Wednesday, Jan 30, 2013

Developers Taking Over Troubled Projects Must Take Caution

A problem that has come to prominence recently is the developer that has run into financial problems and is no longer able to finish the project. Often in these cases the project is taken over by the bank or another developer. Generally speaking, the documents in these projects are in a very uncertain state. Significant problems may arise if some of the lots have been conveyed to the end-user by the original developer. In many cases, the new developer, for market reasons, needs to go in a different direction. In these cases, promises made by the original developer to owners, even oral ones, may be enforceable against the new developer under the law of Equitable Servitudes.

In Virginia, a court may use its equitable powers to enforce the promises made by a developer to an end-user who purchased property under the original scheme of development, even if that scheme of development has not been fully documented in the land records. If a new developer steps in to finish the project and had knowledge of, or even the opportunity to obtain knowledge of, the promises made by the original developer, then the theory of “equitable servitude” can be used to enforce the original developer’s intent, despite the fact that the lot has no recorded covenants.

Recently, we had the opportunity to put this concept to a test. A planned 21 lot single-family residential neighborhood of million dollar plus homes stalled during the middle of the 2008 financial crisis. The bank forced the developer to stop the project. A friendly foreclosure ensued. However, the developer had sold 3 finished lots prior to the foreclosure and had promised those owners that the entire subdivision would remain single-family dwelling units only. The original developer, seeking cash to appease the bank, sold some of the parcels to Loudoun County who intended to put a massive fire station complex on the two lots it purchased. The County knew of the original developer’s original intent for the project but believed it could proceed with the fire station because the restrictive covenants, which were intended to be recorded by the original developer limiting the property to a typical residential subdivision, had not been recorded.

Using the concept of equitable servitude, our attorneys Andy Burcher and Mike Kalish filed suit on behalf of the homeowners who had purchased from the original developer. The goal was to impose an equitable servitude enjoining the County from building anything that was inconsistent with the original developer’s scheme of development: detached single family residences. After a two-day trial, the Loudoun County Circuit Court concluded that the County had actual and constructive knowledge of the original developer’s scheme of development of detached single-family residences. Based on this knowledge, the Court enjoined the County from using the property for anything other than a single-family residence. The case is Oliver, et al v. Board of Supervisors (Loudoun County 2011), Letter Opinion dated December 2, 2011 by Judge Burke F. McCahill. The County appealed the decision and the Virginia Supreme Court denied the appeal, finding no error by the trial court.

For developers, it is important to understand the nature of the property that you are purchasing. Due diligence obviously includes a proper title search. However, due diligence must include a complete understanding of the history of the property and potential obligations of the original owner beyond the land records. The possibility that adjoining parcels that were part of an original scheme of development may be able to thwart your plans through an equitable servitude should not be ignored.