Monthly Archives: May 2017

Third Appellate District Holds Right to Repair Act Precludes Certain Common Law Claims for Damages Caused by Construction Defects

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Michael C. Parme and Zachary A. Price | Haight Brown & Bonesteel LLP | May 23, 2017

In Gillotti v. Stewart (No. C075611, filed 4/26/17, publication order 5/18/17), the California Court of Appeal for the Third Appellate District held that the Right to Repair Act, Civil Code section 895, et seq. (the “Act”) precludes common law claims for damages caused by construction defects within the scope of the Act, subject to its specific exclusions. The Gillotti decision deepens a split of authority between the Third and Fourth Appellate Districts regarding the scope and preclusive effect of the Act.

Background

The Act was enacted by the Legislature in 2002 and establishes a set of building standards for new residential construction, prescribes prelitigation procedures to allow repair of defects without litigation, and provides homeowners with a statutory cause of action against builders involved in the sale of homes and others (including general contractors and subcontractors) not involved in the sale of homes, for violation of the building standards. The Act allows a homeowner to recover, upon a showing of violation of any applicable standard, economic losses without having to show property damage or personal injury. In that regard, the Act abrogates the economic loss rule and legislatively supersedes the California Supreme Court’s holding in Aas v. Superior Court (2000) 24 Cal.4th 627 that homeowners cannot recover damages in negligence from builders for construction defects that have not yet caused property damage or personal injury.

The Trial Court Decision

In Gillotti, the plaintiff purchased a newly-constructed vacation home that developed numerous problems, which included removal of two large trees from the front yard because they were dying and branches were falling from them. The plaintiff filed a construction defect lawsuit against the builder/seller, general contractor, and grading subcontractor. The plaintiff presented evidence the trees were dying due to the addition of mounds of soil on top of the tree roots by the grading subcontractor. This was done by the subcontractor in order to level the driveway on the sloped lot. As the subcontractor was not engaged in selling homes, liability under the Act depended on plaintiff proving the subcontractor negligently caused violations of the Act’s building standards. The jury found the subcontractor was not negligent in any respect. The plaintiff thereafter moved for judgment notwithstanding the verdict or a new trial, arguing in part that the trial court improperly barred a common law negligence theory against the subcontractor. The trial court denied the motions, ruling that Section 897 of the Act required the exclusion of plaintiff’s common law negligence theory.

In denying the motions, the trial court noted that its decision conflicted with the California Court of Appeal for the Fourth Appellate District’s decision in Liberty Mutual Insurance Company v. Brookfield Crystal Cove LLC (2013) 219 Cal.App.4th 98 (Liberty Mutual), issued subsequent to the jury verdict but not cited by the parties in post-trial motions. Liberty Mutual held that the Act “does not eliminate common law rights and remedies where actual damage has occurred” and, therefore, did not bar the common law claims in an insurer’s subrogation action to recover from the builder for payments made under a homeowner’s policy.

The Third District Court of Appeal Affirms

On appeal, the plaintiff argued that the trial court improperly construed the Act as barring a common law negligence claim and failed to follow the Liberty Mutual decision. The Court of Appeal expressly disapproved of the Liberty Mutual decision, concluding the Act does bar common law claims for damages caused by construction defects within the scope of the Act, subject to the Act’s specific exclusions (e.g. fraud, personal injury, etc.). It noted that the Act’s statutory language “clearly and unequivocally expresses the legislative intent that the Act apply to all actions seeking relief of recovery of damages arising out of, or related to deficiencies in, residential construction, except as specifically set forth in the Act,” and that the Act “does not specifically except actions arising from actual damages.” The court further confirmed that the specific driveway issues underlying the plaintiff’s claim were within the scope of section 897 of the Act.

Gillotti adopts a view of the Act that has gained traction in the courts since Liberty Mutual. Indeed, courts are interpreting the Act as a limitation on the legal theories and rights available to a plaintiff who pursues damages in a construction defect lawsuit. Over the past two years, the efficacy of the Liberty Mutual holding, and its narrow view of the Act’s preclusive effect, has been questioned by the developers, contractors, and insurers that defend such lawsuits. The deepening split on this question suggests it is likely to be resolved by the California Supreme Court. The case of McMillin Albany LLC v. Superior Court (2015) 192 Cal.Rptr.3d 53, currently pending before the Supreme Court, will most certainly provide guidance as to which view will ultimately prevail.

Construction One-Minute Read: Allowance or Contingency?

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Randolph E. Ruff and Jonathan M. Mraunac | National Law Review | May 24, 2017

While both relatively simple concepts, allowances and contingencies are often confused with one another. Conflating the two can lead to pitfalls. An easy way to remind oneself of the difference is: allowances are for known unknowns, and contingencies are for unknown unknowns.

Allowances

An allowance is an amount established in the contract documents for inclusion in the contract sum to cover the cost of prescribed items not specified in detail.  Variations between such amounts and the finally determined cost of the prescribed items will be reflected in change orders appropriately adjusting the contract sum.  Contractors may want to keep the following points in mind when allocating and drafting allowances:

  • Allowances are often used: (1) to permit flexibility in materials selection, such as the selection of finishes, lighting, or plumbing fixtures where the specifications have not been finalized; or (2) where a particular scope of work is anticipated but the extent of the work required is unknown at the time of contract formation.
  • Allowances for materials usually cover only the cost of the materials and not the cost of labor to unload and install the materials or the cost of any design necessary for installation. The labor cost usually is already factored into the contract price.
  • Allowances can be drafted to address the following:
    • Whether the allowances cover material only or both labor and material
    • What disclosure and authorization are required to exceed the allowance amounts
    • Whether overages and underages are reconciled through change orders or through the contingency

Contingencies

A contingency is an amount added to an estimate to allow for items, conditions, or events for which the state, occurrence, and/or effect are uncertain and that, in the contractor’s experience, will likely result in additional costs.  There are two general types of contingencies: (1) owner reserve (an amount set aside for additions to the project’s scope or owner’s risk items); and (2) contractor contingency (an amount built into the contractor’s anticipated price for the project to account for various risk factors that cannot otherwise be accounted for in a schedule of values). A contractor contingency is used because there is a degree of statistical certainty that unpredictable individual costs will arise; accordingly, the amount of the contingency is set at a level that balances the desire to have liquidity with the need to control risk. Contractors may want to keep the following points in mind when formulating contingencies:

  • There are many risk factors for which to account, such as: incomplete designs; scope errors; construction disturbances (strikes, accidents, or breakdowns); bankruptcies; regulatory risk; estimating inaccuracy; technological change; calamitous weather; and unanticipated price or interest rate increases.
  • Contingency disputes often arise on projects with cost-plus contracts with a guaranteed maximum price (CP/GMP). Because the contingency is within the GMP, the owner “funds” the contingency from which costs arising from the enumerated risks are drawn until the contingency fund is exhausted. Any unspent contingency funds at the end of the project typically revert to the owner or are shared. Disputes arise over entitlement to access the contingency, permitted uses, and misconceptions about the role of contingency.
  • A good contingency clause does the following:
    • Clarifies whether the contingency is an owner’s reserve or a contractor’s contingency
    • Describes the types of costs (risks) for which the contingency is to be used
    • Sets out the process by which contingency is accessed during the project
    • Describes the paperwork and approvals needed to use contingency
    • Describes the supplemental funding of contingency and sharing of unspent contingency at project closeout.

The contractor’s contingency exists to mitigate project-related risks for which the contractor is responsible. The contractor’s contingency can be understood by all parties to be “spent” money. Disputes frequently arise when the parties lose sight of the basic purpose of the contractor’s contingency and view the contingency as a possible source of project cost savings.

Subcontractors Must be Careful Providing Bonds when General Contractor Does Not

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Christopher G. Hill | Construction Law Musings | April 5, 2017

After I wrote the title to this post, I thought, “Well, that says it all, doesn’t it?” I also considered the fact that for those that read this construction law blog on a regular basis, I am likely stating the obvious. I then thought about the fact that there can be confusion regarding the purpose of bonds versus insurance. Couple this with the fact that Murphy was an optimist, and I thought this would be a good reminder.

Bonds and insurance have one fundamental difference between them. When your construction company buys insurance, that insurance is meant to protect your company. When your company provides a payment and/or performance bond, that bond is there not to protect your company but to protect everyone else on the job and the project itself. Where insurance will pay for your company’s qualifying errors so that that money does not come out of the bottom line, a bond contract will have an indemnification agreement whereby anything paid by the surety will then be reimbursed by you and your company dollar for dollar (as opposed to just the premium).

Given the above, the basic answer to why a subcontractor should be careful of providing a payment and performance bond on a construction project where the general contractor is not providing a bond is that it adds more imbalance to an already unbalanced relationship. The subcontractor is looking uphill for payment and may face contractual issues from a “pay if paid” clause to flow down notice and other provisions from the prime contract. To add payment and performance bonds to the mix, particularly where the general contractor does not provide the same, puts the subcontractor in the position of adding a layer of protection to the general contractor over and above that found in the contract. This is a layer of protection that the general contractor is correspondingly not willing or able to provide to the subcontractor.

Some other questions that should come to mind where this scenario plays out are the following: 1. Is the general contractor in a financial position to be bondable? Its lack of a bond may be due to some financial instability that pushes sureties away because any indemnity would be worthless. 2. Is this a general contractor the subcontractor want to work for? Clearly in this situation, the general contractor is not willing to trust that the subcontractor will be able to complete the work. 3. Is the subcontractor truly willing to take on this additional risk?

Of course, many of these issues are mitigated in the instance where the general contractor provides its own payment and performance bond and exercises its rights either contractually or by statute (such as the Little Miller Act) to require subcontractors to provide bonds.

Construction Defect Reform in CO; HB 1279: Pluses, Pitfalls & Practical Pointers

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Rebecca W. Dow | Holland & Hart LLP | May 23, 2017

Construction defect litigation reform will take a small step forward this week when Gov. John Hickenlooper signs HB 1279 on May 23, 2017. HB 1279 will go into effect immediately after signature by the Governor, and developers and residential builders will need to be aware of certain aspects of the law. HB 1279 has been much touted as a bipartisan effort toward addressing the housing squeeze in Colorado, as reflected by just 3.4 percent of new housing starts in 2016 being for sale condominiums in the Denver metro area. HB 1279 passed unanimously by both the House and the Senate on May 4, 2107. This is the first piece of legislation passed in the last several years to address any aspect of construction defect litigation reform, although during that time more robust construction defect reform ordinances have been passed by approximately 12 cities and counties in Colorado. HB 1279 offers some pluses to developers/builders, but also contains some pitfalls, as discussed below. Finally, this article will provide some practical pointers for residential construction under HB 1279.

PLUSES OF HB 1279:

  1. Majority approval of the owners is required to bring construction defect litigation in a common interest community, as compared to the current approval of only the board of the homeowners association (typically three owners).
  2. Owners are required to be provided notice of a proposed construction defect action, together with 10 specified disclosures, including the potential for increased costs for repair of alleged defects; the applicable legal deadline for filing the claim; that owners might owe a duty to disclose known defects until repaired; the fee arrangement with the association’s counsel; disclosure of other costs related to the action, such as expert fees; that if the action does not prevail then owners may be responsible for paying their own fees and the fees of the opposing party; that the association may not recover enough funds to repair the claimed defects; until claimed defects are repaired the market value of the units might be adversely affected; and until claimed defects are repaired, owners might have difficulty refinancing or buyers might have difficulty obtaining financing.
  3. Prior to the vote by the homeowners, a meeting must be held and the developer/builder is invited to attend and will have an opportunity to address the owners concerning the alleged defect, which developer/builder may, but is not required to, include an offer to remedy the defect.

PITFALLS OF HB 1279:

  1. Homeowners associations and their attorneys are expressing dissatisfaction with the breadth of the required notice, citing costs and expertise to make such disclosures, and are arguing that such disclosure requirement is potentially a violation of the First Amendment’s prohibition of forced speech, which means basically, that the government cannot compel a corporation to make statements of value, opinion, endorsement, or statements of fact that the corporation would rather avoid.
  2. State preemption of the numerous city and county ordinances under an argument that construction defect reform is a matter of state interest, as evidenced by HB 1279, has become a greater threat.
  3. Majority approval by the owners does not include “nonresponsive” owners, which is not defined other than to state that if the vote is challenged, the court shall consider whether diligent efforts were made to contact the owner, whether mail was undeliverable, whether the owner is occupying the unit, and if other contact information such as email or a phone number were used. The majority vote also does not include owners of home types different from the product type subject to the claimed defects, even if in the same association. Votes of lender-owned units are not counted, nor are units owned by a broad list of development parties, including any person responsible for any part of the design, construction or repair of any portion of the community and their affiliates and spouses.
  4. The statute of repose and limitations is tolled during the voting process, and the association has 90 days after mailing of the notice to the owners in which to obtain the vote.
  5. No vote is required if the defect is in a nonresidential facility and the cost to repair does not exceed $50,000. Approval by the owners is not required for the association to proceed with litigation “when the association is the contracting party for the performance of labor or purchase of services or materials”. This appears to refer to work performed by the association; however, the drafting is overbroad and could arguably exempt owner approval for litigation if the association is the contracting party to repair the claimed defect.

PRACTICAL POINTERS FOR HB 1279:

  1. Developers/builders will need to continue to implement numerous strategies to attempt to mitigate risks of construction defect litigation, such as third-party inspections; owner-controlled or contractor-controlled wrap insurance programs; imposing binding arbitration through plat notes, declarations, and retail sales contracts; avoidance of common interest communities when possible; and best practices as to reserve studies, disclosures to homebuyers and turnover procedures to associations.
  2. Many current declarations contain notice and voting procedures with requirement of 67% approval by owners to bring litigation, and will conflict with HB 1279. These declarations should be reviewed, and if possible, amended; particularly to separate binding arbitration provisions from notice and vote provisions that may conflict with HB 1279. Future declarations should be updated to reflect the new law, with the caveat that HB 1279 may be challenged in court due to the “pitfalls” noted above.

Will CO’s New Construction Defects Law Revive its Stagnant Condo Market?

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Kim Slowey | Construction Dive | May 23, 2017

Colorado, like many urban areas across the country, is experiencing a building boom. The influx of new residents has largely been attributed to the state’s physical beauty, culture of recreation and burgeoning tech industry — a magnet for young workers and families. In fact, in its latest survey, Mayflower Moving Company found that, behind Chicago and Dallas, more millennials are heading to Denver than anywhere else in the country.

Others have cited the legalization of cannabis for the recent boom, as industrial areas in Denver undergo a pot-fueled gentrification, bringing in new grow businesses, marijuana retail stores and a marijuana tourism industry, along with the requisite workers.

So, what better way to foster and promote the resulting demand for affordable housing than by making construction of condominiums, which are typically an entry-level vehicle to homeownership, a winning proposition for contractors and insurance companies?

Unfortunately, that wasn’t the case until very recently.

In the 1990s and early 2000s, there was an uptick in defect lawsuits, particularly in the condominium market, according to Jonathan Pray, shareholder at Brownstein Hyatt Farber Schreck in Denver. An offshoot of that wave of litigation was a rise in the cost of insurance policies. As a result, insurance premiums went up, and developers left.

In 2005, the year that more restrictive construction defects provisions were legally enacted to protect homeowners was enacted, condominiums made up 20% of the housing market. Now, they represent only 2% to 3%.

“The original [defects] statute was intended to create a vehicle for plaintiffs’ defect actions to go forward,” Pray said. “There weren’t meaningful protections for developers or contractors. It was a pro-homeowner framework.”

However, a change to that environment was firmly planted earlier this month when the Colorado Legislature landed a blow against that lawsuit-inspiring legislation and passed a bill requiring that a majority of condominium owners approve builder defect lawsuits, not just a majority of the HOA board. It also mandates that homeowners be informed about the drawbacks and benefits that could come from filing a lawsuit.

But will the new law be enough to breathe life back into Colorado’s condominium market?

The current condo construction environment

Lane Schwarzberg, national client manager at Partner Engineering and Science in Denver, said, “Since the late 1970s, the construction defect law has grown into its own industry, generally focused on condominium projects at a large expense to contractors and [the] insurance carriers that underwrite commercial general liability policies.”

Because of the “litigious nature” of those laws, he said, condo construction carries a significant risk of liability, and that has all but halted condo development.

In fact, Denver officials have said the risk of litigation for condo construction defects adds $15,000 per unit to construction costs.

“Insurance got more and more expensive until it wasn’t viable for developers to build condos any longer. It was too expensive, or they couldn’t get it at all.”

Peter Knowles

Executive president at Rider Levett Bucknall

Peter Knowles, executive president at Rider Levett Bucknall, a global AEC cost consultancy firm, said the defect laws made it easy for homeowners’ associations, sometimes consisting of only three members, to make legal decisions regarding construction claims a simple prospect.

“They really didn’t need to jump through many hoops to bring those lawsuits,” he said. Because the lawsuits were coming so fast, contractors and developers had to take out pricey insurance policies to cover claims.

“The argument,” Knowles said, “is that insurance got more and more expensive until it wasn’t viable for developers to build condos any longer. It was too expensive, or they couldn’t get it at all.”

Builders and developers were not the only ones harmed by the unrestrained ability for homeowners’ associations to bring lawsuits against builders. Pray said some homeowners, who might not even have realized that their HOA filed a suit, encountered difficulties in selling or refinancing their units while in the middle of litigation.

Architects and designers, he said, can be sued as well.

“It definitely happens,” said architect Nathan Sciarra, associate principal at KTGY Architecture + Planning, “but more often than not, the developer is brought in and then they bring in the contractor and design team. We all get dragged in somehow.”

Sciarra said apartment projects have been filling in the condo gap. Total new residential units in Denver are in line with past years, but rentals make up 75% of those figures rather than the traditional 25%, he said.

What’s next under the new measure

The majority of experts agree that the change passed by state lawmakers could potentially stimulate new condo work, but they say it’s going to take time for insurance companies to feel comfortable lowering the dollar amount of policies and to see the condo market in Colorado as less risky.

In addition, there were additional measures left on the table that could have sped up condo development but that the legislature found too contentious.

Those include a binding arbitration agreement, allowing judges in defect lawsuits to set percentage of liability for subcontractors at the beginning of the legal process, letting condo owners work directly with construction companies in resolving conflicts, and an effort to redefine what constitutes a defect.

Nevertheless, Pray said the turnaround could take a few years. “My hope is that the bill will get developers back in the market,” he said. “Getting development back in the market will create better loss histories, and that will bring rates down.”

If there isn’t a sea change in the next year or two, maybe there would be an appetite to revisit some of the other measures. This is a great first step.”

Jonathan Pray

Shareholder at Brownstein Hyatt Farber Schreck

Schwarzberg said, “Denver is one of the busiest markets in the country for [our company]. We’re seeing that with a strong population growth and continued shortage of housing, the multifamily market here is especially hot. Municipalities want to increase the stock of condominiums in their cities for young professionals and empty-nesters.”

He added, “While the direct impact of the new law remains to be seen, I expect that reducing an obvious creator of liability risk will [eventually] encourage more risk-averse developers to enter the condo market here at such a competitive time.”

Even with such a modest change to the law, according to Sciarra, opponents of the new regulation say the only ones who will benefit are developers and that the change will promote shoddy construction.

But don’t look to Colorado lawmakers to revisit the issue of defects anytime soon.

“I think that the appetite in the legislature for running another construction defects bill will be fairly low after this,” Pray said. “The next year will be telling to see how many projects get back in the pipeline. If there isn’t a sea change in the next year or two, maybe there would be an appetite to revisit some of the other measures. This is a great first step.”