iAs we see increasing incidents of high-rise and other large-scale condominium projects coming on-line in Colorado, it is timely to review under what circumstances these and other planned community projects may be exempt from the provisions of the federal Interstate Land Sales Full Disclosure Act. This Act, enacted in 1968, was adopted to require disclosure of relevant information, and prevent fraud, in connection with residential real property sales. While it arguably was originally designed primarily to prevent sales of swamp land in Florida, the Department of Housing and Urban Development, which administers the Act, and courts around the country have concluded that the Act also applies to the retail sale of residential condominiums.
If a residential condominium project is not exempt under the Act, the developer must submit a detailed registration statement and disclosure-oriented Property Report to HUD. While a developer may take reservations, it may not enter into enforceable sales contracts until HUD has approved the registration statement and Property Report – a process that can take up to 60 days, or longer. Once the registration is approved, the developer must deliver the approved Property Report to prospective buyers in connection with execution of the sales contract, which must contain a seven-day rescission period following execution. The developer’s failure to comply with the Act allows, at a minimum, the buyer to rescind the contract for two years after its execution. The developer could also be subject to civil and criminal penalties, and could risk the entry of an injunction prohibiting sales in the project until the provisions of the Act have been satisfied.
Given the potentially serious consequences of failing to comply with the Act, developers should carefully consider whether their projects are fully or partially exempt from its provisions before proceeding with sales without registration. There are three primary exemptions on which condominium developers traditionally rely: the two-year exemption; the 25-unit exemption, and the 100-unit exemption.
Sales Closing within Two Years
So long as a developer commits in its contract with the buyer to close on the sale of a completed unit within two years of contract execution, the sale of that unit is fully exempt from registration. The sales contract must not be illusory – the developer must truly be obligated to close on the unit sale within two years, although the contract may contain traditional force majeure provisions. Thus, the buyer’s remedies in the sales contract for breach by the developer cannot be limited to a return of earnest money, and the contract cannot negate the buyer’s rights of specific performance or damages, though it need not expressly recognize those rights. The contract may include a provision allowing the developer to terminate if a pre-sale requirement is not satisfied within 180 days after contract execution, but the 180-day pre-sale provision does not extend the two year requirement for closing on the sale.
Conventional project financing typically contains a pre-sale requirement before the lender will begin advancing construction funds. Because the pre-sale requirement normally calls for binding sales contracts, the developer is forced to enter into contracts sometimes months in advance of commencement of construction, jeopardizing the project’s eligibility for the two-year exemption. In order to secure the two-year exemption, some local developers have financed their projects through equity contributions or alternative debt financing (such as mezzanine or other non-conventional debt), containing no pre-sale conditions. This approach allows the developer to begin construction on a speculative basis, and to defer entering into sales contracts until the developer is certain that construction can be completed within two years. The developer engages in creative marketing and promotional events to assure there is a satisfactory market for completed units prior to commencing construction.
A full exemption from registration means: (a) the developer does not need to register the project or prepare a Property Report; and (b) the anti-fraud provisions of the Act also do not apply to the sale of the unit. Thus, a buyer claiming that he was defrauded in connection with the purchase of a unit would have no statutory right to rescind or to claim penalties under the Act, though the buyer would retain his state law remedies.
No reported decision or HUD advisory opinion addresses the consequences to a developer if it relies on the two-year exemption, and then fails to complete construction within two years. Presumably, so long as the developer’s original, realistic construction budget and time-table contemplated completion of the development within two years, and the developer failed to complete construction due to market factors or other conditions beyond its control, the developer should not be subject to sanctions under the Act, though the buyer, of course, will have a claim for breach of contract. In contrast, if the developer always knew the project would take longer than two years, and entered into the contract knowing it would subsequently default, the buyer may have remedies under the Act in addition to a breach of contract claim.
25 Unit Exemption
Projects containing no more than 25 units are also fully exempt from the provisions of the Act.
100 Unit Exemption
Projects containing fewer than 100 units are partially exempt from the provisions of the Act. The total number of units in a project constructed in phases, and in projects subject to a common promotional scheme, will be aggregated when determining how many units the project contains. To fall within this partial exemption, the sales contract must expressly obligate the developer to construct a completed unit (including providing necessary roads and utilities) and any recreational amenities which the developer has represented to the buyer it will provide.
A partial exemption means that the project need not be registered, and no property report need be delivered to buyers, but the developer is still subject to the anti-fraud provisions of the Act. These provisions generally prohibit a developer from using any scheme to defraud prospective buyers; making untrue statements of material facts, or failing to make material disclosures, to prospective buyer; and engaging in a course of business that operates as a fraud. They also provide that a developer may not represent that roads, utilities, or recreational amenities will be provided or completed without including an express provision in the sales contract requiring the developer to do so.
Aggregation of Exemptions The Act provides that the 100-unit and 2-year exemptions may be combined, apparently resulting in full or partial exemptions for a project that has more than 100 units and will take more than two years to complete. For example, let’s assume a developer proposes a four-building, 120-unit project, to be built in four phases over five years. If the developer is confident that building one, containing 30 units, can be constructed and unit sales closed within two years after contract execution, it appears as though the developer may rely on the two-year full exemption from registration for the sale of the 30 units in that building. Those 30 units then would not count toward the 100-unit partial exemption, and the remaining 90 units could be sold in reliance on that exemption. Conclusion
Developers should carefully analyze the provisions of the Act, and potentially applicable exemptions, before proceeding with unit sales in a condominium project. It may be possible to secure project financing and develop a construction schedule that renders a large project fully exempt from registration.
