Reliance On Expert Opinions Demonstrates Reasonableness

Burns White

The Eastern District of Pennsylvania recently granted an insurer’s motion to dismiss a bad faith claim after finding that the insurer immediately conducted an investigation into the insured’s claim by hiring two professionals, and reasonably relied on the professionals’ opinions when denying the insured’s claim. See Covenant Realty v. Westminster American Ins. Co., 2021 WL 4963519 (E.D. Pa. Oct. 26, 2021).

In Covenant Realty, the glass skylight atrium of the insured’s apartment building collapsed, leaving a hole in the roof and causing debris to fall into the building’s elevator vestibule. The insured immediately filed a claim with their insurer and retained a public adjuster to investigate the cause of the atrium collapse and to assist with the claims submission process. Upon notice of the claim, the insurer also retained an adjuster and a structural engineer to conduct its own investigation of the cause of the collapse. Both parties agreed that the collapse was caused, at least in part, by decay, deterioration, and rot within the atrium, but the parties disagreed as to whether that decay was hidden. The insured claimed that it was not aware of any decay prior to the collapse through routine checking of the building, whereas the insurer’s adjuster and engineer found signs of wear and tear around the atrium, which they opined would have been visible before the collapse. Based on the opinions of its adjuster and engineer, the insurer denied the insured’s claim due to rot, wear, deterioration, and maintenance-related issues, which were excluded from the insured’s policy. The insured further argued that the deterioration had been hidden and was only revealed after the collapse, but the insurer confirmed its denial of coverage. The insured subsequently sued the insurer for breach of contract and statutory bad faith. The insurer moved for summary judgment on both counts.

The Court denied the insurer’s motion as to the breach of contract claim after finding that there was a genuine issue of material fact as to whether the collapse was caused by hidden decay. The Court noted that while the insurer presented photographs taken after the collapse that showed that the decay was not hidden, the photographs failed to demonstrate what degree of decay was visible prior to the collapse.

As for the bad faith claim, the insured argued that there was a genuine issue of whether bad faith exists because the insurer failed to appropriately investigate the loss and denied the loss despite no evidence that the damage was not hidden. The Court disagreed. The Court found that the insurer immediately conducted an investigation into the cause of the collapse by hiring two professionals, an adjuster, and a structural engineer. Both professionals found evidence that the insured knew or should have known of the decay for several reasons: the post-collapse photos showed visible rust, rot, deterioration, and wear and tear; and the application of roof mastic suggested the roof was in a state of disrepair. The Court held that these reports gave the insurer a reasonable basis for denying the insured’s claim. Because the insured failed to point to any evidence from which a jury could clearly and convincingly find that the insurer lacked a reasonable basis for denying benefits and knew or recklessly disregarded its lack of a basis, the Court dismissed the bad faith claim.

Don’t Overlook a Contract’s Liquidated Damages Provision

Nicholas D. Karkazis | Stoel Rives

We’ve written before about contractual provisions that sometimes go unnoticed or unappreciated. Another such provision is a “liquidated damages” provision. Liquidated damages are a way to agree beforehand to the amount of damages that one party will owe the other in the event of a particular type of breach. In construction contracts, liquidated damages provisions are often used to identify the amount of damages that a contractor will owe the owner if there is a delay in completing construction.

For example, the parties might agree that the contractor will owe the owner $500 per day in damages if the substantial completion date is not achieved. (Often the amount is greater than $500.) Thus, if construction were delayed for two days, the contractor would owe $1,000 in liquidated damages. That amount isn’t too worrisome perhaps, but the stakes get higher if the delay lasts months or even years, as can sometimes happen with construction projects.

For contractors, another risk is that contracts are often written broadly enough to impose liquidated damages even if the contractors do not cause the delay. The timing provisions of a contract will often read that in the event of a delay not caused by the contractor, the contractor must still provide written notice to the owner (or owner’s agent) within a specified time period to excuse the delay. Sometimes, due to the normal course of business, this notice is not provided. In such cases, the owner may argue that because it did not receive written notice by the specified time period, the contractor is responsible for the delay. The owner then asserts that the liquidated damages provision was triggered and that the contractor owes liquidated damages because of the delay. The success of this argument may depend on the jurisdiction and court.

Although not all construction contracts contain a liquidated damages provision, many do and they are frequently litigated. Certain businesses keep a liquidated damages provision in their standard template construction contract. Form contracts, such as certain AIA contracts, may have placeholders for a liquidated damages provision to be included.

Ideally, contractors would have processes in place to ensure compliance with all contractual terms so that, among other things, any delays are tracked and documented and that notice is provided to any necessary parties. At a minimum, however, contractors and in-field personnel should understand that delays — caused or not caused by the contractor — could have negative consequences depending on the terms of the contract. Having personnel with knowledge of the potential consequences can help the business issue spot and return to the contract provisions to ensure compliance.

On the other side, owners and their agents should also be aware that timing, notice, and liquidated damages provisions in the contract may benefit them. Liquidated damages provisions can be waived if they are not timely enforced. Although many contracts now contain “non-waiver” provisions that state that the parties do not waive any rights under the contract by delaying enforcement of the rights, some courts have found — perhaps paradoxically — that even “non-waiver” provisions also may be waived.

Because of the harsh consequences that can sometimes result from liquidated damages provisions, some requirements must be met for a liquidated damages provision to be enforceable. These requirements vary by jurisdiction, but generally the requirements are that the actual damages would have to be difficult to prove and the amount of liquidated damages is reasonable in light of the anticipated damages that would stem from a breach. If a court finds that actual damages were easy to calculate or that the amount of liquidated damages was set unreasonably, the liquidated damages provision will not be enforceable. Unsurprisingly, these general requirements are frequent topics of litigation.

Therefore, to avoid potentially harsh consequences, waiver of a potential benefit, and unnecessary litigation, contractors and owners should have — at the least — a general knowledge of liquidated damages provisions. Such knowledge can help the parties issue spot and consult any applicable contracts for compliance.

Utah Digs Deep and Finds “Design Defect” Includes Pre-Construction Geotechnical Reports

Kyle Rice | White and Williams

The Supreme Court of Utah recently found that an incorrect pre-construction geotechnical engineering report is a “defective design.” Thus, actions arising from an incorrect geotechnical report are appropriately governed by Utah’s Economic Loss Statute (Statute), Utah Code Ann. § 78B-4-513(1).

Hayes v. Intermountain GeoEnvironmental Servs. No. 20190764, 2021 UT 62, 2021 Utah Lexis 144, arose out of a suit filed by homeowners Kim and Nancy Hayes (the Hayeses). The Hayeses’ home was part of the Quail Hollow subdivision in Layton, Utah, which was developed by K.C. Halls Construction, Inc. (K.C. Halls). Prior to construction, K.C. Halls contracted with Intermountain GeoEnvironmental Services, Inc. (IGES) for a geotechnical report of the planned development to comply with the requirements of Layton City. The report found that “the subject site is suitable for the proposed construction” and made recommendations to ensure foundational integrity for future construction. The Hayeses ultimately purchased a lot from an agent for K.C. Halls and hired Bob Stevenson (Stevenson) to construct the home. About 14 months after the completion of construction, the Hayeses noticed cracking in their foundation walls.

After discovering the cracking in the foundation, the Hayeses filed suit against K.C. Halls, Stevenson and IGES for damages. The counts against IGES included negligence, negligent misrepresentation and negligent infliction of emotional distress, focusing on the allegation in each count that IGES’s report incorrectly stated the property was “safe and suitable” for residential construction.

IGES moved to dismiss the complaint, alleging that the Hayeses’ negligence claims were barred by both the common law economic loss rule and Utah’s Economic Loss Statute because the Hayeses were seeking compensation for purely economic losses and the case was an action related to “defective design.” The district court granted the motion and its ruling was subsequently affirmed by the court of appeals. The Hayeses petitioned for certiorari, which was granted to address whether the court of appeals erred in its interpretation and application of the Statute by holding the Hayeses’ tort claims “amounted to an ‘action for defective design and construction as that term is used in the [S]tatute.’”

The court began with an analysis of the economic loss rule. The economic loss rule places limits on tort claims for purely economic losses by creating a “fundamental boundary between contract law, which protects expectancy interests created through agreement between the parties, and tort law, which protects individuals and their property from physical harm by imposing a duty of reasonable care.” The common law economic loss rule was first adopted in Utah in American Towers Owners Ass’n, Inc. v. CCI Mechanical, Inc., 930 P. 2d 1182 (Utah 1996).

The court noted the exception to the common law economic loss rule regarding an independent duty of care. If a duty of care exists independent of any contractual obligations, the economic loss rule is excepted, and a tort claim may be brought. The court further noted that after the court’s adoption of the common law rule in 1996, in 2008 the Utah legislature codified the economic loss rule with respect to actions “for defective design or construction.” The Statute does not contain the same exception as the common law rule regarding an independent duty of care.

Given the statute, the threshold question was whether to apply the statutory or common law economic loss rule to the Hayeses’ claim—that is, whether IGES’s geotechnical report was a “defective design.” If the report qualified as “defective design or construction,” the Statute applied. If the report was not “defective design or construction,” the Statute did not apply. If the Statute did not apply, the Hayeses argued the claim was subject to the common law exception to the economic loss rule involving the violation of an independent duty of care.

To determine whether this action was subject to the Statute, the court analyzed what constitutes a “defective design.” The court noted while the Statute governs defective design and construction claims, it never actually defines the word “design.” The Hayeses argued the appropriate definition would be based on those found in the dictionary, such as “to make or draw plans for something” or “a drawing or set of drawings.”

The court found that while the ordinary meaning of a word is “powerful evidence,” it must consider the meaning intended in the context of the statute. If words are used in a “technical sense,” they must be construed within that technical context. As such, the court stated that the term “design” must be interpreted within the realm of construction or engineering.

Analyzing the legislature’s use of the term “design professional” in other statutes and after considering the definition for an “engineering design” utilized by The Accreditation Board of Engineering & Technology, the court defined the term broadly and agreed with the finding of the Court of Appeals that “[a] geotechnical engineer is often an essential participant on the design team.” The court further noted the geotechnical report was “an integral part of the structural design of the building’s foundation.” Although the court acknowledged that IGES failed to identify the structural instability in the soil in their geotechnical report, which resulted in the structural instability of the home, given that the building would not have been constructed in the manner it was but for IGES’s report, the court found the IGES report was foundational to the design of the building. As a result, IGES’s work was structural, which was a defective design, and the action was appropriately governed by Utah’s Economic Loss Statute.

Because the loss was encompassed within the Statute, the common law exception for an independent duty of care did not apply. The court noted that the only possible exception to the Statute involves a claimant in privity of contract “based on an intentional or willful breach of a duty existing in law.” However, since the Hayeses were not in privity with IGES, the exception did not apply.

The Hayes case demonstrates that subrogation professionals must always be mindful of economic loss issues when evaluating claims and determining recoverable damages. It is particularly important to analyze any relevant statutes in the state of loss to ascertain whether an economic loss issue may arise, even where it is not facially apparent that it will affect the claim.

Eleventh Circuit Finds No Coverage for Faulty Workmanship Claims

Tred R. Eyerly | Insurance Law Hawaii

    The Eleventh Circuit affirmed the district court’s grant of summary judgment to the insurer on the general contractor’s claims for damages due to faulty workmanship. Tricon Dev. of Brevard v. Nautilus Ins. Co., 2021 U.S. App. LEXIS 27317 (11th Cir. Sept .10, 2021). 

    Tricon was the general contractor for a condominium project in Florida. Tricon hired a subcontractor to fabricate and install metal railings for the project. The subcontractor was insured by Nautilus under two CGL policies. The policies had endorsements to add Tricon as an additional insured. 

    The subcontractor fabricated some of the railings, but they had defects and damage. Further they were not installed properly and did not meet the project’s specifications. Tricon found another manufacturer to fabricate new railings to satisfy the projects’ requirements. Tricon agreed to pay the cost of removing the subcontractor’s railings and fabricating and installing new ones. If submitted a claim to Nautilus to cover these costs.

    Nautilus denied the claim. Tricon sued and the district court granted summary judgment to Nautilus.

    On appeal, the Eleventh Circuit noted that the policies at issue were post-1986 standard form CGL policies with products-completed operations hazard coverage governed by Florida law. Such policies did not cover the costs of replacing defective products. 

    Applying Florida law, there was no coverage if there was no damage beyond the faulty workmanship, i.e., unless the faulty workmanship damaged some otherwise non-defective component of the project. Further, under Florida precedent, if a subcontractor was hired to install a project component and, by virtue of his faulty workmanship, installed a defective component, then the cost to repair and replace the defective component was not “property damage.”

    Here, Tricon alleged that the subcontractor’s railings were deficient due to having defects and damage, not being installed properly, and not satisfying the project’s specification. Tricon did not allege that the subcontractor’s faulty workmanship damaged otherwise non-defective components of the project. Thus, the costs that Tricon incurred in removing the subcontractor’s railings and the fabrication and installation of new railings did not constitute “property damage” under the policies. 

Protections Against Implied Warranty of Habitability Claims Broadened in Illinois

Scott Ruksakiati | Tyson & Mendes

For many of us of a certain age, our first exposure to the Latin phrase caveat emptor came from an episode of the classic sitcom, The Brady Bunch.  “Let the buyer beware” was the lesson Mr. Brady imparted to Greg for his spontaneous purchase of a beat-up convertible.  That same lesson was one homebuyers learned for many years.  In Illinois, a seller of real property was not liable to a purchaser for defects in the design or construction of the property which existed, even in a latent state, at the time of the sale.

However, the harshness of caveat emptor eventually led to the adoption of the implied warranty of habitability when purchasers discover latent defects in their homes.  This implied warranty, however, is not without limitations.

In Sinema Court Condominium Assoc. v. Champion Aluminum Corp., the Illinois Supreme Court determined the implied warranty of habitability is a creature of contract, not tort, which meant a purchaser of a home could not sue a sub-contractor absent privity of contract.[i]

Recently, in 1400 Museum Park Condominium Assoc. v. Kenny Construction Co. a condominium association unsuccessfully argued its claim for breach of an implied warranty of habitability for plumbing defects was proper against a general contractor since the Sinema decision was limited to sub-contractors.[ii]  The trial court and First District Appellate Court disagreed and, in so doing, clarified the rule.  The Appellate Court began with a discussion about the implied warranty, recognizing its purpose is to protect homeowners from latent defects in their homes which affect the habitability of them.  The Court further observed the loss which can be recovered under an implied warranty of habitability claim is for disappointed commercial expectations which constitute “economic loss” can only be sought in contract and not tort pursuant to the economic loss doctrine.  Accordingly, contractual privity is necessarily required.

The Association, obviously mindful of the privity requirement, creatively argued since the developer-vender had dissolved and become insolvent, the individual unit owners stepped into the shoes of the developer, which did have a contract with the general contractor, to establish privity.  The Association attempted to rationalize its position by further arguing since the individual unit owners contracted with the developer in sales contracts for the latter to construction their residences, this obligation to construction necessarily extended to the general contractor.  The Court rejected the argument for a simple reason: the general contractor was not a party to the sales contracts on which the Association relied.

The Association also argued the dissolved developer assigned its obligations and liabilities under the sales contracts to the general contractor in another attempt to establish privity.  The Court rejected this argument as well, finding there was no evidence to support an assignment.

For these reasons, the Association could not pursue a claim for breach of an implied warranty of habitability against the general contractor.  Similarly, absent privity of contract, the Association could not sue the general contractor for breach of contractor.

1400 Museum Park importantly confirmed the rule of Sinema broadly applies equally to general contractors and sub-contractors alike.  It is not the role an entity plays in a construction project which dictates whether an implied warranty of habitability claim can be asserted against it.  Rather, the fundamental principle of privity of contract is the critical element which must exist whether the defendant is a general contractor, a sub-contractor, a design professional, or any other construction-related entity.

[i] Sinema Court Condominium Assoc. v. Champion Aluminum Corp., 2018 IL 122022.
[ii] 1400 Museum Park Condominium Assoc. v. Kenny Construction Co., 2021 IL App (1st) 192167.