Fall 2009 Newsletter

Volume 5, Issue 3

Real Estate Fraud 101: The Basics

What is Real Estate Fraud?

Generally an attorney must prove the following elements for a claim for real estate fraud: (1) a misrepresentation (such as a false representation, concealment or non-disclosure), (2) knowledge of falsity (called ‘scienter’ in legalese), (3) intent to defraud or induce reliance, (4) justifiable reliance, and (5) resulting damage.

First there must be the lie. It can be an actual lie (or ‘misrepresentation’) or it can be the concealment of a material fact relating to the property or the transaction. The easier fraud case to prove would involve a document by the defrauding person that is simply not true. In a recent case we have been handling, a seller of a shopping center provided the buyer with a signed and certified rent roll that misstated the amount of rent the tenants were providing.

The misrepresentation can also be the knowing concealment of a material fact. In our shopping center fraud case, the seller had the tenants sign false tenant estoppel certificates. While the tenants should not have signed false certificates, the seller still presented the estoppels to the buyer and actively concealed the fact that he knew these certificates were false. This too is fraud.

The next element is knowledge of falsity. That is to say that the person allegedly committing the fraud must know that the information he is presenting is false. In our examples above, it would not be enough to prove to a jury that the rent statements or estoppel certificates were false. As plaintiffs we would have to prove that the seller knew they were false. We would show that these sellers were active in the management of the center, were involved in leasing the spaces, knew how much money they were receiving each month and had even reached agreements with the tenants to lower their rents.

The third element requires that the plaintiff show that the defendant had an intent to defraud or induce reliance. This can be done by showing, for example, that the seller was trying to maximize the sales price by misrepresenting and concealing key facts. The seller did not tell the truth for fear that it would ruin the transaction. This element involves argument and a compelling story.

Misrepresentations do not rise to the level of fraud if the person hearing the misrepresentations does not rely on them. Therefore, the fourth element of a cause of action for fraud requires that the plaintiff have justifiably relied on the lies. In our shopping center case, the seller has admitted that his rent roll was false, that the estoppel certificates were inaccurate and that the operating statements he provided were untrue, but, he argues, he disclosed this all to the buyer before the close of escrow.

The point of this argument is that if the buyer knew these facts before he purchased the property, he cannot establish justifiable reliance. If he knew the buyer should just not have closed the transaction. The weakness in this argument, of course, is that it destroys the defendant’s credibility with a somewhat arrogant argument: “Sure, I lied and fabricated documents, but you knew I was a liar!”

Just as a fraud case will not work if the plaintiff did not rely on the misrepresentations, it will similarly not work if plaintiff was lied to but was not damaged by those lies. In our shopping center case, the actual rental income turned out to be only about a third of the income that was promised. That is true damage. However, there are cases where the misrepresentation does not actually cause any true damage.

Fraud 102: How Big Is Your Space? Really.

Most tenants are familiar with the standard lease language regarding the size of their leased premises: the size set forth in the lease is an approximation which the parties agree is reasonable and the rent will not be changed if it turns out that the actual size is more or less. Moreover, the lease will also state the tenant has made any investigations it desires and is responsible for doing so (or not doing so). Most tenants do not actually measure the space but instead rely on the integrity of the landlord.

In a recent case entitled McClain v. Octagon Plaza, LLC, a shopping center tenant (McClain) sued the shopping center owner (Octagon) for misrepresentation of the size of the leased unit in the lease.

Background: The parties entered into an AIR Standard Multi-Tenant Lease (Net) for a 2,624 square foot retail space. Paragraph 1.2(a) described the size as “approximately 2,624 square feet” while paragraph 2.1 stated that the parties agree that this is an approximation which the parties agree is reasonable and that the rent is not subject to revision if the actual size is more or less. The lease also required the tenant to pay Common Area Operating Expenses (CAMs) of 23%.

Prior to signing the lease, the tenant attempted to confirm the size of the unit. The landlords purported to be offended by her inquiries and represented that measuring the area would be unreasonably expensive. They insisted that they had ultimate knowledge of every detail of the shopping center and that the tenant could rely on their representations.

The Lawsuit: The tenant sued the landlord for, among other things, misrepresentation, stating that because the landlords’ pretense stating that they were offended by her request to confirm the size of the unit and the landlords’ repeated assurances that the tenant could rely on the landlords’ honesty and accuracy, the tenant was induced to accept their representations and placed reasonable reliance on those representations in executing the lease.

Later, the tenant obtained a copy of the landlord’s application for earthquake insurance, which disclosed that the correct size of the shopping center was 12,800 square feet rather than 11,835 square feet and that her unit was 2,438 square feet rather than the 2,624 square feet represented.

This had the effect of overstating her rent by almost $269 per month and causing her to pay 4%more in CAM charges than she should have. As a result of the misrepresentations, the tenant was induced to enter into a lease that obliged her to pay excess rent of more than $90,000 over the term of the lease.

Legal Analysis: The key issue in this case is whether the terms of the lease rendered the tenant’s fraud claim untenable. In other words, did the language saying that the parties agree that the approximation is reasonable, that no rent adjustment would be made and that tenant must do whatever investigation it desired to operate to defeat the tenant’s lawsuit for misrepresentation?

The court noted that “a party to a contract who has been guilty of fraud in its inducement cannot absolve himself or herself from the effects of his or her fraud by any stipulation in the contract, either that no representation have been made, or that any right that might be grounded upon them is waived. Such a stipulation or waiver will be ignored, and parol evidence of misrepresentations will be admitted, for the reason that fraud renders the whole agreement voidable, including the waiver provision.”

Just as an ‘as is’ provision in a contract does not insulate a contracting party from fraud claims, the stipulation intending to bar a fraud claim does not bind the party and the insertion of language agreeing that the material misrepresentation is “reasonable” is of no effect.

The court reinstated the case, allowing it to proceed to trial so that the tenant could establish that the approximations were, in fact, materially and unreasonably inaccurate.

How Can We Help You?

When you or your colleagues are facing a lawsuit relating to commercial real estate, look for attorneys who have the knowledge and experience to help you achieve your goals and fight for your interests in court.

At Wagenseller Law Firm our real estate and business litigation lawyers have extensive litigation and trial experience in a variety of real estate and business lawsuits. We specialize in real estate and business litigation in Los Angeles and Southern California.

We handle real estate and business partnership disputes, real estate fraud, breach of contract, breach of fiduciary duty and corporate dissolution actions, among others.

We invite you to review our website at www.wagensellerlaw.com and call us with any questions you may have.

Message from Laine Wagenseller…

Business philosopher Jim Rohn says, “Don’t wish it were easier, wish you were better. Don’t wish for fewer problems, wish for more skills. Don’t wish for smaller challenges, wish for more wisdom.”

That seems like good advice, especially this year. I am always examining how we do business and how we can get closer to our goal of being the preeminent boutique real estate law firm in Los Angeles.

One short term goal of mine is to form a mastermind group – a group of business people who share advice on how to grow their businesses. I would also like to identify those who have already built a successful business and ask them how they did it.

I would like to team up with others so that we can work together on common goals. Working together our resources, our networks, our skills and our wisdom are so much greater.

Give some thought to how we could work together to achieve greater things and live an outstanding life. I would love to get together to hear you insights and ideas.

Laine

In The Works: Case We Are Working On

  • We were very pleased to have been hired by a national student hosing company to prepare the lease, parking agreement, guaranty and other documents for a new USC student housing project.
  • We recently settled our client’s case against a Homeowners’ Association and a property management firm for negligence in fixing a water leak that led to mold and the total destruction of the unit.
  • A hotel developer has retained us to represent the Company in a potential lawsuit by a disgruntled investor who is seeking the return of its capital contribution.
  • A warehouse owner has hired us to evict a machine shop tenant who has stopped paying rent.
  • A co-owner in an apartment building retained us to negotiate a buy-out of their interest in the property (or to file a lawsuit for partition). We were able to reach an agreement with another co-owner to purchase our client’s interest without the need for a lawsuit.
  • After four years of litigation, we have finally settled a family partnership lawsuit over a residential income property.
  • Our shopping center client’s fraud case against a large tenant continues in the bankruptcy court while another shopping center owner client’s fraud case is scheduled for mediation at the end of the month.

Ten Tenets of Accountability

1. Holding people accountable is nothing to apologize for. In fact, you owe this to your people. Failing to bring out their best is something to apologize for.

2. A leadership obligation is to keep your people out of the gray areas. They must know exactly where they stand and exactly where you stand.

3. People must face reality and see life as it is, not simply as they’d like it to be. Holding people accountable means you shake them out of denial. Denial leads to inertia.

4. Teach your people that they must accept responsibility for their work and their lives. When they choose the behavior, they choose the consequences. They are not victims. Remember that whenever people complain they do so to deflect responsibility away from themselves and onto the cold, cruel world. Hold up the mirror and make them look into it.

6. Don’t allow people to sweep problems and shortcomings under the rug. Push them to the forefront and deal with them.

7. Teach people that failure is not an accident. Either they set themselves up for it or they don’t.

8. When holding people accountable, remember: People do what works. They are not going to continue to do things that bring them personal gain. At some level they’re getting a payoff or they wouldn’t be doing it. Thus to change their behavior, attach a consequence to it.

9. Life rewards action – not experience, knowledge or wisdom.

10. Ultimately, people must understand they are measured by results, not best efforts or good intentions.

– Adapted from Up Your Business! by Dave Anderson

News and Happenings…

  • Laine Wagenseller has joined the Board of Managers of the Stuart M. Ketchum Downtown YMCA. The Board supports the Y in its mission to help all people live better, healthier lives in spirit, mind and body.
  • USC’s football season has started and Laine attended the first game against San Jose St.
  • The Los Angeles Federalist Society hosted Dean Erwin Chemerinsky and Dean Ker Starr in a debate over recent cases before the Supreme Court that Laine Wagenseller attended.
  • Mr. Wagenseller spoke at several real estate investment group meetings in Pasadena and Irvine about his experience in real estate investing and some helpful pointers in forming partnerships.
  • Dick Ziman, the founder of Arden Realty, spoke at a CREW luncheon about his experience in real estate and where he sees the market heading. Mr. Ziman was prescient enough to sell his company at the height of the market (and had done so in the 1990s as well). Susan Barilich organized the event for CREW and Laine Wagenseller attended.
  • Laine Wagenseller was introduced as a new member in July at the LA5 Rotary Club meeting. He is actively involved in the Rotary Club’s Real Estate Group.
  • Mr. Wagenseller attended the memorial service for Ray Watt. Mr. Watt was a leader in the residential home building business in Southern California. The story of his life is an incredibly inspirational one about a man with a driving passion and a dedicated work ethic.
  • In other news, Laine Wagenseller spent a day with the Marines at Camp Pendleton (see inside), attended Unleash the Power Within, a Tony Robbins seminar in San Jose (yes, including walking across hot coals in bare feet), went to the Depeche Mode concert at the Hollywood Bowl and spent a weekend in Los Olivos on a Men’s Retreat with Bel-Air Presbyterian Church.

Wagenseller Law Firm is a full-service business and real estate law firm. Materials contained in this newsletter are for general information purposes and to permit you to learn more about the services that Wagenseller Law Firm offers its clients. These materials are not intended to constitute legal advice relating to any specific matter and do not create an attorney-client relationship. Please consult Wagenseller Law Firm for legal advice regarding specific matters of concern.