Chapter 22 Liability, Agency Problems, Fraud, Ethics in Real Estate Finance

Chapter 22 Learning Objectives n Understand how parties to real estate finance transactions can be held liable for their actions n Understand the structure of agency relationships within real estate finance n Understand that there are agency costs associated with preventing parties from acting solely in their own interest and against the interests of others n Understand how insufficient agency costs allow wealth transfers

LENDERS’ LEGAL LIABILITY n Subject to liability in two areas: –Violation of state or federal laws regulating certain activities –Violation of contractual obligations involving loan arrangements

HAZARDOUS WASTE DISPOSAL n Federal laws regulating hazardous waste: –Comprehensive Environmental Response, Compensation, and Liability Act of 1980 –Superfund Amendments and Reauthorization Act of 1986 –Strict liability even if no laws were violated –Joint and several liability

HAZARDOUS WASTE n Potentially responsible parties (PRPs) for contaminated properties: n Current owners / operators n Owners / operators at time of discharge n Generators of the hazardous substance or parties arranging for disposal n Transporters of the hazardous waste

LENDER’S DEFENSES n Lender claims to not be a PRP n Contamination resulted solely from an act of God, act of war, or omission by a third party n Claims to be an innocent landowner with no knowledge of contamination

APRIL 1992 EPA REGULATION n Rules allowing lenders to foreclose and not be liable: –Actions prior to security interest –Periodic monitoring and/or inspection –Involvement from inspection results –Requiring borrower compliance –Restructuring the loan arrangement

APRIL 1992 EPA REGULATION n Rules allowing lenders to foreclose and not be liable: –Requiring additional rent or interest –Exercising any rights the lender may have under the law or any warranties, covenants, conditions, or promises –Providing financial or administrative advice

OTHER LENDER REGULATIONS n Comprehensive Drug Abuse Prevention and Control Act of 1970 allows confiscation of property used in illegal drug activity n Uniform Commercial Code which specifies rights and obligations of contracting parties

OTHER THEORIES OF LENDER LIABILITY n Prima facie tort n Promissory fraud n Nondisclosure fraud n Breach of contract n Duress and lender control

BANKRUPTCY AND AGENCY COSTS n Bankruptcy and the cram down process n Agency Costs