California construct defect litigation creating perfect storm

In The Perfect Storm, the book that inspired the movie of the same name, author Sebastian Junger defined “the perfect storm” as a tempest that may happen only once in a century, a storm created by so rare a combination of factors that it could not possibly have been worse. In some ways, conditions in California construction defect litigation mirror the “perfect storm” concept — a tempest created by a combination of litigation factors that could not be worse for the building and insurance industries, or for new homeowners.

However, instead of a disaster arising from the crisis in California construction defect litigation, a “perfect storm” of innovation, compromise and change arose. The combination of change encompasses the Right-to-Repair Law in Senate Bill 800 and innovations in insurance, such as wrap-up policies and self-insured retentions. The “perfect storm” returns responsibility and risk management to the builder, allowing participation in repairs by the contractors who built the homes and know their structure and design.

In the mid-1980s, construction law centered on the arguments between owners and contractors about cost overruns and delays. An entire industry sprang up to help resolve quality disputes between homeowners, builders and trade contractors. During those times, attorneys could make a difference, defending the “good guys” and taking cases to the mat. Soon thereafter, the economics of the conflicts won the day. Lawyers, insurers and third-party administrators created an industry that had a stake in the economics and inefficiencies of the evolving system.

Based on the dissatisfaction with a resolution process mired in economics rather than right or justice, efforts toward reform were made, through legislation and insurance industry innovations. Laws and polices were created that continue to change the way construction defect disputes are handled and resolved.

SB 800, the “Right-to-Repair” Law, significantly impacts how construction quality disputes are defined, processed and resolved. During the era of litigation — without a clear definition of a “defect” — builders struggled to hit a moving target of construction defects. The industry saw claims of sulfate attack, toxic mold and other novel “defects” come and go the hard way: through expensive litigation and large settlements to avoid the high costs of rolling the dice at trial. SB 800 changed that. It created functionality standards that define construction defects, reduced the statutes of limitations for certain functionality standards and limited causes of action to repairs only. Most importantly, SB 800 mandated repairs to replace lawsuits. The law allows builders early access to resolve problems resulting in a decreased number of claims that devolve into litigation.

If builders and their insurers strive to abide by SB 800’s guidelines and observe the timing and structure of the rules within the law, the potential for early resolution of claims and greater homeowner satisfaction will ease the current economic crisis driving construction defect dispute resolution.

In addition, in this day of rising insurance costs and policies that provide limited coverage for the money, many insurance companies opted to add a self-insured retention (SIR) to their policies to protect against the risk of loss for the initial “so many” dollars. The SIR appears to benefit only the insurers, requiring builders and contractors to put up cash up front to fund their own defense and indemnity — a cost previously assumed by the insurer. However, the SIR can benefit builders and trade contractors by allowing them to interact directly with disgruntled homeowners, control their own costs and risks, and approach claims resolution with innovation — thinking outside the box to resolve a dispute or satisfy a disgruntled homeowner. Under most SIRs, it is the contractor’s right to direct the litigation during that time, to make judgment calls on whether settlement is in its best interest and to control its loss history by determining whether other insurers should be put on notice of the claim or need to participate. Although policy language varies, the SIR gives the contractor some control over what happens to the claim against his work.

The insurance industry responded to the growing economic crisis by offering wrap-up insurance that enables the builder to manage risk by covering all participants on a project under one policy. Wrap-ups benefit subcontractors by enabling them to obtain insurance to work on a project, which they would otherwise not be able to secure, and avoid claims against their own loss history.

A typical wrap-up policy will provide completed operations coverage for the entire statute of limitations. When a homeowner submits a claim, only one insurer needs to respond, eliminating expensive legal wrangling over tenders of defense, additional insured endorsements and indemnity language in subcontracts.

By using the newly available tools — SB 800, SIRs and wrap-up insurance — to approach construction defect claims, the impending industry tempest may pass. Instead of the ultimate clash of disastrous conditions resulting in devastation, the constraints of the tired, worn and economically unfeasible construction defect litigation system are shed.

Combining the benefits of early resolution and right to repair with the personal responsibility and risk management of a self-insured retention and/or the cost effectiveness of a wrap-up program can create a “perfect storm” of cooperation and decreased litigation costs to builders, trade contractors and insurers.

George Dale is president of DBH Resources and managing partner at Dale, Braden & Hinchcliffe. E-mail Dale@DBHResources.com.