Risk Management 101: Tailor Your Construction Insurance Requirements to the Discipline so You Don’t Get Taken to the Cleaners

James P. Bobotek | Pillsbury Winthrop Shaw Pittman LLP | October 3, 2017

In the world of construction, whether you’re a lender, owner, contractor or subcontractor, your success hinges largely on risk management. While there’s no substitute for sound business and construction practices (such as proper preconstruction planning, proven construction means and methods, use of experienced personnel, and stringent safety programs), among the most important project risk allocation tools are the contracts governing the various parties’ rights and obligations. Within those contracts, risk is primarily allocated through indemnity and insurance requirement provisions. When preparing insurance requirements for construction-related contracts, it is crucial to ensure these pieces are well-fitted and comfortable, like a good piece of tailoring. This requires the indemnity and risk obligations associated with each project discipline to be clearly identified and addressed.

Design professional contract requirements should include auto and commercial general liability, workers’ compensation/employer’s liability and, most importantly, professional liability coverages. Pay particular attention to the limits of the professional liability coverage; requiring excess limits for this coverage may be appropriate depending on the project’s size. Consider requiring that the coverage be “project specific,” either through a separate project policy or sublimits applicable only to the project. For large projects, a lender may consider requiring, or an owner may consider obtaining, owner’s protective professional insurance coverage, which indemnifies the owner directly for losses arising out of professional negligence of architects/engineers exceeding the limits available under the architects’/engineers’ own professional liability policies.

The entities performing construction work on the project should be required to carry auto and commercial general liability insurance, workers’ compensation/employer’s liability, and an excess liability policy providing coverage over the auto and CGL policies’ limits. Many owners also insist on payment and performance bonds from contractors and/or subcontractors. For those contractors and subcontractors performing any design-build functions, professional liability coverage should also be required. To prevent coverage gaps, contractors’ and subcontractors’ insurance requirements should include pollution liability coverage. If the owner procures the property or builder’s risk coverage, contractors and subcontractors should consider the need for an “installation floater” or similar coverage to protect their equipment and supplies onsite, offsite, and in transit.

While the liability coverage referenced above covers most project accidents resulting in (i) bodily injury, or (ii) damage to property other than what is being constructed, in most cases it does not cover damage to the structure being built. Although it is possible to obtain coverage for damage to construction projects under an owner’s existing property policy, coverage limitations in standard property insurance forms make procurement of a builder’s risk policy desirable in most cases. If a builder’s risk policy is purchased, consideration should be given to whether the owner or the contractor obtains it. This determination is best made on a project-by-project basis, taking into consideration such factors as the type of project (i.e., new construction or renovation of an existing structure); type of contract (cost plus or stipulated sum); financing/lender’s requirements (the owner may want to “bundle” soft cost and loss of income coverage with the builder’s risk policy to avoid claim delays and argument among insurers over coverage); the presence of a master property program (owner or contractor); location of project; the parties’ relative economic leverage to negotiate the most favorable premium and coverage; the contractor’s level of sophistication; and the owner’s desire to participate in project-specific risk management.

Finally, numerous risk management products, including insurance policies and bonds, are required to cover the risks presented by a construction project. To the greatest extent possible, the coverage provided by these policies should fit together. Policy provisions are drafted to create in one policy the exact coverage that was excluded by another policy—just as the pieces of a garment are sewn together without unintended gaps. Have your broker and/or attorney review all of your applicable policies to prevent gaps in coverage. You may need to amend one or more of your policies through endorsements, or purchase additional coverage, to close these gaps. Tailored properly, the project’s insurance program should fit like a well-made suit.

When Your “Private” Project Suddenly Turns into a “Public” Project. Hint: It Doesn’t Necessary Turn on Public Financing or Construction

Garret Murai | California Construction Law Blog | September 27, 2017

In 1931, during the Great Depression, the federal government enacted the Davis-Bacon Act to help workers on federal construction projects. The Davis-Bacon Act, also known as the federal prevailing wage law, sets minimum wages that must be paid to workers on federal construction projects based on local “prevailing” wages. The law was designed to help curb the displacement of families by employers who were recruiting lower-wage workers from outside local areas. Many states, including California, adopted “Little Davis-Bacon” laws applying similar requirements on state and local construction projects.

California’s current prevailing wage law requires that contractors on state and local public works projects pay their employees the general prevailing rate of per diem wages based on the classification or type of work performed by the employee in the locality where the project is located, as well as to hire apprentices enrolled in state-approved apprentice programs and to make monetary contributions for apprenticeship training.

Sometimes, however, it can be difficult to determine whether a project is a public works project or a private works project, even when you intentionally try to structure it as a project in which prevailing wages are not required, as one developer found out in the case of Cinema West, LLC v. Baker, California Court of Appeals for the First District, Case No. A 144265 (June 30, 2017).

Cinema West, LLC v. Baker

The Disposition and Development Agreement

In 2004, the City of Hesperia (City) began acquiring vacant property in its downtown area for the development of a “Civic Plaza,” which was to include a city hall, public library, other governmental buildings and “complimentary retail, restaurant, and entertainment establishments.”

In 2010, the City entered into a disposition and development agreement (DDA) with Cinema West, LLC (Cinema West) to develop a “12-screeen digital cinema immediately west of the Civic Plaza Park.” Under the terms of the DDA:

  1. The City was to convey 54,000 square feet of real property to Cinema West for $102,529;
  2. Cinema West was to construct as 38,000 square foot, 12-screen digital theater on the site which was to be operated for a minimum of ten years; and
  3. The City was to construct a parking lot, water retention system and off-site improvements including curbs, gutters and sidewalks for the theater.

In addition, under the terms of the DDA and other related documents:

  1. The City was to provide an interest-bearing loan to Cinema West in the amount of $1,546,363 equal to the City’s estimated cost to build the parking lot, water retention system and off-site improvements ($1,443,834), in addition to the fair market value of the property conveyed to Cinema West ($102,529) which was forgivable over ten years. This amount was later increased by $250,000 on account of rising steel prices and the City’s adoption of new building codes; and
  2. The was to provide a one-time payment of $102,529 as consideration for the ten-year operating agreement.

The DDA stated that the City was not “providing any financial assistance to [Cinema West] in connection with [Cinema West’s] acquisition of the Site or development of the Project thereon” and that Cinema West “is paying fair market value to acquire the Site and is responsible for paying the full costs of all improvements to be constructed on the Site”

The Department of Industrial Relations Decision and Superior Court Writ Proceeding

In November 2012, as construction of the theater and parking lot were nearing completion, the International Brotherhood of Electrical Workers Local 477 (Union) submitted a request to the Director of the California Department of Industrial Relation (DIR) for public works coverage determination for the project.

In response,Cinema West submitted a letter arguing that the theater was a private project not subject to California’s prevailing wage statutes because: (1) Cinema West purchased the property for fair market value; (2) no public financial assistance was involved; (3) there was “no evidence to suggest that the parking lot was built because it was needed to serve the Project”; (4) their was no “no public funding” associated with the  ten-year “forgivable loan”; and (5) the one-time operating agreement payment was never consummated.

The DIR disagreed. First, although under the DDA Cinema West was to construct the theater and the City was to construct the parking lot, water retention system and off-site improvements, the DIR construed  construction of the theater and construction of the parking lot and related improvements as a “single complete and integrated theatre complex” and thus a “public work” subject to prevailing wages. Second, the DIR construed the City’s ten-year “forgivable loan,” one-time operating agreement payment, and construction of the parking lot and related improvements as “public subsidies” also making the project a “public work” subject to prevailing wages.

In April 2013, Cinema West filed an administrative appeal which was denied by the DIR in June 2013. Thereafter, Cinema West filed a petition for writ of mandate under Code of Civil Procedure section 1085 with the Sonoma County Superior Court to challenge the DIR’s decision. As part of its writ, Cinema West submitted evidence that was not part of the administrative record, including statements in its verified petition and three declarations. At the hearing on Cinema West’s writ, the trial court sustained the DIR’s objections to Cinema West’s extra-record evidence and denied Cinema West’s writ concluding that the evidence “in” the record was undisputed and that based on that evidence alone the project was a public works.

Cinema West appealed.

The Court of Appeals Decision

On appeal, the Court of Appeals noted that “[t]he conditions of employment on construction projects financed in whole or in part by public funds are governed by the prevailing wage law,” that “[t]he overall purpose of the prevailing wage law is to protect and benefit employee on public works projects,” and that the public works statutes are “liberally construed to further its purpose.”

The Court of Appeals further noted that Labor Code section 1720 “broadly” defines “public works” to mean “construction, alteration, demolition, installation, or repair work done under contract and paid for in whole or in part out of public funds” including “work performed during the design and preconstruction phases of construction, including, but not limited to, inspection and land surveying work, and work performed during the post construction phases of construction, including, but not limited to, all cleanup work at the job site.”

Further, explained the Court of Appeals, the term “paid for in whole or in part out of public funds” has been broadly interpreted:

It encompasses both direct and indirect subsidies, including “[t]he payment of money or the equivalent of money by the state or political subdivision directly to or on behalf of the public works contractor, subcontractor, or developer”; “[p]erformance of construction work by the state or political subdivision in execution of the project”; “[t]ransfer by the state or political subdivision of an asset of value for less than fair market price”; “[f]ees, costs, rents, insurance or bond premiums, loans, interest rates, or other obligations that would normally be required in the execution of the contract, that are paid, reduced, charged at less than fair market value, waived, or forgiven by the state or political subdivision”; “money loaned by the state or political subdivision that is to be repaid on a contingent basis”; and “[c]redits that are applied by the state or political subdivision against repayment obligations to the state or political subdivision.” (§ 1720, subd. (b)(1)-(6).) The statute excepts from this otherwise broad definition of public funding “a public subsidy to a private development project that is de minimis in the context of the project.”

Cinema West’s Extra-Record Evidence

Addressing Cinema West’s extra-record evidence first, the Court of Appeals noted that “[i]t is well established that the use of extra-record evidence is limited and generally improper since review is normally confined to the record.” And, here, held the Court:

Cinema West implies that there is an exception to the extra-record evidence rule when the court deems the administrative record inadequate or the agency’s efforts to develop a record wanting, but it cites no authority for this proposition. Nor does it explain what criteria the court should consider in determining the adequacy of such record or efforts. Regardless, Cinema West has failed to demonstrate any inadequacy in the PWL coverage proceedings before the Director or in the record there developed. The coverage determination was initiated by the Union, which submitted documentation pertaining to the Hesperia theater and parking lot development. The documents the Union submitted consisted entirely of public records pertaining to the development. While characterizing the Union’s evidence as “one-sided,” Cinema West does not contend that any of the documents submitted by the Union are not genuine, and the City submitted copies of many of the same documents in response to the Director’s request. It does not suggest any pertinent documents are missing from the record. And contrary to Cinema West’s suggestion that the Union’s proffered evidence was all that was submitted, the record reflects that both the City and Cinema West were provided notice of the proceedings and given the opportunity to submit any documents in their possession bearing on the issues. The Director twice requested documents from the City, indicating her intent to have a complete record.

It was in this context that the trial court found Cinema West had the opportunity, but chose not to, submit any evidence in the initial proceeding or the appeal. Cinema West makes much of the fact that it sought and was denied a hearing on its administrative appeal but, as the trial court observed, a hearing was “not a prerequisite for an interested party to submit evidence.” The trial court’s implied finding that the Director did not preclude Cinema West from submitting evidence and the court’s express finding that Cinema West’s failure to do so was its own choice are supported by substantial evidence.

A Public Works Project Under the Labor Code

Next, addressing Cinema West’s arguments that the project was not a public work subject to the prevailing wage laws, the Court held that the project was a public works for two reasons.

First, the theater and the parking lot and related improvements, while constructed separately by Cinema West and the City, should be considered a single project for the following reasons:

  1. The DDA indicated that the parking lot was directly related to the theater and specifies that “[t]he Parking Lot Improvements will be designed and constructed by [City] as necessary to serve the proposed 12-screen theater with 1,800 seats and any other uses contemplated by [City] . . .”;
  2. Cinema West and the City used the same engineering firm to prepare the plans for the design of both the theater and parking lot;
  3. The DDA provided that following the City’s construction of the parking lot Cinema West was obligated to “maintain the Parking Lot Improvement pursuant to the CC&Rs and the reciprocal access and parking agreement, including the cost of utilities (water and electricity)”; and
  4. The theater and parking lot were built together on the same vacant parcel of land.

Second, responding to Cinema West’s argument that “not a penny of public funds was received by Cinema West in connection with the construction of the Theater,” because it was unable to perform some of the requirements of the operating agreement and therefore did not receive or accept the ten-year “forgivable loan” or the one-time operating agreement payment, the Court of Appeals held:

Even if . . . Cinema West never receives any of the promised payments, the DDA and related agreements call for the loans and one-time payment to be made and the one-time payment is not conditional. We agree with the trial court that allowing a developer to accept public benefits and, if a later determination is made that the project is a public work, disclaim public benefits to avoid paying prevailing wages would seriously undermine the [public works law (PWL)]. It would incentivize gamesmanship on the part of local government bodies and developers whereby projects would be publicly subsidized but constructed without PWL compliance. If an investigation later revealed the violation, the developer could still avoid paying prevailing wages and statutory penalties by repaying or disclaiming the public subsidy. And if the developer chose instead to retain the subsidy because its value exceeded the cost of post hoc PWL compliance and penalties, employees would be worse off because the passage of time and transitory nature of construction work increase the likelihood that some employees could not be found. Such a rule would discourage voluntary compliance and place undue burdens on the Department’s limited enforcement personnel. This cannot have been the Legislature’s intent.

Conclusion

Cinema West is a cautionary reminder for developers and contractors that even if a government entity does not directly construct or finance a project, but merely constructs necessary yet appurtenant parts of a larger project and does not directly finance a project but instead provides conditional loans that may never be received, a project may nevertheless be found to a be a public works project subject to prevailing wages. Cinema West also provides an important procedural reminder, that when submitting evidence in an administrative proceeding, provide all evidence on which you intend to rely on or you may be stuck with the “record” in any subsequent writ or appeal.

Is this Product the Answer to Your Clients’ Complex Construction Needs?

Bethan Moorcraft | Insurance Business Magazine | September 22, 2017

The US construction insurance market is a complex space to compete in. State-specific legislation and various approaches to construction management can sometimes make placing liability and settling litigation a real headache.

But there’s a new product on the block that might just make the lives of brokers in the construction insurance space a tad easier.

Liberty Mutual and Ironshore have introduced an Integrated Primary Wrap Up/Project Specific program offering general liability (GL) and professional liability (PL) protection for medium and large construction projects developed through Design-Build or Integrated Project Delivery (IPD).

The new integrated solution was developed after consultations with US brokerages about challenges in the large construction markets and the difficulties posed by changing approaches to construction management.

Design-Build or Integrated Project Delivery (IPD) blur the traditional lines of responsibility found in the more standard Design-Big-Build approach, allowing contractors and designers to work closely together from the early design stage right the way throughout construction. The more traditional approach would keep the processes separate and the designer would hand blueprints over to a contractor to develop.

“The new integrated solution helps remove the potential gaps in coverage intrinsic to the design-build and integrated project delivery methods,” said Aldo Fucentese, vice president, National Insurance Specialty Construction. “The most challenging aspect of the marketplace was how we could blend GL with PL coverage under one form.

“We solved the problem by developing an endorsement – which is a fully-blown PL form – under a GL form. Blending the two forms together also allowed us to consolidate the claims adjusting process should a claim occur.”

Liberty Mutual is also offering GL and PL clash deductible for additional premium, which is “a truly unique feature,” according to Ben Beauvais, executive vice president, casualty & construction, Ironshore.

The more traditional approaches to construction management provoked a lot of finger-pointing between carriers and denial of fault at the point of claim – something brokers were often left to negotiate for their clients. With this streamlined product, the coverage is “seamless” and there’s only one insurer present to sort things out.
Beauvais added: “The design-builder’s PL exposures are related to the professional services assumed in the agreement with the owner and then subcontracted to design professionals on the project.

“The level of project risk that the design-builder undertakes, according to the contract agreement, may vary from very onerous to fair-and-equitable. The PL coverages and the included risk management services are tailored to provide an integrated solution to design-build contractors’ complex exposures.”

Brokers have given a warm reception to the product so far, according to Fucentese. He said Liberty Mutual’s new-product approach is to consult with the brokerage world, understand broker pain-points and find value-add solutions to address any issues.

“We are very excited about the product. It simplifies the task for the brokers and makes the process of adjusting claims much easier to manage,” he added.

The Legal Impact of Drones in the Construction Industry

Amanda Ciccatelli | Inside Counsel | August 28, 2017

Until this past Fall there was some uncertainty regarding the commercial use of drones, specifically the use of drones in construction. As of late, there have been many legal challenges to the use of drones in construction, including non-registration of drones, invasion of privacy concerns, drone use in restricted areas, potential nuisance claims, and property damage claims caused by wayward drones.

In addition, the requirement in many states is that land surveying work be performed by licensed land surveyors, but drones used for land surveying in construction are often not operated by licensed land surveyors. This is a gray area that will need to be addressed by statute, regulation or case law in each jurisdiction.

Garret Murai, of Wendel Rosen as well as Construction Practice Group co-chair and editor of California Construction Law Blog, sat down with Inside Counsel to discuss the rise of drones in the construction industry and the legal impact surrounding it.

According to the U.S. Federal Aviation Administration (FAA) there were about 42,000 commercial drones in the U.S. in 2016, of which 26 percent were used in construction. While that’s a lot of drones, for the FAA, the commercial drone sector is still at an early stage of growth and the number of commercial drones flying above us is expected to increase ten-fold over the next few years to 420,000 commercial drones by 2021. The increasing use of drones in the commercial sector was given a lift when the FAA released its anticipated Small Unmanned Aircraft System regulations. The regulations, which apply to commercial drones, require commercial drones to be registered through FAA’s Small Unmanned Aircraft System (sUAS) Registration Service, require FAA certification of UA (unmanned aircraft) pilots and set forth detailed requirements governing the operation of drones.

How does the construction industry legally benefit from using drones?

Per the FAA, drone use in the construction industry falls only behind the use of drones for aerial photography (26 percent vs. 34 percent), although, as one might expect, the construction industry also uses drones for aerial photography as well as for much, much more.

“While the use of drones in the construction industry is still relatively new and will likely expand as new commercial products are developed, today, owners and construction companies have utilized drones to survey project sites, to inspect and track the progress of a construction project, and with the right tools, to turn collected data into topographic maps, to aid in volumetric measurements of stockpiles and to create 3D models,” he explained.

The bottom line benefit for owners and construction companies is that drones can provide information quickly, more frequently and at a fraction of the cost of traditional methods such as manual surveying and aerial photography and can help construction projects run more efficiently, safely and at lower cost, according to Murai.

The most recent data from the U.S. Department of Labor shows that there were 154,000 open construction jobs in the U.S. as of May 2017. While this is below the cyclical high of 238,000 open construction jobs as of June 2016 there continues to be a pronounced labor shortage in the construction industry. Although the construction industry has been on a rebound since 2012, many workers who were forced out following the 2008 real estate crash.

“While efficiency and cost savings have been the primary drivers of the use of drones in the construction industry, with the current construction labor shortage, drones have had the added benefit of allowing fewer people to do more,” said Murai.

According to the U.S. Occupational Safety and Health Administration, one in five worker deaths were in construction. The vast majority of these (38.8 percent) were the result of falls. While they have yet to develop a drone that can perform actual labor, drones can increase worker safety by allowing construction companies to monitor and inspect projects with a degree of detail that would have been impossible before.

He said, “With drones, construction companies can inspect high-up and hard to reach areas of a project and can monitor project sites to ensure that workplace and worker safety standards and regulations are being followed.”

There are key findings that came out of the FAA’s drone regulations last September that relate to the construction industry, according to Murai. First, commercial UAs weighing 0.55 pounds up to 55 pounds must be registered through the FAA’s sUAS Registration Service. UAs weighing over 55 pounds must seek an exemption from the FAA. Secondly, UAs may only be controlled by a UA pilot certified by the FAA or by someone under the direct supervision UA certified pilot. To become a UA certified pilot a person must either pass an FAA-approved aeronautical test or hold a Part 61 pilot certificate, complete a flight review within the previous 24 months, and complete a UAS online training course. Lastly, UAs may only be operated during daylight or civil twilight hours with anti-collision lighting, may not travel faster 100 mph or fly higher than 400 feet above ground level or within 400 feet of a structure, and UAs may only be flow when there is a minimum weather visibility of three miles from the control station.

Limitations on Contract Damages: The ‘Betterment’ Argument

Benjamin M. Petre | Faegre Baker Daniels | July 12, 2017

A fundamental purpose of contract damages is to place a non-breaching party in the same position that it would have been in had its contract not been breached. Accordingly, remediation “enhancements” that give the non-breaching party more than was intended in the original scope of work must be credited to the damages claimed. These types of enhancements are known in the construction industry as “betterment.”

Betterment can exist throughout a construction project. It appears most frequently in the context of (1) repair of defective work, (2) correction of defective design and (3) substitution of materials. The analysis of whether betterment exists generally begins with the owner’s original project scope requirements and design intent — the theory is that the owner’s expectations are identified and described in the original design and construction contracts. Subsequent enhancements that give the owner a “better” project than that for which the owner originally bargained must be excluded from the owner’s contract damages. Such subsequent enhancements most frequently result from directed or constructive changes in design standards and improvements in materials and workmanship, which (1) permit a better or different use of the project than originally contemplated; (2) provide a more durable project than originally contemplated; or (3) otherwise enhance the value of the project beyond original design intent.

Indeed, betterment can exist in many forms. As a result, the typical analysis involves evaluating subcategories of betterment.

Usage Betterment

“Usage betterment” results from changes in design standards that permit a better or different use of the project than originally intended. For example, suppose a concrete deck on a commercial building is initially designed and constructed to merely facilitate the delivery of items that would be stored inside the building, and the owner subsequently decides to use the deck as an area to actually store items of a significant size and weight. If that deck later collapses and the owner brings an action, the owner will not be entitled the damages to replace the deck with the increased load-bearing capacity. The design professionals and contractor can argue that the change in usage is outside the original intended design requirements for the project, therefore such changes would constitute betterment. The proper measure of damages, therefore, should be the amount necessary to restore the deck to its original condition and intended use. The owner would be responsible for the costs incurred in increasing the load capacity of the deck.

Quality Betterment

In any dispute over repairs, one betterment question is whether the demanded repairs, although not altering usage, will nevertheless result in work that exceeds the owner’s original expectations regarding the agreed scope of and requirements for the completed project. Reasonable repairs that merely effectuate the owner’s original intent do not constitute betterment. But repairs that enhance original design standards and thereby increase the project’s value or extend the project’s original product warranties can constitute betterment. For example, if an owner contracts for the construction of a single-ply roofing system to be installed on a building, and subsequent efforts to replace the allegedly defective roof involve the installation of a four-ply roof, the roofer could argue that the owner is not entitled to their full replacement cost. The improvement in the quality of the roofing materials would constitute betterment, for which the owner could not recover.

Durability Betterment

Even when a replacement product is of the same quality as originally specified, betterment may be found where the replacement product extends the useful life of the work beyond that originally contemplated. The roofing example can also be used to illustrate this point. If the roofing contract specified that the roofing system would be watertight for 10 years, and the system does not begin leaking until the fifth year, the owner may not be able to recover its full replacement cost. The contractor could argue that the owner already had five years use out of the old roof and should not be able to reap the full benefits of a new 10-year roof, because that would effectively extend the expected roof’s life five years beyond the original warranty.
In the end, betterment is a key concept to keep in mind in evaluating potential contract damages in construction disputes. If the damages include an amount for enhancements that give the non-breaching party more than what was originally bargained for or more than what was intended, that amount will likely need to be credited to the damages claimed.