HOW TO MANAGE CONSTRUCTION
DISPUTES TO MINIMIZE SURETY AND CONSTRUCTION CLAIMS. PART 7:
DESIGN AND CONSTRUCTION DEFECTS Claims
Introduction
Construction is a
business fraught with risk. Disputes
over even the smallest of issues can quickly escalate, with crippling
consequences to the project and the parties.
Over the years, the construction industry has developed various methods
of contractually allocating the risk of project delay and disruption. Some of these methods include liquidated
damages provisions, "no damages for delay" clauses, mutual waivers of
consequential damages, provisions that limit liability, claims notice
provisions, “waiver of damages clauses”, acceleration clauses, “time is of the
essence” clauses, change order clauses, and provisions addressing
responsibility for the adequacy of the construction plans and
specifications. Parties frequently
litigate the sufficiency of these risk-shifting efforts in conjunction with the
underlying merits of delay and disruption disputes.
The Most
Frequently-Encountered Construction Claims & Disputes
In Part 1 of our
series of how to manage construction disputes to minimize surety and
construction claims, we addressed the construction delay claims and the methods
typically used to analyze them.
We indicated there
that the most frequently encountered claims include:
1. Construction Delay
Claims
2. Disruption and Loss
of Labor Productivity Claims
3. Design and
Construction Defects Claims
4. Force Majeure
Claims
5. Acceleration or
Compression of the Schedule Claims
6. Suspension,
Termination and Default Claims
7. Differing Site
Conditions Claims
8. Change Order and
Extra Work Claims
9. Cost Overrun Claims
10. Unacceptable
Workmanship or Substituted Material Claims
11. Non-payment Claims
(stop notice (or Notice to Withhold) claims, mechanics’ lien (only for private
construction projects) and payment bond claims)
Part 7 of this
series discusses item 3 above: Design and Construction Defect Claims.
What is a CONSTRUCTION defect?
According to the
Insurance and Risk Management Institute, a construction defect is generally
speaking, a deficiency in the design or construction of a building or structure
resulting from a failure to design or construct in a reasonably workmanlike
manner, and/or in accordance with a buyer's reasonable expectation. The most dangerous defects have the capacity
to fail, resulting in physical injury or damage to people or property. However, many defects present no increased
risk of injury or damage to other property but nevertheless cause harm to the
property owner in the form of loss of use, diminution in value, and extra
expenses incurred while defects are corrected.
This latter type of defect is often referred to as a passive
defect.
Many states have more
specifically defined the term "construction defect" for purposes of
applying statutes that dictate processes for remedying and litigating
construction defect claims. These
statutory definitions vary by state.
Nevada, for example, uses the term constructional defects and defines it
as follows:
“Constructional defect” means a defect in the design,
construction, manufacture, repair or landscaping of a new residence, of an
alteration of or addition to an existing residence, or of an appurtenance and
includes, without limitation, the design, construction, manufacture, repair or
landscaping of a new residence, of an alteration of or addition to an existing
residence, or of an appurtenance:
Which is done in violation of law, including, without
limitation, in violation of local codes or ordinances;
Which proximately causes physical damage to the residence,
an appurtenance or the real property to which the residence or appurtenance is
affixed;
Which is not completed in a good and workmanlike manner in
accordance with the generally accepted standard of care in the industry for
that type of design, construction, manufacture, repair or landscaping; or
Which presents an unreasonable risk of injury to a person or
property.
For architects
and other design professionals, one of the most devastating professional and
business risks is from litigation alleging negligence in performing
professional services. These alleged
negligent acts, errors, or omissions may cause damage to owners, contractors,
or other third parties, and the architect’s firm may be found liable for these
damages.
WHAT ARE THE TOP CLAIMS THAT CAN BE FILED AGAINST AN
ARCHITECT OR ENGINEER?
The Common Law Standard of Care
The standard of care for architects and engineers is set forth in numerous
court decisions as follows:
The architects and other
design professionals are under a duty
to exercise ordinary, reasonable care, technical skill, and ability and
diligence, as are ordinarily required of architects, in the course of their
plans, inspections, and supervision during construction.
The duty owed by architects and engineers was further defined in other
court decisions as follows:
An
architect’s efficiency in preparing plans and specifications is tested by the
rule of ordinary and reasonable skill usually exercised by one in that
profession. (See, Annot., 25 A.L.R.2d 1088.) The duty of an architect depends
upon the particular agreement he has entered with the person who employs him
and in the absence of a special agreement he does not imply or guarantee a
perfect plan or satisfactory result; rather, he is only liable if he fails to
exercise reasonable care and skill. 5 Am.Jur.2d, Architects, Sec. 8.
The standard of care owed by an architect/engineer may be altered
by agreement with the owner. A provision
in an owner-A/E agreement by which the A/E represents that he or she will
follow the highest professional standards in performing all professional
services under the agreement would appear to override the standard of ordinary
and reasonable skill established by the typical court decisions, at
least with regard to a claim by the other party to the design professional’s
contract.
Among the reasons architects have been found answerable in malpractice
actions is because they hold themselves out and offer services to the public as
experts in their line of endeavor. Those who employ them perceive their skills
and abilities to rise above the levels possessed by ordinary laymen. Such persons have the right to expect that
architects, as other professionals, possess a standard minimum of special
knowledge and ability, will exercise that degree of care and skill as may be
reasonable under the circumstances and, when they fail to do so, that they will
be subject to damage actions for professional negligence, as are other
professionals.
In performing services, an architect
must possess and apply the knowledge and use the skill and care that is
ordinarily used by reasonably well-qualified architects. A failure to do so is a form of negligence
that is called malpractice.
The only way in which a judge or a jury
may decide whether the defendant architects possessed and applied the
knowledge, and used the skill and care which the law required of them, is from
evidence presented in the trial by architects called as expert witnesses. The judge or jury must not attempt to
determine this question from any personal knowledge he/she may have.
THEORIES
OF LIABILITY
Below
are the top five avenues of architect liability in New York and most other
states:
1.
Contract Claims. Typical contract based claims against an
architect include: failure to properly design the building, failure to meet the
applicable federal, state or local codes, failure to complete projects on time,
work performed improperly under the architect’s direction, improper design of
moisture and drainage control, leaking roofs and shrinking woodwork. In the absence of any express language
specifying the standard for the architect's performance in a breach of contract
claim, the courts apply a negligence standard.
In a negligence
standard claim, it must be shown that the architect failed to perform in
accordance with the standard of professional care usually exercised by such
professionals in the community.
Caution. Avoid
express warranties, if possible. Express
warranties regarding the quality of architectural and engineering services to
be performed may appear in an owner-architect or owner-engineer agreement. These warranties usually concern compliance
with local codes, rules, and regulations, and state and federal laws. However,
more often than not, qualifying language will have been inserted limiting the
architect’s or engineer’s liability to compliance “to the best of his or her
knowledge, information, and belief.” In the absence of any contract language or
given the qualifier noted above, the architect/engineer would presumably be
held to the standard of ordinary and reasonable care discussed in above under
the common law standard of care.
2.
Warranty Claims. New York does not provide a cause of action
against architects for breach of an implied warranty. Nor does the work of an architect constitute
a product for which strict liability claims could exist. The architect may, however, enter into a
contract with terms that provide for the architect's liability if the architect
fails to produce specific results as guaranteed in the contract, even if the
architect otherwise conforms to the community standard of performance. Other states do incorporate in their statutes
and in their case law the doctrine of implied warranty in connection with the delivery
of professional design services.
Architects and engineers represent themselves to be
competent in the preparation of plans and specifications necessary to the
construction of suitable structures, including but not limited to the knowledge
of and compliance with applicable building codes, and where they fail to use
reasonable care to produce a satisfactory structure in compliance therewith,
they may be sued for breach of an implied contract term. Himmel
Corp. v. Stade, 52
Ill.App.3d 294, 367 N.E.2d 411, 414 – 415, 10 Ill.Dec. 23 (1st Dist. 1977).
To
recover for breach of express warranty, a plaintiff must prove that a warranty
existed, the defendant breached the warranty, the breach proximately caused the
losses claimed as damages, and timely notice of the breach was given to
defendant. An express warranty is not
required to be in any specific form and may be either written or oral. Whether a statement is an express warranty is
a question of fact to be determined by the judge or the jury.
Builders
often provide homebuyers with express warranties protecting various elements of
the physical construction. Additionally,
express warranties are often included to disclaim or limit implied warranties
of habitability, fitness, and workmanship. However, while several cases support the
validity of such disclaimers, the courts have refused to answer whether they
are enforceable, and it remains an open question under Colorado law. Privity of contract or standing as a
third-party beneficiary of the contract is required in order to be protected by
the warranty.
Breach
of Implied Warranty
There are various implied warranties available in most
states. Two important warranties are the
implied warranty of habitability and the implied warranty of workmanlike
construction.
Implied
Warranty of Habitability
A
buyer is "entitled to relief based on the theory of implied warranty of
habitability if he proves the house was not built in a workmanlike manner or
that it was not suitable for habitation." The warranty of habitability has been likened
to strict liability for construction defects, and proof of a defect due to
improper construction, design, or preparations is sufficient to establish
liability in the builder-vendor. Courts
have extended the implied warranty of habitability to situations in which a
home becomes uninhabitable for reasons other than the workmanship, such as soil
expansion. Id. Generally, in these cases, the breach of the implied
warranty of habitability occurs in the builder's selection of the building
location.
Implied
Warranty of Workmanlike Construction
The
warranty of workmanlike construction is another implied warranty. It does not,
however, guarantee perfect construction by the builder. For construction to be
done in a good and workmanlike manner, there is no requirement of perfection;
the test is reasonableness in terms of what the workmen of average skill and
intelligence (the conscientious worker) would ordinarily do.
Statute
of Limitations for Breach of Warranty
In general, a breach of warranty is governed by the
statute of limitations for contract actions and must be filed within a
three-year period. Depending on the
state, there are statutes that either lengthen or shorten the statute of
limitations in a breach of warranty case against a design or construction
professional to two years.
3.
Design Liability. New York State law has established that an
architect's work will be judged by the standard of ordinary and reasonable skill usually exercised by a licensed
professional, unless the parties state otherwise in their contracts. This claim is essentially one for
professional malpractice or negligence in the field of architecture.
To succeed on a
negligence claim, the plaintiff must show (1) the existence of a duty on the
part of a defendant, (2) a breach of that duty, (3) a causal connection between
the defendant's breach and plaintiff's injury, (4) and injury. Generally, a duty is owed to anybody that
could foreseeably suffer damages as a result of a defendant's negligent
conduct.
The more complex
and unusual the architect’s design, the more latitude an architect is allowed. This latitude however can be quite narrow. For example, an architect was found liable for
damages to the owner for roof repairs, not because the roof was installed
incorrectly, but because the design of the roof caused owner significantly
increased maintenance and repair costs.
Design liability
may also rest with the architect for items that are actually beyond the design
of the architect. New York courts have
held that an architect will be liable to the owner for any damages incurred as
a result of the architect's approval of engineering drawings and a defect
therein causes damage to the owner.
Some states require
that an Affidavit of Merit is submitted along with the suit. New York does not have such statute. The Affidavit of Merit for New Jersey is
listed below:
2A:53A-27 Affidavit of lack of care in action for
professional, medical malpractice or negligence; requirements. 2.In
any action for damages for personal injuries, wrongful death or property damage
resulting from an alleged act of malpractice or negligence by a licensed person
in his profession or occupation, the plaintiff shall, within 60 days following
the date of filing of the answer to the complaint by the defendant, provide
each defendant with an affidavit of an appropriate licensed person that there
exists a reasonable probability that the care, skill or knowledge exercised or
exhibited in the treatment, practice or work that is the subject of the
complaint, fell outside acceptable professional or occupational standards or
treatment practices. The court may grant no more than one additional period,
not to exceed 60 days, to file the affidavit pursuant to this section, upon a
finding of good cause.
In the case of an action for medical malpractice, the
person executing the affidavit shall meet the requirements of a person who
provides expert testimony or executes an affidavit as set forth in section 7 of
P.L.2004, c.17 (C.2A:53A-41). In all other cases, the person executing the
affidavit shall be licensed in this or any other state; have particular
expertise in the general area or specialty involved in the action, as evidenced
by board certification or by devotion of the person's practice substantially to
the general area or specialty involved in the action for a period of at least
five years. The person shall have no financial interest in the outcome of the
case under review, but this prohibition shall not exclude the person from being
an expert witness in the case. L.1995,c.139,s.2; amended 2004, c.17, s.8.
A
negligence claim stemming from a construction contract may be barred by the
Economic Loss Rule. This rule prevents
recovery for negligence when the duty breached is a contractual duty and the
harm incurred is the result of failure of the purpose of the contract. However, when a contract neither encompasses a
duty nor requires that specific work be done, any work undertaken by a
professional must be done in a reasonable manner. Failure to do so could result
in an award of actual damages on a negligence claim.
4.
Supervision and Inspection of Work-in-Place. If an architect assumes responsibility for
performing site supervision and inspection, he/she is bound to use due care in
the performance of such duties. The
primary purpose of the inspection requirement is to make it a contract
obligation for the architect to provide the owner with assurances that the work
is being completed in conformance with plans and specifications.
However, as
elaborated in case law from 1866, “the architect must be diligent in inspecting
and supervising the work, but is not obligated to discover every defect in a
contractor's or subcontractor's work and will not be liable for defects so long
as they are not attributable to carelessness, negligence, or inattention on the
architect's part.”
Regardless of
limitations over means and methods as stated above, failure of the architect to
abide by the contract terms of inspection can result in the architect
ultimately being liable to the owner. If
it can be established that the architect breached this obligation, and this
breach was the “proximate cause” of a failure to discover a defect, the
architect may be liable to the owner for the cost incurred in correcting the
defect.
5.
Certification of Progress Payments. Design professionals have become increasingly
subject to claims arising out of their design and construction administration
services. The obligation of the design
professional to issue payment certificates has long been a tedious and dreaded
task and one that often creates numerous liability problems. Although the only
real purpose of issuing payment certificates is to inform the owner or lender
that the contractor is entitled to payment, these certificates are often used
by potential claimants as a basis for many types of legal actions. Courts in New York recognize the numerous
responsibilities owners look to architects to perform. Just as courts recognize that owners may rely
on architects for inspections of work, they also recognize that owners look to
architects for certification of progress payments.
Should an architect
improperly approve a progress payment, or prematurely release retainage, the architect
may be liable to the owner for any damages suffered, as this may decrease the
contractor's incentive to complete the work.
By issuing payment
certificates, the design professional makes a potential claimant out of
everyone involved in the construction process. Those people from whom the
design professional can expect claims include prime contractors, owners,
subcontractors, sureties and construction workers who have suffered personal
injuries.
Claims by Prime
Contractors.
The most common complaint
voiced by prime contractors against design professionals is that of under
certification. When a design professional under certifies a payment request,
they are recommending that too little money be paid out by the owner to the
prime contractor. The prime contractor might claim that the design professional
was negligent and under certified the work because the design professional
failed to accurately measure the progress of the work. If the design
professional does under certify payment, the prime contractor may be harmed and
denied needed resources to complete its work, possibly resulting in a default.
In the case of defective work, the prime contractor will undoubtedly point to
the payment certificates which are issued by the design professional as evidence
that the owner and the design professional accepted the work.
Claims by
Subcontractors.
Subcontractors often
expect the design professional to act as watchdog to make sure that the prime
contractors are paying them with the proceeds received from the owner. If the
design professional fails to monitor the payments made by the prime contractor
to the subcontractor, the subcontractor may argue that the design professional
was negligent and caused a diversion of funds. By failing to monitor such
payments, the design professional could be said to have denied the
subcontractor of needed resources to complete its work, which could possibly
lead to a default.
Claims by Sureties.
Sureties may have
claims against design professionals for both over certification and under
certification. If the design professional under certifies payment and causes a
contractor default, the surety may be forced to complete the contractor's work.
Similarly, if the design professional over certifies payment, thereby reducing
the amount of retainage needed to adequately complete the job, the surety may
be forced to complete the contractor's work, upon default, with insufficient
funds.
Arguments
for Architect Liability to the Surety
Surety
actions against architects share these common arguments:
Improper
Certification of Progress Payments—the approval of
draw requests that result in overpayments to the contractor may result in loss
to the surety if the surety has to step in and is deprived of funds that could
be used to complete the project.
Contractor
“Front-Loads” Pay Requests—to cut down on the expense of
borrowing funds for a project, some contractors may submit pay requests beyond
what the work-in-place would allow. Front-loading a contract prevents the
surety from obtaining the fair value for its continuation of the contract.
Contractor
Shorting Subcontractors and Suppliers—That a surety
may have to make bond payments where an architect fails in its duty to discover
that a contractor is not paying its subs is foreseeable to some courts.
Premature
Release of Retainage—the surety may successfully sue the
architect to recover the improperly authorized release of retained funds when
it is discovered that the architect failed to adequately investigate whether
the contractor had paid for all labor and supplies.
Errors
in Contract Supervision or Inspection—Some courts
recognize the surety’s right to sue an architect where it is alleged that the
architect failed to adequately inspect the work, make an adequate number of
inspections, and improperly authorized payment for defective work.
Failure
to Report Construction Defects and Require Corrections to Defective Work—some
courts hold that the architect is bound to report defective work and see that
it is corrected even when there is no contractual obligation.
Deficient
Design Documents—if a contractor defaults and the
surety’s cost to complete the project increases because of deficient design,
the surety may assert a claim. The foreseeability of harm to the surety is less
certain because the surety is not the intended end-user of the design or the
finished project.
Claims by the Owner.
Claims brought by
owners against design professionals represent the greatest variety of potential
claims. The owner may allege that the design professional negligently over
certified payments or may allege that the design professional was negligent for
failure to adequately supervise the work. Most owners rely upon the issuance of
a payment certificate by the design professional to determine whether the
contractor is entitled to payment. If the design professional over certifies
payment, thereby recommending that payment be made for work that is not yet
done or for patently defective work, the owner may be injured. When the design
professional over certifies payment, the amount of retainage held by the owner
as security for default or defective work is reduced. This, of course, could
leave the owner with insufficient funds to complete the project.
In the case of
defective work, the payment certificates issued by the design professional are
typically used by the owner to attempt to hold the design professional
responsible for the contractor's work. The owner may allege that the design
professional was responsible for inspecting the work prior to issuing payment
certificates to make sure that the work conformed with the Contract Documents.
Owners may also view payment certificates as a guarantee by the design professional
that the work was properly done.
Claims by
Construction Workers.
Claims brought by
construction workers against design professionals, whether for negligence, may
be brought based upon the design professional's duty to issue payment
certificates. A construction worker who is injured on the job site may allege,
by inference, that the duty of the design professional to issue payment
certificates necessarily requires that the design professional visit the site
to check on the progress of the work, and that while checking on the progress
of the work, the design professional has a duty to protect people on the job
from any unsafe construction practices or defective conditions.
LEGAL ANALYSIS
The few cases which
have addressed the duty of the design professional to issue payment
certificates have analyzed that duty based upon responsibilities similar to
those set forth in the standard form AIA Agreements. Despite the use of the
typical disclaimer clauses used by the AIA, which protect the design
professional from liability for issuing payment certificates, the design
professional is often the subject of litigation.
Negligent Over
certification Cases.
There have been few
reported decisions in Illinois regarding the potential liability exposure of a
design professional for under certifying or over certifying payment requests.
Beginning with the case of City of Chicago v. Agnew, 106 N.E.2d 252, 264
Ill. 288, Illinois courts have held that contractors and sureties have standing
to assert claims of "negligent over certification" against owners and
others with whom they are in direct contractual privity. The law is much less
clear, however, whether those same contractors and sureties would have standing
to assert claims of "negligent over certification" against design professionals
with whom they do not have contractual privity.
The court in Southern
American Insurance Co. v. E.W. Corrigan Construction Co. et al. al., 1991
U.S. Dist. Lexis 10368 (N.D. Ill. 1991) held that the surety of a
subcontractor, who defaulted on the job, could not bring an action against the
architect who allegedly over certified the work of the subcontractor, thereby
depriving the surety of its primary source of security to mitigate the costs of
completing the subcontractor's work. The court reasoned that neither the
subcontractor nor the surety had a contract with the architect and therefore
the architect owed no legally cognizable duty to the subcontractor or the
surety. As support for its decision, the court cited the well-known decision of
Moorman Mfg. Co. v. Nat'l. Tank Co., 91 Ill. 2d 69, 61 Ill. Dec. 746,
435 N.E.2d 443 (1982), which prohibits the recovery of economic loss in tort
actions.
More recently, Judge
Jack Hoogasian of the Circuit Court of Lake County in Montessori School of
Lake Forest v. Aetna Casualty and Surety Company of Illinois, et. al., 92 L
1027 (1994), held that a surety could bring a claim for "negligent over
certification" against an architect with whom the surety had no
contractual privity. In that case, the Montessori School of Lake Forest, as
owner, filed a lawsuit against the General Contractor who worked on the job and
its surety for defective work. The surety filed a third-party complaint against
the architect alleging that the architect negligently over certified payments due
the General Contractor, thereby reducing the amount of funds needed to complete
the work. The architect moved to dismiss the third-party complaint on the
grounds that the surety was not a third-party beneficiary to the
Owner/Architect Agreement and that the surety could not recover economic losses
against the architect for its alleged negligent certification of payments.
The surety filed a
brief in response to the architect's motion to dismiss and argued that the
surety was a third-party beneficiary to Owner/Architect Agreement because the
surety was explicitly given the right to use any retainage to complete the job
and was to benefit by the use of this retainage. The surety also argued that
regardless of whether it was a third-party beneficiary to the Owner/Architect
Agreement, the architect owed the surety an independent duty to correctly
estimate the progress of the work and to only certify and approve conforming
work for payment. The surety stated that the architect's representations
concerning certification of payments were negligent and because the architect
was allegedly in the business of supplying information, the Moorman
doctrine did not apply and the surety could bring a claim for negligent over
certification. The court, in an unpublished opinion, held in favor of the
surety.(1)
Negligence.
The liability
exposure of design professionals for negligence, based upon issuing payment
certificates, can be greatly reduced provided that design professionals take
particular care when negotiating their contracts with owners. The potential
liability exposure of a design professional for negligence, whether brought by
owners or personal injury claimants, typically depends upon whether the design
professional has any responsibility for site inspection or review of the
contractor's work for compliance with the Contract Documents.
In Corbetta
Construction v. Lake County Bldg. Commission, 64 Ill. App.3d 313, 21 Ill. Dec. 431,
381 N.E.2d 758 (2nd Dist 1978), the Court held that the architect was negligent
and liable to the owner for the contractor's defective work because the
architect, who had agreed to supervise the construction, should have discovered
the contractor's defective work. In Busick v. Streator Township High School,
234 Ill. App. 3d 647, 175 Ill. Dec. 423, 600 N.E.2d 46 (3rd Dist. 1992), the
Court held that the architect was not liable to an injured construction worker
for job related injuries because the architect had no duty to supervise the
work, nor was he responsible for worker safety. In reaching its decision, the
Court noted that the legal duty of a design professional to third persons, such
as construction workers and other personal injury claimants, is based upon the
scope of the design professional's agreement with the owner (whether the design
professional has agreed to inspect and supervise the work).
HOW THE DESIGN
PROFESSIONAL CAN MINIMIZE LIABILITY EXPOSURE WHILE PARTICIPATING IN THE PAYMENT
PROCESS
Unquestionably, the
best way for design professionals to protect themselves from liability arising
out of the payment process is to avoid issuing payment certificates. Some
owners may be willing to relieve the design professional of the duty to issue
payment certificates and perform this task themselves, or delegate it to a
construction manager, in order to retain greater control over the payment
process. If an owner is willing to absolve the design professional from the
headaches which typically accompany issuing payment certificates, the design
professional should accept the offer. More commonly, the owner will request
that the design professional issue payment certificates. The following
suggestions are ones that the design professional should consider when an owner
has requested that the design professional issue payment certificates.
The Design
Professional Should Only Be Held To A "Negligence" Standard.
Both the B141 and
A201 Agreements seek to limit the liability exposure of the design
professional, for issuing payment certificates, by creating a negligence
standard. These standard forms of agreement carefully provide that such
certificates are based upon the "knowledge, information and belief"
of the design professional, making it clear that the design professional shall
be held only to the professional standard of care -- not a guarantee -- in the
exercise of its certification function. Paragraph 2.6.10 of the B141 Agreement
sets forth the primary duties of the design professional to issue payment
certificates:(2)
"The Architect's
certification for payment shall constitute a representation to the Owner, based
on the Architect's observations at the site as provided in Subparagraph 2.6.5
and on the data comprising the Contractor's Application for Payment, that the
Work has progressed to the point indicated and that, to the best of the Architect's
knowledge, information and belief, quality of the Work is in accordance with
the Contract Documents. The foregoing representations are subject to an
evaluation of the Work for conformance with the Contract Documents upon
Substantial Completion, to results of subsequent tests and inspections, to
minor deviations from the Contract Documents correctable prior to completion
and to specific qualifications expressed by the Architect. The issuance of a
Certificate for Payment shall further constitute a representation that the
Contractor is entitled to payment in the amount certified. However, the
issuance of a Certificate for Payment shall not be a representation that the
Architect has (1) made exhaustive or continuous on-site inspections to check
the quality or quantity of the Work, (2) reviewed construction means, methods,
techniques, sequences or procedures, (3) reviewed copies of requisitions
received from Subcontractors and material suppliers and other data requested by
the Owner to substantiate the Contractor's right to payment or 4
ascertained how or for what purpose the Contractor has used money previously
paid on account of the Contract Sum."
In addition to
limiting the design professional's certification by a "knowledge,
information and belief" standard, Paragraph 2.6.10 sets forth other
protections for the design professional. As discussed in Section III (C) of
this Article, Paragraph 2.6.10 attempts to absolve the design professional from
having any control over the work and from making continuous or comprehensive
on-site inspections. This language is important to the design professional
because it specifies that any on-site visits made by the design professional
are for checking the progress of the work, rather than an
"inspection" of the work for compliance with the contract documents,
which can give rise to a negligence or Structural Work Act claim.
Paragraph 2.6.10 also
gives the design professional the right to retract his previous representations
that the Work is in accordance with the Contract Documents, "subject to an
evaluation of the Work for conformance with the Contract Documents upon
Substantial Completion." This language, once again, illustrates the narrow
purpose of the payment certificates and makes it very difficult for an owner or
surety to argue that a design professional should be held liable for contractor
deviations at the progress payment stage.
The significance of
including exculpatory language, like that used in the AIA standard form
agreements, is underscored by the fact that some owners believe that by issuing
payment certificates, the design professional is giving his
"guarantee" or "certifying" that the contractor has
complied with the plans and specifications. Of course, if the design
professional actually "certifies" that something is perfect, he is
assuming a level of liability well beyond the standard of care required by the
law. This is significant for insurance reasons, as well as potential liability
reasons, because certificates for payment can be construed to be warranties or
guarantees, especially when the certificate contains representations of fact
upon which the Owner will rely, and the design professional's insurance does
not typically cover claims for breach of warranty:
"This insurance
does not apply to liability assumed by you under any contract; but that this
exclusion does not apply if you would have been liable, in the absence of such
contract, due to your own error, omission or negligent act."
When negotiating an
Owner/Architect Agreement, the design professional should explain to the owner
that the provisions in the B141 and A201 Agreements, which provide that payment
certificates are issued based upon the design professional's "knowledge,
information and belief," benefit both the design professional and the
owner by triggering the design professional's insurance coverage. If the owner
wants the design professional to be exposed to liability which is not covered
by insurance, the design professional should request to be paid for those
services and more money should be allocated for comprehensive site inspections
by the design professional.
Demand a Schedule of
Values.
Prior to issuing any
payment certificates, the design professional should insist on receiving a
detailed Schedule of Values from the contractor. The A201 General Conditions
(Paragraph 9.2.1) requires that the contractor provide the architect with a
detailed Schedule of Values, but does not specifically state whether the design
professional's payment certificate is a representation that a certain
percentage of the work is completed, or that the amount which the contractor
seeks coincides with the actual amount of labor and materials put in place.
Typically, the design
professional compares the percentage of work completed against the schedule of
values, rather than attempting to analyze the actual value of the work.
Nonetheless, some owners are now requiring the design professional to certify
that the original schedule of values submitted by the contractor accurately
allocates the contract sum among the various trades in order to avoid
contractor front loading. An example of this type of responsibility is as
follows:
Design Professional shall review and approve the Contractor's schedule of
values and certify that the schedule accurately represents the amounts to which
the Contractor should be entitled for the Work described in each line item and
that the Contractor's schedule of values is of sufficient detail to allow the
Design Professional to certify that the Contractor's Applications of Payment
are accurate representations of the value of the Work put in place.
If possible, the design professional should avoid taking on this type of
responsibility. The design professional's duty to issue payment certificates
should only be an indication that the work "has progressed to the point
indicated" (see A201, 9.4.2), and not a summary of how the money was
spent. It should be left up to the owner/lender to make sure that the money
paid to the contractor is used properly.
Protect Yourself From
Negative Inferences.
Most lawsuits against
design professionals, based upon their role in the payment process, are founded
upon negative inferences typically drawn from payment certificates. It is
common for contractors and owners to equate the duty of the design professional
to issue payment certificates with that of inspecting the work for compliance
with the Contract Documents. To avoid this negative inference, design
professionals should include language in all of their contracts to make clear
that they are not in charge of the work, nor required to make exhaustive or
continuous on-site inspections. Both the B141 and A201 Contracts contain
appropriate language like this which should be incorporated into any contract
entered into by the design professional. Specifically, Paragraph 2.6.10 of the
B141 and Paragraphs 4.2.2 and 4.2.3 of the A201 absolve the design professional
from having any control over the work and from making continuous or
comprehensive on-site inspections.
CONCLUSION
The duty of the
design professional to issue payment certificates exposes the design
professional to a variety of potential claims. The design professional may face
claims for negligence and for alleged Structural Work Act violations, as well
as claims for negligent over certification and under certification of payments.
In order to minimize the design professional's exposure to such claims, the
design professional should, whenever possible, attempt to utilize standard form
AIA documents or incorporate the concepts discussed in this Article into any
contract entered into by the design professional.
Endnotes
1.
Courts
in other jurisdictions have also held that design professionals may be liable
for over certifying payment requests. For example, in State ex rel. National Surety Corp. v. Malavaney, 221 Miss. 190,
72 So. 2d 424 (1954), the court held that an architect was liable to a surety
for negligent certification of payments. See also U.R.S. Company Inc. v. Gulport-Biloxi
Regional Airport Authority, 544 So. 2d. 824 (Miss. 1989); Aetna Insurance Company v. Hellmuth, Obata
& Kassabaum Inc., 392 F.2d 472 (8th Cir. 1968).
2.
Paragraph
2.6.9 of the B141 and Paragraph 4.2.5 of the A201 Agreements similarly provide
that "[b]ased upon the Architect's observations and evaluations of the
Contractor's Application for Payment, the Architect shall review and certify
the amounts due the Contractor."
Design
Professional Liability on Completed Work
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
In that study, 101 federal court cases were
analyzed. Based
on the data findings and analyses, the following conclusions are
proffered. The majority of differing
site condition complications regarding a contractual dispute between the owner
and contractor occur during the bidding phase.
The issue regarding whether the contractor acted in a reasonably prudent
manner when interpreting the contract was the most occurring dispute
element. The proof element, contract
documents contain indications of conditions to be encountered, was the second
highest litigious matter to appear in the study sample, followed next by the
contractor must have reasonably relied on the contract indicates. As can be
concluded, the most occurring or recurring proof element disputes occur at and
result from the bidding phase of a construction project. Two of these proof elements, namely: a) acted
in a reasonable manner, and b) reasonably relied on contract indicates, are
concerned with a contractor processing of bid document indicates. The fourth most frequently recurring proof
element at issue is: failure to investigate site. Here again, being a bidding
phase process failure, more particularly having a strong contractual relation
to the disclaiming language within the contract. The fifth most disputed proof
element is actual condition encountered must be reasonably unforeseeable. This
proof element bifurcates into both a bidding phase analyses and an actual
construction phase question.
Use of DSC clauses
has spread well beyond just federal contracting. The Engineers Joint Contract
Documents Committee, which had previously employed a Standard Form 23A type of
DSC clause, has evolved even further. For instance, the extent to which an owner
may be held liable for subsurface facilities has been altered by distinguishing
between such facilities from other physical conditions. In the case of underground facilities which
were not disclosed or represented in the contract, the contractor may recover
monetary compensation. On the other
hand, if the underground facility is indicated in the contract but is
inaccurately indicated, the risk shifts to the contractor.
A Type I differing
site condition need not always involve project site’s geotechnical conditions.
Something as simple as a previous contractor’s failure to build the preceding
work in accordance with the applicable building codes, which in turn prevents
or hampers another contractor’s performance, could be considered a differing
site condition entitling that contractor to an adjustment in the contract price.
Regardless of which type of condition is encountered, it is imperative for the
contractor performing work on a project to be intimately familiar with the
contract documents.
If a
dispute arises over whether the contractor is entitled to additional money as a
result of a condition that was encountered on the project, the court will
resolve the issue by scrutinizing the contract documents. If those documents
show that the encountered site conditions were concealed or unforeseeable, as
they were in this case, a contractor’s differing site condition claim may well
succeed.
Significant Decision by the Federal Circuit Court
of Appeals in 2014
As was stated
above, the contractors lose about two thirds of these DSC claims. A recent case law may change this trend and
make it easier for the contractor to prove his case.
A recent decision
by the Federal Circuit Court of Appeals represents a major triumph for
contractors pursuing certain types of claims against the Federal Government. In
Metcalf Construction Co. v. United States,
742 F.3d 984 (Fed. Cir. 2014), the Federal Circuit reinforced the principles
underlying the Government’s implied duty of good faith and fair dealing,
reversing a trial court decision that would have made it exceedingly difficult
for contractors to show that the Government had breached that duty. The Federal
Circuit in Metcalf also
clarified that a contractor’s duty to investigate site conditions after
contract award will not prevent a successful differing site conditions claim
that arises from the Government’s pre-award representations.
Background
The project in Metcalf required the prime
contractor to design and build 212 military housing units at the Marine Corps
base in Oahu, Hawaii. The Request for Proposal ("RFP") included a
geotechnical report that indicated that the soil at the site had “slight
expansion potential.” The RFP indicated that the information in the soils
report was “for preliminary information only,” and it required the successful
bidder to conduct its own post-award site investigation. The Government stated during
pre-bid questions and answers that the contract would be modified if unforeseen
soil conditions were encountered.
After Metcalf
Construction Company (“Metcalf”) was awarded the contract, it hired a soil
consultant to investigate the site. The consultant concluded that, contrary to
the RFP, the soils exhibited “moderate to high” – as opposed to merely “slight”
– expansion potential. Because this heightened expansion potential could
adversely affect the stability of the constructed units, the consultant made
several recommendations for mitigating the soil conditions.
Metcalf immediately
notified the Government of the differing condition and requested permission to
follow its consultant’s recommendations. However, the Government insisted that
Metcalf follow the contract’s original construction requirements. Discussions
continued for over a year. Although still without an approved contract
modification, Metcalf pursued its consultant’s recommendations by
over-excavating and replacing the soil with imported fill. Subsequently, the
Government determined there was no differing site condition and refused to pay
Metcalf for the majority of the added costs associated with the issue.
Besides mitigating
unanticipated expansive soils, Metcalf had to remediate certain contaminated
soils at the Project site, despite the Government’s pre-award assurances that
no such remediation would be necessary. Although the Government ultimately
issued a change order concerning the contaminated soils, Metcalf claimed the
compensation was inadequate and failed to address the costs it incurred.
Metcalf also faced other disruptions and hindrances before completing the
Project several months past the contract completion date.
Metcalf
subsequently submitted to the Contracting Officer a claim seeking its costs
associated with the expansive soils and the other issues it encountered during
performance. In its claim, Metcalf argued that the Government had materially
breached the contract and the implied duty of good faith and fair dealing by failing
to timely investigate the findings of Metcalf’s soils consultant and
interfering with Metcalf’s work. After receiving the Contracting Officer’s
Final Decision denying its claim, Metcalf sued in the United States Court of
Federal Claims. The Government asserted a counterclaim for liquidated damages
due to Metcalf’s failure to meet the contract completion date.
Although the trial
court ruled in Metcalf’s favor on certain claims, it awarded the Government
more than $2.4 million in liquidated damages due to late completion of the
Project. The court also ruled that the Government had not violated the implied
duty of good faith and fair dealing, because the Government had not undertaken
“specifically targeted action” to gain the benefit of the contract or intended
to delay or hamper performance of the contract. The trial court also stated
that unless at least one factor is present, “incompetence and/or the failure to
cooperate or accommodate a contractor’s request do not trigger the duty of good
faith and fair dealing.”
Regarding Metcalf’s
differing site condition claim, the trial court ruled that the RFP’s
representations regarding swell potential and contaminated soils were excused
by Metcalf’s obligations to conduct a post-award site investigation. According
to the court, Metcalf was entitled to rely on the Government’s representations
only “for bidding purposes” and not “in performing the...project.” Metcalf
therefore assumed the financial responsibility for any differing conditions
encountered at the site.
The Federal Circuit
Reverses
Implied Duty of Good Faith
and Fair Dealing
The Federal Circuit
reversed, holding that the trial court applied the wrong standard in analyzing
Metcalf’s good faith and fair dealing claim. The Court held that to prevail on
this claim, a contractor need not show that the Government “specifically
targeted” the contractor. Rather, the contractor need show only that the
Government “interfere[d] with the [contractor’s] performance” and “destroy[ed]
the [contractor’s] reasonable expectations...regarding the fruits of the
contract.” The Federal Circuit emphasized that “a breach of the implied duty of
good faith and fair dealing does not require a violation of an express provision in the contract,”
and the Court sent the case back to the trial court to determine whether these
standards had been met.
Differing Site Conditions
The Federal Circuit
also rejected the trial court’s conclusion that Metcalf’s post-award duty to
investigate site conditions shifted the risk of any differing site conditions
to Metcalf, finding that this rationale misinterpreted the contract:
Nothing in the
contract's general requirements that Metcalf check the site as part of
designing and building the housing units, after the contract was entered into,
expressly or implicitly warned Metcalf that it could not rely on, and that
instead it bore the risk of error in, the government's affirmative
representations about the soil conditions. To the contrary, the government made
those representations in the RFP and in pre-bid questions-and-answers for
bidders' use in estimating costs and therefore in submitting bids that, if
accepted, would create a binding contract. The natural meaning of the
representations was that, while Metcalf would investigate conditions once the
work began, it did not bear the risk of significant errors in the pre-contract
assertions by the government about the subsurface site conditions.
The court examined
the purpose of the standard differing site condition clause, Federal
Acquisition Regulation (FAR) 52.236-2, which the court noted was intended to
“take at least some of the gamble on subsurface conditions out of bidding” by
enabling contractors to obtain contract modifications if they encounter
differing subsurface conditions. In that regard, the Federal Circuit confirmed
that provisions requiring a pre-bid site investigation (such as FAR
52.236-3(a)) have been interpreted “cautiously,” and that even those provisions
do not preclude a successful differing site condition claim, as long as a
reasonable pre-bid site investigation was actually performed. Similarly, the
Court held that the Government could not avoid liability simply because its RFP
indicated that the information was “preliminary.” The RFP and other pre-bid
information had advised bidders that they would be entitled to a change order
if they encountered differing conditions, and the fact that Government-provided
information was “preliminary” did not shift the risk of differing conditions to
Metcalf.
Metcalf’s Impact for
Federal Contractors
The Metcalf case represents an
important victory for federal contractors for at least two reasons. First, it
reversed the Court of Federal Claims’ narrow reading of the Government’s duty
of good faith and fair dealing. As a result, Metcalf
opens the door for potentially viable claims based on the Government’s failure
to cooperate or failure to properly administer the contract, even where the
Government has not breached an express provision of the contract or
“specifically targeted” the contractor.
Second, Metcalf reaffirms previous case law
regarding the federal differing site conditions clause and the contractor’s
duty to investigate. After Metcalf,
contractors may pursue successful differing site conditions claims even when
their contract contains provisions that seem to bar recovery. For example, contracting officers will often
use FAR 52.236-3, which generally requires contractors to investigate the site
pre-bid, to shield the Government from liability. As Metcalf and its cited cases
clarify, however, those clauses do not create a duty by the contractor to
investigate conditions beyond a reasonable degree, nor do they completely shift
the risks associated with differing conditions to the contractor.
Example Case where the Court found for the Owner
and Against the Contractor
A 2010 decision
from the Ohio Court of Claims sets forth a dispute over whether a differing
site condition claim was adequately proven, and whether the contractor had
followed the contract’s notice requirements for making a differing site
condition claim. The case is Central Allied Enterprises, Inc. v. The
Adjutant General’s Department (June 18, 2010), Court of Claims of
Ohio No. 2007-Ohio-07841, 2010-Ohio-3229.
A state agency was
having a helicopter apron rebuilt. The agency had an engineering firm assess
the soil composition and prepare a report that determined that the soil was
suitable for construction when brought to proper moisture conditions. The
contractor read the report and walked the site prior to submitting a bid for
the lump sum contract. The plans required the removal of the existing asphalt
and excavation of the soil to a depth of twenty inches, to be replaced with
twelve inches of aggregate topped with eight inches of new asphalt to
accommodate heavier helicopters.
During
construction, the contractor encountered areas of unsuitable soil which
required the contractor to excavate several additional inches to reach stable
soil, and replace the excavated soil with more aggregate. The contractor also
layered geo-fabric with the aggregate to achieve suitable soil strength. The
contractor and the owner’s engineer were unable to reach an agreement as to
payment for the additional work. The contractor chose to proceed with the work
to avoid delaying the project. Both the contractor and the engineer agreed that
the additional costs would be reconciled by a final change order to be
submitted upon completion of the project.
After substantial
completion, the contractor requested the engineer to verify final quantities
for the change order. The engineer did not do so, and the contractor completed
its own calculations and requested the engineer to submit the proposed change
order to the owner. The engineer did not respond to the request. The contractor
then sued the state agency for breach of contract, unjust enrichment and
constructive change order.
The Court of Claims
quickly dispensed with the Type II differing site condition premise by holding
that there was insufficient evidence to establish that the actual nature of the
soil differed from the type of soil normally encountered during excavation in
that part of Ohio. The court relied upon the engineer’s soils report which
stated that all soil values were typical of glaciated deposits found in the
area.
With respect to a
Type I differing site condition claim, the court held that the conditions
encountered by the contractor were not materially different from those outlined
in the contract, and that the actual conditions were reasonably foreseeable. The court based its conclusion on the soils
report, the presence of standing water in various areas of the apron on the day
of the pre-bid meeting, the engineer’s inclusion of catch basins and a
detention pond to facilitate drainage, and the inclusion of geo-fabric in the
design. These factors provided notice to
the bidders that there were excessive moisture and drainage problems in the
subsoil.
Notice for a change order
According to legal
precedence, when a construction contract provides that altered or extra work
must be ordered in writing, the provision is binding upon the parties to the
contract. The contractor cannot recover for such work unless a written
directive (change order) is executed in compliance with the contract, unless
waived.
The contract in
this case provided a Change Order Procedure which prohibited the contractor
from proceeding with any change in the work without written authorization.
Whenever the contractor seeks additional compensation for causes arising out of
or related to the project, the contractor has to follow the contract
procedures, including providing timely notice. Under this contract, the
contractor was required to make a written claim with the engineer prior to
contract completion and no more than 10 days after the initial occurrence of
the facts giving rise to the claim for additional costs. When it comes to
notice provisions, the contractor should always follow the letter of the
contract.
The court found
that the contractor failed to submit a written change order to the engineer or
to the owner prior to the contractor’s completion of the project. The court
rejected the contractor’s argument that the notice provision was waived when
the engineer agreed with the contractor’s decision to proceed with the work and
to submit a final change order at the completion of the project. There must be
a clear and unequivocal act demonstrating the owner’s intent to waive the
contractual notice, change order and claim review requirements.
Constructive change order
A claim for a
constructive change order may have been sustained by the court if the owner had
independent knowledge of the condition complained of and had oral notice of the
contractor’s complaint, and the owner was not prejudiced by lack of prior
written notice. In this case, however, the contractor had communicated only
with the engineer regarding the differing site conditions, and had not
documented these communications. The contractor had failed to submit a formal
written change order to the engineer or to the owner within the time permitted
by contract or even within a reasonable period of time.
When a contractor
has missed a contractual notice deadline, the contractor should continue
written communications to the owner and the owner’s representative addressing
the disputed issue. Even when there has been no response from the owner or
owner’s representative, the contractor should not remain silent.
Central Allied Enterprises,
Inc. v. The Adjutant General’s Department (June 18, 2010), Court of Claims of
Ohio No. 2007-Ohio-07841, 2010-Ohio-3229.
Tips and Misc. Case Law on DSC
A common mistake to
avoid is appealing denial of a claim for contract interpretation that does not
include a separate monetary claim for consideration by the contracting officer.
The Board lacks jurisdiction over any request for monetary relief found in the
complaint for an appeal. See Dick Pacific/GHEMM, JV, ASBCA No. 55829, 08-2
BCA ¶ 33,937 (portions of complaint stricken as claim did not include a request
for release of withholdings or liquidated damages).
Liquidated Damages Construction Claims. When the government asserts
liquidated damages against you, a question arises as to whether you must obtain
a contracting officer’s final determination. The government does not have to
“certify” its own claim against a contractor. An experienced government
construction claims appeal lawyer should assert that there is sufficient
jurisdiction because the contracting officer made a final decision on the
government construction claim asserting liquidated damages and you filed a
timely appeal from that final decision. See Placeway Construction
Corp. v. United States, 920 F.2d 903, 906-07 (Fed. Cir. 1990); cf. M.
Maropakis Carpentry, Inc. v. United States, 609 F.3d 1323 (Fed. Cir. 2010)
(contractor’s separate claims for time extensions and related contract
modifications had to be certified); Sikorsky Aircraft Corp. v. United
States, 102 Fed. Cl. 38, 47-48 (2011).
When the government
assesses construction claims against you, you want to also present facts that
any causes of damages were not due to a situation that is your fault or within
your control.
Project Solutions Group v. DOT, CBCA 3411 (Oct. 23, 2013)
(nonprecedential; excessively high relative humidity levels at installation
site for new flooring were not differing site condition but likely were caused
by fact that contractor repeatedly watered the area to keep down the dust)
Drennon Construction & Consulting, Inc.. v. Dept. of Int., CBCA 2393
(Jan. 4, 2013) (defective specifications and differing site condition made
resulting period of suspension of work unreasonable per se)
D&M Grading, Inc. v. Dept. of Agr., CBCA 2625 (Apr. 24, 2012)
(upholds Default termination because conditions encountered by contractor under
roadway vegetation maintenance contract did not amount to Type I or Type II
Differing Site Condition)
JRS Management v. DOJ, CBCA 2475 (Mar. 1, 2012) (dismisses appeal for
lack of jurisdiction (no contract) because contractor responded to government
order for services by announcing it was substituting different individual from
the one specified in the order, thus making a counteroffer the Government
refused to accept)
Beyley Constr. Group Corp. v. Dept. of Veterans Affairs, CBCA 5, 763
(July 23, 2007) (differing site conditions, constructive change)
Instability of a
highway embankment was held to be an unusual soil condition entitling the
contractor to an equitable adjustment under the Differing Site Condition
Clause. Paul N. Howard Co. v. Puerto Rico Aqueduct Sewer Authority, 744 F. 2d
880 (1st Cir. 1984)
Additional Practical Tips
An assessment of
the contractual allocation of risks should be performed before a bid is
submitted to answer questions such as:
Is there a DSC
clause in the contract?
Are the boring logs
(and other geotechnical data) part of the contract?
Are there
exculpatory clauses wherein the owner denies responsibility for incorrect
subsurface conditions?
These are but a few
of the questions a prudent contractor will address in the course of bid
preparation.
Site Inspection
In the process of
establishing the basis of recovery for a DSC, a contractor should show that a
site inspection would not have disclosed the conditions encountered. Regardless
of the representations (or lack of) made in the contract, the necessity to
perform a reasonable site inspection is vital. Quite obviously, a contractor
will not be held responsible to perform numerous borings (or other
investigations) during the usual short bid period. However, a contractor will
be expected to ascertain, to the extent possible, subsurface conditions from a
reasonably conducted site visit. If conditions are discernable from the site
visit (particularly if they contradict the “represented data”), the contractor
should take such information into account. This relates back to whether (or
not) a site investigation would have allowed the contractor to ascertain the
actual conditions encountered. If the actual conditions could not be reasonably
discovered, the contractor stands a better chance to recover.
Even in situations where the owner includes
all subsurface information in the bidding documents and makes no attempt to
disclaim responsibility for the information provided, contactors cannot rest
easy. In Foster Construction
C.A. and Williams Brothers Company, A Joint Venture v. The United States the U.S. Court of Claims ruled that:
“The contractor is unable to rely on contract
indications of the subsurface only where relatively simple inquiries might have
revealed contrary conditions.”
For example, in a highway project where the
subsurface investigation report contains 30 borings to a depth of 45 feet (and
the deepest cut on the drawings is approximately 25 feet) all of which show no
groundwater, bidders may not be able to rely on the lack of indication of groundwater.
If the contractor could have, for
example, reviewed and determined from the local Soil Conservation Service
office that groundwater records show that at certain times of the year
groundwater levels rose to within three meters of the surface, then bidders
cannot rely upon the bidding information when preparing their bids.
Similarly, if a pre-bid site walk would have revealed
the condition, even though it was not shown in the geotechnical report, then the
contactor cannot rely exclusively on the bidding information.
Timely Notification
The most
substantial roadblock to recovery of a DSC claim is failure to provide
notification. Contracts often contain a notification requirement, particularly
with regard to DSC, and have even required that the uncovered unknown
subsurface conditions remain undisturbed until investigated by the owner.
Failure to strictly adhere to these notice requirements can foreclose a
contractor’s recovery for an otherwise valid DSC claim. This procedure is
necessary to afford the owner the opportunity to modify and alter the design or
performance requirements and thereby minimize and mitigate the actual effects
of the DSC.
Root Causes of Most Construction Claims
·
Lack of
Communication
·
Misinterpretation
of plans, specs or directions
·
Plan
errors / Poorly coordinated contract drawings
·
Poor
Project Management
·
Lack of
Familiarity with Specifications
·
Impacts
of Third parties (damage to your work, delays, utilities, etc.)
·
Changes
in work scope
·
Unknown /
Differing Site Conditions
·
Work
Interruptions (Loss of Productivity)
·
Project
Acceleration / Delay
Steps to Avoid Construction Claims
1. Thoroughly Review Your Contract /
Plans
2. Properly Plan / Manage your
Project
·
Including
detailed schedules with critical dates, constraints and critical tasks
·
Be able
to show how you planned to do work, equipment needed, man-hours, etc.
3. Track your own work Progress
·
Are you
On Schedule, ahead, or already behind, etc.?
·
Have you
documented any delays/impacts to your schedule?
4. Keep Good Records
·
Document,
Document, Document
·
Photos,
time logs, foreman reports, engineers' inspection records, etc.
5. Constant Communication
·
Confirm
things in writing, respond to communication promptly (one way or the other)
·
Never
Assume things when it comes to contract work
·
Ask
questions before starting extra work, confirm scope and payment in writing.
6. Always attempt to Resolve
Disputes Early
·
Average
time to resolve a claim is often over 15 months.
Avoid Five Costly Mistakes Made By
Government Construction Contractors
Although not
intentional, contractors tend to make the following mistakes which can cost
them thousands or millions in construction projects.
Failure to
understand how the various FAR clauses impact your ability to have equal
footing with the agency. Federal
contracts are primarily written for the benefit of the agency. Having your people trained in the various
clauses can save the company a substantial amount of money.
Not understanding
the difference between a Request for Equitable Adjustment and a CDA claim. There is a difference between the two. Having
a government construction lawyer to guide you around the lurking pitfalls can
also save you thousands in unnecessary attorney fees.
Failures to submit
a construction claim that meets the CDA requirements. Both small and large
contractors make fatal procedural and substantive errors then submitting their
claims. See information on Contract Disputes Act and Pass Through Claims. There
are statutory requirements that you must meet including getting
the contracting officer’s final decision. Failure to meet them can create
delays and even rejection.
Not understanding
what constitutes a Contracting Officer’s final decision. Your construction
claim must have a CO’s final decision before you can appeal to the Court of
Federal Claims or Board of Contract appeals.
Failure to properly
address cure notices. When a contracting agency believes that you are a performance
risk, a cure notice is forthcoming.
Prepare, Negotiate
and Litigate Construction Claims in Federal projects allow contracting officers
(COs) great latitude in resolving disputes. However, you may often find your
company trying to negotiate a claim that you know has merit.
Avoid Costly Pitfalls With
Requests for Equitable Adjustment Claims: An important part of the
government construction claims process is understanding the nuances between a
CDA claim and a Request for Equitable Adjustment. Develop Internal
Policies and Controls: Given the mandated increased oversight on federal
contractors, both small and large companies are targeted for audits
and investigations.
Get Help With Government
Construction Proposal Writing: Bidding on government contracts is very
tough business. Whether you are writing proposals for Army Corps Projects, Navy
projects or for another agency, you want to strengthen your technical
proposals, construction bid bond submissions and management approaches.
Federal Construction
Contracting for Small Businesses: The laws associated with government
contracting include a wide array of complex regulations that dictate how you
perform. For example, small businesses are restricted to certain guidelines
under teaming agreements and joint venture contracts.
Issues arise concerning SBA size standards and limitation in
subcontracting requirements. At the law office of Watson & Associates our
government construction law attorneys provide legal advice on matters pertaining
to:
·
Prime
and subcontracting agreements
·
Size
standard disputes
·
Subcontracting
plans
·
Teaming
agreements
·
Joint
venture agreements
·
Filing
construction claims
·
Addressing
construction defect disputes
Metropolitan Engineering, Consulting & Forensics
(MECF)
Providing
Competent, Expert and Objective Investigative Engineering and Consulting
Services
P.O. Box
520
Tenafly,
NJ 07670-0520
Tel.:
(973) 897-8162
Fax:
(973) 810-0440
E-mail:
metroforensics@gmail.com
Web
pages: https://sites.google.com/site/metropolitanforensics/
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 man-made)
