Court Recognizes Day-to-Day Changes Are Compensable Despite Contractual Waivers

Matthew DeVries | Best Practices Construction Law

It happens all the time! The owner-contractor agreement contains a “no damages for delay” clause; a clause requiring that all changes be in writing before work is performed; and a clause requiring partial lien waivers and releases with each periodic payment.  And yet we see a claim for delays and extras filed at the end of a construction project that challenges these very contract provisions.

The Court of Appeals of North Carolina recently grappled with this exact scenario in Gamewell Mechanical, LLC v. Lend Lease Construction (Sept. 1, 2020) (PDF).  The project involved the new construction of three buildings in Durham, North Carolina.  The mechanical subcontractor filed suit against the prime contractor for $2.7m for breach of contract for nonpayment, claims for delay damages and enforcement of its lien rights.  The prime contractor argued that subcontractor’s claim should be limited to its contract balance of approximately $500k in retainage. Ultimately, the trial court awarded the subcontractor more than $800k for its claims.

On appeal, the contractor argued that the award should have been limited to the $500k in retainage.  By executing lien waivers and releases with each periodic payment, the contractor argued, the subcontractor had waived all of its claims other than retainage. The parties’ lien waiver contained language where the subcontractor could have reserved disputed claims, but the subcontractor never did so. The appellate court held that the trial court properly rejected a majority of the subcontractor’s claims that were subject to either the “no damages for delay” clause or the period lien waivers.

Notably, the trial court made a distinction for “day-to-day” or “daily” changes in the field for extra work, which was credited by the appellate court as follows:

[I]t is undisputed that there were delays, numerous Change Orders issued, re-sequencing, and coordination issues occurring throughout the project. Given the daily problems that arose as a result of these issues, [subcontractor’s] failure to reserve claims regarding the day-to-day miscellaneous items done in the field at the direction of [contractor] is not a material breach-of-contract. . . . The waiver and release documents submitted with each pay application could not cover claims not readily apparent due to daily changes on the job.

The appellate court held that competent evidence supported the trial court’s decision on each of these points.

A New Exception?

The opinion is notable because of the court’s findings that are highlighted in bold and underline above. When I read the court’s opinion, I started to think: (1) Is there now a “daily changes” exception to lien waivers and releases? (2) Are day-to-day miscellaneous items compensable even where a party fails to reserve their rights on these type of  cumulative claims? According to the court in Gamewell Mechanical, the answers these questions is yes. It would be interesting to see what other courts have reached similar conclusions.

No Longer in the Dark: A Primer on the Distinction between Delay and Disruption Damages in a Construction Dispute

Matthew DeVries | Best Practices Construction Law

If you are left in the dark about something, you don’t have the information you should have to make an informed decision.  Delay claims on a construction can be confusing, especially when you think about the delay to the work being performed and the disruption to other activities.  A few years ago, I found a case that shed some light on the delay v. disruption distinction.

In County of Galveston v. Triple B Services, LLP, decided on May 26, 2016, the Court of Appeals of Texas reviewed a contractor’s claim for damages on a road expansion project.  While the legal issue focused on the County’s right rely on the defense of sovereign immunity, the Contractor’s (and it expert’s) characterization of the damages was critical to the outcome of the case.  Since the applicable statute waives a county’s sovereign immunity for breach-of-contract damages that are “a direct result of owner-caused delays,” the Court had to decide whether disruption damages—as opposed to delay damages—were recoverable.

The Contract.  The County entered into an agreement with the Contractor to expand a three-mile stretch of road. Under the contract, the County was responsible for moving gas, water, and fiber-optic utilities.  According to the Contractor’s expert, the contract established a “baseline schedule … created by the County’s engineer,” which showed a starting date with unhindered access along the area of the road where the utilities were located. The contract allowed for “delay damages” if the Contractor’s request for those damages “is determined to be compensable.”

Owner-Related Delays.  Although the Contractor’s plans for the construction project anticipated that the County would move the utilities by a particular date, those utilities were moved almost one year later.  Nevertheless, the Contractor completed its work within the contract time.  According to the Contractor, it incurred additional costs to hand-form manholes, set and reset barricades, extended field office overhead, as well as additional labor, equipment, street cleaning, flagging, and traffic control—all of which resulted from the County’s delays in moving the utilities.

Sovereign Immunity Argument.  The County argued that Section 262.007 of the Local Government Code waives a county’s sovereign immunity for construction contracts involving claims for delay damages.  Here, the County relied heavily on the testimony of the Contractor’s expert witness who testified about the Contractor’s damages resulting from the County’s delays. Since the County did not timely move the utilities as anticipated in the original construction plan, that schedule of work was “disrupted.”  By seeking disruption damages, the County argued, the Contractor sought damages that were excluded from recovery under the statute.

So, are these delay damages or disruption damages?

On appeal, the Contractor agreed that its “disruption damages” do not meet the definition of “delay damages” as traditionally understood in the construction law arena. However, it argued that the statutory waiver of sovereign immunity for damages that are “a direct result of owner-caused delays or acceleration” includes more than “delay damages” as defined under construction law: “Disruption and lost productivity costs are … recoverable damages under the clear meaning of the words of the statute.”

The Court turned to the construction law bible written by Phillip Bruner and Patrick O’Connor to address the inquiry, noting that delay damages have a technical definition distinct from disruption damages:

 Delay damages refer to damages “arising out of delayed completion, suspension, acceleration or disrupted performance”; these damages compensate the contracting party that is injured when a project takes longer than the construction contract specified. . . .

Disruption damages, on the other hand, are for a project that may be timely completed but nevertheless includes disruption to the contractor and compensates it for “a reduction in the expected productivity of labor and equipment—a loss of efficiency measured in reduced production of units of work within a given period of time.” . . . Disruption damages can also be caused by an “event [that] both disrupts and delays a critical path activity….” A project that finishes on time but at greater expense because of disruptive events or scheduling errors presents a claim for disruption damages.

The Court’s Decision.  Based upon a plain reading of the statute, the Court concluded that Section 262.007 allows a claim for disruption damages against a county “if the disruption damages directly result from the county’s delay in performance of its contractual obligations….” Significantly, the statute did not distinguish between “delay damages” and “disruption damages” that are directly caused by the breaching party’s delay.

Lesson Learned.   According to the expert in this case, the Contractor incurred significant increased costs to finish the work on time. The Court’s opinion provides an excellent roadmap of the type of expert proof required to establish the damages sought by the Contractor, including the following:

  • The expert examined the “daily summaries” of work and “the manner [the project] was intended to be executed … [and] the manner by which the project was actually executed and some of the specific things that caused that deviation.”
  • Using this information, the expert testified that the Contractor had to adjust its approach to accommodate the County’s delay by “segmenting the work into smaller segments of the roadway, waiting on the utilities … just a various sundry of impacts that caused them to not be as productive from a direct labor standpoint.”
  • The “waiting on the utilities” caused the Contractor to waste “man-hours trying to deal with working around utilities and bouncing around back and forth and dealing with not being able to set barricades and … progress the roadway [in the way] that they thought they would be able to in an unhindered manner.”
  • The expert also testified that the Contractor had to add “a number of crews because they were working in so many different areas to try and progress the work….”
  • Finally, the expert opined that the Contractor’s clean-up crew also had to perform additional work because “whenever you slow down that progression and create situations where you’re excavating and you’re staging materials in one location[,] … you wind up with … more debris than if you were just moving in a steady progressive manner.”

Although the project in this case was finished on time and the Contractor never completely “stopped” its work, the Court readily found that the Contractor was “hindered” because of the County’s actions.  Since the type of recoverable damages include those that are “a direct result of owner-caused delays,” the Contractor could recover its disruption damages.

Contract Clauses Limiting Damages

Stanley A. Martin | Commonsense Construction Law

The NH Supreme Court has enforced contract clauses waiving consequential damages and limiting liability. It has also noted that tort claims asserted when the underlying transaction was based on a contract will be barred by the economic loss doctrine.

The plaintiff was an engineering service firm that works with advanced composite materials for Department of Defense clients. The defendant was an IT service provider. The engineering firm had a problem with a drive in one of its servers, and the IT company was brought in to resolve the issue. Unfortunately, the engineering firm lost data because the IT company had “failed to properly back it up.”

The engineering firm sued for the cost of “massively expensive” testing in order to recover the lost data. It brought claims against the IT company for breach of contract and negligence. The IT company moved to dismiss the costs of testing and any other damages that were not direct damages, and also sought to dismiss the negligence claims. The trial court dismissed the consequential damages, and held that the negligence claim was barred by the economic loss doctrine.

The NH Supreme Court upheld the trial court decision on both issues.

Recognizing that the line between direct and consequential damages “is not capable of exact determination,” the NH high court nonetheless held that the cost of recreating lost data, and the cost of lost business claimed as a result, were consequential damages. Thus, those damages were barred by the parties’ contract.

Speaking more generally, the NH Supreme Court also noted: “Courts cannot improve the terms or conditions of an agreement that the parties themselves have executed or rewrite contracts merely because they might operate harshly or inequitably.” Courts would only do so if the contract term “contravenes public policy.” No such public policy was present here.

Also, the NH court addressed the negligence claim that had been brought in tandem with the breach of contract claim. It noted that contract and warranty standards “are better suited than tort law” to address purely economic loss in the commercial arena. Thus, a contracting party would be barred from pursuing a tort claim unless that party “is owed an independent duty of care outside the terms of the contract.”

Finding no such duty, the court upheld dismissal of the negligence claim against the IT provider, and limited the engineering company to its direct damages. The case is Mentis Sciences, Inc. v. Pittsburgh Networks, LLC, 2020 N.H. LEXIS 155 (Sept. 22, 2020).

Who Decides Who Decides? The Third Circuit Addresses the “Queen of All Threshold Issues” in Arbitration Law

Thomas F. Howley and Robert T. Szyba | Seyfarth Shaw

Who decides the case: a court or an arbitrator?  It’s a simple question at the core of any arbitration dispute.  Then there’s the question of who decides who decides the case?  Typically, the parties decide—they can decide to let an arbitrator decide the case (rather than a court) by entering into a binding arbitration agreement.  In a recent case, the U.S. Court of Appeals for the Third Circuit took these seemingly simple questions one level deeper.

In MZM Constr. Co. v. N.J. Bldg. Laborers Statewide Benefit Funds, the Court addressed what it called a “mind-bending question” and the “queen of all threshold issues” in arbitration law: “Who decides—a court or an arbitrator—whether an agreement exists, when the putative agreement includes an arbitration provision empowering an arbitrator to decide whether an agreement exists?”

Under the circumstances here, the Court gave this “mind-bending” question a simple answer: “the court.”

The Federal Arbitration Act (FAA) empowers courts to decide issues concerning the making of an agreement “unless the parties have clearly and unmistakably referred those issues to arbitration in a written contract whose formation is not in issue.”  In this instance, the plaintiff claimed fraud in the execution of the contract—thereby disputing its very existence—so the court, not an arbitrator, had authority to decide the existence of the agreement.

While the questions presented may be esoteric, the Court’s decision highlights a simple principle: every contract dispute begins with showing the existence of a contract.  An arbitration provision may delegate certain decisions to an arbitrator but, like any contract, it has no effect unless you can show that the parties actually formed an agreement.  Simply put, without an agreement to arbitrate, there can be no arbitration.

The Third Circuit’s Decision

In 2001, Plaintiff, a New Jersey construction company, hired union labor for a construction project at Newark Liberty International Airport.  One year later, a union representative asked the employer to sign a one-page, short-form agreement (“SFA”), which incorporated by reference a collective bargaining agreement (“CBA”).  The union representative allegedly said he would pull the workers if the construction company did not sign and that the SFA was “only for the Newark Airport job.”  The company signed and, from 2001 through 2018, used union labor for various jobs and remitted more than $500,000 in contributions to the union’s benefit funds (the “Funds” wound up being the defendant in this case).

In 2018, the Funds audited the company’s records and determined that the company owed $230,000 in additional contributions.  When the company balked at the demand for payment, the Funds initiated arbitration, citing the CBA’s arbitration provision.  In response, the company sued in the federal District Court to enjoin the arbitration, arguing that there was fraud in the execution of the SFA and therefore, no agreement existed and the parties were not required to arbitrate.  The Funds argued that this issue should be decided by the arbitrator because the CBA stated: “[t]he Arbitrator shall have authority to decide whether an Agreement exists, where that is in dispute.”  The District Court enjoined the arbitration, holding that issues of “arbitrability” were for the court to decide.

The Court of Appeals broke the issue into two questions.  First, does the District Court have the power to resolve questions about the formation of a contract when the putative contract delegates “the authority to decide whether an Agreement exists” to the arbitrator?  Second, did the Plaintiff construction company put formation of the arbitration agreement “in issue” by claiming fraud in the execution

1.  The District Court’s Power

Arbitration agreements often include a “delegation provision,” which gives the arbitrator authority to decide issues of arbitratbility—as the Supreme Court described it, “[t]hink of a delegation provision as a mini-arbitration agreement within a broader arbitration agreement within a broader contract, something akin to Russian nesting dolls.”  Here, the delegation provision gave the arbitrator (not the court) authority to decide whether an agreement existed, but the company argued that the parties never formed a valid agreement due to fraud in the execution.

These facts presented a “catch-22.”  If the Court took up the issue of arbitratbility and determined that there was a valid contract, then the parties were denied their contractual right to have an arbitrator decide that issue.  On the other hand, if the Court enforced the delegation provision and later the arbitrator determined that there was no valid contract, then the parties were compelled to arbitration based on an agreement that never existed!

Ultimately, the Court here turned to section 4 of the FAA—which provides that a federal court must compel arbitration “upon being satisfied that the making of the agreement for arbitration … is not in issue”—and precedent that this section “affirmatively requires” a court to decide questions about the formation of a contract.  This “tilts the scale in favor of a judicial forum” when a party contends that it never agreed to arbitrate at all.  The Court held that, unless the parties clearly and unmistakably agreed to arbitrate questions of contract formation in a contract whose formation is not in issue, those gateway questions are left for the courts to decide.  In so holding, the Third Circuit joins its sister circuits in the Fourth, Fifth, Sixth, and Eighth Circuits, as well as district courts in the Seventh Circuit.

2.  Putting Formation of the Contract “In Issue”

Next, the Court resolved the question of whether the company put the formation of the arbitration agreement “in issue” by stating a claim of fraud in the execution.

It was undisputed that the construction company signed the SFA, which created a presumption that it “read, understood, and assented to” the terms of that document.  Generally, failure to read is not by itself sufficient to avoid the legal effects of a signature.  There is an exception, however, when there is fraud in the execution, which may be present “when a party executes an agreement with neither knowledge nor reasonable opportunity to obtain knowledge of its character or its essential terms” by reason of “excusable ignorance.”  “Excusable ignorance” typically involves misconduct that cuts off the signer’s opportunity to read, such as “significant time pressure” and reliance on an erroneous “assurance.”

The Court found that the construction company adequately claimed fraud in the execution because the union representative’s “threat of halting construction” created a heightened sense of urgency and the company relied on his assurance that the SFA “was only for the Newark Airport job” and not a statewide CBA.  Fraud in the execution renders the entire agreement “void ab initio” as if it never existed—this is in contrast to a claim of fraud in the inducement, which presumes the existence of a contract and merely renders it “voidable.”  Here, the formation of the delegation provision was put in issue, thereby triggering the District Court’s power to adjudicate the claim.

Key Takeaways

The Court covered some complicated issues in this case—it unpacked a mini-arbitration provision, within a broader arbitration agreement, within a collective bargaining agreement, incorporated by reference in a short-form agreement.  The underlying principles, however, provide practical takeaways for contract negotiations and any ensuing litigation (or arbitration):

  • Always read the contract and any documents that it incorporates: In general, failure to read a contract isn’t a good defense. As one court put it, “[w]alking blindfolded through one’s business affairs does not excuse the ensuing collision.”  This is especially true for experienced, sophisticated parties.  The Court here noted that “this entire dispute could have been averted” if the plaintiff had requested and studied the CBA before signing.
  • Let your counter-party read everything: The defendant was unable to enforce the delegation provision here, in part, because the plaintiff wasn’t given a copy of the CBA, was rushed to sign the agreement, and relied on verbal assurances. When contracting with another party, give them everything and time to read it all so they can’t claim ignorance later.
  • Make sure you have an agreement!: The Court emphasized that, despite this ruling, nothing precludes parties from delegating issues of contract formation. However, the legal effect must come from an “independent source” outside of the contract whose formation is being disputed.  For instance, parties can agree to arbitrate issues of arbitrability in pre-negotiation contracts or, after a dispute arises, stipulate to submit their dispute to arbitration.  Either way, make sure you have an agreement that is undisputed.

For additional tips on drafting arbitration agreements and contracts in general, please contact the authors, your Seyfarth attorney, or any member of the Seyfarth team.

Michigan Supreme Court Finds Faulty Subcontractor Work That Damages Insured’s Work Product May Constitute an “Occurrence” Under CGL Policy

Jason Taylor | Traub Lieberman Straus & Shrewsberry

In Skanska USA Bldg. Inc. v. M.A.P. Mech. Contractors, Inc., 2020 WL 3527909 (Mich. June 29, 2020), the Michigan Supreme Court addressed whether unintentionally faulty subcontractor work that damages an insured’s work product constitutes an “accident” under a commercial general liability insurance policy. In aligning itself with a growing number of jurisdictions, the Michigan Supreme Court answered, “yes.” In Skanska, a construction manager brought an action against a commercial general liability (CGL) insurer seeking coverage as additional insured for the cost of repairs to correct faulty work performed by its subcontractor in renovation of medical center. In 2009, the construction manager hired MAP to install a steam boiler and related piping for the medical center’s heating system. MAP’s installation included several expansion joints, which it was later discovered, were installed backward. Significant damage to concrete, steel, and the heating system occurred as a result. The construction manager performed the work of repairing and replacing the damaged property to the tune of $1.4 million, and submitted a claim to MAP’s CGL insurer, Amerisure, seeking coverage as an additional insured.

Amerisure denied the claim contending that MAP’s defective construction was not a covered “occurrence” within the CGL policy. The policy defined “occurrence” as “an accident, including continuous or repeated exposure to substantially the same general harmful conditions,” but did not define the term “accident.” The trial court looked to the Court of Appeal’s decision in Hawkeye-Sec. Ins. Co. v. Vector Const. Co., 185 Mich. App. 369 (1990), which defined “accident” as “…a result which is not anticipated and…takes place without the insured’s foresight or expectation and without design or intentional causation on his part.” But, again citing Hawkeye, the trial court concluded that “[d]efective workmanship, standing alone, is not an occurrence within the meaning of a[ ] general liability insurance contract[;] an occurrence exists where the insured’s faulty work product damages the property of another.”

The trial court held that an “occurrence” may have happened because the damage caused by MAP’s defective installation of the expansion joints may have gone beyond the scope of the work required by the contract between the plaintiff and the medical center. On appeal, however, the Court of Appeals reversed the trial court and ordered that summary disposition be granted to Amerisure reasoning that there was no “occurrence” under the CGL policy because the only damage was to the insured’s own work product.

The Michigan Supreme Court reversed again holding that faulty work by a subcontractor may fall within the plain meaning of an “occurrence,” or “accident.” The Michigan Supreme Court rejected the carrier’s argument that faulty workmanship to the insured’s product was not an “occurrence” because it lacked “fortuity.” According to the court, fortuity is one way to show that an incident is an accident, but it is not the only way. Rather, appropriate focus of the term “accident” must be on both the injury-causing act or event and its relation to the resulting property damage or injury, which must be analyzed from the subjective standpoint of the insured. Thus, even if an insured acts intentionally, the act may still be an “accident” under policy so long as the injury or damage was not specifically intended by the insured. The Michigan Supreme Court also noted that the policy did not limit the definition of “occurrence” by reference to the owner of the damaged property, which might otherwise preclude a finding of an “occurrence” for damage to the insured’s own work product.

The court, referencing other similar rulings in other jurisdictions, resorted to its reading the contract as a whole to confirm its conclusion. For example, the court reasoned that the policy contained an exclusion precluding coverage for damage to an insured’s own work product (the “Your Work” exclusion), but that the exclusion contains an exception for work performed by a subcontractor on the insured’s behalf. Thus, “[i]f faulty workmanship by a subcontractor could never constitute an ‘accident’ and therefore never be an ‘occurrence’ triggering coverage in the first place, the subcontractor exception would be nugatory.” Skanska, 2020 WL 3527909 at *6 (citing cases). Put another way, if the insuring agreement does not confer an initial grant of coverage for injury or damage to the insured’s own faulty work, then there would be no reason for the “your work” exclusion (and the subcontractor exception).

The Skanska Court also reviewed the context and history of CGL policies, including policy language changes from the 1973 policy forms to those adopted in 1986 in support of its conclusion that an “accident” may include damage to an insured’s own work product, and referred to cases holding otherwise as an “outdated view” of the insurance industry. While this history is interesting, it is beyond the scope of this post. Suffice it to say, the Michigan Supreme Court found that “the 1986 reformation of the scope of coverage under the CGL policies underscored a plain reading of “accident”—that faulty subcontractor work may fall within the policy’s coverage. Id. at *10.

In sum, the Michigan Supreme Court’s holding in Skanska aligned Michigan with the growing body of jurisdiction to hold that an “accident” may include unintentionally faulty subcontractor work that damages an insured’s work product. Of course, the next logical inquiry is whether one or more of the CGL policy’s “business risk” exclusion might apply. (Notably, the Court did not address application of the “your work” policy exclusion. Specifically, Amerisure argued that because MAP was a named insured under the CGL policy, the subcontractor exception to the “your work” exclusion did not apply, and the exclusion barred coverage. The Court merely remanded this question, among others, to the Court of Appeals to address, depending on whether it determines they are properly presented and preserved for its review.)