Lenders and Post-Foreclosure Purchasers Have Standing to Make Construction Defect Claims for After-Discovered Conditions

The Colorado Court of Appeals has decided a case which answers a question long in need of an answer: do banks/lenders have standing to assert construction defect claims when they receive title to a newly-constructed home following a foreclosure sale or deed-in-lieu of foreclosure?  The decision was released on August 1, 2013, in the case of Mid Valley Real Estate Solutions V, LLC v. Hepworth-Pawlack Geotechnical, Inc., Steve Pawlak, Daniel Hadin, and S K Peightal Engineers, Ltd. (Colorado Court of Appeals No. 13CA0519).

The background facts of the case are typical of a Colorado residential construction defect case generally.  A developer contracted for an analytical soil engineering report from a geotechnical engineering firm (H-P) which made a foundation recommendation.  The developer’s general contractor then retained an engineering firm (SPKE) to provide engineering services, including a foundation design. The general contractor built the foundation in accordance with the H-P and SPKE criteria and plans.

The house was not sold by the developer and went into default on the construction loan.  These events resulted in a deed-in-lieu of foreclosure to a bank-controlled entity which purchased the house for re-sale.  Shortly after receiving the developer’s deed, the bank-related entity discovered defects in the foundation that resulted in a construction defect suit against the two design firms and related individuals.  The defendant parties moved for summary judgment on the negligence claims, based on the economic loss rule.  The latter rule precludes the bringing of a tort/negligence claim based on a claimed breach of duty which also exists as a term of a contract between the parties.

The Court of Appeals decided this case on an interlocutory appeal by the defendants from the denial of summary judgment.  In reviewing the case, the Court relied primarily on the “independent duties” of construction professionals as applied in the prior cases of Cosmopolitan Homes v. Weller, 663 P.2d 1041, 1042-43 (Colo. 1983) and Yacht Club II Homeowners Ass’n. v. AC Excavating, Inc.,  114 P. 3d. 862 (Colo. 2005).  

The Cosmopolitan case held that a successor homeowner could assert newly discovered claims against a builder-vendor which were latent and therefore not discoverable at the time of purchase of the home.  The separate Yacht Club II case held that there was an independent duty of due care owed by subcontractor construction professionals to homeowners to “act without negligence in the construction of homes.”  To get to its result in Mid Valley, the Court conflated the holdings of both prior cases, and even engaged in retrospective application of Cosmopolitan to the Colorado cases involving the economic loss rule, in order to circumvent its effects in Mid Valley.  In other words, this was more of a case about public policy and avoidance of technical defenses raised by builders than it was a legal analysis of the economic loss rule.

The arguments advanced by the defendants claimed that the economic loss rule should bar the negligence claims of the bank-related homeowner because it was not a “homeowner” in the conventional sense of that word.  The Court said, in substance, that the duties of Comospolitan and Yacht Club II owed by construction professionals were the same regardless of the nature or identity of the “homeowner.”   The Court also said that it could not decide whether the lender was the alter ego of the bank-related entity based on the record before it. Therefore such allegations were not deemed proven, nor were they assumed. However, the tenor of the opinion suggests that the identity of the homeowner was irrelevant to the policy analysis that followed.

In substance, the Court held that the technical arguments of the defendants about the bank-related entity’s standing and the application of the economic loss rule were trumped by the legal “duty” holdings of Cosmopolitan and Yacht Club II as they pertained to construction professionals.  Further, the Court made it clear in its discussion that it did not want to see a “windfall” dismissal of the claims accrue to a construction professional simply because the property owner was not a consumer or a more conventional owner. 

While the case may be limited in its application because it was an interlocutory appeal, and because the factual record was not fully developed, it is the first indication that lenders, foreclosure investors, and even distressed property speculators may have the ability to assert construction defect claims as successors in title.  The case may yet be appealed to the Colorado Supreme Court for further proceedings, but its inclination for taking interlocutory appeals is very small. 

For now, the appellate question of legal standing for successor owners (regardless of their identity) pressing tort claims has been answered, at least where latent and later discovered problems manifest for the first time after the ownership has been transferred. By logical extension of Cosmopolitan, such claims would be barred for a successor owner if the problems were manifest at the time of transfer. 

For additional information regarding Colorado construction litigation, please contact David M. McLain at (303) 987-9813 or by e-mail at mclain@hhmrlaw.com