Fifth Circuit Affirms Dismissal of Bond Counsel in Bombing Range Case While Other Parties Settle

We have previously discussed the complex litigation involving a planned development on a portion of a World War 2 bombing range in Louisiana . In the latest installment of this saga, the Court of Appeals for the Fifth Circuit affirmed the dismissal of a legal malpractice claim filed against bond counsel in Coves of the Highland Community Development District, v. McGlinchey Stafford, PLLC , 2013 U.S. App. LEXIS 9306 (5th Cir. 5/7/13). As previously discussed, MGD Partners, LLC (MGD) purchased 324 acres of timberland near the City of Hammond in March 2006 to develop a residential subdivision. The three principals of MGD were experienced real estate professional. Indeed, Carson Davis (the “D” on MGD) testified in his deposition that he had been that he was intimately familiar with the area, having hunting on the development parcel has a young man.

MGD retained Magnolia Title to perform a title search on the property and render a title opinion. A title abstract showed that a different parcel of land had once been leased to the U.S. Government for a practice bombing and gunnery range known as the Hammond Bombing and Gunnery Range (HBGR). While Mr. Davis had ordered phase 1 reports for other development projects in the area, he testified at his deposition that he did not think a Phase I was necessary for the development parcel because it had only been used as timberland and a dairy farm. Mr. Davis said he was aware that there had been an old WWII bombing range in the area but had believed it had been two or three miles from the development parcel. Moreover, he had never heard of anyone being hurt or of any explosions on the development property. As a result, MGD did not perform a pre-acquisition phase 1. Likewise, the bank that financed the purchase, the First National Guarantee Bank, also did not require a phase 1 report.

MGD formed the Coves of the Highland Community Development District (District) to issue community development district bonds to fund the development. The District Board of Supervisors included the three MGD principals, the attorney that owned Magnolia Title and served as District general counsel and William Bodin, who served as the District consulting engineer and Board Chair.

MGD then entered into a Development Agreement with the District. The development agreement provided in part that MGD would “promptly take and diligently prosecute any and all necessary remedial actions upon obtaining knowledge of the presence, storage use, disposal, transportation, active or passive migration, release or discharge of any Hazardous Materials on, under or about any District lands in violation of any Environmental Laws.” MGD also agreed to “take all remedial action to clean up and remove any matter from any District lands event of a government investigation where the investigation could have a material adverse effect on the project.”

The District retained Crews and Associates (Crews) as bond underwriter. Crews provided MGD with a “Due Diligence Checklist” requesting certain information about the project including the history of the land, adjacent land uses, the development plans, and permits/ and approvals required for the project. MGD and the District provided Crews with a 267-page “due diligence binder” to provide to potential bond purchasers.

The District also retained Breazeale, Sachse & Wilson L.L.P. (Breazeale) to serve as underwriter’s counsel. In connection with its assignment, Breazeale issued an opinion letter to the Crews and prepared the Preliminary Limited Offering Memorandum (PLOM) as well as the final Limited Offering Memorandum (LOM). The PLOM initially included a “placeholder” stating that a Phase I had been performed but the LOM did not have any section discussing a Phase 1. It turns out that Breazeale had used a form another deal when it drafted the PLOM and caught the mistake before the LOM was issued. Mr. Bodin signed the LOM in his capacity as the Chairman of the District’ Board of Supervisors. The other MGD principals testified that they did not carefully review drafts of the PLOM and the LOM.

MGD entered  into a Master  Trust Indenture  dated November  1, 2006 (Indenture) with Regions  Bank, as trustee,  for the issuance of up to $30MM  of  “Coves   of  the  Highland   Community   Development   District,  Parish   of Tangipahoa,  State  of  Louisiana  Special  Assessment  Bonds  Series  2006” (Bonds).  It should be noted that as part of the Indenture, Regions Bank had the right to require District to provide evidence that the project was not contaminated by hazardous substances but failed to do so. In addition, Regions Bank also had the right to use and expend funds to conduct environmental   assessments   and/or remediate   any environmental   hazard but failed to exercise this right.

The District initially issued approximately $7.695MM in Bonds to fund certain infrastructure improvements for the Project, including surface water management and control systems, drinking water and wastewater infrastructure and roadwork. SCB Diversified Municipal Portfolio (SCB) purchased the bonds. The proceeds of the bond sale were also to be used to provide funds for capitalized interest on the Bonds, the funding of a debt service reserve account, and payment of the cost of issuance of the Bonds. The bonds were to be paid back through assessments on each lot.  To further finance the construction of the subdivision, MGD borrowed an additional $1.7 million from the First National Guarantee Bank that was secured by a first mortgage on MGD’s property as well as a lien on the assessments on the 264 lots that was junior to the bond holders. The loan was guaranteed by principals of MGD.

As as part of that initial bond issuance, the McGlinchey law firm issued three legal opinions in its capacity as bond counsel.  The first opinion letter addressed the validity and binding effect of the Bonds, the source of payment and security for the Bonds, and the excludability of interest on the Bonds from federal and Louisiana income taxes. The second opinion letter addressed to the District, Regions Bank, and Crews, stated that McGlinchey reviewed certain portions of the LOM and that those sections contained a fair and accurate summary of certain legal provisions and instruments. This opinion expressly excluded those portions of the LOM that discussed the Property and its development. The third opinion letter was addressed to the District addressed the formation of the District, the validity of the Bonds, the District’s ability to enter into the Indenture, the source of payment and security for the Bonds, and the excludability of interest on the Bonds from federal and Louisiana income taxes.

In connection with the bond issuance, the consulting engineers, Bodin & Webb (B&W), prepared a Certificate of Engineer that certified that the information contained in the PLOM and LOM under the caption “THE DEVELOPMENT” did not contain any untrue statements of material facts and did not omit any material facts. The B&W certification also stated that “all governmental approvals required to complete the acquisition and installation of the Series 2006 Project have been obtained or are obtainable in due course.”Exhibit “A” to the certificate also indicated that the consulting engineer (or MGD) planned on hiring a third party to perform a soil investigation.

By early 2009, MGD had laid out 264 home lots in the first 81.3-acre parcel of the Property, installed streets, street lights, sewer and water lines, 8 acres of ponds. MGD also constructed a 1-acre sewage treatment plant capable of processing waste for 2500 homes. The cash outlay for those improvements totaled approximately $10MM while the District had pre-sold approximately $2 million in lots to home builders.

However, in March 2009, the U.S. Army Corps of Engineers (Corps) published a notice in the Hammond newspaper announcing that a copy of a December 2008 Draft Site Inspection Report (Inspection Report) of the former Hammond Bombing and Gunnery Range (HBGR) had been placed in the local library. The Inspection Report discussed the results of prior investigations, stated that there was a potential for unexploded ordnance (UXO) along with munitions and explosives of concern (MEC) and that the HBGR had been designated as a Formerly Used Defense Site (FUDS). As it turned out, the Corps had conducted a FUDS eligibility assessment in February 1995 site visit and had observed physical evidence of ordnance and explosive waste at the HBGR consisting of old bomb craters and pieces of shrapnel. The Corps had concluded the existence of bomb craters suggested a high probability of buried UXO in the area and recommended further investigation for buried or hidden UXO.  The Corps published an extensive physical, historical and risk assessment analysis in a March 2003 Archives Search Report for the former Hammond Bombing Range (2003 ASR).

The Inspection report indicated that also revealed that the MGD development parcel was located within the southwestern portion of the HBGR but only a small portion of the MGD development site fell within the area of the HBGR that was deemed to pose some risk of the presence of explosives. Based on the relatively low ranking of the areas of concern on the MGD development site, the Corps estimated that funding would not be available to address the MGD parcel until 2030 or 2040. After being told Corps personnel about instances where children have been killed by exploding bombs at other FUD sites, the Tangipahoa Parish Engineer announced a building moratorium in April 2009. The Parish Engineer advised MGD that no additional building permits or approvals would be issued until the UXO and MEC had been fully investigated and remediated. First Guaranty Bank declined to fund the project completion costs. As a result, development of the Coves ground to a halt. The District subsequently defaulted on the Bonds.

The District and SCB subsequently filed a lawsuits against McGlinchey, Crews, Breazeale and the appraiser, Greystone Valuation Services, arguing they each had breached an obligation to ensure that an environmental site assessment (ESA) as part of its bond work. The District argued that Crews, Breazeale and McGlinchey had a duty to review or order a title abstract and failed to do so. Had they reviewed the abstract, they would have learned that the property’s proximity to the HBGR. The District also argued that as underwriter’s counsel, Breazeale had a duty to conduct or confirm the conduct of adequate due diligence with respect to the Bond Issuance, including environmental issues that might delay, impair or prevent development of the Property, and that that Breazeale’s LOM Breazeale was misleading because failed to disclose the risks related to the UXO and MEC contamination risks at or affecting the Property. The district court granted summary judgment to Breazeale and Greystone.  SCB and Crews eventually reached a settlement. SCB appealed the summary judgment granted to Breazeale to the Fifth Circuit but the parties apparently reached a settlement and SCB withdrew its appeal.

The District asserted that had McGlinchey had a duty to perform a phase 1 ESA and that had the firm performed this obligation, the UXO and MEC risks would been, disclosed or could have been remedied before the Bond Issuance, or the District could have elected never to issue the Bonds.  After discovery, McGlinchey filed a motion for summary judgment which the district court granted in January 2012. The district court ruled that the McGlinchey engagement letter did not establish any duty regarding environmental due diligence and that the extrinsic evidence proffered by District likewise failed to create a triable issue of material fact.

The McGlinchey engagement letter provided, in part, that “unless separately engaged, it is outside the scope of bond counsel’s duties to investigate matters relating to the real property encompassed within the boundaries of an assessment district beyond receiving evidence satisfactory to bond counsel as to the ownership of the property so that proper consents and notices may be given and received regarding formation of the district and assessment of the benefits.” The engagement letter also stated that “[McGlinchey] will render [its] legal opinion as bond counsel . . . regarding [inter alia] the source of payment and security for the Bonds.”

District said that the language in the engagement letter providing the firm would render an opinion regarding the “source of payment and security for the Bonds” imposed a duty on McGlinchey to perform environmental due diligence since the ultimate source for repayment of the community development district bonds was dependent on its ability to sell the subdivided lots. McGlinchey countered that the bonds were not secured by the real estate itself but rather by assessments that were to be levied against the subdivided lots, and cited other language in the Engagement Letter stating that McGlinchey would rely on District for “complete and timely information on all developments pertaining to the Bonds, including . . . matters relating to the security for the Bonds.”

The appeals court noted that the engagement letter did not expressly obligate McGlinchey to perform environmental due diligence or otherwise investigate the property’s former uses. Even if the silence of the engagement letter on environmental due diligence could be construed as being ambiguous as to whether the parties intended that McGlinchey perform environmental due diligence, the court said that the district court properly ruled that the extrinsic evidence introduced by District failed to create a genuine issue of material fact on the intent of the parties.

In so holding, the appeals court found that record indicated that MGD had already purchased the property when District retained McGlinchey as bond counsel and that McGlinchey did not represent District or MGD at the time of or in connection with MGD’s purchase of the property.  The court also noted the engagement letter provided that McGlinchey would rely on District to supply it with information regarding the development. In addition, the court pointed out that the LOM specifically stated that a Phase I Environmental Assessment had been performed by the consulting engineering, Bodin and Webb.

The appeals court rejected the District’s arguments that the district court erred in finding that the opinion letter submitted on behalf of the District from real estate attorney Sean Rafferty and excerpts from a Louisiana real estate treatise generated a fact issue as to McGlinchey’s alleged duty. The Rafferty opined that “an attorney representing a client intending to conduct a Louisiana commercial real estate development project has a professional duty to advise his client of the acute need to obtain appropriate environmental reviews of the project property” and that “[s]tandard environmental reviews disclose whether real property likely contain hazardous substances.” However, the appeals court noted, McGlinchey did not represent MGD in connection with the purchase of the property.

Accordingly, the court held that the summary judgment record confirmed that the parties had no intention for McGlinchey’s duty as bond counsel to extend to such matters and affirmed the ruling of the district court.

It should be noted that one of the district court rulings did have a potentially problematic passage for real estate lawyers that was not addressed by the Fifth Circuit. The district court suggested in what is considered dicta that attorneys working on real property acquisitions would most likely have a duty to advise a client regarding environmental issues but this duty did not 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).

Finally, it should be noted that the due diligence materials prepared by Bodin and Webb indicated that “[t]he land was previously used for agricultural purposes and forest land” and did not mention the property’s former use as part of the HBGR. And in what might be viewed as “credit bubble” underwriting, neither bank required any environmental due diligence.

The case is as interesting for the parties that were NOT sued. The District did not file a lawsuit against MGD whose three principals constituted a majority of the District’s Board of Supervisors. As discussed, the MGD did not relied on the local knowledge of Carsen Davis in not performing a phase 1. Usually, phase 1 reports may miss issued because they the consultants fail to interview locals with knowledge of the property. This may be one of those few instances where information from a local source undercut the due diligence process. The District also did not seek damages under its development agreement with MGD-again likely because MGD dominated the District Board. The District also failed to seek damages from the consulting engineers who helped prepared the diligence materials for the underwriter and failed to discuss potential concerns about HBGR and failed to identify the Corps’ prior FUDs studies. Of course, one of the principals of the consulting firm, William Bodin, was the chair of the District Board and also signed several key documents on behalf of the District.

In perhaps the ultimate act of desperation, the District filed a malpractice action against the law firm it retained to file malpractice actions against the various professionals that had advised the District on the grounds that the malpractice firm had to failing to timely file claims against some of the professional service providers. The litigation was dismissed by stipulation of the parties in July 2012. The plaintiffs seem to be trying to blame everyone else but themselves for their inadequate due diligence.

This case is just one example of subdivisions being constructed on former bombing ranges. Our threat “Home on the Bombing Range” have discussed some of these cases.  Prior posts have discussed our in our series Home on the Bombing Range. Another post  has discussed the liability of a developer for a subdivision where World War 2 ordnance was discovered by residents.

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