Condominium work for developers, construction managers, contractors, and design firms continues to be strong after being scarce following the 2008 economic collapse. Many millennials and other first time buyers can and want to invest in condo units in urban areas. And renting is less attractive to a maturing class of residential market participants as they downsize from single-family homes. Condo projects can be tempting work for the design and construction industry but are also high-risk. So how does one successfully manage the risk to compensation ratio?
Know Thy Client
The risk in multifamily housing has been well-documented. A developer who insists on low-quality materials or systems, who minimizes the role of the design team in detailing the design, and who saves costs through construction efforts that focus more on speed than quality can cause the condo project to be plagued with replicative problems. In addition, the expectations of purchasers—often because of marketing hyperbole—tend to be high. Answering to too many “clients” is always a problem.
When a condo is sold based on classy features in each unit or unique amenities in the common areas with no mention of the integrity or durability of the building, buyers often do not understand that their investment could be at risk because of design inadequacies or construction defects. So claims not only come from the actual client—the developer—in the form of cost recovery efforts but also from disappointed buyers and their condo governing body. The law increasingly makes claims from unit owners and their home owners association possible and the cost of such claims can be significant. Therefore, it’s important to manage client expectations and focus on negotiating a fair and reasonable contract for services.
Proactive Risk Management
To a large extent, risk has increased as contractual protections have decreased. For at least the past decade, there has been a steady decline in common law contractual protections. Specifically, privity—the limitation on the ability of an aggrieved party to recover economic losses to only those who have a contractual relationship—has consistently been attacked, and in some instances, completely abandoned.
Because contract law protections have softened with time, there is an even greater need for the design and construction team to proactively manage risk. In many jurisdictions, traditional contract law which protected design consultants and contractors from liability to third-party beneficiaries has been undermined. For instance, in a 2014 California case where a home owners’ association sued the architects of the project—in a situation where the original project was converted into condominium units after its completion—the court held that “an architect owes a duty of care to future homeowners in the design of a residential building where [ ] the architect, in providing professional design services, is not subordinate to other design professionals. The duty of care extends to such architects even when they do not actually build the project or exercise ultimate control over construction.” (In Beacon Residential Community Association v. Skidmore, Owings & Merrill LLP)
Condo work always has presented unique opportunities and risks. The risks continue to expand because contractual protections continue to shrink in the courts and legislation has not countered the judicially enhanced exposure. However, even with the erosion of legal protections and the absence of legislative responses to bring reasonableness back into the risk-reward equation, there are creative solutions to solve many of the problems associated with condo work.
Many condominium design and construction issues for construction managers, designers, and contractors can be resolved with good planning. For instance, one of the major risks to the parties that design and build condos is the client—a developer usually insulates itself from risk by creating a single-purpose entity for that project which is dissolved once the ownership of the project is turned over to the homeowner association. Any exposure when a claim arises is left with those who were involved in the project’s design and construction. While construction contractors also can set up separate entities for projects—and usually are protected by them—the licensed professions cannot do so. Professional services, especially those subject to licensure, means that professional firm is usually at risk at least throughout the period of the statute of repose for design-related claims.
From the perspective of parties involved in the design and construction of condos, the greatest risk management technique is to provide only services for developers who have a long-term stake in the success of each project. They are the clients that are willing to commit to design excellence, construction adequacy, testing and confirmation protocols, and marketing realism.
Governance as Risk Deterrent
An experience developer who wants to prevent misunderstandings and needless litigation can help in other ways. The homeowner association’s governing documents and purchase and sale agreements can be written to help reduce and allocate risk. In most states, condominium bylaws and individual unit purchase agreements can be tailored to restrict the HOA and the unit owners’ power to pursue claims for construction and design defects to a specific time limit following turnover or possession. HOA bylaws can include deterrents like a certificate of merit as a condition precedent to a suit, attorney fee-shifting provisions to discourage entrepreneurial lawsuits, and mandatory mediation or arbitration to avoid the costs and risks of litigation.
There are also “informed consent” efforts that are valuable. Requiring a condo unit buyer to obtain an inspection prior to purchase, followed by signing a release as to the condition of the unit based on that inspection, can also limit issues that can be brought in a subsequent suit.
Design firms also can prepare information on project maintenance for the developer. Such a maintenance manual could be included by the developer in the HOA’s bylaws and additionally, the developer establish a reserve in the project budget for corrective actions or maintenance of the facility at least throughout the applicable statute of repose. Such a fund is in fact required in some states.
The maintenance manual can be helpful in making the HOA aware of the necessity of a continuing investment the common areas. Design firms, however, should not prepare for the developer or the HOA a budget for the ongoing costs of maintenance. This extends the exposure of the design firm into an area beyond the firm’s expertise; establishing and sizing a reserve fund is best done for the developer and HOA by a reserve specialist.
These actions can be somewhat helpful in deterring plaintiffs’ attorneys who specialize in condominium claims, soliciting HOAs and suggesting that fiduciary duties require their boards to pursue design and construction defect claims for their buildings.
All multifamily housing projects tend to have an incongruity in the risk to compensation ratio. Working with a client that understands the need for careful construction of a satisfactorily designed project is critical to managing risk. A developer that is willing to work in the transition from marketing to management so that maintenance problems can be avoided and life-cycle project success can be attained is invaluable. As condos become an increasing part of the residential mix, it is important to learn from the past to moderate the incidence of future claims.
Keep your eye on the four keys to success:
- Know your client;
- Be proactive in your risk management program;
- Be selective in whom you work with and for; and
- Focus on areas where you can proactively mitigate the likelihood of future claims.
These tenets will help guide design firms as they work to navigate a very challenging type of project that is now very much in demand. The firms that can find a way to perform well and consistently in this growing arena will be set up for future success.
Victor O. Schinnerer & Company, Inc. and CNA work with the AIA Trust to offer AIA members quality risk management coverage through the AIA Trust Professional Liability Insurance Program, Business Owners Program, and Cyber Liability Insurance to address the challenges that architects face today and in the future. Detailed information about both these programs may be found on the AIA Trust website, TheAIATrust.com.