Published on: August 7, 2014
In a case handled by MEEB, the Supreme Judicial Court (SJC) has made it easier for condominium associations to win compensation for construction and design defects and has eliminated some of the uncertainty surrounding those claims.
The state’s highest court upheld an Appeals Court ruling (Wyman v. Ayer Properties) holding that the economic loss rule limiting recovery in tort actions should not be applied to community association claims for defects in the original construction and design of a condominium’s common areas. The SJC also rejected a formula for calculating damages the Appeals Court had upheld that based the construction defect award on what the repairs would have cost at the time of the defective construction rather than on what the association would have to pay when the repairs were made.
As we reported in a previous alert, the Appeals Court last year delivered an unexpected victory for community associations by rejecting the economic loss doctrine as a basis for evaluating their construction defect claims. But the court also delivered an unexpected setback by upholding a lower court’s damage calculation that gave the association 20 percent less than the actual cost of repairing the defects it had identified. The combined result of these two rulings was a little like learning that you’ve been hired for your dream job by a company based in Dublin – one of the five places you’ve always wanted to live – only to discover that the firm is relocating its headquarters to Idaho.
Starting with the damage award: Massachusetts law requires the addition of interest calculated at 12 percent annually to a damage award, so that successful plaintiffs aren’t penalized for the time required to obtain a final court judgment. The interest on a straightforward calculation of damages in this case would have equaled 60 percent of the judgment. Apparently finding that to be excessive, the Superior Court judge calculated the damages based on repair costs at the time the construction was completed ─ long before the defects were discovered ─ resulting in an award that was 20 percent less than the actual cost of repairing the defects the association had identified.
The Appeals Court found the use of this formula to be a “permissible” exercise of the judge’s discretion, falling within “the range of reasonable alternative calculations” the court might have used. But the SJC disagreed, finding the 20 percent reduction in the calculated repair costs “largely unexplained and unsupported by any evidence,” and motivated apparently by “a desire to prevent the trustees from receiving the full benefit of the statutorily mandated interest. … Absent any finding that [the repair costs] were excessive,” the court said, “we discern no basis to conclude that the trustees should not be entitled to the costs they [had already incurred] or were going to incur on repairs not yet completed.” The judge’s decision to reduce the damages in order to lower the interest amount was “unreasonable,” the court concluded.
Had the SJC gone the other way and found the damages formula to be reasonable, the implications for community associations would have been enormous and enormously damaging. The lower court had actually used what amounted to a reverse “time-value-of-money” theory to calculate the association’s damage award. Under the typical time value of money analysis, a future loss, such as the loss of an income stream over a long period of time, Plaintiffs wouldn’t get the full value of the loss in year one, because the law presumes that the addition of interest reduces the payment required today to make someone whole for future losses. ..
That approach works reasonably well to calculate future damages, but it doesn’t work at all in reverse. It is difficult to envision any scenario in which a community association would undertake to repair construction defects when the deficient construction occurs… Unless you can assume no inflation ─ no increases in the cost of labor and supplies going forward ─ repair costs will almost certainly be higher in the future than in the past. The formula the lower court used to calculate damages in this case would make it virtually impossible for a community association pursuing a construction defect claim to be made whole, and we are relieved that the SJC rejected it.
Economic Loss Doesn’t Work
Our association client appealed only the award formula; it was the contractor the association had sued who appealed the finding that the economic loss rule should not apply to the association’s claim. The contractor had some reason to be optimistic, as the SJC had reached precisely that conclusion in two previous decisions.
But those past decisions, the court said, did not focus directly on “whether [the rule] applies to damage caused by negligent design and construction of the common areas of a condominium building” regardless of whether the negligence damaged other property. Given the opportunity in this case to address that issue “squarely,” the court concluded, “We hold that the economic loss rule does not ordinarily apply in such circumstances.”
This represents a huge victory for community associations. Under the economic loss rule, plaintiffs in a tort action can recover damages only if they demonstrate harm to other property or personal injury; they can’t recover for defective construction or design flaws unless those deficiencies cause secondary damage. In the condominium context, application of the economic loss rule means that if a roof leaks because it was designed or constructed poorly, the community association can recover only if the leak damages other units or common areas
The theory behind this rule is that property owners can negotiate a warranty on which they can rely if construction is flawed, and so shouldn’t get what courts have termed “a second bite of the tort apple” if they fail to protect their interests. The problem in the condominium context is, only the community association has standing to sue a contractor for construction flaws affecting common areas. But the association has no contract with the developer, no opportunity to negotiate a warranty, and no alternative means of recovery.
That is not how the economic loss rule is supposed to work, the SJC concluded. “We agree with the appeals court that the rule does not require a court to leave a wronged claimant with no remedy.”
Within the condominium structure, the court said, the rule does not achieve either its traditional goal (preventing two bites of the tort apple) or a more recently articulated aim – to limit recovery for unforeseeable economic harm. In condominium construction defect claims, the court said, the damage is tangible and the harm is both quantifiable and finite. “The fundamental purpose of the rule is to confine the indeterminacy of damages, not to nullify a right and remedy for a demonstrated wrong and its harm,” the court said.
Irrational and Unworkable
Like the Appeals Court, the SJC focused on and was ultimately persuaded by the irrational and unworkable results the economic loss rule produced for community associations. Consider the example of a developer who fails to construct a swimming pool or other promised amenity. In order to provide that amenity, the association would have to pay someone to construct it. But because the lack of the amenity has not damaged any other property, under the economic loss rule, the association would not be able to recover its construction costs.
Similarly, if a corner-cutting roofing contractor fails to install a felt underlayment, the roof may not leak right away, but it may not hold up well over time. Instead of the expected 25-year life expectancy, the roof may have to be replaced in 10 years. While no other property has been damaged, the association has clearly suffered a loss — it’s lost 60 percent of the roof’s value. But the economic loss rule would give the association no basis for recovering the cost.
The absurdity becomes more apparent when you apply this theory outside of the condominium context. If I sue a landscaper for negligently knocking over a tree in the yard of my detached, single-family home, a court would not tell me, as the courts have told community associations: “You can recover the cost of removing and replacing the tree only if it damages some other property including property owned by your next-door neighbor.” Under previous applications of the economic loss rule, a condominium association could recover for defective construction if it could show harm to an individual unit – a property in which an association has no more legal interest than I have in my next store neighbor’s property. So if the tree falls on my neighbor’s car, I can recover; it if doesn’t hit anything, I can’t. There is no alternate universe in which this makes any sense.
But that is how the economic loss rule played out for community associations. And dealing with it required feats of evidentiary acrobatics in order to advance construction defect claims. To recover damages for a flawed roof, condominium associations had to demonstrate that the flaw had damaged rugs or walls or something else in owners’ units or other common areas. And then we got to the even more complicated question of how to calculate the damages. Is the award based on the repair of the defective component (the roof) or on the damage to other property?
Even developments in case law over time did not adequately address the issue for condominium associations. One potential answer to the question of damage calculation was a theory by which a property owner could recover for the diminution in market value of the property (a traditional approach where real property is involved) as evidenced, at least in part, by the costs of repairing a defective element. The problem in this context is that a condominium association does not technically own the common areas, the unit owners do. Therefore, the association had financial responsibility to effect repairs to the common area, but no ownership through which it could claim to have suffered diminution damages. The SJC’s decision has happily eliminated the uncertainty, the legal contortions and the often perverse outcomes the economic loss rule created for condominiums.By Thomas O. Moriarty