Published on: May 22, 2007
Judging by the press reports, construction defect litigation seems to have become something of a growth industry. A recent media scan turned up, in fairly short order, a $3 million judgment awarded to a Vermont community association and a $12 million settlement negotiated by a Colorado community to resolve their claims of serious construction flaws, along with a reference to the largest construction defect award to date – a $35 million judgment in favor of a California homeowners’ association.
The Wall Street Journal reported recently that Florida alone has logged more than 2,500 construction defect complaints against developers in the past year. These reports have attracted the attention of the Community Associations Institute (CAI), which has published a guide to help community associations manage the construction litigation process.
You might conclude from this review that construction quality generally, and the quality of construction in common interest ownership communities specifically has plummeted. But the rise in construction litigation claims is more accurately attributable to the decade-long housing boom. We’re seeing more construction complaints simply because we have seen so much new construction.
The vast majority of community associations are reasonably well-constructed and don’t have major problems. However, the potential consequences of poor construction are so severe, it is essential for all community associations to make sure that any construction projects in which they are involved are managed properly, and to understand the process of bringing a construction defect claim should that become necessary.
The most important consideration is timing. Two statutes – the statue of limitations and the statute of repose — define and limit the period within which the association must file a claim. These time periods differ in different jurisdictions. In Massachusetts, you must file a claim within three years of the date on which the problem is discovered or a reasonable person should have discovered it.
This allows for the possibility that a “latent” defect might not become obvious for several years after the construction has been completed. However, the opportunity to file a claim against the developer is not unlimited. Under the statute of repose, the claims window slams shut after six years regardless of when you discover the problem. The clock starts ticking the day the improvement is put into use or is substantially completed, whichever occurs first. Uncover a problem four years after that date, and you have two years to file a suit; find the flaw five years and 11 months after completion, and you have only one month to act; find the problem six years and a day later, and you’re out of luck.
Problems Won’t Disappear
These time limits are strict, so associations must be proactive; construction problems won’t cure themselves. Ignoring the problems will just complicate and possibly preclude your ability to make the developer assume financial responsibility for correcting them.
In a newly constructed development, the association’s response to construction-related problems will depend on whether the problems arise before or after the transition from developer to owner control of the association. During the pre-transition period, the owners’ options are limited, because the developer controls the board. Unless the developer is willing to file suit against himself (unlikely), owners alleging defects in their units or other individual claims could initiate any action only individually (rather than through the association) and using their own funds rather than the association’s communal resources.
While waiting until after the transition might be preferable, that may not be a viable option if the problems are severe or if delay could risk exceeding the time limits on filing a suit. If that is the case, owners can bring a “derivative” action against the developer, in essence, stepping into the shoes of the board and bringing an action that the board should bring (but won’t) on the association’s behalf.
The process is more straightforward if the owners control the association. Immediately after taking control from the developer, the board should commission an engineering study. A building that looks perfect on the outside could have serious structural problems. The only way to identify those problems earlier, when there is plenty of time to act, rather than later, when filing deadlines may loom, is to have an expert analyze the structure.
Even if it turns out that the buildings are as perfect as they appear to be, this exercise won’t be wasted; the engineering analysis will provide essential information about the life expectancies of building materials and components that the board will need in order to set the association’s reserve/replacement policies. An engineering study will also identify the source of the problems the association is experiencing, providing the documentation required to substantiate any construction defect claims.
Notice and Cure
Some states have adopted “notice and cure” statutes, requiring the association to notify developers, builders, architects, designers, etc. of any problems, and in some cases, to give potential defendants a chance to make repairs, before filing a construction defect claim.
Although Massachusetts doesn’t have such a statute, avoiding litigation is almost always preferable, as long as the delay doesn’t jeopardize the association’s future ability to pursue or collect on its claim. With that concern in mind, boards should approach any discussions with the developer cautiously; don’t let the developer’s promises to take care of the problems lull you into missing filing deadlines. Remember, the clock on the statutes of limitation and repose continues to tick while the developer is working on the repairs – or claims to be working on them. The Board must also be careful not to give the developer the opportunity to divest itself of assets and render itself judgment proof. To avoid that risk, boards may want to file suit first and obtain prejudgment security before beginning a dialogue with the developer.
Stopping the Clock
You may be able to stop the statute of limitations clock by entering into a “tolling agreement,” in which the developer agrees to treat any suit you file eventually as if it were filed on the day you signed the agreement. A tolling agreement essentially waives strict application of the statute of limitations, but it is not clear that the agreement also waives the statute of repose; that remains an open question in Massachusetts, because there are no appellate decisions on that point. You will want to consult your attorney first, but absent advice to the contrary, by all means sign a tolling agreement if the board is willing and give the developer an opportunity to cure the defects, but don’t let that process take you beyond the absolute six-year time limit on the association’s ability to file a construction defect claim.
If you are dealing with a new development, the applicable time limits on bringing a claim are fairly straightforward, but a condominium conversion raises some unique issues. Developers who convert a 40-year-old building might well argue, and have, that the statute of repose has long since expired. One of the responses to this argument is that a conversion involves a change in the form of ownership, not the construction of a new building, so the statute of repose doesn’t apply. In a conversion scenario, the association is not suing the developer for negligent construction but rather for breaching the fiduciary duty to deliver the common areas in “good and workmanlike condition.” That fiduciary obligation exists regardless of whether the building was constructed last year or 40 years ago, and notwithstanding whether the developer was negligent in any aspect of the construction process.
Breach of the Implied Warranty
The legal theories under which an association can pursue a condominium developer will vary in different jurisdictions. In Massachusetts, the potential claims now include the breach of an implied warranty of habitability. The state Supreme Judicial Court ruled in 2002 that the implied warranty for consumers who purchase of new home applies equally to the purchase of a new condominium unit. “The legal differences between the purchase and ownership of a condominium and the purchase and ownership of a house are inconsequential when compared with the similarity of purpose underlying both transactions – i.e., the acquisition of a habitable home,” the court held in Berish v. Bornstein.
A crucial element in this decision, was the court’s conclusion that the warranty flows through unit owners individually to the community association, because, the court held, the association’s “exclusive right” to seek remedies for defects in common areas, “combined with the unit owner’s virtually nonexistent control over the common areas may result in an incomplete remedy for unit owners against a builder whose improper design material, or workmanship is responsible for a defect in a common area that causes units to be uninhabitable or unsafe.”
Broadening the Suit
A strategic question that arises in some construction defect cases is whether the association should sue sub-contractors individually, in addition to suing the developer and/or general contractor with overall responsibility for the construction. Broadening the suit has the advantage of creating more ‘pockets’ from which to collect any judgment the court awards. But this can be a double-edged sword. A large developer may have sufficient leverage over subcontractors to persuade them to fix any defects for which they were responsible – a solution that would give the association what it wants (a fix) without costing the developer any additional money.
The subcontractors, for their part, would be motivated both by concern about preserving the good will of the developer and a desire to avoid being sued. Suing the subcontractors will eliminate part – and possibly the greater part — of their incentive to make the repairs voluntarily, and so, perversely, may reduce the association’s chances of resolving the problems without protracted litigation.
Sometimes suing the subcontractors is advisable; sometimes it is counterproductive. The association’s attorney can determine which strategy is best, and that determination will depend on the nature of the complaint. Individual circumstances will also determine whether a suit is the best way to deal with construction defects. This analysis requires a cost-benefit analysis that weighs the cost of pursuing the litigation and the strength of the claim against the cost of the repairs required.
The stronger the association’s claim and the costlier the repairs, the stronger the arguments in favor of filing a suit; the weaker the claim and/or the less costly the repairs, the more likely the associations’ interests will be better served by simply repairing the problems and financing the costs from association funds. You have to consider, among other factors, the possibility that initiating a suit could discourage prospective buyers from purchasing residences in your community, and could make it more difficult for both prospective buyers and existing owners to obtain financing for their units. Of course, levying a special assessment on owners to finance the repair costs could also discourage buyers and have a negative impact on property values.
Pros and Cons
Filing suit and failing to do so both have consequences the board will have to consider. But the analysis of the pros and cons of litigation should be completely objective; the litigation decision has nothing to do with how mean or how nice the developer or contractor has been. The board’s goal is not to punish a developer who has been unresponsive or uncooperative, nor to protect a contractor who has tried to do the right things. The only goal is to correct the structural problems with the smallest out-of-pocket costs for the association as possible. If that means suing a “nice” developer, that’s what the board should do. If it means abandoning any hope of recovering the repair costs from a “bad” developer, so be it.
Absent a finding of unfair and deceptive practices creating liability under the Massachusetts Consumer Protection Act, (G.L. c. 93A), you are not going to recover your legal costs; a court will only award actual damages. The association will never be made “whole” financially. The board’s goal is to make the buildings structurally whole; its fiduciary obligation is to find most efficient and most cost-effective means of doing that.
Some attorneys will handle construction defect claims on a contingency fee basis. This has the obvious appeal of eliminating the concern about financing the litigation costs, but it also has two potential disadvantages:
- The attorney’s fee will be a specified percentage of any award the association wins, which will necessarily reduce the funds available for the repairs. The association may still have to finance at least a portion of the repair costs out-of-pocket, from reserves or through a special assessment. If the goal is to reduce or eliminate the association’s out-of-pocket costs, the contingency fee arrangement won’t necessarily achieve that aim. The contingency fee could be larger, and possibly considerably larger, than the attorney’s fees in a non-contingency arrangement.
- In some cases, the best outcome for the association may be the developer’s willingness to make the required repairs. This would avoid litigation, but it would also eliminate the possibility of the financial settlement required to produce the attorney’s contingency fee – obviously not the best outcome for the attorney. In some cases, a contingency fee arrangement could discourage the most effective means (for the association) of resolving the dispute.
A Few Tips
All construction-related problems, and the decision about how best to resolve them, will be fact- and association-specific, but this general advice applies to any association that has, or thinks it has, a possible construction defect claim.
- Don’t ignore the problems. Construction problems aren’t like wine; they don’t improve with age. In a new development, have an engineering study done immediately after the transition to owner control; in an existing community, have the condition study done as soon as you see evidence of potential construction problems.
- Consult an attorney immediately. The steps you take or don’t take initially could determine the eventual outcome. This is not a time to be penny-wise. Consulting an attorney early in the process could reduce both your legal costs and the cost of the repairs.
- Don’t let an existing problem get worse while you’re deciding when or whether to file suit. You have an obligation to mitigate the damages. A court may eventually require the contractor to pay to repair a leaking roof, but the contractor won’t be responsible for repairing the water damage that occurred in units and common areas because you waited an unreasonable amount of time before beginning the repairs.
- Don’t destroy the evidence you will need to substantiate a construction defect claim. You must absolutely prevent further damage, but you must also give anyone you are planning to sue an opportunity to assess the problem and gather the information they will need for their defense. The legal term for removing or destroying evidence is “spoliation,” and it could result in the dismissal of your suit – another reason to consult an attorney sooner rather than later.
- Have the association’s attorney determine whether the association’s governing documents purport to limit the board’s authority to file a suit. Some documents require boards to obtain prior owner approval or to attempt arbitration before initiating a suit. The board should seek to amend the documents, if necessary, to eliminate any such restrictions on its control over litigation involving the common areas.
- Rely on the advice of experts. This is no time to cut corners. You need an attorney to assess your claim and manage the litigation process; you need an engineer to determine whether your problems result from a construction defect, to support any claim you may have, and to recommend the repairs required. And you want to get that assessment from an objective source – not from the contractors you are hiring to make the repairs, whose objectivity may be questioned, based on their obvious self interest in identifying substantial and costly repairs.