With low interest rates, municipal ordinances favoring high-density housings and a new generation of developers, have come the re-emergence of condominium construction and conversion of apartment complexes to condominium projects. Many apartment owners are considering selling their properties to condominium converters (“Converters”) or converting apartment complexes themselves. Here are two questions to explore if you are tempted to jump on the “condominium bandwagon” and sell your apartment complex to a Converter.

Question #1:
Are You Going to Be Sued as a “Builder” After the Sale?
If you have made few significant improvements to your apartment complex, then your exposure to future litigation for construction defect after you sell the complex to a Converter is not substantial. However, if you orchestrated significant upgrades, repairs or improvements to the asset and these cause or allegedly cause damage to the project or its occupants, you could be sued for negligently designing, constructing or supervising the improvements even if you sell the apartment complex to a Converter.

If you performed improvements or are considering performing such work before sale, several questions should be explored. First, what kind of work was done or will be done? Is it the type of work that typically runs a significant risk of legal exposure? When was the work done and who did it? If you performed significant improvements over the last ten years, you may still have exposure, because the ten-year statute of repose (California Civil Code of Procedure Section 337.15) probably does not even begin to run until after you give up control of the asset. Finally, what is the potential financial risk relative to the potential financial gains from the sale?

Question #2:
What Protection Is The Buyer Willing to Offer You?
Currently, these deals are “rich” for all participants. As a result, buyers who intend to convert are often willing to consider offering protection to the seller to minimize the risk of condominium defect litigation.

One obvious form of protection is an indemnity agreement from the buyer. Sellers should consider the solvency of the buyer before accepting such an agreement as the only form of protection for potential future defect litigation. Is the buyer a “single asset entity” or a real estate investment trust? All buyers are not financially equal.
A second form of protection to consider is insurance. Often the buyer will agree to purchase an insurance product that will include the seller as an additional insured (The seller should make sure that it is an “additional insured”, not a named insured). There are several insurance products in the market, which may offer coverage for future construction defect claims. One type of insurance policy is designed specifically to protect the seller for its work on the project; it typically offers only a one-day window of coverage, but provides for a “tail” that covers all the seller’s improvements to the project. This product is designed to protect the seller for its own work only. A second type of policy that is available is the project-specific policy which covers conventional claims for a period of time ranging from 1 to 5 years. Often the buyer will purchase such a policy for itself and add seller as an additional insured. As a rule of thumb, the greater the coverage, the greater the cost to the buyer and thus the greater reluctance to purchase coverage on the part of the buyer.

A third approach is to require the buyer to include clauses beneficial to you in the conditions, covenants and restrictions (“CC&R”). For example, the buyer should be required to prevent a potential recovery of attorneys’ fees by homeowners or the homeowners association for any claims that they could assert. This can be best accomplished by excluding the attorney’s fee clause from all contract documents for the sale of condominiums as well as inclusion of some form of limitation of liability clause which excludes attorney’s fees as part of potential damages that homeowners may recover. Also, judicial reference should be mandated as the dispute resolution mechanism in such documents, thereby increasing the odds that any litigation will by tried without a jury, before a skilled industry professional and pursuant to California law. Mandatory arbitration is likely not enforceable for defect claims, so avoid any professional that advises this course of action. Mandating that realistic reserves be established for maintenance is likely to ensure that adequate funds are available to properly maintain the project. Also, the CC&R should avoid inclusion of a provision requiring a vote by a supermajority of homeowners for increases of regular assessments so as to decrease the likelihood that homeowners will sue prior owners to rejuvenate HOA reserves.

These protection mechanisms are not perfect. Each should be explored in detail with your real estate broker and attorney as well as an insurance agent who specializes in insuring condominiums. More importantly, you should market your apartment complex with clearly articulated expectations regarding these protections so that offers can be compared properly.

In the end, no professional will tell you that there is no risk associated with selling to a converter. Like all risks, they must be weighed against the benefits. Sensible planning and risk analysis will ensure that all parties are fully informed of the risks and comfortable that the profits make the risk worthwhile.

(c) Copyright 2006 Miller, Morton, Caillat & Nevis. All rights reserved.
The information provided here is intended to educate the reader regarding issues of contemporary business interest. It is not intended to constitute legal advice or recommendations for application to any specific legal dispute. You should always confer with your legal counsel about the application of the principals and issues discussed to your own circumstances.