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Practical Approaches to Managing Risk on Multifamily Construction

Multifamily projects, including mixed-use developments incorporating multifamily features, are once again a bright spot in the industry. As such, development, design and construction firms should pay close attention to risk management practices.

According to the American Institute of Architects AIA Trust, “Condominiums are one of the fastest growing types in America – with a higher than normal risk for architects.” This sentiment easily applies to condominium developers and general contractors. The claims risks posed by multifamily projects reflect both practical and legal characteristics that combine to encourage litigation.

PRACTICAL CONSIDERATIONS DRIVING LITIGATION

  • Ease of “mass/class” litigation. The economics of litigation in a single-family residential construction, especially detached construction, is discouraging to claimants by its nature. Leaving aside builders’ use of warranty terms and requirements that can tend to curb or channel claims into more builder-friendly settings (such as arbitration), typical construction defects tend not to affect numerous homes, forcing each owner to evaluate whether it is worthwhile to commit to the expense of litigation rather than simply fixing the problem (or accepting what the builder’s warranty program or private offer represents).

However, in multifamily settings, workmanship defects or materials-related deficiencies (e.g., leaks attributed to window construction or permeable exterior cladding) tend to affect multiple units, either directly (leaking water enters the unit) or indirectly (no leaks into the unit, but a fear of future leaks as well as reduced market value given the “taint” on the building). In a condominium setting, unit owners with common problems and losses can in effect share litigation costs by filing a multiple plaintiff (“mass”) action or, in appropriate settings, as a class. In an apartment setting, the owner is often well-capitalized and, considering its goals of maximizing occupancy and rental rates (true whether the owner is in “buy and hold” mode or contemplating an early sale of the project), amply motivated to pursue workmanship or materials based claims.

  • Common area/COA considerations. The existence of common areas and a COA make “mass/class” claims particularly knotty in condominium settings. Not only can a builder or developer face claims from a class of owners as well as from the COA, but a COA can be an extremely difficult opponent with which to communicate, much less effectively negotiate. A COA often includes members with varied personalities and backgrounds; for projects with a heavy population of nonresident owners, it can be difficult for the COA to function effectively at all.

LEGAL CONSIDERATIONS DRIVING LITIGATION         

Statutes of limitation and repose impose “use it or lose it” (‘it’ being litigation) pressures. Repose periods may begin to run before the first owner or tenant moves in, triggered by a certificate of occupancy (or other indication the project is ready for occupancy). For example, the six-year repose period for new construction in North Carolina generally begins to run no later than the date of the certificate of occupancy. The public availability of certificates of occupancy makes it simple for legal counsel to reach out to unit owners and COAs whose six-year repose periods are imminent. Unsurprisingly, litigation often follows such outreach.

Statutes of limitations are generally shorter than repose periods, but generally begin to run when the claimants had access to information that a claim might exist rather then when construction is substantially complete. As a rough illustration, a repose statute would kill claims for roof defects regardless of whether owners had any way to know of them. For example, in North Carolina, if the defects caused leaks beginning six years and one day after the repose period, the owners are out of luck. If the same owners began to experience leaks one day after completion, but did not file suit within at least three years from the date leaks began, they are probably also out of luck in North Carolina. In other words, a repose period typically defines the outside deadline to file suit, with the limitations period potentially cutting that deadline even shorter.

APPROACHES TO CONTROLLING LIABILITY

Firms involved in multifamily construction should consider the following means of controlling liability.

  • Notice requirements. Insert into purchase agreements or leases, as well as into condominium governance documents, requirements of written notice of any perceived defect or deficiency as a prerequisite to legal action. Notice provisions have two benefits: They allow the design and construction team to investigate and, if necessary, correct problems without litigation and, if ignored, give the defendants a basis to seek dismissal of claims for failure of notice.
  • Arbitration requirements. Require unit owners, lessees and COAs to arbitrate rather than sue in court, and permit claims to be consolidated in a single proceeding (avoiding the “death by a thousand cuts” of multiple claims by separate claimants). Recent U.S. Supreme Court decisions confirm that properly drafted arbitration requirements can require mass/class claims, as well as claims by separate owners, to proceed in arbitration rather than court.
  • Insurance program Take meticulous care that contractual liability and insurance provisions dovetail among the owner/developer, architect, general contractor and at least major trade subcontractors. The goal is to avoid gaps or inconsistencies that inhibit shifting liability to the firm or firms ultimately responsible for it. For example, claims asserting leaks, heating or cooling deficiencies or structural deficiencies are common in multifamily projects. Equally common are challenges in shifting such liability to the parties involved in designing and constructing the challenged feature due to inconsistent contract terms, or challenges imposed by inadequate capitalization or insurance coverage for a responsible party. Use of owner-controlled or contractor-controlled insurance programs (OCIP or CCIP programs, sometimes called “wrap” insurance programs) can be an effective way to ensure sufficient and consistent coverage for all major project participants.

Use of these means to control liability can help members of the design and construction team avoid the unpleasant surprise these projects can involve, such as multiple claims made years after completion, seeking damages far in excess of any fee or profit the team or its members reaped from their work.

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