New Illinois Law Impacts Retainage For Contractors

Matthew Horn | SmithAmundsen | September 13, 2019

The Illinois legislature recently passed a law modifying the Contractor Prompt Payment Act, impacting retainage on all private projects (except residential projects involving twelve units or less). The law sets the ceiling for retainage at 10%, and requires that retainage be reduced to no more than 5% once the project is 50% complete.

The new law is generally favorable for contractors and subcontractors from a cash flow perspective. However, it raises concern among developers and owners, who have been able to defeat the bill in earlier sessions.  In light of the new law, all applicable construction contracts need to be reviewed and modified to ensure compliance.

Failing to comply with the new law can be costly—if a party fails to adhere to the new retainage requirements, the other party is entitled to suspend performance on the contract and collect 10% interest per annum on all outstanding amounts.

Does a Mediation Trigger the Duty to Defend Under a CGL Insurance Policy?

Joshua Fruchter | Merge Mediation Group | September 4, 2019

Standardized commercial general liability (CGL) insurance policies impose a “duty to defend” that obligates insurers to defend insureds against “suits” seeking damages for claims potentially covered by the policy. The existence of a duty to defend is determined by the allegations in the “suit” filed against the insured.

Does a mediation qualify as a “suit” under a standardized CGL policy? That question was recently litigated in Illinois state court. See Illinois Tool Works, Inc. v. Ace Specialty Ins. Co., 2019 IL App (1st) No. 18-1945 (August 23, 2019). In that case, the insured manufacturer, ITW, operated a facility at a location (referred to as “AUS-OU”) that was later declared a Superfund site by the United States Environmental Protection Agency (EPA) after the discovery of environmental contamination.

In August 2004, another manufacturer notified ITW that it was negotiating with the EPA concerning the payment of cleanup costs related to the AUS-OU site, and claimed that ITW was partially responsible for those costs because manufacturing activities at ITW’s facility had allegedly released hazardous substances. In response, ITW agreed to share in the expense of remediating the AUS-OU site, and entered into a mediation with the EPA and other manufacturers to allocate cleanup costs. ITW notified its insurers about the mediation, and submitted bills for costs incurred, but the insurers did not reimburse ITW for those costs.

Subsequently, ITW was sued for contribution to cleanup costs for an adjacent site (“Site 36”). The insurers funded ITW’s defense of the Site 36 lawsuit.

After the Site 36 lawsuit settled, ITW filed an action against its insurers seeking a declaratory judgment that the insurers had a duty to defend and indemnify it for claims against it regarding both the Site 36 lawsuit and the AUS-OU mediation. The insurers acknowledged that they had a duty to defend ITW in the Site 36 lawsuit, but argued that the same duty did not apply to the AUS-OU mediation because it was not a “suit” under the policies.

The trial court agreed with the insurers that the AUS-OU mediation did not trigger a duty to defend because it was not a “suit” under the policies.

On appeal, ITW abandoned its argument that the mediation qualified as a “suit” under the policies, and instead maintained that the duty to defend triggered by the Site 36 lawsuit extended to the AUS-OU mediation because the contamination at issue in the Site 36 lawsuit and the AUS-OU mediation arose out of the same allegedly hazardous releases. That argument failed, and the appellate court affirmed.

Why did ITW decide, on appeal, not to press its argument below that the mediation qualified as a “suit” under the policies? The appellate court’s decision indicates that the relevant policies were issued to ITW’s predecessor between 1974 and 1985.

As per an August 2002 article published on the International Risk Management Institute, Inc. (IRMI) website by risk management consultant Craig Stanovich, it was only in 1986 that standardized CGL policies began defining the term “suit” to include (i) arbitration proceedings “in which such damages are claimed and to which the insured must submit or does submit with our consent;” and (ii) “any other alternative dispute resolution proceeding in which such damages are claimed and to which the insured submits with our consent.”

While the definition of “suit” in the new standardized CGL policy does not specifically mention mediation, it seems clear that mediation would qualify as an “alternative dispute resolution proceeding.” Importantly, however, the new definition of “suit” obligates the insured to obtain the insurer’s consent to submit to an ADR proceeding before the insurer becomes obligated to defend the proceeding. Accordingly, assuming a mediation qualifies as a “suit” under the policy, an insured would first need to obtain the insurer’s consent to participate in pre-litigation mediation before the insurer would be obligated to cover mediation costs.

At any rate, given that ITW made its insurers aware of the mediation, and they appeared to have consented (or at least not objected), ITW might have prevailed under the newer definition of “suit” that imposes a duty to fund the costs of an “alternative dispute resolution proceeding” to which the insurer consents.

The importance of obtaining the insurer’s consent to ADR is illustrated by a recent California federal court decision. See Harper Constr. Co., Inc. v. Nat’l Union Fire Ins. Co., 377 F. Supp. 3d 1134 (S.D. Cal. 2019). In Harper, the court held that even if an insured’s interaction with the federal government in a construction dispute under the Contract Disputes Act constituted a form a type of ADR proceeding under the new CGL policy, the duty to defend was not triggered because the insurer had never consented to the proceeding.

Illinois’ New Retainage Law

James Rohlfing | Saul Ewing Arnstein & Lehr | September 3, 2019

Effective August 20, 2019, Illinois law provides that a maximum of 10 percent retainage may be withheld from payments under private construction contracts and, after the contract is one-half complete, retainage must be reduced to 5 percent and kept at 5 percent for the remainder of the contract.  With this new law, Illinois joins the vast majority of states that have enacted laws pertaining to retainage on construction contracts.  Like almost every other state, Illinois’ retainage restrictions are unique to Illinois and, therefore, parties to Illinois construction contracts should understand how the new law will impact their projects.  This article will explain the law, discuss how to comply with it and give an example of its application.

When Governor J.B. Pritzker approved SB 1636 it become effective immediately as Public Act 101-0432.  It is an amendment to a law known as the Contractors Prompt Payment Act, 815 ILCS 603/1 (“CPPA”), which governs the timing of payments to contractors on private projects in Illinois.  The new law applies to contracts entered into after August 20, 2019, but not to contracts made before that date.  Public Act 101-0432 provides:   

No construction contract may permit the withholding of retainage from any payment in excess of the amounts permitted in this Section. A construction contract may provide for the withholding of retainage of up to 10 percent of any payment made prior to the completion of 50 percent of the contract. When a contract is 50 percent complete, retainage withheld shall be reduced so that no more than 5 percent is held. After the contract is 50 percent complete, no more than 5 percent of the amount of any subsequent payments made under the contract may be held as retainage.

The above provision can only be understood within the context of the CPPA.  Moreover, the CPPA incorporates definitions from the Illinois Mechanics Lien Act (770 ILCS 60/0.01) (the “MLA”) and, should be applied consistently with the MLA.  The CPPA, including the new retainage section, applies to construction contracts with general contractors as well as those with subcontractors.  It does not apply to contracts for the construction or improvement of residential properties of twelve or fewer units.  Also excluded from its reach are contracts that require the expenditure of public funds, which, consistent with Section 23 of the MLA, should be understood as public improvements for either the State of Illinois or a local government.  The CPPA provides that if full payment is not timely made, including retainage, ten percent interest is due on unpaid amounts, and the contractor is entitled to stop work until proper payment is received.  Importantly, the CPPA raises a presumption that invoices are valid if not objected to in writing within 25 days of receipt.  The provisions of the CPPA are incorporated by law in all Illinois construction contracts to which it applies, even if its terms are not be expressly included in the written contract.    

The CPPA, which governs the timing of payments under construction contracts, apparently takes the view that 50 percent completion of a contract occurs when half of the price of the contract has been earned.  The requirement under Section 5 of the MLA, as well as the common practice in Illinois, is that contractors must furnish sworn statements to owners before receiving payments.  Among other things, the statements set forth the contract price, the amount paid to date, the amount being requested as part of the current payment application, and the amount that remains due to complete work under the contract.  The same information must also be furnished for subcontracts.  Sworn statements will be useful in determining when a contract is fifty percent complete, thereby requiring a reduction of retainage to five percent under the CPPA.  Other evidence will be required for non-fixed price contracts or in situations when substantial and unpredictable change orders greatly increase the difficulty of measuring the 50 percent threshold.  Careful contract drafting should lessen potential conflicts over inevitable  unusual situations. 

Consider the following hypothetical to illustrate how the law should work in practice:

1) an owner contracts with a general contractor to construct a commercial building for a fixed price of $900,000, with payment applications to be submitted on the tenth day of every month until completion;

2) to date, the general contractor has submitted payment applications totaling $400,000 and the owner has approved those applications;

3) retainage of $40,000 (10 percent) has been held from approved payments, so the owner has made net payments totaling $360,000 to the contractor; and

4) now, the general contractor is submitting a payment application with a sworn statement requesting an additional interim payment in the amount of $100,000, less retainage.

Under this hypothetical, the general contractor’s contract with the owner is now more than 50 percent complete ($500,000 of work completed on a total contract price of $900,000), so retainage must be reduced to 5 percent or a total of $25,000, and a maximum of 5 percent retainage may be withheld from all future payments. 

Therefore, the owner may withhold up to $5,000 from the newly submitted payment application and credit the contractor $20,000 for previously held retainage which is in excess of 5 percent.  Thus, the owner would pay the contractor $115,000 ($100,000 minus $5,000, plus a credit of $20,000).  The owner would then be holding retainage of $25,000 (5 percent of $500,000).

Each subcontract is considered separately for purposes of triggering 5 percent maximum retainage upon fifty percent completion.  Thus, a general contractor typically will be restricted to withholding a maximum 5 percent retainage from payments to its demolition and excavation subcontractors before the general contractor reaches 50 percent completion under its own contract with the owner.  In addition, the CPPA requires a contractor to remit to a subcontractor monies received from an owner for that subcontractor’s work (including retainage), within fifteen days of receiving payment from the owner.  Thus, a contractor might request a provision in the general contract that the owner will not withhold retainage from the contractor money the contractor is by law required to pay to its subcontractors.  If an owner is satisfied with a contractor or is otherwise secure that the contract work will be satisfactorily completed, reducing overall retainage to five percent would simplify the project accounting.

In practice, many Illinois commercial construction projects already have reduced retainage to less than 10 percent, and some large public projects in Illinois hold no retainage or a straight 5 percent retainage.  In many other states, retainage is restricted on public and private contracts to amounts less than the maximum permitted by Illinois’ new law.  Some contractors and subcontractors believe the new retainage law does not go far enough, while some owners believe it does not allow them the security they require to guarantee job completion.  Owners, lenders, title companies, contractors, subcontractors, sureties, and other participants in the industry all will need to grapple with the new law, and reach accommodations in the process.

The Seventh Circuit Court of Appeals Weighs In On “Matching”

Edward Eshoo | Property Insurance Coverage Law Blog | August 10, 2019

Last year in one of my blogposts, I wrote about Windridge of Naperville Condominium Association v. Philadelphia Indemnity Insurance Company,1 and the issue whether appraisal is appropriate to resolve a dispute over the cost of repairing physically undamaged siding of townhome buildings to remedy a mismatch with repaired damaged siding. There, a federal district court in Illinois denied the Association’s motion to compel appraisal on the “matching” issue, reasoning it was a question of coverage, not loss amount, and thus inappropriate for appraisal. This coverage issue was subsequently resolved in favor of the Association, the district court concluding that Philadelphia must replace or pay to replace the siding on all four of the townhome buildings’ elevations if no siding is available that matches the undamaged siding on the north and east elevations, as claimed by the Association.2

Philadelphia appealed the district court’s entry of summary judgment in favor of Windridge. The Seventh Circuit Court of Appeals recently affirmed the ruling, rejecting Philadelphia’s argument that because only the south and west elevations suffered “direct physical loss to covered property” within the meaning of the policy’s coverage grant, it need only replace the siding on those elevations.3

With respect to the phrase “direct physical loss,” the Seventh Circuit applied a common sense meaning: physical damage to tangible property causing an alteration in appearance, shape, color, or in other material dimension, which is what occurred to the siding. As to the term “covered property,” the Seventh Circuit concluded that the unit of covered property to consider under the policy (each panel of siding vs. the building as a whole) was ambiguous, meaning that the Association’s reading of the policy prevailed.

One point the Seventh Circuit made clear though was that it was deciding the case on the policy language at hand, including the valuation and loss payment provisions in the Philadelphia policy. That is why the only case it found instructive was National Presbyterian Church, Inc. v. GuideOne Mutual Insurance Company,4 in which a federal district court in the District of Columbia ordered GuideOne to pay to replace all of a church’s exterior limestone panels, including those that were undamaged by a 2011 earthquake, to ensure that all of the panels matched in color and weathering.5 While the coverage grant, valuation, and loss payment provisions in the Philadelphia policy supported the conclusion that Philadelphia must pay to return the buildings to their pre-storm status (matching siding on all sides),6 the Seventh Circuit stated that matching may not be appropriate in situations involving limited damage, such as one mismatched shingle on a roof.

So, is Illinois a “matching” state? With respect to any case filed in an Illinois federal district court under the ISO Commercial Property Building and Personal Property Coverage Form, I would submit yes, as long as matching is sought for something other than “limited” damage as the Seventh Circuit discussed in its opinion. As far as Illinois state courts, the answer likely will depend on the court considering the issue, as Illinois state courts are not bound to follow federal district court opinions, including Seventh Circuit opinions, as they are considered persuasive authority and not precedential authority.7
___________________________________
1 Windridge of Naperville Condominium Association v. Philadelphia Indem. Ins. Co., No. 16-3860, 2017 WL 372308 (N.D. Ill. Jan 26, 2017).
2 Windridge of Naperville Condominium Association v. Philadelphia Indem. Ins. Co., No. 16-3860, 2018 WL 1784140 (N.D. Ill. April 13, 2018).
3 Windridge of Naperville Condominium Association v. Philadelphia Indem. Ins. Co., 2019 WL 3720876 (7th Cir. August 7, 2019).
4 Nat’l Presbyterian Church, Inc. v. GuideOne Mut. Ins. Co., 82 F. Supp. 3d 55 (D. D.C. 2015).
5 The policy at issue in both Windridge of Naperville Condominium Association and Nat’l Presbyterian Church, Inc. was a slightly modified version of the ISO Building and Personal Property Coverage Form (CP 00 10).
6 Philadelphia’s counsel conceded at oral argument that matching siding was not available.
7 Bridgeview Health Care Center, Ltd. v. State Farm Fire & Cas. Co., 10 N.E.3d 902 (Ill. 2014).c

Illinois Supreme Court: Subcontractors No Longer Subject to Claims for Breach of the Implied Warranty of Habitability

Jeremy P. Brummond and Patrick J. Thornton | Lewis Rice | April 29, 2019

Recently, in Sienna Court Condominium Association v. Champion Aluminum Corporation, et al., the Illinois Supreme Court (“the Supreme Court”) held that if a purchaser of a newly constructed condominium or residence does not have a contract with a subcontractor who provided work as part of the building’s construction, then the purchaser cannot assert a claim for breach of the implied warranty of habitability against that subcontractor. The Supreme Court’s holding in Sienna was a major victory for subcontractors and suppliers in the residential construction industry in Illinois. It was a loss for purchasers, owners, and homeowner associations, particularly those whose possible relief against the developer or general contractor with whom they have contracted is no longer viable because that party is defunct or bankrupt.

Brief History of the Implied Warranty of Habitability in Illinois

The implied warranty of habitability protects the first purchaser of a new residence against latent defects that would render the residence not reasonably fit for its intended use. Illinois first started recognizing the implied warranty of habitability in 1979 in its Supreme Court’s decision in Peterson v. Hubschman Construction Co., 76 Ill. 2d 31 (1979). The Court found that the warranty was necessary for public policy reasons in order to respond to changes in the home construction market. By that time, homes had become, essentially, mass produced “from a model or from predrawn plans.” Buyers had “little or no opportunity to inspect” but were forced to “rely upon the integrity and the skill of the builder-vendor…The vendee has a right to expect to receive that for which he has bargained and that which the builder-vendor has agreed to construct and convey to him, that is, a house that is reasonably fit for use as a residence.” The Illinois Appellate Court for the First District (“the First District”) soon thereafter recognized an expansion of the implied warranty and held in Tassan v. United Development Company, 88 Ill. App. 3d 581 (1st Dist. 1980), that if the buyer contracted directly with a developer rather than a builder, then the developer-vendor similarly made an implied warranty of habitability to the buyer that the buyer could enforce against the developer.

However, it was unclear whether the implied warranty of habitability applied to subcontractors and suppliers with whom the buyer did not contract. Initially after Peterson, in Waterford Condominium Association v. Dunbar Corporation, 104 Ill. App. 3d 371 (1st Dist. 1982), the First District held that the implied warranty of habitability did not apply to the subcontractors of a builder-vendor. But the following year in Minton v. The Richards Group, 116 Ill. App. 3d 852 (1st Dist. 1983), the First District ruled to the contrary and held that where the purchaser of a newly constructed residence “has no recourse to the builder-vendor and has sustained loss due to the faulty and latent defect in their home caused by the subcontractor, the warranty of habitability applies to such subcontractor.” Although Minton’s reasoning would later be rejected in Lehman v. Arnold, 137 Ill. App. 3d 412, 417-18 (4th Dist. 1985) and Bernot v. Primus Corp., 278 Ill. App. 3d 751, 754-55 (2d Dist. 1996), asserting a claim for breach of the implied warranty of habitability against a subcontractor (and defending against such claims) was nevertheless common in Illinois over the past 35 years—until Sienna.

Sienna Court Condominium Association v. Champion Aluminum Corporation

In Sienna, a condominium association governing a two-building, 111-residential-unit property in Evanston, Illinois sued the property’s developer, general contractor, subcontractors, and others, alleging that latent defects resulted in water infiltration and other conditions that rendered the individual units and common areas unfit for their intended purposes. Unfortunately for the association, the developer and general contractor went bankrupt, which drastically limited any potential recovery from those entities. The subcontractors moved to dismiss the claims against them, which motion was denied, but the Circuit Court certified questions related to Minton under Rule 308 for an immediate appeal. The Illinois Supreme Court was asked to address whether, under Minton, “a plaintiff homeowner’s claims against a subcontractor for breach of an implied warranty of habitability are barred where either the plaintiff has potential recourse from insurance policies or where actual proceeds are received by the plaintiff from a warranty escrow account.” Instead, the Supreme Court considered an issue presupposing and underlying those questions: whether the purchaser of a newly constructed home may even assert a claim for breach of an implied warranty of habitability against a subcontractor who took part in the construction of the home, where the subcontractor had no contractual relationship with the purchaser. The Supreme Court held that the purchaser may not assert that claim and thus overruled Minton.

The condominium association, in Sienna, argued that the Supreme Court should recognize that the implied warranty of habitability is essentially a duty owed by every contractor, subcontractor, and supplier that performs work or provides material related to the construction of a residence. The association further argued that it (or any homeowner) “should be allowed to proceed directly against a subcontractor under a claim that is ‘analogous to a strict liability claim tort claim.’” The Supreme Court rejected that argument, reasoning that an implied warranty arises only by virtue of a contractual relationship between two parties: the home purchaser and the seller. Even if the warranty is not explicitly written in and expressed in the parties’ contract, the law recognizes that by virtue of the contract, only the seller has implicitly agreed to provide a home that is reasonably fit to be inhabited as a residence.

The Supreme Court further reasoned that the implied warranty is not analogous to a strict liability tort and does not exist independent of that contract, because it would be barred by the economic loss doctrine (better known in Illinois as the “Moorman doctrine”). The economic loss doctrine provides that a plaintiff cannot recover purely economic loss under the tort theories of strict liability, negligence, and innocent misrepresentation. Fireman’sFund Ins. Co. v. SEC Donahue, Inc., 176 Ill.2d 160, 164 (1997) (citing Moorman Manufacturing Co. v. National Tank Co., 91 Ill.2d 69 (1982)). An “economic loss” includes damages for inadequate value, costs of repair and replacement, or consequential loss of profits. Moorman, 91 Ill. 2d at 82. As alternatively explained:

The [economic loss] rule acts[DHL9] as a shorthand means of determining whether a plaintiff is suing for injuries arising from the breach of a contractual duty to produce a product that conforms in quality or performance to the parties’ expectations or whether the plaintiff seeks to recover for injuries resulting from the breach of the duty arising independently of the contract to product a nonhazardous product that does not pose an unreasonable risk of injury to person or property.

2314 Lincoln Park West Condominium Association v. Mann, Gil, Ebel & Frazier, Ltd., 136 Ill. 2d 302, 309 (1990).

A claim for breach of the implied warranty of habitability relates to injuries arising from alleged defects in quality, not defects creating an unreasonable risk of injury to person or property. Thus, under Moorman, the implied warranty of habitability cannot be characterized as a tort. Further, the Supreme Court stated in Sienna that to “allow what is, in effect, a tort claim to be brought directly against subcontractors by homeowners would undermine and, in some instances, render pointless these contractual obligations and restraints.”

Implications of Sienna

As a result of Sienna, purchasers of condos (and their associations) or of residences no longer have the ability to assert a claim for breach of the implied warranty of habitability against subcontractors if those parties do not have a contract. If the developer or general contractor with whom the purchaser has contracted is defunct or bankrupt, the purchaser might not be able to recover anything from an entity that participated in the construction of the home. However, in Sienna, the condominium association was able to recover approximately $308,000 from the developer through a warranty escrow fund that the developer had been required to establish under a City of Evanston ordinance. Going forward, similar local ordinances could be passed and/or enforced to require the establishment of warranty escrow funds, particularly if the developer had created a limited liability company for the project with the intention of shutting it down upon project completion.