FUNDING DEFECT LITIGATION

Construction defect litigation legal fees and costs can be significant and must be factored into the decision to litigate.

COST TO LITIGATE

1.  Experts. Depending on the size of the association and the number of defects, the cost to investigate and document the claim usually falls between $20,000.00 to $60,000.00. Case is one or lost with the expertsthey provide the evidence needed to force settlement.

2.  Attorneys' Fees. In addition to experts' fees, the cost to litigate the case can be significant. Depending on the number of defects and how aggressively the developer defends against the lawsuit, the legal fees to litigate the case usually falls between $100,000.00 and $500,000.00.

a.  Hourly. The association pays as it goes. Usually most advantageous because the association keeps a larger share of the settlement (or award is the association prevails at trial). However, this may not be economically feasible for some associations.

b.  Contingency. Association pays expert fees and costs but no up-front legal fees. Law firm agrees to take a percentage of the recovery. The percentage is fully negotiable.

c.  Modified Contingency. Combination of lower hourly rate and lower contingency pay-out at the end.

FUNDING

1.  Assessments. Special assessments are usually the least desirable method for funding the litigation because of the opposition by the membership. However, if the membership approves, it nets the largest return because you avoid interest payments to lenders. Without membership approval, the Board may do the following:

a.  Regular Assessments. Raise regular assessments up to 20% per year

b.  Special Assessments. Special assess the membership up to 5% per year.

2.  Borrowing from Reserves. If the association has sufficient reserves, borrowing from them is the least painful method for funding the litigation. Section 1365.5(c)(2) of the Civil Code allows a Board to borrow from the reserves if the purpose (including litigation) is related to the repair, restoration, replacement or maintenance of major components for which the reserve funds were established.

a. Decision to Borrow. If the Board decides to borrow from the reserves, it must (i) notify the members in the next available mailing, (ii) prepare an accounting of expenses related to the litigation on at least a quarterly basis; and (iii) make the accounting available for inspection by members (Civil Code §1365.5 (d))

b.  Repaying Reserves. Borrowed reserve funds must be replaced within one year unless the Board makes a finding that it would be in the best interests of the association to take longer.

3. Borrowing from a Lender. Borrowing funds from a lender usually requires approval by the membership. The associations CC&Rs or Bylaws may have guidelines for borrowing. Lenders will usually approve a line of credit up to a certain amount. The money is released as the Board withdraws as needed to fund the investigation and litigation. As collateral, banks usually require an assignment of the association's assessment collection rights, together with current accounts receivables and any settlement proceeds resulting from the litigation.

4. Borrowing from the Membership. It is possible to float a bond and borrow the money from the membership.

5. Borrowing from the Attorney. Even if the law firm is willing to take the matter on contingency, the association still needs to pay for the experts and related costs (usually $20,000.00 to $60,000.00 depending on the case). Some law firms will advance those funds. The firm will usually charge the same rate of interest as banks. The "loan" will not require homeowner approval if the law firm agrees to be paid back only out of the recovery.

6.  Combination of the Above. Association's may use any combination of the above to fund the litigation.

Contact us for more information.

Updated by ADAMS KESSLER 9/22/2008