Recent Cases Have Reduced Defenses to Payment Bond Claims

Jacob E. Roussel | Breazeale Sachse & Wilson LLP | March 11, 2018

It goes without saying that contracts are essential in the construction industry. They govern the relationships between all parties involved on a project, including the owner, the general contractor, subcontractors, and suppliers. In resolving disputes, courts often state the principal that a contract defines the respective rights and obligations of the parties and is the law between them. As such, if the terms of a contract are clear, the contract should be enforced as written.

In the past several years, however, a general contractor’s ability to protect itself through the terms of its contracts have been diminished by courts permitting recovery against a surety furnishing a payment bond notwithstanding the general contractor’s contractual defenses which would otherwise prevent recovery. Of course, in those instances where a surety is held liable on a payment bond claim, the general contractor is ultimately responsible for the amount by way of its general indemnity agreement with the surety.

In 2011, the Louisiana First Circuit Court of Appeal decided the case of Glencoe Educ. Found., Inc. v. Clerk of Court & Recorder of Mortgages for Par. of St. Mary, 2010-1872 (La. App. 1 Cir. 5/6/11), 65 So. 3d 225, wherein the Court held that a surety on a public works project was not permitted to rely upon contractual “pay-if-paid” clauses in the defense of payment bond claims asserted by subcontractors. In essence, the Court reasoned that the “pay-if-paid” clauses in the subcontracts could not shield the surety from liability since the payment bond was a statutory bond intended for the benefit of the claimants. The practical effect of the decision is that the general contractor must ultimately be responsible for the subcontractors’ claims by way of its general indemnity agreement despite having a contractual “pay-if-paid” defense to the claims.

Recently, in January 2018, the holding of Glencoe was extended by the Louisiana First Circuit Court of Appeal. In Bear Indus., Inc. v. Hanover Ins. Co., 2017-0301 (La. App. 1 Cir. 1/4/18), — So. 3d. –, a supplier to a subcontractor filed a lawsuit alleging that it was owed additional amounts for materials furnished in connection with the construction of a Wal-Mart Supercenter. The lawsuit named as a defendant the surety which furnished a payment bond on behalf of the general contractor for the project. The trial resulted in a judgment rendered in favor of the supplier and against the surety. On appeal, the general contractor and surety argued that the trial court erred by ruling in favor of the supplier due to the supplier’s failure to comply with a notice requirement contained in a joint check agreement executed by the general contractor, subcontractor, and supplier. That agreement required that the supplier notify the general contractor in the event there was a failure on the part of the subcontractor to make payment within 60 days of the date of an invoice. Importantly, the agreement further stated that the failure of the supplier to provide such notice shall constitute a waiver of any lien rights or rights to collection against the general contractor.

The Court of Appeal affirmed the ruling of the trial court. Specifically, the Court held that the reasoning of Glencoe also applied to claims brought against a payment bond under the Private Works Act, not just to claims against a Public Works Act payment bond as was the case in Glencoe. The Court then extended the Glencoe reasoning beyond the application of a contractual “pay-if-paid” clause, holding that the surety was not entitled to rely upon the contractual 60 day notice provision as a defense to the payment bond claim. Thus, despite the general contractor having a contractual agreement stating that it would not be liable to the supplier in the absence of the required notice, the general contractor’s surety was still liable; meaning that the general contractor will ultimately be responsible to the surety for the amount.

Don’t Assume A Design Role Unless You’re The Designer

George M. Nicholos | Vandeventer Black LLP | April 4, 2018

Recent weather conditions highlight the importance of avoiding unintentional design responsibility. This first quarter of 2018 has seen persistent periods of wind-driven rain; which often expose building envelope weaknesses. Uncontrolled rainwater penetration, condensation, and moisture related damage commonly result and threaten both structural integrity and building envelope performance. Indeed, virtually 90 percent of such sources of intrusion are uniquely associated with only 1 percent of the interfaces between materials or building components in the building envelope.

Frequently failures of this sort result from the improper integration of related building components, such as windows, doors, and flashing from the design phase of a project. Things such as reduced fees and accelerated schedules can lead to less exhaustive detailing by the designer. But despite this growing trend, such exhaustive detailing is important, and in many cases necessary.

For example, Section 107.2.4 of the International Building Code mandates that construction documents include exterior wall envelope details, including flashing, intersections with dissimilar materials, corners, end details, control joints, intersections at roofs, eaves or parapets, means of drainage, water-resistive membrane and details around openings.

Yet, despite such requirements, and sound practices, some projects get released for bidding with increasingly less information. Instead, those designs attempt to shift design risk to bidding contractors (and their subcontractors) through the shop drawing phase.

The result can be disastrous, and expensive. Poorly conceived submittals or attempting to resolve the designer’s intent in-house can and often results with missed intent and requirements; resulting in widespread leaks and resulting damages to the building and other property. To avoid that, contractors and subcontractors must avoid proceeding without clear, documented direction from the designer.

Savvy contractors negotiate contractual terms to preclude such risk allocation to them, but sometimes that cannot be negotiated. If not, contractors need to proactively address related matters during the submittal process; at the earliest possible stage; and unsavvy contractors that proceed with the mentality of “this is how we always install these components,” proceed at their own peril.

One of the main ways to address unclear designs is effective use of the Request for Information (RFI) process. If there is any question, RFIs regarding design intention, clarifications, and instructions are appropriate for requesting specific guidance from the designer and/or owner. Follow the RFI process strictly, retain all records; and memorialize related discussions.

Additionally, follow-on contract requirements incorporating additional design input received should be formally entered as a contract requirement. Virtually every construction contract includes a requirement for written changes only, executed by authorized contract agents only. Without strict compliance with those requirements, unintentional risks can get assumed regarding not only performance but also design; along with the additional liabilities that follow.

Unfortunate (and Unexpected) Restriction on Additional Insured Status

Stan Martin | Commonsense Construction Law LLC | March 28, 2018

The New York Court of Appeals, in a split decision, has focused on one word in deciding that a owner’s construction manager was not entitled to additional insured status on the general contractor’s policy.

The contract required the GC to include the owner, DASNY, the State of New York, and the owner’s construction manager as additional insured parties. The contract included a sample certificate of insurance identifying each of those parties.

The GC’s policy, though, included the following definition (emphasis added):

WHO IS AN INSURED (Section II) is amended to include as an insured any person or organization with whom you have agreed to add as an additional insured by written contract but only with respect to liability arising out of your operations or premises owned by or rented to you.

The Court of Appeal held that the GC did not enter into a contract “with” the construction manager, and so the construction manager was not a party “with whom” the GC had agreed to include as an additional insured. Thus, the Court of Appeal construed the phrase “with whom” as modifying the phrase “by written contract.” And said that absent the word “with,” the construction manager would have been included. Finally, the appellate court held that the definition was not ambiguous, and so principles of interpretation of an ambiguous term would not come into play.

The dissent goes on at greater length, exploring the nuance of the policy definition. It stated that “the majority focuses on a single word in the blanket additional insured endorsement at issue while ignoring others, thereby finding clarity where none exists.” Which aptly describes the situation, in my view. Noting that the language “is awkward and unclear, at the very least,” the dissent would have ruled that the phrase “by written contract” modifies “to add.” And not “with whom.” That reading further comports with normal expectations for the scope of additional insured coverage.

So a party who, by industry expectation and by standard convention, should have had additional insured status for claims arising from the general contractor’s work, has been left to shoulder the risk arising from the GC’s operations with its own coverage. The carrier is likely the only one arguing that this was the intent. A poor interpretation of an awkwardly-written clause.

Owner’s reps and other owner consultants may want to insist on reading the prime contractor’s additional insured language.

The case is Gilbane Bldg. Co./TDX Constr. Corp. v St. Paul Fire & Mar. Ins. Co., 2018 N.Y. LEXIS 490 (NY Court of Appeal, Mar. 27, 2018).

Like Death and Taxes, AIA Contract Changes are a Sure Thing!

Melissa Brumback | Construction Law in North Carolina | March 23, 2018

Like death & taxes, you can count on the American Institute of Architects (AIA) to regularly update their standard form construction contracts.  Most such forms are updated every 10 years, and 2017 was no exception.

In the 2017 version, the changes are “evolutionary, not revolutionary”, according to AIA Managing Director and Counsel, Kenneth W. Cobleigh.  Ken and I both recently spoke at the North Carolina Bar Association’s Construction Law Forum on various AIA changes.

I’ll be presenting the Top 10 Changes that you need to know about the AIA A201 General Conditions.

Differing Site Conditions

Previously, the A201 required a Contractor to provide notice to the Owner and Architect within 21 days after discovery of unforeseen site conditions.  This notification is required prior to the conditions being disturbed, so as to allow the Design Team the ability to evaluate the site and determine the compensability of any such differing conditions.

The requirement has been shortened to 14 days — that is, under the 2017 version, a Contractor must give the notification within 14 days of discovery.   See Section 3.7.4.

This is a small contract adjustment, but could prove substantially deprive a contractor of potential additional sums if caught unawares.  As the Architect or Engineer of Record, you should also be aware of this new 14 day requirement, which is a week shorter than most AIA deadlines.

Owner’s Right to Carry Out the Work

In prior versions of the General Conditions, if a contractor defaulted and the Owner (after giving notice) opted to cure by carrying out the work itself, an appropriate Change Order would be issued.  However, a Change Order is a contract that requires an agreement by both the Owner and Contractor, and, obviously, Contractors were reluctant to agree that they were in default and responsible for a deductive change order.

The new Section 2.5 allows the Owner to carry out the work if the Architect approves, without a signed change order.  Instead, the Architect can withhold or nullify a payment to the Contractor (under Section 9.5.1) to reimburse the Owner for the work carried out.

If the Contractor disagrees with the actions of the Owner or the Architect, or the amounts claimed as costs to the Owner, the Contractor can institute a Claim under the Claims section (Article 15) of the 201.

Direct Communications between Owners and Contractors

As the Engineer or Architect of Record, you probably have frequently experienced Owners and Contractors communicating directly, in direct contravention of the language of the contract that requires them to endeavor to route all communications through the design team.  With the latest version of the 201, direct communication is now authorized, to recognize both the reality of what was happening on the ground and to recognize that sometimes Owners and Contractors may need to communicate without waiting for the design team.

In the new Section 4.2.4, Owners & Contractors are only required to include the Architect in communications that relate to the professional services of the design team.  HOWEVER, the Owner is required to promptly notify the Architect of the substance of any such direct communication.  The Owner-Architect agreement has been changed as well, to make it consistent with this new AIA 201 procedure.

Is this a good change?  Honestly, the verdict is out on that one (pun intended).  It may prove very helpful in keeping a project on track when the Architect is not regularly on-site.  However, the parties run the risk that they may make decisions that do effect the design team, without design team input.  Be cautious, and make sure the Owner *does* keep you informed.

Contractor’s Means & Methods

First, a little history:  as you know, means, methods, techniques, sequences, and procedures are all part of the Contractor’s responsibility on a construction site.  However, when the AIA A201 was last revised, in 2007, there was a provision put in for that rare time when the Contract Documents gave specific instructions concerning a particular construction method.  If the Contractor viewed such instructions as unsafe, he was to give notice to the Owner and Architect, and was not to proceed with that portion of the Work without further written instructions from the Architect.  If the Architect directed him to proceed, the Contractor was absolved from any risks with following that instruction.  Instead, the Owner assumed the responsibility for any loss or damage.

In the 2017 version (in Section 3.3.1) a slightly different approach was taken.  The Contractor still has the sole responsibility for construction means and methods.  However, if the Documents provide for a specific instruction which is unsafe, the Contractor is to give notice to the Owner and Architect, AND propose alternative means or methods.

The Architect then must evaluate the proposed alternative solely for conformance with the design intent for the completed construction.  Unless the Architect objects to the proposed alternative, the Contractor is to perform the Work using the alternative it proposed.

Take away tip here?  Make sure that you timely evaluate any such alternative proposal!

Financial Arrangements of the Owner

Since 1976, the AIA Contract Documents have allowed the Contractor to require the Owner to provide evidence that the Owner has made financial arrangements to fulfill the Owner’s obligations under the Contract.  That is, the Contractor had the unfettered right to request evidence indiscriminately throughout the Project.  The Contractor also had the unilateral right to stop work if the Owner failed to provide evidence that he was financially sound when requested.  This process could lead to abuse where, for example, a contractor demanded financial evidence as a ploy to get more time and avoid liquidated damages.

In the last contract revision, in 2007, the documents were changed to only allow the Contractor the right to request evidence of adequate financing prior to the start of Construction, and thereafter only if certain conditions were met.  In the 2017 version, revisions were made for clarification, to establish deadlines for receipt of the information, and to restrict the right to stop work relating to a change in the Work.

Now, the Contractor can request financial information before construction (Section 2.2.1) and during construction (Section 2.2.2) ONLY IF (1) the Owner doesn’t make a payment when due; (2) the Contractor demonstrates a “reasonable concern” regarding the Owner’s ability to make payment when due; or (3) there is a change in the work that materially changes the Contract Sum.

If the request is made prior to start of Work, the Contractor has no duty to commence work until the evidence is provided.  If the request is made during construction, the Owner has 14 days to provide the information or the Contractor can stop the Work or, if the request is because of a change in Work, stop work on that portion of the Work affected by the change.  Of course, the Contract Time would need to be extended if the Work is delayed, and the Contract Sum would need to be increased by the amount of the Contractor’s reasonable costs of shutdown, and re-mobilization.

Since Architects are often asked to rule on whether or not a Shut Down is proper, the changes to this provision are important to keep in mind as you administer your construction contracts.

Notice provisions in the AIA A201

Recognizing that we live and work in the electronic age, the A201 now allows written notice to be given electronically.

Written notices can be sent in person, by mail, by courier, or by electronic transmission.  (Section 1.6.1).  The default for establishing requirements for the giving of Notice (EXCEPT Notice of Claims, discussed below) is the use of AIA Document E203-2013, the Building Information Modeling and Digital Data Exhibit.  Alternatively, the parties can use a fill point in Article 12, special terms and conditions.

When establishing an Electronic notification procedure, you should make sure that there is a system in place to capture emails sent to departing employees or others that might otherwise go into the “electronic void”.

Notices of Claims (under Article 15) cannot be by electronic methods.  Instead, they need to be made by certified or registered mail, or by a courier that provides proof of delivery.  This makes sense, since Claims notices are the most important notices and can effect substantial rights, so proof of delivery is required.

There is one more Notice provision with changes, dealing with Financial Arrangements by the Owner.

Financial Arrangements by the Owner

Since 1976, the AIA Contract Documents have allowed the Contractor to require the Owner to provide evidence that the Owner has made financial arrangements to fulfill the Owner’s obligations under the Contract.  That is, the Contractor had the unfettered right to request evidence indiscriminately throughout the Project.  The Contractor also had the unilateral right to stop work if the Owner failed to provide evidence that he was financially sound when requested.  This process could lead to abuse where, for example, a contractor demanded financial evidence as a ploy to get more time and avoid liquidated damages.

In the last contract revision, in 2007, the documents were changed to only allow the Contractor the right to request evidence of adequate financing prior to the start of Construction, and thereafter only if certain conditions were met.  In the 2017 version, revisions were made for clarification, to establish deadlines for receipt of the information, and to restrict the right to stop work relating to a change in the Work.

Now, the Contractor can request financial information before construction (Section 2.2.1) and during construction (Section 2.2.2) ONLY IF (1) the Owner doesn’t make a payment when due; (2) the Contractor demonstrates a “reasonable concern” regarding the Owner’s ability to make payment when due; or (3) there is a change in the work that materially changes the Contract Sum.

If the request is made prior to start of Work, the Contractor has no duty to commence work until the evidence is provided.  If the request is made during construction, the Owner has 14 days to provide the information or the Contractor can stop the Work or, if the request is because of a change in Work, stop work on that portion of the Work affected by the change.  Of course, the Contract Time would need to be extended if the Work is delayed, and the Contract Sum would need to be increased by the amount of the Contractor’s reasonable costs of shutdown, and re-mobilization.

Since Architects are often asked to rule on whether or not a Shut Down is proper, the changes to this provision are important to keep in mind as you administer your construction contracts.

Liquidated Damages

Liquidated Damages can make or break a project.  They can either encourage efficient construction completion, or completely derail a project if there are multiple competing delays and delay claims.  They can also cost a contractor a lot of money if he doesn’t meet the timing requirements of the Project.

In the 2017 contract revision, a specific fill point has been included in all Owner-Contractor agreements (except A105) to prompt the parties to consider including a liquidated damages provision.

The details concerning calculation of the damages, and the limits (if any) to the damages are still left to the parties to negotiate.  The intent of the fill point is to bring the discussion to the forefront, rather than have the provision buried within the Contractor Time section of the contract.

There is also now a separate fill point for bonus or other incentive provisions.

Commencement & Completion Dates in the AIA Documents

Today, dates of commencement & completion.  Technically, I’m cheating, because these changes are in the related contracts, not the A201 itself, although A201 Section 8 discusses commencement & completion dates in general.  However, in the related contract documents (A101 Section 3; A102 Section 4; A103 Section 4), changes were made to encourage specificity.

There is now a check box that allows the parties to select as the Date of Commencement as one of the following:

(1) the date of the Agreement

(2) the issuance of a Notice to Proceed (NTP) by the Owner; or

(3) a different date as agreed to by the Parties.

If no box is checked, the default is the date of the Agreement.  The check box format is meant to clarify any confusion between the parties before the contract is inked.

For Substantial Completion, there is also a new check box to indicate whether such is obtained no later than a specified calendar date or within a certain number of days from commencement.  There is also a new section that addresses Substantial Completion of certain phases of the Work prior to full Completion.

Finally, a new section has been added to cross-reference the new liquidated damages fill point.

The Termination for Convenience Provision

The Termination for Convenience provision (14.4.3) has an interesting history which explains why this small, but very specific, change was made.

Termination for Convenience, an exclusive owner right, was added in the AIA contracts in 1997.  However, contractors and architects were losing the benefit of their bargains, including the fixed overhead and the fee or profit on the portion of Work which was terminated.

To alleviate that problem, in 2007, the contracts were revised to allow the contractor/architect to get payment for work executed, costs of termination, and reasonable overhead and profit on the work not executed.

As many of you know too well, Owners, in response, often completely struck through that provision, denying any overhead or profit for work not yet performed after a termination for convenience.

In the 2017 revision, the A201 (as well as the related Owner-Architect agreements), the automatic entitlement is eliminated, in favor of a fill point to prompt the parties to discuss a fair fee before the project begins.

A negotiated amount also serves to liquidate the Owner’s liability to the Contractor (lost business opportunity and overhead and profit on the Contractor’s unperformed work).  However, the fee is not necessarily designed to completely liquidate the Owner’s liability to the Contractor’s downstream parties.

To protect the Owner from downstream claims, the A401 will need to be edited and coordinated, so that the Owner’s entire liability to the Contractor, inclusive of subcontractors and suppliers, is established in the Termination fill point.

Likewise, if you utilize subconsultants in your architecture or engineering practice, be sure that your contracts are likewise modified to track your entitlement for termination expenses.

Digital Data in the A201 

Building Information Modeling (BIM) is fast becoming common place on larger construction projects.  However, there are multiple risks associated with using digital formats that can be manipulated by multiple parties.

In the 2017 revisions to the A201, there is now a requirement that data protocols be established concerning the development, use, transmission, and exchange of all digital data, including BIM data.  (See Section 1.7).

The E203 form is the suggested document to create the digital protocol.  Note, however, that if the parties have not established a protocol, the use of any digital data is at that party’s own risk.  (Section 1.8).

Further, revised section 3.11 clarifies that the Contractor can keep contract documents, change orders, construction change directives, and other modifications at the site only in electronic format, if it so chooses.

Again, a common theme about these contract changes– they are small, but they are important.  As the designer of record, it is vital that you play a lead role in determining the who/what/when/where/why of data transmission.

At last, we have arrived at the Top Change in the AIA A201— and it deals with the subject that everyone loves to hate (until they need it!), Insurance.

Insurance– everyone needs it; everyone would just as soon not have to deal with it.  I get it, I do.  Attorneys, Insurance Agents– no one likes spending time with those folk!  Good news though.  The changes to the A201 mean that you may end up spending less time with both!

The most important change to the Insurance requirements of the AIA contract is that most of it has moved to a new Exhibit.  Why is this important?  Instead of having to send the entire contract to your agent or broker, you can now send them only the section that they really need to review for compliance.  This also means that if insurance policies change (as they surely will), the entire contract document does not need to be re-written– the Exhibit can be updated accordingly, leaving the rest of the A201 alone.  Nice, right?  This change was made to streamline insurance review and provide for that flexibility of the changing insurance market.

Does this mean that there are *no* insurance requirements in the A201 anymore?  Unfortunately, no.  There are still some insurance provisions in Article 11, such as the requirement that both parties maintain insurance.  (11.1.1 and 11.2.1).

Most notably, it is now the Owner & Contractor, and not the insurer’s, requirement to provide each other with notice of cancellation/expiration within 3 days.  (Section 11.1.4 and 11.2.3).  The party receiving notice can stop work until the insurance lapse is cured.  The reason for the notification change is that prior editions of the A201 required that the insurer notify the Owner of a pending lapse in insurance.  That provision was ultimately removed from the certificates of insurance issued by most insurers, so it was eliminated as a requirement to codify what was happening on the ground between the parties.

There are also some changes to property insurance losses.  The Owner must notify the Contractor of proposed settlements and allocations, and the Contractor has 14 days to object or he will be bound by the allocation.  (See 11.5.2).

The main take-away here is that most insurance will now be in a streamlined, stand-alone exhibit which will make it easier for you to ensure your agent/broker is on board with the requirements before work begins.

In case you are wondering why, as the architect or engineer, you need worry about insurance of the contractor, just remember that it is in your own financial interest to make sure they are properly insured for the project.

That’s it.  You’ve made it through the Top 10 changes.  I do have a few other changes of note, which will be in my next post.  Stay tuned!  As always, if you have any comments or questions, drop me a line or comment below.

 

 

Judge Salinger: Defendant’s Letter Disputing Existence of Contract Does Not Trigger Start of Statute of Limitations Period for Plaintiff

Matthew P. Ritchie and Natalie M. Cappellazzo | Nutter McClennen & Fish LLP | March 9, 2018

In Bay Colony, Judge Salinger denied the defendants’ motion to dismiss a contract claim as time barred even though one defendant (AMB) had sent a letter to the plaintiffs more than six years earlier disputing the existence of a binding agreement between the parties.

Judge Salinger found that the letter itself did not constitute a breach of contract because the plaintiffs did not allege that AMB had no right to terminate the contract. Nor was it an unequivocal repudiation of future obligations under the contract. Notably, AMB did not assert in the letter that it would not pay the plaintiffs for services rendered; instead, AMB merely disputed the existence of a binding agreement and stated that AMB would respond further in writing. AMB’s letter, wrote Judge Salinger, “is not a repudiation of the alleged contract because it is not ‘a definite and unequivocal manifestation of intention [not to render performance]’.” Because no claim for breach of contract or quantum meruit/unjust enrichment had arisen at the time of the letter, the limitations period did not start to run.

Judge Salinger noted that Massachusetts does not generally recognize a cause of action for anticipatory breach of contract. KGM Custom Homes, Inc. v. Prosky, 468 Mass. 247, 253 (2014). The most notable exception to this general rule is where an actual breach accompanies an anticipated breach—for example, if a defendant refuses to pay amounts currently owed while also clearly repudiating an obligation to make future payments. In those circumstances, the statute of limitations would begin to run on claims for both the past and future damages upon repudiation. Callendar v. Suffolk Cty., 57 Mass. App. Ct. 361, 364 (2003).

Bay Colony Prop. Dev. Co., et. al. v. Headlands Realty Corp., et al