Limitations on Covenants in General Warranty Deeds

The covenant language in a typical general warranty deed, which reads as follows:

“GRANTOR WARRANTS AND FOREVER DEFENDS, ALL AND SINGULAR THE SAID PREMISES UNTO THE SAID GRANTEE, AGAINST EVERY PERSON WHOSOEVER LAWFULLY CLAIMING, OR TO CLAIM THE SAME, OR ANY PART THEREOF”

seems straightforward and ironclad. However, in a recent Texas Court of Appeals opinion issued on September 25, 2014, in which our own Kyle Dickson successfully represented the appellant (Grantor), the Court placed two significant restrictions on the covenant to warrant and forever defend. Stumhoffer v. Perales, No.01-12-00953-CV, (Tex. App.-Houston [1st Dist.] 2014, rev’d and remanded).

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The trial court initially held that Grantor’s covenant to defend included attorney’s fees and costs and granted summary judgment in favor of Grantee. With $75,000 at stake, Grantor appealed.

WHAT HAPPENS WHEN THE GRANTOR DECLINES TO DEFEND A LAWSUIT OVER THE TITLE TO THE PREMISES?

The trial court held that, in that situation, the Grantor waived any right to object to the manner in which the Grantee handled the defense of the action. Moreover, if Grantee lost title to any part of the Premises, then Grantor would be liable to Grantee for the fair market value of the portion of the Premises so lost. Ironically, Grantee prevailed in the lawsuit and, thus, Grantor incurred no liability under the general warranty deed.

The lesson is that grantors decline to defend title claims at their own peril.

DOES GRANTOR HAVE AN OBLIGATION TO INDEMNIFY GRANTEE FOR GRANTEE’S ATTORNEY’S FEES ASSOCIATED WITH DEFENDING TITLE TO THE PREMISES?

The Court of Appeals reasoned that, if there had been a failure of title to the Premises, Grantee’s damages would not have included attorney’s fees absent a question of fraud, imposition, or malicious conduct involved. The Court also distinguished several cases in which grantors made additional promises specifically relating to the payment of a grantee’s attorney’s fees, stating no such promise was made in this case. The Court concludes that attorney’s fees are recoverable in Texas only when an agreement between the parties so provides.

The Grantee was also unable to recover attorney’s fees based on a breach of contract because Grantee’s defense of title to the Premises was successful and, therefore, no breach occurred.

As a result of this ruling, a grantee has two options. First, the grantee should get a specific written agreement with the grantor concerning attorney’s fee reimbursement before defending title. If the grantor refuses, the grantee has to weigh the cost of defense against the fair market value of the premises in dispute.

In the case before the Court, one hopes that the Grantee is satisfied that retaining the additional seven feet width of Grantee’s Premises was worth the $75,000 expended in attorney’s fees.

A Look Into Statutes of Limitations

Question: When is the four-year statute of limitations for suit on a debt not governed by the four-year statute of imitations?

Answer: When there is a foreclosure of real property involved.

In a case of first impression, the 14th Court of Appeals in Houston has ruled that following a non-judicial foreclosure sale, the four-year limitations period for breach of a personal guaranty is extended so that the limitations period ends two years after the date of the foreclosure sale.

Prior to this decision by the 14th Court of Appeals, there was a conflict in the limitations period in Section 16.004 of the Texas Practice & Remedies Code and Section 51.003(a) of the Texas Property Code.

Section 16.004 of the Texas Practice & Remedies Code provides that suit must be brought not later than four years after the day the cause of action accrues on a debt. An action on a promissory note and guaranty would normally be governed by this statute.

Section 51.003(a) of the Texas Property Code provides that any action brought to recover a deficiency must be brought within two years of the foreclosure sale.

This is what happened in the case of Sowell v. International Interests, 416 S.W. 3d 593 (Tex. App. [14th Dist.] 2013). On May 30, 2002, DSI–HP 2002, Ltd. (“DSI”) executed a promissory note payable to Bank One, N.A. (“Bank One”) in the original principal amount of $12,823,000 (the “Hobby Place Note”). The Hobby Place Note was secured by a Construction Deed of Trust recorded against a 596–unit apartment complex located at 11911 Martin Luther King, Jr. Blvd., Houston, Texas 77048 (the “Hobby Place Property”). The same day, Donald W. Sowell (“Sowell”) executed a Guaranty Agreement for the benefit of Bank One guarantying repayment of the Hobby Place Note and all renewals, rearrangements, and extensions thereof (the “Guaranty”).

The loan matured on November 30, 2004, and neither DSI nor Sowell paid the Hobby Place Note. On February 6, 2007, three years after the maturity of the Hobby Place Note, the lender (assignee of Bank One) conducted a non-judicial foreclosure, leaving a deficiency of over $8 million. The holder of the Hobby Place Note (assignee) then filed suit on February 4, 2009, five years after the maturity date of the Hobby Place Note.

The cause of action accrued on November 30, 2004, when the Hobby Place Note matured and was not paid. One would think that the holder of the Hobby Place Note must being suit within four years from that date (November 20, 2008). However, under Section 51.003(a) of the Texas Property Code, the holder of the Hobby Place Note must being suit within two years of the foreclosure sale. That bar date would be February 6, 2009.

Therefore, the limitations period against Sowell did not run until February 6, 2009, five years after the maturity date of the Hobby Place Note. In affirming the trial court’s judgment, the Court held that “[u]nder Section 51.003(a), the limitations period for [DSI’s] claims against Sowell under the Guaranty expired two years after the date of the foreclosure sale [February 6, 2007]. Because [DSI’s] filed suit within this period [February 4, 2007], the trial court did not err in concluding that International’s claims against Sowell were not barred by statute of limitations.” Sowell, 416 S.W.3d at 602.

Business Formation – Back to the Basics

So you want to form a business?  Be aware that while the formation of the correct business entity is important, how you get out of the business or how you get another owner out is even more important.

The actual formation of a business entity is easy and relatively inexpensive.  Too many people use online services to form a business, or even when using an attorney, don’t take the more important next step – creating the operative document that delineates the powers, authority, distribution of profits and payment of debts and finally how to deal with a change in “corporate” ownership.  This change could be bringing someone else into the company as a part owner/investor or having an owner leave either voluntarily or not.

The documentation filed with the Secretary of State’s office to initially form an entity does not, in itself, insulate the owners from personal liability. The actual operating agreement must be completed and executed, and the parties must adhere to its provisions to obtain personal liability protection.This important document is not usually obtainable through the online services, and when it is, the document is so generic it is of little practical use.  The governing document is called several things (i.e. shareholders agreement, bylaws, regulations, member agreement, partnership agreement, company agreement). Don’t get cheap in the organization of your business, concentrating on the organization documents, while ignoring the governing document.  If you do, chances are you will pay a lot more without it in litigation.  This is especially true when you have more than one owner.  When you have a single owner the document is important to guide the estate.

For the purposes of this blog post, we will call the governing document the Company Agreement because this is the term for the governing document for a limited liability company (LLC), which has become the most popular business entity because LLC’s do not have to follow corporate formalities.

The first consideration is the percentage of ownership and how it will be evidenced.  You do not have to actually invest money.  What is considered “time, toil, & talent” can also be a basis for the percentage of ownership.  Take for instance someone who wants to form a hair salon and spa business.  The initiator/investor is willing to invest his money, but he knows nothing about hair styling and salon management.  His other owner is the actual person doing the styling and running the operation.  It just so happens that his daughter is a new hair stylist and will be working in the business.   His “dream” is to obviously make a return on his money, but he also wants his daughter to someday become an owner and eventually take his place as an owner when he decides to “cash out”.

So with two owners, each one should own ½ of the business, right? That structure actually sets the owners up for deadlock, with each party essentially having veto power over any decisions. So let’s make it 51% to 49%, which works for the majority owner, but leaves the minority owner unprotected in most instances. The solution is to specifically craft the management decision-making power to fit the circumstances of the business. For example, the “talented” owner makes the day- to-day operations of the business, while the “money” owner has to consent to capital expenditures, cash calls, or sale of the business. The parties can also include an alternative dispute resolution process such as mediation or arbitration.

What if the business is based on some “unique” concept? Provisions that address confidentiality, non-competes and trademark licensing are a few matters that should be included in the Company Agreement.

If the owners of the business are individuals, the owners need to consider adding a buy-sell structure in the event of death, disability, divorce, or bad behavior. Agreeing on a valuation process at the beginning of the relationship avoids protracted disputes when such events later occur. Likewise, if the owners wish to admit additional owners, or sell out, a process should be clearly delineated in the Company Agreement.

As the adage says: “An ounce of prevention is worth a pound of cure.”

Inequality Scales

Collections – Pointers For Success

The first step in Collections is knowing your customer. And we mean, REALLY knowing your customer.

Collection of any debt starts at the very beginning of the debtor/creditor relationship.  Many of you may not think of yourselves as a creditor, but any time you sell a good or provide a service that is not paid via cash or credit card….that is a credit transaction.  Any time you invoice for your goods or services, you are extending your customer credit.  You are betting that your customer will pay per the agreement you have in place, usually net 10 or 30 days.

Too often only a name and address is obtained…however, have you actually verified this information?  For instance, the name “ABC Services” may not have any direct relation to the actual company name.  Here are some examples:

  •  “ABC Services” could be a partial name for the correct business, ABC Services and Construction, LLC. There could be numerous ABC Services.  You must know which one is your customer.
  • “ABC Services” could be an assumed name for John Doe.
  • “ABC Services” could be an assumed name for XYZ, Inc. or worse XYZ, L.P.

And what about that address?  Very often 123 Main is nothing more that a private postal mailing center.

Here are some pointers:

  • When dealing with an individual, get his/her full name and driver’s license number.
  • If you are dealing with a business, get the actual full name and ask what type of business entity they are.  A business entity will typically end with “Inc.”, “LLC”, or “LP”.
  • “Inc.” indicates a corporation.  Find out where it was incorporated and obtain its registered agent and registered address.  Never solely rely on a P.O. Box.  Always obtain a physical address.  If the registered agent is a corporation such as CT Corporate Systems, also get at least one officer’s name and physical address.
  • “LLC” indicates a limited liability company.  Obtain the same info as a corporation.  In this case you also need to ask for the manager’s name and address and its members names and addresses.
  • “LP” indicates a limited partnership.  Obtain the same information as for the other entities, and also obtain the name and address of the general partner.  A general partner of a limited partnership is jointly and severally liable for the debt.  Be aware that the general partner is often a corporation or a limited liability company.  In that case, obtain the requisite info for that entity.
  • Obtain the name and address of a bank reference where they maintain their bank account.  Always keep a copy of any checks received from the customer.  At “crunch time” in the collection process, you might be able to garnish the bank to collect your debt.

These simple beginning steps will go a long way to help you when your customer doesn’t pay and you have to start the collection process.  Being able to give this information to your attorney will save you time and money.  If you need assistance in collecting a debt, please keep Murray-Lobb, PLLC in mind.

Meet David R. Baker

David R. Baker has 30 years of experience representing businesses and individuals in a wide variety of matters. His focus has been upon corporate and real estate transactional matters, with perhaps the best description of his practice being business planning.

In the corporate area, his experience has included the organization, maintenance and dissolution of virtually every legal entity authorized by the laws of the State of Texas. This representation has included negotiating and drafting all of the customary (and even not so customary) documents associated with these legal entities, including employment and consulting agreements, buy-sell agreements, and voting agreements and trusts. He has been extensively involved in a significant number of business acquisitions, both asset acquisitions and stock (or other equity) acquisitions..

In the real estate area, his experience has included the acquisition and sale of all manners of real estate properties, both undeveloped and developed. He has, from time to time, been heavily involved in the representation of lenders and their secured real estate lending. Another area in which David has been extensively involved is the negotiation and drafting of commercial leases, including retail, office and industrial. This involvement has been from both the tenant and the landlord perspective.

In recent years, David has found himself increasingly serving in a capacity much like a so-called “in-house” counsel. His lengthy relationship with many of his clients has led them to consult with him on any legal issue with which they are faced. Many, of course, are within his areas of expertise and he gets involved personally to handle them. Frequently, he has found himself assisting clients in resolving various kinds of legal disputes in the pre-litigation stage. Many matters inevitably involve areas beyond his experience in which case he assists the client in identifying attorneys with the necessary expertise and typically, interfacing with these other attorneys to assure that the matter is efficiently and effectively handled.

Meet Kyle L. Dickson

In the last 20+ years, Mr. Dickson has managed and participated in an eclectic array of legal matters, primarily helping entrepreneurs with their complex legal needs. Mr. Dickson has had the unique experience of going from private practice into business and serving in a variety of executive functions and then he returned to private practice years later. This combination of experience gives him an uncommon perspective on many matters.

Mr. Dickson supports and serves on many boards in his community including Mission Generation, Inc., Associated Credit Union of Texas, Mainland Communities Crime Stoppers, Inc., TCISD Foundation for the Future, Inc. and College of the Mainland Foundation, Inc.

Mr. Dickson resides in his hometown with his wife from the same town and has two grown children. In his spare time he strives to improve his musicianship hoping to one day be a “rock star” and also enjoys boating on Galveston Bay.

Meet Charles E. Lobb, Jr.

Mr. Lobb is a founding member of Murray | Lobb PLLC. Since 1985, Mr. Lobb has been actively involved in litigation, concentrating his skills in construction and collections. Mr. Lobb is well-versed in banking and UCC matters. Mr. Lobb also takes great pride in his risk avoidance and dispute resolution skills prior to suits being filed.

Mr. Lobb is a member of the Houston Bar Association, the Litigation Section and Construction Section of the State Bar. He is the author of several seminar materials on collections and M&M Liens.

A lover of the outdoors, Mr. Lobb is and an avid fisherman, hunter, and scuba diver and has completed 13 marathons. Mr. Lobb is active in his church and supports the CCA, the Quality Deer Management Association and other outdoor environmental associations. Mr. Lobb enjoys traveling and reading in his spare time.

Meet Ronald A. Murray

Mr. Murray has spent over 40 years representing lenders, sellers and buyers in real estate related matters in Harris and surrounding counties. He has served on the Board of Directors for several community banks in the Houston area. He has also served on the Board of Directors of several private schools and civic organizations in the Clear Lake community. He is currently participating in the Meals on Wheels program in the Clear Lake area.

Mr. Murray graduated from the University of Texas with undergraduate and law degrees. He continues to bleed burnt orange and attends many UT athletic events. He served for several years as an Associate Judge in Friendswood, Texas.

Mr. Murray was born and raised in Houston and has lived in the Houston area his entire lifetime. He has two children, two stepchildren and seven grandchildren and another on the way. He enjoys traveling and playing golf.

Pitfalls of Affiliated Companies

Since its humble beginning in Wyoming in 1977, the limited liability company (“LLC”) type of entity formation has gained rapid acceptance as a way to avoid personal liability and still maintain administrative flexibility. In addition, many lenders now insist that borrowers create a separate single-purpose entity for each project. Thus, most businesses consist of multiple affiliated companies that are each supposed to be treated discretely under the law. However, since non-corporate entities such as partnerships and LLCs are not required to hold regular meetings or even appoint officers, the owners of those entities tend to overlook other company formalities as well. This lackadaisical attitude may inadvertently create a situation where creditors come to rely on assets of affiliates, not just the entity with which they have a contract. In a bankruptcy proceeding, the creditors may go so far as to ask the court to substantively consolidate the affiliated companies.

The following are the most common pitfalls that affiliated companies should avoid in effort to preserve the benefit of each company’s independent existence:

Entangled Finances – If affiliated companies co-mingle their funds or one entity pays the bills for another entity without appropriate inter-company transfer records, it becomes increasingly difficult to distinguish the assets and liabilities of each company. Moreover, many affiliated companies produce only consolidated financial statements that imply that additional resources are available to satisfy an entity’s debts. If the entities share bookkeeping personnel, then mistakes become even more likely.

Reliance on Credit of Affiliates – If affiliated companies pledge any of their assets to secure loans to another entity or guarantee such loans, creditors may be entitled to rely on the credit of all of the entities. Creditors often request financial statements from such affiliates and require joint and several liability among the affiliates. Creditors may press hard for consolidation if some entities are asset-rich while others have major liabilities.

No Separate Stationary and Signatories – Often a group of companies will have one overarching trade name and will not clearly indicate the particular affiliate that is acting with respect to a transaction. Similarly, sometimes multiple entities will be executing the same document. If the same person signs the documents for several different entities, it is very easy to make a scrivener’s error and confuse the entities. Likewise, with modern computer technology, duplicated and revised documents with global changes to names, may not reflect the actual intent of the parties in every cases. These similar, yet different, documents can lead to unintended consequences and may require extra time and expense to audit and correct errors.

Undercapitalization – If a company does not have sufficient assets to pay for its liabilities in the ordinary course of business and is dependent on an affiliate for funding, then creditors may seek recovery against the finding entity too.

If a business is structured with several affiliated companies, the owners must still be diligent about ensuring that each entity is capable of standing alone both financially and contractually. Owners should also make clear to creditors that only that particular company may be relied on for payment. If not, all of the effort put into creating the separate companies may be disregarded in favor of producing more equitable results for creditors of affiliated companies.

Shareholder Oppression – The Texas Supreme Court has Spoken

On June 20, 2014 in the case of Ritchie v. Rupe, the Texas Supreme Court declined to recognize a common-law cause of action for shareholder oppression. Much of this article is quoted from the actual opinion.

The Texas Supreme Court found that existing statutory law adequately protects and provides remedies for various categories of conduct identified as frequent causes of shareholder oppression.  The Court addressed each of the common complaints of conduct giving rise to the shareholder oppression cases and identified the statutory cause of action for each.  They are as follows:

  1. Denial of Access to Corporate Books and Records.  A common complaint of those alleging shareholder oppression is the denial of access of the corporation’s books and records.  The Court held that Texas Business Organizations Code, Chapter 21 expressly protects a corporate shareholder’s right to examine corporate records. See Tex. Bus. Orgs. Code §§ 21.218 (examination of records), 21.219 (annual and interim statements of corporation), 21.220 (penalty for failure to prepare voting list), 21.222 (penalty for refusal to permit examination), 21.354 (inspection of voting list) and 21.372 (shareholder meeting list).
  2. Withholding or Refusing to Declare Dividends.  A second complaint of those alleging shareholder oppression relates to the corporation’s declaration of dividends, including the failure to declare dividends, the failure to declare higher dividends, and the withholding of dividend payments after a dividend has been declared.  With regard to the latter, shareholders already have a right to receive payment of a declared dividend in accordance with the terms of the shares and the corporation’s certificate of formation, and they can enforce that right as a debt against the corporation.  When a dividend is declared, it becomes a debt owing by the corporation to the stockholders.   With regard to the failure to declare dividends or the failure to declare higher dividends, those decisions fall within the discretion of a corporation’s directors, and those decisions must be made in compliance with the formal fiduciary duties that they owe to the corporation, and thus to the shareholders collectively.  Shareholders can sue the directors for breach of those duties on behalf of the corporation through a derivative action.  In sum, a remedy exists for dividend decisions made in violation of a director’s duties to the corporation and its shareholders collectively, but no remedy exists for decisions that comply with those duties, even if they result in incidental harm to a minority shareholder’s individual interests.
  3. Termination of Employment.  A third common complaint of those alleging shareholder oppression relates to the termination of the minority shareholder’s employment with the corporation.  Texas is steadfastly an at-will employment state.  The general rule has been absent a specific agreement to the contrary, employment may be terminated by the employer, or the employee at will, for good cause, bad cause, or no cause at all.  There may be situations in which, despite the absence of an employment agreement, termination of a key employee is improper, for no legitimate business purpose, intended to benefit the directors or individual shareholders at the expense of the minority shareholder, and harmful to the corporation.  Such a decision could violate the director’s fiduciary duties to exercise their uncorrupted business judgment for the sole benefit of the corporation and to refrain from usurping corporate opportunities for personal gain.  In such a case, a shareholder may enforce these duties through a derivative action.  Such action could also be potentially “oppressive” under Tex. Bus. Orgs. Code §11.404 and thus justify the appointment of a rehabilitative receiver under Tex. Bus. Orgs. Code §11.404 (a)(1)(c).
  4. Misapplication of Corporate Funds and Diversion of Corporate Opportunities.  A fourth complaint of those alleging shareholder oppression involves the misapplication of corporate funds and diversion of corporate opportunities.  The duty of loyalty that officers and directors owe to the corporation specifically prohibit them from misapplying corporate assets for their own personal gain or wrongfully diverting corporate opportunities to themselves.  These types of actions may be redressed through a derivative action, or through direct action brought by the corporation, for breach of fiduciary duty.
  5. Manipulation of Stock Values.  The final complaint of those alleging shareholder oppression involves the directors’ manipulation of the value of the corporation’s stock.  As a general rule, claims on such conduct belong to the corporation, rather than the individual shareholder.  The individual shareholders have no separate and independent right of action for injuries suffered by the corporation which merely result in the depreciation of the value of their stock.

Importantly, the Court also recognized that the business judgment rule is applicable to decisions made by office and directors in actions under the Tex. Bus. Orgs. Code §11.404 (a)(1)(c).  The Court held that “a corporation’s directors or managers engage in “oppressive” actions under §11.404 when they abuse their authority over the corporation with intent to harm the interests of one or more of the shareholders, in a manner that does not comport with the honest exercise of their business judgment, and by so doing so create a serious risk of harm to the corporation”.

The Court further ruled that the statue (Tex. Bus. Orgs. Code §11.404) does not authorize a buy-out remedy of a minority shareholders shares, even if such actions are deemed oppressive under the statute.

The case can be found here.