LOFTS CASE IS THREAT TO IMPLIED WARRANTIES

In Arizona, it has long been recognized that warranties of workmanship and habitability in new home construction are available not just to the original purchaser of the home, but also to subsequent purchasers of that home. This is true, even though the subsequent purchaser is not in privity with the original builder. The case from the Arizona Supreme Court which is most often cited is Richards v. Powercraft Homes, Inc., 139 Ariz. 242, 678 P.2d 427 (1984). The plaintiffs in the Richards case had purchased homes in a subdivision built by Powercraft Homes. Some of the plaintiffs had purchased directly from Powercraft, but others had purchased from previous owners. The only issue in the case was whether there was an implied warranty which extended to these subsequent purchasers. The Arizona Supreme Court found that it did, based on the same policy considerations underlying the imposition of the implied warranty to the first purchasers. The court found that the imposition of the implied warranty was appropriate given the modern construction industry practices, as well as the relative abilities of the buyers and the builder-vendors to discover latent construction defects.

Surprisingly, the recent Court of Appeals case of The Lofts At Fillmore Condominium Association v. Reliance Commercial Construction, Inc., 561 Ariz. Adv. Rep. 26, may severely limit these implied warranties for subsequent purchasers by giving a very narrow interpretation of the “homebuilder-vendor” concept. The Court held, “We consider that ‘homebuilder-vendor’ means a contractor who also sells to a purchaser who will live in the home.” In the Lofts case, the builder had built its product under contract with the developer and the developer in turn sold the homes to purchasers. The Court of Appeals rejected the plaintiff’s argument that the privity of contract requirement had been abrogated by the Richards court and also the policy argument, that “no single entity builds and sells homes anymore”; and that “implied warranties will disappear from the current legal landscape in Arizona”; and “as a result millions of owners in Arizona who have purchased from an entity that was not the builder will now be unable to recover for construction defects.” It is important to note that The Court of Appeals did not disagree with these dire assertions. Instead, the Court stated that because of the broad implications of doing away with privity of contract when it came to implied warranties of workmanship and habitability, it wished the Arizona Legislature to address the issue.

The “Lofts” Court also rejected the argument that privity of contract must be eliminated in order to protect real estate purchasers from insolvent sellers or developers who construct “shell companies to avoid liability for defective construction.” The Court of Appeals said that there was no evidence that the problem is pervasive enough to require a blanket exception to privity of contract requirement. The “Lofts” Court also noted that there was no assertion that the builder and the developer in that case had entered into a “sham” agreement by which the builder would be insulated from meeting its obligations to perform work in a workmanlike manner. In other words, the Court of Appeals did not really address the situation so common in the building industry of a contractor/builder which contracts to build homes with a wholly-owned subsidiary which then markets the property. In a common arrangement, the contractor/builder entity that is licensed with the Arizona Registrar of Contractors builds a home, transfers it to its development/marketing arm which then sells to the public. Although that type of arrangement was not specifically addressed in the Lofts case, the Court in Lofts does not hold that such a maneuver would be unsuccessful in insulating the contractor/builder from implied warranty claims by subsequent purchasers. The Court of Appeals went on to say “Thus, while we acknowledge that some of the policy considerations in Richards could be applied in favor of Lofts, we leave any further expansion of implied warranty liability of non-vendor builders to the authority and discretion of the legislature.”

The possible impact of the Lofts case should not be understated. If it is not overturned by the Arizona Supreme Court, and if it is applied by the lower courts at face value, Lofts will mean that real estate licensees must be extremely cautious when explaining what type of rights a subsequent purchaser will receive when they purchase a home. If, as is often the case, the builder has a contractor/builder arm and a separate entity which acquires title as its marketing arm, then under the strict application of the Lofts case, few, if any, subsequent purchasers who are not in privity with the contractor/builder will receive a home protected by implied warranties.

Of course, the lower courts may not interpret Lofts as representing such a sweeping change. As noted in Lofts, the Court was not dealing with any allegations that shell companies were established to avoid liability for defective construction. It is possible that a builder who uses the simple expedient of one corporation for building and another corporation for owning and marketing the property, would not receive insulation from liability. Nonetheless, after Lofts, a second purchaser of a home must figure out whether or not the original sale was from a “homebuilder-vendor” to determine whether latent defects in the property would give rise to claims against the original builder. In other words, the Court of Appeals, Division One, has made your job as real estate licensees a great deal more complicated. A Petition for Review to the Arizona Supreme Court has been filed and we hope that the Supreme Court will give such review careful consideration.