Second Circuit Construes ILSA to Rescue Condominium Purchasers

What constitutes a “lot” within the meaning of the statute? In 1973, five years after the statute was enacted, the Department of Housing and Urban Development (HUD), the agency then charged with rulemaking authority under ILSA, promulgated a regulation defining “lot” to mean “any portion, piece, division, unit, or undivided interest in land located in any state or foreign county, if the interest includes the right to the exclusive use of a specific portion of the land.” The identical language appears in 12 C.F.R. section 1010.1, promulgated in 2011 by the Consumer Financial Protection Bureau (CFPB), the current repository of rulemaking authority under ILSA.

The owner of a condominium unit in a multiple-story building does not have the right to the exclusive use of any specific portion of the land on which the building is constructed. Nevertheless, HUD and the CFSB have consistently maintained that the ILSA applies to all condominium units, interpreting the phrase “specific portion of the land” to mean “specific portion of the realty.”

The Berlin Case

In 2007, the Berlins contracted to buy a unit in a residential tower at the Ritz Carlton Hotel in White Plains. The contract price was $1.34 million. The condominium sponsors did not provide the Berlins with the printed property report contemplated by ILSA. After the 2008 crash in the real estate market, the Berlins demanded rescission of the sale contract and return of their downpayment, invoking ILSA. The sponsor contended that ILSA was inapplicable to sale of its condominium units. When a federal district court held ILSA applicable, relying on agency interpretation of its own regulations, the sponsor appealed.

In affirming, the Second Circuit, in an opinion by Judge Jose Cabranes, relied on the principle that when an agency interprets its own regulation, courts defer to it “unless that interpretation is plainly erroneous or inconsistent with the regulation.” (quoting from Decker v. Nw. Envtl Def. Ctr., 133 S.Ct. 1326). The court also deferred to the agency regulation defining “lot,” noting Congressional acquiescence in that regulation over a period of years.

Chief Judge Dennis Jacobs dissented, arguing that “[t]he only way to read the Land Sales Act and the implementing regulation is that the Act applies only to the sale (or lease) of a lot that, by definition, includes a right to use of land that is exclusive.” That definition, he argued, would apply to a townhouse condominium unit in which the owner of the unit has the right to exclude all others from the land on which the townhouse sits, but it does not apply to a single-story unit in a vertical condominium of the sort at issue in Berlin. Chief Judge Jacobs bolstered his argument by reference to legislative purpose ' which was to protect purchasers against unscrupulous sellers of worthless land that the purchasers had never seen.

Although both the equities of the Berlin case and the language of ILSA itself would appear to support the dissent's position, condominium sponsors are in a weak position to argue that the result in Berlin frustrates their reasonable expectations. By the time the sponsor sold units in the Ritz-Carlton, the agency's broad interpretation of ILSA had been in force and available to the public for more than 30 years, and the sponsor could have avoided any rescission rights of the buyer by providing the buyer with the property report contemplated by ILSA.

The 'Improved Lot' Exception

The Ritz Carlton sponsor is not the only one who ignored ILSA's potential application to condominium units. In light of the Second Circuit's decision in Berlin, litigation in subsequent cases will shift to the scope of ILSA's “improved lot” exception. ILSA provides that its provisions do not apply to “the sale or lease of any improved land on which there is a residential, commercial, condominium, or industrial building, or the sale or lease of land under a contract obligating the seller or lessor to erect such a building thereon within a period of two years.” 15 U.S.C. section 1702(a)(2). In Tencza v. TAG Court Square (NYLJ 6/17/13, p. 17., col. 5), Judge Paul Engelmayer of the Southern District had occasion to construe the exception.

In May 2007, the Tenczas contracted to buy, for $2,995,000, a condominium unit in a Queens building in the process of conversion from industrial to residential use. During the construction process, the Tenczas inspected the premises, and on April 16, 2008, the Department of Buildings issued a temporary CO for the entire building. Some punch list items were not yet complete, and, on April 28, 2008 the sponsor entered into an agreement with the Tenczas to complete the remaining items in return for an agreement by unit owner to accept the unit in “as is” condition. On the same day, the Tenczas closed on the unit, and subsequently moved in. They also made some alterations to the apartment. Then, in April 2009, the Tenczas informed the sponsor that they were exercising their right to rescind under ILSA, and requested return of the purchase price. When the sponsor refused to honor the revocation, the Tenczas sued in federal district court.

The sponsor argued that the closing was conducted pursuant to the April 28 “punch list” agreement by the terms of which the Tenczas agreed to accept the premises as-is. Since a CO had already been issued by that time, the sponsor argued that the improved lot exception was applicable, and the Tenczas were not entitled to rescind.

In awarding summary judgment to the Tenczas on the issue of liability, Judge Engelmayer rejected the sponsor's argument, concluding that the punch list agreement did not include the material terms of the sale, and was not a contract to purchase the unit for ILSA purposes. Instead the May 2007 sale contract was the operative contract. Implicit in Judge Engelmayer's decision is the premise that the industrial building sitting on the parcel at the time the parties entered into the sale contract did not bring the contract within the “improved lot” exception, but other cases are likely to explore further the contours of the exception.

Conclusion

So far, however, ILSA has been a boon to at least some condominium purchasers seeking to escape pre-crash sales contracts. Berlin and Tencza should be a reminder to condominium sponsors and their lawyers that failure to comply with the statute's mandates can bring painful consequences.

Stewart E. Sterk, Mack Professor of Law at Benjamin N. Cardozo School of Law, is Editor-in-Chief of this newsletter.

Does the Interstate Land Sale Full Disclosure Act (ILSA), which permits a buyer to rescind a purchase if the buyer has not received a statutorily mandated “printed property report,” apply to single-floor condominium units? In Berlin v. Renaissance Rental Partners, 2013 WL 1859140 (May 6, 2013), a divided Second Circuit concluded that a single-floor condominium unit qualifies as a “lot” within the meaning of the statute, enabling purchasers who had bought a luxury condominium unit before the 2008 real estate crash to escape from their now-unfavorable sale contracts.

The Statutory and Regulatory Framework

As the United States Supreme Court has observed, ILSA was enacted, in 1968, to “prevent false and deceptive practices in the sale of unimproved tracts of land by requiring developers to disclose information needed by potential buyers.” Flint Ridge Dev. Co. v. Scenic Rivers Ass'n , 426 U.S. 776, 778 (1976). The statute makes it unlawful for a developer to use instrumentalities of commerce to sell or lease “any lot” unless the developer has provided the purchaser with a printed property report in advance of the signing of the contract by the purchaser or lessee. 15 U.S.C. section 1703(a)(1)(B). The statute provides that if the seller does not provide the purchaser with the required property report before signing the contract, the purchaser has a right to rescind the contract within two years of its signing. 15 U.S.C. section 1703(c).

What constitutes a “lot” within the meaning of the statute? In 1973, five years after the statute was enacted, the Department of Housing and Urban Development (HUD), the agency then charged with rulemaking authority under ILSA, promulgated a regulation defining “lot” to mean “any portion, piece, division, unit, or undivided interest in land located in any state or foreign county, if the interest includes the right to the exclusive use of a specific portion of the land.” The identical language appears in 12 C.F.R. section 1010.1, promulgated in 2011 by the Consumer Financial Protection Bureau (CFPB), the current repository of rulemaking authority under ILSA.

The owner of a condominium unit in a multiple-story building does not have the right to the exclusive use of any specific portion of the land on which the building is constructed. Nevertheless, HUD and the CFSB have consistently maintained that the ILSA applies to all condominium units, interpreting the phrase “specific portion of the land” to mean “specific portion of the realty.”

The Berlin Case

In 2007, the Berlins contracted to buy a unit in a residential tower at the Ritz Carlton Hotel in White Plains. The contract price was $1.34 million. The condominium sponsors did not provide the Berlins with the printed property report contemplated by ILSA. After the 2008 crash in the real estate market, the Berlins demanded rescission of the sale contract and return of their downpayment, invoking ILSA. The sponsor contended that ILSA was inapplicable to sale of its condominium units. When a federal district court held ILSA applicable, relying on agency interpretation of its own regulations, the sponsor appealed.

In affirming, the Second Circuit, in an opinion by Judge Jose Cabranes, relied on the principle that when an agency interprets its own regulation, courts defer to it “unless that interpretation is plainly erroneous or inconsistent with the regulation.” (quoting from Decker v. Nw. Envtl Def. Ctr. , 133 S.Ct. 1326). The court also deferred to the agency regulation defining “lot,” noting Congressional acquiescence in that regulation over a period of years.

Chief Judge Dennis Jacobs dissented, arguing that “[t]he only way to read the Land Sales Act and the implementing regulation is that the Act applies only to the sale (or lease) of a lot that, by definition, includes a right to use of land that is exclusive.” That definition, he argued, would apply to a townhouse condominium unit in which the owner of the unit has the right to exclude all others from the land on which the townhouse sits, but it does not apply to a single-story unit in a vertical condominium of the sort at issue in Berlin. Chief Judge Jacobs bolstered his argument by reference to legislative purpose ' which was to protect purchasers against unscrupulous sellers of worthless land that the purchasers had never seen.

Although both the equities of the Berlin case and the language of ILSA itself would appear to support the dissent's position, condominium sponsors are in a weak position to argue that the result in Berlin frustrates their reasonable expectations. By the time the sponsor sold units in the Ritz-Carlton, the agency's broad interpretation of ILSA had been in force and available to the public for more than 30 years, and the sponsor could have avoided any rescission rights of the buyer by providing the buyer with the property report contemplated by ILSA.

The 'Improved Lot' Exception

The Ritz Carlton sponsor is not the only one who ignored ILSA's potential application to condominium units. In light of the Second Circuit's decision in Berlin, litigation in subsequent cases will shift to the scope of ILSA's “improved lot” exception. ILSA provides that its provisions do not apply to “the sale or lease of any improved land on which there is a residential, commercial, condominium, or industrial building, or the sale or lease of land under a contract obligating the seller or lessor to erect such a building thereon within a period of two years.” 15 U.S.C. section 1702(a)(2). In Tencza v. TAG Court Square (NYLJ 6/17/13, p. 17., col. 5), Judge Paul Engelmayer of the Southern District had occasion to construe the exception.

In May 2007, the Tenczas contracted to buy, for $2,995,000, a condominium unit in a Queens building in the process of conversion from industrial to residential use. During the construction process, the Tenczas inspected the premises, and on April 16, 2008, the Department of Buildings issued a temporary CO for the entire building. Some punch list items were not yet complete, and, on April 28, 2008 the sponsor entered into an agreement with the Tenczas to complete the remaining items in return for an agreement by unit owner to accept the unit in “as is” condition. On the same day, the Tenczas closed on the unit, and subsequently moved in. They also made some alterations to the apartment. Then, in April 2009, the Tenczas informed the sponsor that they were exercising their right to rescind under ILSA, and requested return of the purchase price. When the sponsor refused to honor the revocation, the Tenczas sued in federal district court.

The sponsor argued that the closing was conducted pursuant to the April 28 “punch list” agreement by the terms of which the Tenczas agreed to accept the premises as-is. Since a CO had already been issued by that time, the sponsor argued that the improved lot exception was applicable, and the Tenczas were not entitled to rescind.

In awarding summary judgment to the Tenczas on the issue of liability, Judge Engelmayer rejected the sponsor's argument, concluding that the punch list agreement did not include the material terms of the sale, and was not a contract to purchase the unit for ILSA purposes. Instead the May 2007 sale contract was the operative contract. Implicit in Judge Engelmayer's decision is the premise that the industrial building sitting on the parcel at the time the parties entered into the sale contract did not bring the contract within the “improved lot” exception, but other cases are likely to explore further the contours of the exception.

Conclusion

So far, however, ILSA has been a boon to at least some condominium purchasers seeking to escape pre-crash sales contracts. Berlin and Tencza should be a reminder to condominium sponsors and their lawyers that failure to comply with the statute's mandates can bring painful consequences.

Stewart E. Sterk, Mack Professor of Law at Benjamin N. Cardozo School of Law, is Editor-in-Chief of this newsletter.