The Impact of Full Disclosure

OP RESIDENTIALBy Steve Benesh and Patrick Caballero

In response to sight-unseen purchases property that turned out to be uninhabitable swamp land, the United States Congress in 1968 enacted the Interstate Land Sales Full Disclosure Act (ILSA) to penalize fraudulent land sales and ensure that consumers are informed about a development before purchasing a subdivision lot. Although ILSA’s regulations apply to developers who sell certain types of unimproved subdivision lots, the remedies for purchasers protected by ILSA can have important consequences for contractors working in the development.

Unless a development falls under an exemption, ILSA requires developers to file a property report with the Consumer Financial Protection Bureau and provide the same report to the purchaser. That report must contain a lengthy list of information, and if there is an error in the report that would have reasonably influenced the decision to make the purchase, then the purchaser has the right to rescind the contract up to two years after the purchase date.

ILSA was intended as a powerful deterrent to the types of land sale scams common during the 1960s and 1970s, but the law was seldom used until the economic downturn in the late 2000s, when use of the statute sharply increased. Purchasers of subdivision lots that cratered in value used property report errors to rescind their purchase contracts and return their properties to the developers. That had a domino effect, as developers were left with undeveloped or partially developed lots that had lost much of their value and no cash flow to complete the projects or pay the contractors who were working on them.

What You Should Know

Developers with good lawyers may already be aware of ILSA’s requirements and pitfalls, but contractors may be less informed about the law. Even though they aren’t directly affected by ILSA, contractors and subcontractors working on developments covered by ILSA can absolutely be affected when a purchaser hands a partially developed lot back to the developer, who must in turn reimburse the purchaser’s payment for the lot. Contractors that want to get paid – in other words, all contractors – should be aware of what types of developments are typically covered by ILSA and how to protect themselves if purchasers within the development start lining up to rescind their contracts and return their properties.

Here’s a short list of things to be aware of regarding ILSA:

* ILSA generally applies to developers selling or leasing at least 25 lots in the same subdivision. If a development has fewer than 25 lots for sale or lease, it is generally exempt from ILSA’s requirements.

* Because of exemptions in the law, ILSA typically applies to the sale or lease of residential lots, but may in some instances apply to commercial, industrial and mixed-use developments.

* ILSA requires developers to provide each purchaser with a property report containing required information about the development that must be delivered to each purchaser before signing their purchase agreement.

* If a development has 25 to 99 lots for sale or lease, it is generally subject to ILSA’s anti-fraud provisions, which gives purchasers the right to rescind their contracts for failure to comply with requirements.

* If a development has 100 or more lots for sale or lease, it is generally subject to all of ILSA’s anti-fraud provisions and registration requirements with the federal government.

* If a developer fails to comply with ILSA where applicable, purchasers have the right to rescind the contract up to two years after the purchase date and get their money back.

* Under ILSA’s improved lot exemption, a developer can avoid the law’s requirements, but must promise that a habitable structure will be in place on the lot within two years from the purchase date.

* ILSA does not impose any obligations on contractors, except to the extent that they are serving as developers selling subdivision lots to consumers.

* If a contractor and developer have a contract regarding construction in a development, ILSA does not directly affect that contract, but a purchaser’s right to rescission may affect the financial stability of a developer that fails to comply with ILSA.

* If a contractor and a consumer have a contract regarding construction on a lot, ILSA does not directly affect that contract.

ILSA is a complex statute that contains a number of requirements and exemptions. Contractors should be aware when they are working on a development covered by ILSA and familiarize themselves with the developer’s representations to purchasers. Contractors should also consider the developer’s trustworthiness and responsibility for ensuring compliance with ILSA’s terms. Standard remedies for contractors not being paid for work performed, such as establishment of a lien on the property, may have little value if an entire development goes belly-up. If that occurs, or to protect against a situation where that could happen, contractors should consider discussing ILSA further with a qualified attorney.

Steve Benesh is a partner and Patrick Caballero is counsel in Bracewell’s Austin office advising clients on legal issues in the construction industry. Benesh can be reached at [email protected], and Caballero can be reached at [email protected]

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