The Dodd-Frank Wall Street Reform and Consumer Protection Act, effective July 21, 2010, was conceived as the federal response to what is often referred to as this country's greatest economic recession since the Great Depression. The Act focuses extensively on banking and securities. Although Title X of the Act (codified at 12 U.S.C.A. Section 5511) establishes the Consumer Financial Protection Bureau (CFPB or "Bureau") and grants it extensive authority over banking and securities, Title X also consolidates under the Bureau's authority administration of a number of consumer-oriented financial and real estate laws to commence on July 21, 2011.
Although most of the consumer-oriented statutes whose administration is transferred to the Bureau are financial in nature and were previously administered by such agencies as the Federal Reserve Board, Office of Comptroller of the Currency and the Federal Trade Commission (FTC), two statutes administered by the Department of Housing and Urban Development (HUD) were shifted as well. The two statutes are the Real Estate Settlement Procedures Act and the Interstate Land Sales Full Disclosure Act (ILSA), 15 U.S. C. 1700 et seq. This alert focuses on the CFPB's initial administration of ILSA and suggests select issues which the Bureau may wish to consider.
Orientation of the CFPB
The landing page of the CFPB website paints its field brightly for all to see:
"The central mission of the Consumer Financial Protection Bureau (CFPB) is to make markets for consumer financial products and services work for Americans—whether they are applying for a mortgage, choosing among credit cards, or using any number of other consumer financial products. At the consumer bureau, we will:
An informed consumer is the first line of defense against abusive practices. The CFPB will work to promote financial education.
Like a neighborhood cop on the beat, the CFPB will supervise banks, credit unions, and financial companies, and it will enforce Federal consumer financial laws.
The consumer bureau will gather and analyze available information to better understand consumers, financial services providers, and consumer financial markets."
The Bureau is organized into four main divisions: Consumer Education and Engagement; Research Markets and Regulations; Supervision Fair Lending and Enforcement; and External Affairs. While aspects of ILSA may touch all four divisions, the daily operational administration of ILSA will be handled by the Non-Bank Supervision group of the Supervision, Fair Lending and Enforcement Division.
The Bureau published in the Federal Register on May 31, 2011 ("Bureau's May 31, 2011 FR Notice"), a list of the rules and orders that it will enforce relative to the statutes which it newly administers. As to ILSA, the following sections of regulations previously promulgated by HUD were expressly transitioned to the CFPB:
- 24 CFR 26.28-.56 – Hearing Procedures Pursuant to the Administrative Procedure Act
- 24 CFR Part 30 – Civil Money Penalties
- 24 CFR Part 1710 – Land Registration
- 24 CFR Part 1715 – Purchasers' Revocation Rights, Sales Practices and Standards
- 24 CFR Part 1720 – Formal Procedures and Rules of Practice
- 24 CFR Part 3800 – Investigations
Seeing the full complement of six ILSA sets of regulations is bracing. Although the 1710, 1715 and 1720 series are quite familiar to experienced practitioners, the three less familiar parts, 26, 30 and 3800, remind us that:
- formal administrative hearings can be initiated upon allegations of violation of any provision
- subpoena power against private parties is fully available at the administrative level both as to production of documents and to compel live testimony
- administrative civil penalty authority exists relative to "any person who knowingly and materially violates any provision of ILSA or the rules and regulations" where "[e]ach day that a violation continues shall constitute a separate violation" with up to $1,375,000 per person "for each violation ... during any one-year period"
Although rarely imposed in the past 20 years during HUD's administration of ILSA, these tools remain formidable and are now securely located in the CFPB's tool kit.
The Exemption Guidelines: Have They Transitioned to the CFPB?
Another important result of the Bureau's May 31, 2011 FR Notice is that the Supplemental Information to Part 1710: Guidelines for Exemptions Available Under the Interstate Land Sales Full Disclosure Act ("Exemption Guidelines") is not explicitly included in the group of six sets of CFR regulations. In a recent teleconference with a number of private practice lawyers and other parties involved with the ILSA program hosted by Peggy Twohig, Director of the Non-Bank Supervision office, she noted that the Exemption Guidelines had not been carried over from HUD but that she foresees a time when new, updated guidance will be drafted, aired and provided. However, a footnote in the text of the Bureau's May 31, 2011 FR Notice suggests the current Guidelines may still be in effect. Footnote 8 states, "Unless otherwise noted, all references to a Part include accompanying appendices and supplements." So the question arises, are the Exemption Guidelines an accompanying appendix or a supplement?
Prior to the "streamlining" of HUD regulations in 1996, the Exemption Guidelines appeared in Appendix A to 24 CFR 1710. In the final rule implementing the streamlining, the Exemption Guidelines were removed from codification, but the commentary appearing at 61 FR 60, p. 13596 (March 27, 1996) ("HUD's March 27, 1996 FR Notice") states that they are "maintained in an uncodified appendix accompanying this final rule" and the heading above the Exemption Guidelines attached to the final rule reads "Supplemental Information to Part 1710: Guidelines for Exemptions Available Under the Interstate Land Sales Full Disclosure Act." As no indication was provided in the Bureau's May 31, 2011 FR Notice, that the Exemption Guidelines Supplement to Part 1710 was not to be included as part of the Regulations to transition to the Bureau, then as provided in Footnote 8, reference to Part 1710 includes the supplement to it, which in this case is the Exemption Guidelines. Thus, at least as a technical matter, the Exemption Guidelines may still be in effect.
The Past and Future of the Exemption Guidelines
Whether in effect or not, the role played by the Exemption Guidelines in the administration of ILSA over the past 25 years is substantial. The Exemption Guidelines were developed in the early 1980s with the benefit at that time of HUD staff with some 15 years of experience. Some had worked in ILSA administration since the initial implementation in 1968. The Guidelines progressed through several iterations and were published for comment and revised based on public comment on several occasions with the most recent amendments appearing in the 1996 version referenced above.
However, over the past several years courts have been inconsistent in acceptance of positions set forth in the Guidelines. In part, this is because (as described above) the guidelines are no longer formally integrated into the ILSA regulations or because, in a few cases, courts wrongly found the Exemption Guidelines had not been published for public comment prior to promulgation and thus were less deserving of deference. Further, several HUD staff members who worked on the ILSA program and who will now become staff at the CFPB do not agree with one or a few key positions taken in the Guidelines – some courts have also questioned these positions. Hence, if the Guidelines are in effect, as a CFPB priority the Guidelines should be closely reviewed and either disposed of or fine-tuned and elevated to the status of regulation so the courts can cite these exemption summaries with confidence. And if the Guidelines are not in effect, the Bureau should consider a new summary of exemptions for promulgation. Where the courts are aligned with the regulations and principles in the Guidelines, it brings a consistency between administration of the law and judicial review of cases and controversies that is of paramount importance to those interested in fair and consistent application of law. Over the years, developers and practitioners have referred to the Guidelines on countless occasions and relied upon them as the official pronouncements of the administrators and interpreters of ILSA. Given the complexity of the statute and regulations, official written guidance to the industry is extremely useful to foster compliance. Whether the text of the existing Guidelines remains "as is" or is substantially revised through rulemaking, some form of public guidance that can be relied upon is recommended.
The "Two Year Contractual Obligation to Build" Exemption
The two year contractual obligation to build exemption ("Two Year Exemption") is found at ILSA Section 1702(a)(2): "the sale or lease of any improved land on which there is a residential, commercial, condominium, or industrial building, or the sale or lease of land under a contract obligating the seller or lessor to erect such a building thereon within a period of two years." The exemption has seen the most litigation of any ILSA provision with more than 35 decisions in a number of federal and state courts including a Florida Supreme Court decision and several decisions in a single federal appellate circuit. One reason the Bureau may want for the Exemption Guidelines to be in effect is the challenge posed to the consumer protective restraints offered by the two year exemption if the Guidelines are dropped. A summary of the issue is offered in the HUD March 27, 1996 FR Notice as referenced above. In the Notice, HUD had this to say about the jeopardy of the exemption:
"On July 11, 1995, the U.S. Court of Appeals for the Eighth Circuit issued an opinion that from HUD's perspective effectively nullified the seller's obligation to construct [a residence]. In fact, it effectively nullified the exemption.
In Attebury v. Maumelle Company, 60 F.3d 415 (8th Cir.1995), a case in which HUD appears as amicus curiae as to the exemption issue only, the developer, Maumelle, used a sales contract that initially recited its obligation to build within two years after the lot sale. The contract then went on to recite a number of conditions, the effect of which was to shift the obligation to build onto the buyer.
HUD argued these [Exemption G]uidelines and several cases ... have recognized an unconditional requirement on the seller to build. In part, the case law adhered to the rule of construction that exemptions from a remedial statute should be narrowly construed. The court, which observed that the plaintiffs had not relied on the HUD Guidelines in the district court, dismissed the government's arguments primarily based on the language in this section [of the Guidelines] that says: "… the contract must specifically obligate the seller to complete the building within two years" (emphasis added), by distinguishing the Guidelines' literal requirement that the obligation to build be "specific" from the argument in this case that the requirement be 'unconditional.'"(61FR60, p.13598, March 27, 1996)
HUD continues in the very next paragraphs by comparing the language in the pre-1996 version of the Exemption Guidelines with the new language in the Guidelines that was being implemented by HUD effective on that day. The essential difference between the old and the new provision is that the new provision drops the word "specifically" modifying the word obligate and adds two new sentences to HUD's description of what constitutes permissible contract provisions: "A contract that conditions construction upon acts of a buyer will not exempt the sale. The essence of this exemption is that it applies to the sale of a house (if not built at the time of sale, then to be built within two years after the sale)." And HUD concludes its analysis of the appeals court decision by saying, "Obviously, a buyer in a non-exempt transaction will shoulder any responsibility for building a house. If the conditions in the Maumelle contract create a similar result, which is the effect of the ruling, there would be no reason for the exemption." (op cit, p.13598-9)
If the Exemption Guidelines are jettisoned as the Bureau seems to say has happened, other courts stand to be persuaded by the Eighth Circuit's Maumelle decision without the counterbalancing statements HUD made in its 1996 notice and explanation of its most recent amendment to the Guidelines. Further, courts could be especially persuaded once it was brought into evidence that the Bureau acted intentionally to drop the Exemption Guidelines. As HUD stated, the outcome would be a far broader application of the Two Year Exemption along with evisceration of ILSA's registration objective. If the Maumelle decision stands, HUD foresaw the virtual elimination of property registration and abandonment of the full disclosure mandate. Whereas in 1996 HUD was satisfied it had plugged the hole created by Maumelle, the CFPB now has an important opportunity to devise a more complete resolution.
Fast forward 14 years to 2009 and another federal appeals decision makes an important statement about this same exemption. The 11th Circuit Federal Court of Appeals in Stein vs. Paradigm Mirasol, LLC, 586 F.3d 849 (2009) held that the exemption allows for force majeure provisions which are beyond the control of the developer and support delay of performance under state law. The lower court in Stein had found the standard to be impossibility of performance and the 11th Circuit which covers the state of Florida and two other states, reversed saying that Florida law should control the dispute arising from purchase of a residential unit at a Florida-located condominium regarding an enforceable force majeure clause. The court continued that under Florida law, delay of performance rather than impossibility of performance is the correct standard. What resolution courts will devise for the other 49 states as an acceptable force majeure clause remains unresolved. This fracturing of an important legal standard leads to the question of whether a revision to the Guidelines could yield a uniform standard. Although the Stein appellate decision is not dependent on language in the Exemption Guidelines, a thorough, well-reasoned treatment of the Stein issue in a revised set of exemption guidelines would go a long way towards restoring judicial confidence in federal administrative interpretation of ILSA.
Other Priority ILSA Issues
One could make the case that a number of regulatory revisions should be priorities of the new ILSA administrators:
- Should registration or exemption be emphasized for condominiums, or for a balanced approach should the Bureau seek meaningful cooperation with the states in state regulation of condominiums pursuant to the State Certification Process described in ILSA Section 1708(a) and the Regulations at Section 1710.500(a)? If needed, amendments to the regulations can be provided to streamline the process and perhaps to create a hybrid status – compliance with the condominium law of the home state plus certain best practice standards in order for a developer to qualify for certification in lieu of registration.
- Should the arbitration clause which developers increasingly insert into their form lot/unit sales contract be limited by substantive regulation or highlighted by disclosure? In another section of the Dodd-Frank Act, the CFPB is authorized to prohibit or limit mandatory predispute arbitration after conducting a study, and any such limits must be consistent with the findings of the study.
- Does a Suspension Notice for an amendment or consolidation suspend only the otherwise statutorily accruing effective date or does it act to suspend sales in the underlying registration?
- Not intended as an exhaustive list, a sampling of other issues also warrant a fresh and thoughtful review, such as whether "stacking" two exemptions as allowed under the Exemption Guidelines should continue to be allowed in light of a recent Second Circuit Court of Appeals decision; clarification of the controversy over "descriptive and recordable lot identification"; review of registration standards and basic requirements for the Property Report and AID sections for traditional subdivisions as well as for condominiums; consideration of a streamlined Voluntary Suspension procedure; clarification of limits to the linkage between the defined terms, "subdivision" and "common promotional plan"; and review of ILSA's statute of limitations provisions in light of judicial interpretations.
Will the CFPB's Wide-Ranging Authority to Prevent Unfair, Deceptive, or Abusive Acts or Practices Be Applied to ILSA-Regulated Developers?
Separate from its administration of ILSA, the Bureau is authorized to issue and enforce rules for consumer protection that govern a wide range of non-depository companies that offer consumer financial products or services. In addition to ILSA, the Bureau also assumes responsibility for interpreting and implementing the federal consumer protection and fair lending laws which affect homebuilders and condominium developers including the Truth-in-Lending Act, Equal Credit Opportunity Act and the Real Estate Settlement Protection Act.
Under the Dodd-Frank Act, the Bureau will have the authority to declare as unfair, deceptive, or abusive any act or practice that (i) materially interferes with the ability of a consumer to understand a term or condition of a consumer financial product or service or (ii) takes unreasonable advantage of a lack of understanding on the part of the consumer of the material risks, costs, or conditions of the product or service, the inability of the consumer to protect their interests in selecting or using a consumer financial product or service, or the reasonable reliance by the consumer on a covered person to act in the interests of the consumer. The Dodd-Frank Act’s definition of "abusive" is vague and, without the benefit of established precedent, may be construed broadly by the Bureau.
In addition, the Bureau may prescribe rules to ensure that the features of any consumer financial product or service are fully and properly disclosed to consumers to understand costs, benefits and risks. In doing so, the Bureau must take into account "available evidence about consumer awareness, understanding of, and responses to disclosures or communications about the risks, costs, and benefits of consumer financial products or services." The Bureau may also develop model disclosure forms, validated through consumer testing, which will provide a safe harbor for compliance.
Scope of Covered Financial Services Providers
In connection with its regulation of non-depository companies and service providers, the Bureau will have the authority to require reports, conduct examinations, require certain record-keeping requirements, and prescribe other rules to ensure that such entities are legitimate entities and are able to perform their obligations to consumers and refer suspected violations of law, including tax noncompliance, to other agencies. For those non-depository institutions that are not engaged in any mortgage-related businesses, payday lending or student lending and are not a "larger participant" of a market for other consumer financial products or services or a service provider for any such entity, the Dodd-Frank Act contemplates the application of the reporting and examination requirements only if the Bureau determines that the covered person has engaged in conduct that poses risks to consumers.
The Bureau’s authority is limited by various jurisdictional exclusions provided for under the Dodd-Frank Act. Subject to certain limitations, the following persons and activities are excluded from the jurisdiction of the Bureau:
- real estate brokerage activities
- persons regulated by a state securities commissioner
- persons regulated by the Securities and Exchange Commission (SEC)
Given the far reaching powers of the Bureau separate from administration of ILSA, will the Bureau seek to combine its powers with respect to ILSA-regulated parties, or will all or most of its attention to home sites, condominium developers and homebuilders be channeled via ILSA? And what about the three categories of exclusions? Does exclusion of real estate brokerage activities mean that because residential real estate products are generally offered by licensed real estate brokers, members of the residential real estate industry are statutorily exempt, too? Unlikely, but one can be sure that these and many related issues will be explored.
Turning the Page – Starting a New Chapter
There is speculation that only about 150 projects throughout the United States are registered and current, a far smaller number compared with years past. This reminds one of the old saying, "What if we had a party and no one came?" Given the tightened standards for registration, the paradoxical effect seems to be loading more complex requirements on the backs of fewer and fewer developers – and the very ones who are trying to comply and not claim exemption. With a few micro-market exceptions, the home site and community development industry has been hit hard and is weaker today than at any time since ILSA's passage in 1968. The condominium industry, in its infancy in 1968, is today beset by a huge inventory overhang that has all but choked new projects – especially larger projects which typically would be candidates for registration.
Given the residential real estate meltdown of the past several years, the benign neglect shown to the ILSA program by HUD for most of the past 20 years up until the past few years, and the confusing, ill-reasoned and sometimes contradictory ILSA court decisions, many would welcome a thoughtful and transparent review of both registration and exemption issues. With the transition of ILSA to the CFPB, experienced practitioners will work hard to engage the Bureau in a constructive role in the revival of the industry while destroying once and for all the false construct of a zero sum game between developer success and purchaser protection. And for developers and other industry participants, it is important to align with counsel who deeply understand where ILSA has been while also understanding the potential for a win-win paradigm of how ILSA can now evolve. From Ms. Twohig's remarks during the teleconference, the Bureau is aware that change is needed and not necessarily change that is negative from a developer's perspective. She implied that the Bureau would seek change that benefits both developers and the next generation of new home and home site purchasers.
The various constituencies involved in the residential real estate development and sales industry – community and residential developers, marketers, and lenders for home site developments and to-be-built or under construction condominium units and free-standing homes in subdivisions and planned communities nationwide – doubtless will take note and should seek informed, constructive engagement in the process that takes ILSA into the future.