Posted On: April 16, 2007 by Cynthia N. Scharf

Could you lose your deposit in a developer bankruptcy?

Contract purchasers of homes in the six Kara Homes developments auctioned recently reportedly have lost hundreds of thousands of dollars in deposit monies, according to reports in yesterday’s and today’s Asbury Park Press. The federal bankruptcy court’s approval of the sale of the six developments recently auctioned to other developers cancelled the contracts of those purchasers who had not closed on uncompleted homes when Kara went under. These purchasers must now stand in line as unsecured creditors who are entitled to repayment only if any funds remain after Kara’s secured creditors have been paid. Their hope of recovery is slim.

Apparently, Kara’s sales contracts provided that purchasers could bond their deposits for an additional fee but many purchasers failed to purchase such extra protection. One purchaser quoted in the Press’s report lost a deposit of $135,000. If this is a typical amount lost, the purchasers’ apparently large-scale failure to bond their deposits is remarkable.

In New Jersey, the deposits of purchasers of units in common interest communities subject to the Planned Real Estate Development Full Disclosure Act (“PREDFDA”) (N.J.S.A. 45:22A-21 to 56) are entitled to the protection of a separate escrow account or bonding as a condition of registration. The regulations provide that the Public Offering Statement must include:

A statement that all monies paid to the developer prior to closing will be held in a separate trust account and the name and location of the institution where the trust account is maintained and the name and address of any trust or escrow agent, until closing or termination of the contract or until a bond or other guarantee acceptable to the Agency [the Department of Community Affairs] is provided.

N.J.A.C. 5:26-4.2(a) 14.

Accordingly, in New Jersey, the deposits for home purchases in common interest developments should be protected through escrow or bonding.

The web is burning with posts demonizing Kara Homes and its lenders. No one appears to be focusing on the cautionary lesson for new home buyers, especially those purchasing new construction outside of common interest communities. Real estate is a cyclical business, and developers can and do encounter financial difficulties. Home buyers, and their financial and legal advisors, should be certain that the contract of sale provides protection for the buyer’s deposit.

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