Material Cost Escalation: Who Bears the Cost Now? And, What Can Be Done to Address the Problem in the Future?

Sherman Botts | Stinson

While an increase in construction costs for materials is not new to the industry, the extent of the cost increases during this COVID-19 time may be beyond anyone’s experience. Prior to COVID-19, material costs have spiked for many products, such as oil, asphalt, concrete and plywood. Those cost increases may have arisen from certain tragedies involving Mother Nature’s hand, such as flooding, hurricanes, fires and tornadoes. In other instances, increased costs may have been prompted by tariffs recently implemented over the past few years by governmental actions. In each case, the increased cost is usually unforeseen and the parties are faced with the basic dilemma: who should bear the cost of the increased costs? Owner? Contractor? Subcontractor? Or, some or all of the above?

With the COVID-19 pandemic, the increased costs and delays appear to affect far more materials than ever before. Beginning in early 2020, construction projects are facing increased costs with structural steel, lumber, copper, plumbing and electrical materials. There is no uniform assessment as to the degree of increase in prices, which have ranged from 25% for tariff-affected materials to more than 70% to 300% for lumber. Some have observed that structural steel has increased by more than 250%.

Coping with Cost Increases and Delays on an Existing Project

A common scenario now involves a construction client who calls and asks two essential questions: (1) who must bear the brunt of the increased cost for a particular material; and (2) whether the increase can be passed on to other parties associated with the project. The construction lawyer’s first response should be: “What does your contract provide?” Indeed, the first step in any analysis must start with the contract that the parties negotiated (or maybe just blindly signed) at the outset of the project. Does the prime contract or subcontract include a “force majeure” clause? (For those new to construction contracts, the title “force majeure” may not appear in the body of the contract but the concept is often present.) The French term “force majeure” means a “greater force” and usually excuses delays experienced by a contractor or subcontractor when the delays are unforeseen and caused by reasons beyond their reasonable control. A common example of a force majeure clause is found in AIA Documents A201, in the underscored portion of Section 8.3.1 below:

§8.3.1 If the Contractor is delayed at any time in the commencement or progress of the Work by (1) an act or neglect of the Owner or Architect, of an employee of either, or of a Separate Contractor; (2) by changes ordered in the Work; (3) by labor disputes, fire, unusual delay in deliveries, unavoidable casualties, adverse weather conditions documented in accordance with Section 15.1.6.2, or other causes beyond the Contractor’s control; (4) by delay authorized by the Owner pending mediation and binding dispute resolution; or (5) by other causes that the Contractor asserts, and the Architect determines, justify delay, then the Contract Time shall be extended for such reasonable time as the Architect may determine.

Would delays and dramatically increased costs in materials caused by COVID-19 be covered by this contract clause in one of the most common contract templates in the construction industry? First, stating the obvious—this clause does not expressly refer to COVID-19 nor does it refer to “epidemics” or “pandemics.” (These words may be found in other published templates.) Because the provision in this instance makes no mention of the pandemic, should the contractor’s or subcontractor’s delayed performance be excused because of a COVID-19-caused event? There is no black and white answer in this regard.

Some would argue that the use of the word “unusual” in Section 8.3.1 means that the event must be unforeseen and that the COVID-19 events are NOT unforeseen or “unusual” because all parties in the construction industry have been dealing with COVID-19 for a long time, at least since the President declared the Coronavirus to be a pandemic on March 13, 2020. The argument continues that, since COVID-19 is a known event, experienced contractors and subcontractors should have learned how to address the risk of cost increases by locking down quotes from suppliers or advanced ordering of materials.

Many would argue, though, that the pandemic need not be expressly mentioned in the provision and that it should certainly qualify as an “unusual delay…. or cause beyond the Contractor’s control.” This is an important delay claim for the contractor or subcontractor to submit, particularly if the contractor or subcontractor faces the risk of a liquidated damage assessment. But an extension of contract time may be the only remedy available to the contractor or subcontractor under this provision. The potential for an increase in the contract sum is not mentioned here and its absence may be damning to a contractor’s request for increased compensation, unless the remedy of increasing the contract sum was negotiated into the contract.

It is important to note, however, that Section 8.3.1 may refer to only contract time extensions but it does not absolutely bar requests for increased costs. Indeed, Section 8.3.3 provides:

§ 8.3.3 This Section 8.3 does not preclude recovery of damages for delay by either party under other provisions of the Contract Documents.”

As such, the request for increased cost recovery may still be submitted provided that the subcontractor’s or contractor’s claim complies with the applicable notice provisions in the contract. In addition, the claimant should consider submitting the claim in the in the form of an equitable request for additional compensation as discussed below.

If the contract provides no relief to the contractor or subcontractor for significantly increased costs, an equitable argument must be presented to deal with the facts at hand. The subcontractor may be placed in such a position that it is not able to perform its duties under its subcontract if it is forced to bear the burden of all increases in costs. Obviously, an assumption of a 300% increase in materials would likely put many subcontractors out of business. If a subcontractor walks off the project for that reason, the project will likely face substantial delays and increased costs that others would have to bear if the project is to continue and if there is no performance bond relief available.

The subcontractor should consider making a very prompt request for equitable adjustment in compensation under the doctrine of impracticality or impossibility to address the increased costs. The equitable claim should be submitted to the tier contractor above it so that it can be processed up the contracting chain. The claim must emphasize that the dramatic increase in costs is unforeseen and renders the subcontractor’s performance an impossibility and that the increased costs will negatively impact the subcontractor’s ability to successfully and timely perform if no relief is provided.

The net result of the increase and the subcontractor’s inability to perform can cripple the completion of the project, which is not in the best interest of any party to the project. Through timely communication among the parties, there may be acceptable alternatives to avoid a shutdown to the project. Perhaps other materials can be used? Perhaps there can be a sharing in the cost? Perhaps design changes can be made?

The courts have reviewed whether dramatic increases in cost of materials will excuse performance by a contractor but jurisdictions vary as to the outcome. On the excused performance side, consider the analysis by the New York court in Moyer v. City of Little Falls, 134 Misc. 2d 299, 301–02, 510 N.Y.S.2d 813 (Sup. Ct. 1986), and its observation and ultimate conclusion that:

[T]here is a growing trend that performance should be excused (1) if governmental action or other contingencies create a substantially unjust situation totally outside contemplation of the parties and (2) which an experienced draftsman would not reasonably anticipate. In this instance, it is stipulated that the 666% price increase [in dumping costs at the required landfill] was not and could not have been within the contemplation of the parties. Such a massive cost escalation is ‘excessive’ as a matter of law and future performance by plaintiff must be excused.

In Pennsylvania, in Aluminum Co. of Am. v. Essex Grp., Inc., 499 F. Supp. 53, 70 (W.D. Pa. 1980), new regulations for oil and pollution control dramatically increased the seller’s smelting costs and would have caused the seller to lose more than $75 million during the life of the contract while the buyer conversely stood to gain a windfall profit. The court found that regulatory changes of this sort were an unforeseen supervening circumstance, not within the contemplation of the parties at the time of contracting. To the relief of the seller, the court found that the seller’s performance became commercially impracticable.

By contrast, some courts in the Eighth Circuit have found that even excessive increases would not excuse performance by a contractor. In Iowa Electric Light and Power Company v. Atlas Corporation, 467 F. Supp. 129, 140 (N.D. Iowa, 1978), the U.S. District Court for the Northern District of Iowa held that an increase in seller’s costs by 52.2%, resulting in the seller’s loss of approximately $2,673,125.00, failed to constitute commercial impracticability, and precluding judicial adjustment or discharge of the contract for supply of uranium concentrate. In making such a determination, the court noted that cost increases of 50-58 percent had generally not been considered of sufficient magnitude to excuse performance under a contractual agreement. Iowa Electric was cited shortly after by Missouri Pub. Serv. Co. v. Peabody Coal Co., 583 S.W.2d 721, 726 (Mo. Ct. App. 1979), where the Missouri Court of Appeals for the Western District found that an escalation in costs did not render the contract “commercially impracticable” or excuse the contractor’s performance: “[i]ncreased cost alone does not excuse performance unless the rise in cost is due to some unforeseen contingency which alters [t[he essential nature of the performance.”

Proactive Steps for Future Projects

For new projects and new contracts, contractors and owners should consider discussing how the risk of cost escalation can be minimized or shared in the future. If past contracts did not provide any answers, a price escalation clause is often discussed for future contracts. The clauses come in all shapes and forms. Frequently, the clause describes a certain limitation or percentage guideline as to when a cost increase will be considered significant enough for cost relief. Consider the following:

Cost Escalation: In the event of significant delay or price increase of material, equipment or energy occurring during the performance of the contract through no fault of Contractor or its subcontractors, the contract sum, time of completion or contract requirements shall be equitably adjusted by change order in accordance with the procedures of the contract documents. A change in price of an item of material, equipment, or energy shall be considered significant when the price of an items increases ___% or more between the date of this contract and the date of installation. If the increase in price is at least ___%, but less than ___%, the equitable adjustment shall be based only on the amount of increase or decrease greater than ___%, but if the price increase is ___% or more, then the equitable adjustment shall be based on the entire amount of the price increase. If Contractor makes a request for an equitable adjustment to the contract price based on an increase in price, Contractor shall be required at that time to disclose its original price that has increased.

Richard A. Stockenberg, Material Price Escalation Clauses, as contained in The Anatomy of a Construction Contract, The Missouri Bar 2004.

Contractors may find some owners unwilling to consider a price escalation clause. From an owner’s perspective, the owner will expect the contractor or its subcontractor to take all necessary steps to control material costs at the outset of the project. These may include:

  1. Requiring the contractor or its subcontractors to purchase materials in advance.
  2. Requiring the contractor or its subcontractors to “lockdown” the price with its supplier.
  3. If a supplier is unwilling to lock down its pricing, an owner would expect the contractor or subcontractor to shop with another supplier. The problem with this alternative is that the market is changing and a growing number of suppliers are unwilling to lock down pricing for an entire project and will sell their materials at whatever price may exist at the time of the delivery.

To counter an owner’s refusal to consider a cost escalation clause, a contractor may include a very healthy contingency in its bid to accommodate the fluctuation in material costs. Is this what the owner wants?

The circumstances for recovery or rejection of increased costs in an existing project or drafting of an escalation clause for future contracts will require consultation with an experienced construction lawyer. Please contact Stinson for questions and assistance with these matters.

Broken Buildings: Legal Rights and Remedies in the Wake of a Collapse

David J. Pfeffer | Construction Executive

A tragedy transpired on June 24 in Surfside, Florida, when the Champlain Towers South suddenly fell, becoming one of the country’s most deadly unintentional building collapses. It is imperative that construction industry professionals be aware of the legal issues that are raised by such ill-fated events.

WHO IS HELD RESPONSIBLE? 

Who can be held responsible for such disasters lies among several possible parties: 

  • The building’s design professionals, particularly its architects and structural engineers. They are charged with ensuring that the building’s design is safe. They must take many factors into account, including, but not limited to, the materials that are used, the foundation, the weight and the height.
  • General contractors and the subcontractors. General contractors implement the design created by the architects and engineers and are responsible for appropriate materials. The general contractor also supervises the subcontractors aiding with multiple areas of the building’s construction and which also share the responsibility of executing the design and maintaining the building’s structural integrity.
  • The owner of the building may be held liable. Property owners have a duty to examine their properties to discover and fix any hazardous conditions that are present, and they must do so with reasonable care. Property managers might also share the burden of responsibility and could very well be held responsible for failing to perform proper maintenance.
  • Building inspectors can be blamed if they do not report a dangerous condition that threatens the safety of the structure.
  • Equipment and material suppliers. Undetected defects in equipment or materials can cause a structure to fail.
WHO PAYS?

Construction professionals need to be aware of whether the damages that result from a collapse will be covered by insurance.

Collapse language is usually found in the additional coverage section of a property’s insurance policy and typically includes an independent insuring clause, an independent list of exclusions and an independent list of exceptions to exclusions. Often, insurance policies that permit coverage for abrupt collapse will require various conditions to be met in order to warrant coverage. 

Regarding the collapse in Surfside, the primary questions are: What caused the collapse? Was the cause previously known to, or at least reasonably discoverable by, the insured? 

If the cause was unknown, or not reasonably discoverable to the insured, the insured might be able to secure coverage. However, if it was due to one of various excluded causes, such as normal wear and tear, bad repairs, deterioration or neglect, and the parties were aware of such conditions, they may be barred from coverage. If there are multiple causes for the collapse, professionals should check their policies for any anti-concurrent causation language, which is used to disqualify coverage for losses that are partly induced by both an excluded cause and an included cause. Also, pursuant to Florida law, false information in an insurance application, intentionally or unintentionally, can void the policy. 

WHO CAN SUE AND WHEN?

After determining which parties can be sued to remedy the harms of a collapse, it is crucial that the action is brought in a timely manner, and time restrictions vary by state. In New York, the statute of limitations for malpractice claims, other than medical, dental or podiatric, is three years from the completion of the project. There is currently no statute of repose in New York to act as an absolute cutoff on construction claims; however, there is a bill moving through the state’s legislature, proposing to institute a 10-year statute of repose, which is common among many states. 

Florida’s statute of limitations for negligence cases is four years. The general rule in Florida’s construction cases is that the statute of limitations begins to accrue at the completion of the project, but if the defect is latent, then it begins to accrue at the time that the defect was, or should have been, discovered with reasonable due diligence. Florida also has a statute of repose for construction claims, which is 10 years from the date of completion; counterclaims, cross-claims and third-party claims that arise out of the same controversy may be brought within one year from the commencement of the action, regardless of whether they fall within that 10-year restraint.

HOW DOES THE ENVIRONMENT FACTOR?

Construction professionals should consistently strive to prevent such accidents from happening. Learning about environmental factors that can lead to a building’s collapse is an essential consideration. The collapse in Surfside made many people ask whether climate change played a part and whether South Florida’s extreme exposure to rising sea levels could lead to the destabilization of other structures. 

In South Florida, the sea level is about eight inches higher than it was 100 years ago, and it is expected to increase—with an additional 17 inches predicted by 2040. To make things worse, the region sits on a bedrock of porous limestone, which allows saltwater to rise through, causing flooding without rain. Although the role of the sea level in this particular collapse is not entirely clear, it certainly poses a threat to other buildings. Saltwater, which corrodes both steel and concrete, can rise through the porous bedrock and weaken foundations. The idea of building a large sea wall to prevent ocean flooding in Miami is no defense against underground water. 

At present, construction professionals must be extremely vigilant when examining foundations and immediately fix cracks or defects.

As technology and education advance, the construction of buildings ideally will reach a point of quality and durability that will avoid such tragedies in the future. However, with the knowledge that non-deliberate structural collapses can still happen, it is in the best interest of construction professionals to be aware of the many issues that these kinds of catastrophes raise.  

Yet ANOTHER Reason not to Contract without a License

Christopher G. Hill | Construction Law Musings

Remember when I stated that you cannot lawfully perform construction work in Virginia without a contractor’s license? Remember when I said that you risk non-payment if you do so?  If you needed another reason, a relatively recent Virginia Court of Appeals decision upholding a criminal conviction for performing construction work without a license should be that reason.

In Riddel v. Commonwealth, the Court took up an appeal from the conviction of Jeff Riddel where Mr. Riddel was verbally asked by homeowners to inspect and then repair their septic system.  Mr. Riddel then contracted with Fairfax Suburban Septic to pump out and repair the system.  Mr. Riddel then delivered the homeowners an invoice from Fairfax Suburban Septic and instructed the homeowners to pay Fairfax Suburban Septic directly.  After payment, the homeowners became aware that the work was not completed and that neither Mr. Riddel nor his subcontractor was licensed to perform septic work in Virginia. 

During the trial, Mr. Riddel argued on a Motion to Strike the Commonwealth’s evidence that (1) he merely arranged for licensed contractors to perform the repairs to the septic system, arguing that Virginia Code §§
54.2-801 to 802 permitted Riddel to arrange the work without a contractor’s license and (2) no written contract to perform a septic inspection or repairs existed.  The Circuit Court denied the motion and Mr. Riddel was convicted under Va. Code 54.1-111 for performing the work without a license.  Needless to say, he appealed.

The Court of Appeals affirmed the conviction.  It first restated the reasons that the Circuit Court properly denied the motion to strike.  These included the necessity for a Class C license for Riddel pursuant to Va. Code 54.1-1100 because he provided an estimate and entered into an agreement to provide the septic repair services with the homeowners (written or otherwise).  Because Mr. Riddel did not hold such a license at the time of contracting, he did so in violation of Virginia statute.  The Court then went on to state that Mr. Riddel’s separate argument under a different set of code sections had been brought up for the first time on appeal and was therefore not properly before the Court.  Be sure to read the opinion (linked above) to get a flavor for these arguments.

In short, contracting without a license can and will get you into trouble civilly and criminally so don’t do it.  If you have questions about whether what you are doing is “contracting” or if you require a license for your work, be sure to contact an experienced Virginia construction attorney for assistance.

Standard for Evaluating Delay – Directly from an Armed Services Board of Contract Appeal’s Opinion

David Adelstein | Florida Construction Legal Updates

Sometimes, it is much better to hear it from the horse’s mouth.  That is the case here.  The Armed Services Board of Contract Appeal’s (ASBCA) opinion in Appeals of -GSC Construction, Inc., ASBCA No. 59402, 2020 WL 8148687 (ASBCA November 4, 2020) includes an informative discussion of a contractor’s burden when it encounters excusable delay and, of importance, the standard for evaluating delay.  It’s a long discussion but one that parties in construction need to know, appreciate, and understand.  EVERY WORD IN THIS DISCUSSION MATTERS.

Construction projects get delayed and with a delay comes money because time is money.  Many claims are predicated on delay.  These can be an owner assessing liquidated damages due to a delayed job or a contractor seeking its costs for delay.  Either way, the standard for evaluating delay and the burdens imposed on a party cannot be understated and, certainly, cannot be overlooked.  For this reason, here is the discussion on evaluating delay directly from the horse’s mouth in the Appeal of-GSC Construction, Inc.:

The critical path is the longest path in the schedule on which any delay or disruption would cause a day-for-day delay to the project itself; those activities must be performed as they are scheduled and timely in order for the project to finish on timeWilner v. United States, 23 Cl. Ct. 241, 245 (1991). In Yates-Desbuild Joint Venture, CBCA No. 3350 et al., 17-1 BCA ¶ 36,870, our sister board compiled an excellent and very helpful synopsis of the standards for evaluating delay claims, which I adopt nearly verbatim among the discussion that follows.

To the extent that the government that delays a contractor’s work and increases its costs, the contractor may seek compensation for its damages. Yet, the mere fact that there is some delay to some aspect of planned contract work is not enough to establish that the contractor’s ultimate contract performance costs or time increased. In evaluating the effect of government-caused delays on the contractor’s ultimate performance time and cost, tribunals generally look to the critical path of contract performance, a method of delay analysis that the United States Court of Claims explained as follows:

Essentially, the critical path method is an efficient way of organizing and scheduling a complex project which consists of numerous interrelated separate small projects. Each subproject is identified and classified as to the duration and precedence of the work. (E.g., one could not carpet an area until the flooring is down and the flooring cannot be completed until the underlying electrical and telephone conduits are installed.) The data is then analyzed, usually by computer, to determine the most efficient schedule for the entire project. Many subprojects may be performed at any time within a given period without any effect on the completion of the entire project. However, some items of work are given no leeway and must be performed on schedule; otherwise, the entire project will be delayed.

Yates-Desbuild, 17-1 BCA ¶ 36870 at 179,684-85 (quoting Haney v. United States, 676 F.2d 584, 595 (Ct. Cl. 1982)).

Where the time frame for performance of an activity, set by the earliest possible start time and the latest possible finish time, establishes a time interval equal to the expected activity duration, the activity is termed ““critical,” and no discretion or flexibility exists in the scheduling of that activity. Items of work for which there is no timing leeway are on the critical path, and a delay, or acceleration, of work along the critical path will affect the entire project. Specifically, then, to prevail on its claims for the additional costs incurred because of the late completion of a fixed-price government construction contract, a contractor must show that the government’s actions affected activities on the critical path. Typically, if work on the critical path is delayed, then the eventual completion date of the project is delayed. Conversely, a government delay that affects only those activities not on the critical path does not delay the completion of the project. As a result, the determination of the critical path is crucial to the calculation of delay damagesId. at 179,685.

To satisfy its burden, the contractor must establish what the critical path of the project actually was and then demonstrate how excusable delays, by affecting activities on the contract’s critical path, actually impacted the contractor’s ability to finish the contract on time. This is done through an analysis to show the interdependence of any one or more of the work items with any other work items as the project progressed. One established way to document delay is through the use of contemporaneous Critical Path Method (CPM) schedules and an analysis of the effects, if any, of government-caused events. In fact, in situations where the contractor utilized Primavera scheduling software to create schedules throughout the life of the project, it would be folly to utilize some other method of critical path analysisId.

Because the critical path of construction can change as a project progresses, activities that were not on the original critical path subsequently may be added, and, to preclude post hoc rationalization and speculation, it is important that the contemporaneous schedules that the contractor uses to show critical path delay are updated throughout contract performance to reflect changes as they happened. Accurate, informed assessments of the effect of delays upon critical path activities are possible only if up-to-date CPM schedules are faithfully maintained throughout the course of constructionId.

Nevertheless, the existence of contemporaneous schedules does not permit a tribunal to ignore, or fail to consider, logic errors in those schedules. A CPM schedule, even if maintained contemporaneously with events occurring during contract performance, is only as good as the logic and information upon which it is based. CPM is not a “magic wand,” and not every schedule presented will or should be automatically accepted merely because CPM technique is employed. To be a reliable basis for determining delay damages, a CPM schedule must reflect actual performance and must comport with the events actually occurring on the job. Tribunals may need to inquire into the accuracy and reliability of the data and logic underlying the CPM evaluation in appropriate circumstances and reject CPM analyses if the logic was not credible or was suspectId. at 179,685-86.

Even if the contractor shows delay by the government that affects the critical path, the contractor must also establish that it was not concurrently responsible for delays. Tribunals will deny recovery where the delays of the government and the contractor are concurrent and the contractor has not established its delay apart from that attributable to the government. Nevertheless, any contractor-caused delays must affect the critical path of contract performance to be considered “concurrent” — contractor delays that, absent the Government-caused delay, would have had no negative impact upon the ultimate contract completion date do not affect the government’s monetary liability. For the same reasons discussed above, because concurrent delays that do not affect the critical path of contract work do not delay project completion, an accurate critical path analysis is essential to determine whether concurrent delays have caused delay damages related to the delayed completion of a complex construction project. Id. at 179,686.

In establishing excusable delay, the contractor may point to causes outside the Government’s control. FAR 52.249-10(b)(1), Default, provides a non-exhaustive list of excusable delays that includes acts of God, acts of a host country government in its sovereign capacity, fires, floods, epidemics, strikes, and unusually severe weather. Obviously, a contractor has no control over whether it rains, whether there is a flash flood, or whether there are forest fires. Nevertheless, the mere fact that a delay is caused by a type of activity listed in the contract as generally excusable does not give the contractor carte blanche to rely upon such excuses. The purpose of the proviso, which is to protect the contractor against the unexpected, and its grammatical sense both militate against holding that the listed events are always to be regarded as unforeseeable, no matter what the attendant circumstances are. A quarantine, or freight embargo, may have been in effect for many years as a permanent policy of the controlling government and, if so, may not meet the definition of a cause “unforeseeable” at the time of contract award, even if quarantines and freight embargoes are listed in the contract as examples of possible excusable causes of delay. Id. at 179,686-87.

Further, even if an unforeseeable cause of delay occurs, the contractor cannot sit back and fail to take reasonable steps in response to it — once such an unforeseeable event occurs, the contractor affected by it has an obligation to attempt to mitigate the resulting damage to the extent that it can. If the contractor fails to do so, it may not recover those damages which could have been avoided by reasonable precautionary action on its partId. at 179,687.

To establish entitlement to an extension based on excusable delay, a contractor must show that the delay resulted from “unforeseeable causes beyond the control and without the fault or negligence of the Contractor,” and the unforeseeable cause must delay the overall contract completion; i.e., it must affect the critical path of performanceSauer Inc. v. Danzig, 224 F.3d 1340, 1345 (Fed. Cir. 2000). Similarly, a contractor’s default is excused only to the extent that there were no additional delays for which the contractor was responsible (beyond those caused by the government) and that “there is in the proof a clear apportionment of the delay and the expense attributable to each party.” SeeBlinderman Constr. Co. v. United States, 695 F.2d 552, 559 (Fed. Cir. 1982) (quoting Coath & Goss, Inc., 101 Ct.Cl. 702, 714-15 (1944).

However, in order to prove that it is entitled to delay damages in the form of time or money, a contractor must prove that the government was responsible for specific delays, overall project completion was delayed as a result of the government-caused delays, and any government-caused delays were not concurrent with delays within the contractor’s controlL.C. Gaskins Constr. Co., ASBCA No. 58550 et al., 18-1 BCA ¶ 36,978 at 180,121-22. If an event that would constitute an excusable cause of delay in fact occurs, and if that event in fact delays the progress of the work as a whole, the contractor is entitled to an extension of time for so much of the ultimate delay in completion as was the result or consequence of that event, notwithstanding that the progress of the work may also have been slowed down or halted by a want of diligence, lack of planning, or some other inexcusable omission on the part of the contractor. Chas. I. Cunningham Co., IBCA No. 60, 57-2 BCA ¶ 1,541 at 5,843.

A contractor is entitled to time extensions for government-caused delays and excusable delays, even when they are concurrent with contractor-caused delay. When a contractor is seeking extensions of contract time, for changes and excusable delay, which will relieve it from the consequences of having failed to complete the work within the time allowed for performance, it has the burden of establishing by a preponderance of the evidence not only the existence of an excusable cause of delay but also the extent to which completion of the contract work as a whole was delayed thereby. The contractor must prove that the excusable event proximately caused a delay to the overall completion of the contract, i.e., that the delay affected activities on the critical path. And it must also establish the extent to which completion of the work was delayed—it is entitled to only so much time extension as the excusable cause actually delayed performanceR.P. Wallace, Inc. v. United States, 63 Fed. Cl. 402, 409-10 (2004).

Thornier issues are posed by concurrent or sequential delays—the first occurring where both parties are responsible for the same period of delay, the second, where one party and then the other cause different delays seriatim or intermittently. Concurrent delay is not fatal to a contractor’s claim for additional time due to excusable delay, but precludes the recovery of delay damages. If a period of delay can be attributed simultaneously to the actions of both the Government and the contractor, there are said to be concurrent delays, and the result is an excusable but not a compensable delay. A contractor generally cannot recover for concurrent delays for the simple reason that no causal link can be shown: A government act that delays part of the contract performance does not delay the general progress of the work when the prosecution of the work as a whole would have been delayed regardless of the government’s act. Id.

Identifying and Accessing Coverage in Complex Construction Claims

Jeffrey J. Vita and Michael V. Pepe | Saxe Doernberger & Vita

I. Introduction

First-party, third-party, builder’s risk, professional liability, commercial general liability, wrap-ups, and additional insured status are all potential sources of insurance coverage for a large construction loss. Therefore, it is critical for construction industry participants, from owners and developers to general contractors and their subcontractors, to have a functional knowledge of the different types of insurance coverage available to them and how those coverages intersect to respond to a loss. This paper presents a brief overview of the various types of coverage available to contractors, construction managers, and owners in a large construction loss and the risks each coverage is designed to insure.

In general, there are two forms of coverage: (1) First-party liability coverage, which protects an insured’s own losses on a project during construction; and (2) Third-party liability coverage, which insures the project participants for losses that become the subject of claims or suits brought against the project participants by third parties. When a loss occurs, such as property damage, both types of coverage can be implicated. For example, if a fire burns down a building under construction, the contractor likely would incur first-party losses such as cleanup costs. The contractor may also have third-party exposure if the owner alleges that the contractor was responsible for the fire. On the other hand, when a bodily injury occurs, all losses to the contractor will be third-party losses. A broad overview of each of these policies is provided below.

II. First-Party Insurance Coverage for Construction Projects

First-party coverage protects the insured or its property against a covered loss.

A. Builder’s Risk Builder’s risk is a form of commercial property policy that provides coverage for direct physical loss to the construction project while it is being built. Unlike liability policies, builder’s risk coverage does not require a claim or suit to be brought against the insured to trigger coverage. Rather, builder’s risk policies provide first-party coverage, i.e., coverage for the insured’s own property (the building that is being constructed), typically along with any materials and fixtures to be incorporated into the finished project.

Generally, builder’s risk policies are written on either an “all-risk” (often referred to as “special form” policies) or “named peril” basis. All-risk policies provide the broadest coverage. All-risk policies typically insure against all risks of loss except those specifically excluded. Most jurisdictions that have analyzed all-risk policies have held that all-risk policies cover all fortuitous losses, which cause some form of physical alteration to covered property.1 Some courts have gone a step further by not requiring any actual physical damage or alteration of property to trigger coverage.2 Courts agree that the initial burden of showing that coverage is triggered is on the insured. This is generally satisfied by proving that there was a fortuitous loss to covered property. Then the burden shifts to the insurer to prove that an exclusion unambiguously applies.3

In contrast, “named peril” policies insure against only those losses caused by a specifically listed peril or cause of loss. Named peril policies typically include coverage for fire, windstorms and hail, flood, earthquake, and other specific risks. The insured has the burden of proving that one of the listed perils caused its loss to obtain coverage.4 Generally speaking, policyholders prefer broad all-risk coverage for construction projects; however, all-risk coverage is more costly than named peril coverage and may not be feasible for every project.

Builder’s risk insurance policies vary widely. Insurance Services Office (“ISO”) has developed a standardized builder’s risk form (CP 00 20), but most carriers nonetheless choose to write builder’s risk policies on their own forms. Also, many policyholders look to the London markets for coverage. Because of the variation in terms, policyholders must carefully review their policies to ensure that they receive the coverage they expect.5

One area to pay particular attention to is who is insured under a builder’s risk policy. An owner may choose not to insure any contractors or only the prime contractor, when the owner purchases a builder’s risk policy. When an owner negotiates with the prime contractor for the prime contractor to purchase a builder’s risk policy, the prime contractor will often require that the owner, as well as upstream parties and lenders, be added as additional insureds. It is possible that a builder’s risk policy may insure only the party that purchased the policy or every party in the contractual chain from the landowner to the lowest tier subcontractor. In addition, most policies limit an insured’s status to the scope of their insurable interest in the project. Thus, a subcontractor may only have coverage for its own work or materials.

Perhaps one of the biggest impacts of who is an insured under a builder’s risk policy is related to subrogation. Parties must be very careful in drafting waivers of claims and waivers of subrogation with respect to first-party losses covered under a builder’s risk policy. Suppose a party that is an insured under a builder’s risk policy has not waived claims against a downstream party, and the downstream party is not an insured under the builder’s risk policy. In that case, the builder’s risk insurer may bring a subrogation claim against the downstream party if the downstream party caused the property damage for which a claim was paid.6 In this situation, the downstream party may be surprised to find out it has liability even though a builder’s risk policy was in place. This example illustrates the importance of carefully drafting risk transfer provisions and reviewing them in conjunction with the insurance that is purchased to ensure the risk transfer mechanisms work as intended.

Finally, it is important to be mindful of the temporary nature of builder’s risk insurance. Builder’s risk coverage ceases once construction is completed. Thereafter, the owner must procure appropriate property insurance to cover operations at its new premises. Some policies call for a specific expiration date of coverage, while others automatically terminate upon occupancy of the project, whether in whole or in part. This may cause a coverage issue if the project contemplates a phased roll-out or if the owner otherwise decides to start its business operations in one area of the project before the entire project is complete. Therefore, builder’s risk policyholders must work with their insurers to ensure that there is no gap in coverage in these scenarios. If there is an overlap, there are appropriate “other insurance” provisions to establish priority clearly.

B. Subcontractor Default Insurance Subcontractor Default Insurance (“SDI”) is a first-party coverage that indemnifies an insured contractor for losses resulting from a subcontractor’s default. SDI insures the cost of completing the work, the cost of correcting defective/non-conforming work, legal and other professional expenses, costs incurred in the investigation, adjustment, litigation, and defense of disputes related to the default and other expenses as set forth in the policy. SDI is often considered an alternative product to performance bonds and differs from such bonds in several respects:

SDI is a two-party insurance agreement between Contractor and Insured as opposed to a three-party guarantee arrangement between bonding company, subcontractor, and contractor. The Contractor prequalifies the subcontractors as opposed to the bonding company. Coverage extends to the policy limit, unlike a bond which is limited to the value of the contract. The insurer responds quickly to the claim as opposed to the bonding company, which can take considerable time to investigate the claim.

III. Third-Party Liability Insurance for Construction Projects

Third-party coverage protects the insured against claims made against it. The person or entity making the claim is the third party that suffered some loss for which it seeks to hold the insured liable.

A. Commercial General Liability Insurance Commercial General Liability (“CGL”) insurance is the most common form of third-party liability insurance purchased by businesses, including those operating in the construction industry. CGL policies are meant to provide the policyholder “with the broadest possible spectrum of protection and to transfer to the insurer the risk of all liabilities for unintentional and unexpected personal injury or property damage arising out of the conduct of the insured’s business.”7

CGL policies are primarily a standardized product, written on a form drafted (and periodically revised) by the ISO (form number CG 00 01). The standard policy form provides coverage for “those sums that the insured becomes legally obligated to pay as damages” because of “bodily injury” or “property damage” caused by an “occurrence,” or because of “personal and advertising injury,” which takes place within the coverage territory during the policy period.8 Standard CGL coverage applies to the insured’s operations nationwide. It is common, however, for construction project participants to purchase a specific CGL policy to cover a single project, such as wrap-up insurance policies which are discussed in more detail below.

CGL insurers have two key duties to their insureds in the event of a covered loss. The first key duty is the insurer’s duty to defend. In practice, the insurer’s duty to defend means that it will retain an attorney on the insured’s behalf when the insured is made party to a lawsuit or claim. This duty to defend may convert to a duty to reimburse,9 or the insured may have the right to select their own counsel, which the insurer pays in cases of a conflict of interest.10 The duty to defend, which essentially functions as “litigation insurance,”11 is typically provided outside of the policy’s limits of liability, meaning that all costs the insurer expends in defense of its insured will not count towards reducing or exhausting the per-occurrence or aggregate limits of liability. Whether an insurer has a duty to defend a given claim is dependent on the policy terms and state law. Most jurisdictions recognize that the duty is broad and is triggered whenever a claim is alleged against the insured that has the potential to invoke coverage under the policy, including those claims which may appear groundless, fraudulent, or false.12

The second key duty is the insurer’s duty to indemnify their insureds from any covered legal liability. Whereas the duty to defend depends on filing a suit against the insured,13 the duty to indemnify is typically triggered by entry of a final judgment, settlement, or other means of final resolution.14 “In short, whereas the duty to defend is measured by the allegations of the underlying complaint, the duty to indemnify is measured by the facts as they unfold at trial or are inherent in the settlement agreement.”15

Parties to construction contracts also may shift their risk by requiring “additional insured” status on another party’s CGL insurance. More specifically, an “upstream” party (e.g., an owner or general contractor) will require in its subcontracts that all “downstream” parties (e.g., subcontractors and suppliers) provide the upstream party with additional insured status on the downstream parties’ CGL insurance. Parties may specify terms such as limits of liability, coverage triggers, and scope of additional insured status. There are several benefits to additional insured status. First, the additional insured is typically entitled to the same coverages under the CGL policy as the named insured, subject to the “triggering” language of the additional insured endorsement, which usually requires some causal connection between the named insured’s work and the additional insured’s liability.16 Second, the upstream party protects its own insurance program by shifting risk from the upstream party’s insurance to the downstream party’s insurance. The upstream party’s limits are not exhausted, and the loss does not count against its loss/claim history. This benefits the upstream party because it avoids the possible negative impact on insurability or increased premiums on future policies.

B. Excess Liability and Umbrella Coverage For many construction projects, the project participants’ risk of potential liability exceeds the amount of coverage available on a primary basis. Accordingly, policyholders often purchase excess and umbrella insurance policies, which provide coverage over and above the insured’s primary insurance. Excess and umbrella coverage responds only once the primary policy or policies have paid their limits of insurance.17 Excess and umbrella insurance, though both purchased to meet this need, differ in function.18

Excess insurance applies only after a set amount of primary insurance exhausts. There are many types of excess forms. Some excess policies strictly “follow form” to the designated underlying policy, except for items specific to the excess policy (e.g., limits and policy period). The policyholder enjoys the same or substantially similar coverage from the first dollar of primary coverage to the last dollar of excess coverage. Other excess policies may only follow form for specific items but not for others. For example, excess policies may contain their own terms that apply to the excess coverage, which may not match all terms of the primary policy.19 As a general rule, excess coverage will not be broader than the underlying primary coverage.

Umbrella insurance is a subset of excess insurance that provides potentially broader coverage than what is provided by the underlying policy. An umbrella policy performs two key functions: (1) it provides an additional layer of insurance for losses that are generally covered by primary insurance; and (2) it provides additional coverage for those less common liabilities that are not usually covered by primary CGL insurance (e.g., malpractice coverage). Thus, umbrella coverage is often considered a hybrid contract, which combines “aspects of both a primary contract and a following form excess insurance contract.”20

C. Wrap-Up Insurance Policies It has become increasingly common for contractors and owners to purchase some form of consolidated or “wrap-up” insurance policy covering the project and all or some of the project participants. Wrap-ups consolidate what would otherwise be multiple policies held by the owner, general contractor/construction managers, and subcontractors into a single, unified insurance program.21 Most often, a wrap-up includes CGL and excess/umbrella insurance; although, a wrap-up may also include workers’ compensation insurance. A wrap-up is usually procured by either the owner (an “Owner Controlled Insurance Program” or “OCIP”) or the general contractor (a “Contractor Controlled Insurance Program” or “CCIP”). All project participants performing on-site work, with a few notable exceptions,22 are typically included as insureds on the wrap-up policies and have equal rights to coverage thereunder. Wrap-up policies provide many advantages to both the entity procuring the coverage and the other project participants. Given the economies of scale involved, the procuring party typically has greater bargaining power with potential insurers. As a result, it can often secure better coverage terms than any one party could obtain on its own. This is particularly important in jurisdictions where subcontractors struggle to procure quality coverage (whether due to poor insurance markets or lack of sophistication). In a “traditional” (i.e., non-wrap) project, the upstream parties must rely on downstream parties to secure appropriate coverage that will protect them as an additional insured. Procuring a wrap-up alleviates this concern. The party sponsoring the wrap-up controls the coverage it procures.

D. Professional Liability Insurance Professional liability insurance is another type of third-party liability coverage that is particularly important to construction project participants performing some form of design or engineering services. Most CGL policies specifically exclude, by endorsement, coverage for bodily injury or property damage “arising out of the rendering of or failure to render professional services.”23 Professional liability insurance is intended to dovetail with this exclusion, providing broad coverage for any kind of act or service that arises out of specialized knowledge, skill, or labor that is predominantly intellectual.24 Although design professionals are not generally required by law to purchase and maintain professional liability insurance; most project owners require that they do to ensure there is an adequate means to respond to a loss caused by a breach of their professional services contract.25

Typically, professional liability insurance is supplied on a “claims-made” basis. This means that the policy will respond to claims first made against the insured during the period when the policy is in effect.26 When a claim is “made” for purposes of triggering coverage, it is often defined as when the insured receives a demand for money or services or is made party to a lawsuit.27 Professional liability policies frequently include a “retroactive date,” a date in the past that cuts off coverage for claims that result from wrongful acts or omissions which took place prior to that date, regardless of whether the claim is made during the policy period. It is critical that construction industry policyholders ensure the retroactive date pre-dates the start of their services or work on the project to avoid incurring a gap in coverage.

Finally, additional insured status is not available on professional liability insurance, so upstream parties should not expect that project consultants can supply the upstream parties with that coverage. There are, however, specialized products available for those project participants who may be concerned about incurring liability on a vicarious basis for the errors and omissions of their consultants. Those products are known as owner’s or contractor’s protective indemnity policies. These protective indemnity policies are a source of recovery for losses incurred by a contractor or owner because of a consultant’s professional negligence.

E. Other types of Coverage Other lines of insurance coverage that may be implicated in a large construction project include, but are not limited to:

Pollution Liability Protects against injury or damage caused by pollution, which is generally excluded under CGL policies. Pollution liability policies can provide coverage for both first-party and third-party losses. Pollution liability policies are often “claims-made” policies, meaning that coverage expires when the project is completed. However, insureds can often purchase a “tail” to provide continued coverage after project completion.

Workers Compensation Worker’s compensation is a type of first-party insurance that protects an insured’s injured workers and limits the insured’s liability for claims.

Business Auto Policy The Business Auto Policy (“BAP”) is an ISO commercial auto policy that provides coverage for both auto liability and physical damage. Auto liability insurance covers third-party loss resulting from accidents caused by vehicles used in the policyholder’s business. Auto physical damage insurance covers first-party loss resulting from loss events, which include, but are not limited to, collisions, hail, theft, and vandalism.

Policyholders may expand coverage available under a BAP by endorsement.

Cyber Cyber risk insurance provides both first-party loss and third-party liability coverage for data breach events, privacy violations, and cyber-attacks. There are variations in the types of cyber insurance policies available; however, cyber insurance generally provides risk shifting for costs associated with having to respond, investigate, defend, and mitigate loss arising from a cyber-attack.

Inland Marine Originally covering ocean materials and vessels, inland marine insurance has expanded to cover various types of property, including tools and mobile equipment at or in transit to a project site.

“Rip and Tear” Third-party coverage insuring contractors from costs to remove and replace defective work.

Crisis Management First-party coverage that protects the contractor for professional responsibility and response costs in a publicized event.

IV. Conclusion In any given construction project, policyholders are faced with a multitude of potential risks. It is critical that policyholders carefully consider and evaluate potential risks in determining which types and amounts of insurance coverage will provide the best protection from those risks. Parties to a construction contract should first obtain some form of first-party insurance: generally, a builder’s risk policy, to protect the property of the insured during the project, and some form of third-party insurance, generally in the form of a CGL policy, to protect parties in the case of third-party claims In addition to those policies, policyholders should consider the advantages of obtaining additional insurance, such as (1) excess coverage to cover losses that exceed the limits of the primary policy; (2) professional liability coverage, to cover risks relating to the performance of a specialized or design-related nature; (3) pollution liability coverage, to cover any risks associated with the release of contaminants and/or mold; (4) a performance bond, to ensure completion of the project; and/or (5) SDI insurance to cover risks associated with subcontractor default.

Once policyholders have obtained coverage for their construction project, they should carefully maintain records evidencing that coverage. Because most third-party coverage is “occurrence” based, policies may still hold value years after the construction project is completed. If policyholders do not carefully maintain records, they may find themselves in a position, years after project completion, where they are forced to pay out-of-pocket because there is no record of the policy in place for that year. Thus, policyholders should carefully evaluate what coverage is necessary and maintain records of that coverage in case of future claims.