HOUSING CONSTRICTION

Spurious lawsuits are strangling California's construction industry.

In 2003, Jon Olivieri, a framing subcontractor in Sacramento, saw his construction insurance premium skyrocket 535 percent, from $85,000 to $540,000, despite a near-spotless record in his 19 years in the business.[35] The premium hike added so much to his costs, averaging about $3,500 more per house, that one big account—Dunmore Homes, worth $12 million in revenues to Olivieri—stopped doing business with him.[36]

Olivieri is one of thousands of small to medium-size contractors in California who are seeing their businesses go south after enduring more than a decade of flimsy lawsuits alleging construction defects, which have driven insurers from the state and put a virtual halt to condominium construction. In 2000, insurers paid out $2.95 for every premium dollar they took in.[37] As a result, only a handful of companies still write construction liability coverage in California; and they charge two to five times what they charge in other states.[38] And they won't touch condos.

The Endangered California Condo

Indeed, the construction of new condos—the home of choice for asset-strapped first-time homeowners—plummeted from 18,691 units in 1994 to 2,945 in 1999.[39] In the mid-1990s, 30 percent of new houses in California were condos; by 2000, only 2 percent were condos.[40] Areas of the state that were job engines in the 1990s, such as Silicon Valley, have started to lose population in part because of the lack of affordable housing.[41] In 2002, California was building one new house for every 3.5 new jobs, barely half of what economists say is required to support growth.[42]

The problem harkens back to the early 1980s, when new favorable tax treatment spurred condo construction in California and other parts of the Sunbelt.[43] Inevitably, a percentage of these new homes were shoddily built, and owners sued the contractors, often with some justification. Trial Lawyers, Inc. quickly determined that the market was lucrative, since hundreds of litigants could be brought into a single suit through their condo associations, vastly increasing the size of potential judgments—and of their lawyers' fees, which are based on a percentage of the verdicts.[44] Aggressive lawyers started blanketing condo communities with flyers listing a litany of potential defects, from leaky windows to loose carpet corners.[45] Firms specializing in construction-defects litigation surfaced, such as the Miller Law Firm of Orange County, whose website www.constructiondefects.com touts its success in "recovering" over $400 million for construction-defects claims.[46]

The result has been a food of litigation in California courts, aided by the state's ten-year statute of limitations on structural defects, one of the longest in the nation, and its plaintiff-friendly strict liability laws.[47] Under a strict liability doctrine, homeowners do not have to prove that a builder was negligent—only that he built a structurally defective home. Thus, if a window leaks, the contractor is liable even if he installed the window properly and met industry standards.

To dig into as many deep pockets as possible, lawyers typically name as defendants as many as 60 subcontractors on a project— and all their insurers—including some who had nothing to do with that portion of the construction where defects are being alleged.[48] As a result, portable-toilet vendors are being dragged into lawsuits over construction flaws, and roofers are being named in litigation over tennis-court defects, inflating costs and causing cases to drag on for years.[49] Insurers understandably prefer to settle these nuisance suits in order to cut their ever-increasing litigation tab.[49]

Repairing the Damage?

Housing starts have failed to keep up with population and job growth, and most families cannot find affordable housing.

Builders and subcontractors are starting to fight back, forming captive insurers (entities that businesses create themselves to provide coverage when insurance companies exit a market), writing more explicit warranties and arbitration clauses into their contracts, and soliciting homeowners for problems before disputes turn into lawsuits.[50] California home-builders groups are asking homeowners to call their builder, not a lawyer, if they have a problem with construction.[51]

Most successfully, builders managed to get California lawmakers to pass a "right-to-repair" law in 2002 that requires most owners of condos and townhouses to give builders an opportunity to fix defects before taking them to court.[52] Condo construction has picked up since its passage, but liability insurance rates are still climbing and skittish insurers have yet to resume writing coverage and are unlikely to come back into the market until they can get a better handle on risk.[53] Moreover, the law does not apply to remodeling projects or to homes built before January 1, 2003,[54] which leaves an estimated 1.5 million homes in the state vulnerable to litigation.[54]

Ever resourceful, lawyers are now turning their attention to homes not covered by right-to-repair laws: single-family homes and seven- and eight-year-old condos that are starting to show wear. Not surprisingly, the rate of increase in building of new single-family homes is slowing, and last year, the Construction Industry Research Board predicted that California may actually see a 3 percent decrease in the number of new one-family homes built in the state.[55]

More troubling, lawyers have lately brewed up a potent mix of allegations that combine construction defects and toxic mold, paving the way for punitive damages and big pain-and-suffering awards.[56] With leaks the most common litigated defect in California, claims of toxic mold damage—and the physical ills it allegedly causes—are proliferating.[57] Despite the junk science that underpins many mold cases, water-related payouts more than doubled between 1997 and 2001 for California's biggest insurers, from $206 million to $431 million,[58] "largely because of the increased cost in treating mold that results from the water damage."[59]

Developers are now pushing two bills in Sacramento that would plug some of the holes in the right-to-repair law, including one that would, among other things, force attorneys to tell prospective plaintiffs the alternatives to litigation.[60] Something needs to be done. In constructiondefects litigation, Trial Lawyers, Inc.'s profits have been California citizens' loss, as housing starts have failed to keep up with population and job growth, and most families cannot find affordable housing (see graphs above). The state's sunny climate notwithstanding, a failure to address this problem could leave many Californians out in the cold.

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35. Insurers' Rate Hikes Hammer Builders, SACRAMENTO (Cal.) BUS. J., May 2, 2003, at 1.

36. Id.

37. See Kelly Zito, Insurance Nightmare: Flood of Lawsuits Alleging Defective Construction Leaves Builders Scrambling to Find Coverage for New Projects, S.F. CHRON., July 11, 2002, at B1 (noting that in 2000, insurers collected $15.2 million in premiums from contractors' liability policies in California and paid out $44.8 million, for construction defects as well as other types of losses) (citing information from the Insurance Services Of.ce, Inc., which provides research for insurance companies). By comparison, insurers in 1998 collected $19.3 million and paid out about $36 million; i.e., they paid out $1.87 for every dollar they took in. See id.

38. Twenty to thirty licensed California insurers offered defect-liability coverage in 1998. See Insurers' Rate Hikes Hammer Builders, supra note 35, at 1 (quoting Mark Sektnan, assistant vice president of the western region for the American Insurance Association in Sacramento). "There are a small handful of insurers that will provide programs," Greg Van Ness, managing director of Acordia of California Insurance Services Inc. in Rancho Cordova, California, told local media. Id.; see Sue McAllister, Law Spurs Condo Construction, CONTRA COSTA TIMES (Cal.), Nov. 12, 2004, at F4. Cf. Melissa C. Tronquet, There's No Place Like Home…Until You Discover Defects: Do Prelitigation Statutes Relating to Construction Defect Cases Really Protect the Needs of Homeowners and Developers?, 44 SANTA CLARA L. REV. 1249, 1250 (2004) (discussing the impact of the flood of litigation against the construction industry, which has been "particularly pronounced" in California).

39. See Zito, supra note 37, at B1.

40. See Homeless Masses, ECONOMIST, July 12, 2003 (explaining that an "epidemic of lawsuits over construction defects [has] made some housing uninsurable. A particular target has been condominiums—jointly owned apartment blocks that are a useful way of putting more people in a limited space."); see Zito, supra note 37, at B1 (quoting San Francisco attorney Tyler Berding and Phil Serna, spokesman for the Home Builders Association of Northern California).

41. See Homeless Masses, supra note 40 (citing U.S. Census Bureau figures released July 2003).

42. Id.

43. See Roger Dunstan & Jennifer Swenson, CONSTRUCTION DEFECT LITIGATION AND THE CONDOMINIUM MARKET 3 (1999), available at www.library.ca.gov/crb/99/notes/v6n7.pdf (last visited Mar. 4, 2005).

44. California state law gives homeowners associations the right to make claims on behalf of all owners in their communities. Davis-Stirling Common Interest Development Act, CAL. CIV. CODE §§ 1350-76 (West 2005); see also Tronquet, supra note 38, at 1261-1262 & nn.95, 96 (discussing evolution of condominium construction-defects claims).

45. See Homebuilders fighting defect lawsuits get aggressive, SACRAMENTO (Cal.) BUS. J., Apr. 30, 2004, at 3.

46. Miller Law Firm, Welcome, at http://www.constructiondefects.com (last visited Mar. 4, 2005).

47. See, e.g., CAL. CIV. PROC. CODE §§ 337, 337.1, 337.15 (West 2005); see also Tronquet, supra note 38, at 1255 n.45; Cynthia Kroll et al., The Impact of Construction Defect Litigation on Condominium Development, CPRC BRIEF, Oct. 2002, at 22 & tbl. 2 (Cal. Pol'y Res. Center 2002), available at http://www.novoco.com/Research_Center/Defect_Litigation_Effects.pdf (last visited Mar. 4, 2005). See generally RESTATEMENT OF TORTS (THIRD): PRODUCTS LIABILITY § 1 (1997); Tronquet, supra note 38, at 1257.

48. See Homebuilders Fighting Defect Lawsuits Get Aggressive, supra note 45, at 3; Melanie Payne, Contractors, Lawyers Square Off, SACRAMENTO (Cal.) BEE, Apr. 4, 2004, at D1.

49. See Homebuilders Fighting Defect Lawsuits Get Aggressive, supra note 45, at 3.

50. See id.; Homebuilders Create New Liability Insurance Options, SACRAMENTO (Cal.) BUS. J., Apr. 30, 2004, at 8.

51. See Homebuilders Fighting Defect Lawsuits Get Aggressive, supra note 45, at 3.

52. S.B. 800, 2001-02 S. (Cal. 2002), codified at CAL. CIV. CODE §§ 895-945.5, 1375 (West 2005).

53. See McAllister, supra note 38, at F4 (quoting Michelle Wolkoys of Hanley Wood Market Intelligence, a research organization used by home builders, and Roger Menard, president of Summerhill Homes in Palo Alto, California, on increase in condominium construction). Sales for new condos in metro areas throughout California were up 80 percent in 2004 over 2002 sales, and sales of condos accounted for 17 percent of all new homes sales in the first three quarters of 2004, compared with just 8 percent in all of 2002. See id. (citing Hanley Wood research). Nevertheless, minimum insurance on a $1.5 million, three-unit condo development in San Francisco's Mission District would run about $250,000, twice what it would have been several years ago. See Zito, supra note 37, at B1 (quoting Hugh Coyle, a broker at Willis Insurance Services in San Francisco).

54. See S.B. 800, supra note 52, at 895(f).

55. Andrew LePage, Home Building Soars in State, SACRAMENTO (Cal.) BEE, Jan. 30, 2004, at D2.

56. See Tamara L. Boeck & Linda M. Boldaun, Underlying Exposures in Mold Claims: What Are the Damages?, 70 DEF. COUNS. J. 218 (2003).

57. See Zito, supra note 37, at B1; MANHATTAN INSTITUTE, TRIAL LAWYERS, INC: A REPORT ON THE LAWSUIT INDUSTRY IN AMERICA 2003 14-15 (2003), available at http://www.triallawyersinc.com (last visited Mar. 4, 2005); THE GROWING HAZARD OF MOLD LITIGATION, MANHATTAN INST. CIV. JUST. REP. NO. 8 (2003), available at http://www.instituteforlegalreform.org/resources/ILRmold.pdf (last visited Mar. 4, 2005).

58. See INSURANCE INFORMATION NETWORK OF CALIFORNIA, CALIFORNIA WATER DAMAGE CLAIMS, 1997-2001 (2002), available at http://www.iinc.org/news/home/waterdamage.html (last visited Mar. 4, 2005).

59. Dean Calbreath, Cost of Homeowner Insurance Rising Fast: Of.cials Seek Ways to Safeguard Coverage, SAN DIEGO UNION-TRIB., Feb. 7, 2003, at C1.

60. A.B. 108, 2005-06 Assem., Reg. Sess. (Cal. 2005) (introduced by Assembly Member Houston, Jan. 11, 2005) (requiring certain disclosures by attorneys in advertising for construction-defects litigation); A.B. 406, 2005-06 Assem., Reg. Sess. (Cal. 2005) (introduced by Assembly Member Hayes, Feb. 15, 2005) (addressing prelitigation procedure for construction defects in homes sold before 2003).