Scott E. Mollen

Appraisals—Plaintiff Required to Pay “Modest Shortfall” in Addition to Substituted Properties to a trust, In Order to Regain Title to a Building—Defendants' Appraiser, “Under Cross-Examination,” Was Unable to Defend His Firm's Report

A court held an evidentiary hearing to ascertain the fair market value (FMV) of a 101,000 sq. ft. multi-tenant office and retail building (building) located in Poughkeepsie, New York.

The building was owned by a trust created by the plaintiff. Pursuant to the terms of the trust, plaintiff exercised his right to substitute for the building “other and equivalent collateral to the trust in order to” reacquire “exclusive title” to the building. There was an existing $2,904,127 mortgage on the building. The trustee defendants and the plaintiff agreed that the three buildings that the plaintiff was “prepared to contribute to the trust, have a [FMV] value of $2,035,000,” but the parties disagreed as “to the [FMV] of the [building].” Thus, the court held a hearing to determine whether there was any shortfall between the FMV of the building and the three properties that plaintiff sought to contribute to the trust.

The court described plaintiff's appraiser as “highly credentialed.” His expert report embodied an “exhaustive analysis” and he had provided “exceedingly credible testimony” in support of his conclusion that the FMV of the building was $5,260,000, “using a direct capitalization approach.” He had relied upon “the historic income and expenses of the [building] over the last four years.” He “reasonably assumed a 15 percent vacancy and collection rate.” The court viewed such assumption as “an optimistic projection,” since 46 percent of the building's space was “occupied without a lease or pursuant to leases that expire in the next 1 1/2 years. Until recently the [building] had an 18 percent vacancy rate.”

The plaintiff's appraiser explained that the building's income had “remained relatively stable over the last four years but noted that the market for office space in the Poughkeepsie area is not growing.” He “valued the vacant and owner-occupied space at $13.25 per square foot instead of the average price of $14.05 per square foot that space in the [building] is presently renting at.” He “calculated actual expenses to be $7.67 per square foot” and had found that “the ratio” was “comparable to other similar buildings.” His conclusion that the building was worth $5,260,00, was “based on a capitalization rate of 9.5 percent,” which was a capitalization rate that he believed was “consistent with a market survey of comparable properties.” Additionally, he asserted that the defendants' appraiser “significantly overstated potential revenue using a discounted cash flow methodology and understated vacancy and collection rates.”

The court found that the plaintiff's expert was “well prepared,” “his report…thorough,…, and persuasive, and his testimony [was] totally credible.” In contrast, the court found that the defendants' expert, also “well credentialed,” “appeared only casually familiar with [defendants' appraisal report].” Moreover, “he was unable, under cross-examination, to defend” the defendants' appraisal of the building “either $7 million using a discounted cash flow approach or $6.8 million using a direct capitalization approach.”

Although the building presently had “an anomalously low 12 percent vacancy rate only since February 2018, the [defendants' appraisal] report assumed that the vacancy rate would remain at 12 percent for the next ten years.” The defendants' appraiser also “assumed that the rental rates…in the [building] would rise annually at a compound 2 percent rate except for leases with fixed and static rents.” The court found that such assumptions bore “no relationship to the building's experience during the last four years when vacancy rates often exceeded the 15 percent vacancy rate and credit risk plaintiff's expert used in his valuation.” Additionally, the defendants' appraiser used four “comparable” buildings which all had vacancy rates above 15 percent and as high as 40 percent and the “comparables” were “arguably in more desirable locations” than the building.

Although the defendants' appraiser disagreed with some of the plaintiff's appraisal report, if the defendants' appraiser had “assumed a 15 percent vacancy rate over time instead of a 12 percent vacancy rate, [the defense appraiser's] direct capitalization appraisal value would be relatively close to plaintiff's direct capitalization appraisal.”

The court rejected the defendants' appraiser's “discounted cash flow appraisal as…flawed given its reliance on ever increasing rents and unreasonable vacancy rates” in the subject rental market, “which is stable at best and perhaps softening based on the testimony of both appraisal experts.” Accordingly, the court adopted the plaintiff's appraisal.

The FMV appraised value had to be reduced by the $2,904,127 balance on the mortgage which encumbered the building. Thus, the court held that the plaintiff had to pay a shortfall of $330,873, in addition to substituting the three properties which had the stipulated value of $2,035,000 and if the plaintiff cannot assume the mortgage, “he will have to pay the trust the amount of the mortgage and the trust will satisfy the mortgage in full.”

Comment: Experienced people know that licensed appraisers are required to adhere to certain principles and rules. Some may overestimate or underestimate the value of a property in order to “please” their client. They will accomplish that by, for example, utilizing certain “aggressive” underlying assumptions. As the subject case illustrates, appraisal reports that are used in litigations or arbitrations need to withstand cross-examination. An appraisal that lacks credibility may enhance the credibility of the adversary's appraisal report.

Some people think that judges and arbitrators will simply compromise and select a midpoint between two different appraisals. That assumption is often incorrect. Furthermore, absent an agreement to the contrary, neither judges nor arbitrators are required to accept either party's appraisal report.

Some parties will resolve an appraisal dispute pursuant to a “baseball” type arbitration or appraisal proceeding. Generally, in such proceeding, the “neutral” is contractually obligated to select the appraisal number that is closest to the number that the neutral thinks is the “accurate” number. The rationale for such process is that it encourages each party to be more “realistic” and fair out of fear that an overly aggressive appraisal will push the neutral to select the adversary's appraisal number.

The subject decision illustrates that appraisers consider not only the amount of income that a property may generate, but also the “quality of the income.” Is the income derived from long term leases with “credit” tenants or is income derived from “at will” tenancies? Since vacancy rates and market rents may change over time, appraisers will look not only at historical vacancy rates and rents in a subject building, but vacancy and rental rates in comparable buildings. In determining what is a “comparable building,” appraisers will consider not merely the location, size and income, but also, for instance, a building's age, physical condition, etc.

On occasion, an appraisal may be mostly done by an employee of an appraisal firm other than the appraiser who is testifying in an action or proceeding. Thus, a “testifying” appraiser should fully familiarize his or herself with the details of his or her firm's appraisal report.

Pastreich v. Pastreich, Sup. Ct., N.Y., Index No. 650740/2018, dated May 11, 2018, Ostrager, J.

Brokerage—Distinction Between Exclusive Right to Sell and Exclusive Agency—Broker Was Not the Procuring Cause—Indemnification Clause For Brokerage Commissions Was Not An Admission That Commissions Were Earned

From on or about April 3, 2006 until on or about Feb. 19, 2014, the plaintiff, a licensed real estate broker, managed a shopping center (Center), pursuant to a written management agreement (agreement). The agreement specified that the plaintiff was “to manage the [Center] and to perform the leasing and renewals for leases within the [Center], as the exclusive agent for [owners].” The agreement had been extended through March 31, 2008, and “was to automatically renew…unless terminated sooner.” The agreement required the plaintiff “to 'make every reasonable effort to obtain and keep…tenants for the property.'” The manager was entitled to receive lease commissions.

In late 2010, the plaintiff approached the owners with a proposal for an existing tenant (tenant) “to renovate and expand…and to enter into a new and extended lease” (new lease). The owners directed the plaintiff to proceed with negotiations. The plaintiff approached the tenant with a proposal for a new lease. Throughout 2011, the plaintiff negotiated with the tenant. The plaintiff had “extensive meetings with [tenant's] architects and personnel from [the Village] to discuss the proposed” expansion.

After the owners authorized the plaintiff, in or about January 2012, “to proceed to agreeing to terms with [tenant],” the plaintiff provided the tenant with the proposed new lease.

Throughout 2012, there were discussions between the plaintiff and the tenant as to proposed revisions to the new lease. In December 2013, after an owner asked the plaintiff about the amount of commission that would be due, the owner “expressed its dissatisfaction with the amount of commissions payable to [plaintiff] under the…agreement.” The plaintiff alleged that on Feb. 14, 2014, the owners terminated the agreement. Thereafter, the owners executed a lease with the tenant, allegedly “for an expanded…space in accordance with the terms procured by [plaintiff].” The owners had not paid any commission to the plaintiff for obtaining the new lease. The plaintiff then sued the owners, asserting claims for breach of the agreement, quantum meruit and unjust enrichment and had moved for judgment on its claims.

The owners asserted that the plaintiff was not the procuring cause of the 2014 lease, the plaintiff was “only the landlord's exclusive agent and did not have an exclusive right to lease,” the terms of the 2014 lease “are materially different” from the 2012 lease proposed by the plaintiff and the 2012 Proposed Lease was neither signed nor accepted by any party. The owners also asserted a counterclaim for attorney's fees and expenses, based on “an attorney fee-shifting clause…in…the agreement.” The court had previously dismissed the quantum meruit and unjust enrichment claims on the grounds that the “dispute was governed by an express contract, specifically the…agreement.”

The tenant explained that it had long sought to expand into adjoining spaces and that it had regularly advised members of the owners who had occasionally stopped by to introduce themselves. The tenant stated that he and the plaintiff had negotiated a deal that he thought would be acceptable to the owners, which included expanding into three adjacent stores with a new rent “starting at $388,995,” and an extended term. However, the plaintiff had advised him that the owners had rejected that proposal. On Aug. 6, 2012, the tenant received an email from the plaintiff terminating negotiations. The tenant believed a new lease had not been signed because of disagreements among the owners as to the terms that would be acceptable.

The tenant also stated, inter alia, that the plaintiff had not notified the owners about his negotiations until on or about July 25, 2012, “at which time the majority owners immediately suspended negotiations.” The tenant further claimed that for more than a year, he was told that the owners were still evaluating possible new lease terms and were not ready to make any decisions.

After the plaintiff had been terminated as managing agent, the tenant learned that the owners had hired a new managing agent. The tenant advised the new manager that he still wanted to expand and extend the lease. The tenant did not receive any further proposal until Sept. 2014. The tenant stated that, at that point, “they started 'completely from scratch.'” The New Manager had provided “an entirely new lease form, with different terms that were less favorable to [tenant].” The new rent was now going to be $491,790 as compared to the prior proposed $388,995. Moreover, the tenant was now being offered only two additional adjacent stores, instead of three additional stores. The tenant learned that the owners had leased the previously discussed third store to a pizzeria.

The tenant further explained that the 2014 lease provided that the owners were indemnified by the tenant from any brokerage claims by Plaintiff. The tenant believed that the plaintiff had not earned a commission since if plaintiff had “succeeded in bringing about a meeting of the minds as to the terms that [tenant] negotiated in 2012, [tenant] would now be in a more favorable position because it would be paying less rent for more space.” The tenant asserted that the plaintiff “could never, and did not, bring about a meeting of the minds regarding the terms proposed in 2012.”

The owners argued that a plaintiff's affirmation misrepresented that the plaintiff worked on the tenant's lease right up until the time the agreement had been terminated. The plaintiff had acknowledged that on Jan. 7, 2014, he was instructed to stop negotiating with the tenant. When confronted with the discrepancy, the plaintiff explained that he was not negotiating, but he was “trying to find out the status of what's going on.” He claimed that he had “conversations, not negotiations.” The owners sought sanctions against the plaintiff based on his allegedly “false statement.”

The plaintiff alleged that by late July 2012, the new lease was ready for execution, he had so advised the owner and only after there was an inquiry as to the amount of the commission was the plaintiff directed to stop negotiations. The plaintiff contended that the tenant was still willing to deal with the plaintiff, citing an Aug. 14, 2012 email from the tenant.

The plaintiff allegedly learned that after he was told not to stop negotiating, and while the agreement was still in effect, the owners met with the tenant regarding a new lease and also met with other tenants of the Center, “to the exclusion of [plaintiff].” The plaintiff also claimed that as late as Jan. and Feb. 2014, before termination of the agreement, the owners had instructed the plaintiff to propose additional terms to the tenant.

The owners and the tenant had executed a new lease in October 2014. The new lease provided that the landlord and the tenant had dealt with no other brokers, other than the plaintiff and that, if the plaintiff sought brokerage commissions, the tenant would indemnify the owners for such liability, provided that landlord cooperated with the defense of such action and would testify that “it did not make any express agreement with [plaintiff]” to compensate plaintiff, “arising out of the execution…of this lease.”

The plaintiff argued that the indemnification provision constituted an admission that the plaintiff was “the procuring cause of the 2014 lease” and that such provision “creates an issue of fact precluding an award of summary judgment to defendants dismissing the amended complaint.”

The owners argued that the agreement specified that the plaintiff was “only entitled to a commission for leases that are 'signed and accepted' by [owner]” that negotiations with the tenant terminated in August 2012 and that as of Dec. 10, 2013, the tenant was asking about one of the stores in the Center which had been part of the 2012 proposed lease. They argued that the 2014 lease “is materially different” than the 2012 lease and the plaintiff was not the procuring cause of the 2014 lease. They also noted that they had decided to extend one of the adjacent store leases and had negotiated a more favorable lease with the tenant which had not been signed until more than two years later. Under the 2014 lease, the owners retained one of the adjacent stores which they then rented to a pizzeria. The owners also argued that the plaintiff was not entitled to compensation under the “tail provision” of the agreement, since, as of Feb. 2014, when the agreement was terminated, the plaintiff “was not actively working with [tenant] to lease space in the [Center].”

Additionally, the owners argued that there was no evidence that they had “acted in bad faith to avoid a commission.” They cited “issues regarding the amount of additional expansion space” and the proposed new rent. The owners also asserted that they established their entitlement to legal fees and expenses, even though it was the tenant who paid the fees pursuant to the leasehold indemnity provision. Alternatively, the owners sought legal fees as a sanction for the plaintiff submitting an allegedly false affidavit in connection with the litigation.

The plaintiff also argued that “the right of the principal to terminate the broker's authority is absolute and unrestricted, provided that he may not do so in bad faith, and as a device to escape the payment of the broker's commissions.” The plaintiff claimed that “by excluding [plaintiff] from the latter stages of the negotiations leading up to the execution of the 2014 lease,” and then citing the plaintiff's “lack of participation…as a pretense for avoiding liability to [plaintiff] for a commission,” the owners acted in bad faith, i.e., there was “a question of fact whether the [owners] terminated the [broker's] activities in bad faith.”

The court explained that generally, “[t]here must be a direct and proximate link, as distinguished from one that is indirect and remote, between the bare introduction and the consummation,” for a broker to be entitled to a commission. Further, brokers are entitled to commissions upon the sale of a “property by the owner only where the broker has been given the exclusive right to sell; an exclusive agency merely precludes the owner from retaining another broker in the making of the sale” and contracts “will not be construed to create an exclusive right to sell unless it expressly and unambiguously provides for a commission upon sale by the owner or excludes the owner from independently negotiating a sale.”

Absent “an agreement to the contrary, or fraud, or bad faith on the part of the seller, the broker is not entitled to a commission on a sale negotiated after the term of his employment.” The court acknowledged that “where the broker is not involved in the negotiations leading up to the completion of the deal, the broker must establish that it created circumstances that proximately led to the sale.”

The court granted the owners' motion to dismiss the plaintiff's claim and denied the plaintiff's cross motion for judgment on the amended complaint. The plaintiff's negotiations with the tenant ended in Aug. of 2012. The court held that the plaintiff was “not entitled to any commission on the lease that was ultimately consummated with [tenant] in 2014.” The court found that the plaintiff “merely negotiated a proposed lease in 2012 which a majority of the owners…rejected.”

Thereafter, the owner “was able to negotiate a much more favorable lease with [tenant], as was its right” and the new lease was “not signed until more than two years after plaintiff ceased its efforts.” The plaintiff had failed to identify “anything specific that it did that could be considered the proximate cause of the 2014…Lease.” Moreover, the plaintiff was not entitled to compensation “under the 'tail provision' of the…agreement,” since the plaintiff “was not actively working with [tenant] to lease space in the [Center]” at the time of termination.

The court also held that there was no evidence that the owners had acted in bad faith. The court reasoned that the 2012 proposed lease had been rejected because the proposed rent was unacceptable and there was an issue as to the amount of additional expansion space.

The court further held that the new lease's indemnity provision did not constitute evidence that the plaintiff “was the procuring cause of the lease.” The court found that the owners “were aware that plaintiff might seek a disputed commission” and they “were entitled to shift that business risk to [tenant]. . . .” The court found that nothing in the indemnity provision “constitutes any…admission that the commission was actually due and owing.”

Finally, the court held that the owners were not entitled to legal fees. They had not incurred any legal expenses, since they were paid for by the non-party tenant. The court also denied the owners' request for sanctions.

Rosen Assocs. Mngt. Corp. v. Suburban Props. Co., Sup. Ct., Nassau Co., Index No. 606460/16, Driscoll, J.

Scott E. Mollen is a partner at Herrick, Feinstein.