MIXED USE, COMMERCIAL, CONDOMINIUM CONVERSIONS AND THEIR RELATED ISSUES. CLM Claims College September 2015 By Elaine K. Fresch & Elaine F.

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1 MIXED USE, COMMERCIAL, CONDOMINIUM CONVERSIONS AND THEIR RELATED ISSUES CLM Claims College September 2015 By Elaine K. Fresch & Elaine F. Harwell WHAT IS THE PROJECT? Mixed Use developments are developments that combine several functions, including residential, commercial or other public accommodations in close proximity. One example is a building with retail uses on the ground floor and residential or office uses on the upper floors. Another example is a larger master planned community consisting of many buildings with retail shops and residential buildings either in the same building or interspersed, paseo style. Compatibility issues are often addressed through performance standards, transition tools, careful site layout and building design, rather than by separating uses into single use zones. Condominium developments are residential developments consisting of one or more individually owned units and where the remainder of the development is owed in common by the owners of the individual units. The relationship between owners is governed by state laws and other rules set forth in a document called the "Covenants, Conditions and Restrictions," or "CC&Rs". Generally, the term "conversion" is used to describe projects that involve changing the title (and sometimes also the use) of an existing structure. California Government Code section provides: "a change of a residential dwelling to a condominium, cooperative, or similar form of ownership." (Gov. Code, (g)(1)). In practice, the existing residential dwelling to be converted is commonly an apartment complex, but warehouses and industrial buildings can also be turned into multi-unit condominium projects, including both residential and commercial individual for-sale units with homeowner's associations in place. WHAT TYPE OF CLAIMS ARISE OUT MIXED USE DEVELOPMENTS? Given the types of land uses involved in mixed-use developments, a broader class of potential claimants / plaintiffs exists should problems arise with the construction. Naturally, this brings a broader class of damages as well. We address these issues in general terms below. Residential Aspects If the residential aspect is apartments, there will likely be a single owner asserting a claim for damage to real property and for damage to the personal property of individual tenants (if they made claims to the owner). If the residential aspect is condominiums, there will often be a claim by the COA for property damage to the common areas (encompassing the same type of damage

2 as the apartment owner would have) as well as both real and personal property claims of the individual unit owners. As such, the damage claims can include the costs to repair the building and replace unit contents, relocation (housing and moving costs). In addition, economic losses might be claimed by the apartment owner (lost rents) or by the developer of the condominiums (carrying costs for any unsold units). Commercial Aspects In mixed use developments, the commercial use can range from small businesses accessed from street level (i.e., eateries of different sizes, convenience stores, retail outlets, small businesses) to larger offices accessed on different levels of the structure. As a result, the damage claims can include the costs to repair the building and replace unit contents, relocation (substitute space and moving costs) as well as economic losses: the business owner, who is often a lessee, may claim lost profits and rent abeyance, and the owner of the commercial space, the lessor, will often claim lost rents. Of course, other types of damages might be claimed in the litigation itself, such as attorney's fees and costs of investigation and experts. It is critical that counsel identify all potential claimants so that when the time comes to resolve the claims, he or she can ensure that they are truly extinguished. HOW DO CC&RS AFFECT CONDO CONVERSIONS? Each individual condominium Homeowners Association ("HOA") also operates under procedures defined in its recorded CC&Rs. The provisions of condominium CC&Rs are enforced by individual homeowners and HOAs. Over the years, courts have interpreted and refined condominium law, publishing precedents and procedures to assist judges and arbitrators when they are called upon to adjudicate disputes among condominium owners. In California, a "Business Judgment Rule" generally prevails, encouraging courts and arbitrators to uphold the majority decisions of the HOA's members or directors regarding the maintenance, control and management of a condominium development, even if a reasonable person might have acted differently. The sole requirement is that the HOA's actions be taken (i) in good faith, (ii) in the best interests of the association, and (iii) upon reasonable investigation (See Lamden v. La Jolla Shores (1999) 21 Cal.4th 249). Some enforcement mechanisms are relatively straightforward and effective, such as in the case of failure to pay HOA dues, where the principal enforcement mechanism is a "lien" a legal claim against the owner's unit, forcing the owner to pay up. Other enforcement mechanisms, particularly when coexistence rules are violated, are more convoluted and are much more difficult to enforce. In such cases, a disputing owner may be forced either to seek resolution in other methods. WHO IS LIABLE FOR CONSTRUCTION DEFECT CLAIMS IN CONVERSION PROJECTS? 2

3 The conversion process may call for extensive renovation, including the upgrading of materials, structural improvements, new roofs, plumbing and electrical systems, the addition of recreational facilities, and a thorough re-landscaping of the entire premises. In many cases, however, the conversion process may simply include a coat of paint and a kitchen renovation. Under either scenario, the typical homeowner may ultimately make claims of construction defects against the converter and in many cases, the original builder. Many cities across the country have enacted ordinances regulating condominium conversions. These ordinances are typically restrictive in nature, and are generally aimed at providing protections to future buyers of these now "new" units. In most instances, cities and counties have the power to regulate and control condominium conversion, and many courts allow cities and counties much discretion in this regard. For example, in Griffin Development Co. v. City of Oxnard (1985) 39 Cal. 3d 256, 217, the California Supreme Court upheld a conversion ordinance as a legitimate exercise of police power, even though the practical effect of the ordinance was to prevent conversions through onerous requirements. Although transforming apartment buildings, hotels or old warehouses may be quicker and less risky than construction from the ground up, conversions create new gray areas of liability. Many developers of conversion projects look to the original owner/developer of the property (if it is someone different), who not surprisingly looks to the original general contractor that built the project, including the structural elements, roof, windows, doors, plumbing, electrical and HVAC components, which are generally the areas at issue in a construction defect lawsuit. The new homeowners and associations may argue, however, that the current developers of conversion projects should be liable for the whole product, and not just the improvements they made. WHAT THEORIES OF LIABILITY ARE USED NATIONWIDE IN CLAIMS FOR CONSTRUCTION DEFECTS IN CONVERSION PROJECTS? For the most part, the same theories of liability are used nationwide in claims for construction defects in conversion projects. This section will explore some of the different theories of liability that may arise in a conversion project. Disclosure to prospective buyers Several states have enacted statutes targeted at condominium conversions. (See for example, Cal. Civ. Code 1134 (2006); Fla. Stat (2005); 765 ILCS 605/22 (2005)). These statues require converters to inspect the major systems of a building and deliver a report to prospective buyers. This report must list all substantial defects or contain a disclaimer stating that the converter has no knowledge of any defects in the major systems. Major systems to be inspected include: the roof, walls, plumbing, air-conditioning, heating, electrical systems, fireproofing and drainage systems. If significant defects are noted in the major systems, the owner/developer may consider legal action against the original builder and subcontractors under standard construction law including negligence, strict liability and breach of contract/warranty. The converter or subsequent purchaser of a building oftentimes seeks to have the original 3

4 owner/developer and, if possible, its general contractor and subcontractors agree to indemnify the converter for all defects, including those arising out of the original construction that the general contractor or subcontractors did not repair or bring to the attention of the owner/developer. In Florida, the District Court of Appeals held that subsequent unit owners could sue (for negligence) the engineering firms that inspected an apartment building before it was converted into condominium units. Bay Garden Manor Condo. Ass'n, Inc. v. James D. Marks Associates, Inc., 576 So. 2d 744 (Fla. Dist. Ct. App. 1991). The engineering firms were asked to make inspections of the building and improvements pursuant to the Florida statute that required the owner of a conversion project to provide each potential buyer with an inspection report on the physical condition of the building. When the new unit owners moved into their respective units, they discovered that the condition of the building was not the same as was represented by the engineering firms. Id. at 745. The court found that the engineers could be held liable if (1) the inspection reports were false, (2) the engineers knew that the unit owners would rely on their opinions, and (3) if the owners suffered a financial loss as a result of their reliance on this information. In Pennsylvania, a public offering statement of a unit in a condominium conversion must warrant: (1) that there are no structural defects in the work done by the declarant or on behalf of the declarant; (2) that all units and common areas have been inspected for visible structural and mechanical defects pursuant to the statute; and (3) that any found defects have been repaired. 68 Pa CS 3404(a)(1) (2005); 68 Pa CS 3411 (c) (2005). Liability may ensue under the Pennsylvania statute and similar statutes enacted in many states for a converter's failure to conduct a reasonable inspection and/or the failure to disclose known defects. If there are discrepancies between what is reported in the disclosure and the actual condition of the building, purchasers of these condominiums may have an action for fraud, negligent misrepresentation and breach of warranty against the converter. The statutes, however, do not define what constitutes "reasonable inspections." Violation of the disclosure requirements proscribed by the statute may subject the owner/developer to liability for a purchaser's actual damages. Drake v. Martin (1994) 30 Cal.App.4 th 984. Negligent Conversion Builders and developers, similar to others conducting business with the public, are held to a standard of reasonable care in the performance of their daily activities. A breach of these duties may create liability under a negligence theory. For builders and developers involved in condominium conversions, this means they can be held liable for defects arising out of a negligent conversion. For a sophisticated builder or developer, this is even truer as they may be held to a higher standard of care in performing the conversion. A converter or subsequent owner/seller may also be liable for construction defects under a negligence theory for: (1) failure to conduct a reasonable inspection of the property for dangerous conditions; (2) failure to disclose all known defects; and (3) failure to comply with local ordinances regarding original construction, which are made a condition to subdivision map approval. 4

5 The California Second District Court of Appeals noted that a developer could be liable for negligent conversion of apartments into condominiums. Orange Grove Terrace Owners Assn. v. Bryant Properties, Inc. (1986) 176 Cal.App.3d 1217, In Orange Grove, the homeowners' association and individual owners in a condominium complex sued the developer for damages caused by faulty repairs made in the course of converting previously existing apartments in the condominium project. Id. at The court stated: We deem it appropriate to note that if the defendants undertook to repair roofs, and in doing so negligently determined that patching, rather than replacing would suffice, the jury could reasonably determine that the roof repairs were negligently performed. Id. at The Unites States District Court for the District of Columbia found the same. (See Towers Tenant Ass'n, Inc. v. Towers Ltd. P'ship, 563 F. Supp. 566, 570 (D.D.C. 1983). In Towers Tenant, the homeowners' association brought suit against the developer of a condominium conversion for damages arising from defects and deficiencies in the property. Id. at 569. The court noted that although landlords do not have a general duty to renovate leased properties, once a landlord begins renovations to improve the property there is a duty to exercise reasonable care. Id. at 570. The court stated that a breach of such duty gives rise to a cause of action for negligence. Id. Statutes of Limitations and Repose a. Statutes of limitation in regards to suits against the original builder/developer A critical issue once a lawsuit is filed in a matter involving a condominium conversion project is the statute of limitations as the original contractor and subcontractors may be protected from claims by the homeowners and converters due to the statute of limitations or repose enacted by each state. For example, in Arizona, an eight-year statute of limitations and a nine-year statute of repose govern actions arising out of construction deficiencies if discovery or injury occurs in the eighth year after completion. Ariz. Rev. Stat (2004). Therefore, if an owner/developer were to purchase an apartment building ten years after it was built, they would not be able to recover from the original owner/developer any damages arising from deficiencies resulting from the original construction of the building. In California, the Court of Appeals found that an architect who rendered services on an apartment complex when it was initially built could not be liable for defects in the original construction that occurred more than ten years before the action was filed. Sandy v. Superior Court (1988) 201 Cal.App.3d The apartment complex was bought by a corporation with the purpose of converting the apartments into condominiums. After the condominiums were built and sold, the homeowners' association sued the converter for construction defects. The 5

6 converter subsequently filed a cross-complaint against those involved in the conversion as well as the original architect. In its reasoning the court determined that since the converter could not be liable for construction defects that arose from the original construction of the complex, the architect could not be liable to the converter for any such damages. Id. at The court noted that every subsequent renovation does not renew the tolling of the statute of limitations. Id. Again, if an action is filed against a converter beyond ten years from the time of original construction, the converter may be barred from obtaining recovery against those entities involved in the original construction. However, it should be noted that in some cases, depending on the facts, it might be possible to pursue other causes of action, including breach of contract and misrepresentation. b. Application of statutes of limitations to condominium converters Condominium conversions may involve substantial renovations and rehabilitation to the previously constructed building. Generally in conversion projects, the original structure has been built and used for years before the condominium units are actually built and sold to their first owner. Due to the timeline involved, there is much uncertainty as to the application of the statute of limitations in an action against a converter and original general contractor. There is agreement in the fact that the statutes of limitations and repose begin to run on the improvements made by a converter once those improvements have been substantially completed. However, there is a dispute between homeowners and builders/developers as to whether the statute of limitations for defects relating to the original construction recommences upon substantial completion of the conversion. Thus, converters who may not actually perform any modifications to the original construction could be liable for defects arising from the original construction of the building if it is deemed that the statute of limitations renews and the conversion project is considered a "new" construction. These converters then typically look to the original general contractor for indemnity on these claims. The Application of "Right to Repair" or "Notice and Opportunity" Laws to Conversion Projects Due to the nationwide trend towards the expansion of construction defect litigation, many have pushed for protections for contractors by enacting laws that govern conditions that must be met before complaints and lawsuits based on claimed defects may be filed. Many states have tackled these issues with differing laws, such as "right to repair" or "notice and opportunity" laws. These states include Alaska, Colorado, Florida, Idaho, California, and Arizona, to name a few. Laws permitting a builder to address homeowners' claimed defects and attempt to make a curative repair and avoid litigation are the favored form of legislation for controlling the large number of construction defect lawsuits. However, in actuality, many believe they have resulted in minimal success in actually limiting these lawsuits. 6

7 While these statutes allow builders the right to repair a home or to waive this right before a lawsuit for construction defects is filed, it should be noted that many of these laws do not apply to condominium conversions. 1 Brief Survey of Conversions Statutes by State 2 The following is a brief survey and summary of the applicable laws related to sampling of states that have enacted conversion requirements: State Code Section Summary of Law Arizona AZ ST AZ ST If the condominium is a conversion from multifamily rental to condominiums, a statement containing all of the following is required: (a) A statement that the property is a conversion from multifamily rental to condominiums; (b) The date original construction was completed; (c) The name and address of the original owner, builder, developer and general contractor as shown on the applicable city, town or county building permit; (d) The name and address of each subsequent owner as determined by a search of the county recorder's records in the county in which the property is located; (e) The subdivider's agreement to provide the following information on request: (i) The name and address of any builder, developer, general contractor, subcontractor, architect and engineer who designed or made improvements to the property immediately before the first condominium was sold. (ii) A specific description of all improvements made. From : Whenever a declarant exercises a development right to subdivide or convert a unit previously created into additional units or common elements, or both: 1. If the declarant converts the unit entirely to common 1 California's SB 800 explicitly states that it is not applicable to condominium conversions. 2 Arizona, California, Colorado, Florida, Nevada, Texas, and Washington are surveyed herein. 7

8 elements, the amendment to the declaration must reallocate all the allocated interests of that unit among the other units as if that unit had been taken by eminent domain. 2. If the declarant subdivides the unit into two or more units, whether any part of the unit is converted into common elements, the amendment to the declaration shall reallocate all the allocated interests of the unit among the units created by the subdivision in any reasonable manner prescribed by the declarant. California Civil Code 1134 The owner, subdivider, or agent of the owner or subdivider, of a rental apartment (as an existing dwelling) that has been converted to a condominium, stock cooperative, or community apartment project must, as soon as practicable before transfer of title for the first sale, deliver to a prospective buyer a written statement listing all substantial defects or malfunctions in the major systems in the unit and the common areas of the project, or a written statement disclaiming knowledge of any such substantial defects or malfunctions. Section 1134(c)(1) defines "major systems" as the roof, walls, floors, heating, A/C, plumbing, or electrical components. The disclaimer may be delivered only after the owner or subdivider has inspected the units and the common areas and has not discovered a substantial defect or malfunction that a reasonable inspection would have disclosed. ( 1134(a)). Any person who willfully fails to carry out these requirements shall be liable in the amount of actual damages suffered by the buyer. ( 1134(d)). These disclosure requirements do not apply to the sales of units in a project that were originally approved as a condominium project, but then were held off the market for a period of time and rented (sometimes called a "shelf condominium project"). Colorado CO ST Colorado Whenever condominium ownership of real property is created or a separate assessment of condominium units is desired, a written notice thereof shall be delivered to the 8

9 Condominium Ownership Act assessor of the county in which said real property is situated, which notice shall set forth descriptions of the condominium units. Thereafter all taxes, assessments, and other charges shall be assessed against and collected on each condominium unit, each of which shall be carried on the tax books as a separate and distinct parcel for that purpose and not on the building or property as a whole. The valuation of the general and limited common elements shall be assessed proportionately upon the individual air space unit in the manner provided in the declaration. The lien for taxes assessed to any individual condominium owner shall be confined to his condominium unit and to his undivided interest in the general and limited common elements. No forfeiture or sale of any condominium unit for delinquent taxes, assessments, or charges shall divest or in any way affect the title of other condominium units. Florida FL ST (1) Each developer of a residential condominium created by converting existing, previously occupied improvements to such form of ownership shall prepare a report that discloses the condition of the improvements and the condition of certain components and their current estimated replacement costs as of the date of the report. (2) The following information shall be stated concerning the improvements: (a) The date and type of construction. (b) The prior use. (c) Whether there is termite damage or infestation and whether the termite damage or infestation, if any, has been properly treated. The statement shall be substantiated by including, as an exhibit, an inspection report by a certified pest control operator. (3)(a) Disclosure of condition shall be made for each of the following components that the existing improvements may include: 1. Roof. 9

10 2. Structure. 3. Fire protection systems. 4. Elevators. 5. Heating and cooling systems. 6. Plumbing. 7. Electrical systems. 8. Swimming pool. 9. Seawalls, pilings, and docks. 10. Pavement and concrete, including roadways, walkways, and parking areas. 11. Drainage systems. 12. Irrigation systems. (b) For each component, the following information shall be disclosed and substantiated by attaching a copy of a certificate under seal of an architect or engineer authorized to practice in this state: 1. The age of the component as of the date of the report. 2. The estimated remaining useful life of the component as of the date of the report. 3. The estimated current replacement cost of the component as of the date of the report, expressed: a. As a total amount; and b. As a per-unit amount, based upon each unit's proportional share of the common expenses. 4. The structural and functional soundness of the component. (c) Each unit owner and the association are third-party 10

11 beneficiaries of the report. Nevada NV ST 116B.355 (NRS ) Nevada Uniform Common-Interest Ownership Act Nevada Condominium Law 1. To exercise any developmental right reserved in the declaration, the declarant shall prepare, execute and record an amendment to the declaration. The declarant is the owner of any units thereby created. The amendment to the declaration must assign an identifying number to each new unit created and, except in the case of subdivision or conversion of units described in this section, reallocate the allocated interests and the allocated liability for shared expenses by the declarant or hotel unit owner among all units. The amendment must describe any common elements, limited common elements, shared components or portions of the hotel unit thereby created and, in the case of limited common elements, designate the unit to which each is allocated to the extent required by NRS 116B Developmental rights may be reserved within any real estate added to the condominium hotel if the amendment adding that real estate includes all matters required by NRS 116B.330 or 116B.335, as the case may be. This provision does not extend the time limit on the exercise of developmental rights imposed by the declaration. 3. Whenever a declarant exercises a developmental right to subdivide or convert a unit or shared components previously created into additional units, common elements, shared components or additional portions of the hotel unit: (a) If the declarant converts the unit or shared components entirely to common elements, the amendment to the declaration must convey it to the association or reallocate all the allocated interests and allocated liability for shared expenses of that unit among the other units as if that unit had been taken by eminent domain; and (b) If the declarant subdivides the unit into two or more units, whether or not any part of the unit is converted into common elements, the amendment to the declaration must reallocate all the allocated interests and shared expenses of the unit among the units created by the 11

12 subdivision in any reasonable manner prescribed by the declarant. 4. If the declarant converts a shared component into a residential unit, the amendment to the declaration must reallocate all the allocated interests and allocated liability for shared expenses to the residential units. 5. If the declaration provides that all or a portion of the real estate is subject to a right of withdrawal: (a) If all the real estate is subject to withdrawal, and the declaration does not describe separate portions of real estate subject to that right, none of the real estate may be withdrawn after a unit has been conveyed to a purchaser; and (b) If any portion is subject to withdrawal, it may not be withdrawn after a unit in that portion has been conveyed to a purchaser. Texas TX PROP TX PROP Texas Uniform Condominium Act If a building contains units that may be occupied for residential use, the condominium information statement of a condominium containing any conversion building must additionally contain: (1) a dated statement by the declarant, based on a report by an independent architect or engineer, describing the present condition of all structural components and mechanical and electrical installations material to the use and enjoyment of the building; (2) a dated statement by the declarant of the expected useful life of each item reported in Subdivision (1) or a statement that no representations are made in that regard; and (3) a list of violations of building code or other governmental regulations of which the declarant has received notice and that have not been cured, together with the estimated cost of curing those violations. 12

13 From : (a) A declarant of a condominium containing a conversion building shall give each residential tenant or subtenant in possession of a portion of a conversion building notice of the conversion at least 60 days before the date the declarant will require the tenant or subtenant in possession to vacate. The notice must state generally the rights of tenants and subtenants under this section and shall be hand-delivered to the unit or mailed by certified United States mail, return receipt requested, to the tenant or subtenant at the address of the unit or any other mailing address provided by the tenant or subtenant. The declarant may not require a tenant or subtenant to vacate on less than 60 days' notice, except for nonpayment of rent, waste, or conduct that violates the rental agreement or is illegal, and the terms of a tenancy may not be altered during that period. Failure of a declarant to give notice as required by this section is a defense to an action for possession. (b) If a notice of conversion specifies a date by which a unit or proposed unit must be vacated and otherwise complies with Section , the notice also constitutes legal notice to vacate on that date for purposes of Section A declarant may not terminate a lease in violation of its terms. (c) Unless expressly authorized by a rental agreement, a declarant may not make substantial alterations to the interior of a leased premises for purposes of a condominium conversion. Washington WA ST WA ST Washington Condominium Act (1) The public offering statement of a conversion condominium shall contain, in addition to the information required by RCW : (a) Either a copy of a report prepared by an independent, licensed architect or engineer, or a statement by the declarant based on such report, which report or statement describes, to the extent reasonably ascertainable, the present condition of all structural components and mechanical and electrical installations material to the use 13

14 and enjoyment of the condominium; (b) A copy of the inspection and repair report prepared by an independent, licensed architect, engineer, or qualified building inspector in accordance with the requirements of RCW ; (c) A statement by the declarant of the expected useful life of each item reported on in (a) of this subsection or a statement that no representations are made in that regard; and (d) A list of any outstanding notices of uncured violations of building code or other municipal regulations, together with the estimated cost of curing those violations. Unless the purchaser waives in writing the curing of specific violations, the extent to which the declarant will cure such violations prior to the closing of the sale of a unit in the condominium shall be included. (2) This section applies only to condominiums containing units that may be occupied for residential use. From : (1)(a) A declarant of a conversion condominium, and any dealer who intends to offer units in such a condominium, shall give each of the residential tenants and any residential subtenant in possession of a portion of a conversion condominium notice of the conversion and provide those persons with the public offering statement no later than one hundred twenty days before the tenants and any subtenant in possession are required to vacate. The notice must: (i) Set forth generally the rights of tenants and subtenants under this section; (ii) Be delivered pursuant to notice requirements set forth in RCW ; and (iii) Expressly state whether there is a county or city relocation assistance program for tenants or subtenants of 14

15 conversion condominiums in the jurisdiction in which the property is located. 15