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January 2012

More Housing Crisis Fallout: Class Action Litigation Alleging Creation of "Instant Slums"

A recent decision of the United States Court of Appeals for the Ninth Circuit held that home buyers may sue builders—including Centex Corp., D. R. Horton, Lennar Homes, Shea Homes, The Ryland Group, among others—based on the creation of instant subdivision slums resulting, in part, from the collapsed housing market. 

The decision, Maya, et al. v. Centex Corp. et al., 2011 DJDAR 14362, is particularly important for home builders.  It is also important reading for brokers and owners of commercial and other properties against whom the same liability theories may apply.  Although the decision is a "standing" decision where the court determined that plaintiffs have a concrete, compensable interest, it also inferentially suggests that the theories for recovery are viable.

In summary, the case concerns the following:

Plaintiffs are individual homeowners who purchased homes in new developments.  Each of them made a down payment of 20% or more of the home's purchase price.  Plaintiffs seek damages, attorneys' fees and costs, and the option to rescind their purchase transactions due to defendants' alleged fraud, negligent misrepresentation, breach of the implied covenant of good faith and fair dealing, and violations of California's Business and Professions Code (CBPC).  They also seek an injunction prohibiting defendants from continuing to engage in practices violating the CBPC and providing mortgage services or financing to buyers purchasing homes from defendants.

Plaintiffs claim that defendants represented that they were building "stable, family neighborhoods occupied by owners of the homes."  According to the plaintiffs, "[i]mplicit in this marketing scheme was that [d]efendants were making a good faith effort to sell homes to buyers who they expected could afford to buy the houses and would be stable neighbors."  Nevertheless, "defendants marketed the houses to unqualified buyers who posed an abnormally high risk of foreclosure."  Similarly, plaintiffs claim that defendants represented that they "discourage speculation . . . [and] intended to sell homes only to people who will occupy them" but, in fact, sold homes to speculators who had no intent to reside in the homes and were more likely to walk away from the homes in times of economic hardship.

Plaintiffs claim that these misrepresentations and omissions were part of a scheme to increase defendants' profits.  They allege that defendants financed at least 65% of the mortgages on homes in their communities.  Plaintiffs further contend that by marketing homes to high-risk buyers, and by financing buyers who may not have been able to obtain other financing, defendants created a "buying frenzy" that artificially increased demand for the homes and the corresponding purchase prices.  They maintain that defendants' marketing and lending practices were material information "related both to the value of their houses and the desirability of the properties."  They allege that "[i]f Defendants had made such disclosures, Plaintiffs would not have purchased the houses from Defendants or would not have paid an inflated price for the house."

Since plaintiffs purchased their homes, "these unqualified and high-foreclosure risk buyers began to default on their loans leading to foreclosures and short sales."  The resulting foreclosures and short sales lead to a substantial loss of value to the surrounding homes.  According to the plaintiffs, the foreclosures and short sales have "drastically altered" the "desirability" of plaintiffs' properties and neighborhoods, resulting in abandoned houses, multiple families living in single dwellings transient neighborhoods, and increased crime.

Plaintiffs' claims fall into two broad categories.  They allege injuries that occurred at the time of sale: that they paid more for their homes than they were actually worth at the time and that they would not have purchased their homes had defendants made the proper disclosures.  Plaintiffs also allege injuries that occurred after the sale: that their homes have decreased in economic value and desirability as places to live. 

The court concluded that plaintiffs have standing to sue, which reverses the trial court's order dismissing the case.  The reasoning behind the decision is twofold; first, the plaintiffs' alleged injuries at the time of sale are actual and concrete economic damages.  Second, regarding plaintiffs' alleged post-purchase damages, plaintiffs should be allowed to amend their complaints to allege how defendants' actions necessarily result in foreclosure and how the decrease in value is caused by the risk posed by their neighbors (absent the foreclosures.)  Thus, plaintiffs have standing, or a sufficient interest in the litigation, to prosecute the lawsuit.

This decision reflects the unintended consequences of misguided social planning whereby everyone is to become a homeowner.  Down payments are waived; teaser, early "easy" loan payments are made available; the financial strength of the buyer is disregarded and other risk factors ignored.  The obvious result – homebuilding surged; subdivisions proliferated; and Fannie Mae and Freddie Mac guaranteed many billions of dollars in loans that went (and will go) sideways.

For home builders the lessons are many and the risks for not taking protective steps are significant.  Marketing must be scrupulously honest and documented.  Introducing a type of buyer into a development who is particularly prone to default may require carefully worded warnings to all buyers.  Brokers should heed the lessons of this decision regarding complete candor and disclosure.  Whether or not the decision will impact commercial property owners and developers remains to be seen.


   1 The summary is taken in part from the decision

Real Estate

Charles V. Berwanger



Real Estate

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