If a condominium unit owner fails to pay a common area maintenance expense assessed against his unit by the condominium association, the delinquent assessment becomes an automatic lien on the condominium unit. In Forest Highlands Community Association v. Hammer, the Pennsylvania Superior Court recently explained that a condominium association cannot execute on the assessment lien without first filing a complaint.

The underlying facts of Hammer are somewhat unclear. After the townhouse owner in Hammer failed and refused to pay the homeowner association’s fees, the association filed a separate lien against the townhouse owner with the Court. The association then somehow obtained a civil judgment in order for there to be a basis for the lien. After the association filed a writ of execution with the sheriff to sell the townhouse to satisfy the money judgment, the townhouse owner filed a motion to strike the writ of execution, claiming that she had never received notice of the delinquent assessment or notice of the lien filed with the Court.

The trial court granted the townhouse owner’s motion to strike the writ of execution upon finding that the record did not show that the association had secured a money judgment against the townhouse owner in advance of attempting to execute on its lien. The association appealed and the case was remanded to the Pennsylvania Superior Court from the Pennsylvania Supreme Court.

Under the Uniform Planned Community Act (UPCA), homeowner associations “ha[ve] within its arsenal of powers: 1) the ability to collect assessments for common expenses from unit owners; 2) to institute litigation in its own name on matters affecting the planned community; 3) to impose and receive payments, fees or charges for the use of the common elements of the Association; 4) to impose charges for late payment of assessments and, after notice and an opportunity to be heard, levy reasonable fees for violations of the Association; 5) to charge a capital improvement fee, annually, for the general common expense to each unit owner; and 6) to exercise all other powers that may be implemented in this Commonwealth by legal entities like the [a]ssociation.”

In order to protect its rights, the UPCA provides that “[t]he association has a lien on a unit for any assessment levied against that unit or fines imposed against its unit owner from the time the assessment or fine becomes due.” An association’s lien is perfected simply by recording its declaration, which also perfects the lien.

APPELLATE DECISION

Since the homeowner association in Hammer was duly recorded, it was undisputed that the association’s lien was perfected on the day the townhouse owner failed to pay her assessments. The appeal thus centered on how the association should have executed on the assessment lien.

The association in Hammer attempted to execute on the lien without instituting a complaint. The association argued that the automatic creation of a lien upon a unit owner’s property for failure to pay assessment fees dispensed with the need to file a complaint and thus allowed the association to seek repayment of the unpaid fees by means of a sheriff’s sale.

The Superior Court did not believe that the association substantially complied with the requirements of UPCA to allow enforcement of Appellant’s assessment lien.

Citing the UPCA, the Superior Court pointed out that an “association’s lien may be foreclosed in a like manner as a mortgage on real estate” and “an association is not precluded from pursuing other avenues to obtain payment of assessments less drastic than foreclosure.” Under the clear language of the UPCA, “an association can avail itself of an action in debt or in contract to collect an assessment.”

In striking the writ of execution, the Superior Court held that the association should have followed the UPCA by filing a complaint, not a second and redundant lien, concluding that the association’s “failure to commence the lawsuit by the filing of a complaint, in contrast to a sheriff’s sale, was its downfall.”

In doing so, the Superior Court rejected the association’s contention “that using a sheriff’s sale to recoup monies claimed due from [the owner] was the proper step to enforce its assessment lien.” Rather, the Superior Court reiterated that “the first step to enforcing an assessment lien is the filing of a foreclosure complaint, action in debt or contract.

Since the association sought enforcement of the assessment lien rather than personally against the townhouse owner, the association was required to file a mortgage foreclosure complaint.

The Superior Court noted there is a world of difference between filing a second lien and a mortgage foreclosure action. The Superior Court pointed out that the procedural requirements for commencing a mortgage foreclosure action are set forth in the Pennsylvania Rules of Civil Procedure and are to be strictly followed.

By following these procedures, the Superior Court reasoned that the townhouse owner would have been unable to contest receiving notice of the action, which she claims never occurred, and would have allowed her the opportunity to question the proper amount, if any, of the assessment lien.

Under this line of reasoning, the Superior Court also found that the writ of execution violated the townhouse owner’s due process rights. The Superior Court stated that the owner failed to receive notice of the alleged debt and was not given means to deny liability.

LESSONS LEARNED

The Superior Court in Hammer was clearly dumbfounded as to why the association attempted to execute on an assessment lien without first filing a complaint. Through its decision, the Superior Court has clearly drawn a line in the sand for any attorneys who represent condominium associations in the enforcement of assessment liens.

Reprinted with permission from the September 25, 2006 edition of The Legal Intelligencer © 2006 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited. For information, contact 877-257-3382, reprints@alm.com or visit www.almreprints.com.

Alan Nochumson

Vertical Position 100%

Natalie Klyashtorny has joined Nochumson P.C.

Klyashtorny’s practice focuses in labor and employment law, commercial and general business litigation, including commercial disparagement, libel and slander, First Amendment and media law.

Prior to purchasing real estate in Pennsylvania, an individual must decide how he intends to own the property. Will he own the property individually, or will he form a corporate entity to hold ownership of the property? The decision should not be taken lightly, as illustrated by a recent ruling handed down by the Commonwealth Court of Pennsylvania.

In Kline v. Commonwealth , the Commonwealth Court found that a husband and wife were obligated to pay realty transfer taxes when they conveyed real property owned by them to their limited liability partnership.

PROPERTY OWNERSHIP

In late 2003, Randal and Carol Kline transferred legal title to 27 properties they personally owned to Randcar, LLP, a Pennsylvania limited liability partnership. The Klines were the sole partners of and owned a combined 100% interest in Randcar, LLP. The Klines formed Randcar, LLP for the sole purpose of transferring the property to the partnership.

For each of the recorded deeds, the Klines claimed a 100% exclusion from realty transfer taxes and no transfer taxes were paid. “The statements of value that were filed with each deed claimed exemption from transfer tax as a ‘corrective or confirmatory deed’ and included the explanation: ‘Grantors and the principals are one and the same, therefore no meaningful transfer of title has occurred and the transfer is therefore exempt under 72 P.S. Section 8102-C.3(4) (see also Commonwealth v. Exton Plaza).’”

The Pennsylvania Department of Revenue subsequently determined that none of the recorded deeds were exempt from transfer tax liability and imposed the 1% state transfer tax, plus appropriate interest, on the value of each of the transferred properties.

After a series of unsuccessful administrative challenges, the Klines filed an appeal with the Commonwealth Court.

APPELLATE REVIEW

On appeal, the Klines contended that, in light of Exton Plaza, a conveyance from a husband and wife to a limited liability partnership is not subject to a realty transfer tax where the husband and wife are the sole owners of the partnership.

In denying the appeal, the Commonwealth Court found the Klines’ reliance on Exton Plaza as misguided.

In Exton Plaza, the Commonwealth Court found that a transfer of real estate from a general partnership to a limited partnership was exempt from transfer tax liability.

The general partnership in Exton Plaza, “for the purposes of becoming a single purpose and bankruptcy remote entity, converted itself into a limited partnership.” In Exton Plaza, the court in Kline noted that “the conveyance was from an association which had decided to change its business form to a newly formed association of another kind which continued to carry out the very same activities”.

The court in Exton Plaza found the transfer was “merely the ’memorialization’ of the conversion from a general partnership to a limited partnership” and concluded that the transfer was “analogous to the exclusion for correctional or confirmatory deed that does not change the beneficial interest in the property.”

The court in Kline was unconvinced that the realty transfer taxes were excluded as a result of the court’s ruling in Exton Plaza. Rather, the court believed that its subsequent decisions in Farda v. Commonwealth and Penn Towers Associates, LP v. Commonwealth were controlling.

In Farda, the court explicitly limited the scope of Exton Plaza. Similar to the Klines, Joseph and Ann Farda were husband and wife who transferred their interest in real estate to a partnership which they completely owned and controlled.

The court rejected the Fardas’ belief that, under “Exton Plaza . . . the transfer tax does not apply . . . because the deed did not transfer a beneficial interest to land to anyone other than to themselves, the grantors.”

In Farda, the court reasoned that “unlike Exton Plaza . . ., the Fardas, as grantors, were individuals, and not a business partnership wishing to change its business form under Pennsylvania law. The deed . . . conveyed legal title to ‘someone other than the grantors’ because the Fardas, as tenants in the entirety, are not Farda Realty, the partnership, an entity governed by the laws for foreign registered limited liability partnerships.”

The court in Farda thus held that a transfer from a husband and wife to a partnership, which they were sole partners, was a taxable event under the Realty Transfer Tax Act.

In Penn Towers Associates, L.P., the Commonwealth Court revisited its decision in Farda. In Penn Towers Associates, L.P., Joseph Soffer had conveyed real estate to a limited partnership. He individually was the sole limited partner with a 99% interest and a limited liability company, owned entirely by him, was the general partner with a 1% interest. Soffer then recorded the deed claiming a 100% exemption from the realty transfer tax because he owned a 100% interest in the partnership and because “the deed in this transaction does not effect a transfer of a beneficial interest in the property to someone other than the Grantor.”

“On appeal, Soffer also cited Exton Plaza in support of his argument that the conveyance was not subject to the realty transfer tax because as the sole owner . . . he effectively transferred the property to himself.”

In rejecting that argument, the court explained that “in Farda, we distinguished the situation in Exton Plaza from that where the Fardas, a husband and wife as grantors, were individuals conveying certain real estate to a limited partnership of which they were the sole partners, not a business partnership wishing to change its business form under Pennsylvania law. Thus, the deed in Farda conveyed legal title to someone other than the grantors because the Fardas were not the same as the partnership to which they transferred the property. . . The situation in Farda is repeated here. Soffer, as grantor, is an individual and is different from Penn Towers, a limited partnership governed by the laws for foreign registered limited liability partnerships. Because the deed in this case, which transferred property from Soffer to Penn Towers, is a conveyance between a partnership and a partner, the transfer is subject to realty transfer tax.”

Relying on Farda and Penn Towers Associates, L.P., the court in Kline pointed out that the Klines were obligated to pay transfer taxes because legal title to the properties passed to an entity other than the Klines themselves.

LESSON LEARNED

In Kline, the court reiterated that an individual conveying real estate to a partnership is a taxable document even if the partners consist of the grantors themselves. The court’s holding is just another example of its insistence on looking at the form rather than the substance of the transfer. In doing so, the court has thus decided that a previously unsophisticated individual may not change the form of ownership without being penalized for his originally imprudent decision.

Reprinted with permission from the August 28, 2006 edition of The Legal Intelligencer © 2006 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited. For information, contact 877-257-3382, reprints@alm.com or visit www.almreprints.com.

Alan Nochumson

Alan Nochumson served as a course planner and faculty speaker at the Continuing Legal Education (CLE) seminar sponsored by Pennsylvania Bar Institute entitled “Fundamentals of Real Estate Practices” which took place in Philadelphia, Mechanicsburg, and Pittsburgh, Pennsylvania.

This program was designed by Nochumson to equip the legal practitioner wishing to develop a real estate practice with the fundamental practical knowledge and information needed to begin that practice.

During the seminar, Nochumson explained the process of obtaining title insurance in Pennsylvania.

Most developers would rather have root canal surgery without Novocain than deal with local governments during the planning stages of a development project. These late night public meetings are commonly filled with the “not in my backyard” folks who are determined to block the project at whatever cost. In the end, many development plans are altered not because of the planning ordinances on the books but rather fear of public backlash.

In Blain v. Township of Radnor, the 3rd U.S. Circuit Court of Appeals refused to allow a property owner’s lawsuit to proceed to trial on a 42 U.S.C.S. Section 1983 claim against the township arising from a zoning dispute which significantly delayed the completion of a subdivision project.

SUBDIVISION APPLICATION

In Blain, the property owner submitted a preliminary subdivision plan for governmental approval. The property owner’s neighbors protested the plan, even though the acreage for each lot exceeded the minimum required by the township ordinance. The township’s planning commission recommended denial of the plan based upon its engineer’s opinion that two other provisions of the township ordinance were not satisfied. The property owner then sought the opinion of the township solicitor, who in a voicemail message to her stated that the plan conformed to the relevant ordinances. In the voicemail message, the solicitor conveyed to the property owner that he had advised the engineer accordingly.

The township’s board of commissioners nonetheless denied the plan based upon the ordinance provisions cited by the engineer.

The property owner then filed an appeal in the Delaware County Court of Common Pleas. The trial court subsequently ordered the board to approve the preliminary plan on the basis that the denial was legally insufficient. Although the township appealed the trial court’s ruling, the appeal was withdrawn before briefing.

After the appeal was withdrawn, the property owner submitted a final plan for township approval. During planning commission meetings, the commissioners proposed three changes: “adding a sewer line benefiting homes outside the subdivision property; limiting construction on Saturdays; and creating walking paths across the property.” A commissioner even threatened to condemn some of the land for walking paths if the property owner did not acquiesce to the requests. Despite the proposed changes and condemnation threats, the plan was approved without amendment.

SECTION 1983 CLAIM

The property owner then filed a Section 1983 claim in federal court against the township and the other related governmental entities.

On summary judgment, the district court dismissed the action, finding that no violation of substantive due process occurred because the township’s conduct did not rise to the level of shocking the conscience. The property owner then appealed the dismissal of the case to the 3rd Circuit.

The 3rd Circuit reiterated that “[i]n land-use cases, only executive action that ‘shocks the conscience’ constitutes a substantive due process violation.”

In a theme running throughout Blain, the 3rd Circuit found that “application of the ‘shocks the conscience’ standard in this context . . . prevents [federal courts] from being cast in the role of a ‘zoning board of appeals.’”

The 3rd Circuit also warned that “’the kind of disagreement that is frequent in planning disputes’ would not be the kind of disagreement leading to a substantive due process violation’”, such as “applying requirements to [the burdened] property not applied to other properties, making unannounced and unnecessary inspections and enforcement actions, delaying permits and approvals, improperly increasing tax assessments, and ‘maligning and muzzling’” the burdened property owners.”

The 3rd Circuit then listed the following land use activities which would actually ‘shock the conscience’: “corruption or self-dealing, hampering development to interfere with otherwise constitutionally protected activity, bias against an ethnic group, or a ‘virtual taking’”.

In Blain, the 3rd Circuit believed that the zoning dispute fell into the former category in that the “frivolous or non-meritorious appeal, condemnation threat, conflict of interest, and improper denial of a subdivision plan alleged . . . d[id] not rise to the level of impropriety to shock the conscious.”

The 3rd Circuit first rejected the property owner’s contention that the township’s board of commissioners “were merely faced with performing a ministerial act, and ‘failure to perform a ministerial act is per se improper’”.

Citing provisions of the Municipal Planning Code (MPC), the property owner believed that “the statute make[s] approval of subdivision plans that conform to an applicable ordinance mandatory.” The 3rd Circuit rejected this narrow interpretation of the MPC, noting that the cited provisions only created the manner by which and the time in which a zoning authority may perform its statutory obligations under the MPC (i.e., “written communication to the applicant and adherence to ordinance provisions.”

In contrast, the 3rd Circuit found that the township ordinances cited by the engineer during the zoning dispute actually “grant[ed] the discretion that the MPC does not limit”, in that the ordinances “mandate[d] that, ‘in interpreting and applying the provisions’” thereof, the “provisions will ‘be held to be the minimum requirements for the promotion of the public health, safety, comfort, convenience and general welfare.’” The 3rd Circuit noted that “the explicit reference to ‘minimum requirements’ suggest[ed] the board may be guided by considerations of ‘the promotion of the public health, safety, comfort, convenience, and general welfare.’” The Third Circuit ultimately found that the ordinances allowed the zoning board to “’consider’ and ‘weigh’ the impact of a particular subdivision plan”.

The 3rd Circuit’s refusal to overrule the district court’s findings of facts also evidenced the 3rd Circuit’s reluctance to intrude upon the zoning board’s discretion.

The 3rd Circuit first discussed the findings of fact surrounding the township solicitor’s interpretation of the ordinances which were left on the property owner’s voicemail. The 3rd Circuit agreed with the district court’s determination that the township’s decision to ignore its solicitor’s legal advice and failure to seek any formal professional advice was “improper” and rose to the level of negligence, but did not shock the conscience.

The 3rd Circuit then rejected the property owner’s contention that the appeal of the state trial court’s ruling was ‘admittedly frivolous.’” The 3rd Circuit pointed out that the property owner’s argument “center[ed] not on whether the appeal itself was frivolous, but rather on the motive for appealing, and bases its understanding of the [t]ownship’s motivation primarily on its withdrawal of the appeal before briefs were due and on the Township’s failure to write a brief.” In accepting the district court’s finding of fact, the 3rd Circuit ruled that that “[t]he standard for determining whether an appeal is frivolous is an objective one, and motivation is not an issue.”

The 3rd Circuit also refused to give much credence to “the board’s attempts to exact the addition of a sewer line and to limit Saturday construction”, concluding instead that “the final approval did not include these restrictions” and that the proposed restrictions were not so ‘patently egregious’ that there could not be a legitimate reason for their imposition.

The 3rd Circuit finally sidestepped the board’s threat to condemn portions of the property for walking trails because the “[b]oard ha[d] the power of eminent domain, and was not threatening action outside the scope of its own authority.

LESSONS LEARNED

The 3rd Circuit in Blain ultimately refused to the lower the due process standard to punish local governments which sometimes act irrationally and recklessly. By doing so, the federal courts allow local governments to continue this type of behavior without repercussion.

Reprinted with permission from the July 24, 2006 edition of The Legal Intelligencer © 2006 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited. For information, contact 877-257-3382, reprints@alm.com or visit www.almreprints.com.

Alan Nochumson

Vertical Position 100%

In planned communities, property owners share the cost of maintaining the common elements through assessments charged by the property owners association.

In Locust Lake Village Property Owners Association v. Wengerd, the Commonwealth Court recently found that a property owner’s obligation to pay these assessments may not be discharged simply because the unit was purchased at a judicial or tax repository sale.

In Wengerd, the property owners had purchased several units in a planned community through judicial and repository tax sales. After acquiring the units, the Association attempted to collect annual dues and assessments from them as unit owners. The Association only sought charges that came due after the property owners acquired title to the units. They nevertheless refused to pay the dues and assessments claiming that, under the Real Estate Tax Sale Law, the restrictive covenants and express and implied easements otherwise obligating them to pay such charges extinguished as a result of the judicial and tax repository sales.

The Association thereafter filed separate lawsuits in state court against each property owner for the dues and assessments. The Association subsequently sought summary judgment against them on the basis that, under the Uniform Planned Community Act (UPCA), it had the power to collect assessments for common expenses from the property owners and that “[t]here is no authority for the proposition that a judicial or tax sale will affirmatively remove or negate covenants running with the land, including those requiring payment of association assessments.”

After the trial court granted summary judgment in the Association’s favor, the property owners appealed the trial court’s ruling to the Superior Court, which transferred the appeal to the Commonwealth Court.

In upholding the trial court’s ruling, the Commonwealth Court concluded that, despite the judicial and tax repository sales, the property owners remained liable for the dues and assessments charged by the Association because the Real Estate Tax Sale Law did not trump the UPCA.

The Commonwealth Court first addressed whether the easements and restrictive covenants requiring payment of the dues and assessments are interests in real property would fall within the meaning of the term ‘estates’ as used in the Real Estate Tax Sale Law. Under the statute, any property sold at a judicial or tax repository sale is conveyed “free and clear of all . . . estates of whatsoever kind.”

Since the Real Estate Tax Sale Law does not define the term “estate”, the Commonwealth Court looked at Black’s Law Dictionary and the First Restatement of Property for guidance.

Black’s Law Dictionary describes an ‘estate’ as “[t]he amount, degree, nature, and quality of a person’s interest in land or other property.”

According to the First Restatement of Property, the term ‘estate’ is an interest in land which “is or may become possessory” and “is ownership measured in terms of duration.” The explanatory comments to the Restatement explain that “[s]uch interests as easements, profits, restrictive covenants and agreements affecting the use of land, powers of appointment and rents are not possessory interests and are not interests which may become possessory.”

Relying heavily on the explanatory comments to the Restatement, the Commonwealth Court concluded that “[c]ovenants running with the land and easements are not ‘estates’ within the meaning of the Real Estate Tax Sale Law because those interests are non-possessory.”

The Commonwealth Court refused to expand the scope of the statute beyond its literal meaning, noting that “[i]f the General Assembly had wanted covenants and easements to be extinguished at the time of judicial and repository tax sales, it could have specifically so stated.”

The Commonwealth Court also found the Supreme Court of Pennsylvania’s ruling in Tide Water Piping Company v. Bell as instructive. In Tide Water Piping Company, the Supreme Court held that a right-of-way was not discharged by a treasurer’s sale in light of an earlier tax sale statute. The Supreme Court in Tide Water Piping Company “[fou]nd nothing . . . to cause [it] to differentiate a tax sale from other judicial sales and, as such, “if land is sold for taxes, an easement, servitude, or interest in the nature of an easement, is not destroyed, but the purchaser takes subject thereto.”

The Commonwealth Court then flatly rejected the property owners’ contention that the trial court “erred in finding that they gained easement rights over the subdivisions’ common elements and facilities when they acquired their units, because their tax claim deeds do not refer to a subdivision plan or a development plan.”

In doing so, the Commonwealth Court stressed that the property owners readily admitted that the restrictive covenants at issue are contained within the chain of title for their deeds and that “the law is clear that a grantee is chargeable with notice of everything affecting his title which could be discovered by an examination of the records of the deeds or other muniments of title of his grantor.”

The Commonwealth Court emphasized that the property owners’ “failure to perform the requisite due diligence is to their own detriment, where the tax claim bureau deeds contain lot and section numbers as well as other information presumably associating the properties with” the Association.

As the final death knell, the Commonwealth Court found their obligation to pay the dues and assessments to be even more compelling considering that, in Spinnler Point Colony Association v. Nash, it had previously forced unit owners to pay assessments even though the chain of title did not refer to the unit owners’ association. The Commonwealth Court in Wengerd cited the following passage of Spinnler Point Colony Association: “residential communities . . . are ‘analogous to mini-governments’ and as such are dependent on the collection of assessments to maintain and provide essential and recreational facilities. When ownership of property within a residential community allows the owners to utilize the roads and other common areas of the development, there is an implied agreement to accept the proportionate costs for maintaining and repairing these facilities . . . If we were to find to the contrary, lot owners would be able to avoid their duty to pay assessments, and because associations would be powerless to operate, the facilities of a development would fall into disrepair.”

LESSONS LEARNED

The Commonwealth Court in Wengerd rightfully blocked the property owners’ attempt to unilaterally discharge their obligation to share the financial burden of maintaining and operating the planned community. Property owner associations have been empowered by the state legislature to serve as mini-governments.  The assessments are a form of taxation. Similar to taxpayers, as evidenced by the property owners in Wengerd, unless required to do so, property owners will resist paying their fair share of maintaining and operating their community.  Since these property owners clearly enjoyed the benefit of the common elements, the Commonwealth Court refused to allow them to escape the burden.

Reprinted with permission from the June 20, 2006 edition of The Legal Intelligencer © 2006 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited. For information, contact 877-257-3382, reprints@alm.com or visit www.almreprints.com.

Alan Nochumson

Vertical Position 100%

With residential new construction exploding throughout the Philadelphia region, many individuals may be unwittingly placing themselves on the hook for unwanted realty transfer taxes when they purchase an undeveloped parcel of land and construct the home of their dreams on that land.

In a rather informative pamphlet titled Commonly Asked Questions: PA Realty Transfer Tax & New Home Construction, the Pennsylvania Department of Revenue states that “[t]he value of a construction contract is subject to the Realty Transfer Tax when . . . an executory construction contract for building a house is effective prior to or contemporaneously with the transfer of the title to a building lot and . . . . the seller and the builder are affiliated in some way.”

According to the Department of Revenue, an ‘executory’ construction contract is “when the purchase takes title to a lot” and “is legally bound to build a house with a specific builder.” The Department of Revenue points out that an affiliation between the seller and contractor may be created by agreement or common ownership.

In the pamphlet, the Department of Revenue sets forth the following examples of an agreement between the seller and contractor causing an affiliation implicating the realty transfer tax:

• an existing contract for the construction of the house between the seller and the builder that is assigned to the buyer;
• options to purchase or buy a lot or lots given by the seller to the contractor;
• rights of first refusal to buy a lot or lots given by the seller to the contractor;
• agreements of sale for a lot or lots given by the seller to the contractor;
• written agreement designating the contractor as the only builder that can build houses on the lots;
• agency agreement whereby the seller acts as an agent for the contractor in selling a lot or lots to the buyer;
• an agency agreement whereby the contractor acts as an agent for the seller in selling a lot or lots the buyer; or
• a partnership agreement or joint venture agreement between the seller and contractor to develop the lots.

The Department of Revenue then lists the following examples where common ownership between the seller and the contractor may cause such an affiliation:

• seller or close relative is a shareholder or partner in the contractor;
• contractor or close relative is a shareholder of a partner in the seller; or
• seller and contractor are owned in whole or in part by the same individuals or entities.

Not all of the affiliations listed by the Department of Revenue may be readily apparent by a buyer. To illustrate, an unsuspecting buyer who purchases an undeveloped lot may use a builder recommended by the seller. Assuming the buyer pays the builder fair consideration for the construction work, if the seller or close relative is a shareholder or partner in the contractor, or vice versa, the buyer would still incur an additional tax burden, even if that buyer was unaware of that relationship when he made the decision to the use the builder.

In order to avoid paying for the value of the construction work, whenever a buyer purchases undeveloped land and constructs a new house onto the land, he should make sure he fully understands the “affiliation”, if any, which may exist between the seller and contractor.

RECENT COURT DECISION

In Harmon Homes, Inc. v. Commonwealth, the Commonwealth Court recently rejected a seller’s attempt to use the “turnkey project” exemption of Pennsylvania’s Realty Transfer Tax Act in order to avoid paying realty transfer taxes for the value of the construction work.

On February 4, 2002, Harmon Homes filed a deed dated January 28, 2002 with the recorder’s office in Monroe County transferring two lots in a planned community to Gerald L. Robbins, Jr.  According to the deed, the lots were purchased for $40,000. When the deed was recorded, a realty transfer tax of $400 was paid. On the day that the lots were conveyed to Robbins, he entered into a separate contract with P.P.F. Homes, Inc., an affiliate of Harmon Homes, for the construction on the lots of a home at a cost of $138,000.

On February 24, 2002, Robbins conveyed the lots to One Stop Realty, Inc. for nominal consideration. When the deed was recorded the following month, the parties presented a Statement of Value exempting the transfer from taxation as a “turnkey project”. Under the “turnkey project” exemption, “[a] transfer of realty to a developer or contractor who is required by contract to reconvey the realty to the grantor after making contracted-for improvements to the realty is not taxable if no beneficial interest is transferred to the developer or contractor. The reconveyance to the grantor is also not taxable.”

Upon completion of the home’s construction, One Stop Realty conveyed the lots back to Robbins for nominal consideration. At recording, the parties once again claimed that the transfer was a turnkey project and not taxable.

The Department of Revenue subsequently notified Harmon Homes of its determination that it owed additional tax on the January 28, 2002 lot transfers to Robbins. The Department explained that the lots had a value of $178,000, not $40,000 as indicated in the State of Value, because Robbins also contracted for the construction of a home on the land received from Harmon Homes on the same day Robbins purchased the lots. After administrative appeals were rejected, Harmon Homes then appealed the Department’s ruling to the Commonwealth Court.

Harmon Homes argued that the value of the building contract executed by Robbins was irrelevant to his purchase of the lots from Harmon Homes because Robbins did not own the lots while the home was being constructed and that Robbins’ conveyance to One Stop Realty separated the value of the executory contract from the value of the real estate conveyed by Harmon Homes to Robbins.

In upholding the administrative ruling, the Commonwealth Court heavily relied on its previous decision in Pennsylvania Builders Association v. Department of Revenue. In Pennsylvania Builders, the Court flatly rejected taxpayers’ argument that an agreement to make future improvements to land does not convey an interest in real estate and, thus, should not be subject to the transfer and instead concluded that Pennsylvania’s Realty Transfer Act “was intended to tax ‘all new home sales uniformly on the full monetary worth of the interest in real estate conveyed.’”

Although the transfers from Robbins to One Stop and back to Robbins were obviously exempted from taxation as a turnkey project, the Commonwealth Court emphasized that it did “not follow that because one part of the transaction by which Robbins acquired his home and land fit the exemption for a turnkey project, that the entire transaction can be considered a turnkey project.”

The Commonwealth Court rather determined that “[t]he intervening transfer to One Stop Realty had no effect on the value of the transaction between Harmon Homes and Robbins that took place on January 28, 2002. When the deed for the transfer from Harmon Homes to Robbins was recorded, the executory building contract was in effect and, thus, the value of the realty subject to the recording included both the combined value of the newly constructed home and the lots.”

LESSON LEARNED

Purchasers of undeveloped land who construct the house of their dreams on that land must be wary of creating the ultimate nightmare of owing realty transfer taxes on the value of their newly constructed home. Only through due diligence and proper planning can these purchasers reap the benefits of the increase in the fair market value of their newly constructed house and adjoining land without giving the state government an unnecessary windfall.

Reprinted with permission from the May 22, 2006 edition of The Legal Intelligencer © 2006 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited. For information, contact 877-257-3382, reprints@alm.com or visit www.almreprints.com.

Alan Nochumson

Vertical Position 100%

Agreements of sale generally contain a laundry list of contingencies which must be satisfied before the settlement date. Most, if not all, of these contingencies allow the buyer to escape from an otherwise unfavorable real estate transaction.

In Watson v. Gerace, the United States Court of Appeals for the Third Circuit recently prevented homeowners from exploiting a mortgage contingency clause contained in an agreement of sale.

SELLERS CANCEL SALE

J. Scott Watson and Laura Watson, who owned the second floor apartment in a duplex in Ocean City, New Jersey, executed a written agreement to sell their apartment to Joseph and Donna Gerace for $665,000. Under the terms of the contract, the Geraces placed $15,000 in escrow and agreed to pay the balance with cash and a $532,000 mortgage.

The contact was a standard form prepared by a real estate company which represented the parties involved through separate agents.

Clause 6 of the contract contained a provision entitled “Mortgage Contingency.” According to Clause 6, “[t]he Buyer’s obligation to complete this contract depends on the Buyer getting a written commitment of an established mortgage lender, or the Seller, as the case may be, to make a first mortgage loan on the property in the principal amount of $ 532,000.00. . . . The Buyer shall supply all necessary information and fees asked for by the lender. The commitment must be received by the Buyer on or before March 22, 2004. . . . Should the buyer not receive the written commitment by the above date then this Contract shall be null and void and all deposit money will be returned to the Buyer; unless the commitment date is extended by Buyer and Seller. The Buyer, at his option, can waive this mortgage contingency at any time. . . . Any mortgage commitment signed by the BUYER will satisfy this mortgage contingency.”

On March 10, 2004, the Geraces obtained a “Credit Approval Letter” from Wells Fargo Home Mortgage, which they signed on March 13, 2004. The letter stated “Congratulations! Your loan application has been approved subject to the terms and conditions included on this credit approval letter. A commitment letter will be forwarded to you by your Mortgage Specialist, once an appraisal report has been reviewed by the Lender.”

The letter contained a number of conditions, including: a verification of the Geraces’ financial status; an appraisal of the property indicating a market value of the agreed upon purchase price; and documentation approving a second mortgage of $33,250.

On March 23, 2004, the Watsons contacted their agent to inquire about the status of the mortgage commitment. They advised him to inform the Geraces that the contract would be considered null and void unless the commitment had been received by him. The following day, the agent faxed a copy of the Credit Approval Letter to the Watsons. Afterwards, the Watsons stated that the letter was unacceptable to them and that the contract was null and void. They then requested that their agent re-list the property for sale.

The Geraces nevertheless appeared at the originally scheduled closing. The Watsons, instead of appearing at the closing themselves, filed a complaint in federal court. In their complaint, they requested a declaratory judgment that the contract was null and void.

In response, the Geraces filed an action in the Superior Court of New Jersey for breach of contract, requesting damages and specific performance. The state court case was eventually removed to federal court and consolidated with the Watsons’ declaratory judgment action. Both parties eventually moved for summary judgment. The district court granted summary judgment for the Geraces primarily on the finding that the Credit Approval Letter satisfied the mortgage contingency clause.

THIRD CIRCUIT SIDES WITH BUYERS

On appeal, the Third Circuit upheld the district court’s ruling strongly stating that “[i]t was in writing, it was received by the Buyers before the deadline, and the loan it approved met the stated financial criteria.”

The Third Circuit summarily rejected the Watsons’ argument that the Credit Approval Letter was not a “mortgage commitment” because it did not definitely bind Wells Fargo to fund the mortgage. Instead, the Third Circuit found that, “[w]hile the Credit Approval Letter does refer to a separate ‘commitment letter’, it is clear from its language that it binds Wells Fargo, subject only to specified conditions.”

The Third Circuit also found the Watsons’ reliance on a line of cases standing for the proposition that a conditional commitment cannot satisfy a mortgage contingency clause as misguided, to say the very least. The Watsons argued that, because the second mortgage and the appraisal were outside the control of the Geraces, the commitment was too uncertain. The Third Circuit found the cited cases as inapposite because, in those cases, the mortgage contingency clauses were conditional on the successful sale of the buyers’ previous homes.

The Third Circuit noted that “[t]here, unlike here, the conditions not only had a substantial likelihood of nonfulfillment through no fault of the buyers, but actually failed before the deadline in the mortgage contingency clause. In contrast, the conditions were both likely to be and actually were fulfilled. The second mortgage was also issued by Wells Fargo; the Credit Approval Letter refers to it as ‘a component of this transaction.’ There is no evidence in the record that there was any genuine risk that the second mortgage would not be available. The appraisal could have blocked the mortgage commitment only if it had been for a value beneath the agreed sales price.”

In all, the Third Circuit emphasized that the Geraces “had the undisputed ability to comply with the remaining conditions, were under a good-faith duty to do so, and did comply with them.”

The Third Circuit also seemed perplexed as to why the Watsons had any right to cancel the agreement of sale per the mortgage contingency clause. The Third Circuit first stated that the Geraces, under the contract itself “had sole and unfettered discretion to determine whether the mortgage contingency they received was sufficient.” The Third Circuit pointed out that the contract specifically provided that “[a]ny mortgage commitment signed by the BUYER will satisfy this mortgage contingency.”

In a forcefully worded rebuke to the Watsons, the Third Circuit ruled that “[t]he Buyers found the Credit Approval Letter sufficient and signed it. The Buyers had the option to waive the mortgage commitment entirely, strongly suggesting that they could waive it to whatever extent the mortgage commitment was insufficient. Further, the mortgage contingency clause makes the mortgage commitment a condition precedent to the Buyer’s ‘obligation to complete this contract,’ indicating that the mortgage contingency clause operates for the Buyers’ benefit.”

PENNSYLVANIA LAW

The standard forms approved by the Pennsylvania Association of Realtor (PAR) are used for most residential real estate transactions in Pennsylvania. Paragraph 6 of the standard agreement contains the mortgage contingency clause. If the parties elect to include the mortgage contingency clause as part of the agreement, the buyer must list, among other things:

1. The loan amount of the mortgage(s);
2. The minimum term of the mortgages(s);
3. The type of the mortgage(s);
4. The mortgage lender(s); and
5. The maximum acceptable interest rate of the mortgage(s).

Under the terms of the agreement, the buyer is required to complete a mortgage application within an agreed upon period of time from the date of the agreement is fully executed by the parties.

If the buyer fails to apply for a mortgage within the agreed upon time period, he is in default of the agreement. The buyer is also in default of the agreement if he furnishes false or incomplete information concerning his legal or financial status or fails to cooperate in good faith in processing the mortgage loan application which results in the mortgage lender refusing to approve a mortgage commitment.

1. After receiving the mortgage commitment, the seller may only terminate the agreement if:
2. the commitment is not valid until the date of settlement;
3. the commitment is conditioned upon the sale and settlement of any other property;
4. the commitment does not contain the mortgage financing terms agreed by the buyer in the agreement itself; or
5. the commitment contains other conditions not specified in the agreement other than those conditions that are customarily satisfied at or near settlement, such as obtaining insurance and confirming employment status.

LESSONS LEARNED

In Pennsylvania, a seller, under the PAR form agreement of sale, clearly has the right to terminate the agreement if the buyer fails to obtain the mortgage commitment as set forth in the agreement. As such, buyers in Pennsylvania should be wary of a homeowner who suddenly succumbs to seller’s remorse.

To illustrate, if the parties in Watson had used the PAR form agreement of sale, the sellers would likely have been allowed to cancel the agreement per the mortgage contingency clause.

The Watsons attempted to terminate the agreement because the mortgage commitment was conditioned upon the Geraces receiving a second mortgage, among other things. Under the PAR form agreement of sale, the Geraces would have been required to reveal whether they intended to finance the sale through a single mortgage or two separate mortgages. If the buyers had not decided on applying for two separate mortgages, the sellers would have been able to cancel the agreement because the buyers could not admittedly have financed the sale without obtaining a second mortgage.

Unlike the agreement in Watson, the PAR form agreement of sale does not allow a buyer to waive the mortgage contingency once the provision is included in the executed agreement. Under the plain and unambiguous terms of the agreement, the Geraces could not have simply waived the contingency (which they ultimately did) after failing to obtain the agreed upon financing, placing them in default of the agreement and, therefore, giving the Watsons the ability to simply cancel the sale without judicial intervention.

Reprinted with permission from the April 24, 2006 edition of The Legal Intelligencer © 2006 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited. For information, contact 877-257-3382, reprints@alm.com or visit www.almreprints.com.

Alan Nochumson

Vertical Position 100%

Local governments are given wide latitude in outsourcing their government services to private independent contractors. Pennsylvania courts generally shy away from challenges by the citizenry with respect to the amounts paid on government contracts.

In a prime example, the Commonwealth Court of Pennsylvania in M&D Properties, Inc. v. The Borough of Port Vue recently rejected a landlord’s constitutional challenge to garbage collection fees assessed by the Borough against its apartment complex.

Under the Borough ordinance, all domestic refuse accumulated upon any property within the Borough had to be collected and removed either by the Borough or an approved independent contractor. Since the early 1990s, the Borough contracted with a private contractor to perform that function by through a public bidding process and selecting the lowest bidder from interested trash collection companies. The annual fee charged by the Borough to owners of real estate for trash collection was $105 per dwelling unit.

M&D owned and operated an apartment complex located in the Borough consisting of 72 single-family units. The apartment residents were responsible for depositing their trash into the dumpsters located within the complex. In accordance with the ordinance, the Borough levied, and M&D paid, the annual trash collection fee of $105 for each of the 72 units in the apartment complex.

TRIAL COURT’S RULING

In 1993, M&D filed a complaint challenged the ordinance on the grounds that the Borough’s annual garbage collection fee was “arbitrary, irrational, unreasonable, confiscatory, and not related to the Borough’s incurred costs of collection of trash.” In support of its claim, M&D offered bids it obtained from two private trash haulers for collection of garbage at the apartment complex. Both bids were for less than half of the $105 per dwelling unit.

After judgment was entered in M&D’s favor, the Borough filed a motion for post-trial relief, which was granted, and the case was retried as a de novo non-jury trial. At the new trial, the judge found that M&D failed to sustain its burden of proof that the Borough’s trash collection fee was unreasonable.

On appeal, the Commonwealth Court directly confronted the reasonableness of the assessed trash collection fees.

Under Pennsylvania law, “fees charged by a municipality for services rendered are proper if they are reasonably proportional to the costs of the regulation or the services performed. A municipality may not use its power to collect fees for a service as a means of raising revenue for other purposes. The party challenging the reasonableness of a fee bears the burden of proving it is unreasonable.”

The Commonwealth Court first addressed M&D’s argument that the Borough’s annual fee of $105 dwelling unit is unreasonable when compared to the proposals from two independent contractors to provide trash collection service to the apartment complex for half of the fee.

Agreeing with the trial court’s determination that the evidence submitted did not support M&D’s conclusion that the Borough’s fees was unreasonable, the Commonwealth Court pointed out that the “fees cover[ed] more than just the contractual payments to its designated trash hauler” and that “[t]he fee also include[d] overhead expenses borne by the Borough for personnel, billing, collection, regulation, inspection and enforcement costs.” The Commonwealth Court emphasized that “[a]ny assessment of the reasonableness of the Borough’s $105 fee must take into account whether the fee is ‘reasonably proportional’ to all of the costs associated with trash collection, not just one part of those costs.”

The Commonwealth Court also rejected M&D’s heavy reliance on the Supreme Court of Pennsylvania’s decision in Ridley Arms, Inc. v. Township of Ridley. In Ridley Arms, Inc., the Supreme Court found “that the payment of approximately $58,000 to a municipality for the performance of services which can be, and actually were provided by the private sector for approximately $23,000, less than half the amount charged by government, [wa]s” unreasonable.

The Commonwealth Court found the facts and circumstances in Ridley Arms, Inc. to be distinguishable.

The Commonwealth Court first pointed out that the Township of Ridley conceded that its actual cost per unit for collecting refuse from apartment complexes ranged from “$19.99 to $ 30.00 during the relevant time period, whereas it charged a refuse collection fee of $ 70.00 per unit.” In contrast, the Commonwealth Court noted that the Borough was not “levying a revenue-generating surcharge.”

The Commonwealth also highlighted that the landlord in Ridley Arms, Inc. paid a private contractor for trash removal in addition to paying the township in fees pursuant to the trash collection ordinance. Since “M&D did not pay a fee to the Borough for services which ‘actually were provided by the private sector’ for half the cost”, the Commonwealth Court believed that the trash collection fees were not per se unreasonable.

LESSONS LEARNED

As illustrated by the Commonwealth Court’s ruling in M&D Properties, Inc., the judiciary refuses to second guess decisions made local governments. This foolhardy approach allows local governments to either intentionally or negligently overcharge their residents for government services. Based upon the language of the court opinion, such challenges are better handled through the electoral process rather than the judicial system.

Reprinted with permission from the March 27, 2006 edition of The Legal Intelligencer © 2006 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited. For information, contact 877-257-3382, reprints@alm.com or visit www.almreprints.com.

Alan Nochumson

Vertical Position 100%

Alan Nochumson was a faculty speaker at the Continuing Legal Education (CLE) seminar sponsored by Pennsylvania Bar Institute entitled “Disasters: Planning Ahead to Avoid the Worst” which took place in Philadelphia, Pennsylvania.

During the seminar, Nochumson discussed what sellers, buyers, and even contractors should know when natural disasters strike.