Laying Down the Law – House Flippers Beware
January 3, 2022
Do investors owe warranty obligations to buyers for construction remodel or improvements the investor pays a contractor to perform before selling a property to a buyer? According to Arizona law, not only is the answer possibly yes, but investors could be on the hook for warranty obligations for up to nine (9) years after closing.
The term “house flipping” is used by real estate investors to describe the process of buying, rehabbing, and selling properties for profit. In 2017, over 200,000 houses were flipped in the United States. That number has only increased since then. https://www.upnest.com/1/post/state-of-home-flipping/ Often times, house flippers (“investors”) partner or contract with a licensed contractor to remodel the property that they intend to sell for profit. The purpose of this article is to inform investors of potential warranties and liabilities they may owe to subsequent buyers after they sell the property.
An implied warranty is created by law without any written agreement between the parties. Implied warranties are imposed by the courts. Most notably, Arizona common law implies the warranty to buyers that the construction completed be done in a good, workman-like manner. Cameron v. Sisson, 74 Ariz. 226, 246 P.2d 189 (1952); Cubby v. Crescent Steel, 105 Ariz. 459, 466 P.2d 753 (1970); Reliable Elec. Co. v. Clinton Campbell Contracting, Inc, 10 Ariz. App. 371, 459 P.2d 98(1969). Notably, implied warranties generally only apply to residential homes and not to commercial parties.
So how long does an implied warranty last? Per Arizona’s Statute of Repose, no action based in contract (which includes implied warranty claims) may be instituted against “a person who develops or develops themselves real property or performs or furnishes the design, specifications, surveying, planning, supervision, testing, construction, or observation of construction of an improvement to real property more than eight (8) years after substantial completion of the improvement to real property.” A.R.S. § 12-552 (A). If the latent defect is not discovered until the eighth year after substantial completion, an action may be brought within one year thereafter. Accordingly, the longest period during which an action may be brought is nine (9) years. A.R.S. § 12-552 (B).
Pursuant to Arizona Supreme Court precedent, implied warranties pertain not only to contractors who sell directly to buyers, but implied warranties attach to contractors generally, regardless of whether they own or sell the property they build or remodel. Indeed, pursuant to Lofts at Fillmore Condominium Association v. Reliance Commercial Construction, Inc., 218 Ariz. 574, 190 P.3d 733 (2008), the implied warranty of workmanship and habitability applies not only to contractors acting in their capacity as sellers of real property to the end-user buyer, but implied warranties extend to contractors in general, regardless of whether the contractor has any contractual privity with the buyer:
“Contractors provide an implied warranty of workmanship and habitability, even if they are not also the seller of the property.” Id. at 577, 736.
In other words, a builder who contracts with an investor to remodel a property owes an implied warranty not just to the investor, but also to the ultimate buyer and subsequent buyers during the relevant period of time per the Statute of Repose.
Moreover, the Lofts holding arguably extends to the owner/developer of the property. Thus, implied warranties are of utmost importance to investors because, pursuant to Arizona law, investors could face liability to not only the buyer who purchases the remodeled property, but also to subsequent buyers for up to 9 years after closing, regardless of whether the investor ever swung a hammer. As a result, investors should be careful with whom they hire or partner with to perform the construction or remodeling of the property they intend to sell. At a minimum, investors should ensure that the contractor they use is licensed, bonded, and properly insured. Further, investors should be sure to negotiate a thoughtful, written construction agreement with the contractor that obligates the contractor to indemnify and hold harmless the investor concerning any claims filed by any subsequent buyers with respect to the construction performed and expressly concerning all implied warranties.
Likewise, contractors should be careful to protect themselves by ensuring that they carry adequate insurance and by careful planning and drafting in their construction agreements to appropriately manage and apportion risk.
Our real estate attorneys at Provident Law® regularly represent contractor and investors. If you or someone you know has questions regarding construction agreements or any other real estate matter, contact us today to schedule an office meeting or virtual consultation with one of our real estate attorneys.
Christopher J. Charles is the founder and Managing Partner of Provident Law®. He is a State Bar Certified Real Estate Specialist and a former “Broker Hotline Attorney” for the Arizona Association of REALTORS® (the “AAR”). Mr. Charles holds the AV® Preeminent Rating by the Martindale-Hubbell Peer Review Ratings system which connotes the highest possible rating in both legal ability and ethical standards. He serves as an Arbitrator and Mediator for the AAR regarding real estate disputes; and he served on the State Bar of Arizona’s Civil Jury Instructions Committee where he helped draft the Agency Instructions and the Residential Landlord/Tenant Eviction Jury Instructions. Christopher teaches continuing education classes at the Arizona School of Real Estate and Business and he can be reached at Chris@ProvidentLawyers.com or at 480-388-3343.