Specific Performance As Legal Strategy
By: Ronald R. Rossi, Esq. and Laurel M. Champion, Esq.
It is often said that the only folks who make money in real estate litigation are the lawyers. While in some instances, unfortunately, that’s true, there are occasions when buyers can make a substantial profit in well-thought-out and strategically planned litigation. Let us tell you about a recent case we handled that demonstrated that fact very clearly.
Our clients were a group of young real estate professionals who buy real property for investment, redevelopment, and holding purposes. They entered into a contract with the seller for a mixed-use project consisting of apartments and retail units in San Francisco in 2012. The property needed repairs and some of the leases were under-market and not as desirable as they could have been, but there was definitely upside potential. Between the time the parties went into contract and the time specified in the contract for closing, the seller realized that the market was rapidly escalating and the property was now probably worth more than the $5,000,000 purchase price, perhaps as much as $1,000,000 more. The seller then tried to back out of the contract in a series of poorly planned and clumsily executed maneuvers.
We advised our clients to sue the seller for specific performance and attendant damages. That put our clients in the driver’s seat – they could control the property at the purchase price or less, and by the time the matter came to trial or arbitration, they could either elect to go through with the lawsuit or dismiss it. This strategy involved the following steps. First of all, a lawsuit for specific performance entitles buyers to record a notice of pendency of action, which prevents an owner from selling the property to anyone else except in extremely rare circumstances. A notice of pendency of action, or a lis pendens, is recorded in the chain of title and operates as notice to any interested party that the property is the subject of litigation and that their purchase is subject to said litigation. Therefore, the buyers were tying up the property at the current contract price of $5,000,000 if the buyers were to prevail in the litigation. As mentioned, if at the time of trial the property had declined in value, the buyers would have the option of dismissing their lawsuit for specific performance.
In another ill-advised maneuver, the seller chose an attorney who did not specialize in real estate litigation to represent him in the lawsuit. The seller played games, his attorney played games, and the case was delayed. Of course, this delay only helped the buyers, because the market continued to escalate.
By the time we went to trial in November of 2015, the property had appreciated by at least $2,500,000. The seller refused to settle, so we went forward with the specific performance and damages case.
The purchase contract in this particular case was a printed form including a provision that the seller would not modify, alter, or renegotiate any of the existing leases on the retail units and apartments after the contract was signed without the buyers’ written consent. The seller, however, being greedy, went ahead and tried to renegotiate the lease of one of the major retail tenants, who was behind in rent to the tune of $100,000. The seller negotiated that down to around $40,000, took the money, and gave the tenant a new lease – all of which was done after the contract was signed but before the lawsuit was filed and the notice of pendency of action was recorded.
To combat this, we focused on how this conduct altered the benefit of the bargain as contracted for by our client. The property was bought at a particular CAP rate, the retail space was substantially under market, and the buyers expected to receive the retail space unencumbered by a lease, given the fact that one of the major tenants was so behind in rent and an eviction would undoubtedly be successful. Thus, we argued that incidental damages should be awarded in addition to a decree of specific performance ordering the seller to convey the property. Additional compensation had to be awarded to the buyer to make the buyer whole, because the buyer bargained for a vacant building but the seller allowed a tenant to pay less than full rent and extend the lease, and the property lost substantial value as a result. During trial, we brought in an expert real estate appraiser who testified that with the old lease in place, and assuming the buyers could not re-rent the retail space at current market rates, the value difference to the building would be worth approximately $1,000,000, utilizing the existing CAP rates.
A number of cases support awarding additional compensation in specific performance lawsuits. These include cases in which buyers have been awarded damages for increased interest rates, for delay in performance due to extended construction contracts, and for fewer acres being sold than contracted for. These cases all support an argument that because the existing retail tenant’s lease was reworked and its term extended with a below-market rent payment, the building was worth less, and those additional damages should be deducted from the seller’s proceeds.
Because the lawsuit dragged on for years, when the case was finally decided, the buyers’ purchase price remained the same ($5,000,000), but there were additional deductions from the price – incidental damages for loss of the retail space at market value in the amount of $1,000,000 and rental income from the apartments and retail units in the amount of $1,200,000. The buyers, therefore, only paid $2,800,000 at close of escrow as opposed to $5,000,000. The seller was entitled to an adjustment for the cost of carrying the property during that time, but the seller’s attorney, not versed in real estate, did not advocate for any such credit to his client.
What’s even more impressive is the fact that by the time the trial concluded in 2015, the property was worth approximately $3,000,000 more than the original purchase price. The buyers ended up paying only $2,800,000 for a property worth $8,000,000.
If the property had instead gone down in value from 2012 to 2015, the buyers could have simply dropped their lawsuit and only been out of pocket for attorneys’ fees, or they could have converted the lawsuit to one for damages based on the difference between the purchase price and the fair market value of the property on the date the seller breached the contract.
Over Ron’s 45-year career, our office has used this specific performance strategy in numerous cases involving properties ranging from single-family homes to large commercial, industrial, and residential complexes. In appropriate circumstances with sophisticated clients, the proper venue, and the right mix of buyer and seller, it can be an excellent device that benefits clients instead of merely lining the lawyers’ pockets.