HOW TO MANAGE CONSTRUCTION DISPUTES TO MINIMIZE SURETY AND CONSTRUCTION CLAIMS. PART 7: DESIGN AND CONSTRUCTION DEFECTS CLAIMS

HOW TO MANAGE CONSTRUCTION DISPUTES TO MINIMIZE SURETY AND CONSTRUCTION CLAIMS.  PART 7: DESIGN AND CONSTRUCTION DEFECTS Claims

 Introduction

Construction is a business fraught with risk.  Disputes over even the smallest of issues can quickly escalate, with crippling consequences to the project and the parties.  Over the years, the construction industry has developed various methods of contractually allocating the risk of project delay and disruption.  Some of these methods include liquidated damages provisions, "no damages for delay" clauses, mutual waivers of consequential damages, provisions that limit liability, claims notice provisions, “waiver of damages clauses”, acceleration clauses, “time is of the essence” clauses, change order clauses, and provisions addressing responsibility for the adequacy of the construction plans and specifications.  Parties frequently litigate the sufficiency of these risk-shifting efforts in conjunction with the underlying merits of delay and disruption disputes.

The Most Frequently-Encountered Construction Claims & Disputes

In Part 1 of our series of how to manage construction disputes to minimize surety and construction claims, we addressed the construction delay claims and the methods typically used to analyze them.

We indicated there that the most frequently encountered claims include:

1.      Construction Delay Claims

2.      Disruption and Loss of Labor Productivity Claims

3.      Design and Construction Defects Claims

4.      Force Majeure Claims

5.      Acceleration or Compression of the Schedule Claims

6.      Suspension, Termination and Default Claims

7.      Differing Site Conditions Claims

8.      Change Order and Extra Work Claims

9.      Cost Overrun Claims

10.   Unacceptable Workmanship or Substituted Material Claims

11.   Non-payment Claims (stop notice (or Notice to Withhold) claims, mechanics’ lien (only for private construction projects) and payment bond claims)

Part 7 of this series discusses item 3 above: Design and Construction Defect Claims.

What is a CONSTRUCTION defect?

According to the Insurance and Risk Management Institute, a construction defect is generally speaking, a deficiency in the design or construction of a building or structure resulting from a failure to design or construct in a reasonably workmanlike manner, and/or in accordance with a buyer's reasonable expectation.  The most dangerous defects have the capacity to fail, resulting in physical injury or damage to people or property.  However, many defects present no increased risk of injury or damage to other property but nevertheless cause harm to the property owner in the form of loss of use, diminution in value, and extra expenses incurred while defects are corrected.  This latter type of defect is often referred to as a passive defect. 

Many states have more specifically defined the term "construction defect" for purposes of applying statutes that dictate processes for remedying and litigating construction defect claims.  These statutory definitions vary by state.  Nevada, for example, uses the term constructional defects and defines it as follows:

“Constructional defect” means a defect in the design, construction, manufacture, repair or landscaping of a new residence, of an alteration of or addition to an existing residence, or of an appurtenance and includes, without limitation, the design, construction, manufacture, repair or landscaping of a new residence, of an alteration of or addition to an existing residence, or of an appurtenance:

Which is done in violation of law, including, without limitation, in violation of local codes or ordinances;

Which proximately causes physical damage to the residence, an appurtenance or the real property to which the residence or appurtenance is affixed;

Which is not completed in a good and workmanlike manner in accordance with the generally accepted standard of care in the industry for that type of design, construction, manufacture, repair or landscaping; or

Which presents an unreasonable risk of injury to a person or property.

For architects and other design professionals, one of the most devastating professional and business risks is from litigation alleging negligence in performing professional services.  These alleged negligent acts, errors, or omissions may cause damage to owners, contractors, or other third parties, and the architect’s firm may be found liable for these damages.

WHAT ARE THE TOP CLAIMS THAT CAN BE FILED AGAINST AN ARCHITECT OR ENGINEER?

The Common Law Standard of Care

The standard of care for architects and engineers is set forth in numerous court decisions as follows:

The architects and other design professionals are under a duty to exercise ordinary, reasonable care, technical skill, and ability and diligence, as are ordinarily required of architects, in the course of their plans, inspections, and supervision during construction.

The duty owed by architects and engineers was further defined in other court decisions as follows:

An architect’s efficiency in preparing plans and specifications is tested by the rule of ordinary and reasonable skill usually exercised by one in that profession. (See, Annot., 25 A.L.R.2d 1088.) The duty of an architect depends upon the particular agreement he has entered with the person who employs him and in the absence of a special agreement he does not imply or guarantee a perfect plan or satisfactory result; rather, he is only liable if he fails to exercise reasonable care and skill. 5 Am.Jur.2d, Architects, Sec. 8.

The standard of care owed by an architect/engineer may be altered by agreement with the owner.  A provision in an owner-A/E agreement by which the A/E represents that he or she will follow the highest professional standards in performing all professional services under the agreement would appear to override the standard of ordinary and reasonable skill established by the typical court decisions, at least with regard to a claim by the other party to the design professional’s contract.

Among the reasons architects have been found answerable in malpractice actions is because they hold themselves out and offer services to the public as experts in their line of endeavor.  Those who employ them perceive their skills and abilities to rise above the levels possessed by ordinary laymen.  Such persons have the right to expect that architects, as other professionals, possess a standard minimum of special knowledge and ability, will exercise that degree of care and skill as may be reasonable under the circumstances and, when they fail to do so, that they will be subject to damage actions for professional negligence, as are other professionals.

In performing services, an architect must possess and apply the knowledge and use the skill and care that is ordinarily used by reasonably well-qualified architects.  A failure to do so is a form of negligence that is called malpractice.

The only way in which a judge or a jury may decide whether the defendant architects possessed and applied the knowledge, and used the skill and care which the law required of them, is from evidence presented in the trial by architects called as expert witnesses.  The judge or jury must not attempt to determine this question from any personal knowledge he/she may have. 

THEORIES OF LIABILITY

Below are the top five avenues of architect liability in New York and most other states:

1.            Contract Claims.  Typical contract based claims against an architect include: failure to properly design the building, failure to meet the applicable federal, state or local codes, failure to complete projects on time, work performed improperly under the architect’s direction, improper design of moisture and drainage control, leaking roofs and shrinking woodwork.  In the absence of any express language specifying the standard for the architect's performance in a breach of contract claim, the courts apply a negligence standard.

In a negligence standard claim, it must be shown that the architect failed to perform in accordance with the standard of professional care usually exercised by such professionals in the community.

Caution.  Avoid express warranties, if possible.  Express warranties regarding the quality of architectural and engineering services to be performed may appear in an owner-architect or owner-engineer agreement.  These warranties usually concern compliance with local codes, rules, and regulations, and state and federal laws. However, more often than not, qualifying language will have been inserted limiting the architect’s or engineer’s liability to compliance “to the best of his or her knowledge, information, and belief.” In the absence of any contract language or given the qualifier noted above, the architect/engineer would presumably be held to the standard of ordinary and reasonable care discussed in above under the common law standard of care.

2.            Warranty Claims.  New York does not provide a cause of action against architects for breach of an implied warranty.  Nor does the work of an architect constitute a product for which strict liability claims could exist.  The architect may, however, enter into a contract with terms that provide for the architect's liability if the architect fails to produce specific results as guaranteed in the contract, even if the architect otherwise conforms to the community standard of performance.  Other states do incorporate in their statutes and in their case law the doctrine of implied warranty in connection with the delivery of professional design services.

Architects and engineers represent themselves to be competent in the preparation of plans and specifications necessary to the construction of suitable structures, including but not limited to the knowledge of and compliance with applicable building codes, and where they fail to use reasonable care to produce a satisfactory structure in compliance therewith, they may be sued for breach of an implied contract term. Himmel Corp. v. Stade, 52 Ill.App.3d 294, 367 N.E.2d 411, 414 – 415, 10 Ill.Dec. 23 (1st Dist. 1977).

To recover for breach of express warranty, a plaintiff must prove that a warranty existed, the defendant breached the warranty, the breach proximately caused the losses claimed as damages, and timely notice of the breach was given to defendant.  An express warranty is not required to be in any specific form and may be either written or oral.  Whether a statement is an express warranty is a question of fact to be determined by the judge or the jury.

Builders often provide homebuyers with express warranties protecting various elements of the physical construction.  Additionally, express warranties are often included to disclaim or limit implied warranties of habitability, fitness, and workmanship.  However, while several cases support the validity of such disclaimers, the courts have refused to answer whether they are enforceable, and it remains an open question under Colorado law.  Privity of contract or standing as a third-party beneficiary of the contract is required in order to be protected by the warranty. 

Breach of Implied Warranty

There are various implied warranties available in most states.  Two important warranties are the implied warranty of habitability and the implied warranty of workmanlike construction.

Implied Warranty of Habitability

A buyer is "entitled to relief based on the theory of implied warranty of habitability if he proves the house was not built in a workmanlike manner or that it was not suitable for habitation."  The warranty of habitability has been likened to strict liability for construction defects, and proof of a defect due to improper construction, design, or preparations is sufficient to establish liability in the builder-vendor.  Courts have extended the implied warranty of habitability to situations in which a home becomes uninhabitable for reasons other than the workmanship, such as soil expansion. Id. Generally, in these cases, the breach of the implied warranty of habitability occurs in the builder's selection of the building location. 

Implied Warranty of Workmanlike Construction

The warranty of workmanlike construction is another implied warranty. It does not, however, guarantee perfect construction by the builder. For construction to be done in a good and workmanlike manner, there is no requirement of perfection; the test is reasonableness in terms of what the workmen of average skill and intelligence (the conscientious worker) would ordinarily do. 

Statute of Limitations for Breach of Warranty

In general, a breach of warranty is governed by the statute of limitations for contract actions and must be filed within a three-year period.  Depending on the state, there are statutes that either lengthen or shorten the statute of limitations in a breach of warranty case against a design or construction professional to two years.  

3.            Design Liability.  New York State law has established that an architect's work will be judged by the standard of ordinary and reasonable skill usually exercised by a licensed professional, unless the parties state otherwise in their contracts.  This claim is essentially one for professional malpractice or negligence in the field of architecture.

To succeed on a negligence claim, the plaintiff must show (1) the existence of a duty on the part of a defendant, (2) a breach of that duty, (3) a causal connection between the defendant's breach and plaintiff's injury, (4) and injury.  Generally, a duty is owed to anybody that could foreseeably suffer damages as a result of a defendant's negligent conduct.

The more complex and unusual the architect’s design, the more latitude an architect is allowed.  This latitude however can be quite narrow.  For example, an architect was found liable for damages to the owner for roof repairs, not because the roof was installed incorrectly, but because the design of the roof caused owner significantly increased maintenance and repair costs.

Design liability may also rest with the architect for items that are actually beyond the design of the architect.  New York courts have held that an architect will be liable to the owner for any damages incurred as a result of the architect's approval of engineering drawings and a defect therein causes damage to the owner.

Some states require that an Affidavit of Merit is submitted along with the suit.  New York does not have such statute.  The Affidavit of Merit for New Jersey is listed below:

2A:53A-27 Affidavit of lack of care in action for professional, medical malpractice or negligence; requirements. 2.In any action for damages for personal injuries, wrongful death or property damage resulting from an alleged act of malpractice or negligence by a licensed person in his profession or occupation, the plaintiff shall, within 60 days following the date of filing of the answer to the complaint by the defendant, provide each defendant with an affidavit of an appropriate licensed person that there exists a reasonable probability that the care, skill or knowledge exercised or exhibited in the treatment, practice or work that is the subject of the complaint, fell outside acceptable professional or occupational standards or treatment practices. The court may grant no more than one additional period, not to exceed 60 days, to file the affidavit pursuant to this section, upon a finding of good cause.

In the case of an action for medical malpractice, the person executing the affidavit shall meet the requirements of a person who provides expert testimony or executes an affidavit as set forth in section 7 of P.L.2004, c.17 (C.2A:53A-41). In all other cases, the person executing the affidavit shall be licensed in this or any other state; have particular expertise in the general area or specialty involved in the action, as evidenced by board certification or by devotion of the person's practice substantially to the general area or specialty involved in the action for a period of at least five years. The person shall have no financial interest in the outcome of the case under review, but this prohibition shall not exclude the person from being an expert witness in the case. L.1995,c.139,s.2; amended 2004, c.17, s.8.

A negligence claim stemming from a construction contract may be barred by the Economic Loss Rule.  This rule prevents recovery for negligence when the duty breached is a contractual duty and the harm incurred is the result of failure of the purpose of the contract.  However, when a contract neither encompasses a duty nor requires that specific work be done, any work undertaken by a professional must be done in a reasonable manner. Failure to do so could result in an award of actual damages on a negligence claim.

4.            Supervision and Inspection of Work-in-Place.  If an architect assumes responsibility for performing site supervision and inspection, he/she is bound to use due care in the performance of such duties.  The primary purpose of the inspection requirement is to make it a contract obligation for the architect to provide the owner with assurances that the work is being completed in conformance with plans and specifications.

However, as elaborated in case law from 1866, “the architect must be diligent in inspecting and supervising the work, but is not obligated to discover every defect in a contractor's or subcontractor's work and will not be liable for defects so long as they are not attributable to carelessness, negligence, or inattention on the architect's part.”

Regardless of limitations over means and methods as stated above, failure of the architect to abide by the contract terms of inspection can result in the architect ultimately being liable to the owner.  If it can be established that the architect breached this obligation, and this breach was the “proximate cause” of a failure to discover a defect, the architect may be liable to the owner for the cost incurred in correcting the defect.

5.            Certification of Progress Payments.  Design professionals have become increasingly subject to claims arising out of their design and construction administration services.  The obligation of the design professional to issue payment certificates has long been a tedious and dreaded task and one that often creates numerous liability problems. Although the only real purpose of issuing payment certificates is to inform the owner or lender that the contractor is entitled to payment, these certificates are often used by potential claimants as a basis for many types of legal actions.  Courts in New York recognize the numerous responsibilities owners look to architects to perform.  Just as courts recognize that owners may rely on architects for inspections of work, they also recognize that owners look to architects for certification of progress payments.

Should an architect improperly approve a progress payment, or prematurely release retainage, the architect may be liable to the owner for any damages suffered, as this may decrease the contractor's incentive to complete the work.

By issuing payment certificates, the design professional makes a potential claimant out of everyone involved in the construction process. Those people from whom the design professional can expect claims include prime contractors, owners, subcontractors, sureties and construction workers who have suffered personal injuries.

Claims by Prime Contractors.

The most common complaint voiced by prime contractors against design professionals is that of under certification. When a design professional under certifies a payment request, they are recommending that too little money be paid out by the owner to the prime contractor. The prime contractor might claim that the design professional was negligent and under certified the work because the design professional failed to accurately measure the progress of the work. If the design professional does under certify payment, the prime contractor may be harmed and denied needed resources to complete its work, possibly resulting in a default. In the case of defective work, the prime contractor will undoubtedly point to the payment certificates which are issued by the design professional as evidence that the owner and the design professional accepted the work.

Claims by Subcontractors.

Subcontractors often expect the design professional to act as watchdog to make sure that the prime contractors are paying them with the proceeds received from the owner. If the design professional fails to monitor the payments made by the prime contractor to the subcontractor, the subcontractor may argue that the design professional was negligent and caused a diversion of funds. By failing to monitor such payments, the design professional could be said to have denied the subcontractor of needed resources to complete its work, which could possibly lead to a default.

Claims by Sureties.

Sureties may have claims against design professionals for both over certification and under certification. If the design professional under certifies payment and causes a contractor default, the surety may be forced to complete the contractor's work. Similarly, if the design professional over certifies payment, thereby reducing the amount of retainage needed to adequately complete the job, the surety may be forced to complete the contractor's work, upon default, with insufficient funds.

Arguments for Architect Liability to the Surety

Surety actions against architects share these common arguments:

Improper Certification of Progress Payments—the approval of draw requests that result in overpayments to the contractor may result in loss to the surety if the surety has to step in and is deprived of funds that could be used to complete the project.

Contractor “Front-Loads” Pay Requests—to cut down on the expense of borrowing funds for a project, some contractors may submit pay requests beyond what the work-in-place would allow. Front-loading a contract prevents the surety from obtaining the fair value for its continuation of the contract.

Contractor Shorting Subcontractors and Suppliers—That a surety may have to make bond payments where an architect fails in its duty to discover that a contractor is not paying its subs is foreseeable to some courts.

Premature Release of Retainage—the surety may successfully sue the architect to recover the improperly authorized release of retained funds when it is discovered that the architect failed to adequately investigate whether the contractor had paid for all labor and supplies.

Errors in Contract Supervision or Inspection—Some courts recognize the surety’s right to sue an architect where it is alleged that the architect failed to adequately inspect the work, make an adequate number of inspections, and improperly authorized payment for defective work.

Failure to Report Construction Defects and Require Corrections to Defective Work—some courts hold that the architect is bound to report defective work and see that it is corrected even when there is no contractual obligation.

Deficient Design Documents—if a contractor defaults and the surety’s cost to complete the project increases because of deficient design, the surety may assert a claim. The foreseeability of harm to the surety is less certain because the surety is not the intended end-user of the design or the finished project.

Claims by the Owner.

Claims brought by owners against design professionals represent the greatest variety of potential claims. The owner may allege that the design professional negligently over certified payments or may allege that the design professional was negligent for failure to adequately supervise the work. Most owners rely upon the issuance of a payment certificate by the design professional to determine whether the contractor is entitled to payment. If the design professional over certifies payment, thereby recommending that payment be made for work that is not yet done or for patently defective work, the owner may be injured. When the design professional over certifies payment, the amount of retainage held by the owner as security for default or defective work is reduced. This, of course, could leave the owner with insufficient funds to complete the project.

In the case of defective work, the payment certificates issued by the design professional are typically used by the owner to attempt to hold the design professional responsible for the contractor's work. The owner may allege that the design professional was responsible for inspecting the work prior to issuing payment certificates to make sure that the work conformed with the Contract Documents. Owners may also view payment certificates as a guarantee by the design professional that the work was properly done.

Claims by Construction Workers.

Claims brought by construction workers against design professionals, whether for negligence, may be brought based upon the design professional's duty to issue payment certificates. A construction worker who is injured on the job site may allege, by inference, that the duty of the design professional to issue payment certificates necessarily requires that the design professional visit the site to check on the progress of the work, and that while checking on the progress of the work, the design professional has a duty to protect people on the job from any unsafe construction practices or defective conditions.

LEGAL ANALYSIS

The few cases which have addressed the duty of the design professional to issue payment certificates have analyzed that duty based upon responsibilities similar to those set forth in the standard form AIA Agreements. Despite the use of the typical disclaimer clauses used by the AIA, which protect the design professional from liability for issuing payment certificates, the design professional is often the subject of litigation.

Negligent Over certification Cases.

There have been few reported decisions in Illinois regarding the potential liability exposure of a design professional for under certifying or over certifying payment requests. Beginning with the case of City of Chicago v. Agnew, 106 N.E.2d 252, 264 Ill. 288, Illinois courts have held that contractors and sureties have standing to assert claims of "negligent over certification" against owners and others with whom they are in direct contractual privity. The law is much less clear, however, whether those same contractors and sureties would have standing to assert claims of "negligent over certification" against design professionals with whom they do not have contractual privity.

The court in Southern American Insurance Co. v. E.W. Corrigan Construction Co. et al. al., 1991 U.S. Dist. Lexis 10368 (N.D. Ill. 1991) held that the surety of a subcontractor, who defaulted on the job, could not bring an action against the architect who allegedly over certified the work of the subcontractor, thereby depriving the surety of its primary source of security to mitigate the costs of completing the subcontractor's work. The court reasoned that neither the subcontractor nor the surety had a contract with the architect and therefore the architect owed no legally cognizable duty to the subcontractor or the surety. As support for its decision, the court cited the well-known decision of Moorman Mfg. Co. v. Nat'l. Tank Co., 91 Ill. 2d 69, 61 Ill. Dec. 746, 435 N.E.2d 443 (1982), which prohibits the recovery of economic loss in tort actions.

More recently, Judge Jack Hoogasian of the Circuit Court of Lake County in Montessori School of Lake Forest v. Aetna Casualty and Surety Company of Illinois, et. al., 92 L 1027 (1994), held that a surety could bring a claim for "negligent over certification" against an architect with whom the surety had no contractual privity. In that case, the Montessori School of Lake Forest, as owner, filed a lawsuit against the General Contractor who worked on the job and its surety for defective work. The surety filed a third-party complaint against the architect alleging that the architect negligently over certified payments due the General Contractor, thereby reducing the amount of funds needed to complete the work. The architect moved to dismiss the third-party complaint on the grounds that the surety was not a third-party beneficiary to the Owner/Architect Agreement and that the surety could not recover economic losses against the architect for its alleged negligent certification of payments.

The surety filed a brief in response to the architect's motion to dismiss and argued that the surety was a third-party beneficiary to Owner/Architect Agreement because the surety was explicitly given the right to use any retainage to complete the job and was to benefit by the use of this retainage. The surety also argued that regardless of whether it was a third-party beneficiary to the Owner/Architect Agreement, the architect owed the surety an independent duty to correctly estimate the progress of the work and to only certify and approve conforming work for payment. The surety stated that the architect's representations concerning certification of payments were negligent and because the architect was allegedly in the business of supplying information, the Moorman doctrine did not apply and the surety could bring a claim for negligent over certification. The court, in an unpublished opinion, held in favor of the surety.(1) 

Negligence.

The liability exposure of design professionals for negligence, based upon issuing payment certificates, can be greatly reduced provided that design professionals take particular care when negotiating their contracts with owners. The potential liability exposure of a design professional for negligence, whether brought by owners or personal injury claimants, typically depends upon whether the design professional has any responsibility for site inspection or review of the contractor's work for compliance with the Contract Documents.

In Corbetta Construction v. Lake County Bldg. Commission, 64 Ill. App.3d 313, 21 Ill. Dec. 431, 381 N.E.2d 758 (2nd Dist 1978), the Court held that the architect was negligent and liable to the owner for the contractor's defective work because the architect, who had agreed to supervise the construction, should have discovered the contractor's defective work. In Busick v. Streator Township High School, 234 Ill. App. 3d 647, 175 Ill. Dec. 423, 600 N.E.2d 46 (3rd Dist. 1992), the Court held that the architect was not liable to an injured construction worker for job related injuries because the architect had no duty to supervise the work, nor was he responsible for worker safety. In reaching its decision, the Court noted that the legal duty of a design professional to third persons, such as construction workers and other personal injury claimants, is based upon the scope of the design professional's agreement with the owner (whether the design professional has agreed to inspect and supervise the work).

HOW THE DESIGN PROFESSIONAL CAN MINIMIZE LIABILITY EXPOSURE WHILE PARTICIPATING IN THE PAYMENT PROCESS

Unquestionably, the best way for design professionals to protect themselves from liability arising out of the payment process is to avoid issuing payment certificates. Some owners may be willing to relieve the design professional of the duty to issue payment certificates and perform this task themselves, or delegate it to a construction manager, in order to retain greater control over the payment process. If an owner is willing to absolve the design professional from the headaches which typically accompany issuing payment certificates, the design professional should accept the offer. More commonly, the owner will request that the design professional issue payment certificates. The following suggestions are ones that the design professional should consider when an owner has requested that the design professional issue payment certificates. 

The Design Professional Should Only Be Held To A "Negligence" Standard.

Both the B141 and A201 Agreements seek to limit the liability exposure of the design professional, for issuing payment certificates, by creating a negligence standard. These standard forms of agreement carefully provide that such certificates are based upon the "knowledge, information and belief" of the design professional, making it clear that the design professional shall be held only to the professional standard of care -- not a guarantee -- in the exercise of its certification function. Paragraph 2.6.10 of the B141 Agreement sets forth the primary duties of the design professional to issue payment certificates:(2)

"The Architect's certification for payment shall constitute a representation to the Owner, based on the Architect's observations at the site as provided in Subparagraph 2.6.5 and on the data comprising the Contractor's Application for Payment, that the Work has progressed to the point indicated and that, to the best of the Architect's knowledge, information and belief, quality of the Work is in accordance with the Contract Documents. The foregoing representations are subject to an evaluation of the Work for conformance with the Contract Documents upon Substantial Completion, to results of subsequent tests and inspections, to minor deviations from the Contract Documents correctable prior to completion and to specific qualifications expressed by the Architect. The issuance of a Certificate for Payment shall further constitute a representation that the Contractor is entitled to payment in the amount certified. However, the issuance of a Certificate for Payment shall not be a representation that the Architect has (1) made exhaustive or continuous on-site inspections to check the quality or quantity of the Work, (2) reviewed construction means, methods, techniques, sequences or procedures, (3) reviewed copies of requisitions received from Subcontractors and material suppliers and other data requested by the Owner to substantiate the Contractor's right to payment or ⁴ ascertained how or for what purpose the Contractor has used money previously paid on account of the Contract Sum."

In addition to limiting the design professional's certification by a "knowledge, information and belief" standard, Paragraph 2.6.10 sets forth other protections for the design professional. As discussed in Section III (C) of this Article, Paragraph 2.6.10 attempts to absolve the design professional from having any control over the work and from making continuous or comprehensive on-site inspections. This language is important to the design professional because it specifies that any on-site visits made by the design professional are for checking the progress of the work, rather than an "inspection" of the work for compliance with the contract documents, which can give rise to a negligence or Structural Work Act claim.

Paragraph 2.6.10 also gives the design professional the right to retract his previous representations that the Work is in accordance with the Contract Documents, "subject to an evaluation of the Work for conformance with the Contract Documents upon Substantial Completion." This language, once again, illustrates the narrow purpose of the payment certificates and makes it very difficult for an owner or surety to argue that a design professional should be held liable for contractor deviations at the progress payment stage.

The significance of including exculpatory language, like that used in the AIA standard form agreements, is underscored by the fact that some owners believe that by issuing payment certificates, the design professional is giving his "guarantee" or "certifying" that the contractor has complied with the plans and specifications. Of course, if the design professional actually "certifies" that something is perfect, he is assuming a level of liability well beyond the standard of care required by the law. This is significant for insurance reasons, as well as potential liability reasons, because certificates for payment can be construed to be warranties or guarantees, especially when the certificate contains representations of fact upon which the Owner will rely, and the design professional's insurance does not typically cover claims for breach of warranty:

"This insurance does not apply to liability assumed by you under any contract; but that this exclusion does not apply if you would have been liable, in the absence of such contract, due to your own error, omission or negligent act."

When negotiating an Owner/Architect Agreement, the design professional should explain to the owner that the provisions in the B141 and A201 Agreements, which provide that payment certificates are issued based upon the design professional's "knowledge, information and belief," benefit both the design professional and the owner by triggering the design professional's insurance coverage. If the owner wants the design professional to be exposed to liability which is not covered by insurance, the design professional should request to be paid for those services and more money should be allocated for comprehensive site inspections by the design professional. 

Demand a Schedule of Values.

Prior to issuing any payment certificates, the design professional should insist on receiving a detailed Schedule of Values from the contractor. The A201 General Conditions (Paragraph 9.2.1) requires that the contractor provide the architect with a detailed Schedule of Values, but does not specifically state whether the design professional's payment certificate is a representation that a certain percentage of the work is completed, or that the amount which the contractor seeks coincides with the actual amount of labor and materials put in place.

Typically, the design professional compares the percentage of work completed against the schedule of values, rather than attempting to analyze the actual value of the work. Nonetheless, some owners are now requiring the design professional to certify that the original schedule of values submitted by the contractor accurately allocates the contract sum among the various trades in order to avoid contractor front loading. An example of this type of responsibility is as follows:

Design Professional shall review and approve the Contractor's schedule of values and certify that the schedule accurately represents the amounts to which the Contractor should be entitled for the Work described in each line item and that the Contractor's schedule of values is of sufficient detail to allow the Design Professional to certify that the Contractor's Applications of Payment are accurate representations of the value of the Work put in place.

If possible, the design professional should avoid taking on this type of responsibility. The design professional's duty to issue payment certificates should only be an indication that the work "has progressed to the point indicated" (see A201, 9.4.2), and not a summary of how the money was spent. It should be left up to the owner/lender to make sure that the money paid to the contractor is used properly. 

Protect Yourself From Negative Inferences.

Most lawsuits against design professionals, based upon their role in the payment process, are founded upon negative inferences typically drawn from payment certificates. It is common for contractors and owners to equate the duty of the design professional to issue payment certificates with that of inspecting the work for compliance with the Contract Documents. To avoid this negative inference, design professionals should include language in all of their contracts to make clear that they are not in charge of the work, nor required to make exhaustive or continuous on-site inspections. Both the B141 and A201 Contracts contain appropriate language like this which should be incorporated into any contract entered into by the design professional. Specifically, Paragraph 2.6.10 of the B141 and Paragraphs 4.2.2 and 4.2.3 of the A201 absolve the design professional from having any control over the work and from making continuous or comprehensive on-site inspections.

CONCLUSION

The duty of the design professional to issue payment certificates exposes the design professional to a variety of potential claims. The design professional may face claims for negligence and for alleged Structural Work Act violations, as well as claims for negligent over certification and under certification of payments. In order to minimize the design professional's exposure to such claims, the design professional should, whenever possible, attempt to utilize standard form AIA documents or incorporate the concepts discussed in this Article into any contract entered into by the design professional.

Endnotes

1.            Courts in other jurisdictions have also held that design professionals may be liable for over certifying payment requests. For example, in State ex rel. National Surety Corp. v. Malavaney, 221 Miss. 190, 72 So. 2d 424 (1954), the court held that an architect was liable to a surety for negligent certification of payments. See also U.R.S. Company Inc. v. Gulport-Biloxi Regional Airport Authority, 544 So. 2d. 824 (Miss. 1989); Aetna Insurance Company v. Hellmuth, Obata & Kassabaum Inc., 392 F.2d 472 (8th Cir. 1968).

2.            Paragraph 2.6.9 of the B141 and Paragraph 4.2.5 of the A201 Agreements similarly provide that "[b]ased upon the Architect's observations and evaluations of the Contractor's Application for Payment, the Architect shall review and certify the amounts due the Contractor."

Design Professional Liability on Completed Work

http://metroforensics.blogspot.com/2014/10/design-professional-liability-on.html

For New York Architects, Landscape Architects, Engineers, and Land Surveyors, exposure to liability on their completed projects may extend long beyond the completion of the project itself. Exactly how long design professionals can be 'on the hook' for claims has been a bit of a moving target in New York, with changes and proposed additional changes to this timeframe.

How long a design professional can be liable for claims, including claims from third-parties, has been governed by the Statute of Limitations. Generally this has provided three years for a design professional malpractice action, and six years for a breach of contract claim.

 The New York State Court of Appeals in 1995 clarified this in holding that claims against design professionals is time barred three years after completion of construction. Newburgh v. Hugh Stubbins & Associates, 85 NY2d 535.

Subsequently the New York State Legislature passed CPLR 214-d, which allows a third party (any injured person who was not the client of the design professional) to bring forth claims against the design professional within three years of their loss or injury, even if such loss or injury occurs 40 or more years from completion. In fact, this regulation only looked at the length of time from the date of injury and made no reference to when the construction actually was completed.

"... a design professional ... is governed by a three year statute of limitations and the cause of action does not accrue until the injury takes place - even if the plaintiff is injured 20, 30, 50, or 100 years after the design professional has completed work on the building or structure."

The effect of this is to cause New York design professionals to be potentially liable for any injuries suffered to third persons on the completed work, even where the architect is not responsible for long term maintenance. Further, often times the design professional may not have been additionally retained to supervise the actual construction itself, or even where the architect is not responsible for long term maintenance, and in defending such a claim so many years beyond completion witness memories may fade, or witnesses may no longer be available and can have the effect of forcing New York design professionals to maintain their malpractice insurance coverage indefinitely.

In seeking to address these unintended consequences, in 2011 the New York Senate introduced S4782-2011 seeking to amend the effects of section 214(d) by among other things establish a new ten year statute of repose for professional injury or wrongful death actions brought against professional engineers, architects, landscape architects, land surveyors or construction contractors. This would eliminate the current legal landscape where the design professional has no effective time limit on how long it could remain liable to third parties beyond project completion.  The legislation recognizes that the design professional has no control over the structure long after construction is complete.

S4782-2011 is still a pending bill in senate subcommittee, and has not yet been enacted into law. Design professionals in New York are encouraged to maintain their records forever, as you could need them in defending against such claims.

Architects and Design Professionals Can Be Held Liable For Defects Based On Third Party Claims

On July 3, 2014, the California Supreme Court decided the much watched case Beacon Residential Community Assoc. v. Skidmore, Owings & Merrill, LLP.  The court held that the “principal architect” “owes a duty of care to future homeowners in the design of a residential building . . . even when they do not actually build the project or exercise control over construction.”  A homeowners association, on behalf of its members, sued a condominium developer and various other parties for construction design defects that allegedly made their homes unsafe and uninhabitable for a significant portion of the year. Two defendants were architectural firms that allegedly designed the homes in a negligent manner but did not make final decisions regarding how the homes would be built. Applying the Supreme Court’s decision in Bily v. Arthur Young & Company (1992) 3 Cal.4^th 390, and relying on the Weseloh Family LTD. Partnership v. K. L. Weseloh Construction Company, Inc. (2004) 125 Cal.App.4^th 152, the trial court sustained a demurrer in favor of the defendant architectural firms, reasoning that an architect who makes recommendations but not final decisions on construction has no duty of care to future homeowners with whom he has no contractual relationship. The Court of Appeal reversed, concluding that the architect owes a duty to homeowners in these circumstances, both under common law and under the Right to Repair Act (Civil Code Section 895 et seq.) The Supreme Court agreed and held that the homeowner may state a cause of action against a design professional for negligence.

Skidmore, Owings & Merrill LLP (SOM) and HKS, Inc., (HKS) were architectural firms (“defendants”) who provided architectural and engineering services to the Beacon Residential Condominiums (“the Project”), a residential community in San Francisco.

The Beacon Residential Community Association (BRCA) sued SOM and HKS. BRCA alleged numerous construction defects as a result of negligent architectural and engineering design and observation. BRCA also complained of “solar heat gain,” excessively high temperatures resulting from the defendants’ approval of inexpensive and nonfunctional windows, and a design lacking adequate ventilation within the residential units. The defendants were named in three causes of action: Civil Code Title 7 – Violation of Statutory Building Standards for Original Construction; Negligence Per Se in Violation of Statute; and Negligence of Design Professionals and Contractors.

The defendants demurred to the complaint, arguing that under Bily v. Arthur Young & Co.(1992) 3 Cal.4th 370 and Weseloh Family Ltd. Partnership v. K.L. Wessell Construction Co., Inc. (2004) 125 Cal.App.4th 152, they owed no duty of care to BRCA or its members. The trial court sustained the demurrers and dismissed the case. The trial court reasoned that liability could not be premised on negligent design because without privity of contract, BRCA was required to show that the design professionals had “control” in the construction process and assumed a role beyond that of providing design recommendations to the owner. The court believed that BRCA failed to meet its burden.

The Court of Appeal reversed, holding that BRCA could state a claim based on design liability that was recognized both under common law and statutory law. The Court distinguished Weseloh, in which judgment was affirmed in favor of design engineers who were sued after a retaining wall failed. There, the outcome was premised on the evidentiary record before the court and was of limited guidance. The Court said that no California court has yet extended Weseloh to categorically eliminate negligence liability of design professionals to foreseeable purchasers of residential construction. The Court also observed that in Cooper v. Jevne (1976) 56 Cal.App.3d 860, an architect’s duty of reasonable care is logically owed to those who purchase an allegedly defectively designed and built condominium.

The Supreme Court granted review. It began its discussion by pointing out that although liability for the supply of goods and services historically requires privity of contract between the supplier and the injured party, the significance of privity has been greatly eroded over the past century. The declining significance of privity had found its way into construction law. The Court noted that it had previously found that manufacturers of defective ladders, elevators, and tires could be liable to persons who were not in contractual privity with them but foreseeably injured by their products. Courts usually apply the same rule to someone responsible for part of a house; e.g., a defective railing.

In addition, the Court said that these third party liability principles had always been applied to architects where the architect plans and supervises the construction work and provides protection to any person who is foreseeably harmed. Generally, liability for deficient goods and services hinges on whether there is a relationship between the buyer and seller. However, the Supreme Court recognized that in certain circumstances a contractual relationship is not necessarily required. In this ruling, it relied on 50-year old precedents in Biankanja v. Irving(1958) 49 Cal.2nd 647. In Biankanja, the California Supreme Court outlined several factors which determine whether a duty of care is owed to non-contracted third parties. Biankanja analyzed many factors, including whether the declared harm was foreseeable from a defendant’s conduct and how close of a connection there was between the conduct and the injuries.

The Court recognized that even though the design firms did not actually build the project, they conducted weekly inspections, monitored contract compliance, monitored design elements when issues arose, and advised the owners of any non-conforming work. In applying the Biankanja factors to these circumstances, the Supreme Court determined the homeowners were intended beneficiaries of the design work, and the design in the project bore a close connection to the alleged injuries. As a result, the Supreme Court held that the allegations in the complaint were sufficient, and if proven, established that the defendants owed a duty of care to the homeowners association.

This case will affect how design professionals allocate risk of future residential projects, perhaps requiring their principals to insure them. However, design professionals are now larger targets in construction defect lawsuits, especially where there is a large design issue and a developer withdraws insurance coverage.

Undoubtedly, plaintiffs will attempt to expand architect/design liability in situations involving general contractors, subcontractors, and materials suppliers. This would have the greatest affect in situations involving a single family home where the architect is in privity of contract with the owner.

We expect that architects will now require that they be listed on the developer’s insurance policy(ies) and be contractually indemnified by the developers. As construction cases are getting increasingly more difficult to settle due to the lack of or exhaustion of insurance, expanding the liability of design professionals will give an added source of funding to settle cases. We expect a great deal of activity in this matter both in terms of litigation and in terms of insurance products being available to developers, contractors, design professionals and owners.

The Spearin Doctrine protections can be lost by contractors if they assume design responsibility

A recent decision by a federal judge in the Eastern District of Kentucky should remind contractors that the Spearin Doctrine protections can be lost by contractors trying to be helpful. In American Towers, LLC v. BPI, Inc., (U.S. D.C. E.D. Ky. Aug. 4, 2014), American Towers, an operator of wireless communications towers, accepted a bid from BPI to construct a new tower. After breaking ground on the project, BPI discovered a problem with American Towers’ plans for the access road to the tower. BPI proposed a solution that American Towers approved. Less than one (1) year later, the access road collapsed.

American Towers sued BPI for breach of contract, and BPI moved for summary judgment. BPI argued that its contract with American Towers required American Towers to issue written instructions regarding how to proceed after BPI discovered the flaw in American Towers’ original plans. BPI argued in the classic tradition of Spearin that American Towers was obliged to consult an engineer before telling BPI what to do and that American Towers must therefore bear the consequences of its own design failure.

The court recognized that BPI’s contract provided that when BPI encountered a problem, it need only inform American Towers and wait for instructions. However, BPI “apparently did more than the contract required” and “proposed a new plan to American Towers.” Because BPI’s contract required it to complete its work with the “highest degree of skill and care,” and an expert witness for American Towers opined that such a degree of skill required BPI to consult an engineer, then BPI could be liable for the design flaw. The court therefore denied BPI’s motion for summary judgment and has sent the case to a jury trial to determine BPI’s level of responsibility for the road collapse.

The American Towers case provides a clear cautionary tale for contractors. Where a contractor has agreed to construct according to an owner’s design plans, and a contractor finds a design flaw in those plans, in order to protect itself, the contractor should hold owner to its required contractual duty to provide the plans. Where a contractor has the expertise to provide suggestions to the plans which could keep the project on track and save the owner significant costs in delays, the contractor should still require the owner to seek the necessary review and approval by qualified experts. In this case, had BPI demanded that American Towers consult with an engineer to certify the sufficiency of the plans, BPI probably would not have been liable to American Towers.

In every construction project the particular facts of the problem should be reviewed in conjunction with each party’s contractual requirements to determine the best course of action. Usually, such problems can be resolved or mitigated with a quick phone call and a short review of each party’s obligations. Taking such action during the project can significantly reduce the likelihood of litigation costs and potential liability as exemplified by the American Towers case.

A CONSULTING ENGINEER / ARCHITECT’S PROTECTION FROM A NEGLIGENCE CLAIM BY A CONTRACTOR

 The case of Recreational Design & Construction, Inc. v. Wiss, Janney Elstner & Associates, Inc., 2011 WL 5117163 (S.D.Fla. 2011), is a recent case discussing whether an independent engineering firm hired as a consultant by an owner can be liable to the general contractor for professional negligence under Florida law.  In this case, the City of North Miami Beach (“City”) hired a contractor to perform all design and construction services for a water slide project (“Contractor”).  The City also hired a separate engineering firm to evaluate and perform inspections of the contractor’s work (“Engineer”).  The engineering firm hired another engineering firm as a subconsultant to perform the engineering inspections (“Subconsultant”).

The Subconsultant issued a report to the Engineer that was provided to the City explaining that the water slide the Contractor designed and started to construct was structurally unsafe.  The report recommended repairs to be implemented on the slide.  The City rejected the Contractor’s work based on the Subconsultant’s recommendation and required the Contractor to implement the repairs before completing the work.

The Contractor, instead of suing the City, sued the Engineer and Subconsultant for professional negligence (also known as professional malpractice) to recover its costs in reconstructing the slide and implementing the repairs recommended to the City.  Both the Engineer and Subconsultant moved to dismiss the Contractor’s complaint arguing that they did not owe a duty of care to the Contractor; therefore, they could not be liable in negligence to the Contractor under the law.  The Southern District of Florida agreed with the Engineer and Subconsultant and dismissed the Contractor’s complaint with prejudice.

In order to be liable for professional negligence, a plaintiff must prove the following elements against the defendant-professional: 1) the defendant owed a duty of care to the plaintiff; 2) the defendant breached its duty of care; and 3) the breach of the duty of care proximately caused damages to the plaintiff.  See Recreational Design & Construction, 2011 WL at *2 citing Moransis v. Heathman, 744 So.2d 973, 975 n.3 (Fla. 1999).   The element of duty, however, is a question of law in Florida and must be determined by the court before a negligence case proceeds to the jury or trier of fact.  See Wallace v. Dean, 3 So.3d 1035, 1046 (Fla. 2009).

The Contractor relied on the Florida Supreme Court’s ruling in A.R. Moyer, Inc. v. Graham, 285 So.2d 397 (Fla. 1973), in arguing that the Engineer and Subconsultant owed the Contractor a duty to perform its work and issue recommendations to the City with reasonable care and due diligence.  In A.R. Moyer, the Florida Supreme Court held that a general contractor can maintain a cause of action against a supervising architect for the architect’s negligent performance of a contractual duty (even though the contractor has no contractual privity with the architect).  Particularly, the Florida Supreme Court found that the following circumstances would present a professional negligence cause of action by the contractor against a supervising architect or engineer:

 “(a) supervising architect or engineer is negligent in preparation of plans and specifications; (b) the supervising architect or engineer negligently causes delays in preparation of corrected plans and specifications; (c) the supervising architect or engineer negligently prepared and negligently supervised corrected plans and specifications; (d) the supervising architect or engineer negligently failed to award an architect’s certificate upon completion of the project; (e) the architect or engineer was negligent in exercise of supervision and control of contractor.”  A.R. Moyer, 285 So.2d at 402.

Of importance, the “professional defendant [in A.R. Moyer] was an architect whose responsibilities on the relevant project were to prepare the designs and plans for the project, approve the overall structural components or framework for the project, and supervise the general contractor’s execution of those plans, including having the authority to halt the contractor’s work.”   Recreational Design & Construction, 2011 WL at *4.   In other words, A.R. Moyer dealt with more of a traditional architect or engineer that, among other things, served as the architect / engineer-of-record for the project and had detailed contract administration services that enabled them to make decisions that could effect the contractor, which is why the Court described the professional as a supervisory architect or engineer.

But, in Recreational Design & Construction, the Engineer and Subconsultant, were really nothing more than a consultant providing expert-related services issuing recommendations, advice, or suggestions to the City in which the City could accept or reject.  The Engineer and Subconsultant did not serve as the engineer-of-record.  They did not design the plans for the City’s project. They did not issue specifications for the project.  They were not performing supervision to ensure that the Contractor’s construction complied with their design (since they were not the designer).  And, they did not have authority to halt the construction of the project or issue corrective details directly to the Contractor.  Instead, as previously mentioned, their services were truly within the realm of consulting services in which it was up to the City to determine how it wanted to utilize any suggestions, advice, or recommendations.   For these reasons, and because the role of the Engineer and Subconsultant in this case was substantially different than the role of the architect in A.R. Moyer, the Southern District held they did not owe a duty of care to the Contractor.  See also McElvy, Jennewein, Stefany, Howard, Inc. v. Arlington, Elec., Inc., 582 So.2d 47 (Fla. 2d DCA 1991) (finding that architect did not owe duty to subcontractor because architect was required to issue advice to owner regarding interpretation of architect’s design, but it was the owner responsible for making the ultimate decision based on the advice of the architect).

An architect or engineer that is serving as the architect / engineer-of-record for a construction project may want to implement certain language in their contract with the owner that while it will render certain advise, recommendations, or suggestions to the owner regarding its design and specifications and interpretations thereof, it is the owner that is required to render the ultimate decision regarding the advice, suggestions, and recommendations.  This way, if the contractor does pursue a professional negligence claim against them, they can argue they were not a supervisory architect or engineer and should not be deemed to owe a duty to the contractor because it was the owner that made the ultimate decision that affected the contractor.

Also, owners on construction projects sometimes hire other consultants or experts to assist in the construction of their project.  For instance, sometimes owners hire a building envelope consultant or a glazing consultant, etc.  These consultants sometimes worry about the contractor asserting a negligence claim against them based on their advice, suggestions, and recommendations made to the owner.  These consultants, however, should be able to rely on the arguments in Recreational Design & Construction to support they do not owe a duty to the contractor.  These consultants can also employ the same contractual language suggestions above so that their contract specifically expresses that it is the owner that is required to act on the advice, suggestions, and recommendations of the consultant so that it remains understood that the owner, and not the consultant, has ultimate control over the contractor’s work.

RISK MANAGEMENT TO REDUCE THE RISK OF LOSS

Whether, and to what to extent, coverage applies in liability policies for claims alleging construction defects is a matter of serious debate both in insurance circles and in the courts.   We wrote few weeks ago about some earthshaking decisions reached by the majority of the jurisdictions during 2013 and 2014, finding construction defect coverage under a contractors’ CGL policy.  These policies, however, are subject to numerous exclusions and Anti-Indemnification Statutes, Right to Repair/Cure and Statutes of Limitations and Repose.  In fact, the defendants in many of these cases have been successful in defeating claims using the defenses of the statutes of limitations and repose.

Among the more frequently addressed exclusions are the so-called “business risk” exclusions, which include the “damage to property”; “damage to your property”, and “damage to your work” exclusions.  Other potentially applicable exclusions concern prior work; contractual liability; EIFS; mold; owned property; earth movement, and known or continuing injury or damage.  Claims for damages resulting from defective drywall began to appear in about 2005, and courts have frequently addressed whether the standard pollution exclusion, in addition to the above-mentioned exclusions, bars coverage for such claims.

The subtleties of each claim, different facts and precise policy language all contribute to the disparity. And, in some cases, the decisions are simply not reconcilable.  Legislation enacted by various states concerning the right to repair/cure, statutes of limitations and repose, and anti-indemnity statutes, are pertinent to the institution of a construction defect lawsuit.

Owners of construction projects face many risk management challenges – whether building new, adding on to existing facilities, or performing rehabilitations.  For a project owner, managing construction risk is significantly different from managing risks inherent in their daily operations. One difference of particular concern is professional liability risk associated with execution of design and other professional services.

Construction-related professional liability insurance is rapidly changing and has often been underinsured relative to the exposures created when commencing a new project. Even on a modestly sized project, an owner can have significant exposure to cost overruns, time delays, and re-work from faulty design, negligent construction management, or errors from other disciplines performing professional services on the project. Losses suffered by project owners can prove to be very costly, confusing to litigate, and difficult to calculate.  The following example illustrates the complex nature of these exposures.

A city medical center and its board of trustees issued separate contracts for the design and construction of a two-year, $150 million expansion to its children’s hospital wing. The architect was responsible for procuring all design services and was required by the owner to evidence $5 million in professional liability insurance limits from their annual practice professional liability insurance program.  The project took three months longer than anticipated and went over budget by $10 million. Along with the delay and cost overruns, numerous other problems were discovered in the HVAC and electrical systems – all attributable to the design team.

The total damages alleged by the owner were $17.5 million. During discovery it was found that the prime architect only had $4 million remaining in its practice professional liability program because of defense and claim payments from the firm’s engagement on other projects during the policy period.  The other liable members of the design team (the mechanical and electrical engineers) each had their full professional liability limits of $1 million available.  However, after defense costs eroded the remaining limits during litigation, only $5 million in combined policy limits were available from the architect’s and the design firm’s insurance policies.  Furthermore, the firms had little or no assets to collect beyond their professional liability policies.  The medical center settled immediately for the $5 million in remaining policy limits and incurred a $12.5 million loss to its bottom line.

This not uncommon scenario raises some questions: Are insurance solutions available that offer construction owners better control over the cost, scope and security of professional liability coverage? Could the medical facility have financed this exposure with an insurance product and collected its own insurance proceeds rather than incur this loss? The answer is ‘yes,’ and the following information outlines these solutions. 

TRADITIONAL SOLUTIONS

Most projects constructed in the U.S. use some form of the design-bid-build delivery system. In that type of scenario, the owner assumes a central role by virtue of contracting separately with design entities and contractors. The owner first hires a designer to provide the design and later the general contractor is hired to build the project. The illustration below depicts this standard relationship.

Since the design-bid-build delivery system separates the design contract from the construction contract, the owner serves as an intermediary between the design and construction entities and takes on significant risk by contracting directly with the architect. Other delivery systems, such as design-build (D/B) or engineer-procure-construct (EPC) and emerging methods such as integrated project delivery (IPD), public private partnerships (P3) and LEAN construction, also pose various professional liability challenges and exposures. This article focuses on the design-bid-build delivery.

The most common and simplest mechanism for an owner to mitigate the professional liability risk associated with its project is to contractually require the primary design professionals to maintain annual practice policies at prescribed limits.  These policies provide professional liability coverage with limits that the owner deems adequate to cover claims that might arise from the design team’s work on the project. However, coverage under the design professional’s policy is in the name of the design professional and does not provide any protection directly to the owner, which cannot be named as an additional insured.  Renewal of the annual practice policy by the design professional is not guaranteed and could be terminated prior to a contractually agreed post-completion insurance requirement.  Claims made on projects unrelated to the owner’s project (as shown in the hospital project claim scenario) may erode or exhaust the limits of liability available under the design professional’s practice policy.  This could leave the owner with an uninsured design professional and no source of recovery.

A second approach is for the owner to purchase a project specific professional liability policy (PSPL) that covers the prime architect and its sub-consultants for the specific job. This option provides dedicated limits to the project, includes an extended reporting period for post-project completion, and replaces the design professional’s annual practice policies, although the annual policies possibly could be excess of the PSPL for the designer’s interests. While a viable risk management solution, there are drawbacks in this approach.

The cost of PSPL programs is significant due to the insurance industry’s experience, which has historically been unprofitable. The cost can often be 1-1.25% of the construction value of a project. The policy does cover the design professionals for the specific job; however, it does not typically extend to construction management. The policy is purchased for the design team and therefore is defended by the insurance carrier for the design team and not the owner. Defense costs can often erode the limits of these policies rather quickly allowing for smaller-than-anticipated recoverable indemnification amounts for the owner. 

THE OWNER’S PROTECTIVE ALTERNATIVE

A third option to mitigate project professional liability exposures is for the owner to purchase an owner’s protective policy.  The policy appeals to owners that directly subcontract the design separately from the construction under the design-bid-build delivery system, as discussed earlier. The owner’s protective policy addresses financial risks associated with the performance of professional services through dedicated project-specific limits similar to the PSPL. However, this solution provides the project owner with protection when a subcontracted design professional or other project consultant’s professional liability coverage is insufficient or not available. The owner still requires the primary design firm to evidence its annual practice professional liability policy at minimum limits via the contract as outlined in the first option above, but the owner then purchases a protective policy to sit excess over the design firm’s annual policy. The named insured on the policy is the project owner allowing control over the insurance acquisition and claim process.

The protective policy is a first-party indemnification policy and third-party professional liability policy intended to indemnify the owner for economic damages, bodily injury, and/or property damage due to the negligent performance of its subcontracted design professionals and provide coverage for the owner from third-party claims.

In a first-party loss scenario, the owner notifies its protective policy carrier at the same time that it brings a claim against its subcontracted design professional. The protective policy is then triggered when the design professional’s limits are exhausted.

For a third-party claim, the owner notifies the carrier when it receives notice of a claim from a third party which triggers coverage under the protective policy. As stated above for first-party losses, the policy sits in an excess position above the subcontracted design professional’s annual practice policy, and if there is no underlying insurance available at the time of a claim or the limits have been exhausted from claims on other projects (again, as seen in our previous example), the protective policy will drop down and pay on a first-dollar basis or excess of any self-insured retention specified on the policy. For third-party claims, the protective policy responds in excess of a self-insured retention.

The policy covers retroactively the design phase, runs through the construction period, and an extended reporting period (ERP) in which to report claims. The ERP is for work that was undertaken during the active policy period or any design or work performed to put the project to its intended use.

Owners also benefit by broadening the field of acceptable design firms as they can lower the required limits of insurance of their subcontractors/consultants knowing they have the protective coverage in place. At the same time the owner can have confidence that the subcontractors/consultants are delivering the appropriate standard of care because their annual practice policies remain in place and are subject to first-dollar exposure. 

The owner’s protective policy is often purchased for projects greater than $50M in hard construction costs. It can be put in place for a variety of projects, including commercial, institutional, schools and colleges, hospitals, airport expansions or renovations, rail, roads/highway transportation or other civil projects, correctional facilities, casinos, hotels and resorts, residential/commercial grade-construction, water, waste water and sewage, and municipal facilities.

This insurance approach, while dedicating broader limits to a specific project, is typically much more cost-effective than buying PSPL coverage due to the first-dollar nature of the PSPL vs. the excess approach used with an owner’s protective policy. The unique first-party and third-party coverages put the owner in a very favorable recovery position in the event of a loss and provides enhanced control over the claim process. With the current state of economic uncertainty and expense management protocols, the owner’s protective policy has quickly become the coverage of choice for managing owners’ professional liability exposures on construction projects.

While risk management challenges for the owner of a construction project can be significantly different from those encountered in daily operations, multiple solutions exist to manage professional liability exposures. Losses from the negligent performance of professional services are extremely costly, complex and can destroy the success of a construction project. Purchasing an owner’s protective policy or another risk transfer mechanism to protect your project – and your bottom line – is a viable solution that should be considered well in advance of contract development.

There are also a growing number of newer and lesser known risks, inherent in the growth of technology and sustainability. With new innovative products, processes, and performance expectations in projects where there are no precedents, the standard of care must now also be defined anew. Because architects contract directly with owners, an architect may be exposed to the risk of a suit for breach of fiduciary duty. There are also important issues now raised by electronic data – including the requirements of the rules of discovery and what must be produced in the event of litigation. In addition, the existence of Metadata or hidden data in documents can divulge information detrimental to one’s firm. There are new liabilities associated with the protection of client confidential data and information as well.

The Risk of the A/E Professional Not Playing Well With Others

Consultants are routinely retained by design professionals.  Their relationship means that the design professional has vicarious liability for any damage caused by the consultant’s negligence. Insured design professionals will want to review their consultant’s insurance status since they will serve as their insurer if that status is inadequate. If a design professional agrees by contract to limit the liability of a consultant, the design professional may find that the risk of the consultant’s negligence has been shifted to the design professional and the design professionals’ insurer. When design professionals serve as sub-consultants to other professionals (or subcontractors to construction contractors), it is important to examine the primary design professional’s coverage or the construction contractor’s coverage to determine where there are gaps in coverage that could result in the sub-consultant becoming the target of a claim. 

Joint ventures, from a legal standpoint, are similar to partnerships, the main difference being that a joint venture usually has a more limited scope or purpose. If a professional liability claim is filed against a joint venture, one or all of the members can be held liable for any judgment rendered against it. Some broad policies provide automatic joint venture coverage while other insurers exclude joint ventures from the basic policy. Coverage for joint ventures with other design professionals may be available by special endorsement for specific situations to provide for the insured’s legal liability for professional services performed on behalf of the named joint venture. Coverage for other participating firms in the joint venture would not be provided by such an endorsement. Each member of a joint venture should obtain evidence from the other joint venture partner(s) that their policies have been properly endorsed as needed to cover participation in the joint venture, usually accomplished by obtaining a certificate of insurance and a copy of the joint venture endorsement.

In any joint venture situation where firms rely on their separate policies, it is best for the policies to be with the same carrier with similar limits and deductibles for all firms. Otherwise, some firms may serve as “deep pockets” for others. 

Project Team Agreements

Strategic Alliances are business ventures and must be protected by insurance with the same concern as with any joint venture or partnership. Clients, or other parties, claiming harm from the actions of a strategic alliance may be able to recover from any member of the alliance. From the injured party’s perspective, the alliance may be viewed as one integrated responsible entity. Whenever a contractor’s responsibility and liability goes beyond construction to project design or construction management, the need for contractors to carry professional liability insurance becomes more critical.

All strategic alliance partners may be held liable for the actions of all, but each looks to the others to be responsible for their own areas of expertise and obligations. From a professional liability perspective care must be taken to match final liability with eventual responsibility. It is far more practical and better protection for the interests of the strategic alliance to be covered by a separate professional liability insurance policy. As a result, coverage disputes and internal indemnification or contribution obligations can be minimized.

Project professional liability insurance covers the design team participants, even those who are uninsured. The policy covers the design professional and named professional consultants for the term of the project plus a pre-determined discovery period after completion of construction. Depending on the insurance carriers of those firms covered by a project policy, coverage may then revert to the individual firms’ professional liability policies.

Project insurance is intended to cover only one project and is usually paid for by the owner who wants coverage beyond that normally carried by the firms. A Project policy ensures that a separate annual aggregate limit is available for that particular job and that the limit is not reduced by claims against a firm arising out of other design work. Project insurance is useful when the project is of such increased scope that it drastically affects the cost of basic coverage and as a way to get coverage for underinsured or uninsured consultants. From the design professional’s standpoint, the billings associated with a project-insured project (and the cost of any claims) do not affect the premium set for the firm’s practice policy. A broker is necessary to compare coverage.

Expanded project delivery approaches have begun to receive coverage for design professionals practicing in roles such as design/builder, construction manager, and land developer. While some companies offer endorsements for these services to the basic policy under some conditions, potential gaps should be investigated to prevent uninsured liability. For example, a construction manager acting as advisor (CMa) to the owner is covered under most professional liability policies; the construction manager constructor (CMc)—acting as a general contractor—is not.

Integrated Project Delivery (IPD) is another new concept and thus exposure in the architect’s potential risks today. Insurers are determining how best to approach this new collaborative multi-dimensional approach to projects. The concept of sharing more information and cooperation between unrelated entities flies in the face of traditional boundaries between owners, architects, engineers and construction companies. Insurers are still trying to assess the new risks presented by IPD.

Settlement Issues require both the insurer and the insured to be involved. Professional Liability policies generally require consent of an insured before the insurer can settle a professional liability claim against an insured. An architect may strongly believe that there was no negligence or error in the design or supervision work performed but the insurer may still want to settle. If the architect refuses to settle and subsequently a judgment is entered against the architect for an amount greater than the suggested settlement, the architect may have exposure for the excess amount. Often called a “hammer” clause, an architect needs to be aware of the implications of that clause. In many cases, the insurers will either limit the architect’s exposure to a percentage of that excess amount or may eliminate the exposure entirely.

Similarly, an architect cannot negotiate the terms of any settlement without the insurer’s permission. Any attempt to settle a case in this way will result in no coverage for the claim because the policy requires the insured to cooperate with the insurer. In any attempt to settle a potential claim before a suit is filed, be sure to get the permission of the claims adjuster from the insurance company even if the amount is less than the deductible.

A Common Problem with Insurers –The Reservation of Rights Letter

It is common when submitting a potential professional liability claim to an insurer that the insured will receive back a “reservation of rights” letter from the insurer. That letter basically points out exclusions or other conditions of the policy that might preclude coverage of the claim presented. It will say that they will defend all allegations of the claim unless and until it is evident that an exclusion will eliminate coverage entirely. The insurer is “reserving their right” to deny coverage later, once all the facts are uncovered affecting the claim.

Two Case Studies

I. Professional Liability

An architect was retained to provide architectural and engineering services for a sports facility in a northern state. The prime architect then retained a local architect and structural engineer. The design team provided a performance specification for a standing seam metal roof.

About three years after substantial completion, a section of the dome blew off during a windstorm. The roof was repaired for $250,000. The sports dome’s property insurer paid for the repairs and two years later filed suit against the prime architect. The city filed their own lawsuit, claiming $5,000 in damages, which was the amount of their deductible, and other unspecified damages. Both suits alleged negligence, breach of contract, and breach of warranty.

Shortly after the claims were filed and while warranty work was being performed on the dome, it was determined that there were structural problems with the standing seam roof. In addition, the city identified problems with the parapet walls, the placement of the vapor barrier below the roof, and the attachment of the standing seam metal roof. The city also raised concerns about snow accumulation and resulting avalanches. The city subsequently increased the amount of their lawsuit to $8 million. The contractors and the roof manufacturer were added as codefendants.

The city later decided that they would pursue a complete replacement of the roof structure and installation of snow fences, ground level roofs, and landscaping to address avalanching, recover their out-of-pocket expenses of $1.7 million, and made their total claim for $6.7 million.

The design team argued that as much as $2.5 million of the city’s replacement costs amounted to betterments or improvements. The design team also raised some legal defenses such as the contractual statute of limitations in AIA Document B141,

Standard Form of Agreement Between Owner and Architect. Using standard form agreements such as those developed by The American Institute of Architects (AIA) and the Engineers Joint Contract Documents Committee (EJCDC) may help reduce risks.

After negotiation, the design team settled the city’s claim for $2.4 million. Legal fees, expert expenses, and the policyholder’s deductible added $1,270,000 to the cost, bringing the total cost for this claim to $2,670,000. The case and settlement was covered and paid by the firm’s professional liability insurance carrier, less the firm’s deductible.

Large public-use centers can result in severe claims. Clearly, there should be some re-evaluation of the design team’s risk management practices. Whether they adequately assessed their risks prior to taking on this project, had sufficient experience with this project type, gave adequate consideration to the geographic and weather considerations that might increase risks, and whether it was the right design, performance specifications, and materials for such a structure or appropriate all should have been thoroughly considered. In the end, implementing good risk management practices while ensuring adequate professional liability coverage and an appropriate deductible will protect the firm.

II. Commercial General Liability

Commercial general liability (CGL) insurance provides coverage primarily for liability arising out of non-professional acts (violations of the personal, business, or property interests of private citizens) that result in bodily injury, property damage, or personal and advertising injury. CGL insurance is designed to cover an insured’s liability arising out of incidents on the insured’s premises or from the nonprofessional aspects of the insured’s practice.

An example of Bodily Injury/Property Damage, one component of CGL, involved a surveyor working on an airport runway. The surveyor left his tripod and prism standing upright on the side of the runway when he left for lunch. A small Falcon 900 airplane came in for landing and the leading edge of the right wing, which was extended over the edge of the runway, clipped the equipment. The surveying equipment created a dent in the leading edge, but there were no injuries. However, the repairs to the plane and other expenses, such as down time, parts, and labor, totaled more than $114,000. This claim illustrates the importance of having an established risk management program - and having adequate general liability coverage.

A design firm’s professional liability policy provides coverage for that firm’s professional negligence. A design firm’s CGL policy provides coverage for the firm’s non-professional negligence. In the surveyor’s claim example, a compelling argument could have been made that the damage arose out of the surveyor’s professional services and, therefore, should have been covered by the PL policy. The surveyor’s claim example illustrates a situation where the CGL insurance carrier could argue that the claim should have been covered by the surveyor’s PL policy while the PL carrier could have argued the same against the CGL carrier. One way to minimize the risk of this situation is to have both the CGL and PL policies with the same insurance carrier.

The focus would then shift to resolving the claim instead of debating which policy should respond to the claim.

Another example of a general liability claim would be if a visitor walks into an insured design professional’s office lobby and slips on the marble flooring after a rain storm and breaks her ankle. The injury occurred on the named insured’s premises and the injured woman would make a claim against the insured for her medical expenses resulting from her broken ankle. This example illustrates the importance of maintaining safe building premises and CGL coverage. It should be noted that this coverage does not cover the insured or the insured’s employees since those claims would likely be covered by workers’ compensation insurance.

Subcontractor's Claim Against Structural Engineer For Negligent Misrepresentation Dismissed

When confronted with extra costs on construction projects caused by architects and engineers who were hired by the owner (and have no contract with the contractor), contractors are generally inclined to seek direct recourse against the perceived wrongdoers.  Generally, unless there is some personal injury or property damage involved, however, the "economic loss rule" precludes the contractor from suing an entity with whom it lacks privity of contract.  

In the words of one court:

[t]he Economic Loss Rule is a judicially created doctrine that marks the fundamental boundary between contract law, which protects expectancy interest created through agreement between the parties, and tort law, which protects individuals and their property from physical harm by imposing a duty of reasonable care. . . .Simply put, the Economic Loss Rule holds that “economic damages are not recoverable in negligence absent physical property damage or bodily injury.

SME Indus., Inc. v. Thompson, Ventulett, Stainback & Assoc., Inc., 28 P.3d 669; 2001 Utah LEXIS 90 (Utah 2001); citing, W. Page Keeton, et al., Prosser & Keeton On The Law of Torts §92, at 657 (5^th Ed. 1984); 86 C.J.S. Torts §26 (1997).

Many other jurisdictions have similarly invoked the economic loss rule to bar negligence and malpractice claims by contractors against architects and design professionals. See, e.g., Berschauer-Phillips Const. Co. v. Seattle Sch. Dist. No. 1, 881 P.2 986, 992 (Wash. 1994); Fleischer v. Hellmuth, Obata & Kassabaum, Inc., 870 S.W. 2d 832, 837 (Mo. Ct. App. 1993); Floor Craft Floor Covering v. Parma Cmty. Gen. Hosp. Assoc., 560 N.E. 2d 206, 212 (Ohio 1990); Bernard Johnson, Inc. v. Continental Constructors, Inc., 630 S.W. 2d 365, 374 (Tex. App. 1982); Blake Constr. Co. v. Alley, 353 S.E. 2d 724, 727 (Va. 1987); Rissler v. McMurry Co. v. Sheridan Area Water Supply Joint Powers Bd., 929 P 2d 1228, 1235 (Wyo. 1996); 532 Madison Ave. Gourmet Foods, Inc. v. Finlandia Ctr., Inc., 750 N.E. 2d 1097, 727 (N.Y. 2001) (the court applied the economic loss rule to bar negligence claims by nearby businesses when a wall collapsed at a construction site, forcing the closing of the entire street in front of the construction site for several weeks).

We have reported cases involving the economic loss rule in many states and the new "independent duty doctrine" in previous posts.  Recently, relying on the "economic loss rule," the Nevada Supreme Court barred a suit by a subcontractor against a structural engineer for negligent misrepresentation and professional negligence.  See Halcrow, Inc. v. Eighth Judicial District Court of the State of Nevada, 302 P.3d 1148 (2013).

A.        New Harmon Hotel in Las Vegas to be Razed

This dispute arises out of the litigation involving the ill-fated 46-story hotel and casino in Las Vegas called the Harmon Hotel.  Construction of the Harmon Hotel was halted when parties discovered flawed steel reinforcements in the hotel structure.  The rebar had been improperly installed in places and was simply missing in several areas, and ultimately the hotel has to be demolished.

The contractor, Tutor Perini Building Corporation ("Tutor Perini")[2], and the owner, MGM, filed suit against each other over responsibility for the expected $500 million loss.  Trial is scheduled for later in 2014.  In August 2013, the Clark County District Court granted MGM's request to raze the partially-built structure prior to trial.  Tutor Perini had opposed this request, arguing that it needed to carry out additional tests on the structure to help prove its case.

B.        General Contractor Sues Rebar Installer and Rebar Installer Sues Structural Engineer

As part of the lawsuit against MGM, Tutor Perini sought indemnity from its rebar installation subcontractor, Pacific Coast Steel ("PCS").  PCS, in turn, filed a complaint against the project's structural engineer, Halcrow, Inc., for professional negligence.  Halcrow was a subconsultant to the architect of record and had no contract with either Tutor Perini or PCS.  The Nevada trial court ruled that the economic loss rule barred PCS's professional negligence claim against Halcrow, but allowed PCS to amend its complaint by adding a claim against Halcrow for negligently misrepresenting the status of its site inspections and on-site adjustments to the steel installation.  PCS claimed that the reinforcing steel was omitted due, in part, to Halcrow's negligent inspections of the steel and its recommendations as to how to correct the reinforcing steel issue.

Negligent misrepresentation refers to false statements made, in this instance, by the engineer in the course of his or her work that are relied upon by another party in making business decisions.  This allegation is different from a professional negligence claim that the licensed architect or engineer failed to exercise the care that a reasonably prudent, similarly situated professional would exercise under similar circumstances.

C.         Nevada Supreme Court Does Not Permit Subcontractor Suit Against Designer

The engineer, Halcrow, petitioned the Nevada Supreme Court to reverse the trial court ruling that allowed PCS to amend its complaint to add a claim against Halcrow.  Halcrow asserted that the negligent misrepresentation claims were also barred by the economic loss doctrine.  PCS maintained that an exception to the economic loss doctrine existed here because (1) Halcrow owed PCS a duty to act with reasonable care in communicating information to PCS about the steel installation, (2) Halcrow failed to conduct timely inspections in accordance with the representations that inspections would take place, and (3) Halcrow erroneously stated that on-site adjustments would rectify the errors in its plans.  PCS asserted that, since it relied on Halcrow's representations regarding the steel installation inspection correction process, Halcrow should be held liable.

The Nevada Supreme Court ruled that allowing third parties to use negligent misrepresentation tort theory against design professionals without allowing them to sue for professional negligence would essentially nullify the economic loss rule.  The court reasoned that such a rule would allow any third party to recast a barred professional negligence claim as a negligent misrepresentation claim.  The court acknowledged that there are certain exceptions to the economic loss rule, but negligent misrepresentation claims do not fall in such a category because "contract law is better suited" for resolving such claims.

Ultimately, the court, reiterated the importance of relying on contract law to resolve complex commercial construction disputes:

The parties' disappointed economic expectations are better determined by looking to the parties' intentions expressed in their agreements....  Thus, requiring parties that are not in direct privity with one another but involved in a network of interrelated contracts to rely upon that network of contracts ensures that all parties to a complex project have a remedy and maintains the important distinction between contract and tort law. Halcrow, 302 P.3d at 1153.

In other words, contract remedies (breach of contract) are preferred over tort remedies (professional negligence and negligent misrepresentation) in construction cases because the outcome is more predictable and the remedies can be negotiated as part of the contract bargaining process.

Comment:  PCS's success on the merits of its amended complaint is difficult to envision.  How failing to conduct timely inspections could constitute negligent misrepresentation is confounding.  The dispute revolves around allegedly defectively installed rebar, and the rebar supplier will ultimately be brought into the suit by those parties with which it contracted.  MGM, for example, has the option of filing a third-party complaint against the architect, who can then in turn bring in the structural engineer.  Although Halcrow might be dismissed from this action, it will probably become part of the lawsuit that is scheduled to occur later this year.

 

Summary of Nevada Law on the Economic Loss Doctrine in the Context of Commercial Construction Disputes

The Nevada Supreme Court has addressed the economic loss doctrine in the context of commercial construction disputes in a number of cases over the past several years. Nevada’s general rule, as detailed below, is that the economic loss doctrine bars recovery in tort for negligence claims asserting purely economic loss. The overarching rationale is that parties in contractual privity with one another, or part of an interrelated network of contracts, should rely exclusively upon those contracts for all remedies because the intentions and provisions set forth therein can best determine a party’s “disappointed economic expectations.” Halcrow, Inc. v. Eighth Judicial District Court, 129 Nev. Adv. Op. 42, 302 P.3d 1148, 1153 (2013).   

The Nevada Supreme Court first addressed the economic loss doctrine in the commercial construction context in Calloway v. City of Reno, 116 Nev. 250, 993 P.2d 1259 (2000). In Calloway, the plaintiffs, owners of townhomes, filed suit against various subcontractors alleging negligence, among other contractual claims for alleged faulty construction (asserted prior to the enactment of Nevada’s construction defect statutory scheme codified as Nevada Revised Statute, Chapter 40). The Supreme Court concluded that because plaintiffs failed to allege any personal injury damage or any damages to property other than the defective entity itself (the townhomes), the plaintiffs suffered purely economic loss, which is not properly addressed by tort law.  Id. at 1269. The Court held that “[c]ontract law is designed to enforce the expectancy interests created by agreement between the parties and seeks to enforce standards of quality.... In contrast, tort law is designed to secure the protection of all citizens from the danger of physical harm to their persons or to their property and seeks to enforce standards of conduct. These standards are imposed by society, without regard to any agreement. Tort law has not traditionally protected strictly economic interests related to product quality—in other words, courts have generally refused to create a duty in tort to prevent such economic losses.”  Id. at 1265-66. Accordingly, the Supreme Court rejected plaintiffs’ negligence claims against the subcontractors, setting the general standard in Nevada that the economic loss doctrine bars negligence claims against contractors and subcontractors in the commercial construction context.  Id. at 1270.

While Calloway did leave open the possibility for exceptions to this general bar, it did foreclose the “foreseeability exception,” holding that purely economic loss, even if foreseeable, falls outside the purview of tort recovery.  Id. at 1270.  And in this vein, after Calloway, the Supreme Court did uphold a bright-line exception to the general bar in the context of construction defect litigation, finding that negligence claims are not prohibited in construction defect actions arising under Nevada Revised Statute, Chapter 40. “[A] negligence claim can be alleged in a construction defects cause of action initiated under Chapter 40.” Olson v. Richard, 120 Nev. 240, 89 P.3d 31, 33 (2004). The Supreme Court concluded that because “NRS 40.640 states that a contractor is liable for any construction defects resulting from his acts or omissions or the acts or omissions of his agents, employees, or subcontractors. This language in no way limits a homeowner’s recovery to construction defects covered by a contract or warranty. Thus, we presume that the Legislature envisioned that Chapter 40 would provide more than just contractual remedies.”  Id. at 33.

The Supreme Court has more recently considered the economic loss doctrine as it applies specifically to design professionals within a commercial construction context. Terracon Consultants Western, Inc. v. Mandalay Resorts, 125 Nev. 66, 206 P.3d 81 (2009). In Terracon the Court determined whether the doctrine applies to preclude “negligence-based” claims against design professionals who provide services in the development, construction, or improvement of commercial properties. Id. at 83. The Court concluded, yes, such negligence based claims are precluded by the doctrine when the alleged damages are purely financial. Id. at 83, 89. The Supreme Court held that “[i]n the context of engineers and architects, the bar created by the economic loss doctrine applies to commercial activity for which contract law is better suited to resolve professional negligence claims. This legal line between contract and tort liability promotes useful commercial economic activity, while still allowing tort recovery when personal injury or property damage are present. Further, as in this case, contracting parties often address the issue of economic losses in contract provisions.” Id. at 89. The Court determined that “the work provided by construction contractors or the services rendered by design professionals in the commercial building process are both integral to the building process and impact the quality of building projects. Therefore, when the quality is deemed defective, resulting in economic loss, remedies are properly addressed through contract law.”  Id. at 90.

Very recently, the Supreme Court in Halcrow, Inc. v. Eighth Judicial District Court clarified its holding in Terracon. The Court was presented with the question of whether the more specific “negligent misrepresentation” claim qualifies as an exception to the general economic loss doctrine bar.  Halcrow, Inc. v. Eighth Judicial District Court, 129 Nev. Adv. Op. 42, 302 P.3d 1148, 1150, 1152 (2013). The Court declined to acknowledge a negligent misrepresentation claim as an exception to the general bar, and concluded that a negligent misrepresentation claim is an unintentional tort which cannot form the basis of liability solely for economic damages in claims against design professionals in commercial construction disputes. Id. at 1154. The Court found no material distinction between a professional negligence claim (asserted in Terracon) and the negligent misrepresentation claim at issue in Halcrow, noting that the evidence necessary for each claim in the commercial construction context is almost identical.  Id. at 1154. The Supreme Court stated that “[a]llowing one and not the other would create a loophole in Terracon’s objective of foreclosing professional negligence claims against commercial construction design professionals and would, essentially, cause the economic loss doctrine to be nullified by negligent misrepresentation claims.” Id. at 1154.

Therefore, Nevada continues to uphold and further solidify its generally recognized prohibition on negligent tort claims asserted for purely economic losses arising in the commercial construction context.

Texas Supreme Court Shields Design Professionals From Tort Liability to General Contractors based on Economic Loss Theory.  May Still Be Liable based on Other Legal Theories.

Occasionally contractors have attempted to assert claims against design professionals in an attempt to recover increased costs incurred on a construction project. These claims have usually been couched as negligence or negligent misrepresentation causes of action because the contractors typically have no contractual relationship with the design professionals. Until a few weeks ago, it was unsettled whether such claims were legally viable in Texas, but the Texas Supreme Court answered the question recently in the negative: contractors cannot recover economic losses from design professionals based on alleged negligence or negligence misrepresentation. See LAN/STV v. Martin K. Eby Construction Co., No. 11-0810, 2014 WL 2789097 (Tex. June 20, 2014).

In LAN/STV, the contractor, Martin K. Eby Construction Co., Inc. (“Eby”), constructed a light rail transit line for DART and then sued the architect, LAN/STV, for increased construction costs and delay damages allegedly caused by errors in the architect’s plans and specifications that DART used to solicit construction bids. At trial, the jury found that LAN/STV was liable for a portion of Eby’s damages based on negligent misrepresentation. Both parties appealed, and the Dallas Court of Appeals affirmed the judgment. On appeal to the Texas Supreme Court, the dispositive issue was whether Eby’s recovery from LAN/STV for negligent misrepresentation was barred by the “economic loss rule.”

What is the economic loss rule?

Because the rule has been applied to a diverse range of situations, the economic loss rule actually encompasses several different formulations based on the particular situation. The formulation relevant here is that a party who lacks privity with another will be precluded from recovering purely economic losses from that party based on a negligent performance of services. The rule is not absolute. Despite the rule, Texas courts have nevertheless permitted, at least in some circumstances, a contractual stranger to recover economic losses from another based on a negligent failure to provide services. See, e.g., Grant Thornton LLP v. Prospect High Income Fund, Ltd., 314 S.W.3d 913, 920 (Tex. 2010) (holding that an accountant may be liable to a strictly limited group of investors for negligent misrepresentations in a corporate audit report, despite lacking contractual privity with the accountant). Thus, whether the rule applies in a particular context depends on whether the underlying rationales supporting the rule justify its application.

Two principal rationales have been proffered to support the rule. First, because the physical consequences of negligence are self-limiting but indirect economic losses are not, allowing recovery of economic losses could result in liability “in an indeterminate amount for an indeterminate time to an indeterminate class.” Id. at *3 (internal quotations omitted). In other words, precluding recovery of pure economic losses is necessary to shield the tortfeasor from virtually unlimited liability—and therefore liability that could greatly exceed the culpability of the conduct. Second, risks of economic losses tend to be especially well suited to allocation by contract. Id. at *4 (quoting Restatement (Third) of Torts: Liability for Economic Harm § 1 cmt. c (Tentative Draft No. 1, 2012)). Therefore, application of the economic loss rule should be applied where the parties are adequately able to determine by contract how economic loss should be allocated.

The question then in LAN/STV was whether these rationales justified application of the economic loss rule in the design-bid-build context.

The rationales for the economic loss rule support insulating design professionals from tort liability to general contractors

The Texas Supreme Court concluded that the underlying rationales supported application of the economic loss rule to preclude contractors from recovering economic loss damages against design professionals based on negligence or negligent misrepresentation. According to the court, if any party in the construction chain could recover economic loss damages from any other party in the chain due to negligence, “the risk of liability to everyone on the project would be magnified and indeterminate.” Id. at *7. Application of the rule would therefore serve to avoid indeterminate and excessive liability.

The ability to allocate the risk of any economic losses by contract also supported application of the rule in this context—and was apparently the rationale that carried the day. In the court’s view, the contractor was freely able to protect itself from its economic losses through its contract with the owner, and in fact it did, which it acknowledged was customary in the industry. See LAN/STV at *8. The court opted for the clarity achieved by restricting the available remedies to those provided by contract because such “clarity allows parties to do business on a surer footing.” Id.

What does this ruling mean?

The bottom line is that now, in a typical design-bid-build scenario, the owner alone holds the right to seek economic damages such as additional costs of completion from the design professional. While this is welcome news for the Texas design professional community, it is not the end of the story.

As you may know, Texas law has long provided that owners do not implicitly guarantee the sufficiency of the project architect’s specifications used to solicit construction bids from prospective contractors.  See Lonergan v. San Antonio Trust Co., 101 Tex. 63, 74-75 (1907). This means that in most cases if a contractor’s price to complete increases because of a design defect, the contractor typically cannot look to the owner to cover that increased cost unless it follows a contract provision for additive change orders. LAN/STV now adds to this a bar precluding the contractor from recovering the increased cost of construction due to inadequate or defective design from the architect. With this additional avenue of recovery squashed, sophisticated contractors may seek to recover increased construction costs from the owner through larger price adjustment requests in the change order process. As such, due to more aggressive change order demands from contractors, design professionals will likely in turn see an increase in demands from owners seeking to recover these increased costs from the design professionals.

Further, nothing in LAN/STV expressly precludes contractors from attempting to recover property and personal injury damages from architects—e.g., on-site materials destroyed or lost by an alleged design defect. Architects should therefore continue to account for potential liability to contractors for these types of damages.

Finally, despite LAN/STV’s holding, contractors may argue that design professionals can still be liable under a fraudulent or negligent misrepresentation theory based on certain direct representations from the architect to the contractor—i.e., a representation the architect made to the contractor on the construction site rather than simply the representations embodied in the architectural plans. In other words, LAN/STV leaves plenty of room for contractors to argue that its holding is limited to tort claims arising out of plans and specifications. Therefore, at least until a consensus emerges regarding the scope of the LAN/STV holding, the best practice for design professionals is to limit their direct communications with the contractors and sub-contractors to follow the procedures negotiated in the governing contracts. In other words, design professionals should still adhere to long-standing simple advice—don’t say something that you may regret later.

A New Jersey Case on the Economic Loss Rule

A federal district court in New Jersey recently held that the economic loss rule does not apply to bar a contractor's negligence claim against the design professional for a project if there is no contract between the contractor and the design professional. Based on the holding in SRC Construction Corp. of Monroe v. Atlantic City Housing Authority, any participant on a construction project in New Jersey may have a remedy in tort.

By its classic definition, the economic loss rule operates to limit a Plaintiff to a recovery of the economic damages that flow from a breach of contractual expectations. Its effect is to prevent contract based actions from being converted into tort claims with more subjective and, often times, higher damages calculations. While there are different permutations of this rule, the concept is generally the same from state to state.

In SRC, the Atlantic City Housing Authority entered into a contract with the contractor to build a senior living center. The Housing Authority also entered into a separate contract with a design professional to design and administer the project. The contractor alleged that the architect increased the contractor's performance costs by delaying the acquisition of building permits, submitting drawings that did not meet the building codes, failing to timely respond to the contractor's request for information, and verbally ordering changes that were not honored by the Housing Authority.  Because the contractor did not have a contract with the architect, it made allegations of negligence to claim its losses. The architectural firm defending the case maintained that the economic loss rule precluded the contractor's claims and, in the alternative, that the contractor's claims were barred because it had the same causes of action in contract against the owner.

The court undertook a review of New Jersey state law on the economic loss rule and affirmed the long held belief that the concept was designed to maintain the distinction between contract and tort claims.  The only exception - which did not apply here - is if the Plaintiff can establish an independent duty of care separate from the contract between the parties.  Plaintiffs should not otherwise be permitted to enhance the benefits of the bargain they struck in the contract by bringing an action in tort. The SRC court illustrated the distinction using two cases analyzed in the New Jersey Supreme Court opinion in Salvatel v. GSI Consultants.

The court held in New Mea Construction v. Harper that a claim against a builder that installed lesser grade materials was effectively a breach of contract action; and attempts by the Plaintiff to cast it as negligence were improper under the economic loss rule. Conversely, homeowners were permitted to pursue the subcontractor in negligence for faulty workmanship since they had no contract with that subcontractor in Juliano v. Gaston.

Based on this analysis, the SRC court determined that a claim for negligence was not barred by the economic loss rule because there was no contract between the contractor and the architect. Because there was no contract, the tort claim cannot be a "contract claim in tort clothing" and the negligence claim was an independent and valid cause of action. Similarly, the assertion that the existence of a similar claim against the owner affords the architect protection is without merit.

This decision is reminiscent of a similar case in Pennsylvania: Bilt Rite Contractors, Inc. v. The Architectural Studio. Both carry some level of common sense with them. The lack of a contract between a design professional and the contractor does not mean that the design professional has no impact on the contractor's performance. While design professionals have long tried to insulate themselves from these types of claims, courts are increasingly holding design professionals accountable for mistakes they make in design or contract administration.

HANDLING COMPLEX CONSTRUCTION DEFECT CLAIMS INVOLVING MULTIPLE CARRIERS AND MULTIPLE POLICIES

https://sites.google.com/site/metropolitanenvironmental/handling-complex-construction-defect-claims-involving-multiple-carriers-and-multiple-policies

 

Complex Construction Claims

In many cases we had to assist the insurers or the insureds with damages to multiple homes in subdivisions or in a high rise building(s).  The presence of multiple buildings or units, the significant amounts of damage money at stake, and the presence of numerous carriers who advocate their separate, conflicting viewpoints makes the handling of such construction defect cases very challenging.

The level of complexity in defective construction claims may result in especially complicated issues for a variety of reasons:

Carriers have been developing special policy formats for this market, including "wrap-up coverage”; with a wrap-up program, the owner furnishes a single insurance program for all parties involved in the project(s) for the duration of the project term.  This insurance relates to the exposures of the project and protects the project owner, contractors, and all tiers of subcontractors.

Some carriers have new contractual provisions - such as policy limitations, which, in effect, provide CGL coverage on a "claims made" basis or preclude application of a "continuous trigger" - in effect which may be difficult to coordinate with traditional formats used by other carriers.

Other policy provisions which apply generally-- such as deductibles, self-insured retentions (SIRs), and the definition of a "claim"— require special analysis in the context of demands being made by a large group of homeowners and insurance carriers with competing interests and policy formats.

What is a CONSTRUCTION defect?

According to the Insurance and Risk Management Institute, a construction defect is generally speaking, a deficiency in the design or construction of a building or structure resulting from a failure to design or construct in a reasonably workmanlike manner, and/or in accordance with a buyer's reasonable expectation.  The most dangerous defects have the capacity to fail, resulting in physical injury or damage to people or property.  However, many defects present no increased risk of injury or damage to other property but nevertheless cause harm to the property owner in the form of loss of use, diminution in value, and extra expenses incurred while defects are corrected.  This latter type of defect is often referred to as a passive defect. 

Many states have more specifically defined the term "construction defect" for purposes of applying statutes that dictate processes for remedying and litigating construction defect claims.  These statutory definitions vary by state.  Nevada, for example, uses the term constructional defects and defines it as follows:

“Constructional defect” means a defect in the design, construction, manufacture, repair or landscaping of a new residence, of an alteration of or addition to an existing residence, or of an appurtenance and includes, without limitation, the design, construction, manufacture, repair or landscaping of a new residence, of an alteration of or addition to an existing residence, or of an appurtenance:

Which is done in violation of law, including, without limitation, in violation of local codes or ordinances;

Which proximately causes physical damage to the residence, an appurtenance or the real property to which the residence or appurtenance is affixed;

Which is not completed in a good and workmanlike manner in accordance with the generally accepted standard of care in the industry for that type of design, construction, manufacture, repair or landscaping; or

Which presents an unreasonable risk of injury to a person or property.

Whether, and to what to extent, coverage applies in liability policies for claims alleging construction defects is a matter of serious debate both in insurance circles and in the courts.   We wrote few weeks ago about some earthshaking decisions reached by the majority of the jurisdictions during 2013 and 2014, finding construction defect coverage under a contractors’ CGL policy.  These policies, however, are subject to numerous exclusions and Anti-Indemnification Statutes, Right to Repair/Cure and Statutes of Limitations and Repose.  In fact, the defendants in many of these cases have been successful in defeating claims using the defenses of the statutes of limitations and repose.

Among the more frequently addressed exclusions are the so-called “business risk” exclusions, which include the “damage to property”; “damage to your property”, and “damage to your work” exclusions.  Other potentially applicable exclusions concern prior work; contractual liability; EIFS; mold; owned property; earth movement, and known or continuing injury or damage.  Claims for damages resulting from defective drywall began to appear in about 2005, and courts have frequently addressed whether the standard pollution exclusion, in addition to the above-mentioned exclusions, bars coverage for such claims.

The subtleties of each claim, different facts and precise policy language all contribute to the disparity. And, in some cases, the decisions are simply not reconcilable.  Legislation enacted by various states concerning the right to repair/cure, statutes of limitations and repose, and anti-indemnity statutes, are pertinent to the institution of a construction defect lawsuit.

IS THERE AN OCCURRENCE AND PROPERTY DAMAGE WITHIN THE POLICY PERIOD?

Is There An Occurrence?

The first step in any coverage analysis is to determine whether the underlying claim or suit comes within the scope of the insuring agreement of the policy including, under a commercial general liability policy, whether the injury or property damage was caused by an occurrence.  “Occurrence” is generally defined as an accident, including continuous or repeated exposure to the same or similar general harmful conditions.  Despite what may be similar policy language and fact patterns involved in these claims, the interpretation of what constitutes an occurrence in the context of a construction defect claim often varies widely from one jurisdiction to the next.

Is There Property Damage?

In order to trigger coverage under a commercial general liability policy, the insured’s liability must be based on actual physical injury to tangible property or an actual loss of use of such property.  Where the construction claim against the contractor does not involve tangible, physical injury, courts have found no covered property damage.  Most courts have also held that claims limited to fixing or replacing all or part of defective construction and/or claims of diminution in value, because of defective construction work or materials with no physical injury, are not claims for property damage.  Defective work or materials in and of themselves do not constitute property damage.

For example, the plaintiff must allege that the buildings experienced cracks in the walls, settling of the slabs, soil subsidence, and separation in floor and walkways, just to name few damages that courts have found that they constitute damage within the meaning of the policy.  Costs

Theories of Trigger of Coverage

After an occurrence and property damage is determined, the next question is how many policies and how many insurers will be liable for the damages or for coverage for the damages, i.e., who pays?  This is accomplished by applying several theories of trigger of coverage.  Trigger of coverage relates to when injury or damage is deemed to have taken place, so as to implicate a particular policy period.  Construction defect claims typically do not concern a discrete catastrophic event, but more frequently, latent or progressive damage that may take place over an extended period of time.  As a result, the determination of when property damage occurred and which policies must respond in the context of a construction defect claim often results in thorny disputes between insurers and policyholders.

Because comprehensive general liability policies insure against damage or injury that occurs during the policy period, courts generally hold that the time the construction defect-related injury or damage occurs is the time the complaining party is actually damaged, not the time when the faulty work was performed.  Courts have adopted several different theories for determining when a coverage-triggering event occurred and which policies may have to respond. The five trigger theories that typically apply to construction defect losses include:

The Manifestation Trigger: The policies in effect at the time the property damage becomes apparent or is discovered provides coverage.  This theory allows for a single policy to be put “on the risk” and “triggered”, with a duty to defend and be held liable for when the injury is manifested or “discovered”.  This theory is much in use in the United States.

The Exposure Trigger: The policies in effect at the time of actual exposure to the damage causing substance or event provides coverage.  This theory also results in multiple policy periods being triggered where an exposure may take place over several years.  The exposure trigger theory has been applied to a variety of insurance decisions including asbestos, silica, pharmaceuticals, and chemicals.

The Actual Injury or Injury-In-Fact Trigger:  The injury-in-fact trigger theory holds that coverage is triggered by the existence of bodily injury or property damage during the policy period.  Each insurance policy “on the risk” during the time period when damage actually occurs is triggered.  Based on the evidence submitted, injury-in-fact may be determined as occurring at any time from exposure through manifestation.  The actual injury/injury-in-fact theory requires the policy holder to prove the discrete injury or damage during the insurance contract period.  Nine states use this theory for CGL insurance liability.  They include: Minnesota, Hawaii, Arkansas, Alabama, Nevada, Oregon, Texas, Washington, and North Carolina.

The Continuous Loss Trigger Theory:  carriers on the risk from the initial exposure through manifestation are considered to be triggered.  All policies in effect over a span of time, beginning from the first exposure to injurious conditions, continuing through any period of latency while the resulting damage remains undiscovered and is progressing, and ending at the time the injury manifests itself to the insured, are implicated.  See Montrose Chemical Corp. v. Admiral Ins. Co., 10 Cal.4th. 645, 1995.  The Court said that there is limitation on potential indemnity, where the damage must occur during the policy period and as a result from the accident or continuous or repeated exposure or conditions.  The policy on the risk at the time the policyholder first obtains knowledge of “bodily injury” or “property damage” is the last policyholder that can be triggered.  Many states follow this continuous loss trigger model in CGL third party liability claims as well. Including: Colorado, New Jersey, Pennsylvania, Indiana, Illinois, Massachusetts, Georgia, Kansas, South Carolina, Wisconsin, Missouri, and Tennessee.

The Double Trigger Theory.  A variation on the continuous or “triple” trigger theory is the “double” trigger theory, applied by at least one court.  Zurich Ins. Co. v. Raymark Indus., Inc., 118 Ill.2d 23, 112 Ill.Dec. 684, 514 N.E.2d 150 (1987), aff'ing 145 Ill.App.3d 175, 98 Ill.Dec. 512, 494 N.E.2d 634 (1986).  Interpreting an earlier version of the uniform CGL policy that defined “bodily injury” as “bodily injury, sickness, or disease,” the Illinois Supreme Court found adequate medical evidence in the record that “bodily injury” in the form of lung tissue damage occurs at the time of exposure, “disease” exists when the condition is manifest or reasonably capable of clinical detection, and “sickness” includes the claimant's disordered, weakened, or unsound state before clinical manifestation.

ALLOCATION OF LOSS

After all the contributing insurers and policies are determined, the final question is how much each insurer and each insurance policy will pay.  Because construction defect claims often implicate consecutive policy periods, the total amount of coverage available to respond to a claim may exceed the total amount of damages.  In such circumstances, the damages must be allocated among the triggered policies or policy years.  The issue of how a loss should be allocated in a construction defect claim is closely tied to the applicable trigger of coverage, and the resolution of one typically compels consideration of the other.

Courts have applied two main methods for determining how policies will contribute to the damages:  the pro-rata allocation and the all sums allocation method.

Pro Rata – Policies respond in a particular policy period in proportion to the “time on the risk” and the total number of years triggered by the loss.  Under this approach, each triggered policy is responsible for a portion of damages based on the years it was on the risk in comparison to the total number of years triggered by the loss.  This approach is tied to policy language limiting exposure to those damages that take place during the policy period.  For this approach to apply, the damage must be continuous and indivisible.

Complex construction defect cases typically involve multiple parties, often with overlapping responsibilities, whose actions are alleged potential causes of some or all of a claimant’s damages.  If the case is decided by a jury, then the common law negligence procedure guides the percentage contribution from each defendant.  For example, pursuant to Colorado’s Pro Rata Act, each party’s damages liability is determined by multiplying the damages attributable to an indivisible injury to which that party contributed by the percentage fault the jury allocates to that party.

All Sums – Policies in a particular policy period may respond in full, subject to their limits.  This approach is based on the “all sums” language in policies and allows an insured to pick which policy years that will respond to a loss.  This method is also called “joint and several liability” method and allows an insured to choose the insurance to which the losses are allocated and the deductible which must be paid.

Anti-Indemnification Statutes, Right to Repair/Cure and Statutes of Limitations and Repose

Outside the case law which impacts the analysis of insurance coverage for construction defect claims, many states have also enacted legislation which further defines, creates or restricts rights among owners, developers, and contractors. This statutory framework may include ant indemnity statutes, “right-to-repair” or “right-to-cure” statutes, and statutes of limitation and repose.

Transfer of risk by contract, via indemnity or hold-harmless agreements, is a common practice in the construction industry. In response to such contractual arrangements, many states have case law or statutory regulations that set up anti-indemnity rules for construction projects, to strictly regulate and in some cases prohibit contractual risk transfer.

Several states have passed legislation, known as “right-to-repair” or “right-to-cure” statutes.

The intent of these statutes is to protect the construction trade and offer an alternative to immediately proceeding to costly litigation.  Key provisions of these statutes include:

Requiring written notice regarding alleged defects from homeowners to builder, with such notice usually required up to 90 days prior to proceeding with filing a suit.

Allowing the builder to inspect the premises.

Providing for a response to the homeowner’s claim, including an offer to repair, pay a monetary compromise, or decline the claim.

Limitations for the “reasonable” cost of repairs and possible reimbursement of legal fees.

Requirement that the right-to-repair provisions are stated in the sales contract.

A “statute of limitations” is a period of time in which a claim may be brought, beginning from the time of discovery of an injury. A “statute of repose” acts as a bar on any claims, and usually starts on a certain date, such as the close of escrow, transfer of title or occupancy, varying by state. Where the periods of time differ, the statute of limitations may be tolled or extended for reasons set forth in the statute. Most states have many, often overlapping statutes of limitations.

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HOW TO MANAGE CONSTRUCTION DISPUTES TO MINIMIZE SURETY AND CONSTRUCTION CLAIMS.  PART 5: Differing Site Conditions CONSTRUCTION Claims

 

Construction is a business fraught with risk.  Disputes over even the smallest of issues can quickly escalate, with crippling consequences to the project and the parties.  Over the years, the construction industry has developed various methods of contractually allocating the risk of project delay and disruption.  Some of these methods include liquidated damages provisions, "no damages for delay" clauses, mutual waivers of consequential damages, provisions that limit liability, claims notice provisions, and provisions addressing responsibility for the adequacy of the construction plans and specifications.  Parties frequently litigate the sufficiency of these risk-shifting efforts in conjunction with the underlying merits of delay and disruption disputes.

Construction Claims & Disputes

In Part 1 of our series of how to manage construction disputes to minimize surety and construction claims, we addressed the construction delay claims and the methods typically used to analyze them.

We indicated there that the most frequently encountered claims include:

1.    Construction Delay Claims

2.    Disruption and Loss of Labor Productivity Claims

3.    Design and Construction Defect Claims

4.    Force Majeure Claims

5.    Acceleration or Compression of the Schedule Claims

6.    Suspension, Termination and Default Claims

7.    Differing Site Conditions Claims

8.    Change Order and Extra Work Claims

9.    Cost Overrun Claims

10. Unacceptable Workmanship or Substituted Material Claims

11. Non-payment Claims (stop notice (or Notice to Withhold) claims, mechanics’ lien (only for private construction projects) and payment bond claims)

Part 5 of this series discusses item 7 above: Differing Site Condition Claims

The Problem

A construction bid package typically contains plans, specifications and possibly a geotechnical report.  When contractors put together bids based upon the information in the bid package, they typically have limited time to investigate site conditions and assume that the site information reflected in the bid package is generally correct and that the project can be constructed pursuant to the plans and specifications. Everyone knows, however, that construction does not always proceed as planned. All too frequently contractors encounter subsurface conditions that differ from the information contained in the geotechnical report, or other conditions in the field that differ from what was expected or shown on the plans, in ways sometimes minor and sometimes significant.

Who Bears the Risk?

As between an owner and a contractor, who bears the risk of the additional costs associated with differing site conditions? Generally, a court will first look to the contract documents; and, if they are unambiguous, the Court will assign the costs associated with the differing condition to the party to whom they are assigned by the contract. In the context of fixed price contracts, the general rule, with some exceptions, is that a contractor assumes the risk of additional costs associated with differing site conditions of which neither party was aware. In some jurisdictions, and particularly with respect to publicly-owned projects, the traditional allocation of differing site conditions risks may be altered by an owner’s misrepresentation of site conditions or concealment of site information from the contractor.

In many construction contracts, attempts to alter the common law allocation of risks are made by a variety of contract terms. Consider the possible impacts of the frequently encountered contract clauses discussed below.

Geotechnical Information Disclaimers

Some owners attempt to avoid responsibility for unexpected site conditions by including in the contract exculpatory clauses disclaiming liability for the accuracy of site condition and subsurface data presented in the contract documents or in geotechnical data made available to the contractor. For example, a standard geotechnical disclaimer might read as follows:

Subsurface information shown on these drawings was obtained solely for use in establishing design controls for the project. The accuracy of this information is not guaranteed and it is not to be construed as part of the plans governing construction of the project. It is the bidder’s responsibility to inquire of the [owner] if additional information is available, to make arrangements to review the same prior to bidding, to conduct whatever site investigation or testing may be required, and to make his own determinations as to all subsurface conditions.

Such broad exculpatory clauses are increasingly common in construction contracts. In some jurisdictions, these exculpatory clauses have been enforced by the courts to the detriment of the contractor encountering unknown site conditions. In other jurisdictions, courts have been less willing to give unqualified effect to such clauses, especially if the contract also contains a differing site conditions clause allowing for the recovery of unanticipated costs. Nevertheless, the contractor encountering such an exculpatory clause must consider at least the following:

·         A possibly contingency in its bid;

·         A pre-bid letter to the owner requesting all site information available to the owner; and

·         A site inspection which goes beyond the traditional “sight” inspection conducted by most contractors.

 

DIFFERING SITE CONDITIONS

Perhaps the most commonly occurring claims at construction sites are the so-called “differing site conditions” (DSC) claims.  There are Type I and Type II DSC claims, mostly applicable to federal government contracts.

In federal government contracting, a Type I DSC is defined as follows:

1.  The contract indicated a particular site condition;

2.  The contractor reasonably interpreted and relied on the indications;

3.  The contractor encountered latent or subsurface conditions which differed materially from those indicated in the contract; and

4.  The claimed costs were attributable solely to the differing site conditions.

As an example, the contract boring logs may indicate that the excavation for a building foundation will be entirely in overburden soil, above bedrock.  If instead the contractor encounters a substantial quantity of rock excavation, a Type 1 differing site condition was encountered.  The key element in establishing a Type 1 DSC hinges on to what extent pre-bid subsurface representations were made.  As another example of an unforeseen condition in an existing structure would be the discovery of asbestos that must be abated before the work proceeds.  Differing underground conditions are classified as either Type I or Type II.  Type I conditions are subsurface or latent conditions which differ from those on the plans or in the contract documents.  Type II conditions are unusual physical conditions which differ materially from those ordinarily encountered.

A Type I differing site condition is typically defined as subsurface or latent physical condition at the site which differs materially from conditions indicated in the contract. As its definition suggests, contractors typically expect Type I differing site conditions to be physical in nature. For example, a contractor may encounter unexpected subsurface rock formations on the project, which should have been but were not disclosed in the contract documents. Or a contractor building a road on the side of a mountain may encounter an undisclosed geological thrust fault, which requires the contractor to spend additional money installing anchors and bolts to stabilize the fault zone to prevent it from collapsing on the road.

It is important to remember, however, that Type I differing site conditions do not always have to involve these types of physical conditions. A Type I differing site condition may arise from incomplete and unfinished work by a previous contractor. Regardless of which type of physical condition gives rise to a Type I differing site condition, the terms of the contract will be the most important factor in determining whether a contractor who has encountered a Type I differing site condition is entitled to additional time or money.

If a contractor is given an opportunity to view the project site, it should do so.  If the contractor fails to visit the site before submitting its bid, it runs the risk of bearing the cost of performing additional work that was not in the plans and specifications but reasonably ascertainable on a site visit.  If you undertake a site inspection and the owner refuses to provide access to critical portions of the prospective project site, the contractor should confirm such limitations by so informing the owner.

If positive representations made proved inaccurate, the recovery potential is high. Additionally, such representations need not only be affirmatively expressed in the contract documents. If a logical deduction can be drawn or inferred from the entire contract document, such inference will in fact be construed as a positive representation.

In connection with this “inference” criteria, the issue of quantity variations potentially giving use to a DSC is worthy of note.  Although a variation from the owner’s bid estimated quantity is in itself not a DSC, if it materially deviates from what was reasonably foreseeable, a DSC may well exist.

On the other hand, in the same setting, a Type II DSC occurs where

1.  the contractor did not know about the actual condition found during performance at the site;

2.  the contractor could not reasonably have anticipated the actual condition at the site from inspection or general experience; and

3.  the actual condition varied in a material way from the norm in similar contracting work.

An example of a Type II DSC is the encountering of a high water table, when no one was expected or known, requiring very active dewatering.

Typically, to establish entitlement to recovery for a Type I differing site condition, a contractor must prove, by a preponderance of the evidence, that: The conditions indicated in the contract differ materially from those actually encountered during performance;

The conditions actually encountered were reasonably unforeseeable based on all information available to the contractor at the time of bidding;

The contractor reasonably relied upon its interpretation of the contract and contract related documents; and

The contractor was damaged as a result of the material variation between expected and encountered conditions.

Failure to prove these elements will likely result in the denial of a contractor’s differing site condition claim, which could have significant cost impacts on the contractor and result in the contractor bearing the liability for delays on the project.

It is imperative for the contractor performing work on a project to be intimately familiar with the contract documents. If a suspected differing site condition is encountered, prompt written notice is essential. If a dispute arises over whether the conditions that were encountered at the site constituted a Type I differing site condition, the board or court will resolve the issue by scrutinizing the contract documents. If those documents show that the encountered site conditions were foreseeable, the contractor’s differing site condition claim will likely fail. To the extent the contract documents are not clear in informing the contractor about the site conditions that could be expected on the project, the contractor should attempt to resolve any ambiguities before submitting its proposal. Encountering differing site conditions that could arguably be foreseeable under the contract documents may not only result in the contractor not being compensated for the extra work performed as a result of those site conditions, but it could also possibly subject the contractor to liability for causing delays on the project.

 

The AIA, state governments and private contracting entities have similar contract clauses, as the Federal Acquisition Regulations (FARs) tend to set the standard.

All federal construction contracts contain some form of a so-called equitable adjustment clause.  This clause is designed to do financial equity for contractors should they meet (for example) a DSC during contract performance. Realizing that contractors who, under the contract would otherwise be held responsible for all costs of completing the contract, even those of which no one has knowledge at bid time, would compel inclusion by bidders of large contingency figures in the bids driving up bid costs needlessly where no problems ultimately exist, the government began employing the clause in 1927.

Numerous non-federal contracts, and many subcontracts have no DSC clause, nor even an equitable adjustment clause.  Because of this, subcontractors are at financial risk and frequently contingencies are added to bids to cover the risk.  In order to reduce the extent to which contingencies are priced in the bid, subsurface conditions expected to be encountered are incorporated into the contract.  While a step in the right direction, an owner’s representing subsurface conditions will give rise to liability for incorrect data.  Make sure you include such a clause in the contract to avoid the risk of suspension, delay and disruption caused by the DSC be shifted to you.

In a contract which does not contain a DSC clause, an increased level of complexity regarding a contractor’s potential recovery for “changed conditions” exists. In general, a contractor will not have an implied right to extra costs because of a differing site condition if there is no specific contract clause addressing DSC or changed conditions.  In a case in which the owner provides subsurface information and a contractor actually encounters materially different conditions, the legal basis for recovery is along the lines of either breach of contract, misrepresentation, superior knowledge or breach of implied warranty.

In addition, just because the problem issue meets the precise tests for a DSC does not mean the contractor will prevail in a claim for a DSC.  Most of the time the owner will vigorously defend based on a number of reasons, largely consisting of failings of the contractor.  At least one scholarly paper sounds a cautionary note for contractors claiming DSCs.  In a study done at the University of Florida in 2002 entitled

“Analysis of a Type I Differing Condition Claim:  An Empirical Study to Determine Which Proof Element is Most Frequently Disputed and Which Party Interest Most Often Prevails”, found at http://www.tamu.edu/faculty/choudhury/articles/9.pdf

In that study, 101 federal court cases were analyzed.  Based on the data findings and analyses, the following conclusions are proffered.  The majority of differing site condition complications regarding a contractual dispute between the owner and contractor occur during the bidding phase.  The issue regarding whether the contractor acted in a reasonably prudent manner when interpreting the contract was the most occurring dispute element.  The proof element, contract documents contain indications of conditions to be encountered, was the second highest litigious matter to appear in the study sample, followed next by the contractor must have reasonably relied on the contract indicates. As can be concluded, the most occurring or recurring proof element disputes occur at and result from the bidding phase of a construction project.  Two of these proof elements, namely: a) acted in a reasonable manner, and b) reasonably relied on contract indicates, are concerned with a contractor processing of bid document indicates.  The fourth most frequently recurring proof element at issue is: failure to investigate site. Here again, being a bidding phase process failure, more particularly having a strong contractual relation to the disclaiming language within the contract. The fifth most disputed proof element is actual condition encountered must be reasonably unforeseeable. This proof element bifurcates into both a bidding phase analyses and an actual construction phase question.

Use of DSC clauses has spread well beyond just federal contracting. The Engineers Joint Contract Documents Committee, which had previously employed a Standard Form 23A type of DSC clause, has evolved even further. For instance, the extent to which an owner may be held liable for subsurface facilities has been altered by distinguishing between such facilities from other physical conditions.  In the case of underground facilities which were not disclosed or represented in the contract, the contractor may recover monetary compensation.  On the other hand, if the underground facility is indicated in the contract but is inaccurately indicated, the risk shifts to the contractor.

A Type I differing site condition need not always involve project site’s geotechnical conditions. Something as simple as a previous contractor’s failure to build the preceding work in accordance with the applicable building codes, which in turn prevents or hampers another contractor’s performance, could be considered a differing site condition entitling that contractor to an adjustment in the contract price. Regardless of which type of condition is encountered, it is imperative for the contractor performing work on a project to be intimately familiar with the contract documents.

If a dispute arises over whether the contractor is entitled to additional money as a result of a condition that was encountered on the project, the court will resolve the issue by scrutinizing the contract documents. If those documents show that the encountered site conditions were concealed or unforeseeable, as they were in this case, a contractor’s differing site condition claim may well succeed.

 

Significant Decision by the Federal Circuit Court of Appeals in 2014

As was stated above, the contractors lose about two thirds of these DSC claims.  A recent case law may change this trend and make it easier for the contractor to prove his case.

A recent decision by the Federal Circuit Court of Appeals represents a major triumph for contractors pursuing certain types of claims against the Federal Government. In Metcalf Construction Co. v. United States, 742 F.3d 984 (Fed. Cir. 2014), the Federal Circuit reinforced the principles underlying the Government’s implied duty of good faith and fair dealing, reversing a trial court decision that would have made it exceedingly difficult for contractors to show that the Government had breached that duty. The Federal Circuit in Metcalf also clarified that a contractor’s duty to investigate site conditions after contract award will not prevent a successful differing site conditions claim that arises from the Government’s pre-award representations.

Background

The project in Metcalf required the prime contractor to design and build 212 military housing units at the Marine Corps base in Oahu, Hawaii. The Request for Proposal ("RFP") included a geotechnical report that indicated that the soil at the site had “slight expansion potential.” The RFP indicated that the information in the soils report was “for preliminary information only,” and it required the successful bidder to conduct its own post-award site investigation. The Government stated during pre-bid questions and answers that the contract would be modified if unforeseen soil conditions were encountered.

After Metcalf Construction Company (“Metcalf”) was awarded the contract, it hired a soil consultant to investigate the site. The consultant concluded that, contrary to the RFP, the soils exhibited “moderate to high” – as opposed to merely “slight” – expansion potential. Because this heightened expansion potential could adversely affect the stability of the constructed units, the consultant made several recommendations for mitigating the soil conditions.

Metcalf immediately notified the Government of the differing condition and requested permission to follow its consultant’s recommendations. However, the Government insisted that Metcalf follow the contract’s original construction requirements. Discussions continued for over a year. Although still without an approved contract modification, Metcalf pursued its consultant’s recommendations by over-excavating and replacing the soil with imported fill. Subsequently, the Government determined there was no differing site condition and refused to pay Metcalf for the majority of the added costs associated with the issue.

Besides mitigating unanticipated expansive soils, Metcalf had to remediate certain contaminated soils at the Project site, despite the Government’s pre-award assurances that no such remediation would be necessary. Although the Government ultimately issued a change order concerning the contaminated soils, Metcalf claimed the compensation was inadequate and failed to address the costs it incurred. Metcalf also faced other disruptions and hindrances before completing the Project several months past the contract completion date.

Metcalf subsequently submitted to the Contracting Officer a claim seeking its costs associated with the expansive soils and the other issues it encountered during performance. In its claim, Metcalf argued that the Government had materially breached the contract and the implied duty of good faith and fair dealing by failing to timely investigate the findings of Metcalf’s soils consultant and interfering with Metcalf’s work. After receiving the Contracting Officer’s Final Decision denying its claim, Metcalf sued in the United States Court of Federal Claims. The Government asserted a counterclaim for liquidated damages due to Metcalf’s failure to meet the contract completion date.

Although the trial court ruled in Metcalf’s favor on certain claims, it awarded the Government more than $2.4 million in liquidated damages due to late completion of the Project. The court also ruled that the Government had not violated the implied duty of good faith and fair dealing, because the Government had not undertaken “specifically targeted action” to gain the benefit of the contract or intended to delay or hamper performance of the contract. The trial court also stated that unless at least one factor is present, “incompetence and/or the failure to cooperate or accommodate a contractor’s request do not trigger the duty of good faith and fair dealing.”

Regarding Metcalf’s differing site condition claim, the trial court ruled that the RFP’s representations regarding swell potential and contaminated soils were excused by Metcalf’s obligations to conduct a post-award site investigation. According to the court, Metcalf was entitled to rely on the Government’s representations only “for bidding purposes” and not “in performing the...project.” Metcalf therefore assumed the financial responsibility for any differing conditions encountered at the site.

The Federal Circuit Reverses

Implied Duty of Good Faith and Fair Dealing

The Federal Circuit reversed, holding that the trial court applied the wrong standard in analyzing Metcalf’s good faith and fair dealing claim. The Court held that to prevail on this claim, a contractor need not show that the Government “specifically targeted” the contractor. Rather, the contractor need show only that the Government “interfere[d] with the [contractor’s] performance” and “destroy[ed] the [contractor’s] reasonable expectations...regarding the fruits of the contract.” The Federal Circuit emphasized that “a breach of the implied duty of good faith and fair dealing does not require a violation of an express provision in the contract,” and the Court sent the case back to the trial court to determine whether these standards had been met.

Differing Site Conditions

The Federal Circuit also rejected the trial court’s conclusion that Metcalf’s post-award duty to investigate site conditions shifted the risk of any differing site conditions to Metcalf, finding that this rationale misinterpreted the contract:

Nothing in the contract's general requirements that Metcalf check the site as part of designing and building the housing units, after the contract was entered into, expressly or implicitly warned Metcalf that it could not rely on, and that instead it bore the risk of error in, the government's affirmative representations about the soil conditions. To the contrary, the government made those representations in the RFP and in pre-bid questions-and-answers for bidders' use in estimating costs and therefore in submitting bids that, if accepted, would create a binding contract. The natural meaning of the representations was that, while Metcalf would investigate conditions once the work began, it did not bear the risk of significant errors in the pre-contract assertions by the government about the subsurface site conditions.

The court examined the purpose of the standard differing site condition clause, Federal Acquisition Regulation (FAR) 52.236-2, which the court noted was intended to “take at least some of the gamble on subsurface conditions out of bidding” by enabling contractors to obtain contract modifications if they encounter differing subsurface conditions. In that regard, the Federal Circuit confirmed that provisions requiring a pre-bid site investigation (such as FAR 52.236-3(a)) have been interpreted “cautiously,” and that even those provisions do not preclude a successful differing site condition claim, as long as a reasonable pre-bid site investigation was actually performed. Similarly, the Court held that the Government could not avoid liability simply because its RFP indicated that the information was “preliminary.” The RFP and other pre-bid information had advised bidders that they would be entitled to a change order if they encountered differing conditions, and the fact that Government-provided information was “preliminary” did not shift the risk of differing conditions to Metcalf.

Metcalf’s Impact for Federal Contractors

The Metcalf case represents an important victory for federal contractors for at least two reasons. First, it reversed the Court of Federal Claims’ narrow reading of the Government’s duty of good faith and fair dealing. As a result, Metcalf opens the door for potentially viable claims based on the Government’s failure to cooperate or failure to properly administer the contract, even where the Government has not breached an express provision of the contract or “specifically targeted” the contractor.

Second, Metcalf reaffirms previous case law regarding the federal differing site conditions clause and the contractor’s duty to investigate. After Metcalf, contractors may pursue successful differing site conditions claims even when their contract contains provisions that seem to bar recovery.  For example, contracting officers will often use FAR 52.236-3, which generally requires contractors to investigate the site pre-bid, to shield the Government from liability. As Metcalf and its cited cases clarify, however, those clauses do not create a duty by the contractor to investigate conditions beyond a reasonable degree, nor do they completely shift the risks associated with differing conditions to the contractor. 

Example Case where the Court found for the Owner and Against the Contractor

A 2010 decision from the Ohio Court of Claims sets forth a dispute over whether a differing site condition claim was adequately proven, and whether the contractor had followed the contract’s notice requirements for making a differing site condition claim.  The case is Central Allied Enterprises, Inc. v. The Adjutant General’s Department (June 18, 2010), Court of Claims of Ohio No. 2007-Ohio-07841, 2010-Ohio-3229.

A state agency was having a helicopter apron rebuilt. The agency had an engineering firm assess the soil composition and prepare a report that determined that the soil was suitable for construction when brought to proper moisture conditions. The contractor read the report and walked the site prior to submitting a bid for the lump sum contract. The plans required the removal of the existing asphalt and excavation of the soil to a depth of twenty inches, to be replaced with twelve inches of aggregate topped with eight inches of new asphalt to accommodate heavier helicopters.

During construction, the contractor encountered areas of unsuitable soil which required the contractor to excavate several additional inches to reach stable soil, and replace the excavated soil with more aggregate. The contractor also layered geo-fabric with the aggregate to achieve suitable soil strength. The contractor and the owner’s engineer were unable to reach an agreement as to payment for the additional work. The contractor chose to proceed with the work to avoid delaying the project. Both the contractor and the engineer agreed that the additional costs would be reconciled by a final change order to be submitted upon completion of the project.

After substantial completion, the contractor requested the engineer to verify final quantities for the change order. The engineer did not do so, and the contractor completed its own calculations and requested the engineer to submit the proposed change order to the owner. The engineer did not respond to the request. The contractor then sued the state agency for breach of contract, unjust enrichment and constructive change order.

The Court of Claims quickly dispensed with the Type II differing site condition premise by holding that there was insufficient evidence to establish that the actual nature of the soil differed from the type of soil normally encountered during excavation in that part of Ohio. The court relied upon the engineer’s soils report which stated that all soil values were typical of glaciated deposits found in the area.

With respect to a Type I differing site condition claim, the court held that the conditions encountered by the contractor were not materially different from those outlined in the contract, and that the actual conditions were reasonably foreseeable.  The court based its conclusion on the soils report, the presence of standing water in various areas of the apron on the day of the pre-bid meeting, the engineer’s inclusion of catch basins and a detention pond to facilitate drainage, and the inclusion of geo-fabric in the design.  These factors provided notice to the bidders that there were excessive moisture and drainage problems in the subsoil.

Notice for a change order

According to legal precedence, when a construction contract provides that altered or extra work must be ordered in writing, the provision is binding upon the parties to the contract. The contractor cannot recover for such work unless a written directive (change order) is executed in compliance with the contract, unless waived.

The contract in this case provided a Change Order Procedure which prohibited the contractor from proceeding with any change in the work without written authorization. Whenever the contractor seeks additional compensation for causes arising out of or related to the project, the contractor has to follow the contract procedures, including providing timely notice. Under this contract, the contractor was required to make a written claim with the engineer prior to contract completion and no more than 10 days after the initial occurrence of the facts giving rise to the claim for additional costs. When it comes to notice provisions, the contractor should always follow the letter of the contract.

The court found that the contractor failed to submit a written change order to the engineer or to the owner prior to the contractor’s completion of the project. The court rejected the contractor’s argument that the notice provision was waived when the engineer agreed with the contractor’s decision to proceed with the work and to submit a final change order at the completion of the project. There must be a clear and unequivocal act demonstrating the owner’s intent to waive the contractual notice, change order and claim review requirements.

Constructive change order

A claim for a constructive change order may have been sustained by the court if the owner had independent knowledge of the condition complained of and had oral notice of the contractor’s complaint, and the owner was not prejudiced by lack of prior written notice. In this case, however, the contractor had communicated only with the engineer regarding the differing site conditions, and had not documented these communications. The contractor had failed to submit a formal written change order to the engineer or to the owner within the time permitted by contract or even within a reasonable period of time.

When a contractor has missed a contractual notice deadline, the contractor should continue written communications to the owner and the owner’s representative addressing the disputed issue. Even when there has been no response from the owner or owner’s representative, the contractor should not remain silent.

Central Allied Enterprises, Inc. v. The Adjutant General’s Department (June 18, 2010), Court of Claims of Ohio No. 2007-Ohio-07841, 2010-Ohio-3229.

Tips and Misc. Case Law on DSC

A common mistake to avoid is appealing denial of a claim for contract interpretation that does not include a separate monetary claim for consideration by the contracting officer. The Board lacks jurisdiction over any request for monetary relief found in the complaint for an appeal. See Dick Pacific/GHEMM, JV, ASBCA No. 55829, 08-2 BCA ¶ 33,937 (portions of complaint stricken as claim did not include a request for release of withholdings or liquidated damages).

Liquidated Damages Construction Claims. When the government asserts liquidated damages against you, a question arises as to whether you must obtain a contracting officer’s final determination. The government does not have to “certify” its own claim against a contractor. An experienced government construction claims appeal lawyer should assert that there is sufficient jurisdiction because  the contracting officer made a final decision on the government construction claim asserting liquidated damages and you filed a timely appeal from that final decision. See  Placeway Construction Corp. v. United States, 920 F.2d 903, 906-07 (Fed. Cir. 1990); cf. M. Maropakis Carpentry, Inc. v. United States, 609 F.3d 1323 (Fed. Cir. 2010) (contractor’s separate claims for time extensions and  related contract modifications had to be certified); Sikorsky Aircraft Corp. v. United States, 102 Fed. Cl. 38, 47-48 (2011).

When the government assesses construction claims against you, you want to also present facts that any causes of damages were not due to a situation that is your fault or within your control.

Project Solutions Group v. DOT, CBCA 3411 (Oct. 23, 2013) (nonprecedential; excessively high relative humidity levels at installation site for new flooring were not differing site condition but likely were caused by fact that contractor repeatedly watered the area to keep down the dust)

Drennon Construction & Consulting, Inc.. v. Dept. of Int., CBCA 2393 (Jan. 4, 2013) (defective specifications and differing site condition made resulting period of suspension of work unreasonable per se)

D&M Grading, Inc. v. Dept. of Agr., CBCA 2625 (Apr. 24, 2012) (upholds Default termination because conditions encountered by contractor under roadway vegetation maintenance contract did not amount to Type I or Type II Differing Site Condition)

JRS Management v. DOJ, CBCA 2475 (Mar. 1, 2012) (dismisses appeal for lack of jurisdiction (no contract) because contractor responded to government order for services by announcing it was substituting different individual from the one specified in the order, thus making a counteroffer the Government refused to accept)

Beyley Constr. Group Corp. v. Dept. of Veterans Affairs, CBCA 5, 763 (July 23, 2007) (differing site conditions, constructive change)

Instability of a highway embankment was held to be an unusual soil condition entitling the contractor to an equitable adjustment under the Differing Site Condition Clause. Paul N. Howard Co. v. Puerto Rico Aqueduct Sewer Authority, 744 F. 2d 880 (1st Cir. 1984)

Additional Practical Tips

An assessment of the contractual allocation of risks should be performed before a bid is submitted to answer questions such as:

Is there a DSC clause in the contract?

Are the boring logs (and other geotechnical data) part of the contract?

Are there exculpatory clauses wherein the owner denies responsibility for incorrect subsurface conditions?

These are but a few of the questions a prudent contractor will address in the course of bid preparation.

Site Inspection

In the process of establishing the basis of recovery for a DSC, a contractor should show that a site inspection would not have disclosed the conditions encountered. Regardless of the representations (or lack of) made in the contract, the necessity to perform a reasonable site inspection is vital. Quite obviously, a contractor will not be held responsible to perform numerous borings (or other investigations) during the usual short bid period. However, a contractor will be expected to ascertain, to the extent possible, subsurface conditions from a reasonably conducted site visit. If conditions are discernable from the site visit (particularly if they contradict the “represented data”), the contractor should take such information into account. This relates back to whether (or not) a site investigation would have allowed the contractor to ascertain the actual conditions encountered. If the actual conditions could not be reasonably discovered, the contractor stands a better chance to recover.

Even in situations where the owner includes all subsurface information in the bidding documents and makes no attempt to disclaim responsibility for the information provided, contactors cannot rest easy. In Foster Construction C.A. and Williams Brothers Company, A Joint Venture v. The United States the U.S. Court of Claims ruled that:

“The contractor is unable to rely on contract indications of the subsurface only where relatively simple inquiries might have revealed contrary conditions.”

For example, in a highway project where the subsurface investigation report contains 30 borings to a depth of 45 feet (and the deepest cut on the drawings is approximately 25 feet) all of which show no groundwater, bidders may not be able to rely on the lack of indication of groundwater.  If the contractor could have, for example, reviewed and determined from the local Soil Conservation Service office that groundwater records show that at certain times of the year groundwater levels rose to within three meters of the surface, then bidders cannot rely upon the bidding information when preparing their bids.

Similarly, if a pre-bid site walk would have revealed the condition, even though it was not shown in the geotechnical report, then the contactor cannot rely exclusively on the bidding information.

Timely Notification

The most substantial roadblock to recovery of a DSC claim is failure to provide notification. Contracts often contain a notification requirement, particularly with regard to DSC, and have even required that the uncovered unknown subsurface conditions remain undisturbed until investigated by the owner. Failure to strictly adhere to these notice requirements can foreclose a contractor’s recovery for an otherwise valid DSC claim. This procedure is necessary to afford the owner the opportunity to modify and alter the design or performance requirements and thereby minimize and mitigate the actual effects of the DSC.

Root Causes of Most Construction Claims

·         Lack of Communication

·         Misinterpretation of plans, specs or directions

·         Plan errors / Poorly coordinated contract drawings

·         Poor Project Management

·         Lack of Familiarity with Specifications

·         Impacts of Third parties (damage to your work, delays, utilities, etc.)

·         Changes in work scope

·         Unknown / Differing Site Conditions

·         Work Interruptions (Loss of Productivity)

·         Project Acceleration / Delay

Steps to Avoid Construction Claims

1.    Thoroughly Review Your Contract / Plans

2.    Properly Plan / Manage your Project

·            Including detailed schedules with critical dates, constraints and critical tasks

·            Be able to show how you planned to do work, equipment needed, man-hours, etc.

3.    Track your own work Progress

·            Are you On Schedule, ahead, or already behind, etc.?

·            Have you documented any delays/impacts to your schedule?

4.    Keep Good Records

·         Document, Document, Document

·         Photos, time logs, foreman reports, engineers' inspection records, etc.

5.    Constant Communication

·         Confirm things in writing, respond to communication promptly (one way or the other)

·         Never Assume things when it comes to contract work

·         Ask questions before starting extra work, confirm scope and payment in writing.

6.    Always attempt to Resolve Disputes Early

·         Average time to resolve a claim is often over 15 months.

Avoid Five Costly Mistakes Made By Government Construction Contractors

Although not intentional, contractors tend to make the following mistakes which can cost them thousands or millions in construction projects.

Failure to understand how the various FAR clauses impact your ability to have equal footing with the agency.  Federal contracts are primarily written for the benefit of the agency.  Having your people trained in the various clauses can save the company a substantial amount of money.

Not understanding the difference between a Request for Equitable Adjustment and a CDA claim.  There is a difference between the two. Having a government construction lawyer to guide you around the lurking pitfalls can also save you thousands in unnecessary attorney fees.

Failures to submit a construction claim that meets the CDA requirements. Both small and large contractors make fatal procedural and substantive errors then submitting their claims. See information on Contract Disputes Act and Pass Through Claims. There are statutory requirements that you must meet including getting the contracting officer’s final decision. Failure to meet them can create delays and even rejection.

Not understanding what constitutes a Contracting Officer’s final decision. Your construction claim must have a CO’s final decision before you can appeal to the Court of Federal Claims or Board of Contract appeals.

Failure to properly address cure notices. When a contracting agency believes that you are a performance risk, a cure notice is forthcoming.

Prepare, Negotiate and Litigate Construction Claims in Federal projects allow contracting officers (COs) great latitude in resolving disputes. However, you may often find your company trying to negotiate a claim that you know has merit.

Avoid Costly Pitfalls With Requests for Equitable Adjustment Claims: An important part of the government construction claims process is understanding the nuances between a CDA claim and a Request for Equitable Adjustment. Develop Internal Policies and Controls: Given the mandated increased oversight on federal contractors, both small and large companies are targeted for audits and investigations.

Get Help With Government Construction Proposal Writing: Bidding on government contracts is very tough business. Whether you are writing proposals for Army Corps Projects, Navy projects or for another agency, you want to strengthen your technical proposals, construction bid bond submissions and management approaches.

Federal Construction Contracting for Small Businesses: The laws associated with government contracting include a wide array of complex regulations that dictate how you perform. For example, small businesses are restricted to certain guidelines under teaming agreements and joint venture contracts.  Issues arise concerning SBA size standards and limitation in subcontracting requirements. At the law office of Watson & Associates our government construction law attorneys provide legal advice on matters pertaining to:

·         Prime and subcontracting agreements

·         Size standard disputes

·         Subcontracting plans

·         Teaming agreements

·         Joint venture agreements

·         Filing construction claims

·         Addressing construction defect disputes

 

Metropolitan Engineering, Consulting & Forensics (MECF)

Providing Competent, Expert and Objective Investigative Engineering and Consulting Services

P.O. Box 520

Tenafly, NJ 07670-0520

Tel.: (973) 897-8162

Fax: (973) 810-0440

E-mail: metroforensics@gmail.com

Web pages: https://sites.google.com/site/metropolitanforensics/

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We are happy to announce the launch of our twitter account. Please make sure to follow us at @MetropForensics or @metroforensics1

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Feel free to recommend our services to your friends and colleagues.

Metropolitan has been engaged by design-build engineering firms, general contractors, and specialty subcontractors to prepare and substantiate differing site conditions claims and has been engaged by project owners and public agencies to evaluate claims submitted by contractors.  Metropolitan has in-house multidisciplinary expertise of engineers, geologists, construction management professionals, and schedulers to analyze all aspects of DSC claims.  The results of our development and evaluation of DSC claims have been presented in discussions with our clients, written reports, and testimony at review board hearings, arbitrations, mediations, and trials.

In general, Metropolitan has expertise to evaluate issues related to:

·         Entitlement (technical merits of claim)

·         Cost analysis 

·         Delay impacts

·         Disruption

·         Productivity Loss

·         Acceleration

·         Design defects

·         Construction defects

In Metropolitan’s evaluations of entitlement, our engineering and construction professionals have used their education, training, and expertise to address issues related to the following types of site conditions: 

·         Excavation and trench failure 

·         Embankment failure 

·         Pile-driving refusal  

·         Rock suitability for drilled shafts 

·         Import fill suitability 

·         Borrow source characterization 

·         Unsuitable material 

·         Subgrade suitability 

·         Embankment/subgrade R-value 

·         Construction equipment mobility  

·         “Pumping” and “rutting” of subgrade 

·         Expansive soil 

·         Collapsible soil 

·         Liquefiable soil 

·         Cobbles and boulders (particle size) 

·         “Running ground” 

·         Sinkholes 

·         Excessive ground moisture 

·         Groundwater and seepage 

·         Groundwater pumping rates and volumes 

·         Rock rippability 

·         Back-cut slope stability 

·         Unmapped landslides 

·         Faults 

·         Ground fissures 

·         Hazardous materials (naturally occurring and man-made) 

HOW TO MANAGE CONSTRUCTION DISPUTES TO MINIMIZE SURETY AND CONSTRUCTION CLAIMS.  PART 6: CHANGE ORDER AND EXTRA WORK CONSTRUCTION Claims

Introduction

Construction is a business fraught with risk.  Disputes over even the smallest of issues can quickly escalate, with crippling consequences to the project and the parties.  Over the years, the construction industry has developed various methods of contractually allocating the risk of project delay and disruption.  Some of these methods include liquidated damages provisions, "no damages for delay" clauses, mutual waivers of consequential damages, provisions that limit liability, claims notice provisions, “waiver of damages clauses”, acceleration clauses, “time is of the essence” clauses, change order clauses, and provisions addressing responsibility for the adequacy of the construction plans and specifications.  Parties frequently litigate the sufficiency of these risk-shifting efforts in conjunction with the underlying merits of delay and disruption disputes.

Construction Claims & Disputes

In Part I of our series of how to manage construction disputes to minimize surety and construction claims, we addressed the construction delay claims and the methods typically used to analyze them.

We indicated there that the most frequently encountered claims include:

1.            Construction Delay Claims

2.            Disruption and Loss of Labor Productivity Claims

3.            Design and Construction Defect Claims

4.            Force Majeure Claims

5.            Acceleration or Compression of the Schedule Claims

6.            Suspension, Termination and Default Claims

7.            Differing Site Conditions Claims

8.            Change Order and Extra Work Claims

9.            Cost Overrun Claims

10.         Unacceptable Workmanship or Substituted Material Claims

11.         Non-payment Claims (stop notice (or Notice to Withhold) claims, mechanics’ lien (only for private construction projects) and payment bond claims)

Part 6 of this series discusses item 8 above: Change Order and Extra Work Construction Claims.

Change Orders

No architect or engineer ever produced a perfect set of plans and specifications.  It is not humanly possible to do so and it would be prohibitively expensive to do so especially on a large project that has many details.  There are too many details that need to be drafted and too many elements of the work must be coordinated in too many ways.  As a result, the plans and specifications cannot prescribe every detail of the work.  That is the reason the contract documents specify that whenever a detail is not provided, the contractor must submit draft details to the engineer for approval prior to installation or construction.   

Furthermore, every construction project is different.  Each is built by a combination of contractors who bring their workers and equipment/tools together, at a single location, for just that one job.  This creates sequencing and trade stacking issues, especially if a delay occurs in one part of the construction phase.  Work is often impacted by the unforeseeable: inclement weather, subsurface conditions, new building codes, unavailability of materials, and activities adjacent to, or sometimes through, the project site.  No set of plans and specifications can anticipate such conditions or events, nor do other factors that make the owner alter the project midstream.  This is why contracts allow owners to make changes in the work.

In most cases, some changes to the plans and specifications or the work contemplated by the contract will be necessary before completion of the project because of lack of detail, errors, omissions, improvements, or aesthetic, cost, or other concerns. Changes and extras can create disputes and careful planning in the contract stage is vital. Accordingly, every construction contract should include a change order clause (“Change Order Clause”), which provides the owner with a mechanism by which it is permitted to require alterations or additions so long as it agrees to compensate the contractor for the additional work.

There are numerous reasons why changes may occur on a construction project, including, but not limited to:

•      Unclear bid documents

•      Owner directed changes

•      Late, incomplete, or defective drawings; specifications, and other contract documents

•      Preferential changes by the owner

•      Misinterpreted contract requirements by the parties

•      Differing site conditions

•      New or revised codes/standards

•      Rework

•      Impacts/changes to the construction means and methods

•      Scope additions

•      Acceleration and/or schedule changes

Frequent sources of change orders in contract documents include:

•      Defective Specifications;

•      Illegal Restrictions;

•      Improvements in Time;

•      Incomplete Design;

•      Intention of the Contract Documents;

•      Lack of Design Discipline Coordination;

•      Latent Conditions;

•      Owner Changes; and

•      Updated Information

The pace of a construction project may be such that subcontractors are faced with a dilemma. They are often asked verbally to perform work they believe was not included in the original contract. Do they go ahead and do the work and risk not getting paid for it? Do they delay the project and take the time to get the change in writing signed by all parties? If they do this, they may risk being in breach of contract for not completing the project on time if a court later determines the work requested was contemplated by the original contract and a change order was not required.

A Change Order as defined in Section 7.2.1 of the A201, is a written document signed by the owner, contractor, and architect setting forth their agreement with respect to the change in the work, any adjustment to the contract time, and any adjustment to the contract sum. Using a Change Order is the preferred method to request a change in the work, because the agreement of the parties as to the change is set forth in writing. If the owner wants the right to make changes that are not included within the scope of work contemplated by the contract, the owner must specifically set out the owner’s right to do so in the contract.

If there were no changes clause in the contract, the contractor would have a right to build exactly what was called out in the plans and specifications.  The owner could order no changes without the contractor’s consent.  If the contractor refused to consent, the change could not be made.

That is why every competently drafted construction contract has a changes clause.  Even after a contract has been written to the satisfaction of all parties, reviewed by an experienced attorney if necessary, and is signed, the contract may need to be amended after the project begins.  A change in the design plans, the materials used, a foreseeable delay in the project completion date, whatever the cause of an alteration to the original terms of the contract, these amendments must be put in writing as “change orders.”  A proper change order lays out the specific modification to a contract term and how said modification affects the project budget. (See California’s Business and Professions Code Section 7159.6.)  Once a change order is signed by all parties it becomes a legally enforceable part of the contract.

The more time spent thinking about what a particular construction project will demand, and clarifying each aspect in writing using unambiguous language, the less opportunity there is for misunderstanding and confusion which can lead to long delays, bad reputations, and potential legal problems.

It is imperative that construction contracts provide a clear and concise directive in dealing with the fluid course every project takes. Doing so will greatly aid in avoiding the confusion and mistakes that often lead to costly and laborious legal action between disgruntled parties.  While there is no such thing as a perfect construction contract, this guide will address the importance of keeping control of costs by making a provision for change orders.

Much like a construction contract, there is no perfect set of construction plans. Even the most meticulous scope of work is subject to change due to any number of unforeseen circumstances before or during the construction process.  Should the client decide to make alterations to the design specifications, desired materials are unavailable or found to exceed the costs outlined in the budget, or conditions at the worksite require amendments to the original plan and/or changes in personnel, a provision for such changes should be made in the construction contract.

While it is impossible to predict every such event, a competently written construction contract includes a “changes” clause that accounts for the likelihood of a request to add to or delete from the original scope of work.  The language of these clauses does vary depending on the contract, but most contain provisions allowing the client unilateral powers to modify the plan and specifications, and compelling the contractor to perform said modifications.

Other common provisions include a means for both parties to agree on how the revisions will affect budget and schedule, and a means for both parties to agree on how to handle any disputes that may arise concerning same.  The changes clause also addresses the prudent legal protocol to follow when parties wish to move forward with adjustments to the original scope of work.

For the protection of all involved and as required by the California Contractors State License Board for residential projects, the clause should mandate that any modifications to the contract be done in writing, in the form of a change order, and specify the change in work. It should show any and all adjustments to the budget and schedule as finalized in the present contract.

Typically a change order is prepared by the architect or the contractor based on his/her discussion with the client. The change order must be signed by all relevant parties to ensure proper payment for the work performed.  On a more practical basis, if the owner wishes to preserve your working relationship with his contractor, having a written change order will prevent differences in memory and the resulting disagreements that go along with it.

Although the language in changes clauses varies from contract to contract – and those variations may have significance – most changes clauses cover the following points:

1.    The right of the owner to unilaterally modify the plans and specifications, and the duty of the contractor to perform the work as changed.

2.    Mechanisms for the owner and contractor to agree on the cost and time implications of the change.

3.    Mechanisms for resolving disputes over costs and time.  Typically, these mechanisms (a) require the contractor to maintain detailed daily records of the labor, services, equipment and material used for the changed work, and (b) specify markups that can be added to those costs to cover overhead and profit.

Elements for Recovery

Even if a CO is executed, recovery for extra work may be barred unless the contractor can show that he in fact performed work over and above what was required under the original contract.  The contractor must establish the following points to obtain additional compensation for extra work:

1)    the work was outside the scope of the original contract,

2)    the extra items or changes were ordered at the direction of the owner,

3)    the owner either expressly or impliedly agreed to pay extra,

4)    the extra items were not furnished voluntarily by the contractor, and

5)    the extra items were not required or made necessary through any fault or omission of the contractor. Duncan v. Cannon, 561 N.E.2d 1147 (Ill. App. Ct. 1st Dist. 1990) (labor and materials that are incidental and necessary to the execution of the contract cannot be regarded as extra work).  The issue of whether extra compensation can be successfully claimed is a fact-intensive question which turns on the extent of the added burden on the contractor's performance and the language in the contract. Any situation involving a disputed constructive change should be carefully documented by the parties, highlighting their communications and the actual impact on performance. In order to recover compensation, a contractor must be able to demonstrate the exact nature of the change and the owner's agreement to the change. Wilmette Partners v. Hamel, 230 Ill. App. 3d 248, 264, 594 N.E.2d 1177, 1189 (1st Dist. 1992); Curran Contracting Co. v. Woodland Hills Dev. Co., 235 Ill. App. 3d 406, 415-18, 602 N.E.2d 497, 504-05 (2d Dist. 1992).

Minor Changes in the Work

Section 7.4 of the A201 permits the architect to order minor changes in the work not involving an adjustment to the contract sum or the contract time. This could be problematic for the owner because the architect specifically has the power to bind the owner to such minor changes. Accordingly, depending on the degree of control an owner desires to exercise over the project, the owner may desire to modify the contract to provide that the order for minor changes should be signed by the owner and architect. 

Additional Work vs. Extra Work

Disputes about changes in the work become important when there is a disagreement as to whether work conducted by the contractor or subcontractor is “extra” work or “additional” work. Extra work is work which is outside the scope of the contract contemplated between the owner and contractor and, accordingly, will support a claim by the contractor for additional compensation or additional time to complete the project, or both. North Shore Sewer & Water, Inc. v. Corbetta Construction Co., 395 F.2d 145 (7th Cir. 1968). Additional work, on the other hand, is work which is within the original scope of the contract and stems from the tasks which were originally contracted for. Additional work will not be subject to additional compensation by the owner, but may permit an extension of time to complete the project. Id.

As noted above, Change Orders under the A101 and A201 require the parties, by their terms, to reach agreement upon the appropriate adjustment to the time for the contractor’s performance and the contractor’s compensation for the modifications described in the Change Order. As a result, disputes regarding whether work required by an owner under the contract constitutes additional work or extra work generally result from Construction Change Directives and minor changes in the work ordered by the owner or its representatives. The types of modifications owners and their representatives have sought to implement by Construction Change Directives and minor changes has proved to be legion. Some of the more common ones follow: (a) the owner directs the contractor to alter the sequence or timing of its work; (b) the owner seeks to “clarify” contract requirements that are vague or ambiguous with regard to performance standards; (c) the owner’s architect or engineer imposes excessive standards at the time of inspecting completed work; and (d) the owner’s architect or engineer seeks to make revisions to correct or revise arguably defective drawings or specifications. Changes of these types frequently can increase the cost of a contractor’s performance or the time it will take the contractor to complete the project. Most contracts will require the issuance by the contractor of a notice of claim for the extra work associated with a Construction Change Directive or a minor change in order for the contractor to preserve its rights to additional compensation or time.

Accordingly, careful documentation and notice to the owner of the contractor's claim are imperative. Wherever possible, the contractor should carefully detail the ways that the revised work is inconsistent with the original requirements, the impact to the schedule, and the other added costs.

Illinois courts clarified the elements of what constitutes additional work and what constitutes extra work in the 1967 case of Watson Lumber Co. v. Guennewig, 79 Ill. App. 2d 377 (1967). See e.g.: Stark Excavating, Inc. v. Carter Constr. Servs., 967 N.E.2d 465 (Ill. App. Ct. 4th. 2012). In Watson, a contractor built a home with a contract price of $28,206, but full payment was withheld by the owner due to disputes over the construction. The contractor sued to recover the full contract price, and made additional claims for extras which were furnished by the contractor. The court in Watson held that a contractor seeking to recover for extras must establish all of the following elements:

•    The work was outside the scope of the contract promises;

•    The extra items were ordered by the owner;

•    The owner agreed to pay extra, either by words or conduct;

•    The extras were not furnished by the contractor as his voluntary act; and

•    The extras were not rendered necessary by any fault of the contractor. (Watson at 390).

The specific type of change encountered affects both the enforceability of the requested change as well as the amount that will be paid for such change. As a general rule, an owner may only request changes which are within the general scope of the work described in the contract documents. Under Illinois law, a request falling outside the general scope of the parties' agreement will not be enforceable under the existing contract, but instead will constitute a new contract. Compare Bulley & Andrews, Inc. v. Symons Corp., 25 Ill. App. 3d 696, 701, 323 N.E.2d 806, 810 (1st Dist. 1975) with Kell v. Kosary, 93 Ill. App. 2d 400, 403, 236 N.E.2d 349, 351 (1st Dist. 1968).

In Kell, the contractor initially agreed to construct new living quarters and garage for the owner. The parties subsequently agreed that the contractor would renovate an old garage at the same location. The Court determined that the agreement to renovate the old garage could not be enforced as part of the initial construction contract, because the subject matter was so different, but instead constituted part of a separate oral construction contract. Kell, 93 Ill. App. 2d at 403, 236 N.E.2d at 351. By contrast, in Bulley, the owner modified the type of “rustification strip” used by the contractor, who was held to have consented to an enforceable modification of the contract, rather than to a new contract, because the modification was consistent with the scope of the existing contract. As a result, the contractor was prohibited from seeking additional compensation for the expanded (but consistent) scope of work in the modified contract. Bulley, 25 Ill. App. 3d at 701, 323 N.E.2d at 810.

The courts have provided little guidance for the determination of whether a proposed change falls within the general scope of an agreement or is beyond the scope. One court has defined such changes as those which fairly and reasonably fall within the contemplation of the parties when the contract was executed. Freund v. United States, 260 U.S. 60, 62 (1922).

Another court has suggested that the determination of whether a change is beyond the scope of the contract is a matter of degree and the ultimate determination can be reached only “by considering the totality of the change” both as to its “magnitude” and “quality.” Saddler v. United States, 152 Ct. Cl. 557, 561, 287 F.2d 411, 413 (Ct. Cl. 1961). The United States Court of Claims focused on whether the changes were such that the end product was substantially different from the work the parties originally agreed to provide. J.D. Hedin Constr. Co. v. United States, 347 F.2d 235, 258 (Ct. Cl. 1965).

Cardinal Change

Other methods, outside the contract, can produce recovery for the contractor for extra work.  The "cardinal change" doctrine is available when the quantum of changes or the magnitude of a change creates a fundamental alteration of the scope of the contract so that it essentially breaches the contract. Air-A-Plane Corp. v. U.S., 408 F.2d 1030 (Ct. Cl. 1969).  The “cardinal change  falls beyond the general scope of the contract.  Allied Materials & Equipment Co., Inc. v. United States, 214 Ct. Cl. 406, 409 (Ct. Cl. 1978).  Cardinal changes are unenforceable and may constitute a breach of contract.  In such a situation, the contractor may terminate performance and sue for damages. Id.

There is no exact formula for determining when a change, or series of changes, alters the scope of the contract, and thereby breaches the contract.  Wunderlich Contracting Co. v. U.S. , 351 F.2d 956, 966 (Ct. Cl. 1965).  Neither the number of changes, nor the character of the modifications is the determining factor. J.D. Hedin Constr. Co. v. U.S., 347 F.2d 235, 258 (Ct. Cl. 1965); Air-A-Plane Corp ., 408 F.2d at 1033.

Constructive Changes

The A201 defines a construction change directive (“Construction Change Directive”) as a written order prepared by the architect and signed by the owner and architect directing a change in the work prior to an agreement on the adjustment to the contract time or contract sum. See Section 7.3.1 of the A201. This method is useful when the parties need to expedite the work and do not have time to gather the necessary information on price. Nonetheless, at the earliest possible time thereafter, the parties should finalize the changes to the contract price and time by way of a written Change Order.

The standard “Changes” clauses specify that a change can only be made to the contract by a written order. Contract provisions requiring changes to be approved in writing are common and enforceable. See Central Penn Indus., Inc. v. Department of Transp., 25 Pa. Commw. 25, 358 A.2d 445 (1976); Linneman Constr., Inc. v. Montana-Dakota Utils. Co., 504 F.2d 1365 (8th Cir. 1974).  See also American Institute of Architects Form A201, General Conditions for the Contract for Construction (1997 ed.). This contract requirement will generally be upheld by the Pennsylvania courts. One Pennsylvania decision has noted:

It is a well-established rule of law that where, by the terms of a contract with a governmental body, written orders for additional work are required, the contractor cannot recover for extra work without compliance with the contractual provisions.

Dick Corp. v. State Public School Bldg. Authority, 27 Pa. Commw. 498, 500, 365 A.2d 663, 664 (1976).

A common issue is whether a directive from an owner or the owner's representative constitutes a change at all. An owner may request a change to the procedure or timing of performance as a project progresses. Such situations may result in an increase to the contractor's cost of performance. In these situations, a contractor will want a written change order to document the change so that it can collect additional costs resulting from the directive.

Conversely, the owner's agent will resist issuing a change order in those instances where it is simply altering the timing or procedure for performing an agreed task. See Duncan v. Cannon, 204 Ill. App. 3d 160, 166, 561 N.E.2d 1147, 1151 (1st Dist. 1990) (labor and materials that are incidental and necessary to the execution of the contract cannot be regarded as extra work). The issue of whether extra compensation can be successfully claimed is a fact-intensive question which turns on the extent of the added burden on the contractor's performance and the language in the contract. Any situation involving a disputed constructive change should be carefully documented by the parties, highlighting their communications and the actual impact on performance. In order to recover compensation, a contractor must be able to demonstrate the exact nature of the change and the owner's agreement to the change. Wilmette Partners v. Hamel, 230 Ill. App. 3d 248, 264, 594 N.E.2d 1177, 1189 (1st Dist. 1992); Curran Contracting Co. v. Woodland Hills Dev. Co., 235 Ill. App. 3d 406, 415-18, 602 N.E.2d 497, 504-05 (2d Dist. 1992).

Procedure for Implementation of Change Orders.

Virtually all construction contracts have provisions requiring a written order signed by the owner for additional work. Nevertheless, Illinois, like most jurisdictions, has carved out an exception to the requirement for a written order where the party has waived it and knew of the change or accepted the work with knowledge of the change. See, e.g., Mendelson v. Ben A. Bornstein & Co., 240 Ill. App. 3d 605, 616-17, 608 N.E.2d 187, 194-95 (1st Dist. 1992) (owner who knew of the change waived written order requirement by not strictly enforcing requirement); Berg and Assoc., Inc. v. Nelsen Signal & Wire Co., 221 Ill. App. 3d 526, 535-36, 580 N.E.2d 1198, 1204 (1st Dist. 1991) (actions or words of parties can waive requirement that written order be required for extra work); Bulley & Andrews, Inc. v. Symons Corp., 25 Ill. App. 3d 696, 703-04, 323 N.E.2d 806, 811-12 (1st Dist. 1976) (owner ordered extra work, was aware that it was extra, and permitted it to proceed without an order, thereby waiving need for written authorization).

A contractor also must guard against following the directive of an owner's representative who does not have the authority to make changes on behalf of the owner. Typically, construction contracts designate the individuals having authority to make changes which are binding upon the owner.

Under Illinois law, a contractor working on a public project acts at its own peril if it follows the directive of an owner's representative who lacks the authority to issue change orders.

NOTICE PROVISIONS.

The parties to the construction contract should pay close attention to the notice provisions of the contract. Notice provisions (i) facilitate requests by the parties for possible modifications and revisions to construction contracts including change orders, and (ii) are necessary to facilitate the discussion between owners and contractors with respect to possible delays in the performance of the work and similar issues arising during the construction process. A typical notice provision will provide for the timing of the notice, the person to whom the notice must be given, the manner in which the notice must be served, and the subsequent documentation to be provided by the party giving the notice. Each contract is different, and the specific times and conditions under which notices are required by owners and contractors vary widely. Nevertheless, courts will generally enforce these provisions, which can impose unanticipated adverse consequences on a party that fails to comply with the notice requirements. See generally Sarnoff v. De Graf Bros., Inc., 196 Ill. App. 3d 535 (1st Dist. 1990).

When notice provisions are clear and unambiguous in a contract, courts will normally construe notice requirements in strict accord with their meaning in the contract. Dean Mgmt., Inc. v. TBS Const. Inc., 790 N.E.2d 934 (Ill. App. 3d 2003). Actual or constructive notice has been deemed adequate by courts in regard to contractors seeking additional compensation for work performed under the agreement when the notice provisions of the terms of the agreement were ambiguous. Id. Additionally, courts have not deemed a failure to strictly comply with the notice provisions of an agreement fatal to a claim. Suburban Auto Rebuilders, Inc. v. Associated Tile Dealers Warehouse, Inc., 902 N.E.2d 1178 (Ill. App. 3d 2009). Written notice requirements of change orders have been waived by courts when the conduct of the parties indicates their intent to waive such stipulations. See e.g.: Lempera v. Karner, 79 Ill. App. 3d 221 (Ill. App. Ct. 1979).

Regardless of whether or not a court may impose strict notice requirements on a claimant under a construction contract, careful attention should be given to the notice provisions in a construction contract to assure that the notice requirements are reasonable under the circumstances, and will provide adequate notice to all parties involved without causing unnecessary burden to either party.

The A101 and A201 provide good examples of the importance of notice provisions in construction contracts. As noted earlier, the time the contractor is required to commence the contract can be set by a notice to proceed from the owner. This is contemplated by Section 3.1 of the A101. The A201 includes more than 15 different circumstances under which one party must give notice to the other (including, among others, claims for changes in the work), and the timing requirements with respect to such notices vary. As a result, both the contractor and the owner should refer to the contract regularly to ensure compliance with the procedures for making and preserving claims under the contract. Moreover, each party should consider whether it would benefit to add a single page to the contract that laying out all of the notice rules and deadlines in a single place in a straightforward way. This 15 minutes of foresight could save substantial time and money during the course of construction, and could serve to reduce the possibility of litigation.

Limitations on the Owner’s Power to Order Changes

A.  Exceeding the Scope, or Defeating the Purpose, of the Contract

Although the changes clause permits the owner to make unilateral changes – and requires the contractor to perform the modified work – there is a limit to the owner’s power (Valley Construction Co. v. City of Calistoga (1946) 72 Cal.App.2d 839, 842, 165 P.2d 521 [“the right to make alterations in the plans is limited to changes that do not unreasonably alter the character of the work or unduly increase its cost”).   Whether the owner exceeds that permissible limit, is a question of fact (Valley Construction at 72 Cal.App.2d 842-44). By doing so, the owner breaches the contract (Amelco Electric v. City of Thousand Oaks (2002) 27 Cal.4th 228, 238, 38 P.3d 1120, 115 Cal.Rptr.2d 900 [“Under the cardinal change doctrine, the cardinal change ‘constitutes a material breach of the contract.’ [citation]  The contractor may recover breach of contract damages for that additional work.”]).

The permissible limit can be exceeded by an extraordinary increase in the quantity of work (Daugherty v. Kimberly-Clark Corp. (1971) 14 Cal.App.3d 151, 92 Cal.Rptr. 120), by an extraordinary decrease in the quantity of work (Hensler v. City of Los Angeles (1954) 124 Cal.App.2d 71, 268 P.2d 12; Boomer v. Abbett (1953) 121 Cal.App.2d 449,463-65, 263 P.2d 476), or by an extraordinary change in the quality of the work (Coleman Engineering Co. v. North American Aviation, Inc. (1966) 65 Cal.2d 396, 55 Cal.Rptr. 1, 420 P.2d 713 [change in the center of gravity of missile transportation trailers that plaintiff agreed to build]).

Hensler v. City of Los Angeles (1954) 124 Cal.App.2d 71, 268 P.2d 12, involved construction of a runway and taxiways for LAX across a state highway.  The city could not get timely consent from the state to detour the highway, so it deleted the affected work by change order.  Hensler laid concrete around this gap, and sued for his lost profits on the deleted work.  Held (124 Cal.App.2d at 78-80):

There is no question but that … the language of this agreement looks to a complete work of public improvement. …  By the terms of the agreement, plaintiff bound himself to deliver the completed work required of him.  The corollary duty assumed by the city was to permit plaintiff to consummate the work he had undertaken, subject to its right to make changes, within designated limitations, in order to complete the project more satisfactorily.  The deletions ordered by the engineer did not have for their purpose the satisfactory completion of that which both parties set out to accomplish; the fact is that the project was abruptly terminated in an unfinished state, thus leaving the so-called improvement unusable in connection with the existing runways.  Nor were those deletions unnecessary to the project — the court found that defendant completed virtually all the work deleted from plaintiff’s contract through the medium of a new contract with a different company. …

The power vested in the engineer to effect changes in the quantities of the work is not so extensive as to enable him to abrogate or change the contract which the parties executed [citations], nor does it authorize defendant to employ such right to defeat the object of the contract which is reasonably deducible from its terms.  The changes which may be ordered … must clearly be directed either to the achievement of a more satisfactory improvement or the elimination of work not integrally necessary to the project.  The purpose of such powers is to maintain a degree of flexibility in adapting conditions to the end sought.  However, the discretion committed to the engineer must be exercised within the framework of the contract and for the purpose of implementing the work originally intended.  It cannot be used in an arbitrary manner, divorced from the object and intention of the contract, for the purpose of legitimatizing the deletion of so integral a part of the work as to leave the improvement in an unfinished condition and still insulate the city from liability.  [citations]  Such a construction would render nugatory plaintiff’s fundamental rights under the contract and give to defendant an unconscionable advantage plainly not intended. …

In Boomer v. Abbett (1953) 121 Cal.App.2d 449, 263 P.2d 476, the federal government contracted with Abbett to build a 25 mile transmission line in northern California that required about 225 steel towers.  Abbett subcontracted to Boomer the erection of the towers.  The subcontract had a typical flow-down clause incorporating the prime contract into the subcontract.  The government issued a change order deleting one mile in the middle of the transmission line involving 16 towers.  Subcontractor Boomer sued Abbett for its costs of preparing to perform that work and its lost profits on that work.  In reversing a directed verdict against Boomer, the court explained (121 CA2d at 464-65):

We do not believe that the prime contract, as a matter of law, authorized the deletion of the 16 towers without liability except for an “equitable adjustment.”  There can be no doubt that the prime contract contemplated that some towers might be deleted during construction, and that such deletion could be made without liability.  But the contract also contemplated and provided that the transmission line was to be constructed.  It is a contract to construct a transmission line, not to construct about 225 towers.  It is one thing to delete towers found to be unnecessary in the construction of the transmission line.  It is quite another to delete an integral part of the work that results in the transmission line not being constructed.  This 1-mile gap in the transmission line was not bridged until four years after this dispute arose, and then by a wooden pole line. …

Under the cases, if the contract imposes a duty on the government to complete the construction of the structure involved in the contract, a “changes” clause does not authorize the deletion of an integral part of the work.  [citations]  These cases establish the law to be that under a changes clause the government has no power to change the essential nature or main purpose of the contract, but may only make changes incidental to the primary object of the contract.  The change order under such clauses may not essentially alter the project contemplated by the contract.

This construction of such clauses is not only in accordance with their obvious purpose, but is also strongly supported by public policy.  If the government were empowered by such clauses to alter materially the object of the contract, after construction had started, all bidders would have to take such possibility into consideration and materially raise their bids in anticipation of such losses, thus increasing the cost of public works.

Thus the question is, did the deletion of the 16 towers materially alter the fundamental object of the contract, or merely provide for a deletion incidental to the primary object of the contract?  This was a question of fact … that should have been left to the jury.

A change order, or group of change orders, that exceeds the permissible limit may be called a change in the scope of the work or change in the character of the work (Valley Const. Co. v. City of Calistoga (1946) 72 Cal.App.2d 839, 165 P.2d 521) or a “cardinal change” in the contract (Cray Research, Inc. v. Department of Navy (D.C.Dist. 1982) 556 F.Supp. 201).  Exceeding the limit may also be characterized as an “abandonment” of the contract (C. Norman Peterson Co. v. Container Corp. of America (1985) 172 Cal.App.3d 628, 218 Cal.Rptr. 592; Daugherty v. Kimberly-Clark Corp. (1971) 14 Cal.App.3d 151, 92 Cal.Rptr. 120; Opdyke & Butler v. Silver (1952) 111 Cal.App.2d 912, 917-19, 245 P.2d 306; but see Amelco Electric v. City of Thousand Oaks (2002) 27 Cal.4th 228, 115 Cal.Rptr. 2d 900, 38 P.3d 1120, where the majority purports to distinguish “abandonment” from “cardinal change” for purposes of local government contracts only [27 Cal.4th at 236-38], and the dissent explains why the distinction is nonsense which no other jurisdiction in the United States has adopted [27 Cal.4th at 248-253]).

Besides describing changes beyond the permissible limit by different names, the courts have also struggled to define the permissible limit.  It has been described as “what should be regarded as having been fairly and reasonably within the contemplation of the parties when the contract was entered into” (Freund v. U.S. (1922) 260 US 60, 63), or as prohibiting “changes [that] are of great magnitude in relation to the entire contract” (Coleman Engineering Co. v. North American Aviation, Inc. (1966) 65 Cal.2d 396, 406, 55 Cal.Rptr. 1, 420 P.2d 713), or as prohibiting changes “to the essential nature or main purpose of the contract … .  Thus the question is, did the [change] materially alter the fundamental object of the contract, or merely provide for a [change] incidental to the primary object of the contract?” (Boomer v. Abbett (1953) 121 Cal.App.2d 449, 464-65, 263 P.2d 476), or as prohibiting changes in “the character of the work or unduly increase its cost” (Valley Construction Co. v. City of Calistoga (1946)72 Cal.App.2d 839, 842, 165 P.2d 521).

The cardinal change/abandonment theory can be used by a subcontractor against a prime contractor (Sehulster Tunnels/Pre-Con v. Traylor Brothers, Inc./Obayashi Corporation (2003) 111 Cal.App.4th 1328, 1343-46, 4 Cal.Rptr.3d 655 [tunnel for City of San Diego]; Daugherty v. Kimberly-Clark Corp. (1971) 14 Cal.App.3d 151, 92 Cal.Rptr. 120 [private job]; Boomer v. Abbett (1953) 121 Cal.App.2d 449, 263 P.2d 476 [transmission line for federal government]).

The Relationship Between Extra Work and Change Orders

A.  General Rule:  Extra Work Requires a Change Order

Change orders should be issued when the contractor is required to do extra work.  Extra work is labor, services, equipment or materials provided by the contractor that was neither required by the contract nor expected to be included by the parties when the contract was executed (City Street Improvement Company v. Kroh (1910) 158 Cal. 308, 321, 110 Pac. 933 [“Extra work is, of course, work not included in the contract.”], C. F. Bolster Co. v. J. C. Boespflug etc. Co. (1959) 167 Cal.App.2d 143, 151, 334 P.2d 247; Frank T. Hickey, Inc. v. L. A. J. C. Council (1955) 128 Cal.App.2d 676, 683, 276 P.2d 52).

If the owner admits that extra work was required, a change order will be issued.  If the owner refuses to issue a change order, the contractor will usually proceed with the work and pursue a claim for extra work under either a breach of contract theory (Byson v. Los Angeles (1957) 149 Cal.App.2d 469, 473, 308 P.2d 765 [“Plaintiff could comply with the demands of the city [for extra work] and sue for breach of contract.”]) or an implied contract theory (City Street Improvement Company v. Kroh (1910) 158 Cal. 308, 323, 110 Pac. 933 [“In cases where extra work is caused by authorized deviations from a building contract, and no agreement is made regarding the price thereof, or payment therefor, the law implies an agreement by the owner to pay the reasonable value of the extra work. … and for the extra labor, the party is entitled to his quantum meruit.”]; Benson Elec. Co. v. Hale Bros. Assoc., Inc. (1966) 246 Cal.App.2d 686, 697-98, 66 Cal.Rptr. 73; C. F. Bolster Co. v. J. C. Boespflug etc. Co. (1959) 167 Cal.App.2d 143, 151, 334 P.2d 247).

B.  What the Contract Requires the Contractor to Do

Most extra work disputes arise when the contractor reads the plans and specifications differently than they are read by the owner or design professional.  These disputes are usually resolved by the parties doing a careful analysis of the contract documents, applicable reference documents, and customs and practices in the industry.  When the analysis reveals that extra work is required, the contractor is entitled to a change order.  If the dispute goes into arbitration or litigation, expert witnesses often will testify about what the contract documents and reference documents really require, or what the industry customs and practices are in these situations (e.g., Warner Constr. Corp. v. City of Los Angeles (1970) 2 Cal.3d 285, 291-93, 85 Cal.Rptr. 444, 466 P.2d 996).

Sometimes these disputes fall into patterns for which legal doctrines have been developed.  The underlying concept is that a contractor only has to build what the parties actually agreed would be built.  This concept leads to (1) the implied warranty that contract documents are complete and accurate, and (2) what amounts to another implied warranty that information made available to bidders accurately and completely represents the actual nature of the work (a breach of this inchoate warranty is now often described as a non-disclosure of material facts).  The implied warranty that contract documents are accurate and complete focuses upon what the contract documents actually require the contractor to do.  It is breached when the contract documents call for work that cannot be done or will not achieve the purpose of the project; therefore, extra work is required to produce the proper or desired result.  The implied warranty of accurate and complete bid information focuses upon all of the information made available to the contractor for preparation of its bid, not just the contract documents.  It is breached when the owner provides incomplete or inaccurate pre-bid information about job conditions, thereby misleading bidders about the scope or nature of the work, and, as a result, requiring extra work to produce the result anticipated by the owner.

Many situations otherwise falling under these doctrines are now addressed by a changed or differing site conditions clause.  That clause is not discussed here.

1.  Implied Warranty of Complete and Accurate Contract Documents

Both statutes and court decisions require the owner to provide the contractor with complete and accurate contract documents.  Any extra work required to correct deficiencies arising from inadequate plans or specifications must be paid for by the owner as either a breach of the implied warranty that that the contract documents are complete and accurate, or as a breach of a statutory duty to provide such contract documents.

Examples of the California statutes are:  California Government Code section 4004 (“Prior to the commencement of the public work, the engineer [defined to include engineers of the state, a county, a city and any “other district or political subdivision or agency of the state”] shall prepare and file in his office … full, complete and accurate plans and specifications …”), and California Public Contract Code section 1104 (“No local public entity [or] charter city … shall require a bidder to assume responsibility for the completeness and accuracy of … plans and specifications on public works projects, except on clearly designated design-build projects.”), section 10120 (“Before entering into any contract for a project, the department shall prepare full, complete, and accurate plans and specifications and estimates of cost, giving such directions as will enable any competent mechanic or other builder to carry them out.” On this statute see discussion in Welch v. State of California (1983) 139 Cal.App.3d 546, 559, 188 Cal.Rptr. 726), section 10503 (“Before entering into any contract for a project, the Regents of the University of California shall cause to be prepared estimates and either: ¶ (a) Complete plans and specifications setting forth such directions as will enable a competent mechanic or other builder to carry them out. … [or] Documents for the solicitation of bids on a design-and-build basis … [or] for construction manager mode of contracting … [or] on a cost-plus fee mode of contracting … [or] other contracting mode …”), section 10720 (“Before entering into any contract for a project, the trustees … shall cause to be prepared full, complete, and accurate plans and specifications and estimates of cost, giving such directions as will enable any competent mechanic or other builder to carry them out.”), sections 20124, 20391 and 20404 for counties, their highways, bridges and subways, section 20621 for county drainage  districts, section 20192 for municipal utility districts, section 20201 for public utility districts, and section 22039 for agencies that have joined the uniform construction cost accounting program.

The court case usually cited as the source for the owner’s implied warranty that the contract documents are complete and accurate is U.S. v. Spearin (1918) 248 U.S. 132, 63 L.Ed. 166, 39 S.Ct. 59.  The court held (at 248 U.S. 137-38):

[I]f the contractor is bound to build according to plans and specifications prepared by the owner, the contractor will not be responsible for the consequences of defects in the plans and specifications.  This responsibility of the owner is not overcome by the usual clauses requiring builders to visit the site, to check the plans, and to inform themselves of the requirements of the work … [¶]  “[T]he insertion of the articles prescribing the character, dimensions and location of the sewer imported a warranty that, if the specifications were complied with, the sewer would be adequate. … [¶] …  The breach of warranty … [made the Government] liable for all damages resulting from its breach.

California cases also find such an implied warranty in contract documents.  The seminal California case is probably Souza & McCue Construction, Co., Inc. v. Superior Court  (1962) 57 Cal.2d 508, 20 Cal.Rptr. 634, 370 P.2d 338.  There the contractor was allowed to amend its cross-complaint to allege that the city had concealed its breach of the warranty.  The court held (at 57 Cal. 2d 510-11):

A contractor of public works who, acting reasonably, is misled by incorrect plans and specifications issued by the public authorities as the basis for bids and who, as a result, submits a bid which is lower than he would have otherwise made may recover in a contract action for extra work or expenses necessitated by the conditions being other than as represented.  [citations]  This rule is mainly based on the theory that the furnishing of misleading plans and specifications by the public body constitutes a breach of an implied warranty of their correctness.  [citations]  The fact that a breach is fraudulent does not make the rule inapplicable.  [citations].

In Macomber v. State of California (1967) 250 Cal.App.2d 391, 58 Cal.Rptr. 393 the plans failed to accurately show the existing conditions into which a new spiral staircase had to fit.  The court observed (at 250 Cal.App.2d 397):

The State does not question the general rule that a contractor who, acting reasonably, is misled by incorrect plans and specifications and who, as a result, submits a bid which is lower than he would otherwise have made, may recover in a contract action for extra work necessitated because of the incorrect plans and specifications.  [citations]  Also, the State concedes that its plans and specifications were incorrect.

In Tonkin Construction Co. v County of Humboldt (1987) 188 Cal.App.3d 828, 233 Cal.Rptr. 587, the contract required work on a seawall to be completed within 40 working days of the notice to proceed, or the contractor would be assessed liquidated damages.  That work could not be performed without a dredge that was under contract with the Corps of Engineers.  The contract informed Tonkin that it had to coordinate scheduling with the Corps.  Despite all of Tonkin’s coordination efforts, the dredge did not timely arrive.  Tonkin recovered its extra work and standby costs.  Held at 188 Cal.App.3d 832:

Clearly an implied term of the contract herein was that once the notice to proceed was issued, the dredge would be available for work on the project.  The apparent intention of the parties was completion of the seawall within 40 working days of the issuance of the notice to proceed. …  This intention of prompt completion of the seawall could not have been effectuated absent an implied term that the County would insure the dredge’s availability for work on the project. …

Tonkin, acting as a reasonable public works contractor, was misled by this incorrect implied representation in its submission of a bid.  Tonkin justifiably relied on this representation in determining the cost of constructing the seawall.  Accordingly, it did not include in its bid the cost of maintaining the seawall for an indefinite period of time while awaiting the arrival of the dredge.  As the County impliedly warranted the correctness of these representations, it is liable for the cost of extra work which was necessitated by the dredge’s failure to arrive.

2.  Corollary to Implied Warranty of Complete and Accurate Contract Documents

A corollary to the implied warranty that the contract documents are complete and accurate is the absence of any duty of the contractor to correct defects in the contract documents by building something other than what the contract documents prescribe.  In Kurland v. United Pacific Insurance Company (1967) 251 Cal.App.2d 112, 59 Cal.Rptr. 258, the subcontract called for the air conditioning system to cool the building 30 degrees below the outside temperature.  However, the subcontractor did not design the system, and the subcontract required the system to be built according to plans and specifications provided by the owner.  The specified system was inadequately designed, and could not achieve the 30-degree temperature reduction.  The subcontractor refused to perform extra work to make the system achieve that goal.  The owner and prime contractor sued the subcontractor’s performance bond surety for the cost of that extra work.  They lost.  Held at 251 Cal.App.2d 117-19:

Our conclusion is that the subcontractor did not warrant or guarantee that the system embodied in the architect’s plans and specifications would produce the desired variation from outside temperature for the cooling of the apartment building.

Since the plans and specifications were prepared by the owners’ architect and not by the subcontractor, and since the subcontractor undertook to do the work in accordance with his specific proposal, we cannot reasonably conclude that the subcontractor assumed responsibility for the adequacy of the plans and specifications to meet the purpose of achieving “a 30 degree variation from outside temperature for cooling.”  The language upon which the plaintiff relies constituted a statement of the purpose sought to be achieved by means of the owners’ plans and specifications rather than an undertaking on the part of the subcontractor of responsibility for the adequacy of such plans and specifications as the design of a system capable of producing the desired result.

In the light of the reasoning which has been heretofore set forth in this opinion, we construe the “guarantee” as being an undertaking on the part of the subcontractor not that the system as designed was adequate to produce the results desired by the owners but that the subcontractor’s work pursuant to the plans and specifications would be done as effectively as possible to achieve those desired results.  Because of the defects in the design to which the subcontractor had to adhere, that goal could not be reached.  It would not be reasonable to construe the language of “guarantee” as being sufficiently broad to constitute a basis for a transfer to the subcontractor of responsibility for defective plans and specifications procured by the owners.

In Sunbeam Construction Co. v. Fisci (1969) 2 Cal.App.3d 181, 184, 82 Cal.Rptr. 446, the owner sought the cost to fix a leaking roof.  The court explained the owner’s argument (at 2 Cal.App.3d 184):

[The owner] concedes that the roof was constructed in a good and workmanlike manner and in exact conformance to the plans and specifications furnished by [the owner], which did not call for a pitch, slope or crown.  [The owner’s] sole contention is that a contractor is liable under an implied warranty for leaking of a roof covering where drainage of water is not provided by it, even though the contractor complies with the plans and specifications furnished which do not provide for drainage.

The court rejected the owner’s argument and affirmed a summary judgment in favor of the contractor.

Thus, when the contract documents tell the contractor what to do, but fail to adequately describe the work or conditions required to achieve the anticipated result, the contractor cannot be compelled to perform extra work to achieve that result without getting a change order for the extra work, or without compensation for the extra work if the contractor proceeds without a change order.

3.       Implied Warranty of Accurate and Complete Bidding Information

(Non-disclosure of Material Facts)

Turning to the implied warranty that bidding information is accurate and complete, the court case usually cited as the source of that warranty is Hollerbach v. U.S. (1914) 233 U.S. 165, 58 L.Ed. 898, 34 S.Ct. 553.  The contract was for repair of a dam; the existing conditions were misrepresented in the bidding documents.  The court held (at 233 U.S. 172):

[T]he specifications spoke with certainty as to a part of the conditions to be encountered by the claimants. …  this positive statement of the specifications must be taken as true and binding upon the Government … [U]pon it rather than upon the claimants must fall the loss resulting from such mistaken representations. …

The seminal California case is probably Gogo v. Los Angeles County Flood Control District (1941) 45 Cal.App.2d 334, 114 P.2d 65.  The contract required excavation of rock for a dam.  The agency represented both orally and in bidding documents that ongoing quarry operations would reduce the rock grade to a certain elevation.  It did not.  When the contractor came onto the job site, it had to remove over twice the estimated 52,000 cubic yards of rock.  Held (at 45 Cal.App.2d 341-42):

It may be stated generally that where the plans and specifications induce a public contractor reasonably to believe that certain indicated conditions actually exist and may be relied upon in submitting a bid, he is entitled to recover the value of such extra work as was necessitated by the conditions being other than as represented. [citations, including Hollerbach]   The facts of the instant case bring it within the foregoing rule.

The authorities are divided concerning the theory upon which recovery is allowed in this type of case. …  [T]he correct basis of recovery is on the theory that the action is one to recover damages for the misrepresentation by which the contract was induced.  (Hollerbach v. United States [233 U.S. 165, 34 S.Ct. 553, 58 L.Ed. 898] …)  It would be inequitable to permit defendant to enforce the literal terms of the contract which called for the excavation of “all materials” necessary to complete the job when plaintiffs were induced by defendant’s misrepresentation to submit a bid which was much lower than was warranted by the true facts.  If instead of stating in the specifications that West Slope Construction Company would excavate to rough grade, defendant had stated the true facts of which it had knowledge–that West Slope Construction Company was obligated by contract to excavate no lower than five feet above grade–the present situation would not have arisen.  Having failed to impart this knowledge to plaintiffs and having willfully or carelessly misrepresented the true situation, defendant is obligated to plaintiffs for the additional work occasioned.

The warranty of accurate and complete bidding information extends to subcontractors.  In Coleman Engineering Co. v. North American Aviation, Inc. (1966) 65 Cal.2d 396, 55 Cal.Rptr. 1, 420 P.2d 713, North American provided bidding documents to Coleman describing trailers North American needed to transport missiles it was building for the federal government.  Those documents indicated that the trailers’ center of gravity was different than North American actually wanted.  Coleman’s bid was based upon the information provided, so it refused to proceed with the revised center of gravity without a substantial price adjustment.  North American terminated the contract.  Coleman sued for its costs trying to perform; North American cross-claimed for the difference between Coleman’s bid and the cost to have another firm build the trailers.  Held (at 65 Cal.2d 404):

A contractor who, acting reasonably, is misled by incorrect plans and specifications issued by another contracting party as the basis for bids and who, as a result, submits a bid which is lower than he would otherwise have made may recover in a contract action for extra work necessitated by the incorrect plans and specifications.

In Warner Constr. Corp. v. City of Los Angeles (1970) 2 Cal.3d 285, 294, 85 Cal.Rptr. 444, 466 P.2d 996, the court describes a breach of the implied warranty that bidding information is accurate and complete as a cause of action for non-disclosure of material facts:

In transactions which do not involve fiduciary or confidential relations, a cause of action for non-disclosure of material facts may arise in at least three instances: (1) the defendant makes representations but does not disclose facts which materially qualify the facts disclosed, or which render his disclosure likely to mislead, (2) the facts are known or accessible only to defendant, and defendant knows they are not known to or reasonably discoverable by the plaintiff;  (3) the defendant actively conceals discovery from the plaintiff. [footnotes omitted]

Thus, the elements of a cause of action for breach of the implied warranty that bidding information is accurate and complete – or for non-disclosure of material facts – are: (1) information that was made available to the bidders contained material facts about the project, and (2) the contractor relied upon that information in preparing its bid, but (3) that information failed to disclose other material facts (a) that the owner concealed from the contractor, or (b) that the owner knew were not reasonably discoverable by the contractor, or (c) that significantly qualified the facts which were disclosed, or (d) that made the facts disclosed likely to mislead the bidder, and (4) as a result of its reliance, the contractor’s bid did not cover all of the work which was required.

Subsequent California cases follow the Warner formulation.  In Welch v. State of California (1983) 139 Cal.App.3d 546, 188 Cal.Rptr. 726, the contract for repair of a bridge fender required work by divers.  The contract documents provided misinformation about the tides and current under the bridge.  Caltrans had recently repaired a nearby fender on the same bridge, had relied upon information from that project to design the one in this case, but failed to disclose any information about that project in the bidding documents for this project.  Strong currents interfered with diving, and high tides forced a change in construction methods from pouring concrete in place to precasting in sections.  Welch sued for the increased costs.  Held (at 139 Cal.App.3d 558):

The undisclosed information doubtless would have qualified or cast doubt upon any false impression of favorable tide conditions given by the tide data in the general note.  The failure to disclose such information compounded the effect of misleading half-truths in the general note.

Therefore, Welch had a cause of action for nondisclosure.

In Howard Contracting Inc. v. G. A. MacDonald Construction Co., Inc. (1998) 71 Cal.App.4th 38, 83 Cal.Rptr.2d 590, the contractor recovered damages for nondisclosure, because the agency failed to disclose construction constraints which it knew would be contained in permits that were not issued until after bid day.

4.  Determining Whether a Misrepresentation or Nondisclosure Occurred

When the contractor asserts a breach of the implied warranty of complete and accurate contract documents, the court will search the contract documents for an actual statement by the owner that misled the contractor.  When the court cannot find one, the contractor loses.  In Wunderlich v. State of California (1967) 65 Cal.2d 777, 784-785, 56 Cal.Rptr. 473, 423 P.2d 545, the Caltrans contract documents told bidders that “samples” taken from potential borrow sites “indicated” material of “satisfactory quality” for base, gravel blanket and mineral aggregate.  Caltrans offered access to its test results from those sites.  For the borrow site Wunderlich ultimately decided to use, an internal Caltrans memo, which was shown to Wunderlich’s estimator before bid time, reported tests showing 55% to 88% of the material passing a No. 4 sieve (material passing this sieve is sand, material not passing is gravel).  Wunderlich assumed from this information that the borrow site would yield the median amount of gravel (about 30%).  Wunderlich found much less gravel, and complained to Caltrans.  Caltrans performed new tests, which were consistent with the pre-bid tests.  Wunderlich sued claiming that Caltrans had warranted the quantity of gravel in the selected borrow pit.  The court rejected that argument (at 65 Cal.2d 783-85):

The Special Provisions state simply that samples had been taken from the pit, and that they appeared to point to the fact that there was suitable material in the pit.  There was no representation as to quantities in the source, or that a consistent proportion of materials would be found throughout the source. … [T]he memorandum … does not purport to disclose the average of overall condition of the Wilder pit.  It purports to explain, rather, that the pit was composed of sand and gravel, and expressly states that “some test holes encountered considerable coarse material, while others were practically all sand.”  It forewarns bidders that there might be more sand than anticipated …  Although the memorandum accurately reported the fact that borings results ranged from 55 percent to 88 percent sand, this would hardly seem to warrant the conclusion that the pit would average the median of that range, as claimed by plaintiffs. …

There is no positive representation as to the material content of the Wilder pit.  The state did little more than report the results of its testing. … and the plaintiffs were given or had access to the identical, accurate information that was available to the state.

What plaintiffs argue, in effect, is that by the presentation of its borings and tests, though accurately reported, the state assumes liability for the contractor’s erroneous assumption in bidding that the pit would average approximately a fixed percentage of gravel. …

In the instant case … [a]ll the information the State had concerning the soil conditions was available to claimant and claimant had been invited to make an investigation of its own.  Under these circumstances, the State is not chargeable for claimant’s loss. …

When the contractor asserts a nondisclosure of material facts, the court will search for an impact on the contractor’s bid from information that was withheld or from half-truths in the bidding information.  When it cannot find any, the contractor loses.  In Wiechman Engineers v. State of California (1973) 31 Cal.App.3d 741, 107 Cal.Rptr. 529, the contract documents offered access to soil borings which showed substantial subsurface boulders, and Weichman’s estimator’s own site visit revealed many boulders on the surface.  When the boulders Weichman encountered made construction of the road much more difficult and time consuming, Weichman sued for nondisclosure of the boulder information Caltrans had.  The court rejected Weichman’s argument, holding (at 31 Cal.App.3d 752-53):

Here, there was no representation of any kind as to subsurface conditions.  Absent such a representation, there was no disclosed fact which was likely to mislead plaintiff.

Secondly, knowledge of the boulderous condition was not known or accessible only to the state, nor did the state have such facts as were not known or reasonably discoverable by plaintiff, if plaintiff had made what would have been admittedly a reasonable and prudent inquiry.

As previously pointed, out, section 5-1.05 of the Special Provisions of the contract provided in part: “Where such investigations [of subsurface conditions in areas where work is to be performed] have been made, bidders or Contractors may, upon written request, inspect the records of the Department as to such investigations . . . .”

Nothing in this language in any way limited accessibility or precluded plaintiff from obtaining all information available if it desired to inquire.  Thus, there was no concealment of the boulderous condition on the job site or the test hole surveys.  The record clearly shows actual visibility of boulders in the job area, a fact readily apparent and known to plaintiff before the bid was submitted, as evidenced by Barkley’s detailed testimony.

Finally, Barkley, the very person entrusted with the responsibility to investigate and prepare the contractor’s bid, not only assumed the state had test information as to the road subsurface, but testified he simply decided not to inquire about the same, fully mindful of the fact that the movement of rocks and boulders necessarily would be involved in the performance of the contract.  We observe that had plaintiff elected to examine the available test hole surveys, it merely would have confirmed what onsite observations disclosed; namely, that the work of construction was to be undertaken in a boulderous area and the degree and nature of the condition would be something to consider when submitting a bid.  Plaintiff elected to make its decision in this regard based on its own expertise in performing the work and its own judgment that further inquiry as to subsoil conditions was not required.

A public entity is not liable for an imprudent or careless investigation on the part of a contractor. …

See also Jasper Construction, Inc. v. Foothill Jr. College Dist. of Santa Clara County  (1979) 91 Cal.App.3d 1, 153 Cal.Rptr. 767.

5.       Effect of Disclaimers

Since commercial contracts seek protection against the unknown, it is not surprising that owners (both public and private) have long sought to insulate themselves from the mysteries that lie beneath or within the subject work area.  Federal agencies first recognized the unfairness caused by this reasoning.  Contractors were expected to be able to predict the conditions and applicable costs of performing work, while being unable to seek additional compensation from the government if the contractor’s “crystal ball” wasn’t accurate on a particular occasion.  Government information was not mandatory, which left the contractor in a position to assume all risks involved.

Federal contract clauses attempt to balance the risk between the parties.  Private contracts, however, do not necessarily possess the uniformity of provisions found in all federal contracts.  Courts interpreting private contracts have demonstrated little uniformity in their decisions as to the effectiveness of exculpatory language vis-a-vis changed conditions.  One reason for this is the vast variety of types of general conditions to be found in private contracts.  Changed condition clauses range from the very explicit to nonexistent, and exculpatory provisions may be generously added.

Differing site claims interpreted under state laws clearly illustrate the principle that each case stands on its own facts, based on various states’ interpretations. Case law precedent becomes less compelling given the different circumstances that may arise from one contract to the next.  Not only will the facts giving rise to the claim always differ, but the provisions upon which the claims (or defenses to the claims) are based may vary by only as much as a phrase and still affect the outcome.

The courts refuse to allow general disclaimers to overcome either of the implied warranties.  In U. S. v. Spearin (1918) 248 US 132, 137, 63 L.Ed 166, 39 S.Ct 59, the court held that the implied warranty that the contract documents are complete and accurate is not overcome by the general clauses requiring the contractor, to examine the site, to check up the plans, and to assume responsibility for the work until completion and acceptance.  The obligation to examine the site did not impose upon him the duty of making a diligent enquiry into the history of the locality with a view to determining, at his peril, whether the sewer specifically prescribed by the Government would prove adequate.  The duty to check plans did not impose the obligation to pass upon their adequacy to accomplish the purpose in view.  And the provision concerning contractor’s responsibility cannot be construed as abridging rights arising under specific provisions of the contract.  [¶]  Neither § 3744 of the Revised Statutes, which provides that contracts of the Navy Department shall be reduced to writing, nor the parol evidence rule, precludes reliance upon a warranty implied by law.  [footnotes omitted]

In Hollerbach v. U.S. (1914) 233 U.S. 165, 58 L.Ed. 898, 34 S.Ct. 553, paragraph 20 of the specifications declared that:

quantities given are approximate only, and that no claim shall be made … on account of any excess or deficiency …  Bidders … are expected … to visit the locality of the work, and to make their own estimates of the facilities and difficulties attending the execution of the proposed contract, including local conditions, uncertainty of weather, and all other contingencies.

And, specifications paragraph 70 required each bidder to “visit the site … and ascertain the nature of the work … and obtain the information necessary to enable him to make an intelligent proposal.”  Nonetheless, the court rejected the argument that these clauses insulated the owner from its positive misrepresentations of job site conditions in other clauses, holding (at 233 U.S. 172):

[I]t would be going quite too far to interpret the general language of the other paragraphs as requiring independent investigation of facts which the specifications furnished by the Government as a basis of the contract left in no doubt.  If the Government wished to leave the matter open to the independent investigation of the claimants it might easily have omitted the specification as to the character of the filling back of the dam.  In its positive assertion of the nature of this much of the work it made a representation upon which the claimants had a right to rely without an investigation to prove its falsity.

California courts follow the same rules.  In E. H. Morrill Company v. State of California (1967) 65 Cal.2d 787, 789-90, 423 P.2d 551, 56 Cal.Rptr. 479, the contract stated, “Boulders … vary in size from one foot to four feet in diameter.  The dispersion of boulders varies from approximately six feet to twelve feet in all directions, including the vertical.”  However, the boulders found were substantially larger and more concentrated.  Held (at 65 Cal.2d 791-93):

[T]he complaint states a cause of action for recovery on a theory of breach of implied warranty …

The responsibility of a governmental agency for positive representations it is deemed to have made through defective plans and specifications “is not overcome by the general clauses requiring the contractor, to examine the site, to check up the plans, and to assume responsibility for the work. …” (United States v. Spearin, 248 U.S. 132, 137 [63 L.Ed. 166, 39 S.Ct. 59].)  Accordingly, the language in section 4 requiring the bidder to “satisfy himself as to the character . . . of surface and subsurface materials or obstacles to be encountered” cannot be relied upon to overcome those representations as to materials and obstacles which the state positively affirms in section 1A-12 not to exist, and plaintiff was entitled to rely and act thereon.

Even when the disclaimers are more specific, California courts are inclined to read them narrowly to preserve a contractor’s implied warranty claim.  In Warner Constr. Corp. v. City of Los Angeles (1970) 2 Cal.3d 285, 85 Cal.Rptr. 444, 466 P.2d 996, the test-hole logs had a warning:

The test-hole information on these plans shows conditions found only at the date and location indicated.  Bidders are cautioned that the city in no way warrants that such information is representative of conditions at any other location, or at any other time.  Groundwater levels, particularly, are subject to change.

City argued that this warning disclaimed the warranty, but the court held (at 2 Cal.3d 292):

[W]e find, on closer examination, that the warranty and the disclaimer pass each other without collision.  The warranty describes the subsurface conditions at the test holes, but says nothing about conditions elsewhere on the site.  The disclaimer states that “the test-hole information … shows conditions found only at the date and location indicated,” and cautions bidders that the city does not warrant that the data is representative of other locations, but it in no way disclaims the accuracy of the test-hole logs.  Reading the two together, we conclude that the bidder takes the risk in making deductions from accurate test data, but the city retains responsibility for any inaccuracy in the data.  [footnotes omitted]

Welch v. State of California (1983) 139 Cal.App.3d 546, 551, 188 Cal.Rptr. 726, holds:

Although the contract between Caltrans and Welch contains a provision requiring on-site inspection by contractors as well as other general disclaimers of warranty, it does not absolve the State from responsibility for positive and material misrepresentations contained in the plans and upon which a contractor had a right to rely.  [citations]  There is no provision in the contract specifically disclaiming any responsibility on the part of the State for the accuracy of the tide data contained in the general note.

In Tonkin Construction Co. v County of Humboldt (1987) 188 Cal.App.3d 828,233 Cal.Rptr. 587, the county argued that the contractual requirement that Tonkin coordinate scheduling with the Corps of Engineers constituted a disclaimer as to the exact time of the dredge’s arrival.  Held (at 188 Cal.App.3d 833-34):

[T]he facts of the instant case do not reveal an explicit disclaimer with respect to the County’s implied representation of the dredge’s availability.  Absent a contract provision specifically disclaiming responsibility on the part of the public body for the accuracy of the contested information, general disclaimers of warranty will not absolve the public body from responsibility for positive and material misrepresentations contained in the plans and upon which a contractor had a right to rely.

However, when the disclaimer is precise and is contained in the same contract clause as the representation on which the breach of warranty claim is based, the disclaimer may be enforced.  In Wunderlich v. State of California (1967) 65 Cal.2d 777, 56 Cal.Rptr. 473, 423 P.2d 545, the court held that there was no representation concerning the quantity of gravel Wunderlich could expect in the borrow site.  The court also pointed out (at 65 Cal.2d 785-86):

[A]ny representation as to the quantity of materials in any of the sources described by the state was explicitly and clearly disclaimed by an express provision of the Special Provisions.  At the outset of the same paragraph in which the representation is found, the bidders are referred to section 6 of the Standard Specifications.  That section provides expressly that when sources of material are designated, the contractor shall satisfy himself as to the quantity of acceptable material which may be produced at the source, and disclaims state responsibility for the quantity of acceptable material.  Hollerbach [v. U.S. (1914) 233 U.S. 165, 58 L.Ed. 898, 34 S.Ct. 553] and the other cases relied upon by plaintiffs to establish liability of the state do not stand for the proposition that the government may never effectively disclaim the intention to warrant conditions.  In the Hollerbach cases there was no specific disclaimer [citation], just as there was no indication to bidders of the basis upon which the statement had been made.  In the instant case, however, the very paragraphs containing the alleged warranty contain direct references to disclaimer paragraphs and to a specific disclaimer of the attributes of the source allegedly warranted.

Given this background, no hard and fast rules can be given regarding disclaimers and their effect on changed condition clauses. The following cases demonstrate why this is true:

A contractor was required to dredge to a minimum depth of 38 feet in a designated area.  Boring logs included in the bidding documents specified sand, silt and limestone fragments.  However, solid, heavy rock was encountered when dredging began.  The owner denied the contractor’s DSC claim on the basis that, among other things, the boring information only represented a general indication of the materials likely to be found adjacent to the boring holes.  The court found that the boring information which was furnished was misleading since it did not, in fact, give a general indication of the materials likely to be found.  Cruz Construction Co., Inc. v. Lancaster Area Sewer Authority, 439 F. Supp. 1202 (E.D. Pa. 1987).

While constructing an irrigation pumping system, the contractor encountered conditions materially different from those indicated in the plans and brought suit for its additional costs under the DSC clause in the contract (identical to the federal DSC clause).  The owner (State of Montana) contended that exculpatory language in the contract required that the contractor make an affirmative effort to inquire about discrepancies in the plans.  The Court held that the exculpatory clauses relied on by the State did not waive, eliminate or modify the contractor’s right to rely on the representations made in the plans; nor did they eliminate its right to rely on the DSC clause.  Stock & Grove, Inc. v. United States, 493 F.2d 629 (Ct. Cl. 1974).

A contractor was denied recovery of extra costs paid to its excavation subcontractor for the removal of a substantial quantity of unanticipated rock, because, among other things, (1) the test boring data made available to bidders by the owner was specifically excluded from the contract, and (2) the data was obtained only upon the contractor’ s unqualified release of the owner from any liability.  Thus, the contractor was not justified in relying on the boring data. (The contract did not contain a “Changed Conditions” clause.) Sornsin Construction Co. v. Montana, 180 Mont. 248, 590 P.2d 125 (1978).

C.       What the Contract Requires the Owner to Do

Besides prescribing the work that the contractor must do, the contract also assures that the contractor will be allowed to proceed with that work.

1.  Site Access and No Interference

Except as specifically allowed by the terms of the contract, the owner cannot interfere with the contractor’s performance of the work; to the contrary, the owner must facilitate the contractor’s performance.  Acts or omissions of the owner, beyond what the contract permits, can disrupt the contractor’s orderly performance of the work, delay performance of some work, or require the performance of some work to be accelerated.  Extra work is often the result.  For that extra work, the contractor is entitled to a change order (Civil Code sections 1655, 1656).  This concept was explained in Gray v. Bekins (1921) 186 Cal. 389, 395, 199 Pac. 767:

In every building contract which contains no express covenants on the subjects there are implied covenants to the effect that the contractor shall be permitted to proceed with the construction of the building in accordance with the other terms of the contract without interference by the owner and that he shall be given such possession of the premises as will enable him to adequately carry on the construction and complete the work agreed upon. Such terms are necessarily implied from the very nature of the contract and a failure to observe them not consented to by the contractor constitutes a breach of contract on the part of the owner entitling the contractor to rescind, although it may not amount to a technical prevention of performance.

This rule has been regularly reiterated in various contexts:  Lapp-Gifford Company v. Muscoy Water Company (1913) 166 Cal. 25, 30, 134 Pac. 989 (“Appellant having contracted for the construction of a pipe-line over a fixed and determined route, the law implies a covenant either that it possesses or will procure a right to construct such pipe-line over the route specified.”); Bomberger v. McKelvey (1950) 35 Cal.2d 607, 613, 220 P.2d 729 (“[The contract contained] an implied covenant that plaintiffs would be given possession of the premises for the agreed purpose at a reasonable time to be chosen by them. … Defendants’ conduct in forbidding plaintiffs to enter, therefore, was sufficient not only to excuse their performance but also to constitute a breach or anticipatory breach of the contract.”); COAC, Inc. v. Kennedy Engineers (1977) 67 Cal.App.3d 916, 920, 136 Cal.Rptr 890 (“District owed appellant a legal duty not to hinder, delay, interfere with or prevent his performance. …  where plans, specifications and conditions of contract do not otherwise provide, there is an implied covenant that the owner of the project is required to furnish whatever easements, permits or other documentation are reasonably required for the construction to proceed in an orderly manner.”); Howard Contracting Inc. v. G. A. MacDonald Construction Co., Inc. (1998) 71 Cal.App.4th 38, 50, 83 Cal.Rptr. 2d 590 (“The rule is well settled that in every construction contract the law implies a covenant that the owner will provide the contractor timely access to the project site to facilitate performance of work.  When necessary permits relating to the project are not available or access to the site is limited by the owner, the implied covenant is breached.”).

ADJACENT PROPERTIES

The latent characteristics of properties adjacent to a construction site may not be fully apparent during the contractor’s pre-bid site investigation. If the owner is aware of possible adverse conditions involving adjacent properties, such conditions should be included in the bid documents. On the other hand, even the owner and designers might not be aware of and/or might not have considered the adjacent property’s potentially adverse effects on construction. Conditions that can potentially cause schedule delays and additional costs may include:

A seasonal watercourse that drains precipitation into excavations

Heavy vehicle traffic that restricts or delays perimeter site mobility and access

Concurrent construction excavation activity that causes unanticipated delays and effects

These kinds of conditions can be difficult to recognize before they begin to affect the work. Accordingly, once they appear, the contractor is advised to attempt to quantify them and notify the owner.

BUILDING CODE COMPLIANCE

The architect and its sub consultants are most often responsible for ensuring that the design meets the requirements of all entities having jurisdiction over the project. Whether it is ceiling headroom, provisions for the handicapped, the number of exits or handrail configurations, engineering and design are the responsibility of the design professionals. Conversely, contractors are most often only responsible for construction means and methods and performing the work per the requirements of the contract documents.

The initial indications of a designer’s failure to meet building code requirements will often come from a contractor’s construction experience, as opposed to design experience. For example, a flashing or exterior finish insulation system (EFIS) detail may be shown completely different from the way the contractor has always seen it in the past. Once an apparent building code violation has been observed, the process may or may not proceed in a straightforward manner, depending upon the owner’s and architect’s responses

BUILDING PERMIT PLAN APPROVALS

Permit plan approval is similar to building code compliance in that it is the designer’s responsibility to incorporate all building code requirements into the documents and satisfy the local building department. The process of applying for and securing the building permit should be little more than the clerical formality of delivering the plans, specifications, and fee to the building department. If schedule delays are experienced because the building department discovers a design error or flaw, that schedule delay typically belongs to the owner and/or the designer. A more common problem is having the permit granted but conditioned on some additional modification to the design. This may not delay the job start, but could result in additional work and costs.

The contractor should not wait until it is moving onto the site to pick up the building permit. It is advisable to file the documents and permit application immediately upon contract award. If a problem is encountered and the permit is likely to be delayed, the contractor should confirm with the responsible building department representative that mobilization and temporary office setup can proceed, pending correction of the design. Before leaving the building department, the contractor might even establish with the building inspector the fastest way to communicate with all interested parties that the changes will need to be incorporated into the design.

EASEMENTS AND RIGHTS OF WAY

The contractor’s access to the site should be clearly identified in the contract. If adequate site access is apparent, the contractor should proceed. Potential change orders usually involve a partial or total restriction of site access. If the contractor can demonstrate that the restrictions are contrary to that which could reasonably have been anticipated at the time of bid, compensation may be justified. To anticipate and avoid such problems, the contractor should review the contract documents looking for potential restrictions to access and for items such as easements, parking, traffic patterns, and businesses at the immediate perimeter of the contract limit lines. If an easement exists, the contractor should request a complete description from the owner of all conditions of the easement. In most cases, site access interferences occur with little or no warning. The first indication might be when job cost reports indicate that job productivity and efficiency have been impacted.

SOIL BORINGS AND SUBSURFACE DATA

Geotechnical and soil boring data provide the contractor with information regarding subsurface characteristics of the site. Contractors should review and develop an understanding of geotechnical data to gain insight into how such data will affect construction. From these data, the contractor can begin the process of assessing the relative ease or difficulty of working at a site. For example, a high percentage of fine particles and low moisture content suggest that construction vehicle traffic may cause surface problems. Water and fine particles could rise to the surface and make the work areas impassable or difficult to access. Under these circumstances, the contractor may need to construct and maintain a temporary road of gravel or crushed stone throughout the construction period.

Considerations related to soil boring locations include:

Relevance to the construction areas - If the geotechnical engineer provides boring data only around the perimeter of the site, the soil conditions in the middle of the site present only some uncertainty. If the boring locations within the building footprint are asymmetrical, they could fail to disclose the existence of subsurface rock.

Water consistency throughout the site - The contractor may have prepared his bid based on a geotechnical report that used few boring points relative to the size of the site. The contractor should review boring data and soil characteristic information and look for inconsistencies in the depths of the borings, erratic boring locations, and the relationship between boring locations and construction areas. In addition, the contractor should analyze water table information and consider where the table will be in dry and wet seasons. When the contractor encounters undisclosed subsurface conditions that are inconsistent with the geotechnical and boring data, the contractor may have a basis to seek additional compensation.

INTERFERENCE FROM UTILITIES

The locations of pre-existing utilities such as storm and sanitary sewer, telephone, power, and water on a site are normally indicated on the plans. This information is typically made available to, the designer(s) by the respective utility companies. Incorrect information often comes from two sources:

errors in the respective utility companies’ recordation or transmittal of as-built information, and

errors on the plans.

A contractor is free to plan activities, locate temporary facilities, stockpile materials, and sequence the work around or between the utilities as required. However, before any excavation is performed, there is usually some entity to contact to reconfirm the exact locations of the utilities. As a precautionary measure, the contractor should endeavor to confirm that the information is consistent with the information on file with the respective utility and that the information has not changed since the information was originally provided to the designer.

The contractor can assume significant risk if it begins work in the vicinity of a utility without verifying its most current status with the respective authority. If damage is done to the utility under these circumstances, the responsibility may rest with the contractor. On the other hand, if the verification process reveals changed information regarding the utility, adversely affecting the work, this clearly justifies a change order.

TEMPORARY UTILITIES

The contractor’s estimator will typically make sure that temporary utilities have been accommodated in the bid estimate. Therefore, unless some qualification was included in the original agreement, the absence of temporary power and other utilities at the site will typically be difficult for the owner to accept as a changed condition. The rare cases where extra costs for temporary utilities become justified often go back to changed conditions between the time the project was bid and the time that the work actually begins at the site. If it can be demonstrated that the conditions observed at the time of bid with respect to temporary utilities were materially different from those when work begins, the contractor may be justified in requesting compensation for additional actual costs.

2.  Third Party Cooperation

Another ramification of the contractor’s right to perform the work is the owner’s duty to obtain third party consent or cooperation necessary to perform the contract.  If the owner fails to do so, regardless of the reason for the failure, the contractor is entitled to a change order for any extra work or delay arising from the third party’s failure to consent or cooperate (Klauber v. San Diego St. Car Co. (1892) 95 Cal. 353, 30 Pac. 555; Hensler v. City of Los Angeles (1954) 124 Cal.App.2d 71, 268 P.2d 12).  Note, however, that the owner’s duty can be altered by the contract.  By the terms of the contract, the contractor may become responsible for obtaining necessary third party consent or cooperation, e.g., pulling building permits.

V.  Contract Clauses Designed to Defeat Extra Work Claims

Owners, design professionals, and other consultants to owners, have created dozens of contract clauses that are designed to control and prevent extra work claims.  Courts will first look closely at the specific language of these clauses in the context of the contract to determine what they require.  Often that is different from what the owner or contractor contends.  Some of the typical clauses and how the courts have interpreted them are discussed below.

A.  Written Change Order Required for Extra Work

Many contracts require a written change order before the contractor performs any extra work, and declare that the failure to  get one is a bar to, or waiver of, all claims for the extra work.  In Acoustics, Inc. v. Trepte Constr. Co. (1971) 14 Cal.App.3d 887, 92 Cal.Rptr. 723, section 29 of the contract General Conditions required defects in the contract documents to be brought to the State Architect for resolution and “[s]hould the Contractor proceed with the work affected without instruction from the State Architect, he shall be responsible for any . . . added cost resulting therefrom.”  Enforcing this clause, the court rejected the extra work claim (at 14 Cal.App.3d 912), because:

Compliance with contractual provisions for written orders is indispensable in order to recover for alleged extra work. …  [¶]  [provisions] of the General Conditions established conditions precedent to the right of Trepte to claim or receive additional moneys for allegedly extra work, and Trepte’s failure to comply with these conditions releases the State from liability therefor.

Most construction contracts provide that the contractor shall not proceed with any extra or changed work until a written change order has been issued.  It is not uncommon, however, for contractors, in an effort to keep the project on schedule, to perform extra work after receiving oral authorization and assurances that a written change order would be forthcoming.  Most contractors have heard this:  “Please go ahead with the extra work so as not to delay the project and we will send you a written change order when we have time to complete the paperwork.”  This practice of performing extra work based on an oral authorization may be common, but it can also be very risky for the contractor—especially on a public contract. 

In a California case, a California appellate court ruled that any oral authorization to perform extra work was insufficient because the contract required all changes to be in writing.  P&D Consultants, Inc. v. City of Carlsbad, 190 Cal. App. 4th 1332 (4th Dist. 2010).  The owner’s prior actions in approving verbal change orders was of no avail for the contractor.

Five Situations Where You May Be Able To Avoid A Contractually Mandated Written Change Order

Almost all written construction contracts require that the contractor obtain a written change order as a condition to payment for the additional work. However, owners customarily direct contractors to perform the work and promise that they will subsequently negotiate a fair price for the work. Almost every contractor can recite an example of such a promise that is then ignored by the owner when the time for payment arises.

Written change order provisions are placed in contracts so that the owner is assured that it will expressly approve any changes to the scope of work. In addition, such provisions are designed to give the owner timely and ample notice of the change in scope so it can investigate the claim and then either avoid the additional cost or take steps to mitigate the additional expense. Courts have routinely upheld such provisions when the additional work was performed without any notice to the owner.

However, the courts will be less inclined to enforce the written change order requirement when the owner has timely notice and orally induces the contractor to perform the changed work. Similarly, courts will not find it equitable to enforce such clauses against subcontractors when general contractors induce them to perform the additional work with a promise that they will be paid for the work at a later date.

The remainder of this article will review five legal theories that have been approved by California courts as a legal basis for avoiding the written change order provision in private works contracts when the owner knowingly approved the additional work. The article will then discuss written change requirements for California public works projects.

Private Works

1. Oral Waiver of the Written Change Order Provision

The doctrine of waiver has long been accepted by the courts. In essence, the courts treat appropriate action or conduct of the owner as waiver of the written change order provision. Quite simply, if the other party orally approves the additional work, it acts in a manner that is inconsistent with that party’s intent to rely on the change order provision. As a result, the court will treat that conduct as a waiver of the clause and allow the contractor to recover the value of the additional work. (See for example Howard J. White v. Varian Associates (1960) 178 Cal App 2^nd 348).

It should be noted that many contracts include additional clauses that seek to avoid such waiver arguments. In addition, some contracts include clauses that state that only certain personnel can approve change orders. For example, the provision may limit the change order approval to home office personnel rather than field personnel. Under appropriate circumstances, such anti-waiver provisions have been upheld by the courts as valid.

2. The Owner May Be Estopped From Relying On The Clause

The doctrine of promissory estoppel has been applied to a number of construction contract disputes. Promissory estoppel occurs when a party makes a promise to the other which the other party would reasonably rely on to take action based on the promise. If the owner promises to pay for the work and then allows the work to proceed it will be estopped from denying the promise to pay for the work.

3. A Requirement For A Written Change Order Can Be Rescinded By The Parties

As in the case of waiver, the parties can effectively rescind the written change order provision by their conduct. If the contractor and the owner orally agree that written change orders are not necessary the courts will treat the provision as being rescinded by the parties.

4. Allowing The Owner To Receive The Improvements Without Compensation Would Unjustly Enrich The Owner

This legal theory is based on the concept that once the work is complete the owner will have the permanent benefit of it and the contractor will not be able to repossess the work. However, the owner can only be unjustly enriched if the contractor was induced to perform the additional work by fraud, coercion, mistake, request or coercion by the owner. Thus the claim must be based on some action of the owner that resulted in the contractor performing the additional work.

5. California Statutory Law Allows A Written Contract To Be Orally Modified

California Civil Code section 1698 allows a written contract to be modified when the oral change order agreement is executed by the parties or if the change order is supported by new consideration. California courts have held that if the contractor fully completes the additional change order the oral modification to the contract is deemed executed by the parties and is thus effective. The section also states that it does not preclude “in an appropriate case the application of rules of law concerning estoppel, oral novation and substitution of a new agreement, rescission of a written contract by an oral agreement, waiver of a provision of a written contract, or oral independent collateral contracts.” Thus, the section does not prohibit the four other legal theories that have been applied by California courts to uphold oral change orders.

California Public Works

California public entity contracts are based on state and local procurement laws. The laws typically require approval for the changed scope of work before it is performed. For example, the Public Contract Code requires the county board of supervisors to approve change orders if the amount exceeds a certain threshold amount. However, the board may authorize the inclusion of a clause in the contract that allows for county employees to approve any work that is necessary for proper completion of the work.

Most public works projects include written change order provisions. The courts will uphold such provisions since they give the public entity timely notice of the change in scope so it can investigate the claim and then either avoid the additional cost or take steps to mitigate the additional expense.

1. A Public Agency’s Misrepresentation Maybe Allow A Contractor To Avoid The Written Change Order Clause

If the public entity was actively negligent in the design of the project or misrepresented the conditions that the contractor would encounter, the courts will not enforce the written change order requirement. Thus, if the contractor can establish that the public agency knowingly and positively misrepresented the site condition such clauses can be avoided. Generally, there is an implied warranty that plans and specifications are complete. If a showing can be made that the plans and specifications were inaccurate and that the public agency provided statements, although unintentional, that mislead the contractor, a contractor can recover the value of the extra work.

2. Reliance On The Statements Of A Public Official May Not Allow A Contractor To Avoid The Written Change Order Provision

While California courts will allow a contractor to avoid a written change order clause if a private owner promises to pay for the additional works, they will not permit a public works contractor to rely on such unauthorized statements to avoid the provision. However, if the contract vests a certain official or the project architect or engineer with the authority to approve the oral change order the courts will enforce the oral change order.

3. If An Unauthorized Public Official Orally Orders The Work, Proceed Under Written Protest

As previously stated, most public works contracts authorize certain public officials to approve change orders so that any additional work that is necessary for proper completion of the work is performed. If an unauthorized public official demands that the change order proceed, the contractor should give prompt notice that such work will be performed under protest. If the contract has a clause that sets forth the method of notifying the public agency of such a change order, those requirements should be followed. If the contractor provides timely written notice that it is proceeding under protest, the courts may not enforce the requirement for a written change order.

Conclusion

Construction contracts typically include a requirement that change orders be in writing. If such a provision exists, a prudent contractor will insist that all change orders be in writing. If the owner, or the prime contractor if the agreement is between a general contractor and a subcontractor, chooses to disregard the requirement of a written change order, confirm the instructions in writing.  The written confirmation should be provided to the other party and the architect, if any.

TIP: AVOID THE VERBAL CHANGE ORDER

Change order disputes take up a large portion of a construction lawyer’s day. Almost half of all lawsuits (and attorney’s fees) in construction law involve the issue of the right to payment for verbal or unsigned change orders.  Was the extra work necessary and reasonable?  Was the extra work authorized?  Can the contractor include these charges in his construction lien?  Is a verbal promise to later execute a change order binding, and if so, for how much?

Instead of paying attorneys to deal with these issues in a lawsuit, we suggest some practical ways to avoid these disputes.  At a minimum, you can strengthen your position even if you have no choice but to record a lien or file a lawsuit.  These suggestions apply to general contractors seeking payment from an owner, as well as to subcontractors seeking payment from general contractors (even though there are some differences between the two situations).

Governments have other defenses for public projects that will not be discussed here.

The typical contract provision dealing with change orders includes requirements that: (1) only certain people can authorize change orders (typically officers, not PMs or supers); (2) the change order must be in writing and signed to be enforceable; (3) the change order can only be for extra work directed by the owner/GC and not for work that can be inferred from the original scope; (4) the contractor must give notice of the claim for extra work within a short period of time after discovering the claim; (5) the subcontractor is not entitled to payment unless the GC is paid by the owner for this extra work; and (6) the contractor must perform the work even if there is a dispute over the change order.

Subcontractors who perform extra work without a written and signed change order often hear these defenses from the GC:

•        We never knew you expected to claim extra money. You never gave notice. Now, it is too late for us to seek payment from the owner.

•        Sure, we knew it would be some extra cost, but had we known how much this was going to cost, we never would have asked you to perform the work.

•        Our project manager did not have the authority to agree that you would be paid for this extra work.

•        Only if and when we get paid for from the owner, we will pay you for your share of the money collected.

General contractors often hear similar defenses from the owner, including:

•      The work was not extra; it was inferred from the plans.

•      You are not entitled to a change order because the plans stated that the GC would use "first class material" or that, in the event of any contradicting provisions, the "most stringent requirement would apply.”

Avoid getting to the point where you have to argue about whether you should be paid for the change order.  Start with the negotiation of the contract.  Because the contract often states that claims for extra money or time are not binding unless they are in writing, it is reasonable for you to add language such as: “Contractor shall not be required to begin any extra work without a change order executed by all parties.”

After the work begins, typical scenarios include:

Scenario Number 1: In the field, the owner or the GC directs you to perform work that you believe entitles you to extra money and/or time, but the work needs to be done now and there is no time to prepare a written change order or wait for the change order to be signed. The GC or subcontractor should:

•      Hold off on performing the work as long as possible as if you were playing a “game of chicken.” You may be at a stage that you can refuse to call for inspections that will “slow” down the project.  The experienced contractor knows that, once they complete the work without a signed change order, your leverage is gone and parties will find excuses not to pay you.

•      If you must begin with the work, immediately send the owner/GC a confirming email stating: "Without a signed change order, you have directed us to perform __________, which we believe entitles us to extra compensation and/or time.  The cost and/or extra time are unknown at this time.  We will continue to perform the work and make a formal claim for which the owner/GC will be responsible after the cost and time become known.  If this is inaccurate in any way, let us know in writing immediately."

•      Send the owner/GC a proposed change order as soon as possible, but certainly within the time required by the contract, even if you don't yet know all the costs or time impact.  To be safe, instead of stating "zero" in the request for extra time, insert "Unknown at this time."  However, when costs and time become known, send a revised proposed change order immediately.

•      Follow the contract requirement for calculating cost. Most likely, this will be cost plus a percentage or unit price. You need to keep great records of your costs, including keeping separate time records for the extra work and having the owner or GC's representative sign the time records each day.

Scenario Number 2: You submit a proposed change order, but there are delays in signing and the owner/GC directs you to start work. The GC or subcontractor should:

·         Send this email: "You have directed us to begin the work in proposed change order ___ despite the fact that we have not yet received a fully executed change order. We will proceed as directed in reliance that the proposed change order is acceptable to you. If this is inaccurate in any way, let us know in writing immediately."

Scenario Number 3: Progress payments and partial releases. It is not uncommon for owners or GCs to require a "clean" release.  In other words, a release with no reservation of any outstanding claims.  To avoid a waiver of your claim for extra work not yet agreed to, first, try to insert a statement that: "This release does not waive any claims for extra work arising from ____________________".

If the owner or GC refuses to pay you with this language added, send the partial release with a separate email or letter stating the same. This is not great, but at least gives you an argument.

Scenario Number 4: You are subject to liquidated damages for failure to achieve a certain milestone, typically substantial or final completion.  But, you never delivered proposed change orders requesting additional time.  Or, you first raise these owner delays at the end of the project when the owner or GC are trying to set off liquidated damages from your last payment. In this case:

•      Most likely, you are taking a discount on the money you have rightfully earned. Learn from your error and, for the next project, be diligent and send proposed change orders to increase the contract time as soon as the cause for the delay occurs.

•      Respect the time deadlines for notice in the contract.  If your claim is made timely, it avoids the argument that "we can't check the validity of the claim now, months later" or "it is too late to back charge another contractor for the delay".

Overall, create a strict procedure for your company to make claims for extra work or time. Who will be responsible for making sure that these requirements are complied with and how? Follow the contract requirements for authorized signature, timing of notice, and calculation of the claim.  All of these items are within your control and failure to comply just gives the other party (and its attorney) an easy excuse to dispute the claim.

If you have no choice but to perform the work without an agreed signed change order, then do the next best thing to strengthen you claim – make disclaimers, send emails and letters, and try to resist the new work as long as possible.

With a smart plan in place to avoid change order disputes, you can also avoid contributing to your construction law attorney’s retirement plan.

The importance of following change order provisions in a construction contract was emphasized yet again in a recent federal court decision:  Carolina Conduit Systems, Inc. v. MasTec North America, Inc.

 In this case, Carolina Conduit, a subcontractor, sued the general contractor, MasTec, for the cost of installing additional flowable fill due to a change in the configuration of duct banks.  Although the design documents called for the duct banks to be constructed in a vertical configuration, field conditions required that the duct banks be built in a horizontal configuration, necessitating additional flowable fill.  Upon this discovery in December, 2008, Carolina Conduit’s president and project manager met with MasTec personnel, who informed Carolina Conduit “not to worry” about the additional fill and costs because plenty of funds were available.  Carolina Conduit proceeded to work on the project throughout the following spring.  In May, 2009, Carolina Conduit’s president again discussed the extra cost of the duct banks and MasTec’s vice president again advised “not to worry” and that Carolina Conduit would be compensated.

At the close of the project, MasTec refused to pay Carolina Conduit for the extra flowable fill.  After suit was filed, MasTec requested the court to grant it summary judgment and dismiss the claim for extra flowable fill.  MasTec asserted, among other things, that the parties’ contract contained a provision governing changes to the scope of work:  “any additional work outside the original scope of work shall be handled through a change order specifying pricing and/or Unit prices approved by [the Owner].”

In opposing summary judgment, Carolina Conduit argued that the contract’s requirements were ambiguous, and that the parties had modified the contract, either by oral agreement or in their course of dealing.

The court ruled in MasTec’s favor while succinctly stating Virginia law applicable to change order provisions:

Virginia law provides that contractual provisions containing written change order requirements are binding upon the parties to the contract . . . .  Contractual provisions requiring written change order requirements maintain order and predictability in the construction business, and are meant to avoid subsequent disagreement and prevent controversy . . . .  For this reason, where there is a method under the contract by which a party can insure the recovery of the cost of extra work, that party is not entitled to recovery where it fails to follow that method.

The court held that since Carolina Conduit failed to follow the change order provision, it could not recover any excess cost.  The court rejected the argument that the design was ambiguous, again noting that regardless of that assertion, Carolina Conduit did not follow the change order provision.

The court also quickly disposed of Carolina Conduit’s argument that the parties had modified the change order provision.  The court determined that MasTec’s statements “not to worry” about additional cost were not sufficient to prove that MasTec had waived the change order requirements.  The court also noted that Carolina Conduit submitted multiple change orders during and after the close of the project on other issues which contradicted the argument that the parties had waived the change order provision.  Finally, the court noted that Carolina Conduit could point to no instance where MasTec ignored the change order provision; hence, there was no evidence of course of dealing indicating a modification to the change order requirements.

This case marks the second time in a year that a federal court applying Virginia law has ruled against a subcontractor who failed to follow a contract’s change order provision.  See Artistic Stone Crafters v. Safeco Ins. Co., see also WM Construction Alert, 10/13/2010, “Stone Crafters, Inc. v. Safeco Insurance:  A Reminder of the Importance of Lien Waivers and Change Order Provisions.”

Rare Exception: Court Allows Recovery For Verbal Extra Work Claim

Most construction contracts have a standard provision requiring changes in the work or directions to perform extra work to be made in writing.  Courts generally hold that a contractor who fails to obtain the required written authorization will not be paid for such work.   

However, a contractor or subcontractor who performs extra work will not automatically lose his extra work claim just because he failed to follow the contract provision requiring written authorization.  Courts are hesitant to deny a just claim for extra work and have found that contractual requirements for written orders can be waived under certain circumstances.   

 In the recent case of Penava Mechanical Corp. v. Afgo Mechanical Services, Inc., an appellate court ruled on whether recovery may be had for orally directed extra work despite the contract provision that an extra work claim must be supported by written authorization.  

Background  

Absolute Electrical Contractors, Inc. entered into a subcontract with general contractor Richter & Ratner Contracting Corp.  The parties’ subcontract contained a so-called “no- oral modification clause.”  Pursuant to the clause, all changes in the work or directions to perform extra work were to be made in writing or were otherwise not compensable.    

During the course of construction, representatives of the general contractor verbally directed the subcontractor to work overtime.  The representatives also orally agreed to pay for this premium time over and above the contract price, as they had previously paid for other overtime work throughout the project.

 The promised overtime payment was in lieu of an extension of time to finish the work.  In addition, the general contractor’s project manager testified that he instructed the subcontractor not to bother with the “tickets” that were usually prepared by the subcontractor for such extra work and formed the basis for change orders issued, but rather directed the subcontractor to “just get the work done.”  The subcontractor sued when the general contractor refused to make payment for the subcontractor’s overtime.
In defense, the general contractor argued that the subcontract’s no-oral modification clause barred any claim by the subcontractor, since the direction to perform overtime work and promise to pay at a premium rate were made orally, and were not in writing.  In addition, the general contractor argued that the subcontractor had waived any claims to the overtime pay pursuant to the express language of the lien waivers signed by the subcontractor.    

The general contractor moved for summary judgment, which the trial court granted.  The subcontractor appealed. 

Decision  

The appellate court reversed the trial court, denying the general contractor’s motion for summary judgment and directing a trial on whether the subcontractor had been paid in full for the overtime work performed.    

According to the appellate court, under New York law, oral directions to perform extra work, or the general course of conduct between the parties, may modify or eliminate contract provisions requiring written authorizations or notice of claims.  The appellate court relied heavily on the verbal directions by the general contractor to the subcontractor to perform the overtime work and verbal promises to pay the subcontractor.

 The court also relied on the general contractor’s verbal direction that the subcontractor not bother with the work tickets that would form a written basis for a formal change order.  Under these circumstances, the court held that the general contractor cannot argue that it did not have to pay for the overtime.  
As to the general contractor’s argument that the claims had been released, the appellate court held that since the subcontractor was required to sign these waivers whenever it received partial payment, and since payments were made after waivers were given, the parties treated the waivers as mere receipts of the amounts stated in the waivers, not as complete waivers of all claims to that point.  

Comment  

While courts routinely seek to enforce the express terms of an agreement that was freely negotiated, courts also seek to prohibit bad-faith dealings.  Here, where the general contractor verbally promised payment, and verbally stated that written work tickets were not necessary to protect the subcontractor’s right to payment, the court would not allow the general contractor to rely on the subcontract’s provisions to the contrary.     

A prudent contractor or subcontractor, however, should not ignore the contractual requirement for written extra work orders in the hope that a court may make an exception and find a waiver of the contract provisions under particular circumstances.  He should insist on a written order in the form specified by the contract provisions before he performs any extra work.  A written extra work order will ensure his right to be paid for performing such work.    

Beware of Orders for Extra Work without Authority

In the California case, the City of Carlsbad hired P&D Consultants (“P&D”) to provide civil engineering and other services for the redesign of a municipal golf course to satisfy numerous conditions imposed by the California Coastal Commission.  The original contract price was $556,745.  The written contract stated that no amendments, modifications, or waivers of contract terms would be allowed unless there was a written agreement signed by both parties.

During the design phase of the project, the City often requested that P&D perform extra work.  When this happened, P&D would typically submit a proposed change order with a fixed price to the City’s project manager, and the project manager provided the City with the information for its preparation of an amendment to the contract.  The City typically took several weeks to execute an amendment and the project manager frequently authorized P&D to begin the extra work before it received a signed amendment.  The parties, following this process, signed Amendments Nos. 1 through 4, which increased the contract price by $63,525.50 for extra work.

After execution of Amendment No. 4, P&D raised concerns about additional extra work the City wanted that P&D believed was beyond the scope of the contract documents.  The City’s project manager notified P&D that the City had “finally reached resolution on what we expect to be the final changes for the golf course per the Coastal Commission.”  The City’s project manager asked P&D to prepare a final projected scope of work and the cost to finish all of the design services to complete the plans and specifications.

P&D, as instructed, submitted a proposed change order for Amendment No. 5 totaling $209,956, which included $69,073 for extra work already performed and $139,833 for the cost “to complete services for final plan submittal and City approval.”  The City was not happy.  The City’s project manager objected to the proposal claiming that the amount was excessive, it included charges for work already specified in the written contract documents, and it exceeded the maximum sum the City had set aside for completion of the design services.  The City’s project manager sent P&D an email stating:  “We have limits for both our purchase order authority and this proposed Amendment No. 5.  We are now at those limits.  No further costs will be authorized nor should be to finish these design packages.”  The City’s project manager told P&D that the breakdown of the costs for the extra work needed to “get below” $100,000.

The parties subsequently negotiated and signed Amendment No. 5, which authorized that the extra work be done on a time and materials basis with a cap of $99,810.  As was customary, at the City’s project manager’s direction P&D began the work several weeks before the City executed the amendment.  P&D completed the work and subsequently sought compensation from the City for additional work that P&D claimed was not covered by Amendment No. 5.  When the City refused to pay, P&D sued the City seeking to recover $109,093.

P&D Wins at Trial

P&D’s trial theory was that the contract’s written change order requirement was modified by the City’s project manager’s oral authorization of the extra work for which P&D sought payment, and by the parties’ conduct in handling Amendments Nos. 1 through 5 whereby P&D would commonly begin performance, as directed by the project manager, before any writing was executed.

At trial, the City’s project manager, John Cahill, testified that after P&D submitted its proposal for Amendment No. 5, P&D began seeking payment for extra work it claimed was beyond the scope of that amendment.  Cahill also testified that P&D’s project manager, Charles Moore, threatened that if the City did not pay the additional amount, P&D would discontinue work.  In Cahill’s view, the work was not extra, but rather work that was included in Amendment No. 5.  He believed that Amendment No. 5 “was a complete, final projection of all costs and work by P&D” necessary to complete the design.  Cahill nonetheless told Moore, “if you feel strongly that you’ve got additional work outside the contract and the amendments, put it together with the proper backup and the City will evaluate it.”  Cahill denied preparing a sixth amendment and he did not recall whether he told Moore he would do so.

Moore testified that Cahill told him that the City was running out of money for the project, and when Moore objected to P&D continuing with extra work, Cahill told Moore to keep working and that he would “take care of it”—words that almost all contractors have heard at some time.  Apparently accepting P&D’s version of the facts, the jury found the City liable for breach of contract and awarded P&D the full amount of damages it requested, $109,093.

P&D Loses on Appeal

The California Court of Appeal reversed the jury award.  The court ruled that any oral authorization by the City’s project manager for extra work beyond the work contemplated in Amendment No. 5, or the parties’ conduct in which they supposedly modified the written change order procedure based on the handling of Amendment Nos. 1 through 5, is insufficient to bind the City.  The court stated:  “The plain language of the contract limits the City’s power to contract to the prescribed method.  By ostensibly relying on Cahill’s oral authorization or direction to begin or perform extra work without a written change order, P&D acted at its peril.  The purpose of including a written change order requirement in a municipal works contract is obviously to protect the public fisc from the type of situation that occurred here.”

Despite the jury award, the court ruled that P&D could not recover for extra work without a written change order as required by the contract.  Instead of getting more than $109,000 for the extra work it performed, P&D got nothing and was ordered to pay the City $6,614.69 for defective or incomplete work and was also ordered to pay the City’s appeal costs.

Lessons Learned

When dealing with a public entity, contractors must be aware of the risk of performing extra work without a written change order as many courts are likely to enforce a public contract’s requirement for written change orders.  These strict limitations on the authority to contract (or to modify a contract) will often trump the public entity’s oral instructions to begin the extra work immediately before the written change order is executed.  Remember, the words “we will take care of you” may not always mean what you think. 

Waiver of the Written Change Order Requirement

However, the written change order requirement can be waived.  In Weeshoff Construction Company v. Los Angeles County Flood Control District (1979) 88 Cal.App.3d 579, 589-90, 152 Cal.Rptr. 19, the court held:

California decisions have . . . established that particular circumstances may provide waivers of written “change order” requirements.  If the parties, by their conduct, clearly assent to a change or addition to the contractor’s required performance, a written “change order” requirement may be waived. [citations]

In the present case, there is much evidence to support plaintiff’s claim that the district intended to force it to utilize temporary pavement on Whittier Blvd.  Trial testimony included: (1) prior to April 20, 1973, plaintiff’s procedure for filling his contractual requirement to restore three traffic lanes daily had been to backfill excavations with hard packed sand (a procedure which was found by the trial court to comply with contract requirements); (2) on April 19, 1973, the district’s senior construction specialist, T. D. Russi, issued a written memorandum directing plaintiff to provide a method of operation which would restore three traffic lanes on Whittier Blvd. at commute hours as required by contract; (3) on April 20, 1973, the district advised plaintiff that if, by April 22, he had not provided sufficient traffic lane restoration, the district itself would commence restoration procedures; (4) when plaintiff inquired of Russi how he must comply, he was verbally ordered to “fix it.” (5) On April 22, the district itself placed temporary pavement on a portion of Whittier Blvd. and informed plaintiff that the cost incurred by district for such restoration would be deducted from plaintiff’s final payment.  Thereafter, plaintiff used temporary pavement to restore Whittier Blvd. at the end of the day and removed the temporary pavement before beginning work each morning. …  [¶]  [I]t is clear that the district, by its conduct, exerted an intentional attempt to affect a contractual change without complying with the change order provision. …  We find there is substantial evidence to support the trial court’s finding that by its conduct, the district did intend to waive the contractual provision requiring a written change order …

See also Frank T. Hickey, Inc. v. L.A.J.C. Council (1954) 128 Cal.App.2d 676, 682-83, 276 P.2d 52.

The written change order requirement can also be overcome by oral modifications to the extent the modifications have been performed (California Civil Code section 1698[b]).  Oral change orders are enforced on this basis (Healy v. Brewster (1967) 251 Cal.App.2d 541, 551-52, 59 Cal.Rptr. 752).  As the court pointed out in Girard v. Ball (1981) 125 Cal.App.3d 772, 785, 178 Cal.Rptr. 406, there is a “commonly known custom and practice in the construction industry where oral agreements frequently modify or extend written agreements.”

The written change order requirement also can be rescinded (McFadden v. O’Donnell (1861) 18 Cal. 160, 164-65 [“Whether the contract provided against extra work except agreed to in writing, is immaterial; for the parties could rescind this provision in the contract if they chose and agree to alterations by parol.”]).

Notwithstanding clauses purporting to prevent modifications of the contract, the parties’ conduct can effect such modifications, including abandonment of the written change order requirement (Opdyke & Butler v. Silver (1952) 111 Cal.App.2d 912, 916, 245 P.2d 306 [“The parties to a written contract . . . are as free to alter it after it has been made as they were to make it, and all attempts on their part by its terms to tie up their freedom of dealing with each other will be futile. …  To this end parol agreements will be as effective as written ones. …  And implied agreements satisfactorily established will have all the force of express ones.”]; Bettelheim v. Hagstrom Food Stores, Inc. (1952) 113 Cal.App.2d 873, 249 P.2d 301 [held, lease provision prohibiting waivers unless in writing was waived; “[e]ven a waiver clause may be waived by conduct.”]).

B.  Notice Requirements and Extra Work Claim Forfeitures

Many contracts require specific notice of claims for extra work, changed conditions or other matters, and frequently declare the claims to be released or waived if the notice is not timely or properly given.

Contracts are to be interpreted reasonably – to avoid unusual, extraordinary, harsh, unjust or inequitable results; to avoid forfeitures; and to avoid placing one party at the mercy of the other (California Civil Code sections 3542 & 3520; Yamanishi v. Bleily & Collishaw, Inc. (1972) 29 Cal.App.3d 457, 462-63, 105 Cal.Rptr. 580; Hertzka & Knowles v. Salter (1970) 6 Cal.App.3d 325, 335, 86 Cal.Rptr. 231; Hawley v. Orange County Flood etc. Dist. (1963) 211 Cal.App.2d 708, 713-16, 27 Cal.Rptr. 478).  This doctrine often impels a court to find ways to interpret notice requirements to avoid forfeitures.  

For example, a notice requirement can be construed as a covenant, or promise by the contractor, instead of a condition precedent to recovery (California Civil Code section 1436; Restatement Contracts 2d section 226).  The courts prefer interpreting the language as a covenant, rather than a condition, in order to avoid a forfeiture of the contractor’s claim (California Civil Code sections 1442, 1670.5, Restatement Contracts 2d section 227; Hawley v. Orange County Flood etc. Dist. (1963) 211 Cal.App.2d 708, 713, 27 Cal.Rptr. 478).  When the notice requirement is found to be a covenant, the owner is entitled to recovery, as an offset against the contractor’s claim, whatever damages the owner actually suffered from not getting timely notice.

The general rule on forfeiture clauses is set forth in Universal Sales Corporation, Ltd. v. California Press Manufacturing Company (1942) 20 Cal.2d 751, 771, 128 P.2d 665 (“Forfeitures are not favored by the courts, and if an agreement can be reasonably interpreted so as to avoid a forfeiture, it is the duty of the court to avoid it.  The burden is upon the party claiming a forfeiture to show that such was the unmistakable intention of the instrument. [citations]  ‘A contract is not to be construed to provide a forfeiture unless no other interpretation is reasonably possible.’ [citations]”)

In D. A. Parrish and Sons v. County Sanitation District (1959) 174 Cal.App.2d 406, 344 P.2d 883, the contract required written notice of a claim within 10 days after discovering the factual basis for the claim, and, it provided: “The Contractor’s failure to notify the Owner within such ten (10) day period shall be deemed a waiver and relinquishment of any such claim against the Owner.”  In refusing to enforce this forfeiture, the court held (at 174 Cal.App.2d 414):  “[A] forfeiture clause, such as this, will not only be strictly construed [citation] but has been interpreted by this court not to apply to claims arising from breaches of the contract caused by the other party.”

Besides interpreting the contract requirement as a covenant or rejecting the forfeiture, courts find that the owner got “constructive notice” thereby satisfying the contract requirement (e.g., Welding, Inc. v. Bland County Service Authority (Va. 2001) 541 S.E.2d 909 [mention of the claim issues in the progress meeting minutes was found to satisfy the notice requirement]) or courts find that the notice would serve no useful function in the context of the case.

Finally, the courts also have inherent equitable power to relieve parties from the failure to perform conditions which result in a forfeiture (California Civil Code section 3275; Restatement Contracts 2d section 229; O’Morrow v. Borad (1946) 27 Cal.2d 794, 800-01, 167 P.2d 483).

C.  No-Damage-for-Delay Clauses

Extra work often causes delays in completion of the project.  Many contracts have a no-damage-for-delay clause.  California cases and statutes limit the enforceability of those clauses.

In Milovich v. City of Los Angeles (1941) 42 Cal.App.2d 364, 108 P.2d 960, the contract required the city to timely provide steel pipe for the water line Milovich was building.  It failed, but asserted the no-damage-for-delay clause as a bar to Milovich’s delay damages claim.  In rejecting the city’s argument, the court narrowly construed the contract language against the city, and observed (at 42 Cal.App.2d 378):

To uphold appellants’ contention in this regard would be to give to the language of the contract a construction at variance with equitable principles and to clothe the appellant department with an unconscionable advantage over the contractor, by permitting the former to make amends for its contractual derelictions, delays and neglect by simply extending the time within which the contract could be completed regardless of the financial loss accruing to the contractor.  This we cannot do in the absence of a plain, unequivocal intention on the part of the contracting parties, as evidenced by the language of the contract, to restrict the remedy of the contractor to that of obtaining an extension of time.

In McGuire & Hester v. City etc. of San Francisco (1952), 113 Cal.App.2d 186, 189, 247 P.2d 934, work on a water line took more than twice the contract time, because the city failed to timely obtain rights of way, thereby pushing the work into winter weather.  Section 49 of the contract provided:

Apart from granting the Contractor extensions of time for unavoidable delays, no payment or allowance of any kind shall be made to the Contractor by way of compensation or damages on account of any hindrance or delay from any cause in the progress of the work or any portion thereof, whether such delay be avoidable or unavoidable.

In refusing to enforce this no-damage-for-delay clause, the court observed (at 113 Cal.App.2d 189)

Nowhere [in the contract] is there the slightest suggestion that defendant will be absolved from damages caused by its not keeping its agreement to secure rights of way prior to the starting of the work.  To construe that language in section 49 . . . to mean that it was thereby intended by the parties that the only remedy for the contractor, when the city broke its solemn agreement to procure rights of way in advance, was for the contractor to obtain an extension of time to do the work, would be to give the clause and the contract as a whole a strained, unreasonable and unfair interpretation.

In Hawley v. Orange County Flood Control Dist. (1963) 211 Cal.App.2d 708, 712, 27 Cal.Rptr. 478, the contract provided:

[I]f the contractor suffers any delay caused by the failure of the District … to supply necessary plans or instructions … the contractor shall be entitled to an extension of time … but shall not be entitled to any damages for such delay.

The trial court found that, given the job conditions, the district had compelled Hawley to keep a sewer trench open for an unreasonable time (2 months), and, as a result, the trench caved-in, dislocating the sewer line, opening up joints in it, and allowing sewage to leak and flood the trench.  Hawley sued for the clean-up costs.  At the close of his evidence, the trial court granted a nonsuit, believing that the no-damage-for-delay clause precluded any recovery.  The appellate court reversed.  First, it extensively reviewed California, out-of-state and federal cases which refused to enforce no-damage-for-delay clauses when the delay was caused by events the parties did not contemplate at the time the contract was executed, such as an owner’s breach of contract.  Then, the court concluded (at 211 CA2d 717) that “whether or not the delay damage clause was intended by the parties to prevent recovery under the peculiar circumstances here involved resolves itself into a factual question requiring the weighing of all the facts presented.”

For public works projects, these California cases have been codified into California Public Contract Code section 7102.  That statute makes unenforceable any public works prime contract or subcontract clause that limits damages for delay when the “delay is unreasonable under the circumstances involved, and not within the contemplation of the parties.”  In Howard Contracting, Inc. v. G. A. MacDonald Construction Co., Inc. (1998) 71 Cal.App.4th 38, 83 Cal.Rptr.2d 590, the contract allowed time extensions for unforeseen events, but not damages, unless the event was an unreasonable and unanticipated delay caused by the city.  The city contended that, given the facts in the case, Howard was only entitled to time, not damages, under the limited no-damages-for-delay clause in the contract.  In rejecting that argument, the court held (at 71 Cal.App.4th 49-51):

[Public Contract Code] Section 7102, however, specifically prohibits public agencies from requiring “the waiver, alteration, or limitation of . . . applicability of [the statute’s restrictions on no-damage-for-delay clauses and renders] [a]ny such waiver, alteration, or limitation . . . void.”  Even before the adoption of section 7102, California courts generally held that “no damage for delay” clauses in public contracts did not apply to delays arising from a breach of contract caused by the other party to the contract. [citations]

. . . The trial court found the delays were caused by the City’s breaches of contract and implied covenant [to provide timely access to the project site] in failing to disclose known restrictions on project performance, to obtain necessary permits, and to provide timely access to perform the work.  Those findings render the “no damage for delay” provision in the contract inapplicable. … [or] a basis exists for concluding that the delays were unreasonable and not within the contemplation of the parties.

D.  Accord and Satisfaction Language in Change Orders

Language in the contract or language in a change order frequently attempts to turn a change order into an accord and satisfaction (California Civil Code sections 1521-1523) for all potential disputes related to the change, for example, delay or impact claims.  Sometimes the courts will buy these efforts and bar the related claims (Huber, Hunt & Nichols, Inc. v. Moore (1977) 67 Cal.App.3d 278, 302, 136 Cal.Rptr. 603), other times they will not (Semas v. Bergmann (1960) 178 Cal.App.2d 758, 761, 3 Cal.Rptr. 277.

The party claiming an accord and satisfaction has the burden of proof (Higson v. Montgomery Ward & Co. (1968) 263 Cal.App.2d 333, 343, 69 Cal.Rptr. 497).

Further, all language in the contract, and in any change order purporting to be an accord and satisfaction, must be interpreted to give effect to the mutual intention of the parties (California Civil Code section 1636; Rabinowitz v. Kandel (1969) 1 Cal.App.3d 961, 965, 81 Cal.Rptr. 897).  That generally permits looking at the circumstances surrounding the execution of the contract or change order, and the conduct of the parties (California Civil Code section 1860; California Metal Enameling Co. v. Waddington (1977) 74 Cal.App.3d 391, 395-96, 141 Cal.Rptr. 443).  These sources frequently provide a basis for avoiding or minimizing the effect of the language in question.

E.  Disclaimers

Disclaimers in contract documents are common.  Typically they say that, if the true conditions on the job are different from information provided in the contract documents, then the owner is not responsible for the difference, so the difference cannot be the basis for an extra work claim.  The disclaimers are usually coupled with a clause requiring the contractor to inspect the site, and rely only upon the information gathered by the contractor.  Information that would have been discovered in the inspection also cannot be the basis for extra work claims.  See the discussion of disclaimers above.

F.  Excuse, Waiver and Estoppel

Whatever the language in the contract, conduct by the parties may excuse performance, waive performance, or estop the party entitled to performance from claiming it.

Any performance required by a contract can be excused by various acts, conditions or events (California Civil Code sections 1440, 1441, 1511, 1512, 1515; Restatement Contracts 2d sections 246 & 247; Peter Kiewit Sons’ Co. v. Pasadena City Jr. College Dist. (1963) 59 Cal.2d 241, 243-45, 28 Cal.Rptr. 714, 379 P.2d 18).

When a contractor’s extra work claim arises from willful acts or omissions of the owner, or a violation of law, then any performance required of the contractor to perfect his claim may be excused (California Civil Code section 1668; Klein v. Asgrow Seed Co. (1966) 246 Cal.App.2d 87, 54 Cal.Rptr. 609; Halliday v. Greene (1966) 244 Cal.App.2d 482, 53 Cal.Rptr. 267; but see limitations on this doctrine in Cregg v. Ministor Ventures (1983) 148 Cal.App.3d 1107, 196 Cal.Rptr. 724; Tokio etc. Co. Ltd. v. McDonnell Douglas Corp. (2d Cir. 1980) 617 F.2d 936).

Any performance required under a contract can be waived.  Examples:  Written change order requirement (Weeshoff Constr. Co. v. Los Angeles County Flood etc. Dist. (1979) 88 Cal.App.3d 579, 590, 152 Cal.Rptr. 19), written claim requirement, even with a contract clause declaring it cannot be waived (Transpower Constructors v. Grand River Dam Authority (10th Cir. 1990) 905 F.2d 1413); Bettelheim v. Hagstrom Food Stores, Inc. (1952) 113 Cal.App.2d 873, 249 P.2d 301 [held, lease provision prohibiting waivers unless in writing was waived; “[e]ven a waiver clause may be waived by conduct.”]).

Any party by its conduct can be estopped to rely upon (prevented from relying upon) any requirement in the contract (Maurice L. Bein, Inc. v. Housing Authority (1958) 157 Cal.App.2d 670, 681-82, 321 P.2d 753).

CONTRACTOR'S RIGHT TO ABANDON FOR UNPAID EXTRAS

When the contractor has not followed the claims procedure set forth in the contract and there is no "Change Order" or "Construction Change Directive," but the contractor has performed extras for which he has not been paid, can the contractor suspend work and abandon the project?

The answer to this question should be found in an analysis of whether there is a legal obligation for the owner to pay.  As a general rule, when one party to contract commits a material breach of that contract, the other party is discharged or excused from any obligation to perform. Hernandez v. Gulf Group Lloyds, 875 S.W.2d 691, 693 (Tex. 1994). Nonpayment sometimes qualifies as a justification for abandonment.  See The Brooklyn & Ownes Screen Mfg. Co. v. U.S., 97 Ct.C. 532 (1942); Overstreet v. U.S., 55 Ct.C. 154 (1920).   However, at least one case has held that, in this context, "nonpayment" refers to nonpayment of agreed contract amounts, but not to claims for additional payments which are not yet resolved. See, DWS, Inc. , ASBCA 33245, 87-3 BCA ¶ 19960, 29 G.C. ¶ 265. That case involves a government contract that was not a construction contract. Nevertheless, it can be used as authority that nonpayment of extras does not justify abandonment.

Oxford Dev. Corp. v. Rausauer Builders, Inc., 304 N.E. 2d 211, 216 (Ind. 1973), on the other hand, held that nonpayment of extras justified abandonment in the context of a construction contract. A distinguishing factor in Rausauer , however, is that the court found a legal obligation on the part of the owner to pay for the extras. It is, therefore, reasonable to conclude that absent a legal obligation to pay, there is no right to abandon performance for nonpayment of extras. That result is consistent with the contractual scheme of the AIA 201. Art. 4.3.4 specifically requires the contractor to proceed diligently with performance of the work pending final resolution of claims.  Furthermore, Art. 4.5.3 requires the same during the arbitration process.

Once the legal obligation to pay for the extras is established, and all other criteria justifying abandonment exist, the contractor is entitled to "walk the job" for the nonpayment of extras.  It should be noted that in some jurisdictions, a contractor can lose the right to abandon performance once it has been obtained. In those jurisdictions, a contractor is put to an election at the time that a material breach occurs. The contractor may abandon performance or continue performance and sue for damages. Board of Regents of Univ. of Tex. v. S&G Constr. Co., 529 S.W.2d 90 (Tex. Civ. App.--Austin 1975, writ ref'd n.r.e.).  Continued performance after the material breach can constitute a waiver of the right to abandon. It is unclear how long a contractor's continued performance must be before a waiver occurs.  It would appear that due to the factually intensive nature of the analysis of the existence of the right to abandon, no practitioner can predict the outcome with any degree of certainty.  To counsel a contractor to abandon performance for nonpayment of extras is risky at best. However, situations exist where it is not only advisable, but it is the only realistic course of action for the contractor.

Drafting Tips

One drafting consideration from the owner's perspective is to include a requirement that the contractor commence and continue performance, including any changed work, pending necessary modifications or amendments to the contract price or time. Standard contract language typically provides the owner with the right to order the contractor to proceed with disputed work, unless the work is so far beyond the scope of the contract as to constitute a cardinal change.

From the contractor's perspective, it is important to articulate who has authority on behalf of the owner to direct and approve changes in the work. The contract should include a clear designation of authority, and a mechanism that permits the contractor to verify authorization of a change or extra work order without violating any contractual duty or direction to proceed with disputed work.

Generally, even if the contractor disputes an ordered change, it must proceed with the work and seek recourse through the contract's respective claims and disputes provisions.

Standard of Proof

Some courts have held that a contractor's extra work claim must be proven by a higher evidentiary standard — clear and convincing evidence. Duncan v. Cannon, supra.

There Must Be Extra Work

Labor and materials which are incidental and necessary to performance of the contract cannot be regarded as extra work for which a contractor or builder may recover. Likewise, "general" or undocumented discussions may be inadequate to prove and present a CO claim.

Time May Also Be Affected

The presence or absence of CO's may have a bearing not only on price and cost, but may also affect time of completion to shorten or extend time allowed for the substantial completion and final completion of the work.

Change Order or Change Directive?

Watch out for proposals or plans originally presented by a party as a CO, for which mutual agreement is required, but if agreement is lacking the same or similar work and changes are then cast or re-labeled as a "Construction Change Directive" or an "Interim Directed Change."

Does Extra Work Allowance Include Contractor Overhead and Profit?

Be sure to review and determine whether the CO provision, and any CO proposed and agreed upon, includes allowance for contractor overhead and profit (added or deleted), implicitly or explicitly. 

Reservation of Rights

An owner, architect or engineer in charge may issue and approve a CO with a reservation of rights. Sample language would be that, "Neither this Change Order nor the extension of time of performance granted hereunder, constitute an admission that Owner is responsible for any delays or hindrance to past or future work under the contract." Travelers Casualty and Surety Company v. Dormitory Authority — State of New York, 2010 U.S. Dist. LEXIS 88320 (S.D.N.Y. 2010).

Sample Clauses:

Article 7 of the AIA A201 General Conditions of the Contract for Construction©:

§ 7.1.1 Changes in the Work may be accomplished after execution of the Contract, and without invalidating the Contract, by Change Order, Construction Change Directive or order for a minor change in the Work, subject to the limitations stated in this Article 7 and elsewhere in the Contract Documents.

§ 7.1.2 A Change Order shall be based upon agreement among the Owner, Contractor, and Architect; a Construction Change Directive requires agreement by the Owner and Architect and may or not be agreed to by the Contractor; an order for a minor change in the Work may be issued by the Architect alone.

§ 7.2.1 A Change Order is a written instrument prepared by the Architect and signed by the Owner, Contractor, and Architect, stating their agreement upon all of the following:

1) the change in the Work;

2) the amount of the adjustment, if any, in the Contract Sum; and

3) the extent of the adjustment, if any, in the Contract Time.

§ 7.3.3 If the Construction Change Directive provides for an adjustment to the Contract Sum, the adjustment shall be based on one of the following methods:

1) mutual acceptance of a lump sum properly itemized and supported by sufficient substantiating data to permit evaluation;

2) unit prices stated in the Contract Documents or subsequently agreed upon;

3) cost to be determined in a manner agreed upon by the parties and a mutually acceptable fixed or percentage fee; or

4) as provided in Section 7.3.7.

§ 7.3.5 Upon receipt of a Construction Change Directive, the Contractor shall promptly proceed with the change in the Work involved and advise the Architect of the Contractor's agreement or disagreement with the method, if any, provided in the Construction Change Directive for determining the proposed adjustment in the Contract Sum or Contract Time.

The AIA© documents identify three different types of possible changes: (1) Formal Change Orders, agreed upon and signed by both the owner and the contractor; (2) Construction Change Directives, signed only by the owner; and (3) Field Orders, signed by the architect for only minor changes in the work.

ConsensusDOCS© refer primarily to two situations, the Change Order and the "Interim Directed Change" –

§ 8.1 CHANGE ORDER — § 8.1.1 The Contractor may request or the Owner may order changes in the Work or the timing or sequencing of the Work that impacts the Contract Price or the Contract Time. All such changes in the Work that affect Contract Time or Contract Price shall be formalized in a Change Order. Any such requests for a change in the Contract Price or the Contract Time shall be processed in accordance with this Article 8.

§ 8.1.2 The Owner and the Contractor shall negotiate in good faith an appropriate adjustment to the Contract Price or the Contract Time and shall conclude these negotiations as expeditiously as possible. Acceptance of the Change Order and any adjustment in the Contract Price or Contract Time shall not be unreasonably withheld.

§ 8.2 INTERIM DIRECTED CHANGE - § 8.2.1 The Owner may issue a written Interim Directed Change directing a change in the Work prior to reaching agreement with the Contractor on the adjustment, if any, in the Contract Price or the Contract Time.

§ 8.2.2 The Owner and the Contractor shall negotiate expeditiously and in good faith for appropriate adjustments, as applicable, to the Contract Price or the Contract Time arising out of an Interim Directed Change. As the Changed Work is performed, the Contractor shall submit its costs for such work with its application for payment beginning with the next application for payment within thirty (30) Days of the issuance of the Interim Directed Change. If there is a dispute as to the cost to the Owner, the Owner shall pay the Contractor fifty percent (50%) of its estimated cost to perform the work. In such event, the Parties reserve their rights as to the disputed amount, subject to the requirements of Article 12.

Under ConsensusDOCS©, the Owner must pay the Contractor 50% of the estimated cost to complete the disputed work, whereas no such obligation exists under the AIA forms. This is an added protection and leverage for the Contractor, but can also benefit the Owner by insuring that the project can move forward while the parties negotiate details.

Federal Acquisition Regulations - § 52.243-5 Changes and Changed Conditions 

CHANGES AND CHANGED CONDITIONS –

a) The Contracting Officer may, in writing, order changes in the drawings and specifications within the general scope of the contract.

b) The Contractor shall promptly notify the Contracting Officer, in writing, of surface or latent physical conditions differing materially from those indicated in this contract or unknown unusual physical conditions at the site before proceeding with the work.

c) If changes under paragraph (a) or conditions under paragraph (b) increase or decrease the cost of, or time required for performing the work, the Contracting Officer shall make an equitable adjustment (see paragraph (d) upon submittal of a proposal for adjustment (hereafter referred to as proposal) by the Contractor before final payment under the contract.

d) The Contracting Officer shall not make an equitable adjustment under paragraph (b) unless—

1) The Contractor has submitted and the Contracting Officer has received the required written notice; or

2) The Contracting Officer waives the requirement for the written notice.

e) Failure to agree to any adjustment shall be a dispute under the Disputes clause.

ARCHITECT LIABILITY TO THE OWNER IN THE CHANGE ORDER PROCESS

The design professional can have liability to the owner in the change order process. Generally speaking, an action against an architect/engineer by the owner can be based on either contract or tort law, or both.  Under contract law principles, an architect may be liable to the owner based upon the breach of the contract between the parties.  Williams Engineering, Inc. v. Goodyear, 496 So.2d 1012 (La. 1986).  Under tort theory, an owner can bring a claim against the architect based upon the breach of a legal duty owed to the owner.  Corcoran v. Sanner , 854 P.2d 1376 (Colo. 1993).  Sometimes, the limitations periods (which can be different) will dictate the type of action an owner is allowed to bring.

Under tort theory, absent a provision to the contrary, implicit in every contract between an owner and an architect is the duty of the architect to "exercise the care of those ordinarily skilled in the business."  Nelson v. Commonwealth of Virginia, 368 S.E.2d 239, 243 (Va. 1988) quoting Surf Realty Corp. v. Standing, 78 S.E.2d 901, 907 (Va. 1953).  A breach of that duty entitles the owner to damages.  Proof of professional negligence by an architect ordinarily requires expert testimony.  Allied Properties v. John A. Blume and Assoc., Eng'rs, 102 Cal.  Rptr. 259, 265 (1972).

Where the architect's duties include formulating changes to the project, initiating the change order process, and processing change orders, it would appear that he must perform those functions under the standard of negligence expressed above.  Hence, failing to process change orders in a timely manner could constitute professional negligence on the part of the architect.  If such failure is established, the architect should be liable to the owner for all damages proximately caused thereby.

For example, a design professional can be liable for delays.  Under the AIA B141 , an architect is specifically obligated not to delay the work on the project.  AIA B141 Art. 2.6.12.  When the time for occupancy of a building is delayed due to the negligence of the architect, an owner may recover damages for the loss of the use of the building, including lost profits.  Northern Petrochemical v. Thorsen & Thorshov, Inc., 211 N.W.2d 159 (Minn. 1973).   One court has gone as far as to award delay damages to an owner against the architect that were based upon the liquidated damages specified in the prime contract (between the owner and contractor).  E.C. Ernst, Inc. v. Manhattan Constr. Co. of Texas , 387 F.Supp. 1001 (S.D. Ala. 1974), modified on other grounds, 551 F.2d 1026 (5th Cir. 1977).  It follows that delays caused by the architect negligently performing change order functions should render the architect liable to the owner for the delay damages.

However, some jurisdictions have held that in actions against an architect based upon negligence, economic damages are not recoverable unless accompanied by physical property damage or bodily injury.  Sandarac Ass'n., Inc. v. W.R. Frizzell Architects, Inc., 609 So. 2d 1349 (Fla. 1992), review denied, 626 So.2d 207 (Fla. 1993).  This is commonly referred to as the "economic loss doctrine." The applicability of this doctrine will depend on the jurisdiction of the lawsuit.

As mentioned above, an architect owes contractual duties to the owner in addition to duties of care implicit to the professional services. For example, an architect can be liable under the contract between the owner and architect when the architect fails to properly supervise the project adequately.  First Nat'l Bank of Akron v. Cann , 503 F. Supp. 419 (N.D. Ohio 1980) affirmed, 669 F.2d 415 (6th Cir. 1982). Hence, if for some reason the owner does not pursue the architect for negligence in the change order process, the architect can still be liable for breach of its contractual duties.

If the contractual duties of the architect include active involvement in the change order process and the scope of that process includes the use of Construction Change Directives, it would appear that the architect would owe the duty to perform that function under the same professional standard as exists for all other functions performed by the architect.  Hence, where there are numerous changes and the change order processing has been slow, the failure of the architect to use, or recommend that the owner use, Construction Change Directives should be actionable conduct based upon both tort and contract principles. It follows that if delays occurred that could have been prevented by using Construction Change Directives, the architect should be liable to the owner for all resulting delays as well as all other damages.  

It should also be noted that one reason change orders may be necessary is because of substandard plans or specifications prepared by the architect. An architect may be liable to an owner for defective or inadequate  plans and specifications.  Huber, Hunt & Nichols, Inc. v. Moore , 136 Cal. Rptr. 603.  Therefore, if defective plans and specifications are the reason for numerous change orders that result in delays to the project, the architect should be liable to the owner for all the resulting damages.

CONSTRUCTION CHANGE DIRECTIVE

The Construction Change Directive procedure detailed in Art. 7.3 of the AIA 201 is a means to compel a contractor to perform extra work even though, for whatever reason, there is no agreement as to price or time adjustments.  This is sometimes called "force account" work.  The procedure calls for the issuance of a written directive from the owner and architect containing proposed price and time adjustments.  The contractor does not agree to the terms of the directive, but is allowed to include the price adjustments in future pay requests, Art. 7.3.2, 7.2.2 and 7.3.1.  If the owner and contractor do not ultimately agree to the adjustments, the matter is referred to the architect for determination.  Art. 7.3.7.

The Construction Change Directive is an innovative procedure designed to contractually obligate the contractor to perform force account work while, at the same time, providing the contractor with some security that he will be given some compensation for it.  The contractor is allowed to include in its "pay applications" requests for payment for changes authorized by the directive. Art. 9.3.1.1 and 7.3.7.  Hence, use of the procedure provides contractors, subcontractors and suppliers with at least some degree of cash flow during the course of the project.  The Construction Change Directive assures the owner that the project will not be delayed because of a lack of agreement with the contractor for an adjustment as to price or time for extra work. With the issuance of the directive, the contractor is given written documentation providing (1) that a change has, in fact, been ordered and (2) a precise description of the scope of the change.

The Construction Change Directive is one approach to force account work.  However, it is not unusual for public entities to use much more strict procedures to compel contractors to perform force account work, and to administer payment therefor.

In order to prove a constructive change or extra work claim, here is what you should do:

Review your contract.  There should be a "Changes", "Alterations", or "Extra Work" clause.  Generally, the clause permits the owner to order the change in the work that has been requested.

Confirm change in writing.  If the changes clause requires the contractor to have a written change order prior to commencing work, then you should make sure written approval has been given.  You would be surprised at the number of disputes arising from supposedly "approved changes" that were never formally approved or reduced to a writing.

Track your notice provisions.  Again, the contract contains the notice provisions regarding changes and the contractor will be required to prove that it complied with those notice requirements.

Prepare for both entitlement and quantum.  The contractor will be required to show that the work was, in fact, additional work required by the owner.  A written change order will go a long way to establishing this claim, but the contractor also has to be prepared for the case when the change is disputed by the owner.  The contractor should keep track of the extra costs it is claiming for proof at mediation or trial or arbitration.

Five Situations Where You May Be Able To Avoid A Contractually Mandated Written Change Order

Almost all written construction contracts require that the contractor obtain a written change order as a condition to payment for the additional work. However, owners customarily direct contractors to perform the work and promise that they will subsequently negotiate a fair price for the work. Almost every contractor can recite an example of such a promise that is then ignored by the owner when the time for payment arises.

Written change order provisions are placed in contracts so that the owner is assured that it will expressly approve any changes to the scope of work. In addition, such provisions are designed to give the owner timely and ample notice of the change in scope so it can investigate the claim and then either avoid the additional cost or take steps to mitigate the additional expense. Courts have routinely upheld such provisions when the additional work was performed without any notice to the owner.

However, the courts will be less inclined to enforce the written change order requirement when the owner has timely notice and orally induces the contractor to perform the changed work. Similarly, courts will not find it equitable to enforce such clauses against subcontractors when general contractors induce them to perform the additional work with a promise that they will be paid for the work at a later date.

The remainder of this article will review five legal theories that have been approved by California courts as a legal basis for avoiding the written change order provision in private works contracts when the owner knowingly approved the additional work. The article will then discuss written change requirements for California public works projects.

Private Works

1. Oral Waiver of the Written Change Order Provision

The doctrine of waiver has long been accepted by the courts. In essence, the courts treat appropriate action or conduct of the owner as waiver of the written change order provision. Quite simply, if the other party orally approves the additional work, it acts in a manner that is inconsistent with that party’s intent to rely on the change order provision. As a result, the court will treat that conduct as a waiver of the clause and allow the contractor to recover the value of the additional work. (See for example Howard J. White v. Varian Associates (1960) 178 Cal App 2^nd 348).

It should be noted that many contracts include additional clauses that seek to avoid such waiver arguments. In addition, some contracts include clauses that state that only certain personnel can approve change orders. For example, the provision may limit the change order approval to home office personnel rather than field personnel. Under appropriate circumstances, such anti-waiver provisions have been upheld by the courts as valid.

2. The Owner May Be Estopped From Relying On The Clause

The doctrine of promissory estoppel has been applied to a number of construction contract disputes. Promissory estoppel occurs when a party makes a promise to the other which the other party would reasonably rely on to take action based on the promise. If the owner promises to pay for the work and then allows the work to proceed it will be estopped from denying the promise to pay for the work.

3. A Requirement For A Written Change Order Can Be Rescinded By The Parties

As in the case of waiver, the parties can effectively rescind the written change order provision by their conduct. If the contractor and the owner orally agree that written change orders are not necessary the courts will treat the provision as being rescinded by the parties.

4. Allowing The Owner To Receive The Improvements Without Compensation Would Unjustly Enrich The Owner

This legal theory is based on the concept that once the work is complete the owner will have the permanent benefit of it and the contractor will not be able to repossess the work. However, the owner can only be unjustly enriched if the contractor was induced to perform the additional work by fraud, coercion, mistake, request or coercion by the owner. Thus the claim must be based on some action of the owner that resulted in the contractor performing the additional work.

5. California Statutory Law Allows A Written Contract To Be Orally Modified

California Civil Code section 1698 allows a written contract to be modified when the oral change order agreement is executed by the parties or if the change order is supported by new consideration. California courts have held that if the contractor fully completes the additional change order the oral modification to the contract is deemed executed by the parties and is thus effective. The section also states that it does not preclude “in an appropriate case the application of rules of law concerning estoppel, oral novation and substitution of a new agreement, rescission of a written contract by an oral agreement, waiver of a provision of a written contract, or oral independent collateral contracts.” Thus, the section does not prohibit the four other legal theories that have been applied by California courts to uphold oral change orders.

California Public Works

California public entity contracts are based on state and local procurement laws. The laws typically require approval for the changed scope of work before it is performed. For example, the Public Contract Code requires the county board of supervisors to approve change orders if the amount exceeds a certain threshold amount. However, the board may authorize the inclusion of a clause in the contract that allows for county employees to approve any work that is necessary for proper completion of the work.

Most public works projects include written change order provisions. The courts will uphold such provisions since they give the public entity timely notice of the change in scope so it can investigate the claim and then either avoid the additional cost or take steps to mitigate the additional expense.

1. A Public Agency’s Misrepresentation Maybe Allow A Contractor To Avoid The Written Change Order Clause

If the public entity was actively negligent in the design of the project or misrepresented the conditions that the contractor would encounter, the courts will not enforce the written change order requirement. Thus, if the contractor can establish that the public agency knowingly and positively misrepresented the site condition such clauses can be avoided. Generally, there is an implied warranty that plans and specifications are complete. If a showing can be made that the plans and specifications were inaccurate and that the public agency provided statements, although unintentional, that mislead the contractor, a contractor can recover the value of the extra work.

2. Reliance On The Statements Of A Public Official May Not Allow A Contractor To Avoid The Written Change Order Provision

While California courts will allow a contractor to avoid a written change order clause if a private owner promises to pay for the additional works, they will not permit a public works contractor to rely on such unauthorized statements to avoid the provision. However, if the contract vests a certain official or the project architect or engineer with the authority to approve the oral change order the courts will enforce the oral change order.

3. If An Unauthorized Public Official Orally Orders The Work, Proceed Under Written Protest

As previously stated, most public works contracts authorize certain public officials to approve change orders so that any additional work that is necessary for proper completion of the work is performed. If an unauthorized public official demands that the change order proceed, the contractor should give prompt notice that such work will be performed under protest. If the contract has a clause that sets forth the method of notifying the public agency of such a change order, those requirements should be followed. If the contractor provides timely written notice that it is proceeding under protest, the courts may not enforce the requirement for a written change order.

Conclusion

Construction contracts typically include a requirement that change orders be in writing. If such a provision exists, a prudent contractor will insist that all change orders be in writing. If the owner, or the prime contractor if the agreement is between a general contractor and a subcontractor, chooses to disregard the requirement of a written change order, confirm the instructions in writing. The written confirmation should be provided to the other party and the architect, if any.

A Change Order Checklist

It is inevitable that change orders will be issued during the course of a construction project. The change in the scope of work can result in the increase of the contract completion time and/or the amount of compensation paid. This article shall provide a checklist that can be followed to help ensure that the contract change order clauses are complied with when a contractor seeks a change order.

From a lawyer’s point of view, a change order is simply an amendment to the construction contract.  Since it is an amendment to the contract it is important to comply with the contract change order clauses. Typically, changes in the scope of work can be made expressly through instructions from the other party or constructively. A constructive change order occurs when the other party effectively requires that work outside the contractually agreed upon scope of work be performed. In all but the least sophisticated contracts there are different change order contract provisions for express and constructive change orders.

The express change order provisions set forth how the change is be documented and the means for pricing the change order. The constructive change order provisions will typically include such provisions along with a notification requirement.

Most contracts have specific requirements for how change orders are to be processed. It is not uncommon for the owner to deny a change order based on an assertion that the contract change order clauses were not complied with by the other party. It should be noted that there are defenses to such allegations, which were discussed in a previous article.

Since most change orders are initiated in the field it is advisable to have a checklist for change orders for field personnel to follow. Contractors should create such a checklist and make it company policy for personnel to comply with it. Such a checklist should, at a minimum, include the following:

1. Have the change order contract provisions been reviewed relative to notice, form, timing and pricing of the proposed change order?

2. Has adequate and timely notice of the changed condition, extra work, and additional time requirements been given to the other party?

When is the deadline for submitting claims?

Contracts will typically require written notification on claims for compensation to be submitted within a certain time period. The time period can range from between 7 to 21 days after a contractor is aware of an event giving rise to a claim. Failure to provide notice within the prescribed time period may result in a claim being barred. Therefore, contractors should be wary of any such notice provisions and deadlines for making claims for changes.

It is important that the notice provisions be complied with when the change in scope of the work is first observed. A common defense to a change order proposal is the failure to give timely notice which prevents the other party from documenting the changed conditions, document the additional work and/or make an informed decision to proceed with the additional work.

3. Is there a method for logging the submission, response and payment of the change order ? If so, has the proposed change order been logged in?

The time that another party takes to respond to a change order can have a direct impact on the timely completion of the contract work. A change order log allows a contractor to track the time between submission and approval of the change order. It also serves as a method for reminding the field personnel to follow-up on a tardy response.

4. Does the proposed written change order provide sufficient information so that the other party can determine why the additional work and/or additional time requirements are outside the agreed scope of work? Have you provided back-up documentation for the change order?

It is advisable to reference all the relevant general conditions and specifications. If you have photographs, entries from daily job logs, relevant correspondence, including such documentation with your change order may speed the acceptance and payment of the change order.

5. Is the proposed change order priced in a manner that complies with the contractual change order requirements? If the change order can be fully priced until the work is complete, are you providing pricing updates in accordance with the contract requirements (e.g. daily, weekly, monthly) ?

Most contracts provide for three basic means for pricing change orders; the choice of which method is left to the owner. They include an agreed fixed amount, time and materials or a requirement that the contract proceed with the work with cost to be negotiated at a later date based on data that is developed during the additional work. If you cannot agree on the exact amount before the additional work is commenced, many contract clauses require the contractor to notify the owner of the exact cost of the work on a regular basis. The clause may provide that the failure to comply with such a requirement may result in a waiver of the claim.

6. If the change order is on a force account basis (i.e., the other party requires you perform the work on a time and material basis), have you complied with the contractual provisions for evidencing that work is being performed? Does the contract require a representative of the other party to sign such documentation? If so, are you complying with that requirement?

It is important to have force account work documented in accordance with contract. Many require that a specific project representative review and acknowledge that the work was performed on a daily basis.

7. Does the proposed change order include a component for any additional time that may be required for the change order? If so, does the time component explain how the project will be impacted?

8. If you are uncertain as to how the proposed change order will impact the overall time for completion of the project and/or impact other work, have you reserved your right to claim such impacts (e.g., loss of productivity, delays, ripple costs, acceleration) at a later date?

The overall impact on a single change order or a series of change orders may not be realized until well after the additional work is commenced. If you are uncertain as to the impact of the change, it is wise to reserve your rights to make a claim for such impacts. It is also advisable to track the impact of the change on the job. A means for tracking the impact could include a time line. In a columnar format, the key date and then a description of what occurred on that date should be set forth. Key dates should, at a minimum, include: (a) when the claim work was discovered, (b) when the claim work was reported, (c) when the claim work was started, and (d) when the claim work was completed.

On some projects the number and extent of change orders are well in excess of what the parties contemplated when they entered into the construction contract. If the size, nature and number of change orders becomes well in excess of that contemplated by the parties, the contractual method for fairly compensating the contractor may not be applicable. As a result, the doctrine of a cardinal change has been developed by the courts. Generally, a cardinal change occurs when the contractor is required to perform work that is such a nature, quantity and/or impact that is dramatically beyond the types of changes the parties contemplated when they entered into the contract. Maintaining detailed documentation of how the excessive changes impacted the job is necessary for proving a cardinal change.

9. If the change order has been denied, have you complied with the contract clauses for later submission of that change order as a claim resolution process? Have you continued to track the costs and impacts of the additional work?

Such documentation should include daily job logs, schedules, photographs, bid documentation, relevant provisions of the plans and specifications, project correspondence, change order pricing estimates and documentation, job cost reports and employee time records for the subject work. Ideally, a separate file should be established to include the aforementioned documents and to track the status of the claim.

Have a provision in the original contract specifically stating that all change orders will be in writing.

Insist that the contract terms be followed and require all change orders to be in writing and signed and dated by the parties involved. The change orders should refer to the original contract terms and note what was included and why the newly requested work requires a change order.

The change order should spell out exactly what the new changes are and spell out how the work is changed from that originally requested. It should present an estimation of the costs that will be incurred based on the changes, establish a new deadline and the payment terms for the additional work and/or materials.

If working on an hourly rate, confirm the hourly rate for the additional work required under the change order.

Do not agree to a change order that is open-ended.

There are times when subcontractors believe they are being asked to do work not covered in the original contract, but the contractor or owner disagree and think the requested work was included in the original contract. This can be prevented if the original contract designates either the project engineer or architect as the decision maker in the event such an issue comes up.

Other things subcontractors can do to protect themselves legally and to minimize disputes over payment include:

Confirming in writing any conversations with contractors concerning matters subcontractors consider changes to the original contract.

Taking photos, preferably videotapes, of work at various s stages of the project.

Keeping all documents and receipts that support their claim that the work order was changed from the terms of the original contract.

Attorneys experienced in construction law and contracts can review the original contracts and work requested to assist in determining whether a change order is required and help with all related construction claims.

Conclusion

The failure to comply with a contractual change order may result in the denial of a substantial change order. Thus, it is important to establish a policy for the processing of change orders. The checklist set forth in this article is not intended to be all inclusive of the items that should be included, but rather represents a sample of items that may be included.

Irrespective, the starting point for every checklist are the contract change order provisions. Based on the author’s experience in prosecuting change order disputes in the courts, the importance of familiarizing yourself with and subsequently complying with change order contract provisions cannot be stressed enough. It is strongly recommended that a contractor require field personnel to read and understand the importance of those provisions. By requiring field personnel to gain an understanding of those requirements, the contractor has made a large step in successfully processing change orders.

Avoid Five Costly Mistakes Made By Government Construction Contractors

Although not intentional, contractors tend to make the following mistakes which can cost them thousands or millions in construction projects.

Failure to understand how the various FAR clauses impact your ability to have equal footing with the agency.  Federal contracts are primarily written for the benefit of the agency.  Having your people trained in the various clauses can save the company a substantial amount of money.

Not understanding the difference between a Request for Equitable Adjustment and a CDA claim.  There is a difference between the two. Having a government construction lawyer to guide you around the lurking pitfalls can also save you thousands in unnecessary attorney fees.

Failures to submit a construction claim that meets the CDA requirements. Both small and large contractors make fatal procedural and substantive errors then submitting their claims. See information on Contract Disputes Act and Pass Through Claims. There are statutory requirements that you must meet including getting the contracting officer’s final decision. Failure to meet them can create delays and even rejection.

Not understanding what constitutes a Contracting Officer’s final decision. Your construction claim must have a CO’s final decision before you can appeal to the Court of Federal Claims or Board of Contract appeals.

Failure to properly address cure notices. When a contracting agency believes that you are a performance risk, a cure notice is forthcoming.

Prepare, Negotiate and Litigate Construction Claims in Federal projects allow contracting officers (COs) great latitude in resolving disputes. However, you may often find your company trying to negotiate a claim that you know has merit.

Avoid Costly Pitfalls With Requests for Equitable Adjustment Claims: An important part of the government construction claims process is understanding the nuances between a CDA claim and a Request for Equitable Adjustment. Develop Internal Policies and Controls: Given the mandated increased oversight on federal contractors, both small and large companies are targeted for audits and investigations.

Get Help With Government Construction Proposal Writing: Bidding on government contracts is very tough business. Whether you are writing proposals for Army Corps Projects, Navy projects or for another agency, you want to strengthen your technical proposals, construction bid bond submissions and management approaches.

Federal Construction Contracting for Small Businesses: The laws associated with government contracting include a wide array of complex regulations that dictate how you perform. For example, small businesses are restricted to certain guidelines under teaming agreements and joint venture contracts.  Issues arise concerning SBA size standards and limitation in subcontracting requirements. At the law office of Watson & Associates our government construction law attorneys provide legal advice on matters pertaining to:

·         Prime and subcontracting agreements

·         Size standard disputes

·         Subcontracting plans

·         Teaming agreements

·         Joint venture agreements

·         Filing construction claims

·         Addressing construction defect disputes

Metropolitan Engineering, Consulting & Forensics (MECF)

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Metropolitan has been engaged by design-build engineering firms, general contractors, and specialty subcontractors to prepare and substantiate differing site conditions claims and has been engaged by project owners and public agencies to evaluate claims submitted by contractors.  Metropolitan has in-house multidisciplinary expertise of engineers, geologists, construction management professionals, and schedulers to analyze all aspects of DSC claims.  The results of our development and evaluation of DSC claims have been presented in discussions with our clients, written reports, and testimony at review board hearings, arbitrations, mediations, and trials.

In general, Metropolitan has expertise to evaluate issues related to:

·         Entitlement (technical merits of claim)

·         Cost analysis 

·         Delay impacts

·         Disruption

·         Productivity Loss

·         Acceleration

·         Design defects

·         Construction defects

In Metropolitan’s evaluations of entitlement, our engineering and construction professionals have used their education, training, and expertise to address issues related to the following types of site conditions: 

·         Excavation and trench failure 

·         Embankment failure 

·         Pile-driving refusal  

·         Rock suitability for drilled shafts 

·         Import fill suitability 

·         Borrow source characterization 

·         Unsuitable material 

·         Subgrade suitability 

·         Embankment/subgrade R-value 

·         Construction equipment mobility  

·         “Pumping” and “rutting” of subgrade 

·         Expansive soil 

·         Collapsible soil 

·         Liquefiable soil 

·         Cobbles and boulders (particle size) 

·         “Running ground” 

·         Sinkholes 

·         Excessive ground moisture 

·         Groundwater and seepage 

·         Groundwater pumping rates and volumes 

·         Rock rippability 

·         Back-cut slope stability 

·         Unmapped landslides 

·         Faults 

·         Ground fissures 

·         Hazardous materials (naturally occurring and manmade)