Kirkpatrick Bank wins $8.8M judgment against Star Ranch

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Star Ranch was supposed to be the site of 72 upscale homes spread over 50 acres on Cheyenne Mountain close to The Broadmoor.

Instead, the project is at the center of a protracted legal struggle, another casualty of the crippled real estate market and a symbol of the growing tensions between banks and developers fighting to protect their interests.

Last week, El Paso County District Judge David Prince ruled in favor of Kirkpatrick Bank in an $8.8 million verdict against the property’s developer, Star Ranch LLC.

Prince’s verdict was response to a countersuit filed by the bank. Star Ranch initially sued the bank for breach of contract.

It was one of the largest verdicts awarded in Colorado this year, although an appeal by Star Ranch is expected.

The prospects for Star Ranch looked much different in 2005.

That’s when it was purchased by two Colorado Springs-based partnerships, Soaring Eagles Orchards and Nichols & Comito, who together make up Star Ranch LLC.

But two years into the project, Oklahoma-based Kirkpatrick Bank, which has offices in Colorado Springs, began withholding portions of loan proceeds after lagging sales and missed interest payments brought the project to a crisis point.

The loan agreement between Star Ranch and Kirkpatrick called for the developers to submit requests for cash in accordance with a pre-approved budget. In May 2007, Star Ranch submitted a request for funds that exceeded the budget by nearly $300,000, and its budget deficits piled up from there.

In making its case, Kirkpatrick Bank in its countersuit points to a request for funds from Star Ranch LLC submitted in October of 2007. The request notes a budget deficit of $478,000, although Kirkpatrick said it later came across internal documents from Star Ranch that revealed a deficit closer to $2.6 million.

Larry Nichols, co-founder of Nichols & Comito, discounts the importance of the finding.

“There was nothing intentionally misleading about that discrepancy,” he said. “It was strictly a timing issue. As a company we were looking at different scenarios because of the deteriorating (real estate) market.”

Star Ranch’s attorney, Joseph Coleman, said the budget deficits were the consequence of operational issues the bank should have been willing to tolerate.

“Star Ranch encountered boulders beneath the surface that hindered their ability to install water lines,” he said. “This lengthened the amount of time they would have to spend on the project, and resulted in interest reserves that were insufficient to make payments on the loan. It’s not an indictment of how the property was managed.”

But the bank had other concerns that led it to consider foreclosure, including changes in the partnership. In October of 2007, right around the time that Star Ranch began missing interest payments on its loan, Soaring Eagles CEO Chris Morris decided to leave the firm.

Coleman said that Morris made the decision prior to the dispute with Kirkpatrick, but the bank might have seen this as the inability of the developers to work together on a project that would need additional funding to survive.

Nichols would not elaborate on the alleged tension between the developers, but there is evidence his firm was looking to end the partnership. Nichols & Comito tendered numerous buyout offers to Soaring Eagles, though no agreement was ever reached. The firms also discussed selling portions of the lot to independent investors, or bringing in a new building partner so that one of them could drop out.

According to court documents, the relationship had deteriorated so much by early 2008 that they cut off communication with one another and were holding separate meetings with the bank. Nichols & Comito finally resigned from the project in May 2008.

Despite the problems on the development side, Judge Prince found that Kirkpatrick Bank had breached its side of the contract by only lending $6 million of the $8.7 million loan. In his 49-page ruling, Prince set out to determine which party had breached first, and thus precipitated a breach by the other side.

Star Ranch argued that it only stopped making interest payments after the bank refused to fully fund its loan requests. But according to Prince’s interpretation of the agreement, the bank had the right to analyze budget items line by line and could refuse portions of the loan based on a “standard of reasonableness.” He went so far as to say that the bank had the right to refuse loan proceeds for “even a $10 discrepancy.”

Even without the difference of opinion on the project’s deficit, Prince said the bank would have been within its rights to claim default based on the property’s weak sales (only seven of 34 houses had been sold), and because of the perceived disintegration of the developer’s relationship.

Nichols, naturally, doesn’t see it that way.

He doesn’t believe that the bank made a good faith effort to work with the developers, and said that any issues the property faced would have been manageable before the market crashed.

“It’s a whole different environment now,” he said. “Banks are working under a lot of pressure from federal regulators now. It’s created a lot of fear and makes them unable to work out what should have been a relatively easy fix.”

Coleman thinks so, too. He said that, at one point, Kirkpatrick Bank invited Kansas City-based Academy Bank to participate in the loan. According to Coleman, Star Ranch reached a verbal agreement to move forward on the project with Kirkpatrick Bank before the litigation began. He said that Academy Bank was the entity that insisted on foreclosure.

“We spent a year negotiating with Kirkpatrick without even realizing that they had ceded veto power to an outside bank,” Coleman said. “The banks have just completely changed their approach. The market turned and the banks decided to dump it onto the borrower.”

John Chanin, one of the lawyers representing Kirkpatrick Bank, scoffed at the notion.

“Once the development was discovered to be over-budget and behind in sales, the borrower attempted to avoid its obligations by alleging multiple acts of bad faith by the bank. The court rejected this “blame the bank” approach and ordered repayment of the loan with interest,” he said. “Even in a difficult real estate economy, contracts between lenders and borrowers still matter.”

Looking ahead, Coleman expects the appeals process to drag on through 2012, and said that prospects of an out-of-court settlement seemed unlikely after a series of polarizing courtroom clashes.

Equally unlikely are the prospects of development continuing on the property until the matter has been settled by the courts. Coleman doesn’t expect any of the parties to come out ahead.

“This is going to cost the borrowers, the banks and the judicial system a lot of money,” he said.