FALL 2002

I. LEGISLATIVE/REGULATORY UPDATE
Pending Legislation

In response to concerns regarding the high cost and the ineffective and inefficient processes associated with construction defect lawsuits, the California legislature has enacted several statutes aimed at streamlining the construction defect litigation process. The statutes are designed to provide incentive for early discovery and resolution.

Additional Pre-litigation Procedures

Effective July 1, 2002, California Civil Code section 1375 mandates pre-litigation information gathering and mediation of cases brought by homeowners' associations in twenty (20) unit or larger common interest developments. Under this new statute, an association is required to provide notice to the builder, developer, and/or general contractor and this notice tolls the statute of limitations for claims against all potentially responsible parties, regardless of whether named in the notice. Hence, upon the association providing notice, the statute of limitations is tolled even as to unnamed subcontractors.

The association's service of notice commences the 180-day period for the parties to resolve the alleged issues. Under Civil Code section 1375, the association is required to provide a general list of defects, damages caused by the defects, any testing results, and initial cost of repair estimates.

The association's notice also triggers the noticed party's responsibilities. Upon receiving notice, the developer, general contractor or builder must notify all potentially responsible parties, including insurance companies, of the association's claims within sixty (60) days. Further, within one hundred (100) days of receiving notice, a dispute resolution facilitator must conduct a case management meeting to develop a case management statement which provides for the publication of a defect list and settlement demand, visual inspections and testing, and mediation. Any party who chooses not to participate in the process may be bound by any settlement reached.

Should the matter not resolve, the association is deemed to have filed a complaint as of the date of its initial notice. The statute permits the setting of a priority trial date.

Challenges to Referees

California Code of Civil Procedure section 639 and California Rule of Court 244.2 provide new guidelines and restrictions on both the appointment and authority of a referee to resolve disputes between parties. Parties may nominate referees to be appointed by the court. The appointed referee is required to disclose any significant personal or professional relationship, both present or past, with a party, attorney or law firm. Parties can submit challenges regarding the referee under Code of Civil Procedure section 170.6. However, if the referee is appointed and remains unchallenged, the referee is permitted to rule on objections, motions, and other issues.

New Construction Defect Legislation, Effective January 1, 2003

On September 20, 2002, the Governor signed Senate Bill 800, which will take effect January 1, 2003, and applies only to residences originally sold on or after January 1, 2003. SB 800 specifies the rights and requirements of a homeowner to bring an action for construction defects, including applicable standards for home construction, the statute of limitations, the burden of proof, the damages recoverable, a detailed pre-litigation procedure, and the obligations of the homeowner. The bill also limits the liability of construction inspectors and plans examiners.

This legislation expressly lists the "actionable defects" with respect to water, structural, soil, fire protection, plumbing and sewer, electrical system, and other miscellaneous (hardscape, exterior wall finishes and fixtures, manufactured products, heating and air conditioning, irrigation and drainage, wood posts and steel fences, paint and stains, roofing materials, landscaping, ceramic tile and dryer ducts) issues, and creates a cause of action for violation of any of the specified standards. The homeowner need only show that the home fails to meet the standards set forth in the statute. No showing of causation and/or damages is necessary.

The bill also provides that, among other things, a builder will have the right and opportunity to repair a condition prior to the filing of a lawsuit. Furthermore, if the builder intends to hold a subcontractor, design professional, product manufacturer or material supplier responsible for its contribution to an unmet standard, the builder must provide sufficient advance notice to that person or entity to allow them to attend the initial or second inspection of any alleged unmet standard and to participate in the repair process. The bill also sets forth applicable affirmative defenses for builders, subcontractors, and others to any claimed violation of a standard, and shortens the statute of limitations for actions brought with respect to certain issues, such as electrical, hardscape, plumbing, etc.

II. JUDICIAL UPDATE

Defense Costs are "Damages"

In Golden Eagle Ins. Co. v. Insurance Company of the West, the insured subcontractor worked on several residential construction contracts. The subcontracts contained an indemnity agreement whereby the insured agreed to indemnify the general contractor for property damage. Three insurers issued commercial general liability policies to the subcontractor for successive policy periods. One of the insurers also named the contractor as an additional insured.

Certain homeowners filed an action against the contractor for construction defects. Two of the three insurers paid the contractor's attorney fees and costs and then sought reimbursement or contribution from the other insurers. The appellate court held that the defense costs of the contractor/indemnitee were sums the insured subcontractor was legally obligated to pay as damages under the subcontract because of property damage. Consequently, the court determined that each of the three insurers was on the risk assumed by the insured subcontractor/indemnitor and that there was no equitable basis for shifting the entire burden to the insurer that had also named the contractor as an additional insured.

Only Reasonable and Necessary Investigative and Repair Costs are Recoverable

In Barratt American, Inc. v. Transcontinental Ins. Co., the insured, a residential developer, sued its insurer, alleging the insurer failed to provide it with a defense in an underlying construction defect lawsuit. It was undisputed that the insurer owed a duty to defend. The primary issue was whether costs the insured incurred to repair homes owned by individuals who did not join the underlying construction defect lawsuit qualified as recoverable defense costs. Barratt had spent $580,714.50 on repairs to the nonplaintiff homes.

The appellate court held that, under Aerojet-General Corp. v. Transport Indemnity Co. and Foster-Gardner, Inc. v. National Union Fire Ins. Co., in a construction defect lawsuit involving a residential development where only a portion of the homeowners join the lawsuit, the developer is not barred as a matter of law from recovering from its liability insurer the costs to repair the homes owned by the nonplaintiffs if the costs are reasonable and necessary to defend the lawsuit that was filed. "There is nothing in the law that limits the type of defense costs to costs spent on investigating or repairing the particular site that is the subject of the lawsuit." However, in Barratt, the court found that the factual record was insufficient to support the conclusion that it was reasonable and necessary for Barratt to spend $580,714.50 in repairing nonplaintiff homes to defend the underlying litigation. There was no meaningful proof establishing a connection between the particular repairs and the defense theory.

Under Business & Professions Code Section 7031(e), Contractor May be Compensated for Work Performed After Discovery of Loss of Licensure

In Slatkin v.White, plaintiff homeowner filed a complaint against defendant contractor seeking damages for breach of contract and a mandatory injunction to vacate the contractor's mechanic's lien on the ground that the contractor did not have a valid contractor's license. Plaintiff challenged the contractor's ability to establish that he substantially complied with the licensing requirements as permitted under California Business and Professions Code section 7031(e).

In construing Section 7031(e), the Slatkin court determined that the contractor did not necessarily lose his right to be compensated simply because he continued to work after discovering he had lost his license, so long as he did not have knowledge or notice of the loss before starting the job. Under the facts of the case, however, the court could not determine whether the contractor substantially complied with the licensing requirements.

Residential Sales Agreements Found Adhesive and Unconscionable

In Pardee Construction Co. v. Superior Court of San Diego County, the plaintiff property owners bought single family entry-level residences from defendant construction company, Pardee. In purchasing those homes, the property owners signed agreements that included clauses waiving the property owners' rights to trial by jury and allowing for judicial reference. The property owners later sued Pardee for construction defects in the homes and underlying lots. Pardee sought to appoint a judicial referee, and the trial court denied the motion. Pardee then sought a writ of mandate.

The appellate court denied Pardee's petition, concluding that the parties' agreements were "adhesive contracts fatally infected with procedural and substantive unconscionability." The agreements were found to be contracts of adhesion because the plaintiff property owners were presented with standardized contracts drafted by Pardee and imposed on the plaintiffs who could only accept or reject them. Further, the judicial reference provisions of the agreements, including the waiver of jury trial, were found unconscionable because Pardee had unequal bargaining power and the provisions were one-sided, only benefitting Pardee, and were buried in the form contracts drafted by Pardee.

No Duty to Indemnify Except for Liability Arising from an Act or Omission by Subcontractor During the Performance of Subcontracted Work

In St. Paul Fire and Marine Ins. Co. v. American Dynasty Surplus Lines Ins., an electrical company and a general contractor entered into a subcontract under which the electrical company was to perform certain work at a maintenance yard. The subcontract contained an indemnity provision. Thereafter, an employee of the electrical subcontractor was working on feeding electrical lines through a conduit, pursuant to the subcontract. While the employee was working, the general contractor was pressure testing a pipe which exploded and injured the employee. A personal injury suit ensued, and the general contractor was found liable. In turn, the general contractor sued the electrical company for indemnity, pursuant to the subcontract.

The appellate court determined that indemnity was not available to the general contractor under the subcontract or under the additional insured endorsement because no act or omission of the electrical company caused the injury to its employee. Rather, the injury resulted entirely from activities of the general contractor that were unrelated to the work called for in the subcontract.

Mediation Privilege Does Not Protect Photographs, Statements and Other Raw Data

In Rojas v. Los Angeles County Superior Court, plaintiff attempted to assert the mediation privilege with respect to certain photographs, statements and other raw data from discovery. The plaintiff argued that, under California Evidence Code sections 1119 and 1120, all materials introduced at or prepared for the mediation, including those of a purely evidentiary nature, are encompassed within the scope of the privilege because they were "prepared for the purpose of, in the course of, or pursuant to" the mediation.

The appellate court rejected the plaintiff's interpretation of the statute, stating that "such a reading would render Section 1120 complete surplusage and foster the evils it was designed to prevent, namely, using mediation as a shield for otherwise admissible evidence." Section 1120 was designed to prevent materials from being introduced in mediation solely to protect them from later discovery or use in litigation.

The court held that the language of Evidence Code sections 1119 and 1120 is clear and unambiguous and that the plain language of the statute's privilege from disclosure does not apply to "evidence." Rather, Sections 1119 and 1120 are meant to protect the substance of mediation, i.e., the negotiations, communications, admissions, and discussions designed to reach a resolution of the dispute.

If you would like to discuss these or any other construction law matters, please do not hesitate to contact any member of Klinedinst's Construction Law Department (Arthur S. Moreau III, Kurt U. Campbell, Susan S. Kohn, Kevin J. Gramling, Dayna L. Chmelka, Maurine P. Travis, Mark H. Nys, Kristin M. Johnson, David N. Bregman, Hartford O. Brown, Bonnie M. Simonek, Gabe P. Wright and Bonnie L. Lutz).

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