As The Condo Market Worsens, The Significance Of Buyers’ Deposits Held In Escrow Grows

Two recent national news items track the ongoing crisis in the condo/residential real estate market, with a particular emphasis on the bad and worsening state of affairs which continues to envelope Miami and South Florida in general.  From CNN, the S&P Case/Shiller Price index, which charts home prices in 20 major U.S. markets, shows that home prices dropped 10.7% in the 12 months ending January 2008.  The weakest markets: Miami and Las Vegas, tied at a staggering annual decline of 19.3% of each, with Phoenix, San Diego, Los Angeles, Detroit, Tampa, and San Francisco not too far behind.

And this article from Saturday’s Wall Street Journal puts the focus on the woes of the condo market, noting colorfully that “Developers in Miami and Fort Lauderdale, Fla., are readying nearly 10,000 total new units in a market already struggling with canyons of unsold condos.”  The 10,000 figure is truly dizzying.   For purposes of illustration, the same article cites, not surprisingly, Atlanta, Phoenix, and San Diego as three other cities where the over-supply of condo inventory is especially severe.  Taken together, the expected new condo inventory for the coming year in those three cities is about equal to the new supply that will be introduced in Miami/Fort Lauderdale alone!

In addition to the numbers, the following passage from the Wall Street Journal article, which hits upon a key and often overlooked point — the importance of the percentage of the purchase price realized in buyers’ preconstruction deposits — caught my eye:

One big question hanging over the market is how many of the buyers who have put down deposits during construction will show up to close the deal. Some deposits were as little as 3% of the purchase price. The price of a condo has frequently fallen more than the amount of the deposit, giving the buyer an incentive to forfeit the deposit.

For example, if a buyer put down $50,000 for a unit priced at $500,000, and the value falls to $400,000, the buyer is apt to walk away — or find some fault with the unit and sue the developer to get the deposit back. Furthermore, some buyers who still want to move in are finding that they no longer qualify for mortgage loans.

It is no secret that the Florida condo market crash has sparked a rash of lawsuits brought by buyers seeking to recover their preconstruction deposit monies instead of closing on units under contract.  Indeed, this blog has followed the development of this litigation, including the salient issues under Florida and federal law.  No doubt, one of the contributing factors behind the upsurge in lawsuits is the typical hefty percentage paid by buyers as deposits for Florida condos.  The range is anywhere from 10% to 30% of the purchase price, with 20% constituting the norm in my experience.  This means that for Florida condos — which frequently bear purchase prices of anywhere from a quarter million to one million dollars and up — buyers often have a significant amount of cash already invested in the deal to make a lawsuit a risk worth pursuing, and particularly so where a buyer has entered into contracts for multiple units in the same or different projects.

Another important factor driving the condo litigation upsurge in Florida courts is the protection afforded by Florida condo law to buyers’ deposit monies.  The key Florida Statute is section 718.202.  The statute provides that all deposits up to 10% of the purchase price must be paid into an escrow account and held there until closing (any deposits above 10% of the purchase price may be released to the developer, but only “in the actual construction and development of the condominium property,” and the purchase agreement must disclose this possibility).  And particularly relevant given current market conditions, the law also forbids the escrow agent from releasing any funds to the developer where “prior to the disbursement the escrow agent receives from the buyer written notice of a dispute between the buyer and developer.”  The only exception to the escrow requirements set forth in the statute are where the developer files proof of acceptable “other assurances” with the State of Florida — such as a surety bond or an irrevocable letter of credit — to secure the buyers’ deposit funds.

In practice, the Florida escrow requirements mean that a buyer in dispute with the developer over the validity of a condo purchase agreement ordinarily has the power to at least temporarily prevent the developer from accessing a sizeable portion of the deposits — that is, by notifying the escrow agent in writing of the dispute.   First Sarasota Service Corp. v. Miller, 450 So. 2d 875 (Fla. 2d DCA 1984), an older case which arose out of a lawsuit brought by the buyers of 8 condo units against a developer seeking rescission of the contracts and refund of their deposits, depicts this general principle in action.  As the court stated, “The obvious purpose of section 718.202 is to protect purchasers under preconstruction condominium contracts from loss of their deposits should the developer fail to perform its contractual obligations.”  As such, the court held, “since the escrow agent had prior written notice of a claim that there was a dispute between the purchasers and the developer, it made . . . disbursements [to the developer] at its peril.”

The fiduciary duty owed to a buyer by the escrow agent has gained increasing importance in a condo market where plummeting values mean that fewer and fewer purchasers are going through with closing on units, and many of them are seeking to recover their deposits through the legal system.  The oft-heard phrase “possession is 9/10’s of the law” applies in this context and ultimately means that the Florida condominium statute provides significant protection to buyers in a weak and weakening market.

By Jared H. Beck, Esq.

This article does not constitute legal advice or the formation of an attorney-client relationship, and is not for re-publication without express permission of the author.

Mr. Beck has a law degree from Harvard Law School, and practices law in the courts of South Florida. His law firm, Beck & Lee Business Trial Lawyers in Miami, is dedicated to the practice of business and real estate litigation. A significant portion of Mr. Beck’s practice is devoted to issues arising under condominium and other real estate purchase agreements. He can be reached at 305-789-0072 or jared@beckandlee.com

 

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