Potential Legal Liability for Western North Carolina Mountain Developers and their Lenders

Western North Carolina mountain developers are marketing and selling hazardous land without risk disclosure. Developers knew when they purchased land for their subdivisions that the majority of mountain slopes throughout the 21 county region were identified as dangerous building locations.

Experts have determined that Western North Carolina's mountain soil composition is erodible and thus “unsuitable” or “poorly suited” for urban development. In addition landslides are endemic and they threaten building sites throughout the region. These findings were presented by the North Carolina Department of Emergency Management in 1998 and were validated by the landslide disasters of September 2004. The North Carolina Geological Survey has issued continual warnings about the consequences of constructing homes and roads on land that has not been investigated for landslides and soil stability.

Legal Jeopardy

E Richard Kennedy provides a review of liability issues in "Litigation Involving the Developer, Homeowners' Associations and Lenders." The following case histories were taken from his April
2004 article:

I. Developer Liability

4. Liability Based upon Common Law Fraud

In a California case, purchasers of homes in a subdivision brought suit against a developer, and others, after their homes began experiencing significant structural problems.43 The facts revealed that the developer had used a tract of land prone to landslides because of percolating waters just under the surface. In addition to the possibility of landslides, the soil was highly unstable. After homes had been constructed on the tract and sold to purchasers, cracks began to manifest themselves in the foundations of several homes. The rear section of one person's patio collapsed, and water accumulating around the left side of the house of another purchaser. As it turned out, the developer was acutely aware of the instability of the soil.44 Indeed, the developer had taken measures early on to remedy the situation. However, the developer neither informed prospective homeowners of the instability of the soil nor informed them of his unsuccessful attempts to remedy it.45

The California court stated that fraudulent concealment occurs when a developer conceals from a purchaser a material fact of the subject matter of the transaction which the developer has a duty to disclose. The court went on to declare that a developer has an affirmative duty to disclose to purchasers information that affects, or might affect, the value of homes which they seek to purchase.46 In the matter before it, the court concluded the developer committed fraud by failing to disclose to the purchasers that their homes might develop structural problems as a result of the instability of the soil.47

6. Liability Based upon Breach of an Implied Warranty to Develop in a Good and Workmanlike Manner

In a similar case from Indiana, Jordan v. Talaga,66 a developer sold land "to a builder who subsequently built a home [thereon] and sold it to the plaintiffs. A little over a year later, the plaintiffs' home began flooding once or twice a year."67 In addition to suing the builder, the plaintiffs sued the developer, who argued that he should not be liable since he had not built the home.68

The court found the developer "did more than sell raw land."69 The developer "platted, subdivided and engineered considerable improvements for [the planned community]."70 The developer also "put in sanitary sewers, storm sewers, and streets; they rough graded the lots all for the express purpose of facilitating the building of homes."71 Given the developer's degree of control over the project and because the developer designed the community, the Indiana court found the facts justified imposing an implied warranty of habitability on the developers.72

7. Developer 's Liability under Deceptive Trade Practices Acts

In a South Carolina case, State ex r el. McLeod v. C & L Corp., the court found a planned unit developer violated the South Carolina Unfair Trade Practices Act in a situation in which the evidence revealed that the developer's "sales agents told prospective buyers whatever they felt the buyers wished to hear."79 In particular, the developer's sales representatives had made empty and illusory promises about paving of subdivision roads, ready access to city water, and installation of streetlights throughout the subdivision. None of these representations turned out to be true. The court found these false representations constituted unfair and deceptive trade practices.80

D. Developer's Liability Under Federal Law

3. Developer's Potential Liability Under the Interstate Land Sales Full Disclosure Act

The Interstate Land Sales Full Disclosure Act128 ("ILSFDA") is primarily designed to insure that buyers are well informed of facts that would enable then to make an informed decision about purchasing property before buying certain kinds of real estate.129 According to courts which have interpreted ILSFDA, the act is to be construed liberally and broadly to effect its goal of prohibiting and punishing fraud in land development enterprises.130

Generally speaking, ILSFDA applies whenever subdivided property is offered for sale or lease through interstate commerce. Specifically, section 1701(3) defines "subdivision" as "any land which is located in any State or in a foreign country and is divided or is proposed to be divided into lots, whether contiguous or not, for the purpose of sale or lease as part of a common promotional plan. . . ,"131 This definition has been construed to include condominium projects as well as more traditional subdivisions.132

Basically, ILSFDA imposes three duties upon a developer offering property for sale through interstate commerce: (1) the developer must register the offered property with the Department of Housing and Urban Development,133 (2) the developer may not deliver to prospective purchasers any information that is inconsistent with the registered materials,134 and (3) the developer may not employ any device, scheme, or artifice to defraud or make an untrue statement of a material fact regarding the sale or lease of the property.135 The ILSFDA grants a private cause of action to any purchaser against a developer or its agent if a property sale violates any of the foregoing provisions.136

A plaintiff need not prove reliance or the defendant's fraudulent intent in order to recover under ILSFDA.137 Instead, the purchaser must only establish a material omission or misrepresentation, however innocent or unintentional, by the developer.138

ILSFDA liability is not limited simply to the developer. In Gibbes v. Rose Hill Plantation Development Co., aggrieved purchasers brought an ILSFDA action against the developer, its agents, and directors of the developer-controlled property owners' association alleging misrepresentations were made in the sale of lots.143 The court found directors of the developer controlled property owners' association could be liable under ILSFDA if they participated in the sale and promotion of lots.144

III. LENDER LIABILITY

What happens in situations in which the developer is potentially liable to a homeowners' association or to individual home or unit owners but the developer is insolvent?

If the developer is insolvent, potential plaintiffs may want to sue the developer's lender because, after all, they assume, financially speaking, that lenders have deep pockets.

If the developer declares bankruptcy and the lender forecloses, those persons or entities who normally would have sued the developer may seek to hold the lender liable on the ground that the lender has, by foreclosing, stepped into the shoes of the developer.

Even if the developer is not insolvent, a lender makes a tempting target for homeowners' associations and individual home and unit owners in situations in which the lender has taken a highly visible and active role in the development. As discussed below, if the lender has done so, and has exercised an inordinately large measure of control over the developer's decisions, the lender could find itself a defendant in a lawsuit brought against the developer by homeowners or a homeowners' association.

A California decision, Connor v. Great Western Savings & Loan Ass'n,210 illustrates the fact that a lender may become subject to liability if it actively participates in the development of the planned unit development. In Connor, the lender, Great Western Savings and Loan Association ("Great Western"), made a construction loan to a developer of a large tract of land located in southern California. The provisions of the loan agreement significantly involved Great Western in the decision-making aspects pertaining to development of the tract.211 Great Western had the right of first refusal to make long-term mortgage loans to buyers of the homes, the right to warehouse the tract of land until the developer began using the property, and, perhaps crucially, the right to refuse to disburse funds if the construction work did not conform to the required plans and specifications.212

The Connor plaintiffs purchased single-family homes in the development. Because of poorly designed and constructed foundations, the homes "could not withstand the expansion and contraction of the adobe soil."213 As a result, the plaintiffs' homes sustained serious damages. The plaintiffs sought damages from the developer and the lender, Great Western. Finding the developer negligently constructed the homes, and ignored soil conditions prevalent at the site, the court allowed the plaintiffs to recover against the developer.214

The court also held that Great Western had a duty to the buyers of the homes "to exercise reasonable care to protect them from damages caused by major structural defects."215 In imposing this duty on Great Western, the court made it clear it was not doing so simply on the ground that Great Western loaned money to the developer. The court emphasized the lending agreement gave Great Western certain specific rights with regard to the project that far exceeded a lender's traditional role. In effect, the court held that Great Western became a partner of the developer with regard to the development of the planned unit development.216

It is important to note that the Interstate Land Sales Full Disclosure Act defines the term "developer" as,

any person who, directly or indirectly, sells or leases, or offers to sell or lease, or advertises for sale or lease any lots in a subdivision[,]
15 U.S.C. s. 1701(5).