THE CURIOUS CASE OF THE CONDO CONVERSION

By Sean D. Allen, Esq. and Daniel J. Brast, Esq.

 

What is a “Condominium Conversion”?

The threshold question is:  Is the project “converted”?  A general definition of a condominium conversion may be found at California Government Code section 65590, which provides:  “a change of a residential dwelling . . . to a condominium, cooperative, or similar form of ownership.”  (Gov. Code, § 65590, subd. (g)(l).)  In practice, the existing residential dwelling to be converted is commonly an apartment complex.  Thus, whether there was “conversion” becomes an important fact under certain legal theories.  All condominium conversions require certain compliance under the Subdivision Map Act, Davis-Stirling Common Interest Development Act, filings with the California Department of Real Estate, and certain disclosures.  Additionally, local and municipal codes provide additional requirements and procedures.  California law does not require any actual construction or renovation work to convert the dwelling unit, so long as it complies with California law and the requisite public report is filed at the time of the conversion.

Often a property is originally constructed with the intent to create a condominium, but economic or other considerations result in the property existing as an apartment complex.  In that case, very limited renovation work, if any, may be required to “convert” the property.  Pre-mapped properties are more desirable to an investor because they require less paperwork and local or state government approval.  Therefore, a party that purchases a project that was originally mapped as a condominium but utilized as an apartment complex may not necessarily be “converted” to condominiums.  If this is the case, the converter should seek immediate judicial determination that it is not subject to the disclosure requirements of Civil Code section 1134.  On the other extreme, some “conversions” require significant construction work by the converter, effectively taking the existing property down to the studs.  This process is still considered a condominium conversion, but different legal theories may arguably be available to the homeowner or homeowners association as a result.

 

Applicable Standards in Condominium Conversion Construction

 

Does Civil Code section 895 et seq. apply?

Civil Code section 895, et seq., (“SB 800”) has become the standard for residential construction in California.  However, the standards set forth in SB 800 are expressly inapplicable to  condominium conversions as dictated by Civil Code section 896 which states:  “As to condominium conversions, this title does not apply to or does not supersede any other statutory or common law.”  Thus, the performance standards outlined in Civil Code section 896 and the pre-litigation procedures outlined in Civil Code section 910, et seq., are inapplicable to condominium conversions.  As such, the resultant damage requirement for tort claims under Aas v. Superior Court (2000) 24 Cal.4th 627 continues to apply to condominium conversion cases.

While the pre-litigation procedures and right to repair under SB 800 do not apply, the pre-litigation requirements set forth in Civil Code section 1375 may be applicable.  Under Civil Code section 1375, “[b]efore an association files a complaint for damages against a builder, developer, or general contractor (“respondent”) of a common interest development based upon a claim for defects in the design or construction of the common interest development, all of the requirements of this section shall be satisfied with respect to the builder, developer, or general contractor.”  Arguably, the applicability of section 1375 would thus depend on whether a condominium conversion is considered “construction” under the statute.  Thus, where a conversion required construction and the homeowners’ association is claiming defects associated with the conversion work, it would seem that section 1375 would likely apply.

 

Common Condominium Conversion Causes of Action:  Negligence

As SB 800 does not apply, construction defects are recoverable through a negligence theory of liability.  Thus, repairs or renovations made by a converter which cause damage may be recoverable against the converter under a theory of negligence.  (See Orange Grove Terrace Owners Ass’n. v. Bryant Properties, Inc. (1986) 176 Cal.App.3d 1217.)  In Orange Grove, a homeowners’ association appealed a trial court’s ruling that it could not recover for damages resulting from conversion repairs that occurred prior to the association assuming its management duties at the project.  (Id. at pp. 1221-1222.)  The court of appeal reversed the trial court ruling, finding that a homeowners’ association had standing to bring a negligence action to recover damages for construction defects.  (Id. at p. 1223.)  However, liability against a converter for negligence assumes that the converter made repairs or renovations to the property.  Where a property is converted with little or no repair or construction work begs the question of whether there is work under Orange Grove.  Arguably, these situations would generally not present a claim for negligence.

 

Common Condominium Conversion Causes of Action:  Strict Liability

California courts have yet to expressly extend strict liability claims to condominium conversion cases.  Strict liability, in the construction context, has been limited to matters involving new mass-produced housing construction.  This is not to say that the courts will not eventually extend strict liability to condominium conversions.  As with any unsettled legal matter, there are arguments for and against the applicability to condominium conversion cases.

Strict liability applies when “the plaintiff proves that he or she was injured while using the instrumentality in a way it was intended to be used as a result of a defect in design and manufacture of which plaintiff was not aware and which made the instrumentality unsafe for its intended use.”  (Kriegler v. Eichler Homes, Inc. (1969) 269 Cal.App.2d 224, 227.)  Consequently, the doctrine of strict liability applies to physical harm to property.  (Ibid.)  “The reasoning behind the doctrine applies to any case of injury resulting from the risk-creating conduct of a seller in any stage of the production and distribution of goods.”  (Ibid.)  “The purpose of such liability is to insure that the costs of injuries resulting from defective products are borne by the manufacturers that put such products on the market rather than by the injured persons who are powerless to protect themselves.”  (Greenman v. Yuba Power Products, Inc. (1963) 59 Cal.2d 57, 63.)

Strict liability was extended to the sale of new mass-produced housing in Kriegler, supra.  (Kriegler, supra, at p. 227.)  Since Kreigler’s initial extension of strict liability to tract home builders, California courts have affirmed that only those entities engaged in the development of new mass-produced housing are subject to strict liability for defects, given the fundamental similarities between newly constructed mass-produced housing and other mass-produced consumer products.  (See Hyman v. Gordan (1973) 35 Cal.App.3d 769, 773-774; see also Jiminez v. Superior Court (2002) 29 Cal.4th 473, 479-481.)  Specifically, the Kriegler court explained that “[b]uyers of mass produced development homes are not on an equal footing with the builder vendors and are no more able to protect themselves in the deed than are automobile purchasers in a position to protect themselves in the bill of sale.”  [Citations omitted.]  (Kriegler, supra, at p. 227.)  The seller of a “used” residential building generally is not liable under a strict liability theory.  (Siders v. Schloo (1987) 188 Cal.App.3d 1217, 1220-1223.)

The general thrust of California case law presents no movement toward extending strict liability into the condominium conversion scenario.  In Peterson v. Superior Court (1995) 10 Cal.4th 1185, the California Supreme Court held that residential landlords are not subject to strict liability.  The Court explained that loss spreading is not a sufficient justification by itself for extending strict liability.  (Id. at 1206-1210.)  Among the reasons for not extending strict liability to landlords and hotel owners, the Peterson Court emphasized the fact that landlords and hotel owners generally have no continuing business relationship with the parties responsible for the design and construction of the building.  (Id. at 1202.)  In Peterson, the Court relied on a line of cases holding that dealers in used machinery are not strictly liable for defects.  (See, e.g., Wilkinson v. Hicks (1981) 126 Cal.App.3d 515; LaRosa v. Superior Court (1981) 122 Cal.App.3d 741; Tauber-Arons Auctioneers v. Superior Court (1980) 101 Cal.App.3d 268.)

The Peterson court fully endorsed the reasoning of those cases and adopted the following passage from Tauber-Arons, supra:

The ordinary used machinery dealer has no continuing business relationship with the manufacturer in the course of which he can adjust the cost of protection from strict liability.  Consequently, the rationale which underlies Vandermark simply is inapplicable to such a dealer.  Moreover, the risk reduction which was sought in Vandermark on the assumption that “the retailer himself may play a substantial part in insuring that the product is safe or may be in a position to exert pressure on the manufacturer to that end,” as pointed out by the opinion in Tillman, is simply unattainable because the “used goods dealer is normally entirely outside the original chain of distribution of the product ….”  (Peterson, supra, at p. 1202, quoting Tauber-Arons, supra, at p. 283.)  [Citations omitted.]

Therefore, where the condominium conversion process did not involve extensive repairs, a converter may argue that the end project is effectively the same, and it is in the same position as the buyer.  Thus, the limitations placed by Kriegler would not be applicable and arguably, strict liability would not apply because the property is not new construction and the converter is not in a better position to discover latent defects.  Thus, strict liability should not apply to condominium conversion cases.

 

Common Condominium Conversion Causes of Action:  Breach of Implied Warranty

Just as California courts have resisted extending liability without fault in the strict liability context, courts have not extended the doctrine of implied warranty to condominium conversion cases.  The California Supreme Court extended the theory of implied warranty to contracts for the construction and sale of new housing in Pollard v. Saxe & Yolles Dev. Co. (1974) 12 Cal.3d 374:

In the setting of the marketplace, the builder or seller of new construction – not unlike the manufacturer or merchandiser of personalty – makes implied representations, ordinarily indispensable to the sale, that the builder has used reasonable skill and judgment in constructing the building.  On the other hand, the purchaser does not usually possess the knowledge of the builder and is unable to fully examine a completed house and its components without disturbing the finished product.  Further, unlike the purchaser of an older building, he has no opportunity to observe how the building has withstood the passage of time.  Thus he generally relies on those in a position to know the quality of the work to be sold, and his reliance is surely evident to the construction industry.  Therefore, we conclude builders and sellers of new construction should be held to what is impliedly represented – that the completed structure was designed and constructed in a reasonably workmanlike manner.  (Id. at pp. 379-80.)  [Emphasis added.]

No case has further extended a theory of implied warranty to the sale of used housing.  In fact, in East Hilton Drive Homeowners’ Assn. v. Western Real Estate, Inc. (1982) 136 Cal.App.3d 630, 632, the court expressly rejected the application of an implied warranty cause of action by an association. In East Hilton, a builder constructed eight condominiums.  A foreclosure resulted in the acquisition of the condominiums by Bank of America.  The condominiums were purchased from Bank of America by Western Real Estate Exchange, Inc. some four years after their construction.  After “repairing and rehabilitating” the condominiums, Western sold the units to their first occupants.  (Id. at p. 631.)  The trial court, applying Pollard, supra, found the HOA members to be the first users of the homes and that Western, as successor in interest to the original developer, and as seller of new construction, had all the same warranty obligations that the original developer and builder would have had.  (Id. at p. 632.)  The appellate court disagreed, despite the fact that Western had repaired and refurbished the condominiums prior to sale.

The court refused to impose liability against Western absent a showing of fault, stating:

But appellant who had no part in building or financing the building of these homes, cannot be considered a seller of new construction whether it occupied the homes or not.  The Pollard case did not say a warranty would be implied for first occupants of buildings.  It said the warranty would be implied for sellers and builders of new construction.  Appellant Western had no better way of knowing of any defects in construction than did respondents.  Appellant is not a builder.  (East Hilton, supra, at pp. 632-633.)

Just as in the case of strict liability doctrine, where a condominium conversion presents such an extensive renovation or remodel that the end product is considered a “new” building, implied warranties may attach.  Moreover, in that scenario, the converter would indeed be in a better position of “knowing of any defects in construction.”  Still, breach of implied warranties has not yet been extended to condominium conversion cases.

 

Common Condominium Conversion Causes of Action:  Failure to Disclose

The most intriguing aspect of condominium conversion cases, and most in need of judicial guidance, are the disclosure requirements under Civil Code section 1134.  The disclosure requirements allow additional avenues for a homeowner or homeowners’ association to recover for construction defects.  Moreover, claims that would otherwise be barred by the statutes of repose could potentially result in liability for the converter, based on a failure to inspect or a failure to disclose.

 

Civil Code section 1134 states:

As soon as practicable before transfer of title for the first sale of a unit in a residential condominium, community apartment project, or stock cooperative which was converted from an existing dwelling to a condominium project, community apartment project, or stock cooperative, the owner or subdivider, or agent of the owner or subdivider, shall deliver to a prospective buyer a written statement listing all substantial defects or malfunctions in the major systems in the unit and common areas of the premises, or a written statement disclaiming knowledge of any such substantial defects or malfunctions.  The disclaimer may be delivered only after the owner or subdivider has inspected the unit and the common areas and has not discovered a substantial defect or malfunction which a reasonable inspection would have disclosed.

According to the statute, “‘major systems’ include, but are not limited to, the roof, walls, floors, heating, air conditioning, plumbing, electrical systems or components of a similar or comparable nature, and recreational facilities.”  However, the statute does not further define what a substantial defect or reasonable inspection entails.

The statute sets two requirements for the converter with regard to disclosure:  (a) the converter must conduct a reasonable inspection of the property; and (b) the converter must disclose substantial defects to major components or disclaim any knowledge of any such defects.  Under Civil Code section 1134, “Any person who willfully fails to carry out the requirements of this section shall be liable in the amount of actual damages suffered by the buyer.”

 

(a)        Due Diligence Inspections and ASTM E-2018

The reasonableness of an inspection to comply with section 1134 is necessarily a factual inquiry based on the individual project and the conversion work completed.  Often, converters retain an inspection company to prepare a Property Condition Report, or similar, based on the investigation guidelines under American Society for Testing and Materials (ASTM) E-2018.  These guidelines “define good commercial and customary practice in the United States of America for conducting a baseline property condition assessment (PCA) of the improvements located on a parcel of commercial real estate.”  (ASTM E-2018, § 1.1.)

One important element of the ASTM E-2018 assessment standards is that the due diligence inspection is non-intrusive.  No destructive testing is required of the converter unless evidence clearly suggests some underlying or latent deficiency.  (ASTM E-2018, § 2.3.44.)  The guidelines also permit the inspector to reasonably extrapolate his or her observations to other similar or typical areas.  (ASTM E-2018, § 3.4.3.2.)  The level of due diligence required by an inspector is variable, depending on the type of property, age of improvements, and time.  (ASTM E-2018, § 3.4.4.)  Moreover, under the ASTM standards, the inspector is not required to be an architect or engineer.  (ASTM E-2018, § 6.7.)

The result of the due diligence inspection under the ASTM standards is often a simple baseline property assessment.  However, the ASTM standards do allow an inspector to provide an opinion as to the course of action to remedy or repair a physical deficiency.  (ASTM E-2018, § 2.3.39.)  Where the noted physical deficiency is beyond the scope of the investigation or expertise of the inspector, the ASTM standards allow for an opinion that further investigation is required.  (Id.)

 

(b)        Disclosures

After conducting a reasonable inspection, a converter “shall deliver to a prospective buyer a written statement listing all substantial defects or malfunctions in the major systems in the unit and common areas of the premises, or a written statement disclaiming knowledge of any such substantial defects or malfunctions.”  (Civ. Code § 1134.)  Converters are required to submit a Supplemental Questionnaire regarding the converted property, including last renovations or replacements of various components specified on the Department of Real Estate form.  This requirement is separate from the disclosure requirements under Civil Code section 1134, and the Supplemental Questionnaire cannot be substituted for the written disclosure.  The vagaries of the form and content of the written disclosure under section 1134 are discussed below.

 

(c)        Negligent Failure to Disclose?

Though there is no case law on the subject, section 1134 by its own language appears to preclude a claim for negligent failure to disclose.  Instead, a plaintiff may only recover where a converter “willfully” fails to carry out the requirements under section 1134.  Thus, while a Plaintiff can recover for negligence in the actual construction performed as part of the condominium conversion, the basis for a negligence cause of action cannot be a negligent failure to disclose.

 

The Curious Grey Area in Condominium Conversion Disclosure Law

With terms like “substantial defects” and “reasonable inspection” in section 1134, there are a handful of factual questions that become the center of any condominium conversion case:  (1) Is the claimed defect(s) the result of original construction or the conversion work?  (2) Was the claimed defect discovered during the pre-conversion inspection?  (3) Was any action taken by the converter to repair the claimed condition prior to sale?  (4) Was the inspection of the property “reasonable”? and finally (5) Was the condition properly disclosed to the condominium buyer?  Naturally, there are no clear answers to these questions, and each will depend on the individual facts of a given case.  However, it is clear that these questions offer plenty of room for arguments by converters in condominium conversion disclosure cases.

 

Is the claimed defect the result of original construction or the conversion work? 

While in some cases the answer to this question may be clear, the intricacies of residential construction can muddy the waters.  Where new components are being placed on top of existing “old” components to create a final “major system,” a resulting alleged defect may not be as easily labeled as new or old construction.  For example, where finish materials such as floor tile were placed on existing substandard underlayment, the resulting cracked tile could be the result of original construction or the condominium renovations, depending on your viewpoint.  Arguably, the cracked tile is the resultant damage of the improper underlayment.  Even more confusing is a situation where the underlayment is improper, but the tile installation during renovation is similarly below the standard of care.  Flooring is considered a “major component” under section 1134; thus, if the improper underlayment was discovered or could have been discovered by a reasonable inspection, a converter likely would need to disclose this fact.

It is important to note that the converter is not under a duty to repair the pre-existing underlayment, but merely to disclose its existence.  If disclosure is made, the question becomes whether the damage to the tile work is recoverable under a tort theory of liability.

 

Was the claimed defect discovered during any pre-conversion inspection? 

Clearly, if an alleged defect is not discovered during the pre-conversion due diligence, it is not going to be disclosed.  The inquiry then becomes whether any pre-conversion inspection was reasonable under section 1134.  As discussed above, the ASTM E-2018 guidelines are the standard in the industry for conducting baseline due diligence inspections.  A converter who has conducted such a property assessment has a solid argument that a reasonable inspection was made prior to sale and/or conversion.  If the inspection presents a need for additional or more extensive investigation, a reasonable due diligence inspection will require some further effort.

Due diligence inspections under the ASTM standards generally do not require intrusive investigation. A claimed defect that may have been discovered or should have been discovered during limited demolition to complete other renovations may raise other questions.  Under this scenario, an otherwise latent defect that would not have been discovered under a “reasonable inspection” could give rise to liability, because it was or should have been discovered during the actual renovation work.  In this situation, issues relating to the reasonableness of inspection are no longer at issue and instead, the converter’s knowledge becomes the key question.  Moreover, if the converter hired a separate contractor to perform the renovation work, the contractor’s knowledge of “substantial defects” discovered during the renovation can be imputed to the converter.  Thus, contractual provisions between the converter and any contractor will be important in this scenario.

 

Was any action taken by the converter to repair the claimed condition prior to sale? 

The difference between an attempted repair of a claimed defect and no repair is important.  Under the disclosure statutes, there is no requirement that the converter make any repair to the major component (though he or she may run afoul of municipal codes and be subject to liability under other theories).  However, an attempted repair gives a prospective purchaser additional remedies than would have otherwise been allowed, especially if the condition would have been subject to a statute of limitations defense.  For the purposes of disclosure, a major component that was repaired during conversion would not need to be disclosed under section 1134.  This would be true even if the repair were unsuccessful, so long as the converter did not know the defect still existed or could not have reasonably determined its existence.  However, the California Department of Real Estate requires that certain filings be made on a converted property which becomes public record.  One such filing, the Supplemental Questionnaire, provides a prospective buyer with a summary of the components and the last known repair or renovation thereto.  Nevertheless, even if there is no requirement for disclosure, a latent defect created during an attempted repair can be recovered under tort and contract theories, within the new ten-year statute of limitations.

 

Was the inspection of the property “reasonable”? 

As with any legal theory invoking the term “reasonable,” the scope and extent of a pre-conversion inspection is open to interpretation.  Fueling the fire is the utter lack of any case law interpreting any portion of section 1134.  It seems generally accepted that the bare minimum for a pre-conversion investigation is an inspection conducted in conformance with ASTM E-2018.  The ASTM standards for property inspections provide significant leeway as to how a property condition assessment may be conducted.  Additionally, the reasonableness of a pre-conversion inspection protocol is a factually-based inquiry.  A property constructed two years prior to the conversion simply would not require the same type of inspection as a twenty-year-old apartment complex.  Similarly, a property in a marine environment would require a different type of inspection than one in a desert environment.  Additionally, the results of an initial property assessment may indicate additional inspections are necessary to conduct a reasonable inquiry.  For example, observations noted on an initial report may require further investigation by another licensed professional with further expertise.

 

Was the condition properly disclosed to the condominium buyer?  

The disclosure statute has form-based requirements for providing the disclosures.  The disclosure must be in writing and list all substantial defects or malfunctions.  Moreover, the written statement should be presented to a prospective buyer (anyone who makes an offer to purchase) either in person, by mail, or to the prospective buyer’s agent.  However, if the disclosure statement is delivered after the execution of a purchase agreement, the buyer will have three to five days (depending on the method of delivery) to rescind the contract.

It is important to note that if the converter has no knowledge of any defects, he or she still must supply a disclosure statement indicating such pursuant to section 1134.  Often, the content of the disclosure itself is at issue.  This is a product of the vague language used in the section.  A disclosure statement must “list all substantial defects or malfunctions to major systems.”  While the statute further defines “major systems,” it does not define “substantial.”  Thus, there is no requirement for the content of the disclosure statement.  A disclosure statement that states “defects exist at roofs” is arguably equally sufficient compared to one that states “roof does not contain proper edge metal.”  Obviously, a buyer faced with a litany of roofing defects will argue that the former is insufficient to disclose the issue.  On the other hand, the converter could argue that the disclosure properly indicated roof problems and buyers were on notice (which is presumably the intent of the statute).

 

Conclusion

The effects of the disclosure requirements for condominium conversions provide a litany of odd legal scenarios for plaintiffs and converters alike.  This is, arguably, the function of a simple statute meant to address a complex problem, with no interpretation or assistance from the judiciary.  In practice, both plaintiffs and converters will have ample opportunity to roam within the framework of the statute to seek recovery or avoid liability.  Without some legislative or judicial assistance, condominium conversion cases will continue to present curious construction defect cases.