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Contingent Fee Agreements For Transition Litigation

Posted on Author By Damon M. Kress, Esquire

Litigating against a community’s developer over construction defects and other issues is a long, slow and expensive process.  An average transition lawsuit can take between five (5) and seven (7) years to reach conclusion.  As if the glacial pace were not bad enough, if an association pays for its transition litigation “out of pocket”, attorney fees could cost $750,000 or more, even if the matter does not reach trial.  In addition to engaging an attorney, associations must hire forensic engineers, and often forensic accountants to substantiate their claims against the developer and numerous sub-contractors.  The cost of those forensic services can easily add another $200,000 to $600,000 to the cost of the litigation.  Therefore, the total average cost of transition litigation can easily range from $750,000 to more than $1,000,000.  In certain cases, the total cost of the litigation can substantially exceed $1,000,000.

Few associations can afford to spend such substantial sums on litigation, especially when recovery is not guaranteed.  Even those associations that could amass sufficient funds from the membership, to pay those costs, may prefer not to because increased assessments may be unpopular with the members.  Whatever the reason, over the last decade, contingent fee agreements have become a more popular option for transition litigation.

Most people have little to no actual experience entering into contingent fee agreements with attorneys. Instead, most people’s only familiarity with contingent fee agreements comes from movies and television where lawyers always seem to get paid a third (1/3) of whatever they recover for the plaintiff.  Unlike television, however, in New Jersey the Supreme Court adopted very specific rules and limits for how much an attorney may charge as a contingent fee for the majority of claims an association would pursue against a developer, and its sub-contractors.  Those rules are found in Court Rule 1:21-7.

As explained in Court Rule 1:21-7(c), in any matter where the association’s claims for damages are based upon the alleged “tortious conduct” of another (tortious conduct generally means civil wrongful acts, or an infringement of rights, that arise out of something other than a contractual agreement), a contingent fee arrangement may not exceed the limits set forth in the Rule.  The Rule lays out a five-tiered framework for calculating the contingent fee, where each tier establishes a ceiling on the percentage of the recovery the lawyer can charge the client as a contingent fee.

Under a tort-based contingent fee arrangement, the Association’s attorney may only collect:

  1. 33⅓% on the first $750,000 recovered;
  2. 30% on the next $750,000 recovered;
  3. 25% on the next $750,000 recovered;
  4. 20% on the next $750,000; and
  5. On all amounts recovered in excess of $3,000,000 the attorneys must apply to the Superior Court for a determination of a reasonable fee in light of all the circumstances.

It is also important to remember that, pursuant to Court Rule 1:21-7(d), the contingent fee is computed on the net sum recovered after deducting all disbursements in connection with the litigation, regardless of whether those disbursements were advanced by the attorney or by the client.  These disbursements include investigation expenses, expenses for expert or other testimony or evidence, and any interest included in the judgment pursuant to certain Court Rules.

An example of how to calculate a contingent fee for a hypothetical transition litigation should help put the application of these concepts and rules into context.

Example:

Association entered into a contingent fee agreement with Lawyer to sue Developer.  The contingent fee agreement was written in accordance with the limits set forth in Court Rule 1:21-7.  Association succeeds in its case and wins a $3,000,000 judgment against Developer.  Association paid a total of $500,000 to cover various disbursements spent in furtherance of the Association’s successful litigation.  Developer immediately pays the $3,000,000 into Lawyer’s attorney trust account satisfying the Association’s judgment in full.

Question:        How much does Association owe Lawyer pursuant to the contingent fee agreement?

Gross sum recovered:             $3,000,000

Less – Disbursements:            ($500,000)

Net sum recovered:                 $2,500,000

Contingent Fee Calculation:

  1. 33⅓% on the first $750,000 recovered           –           $750,000 x .3333 =     $250,000
  2. 30% on the next $750,000 recovered             –           $750,000 x .30 =         $225,000
  3. 25% on the next $750,000 recovered             –           $750,000 x .25 =         $187,500
  4. 20% on the next $750,000; recovered             –           $250,000 x .2 =           $50,000

Total Contingent Fee:           $712,500

Answer:          In this case, the Association owes Lawyer a contingent fee of $712,500.  In this example, Court Rule 1:21-7 did not require an application to the Superior Court because the net sum recovered did not exceed $3,000,000.

It is important to understand the limits the Supreme Court placed on the calculation of contingent fees because it can dramatically affect how much an association pays for these legal services.  For example, in the scenario described above, if the fee agreement simply provided that Lawyer would receive one-third (1/3) of the gross sum recovered ($3,000,000) Association would owe Lawyer a $1,000,000 contingent fee.  Not only would Association’s fee agreement violate Court Rule 1:21-7, the improper fee agreement would also result in Association overpaying Lawyer $287,500 for this litigation ($1,000,000 – $712,500 = $287,500).

Moreover, if the fee agreement simply provided that Lawyer would receive one-third (1/3) of the net sum recovered ($2,500,000), Association would owe Lawyer a $833,333 contingent fee.  This fee agreement would also violate Court Rule 1:21-7 and the improper fee agreement would result in Association overpaying Lawyer $120,833 ($833,333 – $712,500 = $120,833).  Either way, both improper fee agreements result in Association overpaying significantly for the legal services.

These examples demonstrate how easy it is for an association to overpay for legal services under a contingent fee agreement if the board of trustees does not take precautions to ensure the agreement complies with Court Rule 1:21-7.  The overpayment can potentially skyrocket in instances where the net sum recovered exceeds $3,000,000.   Furthermore, even if the agreement itself complies with the Court Rule, board members should also be vigilant to ensure that any contingent fee the association ultimately pays to the lawyer is calculated in compliance with Court Rule 1:21-7.

How can a board of trustees reduce the possibility the association is overcharged under a contingent fee agreement?

An independent attorney could review the contingent fee agreement for compliance with Court Rule 1:21-7.  As explained above, the Court Rule provides a very simple tiered framework for the calculation of contingent fees.  An independent counsel should have little difficulty determining whether the agreement the association is considering entering into, or already entered into, complies with the Court Rule.

In addition to reviewing the agreement for compliance with the Rule, when the litigation reaches conclusion, the association may also wish to have independent counsel review the calculation of the contingent fee for compliance with Court Rule 1:21-7.  Having independent counsel evaluate the actual contingent fee payment for compliance with the Court Rules should provide the board of trustees the greatest assurance that the association is not overpaying.

An association may benefit from having an independent counsel review the contingent fee payment at the conclusion of the litigation regardless of whether the association had independent counsel initially evaluate the agreement.  Court Rule 1:21-7 is very clear, “an attorney shall not contract for, charge, or collect a contingent fee in excess of the following limits.”  In light of this language, even if the Association voluntarily enters into a contingent fee agreement that does not comply with the Rule, the attorney is expressly prohibited from charging or collecting a contingent fee from the Association that is calculated in a manner that does not comply with the methodology established by Court Rule 1:21-7.

Contingent fee agreements are one option a board of trustees can consider.  With some relatively simple counsel and oversight, the board of trustees can ensure that their association does not overpay for the services the association receives under the contingent fee agreement.  Please contact our office regarding our contingent fee agreements or if you would like to have our firm evaluate an existing contingent fee agreement.

The information in this article is provided solely for information purposes. It should not be construed as legal advice on any specific matter and is not intended to create an attorney-client relationship. The information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based upon particular circumstances.  Each legal matter is unique, and prior results do not guarantee a similar outcome.

HOA Homeowners Associations

Bonds May Be Released But The Association’s Claims Are Not

Posted on Author By Patricia McGlone

The transition process involves an engineering evaluation of the Association’s common elements to determine if there are defects.  The engineer’s evaluation  typically identifies defects within the site improvements, for example, the landscaping, roadways, sidewalks, detention basins, etc.  These site improvements are often subject to performance bonds with the municipality.

New Jersey statute N.J.S.A. 40:55D-53 permits municipalities to require a developer to post a performance bond guaranteeing the construction of site improvements.  The amount of the performance bond is calculated by the municipal engineer and is intended to cover the cost of constructing the site improvements in the event that construction is not completed or completed improperly.  The developer is then required to post a cash bond, a surety bond payable to the municipality, or a combination of the two, in order to guarantee the construction of the required improvements.

As construction progresses, the municipal engineer will inspect each site improvement and issue a report stating whether it was constructed in accordance with the approved plans.  The municipality (typically a township council) will then decide whether to reduce or release the performance bond after taking the municipal engineer’s findings into consideration.  Each municipality enacts ordinances setting forth the requirements and procedures for the performance bond process.  Therefore the process may vary depending on the municipality where the construction site is located.

The Association’s transition engineering evaluation should be submitted to the Township Clerk and Township Engineer when received, because the Association wants to alert the municipality that construction defects have been identified in the site improvements before the developer’s performance bonds are released.  This way the Township Engineer will have the benefit of reviewing the Association’s engineering report, and the description of those defects, when deciding whether to recommend a reduction or release of the performance bond to the municipality.

Interestingly, in K Hovnanian at Lawrenceville, Inc. v. Lawrence Township Mayor and Council, 234 N.J. Super. 422 (Law Div. 1988) the court held that the Township Council could not refuse to release or reduce the performance bond where the Township  Engineer recommended doing so.  The court noted that homeowner complaints of defective soil and drainage conditions were not sufficient for the Township Council to deny the developer’s request for bond reduction.  However the court stated that the Township Council would have discretion to deny the request if confronted with competent evidence such as an engineering report.

What happens if an Association receives its transition engineering evaluation after the performance bond has already been released?

Some developers “refuse to consider” an Association’s construction defect claim for bonded improvements if the municipality already accepted the construction of the improvements and released the associated performance bonds.  Do not accept this disingenuous argument.  The Association may pursue claims against a developer, for the defective construction of bonded improvements, even if the items were subject of a performance bond and the municipality already accepted the construction and released the developer’s performance bonds for the improvements.

  1. First, submit the engineering report to the municipality anyway as there may be a maintenance bond in place.  Most municipalities require developers to post a two year maintenance bond once the performance bond is released.  The municipality may perform repairs or replace unacceptable improvements and charge the cost against the maintenance bond.
  2. Second, the Association may pursue claims against the developer for the defective site improvements because the Association is not a party to the performance bond agreement.  Instead, the bonding agreement is only an agreement between the municipality and the developer.  As a result, the Association is not bound by actions taken by the municipality or the developer, pursuant to the bonding agreement.
  3. Third, the municipal engineer’s report indicating that construction was completed in accordance with the plans is not binding on the Association.

The municipal engineer’s report recommending release of a performance is similar to the municipal construction official’s issuance of a certificate of occupancy.  In DKM Residential Properties Corp. v. Township of Montgomery, 182 N.J. 296 (2005) the New Jersey Supreme Court held that a municipal construction official had authority to issue notices of violation for failure to comply with the Uniform Construction Code to a developer for defective EFIS construction after the certificates of occupancy were issued by the municipality.  The court noted that the Code does not limit its enforcement after a certificate of occupancy has been issued.

By analogy, the municipality’s acceptance of a site improvement does not limit the Association’s right to pursue a claim against the developer for Code violations or other basis of construction defect.  The Association obtains its right to pursue construction defect claims against the developer by virtue of the contractual provisions of the Public Offering Statement, the contracts of sale between the developer and the various purchasers, and the Association’s other governing documents.  In addition to these contractual rights, the Association also has independent rights to pursue the developer, on behalf of the unit owners, for various tort based claims relating to the common elements. See Condominium Act, N.J.S.A. 46:8B-12, Siller v. Hartz Mountain Assocs., 93 N.J. 370, 380, cert. denied, 464 U.S. 961 (1983).

Practical advice:

  • It is often helpful to keep the lines of communication between the Association and the municipal engineer open because the Township can be a great asset by holding the developer’s “feet to the fire” and making sure the site improvements are constructed properly.
  • If the Association’s engineer identified construction defects after the bonds are released, the Association’s transition counsel should be armed and ready to dispute the developer’s contention that it is not responsible for site improvement defects once the municipality has accepted them and released the bonds.

Pending legislation of concern:

Finally, everyone should be aware of pending legislation that is attempting to limit the developer’s obligations for performance and maintenance guarantees under the Municipal Land Use Law (A1425).  The proposed legislation would only require a performance bond for those improvements that will be dedicated to the municipality after completion and a municipality would only be able to require a performance bonds for privately owned perimeter buffer landscaping. The proposed bill would remove the following improvements from the performance bond requirement: culverts, storm sewers, erosion control and landscaping.

This legislation, if adopted, would leave an Association with defective private roadways or storm sewers to fend for itself with regard to construction defects and removes the first layer of protection that was provided by the municipality and the performance bond.

The cost to remedy construction defects in these improvements can be substantial.  This proposed legislation does not benefit Associations.

Transition – Evaluate, Communicate, Negotiate, Litigate

Posted on Author By Francis J. McGovern, Jr., Esquire

Transition is the due diligence process required by the board members’ fiduciary duty. In sum, the homeowner-elected board members must determine if the sponsor did what it was supposed to do and, if not, take action to get the deficiencies corrected.

Upon assuming board control homeowner-elected board members must:

  1. evaluate the association’s physical and financial condition
  2. communicate the findings to the members and the sponsor
  3. negotiate for repairs, money or a combination of repairs and money.

Evaluate.

Due diligence begins with evaluating the association’s physical and financial conditions. These evaluations must be undertaken promptly. Delay may result in losing some or all claims due to expiration of warranties, statutes of limitation and/or the statute of repose.

Engineers, architects, accountants and other experts are enlisted by the board and the association’s attorney to ferret out deficiencies and “connect the dots”. “Connecting the dots” requires experts to:

  1. Identify the duty – statutes, architectural drawings and specifications, building codes, industry standards, manufacturer’s specifications, etc.
  2. Specify how the duty was breached – for example, required building wrap was not installed
  3. Specify the damage – for example, moisture got behind the siding and was not shed down and out; instead the moisture damaged the substrate and structural members
  4. Specify how the breach caused the damage – for example, if the required building wrap had been properly installed, water that got behind the siding would have been shed down and out of the building envelope without damage to the substrate and structural members. Instead, the water was absorbed by the substrate and structural members resulting in rot and mold growth.

After “connecting the dots”, the association’s experts should carefully determine how much it will cost the association to fix the various physical and financial defects. This “cost to cure” report provides the board with a basis for prioritizing the deficiencies and evaluating how much the association should spend on attempting to compel the sponsor and others to remedy particular deficiencies. Without reputable experts solidly connecting the dots and determining the cost to cure, the association has little prospect of transition success. Assuming the experts connect the dots and accurately estimate the cost to cure, the board, its experts and counsel must finally evaluate the probability of recovery.

Is there an individual or entity that has the resources to cure the deficiencies or pay the association so that it may cure the deficiencies. Is it the sponsor? Is it the sub-contractors? Is it one or more insurance companies? Typically transition is resolved with contributions by all of these but, if there is little or no prospect of recovery, the association should carefully consider other options such as self-funding repairs, obtaining a bank loan to fund repairs or phasing repairs over time while using “Band-Aid” fixes in the meantime.

Communicate.

Many boards are reluctant to communicate expert findings to the membership. This is a mistake. Everyone hopes that the transition process will be smooth and amicable. However, transition can be long, contentious and expensive. If the membership does not support the board, management, its attorneys and experts, half of the battle is already lost. The board must share as much information as possible with the membership during the transition process so that the members know what it going on, know why various items have not yet been fixed and know why it is important for the association to spend the time and money to see the transition process through to resolution.

Negotiate.

Once the board has a comfort level with the experts’ findings and recommendations, the board and counsel will negotiate with the sponsor, developer, sub-contractors and others. In most cases this negotiation results in an amicable transition agreement whereby the sponsor and other responsible entities make repairs and/or pay the association so that it may make the repairs. In exchange, the association gives the responsible entities a release and hopefully everyone lives happily ever after.

But…should we litigate? If there is no amicable resolution, should the association litigate? This is a big decision and the “cost to cure” and “viability of recovery” evaluations become that much more important. There are many times where a litigated transition is necessary. The board should not shrink from turning to the courts on behalf of itself and its members. But, before doing so, a cost-benefit analysis must be carefully considered.

If the cost to cure and probability of recovery outweigh anticipated expert fees, attorney fees and other expenses, litigation likely makes sense but if the board finds that it is more economical, certain and timely to merely fix the deficiencies itself, it may do so and sign no release. In any case, transition releases should not be signed in exchange for nominal or no consideration. In sum transition is due diligence involving attorneys, experts, managers, board members and association members to cost-effectively resolve physical and financial deficiencies.