Tennessee Looks to Define Improvements to Real Property

Lian Skaf | The Subrogation Strategist

For subrogation practitioners dealing with an installation-based statute of repose, knowing what is an improvement to real property is the first battle in what can, but does not have to be, a long fight. Like many other states, Tennessee’s statute of repose bars claims based on improvements to real property. Tennessee’s statute of repose runs four years after substantial completion of the improvement. See Tennessee Code Ann. § 28-3-202. In the case of Maddox v. Olshan Found. Repair & Waterproofing Co. of Nashville, L.P., E A, 2019 Tenn.App. LEXIS 464, 2019 WL 4464816, the Court of Appeals of Tennessee examined whether or not the work done by the defendant, Olshan Foundation Repair & Waterproofing Co. of Nashville, L.P., E.A. (Olshan) — which addressed bowing walls, cracks in the foundation and walls and water intrusion — qualified as improvements to real property for the purposes of the statute of repose. The court held that the work by Olshan essentially amounted to repairs, and did not qualify as improvements to real property.

In Maddox, the plaintiff, Rachel Maddox (Maddox), noticed cracking in her home in 2005 and hired Olshan to assess the issue and conduct necessary repairs. Olshan made several recommendations and the parties agreed on Olshan’s proposal for the price of $27,000. From their initial work in 2005 until late 2011, Olshan visited the property several times to address ongoing structural issues with the home. Eventually, eight months after Olshan told Maddox they could not fix the house and failed to return her phone calls, Maddox filed suit, alleging fraud against the company.

After a three-day bench trial, the trial court found in favor of the plaintiff for $187,000, plus $15,0000 in punitive damages. Among other holdings, the court rejected Olshan’s statute of repose defense. Olshan appealed, raising the statute of repose issue again.

In determining whether the statute of repose applied, the court focused on the nature of the work. It highlighted the difference between true improvements to real property and work that simply amounts to repairs or replacement. While the former triggers the statute of repose, the latter does not.

The court examined two general tests for determining whether construction amounts to an improvement to real property. The first, the “common law” test, focuses on precedent. The second, the “common sense” approach, focuses on whether the work added to the property’s value, involved labor or money and was designed to make the property more useful or valuable. The court reasoned that it need not adopt one approach over the other, but could use both as tools for analyzing the facts of a particular case.

In this case, the court held that Olshan’s actions in ameliorating the deteriorating condition of the home were repairs and not improvements to property. Its work on the home was corrective and not intended to “enhance its value, beauty or utility or to adopt it for new or further purposes.” The court even used Olshan’s representative’s description of Olshan as a “remedial repair contractor” as support for its finding.

This case is important because, as all subrogation professionals know, dealing with a statute of repose can be a dicey proposition. If the facts of your case fall within the terms of the statute, the statute of repose bars a subrogating insurer from pursuing its claim. However, if there is a way to avoid the statute, it can give new life to a case that would otherwise be dead in the water.

Maddox is a good reminder that the statute of repose fight does not always have to be centered around dates and the timing of work. If you can argue that the work falls outside of the definition of an improvement to real property, there is no need to fight about dates. This case also highlights the importance of knowing how evidence can have unintended consequences. Although Maddox would still have likely prevailed on the statute repose defense, having the defendant’s own statements to use against them may have pushed it over the top.

Significant 2019 Tennessee Construction Decisions

Allison Wiseman, Brian Dobbs and Ryan Lee | Bass, Berry & Sims

This Construction Law Alert highlights some of the significant Tennessee state and federal decisions affecting the construction industry from the past year.

Holdback Payments Are Not Retainage

Tennessee’s Prompt Pay Act (PPA) requires all retainage withheld on construction projects to be deposited into a separate interest-bearing escrow account with a third party, and there are potentially harsh civil and criminal penalties for failing to do so. In Vic Davis Construction v. Lauren Engineers & Constructors, Inc., No. E2017-00844-COA-R3-CV, 2019 WL 1300935 (Tenn. Ct. App. March 20, 2019), a subcontractor alleged the contractor failed to comply with this requirement under a subcontract that called for a final payment of 5% for “Turn-over, As-Builts, Final Clean Up, Demobilize.” In arguing that this “holdback” payment constituted retainage that should have been escrowed, the subcontractor relied, in part, on the fact that Tennessee law limits retainage on construction projects to 5% of the contract amount. The court disagreed, finding that the contractor paid the subcontractor’s first 12 payment applications in full, and the contract explicitly stated that “invoices are not subject to retention.” Although the amount of the final payment likely exceeded the value of the as-builts, final clean up, and other items, the court held that the holdback did not constitute retainage.

Not Paying Retainage above Setoffs Constitutes Bad Faith

In the fallout from the late completion of the Nashville Centennial Sportsplex Indoor Fitness Expansion, the Tennessee Court of Appeals was again called on to consider the PPA. In E Sols. for Buildings, LLC v. Knestrick Contractor, Inc., No. M201802028COAR3CV, 2019 WL 5607473 (Tenn. Ct. App. Oct. 30, 2019), the project’s HVAC material supplier brought suit for nonpayment against the project’s HVAC subcontractor, general contractor, and owner.  Both the HVAC subcontractor and general contractor asserted multiple counterclaims and cross-claims. On appeal, the court found that the general contractor had violated the PPA by withholding more in liquidated damages from the HVAC subcontractor’s retainage than its claim to setoff and that such action constituted bad faith subjecting contractor to attorneys’ fees under the PPA.

Construction Changes on Publicly Funded Projects Could Give Rise to False Claims Liability

In Munson Hardisty, LLC v. Legacy Pointe Apartments, LLC, 359 F. Supp. 3d 546 (E.D. Tenn. 2019), the developer of an apartment complex in Knoxville obtained financing through HUD. During construction, disagreements arose between the developer and the project’s general contractor about payments including the developer’s attempts to refinance its HUD loans. As part of the dispute, the general contractor asserted claims under the federal False Claims Act (FCA) on the basis that the developer made changes to the project’s drawings and specification but did not obtain HUD’s approval as required under HUD’s loan agreements. The developer moved to dismiss the FCA claims, but the court denied the motion finding that the general contractor sufficiently alleged that the developer took actions to retaliate against it when the general contractor refused to cooperate or consent to the project’s refinancing due to the developer’s alleged false statements to HUD.

Whether Multiple Phase Project Has a Single Date Of Substantial Completion Is a Question of Fact

In Palazzo v. Harvey, 380 F. Supp. 3d 723 (M.D. Tenn. 2019), which involved the construction of an indoor horse arena and stable, the project’s designer and general contractor moved for summary judgment on the owner’s breach of contract and negligence claims asserting that the statute of limitations had expired. The designer and general contractor argued that despite there only being a single contract for their work, the arena and stable were two different projects with two different dates of substantial completion for the purposes of the statute of limitations. The court denied the motion finding that genuine issues of material fact existed about whether the parties understood that the work constituted one or more distinct projects. The court noted that Tenn. Code Ann. § 28-3-201 defines substantial completion but “does so in the context of being ‘in accordance with the contract documents,’” so the statutory language alone could not conclusively determine the substantial completion date.

Other Tennessee Construction Decisions of Note:

Maddox v. Olshan Foundation Repair & Waterproofing Co. of Nashville, L.P. (Tenn. Ct. App. Sept. 18, 2019) – A homeowner’s claims against a foundation repair company were not barred by the four-year statute of repose because the foundation repairs did not constitute an “improvement” to real property. The court upheld judgment for the homeowner.

Miolen v. Saffles, No. E2018-00849-COA-R3-CV, 2019 WL 1581494 (Tenn. Ct. App. April 12, 2019) – Trial court’s award of treble damages under the Tennessee Consumer Protection Act, Tenn. Code Ann. § 47-18-101, was not an abuse of discretion where the trial court found that defendant “misrepresent[ed] that [] walls had been engineered by a professional engineer, and by charging plaintiffs $10,000 in ‘engineering’ expenses that were not incurred by an engineer.”

H Group Construction, LLC v. City of Lafollette, No. E201800478COAR9CV, 2019 WL 354973 (Tenn. Ct. App. Jan. 28, 2019) – An unsuccessful bidder for municipal construction projects alleged that the City had engaged in unlawful restraint of trade and violated its competitive bidding ordinances. The court held that municipalities enjoy sovereign immunity against claims for restraint of trade and that the City’s bidding ordinances did not provide a private right of action for monetary damages. A writ of certiorari is the only method for asserting a violation of such ordinances.

SPE GO Holdings, Inc. v. W & O Constr., Inc., No. 18-5404, 2018 WL 6181645 (6th Cir. Nov. 27, 2018) – Affirming district court’s denial of defendant’s request for judgment as a matter of law (which would have nullified the jury verdict) and explaining that determination of whether someone was a third-party beneficiary to a contract was a fact question properly submitted to the jury; owner gave sufficient notice of breach and opportunity to cure under Tennessee law; and evidence was sufficient to support damages award under Tennessee law.

TWB Architects, Inc. v. Braxton, LLC, No. M2017-00423-SC-R11-CV, 2019 WL 3491467 (Tenn. July 22, 2019) – When a condominium developer failed to pay for his services, the project’s architect accepted a condominium unit in lieu of payment.  When the developer’s lender foreclosed on the architect’s condominium unit, a question of fact existed whether the architect’s claims against developer under the original architectural services agreement were eliminated.

Crouch Ry. Consulting, LLC v. LS Energy Fabrication, LLC, No. M201702540COAR3CV, 2019 WL 1949631 (Tenn. Ct. App. Apr. 30, 2019), appeal granted (Oct. 14, 2019) – A Texas company engaging a Tennessee engineering company to provide customized services, which were performed primarily in Tennessee, subjected the Texas company to jurisdiction in Tennessee.

If you have any questions about how these decisions will impact your company, please contact one of the authors or any member of the firm’s Construction Contracts & Litigation Practice Group.

New Construction Lien Legislation In Tennessee

Kathryn K. Van Namen | Butler Snow | August 26, 2019

Changes to Remedies in Lien Enforcement Actions

New legislation in Tennessee has limited the recovery of attorney’s fees, expenses, and actual and liquidated damages in instances where a real property owner seeks to enforce a lien. Public Chapter 142, signed by Governor Lee and effective as of April 5, 2019, repealed Tennessee Code Annotated § 66-21-108. Section 108 provided that an owner who prevailed in an action challenging the validity of a lien was entitled to recover reasonable attorney’s fees, costs incurred by the owner to challenge the validity of the lien, liquidated damages in an amount equal to ten percent of the fair market value of the property, but not to exceed $100,000, and any actual damages incurred by the owner.

The construction industry in Tennessee expressed serious concern based on the risk of liability for general contractors and their subcontractors in the case of any invalid mechanic’s or materialmen’s liens and lobbied for change. The Tennessee Bar Association also previously proposed an amendment to Section 108 to remove the threat of penalizing legitimate lienors for simply pursing their valid lien rights, but the legislation was Section was repealed completely.

Residential Contractors New Continuing Education Requirements

The General Assembly also created new legislation addressing contractor licensing classifications and requiring continuing education for residential contractors, which will be effective as of January 1, 2020. The new provisions to Tennessee Code Annotated § 62-6-112 require all general contractors engaged in residential construction who were licensed on or after January 1, 2009, to complete eight hours of continuing education every two years. The Tennessee Board for Licensing Contractors must approve the continuing education and offer both online and in person options. However, membership in certain trade associations can constitute four hours of continuing education annually.

Changes to Time for Notices of Nonpayment, Rights to Payment, and Retainage

Another critical construction bill to watch during the next legislative session is SB324. As introduced in January 2019, the bill seeks to amend multiple provisions of the Tennessee Code.

First, the bill seeks to amend Tennessee Code Annotated § 66-11-112(a) by increasing the time for “remote contractors” or subcontractors or others who furnish material, services, equipment or machinery on a project to record and enforce mechanic’s and materialmen’s liens from 90 days on the date the improvement is complete to no later than 12 months. The bill also seeks to increase the same length of time for “remote contractors” to serve notices of nonpayment on the owner and prime contractor. Rather than requiring a notice of nonpayment within 90 days of the last day of each month within which the work or labor was provided or supplies, materials, equipment, or machinery furnished, the proposed amendment seeks to allow the remote contractor a full twelve months from the last day of each month the work was performed to provide the requisite notice.

The bill also seeks to amend Tennessee Code § 66-34-103(b) which addresses retainage and would reduce the time owners have to release and pay all retainage for work completed from 90 days to 30 days after the owner receives the certificate of occupancy or the work is substantially complete. It would maintain the language requiring prime contractors to pay all retainage to any subcontractors within 10 days of receipt from the owner.

No More Pay-if-Paid Provisions?

Most importantly, SB324 seeks to prevent the commonly used “pay-if-paid” provisions in contracts between general contractors and their subcontractors. The proposed addition of a new section, Tennessee Code § 66-34-305, would effectively prohibit any condition precedent for payment clauses commonly used to require payment from the prime contractor to its subcontractors only if the prime contractor receives payment from the owner. It would also add Tennessee Code § 66-34-306 which would allow prime contractors and remote subcontractors to suspend performance of the work on a project without penalty until payment is received and entitle the contractor or subcontractor to its pro rata share of any interest provided for in Section 66-34-601. This language would only be applicable to contracts entered into after the effective date. This will be one to watch during the 2020 legislative session.

Think Twice About Depreciating Repair Costs in Our State, says the Tennessee Supreme Court

Andres Avila | SDV Insights | June 11, 2019

Tennessee’s Supreme Court recently held that an insurer may not withhold repair labor costs as depreciation when the policy definition of actual cash value is found to be ambiguous. Tennessee joins other states like California and Vermont that prohibit the depreciation of repair labor costs in property policies.

In Lammert v. Auto-Owners (Mut.) Ins. Co., No. M201702546SCR23CV, 2019 WL 1592687, the Lammerts and other insureds sought property damage coverage from Auto Owners Insurance for hail damage to a home and other structures they owned in Tennessee.

Auto-Owners Insurance agreed to settle the claims on an actual cash value basis (ACV), which is a method of establishing the value of insured property that must be replaced to determine the indemnity by the insurer. There are multiple methods to calculate ACV. Auto-Owners decided to use the ACV calculation method of deducting depreciation from the cost to repair or replace the damaged property. Depreciation is the decline in value of a property since it was new because of use, age or wear. The rationale behind this method is that an insured should not make a profit by recovering the cost of, for example, a new roof for a damaged roof that was ten years old, and thus depreciation is deducted from the indemnity.

Auto-Owners, however, decided to deduct both the materials and the repair and replace labor costs, as depreciation, when calculating the ACV. Neither of both policies under dispute specifically mentioned that repair labor costs could be depreciated in their ACV definitions. The parties thus disagreed on whether depreciation applies only to the materials or to both materials and repair labor.

One of the policies defined ACV as “the cost to replace damaged property with new property of similar quality and features reduced by the amount of depreciation applicable to the damaged property immediately prior to the loss;” while the other did not define ACV but stated that ACV included a deduction for depreciation.

The insureds argued that depreciation should be limited only to the cost of the replacement materials. In their view, the language “depreciation applicable to the damaged property” eliminates labor costs, which are intangible and cannot be depreciated because they do not age or wear out. The insureds also argued that the “prior to the loss” policy language eliminated labor costs because the costs at issue were post-loss repair costs. Auto-Owners contended that neither policy was ambiguous because depreciation of a property is calculated based on the total replacement cost, which includes both labor and materials.

Allowing Auto-Owners to depreciate the cost of labor would leave the insureds with an out of pocket loss inconsistent with the principle of indemnity of insurance to make insureds whole. However, allowing the deduction may in turn cause a windfall to the insureds, also defeating the purpose of indemnity. The Tennessee Supreme Court sided with the policyholders and solved the dilemma by citing to case law from, among others, Oklahoma, Arkansas, Nebraska and Minnesota, as well as regulations in Vermont, California and Mississippi.

The Court noted that Oklahoma uses the “broad evidence” rule to determine ACV. This method, also followed in New York, allows insurers to consider any and every fact and circumstance that logically tends to a correct estimate of the loss.

Accordingly, in Redcorn v. State Farm Fire & Cas. Co., 55 P.3d 1017, 1020 (Okla. 2002), the Oklahoma Supreme Court ruled that repair labor must be depreciated under the “broad evidence” method.

A decade later, the Arkansas Supreme Court was more persuaded by the dissenters than the majority in Redcorn and concluded that labor was not depreciable because labor does not lose value due to wear and tear over time in Adams v. Cameron Mutual Insurance Co., 2013 Ark. 475, 430 S.W.3d 675 (2013). However, in 2017 the Arkansas legislature abrogated Adams and enacted Arkansas Statute section 23-88-106, which specifically included the cost of labor in its definition of an expense depreciation.

The Tennessee Supreme Court further noted that Nebraska, which also uses the “broad evidence” rule, sided with the Oklahoma Supreme Court majority. It held that property is a combination of materials and labor and thus repair labor costs must also be depreciated from the replacement cost to determine ACV. Henn v. American Family Mutual Insurance Co., 295 Neb. 859, 894 N.W.2d 179 (2017). The court also considered a third approach from Minnesota, which also follows the “broad evidence” rule. In Wilcox v. State Farm Fire & Cas. Co., 874 N.W.2d 780, 785 (Minn. 2016), the Minnesota Supreme Court held that certain labor costs may be depreciable making it an issue of fact rather than law.

The Court then turned for guidance to case law from the federal circuit courts of appeals involving the law of Missouri, Kansas and Kentucky. The Tennessee Court found that Missouri and Kentucky lean towards allowing insurers to deduct repair labor costs as depreciation; while Kentucky, on the other hand, leans towards seeing depreciation as an ambiguous term and thus interpreted against insurers, preventing carriers from subtracting repair labor costs as depreciation.

The Tennessee Court then turned to insurance departments’ regulations of the point in California, Vermont and Mississippi. California (Cal. Code Regs. tit. 10, § 2695.9(f)(1) (2019)) and Vermont (Insurance Bulletin No. 184) prohibit the depreciation of repair and replacement labor. On the other hand, the Mississippi Insurance Department Bulletin 2017-8 declared the absence of a statutory prohibition to labor costs depreciation in that state but that insurers should clearly provide for it in the insurance policy if they intended to do so.

Tennessee acknowledges both the “broad evidence” rule and the replacement-cost-less-depreciation method to determine ACV. The Tennessee Supreme Court was persuaded that, since neither of the policies explicitly stated whether labor costs are depreciable when calculating ACV, there was an ambiguity that had to be interpreted against insurers and in favor of insureds.

This decision in Tennessee serves as a warning that, absent policy language stating otherwise, property insurers cannot depreciate repair labor costs when calculating the ACV of a property using the replacement cost less depreciation method in Tennessee.

Tennessee High Court Excludes Labor Costs from Insurer’s Actual Cash Value Depreciation Calculations

Michael S. Levine and Geoffrey B. Fehling | Hunton Andrews Kurth | April 24, 2019

The Tennessee Supreme Court has refused to construe an ambiguous definition of actual cash value to allow for deduction of labor costs as part of depreciation calculations where that subset of repair costs are not clearly addressed in the policy. Despite the split of authority nationwide, the Tennessee case presents a straightforward application of policy interpretation principles to a common valuation issue in first-party property claims.

In Lammert v. Auto-Owners (Mutual) Insurance Co., No. M2017-2546-SC-R23-CV (Tenn. Apr. 15, 2019), insureds brought a class-action lawsuit against their property insurer, Auto-Owners, alleging breach of contract. The plaintiffs each owned buildings damaged by a hail storm and had each submitted claims to Auto-Owners. Auto-Owners accepted the claims and determined that the losses would be determined on an actual cash value basis. In performing those valuations, Auto-Owners depreciated both the building materials and the labor costs associated with repairing the properties. The insureds challenged the labor cost depreciation. Auto-Owners moved to dismiss the lawsuit. In response, the insureds requested that the district court certify to the Tennessee Supreme Court whether, “[u]nder Tennessee law, may an insurer in making an actual cash value payment withhold a portion of repair labor as depreciation when the policy (1) defines actual cash value as ‘the cost to replace damaged property with new property of similar quality and features reduced by the amount of depreciation applicable to the damaged property immediately prior to the loss,’ or (2) states that ‘actual cash value includes a deduction for depreciation?”’

In their briefing to the Court, the insureds asserted that to allow for depreciation of both materials and labor would defeat the purpose of indemnity, which is to make the insureds whole after the hail storm. In response, Auto-Owners argued that applying depreciation only to materials would result in a windfall to the insureds by leaving them in a better position than they were in before the loss (by receiving full value of non-depreciated labor costs). Given the policy’s lack of clarity as to whether depreciation should apply to labor costs, the Court sided with the insureds.

The Court discussed the split of authority among state and federal courts nationwide, but applied basic policy interpretation principles that undefined policy terms are to be construed according to their plain, ordinary, popular meaning and that ambiguous policy language must be construed against the insurer and in favor of coverage. The Court found that both parties presented plausible interpretations of the policies, neither of which explicitly stated whether labor expenses were depreciable when calculating actual cash value.

The Court recognized the principle under Tennessee law that the purpose of indemnity insurance is to reimburse and restore the insured to the position he or she was in before the loss. The Court also looked to the dictionary meaning of “depreciation,” which is “a reduction in value or price of something; specif[ically] a decline in an asset’s value because of use, wear, obsolescence, or age.” Despite Auto-Owners’ plausible interpretation that all components of repair costs, including labor, are subject to depreciation, the Court found that it is also reasonable that a homeowner would understand that depreciation would only be applicable to material goods that can age and experience wear and tear and that an insurer calculating actual cash value of repair costs would only apply depreciation to the physical materials that actually deteriorated. If Auto-Owners had wanted a more technical definition of depreciation that is not evident on the face of the policy, they had the burden of clarifying the policy to incorporate that meaning.

The Lammert decision applies bedrock contract interpretation principles to resolve ambiguous policy language. The decision is also interesting because it addresses a basic property valuation issue that is often disputed but rarely litigated because contested valuation issues that relate to the value or quantum of loss suffered are frequently resolved through the appraisal process, even though issues of policy interpretation and construction should be determined by a court. The concepts of market value, replacement cost, and actual cash value are relevant in nearly every property insurance claim, but despite their ubiquity, the applicable valuation method must be clearly set forth in the policy. Where there is ambiguity, it should be resolved in favor of the insured. This is especially true where, as in Lammert, the undefined term’s ordinary meaning conflicts with the insurer’s preferred technical or industry-specific meaning.