United States: West Coast Real Estate Update: Nov. 22, 2016

Susan Booth, Douglas Praw, Karl Lott are Partners, Ashley Jason and Paul Park are Asscociates, Daniel Dow is a Summer Associate and Geoffrey Geddes is a Public Finance Project Manager in the Los Angeles office

Stacie Goeddel and Robert Haight Jr are Partners in the San Francisco office

California Appellate Court Overturns "Sham Guaranty" Defense

The single-purpose entity (SPE) has become a ubiquitous tool in commercial real estate acquisitions and financing in California. Lenders increasingly require a borrower to form an SPE to hold title to the acquired property, reasoning that a single-asset SPE is less likely to become insolvent than an entity that owns and operates several assets.

In addition to "bankruptcy-proofing" their borrower, lenders also regularly hedge their bets by requiring a guaranty from an entity that holds assets sufficiently valuable to cover the lender's potential losses. When the guarantor happens to be affiliated with the borrower, lenders attempting to enforce a guaranty sometimes experience pushback in the form of the "sham guaranty" defense. Affiliated guarantors will argue that they and the borrower are effectively the same entity and therefore should each benefit from California's anti-deficiency protections, which limit recovery to the value of the assets securing the loan.

Last month, the California Court of Appeal (Second District) overturned a Los Angeles County Superior Court decision in which a guarantor successfully asserted the "sham guaranty" defense. In the original case, an SPE formed by a real estate investment fund (the Fund) purchased a retail property. The Fund provided a loan guaranty for the transaction. When a successor lender sought to enforce the guaranty, the Fund refused to pay amounts in excess of the value of the property, asserting that because it had structured the loan and formed the SPE, the Fund was effectively the obligor under the loan. The Fund argued, and the trial court agreed, that the guaranty was therefore a sham, and the Fund should be covered under the applicable anti-deficiency laws. The Court of Appeal disagreed.

According to the appellate court, in order to successfully assert the sham guaranty defense, the lender would have had to provide substantial evidence showing that the Fund was the true principal obligor under the loan and that it had structured the loan with the intent to circumvent anti-deficiency laws. The court ruled that such evidence was not provided at trial.

Regulators Approve Availability of CRA Credits in Historic Tax Credit Projects

The Office of the Comptroller of the Currency, the Federal Reserve and the Federal Deposit Insurance Corporation (collectively, the Agencies) released a notice clarifying that Historic Tax Credit (HTC) financed projects that also meet the requirements for the Community Reinvestment Act (CRA) credit are eligible for CRA credit.

Historically, there has been confusion about whether investments in HTC projects would also be eligible for CRA credit. As a result, members of the HTC industry requested the Agencies create a presumption that activities related to HTC projects also qualify for CRA credit. While the Agencies rejected creating an outright presumption, they did say that "in instances in which loans to, or investments in, projects that receive HTCs do meet the regulatory definition of community development, including the geographic restrictions, the Agencies concur that CRA consideration should be provided."

The HTC program encourages private investment in the rehabilitation of eligible historic buildings by providing federal tax credits to the owners or lessees of those buildings. The HTC program has been used extensively throughout the United States. The California Office of Historic Preservation called it "one of the most successful and cost-effective community revitalization programs which also attracts private investment in historic cores of cities and towns."

The Agencies' guidance provided specific examples of HTC projects eligible for CRA credit, including those that:

  • house small businesses that support permanent job creation, retention or improvement for low- or moderate-income individuals, in low- or moderate-income areas, or in areas targeted for redevelopment by federal, state or local governments
  • provide affordable housing or community services for low- or moderate-income individuals

This added degree of certainty may afford more opportunities for banks and financial institutions to lend to and invest in HTC projects.

Los Angeles City Council Proposes Ban on Sleeping in Cars

The Los Angeles City Council recently voted in favor of drafting an ordinance that would prohibit people from sleeping in a car in a residential area between 9 p.m. and 6 a.m. The vote was nearly unanimous, with 10 city council members voting in favor of drafting the ordinance, one member voting against the ordinance and three absent from the vote.

Two years ago, the U.S. Court of Appeals for the Ninth Circuit struck down a city ban on living in a car, truck or RV parked on public streets. This new ordinance would specify certain industrial and commercial districts within the city as permitted sleeping areas.

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