Top three ways to get sued in Real Estate
The top
three items that get small-to-medium scale real estate investors in hot water
are:
1.Contract
Disputes
2.Negligence
3.Deceptive
& Unfair Business Practices
1.
Contract Disputes
All too
many lawsuits arise from contracts that were poorly drafted or never drafted.
Contracts are THE primary tools of a real estate investor's trade. I never fail
to be amazed at how many deals are conducted based poor or no contracts. Some
hints with regard to drafting contracts:
Free
contracts are worth what you paid for them.
Good
contracts are result of careful drafting, long experience (even if someone
else's), and review by a qualified attorney. Using contracts straight out of a
real estate course or off of the internet without careful modification is like
bring a knife to a gunfight. If you are too cheap to have an experienced lawyer
work on your contracts, you do not belong in the RE game.
The
purpose of operating agreements (or partnership agreements, joint-venture
agreements, bylaws, etc.) is to communicate with business partners while you
are still on good terms. Once a disagreement arises, negotiating a solution is
MUCH harder, even if the disagreement is perfectly reasonable and in good faith.
Operating
agreements lay out the solutions to problems before a dispute occurs. Such
agreements take a lot of time and thought to craft--they are expensive in terms
of your time and money (to pay for others' time). Handshake partnerships are
made at your peril and are often much more expensive in the long run.
Contracts
with tenants, sellers, and buyers should be tilted in your favor, but not be
grossly unfair. Contracts that are too one-sided will turn a court or jury
against you, at a minimum. Never underestimate the role that perceptions play
when dealing with other humans. If a court or jury thinks you are an SOB, no
good will come of it.
Such
perceptions are very often much more important than the law itself (remember
the Mark Fuhrman trial, I mean, O.J. Simpson trial?). Also, if a contract is
too one-sided, a court can explicitly refuse to enforce it as
"unconscionable" or "shocking to the conscience of the
court." By all means, tilt a contract to your advantage, but avoid grossly
unfair terms.
Contracts
should be understandable and reasonably simple. If one party can argue that
they did not understand a contract, and a court agrees, the court can set aside
or amend the contract. The more convoluted a contract or the less sophisticated
the parties, the more likely that a court will set aside or amend it. Simple
(yet thorough), easy-to-read contracts are much more likely to be enforced.
Before
complicating a deal, be sure that the benefits justify the burdens. For
example, do not use a land trust unless a land trust is truly called for. Most
people do not understand trusts of any sort. Trusts complicate deals.
If a
trust adds enough to a deal to justify the risk that arises from the extra
complexity, by all means, use the trust. If you are using a trust because some
guru said to do so, think twice, because the complexity created by the trust
may outweigh any benefits it adds.
2.
Negligence
Question:
If a tenant trips and falls in a rental unit, is the landlord liable?
Answer:
It depends. The legal theory of negligence determines whether the tenant can
successfully sue the landlord. For the landlord to be negligent in most states,
he must fail to meet his duty to care for the property in a reasonable manner
and must have knowledge that there was a defect on the property.
What is
"reasonably" required varies from state to state and jury to jury. A
few pointers on negligence:
Learn
your state's rules. For example, in Ohio
Find out
what is required and in which areas landlords tend to stray. The rules are not
necessarily intuitive or rational (e.g., landlords have been held responsible
for dog bites inflicted by tenants' dogs).
Whether
or not the landlord knew of a defect is crucial. For example, if the landlord
didn't know that a tenant's lock was faulty, the landlord is unlikely to be
held negligent if a criminal enters a unit as a result and causes damage.
A word of
caution: Tenants will lie and claim they told the landlord about the lock. It
is up to the landlord to document repair requests in a credible manner that
will stand up in court. "He said/she said" is not good enough.
Many
courts hold that a tenant need not prove actual knowledge by the landlord with
respect to defects in common areas (e.g., broken lights in the parking lot). In
these cases, the courts often hold that a landlord should know what's going on
in common areas (also known as "constructive knowledge").
The
landlord should regularly inspect common areas, accompanied by a credible
witness and document what was found and what was done about it.
3.
Deceptive & Unfair Business Practices
Every
state has passed broad consumer protection laws that prohibit deceptive or
unfair business practices. If a state attorney general goes after a real estate
investor, the lawsuit is almost invariably based on these statutes. Some tips:
Deceptive:
The term "deceptive" is extremely broad, especially when dealing with
unsophisticated customers or complicated concepts (e.g., "creative"
techniques). The best way to avoid issues with "deception" is to use
a strong, straightforward and clear disclaimer when transacting business.
The
disclaimer is basically a crystal-clear summary of a transaction and makes the
risks and rewards to all parties clear. Such summaries/disclaimers are
especially important when dealing with people who are under duress (e.g., in
foreclosure), because an Attorney General will not hesitate to accuse an
investor of taking advantage of a "poor victim who was in a bad way and
didn't understand what they were signing."
In
addition, strong and clear language should be used to explain transactions that
involve non-standard techniques (e.g., taking properties subject to the deed)
or lots of moving parts (e.g., anything involving trusts).
Unfair:
In general, a transaction has to be very one-sided to be considered legally
"unfair" but an angry judge or jury can and will nail an investor who
strikes them as unscrupulous. Deals and documents should be tilted in an
investor's favor whenever possible--but they should not be grossly one-sided.
Two examples of practices that are bait for accusations of unfairness:
You buy a
property subject to the deed and reserve the right to give it back if the deal
goes south--basically, heads, I win, tails you lose. The benefit of a true
purchase and sale is that the investor has a deed to the property and therefore
complete control over it. The seller has given up the property.
In
exchange for giving up all control and benefit associated with the property,
the seller receives assurances that the problem property is completely off
their hands--permanently.
Taking
the benefit from the seller (that is, the deed) without relieving them of the
corresponding burden (that is, the problem property) would strike many (myself
included) as unfair. If you want an "out," try a sandwich
lease-option. It's commonly understood that a tenant, unlike a purchaser, can
bail on a lease when it expires.
When
selling on lease option, some investors nullify the option for the smallest of
defaults (e.g., you were a day late on paying). If the tenant/optionee paid a
significant amount for the option or has built significant equity in the
underlying property, a hair-trigger default (especially if the tenant/optionee
was willing to cure the default) is prime meat for an accusation of
"unfair business practices."
Bottom
Line:
Know what
gets investors sued and protect against such issues with reasonable,
straightforward paperwork that sets forth rational terms in a clear and concise
manner. That kind of documentation and business practice makes a lawsuit less
likely and a victory more likely if a lawsuit does arise.
For any
questions, please comment below. For investment services, leave a message at
314-246-9484 or you can email at dhibb99@gmail.com
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