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These past five weeks, I’ve written about several real estate laws – both Federal and Minnesota – that, in my opinion, do not make sense any longer.  I’ve done this to show that good intentions sometimes produce unintended adverse results.  More importantly, some laws are impeding the recovery of the real estate market.

Now, we close out this series of posts with a set of statutes that I think qualify as the most useless real estate law around:  Minnesota’s Torrens system of land title registration.

Many people whom I talk to who are not from Minnesota – including several attorneys – are surprised to find out that Minnesota has two systems of land title registration:  the abstract system, which most other states follow, and a separate system called the “Torrens” system.  This second system, adopted in 1901 and named after Sir Richard Torrens who created a method of registering ships in 19th century Australia, requires interests in real property to be memorialized on a certificate of title, and interests not so memorialized are not valid.

The purpose of the Torrens system is to create conclusive evidence of interests in real property.  Documents that are submitted for recording are reviewed by the county’s Examiner of Titles, and the Examiner’s office’s approval is required before the document can be recorded with the county’s Registrar of Titles (which, by the way, is an office separate from the County Recorder).  The idea behind this system is to keep stray interest, fraudulent documents, etc. from entering the recording system and creating later title disputes.

However, as I’ve written in a prior post, the Torrens statutes have not brought an end to disputes and litigation; rather, the disputes over Torrens titles are just different in scope from title disputes over abstract property.   Take the case of In Re Collier, 726 N.W 2d  799 (Minn. 2007), in which the Minnesota Supreme Court overturning a lower court decision involving a mortgage erroneously recorded in the abstract records rather than the Torrens records.  Joshua Collier, upon discovering the error, purchased the property from the original owner and quickly registered his interest.  The Minnesota Court of Appeals, citing the longstanding purpose of the Torrens system that one need look no further than the Certificate of Title to determine the interests registered on a particular parcel of property, held that the subsequent foreclosure of the mortgage was invalid as against a subsequent purchaser of the property and that Mr. Collier was a “bona fide purchaser”.  The Supreme Court overturned, holding that a party who had actual knowledge of an interest, regardless of whether the certificate of title showed the interest or not, Collier’s actual knowledge of the mortgage made it impossible for him to be a bona fide purchaser.

At the end of the day, the Minnesota Supreme Court made the right decision, but in the process, it called into question the fundamental purpose of the Torrens system; that is, if the interest is not listed on the certificate of title, it is not valid.  Collier’s significance is that it created an exception to that basic premise and in the process, equalized the Torrens and abstract systems.

A more recent Court of Appeals decision, Imperial Developers, Inc. v. Calhoun Development, LLC, et al, again demonstrated the absurdity of the Torrens system, when the Court held that to be valid, a mortgage must be recorded with the Registrar of Titles and memorialized on the Certificate of Title.  In other words, if the Registrar of Titles errs in including a mortgage on the Certificate (which was the case in Imperial Developers), the holder of that mortgage interest was out of luck.  It remains to be seen whether the Minnesota Supreme Court will again intervene and correct this decision.

In Re Collier and Imperial Developers are just two examples of court decisions which would not have existed if Minnesota had only the abstract system.  These types of cases, along with the requirement that a “proceeding subsequent to registration” must be started after any foreclosure in order to obtain a new Certificate of Title for the new owner, start to make the Torrens system look like a “make work” program for real estate attorneys.  

One final point about the Torrens system that favors its extinction:  it is used in only three of Minnesota’s 67 counties.  Hennepin (where Minneapolis is located), Ramsey (St. Paul) and St. Louis (Duluth) use the system with some frequency, but other counties do not, meaning that without a repeal of the Torrens system, Minnesota will always have two separate recording systems and, hence, more cases such as those mentioned above. 

With Minnesota and its counties in a budget crunch, a repeal of the Torrens system could relieve some of the strain on the judicial system (by not having to deal with cases such as Collier) and loosen up county budgets for more important priorities (since the personnel that comprise the county Torrens offices would no longer be needed). 

The Torrens system was enacted to bring clarity to real estate titles in Minnesota.  Instead, it has traded one set of title disputes for another.  For that reason and the others I’ve mentioned herein, the system has outlived its usefulness and lands at No. 1 on the list of the “Top Five Silliest Real Estate Laws.” 

Now that we’ve come to the end of my “screeds”, if you’re a reader of this blog, what should you do with this information?  Spread the word about these laws to others and contact your elected officials.  As I’ve shown, some of these laws go beyond silliness and are adversely affecting our real estate market and its recovery.  Governments at all levels are seeking solutions to the housing crisis and seem to believe that passing new laws – loan modification and short sale programs, tax credits and the like – are the answer, when in fact it could be the repeal of existing laws that are the key to recovery.

Deciding between the No. 1 silliest real estate law and the runner-up was a not an easy decision.  However, when I post about No. 1, you’ll see why this law ended up in the No. 2 slot, even though it was a photo finish: the “extended rescission rights” of the Federal Truth in Lending Act of 1968 (“TILA”), found at 12 CFR 226.15(a)(3). 

TILA was enacted to protect consumers in certain credit transactions by requiring disclosures of certain information about the transaction prior to the consumer entering into the transaction.  Where a transaction leads to a lien on a consumer’s property – such as a mortgage lien – the consumer is given the right to rescind, or cancel, the transaction, within a specified time period.  TILA also requires that the consumer be provided with two (2) copies of a document called a “Notice of Right to Cancel” which informs the consumer of this right of rescission.

In regards to mortgage refinancing transactions, the rescission period is three (3) days…in most cases.  However, under a provision which was paid little attention to until the recent housing market collapse, the rescission period can be extended to three years.  How does this happen?  If the borrower is not provided with the two (2) copies of the Notice of Right to Cancel, 226.15(a)(3) pushes the time for rescission out to three (3) years.

Here’s the astounding part:  the Notice contains a recital that the borrower received two copies of the Notice at closing, and is required to be signed at closing.   TILA, however, provides that the existence of a signed document from the borrower stating that he or she received two (2) copies only creates a rebuttable presumption that the two (2) copies were actually received.  Here’s the more astounding part:  even if the loan is refinanced and paid off, the borrower can still rescind it within the three year period.

With several property owners defaulting on their mortgage loans, the extended rescission rights provision has become the weapon of choice of the consumer law bar.  Defaulting borrowers simply have to claim that they did not receive two copies of the Notice of Right to Cancel – remember, having their signature to the contrary only creates a rebuttable presumption that they actually received it – and they can create a major headache for their lender (or, in some cases, their former lender).  Thus, attempts to exercise these rescission rights have become a tool to force a modification of a mortgage loan which is in default.

Here’s the part that angers me the most:  attorneys who know better are, in my opinion, misleading people who are already struggling financially into thinking that they can “cancel” their mortgage entirely.  That’s not, however, how the TILA rescission rights work.  These rights only give the borrower the opportunity to redeem their property at a price less than the full outstanding balance of the loan.  Any closing costs and interests paid on a loan where the rescission rights apply are subtracted from the outstanding balance of the loan, and the resulting sum must be paid by the borrower in order to rescind.  I question how many borrowers who have defaulted on their mortgage loan(s) because of an inability to pay can afford to redeem for much more than the payments missed in the first place.  What’s worse is that these folks are being solicited, sometimes to pay money up front to try this “Hail Mary” pass and save their property. 

TILA’s rescission rights were enacted to prevent predatory lending practices; they were not intended to be used as a means for borrowers to get out of a legitimate obligation.  Unfortunately, that’s not currently the case, which means that TILA’s extended rescission rights lands on my list of the five silliest real estate laws. 

Stay tuned for the winner…

One of the things that I’ve learned as a real estate attorney from the housing market downturn is the effect that seemingly minor laws can have on the free flow of transactions in residential real estate.  Almost daily I field questions from clients and prospective clients about possible deal structures that make economic sense but cannot proceed due to a legal issue.  The issue could be licensing (which rears its head when a real estate investor wants to buy and sell a large number of properties), but more often than not it is a federal regulation promulgated by the U.S. Department of Housing and Urban Development (“HUD”) and administered through the Federal Housing Administration (“FHA”) known as the “Seasoning Rule”, No. 3 on our list of the Top Five Silliest Real Estate Laws.

On May 1, 2003, HUD imposed a 90 day title “seasoning requirement for all new FHA insured mortgage loans.  This rule can be found at 24 C.F.R. § 203.37a. “Seasoning” refers to the length of time that the seller has owned the property. Home buyers cannot obtain a conforming mortgage if they are putting less than 20% down and the seller hasn’t owned the property for at least 90 days.  The rule was originally put in place to prevent certain “flipping” transactions where a party would purchase a property and immediately sell the same property at a marked-up price.

Like many real estate laws, the objectives behind the Seasoning Rule might have been laudable.  When the real estate market was booming in the late 1990s and early 2000s, a market developed for investors to buy properties and quickly turn them for a profit. 

Unfortunately, a few bad actors ruined it for everyone else.  A practice known as “equity stripping”, where homeowners in foreclosure were induced to sell their home to someone who was offering to help them avoid foreclosure and then lease it with an option to buy it back or buy it back on a contract for deed, only to have the terms of the repurchase be such that default was inevitable, led to government intervention into the market.  Minnesota went so far as to pass a foreclosure reconveyance law and, around the same time, the Seasoning Rule came about.

In the current market, however, the name of the game when it comes to housing prices making a recovery is to clear out the inventory of distressed properties so as to normalize the supply and demand curve in the residential real estate market.  The Seasoning Rule, however, frustrates those efforts as it forces investors to hold properties for at least 90 days before reselling it if the end buyer(s) are obtaining an FHA-insured mortgage.  Many investors, however, can close on, rehab and resell their properties in substantially less time, and the seasoning requirement – since it applies to so many of the mortgage products currently on the market – is a deterrent to their business model. 

Perhaps in recognition of this fact, HUD recently announced the temporary suspension of the Seasoning Rule for sales to first time home buyers.  In my opinion, HUD should go further and suspend the rule in full (as it did for a period of time in 2008) or, even better, repeal the rule in its entirety, as this regulation is a classic example of how government interference in the real estate market adversely affects the market.

Continuing with our theme of real estate laws whose time has come…and gone…No. 4 on our list is the abandoned property provisions of Minnesota’s landlord-tenant statutes, Minnesota Statutes Chapter 504B.

I work with a lot of real estate investors who are purchasing foreclosed properties, rehabbing them and converting them into rental properties.  When asked about whether they should take title to a property in their own name or form an entity, I typically point to Minnesota’s landlord-tenant laws as justification for the latter.  Minnesota’s landlord-tenant laws are perhaps the most tenant-friendly in the nation.  Certainly, a statutory scheme which does not permit self-help to recover possession of a rental property is a good thing, but there are provisions of Minnesota Statutes Chapter 504B that ignore practical realities and afford too many rights to a defaulting tenant, to the detriment of the landlord’s bottom line.

Case in point:  Minn. Stat. § 504B.271, which governs the handling of a tenant’s personal property following termination of the tenancy.  This law provides that if a tenant abandons rented premises, the landlord may take possession of the tenant's personal property remaining on the premises, and shall store and care for the property. The landlord has a claim against the tenant for reasonable costs and expenses incurred in removing the tenant's property and in storing and caring for the property.

Here’s the absurd part of the law:  the landlord may sell or otherwise dispose of the property 60 days after the landlord receives actual notice of the abandonment, or 60 days after it reasonably appears to the landlord that the tenant has abandoned the premises, whichever occurs last, and may apply a reasonable amount of the proceeds of the sale to the removal, care, and storage costs and expenses. Any remaining proceeds of any sale shall be paid to the tenant upon written demand.

Prior to the sale, the landlord shall make reasonable efforts to notify the tenant of the sale at least 14 days prior to the sale, by personal service in writing or sending written notification of the sale by certified mail, return receipt requested, to the tenant's last known address or usual place of abode, if known by the landlord, and by posting notice of the sale in a conspicuous place on the premises for at least two weeks.

In other words, even though the tenant has left behind personal property in their rented property, usually in the wake of an eviction for nonpayment of rent, the law requires the landlord to store the abandoned property for two months.  What’s worse is that the landlord can be held liable for damages if something happens to this property during this time. 

The abandoned property statutes unnecessarily extend the time with which the landlord has to deal with its past tenant.  For small, private landlords, many of whom use their rental income to supplement income from full-time employment, these laws can wreak financial havoc on their business operations, all in the name of some abstract concept of “fairness.”  When a tenant stops paying rent and forces the landlord to evict them, the landlord needs to be able to focus attention on finding a replacement tenant to keep a steady stream of rental income going sufficient to cover the holding costs of the property.  The landlord cannot and should not be forced to worry about what to do with its past tenant’s “junk”.

Frederic Bastiat once wrote that “property does not exist because there are laws, but laws exist because there is property.”  There is possibly no segment of our economy which has spawned more laws than the real estate market.  Legislation, whether state or federal, however, is seldom perfect and inevitably there are going to be a few laws passed that might sound good in theory, but play out much differently in practice.

I am going to devote my next five blog posts to a discussion of five laws which, in my experience as a real estate lawyer, have gone awry.  The original intents in enacting these laws may have been laudable, but the end result of each of these laws has been either an overabundance of litigation, inability to meet the original intent of the law(s), or simply the fostering of absurd results. 

Now then, without further delay, let’s start with No. 5 on my list of laws that need to go:  Minnesota Statutes Chapter 327N aka the Foreclosure Reconveyance Statute.  

In the early to mid 2000’s, as housing prices soared, a practice called “equity stripping” received a great deal of attention.  Equity strippers would contact homeowners who were in foreclosure and offer to “help” them by taking title to the property and then selling it back to the homeowner on a contract for deed or lease with an option to purchase.  The structure of the resale transactions typically would lead to the homeowner defaulting on the contract or lease and losing the property to the party providing the “help.”

In 2004, consumer friendly Minnesota became the first state in the U.S. to enact a law governing these types of transactions.  If the transaction is a "foreclosure reconveyance," Minn. Stat. § 325N.11 requires that all of the details of the transaction be contained in a written contract signed by the foreclosed homeowner and the purchaser. Minn. Stat. § 325N.12 identifies a list of terms that this written contract must contain, including a recitation of the total amount of consideration to be provided to the foreclosed homeowner and a notice to the foreclosed homeowner that it has five business days to cancel the contract. The statute also requires that a form "Notice of Cancellation" be attached to the foreclosure reconveyance contract. Chapter 325N also creates other substantive requirements that must be satisfied in any transaction that qualifies as a foreclosure reconveyance. For example, before entering into the contract, the purchaser must verify that the foreclosed homeowner has a reasonable ability to pay for the subsequent reconveyance. This will be presumed if: (1) monthly payments for housing expenses (which include principal, interest, rent, utilities, insurance, taxes, and association dues) and (2) monthly principal and interest payments on other personal debt of the homeowner, do not exceed sixty percent of the homeowner's monthly gross income. The purchaser may not rely solely upon a statement of assets, liabilities, and income furnished by the foreclosed homeowner, but instead must conduct independent due diligence.

Finally, if the property is ultimately not conveyed back to the foreclosed homeowner, Minn. Stat. § 325N.17(b)(2) requires the purchaser to pay the foreclosed homeowner, no later than 150 days following the owner's relinquishment of possession of the property, consideration in an amount that is at least eighty-two percent of the fair market value of the property (as determined by a licensed appraiser). This "consideration" includes payments made by the purchaser to satisfy debt or other legal obligations of the foreclosed homeowner. Thus, the statute essentially caps at eighteen percent the amount of equity an investor may "strip" from a residential property in a foreclosure reconveyance transaction.

The equity-stripping statute also creates a private right of action in favor of the foreclosed homeowner for any violation of its provisions. The foreclosed homeowner may recover exemplary damages and attorneys' fees incurred in prosecuting an action in the event of a violation of the statute by a purchaser. Additionally, a foreclosure purchaser may be prosecuted criminally for certain violations.

The equity stripping statute could have made a significant impact on Minnesota’s real estate market, but for the crash in housing values in mid-2006.  With that development, the “equity strippers” experienced financial difficulties from being over-leveraged and many filed bankruptcy.  Homeowners who could have benefitted from the foreclosure reconveyance statute therefore lacked a means of recovery, and found themselves out of luck.

Minnesota’s foreclosure reconveyance statute is a perfect example of legislating on special circumstances.  Passed at a time when the housing market was riding high, it now serves little or no purpose in an era of depressed property values (many of which lack any equity to strip) and should be looked at for repeal.

A few years ago, with the housing market at its peak, many developers created housing developments known as “planned communities.”  These neighborhoods were cities within cities, and they came complete with their own form of quasi-government, i.e., the homeowners association.  These associations are established for purposes of maintaining – and financing the maintenance of – common amenities such as neighborhood pools and community centers.  Residents of the neighborhood are members of the association, and these members pay dues – typically monthly, quarterly or semi-annually, depending on the nature of the association – in order to cover the expenses of maintaining these common amenities.  The trade off for these amenities are tight controls on what a homeowner can do to his or her own property, at least until the developer sells off its lots, completes the development and moves on.

As housing prices escalated, these developments were held out as upscale and exclusive because of these common amenities, in contrast to other developments with no such benefits.  As the housing market went south, however, the residents of these neighborhoods found themselves in charge of their associations much sooner than anticipated.  Developers lost their remaining lots to their lenders, and early transitions of the homeowners associations to resident control occurred in numerous circumstances.  In some instances, the lender ended up controlling the association.

The transitions have, in many instances, not been easy.  In part, this is because these types of homeowner association are often times not governed by any state statutes.  In Minnesota, for example, single family homes are not governed by the Minnesota Common Interest Ownership Act (which governs townhomes and condominiums).  Instead, these associations are governed by the declaration of covenants (which was prepared by the developer and/or its attorney), state non-profit corporation statutes, and any rules and regulations which have been passed by the board of directors.  Some of these associations hire professional management companies, while others make a decision to be “self-managed.” 

For associations which have been transitioned to resident control prematurely, there are a number of issues which must be dealt with.  First, the articles of incorporation, bylaws, declaration of covenants and any previously enacted rules and regulations should be reviewed by an attorney and any provisions which existed solely for the developer’s benefit should be expunged.  Second, the association’s Board should review its operating budget and determine how to fulfill its maintenance obligations using only the dues from existing homeowners, and budget cuts and/or dues increases may be necessary to compensate for the fact that less than all of the expected dues paying homes are yet constructed.  Third, a clear collections policy should be established and communicated to the residents so that the dues that can be legally assessed are paid in a timely manner or, if not so paid, the Board can move quickly with legal action to recover these dues from the non-paying homeowner. 

I know whereof I speak, as my own association went through a very painful transition in 2007-2008.  I served as a member of our Board during these times, and we inherited over $50,000 in debt left in the association from the time of developer control for unpaid lawn maintenance and snow removal bills, faced threats of liens being filed against our homes for these bills and dealt with large amounts in outstanding dues from homeowners who were in foreclosure.  Fortunately, we were able to get the bills paid, dues collected and liens removed. 

One last word of caution to homeowners who find themselves on the Board:  if you do not already have a conflict of interest policy, get one in place ASAP!  Conflict of interest policies set forth guidelines of what constitutes a conflict of interest, and if one arises, how it is to be disclosed and how the Board member with the conflict is supposed to act (typically abstaining from the decision making process as to a particular course of action).  Conflict policies have become standard for almost all non-profit organizations in order to ensure that the Board members are putting the organization’s interests ahead of their own.

The consequences of not having a conflict of interest policy can be disastrous.  For all the good our initial resident Board did for our association and our neighborhood, we allowed a major problem to be created when a general contractor who lived in the neighborhood took over our architectural control committee (which has authority to review and approve designs for decks, patios and additions – all things that he does in his business).  The perception became, rightly or wrongly, that unless you used that individual to build your deck, you would not obtain approval from the committee for your planned improvement.  In one instance, this Board member took action at the behest of a resident who had hired him to build a deck.  It took me resigning in protest of these actions for the remaining Board members to realize the need to enact a conflict of interest policy and make the Board member at issue, as well as the other Board members sign it. 

The issues in my association, which have arisen in many associations where the developer left before completion of the neighborhood, are an unfortunate side effect from the residential real estate market’s decline.  These planned neighborhoods, billed as “paradise”, have become anything but.

Saturday's St. Paul Pioneer Press has an outstanding opinion piece which discusses the important role which entrepreneurs play in spurring on an economic recovery.  The article, written by Arnold Kling, a member of the Mercatus Center's Financial Markets Working Group at George Mason University, and Nick Schulz, a fellow at the American Enterprise Institute, goes on to argue that the government's attempts to spur on recovery are doomed to failure, and that policy makers should instead be focusing on taking the necessary steps to unleash the power of entrepreneurs. 

I have been telling people for months now that entrepreneurs and microbusinesses are the key to America's economic recovery, and this article is the most artiiculate one I've seen in describing what needs to happen from a government perspective to encourage these efforts.

You can read the article here.

Minnesota’s Torrens system of land registration can be a confusing one for those not familiar with it.  This system, enacted in 1901 and based upon a 19th century Australian system of registering ships established by Sir Robert Torrens, requires interests in real property to be memorialized on a certificate of title, and interests not so memorialized are not valid.

The purpose of the Torrens system is to create conclusive evidence of interests in real property.  Documents that are submitted for recording are reviewed by the county’s Examiner of Titles, and the Examiner’s office’s approval is required before the document is recorded with the county’s Registrar of Titles.  The idea behind this system is to keep stray interest, fraudulent documents, etc. from entering the recording system and creating later title disputes.

Despite its laudable goals, the Torrens system at times resembles a “make work” program for Minnesota real estate attorneys.  For example, in order to have a new certificate of title issued after a foreclosure sale regarding Torrens property, the new owner must complete a procedure known as a “proceeding subsequent to registration.”  Additionally, each year there seems to be at least one significant case from the Minnesota Court of Appeals or Minnesota Supreme Court involving a title dispute over Torrens property.

The latest case is Imperial Developers, Inc. v. Calhoun Development, LLC, et al, Case No. A08-1883, decided by the Minnesota Court of Appeals on December 8, 2009.  In this case, the Minnesota Court of Appeals was asked to decide what it meant for a mortgage to be “of record” in the Torrens system when the Registrar of Titles records the mortgage but fails to memorialize it on the certificate of title for the subject property. 

The facts of the Imperial Developers, Inc. case are as follows:  one developer sold three lots to another developer, who financed the purchase and granted mortgages on the three lots to two separate lenders.  The Hennepin County Registrar of Titles recorded the warranty deed and the mortgages, but failed to memorialize the mortgages on the certificate of title for two of the three lots.  By the time the error was corrected, two mechanics lien claimants completed work on one of the lots and recorded mechanics liens against that lot.  Predictably, the developer defaulted on the mortgages and failed to pay the mechanics lien claimants, which landed everyone in court fighting over priority to foreclose upon the property. 

The District Court found that the mortgages were of record and the mechanics lien claimants had actual knowledge of them, even though they were not memorialized on the certificates.  The Court of Appeals, in reversing the District Court’s finding as to the mortgages being “of records”, concluded that to be “of record” for purposes of the Torrens system, Minnesota Statutes Section 508.55 requires that a mortgage must be filed for recording and memorialized on the certificate of title; one without the other is not sufficient.  The Court of Appeals, in remanding the case back to the District Court for further determination of whether the mechanics lien claimants had “actual knowledge” of the mortgages given the reversal on whether the mortgages were “of record”, alluded to the mistake by the Hennepin County Registrar in not memorializing the mortgages on the appropriate certificates, and suggested that the lenders should seek redress through the general assurance fund established by Minnesota Statutes Section 508.76, subd. 1. 

The dissenting opinion by Judge Heidi Schellhas (who, it should be noted, happens to be one of only a few judges on the Court of Appeals who was a real estate attorney in private practice prior to appointment) appears to be the better reasoned opinion.  Judge Schellhas, rather than use an abstract statutory construction, applies a more common sense approach:  regardless of whether the mortgages were memorialized on the certificates, the mortgages were actually recorded and document numbers were assigned.  Judge Schellhas further noted, correctly, the lag time between recording documents in the Torrens system and the Registrar issuing a new certificate.  Under the majority’s opinion, parties are left at the mercy of the county registrar to make their interests be “of record”, with their only recourse for errors being a claim against the general assurance fund. 

It is my prediction that this case will be appealed to the Minnesota Supreme Court and Judge Schellhas’ dissenting opinion will be adopted by a majority of the Justices.  Regardless, the Imperial Developers, Inc. case adds yet another Torrens-inspired dispute to the annals of Minnesota real estate law and again begs the question of whether the Torrens system is achieving its goal of clarity, or simply adding a different level of confusion.

 This morning was our annual viewing of the classic movie, Holiday Inn.  This film is, of course, best known for the debut of Bing Crosby singing “White Christmas”, and was the prequel to the Bing Crosby/Danny Kaye film named after the famous tune. 

The plot of Holiday Inn is simple enough:  Jim Hardy (played by Bing Crosby) decides to convert his Connecticut farm into an inn that is open only on holidays.  He finds a young lady named Linda Mason (played by Marjorie Reynolds) to team with him in the fifteen or so performances throughout the year.  Jim’s plan is interrupted upon a visit from his performing friend Ted Hanover (Fred Astaire) on New Year’s Eve where Ted discovers Linda and seeks to make her his new dancing partner.  After considerable scheming on Jim's part to keep Linda and Ted apart, they leave together for Hollywood to star in a film based on the Holiday Inn.  In the end, Jim and Linda are reunited, as are Ted and his former dancing partner, Lila Dixon (Virginia Hale) and all join in the New Year’s Eve finale. 

Aside from some classic music written by the great Irving Berlin, along with Fred Astaire’s dance moves (my personal favorite is his 4th of July number where he dances through exploding firecrackers), the storyline of Jim Hardy’s attempts to keep Linda Mason working at the Inn contains some pertinent lessons for today’s employers, including the following: 

1. Subject to Some Narrow Exceptions, Contracts Need to Be in Writing to be Enforceable.  At one point, Linda Mason promises Jim that she will perform at all shows at the Holiday Inn for the year.  While she initially cites this promise to Ted Hanover when he asks her to leave with him to be his new dancing partner, ultimately she chooses to leave with Ted for Hollywood.  Written contracts are the law’s way of making promises enforceable.  Handshakes, promises, “gentlemen’s agreements”, whatever you want to call them, are no substitutes for written agreements.  This can be a difficult discussion to have, as the suggestion of having a written contract can, to some, imply a lack of trust in another party; nonetheless, a written contract is the only way for all parties to have a clear understanding of their obligations and what rights and remedies each party has to enforce the obligations of the other party/parties.

2. Absent a Written Agreement, Employment Relationships Are “At Will”.  While Linda agreed in February to perform at every show for the year through December, at the conclusion of the 4th of July show, and following Jim’s scheming, Linda leaves for Hollywood, not to return until the New Year’s Eve show.  Most employees in Minnesota and other states have the same freedom of contract that Linda did; that is, they can leave their employment whenever they wish, for any reason or no reason.  If a business owner has a key employee that is integral to the success of the business, then that employee should have a written employment agreement that provides for a fixed term of employment.  An employer can also include a covenant not to compete (described more fully below) to deter a key employee from leaving to work for a competitor.  Absent this type of agreement, the key employee can leave at any time.

3. Use Non-Compete Agreements With Key Employees.  Linda Mason left the Holiday Inn for a more lucrative job on a Hollywood film, and Jim Hardy could do nothing but watch her leave.  What if Linda had signed a non-compete agreement with Jim barring her from leaving for another performing job?  Covenants not to compete can be a powerful tool to protect your business from defections of top talent.  Courts, however, do not favor these arrangements and employers must therefore use them only when appropriate and, even then, these restrictive covenants must be narrowly tailored to balance the interests of both employer and employee.  To enforce a covenant not to compete against a former employee, the employer must show (i) the covenant not to compete was supported by consideration when it was signed (if the consideration for the covenant is the continued employment of the employee, then the covenant must be signed prior to the start of employment to be valid); (ii) the covenant protects a legitimate business interest of the employer (in other words, an employer may have grounds to have a sales employee sign a non-compete agreement but not the cleaning crew); and (iii) the covenant is reasonable in duration and geographic scope to protect the employer, without being unduly burdensome on the former employee's right to earn a living. 

Holiday Inn, of course, ends on a high note, with Linda returning to Jim and the Inn and Ted reuniting with his former dance partner and rekindling his friendship with Jim.  Most real-life employers are not as fortunate, which is why these simple legal tips can help prevent unhappy endings with employees.

When I’m consulting with potential clients on possible lawsuits, I often hear them say that “this case is a slam dunk.”  When I hear this, I feel that it is my job, as someone with experience in handling legal disputes, to educate these individuals that that there is no such thing as a “slam dunk” and the odds of victory in any lawsuit is, at best, 50-50.

I do not give this caution because I doubt my skills or those of my colleagues in litigation matters.  Rather, during my time in law school, I was taught that the law is not always black and white.  Often times, for better or for worse, the particular facts of the case, the personalities of the parties and public policy can all weigh into a court’s decision in a particular case.  My experience in practice has borne this out.

My contracts law professor taught us about the 1917 case of Wood v. Lucy, Lady-Duff Gordon, where the famous Justice Cardozo of the New York Court of Appeals established new legal precedent when he held Lucy to a contract that assigned the sole right to market her name to her advertising agent, Otis F. Wood, despite the fact that the contract lacked explicit consideration for her promise.  Lucy, a leading British fashion designer in her time, and her husband had been passengers on the ill-fated maiden voyage of the RMS Titanic in 1912, and many rumors had circulated that they had bribed their lifeboat crew not to return to save swimmers for fear that the boat would be overloaded and sink itself.  Some have noted Judge Cardozo’s disdain for Lucy in parts of his opinion, and my professor used this case to explained to us how Lucy’s wealth and negative image may have inspired the court to make new law in order to find against her.

The ability of factors other than controlling legal precedent continue to influence court decisions to this day.  Take, for example, a recent Minnesota Supreme Court decision, W3ckUiD3aPc:_Yyc:aULPQL7PQLanchO7DiUsr">David Lee Laase vs. 2007 Chevrolet Tahoe.  In this case, the Minnesota Supreme Court held that if two Minnesotans own something together, and one of them commits a crime that causes that property to be seized, the innocent co-owner is not entitled to get it back.  The Laase case involved a woman who was arrested for drunken driving and, as a result, had her 2007 Chevrolet Tahoe seized.  Her husband, the co-owner of the truck, argued that he was an “innocent owner” and should not lose his 2007 Chevrolet Tahoe pickup truck because of his wife’s actions.  The Minnesota Supreme Court disagreed, and stated that too often the “innocent owner” defense has been used to put a jointly-owned vehicle back in the hands of the dangerous driver.  Certainly, public policy in favor of prevention of drunken driving weighed into the Court’s decision, where Justice Lori Gildea wrote: “Because interests cannot be apportioned, the Legislature seemingly intended that what happens to one owner should happen to all owners.”

Why is this an interesting case?  Because five years ago, the same court (with a few different justices) stood for the opposite proposition.  The case of Kipp v. Sweno, 683 N.W. 2d 259 (Minn. 2004) involved a couple who obtained a personal judgment against the builder of their home.  After obtaining the judgment, the couple sought to foreclose upon the builder’s home, which he owned jointly with his wife (at the time of the case, Minnesota’s homestead exemption for judgments was only $200,000, and the builder apparently had that amount of equity in the home based upon his interest in the home). 

In the Kipp v. Sweno case, the Supreme Court’s finding did not support the proposition that “what happens to one owner should happen to all owners”, as it stated in the Laase case.  Instead, the Court carefully analyzed the longstanding policy in Minnesota to protect the homestead and noted that, by allowing this personal judgment to be foreclosed, the joint tenancy between the builder and his spouse would be severed and she would lose her interest in the home even though she was not liable for the debt.

Are the Laase and Kipp v. Sweno cases inconsistent?  Perhaps, as the Minnesota Supreme Court seems to be saying that, even if you have done nothing wrong, you will nonetheless be held responsible if your spouse drives drunk but not if your spouse has a judgment against them.  I do not necessarily disagree with the Court’s decision in Laase, as I certainly want the courts to do everything necessary to put drunk drivers behind the wheel.  As an attorney who represents several small lenders, I do take issue with the earlier Kipp v. Sweno as it has created difficulties in the area of personal guaranties on large real estate loans.  However, my point in writing this is to point out that there is never a sure thing in our court system.  Public policy, the particular facts of the case, or the litigants’ personalities and demeanor in court can all, for better or for worse, weigh in the court’s decision in a particular case, regardless of what controlling legal precedent might be.