How to Guarantee the HOA Can't Litigate Condo Construction Defect Claims

by Sherman & Howard L.L.C.

Developers and general contractors would like to avoid litigating construction defect claims brought by condominium homeowner associations. There is a way to do this.

It is common practice for real estate attorneys, when drafting declarations for common interest communities, to include arbitration clauses in the declarations. The intent of such provisions is to compel condominium associations to pursue certain claims against the developer, such as construction defect claims, in arbitration rather than in the courts.

Developers and contractors prefer arbitration because it is typically less costly and time consuming than litigation. Homeowner associations ("HOAs"), on the other hand, tend to prefer litigation because the up-front costs of arbitration are greater and they would rather have their cases tried to jury than a panel of arbitrators in the belief juries offer greater potential for high damages awards. In order to circumvent arbitration clauses, HOAs have taken advantage of their statutory right to amend declarations by instructing their members to approve amendments removing arbitration clauses. This procedure has been used often in the last several years. One such case, arising out of alleged defects in the Gold Peak condominium development in Douglas County, Colorado, led to a jury trial that resulted in a verdict in excess of $18 million against the developers and general contractor. Despite a strong public policy favoring enforcement of arbitration agreements, Colorado courts have held this procedure is valid and allowed HOAs to amend the declarations to delete the arbitration provision. See Eagle Ridge Condominium Ass'n v. Metropolitan Builders, Inc. 98 P.3d 915 (Colo. App. 2004). As a result, HOAs have had the power to unilaterally nullify arbitration agreements. This result is contrary to the intent of general contractors and developers that all claims against them be decided in arbitration instead of litigation.

A recent decision from Judge Norman Haglund at the District Court for the City and County of Denver provides important guidance on how to protect arbitration clauses from unilateral nullification. The case involved alleged construction defects in a Denver condominium development. During development of the project, the developer, acting as declarant, recorded residential and master declarations in Denver County. Both declarations, which were drafted by Sherman & Howard real estate attorneys, contained provisions requiring that every claim against the general contractor or developer relating to the design and construction of the project had to be resolved by binding arbitration. Significantly, the arbitration clauses also provided that they could not be removed from the declarations by amendment without the developer's and general contractor's consent.

Residents began reporting the alleged defects, and the Residential Association (the "Association") retained construction defect counsel. Shortly thereafter, the Association voted to amend the declarations to remove the arbitration clause without seeking the developer's or GC's consent. The Association then filed a construction defect suit against the developer and general contractor. Sherman & Howard, as counsel for the developer, and the GC filed motions to compel arbitration and stay the lawsuit. That motion argued the amendment deleting the arbitration provision was invalid because the Association failed to comply with the consent provision.

The Association argued such amendments were valid under the Colorado Common Interest Ownership Act (CCIOA) and that the Eagle Ridge case provided legal authority for amending the declaration to delete the arbitration provision.

Judge Haglund disagreed with the Association based on two factors. First, the Eagle Ridge declaration contained no restrictions on the condominium association's power to amend the declarations. In other words, in that declaration there was no requirement the declarant or GC consent to the amendment. Because the plain language of the declaration before Judge Haglund required consent, which the Association failed to secure, the amendment deleting the arbitration provision was invalid and unenforceable.

Second, the Court recognized the consent requirement did not violate CCIOA's amendment provisions. Although CCIOA does set 67% of unit owners as the maximum "supermajority " required to pass an amendment to a declaration, it does not preclude other conditions on the amendment process like the consent requirement. The Court was also comfortable enforcing the consent requirement because it was limited in scope in that it applied only to the arbitration clauses and not to amendments generally. Hence, the consent requirement was valid under the CCIOA. The judge, therefore, stayed the litigation and compelled the Association to arbitrate.

The takeaway from this ruling is that a simple precautionary measure incorporated into the declarations can prevent HOAs from unilaterally nullifying arbitration provisions. We recommend taking some simple steps to keep builders and developers of condominium projects out of court. For general contractors, request a provision in the prime contract that requires the developer to put an arbitration provision in the condominium declaration and make the general contractor's consent necessary to the delete arbitration provision. For developers, include in the declaration's arbitration clause a provision making your consent required to amend or nullify the arbitration provision. Courts will enforce this kind of consent provision.
If you have any questions about this Client Advisory or any other construction issues, please contact your Sherman & Howard attorney or one of the attorneys in our Construction Group.


DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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