The Interstate Land Sales Full Disclosure Act - ABA YLD 101 Practice Series

By Eric R. Veenstra Esq.

Overview and Analysis
As the residential real estate market has weakened in recent years, many investors and other prospective purchasers who entered into pre-construction sales contracts are now faced with a vastly different economic climate. Many who relied on subprime loans to finance the construction and acquisition are now seeing rates reset causing payments to exceed income levels. Many investors who had hoped to "flip" property are now saddled with property in markets flooded with similar properties which are devoid of ready and willing purchasers. Others, for myriad reasons, are reevaluating their decisions. An increasing number of purchasers are looking for relief from their contractual obligations and a refund of their often substantial deposits. Increasingly, a developer's compliance with the Interstate Land Sales Full Disclosure Act (15 U.S.C. §1701, et seq.) (the "ILSFDA") is being scrutinized as a possible basis for accomplishing these goals. Consequently, a working knowledge of the requirements of the ILSFDA is critical for those serving as legal counsel to both purchasers and developers.

Purpose and Effect
Passed in 1968 as part of the Housing and Urban Development Act, the ILSFDA reflected Congress' desire "to protect purchasers from unscrupulous sales of undeveloped home sites, frequently involving out-of-state sales” of land unsuitable for residential development. Paniaguas v. Aldon Cos., No. 2:04-CV-468-PRC, 2005 WL 1983859 (N.D. Ind. 2005). In broad terms, the ILSFDA is a consumer protection statute promulgated to accomplish two functions: (1) to prevent false and deceptive practices in the interstate land sales industry, and (2) to encourage full disclosure of relevant information concerning the land to a prospective purchaser. To accomplish this second function, developers must register non-exempt subdivisions with the Department of Housing and Urban Development (HUD), file a Statement of Record containing information concerning the subdivided land, and provide a prospective purchaser with a Property Report. See Nargiz v. Henlopen Developers, 380 A.2d 1361 (Del. 1977); see also Pierce v. Apple Valley, Inc., 597 F. Supp. 1480 (S.D. Ohio 1984); Samara Development Corp. v. Marlow, 556 So.2d 1097 (Fla. 1990).

Scope of the ILSFDA; Registration
The ILSFDA applies to every sale or lease of a lot in a subdivision through the use of interstate commerce, unless the sale falls under one of the exemptions to the ILSFDA. If the sale does not qualify for an exemption under the ILSFDA, the developer must register the subdivision with HUD. To register, the developer must file a Statement of Record with HUD. The Statement of Record is comprised of two parts, a Property Report and Additional Information and Documentation ("AID"). The Property Report contains required disclosures, such as the number of lots, method of sale, description of the infrastructure, community associations, and services, as well as real property taxes, and encumbrances on the lot. The Property Report must be provided to prospective purchasers prior to execution of a contract for sale of a lot. The AID is the documentation supporting the representations and disclosures made in the Property Report.

Exemptions; Guidelines; Self-Determination
Due to the time and expense involved in preparing a Statement of Record, many developers rely on the exemptions from the ILSFDA in order to avoid the burdensome registration requirements. Because the exemptions under the ILSFDA are self-determining the developer may rely upon an exemption without applying for a determination as to the applicability of the exemption from the Secretary of HUD.  To assist in the determination of a particular exemption, HUD has promulgated a set of guidelines to the ILSFDA (the "HUD Guidelines") which "clarify agency policies and positions with regard to the exemption provisions of the [ILSFDA]." Although self-determination undoubtedly expedites the time in which the developer may begin offering lots for sale, it also creates a serious risk that a court may disagree with the developer's position and find the contract is in fact governed by the ILSFDA. Such a finding would give rise to, among other things, the purchaser's right of rescission (even after closing and delivery of the deed). See Engle Homes, Inc. v. Krasna, 766 So. 2d 311 (Fla. 4th DCA 2000).  Additionally, the ILSFDA prescribes the imposition of criminal penalties and fines for a person who willfully violates the ILSFDA. 15 U.S.C. §1717.

HUD Advisory Opinions
Where the applicability of an exemption is unclear, or where a developer wishes further assurance that their offering qualifies under an exemption to the ILSFDA, a developer may obtain an Advisory Opinion from HUD. Since an Advisory Opinion is based upon the representations made by the developer concerning the offering, it is therefore of no binding effect if it is found that the Advisory Opinion was based on incomplete, improper or incorrect information. See HUD Guidelines, Part VIII(a).

Definitions
Although the terms "subdivision," "lot," and "developer" are commonly used terms in the real estate industry, under the ILSFDA they are specifically defined under the ILSFDA. A "developer" is defined 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. §1701(5). Under certain circumstances this expansive definition could bring third parties, including banks and resellers, under the purview of the ILSFDA. A "lot" is defined in the regulations supplementing the ILSFDA as "any portion, piece, division, unit, or undivided interest in land located in any State or foreign country, if the interest includes the right to the exclusive use of a specific portion of the land." 24 C.F.R. § 1710.1. Federal case law has interpreted "lot" to include condominiums but the definition of "lot" has not been extended to include storage sheds or hotel rooms. See Winter v. Hollingsworth Properties, Inc., 777 F.2d 1444 (11th Cir. 1985); Trotta v. Lighthouse Land Company, LLC, 2008 WL 413962 (S.D. Fla. Feb. 13, 2008); Becherer v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 43F.3d 1054 (6th Cir. 1995). A "subdivision" is defined 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." 15 U.S.C. §1701(3). (For a discussion of what constitutes a common promotional plan, see N.C. Properties v. Pritchard, 525 So. 2d 1346 (Ala. 1988); Dunaway v. Lewis, 554 P.2d 110 (Div. 1, Ct. App. 1976.)

Exemptions
There are three distinct types of exemptions under the ILSFDA, commonly referred to as follows: (1) full statutory exemptions (15 U.S.C. §1702(a)); (2) partial statutory exemptions (15 U.S.C. §1702(b)); and (3) regulatory exemptions, (15 U.S.C. §1702(c)). The full statutory exemptions exempt sales and leases of lots within a subdivision from both the registration and disclosure requirements, specifically the requirements to file a Statement of Record with HUD and to provide potential purchasers with a Property Report, as well as the "anti-fraud" provisions of the ILSFDA (15 U.S.C. §1703(a)(2)). The HUD Guidelines define the "anti-fraud provisions" in relevant part as "the provisions of the Act that prohibit the use of any sales practices, advertising or promotional materials that: would be misleading to purchasers; contain any misrepresentation of material facts or untrue statements; or would operate as a fraud or deceit upon a purchaser." The partial exemptions exempt sales from the registration and disclosure requirements under the ILSFDA, but do not exempt the sale from the anti-fraud provisions. As will be discussed in greater detail below, the meaning of this exemption has recently become a matter of some uncertainty. Finally, regulatory exemptions are exemptions that may require a determination from the Secretary of HUD that the enforcement of the ILSFDA, with respect to the subdivision or lot, is not necessary to protect the public interest; although certain regulatory exemptions are self-determining without submission to HUD.

The full exemptions under the ILSFDA are as follows:

  • Twenty-Five Lot
    "the sale or lease of lots in a subdivision containing less than twenty five lots." 15 U.S.C. §1702(a)(1). The HUD Guidelines provide that a subdivision with greater than twenty five lots may still qualify for an exemption if less than twenty five of the lots are offered for sale under a common promotional plan. See HUD Guidelines, Part IV(a).
  • Improved Lots
    "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 on the lot within a period of two years." 15 U.S.C. §1702(a)(2). In practice, this exemption is commonly referred to as the "two year obligation" and it has become one of the most frequently used and challenged exemptions in recent years.
  • Evidence of Indebtedness
    "the sale of an evidence of indebtedness secured by a mortgage or deed of trust on real property." 15 U.S.C. §1702(a)(3). The HUD Guidelines state that the "underlying sale of the land is not exempt under this provision." HUD Guidelines, Part IV(c).
  • REIT Securities
    "the sale of securities issued by a real estate investment trust." 15 U.S.C. §1702(a)(4).
  • Government Sales
    "the sale or lease of real estate by any government or government agency." 15 U.S.C. §1702(a)(5). The exemption does not include the sale of real property to federally regulated or governmentally assisted institutions. HUD Guidelines, Part IV(e).
  • Cemetery Lots
    "the sale or lease of cemetery lots." 15 U.S.C. §1702(a)(6).
  • Sales to Builders
    "the sale or lease of lots to any person who acquires such lots for the purpose of engaging in the business of constructing residential, commercial, or industrial buildings or for the purpose of resale or lease of such lots to persons engaged in such business." 15 U.S.C. §1702(a)(7). Note that the sale to a person who acquires the land for the construction of his own home is not exempt from the ILSFDA. See HUD Guidelines, Part IV(g).
  • Industrial or Commercial Developments
    "the sale or lease of real estate which is zoned by the appropriate government authority for industrial or commercial development or which is restricted to such use by a declaration of covenants, conditions and restrictions which has been recorded…" when certain specified requirements are met. 15 U.S.C. §1702(a)(8)(A)-(E).

The partial exemptions under the ILSFDA are as follows:

  • 100 Lot
    "the sale or lease of lots in a subdivision containing fewer than one hundred lots which are not exempt under subsection (a) [the full exemptions]." 15 U.S.C. §1702(b)(1). This exemption has also been frequently used by developers and recent legal challenges to developers' use of this exemption (discussed below) has led to a reexamination of developers' obligations when seeking partial exemption from the ILSFDA.
  • 12 Lot/12 Month
    "the sale or lease of lots in a subdivision if, within the twelve-month period commencing on the date of the first sale or lease of a lot in such subdivision . . . not more than twelve lots are sold or leased." 15 U.S.C. §1702(b)(2).
  • Scattered Site
    "the sale or lease of lots in a subdivision if each noncontiguous part of such subdivision contains not more than twenty lots, and if the purchaser or lessee (or spouse thereof) has made a personal, on-the-lot inspection of the lot purchased or leased, prior to signing of the contract or agreement to purchase or lease." 15 U.S.C. §1702(b)(3).
  • Twenty Acre Lot
    "the sale or lease of a lot in a subdivision in which each of the lots is at least twenty acres." 15 U.S.C. §1702(b)(4).
  • Single Family Residence
    "the sale or lease of a lot which is located within a municipality or county where a unit of local government specifies minimum standards for the development of subdivision lots." 15 U.S.C. §1702(b)(5). This exemption is subject to numerous eligibility requirements, including that "each lot is either zoned for single family residences or, in the absence of a zoning ordinance, is limited exclusively to single family residences." 15 U.S.C. §1702(b)(5)(A)(i). It should be noted that some of the requirements of this exemption apply to single lots while others apply to the subdivision as a whole.
  • Mobile Home
    "the sale or lease of a lot, if a mobile home is to be erected or placed thereon as a residence, where the lot is sold as a homesite by one party and the home by another." 15 U.S.C. §1702(b)(6).
  • Intrastate Sale
    "the sale or lease of real estate by a developer who is engaged in a sales operation which is intrastate in nature." 15 U.S.C. §1702(b)(7). This exemption also includes numerous requirements that must also be met to qualify. Developers wishing to make use of this exemption should also be aware that many states contain land sales acts which regulate the interstate sale of real property and may provide rescission and other rights to the purchaser for noncompliance.
  • Metropolitan Statistical Area (MSA)
    the sale or lease of lots within a subdivision located in an MSA, subject to the same eligibility requirements as the intrastate exemption, with certain exceptions. 15 U.S.C. §1702(b)(8).

Certain regulatory exemptions which do not require a determination by the Secretary of HUD have been established. However, a developer relying on a regulatory exemption must be eligible under the criteria at all times. If the Secretary of HUD determines that a regulatory exemption is not in the public interest with respect to a particular subdivision, site or lot, then the Secretary may deny a developer the use of the exception. The regulatory exemptions not requiring HUD determination are as follows:

  • Inexpensive Lots
    "[t]he sale of lots, each of which will be sold for less than $100, including closing costs, if the purchaser will not be required to purchase more than one lot." 24 C.F.R. 1710.14(a)(1).
  • Five Year Lease
    "[t]he lease of lots for a term not to exceed five years if the terms of the lease do not obligate the lessee to renew." 24 C.F.R. 1710.14(a)(2).
  • Lot Sales to Developers
    "[t]he sale of lots to a person who is engaged in a bona fide land sales business." 24 C.F.R. 1710.14(a)(3).
  • Adjoining Lot
    "[t]he sale of a lot to a person who owns the contiguous lot which has a residential, commercial or industrial building on it." 24 C.F.R. 1710.14(a)(4).
  • Lot Sale to Government
    "[t]he sale of real estate to a government or government agency." 24 C.F.R. 1710.14(a)(5).
  • Sale of Leased Lots
    "[t]he sale of a lot to a person who has leased and resided primarily on the lot for at least the year preceding the sale." 24 C.F.R. 1710.14(a)(6).

No Action Letters
There may also be limited instances in which a sale or lease may fall under the ILSFDA but which may nevertheless be of such a nature that "no affirmative action is necessary to protect the public interest and purchasers." HUD Guidelines, Part IX. In these instances, a developer may request a No Action Letter from HUD. A No Action Letter signifies that HUD will not require registration pursuant to the ILSFDA. However, the receipt of a No Action Letter does not act to shield a developer or prevent a purchaser from exercising a right or remedy which he may have under the ILSFDA.

Jurisdiction
Pursuant to 15 U.S.C. §1719, state courts are given concurrent jurisdiction with federal courts over all suits brought to enforce any obligation or liability imposed under the ILSFDA. Of late, both federal and state courts have been inundated with claims under the ILSFDA. Predominantly, the purchasers bringing these claims have been asserting that the developers fail to qualify under either the "two year obligation" or the "100 lot exemption" and thus demand rescission of the purchase contract and the return of all deposit monies paid.

Recent Case Law
Developers hoping to qualify under a partial exemption, particularly the 100 lot exemption, have traditionally been able to rely on consensus opinion that a partial exemption exempts them from the disclosure requirements set forth in 15 U.S.C. §1703(d). This subsection provides that "[a]ny contract or agreement which is for the sale or lease of a lot not exempt under 1702 [exemptions]" may be revoked by a purchaser within two years of the date of signing such contract unless the contract contains certain specific disclosures. Until recently, the prevailing interpretation, as articulated in Mayersdorf v. Paramount Boynton, L.L.C., 910 So. 2d 887 (Fla. 4th DCA 2005), and reiterated in an advisory opinion from the Director of HUD's Office of RESPA, was that if any exemption under 15 U.S.C. § 1702 of the ILSFDA applied, whether full, partial or regulatory, then the purchase contracts, among other things, did not need to contain the disclosures set forth in 15 U.S.C. § 1702(d).

Three recent decisions have specifically rejected this interpretation and held that developers relying on the 100 lot exemption, and by implication any partial exemption, must include the 15 U.S.C. §1703(d) disclosures in their purchase contracts or the purchasers may rescind the contracts and demand the return of their deposits. See Pugliese v. Pukka Development, Inc., No. 07-14040-CIV-LYNCH (S.D. Fla. Oct. 3, 2007); See also Stockton v. Mustique, No. 07-310-WS-B (S.D. Ala. Aug. 28, 2007), Meridian Ventures, LLC v. One North Ocean, LLC, Case No. 07-80061-CIV-HURLEY (M.D. Fla. Dec. 14, 2007). Although these cases were decided in federal district courts, and are thus of limited precedential value, these decisions could potentially undermine a developer's ability to enforce the terms of its purchase contract and may provide purchasers with grounds to seek rescission.

Arguably the most commonly relied upon exemption to the ILSFDA is the two year obligation. This obligation exempts the sale or lease of lots "under a contract obligating the seller or lessor to erect such a building on the lot within a period of two years." 15 U.S.C. §1702(a)(2). Under the ILSFDA, what constitutes an obligation to complete is a matter of state law, so each jurisdiction will not be identical. The HUD Guidelines provide generally that "[t]he contract must not allow nonperformance by the seller at the seller's discretion. Contracts that permit the seller to breach virtually at will are viewed as unenforceable, because the construction obligation is not an obligation in reality." HUD Guidelines, Part IV(b); See e.g. Mosher v. Southridge Associates, Inc., 552 F. Supp. 1226 (W.D. Pa. 1982). During the 1970s, 80s, and 90s, there were numerous challenges to the reality of a developer's obligation to complete within two years. A significant number of these cases examined the effects of contractual clauses which limited the remedies a purchaser could seek in the event of default.
For example, a developer may not claim an exemption under the ILSFDA's two year exemption when the contract limits the purchaser's remedy solely to rescission and return of the deposit. See Dorchester Development, Inc. v. Burk, 439 So. 2d 1032 (Fla. 3rd DCA 1983); See also Schatz v. Jockey Club III, Ltd., 604 F. Supp. 537 (S.D. Fla.1985), Markowitz v. Northeast Land Co., 906 F.2d 100 (3rd Cir. 1990). The ILSFDA requires that a purchaser be able to seek damages or specific performance in the event of a developer's breach and a contractual limitation of either would be destroy the exemption. See Berzon v. Oriole Homes Corp., 497 So. 2d 670 (Fla. Dist. Ct. App. 1986); see also Samara Development Corp.  v. Marlow, 556 So. 2d 1097 (Fla. 1990).

In recent months, counsel for purchasers have begun to aggressively challenge the nature of a developer's obligation to erect a building within two years. Many of the grounds that have been asserted are matters of first impression in both federal and state courts. Of specific note, recent decisions have held that the construction obligation is illusory where the purchase contract allowed for delays caused by "acts of God, weather conditions, restrictions imposed by any governmental agency, labor strikes, material shortages or other delays beyond the control of the Seller." Stein v. Paradigm Mirasol, LLC, 2008 WL 344492 (M.D. Fla. Feb. 7, 2008). However, it should be noted that force majeure provisions are generally allowed if "such provisions are recognized as defenses to contract actions in the jurisdiction where the building is being erected." HUD Guidelines, Part IV(b); See e.g. Hardwick Properties., Inc. v. Newbern, 711 So.2d 35 (Fla. 1st DCA 1998). Additionally, purchasers have asserted that purchase contracts which permit the developer to unilaterally cancel the contract if buyer cannot secure financing, or in the event of catastrophic damage to the building, or if the developer did not wish to resolve title defects do not constitute true obligations and that under such contracts the developer's obligation to complete is illusory. As of the date of this publication, the cases asserting these positions have not been ruled upon, but decisions should be forthcoming in the near future.

The ILSFDA contains many ambiguities and gaps that have not been explored. As a majority of real estate markets continuing to struggle, it can be safely assumed that we will continue to see increased litigation concerning the ILSFDA. Those who represent developers and those who represent purchasers should make themselves familiar with this act and the rights, remedies, responsibilities, and liabilities of their clients thereunder.

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About the Authors

Eric R. Veenstra is an associate in the Real Estate Practice Group of the national law firm of Quarles & Brady LLP, and works out of the Naples, Florida office. If you have any questions or would like additional information concerning the ILSFDA, please contact Mr. Veenstra at eveenstr@quarles.com.

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