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Real Estate Law FLASHPOINTS May 2020

May 15, 2020Print This Post Print This Post

Michael J. Rooney | 312-401-3454 | E-mail Michael J. Rooney

Swing and a Miss: Seventh Circuit Ends Hitting Streak

Yes, it should be baseball season. Yes, our beloved Cards, Cubs, and Sox (though not necessarily in that order) should be playing baseball — perhaps bundled up against the cold and snow in the Friendly Confines, but playing baseball nonetheless. Sadly, that is not happening, and we fans are the worse for it. For those of you missing baseball, this article reviews a recent Seventh Circuit opinion in which the court broke a very favorable recent batting streak of hits concerning local real property law. It’s only one case, but it broke the string, and the fundamental “miss” on the law does not portend well for future at-bats. Read on and let us know if it’s just one strike or if it’s significant enough to retire the side.

For a while, the U.S. Court of Appeals for the Seventh Circuit had quite a streak going. As described in articles appearing in the May, October, and November 2019 editions of Real Estate FLASHPOINTS, several opinions of the court dealt with issues of Illinois or Indiana real property law and were all properly decided. In United States v. Z Investment Properties, LLC, 921 F.3d 696 (7th Cir. 2019), the court correctly held that a notice of tax lien filed against “Carrol V. Raines” was valid and enforceable against property owned by the debtor, “Carroll V. Raines,” notwithstanding the missing single letter “l” because a properly constructed title search in computerized records would have discovered (and actually did discover) the filed lien even though the search performed by the buyer failed to discover it.

In a tenancy by the entirety case, the court decided that after the death of one tenant by the entirety, a judgment rendered and recorded during the tenancy by the entirety against the surviving tenant by the entirety attached to and was enforceable against the entire property formerly held as tenants by the entirety. In re Jaffe, 932 F.3d 602 (7th Cir. 2019). The court pointed out, however, that a different result would have been required in Indiana due to the differences between the Illinois and Indiana statutes governing tenancies by the entirety. In Boucher v. United States Department of Agriculture, 934 F.3d 530 (7th Cir. 2019), finding that the USDA had acted in an arbitrary and capricious manner in determining that the removal of very few trees on a very small portion of a large farm in Indiana converted wetlands into cropland and disqualified an entire farm from various benefits, the Seventh Circuit reversed the district court and instructed it to enter judgment for the plaintiff farmer. Finally, in Fifth Third Mortgage Co. v. Kaufman, 934 F.3d 585 (7th Cir. 2019), the lender sued both an attorney and a title agency he owned for damages it suffered as a result of mortgage fraud. The lender won in the trial court, and the Seventh Circuit affirmed on appeal.

The end of the successful string of cases is Abellan v. Lavelo Property Management, LLC, 948 F.3d 820 (7th Cir. 2020), and it’s one IICLE® covered in the RESIDENTIAL REAL ESTATE: TRICKS & TRAPS program in early April 2020. It involves a New York seller of an Illinois commercial property that had been leased to an Arizona tenant and sold to a California buyer. Stunningly, the vacant, gutted former fast-food restaurant in Le Roy, Illinois, was sold for $1.55 million! But we’re getting ahead of ourselves here. Let’s go back and start at the beginning.

As with many modern commercial transactions, multiple entities are stacked on multiple entities, but their separate identities are not critical to the outcome, so let’s simplify things. The Arizona tenant bought the property in April 2013 for $321,000. At that time there was a restaurant on the site, but it was then vacant. The Arizona tenant then sold the land to the New York owner in July 2013, still vacant, for $1.1 million. The New York owner, as lessor, and the Arizona tenant, as lessee, executed a 20-year triple-net lease to commence in July 2013 for the operation of a fast-food restaurant. The New York owner said he understood that it would take 9 – 12 months to do the work necessary to “re-image” the restaurant for new operations. 948 F.3d at 828.

To the great surprise of absolutely nobody, the rehab work did not go according to schedule. Delay followed delay in 2013 and 2014. By May 2015, the Arizona tenant said it would be ready to open in 60 days (which was the exact same report it gave the New York owner in September 2014). The California buyer purchased the vacant, gutted restaurant on June 9, 2015, paying $1.55 million and receiving, in addition to a deed, an assignment of the lessor’s interest in the 20-year triple-net lease. (In case you are not familiar with where Le Roy is, take a map and follow Interstate 74 southeast from Bloomington about 15 miles or so, and there sits Le Roy.) The Arizona tenant never made a rent payment, and the entities were either dissolved or simply “ceased to exist.” 948 F.3d at 826. The California buyer ended up paying $1.55 million for a piece of commercial property assessed at $321,000 with outstanding tax bills and a nonperforming tenant. So, in the finest American tradition, the California buyer sued everyone in the United States District Court for the Central District of Illinois under diversity jurisdiction alleging mutual mistake, fraud, and breach of contract.

The California buyer won at trial against the New York owner as seller and was awarded just over $2 million in damages, and the verdict was affirmed on appeal. The Seventh Circuit opinion was thorough in reviewing all the reasons why the New York owner/seller’s appeal failed, including discussing whether the California buyer could “reasonably” rely on the New York owner/seller’s warranty that the lease was not in default at the time of purchase. 948 F.3d at 832. The Seventh Circuit opinion concluded with a ten-line paragraph applauding all involved — the judge, the lawyers, and the jury — and quoting the trial court approvingly in saying that the case was well tried by all and decided by a jury with no axe to grind after following instructions and ending: “It doesn’t get any better than that, as far as I am concerned.” 948 F.3d at 836. Personally, I’d like a second opinion.

Whatever one thinks of the concept of due diligence in connection with commercial real estate transactions, the Seventh Circuit apparently thinks very little of the concept. The California buyer testified that he and his wife wanted to buy a commercial property with a triple-net lease so they could sit in California and do nothing at all other than receive rent checks. One might think in those circumstances that the California buyer would want to take the initiative to find out whether the gutted, vacant former fast-food restaurant in Le Roy should sell for $1.55 million when its assessed value was $321,000 and no one had collected a cent in rent for a couple of years. Apparently, in the Seventh Circuit no such action is required, Illinois law notwithstanding.

Putting aside personal opinion about what the hypothetically reasonable buyer of real property should do in terms of due diligence, Illinois law is instructive in at least a limited way. Why the Seventh Circuit chose to ignore Illinois law in this instance is troublesome, for we are given no idea why the law has been totally ignored, receiving not even a passing mention in the opinion. The title examiner’s bible, IICLE® CLASSICS: WARD ON TITLE EXAMINATIONS 2005 Edition (Including 2009 Supplement) (WARD), discusses the concept of notice, and especially “inquiry notice,” in §11.4. Purchasers of real property are bound to make a physical inspection of the property to determine who is in possession of the property and what estate they claim and by what right they claim it. Stein v. Green, 6 Ill.2d 234, 128 N.E.2d 743 (1955); Ambrosius v. Katz, 2 Ill.2d 173, 117 N.E.2d 69 (1954). The string of cases that go along with this concept make it clear that the purchaser is on inquiry notice of all facts he or she may have obtained had such an inspection been made.

So, for example, obvious easements and encroachments are subject to the notion of inquiry notice. This is why title insurance companies require a current survey to remove the standard exception for such matters that is contained in the typical commitment for title insurance. Because the question of possession of real estate is not apparent from an abstract of title, the Recommended Uniform Rules for the Examination of Abstracts of Title (January 1977 Revision), with Commentary by Michael J. Rooney (contained in the Appendix to WARD) contains a revised Rule 9 that eliminates any reference to possession when discussing what to do about wild deeds. WARD, pp. a-44 through a-47.

The opinion in American National Bank & Trust of Chicago v. Vinson, 273 Ill.App.3d 541, 653 N.E.2d 13, 210 Ill.Dec.426 (1st Dist. 1995), applied the concept in what may appear to be an unusual way. Persons who claimed to be bona fidepurchasers for value without any notice of a competing right bought land from a trustee. However, the purchasers were held to be on notice of the interests of a person who was in possession of the land and operated a gas station on it for 30 years. Although the gas station owner had arranged to have the title to the property placed in his brother’s trust to avoid creditors and a potential ex-spouse, since he clearly possessed the land by operating a gas station on it for so many years and because the purchasers were the owners of immediately adjacent property, the purchasers were held to have taken title subject to the interests of the gas station owner, irrespective of who held title.

What do we make of the Seventh Circuit’s opinion? Do we conclude it is only one swing and one miss, strike one? Or do we decide it’s a bad swing at a ball in the dirt, strike three, you’re out, and the side is retired? For as good as the Seventh Circuit has been lately when it comes to Illinois real property law, this one is baffling. How can there be a 23-page opinion devoted to, of all things, the purchase (and lease-back) of Illinois real estate without ever once mentioning the bedrock requirement of Illinois law that purchasers of real estate in Illinois are required to make an inspection of the real estate they intend to buy to see who is in possession of it and they are bound by what they could have found out had they made such inquiry?

What would the California buyer have found had it made a physical inspection of the property in May 2015 or June 2015? It would have found a former fast-food restaurant that had been vacant since at least 2013. It would have discovered that the building had been gutted, but work had stopped. It would have discovered that there was no tenant operating a fast-food restaurant in possession at that time. It clearly would have uncovered the fact that the Arizona tenant was not making any rent payments. Who knows but what it might also have discovered the $50,000 mechanics lien filed by a contractor for demolition work completed? It certainly would have discovered the extent, if any, of rebuild work following on the heels of the demolition work!

There exist, of course, other questions about this funny little case. First, who cleaned up the title and how did they get around the $50,000 mechanics lien? Or did they? Wouldn’t you like to see the California buyer’s title insurance policy? Second, who prepared (or did anyone prepare) tenant estoppel letters and what did they say? Did the California buyer receive anything from the Arizona tenant saying it was in possession of the premises pursuant to the terms of the lease, that it was operating the fast-food restaurant pursuant to the terms of the lease, that all leasehold payments were current and paid in full, and that the tenant would make all future lease payments to the California buyer? Did any Illinois lawyers represent the New York owner/seller, the Arizona tenant, or the California buyer? If not, who prepared the contracts and lease and deed?

At this point, I leave it to each reader to fill in the play-by-play scorecard on this case. With any luck at all, we’ll be back at our favorite ballpark yet in 2020, and the Seventh Circuit will get another chance to solve the mystery of the swing-and-a-miss at the missing rule of law.

For more information about real estate, see TITLE INSURANCE: LAW & PRACTICE (IICLE®, 2019). EDITION. Online Library subscribers can view it for free by clicking here. If you don’t currently subscribe to the Online Library, visit www.iicle.com/subscriptions.

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