SAN DIEGO-In today’s market, broken residential projects makeattractive targets for real estate investors seeking to takeadvantage of low prices for distressed properties. However, theseprojects come with a hidden cost that might not surface for years:construction defect liability. Residential projects in Californiaare notorious for being the target of construction defect claims.If a purchaser of a residential project does not consider andproperly prepare for potential homeowners’ defect claims, anyprofits can quickly vanish.

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Even after the enactment of SB800, California’s “right torepair” law, some potential homeowners’ defect claims do not expirefor 10 years. Professional residential developers are veryaware of these risks and plan accordingly from the inception of aproject. However, often buyers of broken projects arereal estate investors who plan to perform only a bit of cosmetic“refreshing” before selling units, or who intend to complete onlyminor construction on nearly completed units before selling them,and as a result may not consider the potential for later claims byhomeowners.

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Both the California Civil Code and case law place the purchaserof the project in the line of fire for defect liability. Thepurchaser of the project, as the seller of the individual units, isa target under California defect law and will be sued by theindividual unit buyers in the event of defects.

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If homeowners sue a seller who only acquired the project afterconstruction and sold completed units, the seller of the units mayattempt to turn to the original developer or contractors to resolvethe defect claims. However, that may not be possible ifpurchase documents relieve any preceding owner of liability or thepreceding owner has no remaining assets. In those instances, theinvestor who purchased the broken project looking only to sellcompleted units will be left to bear the burden of constructiondefect claims.

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There are some measures an investor can take to protect itselfagainst this liability. First, prior to purchasing a broken planneddevelopment/condominium project, check for construction defectinsurance and whether it still may be effective to offer coverage.If the project is no longer covered, investigate whether you canget an insurance policy to cover your risks, including theconstruction prior to your involvement. Also, review the property'shomeowners’ documents, including the CC&Rs and form of purchaseagreement, to verify whether you would be tied to a particularclaim resolution procedure and whether you can modify it to suityour needs. In addition to visually inspecting the property, it maybe advisable to perform more thorough testing of certainconstruction components to confirm the quality of theconstruction. Lastly, it is imperative to disclose allmaterial facts that you know about the condition of the project toyour buyers.

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Anyone considering the purchase of a broken project needs to befully informed and should take steps to limit liability, includingfor construction defects, to the greatest extent possible.

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The views expressed in this column are those of the authorand not necessarily GlobeSt.com.

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Lynn Borkenhagen is a partner of Allen Matkins, based in SanDiego. She can be reached at [email protected]. CharlesPernicka is senior counsel based in Allen Matkins’ San Diego officeand contributed to the column. He may be contacted at [email protected].

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