The Granger Firm - Hot Topics
Mechanic's Lien Changes and the State Construction Notices DirectoryOn October 14, 2014, Governor Corbett signed into law Act 142 (the "Act"), which is another amendment to Pennsylvania's Mechanic's lien law (49 P.S. 1101 et seq.). This amendment calls for the creation of a State Construction Notices Directory website whereby property owners having improvements erected, constructed, altered or repaired at a cost exceeding $1.5 million dollars can file a Notice of Commencement with the Directory. If filed, subcontractors would have to file a Notice of Furnishing within forty-five days of providing work or materials to the job site or forfeit the right to file a mechanic's lien. The contract for the project must contain a specific notice that failure to file a Notice of Furnishing will result in the waiver of lien rights. The law also permits, for informational purposes only, owners to file Notices of Completion and subcontractors to file Notices of Non-Payment. However, these filings do not affect a subcontractor's right to file a lien.
The Act applies to both residential and commercial projects that exceed $1.5 million, and is optional. The purpose of the amendment is to help owners identify subcontractors that potentially may not have been paid (and who potentially could file a mechanic's lien) before the owner makes its final payment to the general contractor. This would help prevent the scenario where the owner paid the general contractor in full, only to find out later that a subcontractor was not paid and is now filing a lien. Often, owners wind up paying the subcontractor as well in order to clear the lien.
With the new directory, an owner can take affirmative steps to help ensure that all subcontractors are paid and avoid potential mechanic's liens.
Transfer TaxesThe majority of transactions involving the transfer of real estate in Pennsylvania are subject to transfer tax. It is the recording of the applicable document (most often a deed) that triggers the transfer tax. It is a tax, not on the person, but on the property transferred, with each party to the sale (seller and buyer) technically being responsible for making sure the tax is paid. The Commonwealth of Pennsylvania imposes a one (1) percent transfer tax on transactions. Counties also exact a transfer tax, typically another one (1) percent. However, some local municipalities have their own additional realty transfer tax, which can be one quarter (1/4) of one percent or more. Moreover, in Philadelphia County (the City of Philadelphia) charges three (3) percent as opposed to the one (1) percent in all of the surrounding counties. While parties to a transaction can agree amongst themselves who will pay the taxes, such agreements are not binding on the taxing authorities.
As with most rules, there are exceptions to the above. For example, the United States, the Commonwealth and its municipalities are not subject to the tax. There are also some transfers that are not subject to the tax, such as certain transfers between certain family members, certain transfers to the Commonwealth or a municipality, corrective deeds, certain estate and trust transfers, and certain transfers to shareholders or partners.
Some of the most common questions surround transfers involving partnerships. For example, our appellate courts have held that a transfer between a general partnership and a limited partnership, where a one (1) percent interest was transferred to a limited liability company (“LLC”) as the general partner, and where the remaining ownership interests remained essentially unchanged, was not a taxable event as it did not transfer a beneficial interest in the property to someone other than the grantor.
However, where individuals convey property from themselves to a limited partnership, the transaction has been found to be a taxable event since the conveyance was from individuals to a separate entity. Although the entity may have been comprised of partners who were identical to the individuals who owned the real estate prior to the conveyance, the entity was a legally different owner and thus the tax would be due.
Transfer Tax and Assigning an Agreement of SaleBeware of Assignments of Agreements of Sale. It has been common for buyers of real estate to sign an agreement of sale and after performing due diligence, assign the agreement of sale before closing to a single purpose entity, such as an LLC (whose sole purpose is to hold ownership of the real estate being purchased). Buyers are often reluctant to expend fees and costs to form the single purpose entity until they know they are purchasing the property. In 2008 the Pennsylvania Department of Revenue issued a Bulletin that calls into question whether transfer tax may be due when an agreement of sale is assigned from one party to either a related single purpose entity or a new buyer. At issue in the bulletin was whether an assignment of an agreement of sale could constitute a taxable event for transfer tax. While the implications and issues raised by the decision are beyond the scope of this article, readers should be aware that the issue exists and competent legal counsel is required to evaluate any potential assignment or transfer of an agreement of sale. The Bulletin at issue used as an example the assignment by a purchaser in an agreement of sale to a subsequently formed single purpose entity (typically a limited liability company or limited partnership) that would take title to the property. Under this scenario, the Department stated that there would be two taxable events: the assignment of the Agreement of Sale to the single purpose entity and then the subsequent conveyance of the land by the seller to the single purpose entity. The reasoning given was that at the time the agreement was signed, there was no such entity formed and so the purchaser must have been acting for herself and not as an agent or straw party (where there may have been an exemption) for the single purpose entity.
Parties to a real estate transaction should seek legal counsel and take due care prior to entering into the agreement of sale to determine whether an assignment of the agreement of sale prior to closing may be desired, the potential transfer tax consequences of the same and what strategies may exist to help avoid unforeseen taxation.
Partnership Disputes in Troubled Real Estate Deals: Litigating the Blame GameOne of the many types of fallout from the real estate economy is the breakdown between partners who started a real project in better times, only to find themselves arguing and then litigating who is to blame for the failed real estate deal. Typically, disputes center on any one or more of three issues.
First, when a partnership or venture fails, often times one party to the deal blames another party for the project not working. In real estate deals, partners may each bring different expertise to the table. For example, one party may have the funds, another partner may have the construction knowledge and yet another may have marketing or sales experience. As the current market makes sales of real estate more difficult and time consuming, different pressures come to bear that may not have been foreseen. This puts stress on the partners and the project as a whole, which ultimately may lead to the failing of the deal. A typical example involving the purchase of a lot and the building of a high end spec home in a good neighborhood demonstrates the complexities and issues that quickly arise in a falling real estate market.
Assume the property was purchased using a loan to buy the lot and fund the construction, with one partner initially putting up the $100,000.00 of cash the lender required as a 25% down payment to fund the purchase of the lot. At the time, based on appraisals showing the final as-built value of the project to be well in excess of $1,500,000.00 the lender offered a line of credit of $500,000.00 to build the house, all of which was used in construction. The partners were excited because they believed (based on what the marketing person was saying at the time the project was started) that the project would be completed within a certain time, perhaps 12-18 months at the outside and that profits could be $300,000.00 or more after all expenses were paid. When the project became 24 months old, the partner who put down the $100,000.00 now not only needs his or her money back, but he is not willing (or able) to fund any more holding costs going forward. At the same time, the partner who did the construction has not been paid yet, and is waiting for profits when the property is sold (with no funds to contribute). The partner with marketing experience may also be telling the other partners that not only will the project time now like take 24 months in total, but that due to the market conditions, more work is needed to get the property sold and that the final sales price will be closer to $1,000,000.00 than the original forecasts (the recommendation is that a finished basement or significant upgraded landscaping would help move the house). Who is going to pay for the continued holding costs and upgrades until and when settlement occurs can be a significant issue.
In the meantime, because the house was built using a stucco exterior, more issues have arisen, as windows have shown signs of minor interior leakage. As it turns out, the windows were not flashed using the most current techniques and the house will need the windows removed and proper flashing installed. The partner who put up the funds makes it clear he/she is not funding this work, since it should have been done properly in the first place. Realizing that the property is hopelessly underwater, the funding partner stops making payments on the mortgage to cut his losses. The contractor re-caulks the windows and repaints the water stains, believing (or hoping) that this solves the issues.
The bank then contacts the marketing partner and reminds that partner that he and his wife personally guaranteed the loan for the project. The marketing partner then claims not to have known that neither the construction partner nor did the funding partner sign a guarantee. In the meantime, an offer arrives on the home for $990,000.00, meaning that after payment of closing costs and the outstanding mortgage, there is nothing left to pay the construction partner for all of his work. However, the marketing partner demands that the deal be agreed to since only he and his wife are guarantors on the bank loan. Believing the sales price is too low, the other two partners refuse to sign it and the deal is not made. Ultimately, the house ends in foreclosure, no partners are paid any money and the marketing partner and his wife are sued on the guarantee. He then sues the other two partners and the whole matter ends up in litigation. When the ultimate homebuyer also files suit alleging construction defects, the matter becomes even more complicated.
Depending on what the partnership agreement says and a host of other factors, this dispute may have several endings. But it demonstrated an all too common scenario in today's real estate market – poor planning and bad timing leads to unforeseen scenarios that come into play and may never have occurred if the market had not taken a down turn. Sometimes proper counsel can help avoid outcomes like these with timely and practical advice that may prevent this meltdown from occurring and save some portion of the deal. Other times, a review of the matter demonstrates that one partner did engage in wrongdoing that caused losses to occur. In addition, what professional advice was given, when it was given and who it was given to may become very important in determining what liability exists, if any.
Disputes like this take many forms and the example provided herein is simply one of many that occur. When disputes arise, each party needs his or her own counsel to provide practical and experienced advice.
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