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The quarterly publication of Newman & Simpson, LLP contains timely articles which we have written. They are divided into three categories:

Business/Real Estate which focuses on issues of interest to business owners and real estate investors, Banknotes, which focuses on issues of interest to bankers and other creditors, and Personal Business, which focuses on general legal issues of interest. The following articles have appeared in past publications.

Once a buyer has identified a building to purchase, whether it is a warehouse, an office building or a multi-family residential building, he must perform due diligence before consummating the sale. The scope of due diligence depends upon the nature of the property being purchased so that, for instance, the due diligence in connection with the purchase of a vacant 300,000 square foot warehouse would undoubtedly be move involved than the due diligence in purchasing a two-family residence. However, many of the principles remain the same.

Building Conditions -- All of the functional systems of the building must be evaluated by appropriate professionals. These include the roof, heating, ventilating and air-conditioning equipment, electrical and plumbing. Similarly, exterior conditions such as loading docks, landscaping, lighting and parking areas must be evaluated. Signs of potentially substantial problems such as cracked support walls, should be fully investigated.

Leases -- Copies of all leases should be obtained and studied. It is important to understand where the responsibilities of the tenants end and the responsibilities of the landlord begin. In order to make a projection of the operating income of the property, all expenses paid or payable by the landlord should be reviewed as well as the payments by the tenants so that the buyer can determine whether or not the tenants are paying what they are obligated to pay. Care should be taken to review the leases for options to renew and to determine if they have been exercised. Similarly, any rights of first refusal or options to purchase should be clearly understood. Estoppel certificates should be obtained before closing.

Environmental -- While the law requires that there be compliance with the Industrial Site Recovery Act for any property involving an owner or user which has a standard industrial classification code which subjects it to the Act, compliance with ISRA is never sufficient. It is important to obtain a competent environmental review of every property before its acquisition because if there are any hazardous substances on or under the property, the new owner will be liable for their cleanup. Most commonly buyers engage qualified environmental consultants to perform what is called a Phase I environmental investigation. This includes review of records at the state and federal offices having jurisdiction over the property to determine if there are or were any files pertaining to this property or any neighboring properties. The neighboring properties are important because contamination can flow by ground water or surface water from one property to another.

The Phase I investigation also includes an examination of the property for areas of environmental concern. If such concerns are identified, the consultant may recommend further testing, some of which may involve excavation and lab testing and all of which is expensive. These are commonly called Phase II investigations. It is essential that the environmental risk in proceeding with any transaction be completely appreciated before proceeding.

Land Use -- A buyer must determine what are the permitted uses of the property and whether or not the property is in compliance with all applicable zoning laws. Care must be taken to look not just at the existing uses but the buyer's anticipated uses to be sure that they are permitted. This is particularly critical if the property is vacant or the buyer intends to occupy himself.

As part of such review, the buyer should try to determine if there are any applications pending for development or for variances on any neighboring properties which could adversely affect the subject property. While the buyer should review the zoning code, together with any files of the Building Inspector, Zoning Office or Planning Board regarding the subject property, there is rarely a good substitute for going to the building inspector and other town officials and asking pertinent questions.

Title and Survey -- Besides the minimum, obtaining marketable title, it is important to be sure that there are no easements or restrictions or subsurface conditions which could interfere with the use of the property or adversely affect its value. There may be restrictions on the type of use which are far more restrictive than the zoning ordinances. There may be set backs which are inconsistent with planned expansion for the property. There may be underground pipelines or easements for same which likewise interfere with the existing or anticipated use of the property. All of these items must be explored and understood before proceeding with the purchase.

This publication is intended for general information purposes only and does not constitute legal advice. The reader should consult legal counsel to determine how the law may apply to specific situations.

New Jersey lawsuits follow the American Rule, requiring each party to bear its own legal fees absent a court rule or statute which provides a basis for shifting the attorney’s fees to another party. One major exception occurs when a contract provides for one party to pay another’s legal fees. This includes most bank litigation involving promissory notes or security agreements and suits on leases, guarantees and similar documents, which have specific provisions generally providing that either the creditor or the prevailing party can recover legal fees.

Another exception exists when there is a “fund in court,” a generic term describing a sum of money or an asset which is the subject of a court proceeding. In estate or trust litigation, in many instances, the costs of litigation are paid by the estate or trust and thus, ultimately, by all of the beneficiaries pro rata. The New Jersey Supreme Court has recently made it clear that even where a fiduciary steals money from a trust, the beneficiaries who sue that fiduciary can only recover their attorneys’ fees from the trust fund and not from the fiduciary personally, who remains liable for the damages he causes the trust but not for the attorneys’ fees incurred forcing him to pay.

Another large exception falls under the category of statutes which permit successful parties to recover counsel fees. There are hundreds if not thousands of such statutes, including the Law on Discrimination, the Lemon Law, the Consumer Fraud Act, the Anti-Trust Statutes, the Federal and State Securities Laws, Environmental Protections Laws, etc. If you file a claim under such a statute and are successful, then the court will add reasonable attorney’s fees to your recovery.

Despite all of the above exceptions, in most cases, each party must bear its own counsel fees regardless of the merit of the parties’ positions. To soften the harshness of the American Rule, New Jersey provides two additional vehicles for fee-shifting. The first is the Frivolous Litigation Rule. If one party sues for an improper purpose such as unnecessary delay or increasing costs or for a reason not warranted by existing law or for unsupported factual allegations, then the other party may demand that the pleading be withdrawn because it appears to violate the rule. If the first party does not withdraw the pleading within 28 days and the second party prevails, the prevailing party may then make a motion for sanctions. The sanction ultimately awarded deters repetition of such conduct by either requiring a penalty to be paid to the court or attorney’s fees to be paid to the prevailing party.

The second vehicle for general fee shifting is the offer of judgment rule. Under the rule, any party may file with the court and the opposing party an offer to take judgment in the offeror’s favor or to allow judgment to be taken against the offeror for a stated sum. If the claimant’s offer is not accepted and the claimant obtains a verdict at least as favorable as the rejected offer, then the claimant is awarded reasonable attorney’s fees and litigation expenses incurred after the non-acceptance. In an action for unliquidated damages such as a personal injury case, there are no allowances under this rule unless the amount of the recovery is in excess of 120% or less than 80% of the offer.

While the American Rule is actively followed in New Jersey, the exceptions and interpretations create many opportunities. Using them to your advantage can change your bargaining positions in litigation, whether or not you ever ask a judge to “pull the trigger” and award counsel fees.

Every owner of real property in the State of New Jersey has the right to appeal the assessment of his property. However, most people misunderstand the nature of this appeal process or even what is actual being appealed.

Each year the assessor of each municipality must set forth the assessment of every property in the municipality as of October 1. This assessed value will be the basis for the levying of taxes in the following tax year. This assessed value may have little relationship to the fair market value. However, the assessed value is the basis for the taxation of that property because once the municipality determines the tax rate for the year, it multiplies that rate times the assessed value of each property and sends out tax bills accordingly. For example, if a property is assessed at $300,000.00 and, after adopting the budget, the town strikes a tax rate of $3.50 per hundred dollars evaluation, then the total taxes for this property would be $10,500.00 per year, payable in quarterly installments due on February 1, May 1, August 1 and November 1. While the budget process in each town will determine the tax rate and the amount of taxes paid by each property owner, a property owner does not have a right to appeal his taxes but only his assessment.

In an ideal world, every property would be assessed at its fair value every year and each property owner would pay his fair share of taxes accordingly. However, it is not an ideal world and there are generally significant variances between assessed values and fair market values. Particularly in an inflationary market, as fair values increase, unless the assessments are revised, they will become a smaller and smaller percentage of the fair values.

In order to take into account these changes, each year what is called an average ratio or equalization ratio is determined for each town. It is the ratio of the total of all assessed values of property in the town to the total of all fair values. This is calculated based upon the sales of properties in the town during the prior year. As will be discussed below, this ratio must be factored into computing a tax appeal.

Each year the assessor in each town sends out a postcard to each property owner with the assessed value of the property and the estimated taxes. The card will indicate the deadline for filing an appeal which is generally April 1. This may be extended in certain cases where the town or the county has been delinquent in setting the tax rate.

If the assessment is $750,000.00 or less, then appeal must be taken first to the County Board of Taxation in the county in which the property is located. If the assessment exceeds $750,000.00, then appeal may be taken either to the County Board of Taxation or to the State Tax Court. In either case, the deadline must be met.

Regardless of the forum, the issue in the appeal will be what should be the correct assessment of the property given its fair value on the valuation date, the prior October 1, and the equalization ratio. Thus, for example, if the true value of the property on October 1, 1998 based upon an appraisal is $300,000.00 and the average ratio in that town for the 1999 is 80%, then the property should be assessed for $240,000.00. If the property is assessed for more than $240,000.00, then it is over assessed, but there may or may not be a meritorious appeal.

The major caveat is the effect of what is known as the "common level range." That is a corridor of 15% above and below the average ratio for the town for the year in question. Thus, if the average ratio of assessed values to true values was 80%, the common level range would be from 65% to 95%. The effect of the common level range is that if the ratio for the particular property's assessed valuation to its fair valuation (as determined by the county tax board or the State Tax Court) exceeds the upper limit (95%), then the taxpayer will be entitled to relief by applying the average ratio (80%) to the true value to compute the assessed value. However, if the ratio of the assessed value to the fair value is within the common level range (less than 95%), then the property owner cannot obtain any relief at all.

Using our example, the the fair value were $260,000, then the ratio of assessed value ($240,000) to fair value vould be 92%, which is within the common level range and the property owners would obtain no reduction at all. However, if the fair value were $250,000, the ration of assessed value to fair value would be 96% which is outside the common level range. This would entitle the property owner to a reduction in his assessment by multiplying the fair value ($250,000) by the average ratio (80%), yielding a new assessment of $200,000.

To compute the financial effects of the reduction one must apply the tax rate. Using our example, if the assessed value were reduced from $240,000.00 to $200,000.00, a $40,000.00 reduction, you multiply $40,000 times the tax rate of $3.50 per hundred (in our example), yielding a tax savings of $1,400.00 per year. If this is a result of a judgment as opposed to a settlement, then interest will be paid. In a settlement, interest is generally waived and often the payments owed the property owner is applied to future installments of taxes as part of the bargain.

Practically speaking, it is very rare to try a case in either the County Board of Taxation or the State Tax Court. Almost all cases are settled and, often within the common level range. However, the taxpayer must make out a potential case that meets the statutory requirement of 15% over assessment or else there will be no settlement.

Whether the real property is held as an investment, an operating business property or a residence, the assessment should be reviewed annually to determine if it warrants appeal. For a business, this is the cost of doing business which is a part of managing a business properly. For a homeowner, it is just sensible planning.

Most businesses are owned by small groups of people and are, therefore, “closely-held.” If the business is a corporation, they own stock and are stockholders. The percentages of ownership vary widely from equal ownership to skewed percentages.

Usually the owners of the majority of the shares can elect the board of directors, which in turn elects the officers and thereby controls the operation of the corporation. Absent a stockholders agreement providing specified rights, a minority stockholder cannot elect directors, cannot participate in management, cannot compel the payment of dividends and cannot demand employment. The only rights of a minority stockholder are to share in any dividends, to share upon liquidation of the corporation, if ever, and, perhaps, to vote on certain major corporate decisions such as sale of the company.

This imbalance of power between majority stockholders and minority stockholders has lead to many cases of corporate oppression, where the majority uses its position unfairly against the minority. Examples of such oppression are firing a minority stockholder who is employed by the corporation for no reason related to that person’s employment performance; making changes in corporate operations to hurt the minority stockholder’s status, power or financial standing; refusing to distribute profits although substantial cash is available; and refusing to hold meetings of stockholders or the board of directors. Any material, unjust disparate treatment of the minority stockholder may qualify as oppression. Corporate oppression is often used to “squeeze-out” a minority stockholder - to force him to sell his stock on a distressed basis.

Because of the fundamental unfairness of these acts, the New Jersey Legislature passed the Corporate Oppression Act 25 years ago, which has also been applied to limited liability companies and partnerships. It gives minority stockholders who are victims of corporate oppression and can prove it a number of invaluable rights.

First, a court may appoint a custodian selected by the court to run the corporation without actually declaring a receivership.

Second, the court may appoint a provisional director to serve on the board of directors and to vote on matters of importance coming before the board. This most often occurs when there is split voting power and the corporation is unable to function.

Fourth, and most significantly, the court may order the sale of all shares of the corporation’s stock held by either the majority stockholder or the minority stockholder to the corporation or to the other stockholder. In such case, the court will determine the stock’s “fair value” which will be the purchase price. After determining fair value, the court will set the terms of payment. If the court determines that any party to the suit acted “arbitrarily vexatiously or otherwise not in good faith,” it may also award reasonable expenses, including counsel fees, to the other parties.

The Corporate Oppression Act also applies in cases of corporate deadlock when either (a) there is such a division in voting power that the stockholders have not been able to elect directors at the last two scheduled annual meetings or (b) the directors or officers are unable to act on important corporate issues regarding management of the corporation due to deadlock.

The court may often appoint a custodian or provisional director before discovery and before there has been any final determination of either corporate oppression or deadlock. The goal is to maintain the company's operational status quo pending the litigation and to prevent wrongful acts during the litigation. While such appointments are burdensome, since they include the expense of the appointee and the potential unwieldiness of dealing with an outsider, they often bring dramatic protection for the minority stockholders.

The Corporate Oppression Act applies to every closely-held corporation in New Jersey. Therefore, good planning should try to strike a proper balance in the governing documents between the rights of the majority and the minority. Similarly, where voting power is equal, good planning should anticipate deadlock because people will always disagree. The alternative of a compulsory buyout in court is long and expensive. Often there is no other way out if problems have not been anticipated and provided for in corporate documents.

In today’s world, almost anything can be accomplished without leaving home or office. Overnight delivery services, the telephone, the fax machine and the mail have all facilitated doing business with little or no travel. And now, widespread usage of the internet has made remote business easier than ever before.

While business can be transacted from the comfort of home, lawsuits still involve travel, employing attorneys in the state the lawsuit was filed and considerable additional inconveniences which technology cannot eliminate. The disparity between the convenience of doing business anywhere in the world and the burden of defending a lawsuit halfway around the globe is actually widening with each technological advance. While a New Jersey resident can do business more easily in California, he is also more susceptible to suit in California’s courts.

“In personam jurisdiction” is the legal term for any court’s power over an individual or business entity. While jurisdictional law can vary from state to state, most states’ courts exercise the broadest jurisdictional powers permitted by the United State Constitution. The Constitution requires that a court exercise jurisdiction only over a defendant with sufficient contacts within a state that he should reasonably expect to appear in court in that state.

Those contacts deemed sufficient to confer jurisdiction over a defendant, called “minimum contacts,” can be divided into two categories. Contacts related directly to the facts of a given lawsuit confer “specific jurisdiction.” For example, when a defendant has allegedly breached a written contract that required him to perform significant work in the forum state, that fact will usually confer specific jurisdiction. Contacts not related to the case at hand confer “general jurisdiction,” i.e. jurisdiction for any lawsuit. To establish general jurisdiction, the defendant’s contacts must amount to a regular presence in the forum state.

Significant factors in determining whether or not the courts of a given forum state will exercise specific jurisdiction include the following: Did the defendant solicit the relationship with the plaintiff in the forum state? Did the defendant travel to the forum state to meet with the plaintiff? Did the defendant know that the relationship with the plaintiff would have a significant impact in the forum state? In accident cases, the state in which the accident occurred will usually have jurisdiction. In products liability cases, specific jurisdiction is usually applied very broadly, because one who markets a dangerous product is usually subject to jurisdiction wherever it is sold.

Significant factors in determining whether or not the courts of a given state will exercise general jurisdiction include: Does the defendant do business with residents of the state? Does the defendant own property located in the state? Does the defendant regularly travel to the state? If a defendant has an office or home in the state, then there is always general jurisdiction.

Internet business creates special problems which the courts are only beginning to address. For example, if a buyer and seller meet online, where is the meeting geographically? If the user of a website defames another individual through a posted message, where is the libelous statement disseminated? Because the internet is accessible everywhere on the globe, normal jurisdictional questions become extremely complicated.

For now, and until a generally accepted law of internet jurisdiction is established, it is best to assume that when you do business online you do it globally. This means that you could find yourself traveling long distances to defend your actions, so beware and be careful!

Any business, such as a corporation or a limited liability company, acts through its agents, including its officers and employees. Recently, New Jersey’s Supreme Court has revisited the question of when an officer is personally liable for his own conduct within the scope of his employment.

An officer of a corporation is liable for his own intentional wrongdoing, whether or not that wrongdoing occurred within the scope of employment and without regard to any benefit accruing to the officer. Thus, if an officer of a corporation, while acting within the scope of his employment, commits an assault, an act of fraud, or a theft, that officer will not be excused from personal liability simply because he was acting on a corporation’s behalf.

By contrast, an officer cannot be held liable for a corporation’s breach of contract, even if he is directly involved in the corporation’s efforts or failure to fulfill its contractual obligations. Only a party to a contract is liable for its breach, and an officer is not considered a party to the corporation’s contract, even if he negotiated and signed it, so long as he did so solely on the company’s behalf.

The more difficult question is what happens when the officer is negligent in the course of his employment? Clearly, the company is liable, but what about the officer?

New Jersey’s courts have rarely had occasion to address this issue. Other states have held that an officer is liable for negligence if he participated in the negligent act. New Jersey’s Supreme Court has not clearly ruled, although it did note recently that there is precedent in this state suggesting that this “participation” rule would be adopted.

There is, however, an important caveat. It is always necessary to distinguish whether the officer participated in a negligent breach of a contractual obligation or in a non-contractual act of negligence. Negligence consists of the breach of a duty of care. Where the duty of care exists solely because of a contract, the officer’s participation cannot be the basis for personal liability. However, if the duty of care is one imposed by law, then the question of personal liability of the officer remains open in this state.

· Officer A is participating in the manufacture of a widgit. Due to his negligent mistake, the widgit is built to the wrong specifications and is, consequently, unusable. The Buyer sues the corporation that employs Officer A for economic losses and Officer A for negligence. However, Officer A only violated the duty of care pursuant to the contract and is not personally liable.

· Officer B is participating in the manufacture of a seatbelt for use in an amusement park ride. Due to his negligent mistake, the seatbelt is defective, and someone is physically injured. Officer B owed a legal duty to the public and may, depending upon future rulings in this state, be personally liable.

Sometimes both kinds of duties exist at once. A good example is a law firm. Law firms enter into contracts with their clients that require that individual attorneys exercise due care in their representation of the client, while the law also imposes that duty upon the attorneys. No attorney is immune from personal liability for his own negligence because he is working for a law firm, even if that firm is a professional corporation or a limited liability company. The same rule applies for doctors.

The personal liability of officers for negligence occurring in the scope of their employment is a changing area of the law. While future cases will determine how it develops in this state, be aware that there is a national trend in favor of expanding the personal liability of corporate officers.

Despite the lowering of capital gains tax rates, tax-free exchanges under Internal Revenue Code Section 1031 continue to be popular for real estate investors because a taxpayer can defer much or even all of the gain on the sale of his property and “roll it over” into another property. Anyone who invests in real estate should become familiar with tax-free exchanges.

In a classic tax-free exchange, the taxpayer would come to a closing with another party and they would swap deeds to two properties making whatever monetary adjustments were necessary. Since it is rare for two parties to want to buy each other’s property, most exchanges involve three parties. Often a Qualified Intermediary facilitates the exchange for a fee. A typical tax-free exchange works as follows:

Tony Taxpayer has apartments in Englewood worth $2,000,000. He wants to sell them and reinvest the proceeds in a shopping center in Hackensack owned by Susie Seller. The Hackensack shopping center is worth $5,000,000 and she wants to sell for cash. Bob Buyer wants to buy the Englewood Apartments for cash. With the assistance of Isaac Intermediary, each party will end up with what he or she wants.

Party Owns/Has Wants

Typically the exchange is not simultaneous but deferred. In the first leg of the exchange, Tony sells the Englewood Apartments to Bob for cash. However, by using Isaac as intermediary, the sale is actually done by Isaac, who retains the cash. Tony cannot have actual or constructive receipt of the cash proceeds of the sale.

Within 45 days of the date of the closing, Tony must identify the replacement property he wants to buy, which in this case is the Hackensack shopping center. He must close on that shopping center within 180 days of the closing of the sale of the Englewood Apartments or the due date of his tax return (including extensions) whichever is earlier. During that period, he enters into a contract to buy the Hackensack Shopping Center from Susie for $5,000,000. Prior to the closing, he assigns the contract to Isaac who closes with Susie, using the cash from the Englewood closing plus additional cash and mortgage financing provided by Tony. After the second closing, Tony has the Hackensack Shopping Center, Bob has the Englewood Apartments, Susie has received cash and Isaac has earned a fee.

The taxation of this transaction works as follow: Tony Taxpayer owns the Englewood Apartments, subject to a $1,000,000 first mortgage, with the following tax characteristics:

If Tony were to sell the Englewood Apartments, he would incur a tax liability of approximately $260,000 on that realized gain.

However, by acquiring the Hackensack Shopping Center in an exchange, Tony reinvests all of the $1,000,000 of cash proceeds from Englewood as follows:

Under this exchange, there is no recognized gain or tax due because there is no “boot.”

“Boot” is any consideration received other than real property. There are two types of boot: “cash boot” and “mortgage boot.” Cash boot is cash or anything else of value received. Here Tony has not received any net cash – he has used all $1,000,000 of the proceeds from Englewood to buy Hackensack. Mortgage boot is the excess of the liabilities assumed at the sale over the mortgages assumed on the purchase. Tony has not received any mortgage boot because the $1,000,000 mortgage paid off on Englewood is less than the new $3,500,000 Hackensack mortgage.

The “price” for not paying the tax on the sale of Englewood is the reduction of the basis of Hackensack by the amount of the gain deferred:

By using the tax-free exchange, Tony has avoided paying $260,000 in taxes and has been able to reinvest that money at the small cost of having a reduced basis in Hackensack. Tax-free exchanges are highly advantageous and should be considered whenever proceeds of a sale are being quickly reinvested in a new property.

Controlling the cost of legal services

It is never too late to reduce spending on legal services. If you agree, we would recommend that you carefully consider the following suggestions on how to lower your legal bills.

We spend a great deal of money on insurance. Premium costs anticipate risk (i.e., defense costs and claims payments) plus a generous allowance for insurance company administrative overhead and profit. Given the plethora of potentially uncovered claims (for example, claims for breach of contract, non-payment, unfair competition, wrongful discharge, regulatory charges, etc.) it is not difficult to make a compelling case for legal “audits” of everything from purchase order forms to employee manuals. Since we already “know” your business, we can help you prioritize and budget reasonable expenditures on significant measures to protect your business against expensive claims and losses. Consider the following questions:

(a) Are your customers contractually obligated to pay reasonable service charges, attorneys' fees and costs if you are forced to hire an attorney to collect amounts due?

(b) Have your employees executed confidentiality and non-disclosure agreements covering your marketing strategies, customer and supplier relationships, and intellectual property?

(d) Given the almost unlimited grounds for employment lawsuits, have your employees agreed to forego jury trials in favor of mandatory arbitration of all employment claims?

These and many more “what if?” scenarios merely suggest the same principle that underlies the concept of preventative maintenance—an ounce of prevention…

It is probably not possible to look at any invoice for legal services and rationalize the expense on an item-by-item basis. How can one justify a ten-minute phone call between lawyer and client where nothing is resolved, very little productive information is exchanged, yet a $50 charge appears on the bill? The best response is this: In many situations it is an idea conceived in an instant or a few minutes’ skillful closure of weeks of settlement discussions that produces the greatest portion of the final result. It is simply not possible to bill $50 for “unproductive” conversations and $1000 for five minutes of creative legal work that saves the day. We believe that thorough and efficient legal services performed at competitive billing rates by experienced, competent counsel will get our clients from Point A to Point B at the lowest total cost.

The fact that billing is predicated on the amount of time expended should never preclude the use of project budgets or fee “caps” for many routine legal services. We can often bill at fixed or capped fees for segments of transactional work and other common projects. Initial drafts of many agreements, business governance documents, trusts and wills can be generated quickly and inexpensively. While differing circumstances to complete a particular project will dictate a wide range of costs, it is not unusual for a law firm to stay within budget in terms of anticipated total fees.

Understanding available options and their impact on fees is critical to controlling costs. For instance, we will often discuss due diligence requirements with the client and help prioritize and delegate back that function to others, including the client’s own management. However, there can be circumstances where confidentiality or work force limitations require a considerable effort on the part of the law firm to complete much of the due diligence. Similarly, we are often asked to handle all negotiations in a particular transaction, while in others we are merely scriveners of the “handshake” deal.

Only litigation defies budgeting (the other side is largely responsible, although the courts are nearly as unpredictable). How to manage litigation will be a subject covered in the next LawLine.

Law firms are in the service business. However, as with any service, it's not how much you spend that ultimately determines the quality of the product. Through advance planning and well reasoned, businesslike decision making, you can control expenditures and acquire the quality legal services you need to protect and increase your assets.

Litigation is sometimes necessary, but never productive for business. How much will it cost? More than you want to spend. If you can afford to litigate a case, you can probably settle it for less. Litigation would generally be a viable strategy to resolve virtually any business difficulty if only the other side did not participate. Unfortunately, it's a fact of life in today’s business climate that even the “winner” rarely comes out whole. That being said, consider the following cost-control measures:

(a) Designate one key employee as point person to interact with counsel. While a particular case might require the participation of several employees, efficiency is drastically improved through the use of a liaison who is knowledgeable about the facts of the case, can easily coordinate document productions, the scheduling of conferences and proceedings, and is readily available to assist counsel and provide continuity to the litigation effort.

(b) Don’t attempt to litigate at “low cost.” Keep in mind that your side has no control over the tactics of the opposing parties. Instructing counsel to keep the case going at a “minimum” level is a sure recipe for disaster. As a rule, the stronger you are at the start of the case, the more likely you are to gain real time and money advantages in the course of the litigation. Nothing sends a clearer message to the other side than an easily recognizable lack of litigation resolve. It is actually easier for us, as your counsel, to estimate the cost of a well thought out, properly coordinated initial litigation strategy than a tepid offense or reactive defense.

(c) Always make business decisions. Clients ask us “How much should I pay,” or “How much will they pay?” The answer to the first is a business decision you should make based on a legitimate risk-reward analysis predicated on the advice of counsel. The answer to the second question with you as plaintiff should be discussed and considered before you file a lawsuit. The real difficulty occurs when you base the required “result” on the money spent; that procedure a skews the legitimate business decision making process into an ever increasingly unobtainable or unrealistic objective.

(d) Pick your battles. There are certainly circumstances that justify litigation expense. Many clients use litigation as a tactical device to achieve specific business objectives beyond the result of a particular case. For instance, one large employer will not entertain a settlement demand from any employee threatening suit for a meritless employment claim, but will immediately take steps to resolve a claim with at least some reasonable basis in fact and law. This consistently maintained policy has served the company well—nuisance claims are virtually non-existent and most employees have a sense that legitimate grievances will be disposed of fairly and efficiently. At the same time, meritless claims have been aggressively defended, and, without exception, disposed of satisfactorily. Another client is highly adamant about strictly enforcing its valued contract assets; it is always willing and ready to start litigation at the drop of a hat. As a result, the reputation it has garnered within its business community is one of enviable respect; its rate of contract renewal is the highest in its industry.

While we have had some clients complain about spending a few thousand dollars to resolve a case from start to finish, others have been incredibly appreciative after spending hundreds of thousands on legal fees and paying a significant sum to settle the case. We have never hesitated to attempt to dissuade a client from litigating a dispute if alternative solutions made good business sense. On the other hand, we have tried hard to persuade clients to anticipate and plan for disputes well in advance of their onset. In our collective experience we have learned one truth about judges, juries and our court system: Predictability is not litigation’s strong suit. As with all business decisions, research, preparation and reasoned judgment usually yield the best results.

With ever increasing frequency employers are demanding and employees are signing agreements that limit the employment and other business options available to the employee after termination of employment. Those portions of the employment contract are commonly known as restrictive covenants.

Typically, restrictive covenants include restrictions on the employee's right to work for competitors and to solicit customers of the employer. An example of a restrictive covenant is as follows:

For a period of two years after the termination of employment for any reason, employee agrees that he shall not work in or have any interest in any business which is competitive to that of employer, and employee will not contact, solicit, or accept any business from any customer of employer.

Because these covenants are enforceable only to the extent that they are reasonable under the circumstances, their enforceability can never be determined in the abstract but rather only in the context of the particular facts and circumstances of the employer and employee in question.

Then, even if the covenant is found enforceable, it may be limited in its application by its geographical area, its period of enforceability, and its scope of activity.

An employer's interest in stifling competition is not a legitimate interest in this context. Conversely, if an employee was handed a large number of customers when he started working for his employer, and the employer had developed these customers over many years, the employer would have a legitimate interest in maintaining these customer relationships and preventing the employee from interfering with them. An employer's legitimate interest is increased dramatically in the context of a business acquisition where the employee was previously a principal of the seller.

All restrictive covenants impose some hardship on the employee. The determination of whether or not the hardship is undue is whether it is too harsh a burden on the employee given the legitimate interest of the employer. For example, if an employee came to the job with many years of experience in the industry and many contacts in the industry and worked on customers given to him by the employer as well as customers he developed on his own, a court would be reluctant to foreclose him from working in the industry.

As one court said, "What [the employee] brought to his employer, he should be able to take away." Stated differently, a tradesman who brings tools to his employer may on separation leave with them. Similarly, a scientist who has entered into an employment relationship with a head full of scientific data, some of which he used for the benefit of his employer, may then use it for the benefit of another. As another court said, "Princeton is not to have the exclusive right to Einstein's services just because he is Einstein."

The public interest is implicated in some employer/employee relationships. A good example is that of physicians, where there is a strong public interest in providing medical care generally and in ensuring patients access to their physicians. Thus, it is unlikely that a court would ever enjoin a physician from giving services to a patient. However, a court will enjoin a physician from opening an office within a certain distance of his former employer for a certain period of time. The distance would not prevent the patient from reaching him at his new office but would still give some measure of protection to the employer. In Bergen County, New Jersey, we have seen two- to five-mile restrictions for two years and more upheld by the courts in this context.

After analyzing all of the relevant factors in a given case, courts will often rewrite or "blue pencil" restrictive covenants so that what remains is reasonable under the three-part test set forth above. A prohibition on competition in a large industry might be reduced to a portion of the industry or a prohibition on competition might be eliminated, but a ban on solicitation might remain. A proscribed geographical area or the time period of the restriction might be reduced.

Restrictive covenants are multiplying in employer/employee relationships. Post-employment restrictive covenants are always vital to the employee and often important to the employer. They should be carefully considered by both sides in every case. Through careful drafting, one can eliminate a significant portion of the uncertainty that comes with judicial intervention.

While sexual harassment is a rapidly evolving area of law, it has been clear for a long time that quid pro quo harassment is actionable. Quid pro quo harassment occurs when an employer attempts to make an employee's submission to sexual demands a condition of his or her employment.

The more dynamic area of sexual harassment claims are those based upon a hostile workplace environment. Here, the harassing conduct generally consists of unwelcome sexual touching or comments although they are not necessary elements of a claim. A female plaintiff must prove that a reasonable woman would consider the conduct sufficiently severe or pervasive to alter the conditions of employment and create an intimidating, hostile or offensive working environment. Needless to say, claimants need not be women and the claims need not be based upon heterosexual unwelcome comments or touching.

While most cases involve unwelcome conduct occurring over a period of time, the unwelcome conduct can consist of a single severe act of offensive touching or of multiple randomly occurring incidents. More commonly, there is a pattern of harassing conduct which cumulatively creates a hostile workplace environment.

Much of the sexual harassment litigation involves whether or not the employer is liable for the acts of the employee doing the harassing. That determination is made on a case by case basis and depends on many factors, including whether or not the harasser was a supervisor; if a supervisor, his or her authority concerning the management of subordinates; and whether or not the employer was negligent. It is this last area, employer-negligence, where employers can and should act preemptively.

To avoid a claim of negligence, an employer must use due care. Due care in this context has several elements.

First, an employer must have in place a well-publicized, preferably written, anti-harassment policy. Sexual harassment cannot be tolerated in any workplace and it must be official policy to say so.

Second, each employer should have effective formal and informal complaint mechanisms. If there is a claim of sexual harassment, the employee must know to whom he or she should complain and an investigation should result which is thorough and fair to all concerned. The employee receiving the complaint and conducting the investigation should document all steps. Appropriate disciplinary action must be taken at the conclusion of the investigation if warranted.

Third, there should be training, especially for supervisory employees, concerning what constitutes offensive conduct which makes a workplace abusive or hostile to members of one sex or another. In addition, the training should explain how the complaint and investigative mechanisms operate.

Fourth, there should be some type of effective monitoring mechanism so that the employer can learn whether or not the policies and the complaint mechanisms are trusted and working effectively.

Fifth and most importantly, there must be an unequivocal commitment from the top down that having a workplace free of sexual harassment is not just words but is backed up by consistent firm practice.

Regardless of the procedures in effect, due care always includes a duty to act when evidence of harassment is brought to the attention of supervisory employees. If supervisors learn of potentially abusive conduct, they must investigate, determine if it is harassment and, if warranted, take steps to eradicate it. Supervisors cannot ignore signs of harassment without exposing the employer to liability.

Employment litigation is a booming area of the law. Employers should prepare for the battle not just to win if sued, but because it is the right thing to do to make the workplace a pleasant, productive environment for all.

LIABILITY OF CORPORATE DIRECTORS

by Daniel Simpson, Winter 1999

All corporations share the same basic structure: they are owned by the stockholders who elect the directors who manage the corporation by appointing officers, including a President, who actually run the business. Unfortunately, few people appreciate the responsibilities and liabilities that one assumes as a director of a corporation. Understanding these issues is important before deciding whether or not to accept an offer to become a director. Similarly, one should appreciate these matters before offering a directorship to someone else.

Each and every director is obligated to be familiar with the business and to keep informed about general activities. This is true whether or not the Board of Directors meets frequently or never. This is true whether the minute book is filled with minutes or has absolutely none.

The obligation to keep informed is a continuing one so directors may not close their eyes to misconduct by officers and then claim as a defense that they did not observe the misconduct. It has been said, "the sentinel asleep at his post contributes nothing to the enterprise he is charged to protect."

While a director's duties are to generally monitor corporate affairs and policies rather than to be involved with management on a day-to-day basis, a director should be sure that the Board meets regularly and that he or she attends all, or at least, most meetings. In fact, a director who fails to attend a meeting will be presumed to approve all actions taken unless he files a dissent with the secretary of the corporation within a reasonable time after learning of the action. This is particularly important because certain corporate actions which a director approves can be the basis for statutory liability, including the declaration of dividend or the redemption of shares when there is not sufficient surplus or the distribution of assets to shareholders upon dissolution without paying or providing for all known debts and obligations.

Included in the duty to generally monitor corporate affairs is the obligation to maintain familiarity with the financial status of the company as revealed in its financial statements. In addition, the review of those financial statements may require a director to make further inquiry concerning matters disclosed therein. For instance, if financial statements were to reveal substantial new stockholder loans while the company was losing money, a director should investigate.

Directors are bound to exercise ordinary care in the discharge of their responsibilities, understanding that they have obligations not only to stockholders but to creditors of the corporation. Thus, if a company fails due to misappropriations which a director in the exercise of due care should have discovered, the director may be liable to creditors who are not paid when the company closes.

Part of the obligation of ordinary care is to acquire the knowledge necessary to exercise that due care. Thus, if a director does not feel that he or she has sufficient business experience to be able to perform the responsibilities of a director, he or she should either acquire that experience very quickly or resign the position.

To meet the duty of due care, a director may be under a duty to do more than just object to actions taken at Board meetings. He or she may be may be obliged to seek advice from counsel concerning the propriety of actions taken by officers, other directors or himself or herself.

Contrary to popular belief, there is no such thing as a figure-head director. "A director is not an ornament but an essential component of corporate governance" with attendant responsibilities and liabilities.

The purpose of this article is to explain what a limited liability company ("LLC") is, the special words which comprise the lexicon of LLCs and why LLCs are the entity of choice for most new businesses.

The LLC is a creature of statute from state to state just like a corporation is. It is a legal entity created by filing a document with the New Jersey Department of Treasury called a Certificate of Formation. The Certificate of Formation need not be complex, although it can be. It must state the name of the LLC, the name and address of the registered agent for service of process and the duration which may be perpetual or some shorter period.

Once the Certificate of Formation has been filed, then the LLC can transact business. The LLC is a separate legal entity that can hold title to property, hire employees and enter contracts. The principal advantage of an LLC is that, like a corporation, the owners are not liable to third-party creditors of the LLC (unless they are liable for a reason other than being an owner, such as commission of a tort personally). However, unlike a corporation, the LLC is taxed as a partnership. Consequently, the LLC files a partnership income tax return but pays no taxes, as all items of income and loss pass through the LLC to the individual members.

The owners of the LLC are not called stockholders but members. What members own in the LLC is not stock but their membership interests. There is no fixed management structure for an LLC. This is both an advantage and a disadvantage. The advantage is that the management structure of each LLC can be tailored precisely to suit the members. The disadvantage is that unless a fairly comprehensive document called an Operating Agreement is prepared, there will be no management structure. This flexibility is in contrast to the rigid, well-understood structure of corporations, where the stockholders elect the directors, who, acting as a board, elect the officers, who run the corporation. That is not necessarily so with an LLC. The election of managers can be provided for, or they can be designated by name in the Certificate of Formation of Operating Agreement along with provisions for succession. Similarly, the authority of the managers may be limited or unlimited, as provided in the Operating Agreement. If a more formal management structure including officers such as president, vice president, and secretary is desired, the Operating Agreement can so provide.

The capital structure of an LLC can be anything that is desired. There can be different classes of interest with different returns on investment and different voting rights or no voting rights at all. All of these requirements must be spelled out in the Operating Agreement. In market contrast, in the world of S Corporations, there can only be one class of stock other than the occasional separate class which is identical financially but has different or no voting rights.

Like a well drafted stockholders agreement or partnership agreement, an Operating Agreement will, in addition to setting forth management structure, capital structure and profit and loss sharing, will also have provisions generally restricting the transferability of interests and providing for the purchase of interests in the event of death, bankruptcy or disability, and the potential finding of the same through insurance.

Unlike an S Corporation, any person or entity may be a member in LLC. For example, an LLC is often the preferred entity of choice for ownership of real estate by two or more corporations, other LLCs or other business entities or individuals.

While there are many advantages to the LLC, please do not believe that corporations are dead. They are not. However, an LLC should be considered as an alternative every time a person or persons form a new business entity.

Two recent developments in the area of employment law have created a considerable impact on the responsibilities of employers in protecting the rights of current and potential employees. The first concerns the most recent amendment to the Conscientious Employee Protection Act (CEPA), signed into law by Governor McGreevey on September 14, 2004. Under CEPA, or the New Jersey “Whistleblower” statute as it is more commonly known, employers are now required, in addition to prominently posting notice of their employees’ protections, obligations, rights and procedures under CEPA, to annually distribute such notices to each employee. The notices can be in writing or sent electronically and must be in English and Spanish, as well as any other language spoken by a majority of the employer’s employees.

Employers who are unsure as to the proper form to use for compliance under CEPA can obtain, for a fee, copies of an approved form of notice from the New Jersey Commissioner of Labor. The approved forms can, at the request of the employer, be provided in a language other than English or Spanish.

The new requirement of annual distribution of notices under CEPA does not apply to all employers. Those employers with less than 10 employees are exempt from the obligation to distribute the notices. However, the exemption does not apply to the continued requirement, applicable to every employer in New Jersey, to conspicuously display the notice at the workplace.

The second important development can be found on the federal level and is a direct result of the impact of the war in Iraq on our nation’s workforce. On September 20, 2004, the U.S. Department of Labor (USDOL) issued a set of proposed regulations designed to help both employees and employers understand their rights and obligations under the Uniformed Services Employment and Reemployment Rights Act (USERRA). USERRA was enacted by Congress in 1994 to protect the employment rights of our military men and women once they return from military service to civilian life. The purpose of the new regulations is to help clarify the often confusing language found in USERRA in light of their increased applicability in the face of the largest mobilization of National Guard and reservists since World War II.

In order to accomplish its goal, the USDOL issued the regulations in aion and answer format, using plain language instead of legalese. They are designed to explain how the many goals of USERRA shall be implemented, including the prevention of discrimination against current employees and job applicants based on their military service; the withholding of paid leaveand other earned benefits and promotions from service members during their time away from civilian employment; and the protection of the rights of service members to report back to their civilian jobs after their military service has concluded.

In addition to serving as a guide to employees of their rights under USERRA, the proposed regulations are a useful roadmap for employers who are unsure as to what actions they are permitted to take when confronted with a current or potential employee who is suddenly called upon to satisfy a military obligation. They explain, among other things, the types of employers, employees and service activities covered under USERRA; the type of notice required to be given to an employer by an employee leaving for military service; the procedures to be taken for seeking reemployment upon completion of military activity; the defenses to reemployment given to employers upon completion of the employee’s military service; and the benefits that employers must confer upon returning employees.

Since the USDOL has declared its intention to vigorously enforce the protections granted under USERRA, it is certainly in the best interest of employers to review the regulations in order to prevent potential employee complaints and to be in a position to proffer a proper defense if such a complaint is actually filed.

It is important to note that the regulations are proposed and therefore subject to revision by the USDOL. The regulations can be obtained or reviewed by visiting www.regulations.gov and clicking on the appropriate link. Comments on the regulations may be submitted through November 19, 2004 at the website.

Few concepts involving real property or secured transactions are less understood than Landlord’s Liens. Landlord’s Liens encompass a bundle of rights that a landlord has to recover unpaid rent from the personal property of his tenant. In fact, most landlords have no liens until they distrain, a concept which contributes to the confusion.

Long before the New Jersey State Constitution was adopted in 1947, landlords who were not paid their rent could distrain the personal property of the tenant, typically by padlocking the premises. The landlord would then cause the property to be sold and the proceeds to be applied to the unpaid rent. New Jersey has an 1877 statute, still in effect, which specifically authorizes this procedure.

Except in the case of certain industrial facilities which will be discussed below, a landlord does not actually have a lien on the tenant’s property prior to distraint. The landlord has the right to be paid up to one year’s rent from property of the tenant in the leased premises which property is taken by execution, attachment or court order. Thus, if a judgment creditor of a tenant causes a sheriff to levy upon equipment or inventory in a leased facility, the sheriff will be obligated to pay the landlord up to one year’s rent arrearage out of the proceeds of sale.

A landlord which is not paid its rents may also act proactively to perfect its lien on the tenant’s property within its premises by distraining the property. Prior to 1983, distraint was done the old fashioned way--by padlocking. In 1983, the New Jersey Supreme Court held that that process was unconstitutional because the tenant did not have a right to be heard by an impartial judicial officer before being deprived of its property. Today, a landlord may only distrain a tenant’s property within the leased premises by going to court and obtaining a temporary restraining order distraining the property. To do so, the landlord must show the court that it has a lease, that there is a breach, i.e. unpaid rent, and that the tenant has property on the premises.

Significantly, because the Supreme Court specifically authorizes this procedure, trial court judges are far more likely to grant emergent relief of this kind than in other applications for restraining orders.

If the court orders the distraint, then the landlord must follow the balance of the 1877 statutory framework. Thus, once the distraint has been effected, the tenant has ten days after receiving notice to make a motion to recover its property. Next, on two day’s notice, the landlord may have the goods inventoried and appraised by three persons sworn by the county sheriff or local constable. [In practice, this procedure does not occur without the landlord’s active involvement in hiring such persons.] Finally, on five day’s public notice, the landlord can hold a public sale conducted by the sheriff. The proceeds of sale are applied to the costs of distraint and sale and then to the unpaid rent.

There are certain important factors to keep in mind. First, there is no landlord’s lien with respect to premises solely used as a residence. [A residential apartment used partially for business purposes is still a residence.] Second, the lien does not apply to property removed by the tenant from the premises. The lien only applies to property on site. This is why you will sometimes see tenants moving in the middle of the night, like the Baltimore Colts. Third, the landlord can only distrain one year’s arrears of rent. [This is among the reasons why most leases provide that all monies which a tenant owes, such as common area charges, taxes etc., are considered “additional rent.”] Fourth, the landlord does not have a true lien until the distraint occurs. Until that time it just has a right to obtain the lien and a right to be paid in the event some other creditor seizes the tenant’s property pursuant to a writ of execution, attachment or court order. [Therefore, the landlord’s right to obtain a lien is subordinate to a perfected security interest to a financing company or bank.]

There is special type of lien for certain industrial facilities under the Loft Act. The Act applies to a “mill, factory or loft” leased to a tenant for “manufacturing or other purposes.” Unlike the general statute on landlord’s liens, the Act creates a lien from the date the rent is unpaid, without any requirement to distrain. This lien, however, gives priority up to only six months rent. This lien can prime a secured creditor unless the secured creditor’s lien is placed on the property prior to the commencement of the lease.

As a result of the above statutory framework, most lenders providing financing to tenants require that the landlords sign a document called a “Landlord’s Waiver” before extending the financing. This is often a negotiated document which typically provides that the landlord waives its common law and statutory lien and right to distrain; that the secured party may, on notice to the landlord after default, remove its collateral from the leased premises; that the secured party will pay for damage from any removal; and, often times, that the secured party will pay rent and utilities during some time period while it is removing the property.

The agreements are a benefit to both sides. From the lender’s perspective, it is obvious. From the landlord’s perspective, he is not going to have an operational tenant unless the tenant has financing, so providing a waiver of lien is just part of the bargain. Further, being assured of repair of damage from removal of equipment and any rental for the period of a lender’s use of the premises is a plus. Finally, the landlord is not generally making its credit decision based upon potential resort to the tenant’s personal property.

While most people consider their bank accounts to be "their money," actually they represent amounts owed by the bank to the customer. This is the converse of a normal bank loan where the bank is the creditor and the depositor is the debtor. A bank obtains a right of setoff when it has the legal right to apply the money it "owes" to its customer as represented by an account against monies owed by its customer on a loan.

The first requirement to establish a right to set-off is that the account to be set off must be the property of the same customer who is indebted to the bank. Thus, if a corporation owes money to the bank, the bank cannot set off the account of the corporation's president or of a sister corporation or even a subsidiary unless those parties have given their guarantees of the corporate debt. In that case, they would also be indebted to the bank as guarantors and their accounts would also be subject to setoff.

The second requirement to establish a right to set-off is that the account must be deposited without restrictions. There are many types of accounts which are not subject to setoff. These would include payroll accounts, trust accounts or other special purpose accounts. When a bank accepts accounts with such designations, it acknowledges that these accounts are for special purposes and are not subject to a right of setoff in the event the owner of the account defaults on a loan to the bank.

The third requirement to establish a right to set-off is that the indebtedness to the bank must be due and owing. Thus, until there has been a default and acceleration, the only payments which are due and owing are the current unpaid installments, so a settoff cannot exceed those amounts. After default and acceleration, of course the full amount of principal and accrued interest is due.

While the right of setoff arises from case law extending back hundreds if not thousands of years, typically banks will include a specific contractual right of setoff in loan documents and new account agreements. While this language does not materially alter the right of setoff, it can make it much easier to convince a judge that a setoff was lawful. For example, the typical form guarantee provides for a right of setoff against accounts of the guarantor. Upon default by the borrower, if the bank exercises its right of setoff against an account of the guarantor, it is much easier for the bank to point to the language in the guarantee in which the guarantor specifically agreed to such a right of setoff than to argue from ancient cases that such a right exists.

Many bankers are uncertain how setoff rights are affected by the filing of a bankruptcy. The Bankruptcy Code specifically recognizes setoffs which are taken before the filing of the petition, although the name on the bank account must be exactly the same as the name of the party indebted to the bank. The party indebted to the bank could be liable as a borrower or guarantor but the names must be the same. For example, bankruptcy courts have not permitted setoff of a joint account when the debt was only owed by one party.

However, the Bankruptcy Code has a special preference section just for setoffs. Just as a bank cannot ordinarily acquire additional collateral within 90 days of a bankruptcy unless it gives new value, so a bank may be forced to give back some or all of its setoff. The easiest way to understand the rule is to imagine that the setoff is taken on the day in the 90-day period which is least advantageous to the Bank, ie, the date on which the setoff would have been the lowest possible amount. The Code requires the bank to return the difference between the amount actually setoff and that hypothetical amount. For example, if the amount owed by the debtor to the bank remains essentially constant throughout the 90-day pre-petition period, then the maximum amount of a permitted setoff is the lowest balance in the account during that 90-day period.

This example demonstrates the most important point about setoffs--that is if you do not take them you lose them. Accounts can vanish and bankruptcies can occur so we always our clients to look at the account balances of all parties whose accounts may potentially be setoff, i.e., all borrowers and guarantors, as soon as there is a default and make a conscious decision whether or not to setoff the accounts. Sometimes our clients look at account balances on a daily basis. The decision whether or not to setoff may depend on a host of factors including what other assets may be available, the duration of the default and the confidence the bank has in the debtor. But in all cases it is true that once the money is gone it is lost forever.

Radical Changes in Filing of Financing Statements

Effective July 1, 2001, Article 9 of the Uniform Commercial Code of New Jersey (and of many other states) was replaced. The new Article 9 dramatically changes the form, execution and filing of Financing Statements.

All Financing Statements except fixtures filings must be filed with the Division of Commercial Recording of the State where the debtor (not the collateral) is “located.” Any entity debtor registered with a state, such as a corporation, limited liability company or limited partnership, is “located” in the state of its organization. Thus, for example, if the debtor is a Delaware corporation with principal offices in New Jersey, the only place for a UCC filing will be with the Division of Commercial Recording of Delaware.

In listing the debtor’s name on the Financing Statement, only the actual name as set forth in the Certificate of Incorporation, Certificate of Limited Partnership or Certificate of Formation can and should be used. Adding trade names is superfluous. Filing only in the name of a trade name is meaningless. Lenders should obtain current copies of entity organizational documents (and any available amendments), preferably from the filing office, before preparing a Financing Statement.

A Financing Statement will not have to be signed by the debtor as long as the Security Agreement authorizes its filing, which will facilitate e-mail filing. The debtor’s execution of the Security Agreement automatically authorizes the filing of a conforming Financing Statement. The new form of Financing Statement should be used effective immediately.

Collateral in the Financing Statement can be listed generically as “all assets” or “all personal property” (if applicable), although the Security Agreement must include an adequate description of it.

There are comprehensive transition rules. First, if you filed a Financing Statement before July 1, it will be effective when filed and will remain effective after the new law takes effect.

Second, you may file an initial Financing Statement in lieu of a continuation statement or an “in lieu of” statement. An “in lieu of” Financing Statement is a form of initial Financing Statement, not an amendment; it acts to some extent like a continuation statement; and it may contain amendments. The purpose of the “in lieu of” Financing Statement is to provide a mechanism to transition pre-effective date filings to a new filing office after July 1.

Using the previous example, if the initial filing was with the New Jersey Department of the Treasury, after July 1 the correct location for filing would be the Office of Commercial Recording in Delaware. To properly continue the Financing Statement, a secured party must file an “in lieu of” Financing Statement with the Division of Commercial Recording of Delaware either before July 1 or before the expiration of the original financing statement.

The “in lieu of” statement must have the correct name of the debtor, identify the pre-July 1 financing statement by filing location, date and number, the filing information for the most recent continuation statement, and state that the pre-July 1 Financing Statement remains effective.

Any other change in circumstances which would require an amendment of a Financing Statement now requires a filing of an “in lieu of” Financing Statement. If collateral consists of goods, you must file the “in lieu of” statement before the goods are moved to a new jurisdiction.

If the proper filing office for pre-effective date filing does not change under the new Article 9, use the national standard UCC-3 to file amendments. If a pre-effective date filing needs to be terminated, you can still file a termination statement in the office where the initial financing statement was filed.

The most important part of documenting any secured transaction, whether secured by real estate or personal property, is the proper perfection of the security interest. Adjust quickly to the dramatic changes; keep in mind that thorough searches may require extra-jurisdictional inquiries in order to examine home state filings.

If husband and wife own a piece of real property jointly and a lender obtains a judgment against one of the parties, say, the husband, the judgment lien attaches to his 50% interest in the property. However, because the property is owned in that special form of ownership called a tenancy by the entireties, the lender cannot force a sale of the husband’s interest. This is special protection for the institution of marriage and for homeownership by married persons. On the death of either of the spouses, title to the entire property vests in the survivor. If the husband dies first, then the wife would acquire title to the property free and clear of the judgment lien against her husband. On the other hand, if the wife dies first, the husband will own the entire property subject to the lien of the lender. Thus, the lender does not have a lien it can presently enforce and is left to reading the obituaries and hoping for the right death order. The lender has one other advantage, which is significant: the parties cannot sell or mortgage the property without paying the lien in full.

The big question is what happens if the parties divorce. Hypothetically, each spouse would receive 50% of the property and the lender would be paid from the husband’s 50% share. However, that is not always the case.

Courts are empowered in divorce proceedings to allocate marital assets equitably between the spouses, regardless of ownership. A court may direct the sale of the property and the distribution of the proceeds between the spouses in such proportions as it deems fair in the circumstances. A court may order one spouse to convey the property or a portion thereof or an interest therein to the other.

Thus, a court could order that a wife is entitled to, for example, 70% of the net proceeds of the marital home. The courts have held that this ruling is tantamount to a conveyance to the wife of an undivided 70% interest in the real property as a tenant in common with her former husband. The courts have further held that to the extent necessary to secure that interest pending the sale, the divorce judgment created an equitable lien in the wife’s favor upon the husband’s interest in the martial home.

Since a lender can acquire no greater rights than the husband had in the marital home, in our example, after the judgment of divorce is entered, the wife receives her 70% interest free and clear of the judgment lien against the husband.

In some cases, a court will award 100% of the marital home to the wife. Under the reasoning above, she will take the house free and clear of the husband’s judgment lien.

The possibilities for fraud are clear. A loving couple faced with a substantial judgment against the husband could easily divorce, arrange for the allocation of the marital home to the wife in the divorce and reconcile quietly. Once the title to the property is in the wife’s name free and clear of the lender’s judgment lien, she could sell the property and dispose of the proceeds or just refinance the property.

There is usually a remedy for fraud but it is a long course and the proofs are difficult. Most lenders will not spend the resources to attempt to prove a fraud in this situation.

Very few people are willing to go through the opprobrium and fraud to cook up a divorce to defeat a lender. That is why this scheme does not happen often. However, for the ruthless and conscious-free, it is a viable tactic to avoid a loan obligation of one spouse.

What is the lesson to be learned? The simplest lesson is that a 50% interest in a marital home should not be given great weight in evaluating a financial statement unless the spouse joins in the loan or joins in a mortgage securing the loan.

Every time a bank enters an agreement to reinstate or extend a loan which is in default, it should take advantage of the opportunity to enter into a well drafted work out agreement. Although the financial terms of every work out agreement are different, every work out agreement should have certain provisions. In addition, certain other provisions should always be considered.

· Acknowledgment of Debt. The borrower and guarantors should always acknowledge the sums due, including any applicable late fees and default interest rate. They should also acknowledge the existence of a default. The amount should be specifically set forth.

· Terms of Modification. The precise terms of the work out arrangement should be set forth including what sums if any are to be paid upon execution, how those sums are to be applied and how the remaining sums are to be paid. It is generally best to state the arrearage, the total monthly payment to be applied to arrearage and the total monthly payment to be applied against the regular principal and interest payments going forward. In this way, the arrearage is not added to principal and will not imperil lien priority.

· Reaffirmation of Loan Documents. Each of the principal loan documents should be listed by date or recording information. The borrower and guarantors should reaffirm their obligations under the loan documents and state that they have no defense or offset to any of them and that each remains in full force and effect except as modified by the work out agreement.

· Enforcement. The work out agreement is a wonderful opportunity to improve the bank's ability to enforce its loan documents. Since litigation is often pending, sometimes more than one proceeding, the pending case or cases can be settled with stipulations or consent judgments so that if there is a default the bank can proceed to immediate judgment or execution sale. Inasmuch as the bank has spent a great deal of time any money in moving an action to the point of judgment, it should not have to go back to first base when it makes a settlement. Rather it should sit on third pending a default. The default provision may or may not have a grace period and it may or may not have notice as may be negotiated in each particular case. The original loan documents had a notice period that was onerous to the bank, this would be an opportunity to cure that. Likewise, if the original loan documents did not provide for late fees or default interest, this would be a good opportunity to add those provisions.

· Legal Fees. The bank can usually require the borrower to pay its legal fees in the pending actions through the negotiation and execution of the work out agreement. Sometimes they will be paid in a lump sum on execution. Other times, they will be added to the arrearage to be paid over time.

· Financial Reporting. The bank can usually require borrower to furnish financial at the time of the work out agreement and can require the borrower to agree to furnish financials on a period basis going forward. Again this is an opportunity to improve upon the original loan documents.

· Waiver of Defenses. Every work out agreement should contain language in bold type in which the borrower and guarantors agree that they have no defense to the pending complaints, if any, or to the enforcement of the loan documents. The borrowers and guarantors must waive any and all claims that they have against the bank or its officers, directors, employees or agents, including any which could result in defense, set off or counterclaim.

· Right to Counsel. If the borrower consulted counsel, that should be recited. If not, the fact that the borrower had adequate opportunity to do so should be recited. The agreement should also state that the agreement was entered voluntarily, without duress and that the borrower received substantial consideration for entering the agreement.

· Execution. It is rare for the borrower and guarantors to make a personal appearance to sign a work out agreement. Therefore, adding a notary clause is some degree of protection for a later claim that the agreement was never signed.

· Additional Provisions. As the work out agreement may be the one and only time the bank has an opportunity to improve its position, if it can obtain more collateral or cross-default or cross-collateralization provisions, it should consider negotiating for these provisions.

· Bankruptcy Considerations. Particularly if any additional collateral is given to the bank in work out agreement, careful consideration should be given to what will likely be the effect on the work out agreement of a bankruptcy filed within 90 days. Obviously, any new collateral given to the bank would be lost as a preference in most cases. Care should be taken not to release other collateral as part of a work out agreement until the preference period has passed. Likewise, consideration should be given including provisions which would reinstate the loan documents to their status quo ante in the event of a bankruptcy proceeding filed within the preference period. It may also be possible to negotiate for a provision providing for consent to relief from the automatic stay in the event of a bankruptcy. Such provisions have been enforced by some courts but not universally.

Because the routine provisions in a work out agreement are so beneficial to the bank, often times it is best to enter into a work out agreement even if there is little change in the payment terms. Any lender liability claims from prior acts are waived. Any disputes about the validity or enforcement of the loan documents or the amounts due are resolved. In addition, there are many opportunities to improve upon the original loan documents both legally and practically.

Business debtors under financial duress have two alternate remedies under the Bankruptcy Code. If they believe that they can rehabilitate their affairs by proposing a plan of reorganization which can be confirmed by the court, they will generally file under Chapter 11. Upon the filing, the debtor becomes a debtor-in-possession and retains control of the business, albeit under the watchful eyes of the United States Trustee and many creditors.

If a debtor does not believe that it has a likelihood of rehabilitation, then it can file for liquidation under Chapter 7 of the Bankruptcy Code. In that case, a trustee is appointed to take control of the remaining assets, liquidate them and distribute the proceeds in accordance with law. Since the debtor loses control of its assets immediately upon filing a Chapter 7, most debtors with any prospect of rehabilitation (and some that do not) elect Chapter 11.

The Bankruptcy Code has a special provision which permits any creditor to apply to have a case converted from Chapter 11 to Chapter 7. A wily debtor who has frustrated a lender, often for years, and who believes he is going to retain control of his property in a Chapter 11 can be devastated by conversion to a Chapter 7. When the tests are met, conversion can be a spectacularly successful maneuver. The two tests are whether or not there is whether or not there is a reasonable likelihood of rehabilitation and whether or not the estate is continuing to shrink due to losses or other causes.

Under this test, the court will look at the entire financial picture of the debtor, including its actual prospective income, its assets and the liens on those assets, and will determine whether or not after proceeding through the reorganization process a viable company is likely to emerge. If the debtor has little income or the ability to generate income, there is little to rehabilitate.

The courts have held that where the purpose of the Chapter 11 filing was only to obtain time to either sell or refinance a parcel of real estate, then the case should be converted to Chapter 7. The rationale is that debtors should not be allowed to "speculate at the expense of their creditors while remaining in possession of the property without having to pay rent, real estate taxes or insurance premiums." Absent income to meet these ordinary expenses, generally speaking, the debtor will have little reasonable likelihood of rehabilitation.

Here, the court looks at the actual cash flow and potential depreciation of assets. Post-petition negative cash flow is the principle evidence of continuing losses. Likewise where the current cash flow is insufficient to service accruing interest, taxes, insurance and other costs, the creditor's position would weaken as a Chapter 11 continued. Deferred maintenance is also evidence of continuing shrinkage of the estate.

While not required by the Code in order to obtain a conversion, the courts have held that Chapter 11 is only for debtors who are motivated by a legitimate reorganization purpose and not principally by the desire to prevent foreclosure. Thus, with a single-asset debtor which has little or no equity and which is facing a foreclosure, a court might very well find that a Chapter 11 filing is in bad faith. Lack of good faith is, in and of itself, cause for converting a case to Chapter 7.

Debtors use numerous ploys in the state courts to delay a lender's realization upon collateral. While most lenders dread a bankruptcy filing, it often can serve as an opportunity to improve a lender's position from before bankruptcy. Conversion to a Chapter 7 can be a rude shock to a debtor and may result in a lender being able to realize upon its collateral more quickly than it would have in state court.

Under the Uniform Commercial Code, lien priority is generally established by the date of filing of the financing statement with the New Jersey Department of the Treasury. The principal exception to this priority rule is the right of the Internal Revenue Service.

If any taxpayer fails to pay any tax after demand from the IRS, the amount due, with interest, penalties and costs, is a lien upon all its real and personal property. When the IRS files its notice of tax lien, it then has priority over any subsequently-perfected security interest in any collateral of the debtor. Therefore, the typical Uniform Commercial Code lien search is never sufficient because an IRS lien will take precedence over a subsequently-filed financing statement.

More troubling for secured lenders is that in certain circumstances the filed IRS lien can also take precedence over previously-filed financing statements. This occurs where there is after-acquired collateral such as accounts receivable or inventory that is constantly being replaced by the debtor. While between two secured parties the first-filed lien on accounts receivable or inventory has priority over the second-filed lien, this is not the case with an IRS lien.

In the Federal Tax Lien Act of 1966 (26 U.S.C. §6323), Congress drew a bright line settling the priority of liens in after-acquired property between the IRS and a private lender such as a bank. Under the Act, the bank’s security interest in receivables is superior to the IRS lien if:

(1) the bank’s security agreement was entered into prior to the tax lien filing;

(2) the loan was extended prior to the tax lien or within 45 days afterwards without the Bank’s actual knowledge of the tax lien; and

(3) the debtor acquired the collateral within 45 days after the tax lien filing.

The Act works as follows: As in the typical case, assume the bank is financing receivables. Assume the debtor turns over all of its good receivables in 75 days. If 120 days pass after the IRS files its lien, then the bank will have no remaining receivables because the only remaining receivables will be those which were created more than 45 days (120 minus 75) after the IRS filed its lien.

The Act makes it essential to search for federal tax liens when making or monitoring a loan secured by after acquired-property such as accounts receivable or inventory. While monitoring the loan, it is advisable to check regularly on federal tax liens, to obtain certifications from management that all taxes are paid current and to ascertain that there are no tax liens or audits pending or threatened. If any are pending, they should be watched closely.

If the IRS does file a lien, it is undoubtedly an event of default under the loan agreement with the debtor. The bank should act immediately to protect itself, understanding that it only has 45 days to seize all of the receivables or watch them erode to the IRS day by day thereafter. Proper due diligence, both before and after a loan is made, is essential to protect yourself from being primed by IRS liens.

The moment a creditor obtains a judgment against a debtor and it is docketed in Trenton, it becomes a lien on all of the debtor’s real property in New Jersey. Therefore, the debtor cannot sell or refinance any real property in New Jersey without paying off or obtaining a lawful release of the judgment lien.

However, unless the creditor takes the further step of having the sheriff levy on a specific parcel of real property, the judgment lien is not perfected for the purposes of a bankruptcy. So, if a debtor files bankruptcy, the debtor or his trustee may void the unperfected judgment lien.

In many cases, the debtor or his trustee will take no affirmative step to void a judgment lien and may, in fact, abandon real property subject to a judgment lien. The bankruptcy proceeds to conclusion in a Chapter 7 and, for all intents and purposes, the judgment lien will pass “like a stone” through the bankruptcy process. Once the bankruptcy case is closed, the creditor can immediately pursue its rights under its judgment lien.

There is a relatively little known statute in New Jersey which gives the debtor who has obtained a discharge in bankruptcy the right to void the judgment lien one year after his bankruptcy. Under this statute, if the creditor does not levy prior to the bankruptcy and takes no steps to do so within one year after the bankrupt obtains his discharge, the debtor may obtain an order voiding the judgment lien, by motion in the original lawsuit in which the judgment was obtained.

The lender has two bites at this apple. The first is to levy after obtaining the judgment. The second is to levy after the bankruptcy.

One may wonder why a creditor does not levy automatically upon obtaining every judgment. There are at least three reasons. First, a creditor may not be aware of identifiable real property owned by debtor at that time. Second, New Jersey law requires that a creditor exhaust personal property before collecting from real property. Meeting that test varies from county to county and may be an impediment to levying. Third, in many cases, the bankruptcy intervenes before the creditor can levy.

The message for creditors is to not close that file when the debtor files for bankruptcy or even when he obtains a discharge if there is any real property subject to the creditor’s judgment lien. As in all collections, the race is to the swift – and the diligent

Bankruptcy is a fact of business life, like it or not. Creditors usually focus on what happens after the bankruptcy—-what percentage they will be paid and when. However, there is often a secret drama taking place in the weeks and months preceding every bankruptcy, when the Debtor has control of its dwindling finances, outside of court supervision, and can unilaterally decide which bills to pay and when.

The Bankruptcy Code has explicit rules concerning a Debtor’s activities before the bankruptcy is filed so that creditors may not improve their positions on the eve of the filing. There is a 90-day period preceding the filing known as the preference period. In most cases, if the Debtor is insolvent and makes a payment to a creditor during the preference period on a pre-existing debt, the payment is considered a “preference.”

If a creditor receives a preference payment within the preference period, then the Debtor (or its trustee, if one has been appointed) may actually force the creditor to repay that money to the Debtor. The Debtor has the burden of proof to establish all the elements of a preference. To recover a preference, the Debtor must file an adversary proceeding complaint against the creditor in Bankruptcy Court. Usually there is a settlement, but, if not, the matter is tried before the Bankruptcy Judge.

The Bankruptcy Code does give a creditor some defenses against a preference action. Two of the most common defenses are: 1) that the payment was made as a contemporaneous exchange for products or services given by the creditor to the Debtor; and 2) that the payment was of a debt incurred in the ordinary course of business of both the Debtor and the creditor.

If the Debtor buys goods or services within the preference period and pays for them at or about the time they are delivered or performed, there has been a contemporaneous exchange. Payment must be intended for the actual goods and services delivered and not for a prior outstanding bill. In order to prove this, there should be a link between the amount of the payment and the invoice, and preferably a reference of the invoice on the payment. Further, there cannot be a long delay between the furnishing of the goods and services and the payment, or the exchange is not contemporaneous.

What constitutes contemporaneous is determined on a case-by-case basis based upon industry standards and the normal course of dealing between the Debtor and creditor. Whether or not a creditor has met its burden of proof will depend upon the length of any delay in payment, the reason for the delay, the nature of the transaction and the intentions of the parties.

To establish this defense, the creditor must prove that the payment was made in the ordinary course of business between the Debtor and creditor, and that it was made according to ordinary terms. Whether or not a creditor has met its burden to establish this defense is, again, fact sensitive.

The Bankruptcy Judge will examine the invoices which were paid during the preference period, the ages of the invoices, the pattern of dealing between the parties and the industry standard. For example, if the industry standard was payment in 30 days and for some period prior to the Debtor’s financial difficulties the Debtor had paid the creditor in 30 days, but the invoices paid within the preference period were 90 days old, then the creditor will not meet its burden.

The court may also compare the invoice-payment interval for payments made in the years prior to the bankruptcy to that of the payments made during the preference period. Similarly, the court may compare the distribution of paid invoices by age, i.e., how many payments were made against invoices that had aged say, 80 days or longer, both up to and during the preference period. In a recent case, before the preference period only 16% of the payments were made against invoices 80 days or older but 100% of the preference period payments were 80 days or more beyond the invoice dates.

The controlling factor may well be whether the transactions between the Debtor and the creditor both before and during the preference period were consistent. Thus, late payments can be considered ordinary if that is consistent both before and during the preference period. The irony is that if you, as creditor, receive late payments within the preference period, you have a better chance of retaining them if you never received timely payments.

A creditor rarely knows when a company is going to file for bankruptcy. Even harder to foretell is when the 90-day preference period will commence. It is always better to receive payments and have to worry about having to pay them back than to not receive them at all. In addition, the sooner you get paid, the less likely it is that those payments will be within the preference period.

Therefore, before doing business with a troubled company, try to structure the relationship so as to meet the contemporaneous exchange requirement if at all possible. COD shipments certainly meet that requirement.

While you cannot re-write history, to the extent you are able to obtain payments consistent with the pattern that existed previously, you at least have a potential defense to a preference action.

The 2001 amendments to the Uniform Commercial Code made significant changes in the law concerning perfection of security interests in investment property such as stocks and bonds, whether or not represented by certificates and whether or not held in a brokerage account. Understanding these changes is essential for lenders intending to use investment property as collateral.

A lender may perfect a security interest in investment property by filing a Financing Statement which adequately identifies the investment property. Filing with the State will perfect the security interest so that it will not disappear if the debtor files bankruptcy.

A lender may also perfect by obtaining “control” of the investment property. If a bond is in bearer form, the lender obtains control through possession. If a stock or bond is in registered form, a lender obtains control if the certificate is delivered to the lender and it is either endorsed in blank or endorsed over to the lender, or registered in the lender’s name. If a security is not represented by a certificate, then a lender obtains control if the non-certificated security is delivered to the lender or the issuer of the security has agreed that it will comply with instructions from the lender without further consent by the owner.

A lender can also obtain control of investment property held by a third party such as an account with a brokerage firm. This occurs when the brokerage firm enters a “Control Agreement” in which it agrees that it will comply with orders originating from the lender without further consent of the debtor.

Control takes precedence over filing. Thus, if a lender obtains a perfected security interest in investment property by control after the debtor has already granted a security interest which was perfected by filing, the later security interest, perfected by control, will have priority over the earlier (filed) security interest. No lender should rely solely on filing if there is a risk of the debtor giving a second security interest to another lender.

If two lenders have control over the same investment property, the first to obtain control will have priority. If the brokerage firm has its own lending relationship with the debtor (such as a margin account) and obtains a security interest in the account after a lender has obtained “control” of the account, the security interest of the brokerage firm will take priority. In this case, a lender may want to obtain an agreement from the brokerage firm stating that if it obtains any security interest in the brokerage account, it will be subordinated to that of the lender.

As in all lending, obtaining and maintaining perfection and priority are vital. When the collateral is investment property, the lender can now rely on explicit provisions of the Code, especially if securities are held by third parties such as brokerage firms.

Many lawsuits are settled for less than the original amount claimed. In a suit on a note, it is not uncommon for a settlement agreement to provide for payment over time of the entire principal amount due with a reduction in some interest or late fees. In other contexts, however, the difference between the original claim and the settlement amount can be more dramatic.

The typical settlement provides that upon default the defendant is obliged to pay the full amount claimed in the complaint less payments made under the stipulation of settlement. This is a common provision known as a “claw-back” and is used to add teeth to a settlement. A debtor facing a claw-back is far more likely to pay as agreed than a debtor who is only obligated to pay the reduced balance negotiated in the settlement.

The recent case of Williams v. Swift illustrates the limitations of claw-backs. In Williams, there was a claim for treble damages under the Consumer Fraud Act. The trebled damages totaled $75,000 and there was an additional claim for attorney’s fees. The parties settled the case for $15,000, payable in 12 monthly installments of $1,250 each. After the defendant made nine of the 12 payments, he defaulted. The plaintiff applied to the court, as provided in the stipulation of settlement, for judgment for the full amount due less the payments made to date, which came to over $125,000. Several months later, the defendant moved to vacate the judgment. The trial court vacated the judgment but assessed $5,000 in counsel fees for the plaintiff’s efforts in seeking the judgment, issuing execution, and defending the motion to vacate.

The Appellate Division affirmed the trial court’s decision. The court noted that although the claw-back was intended primarily to insure prompt and full payment of the settlement amount:

Under the circumstances enforcement of such a large penalty provision would have been unjust and oppressive once the settlement amount had been paid in full.

The court reasoned that it has no obligation to enforce a contract that is unfair, oppressive or against public policy.

By contrast, in another recent case, Montague Mini Mall v. Caterall, the Appellate Division upheld a claw-back where the full amount claimed was $12,300, the stipulation provided for four payments of $2,400 each (totaling $9,600) and the defendant defaulted after making three payments.

Clawbacks are excellent mechanisms which should be included in stipulations of settlement whenever appropriate. However, when there is a substantial difference between the amount of the required payments in the stipulation of settlement and the total claw-back, the creditor must understand that there is a possibility, particularly after many of the payments have been made, that a court will decline to enforce the claw-back.

There is no downside for a creditor to protect himself with a claw-back provision. In fact, it is, as intended, a major point of leverage in effecting payment.

Arbitration is being more widely used than ever before. Recent amendments to the New Jersey Court Rules mandate arbitration for most claims for personal injuries and many commercial matters. Given the trend, everyone must have a working knowledge of arbitration.

Traditionally, arbitration would only take place when two parties agreed contractually to submit a claim to an arbitrator. This type of arbitration, consensual contractual arbitration, continues to flourish. The scope of the arbitration, the number, identity or method of choosing the arbitrator(s) and even potential remedies can all be set forth in the contract.

Under contractual arbitration, the arbitrator’s decision is final and non-appealable. The prevailing party can obtain a court judgment consistent with the award that will be enforced like any other judgment in New Jersey. A court can only vacate an arbitration award for fraud, corruption or similar wrongdoing by the arbitrator. Recent case law makes it clear that even a mistake of law by the arbitrator is not grounds to set aside an arbitration award. However, a court can correct a mathematical error made in computing damages or other obvious clerical errors on the part of the arbitrator.

Traditionally, organizations sponsoring panels of arbitrators trumpet arbitration's alleged cost advantage over traditional court litigation. They point out that unless the contract provides for discovery, there will be little or none, and depositions are extremely rare. Discovery and depositions can account for a large part of the cost of a traditional lawsuit.

However, both parties pay the arbitrator’s fees commensurate with his experience and reputation, while they do not pay the judge conducting a trial. If a contract provides for a three-person panel with an average hourly rate of $300 per hour, then the two parties to the arbitration would have to split the $900 per hour for the arbitrators in addition to paying attorney's fees, just to have the case heard. In addition, organizations such as the American Arbitration Association charge substantial fees based upon the amount of the claim on top of their administrative fees. Also, an arbitration rarely proceeds continuously from day to day but is scheduled episodically as the schedules of the parties, their counsel and the arbitrator(s) permit. Conversely, a trial can last for months but has a specific end. The question of whether or not arbitration is less expensive than litigation in court can only be answered, "It depends."

Courts have devised various ways to divert cases from traditional resolution. As noted above, the New Jersey Court Rules now mandate arbitration in a wide variety of civil cases. This arbitration differs markedly from consensual contractual arbitration. The only true similarity is the neutral third party who hears the case and renders a decision. Unlike contractual arbitration, not only is the decision not final and non-appealable but either party can reject the decision and demand a trial in court just by paying a $200 fee. The only downside of rejecting the arbitrator's award is that the rejecting party may sometimes be ordered to pay a portion of the attorney's fees and expert witness fees of the other party if the court award is less than that of the arbitration.

Some might question the purpose of non-binding arbitration. It is to bring the parties together at a time when discovery is complete in order to foster a settlement with the aid of an impartial party. If the parties were at $18,000 and $7,000, and an arbitrator determines that a case is worth $10,000, there is a strong incentive to accept the arbitrator's award and settle the case for $10,000. Every case removed from the court system relieves the case backlog and avoids the risks and expense of a jury trial.

Whatever your personal situation or occupation, you are likely to come into contact with arbitration. A well-drafted contract anticipates what would happen if there is a breach and whether an arbitrator or a judge will enforce it. While there is no right answer, the issue must always be carefully considered.

In effecting collections for a creditor, whether secured or unsecured, we are often reminded of the adage, "The race is to the swift." No case could better illustrate this proposition than the recent case handled by Newman & Simpson, LLP which resulted in a published opinion, United National Bank v. Parish, et als. Newman & Simpson represented the second mortgagee, PNC Bank, on a rental parcel of commercial real estate. UNB held the first mortgage. The debtor defaulted in its obligations to both lenders. Both banks held assignments of rents.

When PNC filed its foreclosure in April 1999, it notified the tenant to pay the rent to it pursuant to its assignment of rents. The tenant commenced making the payments to PNC in May 1999.

UNB filed its foreclosure action in August 1999. By that time, PNC had collected four monthly payments from the tenant of $7,000 each.

In November 1999, UNB moved for an order which would require PNC to disgorge the rents previously received and to appoint a rent receiver. PNC did not object to appointment of a rent receiver and acknowledged that upon asserting its rights, UNB possessed priority as to the future rents. PNC did object to turning over the rents collected prior to UNB's filing of its foreclosure.

UNB argued that its mortgage and assignment of lease were first in priority and that it was entitled to the rents collected notwithstanding PNC's diligence.

The court noted that PNC was well within its rights to take possession and obtain the rents without court order, just as UNB was, had it chosen to act. The court said:

As between two successive mortgagees it necessarily follows that when one exercises his possessory right, either personally or through a receiver in foreclosure, and the other does not do so, the one exercising the right becomes entitled to the rents received by him through the medium of his possession. This must be so, because a mortgagee who does not exercise his possessory right acquires no right to receive the rents.

The court noted that UNB's less rapid action was not necessarily of any significance to a second mortgagee such as PNC since PNC could have readily concluded that UNB considered itself adequately secured. In any event, the court held:

AS PNC correctly observes, it should not be deprived of the remedy it obtained for itself through the exercise of diligence. If PNC had not collected the rents between April and August 1999, then the mortgagor would have collected them and neither creditor would have been compensated. Certainly equity aids the vigilant and not those who sleep on their rights. UNB should not be rewarded for having slumbered between April and August 1999 while PNC diligently sought to receive the rents due on the property.

Another way of looking at it is that when PNC seized the rents, the worst that could happen is that it might have to disgorge them. On the other hand, had it not seized the rents, they would have been "water over the damn;-- gone beyond recall."

When a mortgage goes into default, the lender has many remedies available. Among them is the equitable remedy of appointment of a rent receiver. Appointment of a rent receiver should be seriously considered whenever there is a default on a mortgage securing income producing property because a receiver will collect the rents pendente lite and prevent diversion of the rents by the debtor.

Whether or not a lender holding a mortgage also holds an assignment of rents, it is entitled to apply to a court for appointment of a rent receiver in the event of default. Usually this is done by either an order to show cause or a motion filed in a foreclosure proceeding.

The trial court has a large range of discretion in determining whether or not to appoint a receiver. The basic inquiry of the Chancery Judge is whether or not the appointment of a receiver is necessary to protect the lender against losses which it otherwise might sustain. The key factors in making that determination are:

Whether the value of the collateral net of outstanding prior liens such as taxes is greater than the mortgage, i.e. is there equity.

Possible loss of the property in a tax foreclosure or through an uninsured casualty loss is a significant factor militating in favor of appointment of a receiver.

Most mortgages provide that appointment of a rent receiver is one of the stipulated remedies of a lender upon default. This provision is entitled to consideration by the court but is not binding upon the court.

Appointment of a rent receiver should be contrasted with the alternate remedy of taking possession of the mortgaged premises. Most mortgages typically provide for this alternate remedy as well. If the mortgaged premises are clean and free from any environmental risks, the better course may be to take possession.

The advantage of a rent receiver is that a receiver insulates the lender from claims that might arise from taking possession of the property, such as environmental or other liabilities related to ownership use and possession of the mortgaged premises. A rent receiver as an agent of the court is immune from such claims and appointment of same by a lender does not make the lender liable for such claims.

The only disadvantage of appointment of a rent receiver is the cost, which is usually nominal compared to the rents received. There may also be costs for separate counsel for the rent receiver although some courts will permit counsel for the lender to serve as counsel for the receiver.

In either case, it is important both for preserving the collateral and for increasing leverage with the mortgagor to take away the stream of income which the mortgagor is diverting from the mortgaged premises and servicing the debt. Appointment of a rent receiver is the safest way to achieve such an end and it should be considered in every case involving income-producing property.

When a bank modifies a mortgage, whether a balloon, a work out or an accommodation, it must preserve the priority of its mortgage. Typically, a first mortgage closing occurs after obtaining a full title search and a title insurance policy insuring the first mortgage position is issued. Years may pass and then the mortgage is modified by changing the interest rate, the payments and the term and the new arrangement is evidenced by a mortgage modification agreement. That agreement may or may not be recorded and the bank may or may not order a title search at that time. Since junior mortgages or judgment liens may have attached to the mortgaged premises since the recording of the original mortgage, how can the bank be certain that the mortgage is still a first mortgage and that the other liens are subordinate to it?

The New Jersey Legislature addressed this issue by passing the Mortgage Priority Act (the "Act") in 1985 which was amended twice in 1998. It is important to understand the Act and its amendments because they affect all mortgage modifications.

First, the Act does not apply to construction loans. On construction loans, the bank must secure a run down search at the time of each advance to insure that there are no other liens. The priority of the mortgage loan will only extend to the amounts advanced before any other liens attach.

The Act provides that for all other mortgages, changes in the interest rate, due date or other terms and conditions do not affect the priority of the mortgage. In addition, payments for taxes, assessments, insurance and other charges required pursuant to the terms of the mortgage are entitled to that priority.

The Act has a special provision for line of credit, such as many home equity mortgage. For line of credit mortgages, advances of principal up to the maximum amounts stated in the line of credit are protected by the Act and retain their priority. These mortgages can be paid down and additional advances ban be made from time tot time, with all advances retaining lien priority.

The Act specifically provides, however, that advances of principal on any mortgage other than a line of credit mortgage, do not have lien priority. Thus, if a borrower has an amortizing mortgage with an original principal balance of $100,000 and pays the balance down to $70,000, the bank cannot advance $10,000 in additional principal and retain its mortgage priority as to that advance. This means that in structuring work out arrangements, banks should be careful about capitalizing unpaid amounts and adding them to principal because that could potentially be considered an advance of principal and thereby lose its priority. It is safer to provide for payment of the arrearage separately and for any other necessary modifications of the payment terms.

Finally, the Act provides unless a title insurance policy has a specific disclaimer which indicates that the policy will not continue to apply if the mortgage is modified pursuant to the Act, then the policy will remain in full force and effect after modification of the payment terms. The Act also provides that the modification agreement need not be recorded.

Notwithstanding all of the protections provided in the Act, Newman & Simpson advises bank clients to always obtain a title search at the time of a modification to be sure that taxes are current, that there are no judgments against the borrower, that there are no unexpected secondary liens and that the borrower still owns the mortgaged premises! The firm has defended a lender-liability case which arose after a modification which was executed without a title search where there were three year's of unpaid taxes and over $1 million in judgment liens at the time of the modification.

For over seventy years New Jersey law has prohibited a borrower from granting a security interest in a liquor license. New Jersey’s Alcoholic Beverage Control statute specifically precludes a licensee from utilizing a liquor license as collateral for a loan. Courts have recognized that a liquor license is a privilege, not a right, and is analogous to a temporary permit. The rationale behind these decisions was to defer to the State’s regulatory authority in issuing and monitoring liquor licenses.

Of course lenders do give financing to bars and restaurants. In giving such financing it has been the practice to effectively obtain a lien on the license by taking a pledge of the stock in the licensee. This is done by obtaining a stock pledge agreement from all shareholders in the corporation. If there is a default, the lender can take control of the stock and the Board of Directors, and elect new officers who can then sell the license (and pay down the secured debt). Usually this procedure is sufficient to protect the lender, but not always.

If there is a federal or state tax lien, the holders of the lien can levy on the license and “prime” the lender. In addition, if there is a bankruptcy, the proceeds of a sale of the license by the bankruptcy trustee may be used by the trustee for administration expenses, and for the benefit of creditors generally, including unsecured creditors. Thus, it has always been incumbent upon a lender who is relying on its “lien” on a liquor license to be sure that its borrower is paying its taxes and is solvent.

A recent case has turned the long-settled principles set forth above on their head. This past summer the New Jersey Bankruptcy Court held that the 2001 amendments to the New Jersey Uniform Commercial Code overrode the seventy-year-old provisions of the Alcoholic Beverage Control Act, declaring that a lender with a lien on “general intangibles and the proceeds thereof” held a valid, perfected security interest in a liquor license. This is revolutionary development in the world of lending to bars and restaurants.

The case dealt with a bankruptcy where the trustee sold the liquor license. The court held that 100% of the proceeds went to the secured creditor due to its perfected security interest, priming a subsequent judgment by the State of New Jersey and, of course, unsecured creditors and administration expenses.

The court held that because of the Alcoholic Beverage Control Act and the State’s paramount interest in controlling liquor licenses, although the lender did have a valid perfected security interest in the liquor license, it could not foreclose on the license nor compel its sale. The lender’s only remedy was to wait for a sale by the borrower, a receiver or trustee, and then assert a lien on the proceeds of the sale.

For a lender, this position is far better than only having a lien derived through a stock pledge. The lender cannot be primed by a subsequent tax lien or by creditors in a bankruptcy. In addition, a lender is usually in a position to force appointment of a receiver or to force a bankruptcy once there is default.

There is one large caveat: the case is on appeal to the United States District Court and potentially from there to the Third Circuit Court of Appeals. We will keep you advised. In the interim, lenders to bars and restaurants are well advised to obtain their liens both ways: through the old stock pledge and through a security interest in general intangibles including, specifically, the liquor license.

What happens when parties to a real estate contract arrive at a scheduled closing, fail to agree on a minor adjustment for a condition of the property, and never close? Traditionally, one would expect that if the property was not in the condition required by the contract at closing, the seller would be in breach and the buyer would not be obligated to close. However, the answer is not always that simple.

In the not atypical scenario of Herbert v. Howell, there was a lot of bad blood between the parties before the closing. The seller had a bridge loan outstanding to buy another property; the parties jousted over the closing date for their respective convenience; finally, the buyer set a time of the essence closing date.

At the walk-through inspection of the property the afternoon of the scheduled closing, the buyer observed boxes stacked in the garage. At the closing later that day, the buyer’s attorney demanded that $10,000 be placed in escrow to ensure that the seller would promptly remove the boxes from the garage post-closing. However, the seller only offered to escrow $2,000. As an alternative the seller also offered a “dry closing” where the paperwork would be completed but no funds would be disbursed until he removed the boxes in a day or two, but the buyer would not agree to that proposal. Since negotiations appeared to be at a stalemate, the sellers and their counsel left without making further arrangements for new closing date.

Two days later, when the seller’s attorney called the buyer’s attorney, the buyer’s attorney said, “the deal is dead” because the buyer had found another property. The buyer contracted to buy this second property and ultimately closed on it.

When the buyer’s attorney declared that the seller was in breach of contract and demanded release of the $40,000 deposit, litigation followed.

Two years later at trial, the court held that both parties defaulted under the contract.

There was a case of who is bluffing who and neither party blinked and the closing didn’t occur. That’s what I found happened. . . .

So if there was an effort on both, both parties to bring about this closing that they both wanted, it would have been done. It would have been done. [Sellers] would have gotten word across to [buyer] through their counsel or through the realtor or whatever saying we want this closing. We worked ourselves to a frazzle over the weekend, everything is out of there. We even dragged that stupid satellite dish off of there, we want to close, can we still close it.

Based on the conclusion that both parties breached, the court ruled that the parties should equally divide the $40,000 deposit, reasoning:

Clearly, both parties were unreasonable in failing to reach an agreement to resolve the problem created by defendants’ failure to vacate all of their belongings from the property. Plaintiff’s request for defendants to place $10,000 in escrow and defendants’ suggestion of a “dry” closing until the remaining property was removed, were both reasonable. Unfortunately, neither side would agree to the other’s proposal. Defendants walked out of the closing without trying to extend the agreement or to establish a new closing date.

The first lesson is that it is fine to be tough and to stand on your contractual rights . . . to a point. That point is where your position is completely unreasonable in light of the totality of the circumstances. Then you put yourself at risk of being held in breach of contract.

The other lesson from this case is not to let your emotions cloud your judgment. Obviously, the buyer and sellers hated each other by the closing date. The attorneys may not have had much better regard for each other either. Animosity clearly clouded the parties’ better judgment.

In two recent decisions, New Jersey’s appellate courts have established guidelines for cases where a plaintiff upset by statements or information transmitted anonymously via the internet (such as message board postings) can discover the identity of the culprit. These decisions, Dendrite International, Inc. v. John Doe No. 3 and Immunomedics, Inc. v. Jean Doe, a/k/a “moonshine_fr” were decided July 11, 2001. In both cases, the court adopted the following guidelines:

First, the plaintiff must attempt to notify the anonymous poster that he or she is the subject of a subpoena or other action. This occurs after suit is filed and the subpoena is issued or an application to the court is made. Proper forms of notification include posting an announcement on the same message board on which the offending message appeared.

Next, the plaintiff must advise the court of the exact statements made by the anonymous individual. From this information and any additional proofs submitted by the plaintiff, the court will make its decision.

The court’s decision will weigh the claim that the plaintiff’s rights have been violated against the First Amendment rights of the anonymous party. How the court will weigh these opposing interests and what the result will be will depend heavily upon the unique facts of each individual case. An examination of Dendrite and Immunomedics can provide some insight into how courts may resolve these cases in the future.

In Dendrite, various anonymous defendants had made allegedly defamatory statements about Dendrite’s business practices, largely revolving around an alleged change in Dendrite’s accounting practices, which the posters claimed inflated Dendrite’s profits on its books. Dendrite’s efforts to obtain the identities of the posters from Yahoo!, on whose message board the statements were posted, failed for two reasons. First, Dendrite failed to prove that the statements were false. Second, Dendrite failed to prove it had been harmed. Given these failures, it is easy to see why the court refused to infringe upon the posters’ First Amendment rights.

In Immunomedics, the anonymous defendant, identifying herself as an employee of Immunomedics, disclosed inside information about the company’s business. Immunomedics proved that all of its employees signed confidentiality agreements. Since the anonymous poster had admitted her status as an employee, the wrong and harm had both been proven. The employee’s First Amendment right to anonymity could not survive her own breach of contract, and Immunomedics was entitled to learn her identity.

New Jersey’s appellate court has used these two cases involving cutting-edge technology to underscore language which became part of this state’s constitution over fifty years ago: “Every person may freely speak, write and publish his sentiments on all subjects, being responsible for the abuse of that right.” To pierce the anonymity the internet affords its audience, one must first prove “the abuse of that right.”

Most people are now aware that the federal estate tax exemption per person has risen to $1.5 million dollars for persons dying in 2004, with further increases to take place in future years. In addition, any assets which are left outright to a surviving spouse are also exempt from federal and New Jersey Estate Taxes. This exemption is called the marital deduction.

However, when the federal government decided to increase the exemptions for federal estate tax, many states did not go along with the increase, because it would have deprived them of much needed tax revenues. In fact, New Jersey enacted a new estate tax, which is applicable to estates of any New Jersey resident dying after December 31, 2001. The new law effectively “froze” the New Jersey Estate Tax exemption at $675,000.

Prior to December 31, 2001, most wills prepared for New Jersey residents with estates in excess of $1 million dollars contained a clause which created a credit shelter trust for the benefit of a spouse in an amount equal to the maximum federal estate tax exemption. This provision was designed to reduce the size of the estate of the surviving spouse by the amount which went into the trust. However, amounts left to a credit shelter trust do not qualify for the marital deduction because the surviving spouse does not have complete control of the assets in the trust.

Therefore, if an individual dies in 2004 with a $1.5 million estate and leaves his entire estate to a credit shelter trust for his surviving spouse with the remainder to his children after his spouse dies, there will be no federal estate tax liability because the entire bequest qualifies for the federal estate tax exemption. However, there will be a New Jersey estate tax on the excess over $675,000, the level at which New Jersey froze the maximum exemption. The New Jersey estate tax is computed on the difference between $675,000 and $1.5 million and, in this case, is $64,400. Even a smaller credit shelter bequest--$1 million, for example, will still result in a $33,200 New Jersey estate tax bill.

In order to eliminate the payment of the New Jersey estate tax, the credit shelter trust would have to be limited to $675,000, with the balance of the estate passing outright to the surviving spouse or in a trust which would be included in the surviving spouse’s estate. This arrangement will expose the excess over $675,000 to federal estate tax in the estate of the surviving spouse when he or she dies, at a tax rate which is far in excess of the New Jersey estate tax. For example, if the combined assets of a husband and wife are $3 million, using a credit shelter trust can ultimately pass the entire amount to their children free of federal estate tax if they both die in 2004. However, this arrangement would incur a New Jersey estate tax of $64,400. If the trust in the estate of the first spouse to die were limited to $675,000 to avoid the New Jersey estate tax, there would be a federal estate tax in the surviving spouse’s estate of approximately $250,000.

Clearly there is a need to give the Executor of a decedent’s estate as much flexibility as possible to determine, at the time of the decedent’s death, how much to put into the credit shelter trust provided for in his/her Will. This decision will be based on a number of factors, which include the size of the estate of the surviving spouse and the amount of the federal exemption at the time of the decedent’s death.

There are several drafting techniques which have been used to maximize the flexibility available to an Executor and the surviving spouse in making these decisions. It would be wise to check the wording in your own Will to determine if that flexibility exists. Through the use of certain trusts and disclaimers by the surviving spouse, the Executor would have the option of limiting the amount of the credit shelter trust to minimize the New Jersey estate tax or maximize the amount of the credit shelter trust to reduce the tax in the estate of the surviving spouse.

Interest rates have hit the lowest point experienced by our generation and may go lower. These low rates give everyone an opportunity to lower the cost of carrying existing mortgage debt or to increase liquidity by increasing mortgage debt.

The financial analysis to determine whether or not it makes sense to refinance depends upon many factors, including the existing mortgage balance and interest rate, the new interest rate, how many years remain on your existing mortgage, how long you intend to own your home, and the cost to refinance. The table which follows illustrates the savings in year one, and over the life of the loan, by refinancing an existing 20-year, $200,000 mortgage currently at 7% or 8% with a new 6%, 20-year mortgage. Both cases assume you are at or near the beginning of the loan term on the existing mortgage.

In the examples above, in the first year, refinancing an 8% mortgage at 6% would save $4,000 and refinancing a 7% mortgage at 6% would save $2,000.

Over the life of the loan (a total of 240 monthly payments), the total savings from refinancing a 7% mortgage at 6% would be $28,276 and the savings from refinancing an 8% mortgage at 6% would be $57,641.

Of course, if your loan commitment includes a requirement to pay a point or points (often called a commitment fee), that would be added to your cost. Under certain circumstances your lender may require a new survey (such as where an addition has been added since the last survey); that would typically increase your costs by another $500 or so.

Using our example, even if you refinance a 7% mortgage at 6%, you would recover all of the costs in the first year and would save ten times that amount over the life of the loan. With larger mortgage balances the savings are more dramatic and with smaller mortgage balances the savings are more modest. In most cases, if you can obtain a 1% reduction in your interest rate, you should seriously consider refinancing.

If you do contact lenders, pay particular attention to your protection, or lack thereof, if interest rates move up or down between application and closing. With some lenders you may be able to lock-in a rate in advance. However, if rates go down you may or may not be entitled to a “float down” to the new rate at closing. Remember also, as a last resort, if the rates really move down, you can always rescind the transaction within three days after the closing and start the process over with another lender, losing only your up-front application and appraisal fees.

If you have any questions on the refinance process, or whether or not refinancing makes sense for you, please do not hesitate to call.

Most buyers of homes require mortgages in order to close. Accordingly, most contracts include what is called a mortgage contingency. The mortgage contingency provides that the contract may be cancelled by either buyer or the seller if a mortgage commitment for the required amount is not obtained by a specified date.

In most cases, a mortgage commitment is obtained by the deadline or the parties agree upon an extension and a mortgage commitment is obtained by that deadline. Then, within 10 to 20 days thereafter the mortgage is funded and the closing occurs.

However, every mortgage commitment has certain conditions, some which are standard in every mortgage commitment for a particular lending institution and some of which are special for a particular transaction. One such standard condition which is found in every mortgage commitment is that there be no material adverse change in the financial condition of Borrower. Pursuant to such a condition, a bank is within its rights in revoking a mortgage commitment if the borrower loses his job before the closing. The question is what happens to the real estate contract.

Until recently, it was a law in New Jersey that if the borrower lost his job through no fault of his own or the commitment was revoked through no fault of the borrower, then the borrower would still have a right to cancel the contract and obtain return of his deposit. However, in the recent case of Malus v. Hager decided by the Appellate Division in June, the court held on facts just like these that once the mortgage commitment was obtained, the mortgage contingency was satisfied. So later changes in circumstances, even those beyond the control of borrower, did not relieve the borrower of his obligations under the contract. The court noted:

If the parties wish to provide in their contract for an eventuality such as this, they are free to do so. We decline, however, to impose the risk of an otherwise firm deal unraveling upon an unknowing and blameless seller, leaving him with no ability to recoup his increased expenses.

It is unclear now how the marketplace will react to enhanced mortgage contingency clauses which shift the risk of the bank's revocation of the commitment letter from the buyer to the seller. However, these clauses need to be discussed thoroughly, particularly in the context of the amount of the deposit and whether or not the contract provides for forfeiture of the deposit upon breach.

This issue is an example of the principle that there is nothing routine about a residential real estate closing.

For many years we have had a unified estate and gift tax system. This system treats gifts made during lifetime in excess of the annual exclusion (currently $11,000 per year per person), the same as if they were bequests under a will and were made after death. Since the current exemption from estate and gift tax is $1 million dollars, a person can give away $1 million dollars in gifts during life, with no gift tax consequences.

For several years, estate planners have been recommending to their clients that they use the exemption from gift and estate tax during their lifetime. In other words, if a person could afford to make such a gift without it having an adverse effect on their lifestyle, such a person could give away a total of $1 million to children, grandchildren, or any other beneficiary without incurring any gift tax.

Why is this effective? If such a gift were not made during lifetime, the gift assets would simply continue to grow inside the donor’s estate. The $1 million could grow to be worth $2 million, which at the time of the donor’s death, if exposed to estate tax, could cost his or her heirs $1 million in estate taxes. If the gift of $1 million were made during the donor's lifetime, none of the appreciation would be included in the estate and the appreciation would belong to the beneficiary, free of estate tax.

Although the Federal estate tax exemption is scheduled to increase to $1.5 million in 2004, $2 million in 2006, $3.5 million in 2009 and be repealed in 2010, the gift tax exemption has been frozen at $1 million. All gifts in excess of $1 million will be subject to a gift tax. In 2010, when the estate tax is repealed, the gift tax rate will be equal to the highest income tax rate, which is scheduled to be 35%.

One drawback to gifts is that the recipient acquires the donor’s tax basis of the gift asset. If a donor were to make a gift of General Motors stock currently worth $1 million with a cost basis of $500,000, the recipient takes over the cost basis of the donor; when the stock is sold, the recipient will be taxed on the capital gain. Conversely, if a donor dies owning $1 million in General Motors stock with a cost basis of $500,000, the beneficiary inherits that stock at the value on the decedent’s date of death. The beneficiary acquires what is called a “stepped-up” basis, which permits the beneficiary to use the decedent’s date of death value for the stock as his or her cost, thereby reducing or eliminating the capital gain. It is therefore a critical decision when making lifetime gifts to determine whether an asset has a capital gain which might be erased if that asset were included in the decedent’s estate at death.

It is very common for older people to consider making a gift of a residence to a child or children to protect that asset from claims of creditors resulting from a catastrophic illness. However, if such a transfer is made during lifetime, the rules regarding capital gains apply. If the asset is the personal residence of the donor, upon sale, he or she would be entitled to a $250,000 exclusion from capital gains for an individual or a $500,000 exclusion for a married couple. If the residence is transferred to children who do not use the property as their personal residence, this exclusion is lost.

In light of the foregoing, the overriding question which must be answered before a donor decides to make any of these contemplated gifts is whether the donor’s estate will be subject to estate tax. If it is not, then the advantages of making lifetime gifts may be reduced. However, if a donor’s estate is large enough to be subject to an estate tax, then making gifts of appropriate assets may be warranted.

There are other consequences to be considered in making such gifts, such as protecting the assets from the claims of creditors or whether such gifts will be properly safeguarded by the beneficiaries. In the latter case, there may be a need for a trust or some other vehicle to protect the assets until the beneficiaries are able to manage them.

Recently I was asked to review the wills of clients which had been drawn by a very reputable law firm in 1998. My clients are a husband, age 75, and his wife, age 73, each with two children from a prior marriage. All of the children are married and have two children each. My clients have been married for 20 years. My clients’ combined estate of $3,500,000 consists of their home, valued at $500,000, a $2,000,000 investment portfolio and IRAs in the amount of $1,000,000.

As part of their estate plan they were advised to separate their assets into their individual names in order to take full advantage of the estate tax laws then in effect. The maximum exemption from federal estate tax for each individual in the year 1998 was $600,000 and all bequests to a surviving spouse were fully deductible in any amount.

In order to take maximum advantage of the exemption from federal estate tax and to provide for their children from their prior marriages, the draftsman of my clients’ wills provided that upon the death of the first spouse to die, the estate would leave an amount equal to the maximum exemption in effect on the date of death to their children and the balance of their estate to the surviving spouse. This arrangement made adequate provision for the surviving spouse while taking full advantage of the maximum $600,000 exemption, resulting in no federal estate taxes due in the estate of the first spouse to die, and reducing the estate of the surviving spouse by the exempt amount.

This estate planning technique has been used in a variety of ways in order to minimize the estate tax in the estate of the surviving spouse. Many estate planners, including myself, almost always left the maximum exemption amount in a trust for the benefit of the surviving spouse. This arrangement insures that the surviving spouse will receive the benefits of the entire estate of the first spouse to die, while taking full advantage of the maximum exemption.

The Economic Growth and Tax Relief Reconciliation Act of 2001 provided for a complete change in the maximum amount that can pass free of federal estate tax to individuals other than the surviving spouse. The exemptions increase as follows:

Currently, if either of my clients should die between now and the year 2010, as indicated on the schedule of exemptions listed above, the present will of my clients would result in the distribution of their entire estate to their children without any provision for the surviving spouse. Obviously, this was not their intention.

As you can see, a will which still provides for the maximum exemption to be paid to anyone other than the surviving spouse may result in a much larger bequest to those individuals than was originally planned. This is situation is exacerbated in the many cases where the assets retained by the surviving spouse have lost substantial value due to the recent stock market decline. In light of the recent changes in the estate tax laws and the recent dramatic declines in asset values, it is important to review and possibly update your Wills.

We are all familiar with the following common scenario: A wealthy aged widow with substantial net worth, health problems and at least two children with many grandchildren goes to live with one of her children, in this example, her daughter. During this period of her life, the daughter takes care of her, manages her finances and helps her with all aspects of her life. Sometimes the daughter may make it difficult for other children to see their mother or grandmother. At some point in time, the daughter takes her mother to her own attorney to prepare a new will and power of attorney. The daughter then arranges, with or without the attorney’s aid, to make substantial gifts to herself and her children by establishing a joint bank or joint stock brokerage account or direct gifts. After the widow dies, the other children claim foul and sue.

The basic legal question is whether or not the gifts or the will are tainted by “undue influence.” Undue influence has been defined as mental, moral or physical exertion, usually accompanied by diminished mental capacity, which has destroyed the free will of another by preventing that person from following the dictates of his own mind and accepting instead the domination and influence of another. Thus, the essential question is always: Did the widow make the gifts and the will of her own free choice or was she forced to do so by the domination and influence of her daughter? Every case will turn on its own special facts and circumstances.

As a general rule, the person who is filing the suit has the burden of proving every aspect of his or her claim. In a case of undue influence, however, if the favored person, in our case, the daughter, had a confidential relationship with her mother and there are “suspicious circumstances,” then the court will shift the burden of proof to the daughter to prove that the gifts and will were done freely and voluntarily--without undue influence.

A “confidential relationship” exists where one person places trust in another because of his or her weakness or dependence, or where such trust arises more naturally, such as the relationship between an attorney and a client. In our example, the infirmity of the widow and the control of the daughter over her finances would certainly indicate a confidential relationship.

One suspicious circumstance would be a material change in a long-held testamentary plan. Thus, if the widow’s prior wills treated her children equally and she changed them after she lived with her daughter, this would probably be considered suspicious. It would also be highly suspicious for the widow to make a new will with an attorney chosen by her daughter. It may be unethical for the attorney and, in some cases, ultimately ineffective, because so doing creates this suspicious circumstance which, when coupled with a confidential relationship, shifts the burden of proof to the daughter to show the absence of undue influence.

Not all influence is undue. We are all familiar with the recent case of Anna Nicole Smith where an 80-year old man married a 20-year old dancer. After three or four years of marriage, he left substantially all of his millions to his wife. The children from a prior marriage sued and, after the settlement, his widow still received a very substantial portion of his estate. The reason, as it has often been said, is that no influence from a wife (or a wife to be) can be undue.

When you read these cases or newspaper accounts it is easy to take the moral high ground and to say that one person or another acted heinously. However, in the great majority of cases each party will claim and believe that he or she acted entirely properly and, if benefited by the decedent’s gifts or will, deserved every penny. If a person was denied an expected inheritance, he or she will usually cry “foul!”

The argument follows the money in most cases, and not all people are liars or cheats. It is human nature to believe you are right and, when in conflict, that your adversary is wrong. When these cases are ultimately resolved in court, a judge will conclude to the best of his or her ability who is right and who is wrong following the rules outlined above.

When the buyer’s attorney declared that the seller was in breach of contract and demanded release of the $40,000 deposit, litigation followed.

At trial -- two years later -- the court held that both parties defaulted under the contract.

There was a case of who is bluffing who and neither party blinked and the closing didn’t occur. That’s what I found happened.. . .

Based on the conclusion that both parties breached, the court ruled that the parties should equally divide the $40,000 deposit, reasoning:

The first lesson is that it is fine to be tough and to stand on your contractual rights -- to a point. That point is where your position is completely unreasonable in light of the totality of the circumstances. Then you put yourself at risk of being held in breach of contract.

Theft, Fire and Other Casualty Insurance Claims

By Elliott Joffe, Winter 2001

Most of us believe an insurance company is our ally when we make a claim - that the insurer is simply providing the service it is paid for, and, as the ads say, we are in its good hands. Yet, since theft, fire and casualty insurers are highly susceptible to fraud, they rigorously investigate claims, particularly large claims where the claimant seems anxious, makes repeated inquiries or plans to relocate.

The thin line between investigating a claim and preparing a defense

An adjuster may interview the claimant, inspect damaged property and research the value and/or cost of lost or stolen property. No matter how friendly an adjuster is, remember his job is to save the insurer money. Meanwhile, the insurer will contact police officers or fire officials. Since statements to these officials can form the basis for denying a claim, cooperate without making unnecessary comments. Anything you say can and will be used against you later. If the insurer retains a lawyer to take your statement, assume that you are the target of the investigation and hire an attorney to represent you. In fact, the insurer may have already decided to deny your claim.

Once the investigation is complete, the insurance company has three options: 1) pay the claim in full; 2) pay part of the claim, disallowing some of the value of the claim; or 3) deny the claim. Denials are always in writing and usually cite various reasons. Denials often cite fraud by the claimant as one reason.

Claim denial for alleged fraud

Once the claim is denied, it is up to you as claimant to file a lawsuit and prove your claim. Your award will be limited to the insured amount of your claim unless you can prove that the insurance company had no justifiable reason for denying the claim, i.e., bad faith. If you can establish that the insurer acted in bad faith, you may be entitled to additional damages. These claims are difficult to prove and are often dismissed pretrial. Then, the insurance company has little to lose by continuing the litigation.

By the time a claim has been denied, the insurance company has already thoroughly investigated the claim and taken the sworn statements of relevant witnesses, including the claimant and police officers or fire officials. Meanwhile, you have probably not started preparing for litigation. During the litigation, the insurance company’s attorneys will have an opportunity to take your sworn deposition. Since this deposition is usually taken more than a year after your initial sworn statement, there is a high likelihood that there will be some inconsistencies for the opposing attorney to use against you later at trial.

The discovery process may be your first opportunity to find out the insurer’s basis for denying your claim. While your attorney will be able to depose the various witnesses who gave sworn statements to the insurer during the investigation, unlike the insurer, this will be the only opportunity he has to question these witnesses prior to trial. Meanwhile, an insurer that has defeated a bad faith claim may successfully oppose any effort by your attorney to depose its employees. Many insurance companies will refuse to settle lawsuits in which they have alleged fraud, absent a surviving claim for bad faith.

The weapons at the insurer’s disposal

While insurance fraud is a crime, most denied claims do not result in prosecutions. Yet, the insurer proving fraud has an arsenal of civil remedies at its disposal. One New Jersey statute entitles a defrauded insurer to its attorneys’ fees and other costs of the investigation and defense. Absent bad faith, you are not entitled to any similar remedy. Another anti-fraud statute provides for substantial fines; claims are pursued by a Deputy Attorney General, who acts as co-counsel to the insurer’s lawyer.

Learning that the investigation was merely part of the defense

Since you will not know if an investigation is really preparation for litigation, follow these rules:

1) Always tell the truth to investigators, adjusters, police and fire officials and attorneys. Some claimants feel that small, seemingly inconsequential lies, which simplify their claims, will benefit their cause. While immaterial misrepresentations will not invalidate a claim, even the most inconsequential lie can result in the dismissal of a bad faith claim and make you look dishonest if the case goes to trial.

2) Say as little as is necessary when answering questions. Many claimants are so friendly with investigators and attorneys that they forget that these people may be gathering facts to prove fraud.

3) If the insurance company hires a lawyer, so should you. No matter what the insurance company says, once the insurance company has retained a lawyer, do the same. Of course, you should not cease cooperating with the investigation; indeed, doing so may be grounds for denying the claim.

In general, to protect yourself, be cautious and seek legal advice early in the process.

It is difficult to understand what a cooperative is without first understanding what a condominium is. A condominium is a defined three-dimensional portion of real estate, usually an apartment or a townhouse, which is owned directly by the owners. The owners receive a deed just if they were buying a house. Instead of a house and yard, the owners have a defined apartment plus a percentage share of all of the common hallways, exterior land, parking areas and common facilities. The owners pay a monthly maintenance fee to cover maintenance and upkeep of the grounds and common areas, insurance on the building and exterior and roof repairs. Usually the owners are responsible for repairs to their own heating, ventilating and air-conditioning equipment. A cooperative superficially resembles a condominium because the owners purchase an apartment and share the use and expense of the common areas. However, it is a vastly different animal.

With a cooperative, the entire building and all of the apartments along with all of the common areas are owned by the cooperative corporation. When owners "buy" an apartment they do not receive a deed and do not own any real estate. Rather, they receive what is called a proprietary lease, which is a permanent lease, along with a stock certificate for shares in the cooperative corporation which owns the building.

The differing legal structures of condominiums and cooperatives result in significant practical differences. First, the economics are different. With a cooperative there is usually a mortgage on the entire building which is paid as part of the monthly maintenance expenses. Thus, the owners of a cooperative must pay the loan on their apartment plus their pro rata share of the mortgage on the building, so the maintenance on a cooperative is generally much higher. This may or may not be reflected in a lower purchase price.

Second, because the owners receive a lease and not a deed, the law permits the cooperative corporation to determine whether or not the prospective owners are acceptable. Thus, every contract to buy a cooperative is subject to the consent of the cooperative. While laws banning discrimination in housing prevent discrimination based upon racial, ethnic or similar grounds, the cooperative corporation has a great deal of leeway in determining whether or not to approve a prospective purchaser.

In a recent case handled by Newman & Simpson, LLP, a cooperative corporation refused to approve a woman who had a contract to buy a $40,000 apartment with $350 a month in maintenance even though she had a net worth of over $1 million and over $100,000 per year in income! The Superior Court declined to grant an injunction but allowed broad discovery to determine whether the cooperative corporation acted consistently with its own policies and was otherwise non-discriminatory.

A third significant difference from condominiums is that a cooperative corporation may limit the ability of shareholder-tenants to sublease their apartments. Until recently, cooperative corporations were permitted to have blanket prohibitions on shareholders' subleasing apartments. This could cause a terrific financial hardship if someone moved and could not sell the apartment. The New Jersey legislature provided some relief by making total bans on subleasing cooperative apartments illegal. However, the law still permits cooperatives to limit the percentage of apartments in a building which may be subleased at any one time which, for many owners at any time, may be tantamount to a total ban. The flip side of the restrictions on subleasing an apartment is that once you are living in a building as a member of the cooperative, you will have the ability to exert some control over those who will live with you.

Both condominiums and cooperatives enable a person to own apartments, obtain tax deductions for interest as a homeowner and participate as a stockholder in the corporation running the building. However, there are inherent significant differences between the two forms of property ownership which should be understood before buying either.

The tax of greatest concern estate planning for New Jersey residents is the federal estate tax. Each person has one unified credit to apply in reducing his federal estate tax. The amount is fixed to equate to an estate tax exemption of $650,000 in 1999 and increasing to $1 million by 2006. A chart follows for ready reference.

The tax credit is called a "unified" credit because it is a credit against gifts made during a person's lifetime with the remaining credit to be applied to his estate tax when he dies. For example, if a person uses up $200,000 through taxable gifts in his lifetime and dies in the year 2006, then he will have a unified credit equivalent to an $800,000 exemption remaining to be applied to his federal estate tax.

The federal estate tax is a progressive tax; a taxable estate in excess of $100,000 is taxed at a marginal rate of 30%, in excess of $1,000,000 at 41%, and up to 60% for taxable estates in excess of $10 million.

From the chart one can see that if a person dies with a gross estate of $2 million in year 2006 and utilizes his unified credit equivalent to a $1 million exemption, his estate tax on the remaining $1 million would be $345,000.

The Internal Revenue Code provides that transfers by gift, will or otherwise between spouses are tax exempt. A transfer to a spouse is commonly known as the "marital deduction", a misnomer relating to laws predating the advent of the unified credit. Regardless of the nomenclature, the first goal of estate planning is for each spouse to use his and her full unified credit - $1 million each in 2006. Full utilization of the two credits would shelter $2 million from any federal estate taxes.

The way this is done is for each spouse to execute a will which sets aside the exemption amount equivalent to the unified credit into a separate trust for the benefit of the surviving spouse and thereafter the children. That trust will provide mandatory income to the surviving spouse plus discretionary principal. The balance of the assets would pass to the surviving spouse and be sheltered from tax by the "marital deduction". Thus, the unified credit of the first spouse to die would shelter the by-pass trust from tax and the balance of his or her estate would not be taxed because it would be passing to the surviving spouse.

When the second spouse dies, the by-pass trust will not be included in his or her estate, having been included in the estate of the first spouse to die, and the unified credit of that spouse will be applied to reduce the estate tax on his or her death. In this way the unified credits of both spouses will be fully utilized, sheltering $2 million in assets from federal estate tax in 2006 and subsequently.

One cautionary note is that for this plan to work, each spouse must own property in his or her own name (not jointly) so that whichever spouse dies first has sufficient assets to fund the by-pass trust to the full extent of that spouse's unified credit. Assets held in joint tenancy cannot fund the by-pass trust because they automatically pass to the surviving spouse. Often stock brokerage, bank accounts or even title to real estate need to be transferred between spouses to preserve the unified credit.

Every person should select a team of fiduciaries who will step forward to assume specified responsibilities upon the occurrence of future events. In glossary form, this article will explain each of the essential fiduciary positions.

The terms are synonymous and represent the person who will carry out the provisions of your will. Your executor will collect all of your assets, pay your bills, file any necessary tax returns, make decisions on which assets to sell and when to sell them and which assets to distribute to which beneficiaries.

Your executor should be someone you trust who is responsible about money matters. Most people choose a spouse, adult child, close relative or friend, understanding that whomever is appointed will be able to rely on the advice of counsel.

A trustee is a person who is appointed, usually by will, to invest your property and make discretionary decisions about the timing and amount of distributions to your beneficiaries.

The most typical use of a trustee is for a minor's trust. If you leave assets in your will to a minor child and have no trustee, a legal guardian will have to be appointed by the court to hold and invest those assets. The guardian will not be able to use the assets, absent further court order, until the child turns 18. At that time, the child will have the full right to enjoy those assets without restriction.

This is not what most people want to happen, so if you have a minor child and even a very modest estate, you should appoint a trustee in your will to hold, invest and distribute your assets after you and your spouse have both died. In your will, you can instruct your trustee to distribute monies for a child's education and other needs and to distribute the remaining assets to the child at a later age than 18 or in stages over a period of years.

There are countless uses of trusts besides trusts for minors but in each case, the person should be someone who is trustworthy and a sound manager of money and whose judgment you respect. The trustee may have to make unpopular decisions regarding distributions or withholding distributions and must have the strength to do what is right no matter what.

There are many types of guardians but the most common is the person whom you appoint in your will to raise, feed and shelter your minor children until they reach majority. This person need not be the same person who is the trustee because the two positions require different talents. The guardian is often a close relative or close friend whom you feel confident will give your children the love, guidance and direction that you would have if you were still alive.

The person who is authorized to act by a power of attorney is called an attorney-in-fact. A power of attorney is a written document in which a principal gives the attorney-in-fact the legal authority specified in the document.

Absent a power of attorney, if you become mentally incompetent, your relatives will need to petition the court for appointment of a guardian to manage your affairs. This can be an unpleasant public experience which most people would rather avoid. A power of attorney provides a seamless transition of the management of your property in the event that you no longer can do so and whether or not your condition meets the rather stringent standard for appointment of a guardian.

A person selected as your attorney-in-fact must be completely trustworthy because he will have the legal authority to do anything he wants with your property with no supervision. Most people appoint a spouse or a child.

Through a document known as a living will, you can direct doctors or hospitals which extraordinary measures, if any, you want taken to keep you alive in the event you are incapable of making these decisions. In a living will, you can appoint another person to act as your health care agent and can direct that health care agent how your wishes are to be carried out. The person chosen as your health care agent should be someone who knows you well and understands not just the words in the living will but how you truly feel about these life and death decisions. The person should also be someone who will have the fortitude to carry out your living will if the time comes to do so.

Much care should be given to selecting each of your fiduciaries and alternates in the event any of the first choices are unable or unwilling to serve when the time comes. The decisions can have dramatic effects on you and your family.

Typically a seller of real estate signs a listing agreement with a broker in which the seller agrees that the broker will be the seller’s agent to sell the property during a specific period of time and agrees to pay a commission if the broker sells the property at the listing price within the listing period. In many cases the broker procures a buyer but the transaction is not consummated at a closing. Reasons range from the buyer changing his mind before entering into a binding contract, to the seller defaulting on the contract. Under what circumstances is the seller liable to the broker for a commission—even when no closing has taken place?

As a general rule, unless the parties enter into a contract of sale and there is a closing the seller is not liable for a commission. Courts read into every listing agreement a requirement that, barring default by the seller, a commission will not be due and payable to the broker unless there is a closing.

(a) he produces a buyer ready, willing and able to buy on the terms fixed by the seller;

However, if the seller acts in bad faith or the closing does not occur due to seller’s wrongful act, then the broker can recover a commission from the seller even though there is no closing.

The facts from a recent case demonstrate the nuances of these principles. The seller signed a listing agreement which provided that:

In the event the Broker presents a buyer who agrees to the terms stated in the listing agreement, or any other terms, and the seller fails to proceed with sale, he shall be liable for commission.

The listing agreement was very short - sixty days, ending August 1, 2002. The Seller insisted on closing by August 1, 2002. The broker found a buyer who was willing to close by that date and had a pre-qualification letter qualifying him for a mortgage loan.

The seller’s attorney’s draft contract provided for a closing on August 1, 2002, stated that the initial deposit of $15,000 was due, contained “time of the essence” language and did not contain a mortgage contingency clause.

The buyer’s attorney made a counter-proposal which included a mortgage contingency clause and a 30-day due diligence period. The counter-proposal also deleted the “time of the essence” language.

The seller’s attorney replied that he would not accept a mortgage contingency clause but would accept a due diligence period, but only of seven days rather than thirty days.

The buyer’s attorney replied that buyer refused to delete the mortgage contingency clause or to shorten the due diligence period to less than twenty days.

The seller’s attorney again rejected the mortgage contingency clause and the twenty-day due diligence clause, insisting on the seven-day period previously offered.

The buyer’s counsel sent yet another draft which still contained the mortgage contingency clause but now set a closing date of September 30, 2002.

The seller refused to accept the final proposed contract of sale. The listing agreement had expired and the seller advised the broker that he was removing the property from the market.

The broker sued the seller to recover the full five per cent commission, alleging that the seller engaged in “frustrating conduct” and breached the implied covenant of good faith.

The trial court found that the broker had produced a buyer ready, willing and able to purchase on terms agreeable to the seller, that the buyer and the seller had reached a “meeting of the minds” and that the seller wrongfully changed his mind, frustrating the sale after the broker had earned its commission.

On appeal, the Appellate Division reversed. The court reasoned that from the outset the seller wanted an expeditious closing as evidenced by the short-term listing agreement which indicated that closing would occur on or about August 1, 2002. Despite being on notice of the need to close quickly, the buyer submitted its final contract proposal providing for a September 30, 2002 closing. By that time, the listing agreement had already expired and the broker “had simply failed to produce a purchaser ready, willing and able to perform in accordance with mutually agreed-upon terms, let alone those set by seller.”

The Appellate Division noted that although the listing agreement did not expressly prohibit a mortgage contingency, the buyer’s insistence on such a clause significantly altered the contract. The court ruled that it was clearly within the prerogative of the seller to reject even a full price offer based upon unacceptable terms. The court said:

[A]n owner of a real property who has signed a listing agreement retains the right to withdraw the property from the market before a buyer is produced; subject, of course to every contracting party’s obligations to deal fairly and in good faith.

The court said that the fact that the buyer found the seller’s proposal unacceptable and objectionable is not the measure. Rather, the test is whether the putative buyer was a ready, willing and able buyer and had made an offer conforming with the seller’s reasonable requirements, including, in this case, accommodating the seller’s stated need for a speedy closing.

The court ruled that nothing in the seller’s conduct was inconsistent with his obligation to both the putative buyer and the broker, and that the real estate transaction was aborted because of the failure to agree on essential terms rather than any wrongful conduct on the seller’s part.

It is important to note the extent to which the court delved into the factual underpinnings of seller’s claim of good faith. Good faith is not a given and cannot be presumed. Sellers of real estate should always remember that they may required to demonstrate their good faith when a contract fails to be consummated in the absence of any clear default by the buyer. Walking away for a good reason is markedly different than walking away for no reason or a pretext.