Can Unapproved Change Orders Form the Basis for a Lawful Mechanics’ Lien Encumbering the Project?

Richard Erickson and Amanda Weaver | Snell & Wilmer | July 15, 2019

Contractors and suppliers are sometimes challenged to secure a claim for past due payment with a lien on the project, all subject to lien laws that vary throughout the United States. In Arizona, as in most states, the contractor must have a sound legal basis to record a lien. More specifically, the contractor cannot record a lien while “knowing or having reason to know that the document is forged, groundless, contains a material misstatement or false claim or is otherwise invalid.” A.R.S. § 33-420(A).

From this sensible premise governing lawful liens, a question often arises concerning what amounts the contractor can include in the total lien amount. In particular, a lien is usually necessitated by a dispute over what the contractor is actually owed, even when there may be no dispute over the work actually completed. In some cases, this dispute may center upon change order work that the contractor completed, but without first obtaining proper written approval as required by the contract. In other words, the issue often arises regarding whether a contractor can include extra-contractual, additional and unapproved change work in the lien.

No published Arizona case has expressly addressed this issue. However, a combination of the lien statutes and cases interpreting lien law may be used to argue that a contractor cannot legally encumber the project with amounts it has billed for change order work that has not yet been approved. On the other hand, because lien statutes are liberally construed to favor contractors and suppliers broadly including “materials furnished or value provided,” sufficient backup for the change order claim may prove that the corresponding lien was legally valid and reasonable despite the owner’s refusal to pay. See, e.g., Allstate Utility Constr., LLC v. Town Bank of Ariz., 228 Ariz. 145, 149 ¶ 21 (App. 2011) (“We have repeatedly held that the mechanics’ and materialmen’s lien statutes are remedial and are to be liberally construed in favor of materialmen.” (internal quotation marks and citation omitted)).

There is, nonetheless, an argument that only approved written change orders can form the basis of a lien. For example, A.R.S. § 33-981(A) states that each person providing labor, materials, etc., has lien rights “whether the work was done or the articles were furnished at the instance of the owner of the building, structure or improvement, or his agent.” Under rules of statutory interpretation, this arguably means lien rights should be defined by the work specified in the governing contracts and what has been approved. A contractor or supplier cannot simply lien for any materials or work furnished, even if the owner or agent did not approve the work. Furthermore, A.R.S. § 33-993(A)(3) focuses on the terms and conditions of the contract, and unapproved change orders are not part of the contract. See also Tech. Constr., Inc. v. City of Kingman, 229 Ariz. 564, 569 ¶ 14 (App. 2012) (recognizing that, based on a contract providing for changes to the contract price, change orders modify the contract amount). However, the sticky issue is where the owner or his agent has orally approved the work, but a change order required by the contract has not been executed.

In one unpublished Arizona case, a trial court found “expressly disapproved” change orders were not owed. Farwest Dev. & Constr. of the SW, LLC v. St. Joseph Realty, LLC, 2009 WL 838262, at *2 ¶ 11 (Ariz. App. Mar. 31, 2009). However, the appellate court reversed the trial court on other grounds, specifically concerning remaining factual issues on a grant of summary judgment regarding whether the parties waived the contractual requirement to sign change orders. Id. at *4-5 ¶¶ 19-20. Other jurisdictions have more expressly ruled that the contractor or supplier risks recording a wrongful or invalid lien when including unapproved change orders. See, e.g., Roy Zenere Trucking & Excavating, Inc. v. Build Tech, Inc., 65 N.E.3d 340, 349 (Ill. App. Ct. 2016); Stroud-Hopler, Inc. v. Farm Harvesting Co., Inc., 2005 WL 3693342, at *9 (N.J. Super. Ct. App. Div. Jan. 24, 2006) (relying on the New Jersey lien statute’s definition of a “contract” and allowing liens only for work or materials furnished “in accordance with the contract.”)

Therefore, without any Arizona case law directly on point, contractors and suppliers have risks when recording liens that include amounts for unapproved change orders. While the lien statutes will be liberally construed in favor of the lienholder, there may be consequences including treble damages and attorneys’ fees unless the lienholder can show by credible testimony or evidence that the change order was approved and, therefore, amended the contract which would buttress the lien’s validity.

Arizona Legislature Makes Significant Revisions to Shape of Construction Defect Claims

John Gregory | Jones, Skelton & Hochuli | April 18, 2019

On April 10, 2019, Governor Doug Ducey signed SB 1271 into law. The product of over two years of lobbying and interest group meetings, this bill makes significant changes to the existing the laws relating to residential construction in myriad ways.

REVERSING AMBERWOOD – PROPORTIONAL LIABILITY ONLY

One of the main ways this bill immediately impacts the contractor-subcontractor relationship is by limiting an indemnitor’s potential obligations only to the extent of its own negligence. The 2017 Arizona Court of Appeals case Amberwood Development, Inc. v. Swann’s Grading, Inc., No. 1 CA–CV 15–0786, 2017 WL 712269 found that a subcontractor could be responsible for indemnity broader than its own scope of work and without a finding of fault if the contract did not expressly limit its risk that narrowly. SB1271 creates a new statute, A.R.S. § 32-1159.01, to reverse that (non-binding) decision.

Section A of the new statute voids such broad indemnification agreements in construction or architect-engineer contracts as against public policy. It voids any such provision “to the extent that it purports to insure, to indemnify or to hold harmless the promisee from or against liability for loss or damage resulting from the negligence of the promisee or the promisee’s indemnitees, employees, subcontractors, consultants or agents other than the promisor.” Thus, a subcontractor’s indemnity is now limited only to the extent of its own negligent workmanship.

Section D of the new statute notes that the duty to defend can still apply to claims “arising out of or relating to” the contracting party’s work. Because this does not require a finding of fault to limit the duty to defend, it appears unchanged by the new statute.

Of note to insurers is Section C, which states that an insurer is not required to indemnify an additional insured for the proportion of fault allocated to it. This does not limit the duty to defend, however, so the policy should still be the first place to look when determining any defense obligation owed to an additional insured.

The statute’s scope is limited to construction and architect-engineer contracts between private parties for residential dwellings. A.R.S. § 32-1159.01(E). These terms are given specific definitions that are broad enough to cover the work of virtually all engineers, architects, design professionals, contractors and subcontractors. A.R.S. § 32-1159.01(G). The new statute does not apply to contracts with the state or a municipality (A.R.S. § 32-1159.01(F)(1); agricultural improvement districts (§ 32-1159.01(F)(2)); surety or performance bonds by its principal or indemnitors (§ 32-1159.01 (F)(3)); an insurance agreement between the insurer and named insureds (§ 32-1159.01(F)(4)); and public service corporation’s rules, regulations or tariffs that are approved by the Corporation Commission (§ 32-1159.01(F)(7)). It is likewise not intended to affect insurance policies as between a carrier and its additional insureds (§ 32-1159.01 (F)(5)) or the multiple insureds of a single policy other than the proportionally limits any insured may have to the other insureds imposed by the newly instituted Sections A, B, and C. (§ 32-1159.01 (F)(6)).

REVISIONS TO THE PURCHASER DWELLING ACT

Attorneys’ Fees Reinstituted

The Legislature reinstated A.R.S. § 12-1364 to allow for recovery of attorneys’ fees. A Court now may award reasonable attorneys’ fees to the prevailing party. (§ 12-1364(A)). The homeowner is deemed the prevailing party “if the relief obtained by the purchaser for that contested issue, exclusive of any fees and taxable costs, is more favorable than the repairs or replacements and offers made by the seller….” Id. If it is not, the seller is considered the prevailing party.

The new statute sets guidelines to consider when calculating whether attorneys’ fees are reasonable. The Court should weigh:

  1. The repairs, replacements or offers made by the seller, if any, before the purchaser filed the dwelling action pursuant to section 12-1363.
  2. The purchaser’s response to the seller’s repairs, replacements or offers made or proposed, if any, before the purchaser filed the dwelling action pursuant to section 12-1363.
  3. The relation between the fees incurred over the duration of the dwelling action and the value of the relief obtained with respect to the contested issue.
  4. The amount of fees incurred in responding to any unsuccessful motions, claims and defenses during the duration of the dwelling action.

Id. A “contested issue” is “an issue that relates to an alleged construction defect and that is contested by a purchaser following the conclusion of the repair and replacement procedures prescribed in section 12-1363.” The new statute does not replace contractual fee provisions (§ 12-1364(C)).

Subcontractor Participation in the PDA

The changes now require the general contractor to promptly forward any PDA notice to the subcontractors that worked on the house, and specifically allows electronic service. (§ 12-1363 (A)). The subcontractor is now provided the right to inspect, test, and repair the property that was previously provided to the general contractor in the 2015 revisions (§ 12-1363 (B)-(C)).

Homeowner Affidavits

A homeowner who brings a dwelling action must now submit an affidavit along with their complaint, affirming they have “read the entire complaint, agree[] with all of the allegations and facts contained in the complaint and, unless authorized by statute or rule, is not receiving and has not been promised anything of value in exchange for filing the dwelling action.” (§ 12-1363(N)).

IMPACT ON THIRD-PARTY PROCEDURE

Changes are also made to the procedure of bringing third-party claims. The statutes of limitation and repose (e.g. A.R.S. 12-552) are now tolled from the date that the general contractor receives the PDA notice until nine months after a civil suit or arbitration demand is served on it. (§ 12-1363 (G)). Once suit is commenced, subcontractors must be joined as third-party defendants if feasible and subject to the Rules of Civil Procedure (§ 12-1362(D)). The finder of fact must determine:

  1. if a construction defect exists AND
  2. the amount of damages caused by the defect AND
  3. each subcontractor whose conduct “whether by action or omission, may have caused, in whole or in part, any construction defect.” (§ 12-1362(D)).

The homeowner specifically has the burden of proof as to steps 1.a. and 1.b., but the statute is silent as to who is tasked to proving item 1.c.. The finder of fact must then allocate pro rata shares of fault to the subcontractors whose work is implicated. Id. The general contractor has the burden of proving each subcontractor’s fault in step 2. Subject to the Rules of Civil Procedure, the new bill requires Steps 1 and 2 to be bifurcated. (§ 12-1362(E)).

STATUTE RETROACTIVITY

The statute expressly applies retroactively “to from and after June 30, 2019.” It therefore stands to reason that these statutes apply to all construction defect claims made from June 30, 2019 onward.

NEXT STEPS

As with any new law, the contours have not been fleshed out. Parties have yet to explore the outer confines of what is and is not enforceable about this bill and its changes to the construction statutes. Our firm will continue to monitor the litigation trends and any subsequent action by the Legislature to further revise the way defect cases are handled.

This alert is only a broad summary of the changes made by this new bill. Please look for more detailed analysis from us in the weeks and months ahead.


Caveat Contractor: Arizona Court Of Appeals Interprets Prompt Pay Act As “Prompt Billing Act” To Deny Relief To Unpaid Contractor

Todd A. Baxter | Dickinson Wright | March 5, 2019

The Arizona Court of Appeals recently denied a contractor’s claim that the owner had violated Arizona’s prompt pay act (“Prompt Pay”) despite the owner’s admission that it had not paid the contractor or objected to the payment application within the statutory time.1 The court’s reason for denying the claim? The payment application included items not supplied within “the preceding thirty day billing cycle.”2 That’s it.

The contractor explained that imposing a strict thirty-day billing cycle would up-end the usual dealings between contractors and subcontractors and create problematic situations regarding materials that are often acquired, stored, and installed during different billing cycles.3 The court did not disagree, but stated that such a potential impact made no difference to its ruling. Instead, it noted that if a statute’s “plain language” “results in awkward procedures, or leads to a harsh result” (as it seemed to acknowledge happened here)4, it is up to the legislature to correct the language, not the court.

Most surprising, though, is not that the court found the owner had a right to object to being billed for labor and materials supplied more than thirty days ago (which might be justified), but that it found the owner was not obligated to object or explain its reasons for withholding payment. Despite paying lip service to Prompt Pay’s primary purpose of requiring owners to object to problems early so that those involved in the work (contractors, subcontractors, and suppliers) receive, yes, “prompt payment,”5 the court concluded that the thirty-day billing cycle referenced in the statute imposes an obligation on the contractor in order to “benefit from” Prompt Pay.6If labor or materials are supplied, but are not billed until after the next regular billing or estimate, the owner may withhold payment for those items – without objecting to them – and not violate Prompt Pay.7

A billing cycle that requires owners to either make payment or state objections within a specified time after each billing is in keeping with Prompt Pay’s purpose; depriving contractors entirely of Prompt Pay’s protections – 18% interest and attorneys’ fees – for work not billed within thirty days of performance, is not.

The court may be right that the legislature needs to revise the language of Prompt Pay to avoid the potential for awkward procedures and harsh results. Until that happens (and don’t hold your breath), contractors should be careful to include in every “billing or estimate” 8 all work performed and materials supplied during any given thirty-day billing cycle, and shift the burden to the owner to object to any items it believes should not have been included.

Footnotes

1. SK Builders, Inc. v. Smith, Ariz. Adv. Rep. 15 (App. 2019).

2. Id. at 16, ¶ 12-14.

3. Id. at 16-17, ¶ 15.

4. Id. at 17, ¶ 18.

5. Id. Quoting Stonecreek Bldg. Co. v. Shure, 216 Ariz. 36, ¶ 16 (App. 2007) (quotation and internal citation omitted).

6. Id. at 16-17.

7. An owner would still be required to pay for non-defective work, and potentially be exposed to contract rate interest, but the contractor’s leverage under Prompt Pay is removed.

8. Id. At 16, ¶ 12 (quoting Prompt Pay)

Arizona To Study Indemnity Provisions In Construction Contracts

Gregory Y. Harris and Jared L. Sutton | Lewis Roca Rothgerber Christie LLP | June 25, 2018

On May 16, 2018, Governor Doug Ducey signed Senate Bill 1271, which created a “construction liability apportionment study committee” (the “Committee”) to “research and make recommendations for the apportionment of liability in the construction industry.”

Except for the construction of public buildings or improvements, there currently is no legal restriction on the way parties to construction contracts in Arizona can structure the apportionment of liability via indemnity provisions.  As it was originally introduced, Senate Bill 1271 would have changed that, with language prohibiting indemnity provisions in construction, architecture, and engineering contracts that require one contractor to pay for another contractor’s negligence. The Bill would have created a system of comparative fault, similar to Arizona’s version of the Uniform Contribution Among Tortfeasor’s Act ( A.R.S. §§ 12-2501, et seq.), in which each party involved in the construction of a project bears responsibility only for its portion of fault.

The Bill was, however, substantially amended before it was passed to remove the proposed restrictions on indemnity provisions, and instead created the Committee that will study the issue before making a recommendation to the Governor and legislative leadership by the end of the year. The Committee will be comprised of three members of the Senate and three members of the House, and will be responsible for researching and making recommendations regarding the apportionment of liability in the construction industry, to include:

  1. The use of indemnity provisions in construction contracts;
  2. The allocation of liability based on degrees of fault;
  3. The assignment of financial responsibility to negligent parties;
  4. The opportunity to address and remedy alleged construction defects before litigation;
  5. The frequency of construction defect litigation; and
  6. The affordability of insurance costs associated with construction claims.

The Bill allows the study Committee to hold hearings, conduct fact finding tours and to receive testimony from witnesses to assist the Committee fulfilling its responsibilities. The Committee must meet in public and will be supported by legislative staff. The Bill also requires the Committee to submit its final report to the Governor, the President of the Senate, the Speaker of the House, and the Secretary of State by December 15, 2018.

Regardless of the outcome of the Committee’s investigation, its recommendation to the Governor and Legislature could have a significant impact on construction contractors, architects, engineers, owners, and developers. If the Committee recommends legislation similar to what was initially introduced as SB1271, contractors and designers higher in the contractual chain will potentially bear more financial responsibility for their role in construction defects, and will no longer be able to look to minimally involved sub-contractors for indemnification. If, on the other hand, the Committee recommends no change to the current scheme, sub-contractors will continue to be enticed to agree to risky indemnification provisions in pursuit of large value contracts where the general contractor has shifted the risk of defect. More likely, the Committee will take a more balanced approach, recommending a compromise that takes into account certain liability apportionment principles, but does not completely prohibit contractors from shifting risk in exchange for lucrative sub-contracts.

However the Committee’s recommendation ends up, its work will frame the allocation of risk in Arizona’s construction and real estate industry over the coming years. To the extent your business has an interest in how risk can be allocated in construction contracts, now is the time to act. Contact your industry and trade organizations to make sure they are aware of the issue and take the forthcoming opportunities to be involved in the Committee’s investigative process and recommendation.

We will continue to monitor the Committee’s work and will issue a supplement to this article when the Committee members are named.

Changes in the Arizona Rules of Civil Procedure Will Impact Your Case

Michael Ponzo | Property Insurance Coverage Law Blog | May 14, 2018

In 2017, the Arizona Supreme Court changed the scope and limits of discovery to “any non-privileged matter that is relevant to any party’ claim or defense and proportional to the needs of the case.”1 Starting in July 2018, Arizona Rule of Civil Procedure 26.2, will take effect. Rule 26.2 has been significantly changed, adopting a “Three-Tiered” system of civil case management to make discovery occur in a manner consistent with Rule 26.1(b)(1)—proportional discovery.

The Three-Tiered system limits discovery based in a matter based upon the assigned Tier. Tier 1 includes simple cases that can be tried in one or two days and seek damages of $50,000 or less. Tier 2 includes cases of intermediate complexity cases with more than minimal documentary evidence, more than a few witnesses and seek damages between $50,000 and $300,000. However, most first-party bad faith cases will likely fall under Tier 3. Tier 3 cases are logically or legally complex matters with a large number of witnesses, significant documentary evidence, and seek more than $300,000 in damages.

Cases will be assigned to a Tier either by stipulation or motion for good cause; or by placement by the court based upon the characteristics of the case; or, by the sum of the relief sought by the complaint and any counterclaims or crossclaims. Ultimately, the court has discretion to assign a case to any Tier based upon the totality of the circumstances.

So, what are the new discovery limitations associated with Tier 3 cases? In a Tier 3 case, each side is permitted 30 hours of fact witness depositions; 20 interrogatories; 10 requests for production; and 20 requests for admission. However, the most significant impact will be that discovery needs to be completed in 240 days, absent leave of the court. Far too often, first-party bad faith matters have extended out years based upon claims that additional discovery is needed to prepare the case for trial. The adoption of proportional discovery combined with the substantive associated changes to the limits on discovery should result in earlier case resolution, and reduced costs of litigation.

This time limitation on discovery will require policy holders, who have been treated improperly by their carriers, to rethink how they approach their case. You can no longer wait until the last minute to pursue litigation. To use the rules to the policy holder’s advantage, it is important have key aspects of your case lined up by the time your Complaint is filed. Early planning and preparation will be important. This may include identifying experts, obtaining expert opinions and assembling discoverable evidence by the time the Complaint is filed or shortly thereafter. Proper preparation should help eliminate any good faith basis for extending discovery beyond presumptive limits.

The advantages to policyholders is clear, the changes to the discovery rules should allow cases to proceed to conclusion much faster. The rules will limit the amount of discovery, consistent with the true requirements of the case. The goal should be to prevent the insurer’s counsel from extending discovery, which is typically inconsistent with a policyholder’s need to obtain just compensation to repair their home, office or commercial building, and obtain the benefit of the bargain they are entitle to under the policy.
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1 Ariz.R.Civ.P., Rule 26 (effective 7/1/2018).