An HB Staff Report
Featuring Jeffrey D. Masters

Jeffrey D. Masters is partner with Cox, Castle & Nicholson LLP in Los Angeles, where he defends builders and developers in construction defect disputes, but he primarily serves insureds as insurance coverage counsel. Masters is co-chairing HB’s “Construction Litigation Leaders’ Forum” taking place March 3-4, 2011, in Marina del Rey, Calif. Masters is leading the program along with Richard Glucksman of Chapman, Glucksman, Dean, Roeb & Barger; Kenneth Kasdan of Kasan Simonds Weber & Vaughan; and Rose Madruga, Vice President with Zurich. HB talked to Masters from his office in Los Angeles about the drivers behind the Forum and some of what will be addressed. This is what he told us.

HB: You said you’ve seen changes in the construction defect landscape in the last year or two. What kinds of changes have you observed and what’s behind them?

JM: What we’re seeing is a huge amount of legacy claims against builders and developers for alleged construction defects. And much of this is driven by the macro-economy. Homeowners are even more concerned, in fact they are even panicked about the value of their homes. As a result they’re relatively receptive to the pitches made by plaintiff lawyers that a way to recover some of that lost value is by asserting a construction defect or other claim against the builder or the developer. We’re seeing a lot of claims that are driven by the negative economy.

HB: What kinds of claims are you seeing?

JM: One class of claims is construction defects, of course, but we’re also seeing a broader waterfront of claims to include things like failure by the developer to complete the community, where the number of homes that have been sold and occupied is less than what the homeowner thought was going to be the case. We also see claims for alleged failure by the developer to complete amenities within the community. For example, it’s supposed to be a multi-phased community, but the developer runs out of money or financing, can’t complete common area facilities, can’t complete infrastructure, can’t complete the community as it was originally marketed and contemplated. We’re also seeing a lot of claims by homeowners for fraud, misrepresentation, non-disclosure and even rescission of the purchase agreements, which puts the developer in the unfortunate position of potentially having to buy back one or more homes in the community if the homeowner is successful with their rescission claim.

HB: Chinese drywall litigation was a huge focus last year. What about those kinds of claims.

JM: We are seeing claims driven by flat-out alleged product failures. Chinese drywall is a classic example. This is something that the home builders and the development community never would have contemplated as an exposure and yet it’s turning into a very substantial exposure for home builders and developers particularly in the Southeast. And that’s representative of a trend that includes things like Kitek® plumbing, EIFS (exterior insulation and finish systems), and other systemic product-type failures. So all of this is creating a really adverse and challenging litigation environment for builders and developers.

HB: How can builders and developers reduce these risks?

JM: We’ve been preaching for a long time at my firm a holistic approach to managing the homebuilder’s risks. That includes everything from good due diligence when you’re acquiring land all the way through the construction process with effective contracts, indemnities, insurance provisions, performance standards, and out toward the back end, after completion, to things like very good long-term customer service, a good warranty program, good relations with the homeowners association, and knowing how to turn over the common area of the community to the homeowners association. So it’s a really comprehensive and integrated approach to managing risk. But despite the homebuilders’ best efforts not all of those risk management strategies have succeeded. Basically they have been overwhelmed by this tsunami of alleged defective construction and other claims.

HB: How is the insurance industry reacting?

JM: We are seeing insurers being more aggressive than they ever have in the past in asserting their coverage positions, something that has been very challenging for the development community. The big issues that the [Construction Litigation Leaders’ Forum] will focus on, and I am certainly seeing and litigating, are:

1) Is defective construction an occurrence within the meaning of the general liability policy?
2) If you have an occurrence, is defective workmanship covered by the general liability policy? In other words, is there coverage for the cost to repair the defect or is there only coverage for the cost to repair the resulting damage?
3) The number of occurrences, that is, how many deductibles and self-insured retentions are due? And here we’re seeing the insurers being much more robust in asserting that a typical construction defects suit involves not just one occurrence, but perhaps multiple occurrences.

HB: How is this all shaking out in the courts?

JM: These issues are of national significance and different state courts have come to different conclusions. That’s both good and bad. The good news is, not matter what position you want to assert, you will probably find a court case somewhere supporting your position. The bad news is it reduces predictability for the development community. It puts them in the position of potentially having to reserve far more than they ever anticipated for their operations in terms of number of deductibles, amount of allegedly non-covered damages and so forth. It also increases the frictional costs, the cost of negotiating, settling and litigating construction defect claims because you’ve got these related insurance coverage issues on the table.

HB: So what’s the answer for builders and developers?

JM: Builders need to do even more in their comprehensive integrated approach to managing and insuring risk in this new environment. And I know that’s a difficult challenge because builders are dealing with reduced staffing levels, fewer people, less resources and having to do much more with less. But I think in this environment managing and insuring the risk is even more critical than it was during the boom times, because the consequences of not doing so are now really so adverse.

To hear more from Masters, his co-chairs, and a faculty of experts discussing emerging issues in construction law, join them and HB in Marina del Rey, Calif., for the Construction Litigation Leaders’ Forum. Visit the conference page to register and see the full agenda.