BY RONALD M. SANDGRUND, LESLIE A. TUFT AND JENNIFER A. SEIDMAN
Part 1 of this article discusses potential liabilities that construction professionals may face when undertaking condominium renovations and conversions.
Following the 2007-09 Great Recession, many developers constructed rental apartment units in lieu of for-sale condominiums (condos) and town homes.1 As the home ownership market has improved, converting and selling these apartments as condo units has become an attractive investment, but may create potential new construction defect liabilities for developers, builders, and other construction professionals. Many states have adopted statutes addressing a converting developer's (the converter's) disclosure obligations arising from the conversion process.2 About one-third of all states have adopted statutory warranties for new condo construction (Colorado has not3), but these statutory warranties are typically narrowly targeted at new construction and rarely expressly extend to condo conversions.4
Part 1 of this article examines these potential liabilities. Part 2 will consider ways construction professionals may mitigate their risks, including related statute of limitations/repose and liability insurance issues. While this article focuses on apartment to condo conversions, it also discusses potential liabilities arising from renovations and converting industrial space into residences. This article does not discuss the related topic of legal prerequisites for creating a common interest community.
Condo Conversion Types
Condo conversions are typically characterized as one of the following types, depending on the circumstances leading to the conversion:
■ direct, where a developer builds apartments and then decides to convert them to condos at a later date, after leasing the units.
■ successor, where a developer builds apartments and later sells them to another developer who converts them to condos.
■ distressed property, where a developer buys a distressed, bank-owned apartment building and then converts it to condos.
■ legacy, where a developer buys a many-years-old industrial or other structure and then converts it to condos.5
Nature and Extent of Renovations
Condo conversions may involve four types of renovations, which are characterized by the nature and extent of the construction work and may give rise to different contract and tort liabilities. The converter may renovate individual units, common elements, or both. The renovation types are:
■ no renovations;
■ minor renovations, which include updating finishes, adding new appliances, repainting, and similar work, but do not include significant structural or systems changes or repairs;
■ major renovations, which include significant structural or systems changes or repairs; and
■ like-new rehabilitations, which involve wholesale reconstruction, such as converting industrial space to residential lofts.
In close cases, these designations may be disputed.
Liabilities Arising from Creating a Common Interest Community
A developer assumes certain responsibilities when it creates a common interest community. In Colorado, these responsibilities apparently apply whether the developer creates the common interest community during original construction or as part of a conversion. A 2002 Colorado Lawyer article catalogued developers' potential liabilities arising from creating a Colorado common interest community.6 Since then, both Colorado and other states have scrutinized the conduct of declarant-developers and their appointed home owner association (HOA) board members during the declarant control period to ensure that they have adequately reserved funds for reasonably anticipated maintenance and repair and dealt fairly with HOAs and unit owners regarding known construction defects.7
The Executive Board's Fiduciary Duties
In Colorado, declarant-appointed HOA board members "are required to exercise the care required of fiduciaries of the unit owners."8 One commentator described the liabilities attached to this level of care: "To the extent that a declarant-developer fails to timely investigate, or fails to timely pursue viable claims against those responsible for the construction defects, liability may attach for its breach of fiduciary duty and negligence."9
In an unpublished case, Countryside Community Association v. Pulte Home Corp., the Colorado Court of Appeals found that declarants may be liable for (1) declarant-appointed board members' tortious conduct, including breaches of fiduciary duty under respondeat superior; and (2) annual assessments and assessments for expenses on declarant-owned lots.10 However, based on the language of the declaration at issue in that case, the Colorado Supreme Court reversed the holding that the declarant was liable for assessments on declarant-owned lots subject to future development rights because the lots at issue did not become part of the community until properly annexed, so no assessments were due before annexation.11 Outside Colorado, several courts have upheld suits against developers and their appointed board members for taking actions that were contrary to an HOAs interests during the declarant control period.12
In addition to any physical changes that may precede conversion, creating a Colorado common interest community requires certain organizational and management changes. While the details of such changes are largely beyond the scope of this article, three significant changes typically occur: creation of an HOA and an executive board, installation of a property manager (often drawn from the declarant's staff or from an independent property management company), and turnover of HOA control from the declarant to the unit owners. As one commentator has noted, "In an effort to increase profitability, a condominium converter could be tempted to manage the project in a manner that is under budget or under reserve [d], which would constitute a breach of a director's fiduciary duty to act in good faith and without conflict of interest." Courts have shown little reluctance to hold declarants and their appointed board members liable for breaching their fiduciary duties when controlling HOAs.14
As with any marketing effort, declarants marketing converted units must avoid making material misrepresentations, using deceptive trade practices, and failing to disclose material facts.
Misrepresentation and Nondisclosure
A converter marketing converted units faces issues that generally do not exist for newly constructed units. First, existing units have a history of use, complaints, repairs, maintenance, and exposure to environmental conditions. Thus, there may be a detailed record of potential defects and resulting damage that may need to be disclosed to prospective purchasers.15 Second, a maintenance and repair record, combined with aging construction components, may require the converter to be more forthcoming regarding future anticipated annual maintenance, repair, and capital improvement costs, and therefore more accurate in establishing reasonable financial reserves and annual assessments and dues.16 Third, if the conversion involves significant structural changes or upgrades, systems replacement (e.g., HVAC, plumbing, electrical, etc.), or reconfigurations and/or layered construction (e.g., turning commercial or industrial space into residential lofts as part of a legacy conversion), the disclosure and code-compliance obligations associated with new residential construction sales may arise. Fourth, legacy conversions, major renovations, and like-new rehabilitations may, in particular, give rise to responsibilities to identify and remediate safety hazards.17
Finally, some commercial developers obtain a Property Condition Report based on the investigatory guidelines promulgated by the American Society for Testing and Materials in ASTM E-2018. These guidelines prescribe "good commercial and customary practice... for conducting a baseline property condition assessment." The prescribed due diligence inspection is nonintrusive; the level of due diligence may vary depending on the property type and age of improvements; and the guidelines permit inspectors to reasonably extrapolate their observations to similar areas.
Separately, because converted properties frequently have high insurance loss histories, securing adequate and affordable liability, errors and omissions, and directors and officers insurance may be challenging.18 Commentators have noted that different expectations between apartment renters and homeowners,19 and different experiences and competencies between commercial and residential builders, subcontractors, and design professionals, contribute to greater apartment conversion loss histories. In particular, commercial and industrial space loft conversions require more specialized design and care expertise and experience than new residential construction and ordinary renovation.
Because converted condo units compete against new construction, marketing communications may tout them as "like new," "newly refurbished," "completely overhauled," "just renovated," "updated," and the like. These statements, if they do not qualify as permissible "puffing," could lead to misrepresentation and nondisclosure exposures if buyer expectations reasonably conflict with actual property conditions. Failing to disclose the actual age of the structure or the need for substantial capital improvements, or underfunding reserves and low-balling assessments, could result in serious...