Condos: Should I or Shouldn’t I?

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[Originally published 1st quarter 2005, in arcCA 05.1, “Good Counsel.”]

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Author David Barker is an associate in the South Pasadena office of Collins, Collins, Muir & Stewart, LLP. His practice focuses on the representation of design professionals, incorporating everything from contract drafting and negotiation through trial representation. Before joining Collins, Collins, Muir & Stewart, LLP, he represented contractors and developers in construction litigation. He is a member of the Los Angeles County Bar Association and the Pasadena Bar Association. He regularly lectures to professional design firms and organizations, attorneys, and other construction industry groups.

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Condos are back. Let’s face it: with real estate prices rising beyond the reach of many people, the demand for condominiums, a more affordable form of housing, is exceeding the supply. Consequently, many developers are venturing back into the arena of condos, despite the high risk of litigation arising out of this type of construction. As design professionals, you should not be asking if you will get sued for your involvement in a condo project; you should be asking yourself when you will get sued.

Why Are Condos So Risky?

The reasons for the higher risk in condo projects are several-fold. Once the project is completed and the units are all sold, there are typically a number of owners who find their own complaints about their units, the common areas, or the project overall. What is more, if there is a design defect in one unit, it is most likely present in all of the units. Therefore, what may be a relatively insignificant flashing or window detail when looked at in connection with a single unit can become a much larger problem if the defect was repeated on fifty units in a project.

Won’t My Insurance Protect Me?

One of the most important issues you need to deal with is insurance. Many insurance carriers are simply refusing to cover firms that do a significant amount of condominium projects. In the most recent phase of condo popularity (in the 1980s), litigation from those projects created such a drain on the insurance companies that they began drafting exclusions in their policies. In some instances, rather than draft blanket exclusions, insurers have created limitations on how much condo work their insured can perform and still be covered. For example, an insurance carrier may agree to provide coverage as long as the condo work does not exceed 5% of the architect/ architectural firm’s income. The rumor on the street is that if a particular firm or architect’s income exceeds 20% from condos, they will not be able to get insurance. The secondary question, assuming that an architect can get coverage for their condo project, is: once the inevitable lawsuit comes, will the architect lose coverage? These are not only business issues, but liability issues as well. Ultimately, regardless of exposure, the registered architect who places his stamp on the plans will have personal liability for errors or omissions in the plans.

In recognition of the difficulty that design professionals are having in securing insurance for these types of projects, developers have been coming up with all sorts of schemes and ideas for how to provide insurance for design professionals. These ideas have ranged from ineffective to questionable. For example, a developer may offer to make an architect an additional insured on the developer’s insurance policy. However, a commercial general liability policy to which an additional insured endorsement can be added will typically include a coverage exclusion for professional acts. Therefore, although the architect may have insurance coverage through the developer’s policy, it will not cover the professional architectural services for which the architect has the most liability risk.

Other schemes have included setting up a dedicated trust, which would provide a fund of money to both defend and indemnify the architect should a lawsuit arise in the future. However, until one of these is put through the test of a lawsuit, many questions remain as to their viability. Remember, the statute of limitations for latent (hidden) defects in construction reaches ten years beyond completion of the project. Rare will be the developer that is willing to leave a significant sum of money tied up in a dedicated trust for at least ten years after the completion of a project.

While condos may be rising in popularity again, the insurance market is not as willing as the architects they protect to jump back into this dangerous type of project. As for those few carriers that are allowing condominium work by their insureds (or at least currently providing coverage for it), they remain very hesitant about the potentially large liability that comes with these projects. Again, the repetition of a defect in multiple units can make a small problem very large, and very expensive, very quickly. Consequently, a carrier may provide coverage for an architect to perform condo work, but once the predestined lawsuit is filed, that carrier may not be interested in renewing their coverage of that architect. Moreover, because design professional insurance policies are written on a “claims made basis” (meaning the insurance company that is covering the architect at the time the claim is made is responsible for coverage, regardless of when the project was done) exclusions for condo work in later acquired insurance policies may result in a lack of insurance when a lawsuit is filed eight years after the completion of a condo project.

Thanks for the Bad News. What Is the Solution?

Condos are once again presenting a profitable business opportunity. However, the very careful business decision that must be made is if the reward to be obtained (the fee) is worth the risk that it will bring. As with many decisions, this is a delicate balancing process that architects must make for themselves after careful consideration of all of the relevant factors . Some steps that can be taken to lessen the likelihood of being sued and to better your position when the suit does hit are:

  • Don’t do condos.
  • Include a strong limitation of liability provision in your contract, including protection from third party claims.
  • Include a strong indemnity provision in your favor and against not only the developer (typically an LLC or LLP), but the individuals/entities that own the developer.
  • Consult with an experienced attorney to negotiate the best contract you can get.
  • Obtain a waiver from the developer of any consequential damages.
  • Have the developer establish an escrow account with irrevocable instructions to pay the money in the escrow account to you when you get sued. If you aren’t sued before the statute of limitations runs out, the money can revert to the developer.
  • Get the highest and fairest fee you can because of the time required to pay extra attention to the details of the project. (If you are going to get sued, you might as well be paid well for the privilege.)
  • Don’t do condos.

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