WITH MORE THAN 20 YEARS OF EXPERIENCE navigating the complications of infill development, Millburn, N.J.-based Pinnacle Communities is no stranger to litigation. In fact, the company's CEO, Brian Stolar, is a lawyer. But in 1999, as Pinnacle made plans to redevelop an abandoned warehouse in the affluent community of Mont Clair, N.J., even Stolar was caught off guard by a hydra-headed, five-year legal battle that the company would be forced to endure.

Negotiating the rights for a mixed-use community on a prime corner in the heart of downtown went smoothly. And, the necessary zoning was already in place to support Pinnacle's plans for a project complete with retail, parking, and attached housing. So it came as a surprise when contamination issues arose and the owners—a group of private investors—began bickering among themselves. “There were some environmental clean-up issues, and the owners began finger-pointing at each other. They couldn't come to an agreement, and then they started pointing fingers at us,” says Stolar. “It was becoming a public embarrassment.” That's when Pinnacle found itself caught between the owners and the strong political ties of local development competition.

Despite the fact that Pinnacle owned the rights to the land, the municipality's redevelopment statutes allowed the town to supercede the agreement and issue a request for proposal (RFP). Unwilling to risk losing the project after five proposals were submitted, Pinnacle decided to purchase the property outright for $5.3 million. But despite ownership, the battle raged on until Pinnacle revised its plans and was able to appease its opponents by selling them a piece of the land that had originally been designated as a parking lot.

“It took two to three years to actually get to the point where we were the designated developer of our own property,” recalls Stolar. Then Pinnacle had to fight the appeals that were filed. Today, five years after the legal wrangling began, demolition is finally under way—with an estimated cost of $1.5 million in carrying costs, lawyer fees, extension fees, and plan revisions.

“What does it say when the guy leading the charge on a project is not a builder, he's a lawyer?” muses Stolar. “Eventually, he'll hand it off, but so far the majority of issues consuming our time on this one have been legal oriented.”

Proceed With Caution According to Jeffrey Masters, partner for specialty law firm Cox, Castle & Nicholson in Los Angeles and co-chairman of development for the firm's risk management group, Pinnacle is not alone in this type of scenario. “Infill projects have possible liability issues not as frequently encountered in suburban development,” says Masters. And as more production builders add high-density and infill projects to their product mix, many are unprepared for the overwhelming litigation issues that await them. “There are so many levels of complication with these types of products,” says Stolar. “Probably 30 percent of our time on a project like this is dedicated to litigation-related issues.”

The sites alone lend themselves to greater risk: Everything from former contamination issues to greater levels of ambient noise can spark liability claims. “Fraud claims are huge and dangerous for a builder because they aren't covered by insurance,” says Masters. “And when it comes to disclosure, states tend to advocate the consumer.”

“Proximity issues” also exist in higher-density projects, and residents have been known to file claims related to noise from other units or common areas. Construction techniques often come under scrutiny. And, regardless of how they are configured, attached projects share characteristics that make them litigation targets. Single-story, mid-rise, and high-rise projects all have common areas owned and maintained by the homeowners' association (HOA). “The HOA is a ready-made vehicle for plaintiff lawyers to get a construction defect lawsuit started,” says Masters.

“It started in California, Texas, and Colorado, and in the past 18 months it's spread across the country,” says Masters. “Now, the litigation climate in Nevada is as bad as California has been.” Chalking it up to a “very active group of litigation lawyers,” Masters says that much like builders themselves, litigators are following the path of growth—establishing new offices in cities where there is a lot of building activity.

Approaching HOAs, these litigators typically offer a free inspection. Upon completion, a report is issued and an “educational campaign” is launched to discuss any problems that may have been discovered. Unnerved, the board of the HOA is often led to examine litigation as an option. “They scare people into examining this issue because no one wants their property values to go down,” says Ralph Spargo, vice president and general manager of Standard Pacific Gallery Communities.

“It's very blatant,” says Masters. “We call it farming or prospecting.” And it's costing big bucks. Masters says he has seen clients with deductibles and insurance retention costs increasing “1,000 percent.” And those are for the fortunate. A report issued by the NAHB in June cites that the scope of coverage available to builders has narrowed significantly.

“Now, few markets provide coverage for builders for attached products,” says Masters. In addition, many policies issued to trade contractors and designers actually exclude work on attached products.

Fighting Back But by anticipating the dangerous liability climate, sophisticated infill developers can create plans to address risks through their entire development cycle—from entity structuring through customer service. And successful plans take care to integrate each step in the cycle. “We take care to look at every step in the process as an opportunity to identify and manage risks,” says Masters.

When executives at Standard Pacific made the decision to move into the infill market more than two years ago, they sought out someone with experience to lead their charge. “Although our company is new to this business, I'm not,” says Alan Boecker, Standard Pacific's general manager of the Los Angeles-based urban division. Taking his experience from infill builder New Urban West, Boecker went to Playa Capital Development where he wrote the quality assurance program for the Los Angeles master planned community of Playa Vista. Joining Standard Pacific in 2002, he has built a dedicated staff of 20 members experienced in the nuances of urban development.

By initiating a comprehensive quality assurance program, Standard Pacific has been able to, “protect ourselves well and deliver a good product,” says Boecker. He recalls a recent problem with high-end wood-clad windows specified in a high-density project. “While they were being installed, we found significant failures,” says Boecker. “When the manufacturer couldn't solve the problem, we replaced the windows.” Throughout the process, Standard Pacific has been careful to photograph and document developments each step of the way. By including reports from third-party inspectors, the builder is able to prove that appropriate steps were taken to solve the problem. “We have been approached by litigators in the past, and when we show them our documentation library, that's the last we hear from them,” says Boecker.

According to Steve Olson, chairman of the infill-savvy Olson Co., a home builder's best defense against HOA claims is to offer world-class customer service. “Home buyers that live in this type of environment expect more ‘hoteling,' ” says Olson. “They don't want to have to think about their home at all from a maintenance point of view. We know the profile of our buyers—why they want to live here and what they want. We pay attention and try to satisfy that desire.” Even during move-in, the company takes extra care to satisfy. “If that isn't seamless and comfortable, people get upset. Then that translates into other areas.”

Masters cautions builders to stay in touch with the customer, remain responsive, and use customer service as the critical first line of defense. “They should be working as your eyes and ears against litigation claims,” he says.

The Olson Co. has gone so far as to create a homeowners' association “champion” program—attending HOA meetings and creating an internal policy to always side with the homeowner. “You need to be committed to constant service and availability to your HOA,” says Olson. “It lasts much longer than in a traditional development. [Attached housing] is a much more tight-knit community of buyers. You need to chase down problems very quickly. Otherwise, people get upset, word spreads, and then people start looking for things.”

If it is determined that there is any activity brewing, Masters advises his clients to meet the opposition head on: If a lawyer holds a community meeting, the builder should do that too. Only consider making it bigger and better. “If they serve general refreshments, you should be in there with a latte cart,” says Masters, who stresses that it's critical to remind homeowners that the builder is always available to them if needed. “It's resource intensive,” admits Masters. “But we think it's a good investment. It's a lot cheaper than being sued.”

10 Tips To Deter Litigators There are a variety of measures to minimize the risk of infill litigation, according to Jeffrey Masters, partner for the law firm Cox, Castle & Nicholson and co-chairman of development for the risk management group. Masters suggests that builders examine each step of the development process and advocates a “safety first” model of development:

  • Land acquisition. Every step in the development process offers opportunities to identify and manage risk. Smart land acquisition is more than just a Phase I environmental report. The builder/developer needs to thoroughly understand the site, from environmental challenges to soil conditions to possible adverse factors such as nearby sources of noise
  • Entity structuring. Many developers are using Single Purpose Entities (SPEs) for their attached and infill projects. SPEs are perceived as a liability reduction strategy, and they may well be. However, care needs to be taken not only when setting up such entities, but also operating and unwinding them.
  • Risk transfer provisions in construction and design contracts. Most off-the-shelf construction and design contracts are inadequate to protect the developer from future construction defect claims. Masters suggests conducting an annual review and update.
  • Quality control during design and construction. Sophisticated developers are having their building plans peer-reviewed by an independent architect with forensic claims experience to avoid “designed in” defects. Ongoing quality control-inspections during construction are a powerful tool for catching anomalies so they can be corrected before the walls are closed and the structure is completed.
  • Effective contract administration. Developers are training their purchasing agents and contract administrators how to interpret the many non-standard certificates of insurance and additional insured endorsements being provided by contractors and subcontractors. In addition, they work from a list of “non-modifiables”: important contractual risk transfer provisions such as indemnification, which cannot be diluted without the approval of senior management.
  • Protective provisions in consumer sales agreements and CC&Rs. Most states allow developers to include in their sales agreements and CC&Rs (Covenance Conditions & Restrictions documents, which govern homeowners' associations) such protective provisions as notice of alleged defects, an opportunity to inspect and repair, and use of arbitration to resolve disputes, rather than a conventional civil lawsuit. These alternative dispute resolution (ADR) provisions are where a lot of the action is today, as developers seek to include mechanisms that avoid or reduce construction defect disputes yet still give consumers an opportunity for fast and fair dispute resolution.
  • Disclosures. Disclosures are a critical tool to reduce the risk of fraud claims by consumers. But they also serve another important purpose. “They educate consumers and manage their expectations about the project,” says Masters. “The fewer surprises the better.”
  • Warranties. Warranties are one of the more important but historically underperforming risk management assets available to builders and developers. Virtually every developer has a standard one-year warranty, but in today's legal environment, these older warranties are inadequate. The latest strategy is for the developer to offer a longer and broader warranty, with binding arbitration as the ADR vehicle. The breadth of the warranty coverage offers better protection for the consumer. It also serves as a risk management tool for the builder because it sweeps more customer service and warranty issues into the ADR structure. This tends to avoid or reduce the expense and risks of a construction defect lawsuit.
  • Maintenance manuals. Another newer strategy is to provide homeowners and homeowners' associations with maintenance manuals. These manuals can be as long as 80 or more pages. They contain critical educational information the consumer needs in order for the home or the common area to perform properly. Historically, the building industry has done an inadequate job educating consumers about how to maintain the product. “Lack of proper maintenance has always been a defense in construction defect suits, but the use of comprehensive maintenance manuals gives this defense some teeth,” says Masters. There is an emerging trend in state law to recognize the importance of maintenance requirements. In California, for example, the new notice-and-opportunity-to-repair law, SB 800, specifically validates lack of consumer maintenance as a defense to defect claims.
  • Customer service that goes above and beyond. Masters says he sees a trend toward more effective customer service by builders and developers. “The industry has recognized that servicing a construction problem is cheaper, faster, and more consumer friendly. Some developers have dropped the phrase ‘it's out of warranty' from their vocabulary,” says Masters. This makes good business sense given the large deductibles and self-insured retentions to which developers now are subject. “It's the developer's money. Why not spend it early to keep a customer service issue from potentially becoming a litigation claim?”
  • LEGISLATIVE LEVERAGE Prior to 2002, the “fix it” law, more formally known as the notice-and-opportunity-to-repair law, was in place in only four states. Today, 24 states have some variation of the law in place and seven others have a bill being considered for legislation. Sam Leyvas, the NAHB's director of state and local government affairs, also predicts that the 2005 legislative cycle will find states adopting amendments that strengthen their statutes. But are these laws having a direct impact on today's litigation-crazed environment? According to Jeffrey Masters, partner with Cox, Castle & Nicholson, “It's really too early to tell.”

    Learn more about markets featured in this article: Los Angeles, CA.