01 | 01 | 2010
Los Angeles Lawyer
All too frequently in today’s depressed real estate economy, developers attempting to build and sell condominiums are finding their projects derailed by a lack of buyers. “Broken condominium projects” are those projects in which some units have been sold and the homeowners have an operating homeowners association, but the original developer is unable to complete sales of all the units. To complicate matters, the most recent real estate boom fueled significant speculation in condominium construction and conversion, and the reality of the current condominium market is that more and more broken condominium projects are changing hands. The successor owners of these projects generally are lenders, who acquire the property through foreclosure, or third-party bulk purchasers, who acquire the property under bulk sale contracts.
Acquiring broken condominium projects requires a multifaceted due diligence process. It should include an analysis of a broad range of issues involving resales of the property (including statutorily required public reports), owners associations, and developer’s rights. However, the most important of the potential issues to be analyzed often is the extent of the potential construction defect liabilities that a successor owner may acquire along with the broken condominium project. If the construction defect liabilities are extensive and the acquiring party will be the only entity responding to those liabilities, and if there is no statutory or other protections to assert against claims of liability, the acquiring party may decide that it is not advisable to proceed. However, if the liabilities can be limited or managed or are not the sole responsibility of the acquiring party, the acquisition may be feasible. Identifying the liabilities and developing a strategy to address them may overcome any barriers to acquisition and will be an essential part of the due diligence process.
The most significant factors affecting construction defect liability are 1) the construction, if any, to be completed by a successor owner, 2) whether a successor owner plans to engage in retail sales, and 3) the amount of time that a successor owner plans to hold the property. This last factor must be assessed along with any actions that a successor owner does or does not take during that period regarding maintenance, management, or governance of the project. A successor owner needs to discern 1) the likelihood of construction defect liability, 2) whether the owner will need to make payments to cover any shortfall in assessments or association funds, 3) prospective liability for maintenance, management, or operation of the property, 4) what funds may be available to address potential liabilities, and 5) what additional options may be available to protect against liabilities going forward. Even after the acquisition takes place, actions may still be required to mitigate the risks inherent in a broken condominium project.
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