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Protect yourself from builder's bankruptcy

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"Many roads are lacking their final topping," says Patrick Sheehan, Kenosha's city attorney. "This is usually done when trucks have left the area. Unfortunately, Neumann has left the area."

To solve the problem, the city hopes to draw on the existing letters of credit.

"Municipalities have letters of credit that are posted by the builder with 120 percent of the amount estimated to complete the improvements for roads, water, and sewers and storm detention," says Allen C. Balk, an attorney at Meltzer, Purtill & Stelle LLC.

"These letters of credit are still good because this is money put aside by the lender. It will be the banks that will have to pay for it, and they will have it worse than the consumers."

How can potential buyers protect themselves?
Both Cross and Balk recommend checking out the builder before purchasing a home. Look at the progress in the subdivision. Drive around. Is anyone working? If it looks like there isn't that much production, it may be indicative of other issues.

"You can never assume the builder will always be there," Cross says.

Knock on doors and ask people if they are happy with their home. If you decide you want to live in that community, purchase a completed inventory home, which eliminates much of the risk.

Look up the company on the Internet. If it's a public company, you'll be able to find out how it's doing in different markets. Find out if land is being revalued.

"There is plenty of information out there, but a homebuyer has to do his or her homework," Balk says.

Buyers should also make sure that their earnest money is in a third-party escrow account, because if there is a bankruptcy, there is a right to terminate the deal.

"If the money is not in such an account, you become an unsecured creditor," Balk says. However, this provision can vary from state to state, so it's up to the buyer to find out if this is done in their state.

Buyers sometimes can add a "springing provision" to their contract. This is a clause in the contract that allows the buyer to walk away if the builder files for bankruptcy protection. Most contracts don't contain them. This clause only "springs" into effect with a bankruptcy filing.

"There is nothing wrong with asking your lawyer to put this in the contract," says Balk. "It's important to check with your state to see how enforceable this clause is."

Still, Meltzer, the attorney who represents home builders, remains optimistic that things will work out.

"Depending how long the development sits there," he says, "it could have an adverse effect on the value of your home. But if progress is being made and houses are being delivered, it shouldn't have an effect on the value of your home, meaning it shouldn't be different than the general marketplace."'s corrections policy -- Posted: Dec. 6, 2007
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