In major departure, AG will no longer oversee condo deposit disputes

After years of idle discussion about reform, New York Attorney General Eric Schneiderman has enacted major rule changes to the regulation of condominium and co-op escrow disputes. Following the 2008 financial crisis, the office was swamped with hundreds of such disputes, where condo buyers fought developers to get back their deposits on new construction apartments. Now, the agency will require buyers and builders to settle claims in state and federal court, rather than before the agency, The Real Deal has learned.

Under the new regulations, buyers and developers of condos and co-ops will have to sign a purchase agreement or a “trilateral” agreement with the escrow agent—typically a law firm that holds a deposit until the sale closes—which will have a fiduciary responsibility to both parties. Any disputes involving buyers who want their deposits back will have to be settled in court.

In the past, escrow disputes have largely been settled through three routes: filing complaints with the Attorney General’s Real Estate Finance Bureau, filing lawsuits in state court under the Martin Act or, more recently, filing federal lawsuits under the Interstate Land Sales Full Disclosure Act, a previously little known statute that regulates newly built condos larger than 100 units.

Lawyers have historically opted for state court, as the bureau has long been criticized for being unable to handle escrow disputes in a timely manner, largely due to staffing and budget concerns.

“The AG’s office is woefully underfunded and the staff overworked,” said Steve Sladkus, a partner and co-chair of the real estate practice at Wolf Haldenstein. “From a human standpoint a lot of these cases can’t be [adjudicated].”

However, after the real estate market collapsed, hundreds if not thousands of buyers filed with the Attorney General to rescind their purchase contracts, citing faulty construction, failure to disclose major financial changes at the property or failure to close the first apartment sale by a designated deadline. Many industry observers saw these complaints as frivolous cases from buyers who panicked during the financial crisis—and wanted out of pricey real estate deals.

Indeed, the number of such filings has dropped sharply since the real estate market bottomed out, according to data from the Attorney General’s office. From 2011 to 2012, the number of cases fell roughly 72 percent, from 68 cases to 19, and so far in 2013 only one dispute has been filed, the figures show.

The revised rules are designed to tighten up the dispute process, which some legal experts said would force developers to more explicitly disclose changes in their offering plans and force buyers to more carefully scrutinize buildings where they sign contracts.

Sources familiar with the AG’s deliberations said the agency wanted to refocus on its “mission of regulation enforcement rather than individual disputes.” Sources pointed to a number of expensive and elaborate legal battles before the regulator, most notably the recent dispute between more than 40 buyers at Extell Development’s Rushmore condos at 80 Riverside Drive, who won a $16 million refund, as The Real Deal reported.

Developers will have until the end of 2013 to update their offering plans to comply with the new rules.

Real estate lawyers were largely pleased that the Attorney General was getting out of the escrow dispute business, as the agency has long been criticized for being too overworked to properly review these cases, or in other instances taking too long to resolve the disputes.

Jonathan Canter, a partner at Kramer Levin Naftalis & Frankel, said the new regulations will make the entire escrow dispute process more efficient.

“When the market turned, this was really the easiest way for purchasers who really had no claims whatsoever to slam the brakes,” Canter told The Real Deal. “I can’t say they were all frivolous, but a great many of them were totally frivolous.”

Peter Moulinos, a partner at Moulinos and Associates, noted that the Attorney General’s office was always reluctant to get involved in escrow disputes if there were related cases in court. He says the new regulations will make the entire process more transparent.

“Courts have more power to look at more evidence,” he told The Real Deal. “I don’t think the AG’s office had the wherewithal to deal with this.”

However, Sladkus worried that many issues involving buildings with poor construction, troubled finances or a lack of disclosure will continue until the agency is given the tools to provide adequate oversight, he said.

“It seems to me that we are on the verge of a revival of a whole wave of problems all over again,” he said.

A spokesperson for Extell was not immediately available, nor was Edward Norman, an attorney at Boies Schiller & Flexner who represented the Rushmore developers.