Environmental Due Diligence Critical In Any Real Estate Transaction

By Arlen Gunner

Due to the fact that any person or entity that takes title to real property has essentially perpetual liability for environmental matters (with a few very narrow affirmative defenses that are difficult to prove) under both federal and state of California laws, it has become increasingly important that some level of environmental due diligence should be performed as a condition to closing a transaction involving real property.

Several different situations concerning the environmental condition of real property that was the subject of a long-term ground lease, where one of our clients was the lessor and another was contemplating becoming the lessee, have crossed my desk in recent months. I have also addressed situations on behalf of certain nonprofit clients who were scheduled to receive real property as charitable donations. In reviewing the environmental condition of the properties involved in the aforementioned situations, the environmental condition of each of the separate properties was a determinative factor as to whether or not the transaction would proceed.

One of our clients held title to real property for a long period of time upon which the client was operating a profitable business. Due to overtures made by a very financially stable potential lessee, a long-term ground lease was contemplated and a great deal of time was spent negotiating the proposed lease. The lessee had a contingency in the lease running in its favor which stated that the environmental condition of the property had to be acceptable to the lessee in its sole and absolute discretion.

When an environmental inspection was conducted it was discovered that there was underground hazardous material migration affecting our client's property, which emanated from a nearby gas station. Our client also was informed that the Regional Water Control Board was already monitoring the situation and eventually included our client's land in its investigation thus causing our client a great deal of out-of-pocket expense and a loss of the transaction since the lessee had a cancellation right if the environmental condition of the property was not satisfactory to it.

In another ground lease transaction where one of our clients was contemplating acquiring the tenant's interest under the lease, as well as fee title to other assets owned by the proposed transferor, our client was initially hesitant about incurring the expense necessary to conduct a Phase 1 review of the property in question. With a certain level of persistence (some might call it nagging) the client eventually ordered the Phase 1 report to be prepared by an environmental consulting firm. Within a short period of time, our client's environmental consultant uncovered a serious contamination issue which potentially could have had immense financial liability consequences for our client should it have closed the transaction and enterrd into the chain of title.

I am currently working on a probate situation where the trustee of an estate has instructions to convey the real property to one of our nonprofit clients as a gift. We have advised our client that it should perform the ordinary and customary real estate due diligence that would normally be performed if it was going to buy the property in an arm’s length transaction. While this may cause our client some upfront expense, the cost and expense would be de minimis if the property has any environmental liability attached to it.

One must also keep in mind that any lender, before it will be obligated to fund a loan, will in virtually every instance, involving real property, require an environmental Phase 1 report to be prepared at the borrower's expense, and they would probably also require an indemnity for environmental matters from not only the borrower but also its constituent stakeholders.

In the real estate market that currently exists, the longer a period of time that a property has been in service, the greater chance of environmental contamination coming into play due to the unknown prior uses of the property. Therefore, regardless of what position a client has in its transaction, an environmental review is more than ever a necessary due diligence contingency item.

(Mr. Gunner was named a “Super Lawyer” in 2008 in three practice areas: real estate, corporate and business, and mergers and acquisitions. Arlen was named a “Super Lawyer” in 2009 and 2010 in the area of real estate and also in 2010 as corporate counsel.)

Songwriters And Publishers Continue To Score Tax Breaks

By Michael R. Morris, Esq.

(Mr. Morris recently moderated a California Copyright Conference's panel discussion "Monetizing Music Publishing" on March 9, 2010 in Los Angeles.)
Introduction.
Favorable tax law changes originally made in 2006 continues to offer significant tax planning opportunities for both songwriters and music publishers. The potential tax breaks for songwriters were especially ground-breaking, permitting self-created musical compositions or copyrights in self-created musical works to be electively treated as capital assets. Why does this matter? Because gain upon the sale of a long-term capital asset (i.e., an asset held more than 12 months) is generally taxed at an extremely favorably 15% rate, in lieu of regular personal income tax rates presently ranging as high as 35%. Thus, a seller of eligible self-created musical compositions or copyrights in musical works can save a bundle in taxes. Under a related law, buyers of these rights can elect to write off the purchase price over five years, enabling music publishers to take a tax deduction for the purchase price of copyrights (including songwriter advances) ratably over five years. Let's take a closer look at how these favorable tax laws work.

Elective Capital Gains Treatment for Self-Created Musical Works
Under prior law, copyrights, literary, musical or artistic compositions, letters or memoranda or similar property were not considered "capital assets" in the hands of its creator. Thus, a songwriter who sold his or her own songs, like an artist selling a painting, paid "ordinary" income tax rates (currently up to 35%). Conversely, the same songs in the hands of the music publisher who bought those copyrights were considered tax-favored "capital assets." Not only could the music publisher take a tax deduction for the cost of acquiring the copyrights (as a yearly percentage of the purchase price), but the subsequent resale of such copyrights would be at a tax favored capital gains rate of 15% (provided the songs had been held by a non-corporate publisher for at least the 1-year long-term capital gains period). Congress sought to redress this imbalance in tax rates between songwriters and publishers, stating in a report: “ … it is appropriate to allow taxpayers to treat as capital gain the income from a sale or exchange of musical compositions or copyrights in musical works the taxpayer created.”

Initially, this favorable capital gains election for self-created musical works was set to expire on December 31, 2010, but fortunately for songwriters, it was made permanent. However, this lower capital gains rate is not automatic! A songwriter selling compositions held more than 12 months must affirmatively elect the lower tax rate (sounds like a no-brainer, unless you want to voluntarily reduce the national debt).

This tax law does not define what constitutes a self-created "musical composition" or a self-created "musical work." For example, if one songwriter contributed lyrics and another music to a composition, should there be any tax difference? Probably not. But what if a writer's existing poem became the lyrics of a song to which another writer contributed the melody. That song would generally be covered by a single copyright, and in this author's opinion, the sale of that song should entitle the creators of both the lyrics (i.e. the poem) and the melody to favorable capital gains treatment, even though the sale of the stand-alone poem would not qualify.

The law also fails to address what music assets in addition to self-created songs qualify as "capital assets," only stating that both self-created "musical compositions" and "copyrights in musical works" qualify for elective capital gains treatment. Thus, royalty and other income from the exploitation of musical compositions is not eligible for reduced capital gain rates. However, the term "copyrights in musical works" is intuitively more expansive than "musical compositions," and could include copyrights in self-created sound recordings (which, of course, would be recordings of "musical compositions"). This distinction can have real financial impact upon an artist selling both self-created master recordings and the underlying self-created musical compositions. For example, an artist might sell a library of existing recordings concurrently with the copyrights in the underlying musical compositions to a film-TV music production house. Again, this author believes the transfer of master recordings constitutes the sale of a copyright in a self-created musical work, but the IRS has not yet issued any interpretive rulings.

Just when the 1-year holding period for long-term capital gains treatment begins can also be an interesting question. Obviously, the 1-year period begins from creation of the work for a songwriter who always retained ownership. But what about situations where a songwriter (or heirs) have rights to reclaim previously granted copyrights under the termination provisions of Sec. 203(a) of the Copyright Act? For example, grants made after 1977 of rights in a copyright may be terminated at any time during the 5-year period beginning 35 years after the date the original grant was executed. The right to the subsequent reversion of a previously transferred copyright gets triggered by the songwriter (or statutorily prescribed heirs) providing timely notice and making the proper filing under Sec. 203 (such right would then be "vested"). This notice must be given not less than 2 nor more than 10 years prior to the effective date of termination. Once the termination provisions of Sec. 203 have been met, the copyright automatically reverts at the designated future date during the 5-years following the expiration of the 35-year grant.

Since the rights to this future reversion can be sold, does the 1-year long term capital gain period begin from the date the Sec. 203 notice was given, enabling the sale of that right to be eligible for favorable tax treatment? Or does the 1-year holding period only run from the date the copyright actually reverted? The earliest effective date for termination under Sec. 203 is January 1, 2013 (for grants made on January 1, 1978). Only if the sale of a future reversion is considered the sale of a copyright in a musical work would the songwriter (or heirs) be eligible for reduced tax rates on sales made 1 year after complying with the Sec. 203 termination provisions. Otherwise, the 1-year long-term capital gain holding period would only commence from the date of actual copyright reversion, so that copyrights which begin reverting in 2013 would only then become eligible for long-term capital gain treatment (after being held for at least 12 months following reversion). Again, the IRS has issued no pronouncements on this issue.

Last year, the IRS did, however, issue proposed and temporary regulations providing that the election to treat a musical composition or copyright as a capital asset must be made separately as to each composition or copyright sold or exchanged during the taxable year. This election must be made on or before the due date of the tax return for the year of sale or exchange (including extensions). Accordingly, creators of musical compositions and copyrights in musical works who sold such rights in 2008 are reminded that an affirmative election is necessary to take advantage of favorable capital gains rates.

Five-Year Amortization Period for Musical Works.
Buyers of eligible musical works and copyrights also continue to get “tax bang” for the buck. Under prior law, the cost of acquiring a musical copyright generally had to be amortized and deducted over the period that the song was projected to generate income under the "income forecast" method (a frequently complicated computation).

Since 2006, any expenses paid or incurred creating or acquiring any "applicable musical property" can be amortized over the 5-year period beginning with the month during which the property was "placed in service" (for example, when a song gets exploited). Both songwriters who incurred expenses creating "applicable musical property" and music publishers who acquire them can take advantage of this business-friendly 5-year schedule. For example, assume a music publisher paid $1,000,000 for applicable musical property on January 2, 2008 and places it in service on January 31, 2008. Provided the 5-year amortization election is made, the publisher would get to deduct $200,000 as an expense for 2008 (and a like amount for 2009-2012). The term "applicable musical property" is defined as any musical composition (including any accompanying words) or any copyright with respect to a musical composition that is depreciable under the income forecast method. This means that sound recordings are probably not eligible for the 5-year amortization schedule.

Conclusion.
Congress has lowered tax rates for songwriters who sell their catalogs and electively take advantage of capital gains treatment, provided such songs were held more than one year. This is in stark contrast to the higher non-capital gain tax rates paid by authors and painters who sell their literary works or paintings. In addition, music publishers buying songs can recover the purchase price over an election 5-year period.

Questions do remain as to what constitute self-created musical works eligible for favorable capital rates. Does it include sound recordings and/or vested future reversion rights? Hopefully, the IRS will provide rulings that favorably resolve these issues. In the meantime, these tax incentives afforded songwriters and publishers will continue to provide a powerful stimuli to the music publishing market.
© 2009 Valensi Rose PLC
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Michael R. Morris is a former president of the California Copyright Conference and a principal in the Century City law firm of Valensi Rose PLC (www.vrmlaw.com). A former IRS trial attorney and Certified Specialist – Taxation Law (State Bar of California), Michael's practice emphasizes music, entertainment and tax-related matters.

How To Succeed With In-House Counsel

By Gary F. Torrell
Valensi Rose, PLC

After serving as temporary in-house counsel (IHC) to a client in 1990, I published an article entitled “How to Work With In-House Counsel.” Since then, I have been general counsel at a publicly-owned financial institution and a privately-owned real estate company and developed the following guidelines based on my experience as both IHC and outside counsel. The guidelines may seem unremarkable, but following them will increase your chances of obtaining business from (and developing strong bonds with) IHC and their companies. As with most everything in the law, there are exceptions to every guideline below, and you must always tailor your service to the wants and needs of the particular client and matter.

1. Getting Retained. Most IHC (and their companies) already have a full compliment of outside counsel to contact for new matters. To break in with them, you need a hook to distinguish you and your law firm from other law firms soliciting IHC for business -- e.g. being referred to IHC, promoting specific lawyers (by name) at your law firm with necessary expertise, offering a fee discount, or some other incentive. Money is a huge incentive, but not at the expense of high quality services. As general counsel, I regularly retained lawyers with big-firm training who charged lower rates at their present (smaller) law firm. If your law firm’s regular hourly rates are low compared to national law firms or other lawyers with similar credentials, sell this feature. Consider offering a discount for the initial matter or for an initial time period, to give IHC an obvious reason to try you. Diversity can also be an asset: Advertise and promote the minority lawyers employed at your law firm – this may be an important criteria to IHC. If you simply ask for business because you provide quality lawyers, competitive rates and good service, chances are your solicitation will go in IHC’s round file.

2. Your First Matter. Congratulations – you’ve been retained! The next step is to ask for and review all of IHC’s policies and procedures (written and unwritten), and then share them within your law firm and follow them to the letter. The point is to recognize that IHC is in control of the relationship, so ask how and when IHC prefers you communicate with them and accommodate IHC’s preferences. Do not speak directly with others at the company without IHC’s permission (unless it’s an emergency). When permitted to communicate with others at the company, copy IHC on all written/electronic communications; it’s more than a courtesy, it keeps IHC where they should be—the number one spot.

3. Get Noticed For the Right Reasons. IHC knows the client, the goals in the matter, the budget concerns, the internal politics and the other important considerations. As outside counsel, you should talk less and listen more, especially on your first matter. Let IHC interrupt you and ask questions; they are not hiring you to hear speeches. Encourage IHC to ask questions and ask for their opinion on substantive decisions. Treat them as you would want to be treated as co-counsel. Be humble when asked about your experience; give examples, but undersell. Be cost conscious--ask before you charge substantial fees or incur substantial costs. Try to offer ways to reduce the legal expenses and behave as if you were paying (rather than collecting) the fees and costs being charged.

4. Give Substantive Advice and Be Accessible. If IHC leaves a substantive question on your voicemail, give a substantive response in your return voicemail/e-mail and don’t just say “returning your call.” Give IHC choices on possible legal strategies, but recommend your top choice and justify it. Then, if/when IHC (or the company) chooses a different direction, support the client’s choice. Do not direct – suggest, and always solicit IHC for suggested strategy. When IHC asks about your availability later that day or in the next few days, tell IHC when you are available, rather than what you’re doing that prevents you from being available – IHC didn’t ask for that and doesn’t really care (sorry). Give IHC ample advance notice of your planned absences/unavailability and remind IHC as the dates approach. Return all calls/e-mails promptly. If you cannot, have your assistant promptly return the call/e-mail and politely explain when you will be available again.

5. Predicting Results, Fees and Costs. Often IHC will request a budget from outside counsel for the matter and, in a disputed matter, your opinion on the likelihood of success. (As general counsel, I had a third question for outside counsel: the likelihood of recovery of legal expenses as the prevailing party.) At the outset of a new matter, outside counsel often underestimate the fees/costs and overestimate the likelihood of success. Be conservative on predicting results and on the high side in estimating legal fees; then strive to obtain a better result and charge lower fees than estimated. It is also essential to update all estimates as the matter progresses, to avoid surprises and offer a meaningful option for IHC to change direction midstream, before the fees and costs have gone too high.

6. Meet or Exceed Time Deadlines. The following should be familiar for those of you who have had regular, recurring meetings (business or pleasure) with the same group of people: Certain (few) attendees are almost always early, most are on time or slightly tardy and some are almost always late. Most lawyers (IHC and outside counsel) promise and endeavor to provide prompt service, but often deliver/show up late. To distinguish yourself from many outside counsel, you must accept IHC’s tardiness yet be on time (or early) for meetings. The same goes for providing legal advice and draft documents to IHC. In litigation matters, my rule of thumb is to get a polished (not rough) draft of pleadings to IHC at least a few business days before the filing deadline (earlier for dispositive pleadings), then request substantive input from IHC on the pleadings. To reduce costs, ask whether IHC wants to use company resources to respond to discovery requests, especially gathering documents. Remind IHC as deadlines approach, rather than telling IHC only once about the deadline.

7. Promptly Send Clear Billing Statements. Outside counsel’s billing statements should follow the same general guidelines for good legal writing: They should be clear, concise, descriptive and complete. Many companies now have billing guidelines or requirements; follow them to the letter. Also, a person unfamiliar with your matter may review the invoice, sometimes years later, so it should contain enough information for a stranger to understand what you did for the time charged. Make it easy on IHC to see the total time and billing rate charged for each timekeeper. Describe and itemize the costs in easily understood terms. When you write off time or do not charge for certain services, show that on your invoice (when appropriate) so IHC realizes this benefit you provided. When IHC questions you about the invoice, promptly respond and resolve all doubts in favor of IHC, lest you win the battle but lose future business. Try to get your monthly invoice to IHC within 20 days after the end of the month; you can create problems for IHC (and for payment) with tardy, incomplete or inaccurate billings.

8. Other Important Services. Give credit to IHC for successes, especially in front of IHC’s client and superiors. Offer free services – seminars, etc. Send new published cases and articles of interest to IHC (about relevant legal issues, the company, the industry in general, competitors, etc.). When asked by IHC for a lawyer referral, it’s fine to recommend another lawyer in your law firm (or yourself) if the person has the expertise, but recommend the right lawyer, even if that lawyer is outside your firm. Give practical advice. Suggest IHC and/or outside counsel get involved in any actual or potential dispute early on, to help develop better facts in the event the dispute goes to litigation. Finally, try to be positive and upbeat in conversations and other communications with IHC.

About Gary F. Torrell:
Gary’s career spans over twenty-four years of solid legal and business experience working with extremely sophisticated clients, companies and firms. He spent the first seventeen years of his career working in the Los Angeles area with such notable law firms as Paul, Hastings and Brobeck, Phelger & Harrison, where he honed his legal skills and developed savvy business insight handling creditors’ rights and bankruptcy cases. In 2000, Gary changed the focus of his career to become in-house counsel to several major corporations, including holding the Executive Vice President, General Counsel and Corporate Secretary titles for Downey Financial Corporation, a $16 billion, NYSE traded company that had over 2,500 employees. Gary Torrell’s role as a partner at Valensi Rose brings his practical business thinking and problem solving approach to their clients. Gary helps continue the Valensi Rose tradition of providing clients the highest level of business and legal advice, structured to keep fees and costs in check without sacrificing results.

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