Anatomy of a Construction Defect Lawsuit

I. PARTIES

A. PLAINTIFFS

Arizona Revised Statute (A.R.S.) § 33-1242 and now A.R.S. §12-1361(b) confers standing on homeowners' associations (HOA's) to sue on its own behalf or as a representative of two or more individual homeowners for alleged defects to the common elements. See also Shelby v. Registrar of Contractors, 172 Ariz. 95, 834 P.2d 8l8 (1992). As a result of the statutes, potential plaintiffs include single family homeowners, single family condominium or town-home unit owners, groups of each asserting a class action, or associations representing the common interests of unit owners. A.R.S. 12-1361 et. seq. (the Arizona Purchaser Dwelling Statute (PDA)) confers standing on a person or entity including an "association" to pursue a "dwelling action" against a "seller," which includes "any person, firm, partnership, corporation, association or other organization that is engaged in the business of designing, constructing or selling dwellings." This does not include real estate brokers.

B. TYPICAL DEFENDANTS

  1. Owners/Developers/Builders (Developer)
  2. General Contractors (GC)
  3. Construction Managers (CM)

C. TYPICAL THIRD PARTY DEFENDANTS

  1. Subcontractors
  2. Design Professionals
  3. Material Suppliers

II. COMMON CASE STRUCTURE AND THEORIES OF LIABILITY

A. HOA v. DEVELOPER

Plaintiffs typically sue the Developer for damages arising out of alleged defective construction. The most common of these claims stem from the real estate sales contract, or documents relating to the development, such as the Public Report.

1. Breach of Contract

Privity of contract is required to establish a contract claim, so this theory only applies to the entity that contracted directly with the purchaser, typically the Developer. The viability of a claim against the Developer depends on the express terms of the sales contract. The significance of a contract claim is that the prevailing party is usually entitled to recover reasonable attorney's fees. Sometimes the contract specifies the remedy relating to fees, and if the contract is silent, the Court is charged with discretion to award fees. A breach of contract claim is subject to a six year statute of limitations (subject to the discovery rule), so many times, this cause of action expires before an implied warranty claim, discussed below.

2. Breach of Express Warranty

A claim for breach of warranty sounds in contract. Colberg v. Rellinger, 160 Ariz. 42, 770 P.2d 346 (App. 1988). Contract law enforces expectancy interest between the contracting parties and provides for redress to the plaintiffs who have failed to receive the benefit of their bargain. Carstens v. City of Phoenix, 206 Ariz. 123, 75 P.3d 1081 (App. 2003). A warranty is an assurance by one party to a contract that the existence of a fact upon which the other party can rely. An express warranty amounts to a promise to indemnify the promisee for any loss if the fact warranted proves itself to be untrue. Hoover v. Nielson, 110 Ariz. 329, 331, 518 P.2d 990 (1974). The proper measure of damages in a contract based claim for construction defect is the cost of repair. Fairway Builders, Inc. v. Malouf Towers Rental Co., Inc., 124 Ariz. 242, 253, 603 P.2d 513 (App. 1979).

This theory can apply to a Developer if there is an express warranty contained in the sales documents. These claims have to be assessed on an individual basis and depend entirely on the language of the involved documents. Since warranty claims are based in contract, the prevailing party is typically entitled to reasonable attorney's fees and costs. Express warranties are typically limited to short periods of time and can therefore expire before other contract claims.

3. Breach of Implied Warranty of Workmanship and Habitability

a. Within the context of construction defect, Arizona does not recognize a breach of implied warranty of fitness for a particular purpose. This warranty only exists in the context of contracts for sale of goods. A.R.S. 47-2315. Even in the absence of a specific contractual provision, the law implies a warranty on the part of the contractor to perform the agreed task in a good and workmanlike manner and in a manner befitting a skilled contractor. Kubby v. Crescent Steele, 105 Ariz. 459, 466 P.2d 753 (1970); Columbia Western Corp. v. Vela, 122 Ariz. 28, 592 P.2d 1294 (App. 1979).

b. This cause of action only applies to developers who were actively involved in the construction process as opposed to those who merely financed a project and hired a general contractor to do the building. See, Smith v. Continental Bank, 130 Ariz. 320, 636 P.2d 98 (1981).

c. In Arizona, workmanship and habitability are considered one warranty. The standard for satisfying this warranty is reasonableness and not perfection. The test is whether the work performed is comparable to work ordinarily done by a worker of average skill and intelligence. Nastri v. Wood Brothers Homes, Inc., 142 Ariz. 439, 690 P.2d 158 (App. 1984). Thus, the analysis of the habitability/workmanship issue is based on the determination of whether the home is "reasonably suited for its intended use." Richards v. Powercraft Homes, 139 Ariz. 242, 678 P.2d 427 (1984).

d. This cause of action does not require privity between the purchaser and builder. The ability to sue a builder under an implied warranty theory runs to subsequent purchasers. Nastri; Richards. A purchaser can bring a claim for breach of warranty against a contractor even though they had no direct relationship with the contractor and the contractor was not a builder-vendor. See Lofts at Fillmore Condominium Ass'n v. Reliance Commercial Const., Inc., 218 Ariz. 574, 190 P.3d 733 (2008).

4. Breach of Fiduciary Duty (or Breach of CC & R's)

A fiduciary duty does not exist between a seller and a purchaser of property. Alaface v. National Investment Company, 181 Ariz. 586, 892 P.2d 1375 (App. 1994). However, the developer may owe a fiduciary duty to the HOA where the Developer controls the association prior to homeowner control. It is common for a Developer to act as the "declarant" during the start up of an HOA, and/or appoint or elect developer's employees or persons under the developer's control to serve as the initial board of directors. The Developer and the individuals serving as officers and directors owe a fiduciary duty to the homeowner's association and therefore face potential claims for the manner in which they operate and manage the community association. The developer may also have certain financial obligations to the community under the CC&Rs giving rise to claims for alleged failure to meet those obligations, such as "underfunding the reserve account" and related claims.

5. Negligence/Negligence Per Se

In Arizona, a claim for negligence generally cannot be made against a Developer unless there has been actual damage to personal property, or personal injury, resulting from the alleged defective construction. Flagstaff Affordable Housing Ltd. Partnership v. Design Alliance, Inc. 212 P.3d 125 (Ariz. 2010). Traditionally, Arizona law has made a distinction between remedies available in tort, and those available in contract. The "Economic Loss" rule, as it has come to be known, generally prohibits the recovery of "expectation" damages (purely economic damages) in construction defect cases through tort claims (negligence), but allows such recovery through contract claims (breach of contract/express warranty/implied warranty). Id. A tort claim can still be brought, however, if the contract allows for it. Id.

The threshold question in a negligence action is whether the defendant had a legally recognizable duty to conform to a particular standard of conduct to protect the plaintiff from unreasonable risk of harm. Duty arises out of the relationship between the parties and imposes a legal obligation on the party for the benefit of the other party. To determine whether a defendant had a duty to a plaintiff, a court must consider whether their relationship required the defendant to exercise care to prevent injury to the plaintiff. the issue of whether a duty exists is usually for the court to decide as a matter of law. Delbridge v. Maricopa County Community College District, 182 Ariz. 55, 57-58, 893 P.2d 55 (App. 1994). If a duty is found, the plaintiff must show that the duty was breached and that damages were caused by the breach. In other words, negligence is not enough to establish fault. Negligence that causes damage results in fault.

Negligence Per Se claims are usually based on alleged violations of building codes or statute. These claims are subject to dismissal in the same manner as negligence claims.

6. Negligent Misrepresentation

In order to prevail on a negligent misrepresentation claim, the homeowner's association/owner must prove that the defendant misrepresented existing, ascertainable, material facts. McAllister v. City Bank, 171 Ariz. 207, 829 P.2d 1253 (App. 1992). An opinion or promise of future conduct may not form the basis of a negligent misrepresentation claim. This is a critical distinction because the Developer often employs sales people who routinely offer opinions about the quality of construction and the aesthetics of the particular units. For liability to attach to Developer, the plaintiff must, therefore, prove that the developer knew, or should have known, that the units were not of as good quality or of as good value as advertised.

Section 552 of the RESTATEMENT (SECOND) OF TORTS provides: (1) One who, in the course of his business, profession or employment, or in any other transaction in which he has a pecuniary interest, supplies false information for the guidance of others in their business transactions, is subject to liability for pecuniary loss caused to them by their justifiable reliance upon the information, if he fails to exercise reasonable care or competence in obtaining or communicating the information.

(2) Except as stated in Subsection (3), the liability stated in Subsection (1) is limited to loss suffered (a) by the person or one of a limited group of persons for whose benefit and guidance he intends to supply the information or knows that the recipient intends to supply it; and (b) through reliance upon it in a transaction that he intends the information to influence or knows that the recipient so intends or in a substantially similar transaction; (3) The liability of one who is under a public duty to give the information extends to loss suffered by any of the class of persons for whose benefit the duty is created, in any of the transactions in which it is intended to protect them.

7. Consumer Fraud

Consumer Fraud is statutorily created liability under Ariz.Rev.Stat. § 44-1522. These claims are similar to negligent misrepresentation claims in that liability only attaches for the misrepresentation of a material fact in connection with the sale of real property. This claim often is dismissed because it is statutorily created liability and, therefore, subject to a one year statute of limitations. Ariz.Rev.Stat. §12-541(5). The claim is better suited for use in the sale of goods, but can apply in some situations where the defendant is in the business of selling real property. The claim requires the showing of actual knowledge, and a certain level of intent, as opposed to negligent misrepresentation, which only requires that the seller should have known about the alleged fact at issue at the time of disclosure.

8. Fraud

Fraud is subject to a higher burden of proof, and requires a more stringent showing of intent. In order for a plaintiff to prevail on this theory, it must prove nine elements by clear and convincing evidence including that the developer intentionally misrepresented or omitted a material fact upon which the unit owner relied in purchasing the particular unit. Because the burden of proof is higher, this claim in not as common.

9. Strict Liability

Arizona has not recognized a claim for strict liability arising out of construction defects. In Nastri, the Arizona Court of Appeals held that a defect which causes damage to the product itself is not a harm which product liability is designed to redress. In Menendez v. Paddock Pool Construction Company, 172 Ariz. 258, 836 P.2d 968 (App. 1991) the Court of Appeals went one step further and held that a structural improvement to realty is not a "product" subject to strict liability claims. The Arizona trial courts have consistently granted motions for summary judgment on this theory of liability under the present status of the case law.

10. Public/Private Nuisance

Nuisance is defined as a "condition which represents unreasonable interference with another person's use and enjoyment of his property and causes damage." Graybar v. City of Peoria, 156 Ariz. 553, 753 P.2d 1209 (App. 1988). Under the Restatement Second of Torts, one who creates or has knowledge of a nuisance on his property and then transfers the property may have liability in the future for failing to disclose the nuisance.

A public nuisance is an unreasonable interference with a right common to the general public. In contrast, a private nuisance affects a relatively few or a determinate number of persons. Claims for public nuisance in a construction defect context are usually subject to dismissal since the alleged "nuisance" does not typically affect anyone beyond the homeowner's association.

Private nuisance claims may be subject to dismissal since the homeowner's association cannot normally establish that the construction defect unreasonably interferes with the owner's use and enjoyment of the property. Graybar v. City of Peoria, 156 Ariz. 553, 753 P.2d 1209 (App. 1998).

B. HOA v. GENERAL CONTRACTOR

1. Implied Warranty of Workmanship/Habitability.

Residential homeowners no longer have to be in privity of contract to bring an implied warranty claim against a builder that is not also the "vendor" of real property. Lofts at Fillmore Condominium Ass'n v. Reliance Commercial Const., Inc., 218 Ariz. 574, 190 P.3d 733 (2008); Flagstaff Affordable Housing Ltd. Partnership v. Design Alliance, Inc. 212 P.3d 125 (Ariz.2010). Practically, this means a plaintiff can bring direct action against the general contractor where the plaintiff purchases the residence from a Developer, or other entity. There is no practical difference in the elements needed to prove this claim against a Developer or GC.

Even in the absence of a specific contractual provision, the law implies a warranty on the part of the contractor to perform the agreed task in a good and workmanlike manner and in a manner befitting a skilled contractor. Kubby v. Crescent Steele, 105 Ariz. 459, 466 P.2d 753 (1970); Columbia Western Corp. v. Vela, 122 Ariz. 28, 592 P.2d 1294 (App. 1979). In Arizona, workmanship and habitability are considered one warranty. The standard for satisfying this warranty is reasonableness and not perfection. The test is whether the work performed is comparable to work ordinarily done by a worker of average skill and intelligence. Nastri v. Wood Brothers Homes, Inc., 142 Ariz. 439, 690 P.2d 158 (App. 1984). Thus, the analysis of the habitability/workmanship issue is based on the determination of whether the home is "reasonably suited for its intended use." Richards v. Powercraft Homes, 139 Ariz. 242, 678 P.2d 427 (1984).

2. Breach of Contract/Express Warranty.

If the GC actually contracts with the purchaser, then it could also be subject to breach of contract and/or express warranty claims as set forth above.

3. Negligence/Negligence Per Se.

The same discussion above applicable to Developers applies equally to GCs.

4. Misrepresentation/Fraud.

Unless the GC also sells the residence, it would not be subject to claims for misrepresentation, or fraud. But if it does, the elements would be the same.

5. Third Party Beneficiary.

HOAs sometimes assert that they are third party beneficiaries of the contract between the developer and subcontractor/professionals. If there are no contracts between the developer and subcontractors/professionals, then this claim must necessarily fail.

If there are contracts, then one must look at the language of the contract to determine the validity of the third party beneficiary claim. In Arizona, a contract must expressly specify that the parties intended the contract to directly benefit a third party or a class of which a third party is a member. Lake Havasu Resort v. Commercial Loan Insurance Co., 139 Ariz. 369, 678 P.2d 950 (App. 1983). It is not enough that a contract operates to the benefit of the third party; there must be a specific contract provision that cites members of the class as primary parties in interest. Basurto v. Utah Construction and Mining Co., 15 Ariz. App. 35, 485 P.2d 859 (App. 1971).

Standard AIA contracts do not identify the homeowner's association or individual unit owners as beneficiaries and would, therefore, not have the requisite language to confer third party beneficiary status on the homeowner's association or homeowner. Contracts with the professionals and sub-trades do not typically identify the individual homeowner or homeowner's association as a beneficiary. Thus, in most cases the subcontractor or professional should be successful in summary judgment on this claim.

C. DEVELOPER v. GENERAL CONTRACTOR/SUBCONTRACTOR/

DESIGN PROFESSIONAL; or

GENERAL CONTRACTOR v. SUBCONTRACTORS/DESIGN PROFESSIONAL

This level of litigation is typically referred to as third party litigation, and follows a complaint by the HOA against the developer or general contractor, or both. If the Developer has indemnity rights against the GC, a third party claim, or cross claim may be filed to preserve the Deveoper's rights against the GC. If the Developer, or GC has indemnity or other contractual rights against the sub-trades, a third party complaint can be filed against those entities to similarly preserve rights. Although the relationships between the parties change depending on the case, the motive behind third party litigation is the same: to shift the risk of loss to those that should bear the loss, either because of contractual obligations, or because equity demands it. The following claims are typically used to support the effort to allocate or shift responsibility for alleged defects.

1. Breach of Contract

Privity is required. This claim can be made by the developer against the design professionals, and/or by the developer against the general contractor. This claim is typically made by a GC against the involved sub-trades to enforce rights in the subcontracts. The viability of the claim depends upon the terms of the contract.

2. Express Indemnity (stemming from a construction contract)

a. Specific Indemnity Agreements

In Arizona, an express indemnity provision will not protect an indemnitee against its own negligence unless that intent is evident from the terms of the contract. Washington Elementary School District No. 6 v. Baglino Corp., 169 Ariz. 58, 817 P.2d 3 (1991); Cunningham v. Goettl Air Conditioning, Inc., 194 Ariz. 236, 980 P.2d 489 (1999). In other words, and by way of example, the general contractor cannot contract away its own negligence unless the indemnity provision clearly expresses an intent that the GC to obtain indemnity if it is negligent. Where specific indemnity exists, the indemnitee (the Developer or GC) can obtain indemnity relief even if it is 99% at fault for the liability causing event. Any amount of fault by the indemnitor (the subcontractor) will trigger full indemnity relief.

It is against public policy to obtain indemnity for one's sole negligence, or fault. A.R.S. §32-1159.

b. General Indemnity Agreements.

Where the indemnity provision fails to specifically address the indemnitee's own negligence, the provision is a general indemnity agreement. Under a general indemnity agreement, an indemnitee is entitled to indemnification for a loss resulting from its own passive negligence but not for its active negligence. The distinction is as follows: generally, active negligence is found if the indemnitee has personally participated in an affirmative act of negligence, was connected with the negligent act or omission by knowledge or acquiescence, or has failed to perform a precise duty which the indemnitee had agreed to perform. On the other hand, passive negligence is found in mere nonfeasance, such as the failure to discover a dangerous condition, perform a duty imposed by law, or take adequate precautions against certain hazards inherent in employment. This is an all or nothing proposition. (See the discussion below on implied indemnity agreements).

3. Implied Indemnity

Implied indemnity is much like a general indemnity agreement in that implied indemnity is forbidden where the indemnitee has actively participated in the liability creating event. Shea v. Superior Court of Maricopa County, 150 Ariz. 271, 723 P.2d 89 (1986); INA Insurance Co. of North America v. Valley Forge Insurance Co., 150 Ariz. 248, 722 P.2d 975 (App. 1986). However, implied indemnity is only permitted where the party seeking indemnity did not participate at all in the alleged liability creating event. An omission can still be active negligence, preluding indemnity. Cella Barr Associates, Inc. v. Cohen, 177 Ariz. 480, 868 P.2d 1063 (App. 1994). This theory does not support a comparative fault argument.

4. Breach of Warranty.

This claim depends entirely on the language contained in the relevant contract documents, and can form the basis of a third party claim against a sub-trade.

5. Claims against Design Professionals.

Architects, engineers and other design professionals, such as surveyors, often contribute to defective construction by failing to prepare adequate plans and specifications, or by failing to carry out their portion of the work within the applicable standard of care. Often, design professionals are contracted to provide their services; the contract provides a basis for liability and "expectation" damages (purely economic damages) cannot be recovered through tort claims (negligence). Flagstaff Affordable Housing Ltd. Partnership v. Design Alliance, Inc. 212 P.3d 125 (Ariz. 2010). Even absent a contract, design professionals can be held responsible for their contribution to loss. "[d]esign professionals have a duty to use ordinary skill, care, and diligence in rendering their professional services,' and are liable for 'foreseeable injuries to foreseeable victims which proximately result from their negligent performance of their professional services.'" Hughes Custom Bldg, L.L.C. v. Davey, 221 Ariz. 527, 531, 212 P.3d 865, 869 (App. 2009). "Design professionals, in the absence of an express guarantee, do not 'warrant' that their work will be 'accurate,' Rather, as noted above, they 'warrant' merely that they have exercised their skills with care and diligence and in a reasonable, non-negligent manner. A claim for breach of a common law warranty does not require privity." Donnelly Const. Co. v. Oberg/Hunt/Gilleland, 139 Ariz. 184, 189, 677 P.2d 1292, 1297 (1984). To the extent a design profession is proven to have failed to exercise his skills with care and diligence and in a reasonable non-negligent manner, the design professional can be found to have breached his common law warranties and face liability for construction defects.

III. ECONOMIC DAMAGES AND FEES.

A. Loss of Use

Loss of use is recoverable. If a homeowner must be relocated, the cost of replacement housing equivalent to the loss of use of the primary residence is recoverable. The analogy is to ALE in a first party property loss claim.

B. Attorneys' Fees

Ariz.Rev.Stat. § 12-1364 now provides directly for the recovery of attorney's fees, expert fees and costs. The new provision works much the same way as an offer of judgment pursuant to Rule 68, Arizona Rules of Civil Procedure. The statute does not abrogate the long standing rule applicable to attorney's fees.

Recovery of attorneys' fees is otherwise governed by Ariz.Rev.Stat. § 12-341.01, which provides for an award of attorneys' fees in "any contested action arising out of contract, express or implied." An award of attorney's fees is discretionary with the court. Arizona courts have construed this language very broadly, allowing for awards in many types of cases. See ASH, Inc. v. Mesa Unified School District No.4, 138 Ariz. 190, 673 P.2d 934 (App. 1983). In the construction defect context where negligent claims and implied warranty claims are so intertwined, the courts will have more latitude in awarding fees. Moreover, if the homeowner's association succeeds on even one count that sounds in contract, or arises out of contract, the court has the discretion to award total fees as opposed to apportioning them. Sparks v. Republic National Life Insurance Company, 132 Ariz. 529, 647 P.2d 1127 (1982). If a subcontractor prevails on a third party claim for indemnity or breach of contract, the general contractor or developer may be entitled to pass on an award of attorney's fees to the homeowner's association. Nationwide Resources Corporation v. Ngai, 129 Ariz. 226, 630 P.2d 49 (App. 1981).

C. Costs

Recovery of costs in construction defect cases is also governed by Ariz.Rev.Stat. § 12-332. This statute mandates the award of taxable costs. The law interpreting this statute is well settled that a party cannot recover litigation expenses as taxable costs unless a statutory basis exists for recovery. Sweis v. Chatwin, 120 Ariz. 249, 585 P.2d 269 (App. 1978). This statute has been further interpreted to allow recovery of expert witness fees incurred in taking the deposition or trial testimony of the expert. However, recovery of the expert's investigative fees are not considered taxable costs and, therefore, not recoverable. However, as mentioned above, Ariz.Rev.Stat. § 12-1362 will most likely allow even greater recovery of expert fees and thus the costs requested under this section will most likely be less significant.

IV. DAMRON AND MORRIS AGREEMENTS.

In Damron v. Sledge, 105 Ariz. 515, 460 P2d. 997 (l969), the Arizona Supreme Court recognized that when an insurance company refuses to defend its insured in a suit brought by a third party, the insured is entitled to settle with the plaintiff without the carrier's consent. These agreements have three essential parts: First, the plaintiff gives the defendant/indemnitee a covenant not to execute upon any judgment it might obtain against it. Second, the defendant assigns all of its rights against the insurance carrier/indemnitor to the plaintiff. Third, the defendant/indemnitee agrees to stipulate to a judgment or withdraws its answer and allows a default judgment to be taken against it.

In Damron v. Sledge, 105 Ariz. 151, 460 P.2d 997 (1969), the insurer denied coverage under an auto policy and declined to defend the insured. The insured entered into an agreement with the plaintiff under which the plaintiff gave him a covenant not to execute in return for his stipulation to a default being entered against him and an assignment of his bad faith claim against the insurer. A default judgment was entered against the insured after a default hearing.

The Arizona Supreme Court held that the insured's action was a proper self-protective response to the insurer's denial of a defense. It held that the agreement was not collusive under the circumstances even though it resulted in a significant ex parte judgment against the insured. It placed the risk of ultimately having to pay an unduly large judgment on the insurer that refuses to defend. The case gives name to "Damron agreements" in Arizona.

If an insurer defends under a "reservation of rights," an insured has a right to enter into a Morris agreement as described in United Services Automobile Association v. Morris, 154 Ariz. 113, 741 P.2d 246 (1987). In Morris, the insured entered into an agreement with the plaintiff in which the plaintiff gave him a covenant not to execute in return for a stipulation to allow the entry of a $100,000 judgment against him and an assignment of his rights against his insurer.

The Arizona Supreme Court held the agreement did not constitute a breach by the insured of the cooperation clause because the insurer had not extended unreserved coverage. But it concluded that the stipulated judgment would not be binding on the insurer if it could ultimately prove that there was no coverage. In addition, the insurer could attack a judgment on the basis that the insured's settlement was not fair and reasonable under the circumstances. It could also attack a judgment that was collusive or fraudulent.

A reservation of rights must be "properly communicated" to the insured in a timely manner. In other words, a reservation of rights letter must, in a straightforward manner, fairly inform a reader of average intelligence of the fact that the insurer is providing a defense without waiving its rights to later contest coverage. Equity General Insurance Co. v. C & A Realty Co., 148 Ariz. 515, 715 P.2d 768 (App. 1985). It must also inform the reader of the concerns that the insurer has with coverage. Globe Indemnity Co. v. Blomfield, 115 Ariz. 5, 562 P.2d 1372 (App. 1977). A reservation of rights should be sent before the insurer assumes the defense, otherwise, the insured may reasonably rely upon the non-existence of policy defenses. Equity General.

Under a Morris agreement, an insured agrees with the plaintiff to allow judgment to be entered against it (either by default or stipulation). The insured also agrees to assign to the plaintiff all rights it may have under its liability insurance policy. The plaintiff, in turn, gives the insured a covenant not to execute upon any of the insured's assets and agrees to collect the judgment only from the liability insurance. The plaintiff then brings a breach of contract/declaratory judgment action against the insurer as the insured's assignee.

The Arizona Supreme Court held in Morris that an insurer's defense under a reservation of rights narrows the reach of the cooperation clause and allows the insured to take reasonable steps to protect itself from the danger of personal liability. Thus, the insured may enter into a settlement agreement as described above without breaching the cooperation clause. The insured's stipulation to liability and damages under a Morris agreement is not binding upon the insurer unless the insured (or its assignee) can show that the settlement was reasonable and prudent. The insured must give the insurer notice of a proposed Morris agreement and give it the opportunity to defend unconditionally.

Since Damron and Morris and some of the subsequent related cases, there has been an impression that an insurer could be held strictly bound by a stipulated judgment of any amount entered in connection with a Damron agreement (refusal to defend), but could only be bound by a judgment of a reasonable amount entered in connection with a Morris agreement (defense under a reservation of rights). See, Arizona Prop. & Cas. Guar. Fund. v. Helme, 153 Ariz. 129, 735 P.2d 451 (1987).

Recent re-examination of language in Helme (which came before Morris) suggests that a Damron settlement also has to be for a reasonable amount. Thus, whether an insurer refuses to defend or defends under a reservation of rights, the insured should only be able to stipulate to a judgment that is "reasonable." See discussion at Barrett v. Samaritan Health Services, Inc., 153 Ariz. 138, 735 P.2d 460 (West note 14). The issue may not come up if the agreement allows a neutral fact-finder to determine the amount of the judgment.

These cases are especially relevant in the CD context in Arizona, where the notice and opportunity to repair statute (NOR) requires insurers to defend on the seller's (insured's) receipt of a Notice of Deficiencies. A.R.S. §12-1362(B). Under the current statute, a seller (insured) only has sixty days to evaluate the buyer's (plaintiff's) claims and provide a good faith response, in other words, an offer to repair or replace. The offer can be in the form of a monetary equivalent of the value of necessary repairs. However, if this opportunity is missed, the plaintiff can immediately file its complaint, and get the benefit of mandatory fees and costs if she is the prevailing party. In the absence of any offer, it is safe to assume plaintiff will be the prevailing party if she obtains only one dollar at trial. On the other hand, a seller can "set the bar" by offering repairs, or an equivalent amount, which can provide significant leverage later in the case. For this reason and others, it is imperative that carriers immediately undertake a coverage investigation on the receipt of a CD claim under the statute, regardless if that obligation arises for a direct or additional insured. Equally important is the early, thorough evaluation of the value of the CD case to make meaningful use of ADR opportunities provided by the NOR statute.

Developers can oftentimes extricate themselves from lawsuits by entering into a Damron Agreement with the homeowner's association. Where the developer has a written contract with a general contractor or subcontractor that requires that entity to indemnify the developer, the developer can tender the defense to the other party. Should the other party refuse to accept the tender, the developer can enter into a type of Damron Agreement with the homeowner's association, protect itself from execution of the judgment and assign its express indemnity rights against the subcontractors to the HOA. The HOA then steps into the shoes of the developer and pursues the subcontractors via the express indemnity contracts.

Either way, early defense and meaningful evaluation of CD cases on behalf of insureds can go a long way toward militating against Damron/Morris assignments, which most often result in more headaches and expense for carriers.

V. ADDITIONAL INSURANCE

Many construction contracts require the subcontractor to name the general contractor and/or the owner/developer as an additional insured under its commercial liability policy. Subcontractors can fulfill this obligation to name them as an additional insured by purchasing a broad form Additional Insured Endorsement. The subcontractor may also request that its insurance carrier specifically name the general contractor/developer owner as an additional named insured. Generally, this affords the same coverage to the additional named insured as provided to the named insured/contractor subject to similar limitations and exclusions contained in the insuring agreement.

The typical additional insured endorsement limits coverage to the work performed by the named insured, for example, to the extent a general contractor seeks Additional Insured Endorsement coverage from a subcontractor, the coverage is typically limited to covered damages arising out of the work of the subcontractor. And we are seeing most AI Endorsements excluding "completed operations" among other things, which has drastically limits the available AI coverage for Developers.

For the most part, there has been a scarcity of published authority on which to base sound coverage decisions in Arizona. Reliance on cases dealing with more traditional coverage questions has been the norm, and has, not surprisingly, led to more than a few coverage contests in the CD arena. Fortunately, from a coverage perspective, the recent flurry of CD litigation in Arizona has finally resulted in a handful of decisions providing some guidance, but there are still quite a number of unanswered questions. This article provides some background in the recent development of Arizona authority relating to coverage for CD claims, with a focus on how those decisions relate to additional insurance coverage.

A. Definition of "Occurrence", and Coverage for Property Damage

Traditionally, Arizona Courts held that insurance policies provided coverage when the resulting injury occurs within the respective policy period. Century Mutual Insurance Co. v. Southern Arizona Aviation, 8 Ariz. App. 384, 446 P.2d 490 (1968); State v. Glen Falls Insurance Co., 125 Ariz. 328, 609 P.2d 598 (Ariz. App.1980). Although these cases did not involve claims of progressive property damage, they seemed to contemplate multiple policy triggers if damage occurred over subsequent policy periods.

The basic bright line rule relating to an occurrence involving construction defect damages was established in United States Fidelity & Guaranty Corp. v Advance Roofing & Supply Co., Inc., 163 Ariz. 476, 788 P.2d 1227 (App. 1989). In Advance Roofing, a roofing contractor failed to complete its contract to re-roof 250 units in a condominium complex. The company only installed roofs on 40 units and that work was defective. The homeowners association sought to recover the entire contract price it had paid the contractor. The Court found that "mere faulty workmanship, standing alone" does not constitute an "occurrence" under a contractor's CGL policy, and thus held the contract damages were not covered by the involved policy. The Court also held that the cost of repairing faulty workmanship would not constitute "property damage". Implicit in this holding is a conclusion that defective performance of construction work is not considered to be an accident. The court's definition of "mere faulty workmanship, standing alone" is not entirely clear from the opinion. In reaching its opinion, the court relied upon a decision by the New Hampshire Supreme Court, McAllister v. Peerless Insurance Company, 124 N.H. 676, 474 A.2d 1033 (1984). The court in McAllister found that there was no coverage for a landscaping contractor's faulty work, noting,

[ The claimant ] did not claim that such defects had caused damage to any other property than the work product, nor did he claim any damage to the work product other than the defective workmanship.

Id., 474 A.2d at 1035. In McAllister, the claimant alleged that the contractor had improperly constructed a leach field resulting in inadequate dispersal of effluent. The Advanced Roofing Court's reliance on the McAllister quotation signaled the Arizona court would find coverage if defective work was alleged to cause damage to property other than the work product. In other words, if the defective roof leaked and property inside suffered water damage, there would likely be coverage under the Advance Roofing opinion.[1]

Most recently, the Arizona Court of Appeals had an opportunity to take the Advance Roofing decision a step further in Lennar Corp. v. Auto-Owners Ins. Co., 214 Ariz. 255, 151 P.3d 538 (App. 2007). The case involved a Complaint by homeowners at the Pinnacle Hill development in Glendale, Arizona alleging damage from expansive soils, and inadequate foundations. Early in the litigation, Lennar filed a third party complaint against various implicated sub-trades. Lennar also tendered the case to its sub-trade's insurers, demanding coverage as an additional insured.

Lennar retained Roel Consulting Group to investigate the allegations. Roel concluded the primary cause of damage at the project was the faulty work of certain sub-trades. Lennar compiled affidavits from Roel identifying which sub-trades contributed to the alleged damage and detailing how much damage was caused. Plaintiff's expert, Randy Marwig, established through deposition testimony that there may have been "specific deficiencies which may be either made worse or created by the construction deficiencies ... even in the absence of soil movement."

The involved AI insurers refused to provide Lennar a defense under their respective policies. Lennar then filed various cross-claims, counter claims and a third party complaint alleging bad faith against the AI insurers. Separately filed declaratory relief actions were brought by two of the involved AI carriers. The Court bifurcated the bad faith issues from the duty to defend issues, and motions for summary judgment were filed by the insurers alleging they did not owe a duty to defend Lennar. The trial Court granted the insurers motions as to all claims, including the bifurcated bad faith issues and Lennar appealed.

The Lennar Court initially noted insuring language from the involved insurance policies providing that the insurers: "will have the right and duty to defend the insured against any 'suit' seeking damages to which the insurance coverage applies," and that pursuant to such language, the insurers "would have the duty to defend a suit alleging facts that, if true, would give rise to coverage, even though there would ultimately be no obligation to indemnify if the facts giving rise to coverage were not established." The long and the short of the Lennar case is that for a variety of reasons, the Court found coverage in favor of Lennar. To this end, the Court stated: "to the extent that property damage occurs during the period for which Lennar is a named insured on a policy purchased by one of its subcontractors, it is entitled to coverage for qualifying occurrences during that policy period, and thus to a defense on a complaint alleging such claims."

Several important conclusions were reached by the Lennar Court. To begin with, the court confirmed that faulty workmanship, standing alone, does not constitute an "occurrence" under a CGL policy, and that the cost of repairing such faulty workmanship is not "property damage." The court then clarified what was only implied in Advance Roofing: an occurrence is sufficiently alleged if faulty workmanship allegedly causes damage to other portions of a building (such as the wall and floor cracks that resulted from soil expansion). The Court found this to be true even though this alleged "resulting damage" constituted only a portion of the allegations in the plaintiff's complaint.

The Court highlighted long standing Arizona law establishing that "if any claim alleged in the complaint is within the policy's coverage, the insurer has a duty to defend the entire suit, because it is impossible to determine the basis upon which the plaintiff will recover (if any) until the action is completed."

In addition, the court rejected two coverage arguments that have been used by insurers around the country. It ruled:

  • "Property damage" resulting from faulty workmanship is covered even though it might be considered a natural consequence of faulty workmanship. Faulty construction may constitute a "general harmful condition," and when accidental property damage results from continued exposure to faulty construction, that property damage is an "occurrence" as defined by the involved policies.
  • Faulty workmanship is not an intentional act that would preclude the finding of an accidental occurrence, even though it could be argued that a contractor intended to perform the faulty work. Additionally, whether an event is accidental is evaluated from the standpoint of the insured, here Lennar, which did not perform the work. No evidence was submitted to establish that Lennar intended its subs to perform faulty work.

Other highlights of the Lennar decision include:

  • Because "some factual showing" was made by Lennar to establish coverage (the affidavits supplied by its expert together with the deposition testimony of plaintiff's expert), the insurers could not deny coverage on the basis the complaint was insufficient to implicate the work of a particular sub-trade. At the point at which "some factual showing" is made by an insured, an insurer must investigate and establish that the true facts of the case take the complaint outside the policy coverage." See also, Mark Hancock Development v. Atrium Door & Window Company, et. al., (memorandum decision - 1 CA-CV 05-0789)(subcontractors must prove the absence of any evidence to support a developer's third party claim to obtain summary judgment; charts by experts summarizing defects present in each home, which subs were responsible, the percentages of responsibility and costs to cure each defect were adequate to survive summary judgment).
  • The Lennar Court arguably adopted a continuous trigger theory as discussed below.
  • The Court recognized the "known-loss" rule, but declined to consider its application because it has not been adequately raised in the trial court.
  • The Court also recognized that the subcontractor exception to the "damage to your work" exclusion extended coverage for damage to an insured's work resulting from the work of the insured's subcontractor. Lennar, as the developer/general contractor, was entitled to coverage even though the houses were its "work."

B. Coverage Under a Blanket AI Endorsement

Of interest to those concerned about additional insurance coverage is the discussion in Lennar concerning the UNIC blanket additional insured endorsement. UNIC issued a blanket endorsement on one of the involved subcontractor policies (Wheeler Construction). Lennar contended the blanket endorsement provided coverage to Lennar when read together with the subcontract. The Court, however, denied coverage to Lennar through the Wheeler AI endorsement because the subcontract, while requiring Wheeler to insure Lennar, did not specifically require Wheeler to provide AI coverage. And Wheeler's obligation to "indemnify" Lennar in the subcontract was not sufficient to establish an obligation by Wheeler's insurer to provide a defense.

The Court appeared to require one of two things by a claimed insured to establish an obligation on the part of an AI carrier in the event of a blanket endorsement: either 1) an AI endorsement in favor of the developer/GC; or, 2) a blanket AI endorsement and a specific requirement by the insured sub-trade to provide AI coverage to the developer/GC. Obviously, the language of the subcontract is critical in the absence of an endorsement specifically covering the project.

C. Determining the Date of "Occurrence" or Loss, i.e., Manifestation vs. Continuous Trigger.

Arizona's appellate courts have been historically inconsistent regarding the determination of an occurrence trigger relative to insurance policies. See, Mutual Ins. Co. v. Southern Arizona Aviation, Inc., 8 Ariz. App. 384, 446 P.2d 490 (1968)(airplane accident caused by installation of faulty propeller; date of the negligent installation of the propeller was not the occurrence; accident after policy expired was the "occurrence"); and, State of Arizona v. Glen Falls Ins. Co., 125 Ariz. 328, 609 P.2d 598 (App. 1980)(claim by depositors for loss of funds deposited into thrift associations; occurrence or accident was when depositors were actually damaged, not time of the wrongful act; actual damage occurred when thrifts were placed into receivership and depositors could not withdraw funds; there was only potential damage at time when thrifts became insolvent); as opposed to: University Mechanical v. Puritan Ins. Co., 150 Ariz. 299, 723 P.2d 648 (1986)(leaks in plumbing couplings and O-rings purchased from a supplier; leaks discovered over one year after installation and after supplier's policy expired; leaks caused because faulty couplings cut into O-rings; Court found installation of O-rings to be property damage to entire facility with no further explanation; damage called "loss of use" by court, but damage in reality was the cost of repair/replacement; policy covered loss of use at any time as long as property damage occurred within policy period).

The United States District Court in Arizona, purporting to apply Arizona law, applied a continuous trigger theory in Aetna Casualty & Surety Co. v. PPG Industries, Inc., 554 F. Supp. 290 (D. Ariz. 1983). More recently, the Court of Appeals applied a continuous trigger theory to a toxic tort case where continuous contamination to groundwater chemical exposure resulted in a Morris agreement. Associated Aviation Underwriters v. Wood, 209 Ariz. 137, 98 P.3d 572 (App. 2004). The Wood Court found that the insurer could not contest underlying liability and damages issues because the Morris judgment was binding and had collateral estoppel effect. In its application of a continuous trigger theory, the Court found that damage began on first exposure and continued to manifestation.

The Lennar decision went a bit further to apply a continuous trigger theory to construction defect. In Lennar, the insurers argued the Court should apply a manifestation trigger theory and limit coverage to the policies in force when the damages first appeared. The Court rejected this argument and appears to have adopted a broad continuous injury trigger theory, although it did not engage in any discussion or analysis of the competing trigger theories. The Court stated that under the insuring language of a CGL policy, an insurer must provide coverage for property damage that occurs during its policy period even if other similar damage preceded that damage. Under the Court's ruling, coverage would not necessarily end upon the first manifestation of damage, as some other Courts have held. Instead, it appears the decision supports the argument that coverage could continue as long as damage continues, in other words, under successive policy periods.

D. The Duty to Defend the Additional Insured

The obligation of an insurer to defend an "additional" named insured, once established, is the same as the obligation to defend a "primary" named insured. The term "additional insured" is actually a misnomer as it applies to the duty to defend. On the other hand, an insurer's duty to indemnify may be more greatly restricted by an AI endorsement than the general insuring agreement.

Generally, an insurer is required to defend an insured in Arizona at the earliest stages of litigation, even if the claims against an insured are groundless, and regardless if the insured is found liable. Paulin v. Fireman's Fund Insurance Co., 1 Ariz.App. 408, 403 P.2d 555 (1965); INA Insurance Co. v. Valley Forge Ins. Co., 150 Ariz. 248, 722 P.2d 975 (App.1986). The duty extends to covered and non-covered claims. Western Casualty & Surety Co. v. International Spas of Arizona, Inc., 130 Ariz. 76, 634 P.2d 3 (App. 1981).

Typically, an insurer is not required to defend until it receives a complaint filed against an insured. Manny v. Estate of Anderson, 117 Ariz. 548, 574 P.2d 36 (App. 1977). Obviously, most typical CGL policies that follow the ISO standard form require a defense to a Demand for Arbitration, which is included in the definition of "suit."[2] However, in Arizona, under the more recently adopted purchaser dwelling act, an insurer must treat a notice of defects received by a seller (insured) pursuant to the statute as a notice of claim. ARS 12-1362(B).

Notwithstanding this directive, the duty to defend is not absolute and will depend upon the actual facts rather than upon the allegations of the complaint. Generally, if the complaint, on its face, alleges facts which come within the coverage of the policy, the insurer is required to defend. If the alleged facts fail to bring the case within the policy coverage, the insurer is free of such obligation. If the alleged facts ostensibly bring the case within the policy coverage, but other facts which are not reflected in the complaint take the case outside the policy coverage, there is no duty to defend. See Kepner v. Western Fire Insurance Co., 109 Ariz. 329, 509 P.2d 222 (1973); Granite State Insurance Corp. v. Mountain States Telephone & Telegraph Co., 117 Ariz. 432, 573 P.2d 506 (App. 1977) and Salvatierra v. National Indemnity Co., 133 Ariz. 16, 648 P.2d 131 (App. 1982). An insured is required to give its insurer notice of any amended pleadings which would impose a duty to defend. See, Salvatierra, supra.

An insurer may initially rely on the allegations of a complaint to determine whether it owes a defense. It may not rely on that determination, without investigating the facts, if the insured comes forward and makes some factual showing that the suit is actually one for damages resulting from events that do fall within the policy terms. See Advance Roofing, and Lennar, supra.

If any claim alleged in the complaint is within the policy's coverage, the insurer has a duty to defend the entire suit, because it is impossible to determine the basis on which the plaintiff will recover (if any) until the action is completed. Western Casualty & Surety Co. v. International Spas of Arizona, Inc., 130 Ariz. 76, 634 P.2d 3 (App. 1981); Lennar, supra.

In California, the issue of the extent of an AI carrier's obligation to defend an additional insured has been established for a decade. See, Maryland Casualty Co. v. Nationwide Insurance Co., 65 Cal.App.4th 21 (1998).

Arizona has now officially followed suit. In the recent case of Regal Homes, Inc. v. C.N.A. Insurance, 171 P.3d 610, 217 Ariz. 159, 518 Ariz. Adv. Rep. 18, Division One of the Arizona Court of Appeals applied long standing coverage principles to a case involving additional insurance in the construction defect context. The Court held that, among other things, an insurer owes the duty to defend the entire suit on behalf of its additional insured.

Regal was the builder of a residential community known as "The Shores." Regal obtained primary coverage from Auto Owners for one year (1995) and Zurich for three additional, successive years (1996-1998). Regal hired GMS concrete, which provided additional insurance to Regal through CNA for simultaneous policy periods (1995 - 1998). Two separate lawsuits were filed by two groups of homeowners. The first settled with payments by Regal, Auto Owners and Zurich totaling 2.4 million (neither Auto Owners nor Zurich exhausted their respective policies). The second went to trial and resulted in an award against Regal, and a determination that GMS was not at fault.

CNA did not participate in either case despite tenders of defense to the company.

The Regal Court first noted that the judgment in favor of GMS established for purposes of appeal the absence of fault and/or proximate cause on the part of GMS.

In the appeal, Auto Owners sought to establish, among other things, that CNA owed a defense and indemnity to Regal. In support of its defense, CNA argued that because GMS was found to be free of fault for the allegations levied against Regal in the second case, it did not owe a defense or indemnity to Regal through its AI endorsement in the first case. CNA based its argument on the absence of causal connection between GMS' work and Regal's liability.

The endorsement at issue contained commonly found language providing that Regal was "an additional insured only with respect to liability arising out of GMS' work for Regal." The Court noted that "the commonly understood meaning of the words "arising out of" requires only some causal relationship between the injury and the risk for which coverage was provided." The Court held, as a result, that the determination of no fault or liability on the part of GMS did not end the inquiry, because the causal connection necessary to satisfy the "arising out of" requirement is less than that required for proximate cause. The Court remanded the case with further instructions, namely, that "the question whether the alleged liability of Regal arose out of GMS' work must be determined initially from the allegations in the complaint against Regal and the facts known at that time."

The Court indicated that "it is possible the requisite nexus (arising out of) could be established for the duty to defend but not for the duty to indemnify." In essence, then, if the facts known at the time the complaint was filed established some causal relationship between GMS' work and Regal's liability, CNA would be responsible for the defense of Regal, regardless that GMS was ultimately found free of fault by a trier of fact.

The Court determined that, due to a factual finding, the CNA endorsement did not require primary coverage as applied to the Auto Owners policy, which was held to be primary for its policy term. However, the Court found the CNA policy was primary as applied to the Zurich policy because the "other insurance" clauses of each were mutually repugnant. In that instance, the Court held, both policies are primary.[3]

With this background in mind, the Court held that because each of the three insurers were primary, and because Regal alleged the occurrence of damages within each of the four successive policy periods, each policy was triggered, and therefore, each insurer had an equal obligation to defend the underlying case. The Court specifically held that regardless of the number of policy periods insured by the involved carriers, each owed a duty to defend the entire case. This ruling applied equally to both direct and additional insurers.

E. Allocation of Damages Given Multiple Policies

The 86,000 dollar question still persists in Arizona.

The Regal Court provided some guidance. The Court remanded the case to the trial court for a determination of allocation of defense costs amongst the participating carriers under the theory of equitable subrogation. The Court made it clear that the insurer requesting reimbursement under an equitable subrogation theory must prove it paid more than its "fair share" in defense costs. Although the Court declined to determine the appropriate method to allocate such costs, it referred the parties to the discussion of six acceptable methods in Centennial Ins. Co. v. U.S. Fire Ins. Co., 105 Cal.Rptr.2d 559, 562-64 (Cal. Ct. App. 2001)(equal shares; time on risk; policy limits; combined policy limit - time on risk; premiums paid; and maximum loss).

Some guidance can be gleaned from cases involving indemnity allocations to sub-trades. It should be noted here that in Arizona, an expert witness cannot be utilized to apportion percentages of fault for a jury; such testimony constitutes inadmissible legal conclusions under Rule 704, Ariz.R.Evid. Webb v. Omni Block, 166 P.3d 140, 216 Ariz. 349, 512 Ariz.Adv.Rep.28. However, when considering an appropriate method to allocate damages amongst sub-trades, at least one Court has suggested comparison of costs to repair. See, Mark Hancock Development v. Atrium Door & Window Company, et. al., (memorandum decision - 1 CA-CV 05-0789)(if the trial court engages in any comparisons to make the allocations, it will be comparisons of costs to repair, not of degrees of negligence). Obviously, expert opinions regarding percentage of fault of sub-trades can be helpful, even necessary, to resolve issues of allocation where more than one sub-trade can be blamed, because to some extent repair costs will overlap. But because the cost of repair attributed to each sub-trade appears to be the accepted valuation, focusing allocations on actual repair costs associated with the work of the particular sub-trades seems the most appropriate method for indemnity allocations in Arizona.

VI. DEFENSES

A. Contributory Negligence, Comparative Fault of Parties and Non-Parties

Construction defect claims are governed by Ariz.Rev.Stat. §12-2506, which provides in pertinent part:

"In an action for personal injury, property damage or wrongful death, the liability of each defendant for damages is several only and is not joint . . . Each defendant is liable only for the amount of damages allocated to that defendant in direct proportion to the defendant's percentage of fault, and . . . judgment shall be entered against the defendant for that amount."

The statutory definition of property damage under Ariz.Rev.Stat. §12-2501G is exceedingly broad:

"'Property damage' means both physical damage to tangible property and economic loss proximately caused by a breach of duty."

Thus, several only liability is the rule in commercial disputes as well as personal injury and death cases. For example, in Gemstar Limited v. Ernst & Young, 185 Ariz. 493, 917 P.2d 222 (Ariz. 1996), several-only principles were applicable to a commercial dispute involving claims of breach of contract, negligence, and breach of fiduciary duty.

In assessing the "percentage of fault" of each party, the fact-finder must assess the fault of all parties and non-parties who have been designated and who contributed to the injuries or damages. See Ariz.R.Civ.P. 26(b)(5); see also A.R.S. Section 12-2506(B) (Uniform Contributory Among Tortfeasors Act) (hereinafter "The Act"). The Act broadly defines fault as: [A]n actionable breach of legal duty, act or omission proximately causing or contributing to injury or damages sustained by a person seeking recovery, including negligence in all of its degrees, contributory negligence, assumption of the risk, strict liability, breach of express or implied warranty of a product, products liability and misuse, modification or abuse of a product.

A.R.S. Section 12-2506(F)(2); see also Zuern By and Through Zuern v. Ford Motor Co., 188 Ariz. 486, 490-91; 937 P.2d 676, 680-81 (App. 1996). Claimant cannot recover any damages resulting from its or its members' own negligence or the negligence of their agents or employees. See INA Ins. Co .of North America v. Valley Forge Ins. Co., 150 Ariz. 248, 255; 722 P.2d 975, 982 (App. 1986). This includes the fault of Claimant and their members in failing and/or refusing to perform repairs or agree to have repairs performed at the Project.

Any construction defects at the Project that are found to exist are likely the result of work, actions, and/or inactions of other persons or entities and not from the actions of the Developer. This includes Claimant as well as any other entity who performed repairs, maintenance, inspections and expert testing at the Project. Additionally, Claimant cannot recover any damages resulting from their own negligence. See INA Ins. Co .of North America., supra.

B. Failure to Mitigate

Once Claimant determines that the common areas and units within the Project were experiencing problems, the Claimant is obligated to take reasonable steps to resolve the problems as quickly as possible in order to minimize any resulting damage. See Coury Bros. Ranches, Inc. v. Ellsworth, 103 Ariz. 515, 518; 446 P.2d 458, 461 (1968). Claimant cannot recover for loss which occurred as a result of Claimant's failure to take reasonable steps to avoid additional and/or continuing losses. Continental Townhouse East Unit One Ass'n v. Brockbank, 152 Ariz. 537; 733 P.2d 1120 (App. 1986).

C. Extrapolation Invalid

Claimant must prove its damages with reasonable certainty. Continental Life & Acc. Co. v. Songer, 124 Ariz. 294; 603 P.2d 921 (App. 1979). To the extent that Claimant seeks to rely on indirect observations and/or statistical probabilities to support its claim, extrapolation is not an appropriate or acceptable basis for Claimant's expert's opinions. Claimant's experts are unqualified to render opinions on the statistical probability that all of the residences at the Project have the same alleged defects without conducting actual investigations to qualify and quantify the allegations. Therefore, each alleged deficiency for each alleged location and structure must be proven through visual inspections, or if necessary, through destructive testing.

Therefore, Claimant's experts are precluded from offering testimony regarding defects that have not been properly tested and/or observed. Evidence of one observed defect is inadmissible to prove the existence of another defect because such evidence is highly prejudicial and not probative of actual defects that may be present. Even if the evidence of observed defects has some bearing on the construction of the alleged unobserved defects, the prejudicial and confusing nature of the evidence strongly outweighs any probative value and the testimony should be excluded pursuant to Rule 403 of the Arizona Rules of Evidence.

D. Diminution of Value

If Claimant seeks to recover for alleged diminution in value, it is only entitled to the lesser amount between the diminution in value and the alleged cost to repair the alleged defects. Arizona law dictates that the measure of damages for injury to land and improvements thereon is the "difference in the market value of the land immediately before the injury and immediately after the injury, but if the land may be restored to its original condition, the cost of restoration may be used as the measure of damages if it does not exceed the diminution in the market value of the land." Blanton & Co. v. Transamerica Title Ins. Co., 24 Ariz.App.185, 188; 536 P.2d 1077, 1080 (App. 1975). Claimant has the burden of proving the cost of repair for each of the alleged defects in each unit as well as a diminution in property value. Only if Claimant can make such a showing are they entitled to less of the amounts between the cost of restoration and the diminution of value.

E. Economic Waste

Economic waste is applicable where a plaintiff's expert opines that "spot repairs" are inadequate and that the existing structure or system must be replaced. A.I.D. Inc. Services v. Riley, 25 Ariz.App. 132, 136; 541 P.2d 595, 599 (App. 1975). "The cost or repair or replacement cannot exceed the difference between the fair market value of the structure before and after the injury." Id. The concept of economic waste changes the general cost of repair rule according to Comment (b) to the RESTATEMENT OF CONTRACTS, Section 346(1) (1932);

The purpose of money damages is to put the injured party in as good a condition as that in which full performance would have put him; but this does not mean that he is to be put in the same specific physical position . . . . There are numerous cases . . . in which the value of the finished product is much less than the cost of producing it after the breach has occurred.

Sometimes defects in a completed structure cannot be physically remedied without tearing down and rebuilding, at a cost that would be imprudent and unreasonable. The law does not require damages to be measured by a method requiring such economic waste.

Damages in the form of cost of repair are generally applicable to a breach of construction contract and result in damages awarded for the reasonable costs of construction and completion in accordance with the construction contract. Sorensen v. Robert N. Ewing, 8 Ariz.App. 540; 448 P.2d 110 (App. 1968). However, if economic waste rule would result from awarding damages in accordance with the cost of repair rule, damages will be awarded for the difference in value of the building had it been completed in accordance with the contract versus the value of the building as erected rather than on the basis of reasonable cost of completion to conform to the contract. Maricopa County v. Walsh & Oberg Architects, Inc., 16 Ariz.App. 439; 494 P.2d 447 (App. 1972).

F. Statute of Limitations and Repose

  1. 8 year statute of limitations: breach of implied warranties - the statute of repose. Claimant's claims may be barred by the application of the statute of limitations. A.R.S. Section 12-552 precludes contract and implied warranty claims against developers and builders filed more than eight years after substantial completion of the improvements. Only if the injury occurs during the eight year after substantial completion or a latent defect is discovered during the eight years does the limitations period extend by one year. Id. ("If the injury or discovery of a latent defect occurs during the eighth year, the action must be filed within one year of the injury or discovery."). Claimant's claims that fall outside of the applicable limitations period are barred. See Maycock v. Asilomar Dev. Inc., 207 Ariz. 495, 496; 88 P.3d 565, 567 (App. 2004). In addition, where owners and/or subsequent purchasers of units at the Project knew or had notice of the alleged defects yet failed to bring their claims within eight years of substantial completion of the Project, such actions are barred by the statute of limitations. Id.
  2. 6 year statute of limitations:
    1. Breach of contract
    2. Breach of express warranty
  3. 3 year statute of limitations: fraud
  4. 2 year statute of limitations:
    1. Negligence
    2. Negligence per se
    3. Negligent misrepresentation
    4. Nuisance

Claimant's tort claims are subject to a two year statute of limitations. Any tort claim filed by Claimant more than two years after completion of the Project is time barred. A.R.S. Section 12-542.

G. Waiver

Waiver is an express, voluntary, and intentional relinquishment of a known right or conduct that shows an intentional relinquishment of that right. American Continental Life Ins. Co. v. Ranier Construction Co., 125 Ariz. 53; 603 P.2d 372 (1980). A waiver may be expressly stated by a party or it may be implied by or inferred from actions taken by a party that are inconsistent with an intention to assert a particular contractual right. Id. Similarly, by knowingly and unconditionally accepting defective performance, a party has waived any objection to it. Id. Claimant also waived their right to recover where they or others made modifications with respect to the Project that has caused or contributed to the alleged damages.

H. Consent, Completion, Acceptance and Estoppel

To the extent that Plaintiff was on notice of, and consented to, the manner of construction that it now alleges caused/contributed to its alleged damages, Claimant has consented to and accepted the work performed by Developer and its Subcontractors. As such, Claimant would be estopped from arguing that they have been damaged by such work. Therefore, the Developer would not be responsible for payments related to damages from work previously accepted by Claimant.

I. Failure to State a Claim/Cause of Action

The Developer affirmatively alleges that Claimant's Demand for Arbitration fails to state a claim upon which relief may be granted. Ariz.R.Civ.P. 12(b)(6). Claimant has not specifically alleged how the Developer was negligent or by stating specifically how the Developer breached the implied warranties or contract.


[1] It should be noted that the Advance Roofing case is consistent with the prior Arizona case of Continental Insurance Company v. ASARCO, Inc., 153 Ariz. 497, 738 P.2d 368 (App. 1987), citing Weedo v. Stone-E-Brick, Inc., 81 N.J. 233, 405 A.2d 788 (1979), in that it recognizes that the business risk of defective construction is not a risk typically covered by CGL policies. The court noted that to provide coverage for defective workmanship would be to improperly turn a CGL policy into a performance bond.

[2] In 2007, the Arizona Court of Appeals confirmed the broad reach of arbitration provisions when it bound a subcontractor to arbitrate a dispute despite the lack of a specific arbitration provision in the operative subcontract. It was sufficient that the subcontract incorporated the general conditions of the prime contract, and the general conditions incorporated the arbitration provision of the prime contract. Weatherguard v. d.r.Ward, 214 Ariz. 344, 152 P.3d 1227 (App.2007).

[3] The Court reached this decision even though Zurich was not a party; the determination was necessary to complete the analysis of AI coverage for Regal.