A recent Wall Street Journal blog post reports that New York courts are allowing more residential real estate buyers to rescind contracts pursuant to the Interstate Land Sales Full Disclosure Act (ILSFDA). As noted in the post, and as we are also seeing here, many buyers are trying to get out of their contracts. Those buyers with large earnest money deposits at stake have real incentive to find legal arguments that will allow them to both keep their earnest money and cancel the contract. While this may not be surprising, some developers are shocked to learn that they may have unwittingly given buyers an easy way out of their contracts under ILSFDA.
ILSFDA applies to the sale of real estate and is generally modeled after securities laws. It requires that a real estate developer register its projects, unless the project qualifies under an exemption. Rather than going through the elaborate (and lengthy) registration process, many developers choose to rely upon an exemption. The exemptions are self-determining, meaning that there is no government sign-off on a developer’s compliance for a particular project. This is where many developers get tripped up as compliance with exemption requirements can be very tricky. If buyers successfully argue that a project was not registered and did not meet the requirements for a particular exemption, the buyers can rescind the contract for a two-year period, starting on the date of the buyer’s execution of the contract.
This rescission right is a powerful tool and drives home the point that developers need to (a) carefully consider ILSFDA’s requirements, and (b) evaluate whether any of the pending sales contracts are at risk for rescission rights under ILSFDA. In today’s market it is also important to consider the impact this could have on lenders. As lenders deal with distressed development loans and negotiate loan workouts, they should make a serious assessment of whether any pending sales contracts are at risk of rescission under ILSFDA. A representation of compliance with ILSFDA in a loan agreement given by a now nearly bankrupt development entity is really of no help in this context.
We can all hope that this litigation will help developers and lenders more fully understand the magnitude of the risk of noncompliance with ILSFDA and will help real estate lawyers better counsel their clients on compliance issues. Time will tell.