The Real Deal New York

To prevent bailing buyers, becoming a developer in name only

Builders at failing projects stay on paper to block buyers from using 'right of rescission'

March 31, 2009
By Alison Gregor

Lenders who are thinking of kicking developers off a failing condo project may want to reconsider. Boot the developer, and you might lose all your buyers.

As a result, some lenders are exploring the option of keeping faltering developers, or sponsors, on in name only.

The strategy is being bandied about in response to the so-called “right of rescission,” which allows buyers to back out of deals if the sponsor makes any significant change to the offering plan that could adversely affect the buyer.

As lenders attempt to replace problematic developers at stalled or failed projects — a move that would typically require an amendment to the offering plan — they are going out of their way to avoid triggering the buyers’ right of rescission, said Matt Blesso, the president of the development firm Blesso Properties.

To do that, some lenders are agreeing to keep the original developer technically connected to a project as sponsor even if they are not involved in building anymore.

“This is something I’ve heard about from talking to lenders and other people,” said Blesso, who was a commercial real estate lender before he founded his company. “It’s a factor that is coming into play.”

In the booming market of recent years, invoking the right of rescission was never a point of contention between buyers and sponsors — because if a buyer pulled out, the sponsor could easily sell the apartment again, often at an even higher price. In this market, however, sponsors are doing everything in their power to hang onto the buyers they have.

Gary Rosenberg, a founding partner of the law firm Rosenberg & Estis, said he had also heard of the strategy being discussed.

“I haven’t specifically done this, but I can understand it, and I’ve heard of it being explored,” he said. “You can still leave somebody in name as the sponsor, who qualifies as the sponsor under the law, but have somebody else contractually finish the project.

“Since everybody’s looking for an opportunity to bail on a condo and get back their down payment, the last thing you want to do as a sponsor is give anybody an excuse,” Rosenberg said. “So banks are getting creative and finding a way to work with the existing developer, as well as the new developer, to keep the existing developer as the sponsor, trying not to trigger that rescission.”

Rosenberg said that it may be a bit early in the market cycle to be seeing these types of deals finalized by lenders, though he also pointed out that if structured correctly, the deal would not necessarily be a public transaction. “I guess if you do it well, nobody will know,” he said.

Steven Herman, a partner with Cadwalader, Wickersham & Taft, said he has not heard of such a deal and cautioned that the arrangement might lead to challenges on the part of buyers if they got wind of it.

“Coming up with creative structural ways to be in compliance technically with the requirements of a contract or offering plan are fine, but when it’s form over substance, you are opening yourself up to claims,” Herman said.

In that case, a real estate lawyer could seek a number of buyers in the same situation to band together to file a claim.

“The more the original developer is there in name only, and has no economic and no operational connection to the project, the more suspect it will look,” Herman said.

“It’s not clear whether or not the claim will be a winning claim,” he said, “but you don’t have to necessarily win; you need leverage to negotiate.”

A sponsor would then have to decide if they wanted to litigate, a move that could lead to negative publicity, which could further depress sales, he noted.

Buyers who claim they were improperly denied their right of rescission could also file a complaint with the New York State Attorney General’s office, said Allison Scollar, the head of the real estate practice at the Manhattan-based firm Guzov Ofsink.

“This is the last thing you want on your project, because once that starts happening, the AG looks into it, and this AG has been much more proactive in looking after buyers, especially in the current market,” she said.

Attorney General Andrew Cuomo’s office did not return calls for comment.

While she said that she hadn’t specifically heard of any deals where the original developer was relegated to “in-name-only” status, Scollar said she didn’t doubt there were restructurings taking place. “I’m sure that’s probably happening a lot, especially when, let’s say, the 10 percent equity owner is not interested in being part of the development any more, so he or she just goes away,” she said. “And at 10 percent, you don’t have to disclose anything.”

Meg Goble, a partner at the law firm Hanley Goble, noted that changing sponsors on a condo project is not necessarily something that would “adversely” affect buyers, as the law says it must to trigger a right to rescind.

“If the substitution of the sponsor, one entity for the other, is not something that adversely affects the purchasers, then it’s possible there would be no right of rescission dictated in that situation,” she said.

However, in the current deflating market, it might not matter, since even if buyers were better off with the switch, they might still seize upon the change and file a claim to try to back out of their contracts, Goble said.

Rosenberg said that other problems could emerge as well, especially since keeping on the original sponsor in name means they still have equity in the project.

“Remember, you’re not taking him out of his ownership position,” he said. “You’re leaving on the sponsor without necessarily getting into the details as to exactly what that may mean, so whenever you try writing documents that don’t say what you mean, you never know when something’s going to come back and bite you.”

But, he said, “It makes a lot of sense if you have a cooperative sponsor. These sponsors are losing their investment, too, just as the bank is losing on the deal.”

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