Monthly Archives: August 2019

Blockchain and Smart Contracts May Solve the Unsolvable Problem in Construction

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Thomas D. Franklin and Brian R. Gaudet | Kilpatrick Townsend & Stockton | August 22, 2019

Every construction project, from contract negotiation through the payment of the final pay application, suffers from the same conundrum born out of every parties’ desire for certainty and finality. That problem is the issue of the exchange of lien waivers for payment. The issue is those parties lower in the construction chain are asked to provide unconditional lien waivers (swearing that they have already been paid) as part of their request to be paid. This happens all the way up the chain until you reach the top. It is borne out of the project financer’s desire to make sure that when they issue a progress or final draw on funding that they are achieving finality on costs of construction for everything that transpired prior to that draw. This, of course, helps insure that their investment in the project is not attacked by mechanics and materialmen’s liens filed by unpaid subcontractors and suppliers down the chain. (While the financiers typically have a superior priority in the property, the financiers would rather that the borrower occupy the property and pay them back in accordance with the repayment schedule, than to foreclose, fight over priority, and suffer loss from an insufficient recovery on foreclosure or to have to hold the property for some extended period of time.)

Several states have passed laws, and in other places, parties negotiate the exchange of a conditional release in exchange for a check, which would be followed up, in theory, with an unconditional release when the check is honored by the payor bank and becomes “good funds.” A conditional release is a compromise position that is sometimes rejected and it has its own problems. Rather than relying on a single executed document, a party would need to also have proof of the funding of the check in order to know whether it may rely on the conditional release or not. This need to look to external sources is less than ideal from the finance side.

There are other imperfect solutions to this problem up until blockchain and smart contracts, which may be the perfect solution. One solution was to have the prime contractor prepay its subcontractors prior to submitting what essentially would be a request for reimbursement from the Owner for what was already spent. The subcontractors, as a precondition to receiving that payment, would have already had to prepay their lower tiered subcontractors and suppliers. In theory, that solution works. In practice, it fails. The reason it fails is that the parties with the least financial wherewithal are asked to prefund a significant payment and hope for a timely reimbursement. The larger the project, and the higher the monthly burn rate on expenditures, the more unlikely you are to succeed in this pre-payment paradigm.

Another solution, which is even more impractical in practice, is for every party on the construction project who is expected to receive a portion of a particular monthly draw to assemble in a large conference room and exchange cash for unconditional releases in an elaborate closing ceremony, each and every month. This would permit the exchange of hard currency for unconditional releases, seemingly satisfying the finance side’s desire for finality and certainty, as well as the working side’s desire to make sure they do not end up financing the project themselves. There are obvious problems with this scenario, including the logistics and time necessary to perform it, and the security risks. Through the use of blockchain, however, the parties can accomplish the same thing electronically.

What are blockchain and smart contracts? Blockchain is a cryptographic technique to validate transactions for each transaction so that there is trust in what transpired at any given moment, because the algorithm is so strong. A distributed ledger (it exists in multiple locations) for the blockchain provides an unhackable solution, as many parties possess a copy, and it would be impractical to hack all of them to change the ledger. Some blockchains integrate smart contract capability that uses software code to automatically enforce one or more contract terms before the underlying transaction takes effect. A smart contract could be used in conjunction with, or to replace, project management/finance software to set up rules for the execution of a transaction or series of transactions. This can provide enhanced visibility or other functionality in a secured way with a distributed ledger and algorithmic security. Since many possess a copy of the blockchain and understand the underlying rules of the smart contract, there are no secrets and no chance at manipulation.

How would this work to solve the problem discussed above, is as follows. Using software with controlled access to the blockchain, the parties participating on the construction project would register and be invited into the project finance database. Parties lower in the chain could upload their unconditional releases, which the system would hold in escrow. The project financier (owner or lender) would pre-load the draw payment on its end either just prior to funding or before the next month of work began, so that the parties performing work could be assured that payment was locked in the system. Once the system received all of the unconditional releases required for the draw, the funding would happen through some combination of the smart contract or traditional software to enforce the rules so that the blockchain records the compliance with a perfect audit trail. The payment would not just flow from the bank to the owner. The entire distribution could simultaneously occur, with the payment simultaneously flowing throughout the entire matrix of those expecting payment. The suppliers and subcontractors would be paid at the same instance the draw was funded to the general contractor. The blockchain would be used to securely track and distribute the funding, as all parties can be assured the prerequisite conditions for proceeding were met. Because of its distributed ledger system, there would not be the ability of one party to manipulate the system. The releases could be created through the software system or smart contracts so that a party could not simply upload a blank page to trick the system. There would still need to be human oversight in determining who should be a participant in payment system, as well as validation of whether work was performed, and at what percent of completion. As this approach catches on over time, anyone who supplies or provides labor to a project would know to register on the project to secure its payment.

Certainly there are still “What ifs…” to be worked through on a per project basis, but the fundamental problem has been solved with technology that is secure, unhackable, transparent, and lightning fast.

You May Think You Are Insured as an Additional Insured But You May Find You Are Not Covered

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Louis Adolfsen | Melito & Adolfsen | August 22, 2019

Anyone who hires someone to do construction should ask the contractor to name them as an additional insured on the contractor’s policy. The contractor may agree to provide the coverage but then may fail to follow the rules in the policy for providing additional insured coverage. You may not learn about the mistake until you are sued and find you are not covered.

At the outset, it is important never to rely on a certificate of coverage on the “ACORD” form, which is generally supplied by a contractor as “proof” of coverage. It is not proof of coverage that does not provide proof of coverage. Indeed, the ACORD form has warning, in capital letters, advising that it is not proof of coverage:

THIS CERTIFICATE IS ISSUED AS A MATTER OF INFORMATION ONLY AND CONFERS NO RIGHTS UPON THE CERTIFICATE HOLDER. THIS CERTIFICATE DOES NOT AFFIRMATIVELY OR NEGATIVELY AMEND, EXTEND OR ALTER THE COVERAGE AFFORDED BY THE POLICIES BELOW. THIS CERTIFICATE OF INSURANCE DOES NOT CONSTITUTE A CONTRACT BETWEEN THE ISSUING INSURER(S), AUTHORIZED REPRESENTATIVE OR PRODUCER, AND THE CERTIFICATE HOLDER.

There are basically three ways that a party becomes an additional insured under a policy.

The simplest way is for the policyholder to ask the carrier to designate a person as an additional insured. General Liability (‘GL”) policies commonly include, in the definition of “Who Is An Insured,” the following:

Anyone designated in the declarations is an insured.

In that instance the person is not actually an additional insured but a “named” insured who has the same contractual rights as the policyholder.

GL policies also include other people who one would imagine should be covered as insureds. The policy standardly includes the following wording:

To be an additional insured, if you are not included in the definition of “Who Is An Insured” or named as an insured in the declarations, you must have a provision that amends the provision for “Who Is An Insured.” Here, there are basically two types of coverage.

One form of coverage provides that an insured is any person… “to whom you are obligated by virtue of written contract or agreement or by virtue of the issuance or existence of a permit, to provide insurance such as is afforded by this policy.”

Another more complex provision is known as a Blanket Additional Insured provision required “by virtue of a written contract” or “the issuance of a permit.” The two basic provisions are quoted below.

The “Short Form” provision states:

WHO IS AN INSURED (SECTION II) is amended to include as an insured any person, organization, trustee, estate or governmental entity to whom or to which you are obligated, by virtue of a written contract or agreement or by virtue of the issuance or existence of a permit, to provide insurance such as is afforded by this policy.

The “Long Form” of a “Blanket Addition Insured” provision states:

2.) BLANKET ADDITIONAL INSUREDS-REQUIRED BY CONTRACT OR ISSUANCE OF A PERMIT

(A) WHO IS AN INSURED (Section II) is amended to include as an insured any person, organization, trustee, estate or governmental entity to whom or to which you are obligated, by virtue of a written contract or agreement or by virtue of the issuance or existence of a permit, to provide insurance such as is afforded by this policy, but only with respect to liability arising out of:

1. “Your work” for the additional insured(s) or for which a governmental entity has issued a permit, or

2. Acts or omissions of the additional insured(s) in connection with their general supervision of “your work”;

then only for the limits of liability specified in such contract or agreement, but in no event for limits of liability in excess of the applicable limits of liability of this policy provided that

1. such person, organization, trustee, estate or governmental entity shall be an insured only with respect to occurrences taking place after such written contract or agreement has been executed or such permit has been issued, and

2. a) the name of such person, organization, trustee, estate or governmental entity has been furnished to the company as of the effective date of the policy, or

b) (i) such contract or agreement takes effect or such permit is issued during the policy period, and

(ii) the named insured notifies us, within 180 days after the effective date of the contract or agreement or the issuance date of the permit, of the date as of which such person organization, trustee, estate or governmental entity shall be included as an insured.

Here is where it gets tricky. In the Short Form there is only the requirement that there be a “written contract or agreement” or “the issuance or existence of a permit.” An oral agreement will not be enough. Similarly, if a permit does not exist there will be no coverage.

These same two provisions – a written contract or a permit – are included in the Long Form. But there are many other requirements.

The Long Form applies only for “your work” for the additional insured or for which a government entity has issued a permit or acts or omissions of the additional insureds in connection with their general supervision of “your work.”

The Long Form also provides an additional requirement that the person is insured “only with respect to occurrences taking place after such written contract or agreement has been executed or such permit has been issued.”

Finally, the Long Form requires the named insured to notify the carrier within one hundred and eighty (180) days of the effective date of the contract of the agreement or the permit. Thus, all of these requirements must be met.

The Short Form is the easiest to comply with. The Long Form has many requirements and is a trap for the unwary. If there is no written contract or permit, the provision is limited to liability arising out of your work or acts or omissions of the additional insured in connection with their general supervision of your work, the occurrence has to take place after the written agreement or permit has been issued and notice has to be given to the carrier within the first one hundred and eighty (180) days.

The caselaw is legion with instances where all of these requirements were not met. The bottom line is you can’t rely on the ACORD certificate of insurance and you must ask the contractor to let you look at the policy itself. You should have a written contract and you should make sure that the policyholder does everything it has to do. If you have the Long Form you can be sure that you won’t have any coverage if it doesn’t arise out for your work of the additional insureds or in connection with their general supervision of “your work.” These pitfalls require someone who needs additional insured coverage to make sure that they are either named on the policy or that all the rules of the additional insured provision have been followed.

Developer is not Indemnified for its own Conduct Without an Express Agreement in the Indemnification Clause

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Sunu M. Pilai | Construction Industry Counselor | August 22, 2019

In a case where the jury found both the Architect and the Developer separately responsible for Plaintiff’s damages, an Appellate Division of the New Jersey Superior Court recently held that the Developer is not entitled to be indemnified by the Architect.  See Grandview at Riverwalk Port Imperial Condo. Ass’n, Inc. v. K. Hovnanian at Port Imperial Urban Renewal II, LLC, No. A-2308-17T2, 2019 WL 3798427 (N.J. Super. Ct. App. Div. Aug. 13, 2019)(unpublished decision). The appellate court agreed with the Developer’s argument that the Developer’s breach of warranty would not have occurred but-for the Architect’s negligence. However, the appellate court denied the Developer’ demand for indemnification because the indemnification clause in the Developer-Architect contract did not unequivocally express an intention for the Architect to indemnify the Developer against losses resulting from the Developer’s own negligence.

This case involved a residential project containing 132 units, categorized as a Type 2B building that required fire-retardant-treated wood. By the time the Architect realized that the plans called for untreated plywood in floor assemblies and therefore did not meet Type-2B requirements, more than half the plywood was installed and Developer was not willing to consider solutions that would disrupt the schedule.  Following discussions, the Architect drafted plans to revise the building classification to Type 3A that would allow the untreated wood to remain. However, the Town never approved the revised plans, and the Developer never ensured that the revised plans were approved for a Type 3A Building.  The jury determined that the Developer breached its warranty to buyers of the residential units because it never disclosed to the buyers that the building’s classification was never approved, and, according to Plaintiff’s expert, the building would not meet Type 3A requirements either.  The jury found the Architect to be negligent in the design, and that the Developer breached an express promise that the Building’s common elements would be fit for their intended purpose.  The jury assessed damages of $1 Million against the Architects for its negligence and $3 Million against the Developer for its breach of an express warranty, which was trebled to $9 Million due to a finding of consumer fraud.

In the appeal, the Developer argued that the Architect was contractually obligated to indemnify it for the damages because the damages arose out of the Architect’s negligence in designing a building contrary to code requirements. The appellate court noted that, though public policy does not preclude such indemnification, a contract will not be construed to provide indemnification for losses resulting from a party’s own negligence unless such an intention is expressed in unequivocal terms.  The appellate court found that the indemnification clause only provides that the Architect will indemnify the Developer for Architect’s own negligence, and hence the clause cannot be construed to indemnify the Developer for its own conduct (when it breached its express warranty to residential buyers).

The decision, though non-precedential, highlights the importance of careful and effective drafting of indemnification clauses.

The Advantages of Virtual Reality in Construction

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Spivey Lipsey | Construction Executive | June 20, 2019

Virtual reality provides an unparalleled spatial sense for visualization at a lower cost than full-scale replicas. Today, VR is being used heavily in preconstruction to align owner expectations and educate design team stakeholders. For those already employing BIM solutions, coordination can be made much more effective by leveraging existing design models with very little added cost.

As anyone who has tried a VR headset before can attest, the ability to accurately perceive spatial relationships in design cannot be replicated through traditional 2D media such as screens or paper. VR solutions also have the ability to iterate rapidly. These technologies are linked to BIM, providing real-time feedback as the design changes. This is in stark contrast to traditional full-scale mockups and offline renders, which are cumbersome and time-consuming to update with design changes. 

SUBSTANTIAL BENEFITS WITHOUT A HEFTY PRICE TAG

Budget limitations and ROI are always a concern with emerging technology. Fortunately, VR comes cheaply with BIM production. These solutions are significantly less expensive than full-scale mockups and far more efficient when compared to longhand sequencing explanations and esoteric detailing of complex designs. Even the most elaborate VR setups are a fraction of overall construction cost, ranging from a few hundred to a few thousand dollars depending on the level of adoption.

Design and coordination models are widely available in construction today and facilitate VR use with little additional effort. The immersive aspect and spatial recognition are intuitive and efficient compared to 2D plans. Even 3D models viewed through design software is not full scale and is fragmented to produce traditional construction documentation.

Augmented reality can also aid with the sequencing of elements from a Gantt chart. Using Navisworks or similar software, schedule information can be imported and linked to geometry. The 3D elements are then automatically animated and updated with changes to the model and schedule. Additionally, VR allows us to see how these components come together in a scaled environment and reveal conflicts that may be otherwise hidden. This is particularly useful for construction with tight clearances due to existing infrastructure. 

Without a complete design model, VR can be expensive and time-consuming to maintain with design changes. For BIM projects, however, it’s a solid investment with many rewards. VR is another tool in the belt of designers and contractors to ensure construction adherence to design intent. 

GETTING STARTED WITH VR TECHNOLOGIES

For a company using VR for the first time, a curated experience is recommended. Small flaws in the design can easily become focal points in VR and it’s important to ensure user focus remains on priority items. This can be done through limiting user interaction with the model and ensuring viewable areas are more polished.

For example, a more curated experience can be accomplished by exporting specific areas individually from the model to present as separate scenes. Another option is to create boundaries with hidden geometry to limit movement to a particular area, ensuring users only see polished parts of the model and aren’t overwhelmed by accidentally veering off to unfinished or non-navigable areas.

To achieve the ROI that VR solutions are capable of delivering, accurate models are of paramount importance. Models lacking consistency and accuracy will contain distracting errors and detract from the focal points and design elements intended for discussion. Excess modeling should also be avoided as it can significantly impact performance in VR and create additional cleanup. 

LOOKING AHEAD

From the design team to the contractors and owners, VR improves understanding and expectation of deliverables across the board, greatly enhancing both project coordination and the review process. Managerial roles that, in the past, had been technology-averse now use VR for its intuitive view of the design BIM and investigating model elements in ways they would previously have avoided.

Visualizing the spatial relationship between model elements is where VR really shines. Steve Jobs famously said that computers are like a bicycle for the mind. VR is very much a bicycle for our spatial cognition. High ROI on BIM projects, combined with hardware that is growing less expensive and more powerful each year, makes one thing very clear—VR is here to stay.

Dispute Review Boards for Real-Time Dispute Avoidance and Resolution

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Neal J. Sweeney | ConsensusDocs | July 19, 2019

The use of dispute tribunals generally referred to as Dispute Review Boards or DRBs on major projects has matured. Use of a DRB cannot guarantee elimination of post-project litigation, but when used properly, a DRB can be an enormously effective tool to avoid and resolve disputes rapidly and during construction.

The modest out-of-pocket costs of a DRB can pay big dividends. DRBs offer the opportunity to shorten the life cycle of a dispute by requiring the principals to confront and address the merits of their dispute, rather than simply hunkering down and focusing on posturing and preparing for arbitration or litigation. Even when a DRB cannot immediately resolve a dispute, the process can still facilitate subsequent settlement and cost-effectively prepare both parties for formal adjudication. DRBs can also enhance communications and help the parties avoid and resolve problems before they spiral into disputes.

DRBs were first and are most widely used on big civil and infrastructure projects, but the benefits of a DRB extend equally to major building projects, particularly hospitals, and industrial projects and should be used in those sectors.

Key Details – The DRB Specifications
DRBs are a creature of contract; the scope and authority of the DRB as well as DRB procedures are established in the construction contract, generally incorporated through the specifications and other attachments (“DRB specifications”). It is important to review the DRB specifications on each project before submitting a bid or proposal. Although there is a fair amount of standardization, details may be customized, and those details can have considerable practical, legal and risk implications. Examples of standard DRB specifications are provided by the DRB Foundation and ConsensusDocs . Some of the key details are the DRB member selection process, the scope of the DRBs authority, who can directly participate in the DRB process, and the impact of a DRB decision.

Regular DRB Participation on the Project to Avoid Disputes
Although focus is often placed on DRBs rendering formal decisions on disputes, the role of a DRB can and should be broader. The DRB should be part of the communication structure of the project, with regular project visits and meetings so the DRB members are generally aware of the nature and progress of the work and become familiar with the principals for the parties.

The DRB members are most often experienced industry professionals or construction attorneys. DRBs are most effective when the DRB members know the project and the people on a retail level. The DRB should not be trotted out only when a problem has degenerated into a polarizing dispute that the DRB is asked to decide.

These regular site visits and meetings provide an informal and non-adversarial forum in which the principals are called on to identify and discuss potential problems before they become disputes. These group interactions with the DRB help enhance communication and preserve relationships between the parties as they address issues in a non-contentious setting. In this way, problems are more likely to be addressed and disputes avoided or at least mitigated before moving down the trail to a formal disposition with a DRB hearing and decision.

Formal DRB Hearings and Recommendations
When the DRB is asked to formally resolve a dispute by rendering a formal decision the principals have less control than they do in bilateral negotiations. With the DRB, the dispute will be “judged” and a decision will be rendered. Although that DRB decision is generally nonbinding, the DRB decision and the process required to get to a decision can be tremendously valuable to both parties. Far more often than not the DRB recommendation leads directly or indirectly to the resolution of the dispute and avoidance of litigation or arbitration. The written submissions and hearings that are part of the process for the DRB to decide a dispute are more formal than the regular site visits and meetings, but far more informal than a court or arbitration proceeding.

Attorney participation in DRB hearings is a recurring issue, and should be addressed in the DRB specifications. Based on extensive experience with DRB hearings, this author believes DRBs are most effective with minimal to no direct attorney participation in presentations. Even in DRB hearings in which the parties make detailed and extensive presentations, it appears to be more effective to limit the presenters to project personnel, even if attorneys are permitted to attend the hearing and assist in the preparation for the hearings and of written submissions to the DRB. Limiting attorney participation does appear to lower adversarial tensions, reduce formality and allows the DRB and both parties to hear directly from first hand participants.

There is no need to restrict a formal DRB hearing to multi-million dollar claims. On the contrary, when there is a dispute on a recurring issue that can be presented before the costs mount, it may be possible to have the DRB decide entitlement quickly on a single occurrence that provides guidance to the parties about how the DRB will view all the other similar occurrences. The parties may still disagree over the issue and the DRB recommendation, but with that guidance, the parties have the opportunity to react and adjust during construction rather than waiting until all the costs are incurred.

Impact of the DRB Recommendation
A DRB decision is generally called a recommendation, and it is just that — a recommendation. It is not binding on either party unless both parties accept the recommendation. It is not like an arbitration award that either party can unilaterally enforce.

An important consideration is whether the recommendation is admissible in a subsequent litigation or arbitration if the parties do not settle. The issue of the admissibility of the DRB recommendation must be addressed in the DRB specification, such as the ConsensusDocs 200.4. Even if the DRB recommendation is not binding, a judge, jury or arbitrator will likely give a lot of weight to a detailed recommendation by three industry professionals who were selected by the parties and were familiar with the project. Those in favor of the admissibility of DRB recommendations seem to recognize the heavy weight the recommendation will carry if admissible, but believe that by knowing that weight, the parties will be more likely to fully invest in and make the most of the DRB process.

In some international standard forms contracts, such as the FIDIC documents, the decision of the tribunal, called a dispute adjudication board, is binding on an interim basis. The decision can immediately provide financial or schedule release to the prevailing party, but the distinction is still subject to general challenge in any subsequent court or arbitration proceeding.

Activate the DRB at the Beginning of the Project
If your contract calls for a DRB, do not wait for a dispute before you activate the DRB. The DRB should be set up immediately. The ConsensusDocs 200 Standard Agreement Between Owner and Constructor requires, at section 12.3.1, that if a DRB is selected that the parties select a DRB “as soon as practicable after the execution of this Agreement Once there is a serious dispute, it is tough to agree on anything, including setting up a DRB. In addition, by waiting, you lose the potential benefit of the DRB as a dispute avoidance tool.

Do not wait to use the DRB process to air out potential problems that may become disputes. That does not mean dump every problem on the DRB to solve. On the contrary, use the regular DRB site visits and meetings to enhance communication with the other side to help limit lack of communication, misunderstanding, or a party sticking its head in the sand. More open communications help the parties address problems and mitigate disputes.

When a formal DRB hearing and decision is sought, do not wait and see for the outcome before digging into the issue and investing serious effort into evaluating and supporting your position. At that point it will be too late. If you get an adverse DRB recommendation, the DRB is unlikely to give you a “do-over”, especially if the problem was lack of preparation. The consequences of not properly preparing for a DRB hearing are compounded when the adverse DRB recommendation is admissible in court or arbitration.

DRBs when properly understood and employed are a tremendous benefit and value on any major project to help avoid, mitigate and resolve disputes in an expeditious and cost effective manner.