Timeliness of construction defect claims—commencement of California’s 10 year statutory repose period. Hensel Phelps Construction Co. v. Superior Court. Court of Appeals of California (2020).by Hugh Anderson

Summary: Hensel Phelps was the general contractor on a mixed-use project in San Diego. The project included construction of a residential condominium tower. The contract between Hensel Phelps and the original owner/developer included a requirement to substantially complete the work by a specified time, and defined Substantial Completion in a lengthy, detailed provision that identified five prerequisites for Substantial Completion. On May 24, 2007, the project architect signed the Certificate of Substantial Completion (apparently using the standard AIA form for that purpose); the owner/developer recorded a notice of completion with the city on July 10, 2007.

After completion, the residential units were sold to individual owners, and the Smart Corner Owners Association assumed the management and maintenance obligations for the residential tower. On July 6, 2017, Smart Corners formally notified Hensel Phelps of a construction defect claim, based on allegations of problems with the project’s windows, doors, roof, plumbing, parking structure, and other features. The lawsuit that followed alleged a single cause of action arising under California’s Right to Repair Act. Under that statute, construction defect claims must be initiated within:

…10 years after substantial completion of the improvement but not later than [10 years after] the date of recordation of a valid notice of completion.

The Right to Repair statute does not define Substantial Completion, other than specifying that the 10-year repose period is triggered, at the latest, by the recording of a valid notice of completion.

Hensel Phelps moved for summary judgment, arguing that under the provisions defining Substantial Completion in the construction contract, Hensel Phelps had attained Substantial Completion on May 24, 2007, and the 10-year defect claim period began to run on that date; therefore the Smart Corner claim was late by more than a month. In response Smart Corner pointed out that it was not a party to the construction contract, and that the Substantial Completion provisions in that contract were not definitive in establishing whether Substantial Completion had occurred for purposes of the statute. The trial court denied the Hensel Phelps motion for summary judgment. The court ruled that Hensel Phelps “had not provided any authority to support its argument

that its contractual definition of substantial completion should apply to the statute [of repose].” In addition, the court found that there were triable issues of fact regarding when Substantial Completion had occurred under the definition in the construction contract. Hensel Phelps appealed the adverse decision.

Decision: In the California Court of Appeal, Hensel Phelps argued that the determination of Substantial Completion by the parties to a construction contract should be “conclusive” and binding in all later litigation. Specifically, Hensel Phelps called for a “bright line rule that, if an AIA Certificate of Substantial Completion is issued and all the provisions of the Certificate have been complied with,” then the date of the Certificate conclusively commences the 10-year repose period. This “bright line” standard would give certainty to the parties and other potential claimants as to the deadline for bringing a claim, and would be consistent with the reasons for having a statute of repose, which include avoiding the uncertainties of traditional legal concepts regarding accrual of claims, and adherence to an “independent, objectively determined and verifiable event.”

The Court of Appeal concluded that what matters in applying the statute is not the contracting parties’ agreement regarding the definition or accomplishment of Substantial Completion, such as the issuance of a Certificate, but rather “the actual state of construction of the improvement and whether it is substantially complete.” The court further held that a standard of “actual state of completion” provides sufficient certainty to the construction industry:

The statutory standard of substantial completion ensures that contractors and developers can, on the basis of evidence available to them, determine with reasonable certainty when their liability for construction defects will end.

The court rejected what it portrayed as Hensel Phelps’s demand for “absolute certainty,” and was dismissive of the position that without being able to rely on the date of the Certificate of Substantial Completion it would be “impossible” for a general contractor to know when its liability will end. In fact, the court pointed out that the statute explicitly does create a “bright line” end for exposure to claims, if there is a recorded notice of completion.

The court’s rejection of the contractor’s position also emphasized the impropriety of conferring “on private parties [the two contracting parties] the ability to determine when the limitations period begins to run on another party’s [a third party’s] claim.”

Comment: A close reading of the Hensel Phelps decision reveals that the Court of Appeal acknowledged that the date of Substantial Completion determined by the parties at the end of construction often will be “persuasive indirect evidence of the state of construction [completion],” though not conclusive, as asserted by Hensel Phelps. Thus the importance of contractually defining Substantial Completion (see EJCDC® C-700 2018, Paragraph 1.01.A.42), and contractually establishing procedures for Substantial Completion (see EJCDC® C-700 2018, Paragraph 15.03, and EJCDC® C‑625—Certificate of Substantial Completion), is in no way diminished by the ruling in this case.

The appellate court also confirmed that the parties to a contract may contractually alter the statutory limitations periods for claims between them. This approach is taken in some EJCDC documents, such as EJCDC® E-500, in which the Owner and Engineer agree that any claims between them will accrue no later than the date of Substantial Completion (cutting short potential discovery-based accrual times). Although the decision was adverse to the specific general contractor in this specific circumstance, it ultimately may be beneficial to contractors. Architects and engineers do not always issue Certificates of Substantial Completion, and when certificates are issued the date is not always accurate or favorable to the contractor. Non-standard contracts may contain unreasonable definitions or conditions that purport to deny substantial completion has occurred, even after owner use and occupancy of the project. The Hensel Phelps case confirms that in California actual Substantial Completion, based on facts, is the prevailing standard for defect claims, not the potentially inaccurate or non-existent formal completion documentation of the project. In some situations this will allow contractors to prove an earlier actual date of Substantial Completion, thus shortening the period of exposure to claims.