At What Cost? Navigating the Costly, Tricky Trends in Smaller Construction-Defect Disputes

Megan Ferris and Kristin Tannler | Construction Claims | Winter 2018

There is an ongoing trend in construction-defect litigation where lawsuits or arbitration claims involving contract, payment, or punch-list disputes transform into stubborn, unpredictable, and litigated disputes for which fees and expert costs far exceed the actual issues in dispute. These are not the multi-million-dollar condominium cases with hundreds of units and just as many parties and attorneys, but rather smaller, custom projects for individual homeowners.

The underlying contracts in these matters often contain a prevailing party-fee clause, but little else with respect to key terms.

These matters, because of cost and attorney-fee exposure, rarely go to trial or arbitration, and we don’t have the opportunity to see how courts would rule in such matters if they were given the chance. Recently, the Oregon Court of Appeals issued an opinion in Cedartech, Inc. v. Strader, 293 Or App 252 (2018) that touches on all of these themes.

Defendant Strader owned a historic home with a cedar-shingle roof. Strader contracted with Cedartech to perform certain work on her roof. That work included cleaning and treating the roof. Sometime after the written contract, Strader requested that Cedartech repair two leaks in the roof. However, while attempting to perform those repairs, Strader refused to allow Cedartech to enter the home to investigate the cause and source of the leaks.

The matter proceeded to judgment by way of bench trial. The trial court found in favor of Cedartech, the contractor, for $7,045 (less $1,200 in offset in favor of Strader). The Court of Appeals affirmed the general judgment in favor of Cedartech, finding that Cedartech had substantially performed under the contract.

Even though the Court of Appeals affirmed the general judgment in favor of Cedartech, it remains to be seen if Cedartech will recover substantial prevailing party fees. The trial court denied Cedartech’s petition for $80,829.50 in attorney fees. The trial court held that no factor supported awarding attorney fees and denied Cedartech’s petition in its entirety. The Court of Appeals remanded the attorney-fee issue back to the trial court, which is still pending.

Cedartech does not establish any new significant points of law to guide our practice, but it does inform us that the courts may be willing to enforce contract terms against homeowners and in favor of contractors. Cedartech also serves as a cautionary tale on the attorney-fee issue, which is often the tail that wags the dog in these contractors-versus-homeowner disputes.

These “small” disputes between the contractor and homeowner often land on our desks after the notice of defect period has elapsed, the homeowner has already incurred attorney fees to get the claim to suit, and the contractor has a breach of contract claim for non-payment. On top of that, the dispute has morphed into allegations of over-charging or bad work against the contractor.

Cedartech is a good reminder that the contractor is sometimes right, however obstacles often block the path to a favorable ruling. In addition, there is an ever-mounting fee petition on both sides. As we continue to litigate these contract disputes disguised as construction-defect claims, we should be mindful of the following issues:

  • The potential for a myriad of coverage issues to be addressed when reporting, including how to tiptoe around issues such as an unfinished project, allegedly fraudulent accounting, and often a lack of property damage (in the conventional sense).
  • Emotional investment of the contractor in the job gone wrong, which often implicates matters of pride, workmanship, and a separate worry that there will not be sufficient coverage.
  • Emotional plaintiffs and punitive litigation tactics that are aimed more at punishing the contractor than negotiating a resolution.
  • The decision on whether to file third-party claims against subcontractors whose worst offense is that they were not permitted to finish their work. Bringing the third-party claims increases the breadth and scope of issues and adds a whole new layer of expense, but it also may help raise settlement funds to increase the chance of a mediated resolution. These subcontractors may have their own coverage concerns and claims for non-payment to add to the mix.

In undertaking triage and mapping out the initial strategy, the contractor’s counsel may consider these tactics:

  • A frank discussion with the contractor client about how to approach a non-payment claim and the likelihood of recovery. This is often where personal counsel may be of aid in either aggressively pursuing a counterclaim or assisting the contractor client in making the decision to forego recovery in exchange resolution of the claim.
  • Attempt to outline items that require remediation versus a part of the job that simply has to be finished and arguably is not the basis of a defect claim against the original contractor.
  • Develop contractual arguments in the contractor’s favor. Did the homeowner wrongfully terminate? Did the homeowner improperly withhold payment? What was the homeowner’s role in contributing to project delays?
  • Engage an expert on behalf of the contractor to immediately document the job-site condition, preferably before remediation or repairs have commenced. Even if repairs have begun or have been completed, a consultant will be able to assist in evaluating reasonableness of cost of repairs and assist in sorting out repair costs from costs to finish.
  • Early evaluation if the case requires deposition discovery before attempting ADR. In some cases, even though we all appreciate the need to keep attorney-fee exposure at a minimum, the plaintiff homeowner has to go through a deposition and be forced to appreciate some of its inherent weakness and to educate her own counsel. Further, early discovery assists in identifying facts that can be developed in favor of the contractor client.

Once the initial discovery issues are mapped out and the pressure points are identified, the case can be set on a course for resolution. If resolution is not possible, perhaps certain contract terms can be construed in favor of the contractor, especially where the contractor was improperly terminated before completion of the project or prevented from completing work. If the analysis in Cedartech can be extended to these other instances, then homeowners should be more hesitant to prosecute contract claims where they themselves were in material breach and should be advised that attorney-fee recovery is not always a given.

Ohio Supreme Court Narrows Coverage for Construction Defect Claims

Arnanda M. Leffler and Anastasia J. Wade | Brouse McDowell | February 10, 2019

On October 9, 2018, the Ohio Supreme Court issued its long-awaited decision in Ohio Northern Univ. v. Charles Constr. Servs., 2018-Ohio-4057, holding that a general contractor was not entitled to insurance coverage for its subcontractor’s faulty work. Since then, some commentators have described the Court’s holding as eliminating all insurance coverage for claims involving defective construction. Such a broad reading is not warranted. Still, Ohio’s insureds would be wise to consider purchasing an endorsement that is readily available in today’s insurance market.

Coverage for Construction Defect Claims Nationally

For years, courts around the country have grappled with coverage for claims involving defective or faulty construction. These cases generally turn on whether the court determines that defective construction is an “occurrence.” An “occurrence” is defined as an accident, including continued or repeated exposure to harmful conditions. In practice, faulty work is almost always an accident as that word is commonly understood—contractor-insureds rarely, if ever, intend or expect to cause injury to persons or property, including their own work. Thus, the industry has long understood that insurance policies will generally provide at least some coverage for damage arising from defective work, subject to policy exclusions that bar coverage for the actual repair or replacement of an insured’s faulty work. Insurers, however, argue that defective work is a non-accidental “business risk” that is not an “occurrence” covered by the policy. Since 2012, almost all courts that have considered the issue have held that defective construction is an “occurrence” and, thus, it is covered by the policy, at least to the extent that work other than the insured’s work is damaged. See Black & Veatch Corp. v. Aspen Ins. (Uk) Ltd, 882 F.3d 952, 966 (10th Cir.2018) (citation omitted).

Ohio’s Position: Westfield Ins. Co. v. Custom Agri Sys., Inc.

In 2012, the Ohio Supreme Court decided Westfield Ins. Co. v. Custom Agri Sys., Inc., 2012-Ohio-4712, holding that claims for the cost to repair an insured’s defective work are not covered because they “are not claims for ‘property damage’ caused by an ‘occurrence’ under a commercial general liability [CGL] policy.” In its decision, however, the Court cited and approved of prior Ohio case law which held that consequential damages arising from a policyholder’s defective work generally are covered by CGL policies. Since Custom Agri, insurance practitioners and courts in Ohio have generally agreed that:

  • Repair and replacement of a policyholder’s defective work is not “property damage caused by an occurrence” and is not covered by standard CGL policies; and
  • Consequential damages to property other than the policyholder’s work is “property damage caused by an occurrence” and may be covered by a standard CGL policy depending upon the applicability of the policy’s exclusions and conditions.

Notably, however, the Custom Agri Court did not address whether a typical CGL policy would provide coverage for the repair or replacement of defective work performed by the policyholder’s subcontractors. The Court addressed this issue in Ohio Northern.

Coverage for Subcontractor Work: Ohio Northern

In 2008, Ohio Northern contracted with Charles Construction Services (CCS) to construct a hotel and conference center. After CCS and its subcontractors completed the work, Ohio Northern discovered significant issues with the work and brought suit against CCS. CCS tendered the claim to its insurer, Cincinnati Insurance Company, which argued that it had no coverage obligations under Custom Agri. In response, CCS argued that Custom Agri was inapplicable because subcontractors performed almost all of the work at issue, not CCS.

The trial court granted summary judgment to Cincinnati, but the Third District Court of Appeals reversed. In finding in favor of CCS, the appellate court analyzed certain policy exclusions that expressly preserved coverage for damaged work or damages arising from faulty work if: (1) a subcontractor performed the work; and, (2) the damage occurred after project completion. Cincinnati then appealed to the Ohio Supreme Court, which accepted the following proposition of law for review:

[Custom Agri] remains applicable to claims of defective construction or workmanship by a subcontractor included within the “products-completed operations hazard” of [a] commercial general liability policy.

Thus, the question before the Court was whether Custom Agri applies to claims involving a subcontractor’s faulty work. In its decision, the Court concluded that Custom Agri does apply to such claims.

The Court acknowledged that its decision went against the weight of authority from its sister-courts nationally, but nonetheless applied Custom Agri to hold that “property damage caused by a subcontractor’s faulty work is not fortuitous and does not meet the definition of ‘occurrence’ under a CGL policy.” The Court failed to address several arguments, including: (1) that this interpretation rendered meaningless the carve-back for subcontractor work in the Your Work exclusion; (2) that the drafting history of the exclusions confirmed that the insurers themselves intended to provide coverage for subcontractor defective work; and, (3) that the meaning of “occurrence” used in Custom Agri contradicted the long-standing meaning given to the word in every other context. Instead, the Court suggested that the Ohio General Assembly could address the issue by requiring that all policies issued in Ohio define “occurrence” to include defective workmanship. Of course, this suggestion brings little comfort to the contractor-insureds that paid substantial sums for “completed operations” endorsements that were intended to provide coverage for these claims in the first place.

What’s Next for Ohio’s Construction Insureds?

Many commentators have written that the decision in Ohio Northern eliminates all coverage for construction defect claims. Taken to its logical conclusion, the absurdity of this argument is evident. Suppose an insured incorrectly affixes materials to the façade of a building, resulting in falling masonry that strikes and kills an innocent bystander. Or, suppose an insured incorrectly installs wiring during construction, resulting in a fire that destroys both the project and surrounding homes. Would any insurer even argue that there is no coverage for such claims?

The Court’s opinion in Ohio Northern cannot be read so broadly. The Court answered a narrow question: does Custom Agri apply to subcontractor work? The answer, according to the Court, is yes. But, Custom Agri held that, while there is no coverage for the repair or replacement of a policyholder’s defective work, there is coverage for consequential damages arising from that defective work. While at times the Court’s language in Ohio Northern is imprecise, the Court makes clear over and again that it is simply applying its precedent, Custom Agri. Notably, the Custom Agri Court relied upon multiple cases previously decided by Ohio courts holding that consequential damages arising from defective construction are covered occurrences. Had the Ohio Northern Court intended to overrule this prior precedent, cited in Custom Agri, it easily could have stated its intention to do so. The Court’s silence on these cases means they are still applicable to Ohio policyholders. Thus, consequential damages arising from defective construction should still be covered under CGL policies.

In fact, even Cincinnati recently confirmed that the Court’s opinion cannot be read so broadly as to eliminate coverage for consequential damages. In its response to a motion to reconsider filed by Ohio Northern, Cincinnati stated that the opinion “correctly recognizes that consequential damages, when they exist, may be covered.” For example, Cincinnati acknowledged that a subcontractor’s CGL coverage would apply at least “where a subcontractor damages part of a construction project that is not within its subcontract.” According to Cincinnati, the Court found no coverage for the consequential damages at issue in Ohio Northern because CCS was a general contractor and all of the damage to the project was CCS’s “work.”

An Ounce of Prevention…

While coverage firms like Brouse McDowell can and should continue to advocate for coverage for consequential damages, Ohio’s contractors should nonetheless consider purchasing additional coverage, particularly if they are acting as a general contractor. Numerous insurers now offer endorsements that reinstate the coverage that the Ohio Northern decision arguably eliminated. For example, some insurers amend their insuring agreement to specifically cover property damage to an insured’s work if it is performed by a subcontractor and falls within the products-completed operations hazard. Other insurers “deem” that property damage to the insured’s work is caused by an occurrence if it is unexpected and unintended. Yet other insurers amend the definition of “occurrence” to include “subcontracted property work damage.”

There may be material differences in how these various forms operate and the extent of coverage they provide, which is a subject that is beyond the scope of this article. Policyholders in Ohio should contact their brokers to discuss the options available to them and, if appropriate, should contact coverage counsel to discuss how the various, differing forms would operate. For their part, owners and developers should amend their construction contracts to compel contractors to purchase such endorsements.

Insureds and sophisticated brokers will understandably question why they and their clients must pay higher premiums to purchase endorsements to protect themselves from claims that the insurers intended would be covered by the existing CGL form. Nonetheless, here, an ounce of prevention is worth a pound of cure, and construction industry participants should contact their brokers and counsel today.

Ohio Supreme Court Bucks Recent Trend and Holds No Coverage for Construction Defects Under Commercial General Liability Policy

Heather Howell Wright | Bradley | December 2018

The insurance coverage analysis under a commercial general liability (“CGL”) insurance policy begins with the “insuring agreement.” The standard CGL policy provides coverage for “those sums that the insured becomes legally obligated to pay as damages because of ‘bodily injury’ or ‘property damage.’” The standard CGL policy further provides that the property damage must be caused by an “occurrence,” which is in turn defined as “an accident.” Traditionally, courts had held that a construction defect was not an “accident,” and thus losses associated with such defects or faulty workmanship were not covered under a CGL policy. However, the recent trend has been for courts to find that construction defects or faulty workmanship do satisfy the “occurrence” and “property damage” requirements for CGL coverage. Yet, a recent decision out of Ohio bucks this trend of finding that claims of faulty workmanship may be covered under a CGL policy.

In Ohio N. Univ. v. Charles Constr. Servs. Inc., the Ohio Supreme Court recently held that construction defects do not constitute an occurrence under a standard-form CGL policy, and that an insurer has no obligation to defend or indemnify claims for defective work. The underlying claim in this case involved a contract between Ohio Northern University (“Owner”) and Charles Construction Services, Inc. (“Contractor”) to build a new conference center and hotel. After the project was complete, Owner discovered extensive water damage and structural defects. Owner filed suit against Contractor, which in turn filed third-party claims against its subcontractors. Contractor tendered the defense to its insurer, Cincinnati Insurance Company (“Cincinnati”), which intervened and sought a declaration that it had no duty to defend or indemnify Contractor.

In the trial court, Cincinnati filed a motion for summary judgment on the declaratory judgment claim and asserted that claims for defective workmanship are not claims for “property damage” caused by an “occurrence.” The trial court granted Cincinnati’s motion for summary judgment, finding there was no duty to defend or indemnify for faulty workmanship.

On appeal, the Ohio Supreme Court considered the CGL policy definition of “occurrence” as an “accident including continuous or repeated exposure to substantially the same general harmful conditions.” The court opined that an accident was unexpected or unintended – involving fortuity. Because a subcontractor’s faulty work is not fortuitous, it could not satisfy the “occurrence” requirement in the CGL.

Importantly, the Ohio Supreme Court recognized that its decision conflicted with decisions in other states as well as the trend of finding coverage for construction defects – but the court explained that “[r]egardless of any trend in the law,” it was required to interpret the plain and unambiguous language of the policy. The court also noted that the Arkansas legislature had enacted a statute requiring that a CGL policy sold in Arkansas must define “occurrence” as including “property damage resulting from improper workmanship.” The Ohio N. Univ. Court noted that the Ohio General Assembly could pass similar legislation in response to the decision.

While the recent trend across the country has been for courts to find that construction defects may be covered under a CGL policy, this case may indicate a pendulum swing in the other direction. Even if it proves to be an outlier, it highlights the importance of knowing which law will apply to the interpretation of insurance policies, because the law can vary significantly from one jurisdiction to another.

Coyness is Nice. Just Not When Seeking a Default Judgment

Garret Murai | California Construction Law Blog | February 4, 2019

As Morrissey of the Smith’s sang: Coyness is nice, but Coyness can stop you, from saying all the things in life you’d like to.

It’s not uncommon in litigation to see a complaint asking for “damages according to proof.” Call it laziness. Call it hiding the ball. Call it coy, even. I call it risky.

And here’s why: If a defendant doesn’t appear and you need to seek a default judgment against him, her, or it, you are barred from doing so, since you are limited to recovering the amount you sought. And last I checked, something of nothing is nothing.

In Yu v. Liberty Surplus Insurance Corporation, California Court of Appeals for the Fourth District, Case No. G054522 (December 11, 2018), one plaintiff found this out the hard way, although perhaps not quite in the way they expected it.

Yu v. Liberty Surplus Insurance Corporation

In Yu, Bann-Shiang Liza Yu hired Automatic Teller Modules, Inc. (ATMI) to design and build a hotel. Not judging, but with a name like that, one might expect problems. And problems there were.

After the hotel opened, Yu filed a complaint against ATMI alleging various construction defects and seeking damages of “not less than $10 million dollars.” ATMI in turn filed a cross-complaint against various subcontractors on the project, including Fitch Construction and Fitch Plastering (collectively, “Fitch Entities”). ATMI’s cross-complaint sought “compensatory damages according to proof.”

While the case was pending Yu and ATMI settled. Pursuant to the settlement, ATMI assigned its cross-complaint to Yu who, stepping into the shoes of ATMI, obtained a default judgment against the Fitch Entities in the amount of $1.2 million. Yu then sued the insurance carriers of the Fitch Entities to collect on the default judgment, but the trial court voided the underlying default judgment finding that ATMI’s cross-complaint did not state an amount of damages.

Yu appealed.

The Court of Appeal Decision

On appeal, the 4th District Court of Appeal noted that:

Procedural due process requires that a defendant be given notice of the existence of a lawsuit and notice of the specific relief which is sought in the complaint served upon him. The law underlying this principal is simple: a defendant who has been served with a lawsuit has the right, in view of the relief which the complaint is seeking from him, to decide not to appear and defend. However, a defendant is not in a position to make such a decision if he or she has not been given full notice.

While there are exceptions to this rule, such as in cases involving personal injury or wrongful death, or when the a plaintiff is seeking punitive damages (in which case, no punitive damage amount may be stated), this rule is so generally accepted, explained the Court of Appeal, that it has been codified in numerous statutory provisions. Code of Civil Procedure Section 425.10 requires that complaints and cross-complaints state :the amount demanded.” Similarly, Code of Civil Procedure Section 580 states that “[t]he relief granted to the plaintiff, if there is no answer, cannot exceed the amount demanded in the complaint.” And, Code of Civil Procedure Section 585 provides that, in an action arising upon contract or judgment for the recovery of money or damages only, a default judgment is limited to “the principal amount demanded in the complaint.”

In response to Yu’s argument that the cross-complaint “incorporated by reference” the $10 million alleged in the complaint, the Court of Appeal disagreed. “The phrase ‘incorporation by reference’ is almost universally understood, by both lawyers and nonlawyers,” explained the Court, “to mean the inclusion, within body of a document, of text which, although physically separate from the document, becomes as much a part of the document as if it had been typed directly” (emphasis in original). And here, held the Court, ATMI’s cross-complaint did not clearly and unequivocally incorporate Yu’s complaint and, in fact, contradicted the complaint by stating that damages were “in an amount precisely unknown.”

Moreover, held the Court of Appeal, the fact that a final defect list and cost of repair report were allegedly served on the Fitch Entities also did not provide adequate notice since due process requires “formal notice” to a defendant of its potential liability, namely, compliance with the Code of Civil Procedure, not “actual notice.”

Conclusion

So, there you have it. If you’re going to sue, state the amount you are suing for. Don’t be coy about it.


Illinois Supreme Court Holds That the Implied Warranty of Habitability Does Not Extend to Subcontractors

Michael J. Ciamaichelo | The Subrogation Strategist | January 17, 2019

The implied warranty of habitability allows a homeowner to recover damages for latent defects that interfere with the intended use of a home. In Sienna Court Condo. Ass’n v. Champion Aluminum Corp., 2018 IL 122022, 2018 Ill. LEXIS 1244 (2018), the Supreme Court of Illinois held that buyers of new homes cannot assert claims for breach of the implied warranty of habitability against subcontractors involved in the construction of the homes because the subcontractors have no contractual relationship with the homeowners and the damages are purely economic. As the court explained, the implied warranty of habitability is a creature of contract (not tort) and, therefore, only exists when there is contractual privity between the defendants and the homeowners.

In Sienna, a group of condominium unit owners alleged that their new homes contained latent construction defects and asserted claims against the various parties involved in the construction and sale of the homes, including claims against the defendant subcontractors for breach of the implied warranty of habitability. The plaintiffs contracted with the property developer to purchase the homes, but the plaintiffs had no contractual relationship with the subcontractors involved in the construction of the homes. The Sienna court, overturning the decisions of the trial court and the appellate court, granted the subcontractors’ joint motion to dismiss the plaintiff’s claims for the implied warranty of habitability because the plaintiffs had no contractual relationship with the subcontractors and the damages were purely economic.

The court’s ruling was based upon the “economic loss rule,” which preserves the distinction between tort and contract claims and denies plaintiffs a tort remedy when their complaint is rooted in disappointed contractual or commercial expectations, i.e., economic loss. The Supreme Court of Illinois defines “economic loss” as “damages for inadequate value, costs of repair and replacement of a defective product, or consequent loss of profits – without any claim of personal injury or damage to other property. . .” Moorman Mfg. Co. v. Nat’l Tank Co., 435 N.E.2d 443 (Ill. 1982). In Sienna, the plaintiffs’ damages were purely economic because the plaintiffs’ homes were the only items that were damaged and, therefore, the plaintiffs’ claims were solely based in contract. Since the plaintiffs had no contractual relationship with the subcontractors, the plaintiffs could not sustain their implied warranty claims against the subcontractors.

The plaintiffs argued that the court should sustain their claims against the subcontractors for breach of the implied warranty of habitability because, otherwise, they would be left with no judicial remedy because the property developer (i.e., the only party with whom the plaintiffs had a contractual relationship) declared bankruptcy before the lawsuit was filed. The Illinois Supreme Court rejected this argument and explained that the bankruptcy of a defendant is a risk faced by every civil litigant.

The Sienna holding establishes that a claim for a breach of the implied warranty of habitability for a new home in Illinois can only be sustained against parties with a contractual relationship to the homeowner (e.g., developer or general contractor) when the damages are purely economic, regardless of whether the defendants with privity to the homeowner are solvent.