What s all the Buzz About Construction Defects?

What s all the Buzz About Construction Defects? Brian J. Connolly Attorney, Otten Johnson Robinson Neff + Ragonetti Matt Goebel, AICP Director, Clarion Associates The state s construction defects laws have been blamed in recent years for the metro area s short supply of condominiums at lower price points. Denver Business Journal, Sept 14, 2016 1

Overview Overview of construction defects issues (Matt) Overview of Colorado construction defect law (Brian) Recent changes in law and proposed reform (Brian) Discussion of planning impacts (Matt/Brian/audience) OVERVIEW OF CONSTRUCTION DEFECTS ISSUE 2

What s the issue? Condo construction is down Most new multi family construction in Colorado in recent years has been rental apartments Developers and business groups say they don t build condos because of the state s construction defects law, which has led to numerous lawsuits and in turn made insurance cost prohibitive City leaders worry about the loss of housing diversity, especially affordable options Both the state and local governments have pursued legislative remedies The housing market crashed Housing development crashed during the Great Recession 2009 (lowest production year): For sale attached permits: 20% of 2000 12 average (592/3028) Rental attached: 13% of 2000 12 average (438/3391) [TABLE?] 3

Year Number of Condominium Unit Starts Percentage of all Housing Starts 2005 3,589 18.5 2006 3,863 21.9 2007 2,342 22.9 2008 1,047 18.8 2009 281 10.1 2010 216 5.8 2011 97 2.7 2012 86 1.8 2013 244 3.7 2014 238 3.1 Source: Denver Post Condos have been slow to recover Most segments of the housing market have recovered in Colorado But condos have been slowest to bounce back Recovery rates: Apartments: 300% increase Condos: 53% increase 2015 condo starts: 173 units (2% of all new home activity) (Metrostudy) 4

Impacting housing diversity DRCOG: Accommodate 50% of region s new housing and 75% of new employment in Urban Centers between 2005 and 2035 To fulfill this vision requires a wider variety of housing at various price points, especially for entrylevel homebuyers Impacting affordable housing We need every tool in our tool chest to help us begin producing as much affordable and market rate housing as we can. Denver Mayor Michael Hancock 5

Why no condos? EPS (2013): Many factors affect housing construction and market demand for condos Lending Foreclosures Economic and market factors Demographics Construction defects Why no condos? Pacey Economics (2015): Lack of condo construction is based on lack of demand for that kind of housing, plus stricter financing qualifications When the market comes back, condos will be built Right now, apartments are more profitable 6

Building quality Example: Beauvallon (Denver) Building envelope issues, including the integration of EIFS and stucco, waterproofing of fenestrations, and drainage issues at walkways and patios Intrusive testing required to document mold, structural damage, etc. Rehabilitation: Demolition of entire exterior Replacement of 700+ windows and 400+ doors Installation of water management system and a reapplied finish Removal of biogrowth in affected units (Source: SBSA, Inc.) Example: Swallow Hill (Denver) Reconstruction included completely deskinning two condo buildings and repairing masonry End dams, flashings, and weeps added to brick facade so the system could manage and discharge water (Source: SBSA, Inc.) 7

A typical situation Homeowner buys condo Issues arise (such as water leakage) If common problems occur, HOA gets involved Homeowner and/or HOA request repairs from builder Builder offers repairs that owners/hoa believe are insufficient (or no repair) HOA either self funds repairs, or hires attorney 8

The trial lawyers If HOA finds attorney willing to take case (contingency basis), files suit Suit proceeds to trial, or possibly settles Repair efforts cease during trial phase Discovery likely involves intrusive testing If case settles, attorney takes fee, HOA takes balance for repairs It is challenging to refinance or sell units while litigation is pending Repairs HOA oversees repairs to the building, typically working with a specialized firm 9

Insurance The threat of litigation makes most projects more expensive for developers to finance Wrap policies are increasingly used, covering every person on project for life of project plus 8 years (6 years response and 2 year statute of limitations from notice of defect) Additional insurance due to construction defects liability: EPS: additional $15,000 in insurance costs per unit (v $3,000/unit for apartments) Pacey: results not supported by evidence; strongly disagree Other costs Condo developer s experience Construction modifications Concrete vs. wood construction (20 30% cost increase) No stucco; use concrete, metal panels, glass, brick, durable surfaces Central boiler/hvac instead of individual unit 60 STC walls vs. typical 50 55 STC ($1M 2M cost increase) Ongoing maintenance Weatherproofing every 5 8 years (about $350K per event) Contractor search Many architects, contractors loath to participate (contract for construction of one condo building went from $9M to $12M to get a contractor on board and insured) HOA board membership Retain developer representation on board for entire 8 year period of the statute of repose 10

Project viability Relative risk/return: For projects at higher price points, margin may be sufficient to allow developer to absorb cost, assuming it would be willing to accept a lower return or could raise sale prices. For projects at lower price points, margin may be too small to justify risk A polarized debate The developer s perspective The lawyers and their frivolous lawsuits have made it impossible to build affordable condos! They persuade HOA boards to enter into expensive litigation over the slightest issues, rather than letting us fix the problem! Numerous costly lawsuits have driven up costs of insurance, making condo projects infeasible! Builders and developers Metro Mayors Caucus Denver Chamber of Commerce 11

We have a saying here that there are two types of condo projects the ones that have been sued, and the ones that haven t been sued yet. Gary Godden, Godden Sudik Architects (to the Wall Street Journal) A polarized debate The homeowner s perspective They want to put up shoddy construction and not be held accountable for it! Developers just want to be left off the hook and pass the burden of repairs onto the homeowners! Young people are buying poor quality condos they can t afford to fix! Homeowner associations Plaintiffs attorneys 12

The strategy now is to use [the] downtown and the fact that condos weren t built as an excuse to provide immunity to builders to build poor products and walk away from them. Attorney Scott Sullan I do believe the mayors are being played by the builders. It s no secret that woven through this entire topic is conflict and litigation and lawyers and money. Senator Mark Scheffel (R Douglas County) 13

OVERVIEW OF COLORADO CONSTRUCTION DEFECT LAW Sources of Construction Defect Law Common law: implied warranties that a house was built in an efficient and workmanlike manner and of proper materials and when finished would be fit for habitation. Carpenter v. Donohoe, 388 P.2d 399, 402 (Colo. 1964) [T]he rule of caveat emptor... was based upon an armslength transaction between the seller and buyer and contemplated comparable skill and experience, which does not now exist; they are not in an equal bargaining position and the buyer is forced to rely on the skill and knowledge of the builder. Sloat v. Methany, 625 P.2d 1031, 1033 (Colo. 1981) Differs from commercial contracts; no duty is owed between buyers and sellers 14

Sources of Construction Defect Law Colorado Consumer Protection Act (C.R.S. 6 1 101 et seq.) Colorado Construction Defect Reform Act (C.R.S. 13 20 801 et seq.) Colorado Common Interest Ownership Act (C.R.S. 38 33.3 101 et seq.) Homeowner Protection Act (C.R.S. 13 20 807) Soils Disclosure Statute (C.R.S. 6 6.5 101 et seq.) Source: Coloradoan.com Claims Breach of contract Breach of express warranty Breach of implied warranties Negligence Deceptive trade practices Knowingly making a false representation as to the characteristics of property C.R.S. 6 1 105(1)(e) Represents that goods, food, services, or property are of a particular standard, quality, or grade... if he knows or should know they are of another. C.R.S. 6 1 105(1)(g) Advertising property with intent to not sell them as advertised C.R.S. 6 1 105(1)(i) Guaranteeing goods or services without clearly disclosing the nature and extent of the guarantee C.R.S. 6 1 105(1)(r) Failure to disclose material information C.R.S. 6 1 105(1)(u) 15

Remedies Civil penalties C.R.S. 6 1 112 [A]ny person who, in a private civil action, is found to have engaged in or caused another to engage in any deceptive trade practice listed in this article shall be liable in an amount equal to the sum of... C.R.S. 6 1 113(2) Actual damages $500 Three times the amount of actual damages sustained (if bad faith conduct) Bad faith conduct: fraudulent, willful, knowing, or intentional conduct that causes injury Attorneys fees and court costs Remedies Source: Denver Post Actual damages means the fair market value of the real property without the alleged construction defect, the replacement cost of the real property, or the reasonable cost to repair the alleged construction defect, whichever is less plus relocation costs and other direct economic costs. C.R.S. 13 20 802.5(2) 16

Remedies CDARA limitations Construction professional not liable for more than actual damages if settlement offer is less than 85% of the amount awarded as actual damages or repair cost $250,000 limit per action, adjusted for inflation since 2003 Express waivers or limitations on legal rights are void Source: coloradopols.com Statutes of Limitation and Repose Statute of limitations Two years after claim for relief arises, i.e., when the problem is discovered C.R.S. 13 80 102 Statute of repose Six years after substantial completion of the improvements C.R.S. 13 80 104 In the event the cause of action arises during the 5 th or 6 th year after substantial completion, period is extended two years from the discovery of the problem Difficult to ascertain the accrual date of a cause of action, thus many construction defect claims do not get dismissed easily Accrual of cause of action is often a factual question 17

Who is Liable? Common law rule: Builder vendor is one who is in the business of building who sells a home to a member of the general public Sloat, P.2d at 1033 Statutory law: construction professional Architect, contractor, subcontractor, developer, builder, builder vendor, engineer, or inspector performing or furnishing the design, supervision, inspection, construction, or observation of the construction of any improvement to real property. C.R.S. 13 20 802.5(4) Notice of Claim Process (CDARA) Written notice of claim must be delivered to construction professional at least 75 days prior to filing an action Requires list of asserted defects Inspection within 30 days of delivery of NOC Report and offer to settle or remedy within 30 days of inspection Deemed rejected within 15 days of offer Action for construction defect Statute of limitations tolled during NOC process 18

Observed Problems NOC process Fishing expeditions Does not provide a realistic opportunity to settle disputes due to limited time periods, limited factfinding opportunity Jury bias No opportunity for arbitration, juries have typically been homeownerfriendly HOA board initiated litigation CCIOA allows HOA boards to initiate litigation in the board s own name on behalf of itself or two or more unit owners on matters affecting the common interest community C.R.S. 38 33.3 302(1)(d) CDARA requires notice to be given to homeowners regarding litigation C.R.S. 38 33.3 303.5 Class action suits Class action suit can arise out of same set of circumstances/events Observed problems General approach to defect claims Plaintiff side attorneys seek out HOA boards to file suit against developers; generally work on contingency fee basis HOA board sends notice of claim on behalf of all owners, hire third party contractors to develop exhaustive lists of defects Notice of claim contains a demand for large sum of money Developer settles due to risk of treble damages 19

RECENT CHANGES IN LAW AND PROPOSED REFORMS Recent Changes and Reform Efforts Three categories of changes: State legislative efforts (failed) Judicial decisions Local reform efforts Modified private sector building practices 20

Recent Changes and Reform Efforts Attempts at state legislative reform: Increase HOA board/vote hurdles for filing defect action Mandatory notice to all HOA members regarding prospective cost and impact of defect action Prohibit removal of mandatory arbitration provisions in HOA declarations Right to repair : allow builders a right to repair defects before an action can be filed Further limit statute of repose State legislature has failed to take any action on construction defect reform Recent Changes and Reform Efforts Source: ktgy.com Judicial action Vallagio at Inverness Residential Condominium Association v. Metropolitan Homes, Inc., 14 CA 1154, 2015 WL 2342128 (Colo. App. 2015) (HOA could not remove mandatory arbitration provision of condominium declaration without declarant s consent) Petition for writ of certiorari granted by Colorado Supreme Court in June 2016, has not heard oral argument 21

Recent Changes and Reform Efforts Local Lakewood Define construction defect based on building code Right to repair Majority homeowner consent to litigation (no proxies); notice must contain estimated cost of action Encourage alternative dispute resolution Aurora, Commerce City, Lone Tree, others use similar language Recent Changes and Reform Efforts Local Denver Violation of building code alone does not create private right of action without (1) actual damage; (2) actual loss of use; (3) bodily injury or wrongful death; or (4) risk of injury Code compliant improvements are not actionable Required form of notice to homeowners Majority homeowner consent to litigation Arbitration clauses may not be removed without declarant consent Legal questions surrounding local reform efforts matters of statewide concern? 22

Other States Arizona Eight year limitations period Right to repair: cannot file an action until seller has completed all intended repairs and replacements; cannot reject an offer to repair or replace; repairs must commence within 35 days Defect: material deficiency No attorney and expert fee recovery HOA actions require notice to all members, meeting of full HOA California Up to 10 year limitations period Cash offer or offer to repair within 30 days of inspection Damages limited to reasonable value and cost of repairs, relocation, storage costs, lost business income, investigation costs Limitation on builder liability for acts of nature, homeowner failure to follow recommendations Other States Nevada Six year limitations period Reasonable opportunity to repair defect, must be completed within 105 150 days depending on number of claims May recover reasonable costs of repair/replacement, no attorneys fees Lengthy definition of defect: presents an unreasonable risk of injury to a person or property or proximately causes physical damage to the residence, an appurtenance or the real property HOA may only bring claim on common elements Texas 10 year statute of repose; 2 year limitations period Claim in excess of $7,500: may compel mediation Rejection of settlement offer/offer to repair results in severe limitations on potential damage award Limitation on damages: reasonable cost of repairs, damaged goods, engineering and consulting fees, temporary relocation, reduction in value, attorney s fees Definition based on physical damage 23

Building Practices High price, market rate development Steel, concrete construction = high rise development Construction monitoring Arbitration clauses, right to repair clauses in community declarations Extended developer control over HOA boards HOA less townhouse developments DISCUSSION OF PLANNING IMPACTS 24

Moving forward Today, condo construction is actually on the uptick in Denver and in Colorado. Preemptive strategies to avoid litigation: Photographing, filming construction, adding costs to test materials, systems Peer reviews Maintain reserves Develop upfront legal strategies We are being ultra careful about everything. Roy Kline, Western Development Group 250 Columbine Moving forward We re going to make sure we mitigate risks and maintain quality. Tim Walsh, Confluence Cos., Denver Business Journal, Sept 14, 2016 (referring to new TOD project under Denver s new ordinance) Expect some new apartments to convert to condos after 8 years 25

For planners: Recognize competing interests Have we created a false dichotomy? Do sides have to be chosen? Positions are not mutually exclusive. Multiple competing interests Diversity of housing stock Housing affordability Community quality and sustainability Consumer protection Implementation of regional planning goals TOD success Other? 26

A common goal All sides should focus on solutions that minimize defects in the first place, and identify and repair any defects that do occur early, when costs can be minimized. Discussion Brian Connolly / Otten Johnson Robinson Neff + Ragonetti, P.C. (303) 575 7589 / bconnolly@ottenjohnson.com Matt Goebel / Clarion Associates (303) 830 2890 / mgoebel@clarionassociates.com 27