A Brave New World: Considerations when Reentering the Condominium Market

June 8, 2018

Author: Sarah M. Wright

The need for quality, affordable housing in Colorado is undeniable. In the past, condominiums often served this need and provided a stepping stone toward home ownership for many middle-income families. However, due to Colorado’s construction defect laws, which facilitate lawsuits by home or unit owners’ associations for workmanship issues, developers simply could not risk the liability associated with condominium development. As a result, the number of condominiums being built in Colorado had all but come to a standstill. 

In the wake of recent construction defect reforms, however, we have seen a resurgence of interest from our clients in condominium development.  Undoubtedly, the lack of new condominiums available in the market provides a real business opportunity for developers looking to break into the market.  Nonetheless, there are still issues the entrepreneurial developer must be aware of before venturing into the condominium development market. In this article, I will address three of these issues, including the most recent amendments to Colorado’s Construction Defect Action Reform Act (CDARA), which choice of entity affords the developer the best protection, and how to utilize the condominium Declaration to help protect Declarant rights.

  • Amendments to CDARA: HB 17-1279 and Vallagio

 

In an effort to reinvigorate the condominium development market, the Colorado legislature spent substantial time and effort on construction defect reform in the 2017 legislative session. The result was HB 17-1279, which imposes certain requirements on Home Owners’ Associations (“HOA”) prior to instituting a construction defect claim against a developer. The bill was signed into law on May 23, 2017.

The bill requires that before the HOA commence any construction defect litigation, it must notify all unit owners, and the developer or builder against whom the lawsuit is being considered, of the potential legal action. Additionally, the HOA must call a meeting at which the executive board and the developer or builder will have an opportunity to present relevant facts and arguments to the unit owners. The developer or builder will have the opportunity to make an offer to remedy the defect.  Finally, the HOA must obtain the approval of a majority of the unit owners themselves, rather than HOA Board Members, to proceed with a lawsuit after providing detailed disclosures about the lawsuit and its potential costs and benefits.

Less than two weeks after the bill was signed into law, the Colorado Supreme Court issued its opinion in Vallagio at Inverness Residential Condo. Ass’n v. Metro Homes, Inc., 2017 CO 69.  In Vallagio, the Court upheld a developer-declarant’s retained right to consent to certain proposed amendments to a common interest community’s declaration, including a mandatory arbitration provision for construction defect claims. Taken together, HB 17-1279 and Vallagio are two important steps forward in creating a favorable landscape for condominium development in Colorado.

Choice of Entity

After deciding to reenter the condominium market, the first question that should be on a developer’s mind is what type of entity to use. While HB 17-1279 and Vallagio have added protection for developers, the extent and scope of those protections is still unclear. As a result, developers must structure their business ventures in a way to best avoid liability and limit the assets connected to development.

While every development has its own unique characteristics that must be taken into consideration, generally, a developer is best served by forming separate, single-purpose limited liability companies (LLC) to hold title to the land being developed and sold, and for property development, and property management. Assuming the proper maintenance of corporate formalities, by holding the real property in a separate LLC, the real property is sole asset that can be attached by claims by any creditors, protecting the owner and the owners other unrelated assets from claims by third parties. The single purpose entity LLC should be sure to have a purpose statement in its operating agreement that specifies that it has been organized to hold title to and then sell real property, and not a ‘blank-check’ purpose that allows the LLC to conduct any lawful business under the sun.

However, simply forming separate LLCs is not enough. The prudent developer would be careful to run all development activity through the LLC formed for that specific purpose, i.e. property development activities are run through the property development specific LLC.  Co-mingling development activity between associated entities, such as hiring and paying employees of the single-purpose property development entity via a parent company or using letterhead of an associated entity to communicate with others about the project, could extend liability to those associated entities.

Utilizing the Declaration to Your Advantage

In connection with any condominium development, the Colorado Common Interest Ownership Act requires a condominium Declaration and a Condominium Map, which together contain all of the covenants, conditions, and restrictions for the project. The prudent developer would be well-served to use the Declaration not just as a statutory requirement, but as a document that can be used to his advantage. For example, the developer may choose to incorporate into the Declaration relevant disclaimers from the Purchase and Sale Agreement for each unit, such as environmental or nuisance disclaimers, thereby binding buyers to these disclaimers who purchase units on the secondary market.

In the wake of the Vallagio case, a Declarant may include a provision in the Declaration that requires the Declarant’s consent before a mandatory arbitration provision is amended or deleted from the Declaration. If arbitration is desired, the Declaration should be worded such that the unit owners cannot amend the Declaration to eliminate that requirement. If drafted appropriately, the declarant-consent requirement can last in perpetuity, even if the Declarant no longer owns any units in the project, thus providing important long-term protections for the Declarant-developer. Of note, certain jurisdictions, have adopted their own code provisions regarding construction defect claims, so the developer will want to consider additional local requirements when drafting the Declaration. For example, the City of Denver requires specific disclaimer language as set forth in Denver Municipal Code §10-204 to take advantage of these protections.

Despite those protections afforded by Vallagio, Colorado courts do not favor broad, blanket prohibitions on amendment to the Declaration without Declarant consent. The Declarant-developer must make sure any Declarant consent requirements are narrowly tailored to protect the rights that are of the utmost importance to the Declarant.

Conclusion

Condominium development appears to be on the rise in Colorado. While there is undoubtedly significant market potential, developers would be wise to consult with legal representation before embarking on any such venture to determine how best to structure the project and governing documents to limit liability and maximize investment returns.

-Sarah M. Wright is a real estate attorney with Fairfield and Woods, P.C., in Denver, CO.