Real Estate Law, 0916 COBJ, Vol. 45, No. 9 Pg. 63

Author:Ron Garfield , David Lenyo

45 Colo.Law 63

Real Estate Law

Vol. 45, No. 9 [Page 63]

The Colorado Lawyer

September, 2016

Ron Garfield , David Lenyo

S K Peightal v. Mid Valley—Construction Defect Litigators and Bank Attorneys Take Notice

Recent developments in case law highlight issues that both transactional attorneys and litigators should consider when handling construction defects cases. This article discusses the impact of S K Peightal Engineers, LTD v. Mid Valley Real Estate Solutions V, LLC on this area of the law.

This article addresses issues that litigators handling construction defect actions and transactional attorneys representing lenders may wish to consider in light of the recent Colorado Court of Appeals and Colorado Supreme Court opinions in S K Peightal Engineers, LTD v. Mid Valley Real Estate Solutions V, LLC.1 Author Ron Garfield represented Alpine Bank and its wholly owned subsidiary, Mid Valley Real Estate Solutions V, LLC (Mid Valley), respondent in the Colorado Supreme Court proceedings, in the deed in lieu transaction that is described in the Colorado Supreme Court opinion.2 Co-author David Lenyo represented Alpine Bank and Mid Valley in the construction defect action that was the subject of the interlocutory appeal by the engineering defendants that sought dismissal of the negligence claims asserted against them under the economic loss rule. Ultimately, the negligence claims survived after the Supreme Court remanded three questions to the Garfield County District Court. After the trial court ruled in favor of Mid Valley on two of the three questions, the construction defect action was resolved a week before the scheduled commencement of the jury trial. The resolution of the remanded questions, however, does not mean that other construction defect cases involving a construction lender will have the same outcome, because the trial court’s order on the remanded questions depended in large part on the specific facts regarding the engineering contracts at issue.

Factual Background

In 2001, developer Sun Mountain Enterprises LLC (Sun Mountain) obtained a secured loan from Alpine Bank (Alpine) to buy three vacant lots in a subdivision in Carbondale, Colorado. The construction defect action at issue arose out of a residence that Sun Mountain eventually built on one of the lots (the home).

In 2005, Sun Mountain executed a professional services agreement with a geotechnical engineering firm, defendant Hepworth-Pawlak Geotechnical (HP Geotech), to study the soils and recommend a foundation design for the home (the HP contract). The HP contract contained a limitation of liability provision under which Sun Mountain agreed to cap HP Geotech’s liability at $50,000. Alpine was not a party to the HP contract and did not participate in the negotiations leading up to it.

The HP contract also contained the following contractual standard of care, which substantially differs from the statewide standard of care applying to professional engineers under Colorado common law:3 “STANDARD OF CARE: Services performed by [HP Geotech] under this Agreement will be conducted in a manner consistent with that level of care and skill ordinarily exercised by members of the profession currently practicing under similar conditions in the same locale.”

In July 2005, HP Geotech issued a soils report and foundation recommendation for the home. The report stated it was written “for the exclusive use of [Sun Mountain] for design purposes.” The report identified “hydrocompressive” soils,4 which posed “a risk of post-construction settlement if the soils . . . become wetted.” Nevertheless, HP Geotech recommended a spread-footing foundation rather than a deep-pier foundation, the latter of which is designed to prevent damage to homes if soils compress.

Shannon’s Custom Homes (SCH) was Sun Mountain’s general contractor for the home. SCH orally retained defendant S K Peightal Engineers, Ltd. (S K Peightal), a structural engineering firm, to design the home’s foundation. SCH provided S K Peightal with HP Geotech’s soils report. In a deposition given in the underlying construction defect action, an SCH representative testified that the only terms of the oral contract were that Peightal would “do a good job” in return for an “approximation of how much money would be involved.” Alpine was not a party to the oral contract with S K Peightal and did not participate in the negotiations leading up to this oral contract. Construction on the home began in March 2007.

In April 2007, Sun Mountain obtained a second secured loan from Alpine to finance the home’s construction costs. Under the construction loan agreement, Alpine agreed to periodically release money to Sun Mountain, in the form of loan disbursements or draws, as work on the home progressed and accompanying construction costs were incurred. As is typical in the construction lending industry, the construction loan agreement required Sun Mountain to “use the [loan] funds solely for the payment of the costs of constructing” the home, as opposed to some other project on which Sun Mountain also may have been working. Also, the agreement allowed Sun Mountain to “apply only for [loan] disbursement[s] with respect to work actually done” on the home, to ensure that the amount of disbursements at any given time was commensurate with the home’s stage of completion at that same time.

The form construction loan agreement5 included standard provisions to ensure that the loan proceeds were used only for reasonable construction costs, including provisions that Alpine could:

1.approve the subcontractors used;

2. review the plans and specifications, and government permits;

3. approve budget and cash flow projections, and the schedule of estimated disbursement as construction progressed;

4. receive the soils report, to see if soil conditions would require extra expense;

5. require Sun Mountain to furnish proof of work done and the progress of work, and the bases for requested disbursements as work progressed; and

6. inspect Sun Mountain’s books and records, as well as the property, materials, and labor performed.

In the underlying construction defect action, Alpine’s branch president testified as to the bank’s limited reasons for including these boilerplate provisions in the construction loan agreement, stating: “We go out and take a look at the property periodically . . . . What we’re looking for is overall is the money going into the project as the builder told us and any glaring overruns . . . that we may have. I mean, we’re not qualified as construction inspectors. We’re lenders. We just want to make sure the money is going into the property.” He further testified that Alpine was “just simply monitor[ing] percentage [construction] complete versus what we have drawn [from the loan].”

The construction loan agreement also contained a “Limitation of Responsibility” provision confirming that Alpine’s rights under the loan agreement were intended to safeguard Alpine’s money as a lender, rather than make Alpine a participant in actual construction work:

The making of any Advance by Lender shall not constitute or be interpreted as either (A) an approval or acceptance by Lender of the work done through the date of the Advance . . . . Inspections and approvals of the Plans and Specifications, the Improvements, and the exercise of any other right of Inspection, approval or inquiry solely for the protection of Lender’s interests, and under no circumstances shall they be construed to impose any responsibility or liability of any nature whatsoever on Lender to any party . . . . No disbursement or approval by Lender shall constitute a representation by Lender as to the nature of the Project, its construction, or its intended use for Borrower or for any other person, nor shall it constitute an indemnity by Lender to Borrower to any other person against any deficiency or defects in the Project or against any breach of any contract.

In October 2008, Sun Mountain obtained a third, smaller secured construction loan from Alpine to finish the home. At this juncture, Mid Valley did not yet exist; therefore, it was not a party to the construction contracts and was not an intended beneficiary of any of the construction professionals’ contracts. When the home was completed in November 2008, Sun Mountain listed it for sale. Initially, the home was built for resale to an end user or as a “spec home.” However, due to the over-supply of spec homes[6] —in addition to the real estate market’s falling flat in the great recession—the home received no offers during the two-and-a-half years that Sun Mountain had it listed for sale.

The 2001 loan for the vacant lots, as well as the 2007 and 2008 construction loans, all matured in April 2011, at which time the home remained unsold. Sun Mountain defaulted on $1.63 million it owed to Alpine Bank. Alpine created Mid Valley in April 2011 as a Colorado limited liability company, with Alpine being its sole member. In May 2011, Alpine and Sun Mountain executed a deed in lieu of foreclosure agreement to resolve the loan defaults. They agreed that the $1.63 million due exceeded the home’s value by $355,000. Alpine accepted $355,000 and conveyance of the home to Mid Valley in exchange for a release of the personal guarantors of the loans. Thus, the home was valued at $1.28 million.

Alpine created Mid Valley (1) to add a layer of liability protection for Alpine, both while it held the property and in anticipation of any resale, so claims regarding the home would be limited to the subsidiary instead of exposing Alpine’s other assets, and (2) so the home could be more effectively marketed in the name of an entity other than a bank, because buyers devalue bank-listed homes. When Mid...

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