For a newer community association board that has recently undergone transition from developer to unit owner control, there is significant temptation to accept a quick, lump sum settlement from the developer to “settle” any remaining punch list items. New board members are often in active and frequent communication with the developer, including any developer-appointed (non-unit owner) representatives who are still sitting on the board. In addition, developers are often willing to work with associations up to and during transition to resolve any outstanding construction issues. With a seemingly cooperative developer on the one hand, and the immense costs posed by litigation on the other, boards frequently adopt a “take what we can get” approach to resolving outstanding issues with a developer rather than digging in and using the threat of litigation to leverage a better settlement. At best, this approach will most likely result in the association leaving money on the table; at worst, it will cost unit owners tens of thousands in future special assessments.

When a developer sells 75% of the units in a condominium or home owner association development, majority control of the association board is turned over to unit owners from the developer (who, up until this point, had its own representatives controlling the board). During this process, known as Transition, a developer’s primary concern is to pave the way to selling off the remaining units, obtain releases of its performance bonds and, most importantly, get the association to sign a litigation release that will prevent the association from ever suing the developer in the future. In order to get a litigation release, the developer will often offer a seemingly large sum of money. Often, the amount the developer offers actually exceeds the cost to fix any open punch list items that have yet to be completed. This seemingly generous offer by the developer is designed to tempt the board into quickly releasing the developer from any future claims.

While settling with a developer shortly after transition might seem like a good thing (in that it results in an immediate infusion of capital), an effective association board must take a few fundamental steps to protect the interests of the association and its members. Here is what an association board should do before considering a settlement with a developer:

  1. Hire a well-respected engineer to perform a Transition Study. A Transition Study is essentially a large-scale equivalent of a home inspection, but is focused on the building(s)’ common elements and infrastructure. There are a handful of engineering firms in the tri-state region that specialize in community association Transition Studies. This study will alert the board to any evidence of construction defects such as water infiltration, improper flashings, structural issues, etc.In the event the Transition Study reveals any of these issues, a more detailed forensic study might be necessary to determine precisely what the defect is, the trade contractor(s) responsible, how the defect and any resultant damages can be fixed, and how much it will cost.
  2. Hire a well-respected accounting firm to perform a Capital Reserve Fund analysis. In addition to building your community, the developer is also required to form the association and provide a reserve fund for future expenditures. Unfortunately, this fund is often under-capitalized or improperly structured. Before settling with a developer, the board should hire an accountant to determine if there are any deficiencies in the reserve fund.
  3. Hire legal counsel specializing in community association law. Effective legal representation is essential during Transition. In exchange for a settlement payment, the developer will ask the board to sign a voluminous and very pro-developer settlement agreement and release. This document, which will be drafted by the developer’s very savvy attorneys, will essentially require the association to forever release the developer from any and all claims (such as construction claims, capital reserve fund deficiencies, etc.). This release will likely encompass any claims that the association is not even aware of yet. If it turns out that there were hidden construction defects that will cost far in excess of the settlement amount to repair, the association still will not be able to sue the developer. For this reason, the board should have legal counsel negotiating on its behalf, drafting/revising the settlement documentation so that it is more equally balanced, and explaining in plain English the ramifications of each clause of Legaleese appearing in the settlement agreement/release.In the event the community is suffering from extensive construction defects, the association is not necessarily left with having to spend tens of thousands in legal fees to litigate against the builder. While litigation is very costly, a legal practice such as Stark & Stark’s Construction Litigation Group might take a case against the developer, design professionals, and trade contractors on a contingency-fee basis, where the association only pays the attorneys if and when the case settles or results in a jury verdict.

Only after a post-transition board has obtained input from its engineer, account, and legal counsel will it be in a position to evaluate whether the settlement offer from a developer is a good deal