Category: Column

Short Sales

   As seen in “Our Colorado News.” Written by John Kokish.

While the real estate market in Colorado purportedly is showing signs of life, there still are thousands of homes in foreclosures and/or on the market for short sales.  Although a short sale is surrounded by complexities and mystifies homeowners who are not familiar with the process, there is no question that short sales, although not for everyone, have some substantial advantages over allowing a home to go though the foreclosure process.

Simply defined, a short sale is one in which the lender, usually a bank, is willing to extinguish a deed of trust or mortgage for an amount less than the balance due on the loan.  For example, if the balance on the loan is $200,000, and the lender is willing to cancel the note for $150,000 more or less, provided the seller finds a buyer willing to pay the reduced amount.  A lender will do this because accepting a lesser amount often is more economical than shouldering the expense of a foreclosure and then pursuing a deficiency which it almost never gets.  In addition, the amount that the lender gets from the short sale is often more than it would receive from a foreclosure, once all of the foreclosure costs, sales commissions and other expenses are subtracted from the often laborious process of selling the property.

For the struggling homeowner, a short sale has less of an impact on the homeowner’s credit score than the devastating effect of a foreclosure.  In addition, depending on the nature of the short sale and the deficiency accrued by the homeowner, the homeowner may be eligible to purchase another home in anywhere from two to four years; where it would take some seven years if the bank takes the home back through foreclosure.

The homeowner would be wise to consider a short sale before falling too far behind on his mortgage payments, since the consequence of default on the mortgage payment will sometimes outweigh the benefits of a short sale.

Unfortunately, a short sale is not necessarily an easy road to redemption, especially for the buyer.  A buyer looking to purchase a property at a bargain price may have to be somewhat flexible in order to learn if a significant price reduction will be accepted by the bank, since no short sale can occur without the lender’s approval.  This can take anywhere from a few months up to a year,.  A person who needs a home within a certain time period would be better off going in another direction.

Additionally, the Colorado Real Estate Commission requires that all short sale contracts contain a short sale addendum which allows either party to cancel the contract at any time for any reason.  This takes away the certainty that the contract will indeed close, and essentially nullifies the inspection clause of the contract since short sale lenders generally require that the property be sold “as is.”  On the other hand, a property in foreclosure is often in far worse condition than a property subject to a short sale, since the owners attempting the short sale are generally still living in the home.

One major advantage of a short sale and even a foreclosure is the recent extension of the Mortgage Forgiveness Debt Relief Act of 2007.  Before the act was passed, an individual completing a short sale may get forgiveness of the difference between the amount owed on the loan and the amount the bank is willing to take for the property. However, the bank was required to give the homeowner an IRS Form 1099, in which the Internal Revenue Service saddles the homeowner with ordinary income for the difference.  In other words, if the amount of the loan is $150,000.00, and the amount the bank accepts is $100,000.00, the homeowner would end up paying income tax on $50,000.  Under the Mortgage Forgiveness Debt Relief Act, that debt forgiveness becomes tax free, provided the home is the seller’s primary residence.  While the act was scheduled to expire on December 31, 2012, the “fiscal cliff” compromise reached by Congress extended through January 1, 2014, the tax free aspect of the debt forgiveness.  The Act also covers deficiencies created by foreclosure.

Because there are so many twists to a short sale, it is strongly recommended that a homeowner considering a short sale, either as buyer or seller, utilize the services of a competent real estate broker or real estate attorney knowledgeable in the short sale market.

Security Deposit

As seen in “Our Colorado News.” Written by John Kokish.

 If you either are or have been a landlord or tenant, you undoubtedly have heard of Colorado’s treble damage statute pertaining to security deposits.

Knowing that the statute exists is not enough.  It is important to understand how it really works.  The purpose of a security deposit is to provide the landlord with a financial resource in the event of a default by the tenant or for damages done by the tenant to the property.  However, the money, although held by the landlord, still belongs to the tenant.

Colorado law requires that at the end of one month after the termination of a lease or surrender of the premises, whichever occurs last, the landlord must either return the full amount of the security deposit to the tenant or provide the tenant with a written accounting of the damages incurred and how that portion of the security deposit is to be withheld and applied by the landlord to repair damages.  This is true, whether there is a written lease or not.  The landlord may, in a written lease, extend the one month time period to no more than sixty days from the lease termination or surrender of the premises.

If the landlord fails to either return the full amount of the security deposit or does not provide the written accounting required by the statute, together with the check for the remainder of the security deposit, the landlord forfeits all of his rights to recover any part of the security deposit.  The landlord then also becomes potentially liable for treble the amount of the security deposit, plus attorney fees and court costs, in the event that suit is brought against him.  However, in order for the tenant to recover treble damages, attorney fees and court costs, he must send a written notice to the landlord providing him with a seven day notice that a suit will be brought in the event that the full amount of the security deposit is not returned.  It is then too late for the landlord to get a second bite of the apple and refund only that portion of the security deposit after damages are deducted.  The landlord must return the full amount of the security deposit since he has forfeited all of it in failing to comply with the original one month or 60 day deadline called for by the statute, under C.R.S. 38-12-103.  Too often landlords think that they can provide a list of damages within the seven day notice period and return only that portion of the security deposit that they feel the tenant is entitled to because of the damages incurred.  However, the landlord has missed the boat and is now responsible for the full amount of the deposit despite any damages that may have been done to the premises.

If the case is brought to court, the landlord will be stuck with treble damages, attorney fees and court costs, but may be allowed an offset for the damages incurred.  If he fails to request that offset, he might have to bring a separate court action only on damages incurred to the premises, but in both cases, he will still be stuck with treble damages, attorney fees and court costs, all of which will make his oversight, even if  an offset is allowed, a losing proposition.

It is probably a good idea for a landlord to include in his lease a 60 day time period within which to return the security deposit in order to give him sufficient time to assess the amount of damages, if any, that were incurred.  It is also important to note that the landlord may retain the security deposit in full for non-payment of rent, abandonment of the premises, non-payment of utility charges, repair work or cleaning contracted for by the tenant.  He may not retain any portion of the security deposit for normal wear and tear.

Knowing how the statute works is essential to understanding your rights, whether you are a landlord or tenant.

Priority of Liens

As seen in “Our Colorado News.” Written by John Kokish.

Why and when should you know about the priority of liens on Colorado real estate? Some reasons may surprise you but you really need to know if you are:

  • buying a house out of foreclosure;
  • obtaining a judgment against a debtor;
  • dealing with a worker who has added something to your home but, for whatever reason, has not been paid;
  • looking to foreclose on a second mortgage (or deed of trust) on a rental property that you own.

A lien is an encumbrance on a property. Colorado law provides that liens are prioritized in a certain order to determine payment rights and the foreclosure process.  There are numerous ramifications on how various liens play out.  Many of them are tricky, but you should know the basics, although you might eventually need the assistance of competent counsel.

One basic tenet is that real estate taxes have priority over all other liens.  If unpaid, they are the first lien and can’t be extinguished by other liens.  Second in line is the so-called super priority lien (“super lien”) created by the Colorado Common Interest Ownership Act (“CCIOA”) that was enacted by the Colorado legislature to allow homeowners’ associations to recover at least some back assessments when a homeowner defaults.  The super lien, however, is limited to an amount equal to the monthly assessments that would have become due during the six months immediately preceding either a foreclosure by the association or the holder of the first deed of trust (which may not be a first lien.)

A deed of trust or mortgage is actually third in line, behind the real estate tax lien and the super lien.  Fourth in line is the association lien or assessment of charges above and beyond those assessed for the six months preceding the initiation of the foreclosure.  In other words, if the homeowner owes 10 months in back assessments, six months falls into the super lien in second position and the remaining four months fall into fourth position.

Next are second mortgages which fall to fifth position if the community is subject to CCIOA and a super lien. Finally, the sixth position, seventh and so on are any third mortgages, mechanics’ liens, judgments and other encumbrances against the property.

A mechanics’ lien, or a lien for unpaid work on the house, actually trumps all liens except the real estate tax lien, the super lien, and the first mortgage lien, and can even take priority over the first mortgage lien if the work was started before the first mortgage was filed.  This exception provides protection for the worker who improved the property who can then foreclose without having to deal with the first mortgage or deed of trust.

Recently, the super lien has created some nightmarish situations.  An unscrupulous group of investors  has been purchasing lien assignments from homeowners’ associations when they learn that a property is in financial trouble.  This group then lays back, waits for the bank to foreclose on its  first deed of trust and then swoops in after the foreclosure is complete to either collect the amount of the super lien, or worse yet, initiates a judicial foreclosure to try to steal the property from the  unsuspecting bank or the new property owner.  This has caused expensive litigation.

There are countless other issues involving lien priorities.  When in doubt as to how these lien priorities work, consult a competent real estate attorney to assist you before you even think about fighting that battle on your own.

Mechanic’s Liens

As seen in “Our Colorado News.” Written by John Kokish.

So you want to build a redwood deck on the back of your home?  You contact Joe Contractor and he agrees to build it for $15,000.00.  You pay him $5,000.00 down, make progress payments to him and pay the remaining amount at the time the project is finished.  You love your deck.

Two weeks later, you receive a notice from ABC Lumber Company.  Joe Contractor did not bother paying for the 2x4s and other lumber which he used to build your deck, and the supplier now wants his $10,000.00 for the lumber.  The supplier is threatening to place a mechanic’s lien on your property unless he is paid.

A mechanic’s lien is a tool used by contractors, workers and suppliers for payment for work that has been done on your property which improves it.  You are obviously upset because you paid the full amount to Joe Contractor, and expected him to pay his supplier, only he did not.

Well, Colorado law has protected you.  In residential properties, as long as the contractor is paid, any lien placed upon your property by a subcontractor or supplier is invalid and any suit brought on that lien will be dismissed.  Still, it is a nuisance and could take  up to a year for a title company to remove the lien from your property.

If you own a commercial property, the Colorado statute discussed above does not apply.  However, commercial landowners are also protected thanks to the so-called “trust fund” statute.  That law states that any money paid to a contractor is held in trust by that contractor for the specific purpose of paying all of his subcontractors and suppliers for that particular job.  If he uses the money for other purposes, he commits theft and could face criminal charges.  A letter to the non-paying contractor pointing out that he is in violation of the trust fund statute usually brings results.

Another glitch in the mechanic’s lien process is when you are the property owner, and your tenant tries to make improvements without your permission, leaving you holding the bag for the $15,000.00 redwood deck.  In such cases, in order to avoid a lien on your property, you must post a notice of non-liability on the site of the property in a conspicuous place within five days after you have learned what your tenant has done and the work has started.

Weigh Advantages, Disadvantages When Choosing Form of Business

As seen in “Our Colorado News.” Written by John Kokish.

So why are you running your business as a sole proprietorship?  Why don’t you incorporate?  How about an LLC, but what is that anyway?  Maybe you need a partner.

When operating a small to medium size business, making an intelligent choice of what form of entity you want can make a huge difference in the ease or difficulty of how you run the business.  Each of the four basic forms of business has advantages and disadvantages, but trying to determine which is best for your business can be a daunting challenge.  The four basic forms of business are the sole proprietorship, partnership, corporation and limited liability company. (LLC)

If your business is small and uncomplicated, a sole proprietorship might, in fact, work for you.  The bookkeeping is simple, tax filing is uncomplicated and the operation of the business is probably straight forward.  But there is one basic problem with a sole proprietorship, and that is that your personal assets are always at risk.  If your company goes heavily into debt, a creditor can come not only after your business assets but your personal assets as well.

Some folks worry about injuries happening at the business and potential lawsuits that result from them.  That is not a real concern however, since insurance can cover those.   But insurance doesn’t cover contractual debts.

A partnership has all of the disadvantages of a sole proprietorship and very few of the advantages. Many people have trouble getting along with their spouses and this can be even more pronounced when trying to get along with partners.  Not only do disputes arise, but the liability incurred by your partner can be attributed to you.  In other words, if your partner decides to purchase 10 expensive race horses without your permission, you might well be stuck with the bill if your partner then bails out on his obligation to pay for the horses.  Partners can be useful for raising money, but the same warning holds true for partnerships as it does for sole proprietorships.  Personal assets are always at risk, not only for what you have gotten into, but also what your partner has done.  If you enter into a partnership, it is important that an attorney draw up a carefully worded partnership agreement so that all of the partners’ obligations are clearly spelled out.

A corporation is form of entity that was created primarily to protect the owners’ personal assets when properly operated. There are two types of corporations- a C corporation and a Sub-Chapter S corporation, both named after the provisions of the Internal Revenue Service Code that creates them for tax purposes.  The C corporation, or traditional corporation, is the form of entity used by all public companies on the various stock exchanges.  They have the advantage of allowing unlimited participants, numerous fringe benefits, such as cafeteria plans, group life insurance, disability insurance and other benefits. Most important, the participant’s liability is limited to the amount  he/she  actually invested in the company, meaning  his/her personal assets are safe provided the company is properly run.  The biggest problem with the C corporation is double taxation; that is, if the corporation shows a profit, it will be taxed at the corporate level and then taxed to each individual participant when it is distributed.  This double taxation aspect makes it less than desirable for many small businesses.

In order to avoid double taxation, the Sub-Chapter S corporation was created.  The Sub-S corporation has many of the advantages of the C corporation, but also allows a “flow through” system of taxing profits only to the individual who actually receives the money, and carrying any losses through as well.  This can be tricky, however.  If the corporation earns money and the shareholder or shareholders do not pay themselves at the end of the fiscal year, are then taxed to the shareholders any way and a phenomenon known as “phantom income” results.  This is when you are taxed on profits not actually received.  Also, the S corporation has many limitations as to its use, which can hand-cuff the owners in their attempt to make it more flexible.

In recent times, the popularity of the limited liability company or LLC has exploded and is permitted in most states, including Colorado.  The limited liability company is essentially a hybrid or combination of the partnership and the Sub-Chapter S corporation.  It shields the owners from personal liability, but allows the flexibility of a partnership to remain.  It is probably the entity of choice for most small businesses in Colorado because of the “flow through” profits that avoid double taxation, the protective shields for the owners and the ability to allow certain freedoms that the Sub-S corporation restricts.  Shareholders in an LLC are known as “members” and the directors are known as “managers,”   but the operation of any LLC is similar to that of a Sub-S corporation.  Bookkeeping is much simpler than it is in any corporate form and single member LLCs are allowed.  Additionally, the owners have a choice of being taxed as a partnership or as a Sub-S corporation.  One caveat, however – the phantom income exercise also applies to LLCs.

Ultimately, making the choice as to what entity your business should adopt can be a complicated matter, and the assistance of an attorney or an accountant is truly helpful  to avoid putting a square peg in a round hole.  As indicated before, all of these forms of entities have advantages and disadvantages and sorting them out  may take professional advice.

Covenant Not to Compete More Complex Than It Seems

As seen in “Our Colorado News.” Written by John Kokish.

Many employers think that a covenant not to compete will solve their problems of employees who quit and set up competing businesses.  Unfortunately for those employers, it is not that simple.

  • In Colorado, the courts and the legislature frown upon covenants not to compete.  Pursuant to C.R.S. 8-2-113, covenants not to compete are presumptively void unless they meet certain exceptions.  Those exceptions are:
  • Any contract for the purchase and sale of a  business or the assets of a business;
  • Any contract for the protection of trade secrets;
  • Any contract providing for the recovery of the expense of educating and training an employee who has served as an employee for less than two years; or
  • Executive in management personnel and officers and employees who constitute professional staff to executive and management personnel.

Even if the covenant not to compete falls within one of the exceptions, it still must be “reasonable” in terms of geography and time.  Depending on the nature of the business, the courts normally will enforce a covenant not  to compete if it is for five years or less, but the radius depends on the nature of the business of the employer.  A radius reasonable for a retail business may be 10 to 20 miles, while the radius for a company that does business on a state or national scale may be 100 to 300 miles, or even the boundaries of the home state of the employer.

The reasoning behind the tough requirements  that the legislature and courts have imposed upon these covenants is that while it aids the party seeking to enforce it by preserving  its good will,  it can very well be a hardship to the party bound by it by preventing him or  her from making a living.

Therefore, the courts will often look for ways to avoid enforcement by examining what it takes to protect the goodwill of the party seeking to enforce it, and balancing this against the potential hardship to the employee.

Often an employee who leaves his position, either voluntarily or involuntarily, has experience and training in only one area and must seek employment in the area in which he is proficient.  This is why covenants relating to employees are strictly limited to executive personnel or upper management personnel and professional staff of executive and management personnel.  The courts have defined these terms narrowly.  In other words, hiring a salesman and giving him the title of sales manager, does not work.  One has to be at a much higher-level of management to be bound by these covenants.

Two cases decided by the Colorado Court of Appeals pretty much control the existing law in Colorado.

In Phoenix Electric City AL, Inc. v. Dowell, the court held that an employee who is not a manager at the time of the execution of a covenant not to compete but later became a manager was not bound by the covenant, since the time of execution controls the status pursuant to the statute.

In that case, the court also held that solicitation of customers is included in a covenant not to compete, and that if the covenant is void, so was the prohibition against soliciting customers.

However, solicitation of employees was not part of the covenant not to compete, and therefore, prohibition against soliciting of employees could be enforced against the party signing the covenant.

In another case, Reed Mill  & Lumber Company, Inc. v. Jensen, an employee of Reed Mill signed a covenant not to compete that provided when his position at Reed Mill was terminated, he would be bound not to compete with the company for three years.

Jensen, however, worked for six years before terminating his employment and then immediately began soliciting and competing with the company.  The company sued on the covenant that Jensen had signed.

The court held that the purpose of the covenant was to protect the company’s good will for three years, and that Jensen did more than that during the six years of his employment before he quit.  Therefore, the covenant which attempted to prevent him from competing for three years after his termination, in effect, was a nine year prohibition, since he executed the contract six years before he resigned.  The court held that nine years was an unreasonable time to be bound.

It is evident from both of the above cases that the Colorado courts look for ways to strike down  covenants not to compete when they prevent an individual from making a living.  The states differ in the enforcement of these covenants.  In Florida, the covenant not to compete is almost always strictly upheld.  On the other hand, in California, it is virtually impossible to enforce a covenant not to compete.  Colorado takes a middle ground, but leans toward prohibiting enforcement if it prevents an employee from making a living and, in the case of a business, prevents a new business from flourishing.

Therefore, attorneys for employers and sellers of businesses need to be very careful crafting the language of a covenant not to compete.