Navigating Legal Risk in Real Estate Development

The old adage about real estate is "location, location, location!” In this Speaking of Litigation podcast episode, however, the central theme shifts to "litigation, litigation, litigation!" as the discussion focuses on the significant implications of legal disputes and challenges in the realm of real estate development.

Detailing storied examples of development litigation controversies, such as that involving the “American Dream” retail and entertainment center in New Jersey, Epstein Becker Green attorneys Keith Randall, Sheila Woolson, and Jeremy Oliver explore the legal challenges developers face throughout a project's life cycle. From entitlement and environmental issues to construction disputes and more, this episode addresses the ways you can mitigate these challenges from interfering with your next development endeavor.

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Transcript

[00:00:00] Keith Randall: Welcome. Today on Speaking of Litigation, we're discussing different types of litigation you may encounter in real estate development. Hello everyone. I am your host today, Keith Randall. I'm an attorney in Epstein Becker Greene's litigation practice and I am based out of our Nashville offices. My practice primarily involves representing owners, including real estate developers, in design and construction matters, which we will talk about some today.

[00:00:25] Keith Randall: But I often find myself adjacent to litigation matters facing real estate developers throughout the whole life cycle of a project, which is why I have some other guests today. When you're thinking about developing real estate, it's a complex and often risky prospect. Real estate developers have to navigate everything from entitlement issues, which are usually at the municipal level, to environmental issues, which are regulated at the state and federal level, to design and construction issues.

[00:00:52] Keith Randall: Just this term, the Supreme Court weighed in on the interpretation of the Clean Water Act’s definition of “the waters of the United States” in Sackett v. EPA. Whatever you may think about that decision, it's notable that no greater authority than the Supreme Court somewhat regularly weighs in on the regulations and state laws affecting real estate developments, whether the cases relate to environmental regulations or due process issues revolving around entitlements or condemnation.

[00:01:17] Keith Randall: Every step through the process of a real estate development project can lead to a lawsuit, and we are going to talk about some of those examples today, as well as our experience. But before we dive in today, a request to you, our listeners, if you like the information we're sharing today, please take a moment to subscribe to the show.

[00:01:36] Keith Randall: Speaking of Litigation is available on YouTube and wherever you get your podcasts. Now to our guests joining today, Jeremy Oliver, a Member of our Firm in our Nashville office, practices complex business and commercial litigation across the country with clients across a diverse range of industries, including commercial real estate, construction, and retail and hospitality.

[00:01:54] Keith Randall: They value Jeremy's commitment to competitive spirit, particularly within the courtroom setting. Sheila Woolson is also joining us today. She's a Member based out of our firm's Princeton office. Prior to law school, Sheila had a degree in chemistry and worked in the pharmaceutical industry.

[00:02:12] Keith Randall: And now she uses that chemistry background to litigate products, liability, and matters related to real estate development, especially those related to environmental contamination and remediation issues. Thank you both for joining us today.

[00:02:23] Jeremy Oliver: Good morning.

[00:02:24] Sheila Woolson: Morning.

[00:02:26] Keith Randall: Sheila, as an introduction to our discussion today, can you tell us why real estate development litigation is such a hot area right now?

[00:02:34] Sheila Woolson: Certainly. I think most everyone, if they are driving along in their cars, have seen the recent development where malls have suddenly become empty. They're now being torn down. They're being converted into warehouses or big box storage. There's a lot of redevelopment in terms of the next cycle of business and what that's going to look like, and that entails issues of zoning.

[00:03:01] Sheila Woolson: It can involve issues related to environmental remediation and cleanup, wetlands restoration, greenlands preservation, so that there's parks and trails and bike trails for people, as well as zoning issues and even deedrestrictions about what kinds of businesses and what kinds of operations can go on as, as minute as what goes into a local strip mall, that too can be controlled by a deed restriction and a lot of those issues result in litigation if they can't be negotiated up front.

[00:03:34] Keith Randall: So it sounds to me like, and like I said, I'm more of a construction attorney, but it sounds to me like what we're considering is more redevelopment, changing uses of land from an older or lesser use to a more modern, commercially successful use. Is that a fair statement?

[00:03:51] Sheila Woolson: Yeah, I think that's exactly right.

[00:03:52] Sheila Woolson: I mean, we have an interesting example here in New Jersey. But before I go into that, Jeremy, did you want to add anything?

[00:03:58] Jeremy Oliver: Yeah, I would add that I think since COVID, there's been a lot of geographical relocation for people across the country and globally, frankly. And here in Nashville, we've seen an influx of people moving from various parts of the country, especially California, New York, et cetera.

[00:04:17] Jeremy Oliver: And I think with that migration, you see an increase in development, not just residential, but on the commercial side to kind of satisfy or serve that increased population in areas in the Sun Belt and other kinds of growing, developing areas across the country.

[00:04:38] Sheila Woolson: Yeah, I think that’s exactly right. I mean, we have an example up here in New Jersey, called the Meadowlands American Dream Mall that has this really long and tortured history that goes all the way back to like 1994.

[00:04:52] Inside Edition Clip: The death of malls across America has been underway for years. 9,000 stores closed just last year. Experts say for malls to survive, they must offer more than just shopping. It's got to be an experience.

[00:05:06] Sheila Woolson: There was a plan to develop an office, hotel and retail mall, but it was going to be built in wetlands.

[00:05:15] Sheila Woolson: So that immediately triggered litigation that stopped the project until about 2003. The project got underway again. Four years later, the first developer declared bankruptcy. Two years later, we had the Great Recession. Project got stalled again. A year later, a new developer took over the reins and planned a whole different kind of concept.

[00:05:36] Sheila Woolson: This involved retail, but it involved an amusement park, a water park, skating rink, Legoland, helicopter rides, you name it, that was the plan. And that sort of speaks to the changing nature of what consumers want. They didn't just want retail. They wanted a whole sort of family experience. However, that too then led to more litigation.

[00:06:00] Sheila Woolson: And then the project was stalled until roughly about 2017, when it started again, and the amusement side started to open, ski lifts, the skating rink. And just as the stores were beginning to open, it was 2020 and we were faced with COVID. A lot of the retailers pulled out because they couldn't sustain a mall anymore.

[00:06:21] Sheila Woolson: Brick and mortar stores weren't working. The mall couldn't open for I think seven or eight months. It finally reopened in late 2020. People started coming back. Some of the retail stores opened. The other attractions continued to operate. And here we are three years later, more litigation. Why? Because the owners can't make their payments on their bonds and their other obligations.

[00:06:44] Sheila Woolson: Because of all the changes that have happened in the years since the plan was proposed. Which is sort of the issue with litigation, right? It slows everything down, and it can become a big problem when you're trying to develop a piece of real estate.

[00:06:57] Keith Randall: And in that instance, it sounds like we're talking about a 30-year development, with multiple rounds of litigation.

[00:07:03] Keith Randall: I mean, multiple people have come and gone. They’ve got all sorts of problems.

[00:07:07] Sheila Woolson: Exactly. And you know, sometimes there's no defense against bad luck. I mean, nobody knew COVID was coming, but it really hit the retail industry very hard. And it makes these concepts that made sense four or five years earlier suddenly maybe, make not so much sense.

[00:07:24] Keith Randall: Jeremy, what kind of trends are you seeing right now, whether in the Nashville market or other markets?

[00:07:28] Jeremy Oliver: Yeah, I think like I was discussing earlier, kind of growing markets, or kind of the hot, “it” cities, if you will, like Nashville and Phoenix and others.

[00:07:39] Jeremy Oliver: What you're seeing is kind of a shift away from, the complacency or satisfaction with a long term lease. You're seeing more aggressive landlords wanting to find opportunities to potentially break long term leases to replace a pre-existing tenant with a new tenant on more favorable lease terms because of the increased pricing, et cetera.

[00:08:13] Jeremy Oliver: So what you'll see is an uptick in litigation with landlords, you know, declaring defaults more readily than they otherwise would. Looking for, you know, potential hooks under the lease terms to, you know, arguably gin up an alleged default to gain some sort of negotiating or bargaining power with a tenant.

[00:08:38] Jeremy Oliver: And then you also see kind of on the flip side to Sheila's point. You see kind of more distressed tenants who aren't able to satisfy lease terms. And, you know, it depends on the location, the developer, their appetite to go through kind of the search process to locate a new tenant, as to how willing that landlord or owner might be to negotiate or play ball or grant extensions or rent abatements or deferrals.

[00:09:11] Jeremy Oliver: We saw a lot of that during COVID. But now that's going by the wayside. And then also with the current economy, interest rate hikes, et cetera, it's becoming more expensive to rent, to own, to refinance, et cetera, which has trickled down, impacts from owners to tenants and customers, et cetera.

[00:09:37] Keith Randall: All through the lifetime of a project, you know, even entitlements, construction, even ownership, there's a potential for ongoing litigation. Is that a fair statement?

[00:09:45] Jeremy Oliver: Definitely a fair statement. I mean, really, anytime you see increased activity, especially on the development front where there's a lot of things that can go wrong.

[00:09:58] Jeremy Oliver: Increased activity necessarily brings along an increased amount of risk, and out of that risk there are problems that arise that need solutions. You know, oftentimes clients will want to take a pass at, you know, whether there's some way to negotiate a dispute before litigation, because litigation can be costly, but oftentimes what you'll see is that the parties are just unable to reach an agreement.

[00:10:28] Jeremy Oliver: Or that the dispute is such that there's just no clean way out and you need a third party, whether it's a court, a judge in a courtroom, or an arbitrator in an arbitration, to make that decision for the parties.

[00:10:46] Keith Randall: Sheila, coming back to you, as I mentioned earlier in your introduction, you have a unique background of someone having, you were a chemist in a prior career.

[00:10:55] Keith Randall: Can you tell us how that affects your real estate litigation practice, how that assists your clients or assists you in being able to analyze environmental issues?

[00:11:03] Sheila Woolson: Certainly. So when I first started practicing law, because of my background with chemistry and my understanding of reagents and interactions with the human body and how things could affect both real estate and individuals in their health.

[00:11:23] Sheila Woolson: I began working in the environmental field initially, and as a result I'm familiar with reading a lot of environmental reports, phase one’s, phase two’s. And so I work on the due diligence side, often for clients who are considering transactions to give them an evaluation of the condition of the property.

[00:11:43] Sheila Woolson: And also to help them negotiate if remediation is going to be necessary. Certain states like New Jersey and Connecticut actually have statutes that require purchasers and sellers to agree with the state to remediate certain kinds of contaminated property as a condition for transferring title. So those types of things need to be negotiated up front.

[00:12:03] Sheila Woolson: Similarly, if someone's interested in redeveloping a property that has contamination or has a consent decree against it, maybe because wetlands were filled, i.e. the Sackett case, or some other environmental issues, t here will be consent decrees that need to be negotiated, usually with the United States government, sometimes with the state equivalent of the DEP, that talk about what is required to remediate the property, what needs to be preserved, what activities can and cannot take place, milestones for hitting remediation, all the way down to the level of the type of seed that you have to plant on the property.

[00:12:35] Sheila Woolson: And these kinds of negotiations are very time consuming. But they're important to work out up front, before your client, if you're representing the buyer, acquires the property. Because otherwise the buyer is stuck and has this piece of property that it needs to remediate and it may be very expensive and very time consuming and vice versa,

[00:13:02] Sheila Woolson: if you're representing the seller, you want to make sure that once the deal is over, the seller walks away, the deal is over, and he's not going to, or she's not going to get sued again. These negotiations can take a long time. The history of these cases is very long. I recently read a Third Circuit case where just this year, the Third Circuit affirmed a consent decree that was entered 30 years ago.

[00:13:25] Sheila Woolson: The owner violated the consent decree, got sued again, and now here we are 30 years later. This person can't sell their property, hasn't redeveloped the property, and is now required to remediate the property and that's going to be an impact on any opportunity to sell or redevelop down the road.

[00:13:43] Keith Randall: Yeah, so that's a fascinating background on environmental issues. They're usually done and handled by the time I'm involved, or I hope they are at least in the design and construction part.

[laughter]

[00:13:53] Keith Randall: Obviously, sometimes they come back up as you're mentioning a 30-year-old consent decree. I appreciate you running through that for us. I'd like to move to another area that typically gets done before I get involved. It's often early in the project, much like the environmental issues. And that's zoning or entitlement issues.

[00:14:14] Keith Randall: I know both of you have experience in this area. I was wondering if you could give me some examples of what real estate developers face as it relates to zoning or deed restrictions. Jeremy, we'll start with you. You guys feel free to jump in when you have an example.

[00:14:29] Jeremy Oliver: Sure. I mean, what you typically see is, with regard to zoning disputes, is an area that has been zoned a certain way historically.

[00:14:42] Jeremy Oliver: And the area, the surrounding area, is redeveloping or changing such that the developers want to have it rezoned. So it's rezoning issues really that’s at the heart of the matter. So, what you'll have then is a lot of pushback from the local community. As far as, you know, increased traffic, not adequate parking, the effect on, you know, surrounding or preexisting businesses that have been there a long time and have been, you know, sort of pillars in the community. So you'll see a lot of neighbors file lawsuits to try to prevent, or competitors, frankly, to try to prevent the construction, and development in the first instance.

[00:15:33] Jeremy Oliver: And then what you'll often see too is, Nashville for example, we have a great local government, but they have dealt with a lot of, you know, increased demand, and comes with that, you know, issues. So, frankly, with the influx of people moving to Nashville and the extent of development going on here, the local government hasn’t been able to keep up, and the surrounding areas as well.

[00:16:00] Jeremy Oliver: So then you'll have the beginning of, and we'll talk about this a little bit later, but delays with development, and that permeates from zoning throughout the life of the project and beyond. So, those are some of the things we've seen on the zoning front.

[00:16:22] Sheila Woolson: Yeah. And I would just add to what Jeremy said. Up here, we're seeing a lot of the warehousing being built. So the fulfillment centers being built, old farms being sold, fulfillment centers going up, malls being demolished, fulfillment centers going up. And there's a lot of pushback from the neighborhoods because they don't want the truck traffic.

[00:16:42] Sheila Woolson: They don't want all the litter and everything else that goes with it. They don't want the 24/7 traffic on the roads. And so the neighbors are really banding together and challenging these projects and making them more complicated to accomplish. Other things that we have seen include situations where, for example, dispensaries. Medical marijuana is now permitted in New Jersey, but not everyone wants to have a dispensary in their neighborhood.

[00:17:13] Sheila Woolson: So people are objecting to that. And additionally, you will find in a lot of these various development strip malls and things, there are restrictive covenants that preclude certain businesses or additional certain types of businesses from coming in and opening up, or have limits on the size or whether there can be a liquor store or there can befood that gets taken out or prepared food that gets taken out of the store.

[00:17:43] Sheila Woolson: And so all of these things need to be negotiated upfront. Otherwise you're finding yourself in litigation just to find out whether or not you can build the project that you want to build.

[00:17:53] Jeremy Oliver: That’s a great point, Sheila. And I would add, you know, you can negotiate it the best as humanly possible on the front end.

[00:18:02] Jeremy Oliver: But nobody, at least that I'm aware of, has a crystal ball and can fully negotiate in the contract, you know, what might come down the road. And that's five, 10, 20, 30, you know, and beyond. And the strip malls are a great example. Sheila, I had a case here in Nashville where we represented a national restaurant, and there was a nightclub in the strip mall that was open late beyond the hours permitted in those restrictive covenants that govern the strip mall and surrounding areas and businesses.

[00:18:41] Jeremy Oliver: And there was an increase in criminal activity in the parking lot and it was turning away customers, etc. So we had to go on offense and file suit against the owner of the strip mall, as well as the nightclub owners, and enforce the restrictive covenants. And what you're seeing though is, with a lot of the change that's happening, they're trying to kind of, like the argument that the defendants made was that there's been a change of circumstances, which is a legal theory that hasn't really been implemented much over the past 50 years.

[00:19:20] Jeremy Oliver: It was more from when predominantly farm or residential areas were kind of changing into more commercial developments that, you know, would grant some relief from the restrictive covenants because there was a legitimate change of circumstances. Now what you're seeing is real estate owners and developers kind of flipping that argument and saying, well, you know, now that the area has been developed there should be more ability to do and operate our business however we want, and less restrictions, so invalidate their restrictive covenant in the first instance. So it's just an interesting kind of shift of how legal theories that might have been used offensively for one party are now being used defensively by another party.

[00:20:10] Keith Randall: Thank you both for that background on zoning, entitlements, and issues that landlords and developers run into. The last topic we're going to talk about briefly and sort of as a preview of coming attractions. And that might have been foreshadowed by some construction noises that you're hearing from Jeremy and I in our Nashville office.

[00:20:30] Keith Randall: We also spend a lot of time doing design and construction issues. Developers, once they've managed their entitlements, once they've managed their environmental issues, then have to get into the design and construction, and that is a risky process. Ideally things will go great, maybe they won't. Obviously over the last couple of years COVID and inflation have managed to cause additional risk and litigation in the design and construction world.

[00:20:58] Keith Randall: We anticipate and plan for a future Speaking on Litigation podcast about design and construction issues. Just as a little bit of background on those issues, Jeremy, can you run us through some of the examples of how a design construction process might spawn off litigation?

[00:21:15] Jeremy Oliver: Yeah, definitely. I mean, your bread and butter construction dispute involves one or two primary issues, those being delay, and typically construction contracts will have a target completion date. Substantial completion is kind of the trigger phrase. And it's typically tied to the receipt of a certificate of occupancy. And then there are built-in liquidated damages provisions typically in the construction contracts, that if that substantial completion date is not met damages accrue on a daily, weekly, monthly business, and we're seeing significant amounts that can quickly get into 7 figures and beyond. So delay is one, and defects, design and construction defects are the other. And something we've seen a big uptick in, since COVID, are both the supply chain disruptions and labor shortages.

[00:22:26] Jeremy Oliver: And I think with both of those, obviously they lend themselves to delay claims, but also defects, because contractors are having to find subcontractors that are in extremely high demand, not as much supply of labor. So, you know, the quality of workmanship isn't quite what it was and what it arguably should be.

[00:22:51] Jeremy Oliver: So you're seeing a lot of defect claims, and then your typical kind of lien claims, you know, if a party has been paid, they'll file a lien. It'll affect the title. So when the owner/developer is going to refinance, which typically occurs during the construction of a project, obviously dependent upon the economic conditions, but that'll mess up or interfere with the owner's ability to refinance.

[00:23:18] Jeremy Oliver: So it's just kind of this cascading effect of disputes that starts at the top and trickles all the way down to the kind of lowest tier subcontractor.

[00:23:28] Keith Randall: Thanks for that, Jeremy. Like I said, we'll be having a future podcast on Speaking on Litigation about design and construction issues. We look forward to that as well.

[00:23:38] Keith Randall: In closing with two guests today, I just want to ask one more question. What should aspiring or current developers consider the biggest risks in their project? What should they be losing sleep over when they're thinking about financing, when they're just dreaming about future projects, or when they're in the midst of projects?

[00:23:55] Sheila Woolson: From my perspective, I think that the things that they should be most concerned about are delays that can be caused by a variety of reasons that you can't control. How that's going to affect the project. The rate of change in the world in which we live is accelerating exponentially. So what you thought was a good project two years ago might not be a good project now.

[00:24:22] Sheila Woolson: And so I think that developers need to be always keeping in mind, do I have a pivot if this project gets delayed, if it turns out that what I thought was a great project no longer is a great project because of those delays, if there's, you know, God forbid, another pandemic or another unforeseen issue, do I have enough flexibility that I can get out or get the project complete and still make an economically viable deal. I think it, from my perspective, would be the biggest concern because, you know, we have all heard that phrase, the known unknowns and the unknown unknowns. And I think the unknown unknowns are the things that always keep me awake at night.

[00:25:06] Jeremy Oliver: Yeah. And believe it or not, Sheila and I did not exchange notes on this question, but I would say the exact same thing.

[laughter]

[00:25:14] Jeremy Oliver: Delay. And really in three phases. Two we've already really talked about. One on the zoning side. You know, I think developers need to expect that their ability to break ground is going to be longer than what they thought. So that's just the first instance of delays. Second, through the construction itself.

[00:25:40] Jeremy Oliver: Because of the labor shortages, the supply chain disruptions that we previously discussed, there are going to be delays, you're not going to hit your substantial completion date when you thought. So anticipate that. And then third, I think delays in whether the owner is going to continue to hold the property and lease it.

[00:26:02] Jeremy Oliver: I think there's going to be a dragged out timeline as far as reaching, kind of, critical mass occupancy, or if an owner is planning to sell, whether it's to a single buyer or in a condominium situation to multiple buyers. I think they're going to carry the inventory longer than they had anticipated, which is going to impact financing, the overall cost, and their ability to redeploy the sales proceeds and that capital into future projects.

[00:26:32] Jeremy Oliver: So, I think developers should be, you know, hopeful to meet the timelines, but realistic that they're probably not going to be met. And as a result, save some money on the front end and throughout the course of the project, to have a little bit of a war chest that's project specific to kind of offset some of those delays and potential disputes that may arise.

[00:27:08] Keith Randall: Great. Thank you both, Jeremy and Sheila, and you, audience out in legal podcast land. If you like the information we've shared today, please take a moment to subscribe to the show. Speaking of Litigation is available on YouTube and wherever you get your podcasts.