In the current adverse sales environment, many developers are electing to complete their condominium projects but rent the units as apartments until the market improves. This strategy raises a significant question about the effect of California's 10-year statute of repose for latent construction defects: Does the statute commence to run upon substantial completion of the project or from the date of sale of the units?
A recent decision of the California Court of Appeal provides some comfort to developers confronting the often-complex application of the statute of repose for construction defect claims.
By its terms, the statute of repose - California Civil Code section 337.15 - imposes a maximum 10-year outside time limitation on actions for property damage caused by latent deficiencies in design or construction. Section 337.15(g) specifies that the 10-year period commences upon "substantial completion" of the improvement, defined as the earliest of: final inspection by the applicable public agency, the date of recordation of a valid notice of completion, the date of use or occupation of the improvements, or one year after termination or cessation of work on the improvement.
But does the statute still commence to run upon substantial completion in a situation where the developer retains ownership of the asset? Plaintiffs can be expected to assert that the statute of repose is stopped from running (tolled) while the developer continues to own the improvement. Plaintiffs also may rely upon Section 337.15(e), which provides that the 10-year defense may not be asserted by any person "in actual possession or ... control" of the improvement "at the time any deficiency in the improvement constitutes the proximate cause for which it is proposed to bring an action".
In Gundogdu vs. King Mai Inc., the appellate court rejected these arguments. The court affirmed summary judgment in favor of King Mai, the developer of a single-family home, based upon expiration of the 10-year statute of repose. The court concluded that the 10-year statute commenced to run upon substantial completion of the home, despite the fact that the developer owned the home for more than 16 months after recording the notice of completion but before selling the home to the plaintiffs.
The court rejected the assertion that the 10-year statue was tolled because the developer continued to own the home. The court stated:
"Plaintiffs' argument, for which they cite no authority, is contrary both to the plain language of the statute and substantial case law."
The court reiterated the legislative purpose behind the statue of repose. "[T]he purpose of section 337.15 is to protect contractors and other professionals and tradespeople in the construction industry from perpetual exposure to liability for their work."
The court observed:
"Plaintiffs do not allege that King Mai's work after completion of the home caused their damages. The defects they allege caused their damages occurred during construction of the building. Thus, the question is whether King Mai's passive ownership of the property prior to its sale precludes King Mai from asserting the limitation defense. We conclude that such an interpretation of section 337.15 subdivision (e) would be contrary to the purpose of the statute."
Despite the positive holding in King Mai, developers still face a 10-year period of risk for construction defect claims. Indeed, this period may be longer than 10 years because the statute of repose is subject to exceptions for actions based upon "willful misconduct or fraudulent concealment" and for bodily injury actions.
As a result, when structuring products-completed operations coverage for condominium projects and other real estate developments, developers should seek an extended coverage period not limited to 10 years. Instead, the extended coverage ideally should remain in effect until claims and suits arising out of the project are finally barred by the applicable statutes of limitations and repose.
In addition, residential developers must implement robust construction defect risk management strategies. These include construction quality assurance programs, alternative dispute resolution provisions in consumer sales documents and CCRs, and effective long-term customer service.
By applying a comprehensive and integrated insurance and risk management approach, developers can position themselves for success when the market recovers.
Jeff Masters and Joanna Huchting are litigation partners and member of the Development Risk Management Practice Group at Cox, Castle & Nicholson LLP in Los Angeles. They represent developers, lenders and investors in complex real estate and construction matters. Reprinted with permission from Cox, Castle & Nicholson LLP.