In mid-2019, a developer and a contractor entered into a contract to flip a house in Pacific Palisades. They formed an LLC (a limited liability company), which they jointly owned and which would buy the home, then sell it after the renovations were complete. The house-flip contract provided that the contractor would act as a general contractor, overseeing construction, and the developer would obtain financing, get approvals from the city, and handle the sale. They would split the profits 50/50. The profits would be their only compensation. The contractor would not receive his normal fee, and the developer, who was a real estate broker, would not receive a commission from the sale. In that way, the construction costs would be less, and they would not have to pay a commission. Though the house-flip contract only covered the one house in Pacific Palisades, the developer knew of other houses in the area he could flip. Success on this project would elevate his reputation for producing high-quality homes, leading, he hoped, to several more house flipping projects.

The house was for sale for $800,000. They estimated the cost of fixing it up would be $700,000, which was low because the contractor was foregoing his normal fee. An outside general contractor would charge at least $50,000. In addition, they budgeted another $100,000 for architectural and engineering plans. Construction was estimated to take about 3 months, once a building permit was issued. In December 2019, the LLC entered into a loan agreement with One Source for a $1,600,000 loan. According to the loan agreement, not all of the loan funds would be available at the outset. $900,000 would be released initially, which was enough to buy the house and to pay for the renovation plans. The rest of the funds would be available when the city had approved the plans and was ready to issue a building permit. The loan was due August 1, 2020.

In late December, One Source disbursed $900,000. The LLC purchased the home and had the renovation plans prepared. In mid January, the plans were submitted to the city building department and to the planning commission. The building department signed off on the plans on March 1. The planning commission was taking longer. Some neighbors objected to the proposed renovations, feeling it would make the home so big it would be inconsistent with the feel of the neighborhood. The planning commission was scheduled to meet March 20 to vote on the plans. Once the planning commission approved the plans, a building permit would be issued and construction would begin. That would give the LLC 3 months to complete construction and a month to sell the home and still have some leeway to meet the August 1 deadline for repaying the loan.

Then Covid hit. On March 19, the governor issued his stay-at-home order. As a result,

(1) The planning commission postponed its March 20 meeting.

(2) One Source said it would fund only $300,000 of the rest of the loan, even if a building permit were issued. It explained that it did not have all of the funds. It was partnering with Wholesale Lending who had agreed to contribute $400,000 (of the full $1,600,000), but when Covid hit, Wholesale Lending told One Source it was going to use that money for Covid-related loans instead. (The Covid-related loans would command higher interest rates.) The loan agreement between the LLC and One Source did not mention anything about Wholesale Lending. It simply said One Source was loaning the money. However, during negotiations One Source mentioned to the developer that it might have to get another bank to contribute some of the loan funds, since One Source was already committed to other loans. That did not come as a surprise to the developer, who knew from experience that it was normal in the house-flipping industry for several lenders to join forces to come up with loan funds.

(3) The contractor was swamped with work installing plexiglass barriers in stores and making modifications to buildings of his other clients to accommodate social distancing requirements.

(4) The developer looked everywhere for another loan, but no traditional lender was willing to make a loan given the uncertainty in the real estate market, particularly for high-end homes. There were loans available from private lenders, but they charged such high interest rates that interest charges would eat up all the profit margin for the project.

None of the contracts involved contained a force majeure clause. Such a clause typically says that in the event of an extraordinary event, like an earthquake, flood, war, terrorist attack, or pandemic, either party may terminate the contract without further liability.

This case study involves three contracts: (1) the home-flip agreement between the developer and the contractor, (2) the loan agreement between the LLC and One Source for the $1,600,000 loan, and (3) the loan funding agreement between One Source and Wholesale Lending.

For your final, answer the following questions. Explain your reasoning. Discuss arguments on both sides. Emphasize the points we covered in class and in your readings. Impossibility is an important issue in many of the questions, but it is not the only issue we covered this semester that should be included in your analysis. Discuss as many issues as you can see. Finally, I’m less concerned about your conclusions than I am about how you arrived at them.

1. For the contractor/developer house-flip agreement:
   1. Did the developer breach the contract by not getting the loan to finish the project?
   2. Did the contractor breach the contract by not getting a building permit?
   3. Did the contractor breach the contract when he took jobs for his other clients?
2. For the LLC/One Source loan agreement:

2.1 Did One Source breach the contract by failing to provide the remaining $700,000 in loan funds?

2.2 What effect, if any, will the events and the actions of the parties have on the due date for the loan?

2.3 Assuming One Source breached the contract, can the LLC recover the profits it hoped to realize from flipping other houses in the future?

3. For the One Source/Wholesale Lending loan funding agreement:

3.1 Did Wholesale Lending breach the contract by failing to provide its share of the loan funds?

3.2 Assuming Wholesale Lending breached the contract, would it be liable to the LLC for breach of contract?

3.3 Would Wholesale Lending be liable to the LLC for interference with the house-flip contract and/or interference with the LLC/One Source loan agreement?

3.4 Would Wholesale Lending be liable to the LLC for interfering with the prospective economic advantage it expected to realize from flipping more homes in the future?

Answer rating: 100% (QA)

1 Did the developer breach the contract by not getting the loan to finish the project No the developer did not breach the contract by not getting the loan to finish the project While the contract did ... View the full answer