Condo developers must file a warranty bond or letter of credit with the D.C. Government to cover structural defects in every new condo unit offered for sale for a period of two years from the date of first sale.  This warranty cannot be disclaimed by “sold as is” language for any residential condo.  For conversion condos purportedly “sold as is,” the warranty cannot be disclaimed either for any components that were installed by the conversion condo developer.  D.C. Code § 42-1903.16. 

The law seems airtight as written, but is full of holes in the enforcement.  In 2006 the D.C. Department of Consumer and Regulatory Affairs (DCRA) discovered an apparently forged letter of credit filed with the agency by the developer of the Chelsea, a condo community in Lincoln Park near RFK Stadium.  Eventually DCRA issued a cease-and-desist order against the developer to prevent him from selling the remaining defective units, but it was already too late for D.C. residents who had purchased units at the Chelsea. 

Flash forward to 2009: Oversight of the warranty security law had changed hands, to the D.C. Department of Housing and Community Development (DHCD).  Condo owners at three different conversion condo communities (Eighth Street Plaza Condominiums, Eastern Avenue Plaza Condominiums, and A Street Condominiums), located in Wards 7 and 8, attempted to draw on the warranty security and were informed by DHCD that the developer had posted either falsified letters of credit or no letters of credit.  The developer filed for bankruptcy in 2009, leaving the condo owners with no one to sue for myriad structural defects in their condos. 

D.C.’s failure to enforce the warranty security law seems to have no end in sight, as DHCD has taken the position that it is the developer’s affirmative duty to post the warranty security, and not D.C.’s affirmative duty to verify the authenticity of the bond or letter of credit before sales take place.  While arguments can be made that D.C.’s budget limits the manpower available for oversight, how much manpower does it take to make a simple phone call to the bank on which the letter of credit is allegedly drawn?  DHCD’s position is entirely self-serving, and taken for purposes of avoiding liability, especially given that D.C. was on notice as recently as 2006 that bad actors may file falsified letters of credit.

As so many (indeed, most) development projects are carried out by companies that are dissolved by the time construction defects are discovered, or that file for bankruptcy as soon as lawsuits are filed, D.C.’s failure to implement a “system” (i.e., a simple phone call, made to the bank on which the letter of credit is allegedly drawn) to verify the warranty security posted for each development project shows the devastating consequences to society when government, incomprehensibly, refuses to do its job.

Builders and financiers of residential condo communities may create a separate corporate entity for each development project.  It’s a legal strategy designed to limit liability if construction defects are discovered and purchasers sue for damages.  Theoretically liability would be limited to the separate entity, and not imputed to the lender and builder (and their millions in assets) who are behind the project.

If the evidence shows, however, that the entity has been sloppy in observing corporate formalities, and is in fact just a shell, the Court has authority to “pierce the corporate veil” and impute liability to the shareholders (the lender and builder). 

If the lender, builder, and corporate entity all share the same directors, employees, office space, and accounting department, for instance, the evidence is strong that the corporate entity is just a shell. 

While no building project is perfect, the attempt to avoid legal liability by forming a corporate shell that is severely underfunded and has no life of its own is not the answer.  The real parties in interest (the lender and builder) should devote their energies instead to quality workmanship, to creating a livable community with minimal defects, and, once defects are discovered, to correct them in a timely, professional manner.

There is a duty to disclose “non-discoverable” defects in an old condo unit.  If you’re planning to sell real estate with known defects (such as recurring water damage), it is unlawful to fix the defects just for the purpose of sale and to fail to disclose the recurring damage to the potential buyer.  Such actions may be construed as “active concealment,” and subject you to liability for misrepresentation and fraud.

It’s also unlawful to remain silent in the face of a known misunderstanding by the potential buyer, or to omit information that a reasonable person would consider important.  Special duties also are imposed upon agents toward their principals.  For instance, if a sales agent represents a buyer, the sales agent cannot conceal defects or fail to disclose defects in the hope of making the sale.  Such action by a sales agent would subject him to additional liability for breach of fiduciary duty, not to mention potential disciplinary action by the Real Estate Board.

The statute of limitations for fraud in D.C. is three years.  A buyer who finds himself or herself the owner of a defective property should ask neighbors whether the previous owner suffered the same type of damage.  If so, the buyer could investigate further, and consider filing a lawsuit against the previous owner for the cost of the damage, as well as punitive damages. 

Was a home inspection conducted before the purchase?  If the inspection revealed no major defects, it may be an indication of “concealing” repairs by the seller for the purpose of sale, or a negligent home inspection that failed to discover defects that a reasonably diligent inspection would have discovered.  The home inspection report will contain disclaimers and limitation of liability provisions.  Review those provisions carefully, as you may have a cause of action against the home inspector as well.

Condo associations operate collectively, but many do so without filing Articles of Incorporation as either a nonprofit corporation or a limited liability company (two of the more popular organizational forms for condo associations).

Not incorporating might save money in the short term, but could result in devastating legal liability for individual unit owners if a lawsuit is filed against the association. If the association loses the case, and if the judgment involves a claim not covered by the condominium’s insurance policy, the individual unit owners could be ordered to pay the judgment.

Unit owners should be up in arms if their condo association is still operating as an unincorporated association.

Once the association is incorporated, the legal liability of individual unit owners is limited. Any court judgment must be paid by the corporation (through its reserves). And if the reserves are insufficient to pay the judgment, the creditor may execute upon property of the corporation.

If the judgment still remains unsatisfied, the corporation could seek bankruptcy protection by filing a voluntary bankruptcy petition under Chapter 11 of the Bankruptcy Code. Chapter 11 permits postponement or restructuring of an organization’s debts, while allowing the organization to continue to operate.

If the corporation makes all payments required under the Chapter 11 Plan of reorganization, generally all debt that preexisted filing of the bankruptcy petition is discharged. There are exceptions to discharge for certain kinds of debt, fraud being one of the principal exceptions in organization cases.

In D.C., a recorded first mortgage on a condominium takes priority over all but 6 months of a lien for unpaid condo fees filed by a condo association.

Several states have enacted “Super Lien” legislation that is more worthy of the name, permitting condo associations to sue for costs and attorneys’ fees incurred in collecting upon the condo lien. The collection action is usually brought against the foreclosing lender, who, not surprisingly, often neglects to escrow the 6 months of unpaid condo fees from the foreclosure sale proceeds.

In the current battered real estate market, which has hit small condo communities especially hard, Super Lien legislation is ineffective without a provision for recovery of costs and attorneys’ fees incurred in enforcing the Super Lien. Foreclosing lenders know that small communities are strained to pay attorneys to collect a mere 6 months of unpaid condo fees. So the lenders are motivated to avoid paying until a lawsuit is filed against them.

How can condo purchasers protect themselves? Avoid buying in a small community. Some communities are as small as 4 units. The domino effect is swift, if even one owner stops paying condo fees. The community loses one-fourth of its income to pay for water, gas, electricity, maintenance, security, etc. Even large communities are not insulated. Some large condo communities of over 200 units in South Florida have gone to ruin, become dilapidated and overrun with vermin, due to the large number of owners defaulting on their condo fees.

What if you’re already stuck in a small community, or one that is not well-financed? Put pressure on non-paying owners immediately. Don’t wait until they are 6 months to a year behind, as many small communities do. A condo owner headed for foreclosure usually stops paying condo fees long before he stops paying his mortgage. The lender will try to work with the owner when he defaults on the mortgage, and this process takes another several months, during which the condo association loses more fees.

When the foreclosure finally does take place, lenders may or may not escrow 6 months of unpaid condo fees from the foreclosure sale proceeds. And if they don’t, a lawsuit needs to be filed. However, many associations choose not to pay an attorney to collect a mere 6 months of fees from a mortgage lender who is motivated not to pay. While the lawsuit could be filed against the defaulting owner, instead, for the entire amount of the unpaid condo fees, that owner usually is without resources to pay any court judgment (having just lost his house), and so a lawsuit would be futile.

The current real estate market has heightened problems for small condo communities, which are now riddled with vacancies. Emergency federal legislation needs to be enacted, and not just of the Super Lien variety. Current efforts by the federal government to keep homeowners in their homes hasn’t been enough to revive the housing market that is dragging down the entire economy. The next iteration promised by the feds—a reduction in mortgage principal owed by distressed homeowners—would address the problem of artificially inflated housing prices. Mortgage lenders, in collusion with credit rating agencies, have managed to sell such inflated inventory at many times their inherent value, and at steep interest rates, to those who can least afford to pay the higher interest rates. Tougher regulation of the financial services industry is long overdue. For many small condo communities, however, it may be too late.

A potential solution is for several small communities to band together, and to find a buyer who can turn the communities into rental housing.  Or the communities could work together to obtain title to the vacant units and to manage them as rentals.