THE ORIGINS AND IMPACTS OF CALIFORNIA SENATE BILL 800. A Project. Presented. To the Faculty of. California State University, Chico

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1 THE ORIGINS AND IMPACTS OF CALIFORNIA SENATE BILL 800 A Project Presented To the Faculty of California State University, Chico In Partial Fulfillment of the Requirements for the Degree Master of Science in Interdisciplinary Studies: Construction Management by Jubal Raymond 2011 Summer 2011

2 THE ORIGINS AND IMPACTS OF CALIFORNIA SENATE BILL 800 A Project by Jubal Raymond Summer 2011 APPROVED BY THE DEAN OF GRADUATE STUDIES AND VICE PROVOST FOR RESEARCH: Eun K. Park, Ed.D. APPROVED BY THE GRADUATE ADVISORY COMMITTEE: Sara A. Trechter, Ph.D. Graduate Coordinator Rovane Younger, M.S., Chair Lori A. Brown, MSEE

3 PUBLICATION RIGHTS No portion of this thesis may be reprinted or reproduced in any manner unacceptable to the usual copyright restrictions without the written permission of the author. iii

4 DEDICATION To my wife, Catherine Anne Raymond. iv

5 ACKNOWLEDGMENTS I sincerely thank those who have contributed their knowledge, understanding, and support. I thank my family for emotional and financial support and having confidence in me. Next, I thank the construction management faculty at California State University, Chico, who demonstrate the most professional and educational learning environment available at a university. In particular, I thank Professor Rovane Younger, who helped to provide me with the motivation and expertise with which to complete this program. Finally, I thank the contractors who taught me the building trades. Their guidance helped complete my construction management education. v

6 TABLE OF CONTENTS PAGE Publication Rights... Dedication... Acknowledgments... Abstract... iii iv v viii CHAPTER I. Introduction... 1 II. The Origins of Senate Bill Common Law Origins of Construction Defect Resolution... 5 Implied Warranty Origins... 6 Senate Bill 800 s Case Law Origins... 7 Landmark Case Law... 9 Landmark Case: Huang v. Garner... 9 Landmark Case: Seely v. White Motor Company Landmark Case: Aas v. Superior Court of San Diego County III. Senate Bill 800 Analysis IV. Economic Factors and Senate Bill The Overburdened Legal System Growing Insurance Premiums Senate Bill 800 and the Homeowner Senate Bill 800 and Economic Factors V. Conclusion Industry Changes California s Legal System and Economy vi

7 CHAPTER PAGE Senate Bill 800, Builders Insurance Premiums, and Litigation References vii

8 ABSTRACT THE ORIGINS AND IMPACTS OF CALIFORNIA SENATE BILL 800 by Jubal Raymond 2011 Master of Science in Interdisciplinary Studies: Construction Management California State University, Chico Summer 2011 This study will show how one California Senate Bill 800 contributes to the legal regulation of construction defect resolution in the residential construction industry of California. By conducting a study of California Senate Bill 800 this paper will demonstrate how this important statute affects construction defect resolution law and how it is an important topic for construction management. An analysis of California Senate Bill 800 known as the Right to Repair Law will shed light on the construction defect liability dilemma while examining an important legislative statute and its intended purpose. This study will analyze how Senate Bill 800 became incorporated into the California Civil Code through the current legislative lawmaking process in California. Furthermore, this research will describe how Senate Bill 800 affects the construction defect resolution process, the economy of the residential viii

9 construction field, and the economy of California, thus helping to bring the construction defect liability topic into perspective for the construction management student. ix

10 CHAPTER I INTRODUCTION In the United States, construction law contains a group of regulatory codes and procedures that legally regulate the construction industry. Construction law is a group of laws specifically intended to dictate the legally binding rules of contract law, bonds and bonding, guaranties and sureties, construction claims, in fact, all processes involved with a construction project. Within construction law is a framework of codes, provisions, procedures, ordinances, and other regulatory language, providing guidelines that allow the many constituents who perform a project to work cooperatively and productively without conflict. The laws governing construction litigation begin with case law and administrative law and they are then written into law by legislation. This legislation is combined to form a set of government-mandated standards that regulate litigation for the construction industry. Senate Bill 800 (2002) or the Right to Repair Law, as it is commonly known, is California Civil Code, sections This statute dictates the rights of persons involved in a residential construction defect situation and their recourse to construction defect resolution. It is known as the Right to Repair Law because it gives contractors the opportunity to repair defects before cases are brought into formal litigation. Senate Bill 800 would specify the rights and requirements of a homeowner to bring an action for construction defects, including applicable standards for home construction, 1

11 the statute of limitations, the burden of proof, the damages recoverable, a detailed 2 prelitigation procedure, and the obligations of the homeowner (S.B. 800, 2002, Intro.). Consequently, in addition to the homeowner, the construction industry general contractors, specialty contractors, owners, architects, sureties, material suppliers, equipment manufacturers, and others involved with a project will be affected by this statute. Some contractors and subcontractors who have never been involved in construction defect litigation are unaware of the legal procedure that dictates construction defect resolution. Others retain legal counsel to insure legality in all areas of their work because they can be seriously affected financially by construction defect lawsuits. These lawsuits, when compounded, can negatively affect the development and construction in California and impede California s economic development. Contractors and construction companies project completion can also be adversely affected by construction defect litigation delays. To avoid being involved in construction defect lawsuits, most contractors very diligently try to build in strict accordance to the California Building Code. They also employ lobbyists, law firms, legal consultants, and others to defend against construction defect litigation. Contractors and clients suffer financially due to lawsuits incurred by construction defects. Construction defect resolution is largely what Senate Bill 800 attempts to regulate before lengthy and expensive lawsuits ensue. Senate Bill 800 attempts reroute the way construction defects are arbitrated by giving both sides the opportunity to rectify a grievance before a trial.

12 3 The management of a construction company must be aware of the construction defect litigation procedure because one lawsuit can cause the failure of a company. On a greater scale, construction defects and how they are remedied concern our government because they can contribute to the ascent or decline of construction markets like condominium or commercial construction which greatly affect our economy. State legislation pertaining to construction defects and conflict resolution is vitally important to large companies, homeowners, business owners, subcontractors, and all others involved in construction projects. This document analyzes the significance of Senate Bill 800 and its legal precedents as they have affected construction defect resolution in California historically and particularly in the last 20 years. Analysis of Senate Bill 800 will explain in detail how it changes the residential construction defect resolution process. This study will also examine how California legislators intend Senate Bill 800 to positively impact the economy of California and relieve its overburdened court system. California is continuously undergoing a period of developmental expansion. In fact, according to the U.S. Census Bureau, California underwent a population increase of 6% from the years 2000 to That is an addition of 2 million people. This continuous population growth stimulates a demand for housing and for the construction industry. As structures are hastily erected, construction law must quickly evolve to regulate the legal issues of the construction industry. Foremost among these legal issues is construction defect resolution because defects lead to lawsuits, and when lawsuits accumulate, they have a negative impact on the construction industry and our economy.

13 4 This topic is important in advancing the field of construction due to the potential detrimental fiscal effects that defect litigation has on construction. With an enhanced understanding of new developments in construction defect resolution, builders, homeowners, and other professionals involved in the construction process will become aware of this new legislative statute that is designed to enable them to avoid costly litigation. My research is based on case precedents pertaining to Senate Bill 800, industry reactions to the new statute, and economic trends pertaining to construction in California. I chose this topic because law and how it affects the construction field is very important and dictates the course of construction and, ultimately, economic development in California. The first chapter of this report documents the historic legal doctrines and case precedents that led to the formulation of Senate Bill 800. The second chapter focuses on getting the reader acquainted with content of Senate Bill 800. The third chapter discusses the economic impact that legislators intend Senate Bill 800 to address. The final chapter presents the main findings and discusses the industry changes that Senate Bill 800 has caused.

14 CHAPTER II THE ORIGINS OF SENATE BILL 800 Common Law Origins of Construction Defect Resolution The origin of common law origins date back to medieval England. The Latin term caveat emptor literally means let the buyer beware. Historically, this doctrine has dictated the outcome of most disputes over faulty craftsmanship in western society. Yet our legal system depended on this doctrine until the beginning of the 20 th century concerning construction defect resolution. Currently, the building industry requires more than the broad common law doctrine to ensure fairness in construction defect resolution among builders, contractors, developers, and buyers. The construction of homes, buildings, and commercial structures has moved from a craft to a complex science incorporating many trades. Construction defect resolution laws must evolve to serve the builders and consumers. Senate Bill 800 is a statute that focuses specifically on construction defect conflict resolution. The doctrine of caveat emptor met its full demise soon after America s first housing boom (Poulson, 2006, p. 100). Post-World War II America was a booming market for both commodities and housing. The demand for homes in America increased rapidly and real estate development hurried to meet that demand. An unfortunate side effect of this rush to develop was building defects. Consumer goods were protected by a 5

15 common law-rooted doctrine of implied warranty guaranteeing the quality of an item to a minimum degree of functionality. Homebuyers soon learned that there was no such implied warranty attached to home sales guaranteeing reasonable quality. In fact, it was said the law offered greater protection to the purchaser of a seventy-nine cent dog leash than it did to the purchaser of a 40,000-dollar house (Haskell, 1965, p. 53). It was now evident that the doctrine of caveat emptor did not protect buyers of structures. Implied Warranty Origins As a result of this inequity in consumer protections, there was a flood of litigation that eventually pressured courts to extend the common law concept of implied warranty to the sale of new homes. The first case in America to use the implied warranty concept borrowed from English law was Vandershrier v. Aaron in 1957 in Ohio. The court s verdict found In the law of England, we find the rule to be that, upon the sale of a house in the course of erection, there is an implied warranty that the house will be finished in a workmanlike manner. (Vanderschrier v. Aaron, 1957, p. 819) Due to the complexity of homebuilding and the unseen factors that lurk behind every wall, the Ohio court decided not to rule on this case, based on the precedents set forth by the caveat emptor concept. Instead, the court adopted the English law of implied warranty of workmanlike construction, which is essentially an assurance made during the sale of property or products due to the circumstances of the sale (Vanderschrier v. Aaron, 1957, pp ). These assurances are interpreted as warranties whether or not the seller has expressly promised them verbally or in writing. The Ohio court based its ruling on the average home buyer s lack of knowledge of the many 6

16 factors that go into building a home. The Ohio Court found that the builder should be 7 conscious of all these factors and is obligated to build the house to modern building codes. This case inspired a trend of using the doctrine of implied warranty in construction defect litigation until virtually all states began to enforce this sort of warranty from 1950 through It is important to mention that in addition to this switch, most state supreme courts have ruled that the implied warranty of workmanlike construction be added not only to the primary owners but should be extended to subsequent owners as well. However, states with large economies based on construction, such as California and Texas, did not implement this rule until later for fear of hindering the pace of housing development. Senate Bill 800 s Case Law Origins Case law is a body of law developed by analyzing similar cases that have transpired in the past and relying on the verdicts of these precedents to develop a logical basis for a verdict in a current case. In a landmark case law hearing concerning construction defects in California, the warranty of workmanlike construction was adopted by the California Supreme court in In the case Pollard v. Saxe & Yolles Development Company, the plaintiffs were owners who sued a developer for defects caused in the use of faulty support beams. The court ruled that builders and sellers of new construction should be held to what is impliedly represented that the completed structure was designed and constructed in a reasonably workmanlike manner (Pollard v. Saxe & Yolles Development Company, 1974, p. 88). That is to say, builders should be responsible

17 for producing structures that perform and withstand what is typically expected from a 8 well-built structure. The Pollard v. Saxe & Yolles Development Company case established the implied warranty of workmanlike construction in California, and it is effectively the modern precursor to Senate Bill 800. However, as subsequent cases showed, the Pollard case limited recovery only to original purchasers and barred subsequent purchasers from benefiting from the implied warranty. One may wonder why this implied warranty was not extended to future owners, especially because other states did extend that right soon after, as early as 1976 in Indiana s case, Barnes v. Mac Brown & Company. The reasons to extend the warranty to subsequent owners are many, including the fact that many construction defects do not become apparent for a significant amount of time. Also, many homes are sold and resold within a short period, which allows for builders and initial sellers to sidestep the implied warranty and pass a potentially defective home to an unsuspecting buyer. Most buyers do not have the knowledge to give the home a full inspection. Only later do they discover defects that are often difficult for experts to diagnose. Finally, it seems logical that the builder should bear the burden of building in accordance to code with quality materials. The burden should not be placed upon an unsuspecting buyer. So why didn t California extend this implied warranty to subsequent buyers? The answer has economic roots and this inequity gave rise to the need for new legislation.

18 Landmark Case Law 9 Pollard v. Saxe & Yolles Development Company and Vandershrier v. Aaron, addressed above, are among the most influential construction defect cases prior to However, California was slow to adopt such measures, possibly because it has a massive economy that is directly dependent on the success of the construction industry, and lawmakers were hesitant to implement law that would hinder housing development as the next cases will show. In order to understand the procedure by which case precedents, legal settlements, and other legal entities built the foundation for a Senate Bill 800, it is important to analyze the origin of construction defect legislation in California. In California, a warranty protects only purchasers of new homes, and warrants the home against latent defects discovered within a ten year period. (California Code Civil Procedure, 2005, ) Regardless of the ten-year period, according to California common law, a house is not new after being sold by its original owners, regardless of age. Therefore, some subsequent purchasers in California cannot sue the builder for latent defects even if they are recent. This technicality exposes a hole that can protect a builder from liability, even if they have performed defective work, as long as the original owner has sold the house. The following cases were important to the evaluation of laws regulating the building industry in California. Landmark Case: Huang v. Garner One of the case precedents in contract law that led to the necessity of California Senate Bill 800 is that of Huang v. Garner in In this case, the court ruled that in order to file suit under contract law for construction defects, you must be one of

19 the original purchasers of the property. This makes it necessary for a property owner to be a party of the original building contract in order to obtain legal rights regarding defect recovery (Huang v. Garner, 1984). However, Huang v. Garner is not sufficient to serve California s modern housing market because it does not provide subsequent buyers any legal standing concerning construction defect litigation. There remained the need for a piece of legislation that gave the subsequent purchaser more legal rights concerning defects. Landmark Case: Seely v. White Motor Company Another division of law from which Senate Bill 800 was conceived is tort law. Tort law applies to personal injury and property damage not covered by legislative law or contract law. According to Seely v. White Motor Company (1965, p. 2d 145), The economic loss rule in tort law bars recovery for latent defects unless the defects have caused personal injury or secondary property damage. Although this case precedent applies to a motor vehicle, it is important to note that it has often been applied to construction defect cases. This case precedent helps protect a homeowner in case of a dangerous defect or one that caused personal property damage due to defective construction, but does not address recovery of repair costs. Landmark Case: Aas v. Superior Court of San Diego County In California, collecting for construction defect damages is difficult because of two cases. Huang v. Gardner (1984) made it difficult for subsequent homeowners to collect damages under contract law. In Seely v. White Motor Company (1965), recovery for damages is limited due to the limitations of tort law in construction defect cases. A 10

20 more current case that was instrumental in formulating Senate Bill 800 due to its 11 limitations was Aas v. Superior Court of San Diego County in Aas provided that builders not be held liable for construction defects unless those defects have caused death, bodily injury, or actual property damage. According to the Aas case, The California Supreme Court has held that when construction defects do not cause property damage, the plaintiff homeowner and homeowners association bringing actions in negligence against the developer, contractor and subcontractor that built the dwellings are barred from recovering damages for economic loss. (p. 627) This language indemnified the builders from any damage except personal property damage and injury. The case involved a homeowners association that sued a development company for alleged construction defects. The actual defects were not physical damage, but were building code violations that did not cause property damage, resulting in diminished value of the residences in question. The latent defects in the homes were dismissed because the claims were brought under negligence, and the plaintiffs had not proven personal injury or property damage. So, just as in the landmark cases that preceded this, homeowners were not able to collect under the circumstances due to the California Supreme Court s rulings that protect developers and contractors under limitations in tort and contract law. At this point one might start to think that the Aas case and the ones before it are unfair and favor the development companies and contractors without any protection for individual consumers. In fact, Chief Justice Judge George said the Aas decision offends... basic common sense (Poulson, 2006, p. 102). What makes the Aas case noteworthy is the actual insight that the court offers as to why it is defending the devel-

21 opers. The plaintiffs argued to ignore the economic loss rule mentioned above in 12 Huang v. Gardner (1984), which indemnified developers almost completely, and forced the builders to pay for defects before injury or property damage occurred. In response, the Supreme Court finally stated, Such a rule would likely increase the cost of housing by an unforeseeable amount as builders raised prices to cover the increased risk of liability (Aas v. Superior Court of San Diego County, 24 Cal. 4th 627, 2000). The court was concerned that overturning this rule would cause an excessive amount of liability claims by homeowners, subsequently resulting in higher housing costs. These higher housing costs would result, in part, from a rise in insurance premiums for builders because homeowners and subsequent homeowners would have legal recourse for construction defects. This inequity was doggedly enforced by the courts because legislators are concerned with economic growth that is intricately tied to the residential construction industry, and any impediment would be detrimental to the state s growth and economic well being, even at the cost of fairness. According to the California Department of Finance, California needs 250,000 new housing starts per year to accommodate the population; yet only 139,000 units were built in Statistics such as these would reinforce the courts concerns that litigation would inflate insurance premiums and scare builders from the residential housing market, especially small to medium size builders. The result of these courts concerns inadvertently protected those responsible for construction defects. The Aas case elicits legislators concern of economic factors and how these concerns influence the body of legal precedents and their outcomes. The Aas case was a landmark case because scholars and lawyers alike criticized the decision of the court due

22 13 to the flaws protecting those guilty of the construction defects. It was at this point that it was collectively realized by lawmakers, economists, and judges that new legislation needed to be written in order to fairly compensate homeowners for damages, give builders recourse to make repairs without being faced with lawsuits, and give relief to an overburdened court system in California without jeopardizing residential development.

23 CHAPTER III SENATE BILL 800 ANALYSIS A senate bill is a draft of a proposed law composed by legislative representatives and presented for approval to a legislative body. In this case, the proposed law is Senate Bill 800, and in order for the bill to become a law it must be passed by both bodies of California s legislature, the senate and the assembly. In September 2002, California lawmakers passed legislation that effectively gave the primary homeowner and subsequent homeowners the right to bring legal action for construction defects to a licensed contractor, builder or developer, after proper notice and the opportunity to repair are given to that contractor in the form of Senate Bill 800. The new bill states that the legislation applies to all homes and condominiums built after January 1, 2003, and it gave homeowners recourse to receive reparations for faulty and damaged homes by giving substance to a law finally established by the serious inequity in construction defect resolution. Senate Bill 800 was proposed by Senator John Burton (D-San Francisco), who drafted the bill to reduce the amount of court cases in an overburdened court system and to balance the competing interests of homeowners, developers, and builders all of whom hoped to reduce litigation. Governor Gray Davis signed Senate Bill 800 on September 20, 2002, and this law was intended to relieve the shortage of residential homes and condominiums and townhouses due to inflated insurance premiums. Senate 14

24 Bill 800 was also designed to relieve California courtrooms from construction defect 15 litigation. Senate Bill 800 received its final unanimous legislative approval in September 2002 by a vote of The California Civil Code is a body of statutes governing the State of California. A statute is a formal written enactment of legislative authority that governs a state, city, or county. The California Civil Code is made up of statutes which govern the obligations and rights of the people within this state. According to California s Civil Code preamble, the Civil Code is divided into four divisions: the first relating to persons, the second to property, and the third to obligations, while the fourth contains general provisions relating to the three preceding divisions (California Civil Code). Within this legal context, Senate Bill 800 deals with the rights and obligations of persons pertaining to property, particularly construct defect conflict resolution. Senate Bill 800 s place in the California Civil Code is stated in the introduction of the bill: As of February 23, 2001, Senate Bill 800 is an act to add Section to, and to add Title 7 (commencing with Section 895) to Part 2 of Division 2 of, the Civil Code, relating to construction defects (S.B. 800, 2002, Intro.). Chapter 1 of Senate Bill 800 is titled Definitions. It is intended to clarify any misunderstanding of the definitions of five key categories that can be misconstrued or manipulated in a defect dispute. These definitions are classified under Title 7 (Requirements for Actions for Construction Defects). For instance, building terms such as Section 895(b) Designed moisture barrier (any material used in construction to prevent unwanted moisture from entering the home) means an installed moisture barrier

25 16 specified in the plans and specifications, contract documents, or manufacturer s recommendations (Sec. 895(b)). This definition defines the particular construction element in question, thus giving it clarification for legal purposes. The other definitions given, such as for structure and close of escrow, are common to construction defect litigation. Therefore, these definitions must be included for clarity in legal and arbitrative arenas. Chapter 2 of Senate Bill 800 is titled Actionable Defects, meaning construction defects covered by Senate Bill 800. It lists 18 items and expands on them into many other categories specifying common construction defects that should be addressed by the builder, subcontractor, material supplier, individual product manufacturer, or design professional, if the need arises. This chapter is divided into the following issues: 1. Water issues 2. Structural issues 3. Soil issues 4. Fire protection issues 5. Plumbing and sewer issues 6. Electrical systems 7. Other areas of construction All of the items contained within the list of actionable defects are written in basic language that is easily understood. Each item is short and succinct. For example, Chapter 2, Section 896(b(4)), states,

26 A structure shall be constructed so as to materially comply with the design criteria for earthquake and wind load resistance, as set forth in the applicable government building codes, regulations, and ordinances in effect at the time of original construction. 17 These standards are the basis for what could constitute construction defect action and are some of the most important parts of the new law, that is, setting definitions and standards to follow for both parties protection. In addition, Senate Bill 800 provides that if any function or component is not addressed in the law, it shall still be actionable if it causes damage. Chapter 3 of Senate Bill 800 is titled Obligations and contains language that covers the concept of an enhanced protection agreement, defining this agreement and how it operates within the structure of Senate Bill 800. Although Senate Bill 800 was recently passed, the concept of the builder s providing a warranty or enhanced protection agreement protecting and insuring a builder s craftsmanship is not new. Many builders provide this sort of warranty regardless of the legal requirements. The language in Chapter 3 is designed so that an enhanced protection agreement does not conflict with the guidelines set in Senate Bill 800. Chapter 3 (Obligations, Section 901) states: A builder may, but is not required to, offer greater protection or protection for longer time periods in its express contract with the homeowner than that set forth in Chapter 2 (commencing with Section 896). A builder may not limit the application of Chapter 2, or lower its protection through the express contract with the homeowner. This type of express contract constitutes an enhanced protection agreement. The basic premise of the first part of this chapter is to define and state a builder s warranty, and to put into plain language the requirements and definitions of such a warranty. It makes clear that if a builder s enhanced protection agreement is