California real estate has always been a desirable investment and may seem even more attractive in light of recent uncertainty in the financial markets. An important difference between owning real estate and owning stock, though, is the risk of a lawsuit.

Aside from the risk related to the ownership of investment property, the process of buying or selling such property can easily lead to litigation as well. Financial models developed for investment property rarely consider the increasing cost of litigation, which could result from the purchase transaction alone. To that end, it is important to know how to reduce the likelihood of claims between buyers, sellers, and land users of investment real estate.

Limited Liability Companies, Limited Partnerships

There are a number of benefits, including tax benefits, for acquiring or selling property using a limited liability company or limited partnership. For example, since the majority of lawsuits in real estate transactions are brought by buyers against sellers, if the seller of a property is a business entity - as opposed to one or more individuals - any lawsuit relating to the transaction may be limited to the resources of the selling company, rather than the wealth of its principals. Of course, there is always the possibility that one or more of the principals could be named in the lawsuit, but it is far more difficult to prove liability for an individual who is properly acting within the scope of company operations than it is when one or more individuals sell property held in their own name.

The advantages of the LLC form are further increased when a property is held by more than one individual or firm. An LLC can help eliminate the risk that a plaintiff can convince a court that the owners were involved in a "partnership," where one "partner" may be liable for the acts of the others, even without knowing the others' actions or having intended to form a partnership.

For those buying property, the offer should be made in the name of the LLC - not the name of one or more individuals. Particularly as the real estate market slows, sellers may be more likely to consider legal action against buyers when a transaction is not completed. Again, if the offer is made in the name of a business entity, rather than that of an individual, the lawsuit may be limited to the resources of the LLC, which may often be far more limited than those of its members.

Beware of Standardized Purchase, Sale Agreements

A growing trend in larger transactions is to depart from the standardized purchase and sale agreements, many of which are produced by broker organizations in an attempt to balance the interests of buyers and sellers. Although reducing the likelihood of lawsuits is often a primary goal of the parties drafting these agreements, an increasing trend among savvy sellers is to have a "custom" agreement already prepared and ready to be signed by both parties when acceptable terms are reached - rather than the more traditional arrangement where the buyer begins by submitting an offer, and a series of counteroffers can follow.

An important advantage of the single-contract approach is less confusion for all parties involved. Because the terms in a series of counteroffers are often amended in each successive version, it can often be confusing for lawyers, escrow and title agents, brokers and others to understand or agree on exactly what the "deal" is.

An even more important advantage of the "custom" contracts is their ability to proactively reduce lawsuit risk. For example, a potentially beneficial provision for sellers - and, arguably, for buyers as well, to the extent it discourages litigation - is to create arrangements whereby the buyer is given broad access to the property during an extended pre-closing inspection period, but then after closing occurs, the buyer's recourse is particularly limited against the seller (absent fraud, concealment and the like). This trend is suppose to encourage buyers to actively and diligently inspect the property before closing by using contract language that makes filing claims after closing particularly difficult. The mere "as is" language in many standardized agreements will likely be inadequate to accomplish this goal.

Another important benefit of "custom" purchase and sale agreements is the opportunity to insert enhanced dispute resolution provisions. For example, by requiring any party alleging harm to give the responsible party written notice and an opportunity to "cure" the problem before initiating litigation, many small problems that should not lead to lawsuits can be resolved informally. A provision whereby the parties each agree to restrict the time period in which either can bring a claim of any sort can also provide considerable comfort, at least for sellers.

Finally, more detailed arbitration provisions can afford the parties greater certainty - because arbitrators are not required to follow the law in their decisions, and there is often no opportunity to appeal their determination.

A particularly troubling case for California sellers, Jue v. Smiser (1994) 23 CAL> APP. 4th 312, supports the proposition that, under certain circumstances, a buyer learning of a misrepresentation prior to closing can nevertheless proceed to close escrow and sue for damages later. The need for parties to address in writing the holding of Jue, so as to cause all disclosures and representations to occur before the contract is signed, is another important reason to consider a custom agreement.

Of course, one of the standardized forms can also be adapted and modified to accommodate the considerations highlighted here, and others that could be revised to limit lawsuit risk, but the number of changes that may be required could make the final result confusing and unwieldy.

The many risks of buying and selling real estate requires that "Business As Usual" - at least as it involves industry-standard forms and practices - be significantly revised to include simple policies and procedures designed to reduce law suit risk. Unfortunately, buyers and sellers may not be able to rely on their brokers to correctly structure a transaction in light of these developments, and should consult qualified legal counsel as to all steps of the transaction.