In this "Summer E-Bulletin," we will discuss various real estate topics in the context of a hypothetical fact pattern. Our story involves a man named Steve, a poor apple farmer who hopes to sell his apple orchard. Steve has owned and operated the property for the past four years. Steve purchased the property from his cousin, Nancy. Steve's property contains 78 acres. At the time of the sale to Steve, Nancy retained two adjacent acres of land and four (4) land division rights associated with the original 80-acre parcel. Steve hopes to sell the property to a young developer named Bob. Bob intends to develop the property as a retail, office and residential project. The property contains approximately ten acres of wetlands, which impact access to the property. When Steve acquired ownership of the property, he filed the appropriate documents to claim the property as Qualified Agricultural Property. During the past few years, urban development associated with a neighboring village has crept closer to the property. Steve feels the time is right to sell and Bob is anxious to make his fortune developing the property.
To see how our real estate professionals have analyzed various topics in the context of this story, please access the links included in this E-Bulletin.
I. Title Issues
Prior to purchasing the property, Bob should be certain that Steve holds marketable title to it. The purchase agreement between Bob and Steve should clearly require either Bob or Steve to provide evidence of Steve's title to the property. In Michigan, evidence of title typically comes in the form of title insurance issued by a title company.1
In most cases, the seller of property purchases the title insurance at his expense.
Two types of title insurance policies are typically used in Michigan: an owner's policy and a mortgagee's policy. Bob should obtain an owner's policy, which will name him as the insured party and will protect him against loss or damage covered by the policy. If Bob obtains financing for his purchase of the property, his lender will likely require a mortgagee's title policy, which will protect the lender against loss if a valid and enforceable lien does not exist on the interest taken on the property. Bob should note that any policy of title insurance does not guarantee that perfect title exists in the insured. The title company will review title carefully and will sometimes insure over risks the title company considers to be insignificant or unlikely to cause problems.
The title company initiates the title insurance process by issuing a title commitment prior to the closing. With the title commitment, the title company promises to issue its standard form of title insurance policy on the date set forth in the commitment upon the satisfaction of the requirements set forth in the title commitment. Once the purchase closes, the title company will issue a final title policy to the buyer, insuring the buyer in the amount of the purchase price. The form of owner's title policy that is commonly used in Michigan is the American Land Title Association ("ALTA") Owner's Policy. It includes an insuring clause, exclusions from coverage, particulars of the transaction, standard exceptions from coverage, and conditions for coverage.
Prior to closing, Bob, or his attorney, should review the title commitment very carefully. He should examine all of the underlying title documents that detail any exception to coverage listed on the title commitment. For example, the property may be encumbered by restrictive covenants that were placed on the property several years ago. A summary of such restrictions should be listed on the title commitment. Bob should obtain a copy of the document detailing the restrictions to make sure that his proposed use does not violate the restrictions. If it does, Bob should work with the appropriate party to remove or limit such restrictions.
Because significant changes in title could take place between the time the title company issues the title commitment and the time of the closing, the title commitment should be updated through the exact time of the closing of the transaction. In order to fully protect himself, Bob should request from the title company that the standard exceptions be removed. This can be accomplished by providing the title company with the proper documentation (usually in the form of an affidavit provided by the previous owner of the property, Steve, warranting the title condition of the property, and a survey).
Additionally, Bob should request certain endorsements to cover special risks and to insure over defects caused by the development he plans to build. Some endorsements are available for free and some are available for a premium. Bob may consider the following endorsements: contiguity (insuring against loss caused by parcels in the property failing to be contiguous), access (insuring vehicular and pedestrian access to the property), future advance (allowing Bob to increase coverage as the development advances), condominium (if the development is a condominium in whole or in part ), zoning (insuring zoning classification of the property).
There are many aspects to reviewing title that Bob should consider, including those mentioned above. Because title issues can be complex, Bob should consider hiring an attorney to conduct a full title review and analysis. At that point Bob may be in a better position to evaluate whether Steve's title is marketable and acceptable for his development.
II. Survey Issues
Bob should not go forward with purchasing the property unless he obtains a survey of the property. A survey will show Bob the boundaries of the property and will depict any improvements on the site. It will disclose any existing problems with access and/or gaps in contiguity as well as identify possible boundary disputes, making it possible for Bob to make an educated decision as to whether he should purchase Blackacre. As with title, survey reviews can be complex. Bob may wish to hire an attorney to conduct a thorough survey review and analysis.
The survey should be prepared in accordance with recognized industry standards and should contain a certificate from the surveyor indicating that the prepared survey meets such standards. Bob should request that the survey be certified to all interested parties in the transaction, such as himself and Steve, the title insurance company, the lender, and Bob's attorney. There are many different types of certifications a surveyor may issue. The most common for large real estate transactions is a form of certification adopted jointly by the American Land Title Association and the American Congress on Surveying and Mapping ("ALTA Survey"). Because Bob's purchase will rely to a significant degree on the results of a survey, it is advisable that Bob obtain an ALTA Survey of the property. Additionally, Bob may enhance the ALTA Survey by requiring the surveyor to place more detailed information on the survey.2
Another reason for Bob to obtain a survey is because presentation of a proper survey to the title company will remove one of the standard exceptions in the title insurance policy (see above). This will provide Bob with additional title protection under his owner's title policy.
Another method to evidence title is to compile as abstract of title, which is a summary of the history of the chain of record title for a particular parcel of property. Abstracts of title are often used to review mineral titles.
This additional optional information is known as Table A information.
There are several potential environmental problems Bob may encounter in purchasing the property. Because of typical farming practices associated with the property, there is a high likelihood that the property contains ground contamination. Historically, apple orchards have been treated with toxic pesticides to promote the production of apples. Such pesticides may contaminate the soil and groundwater. Although there has been a recent switch to less toxic substances, these older pesticides may have seeped into the ground, producing an environmental hazard which may pose serious health risks. In addition to potential contamination from pesticides, the orchard may be contaminated from refuse on the property.1
Such refuse may cause hazardous materials to emit into the soil. Thus, Bob may wish to investigate the property carefully for such contamination.2
If Bob does not address such environmental issues before his purchase or within a short time after his purchase of the property, he may face extensive liabilities for cost and damages relating to the environmental condition of the property.
Under Part 201 of the National Resources and Environmental Protection Act ("NREPA"), the property may be considered a "facility." A facility is any site where a hazardous substance existed or has otherwise come to be located. A person who becomes an owner or operator of a facility is liable for damages flowing from the release or threatened release of a hazardous substance from that facility.3
If the property is contaminated from previously sprayed pesticides or other contaminants, it will likely be deemed a facility. However, simply acquiring a facility does not automatically impose liability on Bob. In addition to the property being a facility, there must be a release or threatened release of a hazardous substance. Under law, a release is any discharge or escape into the environment.4
Courts define a release and a threatened release very broadly. For example, courts have found that if there were previous releases from the site and the site still contains hazardous materials, there is a threatened release.5
In light of the foregoing, Bob must take precautions to avoid liability flowing from existing contamination on the property. Even if the property is considered a facility that contains a release or threatened release of a hazardous substance, Bob can avoid liability if he complies with two requirements: performing a baseline environmental assessment ("BEA"); and sharing the results of the BEA with the Michigan Department of Environmental Quality ("MDEQ") and any subsequent purchasers.
To comply with the first requirement, Bob must perform a BEA before or within forty-five (45) days of the acquisition of the property. A BEA is an evaluation of the environmental conditions of the property so that in the future there is a proper measurement of new contamination versus contamination that existed at the time of acquisition of the property. In our case, Bob may assume that the property has some form of contamination. Therefore, some degree of BEA should be performed. There are three types of BEAs which range from simply performing a basic test, because there is no expected future contamination, to performing an extensive delineation of the nature and extent of the contamination. The extent to which Bob expects to produce hazardous substances in connection with his use of the property will determine the degree of BEA employed. If Bob expects no additional contamination from his use of the property, he may consider performing a category N
BEA. This entails a phase I environmental assessment, which consists of a simple environmental assessment to confirm that the site is in fact a facility. If, on the other hand, Bob expects to use hazardous materials that are different from those used by the previous owner or the contamination existing in the ground, then Bob should perform a category D
BEA. This consists of Bob collecting enough data to confirm that the hazardous materials in the ground are different from the materials he intends to use. Moreover, if Bob intends to use the same hazardous materials found in the ground, he must perform a category S
BEA. He would have to determine the full delineation, nature and extent of the contamination or gather some delineation in combination with controls to determine new contamination from existing contamination.
Secondly, if the property has been determined to be a facility, after the performance of a BEA, its results must be shown to the MDEQ and to subsequent purchasers. If the property is not determined to be a facility Bob does not have to show the report to the MDEQ.
If these two requirements are met, then Bob will not be liable for any contamination existing up to the date of purchase of the property. At this point, Bob may voluntarily petition the MDEQ for a determination of exemption from liability. Although this is not required, it may be very useful in the future. In order to receive this exemption, Bob must submit a petition, along with $750 and a detailed description of the future use of the land and any clean up planned. The MDEQ has fifteen (15) days to respond to such a petition.
In addition to the contamination described above, the property may contain underground or aboveground fuel storage tanks. Large farms, such as the property, sometimes contained on site fuel tanks used for the operation of farming vehicles. These tanks may exist aboveground or belowground. Aboveground leakage into the environment can be included in the BEA (as described above) and the tank may be removed. However, if there is an underground storage tank containing petroleum or other listed chemicals, it must be registered with the MDEQ and its owner must pay a fee for the tank every year. There are very stringent guidelines surrounding the removal of an underground tank. In addition, anyone that is liable under Section 201 of the NREPA is also liable for the investigation and correction of contamination from the underground tanks.6
Items that may have been abandoned on the property may include appliances, chemical drums, tires, old tools, used or old parts, glass, irrigation tubing, or plastic containers.
Bob may find it helpful to ask neighbors, or look for mounds of dirt, wetlands, ravines, sparse vegetation areas and old building foundations as places where items and refuse may be dumped.
42 USC 96011
5United States v. Northernaire Plating Co
, 670 F Supp 742 (WD Mich 1987), aff'd sub nom United States v RW Meyer, Inc
, 889 F2d 1497 (6th Cir 1989), cert denied
, 494 US 1057 (1990).
Bob faces several issues in connection with the historical agricultural use of the property and how the property has been and will be taxed. One aspect has to do with the Agricultural Exemption and the other has to do with Qualified Agricultural Property filings that have been made with respect to the property.
Steve, the seller, has used the property for an orchard for the four years he held the property. As a result, the property has qualified for the "Agricultural Exemption" which gives a property owner an 18 mill cut in property tax rates. This is the same reduction that a home owner can receive on the tax rate for his or her homestead. The Agricultural Exemption results from either the local assessor classifying the property as agricultural real property or by the property owner properly filing a form with the assessor called Claim for Farmland Exemption from Some School Operating Taxes.
In order for the local assessor to classify the property as agricultural real property, its use must fall within a definition of "agricultural operations," which includes a wide variety of farming operations such as an orchard. In order to properly file the Claim for Farmland Exemption, the property must meet a separate but similar definition of "agricultural use." Orchard operations would also fall within the second definition. While the assessor may continue to classify the property as agricultural operations for its purposes after Bob closes on the purchase of the property, Bob would be well advised to file the Claim for Farmland Exemption as well, assuming he continues to use the property for farming operations for some period after closing. For that time, Bob should continue to enjoy the 18 mill reduction in tax rates that Steve benefited from during his ownership.
As Bob converts more than 50% of the property acreage from orchard operations to satisfy his development goals, he will need to rescind the Agricultural Exemption by filing a form known as Request to Rescind the Qualified Agricultural Property Exemption.1
The filing deadline for that form is 90 days after the property ceases to meet the 50% test.
Once Bob files his rescission, he will no longer enjoy the 18 mill reduction on any part of the property, unless the assessor continues to classify some portion of the property as containing agricultural operations. Bob will want to plan for such increased tax levels in his budgeting.
Qualified Agricultural Property
The second concept has to do with the "Qualified Agricultural Property" classification (sometimes called QAP), which is a slightly more complicated matter but can also result in much lower property taxes for the benefiting parties.
By way of background, Proposal A was adopted in Michigan in 1994. Among other things, it limited increases in property taxes. This was accomplished by putting a cap on the amount that a property's taxable value could increase. Taxable value (in addition to millage rates) is the basis for calculating tax bills with respect to a property. In general because of Proposal A, a property's taxable value can only increase by the lessor of (i) 5% or (ii) the inflation rate. There are exceptions that allow the "cap" to come off. One exception arises when the property is transferred. Thus, when Steve acquired the property 4 years ago and when Bob now acquires the property from Steve, the cap would ordinarily come off, resulting in a potentially large increase in the taxable value for the property. However, Steve took steps to see that the cap remained in place. Bob may be able to do the same.
When Steve purchased the property, he intended to continue the agricultural use of the property. He, therefore, filed with the assessor and recorded with the register of deeds a form called Affidavit Attesting That Qualified Agricultural Property Shall Remain Qualified Agricultural Property. If a person does this, and the property continues to be used for agricultural purposes, the conveyance of the property is excluded from the definition of transfer of ownership for purposes of uncapping the taxable value. As a result, while Steve held the property, the taxable value could only increase over the previous year by the amount of the cap. In the meantime, the property's true cash value and the state equalized value that may have increased tremendously.
Assuming Bob will continue to allow the property to be used for orchard purposes for some time after his purchase, he may well wish to file and record the Affidavit Attesting that QAP shall remain QAP. This will allow Bob to continue enjoying the benefit of the capped increases in taxable value, until he has a change in use.
A critical point for Bob, however, is that a change in use will trigger a recapture tax. If he wishes, he can take actions now to make sure that he does not pay the recapture tax.
The amount recaptured by the recapture tax is essentially the benefit (in form of lower taxes) received during the benefit period, not to exceed 7 years. The recapture tax is triggered when a then present owner of a Qualified Agricultural Property converts the property to a non-agricultural use or a buyer files a form indicating that the Qualified Agricultural Property exemption will be rescinded (the form is called Notice Of Intent To Rescind the Qualified Agricultural Exemption). Thus, before closing Bob could file the rescission form and, unless the parties had agreed otherwise, Steve will be required to pay the entire recapture tax. Alternatively, Bob may wish to continue to have the cap in place on the parcel. However, once he converts the property to a non-agricultural use he will be required to pay the recapture tax. As a result of this structure, there is a real planning opportunity for the purchase documents to allocate or share the ultimate burden of paying the recapture tax between Bob and Steve.
Another planning opportunity arises because Bob is likely to develop portions of the property over time. By creating separate new parcels, Bob may be able to keep the cap in place for areas where the agricultural use will continue.
Careful planning and proper use of the Qualified Agricultural Property classification and the Agricultural Exemption discussed earlier can save a buyer of agricultural real estate substantial sums.
It is unfortunate that the Department of Treasury used the term Qualified Agricultural Property in the name of this form. The form relates to the 18 mill reduction and not the Qualified Agricultural Property concept described later in this article.
In a typical development virtually every aspect of a rezoning and development will be regulated under local zoning. For example, land division and condominiums that are discussed elsewhere will also be covered by the zoning ordinance, setting forth standards and procedures for approval. Use and density, dimensional standards, open space, and the protection of wetlands and groundwater are similarly dealt with in most zoning ordinances and will define what kind of development is feasible on any particular parcel of land.
In most municipalities two documents, the Zoning Ordinance and Master Land Use Plan, govern present and future land use. Review of these documents should answer the following questions with respect to Bob's parcel:
What is the current zoning under the Ordinance?
What is the future land use envisioned in the Master Land Use Plan?
What are the standards and procedures for rezoning of a particular parcel to a particular use?
Steve's property is currently zoned agricultural, which in addition to farming usually allows low density residential use. The master land use plan needs to be consulted to determine what future use is envisioned for the property. Because of its proximity to a village, it is probable that the master plan will envision either a denser residential use or a commercial use, and maybe a combination thereof. Once we determine the appropriateness of the rezoning under the master plan, the ordinance will provide what standards need to be met to justify the rezoning at the current time. Municipalities look to the adequacy of roads and utilities, population growth in the area, impact on schools, environmental issues and whether public infrastructure such as water and sewer is required and adequate for the projected use.
The costs and benefits water supply and disposal will often dictate what kind of a development can be proposed. A zoning ordinance may require public water and sewer for multi-family residential, commercial and industrial development. Some uses require large amounts of water and the generation of substantial wastewater. Many ordinances therefore require public water and sewer for restaurants, car washes and other high water uses. The source of water will also affect insurance premiums; water for fire hydrants and sprinkling systems can reduce fire insurance rates for property making the development more appealing to developers and tenants.
Public water and sewer will increase the initial cost of the project. There will be the direct costs of extending mains adequate to service the development and the hook-up fees when buildings are completed. Some direct costs may be recouped in part. If there is going to be an extension of utilities for a substantial distance, a "pay back" agreement should be explored with the municipality to reimburse the developer if other properties hook up to the extension within a specific period of years. There may also be indirect costs. In Bob's case, where the property is located in a township and the public services exist in an adjacent village or city, that village or city may require annexation before extending service. This may increase substantially the local governmental general tax millage that can be levied against the property being annexed.
In cases where public water and sewer is not available, developers may explore the creation of a private utility that would be owned and operated by the owners of the development. In addition to the costs associated with the building of a private system, there is often local governmental and citizens' resistance to private systems that can lead to delays and disappointments for developers.
With respect to the rezoning of the property for a variety of uses, Bob could bring multiple applications to rezone portions of the property to different uses, or he could make one application for a Planned Unit Development ("PUD"). Under Michigan law, a PUD includes "cluster zoning" and is used to "encourage innovation in land use and variety in design, layout, and type of structures constructed, achieve economy and efficiency in the use of land, natural resources, energy, and the provision of public services and utilities, encourage useful open space. . . " Under a PUD application, the rezoning of the property to one or more uses and the site plan for the development are all taken up by the municipality at the same time. In large developments PUD approval may also occur in phases, which ties in nicely with the phased approach to a condominium development. In Bob's situation, the existence of the wetlands may encourage the use of "clustering." Clustering increases density in one portion of the project while leaving open space in another. The open space can be parks, woodlands, fields, or in Bob's case, the protected wetlands. Under many ordinances, the developer is rewarded with additional or bonus building units if he provides a cluster development. Some ordinances allow sensitive environmental areas to be included in the open space under a cluster development for yield calculation, in which case Bob would be able to develop as many units as he would under a normal 78 acre development. Even if Bob cannot use the wetlands for his yield calculation, he may get bonus units for an open buffer zone protecting the wetlands. The cluster development could also save in infrastructure costs. Developing less land more densely rather than spreading the development over the entire 78 acres will reduce the length (and therefore the cost) of streets and utility mains.
With a condominium development Bob will have to decide whether to have public or private roads within the development. While cost of construction may be an consideration, it is becoming more common for municipalities to require that private roads be built to public standards, usually to the standards for a county road. An obvious benefit to having public roads within the development is that maintenance and repair is borne publicly rather than directly by the owners within the development.
The design of streets within the development and the number of access points to arterial roads will be an issue dealt with in the site plan review. Bob should be made aware that the municipality's emergency services department will weigh in on street layout. Areas within the development served by a single access road (e.g. dead end streets and cul de sacs) are of great concern to officials responsible for getting fire and ambulance vehicles to and from an emergency. Having the single street blocked by an accident or other occurrence is a nightmare for both the property owner and the emergency service provider. Therefore ordinances often limit the length that a dead end street can be.
Limiting the number of access points to arterial roads will also be given attention by the municipality. While two access points will be required to meet the concerns of emergency services, highway safety officials will frown on a plethora of driveways coming out of the development. Lots having frontage on the public road will be encouraged to have their access from within the development rather than having a driveway to the road. Many zoning ordinances encourage the development of a "service road," running parallel to the arterial road, allowing traffic to flow from one building to another within the development without making turns onto and from busy arterial roads. Often property owners are required to enter into joint drive and access easements with neighboring properties as a condition for approval of a commercial building.
The design of streets in Bob's development may require some creativity. We are told that the location of wetlands may limit access to the development. If Bob's property has only one location for access to and from the arterial road, emergency access may be accomplished through a boulevard access drive having a median, thereby providing emergency services a way around an accident or other obstruction. In addition Bob could design and stub internal streets so that, upon development of a neighboring parcel, the streets of the two properties could be joined providing additional emergency access and the for flow of traffic between the properties without vehicles entering the arterial road. A meeting with the municipality's planning department can educate the developer as to the traffic and access issues that need to be solved for the development of his property.
I. Land Division Issues
It is not an uncommon event for the purchaser of real property to know little to nothing about the Land Division Act. As a result, evaluation of the property in the context of the Land Division Act and its requirements is often overlooked by a purchaser who does not have the guidance of legal counsel.
The Land Division Act addresses two types of property: (i) platted property, and (ii) unplatted property. Property is platted when it is laid out in a "plat" on a "plat map" that designates each parcel as a "lot." The streets in a plat are often public streets, but do not have to be public. Platting requires significant time and effort to achieve because the plat map must be approved by various local and state governmental authorities. Thus, numerous public hearings and meetings are required. The average plat is approved within two years. Recently, the Michigan legislature passed legislation to allow public hearings to occur concurrently in an effort to expedite the platting process. Unfortunately, there is a certain series of events in the platting process that work best when done in a chronological fashion. Thus, most estimate that the savings in the platting process is a few months at best. Bob knows this and he knows the farmland he proposes to purchase has not been platted. Rather, it is simply defined by what we refer to as a "metes and bounds" description (such as 42ºN12'3"E 200 feet; then 65ºN0'0"E 1000 feet). Because the adage "time is money" rings true for Bob, Bob cannot patiently wait two years to complete a plat of the property that he intends to develop.
So, it becomes important to Bob during his due diligence period to examine what he can do with the property without platting. As earlier mentioned, unplatted property is also governed by the Land Division Act. A landowner may split his or her property a specified limited number of times, depending on (i) the size of the "parent parcel" or "parent tract", (ii) the number of times that the parent parcel or tract had previously been divided, and (iii) the number of "division rights" that the landowner received from the prior landowner.
The parent parcel or parent tract is a defined configuration of property that was established in 1997 for all unplatted property in Michigan. Essentially, the Michigan legislature took a snap shot of the configuration of all unplatted Michigan property on March 31, 1997. Based on those configurations, the legislature allocated each parent parcel or parent tract the right to divide these parcels a certain number of times. For example, a parent parcel or tract that was 16 acres on March 31, 1997, can be divided three times to create four parcels. A parent parcel or tract that consisted of 32 acres can be divided five times to create six parcels with the opportunity to create two additional "bonus" parcels if certain conditions for development are met.
Steve is presently the owner of 78 acres of property. The 80-acre parent parcel from which the property was created is entitled to create eleven (11) parcels with the option of creating two additional parcels. Upon the split of Steve's 78 acre parcel (i.e., the property) from Nancy's adjacent 2 acres, one division was used. Since Nancy also retained the right to create four (4) parcels associated with the parent parcel, Steve is only able to transfer the right to create six (6) parcels (plus the option to create two bonus parcels) to Bob. Bob will likely wish to create more than eight (8) parcels to accomplish his sophisticated development. Thus, Bob will either need to plat the property or use an alternative means (e.g., a condominium) to parcel the property for separate ownership.
II. Condominium Issues
Assemblage of real property is difficult enough but then add the complexity of the Land Division Act as discussed above. For some, this is enough to dissuade business owners, such as Bob, from developing the land and instead relegate the owner's business to long-term leasing relationships, especially if the business owner desires only to use a portion of the land for his or her own business operations. For others, however, development of land is just an opportunity to express his or her creativity . . . establishing a condominium over property challenged by the Land Division Act serves the creative developer well.
As in Bob's case, when splitting Steve's property is impeded or fully prohibited by such things as the Land Division Act, zoning ordinances, or the vertical limitations of land splits, the Michigan Condominium Act is a tool in the arsenal of the savvy business owner/developer. A developer of property can "condominiumize" property which effectively allows the property to be split into separate ownership, but with all owners jointly owning certain "common elements" such as roads or hallways, depending on the type of condominium development.
There are two types of condominiums. The traditional condominium whereby all condominium owners own essentially an apartment or unit within one or more buildings. The common elements then consist of the hallways, lobbies, elevators and parking areas. The second type of condominium is one that serves a developer who desires to split up land. This is a "site" condominium. The site condominium is comprised of each condominium owner's unit which are separate parcels of land, and the common elements, such as the roadways. All types of property can be condominiumized.
Because of the limitation arising from the Land Division Act and zoning, Bob can establish a site condominium over his property to allow him to split the property, including Steve's 38 acres of property. Condominiums are excepted from the statutory regiments of the Land Division Act and from certain portions of a zoning ordinance. Bob can create a site condominium by recording a "Master Deed" against his property. The Master Deed dedicates the property to condominium ownership and includes the condominium bylaws and condominium site plan. The condominium bylaws typically establish the framework of the condominium association and restrictions on the use of the property, and the condominium subdivision plan is a graphic depiction of each condominium owner's individual property and the common elements.
With the benefit of the Michigan Condominium Act, Bob's development plans may go forward. He can now establish a condominium that has a number of different uses that are quite dense in use. Bob plans to establish a retail center that includes a grocery store, café, dry cleaners and bank. He could set aside a portion of the property for apartments or town homes and develop 25 single-family homes. He has not decided yet but he still has 42 acres. Perhaps, he will establish an office complex or some other ancillary use that complements the proposed retail and residential uses. Alternatively, he could berm the area between the retail and residential uses and establish an industrial park, depending on the zoning in the area and/or whether he decides to seek rezoning of the property as discussed above.
Bob will seek commercial loan financing for the bulk of his acquisition and development costs. He also wishes to raise equity from investors. He will need to take great care in the manner in which he offers and sells interests in his new development company.
Both federal and state securities laws will impact Bob's efforts in this area. Failing to comply with those laws can result in severe consequences for Bob. He can be subject to regulatory or even criminal proceedings by state, SEC or other regulatory bodies. He can also find himself personally liable for a refund of the investors' money plus interest, generally at 6%. This can be the case even if his non-compliance is inadvertent and the project is unsuccessful for matters outside of his control.
Under federal and state securities laws, the offer and sale of all securities must be registered or an exemption from registration must be satisfied. Stock in a corporation is a security and membership interests in a limited liability company are almost always deemed securities. Registration of the securities will not be an appealing alternative for Bob. It is an expensive and time-consuming process. It makes sense for large companies that wish to have tradable securities after the transaction. It almost never makes sense for a developer of a project like Bob's. As a result, Bob will need to work with counsel to identify federal and state exemptions from registration for what he is offering.
Exemptions from Registration
Most likely, Bob will seek to rely on the federal exemptions from registration provided by Regulation D, adopted under Section 4(2) of the Securities Act of 1933. That exemption permits the private offering (i.e. there can be no general solicitation or advertising) of interests in his new entity that meets the requirements of Regulation D, which have to do with the information provided to offerees, the requirement of a notice filing with the SEC, the financial standing and sophistication of offerees, and the manner of offering, among other things.
One of the principal concerns for Bob is the prohibition on any general solicitation. To be safe, he will only offer interests to people with whom he has a pre-existing relationship sufficient for him to have an understanding of their financial standing and business and investment sophistication. For a private offering like this, Bob cannot seek investors at seminars, distribute flyers, or even mention his capital raising process in any press accounts of the overall project. Any publicity about the capital raising will likely cause Bob to lose the availability of a private offering exemption and force him into a public offering.
In addition to identifying an exemption at the federal level, Bob will need to work with counsel to identify and comply with exemptions at the state level. For most Regulation D offerings, his compliance will be limited to making a notice filing (which is the same filing to be made with the SEC) and the payment of what is usually a fairly nominal fee.
In addition to identifying and satisfying exemptions at the federal and state levels, Bob must be certain that he discloses all material information about the potential investment to investors. This requirement is separate and distract from the exemption requirements, some of which also require specified disclosure. The material information requirement, sometimes called the antifraud rules, means that Bob must reveal to prospective investors all information that a reasonable investor would want to consider to evaluate the investment. Certain items are almost always deemed material, such as any compensation Bob is taking as the promoter of the investment or manager of the company and any conflicts of interest Bob may have in the project (for example, Bob's construction company will likely be the general contractor for construction work). Bob's compliance with the antifraud rules would usually be accomplished by Bob preparing a disclosure document and sharing it with potential investors. In this way, there is a reduced chance of later disagreements about what was disclosed.
There are other federal and state securities laws and rules that often impact the offer and sale of securities in a project like this. For example, if there is a minimum amount of equity that must be raised or if there is some other contingency (for example, zoning approval), that must be met before an offering is completed, special rules apply to the handling of investor funds pending satisfaction of raising the minimum or satisfying the contingency. Close consultation with securities counsel will be wise for Bob to ensure compliance with the exemption, disclosure and other applicable rules. Failure to comply can result in real pain for Bob.