Trust vs. Best Practices: the Dangers Posed by Lien Waivers

David A. Eisenberg – October 10, 2013

Every contractor has done it — signed a lien waiver prior to receiving payment — fully expecting to be paid. You have always been paid and it has never been an issue. But is it a safe practice?

To understand the risk of this common practice, it is first necessary to understand what a lien waiver is and what it does. Owners oftentimes require contractors, subcontractors and other lower-tier contractors to submit lien waivers to ensure that unexpected mechanics liens don’t pop up on projects. There are typically two types of lien waivers: waiver-to-date and final waiver. The waiver-to-date is frequently submitted for a progress payment and waives lien rights up to the date of the lien waiver. The final waiver is submitted upon receipt of final payment and waives all lien rights on the project.

The lien waiver is an affirmation by the contractor to the owner that it has received a payment and will not record a lien against the property for that work. When a contractor signs a standard lien waiver and submits it to the owner, the contractor has waived any and all lien rights it may have had to any work it has performed on the project to date, regardless of whether the contractor has actually received payment. The purpose of the lien waiver for the owner is clear: to ensure that all contractors are paid and accounted for so as to reduce the risk of mechanics liens on the property. But because owners and title companies often require the lien waivers be submitted prior to releasing payment, the above scenario has become all too familiar in the construction industry.

In order for a lien waiver to be a valid waiver of a contractor’s lien rights, the owner must be able to justifiably rely on the statement. And an owner has every right to rely on the veracity of verified lien waivers. It is only when that reliance is not justifiable that they become unenforceable. For example, if an owner were to require a lien waiver from a prime contractor, receive the lien waiver, and then withhold payment, could it rely on that waiver? Of course not — the owner knows the prime contractor was not paid. However, when a lower-tier subcontractor verifies that it has been paid, an owner may be entitled to rely on that statement, whether payment has been received or not.

The safest way to protect one’s lien rights is to make a simultaneous exchange of lien waiver for payment. But we all know that in the construction industry it just doesn’t work that way. The owner or the escrow agent requires lien waivers from subcontractors and suppliers prior to each payout. So, in order to get paid, those downstream contractors need to submit the lien waivers and trust that upstream contractors will pass the payment along. In this day and age, trust is hard to come by and may not be a contractor’s best practice. So how can a contractor protect its lien rights without delaying payment?

Conditional Waivers

Owners and escrow agents may not like them, but downstream contractors need to protect themselves. A conditional lien waiver clarifies that the waiver does not become effective until payment is actually received. The waiver is conditioned upon receipt of payment.

A conditional lien waiver effectively puts the owner on notice that the contractor has not actually been paid. The owner cannot rely upon the lien waiver to the same extent it does an unconditional lien waiver.

Make Sure the Dates Match

As previously discussed, a typical lien waiver waives any and all lien rights a contractor may have had to any work it has performed on the project to date. So it is essential that the contractor ensures the date on the lien waiver matches the date of work to be paid. If not, the contractor risks waiving lien rights to work for which it is not yet seeking payment.

For example, a payment request may only seek payment of work performed through January. But if the date on the lien waiver is February 15, the contractor will actually waive its lien rights for work performed through February 15.

Be careful. Make sure that the date on the lien waiver matches the date of work for which you are seeking payment.

Exclude Retainage

Retainage creates a tricky issue, because the lien waiver is supposed to waive lien rights to all work performed up to the effective date. If an owner is withholding retainage, contractors risk waiving their lien rights if they submit unconditional lien waivers.

In order to preserve lien rights to retainage, a contractor can either list the precise dollar amount of the work for which it is being paid and waiving its lien, or specifically exclude retainage from the lien waiver with a notation to that effect.

The most important thing when dealing with lien waivers is to understand the effect of the document you are signing. If you have done your best to understand the document and follow these steps, that one time that payment does not make it downstream, you will have retained the added protection of lien rights in the property.

via Trust vs. Best practices: the dangers posed by lien waivers – Lexology.

Home Defect Case Highlights Option-to-Purchase Pitfall Under Mutual Mistake Doctrine

Joe Forward, WisBar News – September 19, 2013

A couple who designed and built a home containing defects is not liable to the couple who bought the home, a state appeals court has ruled. The ruling is a contract warning for home buyers who lease homes with an option-to-purchase.

Buyers Niksa and Kelly Ivancevic brought mutual mistake and breach of contract claims against sellers Ronald and Debra Reagan after purchasing a home with a faulty roof and ventilation system, which led to second floor water leaks around windows.

Pre-purchase inspections found no defects. After purchase, an architect said the home’s ventilation system was faulty and did not meet building code standards.

The lease, which governed the landlord-tenant relationship before purchase, had stated that the home would be “delivered in clean condition and good repair, free of mold and toxic substances, suitable for habitation in compliance with all laws.”

The Ivancevic’s sued, asking for damages and recission of the option to-purchase contract, but circuit court ruled in favor of the Reagans. The court denied the breach of contract claim because the Reagan’s never represented the residence to be defect-free.

The circuit court also denied the Ivancevic’s mutual mistake claim, and a three-judge appeals court panel affirmed in Ivancevic v. Reagan, 2012AP2294 (Sept. 17, 2013).

The doctrine of mutual mistake allows reformation of contracts in cases where “both parties of a contract are unaware of the existence of a past or present fact material to their agreement,” the panel explained, citing prior caselaw.

The Ivancevic’s argued that both parties were unaware of ventilation problems, so the sales contract should be reformed. But the three-judge panel rejected this argument.

“[T]he Ivancevics, as the party seeking reformation, were required to present evidence of the possibility that the parties were mutually unaware of a fact material to their agreement at the time they entered into it,” Judge Kitty Brennan wrote.

The Ivancevics, the panel ruled, did not present evidence that a faulty ventilation system would be material to the sales agreement, because the agreement did not require the home to be free of defects.

“In fact, the circuit court dismissed the Ivancevics’ contract claim, which was based on their argument that the Reagans represented that the Residence would be defect-free, and the Ivancevics did not appeal that dismissal,” Judge Brennan wrote.

The panel also rejected the Ivancevics’ argument that the ventilation system violated building code, as indicated by the architect who inspected the home after purchase, and the Reagans promised to deliver the residence in compliance with all laws.

In doing so, the panel separated the “lease” from the “option-to-purchase” contract. The lease promised to deliver the residence in compliance with all laws. The purchase agreement did not, and the purchase agreement did not incorporate lease terms.

“[T]he plain language of the Option to Purchase makes it clear that the terms of the lease are not part of the sales contract,” Judge Brennan wrote. “In short, the Ivancevics’ reliance on the language in the Lease is misplaced.”

The panel noted that the sales contract included a “buyer due diligence” clause that urged the buyer to perform appropriate inspections before purchasing the home.

Finally, the panel rejected the Reagans’ counter claim for sanctions. Seeking attorney fees, the Reagans said the Ivancevics filed a frivolous lawsuit and a frivolous appeal.

“While the substance of their mutual-mistake claim is not strong, it is not meritless,” Brennan wrote. “There is very little caselaw on when to apply the mutual-mistake doctrine to sales contracts; the parameters of the doctrine in this context are not well-defined.”

via Wisbar.org Homepage: Home Defect Case Highlights Option-to-Purchase Pitfall Under Mutual Mistake Doctrine:.

Calif. Court Limits Bad Faith Claims Against Insurers

Bibeka Shrestha, Law360 – October 8, 2013

A California appeals court on Monday limited insurers’ exposure to bad faith claims by holding that carriers are not required to proactively settle a claim just because it’s clear that the stakes are higher than what their policy offers in coverage.

The published ruling marks a victory for Mercury Insurance Co. in a coverage fight over a $5.9 million judgment awarded to a now-deceased victim of a serious car accident caused by a Mercury policyholder. According to the decision, an insurance company is not obligated to initiate settlement negotiations merely because there’s a good chance that the claim could surpass policy limits.

When a victim has not made a settlement demand or shown that he or she is interested in settling with the insurer, the insurance carrier cannot have acted in bad faith by failing to settle, even if there’s a significant risk of a judgment that surpasses policy limits, the appeals court said.

“Nothing in California law supports the proposition that bad faith liability for failure to settle may attach if an insurer fails to initiate settlement discussions, or offer its policy limits, as soon as an insured’s liability in excess of policy limits has become clear,” the decision said. “Nor will this court make such a rule of law, for which neither precedent nor sound policy considerations have been offered.”

The decision comes nearly a year after the Ninth Circuit backpedaled from its well-publicized ruling in Du. v. Allstate Insurance Co., which held that insurers in California have a duty to initiate settlement discussions when their policyholder’s liability is clear.

California courts have commonly held that insurance companies have a duty to settle when they unreasonably reject a settlement offer within policy limits. The Ninth Circuit raised eyebrows by initially ruling in June 2012 that insurers’ duty to settle more broadly requires carriers to try to settle a claim when an insured’s liability is clear — even when the injured party has not made a settlement demand.

The Ninth Circuit later amended its opinion so it did not reach the duty-to-settle question, something the California appeals court noted in Monday’s opinion.

The case before the state appeals court involved an automobile insurance policy that Mercury issued to Zhi Yu Huang, providing $100,000 per person and $300,000 per accident.

According to the ruling, Huang drove past a red light and crashed into Shirley Reid’s car, which then collided with a third car driven by Chinelo Ogbogu. Reid, who suffered severe injuries, the other driver and two passengers made claims to Huang for their injuries.

Shirley Reid’s son, Paul Reid, told his lawyer he wanted to quickly settle with Mercury so he could access the $250,000 in underinsured motorist coverage provided by his mother’s State Farm policy, according to the ruling.

Mercury said it needed complete medical records for all victims, a recorded interview and other information before it could settle.

Paul Reid then sued Huang and won a $5.9 million judgment more than two years later, forcing Huang into bankruptcy and obtaining her rights against Mercury. Paul Reid brought suit against Mercury for more than $6.9 million, accusing the insurer of acting in bad faith. He claimed that Mercury discouraged any efforts at settlement, refused to investigate the claim promptly and insisted on receiving information that was already known or immaterial to settling the claim.

The appeals court stressed that Reid had made no settlement offer to the insurer, and Mercury had no way of knowing that Reid desired a deal.

For an insurer to act in bad faith by failing to settle, there must be evidence that the injured party has shown interest in settling or that there were circumstances making clear to the insurer that a settlement could be negotiated, the ruling said. Without this kind of evidence, plaintiffs cannot show that an insurer acted in bad faith by ignoring an “opportunity to settle,” according to the decision.

Reid’s “bare request” for the amount of coverage provided under Huang’s policy was not an “opportunity to settle” that Mercury rejected in bad faith, the court held. Moreover, a significant risk of an excess judgment also does not give rise to an “opportunity to settle,” the ruling said.

Courts have held that an insurer can be liable for a bad faith failure to settle without a formal settlement offer under some circumstances, but none of those cases suggested that an insurer must initiate settlement discussions when there’s no sign that an injured party is inclined to settle within policy limits, the ruling said.

John Hager, a Hager Dowling Lim & Slack PC attorney who represents Mercury, told Law360 that the ruling was significant in California.

“The plaintiffs’ bar would like to impose a higher duty on insurers whenever they can, so it’s important here that the court has drawn a line, so to speak, around the duty,” Hager said. “It doesn’t necessarily insulate them from liability because they can’t reject opportunities to settle, but they don’t have to initiate [settlements] themselves.”

The case is Paul Reid v. Mercury Insurance Co., case number B241154, in the Court of Appeal for the State of California, Second Appellate District.

via Calif. Court Limits Bad Faith Claims Against Insurers – Law360.

Shift in Minnesota’s Law on Indemnification in Construction Contracts

Laura N. Maupin – October 10, 2013

On Aug. 1, 2013, a significant overhaul of the Minnesota statute governing indemnification and risk-shifting in construction contracts went into effect. Generally, the amendment eliminates a long-standing exception to a prohibition against risk-shifting in the construction context. However, some language in the statute leaves lingering doubt regarding the ultimate impact of the amendment.

Since 1984, Minnesota law has prohibited risk-shifting agreements in construction contracts which require one party to indemnify another from that party’s own negligence. See Minn. Stat. § 337.02 (2012). However, the pre-amendment version of Minn Stat. § 337.05, Subd. 1 carved out a huge exception to this general prohibition by allowing contracting parties to procure insurance for the benefit of one another, stating that § 337.02 does “not affect the validity of agreements whereby a promisor agrees to provide specific insurance coverage for the benefit of others.” In the event of a failure to procure the promised insurance policy, the statute went further, stating, “…regardless of section 337.02, the promisee shall have indemnification from the promisor to the same extent as the specified insurance.” Id. Practically speaking, the exception swallowed the rule. As a matter of course, subcontractors were contractually required to procure insurance indemnifying general contractors for the generals’ own negligence.

As you might expect, subcontractors were not in favor of this law and lobbied for a change. Effective August 1, 2013, Minn. Stat. § 337.05, Subd. 1 is significantly amended. The statute now states:

(b) A provision that requires a party to provide insurance coverage to one or more other parties, including third parties, for the negligence or intentional acts or omissions of any of those other parties, including third parties, is against public policy and is void and unenforceable.

Minn. Stat. § 337.05, Subd. 1(b) (2013). If the amendment stopped here, there would be little question that the law had changed and that it was no longer possible to require one party to procure insurance which in effect obtained indemnification for one’s own negligence.

Some doubt remains as to the impact of the prohibitions contained in (b), however, because of the subsequent paragraph:

(c) Paragraph (b) does not affect the validity of a provision that requires a party to provide or obtain workers compensation insurance, construction performance or payment bonds, or project-specific insurance, including, without limitation, builder’s risk policies or owner or contractor-controlled insurance programs or policies.

Minn. Stat. § 337.05, Subd. 1(c) (2013) (emphasis added). While builder’s risk policies and owner or contractor-controlled insurance clauses are readily understandable industry terms, ambiguity exists as to the meaning of “project-specific insurance.” This term is undefined in the statute and is not a term of art in either the insurance or construction contexts. Already, some have argued that this term refers to commercial general liability (CGL) policies for a given project, an interpretation which would render the amendment meaningless and return to the pre-amendment status quo. This is not a logical conclusion – surely the Legislature did not intend a largely meaningless amendment. But until Minnesota courts have had the opportunity to interpret the meaning of “project-specific insurance,” there will likely be litigation regarding its meaning.

In the meantime, construction contracts that rely on the pre-amendment version of Minn. Stat. § 337.05 should be reworked in an attempt to comply with the new statute and to maintain desired outcomes, which either impose or avoid the risk-shifting indemnification requirement.

via Shift in Minnesota’s Law on Indemnification in Construction Contracts | The National Law Review.

Statute of Limitations in Colorado

David Furtado, Merlin Law Group – October 9, 2013

My first blog as a member of Merlin Law Group is regarding the statute of limitations for certain actions in Colorado. I chose this topic since it is the first thing I analyze and advise a prospective client when I am contacted regarding a possible first party insurance claim.

The purpose of having statute of limitations is to promote justice, discourage unnecessary delay, and to forestall prosecution of stale claims.1 Their conclusive effects are designed to promote justice by preventing surprises through revival of claims that have been allowed to slumber until evidence has been lost and witnesses have disappeared.2 Pursuant to Colorado Revised Statute Section 13-80-101, the statute of limitations for a breach of property insurance contract in Colorado is three (3) years from the date the action accrues.

Colorado Revised Statute Section 13-80-108 defines the accrual date as the date both the damage to the property and the cause of the damage are known or should have been known by the exercise of reasonable diligence. Simply put, the date that the insured property sustained damage is the accrual date. This means that a lawsuit must be filed within three (3) years of the occurrence of the loss or, the date the insured property was damaged.

In cases where a tortious breach of contract is part of the causes of action against an insurer, Colorado Revised Statute Section 13-80-102 provides for a two (2) year statute of limitations. This means that a bad faith breach of insurance contract claim is governed by the two (2) year statute of limitations.3 For prospective clients, this means that although the statute of limitations for a breach of contract claim is three years from the date of loss, the shorter statute of limitations period of two years is what I use to determine the timing of the filing of a lawsuit to toll the statute of limitations if our client’s claim is against an insurer who did not treat the client fairly and failed to adjust the client’s claim in good faith.

1 Colorado State Bd. of Medical Examiners v. Jorgensen, 599 P.2d 869, 198 Colo. 275 (Colo. 1979).

2 Continental Bank & Trust v. Tri-State General Agency, Inc., 185 F. Supp. 208 (D. Colo. 1960).

3 See Cork v. Sentry Ins., 194 P.3d 422 (Colo. App. 2008).

via Statute of Limitations in Colorado : Property Insurance Coverage Law Blog.