Landmark Ruling Requires Developers to Establish Sounds Fiscal Basis for HOA

5-25-2010

A landmark ruling recently issued by the Utah Supreme Court in Davenport at Pilgrims Landing Homeowners Association v. Davencourt at Pilgrims Landing, LC requires developers to make disclosures to and establish a sound fiscal basis for homeowners associations prior to relinquishing control to homeowners, and recognizes a new implied warranty of workmanlike construction and habitability on new residential construction.
 
The Davencourt ruling applies to developers who create a homeowners association that is obligated to maintain and repair common areas, and the developer is the initial owner of all units and the initial controlling member of the HOA. Davencourt mandates that while the developer controls the HOA before turning over control to homeowners, the developer use reasonable care and prudence in managing and maintaining common areas, that it establish a sound fiscal basis for the HOA with sufficient reserves for future maintenance and replacement of common property, and that when it turns over control of the association to the homeowners the developer discloses all material facts and circumstances affecting the condition of the property that the HOA is responsible for maintaining. 
 
When the HOA of the 145-unit townhome development Davencourt at Pilgrims Landing discovered water intrusion into units resulting in dry rot, mold, staining and degradation of the stucco caused by faulty design and workmanship, defective materials, improper construction and noncompliance with building codes and land subsidence, the HOA sought the developer’s cooperation in addressing the substantial repair costs. When the developer refused, the association brought suit against the developer and the builder. The suit was dismissed under the economic loss rule which, in essence, holds that certain damages such as costs of repair and replacement may not be recovered in cases between parties to a contract. 
 
On appeal, however, the Utah Supreme Court held the developer breached its newly-recognized limited fiduciary duties owed to the HOA, which the Court further held was also a new exception to the economic loss rule. The Court therefore held the association could maintain its claims for negligence and negligent misrepresentation for (1) failure to use reasonable care and prudence in managing and maintaining common property, (2) failure to establish a sound fiscal basis for the association by imposing and collecting assessments and establishing reserves for the maintenance and replacement of common property, and (3) failure to disclose all material facts and circumstances affecting the condition of the project property that the association was responsible for maintaining.
 
The Court found that a developer has a limited fiduciary duty to ensure a property has been reasonably and prudently maintained, according to Felicia Canfield, an attorney with Fabian & Clendenin from Fabian Attorneys at Law. The developer will also need to establish a sound monetary basis by imposing and collecting fees, which can be used for repairs or deposited, into a reserve for future repairs. The ruling does not set exact monetary boundaries necessary to establish a sound fiscal basis, leaving that to be determined on a case-by-case basis.
 
“The developer now has to be sure they set enough money — enough reserves — aside to cover any maintenance issues for the common property,” Canfield said. This case implements a sort of self-policing mechanism, but adds a burden on the developer without solid guidance as to how much money is needed to meet the reserves requirement for any given development.  It will take some time to get greater guidance on that issue, Canfield noted.
 
As part of the Davencourt ruling, the Utah Supreme Court also recognized that builder-vendors and developer-vendors owe to purchasers of new residential construction an implied warranty of good workmanship and habitability. Under the Davencourt ruling, in every contract for the sale of a new residence, a vendor in the business of building or selling such residences makes an implied warranty to the vendee that the residence is constructed in a workmanlike manner and fit for habitation. To establish a breach of the implied warranty, Bradley Tilt, also an attorney with Fabian & Clendenin, explained a party must show that the residence contained a latent defect that manifested itself after purchase, was caused by improper design, material or workmanship, and which creates a question of safety or makes the house unfit for human habitation. 
 
“They aren’t talking about every ticky, tacky thing that isn’t done right,” Canfield said. Only things raising safety and habitability issues are within the scope of this newly-recognized implied warranty, and only for new residential construction, not sales of existing homes. In most cases the implied warranty has a six-year statute of limitations, Canfield said.
 
Canfield and Tilt agreed that the Davencourt ruling is cause for concern among those in the construction and development industry, but not for alarm. As with any case, the particular facts alleged in the Davencourt case are what drove the outcome. 
 
“Ultimately, the Court was saying, ‘Do the right thing. If you know something, tell somebody about it or do something about it or take steps to fix it,’” Tilt said.
 
“Or set enough money aside to handle it,” Canfield added.
 
The Davencourt ruling highlights the need for careful communication, planning, and performance in all aspects of development and construction.
 
“People should be a little more self-aware and a little more willing to take on the burden of self-policing because it comes out of their own pockets” now if they don’t, Tilt said. Companies should review, or implement, policies on quality control and communications and disclosures, and should be proactive in making needed repairs and aggressive in setting assessments and using other available means to fund reserves for future maintenance and repairs, he added.

realestatenewsutah.com

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