When parties enter a contract involving an appraised value of real estate, they need eventual finality with respect to that appraised value, but they also want fairness in the appraisal process. In Buffalo-Water 1, LLC v. Fidelity Real Estate Company, LLC, 481 Mass. 13 (2018), the Supreme Judicial Court of Massachusetts recently considered the question of whether the appearance of bias alone is sufficient to invalidate a contractually binding appraisal.
The dispute arose out of a sale leaseback of commercial property in Boston’s Financial District. The defendant, Fidelity Real Estate Company, LLC, sold the subject property to the plaintiff, Buffalo-Water 1, LLC, and leased the property from Buffalo-Water retaining the option to re-purchase it during the last year of the lease for the greater of a fixed amount and a percentage of the property’s fair market value.
The lease provided that if Fidelity exercised its option, the fair market value would be determined through a relatively common approach: First, the parties would attempt to agree on the value. If they couldn’t agree, the parties would each appoint a qualified appraiser, and the two appraisers would determine the value, or, if the two appraisers could not agree and their appraisals differed by five percent or less, the value would be the average of the two appraisals. If the two appraisers could not agree and their appraisals differed by more than five percent, the two appraisers would appoint a third appraiser to make a binding determination of the value.
So, just how much did the initial two appraisals differ after Fidelity exercised its option to re-purchase and the parties failed to agree on a fair market value? A lot.
Buffalo-Water’s appraiser valued the property at $36 million, while Fidelity’s appraiser valued the property at $17 million. Enter the third appraiser, who valued the property at $22.9 million.
After initially disputing the third appraiser’s determination on the basis of purported “factual errors” in the appraisal, Buffalo-Water discovered that the employer of the third appraiser, a large real estate services company, had a national representation contract with Fidelity, prompting Buffalo-Water to file a lawsuit seeking to invalidate the appraisal.
The third appraiser’s contract with the parties included provisions relating to conflicts of interest, disclosure of prior services, and compliance with certain codes of professional ethics. Emphasizing that Buffalo-Water’s complaint did not allege that the third appraiser had a personal interest in the outcome of his valuation or that the third appraiser actually knew of his employer’s contract with Fidelity, the SJC held that no contractual breach occurred.
The SJC then considered Buffalo-Water’s argument that the appearance of bias should invalidate the appraisal. As the SJC explained, a contractually binding appraisal may be overturned under existing Massachusetts common law principles where the appraisal was tainted by “fraud, corruption, dishonesty or bad faith.” The SJC found that the appearance of bias falls short of these four thresholds and that “[a]llowing appraisals to be invalidated based on the appearance of bias alone would considerably diminish the finality of appraisals without significantly improving their over-all integrity.”
Towards the end of its decision, the SJC alludes to an important takeaway lesson: “When parties negotiate a contract that provides for a binding appraisal, they are free to include provisions that establish more stringent impartiality requirements than those in our common law and specify that the appraisal will be invalid where those requirements are not met.”
In other words, if just the possibility of bias is a particularly serious concern for a party entering a contract with a binding appraisal component, that party should consider requiring more expansive grounds for invalidating the final appraisal or more specific requirements for the appraiser’s eligibility or both. Without such additional provisions in a contract, and absent demonstrable “fraud, corruption, dishonesty or bad faith,” Massachusetts courts will not disrupt the finality of a contractually binding appraisal.