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Reforming Construction Defects Law and Practice

Reforming Construction Defects Law and Practice


AB 125 is not a license to sell a defective home. It does not eliminate a homeowner’s right to a defect-­‐free home. It does not impair the homeowner’s right to seek legal redress for defects. AB 125 merely targets the practical development of a system that, at best, unnecessarily increases the cost of resolving disputes and, at worst, facilitates a form of extortion. Chapter 40 was originally devised to give a home builder notice of a claim of defect, identify the trade(s) responsible, and attempt to Tind a solution — either by repairing the condition or making a cash settlement — before facing a complaint in court. Under this reasonable system, many defects were cured to the satisfaction of home buyers and builders. Over time, the system devolved into a form of legal extortion where the home buyers simply became a way for lawyers and “expert” consultants to make money. The following pages will summarize some of the particular abuses targeted by AB 125. It is also important to recognize that the reforms in AB 125 do not apply to every home. All of the reforms apply to homes that were substantially completed and sold after enactment. None of the reforms apply to homes that were already in litigation. For all of the other homes between these two benchmarks, some reforms will apply and some will not. Over time, AB 125 should reduce the cost of liability insurance for builders and subcontractors. But builders can significantly reduce exposure to liability and litigation expense with sound project management and through common sense provisions in sales contracts. These techniques and contracting concepts are outside the scope of this discussion of AB 125. Note: This document is not intended as a comprehensive guide for legal practitioners. It is intended only as a superficial summary for laymen involved in the building industry. Like existing provisions of Chapter 40, lawyers and judges will likely debate the meaning and applicability of AB 125 for years to come. Views expressed here may not be universally accepted among lawyers and judges litigating residential construction defect claims. This document is not legal advice, and does not establish an attorney-­‐client relationship. Circumstances of each claim may be unique, and may create an exception to general rules summarized in this document.


Definition of “Constructional Defect”

AB 125 changes the definition of “constructional defect.” Before AB 125, the term was defined as follows:

NRS 40.615 “Constructional defect” defined. “Constructional defect” means a defect in the design, construction, manufacture, repair or landscaping of a new residence, of an alteration of or addition to an existing residence, or of an appurtenance and includes, without limitation, the design, construction, manufacture, repair or landscaping of a new residence, of an alteration of or addition to an existing residence, or of an appurtenance:

  1.  Which is done in violation of law, including, without limitation, in violation of local codes or ordinances;
  2.  Which proximately causes physical damage to the residence, an appurtenance or the real property to which the residence or appurtenance is affixed;
  3.  Which is not completed in a good and workmanlike manner in accordance with the generally accepted standard of care in the industry for that type of design, construction, manufacture, repair or landscaping; or
  4. Which presents an unreasonable risk of injury to a person or property.

Under this definition, a negative condition that did not cause property damage or pose an unreasonable risk of personal injury was nevertheless actionable. Purely cosmetic conditions could be considered a “constructional defect,” even though a negative condition was based on years of neglected maintenance. Further, disagreements over the meaning of vague building codes would be the basis for claims of “constructional defect.” AB 125 amends NRS 40.615 to clarify that a “constructional defect” either: (1) presents an unreasonable risk of injury to a person or property or (2) is not completed in a good and workmanlike manner and proximately causes physical damage to the residence, an appurtenance, or the underlying property. Further, the alleged violation of building codes is no longer a sufficient basis to claim “constructional defects.” As a practical matter, this definitional change will probably not alter the notice of defects. A homeowner will not be required to prove risk of injury or actual property damage at the time of giving the notice. (Once the claim is in litigation, the defense will attempt to show that the condition is not a “constructional defect.”) However, this definitional change could impact the relationship between insurers and insureds. Even when insurers provide a defense, they often disclaim indemnity (responsibility to pay for repairs or a judgment) on grounds that the alleged negative condition did not cause personal injury or property damage. This change to the definitional change may make it more difficult for insurers to reserve rights based on lack of property damage.

Effectiveness Note: Sec. 21(2). This change applies to any claim that “arises” on or after enactment. A claim for breach of contract, breach of implied warranties, negligence, or fraud arises when the home was substantially completed or sold. Therefore, this change would not apply to homes sold before enactment.


The Notice of Defect

General Considerations
Under Chapter 40, the process of adjudicating or resolving a dispute over a claimed defect begins a Notice of Defect. AB 125 includes a number of important reforms. The law limits the ability of homeowner associations to bring claims for defects in improvements that are not owned by the association. The law requires more specificity in the notice and reforms inspection practices. The law requires that the claimant acknowledge that claims are being asserted.

Specificity in Notices Chapter 40 always envisioned a reasonable notice of specific defects. However, some lawyers attempted to avoid the cost of making reasonable inspections, and simply sent out “shotgun” notices that vaguely allege defects in soils, foundations, framing, roofs, plumbing, mechanical systems, and landscaping. In many cases, lawyers send the “shotgun” notices only to stop statutes of limitation and repose from precluding later, more specific claims. See NRS 40.695. Often, the “shotgun” notice is a good indicator that the lawyer is not serious about taking the matter to trial so long as the builder will pay tribute at the start of the process. Over objections (usually from subcontractors), some courts have tolerated this practice. AB 125 amends NRS 40.645 (notice of defects) to require a statement that Identif[ies] in specific detail each defect, damage and injury to each residence or appurtenance that is the subject of the claim, including, without limitation, the exact location of each such defect, damage and injury… Section 8.

Common defects notices

Under prior law, a single claimant could allege a defect common to similarly-­‐situated homes. NRS 40.645(4). A claim of common defect had to be supported with an expert opinion that, based on representative sampling, the defect would exist in homes that were not specifically identified in the notice. NRS 40.645(4)(b). The owners of homes so situated would then be deemed “claimants” under NRS 40.610(3). After receipt of a notice of common defect, the builder must provide the notice to all the unnamed owners of similarly-­‐situated homes. NRS 40.6452. The scheme effectively makes the named claimants representatives to negotiate a pre-­‐ litigation settlement on behalf of the unnamed claimants. The entire procedure for common defect notices is in NRS 40.645, 40.646, 40.6462, and 40.648.

AB 125 eliminates the common defect procedures and representative standing. See sections 5 [deleting NRS 40.610(3)], section 8 [deleting NRS 40.645(3), (4)], section 9 [deleting NRS 40.646(4)], section 10 [deleting NRS 40.6462(2)], and section 13 [deleting portions of NRS 40.648(2)].


In addition to the notice requirements, AB 125 now requires that the claimant must be present an inspection to identify the exact location of each alleged defect. Section 11. Additionally, if the notice of defect includes an expert opinion, the expert must also be present at the inspection. Id. These provisions address frustration by the builders and subcontractors with existing inspection practices. Often, homes were opened for inspection, but the defendants could not Tind the claimed defects. This process will now aid the builders and subcontractors identify the defects so that they can more readily propose a repair or monetary settlement. In many cases, the practical impact will be more time-­‐consuming inspections.

Claimant Verification

Under AB 125, the notice of defects must now:

  • Include a signed statement, by each named owner of a residence or appurtenance in the notice, that each such owner verifies that each such defect, damage and injury specified in the notice exists in the residence or appurtenance owned by him or her….

This provision is designed to address a very specific litigation abuse. Under NRS 40.688, a claimant has a duty to disclose to subsequent purchasers: (1) notices of defect related to the residence; (2) expert opinions received by the claimant; (3) terms of any settlement or judgment; and (4) a detailed report on repairs made to the residence as a result of a defect claimed in a notice of defects. Certain lawyers were deliberately insulating homeowner claimants from these disclosure requirements by keeping them in the dark about defects claimed for their homes. Thus, this “verification”1 creates a paper trail to enforce the disclosure requirement of NRS 40.688. Theoretically, this amendment encourages repairs that improves the housing stock and confidence in the building industry.

Effectiveness Note:

Sec. 21(3)-­‐(4). These provisions regarding the notice of defect and inspections are effective upon passage of AB 125. Thus, any new notice of defect must comply with these new requirements.

A pre-­‐enactment notice of common defect will still be effective, and will trigger the the right to assert claims in a representative capacity.

In practice, claimants sometimes amend notices of defect. For example, a “shotgun” notice begins as a placeholder asserted for the purpose of tolling the statutes of limitations or repose. The homeowner subsequently sends a more detailed notice. It is unclear how these new provisions will apply to amended notices. We contend that any amended notice must comply with these new requirements.

In the past, courts have seldom ruled that an insufficient notice fails to toll the statutes of limitations and repose, or fails to trigger the right to commence a court case. District courts are much more likely to heed the legislative mandate for specificity in notices of defect. It is also likely that the Supreme Court will accept writs challenging the sufficiency of notices under the new statute. On the other hand, it is unlikely that court will throw out cases for claimants who demonstrate good faith and reasonable compliance.


Representative suits by homeowner associations

Under Chapter 40, home owner associations could bring claims for defects in improvements owned by individual unit owners. HOAs could pursue claims on behalf of individual members and unit owners in a representative capacity, even though there was no certification of a plaintiff’s class under NRCP 23.

An HOA’s ability to sue in a representative capacity led to well-­‐published abuses in which gangs of lawyers, consultants, and contractors hijacked HOA board elections in order to gain control and pursue defect claims without permission from the individual unit owners. This imposed the individual unit owners with the disclosure requirements even though the individuals never received cash or repairs to their units.

Under Section 5, the definition of “Claimant” is amended to eliminate the HOA’s standing to sue for defects in improvements for which the HOA is responsible. Section 22 makes clear that the HOA has standing to sue only with respect to improvements that are owned by the HOA:

  • The association may not institute, defend or intervene in litigation or in arbitration, mediation or administrative proceedings in its own name on behalf of itself or units’ owners with respect to an action for a constructional defect pursuant to NRS 40.600 to 40.695, inclusive, and sections 2 and 3 of this act unless the action pertains exclusively to common elements.

“Common elements” is defined in NRS 116.017. So, the association still has standing to sue for alleged defects in a community center, roads, sidewalks, curbs, and other infrastructure improvements.

Section 8 provides that a notice of defects given by an HOA must be signed under penalty of perjury by a member of the HOA’s executive board or an HOA officer.

Effectiveness Note:

Sec. 21(7). The effectiveness of these limitations on association standing is based upon the timing of the notice of defects. If an association previously gave a notice for defects in improvements owned by the members, not the association, AB 125 should not impact the association’s ability to proceed in a representative capacity on those claims.


Exhaustion of home warranties

Under prior law, a claimant must “diligently pursue” a claim that is covered by a warranty before sending a Chapter 40 notice of defect to the builder. NRS 40.650(3). The “homeowners warranty” addressed here is a form of insurance policy defined in NRS 690B.100. The exhaustion of warranties concept did not extend to written warranties given by the builder, subcontractors, or suppliers and manufacturers.

AB 125 now mandates that a homeowner cannot give a Chapter 40 notice of defects without Tirst submitting the claim to the insurer on the warranty and the insurer has denied the claim. Section 14. The claimant may include in a notice of defects only defects for which the insurer has denied the claim. Further, the statutes of repose and limitations for a claim that is submitted under the warranty are tolled until 30 days after the denial of the claim by the insurer.

Note that AB 125 does not require exhaustion of warranties contained in the sales contract or otherwise offered by subcontractors and suppliers/manufacturers. Home builders should consider including language in sales contract providing that the buyer exhaust warranties given by the builder, subcontractors, appliance manufacturers, etc. before ever sending a Chapter 40 notice of defects. But the home builders should also attempt to avoid claims by reasonably adjusting warranty claims.

Effectiveness Note:

Sec. 21(3). Existing law already imposed some responsibility to “reasonably pursue” the insurance-­‐backed warranty before giving a notice of defect. This provision is effective upon passage. So, exhaustion of the warranty is a precondition to the right to give a new notice of defects after the enactment of AB 125. Again, the impact of this statute on post-­‐enactment amendments to pre-­‐enactment notices is unsettled.


Attorney fees

Section 15 of the bill eliminates attorney fees as an element of recovery under NRS 40.655.

The original intent of Chapter 40 was to reduce litigation by giving builders an opportunity to repair defects, and giving homeowners the incentive to accept repairs rather than seeking a monetary award. AB 125 proponents have argued that the so-­‐called “entitlement” to attorney fees subverts the original purpose of Chapter 40 by incentivizing monetary settlements and judgments. In several highly-­‐ publicized cases, the courts have awarded attorney fees that are disproportionate to the monetary award. In mediation, attorney fees have become a barrier to resolving cases with repairs and have been serious stumbling blocks for monetary settlements.

AB 125 opponents have argued that homeowners cannot afford to Tinance litigation. In other words, if a claimant is only award the cost of repairs, but must pay the attorney fees from the award, the claimant may win but still be unable to repair defects. Further, trial lawyers have argued that they are unwilling to Tinance the litigation without a guarantee that they will recover their attorney fees. Therefore, they argue, eliminating attorney fees as part of the remedy in NRS 40.655 reduces or eliminates access to justice for aggrieved home buyers.

AB 125 does not remove every basis for recovery of attorney fees.

Justice Court claims up to $10,000. A claim to recover up to $10,000, exclusive of interest, may be commenced in Justice Court. NRS 4.370(1). In Justice Court, the prevailing homeowner can recover attorney fees as costs. NRS 69.030.

District Court claims up to $20,000. A claimant who recovers up to $20,000 in District Court may recover attorney fees under NRS 18.010(2)(A).

We believe that the $20,000 ceiling in NRS 18.010(2)(A) would be applied on a claimant-­‐by-­‐claimant basis. If a case included owners of 50 homes, but less than $20,000 were awarded for each home, NRS 18.010(2)(a) would authorize an award of fees for each homeowner. It will be important for claimants’ lawyers to carefully document and allocate attorney fees to each home or plaintiff.

Unreasonable defenses. During debate in the Legislature, opponents of AB 125 argued that, in some cases, the courts have awarded homeowners fees in excess of the principal because the defense was unreasonable. The District Court’s ability to award attorney fees against a party as a sanction for an unreasonable claim or defense is preserved in NRS 18.010(2)(B).

Offers of judgment. Both claimants and defendants have the right to make offers of judgment. (In fact, section 3 of the bill provides both sides the ability to make an offer of judgment during the Chapter 40 pre-­‐litigation process.) A homeowner who makes an offer of judgment and then beats the offer will be entitled to recover reasonable attorney fees.

Contractual fee-­‐shifting provisions. In our experience, several national homebuilders include fee-­‐shifting provisions in their contracts. We are not aware that the builders have ever attempted to enforce these provisions against home buyers. Because of the previous “entitlement” to attorney fees, it would be impractical for homeowners to seek enforcement of a contractual fee-­‐shifting provision.

Effectiveness Note:

Sec. 21(2). This change applies to any claim that “arises” on or after enactment. A claim for breach of contract, breach of implied warranties, negligence, or fraud arises when the home was substantially completed or sold. Therefore, this change would not apply to homes sold before enactment. For the foreseeable future, the “entitlement” to recover attorney fees will be part of Nevada practice.


Statutes of Repose

It is important to understand the distinction between a statute of limitations and a statute of repose:

“Statutes of repose” bar causes of action after a certain period of time, regardless of whether damage or an injury has been discovered. In contrast, “statutes of limitation” foreclose suits after a Tixed period of time following occurrence or discovery of an injury.

Allstate Ins. Co. v. Furgerson, 104 Nev. 772, 766 P.2d 904, note 2 (1988).

AB 125 only impacts the applicable statutes of repose. Under prior law, statutes of repose begin to run upon substantial completion of an improvement. Before AB 125, statutes of repose for claims against the builders and designers depended on whether the deficiency was fraudulently concealed or the result of willful misconduct, known, latent, or patent:

 Fraudulent concealment Willful misconduct No time limit NRS 11.202
 Known deficiency 10 years NRS 11.203
 Latent deficiency 8 years NRS 11.204
 Patent deficiency 6 years NRS 11.205

This statutory scheme invites litigation over whether defects are patent, latent, or known.

Section 22 repeals NRS 11.203, 11.204, and 11.205. Section 17 amends NRS 11.202 to provide a single, six-­‐year statute of repose for all defect claims, regardless of the nature of the defect or the allegation of fraudulent concealment or other willful misconduct.

Opponents of AB 125 have pointed out that a home builder who fraudulently conceals a constructional defect is exonerated if the buyer does not discover and sue for the defect within six years. Fraud must be proved with clear and convincing evidence. Claims of fraud are extremely rare. Additionally, a fraud claim might fall outside of Chapter 40. For example, a homeowner could sue for rescission of the sales contract based on fraud. (A successful rescission action would force the home builder to buy back the house.)

Effectiveness Note:

Sec. 21(5)-­‐(6). Changes to the statutes of repose are effective upon passage. These changes apply “retroactively to actions in which the substantial completion of the improvement to the real property occurred before” enactment. However, there is a one-­‐year grace period so that actions commenced before February 25, 2016 will be controlled by the old statutes of repose.


Pre-litigation offers of judgment

Under existing law, builders had the right to make an offer to the claimant to settle before litigation. If the claimant unreasonably rejected the written offer, the court could shift fees and costs. NRS 40.650(1). Furthermore, once litigation commences, any party can make an offer of judgment under NRCP 68.* In very broad terms, if the offeror beats the offer at trial, then the offeror can (a) preclude the offeree from recovering certain costs and attorney fees and (b) recover attorney fees and costs from the offeree.

AB 125 now makes the offer of judgment rule applicable between the notice of defects and the commencement of the lawsuit. Section 3. Rule effectiveness of an offer of judgment under AB 125 or NRCP 68 becomes complex any time there are multiple offerors or multiple offerees involved.

Before enforcing an offer of judgment under NRCP 68, the courts “must carefully evaluate the following factors: (1) whether the plaintiff’s claim was brought in good faith; (2) whether the defendants’ offer of judgment was reasonable and in good faith in both its timing and amount; (3) whether the plaintiff’s decision to reject the offer and proceed to trial was grossly unreasonable or in bad faith; and (4) whether the fees sought by the offeror are reasonable and justiTied in amount.” Beattie v. Thomas, 99 Nev. 579, 588-­‐89, 668 P.2d 268, 274 (1983). We predict that courts will apply these “Beattie” factors to an offer of judgment made under AB 125, section 3.

*Note -­‐ AB69 repealed NRS 17.115 (the statutory offer of judgment rule)

Effectiveness Note:

Sec. 23. This section of AB 125 is effective upon passage. Therefore, the new post-­‐ notice of defect, pre-­‐litigation rule would apply to existing Chapter 40 cases in the pre-­‐litigation notice, inspection, and mediation period.


Indemnity and insurance

A typical subcontract provides that the subcontractor (indemnitor) will indemnify, hold harmless, and defend the prime contractor (indemnitee). There are similar provisions in design contracts, purchase orders and other contracts in the home development and construction world. These indemnity provisions are simply a mechanism to allocate the risk of various losses between the contracting parties.

Scope of indemnity

The scope of indemnity provisions varies widely. In some cases, the subcontractors effectively hold the prime contractor harmless for ALL injuries, property damage, or claims, regardless of which party actually did something wrong. In some cases, indemnity provisions are narrowly crafted to provide that the wrongdoer will protect other parties in a suit. Nevada practitioners have adopted the California lingo for categorizing indemnity agreements as Type I, Type II, and Type III.

Type One. The provision includes express indemnity of another, even if the indemnitee is guilty of active negligence.

Type Two. The provision requires indemnity only where the negligence of the indemnitee is passive, not active. The subcontractor must protect the general contractor in situations where the general contractor did not do anything wrong.

Type Three. The provision requires indemnity only where the indemnitor was the negligent party, and the negligence is not the result of either active or passive negligence by the indemnitee.

AB 125, Section 2, addresses indemnity contracts and insurance issues. Section 2 resulted from the work of a study group of construction lawyers. The provisions only affect contractual indemnity provisions in home construction, not commercial construction.

AB 125 outlaws all Type One and Type Two indemnity agreements in subcontracts except as otherwise provided. AB 125, section 2(1)(a). The “except as otherwise provided” language then allows indemnity agreements with limited scope. Section 2(1)(b) allows a provision to the extent that it…

  • requires a subcontractor to indemnify, defend or otherwise hold harmless [the general contractor other developer entities] from any liability claim, action or cause of action resulting from a constructional defect arising out of, related to or connected with the subcontractor’s scope of work, negligence or intentional act or omission.

However, this indemnity is not applicable where the claim arose because the subcontractor’s work was altered by somebody else.

Example provision:

  • Subcontractor shall defend, indemnify and hold harmless Contractor, Construction Manager and Owner from any liability, claim, action or cause of action resulting from a constructional defect arising out of, related to or connected with the Subcontractor’s scope of work, negligence, or intentional act or omission. Subcontractor’s duties shall not extend to and include the duty to defend, indemnify, or hold harmless Contractor, Construction Manager or Owner for their own respective negligence, whether active or passive, or for any liability, claim, action or cause of action resulting from a constructional defect arising out of, related to or connected with that portion of the Subcontractor’s work which has been altered or modiCied by another trade, Contractor, Construction Manager or the Owner.

Duty to defend

Indemnity contracts typically impose a duty to defend the indemnitee. Under AB 125, the duty to defend arises when upon presentment of a notice of defects (NRS 40.645) “from which it can be reasonably inferred that an alleged constructional defect was caused by or attributable to the [indemnitor’s] work, negligence, or wrongful act or omission.” Furthermore, if the indemnitee is also an additional insured on the indemnitor’s insurance policy, the indemnitee must exhaust that insurance policy before receiving a defense or otherwise asserting a claim for reimbursement of defense costs from the indemnitor. AB 125 section 2(1)(e).

Other insurance issues

For some projects, the developer establishes a single “wrap-­‐up” insurance policy that protects the builder, subcontractors, and key suppliers. The developer can then compel the contractor, subcontractor, and others to contribute portions of the premiums. AB 125, section 2(2) targets certain abuses by developers who collect more than the actual cost of the premiums.

It is important to note that the subcontract agreement must contain several disclosures related to the wrap-­‐up policy (section 2(2)(b)). In lieu of some of the disclosures, the subcontractor can be provided copies of the binder or declaration. Section 2(2)(c).

In the event of an occurrence, a subcontractor’s monetary contribution obligation under the wrap-­‐up policy cannot be greater than the amount the subcontractor would have been required to pay as a self-­‐insured retention or deductible under a CGL policy of comparable insurance in the speciTic market at the time the subcontract is entered into. Section 2(2)(i).

Effectiveness Note:

Sec. 21(1). The state and federal constitutions prohibit legislation that impairs the obligation of existing contracts. Therefore, AB 125 provides that the prohibition and effect of indemnity contracts applies only prospectively, to contracts formed after enactment. Also, the indemnity and defense changes provided by AB125 only apply to residential construction.

1 The use of the term “veriTied” is unfortunate. The “veriTied” statement in this section is not a sworn statement in the sense that a pleading is veriTied. As introduced, AB 125 required that the claimant’s statement be sworn under penalty of perjury. Legislative history reTlects that the penalty of perjury concept was removed by amendment.