05 June 2017

Colorado Supreme Court rules that developers can retain perpetual control over HOA covenants

The Colorado Supreme Court ruled today that developers can retain control over community covenants in perpetuity by recording a covenant that requires declarant consent to any amendments. Although the Colorado Common Interest Ownership Act (CCIOA) states that such controls should be void, the court nevertheless ruled that a declarant may veto amendments that alter the dispute resolution procedures for construction defect actions at any time.

The case of Vallagio at Inverness Residential Condominium Ass’n v. Metropolitan Homes, Inc., 395 P.3d 788, 2017 CO 69, arose when the community’s members discovered widespread construction defects.

When the declarant developed the project, it had recorded a declaration of covenants that purported to waive the homeowners’ right to a jury trial and instead require that any construction defect disputes be resolved by a private arbitration panel. The declaration also prohibited the homeowners from recovering attorney fees and costs, and it limited the declarant’s liability for damages. Consistent with CCIOA, the declaration allowed the homeowners to amend their covenants by a 67% vote, but it recited that the declarant could veto any such amendment prior to the sale of the last unit to a homeowner. The covenants further stated that the declarant must consent to any amendment that altered the construction defect restrictions.

When the developer refused to make acceptable repairs to the defects, the Vallagio homeowners voted to amend their covenants to eliminate the restrictions and liability limitations. Their vote occurred after the sale of the last unit and passed with a 67% majority, but the declarant did not provide its consent. Shortly thereafter, the association filed suit to recover the cost of repairing the defective work and damages for violating the Colorado Consumer Protection Act (CCPA), and it demanded a jury trial. The association named the declarant as a defendant along with the community’s general contractor and two former board members.

The defendants moved to compel arbitration and argued that the homeowners’ vote was ineffective without the declarant’s consent. They further argued that arbitration clauses in homeowners’ individual purchase agreements bound the association. In response, the association asserted that the homeowners’ vote was valid, that the requirement of declarant consent was void under CCIOA’s provisions for amending covenants, that only the declarant (not the other defendants) had standing to enforce the arbitration covenants, that the homeowners’ individual purchase contracts did not bind the association, and that CCPA claims were not arbitrable. The district court agreed with the association and denied the defendants’ motion.

The defendants appealed, and a division of the Colorado Court of Appeals reversed. The division concluded that, although CCIOA prohibits a declarant from recording covenants that require more than a two-thirds majority vote to amend a declaration, CCIOA did not invalidate a covenant that required a declarant’s consent to such an amendment. The court rejected the defendants’ argument that the purchase contracts bound the association, but it held that CCPA claims could be subject to arbitration on remand. The division remanded the case for determination of whether the other defendants had standing to enforce the arbitration covenant, or whether this term only protected the declarant itself from suit.

After granting certiorari review, the supreme court affirmed the court of appeals. The court held that the provisions of CCIOA that invalidate higher voting percentages for declaration amendments did not preclude declarants from adding a separate requirement that they consent to amendments that passed with the required 67% majority. The court found support for its decision in other sections of CCIOA that require declarant consent, apparently choosing to ignore the statutory language that creates express exceptions for those situations.

The court also rejected the association’s argument that declarant-consent provisions violate CCIOA’s prohibitions on terms that favor the declarant over other unit owners. The court declined to consider the association’s alternative argument that perpetual declarant control violates CCIOA’s other provisions that impose a time limit on exercise of declarant rights, prohibit unconscionable contract clauses, and allow an association to terminate contracts with a declarant; the court found that these issues had not been fully briefed.

Finally, the court ruled that CCPA claims can be subject to binding arbitration, and that public policy does not prohibit a contractual waiver of a consumer’s right to file such claims in court.

Justices Márquez and Coats dissented from the majority. They recognized that, while CCIOA contemplates the possibility of declarant consent, the consent-to-amend provision at Vallagio evades the limitations and prohibitions of CCIOA “by effectively allowing the Declarant to grant itself permanent veto power over a supermajority of unit owners and thus unilaterally control the Association’s ability to amend the Declaration, even after the Declarant’s control period ends.” They further recognized that, while the majority’s decision arose in the context of a construction defect dispute, “its logic will permit declarants to control homeowners’ associations’ affairs into perpetuity simply by drafting self-serving provisions and then including a consent-to-amend provision that allows the declarant to demand consent to the amendment of any provision in the declaration.” This goes directly against CCIOA and the protections that the legislature enacted for homeowners.

Arbitration can be a quick, effective means of dispute resolution between sophisticated parties who choose to engage in alternative dispute resolution. Parties with equal bargaining power can specify what discovery is needed, how quickly the case must be resolved, and whether to limit administrative fees. Unfortunately, many corporations see arbitration as a way to avoid state consumer protection remedies, and they try to foist complicated, slow, costly procedures on consumers by inserting unfair arbitration clauses into form contracts. In the homebuilding context, national developers have begun to record such clauses in community declarations, giving homeowners zero opportunity to negotiate the terms or opt out of unfavorable terms. The Vallagio case provides one such example of this tactic. Unfortunately, Colorado courts have now ruled that this is permissible.

How this will affect homebuilding in the state remains to be seen. Last month, the General Assembly passed a compromise bill on construction defect litigation intended to spur housing construction by requiring homeowner association boards to provide additional notice to their members before filing suit over negligent work. This law, coupled with the Vallagio decision, may embolden some developers to cut corners on quality control and offer more cheap multifamily homes in the name of affordable housing.

Today’s decision comes on the heels of two other cases in which the Colorado Supreme Court ruled that CCIOA offers little protection for homeowners against developers who draft self-serving declarations, Ryan Ranch Community Ass’n v. Kelley, 380 P.3d 137 (Colo. 2016), and Pulte Home Corp. v. Countryside Community Ass’n, 382 P.3d 821 (Colo. 2016). The supreme court has now made clear that it will enforce covenants and statutes that benefit developers while ignoring covenants and statutes that benefit homeowners. Unless the legislature acts to strengthen CCIOA and make clear that the courts must uphold its consumer protection terms, this trend is unlikely to stop.