The Tennessee section of this year’s Chambers USA
Regional Real Estate Guide was contributed by Butler Snow LLP
and co-authored by Jason G. Yarbro, Robert M. Holland,
Jr., Christopher J. Tutor and John C. Taylor, Jr..
Law and Practice
1. General
1.1 Main Substantive Skills
Real estate law requires not only an understanding of buying and
selling real estate, closing processes, real estate title, leasing
and finance, but also experience in other areas that are important
to many real estate deals and specific industries. In particular,
law firms must have professionals who are familiar with
environmental laws, land use and zoning matters, development and
construction, joint ventures, complex financing structures,
restructurings and workouts. In addition to good analytical,
organizational and negotiating skills, effective real estate
lawyers must have an understanding of their client’s industry
and business objectives.
Several current trends have impacted the skills required by real
estate lawyers, including the popularity of large mixed-use
projects and the increasing use of tax credits and other complex
financing structures for large real estate projects. Many
traditional real estate projects involve primarily the acquisition,
sale or development of a single building, parcel or contiguous
parcels of real estate by one owner, with financing from a single
lender or lender group. By contrast, large mixed-use projects often
involve the development of large areas and sometimes multiple
blocks of non-contiguous real estate by multiple owners with
various lenders and financing structures.
These projects frequently have complex land use and entitlement
issues and a variety of ownership structures that require greater
experience with corporate and business laws. Likewise, the
increased use of tax credits requires experience with tax law and
the structuring of these credits and project financing in a manner
compatible with the business interests of the owners, developers
and lenders.
1.2 Most Significant Trends
Some of the most significant trends in the Tennessee real estate
market have been:
- the popularity of large mixed-use projects, both in
urban cores as part of the redevelopment of blighted areas and in
suburban areas as standalone projects; - the use of tax credits, including historic tax
credits and new markets tax credits, in large redevelopment
projects; and - a construction boom in Nashville with a number of
large office, hotel and residential towers.
The most significant real estate deals in Tennessee include the
following:
- the FedEx Hub expansion, an approximately USD1.5
billion project; - the Nashville Yards Project, an approximately USD1
billion mixed-use project that includes a new Amazon operations
center; - the FedEx Logistics headquarters in downtown
Memphis; - the Broadwest project, an approximately USD540
million mixed-use development in downtown Nashville; - the One Beale project in downtown Memphis, an
approximately USD225 million mixed-use project; - the Fifth & Broadway project, an approximately
USD450 million mixed-use development in downtown Nashville; - the Walk on Union project, an approximately USD1
billion mixed-use project in downtown Memphis; - the oneC1TY project, an approximately USD400 million
mixed-use project in Nashville; - the Snuff District project, an approximately USD200
million mixed-use project in downtown Memphis; - the W Hotel development, an approximately USD190
million hotel in downtown Nashville; - the USD2 billion expansion of the St. Jude
Children’s Research Hospital, including a USD412 million
research tower, in downtown Memphis; - 222 Second Avenue, a USD250 million high-rise in
Nashville; - the Capitol View project in Nashville, a USD750
million, 32-acre mixed-use development in Nashville; and - the Pinch District, an approximately USD605 million
mixed-use project in downtown Memphis.
As a result of the COVID-19 pandemic, including social
distancing guidelines and “stay home” orders and travel
restrictions, many tenants, in Tennessee as elsewhere, especially
in the restaurant and hospitality industries, were forced to
suspend operations and negotiate rent deferrals and lease workouts.
Parties are also pursuing other contractual remedies in light of
the pandemic, including force majeure provisions and
“frustration of purpose/impossibility/impracticability”
doctrines. Businesses are also making claims for business
interruption with their insurers. Additionally, with
bricks-and-mortar retail declining, demand for office space
declining while many employees work from home, and e-commerce on
the rise, the traditional retail and office market has softened
state-wide but industrial has strengthened as demand for warehouses
and logistics facilities has surged, especially for online
retailers.
Nashville, TN, has also seen continued population and market
growth as the increase in businesses embracing a
“work-from-home” or digital work environment has prompted
businesses in media, healthcare, and finance to migrate from more
expensive cities such as Los Angeles or New York.
1.3 Impact of
New US Tax Law Changes
The primary effects from the Tax Cuts and Jobs Act adopted in
2017 (the “2017 tax act”) on real estate investment and
development are as follows:
- the allowance for non-C Corporation taxpayers to
deduct up to 20% of their qualified business income earned through
pass-through businesses; - the increase in the long-term capital gains holding
period to three years for taxpayers receiving a “carried”
or “profits” interest; - the limitation on a taxpayer’s ability to deduct
interest expenses up to 30% of the taxpayer’s net income;
and - limiting interest deductions for home mortgage
indebtedness and home equity loans to USD750,000 from USD1
million.
In certain circumstances, the 20% deduction is limited to 50% of
the taxpayer’s allocable share of W-2 wages or 25% of the
taxpayer’s allocable share of W-2 wages, plus 2.5% of the
taxpayer’s allocable share of the unadjusted basis of
“qualified” property (to be “qualified”,
property must be depreciable), whichever is greater. The provision
for 2.5% of the unadjusted basis is beneficial to real estate
investors and developers in capital-intensive sectors with large
capital investments and comparatively minor labor costs. In
addition, taxpayers are allowed to deduct 20% of REIT dividends
without being subject to the limitations described above.
The 2017 tax act included a new incentive designed to encourage
investment in qualified opportunity zones, which are certain
low-income communities designated within each state. A list of
eligible census tracts in Tennessee is online. This incentive
allows investors to defer capital gains tax by reinvesting the gain
in a qualified opportunity fund within 180 days after the creation
of the gain. In addition, 10% of the gain is permanently forgiven
if the investment is held for five years and another 5% is
permanently forgiven if the investment is held for seven years.
Finally, if the investment is held for ten years, the
investor’s basis in the asset becomes the fair market value of
the asset at the time of any sale, meaning the investor would pay
no tax on any appreciation of the asset. Several Opportunity Zone
funds have been created which should provide capital for eligible
projects in the near future.
2. Sale and Purchase
2.1 Ownership Structures
Purchasers typically acquire commercial real estate through the
use of limited liability companies and corporations. Depending on
the nature of the purchaser’s business, the use of single or
special-purpose entities that own solely commercial real estate is
a common legal tactic to limit liability to such single or
special-purpose entity, thereby protecting the assets of the
purchaser’s affiliates.
2.2 Important Jurisdictional Requirements
No special jurisdictional rules apply to the transfer of title
to real estate in Tennessee. Statutory law does not require
specific language to transfer title, but does provide examples of
conveyance language that is sufficient for the transfer of title by
general and special warranty and quitclaim, and for purposes of a
deed of trust (Tennessee Code Annotated (TCA) Section 66-5-103). A
deed of conveyance must be acknowledged in accordance with
Tennessee law, or proved by two sworn witnesses (TCA Section
66-5-106).
Sellers of residential one to four-unit properties (including
single-family homes) are typically required to deliver disclosure
statements to prospective purchasers containing all items set forth
in TCA Section 66-5-210. Transfers of residential real estate must
also comply with applicable federal laws and regulations.
2.3 Effecting Lawful and Proper Transfer of Title
A purchaser can effectuate the transfer of title to real estate
by recording its deed in the office of the register of deeds in the
county where the acquired property lies.
2.4 Real Estate Due Diligence
In performing their due diligence on real estate, buyers
typically rely on various third parties to determine the
suitability of the property for their intended use such as
engineers, environmental consultants, title agents, zoning
consultants, and surveyors. Attorneys for buyers will primarily be
responsible for a detailed review of the survey and recorded
instruments affecting title and which may ultimately affect the
buyer’s economic return on the property.
2.5 Typical Representations and Warranties for Purchase and
Sale Agreements
Purchase and sale agreements typically contain representations
and warranties with respect to:
- the seller’s existence and authority to sell the
property; - the status of the seller’s title to the
property; - pending or threatened litigation or administrative
proceedings, including environmental or zoning violations; - the seller’s compliance with applicable
laws; - any leases in effect at the property;
- the accuracy of seller-provided property information;
and - the seller’s absence from restricted lists
maintained by the Office of Foreign Asset Control.
Implied and statutory warranties do not exist with respect to
transfers of title to real property, but sellers commonly seek to
disclaim any implied warranties and transfer property in
“as-is” condition, subject only to representations and
warranties expressly contained in the purchase and sale
agreement.
If the purchase and sale agreement does not provide that a
seller’s representations and warranties will survive closing
and delivery of the deed then the terms of the purchase and sale
agreement are deemed to merge into the deed, whereby the deed is
deemed the final contract between the parties. Fraud and mutual
mistake of the parties are exceptions to the doctrine of
merger.
In the event of a seller’s misrepresentation, a buyer may
generally terminate a pending purchase and sale agreement prior to
closing and occasionally may be able to be reimbursed for all or
some of its due diligence costs. Assuming that the Purchase and
Sale Agreement provided for post-closing survival of the
seller’s representations and warranties, a buyer may recover
its actual damages as a result of losses resulting from the
misrepresentation. Parties to a commercial real estate sale
frequently negotiate threshold amounts for buyers to recover
damages for misrepresentation and maximum amounts (anywhere between
1% and 10% of the purchase price) over which the seller will have
no liability, but fraud or intentional misrepresentation of the
seller are usually excluded from such contractual limitations.
2.6 Important Areas of Law for Foreign Investors
Foreign investors purchasing real estate in the USA should
carefully consider the impact of potential US tax liabilities and
reporting obligations incurred in connection with the acquisition
of real estate. Specific reporting obligations may stem from:
- the choice of entity, jurisdiction of formation, and
transaction structure; - anti-money laundering laws and Financial Crimes
Enforcement Network (FinCEN) reporting requirements; and - sanctions administered by the Office of Foreign Asset
Control (OFAC).
Tax consequences and additional specific reporting obligations
may result from the following:
- transaction structure;
- income from the property is or will be
‘effectively connected’ to a US trade or business; - the imposition of branch profits on foreign
corporations, if applicable; - the provisions of the Foreign Investment in Real
Property Tax Act (FIRPTA); - the requirements of the US Department of Commerce
Bureau of Economic Analysis, including the filing of either Form
BE-15 Claim for Exemption or the appropriate annual report; - the imposition of other US income tax return
requirements and filings; and - potential US gift and estate tax liability.
None of the housing markets in Tennessee are currently subject
to the additional disclosure requirements the FinCen has imposed on
title companies regarding foreign buyers paying cash for high-end
residential properties. However, FinCEN encourages title companies,
financial institutions, brokers and other professionals to
voluntarily file suspicious activity reports (SARs) in order to
report any suspicious transactions or activity. Also, a SAR is
required to be filed for currency and similar transactions in
excess of USD10,000.
Expanded CFIUS Powers
The Foreign Investment Risk Review Modernization Act of 2018
(FIRRMA) provided the Committee on Foreign Investment in the US
(CFIUS) with expanded powers of regulation.
First, CFIUS may now review non-controlling foreign investments
in US businesses involved in certain technologies, certain
infrastructure, or personal data of US nationals. However, there
are exceptions for certain foreign countries, investors, and
private equity funds.
Second, CFIUS may now review “Covered Real Estate
Transactions” which include the purchase, lease, or concession
of real estate by a foreign person or entity and such real estate
is located within or is part of an airtime or maritime port or that
is near specific military installations or other US government
sensitive facilities. There are exceptions here, as well,
including, but not limited to, certain transactions relating to
real estate within urban areas or involving commercial office space
and retail, accommodation, and food establishments. Certain foreign
investors may also be exempted.
2.7 Soil Pollution and Environmental Contamination
Under both the Comprehensive Environmental Response,
Compensation and Liability Act of 1980 (CERCLA), as amended by the
1986 amendments to CERCLA, known as the Superfund Amendments and
Reauthorization Act (SARA), and the Tennessee Hazardous Waste
Management Act of 1983, after a buyer takes title to property, it
becomes a potentially responsible party (PRP), even if the buyer
did not cause or contribute to the existing pollution or
contamination. However, in some cases, CERCLA and SARA allow the
apportionment of liability for site clean-up (see TCA Section
68-212-207). Further, there are also defenses to prevent a Buyer
being declared a PRP. In all cases, the buyer must conduct
“All Appropriate Inquiry” prior to purchasing the
property and comply with any continuing obligations related to the
allowable use of the property and the management of existing
pollution.
2.8 Permitted
Uses of Real Estate under Zoning and Planning Law
A buyer may search for zoning information online but should also
contact the relevant zoning authority to obtain a zoning letter
confirming those uses for the subject parcel. Alternatively, buyers
often engage a third-party service to prepare a planning and zoning
report for the target property, which is often more informative
than zoning letters and will include information on zoning
compliance, special use permits and other details that might prove
helpful in the due diligence process. Tennessee and its local
jurisdictions enjoy wide latitude to approve developments,
including entering into development agreements with developers, and
provide public development incentives.
2.9 Condemnation, Expropriation or Compulsory Purchase
Tennessee permits eminent domain by a condemning authority (eg,
the Tennessee Department of Transportation, public utility) and, in
certain limited situations, a person or corporation, for public
purposes or internal improvements, but not a private purpose.
Eminent domain is commenced by filing a petition in circuit court
against all persons with an interest in the property. Notice must
be given upon the filing of a petition.
Just compensation based on the fair market value of the property
will be determined in court or by agreement. Overall, Tennessee is
fairly permissive regarding the condemning authority’s exercise
of the power of eminent domain.
2.10 Taxes Applicable to a Transaction
In the case of a warranty deed transferring title to real
property, the recording of the deed requires payment of a
recordation tax (sometimes referred to as a transfer tax) equal to
USD0.37 per USD100 of either the consideration for the transfer or
the fair market value of the property, whichever is greater. The
recording of a quitclaim deed requires payment of a tax equal to
USD0.37 per USD100 of the actual consideration given for the
conveyance. Register offices also assess nominal per-page recording
fees, which vary by county.
Buyers pay the transfer tax on sales of real property in
Tennessee but seek to offset the transfer tax by negotiating other
closing cost divisions, particularly in commercial transactions.
The deed tax does not apply in limited situations, such as
transfers between spouses or deeds from executors of estates.
Mergers, changes of control or transfers of equity ownership
(direct or indirect) in property-owning entities are not subject to
transfer tax.
2.11 Rules and Regulations Applicable to Foreign Investors
See 2.6 Important Areas of Law for Foreign
Investors.
3. Real Estate Finance
3.1 Financing Acquisitions of Commercial Real Estate
Tennessee commercial real estate transactions do not offer any
unique financing options or strategies. Buyer-borrowers frequently
utilize traditional term financing, bridge and construction
financing, and – for buyers pursuing a series of property
acquisitions or developments – lines of credit. For larger,
ongoing credit facilities, lenders arrange financing through
syndication or participation.
Rates of interest, loan charges and commissions in commercial
lending transactions governed by Tennessee law are generally
subject to a maximum “formula rate” published monthly by
the Tennessee Department of Financial Institutions, which is 4%
over the average prime rate. However, through a relatively complex
statutory framework, federally chartered banks and
Tennessee-chartered banks may charge interest of up to 24%
annually.
One of the main differences between financing structures in
public and private entities is that public entities may also depend
on investment through publicly traded securities on the stock
market. Many public real estate entities are set up as REITs
whereby investors pool their money to build a real estate portfolio
which also operates as a publicly traded stock. A public REIT, in
particular, may enjoy potentially higher returns and greater
liquidity from being traded on the stock market.
Private entities may also be set up as REITs but are not
publicly traded. On the other hand, this may allow private REITs to
avoid the potential volatility of the stock market for more steady
returns.
3.2 Typical Security Created by Commercial Investors
Tennessee law permits a commercial real estate investor to grant
several types of security interests to creditors for the purpose of
borrowing funds to acquire or develop real property, but deeds of
trust are the customary form of security instrument for real estate
finance. Tennessee is a title theory state with respect to real
property security interests, meaning that legal title to real
property is conveyed by the borrower via a deed of trust to a
trustee on behalf of the lender. The borrower retains equitable
title to the property, including rights of possession and
income.
The deed of trust is filed in the register of deeds office in
the county where the property is located. Although most deeds of
trust include language creating a security interest in the fixtures
attached to the real property, creditors commonly file a separate
UCC-1 “fixture filing” financing statement in the
register of deeds office with respect to the secured fixtures.
Typically, a lender will also require a separate assignment of
leases and rents from the borrower.
The assignment of leases and rents is also filed in the register
of deeds office in the county where the property is located.
3.3 Regulations or Requirements Affecting Foreign Lenders
Out-of-state lenders are generally not required to be qualified
to do business in Tennessee or be registered with state agencies in
order to make a typical commercial loan secured by real estate as
such activities typically do not constitute transacting businesses
within the state by themselves. Except for those activities that do
not constitute transacting business in Tennessee under TCA Section
48-25-101 and certain others, non-Tennessee corporate entities must
qualify to do business in Tennessee with a certificate of authority
and register with the Tennessee Department of Revenue for franchise
and excise taxes.
Tennessee requires trustees who hold legal title to secured real
property on behalf of a lender to be one of the following:
- a Tennessee resident;
- a Tennessee corporation or non-Tennessee corporation
whose principal place of business is Tennessee; or - an individual whose principal place of employment is
in Tennessee.
Tennessee also allows a resident of a non-Tennessee state to
serve as trustee if such non-Tennessee state permits Tennessee
residents to serve as trustees.
3.4 Taxes or Fees Relating to the Granting of Enforcement of
Security
The recording of an instrument evidencing indebtedness (eg, a
deed of trust or UCC-1 financing statement), whether at the county
or state level, requires payment of an indebtedness tax equal to
USD0.115 per USD100 of indebtedness, excluding the first USD2,000
of indebtedness, which is exempt from the tax calculation.
3.5 Legal Requirements before an Entity Can Give Valid
Security
Tennessee does not maintain any financial assistance or
corporate benefit rules with respect to real estate assets.
3.6 Formalities When a Borrower Is in Default
Tennessee allows judicial foreclosure and non-judicial
foreclosure upon the default of a loan secured by a deed of trust
or mortgage. Judicial foreclosure proceedings are rarely used, as
most real estate financing is secured by a deed of trust that
allows for power of sale through non-judicial foreclosure.
A properly executed, acknowledged, and recorded deed of trust or
mortgage provides constructive notice to all persons and will
establish priority over subsequent liens and interests.
Non-judicial foreclosure proceedings are initiated by providing
the debtor with notice of default. Next, the creditor must publish
notice of the foreclosure sale at least three times in a newspaper
published in the county where the property is located and in
compliance with any additional requirements in the deed of trust. A
non-judicial foreclosure sale must comply strictly with the
language in the deed of trust.
The notice of foreclosure sale must include information such as
the names of interested parties, a description of the property, the
time and place of the foreclosure sale, and other related items.
Tennessee law requires the trustee to search for state tax liens on
the property, and also governs the manner and timing of the sale
process. Specifics may be found in TCA Section 35-5-101 et seq.
Non-judicial foreclosure in Tennessee typically requires around 30
days from start to finish.
3.7
Subordinating Existing Debt to Newly Created Debt
The holder of a deed of trust or mortgage may consensually
subordinate its lien by contract pursuant to a subordination
agreement. The subordination agreement should be recorded in the
same manner as the original deed of trust or mortgage in order to
be valid against third parties. Taxes and mechanic’s liens, if
certain requirements are followed, may also take priority over a
recorded lien.
3.8 Lender’s Liability under Environmental Laws
A lender holding or enforcing security over real estate may be
liable under environmental laws, even if it did not cause any
pollution of the real estate under federal laws or the laws of
Tennessee if it engages in “active participation” in the
management of a facility. “Active participation” must be
more than “the mere capacity, or ability to influence, or the
unexercised right to control a site, vessel or facility
operations”, and requires “actual participation in the
management or operational affairs by the holder of the security
interest”. The Tennessee Waste Hazardous Waste Reduction Act
of 1990 (the Tennessee Superfund Act) generally follows the
provisions of SARA, which afford certain liability protections to
lenders that are not active participants in the management of a
facility (TCA Section 68-212-301, et seq (2018)).
If a lender’s indicia of ownership are held primarily to
protect a security interest, they do not indicate active
participation (TCA Section 68-212-401(B)). In the event of a
foreclosure, a holder of a security interest will continue to be
considered as an un-active participant, provided that the holder
undertakes to sell, re-lease or otherwise divest itself of the
property or facility in an expeditious manner (TCA Section
68-212-403).
3.9 Effects of Borrower Becoming Insolvent
The automatic stay, effective upon the filing of a federal
bankruptcy petition, will stay all foreclosure actions against a
debtor’s real property. Furthermore, under Tennessee law, a
non-judicial foreclosure becomes final upon execution of a
trustee’s deed to the purchaser – not upon final oral cry
at the non-judicial foreclosure sale or upon a memorandum of sale.
If a federal bankruptcy petition is filed any time before the
execution of a trustee’s deed, the foreclosure action will be
automatically stayed by bankruptcy and the lienholder will be
forced to proceed in the federal courts to get relief from the
automatic stay before finalizing the foreclosure under Tennessee
law.
Furthermore, Federal bankruptcy law will allow a bankruptcy
trustee or debtor in possession to avoid any lien that has not been
properly recorded in a timely manner under Tennessee law, or a lien
that was given for less than reasonably equivalent value while
insolvent or other fraud. Tennessee allows fraudulent liens to be
avoided any time within four years after the lien attaches.
The primary protection against bankruptcy risks is a disciplined
credit program. A lender should understand its risks before
deciding to lend. In addition, timely perfected security interests
in collateral with real value assure that a loan will be repaid
even in the event of bankruptcy.
Most efforts to contract around bankruptcy will be determined
void as against federal bankruptcy policy.
3.10 Taxes on Mezzanine Loans
Tennessee does not have any taxes specifically applicable to
mezzanine loans. Under T.C.A. Section 67-4-409, however, the
recording of an instrument evidencing indebtedness (eg, UCC-1
financing statement in connection with a mezzanine financing)
requires payment of an indebtedness tax equal to USD0.115 per
USD100 of indebtedness, excluding the first USD2,000 of
indebtedness, which is exempt from the tax calculation.
4. Planning and Zoning
4.1 Legislative and Governmental Controls Applicable to Design,
Appearance and Method of Construction
Tennessee and its political subdivisions use a variety of
legislative and governmental controls or regulations, such as
county, municipal and historical zoning laws, and building
ordinances that govern design, appearance and construction methods
of new buildings and refurbishments at the regional and municipal
level.
Additionally, historical zoning commissions exist at the county
or municipal level; in any area of the state served by a regional
planning commission, the local legislative bodies of the region
served by such commission may create a regional historic zoning
commission. The growth and construction of non-residential or
multi-family residential buildings located in areas of historical
significance are also regulated. Counties have the authority to
create design review commissions, which then may develop general
guidelines for the exterior appearance of and entrance to
properties located in historical areas.
4.2 Regulatory Authorities
Tennessee has planning commissions on the regional, municipal,
and community level.
The types of legal restrictions and requirements on development
and use of real estate include regulations promulgated by the
regional and municipal planning commissions. Examples of
requirements include plat approval and building permitting. There
are also county, municipal and historic zoning regulations, which
vary but are generally enacted for the purpose of promoting the
health, safety, morals, convenience, order, prosperity and welfare
of the present and future inhabitants of the state and of its
counties.
The chief legislative body of a municipality is responsible for
enacting zoning ordinances, which regulate the location, height,
bulk, number of stories, and various other aspects of
properties.
At the neighborhood level, pursuant to Tennessee’s
Neighborhood Preservation Act, owners of residential property are
required to maintain the exterior of such property and the lot in
accordance with community standards of other residential property
in the area.
4.3 Obtaining Entitlements to Develop a New Project
The process for obtaining entitlements to develop a new project
or to complete a major refurbishment in Tennessee includes
submitting preliminary and schematic plans to the appropriate
planning commission for approval. The commission will review and
approve or disapprove of a plan, often requiring changes which can
then be re-submitted for approval once made. Plans are subject to a
public hearing where third parties may support or object to the
plan.
With respect to historically zoned areas, all applications for
permits for construction, alteration, repair, rehabilitation,
relocation or demolition of any building or structure, or for other
improvements to real estate situated within a historic zone or
district are referred to the local historic zoning commission or
the regional historic zoning commission. The applicable zoning
commission is also authorized to review construction or alteration
plans even where a permit is not required.
Affected parties have the right to participate in or object to
planning decisions.
The process to re-zone property normally requires a
pre-application conference, neighborhood meeting, formal
application, planning department review and hearing, and a hearing
and decision by the governing body. This process takes several
months at minimum.
The process to obtain a variance primarily requires an
application, review and recommendation by the planning department,
and a hearing and decision by the board of adjustment. This process
also typically takes several months.
4.4 Right of Appeal against an Authority’s Decision
Each county and municipality has the authority to create a board
of zoning appeals, which has the power to hear and decide appeals
where it is alleged by an individual that there is error in any
order, requirement, permit, decision or refusal made by the
applicable commissioner or any other administrative official in the
carrying out or enforcement of any provision of any ordinance.
At the planning commission level, if the applicable commission
approves or disapproves a development plat after a hearing thereon
then the applicant submitting the plat, or any person who was a
party for or against the plat, who so requests at the planning
commission hearing has the right within 30 days of such approval or
disapproval to have the action of the planning commission reviewed
by the appropriate municipal legislative body, which shall approve
or disapprove the development plans by majority vote. Any further
appeal would proceed in the chancery or circuit court.
Property owners affected by historical zoning guidelines or who
do not comply with the guidelines may appeal a decision of the
design review committee or the county building commissioner to the
county board of zoning appeals.
4.5 Agreements with Local or Governmental Authorities
It is possible in Tennessee to enter into agreements with local
or governmental authorities or agencies or utility suppliers in
order to facilitate a development project. Such arrangements
typically take the form of participation agreements or development
agreements with the applicable municipality or utility or even the
planning department in order to effectuate certain types of
projects – eg, parks, roads, infrastructure, and other public
developments that can be built more efficiently with the use of a
private developer.
4.6 Enforcement of Restrictions on Development and Designated
Use
Public agencies in the state have the administrative authority
to remedy noncompliance with planning regulations or zoning
ordinances. For example, a zoning board has the ability to
institute an injunction, mandamus, abatement or other appropriate
action to prevent, enjoin or remove an unlawful construction.
Alteration, maintenance or use of any real property in violation of
a zoning commission’s regulations is a misdemeanor, with each
day that an illegal construction or use of land or structure exists
being a separate offense.
5. Investment Vehicles
5.1 Types of Entities Available to Investors to Hold Real
Estate Assets
Real estate owners may hold title to their property through
limited liability companies (LLCs), corporations, limited
partnerships, limited liability partnerships or general
partnerships, or in their individual names. Limited liability
companies and corporations are most frequently used due to the
familiarity of investors and lenders with their organisational
structure and their inherent liability protection.
5.2 Main Features of the Constitution of Each Type of
Entity
A corporate structure can decrease transaction costs and can
expedite the formation and closing timelines in property-related
private equity offerings or financing transactions. However,
continuing development and the increasing ubiquity of limited
liability companies have allowed for greater organisational
flexibility while maintaining as simple or sophisticated a capital
structure as necessary for a given transaction. General
partnerships and individual ownership of commercial property are
infrequent, due primarily to the unlimited liability exposure, but
their use allows owners to avoid Tennessee franchise and excise
taxes on the real property.
In addition, a limited liability vehicle such as an LLC may
elect to be an “obligated member entity” to avoid this
issue.
5.3 Tax Benefits and Costs
The inefficiency of the double taxation regime applicable to
standard C-corporations is the largest tax disadvantage to
selecting such corporate structure for ownership of an
income-producing real estate asset; however, in certain contexts,
owners may be able to elect Subchapter S treatment under the
Internal Revenue Code and receive pass-through tax treatment on
earnings. Absent the affirmative election to be taxed as a
corporation, limited liability companies offer the default benefit
of pass-through tax treatment on earnings.
5.4 Applicable Governance Requirements
The governance structure of corporations is characterised by
management by a board of directors and the day-to-day operations of
the corporation are carried out by officers. Shareholders of a
corporation typically have no management rights, but they have
voting rights with respect to the election of directors and certain
significant corporate transactions, such as merger, dissolution and
a sale of substantially all the assets of the corporation. The
governance structures of Tennessee limited liability companies are
variegated and such entities may be managed by their members, a
manager or a board of managers, or a board of directors.
LLCs may also employ officers to oversee day-to-day operations.
Default statutory rules apply in the case of corporations and
limited liability companies, but Tennessee law provides a much
greater degree of flexibility in the drafting of documents
governing limited liability companies management and governance
rights when compared to default statutory rules.
6. Commercial Leases
6.1 Types of Arrangements Allowing the Use of Real Estate for a
Limited Period of Time
Tennessee law broadly recognizes three arrangements under which
a person, company or other organization may occupy and use real
estate for a limited period of time without buying it outright: by
lease, by easement and by license.
Under a lease arrangement, one party (the lessor or landlord)
leases real property to another party (lessee or tenant) and grants
the right of exclusive possession thereof for a period of time, in
exchange for a consideration, which most often takes the form of
rent. Leases with a term of more than one year must be in writing
and signed by the party against whom enforcement is sought. In
order for leases with a term of more than three years to be binding
on anyone other than the landlord, the landlord’s heirs and
devisees, or third parties with actual notice, they (or memoranda
thereof) must be registered in the county where the subject
property is located, in accordance with the requirements of the
Tennessee recording statutes (TCA Section 66-24-101 et seq). In
Tennessee, a lease constitutes an interest in real property.
An easement is also considered an interest in real property and
confers upon its owner the right to use the property of another for
a particular purpose. To be enforceable, easements created by
agreement must be in writing, and to be binding upon subsequent
purchasers or interest holders without notice they must be
registered in the county where the property is located, in
accordance with the requirements of the Tennessee recording
statutes.
A license confers to the licensee only a personal right to
undertake specific activities on the licensor’s real property,
with or without corresponding obligations. A license is generally
revocable and, in the absence of express language to the contrary,
cannot be transferred or assigned. Unlike the lease and the
easement, a license does not create an interest in land and is not
governed by the Statute of Frauds, and thus does not need to be in
writing.
6.2 Types of Commercial Leases
Commercial leases often take different forms, depending on the
use of the leased premises. A lease for an office in an office
building will be substantially different from a lease of warehouse
space in an industrial park, or retail space in a shopping center,
or commercial space in a single-tenant property. There are
different considerations, protections for the landlord,
representations and warranties, and different ways to handle the
charges to be paid by the tenant.
There are multiple options with respect to the charges to be
paid by the tenant, including gross (ie, fully serviced), net,
modified gross and percentage. A gross lease is where the landlord
pays for the property taxes, insurance and maintenance, and the
tenant pays a single flat fee. A net lease is the opposite of a
gross lease.
There are three types of net leases: single net, double net and
triple net. A single net lease is where the tenant is responsible
for rent and property taxes; a double net lease is where the tenant
is responsible for rent, property taxes and insurance; and a triple
net lease is where the tenant is responsible for rent, property
taxes, insurance and maintenance. A modified gross lease is a
hybrid between a gross lease and a net lease. A percentage lease is
where the tenant pays base rent as well as a percentage of revenue
earned from its business on the property.
A ground lease is where the tenant pays rent and also constructs
improvements on the property during the term of the lease, after
which the land and improvements are turned over to the landlord.
Ground leases typically have longer terms.
6.3 Regulation of Rents or Lease Terms
Neither rents nor lease terms are regulated in Tennessee, with
the exception of certain limitations placed on the term for oil and
gas leases: Tennessee law generally limits the term of such leases
to a maximum of ten years from the date of execution, unless
natural gas or oil is being produced for commercial purposes at the
expiration of the ten-year period (TCA Section 66-7-103).
6.4 Typical Terms of a Lease
Although most terms for commercial leases are the product of
negotiation, a lease term of five to ten years with renewal options
is not uncommon. Ground leases and build-to-suit leases typically
have longer terms.
Typically, the landlord is responsible for the maintenance and
repair of any common areas of the building or shopping center, for
structural components of the building/demised premises and for any
utility lines to the boundary of the demised premises. Tenants are
typically responsible for all maintenance and repair within the
demised premises.
Rent is often paid in advance at the beginning of each month,
but leases in Tennessee must expressly state that rent shall be
paid in advance, contrary to the common law presumption.
6.5 Rent Variation
The rents are determined by the terms of the lease agreement.
Many rental rates increase during the term, particularly for terms
of longer duration.
6.6 Determination of Changes in Rent
Leases may include rent escalation provisions that cause the
rent to increase annually based upon agreed percentages (with 2% of
3% being typical), or upon market indicators such as increase in
fair market value or increases in the Consumer Price Index. All
rent provisions must include a key that allows for the rent amount
to be objectively determined.
6.7 Payment of VAT
No VAT or other taxes or governmental levy is payable on
rent.
6.8 Costs Payable by Tenant at the Start of a Lease
At the start of a lease, the tenant may be responsible for a
security deposit, any application fees and the first month’s
rent. In some instances, the landlord could require first and last
month’s rent. Tenants are sometimes responsible for the
build-out and preparation of the leased premises, as well.
Capital improvements in a lease are typically paid for by the
landlord; however, the lease may be negotiated such that certain
capital expenses such as improvements to reduce operating costs or
comply with applicable laws are passed through to the tenant and
amortized over a certain period.
6.9 Payment for Maintenance and Repair
Common area expenses are often divided among the multiple
tenants in proportion to the amount of space leased. Unless the
rent is structured as a full-service gross arrangement (where
tenant pays a set, all-inclusive rent), tenants will usually pay a
monthly estimate of these common area expenses (or CAM expenses) to
the landlord in addition to monthly base rent payments. All of the
common expenses for these areas are estimated and amortized over
the lease year. The landlord is typically responsible for
maintaining the common areas in good working order and condition,
but will recoup those fees and costs from the funds paid by each
tenant for CAM expenses.
6.10 Payment for Services, Utilities and
Telecommunications
The payment of services, utilities and telecommunications that
serve a property occupied by several tenants will likely be
determined by whether the separate premises are separately metered.
Where separately metered, it is common for tenants to pay utilities
directly. If not separately metered, the landlord will usually pay
utilities and assess the tenants proportionately or build utilities
costs into the base rent.
The negotiated contract will establish specific utilities
payments.
6.11 Insuring Real Estate That Is the Subject of a Lease
Various considerations will determine whether the landlord or
the tenant ultimately insures the property, including which entity
can negotiate lower pricing and better coverage. A multi-tenant
site will usually be insured by the landlord with costs passed to
the tenants, while a single tenant site may be insured by the
tenant. Most events causing damages are insured through an all-risk
or special form property policy.
Special endorsements exist in areas where there are high risks
of earthquakes or other special casualty events.
6.12 Restrictions on the Use of Real Estate
Restrictions on the use of the premises may generally be imposed
within the lease in the form of a narrow permitted use provision,
general terms aimed at minimising risk or property damage, or
generally applicable rules and regulations that may be amended from
time to time by the landlord. Tenants will often expressly be
required to use the premises in accordance with all laws.
Tennessee allows for local governments to regulate use through
zoning laws, but use restrictions may also arise from private
covenants and restrictions, easement agreements, and other recorded
instruments governing or restricting the use of property.
6.13 Tenant’s Ability to Alter or Improve Real Estate
The landlord usually wants control or consent rights over any
improvements to the premises during the lease term and will usually
specify what work can be performed to the demised premises, and can
cap the work at a certain dollar threshold or require prior written
consent for work beyond a dollar threshold.
6.14 Specific Regulations
Residential leases in Shelby, Davidson, Knox and other populous
counties must comply with the Tennessee Uniform Residential
Landlord and Tenant Act, which protects residential tenants from
certain actions of a landlord. Most provisions of commercial
leases, however, are creatures of contract law that override the
default landlord-tenant laws.
6.15 Effect of Tenant’s Insolvency
A tenant’s insolvency may cause default under a lease, but
federal bankruptcy law will ignore as void any insolvency provision
in a lease. If bankruptcy is sought, Section 365 of the Bankruptcy
Code states that a debtor tenant may assume, assign or reject the
lease. Assumption of the lease is a decision to retain or continue
the lease by the bankruptcy estate, whereas a rejection is a
decision to terminate.
The tenant must cure any lease defaults and assure future
performance under the lease before assuming or assigning the
lease.
6.16 Forms of Security to Protect against Tenant’s Failure
to Meet Obligations
Typically, a landlord will collect a security deposit at the
beginning of the lease term for a month or several months of rent
payments. Upon default, a landlord may liquidate the security
deposit and use it to cover some of the tenant’s obligations
under the lease. A tenant may also be required to provide an
irrevocable letter of credit from a financial institution.
If the tenant defaults, the landlord can draw upon the letter of
credit to satisfy outstanding rental obligations. Furthermore, for
the same reasons, a tenant may also be required to provide a
personal guarantee from the principal, a parent guaranty, or some
other credit enhancement.
6.17 Right to Occupy after Termination or Expiration of
Lease
A tenant does not have a right to occupy the premises outside
the stated lease term. However, most commercial leases will contain
a holdover provision that converts the tenancy at expiration to a
tenancy at will with an increased rental amount; this holdover rent
is usually high enough to discourage the tenant’s continued
possession. In order to recover possession where the tenant fails
to surrender the premises, a landlord will need to terminate the
lease, seek a forcible entry and detainer against the tenant, and
obtain a writ of possession.
A lease should specify that abandonment of the premises allows
the landlord to re-enter, take possession and terminate the
lease.
6.18 Right to Terminate Lease
An event of default that could result in termination of the
lease is governed by the terms of the lease. Nonpayment is the most
common event of default. Events of default should also include the
breach of any material provision in the lease.
Upon an event of default, a lease will often require the
non-defaulting party to provide notice to the defaulting party and
give a reasonable cure period. If the event of default is uncured,
the right to terminate should be permitted. Abandonment should also
give a right to terminate the lease.
Failure to pay taxes, material changes or termination of
insurance and unauthorised or illegal uses of the premises will
ordinarily provide a right of termination. It is also common to
have anti-assignment provisions that cause termination of the
lease. The lease should also specify rights to termination upon
certain casualty or condemnation events.
6.19 Forced Eviction
In the event of default prior to the expiration date, a tenant
can be forced to vacate the leased premises through the process of
eviction. Even though most leases contain a covenant allowing the
lessor to re-enter the premises and remove a tenant upon default,
Tennessee prohibits landlords from exercising self-help. Instead, a
writ of possession must be obtained through the eviction
process.
The typical eviction process is a forcible entry and detainer
action in general sessions court or circuit court. The time of
trial may not be less than six days from the date of service of the
summons on the tenant, in accordance with TCA Section 29-18-115. A
writ of possession for the recovery of the property from the tenant
will not be issued against the tenant until ten days after judgment
is rendered in favor of the landlord.
The tenant may appeal within ten days (TCA Section 29-18-101 et
seq).
6.20 Termination by Third Party
The government or a municipal authority may terminate a lease by
condemnation, which occurs when part or all of the leased premises
are taken for a public purpose by an entity with the power of
eminent domain. Most leases include a condemnation clause that
provides for what will occur in the event condemnation occurs. Any
rents paid in advance, prior to any condemnation, are required to
be refunded to the tenant.
A senior lender cannot terminate a lease unless it has such
right in the lease or a separate subordination, non-disturbance and
attornment agreement. For example, if the lender has foreclosed on
its leasehold mortgage and replaces its borrower as the tenant
under the lease pursuant to certain leasehold mortgagee provisions
in the lease, the lender may have termination rights pursuant to
such provisions.
7. Construction
7.1 Common Structures Used to Price Construction Projects
Commonly used pricing structures for construction projects
include the following:
- fixed price (sometimes referred to as lump sum);
- cost-plus, where the price is based on the actual
cost of labor and materials plus a fixed or percentage fee for the
contractor’s overhead and profit; and - cost-plus with a guaranteed maximum price (or GMP),
where the contractor agrees that the actual cost plus the fee will
not exceed a certain guaranteed maximum price.
Unit prices may be used as a component of fixed price and
cost-plus contracts.
7.2 Assigning Responsibility for the Design and Construction of
a Project
Responsibility for the design of most projects is allocated to
the architect through an agreement between the owner and the
architect, and responsibility for the construction of the project
is allocated to the contractor through a separate agreement between
the owner and the contractor. The allocation of certain design
responsibilities is frequently negotiated among the parties. For
example, responsibility for site and foundation work may be
assigned to an engineer that has contracted directly with the
owner.
Likewise, design responsibility for shop drawings and submittals
during construction is often negotiated and sometimes shared by the
architect and the contractor. For projects utilizing the
“design-build” method of project delivery, the
design-builder is responsible for both the design and the
construction of the project.
7.3 Management of Construction Risk
Construction risk is primarily managed through the contractual
provisions between the owner and the contractor. Most construction
contracts, including the popular American Institute of Architects
(AIA) contract documents, include basic warranties and
indemnification provisions. The scope of and exclusions from these
provisions are often negotiated. Indemnification provisions are
enforceable under Tennessee law, subject to certain limitations and
requirements.
Tennessee recognises the nearly “universal rule that there
can be no recovery where there was concurrent negligence of both
the indemnitor and the indemnitee unless the indemnity contract
provides for indemnification in such case by “clear and
unequivocal terms” and general words will not be read as
expressing such intent” (Kroger Co v Giem, 387 SW 2d 620, 624
(Tennessee 1964)).
Further, an indemnity provision in a construction contract that
purports to indemnify a party for damages caused by such
party’s sole negligence would be void under Tennessee law as
being against public policy (TCA Section 62-6-123); see 7.5
Additional Forms of Security to Guarantee a Contractor’s
Performance.
7.4 Management of Schedule-Related Risk
Construction schedule-related risk is managed through
contractual provisions and the possible use of liquidated damages
for delays. Owners should consider including a “no damage for
delay” clause, which provides that an extension of time is the
sole remedy of the contractor in the event of a delay. The contract
may include financial incentives for the early completion of a
project or an acceleration provision giving the owner the right to
demand acceleration of the project.
The development of the project schedule and negotiation of
events or circumstances allowing for extensions of the contract
time are key components of managing schedule-related risks.
Liquidated damages clauses providing for the payment of a
stipulated amount of damages for the failure of a contractor to
complete a project or reach a certain milestone in a timely manner
are enforceable in Tennessee, provided that the stipulated amount
is a reasonable estimate of damages at the time the parties entered
into the contract.
7.5 Additional Forms of Security to Guarantee a
Contractor’s Performance
Payment and performance bonds are sometimes required by owners
to provide security for the contractor’s performance under the
contract and payment of its subcontractors and materialmen. Some
owners do not require payment and performance bonds as the cost of
these bonds is generally passed through to the owner, but such
bonds are frequently required by lenders providing construction
financing. Public projects in Tennessee require payment and
performance bonds, and some public projects also require bid
bonds.
Although less common, a letter of credit or parent-company
guarantee is sometimes provided by a contractor as an alternative
to payment and performance bonds.
Retainage of a small percentage of each progress payment is
commonly used to protect the owner. In Tennessee, retainage is
limited to 5% of the gross amount of the contract by the Tennessee
Prompt Pay Act of 1991 (TCA Sections 66-34-101, et seq). If the
prime contract is USD500,000 or more, the retainage must be
deposited by the owner into a separate interest-bearing escrow
account (TCA Section 66-34-104). This requirement cannot be waived
or modified by contract and the interest earned on the account is
the property of the contractor.
7.6 Liens or Encumbrances in the Event of Non-payment
Contractors, materialmen, architects and others making
improvements to the real property have statutory lien rights in
Tennessee; however, only prime contractors have lien rights on
residential property consisting of one to four units. These liens
relate back to the “visible commencement of operations”,
excluding demolition, surveying and certain site work. A
construction loan secured by a deed of trust recorded prior to the
“visible commencement of operations” has priority over
mechanics’ and materialmen’s liens, which can be removed by
posting a bond to indemnify against the lien.
7.7 Requirements before Use or Inhabitation
The process for obtaining a certificate of occupancy varies
according to the location of the project. Most local jurisdictions
have inspection requirements before a certificate of occupancy will
be issued, and a temporary certificate of occupancy is sometimes
issued when the project is substantially complete. Under Tennessee
law, “[s]ubstantial completion means that degree of completion
of a project, improvement, or a specified area or portion thereof
(in accordance with the contract documents, as modified by any
change orders agreed to by the parties) upon attainment of which
the owner can use the same for the purpose for which it was
intended” (TCA Section 28-3-201(2)). Additionally, state and
federal government inspections and approvals may be required for
certain projects, such as healthcare facilities.
8. Tax
8.1 Sale or Purchase of Corporate Real Estate
See 2.10 Taxes Applicable to a Transaction.
8.2 Mitigation of Tax Liability
Methods commonly used to mitigate the cost of the transfer tax
are the structuring of transactions as mergers, changes of control,
or transfers of equity ownership in property-owning entities.
8.3 Municipal Taxes
With few exceptions, Tennessee levies a business tax on gross
receipts of all businesses that sell goods or services. Businesses
must obtain a business license from the county or municipality and
report gross receipts to the Tennessee Department of Revenue on
annual returns. Most municipalities – including Nashville,
Memphis, Knoxville and Chattanooga – have adopted additional,
copycat business taxes on gross receipts.
Exemptions apply to nonprofit, religious, medical, farm,
charitable, legal, educational, domestic, accounting services,
architecture, engineering, surveying and veterinary entities, and
entities that generate less than USD10,000 in sales.
8.4 Income Tax Withholding for Foreign Investors
Tennessee does not have an income tax. When a non-US person
disposes of an interest in US real estate, the proceeds are subject
to 15% withholding under the Foreign Investment in Real Property
Tax Act (FIRPTA). The amount of withholding can be adjusted by
obtaining a withholding certificate from the Internal Revenue
Service.
8.5 Tax Benefits
The primary tax benefit from owning real estate is that property
taxes paid are deductible for federal income tax purposes. While
land is not depreciable, improvements to land are subject to
depreciation. This depreciation is deductible on the owner’s
federal income tax return.
Owners may also take advantage of the IRC Section 1031 exchange
rules, assuming all conditions are satisfied.
State Incentives and Tax Benefits
The State of Tennessee and its municipalities offer a number of
incentives and tax benefits which may be available to certain real
estate projects. The Tennessee Department of Economic and Community
Development (ECD) offers grants through its Fasttrack Programs. The
Fasttrack Infrastructure Program helps local governing bodies make
infrastructure improvements which may benefit companies creating
new jobs or making new capital investments. The Fasttrack Job
Training Assistance Program grants expanding companies funding to
support the training of new full-time employees.
The Fasttrack Economic Development Fund is used to offset costs
companies incur when expanding or locating a business operation in
Tennessee, including acquiring or developing real property, with
reimbursable grants made to local governing bodies. ECD also offers
its various Job Tax Credits, Enhanced Jobs Tax Credits, Industrial
Machinery Tax Credits, and other Sales and Use Tax Exemptions.
Local Industrial Development
Local Industrial Development Boards and other municipal bodies
in Tennessee may also offer various grants and incentives for real
estate projects. For example, the Economic Development Growth
Engine Industrial Development Board of the City of Memphis and
County of Shelby, Tennessee (EDGE) offers its Inner City Economic
Development Loans which helps develops inner city business
districts through small, forgivable loans and its Neighbourhood
Emergency Economic Development Grants which provide relief to
neighbourhood serving businesses affected by COVID-19 in the
city’s most distressed areas. EDGE also offers a variety of
Payment in Lieu of Tax (PILOT) Incentives which provide a
temporary, partial abatement of real property taxes for
participants in return for a participant’s commitment to employ
local minority/women-owned firms and small businesses, to create or
retain jobs, and to make an agreed upon investment.
A PILOT transaction typically involves the participant
purchasing real property which is then sold to EDGE and leased back
to the participant to develop. As the property is then owned by a
municipal entity, the property tax is abated but the participant
will make lease payments (representing a discounted property tax)
instead. EDGE may also engage in tax increment financings (TIF)
which reinvests the increase in real property taxes back into the
development of a project. Tourism Development Zone (TDZ) financings
are yet another method of financing real estate projects in
Tennessee whereby the sales tax increase from an area is reinvested
back into the development of the project. PILOTs predominate in
Memphis whereas other incentives like TIFs are popular elsewhere in
Tennessee.
There are a number of similar boards and bodies across Tennessee
with similar grants or programs, including various PILOT, TIF, and
TDZ programs, which can be utilized to subsidize the costs of real
estate projects.
8.6 Key Changes in Federal Tax Reform
See 1.3 Impact of New US Tax Law Changes.
THE TENNESSEE REAL ESTATE LAW AND PRACTICE SECTION OF THE
2021 CHAMBERS USA REGIONAL REAL ESTATE GUIDE WAS
ORIGINALLY PUBLISHED HERE.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.