Defending the Condominium Developer

DEFENDING THE CONDOMINIUM DEVELOPER

By Robert M. Meisner

A condominium association's board of directors, which is responsible for administering the affairs of the association, is initially appointed by the developer until a certain number of units is sold. This can lead to a conflict of interest in setting the monthly maintenance fees, since the developer has an interest in setting low fees to attract buyers. Then the owners of the individual units (called "co-owners") take control of the board, they may conduct financial and physical audits, and those audits may lead them to assert claims against the developer as a board member. The developer needs to take preventative steps to protect itself by structuring its legal and business affairs to reduce the likelihood of claims and the ease and cost of defending them. This includes providing for alternate dispute resolution, obtaining necessary insurance to cover (and defend against) claims of physical defects, and arranging for the assistance of expert witnesses in defending both physical and financial claims.

With the increase in condominium developers, including "site condominiums", there has been a concomitant increase in condominium associations organized to manage the affairs of the condominium project, typically through a nonprofit corporation and its board of directors. The members of the board are initially designated by the developer, and later elected by the membership of the association. This takes place in phases dependent upon the number of condominium units sold by the developer. The board is generally given the power to appoint officers of the association and other committee members. A condominium association is given the responsibility under the Condominium Act to bring and defend actions on behalf of its members regarding the common elements of the condominium project.

The common elements can vary, depending upon the nature of the condominium regime. In a traditional condominium, where the units are attached in buildings, the common elements typically include the physical structure of the building, including basements, foundations, roofs, and structural walls as well as the utility amenities serving the units up to the point of connection with the fixture inside the unit.  The common elements may also include the roads, land, pools, community facilities and the like.

In a site condominium, the common elements may be limited to the roads and/or driveways, and the physical residential structure will generally constitute the unit in its entirety or may be a part of the unit and is generally the homeowner's responsibility to maintain repair and/or replace when there are problems with the structure.


Developer's control of board inherent conflict of interest

As noted, the developer typically controls the condominium association and has the right to designate its own individuals as members of the board of directors, until a certain number of units are sold, at which point it relinquishes control of the board of directors of the association. The presence of developer designees on the board can create an inherent conflict in that the developer, on the one hand, is attempting to sell units in the condominium and, at the same time, is managing the affairs of the association. Because it controls the board, the developer can determine the amount of monthly assessments for maintenance that will be levied. The developer's interest in selling units may lead it to "lowball" these assessments in order to increase sales. If there are insufficient funds available at the time of turnover of control for the association to meet its expected needs, including a reserve fund for major repair and replacement, then the developer will be responsible for replenishing the reserve up to ten (10%) percent of the budget of the association on a noncumulative basis. The developer may also be accused of improperly "low balling" the assessments.   Because it controls the board, the developer can determine the amount of monthly assessments for maintenance that will be levied. The developer?s interest in selling units may lead it to "lowball" these assessments in order to increase sales
 


Financial and physical audit

When the "co-owners," as the owners of the individual units are referred to, take over control of the association, they may well undertake various audits. These may include a financial audit, to determine whether the developer has properly managed the financial affairs of the association, and a physical audit to determine the nature and extent of any defects and deficiencies in the common elements for which the developer will be responsible. In connection with the physical audit, may condominium will hire architects and/or engineers to investigate the common elements to determine if there are construction defects and deficiencies.

The developer will typically attempt to limit its exposure by way of forming a corporation or limited liability company and may utilize other techniques in the condominium documentation to insulate itself from liability, including inserting provisions in the articles of incorporation to take advantage of the Nonprofit Corporation Act limiting director and officer liability. However, developers often appoint themselves as directors of the association. This can subject them to personal liability for breach of fiduciary duty, conflict of interest, breach of duty of loyalty and other theories of liability attributable to persons who are wearing potentially "two hats," which may be inconsistent with one another.

It is important, therefore, that in organizing the condominium regime, the developer take into consideration not only the physical quality of the units being constructed, but also take the time and care to retain counsel who can prepare condominium documents which will be fair to the purchaser but, at the same time, will reasonably insulate the developer from potential liability. There are provisions that can be placed in the condominium documents which will help to limit the exposure of the developer. The developer, however, must be familiar with its own documents to ensure that it takes care of complying with them during the course of its control of the association.


Alternate dispute resolution

The developer should attempt to provide for an alternative dispute resolution process for any disputes that my arise with the association (to the extent permitted by law), as well as with individual purchasers regarding their units (i.e. non-common elements matters). Generally speaking, developers will fare better before an arbitration panel than a jury, although developer's counsel should not underestimate the difficulty which associations may experience in raising the funds necessary to pursue a major construction defect lawsuit against the developer.   It cannot be overemphasized that the quality of the condominium documents will have a significant impact on the potential issues for the developer. It is often the case that poorly drafted condominium documents can create challenges for the developer even if the physical structures constructed by the developer are not causing a problem.

Insurance coverage

The developer should also attempt to obtain broad based insurance coverage, including products liability coverage to the extent possible, in developing a condominium project. The developer should also maintain directors and officers liability insurance to insure the directors and officers who are appointed by the developer while it is in control of the association.

The developer should also, through its counsel, notify its insurance carrier in order to engage the carrier's counsel to defend the lawsuit and there by avoid the potential costs of defending the case, even if the carrier is taking the case under a reservation of rights, which frequently occurs. This may have a significant effect on the association's willingness to actively pursue the matter when it realizes that the developer is, in a sense, getting a "free ride" in regard to the defense costs of the litigation and/or arbitration proceeding.


Defenses

If a lawsuit arises, the developer's counsel should be totally familiar with the condominium documents as well as the Condominium Act, which now contains its own statute of limitations regarding claims brought on behalf of the association. The Statue requires suit to be brought within two years of accrual of the action or three years from the transitional control date, whichever is later. In addition to the other defenses which would normally be raised by a developer, the developer should also be cognizant of the fact that there may be preconditions in the condominium documents which must be satisfied before the association has standing to bring the lawsuit. The developer may be able to bring a preliminary motion to dismiss the lawsuit if these preconditions have not been met, assuming, of course, that these preconditions are deemed to be reasonable.

It cannot be over emphasized that the quality of the condominium documents will have a significant impact on the potential issues for the developer. It is often the case that poorly drafted condominium documents can create challenges for the developer even if the physical structures constructed by the developer are not causing a problem. Certainly, the purchase agreement and the limited warranties, if there are any given by the developer, should be carefully drafted by the developer's counsel, who should have expertise in condominium law, keeping in mind the consequences if these documents do not contain the proper disclaimers as well as the requirements that may be mandated by state and federal law as well as the Condominium Act.


Expert witnesses

Finally, if a construction defect case is filed, it will frequently include a claim that the association was "financially shortchanged" by the developer, both in the manner in which the developer managed the association and, perhaps, in the way in which the developer spent association funds.  The developer's counsel will, therefore, need to engage the services of competent experts both in the engineering and architectural fields at the outset as well as experienced accountants and/or managing agents who have had experience in representing condominium associations. These people can assist the developer and its attorney in the ferreting out the legitimate claims of the association from those that may be overstated. Also, communication with the association and active responsiveness by the developer to the association's concern are paramount in order to avoid exacerbating already existing problems or creating new problems.

In summary, it would appear that there will be more litigation in the condominium association arena just from the sheer number of condominium associations that are being developed and the sloppiness on the part of many developers in having documents prepared by people who have not had sufficient experience in determining the potential problems and shortfalls of condominium development. With a team of experts in place who have had experience in condominium operation and management, the developer can avoid legal problems before they arise. Just as in any other situation, preventative law maintenance is much cheaper than trying to extricate oneself from a lawsuit that could have been avoided through proper planning and communication with the purchasers.

Bingham Farms attorney, Robert M. Meisner, has extensive experience in condominium law. He is an adjunct professor of law at the Detroit College of Law in Michigan State, and also teaches condominium law and operations at Oakland Community College. He is a co-draftsperson of the 1978 Michigan Condominium Act, a columnist for the Observer and Eccentric newspapers in Southeastern Michigan, and a frequent lecturer throughout the country and at ICLE seminars on condominium and community association law and development.