Construction Litigation Law Blog

Donald B. Brenner, Shareholder and Chair of Stark & Stark's Construction Litigation Group, presented materials related to minimizing acrimony and conflict while preserving an Association's rights with respect to construction defects and/or repairs, in conjunction with David J. Byrne, Esquire, during a seminar entitled "Managing Costs and Risks in Challenging and Uncertain Economic Times". The presentation was held at the Meadowlands Exposition Center in Secaucus, New Jersey on Wednesday, May 13, 2009.

Mr. Brenner focused his presentation on transition, building defects, alternative dispute resolution and how associations should review insurance policies for recovery and/or possible settlement prior to litigation.

The Environmental Protection Agency released new information from recent tests conducted on the materials used in Chinese Drywall. The EPA reports that drywall produced in China contains sulfur, and two other organic compounds which are generally used in the production of acrylic paint. These materials are not used in the production of drywall made in the United States. The EPA also found that Chinese produced drywall contains 10-times the amount of strontium (a metallic element) than that of American made drywall.

While these tests help to understand what has caused the catastrophic disasters in more than 100,000 US homes, the EPA has said that more tests are needed. In future tests, the EPA plans on including air samples in homes which contain the Chinese drywall in order to determine whether the drywall is the cause of the corroded wiring and appliances, as well as the reported health problems, like many currently believe.

The first congressional hearings on Chinese drywall are set for tomorrow, Thursday May 21, 2009. The Senate Subcommittee on Consumer Protection, Product Safety and Insurance will investigate health and product safety issues associated with the drywall. Experts from the U.S. Centers for Disease Control and Prevention, the EPA, the Consumer Product and Safety Commission and homeowners who have been affected by the drywall are expected to testify as witnesses at the hearing.

If you suspect your home may be built with defective Chinese drywall, contact us here for a free no obligation case review.

Contributory negligence is the common-law construct whereby any negligence by a plaintiff acts as a total bar to recovery against a negligent tortfeasor. The contributory negligence doctrine has been uniformly criticized as overly harsh, allowing culpable parties to avoid the consequences of their actions, and leaving relatively innocent plaintiffs without recourse. 57A AmJur2d 752, Negligence, § 856. In response, the vast majority of states, including New Jersey, have replaced the contributory negligence doctrine with some form of comparative negligence, whereby the fault of a plaintiff is compared with the negligence of the defendant and may serve to reduce the plaintiff's recovery of damages instead of completely barring the plaintiff's action. Id. See, e.g., Muldovan v. McEachern, 271 Ga. 805, 810 (Ga.,1999). In this way, states have modified the doctrine to achieve results more consistent with modern notions of fairness. The 1973 enactment of New Jersey’s Comparative Negligence Act (the “Act”), N.J.S.A. 2A:15-5.1 to -5.8, adopted this construct, providing that the fault of a plaintiff may be considered in allocating liability among the parties, but may only act as a total bar to recovery if it exceeds the fault of the defendants. Subsequent decisional law has construed the Act broadly, applying it not only to negligence claims, but also to claims sounding in strict liability. See, e.g. Cruz-Mendez v. ISU/Insurance Services of San Francisco, 156 N.J. 556, (N.J.,1999)

Notwithstanding the clear legislative and judicial repudiation of contributory negligence, a recent Appellate Division decision appears to revive that antiquated notion as applied to homeowner claims against manufacturers of defective building components. In Dean v. Barrett Homes, Inc., 406 N.J. Super. 453 (App. Div. 2009), the Appellate Division upheld the application of the “economic loss rule” to shield manufacturers of defective building materials from liability to the purchasers of pre-owned houses that incorporate the materials and sustain physical damage as a result. The economic loss rule, as codified by the New Jersey Product Liability Act, limits the availability of tort remedies to plaintiffs who have suffered personal injury or “physical damage to property other than the product itself.” N.J.S.A. 2A:58C-1(b)(2). (For a more extensive critique of the rule see The Economic Loss Doctrine: A license to sell defective building products?).

Even though the concurring majority in Dean, led by Judge Sabatino, acknowledged that the defective component, in that case—a synthetic stucco product known as Exterior Insulation and Finish System (“EIFS”)—had caused injury to property beyond “the product itself,” the court nevertheless barred plaintiffs’ tort remedies, finding that the unique circumstances of the underlying transaction weighed in favor of a restrictive application of the economic loss rule. Critical to the concurring majority’s analysis was the fact that plaintiffs received a home inspection report, prior to their purchase of the home, disclosing the potential defects in the EIFS:

In my view, [an] innocent home purchaser should be able to recover, under the Product Liability Act, N.J.S.A. 2A:58C-1 to -11 (“PLA”), reasonable compensation from the manufacturer of that defective component for the physical harm the component caused to other portions of the home and to any other property owned by the plaintiff.

In the present case, however, we are not dealing with [an] entirely latent defect, but one that was pointed out to the Deans, both orally and in writing, by their astute home inspector before they purchased the house. I agree with Judge Carchman that, whatever the proper scope of the economic loss doctrine may be, tort principles should not cover those losses in the particular setting of this transaction. Once alerted to the potential risks of the sheathing, the Deans could have insisted on a warranty from the builder to guard against future consequential harms, or demanded that the sheathing be replaced, or walked away from the purchase altogether. They did none of those things. The defect in the EIFS was no longer, with respect to the Deans, latent. Given this particular transactional context, I have no problem in confining plaintiffs to other remedies that are not based in tort or under the PLA.

Dean, supra, at 475, 483 (Sabatino, J., concurring) (emphasis added).

While differing on the issue of whether consequential damage to collateral components of the home constitutes damage to “other property,” Judge Carchman, writing for the court, agreed with the concurring majority that plaintiffs’ opportunity to avoid the loss asserted, and failure to take reasonable precautions to protect their own interests warranted foreclosure of their tort remedies:

We recognize the thoughtful and well-articulated concerns expressed by our concurring colleagues regarding the application of the economic loss rule as a bar to innocent purchasers recovering under the PLA from a manufacturer of a defective component of the home, where that component causes physical damage to other portions of the home; however, that is not the case we have before us on this appeal. As our concurring colleagues observe, plaintiffs, here, had appropriate opportunities to protect themselves from the potential of loss caused by the defective component.

Id. at 472 (emphasis added).

Though couched in terms of the economic loss rule, the effect of the Dean holding is the application of a contributory negligence standard to product liability claims asserted by homeowners against building component manufacturers. Where a homeowner knew or should have known of an injurious product-defect prior to purchase, no recovery may be had in tort for subsequent damage to “other property” caused by the defect. Yet, the New Jersey Legislature and Supreme Court have made clear that a comparative fault standard should govern the analysis of the relative "innocence" and "blameworthiness" of the victim and tortfeasor:

The final issue concerns the effect of plaintiff's comparative negligence on the [defendant's] liability under N.J.S.A. 21:3-5. That issue requires consideration of the Comparative Negligence Act, N.J.S.A. 2A:15-5.1 to -5.8, which provides that a plaintiff's own negligence may be considered in allocating liability among the parties. . . . The Act applies in strict-liability actions. Gennari v. Weichert Co. Realtors, 148 N.J. 582, 608-09, 691 A.2d 350 (1997); see also Suter v. San Angelo Foundry & Mach. Co., 81 N.J. 150, 164 (1979) (holding that Act provides a defense in most strict-liability actions, except in some workplace injury cases in which worker had no meaningful choice whether to encounter risk). A plaintiff's fault is an affirmative defense in a strict-liability action if his or her conduct constitutes an “unreasonable and voluntary exposure to a known risk.” Lewis v. American Cyanamid Co., 155 N.J. 544, 559, 715 A.2d 967 (1998); Cartel Capital Corp. v. Fireco of N.J., 81 N.J. 548, 563, 410 A.2d 674 (1980). To establish an affirmative defense, therefore, the Insurers must prove that plaintiff voluntarily encountered the risk with actual knowledge of the danger. The mere fact that plaintiff was negligent will not suffice.

Id. (emphasis added). See Cepeda v. Cumberland Eng'g Co., Inc., 76 N.J. 152, 185, 386 A.2d 816 (1978) (holding that “contributory negligence in the sense of mere carelessness or inadvertence” is not a defense in strict liability cases), overruled in part on other grounds Suter v. San Angelo Foundry & Mach. Co., 81 N.J. 150, 177, 406 A.2d 140 (1979). Under New Jersey law, even where a manufacturer proves that a consumer failed to take reasonable precautions against a product defect of which he knew or should have known, the result is a mere reduction of the plaintiff's recovery, not a complete bar, unless the jury makes a determination that a majority of fault lies with the plaintiff (a quintessential fact determination). In New Jersey, and in a vast majority of jurisdictions, an injured consumer’s “notice” of a product defect will not foreclose tort remedies unless the manufacturer meets a burden of establishing the consumer’s subjective knowledge of the danger and unreasonable conduct in the face thereof. See Id. See, e.g., Martinez v. Triad Controls, Inc., 593 F.Supp.2d 741 (E.D.Pa.,2009); Anderson v. Four Seasons Equestrian Center, Inc., 852 N.E.2d 576, 582 (Ind.App.,2006); Krajewski v. Enderes Tool Co., Inc., 396 F.Supp.2d 1045, 1052 -1053 (D.Neb.,2005); Warner Fruehauf Trailer Co., Inc. v. Boston, 654 A.2d 1272, 1274 -1275 (D.C.,1995)

Dean’s emphasis on plaintiff homeowners’ “innocence” is particularly problematic given the underlying purpose of the economic loss rule. The rule “defines the boundary between the overlapping theories of tort law and contract law by barring the recovery of purely economic loss in tort, particularly in strict liability and negligence cases.” Dean, supra, at 470 (citation and internal quotation marks omitted). It acts as a shorthand means of determining which duty has been violated by the defendant—that is, was it one that arose solely under contract, or did it also arise incident to the common-law obligation to avoid unreasonable risks of harm to persons or property? See Id. The Dean court essentially looked to the purchaser's fault to determine the source of a manufacturer's breached duty. This seems incongruous. The fact of the Deans’ "notice" does not change the quality of the manufacturer's culpable conduct, which presumably occurred long before plaintiffs purchased their home. The notice issue would have been more appropriately addressed in terms of comparative fault. While the Supreme Court did sanction an examination of unique transactional circumstances in applying the economic loss rule in Alloway v. General Marine Industries, L.P., 149 N.J. 620, 629 (1997), the purpose of that examination is to avoid an overly restrictive application of the rule, not to facilitate it.

Stark & Stark Shareholder and Construction Litigation group Chair, Donald B. Brenner, will serve as the moderator and as a presenter at the New Jersey Institute for Continuing Legal Education's seminar, Tackling Construction Law Issues. The seminar will take place Wednesday, July 29, 2009 from 9:00 AM to 4:00 PM at the New Jersey Law Center, New Brunswick, New Jersey.

The seminar will focus on the wide range of issues Construction Lawyers need to be aware of when representing clients, including public contracting, development, and insurance concerns to OSHA compliance, subcontracting and mediation issues.

Mr. Brenner will present a discussion on the recent Chinese drywall crisis occurring throughout the United State. Mr. Brenner will answer frequently asked questions relating to the defective drywall, including: What is it? What is the nature of the defect in Chinese Drywall? How does it damage property? What is the status of class actions involving Chinese drywall? What are the prospects for litigation in New Jersey relating to Chinese drywall?

John Randy Sawyer, Stark & Stark Construction Litigation group Shareholder, will also present a seminar as part of the Tackling Construction Law Issues seminar discussing the New Jersey Products Liability Act and the Economic Loss Rule, focusing on the very important recent Appellate Division decisions in Marrone v. Greer & Polman Construction and in Dean v. Barrett Homes.

Additional seminar information, including information on how to register for the seminar, is available online here.

An amendment calling for an immediate investigation into the correlation between Chinese drywall and the national foreclosure rate has been passed. Earlier this month, the drywall-related provision was successfully offered as an amendment to the “Mortgage Reform and Anti-Predatory Lending Act.” The provision was authored by Representatives Robert Wexler and Mario Diaz-Balart of Florida.

The legislation requires the United States Department of Housing and Urban Development, in conjunction with the United States Treasury Department, to provide a report of the problem within the next 120 days. The report should detail how many foreclosures are a direct result of the defective drywall, which was imported from China between 2004 and 2007. The legislation also asks that federal agencies work to research if homeowners insurance was available to those homes which were affected by the Chinese drywall.

If you suspect your home may be built with defective Chinese drywall, contact us here for a free no obligation case review.

On Wednesday, May 27, 2009 the United States Supreme Court will hold a hearing in Louisville, Kentucky in order to decide whether cases filed in federal court for those homeowners affected by defective Chinese Drywall across the country should be consolidated in one court with one judge. A panel of federal judges appointed by the United States Supreme Court will conduct the hearing.

Over 150 suits have been filed in Florida alone, representing 15,000 Florida homeowners who have damage and health problems as a result of the defective drywall. Hundreds of suits have been filed across the country, but attorneys who have filed cases on behalf of homeowners believe the cases will most likely be consolidated in New Orleans, Louisiana, Miami, Florida or Fort Myers, Florida.

If you suspect your home may be built with defective Chinese drywall, contact us here for a free no obligation case review.

Stark & Stark Construction Litigation Shareholder, John Randy Sawyer, and Associate, Joseph D. Gumina, authored the article, The Economic Loss Doctrine: A license to sell defective building products? for the May 11, 2009 edition of the New Jersey Law Journal. The article is available below, or online here. (PDF)

Underlying the entire complex of laws governing the construction and sale of residential property in New Jersey is a clear recognition that, “for most people, the purchase of a house will be the most important investment of a lifetime.” Gennari v. Weichert Co. Realtors, 148 N.J. 582, 607 (1997). That understanding is reflected in forty years of judicial and legislative advances against archaic common-law notions, such as caveat emptor, merger, and privity, that unfairly obstruct homebuyer remedies for material defects in construction. See, e.g. McDonald v. Mianecki, 79 N.J. 275, 294 (1979). Two recent Appellate Division decisions move the law in a seemingly contrary direction. In Marrone v. Greer & Polman Constr. Inc., 405 N.J.Super. 288 (App.Div. 2009) and Dean v. Barrett Homes, Inc., 2009 WL 1025565 (App. Div. 2009), the Appellate Division upheld the application of the economic loss rule to shield manufacturers of defective building materials from liability to the purchasers of pre-owned houses that incorporate the materials and sustaine physical damage as a result. The economic loss rule, as codified by the New Jersey Product Liability Act, limits the availability of tort remedies to plaintiffs who have suffered personal injury or “physical damage to property other than the product itself.” N.J.S.A. 2A:58C-1(b)(2).

The critical issue addressed in Dean and Marrone is whether “the product itself,” as applied to plaintiff homeowners, encompasses the entire house (disallowing tort claims for damage to other parts of the residence) or is limited to the defective building component supplied by the defendant manufacturer (allowing such claims). That question was previously answered in DiIorio v. Structural Stone & Brick Co., Inc., 368 N.J. Super. 134 (App. Div. 2004). In DiIorio, plaintiff homeowner filed suit against the manufacturer of defective stone siding that damaged the rest of the house in which it was integrated. The action was commenced outside the four-year statute of limitations of the U.C.C., but within the six-year statute applicable to claims for tortious injury to property. Concluding that “this [was] a product liability case[,]” the trial court permitted plaintiff to take advantage of the longer statute. On appeal, the manufacturer argued that the four-year statute should apply because “recovery of economic losses caused by goods that damage only the goods themselves are recoverable only in accordance with the comprehensive provisions of the U.C.C and not pursuant to theories of tort.” In rejecting this argument, the court noted that the asserted damages were “not limited to the value of the stones themselves.” Viewing the stones, not the damaged house, as the relevant “product,” the court determined that plaintiff had sustained “other property” damage, recoverable in tort, outside the limitations of the U.C.C.

In Marrone, the Appellate Division revisited the issue of what constitutes “the product itself,” as applied to pre-owned residential construction. Plaintiffs sued the manufacturer and distributor of an exterior siding product known as Exterior Insulation and Finish System (EIFS). They alleged that defects in the EIFS had allowed water to infiltrate and injure the underlying structure of their home. In dismissing plaintiffs’ tort claims, the trial judge viewed the home as the relevant “product,” concluding that plaintiffs had not alleged “personal injury or loss of personal property other than the damage to the home itself.” The Marrones argued on appeal that this ruling was inconsistent with DiIorio. The Appellate Division disagreed. Unlike the plaintiff in DiIorio, the Marrones “were not the original owners of the house. They bought the house. . . from the original owners. . . who in turn had contracted for its construction[.]” The court determined that, as subsequent purchasers, plaintiffs could not circumvent the economic loss rule by “attempting to break the house down . . . into its component parts[.]” To conclude otherwise would, in the court’s judgment, carry the realm of tort liability too far, potentially allowing “a buyer who purchased plaintiffs' house fifty years from now . . . [to] sue the [manufacturer and distributor of a defective building product] for water damage to the house.” The policy of shielding manufacturers against “potentially unlimited liability” was deemed sufficient reason to foreclose plaintiffs’ PLA remedies.

The combined result of Marrone and DiIorio is that, where a defective component causes damage to residential construction in which it is integrated, the manufacturer’s liability in tort will run to the injured homeowner who has “contracted directly with a builder to construct a house[,]” but not to the subsequent purchaser who, though suffering the same injury, stands further “downstream in the chain of distribution.” By limiting DiIorio in this manner, Marrone reanimates the notion of “privity” that was put to rest nearly a half century ago in Henningsen v. Bloomfield Motors, Inc., 32 N.J. 358, 161 (1960).

The authors submit that Marrone was wrongly decided, as it conflicts with the prevailing rule that a manufacturer’s liability to an end user of its product turns, not on privity, but on foreseeability. The key inquiry, which receives short shrift in Marrone, is whether a manufacturer who places a component in the stream of commerce for use in residential construction could reasonably envision anything but a class of end users that includes remote homebuyers. See N.J.S.A. 2A:58C-2. The answer to the court’s concern of “potentially unlimited liability” is “not the judicial obstruction of a fairly grounded claim for redress[, but] a more sedulous application of traditional concepts of duty and proximate causation to the facts of each case.” People Exp. Airlines, Inc. v. Consolidated Rail Corp., 100 N.J. 246, 254 (1985).

On facts strikingly similar to Marrone, the Appellate Division in Dean v. Barret Homes, 2009 WL 1025565 (App. Div. 2009) again affirmed dismissal of PLA claims asserted by subsequent homeowners against the manufacturer of EIFS, where consequential damage had extended to other parts of the house. The panel issued two opinions: one by Judge Carchman delivering the judgment of the court; and the other by Judge Sabatino, concurring in the judgment but differing on the “critical issue” of what constitutes the relevant “product.” Rejecting DiIorio’s analysis of that issue as dicta, Judge Carchman embraced the view of the Marrone court—that the house constitutes “the product itself”—and concluded that the damage to the home’s underlying structure was not damage to “other property.” This conclusion notwithstanding, DiIorio’s discussion of the economic loss rule cannot be relegated to the category of dictum where it was demonstrably on point with the issues presented by the appellants in that case. Indeed, Judge Sabatino, joined by Judge Simonelli, characterized Carchman’s departure from DiIorio as “troublesome,” and his resolution of the “critical issue” as inconsistent with “the dominant view of other states” that a defective component “incorporated into an improvement to realty does not lose its identity as a product[.]” Looking to the PLA, Sabatino expressed “considerable doubt that the Legislature intended to treat a single family house as a ‘product’[.]” Despite their differences on the issue of what constitutes “the product itself,” Carchman and Sabatino agreed that examination of unique transactional circumstances, particularly the relative ability of the parties in that case to avoid the loss asserted, weighed in favor of confining the Deans to their non-tort remedies.

In the authors’ view, Judge Carchman’s analysis is problematic, both for its interpretation of the PLA and for its potential impact on homeowner protections. The PLA expressly excludes “seller[s] of real property” from the definition of “product seller.” N.J.S.A. 2A:58C-8(1). This begs the question—if a seller of real property is not a “product seller” under the PLA, how then is a house, an improvement to the real property, considered “the product itself”? That view of the house would, under a literal reading of the PLA, confine homeowners to their warranty remedies whenever a defective component failed to spread devastation beyond the house itself. Consider defective wiring that starts a fire, resulting in nothing less (and nothing more) than the house’s total destruction. Is this a mere disappointment of economic expectations for which the law affords no recourse outside of warranty? The ability of a homeowner to “recover down an unbroken chain of warranties to the original source of the defect is greatly impeded in construction cases by the high number of insolvencies, bankruptcies, and business failures in the industry.” Cheezem, "Economic Loss in Construction Setting: Toward Appropriate Definition of ‘Other Property’”, 12-Apr Conslaw 21, 23 (1992). Even where all parties remain subject to service of process, common experience in the “volatile world of contractors, subcontractors, and material suppliers” confirms the impracticality of supposing a sequence of breach of warranty claims, transferring loss from the afflicted homebuyer to the component manufacturer bearing ultimate responsibility. It seems unlikely the Legislature intended to shield manufacturers and deprive homeowners of a practical recourse under these circumstances.

At the end of the trail from DiIorio to Marrone and Dean, it is unclear whether homeowners have any remedy against manufacturers of building components that damage pre-owned residential construction. Marrone’s conclusion that the PLA offers no such recourse conflicts with the view of the concurring majority in Dean. Because Judge Carchman’s endorsement of Marrone failed to attract a majority of the Dean panel, no new legal authority for that position was granted. The authors submit that DiIorio’s view of the component as the relevant “product,” as endorsed by Judge Sabatino, cleaves more closely to the PLA’s plain language and is in line with New Jersey’s sound policy of protecting residential consumers. And, as to original homeowners, that view remains the settled law.

Reprinted with permission from the May 11, 2009 issue of the New Jersey Law Journal, © 2009 Incisive Media US Properties, LLC. Further duplication without permission is prohibited. All rights reserved.

The New Jersey Supreme Court announced a sweeping expansion of the NJ Consumer Fraud Act, N.J.S.A. 56:8-2 ("CFA"), to include work done by contractors performing interior work on new construction. In Czar Inc. Heath, A-114-07, decided 3/13/09, the Supreme Court ruled 6-1 that new homeowners who act as their own general contractors for interior finish work have a right to assert claims under the CFA against the Czar, Inc ("Czar"), the subcontractor responsible for doing installation of kitchen cabinets, doors, chair railing and other interior finishes.

The owners of the home were unhappy with the subcontractor's work and withheld $80,000 from the bill. When they were sued by the subcontractor, the owners counterclaimed based on, among other things, violations of the CFA. Czar moved to dismiss the CFA claim arguing that HOW and its implementing regulations specifically exclude application of the CFA because this case involved "construction of a new residence" . The trial court agreed and dismissed the CFA claim.

The Appellate Division reversed the trial court holding that the exemption for construction of a new residence in the home improvement regulations under HOW did not apply to the work of the subcontractor. The Appellate Division panel reviewed the Contractor's Registration Act ("CRA") and noted that it regulates contractors who are involved in the home improvement business. The CRA exempts from its reach any person who is required to register under the New Home Warranty and Builder's Registration Act ("HOW") and who were already subject to a registration requirement. The Appellate Division reconciled the regulatory schemes set forth in the CRA and HOW, noting that HOW created a warranty program and an election of remedies by the homeowner. By contrast, instead of requiring warranties, CRA requires insurance and disclosures and, through its implementing regulations, defines unlawful practices which are punishable under the CFA.

The Court noted that Czar had not registered as a new home builder under HOW and had not provided the required warranties. The Court refused to allow Czar to simultaneously escape the requirements for the warranty under HOW while also escaping from the registration requirements of the CRA and the remedies afforded to consumers protected by the CRA. Essentially, the Court declined to allow Czar to have its cake and eat it too. Since Czar did not register as a builder of new homes under HOW, the Court rejected its argument that it was involved in building new homes. Czar therefore did not fall within the ambit of HOW, was not entitled to the safe harbor of the exclusion for new home builders and was subject to the CFA.

The "business risk" doctrine has become a fixture of insurance coverage law, with profound implications for insured contractors and plaintiff property owners involved in construction-defect litigation. Concisely stated, the doctrine holds that “faulty workmanship standing alone, resulting in damage only to the work product itself. . .” falls outside the ambit of coverage provided by a CGL policy. Firemen's Ins. Co. of Newark v. National Union Fire Ins. Co., 387 N.J.Super. 434, 449 (App. Div. 2006) (citations and internal quotation marks omitted). See also 4 Bruner & O'Connor Construction Law § 11:37.

 
A review of the decisional law advancing this principle reveals a lack of consensus with respect to its rationale and application. A particularly uneven treatment of the “business risk” distinction is found in cases where damages are confined to an insured contractor’s work product but extend, qualitatively, beyond mere faulty workmanship. Consider the following example:
 
A residential developer undertakes the construction of a wood-framed apartment building. The exterior of the building is clad in a synthetic stucco system, which, due to faulty workmanship, allows water infiltration into the building’s main walls. This water infiltration, in turn, causes damage to contiguous building materials (stud framing, sheathing, interior finishes, etc.), which are otherwise defect-free. No damage is sustained beyond the building itself.
 
Purchasers of the building file suit against the developer seeking recovery for (1) the cost of replacing the defective synthetic stucco system; and (2) the cost of repairing the consequential damages to the underlying building materials.
 
The developer submits to its insurer a claim for defense and indemnity under a CGL policy covering “property damage” caused by an “occurrence” and featuring the standard “business risk” exclusions.
 

A reoccurring controversy in insurance coverage law is whether the damages in item 2—the cost of repairing consequential loss stemming from a defective component in the insured’s work product—are covered under a CGL policy. To the extent such damages affect only the “work product itself,” they would seem, at least facially, to come within the preclusive ambit of the “business risk” doctrine—they are not damage to “other” or “third-party” property. However, a more thoroughgoing analysis, as presented in two recent Federal Circuit opinions—Stanley Martin Companies, Inc. v. Ohio Cas. Group, 2009 WL 367589 (4th  Cir. Feb. 12, 2009) and Mid-Continent Casualty Co., v. JHP Development, Inc., --- F.3d ----, 2009 WL 189886 (5th Cir. Jan. 28, 2009)—leads to a different conclusion. These cases shed new light on the contours and limitations of the “business risk” doctrine, distinguishing between the defects in an insured’s work product, which generally are excluded from coverage, and the consequential injuries stemming from those defects to other parts of the same work product. According to the recent decisions, the latter category of damages is not necessarily excluded.

 
In Stanley Martin, decided February 12, 2009, the Fourth Circuit Court of Appeals determined that damages caused by defective trusses supplied by a subcontractor and used in the construction of new townhouses constituted a covered “occurrence” within the meaning of the general contractor’s CGL policy. In keeping with the standard coverage form, the policy at issue defined “occurrence” as “an accident, including continuous or repeated exposure to substantially the same general harmful conditions.” Stanley Martin, supra, at 1. The underlying litigation stemmed from mold damage, originating from the defective trusses, and spreading to other, non-defective, components of the buildings. No damage was sustained beyond the building itself.

 
Applying Virginia law, the lower court had determined that the alleged damages did not come within the scope of the relevant policy because the general contractor’s “remediation costs arose out of damage to [its] own ‘work’ caused by the faulty workmanship of its subcontractor[.]” Id. at 2. This exigency, in the court’s view, “was not ‘unexpected’ or an ‘accident.’” Id. It was an anticipated, and therefore uninsured, risk of doing business.
 

In the decision reversing the lower court’s ruling, the Court of Appeals confronted a divergence of opinion in the Fourth Circuit with respect to the proper application of the “business risk” principle to such circumstances. Four years prior, the Fourth Circuit had addressed a similar set of facts in Travelers Indemnity Co. of America v. Miller Building Corp., 142 F. App’x 147 (4th Cir. 2005). Apparently relying on the “business risk” distinction, the Miller court held that the consequential injuries to the building, which “allegedly [were] a result of the subcontractor’s defective performance,” were confined to the building itself and, therefore, “not considered to be ‘unexpected’ or caused by an ‘occurrence.’” Stanley Martin, supra, at 2 (quoting Miller, supra, at 149) (internal quotation marks omitted). Because, in the court’s view, the damage to the general contractor’s work did not constitute an “occurrence,” it did not trigger the insurers duty to indemnify.

 
The Fourth Circuit reached the opposite conclusion a year later in French v. Assurance Co. of America, 448 F.3d 693 (4th Cir. 2006). In that case, the court distinguished between the subcontractor’s defective work and the damage caused to the surrounding components, which were, in themselves, defect-free. The coverage dispute stemmed from the circumstances presented in the introductory fact pattern—a residential developer hired a subcontractor to clad the exterior of a new home with synthetic stucco system known as “Exterior Insulation Finishing System” (“EIFS”). Defects in the EIFS allowed moisture intrusion that caused damage to the home’s underlying structure. While acknowledging that the subcontractor’s defective work was, in and of itself, an excluded business risk, the court determined that the damage caused by that defective work to the surrounding non-defective components did constitute “an accident, and therefore a [covered] occurrence under the initial grant of coverage of the [CGL policy].” Stanley Martin, supra, at 2 (quoting French, supra, at 704-05) (internal quotation marks omitted). In reaching this conclusion, the court reasoned that, “[a]s delivered per the construction contract,” the surrounding components were “defect-free,” such that their subsequent damage was unexpected. Id.

 
Faced with these diverging opinions, the Stanley Martin court rejected Miller and endorsed French as the controlling iteration of the “business risk” distinction. The bifurcation of the insured’s work between defective and non-defective components was, in the court’s view, well “grounded in the plain language of the policy and the interplay between the policy’s broad definition of an ‘occurrence’ and the policy’s ‘your work’ exclusion” which excepted subcontractor work. See Stanley Martin, supra, at 2 (quoting French, supra, at 703 (internal quotation marks omitted). At oral argument, the insurer in Stanley Martin tried to distinguish French on the basis that the moisture intrusion that damaged the home’s non-defective structure was a separate event that could constitute an occurrence. The mold at issue in Stanley Martin, on the other hand, was present in the townhouses as soon as the trusses were installed. The court found this argument unpersuasive, characterizing it as a “labored distinction [that] places more weight on the policy language than it can bear.” Id. at 2. Because there was “no allegation that the general contractor either expected or intended that its subcontractor would perform defective work or that the spread of mold beyond the defective trusses was expected or intended,” the court determined that these events were “occurrences” capable of triggering coverage under CGL policy. Id. at  3 (internal quotation marks and citations omitted).

 
The Fifth Circuit’s January 28, 2009 decision in Mid-Continent also addressed the application of the “business risk” principle in the context of a construction defect case. Mid-Continent focused, not on the meaning of the word “occurrence,” but rather on the scope of the standard “business risk” exclusion for damage to “[t]hat particular part of any property that must be restored, repaired or replaced because ‘your work’ was incorrectly performed on it.” Id. at 3. Like the Stanley Martin court, the Fifth Circuit emphasized a distinction between the defective and non-defective components of the insured’s work product. Factually, the coverage dispute stemmed from an insured developer’s construction of a four-story, wood-framed residential building with inadequate water-sealants and retaining walls. As a consequence of these deficiencies, large quantities of water penetrated the interior of the structure through the ceilings and walls, under doors, and at other points, damaging contiguous building materials, which were, in themselves, defect-free. After receiving a demand for defense and indemnity, the developer’s CGL insurer filed a declaratory judgment action seeking, among other things, a declaration that coverage was barred by the above-quoted “business risk” exclusion. Id. at 3. The Fifth Circuit Court of Appeals framed the issue in the following manner: 
 
Whether the exclusion bars recovery for damage to any part of a property worked on by a contractor that is caused by the contractor’s defective work, including damage to parts of he property that were the subject of only non-defective work, or whether the exclusion only applies to property damage to parts of the property that were themselves the subject of the defective work.
 

Id. at 6. Examining the plain language of the exclusion, the court determined that only property damage “to parts of the property that were themselves the subjects of the defective work [was] excluded.” Id. at  6 (emphasis added). The court rejected as unpersuasive the approach taken in another jurisdiction in which consequential damages to non-defective components were necessarily deemed an excluded “business risk.” Id. at 7 (declining to follow Century Indemnity Co. v. Golden Hills Builders, Inc., 384 S.C. 559 (2002)). Such an approach, the court reasoned, improperly subordinates analysis of the policy’s language to a presumption about the underlying purpose of CGL coverage. Id. at 7. “The mere fact that a policy is designated as a ‘commerical general liability’ insurance policy is not grounds for overlooking the actual language of that policy.” Id. The court therefore cabined its discussion to the terms of the policy before it and determined that the consequential losses in question went beyond the “particular part of the [the contractor’s] work” containing defects. Thus, the “business risk” exclusion was inapplicable and coverage obtained.
 

Stanley Martin and Mid-Continent continue a discernable trend in favor of coverage where an insured contractor’s faulty workmanship results in damage to otherwise non-defective work product. While it can generally be said the faulty workmanship is, itself, an anticipated risk of doing business, the consequences flowing from such workmanship are not so easily categorized. The Fourth and Fifth Circuit decisions reflect a growing recognition across jurisdictions that broad-stroked applications of the “business risk” rule—which is essentially an insurance industry trade concept—must not supercede analysis of the plain language of insurance contracts. See Zacarias v. Allstate Ins. Co.  168 N.J. 590, 595 (2001) (“In the first instance, the words of an insurance policy are to be given their plain, ordinary meaning.”) See also 4 Bruner & O'Connor Construction Law § 11:37. Absent a particular policy exclusion, the logical basis for differentiating between consequential loss to an insured’s work product and consequential loss to other property remains tenuous, and all but a shrinking minority of jurisdictions have either abandoned or qualified the distinction.

The construction industry appears to be the latest victim of the stream of defectively manufactured goods from China that have poured into our country over the last few years. As if the construction market has not experienced enough hardship in these trying economic times, reports have recently surfaced of defective drywall products that were imported from China as the likely cause of putrid sulfur odor emissions being experienced in newly constructed homes and failure of metal devices typically installed behind sheetrocked walls, such as HVAC systems and metallic wiring. (See http://online.wsj.com/article/SB123171862994672097.html). Although drywall products used by American builders were typically manufactured in the U.S., a shortage of construction materials in the Gulf Coast following Hurricane Katrina lead to builders importing the products from overseas.

A handful of builders and environmental consultants, mostly in the Florida area, are investigating whether the drywall that was imported from China is emitting sulfur-based gases that could be corroding air-conditioner coils, computer wiring and metal picture frames. Homeowners in several Florida counties have reported that their evaporator coils of air-conditioning equipment prematurely failed, were replaced, and then failed again. The Sulfur odors have been associated with erosion on copper in electrical outlets, metal surfaces behind refrigerators and other places where metal is in these homes. The Sulfur odor can also cause people to experience mild and moderate respiratory irritation that clears up only when they leave the homes. These reports have lead to homeowners expressing concerns whether the odor will cause long-term health conditions if they stay in the home.

The Environmental Protection Agency has investigated the problem and confirms there is a problem with the drywall from China:

“It is the drywall, and from what I gather it is causing a problem with copper and, specifically, air conditioning units,” said Dawn Harris-Young, spokeswoman from the EPA’s Region 4 in Atlanta.

The extent of the problem is not yet known, with reports coming in mostly in the southeast, but at least one case reported in the Virginias. Officials have indicated that children and the elderly are at the highest risk for health problems from the sulfur gas emissions, and that individuals with asthma or chemical sensitivity are at an even higher risk.

If you suspect your home may be built with defective Chinese drywall, contact us here for a free no obligation case review.

Last Thursday the Nevada Supreme Court denied attempts from Del Webb (a national builder of active adult communities) and their contractors seeking to limit the number of homeowners within a community from pursuing construction defect claims. The court stated that subsequent buyers of a home (in addition to the original owners) which had been deemed defective have the right to sue under the Nevada State defect law.

The ruling, also referred to as the “Stucco Case,” found in favor of 700 homeowners who had been involved in litigation since the original complaint was filed in June 2003. Defects in the stucco installation resulted in the formation of mold, which caused the homes to be deemed dangerous and hazardous to residents.

According to several of the homeowners’ attorneys, not including attorney’s fees and interest accrued over the past five years, the estimated cost to repair the damage to the homes was nearly $90 million. Though the case is expected to be appealed to the United States Supreme Court the outcome is sure to have in impact on similar cases across the country.

Every builder operating in New Jersey is most likely aware that our state has plaintiff-friendly laws in the context of construction defect litigation. Even so, the gravity of claims made against builders for alleged defects typically has a direct correlation to relatively known and controllable factors, i.e. their contract performance and quality of product. However, there is another category of claims being made with increasing success in defect cases made under New Jersey’s Consumer Fraud Act (CFA).

The CFA is aimed at unlawful sales and advertising practices designed to induce consumers to purchase merchandise or real estate. Intended to give New Jersey one of the strongest consumer protection laws in the nation, it receives liberal interpretation from the Courts in favor of consumers. The CFA declares as an unlawful practice “[t]he act, use or employment by any person of any unconscionable commercial practice, deception, fraud, false pretense, false promise, misrepresentation, or the knowing, concealment, suppression, or omission of any material fact with intent that others rely upon such concealment, suppression or omission”. Affirmative misrepresentations under the Act do not require proof that the alleged violator actually intended to deceive the consumer. Concealment or omission claims require only that the alleged violator knowingly concealed a material fact with the intent that the omission be relied upon by consumers.

The scope of the CFA’s consumer protections can be seen in its language that “any person who suffers any ascertainable loss of moneys or property, real or personal, as a result of the use or employment by another person of any method, act, or practice declared unlawful under this act…may bring an action”. Courts have interpreted that, an “ascertainable loss” occurs simply when a consumer receives less than promised.

Additionally, no proof is required under the CFA that a consumer actually relied upon any alleged statement or conduct by a defendant to make a claim. Rather, the Act specifically provides that consumers are protected “whether or not any person has been misled, deceived, or damaged thereby”. There is also no requirement that consumers have a contract with the alleged violator, or be in direct contact with a party who has allegedly violated the CFA, in order to assert claims. How these principles have been applied in defect cases shows how broad the potential scope of liability can be for builders and contractors.

In Chattin v. Cape May Greene, a developer had distributed a brochure to homeowners that indicated the homes would contain “insulated aluminum windows”. The windows actually used in the homes had a double pane of glass, which provided insulation. The aluminum frames of the windows, however, had no insulating features. Homeowners claimed the frames of the windows allowed air infiltration and caused condensation damage to the sills and woodwork. Homeowners who received the brochure won at trial because the Court agreed that the representation about the windows in the brochure was misleading under the CFA. On appeal, the Appellate Court sent the case back for a new trial, but only because it wanted the jury to determine whether the average consumer would understand the term “insulated aluminum windows” to refer only to the glass or to the entire window unit.

Recently in Matera et. al. v. M.G.C.C. Group, Inc. et. al., a defendant bank concealed information from a local planning board regarding drainage problems connected to land it was selling to a developer, in order to gain approval from the planning board for construction of homes. Homeowners in an adjoining property all began experiencing flooding after the developer bought the land from the bank and built the homes. Despite the homeowners having no direct contact with the bank, and despite the facts that the homeowners never heard any of the bank’s misrepresentations and were never directly exposed to any of its omissions, the Court found the homeowners could still maintain CFA claims against the bank.

With cases like Chattin and Matera, which involved liability to homeowners under the CFA for statements in a brochure and statements to a planning board, it may seem difficult for a builder to avoid claims under the CFA. However, builders and contractors can take steps to protect themselves by having an understanding of the broad scope of potential liability under the CFA and using that knowledge to serve as a filter for all statements and advertisements made in developing and marketing a project.

Matera et. al. v. M.G.C.C. Group, Inc. et. al., Docket No. L-1812-04

Judge Louis Locascio of the New Jersey Superior Court recently ruled in the matter of Matera et. al. v. M.G.C.C. Group, Inc. et. al., Docket No. L-1812-04, that a cause of action under New Jersey’s Consumer Fraud Act exists where there is no direct contact between the parties but there is a connection between the defendants’ “alleged violation of the Consumer Fraud Act and plaintiff’s ascertainable loss.”

The Plaintiffs, homeowners who purchased homes in a development called Crystal Creek Estates, argued that the defendant Bank of America (“BOA”) had concealed information and made misrepresentations to its purchaser, Defendant Developer M.G.C.C. Group, Inc., and to the Howell Township Planning Board, in order to gain approval for constructing the final phase of Crystal Creek Estates, known as Section III. The Plaintiffs all bought homes within Section II of Crystal Creek Estates and began experiencing flooding in their basements and back yards after defendant M.G.C.C. Group, Inc. constructed Section III of the development.

BOA, as the successor to the original financier of the project, took title to two undeveloped lots in Section II and all of the undeveloped lots in Section III of the Crystal Creek Estates development. BOA obtained approvals for the construction of Section III of Crystal Creek Estates from the Howell Township Planning Board before selling the land to Developer M.G.C.C. Group, Inc. In obtaining those approvals, BOA failed to disclose to either the Howell Township Planning Board or M.G.C.C. Group, Inc. that BOA knew about serious drainage problems that would occur in Section II of the development if Section III was constructed as planned and approved. BOA also knew but concealed that Section II of the development would have to be re-graded in order to deal with excessive drainage to the section caused by the planned construction of Section III, and that an engineer had provided BOA with an opinion that there were serious drainage issues between the two sections.

Judge Locascio found that BOA’s misrepresentations and omissions were not only made directly to the Howell Township Planning Board, but were also “intended to be conveyed to the buyer” (defendant M.G.C.C.), because obtaining planning board approval “was necessary to complete the real estate transaction with defendant M.G.C.C.” Id. at 5. The Judge concluded, therefore, that BOA’s misrepresentations and omissions were “in connection with the sale of real estate,” a requirement for application of the Consumer Fraud Act.

The Judge then went on to find that a “causal nexus” existed between the Plaintiffs’ damages and BOA’s misrepresentations and omissions to M.G.C.C. Group and the planning board. Noting that the Consumer Fraud Act does not require privity between a defendant and a consumer, Judge Locascio concluded that the Plaintiffs did not need to be directly exposed to BOA’s misrepresentations and omissions because the Consumer Fraud Act states that a violator of the Act “is liable for any misrepresentations whether ‘any person has in fact been misled, deceived, or damaged thereby’ ... [the Act] did not say any party.” Id. at 6 to 8 (emphasis in original). The Judge found, therefore, that because BOA’s misrepresentations to the planning board and to M.G.C.C. Group ultimately damaged the Plaintiffs, there existed “a causal nexus” between BOA’s violation of the Consumer Fraud Act and the Plaintiff’s “ascertainable losses.” The Judge reasoned that if BOA “did not misrepresent facts to the Howell Township Planning Board, the planning board would not have granted the letter of compliance and section III would not have been built, or in the alternative, the drainage problems would have been corrected before the letter of compliance was granted.” Id. at 9. “Under either scenario, plaintiffs’ properties would not have been flooded.” Ibid. Therefore, it is “proper to hold BOA liable for the damages under the Consumer Fraud Act even though BOA had no contact with plaintiffs.” Ibid.

If you are interested in more information on this topic or have any questions, please contact John Randy Sawyer, Esq. at (609) 895-7349, or by email at jsawyer@stark-stark.com.

The New Jersey Appellate Division ruled this month in two companion cases, New Jersey Shore Builders Association v. Township of Jackson, A-5805-06 (June 23, 2008) and Builders’ League of South Jersey v. Egg Harbor Township, A-1563-07 (June 23, 2008), that municipalities cannot require as a condition of approval that builders and developers provide on-site recreation areas or facilities, or common open space, outside the context of planned unit developments. The Court also held that municipalities cannot require payment of monies to built such facilities off-site in lieu of providing them on-site. The Court found that ordinances requiring such conditions of development approvals were not authorized under the Municipal Land Use Law (MLUL). Through this ruling, the Court has ended a longstanding practice of municipalities to exact these types of conditions from developers, and, for developers who have in the past been made to remit payments in lieu of providing on-site recreation areas, facilities, or common open space, the decision may open a floodgate of demands for reimbursement of those payments.

Ordinances in two municipalities, Egg Harbor Township, Atlantic County and Jackson Township, Ocean County, were the subject of the attack. Both ordinances compelled developers seeking approvals to set aside a certain amount of acreage on-site for use as public open space and/or recreational facilities such as tot lots, tennis and basketball courts, and baseball, soccer and football playing fields. Both townships’ ordinances also provided for payments in lieu of providing those facilities on-site for use in constructing such facilities off-site.

The Appellate Division found that both ordinances were not permitted under the MLUL did not permit the recreational open space exactions required by the ordinances. The Court rejected the Townships’ arguments that the MLUL should be read expansively to implicitly authorize the imposition of open space and recreation exactions. The Court held instead that the MLUL contains explicit language specifically limiting municipalities’ powers in that regard. The Appellate Court held that while providing public open space and recreation facilities is an important goal of New Jersey land use law under the MLUL, it is a goal that can only be accomplished within the strict and specific limits of the MLUL. Municipalities cannot require developers to provide common open space and recreation facilities on-site as a condition of development approval, or require payments in lieu thereof, outside the context of planned unit developments.

Donald B. Brenner, Shareholder and Chair of Stark & Stark's Construction Litigation group, authored the article Homeowner's Association Standing To Assert Without Joining the Homeowners for the March 24, 2008 edition of the New Jersey Law Journal.

You can read the full article here.

On March 11, 2008, in the matter of Camelot Condominium Association, Inc v. Dryvit Systems, Inc., pending before the Superior Court of New jersey, Docket No. BER-L-012457-04, a jury entered a verdict in favor of the Plaintiff and against Dryvit Systems, Inc ("Dryvit") for violations of the New Jersey Consumer Fraud Act. Dryvit Systems is the largest manufacturer of Exterior Insulation and Finish Systems for residential and commercial construction in the United States.

With settlements the Plaintiff obtained before and during trial from other defendants, the total irecovery for the Plaintiff following the jury verdict was $5,046,000.

The case involved a joint repair project done in 1998 on what was then a 16 year old high rise building clad with roughly 300 panels coated with Dryvit's EIFS. The jury returned a verdict that charged Dryvit with knowledge that the Dryvit EIFS finish coating on the buildng's exterior panels softened when exposed to substantial water penetration. That softening caused cohesive failures at critical caulk joints, which resulted in openings for water to penetrate inside the building and cause catastrophic damage to the framing and sheathing on the building.

The jury found that Dryvit made knowing omissions and affirmative misrepresentations of material fact in connection with the repair of the Exterior Insulation and Finish System (EIFS) on the building located in Hackensack, New Jersey. This is the first time in New Jersey that an EIFS manufacturer has been subjected to a jury verdict for violations of the New Jersey Consumer Fraud Act. There will be no appeal.

John Randy Sawyer and Donald B. Brenner Shareholders of Stark & Stark’s Construction Litigation group represented the Plaintiff in the case.

In an unpublished case, the Appellate Division recently affirmed the trial court’s decision that defendant property owner did not waive the arbitration clause of its AIA construction contract with plaintiff construction company by participating in plaintiff lawsuit for a year before invoking the arbitration clause. Delam Construction Corp. v. 15 Thornton Road, L.L.C., A-0582-06T1 (App. Div., December 10, 2007. After weighing a variety of factors, including plaintiff’s incurring the expenses of litigation, plaintiff’s bringing a lawsuit although it must have known of the arbitration clause, and defendant’s “playing fast and loose” with the court until invoking the arbitration clause on the eve of trial, the court concluded that plaintiff would not be prejudiced by remitting the case to an arbitrator since the discovery accomplished during the pendency of the lawsuit would be useful in the arbitration.

Neither party disputed that $187,368 plus interest remained unpaid to plaintiff following its completion of construction of defendant’s building. The parties had signed an AIA standard construction contract, which required the parties to submit their disputes to arbitration. Nonetheless, plaintiff sued on the contract in May 2005, amending its complaint in October 2005.

In its answer to the amended complaint, filed in December 2005, defendant counterclaimed for damages attributable to construction deficiencies in plaintiff’s work. Nonetheless, in October 2005, in response to plaintiff’s interrogatories, defendant certified that it had retained no experts to offer opinions on the alleged construction deficiencies. The discovery end date was April 24, 2006.

One month later, plaintiff moved for partial summary judgment, citing defendant’s lack of expert testimony regarding the alleged construction difficulties. On June 6, 2006, defendant responded by amending its interrogatory answers to disclose the names of two experts and providing copies of their reports. Plaintiff moved to bar defendant’s experts since they were named after the discovery end date. The motion’s return date was June 28, 2006, the scheduled trial date.

The trial court’s decision emerged from a blur of motion practice. The court heard oral argument on plaintiff’s summary judgment motion on June 23. On June 27, 2006, the court denied the summary judgment motion pending the outcome of the motion to bar defendant’s experts but granted defendant’s motion to set aside plaintiff’s construction lien. Thereafter, defendant withdrew its supplementary interrogatory answers naming its construction experts.

When the parties appeared for trial on June 28, 2006, plaintiff sought to postpone the trial to allow reconsideration of its summary judgment motion in light of defendant’s withdrawal of its experts. The judge adjourned the trial to allow plaintiff to re-file its summary judgment motion and defendant to file whatever new motions it deemed appropriate.

On June 30, plaintiff moved for partial summary judgment. On July 19, defendant retained new counsel. On July 29, defendant cross-moved to, among other things, dismiss plaintiff’s complaint based on the parties’ contractual duty to arbitrate their differences. Defendant certified that it had been unaware that its prior counsel had missed the deadline for naming its expert witnesses.

After hearing oral argument on August 17, the trial judge decided that the matter should be submitted to arbitration even though defendant’s original counsel had pursued the unusual strategy of “neither raising the arbitration clause [nor] presenting any expert reports.” The court order declared that plaintiff’s summary judgment motion was moot, granted defendant’s motion to dismiss plaintiff’s amended complaint, reinstated plaintiff’s construction lien and ordered defendant to file its demand for arbitration by August 31, 2006. Defendant demanded arbitration on August 30, 2006.

Plaintiff appealed, contending that the trial court’s decision caused it undue prejudice. It argued that defendant waived its right to arbitration by participating in the lawsuit, by failing to raise arbitration as an affirmative defense, and by failing to demand arbitration at an earlier date. Defendant responded by citing contractual language requiring the waiver of any right under the contract to be written.

The appellate court acknowledged the trial court’s reliance on Wasserstein v. Guild Contracting Corp., 261 N.J. Super. 277, 290 (App. Div.), certif. denied, 133 N.J. 440 (1993), which recognized a trial judge’s right to refer a case to arbitration at any time before judgment. Nonetheless, the appellate court viewed its task as reconciling two other competing lines of authority. The first line, including cases such as Ohio Casualty Ins. Co. v. Benson, 87 N.J. 191, 199 (1981) and Marchak v. Claridge Commons, Inc., 134 N.J. 275, 281 (1993), favors arbitration as a cheap and speedy alternative to litigation. The other line, including Wein v. Morris, 388 N.J. Super. 640 (App. Div. 2006), certif. granted, 190 N.J. 254 (2007), holds that active and prolonged litigation of disputes will result in the court’s finding that the parties have waived their right to compel arbitration.

The court resolved its dilemma by reference to Hoxworth v. Blinder, Robinson & Co., Inc., 980 F.2d 912, 925 (3d Cir. 1992), which recognized prejudice as the relevant factor in determining whether or not the right to arbitration has been waived. Here, said the appellate court, plaintiff was not greatly prejudiced since the knowledge gained during discovery would be useful in the arbitration proceeding. Further, to the extent that any prejudice does result from remitting the parties to arbitration, plaintiff shared the fault by bring the action in derogation of the contract. Accordingly, the appellate court affirmed

The New Jersey Supreme Court Appellate Division recently upheld a judgment against a stucco/masonry contractor under the New Jersey Consumer Fraud Act in Briggs v. Luisi, et al.. The case involved allegations by the owners of a single family home that the stucco/masonry contractor negligently performed repair work on the exterior of the house and on cracks in the home's foundation, and that the contractor violated the Consumer Fraud Act through affirmative misrepresentations and knowing omissions in connection with a five year warranty issued covering the work.

After performing only a portion of the scope of work he was retained to complete, the contractor gave the homeowner a guarantee on the exterior stucco surface and the foundation of the entire house against cracks and defects for a period of five years. In discovery, however, the contractor admitted that he did not complete all of the work that was described in the warranty. He also acknowledged that the plaintiff and the plaintiff's lending institution relied on the warranty. Based on this evidence, the Appellate Court affirmed the $89,485 judgment against the contractor and in favor of plaintiff, as well as affirming the jury verdict apportioning twenty percent of the total damages against the contractor as attributable to the contractor's violation of the Consumer Fraud Act, which portion was then trebled by the Court and was the basis for an award of counsel fees.

After a bench trial, a judge in New Haven, Connecticut ruled that the seller of a house that had obvious, visible mold damage - black mold stains in the utility room and water stained and rotted wood inside - had intentionally concealed the existence of this problem, and was liable to the buyers for the cost to prevent further water intrusion, the cost to repair the damage caused by past water intrusion, and $25,000 for emotional distress. The case is Camerone v. Phillips, 2007 WL 241258, (Conn. Super. Jan. 17, 2007), The award of emotional distress damages was later vacated. Camarone v. Philips, WL 2081330 (Conn. Super. April 17, 2007).

The plaintiffs purchased a home in North Haven, Connecticut from the sellers in 2003. Upon moving in, they immediately noticed severe water seepage in the lower level of the house, and brought suit against the sellers for failing to disclose the problems. Sellers argued that the buyers had hired a home inspector, and relied upon his inspection, and proceeded to closing, despite the fact that the inspection noted several potential trouble spots. The court specifically found that the seller was not truthful, and based its findings largely on discrepancies between the MLS description and the seller’s testimony. For example, the MLS listing described the home as “mint condition” and “like new”. New walls, new carpeting and new paint were highlighted. At trial, however, the seller testified that the items were not all new, in fact some of the items had been installed in 1999. The seller testified that he never saw anything that indicated that the home was subject to water seepage. The court stated in its opinion that it did not believe him.

The court specifically found that the seller could not have been unaware of the serious water problems and resulting mold throughout the house. Carpet which had been installed just before the sale was soaking wet when lifted. There was black mold in the utility closet, obscured by boxes and storage items. Wood support beams were visibly stained and rotted through, in areas where sheet rock was missing from the walls, so the seller could not have missed it. The evidence appears to have been overwhelming that the house was in terrible condition.. The court did not discuss the contents of the home inspector’s report. It appears that the defendant’s deception and untruthfulness was hugely significant and overcame any argument that the home inspector should have noted these deficiencies. The judge specifically found that the seller/defendant’s conduct was “outrageous” and “intentional” and that his actions exceeded “all bounds usually tolerated by decent society.”

The buyer was awarded compensatory damages of $96,282 to compensate for the cost of waterproofing the house, repairing the damage and remediating the mold problem. The court initially awarded $25,000 in damages for emotional distress, but vacated that order four months later when it was pointed out that the Plaintiff had not introduced any evidence of her emotional distress. The court found that it was “unduly swayed” by the photographic evidence, and by the Plaintiffs emotional state when she testified.

A component product’s failure to perform as represented by its manufacturer is a frequent claim in a construction defect cases. Often, defendants of such claims attempt to hide behind general disclaimers and limitations of warranty. Addressing the failure of a component product of yachts, the Federal Court for the New Jersey District recently denied a manufacturer’s summary judgment motion, having concluded that a general disclaimer of warranty will not automatically defeat an express warranty created by representations, descriptions and affirmations set forth in a product bulletin. Viking Yacht Co. v. Composites One LLC, ___ F. Supp.2d ___, 2007 WL 2153243 (D.N.J. July 26, 2007).

Defendant’s distributor sold the plaintiffs, two New Jersey yacht manufacturers, the gel coat used as the outermost surface of the yachts. Gel coat provides an attractive finish while protecting the yacht from water and other materials. Prior to their purchase of gel coat, defendant provided the plaintiffs with its literature for the product, touting its improved flexibility and weather resistance, as compared to a prior gel coat that plaintiffs had purchased from defendant. The literature included a descriptions of the gel coat’s characteristics, a product bulletin, and test data supporting defendant’s claims that the new product was an improvement over the old. Defendant also provided a limited warranty that the gel coat met specifications when shipped as well as a general disclaimer and limitation of warranty, stating that a buyer’s exclusive remedy was replacement of the product or refund of the purchase price.

Plaintiffs conceded that they had not purchased the gel coat based on its improved flexibility. Instead, each tried the new product, hoping that it would demonstrate better “buffback qualities” than the earlier product. Unfortunately, both plaintiffs discovered that the new gel coat cracked extensively on boats that were stored or used in cold weather. Plaintiffs sued defendant, alleging that it new of the gel coat’s inherent problems and failed to disclose them. Defendant replied that it had been unaware that the product was subject to cracking, that the cracking could have been attributable to the plaintiff’s errors in using the gel coat, and that, under the limited warranty, it was not liable for plaintiffs’ damages.

The court disagreed with defendant. Governed by the Uniform Commercial Code, express warranties arise whenever a seller states a fact or makes a promise about the goods becomes part of the basis of the bargain or whenever the seller’s description of the product, specification list, expression of a standard, representation of quality, or provision of a sample or exemplar is a basis of the bargain. A disclaimer of such an express warranty may only be effective if it is “clear and conspicuous,” and written so that “a reasonable person against whom it is to operate ought to have noticed it.” And even if the disclaimer is clear and conspicuous, it will not be found effective to the extent that it is inconsistent with express warranties extended by the seller. Here, the properties of the gel coat were trumpeted on the first page of a flyer while the limitation of warranty was buried within it. Accordingly, the court declined to grant summary judgment to defendant based on its disclaimer and limited warranty.

On April 26, 2007, the Appellate Division of the Superior Court of New Jersey rendered its decision in the matter of Golomb v. Warwick Condominium Association, Inc., 2007 WL 1215083 (App. Div. 2007) which is instructive for condominium associations. The Warwick Condominium is a 9-story building consisting of 275 units located in Atlantic City. The 50-year-old building suffered severe damage in a storm. As a result, the Board of Trustees of the Condominium Association authorized three special assessments totaling in excess of $2,200,000. Most of this money was used to fix storm damage. The insurance carrier for the Condominium Association disclaimed coverage, arguing that the damages claimed were not caused by the storm.

The Condominium Association filed suit against the insurance company and ultimately obtained an award in excess of $400,000. By the time the Condominium Association received the money in January, 2003, the plaintiffs had already sold their units. Plaintiffs demanded that they be reimbursed from the insurance proceeds for their pro rata share of the special assessments that they had paid in order that the building could be repaired. Plaintiffs relied upon N.J.S.A. 46:8B-24(a), which provides:

Damage to or destruction to any improvements on the condominium property or any part thereof or to a common element or elements or any part thereof covered by insurance required to be maintained by the association shall be repaired and restored by the association using the proceeds of any such insurance. The unit owners directly affected shall be assessed on an equitable basis for any deficiency and shall share in any excess.

The trial judge found that the statute was unambiguous. Based upon the plain meaning of the statute, the By-Laws of the Association and the Master Deed, the court found that the insurance proceeds were “solely the cost of damage caused by the storm, and since costs for that damage [were] fully covered by the assessments, the monies awarded in the underlying trial are properly identified as excess.” That being the case, the trial judge found that the plaintiffs were entitled to be reimbursed for their pro rata share of the special assessments they had paid prior to selling their units.

On appeal, the Condominium Association challenged the claim of the plaintiffs that they were “unit owners directly affected” within the meaning of N.J.S.A. 46:8B-24(a). The Appellate Division reasoned that:

It is hard to understand how the unit owners actually paying, by way of assessment, for repairs to the building that were ultimately found to be the responsibility of an insurer could not be considered “directly affected.” Those owners paid for the repairs; they are surely directly affected by the damage to the condominium property for which insurance is in place.

Having reached that conclusion, the Appellate Division next stated that it could not imagine
“how the proceeds, no longer needed to repair the damage by virtue of the previous assessment, cannot be ‘excess’ proceeds.”

In explaining its reasoning, the Appellate Division stated as follows:

Owners paying for repairs should not be prejudiced because an insurance carrier wrongfully denies coverage. Had the proceeds been paid promptly, plaintiffs would not have paid at least some of the assessment. They should not be in a worse position because of the delay in receipt of those insurance proceeds. Indeed, if the assessment is viewed as a loan pending receipt of the insurance proceeds, the obligation of [the Association] is clear.

The Condominium Association further argued that its fiduciary duty to unit owners did not extend to those unit owners who had already sold their units at the time the insurance proceeds were collected. The Appellate Division rejected this argument noting that “the sale of the plaintiffs’ units, under these circumstances, does not discharge that duty with respect to the insurance proceeds.”

In short, the Appellate Division felt that it would be unfair to the owners of condominium units who had sold their units before the insurance proceeds had been received, but who had paid their pro rata share of special assessments, for the current owners of those condominium units to receive the benefit of those insurance proceeds. In the opinion of the Appellate Division, this would “allow a windfall to those [current] owners because they would receive both the benefit of repairs funded by others and funds intended to pay for those repairs that may now be used for other purposes.”

Interestingly, the Appellate Division noted that if the Condominium Association had provided in its Master Deed or By-Laws that insurance proceeds need not be used to repair a covered loss, it might have ruled otherwise. In the absence of such a provision, the Appellate Division affirmed the judgment of the trial court in determining that the Condominium Association “could not appropriate the insurance proceeds for purposes other than reimbursing those who had funded the repair of the covered losses by way of assessment.”

In a unanimous vote of 26-0, Oregon State Senators, led by Senator Jackie Winters (R-Salem), voted to ban the use of synthetic stucco on Oregon homes. This decision came after Senator Winters told the story of an 11-year old Salem resident, Whitney McClain, who is currently being treated for multiple brain tumors after a mold outbreak in her home. The girl is Senator Winters’ granddaughter, and just one of many sufferers of several diseases (including brain tumors, pneumonia and bronchitis) caused by mold infestations in their homes.

After the unanimous vote by the Senate, the bill was sent to the House of Representatives. Representative Paul Holvey (D-Eugene), led an initiative to deny the bill, until it also includes banning stucco on commercial buildings. While this would increase the safety for the residents of Oregon, many feel the ban on commercial properties is not necessary. A conference committee was assigned to reconcile House and Senate approaches in HB 2112-B.

While the bill is still awaiting final approval, the Oregon senators hope this vote will ensure that other families will not have to endure the devastating side effects of insufficient Exterior Insulation and Finish Systems (EFIS), like the McClain family had to.

You can read more on the bill, and the McClain's story here.

The New Jersey Legislature has recently enacted a new Act called the “Prompt Payment Act.” The Act entitles all contractors, subcontractors, sub-subcontractors and product suppliers to prompt payment on all public and private projects. By its terms, the Act is only applicable to contracts entered into after September 1, 2006.

The Act requires a project owner to pay a contractor not later than thirty (30) days from the date the contractor’s bill is received. The Act applies only when the bill has been “approved and certified.” However, the Act states that a bill will be deemed “approved and certified” if twenty (20) days after the owner receives it, the owner has not objected to the bill, in writing, and specified the amount objected to and the reasons for the objection. The Act has different procedures, however, for certain public entities that have approval mechanisms for payment of contractors on public projects. Subcontractors, sub-subcontractors, and suppliers are entitled to receive payment from contractors they are under contract with or supplied material to within ten (10) days of the contractor’s or subcontractor’s receipt of periodic payments from the owner, unless otherwise agreed to in writing.

The Act also provides for payment of interest on unpaid amounts at prime plus one (1%) percent in the event payment is not made within the time period provided by the Act. In addition, the Act allows a contractor, subcontractor and sub-subcontractor to suspend work upon seven (7) days written notice if; a) the unpaid party is not provided a statement of the amount withheld and the reason for the withholding, and b) the payor is not engaged in a good faith effort to resolve the reason for the withholding of payment.

The Act provides that a party who sues under the Act and wins is entitled to an award of statutory costs and attorneys fees for bringing the action.

If you have any questions about how the Prompt Payment Act may affect your contracts or work, please contact John Randy Sawyer, Esquire.

John Randy Sawyer, Shareholder and member of Stark & Stark's Construction Litigation group, was quoted in the artilce Alert: Contractors on hook to condo boards, in the June 11, 2007 edition of the New Jersey Lawyer.

You can read the full article here.

The Appellate Division issued a decision today in PORT LIBERTE HOMEOWNERS ASSOCIATION, INC., et. al. v. SORDONI CONSTRUCTION COMPANY, et. al., which has be approved for publication.

The Plaintiffs in the PORT LIBERTE matter, the Port Liberte Homeowners Association, Inc. and the Port Liberte Condominium Association I, Inc., originally filed suit in June of 1992, in connection with various construction deficiencies at the Port Liberte Development located in Jersey City, New Jersey. The construction deficiencies included defects in the Exterior Insulation and Finish System ("EIFS") installed as the exterior cladding on the buildings at Port Liberte. The EIFS products were manufactured by Defendant Dryvit Systems, Inc. (“Dryvit”). After approximately eleven years of litigation and eight years of non-binding arbitration, the Plaintiffs settled with all Defendants except Dryvit.

The Plaintiffs’ claims against Dryvit include allegations that Dryvit committed common law fraud and violations of the New Jersey Consumer Fraud Act through misrepresentations and omissions of material fact about its EIFS products during Dryvit’s interaction with the original Developer of Port Liberte, Port Liberte Partners, when that entity was selecting what EIFS products to use in constructing the Port Liberte Development.

Dryvit was granted summary judgment by the trial court in September of 2003. The trial court dismissed the Plaintiffs’ fraud and consumer fraud claims because it found that the Plaintiff Associations had no standing to assert such claims against Dryvit. The trial court reasoned that since Dryvit’s alleged misrepresentations and omissions about its EIFS products were made to Port Liberte Partners when it was choosing what products to use to construct the development, which was at a point in time when the Associations that would eventually govern the common property of the development had not yet been created as legal entities, then the Associations could not have standing to assert claims based on those misrepresentations and omissions by Dryvit to Port Liberte Partners.

The Plaintiffs appealed the trial court’s decision on January 5, 2005. They were represented by E. Richard Kennedy, Esquire and Dennis Drasco, Esquire. The Community Association Institute (“CAI”) was granted leave to appear as amicus curiae by the Appellate Division on July 6, 2005. The Appellate Court allowed CAI to be heard on the appeal due to the significant effect the trial court’s decision would have on the rights of community associations throughout New Jersey. Stark & Stark Construction Litigation Shareholder John Randy Sawyer, Esquire filed the brief and argued the cause for amicus curiae CAI.

The Appellate Division held that under New Jersey’s legislative scheme for community developments, a condominium association is the intended beneficiary of a developer’s actions in developing a community project. Any subcontractor or product manufacturer, the Court reasoned, that enters into a contract with a developer or supplies it products for use in construction of the common elements of such a project “after the developer registers the condominium with the [Department of Community Affairs], pursuant to the Planned Real Estate Development Full Discosure Act, N.J.S.A. 45:22A- 21 to -56 (PREDFDA), specifically N.J.S.A. 45:22A-26, is on constructive notice that representations made to, and omissions withheld from, the developer will be deemed as if they were made to, or withheld from, the association, once the association assumes control of the condominium.” The Court went on to hold that a condominium association has standing to assert claims for common law fraud and consumer fraud against third-party contractors and material suppliers for defects in the construction of the common elements of the development, “regardless of whether the association formally existed at that particular point in time.”

The Appellate Division adopted the arguments made by Plaintiffs and amicus curiae CAI in its determination that a condominium association essentially “stands in the shoes” of the developer and is the intended beneficiary of all of the developer's actions in connection with the common elements, including all of its interactions with contractors, subcontractors and material suppliers during the construction phase of the development. The Plaintiffs and amicus curiae CAI argued that, under PREDFDA and the New Jersey Condominium Act, a developer of a community project is required to register the project with the Department of Community Affairs and incorporate an Association that will be responsible for the maintenance and control of the development’s common elements. The legislative scheme, however, also requires the developer to control the Association until a certain number of units within the development have been sold, at which time control of the Association is turned over to the independent unit owners who decided to live within the development. That process, called transition, often does not occur until well after construction of the development is under way and all decisions regarding what contractors to use for the work and what material suppliers to purchase from have already been made by the developer. The Appellate Court agreed with Plaintiffs and amicus curiae CAI that preventing community associations from having standing to assert claims against product suppliers like Dryvit, simply because the suppliers only made misrepresentations or omissions to the developer prior to creation of the Association or prior to transition, would produce an “unjust result and is contrary to the legislative scheme permitting a condominium homeowners association to institute suit to recover damages to the common elements. N.J.S.A. 46:8B-14, -15(a), and -16(a).”

The dismissal of Plaintiffs' common law fraud and consumer fraud act claims was reversed and remanded to the trial court for further proceedings.

John Randy Sawyer is available to discuss the arguments made to the Court by amicus curiae CAI and the impact the Court's decision will have on community associations pursuing construction defect claims against developers, product manufacturers, contractors and sub-contractors.

He can be reached directly at 609.895.7349 or by email at rsawyer@stark-stark.com.

In a recent case, St. Louis, L.L.C. v. Final Touch Glass and Mirror, Inc., 386 N.J. Super 177, 899 A.2d 1018 (App. Div. 2006), the Appellate Division of the New Jersey Superior Court found that appropriate compensation for defective construction was the disunion in value of the home, and an acceptable way of valuing that disunion is to look at the cost to repair the defects.

A husband and wife bought 48 acres of land in Franklin Township, New Jersey. They hired an architect to design a two-story, 36,000 square foot house with all of the exterior walls made of glass. The house was built on the property at a cost of $8.5 million. Id. at 179. The homeowner served as his own General Contractor, and he hired defendant Final Touch to install the glass panels that would make up the walls. There were numerous roof drains, vent pipes and other utilities, and these were all designed to be contained within vertical steel columns which also supported the house. Id. The glass panels were to be attached to the steel columns with screws. When Final Touch attached the panels, it punctured nearly all of the pipes contained within the columns. Id. at 180. These pipes then leaked water into the house every time it rained. Id. at 183. Due to these defects, the plaintiffs could not live in the house, and ultimately sold it during the litigation. The house was listed at $18 million, but after more than a year, it was ultimately sold for $2.5 million, largely due to the existence of construction defects. Id. at 184-185.

At trial, Final Touch offered expert testimony that the house was only worth $2.8 million, primarily because it was too big, and the local market would not support a more expensive house. Plaintiff obtained a jury verdict it its favor of $737,000. Id. at 191. Final Touch appealed, arguing that Plaintiffs had not established damages.

The Court of Appeals strongly disagreed with Final Touch. The analysis started with the observation that, generally, compensatory damages (in a breach of contract case) are supposed to put the injured party in as good a position as he would have been if performance were rendered as promised. Id. at 188. (citing 525 Main St. Corp. v. Eagle Roofing Co., 34 N.J. 251 (1961)) Specific rules or formulae are subordinate to this broad purpose. The general rule with respect to building contracts is that the owner may recover the costs of completion, or the costs of making necessary repairs. Id. The determination of whether to use cost of repair or diminution in value as a measure of damages depends on “good sense rather than a mechanical application of a single formula.” Id. The Court stated that “generally, either diminution in the value of the property, or the reasonable cost of restoring or repairing the damage may be appropriate. The Court held that Final Touch’s position that the plaintiff could only be compensated if he proved a diminution in value is incorrect. Cost of repair is also an appropriate measure of damages. Id. at 190.

This is a useful decision, since in many cases it is difficult to determine if a home has decreased in value due to construction defects. In a hot real estate market, many buyers simply overlook what they see at the time as “minor” defects, or they negotiate a nominal redaction in the purchase price, which usually has very little to do with the actual cost to repair the defects. Also, many pieces of real property are difficult to value, therefore diminution is difficult to prove. For example, common areas of a condominium project may be the property of the unit owners, but there is no way to do a real estate appraisal on that property, since there is no market for it. Allowing proof of damages to include cost to repair is the only sensible and fair way to ensure that injured parties, be they homeowners or condominium associations, get compensated properly and fairly for their damages.

In New Jersey, a buyer of a newly constructed home generally can’t move in until the municipality (or other governmental entity) has issued a certificate of occupancy, often referred to as a “C.O.” Issuance of a C.O certifies that the construction to which it relates has been completed in compliance with the construction permit and applicable provisions of the Uniform Construction Code. N.J.S.A. 52:27D-121; N.J.S.A. 52:27D-133. Commentator David Frizell has opined that “[i]t is clear that the Legislature . . . intended the C.O. to be conclusive (except in cases of obvious mistake or fraud) evidence of compliance and the right to occupy.” 36 N.J. Prac., Land Use Law §13.8 (3d ed. 2006-07).

Not surprisingly, builders and contractors frequently assert the municipality’s issuance of a C.O. as an iron-clad defense to a property owner’s allegations of negligent construction. The defense is not a sure winner. New Jersey’s courts do not view C.O.’s as the final word on compliance with the Uniform Construction Code (UCC) when code violations are identified after the C.O. has been issued and the property conveyed from the builder to the property owner.

Court holdings rejecting C.O. finality have twice emerged in cases in which governmental bodies sought to enforce UCC provisions. In DKM Residential Properties Corp. v. Montgomery Tp., 182 N.J. 296, 308-09 (2005), the Supreme Court held that the municipal code enforcement entity could issue notices of violations to the builder/developer even after C.O.’s had been issued and the properties conveyed. And, in Cyktor v. Aspen Manor Condo. Ass’n, 359 N.J. Super. 459, 464 (App. Div. 2003), the Appellate Division recognized the propriety of the Department of Community Affairs bringing a post-C.O., post-conveyance enforcement action against a builder/developer so long as the action was initiated within the ten-year period prescribed by the statute of repose.

Long before, the Appellate Division held that issuance of a certificate of compliance for a new septic system did not preclude the property owner’s action against the vendor when usage revealed that the system did not meet code. Andreychak v. Lent, 257 N.J. Super. 69 (App. Div. 1992).

New Jersey has abolished the doctrine of caveat emptor in real estate sales, imposing an implied warranty of habitability and fitness for use. McDonald v. Mianecki, 159 N.J. Super. 1, 14 (App. Div. 1978), aff’d, 79 N.J. 275 (1979). Imbuing the C.O. with finality on questions of compliance would effectively foreclose buyers’ actions against builders and contractors on any construction maters governed by UCC provisions. That result would be contrary to the recourse against negligent builders that the Court gave home buyers when it abolished the doctrine of caveat emptor in McDonald.

Contract purchasers of homes in the six Kara Homes developments auctioned recently reportedly have lost hundreds of thousands of dollars in deposit monies, according to reports in yesterday’s and today’s Asbury Park Press. The federal bankruptcy court’s approval of the sale of the six developments recently auctioned to other developers cancelled the contracts of those purchasers who had not closed on uncompleted homes when Kara went under. These purchasers must now stand in line as unsecured creditors who are entitled to repayment only if any funds remain after Kara’s secured creditors have been paid. Their hope of recovery is slim.

Apparently, Kara’s sales contracts provided that purchasers could bond their deposits for an additional fee but many purchasers failed to purchase such extra protection. One purchaser quoted in the Press’s report lost a deposit of $135,000. If this is a typical amount lost, the purchasers’ apparently large-scale failure to bond their deposits is remarkable.

In New Jersey, the deposits of purchasers of units in common interest communities subject to the Planned Real Estate Development Full Disclosure Act (“PREDFDA”) (N.J.S.A. 45:22A-21 to 56) are entitled to the protection of a separate escrow account or bonding as a condition of registration. The regulations provide that the Public Offering Statement must include:

A statement that all monies paid to the developer prior to closing will be held in a separate trust account and the name and location of the institution where the trust account is maintained and the name and address of any trust or escrow agent, until closing or termination of the contract or until a bond or other guarantee acceptable to the Agency [the Department of Community Affairs] is provided.

N.J.A.C. 5:26-4.2(a) 14.

Accordingly, in New Jersey, the deposits for home purchases in common interest developments should be protected through escrow or bonding.

The web is burning with posts demonizing Kara Homes and its lenders. No one appears to be focusing on the cautionary lesson for new home buyers, especially those purchasing new construction outside of common interest communities. Real estate is a cyclical business, and developers can and do encounter financial difficulties. Home buyers, and their financial and legal advisors, should be certain that the contract of sale provides protection for the buyer’s deposit.

The New Jersey Appellate Division recently upheld an award of $105,000 by a Burlington County jury against a contractor hired to perform improvements on the Plaintiff's home. in Carboni v. Massimo, BUR-L-0369-04, the jury found in favor of the Plaintiffs on a consumer fraud claim against a contractor they paid almost $35,000 to make improvements to their home. The jury found that the contractor had improperly used metal connectors, had inserted nails that were not engaged in the wood, had impermissibly cut prefabricated framing connectors and that he committed additional building code violations. Moreover, the contractor attempted to deceive the Plaintiffs by covering up the improper work with Sheetrock. The jury awarded the full amount of the damages, which was trebled by the trial court pursuant to the New Jersey Consumer Fraud Act. The Appellate Division rejected the Defendant's argument that the Consumer Fraud Act did not apply because the Plaintiffs acted as their own general contractor and upheld the jury's determination.

Fall-out from Kara Homes’ bankruptcy is having a heavy impact on homeowners in its partially finished developments as well as the municipalities in which they are located, according to a February 26, 2007 report published by the Press of Atlantic City. Homeowners and municipalities are reporting adverse and unexpected expenditures to address a variety of health and safety problems related to unfinished landscaping and construction. According to the Press report, Kara abandoned developments in eighteen New Jersey municipalities.

In Hamilton Township, Kara left destroyed woodlands, unfinished homes, and mountains of trash at Glen Eyre. Township officials estimate that the cost just to clear garbage and construction debris, dumped on the site when trash disposal companies reclaimed their dumpsters, will exceed $25,000, rendering the clean-up subject to municipal bidding requirements. Hamilton is also adversely affected by lost tax revenue on the abandoned property. Meanwhile, owners of completed and closed homes find the enjoyment and value of their properties minimized by the ugly wasteland surrounding them.

Owners of units in The Landings, a Manahawkin condominium project that Kara abandoned, are paying monthly common expense assessments but receiving no services. Common elements such as roads and grounds are incomplete. Several units flooded when pipes froze and burst in adjacent, abandoned units. Delinquent property tax payments from Kara to Stafford Township, of which Manahawkin is a part, approximate half a million dollars. Like Hamilton Township, Stafford has had to address health and safety problems left by Kara, particularly, filling in or fencing excavations for the foundations of buildings that were never built.

In Little Egg Harbor, homeowners are attempting to cope with incomplete homes next door, improperly paved roadways, burst sprinkler systems and sewer back-ups.

Owners and municipalities anticipate improvement in some developments once they are conveyed in Kara’s planned auction. On February 27, 2007, various sources, including the Asbury Park Press, reported that six developments are currently being advertised by auctioneer Sheldon Good & Co.

The sale of these developments will likely not mark the end of problems for existing homeowners and municipalities. In those communities with common interest ownership, such as condominiums or homeowners’ associations, successor sponsor/developers will purchase both the uncompleted homes and units and their appurtenant interests in common elements or common property. The successor will then need to address not only physical completion of the site but also the details of the community’s registration under the Planned Real Estate Development Full Disclosure Act (“PREDFDA,” N.J.S.A. 45:15-16.27 et seq.) and the governing scheme of the condominium or homeowners’ association as set forth in its Master Deed or Declaration and the association’s by-laws. In light of Kara’s failure to develop the communities profitably during the current real estate downtown, anticipating material changes in the development would not be unreasonable as the successors attempt to salvage value from Kara’s cast-offs.

The front page of Sunday's New York Times Real Estate section headlined the dubious proposition that, if a builder chooses to live in one of his own condominiums, the condo would "most likely work for the buyer" since "the developer's eye is on every detail." (Vivian S. Toy, "If It Seduces the Builder . . ., New York Times, Real Estate, Section 11, p. 1 (October 29, 2006).) Our experience suggests that there are better ways to evaluate the quality of a potential condominium purchase than the builder's decision to buy a unit himself.

Attention to detail has not been apparent in an ocean-front community that we represent, even though approximately one in three initial sales was to a principal of the developer, a subcontractor, or a party with financial connections to the developer. From our point of view, another factor that Toy identified is much more important to a developer's decision to purchase a unit in a condominium he or she has built: the opportunity to "get first choice, sometimes at a substantial discount." Speculating that his unit might sell for $6 million, one developer reflected to Toy that he paid "more than it cost to build and less than market value." Often a developer's purchase price is less than the unit cost to build, with the difference made up by skimping on construction and materials elsewhere in the development.

The advantage of first choice is especially apparent when certain units boast extraordinary advantages, such as ocean frontage or a magnificent view. The developers that Toy profiled selected such units as a "penthouse with sweeping city views" and a Brooklyn waterfront unit with "views of eight different bridges." Non-developer unit owners in one of our client communities were surprised to discover that what had appeared to be common green space above the beach in the plans and models was actually the back yards of the beach front units, which were, for the most part, owned by the developer and his associates. Prospective condo buyers need to look carefully at both the prospectus and what is actually being built to ensure that apparent amenities are not disproportionately allocated to the builder and his cronies, with other unit owners footing the bill through inflated purchase prices or maintenance fees.

Builder's options are enhanced by early choice and limited only by constraints imposed by one's business partners, reported Toy. The profiled developers incorporated into their units additional space and custom features, such lap pools, rooftop party spaces, and casitas for the grandchildren, without the necessity of approval from condo associations that were not yet formed. Toy does not acknowledge that condo associations might reasonably frown on upgrades that have the capacity to increase the association's insurance or maintenance costs, to pose a threat of water leakage, or to overtax the building's structure.

Focusing on the congenial developers interviewed for her story, Toy extolls the advantages of unit owner/developers who can "hurry the contractor[s] along," resolve plumbing and electricity issues as they occur, and make sure "the lobby's going to be clean." The author seems not to have encountered the overextended builders and developers that we construction litigators too often see: cutting corners on construction, rushing closings in hopes of quieting the creditors, and ignoring unanticipated (and unbudgeted) defects and deficiencies because adequate funding simply isn't there. The importance of keeping the lobby clean fades when the builder is desperately trying to pay the dry wall contractor enough to keep him on the job until the last units are finished. As the real estate market cools, more builders and developers will find themselves shortchanging construction quality and customer service in order to satisfy unanticipated carrying charges.

"Having a developer living on site should also assure buyers that the typical problems that come up as any development is being completed will be dealt with quickly," Toy gushes. The unacknowledged assumption underlying Toy's premise is its dependence on the builder/developer's self-interest being concurrent with that of other unit owners. Conflicts of interest between the developer and other unit owners quickly emerge when construction goes bad or the money runs out. In short, the fact that the builder has been "seduced" by his latest project offers no assurance that purchasing a unit will work for an unrelated buyer.

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Behind Some Stucco-Like Walls, Problems

When Gary and Pamela Cohen brought their four-bedroom colonial-style house in the Tamaron Woods development seven years ago, they loved the ornate stucco facade, which seemed to fit perfectly with the neighborhood.  More...