Big Builder

March 2000

On Trial: In the frenetic rush to meet production demands, builders may be sowing the seeds of their own destruction. Liability lawsuits in some states are reaching epidemic levels.

By: Annette Kornblum

In April 1999, an arbitrator ordered the Writer Corp. to pay more than $1 million to Colorado homeowners Cindy and James Morgan and another couple, John and Patricia Duffy, who had brought a lawsuit against the company. The builder was found to have knowingly built on unstable soils without telling the buyers that their home did not meet the building code. Triple damages and attorneys’ fees were awarded to the homeowners…

Liability. It’s every builder’s nightmare. With an unpredictable labor force, untested products, geological unknowns, and Web terrorism, the building industry is caught in a flash fire of destructive litigation and builder bashing. When the smoke clears, it’s the building industry on trial.

Homeowners and builders across the country are warring over castles in the sky that turn into houses of horrors. According to industry experts, construction defect litigation is snowballing. The cause of action can be anything from a leaky roof to a buckling floor. Because so many disputes are settled privately, it’s impossible to know the scope of the situation. This much is sure: The industry is being taken on by a booming cottage industry of lawyers, experts, arbitrators, and insurance companies.

These disputes predictably come at a time when housing starts are at boom-time levels, with speculative inventory at record lows and builders racing to meet move-in dates. At the same time, skilled craftspeople and seasoned superintendents are in short supply. If ever there was a time to stress construction quality within your organization, this is it. “You can’t bury your head in the sand and say there’s no problem,” says Tom Brick, director of construction and quality initiative programs for U.S. Home Corp. in Dallas. “There is a building boom, product shortages, and subcontractors are not as competent or knowledgeable as they were yesterday.”

Home buyers, on the other hand, have much more information at their disposal, thanks to the Internet. Home Owners for Better Builders (HOBB), a Web-based home advocacy group, has chapters springing up across the country, and other groups- representing particular defects, such as EIFS or workmanship failings- proliferate as well.

Case in Point

The Writer Corp. settlement is a fascinating case study into how the current legal environment works and builder attitudes toward new-home defects.

Barely three months after the Morgans moved into their new $200,000 dream house in Denver’s Highlands Ranch, the earth began to move, and the foundation cracked. Writer Corp. argued that the settling, caused by widely publicized expansive soils at Highlands Ranch, was normal. The couple turned to their homeowners’ warranty, but the company denied coverage. So Cindy asked the subdivision’s construction manager to make the many needed repairs. He allegedly responded, “We’ll fix the drywall, and you can paint.”

Writer countered that the Morgans, because they denied the builder access to their home, were responsible for hairline cracks that turned into $95,000 worth of structural damage. Throughout the proceedings, Writer insisted that it tried to do right and got burned by homeowners who knew about the unstable soils in Highlands Ranch all along.

“The Morgans [and Duffys] had one thing on their mind and that was a big lawsuit against us,” declares Writer president Dan Nickless. To make matters works, he contends, “John Duffy had a personal crusade against us; we saw a shrine on his garage wall showing when his name appeared in an article and copies of speeches given to the state legislature.”

Duffy’s lawyer, Scott F. Sullan , counters that Writer misrepresents the facts. “The lot was designated high risk, and the law requires disclosure of the site analysis and recommendations at least 14 days before closing,” he says. “Everyone involved know [about the expansive soils] except the homeowners.”

Hundreds of other cases, including eight class action lawsuits, were filed against other builders in Highlands Ranch. In most, homeowners either won or builders agreed to repair or replace cracked foundations for a few thousands dollars. The Morgans and Duffys were the only ones to win a windfall, although informed sources say that besides absorbing the cost of repairs, other builders paid six and seven figure legal fees.

In 1999, in response to the Colorado home builders’ lobbying campaign, the state’s legislature toughened the proof needed to trigger the state’s Consumer Protection Act. Triple damages are now awarded only if the homeowners have clear and convincing evidence that the builder acted intentionally, willfully, knowingly, or fraudulently.

Many might ask: Why didn’t Writer just buy back the Morgan and Duffy homes? As Sullan tells it, “Writer played hardball and wouldn’t talk settlement.” Nickless claims that it didn’t make sense to buy back homes that were essentially solid. “We bet wrong that the issue would center on the cost of repairs, when [the lawsuit] was over how to get as much as possible with triple damages,” Nickless said.

Lessons Learned

The clear lesson from the Writer experience: Don’t let a small problem get out of hand. Correspondence shows that Writer did not respond in writing until 1995 - two years after the Morgans and Duffys began to complain. The breakdown in communication continued well into 1999. In addition, ignorance is no longer bliss when it comes to expansive soils- you’ve got to check for them, and if you find them, do something. “If [Writer] had dealt with the foundation properly when they put up the houses, there would have been no hairline cracks” and presumably no lawsuit, says Tom Anderson, president of Tactical Construction Solutions in Sonoma, Calif.

As for the soils problem, experts agree that is pays to heed engineering directives. Anderson, an expert witness on construction defects has testified about expansive soils in California, Nevada, and Colorado. Two common failings: The builder neglects to properly provide and get written disclosure and/or acceptance from the buyer, and/or he ignores engineering directives about how to design an invulnerable foundation.

Builders, says Anderson, need to take a more proactive approach toward repairs. He describes a typical old-school situation: “The owner has a leaky roof and water comes in. He calls the builder, and someone comes out, but the roof and water comes in. Finally the builder’s warranty expires, and he says there is nothing he can do. All the while he ignores letters from the owner, articles, ads, and billboards that say, ‘We’re construction defect lawyers; come and see us.’ What could have been resolved for a few bucks ends up with a lawyer walking away with a windfall.”

David Stern, vice president of West Coast Casualty Co., in Carlsbad, Calif., agrees. He urges builders to talk things over with homeowners, stand behind their product before things turn nasty, and to insert an arbitration and/or mediation clause into the sales contract. “Most people forget that if an understanding is achieved between the builder and buyer, it cuts out the lawyers,” Stern says.

The facts seem to bear this out. In any squabble, each party has its own version of events after communication breaks down. If there’s a familiar ring to construction defect disputes, it is the passionate differences of opinion about facts and who is culpable for a problem that involves high stakes.

The homeowner says he sued after the builder ignored or gave him the runaround when he complained about shoddy construction. The builder says the homeowner nit-picked him to death and wouldn’t authorize repairs. The plaintiff lawyer claims that, to maximize profits, builders cut every corner. The defense lawyer says the other side made a mountain out of a molehill and the plaintiff’s lawyer is lining his pockets at everyone’s expense.

Behind the scenes, the plaintiff lawyer stages a relentless marketing campaign to woo clients who may have settled. Meanwhile, the defense urges builders to keep a low profile, which always raises eyebrow. The builder, of course, would rather fight than fix for a fraction of the legal bills. And the homeowner makes a predictable plea to the press.

Dicey Behavior

How much responsibility should the homeowner take for the quality of the home he buys? Should some sort of buyer beware standard apply? In a story that appeared in the San Jose Mercury News, Reid Gustafson, president of Shea Homes, Northern California, passed the buck back to his consumers for failing to monitor the house during construction. Gustafson claimed that only half of the company’s buyers take up its offer to check out the home after framing is complete, before tile is installed, before the home is finished, and for a final walk-through.

The sounds good in theory, but maybe not in practice. “How can a buyer know whether a builder is building in accordance with standard, when they have no ability to second-guess structural issues?” asks attorney Sullan . “To expect the homeowner to pick up the plans and say ‘You didn’t get it right’ would be like asking me to check out my car. How do I check out wheel bearings when I can’t even change the oil?”

That doesn’t stop many self-avowed experts from blasting builder construction practices on the Web. For example, a warning about Shea Homes and mold- allegedly involving cases of shrimp inhabiting a living room and fallen birdseed growing into plants in soggy carpet- screamed from a Web site: “Beware!.. Avoid years of litigation and unnecessary expenses! Learn the facts before you buy a house built by Shea Homes… Shea Homes developments…[have] Toxic Mold.”

Shea Homes admits to aggressively defending itself against liability claims, even when the cost of repairs represents a small fraction of what it costs to go to court. For Shea, as well as Carlsbad, Calif., builder Barratt American, two key players in the legislative arena, it’s a matter of principle.

“Our industry - the most over-regulated on the planet - made a mistake in believing that local government, building inspectors, and approvals were an acknowledgment that home building could withstand a strict liability standard,” says Mick Pattinson, president of Barratt American. He denounces the hundreds of millions of dollars paid out in judgments and settlements. “What we found was that strict liability means perfect or near perfect. A house is the only handmade product held to that standard.

“If all these lawsuits were limited to legitimate claims, I’m not sure the building industry would be so up in arms,” Pattinson adds. “The only way to bar the insurer from settling these cases is to give up our coverage.”

Few builders will comment on their litigation track record. Pattinson is not so shy, however, and reports that his company was the subject of multiple construction defects suits, a major one involving complaints of leaking windows, improperly installed roof tiles, and loose shower heads. In that case, the homeowners association asked Barratt American for $18.5 million but settled for $10.5 million.

Liability’s Price Tag

Indeed, as homeowner advocacy organizations report a surge in complaints, lawsuits have either jacked up or dried up the cost of liability insurance, particularly in high-risk states such as California, Nevada, Arizona, Texas, and Colorado. Building industry losses are hard to nail down since the insurance industry does not keep tabs or won’t disclose payouts, and cases fluctuate state to state, jurisdiction to jurisdiction.

However, according to George Dale, a defense attorney for home builders, the cost for both sides can be staggering: “It’s not how many cases have been filed; it’s the cost of resolving these disputes that has had a huge impact in the price, availability, and insurance coverage provided.” According to the American Insurance Association, for every dollar paid homeowners in settlement or judgment costs, the insurer will pay $2 to $5.

“It’s not about winning or losing,” says Kathleen Carpenter, a defense lawyer. “It’s about how much you’re going to have to pay. People have such a bad attitude towards builders, you don’t even have to be a good lawyer [to win the case for the owner].”

With the risks higher than ever, the building industry is paying more to protect itself against the tide. Jansen & Hastings, a British-based insurer, requires higher deductibles and self-insured retentions, meaning builders assume the initial risk before insurance kicks in. Zurich, U.S., one of the nation’s biggest property insurers, is getting into the residential business but will demand a higher deductible up front.

Meanwhile, virtually none of the major insurers will write policies in California anymore. Arizona-based Scottsdale Insurance Co. got out in 1994 after suffering heavy losses and now sticks to the other 49 states. “We just don’t think there’s an opportunity to make a profit, and there’s too much risk,” says Scottsdale president Max Williamson. “It’s a combination of the legal climate and concern that defect liability is a trend spreading across the country.”

Juan Acosta, a lobbyist with the California Building Industry Association (CBIA) in Sacramento, points out that a recent survey of California builders shows a typical insurance policy to protect a builder against future lawsuits costs $300,000 and carries a $600,000 deductible- meaning the industry bears $900,000 in annual costs before insurance coverage even takes effect. Experts say that states without strict liability have substantially lowered costs.

Under current law in most states, notes CBIA’s Acosta, “there is no legal definition of construction defects. They can range from chipped sinks and cracked floor tiles to water leakage and other serious structural damage that can result in personal injury.

“The problem boils down to this,” Acosta continues: “If homeowner and a builder have an issue, more often than not that issue, even a leaky window, gets resolved one way only- through litigation. Once it gets there, it’s not just about a window. The plaintiff’s lawyer files a complaint that lists every design and construction component of the home as being defective… and then uses the discovery process to sort it all out. It’s sort of ready, shoot, aim. I’m sure it’s not the best system to resolve these issues.”

Desperately Seeking Perfection

Builders admit that the nation’s last handcrafted product is being built with assembly-line speed, without the consistent quality control found in new car production. And it appears most buyers don’t take the time to give their new homes a professional once-over while they are being built. “Construction defect litigation is a huge growth area not because of negligence but because of the process,” says attorney Dale, who is also chairman of the CBIA Report Task Force.

“Buyers have ‘unfulfillable’ expectations that can’t be satisfied for three reasons,” seconds H. Alan Mooney, president of Criterium Engineers: One, you’re building with wood, which isn’t perfect; two, you’re building on Mother Earth, which isn’t perfect; three, you’re building using human beings, who aren’t perfect. You’re simply not going to have a perfect house.”

Some California builders realize perfection is impossible, but they’re determined to improve quality in the face of increased litigation. Brookfield Homes in San Diego has adopted a three-pronged approach. “[It] involves better document keeping, using the same details and specs for each project, a system of sign-offs and check-offs with a third-party inspector, and an education program that teaches buyers how to maintain their property- to ensure fewer issues over construction defects,” says company president Stephen Doyle.

U.S. Home also tries to steer clear of litigation. “There is never a time you build a house for predictable failure. When problems develop, that doesn’t eliminate our responsibility to stand behind the product,” Brick explains. “We have a passion for the customer and company, and need both to provide the highest degree of protection against exposure to unprofessional [work]. [We conduct a] quality inspection program at every stage of construction from installation to post-construction. Instead of a shotgun approach, we find the root cause of a problem so we can readily address the problem,” Brick says.

To reckon with construction defects, Brick says that U.S. Home prides itself on a comprehensive preventive action program it dubs “I Care.” The builder videotapes and documents ever facet of construction activity with laser graphic recordings of the grading in backyards. It hires independent third-party inspectors to oversee construction and ensure quality control.

Customer service has been beefed up to handle any problems that arise after a buyer moves in as part of its post-construction evaluation program. All U.S. Home builders have a customer service and warranty department and, says Brick, any time a problem arises in the first year the builder’s customer service representative will evaluate and correct the problem.

The complaint is then sent back to the construction department to determine at what stage of construction the problem arose and why. U.S. Home will investigate to see whether stucco was applied properly whenever there are stucco and sheet-rock cracks. “If the cracks are due to workmanship or material failure, we feel we must defend the customer and make whatever repairs are needed,” says Brick.

Moving On

The object of the home building game is for both buyer and builder to emerge from the transaction satisfied with the deal. In the interest of protecting themselves from litigation, builders would do well to remember that for every house sold a real live buyer stands on the other side. Chances are, these people will have spent more money on their house than on anything they’ve bought in their lifetimes. They may be spending the next 30 years in the structure you’ve built. That’s what makes the stakes so high.

Cindy Morgan and folks like her, for better or for worse, are buyers you will likely deal with one day. After the litigation with Writer wrapped up, she bought another new house. “I can’t tell you how nervous I am,” she says. “I keep thinking about whether I’ve protected myself. It’s something like taking another flight after you’ve been in a plane crash.” Her advice to builders? “Let people know what they’re buying. Give them a chance to back out if the house is not what they’re looking for, and [if not] stand behind your product and make it right.”

Otherwise, see you in court.