More construction could equal more defect lawsuits

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Before John Lindbloom rented out and left his Franklin condo, he was living under water.

Lindbloom, who was president of the Kaitlin Woods Condominium Association Inc. before he left, said owners there had noticed water seeping through roofs and windows, especially in garages. So the association hired an engineer to inspect the units.

“They would open up the wall,” Lindbloom said, “and water would pour out.”

The problems were the same throughout the complex, he said, so the association suspected shoddy construction.

The upper estimate for repairs, Lindbloom said, is $6 million and is the focus of a defect lawsuit, which was filed in Milwaukee County Circuit Court in August 2012 against the project’s developer, 15 contractors that worked there and a handful of insurance firms. The case is still open.

Sign of the times

The Kaitlin Woods lawsuit is one of many popping up around the country, particularly in states such as California, Texas and Florida, where residential construction is on the rise. Increases in the pace of construction generally equate to more defect lawsuits, and those lawsuits can drive up insurance rates.

In Milwaukee, the forecasted uptick in residential construction is expected to be more tempered than in other parts of the country.

Still, multifamily construction in the city should “remain at a heightened pace” in 2014, according to a 2013 fourth quarter report on the Milwaukee market compiled by national real estate investment firm Marcus & Millichap Inc., which has an office in Brookfield. About 1,600 apartment units were built in the past year, according to the report, and 765 units are expected to be complete by the end of 2015. There also are 1,900 units “in the planning pipeline,” according to the report.

But the connection between defect lawsuits and construction is not always as simple as more volume equaling more problems, said Dan Stevens, an attorney and partner at Brookfield-based Stevens & Kuss SC, who is not involved with the Kaitlin Woods case. He said builders tend to constrict operations when construction slows, and they stop using their regular subcontractors.

When construction picks up, he said, those subcontractors might not be available, meaning contractors lose their safety nets.

“You’re scrambling around for subcontractors,” Stevens said, “and then there’s kind of like a shortage.”

That scramble, he said, often leads to low-quality work.

Construction insurance does not cover bad workmanship, Stevens said, but proving coverage does not exist can cost insurance companies, which then raise their rates and shift the expenses to clients.

“There is a connection there,” he said, “to a certain degree.”

Rising rates

Willis North America, a national insurance firm, has predicted project-specific, general liability rates will increase between 3 percent and 8 percent, according to a 2014 preview. Tim McGinnis, senior vice president of the firm’s national construction practice, said construction defect claims, especially in California and other areas experiencing a surge in building, are driving that increase.

“Once the HOA, the homeowners’ association, is formed, I don’t know the percentage, but I think it’s probably 75 percent to 90 percent that a lawsuit is filed,” he said. “And most of those lawsuits are template lawsuits. They’ve already been written.”

Those types of lawsuits suggest some attorneys are drumming up business, said David DeLaRue, senior vice president of Willis North America and managing director of the project insurance practice. The increase in lawsuits, combined with aggressive, sometimes shoddy construction, he said, drove up Willis’ nationwide average starting points for project-specific rates between 20 percent and 30 percent in the past year.

That translates to $2 to $3 per $1,000 of estimated construction costs for commercial projects, $3 to $4.50 for apartment projects and $7 to $9 for condominium projects, DeLaRue said.

But Wisconsin, he said, seems to be buffered from much of the volatility. Construction is not accelerating as rapidly as in other states, DeLaRue said, and Wisconsin generally is less litigious.

“The Midwest,” he said, “is probably a more favorable place than anywhere else to do this business right now.”

Apartment-condo threats

But Wisconsin is not immune to defect lawsuits, particularly if a building material is found to be substandard, DeLaRue said, using as an example the Chinese drywall lawsuits that were consolidated in Louisiana. Those lawsuits allege defective drywall, which had been imported from China, was causing health and safety problems in homes.

“Anything,” DeLaRue said, “could be, could be lurking around the corner.”

Some insurers suspect that thing around the corner could be connected to condo construction.

“We’ve recognized for a very long time that residential contractors involved in condominium projects or large-tract housing projects do have a larger exposure when it comes to class-action lawsuits,” said Tom Holman, director of commercial product management for West Bend-based West Bend Mutual Insurance Co., adding that his firm anticipates a 5 percent to 6 percent increase in multifamily, project-specific general liability rates in 2014.

The skepticism insurers are directing toward condominium projects indirectly extends to apartment buildings.

The chances of class-action lawsuits from apartment owners are “extremely remote,” said Jim Dunlap, construction casualty placement leader and Midwest zone senior vice president for national firm Marsh Insurance. But if a building is converted into condominiums, a homeowner’s association is formed, and those groups, as McGinnis and Willis said, are more likely to sue.

That possibility, Dunlap said, has prompted Marsh and other firms to include exclusions in policies that stipulate if an apartment building is converted into condos, coverage is revoked.

“That issue,” he said, “needs to be known upfront by the contractor.”

If a contractor wants coverage to continue for a condominium conversion project, Dunlap said, Marsh will do it, but the price might be daunting.

“That policy,” he said, “might be two to three times more expensive than if it was just an apartment building.”

The conversions from apartments to condos can put homeowners in a position where they have little recourse other than a lawsuit, said Lydia Chartre, a shareholder at Milwaukee-based Whyte Hirschboeck Dudek SC. Projects designed as condominiums likely have reserve accounts built into construction costs to cushion homeowners from the full weight of future repairs, she said.

But if an apartment building is converted to condos and a problem is discovered later, Chartre said, that cushion probably is not there.

“That’s usually an expense people aren’t planning for,” she said.

Other options

If more policies exclude conversion coverage, contractors might have to fall back on protections outside their insurance.

Kim Hurtado, managing shareholder of Wauwatosa-based Hurtado SC, said the state has protections to keep contractors out of the courtroom. According to a law that took effect in October 2006, contractors building or renovating dwellings must provide information about the state’s “right to cure law,” which establishes the steps before a homeowner can sue over alleged faulty construction. Those steps include giving the contractor a chance to repair a defect.

Although such laws slow down defect claims, Hurtado said, the law sometimes can have the reverse effect.

“It’s sort of planting the seed,” she said, “for homeowners to litigate if they don’t like what happens to their house.”

Those seeds, though, sometimes take a long time to grow.

The Kaitlin Woods homeowners, Lindbloom said, were not sure they wanted to sue, although he said the case is solid.

When he was president, many owners were skeptical, he said, because the association had been told recovering damages could be difficult. The developer, Mequon-based Kaitlin Woods LLC, he said, since has gone out of business.

The decision was taken out of Lindbloom’s hands with a change in leadership. He was ousted as president, he said, and his replacement wanted the lawsuit. That continuing difference of opinion, he said, prompted him to move to Waterford and rent out his Kaitlin Woods condo, although he wants to sell it.

And that, he said, will be the last time he owns a condo.

“I will be happy to be rid of it,” he said, “as soon as I possibly can.”

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