May 25, 2016

Residential Builders Prevail in Illinois Supreme Court Decision, Also Benefiting Homebuyers

The Illinois Supreme Court’s May 19 decision in Fattah v. Bim represents a significant victory for residential construction companies and will also benefit homebuyers. In its decision, the Court unanimously defined a common sense limit on the reach of one common law warranty—the implied warranty of habitability (IWH)—in instances in which a builder has negotiated to obtain a contractual waiver of that warranty. A home builder’s potential liability for construction defects in Illinois depends heavily on the parties’ contract and on case law developed by the state’s courts within roughly the past 40 years, and this decision will go a long way in preventing unrest in the residential construction market.

What is the Implied Warranty of Habitability in Illinois?

In 1979, the Illinois Supreme Court declared in Petersen v. Hubschman Construction Co. that in a contract for sale from a builder-vendor to the first purchaser of a newly constructed house, there is an implied warranty that the house will be free from latent defects that unreasonably interfere with its intended use. In the same ruling, the Court recognized that this warranty could be waived if certain conditions are met. Later decisions by the Court held that to be effective, the builder-vendor was required to establish the waiver was actually the agreement of the parties, that it was called to the purchaser’s attention, that the consequences of the waiver were made clear and that the IWH was specifically mentioned by name in the waiver.

A short time after Petersen, the Court’s decision in Redarowicz v. Ohlendorf extended the IWH to subsequent buyers of a home if a latent defect arises within a reasonable time after the initial sale. This meant a second or third buyer could sue the builder even in the absence of a contract with the builder. Other lower appellate court decisions since then have even allowed buyers to sue general contractors and subcontractors directly, despite the absence of contractual privity, when the builder-vendor is insolvent.

So Why is Fattah v. Bim Important?

Until now, a key question has been left unanswered by the Illinois courts: does the IWH extend to subsequent purchasers even if it was waived by the first buyer? In Fattah v. Bim, the Illinois Supreme Court was faced with exactly this question. Stated differently, the Court was asked to decide whether, as a matter of public policy, the IWH extends to all buyers of newly constructed homes, notwithstanding a prior owner’s waiver, or if a waiver binds all future owners.

The facts of Fattah, which mirror those of many home sales in Illinois, gave the Court a perfect opportunity to clarify this uncertainty and shape Illinois law on the issue moving forward. In this case, the home builder obtained a valid and enforceable waiver from the first purchaser in accordance with the Supreme Court’s earlier opinions. In exchange, the first purchaser received an express written one-year warranty, and the builder performed warranty service under that agreement. The subsequent purchaser, Mr. Fattah, bought the house a few years later “as is,” and shortly into his ownership a latent defect in the home’s patio manifested, resulting in damage. Fattah sued the builder, claiming breach of the IWH. When the builder raised the first buyer’s waiver as a defense, Fattah argued he never knew about the waiver and that it didn’t apply to him, citing the aforementioned cases requiring an actual agreement between the parties.

The trial court ruled in favor of the builder, noting that “no builder or developer can predict who will buy the home in the future” and that “[r]equiring the builder to rely on the original purchaser to disclose to a subsequent purchaser that the implied warranty was waived and disclaimed would unnecessarily frustrate the policy favoring the enforcement of knowing waivers.”

A three-justice panel of the Illinois appellate court unanimously reversed in early 2015, holding that the IWH extends to subsequent purchasers, and Fattah’s agreement to purchase the home “as is” did not meet the requirements of a knowing waiver.

But the Supreme Court unanimously reversed the lower appellate decision and reinstated the trial verdict, stating “[i]t is not a given that the implied warranty may be extended to a second purchaser when a waiver of the warranty exists.” It explained that in the absence of a waiver, the second purchaser is merely stepping into the shoes of the first purchaser, and it is fair to hold the builder to the same burdens it would have faced as to the first purchaser. In such a case, the second purchaser is only seeking damages that would have been available to the first purchaser.

But in light of the waiver, the Court noted, Fattah was necessarily seeking to recover more than what the first purchaser would have been entitled to, and extending the warranty in these circumstances would significantly alter the burdens and expectations of the builder. The builder obtained a bargained-for waiver in order to ascertain a date certain on which its financial risk exposure would end, giving an express warranty instead. Allowing a subsequent purchaser to sue the builder despite a first purchaser’s waiver, the Court ruled, would render the waiver agreement worthless. Invoking a husband and wife analogy, it outlined how a ruling in the alternative would allow buyers to manipulate the sales process to obtain the benefit of both sides of the bargain. Thus, the Court held that the IWH may not be extended to a second purchaser of a house when a valid, bargained-for waiver of the warranty has been executed between the builder-vendor and the first purchaser.

What is the Practical Impact of the Court’s Decision?

All participants in the residential construction industry, including new homebuyers, will benefit from the Court’s ruling. Those involved in Illinois home building can have confidence that if they comply with state law in negotiating home warranties, those agreements will be enforced against future buyers. Builders will not suddenly face the risk of additional, unexpected exposure merely because a house is sold to someone else, and they will not have to inject themselves into future sales to ensure the waiver standards are met for every subsequent owner of every house they construct.

Absent this assurance, the price of every newly built home in Illinois would have necessarily risen to account for the sudden increase in the builder’s risk exposure and its inability to manage that risk with a reliable waiver. The ability to allocate risk has a significant impact on the total construction costs paid by owners. See, e.g. 2 Bruner & O’Connor Construction Law §§ 7:4, n. 3, 7:8, and 7:29.50 (2015). As a result of this ruling, new homebuyers in Illinois should not expect to see a drastic increase in prices due to builder concerns about whether warranty waivers are enforceable.

Faegre Baker Daniels represented the builder in Fattah v. Bim before the Illinois Supreme Court.

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