Real Estate Appraised Valuations vs. Fair Market Value

I’m a subscriber to Zillow.com, which, according to its website, is a home valuation site that provides an estimate of a home’s market value. According to Zillow, the “Zestimate” of my home increased 1.1% in January while according to the Zestimate I received last week, the value decreased by 0.5%. Since I have no present intention of selling my home, I find these fluctuations to be more interesting for their entertainment value than anything else.

According to Zillow.com, it differentiates its Zestimates from appraisals because Zestimates are computed using a proprietary formula. Real estate appraisals on the other hand are performed by qualified professionals, often – although not always – by an appraiser who is a Member of the Appraisal Institute (“MAI”), which means the appraiser has fulfilled specific educational and experience requirements and passed an examination. (See, http://www.appraisalinstitute.org.)

Are real estate appraised valuations the equivalent of the fair market value (“FMV”) of real estate?

Maybe, but not necessarily.

In one variation or another, FMV is defined as the price at which a bona fide knowledgeable, willing seller under no pressure to sell will sell a real estate asset and the price a bona fide knowledgeable, willing buyer under no pressure to buy will pay for that asset.

The appraised value of real estate is basically the opinion of the appraiser and can take one of several forms, including:

The “cost value” approach, which is the aggregate of the land value and the depreciated value of any existing improvements.

The “sales comparison” approach, which is predicated on the recent sales value of similarly situated comparable properties.

If the property is commercial, retail or industrial, the “income capitalization” approach may be the basis for an appraisal, which capitalizes the income stream to be generated by a particular property and bases the value of the property on the “cap rate.”

So, for example, a cost value may, at any particular point in time, be significantly higher than a prudent buyer would pay for a property. Similarly, the cost value may be significantly lower than the price a prudent buyer would pay, thus leading to an enviable “bidding war” among competing buyers, one of whom will end up paying more than the asking price for the property.

So, why is my Zestimate up one quarter and down the next? Apparently, because of fluctuations in the recent sales prices of “comparable” homes in my neighborhood. Of course, I think my home is incomparable – but that would lead me into a discussion of “intrinsic” value, which is a different proverbial kettle of fish.

As a pretty clear demonstration that value is in the eye of the beholder, a recent Zillow.com value for my home was 15% greater than the MAI appraised value conducted in connection with a mortgage refinance at the same time. Apparently, the value of my home is worth 15% less for loan security purposes than it is for sales purposes. Presumably, the MAI appraiser conducting the appraisal for my prospective lender knew the purpose of the appraisal and chose to be conservative. Thus the often-heard sobriquet, “Made As Instructed”!

Who Owns Copyright in Source Code in Technology Start Up Company?

Start-up ventures, especially in the area of technology, often begin based on nothing more than good faith assumptions of the founders. Frequently they operate informally without understanding the need to document the relationships among the venture, its principals and its employees. More often than not avoidable disputes ensue, creating needless expense, arguments and sometimes the split-up of the founders or the loss of key employees leading to the dissolution of the venture.

JustMed, Inc. v. Michael Byce, a case decided by the U.S. 9th Circuit Court of Appeals earlier this month, involved a dispute between the founders of the venture about the ownership of the copyright in computer source code. This case is a classic illustration of what not to do; these facts are often present in startup companies (not only the IT field), namely the absence of written agreements and formal employment procedures.

Former brothers-in-law, Joel Just and Michael Byce, patented a device to help those whose larynxes have been removed. Together they formed JustMed for the manufacture and development of the necessary hardware and software. Byce was a shareholder and served on the Board of Directors. He took over the development of the software from a company employee, and basically rewrote the source code. JustMed had no employment agreement with Byce; he created the source code at home; worked his own hours; and his pay was in company stock.

Byce was anxious that he would not receive his fair share should there be a buy-out or merger of the company. So, to protect what he considered his intellectual property, he deleted the source code from the company’s computers.

The expected lawsuit followed. From JustMed’s point of view, it owned the copyright in the software on the theory that Byce was its employee and, therefore, the source code was a “work made for hire.” Byce countered, arguing that he was an independent contractor and, therefore, owned the copyright in the work.

In deciding whether an employer/employee relationship existed, the Court examined several factors to determine to what extent JustMed controlled the manner and means of the creation of the source code. Typically in employee vs. independent contractor disputes, factors such as whether an employment agreement exists; whether taxes are withheld and social security paid; to what extent the employer controls the creation of the work product; and what level of skill is required in the work, are examined to see which side proves stronger.

Here, despite that JustMed operated informally as to Byce’s compensation, namely, by the issuance of stock; did not exert control over the manner and means of the creation of the source code; and was lax in its tax and withholding procedures, the Court nevertheless concluded that Byce was an employee, making the source code a work made for hire, which meant that JustMed owned the copyright in it.

In other circumstances, such informal employment practices could be seen to favor an independent contractor interpretation. Here, because of the start-up nature of the technology enterprise, the Court relied on other factors (such as that a software developer is expected to be inventive and work independently, that the project was central to JustMed’s business and that Byce performed other tasks for JustMed) to buttress its conclusion that he functioned as an employee.

Regardless of whether one considers the outcome fair in this case, had some of the variables changed slightly, it is unclear whether another court would give similar leeway to a technology company faced with a challenge to its copyright ownership in its software. But why take the risk? Had JustMed documented its relationship with Byce and specified who owned the copyright, it could have avoided the expense, disruption and animus that both sides experienced.

Commercial Photographer Dilemmas in Protecting Copyright in Photographs

A case recently decided by the US Eleventh Circuit Court of Appeals offers commercial photographers a primer on what to do and what not to do in order to protect their copyright interests in their photographs. While the case involved some well known players—Kawasaki Motors and Roaring Toyz—and the unveiling of the ZX-14 sports motorcycle at the Daytona Bike Week in 2006, it took four years for the 11th Circuit to rule on the copyright claims of a photographer, and not all of the issues have yet been resolved.

The basic facts were that Kawaskai wanted to focus on the customization potential of its new motorcycle. It hired Toyz to customize some ZX-14 motorcycles to display at Daytona. As part of its customization efforts, Toyz hired an independent contractor, Ryan Hathaway, to apply custom paint and graphics to the vehicles. Toyz also hired Todd Latimer, a motorcycle photographer known for his unique and artistic style, to photograph the two customized ZX-14s.

The dispute arose over whether Kawasaki and Toyz used Latimer’s photographs in ways beyond those he claimed to have authorized. In response to Latimer’s claim of copyright infringement, the defendants raised significant arguments that he had to rebut. By examining some of these defensive arguments, you can learn from Latimer’s miscues.

Latimer’s first mistake was not having a written agreement that clearly stated what uses of his works he was permitting. Not taking the time to consider and memorialize, even if by an e-mail, what uses are permitted, subjected Latimer to the task of proving a negative, namely, that he did not authorize the use about which he then complained.

Ironically, Latimer had to overcome the argument that because his photographs were shot without Hathaway’s permission, he infringed on Hathaway’s copyright in the graphic art appearing on the motorcycles. Therefore, Latimer’s second mistake was not recognizing that what he was photographing contained separate copyright --protected material, thereby exposing himself to the claim that his photographs were not protected by copyright because they infringed Hathaway’s work. Only because the Court concluded that Hathaway had granted an implied license to have his work on the customized ZX-14s photographed was Latimer able to remain in the game. However, in accordance with the well-settled legal principle that “What is good for the goose is good for the gander,” Kawasaki and Toyz argued that their uses of the photographs came within an implied license from Latimer.

At this point it is useful to discuss how a court will determine the existence of an implied license. Basically, an implied license can be inferred from the conduct of the parties. The objective facts of a photographer creating a work at the request of another, delivering that work and intending that the person will copy and distribute the work, (i.e., knowing how the client intends to use the work), show the existence of an implied license. Once an implied license is established, it will be interpreted broadly unless there is proof that at the time of the work’s delivery, the photographer placed limitations on its use.

Latimer’s third mistake was not recognizing that his actions could be viewed as his grant of an implied license to use his photographs. In this case, the Court concluded that Latimer’s conduct resulted in an implied license. The unanswered question was whether any of Kawasaki’s uses exceeded the scope of the license.

Latimer’s fourth mistake was not having any clear proof when he delivered his work product (the photographs), that he intended to limit the scope of their use. This absence of proof of his intent resulted in the case being returned to the trial court to examine the facts on that issue.

The lesson from all of this is that commercial photographers can avoid Mr. Latimer’s problems by taking relatively simple steps to protect the use of their work.

The Virtues of Joint Venturing

Small businesses face multiple hurdles new and old, from identifying lucrative contact opportunities to determining how best to use limited resources to penetrate new markets. In this post, I will extol the virtues of joint venturing or teaming with equals or larger companies to gain a competitive advantage and multiply earning potential.

As a lawyer, I see companies, particularly closely held businesses, grapple with subcontracting agreements and similar contractual arrangements in which they have little leverage to shape the final terms. The scenario usually involves me reviewing a subcontract with terms such as: “the subcontractor shall not be paid unless and until the owner approves of all work performed …” and “in the event that the owner does not pay the prime for any reason, the prime shall have no obligation to pay the subcontractor.” Another favorite: “as a condition precedent to final payment, the subcontractor shall execute and deliver to the prime a release of all claims against the prime and the owner arising under or by virtue of this agreement.” I promptly revise the most offensive terms, the other party or their counsel objects citing their reasons, and in the end the parties have a finished product that reflects their unequal bargaining positions.

Joint venturing, which is simply forming a strategic alliance with one or more other businesses, could be a powerful weapon for these businesses and a more advantageous alternative to the traditional subcontracting arrangement. In the case of a small business teaming with another small business, the advantages are evident:
(1) each company maintains their autonomy (making teaming a superior alternative to mergers);
(2) the companies collaborate to compete for business they could not otherwise hope to win on their own; and
(3) most importantly, they equitably split the rewards of their labor.

Incidentally, government contracting officials and others with a vested interest in small businesses winning their fair share of contracting opportunities often report that small businesses would be much better positioned to win and successfully perform contracts if they simply joined forces with one another. What’s more, the value and potential of both companies suddenly expand manifold.

The big guys are adept at this. In a recent issue of Business Week, for example, an article about Thermax, Ltd., an Indian power equipment maker, noted the company’s market value rose to its highest in seven weeks after it merely announced a joint venture with Houston-based Babcock & Wilcox Power Generation Group, Inc. The deal is expected to add $30 billion to Thermax’s sales by March 2015. Its CEO was quoted as saying: “We no longer need to be a part of any consortium to bid for projects. We will be able to compete with bigger rivals now.”

Joint ventures are in, and if you're not utilizing this powerful tool, chances are your competition is, or will soon be. The trick is knowing when it makes sense to collaborate with your peers on a project. First, consider whether a prospective joint venture partner has an accommodating culture with compatible broader business strategies. Second, don’t overlook the importance of having a carefully drafted legal document (the joint venture agreement) that describes what each party brings to the joint venture in detail. Finally, and more important than the process itself, is the execution of the joint venture—start with a full-fledged joint business plan, including (very important) an exit strategy.

Business Financing & the Bursting of the Commercial Real Estate Bubble

A few weeks ago, I wrote about the economy in general and the commercial real estate market in particular.

Last week, The Washington Post had an article suggesting that the other shoe is about to drop when it comes to commercial real estate. The article makes for sober reading, suggesting that the commercial market is a bubble that is about to burst (although, unlike home foreclosures, it is likely that few, if any, commercial and retail tenants will find themselves out on the street because of a foreclosure).

A spate of commercial foreclosures is something we have seen before. During the S&L crisis of the early 90s, I recall one banker telling a client of mine that his project was going to be foreclosed upon and it would just be added to the pile of other properties that the bank had already acquired in that manner. The banker did not seem particularly troubled.

Just this week, we learned that bank lending dropped 7.5% during 2009, supposedly the largest annual decline since the 1940s. Is there a corollary between the dearth of lending activity and the upcoming bubble burst? In my opinion, there is; it’s not hard to imagine how the former will cause the latter. Most businesses need to be able to borrow money in order to operate and smooth out cash flow ups and downs. Debt is not necessarily an evil to be avoided and, in fact, if used wisely, is a good cash management tool. When a business needs new expensive equipment, why should it pay the full price up front when debt will allow it to amortize the cost over the effective life of the equipment? And in today’s economic climate, where customers age their receivables as long as possible, a business may need to dip into its operating line of credit to meet those obligations which cannot be aged – payroll, for example.

When banks stop lending, businesses find it hard to operate – let alone grow. And for a business that is marginally profitable, or for a business that is currently in an economic trough, the unavailability of credit can make it impossible for the business to continue. A business can, of course, ask its landlord for rent relief, but a too-understanding landlord may suddenly find itself unable to generate enough rent revenues to meet its debt service obligations or find that, even with rent relief, its business tenant cannot long survive; this, obviously, impairs the landlord’s rent revenues and its ability to meet debt service obligations. So, it is not hard to draw a straight line from the lack of business financing to the bursting of the commercial real estate bubble.

Back in 1990, I started a law firm with two colleagues. During our first year our revenues were, as one might expect for a start-up, acceptable, but not spectacular; nevertheless, we all did quite well economically because we offset the low revenue stream with a close eye on operating costs; what we didn’t make in revenues we enjoyed in savings.

While I don’t want to suggest that the road to survival is layoffs, there are many areas of discretionary spending that can be reduced if not eliminated. How many businesses have a budget that is continuously reviewed and updated? My guess is that there are very few that do. Contrary to popular sentiment, I think it’s currently prudent to sweat the small stuff.

Best Wishes for a Happy and Prosperous 2010

It’s been some time since I’ve blogged, what with the Thanksgiving, Christmas and New Year holidays, but I suspect I’m not alone in breathing a sigh of relief that 2009 is past. (Of course, I hope that this time next year, we’re not looking back on 2009 as the “Good Old Days.”)

When people ask how Press, Potter & Dozier fared in 2009, my stock response is “We made a larger profit than GM and Chrysler combined.” Of course, that’s not necessarily saying much.

If you had asked me last October if I thought the commercial real estate market was showing signs of life, based on the sudden spike in first generation lease activity that kept me busy, I would have said “Yes.” But things slowed considerably in November and December and January has been somewhat of a roller coaster.

I’ve seen small spurts of activity, mostly with the renewals of existing leases, but nothing of long-term significance to suggest to me that the end of the downturn is in sight. As long as businesses tread water or, worse, contract, there does not seem to be any reason for the commercial real estate market to show any vibrancy.

And until consumers – which, in reality, are all of us – start to regain confidence and begin spending, there will be little reason for businesses to expand by increasing production or adding employees. In that sense, I suppose Pogo (the classic Walt Kelly comic strip character) was right when he said “We have met the enemy and he is us.”

I invite you all to return here regularly to see what my colleagues and I think is of interest to the real estate, general business and ADR and environmental law communities and, of course, I really, really, really mean it this time when I wish each of you a Happy and Prosperous 2010.

Intro to Lease Causes: For the Landlord and the Tenant

In my last two posts, I discussed commercial lease clauses that should be included from the perspective of a landlord or that of a tenant. This week I want to discuss lease clauses that are of mutual benefit to both the landlord and tenant. I’ll also answer last week’s puzzler question.

First, to lease issues. When a landlord is going to be providing extensive leasehold improvements, in addition to a clear mutual understanding of the scope and cost responsibility for the improvements, there should be a clear change-order procedure. Almost every construction job brings with it the attendant “while you’re at it” changes, as well as changes that only become apparent once actual construction is underway.

Without clear understanding of how to document those changes and the costs, both parties are asking for post-execution confusion and disagreement. A clear procedure for documenting changes should be included as part of the lease documentation.

In any lease having a term of five or more years, it is likely that sometime during the term of the lease the tenant is going to want to make decorating changes.
So long as these changes are non-structural and not visible from outside the premises, the landlord should be willing to let the tenant make them without the landlord’s consent so long as the tenant understands that, at the end of the term, the landlord has the right to require the tenant to restore the premises to their original condition, ordinary wear and tear excluded.

Any other type of change or alteration should be subject to the landlord’s prior consent, but that consent should be subject to a “not to be unreasonably withheld, conditioned or delayed’ standard.

If the premises are served by an HVAC system located within the premises, the lease should be clear on the maintenance responsibility. It is fair and reasonable for a landlord to require the tenant to purchase a service contract with a contractor acceptable to the landlord and to be responsible for minor, ordinary operating repairs but the landlord should bear the responsibility for replacing a unit if it fails during the term and for making major repairs.

Insurance requirements are important to both the landlord and tenant. In addition to the obvious need for both parties to carry adequate liability insurance, landlords have an interest in requiring their tenants to carry property insurance equal to 100% of their property in the premises.

Otherwise, the landlord and tenant could discover that, after a fire in the premises (regardless of who was at fault), the tenant no longer has sufficient financial ability to re-fixture the property, purchase inventory and the like.

One subject area that is often misunderstood is the distinction between a tenant’s “waiver of claims” and a tenant’s obligation to provide a “waiver of subrogration.” A waiver of subrogation is not a waiver of claims.

A “waiver of claims” is a lease provision in which one party to the lease waives all claims it may have against the other party for losses or damages suffered by the tenant (e.g., interruption of business due to a fire). So long as the waiving party insures against the claims being waived (e.g., property damage or business interruption) in the event of a loss, it will have recourse to its own insurance. If a party affirmatively chooses not to purchase adequate insurance, the other party should not have to bear the consequences.

A “waiver of subrogation” on the other hand requires the tenant’s insurer to agree that if, the landlord causes loss or damage to the tenant or its property or business and the tenant’s insurer compensates the tenant for such loss or damage, the tenant’s insurer will not take advantage of its legal right to be subrogated to the claims of its insured and pursue recoupment against the landlord.

One subject that causes landlords and tenants alike much angst are indemnity provisions. Both parties often mistakenly think that, absent an indemnity in their favor, they risk waiving recourse against the proposed indemnitor.

All an indemnity provides is that the indemnitor will step in upon notice from the indemnitee to defend a claim or satisfy a loss. If the indemnitor fails to act (and a clever attorney can frequently find a reason why the indemnity is inapplicable), the indemnitee typically still has the same recourse against the proposed indemnitor except that to realize upon that recourse it may have to bring a lawsuit.

Admittedly, indemnity clauses frequently go beyond the two parties to the lease and include their respective principals, partners, shareholders, directors, etc., but in most lease situations those “tag-alongs” are generally not at risk anyway.

It is always a benefit to both parties to a lease to have unambiguous provisions. Lease transactions generally result in long-term relationships and it is in everyone’s interest that the parties get along and not have needless disputes because respective rights and obligations are not clearly articulated.

Finally, as promised, the answer to last week’s puzzler, namely from whence the term “saved by the bell”? During the plague in medieval Europe, there was a rush to bury people. The problem was that some people weren’t dead; they were only in comas. Sometimes those people awoke from the coma during the funeral – or worse, after burial.

Worried that perhaps someone who appeared to be dead wasn’t, one solution was to tie one end of a string onto the "dead" person's hand and the other to a bell; if the person revived enough to pull the string and ring the bell, s/he would be unburied and would have been “saved by the bell. If a buried person pulled the string that rang the bell, s/he was a “dead ringer,” and, in some graveyards, a person was assigned to sit by the grave to listen for the bell – hence the term “graveyard shift.”