I often remind my clients that when it comes to the Fair Housing Act and Americans with Disabilities Act the adage “ignorance is bliss” does not apply. Last week’s decision from the Southern District of Mississippi, U.S. v. Dawn Properties, Inc. et al 2014 WL 5775324 (S.D. Miss. Nov. 6, 2014) is a reminder that ignorance may turn corporate liability into personal liability for managers or owners, and that time may not be enough to insure safety.
The underlying business deals were common in the real estate development business. An LLC, Ridgeland Construction One LLC, was created to develop an apartment complex. Construction was finished in 2000 and the LLC was merged into a Delaware LLC of the same name. It was then sold to a new group of investors. In 2006 the property was sold and, two years later, the LLC was dissolved. No one involved suspected that there might be FHA accessibility violations although it appears no survey was ever conducted to make sure.
In 2014, eight years after the sale and six years after the dissolution the Department of Justice sued everyone involved in the project, including the defunct LLC. Remember that while the 9th Circuit has held that limitations runs two years after the issuance of a certificate of occupancy, other circuits have not agreed. In any case, the LLC’s defense was based on ignorance. The LLC’s last managers — the investors who bought it — were not involved in construction and had no way of knowing the apartment complex was in violation of the FHA. This ignorance mattered because under Delaware Law, as under the law of most states, the managers of an LLC are required to reserve only for liabilities that are reasonably foreseeable. If they fail to reserve for such liabilities they may be personally liable. If, on the other hand, the liability could not be reasonably foreseen, they are home free.
The Court was having none of this argument based on ignorance. It wrote:
The Court finds that under Ridgeland’s own analysis, Ridgeland, as a developer of multi-family dwellings, should have reasonably anticipated claims, such as those resulting from the design and construction of those dwellings, just as a product manufacturer should reasonably anticipate claims resulting from the manufacture, sale and use of a product.
The fact that the new investor group was not around at the time of construction did not matter. The LLC had constructive knowledge of the alleged defects, and it was the LLC they bought.
The Court’s decision rests in significant part on a policy problem. Because FHA design/build liability attaches only to the original developer, subsequent owners generally escape any obligation to bring the property into compliance with the FHA. (see my blog of July 14, 2014). The government argued and the Court agreed that it was not acceptable for the original developer to:
escape liability for faulty design and construction by simply selling the subject property prior to any lawsuit being filed.
However, the continuing liability of the original developer has never been an issue in FHA litigation. Unless limitations has run the original developer is liable no matter how far removed it is from current ownership. The real “problem” faced by the Court was that dissolution of the original developer makes liability meaningless unless that liability attaches to its owners or managers. And so the Court, without explicitly saying so, created a doctrine under which there is endless liability, and it is personal if the entity is dissolved.
The message is clear. Ignorance is not bliss, and developers need to know whether their projects are FHA compliant before they sell, because liability cannot be sold away and will not disappear. Buyers — at least those who buy by acquiring the entity that developed the property — have the same imperative because they are buying imputed knowledge of the property’s FHA defects. The benefits of acquiring the entity instead of the property itself have to be weighed against this new risk of never-ending liability. Finally, of course, any entity that acts as original developer or a property must conduct an FHA survey before it dissolves so it can create appropriate reserves and thereby protect its managers and owners. Until we have a national agreement on the two-year statute of limitations, which isn’t likely to come soon, original developer liability is endless, and it can get personal.