The Paradigm Shift on Risk in Construction

Joseph A. Cleves, Jr. | Taft Stettinius & Hollister LLP | November 7, 2017

Many owners still rely on heavy-handed contracts to provide them with risk certainty. The goal is to reduce their risk by shifting it to designers and contractors.

While this approach has a certain logical appeal, it has the paradoxical result of increasing risk instead of eliminating it. A review of case law shows that careful drafting of contracts does not provide the imagined protection. The reason is found in the contradictory, unpredictable results that reported decisions reveal on provisions that either limit or shift liability. For example, a limitation on delay damage claims may cancel an owner’s implied warranty in one court’s estimation. Yet another court may nullify such a clause, citing the owner’s planning and design deficiencies as the root cause of the delay. More and more litigation of bedrock cases and principles, such as Spearin and the Economic Loss doctrine, have resulted in a proliferation of inconsistent decisions. The deeply fractured landscape of legal precedent has resulted in an environment where the outcome of disputes and impact of contract terms are unforeseeable. Rather than placing a premium on careful contract drafting, this approach renders careful contract drafting useless in the circumstances for which it was intended.

The search for stability calls for a dramatic change in approach — a paradigm shift. Among the possible solutions on the horizon, only an approach that eschews claims-making and litigation seems to offer the potential for success. Integrated Project Delivery (“IPD”) provides a radically different approach to construction. It supplants adversarial and fragmented relations with a contractual commitment to incentivizing collaboration among project participants. Strong consideration of IPD becomes essential in light of recent case law and recurrent conflicts spawning litigation among owners, designers and contractors.

Construction Law Practice Tip: General Contractor Liability for Subcontractor Injury

Pierre Grosdidier | Haynes and Boone LLP | October 26, 2017

AIA Document A201TM, General Conditions of the Contract for Construction (the “General Conditions”), is a form agreement often incorporated into a main contract between an owner and a general contractor.1 The General Conditions place project control squarely in the hands of the general contractor. The issue is important because who controls the project might end up owing a duty of care to injured independent contractor employees.2 For example, in Saenz v. David & David Constr. Co., Inc., Saenz, an independent contractor employee, appealed the trial court’s take-nothing judgment in favor of David & David after a crane load struck him on the head, precipitating his fall from a roof.3 Saenz argued, inter alia, that the contract between the owner and David & David, and the subcontract between the latter and Saenz’s employer gave David & David control as a matter of law. The contract between the owner and the general contractor contained clauses almost identical to those in General Conditions §§ 3.3.1, 5.3, and 10.2.1.4 The contract provided that

[t]he contractor shall be solely, subject to the terms of Article 4, responsible for and have control over construction means, methods, techniques, sequences and procedures and for coordinating all portions of the work under the contract unless contract documents give other specific instructions concerning these matters[;]5

and that

[t]he contractor shall take all necessary precautions for safety and shall provide all necessary protection to prevent damage, injury or loss to all persons on the work and other persons who may be affected thereby.6

But the contract also required the general contractor to pass its obligations on to its subcontractors via the following clause:

The contractor shall require each subcontractor, to the extent of the work to be performed by the subcontractor, to be bound to the contractor by terms of the contract documents and to assume towards the contractor all obligations and responsibilities which the contractor by the contract documents assumes towards the owner and architect.7

The court held that this last “contract clause modified the previous control clauses.” The subcontract gave effect to this last clause with the following clause:

Subcontractor . . . assumes the responsibilities of an employer for performance of the Work and acts as an employer of one or more employees by paying wages, directing activities, and performing other similar functions. Subject to the right (but not the obligation) of [David & David] to direct Subcontractor or its employees to cease or change unsafe work practices. Subcontractor is an independent contractor, free to determine the manner in which the Work is performed. (emphasis added).8

The court held that the contracts assigned “the contractor’s responsibility for controlling the construction means, methods, techniques, sequences and procedures” to the subcontractor. The court could not agree, in light of the two contracts, that “David & David’s control of the subcontractor’s work is uncontroverted and thus established as a matter of law.”9 The court overruled Saenz’s issue on appeal and affirmed the trial court’s take-nothing judgment in favor of David & David. This next case shows what happens when the subcontract does not include a provision that passes project control to the subcontractor for the latter’s scope of work.

In Maggi v. RAS Dev., Inc., the plaintiff, a subcontractor’s employee, fell from a height on a construction site and died of his injuries.10 A jury awarded Maggi’s estate $3.3 million against RAS Development, the general contractor. On appeal, RAS Development argued, inter alia, that it should not be held liable for Maggi’s death because it did not control or supervise his work. The subcontract between RAS Development and Maggi’s employer “expressly incorporated” AIA Document A201TM, including form language from §§ 3.3.1, 3.3.2, 10.1, 10.2.1, 10.2.3, and 10.2.6, which gave the contractor control of the worksite and responsibility for its safety. For example, the General Condition’s § 3.3.1 stated that

[t]he Contractor shall supervise and direct the Work, using the Contractor’s best skill and attention. The Contractor shall be solely responsible for and have control over, construction means, methods, techniques, sequences and procedures and for coordinating all portions of the Work under the Contract, unless the Contract documents give other specific instructions concerning these matters.11

The court of appeals held that these clauses made it “clear that the parties intended RAS Development to be responsible for supervising, directing, and controlling the construction project,” and it affirmed the trial court’s judgment.12 We can infer that the subcontract did not contain a provision passing control to the subcontractor and making the latter an independent contractor, free to perform its work, as in Saenz.13 RAS Development might have avoided a holding of control-by-contract had such a provision been in place.14

Don’t Just Go With the Flow (Down)

John Benjamin Patrick | Gordon Rees Scully Mansukhani | November 7, 2017

There are some contract provisions that we see so often that we occasionally stop actually reading them, stop actually thinking about them, and just mentally check the provision off our list of things we expect to see in the contract. They fall into the catchall description “boilerplate,” and indeed often populate a section of the contract referred to merely as “Miscellaneous.” While this is obviously not a best practice, it’s also fair to say that some terms (like integration clauses) are virtually never negotiated, and therefore not worth as much time and attention as others. To paraphrase George Orwell, all contract clauses are equal, but some are more equal than others.

One clause that is often treated this way is the flow-down provision, which usually reads something like “We shall have all rights, remedies, powers, and privileges as, to, or against You which the Owner has against us. To the extent that the Subcontract Documents relate in any respect, whether directly or indirectly, to your scope of work under the Subcontract, You agree to be bound to us in the same manner and to the same extent as we are bound to the Owner.” While such clauses are, indeed, common-place, the reality is that they would frequently benefit from far more fine-tuning than they actually receive. One size does not fit all.

Consider dispute resolution proceedings. On public contracts, dispute resolution between the prime contractor and the owner is virtually always litigation in a local court. A smart prime contractor wants a far more nuanced approach to dispute resolution with its subcontractors. Indeed, very often, a smart prime contractor wants an array of options made available to it, to be chosen as appropriate given the nature of the dispute. Disputes solely between the prime and a sub can be resolved via arbitration, whereas any dispute that the prime believes involves the owner must be resolved via the process outlined in the prime contract, and the sub agrees to be joined to any litigation with the owner in the event that the sub’s work is implicated in that litigation. Such provisions are reasonably common, but often run directly afoul of the flow-down provision, which would mandate litigation in all disputes between the prime and the sub, because litigation is mandated in all disputes between the prime and the owner.

Conflicts like these are often addressed (or intended to be addressed) via an order of precedence clause, which exists to explain which document (the prime contract or the subcontract) governs in the event the two are in conflict. But this solution only masks the real problem: the best order of precedence is not necessarily the same in all situations. With respect to some kinds of clauses (like dispute resolution), the prime contractor usually wants the subcontract terms to supersede the prime contract terms. With respect to other kinds of clauses (like the sort of documentation that must be submitted to obtain a progress payment), the prime contract frequently wants the prime contract terms to supersede the subcontract terms. Therefore, a typical blanket order of precedence clause (“in the event of any express conflict between the terms of this Subcontract and the terms of the Prime Contract, the terms of this Subcontract shall prevail[,]”) will not work. Even worse is the attempt to use “higher, stricter, or better” order of precedence language—which form of dispute resolution requires the higher, stricter, or better performance?

Sadly, the only solution to this problem, like so many problems in life, is thoughtfulness and hard work. Post-contract award, and prior to entering into subcontracts on a project, the prime contractor’s project management and risk management staff need to sit down and have a thoughtful discussion about which prime contract terms ought to flow down, and which should be superseded by the subcontract terms. A simple work product that can be produced in such a meeting is a “flow down chart” that identifies each of the prime contract terms and indicates (via the use of a check-a-box graphic, if so desired) which terms flow down versus which are superseded by the subcontract terms. That chart can then be made part of the subcontract documents.

So, the next time a contract comes across your desk, take a moment to really think about those few, forgotten, but proud terms in the back of the contract. Some of them represent opportunities to add real value, so long as you pause for a moment, and don’t just go with the flow.

Preparing for the Changes in the New AIA 2017 Forms

Justin L. Weisberg | K&L Gates | November 6, 2017

After a decade, the AIA  released new design and construction contract forms in April 2017.  Some of the more notable changes to the AIA construction contract documents are summarized below.

Probably as a reflection of advancements in the use of technology in the design and construction industry, the construction forms now default to the E203-2013 Document titled Building Information Modeling and Digital Data Exhibit. The E203-2013, which is identified in the AIA construction agreement forms as a Contract Document, requires the parties to create a digital data protocol and, if building information modeling (“BIM”) is to be used, to create a BIM modeling protocol.  The A-201 requires the parties to agree on the Protocols set forth in the E203-2013 for the use, transmission and exchange of digital data.  The E203-2013 references two protocol forms, the G-201-2013 Project Digital Data Protocol Form and the G-202-2013 Project Building Information Modeling Protocol Form.  Any reliance by the Owner  or Contractor  upon digital data or a building information model without the completion and incorporation of the E203-2013 is at the relying party’s sole risk.

Another new Exhibit, which may be referenced in the construction contract, is the E204 -2017, the Sustainable Projects Exhibit. This E-204 – 2017 sets forth the obligations and terms between the Owner, Architect, and Contractor  for a project that seeks a sustainable objective or third-party certification of a sustainable objective or energy or environmental performance such as LEED®.

The A-201 now provides for direct communications between the Owner and the Contractor. While with the past forms all communications with the Contractor were supposed to go through the Architect, under the A201-2017, the Owner and Contractor can communicate directly, although the Architect is to be included in all communications that relate to or affect the Architect’s services or responsibilities.

The method of calculation for progress payments has been revised. For example, the calculation of progress payments on the AIA A-102 Cost Plus with a GMP  contract now incorporates the allocation of contingencies under the GMP requiring any contingency for costs to be allocated in the schedule of values.  The progress payment calculation under the AIA A-102 is as follows: the Contractor first provides evidence that the costs it has incurred exceed the progress payments previously received plus the current payroll minus the Contractor’s fee.  Assuming the costs plus Contractor’s Fee exceed the progress payments and payroll, the actual amount approved is calculated as: a) the percentage of work completed under the GMP; b) with the addition of amounts from any equipment delivered and suitably stored at the site; plus c) the portion of Construction Change Directives that the Architect believes to be reasonably justified; and  d) the Contractor’s Fee.  The amount calculated is then reduced by: a) the previously paid amounts; b) any amounts for uncorrected defective work; c) any amounts that a Contractor does not intend to pay a subcontractor or supplier; and d) any amounts that the Architect is authorized to refuse to certify under the General Conditions.

The list of amounts that the Architect is authorized to refuse to certify under the General Conditions remains unchanged and includes: 1) defective work; 2) third-party claims; 3) failure to pay subcontractors or suppliers; 4) reasonable evidence that the contract cannot be completed for the unpaid contract balance; 5) damage to the Owner; 6) reasonable evidence that the Contractor will not finish on time and that the remaining unpaid balance is not sufficient to pay the actual and liquidated damages; and 7) evidence of repeated failure to carry out the Work in accordance with the Contract documents. Of course, the final listed item of reduction for progress payments in the A-102 is retainage.

A major change to the construction forms includes removal of a number of insurance provisions in the A-201 and the placement of most of the insurance requirements into a new A101 – 2017 Exhibit A Insurance and Bonds form. Exhibit A is incorporated into the A101-2017, A102-2017, and A103-2017 construction contract forms.  The new insurance exhibit incorporates many of the insurance provisions previously included in the A201-2007, although the A101-2017 Exhibit A also has new insurance requirements including specifically identified additional ISO insurance forms.

The Insurance Exhibit A now specifically requires additional insurance endorsement ISO forms CG 20 10 07 04, CG 20 37 07 04, and with respect to the Architect CG 20 32 07 04. It should be noted, that unlike the previous CG 20 10 11 85 endorsement, which covered ongoing and completed operations in a single form “for liability arising out of ʻyour work’ for that insured by or for you,” the CG 20 10 07 04 form only covers liability “caused in whole or part by: 1. Your acts or omissions; or 2. The acts or omissions of those acting on your behalf in the performance of your ongoing operations for the additional insured(s). . ..”  The CG 20 37 07 04 form only covers liability “caused in whole or part by “your work” . . . “performed for that additional insured and included in the products completed operations hazard.”  Given the limitations stated in the specified forms as compared to forms such as the CG 20 10 11 85 form, or the more recent CG 20 10 10 01 and CG 20 37 10 01 forms, parties that are beginning to use the newly required forms for the first time should consult with their attorneys and brokers to determine whether they are in compliance with these new insurance requirements.  The parties should also consult with their attorneys to determine whether under the laws applicable to the project, the required forms have minimized exposure to any potential uncovered indemnity claims and are not precluded by any statutory restrictions.

The Insurance Exhibit A requires the Owner to obtain the Builders Risk Insurance but allows the obligation to be shifted to the Contractor. The Insurance Exhibit A also provides for the parties to elect from a menu of coverages including, for example, pollution coverage, professional liability coverage, manned and unmanned aircraft coverage, and cyber security insurance.

The right to request financial information during the project has been supplemented to allow the Contractor to request financial information if the Owner fails to make payments, or if the Contractor identifies a reasonable concern regarding the Owners ability to make payment. The Owner can now also identify any such information provided as confidential and require the Contractor to maintain the confidentiality of the designated information.

Under the cost plus forms, the method in which subcontractors are selected has been changed. Rather than the Owner with the advice of the Contractor and Architect determining which subcontractors are selected after submitting bids, the Contractor now selects the subcontractors subject to the Owner’s right to object.

An additional obligation now placed upon the Contractor under the A-201 requires the Contractor to defend and indemnify the Owner from subcontractor and supplier lien claims as long as the Owner has fulfilled its payment obligations to the Contractor.

If the Contractor terminates the Contract for cause it is now entitled to reasonable overhead and profit on Work not executed. If the Owner terminates the Contract for convenience, the Contractor is now entitled to a termination fee to be set forth in the Agreement, rather than reasonable overhead and profit on Work not executed.

In conclusion, given the amount of time that has passed since 2007 when the former AIA construction forms were updated, the extent of revisions in 2017 cannot be described as sweeping changes from the prior versions. However, as noted in the summary above, there have been some significant modifications in the new forms that contractors and owners need to consider when negotiating projects in the future with the new 2017 AIA construction forms.

Contingent Payment Clauses in Utah – “Deal or No Deal?”

Kent B. Scott | Babcock Scott & Babcock, PC | November 2, 2017

Introduction.  Contingent payment clauses provide parties involved in a construction project with a contractual method for determining who will absorb losses that may occur if the owner fails to pay for work performed on the project. In Utah, the law remains unsettled in this area, though some statutes clarify the treatment of contingent payment clauses in certain cases.

Contingent Payment Clauses. One type of contingent payment clause, called a “pay-when-paid” clause, requires a contractor to pay a subcontractor or supplier within a reasonable period of time for work or material furnished to a project. These clauses do not shift the risk of owner nonpayment to the subcontractor or supplier. If the owner fails to pay the prime contractor, the prime contractor is still liable to pay its subcontractors and suppliers.  A pay-when-paid provision might read, “Prime shall pay subcontractor within ten days of receipt of payment from owner.” Pay-when-paid clauses are generally accepted because the risk of loss due to nonpayment is retained by the upper-tier contractor, who the courts view as the party in the best position to evaluate the risk of dealing with a particular owner.

Pay-if-paid clauses, the second type of contingent payment clause, provide more protection to the prime contractor. This type of contingent payment clause conditions the subcontractor’s payment on whether the prime contractor has been paid by the owner. A pay-if-paid clause shifts the risk of loss due to owner nonpayment from the upper-tier contractor to the lower-tier contractor. A pay-if-paid clause may read: “The subcontractor assumes the risk of the owner’s nonpayment to the prime contractor and the subcontract price reflects this risk. Payment to the prime contractor will be a condition precedent to any funds being due the subcontractor.

Pay-if-paid clauses are not as widely accepted as pay-when-paid clauses. Some courts have interpreted a pay-if-paid clause as if it were a pay-when-paid clause, thereby keeping the risk of nonpayment in the hands of the upper-tier contractor. A limited number of states have prohibited the use of pay-if-paid clauses. In states where pay-if-paid clauses have been enforced, courts will generally enforce only clauses that use specific words or otherwise clearly demonstrate that the contracting parties intended to shift the risk of nonpayment.

While an enforceable pay-if-paid clause prevents a subcontractor from recovering unpaid funds from the prime contractor, the subcontractor may still be able to pursue other means of recovery, such as a mechanic’s lien.

Contingent payment clauses in Utah. Utah has yet to determine many of the legal issues surrounding pay-if-paid and pay-when-paid clauses.  The Utah legislature has enacted some statutes, though, relating to these clauses that provide contracting parties with some direction.

In Utah, contingent payment clauses are generally not enforceable against mechanics’ liens, though they may be enforceable in residential contracts.  The Utah Legislature has enacted Utah Code section 13-8-4(3) which provides, “The existence of a contingent payment contract is not a defense to a claim to enforce a mechanics’ lien [but this section] does not apply to private construction work for the building improvement, repair, or remodeling of residential property…”  According to this statute, in most cases, even though a subcontract agreement may include a contingent payment clause that would otherwise bar the subcontractor or supplier from recovering from the prime contractor, that subcontractor may still pursue a mechanics’ lien claim against the property. This statute does not extend this protection to residential contracts, but the subcontractor or supplier may still have a claim against the Residential Lien Recovery Fund.

Additionally, Utah law states that, when a subcontractor may be entering into a contract that includes a contingent payment clause, the subcontractor may request from the contractor financial information prior to signing the contract that the contractor has received from the owner regarding: (1) the project financing, and (2) the owner’s financial situation. This allows the subcontractor to evaluate the risk that it may be assuming.

Conclusion. Contingent payment clauses are common in the construction industry.  They allow parties to allocate the risk of an owner’s nonpayment as part of the contract.  As the applicability of contingent payment clauses in Utah is generally undecided, members of the construction industry should be aware of the potential vulnerabilities and benefits of entering contracts that include them. A contractor should seek legal counsel when determining the effect of contingent payment clauses that have been or will be included in their contracts.