In the litigation fallout from the real estate market crash, the latest round of lawsuits in Florida involves developers of troubled projects bringing claims against their lenders. Here are three major examples from recent weeks: the original developer of the Il Lugano condo hotel in Fort Lauderdale sued KeyBank for allegedly erecting “unreasonable hurdles” as a condition of continued financing; the developer of the Logik 1 office-condo sued Bank of America for pulling financing and allegedly causing construction of the project to stop; and, as a counterclaim in a foreclosure action, the developer of the Promenade Lakes at Doral condo sued Wachovia for failing to fully fund the project’s construction loan.
This recent trend is certainly no surprise, given the extent to which so many developers are embattled these days. Bringing a claim for breach of a loan agreement against a lender which has initiated foreclosure proceedings is a logical maneuver to deploy in the developer’s defense of the foreclosure itself (with the operative litigation principle being that the best defense is often a good offense). But at the core of these claims are, potentially, factual issues which suggest a deeper reason for the sudden burst of the housing bubble: a mad scramble by financial institutions to cash in on the once-torrid housing market through construction lending, which ultimately led to the financing of non-viable projects. In connection with this phenomenon, consider this recent New York Times article describing just how exposed Wall Street is on the commercial real estate lending side of the equation, which may very well be the next sector to topple on the heels of the secondary mortgage market.
The pressing question for buyers/investors in troubled Florida projects, where the developer has brought suit against its lender, is whether such claims will further the chances of recovering money from the deal, for example, by now enabling buyers to go after the developer’s lender. The starting point for the analysis is to realize that under Florida law, the bar to establishing “lender liability” is a high one. Illustrating this principle is a case called ZP No. 54 Ltd. Partnership v. Fidelity & Deposity Co. of Maryland, 917 So. 2d 368 (Fla. 5th DCA 2005), where a Florida appellate court dismissed a claim brought by a developer against a surety bond company that issed a performance bond to a crooked contractor hired by the developer. While the developer argued that the surety bond company “aided and abetted” the contractor’s fraud by failing to adequately investigate the contractor before issuing the bond, the court didn’t accept the theory, holding that “a performance bond is not designed or intended to protect an owner from his own folly or lack of due diligence.” By the same token, one might expect that a lender, upon being hit with a “lender liability” claim from a buyer in a troubled development, will argue, analogously, that a lender’s issuance of a construction loan does not absolve an investor from the responsibility of conducting his or her own due diligence prior to buying into a given project.
Whereas the common law of Florida may not look favorably upon lender liability, as I have previously written on this blog, banks could be seriously exposed under the Interstate Land Sales Full Disclosure Act (ILSA), a federal consumer protection law which applies to real estate transactions, and has an expansive definition of “developer.” A key opinion in this regard is Timmereck v. Munn, 433 F. Supp. 396 (N.D. Ill. 1977), where a large group of real estate buyers alleged that they were defrauded in the sale of undeveloped lots, and named as one of the defendants a bank which purportedly helped finance the development by agreeing to purchase the buyers’ mortgage notes. While the court recognized that ILSA “exempts lending institutions acting in the normal course of their business,” it held that the plaintiffs could state a viable claim against the bank by showing that it “exceeded the normal scope of financing practices and actively participated in and aided the advancement of a fraudulent scheme, or otherwise assisted in the luring of purchasers for an allegedly dubious project.” Lender liability under ILSA, the court also noted, is critical to the statute’s aim of protecting consumers due to the ever-present risk that the principal developers in a fraudulent land sale “might become bankrupt and leave the victims . . . without a remedy.”
An important basis for the court’s decision in Timmereck was evidence that the defendant bank had conditioned its agreement to purchase the buyers’ notes upon receiving adequate assurances from the developer that there were “sufficient funds” available to construct the development’s many proposed amenities. That is to say, the court saw, in the bank’s conduct, a palpable level of involvement in the project’s actual construction, which was suitable grounds for alleging an ILSA claim against the bank.
As such, Timmereck might allow us to make the following prediction with respect to those cases where a developer has sued its lender for breach of the loan agreement. Where such cases reveal an unusual level of involvment by the lender in managing the construction of the project, and there are potential claims for fraud and/or misrepresentation on the part of the buyers, the lender may be on the hook under ILSA. Otherwise, establishing lender liability from the buyer’s perspective will be a tough sell.
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 purchase contracts for real estate, including condominiums, condo-hotels, single-family homes, and commercial property. He can be reached at 305-789-0072 or firstname.lastname@example.org