Developers of Common Interest Communities: Be Prepared for the Next “Perfect Storm”

For this week’s Guest Post Friday here at Musings, I welcome a friend. John Tarley is an attorney with the Williamsburg law firm of Tarley Robinson, PLC. John is the managing partner for the firm and leads the firm’s business and litigation practices. A large part of the firm’s practice involves homeowners’ associations, as the firm represents nearly 100 associations throughout southeastern Virginia. In his spare time, John teaches two classes a semester as an adjunct at the William & Mary Law School, serves as the 9^th Judicial Circuit’s representative on the Virginia State Bar Council where he serves as Vice-Chair of the Budget and Finance Committee, and is the editor of the Tarley Robinson blog and the @TarleyRobinson twitter account.

In our practice, we represent numerous common interest communities, more commonly referred to as homeowners associations. When the building industry flourished, we also represented a fair number of builders/developers of common interest communities. Obviously, the building market has taken a big hit, and at least in our area, few, if any townhouse or condominium communities are being built. In this blog, we will address the issues faced by developers of common interest communities facing the uncertainty of liability claims for damages for defective construction.

As if the residential construction business did not have enough obstacles to recovery, the litigation pertaining to the use of defective Chinese drywall threatens the viability of these remaining builders. These builders constructed our neighborhoods of single-family homes, townhouses, and condominiums, but many remain “on the hook” for defective construction claims, including claims regarding the use of Chinese drywall.

What could these builders have done differently? Unfortunately, the answer may be “Nothing,” leaving us to struggle to find lessons from this morass. Chris has written at length about Dragas Management Corporation’s efforts to remedy its Chinese drywall issues, but has found no relief from the courts.

Chinese drywall is just the latest problem faced by Virginia builders in the past twenty years from product failures for which they had little control such as Polybutylene Pipes; Defective fire-retardant plywood used for roofing; and EIFS. Builders struggle to learn what they can do differently to shield themselves from large liability claims, but the options are few.

In condominium construction, for example, a developer provides a warranty by statute, Va. Code Ann. § 55-79.79. Although the developer’s attorney drafted the Condominium Instruments for the condominium project, this warranty cannot be disclaimed. Furthermore, although the developer will maintain control of the condominium’s board of directors for up to five years, the members of the board have a fiduciary duty to exercise their duties in good faith and in the best interests of the association. Therefore, if a known problem arises while the developer controls the condominium board, the developer members are faced with an uncomfortable dilemna: file an action on behalf of the board against its builder entity, or breach fiduciary duties by taking no action.

In addition, as Chris has written, courts in Virginia have held that the builder’s and supplier’s liability insurance policies do not cover the damages caused by Chinese drywall. Of course these decisions forced suppliers and subcontractors out of business, making it less likely that a builder can seek indemnity from other parties.

The building industry will recover, as it has from other real estate crashes. In due time, builders will once again start constructing common interest communities, including condominiums. What good business practices can a builder/developer use to minimize risk? There are no easy answers, but these suggestions can help:

• At the outset, have an experienced HOA attorney draft your governing documents. The world of common interest community law has changed dramatically. Your real estate attorney may not keep current in the ever-changing laws relating to community associations. Understand the importance of the governing documents and how you can protect your project, your company, and the association from the traps for the unwary.
• Be selective in your use of subcontractors and material suppliers. Your written indemnity agreement is worthless if there is no entity left for you to claim indemnity against.
• Establish best practices in your construction projects, including quality control and inspections during construction. All the major problems discussed earlier related to products that promised more than they could deliver. Make sure your subcontractors are using quality products that have sufficient history with stable manufacturers. Finding problems after dozens of units are fully constructed dramatically increases your exposure.
• Address warranty and punchlist items promptly and completely. You may catch a serious problem early, helping you to minimize your potential liability exposure.

It bears repeating that when the “perfect storm” hits, there may be little that you can do. That is why it is important for you to take great care when setting up your common interest community project. Those steps may help you survive the next construction industry tsunami.

As always, John and I welcome your comments below.  Please subscribe to keep up with this and other Guest Post Fridays at Construction Law Musings.