Considerations when re-entering the condominium market

Sarah M. Wright
Real estate attorney, Fairfield and Woods PC

The need for quality, affordable housing in Colorado is undeniable. In the past, condominiums served this need and provided a stepping stone toward homeownership for many middle-income families. However, due to Colorado’s construction defect laws, developers simply could not risk the liability associated with condominium development. As a result, the number 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. Undoubtedly, the lack of new condominiums available provides a real business opportunity for developers looking to break into the market. Nonetheless, there still are issues the entrepreneurial developer must be aware of before venturing into the market.

Amendments to Colorado’s Construction Defect Action Reform Act. 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 H.B. 17-1279, which imposes certain requirements on homeowners’ associations prior to instituting a construction defect claim against a developer. The bill was signed into law 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. 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.

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 H.B. 17-1279 and Vallagio have added protection for developers, the extent and scope of those protections still is 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 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 the sole asset that can be attached by claims by any creditors, protecting the owner and the owner’s 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 “blankcheck” 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. 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 only as a statutory requirement, but also 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.

Featured in CREJ’s June 6-20, 2018, issue

Edited by the Colorado Real Estate Journal staff.