Tennessee Actual Property Regulation And Observe – Chambers USA Regional Actual Property Information 2021 – Actual Property and Development

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.

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