Orange County Voices : COMMENTARY ON INSURANCE : The Litigation Epidemic Is Killing Off Affordable Housing : Bogus or unwarranted construction-defect suits have forced builders to drop projects. Here is a constructive alternative.

When you and I buy auto insurance, we can obtain lower rates if we have no moving violations, because we’re a better risk. Unfortunately for Orange County builders, liability insurance companies can no longer afford to differentiate between builders with perfect records and those with a history of problems--either one is likely to be sued.

We know several builders with as many as 20 lawsuits pending against them--reputable, large builders who have been in business for years. They’re being sued by homeowners associations for alleged defects in construction and design that either don’t exist, or that could be fixed for a fraction of the cost of going to court.

This epidemic of construction-defect lawsuits is killing off the supply of affordable housing in Orange County and is spreading throughout the state.

As you would suspect, insurance companies often settle claims, whether or not any proof of a defect exists, because it is cheaper than litigating. Then the insurer drops the builder client. Since they can’t get insurance to do multifamily, condominium or planned-unit developments, many builders are changing their business plans and won’t build these projects anymore, particularly those involving homeowners associations.

Not a single state-admitted insurance carrier is covering liability for condo or multifamily construction right now, even for developers with decades-long records of defect-free building. The only liability insurance available is from higher-risk, higher-premium carriers located out of state.

Even architects and engineers who design primarily single-family homes find themselves unable to get liability coverage if they do even a small portion of work on multifamily or condo units--so they, like many builders, are either dropping out of that market or are dangerously working without coverage.

Unfortunately, all of this is happening at a time when condos are the most affordable for-sale housing in the Orange County area. The Tax Reform Act of 1986, which eliminated many of the tax incentives for the creation of multifamily housing, and the recession have combined to all but shut down the building of rental and for-sale multifamily housing.

From a peak of 15,101 units in 1986, production in Orange County dropped to 2,980 in 1991, 2,361 in 1992, and 1,826 in 1993.

To address this growing crisis, the California Building Industry Assn. is sponsoring legislation that would create an alternative way to resolve disputes about construction defects--anything from face-to-face meetings between the parties to arbitration to mediation-- without going to court. The legislation, SB 2073, introduced by state Sen. Charles M. Calderon (D-Whittier) is scheduled for its first hearing May 3.

We recognize there are legitimate construction defects and that a homeowner and the homeowners association have the right to get them fixed.

We also recognize that it is likely for disputes to occur between people. But we do not believe these disagreements must be settled in court. Homeowners associations and builders risk spending hundreds of thousands of dollars in legal fees and hundreds of hours in depositions trying to create a legal solution to what may well be a technical or communication problem.

In many cases, homeowners associations file lawsuits without even notifying the builder that a problem exists. In others, no problem exists: There is, rather, an aggressive plaintiff’s attorney who manages to convince the association to do “destructive testing,” such as knocking down plasterboard or punching holes in the roof, to see if a defect which has yet to manifest itself in any form might be lurking inside.

Some attorneys even threaten to sue association board members unless the board pursues litigation. A more common and subtle approach is for a law firm to offer the association board members a “free” seminar on construction defects and an inspection to see if the project is sound.

Often, these lawsuits are filed with only the vaguest description of an alleged defect.

Attorneys working on a contingency-fee basis aren’t always interested in getting a builder to fix the problem--that won’t get them a percentage of any cash settlement. Often by the time the attorney takes his or her 30% or 40% fee, there may not be enough money to repair the defect, if there was one. But no one is required to explain that to the homeowners.

A cash settlement in a roofing problem, for example, might never be spent to repair what amounts to an undamaged roof. The cash becomes what amounts to fraudulent enrichment of attorneys and homeowners associations, perhaps to the detriment of the homeowner.

Sen. Calderon’s legislation requires the homeowners association to notify the builder in writing of the existence of specific defects of problems that are being alleged.

The builder may then submit in writing an offer to settle by either doing the remedial work, paying the association a cash settlement, or some combination thereof. After the evaluation is completed, a majority of association board members must meet and confer with the developer to discuss any outstanding issues.

SB 2073 also calls for the informed consent of a majority of the individual homeowners before the association can bring a lawsuit.

The information should tell homeowners what is wrong with the property, what the developer is or is not willing to do to correct the problem, an estimate of what the lawsuit will cost to prosecute, whether enough money is likely to result from the suit after costs to repair the defect, and what the arrangement with legal counsel will be.

Homeowners should know that refinancing opportunities and home sales can be blocked until litigation is resolved.

If at any time the builder does not fulfill his or her obligation to respond, evaluate, communicate and meet with the homeowners association, the group is free to pursue the lawsuit. But the association must give the developer the opportunity to cure the problem before the suit can be filed.

During the whole process of trying to work things out, the clock that’s ticking away toward the end of the 10-year statute of limitations is stopped. The association won’t lose its right to go to court in the event the builder does not satisfactorily address the problem.

Litigation should be a way to resolve disputes that can’t be resolved otherwise. But effective dispute resolution is not possible without detailed, good-faith communication between the parties.

SB 2073 is intended to encourage this communication and resolve at least some of these disputes without further clogging the judicial system and jeopardizing the construction of affordable housing in Orange County and the state of California.