Court Opinion Reiterates Deference to Trial Court in Confirmation Proceeding

Posted on January 17, 2010 by Kevin Caiaccio

As I wrote back in November, the dramatic fall in real estate values is leading to litigation  involving confirmation proceedings after a non-judicial foreclosure.  Under Ga. law, a creditor is allowed to foreclose on real property without a court hearing or other judicial action.  However, if the lender claims that the foreclosure sale did not fully satisfy the debt obligation and seeks to recover the deficiency, the lender must file a confirmation action which requires a court hearing and testimony as to the fair market value of the property.

The Ga. Court of Appeals issued an opinion earlier this month in Statesboro Blues Development, LLC v. Farmers and Merchants Bank (PDF) which reiterates the deference given to the trial court in determining fair market value.  The case involves a very typical scenario in Georgia:  the borrower purchased a large acreage tract with the intention of developing the property for single-family home lots.  After the residential  market collapsed, the borrower defaulted.  At the time of default, the outstanding loan balance was over $3.5MM.  The bank was the sole bidder at the foreclosure sale (as is usually the case) and bid $2.915MM.  After the foreclosure, the bank sought to recover the deficiency from the borrower and guarantors.

At the hearing, the borrower contested the bank's appraiser's use of comparable sales and his estimate of development costs.  The trial court accepted the appraiser's calculations and found for the bank.  On appeal, the court reiterated Ga. law:  “The trial court is the trier of fact in a confirmation proceeding, and an appellate court will not disturb its findings if there is any evidence to support them.”  Because the trial court found in favor of the bank, the court of appeals held:  "it appears that the opinion is not based on sheer speculation, then this court cannot second guess the methodology utilized to reach the opinion.”

The upshot for future litigation is that the ruling of a trial court will not often be overturned.  The trial court judges are relying on appraisers who are often guessing at fair market value.  The result will be inconsistent rulings based on the leanings of the appraisers and the judges.  In other words, borrowers can only hope for friendly judges.

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Recent Court Ruling Highlights Importance of Co-Tenancy Clauses in Retail Leases

Posted on November 17, 2009 by Kevin Caiaccio

As more retail tenants file for bankruptcy and close shop, surviving tenants in strip centers and malls are increasingly invoking co-tenancy provisions in their leases to pay reduced rent. 

Under a co-tenancy clause, which is a common provision found in many retail leases, a tenant is entitled to either pay reduced rent (typically based on gross receipts), or even terminate their lease, if an anchor tenant or a specified number of smaller tenants close for business and are not replaced by a comparable tenant or tenants within a specified cure period.

Co-tenancy clauses can create a domino effect in a retail center and are causing increased pain for landlords at a time when rents are continuing to fall. Savvy tenants are paying close attention to their co-tenancy clauses in an effort to cut fixed costs as sales continue to slide.  A website, www.co-tenancytrack.com, is assisting tenants in these efforts.  As a result, landlords must identify and work with tenants whose leases include a co-tenancy provision.

A recent Georgia Court of Appeals decision, Rainbow USA, Inc. v. Cumberland Mall, LLC (PDF),  highlights the complexity involved in drafting a co-tenancy clause for Georgia landlords.  In Rainbow, two department stores in Cumberland Mall closed, and the tenant invoked its right under the lease to pay 6% of gross sales in lieu of minimum rent.  The landlord subsequently demolished the JC Penny premises and later constructed a Costco warehouse in a free-standing one-level building adjacent to the mall.  The landlord then sought to return the tenant's rent to the pre-violation level.   On appeal, the court reversed the trial court and held in favor of the tenant .  The court reasoned that because the Costco was a free-standing building, it constituted an outparcel rather than a replacement tenant "in the shopping center."  Therefore, the construction of the Costco store did not remedy the co-tenancy violation created by the closing of the mall anchors.

As indicated by the court's analysis in Rainbow, co-tenancy clauses are often lengthy and complex, and the outcome in any given situation will depend on the specific wording found in the lease.  Because tenants have the leverage in the current economic climate, landlords in lease negotiations must attempt to limit their exposure in the event of a co-tenancy violation.  Specifically, there are several ways in which a landlord may accomplish this:

  1. The landlord should have an adequate period of time (e.g., 90 days) to cure the violation before the tenant may invoke its remedies. 
  2. There should be certain conditions that must remain satisfied while the tenant is paying reduced rent, such as the tenant remaining open for business (in order to mitigate further losses due to co-tenancy violations) and the tenant complying with the other terms of  the lease.
  3. The lease should limit the length of time that the tenant may pay reduced rent.  A typical provision may require the tenant to either terminate the lease or resume paying full rent within 12 months of the violation.  (Although in the current environment, tenants may demand-and receive- longer periods of reduced rent.)
  4. The right to pay reduced rent should be waived if the tenant exercises a right to extend the lease term while the violation exists.

In today's environment, co-tenancy clauses will continue to be put to the test.  Because numerous variables are involved in these provisions, each tenant will have varying rights and remedies depending on the specific wording of their leases.  Many landlords may find that the outcome of these co-tenancy negotiations will be the tipping point in determining whether the landlord survives the current downturn. 

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Recent Developments in Georgia Law Relating to Confirmation Proceedings

Posted on October 11, 2009 by Kevin Caiaccio

Given the dramatic drop in commercial real estate values over the past two years, many borrowers are finding that their loan balances exceed the value of the property at the time of a default.  As a result, there has been an increase in litigation surrounding confirmation proceedings after a non-judicial foreclosure.

Under Georgia law, a creditor who forecloses on real property is barred from seeking a deficiency judgment against the borrower and guarantors unless the creditor files an application for confirmation within 30 days of the date of the foreclosure sale.  There are only two issues in a confirmation proceeding:  (1) whether the sale was properly conducted (i.e., in compliance with legal requirements concerning notice and conduct of sale), and (2) whether the property sold for fair market value.  Most of the cases which are litigated deal with the second issue.  Specifically,  the creditor must show in a confirmation proceeding that the property sold for fair market value.

Concerning the determination of fair market value, recent Georgia appellate cases have held as follows:

These recent cases reiterate that the appellate court will give great deference to the trial court in weighing the evidence of fair market value.  Borrowers defending a confirmation action must be prepared to submit evidence refuting the lender's calculation of fair market value.  The case law indicates that on appeal the court will not overrule the trial judge's ruling if decided on any rational basis. 

Because of the challenges in setting values and the broad discretion afforded to the trial courts, it will be interesting to follow the trends in the court rulings as more confirmation proceedings are contested in the current real estate market.

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