This certainly could have warranted a lawsuit and we still may send him a letter, but the big deal is that the place could not be rented until all of the open permits were closed and the work redone to code.

Not exactly sure how the suits works where you are, but I would think the attorney ad litum for the defendants should have done their research for heirs and included them or made mention of that in the lawsuit. 

Doing the amount of work of adding an ADU (including when hiring out all the work possible, still leaves hiring, design decisions, finishing decisions - similar work to hiring out all work for a rehab as part of BRRRR) and having it add less value than it costs, I do not get why anyone would do this as an RE investment (I do get it as in-law suite for family where the return is not the primary motivation). 

Typically, a condo is considered warrantable if no single entity owns more than 10% of the units in a project, at least 51% of the units are owner-occupied, fewer than 15% of the units are in arrears with their association dues, the homeowners association (HOA) is not named in any lawsuits, and commercial space accounts for 25 percent or less of the total building square footage.

I could definitely see a possible lawsuit as so and so did not get that antique buffet that has been in the family for 200 years.It is a shame that the death of a family member is often seen as a cash grab.

You may want to get the heirs sign a law suit waiver in order to get the deposit back.

I was hoping to avoid a lawsuit. 

Several house hack strategies that I have seen work well include, rent-by-the-room, LT/STR in-law suite, LTR/STR basement unit conversion, etc.

Owner hereby agrees to hold Manager harmless from, and to defend Manager against, any/all claims, charges, debts, demands, and lawsuits and for any/all damage done to or about property by any employee, tenant or guest of Tenant.

I see another lawsuit coming if non-owner occupied STR is allowed and the city does not provide licenses for it without a good reason.