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Tuesday, August 31, 2021
Welcome to the ACREL News & Notes! It is published six times throughout the year and
features articles on substantive areas, noteworthy cases and hot topics, upcoming meetings,
ACRELive presentations and Fellow and local ACREL events.
We welcome your suggestions! Send ideas to David Gordon, [email protected]
--ACREL Communications Committee
As we go to press, summer is slowly winding down, Labor Day is less than one week away, and the
ACREL fall meeting in Nashville is less than 2 months away with more than 425 registered
Fellows and guests. Given our inability to meet in person for the past two years, the outstanding
CLE programs that line the Educational Agenda, the ACREL-only Sara Evans event at the
Country Music Hall of Fame, and the VIP seats at the Chris Stapleton concert, it is no wonder
that so many Fellows and their guests are looking forward to Nashville!
While we are continuing to receive new registrations weekly, we are hearing from time to
time from Fellows who are inquiring about health-related protocols for the Fall meeting. As I wrote
to you in a special email three weeks ago, the Executive Committee is acting deliberately to monitor
the situation so that we can provide Fellows and guests with a comfortable, yet prudent, meeting
experience. As I described in my email in early August, we are implementing a new seating plan
for the plenary sessions, all social events at the hotel will be held outdoors (this was the plan even
before COVID as the outdoor space at the JW Marriott is highly desirable), the Country Music Hall
of Fame allows for significant spacing including an outdoor terrace, and the JW Marriott, which is
only three years old and state-of-the-art in design, has implemented a number of COVID-related
upgrades and protocols. Please watch for additional announcements from the College as we move
into the fall.
* * * *
Looking ahead, I hope that you will join us for two special, first-of-a-kind ACREL events:
First-Ever ACREL Nominations Workshop. Leaders of the Member Development
Committee and the Membership Selection Committee are hosting the first-ever ACREL
Nominations Workshop at 2:00 p.m. eastern on September 9, 2021. Peggy Rolando, Marianne
Ajemian, Gail Mills and Bill Sklar will explain the nomination process and describe what makes
for a strong candidate and a successful nomination. The identification, nomination and admission
to ACREL of the country’s top real estate lawyers adds to the strength and vitality, and ensures the
long-term continuity, of the College. If you are thinking of nominating a prospective Fellow or
would just like to know more about the process, please attend the Nominations Workshop. There
will be ample time allotted for questions and answers. Please feel free to either raise your questions
during the program or to send them in advance to Peggy, Marianne, Gail or Bill.
Inaugural Meeting of the International Practice Group. I wrote in July of the
formation of the ACREL International Practice Group (IPG) led by Abe Schear. The IPG will
offer periodic programming with topics of interest for Fellows whose practices involve cross-border
transactions, whether inbound or outbound. I am pleased to announce the inaugural meeting of the
IPG, which will take place on September 23, 2021 at 1:00 p.m. eastern and will feature, as guest
speakers, Jane Helmstadter, of Bennett Jones in Toronto, and Richard Burgos, of Lavery in
Montreal. Please contact Abe if you have suggestions for future meetings and presentations, or if
you are interested in helping with the planning and coordination of the IPG. We are also planning
on an in-person strategy and brainstorming meeting of the IPG in Nashville so please watch for
further announcements prior to the fall meeting.
Please see the “What’s Happening This Week” email that you receive each Monday
from the College for more details and links to these presentations.
* * * *
In closing, I want to say a few words about one of our Fellows from the Class of 2021.
David Lust, from Rapid City, South Dakota, was approved for admission to the College by the
Board of Governors at its meeting in March of this year. David practiced law with the firm of
Gunderson, Palmer, Nelson & Ashmore and was a member for several years of the South Dakota
House of Representatives, including serving as Majority Leader. Many of us remember meeting
David virtually in March at the College’s inaugural New Fellows Council reception where we
welcomed our newest Fellows. I personally remember speaking with David, and I remember his
smile when I told him that Renee and I visited Rapid City last summer on a trip to Mount
Rushmore. Those of us on the Executive Committee were profoundly saddened and shocked when
we were notified by David’s firm in late July-- only four months after his admission to the College
and our Zoom meeting-- that David had passed away after suffering a cardiac event, leaving behind
his wife Rebecca and four children. At ACREL, all of our Fellows-- new and old-- are special and
very important to us. I have sent a card to David’s family on behalf of the College, and I extend
now my deepest condolences to those Fellows who knew David, including those who nominated or
seconded him for membership, and those who simply had the privilege of working with him.
ACREL News & Notes is made possible with help from our sponsors. To show appreciation for our sponsors, please support them for your legal needs whenever possible. For more information on our gold sponsors, click on their logo below.
Gold Level Sponsors
Silver Level Sponsors
Call for 2022 Sponsors of ACREL
Do you know of a company that would benefit from being a sponsor to ACREL?
The Finance Committee is working hard to solicit sponsors for next year and
would love to hear from you if you have a contact or company in mind.
For more information, click here for the 2022 ACREL Sponsorship Brochure, or
email Julie Burgess.
Report of the ACREL Nominating Committee for 2022 Board of
Governors & Officers
We are pleased to release the report of the 2021 Nominating Committee, thanks to the
hard work and diligent efforts of this year's committee, led by Marilyn Maloney.
View Report
Fisher
Happy 85th Birthday to
Morty Fisher! Morty, an
ACREL Fellow since
1981 and Past President
of 1989, celebrated
among friends, including
Fellows and two ACREL
Past Presidents, Barry
Greenberg, Ray Truitt,
Roger Winston and Jay
Epstien.
Hagner
Congratulations to John
Hagner, from
Washington, D.C., on his
retirement from Womble
Bond after 44
years! John has been an
ACREL Fellow since
1987 and we wish him a
very happy retirement,
alongside his wife, Ellie.
Shierk
Kim Shierk has been
named to Michigan
Lawyers Weekly’s debut
list of “Go To Lawyers”
practicing in real estate
and condominium law.
One of the most
accomplished and
respected real property
and development
lawyers in Michigan,
Kim has blazed a trail
and broken new ground
for herself and other
women lawyers in a
world mainly comprised
of men. From small- to
large-scale residential
and commercial projects,
wireless communication
structures, and a host of
other real property
matters and initiatives,
Kim’s fingerprints–and
footprints–are all over
Michigan.
Lifetime Achievement Award Winners (Locke, Dysart)
Additional Awards Recipients (Love, Markel)
Presenters and Planning Team
The State Bar of Texas Advanced Real Estate Law Course was held July 7-10 at the
Hyatt Regency Hill Country Resort in San Antonio. Roland Love served as the
Course Director, and ACREL presenters included Art Anderson, Robert Bliss, David
Dickson, Diane Dillard, Sara Dysart, Roland Love, Marc Markel, Kent Newsome,
Katherine Tapley, David Weatherbie, Thomas Whelan, and Reid Wilson. The
Planning Committee also included Cary Barton and David Conoly.
Making up for the pandemic virtual year, awards and recognitions were made for 2019
through 2021. Recognition of ACREL Fellows included the following:
Lifetime Achievement Award: Bill Locke (2020) and Sara Dysart (2021)
The highest award and recognition made by the Real Estate Probate and Trust Law
Section
Best Speaker 2019: Roland Love and Marc Markel
Workhorse Award 2020/2021, Best Paper 2019: Roland Love
It is with great sorrow we inform you of the passing of the following Fellows of the College. Our thoughts are with their families, friends and colleagues.
John "Tim" Carssow Fort Worth, TX
1944-2020 ACREL Fellow since 1982
Join us in making a contribution in John's honor.
Warren J. "Bud" Daheim St. Paul, MN
1930-2020 ACREL Fellow since 1983
Join us in making a contribution in Warren's
honor.
Don L. Kortz Denver, CO
1940-2021 ACREL Fellow since 1983
Join us in making a contribution in Don's honor.
David E. Lust Rapid City, SD
1968-2021 ACREL Fellow since 2021
Join us in making a contribution in David's
honor.
John N. Patterson Santa Fe, NM
1943-2021 ACREL Fellow since 1987
Join us in making a contribution in John's honor.
Lawrence Rivkin New York, NY
1921-2021 ACREL Fellow since 1980
Join us in making a contribution in Lawrence's
honor.
ACREL Nominations Workshop
Thursday, September 9 @ 2 pm Eastern
Add to your calendar
2021 ACREL Annual Meeting
Nashville, TN
October 21 - 24
Register
ACREL News & Notes
August 2021
A Message from the Advocacy and Amicus Committee
Once again, we want to introduce the Advocacy and Amicus Committee to you. The
Committee is prepared to advocate for laws that will be beneficial to the real estate community.
In that advocacy, we will coordinate among others with the Uniform Law Commission which
adopts uniform acts or, in the case of acts which we think will act to the detriment of the real estate
community, we advocate to deny adoption. Recently, we successfully stopped the Uniform Drone
Act after our Committee found it overreaching and it modified certain common law principles
which should not have been modified. The work on this matter will probably continue until
eventually there will be a satisfactory Uniform Drone Act.
We are also focused on preparing Amicus briefs in cases of interest. A few years ago, we
filed a brief in the highest Court of New York and our brief was cited by the adoption in the Courts’
language with a result that our Committee achieved a successful confirmation of the lower Court’s
ruling.
Many issues of advocacies or amicus briefs create inherent conflicts among our Fellows.
However, we make every effort to directly take on those matters we believe will not impact our
Fellows or their clients. A case in point is that we were recently asked to file an amicus brief in a
pending case in which, in the judgment of the Committee, a lower Court made a grievous error.
We were unable to assist in this matter because College Fellows were involved in both sides of the
case.
Notwithstanding the potential conflicts, we are also available to assist in helping advocates
with a position on any side of a matter find other willing advocates without taking a Committee
position.
We look forward to seeing you in Nashville. If you have any suggestions, ideas, etc. for
the Committee, please stop any of the members listed below so that we may take up the topic.
See you in October!
ADVOCACY & AMICUS COMMITTEE
Barry B. Nekritz IL Chair
Thomas F. Kaufman DC Vice Chair
Calvert Chipchase HI
Joseph P. Forte NY
David R. Kuney DC
Cliff McKinney AK
Michael H. Rubin LA
James C. Wine IA
ACREL News & Notes
August 2021
Specialty Courts for Real Estate Disputes?
Carl J. Circo, Ben J. Altheimer, University of Arkansas School of Law, Fayettville, AR
Our judicial system features many specialty courts—juvenile, drug, and veterans courts
for the criminal arena, probate and bankruptcy courts on the civil side. The past three decades,
however, have seen an uptick in business and commercial courts. In addition to Delaware’s
famous Court of Chancery, dating from 1792, approximately half of U.S. states now have some
form of business court or distinct docket for business disputes.1
In some countries, business courts play more prominent roles than in the U.S. The United
Kingdom, which has several specialty courts for business disputes, established the tribunal now
known as the Technology and Construction Court (TCC) in 1873.2 Owing to my academic
interest in construction law, I find the TCC a particularly interesting example of specialization
geared to technical and complex disputes within a narrowly defined industry.
The TCC, a subdivision of the Queen’s Bench Division of the High Court of Justice,
hears a range of cases considered too technical for a generalist court and a jury, but its reputation
as a highly efficient and effective institution stems primarily from its history with construction
and engineering cases.3 The TCC has developed procedures to assure timely and high-quality
dispositions tailored to the construction industry context, including a “Pre-Action Protocol for
Construction and Engineering Disputes.”4 TCC judges have broad case management discretion
to engage in proactive steps to control costs, to encourage alternative dispute resolution, and to
resolve cases efficiently. Among several procedures governing experts and expert testimony is
an option for “the experts for all parties to be called to give concurrent evidence, colloquially
referred to as ‘hot-tubbing.’”5 Another procedure, not unique to the TCC but particularly
important in construction litigation, is the U.K.’s statutory adjudication option in which a neutral,
overseeing a highly abbreviated proceeding, renders a decision that is binding and almost
immediately enforceable, although still subject to a final, subsequent determination by the TCC.
In practice, many adjudication decisions conclude the case.6
A commercial court as specialized as the TCC (say one dedicated to construction industry
or real estate transactions) seems unlikely in the United States. Under our federal system, few, if
any, individual states would likely have sufficient caseloads to support a court specializing in
such targeted legal fields. Having no personal experience with business courts, I would be
interested in hearing from ACREL members who have war stories of real estate or construction
industry litigation in a business or commercial court.
1 See Lee Applebaum, et al., Through the Decades: The Development of Business Courts in the United States of
America, 75 Bus. LAW. 2053 (2020). 2 See https://www.gov.uk/government/publications/technology-and-construction-court-guide (TCC Guide). 3 See generally John Uff, Construction Law - the First 25 Years, 7 CONSTRUCTION L. INT'L 40 (2013). 4 See TCC Guide, § 2. 5 TCC Guide, § 13.8.2. 6 See Humphrey Lloyd, Adjudication & the British Courts, DISP. RESOL. J., July 2001, at 64.
ACREL News & Notes
August 2021
Towards a Hypothetical ACREL Shares 2.0
Justin L. Earley, First American Title Insurance Company, Santa Ana, CA
As you may know, this year the Innovation & Practice Committee is delighted to have the
support of a team of graduate students from the University of California, Irvine. These students
are completing master’s degrees in human-computer interaction design (often shortened to
“HCI”). What is HCI? In short, it’s the study of how to build computer systems that “just make
sense” to the people who use them. It’s one of the most important 21st century job fields, and it
has exploded in importance in the last decade. If you want to see what happens when software
isn’t usable, watch this.
One of ACREL’s key pieces of software is ACREL Shares. ACREL Shares is aptly described as
a “treasure trove” of collected legal knowledge, but the College is aware that Shares also has
some usability challenges. Working with graduate student experts in this space was a fantastic
opportunity to benefit the College. The team working on ACREL Shares consists of Alexandra
Eftimie, Isaac Sonnenburg, Karina Dandia, Maddy Thomas, and Melania Antillon, and I have
been meeting with them weekly since their project started in March. They are a great team and a
delight to work with.
A big “thank you!” goes out to all the Fellows who have generously given your time to our
student team as part of their research efforts. Through surveys, interviews, and observations, the
team has been able to distill key lessons that suggest ways for us to improve ACREL Shares.
This user-experience research is of immense value to the College, and we owe a big “thank
you!” to the student team as well.
The students’ project will be winding up late this summer, and they will be giving their final
report and recommendation to the Innovation & Practice Committee shortly before they graduate
in September. Between now and then, the student team is exploring and testing possible solutions
that will move us towards a hypothetical ACREL Shares 2.0. While we aren’t sure as I write this
text in July what a hypothetical Shares 2.0 might be, we do know that whatever it might be needs
to work for you. Your participation is key to creating a user-friendly system, so please be on the
lookout for more opportunities to support this project by offering feedback on possible solutions
that the students are exploring.
And for those who are as passionate about this subject as we are, please be sure to join the
Innovation & Practice Committee’s in-person meeting at the October convention in Nashville,
where we’ll be considering the next steps that derive from our graduate student partners’
research. Whatever ACREL Shares 2.0 may ultimately be, we’ll need robust support from the
Fellows to bring it to life!
ACREL News & Notes
August 2021
1 117862256v1
Homelessness is Still with Us, and ACREL is Still Involved
David H. Jones, Troutman Pepper, Charlotte, NC
Since its annual meeting in Los Angeles in 2017, ACREL has been investigating what it
might do, either institutionally or in support of its individual members, to address issues of
homelessness in our communities. This effort was sparked by our plenary session at that meeting
during which local officials and homelessness advocates presented the face of homelessness in
Los Angeles County and the steps being undertaken toward housing solutions.
Following that meeting, then in-coming president, Jay Epstien, asked Jane Smith to head
an ad hoc task force to determine whether there was a role for ACREL in addressing the problems
of the homeless. Jane recruited ACREL members to be involved and, since that time, has
facilitated countless meetings. Many ACREL members have been able to attend one or more
meetings and roughly 20 or so members have formed a core group that attend most, if not all, of
them. The group’s deliberations have continued to be supported by ACREL leadership as each of
the Presidents, since Jay, have been active champions of the effort, and both Jay and Marilyn
Maloney are core participants.
At first, the group was overwhelmed by the data and the issues and a bit daunted in trying
to determine how ACREL could be of use. Early on, we focused on gathering information about
homelessness: the number of victims and how they differed, the causes, and what local
communities were doing to address the issues. We felt we needed to learn as much as we could,
if we had any hope of making recommendations to ACREL.
The pandemic brought a new challenge. Dropped into what was already a domestic
humanitarian catastrophe was the prospect that hundreds of thousands of previously securely
housed families could find themselves on the streets due to quarantine induced economic
disruption. This disruption would lead to wage and job loss and which in turn would lead to rent
payment defaults. Quickly invoked eviction moratoria were put into place which stanched what
would have been an immediate flow of newly homeless people; however, it was apparent that not
all communities respected the moratoria and that in all events the moratoria would end at some
point.
For a while the committee narrowed its focus to the effect of the eviction moratoria and
the impact of their eventual end. Part of our deliberations centered on how the rental support
provisions of the federal and state relief packages were being administered. One of the revelations
to us was that most landlords who rent to the tenants most likely to be affected by the pandemic
related economic layoffs were smaller landlords who did not have the ability to absorb sustained
rental losses. To avoid foreclosure, they would be under the most pressure to evict tenants and try
to re-let those units.
The communities that were more efficient at getting the rental subsidy payments into the
hands of tenants and landlords were, as a result, the ones with lower pending eviction caseloads.
117862256v1
Drawing on what we learned, the committee prepared a white paper which contained a proposal
urging continued rent subsidy appropriations and listing some of the best practices we saw as to
how to get the money into the hands of landlords and tenants efficiently.
Through the good offices of ACREL member Lee Chilcote, an introduction was made to
an attorney with close ties to the new HUD Secretary, Marsha Fudge. Our paper was submitted to
HUD through this channel. While no direct action has come from HUD with respect to the paper,
we note, with some satisfaction, that a number of studies and articles that have been published
since that time have focused on the need to efficiently get rental subsidy payments into the hands
of smaller landlords as a key to avoiding additional increases in homelessness.
More recently, the task force has decided to refocus its efforts as to what role ACREL can
play to help reduce homelessness, more broadly. A smaller group is being asked to compile the
information we have gathered to date and the possible solutions that are under consideration by
advocacy groups and local governments. This small group hopes to report to the entire task force
later this year with a menu of policy options and individual actions where ACREL and its members
could bring their talents to bear in an effort to make safe and secure housing a realty for all.
ACREL News & Notes
August 2021
1
Amendments to Uniform Common Interest Ownership Act
and the Uniform Condominium Act
James C. Smith, University of Georgia School of Law, Athens, GA
The Uniform Law Commission approved amendments to the Uniform Common Interest
Ownership Act (UCIOA) at its July 2021 annual meeting held in Madison, Wisconsin. Parallel
amendments will be made to the Uniform Condominium Act. The most significant amendment
concerns the scope of UCIOA. The act since its inception in 1982 has generally applied only to
common interest communities created after the act’s effective date. Older communities are
grandfathered, regulated by preexisting state law, whether statutory (for condominiums) or largely
common law (for planned communities and cooperatives). The amendments apply UCIOA to all
common interest communities, regardless of time of creation, while retaining the act’s existing
exemptions for small cooperatives, small planned communities (“small” means 12 or fewer units),
and planned communities with small assessments. The change in scope responds to concerns that
grandfathering old communities, thus creating two sets of law based on the age of communities,
has created complex issues for the legal community and for residents. The administration of law
and practice within a state is considerably improved by uniformity, i.e., by making all communities
subject to the same law to the maximum extent feasible.
Other significant amendments include:
Emergency Powers. The amendments add a new section on emergency powers prompted
by challenges faced by common interest communities and their associations during the coronavirus
pandemic. The new section: (1) adds a definition of “emergency,” (2) relaxes the normal notice
rules to allow meetings and actions when notifying only persons “whom it is practicable to reach”
with notices given “in any practicable manner,” and (3) authorizes the executive board to take any
action it considers reasonably necessary to protect the unit owners and other persons during an
emergency.
Adverse Possession. Sometimes a unit owner makes long-term unauthorized use of a
common element, and when the association or neighboring owners object to the use, the unit owner
raises adverse possession or prescriptive easement as a defense. The amendments add a new
section that immunizes common elements from loss by unit owners’ claims of adverse possession
or prescriptive easement.
Termination of Common Interest Community. During the past decade, terminations of
common interest communities have become more frequent, triggered by older buildings becoming
obsolescent, by casualty destruction, and by the economic failure of new developments before
completion. The amendments make four important changes. First, the amendments prevent a
developer who owns many unsold units from forcing termination by requiring the approval of 80
percent of the sold units in addition to 80 percent of all units. Second, the existing text allows
termination by an 80-percent vote only for communities with multi-story dwelling units (stacked-
units), requiring unanimity (100 percent) when any non-stacked units are present. The amendments
apply the 80-percent vote for all communities, regardless of building type. Third, the amendments
ACREL News & Notes
August 2021
2
protect owners from low appraisals of their units by allowing an owner to obtain an independent
appraisal and to have an arbitral panel of three appraisers determines fair market value. Fourth, the
amendments add a new procedure for a “partial termination,” which allows the removal of some
but less than all of the units from a common interest community.
Master Associations. The existing act requires that delegations of powers to master
associations be set forth in the declaration. The amendments add flexibility by allowing the
executive board to delegate powers to a master association, subject to review by the unit owners.
The amendments also change the rules for the election of the executive board of a master
association to ensure that the unit owners of the sub-associations have effective voting power.
Limited Common Elements. The amendments make it easier to convert a common
element into a limited common element by allowing a conversion by approval of the executive
board of the association, subject to review by the unit owners.
Special Declarant Rights. Special declarant rights include rights of the declarant to make
changes to the community and to control the executive board. The draft reorganizes the rules and
defines special declarant rights as interests in real estate, appurtenant to all units owned by the
declarant and any real estate subject to a development right to create additional units.
Meetings and Voting. The amendments permit and facilitate electronic meetings of unit
owners, a topic that has become especially timely since the coronavirus pandemic. They authorize
unit owners to participate remotely at a meeting held at a geographic location and authorize “all-
electronic” meetings where there is no geographic location for in-person attendees.
Assessments. First, the amendments respond to the practice of executive boards, which
happens with increasing frequency, of assessing common expenses to one or a few unit owners
who are “benefitted” by the expense (usually a replacement or repair of a common element, such
as a door, porch deck, or skylight). The amendments modify the “benefitted” standard by
removing board discretion and by requiring the declaration to identify the common expense by
specific listing or category. Second, the amendments change for rules for assessing expenses based
on a unit owner’s “bad behavior” by (1) dropping the ability to do so for gross negligence, (2)
adding liability for a unit owner’s failure to comply with maintenance standards, and (3) protecting
unit owners by requiring that the association cover the loss by available insurance proceeds before
making an assessment against the unit owner.
ACREL News & Notes
August 2021
4849-4378-5459 v1
“Good as Gold or Fool’s Gold – What Does It Mean to an Owner for
a Contractor to be Licensed, Bonded, and Insured?”
Trippe Hawthorne, Kean Miller LLP, Baton Rouge, LA
Every property owner who has endeavored to undertake a construction, renovation, or repair
project has heard or seen the phrase “licensed, bonded, and insured”. But what does this mean,
and does it really matter? Like all good questions, the best answer is, “it depends”.
Licensing: Many but not all states require contractors to be licensed. If the project is in a state
where a contractor’s license is required, the importance of observing the licensing laws is
critical. Violations of state licensing law can have catastrophic consequences to the unlicensed
contractor and to the project. While owners do not typically have direct liability for a
contractor’s violation of state licensing law, a project employing unlicensed contractors is
subject to being shut down by licensing board investigators and authorities, which will
undoubtedly cost the owner significant time and money. Also, it is generally the case that where
a license is required for a particular type of work, a contract for such work with an unlicensed
person may be subject to nullification.
The licensing process varies from state to state, but it is generally structured to require proof that
a contractor has basic financial, business, and technical competency to perform the work for
which the license in a particular classification has been issued in a responsible way. Technical
competency is typically addressed through testing and/or required levels of experience in the
specific area for which the license is sought. Many states have a tiered or subdivided contractor
license system under which the state’s requirements for licensing are differentiated based on the
monetary value of the contractor’s contracts and/or the type of services the contractor offers.
Contractors that are licensed for large commercial construction contracts may hold a different
type of license than subcontractors who are not dealing directly with owners, or contractors that
only perform residential construction or home remodeling. Contractors and subcontractors
performing inherently dangerous work which can threaten life, health, and safety (such as
plumbing or electrical work) might need still other types of licenses.
Financial and business competency and viability is typically addressed through minimum asset
requirements, examination of basic financial records, and background checks. The background
checks may be for the licensed contractor and its key employees and agents, and will include
review for things like bankruptcies or unsatisfied judgments.
The structure and purpose of most state contractor licensing systems is to ensure basic
competency and basic levels of financial stability. State licensing requirements help create,
identify, and illuminate the channels available to customers, creditors, and the government to
hold a contractor accountable, particularly where there is a public threat to life, health, or safety.
Nevertheless, a contractor’s ability to obtain a license should not be overvalued, particularly with
regard to competency, and state licensing law is generally of little help to owners in the event of
a contractual dispute with a licensed contractor. A license (where required) is the bare minimum
that any responsible contractor needs before they begin to accept contracts.
ACREL News & Notes
August 2021
4849-4378-5459 v1
Bonded: While, as discussed below, traditional insurance is not intended to guarantee a
contractor’s performance under a construction contract, certain types of surety bonds are.
“Bonded” means that a surety will stand behind the contractor for some obligation owed by the
contractor. The surety guarantees some aspect of the contractor’s performance to someone. The
key questions then are “what performance has been guaranteed” and “to whom”?
Generally, when the words “licensed, bonded, and insured” are used in an advertisement for a
contractor, the word “bond” generally refers to a license and/or permit bond. This license and/or
permit bond guarantees that the contractor will abide by the terms of the license issued and/or the
permit they have pulled, protecting some or all of the licensing board, the public works
department, the owner, or the general public. The existence of and requirements for obtaining a
license and permit bond vary greatly by state, county, or municipality. In the event of a troubled
contractor, though, the proceeds of these bonds are likely to be claimed by a number of different
people, and the amount of the bond may not be likely to be sufficient to cover the contractor’s
liabilities. In other words, while it could be nice that a bond of general applicability exists,
owners should not place any reliance on such a bond in their decision-making process.
For a significant project, the owner will want to dictate the terms and conditions of the bond and
have it dedicated to the project and that particular owner. Typically this is done through a
“payment and performance bond” issued for a specific project. The payment bond guarantees
payment to subcontractors, material suppliers, laborers, and others that have worked on the
project, and who may have lien rights against the owner. The performance bond generally serves
as a guarantee by the surety to the owner that the contractor will perform the work pursuant to
the terms and conditions of the contract. The performance bond does not entitle the owner to
anything more than is owed under the construction contract, but does provide security that the
project will be completed for the contract sum, even if not by the contractor.
Insurance: Whether a contractor is “insured” may be the most important or least important part
of the trio, depending on the risk at issue. Insurance is the most valuable tool in protecting
against the risks to third parties created by a construction project, but is not particularly useful in
protecting the owner for its own damages caused by the contractor’s breach or bad work.
The most common risks addressed by a contractor’s liability insurance include property damage,
injuries, and workers’ compensation claims. Many states’ contractor licensing laws require a
minimum amount of general liability and workers’ compensation insurance in order to obtain
and maintain a license. Liability and worker’s compensation insurance is important to protect
owners from claims by third persons arising out of or related to their project, and insurance for
these claims is of critical importance if they arise. While an owner can ascertain and determine a
contractor’s available insurance through review of an insurance certificate supplied by the
contractor’s insurance agent, for more significant projects, the owner will want to be added as an
“additional named insured” to the contractor’s liability insurance policies and ensure that the
available insurance has appropriate coverage and limits for the work at issue, and will defend the
owner and contractor in the event of a claim.
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August 2021
4849-4378-5459 v1
While a contractor’s liability insurance may protect the contractor and even the property owner
from claims for damages to third parties arising out of the project, it is not intended to protect the
owner against breach of contract by the contractor or bad workmanship. In other words,
“insured” means that a contractor has insurance to protect against risks to people other than the
owner, and it is not likely to protect the owner from the owner’s own damages that may arise out
of or relate to the project.
Construction projects also typically involve different types of property insurance, ranging from
the owner’s property insurance policy or program to a builder’s risk policy, which protects the
project and the materials and component parts thereof while the work is incomplete.
It’s important to understand the difference between being bonded and insured. For a contractor,
one of the biggest differences between insurance and bonding is which entity takes on the risk;
an insurance policy transfers the risk to the insurer, while a bond ultimately keeps the risk with
the bonded contractor. For an owner, the main difference is in which types of circumstances are
covered by bonds versus which are covered by insurance. Bonds should generally be associated
with the Contractor’s performance of its obligations under the contract, whether to perform the
work, or to pay subcontractors and material suppliers. Insurance should be associated with
personal injury or property damage, typically to third parties.
The cost of licensing and insurance for a contractor is typically a general cost of doing business,
while the cost of a project specific bond is… project specific. So, for projects where cost is a
key factor (are there any where it is not?) many times, eliminating bonding requirements is a way
to reduce project costs.
Surety bonds protect the interests of the project owner and ensure that the projects are completed
correctly, securing the completion of the job and the security of the owner’s investment. Many
surety bond companies won’t issue a bond without having sufficient security from the contractor
and unless the contractor is sufficiently insured. If an incident occurred, causing property
damage or personal injury, the surety would want to be confident that the contractor’s insurance
would protect the continued viability of the contractor and its ability to complete the project,
which the surety has guaranteed.
From a planning perspective, knowing that a contractor is “licensed, bonded, and insured” is
certainly better than hiring a contractor that is not licensed, is not insured, and can’t get a bond,
but prudence will always suggest consideration of the requirements and ramifications of the
particular project, and at least some analysis of whether the protections offered by this contractor
for a particular project are appropriate and sufficient.
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August 2021
Why Is This So Complicated?
An Introduction to Common Tax Structures and
Considerations for Domestic and Foreign Investors in U.S.
Private Equity Real Estate Funds
John L. Mallinson1, AIG Global Real Estate Investment Corp, New York, NY
I. INTRODUCTION:
Interest in U.S. real estate as an investment asset class is robust amongst both foreign and
domestic investors. Not surprisingly, private equity real estate funds (“PERE Funds”),
which are a critical outlet for this demand, continue to attract significant levels of capital
and are becoming increasingly more important participants in the market. Despite their
ubiquity, forming and structuring a PERE Fund is a complex undertaking. This
complexity arises principally from the fact that a PERE Fund is often a Noah’s Ark of
varying international and domestic investor types each having their own tax and regulatory
sensitivities and requirements. The PERE Fund must address these sensitivities and
requirements not only on an individual investor basis but also within the context of an
overall investment structure that needs to work for all parties in the aggregate.
This article seeks to demystify some of the complexity surrounding PERE Fund structures
by providing an overview of some important categories of investors organized by tax
profile and examples of some structures through which they often invest. While there can
be many drivers behind a PERE Fund’s internal organizational complexity, very often the
most important driver is tax.2 For certain categories of investors in PERE Funds, the
failure to properly understand the tax impact of certain investment structures and to plan
accordingly can have significant economic consequences. This article endeavors to clear
some of the fog surrounding these structures by means of an introductory and necessarily
incomplete discussion of the topic. This article does not purport to provide tax or legal
advice and readers should consult their own professional tax advisors relative to any
particular tax question or circumstance. The structuring of a PERE Fund in actual practice
entails a myriad of additional important details, judgment calls, individual circumstances
and preferences, business drivers and other considerations producing a frequently bespoke
final product.
1 John L. Mallinson is the General Counsel of AIG Global Real Estate Investment Corp. Mr. Mallinson received his B.A. from
Binghamton University and a J.D. from New York University School of Law. Mr. Mallinson serves as the Chair of the Equity Investment Structures Committee of the American College of Real Estate Lawyers whose work on investment funds provided the impetus for this article. The author would like to thank Robert LeDuc of DLA Piper LLP, Dan Zygielbaum and Roger Singer of Gibson, Dunn & Crutcher LLP and Stevens Carey of Pircher, Nichols & Meeks LLP for their kind and thoughtful contributions to this article. 2 Even the use of a Delaware limited partnership as the standard PERE Fund entity is to a large extent the product of the tax
needs of prospective foreign investors despite the existence of the newer form LLC which may be considered superior in many respects. The U.S. treaty network typically requires a PERE Fund to be organized as a limited partnership if treaty benefits are to be claimed by foreign investors on dividends and/or interest passed through the PERE Fund, including dividends from a subsidiary REIT.
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August 2021
Part II of this Article provides a glossary of key terms used in the balance of this Article.
Part III provides a brief discussion on private REITs given their importance and prevalence
in PERE Fund structuring. Part IV lists the varying types of investors who typically invest
in a PERE Fund and some general statements about their tax profiles and typical approach
to achieving tax efficiency. Part V provides some concluding thoughts on PERE Fund
structuring.
II. KEY TERMS
Branch Profits Tax means a 30% branch profits tax on a foreign corporation’s
earnings and profits constituting ECI.3 The Branch Profits Tax may be reduced or
eliminated by treaty.
Blocker means a corporation or other entity, such as an LLC, electing to be taxed as a
corporation.4
Code means the U.S. Internal Revenue Code of 1986, as amended.
ECI means income effectively connected with the conduct of a U.S. trade or business
within the meaning of the Code.5 As a general matter income from operations or sale
of real estate in the U.S. constitutes ECI. A foreign investor who receives ECI from a
PERE Fund will be subject to U.S. federal (and potentially state) income tax and will
be obligated to file tax returns in the U.S., including potentially at the state level.
Leveraged Blocker means a Blocker that is capitalized with a combination of
shareholder loans and equity.
Non-REIT Qualifying Investment means assets within a PERE Fund which are
considered non-qualifying for various purposes of the REIT qualification tests.
REIT means a real estate investment trust as set forth within subchapter M of Chapter
1 of the Code.
REIT Qualifying Investment means assets within a PERE Fund which are considered
qualifying for various purposes of the REIT qualification tests.
QFPF means a qualified foreign pension fund within the meaning of Section 897(l) of
the Code.
3 I.R.C. Sec. 884(a).
4 In tax structuring parlance a “blocker” generally refers to an entity that is or elects to be opaque for tax purposes, as opposed
to a pass-through entity.
5 See I.R.C. Sec. 864(c).
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August 2021
Section 892 Investor means a “foreign government” investor, including a sovereign
wealth fund,6 within the meaning of Section 892 of the Code. Note that many foreign
pension funds are entitled to both Section 892 benefits and significant treaty benefits
and may also be QFPFs.
UBTI means unrelated business taxable income which is generally defined under the
Code as income that is unrelated to the exercise or performance of a U.S. tax-exempt’s
purpose or function but generally excludes dividends, interest and capital gains.7
USRPHC means a U.S. real property holding corporation within the meaning of
Section 897 of the Code.
III. PRIVATE REITs
While the general public is largely familiar with REITs that are listed on an exchange, a
REIT is not required to be publicly traded. REITs may be privately held and are fairly
common and well-established structures in the real estate investment world.8 REITs were
meant to provide access to the retail investor to larger real estate projects, the legislative
impression having been that such investment had been previously available as a practical
matter only to institutional investors and the wealthy.
The principal advantage of a REIT is that while it is a taxable entity, it is entitled to a
deduction for dividends paid.9 In circumstances where all or virtually all income is paid
out, the REIT should expect to owe little or no income tax.10 In order to receive various
tax benefits and otherwise qualify as a REIT, the REIT must meet various requirements
under the Code, including, generally speaking, annually distributing at least 90% of its net
taxable income (excluding net capital gains) and meeting certain asset tests such as that at
least 75% of the REIT’s total assets must be real estate assets, cash and government
securities at the close of each quarter of the calendar year. A REIT is required to (i) avoid
being more than 50% owned, by value, by five or fewer “individuals”, which can include
certain entities (the “5/50 Test”), and (ii) have at least 100 shareholders.11 Service firms
exist that source equity commitments from REIT investors and manage the relationship
with those investors.
As the number of requirements described above suggest, the utilization of private REITs
entails not insignificant administrative and formation costs and limitations on operational
6 For a definition of “sovereign wealth fund” see U.S. Department of the Treasury, Semiannual Report on International
Economic and Exchange Rate Policies, June 2007, at www.treas.gov/offices/international-affairs/economic-exchange-rates/pdf/2007_FXReport.pdf (March 3, 2008). 7 See Internal Revenue Service Tax on Unrelated Business Income of Exempt Organizations Publication 598 (Rev. March 2021)
8 For a discussion of the use of private REITs by PERE Funds see Michael Belotin, Why Private Investment Funds Are Using REITs
to Invest in Real Estate Tax Notes Federal 166-7 (February 17, 2020).
9 Note that private REITs can lose the deduction for dividends that are “preferential.” 10 Note that REITs will typically endeavor to distribute all of their income and net capital gain as undistributed amounts are
subject to income tax in the hands of the REIT.
11 Both of these ownership requirements have a limited grace period for newly formed REITs. The 5/50 Test takes into account
indirect and constructive ownership.
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August 2021
flexibility. Further, due to certain assets being Non-REIT Qualifying Investments, a REIT
will limit the appeal or add to the complexity of a PERE Fund investing in certain asset
types, such as hotels, residential condominiums, senior housing and horizontal
development of land lots. Additionally, sale of any property type within two years after it
is constructed could be considered a “prohibited transaction”12 if it does not fall within the
various safe harbor provisions of Section 857(b)(6)(C) of the Code; therefore the REIT
structure could impact a PERE Fund’s disposition and sale strategy relative to development
projects. Obviously, utilization of a REIT by a PERE Fund should reflect the view that the
prospective tax and regulatory benefits of the REIT outweigh the costs and limitations of
the REIT structure.
IV. INVESTOR TYPES BY TAX PROFILE
This Part provides a catalogue of investors organized by their tax profile and a discussion
of how an investor with such profile may often invest in a PERE Fund and some of the
benefits, trade-offs and considerations of such a structure. The structures outlined below
by no means exhaust the universe of potential structures.13 A typical PERE Fund will seek
to include a number of these structures within the PERE Fund or through one or more
alternative investment vehicles that invest alongside the fund.
U.S Investors:
Overview
U.S. investors can be broadly divided into two categories: taxable and tax-exempt. For
taxable investors, the investment structure in a PERE Fund organized in the U.S. is often
very straightforward. Investment structures for tax-exempt investors are often less straight
forward (unless the investor is a governmental pension fund in which case the structures
may be relatively simple). Two types of tax-exempt entities, corporate pension funds and
endowments, are critically important categories of PERE Fund investors; understanding
the rules applicable to them is essential in PERE Fund structuring.
U.S. Non-Tax Exempts (Corporations, Individuals) – Direct Investment Structure
These investors are generally going to be subject to U.S. federal income tax on their
allocable share of the Fund’s income and capital gains at the relevant current rates. Such
investors will typically invest as direct limited partners in the Fund or through vehicles
organized for purposes other than tax. These investors typically prefer structures that are
fully transparent and pass through from a tax perspective to avoid double taxation, although
some investors may prefer investing in a REIT to potentially reduce state tax filing and/or
payment obligations.
U.S., State and Local Pension Funds – Direct Investment Structure
12 I.R.C. Sec. 857(b)(6).
13 Despite the discussion below on Leveraged Blockers, for example, some if not many foreign investors for a variety of reasons
may opt to invest simply through a Blocker or directly into the PERE Fund itself.
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August 2021
These investors are known as “Super Exempt” organizations. Many of these government
pension investors14 take the position that they are not subject to federal or state income tax
on UBTI by virtue of Section 115 of the Code which excludes from the definition of gross
income any income derived, inter alia, from the “exercise of any essential governmental
function.”15 Based on such position, these investors may opt to enter the PERE Fund
directly as limited partners and not require REIT or other blocker structures.
Corporate Pensions and University/College Endowments – Single REIT Structure16
U.S. pension funds and endowments generally enjoy tax exempt status in the U.S. This
tax-exempt status, however, is not absolute. Congress did not, for instance, intend this
tax-exempt status to extend to activities that were not core to the mission of the
particular tax-exempt party. Income from such non-core activities is referred to in the
Code as “unrelated business taxable income” or “UBTI” and is subject to tax. Congress
has defined UBTI to include various items of income. Most notably income from real
estate with debt financing on it may, to a significant extent, be considered UBTI. The use
of mortgage financing is a core and a very traditional element of real estate investment.
Consequently, the inclusion of this income from debt financed properties as UBTI would
have a material impact if not addressed in some fashion. UBTI can also be generated by
properties or activities whose income may be viewed as more from business operations
than rent from real estate, such as hotels, and from “dealer” activities, such as the sale of
condominium units. Most tax planning for these tax-exempt investors will take into
account and seek to manage or eliminate UBTI.
Corporate pensions and endowments will typically invest directly in the PERE Fund but
will need the PERE Fund to have a subsidiary that is a REIT that in turn owns the individual
assets or invest in a fund that complies with the “Fractions Rule” in order to avoid the
adverse tax consequences of UBTI for leveraged investments. A discussion of the
Fractions Rule is outside the scope of this Article but suffice it to say that many investors
and sponsors prefer avoiding UBTI through utilization of a REIT rather than monitoring
and implementing a Fractions Rule compliant investment. Generally speaking, a REIT as
a corporate entity “blocks” 17 the attribution of income characterization as UBTI to
investors in the REIT.18 Care must be taken to avoid having the REIT be considered
“pension-held” or the UBTI blocking benefits could potentially be lost for certain pension
fund investors.19
14 Conversely, some government pension investors require UBTI blocking structures to eliminate any concern. 15 I.R.C. Sec. 115(1). 16 If the fund invests in Non-REIT Qualifying Investments a fund structure may include a separate and parallel blocker structure
to manage UBTI.
17 It should be noted that while the REIT structure blocks the imposition of UBTI to investors the REIT rules themselves
impose a set of restrictions on permissible income at the REIT not dissimilar to much of the UBTI regime. 18 See Mitchell Berg and Ian Tattenbaum, Using Private REITs to Minimize UBTI in Real Estate Investment Funds, Real Estate
Finance Journal (Winter 2003). 19 A REIT can be a “pension-held REIT” if either (i) at least one pension trust holds more than 25% of the value of the interests
in the REIT, or (ii) a group of pension trusts each individually holding more than 10% of the value of the REIT’s stock, collectively owns more than 50% of the value of the REIT’s stock, provided certain other factors are also present.
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August 2021
Not all assets in a PERE Fund are necessarily going to be REIT Qualifying Investments
entitled to preferential tax treatment. A residential condominium development project, for
instance, may be a Non-REIT Qualifying Investment. Corporate pensions and
endowments will want to avoid receiving income from Non-REIT Qualifying Investments
directly to avoid the need to file federal and perhaps state income tax returns. Accordingly,
many PERE Funds will employ either a Blocker or taxable REIT subsidiary (TRS)
ordinarily owned by a REIT to hold Non-REIT Qualifying Assets. Payment of tax and the
filing of tax returns will occur at the Blocker or TRS level, as applicable.
Foreign Investors:
Overview.
The enactment in 1980 of the Foreign Investment in Real Property Tax Act (“FIRPTA”)
was undertaken amidst legislative concerns about foreign ownership of, and investment in,
U.S. real estate. FIRPTA placed levels of taxation on those activities by most foreign
investors higher than those in respect of other investment classes. Accordingly, FIRPTA
has served as a headwind to foreign investment in real estate. Significantly, FIRPTA treats
gains from the sale of a “US real property interest” as ECI irrespective of whether they
would have otherwise constituted ECI. Subsequent amendments to FIRPTA and the
adoption of accepted tax planning strategies have alleviated some of these disincentives.
Even still, many foreign investors will be subject to substantive levels of U.S. tax and their
tax planning strategies will be to mitigate against even higher levels of tax.
In addition to the significant tax burdens applied to certain forms of investment under
FIRPTA, foreign investors may also subject themselves to the need to file a tax return in
the U.S. and perhaps various states and further subject themselves to the subpoena power
of the IRS relative to their other investment activities in the U.S. Tax planning for foreign
investors often leads to structures that avoid the need to file a U.S. tax return and its
resultant consequences.
Foreign Investor (QFPF) – Single REIT Structure
The 2015 PATH Act was designed to increase investment in U.S. real estate by certain
qualified foreign pension funds by exempting these entities from FIRPTA altogether. This
means that gains from the disposition of a USRPI, including capital gain dividends from a
REIT, are generally tax-free for QFPFs. 20 However, ordinary REIT dividends will
continue to be subject to withholding tax unless reduced or eliminated by a treaty or Section
892. Accordingly, a QFPF will generally invest directly in the PERE Fund but require a
REIT that is wholly owned by the PERE Fund to hold the underlying assets. The REIT
serves to block the creation of ECI and therefore the need to file a U.S. tax return.
However, a QFPF will be subject to withholding tax on ordinary dividends if and to the
20 Care must be taken to avoid having such gains be otherwise connected to a U.S. trade or business however, as this could
trigger U.S. taxation on such gains even for a QFPF. Accordingly, QFPF investors generally prefer to invest through REIT structures rather than pure passthrough structures.
ACREL News & Notes
August 2021
extent not reduced or eliminated by an applicable treaty or unless the QFPF is owned by a
foreign government and falls within Section 892. Unlike a Section 892 Investor, a QFPF
may receive capital gain dividends that originate from sales of U.S. real estate without tax,
and without regard to how much of the REIT is owned by the QFPF.
Foreign Investor (Non-QFPF)- Leveraged Blocker Structure.21
Absent use of a Leveraged Blocker Structure, many foreign investors (other than QFPFs
and Section 892 Investors) could be subject to federal tax at a rate in excess of 44% and an
obligation to file federal tax returns with its attendant IRS audit and subpoena implications.
Accordingly, the Leveraged Blocker is a common structure inside PERE Funds. The
Leveraged Blocker Structure, however, is not a panacea as the foreign investor may still
pay, at least indirectly, a significant amount of tax. However, effective tax rates should
be expected to be brought down significantly in most cases.
Under this structure, the investor contributes equity to the Leveraged Blocker and makes a
shareholder loan to the Leveraged Blocker.22 The Leveraged Blocker is the investor in the
PERE Fund limited partnership. The Leveraged Blocker will generally obviate the need
for the investor to file a U.S. tax return because ECI will occur at the blocker level, unless
the investor disposes of its shares in the Leveraged Blocker while it is a USRPHC. There
may no withholding tax or a reduced rate on interest and dividends from the Leveraged
Blocker depending on applicable treaties and/or structuring the loans to qualify under the
“portfolio interest exemption.”23 However, the Leveraged Blocker will typically be subject
to state and Federal tax to the extent interest on the shareholder loans is not deductible.24
Care must be taken that the affiliated loan structure is respected as debt for federal tax
purposes. Among other matters, the loans must bear interest at an arms-length rate, have
appropriate loan to value ratios and not permit excessive deferral of interest.
Assuming the Leveraged Blocker is a U.S. entity (typically a Delaware C-Corp or a
Delaware LLC electing to be taxed as a corporation) the foreign investor should not be
subject to a Branch Profits Tax.
Federal and state income tax will be paid at the Leveraged Blocker level, net of allowed
deductions for interest on the shareholder loans and other allowable expenses. An investor
in the Leveraged Blocker will be entitled to receive a return of principal on its shareholder
loans, interest on its shareholder loans, a return of its capital contributions and profit on its
capital contributions. The amount of tax in respect of each of these will depend on a
variety of facts and circumstances, including applicable treaties and whether the investor
is a Section 892 Investor.
21 Other considerations for Leveraged Blockers are beyond the scope of this article. These considerations include the relatively
new Section 163(j) interest deduction limitations, the new Section 59A “base erosion” rules, the anti-hybrid rules of new Section 267A, and the repeal of Section 958(b)(4) which can frustrate certain portfolio interest planning.
22 Oftentimes a limited partnership (a “feeder partnership”) is interposed between the Leveraged Blocker and the investors.
23 I.R.C. Sec. 871(h) and 881(c). 24 The new Section 163(j) rules regarding interest deductibility must be considered carefully.
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August 2021
Foreign Investor (Non QFPF)- Multiple Leveraged Blocker Structure.
This is a variation of the Leveraged Blocker structure. In this variation, a Leveraged
Blocker is inserted into the fund structure with respect to each and every asset. Under
certain circumstances and subject to certain limitations, tax may not be payable by the
foreign investor on proceeds from a sale of an underlying asset if done in connection with
an ultimate liquidating distribution of the Leveraged Blocker. The Leveraged Blocker will
of course pay tax on its net income/gains to the extent not reduced by interest expense. A
liquidating distribution is generally not considered a dividend subject to withholding tax
and therefore is treated differently than dividends. A detriment of this structure is the
potential inability to offset losses of an investment made in one Leveraged Blocker against
gains made in another.
Foreign Investor (Non-QFPF) – Baby REIT Structure.
In a so-called “Baby-REIT” structure, the fund forms a Parent REIT that in turn owns all
or a substantial amount of the assets in the fund through special-purpose vehicles that are
REITs that own the individual properties. Sales of the individual properties occur through
a sale of shares of the property level REIT that owns the asset. Under FIRPTA, assuming
the applicable REIT in question is “domestically controlled” - meaning that foreign
ownership of the REIT is less than 50% during a specified testing period - then, generally
speaking, proceeds from such sale will be made free of federal income tax to the foreign
investor.25 The Parent REIT receives operating income and the REIT structure will
provide applicable tax benefits in respect of that income. Because the tax benefits are
significant, many foreign investors (other than QFPFs, which have been afforded alternate
means of obtaining tax efficiency) find the appeal of Baby-REIT structures quite strong.
A limitation of this structure is its practicality in a PERE Fund with many assets and
perhaps multiple asset level operating partners who may or may not wish to operate the
individual assets in a REIT structure or to limit the exit of the investment to a sale of REIT
shares. There is also the cost and complexity of operating this many REITs in a single
structure.26 Given these limitations, Baby-REIT structures are often employed in joint
venture arrangements as distinct from traditional PERE Fund structures or in PERE Funds
where the sponsor seeks out a large U.S. co-investor to take 51% of every deal on a deal-
by-deal basis with the PERE Fund investing the remaining 49%.
V. Conclusion
PERE Funds provide capital and liquidity to U.S. real estate markets and offer institutional
investors across the globe a means of achieving exposure to this important asset class.
25 If the Baby REIT is indirectly less than 50% owned by vote or value by a Section 892 Investor, and such Baby REIT is not
otherwise effectively controlled by the Section 892 Investor, similar results should obtain for such an investor even if the REIT is not domestically controlled.
26 In addition, sales of REIT equity in order to obtain the benefits of a domestically controlled REIT can require robust tax
indemnities and/or tax insurance to be obtained.
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August 2021
However, investment in U.S. real estate is often subject to special tax treatment under
FIRPTA, the REIT compliance regime, UBTI considerations and other important
requirements whose impact may vary from investor to investor. Harmonizing these
interests into a coherent and workable fund structure is the product of significant effort
supported by appropriate expertise.
ACREL News & Notes August 2021
P3 Projects: P3 Risks and Responsibilities
Wm. Cary Wright1, Carlton Fields, Tampa, FL
Public-Private Partnerships, generally referred to as “P3s,” are becoming increasingly more
common in the United States as the demand to update and provide new public infrastructure
facilities becomes overwhelming.1 Simplified, P3s are “contractual agreements between a public
agency and a private entity that allow for greater private participation in the delivery of projects.”2
However, P3s can be very complex and come in many different forms. P3s range from the
design-build method that transfers typical design and construction risks to the turnkey method
where there is a complete risk transfer.3 The in-between forms include “a variety of project delivery
approaches that add options by which public and private participants may tailor their respective
interest in sharing project risks and responsibilities across the entire scope of project services for
ownership design, construction, financing, operation and maintenance of the work.”4
The use of P3s spans across a range of infrastructure projects, including, but not limited to,
transportation, courthouses, prisons, water infrastructure, recreation, education, and hospitals.
Currently, the United States has relatively limited experience; nonetheless, interest continues to
grow at both the state and federal levels, as more legislation is being drafted and lessons are being
learned from recent projects. This Article discusses the general risks and responsibilities P3
projects present to assist public owners and private entities in deciding if a P3 delivery system is
appropriate for a project.
The decision to enter into a P3 cannot be made lightly. “Public agencies have to make
important and complicated decisions to develop effective P3 programs and projects, often under
intense public scrutiny.”5 An early identification of potential projects to be delivered as P3s is
integral to long-term success in performance and economics. The main characteristics of a project
that are indicative that a P3 delivery method is suitable for the project include “opportunities for
available revenue streams, risk transfer scalability, proper statutory authority, public vs. private
cost of financing and the long-term performance strategy for asset owners.”6
Risks & Responsibilites
How risks and responsibilities are treated in a P3 project is entirely different from how
risks and responsibilities are treated in private-sector projects. Who carries the risks and
responsibilities on the P3 project should be very clearly established in a P3 contract; this precludes
the parties from forming an agreement that is comparable to commercial “partnership,” in which
the “partners” owe fiduciary duties and share any profits, losses and liabilities of a business
venture.7 Specifically, negotiation of the P3 contract defines and restricts the P3 partnerships.
“Such a venture, although a contractual arrangement, differs from typical service contracting in
that the private-sector partner usually makes a substantial cash, at-risk, equity investment in the
project, and the public sector gains access to new revenue or service delivery capacity without
1 Wm. Cary Wright is a shareholder with Carlton Fields and chairs its Construction Practice Group. He would like to acknowledge the assistance of Monica S. Towarnicky, an associate at Carlton Fields, for her assistance in writing this article.
ACREL News & Notes August 2021
having to pay the private-sector partner.”8 This method of long-term contracting requires abundant
flexibility and trust on the part of both parties.
Not only is the treatment of risks different for P3s, but the potential risks differ from
traditional contractual relationships. These risks arise at all phases of the project: the development
phase, the construction phase, and the operation and maintenance phase. Risk identification is a
critical piece in the development of a P3.
Development Phase Risks
In order for a P3 to be successful, there must be strong governmental support.
Governmental support for P3s is often challenged by the political will of public officers and the
general public.9 “Manifestations of political risk include the outright cancellation of projects by
the public agency, the inability to reach an agreement between the public and private partners on
the project structure, and the failure to appropriate funds necessary for the proposed project.”10 As
with a lot of ventures in the government, public officers need to please their constituents. The
novelty of P3s can cause apprehension by the public, which in turn puts pressure on public officers
to avoid being in favor of the potential P3 project.11 The public can be uneasy about the private
sector, the implementation of new tolls, and the employment prospects and/or losses. This
apprehension can be eased by enhancing transparency and providing straightforward, simplistic
content to educate the public.12
To attract private entities to public P3 projects there needs to be a sufficient regulatory
framework. The long-term nature of P3s calls for clarity and flexibility in regulations to satisfy the
private entities, while also providing protection for the public.13 “Desirable provisions in P3
legislation include a requirement for clear procurement guidelines and decision criteria, flexible
project eligibility criteria, . . . the ability to revise toll rates [for transportation projects] over the
project’s life . . . limitations on leasing, [and] limitations on use of financing instruments. . . .”14
It is important to establish a framework for permitting. The responsibilities of permitting
can be given solely to the public agency or the private entity or it can be a shared responsibility. If
not clearly allocated or if governmental red-tape is not cleared for private entities, then a P3 project
can suffer significant delays.15
Complications can arise with procurement on P3 projects. There can be misunderstandings
on whether the P3 project is free from the constraints of federal and state procurement law, since
procurement laws usually apply when a project is government funded. Besides unclear legislation
regarding this issue, “procurement issues can arise from a lack of clarity in response requirements,
excessive financial commitment requirements, insufficient protection of design and proprietary
information, or a lack of transparency in the selection criteria.”16 Courts have interpreted P3
procurement by looking at whether the infrastructure was constructed for a public purpose and
with public funds.17
Construction Phase Risks
ACREL News & Notes August 2021
During the construction phase, the potential risks include design risk, construction cost
risk, including market risk, and latent defect risk. If not sufficiently negotiated and discussed at
the outset, the cost overruns, relief events and delays can become unnecessarily numerous.
Generally, the design risk falls to private entities in P3 projects. Constructability,
completeness and coordination of design and design documents can be allocated to an architect or
engineer, or shared across the private entities.18 The negative effects resulting from flawed design
work creates a myriad of issues, including delays and cost overruns, as well as safety issues in the
present and in the long-term.19
The long-term nature of P3s increases the construction cost risk, especially since there is
such a broad spectrum of items affecting construction costs — labor costs, delays, cost of
performance bonds, and material costs. At the core of P3 projects is the transfer of this highly
sensitive risk area to the private entities.20 “Construction costs are estimated during the design
phase and can be locked in through lump-sum turnkey contracts . . . which allow for fixed costs
and penalties in case of completion delays.”21 At the outset, the public agency should “produce as
clear and concise a set of output specifications as possible” to allow the project to be precisely
priced.22 Fluctuations in macroeconomic conditions may cause distress to material costs, labor
costs, and inflation rates.23 To protect from this, private entities should include inflation rate
considerations in the final bid. In contrast, public entities may chose a fixed priced contract.24
Latent defects are another risk that differs when entering into a P3. Given the length of P3
contracts, the responsibility for latent defects is more easily contracted for beyond the standard
statutory limitation period. Major defects that appear years after construction is complete may be
allocated as the responsibility of the private entity who may be responsible to operate and maintain
the completed project for forty to fifty years before it is returned to the public owner.25 This must
be taken into consideration as an incentive, not only when negotiating the contract, but also while
performing the work.
Operational and Maintenance Phase Risks
The major difference in risk allocation for P3s is found in the operational and maintenance
phase. “The operational knowledge and the need to maintain a cooperative relationship [between
the public agency and private entity] for the life of the contract” is unique.26 Once a private entity
becomes responsible for the operation and maintenance of the project for years after completion,
new and unfamiliar risks arise. The same amount of focus should be put on the operational and
maintenance phase that was put on the development and construction phases.
The first, and maybe most obvious, risk in this phase is the actual operation and
maintenance of the project. Risks here stem either from actual physical issues or the increase in
costs to operate and maintain. Properly forecasting increases in costs at the time of project
development is crucial.27 However, financial losses often occur because anticipation of cost
increase is not always accurate.28 Additionally, if not properly maintained, the project condition
can deteriorate leading to more expensive maintenance down the road.29
ACREL News & Notes August 2021
Traffic and tolls are also a post-construction risk private entities are not familiar with when
it comes to transportation P3 projects, which arise in P3s that provide the private entities with the
ability to manage toll services.30 “Traffic risk . . . refers to the risk that over the life of a project
actual traffic levels do not reach projected levels.”31 If traffic levels are low, the project’s cash
flows will be negatively impacted making the private entities unable to repay the debt and generate
profits.32 An increase in toll rates can also present problems as the public’s lack of information as
to where the money is going and why a toll is necessary can cause resistance.33 This type of public
resistance can lead to political opposition that can change the nature of the contract if public
officers yield to the constituents by removing any toll clause in the contract.34 For instance, a
project in California that was initially to be built as a toll-revenue P3 “faced strong public
opposition against tolls,” causing the contract to change “to availability payments because of
strong local political opposition . . . that killed the toll element.” 35
Another major risk is found in insurance coverage. “Before a contractor expands its role in
what would otherwise be a public project, the contractor should carefully identify any potentially
costly gaps in its insurance coverage.”36 The need for professional service liability insurance may
arise, when previously the private entity only needed CGL coverage.
The period of handback becomes a major risk for both private entities and public agencies.
There is always a possibility that the project was not properly maintained during the operation and
maintenance period, and the condition of the project is less than anticipated or contracted for.37
Including incentives in the contract and clearly specifying expectations can “encourage the private
partner to make the investments necessary to handback the facility to the public agency in suitable
condition.”38
Conclusion
As federal and state agencies become more comfortable and eager to use P3s, private
entities need to come prepared and knowledgeable. This Article provides just a general overview
of the risks and responsibilities each party may experience at the development, construction, and
operation and maintenance phases of the project life cycle. Understanding that the risks and
responsibilities of a P3 project are treated differently is a first step for both public agencies and
private entities. Learning and examining the unique risks and responsibilities will put each party
in a better position for a successful project.
1 NCSL P3 State Legislative Update: 2016-2018, NAT’L CONF. OF STATE LEGISLATURES (June 18, 2019), https://www.ncsl.org/research/transportation/ncsl-p3-update.aspx. 2 Build Am. Bureau, Public-Private Partnerships (P3), U.S. DEP’T OF TRANSP., https://www.transportation.gov/buildamerica/project-development/public-private-partnerships-p3/public-private-partnerships-p3 (Feb. 28, 2018). 3 PHILIP L. BRUNER & PATRICK J. O’CONNOR, JR., BRUNER AND O'CONNOR ON CONSTRUCTION LAW § 2:18 (2020). 4 Id. 5 FEDERAL HIGHWAY ADMINISTRATION, ESTABLISHING A PUBLIC-PRIVATE PARTNERSHIP PROGRAM: A PRIMER 5-1 (2012).
ACREL News & Notes August 2021
6 Building-Up: How States Utilize Public-Private Partnerships for Social & Vertical Infrastructure, NAT’L
CONF. OF STATE LEGISLATURES (Feb. 16, 2017), https://www.ncsl.org/research/transportation/building-up-how-states-utilize-public-private-partnerships-for-public-multi-sector-vertical-infrastructure.aspx. 7 See LaSalle Partners v. United States, 48 Fed. Cl. 797, 810-11 (Fed. Cl. 2001) (finding “no doubt that the agreement between [the private party] and the government never rose to the level of a legally-binding commercial partnership in which each side owes a fiduciary responsibility to the other”). 8 Id. at 810 (emphasis removed). 9 FEDERAL HIGHWAY ADMINISTRATION, RISK ASSESSMENT FOR PUBLIC-PRIVATE PARTNERSHIPS: A PRIMER 3-1 (2012). 10 Id. 11 See M. Julie Kim, Understanding and Mitigating Political Risks of Public-Private Partnerships in U.S. Infrastructure 54 (Jan. 2014), https://www.researchgate.net/publication/272242308. 12 See Id. at 10. 13 See FEDERAL HIGHWAY ADMINISTRATION, supra note 9, at 3-2. 14 Id. at 3-3. 15 See Id. 16 Id. at 3-4. 17 See Associated Subcontractors of Mass., Inc. v. Univ. of Mass. Bldg. Auth., 810 N.E.2d 1214, 1221 (Mass. 2004); Achen-Gardener, Inc. v. Superior Court, 809 P.2d 961, 967 (Ariz. Ct. App. 1990), vacated on other grounds, 839 P.2d 1093 (Ariz. 1992); Decker v. Kan. Dep't of Soc. Rehab. Servs., 942 P.2d 667, 669 (Kan. Ct. App. 1997). 18 See TIMOTHY J. MURPHY, STRUCTURING AND MANAGING CONSTRUCTION RISKS IN PUBLIC PRIVATE
PARTNERSHIPS 15 (2020). 19 See Id. at 15-16; FEDERAL HIGHWAY ADMINISTRATION, supra note 9, at 3-6. 20 See MURPHY, supra note 18, at 8. 21 FEDERAL HIGHWAY ADMINISTRATION, supra note 9, at 3-6. 22 MURPHY, supra note 18, at 10. 23 See FEDERAL HIGHWAY ADMINISTRATION, supra note 9, at 3-6. 24 See FEDERAL HIGHWAY ADMINISTRATION, supra note 9, at 3-7. 25 See Id. at 3-6. 26 Kim, supra note 11, at 10 (“[T]he crux of P3 contract management is in the operations phase.”). 27 See FEDERAL HIGHWAY ADMINISTRATION, supra note 9, at 3-8. 28 See Id. 29 See Id. 30 Id. at 3-7. 31 Id. 32 Id. 33 Kim, supra note 11, at 54. 34 Id. 35 Id. at 53 (“With availability payment-based concession, the public agency retains the traffic risk by making payments directly to the private sector partner based on the availability of the facility rather than on the number of vehicles.”). 36 P3 Considerations for Contractors, AGC, https://www.agc.org/p3-considerations-contractors (last visited June 23, 2021). 37 See FEDERAL HIGHWAY ADMINISTRATION, supra note 9, at 3-9. 38 Id.
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