By James C. “Beau” Brincefield, Jr. and Lisa Wells
From Common Ground, Volume X, Number 1
The most important year in the life of any homeowners’ association is the first year of homeowner control. It can also be the most dangerous. First, the initial homeowner elected board is usually inexperienced in association management issues. Second, if potential claims are not asserted promptly after the homeowners assume control, they may become uncollectable. The homeowners would then bear the costs of correcting deficiencies costs that should not be their responsibility. The board members might find themselves exposed to liability for such losses.
It doesn’t have to be that way. As this article will show, an association’s first two years can be the building blocks for future security and success.
Taking Those First Steps
A newly elected homeowner board should take several steps to identify and preserve potential claims. These steps include:
Selecting Independent Legal Counsel
After assuming control of the association, the board should retain its own independent legal counsel. It is essential that the attorney have experience in dealing with association claims, in particular transition claims. This requires knowledge and experience in identifying potential claims and defendants, determining who has the right to assert any claims, and determining what statutes of limitations apply to each of the potential claims.
Collecting All Relevant Document
One of counsel’s first tasks will be to help the board identify and collect all relevant documents. Among the most important are current and complete sets of the association governing documents; marketing materials used by the developer; plans and specifications for the project; association contracts; and all financial and other records and correspondence. These documents reflect the most important rights and duties of the association.
Determining the Physical Condition of the Property
Along with assuming control of the association, the first homeowner elected board assumes responsibility for the physical components that comprise the common elements. The board must make certain that these common elements are in the condition promised by the developer.
The developer usually gives the homeowners certain warranties on the condition of the property. These warranties may be statutory, contractual, or implied by law. They may be found in sources such as state laws, purchase contracts, public offering statements, marketing materials, written warranty documents, and statements from sales representatives.
To help evaluate the physical condition of the property, the board should retain an independent inspector – usually an architect or engineer – to conduct a thorough inspection.
Before the inspection, counsel should talk with the inspector to explain any legal terms or issues that may have a bearing on it. For example, if the property is a condominium, the inspector must understand the definition of the term “structural defect” as it is defined in many state condominium statutes. The Act’s definition of the term is substantially different from the way it is understood by most architects and engineers. The inspector may erroneously conclude that some of the defective or deficient conditions are only “maintenance” items or not the responsibility of the developer.
The inspector should carefully check the property for any signs of defects in design, materials, or workmanship. Afterwards, the inspector should meet again with the board and counsel to review the findings. Counsel can then advise the board whether any claims may be asserted.
Determining the Financial Condition
The second major task is to determine if the developer has met its financial obligations. This must be done immediately – delays in asserting claims may prevent the board from proving or collecting them. Shortly after it takes control, the board should hire an independent accountant to audit the association’s finances. At a minimum, the audit should determine if the developer has paid all required capital contributions and all regular and special assessments that it owes, including any accrued interest and/or penalties. The accountant should also review expenses paid by the association while it was under developer control, to ensure that they were not in fact the developer’s obligations.
Finally, the accountant should work with the inspector and the association’s management firm to determine if the budget prepared by the developer will meet the short- and long-term needs of the association. If the budget is inadequate, the board will need to adjust the level of assessments and decide whether to assert any claim.
Other Transition Issues
After the governing documents have been collected, counsel should confirm that they comply with applicable laws. The board and counsel should also evaluate the association’s insurance coverage and review the terms of any contracts entered into by the board during the developer controlled period. Other issues are:
Hiring an Independent Management
Firm: Selecting the right property management firm is critical to the long-term success of any homeowner association. A good property management firm can be of enormous assistance to the transition board. Boards should be wary, however, of management firms that have a strong relationship with the developer.
After reviewing the inspection and audit results, counsel can begin to determine if any claims exist. The questions for the association are usually: “What amount of damages are we likely to recover?” and “What will it cost to find out?” Answering these questions, however, may require extensive investigation and complex analyses. And it leads to a host of subquestions. For example: who are the proper plaintiffs? Who are the proper defendants? What types of claims can be asserted against each defendant? What witnesses, documents, and other evidence are available to prove liability and the amount of damages? What are the statutes of limitations that are applicable to each of the claims?
It can be difficult to determine who the proper plaintiff is for asserting a given claim. In legal terminology, this is called “standing to sue.” In some cases, only the homeowners may have standing to sue. In other cases, only the board or the association itself may have standing. Conflicting decisions, even within the same state, are common. The safest action usually is to name everyone and let the trial court determine the proper plaintiffs.
It can also be difficult to determine who are the proper defendants. The developer is almost always a target, but others may be liable as well. For example, the developer appointed members of the board have fiduciary duties to the unit owners that may be difficult to discharge if they have conflicting loyalties to the developer. If they have breached these fiduciary duties, they may be personally liable to the homeowners.
Perhaps the real estate sales representatives misrepresented the condition or character of the property or the association. A property management firm selected by the developer that fails to perform its duty to the association or the homeowners during the declarant control period may find that it has breached its obligations. In some cases, counsel for the developer will handle settlements and fail to make proper disclosures to homeowners when they conduct the settlements on their homes. Too often, a developer’s attorney also represents the association. In such cases, the attorneys may be liable to the homeowners for bad advice due to conflict of interest.
Damage claims are commonly made against the developer for construction defects or inadequate finances. But there are many other potential theories of liability against various defendants that may be useful in collecting association claims.
Delays in Asserting Claims
Delays in asserting claims make it more difficult – and sometimes impossible – for the association to recover damages for otherwise valid claims.
One of the most difficult areas in association litigation relates to statutes of limitations. Statutes of limitations define the time period within which a suit must be filed on various types of claims. Courts have frequently disagreed on both the duration of the statutes that apply to different types of claims and the dates when the statutes begin to run. Consequently, it can be extremely difficult to determine whether or not the applicable statute of limitations has expired with respect to any given claim.
However, expiring statutes of limitations are not the only delay related concern. The amount collected on any given claim usually decreases in proportion to the amount of delay. For example, developers often create a separate company to build each project. The developer may terminate this entity or transfer assets or otherwise dissipate funds that might otherwise be available for the payment of claims. As time passes, essential witnesses die or move away; their memories fade or become jumbled. Essential documents ate lost or destroyed. The availability of a key witness or piece of evidence can make the difference between a large recovery or no recovery at all.
For the association that delays in asserting a claim, however, there is a bright side. Experienced and creative counsel can frequently develop solid arguments for extending statutes that appear to have expired. This can preserve or revive a claim that appeared lost. Sometimes, merely asserting the claim and presenting the arguments can persuade a developer to settle the claim for a reduced amount than take the chance of litigating and paying a larger amount.
Negotiation Versus Litigation
Once claims have been identified, counsel should notify the potential defendants and attempt to negotiate a mutually satisfactory settlement. But if negotiations fail or statutes of limitations expire before negotiations can be concluded, filing suit may be necessary to preserve claims.
When negotiations fail, litigation is a last resort. Association litigation tends to be time consuming and costly. Before filing suit, the board and counsel should weigh the probable costs of litigation against the probable benefits, if successful.
The prompt identification and assertion of claims is essential to protect the interests of the association and its members. It may appear time consuming and costly to conduct the investigations and analyses outlined in this article, but years of experience in condominium law and litigation show that it is less time consuming and costly than the consequences of failing to do so. Better to start strong than to pay for someone else’s mistakes.
Reprinted from Common Ground, January, 1994.