Revisiting Condominium Design and Construction Risks: Applying Lessons Learned to a Rekindled Market
Date: June 09, 2016
Increasing Opportunity, Increasing Risk
Condominium work for developers, contractors and architects is reappearing after being scarce for several years, as leasing becomes less attractive to a maturing class of residential market participants. Condo projects can be attractive work, but are also high-risk. To a large extent, risk has increased as contractual protections have decreased. For at least the past decade, practitioners have noted a decline in common law contractual protections. Specifically, privity has consistently been attacked, and in some instances, completely abandoned. For contractors and design professionals, this means higher insurance rates and an increased potential of liability outside of coverage.
A Mistake Now Can Cost You Later
A 2014 case out of California should serve as a cautionary tale. In Beacon Residential Community Association v. Skidmore, Owings & Merrill LLP, a condominium homeowner association (HOA) sued, among others, the two architectural service providers – Skidmore, Owings & Merrill and HKS, Inc. (collectively, the Architects). The HOA had never contracted with the Architects. Instead, a developer contracted for design and construction of a building that was, shortly thereafter, converted into condo units, at which point the HOA came into existence. While traditional contract law protected design consultants and contractors from liability to third-party beneficiaries, that is no longer the law in many jurisdictions. The Beacon court looked to a series of cases stretching back over 50 years in which privity of contract protections were undermined, and found “(a)lthough liability for the supply of goods and services historically required privity of contract between the supplier and the injured party, the significance of privity has greatly eroded over the past century.” 59 Cal. 4th 568, 574 (2014). Accordingly, the court held “an architect owes a duty of care to future homeowners in the design of a residential building where [ ] the architect, in providing professional design services, is not subordinate to other design professionals. The duty of care extends to such architects even when they do not actually build the project or exercise ultimate control over construction.” Beacon at 571.
Develop a Plan
As legal protections have waned, condominium work has become an increasingly risky market for the design and construction industry. Understanding and managing risk is critical to success before, during and after project close-out. Developers and architects, in consultation with other project participants, should create and implement a risk management plan that includes a continuous review of:
(1) governing documents, including permits, codes and condominium management agreements, (2) specifications and drawings, and (3) marketing materials circulated in anticipation of the final project. Among the myriad other issues a sound risk management plan should consider, five others are especially noteworthy.
1. The Disappearing Act
Frequently, a developer initiating a condominium project insulates itself from risk by creating a single-purpose entity for that project. When ownership is turned over to the HOA, the developer dissolves that entity and rides off into the sunset. The last project participants still standing – the architect and contractor – are left with much of the risk if a subsequent claim arises. Knowing this risk is present, architects and contractors should vet their developer-clients carefully to better the chances of long-term stability.
2. Wrap It Up
Many insurers no longer offer general liability coverage for contractors working on condominium projects, including endorsements for construction defects, because of increased litigation. Condo project participants should insist on an owner-controlled insurance program (OCIP or Wrap Up) wherein the condo developer works with an insurance broker to acquire one set of policies for all of the condo’s constructors. Importantly, design professionals’ errors and omissions are not covered under such a Wrap Up. To fill that gap in coverage, a project-specific professional liability policy (Project Specific Policy) covers a condo’s design team, much like the Wrap Up does for constructors.
These insurance programs are expensive, but are often the only adequate coverage for condo projects. One way to keep Wrap Up and Project Specific Policies cost-effective is to limit their tail period. A condo’s bylaws and individual unit purchase agreements can be tailored to restrict the HOA and the unit owners’ power to pursue claims for construction and design defects to a specific time limit following turnover or possession. Such a time limit may allow an underwriter to more appropriately insure the risk and control costs.
3. Frivolous Claims Shouldn’t Pay
Plaintiffs’ attorneys who specialize in condominium claims solicit HOAs and suggest that fiduciary duties require their boards to pursue design and construction defect claims for their buildings. In order to deter entrepreneurial suits, HOA bylaws can include deterrents like a certificate of merit as a condition precedent to a suit, attorney fee-shifting provisions and mandatory mediation or arbitration. Requiring a condo unit buyer to obtain an inspection prior to purchase, followed by signing a release as to the condition of the unit based on that inspection, can also limit issues that can be brought in a subsequent suit.
4. Budget Some, Save Some
A new HOA often receives a budget furnished by the building’s developer for ongoing costs and maintenance. It’s not uncommon for an architect to prepare that budget for the developer, which can result in future liability. Generally, project architects should decline to prepare HOA budgets and advise or require that the developer employ a reserve specialist. Developers should also consider creating a thorough maintenance manual that is included in the HOA’s bylaws and establish an escrowed reserve in the project budget for the use of the HOA, architect and contractor until the statute of limitations bars claims. Some states require such a mandatory HOA reserve, others do not. However, establishing and sizing a reserve should be done to adequately mitigate risk and not solely to meet a state’s minimum requirements.
5. Sell the Details
Cost, quality and time are factors in every project. In a condominium project, low-quality materials and poor design detailing are especially problematic because they are replicated hundreds of times over in a building that gets scrutinized by individual owners with high expectations. When a developer’s focus is on enticing buyers with interior finishes, a building’s utilitarian components, such as the building envelope, can lack attention and quality. Accordingly, water infiltration through windows, roofing and wall cladding are common problems. Sound detailing and product selection by the architect, and quality shop drawings and installation by the contractor, must be considered essential to all project participants and future condo owners. Furthermore, when drafting the legal documents, the more ownership of the building that can be attributed to the individual units, the less a HOA can pursue claims. In high-risk geographic locations where water infiltration is a common problem, some developers go so far as to retain ownership of a condo building’s exterior surfaces and not allow unit owners or the HOA to gain control until the project jurisdiction’s statute of repose bars claims.
As the real estate and construction markets continue to grow, condominium construction will strengthen. Architects and contractors should understand that condo work presents unique opportunities and risks. Those risks continue to expand as contractual protections shrink in the courts. However, there are creative solutions to solve many of the problems associated with condo work.
FOR MORE INFORMATION
For more information, please contact:
Jeffrey R. Appelbaum
Daniel M. Haymond
This advisory bulletin may be reproduced, in whole or in part, with the prior permission of Thompson Hine LLP and acknowledgment of its source and copyright. This publication is intended to inform clients about legal matters of current interest. It is not intended as legal advice. Readers should not act upon the information contained in it without professional counsel.
This document may be considered attorney advertising in some jurisdictions.
© 2016 THOMPSON HINE LLP. ALL RIGHTS RESERVED.