In an October 21, 2016, published decision titled In Majorca Isles Master Ass’n, Inc., 560 B.R. 824 (Bankr. S.D. Fla.) (“Majorca Isles”), the United States Bankruptcy Court awarded a Florida Master Association with an incredible $16.3 million judgment against a developer and its appointed trustees, in what the Court described as a “modern day story of David and Goliath.”  Setting aside the transition aspects of the case, the decision provides an excellent guide for boards and property managers – particularly those involved with master associations – facing issues of poor record keeping and conflicts of interest.

In Majorca Isles, developer D.R. Horton appointed trustees to sit on both a master association (the “Master”) and its five subsidiary associations (the “Subsidiaries”).  The Master was responsible for shared property and services, including swimming pools, clubhouses, parking areas, landscaping, gate facilities, security guards, and cable television.  The various governing documents of the Master and the Subsidiaries condominium associations provided:

  1. Each unit owner was personally obligated to pay assessments to the Master;
  2. The Master was empowered to impose, liens, late charges, and attorney’s fees on delinquent unit, and to bring foreclosure and money judgment actions against the individual owners;
  3. The Master was required to maintain complete and accurate records as to assessments paid by each individual owner;
  4. The Master could choose to delegate its assessment collections to the Subsidiaries, in which case the subsidiary associations were to pay the master assessments in full prior to the Subsidiaries’ expenses.

Despite these requirements, beginning in March 2006, the Master collected assessments from unit owners without creating any financial records of the assessments.  Then, in October 2007, the trustees determined to collect the Master’s assessments by “bulk billing” the Subsidiaries.  As a result of the bulk billing, the Master continued to create no financial records for individual owners.

As the great recession set in, revenue dropped and nearly half of the Master’s unit owners became delinquent.  The trustees, sitting on both the Master and Subsidiary boards, decided to cut funding to the Master in favor of the Subsidiaries, removing amenities like security personnel, home alarm monitoring, and cable television.  Facing growing delinquencies, the Master sought the assistance of a collections law firm in September 2009.  The firm, after reviewing the governing documents, advised the trustees: (1) the Subsidiaries were prohibited from paying their own expenses prior to fully funding the Master; (2) collections were made impossible by the lack of financial records; and (3) owners would likely be able to successfully defend against any collections actions due to the trustee’s non-conformance to the governing documents.  The trustees wrote off their attorney’s advice as “just a legal opinion”, and quietly abandoned attempts to recover the unpaid assessments.

Control of the master board turned over to the unit owners in January 2011.  Lacking records necessary to collect delinquencies, and unable to pay its expenses, the Master became immediately insolvent and filed Chapter 11 Bankruptcy, bringing it under the jurisdiction of the Bankruptcy Court and to the attention of Barry Mukamal, a bankruptcy trustee.  Mukamal, in what the Court described as an “extraordinary” service to the Master, recreated seven years of assessments records “from scratch,” and successfully pursued the developer and its trustees for a $16.3 million judgment.

Importantly, the Court found the individual trustees breached their fiduciary duties to the Master.  In doing so, the trustees managed to satisfy almost every major method for undermining the business judgment rule protecting fiduciaries: (1) acting despite a direct conflict of interest; (2) acting contrary to specific terms of the governing documents establishing their authority; and (3) disregarding the specific advice of qualified professionals such as legal counsel.  The Court concluded the trustees were personally liable to the Association for over $3.8 million for, among other things:

  1. $750,000 in delinquent assessments made uncollectable by the failure to institute a collection program, the failure to collect from the Subsidiaries, and the disregard of advice from outside counsel;
  2. $200,000 to recreate the Master’s financial records due to the failure to create or maintain adequate records; and
  3. $867,066 for unilaterally removing security services and cable television amenities, thereby favoring the Subsidiaries and the developer.

Majorca Isles must be read in the larger context of the trustees’ roles as employees of the developer, as among other things, the trustees were therefore not protected by any indemnification clause in the governing documents.  While the egregious conduct in the case would likely fall outside of a traditional indemnification clause, it is also likely the Court would have been more sympathetic to elected volunteer trustees.  Additionally, the Court’s decision, applying Florida statutes and common-law, can only serve as persuasive precedent in New Jersey.

Nevertheless, the decision drives home that trustees and property managers owing a fiduciary duty to a condominium or homeowners association can be sued for failing to create accurate and complete financial records, failing to establish a meaningful collections program, and failing to provide advertised amenities.  In particular, trustees and property managers should strongly consider abstaining from decisions where any of the following apply: (1) a direct conflict of interest splits fiduciary duties between a master and subsidiary association, or between an association and some third party; (2) the action, course of conduct, or lack of action contradicts the governing documents; or (3) the decision contradicts the advice of the qualified professionals such as engineers and legal counsel.

In Etelson v. Shore Club Urban Renewal LLC, a Hudson County jury found that the developer, the LeFrak Organization, Inc., Newport Associates Development Company and James LeFrak violated the Consumer Fraud Act and Planned Real Estate Development Full Disclosure Act (“PREDFA”) in their advertising and marketing of a luxury high rise riverfront condominium in Jersey City (Shore Complex, North and South Towers). The jury found that the developer and its marketing materials misled purchasers of condominium units by advertising breathtaking and panoramic views of the water and Manhattan skyline when the developer knew those views would be blocked in the near future.

The jury relied upon several key facts in order to find the Developer liable for consumer fraud.  The developer’s marketing materials included a painting of the Shore Complex showing a smaller 11- 12 story building to be constructed across the street and northeast, between the Shore Complex and the Hudson River.  The developer’s sales brochure and website did not show any buildings located between the shore Complex and the Hudson River. There were some drawings that showed a smaller building to be constructed in the future.  In addition, to the Developer’s marketing materials, the developer’s sales staff told potential purchasers that a smaller building (12-15 story) might be constructed on the nearby parcel. All the while the Developer was constructing a larger building that would block the view of the river and the Manhattan skyline.

The unit owners testified that they purchased these units for the views of the river and the Manhattan skyline. The unit owners also testified that they would not have purchased the units if they were informed that a taller building was going to be constructed across the street blocking their views.

The jury awarded the unit owners $1,253,420 in damages representing the reduction in value of their units without the views. Because the jury found that the developer violated the Consumer Fraud Act, the plaintiffs were awarded treble damages, plus their costs and attorneys fees for a total damage award of $4,817,638.12.  The developer appealed and the Appellate Division affirmed the jury verdict and found that it was supported by the evidence.

The evidence at trial showed that while actively marketing the Shore Complex, the developer had submitted plans to the City planning board seeking approval for a 31 story rental apartment building tower to be constructed which would block the Shore Complex unit owners’ views of the river and the Manhattan skyline. The developer did not change its marketing material and did not disclose this to potential purchasers. Instead the developer continued to market the units by advertising spectacular views knowing that they would not last for long.

The jury found that the developer had misrepresented the views and failed to disclose their plan to develop the taller 31 story tower that would block the views. None of the developer’s sales agents told prospective purchasers that a taller building would be constructed between the Shore Complex and the Hudson River.  The Developer’s sales staff was not told about the plans to construct a 31 story tower.  They assured potential purchasers that the building to be constructed in the future would not block views for anyone residing on the 15th floor or higher.  Interestingly, the Developer’s sales staff testified that if they had known of plans to construct a 31 story tower between the Shore Complex and the river, they would have disclosed this to potential purchasers.

At trial, the developer argued that it did not mislead the purchasers because there were disclaimers on the marketing material and in the Public Offering Statement. The Appellate Court noted that these disclaimers were not dispositive on the issue of misrepresentation and indicated that the developer would still be liable if the jury found that there were misrepresentations or omissions that induced a purchaser to buy a unit.

This case is significant to Associations who are in the process of transition, the transfer of control from the developer to the Association and the identification and resolution of construction defects and financial defects.  The court affirmed that a developer can be liable to individuals for consumer fraud in the marketing and advertising of the condominium. The court also noted the significance of marketing materials, advertisements and conversations that were not part of the sales contract or the POS.