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What is recoverable when a deal falls apart

July 31, 2012

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It happens more often than investors would like to admit — a potentially profitable project or other type of deal breaks down, and the parties end up in court. In the case of construction contracts, the injured party usually seeks to recover its lost profits. But the calculation of those profits can prove tricky.

What effect, for example, does a post-breach downturn in the real estate market have on the calculation of lost profits? As one recent case illustrates, it could have no effect at all.

Project gone bad

In CR-RSC Tower I, LLC v. RSC Tower I, LLC, CR-RSC owned a 53-acre tract of land in Maryland. It entered (as landlords) into two 90-year ground leases with RSC — a “successful real estate company that has developed a variety of different buildings in the community for over 20 years” — for a total of about five acres.

Under the ground leases, RSC agreed to construct two apartment buildings — Towers I and II — that it would sell after construction and initial rental. Construction on Tower II was projected to begin about two years after construction of Tower I. The leases contained provisions obligating the parties to cooperate with each other in the development of the apartment buildings and the rest of the tract.

After executing the leases, in late 2004 and early 2005 the parties modified their agreements to permit development of condominium buildings, a hotel and a spa rather than apartments. They executed several agreements related to this project but, in September 2006, the parties abandoned it and entered into a termination agreement. RSC then obtained county approval to revert to the original plan to build apartments and arranged financing to construct Tower I.
CR-RSC, however, failed to provide estoppel certificates required to secure financing. In November 2006, RSC sued CR-RSC for breach of contract, and in early 2007 a court ordered CR-RSC to provide the certification. RSC subsequently sought recovery of lost profits, claiming that the real estate and credit markets had deteriorated to the point that it could no longer obtain financing for the apartment project. After the jury found for RSC, CR-RSC appealed.

Post-breach conditions

RSC based its lost profits claim on market projections as of December 2006, the time of the initial breach. CR-RSC contended that, because in 2006 the towers weren’t projected to be fully leased until 2010 and 2012, the actual market conditions in that time frame were relevant. And in those conditions, it argued, RSC wouldn’t have profited.

But the Maryland Court of Special Appeals held that lost profits damages are measured at the time of the breach. Unforeseeable subsequent events, such as post-breach fluctuations in value, frequently are “irrelevant for damage determinations.” Accordingly, the court affirmed the lost profits award of more than $36 million for collateral damages.

Results may vary

The Maryland court cited courts in other jurisdictions, including the District of Columbia and Arizona, that have come to the same conclusion about the irrelevance of post-breach events in construction cases. Some courts, however, have considered such evidence.

The laws in your jurisdiction may vary, so be sure to retain a qualified real estate lawyer. In addition, working with a financial advisor can help you maximize your recovery if a deal goes bad.

All content provided in this article is for informational purposes only. Matters discussed in this article are subject to change. For up-to-date information on this subject please contact a Clark Schaefer Hackett professional. Clark Schaefer Hackett will not be held responsible for any claim, loss, damage or inconvenience caused as a result of any information within these pages or any information accessed through this site.

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