A Lawyer, an Underwriter and an Appraisor-An Update

The title of this post sounds like a teaser to a bad joke but unfortunately it refers to the latest round of motions in two sprawling lawsuits involving a defunct planned community that was to be developed on what proved to be a part of a world war 2 bombing practice range. The defendants include the project developer, the bond underwriter, bond counsel, the district established to issue the bonds, the appraiser, the title company and the seller of the property.

Several motions for summary judgment were recently decided by the federal district court for the eastern district of Louisiana. Coves of the Highland Community Development District v McGlinchey Stafford, 2011 U.S. Dist. LEXIS 109187 (E.D.LA. 9/26/11); SCB Diversified Municipal Portfolio v Crews & Associates, 2011 U.S. Dist. LEXIS 136177 (E.D.LA 11/28/11) and SCB Diversified Municipal Portfolio v Crews & Associates, 2011 U.S. Dist. LEXIS 141987 (E.D.La. 12/9/11). A third related case, MGD Partners v First American Title Insurance Company, 2011 U.S. Dist. LEXIS 18699 (E.D.La 09/08/11), was recently dismissed and will not be discussed in this post. The Cove of the Highland Community Development District is scheduled to go to trial in January while the SCB trial is scheduled for February.

Common Facts

In March of 2006, MGD Partners (“MGD”) purchased 324 acres of real property (the “Property”) inTangipahoa Parish,Louisianato build a planned residential community known as The Coves of theHighland(the Project”). MGD did not perform a phase 1 environmental site assessment (Phase 1 ESA). A MGD partner testified in a deposition that he did not order a phase 1 ESA because he had lived in the area and the property had timber or farmland for all his life. He did say that he was aware that there had been a World War 2 practice bombing and gunnery range in the area but believed it was about a mile to the east of the Project. Moreover, the title abstract indicated that the practice range was on a different parcel. In addition, the bank that financed the acquisition of the property, First Guaranty Bank, did not require a Phase 1 ESA.

In June 2006, MGD retained Defendant McGlinchey Stafford (McGlinchey) to a special municipal district known as the Coves of the Highland Community Development District (the “District). The purpose of the District was to finance and manage the Project infrastructure. MGD transferred title to the District who then issued tax-exempt bonds to finance certain infrastructure improvements such as roads, utilities and sewers. The District had five board of supervisors. Three of the board supervisors were partners of MGD. The other two board members were the attorney who served as the District’s general counsel and the consulting engineer for the Project.

On November 1, 2006, the District entered into a Development Agreement with MGD to facilitate development approvals and infrastructure financing. MGD represented there were no violations of any Environmental Laws or any material environmental claims affecting the property. MGD also agreed in section 3.10(b) that it would take all remedial actions necessary to clean up or remove of any hazardous materials discovered on the Property.

The District also entered into a Master Trust Indenture with Regions Bank, as trustee, for the issuance of up to $30MM in tax exempt bonds. Defendant Crews and Associates (“Crews”) was the underwriter of the bonds to be issued by the District. Crews worked with MGD to assemble a 480-page “Due Diligence Binder” to support the bond offering. To develop this binder, Crews gave MGD a “Due Diligence Checklist”.

The District issued $7.695MM in bonds that were sold through a prospectus called a ‘Preliminary Limited Offering Memorandum (“PLOM”) and a “Limited Offering Memorandum” (“LOM”). Bond investors typically use the PLOM to make purchase decisions with the bond pricing left blank. After the bond purchases are confirmed, the LOM is then issued with the only changes typically being the pricing information.

Defendant Breazeale, Sachse & Wilson (“BSW”) prepared both the PLOM and the LOM. The PLOM contained a paragraph titled “Development” that stated the developer had provided a number of documents including a Phase 1 ESA. This paragraph also stated that although the information furnished was believed to be reliable, “the neither District, the Underwriter nor their counsel have independently verified the information provided by such parties.” The PLOM also had a section title “Phase 1 Environmental Site Assessment” that stated a phase 1 with the date left blank had been performed and no RECs had been identified. When the LOM was issued, the phase 1 section had been deleted but the “Development” section still stated that a phase 1 had been one of the documents furnished by the developers. BSW issued an opinion letter to Crews stating that the firm was not aware of any information that caused it to believe that the LOM contained any untrue statement of material fact or omits to state any material fact.  The LOM also contained the standard bold boilerplate that investors should not rely on any investigations by any party to the transaction

Greystone Valuation Services (“Greystone”) was retained by MGD to prepare a feasibility study known as a marketing study which was attached as an appendix to the LOM. McGlinchey issued Bond Counsel Opinion, Supplemental Opinion and opinion to the District. The opinions were delivered on November 16, 2006, the date of the closing of the issuance, sale and delivery of the Bonds.

Crews purchased the bonds pursuant to bond purchase agreement drafted by McGlinchey. Crews then sold the bonds to several series of the Sanford C. Bernstein Fund Diversified Municipal Portfolio (“SCB”), a municipal mutual fund for the face amount of the Bonds. In connection with the SCB closing, BSW issued an opinion letter to Crews stating that the LOM did not contain any misrepresentations or omissions of facts.

Discovery of the Former Bombing Range

As it turns out, the property was part of the Former Hammond Bombing andGunneryRange(“HBGR”) that the federal government had leased from 1942 to 1945. The 1943 deed expressly stated that the property was being leased to the United States Army Air Corp for “a practice bombing and gunnery range.” The HBGR was subsequently designated as a “Formerly Used Defense Site” (“FUDS”) and in 1995 the Army Corps of Engineers (“Corps”) conducted an assessment to determine if the site was eligible for funding under the Defense Environmental Restoration Program for Formerly Used Defense Sites (DERP-FUDS). The inspection revealed physical evidence of ordnance and explosive waste consisting of old bomb craters and pieces of shrapnel. The Corps also concluded the existence of bomb craters suggested a high probability of buried unexploded ordnance (“UXO”) as well as munitions and explosives of concern (“MEC”) on the HBGR. In August 1996, the Corps determined the site was eligible for DERP-FUDS inclusion, based on the likely presence of UXO and MEC. In 1996, a local historian wrote a book “Hammond Army Air Field and Early Aviation in the Hammond Area” which contained extensive detail about the HBGR and interviews with former military personnel who had used the HBGR. Indeed, the Corps used this book to locate some of the target areas.

After Sept. 11, 2001, Congress took a particular interest in the approximately 10,000 FUDs across the country because their potential for terrorist activity. In connection with this initiative, the Corps returned to the HBGR in 2002 and performed an extensive physical, historical and risk assessment analysis. The results were published in the March 2003 Archives Search Report for the formerHammondBombingRange(“2003 ASR”).

In 2005, the Corps issued a contract to Parsons Infrastructures and Technology Group, Inc. (“Parsons”) to conduct a Site Inspection at the HBGR to further define the scope and extent of munitions, including any UXO and MEC, remaining on or at the HBGR, and to determine what, if any, further action would be required to remove this material from the HBGR. Parsons issued a draft report in December 2008 which showed that the Project was located within the HBGR.

By the spring of 2009, the District had completed the 120-acre phase 1 of the Project consisting of 264 home lots, installed streets, street lights, sewer and water lines, eight acres of ponds, and a one acre sewage plant that was capable of serving 2500 homes. MGD was preparing to close on $2.5MM in lot sales when the Corps published a public notice in the local newspaper advising of the results of the site inspection. The study contained maps showing that a portion of the Project was located within the outer boundary of the former strafing target area, rifle range, multiple use target area, and three of the five munitions response sites located within the HBGR. The Corps said that the munitions used at the HBGR included 100-pound general purpose bombs, 100-pound practice bombs, 100-pound concrete practice bombs, 2.25” practice rockets, spotting charges, .50-caliber machine gun ammunition, 3-pound practice bombs, 4.5-pound practice bombs and general arms ammunition. The Corps indicated that it would probably not begin remediation work until 2030 depending on Congressional funding.

Following publication of the notice, the Tangipahoa Parish Engineer issued a building moratorium until the risk of UXO and MEC contamination had been fully investigated and remediated. As a result, development of the Project ceased, the lots could not be sold and the District defaulted since the bond payments were to be funded from assessments. There were also allegations in the briefing for the various motions that the Project had been encountering financial difficulties. Reportedly, MGD as well as its principals had to borrower an additional $1.3MM in late 2008 money to fund the work. In 2009, MGD allegedly was behind on its assessment payments, interest payment for the bonds and an installment payment on a promissory note for land that was to be used for the other phases of the Project.

The District Litigation

After the District defaulted on the Bonds, the District filed a lawsuit against McGlinchey and BSW alleging violations of federal securities law and state claims for professional malpractice The District said that under the bond offering documents and CERCLA, the District and MGD were obligated to remediate the property at an estimated cost of $1,3MM

Specifically the District argued that as its bond counsel, McGlinchey had strict “due diligence” duties to conduct a reasonable investigation into the facts supporting its opinion letters, including performing basic environmental due diligence. The District also claimed McGlinchey had failed to alert its client’s attention that the LOM inferred that the Developer had obtained a Phase I ESA when in fact no such environmental site assessment had been performed. As a result, the District said the LOM was misleading and subjected it to securities litigation with the bond purchasers. The District also asserted that McGlinchey had a duty to review the abstract of title obtained by its general counsel or should have ordered its own abstract of title.

McGlinchey filed a motion to dismiss and in 2010 arguing as bond counsel it had no obligation to investigate environmental issues and that its engagement letter expressly stated that the firm would be relying on information provided by the District and MGD. In an October 2010 opinion, the court noted that documents such as the engagement letter outlining the scope of the firm’s services seemed to contradict or undermine the District’s allegations. While concluding that the allegations raised sufficient questions to defeat a motion to dismiss, the court said it was skeptical of the alleged expanded scope of the law firm’s representation. Therefore, the court said it would welcome an appropriately-supported motion for summary judgment after sufficient discovery had been completed.

The law firm also argued that the complaint that had been filed on November 10, 2009 was barred by the three-year statute of limitations. The court agreed that any claims relating to any alleged misrepresentations, errors, omissions, or misstatements of fact upon by McGlinchey that the District relied on to its detriment that occurred prior to November 10, 2006 were barred.

The District then sought permission from the court to file an amended complaint to clarify the misstatements, misrepresentations or omissions committed by McGlinchey that had been learned during discovery. However, the court denied this motion. Coves of the Highland Community Development District v McGlinchey Stafford, 2011 U.S. Dist. LEXIS 109187 (E.D.LA. 9/26/11)

The District also alleged that BSW committed legal malpractice when it (1) failed to advise the District that its bond offering memorandum referenced the Environmental Phase 1 study; (2) did not advise the District that this reference to an Environmental Phase 1 study amounted to a representation that an Environmental Phase 1 study had been performed; (3) failed to disclose to the District that an Environmental Phase 1 study had not been completed; (4) did not remove reference to the Environmental Phase 1 study in the LOM; and (5) did not advise the Plaintiff that an Environmental Phase 1 study should have been performed to protect against unknown conditions associated with the property that may delay the development or affect the Plaintiff’s ability to meet its debt obligations. The District also stated that the firm had a “duty” to evaluate the Plaintiff’s bond offering memorandum, disclose the terms of the memorandum, and advise the Plaintiff about the possible consequences of the memorandum.

SCB Litigation

SCB filed a complaint against the District, Crews and Greystone, alleging the LOM was also misleading because it failed to disclose the UXO and MEC contamination risks affecting the Property. SCB asserted the defendants had strict due diligence obligations in connection with the bonds that included environmental due diligence.

SCB Claims Against BSW

Specifically, SCB charged BSW with negligent misrepresentation for (1) failing to reveal relevant facts relating to the proximity of the HBGR to the Project; (2) failing to reveal that a Phase I Environmental Site Assessment had not been conducted on the property; (3) drafting the PLOM and LOM which allegedly contained misleading statements regarding a Phase I Environmental Site Assessment;” and (4) issuing an opinion letter to Crews which states that the PLOM and LOM did not contain misrepresentations or omissions of facts.

BSW filed a motion for summary judgment. The court said that even if it assumed BSW had a duty of disclosure and breached that duty, SCB have failed to establish justifiable reliance on any alleged misrepresentation. The court said SCB was essentially claiming that its financial analyst interpreted the reference to the section captioned “Phase I Environmental Site Assessment” meant a Phase I ESA had been performed on the Property and relied upon that statement in making the decision to purchase the Bonds. However, the court noted that SCB’s financial analyst who read the PLOM had testified that he had failed to notice that the caption “Phase I Site Assessment” was missing from the LOM. Since he was the only SCB representative who read the PLOM, the court ruled that SCB could not claim reliance on this alleged misrepresentation by BSW.

SCB also argued that BSW made misrepresentations in its opinion letter that the PLOM did not contain any misrepresentation or omission of material fact. However, the court said even assuming BSW had a duty of disclosure and breached this duty by making misrepresentations or omitting material facts in its opinion letter, SCB had not presented any evidence of justifiable reliance. In particular, the court noted that SCB’s financial analyst testified in his deposition that SCB did not rely on the opinion letter in purchasing the Coves Bonds. Accordingly, summary judgment was granted to BSW. SCB Diversified Municipal Portfolio v Crews & Associates, 2011 U.S. Dist. LEXIS 141987 (E.D.La. 12/9/11)

SCB Claims Against Greystone

SCB asserted claims against Greystone for negligent misrepresentation for failing to conduct an environmental investigation. SCB also argued that as a certified and licensed real estate appraiser, Greystone had a duty to obtain and review a title search to determine any historical issues regarding environmental contamination

The Marketability Study stated that was “a comprehensive analysis and review” of forces affecting the Project including “environmental (physical) and governmental features of the defined market area. SCB alleged that Greystone had a duty to discover and disclose the lack of a Phase I Environmental Site Assessment; had breached that duty; and that SCB had relied on such statements when it decided to purchase the Bonds.

In Greystone’s motion for summary judgment, the court said that SCB had failed to identify any source of law that could impose upon Greystone a duty to obtain an environmental assessment or to disclose is absence. Even assuming that Greystone had a legal duty, the Court said, Greystone did not breach that duty. The court said there was no mention of any environmental assessment in Greystone’s report. Moreover, the court said the Marketability Study contained several “Underlying Assumptions and Conditions” that make clear that the analysis was based on the Property being in full compliance with all applicable environmental and laws unless stated otherwise. Moreover, SCB’s financial analyst testified that he did not rely on the Greystone’s study. The court said it was undisputed that the SCB financial analyst understood from the PLOM that any Phase 1 ESA was supplied by the developers and not from any other source. Because SCB could not demonstrate justifiable reliance on the Greystone study regarding the existence of a Phase I Environmental Site Assessment, the court granted Greystone’s motion for summary judgment. SCB Diversified Municipal Portfolio v Crews & Associates, 2011 U.S. Dist. LEXIS 136177 (E.D.LA 11/28/11)

SCB Claims Against Crews

SCB asserts the LOM was misleading because it failed to disclose the Project was located on the HBGR and may contain UXO and MEC. Crews failed to disclose the above alleged material facts. SCB alleges that as the underwriter, Crews had a duty to inquire into the accuracy, truthfulness and completeness of the key representations of the District and had a duty to exercise reasonable care by conducting due diligence to investigate and disclose all material facts surrounding the issuance of the bonds. In particular, SCB claims that Crews had a duty to conduct basic environmental due diligence as to potential environmental contamination of the Project. SCB claims Crews knowingly and recklessly failed to verify or inquire into whether there was any basis for this representation even though a Phase I Environmental Study is a basic component of due diligence on a real estate transaction of this size. Crews has filed a summary judgment motion but the court has not yet decided the motion.

This case is just one of a number of high cases involving residential developments that were unknowingly constructed on former bombing practice ranges. In some instances, the parties were aware that a former bombing range had been located in the vicinity of the development but the developments were not close enough to the target areas to represent a significant risk. The underlying assumption in those decisions was that all of the bombs fell on the intended target. Given that these were PRACTICE ranges for new pilots, one has to wonder why the developers and their engineers assumed all of the bombs fell on the “x”! Discussions of the other cases are available from our Archived Posts.

It is also interesting that the District was dominated by the developer who made the decision not to conduct environmental due diligence. Call my cynical but it does seem somewhat repugnant that the District is trying to blame professional service providers who do not normally deal with environmental issues for the negligence of its own members.

Update on McGlinchey Lawsuit

In January, the court granted summary judgment to McGlinchey. The court said that the terms of the engagement letter provided that McGlinchey’s role in the venture was limited to assisting Plaintiff in its formation under Louisiana law and in issuing bonds. The court said the firm’s review of the PLOM did notinclude the section regarding the development, which is where the mention of a Phase I Environmental Site Assessment is located.

The court also rejected the District’s claim that McGlinchey had violated the rules of professional conduct for attorneys by limiting its representation without obtaining informed consent to such limited representation. The District had introduced expert testimony that any attorney representing, in any capacity, a client who is engaged in developing real estate must advise a client about the need for environmental reviews. However, the court said this  standard of practice was too broad, finding that environmental issues are outside the scope of bond counsel’s traditional role in municipal finance transactions. Since environmental due diligence was not in the scope of McGlinchey’s duty to Plaintiff, McGlinchey did not commit legal malpractice by reviewing the PLOM and failing to notice the mention of a Phase I Environmental Site Assessment-especially in this case where McGlinchey was retained after the client had acquired the property.

Of some concern to real estate lawyers, though, was the court suggestion that attorneys working on real property acquisitions would most likely have a duty to advise a client regarding environmental issues but this duty didnot extend to every attorney who comes into contact with a client developing real estate. SCB Diversified Mun. Portfolio v. Crews & Assocs 2012 U.S. Dist. LEXIS 754  (E.D.La. 1/4/12)