Construction Law Client Advisory: What The Recent Beacon Decision Means For Developers And General Contractors

On July 3, 2014, the California Supreme Court (the “Court”) came out with its decision in Beacon Residential Community Association v. Skidmore, Owings & Merrill, et al. The Beacon decision settled a long-standing dispute in California about whether design professionals such as architects and engineers owe a duty to non-client third parties. In finding that the plaintiffs in Beacon could state a claim against the architects of the Beacon project, the Court also sowed the seeds of change in the way contracts are structured between developers, architects, engineers, and even general contractors.

So, how will Beacon change the landscape for developers and general contractors? It is important to understand the factual background in Beacon to predict how the decision may alter the playing field. For a detailed analysis of the Amicus briefs in the Beacon matter from the AIA, the CBIA, and the Consumer Attorneys of California, please click here.

The Beacon case arose from a common development model in California: a developer conceives a multi-unit project, maps the project as a condo development but rents as apartments. Shortly after completion of the Beacon project, the developer sold the entire project and the new owner finalized the existing condominium map and placed the units on the market as condominiums. Although the architects always knew they had designed a residential structure, the project ultimately became a condominium development. The newly formed homeowners’ association filed a construction defect suit against the developers, general contractor, the subcontractors and the architects for design and construction defects.

Starting a project as “apartments” and later selling them as condominiums has been a major source of litigation. Moreover, the evolution of such a project creates complex issues involving indemnity and insurance. The decision to market a project as apartments rather than condominiums is normally driven by, among other things, timing and cost. The timing element boils down to the developer’s assessment of market conditions. The cost element boils down to which project (i.e., apartment or condo) will be more profitable. The cost to obtain insurance on an apartment project is less than the cost to obtain insurance for a condo project, thus the incentive for the developer to start the project as an apartment.

The most immediate result of the Beacon decision will likely be that design professionals will use the result as leverage in price negotiations on certain projects to account for the real or perceived risk that they may be brought into a lawsuit involving third parties.

Developers will also likely see an increase in indemnity and deed restriction requests from design professionals. Construction defect litigation concerning apartments is infrequent. In contrast, a significant percentage of condominium projects go into construction defect litigation. Many years ago, general contractors felt that the developer client’s decision to convert to condominiums left them with significant litigation exposure so they began demanding deed restrictions and reverse indemnity in the event of a conversion. Developers can now expect much the same from architects where they seek indemnity or deed restrictions on condo conversions.

Similarly, developers can also expect renewed efforts by design professionals to limit liability under the contract. Limitations of liability are still valid under Civil Code section 2782.5. While such liability limitations will probably not be binding on third parties, it will bind the developer in the event of an issue.

Although California has fairly strong anti-indemnity statutes, the plain wording of Civil Code section 2782.05 still at least allows indemnity for passive negligence in non-residential projects. Apartments would qualify as non-residential. General Contractors must be more vigilant than ever regarding indemnity provisions, particularly provisions that purport to indemnify the architect, such as the AIA General Conditions A201, section 3.18.1. In the event a General Contractor is provided with an A201, that document must be modified to take into account a possible change in indemnity obligations in the event of a conversion of the project to condominiums.

Finally, look for the insurance market to realize an opportunity when it sees one. Normally design professionals have their own E&O insurance, but design wraps do exist. On some projects, it might make a whole lot of sense for the owner to put together a program that covers the contractors and a program that covers the design professionals. This model could take a lot of pressure off owners when it comes to increased pricing, deed restrictions, and indemnity.

It will be years from now before we understand the full effect of the Beacon decision. There will likely be effects that are currently unforeseen. In the long term, and after all the hoopla surrounding the decision is yesterday’s news, the effects of the Beacon decision could turn out to be marginal. What is for certain is that the building industry will inevitably find an equilibrium point around which it will do business, with or without the Beacon decision.

This document is intended to provide you with information about construction law related developments. The contents of this document are not intended to provide specific legal advice. This communication may be considered advertising in some jurisdictions.

August 14, 2014