Remember the Statute of Limitations

Contract claims and negligence claims are subject to different statutes of limitations, and if you are a participant in a construction project and believe you have been injured by another, it is important to understand what claims you may have, what statute of limitations applies to those claims, and when the limitations period may run out, leaving you with no remedy. In my latest article for the Daily Journal of Commerce, I look at a recent Court of Appeals case in Washington that illustrates these points. Read the full article here.

“Remember the Statute of Limitations” was originally published by the Daily Journal of Commerce on March 15, 2018.

A Lawyer’s Checklist for Starting Strong

In the push to get a construction project started, important management tasks may be overlooked or subordinated by “higher priority” tasks, and the importance of completing many of those tasks may not become apparent unless there is a legal dispute. In my latest article for the Daily Journal of Commerce, I provide a brief checklist that will help you start your next project on the right foot and give you a decided advantage should a dispute arise. Read the full article here.

“A Lawyer’s Checklist for Starting Strong” was originally published by the Daily Journal of Commerce on February 15, 2018.

Avoiding Development Disasters: Land Inventory and 1031 Exchanges

The ability to defer taxes through a 1031 Exchange can make or break a real estate transaction.  But federal tax law does not treat all real estate owners equally. Under IRC Section 1031(a)(2), real property held “primarily for sale” in the ordinary course of a trade or business is excluded from Section 1031 and may be subject to ordinary income taxes in the event of a sale.

Generally, land held for investment purposes can be swapped for “like kind” property without triggering taxable gain. However, certain property is excluded from 1031 because, under IRC Section 1221(a)(1), it is not a capital asset, including:

(i)   Stock in trade of the taxpayer
(ii)  Inventory; or
(iii) Property held by the taxpayer primarily for sale to customers in the ordinary course of a trade or business.

Such property, including any real estate which qualifies as inventory, is excluded from 1031 treatment and, upon sale, is taxed at ordinary income rates. This means that active developers dealing in subdivided property for sale in the ordinary course of business may be excluded from capital gains tax treatment.

The key is whether the real property at issue is a capital asset or inventory. Capital assets are assets held as an investment or for productive use in a business.  Inventory or stock in trade is fundamentally different from capital assets in that it is held for the purpose of resale to customers in the ordinary course of business.

Whether real estate is a capital asset eligible for 1031 depends both on the nature of the owner’s business and the owner’s activities with respect to the property. A real estate developer marketing subdivided lots and spec homes for sale may qualify as a dealer selling inventory.  The same party holding separate land for investment without subdivision or major development may be an investor. Meanwhile, a part-time investor actively marketing property for sale may not be deemed a dealer because the activities do not constitute a trade or business. See Evans v. IRS, T.C. Memo. 2016-7 (Jan. 11, 2016).

There are no bright lines.

In the Ninth Judicial Circuit, which includes California, Washington, Oregon, Alaska, Idaho, Nevada, Arizona, and Montana, courts look to five factors to determine the nature of the taxpayer’s business and whether property is held primarily for sale to customers in the ordinary course of the taxpayer’s business:

  1. The purpose for which the property was acquired;
  2. The frequency and continuity of property sales over an extended period;
  3. The nature and extent of the taxpayer’s business;
  4. The activity of the taxpayer with respect to the property; and
  5. The extent and substantiality of the taxpayer’s transactions.

See Redwood Empire Sav. & Loan Ass’n v. Comm’r, 628 F.2d 516, 517 (9th Cir. 1980); Pool v. Comm’r, 251 F.2d 233, 237 (9th Cir. 1957); Evans, T.C. Memo. 2016-7.

The more the facts suggesting the taxpayer is in the business of selling real estate and the property was held for sale in the ordinary course, the higher the likelihood the property will be deemed inventory, excluded from like-kind exchange treatment, and, upon sale, subject to ordinary income tax rates.

IRS Safe Harbor? Don’t Bet on It

Section 1237 of the Internal Revenue Code contains a safe harbor that allows a taxpayer to sell up to five lots and pay tax at the long-term capital gains rate if certain requirements are met.  However, the requirements are burdensome. For example, the development entity must hold the property for five years, and the developer must not make any significant improvements during the holding period. This is only a partial list of requirements.  Because few developers mothball property for such long periods without development, the safe harbor may have little practical value.

Structuring to Minimize Taxes

There are no guarantees about how the IRS may view real estate sales.  However, good practice for developers holding property as investments is to place the property in an entity separate from their inventory properties. The investment property should be managed discretely consistent with its purpose as an investment. Also, an investor seeking to qualify for like-kind exchange treatment should consider limiting the amount of development and advertising activities with respect to the investment property.

Questions? Contact Ben Spiess at ben.spiess@stoel.com or Kevin Pearson at kevin.pearson@stoel.com.

Solar PPA Provider That Only “Arranges” Installation of System It Owns Is Not a “Contractor” in California

In the recently issued but unpublished decision Reed v. SunRun, Inc. (Los Angeles County Super. Ct. No. BC498002, Feb. 2, 2018), the Second District Court of Appeal ruled that a solar power purchase agreement (“PPA”) provider that only sells solar energy to homeowners is not required to be a licensed California contractor under certain circumstances.  Specifically, the court held that where the PPA provider “arranges” installation by a licensed contractor of the solar energy system (“system”) installed on the homeowner’s house but the PPA provider retains ownership of the system and sells the electrical output from the system to the homeowner, the PPA provider does not need to be a licensed contractor.

This ruling is good news for PPA providers in the state, whether they are marketing PPAs for residential or commercial property owners. Further, the ruling does not harm homeowners or other property owners or otherwise run afoul of the regulatory purpose of the Business and Professions Code (“BPC”) where the actual physical installation of the system must still be performed by qualified licensed contractors. This decision, if published, would also benefit the state by the further refinement of several California decisions that otherwise seem to restrict “arrangers” unless they carefully craft their contracts and actual activities within a narrow aspect of non-construction services.

The facts leading to the SunRun decision are familiar to lawyers involved with clients in both the energy sector and the heavily regulated licensing scheme under California law:  SunRun sought to facilitate the use of solar in California through a PPA structure that enables homeowners to purchase energy from SunRun-owned solar systems installed on the homeowners’ rooftops.  SunRun itself was not a licensed contractor prior to February 2012, but worked with a number of licensed contractors for the installation of the systems.  SunRun and a licensed contractor would 1) visit the home and evaluate what was optimally required for the system, 2) the contractor would present a design to the homeowner for approval, 3) the contractor would install the system (using SunRun’s “best practices” and SunRun’s modular parts), 4) SunRun would retain ownership of the system (including maintenance and insurance obligations), 5) the homeowner would agree to buy energy from SunRun for 20 years, with an option to buy the system during that time, and 6) if the homeowner breached the agreement, SunRun had reserved its right to remove the system (which would take about one day).  SunRun’s agreement with the homeowner provided that SunRun would “arrange for the design, permitting, construction, installation and testing of the” system, but specified that a separate contractor would “furnish all installation and construction services” and that separate contractor was to be “solely responsible” for all aspects of the installation related to construction.  Although SunRun could refuse to pay a contractor if the installation was not satisfactory, the approval was fairly superficial and cursory, taking “15 seconds to two minutes.”  SunRun did not oversee installation nor was it physically present at the installation sites.

In August 2011, Reed contracted to purchase power from SunRun pursuant to a PPA styled as a “Solar Power Service Agreement.” Reed made only four of the monthly payments under the PPA and then sold his home.  The new owner assumed the SunRun agreement.  Later in January 2013, Reed sued SunRun and sought to certify a class on the grounds that SunRun was an unlicensed contractor and engaged in unfair competition.  Although abandoning the “solar energy claims” and not pursuing the subclass he originally asserted, Reed still sought to pursue the contractor license violation allegations.  Motions for summary adjudication/judgment followed by SunRun in 2014 and 2016.  Relevant to the license analysis, in April 2016 after further discovery, the trial court ruled that SunRun was not a “contractor” under BPC 7026 because 1) it “did not direct or supervise its licensed installers’ work at any job site” and any approval was limited “exclusively to ensur[ing] the local designer and installer’s design matched the agreement,” and (2) even if SunRun were a contractor, it fell within the exception under BPC 7045 for a finished product that was not a fixed part of the home.  An appeal by Reed followed.

On appeal of that aspect of the ruling, the appellate court affirmed in full the trial court’s determination. Importantly for those navigating California’s licensing regulations was the court’s reiteration of the public policy undergirding the BPC, while yet noting that the penalties that Reed sought to enforce hinged on whether or not SunRun was a “contractor” under BPC 7026.  The court emphasized that a “contractor” historically had to 1) actually perform construction services, 2) supervise the performance of services, or 3) agree by contract to be “solely responsible” for construction services.  Citing The Fifth Day, LLC v. Bolotin (2009) 172 Cal.App.4th 939, 947-950, the court stated that “[h]owever, a license is not required if a person merely coordinates construction services performed by others.”  Rejecting Reed’s counter arguments outright, the court did not find it necessary to reach the alternative ground ruled upon by the trial court:  whether SunRun’s system was within the non-fixture exception to licensing under BPC 7045.

Another helpful element of this lengthy litigation, although not at issue on appeal, was the initial motion for summary adjudication by SunRun in February 2014 where the trial court ruled that the applicable statute of limitations under BPC 7031 was one year. As the trial court succinctly stated:

This statute imposes forfeitures. The contractor’s work can be perfect and the client delighted. Then there would be neither damages nor any equitable basis for compensation or a remedy. Yet the legislature put in this provision to get contractors’ attention: get your license, or else. It is the financial equivalent of flogging. That is simple and harsh by design, and it is to drive home a point. A simple and harsh punishment serves “the clear statutory policy of deterring unlicensed contract work.” (Hydrotech Systems, Ltd. v. Oasis Waterpark (1991) 52 Cal.3d 988, 992; see also id. 995, 996, 997, and 998.) SunRun’s analysis is correct.

While neither the statute of limitations analysis nor the licensing ruling is published, both still serve as very good guidance using common sense in their application under California law. Nevertheless, entities looking to walk that line should be very mindful of the underlying facts and the points highlighted by the appellate court in this case, and ensure that neither their contract language nor their actual activities move them across the line and therefore potentially under the California contractor regulatory scheme found in the BPC.

Advance Contractual Lien Releases in Washington – An Enforceable Shield or Unintended Liability?

As the construction boom continues in Washington (and especially in Seattle), owners and developers look for ways to mitigate risk on projects. Risk mitigation is often accomplished through negotiated terms and conditions of the parties’ contractual agreements. In my latest Daily Journal of Commerce article, I explore the validity of advance contractual lien releases and highlight issues for owners and developers to consider before implementing these releases on projects in Washington. Read the full article here.

Originally published as “OP-ED: Advance contractual lien releases in Washington” on January 18, 2018, by the Daily Journal of Commerce.

Criminal Charges for Contractor in Trench Collapse

A contractor’s duty to provide a safe workplace includes a duty to comply with safety regulations about worksite conditions, worker equipment, and work methods. Those regulations are enforced by the Washington Department of Labor and Industries (“L&I”), which has authority to inspect worksites and to impose fines and stop work orders.

In a recent case, the State of Washington determined that a contractor’s practices were so unsafe that L&I fines were insufficient. The King County prosecutor has charged the owner of the company with manslaughter in the second degree, a felony, defined as follows:

A person is guilty of manslaughter in the second degree when, with criminal negligence, he or she causes the death of another person.

RCW 9A.32.070(1). This appears to be the first time that an individual owner of a contractor has faced a felony charge arising from a breach of workplace safety.  The charge arises from a project in Seattle where a worker died while working in a trench.  The owner of the construction company, who supervised the work, violated a number of regulations relating to trench work.  A recent news article provides further details.

 

Here is a link to a statement from L&I about the case.

 

Most contractors already recognize the need for a thorough safety program, even on small jobs. The criminal charge outlined above has raised the stakes even higher for those who want to cut corners.

Best Practices for Staying Off of OSHA’s “Naughty List”

Construction projects, both big and small, pose a host of safety risks and challenges and, as a result, are subject to a number of regulations designed to limit the probability and severity of jobsite accidents. In my latest article for the Daily Journal of Commerce, I discuss common violations, some recent regulatory changes, best practices for complying with OSHA regulations, and some do’s and don’ts in the unfortunate event that an accident occurs. Read the full article here.

Originally published as “OP-ED: Best practices for staying off of OSHA’s ‘naughty list’ ” by the Daily Journal of Commerce on December 14, 2017.

Microsoft Planning Large Campus Renovation and Expansion Project in Redmond

Microsoft Corporation recently announced plans to revitalize its 500-acre Redmond campus with dramatic renovation and expansion work to be completed over the next five to seven years. The project will include the addition of 18 new buildings, 6.7 million square feet of renovated office space, $150 million in transportation infrastructure improvements, public spaces, sports fields and green space.  Upon completion of the project, the Microsoft campus will have 131 buildings of modern workspaces to accommodate 47,000 employees, with room to add up to 8,000 more people.

Microsoft has been headquartered in Redmond since 1986, and this project will modernize many of the historic structures on the campus. The new “refreshed” campus will feature more open space to capture more light and will be divided into “team neighborhoods” to promote personal creativity and innovation in the industry.   In addition, personal transportation will figure prominently in the design, as all automobiles will be moved to an underground parking facility in favor of bike paths and pedestrian walkways.  This concept will extend to Microsoft’s planned investment in the region, with construction of a foot- and bike-only bridge across WA-520 to connect both sides of the campus and eventually to join with Link Light Rail’s Redmond Technology Transit Station, to be completed in 2023.

More information about this exciting and transformative Microsoft project, including an entertaining 3-D video rendering of the development, can be found here.

What is Imputed Agent Knowledge Under California’s Real Estate Disclosure Rules

Recently, in RSB Vineyards LLC v. Orsi, the First Appellate District Court of Appeal confirmed the long-standing rule in California: sellers must disclose all known material matters.  While this affirmed rule was not surprising, the court was very helpful  in providing the first detailed framework for what it means for a seller to have “knowledge” of such material matters.  The devil, as they say, is in the details, and that is no different in a failure to disclose dispute.  Although a number of cases addressed the “type” of disclosures a seller must make and what is required of a seller when selling real estate (which we addressed in our prior blog article), no previous court addressed in any great detail what exactly constitutes “knowledge” for purposes of a seller’s disclosures and representations.

Here, the plaintiff purchased a vineyard property that included a residential building that had been renovated in 2010 to be used as a wine tasting room. Shortly after closing, the plaintiff discovered that the building had structural defects that were not disclosed by the sellers.  The plaintiff sued, and the sellers claimed that they had no knowledge of the building’s flaws and submitted declarations to demonstrate that the four members comprising the sellers had no such information.  According to the evidence, the sellers had previously hired an architect to prepare the plans for the building and the county approved such plans, and the construction work was completed by a licensed contractor.  The work was subsequently inspected and approved by county officials and a certificate of occupancy was issued before the property was sold to the plaintiff.  In the plaintiff’s deposition, its own representatives admitted that they had no information to suggest that the sellers had actual knowledge of the defects.  However, the plaintiff hired its own civil engineer who evaluated the property and concluded that (a) the building floor was defective and (b) the various deficiencies were substandard for commercial construction.  The trial court rejected the plaintiff’s argument and held in favor of the sellers, stating that the plaintiff had not established that the sellers had actual knowledge of the undisclosed defects.

On appeal, the plaintiff’s primary theory was that the sellers possessed imputed knowledge of the defects because the construction professionals were agents and had acquired knowledge of the defects. In analyzing the allegations, the court provided the framework for determining when knowledge will be imputed to a seller as a result of information acquired by such seller’s consultants or professionals.  In its detailed analysis and ruling, citing to Trane Co. v. Gilbert (1968) 267 Cal.App.2d 720, 727, the court stated that the general rule established in California provides that “the principal is chargeable with, and is bound by the knowledge of, or notice to, his agent, received while the agent is acting within the scope of his authority, and which is in reference to a matter over which his authority extends.”  However, this rule is subject to significant limitations concerning the circumstances when the principal will be bound by his or her agent’s knowledge.  First, not all professional services result in an agency relationship.  Thus, if a professional simply furnishes services or advice to a principal and does not interact with third parties as a representative of the principal then such professional is not acting as an agent.  Second, a professional merely acting “for the benefit” of the principal is not an agent for imputed knowledge purposes because such consultant must also act in such manner in his or her dealings with third persons.  Therefore, an architect who merely provides architectural services to the principal and nothing more is not an agent of the principal until and unless such architect acts for the benefit of the principal in his or her dealings with third persons.  In that instance, knowledge acquired by a professional while not acting as an agent will not be imputed to the principal.  Third, such professionals must actually acquire knowledge of the defect or misrepresented matter while they are acting as an agent of the principal.  So, if a professional is deemed to be an agent, then before knowledge will be imputed to the principal such agent must have acquired knowledge of the defect or misrepresented matter (i.e., an architect would not have knowledge of how a general contractor constructed a building unless he or she was hired to perform inspections that revealed the defect, and thus structural defects would not be imputed to the architect as a matter of course).  In affirming the trial court, the appeals court concluded that in the present case the professionals who worked for the sellers did not act as agents, and the sellers did not have actual or constructive knowledge of the defects because the defects were only discovered when the wine tasting room was demolished by the plaintiff.

While the court also analyzed other aspects of the case, the discussion on imputed knowledge and what constitutes an agency relationship for such knowledge will have a lasting impact on how both buyers and sellers proceed in California real estate transactions.

When Three’s Company, and Not a Crowd

Negotiating construction contract language in 2017 can have important consequences years into the future. The obligations and rights arising from one often overlooked clause, that addressing contractual “third-party beneficiaries,” i.e. “a person or entity who, though not a party to the contract, stands to benefit from the contract’s performance,”  can vary considerably from state to state and even case to case. In my latest article for the Daily Journal of Commerce, I look into the legal aspects of the third-party beneficiary clause in Oregon, Washington and Utah and give you some pointers to protect your rights with regard to the clause in your next contract negotiation. Read the full article here.

“When Three’s Company, and Not a Crowd” was originally published by the Daily Journal of Commerce on November 17, 2017.

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