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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.
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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
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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. |
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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
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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
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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.
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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
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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.
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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. |
