Construction Claims – No Contract, No Claims?

Andrew Atkins, Peter Marino and Patrick Wilson | Smith Anderson

The North Carolina Supreme Court recently issued a decision in Crescent University City Venture, LLC v. Trussway Manufacturing, Inc.[1] The case decided the question of whether a commercial developer-owner can bring a negligence claim directly against a supplier of defective building material where no direct contract existed between the owner and supplier. The Supreme Court held that the owner could not maintain such a claim and reaffirmed that the “economic loss rule” applied. The economic loss rule provides that, when a duty to perform arises from a contract, no negligence claims can be brought for failing to perform that duty. Instead, only contract claims can be brought.

In the construction context, there are frequently multiple layers of contracts, from the owner’s agreement with the general contractor to multiple tiers of subcontractor and supplier agreements. Under North Carolina law, and as recently clarified in the Crescent case, in the event a subcontractor fails to perform or if a supplier provides a defective product, absent a specific warranty provided by the party at issue, the owner must pursue a contract claim against the party with which it has a contract (i.e., the general contractor). No matter the nature or amount of damage, the owner is precluded from bringing negligence-based claims directly against the offending subcontractor or supplier. This can be problematic in the event that a general contractor goes out of business, especially in the case where an owner did not require a performance bond(s) on the project covering such circumstances. The economic loss rule applies to and poses similar risks and limitations on a general contractor’s claims against lower tier subcontractors and suppliers with whom the general contractor has not contracted directly.

There is a wrinkle. North Carolina courts recognize a limited number of exceptions to the economic loss rule. One such limited exception involves residential home construction. The North Carolina Supreme Court has long held that subsequent residential home buyers can maintain negligence claims directly against home builders, despite the fact that the obligation to build the home arose from a contract to which the subsequent purchaser was not a party. The North Carolina courts have justified this exception by applying equitable principles, noting that residential home buyers expend considerable personal resources to buy a home, subsequent buyers have no input or oversight over the original construction of the home and otherwise would have no recourse against the builder in the event that a latent construction defect is discovered.[2] 

One unresolved issue in North Carolina is whether subsequent owners of commercial properties can benefit from the same exception that has been recognized in the residential context. While the Court in its recent Crescent decision stated it was not inclined to extend the exception to the commercial development and construction context, the issue was not squarely before the Court. Indeed, the commercial owner in the Crescent case was the original owner and had a contract with the general contractor. Because this specific portion of the case is dicta, or non-essential to the Court’s ruling, lower courts are not bound to follow it. With this in mind, there may still be an opening in a North Carolina case to argue that the “subsequent owner” exception to the economic loss rule should be extended to disputes involving commercial construction projects.

The Supreme Court’s recent decision in Crescent is a reminder to project owners, general contractors and all project participants to diligently ensure their “downstream” contracts, insurance, warranties and bonding requirements adequately protect them in the event of the default or dissolution of other project participants. As always, a thorough vetting of key contractors, subcontractors and suppliers goes a long way to effectively manage risk.

[1] Crescent Univ. City Venture, LLC v. Trussway Mfg., Inc., No. 407A19, 2020 WL 7415061, at *1 (N.C. Dec. 18, 2020).

[2] A six-year repose period applies to bar claims brought more than six years after substantial completion of the home.

The Anatomy Of A Change Order Clause In A Construction Contract

Amy Wolfshohl | Porter Hedges

Change orders can quickly become a source of contention on construction projects and are often the subject of major disputes.  As a result, it is important for stakeholders to carefully draft and negotiate the change order and related provisions pre-contract. 

The key portions in a change order clause beyond the obvious (i.e. changes have to be in writing) include the following:

  • Condition Precedent to Payment. In order to protect the enforceability of the change order provision, the change order procedure is best described as a condition precedent to payment.
  • Addressing Cost and Time. A frequent mistake is the failure to address the time component of a change in the context of a change order clause. Namely, the contract change order clause should address how and when the schedule will be modified.   
  • Calculation of a Change Order Amount. Large construction contracts may include a pre-negotiated amount for certain anticipated changes. Additionally, it may be preferable for both parties to include pre-negotiated time and material rates for scopes that have less certainty. 
  • Unilateral Changes. If an owner wants to have the ability to issue a change order for the work to proceed without coming to terms on the pricing of the change order, then a unilateral right to issue change orders should be included. These changes orders are often referred to as a change directive. Naturally, a method or procedure for determining the pricing on the backend should be included as well.
  • Waiver of Claims. Most parties in an upstream position want to have a single negotiation over the effect of a change—including the cumulative effect of changes. If the change order provision does not address cumulative effect or indicate that claims addressed in a change order are released, consider whether the change order is the final, integrated agreement on the subject of the change.
  • Deletion of Work. When drafting a change order provision on behalf of an owner, it is helpful to have the ability to delete work without invoking the termination for convenience clause. This provides two potential avenues for full or partial termination or supplementation.  Contractors should carefully negotiate such a provision.
  • Notice Periods. Most well drafted change order provisions include a notice provision requiring notice within a certain period after the change arises. Contractors seek to expand or eliminate this period and owners seek to shorten it. The notice period should be for changes expressly issued by the owner as well as contractor changes that the owner may dispute. The notice provision should also be carefully drafted so the parties understand when the clock begins to run.
  • Form of Change Order. Including a form of change order helps the project team to follow the change order clause.  For example, including a line item in the form for the effect on the project schedule allows the team to track schedule impacts. The change order form should also indicate the total amount of the change order as well as the adjusted contract price after the change.
  • Compensable Events. Change order or related clauses often also address whether certain events are compensable. For example, is a force majeure event relating to weather compensable? What about delays caused by the owner or contractor?  The failure to address these types of events may result in unintended consequences.

Considering these elements on the front end of drafting and negotiating the change order provision can help to avoid disputes in construction projects.

Another Reminder that Contracts are Powerful in Virginia

Christopher G. Hill | Construction Law Musings

Regular readers of this construction law blog are likely tired of my refrain that the contract is king here in Virginia.  With few exceptions, some of which have been passed in the last few years, the contract can and does essentially set the “law” for the transaction.  A recent opinion from the 4th Circuit Court of Appeals confirms this principle.

In Bracey v. Lancaster Foods, LLC, the Court looked at the question as to whether parties can contractually limit the statute of limitations in which a plaintiff or arbitration claimant can file its claim for relief.  In Bracey, Michael Bracey, a truck driver, sued his former employer, Lancaster Foods, asserting various employment law claims. Lancaster moved to dismiss and compel arbitration based on the terms of an alternative dispute resolution agreement Bracey signed when he was hired, under which he consented to arbitration of any employment-related claim and waived all rights he may otherwise have had to a trial. Bracey challenged the arbitration clause, one that also included a 1-year limitation on the time in which Bracey was allowed to file any claim, as unconscionable.  A federal judge in Maryland agreed and granted the motion to dismiss.

After dispensing with some procedural formalities, the 4th Circuit agreed with the lower court stating:

[a]s a general rule, statutory limitations periods may be shortened by agreement, so long as the limitations period is not unreasonably short” and the statute at issue does not prohibit a shortened limitations period. In reaching this decision, we explained that “[c]ourts have frequently found contractual limitations periods of one year (or less) to be reasonable.

While Bracey argues that it would be difficult to exhaust his claims before the EEOC prior to making a demand for arbitration, it is not entirely clear that administrative exhaustion would even be required when the parties contractually agree to resolve employment disputes in arbitration.

In short, even in the instance where there could be other factors that would make the shortened limitations period a burden on a claimant, there is no categorical rule that states that a shorter limitations period is unconscionable when entered into by contract.

While this is not a construction case, it does highlight the need to carefully review your construction contracts with the help of an experienced Virginia construction attorney.  Absent a careful review and possible edit of the contract, you could be stuck with a limitations period shorter than that of the applicable statute.

As always, I recommend that you read the opinion in its entirety and draw your own conclusions.

Burden Supporting Termination for Default

Terminating a contractor for default is a “‘drastic sanction’ and ‘should be imposed (or sustained) only for good grounds and on solid evidence.’” Cherokee General Corp. v. U.S., 150 Fed.Cl. 270, 278 (Fed.Cl. 2020) (citation omitted).    This is true with any termination for default because terminating a contract for default is the harshest recourse that can be taken under a contract.  It is a caused-based termination.  For this reason, the party terminating a contract for default needs to be in a position to carry its burden supporting the evidentiary basis in exercising the default-based (or caused-based) termination.  Stated differently, the party terminating a contract for default needs to justify the reasonableness in terminating the contract for default.

A party looking to terminate a contract for default should smartly work with counsel to best position its justification in exercising the termination for default.  Likewise, a contractor terminated for default should immediately work with counsel to best position the unreasonableness or the lack of justification for the default-based termination.

The recent Court of Federal Claims opinion in Cherokee General Corp. contains a worthwhile discussion on termination of contracts for default in the federal government contracting arena (including the contractor’s argument that the termination for default should be converted into a termination for convenience).  As explained by the Cherokee General Corp. Court, a contracting officer is given broad discretion to terminate a contract for default. Cherokee General Corp., 150 Fed. Cl. at 277 (citation omitted).  This discretion may be overturned if the contracting officer’s decision to terminate the contract for default is “arbitrary, capricious, or an abuse of discretion.  Id. (citation omitted).  In support of this broad discretion, however, a court can “sustain a [contracting officer’s] default termination ‘for all of the reasons noted by the contracting officer at the time [of his/her default termination letter],’ or ‘for any additional valid reason [justifiable by the circumstances].’” Cherokee General Corp. at 280 (citation omitted).

A termination based on the contractor’s refusal or inability to perform the work with the necessary diligence is appropriate where the contracting officer reasonably believed that “there was ‘no reasonable likelihood that the [contractor] could perform the entire contract effort within the time remaining for contract performance.’ If, however, “[t]he delay in completing the work arises from unforeseeable causes beyond the control and without the fault or negligence of the Contractor,” then “[t]he Contractor’s right to proceed shall not be terminated nor the Contractor charged with damages.”  “Examples of such causes include (i) acts of God or of the public enemy, (ii) acts of the Government in either its sovereign or contractual capacity, (iii) acts of another Contractor in the performance of a contract with the Government, (iv) fires, (v) floods, (vi) epidemics, (vii) quarantine restrictions, (viii) strikes, (ix) freight embargoes, (x) unusually severe weather, or (xi) delays of subcontractors or suppliers at any tier arising from unforeseeable causes beyond the control and without the fault or negligence of both the Contractor and the subcontractors or suppliers.” 

The government bears the initial burden of proving a contractor’s“demonstrated lack of diligence” which “indicat[ed] that [the government] could not be assured of timely completion. The “factors usually relied upon by courts and contract boards” to determine whether the government has met its burden include “a comparison of the percentage of work completed and the amount of time remaining under the contract; the contractor’s failure to meet progress milestones; problems with subcontractors and suppliers; the contractor’s financial situation; as well as a contractor’s performance history; and other pertinent circumstances.”  If the government meets its burden of proof, then the burden shifts to the contractorto show that its default was excusable

Cherokee General Corp., 150 Fed.Cl. at 278.

Mentioned above, but worthy of repeating, a party terminating another based on a contractual default needs to appreciate that it maintains a burden supporting the basis of the termination.   Ignoring this burden, or not appreciating the significance of this burden, can result in a party not being able to substantiate the reasonableness and justification for the termination for default.  Noteworthy, the discretion afforded a contracting officer under a federal government contract is not the same discretion afforded to every party under every contract.  Knowing this makes the appreciation of the burden supporting the basis of the termination for default a very important consideration.

Time is of the Essence, Even When the Contract Doesn’t Say So

Christopher G. Hill | Construction Law Musings

Welcome to 2021!  As often happens here at Construction Law Musings, the year starts with a few posts on notable construction law cases that dropped in the past year or so.  Not only does this review hopefully help you keep up, but helps me keep up with the latest developments (one of the reasons why I keep blogging).

The first of these cases is Appalachian Power Co. v. Wagman Heavy Civil, Inc. out of the Western District of Virginia federal court. In this case, Wagman Heavy Civil, Inc. (“Wagman”) and the Virginia Department of  Transportation (“VDOT”) contracted for the design and construction of a highway interchange project (the “Project”). Wagman and the Appalachian Power Company (“APCO”) entered into a written contract (the “Written Contract”) for APCO to remove and relocate its utility structures (the “Work”) in order to facilitate construction for the Project.

APCO filed suit against Wagman for payment pursuant to the contract. In response, Wagman filed a counterclaim alleging $1,039,074.20 in delay damages resulting from APCO’s breach of its obligations under the  Written Contract to use its best efforts to perform the Work within a reasonable period. Wagman alternatively asserted damages resulting from APCO’s breach of an unwritten contract (the “Unwritten Contract”).

Needless to say, APCO filed a Motion to Dismiss both counts of the counterclaim.  As to the first count, APCO claimed that the delay damages claim was without merit because there was no schedule of performance or “time is of the essence” clause in the Written Contract and because delay damages are “special damages” that are not ordinarily anticipated.  As to the second count, APCO claimed that Wagman did not plead the terms of the Unwritten Contract with the required specificity.

The Court denied the Motion to Dismiss Count I stating that neither ground stated was adequate for dismissal.  As to the delay claims, the Court stated as follows:

[t]he Court will refrain from determining whether they should be analyzed in light of the merger clause or as a subsequent modification to the Written Contract. The Written Contract itself is silent as to the schedule for performance, and it has long been established under Virginia law that “when a contract is silent as to the time within which an act is to be performed, the law implies a reasonable time.”  And, as the Supreme Court of Virginia has indicated, “what constitutes a reasonable time is generally an issue to be decided by a properly instructed jury, under all circumstances of the case.” Id. (ruling that the trial court erred in sustaining demurrer). At least at this stage in the litigation, contrary to APCO’s contention, Wagman need not provide additional allegations as to the schedule for performance in order to adequately plead its claim.

As to the oral contract claim, the Court simply stated that the specifics were a matter of proof and not pleading.

In short, and despite the fact that contracts are king here in the Commonwealth of Virginia, the courts occasionally read reasonableness into a contract where the contract is silent like in this case.  Would Wagman and APCO have been better off to have a time is of the essence clause?  Of course.  It is always better to set the terms of the deal in writing.  This case simply adds an argument for your local Virginia construction attorney in the event there is a timing hole in the contract.

As always I recommend that you read the case for yourself and that you let me know if you have any thoughts.