By Todd A. Levine and Lisa J. Jerles
Prior to the 2008 recession, the South Florida skyline was teeming with cranes as the real estate market boomed. But then the newly or partially completed projects remained empty as developers and brokers were unable to sell residential and commercial properties and projects. With the entire real estate community reeling, brokers, developers, lenders, investors and buyers and sellers often turned to the courthouse to resolve issues that emerged as the South Florida real estate market was plummeting. As we emerge from the recession, a review of the events of the past few years may help to avoid future litigation.
During the recession, we saw many real estate brokers resorting to litigation when they were not paid commissions they believed were due under their agreements. In condo projects, the agreements between developers and brokers often called for brokers to receive commissions in a series of payments. For example, a broker may have been paid one-third of the commission after the first deposit, one-third of the commission after the second deposit and the final third of the commission after closing. But as the economy slipped and units stopped selling, there were often insufficient funds to make the last commission payment or payments, forcing brokers to litigate. Many cases settled for a portion of the full amount due. Brokers whose experience and reputation give them leverage to demand more money upfront learned from this experience, which has likely already led, or will continue to lead, to restructured brokerage agreements.
Much of the real estate litigation that arose during the recession was directed at developers, who often fended lawsuits from all sides — brokers, lenders, investors and buyers. Aside from foreclosures and suits on guaranties, developers saw lawsuits from investors seeking to recoup dollars after failed projects and from buyers whose deposits were paid but who were unable to close. Developers also faced issues relating to their ability to borrow money from lenders. Because the borrowing base loans are tied to the value of the property, as property values plummeted, so did the amount of money that the developers could borrow, leading to further disputes with lenders. Many of these disputes were resolved out of court through various dispute resolution tactics. Many banks, not wishing to become landowners, ultimately agreed to renegotiate loan terms and similarly, investors were amenable to restructuring payment terms to avoid the cost and risks of protracted litigation.
In the early stages of the recession many institutional lenders grew fearful of defaults and began accelerating loans based upon non-monetary defaults in an attempt to avoid an eventual foreclosure and to put pressure on borrowers to obtain refinancing from different sources. Many financial institutions also saw a new crop of counterclaims from developers claiming that the banks were in possession of research analyses and other data that forecasted the recession and were complicit in the projects’ failures. Many of these claims were sustained by the courts, which ultimately put pressure on the institutions to settle the cases. Most lenders do not provide financing with the expectation that they will one day own the project. Banks were ill-equipped to be landowners, which further motivated settlements. Private lenders — often real estate private equity groups — were more motivated to foreclose and take over the projects, rendering settlements unlikely possibilities.
There were also a significant amount of disputes by investors in failed real estate projects. Former friends and business partners were pitted against each other as dollars were lost in the face of a declining economy. With claims ranging from breach of contract to claims of fraudulent conduct, investors scrambled to recoup their investments, from whatever source they felt they could blame and from whom they could recover damages. As the economy rebounds, projects that were tabled are revived. Some of these projects are being sold or restructured, allowing investors to recover some of their initial investment. But real estate investment portfolios were hit hard by the recession and are still rebounding.
Buyers and sellers also faced litigation during the recession. Aside from the routine foreclosures that clogged the courts and forced many judges to hold motion calendars and hearing dates solely to handle these issues, many buyers were simply unable to obtain financing, leading to failed purchases and disputes with sellers over deposits in escrow. Conversely, sellers faced declining property values and low appraisals. Financing issues plagued buyers and sellers alike throughout the recession and some of the lingering effects remain today as lenders remain cautious about approving mortgages.
While all these constituencies were impacted by the recession in various ways, there is one pervasive theme: South Florida, which was in the midst of a real estate boom when the recession hit, may have suffered more than other demographic areas because it was growing so rapidly. Hindsight is 20/20. In an effort to mitigate the disasters that befell the local economy during the recession, there have been some changes in the way real estate projects are being structured. For example, buyer-financing – where buyers are required to put down as much as 50% for a deposit on a new construction project – has grown in popularity as developers seek to rely less on institutional funding. Of course, these attempts to avoid future litigation will likely cause their own set of disputes that may eventually find their way into the courts. But, as the economy rebounds and cranes again rise in the sky, brokers, developers, lenders, investors, buyers and sellers should use the lessons of the past to look clearly towards protecting their futures.