Condominium Law – Developer And Director Liability – A Wake Up Call To Budget Correctly – April 6, 2017

Dated: April 6 ^th, 2017 .

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Introduction

Mr. Andrew Cuevas, Esq., is the President of Cuevas, Garcia & Torres, P.A., and Vantage Property Title Company. Cuevas, Garcia & Torres, P.A., provides legal services in the areas of Community Association Law, Corporate Law, Real Estate law, and Business Immigration, including title insurance services through Vantage Property Title Company. If you have any questions regarding this article or any other questions, you may contact Mr. Cuevas at (305) 461-9500 or via e-mail at [email protected]. If you are interested in reading previous newsletters, please visit www.cuevaslaw.com, select the icon for Newsletters, and then choose the area of law you are interested in.

Developer and Director Liability – A Wake Up Call to Budget Correctly.

In a vicious rebuke to a Developer and the Developer pre-turnover appointed Members of the Board of Directors, the United States Bankruptcy Court in the matter of In re: Majorca Isles Master Association Inc v. D.R. Horton, Inc., ruled against the Developer in the amount of $16.0 Million plus prejudgment interest, attorney fees, and costs, which included $12.5 Million for punitive damages due to the outrageous acts of the Developer and their assigned Directors in not protecting the interests of the community association prior to turnover. A review of the decision was quite impressive with the list of the findings of the court listed numerous improprieties, conflicts of interest, mismanagement, and intentional misconduct, all resulting in damages to the homeowners of the community. This decision highlights the duties of directors generally, and in particular that developer appointed directors still owe a fiduciary duty to the members. .

D.R. Horton is a New York stock exchange company and one of the largest residential developers in America. The Majorca Isles Master Association, Inc. was to supposed to administer a 681 unit project in Miami Gardens for low to moderate income single family and condominium residences with nine sub-condominium and homeowners’ associations. D.R. Horton appointed four individual directors, one of which was an attorney. Each of the directors were also employees of D.R. Horton (the “Developer”).

In 2005, only 355 units were completed which made up only five of the nine planned sub-associations, and then the recession came. Sales stopped, construction ceased, and D.R. Horton withdrew the presumably undeveloped property from the project. Unit valuations plummeted. The Master Association needed $40,000 per month to function but was only collection $20,000 per month.

The Court determined that D.R. Horton was obligated to deficit fund the Condominium Association and Master Association expenses. The Court found that the Developer shifted burdens to owners by cutting services and amenities, including security and maintenance as “can only be classified as somewhere between not nice and evil.” The Master Association’s insolvency resulted in a Chapter 11 Petition and appointment of the Trustee. The Bankruptcy Court placed responsibility on the four developer appointed employees, remarking that they had conflicts of interest by their roles as D.R. Horton’s employees and agents, condominium association directors and master association directors. The developer had vicarious responsibility under ” respondeat superior.” The Court also referenced the Directors qualifications and experience, and that they had “knowledge of the obligations and responsibility imposed by the documents governing the Master Association.” Key was the individuals’ fiduciary obligations as directors to the Master and sub-Associations.

In the realm of director liability, the Court specifically called out one director’s conflict of interest, further finding that the director’s testimony “was not forthcoming or credible, especially for a lawyer and officer of the Court”. The Court found that the director “knew of her responsibilities and fiduciary duties as a board member of the Master Association and intentionally breached those duties, for D. R. Horton’s benefit and financial gain.” A list of improprieties in managing the community included:

· Failure to keep individual unit ledgers

· Failure to keep a roster of members

· Failure to create and maintain any financial record-keeping whatsoever

· Failure to keep electronic records of association finances. The Master was unable to certify the accounting of any owner account

· Intentional manipulation of the annual budgets to materially understate the amount of expenses and create a monthly assessment that the Developer knew was insufficient to fund the operations of the Master Association, by: a) understating the calculated bad debt in the form of uncollectable assessments; and b) basing the per unit assessment on spreading the expenses over 681 units, hundreds of which were not and would not ever be built.

· Even more unbelievable was the Developer-appointed Directors who manipulated the Master Association financial statements to re-characterize the Developer’s required deficit funding obligation as a debt that the Master Association had to repay to the developer!

· The court found that the Directors did not know if the so-called “actual” “maintenance fees” were actually received.

The Court’s conclusions concerning the Developer appointed directors is of particular interest. In anticipation of turnover of a 355 unit community to the unit owners, the Developer appointed Board did nothing, with disastrous results. As fiduciaries, they owed the Master Association a duty to act reasonably and in its best interests. They:

a) Did not advise the members of the Master Association of the extent of the deficit funding (the full nature of which had been concealed from the unit owners);

b) Did not advise the Master Association that the calculated and published budget was woefully inadequate, even if it was fully collected;

c) Did not write off or write down the uncollectable Assessments;

d) Did not institute a meaningful collection program;

e) Did not leave the Master Association with any meaningful reserves.

In short, the Developer and its handpicked Board took no action to advise the members of the Master Association of the inadequate revenue, the lack of collectable assets, or the extent of the Master Association’s ability to function.

The Court found that D.R. Horton violated Florida’s Deceptive and Unfair Trade Practices Act. §502.201, et seq., “based upon the clear and convincing evidence that D.R. Horton engaged in an unfair practice ‘that offends established public policy and one that is immoral, unethical, oppressive, unscrupulous.’ ” Actual damages were measured by the difference between the value of the Master Association at turnover as represented and the actual value, $457,854.27. In addition to individual breaches of fiduciary duty, the Developer, and the individual defendant-directors were found to have conspired and were also liable for aiding and abetting each other. Adding to this very strong decision, the Court found the Developer was “guilty of intentional misconduct or gross negligence” and stated:

“the wrongful conduct was motivated solely by greed for unreasonable financial gain and D.R. Horton, through its agents and employees, knew the conduct was certain to cause injury to the Master Association and unit owners.”

The Court awarded punitive damage award of $12,500,000

The moral of the story is that directors, including developer-appointed directors, need to pay attention. While not addressing the minimum level of director inquiry to staff or management, there is apparently a minimum duty to inquire as to the status of unit ledgers, rosters and in recessionary times, bad debt budgeting. Realistic budgeting is the Board’s responsibility . .

This article is solely a partial explanation of all the issues related to the topic of this newsletter, and is not to be considered legal advice. Associations should seek legal advice for all issues related to Developer turnover as well as proper budgeting practices. This Newsletter is for informational purposes only and should not be relied upon as a legal opinion. .