September 1, 2008

AZ Business Magazine

New Owners Of Commercial Buildings Can Enforce Warranties Against Original Contractors

Does the new owner of a commercial property have the same rights as the former owner when pursuing a claim against the original general contractor for construction defects? The Arizona Court of Appeals phrased the question this way:

“We are asked to decide whether a subsequent purchaser of commercial property can sue for breach of the implied warranty of workmanship and habitability pursuant to an express assignment of that warranty by the original owner.”

The answer in Arizona now is yes, if the new owner obtained an assignment of the construction warranties from the seller.

Case Study
In the case of Highland Village Partners vs. Bradbury & Stamm Construction Co. Inc., the owner hired a general contractor to build a number of separate apartment buildings and related improvements. Years after construction was complete, the owner sold the property and assigned to the new owner its basic warranty rights. The assignment included:

“All presently effective warranties or guaranties in (original owner’s) possession from any contractors, subcontractors, suppliers, servicemen or material men in connection with … any construction, renovation, repairs or alterations of the improvements or any tenant improvements (as well as) all contracts with general contractors, subcontractors and/or specialty contractors for the improvements which are in the possession and/or under the control of (original owner).”

A few months after the sale, the new owner sued the general contractor for alleged building defects, including problems with the flashing and siding.

Defining the Fine Print
The general contractor tried to have the lawsuit dismissed by arguing that the implied warranty of workmanship, which is implied in the law based on a contractual relationship between parties, belonged only to the original owner with whom it contracted, and could not be asserted by a new party such as the new owner.

This defense, often described as a “lack of privacy,” limits the claims that can be made by those who are not direct parties to a contract. In the residential home building context, an Arizona appellate decision had previously expanded this otherwise narrow scope of warranty claims by non-parties to a contract, allowing warranties to be enforced by a purchaser of a home who was not in privity of contract with the original home builder. That decision was based on public policy considerations, where the court noted that large home builders enjoy superior bargaining power and construction knowledge over individual home buyers — that builders know that homes will change hands frequently, and whether a construction defect is suffered by the original home buyer or rather a subsequent homeowner is not a meaningful distinction from a fundamental liability perspective.

But the Arizona courts had declined to expand warranty liability in the commercial field because similar public policy considerations did not apply. Commercial builders and commercial owners were presumed to have comparable sophistication levels.

In the Highland case, the new owner argued there was a key difference in its facts: It obtained an express assignment of the warranties when it bought the property. Therefore, the new owner now explicitly held the benefits of those contractual warranty rights. The general contractor responded that the distinction didn’t matter. There never was a direct contract between the general contractor and this new owner, and essentially there was nothing effective against the general contractor that could be assigned.

In the end, the court sided with the new owner. It reasoned that there was nothing unusual about allowing assignments of contractual rights, including warranty rights, unless the assignment would materially change the duties of the general contractor — or if the assignment was forbidden by statute, was against public policy or otherwise was precluded by contract.

The general contractor contended that extending liability in favor of new owners might encourage owners to take their sweet time in giving notice of a construction problem. The court disagreed, citing the Arizona statute requiring that any claims for defects must be filed no later than eight years after substantial completion of the improvements.

So the statute of limitations already in effect would preclude stale claims.

The Solution
The court pointed out that a general contractor has a straightforward way to limit its exposure by including a clause in the original construction contract that prohibits assignment of the warranties. With that limitation, only the original owner would, by contract, be able to enforce warranty claims against the general contractor. This would essentially insulate the general contractor from remote warranty claims from purchasers down the line.

However, any existing non-assign ability clause now would likely be the subject of a more focused analysis, because any new buyer, in assessing whether to purchase property, will view a lack of ongoing warranties more critically. Similarly, the original owner might evaluate a warranty transfer restriction advanced by a general contractor in the construction contract in terms of its affect on the future marketability of the property.

End ResultsArizona Business Magazine, September 2008
This case represents a significant extension of the potential liability of general contractors and builders of commercial property to subsequent owners, particularly given that prospective buyers will require (if they did not in the past) an express transfer of any warranty rights along with the commercial property from the original owner.

Christopher M. McNichol is a partner with the law firm of Gust Rosenfeld P.L.C. in Phoenix. His practice includes general commercial transactions and litigation, with an emphasis on real property matters. He can be reached at 602-257-7496 or