Condo Concerns

High-Rise Residential Boom May Encourage HOA Litigation

by Jennifer D. Duell

The recent condo boom in the Dallas-Fort Worth region means the area is perfectly positioned for a surge in residential condo-related lawsuits. Developers, contractors and design firms are being forced to spend more money to protect themselves and are hiring risk-management consultants, purchasing comprehensive insurance policies and drawing up complex legal documents.

Like many areas across the nation, high-rise residential condominiums are popping up across the Metroplex. Currently, there are more than 20 condo projects under construction, and more than 3,200 condo units will come online this year, up from 1,600 last year, according to Property and Portfolio Research, an independent real estate research firm based in Boston, Mass.

"Condo litigation is happening in places where a high concentration of condo development is occurring - like California and Florida," said Greg Noschese, an attorney and shareholder with Munsch Hardt Kopf & Harr PC of Dallas. "Now that we are seeing more condo development in Texas, we're going to see more litigation."

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Unhappy HOAs "Every time we've had a condo boom, we've had a massive increase in litigation," said Joe Bryant, a partner with McLaughlin Brunson Insurance Agency LLP, a Dallas-based firm that specializes in risk-management services for architects and engineers. "All the lawsuits we had in the 1990s came from the building boom in the 1980s. That litigation was the reason why condos went away in the 1990s."

Some experts have noted that the most recent round of lawsuits is significantly different from those in the past. "Most of the previous condo litigation related to construction defects involved lawsuits where the developers sued the subcontractors," said Tina Ross, a partner in the real estate group of Greenberg Traurig LLP, a Dallas-based law firm. "Today, we're seeing condo owners or the condo homeowners associations sue the developers and contractors."

For example, the HOA for the Vendôme on Turtle Creek, a luxury residential high-rise in Dallas, is currently embroiled in litigation against the condo tower's developers, a joint venture between New York City-based Metropolitan Development Group and Lehman Bros. Holdings Inc. and general contractor Manhattan Construction Co., with offices in Dallas and Houston.

The suit, which was filed in 2004 and is currently in arbitration, cites a number of defects ranging from lobby décor to landscaping to faulty elevators.

HOA lawsuits tend to have more resources behind them than those involved in single-family homes, Ross said. "With condos, you have the power of a group because multiple owners can combine their resources to act against the developer," she added. In Texas, an HOA has the right to pursue litigation if just two unit owners are unhappy.

The Vendôme on Turtle Creek, a luxury residential high-rise in Dallas, is currently embroiled in litigation with its developer and contractor. The HOA lawsuit is among a growing number of condo-related lawsuits that some industry experts say is an epidemic.

No Legal Protection The condo construction boom isn't the only reason that Texas is ripe for plenty of condo lawsuits, Noschese said. "There are some environments that are friendlier to lawsuits than others, and Texas seems to be one of those places," he said.

Although Texas recently passed legislation to resolve disputes between homebuilders and homeowners through the Texas Residential Construction Commission, the new law leaves condos out in the cold, said Joe Dirik, an associate with Jenkens & Gilchrist PC of Dallas. (See Dirik's legal column, "Condo Concerns," this issue.)

A landmark court case in 2002 - Centex Homes v. Bucher - said that an implied warranty for good workmanship exists, but allowed that builders have a right to fix the problem and afforded some protection for them. Surprisingly, that finding does not extend to condos. While condo developers are responsible for certain levels of workmanship, the law that exists for single-family homes says that homeowners have to give builders a chance to fix their work. Condo builders and developers aren't given the same protection, and in some cases condo owners are choosing to sue.

"The biggest problem is that there is no law to limit these condo lawsuits so people are running to lawyers instead of letting the developer fix it," Noschese said. "As a result, there are really no limits to what they can achieve."

And, although a lot of condo developers are working with their legal teams to draft contracts that address certain building issues, some get overlooked. When that happens, the HOA's lawyers are quick to exploit any language that was left out.

That's why many developers, contractors and architects are beginning to shy away from condos. "There are developers who've turned from condos toward apartments," said Ric Glover, a senior vice president of construction in the Dallas office of Marsh Inc., a global risk-management firm and insurance broker.

But, many in the construction industry feel that the risks involved with condo development are outweighed by the rewards, Glover said. "People are evaluating condo development more carefully than they were, but they continue to move ahead with these projects because the return seems to be there," he added.

Those who roll the dice and take the chance on condos are paying far more for liability insurance than they ever have because many insurance companies were burned by litigation in California and Florida.

"These insurers were hemorrhaging badly because of the condo claims," said Don Neff, president of La Jolla Pacific Ltd., an Irvine, Calif.-based third-party quality-assurance-services firm that focuses on litigation prevention. As a result, insurance rates have increased around the U.S. and particularly for projects in California and Florida.

In California, the price of condo liability insurance is $60,000 per unit (liability insurance covers negligent acts and errors of omission). In comparison, Texas' rate is $15,000 to $25,000 per unit. But, that cost adds to entitlement, design and construction expenses, and insurance for a condo tower with 300 units would add roughly $7 million to the total price tag.

Many companies involved in condo construction are choosing "wrap" insurance policies, which allows a developer to buy an insurance product that will insure it and all subcontractors for up to 10 years. The premium is usually 1 percent of the development cost, Noschese said.

It's rare for a developer to forgo insurance because it would be next to impossible to obtain financing for a condo project without it, Glover said. But, "I don't find insurance to be a great tool to deal with the risk because the expense is significant and the coverage is not," he added. A typical policy with $2 million coverage would cost $1.2 million to $1.6 million and a $50,000 deductible per occurrence.

When it comes to condo litigation, design and engineering firms may be in an even more precarious situation than developers and general contractors, said Joe Bryant, partner with Dallas-based McLaughlin Brunson Insurance Agency LLP.

"A developer has better protection because typically every project is an LLC and the liabilities are limited to that LLC," Bryant said. "A design or engineering team puts the entire firm on the line."

He added that residential condos are the single most litigious projects by 10 times over for a design or engineering firm.

Long-Term Impact Although the construction industry has taken protective measures against condo litigation, it has been unwilling to absorb the additional expense, according to Noschese. Instead, these expenses are passed along to condo buyers.
"Condo litigation is doing nothing but causing prices of condos to increase," he said.
Instead, these expenses are passed along to condo buyers.

Higher condo prices are a concern for many reasons, Glover said. "If things keep going as they are, the cost of condos will keep rising and we won't see any in the affordable-housing arena," he added. "And, the higher costs really don't contribute to the value of the units."

Ross said that the market will only support so much price escalation. "The pass-through to the consumer is limited," she said. "When the developer and contractors have to start to absorb these costs, we are going to see fewer condo starts."

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