Condominiums—Purchaser Claimed That Plaza Hotel Penthouse Construction Failed to Comply With Representations

This case “arose because plaintiff’s expectations for the penthouse apartment that it had agreed, pre-construction, to purchase were not met by the apartment as built.” The issue was whether the plaintiff had “any legal recourse, in view of the provisions of the purchase agreements” (contracts), offering plan (plan) and construction plans that “defendants rel[ied] on in making a motion to dismiss.” On a prior appeal, the court had modified the dismissal of the original complaint and reinstated a claim for breach of contract. The court now addressed “the propriety of the motion court’s subsequent dismissal of both a new complaint…and an amended complaint….”

In August 2007, the plaintiff entered into “two purchase agreements: one for a planned penthouse unit, at a price of $31 million, and the other for a smaller unit…to be used for the household help….” The plaintiff’s representative had determined that “the penthouse was different from the unit plaintiff had expected. Instead of a large, light and airy expanse of open living space with floor-to-ceiling 11-foot-high windows providing expansive views of Central Park, plaintiff found a living area broken up by several large columns that also blocked the view, with small, three-foot-tall windows beginning three feet from the floor and ending at the six-foot line where the sloped skylights in the ceiling began, and a cramped feel to the room due to the low height at which the ceiling and skylights met the wall and windows. Instead of an open, light kitchen space with four large windows and a moderate-sized kitchen island surrounded by sufficient floor space, plaintiff found the kitchen floor space largely taken up by an excessively large island, and an obtrusive, steeply pitched ceiling ending at a height of six feet, which, as in the living room, gave a cramped feel to the breakfast area; in addition, the kitchen had only two small windows instead of four large ones, drastically diminishing the expected view.”

The plaintiff also claimed that although the plans had showed “the exterior wall of the penthouse as continuous with that of the lower floors, the exterior wall as constructed was set back approximately three feet, and a drainage grate not shown in any plans had been situated directly outside the exterior wall, below the living room and kitchen windows, inside a three-foot ledge.” The plaintiff first sought rescission of the contracts and thereafter commenced the subject action.

The original complaint had asserted claims for breach of contract and fraud, and sought rescission, return of the down payments and legal fees. The complaint alleged “failure to construct the penthouse in accordance with the plans, model or representations relating to such aspects of the units as room size, ceiling height, number and size of windows, layout, and other design details.” The plaintiff also alleged that the defendants “failed to provide notice of the changes made, in an effort to deprive plaintiff of its right and ability to rescind the purchase agreements.” A claim had been made against a brokerage firm for “fraudulent inducement” based on “the use of the model apartment relating to the penthouse’s layout and design,” that they allegedly “knew to be untrue.” The defendants’ motion to dismiss the original complaint was based primarily on a “No Representations provision” contained in the contracts. The plaintiff had disclaimed reliance on any plans, brochures, advertisements, representations, warranties, statements or estimates of any nature whatsoever, “whether written or oral, made by Sponsor, Selling Agent or otherwise,” except as represented in the contracts or in the plan.

The motion court had dismissed the complaint, holding that the “No Representations clause” established a complete defense to the plaintiff’s claims and rejected the plaintiff’s reliance on a provision in the plan, which was incorporated by reference into the contracts, that provided for a right of rescission if the sponsor made material alterations in the plans.

The motion court found that the complaint failed to describe any changes that would be considered “material.” The Appellate Division (court) disagreed in part, reinstating the breach of contract claim. The original complaint asserted that “the penthouse unit was constructed in a manner materially different from that set forth in the filed plans and specifications, contrary to the requirements of the…Plan, which required that the work be performed substantially in accordance with those filed plans and specifications and that material alterations be the subject of an amendment to the plan.” The court had upheld the motion court’s dismissal of the fraudulent inducement claim, because the “No Representations” provision in the contracts precluded the plaintiff’s reliance on the “alleged extracontractual representations.”

The second complaint contained claims “for breach of contract, fraud and negligent misrepresentation, breach of the covenant of good faith and fair dealing, and deceptive trade practices under General Business Law [GBL] §349, and a claim under 15 USC §1703(a), known as the Interstate Land Sales Act” (ILSA). The motion court granted the motion to dismiss on the ground that such action “was barred by the res judicata effect of the order dismissing the first action,” since the prior complaint and the current complaint stemmed from the same transaction and sought the same damages.

The defendants had also moved for release of the down payments and for attorneys’ fees as the “prevailing party” under a prevailing party provision contained in the contracts. The motion court denied the plaintiff’s request for such relief. The court affirmed the motion court’s ruling with respect to the applicability of res judicata.

An amended complaint contained many allegations that were based on “extracontractual statements and promises,” which were “precluded by the ‘No Representations’ clause.” For example, allegations cited “‘the marketing materials, the model apartments, the website and the physical mock-ups of the duplex [p]enthouse shown to plaintiff’s representatives,’ as well as the sales agent’s oral representations promising such characteristics as ‘opulent grandeur.’” The amended complaint also alleged “a breach of the Sponsor’s contractual obligations based on the alleged failure to build the penthouse in accordance with the plans and specifications, and the making of material alterations to those plans and specifications without notice to plaintiff.” The court found that those allegations were “not barred by the ‘No Representations’ provision,” and they were not precluded “by any other, general provisions of the [contracts].”

The defendants had argued that the contract provided that “[t]he issuance of a temporary or new permanent Certificate of Occupancy for all or any portion of the Building shall be deemed presumptive evidence that renovation of the Building or of such portion of the Building…and the Residential Units therein has been substantially completed in accordance with th[e]…Plan and the Plans and Specifications.” The court explained that such clause could not “invalidate or negate the requirement of the…plan, incorporated into the [contracts], that if the sponsor intends to implement material changes to the filed plans and specifications, it must amend the plans and notify the purchasers and allow for a right of rescission.”

The defendants also cited an amendment to the plan with regard to the additional large columns in the living room. The amendment reported “‘the relocation of vertical shafts and the movements of walls in order to complete the coordination of the HVAC systems and infrastructure,’ and appended new penthouse floor plans.”

The court stated that even if it could interpret the submitted plans as a matter of law, “and upon doing so were to preclude plaintiff’s claim regarding additional columns, nevertheless, plaintiff claims other alterations to the plans that are not conclusively disproved by the submitted documents.” For example, the defendants’ submissions did not conclusively disprove plaintiff’s claim with respect to ceiling heights. The defendants had noted that an amendment provided for reductions and ceiling heights in certain rooms from 9 feet to 8½ feet. The court noted that the defendants’ inclusion of such changes in the amendment, tended to indicate that such change may have been a material alteration. Moreover, the amendment discussion of reduction in the height did not address “the ceiling heights in the principal living spaces of the Residential Units.”

Additionally, the defendants’ plans indicate “a bank of four windows in the kitchen; a reduction to two windows may well constitute a substantial, material change, especially in combination with other alterations to the plans.” The court also opined that “the inclusion of the drainage grate outside the exterior, below the living room and kitchen windows, constituted or created a material alteration….”

The defendants further argued that the sponsor has “broad discretion and flexibility to modify the units during construction.” The floor plans warned that “[a]ll dimensions [were] approximate and subject to normal construction variances and tolerances….” The court explained that such provisions were insufficient grounds to dismiss the complaint. “They cannot negate the provision of the…plan, incorporated in the [contracts], that imposed on the sponsor an affirmative duty to file an amendment to the plan for any material changes that would materially adversely affect the purchaser….” The court held that at this stage, it could not determine whether “the alleged changes…constituted sufficiently material changes that they should have been the subject of an amendment to the…plan.” Since the plaintiff’s reliance on the alleged alterations to the plans and specifications was not precluded by any of the documents submitted on defendants’ motion, dismissal of the complaint was not warranted.

Further, the allegation that the “breach of contract was also established by a lack of promised services and facilities may seem difficult to press, in the face of the…plan provision warning that at first some of the services and facilities…may not be available; however, that provision does not absolutely preclude the possibility that a failure of services or facilities may constitute a breach of contract.” The court believed that it was “more appropriate to address this claim on the merits than on the pleadings alone.” Thus, the court held that the “claims that the construction…created material alterations to the filed plans, without the notice and right of rescission required by the [contracts],” stated a cause of action, since they were “not entirely precluded by the ‘No Representations’ clause or any other submitted documents.”

The court dismissed the implied covenant of good faith and fair dealing claim as duplicative of the breach of contract claim. The court also dismissed the GBL §349 claim, since the alleged violations did “not have ‘a broad impact on consumers at large.’” Finally, the court rejected the defendants’ argument that the complaint failed to state a breach of contract for the smaller unit. The court explained that “[t]he lack of an explicit contingency provision linking the two units is not dispositive; the allegations of the complaint are sufficient for these purposes.”

Comment: Douglas P. Heller, a partner at Herrick, Feinstein, who specializes in condominiums and co-ops, explained that most down payment disputes are handled by a dispute resolution process conducted by the Attorney General’s office. There is however, a proposal to eliminate that process, primarily as a result of budget and staffing considerations.

Plaza PH2001 v. Plaza Residential Owner, 7055, NYLJ 1202561576432, at *1 (App. Div., 1st, Decided June 26, 2012). Before: Saxe, J.P., Sweeny, Jr., Freedman, Manzanet-Daniels, JJ. Opinion by Saxe, J. All concur.

Façade Easements—Tax Court Disallowed Deduction on Ground That There Was No “Qualified Appraisal” Within Meaning of Treasury Regulation §1.170A-13(c)(3)—Second Circuit Held Appraisal Satisfied Regulatory Specifications and Remanded the Matter—Appraiser Valued New York City Façade Easement to Be Between 11 and 11.5 Percent

A taxpayer appealed a decision of the Tax Court disallowing her deduction for “the value of a ‘façade conservation easement’” (easement) that she “donated to the National Architectural Trust [Trust].” The Tax Court held that her appraisal “insufficiently explained the method and basis of valuation, and thereby failed to comply with the Treasury Regulation [Trea. Reg.] defining a qualified appraisal. See Treas. Reg. §1.170A-13(c)(3).” The Second Circuit Court of Appeals (court) held that “the appraisal sufficiently detailed the method and basis of valuation.”

The Tax Court had also “disallowed her deduction for a cash contribution…to the Trust on the ground that it was quid pro quo for the Trust’s acceptance of the easement.” The court disagreed “because the Trust’s agreement to accept the gift of the easement was not a transfer of anything of value to the taxpayer and thus did not constitute a quid pro quo for the gift of the cash.” Thus, the court vacated the Tax Court decision and remanded the matter for further consideration.

A façade conservation easement is “an undertaking by a property owner, granted to an organization, that a building’s façade will be maintained unchanged in perpetuity.” “Congress has created a tax benefit for taxpayers willing to donate property rights for conservation purposes, including the right to alter a property’s façade.”

The taxpayer had applied to the Trust to donate an easement for her Brooklyn brownstone. The easement would bar the taxpayer “from altering the façade without” the Trust’s permission and “would require her to maintain the façade and the rest of the structure.” The Trust would have the right to inspect the façade, the taxpayer must “cure any violation of her easement obligation” and it would run with the land in perpetuity.

The donation process required an appraisal of the easement. The taxpayer’s appraiser valued the easement at $115,000. He employed the “before-and-after method.” He subtracted the value of “a house burdened with an easement from the value of the house without one.” He estimated the value of the property after granting the easement at $900,000 and the value before granting the easement at $1,015,000.

The donor also had to make “a cash contribution toward operating costs equivalent to ten percent of the value of the easement.” The taxpayer paid $9,275, which represented 10 percent of the value of the easement less certain adjustments. The Trust then sent the taxpayer “an IRS form for noncash charitable contributions (Form 8283), signed by [the appraiser] and the Trust, reflecting a fair market value for the easement of $115,000.”

The IRS thereafter determined that she had failed to establish the fair market value of the easement and imposed a penalty. The Tax Court had found that the appraisal was not a “qualified appraisal,” because “it failed to state the method of valuation and the basis of valuation, as required by Treasury Regulation §1.170A-13(c)(2)(J) & (K).” The Tax Court had not determined “the value of the easement de novo, which it would have done had it found that [the taxpayer] satisfied” the necessary prerequisites. The Tax Court also rejected the cash contribution deduction. The Tax Court reasoned that “a charitable gift or contribution must be a payment made for detached and disinterested motives.” The Tax Court reasoned that the taxpayer “had made the donation for the purpose of inducing the Trust to accept her easement so that she could enjoy a tax benefit.”

The court explained that “[t]he regulatory requirements for a qualified appraisal…generally require[s] information about the property, terms of the donation, identity of the appraiser, and fair market value of the donation.” The appraisal had to specify, inter alia:

(J) The method of valuation used to determine the fair market value, such as the income approach, the market-data approach, and the replacement-cost-less-depreciation approach; and

(K) The specific basis for the valuation, such as specific comparable sales transactions or statistical sampling, including a justification for using sampling and an explanation of the sampling procedure employed.

Treas. Reg. §1.170A-13(c)(3)(ii)(J) & (K).

At the time when the taxpayer sought the deduction, it was sufficient that she submit “a summary of the appraisal (Form 8283) with her tax return, not the appraisal itself.” The summary Form 8283 “requires no information about how the fair market value…was determined, only a description of the property, the estimated fair market value, and…the appraiser’s qualifications and compensation.”

The Tax Court found that the appraiser had “omitted ‘[t]he method of valuation used to determine the fair market value, such as the income approach, the market-data approach, and the replacement-cost-less-depreciation approach.’” The court explained that the “before-and-after method used by [the appraiser] is an accepted means of valuing conservation easements.” The court noted that the “purpose of an appraisal is to determine the ‘fair market value’ of the donated property, which is ‘the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of relevant facts.’” The “before-and-after method is generally used if no substantial record of market-place data is available….”

The IRS had not challenged the appraiser’s conclusion “that there was insufficient market data to support other valuation methods.” The appraisal had considered “the IRS’s past treatment of façade conservation easements….” The appraisal stated that it was “generally recognized by the [IRS] that the donation of a façade easement of a property results in a loss of value…of between” 10 percent and 15 percent. The donation of a commercial property results in a loss of value of between 10 percent or 12 percent or higher “if development rights are lost.” The inclusive data support at least these ranges, depending on how extensive the façade area is in relation to the land parcel.” Although the “inclusive data” was not identified, the appraisal relied on a Tax Court case that valued an easement at 10 percent of the property value and a government-published article which reported that the IRS engineers had concluded that “the proper valuation of a façade easement should range from approximately” 10 percent to 15 percent of the value of the property. The appraiser had “narrowed the range to 11 to [11.5 percent] by considering the location of the property in New York City [NYC] and the existing restraints imposed by the City’s historic preservation laws.”

The appraiser selected the before and after method after using “comparable sales to calculate a baseline value for the property ($1,015,000).” The appraiser then applied an 11.33 percent discount to the original value and the difference was the value of the easement. The court opined that such was enough to explain “the method of valuation used to determine the fair market value.” The court found that the appraiser had, in fact, explained “at some length how he arrived at his numbers” and that it was “irrelevant that the IRS believes the method employed was sloppy or inaccurate, or haphazardly applied—it remains a method, and [the appraiser] described it.” The regulation required “only that the appraiser identify the valuation method ‘used;’ it [did] not require that the method adopted be reliable.” Thus, by providing the information required by the regulation, the appraiser had “enabled the IRS to evaluate his methodology.”

The Tax Court contended that “the appraisal failed to ‘include…[t]he specific basis for the valuation, such as specific comparable sales transactions or statistical sampling, including a justification for using sampling and an explanation of the sampling procedure employed.’” The Tax Court asserted “that the valuation lacked ‘meaningful analysis,’ failed to ‘explain how the specific attributes of the subject property led to the value’ assigned, and ‘displayed no independent or reliable methodology.’”

However, the court found that the appraiser had “sufficiently supplied the bases for the valuation: IRS publications (since removed from circulation), tax court decisions, [the appraiser's] past valuation experience, and the location of the house in the regulatory environment of [NYC].” The IRS article cited and a prior decision “yielded the initial range” of 10 percent to 15 percent “diminution in value; whether that range is accurate or reliable is not at issue on this appeal.” The appraiser then considered the location of the house “in [NYC], ‘where there are many municipal regulations restricting changes to properties located in historic districts’ that tend to limit the incremental loss in value to a range of about” 11 to 11.5 [percent] of the total value of the property. The court stated that the appraiser’s approach was “nearly identical to that approved by the Tax Court” in a prior decision.

Although the IRS may have deemed the appraiser’s “‘reasoned analysis’ unconvincing,” the court found that it was “incontestably there.” The Treasury Regulations did not provide “substantive requirements for what a qualified appraisal must contain.” The court noted that the Treasury Department could “use the broad regulatory authority granted to it by the Internal Revenue Code to set stricter requirements for a qualified appraisal.” Further, the IRS could review the subject appraisal “in the context of a considerable body of data.”

At around the time of the taxpayer audit, the IRS had reviewed “about 700 façade conservation easements….” The court concluded that the subject appraisal “accomplishes the purpose of the reporting regulation: It provides the IRS with sufficient information to evaluate the claimed deduction and ‘deal more effectively with the prevalent use of overvaluations.’” The court stated that “since the Commissioner’s bottom line is that the donation had no value at all, it is hard to see how any defect in the appraisal would matter.”

The Tax Court had also found that the summary Form 8283 filed by the taxpayer had not included the date and manner of acquisition of the property or its cost basis. The Tax Court asserted that “those ‘defects alone demonstrate that there has not been strict compliance with the regulation['s] requirements.’” The court rejected such argument. The taxpayer had submitted “two Form 8283s, which together contained the information required.” At most, this was a technical deficiency, which was “properly excused” on the basis of “reasonable cause (see 26 U.S.C. §170(f)(11)(A)(ii)(II); and the doctrine of substantial compliance.”

The court then noted that the delivery of a qualified appraisal did not alone entitle the taxpayer to a deduction. The IRS had argued that the taxpayer had “failed to comply with other statutory and regulatory requirements, including that the contribution be exclusively for conservation purposes…and that it be protected into perpetuity….” Since the Tax Court had yet to decide those issues, remand was appropriate. If the taxpayer satisfied those remaining issues, the Tax Court would then have to determine the value of the taxpayer’s easement on the basis of the parties’ submissions. Although the taxpayer’s appraisal met the minimal requirements for a qualified appraisal, that determination did not mean that the Tax Court must “find it persuasive,” or that the taxpayer is entitled to a deduction for the donated easement.

The court then held that “[the taxpayer's] $9,275 contribution to the Trust was ‘charitable,’ and therefore deductible” since it was “made with no expectation of a financial return commensurate with the amount of the gift.” The “sine qua non of a charitable contribution is a transfer of money or property without adequate consideration…. The consideration need not be financial; medical, educational, scientific, religious, or other benefits….” Although the taxpayer’s $9,275 donation may be described “as a prerequisite of the Trust’s acceptance of the easement donation, the Trust gave the taxpayer no ‘goods or services,’ or ‘benefit,’ or anything of value in return for her making the money gift. The only transfer of benefit was what the taxpayer gave to the Trust in the two gifts.”

The court noted that “[a] donee’s agreement to accept a gift does not transfer anything of value to the donor, even though the donor may desire to have his gift accepted, and may expect to derive benefit elsewhere (such as by deductibility of the gift on her income taxes).” Thus, the court held that the taxpayer’s cash payment “was part of her donation to the Trust.” Moreover, “[c]ontributions toward operating expenditures are commonplace among entities…that hold and administer façade contribution easements.” In addition to helping defray administrative expenses, funds are needed for a monitoring compliance procedure. “[A]n easement of this kind is easily violated, withdrawn, or forgotten.”

Here, the taxpayer had received “nothing in return for her cash donation and façade conservation easement.” The taxpayer had hoped to obtain a charitable deduction for her gifts. However, this would not come from the recipient of the gift. “It would not be a quid pro quo. If the motivation to receive a tax benefit deprived a gift of its charitable nature under Section 170, virtually no charitable gifts would be deductible.” Accordingly, the court vacated the decision and the Tax Court remanded the matter for proceedings consistent with its opinion.

Scheidelman v. Commissioner of Internal Revenue, 10-3587-ag, NYLJ 1202560160915, at *1 (2d Cir., Decided June 15, 2012). Before: Jacobs, Ch.J., Leval and Livingston, C.JJ. Opinion by Jacobs, Ch. J. All concur.

Scott E. Mollen is a partner at Herrick, Feinstein and an adjunct professor at St. John’s University School of Law.