How to Contain Construction Disputes


John Cooper | Jones Day | December 28, 2015

Imagine if, when a dispute involving defective design or defective construction first arose, it could be dealt with in a safe environment so that the defects could be remedied and the possible impacts of them limited, reduced or avoided?

There is no reason why this cannot occur. All that is necessary is an environment where relevant experts (internal or external) are free to focus on remedying the defects.


In the author’s experience, complex commercial construction and engineering projects often suffer defects and, at least occasionally, these defects will, if not addressed quickly, result in serious financial consequences for the owner/user of the building, plant or equipment. The defects might also require significant analysis and engineering, with input from all parties, before a cost-effective remedy can be found and a partial or total rebuild is avoided. Sometimes the most cost-effective remedy might involve the owner being left with something different from that which was originally promised but which will be more than adequate for the owner’s purposes.

Consider the following scenario. An owner of a mineral reserve engages an engineering, procurement, and construction (“EPC”) contractor to design, procure, and construct a processing plant for many hundreds of millions of dollars. The owner provides the contactor with a run of mine ore specification along with the specification required for the product. The contractor, in the EPC contract, promises that the plant, as built, will have a minimum output of product that will meet the product specification.

After a number of years of design and construction, the plant is commissioned and it is discovered that the plant will not produce the quantity of “in specification” product required. The owner alleges that the plant is defective, and the contractor alleges that the run of mine ore contains elements that were not mentioned in the run of mine ore specification in the contract. A dispute ensues. The superintendent refuses to grant commissioning, the contractor disputes this refusal and refuses to accept responsibility, and the owner refuses to take the plant and operate it. While the plant sits idle, many millions of dollars are being lost due to lost production. The contract contains a limitation of liability clause, but there is no limit in respect of a failure to achieve commissioning.

If the dispute is allowed to continue, without the plant being fixed, the commercial problem will increase in size.

What Are the Options?

The options available to the parties include the following:

  1. Continue with the standoff;
  2. One or both parties seek to terminate and then seek to recover damages;
  3. One or both parties refer the matter to dispute resolution under the contract;
  4. One or both parties give up some or all of their rights (e.g., the owner accepts the defect or the contractor takes steps to remedy the defect);
  5. One or both parties take steps to rectify the defect while reserving their rights (e.g., the contractor rectifies the defect but argues that it is entitled to a variation and extension of time for doing so).

None of these options is likely to see the parties working together to arrive at a cost-effective way to rectify the defect.

The ideal option would be for the parties to combine their experience and expertise and analyze the problem, consider all possible methods of rectification and agree on the most cost-effective method of rectification, while also reserving their legal rights.

How can this option be pursued?

How Do We Create a Safe Environment?

In order for the parties to work together in the manner set out above, it is necessary for the parties to come together and work as a team, and for the result of their work to affect the parties’ rights as little as possible.

Creating Teamwork. According to Katzenbach and Smith, “A team is a small number of people with complementary skills who are committed to a common purpose, performance goals, and approach for which they hold themselves mutually accountable.”

Therefore, if teamwork is to be achieved, it will be necessary to bring together, from the various parties (and possibly from beyond the parties), individuals with complementary skills that are relevant to the rectification of the defect. It will also be necessary to ensure that they have, and are committed to, a common purpose (e.g., to work in good faith together to work out the problem and arrive at a rectification of the defect), performance goals (e.g., a timeline to arrive at rectification of the defect), and approach (e.g., sharing ideas and information). Finally, it is important that they hold themselves mutually accountable to the purpose, goals, and approach. This can best be achieved by ensuring that all of the parties contribute equally in terms of resources and that all work is carried out in an environment free of blame and risk. This environment can be created if the environment in which they work is without prejudice, is confidential, and will not result in any rights being lost due to participation in the process.

A Without-Prejudice Environment. The parties can agree that their interactions will be without prejudice and that all documents created in the process will be privileged from production, and not require to be produced, in any proceedings.

This will allow the parties to communicate openly and without needing to be concerned about admissions made and documents created being used against them later in proceedings.

Some parties might want to go further and also cloak with privilege documents used in the process. The risk of this approach is that documents that would otherwise not have attracted privilege and would have been required to be produced in proceedings might no longer be required to be produced. If this approach is going to be adopted, it is recommended that the parties discuss and agree upon the documents or categories of documents that are going to be so protected, in order to guard against any party being unintentionally prejudiced by being unable to call for production of documents that were created before entering into the without-prejudice process.

Confidential. It is easy to make all communications confidential, but thought needs to be given to what will be excluded from any obligation of confidentiality. For example, communications might include information that was in existence prior to commencement of the process and that would not otherwise have been confidential (and might have been required to be disclosed in any proceedings). Unless there is some good reason for preventing preexisting information from being used or disclosed for other purposes (including being used in subsequent proceedings), it might be appropriate to exclude it from the obligation of confidentiality.

Likewise, if the information is going to be required to rectify the defect, it may be necessary to disclose it to contractors and others involved in carrying out the rectification work. It will therefore be necessary to exclude communication of information to the extent it is necessary to carry out that work.

In addition to dealing with confidentiality, it might be appropriate to include a restraint on the use of all or some of the information. For example, it might be appropriate to restrict the use of information created during the process to use for the purpose of rectifying the defect.

Preserving the Parties’ Rights. Teamwork and open and honest communication, and therefore good problem solving, are unlikely to occur if the parties are concerned about losing their rights, or worse still, prejudicing their positions.

A number of rights need to be protected.

First, there are the rights that might be affected by the efluxion of time. These can be protected by the parties agreeing that time stands still in respect of these rights while the process is ongoing. Time bars which affect the prosecution of rights in the future may need to be dealt with by these stand still arrangements. Care needs to be taken in the drafting to ensure that rights that have already been lost due to the passage of time are not enlivened by mistake.

Second, there are the rights that might be affected by the exchange of information (e.g., the making of admissions). These can be protected by the mechanisms discussed above (privilege, confidentiality, and restraints on use of information).

Third, there are the rights that might be affected by the finding of a cost-effective method of rectification. These are best left to be considered once a cost-effective solution has been found.

What Should Go into the Agreement?

The process should be governed by an agreement between the parties to the original contract who will be involved in the process. It would also be wise to include any other parties who will be involved in the process (for the purpose of dealing with privilege, confidentiality, and restraints on use of information).

The agreement should include provisions that deal with:

  • The contribution to be made by each party (and the payment of expenses);
  • Acting and communicating in good faith;
  • The standstill arrangements;
  • Confidentiality;
  • Use of information; and
  • Privilege.

Does It Work?

The author recently used the process on a major project. It resulted in the defect being…

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“Consumer Expectations” Test In Design Defect Products Liability Case

Eugene Polyak | Smith Currie & Hancock | December 24, 2015

In Aubin v. Union Carbide Corp., 40 Fla. L. Weekly S596 (Fla. Oct. 29, 2015), the Florida Supreme Court recently resolved an important conflict between Florida’s intermediate appellate courts with respect to the test used in adjudicating design-defect claims in product liability cases.

While working as a construction supervisor in the 1970’s, William P. Aubin inhaled dust containing asbestos fibers from SG-210 Calidria, an asbestos product manufactured by Union Carbide Corporation. In 2008, Aubin was diagnosed with malignant peritoneal mesothelioma, a fatal form of cancer in the lining of the abdomen. Aubin sued and won at the trial level where the jury awarded him $6,624,150 finding that Union Carbide was liable for Aubin’s damages under theories of negligence and strict liability for defective product design and failure to warn.

Union Carbide appealed and won at the Third District Court of Appeal, which held that the trial court erred by, among other things, failing to apply the Restatement (Third) of Torts, which exclusively adopts the “risk utility” test for design defect claims like Aubin’s and imposes on plaintiffs the burden of presenting evidence of a reasonable alternative design.

The case was appealed to the Florida Supreme Court, which reversed the Third District’s decision and rejected the Third District’s adoption of the risk utility test for design defect cases. In reaching its conclusion, the Florida Supreme Court noted that the Third District’s decision conflicted with the Florida Supreme Court’s holding in West v. Caterpillar Tractor Co., 336 So.2d 80 (Fla. 1976) which applied the Restatement (Second) of Torts to strict products liability cases and utilized the “consumer expectations” test as an essential part of determining whether a design defect exists.

Under the consumer expectation test, a product is deemed defectively designed if the plaintiff is able to demonstrate that the product did not perform as safely as an ordinary consumer would expect when the product is used in the intended or reasonably foreseeable manner.  Under the risk utility test, adopted by the Third District, the plaintiff must demonstrate that the foreseeable risks of harm posed by the product could have been reduced or avoided by the adoption of a reasonable alternative design by the seller or other distributor, and the omission of the alternative design rendered the product not reasonably safe.

In Aubin, the Florida Supreme Court explained that in West it adopted “consumer expectations” test because the cost of injuries resulting from defective products should be borne by the makers of the products who put them into the channels of trade, rather than by the injured persons who are ordinarily powerless to protect themselves.  For this reason, in West the Court held that a manufacturer is strictly liable in tort when an article it places on the market, knowing that it is to be used without inspection for defects, proves to have a defect that causes injury to a human being.

The Aubin Court noted that the risk utility test conflicts with West by imposing a higher burden on consumers to prove a design defect by requiring the injured consumer to prove that a reasonable alternative design was available to the manufacturer.  TheAubin Court also expressed…

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Looming Texas Supreme Court Decision Could Impact Contractor Liability in Construction Cases

Andrew D. Ness, William R. Taylor and J. Laurens Wilkens | Jones Day | December 2015

In November 2015, the Texas Supreme Court heard oral arguments to determine if a general contractor was a “seller” under Chapter 82 of the Civil Practice and Remedies Code and entitled to indemnification from the manufacturer of an allegedly defective roof truss. See Centerpoint Builders GP v. Trussway, Ltd., 2015 LEXIS 799 (Tex. Sept. 4, 2015) (granting petition for review). If the Court agrees with the general contractor, then the decision would likely increase the risk of liability for both general contractors and manufacturers of products installed by general contractors.

Chapter 82

Chapter 82 provides a means for an “innocent” seller to seek indemnification from the manufacturer of an allegedly defective product. SeeTex. Civ. Prac. & Rem. Code § 82.002. The statute requires a manufacturer to indemnify and hold harmless a seller against loss arising out of a product liability action, except for any loss caused by the seller’s negligence, intentional misconduct, or other act or omission for which the seller is independently liable. Id. at § 82.002(a). “Seller” is broadly defined in the statute as “a person who is engaged in the business of distributing or otherwise placing, for any commercial purpose, in the stream of commerce for use or consumption a product or any component part thereof.” Id. at § 82.001(3).

Notably, the Texas Supreme Court in Fresh Coat, Inc. v. K-2, Inc., 318 S.W.3d 893 (Tex. 2010) held that a contractor hired to apply synthetic stucco components to homes according to the manufacturer’s instructions and training is a “seller” of the synthetic stucco components. The Court inFresh Coat held that Chapter 82’s definition of “seller” does not exclude a seller who is also a service provider, and Chapter 82 does not require the seller to sell only the product at issue. Id. at 899.

Case Background and the Beaumont Court of Appeals’ Decision

Centerpoint began as a personal injury action filed by Merced Fernandez against Centerpoint Builders GP, LLC (“Centerpoint”) and Trussway Ltd. (“Trussway”) for injuries sustained while installing drywall at an apartment complex construction project. Centerpoint was the general contractor and Fernandez was an independent contractor. At the time of the accident, Fernandez was standing on a roof truss that had not yet been installed. The truss broke and Fernandez was severely injured from his fall. Fernandez filed suit, asserting that the truss, which was manufactured by Trussway and purchased by Centerpoint, was defective and unreasonably dangerous.

Centerpoint filed a claim against Trussway seeking statutory indemnification under Chapter 82. Trussway filed a cross-action against Centerpoint, denying that Centerpoint was a seller under Chapter 82 and contending that it was actually an innocent seller that was entitled to indemnification from Centerpoint. The trial court granted Centerpoint’s motion for summary judgment and held that Centerpoint was a “seller” under Chapter 82, but denied Centerpoint’s motion for partial summary judgment regarding its entitlement to indemnity. The trial court also held that Trussway was not entitled to indemnity from Centerpoint. The parties then filed a joint notice of agreed interlocutory appeal.

On appeal, the Beaumont Court of Appeals reversed the trial court’s order and held that Centerpoint does not fit the statutory definition of a seller.Centerpoint Builders GP, LLC v. Trussway, Ltd., 436 S.W.3d 882 (Tex. App.—Beaumont, pet. granted). The court examined Fresh Coat, but held that the case was distinguishable for several reasons:

(i) Unlike in Fresh Coat, Fernandez’s accident occurred before the trusses were installed and there was no indication Centerpoint or its subcontractors installed the truss pursuant to training or instructions from Trussway. Id. at 888,

(ii) Centerpoint’s contract with the apartment owner covered numerous products and materials as opposed to the contract in Fresh Coat, in which the contract covered only the specific product at issue.Id.,

(iii) Centerpoint was not engaged in placing the trusses into the stream of commerce when Fernandez’s accident occurred, and

(iv) Fresh Coat merely stands for the proposition that a contractor that provides services is not precluded from being a “seller” under Chapter 82. Id. The court in Fresh Coat did not, however, hold that a contractor who installs a product is always a “seller.”

For these reasons, the Beaumont Court of Appeals held that Centerpoint was not a “seller” under Chapter 82 and thus not entitled to seek indemnity from Trussway. Id. at 888-89. The court noted that this conclusion was consistent with the common law definition of “seller.” Id. at 888. The court also held that Centerpoint was not a manufacturer of the truss and was not obligated to indemnify Trussway. Id. at 889.

Arguments Before the Texas Supreme Court

On September 4, 2015, the Texas Supreme Court granted Centerpoint’s Petition for Review. Centerpoint Builders GP v. Trussway, Ltd., 2015 Tex. LEXIS 799 (Tex. Sept. 4, 2015).

Centerpoint’s primary argument before the Texas Supreme Court was that the Beaumont Court of Appeals’ decision conflicts with Fresh Coat. Centerpoint asserted that the Court of Appeals improperly relied on § 82.002(d) (which states that a wholesale distributor or retail seller “who completely or partially assembles a product in accordance with the manufacturer’s instructions shall be considered a seller”) in its attempt to distinguish Fresh Coat because Centerpoint did not assemble the truss. Centerpoint also argued that the Court of Appeals added requirements to Chapter 82, “such as requiring the ‘seller’ to sell only one product as opposed to ‘innumerable’ products” and adding an improper “temporal requirement” that the seller be engaged in placing the product into the stream of commerce at the time of the accident. Petitioners’ Brief on the Merits at p. 7. Finally, Centerpoint argued that the Court of Appeals erred in concluding that a determination that Centerpoint was a “seller” would improperly expand the common-law definition of “seller.”

Trussway, conversely, argued that Centerpoint is a construction company engaged in the business of building apartment complexes, not selling products. Further, by purchasing the roof trusses, according to Trussway, Centerpoint was the user or consumer; it did not place them into the stream of commerce. Next, Trussway argued that the Court should consider the fact that a builder is not a seller under the common law. Centerpoint also emphasized that Chapter 82 does not transform a builder into a seller of every building material used on a project. Trussway argued that applying Chapter 82 would “lead to absurd results by transforming most negligence or premises-liability cases against general contractors into products liability indemnity cases against material suppliers.” Respondent’s Brief on the Merits at p. 12. Finally, Trussway argued that Centerpoint could not possibly be a “seller” of a “product” because “if Centerpoint sold anything (other than its construction services), it sold a large, completed, custom-built, 166-unit apartment complex, which is not a product.” Id.

Practical Implications

Texas courts have struggled with establishing the parameters of Chapter 82’s definition of “seller.” The Texas Supreme Court in Fresh Coat tackled one such application of the term in the construction context, and Centerpoint represents an opportunity for the Court to either curtail Chapter 82’s applicability to construction cases or dramatically expand it.

Of particular note…

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SB 800 – Can Builders Enforce It, Or Not?

Steven M. Cvitanovic, David A. Harris and Theresa M. Wynne | Haight Brown & Bonesteel LLP | December 18, 2015

Story #7 of 10 in Haight’s series of Top Ten Stories in California Construction for 2015

15 years ago, the California Supreme Court held in Aas v. Superior Court, 24 Cal.4th 627 (2000), that homeowners could not recover for construction defects unless the defects caused consequential damages to the building. In other words, a homeowner could not sue for windows that were installed incorrectly, unless the defect caused secondary problems such as water damage to the interior of the house.

In response to the Aas decision, the California legislature enacted California Senate Bill 800, known as “The Right to Repair Act” (“the Act”). SB 800 overturned Aas and provided homeowners who purchased homes after January 1, 2003, with a statutory cause of action to recover purely economic damages related to construction defects even if there was no consequential property damage. Under SB800, litigation was stayed while the parties worked on a potential fix to the claimed defects. The Act’s stated purpose was to limit the number of court cases by allowing a builder to resolve construction defect claims by agreeing to repair the homeowners’ residence. The hope was that by allowing builders to fix problems homeowners would be able to avoid suing. For almost a decade, the construction bar followed the Act’s statutory scheme.

In 2013, the Act was upended when the Court of Appeal for the Fourth Circuit ruled inLiberty Mutual Ins. Co. v. Brookfield Crystal Cove LLC (2013) 219 Cal.App.4th 98, that homeowners did not have to follow SB800 if they only brought common law construction defect tort causes of action. Under the holding, homeowners could avoid the act’s prelitigation requirements, including the right to repair, and proceed straight to litigation, if they only brought tort causes of action. The decision was viewed by many in the builder community as gutting the statutory intent of the Act.

In August 2015, the Court of Appeal for the Fifth District repudiated the holding of Liberty Mutual, and held that plaintiffs in construction defect actions must comply with the statutory prelitigation inspection and repair procedures mandated by the Act regardless of whether they plead a cause of action for violation of the Act.

In McMillin, 37 homeowners filed a lawsuit against the builder of their homes, alleging eight causes of action, including strict products liability, negligence, and breach of express and implied warranty. Plaintiffs’ third cause of action alleged SB800 violations. The plaintiffs did not follow the Act’s notification procedures and filed their lawsuit without providing the builder with an opportunity to repair the alleged defects.

Plaintiffs and the builder attempted to negotiate a stay of the lawsuit to complete the Act’s prelitigation procedures. When talks broke down, plaintiffs dismissed their SB800 cause of action and contended they were no longer required to follow the Act’s prelitigation procedures. McMillin filed a motion to stay with the trial court.

The trial court denied McMillin’s motion concluding that under Liberty Mutual, “[plaintiffs] were entitled to plead common law causes of action in lieu of a cause of action for violation of the building standards set out in [the Act], and they were not required to submit to the prelitigation process of the Act when their complaint did not allege any cause of action for violation of the Act.”

McMillin filed a writ petition seeking to reverse the trial court’s holding. The Court of Appeal granted the writ, and held that all homeowners must comply with the Act’s prelitigation procedures even if their complaint only alleges common law causes of action. The Court writes:

“[W]e conclude the Legislature intended that all claims arising out of defects in residential construction, involving new residences sold on or after January 1, 2003 (§938)’, be subject to the standards and the requirements of the Act; the homeowner bringing such a claim must give notice to the builder and engage in the prelitigation procedures in accordance with the provisions of Chapter 4 of the Act prior to filing suit in court. Where the complaint alleges deficiencies in construction that constitute violations of the standards set out in Chapter 2 of the Act, the claims are subject to the Act, and the homeowner must comply with the prelitigation procedures, regardless of whether the complaint expressly alleges a cause of action under the Act.” (Emphasis added).

The Court’s conclusion was based on its finding that the holding of Liberty Mutual was contrary to the Legislature’s stated intent of reducing construction defect litigation, and encouraging builders to take responsibility for basic building functionality standards. The Court found that the Legislature did not intend to allow a plaintiff to “plead around” the Act, or avoid its mandatory prelitigation provisions by only pleading tort causes of action. The Court writes:

We doubt the Legislature would have viewed the legislation as ‘groundbreaking reform’ or a ‘major change[]’ in the law of construction defects if its provision were mandatory only when the defect had not yet caused damage, and the homeowner could still sue for damages under any common law theory once property damage occurred, without being subject to the [Act’s] statutory prelitigation procedures.

The McMillin decision is remarkable in that…

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Engineers Beware !! California Courts have held Engineers Owe a Duty of Care and are Liable to Contractors for Plans and Specifications used in the Bidding Process

James C. Earle, Esq. | Ervin Cohen & Jessup LLP | December 18, 2015

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In a detailed explanation of an Engineer’s duties and responsibilities, the United States District Court for the Northern District of California held that an engineer that prepares plans and specifications relied upon by contractors in preparing their construction bids for a project owes a duty of care to those bidding contractors. The court held that an engineer can be liable to the contractors for breach of professional duty and/or negligent misrepresentation. (See Apex Directional Drilling, LLC v. SHN Consulting Eng’rs & Geologists, Inc., 2015 U.S. Dist. LEXIS 105537 (N.D. Cal. Aug. 11, 2015)

The contractor, Apex Directional Drilling, LLC (“Apex”), encountered problems on a municipal sewage construction project (“Project”). Apex entered into a contract with the City of Eureka, California (“Eureka”) to install a new wastewater pipeline utilizing a drilling technique known as “horizontal directional drilling” (“HDD”). This is a technique that can only be successful in soil that is sufficiently stable and dense. Eureka, prior to entering into the contract with Apex, hired SHN Consulting Engineers & Geologists, Inc. (“SHN”) to serve as lead engineer and project manager for the Project.

SHN conducted geological studies and prepared plans, reports and specifications describing the conditions on the Project. Eureka and SHN furnished a report, the Geotechnical Baseline Report (“GBR”), to potential contractor bidders to allow the bidders to prepare an estimate of the cost to complete the work. The GBR indicated that “the majority of the subterranean region targeted by the project was composed of stable soils suitable for HDD.”

Apex, relying on the GBR, submitted the lowest bid and was awarded the contract. Subsequently, Apex ran into problems when it encountered mud and flowing sands that were not soils described in the GBR. Thereafter, Apex reported these different soil conditions to Eureka and SHN. Apex submitted change order requests to Eureka seeking reimbursement for the cost overruns resulting from the adverse soil conditions. Eureka, in reliance upon recommendations from SHN, rejected the Apex change order requests. Eureka then terminated Apex.

Apex sued Eureka and filed a separate complaint against SHN asserting claims for breach of professional duty and negligent misrepresentation. SHN moved to dismiss Apex’s complaint for failure to state a claim. The court refused to dismiss Apex’s claims finding that SHN owed a duty of care to Apex.

In addition…

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