N.C. Condo Owners Should Get Their Ducks in a Row Before Filing Derivative Claims for Construction Defects

Under the N.C. Nonprofit Corporation Act, members of North Carolina nonprofit corporations, including incorporated condo associations, have standing to assert the rights of their organizations derivatively.  N.C. Gen. Stat. § 55A-7-40(a).  That means members of incorporated condo associations upset about perceived construction defects can assert the rights their associations might have against the parties potentially responsible for those deficiencies.

Why would condo members want to assert defective construction claims derivatively, as opposed to individually?  Simple answer: prevailing plaintiffs under the Act can recover their expenses in maintaining derivative claims, including their attorneys’ fees.  N.C. Gen. Stat. § 55A-7-40(e).  That arguably creates an incentive for condo owners to join derivative claims alongside individual claims when suing for defective construction.

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But as the N.C. Court of Appeals (“COA”) made clear in its January 21, 2014 decision in McMillan v. Ryan Jackson Properties, LLC, condo owners who want to assert claims for construction defects on behalf of their associations had better get their facts straight before pulling the litigation trigger.  Pointing the finger at the wrong guy can lead not only to dismissal of a derivative claim, but also to an award of attorneys’ fees in favor of the defendant.

The plaintiffs in McMillan were two condo members whose basement units had flooded, resulting in extensive damage that required the plaintiffs to relocate.  The property in question, formerly an office building in downtown Greensboro, had been acquired by a developer who hired a GC to convert it into a residential condo complex.  The plaintiffs’ lawsuit included claims brought in their own names against the developer as well as both individual and derivative claims against the GC.  The derivative claim alleged that the plaintiffs’ condo association had “incurred prospective liability and compensatory damages for the costs of repairs to common areas caused by the negligence of [the GC].”  The plaintiffs acquired a default judgment against the developer when it failed to answer the complaint and pursued their claims against the GC in litigation.

The plaintiffs identified three potential causes of the flooding: (1) the exterior water handling system; (2) a dam effect created by the north retaining wall; and (3) a change in topography of the parking lot.  The undisputed evidence, however, demonstrated that the GC had not performed any work whatsoever on the water handling system, the retaining wall or the parking lot, and that the GC did not have exclusive control over the construction project.  That undisputed evidence supported the GC’s successful motion for summary judgment and dismissal from the suit.

After the trial court entered judgment in its favor, the GC moved for an award of attorneys’ fees under the Nonprofit Corporation Act.  A provision of that statute allows derivative claim defendants to recover their attorneys’ fees when the plaintiffs’ action is brought “without reasonable cause.”  N.C. Gen. Stat. 55A-7-40(f).  The trial court so found, and the plaintiffs appealed.

The COA ruled that an action is brought “without reasonable cause” when plaintiffs have “no reasonable belief in a sound chance that [their] claim could be sustained.”  Applying this rule to the facts before it, the Court held that the plaintiffs could have no reasonable belief in a sound chance their claim could be sustained because they lacked evidence at the summary judgment stage that the GC had actually caused their damage; “it follows that they also had no such evidence when they filed the derivative action almost a year earlier.”  The fact that the permit pulled for the project listed the GC as the project’s only contractor was not enough to support a “reasonable belief in a sound chance” the plaintiffs’ claim could be sustained.

The moral of the story?  The incentive for condo owners to rely on derivative claims — i.e., the potential recovery of attorneys’ fees when a claim is successful — is a double-edged sword.  Because defendants can recover their attorneys’ fees when a claim is asserted “without reasonable cause,” a pre-suit investigation into the facts and circumstances of a case is likely a good idea.  At a minimum, whenever problems arise on a completed condo project, both potential plaintiffs and defendants should make sure they retain experienced construction attorneys to represent their interests.