Creative Consensus, Inc.

box 473, HCR 33, Spruce Head, ME 04859

phone: 207-596-6373 fax: 207-596-0538 email: cci@midcoast.com

VIKING INVESTMENTS (Principals)

Leonard Greenhalgh
Dartmouth College

The Condominium Development Problem

ROLE FOR PAT OLAFSON
Meanwhile, the 100-unit condominium development
You run Viking Investments, a real estate you began one year ago looked like such a great
development corporation that tends to concentrate on project at the time (walking/biking distance from
a small affluent town in the Midwest. You have a town, full cooperation from the zoning board and
solid business, but the comfortable times for real green-light from the town with no special
estate sales have come to an end based on a regional requirements) that you didn't take on any partners.
economic recession. Houses remain unsold, even Profit estimates were healthy.
when prices are slashed. The pressures on Viking
have grown steadily over the past six months. However, soon after Viking signed all the contracts
that committed the company to the project, a rival
One bright spot is that because of the bad market developer began a 75-unit condominium complex on
conditions, there are some fabulous deals to be had. the other side of town. Your research indicates that,
There are two deals you’d like to invest in soon, if even in good times, the market is not big enough to
possible. One of these is an out-of-state lakefront support two large condominium complexes, and
property that can be had for $200,000 if Viking times are anything but good (a large employer in
moves fast. Even undeveloped, it is worth $250,000 town was recently shut down by the parent company
in a normal market, and there is considerable with no warning).
development potential. The other is for a hotel
property with some friends you trust implicitly, Sensing you were in trouble, you decided to go for a
though the buy-in for that deal is steep at $500,000. “quality” appeal by upgrading every aspect you
Ideally, you’d really like to be a part of both deals. could, from carpentry to landscaping to window type.
You also decided to finish your project ahead of your
Viking has a $200,000 loan coming due in 30 days competitor’s. Your subcontractors were willing to
from WoodCrafters, a carpentry business owned by accommodate you, since this market made their own
Sandy Wood. The loan yields 10 percent interest, but economic futures bleak as well. These contract
the lakeside property alone has so much upside amendments raised your costs and cut potential
potential that Viking would have to double the profits by about 20%, but you expect the upgrades to
interest on the loan to 20 percent in order to gain an help these units outsell the over-priced competing 75
equivalent return. The loan is a one-year renewable "no-frills" units. In particular, the work by
loan that has rolled over for the past five years. Sandy WoodCrafters, which you hired to do the fine
has made the interest payments on schedule, but carpentry on this project, could help tremendously
you’d now like to call in the $200,000 to pursue these
with the quality image, since carpentry is so visible to
other options.
the buyer.

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 Creative Consensus, Inc.
The Dispute You next called Fawn after a week of hiking in India,
and were assured that everything was still on
A problem, however, has now arisen with Sandy and schedule and under control on the condominium
Woodcrafters because of some changes Sandy made construction project. She said something about Sandy
when you were recently out of town on vacation. Wood insisting on changing the type of lumber used
With the wisdom of hindsight, you wouldn't have for the trim.
taken your vacation before the condominium project
was completed, but you were thoroughly burned out, You had a bad connection, so conversation was
and all work that required close supervision was done difficult. You asked what the change would cost, and
- or so you thought. You had gone over every point to she said Sandy had estimated "less than three
be sure the crew understood exactly what was percent." Sandy’s contract was for $7,000 per unit, so
expected. You re-emphasized the need to keep three percent was only around $200 per unit. You
quality high, and Sandy gave assurances that all of figured Sandy must have run into a problem caused
WoodCrafter’s carpenters were committed to top by one of the other subcontractors, so you told Fawn
quality work and no delays. Finally, you assured you’d talk it over with Sandy when you got back, but
Sandy that your secretary, Fawn, could handle any not to authorize any changes that would cost money,
details that came up in your absence. since the sale to Margaret gave you little profit
margin to work with.
Your vacation was a round-the-world trip, paid for
mostly with frequent-flier mileage and hotel points. A Nasty Surprise
A trip like this has been a lifetime dream, but you
have always had other things to do with your time Jet-lagged but relaxed, you got back to work, but
and money. You contacted Margaret Walker, a were immediately shocked to open first a letter from
college classmate who has a cottage in the Hebrides the painter asking for a surcharge for staining instead
Islands, off the coast of Scotland, and the two of you of painting the “fine wood” in the units, and then a
decided to spend a few days together at her cottage. letter from Sandy containing a new invoice for the
Because the two of you had planned to fly out work on the condominiums. Instead of the originally-
together, Margaret toured the Viking project the agreed-upon $700,000 ($7,000 per unit based on
morning before you left—as a shrewd investor in the using pine and spruce wood), Sandy is now billing
real estate business, you were curious for her opinion. you $950,000 ($9,500 per unit based on the increased
She was very positive about it. cost of high-quality oak and increased labor involved
in using it).
Indeed, while in the Hebrides, Margaret agreed to
buy the entire condominium complex, even though You asked Fawn to explain why Sandy changed from
you had disclosed all of your fears about the market inexpensive lumber to oak. While recounting her
and the other complex in town. Happily for you, conversation with Sandy, she mentioned that Sandy
Margaret was willing to take the risk at a price that had written down some figures on the back of an
was low in terms of your original expectations, but envelope, but she hadn't understood them.
would not result in any red ink for Viking. She saw a
great opportunity to pick up a high-quality complex Sandy had upgraded the fine carpentry specifications
at a low price, then rent out the units with an option and increased costs not by three percent as Fawn had
to buy, but made it clear that the deal was not re- led you to believe, but rather by $2,500 per unit,
negotiable, and that Viking was responsible for any which is over 30%! Plus, with the extra $30,000 the
cost overruns or delays, as well as for all liability painter now wants for staining fine wood instead of
suits until the complex was turned over to her. It was painting it, Sandy has set you up to lose $300 per
a good deal for both of you, and you were immensely unit. If Sandy is allowed to get away with this,
relieved to have it sold.
instead of making $250,000, you will post a net loss
of $30,000 on this entire project ($250,000 extra in
payment to Sandy plus this $30,000 painter’s fee).

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 Creative Consensus, Inc.
Shocked, your assumption about what happened is
this: Sandy bid low in order to get the job, and then 1. WoodCrafters shall be responsible for any cost
decided to try to get you to pay more to make the job overruns on labor or material. In no event shall
more profitable. Sandy found some cheap oak, and Viking be obligated to reimburse WoodCrafters for
saw a way to make higher profits (a constant 7.5% any cost overruns not expressly agreed to by Viking.
markup of higher labor and materials yields higher
profits). It was probably easy to convince Fawn not 2. This contract is final and binding. No
to refuse the change. As smart as Fawn is, she’s amendments to this contract shall be effective unless
trained as a secretary and does not have the in writing and signed by both parties.
background or experience necessary to make major
financial decisions. You called Dana Simons, a friend and
businesswoman in town, to discuss the situation. She
Over the years, Fawn has from time to time agreed to said that the recession was bringing out the worst in
minor contract changes proposed by Sandy and other people. A large number of people in the building
contractors, but never without checking with you trades and real estate businesses were overextended
first. You assume that the contractors in these cases and grasping at straws to avoid bankruptcy. She said,
understood that she was not acting on her own, and there were rumors around town that Sandy was on the
that she did not have the authority to do so. edge of bankruptcy.

Fawn said that she told Sandy she wasn't able to Her advice was that you deduct the $200,000 loan
approve the change, but Sandy browbeat her by amount from the $700,000 you owe Sandy on the
saying that the rival condominium developer was contract, and thus pay Sandy only $500,000.
going to buy the oak instead and negate the quality-
You then called your lawyer. After reviewing the
image advantage you were striving for. Sandy never
situation, and discussing various options, your lawyer
should have put Fawn in that position.
advised you that:
Sandy must be desperate for cash, but this low-bid
“bait and switch” tactic is unacceptable. You know • As a result of the two contract clauses referred to
Sandy has very expensive tastes, living in one of the above (which your lawyer had drafted), your position
most luxurious houses in the region. It sits proudly on that you owe Sandy only $700,000, the original
a hilltop and must be worth a million dollars or more, contract price, is quite strong.
and Sandy keeps making improvements every time
the WoodCrafters crew is not busy with outside • The problem with following Dana Simons’
projects. Perhaps with the increasing pressures of the advice as a means of obtaining repayment of the
recession, Sandy feels the need to extract more $200,000 loan is that it may cause Sandy to declare
money from clients in order to cater to those bankruptcy. If Sandy declares bankruptcy, the court-
expensive tastes. It doesn’t seem wise to keep so appointed trustee in bankruptcy could treat the loan
much capital in that house—you yourself sold your as improper “preferences,” because you were repaid
big house years ago to raise money for a capital in full, while Sandy’s other creditors were not. The
investment. You understand that Sandy is desperate trustee could either recover the $200,000 from you,
to keep the Woodcrafters crew intact, but not at your or seize any assets you had purchased with the
expense. $200,000.

After you felt you fully understood what had

happened, you checked the original contract with
Sandy. You found the following two clauses that
appear to you to be relevant to this matter:

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The Telephone Call Viking’s Current Financial Status
Feeling more calm and reassured, you called Sandy Because of time pressures, you will have to make all
to object to any changes in the dollar amount of the of your final commitments in the upcoming meeting
contract. You told Sandy that you could not absorb with Sandy. You may not put off your decisions with
the costs of lumber that didn't meet the written respect to Sandy until some point in the future, and
specifications. You stifled Sandy's attempt to protest you are very clear that your main goal is to, ideally,
and you read aloud the clause in the contract that said protect enough cash to invest in both upcoming
all amendments to the contract must be made in opportunities (which would require $200,000 for the
writing and signed by both parties. lakefront and $500,000 for the hotel deal).
You then explained that the condominiums had been To summarize, your investable resources (after
sold to a speculator and that you weren’t going to paying Sandy $700,000, plus $30,000 for the higher
take a loss because of Sandy's attempt to increase painter’s fees, and calling in the loan) would be:
WoodCrafters profit margin. Sandy would be paid
the contract amount, $7,000 per unit, within thirty
days. (The money is in your bank account; there are Cash on hand: $300,000
no consequences--in terms of interest you will owe--
so long as you pay by the end of the 30-day period.) Profit from condominiums: $220,000

Still resisting interruption, you explained that you got Sandy’s loan due: $200,000
no benefit from the higher-quality lumber; the sales
Total resources: $720,000
contract with the speculator was already signed and
was not re-negotiable.

At this point, Sandy exploded. You soon joined in a

round of insulting each other. When both of you had
vented your pent-up anger and frustration, you agreed
that the two of you should meet to discuss this issue,
as well as the issue of your loan to Sandy.

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