History of Construction Defect Litigation

In 1958 Puerto Rico created the first condominium legislation, effectively making Puerto Rico the first place in the Unites States to start building condominiums.

The state of Utah adopted condo legislation in 1963 and by 1965 the condominium revolution had begun to spread throughout the United States. The nature of condominium development is the production of mass-produced homes where the developers rely primarily on the work of sub-contractors to construct the individual condominium units.

As more units hit the markets, it did not take long for the owners to identify challenges in the construction and craftsmanship of the condominium units and by the late 1970s, the construction defect litigation industry began to expand. At this point in time, construction defect law is a very large segment of law for California Lawyers at an enormous expense to developers, contractors, and the insurance companies that underwrite commercial general liabilities policies.

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Statute of Limitations for Construction Defect Litigation on a Condo Project

Construction defect cases in the State of California fall underneath the statutes of limitation within the California Code of Civil Procedure sections 337.1 and 337.15. These sections allow for a four- year window to file a suite for a “patent” defect and a 10-year window to bring a suite for a “latent” defect and the time frames start at the date of completion of the unit.

California Senate Bill 800 (SB800) went into law effective January 1, 2003, and further developed standards and a mandatory process for the filling of construction defect claims against a builder or developer.

Common examples of construction defect litigation can include, moisture problems due to improper draining or waterproofing, faulty plumbing, slanting of floors and walls, moisture accumulation in the windows, doors and windows that do not close correctly, cabinets or countertops that are separating from walls, structural integrity, concrete, masonry, unstable foundations, expansive soils and challenges with the finishes.

The Process of Construction Defect Litigation

Construction Defect Litigation is big business, legal fees in many situations represent 25-35% of the total settlements costs. As a result, law firms will contact the home owner’s associations of as many condominium developments based on the time that the complex was completed typically between years 4-7 as to have plenty of time to develop a filing before the 10-year statute of limitations has expired. Many of these law firms will be marketing to the homeowner’s association regardless if there are any problems within the complex. The goal of the law firm is to have the HOA hire them to represent them in a lawsuit against the builder, developer, and subcontractors. Once the law firm has been retained they will begin building a case and documenting as many aspects of construction defect within the complex.

With the documentation of construction defect, the law firm will approach the builder developer etc. will provide all parties with a notice of Pre-Litigation thru the process known as SB 800. Effectively this is where the attorneys try and reach a settlement with the builder, and or their insurance companies. In these situations of Pre-Litigation, the construction defect lawsuit has not been formally filed.

The builders have a specific period of time to participate in a settlement with the HOA, if that is not arrived upon the HOA will file formal litigation and move on to some form of Arbitration. Arbitration is a form of alternative dispute resolution where the parties resolve the action outside of court. In some situations, the litigation can be resolved in as little as 4 months while some construction defect litigation can take over 4 years to reach an agreement. As soon as the construction defect lawsuit has formally been filled, there is an impact on the marketability and access to financing for both existing home owners within the complex and anyone looking to purchase a unit within the HOA that is in litigation.

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Financing Impact of Construction Defect Litigation

It has been estimated that nearly 70% of the mortgages made by banks are backed by Fannie Mae or Freddie Mac. Neither Fannie nor Freddie will provide financing on a condo that is currently involved in construction defect litigation. If the building was FHA or VA approved prior to the formal filing of the litigation, that approval will be suspended until the litigation has been formally settled. These government sponsored entities, do not want to take the time to evaluate the potential impact of the lawsuit on the HOA in the event that the lawsuit was dismissed, and now the community had a bunch of repairs to the complex potentially without the ability to pay for the repairs. As a result of the unknown the general rule of thumb is to avoid any financing to a complex in construction defect litigation. There are situations where the litigation only covers “common areas” and the actual condo unit is not included in within the lawsuit.

There are lenders that will provide loans backs by Fannie and Freddie under these circumstances with the corresponding documentation. Most construction defect lawsuits will contain issues that impact the individual condominium units and are referenced in the actual litigation language. Identifying a loan for a condominium that is under active construction defect litigation is not impossible and there are many lenders that offer these types of loans.

Mortgage Loans for Condos in Construction Defect Litigation

The type of lender that you are seeking to facilitate a home loan within a complex that is under active construction defect litigation is a portfolio lender, a company that does not sell their loans on the secondary mortgage markets. A portfolio lender makes money off of the loan fees and also seeks to make profits off the interest paid on the mortgages that the make. Portfolio lenders are usually savings and loan institutions, credit unions and sometimes banks. They are typically willing to make non-traditional loans and many of them will consider loans on condos that are under active construction defect litigation. Portfolio lenders typically rely on mortgage brokers to identify the transactions, so you will need to seek out a mortgage broker who can offer these portfolio programs.

What to Expect from a Portfolio loan on a Condo in Construction Defect Litigation

  1. Down-payment- Lenders offering loans on condos in construction defect litigation will require a minimum down-payment of 20%
  2. Loan Terms- Lenders offering loan programs for condos in construction defect litigation typically are not going to offer a thirty year fixed mortgage. 5/1 ARMS, 7/1 ARMS, 15 year fixed programs are available.
  3. Interest-Rates-Interest-rates offered to buyers or homeowners that are involved in active construction defect litigation will be comparatively higher than that of a condo that is not in active litigation.

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Chad Baker is Regional Manager for RPM Mortgage. Chad is consistently recognized in the top 1% of mortgage originators in the United States 2011-2016.
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