Consequential Damages can be Recovered Against Insurer in Breach of Contract

David Adelstein | Florida Construction Legal Updates | June 1, 2019

In a favorable case for insureds, the Fifth District Court of Appeal maintained that “when an insurer breaches an insurance contract, the insured is entitled to recover more than the pecuniary loss involved in the balance of the payments due under the policy in consequential damages, provided the damages were in contemplation of the parties at the inception of the [insurance] contract.”  Manor House, LLC v. Citizens Property Insurance Corp., 44 Fla. L. Weekly D1403b (Fla. 5thDCA 2019) (internal citations and quotation omitted).   Thus, consequential damages can be recovered against an insurer in a breach of contract action (e.g., breach of the insurance policy) if the damages can be proven and were in contemplation of the parties at the inception of the insurance contract.

In Manor House, the trial court entered summary judgment against the insured holding the insured could not seek lost rental income in its breach of contract action against Citizens Property Insurance because the property insurance policy did not provide coverage for lost rent.  However, the Fifth District reversed this ruling because the trial court denied the insured the opportunity to prove whether the parties contemplated that the insured, an apartment complex owner, would suffer lost rental income (consequential damages) if the insurer breached its contractual duties.

This ruling is valuable to insureds because Citizens Property Insurance, a creature of statute, cannot be sued for first-party bad faith.  However, the Fifth District found that the consequential damages in the form of lost rental income did not require the insured to prove the insurer acted in bad faith, but merely, breached the terms of the policy.   This holding can be extended to other breach of contract actions against an insurer when the insured suffered and can prove consequential-type damages caused by the breach. 

It’s Not What You Thought You Signed That Counts: Chancery Court Rejects Plaintiffs’ Claims For Breach of Contract Plaintiffs Thought They Had Made

Remsen Kinne and Alidad Vakili | K&L Gates | July 1, 2019

In Concerned Citizens of the Estates of Fairway Village, et al, v. Fairway Cap, LLC and Fairway Village Construction Inc., C.A. No. 2017-0924-JRS (Del. Ch. March 6, 2019), homeowners resident in Fairway Village, a residential planned community (“Plaintiffs”) claimed that plans and actions taken by one of the community’s developers, defendant Fairway Cap, LLC (“Fairway Cap”), to construct, own and lease townhouse condominiums in the community for use as rental apartments breached contractual provisions of Fairway Village’s governing documents. In its verdict for defendants, the Court of Chancery (the “Court”) rejected those claims, and concluded that Plaintiffs failed to prove a breach of contract and denied Plaintiffs’ motion for summary judgment.

In proceedings prior to trial, the Court granted Plaintiff’s motion for preliminary injunction and enjoined defendants from renting townhouses in the community pending the outcome of the trial. Subsequently, the Court dismissed Plaintiffs’ breach of fiduciary duty and fraud claims, leaving only the breach of contract cause of action for trial.

In its findings the Court indicated that Fairway Cap initially wanted to acquire and develop only certain lots within the Community. The prior owner of the undeveloped lots in the Community defaulted on its loan presenting Fairway Cap with the opportunity to purchase the defaulted loan. By purchasing the defaulted loan, Fairway Cap was able to acquire all the remaining undeveloped lots within the Community. After several years of sluggish sales, Fairway Cap re-evaluated its objectives and decided the best and highest use of the remaining lots would be to build townhouses for use as rental apartments, maintain ownership, and rent them to long-term tenants. Testimony at trial indicated this would result in Fairway Cap owning and leasing more than 76% of the community’s condominium units, in turn potentially increasing financing costs for homeowners purchasing and refinancing units and reducing Fairway Village’s property values.

The decision’s analysis first addressed Plaintiffs’ argument that Fairway Village’s governing documents contain restrictive covenants prohibiting the developer’s plans. Plaintiffs bore the burden of proof, the Court held, to identify contractual restrictions on the use of Fairway Cap’s property and how those restrictions had been breached. The Court noted that in real property-related contract breach claims such as Plaintiffs’, the law facilitates free use of land not otherwise validly restricted.

The Court ruled that Plaintiffs failed to meet their burden of proof because they did not identify any contractual commitment that restricted Fairway Cap from owning and renting units in the Community. The Court found that the governing documents clearly provided that a builder or developer can own units to sell or to rent and that “express references to, or implicit recognition of, an owner’s right to rent its condominium unit for residential purposes through the governing documents are too numerous to cite.” A recital in a peripheral declaration document stating that the developer “will offer Condominium Units for sale to the public”, the Court determined, was not incorporated in the governing documents and at best reflects only a then-present intention of the developer, “not … a promise to refrain from all other permitted uses in perpetuity.”

Next, the Court addressed Plaintiffs’ request for a permanent injunction (i) to prevent the developer from constructing townhouses for use as rental units, and (ii) to require the developer to construct townhouses for sale that conform with those already constructed. The Court held that by failing to prove a breach of contract, Plaintiffs also had not proven any predicate wrong and corresponding right of action as required for the Court to grant an equitable remedy such as a permanent injunction. That remedy may not be invoked, the Court indicated, to prevent the developer from lawfully exercising its contractual rights or from putting its property to a lawful use.

The Court rejected Plaintiffs’ contention that the Court should view the Fairway Village’s governing documents “in a macro sense” through Plaintiffs’ eyes. Instead, the Court stated that Delaware law requires adherence to the objective theory of contracts in interpreting the governing documents, “by ‘standing in the shoes of an objectively reasonable third-party observer’ who is bound to give ordinary meaning to the words used by the parties and to enforce the agreements as written when that meaning can be readily discerned.” The Court did not accept Plaintiffs’ argument that Fairway Cap’s rental plan should be enjoined because it fundamentally alters the community and its governance scheme, leaving the developer in control of Fairway Village’s condominium council, even though homeowners contemplated that control would be turned over to them, in support of which Plaintiffs cited references in the governing documents requiring the developer’s consent to certain amendments. The Court went on to observe that no restriction in the governing documents or in law prohibited Fairway Cap’s ownership of multiple units and resulting voting control. The Court noted that Plaintiffs’ “vague sense” of being treated unfairly is not sufficient to justify granting equitable relief.

Notably, in reaching its verdict for the defendants, the Court pointed out that the “Plaintiffs cannot prevail on their breach of contract claim by proving Defendants breached the contract Plaintiffs thought they had made.”

Design Professional Asserting Copyright Infringement and Contributory Copyright Infringement

David Adelstein | Florida Construction Legal Updates | April 7, 2019

Standard form construction contracts between an owner and design professional will address copyright protection, as well as other contractual protections, associated with a design professional’s “instruments of service.”   An owner negotiating an agreement with a design professional should consider alternative language that broadens the scope of the contractual license given to it with respect to the use of the design.  Regardless, a design professional’s copyright infringement claim is still a challenging claim to ultimately prevail on.   While a design professional may likely survive the motion to dismiss stage in a copyright infringement claim, whether it survives the summary judgment stage is another, more challenging, story.

To state a claim for copyright infringement a plaintiff [design professional] must assert [and prove the following two prongs]: ‘(1) ownership of a valid copyright, and (2) copying of constituent elements of the work that are original.’” Robert Swedroe Architect Planners, A.I.A., P.A. v. J. Milton & Associates, Inc., 2019 WL 1059836, *3 (S.D.Fla. 2019) quoting Feist Publ’ns, Inc. v. Rural Tel. Serv. Co., Inc., 499 U.S. 340, 361 (1991).  

In the first prong, the design professional must establish it complied with statutory formalities to own a valid copyright. Id.

In the second prong, the design professional must establish that the defendant copied constituent elements that are original.  Id.

There is also a claim known as contributory copyright infringement.  

Contributory copyright infringement occurs where a party with knowledge of infringing activity materially contributes to the infringing conduct of another.” Robert Swedroe, 2019 WL at *4.   Actual knowledge is not required – it just needs to be shown the defendant had reason to know (i.e.,knew or should have known) of the copyright infringement.  Id. (citations omitted). 

For example, in Robert Swedroe, an architectural firm was hired by a developer to prepare plans and specifications in connection with a residential building project.  The contract was based off an AIA B141 agreement between an owner and architect. The architect was to initially prepare plans to obtain approval of the governing Planning Board and, upon approval, prepare the permit plans for the residential building.    Once the Planning Board approved the project, the developer sold the property to another developer. The new developer, however, hired another architectural firm–that was provided and had access to plans from the initial architect–with the intent on moving forward with the design and construction of the residential building.

The original architect submitted its technical drawings and architectural work to the United States Copyright Office and obtained a Certificate of Registration.   (Notably, this satisfied the first prong on the copyright infringement claim as the original architect satisfied statutory formalities).  The original architect sued the new developer and new architect for copyright infringement asserting the new architect copied original elements of its design for the residential building project.  The original architect also sued the new developer for contributory copyright infringement.  The new architect and new developer moved to dismiss the copyright infringement claims. Although the trial court denied the motion to dismiss, the original architect will still need to support the burden of its copyright infringement claims.  For more information on the difficulties proving a design professional’s copyright infringement claim, review this article.  

The Economic Loss Rule and Why It Matters in Construction Litigation

William S. Durr | Ward and Smith | March 20, 2019

In its broadest sense, the “economic loss rule” prohibits recovery in tort for purely economic loss incurred under contract law. 

The Merriam-Webster Dictionary online defines tort as “a wrongful act other than breach of contract for which relief may be obtained in the form of damages or an injunction.”  Negligence, the most common tort claim, is the failure to exercise the care that a reasonably prudent person would exercise in similar circumstances.  Thus, where a contract exists governing the subject matter of the dispute, claims between the parties must be based on the contract terms, and a tort-based claim between the parties will typically be barred.

The rationale for the economic loss rule is that where a contract exists, the parties have freely negotiated to include or exclude terms governing the parties’ respective rights, obligations, and remedies.  If a party to that contract could extend its remedies beyond those set forth in the contract, this would effectively allow the party to obtain something more than (or inconsistent with) what they bargained for in the contract.  This is especially true in the products liability context, where the economic loss rule first arose.

In 1978, some twelve years prior to the express adoption of the economic loss rule, the North Carolina Supreme Court addressed the essential elements of the rule (without referring to it by name in the decision) in a dispute between an owner and general contractor.  The case, North Carolina State Ports Authority v. Lloyd A. Fry Roofing Co., et al., 294 N.C. 73, 240 S.E.2d 345 (1978), involved a claim for damages arising from leaking roofs.  The owner, the North Carolina State Ports Authority, asserted two claims against the general contractor, as well as other project participants.  One claim was for breach of the construction contract, the other for negligence in constructing and installing the roofs.  The Court found that a tort claim is unavailable “against a promisor for his simple failure to perform his contract, even though such failure was due to negligence or skill.”

The North Carolina Court of Appeals expressly adopted the economic loss rule in a 1990 products liability case, Chicopee v. Sims Metal Works, 98 N.C. App. 423, 391 S.E.2d 211 (1990).  Since Chicopee, case law has intertwined the concepts set forth in Ports Authority and Chicopee and extended the economic loss rule to a number of other substantive areas.

There are exceptions to the economic loss rule.  Ports Authority identifies the following exceptions:

  1. The promisor’s negligent act or omission in the performance of the contract caused injury to the person or property of someone other than the promisee.  By way of example, if a crane falls over and injures a third party who had no connection to the promisee, a claim for negligence brought by the third party against the crane supplier would not be barred by the economic loss rule, as there was not a contract between the crane supplier and the third party.
  2. The promisor’s negligent, or willful, act or omission in the performance of his contract, caused injury to property of the promisee other than the property which was the subject of the contract, or personal injury to the promisee.  Thus, if a crane fell over and damaged the utility lines of the building and the contract with the crane supplier did not involve work on the utility lines, a claim for negligence against the crane supplier for damage to the utility lines would not be barred by the economic loss rule.  This makes sense as the contract with the crane supplier did not include or govern the utility lines and, therefore, there was not a contract that applied to the specific subject matter of the dispute (the utility lines that were damaged).
  3. The promisor’s negligent, or willful, act or omission in the performance of his contract, caused loss of or damage to the promisee’s property, which was the subject of the contract, and the promisor had a legal duty, as a matter of public policy, to use care in the safeguarding of the property from harm, as in the case of a common carrier, an innkeeper or other bailee. 
  4. The injury caused by the promisor to the promisee was a willful act.  

In applying and, in many cases, expanding these exceptions, the relevant inquiry under North Carolina law is whether the injured party has a basis for recovery in contract or warranty.  If there is a basis for recovery under a contract or warranty provision, then the Court will generally recognize and apply the economic loss rule, provided that there is not an independent legal duty which is identifiable and distinct from the contractual duty.  See, Bradley Woodcraft, Inc. v. Bodden, 795 S.E.2d 253, 258-59 (2016).  By way of example, an architect is held to a professional standard of care.  While this professional standard of care may be referred to in the contract between owner and architect, the duty to adhere to a professional standard of care is an independent legal standard and the owners’ tort claims against the architect are not barred by the economic loss rule. Put simply, the architect cannot contract away its obligations to perform at a minimum professional standard of care.    

In Bradley Woodcraft, the homeowner entered into a contract with the general contractor to undertake some interior finish work and kitchen remodeling.  The homeowner became dissatisfied with the contractor’s work.  After meeting with the contractor the homeowner paid the contractor an additional sum, using two credit card transactions.  The homeowner testified that payment was made with the understanding that the contractor would complete the project.  The contractor took the funds but never returned to the job.  The homeowner disputed the two credit card charges, which were reversed by the credit card company.  The contractor sued the homeowner for breach of implied and express contract, and the homeowner counterclaimed, alleging among other claims, breach of contract and fraud.  The homeowner argued that their fraud claim should survive the economic loss rule defense.  The Court agreed, “…while claims for negligence are barred by the economic loss rule where a valid contract exists between the litigants, claims for fraud are not so barred…”  Bradley Woodcraft at 259.  Bradley Woodcraft seems to suggest that a tort claim, other than negligence, will survive in an otherwise clear contractual dispute and not be subject to the economic loss rule. 

Fortunately, a 2018 federal case rejected the broad statement that the economic loss rule barred only negligence claims and distinguished Bradley Woodcraft by stating that the proper inquiry is whether there is an independent legal duty, which is identifiable and distinct from the contractual duty.  Legacy Data Access, Inc. v. Cadrillion, LLC, 889 F.3d 158, 166 (4th Cir. 2018).      

An earlier construction case, Lord v. Customized Consulting Specialty, Inc., 182 N.C. App. 635, 643 S.E.2d 28 (2007), allowed the owners of a home to pursue a tort claim against a subcontractor, holding the economic loss rule did not bar claims of negligence given the particular facts of the case.  In this case, the homeowners (Lords) discovered the trusses used to construct their home were defective.  The Lords sued their contractor (Customized Consulting Specialty, Inc.) and the subcontractor who designed the trusses.  The claims against the subcontractor included a negligence claim.  The subcontractor argued the economic loss rule applied to bar the homeowners’ negligence claim, relying on the holdings from several cases involving damage resulting from the use of synthetic stucco, some decided in Federal Court. The North Carolina Court of Appeals rejected the subcontractor’s arguments.  The Court found that no contract existed between the subcontractor and the homeowners, that the economic loss rule did not apply and that the economic loss rule did not operate to bar the homeowners’ negligence claim.     

In summary, while the economic loss rule does not provide an absolute defense to all tort claims, it must certainly be considered in litigation that involves claims sounding in both contract and tort. 

More importantly, the protection of the economic loss rule begins with the contract itself.  Creating, maintaining, and properly executing well-drafted contracts is a foundational requirement to controlling and allocating risk in the construction industry.  If you give less attention to your contracts than you do other details of a project, you are placing your company at risk, as you may find yourself defending both contract and tort claims.

Understanding Contract Payment Provisions

Amandeep S. Kahlon | Bradley Arant Boult Cummings LLP | March 19, 2019

Payment terms and conditions are an important piece of every construction contract. Taking some time to understand your payment obligations will help you successfully administer your project and, hopefully, avoid disputes. Although many construction projects utilize industry-standard form contracts with set payment terms, such provisions may, in practice, vary slightly or substantially from contract to contract, and it is important to understand the different obligations and rights that may arise under the payment section in any contract, regardless of the form used. Below is insight on how to navigate and apply some of the typical elements of payment provisions in construction contracts.

Timing

Be aware of the payment timing requirements in your contract regardless of whether you are billing for or paying for the work. If you are a contractor contracting with a subcontractor, make sure your project manager understands the time period provided for review and approval of a subcontractor’s payment application. Many contracts will require a contractor to dispute an application within a certain number of days; otherwise, the application will be deemed approved.

That same contractor will also want to know when payment on undisputed amounts is due in order to avoid any state prompt payment act violations. Many states use prompt pay acts to ensure timely payment from owners to contractors and contractors to subcontractors. Failure to adhere to the requirements of a particular state’s prompt pay requirements can make the paying party liable for interest on past due payments, as well as payment of the billing party’s attorneys’ fees and costs incurred in order to collect on the past due payment.

For subcontractors, be mindful of “pay when paid” or “pay if paid” provisions in the contract. If your payment is tied to owner payments to the contractor and there is any delay in paying the contractor, you may experience delays irrespective of the timing requirements contained in your agreement. You need to plan your cash flow needs accordingly.

Conditions for Payment

Many contracts will require submission of a signed payment application before the obligation to review and approve billings accrues. Other contracts require additional documentation, which may come in the form of partial lien waivers or itemized schedule of values documenting percentage of work completed. Before beginning work, you should make sure you understand what documentation is required, as failure to satisfy express documentation requirements is a simple way for a party to delay payment on a bill that is otherwise due and owing.

Pay particular attention to any partial lien waivers that an upstream party requires as a condition for payment. Aggressive upstream parties may draft broad lien waiver forms that effectively waive all claim rights through the date of partial payment on a particular payment cycle. Many courts will enforce the express terms of these waivers, so you should be weary of executing such forms, especially when you have pending claims or disputes with the owner or contractor you are billing. If an upstream party insists on submission of a broad waiver and you know you have change orders or other claims pending, one way to handle is to include a reservation of rights in the form before signing.

As mentioned above, an upstream party may also have review and approval authority over any payment application. As the upstream party, you should understand and try to adhere to any contractual notice requirements if you decide to dispute payment. As the billing party, you should recognize the contractual reasons that may be proffered for disputing or rejecting payment and be prepared to rebut in writing any such excuses for nonpayment.

Conclusion

Payment on construction contracts can be contentious. Owners are often dealing with lender financing issues that may complicate or delay payment, and contractors and subcontractors may encounter cash flow concerns if payment is withheld, which can impact the project schedule and progress of the work. If payment terms are properly dealt with through the parties’ contract and the parties operate in good faith, most construction projects will achieve successful completion without substantial payment disputes arising.

However, if disputes regarding payment do arise, you should comply with your contract requirements as best you can. In the event that your dispute escalates to litigation, compliance with the contract payment terms will likely be given substantial consideration by whatever judge or arbitrator is hearing your case. If you have a substantively sound argument for disputing or demanding payment but fail to satisfy express payment terms under your contract, you may face an unfavorable outcome, so proceed diligently and carefully to avoid that result.