Reconstruction or Bust; A Roadmap to the Reconstruction Process

By Michael T. Kennedy, Jr., Berding & Weil, LLP and Lisa Esposito, ACT Construction

INEVITABLY, EVERY MANAGER and every condominium community will face some large scale repair/reconstruction project of common areas. Whether the association is repairing construction defects or reconstructing deteriorated building components in an aging community, the board, with the manger’s guidance, can make decisions and select partners that can either make the process much easier or much harder. Each project has its own unique challenges, but many of the best practices and pitfalls are similar, whether the manager and board are facing repairs after resolving a construction defect claim on a newer building; long planned repairs which have been planned for (saved for) in reserves; or newly discovered dry rot or other issues caused by deferred maintenance, lack of previous inspections or simply previous boards that procrastinated necessary repairs.

WHEN IS IT TIME TO TAKE ON THIS PROJECT?

Repair projects should always be tackled sooner rather than later. Water damage and other building component deterioration does not heal itself; it only gets worse, and the cost to repair it only goes up. The temptation to procrastinate a large project is strong; many boards rationalize that "it’s just not the right time." Maybe there is a vocal homeowner who always speaks up and complains at meetings, or the board dreads the thought of a special assessment. But, delaying only increases the price tag. If asking the builder to make or fund repairs through the SB800 process is still an option, that option could be lost by delay. Some statutes of limitation in SB800 are as short as one year, and big ticket items, such as plumbing defects, are subject to a four-year statute of limitations, which runs from when the Notice of Completion was recorded, even if the builder kept control of the board for multiple years.

Whatever the cause, the sooner the board acts, the less expensive the repairs will be.

KEY PLAYERS IN THE PROCESS

The list of key players varies somewhat, depending on the impetus for the project. If there is an SB800 claim, then the first key player will be the construction defect counsel and his or her experts. The cause of the defects, the extent of resulting damage (i.e. rotted framing from balcony or window leaks) will be evaluated, and a proposed scope of repair prepared by the experts as part of the SB800 process. If the association’s attorney and the builder’s attorney have worked together in a real, good faith effort to resolve the case, the builder’s repairs may resolve the claim. With the right attorneys and large production builders the process can be completed at this point, once the repairs are verified by the association’s consultants.

Too often, however, the Right to Repair process doesn’t work the way it is supposed to, arbitration or litigation is necessary and eventually the association will still need to undertake its own repairs. The builder’s repairs during the SB800 process may have changed the necessary scope of repair as determined by the association’s consultants; those repairs may have partially repaired the defects, may have made them worse, or may have properly repaired some issues, but not others.

The attorney’s role is to recover sufficient funds from the builder or its insurance so that the association’s "net" recovery (after fees and costs are deducted from the gross amount of the settlement or judgment) is enough to perform necessary repairs based on this new, updated scope of repairs. The board, and not the attorney, always has the authority to say "yes" or "no" to any settlement offer, and the attorney’s job is to keep the board informed of the proper "net" amount required, and to work the case up so that sufficient funds are recovered. If not, there will not be sufficient funds to perform repairs.

There are options that the board may explore, such as a bank loan. Industry participating banks have made this option quite attractive and doable. A bank loan allows the majority of the work to be completed rather than dragging on for many years as funding becomes available.

The construction manager or design experts prepare a scope of anticipated repairs. If it is a post-SB800 settlement situation, then their task is to determine how best to spend the "net" recovery from the claim; how best to stretch the funds and to prioritize repairs. If the project is older and the work is funded directly by the association and its members (through reserves, special assessment or loan), then the designer or construction manager first determines the scope of necessary repairs. Is the association rebuilding balconies? Will their design be changed to prevent future deterioration/make maintenance easier? Will siding and plywood sheathing need to be replaced due to water intrusion damage? How much of the plywood?

The problem here is that it can be difficult to determine the extent of the damage and thus the extent of necessary repairs without peeling back the layers of the building, but before the association can start that, its consultants have to determine the scope of work. It’s a chicken-and-the-egg problem, and that is one of the many reasons why it is critical that the association utilize experienced business partners with deep experience in repair and reconstruction of an existing, in-use building.

During the actual construction, the construction manager’s role is to ensure that the job is progressing on time, approve payment applications from the contractors (after first verifying that the work being billed for has actually been completed), coordinate unit access and to generally act as the liaison between the contractors, owners, board and management. Construction managers are generally paid a percentage of the overall contract price. Smaller, simpler jobs don’t usually require a construction manager, but on larger, more complicated projects the extra layer of cost is well justified.

Selection of the contractor is another very important decision for the board, with the guidance of the community manager and perhaps the attorney. Here again, it is critical to work with a business partner with an extensive background in the HOA industry, with experience coordinating repairs with unit owners, coordinating access to units during construction and familiarity with the dynamics of boards, associations and managers. Usually, the construction manager will recommend three contractors to bid on the scope of work, with input from the community manager. This is another advantage of working with vendors who are experienced and well known in the HOA industry; in selecting contractors to be invited to bid on a given project, those contractors will have a familiar track record and a level of trust with the community manager and construction manager based on past experiences on other projects.

 

If the repairs are taking place after the resolution of an SB800 construction defect claim, there will have been destructive testing, and repairs after testing, as part of the investigation of the claim. This testing usually involves opening building components, such as cutting into balconies or roofs, or exterior walls in areas of leaks to determine the source of the leaks and the extent of the damages. The work is done under the supervision of the expert consultants in the case, but the actual work is done by a general contractor. Later, after the case resolves and it’s time to commence repairs, that contractor is familiar with the project and its challenges and (if post-repair patching has gone smoothly) has built some trust with the residents, board and manager that provides a comfort level in the working relationship during the later repairs.

The community manager’s role should be clearly defined (if the correct business partners are in place and if the job is going smoothly). The attorney and the construction manager have the responsibility to ensure that the manager has relevant information in time to update the board at meetings, whether by providing a report to the manager or by attending meetings to update the board as necessary.

FUNDING ISSUES

The list of potential funding sources is short: either the builder pays for the work or the members of the association do. That is why it is critical that the community have an extensive "check-up" before time runs out to have the builder pay for repairs. If the project is more than 10 years old, and/or the project is necessitated by deferred maintenance rather than construction defects, then the members will need to fund repairs, whether through reserves, a loan or a special assessment.

Whatever the source, it is imperative to ensure that the project stays within budget. This sounds obvious, but the scope and costs of a reconstruction project are always somewhat fluid due to the fact that hidden damage is very common, and once building components are exposed it is common for damage to be either more or less extensive than anticipated. Thus it is common for estimates to be expressed in "allowances" that estimate the amount of labor and materials for different parts of the project and to cost out different levels of repair. For example, a cost for a "Level 1," "Level 2" and "Level 3" repair, and a deck that was originally expected to be a "Level 1" repair is found to actually be a ‘Level 2" repair once it is opened up, or vice versa. That is another reason to engage experienced designers, contractors and, where appropriate, experienced construction managers to minimize the impact of unforeseen conditions on the budget.

CONTRACT ISSUES

Generally, the designer (architect or engineer), construction manager and general contractor are directly in contract with the association. Subcontractors (roofers, framers, plumbers, etc.) are in contract with the general contractor. The association should always ensure that the party it is in contract with is the same one who is licensed for the job, and is the named insured on the contractor’s insurance since sometimes a contractor has several different entities – such as subsidiary corporations – under the same ownership. This sort of cross-checking is one of the services the construction manager typically performs, and the idea is to make sure that the contractors are properly licensed and insured for the work being performed.

It is also important to ensure that the contracts are very clear about the scope of work; not just the literal construction work (Are roofs included? What type of siding is to be used? What grade of lumber?), but also other, related issues. Does the contractor have authority to substitute other types of materials? Make decisions on locations of repairs? Who has the responsibility to obtain permits? To obtain lien releases from subcontractors? How are issues of the addition or deletion to the scope of work handled? How is defective work to be corrected?

The contract should be clear about insurance requirements. What minimum policy limits is the contractor required to maintain? Is the contractor required to maintain a "tail" on the policy for a set number of years (which ensures coverage for problems discovered years later)? And finally, who is insured under the general and subcontractors’ policies? The association should be a "named insured" on all of the contractors’ policies so that if there is a construction site accident or other issue during construction, it has coverage under the contractors’ policies.

There are also several legal issues to keep in mind. Are there arbitration provisions in the policies? There are pros and cons to binding arbitration which could be the subject of a whole separate article, but the association and all parties to the contract should make a conscious decision about whether or not they want to enter into such an agreement, because courts always enforce them. Attorneys’ fees provisions should also be thought through before being included in the contract. An attorney’s fee provision is very helpful to the non-breaching party (i.e. the good guys) because they provide a very strong incentive to resolve disputes quickly, before the costs get out of hand. However, for the party breaching the contract, the attorney’s fee provision can end up resulting in a significant escalation of liability.

CONTRACTOR PAYMENT ISSUES

Contractors are typically paid in stages. California law is not allowed to charge a deposit of more than $1,000 before the work starts (called "mobilization"), but it is common to be paid 10 percent at mobilization and then a percentage at significant milestones, such as for each building completed, less a retention amount. These are called progress payments.

The general and subcontractors have the right to record mechanics’ liens for work performed and not paid for. The association should obtain partial lien releases for each progress payment made, from both the general and subcontractors. The general contractor is paid by the association and is then supposed to pay their own subs, but if they do not, those subcontractors can lien common areas. Therefore, it is important to clarify in the contract with the general contractor that it must indemnify the association from subcontractors’ mechanics’ liens, and to get lien releases from those subs as they are paid.

Some percentage is held back at the end (typically 10 percent). Called "retention," this is not released until the construction manager and association sign off on all of the work. Often, there is what’s called a "punch list" of loose end types of tasks at the end of a project. Perhaps there is paint overspray on a window, or landscaping that was damaged by scaffolding, or the latch on the new gate doesn’t work correctly, or something else that isn’t effective work necessarily, but just a loose end that needs to be taken care of. Building permits need to be closed after final inspections, warranty documents for new components provided to the association or manager, key fobs provided, etc. Once all the punch list items are signed off, the retention is paid to the contractor (released).

The goal is to ensure that everyone is as satisfied as possible at the end of the project. No one is having fun when faced with a large reconstruction project, but at the end, hopefully the manager, board, homeowners, contractors, construction manager and attorney are all still friends (or at least not enemies).

Here, communication is key. Have a town hall meeting before the project begins so that owners understand who is in charge of what, how the project is being funded, and how they and their unit will be impacted. They will want someone to communicate with during the project, whether it is a board subcommittee, the manager or the construction manager. Have another town hall meeting at the end, to celebrate the completion of the project and to address any lingering questions or concerns. The members will communicate anyway, whether in social media or when they run into each other at the mailboxes. It’s best for everyone if they have accurate, helpful information instead of rumors and unresolved complaints.

Nearly every community will eventually face a large reconstruction project. Just like people, buildings age and need help as they get older. However, addressing problems when they are discovered, and involving experienced, trustworthy business partners can make the process relatively painless. Get good people involved, keep the membership informed and resist the urge to procrastinate, and a community can come out of a reconstruction project looking much better – and with much better property values.