And the foundation for good risk management requires taking steps now to anticipate, avoid and ameliorate the financial dangers you face from construction defects caused by you or others.

Luckily, an effective risk management strategy involves some very straightforward operational safeguards that have the added benefit of improving your business operations and increasing your chances of avoiding litigation or costly verdicts.

What is a construction defect?

Everyone in the multi-housing development and construction chain can be victimized by a single construction defect that goes undetected, unreported or unresolved.

In a California mold case recently settled for $22 million, the supplier, contractor, developer, engineer and 13 other defendants paid the price for using lumber sitting in a pool of water and visibly covered with mold. The incident and parties involved illustrate how, under various state laws and rulings, construction defects can fall into one or more of three broad categories that should be avoidable:

• Material deficiencies stemming from using inferior building materials or materials with manufacturing problems;

• Design deficiencies arising from architects, engineers or subcontractors not performing their work as specified, either to cut costs or because of mistakes; and

• Construction deficiencies that are the result of shoddy workmanship or subsurface problems (such as inadequate compacting leading to foundation problems).

Managing your risk before the project start

The first step in protecting yourself against a construction defect case is to have your attorney, risk manager or insurance broker review your insurance and that of your suppliers, builders and other vendors.

You want to make sure that you understand your own coverage and are confident that it has no major holes.

Additionally, you also need to be able to answer the following questions so as to avoid any number of potential pitfalls:

1. Product warranties - What is covered, how and when by the suppliers and manufacturers whose goods and services you are using in your multi-housing project?

2. Certificates of insurance - Has your general contractor and/or sub-contractors provided you with certificates of insurance, along with specific additional insurance endorsements naming you?

3. Indemnification - Do you rely solely on indemnification to protect your interests? Some state courts have ruled that indemnification is only enforceable if the “offending” firm is insured. A vendor’s insurance status needs to be monitored regularly.

4. Coverage periods - Does your project involve multiple firms with multiple insurance policies offering different periods of coverage, definitions of what constitutes an insured event, and how and when incidents must be reported? If so, you need to analyze these policies to make sure that your project isn’t sitting in the middle of a coverage “doughnut hole” in which only you are liable for damages.

5. Statute of limitation - Do you know what the statute of limitations regarding construction defects in your state? It varies state to state and can be different for the general contractor and the subcontractor.

Once work is underway

One of the most powerful risk management tools is a well-trained staff that understands your project’s goals, applicable construction standards and methods for reporting potential problems – even if outside their contractual focus.

Setting up and maintaining such a training program is expensive and provides no immediate return on investment. However, it is a potent legal safeguard that pays off operationally in the long run.

And as your reputation for a well-trained work force grows, it is likely that better quality work with higher profit margins and lower legal risks will come your way.

Your people should deploy their training within the context of a formal schedule of regular inspections. Often the key to heading off costly legal problems down the road is to nip a small problem in the bud. Regular inspections will give you confidence that you have not missed problems with workmanship or materials.

Courts also favor those who’ve noticed a problem and tried to remediate it during construction. Thoroughly document the inspection process and schedule used, as well as the steps you took afterwards to notify affected parties and to correct the problems under your control.

When the project is finished

In its own way, a building is a piece of complicated machinery, with systems that can be terribly damaged if not operated properly.

Yet a building is one of the few major “mechanical” purchases people make that doesn’t come with an owner’s manual.

And a new owner or tenant may damage a building through abuse or neglect because they don’t know any better, a fact that won’t prevent them from coming after you for any problem.

Protect yourself by creating a new building’s owner or tenant manual. Include instructions on how to maintain the building and its systems, copies of warranties and other information that may help others understand their obligations for properly “operating” their new building.

Such a manual may seem an unnecessary expense. But its availability may deter suits, minimize risk from those that are filed and, in a more positive light, be seen by others as an example of what a smart, insightful organization you run.

The key lesson to learn – foster open communication about problems

Here’s a truism about construction defects: Someone on the job knew about the problem but didn’t speak up.

Employees, subcontractors or other project personnel need to know that you want to be informed of problems – or even potential problems – at the earliest possible moment.

You, in turn, need to make sure that all potentially affected project decision makers know about the problem and the steps you’re taking to fix it, being sure in the process to document notification and remediation efforts.

If your words and deeds reinforce the idea that you’re focused on fixing the problem – rather than the blame – you empower people to help you spot and fix problems at the earliest, easiest and cheapest stage.