Developer Pre-Conditions in CC&Rs Limiting Ability of HOA to Make Construction Defect Claims, Fo

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The Davis-Stirling Common Interest Development Act (Civ. Code §4000, et seq.), also known simply as “Davis-Stirling,” is a statute that applies to condominium, cooperative and planned unit development communities in California. The statute, which governs the formation and management of homeowners associations or HOAs, also governs lawsuits filed by HOAs for construction defects.

In the next case, Smart Corners Owner Association v. CJUF Smart Corner LLC, Case No. D076775 (May 20, 2021), the 4th District Court of Appeal addressed the pre-litigation voting requirements of Davis-Stirling and the impact of recent amendments to the Act.

The Smart Corners Case

In 2004, CJUF Smart Corner LLC contracted with Hensel Phelps Construction Company for the construction of the Smart Corner condominium project, a 19-story mixed-use development with 301 residential units and common areas, in San Diego, California. As part of the development an HOA was formed, the Smart Corner Owner Association.

On July 6, 2017, the Smart Corner HOA filed a notice of construction defects with CJUF Smart Corner and Hensel Phelps under the Right to Repair Act (Civ. Code §895 et seq.) and under Davis-Stirling. The notice identified defects in the project’s exterior barrier coating, windows, door casings and doors, private decks, waterproofing, concrete, bathtubs and showers, roof membrane and roof flashing, roof laps and seals, tower floors, plumbing, venting, garage, and parking structure.

On September 27, CJUF Smart Corner and Hensel Phelps notified the HOA of their election to opt out of the Right to Repair Act and Davis-Stirling pre-litigation procedures.

On October 6, 2017, the HOA filed suit against CJUF Smart Corner and Hensel Phelps alleging causes of action for negligence, strict liability, breach of warranties, and violation of the construction standards of the Right to Repair Act. In its answer, CJUF Smart Corner asserted as a defense that the HOA had not complied with the CC&R requirements for maintaining a claim, specifically, that a majority of the members of the HOA did not vote in favor of filing suit.

On May 14, 2018, the HOA filed a declaration by its attorney who, while stating that he did not believe the majority-vote requirement of the CC&Rs were enforceable, that by February 15, 2018, a majority of the members of the HOA had voted in favor of filing the lawsuit and ratified the past actions of the HOA’s Board in filing the lawsuit.

While the case was pending, the 4th District Court of Appeal, in another case entitled Branches Neighborhood Corp. v. CalAtlantic Group, Inc. (2018) 26 Cal.App.5th 743, upheld an arbitration decision which found against an HOA which had failed to obtain a 51% vote prior to filing suit against a developer, even though 92 of 93 members of the HOA later voted ratify the HOA’s Board’s earlier decision to file suit against the developer.

In December 2018, based on the decision in Branches, CJUC Smart Corner filed a motion for summary judgment arguing that Smart Corner HOA’s lawsuit was barred because it had failed to follow the pre-litigation voting requirements of its CC&RS and, pursuant to Branches, the members of the HOA could not later ratify the actions of the HOA’s Board in filing the lawsuit.

On July 29, 2019, the trial court, rejecting the HOA’s argument that the Branches decision only applied to arbitration decisions, found in favor of CJUC Smart Corner, stating that “Branches analyzes the substantive, legal issue of enforcement of a CC&R member consent requirement and, as such applies irrespective of the forum” and that under Branches “Plaintiff’s failure to obtain the requisite consent of the membership prior to bringing this action against the [Developers] renders [the Association’s] original complaint invalid.”

CJUC Smart Corner appealed.

The Appeal

In a case marked by twists and turns in case law while the case was pending before the trial court another twist occurred during pendency of the appeal. On August 30, 2019, the California State Legislature enacted Senate Bill 326 which was signed by the Governor, and became effective January 1, 2020. The new legislation nullified pre-litigation vote requirements like those involved in the Branches decision.

One of the legislative analyses of the bill described it as follows:

As part of the creation of a new HOA, the developer typically begins laying the groundwork for the HOA’s future self-governance. This includes establishing the initial governing documents for the HOA, including the HOA’s “declaration” [of] covenants, conditions, and restrictions (CCRs). While the HOA developer is still selling off the separate properties within the HOA to homeowners, it is also common for the developer to serve, or appoint people to serve, on the HOA board of directors. In these ways, HOA developers exercise a great deal of control over how the HOA will operate going forward, even though, over time, the developer’s direct involvement with the HOA typically fades away. The involvement of HOA developers in the creation of the HOA’s initial government documents and the appointment of early HOA board members can sometimes create conflicts of interest because the HOA and the developer’s interests are not necessarily aligned. [T]his bill addresses one such circumstance. In drafting the governing documents for the HOAs they are creating, developers sometimes add provisions that make it quite difficult for the HOA to sue the developer in the event that construction defects are discovered at the HOA. [¶] While it could be argued that requiring a vote of the HOA members prevents the board of directors from spending the HOA’s money on legal disputes without the support of the members, the fact that these provisions are limited to construction defect claims against the developer suggests that more is afoot. Moreover, Civil Code Section 6150 already provides some protections against an overly litigious board bent on suing the developer: it requires an HOA board to hold a meeting of the members 30 days prior to filing a lawsuit, stating its reasoning and laying out the options available to the HOA. [¶] This bill ensures that developers cannot reap the benefit of having taken advantage of their participation in the creation of the HOA in this way.” (Sen. Rules Com., Off. of Sen. Floor Analyses, 3d reading analysis of Sen. Bill 326, as amended May 1, 2019, pp. 6-7)

The bill added Civil Code section 5986 which provides in pertinent part:

The governing documents shall not impose any preconditions or limitations on the board’s authority to commence and pursue any claim, civil action, arbitration, prelitigation process pursuant to Section 6000 or Title 7 (commencing with Section 895) of Part 2 of Division 2, or other legal proceeding against a declarant, developer, or builder of a common interest development. Any limitation or precondition, including, but not limited to, requiring a membership vote as a prerequisite to, or otherwise providing the declarant, developer, or builder with veto authority over, the board’s commencement and pursuit of a claim, civil action, arbitration, prelitigation process, or legal proceeding against the declarant, developer, or builder, or any incidental decision of the board, including, but not limited to, retaining legal counsel or incurring costs or expenses, is unenforceable, null, and void. . . .  This section applies to all governing documents, whether recorded before or after the effective date of this section, and applies retroactively to claims initiated before the effective date of this section, except if those claims have been resolved through an executed settlement, a final arbitration decision, or a final judicial decision on the merits.

God, or rather the State Legislature, had spoken. In response, CJUC Smart Corner argued that the HOA could not benefit from the recent enactment of Section 5986 because the trial court’s decision on CJUC Smart Corner’s motion for summary judgment was a “final decision on the merits” which had been entered before effective date of the statute.

Noting that “no court of review of this state has yet interpreted the phrase ‘final decision on the merits,’ the Court of Appeals explained that what the phrase means, depends on statutory interpretation. And, here, explained the Court, the general rule is that “civil statutes are presumed to operate prospectively ‘in the absence of a clear indication of a contrary legislative intent.'” 

In interpreting a statute, explained the Court of Appeals, three-step process is followed: “We first look to the plain meaning of the statutory language, then to its legislative history and finally to the reasonableness of a proposed construction.” Following each of these steps, the Court found that:

  1. Plain Meaning: Analyzing the use of the phrase “final judicial decision” in Section 5986, the Court of Appeal explained that the term “judicial” is a general term that refers equally to a trial court, appellate court, or a high court of review” and that “[h]ad the Legislature meant to exclude from the retroactive reach of section 5986 claims that had already been resolved by the trial court, it could have easily have done this by inserting the words ‘trial court’ in place of ‘judicial.'”

  2. Legislative History: As to the legislative history of Section 5986, the Court of Appeal found it compelling that the State Legislature was attempting to address a “trend of developers taking advantage of their ability” to dictate CC&R provisions and that the State Legislature clearly intended the statute to apply retroactively but placed limits on its retroactive effect to cases in which a final judicial decision  had been reached. As such, the court found that the “Legislature intended ‘final judicial decision’ to refer to a judgment for which the time to appeal had passed, or, if an appeal was then, had reached finality after completion of the process of appellate review.”

  3. Reasonableness of Construction: The Court of Appeal also noted that its interpretation was consistent with reason and common sense because if “final judicial decision” meant a “final judicial decision” by a trial court it would “create the possibility of judicial enforcement [by reviewing courts] of a provision that our Legislature has already declared in the strongest possible terms – through explicit statutory directive – should be treated as null and void.”

As a further, independent ground the Court of Appeal also found that the majority vote requirement as a pre-condition prior to filing suit was void as to public policy when a majority of the members voted in favor of filing suit after the lawsuit was filed.

Conclusion

For developers, the most important take-away from the Smart Corner case is that under Civil Code section 5986 CC&R provisions establishing pre-conditions or limitations on a HOA Board’s authority to commence and pursue construction defect claim will be found void and enforceable.

#DavisStirling #SmartCorner #CiviCodesection5986 #RighttoRepairAct #CJUF

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