United States: What Condominium Developers and Homebuilders Need to Know About the Interstate Land Sales Full Disclosure Act

Robert Chasnow is a Partner in our Washington, D.C. office.

REGISTRATION, EXEMPTIONS AND OTHER KEY ISSUES

Now more than 40 years old, the Interstate Land Sales Full Disclosure Act (ILSA) (15 USC §§ 1701 et seq.) was enacted into law in 1968 early in the ascendant consumer and environmental protection era in the United States. Its impact on condominium developers and homebuilders has received much scrutiny – especially in the past five years, with unprecedented litigation involving purchasers seeking rescission or damages from condominium developers and homebuilders who sold them condo units and single-family homes. This article is designed to help untangle the sometimes contradictory case results by a review of ILSA from the perspective of the practical considerations of the alternative compliance methods: registration and the main applicable exemptions.

Summary of ILSA and Its Registration Provisions

As its name states, the main objective of the statute is full disclosure through the filing of a "registration" of the facts and circumstances of the sales of lots in a subdivision. Note that unbuilt homes and condominium units and those not yet complete have been defined as "lots" under the circumstances described below. ILSA calls for a developer's registration with the U.S. Department of Housing and Urban Development (HUD) of a Statement of Record that includes: (i) a full disclosure statement, called a "Property Report," to be provided to prospective lot purchasers, and (ii) a section called "Additional Information and Documentation" that includes substantial supporting documentation along with detailed descriptions of the documents and other information.

In a nutshell, the main topics covered in registration and drafting the "full disclosure" Property Report are as follows:

• platting, title and land use
• description of arrangements for completion of project infrastructure, including contact information of utility providers
• summary disclosure of the developer's financial information and disclosure of financial assurances of completion of the project, if any
• disclosure of the developer's background, including relevant regulatory violations and litigation; a statement of the developer's and affiliates' other projects
• information and description that includes completion status of the condominium or residential community (e.g., amenities and facilities)
• disclosure of weather-related, geographic and topographic hazards
• a description of the owners association and its assessments, fees and control issues
• provisions relating to the form purchase agreement relating to resale, rights of first refusal, unit exchange, federal rescission rights and, if applicable, limitations of retained amounts by seller for buyer's pre-closing breach
• disclosure of property tax amounts
• disclosure of local facilities and schools

Also, unless an exception applies, audited financial statements are required to be filed with HUD and are required to be made available to prospective purchasers.

For projects outside the United States, the regulations call for additional information on the country and its laws and policies for U.S. residents regarding purchase of property and residency in the situs country.

Although not part of the publicly distributed Property Report, the Additional Information and Documentation section includes further information on the developer and its affiliates, as well as on its other land or condominium projects; also, information on whether exemptions or registrations were used with respect to the other projects. For example, an exhibit, not for use in the property report but filed with HUD as part of the overall registration, calls for disclosure of estimates of the cost or value of the land, cost of improvements, marketing and sales costs, overhead and gross project profit.

For most of the past 15 years, HUD did not closely evaluate documentation filed as part of the registration but simply recorded whether the registration appeared to be superficially complete. Starting in 2008-09, however, HUD modified its approach to registrations. It has become more active in its review and more thorough in its standards for determining whether a registration is accurate and complete. As a result, close attention must be paid to the registration regulations in order to accurately describe the full range of facts and circumstances of the projects as called for by the regulations; counsel with substantial hands-on experience can offer true "value-add" to reduce the time and expense of registration.

Main Exemptions from Registration – Condominium Developers and Homebuilders

A number of exemptions and exceptions to registration are included in ILSA. Most exemptions pertain to homesite subdivisions. However, as noted, HUD and the courts have long held that, unless exempt by statutory exemption, condominium and homebuilding projects must register under ILSA, just like homesite subdivisions.

Essentially, three main exemptions are available to condo developers and homebuilders:

Completed unit exemption. If at the time of entering into a sales contract with a purchaser the unit or home is completed and in move-in condition, preferably documented by a certificate of occupancy from local government, the sale of the condominium unit or freestanding single-family home is entirely exempt from ILSA.

Two-year commitment to build exemption. This exemption applies when the unit purchase agreement contains a strong two-year commitment from the seller to complete construction within two years from the date the purchaser signs the agreement. In terms of drafting such a contract, the draftsperson needs to focus on clauses on contingencies, force majeure, remedies limitations and other provisions not generally perceived by sellers or their counsel as required by the exemption.

The two-year completion exemption has given rise to misunderstanding, controversy and extensive litigation; it is not an easy one for a developer to count on. To date, of several dozen or so developers who relied on this exemption and were challenged in court by one or more of their purchasers, in those cases where the court ruled on the substance of the claim, more court decisions than not side with purchasers who allege the developer did not meet the terms of the exemption. Subject to the statute of limitations – itself hotly litigated as to whether two years or three years from the date of signing the purchase agreement is the appropriate period of repose – the usual civil remedy for this kind of ILSA violation is immediate rescission in favor of the purchasers. If such a judgment is issued, questions can arise from many other similarly situated purchasers in the project who also may be interested in rescission. Developers and homebuilders in Florida, Georgia and Alabama could breathe a collective sigh of relief when the U.S. Court of Appeals for the Eleventh Circuit recently ruled in favor of a developer in withstanding a challenge from a purchaser of a condominium unit. However, for companies operating in the 47 other states, the District of Columbia, and even in the Eleventh Circuit, many questions remain.

100-unit exemption. The 100-unit exemption is for new developers without affiliates or other projects where the project and promotional plan consist of fewer than 100 units. Further, under limited circumstances, the 100-unit exemption may be able to be combined with either or both the completed unit exemption and the two-year commitment to build exemption, as described above – but courts have been inconsistent in their approach to the circumstances in which the 100-unit exemption can be combined with these other two exemptions. Although HUD, which administers ILSA, has been consistent nearly without exception over the years that the combination of these exemptions is permitted within fairly broad parameters, courts are not required to defer to HUD and sometimes disagree or discount HUD's positions on ILSA questions, including application of the 100-unit exemption when combined with other exemptions.

Exemptions generally. When called upon to decide exemption controversies, courts often state that given the essence of ILSA as a consumer protection and anti-fraud statute, exemptions are to be narrowly construed. In cases where it is not clear if an exemption applies, courts may find that the exemption does not apply, based in part at least on the following premise implied or articulated in the decisions themselves: In light of the fact that confirming application of an exemption serves to deny purchasers ILSA's signature benefit of receipt by the prospective purchaser prior to the time of sale of a full disclosure Property Report (drafted pursuant to the registration process described above) and a federal seven-day rescission period during which the purchaser can review and evaluate the disclosures so obtained, confirmation of exemptions should be reserved for instances of clear applicability, rather than close calls.

Federal regulations for registration and exemptions are found at 24 CFR 1701 et seq., as well as online at http://www.access.gpo.gov/nara/cfr/waisidx_01/24cfrv5_01.html.

HUD's exemption guidelines are found online at http://www.hud.gov/offices/hsg/ramh/ils/ilsexemp.cfm.

As to the guidelines, note that court cases have sometimes not accepted what HUD has stated in its guidelines. As a result, a developer or homebuilder and their counsel must carefully evaluate prior to relying heavily on the guidelines in determining compliance.

Benefits of Registration

From the point of view of condominium developers and homebuilders, the benefits of registration may be summarized as follows:

• Registration and the disclosure it brings to unit purchasers is the signature compliance feature of ILSA (again, the very name of the law is the Interstate Land Sales Full Disclosure Act). Prior to the virtual halt of new projects in 2008-09, an increasing number of planned or under-construction condominium projects and homebuilder communities were registering, especially projects which, from time of first advertising and marketing to time of completion of units, were estimated at close to or beyond a two-year period.
• Registration means that a "full disclosure" document, the Property Report, has been accepted by HUD for the seller to provide to purchasers prior to execution of purchase contract and provides purchasers with a seven-day rescission period.
• Registration removes the easiest route of a two- or three-year rescission option for purchasers; in a slow market, registration helps sales to stick by removing a strong threat from the tool kit of disgruntled purchasers and their lawyers. Although not absolute assurance, rescission granted by the courts to purchasers who received Property Reports for units in registered projects is rare, whereas rescission often has been granted in cases where exemptions are relied upon.
• Registration is based mostly on disclosure of existing facts and circumstances backed by basic documentation, not on a long list of new substantive standards to be met. Although disclosure can be trying for the developer who is displeased with the resulting text, sometimes such disclosure can lead to positive change by the developer in its approach, thus leading to more positive disclosure.
• Some developers think ILSA's exemptions from registration are easy and straightforward, but they often wind up spending about the same in legal fees in compliance efforts with one or more of the exemptions. The HUD regulations provide that although statutory exemptions are self-determined, HUD provides advisory opinions on exemptions. Developers will receive important support by applying for and obtaining an advisory opinion although the process can be a challenge.
• Often the Property Report provides detailed information on the project, which has the effect of reassuring purchasers and others, such as lenders.

Risks of Registration

The following are points to keep in mind regarding the risks and disadvantages of registration for condominium developers and homebuilders:

• Registration adds time and legal expense, and diverts management/staff attention to undertake and accomplish a property registration. Use of experienced counsel can reduce these costs, however.
• Where registration is undertaken after sales have begun in the project, registration may force disclosure to HUD of information on prior sales if such sales were made without benefit of reliance on an exemption.
• In registration, disclosure must be made to HUD of the developer's affiliates and their projects, and whether such other projects are subject to ILSA. Although unlikely, it is possible that "skeletons in the closet" could bring an element of jeopardy to a non-compliant affiliate.
• Property Report disclosures may expose facts and circumstances about the project that the developer would rather not show to prospective purchasers, including the developer's lack of financial assurance for completion of the condominium, the risk of loss of the purchasers' deposits, thin capitalization and financial loss to date of the developer entity.
• Where sales are made more than 180 days prior to completion and closing of unit, ILSA has a special set of three requirements: (1) where a purchaser defaults prior to closing, ILSA requires a contractual provision calling for the developer to provide a 20-day notice and cure period for any default by the purchaser; (2) in case of continued purchaser default past the notice and cure period, a contract provision limits developer's retention of purchaser deposits to 15 percent of the total cash purchase price or actual damages, whichever is greater; and (3) aside from the two contract provisions, the property description used in the contract must be one that is legally effective in the local jurisdiction.
• Suits for misrepresentation and omission of material facts under the Property Report are fully authorized by ILSA, so registration does not render the developer immune from suit. In connection with such suits, ILSA grants to courts the full range of equitable remedies, including rescission. However, the usual remedy for misrepresentation and omission unless overwhelmingly material is a measure of damages suffered by the purchaser rather than the remedy of rescission.

Remedies for Violation of ILSA

In addition to the remedy of rescission discussed above, ILSA provides for three main types of remedies for non-compliance with the statute and regulations: (1) criminal penalties, (2) civil money penalties levied by HUD, and (3) civil liabilities generally expressed in financial terms available to purchasers through the courts.

First, "any person who willfully violates [and is convicted of violating the Act shall] be fined not more than $10,000 or imprisoned not more than 5 years or both." (15 U.S.C. §1717).

Second, HUD may impose a civil money penalty of $1,000 per violation per day, not to exceed $1 million per year on "any person [who] knowingly and materially violates [the Act] ... the penalty shall be in addition to any other" civil, criminal and/or other administrative sanctions. (§1717a(a)).

Third, if a purchaser successfully sues in a private action, a "court may order damages, specific performance, or such other relief as the court deems fair, just and equitable." (§1709(a)). In that connection, a court may direct a purchaser to recover "interest, court costs, and reasonable amounts for attorneys' fees, independent appraisers' fees, and travel to and from the [property]." (§1709(c)). Additionally, purchasers can sue to enforce their right to revoke their contract under specific circumstances including circumstances where developer claims exemption without sufficient foundation. (§1709(a) and (b)).

Finally, HUD is authorized to review allegations of violation and administratively come to settlement. Since 1968, it is estimated that HUD has required tens of thousands of rescissions and administrative settlement fees of as much as several hundred thousand dollars per project.

Conclusion

Given the increase in litigation involving purchasers seeking rescission or damages, condominium developers and homebuilders should carefully consider registration and exemptions under ILSA. Holland & Knight attorneys have extensive experience in this area, and can assist with evaluation of the alternatives and implementation of the solution best suited to your project's specific facts and circumstances.

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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.