With the onset of our recent economic turndown, some buyers cannot close on pre-construction contracts that they entered into several months or even years prior to the completion of the purchased property. While some simply cannot afford the economic sting of an extra mortgage, others cannot close because they are unable to obtain a sufficiently large mortgage. Lenders determine maximum mortgage amounts based upon post-bubble comparable sales. These amounts may be too low to allow buyers to close on pre-bubble contracts.

Many of these buyers have put down substantial earnest money and upgrade deposits, often equaling 15% or more of the purchase price of the yet to be completed property. It's not uncommon for the developers to refuse to refund all or a portion of these deposits, claiming them as liquidated damages under the contract. Some developers have taken a more aggressive stance and have threatened to sue the buyer under specific performance rights if that remedy is contemplated in the contract.

Investors and other buyers facing this situation have a number of options. If the developer did not perform an obligation under the contract, and this breach occurred prior to a default by the purchaser, then the developer may be in substantial breach of the contract, thereby permitting the purchaser to claim certain relief, often contemplated as a return of all monies. If there is proof that a developer has breached and thereby defaulted under the contract, that may be a buyer's best means to get out of the contract and recover the money he or she has invested.

If no breach has occurred, then a buyer must look beyond the four corners of the contract, and consider other claims against the developer. Buyers should consider whether they think the developers misrepresented any information to them about the development, as this could lead to claims of fraudulent inducement into the contract, or negligent or fraudulent misrepresentation or concealment, which also may allow buyers to get out of their contract.

The Interstate Land Sales Full Disclosure Act (“ILSFDA“ or “Act”) could also give buyers an out. ILSFDA regulates interstate land sales and offers protections to consumers from fraud or abuse in the sale or lease of land. While ILSFDA does not apply to all developments, for those that it does apply to, ILSFDA sets out a number of requirements regarding the advertisement of property, as well as the purchase process, which may include, but is not limited to the following:

• Developers may be required to provide a seven-day period of rescission to the purchaser from the date that the contract or pre-construction contract was signed. In other words, for those buyers who have “buyer's remorse” soon after entering into the contract, there is a week period of time for them to rescind the contract and receive all money back from the developer.
• Developers may be required to register and file a Statement of Record, comprised of a Property Report and additional information, with the Department of Housing and Urban Development (“HUD”), the federal department that enforces ILSFDA, prior to the sale or lease of property. Buyers can sue for damages if the developer does not follow these procedures.
• Developers may be required to furnish consumers a Property Report, a lengthy document providing certain information about the development project, prior to the consumer entering into a purchase or lease contract. If the developer does not follow this procedure, the purchaser has a two-year period of time from the date of the contract to cancel the contract and receive a full refund of any monies invested.
• Developers may also be required to comply with anti-fraud provisions of the Act, which explicitly ban certain unlawful or misleading sales practices. So, for example, if a developer fails to complete facilities promised to a buyer either through advertising or as stated in the Statement of Record or Property Report, or in any way misrepresents the property or fails to disclose necessary facts to the buyer, the purchaser could sue under the Act for damages. HUD may separately pursue civil or criminal claims against a developer where fraudulent sales practices have occurred.

If you believe that a developer has breached its obligations to you under ILSFDA, your remedies may be significant. You could bring an action against the developer for violation of the Act, or to enforce your revocation rights, and a court may award damages, specific performance, or other appropriate relief, as well as possibly awarding attorney fees and costs. In a separate action, HUD may also impose civil penalties ($1,000 per violation, not to exceed $1 million per year) or criminal penalties (fines up to $10,000, imprisonment for five years, or both).

Regardless of whether the buyer has a legal ability to compel the seller to release the buyer from the contract, the seller may understand that the buyer's inability to close is solely based upon the decline in the market value of the unit. Most developers, in this market, would much rather prefer to close on a sale than to take a buyer's earnest money. Regardless of whether the buyer has any legal leverage against the developer, the developer might be willing to lower the sales price low enough to allow the buyer to obtain financing to close. It doesn't hurt to ask.

This article is intended to provide buyers who entered into a pre-construction contract that they cannot close on a summary of what options may be available to them. However, this article is not exhaustive and buyers' claims of relief may vary depending on the contract they entered into and the specific facts and circumstances of their case. Buyers facing this situation should consult with legal counsel to determine what rights they have.

Kirsten A. Westerland is an associate with Frascona, Joiner, Goodman and Greenstein, P.C., a Colorado law firm. Her practice areas include Civil and Commercial Litigation, Appeals, and Real Estate. She can be reached at contact Kirsten Westerland.

Jonathan A. Goodman is a shareholder in Frascona, Joiner, Goodman and Greenstein, P.C., a Colorado law firm.   His practice areas include Real Estate, Brokerage Law, Contracts, Land Use, Leasing, Real Estate Title, Association Law, Business Law, and Finance.   He can be reached at contact Jonathan Goodman.

Disclaimer -- Content is general information only. Information is not provided as advice for a specific matter, nor does its publication create an attorney-client relationship. Laws vary from one state to another. For legal advice on a specific matter, consult an attorney.