ASBCA Confirms that the Government’s Failure to Identify a Defect During Construction is a Constructive Waiver of the Specifications

Maria Panichelli and Michael Richard | Obermayer Rebmann Maxwell & Hippel

Many federal construction contractors have been there: it’s near the end of the project and the government raises an issue with work that was done much earlier, but is not in strict compliance with the specifications. The contracting officer demands strict compliance with the specifications, even if it means tearing out completed work to fix the defect. And of course, the contracting officer insists that the government does not have to pay for the additional work. The contractor has to proceed as directed, but is the contractor actually entitled to additional compensation or not? On December 17, 2019, the Armed Services Board of Contract Appeals handed down its decision in the Appeal of Buck Town Contractors & Co., confirming that if the government knew about the defective work during performance but said nothing, then it has constructively waived strict compliance with the contract specifications and the contractor is entitled to additional compensation.

Buck Town involved a U.S. Army Corps of Engineers project to rebuild a levee with strips of reinforcing geotextile. The specifications required that all seams between the strips be perpendicular to the centerline of the levee. The contractor installed the strips in the right direction, but when it reached the end of a roll of geotextile, it would simply continue that installation with a piece from a new roll. This created a seam on certain strips that was parallel to the centerline of the levee, in clear violation of the specifications.

During performance, this non-compliant work was observed by the Corps’ Quality Assurance representatives, who approved of the work without objection. Buck Town’s installation of connected strips with parallel seams was noted in both the government’s QA logs and the contractor’s Quality Control logs, without identifying it as non-compliant with the specifications. In reliance on the government’s approval, Buck Town rebuilt the levee above the non-compliant geotextile installations. Later on, Corps’ personnel from another project discovered the defect, and the contracting officer directed Buck Town to remove the levee and reinstall the geotextile in compliance with the contract specifications. Buck Town did the additional work and then submitted a claim for the time and costs incurred.

The Corps denied the claim arguing that it was entitled to strict compliance with the contract specifications. Buck Town appealed to the ASBCA, arguing that the Corps had waived strict compliance by approving the non-compliant installation and allowing it to proceed with the work. The contracting officer testified that he was unaware of the non-compliant installations, and the Corps’ QA representatives testified that they were unaware that the geotextile installations failed to meet the contract requirements. The Corps argued that it could not have waived compliance with the contract specifications when the contracting officer did not have actual knowledge that the reinforcing geotextile was not being installed in conformance with the contract requirements.

The Board rejected these arguments, holding that the knowledge of the QA representatives was imputed to the contracting officer and therefore he knew, or should have known, that the work was not being performed in strict compliance with the contract. By failing to identify the non-compliant work during performance, the government waived strict compliance with the contract specifications. The Board sustained Buck Town’s entitlement to time and money incurred in correcting the defective work.

The takeaway for contractors is that you may be entitled to additional time and money for corrections to defective work, provided you can show that the government knew about the defective work and allowed you to proceed anyway.

Contractor Liable Thirteen Years After the Fact??

Earl K. Messer | Taft Stettinius & Hollister | June 28, 2019

Imagine you built a school back in 2005. Years go by. Many employees who worked on the project are gone. Their emails are no longer available to review. Most other records are buried somewhere, maybe. The owner has handled maintenance year after year without your input. The building has aged and felt the effects of changing weather. And then, you are sued, thirteen years after the job is complete—for moisture intrusion. What a nightmare.

The Ohio Court of Appeals for Stark County has just considered such a case and affirmed the trial court’s application of the ten-year statute of repose to bar the claim. Unfortunately, it’s not over yet. The appellate court ruled on May 6, 2019, and the local school district has filed motions to have that ruling reversed. There is probably plenty more litigation to come in this case. Stay tuned.

In the meantime, though, it is constructive to consider what issues are at stake, for both contractors and owners. Ohio has a statute of repose. This is different from a statute of limitations. Most people understand that a statute of limitations sets a time within which a lawsuit must be filed or the claim is lost. The thing that fewer fully understand is that the clock for the statute of limitations may not start to tick until the injured party has reason to believe it has been damaged. In other words, defective construction that a reasonable person would not detect for a while does not start the statute of limitations clock ticking until something occurs to give the owner reason to believe there may be defective work. Think a slow leak inside a building wall that causes wood to rot and mold to grow, but otherwise does not become evident to the owner for five years. Typically, the statute of limitations clock would not begin to tick during those five years. Since the current statute of limitations for breach of contract in Ohio is eight years, the contractor would be exposed to suit for defective work for at least thirteen years.

That would only be the case, though, if the statute of limitations was the only time cut off for construction claims. It is not. Ohio, as well as many other states, also has a statute of repose. The statute of repose in Ohio basically cuts off any ability to sue after ten years following substantial completion. There is an exception if the owner discovers the defects in the final two years of the ten-year period. If the owner does discover defects in those last two years, it gets two more years before it no longer has a claim against the contractor.

So, what does the Stark County case have to do with this? In that case, the contractor, the architect and the contractor’s bonding company were sued for moisture intrusion related issues over thirteen years after the project had been completed. The owner alleged that the Ohio School Design Manual required the defendants to warranty their work for forty years for minor repairs and, astoundingly, one hundred years for major structural or exterior enclosure repairs. The defendants filed motions to dismiss arguing that the statute of repose barred the school district’s claims because it was filed thirteen years after substantial completion, three years beyond the expiration of the statute of repose. On appeal, the appellate court, so far, has affirmed the trial court’s dismissal.

The school district made several arguments as to why the appellate court should have reversed the trial court. The most troublesome for contractors was that when the contractor and the architect agreed in their contracts to be bound by the Ohio School Design Manual, they were more or less agreeing that the school district could make claims against them for up to one hundred years despite the statute of repose. The appellate court did not reject that argument. Instead, it avoided it on a technicality. The school district had not raised that argument with the trial court, and an appellate court will not consider any argument on appeal that a party failed to make first to the trial court. So, contractors can expect owners in the future to test that argument in another case.

Having said that, it seems fairly clear that if the argument had been made to the trial court, the appellate court would have rejected it. The school district’s warranty claim is nothing more than another kind of breach of contract claim. The appellate court affirmed all the good reasons why a breach of contract claim cannot be brought after ten years. All those reasons would apply just as well to a breach of warranty claim, since the warranty was part of the written contract between the parties. Those reasons were that the architect and contractor had no control over the building or its maintenance for all those intervening years. They had no control over extreme weather events that may well have affected the building over thirteen years. Much of the relevant evidence would simply be gone after thirteen years.

So, what is the practical import of all of this?

  1. Both the contractor and the owner should hang on to their written records, including electronic records, for at least ten years, and possibly up to twelve, following project completion.
  2. Owners need to keep their eye on the clock up to ten years after the project is complete in case they may have any viable claims.
  3. Remember that the longer it takes to litigate a matter, the more unclear many things become. For example: what really caused the moisture problems—was it defective work, poor maintenance, natural wear and tear? The owner has the burden of proof to show that it was defective work that caused the problem.
  4. And the longer it takes to litigate, the fewer witnesses that will remain available and the more distant and foggy the memories will be.

Construction One-Minute Read: “OH No!” Buckeye State’s Supreme Court Nixes Insurance For Subcontractors’ Defective Work

Eric A. Berg | Ogletree Deakins | October 15, 2018

In an opinion released on October 9, 2018, the Supreme Court of Ohio held that a general contractor’s commercial general liability insurance did not cover the defective work of either that contractor or its subcontractors. Ohio Northern University v. Charles Construction Services, Inc., No. 2017-0514 (2018).

Breaking with an emerging national trend extending commercial general liability (CGL) insurance coverage to construction defects, the Supreme Court of Ohio reversed an intermediate appellate court’s interpretation of policy language. Per the Supreme Court of Ohio’s opinion, CGL insurance is not intended to cover defects.

The facts before the court were familiar to any general contractor: An owner hired a contractor to build a building, and the contractor obtained CGL insurance and hired subcontractors to complete the task. The project having been completed, the contractor closed it out, demobilized, and handed the building over to the owner. Three years after the owner hired the contractor, defective work by the contractor and its subcontractors allegedly led to water leaks and property damage. Further investigation uncovered structural defects, all of which required repairs in excess of $6 million. The owner sued the contractor for breach of contract and for other claims related to the damage.

The contractor tendered the claim to its CGL insurer, citing its products and completed operations endorsement. The insurer denied coverage and filed a separate lawsuit asking the court to confirm the denial.

After the dispute made its way to the Supreme Court of Ohio, the court sided with the insurer and denied coverage. The court reasoned that the insurance policy was basically a contract and therefore should be interpreted according to contract-law principles. The contract said in its plain language that coverage would only be in place in the case of an “occurrence” which the policy defined as an “accident, including continuous or repeated exposure to substantially the same general harmful conditions.” An accident, the court noted, is something that is “‘unexpected, as well as unintended.’” Faulty workmanship claims therefore are generally not covered, except for their consequential damages, “because they are not fortuitous.”

The Supreme Court of Ohio had previously held that a contractor’s faulty work was not an “occurrence”; now it has extended that holding to the faulty work of subcontractors. Faulty workmanship, the court found, is a business risk and therefore not covered. (Derivative damages are covered, however.)

The court’s reasoning was based on its prior holding that CGL policies are not intended to protect owners from ordinary “business risks” that are “normal, frequent or predictable consequences of doing business that the insured can manage.” In other words, these risks are better dealt with in the project contract’s language and reflected in the price the contractor charges the owner.

The Supreme Court of Ohio admitted that its ruling runs counter to the current trend across the country that expands CGL coverage to faulty workmanship by contractors and their subcontractors.

7th Circuit: Damage to Property Exclusion Applies Broadly to Damage Caused by Defective Work

Melissa Brill and Alexander Selarnick | Cozen O’Connor | January 8, 2018

On December 18, 2017, the U.S. Court of Appeals for the Seventh Circuit issued a decision that will impact insurance coverage for property damage claims, especially in Illinois. In W. Side Salvage, Inc. v. RSUI Indem. Co., the Seventh Circuit, applying Illinois law, held that the damage to property exclusion in a commercial general liability policy applies broadly to exclude coverage not only to the precise area on which the insured was working but also to other parts of the property damaged by the defective work.1

This was not the first time this dispute was pending before the Seventh Circuit. In 2010, ConAgra discovered a hot grain bin — a bin with rising grain temperatures that poses a risk of explosion — at its Chester, Ill., facility. ConAgra hired West Side to fix the problem, but the grain bin exploded while West Side was performing its work. The explosion caused severe injuries to three workers and damaged the grain bin. The injured workers sued West Side and ConAgra, and ConAgra filed a cross-claim against West Side for property damage to the bin.

West Side had a $1 million primary insurance policy with Colony Insurance and an $11 million excess insurance policy with RSUI Indemnity Company. After the parties failed to reach a settlement, a jury found West Side liable for the property damage to ConAgra’s grain bin. On appeal, the Seventh Circuit affirmed the judgment against West Side on ConAgra’s property-damage claim, leaving West Side facing significant liability in excess of its policy limits.

West Side had also filed a complaint in the district court against RSUI for failure to settle ConAgra’s property-damage claim within policy limits. RSUI moved for summary judgment, arguing that its insurance policy did not cover the property-damage claim, in part, because the following exclusion precluded coverage for property damage to:

(5) [t]hat particular part of real property on which you or any contractors or subcontractors working directly or indirectly on your behalf are performing operations if the “property damage” arises out of those operations.

The district court, relying on out-of-state authority, interpreted this exclusion narrowly, concluding that the exclusion applied only for damage to property caused by work on that particular piece of property. Specifically, the district court noted that “a reasonable interpretation of the facts could lead to the conclusion that [West Side] [was] not doing any work on the physical structure of the grain elevator itself, but [was] instead focused solely on handling the material within the bin that caused it to be classified as a ‘hot bin.’”2 The district court concluded that “[w]ork on the bin itself would have fallen within the damage to property exclusion — such as work to physically repair manhole covers or to change the physical characteristics of the bin,” but that “work on the contents of the bin would only fall within the damage to property exclusion to the extent the damage sought was for repair or replacement of the actual contents of the bin lost.”3 Here, the claim was for damage to the bin itself, not to the loss of the grain in the bin making it a “hot bin.”4 Accordingly, the district court denied RSUI’s motion for summary judgment based on the applicability of the exclusion.

On appeal, the Seventh Circuit declined to adopt this interpretation, instead holding that the RSUI policy did not cover the grain bin at all because West Side performed its work incorrectly by failing to reduce the grain temperature in a timely manner.5  In other words, even if West Side was only working on the actual grain when the explosion occurred, this was immaterial because “[t]he damage-to-property exclusion does not apply only to the precise area of the property being worked on if the work performed was poor.”6 The Seventh Circuit recognized that the damage-to-property exclusion is “premised on the theory that liability policies are not intended to provide protection against the insured’s own faulty workmanship or product, which are normal risks associated with the conduct of the insured’s business.”7 Here, the damage that West Side caused was a normal risk associated with its business of remedying hot grain bins before they explode. Accordingly, the Seventh Circuit granted summary judgment to RSUI and dismissed West Side’s claims on the merits.

With this decision, the Seventh Circuit has joined the Eighth Circuit8 in interpreting the damage to property exclusion to apply not only to the precise area of the property being worked on but also to other parts of the property damaged by defective work.

1 No. 16-3928, 2017 WL 6422107 (7th Cir. Dec. 18, 2017).

2 W. Side Salvage, Inc. v. RSUI Indem. Co., 215 F. Supp. 3d 728, 738 (S.D. Ill. 2016), aff’d, No. 16-3928, 2017 WL 6422107 (7th Cir. Dec. 18, 2017).

3 Id. at 738.

4 Id.

5 W. Side Salvage, 2017 WL 6422107, at *1.

6 Id. (citing Pekin Ins. Co. v. Willett, 301 Ill.App.3d 1034, 704 N.E.2d 923 (1998).

7 W. Side Salvage, 2017 WL 6422107, at *1.

8 See Spirtas Co. v. Nautilus Ins. Co., 715 F.3d 667, 673 (8th Cir. 2013).

If Defective Work Is An Accident, Does That Mean It’s Covered?

Charles W. Surasky | Smith Currie & Hancock | October 25, 2017

In our last issue, we discussed the growing trend of courts recognizing that most defective work is accidental for purposes of commercial general liability insurance coverage. Does this mean that CGL insurance will pay for property damage caused by defective work? In many cases the answer is no, it will not. A CGL insurance policy is a contract. Most CGL insurance policies/contracts cover property damage caused by an occurrence. The policy/contract defines an “occurrence” as an accident, but does not define “accident.” The common meaning of accident is an event that occurs unexpectedly and unintentionally. Since the vast majority of defective construction work is the result of negligence, not intentional wrongdoing, the modern trend merely applies the widely accepted rule that undefined contract terms are to be given their ordinary and common meaning.

The old majority view was that insurance, as a matter of public policy, should not pay for defective work because work quality is within a contractor’s or subcontractor’s control. This public policy approach to enforcing contracts, which is still followed by some courts, produces decisions that can be at odds with the language of the insurance policy/contract itself. The modern trend does not condone or encourage defective work. It does recognize that insurance is a contract, that rates are based on the contract’s terms, and that insurance companies should be held to the terms of their contracts. The modern trend also recognizes that standard form CGL policies do a good job of protecting insurance companies from business risks within a contractor’s control.

As was discussed in our last issue, standard form CGL policies start with a broad grant of coverage that is then limited by a long list of exclusions. The bodily injury and property damage part of the Insurance Services Office’s latest CGL policy, issued in 2013, has 17 major exclusions (a – q) most of which have numerous subparts. Exclusions j.(5), j.(6), l., and m. are directly applicable to defective construction work. These four exclusions will be discussed in detail, but first we need to look at four defined terms that are integral parts of these exclusions. You can read these now or skip on and refer back to them as needed.

  1. “Impaired property” means tangible property, other than “your product” or “your work,” that cannot be used or is less useful because:

a. It incorporates “your product” or “your work” that is known or thought to be defective, deficient, inadequate or dangerous; or

b. You have failed to fulfill the terms of a contract or agreement; if such property can be restored to use by the repair, replacement, adjustment or removal of “your product” or “your work” or your fulfilling the terms of the contract or agreement.

16. “Products-completed operations hazard”:

a. Includes all . . . “property damage” occurring away from premises you own or rent and arising out of . . . “your work” except:

(2) Work that has not yet been completed or abandoned. However, “your work” will be deemed completed at the earliest of the following times:

(a) When all of the work called for in your contract has been completed.

(b) When all of the work to be done at the job site has been completed if your contract calls for work at more than one job site.

(c) When that part of the work done at a job site has been put to its intended use by any person or organization other than another contractor or subcontractor working on the same project.

Work that may need service, maintenance, correction, repair or replacement, but which is otherwise complete, will be treated as completed.

17. “Property damage” means:

a. Physical injury to tangible property, including all resulting loss of use of that property. All such loss of use shall be deemed to occur at the time of the physical injury that caused it; or

b. Loss of use of tangible property that is not physically injured. All such loss of use shall be deemed to occur at the time of the “occurrence” that caused it.

22. “Your work”:

a. Means:

(1) Work or operations performed by you or on your behalf; and

(2) Materials, parts or equipment furnished in connection with such work or operations.

b. Includes:

(1) Warranties or representations made at any time with respect to the fitness, quality, durability, performance or use of “your work”; and

(2) The providing of or failure to provide warnings or instructions.

Exclusion j.(5) That Particular Part of Real Property.

Exclusion j.(5) excludes coverage for property damage to:

That particular part of real property on which you or any contractors or subcontractors working directly or indirectly on your behalf are performing operations, if the “property damage” arises out of those operations

Consider the following example. General contractor contracts to convert a warehouse to a student dormitory. The work includes erecting steel framework and structural wood decking within the existing exterior walls. During erection, part of the steel framing is incorrectly bolted and collapses damaging the wood decking and the exterior walls. The steel members that collapsed are also damaged. The owner makes a claim against the contractor for the damage to the steel, wooden decking and exterior wall. The contractor submits the claim to its CGL carrier. The incorrect bolting is defective work. Is there coverage for the resulting property damage?

The steel framing is the particular part of the real property, the student dormitory, on which the contractor was performing operations, so there is no coverage for the damaged steel. The existing exterior walls were not part of the real property on which the contractor was working. Damage to the exterior walls is covered. What about the wood decking? Was it included in the “particular part” of the real property on which the contractor was working? That is less than clear, and, depending on the amount of money involved, could easily lead to a coverage dispute.

Exclusion j.(6) Any Property Damaged By Defective Work.

Exclusion j.(6) excludes coverage for property damage to:

That particular part of any property that must be restored, repaired or replaced because “your work” was incorrectly performed on it.

This exclusion would also bar coverage for the steel damaged in the example above, but exclusion j.(6) is broader than j.(5) in that it applies to “any property” not just “real property.” Suppose the dormitory contract includes installation of furniture and that bookcases and desks are damaged because they were incorrectly assembled by contractor’s furniture subcontractor. Exclusion j.(5) would not apply because the desks and bookcases are not real property. Exclusion j.(6) would apply even though the defective work was done by a subcontractor. The definition of “your work” includes work performed on the contractor’s behalf and materials furnished in connection with such work.

Exclusion l. Damage To “Your (Completed) Work”

Exclusion l. excludes coverage for:

“Property damage” to “your work” arising out of it or any part of it and included in the “products completed operations hazard.”

This exclusion does not apply if the damaged work or the work out of which the damage arises was performed on your behalf by a subcontractor.

While exclusions j.(5) and j.(6) apply to property damage caused while work is ongoing, exclusion l. excludes coverage for work that has been completed or put to its intended use. Unlike exclusions j.(5) and j.(6), exclusion l. does not apply to property damage caused by a subcontractor. Continuing with the dormitory example, suppose the contractor incorrectly bolted the steel framing such that the bolts worked loose over time causing the steel frame to sag after the dormitory was occupied causing damage to the frame and to the studs, ceiling grid, walls and ceilings attached to the frame. Because the dormitory was occupied all of the damaged property is included in the “products completed operations hazard”. Since the contractor installed the steel framing, there is no coverage for the damage to the steel itself. But there is coverage for damaged property such as metal studs, drywall, ceiling grid, ceiling tile and any other work installed by subcontractors. If the steel framing had been installed by a subcontractor, all property damage caused by the defective work would be covered under the general contractor’s CGL policy. Courts that adhere to the “defective work is not an occurrence” doctrine do not give contractors the benefit of subcontractor exception to exclusion l.

Exclusion m. Impaired Property

“Property damage” to “impaired property” or property that has not been physically injured, arising out of:

(1) A defect, deficiency, inadequacy or dangerous condition in . . . “your work”; or

(2) A delay or failure by you or anyone acting on your behalf to perform a contract or agreement in accordance with its terms.

This exclusion does not apply to the loss of use of other property arising out of sudden and accidental physical injury to . . . “your work” after it has been put to its intended use.

Referring back to the definition of “property damage,” remember that property damage includes “loss of use of tangible property that is not physically injured.” Suppose the fire marshal refuses to issue a certificate of occupancy for the dormitory because she determines that the smoke detector and fire alarm installation does not meet code. While the fire alarm system can be reworked to meet code, the rework will take a month or more at considerable expense. This delay prevents the owner from leasing rooms at the beginning of the new school term. The owner asserts a claim for the cost of the rework and lost revenue. For purposes of the contractor’s CGL coverage, the dormitory is impaired property. The dormitory cannot be used because it incorporates the contractors defective smoke detectors and fire alarm and the contractor has failed to meet the requirements of its contract, but that failure can be remedied. Exclusion m. precludes insurance coverage for either the repair of the fire alarm system or the owner’s claim for lost rents.

What about the exception to the exclusion? Suppose the fire marshal does not object to the smoke detector and fire alarm installation, and students occupy the dormitory. Several months later, a short somewhere in the system causes the fire alarm to sound throughout the building and the owner’s maintenance personnel cannot turn it off. The owner is required to vacate the building, rehouse the students, and spend substantial time and money to locate the short and repair the system. Again the owner makes a claim for the cost of repair and the cost of rehousing the students necessitated by owner’s loss of use of the dormitory. Here there has been sudden and accidental physical injury to the contractor’s work, so the exception to the exclusion should apply to allow coverage of the owner’s claim for the loss of use of its impaired property. Moreover, if the fire alarm system was installed by a subcontractor, the contractor should have coverage for the cost of repair under the exception to exclusion l. discussed above.

The Takeaway

There is a clear judicial trend recognizing that defective work can be occurrence triggering the potential for CGL insurance coverage. In many cases that potential will not be realized because coverage is eliminated by one of the business risk exclusions discussed above. Still, the trend is important because it gives contractors the benefit of the exceptions to exclusions l. and m. States that continue to adhere to the defective work is not accidental doctrine will deny coverage for defective work that falls squarely within the subcontractor exception to the exclusion l. and the sudden and accidental exception to exclusion m. Contractors who pay for the coverage provided by those two exceptions are well advised to investigate whether that coverage is judicially revoked in any of the states where they are working.