The “Catch-22” of HOA Construction Defect Litigation

The dictionary defines “catch-22” as “a dilemma or difficult circumstance from which there is no escape because of mutually conflicting or dependent conditions.” In many respects, a “catch-22” situation is inherent in construction defect litigation involving homeowners associations. This often becomes apparent after a construction defect case has been successfully resolved and the homeowners association has received proceeds from the case. Appreciating the dilemma necessitates a basic understanding of how construction defect litigation is handled by the lawyers who represent the homeowners association.

Nearly all construction defect cases brought by homeowners associations are based on “contingent fee” relationships with the attorneys who represent the homeowners association. Typically, under the terms of such a relationship, the attorney receives one-third of the gross recovery if the case is settled without trial, and forty- percent if there is a recovery after the case goes to trial. For obvious reasons, when attorneys are brought in to evaluate a construction defect case on behalf of a homeowners association, they are motivated to find as many problems as possible in an effort to increase the amount that is sought as damages in the case. Additionally, the HOA is responsible for payment of the costs incurred in connection with the handling of the case such as court costs and the fees and expenses for expert witnesses, process servers and court reporters. In preparation for bringing a construction defect lawsuit, the association will typically expend a considerable amount of money that was not anticipated for temporary repairs and/or to investigate the facts that ultimately give rise to the construction defect litigation. The funds that are expended will frequently be generated by either borrowing from association reserves and/or levying special assessments on homeowners.

Most construction defect cases that are filed are settled before completing an actual trial for a compromise amount that represents only a percentage of the full amount that was claimed by the association as being necessary to correct the defects that were the basis of the HOAs claims in the lawsuit. Thus, for example, the association could be facing a cost of $2,000,000.00 to actually repair the construction defects that were the basis of a construction defect lawsuit filed by the association, but the case could be settled during the course of a trial for $1,000,000.00. In such an example, the attorney would receive $400,000.00 and the HOA would receive $600,000.00, less all of the costs and expenses of bringing the case. Depending on the nature of the issues and the number of experts involved, the costs and expenses that are deducted from the association’s share of the recovery become considerable. At the end of the day, after the expenses are paid the HOA’s net recovery may be closer to 50% of the gross settlement proceeds. This creates the “catch-22” situation.

In the example described above, as a result of the settlement for $1,000,000.00 (which seemed like a lot of money at the time), the association might actually receive an amount that is closer to $500,000.00. What happens now when the association is looking at repairs that could cost $2,000,000.00? In such a situation, the HOA board of directors must evaluate and decide on whether to seek the imposition of a special assessment on the members to cover the shortfall, or to make some, but not all, of the necessary repairs that are required to remedy the defective construction. In the real world, absent a compelling need to immediately undertake certain repairs that would necessitate the imposition of a special assessment to make up the shortfall in the available funds, the board of directors makes choices about the nature and extent of the repairs that will be undertaken to correct the defects.

Aside from the fact that certain necessary repairs may not be made, the impact of a shortfall in the proceeds received from the resolution of a construction defect lawsuit can be detrimental to the individual homeowners’ property values because state laws require that the owners of property disclose value of the homeowner’s property and the owner’s ability to sell the property. As such, conditions that they are aware of which might impact the potential buyer’s decision to the purchase the property. Additionally, homeowners who are members of a homeowners association and want to sell their property, need to disclose to potential purchasers the history of construction defect litigation that pertained to the owner’s separate interest and the common area property and the existence of areas that experts identified as being defective that have not been repaired. Such disclosures could have a negative impact on the homeowners may “overlook” making the required disclosures to prospective purchasers of their property thereby leaving themselves vulnerable to potential future litigation by an unwary buyer of their property.

Homeowners’ association directors and homeowners should be aware of the realities that are associated with construction defect litigation and the likely scenario that the net proceeds that are ultimately recovered from such litigation will not be sufficient to make all of the repairs that are necessary to fully correct all of the deficiencies that gave rise to the claims that were the basis of the construction defect litigation. As such, the ability to make necessary repairs will require advance planning and budgeting combined with appropriate special assessments that the owners must be prepared to absorb.