Construction Defects, Worn Out Systems And Components And Other Surprises

By Glenn H. Youngling

As a general rule, there is no higher duty required of community associations than to properly care for the buildings under the association's control. In a condominium complex, the duty is pervasive through nearly all of the project improvements. In a planned development, the association is typically responsible for all exterior building systems such as roofing, stucco and siding. In either case, the CC&Rs and the Davis-Stirling Common Interest Development Act (Davis-Stirling Act) require the Association to anticipate what maintenance, repair and replacement will be necessary over the life of the project. That work must then be funded and performed as required to keep the project in good repair.

When the buildings are found to have significant defects, fall into disrepair and/or sufficient funds have not been earmarked and accumulated, something has gone wrong. How a board should address this problem depends on many complex factors, but certain principles will help guide the way toward a realistic plan of action. The purpose of this article is to provide you with those principles, as well as an understanding of how they should be applied. It is important to stress at the outset that the following principles should be applied nearly simultaneously.

Examine Whole Building Systems

With the advent of mass produced housing, great economies of scale were achieved. Unfortunately, where proper care is not taken in the design and construction of mass produced housing, those same economies of scale can turn into repetitive integration of defects in large numbers of homes. All too many associations responsible for the maintenance and repair of building components start out believing defects are isolated occurrences, but later find they are part of an overall pattern of repetitive defects on a large scale. Failure to properly diagnose a defect as systematic may permit additional damage, cause under-budgeting for repairs and may even cause statutes of limitations on the larger problem to expire.

There are innumerable ways a construction project can go bad at the outset. It may be inadequate design, lack of supervision, lack of coordination between trades and/or inexperienced subcontractors. Introduction of new products and materials in the construction industry can also leave a ripple effect for years as they mature and in some cases fail prematurely. Examples include failures of ABS plastic pipes (often used in waste lines), failures in polybutylene plastic pipes (often used as water supply lines), two ply tar and gravel roof systems ("dual-80"), exterior textured coating systems ("tex-cote") and oriented strand board known as OSB (used in siding and other applications), asbestos (in textured ceilings, floor tiles, roofing, heating ducts and more), lead paint and prestressed and post tension concrete structural members.

Not all small problems end up to be large ones, but typically all large ones start out seemingly small. How does an association tell the difference? It's not always easy.

Once an association has determined that a problem exists that has the potential to grow, it must begin the investigative process. This starts with assembling the right team.

Build the Right Team of Professionals

Successful troubleshooting on a large scale requires building the right team of experienced professionals. Directors are expected (and are entitled) to rely on the advice of competent professionals.

Architect and/or Engineer. The role of the architect or engineer is to investigate symptoms of problems, define the problems, propose repair options and provide at least an "order of magnitude" of the costs of repair. It is important that this licensed professional have significant experience troubleshooting existing construction and be qualified to act as an expert if necessary in any related defective construction litigation. Depending on the nature and extent of problems, this person may bring in other consultants who have expertise in specialty areas such as soils, structural engineering, roofing, estimating and electrical systems.

Attorney. Particularly if there is likely to be litigation, the attorney assumes the role of "quarterback." The attorney must be flexible and may be called upon to act as educator, advocate, negotiator, problem solver, spokesperson, decision maker and drafter and/or team coordinator. The more experience with community associations and familiarity with applicable statutory and case law, the better. The attorney evaluates the potential claim and potential statutes of limitations, coordinates experts, advises the directors, assists with member communications, and prosecutes the litigation. If litigation is not an option, an experienced attorney will be necessary to assist in proper disclosures, governing document and statutory compliance, insurance analysis, drafting of repair contracts and implementation of a funding plan.

Others. Depending on the association's circumstances, a reserve study consultant, banker, contractor and others may be called upon to render advice and provide assistance.

Once these professionals are assembled, the association can move forward and determine the full nature and scope of the problem. Typically, this process results in a determination of the "order of magnitude" of the problem in terms we all understand - how much will it cost to fix these problems? That brings us to the next step, funding options.

Consider All Funding Options

In the simplest sense, there are two ultimate sources of funding for repairs: from outside the association (where there is insurance coverage and/or someone who has been negligent or otherwise is liable for injuring or damaging the association), or from within the association (i.e. members' pockets).

Funding From Outside the Association

Insurance is a traditional source of repair funds that comes from outside of the association. When thinking about fire or storm damage, this is a source which naturally comes to mind. Yet the interplay between third party and first party coverage and the category of loss assessment coverage often yields strong arguments for coverage where none may be apparent on the surface. For unusual defects or damage or where a claim has been denied, the association should consult with counsel experienced in insurance coverage and claims.

If the association is addressing defects or damage for which others may be liable, litigation may be a viable source of funds. In this context, litigation really is a funding option, no more and no less. A shortsighted view would see litigation solely as a funding drain. But with proper perspective, it should be viewed as a funding option that requires significant investment of funds in the "short run" with the longer term goal of collecting much more than invested. The "short run" investment funds typically come from within the association, so this funding option actually requires a working knowledge of funding from within the association.

Funding From Within the Association: Assessment Options

Regular and Special Assessments. Regular Assessments may be increased by the Board of Directors up to 20% annually without a vote of the membership (where there has been compliance with applicable financial reporting requirements). Special Assessments may be imposed up to an annual total of 5% of the budgeted aggregate gross expenses of the association for that fiscal year.

In order to raise either regular or special assessments over the amount imposed on the Board's discretion, the matter must be put to the membership for approval. A quorum of the membership must participate in the vote. A quorum is defined as more than 50% of the owners. A majority of the quorum must approve any increase over the discretionary limits placed on the Board.

Emergency Assessments. Another category of assessment is known as an emergency assessment. There are virtually no restrictions on the Board's discretionary ability to raise assessments where an "emergency situation" is present. An emergency situation is any one of the following: (1) an extraordinary expense required by an order of a court, (2) an extraordinary expense necessary to repair or maintain the common interest development or any part of it for which the Association is responsible where a threat to personal safety on the property is discovered, (3) an extraordinary expense necessary to repair or maintain the common interest development or any part of it for which the association is responsible that could not have been reasonably foreseen by the Board in preparing and distributing the pro forma operating budget. In order to impose an emergency assessment, the Board must pass a resolution containing written findings as to the necessity of the extraordinary expense involved and why the expense was not or could not have been reasonably foreseen in the budgeting process. The resolution must be distributed to the members with the notice of the assessment. Experience shows, however, that imposition of an emergency assessment on an unsuspecting membership will cause political turmoil that can overshadow the pressing need for which the funds are being raised.

Funding From Within the Association:

Non-Assessment Options

In recent years, some associations, by necessity, have become quite creative in managing their cash flow and making their finances meet pressing needs. An obvious resource that is often the first utilized is reserves. An association may borrow ("in-house") from reserve funds. (You must comply with Civil Code Section 1365.5). Another source of funds may be a conventional loan secured by reserves. This has the effect of freeing up cash in the form of a loan and locking up some reserves for the longer term. Typically there is a shortfall between the amount paid for the loan and the amount earned on the reserve, so this option is not widely used. Another resource which is now gaining wider acceptance is a conventional loan secured by the association's future assessment stream.

Identify Applicable Statutes of Limitations

When dealing with a potentially large construction related problem, the association must ask itself what legal rights may be involved and how long those legal rights will survive while other information is gathered and a plan implemented.

The period of time in which an association retains the option of enforcing legal rights is subject to time constraints called statutes of limitation. Statutes of limitation are "window periods" in which an injured or aggrieved party must file suit or be forever barred from seeking recourse in the courts. Generally speaking, these periods commence when the party knows or should have known of the wrong or injury. Depending on the legal theory applied, these windows close at anywhere from one to four years. The frequently used legal theories of negligence and strict liability lapse three years after the injured party knew or should have known of the problem. Some statutes of limitations are less.

The subject of construction defect statutes of limitations (whether original construction or subsequent work) generally requires sorting out a myriad of facts and applying them to complex legal principles. For example, facts which may evidence that the clock has started to run may be found in: (1) references to problems or unbudgeted expenses in the board minutes or manager reports, (2) letters to the developer or builder complaining of problems that should be fixed by them, (3) reports from contractors performing maintenance or repairs for the Association stating that further problems should be addressed, (4) complaints from owners to the association, and (5) meetings with an attorney to inquire as to legal rights.

For every general rule, there are nearly always exceptions. Factors which may extend the existing statutes of limitation or start them over again are often narrowly construed by the courts but may include: (1) builder repairs or other work performed to the problem areas, (2) promises by the developer or contractor to repair which are not fulfilled, (3) faulty repairs by the contractor or developer and/or (4) developer control or management of the association over a significant period of time.

There may even be different time frames applicable to different problems and to different parties. It is also not at all clear when an association as an entity has notice of a problem, as opposed to members, a manager or a minority of directors.

To make matters more complicated, regardless of what "window periods" may have existed earlier on a new project, one general rule for which there are few, if any, exceptions is the ten year cut off for actions for injury to real or personal property arising out of latent defects in the design, planning, or construction of improvements to real property. This ten year time frame does not automatically give an association ten years in which to bring an action, it acts to cut off all other rights on the tenth anniversary. This is true whether or not the defects have manifested themselves.

Once you are aware of a problem, it is your duty to obtain sufficient information to make informed decisions and act. The legislature and courts have little or no "sympathy" for those who fail to act in a timely fashion, regardless of the reason.

Even if your project is more than ten years old, there may be legal rights that need evaluating. For example there may be premature failure of work performed for the association, such as reroofing or other reserve component expenditures.

The bottom line is that evaluation of legal rights and how long those rights survive requires the assistance of experienced legal counsel.

Communicate With Your Members

It is extremely important that the association maintain good communications with members. One difficulty is the lack of full information at any particular point in time, especially early in the problem evaluation process. It is often not fully appreciated that informing members of what you do not know can be as important or more important than telling them what you do know. The following could be used to provide you with a structure for your communication memo to owners:

1. Tell them what you know.

2. Tell them what you don't know.

3. Tell them what you are doing about what you don't know.

4. Tell them when you expect to have sufficient information and when the association is likely to act on the information.

As an example and in greatly abbreviated form, such a communication might look like the following:

The Association has received complaints from many owners about leaks. Temporary efforts are underway to stop active leaks, but the Association does not know what the underlying problem may be or how widespread it is. The Association has retained an architect to investigate the waterproofing systems. The Association has retained counsel to advise it of what legal rights it may have and how long litigation will remain a funding option. A report from the architect is anticipated in about ninety days. Thereafter, the Association will examine the recommendations and it hopes to act on them at that time. To report a leak, please contact the manager. If you are offering your home for sale, you should consult with your real estate agent regarding appropriate disclosures. The Association will periodically provide you with additional information as it becomes available.

Providing accurate general information in a timely manner is important to building community and forming the support necessary to see through whatever problem is facing the association. Also, with many associations being targeted by disgruntled buyers for nondisclosure issues, consistent and accurate communication will serve as the best defense against those lawsuits.

In Conclusion

Following these five basic principles should give you the tools necessary to develop and implement a course of action which will ultimately result in safe and maintainable buildings that hold their value, as well as provide an attractive and desirable community in which to live.