The Blizzard of Construction, Remodel, Fix-and-Flip and Maintenance Defects and Claims

Eckley & AssociatesBy: J. Robert Eckley
Real Estate and Construction Attorney
Eckley & Associates

THE BOOM THAT BUSTED

THE FIRST CASUALTY: THE MARKETPLACE

The U.S. residential construction boom throughout the late 90s and the first decade of the 2000s  left more than miles of empty subdivisions in its wake when real estate imploded after 2005.  It also left an immense store of broadly defective assets.   

Right along with the headlong rise in easy-money-fed, price-is-no-object consumer demand for housing came a frenzied builder scramble to scoop up all the foolish dollars blowing around.   Builders caught the green gusher with as deep of inventory tub as pre-purchase orders could finance.  It was “every inch of sail to the production wind” to catch the blizzard of buyer bucks.

Production chaos ensued.  Any Yahoo with a hammer and a pulse was put on the payroll.  Every inch of dirt—including expansive clays, collapsible sands and flood zones–was blindly wetted, back-hoed and built on before the ink was dry on the permits.  Bank and construction Regulators went deaf, dumb and blind to the rules-be-damned transgressions of the Big Five Builders as their backroom lobbyists kept their political cups full of drippings from the spoils.

It was a ten-year marketplace in which it seemed that the only financial option for a buyer or builder was to be either “the quick or the dead.”   Little did either anticipate that the greed and the rule-bending would ultimately make them both.  

By 2005, the builders’ and banks’ knuckle-busting clamor to get land and sticks jammed together to equal the bombastic buying pace had stretched consumer credit beyond its seams, ran far past the underlying economic fundamentals for any likely end-user who might inherit the glut and consequently, when the funding and spending binge suddenly awakened to that conclusion and ran dry in approximately July of 2006, is was Armageddon justly thereafter.

The rest of the U.S. Real Estate Story has been the agony of surviving the Big Bust.  What has kept much of the attention of the marketplace now has been applying triage to the financial hemorrhaging.   Real estate values and huge mortgage tranches are in decimation—to the point of threatening even sovereign-level stability.

THE SECOND CASUALTY:  THE ASSET QUALITY

But there is another asset casualty in real estate yet to be confronted, not as apparent now as it will be within the next few years when the wounds of over-paying and over-building command less attention.  It is the latent construction defects lying wait in all those “midnight build-outs” the Regulators let flood past– those miscreants of technical myopia hammered together by the talentless and long-gone transients who were formerly employed by bankrupt (or soon to be) contractors—that will provide the next wave of investment loss as the foundations of what they built start to crack and the paint starts to peel.

Real estate assets that are currently being orphaned by finance will also be left parentless once again by those who built them under the third-rate construction regulation and standards of the Boom.  More than a large segment of those builders went broke (or would go if pushed much for upcoming warranty liabilities).  More of those properties will simply miss the statute of limitations on which to file the warranty claims by the time they land in the hands of a holder who can focus less on historic market fluctuations and once again more on latent, intrinsic asset condition and maintenance or rehab costs.  That “short sale” or “REO bargain” property of today could become tomorrow’s economic fiasco at any price when the ill-engineered frame finally starts to twist and the roof starts to sag.

Who is going to back up billions of dollars of construction defect damages covered by millions of construction warranties owed by thousands of contractors, architects and engineers–whom the Bust not only ushered out of town but did so with no forwarding address?   This question will become more pressing when the 5 to 7 year-old homes start to disintegrate, neighborhoods of once immaculately-kept facades show blocks of fading, bulging and cracking exteriors, tenants replace owners at the same rate as the erosion to shabbiness, social services proportionately increase and long-term tax bases are lost.

This “second tsunami” will negatively impact everyone from builders to owner-occupiers to tenants to investors and, finally, the socioeconomic base of larger community.

THE IMPACT OF THE “DOUBLE-WHAMMY”:

With construction defects remaining undervalued or unheeded as a risk throughout the boom period, the liability for the Frankenstein Property will likely be inherited by the rest of the professional real estate community, already one of the professions hit the hardest by the Bust.  Why?  Because the real estate professional has in most cases been there through both the Boom and Bust and been the primary party assisting in selling, buying, evaluating or managing (what turned out to be) the defective property and in those jurisdictions where the builder’s warranty periods often have run out, the real estate licensees’ typically have not.  It’s a case of suing who is left.

What this tells the real estate licensee, financial advisor, portfolio manager, property manager any other professional related to the selling, purchasing, holding, inspecting and maintaining improved real property and certainly what it tells owners is that conducting due diligence for construction or rehab defects and to determine the pendency of warranty periods is at most an ongoing duty and at least a relevant component of accurately assessing value.

COPING WITH THE COMING DEFECT CLAIMS

THE STEPS FOR PROFESSIONALS:

How can this risk and duty be coped with by those whose professionals in the post-builder loop who bear the risk right along with the builder and sometimes more risk than the builder for a failure to find the builder’s buried construction defects?

First, the professionals can realize that even in the under-selling present market, a detailed, highly-competent, pre-closing inspection, whether in a conventional sale, short-sale, foreclosure or REO and especially for those “great buys” (that are sometimes “great” for a tragic reason) are STILL important.  Liberal inspections are surely important in commercial properties, where warranties tend to be few and short and so vigorous inspections are the only real professional protection; but this due diligence has to be assumed as equally important in residential properties where the warranties tend to be longer, wider and more “generous”.  The asset evaluation should not miss a defect issue or reject a property for what could be a fully compensable shortfall.  Due diligence focuses like this are not just to ferret out the “DOA” properties that one may want to avoid handling at all, but to find, know about and have the ability if elected to press significant construction defect claims and make warranty corrections or recoveries while they are still actionable.  In most cases, no transfers whether by re-sales, short sales or foreclosure, can terminate the builders’ warranty and warranty claims may not only be direct, but also might include access to the insurance, bonds and state recovery funds even for one out of business.   For residential properties, the legal warranty usually runs with the property, irrespectively of how obtained.  Indeed, for the sharks, the unappreciated construction defect claim that is large and still valid may even be one of the best “hidden bonuses” in a potential purchase.

Second, it would surely make sense in every deal to check into when the property was built and by what builder (or when remodeled, as repairs and remodels are also warranted) to determine whether there are warranty coverages in the event a construction issue is found or ever arises.  One does not even have to locate a written warranty from the builder—in most states, the mandatory warranty is spelled out by law.  Access to state statutes or state appellate case precedents are usually enough to know what one is looking for.  A continuing, valid warranty with a solvent builder still in business is a competitive property “PLUS” in any sale or purchase—even a short-sale or a foreclosure–that ought to be known and certainly ought to be given asset value by the professionals.  Most of the time, regrettably, real state professionals neglect to research that significant factor and often fail to appreciate the value-added reality of valid, existing warranties.

Third, after discovery of the construction or remodeling issues by inspection and determining by due diligence that the builder is “still alive”, one obviously needs to know what is covered, what the warranty period actually is and after determining that the warranty period is not over, how does one actually make any eligible builder claim to stop the statute of limitations? The following materials are a thumbnail answer for those questions.   The below materials cover rules of thumb for two state methods, with anecdotes taken as examples from Arizona and California, two of the five states with the highest historic rate or number of construction defect claims.  The laws and procedures noted do not always include all states so one must consult the local laws and cases for local applicability.

KNOWING THE STATE LAWS GOVERNING CONTRUCTION, REMODELING, INSPECTION, SERVICE AND MAINTENANCE

Obviously, anyone in the real estate business or supportive services, and certainly builders, remodelers, fix-and-flippers, tradesmen, inspection and service vendors and naturally the real estate licensees (who have exposures here) need to know what constitutes defects and what the duties and rights are in these liability areas.  In the remainder of these analyses, defects are indentified, rights regarding them are discussed and remedies for them—the steps that need to be taken to preserve any rights for correction or recovery–are explained.

Essentially, all states allow two directions with construction defects claims.  One is administrative in which one can complain to the construction regulators, such as the state Registrar of Contractors of Licensing Boards (general contractors and sub trades), Boards of Technical Registration (architects, engineers) and the like and one can utilize non-regulatory administrative processes for a solution.  The other is pure litigation, i.e. the use of a court or separate private arbitration organization—a more formal solution.

It is also important to note that there are two categories of properties on which claims are made—one category is a residential property where state law usually has a number of required (“implied”) consumer protection laws and warranties which usually cannot be disclaimed by the builder and the other category is a commercial property with shorter complaint times, fewer mandatory warranties are eligible and where the builder can often disclaim warranties that are not for matters otherwise require by state law for zoning, health and safety.

THE REGULATORY COMPLAINT

If complaints are made in the administrative/regulatory system, these are usually heard after complaint first in an informal site examination by a regulatory inspector, who makes a subsequent report on which the regulator makes a finding of whether the property has shortfalls or not.  If the disputants do not agree to the findings, the complaint usually gets a formal hearing through administrative law procedures with an administrative law judge.   Invasive site testing by the regulatory inspector does not take place.  If any is done, it needs to be done by the complainant and open for the inspector when he or she gets there.  Rarely does the process award damages and it never awards attorney’s fees and costs to the prevailing party.  It can but rarely does order “restitution” (i.e. giving back money paid).  The regulator or judge usually simply orders the builder to make workmanship like repairs at the builder’s own cost.  The time to bring regulatory complaints after the structure or work was substantially completed is usually short.  In California for example, it is generally 4 years after COO and in Arizona it is 2 years after the COO.  In addition, notice of an intent to claim against a bond or a state recovery fund must be given in writing to the Regulator within the same period as the complaint—even if one is going to sue in a court instead of handle the matter regulatorily and even if the ultimate judgment comes long after the end of the regulatory period.  If the notice of intent to claim against the bond or recovery fund is given in a timely manner, the actual award and recovery can be years after the notice, when a long period of litigation has often been completed.

THE LITIGATION OPTION

The other option, litigation, can be by filing a suit in a court of law or by a notice of arbitration where the contract calls for one and where mandatory arbitration is enforced—many states like California will first test to see that a builder’s arbitration clause is not onerous to the residential consumer in one way or another before it enforces mandatory arbitration.  If it finds it onerous—that is denying fairness either substantively or procedurally–it may void the arbitration clause in whole or part and allow the consumer who wishes to go to court and have access to a jury to do so.  Most states, however, tend to enforce these under various readings of the Federal Arbitration Act which purports to supersede state laws to the contrary.

THE WARRANTIES MANDATED BY LAW

The following paragraphs set out the residential warranties for Arizona and California, which are being used as examples for this analysis.  It must be remembered that these cannot be disclaimed by the builder and they do not need to be in written form to be enforceable and in most respects they cannot be disclaimed by the builder or sub.  They are required by law and “implied” into all professional work.

EXAMPLE: CLAIMS IN ARIZONA

THE CLAIMS

(1)  GENERALLY:   There are three types of claims in Arizona for a construction defect.

A. BREACH OF CONTRACT:  One claim is in express or implied contract.  In “express” contract the breach would be failure to build according to an expressly-stated standard or term and in “implied” contract the breach is the failure to do a workmanship like job and to provide a habitable structure, duties that are implied in professional standards for the professional, whether or not expressly written into an agreement.  Kubby v. Crescent Steel, 105 Ariz. 459, 466 P.2d 753 (1970), (habitability) Nastri v. Wood Brothers Homes, Inc. 142 Ariz. 439, 690 P.2d 158 (1984).  The warranty cannot be disclaimed by the builder in writing or otherwise, Hembree v. Broadway Realty & Trust Co., 151 Ariz. 418, 729 P.2d 288 (1986) and applies even if the builder was not building the house originally for resale, such as a model or for himself, Dilling v. Fisher, 142 Ariz. 47, 688 P.2d 693 (1984), as the purpose of the warranty is strictly to protect ALL home purchasers by holding home builders accountable for their work, Richards v. Powercraft Homes, Inc., 139 Ariz. 242, 678 P.2d 427 (1984).  Even a disclaimer against the very item that is defective contained in the original builder’s agreement with the first buyer will not affect a successor buyer’s rights against the builder, Nastri, id..  Thus, the warranty is clearly not usually capable of being disclaimed and includes not only workmanship but overall habitability.  See also Columbia Western Corp. v. Vela, 122 Ariz. 28, 592 P.2d 1294 (1979).   Such warranties run with the property such that direct contractual privity is not required to maintain an action against a builder vendor of a home for a breach of implied warranty of workmanship and habitability in a claim for defective, latent conditions Richards, id.   Accord: Donnelly Construction Co. v. Oberg/Hunt/Gilleland, 139 Ariz. 184, 677 P.2d 1292 (1984).  The Lofts at Fillmore v. Reliance Commercial Construction  CV-07-0416-PR (Ariz. S. Ct., 2008).

Caveat in Arizona, Commercial Properties:
  It appears that in commercial properties, contract-based construction warranties may need to be expressly written and expressly assigned between subsequent owners after the original new-build, though professional negligence claims would not need to be.  Most well-written construction and commercial resale agreements do create and do assign such rights.  Hayden Business Center Condominiums Association v. Pegasus Development Corp., 1 CA-CV 03-0143 (Jan 25, 2005).  Not getting that warrant or an assignment of it in a resale is surely a trap for the unwary buyer and agent.

B. PROFESSIONAL NEGLIGENCE:  Another claim is in professional negligence, i.e. a breach of the professional duty to build the property habitably and in a workmanship like manner.   Non-contract claims like this are called “torts” in law parlance.   The builder can be sued for personal injury or damage to some property interest other than the structure under a negligence claim.  The builder can also be sued for other torts such as fraud and other statutory claims such as consumer fraud, but absent a showing of some kind of egregious conduct above and beyond bad workmanship, these claims are not favored.

C. STATUTORY CLAIM: The third method is to make a statutory claim under ARS 12-1361, et. seq., elaborated, below.  For residential claims, ARS 12-1361 is now likely the only claim that needs to be made, as it appears that the statute intended to supersede the common law of contract and negligence claims.  Moreover, it grants certain types of relief to the consumer claimant that was unavailable or unclear in the former claims types, such as attorney’s fees and forensic and expert witness litigation costs that were not clearly recoverable before.   The generosity of the relief has a price though, and that is in the tougher pre-litigation steps a claimant has to take to qualify for the remedy, as noted, below.

Contrary to local myth, there is no “Registrar’s Warranty” of 2 years.  That is a corrupted description of the Arizona Registrar of Contractor’s 2-year jurisdiction over builders for the making of Regulatory or administrative claims for poor workmanship.  See above.  The Registrar does not warrant the property or require a builder to issue a warranty.  It enforces licensure rules and building standards.  These types of claims must be made through the Registrar as noted above, and do not in most produce any monetary remedies—only a corrective repair.

The Nastri court and others since also held that there is only a contract claim and not a negligence claim when there is damage to the structure, only.  These damages relate to the bargain between the parties.  A tort claim will arise when there is damage to separate personal property or personal injury or some other injury than the object of the contract, itself that was caused by the defective condition.  Nastri, 690 P.2d at 444-5.  See also Menendez v. Paddock Pool Construction Co., 172 Ariz. 258, 836 P.2d 968 (App. 1991); Colberg v. Rellinger, 160 Ariz. 42, 770 P.2d 346 (App. 1988).  “For example, if a fireplace collapses, the purchaser can sue in contract for the cost of remedying the structural defects and sue in tort for damage to personal property or personal injury caused by the collapse.”  Woodward v. Chirco Construction Company, Inc., 141 Ariz. 514, 687 P.2d 1269, 1271.  This is called the “separate economic loss” doctrine, observed in Arizona and upon which there has been much recent litigation in commercial settings, with the latest case being Flagstaff Affordable Housing LP v. Design Alliance, Inc., Ariz S. Ct. CV-09-0117-PR (Feb., 2010).  But a residential property claim under ARS 12-1361 blurs or makes that doctrine somewhat moot, as the statute makes no distinction between “contract” and “tort.”  If anything, it lumps it into one and treats it like an action in contract with extended litigation cost recoveries and substantive remedies.

MAKING THE RESIDENTIAL CLAIM:

Residential claims by consumers against Arizona builders are governed now by ARS 12-1361.  That statute provides a “notice and preliminary right to repair” process that is required before a claim against a builder may be filed.   It provides that a “purchaser” may maintain a “dwelling action” against a “seller” for damages, expert costs and attorney’s fees as set forth in the statute unless otherwise agreed by contract between the parties.  The claim is available for successor buyers of the defective property who had no connection with the original builder.  ARS 12-01361 6. .  A “seller” is any person, firm, partnership, corporation, association or other organization that is engaged in the business of designing, constructing or selling dwellings (obviously including builders, subs and obviously including fix-and-flips and remodels).  ARS 12-1361 7.  Note that a “seller” is not defined as a “Mom and Pop” selling their personal residence.  Note that a “seller” could, however, be a real estate licensee in the initial sale between a builder and a purchaser, though it does not include a real estate broker or real estate salesperson that provides services in connection with a later resale of a dwelling following its initial sale. That makes it clear that a real estate licensee in the initial sale could be held accountable for construction defect damages under this statute.  ARS 1363 mandates that at least 90 days before filing an action, the purchaser must give written notice by certified return receipt mail specifying in reasonable detail the basis of the “dwelling action.”  ARS 12-1263(A).  If this is not done, the court may stay or dismiss the action for 90 days to allow compliance.  ARS 12-1362.  After receipt of the notice, the “seller” may inspect to determine the nature and cause of the alleged defects and the repairs needed to remedy them.  The purchaser is required to make the dwelling available no later than 10 days after the notice was received.  ARS 12-1362(C).  Within 60 days after receipt, the “seller” must send (certified return receipt) a good faith written response.  This response mayinclude an offer to repair, monetary compensation or a combination of both. The offered repairs must be described in reasonable detail.  ARS 12-1362(D).  If not provided within 60 days of the purchaser’s notice, the purchaser may file an action without waiting for the 90 days to expire.  The purchaser, after receiving the “seller’s” offer has 20 days to provide a good faith written certified return receipt response.  If the offer is rejected, the purchaser must include a basis for the rejection.  A counteroffer may be included.  Within 10 days, the “seller” may make a “best and final offer.”  ARS 12-1362(F). If there is a judgment more favorable than the offer made or received in the procedures above, the party who made it will be deemed the successful party from the date of the offer of best and final offer.  In that event, the court must award reasonable attorneys’ fees, expert costs and taxable costs from the date of the offer.

ARS 12-1361 EXCLUDES SOME TYPES OF CASES:  The ARS 12-1361 claim is NOT applicable in some situations, one of which is where the claims relate solely to seeking recovery of monies expended for repairs to alleged defects that have already been repaired by the purchaser.  This is where, for instance, the homeowner elects to make the repairs himself with his own contractor and then sues the original builder for the costs.  It also appears that the law may not apply to an action for rescission of the contract, as it is not a claim to enforce it or for repair or “damages”, so it is doubtful that it must go through the ARS 12-1361 process at all.

STATUTE OF LIMITATIONS:

The first statute of limitations is if the claim is in contract and it is six years pursuant to ARS 12-548, but subject to discovery and the ultimate repose statutes, below.

The second, for a construction claim in tort, is governed by ARS 12-542, is a two year statute, subject, of course, to the “discovery rule” noted, below.  Other torts like fraud or statutory claims like consumer fraud go by their own statutes of limitations.

The third is ARS 12-552, which is not really a “statute of limitations” as much as a “statute of ultimate repose” (meaning a time by which in any event all claims, known or not, are over) provides a limitation of eight years after substantial completion of improvement to real property.  However, if the injury occurs in the eighth year (or was not discovered until then), an action may be brought within one year after the date of the injury or discovery of the latent defect, but not more than a total of nine years after substantial completion.  A repair will start the statute again just as to the component or issue that was repaired.

THE DISCOVERY RULE:

In moist cases, the claim time starts ticking from the date of “discovery.”  Arizona has long followed the “discovery rule.”  Seei.e.Matusik v. Dorn, 157 Ariz. 249, 756 P.2d 346 (App. Div. 2 1988).  Under the discovery rule, “cause of action does not accrue until the plaintiff discovers, or by the exercise of reasonable diligence should have discovered, that he or she had been injured by the defendant’s negligent conduct.”  Matusik, 756 P.2d at 347, 157 Ariz. at 250; Gust Rosenfeld & Henderson v. Prudential Ins. Co. of America, 182 Ariz. 586, 898 P.2d 964 (1995); Logerquist v. Danforth, 188 Ariz. 16, 932 P.2d 281 (App. Div. 2 1996). The court in Matusik extended the discovery rule to tortuous injuries to property.  Id.  Furthermore, the Matusik court held that contract claims arising out of deficient design or construction were subject to the discovery rule and do not accrue until the plaintiff knows or should know (with reasonable diligence) of the injury.  Matusik, 756 P.2d at 349, 157 Ariz. at 251.  “Thus, there is an underlying notion that plaintiffs should not suffer where circumstances prevent them from knowing they have been harmed.  And often this is accompanied by the corollary notion that defendants should not be allowed to knowingly profit from their injuree’s ignorance.”  Gust Rosenfeld, 182 Ariz. at 589, 898 P.2d at 967.  Ultimately the court found that “the important inquiry . . . is whether the plaintiff’s injury is difficult for the plaintiff to detect, not whether the action sounds in contract or tort.  Gust Rosenfeld, 182 Ariz. at 590, 898 P.2d at 968.

EXAMPLE: CLAIMS IN CALIFORNIA

THE CLAIMS:  

GENERALLY:  California law is much like Arizona because for the most part Arizona copied some of it.  The claims for construction defect in California are usually (all or one):  Strict Liability, negligence, breach of implied warranties, breach of express warranties, other non-construction commercial torts and statutory claims as also noted above for Arizona, are also actionable in California outside of the statutory SB 800 process noted, below.  And, of course, there can also be administrative claims through the builder’s licensure authority, the California Contractors State License Board. It has jurisdiction over all contractors, licensed or unlicensed, for 4 years after substantial completion of the defective work.

STRICT LIABILITY CLAIM:  The claim of strict liability only lies for residential property.  There is a requirement that there be a “resultant damage” caused by the construction defect for strict liability claims.  “Resultant” damage is where one building component causes damage to another. For example, if a roof leaks when it rains, then recovery against the builder under strict liability requires that the leaking water causes adjacent damage, such as degrading adjacent walls.  The recovery sought is the repair of the construction defect and the repair of the additional damage caused by the construction defect.

BREACH OF CONTRACT CLAIM:  The owner is entitled by law to a building free of defects.  Again, this is much like the Arizona law in that it is divided into “express” and “implied” contract warranties, that is to say, between a warranty that is written into an agreement and the general ones of good workmanship and habitability  that are implied into all professional construction, whether or not written. In implied contract, the proof of a defect due to improper construction, design, or preparation is sufficient to establish liability of the builder or developer.

NEGLIGENCE CLAIMS:  Negligence is the breach of a duty that results in or causes damage. The duty of the builder and/or subcontractor who constructed a building is to exercise the standard of care of reasonable tradesmen conducting the same type of work. If a breach of this standard of care occurs, resulting in a construction defect which causes damage, the property owner may file a lawsuit against the builder and any responsible subcontractors that worked on the property during the original construction. This cause of action can be available to the property owner whether the property owner directly purchased the property from the builder or a third party.

STATUTORY CLIAMS:   Residential claims were overhauled by Senate Bill 800 (SB 800), which establishes building standards that, if violated, may allow a homeowner to file a claim against the builder. The building standards of SB 800 are applicable to new residential construction when the original purchase agreement for residential property was signed by the seller on or after January 1, 2003.  Like ARS 12-1361 for Arizona, above, SB 800 contains pre-litigation requirements for construction defect claims, such as the consumer’s duty to generate a punch list of issues and serving them on the builder prior to filing any claims and a builder’s right to inspect for them and rebut or propose a remedy to settle them. However, builders are allowed to opt out of the SB 800 pre-litigation procedures. At the time the purchase and sale agreement is signed, the builder must choose whether to utilize the pre-litigation procedures or opt out of the pre-litigation procedures.   Under SB 800, if the builder’s contract writes in the pre-litigation procedures of SB 800 (or if the builder failed to make an election to opt out) then the homeowner is required to give the pre-litigation punch list notice of the violations of the building standards, and then the builder has the opportunity to inspect the home and respond.  If the builder fails to make an offer to repair, fails in the repair, or fails any of the obligations that the builder has during the SB 800 pre-litigation process, only then does the homeowner have the right to file a lawsuit.  The lawsuit may claim damages, attorney’s fees, forensic and expert costs. SB 800 is overlaid with a construction defect process before January 1, 2003 referred to as the “Calderon” rule which is included by mention, below, but does not need to be elaborated upon in this analysis.

THE CALDERON/SB 800 PRE-LITIGATION PROCESS FOR MAKING A CLAIM:

The statutory process of making a claim for those inside SB 800 is much as noted above for Arizona:  Before any litigation is filed, a written punch list of issues must be developed by the owner and be served on the builder and the builder gets a review, rebuttal and proposal right.

From SB 800:  “The claimant or his or her legal representative shall provide written notice via certified mail, overnight mail, or personal delivery to the builder…..of the claimant’s claim that the construction of his or her residence violates any of the standards.”  Within 30 days of a written request by a homeowner or his or her legal representative, the builder must provide copies of all relevant plans, specifications, mass or rough grading plans, final soils reports, Department of Real Estate public reports, and available engineering calculations, that pertain to a homeowner’s residence specifically or as part of a larger development tract. Furthermore, the builder shall provide to the homeowner or his or her legal representative copies of all manufactured products maintenance, preventive maintenance, and limited warranty information.”

Within fourteen days of receiving the claim the builder must complete the initial inspection. A second inspection maybe made if notice of that inspection is given within three days of the initial inspection. If a builder intends to hold a subcontractor, design professional, individual product manufacturer, or material supplier, including an insurance carrier, warranty company, or service company, responsible for its contribution to the unmet standard, the builder shall provide notice to that person or entity sufficiently in advance to allow them to attend the initial, or if requested, second inspection of any alleged unmet standard and to participate in the repair process. The second inspection must be completed within forty days. The cost of the investigation is borne by the builder.

The builder is also obligated to notify all responsible parties of the time inspection so that they may attend the inspections. Within thirty days of the completion of the inspection the builder must make an offer to repair all applicable damages. “Any such offer shall be accompanied by a detailed, specific, step-by-step statement identifying the particular violation that is being repaired, explaining the nature, scope, and location of the repair, and setting a reasonable completion date for the repair. The offer shall also include the names, addresses, telephone numbers, and license numbers of the contractors whom the builder intends to have perform the repair. Those contractors shall be fully insured for, and shall be responsible for, all damages or injuries that they may cause to occur during the repair, and evidence of that insurance shall be provided to the homeowner upon request. The offer shall also advise the homeowner in writing of his or her right to request up to three additional contractors from which to select to do the repair…” “Upon receipt of the offer to repair, the homeowner shall have 30 days to authorize the builder to proceed with the repair. Within 20 days after that presentation, the homeowner shall authorize the builder or one of the alternative contractors to perform the repair.”

“The offer to repair shall also be accompanied by an offer to mediate the dispute if the homeowner so chooses. The mediation shall be limited to a four-hour mediation, except as otherwise mutually agreed before a nonaffiliated mediator selected and paid for by the builder. At the homeowner’s sole option, the homeowner may agree to split the cost of the mediator, and if he or she does so, the mediator shall be selected jointly. The mediator shall have sufficient availability such that the mediation occurs within 15 days after the request to mediate is received and occurs at a mutually convenient location within the county where the action is pending. If a builder has made an offer to repair a violation, and the mediation has failed to resolve the dispute, the homeowner shall allow the repair to be performed either by the builder, its contractor, or the selected contractor.”  At any time during the dispute resolution process a builder may offer to pay cash rather than make the repairs.

The builder often blames the issues on poor maintenance by owners and that can be a better defense in California than in Arizona. “A homeowner is obligated to follow all reasonable maintenance obligations and schedules communicated in writing to the homeowner by the builder and product manufacturers, as well as commonly accepted maintenance practices. A failure by a homeowner to follow these obligations, schedules, and practices may subject the homeowner to the affirmative defenses…”  SB 800.   Often, the builder has not communicated any such obligations or schedules and then the homeowner needs to argue that whatever maintenance he did was “correct and reasonable.”  The “homeowner’s maintenance duty” does not include paying for the cost of correcting the builders defects which caused the need for repairs, service or maintenance.

STATUTES OF LIMITATIONS

In California, the time period to bring a construction defect action against the builder is based on (1) the time period after the substantial completion of the property, (2) the nature of the defect, and (3) when the defect was discovered by the property owner.
Like Arizona, California statutes of limitation are also divided into two categories:  those imposing time limits on actions which are triggered by the discovery of damage or the occurrence of some event that leads to damage; and those that impose outside limits on the right to sue regardless of when the damage occurs or is discovered—the “ultimate repose” statutes.  For negligent claims or breach of contract claims, no action may be brought later than the dates established by various statutes of repose
For sales prior to January 1, 2003, CCP 337.15 applied, which applied a limitation period of ten years starting with the earliest of four different definitions of the “substantial completion” of a project. In January 1, 2003, SB 800, provided shorter statutes of repose for actions for damage to certain specific components of a building. Therefore, the first task in all cases is to determine which statute applies, and thereafter, how its provisions govern the right to bring an action against the builder.  CCP 337.15, CC P 895(e), CCP Section 941.

CLAIMS FOR DEFECTS CAUSED BEFORE JANUARY 1, 2003:

If the project was sold before January 1, 2003, it is not subject to the provisions of SB 800, so all civil litigation-type claims can be brought as late as ten years after the defective act or omission as long as the claims are filed within three years of the time of discovery of the problem.

CLAIMS FOR DEFECTS CAUSED AFTER JANUARY 1, 2003:

For properties first sold after January 1, 2003, SB 800 applies, so the time to file actions to recover for defects is governed by the type of defect, which can be one year for cosmetic matters and up to ten years for foundation and structural issues.  That is to say, for example, if a claim for a cosmetic defect is to be made, the claimant has 3 years from discovery to file it but an ultimate repose of 4 years to file, assuming it was discovered on the last day of the one year warranty period.  If it was a foundation defect, which has a 10-year implied warranty, then one would be required to file it within three years of discovery, but not later than 3 years after the end of the 10-year implied warranty, assuming for the example the defect was discovered on the last day of the 10 years.

DISCOVERY:

Also, as in Arizona, California has “Discovery” Statutes.  Actions times run from the date of discovery.  Claims in strict liability, negligence, implied warranty, express warranty, negligent misrepresentation and intentional acts such as fraud have their own statutes of limitation and for properties sold before January 1, 2003, those would be very relevant.  CCP 337 governs actions for damage arising from the breach of a written contract which must be brought within four years from the date of the breach. CCP 339 governs actions for breach of an oral contract which must be brought within two years from the date of breach. For those sold after January, 2003, though, SB 800 provides only for a single, statutory cause of action for each type of component in the event that a component does not meet the standards set forth in that code.  Claims there would be governed by CCP 338 which provides that actions must be taken within three years from date of the claimant’s “discovery” of the facts supporting the claim. If these shorter limitation periods apply, regardless of what the “outside” time limit may be in a particular case, an action brought by a community association (or any other plaintiff) has to meet these time requirements even thought the applicable statutes of repose may be longer. Of course, the most prudent course is to act to suspend all limitation periods well before their expiration by inspecting for them and filing the above notice for them immediately upon discovery.  In both California and Arizona, the pre-litigation notice process tolls the statute of limitations for the period of the process.

As noted, since SB 800 has for the most part set the statute for most residential claims for properties built on or after January 1, 2003, a review of it is usually the more informative. As stated, above, SB 800 provides a required “length of service free of defects” time limit for each individual building violation addressed with time periods ranging from one year(cosmetic matters)  to 10 years (foundation and structural matters), depending on the building component.  Upon discovery of the problem during that time period, one has 3 years to file.  It is important to note that the various SB 800 building standards that are affected by statutes of limitation are different from the warranty sometimes provided by the builder. The warranty builders provide in their written agreements typically lasts for one or two years and likely has no impact on one’s rights to a remedy pursuant to the SB 800 building standards.   That is to say, the builder cannot shorten or conclude the period of the builder’s construction liability.  It is a violation of public policy. The builder can, of course, lengthen the warranty period or make the warranty more generous than the statute by a written agreement.

OTHER STATES
As noted, above, all states have their own rules but all of them will be have one or other of the various rights and one of the complaints or complaint systems noted above.  What changes state-by-state is the complaint resolution methods, the right to seek an award of not just the principal relief, but all litigation costs, and the statutes of limitations governing each type of claim.

INEFFECTIVE DISCLAIMERS

It is important in these analyses to review the effect of disclaimers.  Virtually every builder in all states attempts to disclaim the duty to meet any kind of habitability or workmanship standards and liability for any type of defect.   Most state laws provide that the warranties given by statute or common law at the appellate level or in licensure law are PULBIC POLICY and cannot be disclaimed by the builder.  The concept is that there can be no “AS IS” work or product where professional standards of care are otherwise publicly mandated.  In California and Arizona, for example, the licensure regulations for builders expressly prohibit or void and such builder disclaimer clauses—even calling them a violation of licensure if they are used–and the reasoning is simple—a builder has no legal ability to hold that he or she will not build to the standards of care his or her licensure authority has mandated that he must.  One of those regulatory duties is also to comply with building codes and things like city and county permit laws, which also mandate defect-free construction to various standards.  In Arizona, for example, see Nastri at Ariz. 442. and P.2d at 161.  The “law does not look with favor upon one exacting a covenant to relieve himself of the basic duty which the law imposes on (him)…This would tend to promote carelessness.  Salt River Project Agric. Imp. & Power Dist. V. We, 143 Ariz. 368, 368; 694 P.2d 198 (s. Ct. 1984), quoting Union Pacific Railroad Co. v. El Paso Natural Gas Co., 17 Utah 2d 255, 259, 408 P.2d 910, 913 (1965).   The subdivision laws of all states, including California and Arizona, do not permit a builder or a subdivider to ask the buyer to waive or disclaim material representations relied on by the purchaser and hold that any attempt to do so is void.  The builder or remodeler is also a “seller” and in all of the western and southwestern states, the “seller’ must disclose known, latent defects to a buyer before he buys.S Development Company v. Pima Capital Management Co., 201 Ariz. 10, 31 P.3d 123, 355 Ariz. Adv. Rep. 24 (Ct. App. 2001).
In California, the law recognizes an implied covenant of good faith and fair dealing in every contract that neither party will do anything which will injure the right of the other to receive the benefits of the agreement, which, when applied to a construction, remodeling or repair contract, means that the customer has the right to assume a non-disclaimable  promise from the workman to avoid implementing defects or a failure-prone status into the product being purchased.  Comunale v. Traders & General Ins. Co. 50 Cal.2d 654, 658 ,328 P.2d 198 (1958); Carma Developers (Cal.), Inc. v. Marathon Development California, Inc., 2 Cal.4th 342, 371-372, 6 Cal.Rptr.2d 467, 826 P.2d 710 (1992); Guz v. Bechtel National, Inc., 24 Cal.4th 317, 349-350 [100 Cal.Rptr.2d 352, 8 P.3d 1089 (2000).  Arizona generally follows the same good faith covenant in contract cases.  Wagonseller v. Scottsdale Mem. Hosp., 147 Ariz. 370, 383, 710 P.2d 1025 (1985).

Last on disclaimers, the law of most states does not favor boilerplate clauses which seem to run against the entire intent of the parties or purchase.  “Boiler plate” clauses will not change the “actual deal” which the parties bargained for or could anticipate, including warranties implied by law.  The buyer is entitled to his “dickered deal” and the reasonable expectations of the bargain.  These are not defeated by the boiler plate exculpatory terms of a standardized purchase contracts that were not the subject of negotiation.  See e.g Darner Motor Sales, Inc. v. Universal Underwriters Insurance Co.140 Ariz. 383, 682 P.2d 388 (1984).  Attempts to exculpate warranties. promises and duties owed by law violate the good faith and fair dealing covenant implied by most state laws into all contracts.  Examples:  In California, Comunale v. Traders & General Ins. Co. 50 Cal.2d 654, 658 ,328 P.2d 198 (1958); in Arizona, Wagonseller v. Scottsdale Mem. Hosp., 147 Ariz. 370, 383, 710 P.2d 1025 (1985).  The covenant of good faith requires that neither party do “anything that will injure the right of the other to receive the benefits of their agreement” and the duty not to act in bad faith or deal unfairly is part of contract, and remedy for its breach generally is on contract itself.  Id., Wagonseller.  In California, the breach of the implied covenant of good faith is itself a separate cause of action both in tort and contract.  In Arizona, other than in contract claims, the tort claim is usually only available in insurance bad faith cases and some breach of fiduciary duty cases.

USE OF CONSTRCUTION DEFECT CLAIMS COLLATERALLY OR DEFENSIVELY

Due to the great economic collapse of recent years, a new use for construction defect claims is emerging:  It is being raised COLLATERALLY or DEFENSIEVLY against an enforcement of a sale contract or loans secured by the property as an indemnity for the investment mistake or loss.  Buyers and debtors who are either not happy with the investment wisdom of former purchases or the size and terms of loans against their properties or unable to pay them are defending against them by raising construction defects in what they were sold or in what the lender loaned against as a defense or counterclaim.  The argument by a buyer against the seller ranges from allegations of a fraudulent sale (non-disclosure of known latent defects) or a rescission based upon mutual mistake (a transaction in which both sides were ignorant of a substantial defect and it would be unfair to allow the seller to profit from it or the seller to be penalized by it).  The argument against the lender (unless the lender is also the seller such as in an REO on which event the borrower uses the “seller” argument) is usually an allegation that the lender failed in its “loan due diligence and truth and accurate representation duties”, such as by obtaining a negligent site review, inspection or appraisal which missed or misstated the issue.  The argument against the collateral people is the usual one, i.e. “..how did I get put into this dog-eared investment or property..”

In both California and Arizona and many other states, the borrower is allowed to rely on  lender-conducted appraisals as being a valid, well-researched statement of condition and a value based upon an actual condition competently determined.   Obviously these defenses and affirmative claims also go for actions against inspectors, real estate agents and the like.   The buyer/borrower has been deemed in most states to have rights to rely and claim against those who facilitated the deal for various due-diligence failures, such as inspectors and real estate licensees.  Builders may even be sued for the loans taken against the property on the contention that the plaintiff “…would not have made the purchase or have taken out the loan had he known of the builder’s defect..”

Cases in which construction defects are raised as a method of defending against enforcement of a sale agreement or a loan are now as plentiful as those against the builder for pure construction claims.  The buyers/borrowers of the world are no longer interested any more in a repaired building (worth less than half of what was paid due to the downturn).  They are interested now in ridding themselves of it as a “bad buy” and collecting damages or getting their money back for being put into it.  This is not a true “construction complaint” in fact, but a “real estate investment remorse” claim disguised as one.  Moreover, this approach works well for that greater group of contemporary property holders who are suffocating in a “bad buy” or “bad loan”, have considerable personal liability and are out of other options or ideas to solve the problem.  A builder’s defect claim or a professional malpractice claim is seen as a legitimate strategy for “leveraging” out of the problem.

A suit for rescission of the entire agreement by reason of a substantial, unknown error or defect in the property or in information supplied about the actual condition of property is possible in most states.  In California, buyer or borrowers look to CC 1688 et seq.. The rescission remedy assumes that the contract was properly formed, but finds that there never was a true meeting of the minds on the essential terms, as the parties to it labored under ignorance of a material fact that vitiated the purpose of the transaction, such as a huge undiscovered defect in the property.  In a rescission, monies and properties are all returned back to where they started.   In Arizona, see the similar Renner v. Kehl, 50 Ariz. 94, 722 P2d. 262 (1986).  The rescission rules trump boilerplate disclaimers, integration clauses  and “AS-IS” clauses in the contract, rescinding them, too.

FINAL HOUSEKEEPING ITEMS

To be thorough on this important subject, some final vignettes:

First, there is a bit more about determining and punch listing the defects and adverse conditions:  Examining the property to determine the defects and issues and punch listing them is really more than what a home inspector is trained for and certainly, in those states where home inspectors have been registered, licensed or “listed” by state regulation, such as Arizona (though California has not) it is often more than they are authorized by law to do.  It is probably best to engage licensed builders, plumbers, electricians or registered engineers or architects to make these statutory kind of examinations and make those punch lists.  In most cases, for damages purposes, the investigator also has to make cost estimates for repair and generating building repair invoices is far beyond the scope of what home inspectors should be doing.  Moreover, in almost all states (certainly California and Arizona) the inspector may later have to qualify as an expert for purposes of testimony if litigation ensues.  One of the surest challenges to such an expert by the other side would be that he or she is not properly licensed for the trade or professional they are testifying about.  Moreover, the other side will oppose the claimant’s experts with high-level ones of their own and the claimant can be sure those opposing experts will have all of the credentials.   This said, it is also then wise to engage experts right up front that have been qualified by courts as experts in this area before—they have “been to this Rodeo before”–know what is expected of them, know the roles, are fully credentialed for them and are comfortable in court.  An expert name for most states–whether for inspection or for litigation or for builder, inspector, seller defense or for prosecution for claimants can usually be obtained by e-mailing experts@nationalbuildmasters.com, describing the need and use and asking for the name of one.
Second, there is a bit more to add about where else to file claims:   With insurers!   Not necessarily builder’s insurers, though this, too, is important; but instead with past or present casualty insurers for the property.   Some of the defects or losses may be covered by past or present policies insuring losses against the property. Some policies may have exclusions for “construction defects” but not have exclusions for “resulting losses” from them.  In “insurance-speak” a “resulting loss” is one that insures damage from another cause other than the cause’s own failure, which could even be an otherwise excluded cause.   For example, a roofer does a bad roof repair and rainwater subsequently leaks down into the home and destroys furniture and flooring.  The roofer filed Chapter 7 three years ago.  The owner’s casualty policy states that it excludes “workmanship defects or vice”, but it cover “resulting loss.”  Net coverage?  The repair of the roof workmanship defect is not covered by the policy, but the damage that “resulted” to what was below it is.  Do not be dissuaded from filing by insurance claims managers who poo-poo the claim or warn that “rates might be increased” or one might get “cancelled.”   We all know that game and why it is played by insurers:  “It’s all about premiums and no payouts.”  The defect loss could be substantial enough to make concerns like those risks minor to moot.  And even after cancellation, the insurer is still on the hook for the claim made before the cancellation.  Most policies require the filing of a claim to be done within 30 days or so after discovery (defined about the same way as defined for law suits, above) to get coverage, so “holding back” might miss the reporting period.  Since most property casualty policies are an “occurrence” type policy, even expired policies could have coverage if the incident of loss occurred during the policy period.   Many components also have their own warranties.  One example is an air-handling system.  Many of these have long manufacturer’s or installer’s warranties (10 years is not unusual) which run with the property, so even a subsequent buyer can make claims.  But they or their agents and jobbers have to do their due diligence to find these claims and coverages and make claim reports within the narrow periods!

When a big defect is found and especially one after statutes of limitations have run on the builder or in cases with a known-to-be-flakey or out-of-business builder, it is likely SOP to file that notice of claim with the insurer every single time, regardless of how coverage turns out.

Third, there has been a great amount said about the licensed professional, but what about defect caused by the unlicensed workman or by poor work done by an unlicensed owner?   Are they off the hook?  “No” in all states, but how and to what extent varies.  The first exposure for most such defendants, obviously, is to the licensing authority for working in a regulated trade without a license.  That can usually cause a lot of troubles, including criminal ones, for the unlicensed non-owner (and a huge amount of trouble for the real estate licensee who permits or fails to disclose it or the inspector who fails to spot it in a sale).   But most states exempt work done by an owner from licensure for work done by them personally on their own property.  In most states, though, where the owner is building with an actual or implied intent to resell, licensure obligations can still apply.   And irrespectively of whether licensed or not, the person who did the poor work is liable to injured persons for defects and damages cased by it.              

THE MORNING-AFTER HANGOVER FROM THE REAL ESTATE BINGE

There is always more to be said on this immense issue and obviously every state has some law variations, but this is the “main thrust” of these type of risks and claims and what to do about them.

The long and short of it is that our past vigorous, let-it-all-hang-out economy made for haste, a lot of mistakes and a lot of market apathy about the impact of defects and the length and scope of warranty pendencies to intrinsic condition and value.  A bad economy makes for a “morning after” discovery of those mistakes, a reconsideration of the financial impact of them…….and a lot of resultant claims not just against the builders who committed them but all those professionals in the transactional loop who did not look for or find them.   These claims are likely to cause a lot of heart pangs for the next 10 years of real estate starvation for those who were in the transactional chain and got sloppy.  That’s the negative part of this story.

The positive part is that armed with these reminders,  the owner and the professional community now knows enough to more thoroughly inspect for them in what they have and what they buy or sell and now knows what to do if they are found.  The first sin may have been to have missed the defect or warranty lapse in the first place and not do anything to discover it today even with existing holdings, but the second and worst sin is to know of one or find one and do nothing about it when something could have been done.  Letting that statute of limitations or statute of ultimate repose blow by without taking action (or, if one is a professional like a real estate licensee, property manager, maintenance manager, investment advisor, inspector) without detecting the issue now and advising the client (seller, buyer or current owner or investor) that the client needs to take action) is stepping off the jagged edge.  Unlike Wiley Coyote who only falls over the cliff if he notices that he ran past the edge, we in the real world will suffer that bloody fall whether we see the edge or not.

The solution?  It’s as the old police Sergeant used to say after he gave the bulletins of the day to his patrolmen in the 1970s hit TV serial “Hill Street Blues”:  “Hey!  Let’s be careful out there!”

‘Nuff said.

BIO FOR J. ROBERT ECKLEY

J. ROBERT ECKLEY  is a real estate, agency  and construction law lawyer with a multi-state practice.  He has written extensively in law and professional publications for these areas of law.  He received the “DISTINGUISHED AMERICAN ATTORNEY”  designation awarded by the prestigious MARQUISE’s “WHO’S WHO IN AMERCIAN LAW.”  His background is not just a legal one.  It is also a technical one.   Prior to attending law school and as his first career, he spent a decade as head of an engineering division for a Fortune 100 firm. He is founder of National BuildMasters,™ an expert construction defect consultancy.

 

He has been or is currently a member of the American Society of Structural Engineers (ASSE), Arizona Structural Engineers (ASE), the American Society of Civil Engineers (ASCE), the National Home Builder’s Association (NAHB), the American Society of Interior Designers (ASID) and the Arizona Chapter of the American Institute of Architects (AIA of Az.).   He was appointed to the national American Society of Testing and Materials (ASTM), a scientific organization analyzing national toxic levels and real estate appraisal standards in toxic or impaired environments. The ASTM findings, standards and formats are often adopted as rule, law or practice by the federal and state governments, industry, regulators and national lenders.

 

Mr. Eckley was appointed to the Arizona Registrar of Contractor’s Advisory Committee for a period of two years.   He is General Counsel for the Arizona Chapter of the American Society of Home Inspectors (“ASHI”) and has represented ASHI as amici in protection of home quality and homeownership before the Supreme Court of Arizona.  He was one of the prime amicus attorneys in the prevailing appellate work in the keystone Lofts at Fillmore case, setting Arizona precedent still followed today.  H is currently appointed to the Commissioner’s Advisory Committee for Education for the Commissioner of the Arizona Real Estate Department.

 

He has received leadership awards and honors from former California Governor and late U.S. President Reagan and former Arizona Governor and later Secretary of U.S. Homeland Security, Janet Napolitano, to cover just a few of the miles he has gone.  He is a “been there, done that” type equally at home in a suit in the U.S. Federal District Court or blue jeans hanging from a sling to inspect the roof on a hi-rise building who is often as entertaining as he is practical and enlightening!  See more at eckleylaw.com .  To be on his “Counselor’s Corner” monthly hotline e-mail to education@eckleylaw.com or call 1-800-999-4LAW and ask to get on the hotline!

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