Defects

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The apartment business is booming right now. Unfortunately, construction defects persist as well, particularly in garden-style and wood-framed construction. Most developers are savvy enough to maintain a good insurance program, but many do not understand (until too late) that the policies they bought may not cover the risk of construction defects. 

As an owner-developer, neither your property insurance policy (including your builder’s risk policy) nor your general liability policy is likely to protect you from the cost of repairing defects to property you own. Most likely, your property policy has an exclusion for any damages caused by defects in construction or design. And your liability policy has exclusions for property damage to any property you currently “own, rent, or occupy.” (See exclusion J(1) below.) 

Even more surprising to some is another exclusion that prevents coverage for property damage to property that you “sell, give away or abandon” (known as the “alienated property exclusion”).  (See exclusion J(2) below) This means that for projects you develop, occupy (i.e., rent) and sell, you likely have no coverage during your occupancy of that project or after you sell  (whether to unit owners through a condo conversion or to another apartment owner). 

j.          Damage to Property

“Property damage” to:

(1)        Property you own, rent, or occupy, including any costs or expenses incurred by you, or any other person, organization or entity, for repair, replacement, enhancement, restoration or maintenance of such property for any reason, including prevention of injury to a person or damage to another’s property;

(2)        Premises you sell, give away or abandon, if the “property damage” arises out of any part of those premises;

Upon learning of this unfortunate situation, many developers ask: What good is the policy if it doesn’t cover me when I own the project and it doesn’t cover me after I sell it? Good question. The insurer’s response is that the policy only covers damage to other people’s property (like the project next door), not damage to your own property or the property you once occupied and sold.  Strangely, if you sell the project before you occupy it, coverage is more likely. 

Solutions?  There are steps you can take to minimize your risk: 

You may have recently heard that on December 11, 2013, the California Supreme Court denied the builder’s Petition for Review of the published decision in Liberty Mutual Insurance Co. v. Brookfield Crystal Cove LLC, 163 Cal. Rptr. 3d 600, Cal. App. 4th 98 (2013). For builders and contractors, this is very frustrating news and undermines…

The Oregon Supreme Court will review two recent Court of Appeals decisions related to statutes of limitation and repose on construction projects. In the first case, Sunset Presbyterian Church v. Brockamp & Jaeger, Inc., the Oregon Supreme Court will address the following questions: (1) When the construction contract includes an accrual provision, is the …

The Oregon Court of Appeals recently applied the so-called “economic loss rule” to a construction dispute (Marton v. Ater Construction Co., 256 Or App 554, __ P3d __ (2013)). Among other issues, the court decided whether the prime contractor’s negligence claim against its subcontractor was barred under the economic loss rule.

Under the…

Can parties waive both the commencement and length of the statutory limitation periods for construction defect actions?  Yes, answered the Fourth Appellate District, by allowing the parties to contractually preclude the application of the “delayed discovery” rule that normally triggers the commencement of the limitation time period and affirming case law permitting the shortening of the 10-year latent limitation period to four years.  The court did hold, however, that such waiver and shortening is permitted where there are sophisticated parties, in a commercial context, and perhaps that the contract must even be highly negotiated (or at least such negotiation is available).

On June 3, 2013, in Brisbane Lodging, L.P. v. Webcor Builders, Inc. (Cal. Ct. App., June 3, 2013, No. A132555) 2013 WL 2404154, the appellate court reviewed the trial judge’s granting of summary judgment in favor of the general contractor (“Webcor”) on the grounds that a provision in the 1997 version of the AIA 201 (General Conditions to the prime agreement between Owner and Contractor) unambiguously barred all claims, contract and tort, brought more than four years after substantial completion of the project, rather than four years after the Owner discovered the alleged breach or defect and within the 10-year statute of repose.  The key language for both the trial court and the appellate court was found in provision 13.7:

“13.7 Commencement of Statutory Limitation Period

“13.7.1 As between the Owner and Contractor:

“.1 Before Substantial Completion. As to acts or failures to act occurring prior to the relevant date of Substantial Completion, any applicable statute of limitations shall commence to run and any alleged cause of action shall be deemed to have accrued in any and all events not later than such date of Substantial Completion ….” (AIA A201, Article 13.7.1.1 (Article 13.7.1.1), bolding and capitalization omitted.)

A reminder from the Idaho Supreme Court for parties to a construction contract:  the plain language of the parties’ contract governs the obligations between them in the absence of ambiguity.  In City of Meridian v. Petra, Inc., No. 39006, 2013 WL 1286014 (Idaho Apr. 1, 2013), the Idaho Supreme Court reviewed a construction dispute between the City of Meridian and its construction manager, Petra.  Not atypically, unfortunately, a project ballooned from $12.2 million in 2006 to over $21 million by October 2008 for a variety of reasons.  As the project progressed, Petra, pursuant to its contract with the City, notified the City of the proposed increased costs of construction and the City approved them, or often the City directed the changes itself.  During this same time, Petra notified the City of Petra’s right to an equitable adjustment to Petra’s fee based on the changing nature of the project. At that time, Petra agreed to wait until the final project value was determined before submitting the fee request. Thereafter, Petra managed the project for the City through occupancy.  Approximately six months prior to occupancy, Petra issued a change order requesting an equitable adjustment in the amount of 4.7% of the excess of the original base contract, which was the same percentage used for the original fee and a significant change order previously. The City denied the request.

 

  When mediation didn’t resolve the dispute, the City filed suit against Petra for declaratory relief and alleged breach of contract, among other claims.  Although the case itself addresses a number of related and interesting topics regarding evidence at trial, evidentiary issues relating to the claimed breach by Petra, and attorney fees, the foundational issue addressed by the court is the clarity of the contract and the allowance of the equitable adjustment.  On that score, the trial court found against the City on all but the lesser claims, and awarded Petra $595,896.17 in costs and $1,275,416.50 in attorney fees, in addition to its requested (as adjusted) fee of almost $325,000.  

The Nevada Supreme Court has answered a question that developers and contractors have been asking for years:  can the statutory limitation period for a construction defect action be shortened?  The court answered in the affirmative but held that there must be no statute to the contrary and that the reduced limitation period must be reasonable …

There are now 25 states in the U.S. that hold that construction defects are not an “occurrence” and are therefore not covered under commercial general liability policies insuring contractors.  Couple this troubling statistic with the ever increasing number of policy exclusions and limitations, and we begin to realize that in many situations the contractor’s insurance policy is inadequate (or non-existent) protection against defects. 

The importance of performance bonds as security to pay for construction defects is therefore growing.  While some sureties who sell the bonds will tell you that bonds merely guarantee completion, and do not insure against latent defects, the language of the typical bond defies this position.

 

Bonds plainly state that they guarantee each and every obligation of the contractor under the contract.  Those obligations usually include the duty to perform work according to the plans and specifications, the standard of care, and without defect or nonconformity.  This author has not seen a bond that attempts to carve out construction defects from its coverage.  And bonds do not have the host of exclusions or limited coverage grants that plague the value of insurance policies.  By the same token, bonds are not perfect and owners should consider the following to get the most protection from a bond:

 

First, the bond duration should extend at least as long as the warranty period (typically one year from completion but sometimes longer) and for as many years thereafter as possible, up to the statute of repose period in the state in which the project is located.  Because construction defects often appear years after completion, the bond duration is critical.  You may pay more for a bond with a longer duration, but if the bond is needed, you should be paying less for the unreliable insurance carried by the contractor.

 

Last month the Oregon Supreme Court heard oral argument in Abraham v. T. Henry Construction, Inc., a residential construction defect case.  Shortly after the Oregon Court of Appeals published its opinion in September 2009, Ahead of Schedule authors Eric Grasberger (“Negligence Claims Take Another Twist in Oregon” and Kip Childs (“Oregon…

Today the Consumer Product Safety Commission recommended removal of all sulfur-containing drywall from homes built with the problem drywall. The CPSC’s recommendation is contained in its Interim Remediation Guidance for Homes with Corrosion from Problem Drywall. In addition to the problem drywall, the CPSC recommends removal and replacement of all fire safety alarm systems…