Caveat Emptor – Did You Just Buy Constructive Knowledge of a Defect?

The discovery rule in construction defect cases may sound straightforward, but it can be an amorphous concept.

The issues faced by purchasers of existing properties can be daunting, with concerns about financing, return on investment and building quality coming to the fore. However, purchasers may not have given any thought to the statute of limitations on a subsequently discovered construction defect. As a result, they may be -unpleasantly surprised to learn that their construction defect claim is barred due to the expiration of the statute of limitations before or shortly after they closed on the -property and that the “discovery rule” may offer little help.

New Jersey, like most states, follows the discovery rule for the statute of limitations, which means that the clock to file an action for an injury begins to run when the plaintiff had actual or constructive knowledge about the harm. (Black’s Law Dictionary defines “constructive knowledge” as knowledge “that one using reasonable care or diligence should have, and therefore that is attributed by law to a given person.”) The discovery rule in construction defect cases, however straightforward it may sound, can be an amorphous concept. In a recent opinion, the New Jersey Supreme Court held that the statute of limitations begins to run when the entity, not necessarily the plaintiff, that could bring a claim possesses actual or constructive knowledge of the injury (The Palisades at Ft. Lee Condominium Assoc., Inc. v. 100 Old Palisade, LLC, 230 N.J. 427, 2017). Moreover, the court held that for statute of limitations purposes, the buyer and seller should be treated as one entity.

Factual Background and Legal Decision

In 1999, Palisades A/V Acquisitions Co., LLC (“Palisades A/V”) began developing the residential building complex in Fort Lee known as The Palisades when it engaged AJD Construction Co., Inc. (“AJD”) as its general contractor. The project ultimately achieved substantial completion on May 1, 2002. In June 2004, Palisades A/V sold the project to 100 Old Palisade, LLC (“Old Palisade”), which began the process of converting the development into condominium ownership. On October 1, 2004, Old Palisade commissioned an inspection and report by Ray Engineering Inc., which identified some concrete spalling and sporadic cracking, but did not identify any structural concerns at that time (“Ray Report”). Old Palisade began selling condominiums in January 2005. The Palisades at Fort Lee Condominium Association Inc. (“Association”) was incorporated in February 2005, but did not take over management of the development until July 2006, when 75 percent of the units had been sold.

The Association then commissioned the Falcon Group to perform its own investigation of the development, resulting in a June 2007 report (“Falcon Report”). The Falcon Report detailed construction defects in exterior walls, roofing, concrete flooring, plumbing, the parking garage, landscaping and other areas. The Association filed various lawsuits against AJD and its subcontractors for the defects identified in the Falcon Report in March 2009, April 2009 and September 2010. The defendant contractors eventually sought to dismiss these lawsuits, citing New Jersey’s six-year statute of limitations.

The trial court dismissed the actions, setting the May 1, 2002, substantial completion date for the start of the statute of limitations clock. The Appellate Division reversed, holding that the clock could not start until the Association took over, arguing that it should be entitled to the full six-year statute of limitations term because “it would be unreasonable for the statute of limitations to run on the claim of a condominium association, unless a unit owner, or group of owners, took on that responsibility,” and that it did not have the requisite information until the 2007 Falcon Report. Essentially, under the Appellate Division’s reasoning, the timer would start anew with each successive purchaser. To address the argument that this could lead to indefinite responsibility, the Appellate Division pointed to New Jersey’s 10-year statute of repose. This statute prohibits a construction defect action for an error that is “defective and unsafe” against anyone who participated in the design or construction of an improvement to real property more than 10 years after their work on the property was done.

Believing both lower courts wrong, the New Jersey Supreme Court reversed and set out its own standard for determining when the clock should start to run. The Court focused on when the person with the right to bring an action first knew or should have known. The Court rationalized that no purchaser should be in a better position with regard to filing a lawsuit than the seller it bought the property from, and a seller cannot convey any more rights than it owns. Ultimately, the Court reasoned that “if the building’s owner knew or reasonably should have known of construction defects at the time of the sale … the purchaser takes title subject to the original owner’s right – and any limitation on that right.” Of course, if the seller did not know of any defect, despite reasonable diligence, the clock begins to run when the purchaser eventually discovers (or should reasonably discover) the defect itself. So, despite the change in title, the owners are considered one entity for the purposes of the discovery rule.

Practical Implications

As an initial matter, the Palisades decision adds uncertainty for the purchaser, who cannot assume it has a full six years (subject to the statute of repose) to investigate and bring an action after it purchases the property. Instead, it has an uncertain amount of time based on when the seller knew or should have known of the defect.

When buying a property, the purchaser may, even if the building is less than 10 years old, have already lost the right to sue a contractor for defective work prior to its purchase of the building. After the Palisades decision, the onus is on the purchaser to perform an even more thorough due diligence review. Now the purchaser must ascertain not only the building’s current condition but what, if anything, the seller knew or should have known, and when the seller should have known it. Assuredly, there should be no issue if the seller had actual knowledge of the defect, as that should be communicated to the purchaser during the purchase process, and a date certain can be established for statute of limitations purposes. However, if the seller is unaware of the defect, the purchaser must then determine when, if at all, the seller should have known.

To adjust to this new reality, a purchaser must essentially perform an engineering and construction review thorough enough to -uncover the seller’s constructive knowledge of any defects. Without such a review, the risk of running into an uncertain statute of limitations remains.

George R. Talarico is a member of the Sills Cummis & Gross Litigation, Mass Tort and Product Liability practice groups. He has a broad range of experience representing clients in commercial litigation, including toxic torts, product liability and commercial disputes. Before Mr. Talarico became a lawyer, he spent eight years in the construction engineering field. Reach him at [email protected].

Aaron S. Brotman is an associate in the firm’s Real Estate Department and focuses on land use, development and construction law. Reach him at [email protected].