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Condominium Law FLASHPOINTS September 2021

Kenneth Michaels, Jr., Bauch & Michaels, LLC, Chicago
312-588-5000 | E-Mail Kenneth Michaels, Jr.

First District Extends Sienna Court To Vitiate General Contractor Liability for Implied Warranty of Habitability

In 1400 Museum Park Condominium Association by Its Board of Managers v. Kenny Construction Co., 2021 IL App (1st) 192167, ¶¶4 – 8, a condominium association sued the general contractor Kenny Construction Company for defective design, materials, and construction of plumbing in a 260-unit condominium building begun in 2006 and completed in 2008. The developer sold units from 2008 through 2011. By the time the lawsuit was filed, the developer was insolvent and involuntarily dissolved. The association learned of the construction defects in June 2013 and incurred repair costs in excess of $1 million. The association sued the general contractor in late 2016 for breach of implied warranty of habitability and in September 2018 added a count against the subcontractor Franks Mechanical Contractors Inc. In May 2019, the association added a count against the general contractor for breach of contract.

On December 28, 2018, the Illinois Supreme Court overruled 35 years of consumer protection and contract law for new home purchasers by holding that, because of a lack of privity, an action would not lie against subcontractors (when the developer and general contractor were insolvent or dissolved) for breach of the implied warranty of habitability. Sienna Court Condominium Ass’n v. Champion Aluminum Corp., 2018 IL 122022, 129 N.E.3d 1112, 432 Ill.Dec. 569. Sienna Court was discussed in the January 2019 Condominium Law FLASHPOINTS (available in the IICLE® Online Library to subscribers). It is also discussed in §1.11 of Howard Dakoff’s chapter, Condominium Management, and §6.9 of this author’s chapter, Liability Problems, in CONDOMINIUM LAW: DAILY OPERATION CHALLENGES (IICLE®, 2021).

In 1400 Museum Park, the Illinois appellate court applied the Sienna Court analysis to hold, for the same reasons, that absent privity of contract, a general contractor of new residential construction is not liable for breach of the implied warranty of habitability when the construction or design is defective.

After three days of hearings, the trial court granted the general contractor’s motion to dismiss with prejudice in a Supreme Court Rule 304(a) order, which the association timely appealed.

Appellate Court’s Analysis

Standard of Review. The trial court dismissed with prejudice the breach-of-implied-warranty claim pursuant to §2-615 of the Code of Civil Procedure, 735 ILCS 5/1-101, et seq., and dismissed with prejudice the breach-of-contract claim pursuant to §2-619(a)(9). 2021 IL App (1st) 192167 at ¶¶9, 11. The general contractor’s argument as to both claims was that no privity of contract existed between the association and general contractor and, therefore, no action could lie. The appellate court noted that, under §2-615 challenges, all well-pleaded facts are taken as true and all reasonable inferences are drawn in favor of the plaintiff. “A ‘cause of action should not be dismissed pursuant to section 2-615 unless it is clearly apparent that no set of facts can be proved that would entitle the plaintiff to recovery.’ ” 2021 IL App (1st) 192167 at ¶17, quoting Marshall v. Burger King Corp., 222 Ill.2d 422, 856 N.E.2d 1048, 1053, 305 Ill.Dec. 897 (2006). Motions to dismiss under §2-619 essentially admit the sufficiency of the complaint but raise an affirmative matter defeating the claim. Well-pleaded facts are accepted as true, and reasonable inferences are construed in favor of the plaintiff, but the court cannot accept conclusions not supported by the facts. Motions to dismiss under both §§2-615 and 2-619 are reviewed de novo.

Merger Doctrine and Caveat Emptor. Unlike Sienna Court, the appellate court here began its analysis exploring the common-law merger doctrine and doctrine of caveat emptor. (In fairness, Sienna Court made a passing reference to caveat emptor.) The appellate court explained that under the merger doctrine, provisions contained in a real estate sale contract are merged into the deed unless the deed contains a reservation of rights provision. “[T]he deed supersedes the provisions of the real estate contract and becomes the only binding instrument between the parties.” 2021 IL App (1st) 192167 at ¶21, quoting Czarobski v. Lata, 227 Ill.2d 364, 882 N.E.2d 536, 540, 317 Ill.Dec. 656 (2008). The purpose of the merger doctrine is to protect the security of land title and to bring finality to real estate contracts. Its effect is to enforce caveat emptor in real property transactions. Under the doctrine of caveat emptor, absent an express warranty or fraud or misrepresentation, a seller of real property was not liable to the purchaser for design or construction defects at the time of sale. The doctrine presumes buyers and sellers of similar abilities engaged in an arm’s-length transaction. 2021 IL App (1st) 192167 at ¶22.

Implied Warranty of Habitability. To protect residential home purchasers from the harshness of caveat emptor and the merger doctrine regarding latent defects, courts recognized the existence of an implied warranty of habitability by a builder-vendor arising from the execution of a sale contract and surviving the deed. 2021 IL App (1st) 192167 at ¶¶23 – 24. Three justifications exist for the implied warranty: “(1) the modern home buyer is unusually dependent upon the competency and honesty of the builder rather than on the buyer’s own ability to discern latent defects, (2) the buyer is making the largest single investment of his or her life, and, (3) in fairness, the repair costs of defective construction should be borne by the builder-seller who created the latent defects.” 2021 IL App (1st) 192167 at ¶25, quoting Board of Managers of Park Point at Wheeling Condominium Ass’n v. Park Point at Wheeling, 2015 IL App (1st) 123452, ¶8, 48 N.E.3d 1250, 400 Ill.Dec. 810.

Economic-Loss Rule. In Illinois, the economic-loss rule, also known as the Moorman Doctrine from its recognition in Moorman Manufacturing Co. v. National Tank Co., 91 Ill.2d 69, 435 N.E.2d 443, 61 Ill.Dec. 746 (1982), precludes tort recovery for claims solely for economic damages unless accompanied by personal injury, property damage, intentional fraud, or misrepresentation. This rule is premised on the presumption that contract law rather than tort law is better suited for providing remedies in commercial transactions. Under Moorman, economic loss includes damages for inadequate value, repair and replacement of defective products, consequential loss of profits, and diminution in value of property. 1400 Museum Park, supra, 2021 IL App (1st) 192167 at ¶¶27 – 28, citing Moorman, supra, 435 N.E.2d at 449. The economic-loss rule requires contractual privity between the plaintiff and defendant.

In Redarowicz v. Ohlendorf, 92 Ill.2d 171, 441 N.E.2d 324, 65 Ill.Dec. 411 (1982), the Illinois Supreme Court held that privity of contract was not required to assert a claim for breach of the implied warranty and extended the implied warranty to a subsequent purchaser of a newly constructed home. The following year, in Minton v. Richards Group of Chicago, 116 Ill.App.3d 852, 452 N.E.2d 835, 72 Ill.Dec. 582 (1st Dist. 1983), the appellate court held that the implied warranty applied to subcontractors when a vendee homeowner sustained losses from a defect caused by a subcontractor and the homeowner could not recover from the builder-vendor because of its insolvency. Sienna Court, supra, 2018 IL 122022 at ¶42. Thereafter, for years Illinois courts recognized that when the builder-vendor or developer had dissolved or become insolvent, purchasers could proceed (within the statute of limitations) against the general contractors or subcontractors who were responsible for the latent defects through an action for breach of the implied warranty of habitability.

However, the Supreme Court subsequently backtracked on its holding in Redarowicz, redefining it as a recognition of an implied assignment of rights from the first home purchaser to a subsequent purchaser. In Sienna Court, the Illinois Supreme Court held that privity of contract is required to pursue an action for breach of an implied warranty of habitability. The Supreme Court overruled Minton. Sienna Court, supra, 2018 IL 122022 at ¶25. Because such actions almost always involve solely economic losses, subcontractors’ liability for breaches of an implied warranty of habitability almost entirely evaporated.

Privity of Contract. In 1400 Museum Park, after reviewing Sienna Court the appellate court noted that privity of contract is a “mutual or successive relationship to the same rights of property.” [Emphasis in original.] 1400 Museum Park, supra, 2021 IL App (1st) 192167 at ¶38, quoting Collins Co. v. Carboline Co., 125 Ill.2d 498, 532 N.E.2d 834, 839, 127 Ill.Dec. 5 (1988). The court observed that privity of contract may be effectuated by operation of law, by descent, or by voluntary or involuntary transfers, including assignments. 2021 IL App (1st) 192167 at ¶38.

The condominium association argued that when the developer dissolved or became insolvent the unit owners stepped into its shoes and were therefore in privity of contract with the general contractor. As support for this the association relied on two paragraphs in the unit owners’ sales contracts, one wherein the developer covenants to construct the building in accordance with plans and specifications and the other reserving rights for the developer to use the building to complete construction. 2021 IL App (1st) 192167 at ¶¶39 – 42.

The appellate court found that neither paragraph in the sales contract established privity between the unit owners and general contractor. While the appellate court’s conclusion is understandable, the court’s statement — “it was Museum Park, not Kenny, who hired the subcontractor who constructed the risers” (2021 IL App (1st) 192167 at ¶43) — confused the contractor relationships in this construction project. If the developer hired the plumbing contractor, instead of it being hired by the general contractor, the plumbing contractor would be, by definition, a general contractor and there would have been no reason for the association to sue the general contractor and subcontractor. The opinion refers to the plumbing contractor as a subcontractor. 2021 IL App (1st) 192167 at ¶¶1, 5, 9. The appellate court’s opinion also found no evidence in the record that the developer “intended to assign or delegate its rights, obligations, and liabilities existing under the sale contracts to Kenny, either expressly or by implication, which would render Kenny an assignee.” 2021 IL App (1st) 192167 at ¶47.

The association also argued that privity was established through the developer’s property report or the condominium declaration. The property report argument was readily rejected because a property report is not a contract but a disclosure document. Regarding the declaration, the association relied on a blanket easement in the declaration granting the developer and its contractors and subcontractors and others access to the property for constructing the condominium building. 2021 IL App (1st) 192167 at ¶¶48 – 50. The association’s easement argument was rejected by the court because the association provided no authority to support its argument, and the court found no authority in support on its own. Furthermore, the court rejected this argument because the general contractor did not sign the sales contracts and no acts supported a contention that the general contractor was a party to the sales contracts.

Retroactivity of Sienna Court. Finally, the appellate court rejected the association’s argument that Sienna Court should not be given retroactive effect by examining the three factors for applying decisions retroactively outlined in the United States Supreme Court’s decision in Chevron Oil Co. v. Huson, 404 U.S. 97, 30 L.Ed.2d 296, 92 S.Ct. 349, 355 (1971). These factors are (1) whether the decision established a new principle of law by overruling a clear past precedent or deciding an issue of first impression that was not clearly foreshadowed, (2) whether the new rule’s operation will be retarded or promoted by prospective application, and (3) whether substantial inequitable results would be produced if the decision is applied retroactively. 1400 Museum Park, supra, 2021 IL App (1st) 192167 at ¶56. Focusing on the first factor without more, the appellate court found that the Sienna Court decision did not establish a new principle of law and the decision was foreshadowed. Therefore, Sienna Court should be given retroactive application. 2021 IL App (1st) 192167 at ¶58.

Because of the lack of privity of contract, dismissal of the association’s breach-of-contract claim against the general contractor was also affirmed. 2021 IL App (1st) 192167 at ¶61.

Takeaway

One of the fundamental problems with the economic-loss rule is that it eschews economic realities and the disparity of parties’ bargaining positions in contemporary society. It presumes a fictional universe void of the circumstances that led courts to find it necessary to adopt a judicial doctrine such as the implied warranty of habitability. For example, builder-vendors, even those who may be competent and honest, are going to be much more profitable by creating single-purpose entities for construction of a residential project and then dissolving the company and distributing proceeds to its principals. The premises underlying doctrines such as the economic-loss rule, caveat emptor, and the merger doctrine are a nostalgic world of free enterprise in which people had equal bargaining powers and common knowledge of the facts. This world does not exist today and never did exist, except in legal fictions.

On the question of assignment of warranties, a newly turned-over association should request a developer’s assignment of warranties as contemplated by §18.2(d)(4) of the Illinois Condominium Property Act, 765 ILCS 605/18.2(d)(4).

(d) Within 60 days following the election of the first unit owner board of managers, the developer shall deliver to the board of managers:

* * *

(4) A schedule of all real or personal property, equipment and fixtures belonging to the association, including documents transferring the property, warranties, if any, for all real and personal property and equipment, deeds, title insurance policies, and all tax bills.

Perhaps such an assignment may preserve claims against general contractors or subcontractors when the developer is inevitably dissolved. Additionally, there may be sufficient language here to argue, as in Redarowicz, that §18.2(d)(4) grants an implied assignment of any warranties, including the implied warranty of habitability, from the developer to the association and unit owners.

For more information about condominium law, see CONDOMINIUM LAW: GOVERNANCE, AUTHORITY, AND CONTROLLING DOCUMENTS (IICLE®, 2021). Online Library subscribers can view it for free by clicking here. If you don’t currently subscribe to the Online Library, visit www.iicle.com/subscriptions.

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