Consider Your Condo Conundrum

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Article provided by Professional Liability Agents Network

Residential design and construction is booming across many parts of the nation. A recovering economy and shortage of housing has led to good times for home designers and builders.

Within the residential sector, condominiums, townhouses and similar multi-resident complexes have been in particularly high demand. Baby-boomers are downsizing as they reach retirement and seek a smaller living space and a low-maintenance environment. At the same time, millennials are choosing multi-unit housing for their initial real estate purchases due to the high cost of single family homes and the many amenities residential complexes can provide.

For architect and engineers, this construction boom presents a double-edged sword. Many residential designers are finding a big demand for their services, which means added business and income. But, unfortunately, these multi-resident complexes, condos specifically, are by far the riskiest type of structure to design when it comes to professional liability.

What’s All the Worry About?

Why do condominium projects present such a conundrum for designers? Here are our top 10 worries:

  1. Highly leveraged developers. Not all condominium developers are highly leveraged, but a disproportionate number are. It’s not surprising to discover that a condo developer operates through a shell corporation and, should they get into financial trouble of face a claim, there are few assets to be found. This often means designers, contractors and others will be brought into any dispute or suit regarding the project.
  2. Low design fees. To shave costs and maximize profit, developers often look for low-bid designers and contractors to work on their projects. That means design fees are low and the designer’s profit margins squeezed. The risk versus reward ratio can be way out of balance.
  3. Narrow scope of services. Condo developers often cut costs by only paying for the most basic of design services. Activities such as construction observation are often cut from the designer’s scope, and this increases risk substantially.
  4. Below par construction. Just as developers may slash design services from the designer’s scope of work, they may also scrimp on materials and construction services. It’s not unusual for developers and their contractors to demand material substitutions that are cheaper and of lower quality. They are quick to “value engineer” the project as a cost-cutting effort, which usually takes further from the quality of construction. That leads to construction defects and claims.
  5. Duplicative construction, duplicative liabilities. With many large condominium projects, a lead architect is hired to design a few basic condominium units and those designs are then constructed many times over throughout the complex. This results in a low fee for the designs and substantial liabilities if a design or construction error is replicated throughout the entire project.
  6. Unsophisticated buyers with unrealistic expectations. As mentioned previously, elderly retirees and young first-time home buyers are two of the primary markets for condominiums. These unsophisticated real estate investors are often wooed by the developer’s shiny marketing brochures and enter their new residences with extremely high expectations. When expectations aren’t met, claims aren’t far behind.
  7. Poorly run homeowners’ associations. Virtually all condominiums are run by a homeowners’ association (HOA), which governs the day-to-day operations of the complex. The quality of HOA management varies greatly — some ensure the grounds and common facilities are expertly managed and maintained; others, not so much. The HOA assessments are needed to help maintain common areas, which for condos include the exterior structure. These assessments are often inadequate and maintenance requirements are not followed. Consequently, many HOAs are quick to file shotgun claims against developers, contractors and designers at the first sign of paint chipping or sidewalks cracking.
  8. Legal pitfalls. Many states have specific laws, including “homeowners protection” acts, regarding duties owed by the designer to the individual owners of the condominium units. When states impose this duty and apply the doctrine of joint and several liability, the designer may find itself fully liable for all damages sought in a class action suit even though their design error was only a minor part of the overall claim.
  9. Aggressive lawyers. Add together all of the potential liabilities listed in the eight reasons above and it’s not surprising that litigation lawyers consider condominium projects breeding grounds for potential business. Indeed, some lawyers seek out condominium HOAs and conduct a witch hunt, looking for design and construction flaws they can blame on developers, contractors and designers. They remind the HOA board of directors that they each have a personal fiduciary liability to serve all of the association’s members. Unfortunately, it is the designer who gets hit the hardest financially when the developer no longer exists and the contractor lacks appropriate liability insurance.
  10. Costly, hard-to-find insurance. Considering the nine issues above, it’s no surprise that insurance companies are not lining up to offer professional liability coverage to designers of condominium projects. But some level of coverage can normally be found. Some insurers put a tight cap on the amount of condo work they will cover, or the aggregate limits they will pay out. Some insist on placing condo work on a separate practice or project-specific policy with high premiums.

Making Condo Work More Palatable

No doubt, the liability issues associated with condo projects are daunting. But that doesn’t mean you need to turn your back on all potential condominium work. It just means you have to approach such projects with your eyes wide open and the steadfastness to demand certain safeguards. Here are 10 rules you should apply to any condo design work you may consider.

  1. Only work with developers with a successful track record building condos and a commitment to quality. If a developer lacks a history of successful projects or has a long trail of condo claims, it’s probably time to say “Thanks, but no thanks.” You don’t want to be the guinea pig for a developer just entering the arena or trying to finally get one condo project right. Your early conversations with a developer should give you a strong clue as to where design and construction quality falls on its priority list. If you don’t hear a strong commitment, it may be time to look elsewhere for your next project.
  2. Choose developers with a penchant for risk management. Conscientious developers should be well aware of a condo project’s reputation for high liability risks and be open and up front about their approach to risk management, including the use of counsel for the entire team. The best protective measures need to be deployed as a team: developer and design team. The developer needs to be willing to pay for certain services that will help reduce the likelihood of future claims, such as an envelope consultant and an acoustical consultant.
  3. Set up legal protections and requirements. The team can apply legal steps to take away some of the tools used by enterprising HOA attorneys. For example, the team could build rules and requirements into the condominium plan and/or the declaration of condominium. Some of those requirements might include a super majority vote to bring claims against the development team; the development team’s right to repair before litigation; acquiring a certificate of merit from peers prior to bringing claims against the development team; O&M procedures to be followed and documented in order to bring claim against the development team (or a limitation of liability will apply); a shortened statute of limitations where possible; and more. A competent design firm attorney will be able to assist in crafting such language on behalf of the developer and design team.
  4. Look for adequate project financing. Don’t hesitate to discuss the developers financial standing. Ask for recent financial statements, and be willing to share yours as well. Ask about budgets, contingency funds and any bankruptcies or other financial problems with past condo projects.
  5. Avoid single-purpose LLCs or other paper or shell corporations. Try to draft your contract with the entity that holds the bulk of the developer’s assets. If the project is operated as a single-purpose company, ask about previous such entities and seek references from the design firms that worked on those projects.
  6. Insist on providing a full scope of services. Construction observation and detailed and complete construction documents are essential to claims-free condominium projects. Push to include peer design reviews and contractor constructability reviews to supplement your services as well.
  7. Avoid projects with low-bid contractors. Contractor selection should be quality-based, not price-based. If you are involved early in the planning process, insist on helping to select or at least approve the contractor as a condition of accepting the project.
  8. Examine the developer’s marketing approach. To whom is the developer marketing the condo project? What promises or guarantees are they making through their sales and marketing effort? Overpromising leads to sky-high expectations, which lead to disappointment and, finally, to claims. Don’t hesitate to bring up your objections to the developer’s marketing efforts, and explain why you have concerns.
  9. Insist on approving all substitutions and changes in materials and design. Your designs should stress quality above all, and cheap substitute materials only sabotage your efforts. This is particularly true when it comes to building envelopes and mechanical systems such as HVAC. You have every right to demand to approve every design, material or equipment change.
  10. Schedule and conduct regular communications. Start with risk management discussions with the developer and contractor prior to signing the contract. Push for bi-weekly face-to-face meetings with project parties throughout design and construction. Meet with the HOA board at occupation to discuss management and maintenance of the complex.

Contractual Protection

An ironclad contract with the developer is paramount to a successful condo project. This begins with a detailed scope of services that includes the development of completed designs and plans, construction observation services and maintenance manuals for the HOA. The contract should cover the developer’s commitment to establish a contingency fund; your right to maintain ownership of your plans and specifications (to ensure the developer doesn’t reuse your plans without your knowledge); your right to terminate your services should the developer fail to live up to the contract; the establishment of mediation as the dispute resolution technique of choice; and the prohibition of unauthorized changes to your plans.

For all but the most risk-free condo projects, there are two contract provisions that you should consider deal-breakers if your client refuses to include at least one of them. They are:

Indemnity agreement. Your contract should include a clause that, in recognition of the inherent high risk of condominium projects and the disparity between your fees and your liabilities, requires the developer to protect you from third-party claims. Preferably, this clause should also state that the developer will not file a claim against you except for your sole negligence or willful misconduct. Work with your attorney to draft such a clause in light of prevailing state laws regarding indemnities in general.

Limitation of Liability (LoL) clause. If your client refuses to accept an indemnity agreement in your contract, then demand that an LoL clause be included. This clause should set a reasonable dollar limit to your liability, such as the amount of your fees for the project or your available limits of professional liability insurance.

Beware of These Stealthy Surprises

Believe it or not, even designers who purposely avoid taking on condominium projects may find themselves caught in the condo liability net. The first problem is the condo conversion, an existing apartment or other residential or commercial structure you designed that is later converted for condo use. Even though you never gave approval for such a conversion you may find yourself sued by the condo’s HOA, particularly if the developer is nowhere to be found.

The second and more insidious problem is the so-called “stealth condo.” Here, a developer hires a designer for a purported apartment complex. At or near substantial completion of the project, however, the developer suddenly converts the units to condominiums. The designer now faces all of the added liabilities of a condo complex with no added contractual protection or design fee.

Your best defense here is to include a clause in your contract for designing any apartment complex which states your project was intended as residential rental units operated by a single owner. Note that if the property is changed to any other use, including condominiums, the client agrees that you will be released from all liabilities. Also require that the client agrees to indemnify you and hold you harmless for all services you performed on the project.

Hold Firm on Your Demands

Designers considering condo projects may question whether they will have the bargaining power to insist on all of the risk management tactics outlined herein. Realize that you may wield a significant bargaining advantage, particularly when the developer is having difficulty finding a design firm willing to take on its condo project. We will be happy to assist you and your attorney in finding professional liability insurance options and preparing to negotiate a condo contract, providing sample language you can adapt to your particular situation.

We may be able to help you by providing referrals to consultants, and by providing guidance relative to insurance issues, and even to certain preventives, from construction observation through the development and application of sound human resources management policies and procedures. Please call on us for assistance. We’re a member of the Professional Liability Agents Network (PLAN). We’re here to help.