366 (testamentary general power of appointment); Rev. Rul. 55-518, 1955-2 C.B. 384 (inter-vivos general power of appointment).

In short, the theory underlying the above-described treatment of general powers of appointment is analogous to the theory that the existence of the legal right to withdraw the contribution, and not the notice of such right or the appointment of a guardian or conservator for a minor, incompetent, or disabled beneficiary, is what creates a present interest and allows the donor to use the gift tax annual exclusion.

How to Deal with a Life Insurance Policy That Is No Longer Adequate or Appropriate

If the current life insurance policy is no longer adequate or appropriate or is too costly, or if a newer type of life insurance product would better suit the needs of the grantor, consider the following.

Tax Deferred Exchange of Life Insurance Policy

I.R.C. § 1035 permits owners of life insurance and annuity contracts to exchange their contracts for similar or related types of contracts without the recognition of any unrealized gain that may have accrued in the contract surrendered in the exchange. Although such exchanges would ordinarily be taxable transactions with gain or loss measured by the difference between the fair market value of the new policy and the owner’s basis in the old policy, exchanges that meet certain basic requirements are granted nonrecognition treatment by I.R.C. § 1035. I.R.C. § 1035 does not provide a permanent income tax exclusion for gains on such exchanges but merely a deferral—since the basis of the contract given up is carried over as the basis of the new contract received.

Painful

income tax consequences can accompany the lapsing or cancellation of a life insurance policy whose cash value has previously been substantially depleted through policy loans.

Caution: Debt Release as Boot

If an exchange comes within I.R.C. § 1035, except that other property or money is also received “to boot,” gain (in the policy given up) is recognized up to the value of the boot received. I.R.C. § 1031(b).

If a policy that is subject to an outstanding loan is exchanged in a transaction otherwise qualifying for nonrecognition under I.R.C. § 1035, the balance of the loan at the time of the exchange is treated as “boot” to the extent that it exceeds the amount of any loan balance outstanding on the new policy received. Treas. Reg. § 1.1031(b)-1(c). This rule prevents abuse of the nonrecognition provision in a disposition transaction intended to yield cash (which would otherwise be taxable as boot) by structuring the transaction as a nontaxable loan followed by a nonrecognition exchange.

If a policy subject to an outstanding loan is exchanged for a new policy, and the new policy is issued with an identical outstanding loan amount, there is no boot. I.R.S. Priv. Ltr. Rul. 8604033 (n.d.); I.R.S. Priv. Ltr. Rul. 8816015 (July 1, 1988). If the new issuing company will not issue a policy subject to indebtedness, another way of avoiding boot is to pay off the loan on the old policy prior to the I.R.C. § 1035 exchange and then, if necessary, borrow against the new policy.

Prepare a New ILIT and Obtain a New Life Insurance Policy

Sometimes, the existing ILIT is woefully inadequate either for tax reasons or because of changed circumstances. If the grantor is insurable at reasonable rates, the grantor can stop funding the existing ILIT, establish a new ILIT, fund the new ILIT, and then have the new ILIT purchase a life insurance policy

that is better suited to the grantor’s current situation. Obviously, this solution has the benefit of being “clean” for tax purposes; however, it is not viable where insurance is no longer available on the life of the grantor at a reasonable cost or where the grantor is uninsurable. Once the new ILIT is operational, the old ILIT can continue as an investment vehicle, be terminated through discretionary distributions, or be terminated because it is no longer economical to continue the trust.

Caution: Painful income tax consequences can accompany the lapsing or cancellation of a life insurance policy whose cash value has previously been substantially depleted through policy loans. Life insurance contracts have traditionally been accorded highly favorable income tax treatment. One of the most important of these benefits is the taxfree inside build-up of cash value in a policy (as long as it satisfies the Code’s definitional parameters for a life insurance contract). Not only may the cash value accumulate within the policy without current taxation, but this untaxed income may even be utilized by the policy owner, still without income recognition for tax purposes, in the form of an interest-bearing policy loan. The nonrecognition of this income will become permanent when the insured dies and the death benefit (net of any policy loan balance) is paid. Under the general rule of I.R.C. § 101, the death benefit under a life insurance contract is excluded from gross income. This avoidance of income recognition, however, will not be permanent when a policy loan is effectively retired by offset against the cash value in connection with cancellation (or lapse) of the contract. In such an event, the income recognition will be only deferred, and it

must be recognized at the time of cancellation (or lapse) of the policy.

Checklist

Below are several additional items that a practitioner should consider when advising on ILITs. This checklist assumes that the practitioner has experience and knowledge concerning tax law, estate planning, and trust drafting.

1. Avoid ETIPs and Taxable Releases

The spouse’s withdrawal right should be limited to the five-by-five safe harbor amount of I.R.C. § 2514(e) and the withdrawal right should lapse 60 days after the date of contribution (not 60 days after notice). This will avoid the GSTT estate tax inclusion period (ETIP) issue for the spouse. Also, the spouse should not be given a hanging power of withdrawal since it does not come within the ETIP safe harbor rules set forth in Treas. Reg. § 26.2632-1(c)(2) (ii). Another concern is the I.R.C. § 2026 estate tax problem when the spouse’s lapse of a withdrawal right is greater than the five-by-five safe harbor resulting in the spouse making a transfer with a retained interest.

2. Avoid Naked Crummey Withdrawal Rights

The IRS frowns upon beneficiaries who have Crummey withdrawal rights and are merely contingent remainder beneficiaries. Fortunately for taxpayers, the Tax Court disagrees with the IRS concerning contingent remainder beneficiaries who hold Crummey withdrawal rights, and the Tax Court has permitted contingent remainder beneficiaries (grandchildren, who would take only if their parents (the current beneficiaries) predeceased them) to be recognized as valid Crummey beneficiaries for whom the gift tax annual exclusion was available to the grantor. Estate of Maria Cristofani v. Commissioner, 97 T.C. 74 (1991), acq. in result only, 1996-2 C.B. 1. An especially cautious practitioner may want to consider giving the contingent remainder beneficiaries (such as the grandchildren) a certain percentage of the ILIT after the death of the surviving spouse, or a specific dollar amount to

each “unvested” contingent remainder beneficiary who has a Crummey withdrawal right.

3. Provide Beneficiaries with Sufficient Time to Exercise Their Crummey Withdrawal Rights and Give the Trustee Broad Powers to Satisfy Any Crummey Withdrawal Right

According to the IRS, a beneficiary must have a reasonable amount of time to exercise the Crummey withdrawal right before it lapses, with 30 to 60 days being typical. Make sure that any Crummey withdrawal right may be satisfied not only against the contribution but also against other trust property, including any insurance policy or fractional interests in the insurance policy. This will provide substance to a Crummey withdrawal right, especially as concerns any split-dollar or group term policies held by the trust.

4. Noninsured Spouse as Trustee

A noninsured spouse who is a beneficiary of an ILIT (when the other spouse is the sole insured under the ILIT) can serve as trustee of the ILIT during the insured spouse’s lifetime, provided (i) the noninsured spouse holds no powers as trustee that constitute a general power of appointment, (ii) the noninsured spouse is prohibited from making distributions that would have the effect of discharging that individual’s legal obligations, including the obligation of support, and (iii) the noninsured spouse does not make any gifts to the ILIT (other than merely consenting to gift splitting under I.R.C. § 2513). After the death of the insured spouse, the noninsured spouse can serve as trustee of the ILIT, even if that individual is a beneficiary, provided the noninsured spouse holds no powers as trustee that constitute a general power of appointment.

5. Effect of Gift Tax Annual Exclusion upon GSTT Taxability

It is important to realize that a lifetime gift that creates an interest in a skip person (other than in the case of an I.R.C. § 2642(c) trust) is potentially subject to GSTT even though the gift qualifies as

excludable from gift taxation. In other words, not all gifts that are excludable from gift taxation (by reason of the $17,000 (as indexed) gift tax annual exclusion) are excludable from the operation of the GSTT. Thus, it is necessary to allocate an appropriate amount of the GSTT exemption to gift tax annual exclusion transfers (other than in the case of I.R.C § 2642(c) trusts) in order to exempt future generation-skipping transfers.

6. Avoid the Creation of Reciprocal ILITs

In determining whether the reciprocal trust doctrine applies, the following factors should be considered and analyzed: (i) the similarity of the trusts’ terms, (ii) the similarity of the trusts’ corpus, (iii) the trustees, (iv) the beneficiaries, (v) the proximity of the trusts’ execution date, and (vi) the grantors’ intent concerning a pre-arranged plan.

To avoid the reciprocal trust doctrine, consider the following drafting suggestions: (i) Give one spouse (but not the other) a broad inter-vivos limited power of appointment; (ii) give each spouse a different form of entitlement under each other’s trust—one spouse may be entitled to mandatory distributions of income and distributions of principal for health, education, support, and maintenance, but the other spouse may be entitled to receive distributions of income and principal in the sole discretion of an independent trustee; (iii) vary the terms of the trust—one trust may be a GSTT-exempt dynasty trust and the other trust may be for a specified length of years; and (iv) execute the trusts on different dates—the farther apart the better.

7. Vest Ownership of the Life Insurance Exclusively in the ILIT Trustee

The ILIT should provide that the grantor relinquishes all incidents of ownership over transferred policies and that any life insurance policy purchased by the ILIT on the grantor’s life is owned exclusively by the trustee (i.e., the insured must not possess any “incidents of ownership” in the life insurance policy). I.R.C. § 2042.

8. Avoidance of the Three-Year Rule Problem When a New Policy Is Involved

Under I.R.C. § 2035(d)—the so-called three-year rule—if an insured person transfers an insurance policy to an irrevocable life insurance trust, even though the insured may no longer retain any incidents of ownership, but then dies within the three-year period following the transfer, the entire policy proceeds will be includable in the insured’s gross estate, effectively defeating the major objective of the irrevocable trust plan. For the most part, the three-year rule problem can be eliminated by establishing the trust with a new policy (i.e., one never owned by the insured). This, of course, is not a viable alternative when an existing policy is involved.

In general, the trust should be established first, with a transfer of cash from the grantor to be used to pay the initial premium. The trustee would then submit the formal application, with the trust as the original applicant and owner. The grantor-insured would participate only to the extent of executing required health questionnaires and submitting to any required physical examination. The critical factor in assuring the inapplicability of I.R.C. § 2035(d) is that the grantorinsured not have possessed, at any time, anything that might be deemed an incident of ownership with respect to the policy.

In Technical Advice Memorandum (TAM) 9323002 (Apr. 20, 1998), the IRS held that reapplication by a third-party owner (such as an ILIT trustee) after the decedent initially applied for the insurance (with no money submitted with the “initial” application) within three years of death did not present a three-year rule problem. Central to the technical advice is the notion that an application for insurance (as long as money is not submitted with the application) is only an offer to contract. There being no contract between the parties, the decedent never held any incidents of ownership. n

UNDERSTANDING THE ENERGY EFFICIENT COMMERCIAL BUILDINGS DEDUCTION

By Bryanna C. Frazier

Owners of commercial buildings may be able to reduce their taxable income by making energy efficiency upgrades. Section 179D of

Bryanna C. Frazier is a renewable energy transactions attorney with McCauley Lyman LLC in New Orleans, Louisiana. She serves in various leadership positions within the Section including as a Vice-Chair of the Diversity, Equity and Inclusion Committee and as a member of the Continuing Legal Education Committee.

the Internal Revenue Code allows a taxpayer to take a deduction for the cost of energy efficiency upgrades placed in service during the tax year if certain requirements are met. This deduction, commonly referred to as the § 179D deduction, has been around since 2005. Over the years, there have been several modifications to the § 179D deduction, the most recent of which came with the passing of the Inflation Reduction Act of 2022 (the IRA). This article provides a brief introduction to the §179D

deduction and issues that should be taken into consideration when deciding whether this deduction may be appropriate. Although this article focuses on energy efficiency upgrades, the § 179D deduction is also available for the cost of energy efficiency materials that are installed in a newly constructed building.

There are two options for a deduction under I.R.C. § 179D. The general deduction, found under I.R.C. § 179D(a), is for energy efficient

commercial building property (EECBP). The alternative deduction, found under I.R.C. § 179D(f), is for energy efficient building retrofit property (EEBRP). A discussion of the differences between these two options follows, but it is important to note at the outset that a threshold requirement for both options is the establishment of a plan to install upgrades that will improve the building’s energy efficiency by 25 percent or more. Therefore, before making any decisions regarding energy efficiency

upgrades, building owners interested in the § 179D deduction should consult with their contractors and create a plan that includes conducting an analysis of the building to determine which upgrades, if any, will meet the requirements of I.R.C. § 179D.

The General Deduction

I.R.C. § 179D(a) provides that “[t]here shall be allowed as a deduction an amount equal to the cost of energy efficient commercial building property

placed in service during the taxable year.” “Energy efficient commercial building property” is defined as property that is (i) depreciable (i.e., materials used to run a business such as machinery, equipment, buildings, vehicles, furniture); (ii) installed on a building located in the United States and within the scope of Reference Standard 90.1 (discussed below); (iii) installed as part of the building’s interior lighting systems, its heating, cooling, ventilation, and hot water systems, or the building

The alternative deduction presents an opportunity to take a deduction for upgrades made to older buildings.

envelope (i.e., walls, windows, roof, and foundation); and (iv) certified as being installed as part of a plan designed to reduce the total annual energy and power costs with respect to the interior lighting systems and the heating, cooling, ventilation, and hot water systems of the building by 25 percent or more in comparison to a reference building that meets the minimum requirements of Reference Standard 90.1. To qualify for the general deduction under I.R.C. § 179D, materials installed as energy efficiency upgrades must meet all four requirements.

Reference Standard 90.1 is mentioned twice in the definition of EECBP. What is Reference Standard 90.1? Every three years, the American Society of Heating, Refrigeration, and Air Conditioning Engineers (ASHRAE) and the Illuminating Engineering Society of North America (IES) publish the minimum requirements for energy efficient designs for certain buildings. Standard 90.1 is the Energy Standard for Buildings Except Low-Rise Residential Buildings. All buildings except singlefamily homes, multifamily buildings less than four stories, mobile homes, and modular homes are within the scope of Standard 90.1. I.R.C. § 179D(c) (2) defines Reference Standard 90.1 as the more recent of (i) Standard 90.1-2007, meaning the minimum

requirements published in 2007; and (ii) the most recent Standard 90.1 that the US Department of Energy and Secretary of the Treasury have approved for purposes of I.R.C. § 179D within the four years prior to the upgrades being placed in service. Pursuant to IRS Announcement 2024-24, Reference Standard 90.1-2007 is to be used for EECBP placed in service after December 31, 2014, and before January 1, 2027. Reference Standard 90.1-2019 is to be used for EECBP placed in service after December 31, 2026, and before January 1, 2029, and Reference Standard 90.12022 is to be used for EECBP placed in service after December 31, 2028.

Computer modeling is used to determine whether energy efficiency upgrades will reduce the total annual energy and power costs of a building by 25 percent or more. To do this, two virtual models of the building are created. The first model, Model A, is created to show the building as including energy efficiency materials that meet the minimum requirements of the applicable Reference Standard 90.1. If a building owner is looking to install energy efficiency upgrades by 2025, Model A of its building will incorporate energy efficiency materials meeting the minimum requirements of Reference Standard 90.1-2007 because that is the applicable Reference Standard 90.1 for EECBP

placed in service after December 31, 2014, and before January 1, 2027. The second model, Model B, is created to show the building’s inclusion of the desired energy efficiency upgrades. The two models are then compared. If the results show that Model B’s total annual energy and power costs are less than Model A’s by 25 percent or more, this requirement is met for EECBP.

The Alternative Deduction

The alternative deduction under I.R.C. § 179D has more requirements and is more time consuming to pursue than the general deduction. Why would an owner of a commercial building be interested in the alternative deduction? The alternative deduction presents an opportunity to take a deduction for upgrades made to older buildings. Before being revised under the IRA, I.R.C. § 179D included only the general deduction and the energy cost saving threshold was set to 50 percent, double the current threshold. It was difficult for energy efficiency upgrades to older buildings to meet this threshold. Under the revised I.R.C. § 179D, however, not only is the threshold lowered to 25 percent, but the alternative deduction focuses on comparing the building’s own energy use over time, rather than the building’s energy cost in comparison to the ASHRAE Standard 90.1 reference building.

Energy use intensity (EUI) is calculated by dividing a building’s total annual energy consumption by the building’s total gross floor area. A lower EUI generally signifies that a building has good energy performance. Site EUI, which is generally reflected on the utility bill, is the amount of energy consumed by a building. Source EUI is the amount of all energy used to produce, transmit, and deliver energy to a building in addition to the energy consumed at the building. The I.R.C. § 179D alternative deduction considers the building’s site EUI.

The alternative deduction is for “energy efficient building retrofit property,” which is defined as property that is (i) depreciable (i.e., materials used to run a business such as machinery,

equipment, buildings, vehicles, furniture); (ii) installed in or on a “qualified building,” which is defined as a building located in the United States and originally placed in service not less than five years before the establishment of the “qualified retrofit plan” (discussed below); (iii) installed as part of the building’s interior lighting systems, its heating, cooling, ventilation, and hot water systems, or the building envelope (i.e., walls, windows, roof, and foundation); and (iv) certified as installed on a qualified building and as part of the building’s interior lighting systems, its heating, cooling, ventilation, and hot water systems, or the building envelope.

The required “qualified retrofit plan” must be written and prepared by a “qualified professional” such as a licensed architect or engineer. The qualified retrofit plan also must specify the energy efficiency upgrades to be made to the building that are expected to reduce the building’s EUI by 25 percent or more in comparison to the building’s baseline EUI. Finally, the qualified retrofit plan must provide for three different certifications, all of which must be made by a qualified professional. The first certification must confirm the EUI of the building one year before the EEBRP is placed in service. This establishes the building’s baseline EUI. The second certification must confirm that the EEBRP is installed on a qualified building and installed as part of the building’s interior lighting systems, its heating, cooling, ventilation, and hot water systems, or the building envelope. And the third certification must confirm the building’s EUI more than one year after the EEBRP was placed in service. The I.R.C. § 179D alternative deduction can be claimed for the tax year in which the final certification reflects that the building EUI has been reduced by 25 percent or more.

The Amount of the Deduction

The amount of the § 179D deduction is the lesser of (i) the cost of the energy efficiency upgrades, meeting the requirement of either EECBP or EEBRP, installed in the building; or (ii) the amount equal to the product of the

building’s square footage multiplied by the “applicable dollar value.” The applicable dollar value ranges from $0.50 to $5.00, depending on the amount of the building’s energy savings and other factors. For buildings that obtain a 25 percent energy savings, the applicable dollar value is $0.50 per square foot. For buildings that obtain more than 25 percent energy savings, the applicable dollar value is $0.50 per square foot plus an additional $0.02 per square foot for each percentage point of energy savings above 25 percent, up to a maximum of $1.00 per square foot. See “Energy Efficient Commercial Buildings Deduction,” https://tinyurl. com/3jcwf79m.

If the federal prevailing wage and apprenticeship requirements are met, the applicable dollar value increases five times. Thus, for buildings that obtain a 25 percent energy savings, the applicable dollar value is $2.50 per square foot. And for buildings that obtain more than 25 percent energy savings, the applicable dollar value is $2.50 per square foot plus an additional $0.10 per square foot for each percentage point of energy savings above 25 percent, up to a maximum of $5.00 per square foot.

The federal prevailing wage and

apprenticeship requirements, found under I.R.C. § 45(b)(7) and (8), generally require that the laborers and mechanics who are contracted for the construction of the energy efficiency upgrades be paid at or above the prevailing wage rates, as established by the US Department of Labor, for similar work performed in the area where the building is located; and that a certain number of the work hours for construction of the energy efficiency upgrades be performed by qualified apprentices. The rules related to federal prevailing wage and apprenticeship requirements are complex, and a detailed discussion is outside the scope of this article. When making decisions regarding the § 179D deduction, however, it is important to consider whether it is worth going through the additional effort (and possibly an increased cost) required for compliance with these requirements for the sake of getting the increased applicable dollar value.

Allocation of the Deduction

The § 179D deduction can be claimed by commercial building owners or, solely in the case of buildings owned by a “specified tax-exempt entity,” can be allocated to and claimed by those responsible for designing the energy

At the discretion of the building owner, the § 179D deduction can be allocated among several designers, if there are more than one working on the project.

efficiency upgrades. A “specified taxexempt entity” is defined as (i) the United States, any state, political subdivision, or possession of the United States, or any agency or instrumentality of the foregoing; (ii) an Indian tribal government or Alaskan Native Corporation; and (iii) tax-exempt organizations. Essentially, these are entities that do not pay taxes and therefore would not be able to use a tax deduction. Before being revised under the IRA, the § 179D deduction was allocable only for government-owned commercial buildings.

Under IRS Notice 2008-40, a designer is the person that creates the technical specifications for installation of the energy efficiency upgrades, such as an architect, engineer, contractor, environmental consultant, or energy services provider. At the discretion of the building owner, the § 179D deduction can be allocated among several designers, if two or more are working on the project. The amount that may be allocated to the designer includes all costs incurred by the building owner to place the energy efficiency upgrades in service, except any amounts paid as income to the designer.

To allocate the § 179D deduction, both the building owner and the designer must execute a document that includes the following details: (i) the

name, address, and telephone number of the building owner; (ii) the name, address, and telephone number of the designer; (iii) the address of the qualified commercial building; (iv) the cost of the EECBP or EEBRP installed; (v) the date that the EECBP or EEBRP was placed in service; (vi) the amount of the § 179D deduction allocated to the designer; (vii) the signatures of the building owner and designer; and (viii) a declaration under penalty of perjury. The IRS does not have a specific form or letter template to use for this allocation document. The designer is not required to attach the allocation document to its tax return but must keep it, along with all other documents that may be helpful for substantiating the claimed deduction, in case of an audit.

Special Rules

I.R.C. § 179D(d) provides various other requirements that must be followed when pursuing the § 179D deduction. For example, the calculation and verification of a building’s energy and power consumption and cost can be prepared only by “qualified computer software.” On its website, the US Department of Energy maintains a list of computer software that meet the requirements for use with the § 179D deduction. Additionally, for the various certifications required under

I.R.C. § 179D, there are rules regarding the certification process, including which professionals are allowed to be a part of the certification process.

Although I.R.C. § 179D(h) authorizes the promulgation of regulations related to the provisions of I.R.C. § 179D, none has been issued to date. The IRS, however, has issued guidance through Notices (Notice 2006-52, Notice 2008-40, and Notice 201226), a Chief Counsel Advisory (CCA 201451028), and Chief Counsel Attorney Memoranda (AM 2010-007 and AM 2018-005). Because of revisions of I.R.C. § 179D under the IRA, some of the information in these guidance documents may be obsolete. Nevertheless, these documents still assist with understanding how the § 179D deduction works, and much of the information is still relevant.

Conclusion

Determining whether it is possible to take the § 179D deduction requires some upfront work. The commercial building owner and contractor will need to take a few steps beyond simply discussing the desired energy efficiency upgrades and executing a contract. Modeling will need to be completed to determine whether the general deduction or the alternative deduction should be pursued and to ensure that the desired upgrades will meet or exceed the threshold requirement of improving the building’s energy efficiency by 25 percent or more. Both the general and alternative deductions require that the upgrades be installed pursuant to a plan, so that will need to be created. Additionally, the building owner should consult with its accountant to calculate the deduction amount and to determine the appropriate documents to keep or file with the IRS. And the building owner should also consult with an attorney knowledgeable in this area to ensure that the requirements of I.R.C. § 179D are being met. It may be a bit of a hassle at the outset, but for a deduction worth up to $5.00 per square foot, the § 179D deduction may be worth considering for some commercial building owners. n

DON’T GUESS AND MAKE A MESS WITH QSBS

By Justin T. Miller

Tax deferral can be great, but nothing beats tax-free. And one of the best taxfree gifts the federal government offers to business founders, executives, and investors is an exclusion from capital gains up to the greater of $10 million or 10 times basis for the sale of stock in a C corporation that meets the requirements for qualified small business stock (QSBS) under I.R.C. § 1202. If the QSBS was issued on or after September 28, 2010, before the company’s gross assets exceeded $50 million, and held for at least five years, then zero federal tax would be owed upon a sale of that QSBS up to the greater of $10 million or 10 times basis—even if what started as a small business has grown in value to be worth billions of dollars. Moreover, each individual and nongrantor trust that receives QSBS via gift or inheritance will be independently entitled to an additional QSBS exclusion of the greater of $10 million or 10 times basis. In addition, the sale of QSBS often avoids income taxation at the state level because many states either have no state income tax or provide a similar QSBS exclusion for state income tax purposes.

Congress continues to support the QSBS tax incentive for entrepreneurs to start new businesses and for outside investors—such as angel investors and venture capitalists—to invest in those businesses because small businesses produce jobs, innovate, and help drive the economy. Per a report by the US Small Business Administration Office of Advocacy (Apr. 2022), small businesses with fewer than 500 employees have generated 12.9 million net new jobs over the past 25 years— compared to only 6.7 million net new jobs from large businesses. In other words, small businesses have accounted for 66 percent of employment growth over the past 25 years—that is, two out of every three jobs added to the economy. According to the legislative history for I.R.C. § 1202 (H.R. Rep. No. 103-111, at 831 (1993)), the exclusion provides “targeted relief for investors who risk their funds in new

Justin T. Miller is a partner and the national director of wealth planning at Evercore Wealth Management. He is the co-chair of the ABA RPTE Business Planning Group and the co-chair of the Individual and Fiduciary Income Tax Committee.

ventures [and] small businesses” and can “encourage the flow of capital to small businesses, many of which have difficulty attracting equity financing.” The QSBS exclusion also is a key tool for recruiting and rewarding employees.

The Evolution of the Section 1202 QSBS Exclusion

The QSBS tax benefit initially was enacted during the Clinton administration as part of the Omnibus Budget Reconciliation Act of 1993 to encourage small business investments. The original QSBS law excluded 50 percent of the capital gains from the sale of QSBS—not to exceed the greater of $10 million or 10 times the tax basis in the stock—based on a 28 percent rate, which was the capital gains rate that was in effect in 1993. In other words, the original QSBS tax benefit basically provided a more attractive 14 percent effective tax rate versus a 28 percent rate on the greater of $10 million or 10 times basis.

Although the greater of $10 million or 10 times basis threshold has not changed since 1993, the percentage of capital gains that can be excluded under that threshold was increased during the Obama administration. The exclusion percentage went from 50 percent to 75 percent for QSBS acquired between February 18, 2009, and September 27, 2010. It was increased again to 100 percent for QSBS acquired on or after September 28, 2010. The 100 percent exclusion percentage was then made “permanent”—that is, no automatic expiration date—under the Protecting Americans from Tax Hikes (PATH) Act of 2015.

There are two main reasons why the government expanded the QSBS benefit. First, after the highest capital gains tax rate was reduced to 15 percent from 2003 through 2012, the QSBS incentive for taking on the additional risk of starting or investing in a small business was somewhat minimal. In other words, the QSBS exclusion saved only 1 percent by imposing a 14 percent effective tax rate—that is, 50 percent of the 28 percent rate set in 1993. The second reason is that during the so-called Great Recession with the market downturn in 2009, the federal government wanted to further incentivize investments in small businesses to help boost the country’s economic recovery.

The QSBS benefit became an even more powerful tax incentive after the highest capital gains tax rate was increased to 23.8 percent in 2013— including the additional 3.8 percent net investment income tax that became effective in 2013 pursuant to the Patient Protection and Affordable Care Act of 2010, as amended by the Health Care and Education Reconciliation Act of 2010 (colloquially known as Obamacare). Moreover, the 100 percent QSBS exclusion also avoids a portion of the gains from being included as an addback for alternative minimum tax purposes.

Despite the potential economic benefits resulting from the creation of—and investment in—small businesses, the House of Representatives attempted to reduce the 100 percent QSBS benefit back to the original 50 percent limitation under different versions of the proposed Build Back Better Act in 2021. The nonpartisan Joint Committee on Taxation estimated that the QSBS tax

expenditure would cost $1.8 billion in 2021, and the aggregate reduction of the QSBS benefit over a 10-year period would have provided the government with flexibility to offset other new spending proposals in the Build Back Better Act as part of the budget reconciliation process—which would have allowed the Senate to pass the bill by a simple majority of 51 votes or 50 votes with the vice president serving as a tie breaker. The new 50 percent exclusion would have applied to individual taxpayers with adjusted gross income of $400,000 or more and all nongrantor trusts and estates regardless of adjusted gross income. Moreover, the proposed Build Back Better Act threatened to apply to sales and exchanges of QSBS on or after September 13, 2021, even if the shareholder had acquired the QSBS before that date in reliance on the laws in effect at that time.

It would seem patently unfair that the government could change the tax rules after the fact on taxpayers who had already acquired QSBS—especially founders, investors, and employees who were willing to take on the additional risk associated with small businesses specifically because they thought they would be entitled to the QSBS tax benefits that the law appeared to promise at that time. But unlike the constitutional limitation on retroactive—that is, ex post facto—criminal law changes, retroactive tax law changes are constitutional. For example, the Supreme Court in United States v. Carlton, 512 U.S. 26 (1984), unanimously upheld the retroactive repeal of a tax deduction and even stated, “Tax legislation is not a promise, and a taxpayer has no vested right in the Internal Revenue Code.”

Fortunately for founders, executives, and investors with QSBS, the Build Back Better Act was not enacted because of insufficient support in the Senate in 2021, and similar proposed QSBS limitations have not been included in any legislation since that date.

C Corporation and the $50 Million Requirement

To qualify for the QSBS exclusion, the business entity must be a domestic C corporation for tax purposes and the company’s gross assets must not exceed $50 million at any time through the time of the stock issuance—including cash received in exchange for the issued stock. For the gross assets test, the value generally includes cash plus the adjusted basis of the company’s assets— not the fair market value—and does not include self-created intangible value such as goodwill.

Even though there could be potential QSBS exclusion benefits from a future sale of a C corporation, founders starting a new business should not necessarily let the tax tail wag the planning dog by immediately creating a C

corporation. A major disadvantage with a C corporation is that there is a double layer of taxation including a 21 percent tax at the corporate level, which was reduced from 35 percent by the Tax Cuts and Jobs Act of 2017. There also is a second layer of tax for C corporations at the shareholder level up to a 23.8 percent federal tax rate—including the 3.8 percent net investment income tax—on qualified dividends distributed from the company. For many founders starting a business, there could be significant ongoing tax advantages to using a different type of limited liability entity—such as an LLC taxed as a partnership under subchapter K—that allows for passthrough taxation and only one layer of taxation at the owner level.

Fortunately, it may be possible for a business to start out as something other than a C corporation and then convert to a C corporation at a later date for QSBS planning purposes. For instance, an LLC taxed as a partnership could check the box under Treasury Regulation section 301.7701-3 to be a C corporation, which is treated as a

deemed transfer of all the LLC’s assets in a section 351 transfer in exchange for stock and a deemed liquidation of the LLC. So long as the fair market value of the appreciated assets—not the historical tax basis—do not exceed $50 million at the time of conversion, the future appreciation after the conversion could qualify for the QSBS exclusion equal to the greater of $10 million or 10 times basis. As an example, if the fair market value at the time of the LLC conversion was $49.5 million and the founder owning 99 percent of the business had close to a zero basis for tax purposes, then the founder’s first $49 million from a future sale would be subject to a tax on capital gains, and then the founder would benefit from a $490 million QSBS exclusion—equal to 10 times basis—for any gain above the first $49 million.

Although more complicated than an LLC partnership conversion for QSBS purposes, it also may be possible to have an S corporation establish one or more new subsidiary C corporations and contribute assets in a section 351 transfer to take advantage of the QSBS exclusion.

Qualified Trade or Business and the 80 Percent Requirement

Even with a C corporation that does not have more than $50 million in gross assets, not every trade or business will be eligible for QSBS treatment. Other than a special exception for working capital for the first couple years of a business, at least 80 percent of the company’s assets must be used in the active conduct of a qualifying trade or business. Although there is no specific definition for what does qualify, I.R.C. § 1202 specifically lists numerous exceptions for what does not qualify, including “(A) any trade or business involving the performance of services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of 1 or more of its employees, (B) any banking, insurance, financing, leasing, investing, or similar business, (C) any farming business (including the business of raising or harvesting trees), (D) any business involving the production or extraction of products of a character with respect to which a deduction is allowable under section 613 or 613A, and (E) any business of operating a hotel, motel, restaurant, or similar business.”

A major exception to the original issuance rule is that a shareholder that receives a gift or inheritance of QSBS will qualify for the shareholder’s own additional QSBS exclusion.

Given the lack of a clear definition for what type of trade or business qualifies under I.R.C. § 1202, a private letter ruling could be helpful in certain circumstances to address the uncertainty. Beginning in January 2024, however, under Rev. Proc. 2024-3, 2024-1 IRB 143, the IRS stated that it would temporarily stop issuing private letter rulings on whether a coproration meets the “active business” requirement for QSBS purposes. Despite all the listed exclusions under section 1202, there have been numerous private letter rulings issued by the IRS that have approved QSBS treatment for businesses such as a temporary staffing business (I.R.S. Priv. Ltr. Rul. 202352009 (Dec. 29, 2023)), an enterprise cloud application services software company (I.R.S. Priv. Ltr. Rul. 202319013 (Feb. 14, 2023)), the manufacture of products prescribed by health care providers (I.R.S. Priv. Ltr. Rul. 202125004 (Mar. 29, 2021)), and a business that contracts with insurance companies and wholesalers (I.R.S. Priv. Ltr. Rul. 202114002 (Jan. 13, 2021)).

See also I.R.S. Priv. Ltr. Ruls. 202221006 (Mar. 3, 2022), 202144026 (Aug. 10, 2021), and 201436001 (May 22, 2014).

Even though private letter rulings provide an indication of how the IRS might address a certain matter, note that private letter rulings may not be relied upon by taxpayers other than the specific taxpayer who was issued the

ruling. And while the IRS has issued many favorable private letter rulings related to QSBS, the IRS did release Chief Counsel Advice 202204007 (Nov. 4, 2021), which found that an online services company’s business of facilitating the leasing of real estate—which could have been Airbnb, Vrbo, or a similar company—did not qualify for QSBS treatment because it was a brokerage service under I.R.C. § 6045, even though it was not one under I.R.C. § 199A.

Original Issuance and the Exception for Gifts and Inheritance

To qualify for the QSBS exclusion, the shareholder cannot be a C corporation, but it may be an individual, partnership, S corporation, or trust. That shareholder must acquire the stock in exchange for money or other property (not including stock) or as compensation for services provided to the corporation (other than as an underwriter). In other words, stock purchased from an existing shareholder or on a secondary market does not qualify for the QSBS exclusion.

A major exception to the original issuance rule is that a shareholder— including an individual or nongrantor trust—that receives a gift or inheritance of QSBS will qualify for the shareholder’s own additional QSBS exclusion.

and four nongrantor trusts for children

Example assumes the shares meet the requirements for QSBS, each of the shareholders is subject to the highest federal income tax rates on capital gains of 20 percent plus the 3.8 percent net investment income tax, and the original shareholder is a resident of California subject to a 13.3 percent state income tax.

The recipient also will be treated as having the same basis and holding period as the donor for QSBS purposes. As a hypothetical example from a trust and estate planning perspective, a QSBS shareholder with four kids could use the 2024 $13.61 million lifetime exemption amount to set up four nongrantor trusts with $3.4 million of QSBS without paying any gift taxes—colloquially referred to as “stacking.” Each one of those four trusts would get its own QSBS exclusion up to the greater of $10 million or 10 times basis. In other words, the value of the QSBS in each trust could roughly triple to $10 million, and each trust would be able to exclude the entire capital gain from the sale of the QSBS. Not only would the original shareholder get a $10 million QSBS exclusion, but the four nongrantor trusts set up by the shareholder for the four children would get an additional aggregate $40 million QSBS exclusion. Moreover, even if the shareholder is a resident of a state that does not provide a state income tax exclusion for QSBS, those four nongrantor trusts could be set up in a state that provides the benefit of zero state taxes in addition to the federal QSBS benefits. The table above shows the tax savings potential in this example.

When creating multiple nongrantor trusts for loved ones, it is imperative that the trust agreements are carefully drafted to prevent any grantor trust triggers under subpart E of subchapter J. While intentionally defective grantor trusts (IDGTs) generally are the bread and butter of estate planning for wealthy families, it is important to avoid creating an unintentionally

defective grantor trust (UDGT) if the purpose is to create a nongrantor trust to obtain an additional QSBS exclusion. Furthermore, each separate nongrantor trust should be different enough to steer clear of the multiple trust rule under I.R.C. § 643(f). If two or more trusts have substantially the same grantors and beneficiaries, and the principal purpose is avoidance of tax, then those trusts will be treated as one trust for income tax purposes—meaning only one QSBS exclusion. Moreover, the IRS announced in Rev. Proc. 20213, 2021-1 IRB 1, that it would not issue any private letter rulings to approve any proposed planning related to multiple trusts under I.R.C. § 643(f).

Five-Year Holding Period and Qualified Rollovers

To qualify for the QSBS exclusion, the QSBS must have been held for at least five years. For purposes of the five-year holding period, shareholders— including individuals and nongrantor trusts—that received QSBS as a gift or inheritance will keep the same holding period as the original shareholder. As an example, if a founder has held QSBS for five years and then gifts QSBS shares to a nongrantor trust for the benefit of a child, that nongrantor trust will have met the five-year holding period requirement and will qualify for its own greater of $10 million or 10 times basis exclusion.

If a shareholder is selling QSBS before the end of the five-year holding period, all is not lost. That shareholder can continue the existing holding period by purchasing replacement QSBS under I.R.C. § 1045 within 60

days. For example, if a shareholder held the original QSBS for only four years at the time of sale, that shareholder could go ahead and purchase new shares that qualify as QSBS and only would need to hold those new shares for one more year to take advantage of the tax-free QSBS benefits. As another option, a shareholder could even create the shareholder’s own brand-new C corporation with a plan for a trade or business that would qualify for QSBS treatment and then continue the existing holding period with the new QSBS. I.R.C. § 1202(e)(6) even provides a special rule for working capital during a corporation’s first two years before it is required to be used in active conduct of a business.

Common Pitfalls with Redemptions and Family Partnerships

Redemptions—that is, a purchase by the C corporation of its own stock—are a common major pitfall that a company may want to avoid since it could cause shareholders to lose their QSBS exclusion benefits. A shareholder’s stock will no longer be treated as QSBS if (1) at any time during the four-year period beginning on the date two years before the issuance of such stock, the corporation purchased (directly or indirectly) more than a de minimis amount of its stock from the shareholder or person related to the shareholder or (2) during the two-year period beginning on the date one year before the issuance of such stock, the corporation made one or more purchases of more than a de minimis amount of its stock with an aggregate value (as of the time of the

Founder Fred 1/1/2016

Ellen

(options exercised)

respective purchases) exceeding 5 percent percent of the aggregate value of all its stock as of the beginning of such two-year period. An amount would be more than de minimis if the aggregate amount paid exceeded $10K and the corporation purchased more than 2 percent percent of the stock held by the shareholder or a related person.

Another major pitfall to avoid would be the contribution of QSBS to a partnership, such as a family limited partnership. While such planning structures often provide families with significant benefits from an investment and estate planning perspective, the contribution of QSBS to a partnership would disqualify the stock from QSBS treatment under I.R.C. § 1202.

Hypothetical Example

In January 2016, Founder Fred formed a domestic C corporation and started a small business with $100,000 to manufacture medical equipment for hospitals. In June 2017, Investor Ivan invested an additional $300,000 to help the business grow more quickly. As the business rapidly expanded and needed access to more capital, Venture Capital Firm agreed to invest $3 million in the business in January 2018. Then, in June 2019, Employee Ellen exercised $200,000 in stock options that were granted by company back in January 2016. Finally, on December 31, 2023, the company was sold for $60 million in cash.

Founder Fred, Investor Ivan, and Venture Capital Firm each received their stock after September 27, 2010, and have met the five-year holding requirement, so they each are entitled to a 100 percent exclusion of capital gains tax up to the greater of $10 million or 10 times basis. As a result, Founder Fred will be able to exclude $10 million of capital gains, which reduces his federal tax bill from $5.7 million to $3.3 million—saving $2.4 million in taxes. Had Founder Fred made gifts to loved ones— or to nongrantor trusts for the benefit of loved ones—each one of those shareholders also would have qualified for separate QSBS exclusions up to $10 million. Investor Ivan will be able to exclude the entire amount of his $7.5 million gain, which saves him $1.8 million in taxes. Because Venture Capital Firm had a basis of $3 million in QSBS, it will be able to exclude the entire $24 million of capital gain under the 10 times basis rule, thus saving $5.7 million in taxes.

Unfortunately for Employee Ellen, she did not exercise her options until June 1, 2019, so she did not meet the five-year holding period for QSBS as of the date of sale on December 31, 2023. However, as discussed earlier, she does have the option of rolling over her proceeds into a new QSBS investment for an additional six months to meet the five-year holding period— which could even include investing in a C corporation that she created

herself as a new business qualifying for QSBS treatment. The chart above summarizes the results for each of the shareholders.

Conclusion

To take advantage of the QSBS exclusion and optimize the tax benefits for current and future generations, business founders, executives, and investors should work closely with their attorneys, accountants, and wealth managers to address the technical requirements and potential planning opportunities. Proactive tax, trust, and estate planning with QSBS can help shareholders maximize the income, gift, estate, and generation-skipping transfer tax benefits for families over multiple generations. Although there is no special election that needs to be made for shares to qualify as QSBS at the time of issuance or the time of sale, shareholders must report the sale of QSBS correctly on their income tax returns to take advantage of the QSBS tax benefits. Because of the strict requirements for QSBS eligibility, it is important for both shareholders and the issuing company to maintain accurate records of purchase dates and amounts, track when the company’s gross assets exceed $50 million after the purchase of shares, and confirm that at least 80 percent of the company’s assets are used in the active conduct of a qualifying trade or business. n

NEW RPTE PUBLICATIONS

LITIGATING ADVERSE POSSESSION CASES: PIRATES V. ZOMBIES

By Paul Golden

2024, 279 pages, 6x9

Paperback/ebook

PC: 5431138

Price: $119.95 (list) / $95.95 (RPTE Members)

Can a neighborhood Napoleon simply take over, and become the owner of, another neighbor’s property? Any attorney even considering approaching an adverse possession case, regardless of which side, must start here. This is the first known book that focuses on just this issue—and from the litigator’s point of view. It is a one-stop shop for practitioners, with not only full descriptions of the ins and outs of the elements and potential defenses, and sample pleadings, but also various practical tips, tricks, clues, and ideas for successfully litigating these unusual cases.

“Who would believe that a thirty-eight-chapter deep dive into every aspect of litigating adverse possession —that hoary doctrine that somehow transforms trespass into ownership—could also be an engaging and accessible read? Paul Golden has somehow pulled it off. This erudite and comprehensive volume will prove truly invaluable for practitioners as well as academics and students engaging with one of the most enigmatic, yet practically important, areas of property law.”

Nestor M. Davidson

Albert A. Walsh Professor of Real Estate, Land Use and Property Law, Fordham Law School

“Paul Golden’s book is a gold mine for any lawyer litigating an adverse possession case. The book collects cases on every aspect of adverse possession doctrine, and does far more than survey standard problems that complicate adverse possession law. Golden examines the peculiarities of local law in many states and outlines a variety of defenses available to adverse possession litigators. To top it off, Golden’s refreshingly breezy style makes it easy to digest the valuable information he doles out.”

Stewart Sterk

Mack Professor of Law at the Benjamin N. Cardozo School of Law of Yeshiva University

ENVIRONMENTAL LAW UPDATE

Running Down the Clock—The Biden Administration’s Recent Environmental Regulatory Actions

The last year of a US presidential term usually produces a flurry of regulatory activity. The current administration devoted much of its first three years in office to developing and refining discrete environmental policies, such as the PFAS Roadmap issued in October 2021 to address contamination from per- and poly-fluoroalkyl substances (PFAS). Still, it did not propose significant regulations under traditional environmental laws. During those years, the administration focused on clean energy initiatives to reduce greenhouse gas (GHG) emissions. During its final year, the administration has broadened its focus to include proposed regulations and policies under “traditional” federal laws governing hazardous waste, clean water, clean air, and toxic chemicals. This column briefly overviews the administration’s efforts and the potential implications for the regulated community.

Clean Energy Initiatives

The Inflation Reduction Act contains several tax incentives, including those designed to make energy-efficiency retrofits of existing buildings more likely, increase clean energy use, and reduce GHG emissions. In March 2022, the Securities and Exchange Commission (SEC) issued proposed regulations requiring publicly traded companies to disclose climate risks related to their business operation.

The proposed SEC regulations will require public companies to report

Environmental Law Update Editor: Nancy J. Rich, Katten Muchin Rosenman LLP, 525 W. Monroe Street, Chicago, IL 606613693, nancy.rich@katten.com.

Environmental Law Update provides information on current topics of interest in the environmental law area. The editors of Probate & Property welcome suggestions and contributions from readers.

their Scope 1, Scope 2, and certain Scope 3 GHG emissions. Scope 1 emissions are the GHG emissions that a company makes directly (e.g., operating computer equipment, data centers, boilers, and vehicles). Scope 2 emissions are the emissions the company makes indirectly (e.g., heating and cooling buildings by buying electricity or energy from GHG sources).

Scope 3 emissions are all the emissions not associated with the company itself but those for which the company is indirectly responsible, both up and down its value chain (e.g., from buying products from its suppliers and from its products when customers use them). The SEC’s proposed rule would cover Scope 3 emissions when they are “material” and when companies have set reduction targets. As of March 2024, the SEC plans to issue a scaled-back final regulation on March 6, 2024. If the SEC’s final regulation eliminates Scope 3 emissions from its final rule, it would deviate from the European Union’s recent rules, which made Scope 3 disclosures mandatory for large companies beginning in 2024.

Regular watchers of environmental regulatory trends know that California has historically enacted environmental laws and regulations that, in areas

not preempted by federal law, are more stringent than federal requirements. This trend continues regarding GHG reporting. In October 2023, California Governor Gavin Newsom signed three landmark climate disclosure bills that were more stringent than the proposed and anticipated final SEC rules. California’s new laws address (1) GHG emissions reporting in compliance with the Greenhouse Gas Protocol, (2) climate-related financial risk reporting in accordance with the recommendations of the Task Force on Climate-Related Financial Disclosures (TCFD), and (3) disclosure of information about certain emissions claims and the sale and use of carbon offsets.

Although the SEC’s climate disclosure proposal includes GHG Protocol and TCFD requirements, unlike the SEC’s proposed rule, California’s requirements apply to both private and public companies that have business activities in California. The Voluntary Carbon Market Disclosures Act applies to entities that (1) operate and make emissions claims within California or (2) buy or sell carbon offsets within California. A.B. 1305, codified at 26 Cal. Health & Safety Code § 44475.

The Climate Corporate Data Accountability Act applies only to business entities with annual revenue over $1 billion that do business in California. Cal. S.B. 253, codified at 26 Cal. Health & Safety Code § 38532. It requires disclosure of Scope 1, Scope 2, and Scope 3 GHG emissions. Annual reporting of Scope 1 and Scope 2 GHC emissions will be required for covered entities beginning in 2026 (for the 2025 fiscal year). Annual reporting of Scope 3 GHG emissions will be required starting

in 2027. The Climate Risk Reporting Act addresses climate-related financial risks of GHG emissions. S.B. 261 (2023), codified at Cal. Health & Safety Code § 38533. It applies to business entities that do business in California if their annual revenue exceeds $500 million. Disclosure will be required on or before January 1, 2026, and biennially after that.

Environmental Regulations and Policies

Significant recent regulatory actions of the Environmental Protection Agency (EPA) include requiring more stringent particulate emission standards under the Clean Air Act, proposing to regulate certain PFAS as hazardous substances, and issuing a policy to reduce acceptable levels of lead at remediation sites.

More Stringent Health-Based Particulate Matter Standard

On February 7, 2024, EPA revised the primary (health-based) annual standard for PM2.5 from 12.0 parts per billion (ppb or µg/m3) to 9.0 µg/m3. EPA retained the 24-hour standard for PM2.5 and the current primary 24-hour standard for PM10, which protects against coarse particles. EPA is also not presently changing the secondary (welfare-based) standards for fine particles and coarse particles.

Proposed PFAS Regulations

On February 8, 2024, EPA released two proposed regulations addressing PFAS under RCRA. One regulation proposes to list nine PFAS as hazardous constituents under RCRA. The other proposed regulation changes the regulatory definition of “hazardous waste” for the purposes of RCRA’s Corrective Action Program.

If finalized, the new regulations would apply to permitted operators of hazardous waste treatment, storage, and disposal facilities (TSDFs) with solid waste management units required by their permits to take corrective action for releases of hazardous waste and constituents. Although other sections of RCRA reference “hazardous constituents,” EPA expects only negligible

effects because of existing processes and procedures. Future EPA rules may require that other entities that generate, transport, or store PFAS treat their PFAS as hazardous waste under RCRA.

Lead Screening Levels at Certain Remediation Sites

EPA recently lowered the recommended regional screening level (RSL) and regional removal management level (RML) for lead-contaminated soil in residential areas where children live and play from 400 parts per million (ppm) to 200 ppm. EPA recommends using an even lower RSL of 100 ppm in areas with other sources of lead exposure (including lead water service lines and lead-based paint) and areas identified as non-attainment areas for lead emissions under the Clean Air Act. The guidance applies to sites addressed under CERCLA and at RCRA Corrective Action facilities.

RSLs are conservative values used to identify contaminated media (i.e., air, water, or soil) that may require further study. RMLs are generic levels used to define areas, contaminants, and conditions that may warrant a removal action under CERCLA, such as providing alternative drinking water or hot-spot remediation.

“Residential” sites include all areas where children have unrestricted access, including properties where children may live, but also vacant lots in residential areas, schools, daycare facilities, community centers, playgrounds, parks, and other recreational areas.

The regulated community should know that the new guidance can trigger a reopener for Superfund and RCRA Corrective Action sites where lead remedies have already been completed or are underway. In the new guidance, EPA acknowledges that a “significant number of residential properties could undergo evaluation and cleanup because of this guidance.”

Revised Wetlands Regulation and Guidance after Sackett

In May 2023, the US Supreme Court’s decision in Sackett II limited the jurisdiction of EPA and the Army Corps

of Engineers over wetlands. Sackett v. EPA, 598 U.S. 651 (2023) (Sackett II). The Court held that the Clean Water Act’s use of “waters” encompasses only those relatively permanent, standing, or continuously flowing bodies of water forming geographical features that are described in ordinary parlance as streams, oceans, rivers, and lakes. The Court held that the Clean Water Act “extends to only those wetlands that are as a practical matter indistinguishable from [other jurisdictional] waters of the United States.” The Court further stated that for the federal government to assert jurisdiction over a wetland, it must show “that the wetland has a continuous surface connection with that water [i.e., an otherwise jurisdictional water], making it difficult to determine where the ‘water’ ends and the ‘wetland’ begins.”

In August 2023, EPA and the Corps issued a regulation to conform the “waters of the United States” definition to the Supreme Court’s decision in Sackett II. This conforming rule amends the provisions of the January 18, 2023, definition of “waters of the United States” that are invalid under the Supreme Court’s interpretation of the Clean Water Act in the Sackett II decision. The final amended conforming rule became effective on September 8, 2023. 40 C.F.R. § 120.2(a)(4)(ii).

A guidance document issued by EPA and the Corps in November 2023 is arguably more stringent than allowed by the Court’s decision in Sackett II and the August 2023 conforming regulation. The guidance focuses solely on the “continuous surface connection” language of Sackett II and does not discuss the Court’s requirement that the wetland be indistinguishable from water subject to the Clean Water Act. The guidance broadly states that a continuous surface connection may be created by “a discrete feature like a non-jurisdictional ditch, swale, pipe, or culvert” and that such connection results in the wetland becoming subject to the Clean Water Act. As a result, further litigation is likely to attempt to require EPA and the Corps to comply with the Court’s holding in Sackett II n

TECHNOLOGY PROPERTY

Back to the Future of Digital Ink

In the 1989 movie Back to the Future: Part II, Marty McFly is asked to electronically sign on a tablet to make a $100 donation to save the town’s historic clock tower. Fast forward to 2024, and practically everyone uses cell phones, iPads, or tablets. On these devices, each of us engages in hundreds of verified transactions. Most of these transactions are simple contract agreements for a purchase-sale or a service subscription. An increasing number, however, involve workflows for the approval of complex transactional documents, to the point that most modern-day legal closings are now virtual.

Validity of Electronic Signatures

With the rise of electronic commerce over the internet, growth was initially limited by the requirement for “wet ink” signatures. In 1999, to resolve this issue, the Uniform Electronic Transaction Act (UETA) was adopted by the National Conference of Commissioners on Uniform State Laws. To date, UETA has been adopted by every state except New York. UETA essentially said that a contract or signature that is an electronic record cannot be denied legal effect simply because it is an electronic record.

New York chose to implement its own statute, the Electronic Signatures and Records Act (ESRA). ESRA approves electronic records except in the area of estate planning and health care directives. Under the authority of ESRA, New York has established guidelines on the use of electronic records. See https://tinyurl. com/4yd2bsp6.

Technology—Property Editor: Seth Rowland (www.linkedin.com/in/ sethrowland) has been building document workflow automation solutions since 1996 and is an associate member of 3545 Consulting® (3545consulting.com).

Technology—Property provides information on current technology and microcomputer software of interest in the real property area. The editors of Probate & Property welcome information and suggestions from readers.

On June 30, 2000, the Electronic Signatures in Global and National Commerce Act (15 USC 7001) (E-SIGN) was signed into law. E-SIGN extended the validity of electronic signatures to transactions that are part of interstate or international commerce.

The COVID-19 health emergency and shutdown, which began on March 11, 2020, accelerated the trend to virtual closings. During this time period, in person meetings were either discouraged or illegal, and the vast majority of commercial transactions were completely electronic. By the time the COVID-19 health emergency ended on May 11, 2023, digital transactions had spread around the globe.

The United States was not alone. In Japan, where the use of seals, or “hanko” on official documents goes back hundreds of years, offices were forced to re-evaluate their practice of affixing personal or company seals to legal documents. These days, except for birth, wedding, or death certificates, and wills, codicils, and testamentary trusts where blue ink and a pressed notary seal are the standard, electronic signatures are the norm.

Electronic Records vs. Digital Signatures

UETA, ESRA, and E-SIGN talk about the validity of electronic records not being unauthorized just because they

are saved in electronic format. It does not mean that all electronic records have equivalent legal status as binding agreements. A document saved in .docx format in Microsoft word and a paper record that has been scanned and saved as a PDF (portable document format) are both “electronic records.” There needs to be something more to make that electronic record an enforceable contract between the parties. Just as a blue ink signature needs to be verified by witnesses and circumstances, an electronic record also needs to be verified. In fact, given the right process, electronic records can be more precisely verified than paper records.

If you type your name at the end of a contract or paste an image of your signature into a document, it is signed and binding if you intend for it to be binding on you. If, as a secretary or associate, you paste your boss’s signature into a document, that signature is binding on your boss if your boss authorized you to so bind him to that agreement. Such approaches, while binding under the circumstances, are not trustworthy or easily verifiable.

There is a common practice among transactional attorneys to create and circulate signature packages consisting of the execution pages of all documents required in a closing. The affected agreements may include a provision expressly authorizing the agreement to be executed in counterparts. These pages may be printed, signed with wet ink, and then returned or they may be electronically signed and returned to the closer. At the closing, the signature pages are assembled with the underlying final agreements and presented in a package to the parties and their lawyers. In such an approach, it is ultimately the credibility of the lawyers that really authenticates the agreement.

Digital signatures offer a different and better paradigm. Without getting into the technological weeds, a digital signature guards against inauthentic documents being presented as real because the document is tied to a specific signer. It also guards against unauthorized changes being made to the document between the initial presentation and the final execution. Depending on the technology or service you use to sign the document, a wealth of information about the signer travels with the document. At minimum, the information captured with the signature will include the date and time the document was signed, the device on which it was signed, the IP address of that device, and the location where that device was used.

If you are using a personal digital signature certificate, it will also include the certificate ID, which can be used by the issuing authority to get all the information it has on the person who got the certificate. If you are using third-party services like DocuSign (www.docusign.com) or PandaDoc (www.pandadoc.com), you will have access to the information such as the user’s login information, and any authentication or user verification offered or required by that service. If you recently filed your tax returns online, you likely used a website called ID.me and got a certificate verifying you to the government. When I last filed my returns, I had to correctly answer several very personal questions and had to go through a video interview. After that, I was issued an ID and a personal identification number (PIN). Armed with that information, I could then pay my taxes.

At the most advanced level of e-signatures, authentication can use blockchain technology with advanced encryption. The contract becomes a one-of-a-kind certificate. With the signature timestamp on the blockchain, a full history of the participants travels with the document and cannot be manipulated as the document flows through the approval process. This is the approach used by DoxyChain (https:// doxychain.com). Some pundits have predicted that all commercial transactions will become blockchains at some point in the future.

Benefits of eSignature Platforms

eSignature solutions establish trust

between the participants that they are signing the document that they agreed to, even if the participants are on opposite sides of the world. The solution ultimately saves time—the time that participants would have spent traveling to a centralized location to sign in person at a formal closing and money—the cost of managing and monitoring the execution process. eSignature platforms allow asynchronous execution. The signer can sign the document at the time and place of their choosing. The actual execution date and time is recorded with the document in a way that can be independently verified. There is a full audit trail. Though the possibility of fraud can never be entirely eliminated, the risk can be mitigated. The identity of the signer can be verified, including the signer’s authority to sign on behalf of the contracting party. Digitally signed documents cannot be changed. The possibility of signing one document but then being presented with a different document is removed because the signature is part of the document and not just an attachment.

How to Evaluate eSignature Solutions

Not all eSignature solutions are created equal. The solution you choose needs to be evaluated based on specific use cases. Here are some factors to consider in choosing a solution.

Per Envelope Price: Price is always a factor. Most eSignature solutions look at the number of envelopes that you send. An envelope can contain a single document or multiple documents and can be routed to a single signer or a chain of signers. If you do only a few envelopes a month, you will want a service with a low base price subscription. If you expect to send hundreds of envelopes a month, you will want a service that has unlimited envelopes or a very low per envelope price.

If you are sending only a few documents out for execution a month, you may find a signature solution in a service you already use. If you have the subscription service for Adobe Acrobat, you can now sign documents, request signatures, and track responses in real time at no additional charge. If you are not using the Adobe Sign service, be sure to understand

the difference between digital stamping and a full signature workflow.

If you use online document storage, you may already have eSignatures included. DropBox recently bought HelloSign and rebranded it as DropboxSign (https://sign.dropbox.com/). If you have a personal version of Dropbox, you can send three envelopes a month at no extra charge, but with the Essentials or Business offerings you get unlimited signature requests. Similarly, Citrix Sharefile, which purchased RightSignature, is now bundling unlimited eSignatures into their premium cloud storage and file sharing offering (https://www.sharefile.com/ rightsignature). And Box.net includes free eSignatures with all its pricing plans (https://www.box.com/esignature).

Ease of Use: When it comes to signatures, the process must be user-friendly and intuitive. Can the sender understand where to place the signature tags and how to route the envelope to all the parties who need to sign? Will the recipient understand how to sign the document if they don’t already have a login to your eSignature platform? It is always worth getting a free trial login to evaluate the eSignature platform. Just be sure to timely cancel the service if you don’t like it.

Functionality: Here, you need to understand all your use cases. If all you want to do is send an engagement letter out to client, a click through web-form may be enough. But if, in addition to a signed engagement contract, you want to query your client for information required before your initial meeting, you may want to look to a platform that also includes digital forms for gathering information. If your contracts need to go through several persons before final approval is granted, you will want workflow capability that can route the documents to each user and include audit trails so you can identify agreements that are stuck. If you are uploading a package with multiple documents, you may want an envelope template with anchor tags in the document that will automatically flag all the places in the package that require signatures or initials.

Flexibility: Flexibility may be important to your signature workflow. If you want to require the signer to initial each

page of the agreement, your eSignature platform should allow you to add anchor tags in the footer on each page that it will recognize. DocuSign and PandaDoc support custom anchor tags. If you want to route an agreement to your financial comptroller for approval before it is sent out to the counter party, make sure you can require non-signers to approve the document as part of the workflow.

Integration: Documents don’t exist in isolation. They may be drafted with a document assembly tool, or they may exist in a document management system. You will want to reduce the time from drafting to final execution. Some solutions allow you to send directly from your word processor or Outlook. Others require you to upload a document to their eSignature platform. NetDocuments offers a DocuSign integration wherein you can right-click on a document and send it to DocuSign. See https://tinyurl. com/4zdyt8yw. Once the DocuSign process is completed, the fully executed document returns automatically to NetDocuments.

Security and Compliance: Depending on your practice, there may be corporate governance requirements you need to comply with. It may not be enough that the documents are signed. You may want certifications that the platform is compliant with relevant eSignature laws such as E-SIGN Act, UETA, or eIDAS. Don’t assume full compliance. Check out the website and their security documents. If your documents include personal information and are stored on the platform’s website, you are obligated to ensure that the platform complies with law. Platforms like RPost (https://rpost.com) focus on secure delivery of information as well as certification of signatures.

Identity Verification and Authentication: There is a difference between drawing your signature on a tablet to approve a document and requiring the signer to verify its identity. The former may meet the minimum requirements. Although identity verification may slow down the execution process, it may also result in a more easily enforceable agreement. Some eSignature platforms include an option to require use of an independent verification service like ID.me,

AuthenticAte.com, or vouched.id. Others, like OneSpan (https://OneSpan.com), include digital identity verification as part of their offering.

Audit Trails: It can be assumed that an audit trail will identify who signed the documents and when it was signed. But there are several steps between the initial submission of the document and when it is finally executed. The audit trail may include the identity of every person who accessed the document, even if they are not actual signatories. It could include all downloads and online reviews. This information can provide insight into why a document may not yet be executed. In the event of litigation, it could be used to prove awareness of the terms of the agreement by non-signatories.

Workflow and Templates: If your volume is more than occasional, you will want to find an eSignature platform that has templates for transactions that are used on a repeat basis. You will find support for templates in platforms like DigiSigner (www.digisigner.com) or XodoSign (https://eversign.com).

Support: Check the service to understand the level of support it provides. It may be email only or chat-based. There may be a charge for a live support person. Most eSignature platforms are easy to use, so online help, tutorials, and videos may be all you need. Review the offerings. If you have a complex workflow, you may want to find an eSignature consultant to help you design and implement your process.

Mobile Friendliness: All platforms will work with a PC, whether desktop or laptop. But will your eSignature platform allow you to execute the agreement on a cell phone or a tablet? If you want to reduce the friction of signature, having a mobile-friendly platform can be quite helpful. Some platforms like SignNow (https://signnow.com), JetSign (https:// www.jetsign.com), and SignEasy (https:// signeasy.com) got their start as mobile applications.

Scalability and Management Consoles: If your organization is small with only a few authorized signers, almost any system will do. But as your organization grows, you will want to centralize the tracking of executed agreements. You

may need a tool that includes Contract Lifecycle Management (CLM) features. CLM will allow you to access executed agreements as well as gather meta-data from those agreements. Some of the eSignature platforms have added an artificial intelligence feature set that will read and summarize the terms of the agreements, both before execution and after execution.

Form Building: If your practice involves long, heavily negotiated agreements, your needs for eSignature will focus on ease of execution and identity verification. If, however, your company originates most of the paper, you may be interested in some of the more advanced drafting features available in platforms like PandaDoc (https://www. pandadoc.com), SpotDraft (https://www. spotdraft.com), and HoneyBook (https:// www.honeybook.com). If you want serious, rule-based document assembly with eSignatures, you might consider XpressDox (www. xpressdox.com) which has hooks to connect you to many eSignature platforms.

Data Gathering: Several eSignature platforms also offer secure data gathering. You can use a verified form to get information from your clients that meets the privacy act requirements for data gathering and secure storage. Platforms like Jotform (https:// wwwjotform.com), formstack (http:// www.formstack.com), and zoho (https:// zoho.com/forms) start with data gathering but also include authentication options, whereas programs like Adobe and DocuSign let you add custom anchor tags on a document and let you require users to fill these out as part of the execution process.

The COVID-19 pandemic-induced shutdown demonstrated that in-person closings are not actually necessary in the modern world. In many ways, virtual closings and eSignatures are a preferable way of doing business, offering significant savings in terms of time and money. Resistance to the adoption of eSignatures often stems from concern about potential fraud or the possibility that a party to a contract will claim that they were unaware that their signature had been used. It is the responsibility of an attorney to meticulously choose the best eSignature software, both for their firm’s use and to recommend it to their client. The era of relying solely on ink signatures is behind us: Back to the Future is already here. n

Court Finds Substantial Burden under Federal Religious Land Use and Institutionalized Persons Act

Micah’s Way v. City of Santa Ana, 2023 WL 4680804 (C.D. Cal. June 8, 2023), refused to dismiss a complaint that the city violated the Religious Land Use and Institutionalized Persons Act (RLUIPA) by substantially burdening the religious activities of a religious organization. RLUIPA preempts local zoning by providing that “No government shall impose or implement a land use regulation in a manner that imposes a substantial burden on the religious exercise of a person, including a religious assembly or institution” unless the burden furthers and is the least restrictive means of furthering a “compelling governmental interest.” 42 U.S.C. § 2000cc. “Land use regulation” means a zoning law that limits the use or development of land. Id. § 2000cc-5(5).

Micah’s Way, a faith-based Christian ministry, delivers canned food to needy families and snacks and beverages to persons at their Resource Center. After neighbors complained about a needle exchange program that opened two doors away, the mayor directed top city officials to remedy the “acute effect” that Micah’s Way and the needle exchange program have on the neighborhood. After these officials instructed their subordinates to compel these organizations to move or severely curtail their operations, the police department staked out Micah’s

Land Use Update

Editor: Daniel R. Mandelker, Stamper Professor of Law Emeritus, Washington University School of Law, St. Louis, Missouri.

LAND USE UPDATE

Case Law Update

Way and carried out other harassing activities. The city also cited Micah’s Way for code violations and threatened it with “appropriate action.” The mayor expressed his antagonism at a neighborhood meeting. Next, the city refused a Certificate of Occupancy (COO) unless Micah’s Way discontinued food distribution, ignoring a successful appeal to a hearing officer. Finally, Micah’s Way sued the city.

Micah’s Way plausibly alleged that its food distribution activities were “religious exercise” as defined by RLUIPA. They were “an “important part of its Christian ministry” and a “religious path” followed by its members. Micah’s Way also plausibly alleged that the city’s ban on its food distribution activities constituted a “substantial burden” because the city put “substantial pressure” on it to “modify [its] behavior and to violate [its] beliefs.” The city threatened Micah’s Way with “administrative fines” and “criminal prosecution” if it continued to distribute food, and the city continued to refuse Micah’s Way a COO unless it ceased its services for poor and homeless individuals.

Any readily available alternatives would cause “substantial uncertainty, delay, or expense.” Micah’s Way could not relocate because it could not afford to move, and the mayor opposed its operating “anywhere else in the city.”

This case is a good example of zoning strategies that municipalities can use to block religious activities by religious organizations. The Eleventh Circuit has made the substantial burden test even easier to meet. Vision Warriors Church v. Cherokee County Board of Commissioners, 2024 WL 125969, at *8 (11th Cir. Jan. 11, 2024)

(“substantial burden inquiry does not require a Plaintiff to establish an ‘unmet’ religious need in the community, and its religious exercise need not be completely hamstrung to meet the substantial burden threshold”).

Court Refuses Summary Judgment on Complaint that Growth Management Ordinance Violated Federal Fair Housing Act

In Brookline Opportunities, LLC v. Town of Brookline, 682 F. Supp.3d 168 (D.N.H. 2023), the court refused summary judgment on a complaint that moratorium and growth management ordinances violated the Fair Housing Act (FHA) by discriminating against familial status. The FHA prohibits discrimination based on familial status because it is unlawful to “refuse to sell or rent . . . or otherwise make unavailable . . . a dwelling to any person because of race, color, religion, sex, familial status, or national origin.” 42 U.S.C. § 3604(a). The FHA applies to zoning because it makes it unlawful to make a dwelling “otherwise unavailable” to persons protected by the law.

The plaintiffs were developers who planned to build rental workforce housing, which state law requires each municipality to build and which must be affordable for a three-person household with no more than 60 percent of the median income in the county where it is located. Brookline officials and many residents quickly mobilized to oppose the project. At a special town meeting, residents adopted a one-year moratorium on building permits for new housing, thereby blocking the plaintiffs’ project. The rationale of the moratorium was that “continued

development will significantly impact the ability of the Town of Brookline to provide adequate school services.”

Brookline residents adopted a Growth Management Ordinance (GMO) following a study committee report that a “rapid growth rate” would strain school services by raising enrollment. The GMO capped the number of residential building permits available each year, required phasing for developments with more than two proposed dwelling units, and allowed only six permits in a project’s first year and five in each subsequent year. These restrictions required an 80-unit project like the plaintiffs’ to take a minimum of 16 years to complete and precluded financing with low-income housing tax credits.

School capacity was the express reason for enacting the moratorium and GMO. The ordinances were facially and generally applicable, operated by reducing allowable residential construction for all, and did not apply facially in a different way to families with children, either directly or by proxy.

Neither were the ordinances invalid on their face because they had a discriminatory purpose. The town’s stated concern about the impact of residential development on school services was not a mere proxy for familial status discrimination. School impact is not merely a “technical” substitution for families with children.

Neither was facially neutrality destroyed by direct evidence that the town adopted the moratorium and GMO with “an intent to limit housing opportunities for families with children.” Statements in the ordinances and by Planning Board members that the town adopted the ordinances to manage growth in Brookline’s schools did not qualify as direct evidence of discriminatory animus nor as an aversion to families with children. New Hampshire law recognizes that local communities have a legitimate interest in managing growth in their schools. Brookline could have been brought as a case of discriminatory racial impact. The US Supreme Court has held that discriminatory racial impact

is actionable under the FHA. Texas Department of Housing & Community Affairs. v. Inclusive Communities Project, Inc., 576 U.S. 519 (2015). The moratorium and GMO had a discriminatory racial impact. They fell more heavily on Black and Latino minorities than on whites because Black and Latino minorities have incomes lower than whites, and the moratorium and GMO blocked housing intended for households with 60 percent of median income. The town’s reliance on school problems for non-discriminatory purposes is suspicious because the town discovered these problems only after the developers proposed affordable housing.

In a comparable case, the Second Circuit found disparate racial impact when a county rejected rezoning for a 300-unit, mixed-income development where several minorities would likely have been tenants and adopted singlefamily and townhouse zoning instead. Mhany Management, Inc. v. County of Nassau, 819 F.3d 581 (2d Cir. 2016).

Court Upholds Denial of Certificate of Appropriateness for External Façade Alteration in Historic District

Kirwan v. City of Deadwood, 990 N.W.2d 108 (S.D. 2023), upheld the denial of a certificate of appropriateness for altering a historic façade in a historic district. As authorized by state statute, the city created the Deadwood Historic District and Historic District Commission. After establishing a historic district, the statute charges the Historic District Commission to approve or deny a certificate of appropriateness for the alteration of the “exterior portion of any building” located within a historic district. S.D. Codified L. § 1-19B-42.

A saloon owner in the Historic District covered his building’s existing facade with unpainted rough-hewn wood vertical slats made from pine trees harvested from the Black Hills. This exterior alteration differed from the initial painted horizontal wood lap siding design. The alteration reflected the “boomtown” look of buildings built before 1879, but the saloon was constructed after 1879, and the exterior

alteration was inconsistent with the more modern design of buildings constructed after that time. The saloon owner applied to the Historic District Commission for a certificate of appropriateness.

The Historic Preservation Officer reviewed the application and submitted a staff report to the Historic District Commission, concluding that “the proposed work ... does encroach upon, damage or destroy a historic resource and has an adverse effect on the character of the building.” At the Historic District Commission hearing, he cautioned that “altering these traditional elements by introducing non-painted materials and stylistic elements as proposed” would be incompatible with the building’s historic character. The Historic District Commission refused to issue the certificate, and the circuit court affirmed.

On appeal, the supreme court first had to decide on the judicial review standard because the statute authorized appeals from Historic District Commissions but did not prescribe a standard of judicial review. To fill this gap, the supreme court prudentially adopted a clearly erroneous judicial review standard. It observed that this standard is a familiar and acceptable means for routinely reviewing factual findings, which acknowledges a fact-finder’s advantage for weighing evidence and the limitations of a reviewing court.

The supreme court added that the “clearly erroneous” standard fits somewhere between de novo judicial review with no deference and “substantial evidence” judicial review with considerable deference. A court should reverse using clearly erroneous review only if it is definitely and firmly convinced that the Historic District Commission has made a mistake. Other courts differ and have adopted a substantial evidence standard of judicial review for reviewing historic district commission decisions.

The supreme court next considered the statutory “general factors” a Historic District Commission “shall” consider when it decides whether to approve a certificate of appropriateness. These are

the architectural design of the resource and its proposed alteration; its historical significance, condition, and general appearance; the size of the resource and its materials; how these factors relate to and affect the immediate surroundings and “the district as a whole and its architectural and historic character and integrity;” and “the location and visibility of the alteration and resource.” A Historic District Commission must also consider the “compatibility” of an “exterior alteration” with historic and related

resources and the original design. These statutory factors are based in part on the district’s historic character, but they allow a Historic District Commission considerable discretion when making decisions.

The supreme court decided that a Historic District Commission does not have to consider every statutory factor when making a decision and does not have to issue discrete, corresponding factual findings. Without discussing the exterior alteration in detail, the court

deferentially held that the Historic District Commission considered the relevant factors in its decision and that considering similar federal standards was not a basis for reversal. This case has important implications for hearings before Historic District Commissions in South Dakota. It means that applicants who apply for a certificate of appropriateness must prove their case in their hearing before the Historic District Commission because judicial review is limited. n

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CAREER DEVELOPMENT AND WELLNESS

The Importance of Client Service—Tips from a Former Waitress

I once participated in a survey of 150+ attorneys that asked them what was most important to growing their practice. Of the ten options, client service came in seventh. The low ranking given client service is misguided—the practice of law is a service industry and those providing the service will be wellserved to know what that means. For me, client service is Number One, and I credit it to my practice and the firm I have built and maintained.

To get into the field, lawyers take countless classes, study for exams, and hold internships or other legal jobs to prepare themselves. I was no different, but the most helpful thing I did before becoming a lawyer, surprisingly but with hindsight undoubtedly, turned out to be working in the restaurant business as a waitress. Waitressing is a job where it’s clear that customer service can make or break the experience. Through analogy, this article will explain why it’s just as important in the practice of law.

These tips apply as much to the person managing the client relationship as they do to a more junior team member in relation to the supervising attorney (who is their client in this analogy). The supervising attorney can only provide optimal client service if the other team members do the same.

Managing Expectations

Imagine entering a restaurant and being seated immediately but then waiting 45 minutes for someone to come to your table to take your drink order. Or being told your food is coming right out, and it doesn’t appear for another 20 minutes. Compare this to being told there’s a 45-minute wait to be seated, but when you’re seated, you’re immediately greeted, or being told the kitchen is backed up, but could they start you with bread or freshen your drink?

Managing client expectations can avoid a lot of disgruntled clients. This concept doesn’t require immediate attention; it’s about providing a realistic turnaround time so the client can plan accordingly or alert you to exigent circumstances that

Contributing Author: Marissa Dungey is a co-founder of Dungey Doughtery

PLLC,

co-chair of the

RPTE Business

Planning Group, and vice-chair of TE CLE for RPTE.

Responsiveness

may require an expedited timeline. A client is more likely to be dissatisfied if you under-deliver on a promised timetable. In contrast, if you manage expectations with a realistic timeline and then deliver, you’ve kept your promise. When you keep your promises, you build trust and a reputation for being reliable.

It may be that you miss an opportunity because the client needs it faster than you can provide it, but turning away work you can’t do is not only ethical, but also respectful. Admitting as much also builds trust and credibility.

As a waitress, I habitually scanned my section to see if anyone was trying to make eye contact with me. The first thing a restaurant client does when she needs something is look up to find her server. If that doesn’t work, she will call the server or wave a hand to get the server’s attention. If even that doesn’t work, she’ll ask another server or get up to find a server. As you might imagine, responding to eye contact is optimal because it reduces the effort customers have to put in and means their needs are being addressed promptly. The longer it takes to get your server, the more it detracts from the dining experience.

Responsiveness is just as important to clients when it comes to their lawyers. It’s the most essential quality to a client outside of being technically competent. Clients are very appreciative if you answer the phone when a client calls or respond promptly to an email. You may not be able to answer the question immediately or be available to pick up the phone—a good rule of thumb is to respond within 24 hours. If the client has to chase you, it will detract from the experience.

When I hear about a client who is dissatisfied with her counsel, the reason is, more often than not, that it’s too hard to get ahold of her attorney.

Anticipating Needs

The best server brings over or suggests what you’d like even before you ask because the server anticipated the need. If the server has been waiting tables for a long time, the

server’s experience with the needs of other customers should have improved the server’s ability to anticipate. Many of us can relate—consider the difference between having ketchup brought to the table when you ordered French fries compared to your experience ordering French fries and then having to ask for ketchup when they arrive at the table sans ketchup.

Clients LOVE when their attorney anticipates their planning needs and brings proactive planning ideas to them that reflect that the attorney understands their circumstances and planning goals. An attorney can be wellpositioned to do this, particularly when there is a change in case law, pending legislation, proposed rule-making, or the interest rate environment—in other words, a change that’s not specific to the client. The proactive idea comes from knowing the development and being able to apply it to a specific client for whom it’s relevant. Clients will feel well taken care of when asked instead of having to ask themselves.

Of all the examples, this one is the least expected by a client and most challenging for an attorney to find the time, but it only takes one great proactive idea to endear yourself to a client!

Checking In

A server typically checks in on a table periodically throughout a meal. If the customers have not decided on their order, the server gives more time and follows up. Following up and checking in to ensure the customers have what they need is expected and helps move the customers through the meal. The same applies to legal matters. Following up encourages continued engagement on the matter and will facilitate completing the project.

Quality of the Product

The most obvious aspect of client service is delivering the product. A customer of a restaurant expects to receive the meal that was ordered and that it be timely and taste good. It’s also the most obvious aspect of seeking legal services —the clients expect to get what they asked for and that it be done correctly

per applicable laws and regulations. Some projects (and meals) require more technical competency than others, but there are unforced errors relevant to all matters that should be avoided. These include accurately reflecting the terms, spelling names correctly, and gathering and confirming information. Consider how disappointing a dining experience is when the server brings a meal that doesn’t reflect what was ordered. Take the time to get it right.

Multitasking

Like a lawyer, a waiter manages multiple clients at a time, arriving at different times and progressing through their meals at their own pace. This multitasking is efficient because if everyone ordered simultaneously, the bar and kitchen would sometimes be overwhelmed and otherwise in a lull. Maximizing the economics means closing out tables so new customers can be seated; the same is true in progressing and closing out legal matters. Juggling multiple matters at the same time while

still providing optimal client service to each individual client is a critical skill set to master in maintaining and building a book of business.

Client Referrals

Why is excellent client service important? What do you do when you’ve gone to a restaurant where you had a great meal with great service? You tell your friends about it, and then they go. Excellent client service begets more projects from the same client, and those clients recommend you to their friends. A personal recommendation from a friend who is also a client is an easy pitch for an attorney and a near-guaranteed new engagement. In contrast, a bad client service experience means the client probably isn’t going to come back to you, and they may even tell others about the bad experience, resulting in lost opportunities.

Here’s a big tip: great client service is the best marketing you can do, and it doesn’t require marketing time or budget. n

THE LAST WORD

The Problem of Nominalizations

Nominalizations are nouns that are created from a verb or adjective. They provide an opportunity for a writer to use a word that is not a noun as though it were one. The verb “evaluate” becomes the noun “evaluation.” The verb “decide” becomes the noun “decision.” Some gerunds, such as “arguing” in the phrase “their loud arguing kept me up last night,” are also nominalizations.

In legal and academic writing, nominalizations appear frequently, partly because they carry an air of dignity. As one commentator posted, no doubt with sarcasm, “The inclusion of nominalizations may evoke the impression of professionalism.”

Nominalizations aren’t always bad, but they can make sentences harder to understand because the key action that ought to be the verb gets buried in noun form. Verbs propel; nominalizations forestall. For example: “A group of 3L students conducted an investigation of the passive action of the law school’s faculty.” An edit that switches from the nominalization of the action verb “investigated” makes the sentence crisper and shorter: “A group of 3L students investigated the passive action of the law school’s faculty.”

As a student, I was frequently told to choose strong active verbs and to avoid overusing nonspecific verbs such as “be,” “do,” or “have.” At times, I found this advice confusing because it’s difficult to avoid those common and useful verbs. Now the advice makes more sense when understood in terms of the

The Last Word Editor: Mark R. Parthemer, Glenmede, 222 Lakeview Avenue, Suite 1160, West Palm Beach, FL 33401, mark. parthemer@glenmede.com.

problem of nominalizations. Overuse of “to be” is a sign that the important verbs may be hidden in abstract nominalizations.

Can you spot the two nominalizations in the sentence in a fictitious email from a partner to an associate: “It is my requirement that a review of the terms of the contract be done by you.” They are “requirement” and “review,” which I am confident all readers identified. Now, let’s convert those nominalizations into verbs, and make people the subjects of those verbs, to see if the sentence is clearer: “I require that you review the terms of the contract.”

Susie Salmon, the director of legal writing at the University of Arizona, offers an example by Bryan Garner that shows nominalizations can add bulk:

Clunky: The court placed principal reliance on its finding that the existence of official signs as well as state and national flags on the building created the appearance of a government stamp of endorsement on discriminatory conduct. (36 words)

Better: The court principally relied on its findings that the signs and state and national flags hung from the building made it appear that the government endorsed discriminatory conduct. (28 words)

Demolish Nominalizations, Let Verbs Propel Your Prose, Ariz. Attorney (Feb. 2014), p. 10 (quoting Bryan Garner, The Winning Brief 193 (2004)).

In my youth, I was told that “antidisestablishmentarianism,” with its 28 letters and 12 syllables (an-ti-dises-tab-lish-ment-ar-i-an-is-m), is the longest word in the English language. It may not have been the longest, but

even now Oxford Dictionaries Online ranks it the sixth longest word. It is the quintessential nominalization, containing an amazing collection of two verbs, three adjectives, and six nouns.

Laura Graham, a professor at Wake Forest University School of Law, provides a list of common nominalizations and their more powerful verb counterparts.

• made the decision > decided

• made the argument > argued

• made the observation > observed

• made clear > clarified

• made a motion > moved

• made the statement > stated

• made mention of > mentioned

• made the request > requested

• made a ruling > ruled

• made an effort > tried

• made a promise > promised

• gave consideration to > considered

• gave assistance > assisted

• gave an explanation > explained

• gave an answer > answered

• gave an apology > apologized

• conducted an analysis > analyzed Avoiding “Zombie Nouns” (Nominalizations): One Way to Bring “Blah” Legal Writing to Life, N.C. Lawyer Magazine (May 2021). She further shares a quick way to catch nominalizations during your editing process: Add the words “made” and “make” and the words “gave” and “give” to your “hit list” of search terms using Microsoft Word’s “Find” feature. Not all nominalizations begin with these words, but many do. One can nominalize a word that is not a noun so it can be used as a noun, but the art of clear expression typically dictates otherwise. For example, to be clear, don’t say the noun “nominalization” ever; you should use the action verb “nominalize” instead. n

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