Applicability of the Interstate Land Sales Act in New York

In two recent cases, sponsors in New York State, the state that has the most complex regulatory scheme for the sale of condominiums in the United States, have been found to have failed to comply with the less rigorous disclosure mandated by the Interstate Land Sales Act (“ILSA”). In both cases ' Bacolitsas v. 86th & 3rd Owner, LLC, No. 09 (iv.7158(PKC)(S.D.N.Y. Sept. 21, 2010), and Nu-Chan, LLC v. 20 Pine Street LLC, No. 09 (iv.00477(PAC)(S.D.N.Y. Sept. 30, 2010) ' the sponsors were required to refund deposits regardless of the amount of disclosure that had been given to the purchasers.

Bacolitsas

In Bacolitsas, the sponsor filed a Statement of Record and an accompanying Property Report with the U.S. Department of Housing and Urban Development (HUD), as required by ILSA, which the purchasers received with the Offering Plan. When the purchasers failed to make the third payment required by the sale contract and filed an application with the New York Attorney General for the return of their down payment, the Attorney General investigated and found in favor of the sponsor. Nevertheless, the U.S. District Court ruled that the purchasers still had the right to rescind the agreement and have their deposit refunded as a result of the sponsor's failure to comply with section 1703(d)(1) of ILSA, which permits a purchaser to revoke “any contract ' for the sale ' of a lot ' which does not provide – (1) a description of the lot which makes such lot clearly identifiable and which is in a form acceptable for recording by the appropriate public official responsible for maintaining land records in the jurisdiction for which the lot is located ' .” The court found that because the Agreement between the sponsor and the purchaser was not acknowledged before a notary public or other specified officer and contained a provision precluding the recording of the Agreement or a memorandum thereof, the purchasers had the right to cancel the agreement and obtain a refund of their deposit.

Particularly troubling is the requirement in the Bacolitsas decision that the purchase agreement needs to be in recordable form, because no construction lender would ever approve of having either a lot description or the purchase agreement recorded. Moreover, even if the lender did not object, neither the lot description nor the purchase agreements could be recorded against the lots, because the lots do not exist until the Declaration is recorded, which cannot occur until after the Offering Plan is declared effective shortly before the closings are set to commence. Accordingly, accepting the court's interpretation of ILSA, a sponsor could not comply both with ILSA and with the Real Property Law.

Nu-Chan

In Nu-Chan, the district court found that ILSA applied to an office building that was being converted to residential use, although the court also found that the purchaser's right to automatically rescind the purchase agreement must be asserted within two years of the agreement being executed as required by 15 U.S.C. 1703(c) but, because ILSA has a three-year statute of limitations, the court found that purchasers might still be entitled to equitable remedies and/or damages (which may include equitable rescission) if they bring claims under 1709(b) before the three-year statute of limitations has tolled and they are able to prove that they were in some way harmed by the ILSA violation.

Prior to Nu-Chan, the general consensus was that existing buildings that were undergoing conversion were exempt from ILSA due to the “improved lot” exemption which, pursuant to 1702(a)(2), requires that the unit either “must be completed before it is sold, or it must be sold under a contract obligating the seller to erect the unit within two years from the date the purchaser signs the contract of sale.” In Nu-Chan, the court found that the condo units at issue were not exempt from ILSA because they were not physically habitable as residential units at the time the purchase agreements were signed.

Fraudulent Conduct

Neither in Bacolitsas, Nu-Chan nor any other New York ILSA decision has there been the slightest hint of false or deceptive practices or unscrupulous sales. In response to this issue, the court in Bacolitsas noted that “the rescission remedy of section 1703(d) is not contingent on a showing of fraudulent conduct by a developer or a resulting injury to the purchaser.” It is worth noting that the Martin Act, the Regulations issued by the Office of the Attorney General, and the review process by the AG that takes anywhere from six to 15 months, provides far more protection from false or deceptive practices than that called for under ILSA

ILSA

No appellate court has ruled on the applicability of ILSA to condominiums in New York, although it is likely that one or more of the six ILSA decisions will be the subject of a Second Circuit decision within the next few months. Each of the district court decisions presumes that ILSA is applicable to condominium units; however, that is not necessarily the case. Although ILSA was originally intended to cover unimproved land, in 1978, Congress amended it and inserted the word “condominium” in only one place in the Act. Section 1702(a) (2) was amended to extend an existing exemption to condominiums. The Senate Committee explained:

Section 715(b) (1) of the bill would amend section 1403 (a)(2) [now ' 1702 (a)(2)] of the act to provide an exemption for the sale or lease of any improved land on which there is a condominium or on which a condominium is to be built within two years. Section 1403(a)(3) provides an exemption for land on which there is or will be built within 2 years, a residential, commercial, or industrial building. Present HUD regulations do not provide an exemption for condominiums.

Housing and Community Development Amendments of 1978, Report of the Committee on Banking, Housing and Urban Affairs, United States Senate (Report No. 95-871, U.S. Code Congo & Admin. News 1978, p. 4773) at page 97. The Conference committee that considered the amendments said:

The Interstate Land Sales Full Disclosure Act is amended to broaden the exemptions to include sale or lease of land on which there is a condominium building on or which a condominium building is to be built within two years ' .

Public Law 95-557, Summary of the Act, Joint Explanatory Statement of the Managers of the Committee of Conference at page 80.

Indeed, the House report accompanying 1979 amendments to the act establishes that Congress never intended to include the sale of condominium units within the scope of ILSA:

[P]roponents of the legislation expressed strong concern over what they believe to be special problems which exist in South Florida'The Committee believes that states and local governments now perceive the need to enact appropriate safeguards and are taking steps to solve these problems. Accordingly, it does not, at this time, see an overwhelming need for establishing national minimum standards of disclosure and protection. [Emphasis added.]

House Report (Banking, Finance and Urban Affairs Committee) No. 96-154, May 15, 1979 (to accompany 3875) at 28, 29, U.S. Code Congo & Admin.News 1979, pp. 2344-45.

Conclusion

In New York, ILSA is being used by purchasers, who are attempting to reverse their economic decisions based on a change in market conditions notwithstanding the fact that there had been adequate disclosure. Although these decisions are creating havoc for sponsors at the present time, the impact of these decisions will be short-lived. Now that sponsors know that ILSA is applicable and see the manner in which the courts interpret it, in the future sponsor's counsel will change the procedures they utilize in selling condominium units in order to take the necessary steps to avoid ILSA's use an offensive weapon. In the meantime, however, already cash strapped sponsors and their lenders will have to deal with the consequences of these decisions.

In two recent cases, sponsors in New York State, the state that has the most complex regulatory scheme for the sale of condominiums in the United States, have been found to have failed to comply with the less rigorous disclosure mandated by the Interstate Land Sales Act (“ILSA”). In both cases ' Bacolitsas v. 86th & 3rd Owner, LLC, No. 09 (iv.7158(PKC)(S.D.N.Y. Sept. 21, 2010), and Nu-Chan, LLC v. 20 Pine Street LLC, No. 09 (iv.00477(PAC)(S.D.N.Y. Sept. 30, 2010) ' the sponsors were required to refund deposits regardless of the amount of disclosure that had been given to the purchasers.

Bacolitsas

In Bacolitsas, the sponsor filed a Statement of Record and an accompanying Property Report with the U.S. Department of Housing and Urban Development (HUD), as required by ILSA, which the purchasers received with the Offering Plan. When the purchasers failed to make the third payment required by the sale contract and filed an application with the New York Attorney General for the return of their down payment, the Attorney General investigated and found in favor of the sponsor. Nevertheless, the U.S. District Court ruled that the purchasers still had the right to rescind the agreement and have their deposit refunded as a result of the sponsor's failure to comply with section 1703(d)(1) of ILSA, which permits a purchaser to revoke “any contract ' for the sale ' of a lot ' which does not provide – (1) a description of the lot which makes such lot clearly identifiable and which is in a form acceptable for recording by the appropriate public official responsible for maintaining land records in the jurisdiction for which the lot is located ' .” The court found that because the Agreement between the sponsor and the purchaser was not acknowledged before a notary public or other specified officer and contained a provision precluding the recording of the Agreement or a memorandum thereof, the purchasers had the right to cancel the agreement and obtain a refund of their deposit.

Particularly troubling is the requirement in the Bacolitsas decision that the purchase agreement needs to be in recordable form, because no construction lender would ever approve of having either a lot description or the purchase agreement recorded. Moreover, even if the lender did not object, neither the lot description nor the purchase agreements could be recorded against the lots, because the lots do not exist until the Declaration is recorded, which cannot occur until after the Offering Plan is declared effective shortly before the closings are set to commence. Accordingly, accepting the court's interpretation of ILSA, a sponsor could not comply both with ILSA and with the Real Property Law.

Nu-Chan

In Nu-Chan, the district court found that ILSA applied to an office building that was being converted to residential use, although the court also found that the purchaser's right to automatically rescind the purchase agreement must be asserted within two years of the agreement being executed as required by 15 U.S.C. 1703(c) but, because ILSA has a three-year statute of limitations, the court found that purchasers might still be entitled to equitable remedies and/or damages (which may include equitable rescission) if they bring claims under 1709(b) before the three-year statute of limitations has tolled and they are able to prove that they were in some way harmed by the ILSA violation.

Prior to Nu-Chan, the general consensus was that existing buildings that were undergoing conversion were exempt from ILSA due to the “improved lot” exemption which, pursuant to 1702(a)(2), requires that the unit either “must be completed before it is sold, or it must be sold under a contract obligating the seller to erect the unit within two years from the date the purchaser signs the contract of sale.” In Nu-Chan, the court found that the condo units at issue were not exempt from ILSA because they were not physically habitable as residential units at the time the purchase agreements were signed.

Fraudulent Conduct

Neither in Bacolitsas, Nu-Chan nor any other New York ILSA decision has there been the slightest hint of false or deceptive practices or unscrupulous sales. In response to this issue, the court in Bacolitsas noted that “the rescission remedy of section 1703(d) is not contingent on a showing of fraudulent conduct by a developer or a resulting injury to the purchaser.” It is worth noting that the Martin Act, the Regulations issued by the Office of the Attorney General, and the review process by the AG that takes anywhere from six to 15 months, provides far more protection from false or deceptive practices than that called for under ILSA

ILSA

No appellate court has ruled on the applicability of ILSA to condominiums in New York, although it is likely that one or more of the six ILSA decisions will be the subject of a Second Circuit decision within the next few months. Each of the district court decisions presumes that ILSA is applicable to condominium units; however, that is not necessarily the case. Although ILSA was originally intended to cover unimproved land, in 1978, Congress amended it and inserted the word “condominium” in only one place in the Act. Section 1702(a) (2) was amended to extend an existing exemption to condominiums. The Senate Committee explained:

Section 715(b) (1) of the bill would amend section 1403 (a)(2) [now ' 1702 (a)(2)] of the act to provide an exemption for the sale or lease of any improved land on which there is a condominium or on which a condominium is to be built within two years. Section 1403(a)(3) provides an exemption for land on which there is or will be built within 2 years, a residential, commercial, or industrial building. Present HUD regulations do not provide an exemption for condominiums.

Housing and Community Development Amendments of 1978, Report of the Committee on Banking, Housing and Urban Affairs, United States Senate (Report No. 95-871, U.S. Code Congo & Admin. News 1978, p. 4773) at page 97. The Conference committee that considered the amendments said:

The Interstate Land Sales Full Disclosure Act is amended to broaden the exemptions to include sale or lease of land on which there is a condominium building on or which a condominium building is to be built within two years ' .

Public Law 95-557, Summary of the Act, Joint Explanatory Statement of the Managers of the Committee of Conference at page 80.

Indeed, the House report accompanying 1979 amendments to the act establishes that Congress never intended to include the sale of condominium units within the scope of ILSA:

[P]roponents of the legislation expressed strong concern over what they believe to be special problems which exist in South Florida'The Committee believes that states and local governments now perceive the need to enact appropriate safeguards and are taking steps to solve these problems. Accordingly, it does not, at this time, see an overwhelming need for establishing national minimum standards of disclosure and protection. [Emphasis added.]

House Report (Banking, Finance and Urban Affairs Committee) No. 96-154, May 15, 1979 (to accompany 3875) at 28, 29, U.S. Code Congo & Admin.News 1979, pp. 2344-45.

Conclusion

In New York, ILSA is being used by purchasers, who are attempting to reverse their economic decisions based on a change in market conditions notwithstanding the fact that there had been adequate disclosure. Although these decisions are creating havoc for sponsors at the present time, the impact of these decisions will be short-lived. Now that sponsors know that ILSA is applicable and see the manner in which the courts interpret it, in the future sponsor's counsel will change the procedures they utilize in selling condominium units in order to take the necessary steps to avoid ILSA's use an offensive weapon. In the meantime, however, already cash strapped sponsors and their lenders will have to deal with the consequences of these decisions.