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.
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
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.4th 390, and
relying on the Weseloh
Family LTD. Partnership v. K. L. Weseloh Construction Company, Inc.
(2004) 125 Cal.App.4th 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 (5th 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
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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 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 2nd 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.
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.
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 2nd 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)
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/
https://sites.google.com/site/metropolitanenvironmental/
https://sites.google.com/site/metroforensics3/
We are happy to announce the launch of our twitter account. Please make
sure to follow us at @MetropForensics or @metroforensics1
Metropolitan appreciates your business.
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 manmade)