Contamination at Heart of Litigation Over Failed Subdivisions

The Great Recession caused hundreds of residential development projects to ground to a halt. Not surprising, these failed projects have spawned lots of litigation. An interesting Maryland lawsuit involves allegations of fraud and misrepresentation of environmental issues at a development site, and has ensnarled a foreclosing lender.

In U.S. Home v Settler’s Crossing, 2010 U.S. Dist. LEXIS 22653 (D. Md. 3/11/10), U.S. Home (USH) entered into a $134MM Purchase Agreement with Settlers Crossing, L.L.C. (“Settlers”) and Washington Park Estates, LLC (WPE) in November 2005. The agreement provided that USH would acquire membership interests of WPE, which owned approximately 1,250 acres of undeveloped land Prince George’s County, Maryland that had been formerly farmland. Simultaneously, USH also entered into a Contract for Services (“Services Contract”) with the Bevard Development Company (“Bevard”) to conduct development activities as well as to obtain certain approvals and entitlements for the Property. The agreements required USH to make a $16MM deposit under the Purchase Agreement and a $ 4MM Development Fee deposit for the Services Contract.

Section 12.2(d) of the purchase agreement provided that “to the best of Seller’s knowledge” and “except as disclosed in environmental reports” provided to the purchaser, there were no Hazardous Materials located at the property and that the property had not been used to store or dispose of Hazardous Materials. Section 13(a) of the agreement also provided that USH would have the right through November 18, 2007 (“feasibility period”) to conduct investigations, studies and tests as the Purchaser deemed necessary or appropriate. This provision also stated that purchaser was given copies of all “environmental reports” and other studies prepared by third parties for the Property. At the conclusion of the feasibility period, any further access to the property would be subject to approval of WPE.

In March 2007, Settlers Crossing claimed that all conditions precedent were satisfied, thereby allowing the parties to schedule a closing date. USH responded with a Notice of Termination March 30, 2007 based upon the failure of conditions precedent. In particular, USH raised delays in obtaining zoning approvals. The parties resolved their dispute by entering into an amendment of the purchase agreement that also reduced purchase price and extended the closing to December 5, 2007.

Meanwhile, WPE obtained replacement financing in the amount of $100MM from iStar Financial Incorporated (“iStar”) in June 2007. The financing was a one-year bridge loan intended to be repaid at the closing. The parties executed another amendment to the purchase agreement to facilitate the bridge loan.

After completing its due diligence, USH made a deposit of $20MM, consisting of $16MM deposit and $4MM for the services. The parties then set an initial closing date of December 5, 2007. However, if any conditions precedent were unsatisfied as of the closing date, the settlement date would automatically be extended to 30 days after all conditions precedent were satisfied but no later than March 15, 2009.

In November 2007, USH notified Settlers Crossing and WPE that certain conditions precedent had not been satisfied and invoked the automatic 30-day extension. The Sellers responded with a lawsuit seeking declaratory judgment on what conditions precedent remained unsatisfied. On January 3, 2008, US Home requested permission to inspect the property pursuant to Section 13(a) because it had concerns about the environmental condition of the Property. WPE denied this request for access.

As it turns out, USH learned sometime in early 2008 from public records that a portion of the property had been used to dispose sewage sludge from 1975 to at least 1989. When USH repeated its access request in March 2008, WPE again denied the request. The Sellers then set a closing date of May 26, 2008.

USH objected to the closing date on grounds that it still had not been granted access to inspect the Property. USH then tendered a Notice of Default based on Sellers’ refusal to permit an inspection. USH followed the default notice with another letter advising Seller that because certain conditions precedent remained unsatisfied, it was not obligated to proceed to settlement on May 27, 2008. After the sellers tendered their own notice of default, USH sent a notice of termination based on failure to provide access as set forth in Section 13(a).

USH then filed a lawsuit asserted several contract-related claims, including breach of environmental representations and warranties, fraudulent inducement, and fraud by concealment. USH also asserted that by denying access, Sellers were also preventing USH from satisfying the requirements of EPA’s All Appropriate Inquiries (AAI) rule. At some point, IStar foreclosed on the property. In the ensuing litigation, IStar filed its own claim for specific performance.

USH based both of its fraud claims on the representations of § 12.2(d). While the USH complaint acknowledged that the sludge disposal had been allowed by the Maryland Department of the Environment (MDE), USH asserted that the sewage sludge was a “Hazardous Material” within the meaning of the Agreement. USH asserted that the Sellers owed a duty to ensure the truthfulness of all warranties in the Agreement. USH claimed that the Sellers intentionally and knowingly misrepresented and warranted that the Property had never been used for the disposal of Hazardous Materials, and that it relied on the representations when it executed the Purchase Agreement.

The Sellers sought dismissal of the fraud claims on the grounds that any reliance by USH would have been unreasonable because the rep was limited Sellers knowledge and the enclosed documents. Moreover, the sellers argued that USH was a sophisticated homebuilder who should have known from the environmental reports it received that the Sellers had never tested portions of the property’s soil or groundwater to confirm where Hazardous Materials were located. In addition, Sellers claimed that USH knew that soil and gravel operations had been previously conducted at the property and that USH had failed to take any of its own samples during the Feasibility Period. Sellers also argued that the fraud counts were barred by the Maryland statute of limitations.

On the statute of limitations, issue the court said was not obvious from the face of the complaint when USH had adequate knowledge of the alleged fraud and that the parties disagreed over when USH should be deemed to have acquired the knowledge necessary for the clock to start running, with the sellers claiming the tolling period should have started to run the day the Purchase Agreement was executed (November, 15, 2005) while USH stating that it did not have knowledge until 2008. Because the complaint alleged that the fraudulent conduct continued well into 2008, the district court denied the defendant’s motion to dismiss.

The sellers also argued that the fraud claim did not meet the heightened pleading requirements. In a fraud case, a plaintiff must prove either that the defendant had a duty to disclose a material fact to them and failed to do so, or that the defendant concealed a material fact for the purpose of defrauding the plaintiff. The court said that USH was arguing that Seller omitted important facts about the sludge disposal in its representations and did so with the intent to defraud USH. Because the Sellers were aware of the factual basis of the USH claims and the precedent of the United States Court of Appeals for the Fourth Circuit cautioned against dismissal of complaints under such circumstances, the district court denied the motion to dismiss

On the breach of contract claim based on the reps and warranties, USH asserted that the public records gave actual or constructive knowledge of the prior sludge disposal activities. Sellers responded that USH had not alleged that the Sellers possessed the alleged MDE records, knew the records existed or was aware of the information contained in them, that Sellers had any obligation to know about them or that the Sellers prevented USH from obtaining the public records sooner. However, the court ruled that because it was possible that USH could prove at some point that the best of Seller’s knowledge included information about the sludge disposal operation.

USH also argued that the Sellers had no standing to bring their claims because they had assigned all their rights under the Purchase Agreement to iStar and IStar had foreclosed on the property. The court said there was no dispute that an event of default had occurred under the loan agreement and that IStar could exercise all rights it had under the loan agreement. However, the court said since it had yet to determine the rights under the Purchase Agreement, it would be more efficient to resolve who could enforce rights under the Purchase Agreement. Likewise, in response to USH’s motion to dismiss iStar’s counter-claim for specific performance and declaratory judgment, the court denied these motions on grounds that these claims were closely tied to the issues in the main litigation and should be resolved all at once.

The Fourth Circuit affirmed in Settlers Crossing, L.L.C. v. U.S. Home Corp (4th Cir. 6/16/10). Since that decision, the parties have been engaged in discovery and various discovery-related motions that primarily involve IStar and USH’s parent corporation, Lennar Corporation.


In another failed Maryland development, USH filed another lawsuit alleging that the seller failed to disclose contamination from an adjacent trap shooting range in U.S. Home Corp. v. Powers, 2010 U.S. Dist. LEXIS 28514 (D. Md. 3/25/10). This case had very similar facts to the Settlers Crossing case and involved similar claims but was eventually settled.

In the Powers litigation, USH entered into a purchase agreement with M&J Capital (M&J) in July 2005 to acquire all of the membership interests of Eldersburg Ventures (Eldersburg) for $16.125MM. Eldersburg owned approximately 68.7 acres of land in Carroll County, Maryland that USH planned to construct a (the Property). The agreement provided that USH would have a 45-day feasibility period to conduct due diligence. In addition, M&J represented, inter alia, that it had no knowledge of any hazardous materials on the Property that would subject USH to liability under federal or state law (the Hazardous Materials Warranty). The agreement also provided that all representations and warranties would be true and correct as of the closing date. The agreement contained a survival clause providing that the Hazardous Materials warranty would extend for one year from the closing, and that any claims for a breach of the Hazardous Materials warranty would have to be brought within six months of discovery. Thus, the maximum period for bring a claim under the Hazardous Materials warranty would have been 18 months. The transaction closed in June 2006

In June 2009, USH obtained information that a substantial portion of the Property was contaminated with lead, arsenic, and other hazardous materials and filed a complaint seeking rescission of the agreement and damages based on breach of contract, fraudulent inducement and negligent misrepresentation. According to the complaint, the principals of M&J, Mark and Jeffery Powers, were informed by Carroll Country in May and August 2005 that a portion of the Property was likely contaminated by the prior adjacent trap shooting range. Specifically, USH alleged that the Planning and Zoning Commission provided Powers with minutes of an August meeting and a letter from a local property owner that it was not possible to grow crops on some of the lots comprising the Property because of the presence of lead.

Defendants moved to dismiss the complaint on grounds that its was filed 3 ½ years after the closing date and thus beyond the survival period. The defendants also argued that the Powers could not be held liable individually because any statements made by them were made solely in their capacity as officers of M&J, and M&J had no independent duty of disclosure outside the agreement.

At the heart of the USH claim was that survival clause operated to imposed an on-going representation and an affirmative duty on M&J to disclose any information it learned for one year post-closing regarding hazardous materials on the Property. USH then argued it had to file suit within six months of the discovery of a breach, regardless if discovered the breach during or after the one-year post-closing period. Effectively, USH contended the only possible bar to a breach of contract action was that it had to file a claim within six months of discovery.

The court agreed with the defendants, holding that nothing in the agreement suggested that the representations would continue to be made after the closing date. The court said that absent the survival language, USH would have been precluded from bringing a breach of warranty or representation claim because any warranty or representation would have merged into the deed and ceased to exist. Instead of imposing an affirmative post-closing obligation on M&J, the court explained, the survival language extended preserved the warranties and representations to allow USH an additional, post-closing time period to detect and make a claim for breach. The court also said this interpretation was consistent with other provisions of the agreement that addressed the timing of the warranties and representations. For example, the court pointed to the “Seller’s Default” clause in Section 10 that provided measured the accuracy of M&J’s warranties and representations at both the execution of the Agreement and at closing. This language protected the buyer during the 11-month period between execution of the Agreement and closing, a period during which the seller’s state of knowledge may change.

The court also pointed out that the indemnification language of section 12 provided that M&J must indemnify USH for a claim made by a third party based on one of the warranties in the Agreement if the claim is made during the survival period specified for that particular warranty. The court said that limiting the time during which an indemnification claim may be brought was consistent with the purpose of the survival clause because, while it protects the buyer by preventing these claims from dying upon closing, it allows the seller to limit its potential liability to a finite time period and better allows the seller to evaluate its potential risk as part of the transaction. Since the Hazardous Materials warranty expired on June 30, 2007 and USH did not allege that it detected a potential breach until June 19, 2009, the court ruled that the breach of contract claim was time barred.

On the claim for fraudulent inducement and negligent misrepresentation, the court distinguished the survival clause in the agreement from those cited by the defendants where the clauses encompassed ” any and all claims. By contrast, the survival clause in this case was narrowly drafted to apply only to contractual warranties and representations. Thus, the court ruled that the claims for fraudulent inducement and negligent misrepresentation were not time barred. However, the court then went on to hold that the complaint failed to comply with the heighten pleadings requirements for fraud claims. Thus, court dismissed the fraudulent inducement claims against the Powers as individuals.

On the claim for negligent misrepresentation, the court found that the allegations that the Powers obtained personal knowledge of the contamination through attendance at public hearings and through receipt of correspondence, that they had such knowledge prior to execution of the Agreement and prior to reassertion of the warranties and representations at closing were sufficient against the Power defendants to survive a motion to dismiss.

The defendants also argued that M&J under the doctrine of caveat emptor to disclose material facts. However, the court said that a duty might be created if a party makes “an active misstatement of fact, or only a partial or fragmentary statement of fact, which misled the purchaser to his inquiry. The court noted that the USH complaint alleged that M&J breached a duty because the agreement contained an affirmative statement that M&J had no knowledge regarding the presence of hazardous materials on the Property. Furthermore, the complaint alleged that M&J did have such knowledge and failed to inform USH. The court said these allegations are analogous to the active misstatements and denied the defendants motion to dismiss on this ground.

Environmental compliance issues can often arise when demolition or constructed projects are halted before work is completed. These potential liabilities are not limited to developers but can also extend to foreclosing lenders. (See our post Foreclosing Lenders May Be Subject To Stormwater and Dust Violations).

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