Published on: October 27, 2012
“Don’t try this at home!” This warning, which scrolls under some television ads and programs, would be equally appropriate advice for the way one community association board managed a major construction project. (This is not actually one specific board but a composite, reflecting the experiences of several different boards.) The trustees obviously didn’t set out to provide a case study in how not to manage a construction project, but on the list of “things not to do”, they got a nearly perfect score – they did pretty much everything wrong.
Although the errors cost unit owners a lot of money and cost the trustees their board positions, they also provide an object lesson that may help other board members avoid similar problems in planning and implementing their own construction projects.
The board in this case study faced an unpleasant situation. Municipal officials had identified significant deficiencies and code violations in the construction of nearly all of the 100 units in this condominium community and had ordered the board to correct these problems. The estimated cost of completing all of the necessary repairs was almost $1,000,000.00.
Although I said the board of trustees did pretty much everything wrong, to be fair, they did do some things right. When the construction issues were identified, the board engaged an engineering firm to help them define the scope of the necessary repairs and develop the plans and specifications for the project – both high on the list of “best practices” industry executives recommend for construction projects. The board also consulted the association’s attorney ― another good practice, although they generally ignored the attorney’s advice (a practice that we generally do not recommend).
But that’s about it for the best practices this board adopted. The list of things the trustees got wrong is unfortunately a lot longer. The worst mistakes:
- The board levied a special assessment to finance the project without providing owners with any specifics beyond a threat to sue owners who failed to pay their share of the assessment within 30 days. There was no advance warning that a substantial assessment was being discussed, no explanation of why the construction work was needed, how the situation with the town was being addressed, what the project would entail and how it was being managed – just a statement saying in essence, “We’re undertaking a $1 million project and need this assessment to pay for it.” Ignoring owners’ complaints and their demands for transparency, the board took the position that, because they did not need owner approval to proceed with the project, which was true, they had no need to discuss the project and its financing or keep owners informed in any meaningful way – which was not true at all.
- Instead of soliciting competitive bids from and selecting a general contractor to oversee the project (almost always recommended for larger projects), the board elected instead to act as its own general contractor, hiring and supervising an army of subcontractors. Making matters worse, instead of using a competitive bidding process to select the individual contractors, the board dealt exclusively with companies known to individual trustees.
- The trustees negotiated and signed brief contracts with the subcontractors containing little detail other than the price and scope of the work, and they did all of this negotiating and signing behind closed doors, without input from the association’s attorney (and in fact contrary to the attorney’s advice) and without communicating what they were doing to the unit owners.
Not surprisingly, owners began asking questions which the board and, as the board continued generally ignored and continued to ignore as the owners’ questions became concerns, the concerns became complaints, and the complaints became louder, angrier and widespread. By the time the trustees recognized the extent of the problem they were facing, it was too late. A large group of unit owners had initiated a petition to remove all of the existing trustees, who were compelled either to resign or not seek re-election. A new board was elected with a mandate to take over this badly managed project and to remedy the damage that had been done by the prior board.
”What we’ve got here is failure to communicate…”
On the long list of errors and omissions in the management of this construction project, the board’s failure to communicate adequately with unit owners stands out, because it reflects a more fundamental failure to recognize: a) that the trustee’s position in a community association is ultimately a political one; and b) that when trustees approve expenditures for the community, they are dealing with “other peoples’ money.”
Although association boards universally have the authority and the responsibility to make decisions for the community, including decisions related to the repair and maintenance of the common areas and facilities, owners have a legitimate interest in knowing how these decisions are being made and an understandable need to know that their money is being spent wisely and well. Transparency is important and desirable in all aspects of association governance, but it is essential when a board is involved in a project as large, as costly, and as controversial as this one. Transparency in this case wasn’t just lacking – it was virtually nonexistent.
Before levying assessments and long before it began negotiating with contractors to do the necessary repairs, the board should have informed owners that a major construction project that would likely require a significant assessment was on the radar. A special meeting with the engineering and legal consultants in attendance would have been an excellent way to inform owners, to give them a chance to ask questions and make suggestions, and to make them feel as if they were part of the process.
Some owners would undoubtedly have objected, and the board’s assumption that it had the authority to proceed despite those objections was correct. If the construction was essential to protect the value of the community, the board had a fiduciary obligation to undertake it. But it was also in the board’s interests and in the interests of the community to make sure owners understood the project and the decisions the board had made in connection with it. Full disclosure and complete transparency from the beginning wouldn’t have ensured unanimous approval for the project, but it would almost certainly have prevented the concerns of a few owners from escalating into a full scale revolt. Of all of the mistakes these trustees made, their failure to communicate with the unit owners was, by far, the most damaging and the easiest to avoid.
Other Errors of Omission
The board’s failure to communicate with owners was a huge error of omission, but it was not the only one. Also on this long list:
- The board failed to solicit competitive bids from contractors. Although competitive bidding isn’t required, it is an effective means of identifying the best combination of quality and cost in a construction project. The board isn’t required to choose the lowest bidder if it does put the job out to bid, but it should be prepared to demonstrate that its decision-making process was objective and reasonable, and competitive bidding underscores that point. Selecting a contractor without comparing competing proposals suggests that the decision was (at best) more arbitrary than thoughtful and (at worst) potentially self-dealing and suspicious. Engaging a contractor simply because it is a friend or relative or someone “known” to the trustees creates the suspicion, justified or not, that acting in the community’s interests may not be the priority it should be for the board. Competitive bidding conveys another important message to owners. It tells them the trustees are using their best efforts and exercising due diligence in order to make the best decisions for the community; it tells them that the trustees take very seriously their obligation to spend “other peoples’ money” wisely and well.
- Because the board didn’t go through a competitive bidding process, it didn’t develop a formal request for proposals defining the scope of the work to be performed, the materials to be used and the standards to be met. In addition to ensuring that competing contractors are basing their bids on the same specifications, the RFP can provide an essential benchmark when incorporated in the contract, making it very difficult for contractors to contend that they weren’t expecting to do the work described for the amount specified.
- The board didn’t have an attorney draft or even review the construction contract(s) before signing them. Most of the contract problems community associations encounter arise not because one party is trying to take unfair advantage of another, but because the parties have different expectations that the contract failed to recognize and reconcile. For that reason, a contract for a construction project of any significance should be as specific and as detailed as possible, leaving as little as possible open to the imagination or interpretation of either party. The contract should be clear enough and sufficiently detailed and comprehensive that a third party reviewing it (that would likely be a judge) will have no question about its meaning or intent or its application to any dispute that may arise in connection with the agreement.
A Well-drafted Contract
Of course, no contract can anticipate every risk, but a well-drafted one will avoid many potential problems and increase the likelihood that the association will have recourse should conflicts develop. The following list doesn’t include every provision associations might want to include in a construction contract, but it covers the most important ones.
- A detailed description of the project, describing the scope and cost of the work and incorporating terms and conditions detailed in the RFP or the bid package.
- A start date and a finish date. The need for this is obvious. A project that begins and ends “whenever,” will begin “any time” the contractor decides it’s convenient and may never end. Specifying an “end date” will also allow the board to pursue remedies (withholding payments, assessing “per day” liquidated damages and potentially terminating the contract) if the work isn’t completed on time.
- A process for dealing with change orders. This provision should specify that change orders must be approved in writing by at least two association representatives and the contractor. A board of trustees, even one that has engaged an engineer or other design professional, cannot always anticipate all unforeseen circumstances that may arise during a construction process nor predict the changes or additional work that might be needed. However, describing the process through which change orders will be negotiated and implemented can insure that any necessary changes are made in a thoughtful manner and with an understanding of how they will affect the project’s cost and its timetable.
- Payment procedures. Although all contracts will include a price, a well-drafted construction contract should specify not just how much the contractor will be paid, but how and when those payments will be made. There are many ways to structure the payments – in phases or percentages (one-third, one-third, one-third) or when specified construction benchmarks have been met and verified. However the payments are structured, a board will want to make sure there is enough still owed the contractor (the technical term for this is “retainage” – a process by which a specified percentage of each progress payment is held back or “retained” until the entire work has been completed in accordance with all the contract terms) to provide the leverage that may be needed to ensure that the project is completed and any outstanding problems are addressed.
- Lien waivers. Contractors who perform construction work involving “improvement to real property” (such as buildings in a condominium) have a right under the laws of most states to impose a mechanic’s lien on that property if the contractor is not paid in a timely fashion for the work. A well drafted construction contract will require, as a condition of each progress payment and the final payment, that the contractor: (i) waive its right to impose a mechanic’s lien; (ii) release the owner from any further obligation for payment under the contract; (iii) warrant that all subcontractors and suppliers have been paid and accept liability and responsibility for curing the problem if that is not the case. The language should specifically require the contractor to indemnify the association and take action to remove any mechanic’s liens filed against the association or to compensate the association for any costs it incurs in removing those liens. In larger projects we recommend that associations obtain partial waivers indicating that suppliers and subcontractors have been paid to date, before releasing progress payments.
- Other Provisions. In addition to the obvious (completing the project under the terms and to the specifications detailed in the contract), these provisions should specify the contractor’s obligations to:
- Obtain and provide evidence of all appropriate insurance (workers’ compensation and liability coverage) in sufficient amounts, which the contract should specify. The contract should also require the contractor to name the association as an additional insured under the contractor’s liability policy.
- Provide all applicable warranties. Manufacturers provide some warranties automatically, but the contractor has to pay to obtain others and you want to make sure the contract specifically requires the contractor to do this.
- Indemnify the association. Indemnification clauses requires a contractor to hold the board of trustees harmless (i.e., be responsible for all costs and expense incurred by the board) in connection with claims and damages which may arise from the contractor’s work at the property (specifics depend on the actual contract language). The inclusion of this important provision insulates the community (as much as possible) from liability in any suits filed against the contractor for injuries or property damage related to the construction work. Ideally, you want the indemnification language to include owners individually as well as the community as a whole.
- Obtain payment and performance bonds. These bonds protect the association against losses it may incur if a contractor breaches its contract (by abandoning the project, failing to complete it on a timely basis, or defaulting in other ways) or fails to pay its subcontractors and/or suppliers. The association must pay for the bonds and the cost ― usually a percentage of the total construction cost – can be high. Many boards forego the bonds for that reason, but some obtain them, at least in part to demonstrate that they are taking care to protect the community’s financial interests. The general rule is, the larger the project and the greater the risk posed by a contractor’s breach, the stronger the argument for purchasing the bonds. Like any form of insurance, payment and performance bonds are expensive if you don’t have to tap them and a bargain if you do.
Once a board of trustees has negotiated and signed a construction contract, it should explain the details to owners and make the agreement available to those who want to review it. This brings us back to where we began this discussion –the importance of communicating openly with owners. While open and free-flowing communication with the unit owners cannot ensure unanimous support for any project, communication and the transparency it creates will avoid the suspicion and anger that can undermine unit owners’ confidence in the board and its decision-making process. There is at least one group of former board members who would likely still be trustees had they followed this advice.