Construction Defect Damages May Exceed Cost To Repair

Peter Selvin | Ervin Cohen & Jessup

Construction defect cases often involve damage claims beyond simply the cost to repair the allegedly defective unit or component. These consequential damages may include damages for loss of use, expenses for mitigation and even attorney fees. For this reason, builders, suppliers, contractors and subcontractors who are faced with such claims should carefully review their insurance coverages, especially their CGL policies.

At the threshold, a defendant seeking coverage under its CGL policy in connection with a construction defect claim must satisfy the policy’s “occurrence” requirement. Although there is a split of authority on this point nationally, California law is settled that inadvertent property damage caused by intended construction activity constitutes an “occurrence.” See, e.g., Geddes & Smith v. St. Paul Mercury Indemnity Co., 51 Cal. 2d 558, 563 (1959); Anthem Electronics v. Pacific  Employers Insurance, 302 F.3d 1049 (9th Cir. 2002). See also Scott C. Turner, “Insurance Coverage of Construction Disputes,” Sections 6:56, 6:62 (2nd Ed.).

The next step is to establish that there has been “property damage.” This is because the basic coverage grant typically provides that the CGL insurer is responsible for paying “those sums that the insured becomes legally obligated to pay because of … property damage to which this insurance applies.” In turn, “property damage” is typically defined as either “physical injury to or destruction of tangible property … including the loss of use … resulting therefrom” or “loss of use of tangible property which has not been physically injured or destroyed [that has been] caused by an occurrence.”

It has been generally held that incorporation of defective components or faulty workmanship into a project constitutes “physical injury to tangible property,” thereby allowing coverage for damages from the loss, including damages measured by resulting decrease in the property’s value. See, e.g., United States Fid. & Guar. Co. v. Wilken Insulation Co., 550 N.E. 2d 1032 (Ill.App. 1989). The theory behind this rationale is that typical a coverage grant requires the CGL carrier to pay “those sums that insured becomes legally obligated to pay because of … property damage” (emphasis added). In other words, carrier responsibility includes not only damages that arise directly from the “property damage,” but also all sums arising because of the property damage. See, e.g., AIU Ins. Co. v. Superior Court, 51 Cal. 3d. 807 (1990) (reimbursement of response costs and the costs of injunctive relief under CERCLA and related statutes are insured “because of” property damage). While not exhaustive, the following examples illustrate some of the categories of consequential damages for which a CGL carrier may have responsibility.

Damage to the Larger Structure Caused by the Construction Defect

It is well established that damage to a physical structure, including the structure’s non-defective units or components, arising from the incorporation of the defective work should be covered under a CGL policy. See e.g., Economy Lumber v. Insurance Company of North America, 157 Cal. App. 3d 641 (1984). In some cases, damages are expressed as the diminution in value of the larger structure caused by the construction defect. See Franco Belli Plumbing & Heating v. Liberty Mut. Ins. Co., 2012 WL 2830247, *8 (E.D.N.Y. 2012) (“when one product is integrated into a larger entity, and the component product proves defective, the harm is considered harm to the entity to the extent that the market value of the entity is reduced in excess of the value of the defective component”); see also Anthem Electronics 302 F.3d at 1056-57 (“we decline to hold that coverage was precluded simply because the extent of such damage is expressed as an economic loss”).

So-Called “Rip and Tear” Damages

Where an owner must undertake repair work to existing conditions in order to access and remediate the defective work, the damages resulting therefrom may be covered. Thus, costs and expenses relating to this activity are considered part of consequential damages for which there should be coverage. Turner, supra, Section 6.29 (coverage for the damage to other, non-defective work necessarily caused in the course of removing or repairing the defective work).

Coverage for Costs Arising from Mitigation Efforts

In some cases, an owner may be obliged to take actions and incur expenses in order to protect the project from further damage caused by the alleged defect. Although the courts are split on this issue, the majority say these expenses are also considered as part of consequential damages for which there should be coverage. Turner, supra, Section 6.14, 6.22 (“costs incurred for mitigation or prevention of further property damage” are recoverable against CGL carrier).

Loss of Use

Damage resulting from the loss of use of the premises is a key item within the larger category of consequential damages. Am. Home Assurance v. Libbey-Owens-Ford, 786 F. 2d 22,  25 (1st Cir. 1986); Federated Mutual Insurance Co. v. Concrete Units, 363 N. W. 2d 751 (Minn. 1985); Gibraltar Casualty Co. v. Sargent & Lundy, 214 Ill. App. 3d 768 (1990); Lucker Manufacturing Co. v. The Home Insurance Co., 23 F. 3d 808 (3rd Cir. 1994); M. Mooney Corp. v. United States Fidelity & Guaranty Co., 618 A.2d 793, 796 (N. H. 1992); Thee Sombrero v. Scottsdale Ins. Co., 28 Cal. App. 5th 729 (2018); Turner, supra, Section 6:33.

Attorney Fees Awards

Some courts have held that attorney fees awards against the negligent contractor, subcontractor or supplier qualify as an element of consequential damages recoverable under a CGL policy. For example, in APL Co. v. Valley Forge Ins. Co., 754 F.2d 1084 (N.D. Cal. 2010), reversed on other grounds, 541 Fed. Appx. 770 (2013), the court concluded that the attorney fees award against the insured was covered under the insurance policy at issue. The court cited the policy provision there that coverage was provided for “those sums that the insured becomes legally obligated to pay as damages because of …’property damage.’” The court noted that inasmuch as the insured became obligated to pay attorneys’ fees to the claimant arising out of the underlying property damage claim, the award was properly recoverable against the insurer. 754 F.2d at 1094.

Other cases have reached the same result. See, e.g., American Family Mutual Ins. Co. v. Spectre West Building Corp., 2011 WL 488891 (D. Az. Feb. 4, 2011) (in the context of a construction defect case, the Court found that attorneys’ fees that were assessed against the insured were covered under the insurance policy, noting that “the issue before the court is not whether attorneys’ fees and costs can be characterized as ‘property damage’, but whether they can be characterized as damages that [the defendant construction company] became legally obligated to pay because of property damage”).

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.

What You Need to Know About Delay Claims and How to Prove or Defend Against Them

Denise M. Motta | Gordon Rees Scully Mansukhani

It is inevitable that a steel fabricator will be delayed or be accused of delay on a project.  There are many considerations that go into proving and defending delay claims.  From a legal perspective, several issues must be addressed: (1) the type of delay; (2) proof required for delay claims; and (3) types of damages.  This article addresses the legal implications of proving and defending delay claims.

Overview of Delay Claims

Delay damages may be awarded when the defendant has caused the period of performance to be extended.[1]  Delay damages can fall into any of the three general categories of contract damages: (1) expectation; (2) reliance; or (3) restitution.[2]  To prove any delay claim, expert testimony is generally necessary.

A. Elements and Types of Damages

To prove a delay claim, the delayed party must show: (1) the defendant was responsible for the delay; (2) the delays caused a delay in completion of the contract (eliminating overlapping or duplication of delays); and (3) the plaintiff suffered damages as a result of those delays.[3] Once contract time becomes impacted, the impact must be analyzed to determine: [4] [5]

  1. Its cause;
  2. Whether the cause is within the “control” of either party;
  3. Whether the cause impacted the contract’s “critical path” for completion and; if so,
  4. By how much.

The party alleging delay has the burden of proof and must prove each of the elements listed above.  To do so, the delay itself will need to be analyzed to establish the cause of the delay and who was responsible for the delay.  Importantly, the delay must impact the critical path of the project.  Further, the alleged damages must be proven by a reliable method.  Each of these components requires the use of a delay expert to analyze the project schedule so as to determine whether there was a critical path delay and the responsible trade.  Further, the delay expert will need to conduct a detailed analysis to prove and/or defend against alleged damages.

B. Types of Delay

There are multiple types of critical path delays. Whether a delay is compensable depends on the nature of the delay.  Additionally, the contract terms will also be considered in determining whether a delay is compensable or if the delayed party is only entitled to a time extension.

1. Excusable and Compensable

In order to be compensable, a delay must be caused solely by the delaying party to qualify as compensable.  However, third-party delays may be compensable as well depending on the provisions of the contract.  For compensable delay, one must prove that the scheduled completion date of the project has been extended.[6]  

Courts turn their focus first to the contract language to determine the scope of excusable and compensable delays.  For example, in Kiewit Power Constructors, the court determined the contract defined excusable delays to be “those resulting from circumstances beyond the reasonable control and without the fault or negligence of the [delayed] party.”[7]

While the general rule is that there can be no recovery for concurrent delays, in some cases where multiple subcontractors or multiple prime contractors are simultaneously responsible for delay, the delayed party may still be able to recover its costs split between the responsible parties as long as the claiming party had no fault or responsibility for delay during the period claimed.[8]

2. Excusable But Not Compensable

Excusable, but not compensable delays typically result from “third-party events, force majeure events, unusually severe weather, and owner-caused delays.”  The compensability of these types of delays depends on the provisions of the contract.  If the delay is outside the control of both the owner and the contractor, it could be “excusable but non-compensable.”[9]

Courts have found that concurrent delays generally are not compensable: “[i]f a period of delay can be attributed simultaneously to the actions of both the [Owner] and the contractor, there are said to be concurrent delays, and the result is an excusable but not a compensable delay.”[10]

3. Not Excusable[11]

Delays are not excusable when the delay results from an act or neglect of the contractor, or its subcontractors or suppliers at any tier, or is the result of a risk assumed by the contractor pursuant to contract.  Because these delays may be caused by negligence or poor performance of the contracting parties, they are controllable.[12]

Non-excusable delays are usually rooted in at least some of the following causes: improper scheduling, ineffective site management, incorrect methods of construction, delayed performance in overall activities, and poor monitoring and control.[13]  Many commentators address this type of delay as a defense to a contractor’s claim for an extension of time, but the theories that apply also implicate the government or owner’s entitlement to assess liquidated damages.[14]

C. Methods of Proving Delay Damages

A damage award must not be based on mere speculation, guess, or conjecture.  Courts have interpreted this to mean that time impacts and resulting damages must be measured with a heightened “degree of certainty,”[15] leading to judicial skepticism of theoretical time impact analyses and damage presentations based on unsegregated “total cost” methods.[16]  Damages must be proven by reliable expert testimony or the delayed party runs the risk of not being awarded damages.

1. Measured Mile Analysis

A measured mile analysis compares the actual labor costs or labor productivity of performing work during a time period in which the work was not impacted by the actions causing labor inefficiency to the actual labor costs or actual productivity rate for performing work during a period that was impacted by the delay.[17]  A measured mile analysis has the ability to “isolate the productivity loss during an impacted period from all other project factors via achieved progress in an un-impacted period” and is considered the preferred method of proving damages.[18]  By and large, a measured mile analysis is the most “reliable,” and therefore, preferred method.

2. Total Cost Method

The total cost method involves subtracting the contractor’s bid estimate from the total of all project cost incurred, producing a total cost attributable to the owner’s breach.[19] 

The total cost method has been applied by some courts only under exceptional circumstances and even then, only as a last resort.[20]  In those cases, courts may allow proof of damages by the total cost method when there is no other alternative method of computing damages.[21] 

3. Modified Total Cost Method

The modified total cost method is allowed only when the evidence suggests proving damages by any other means might be impracticable.[22]  To prove a modified total cost claim, the plaintiff must prove “that (1) the nature of the particular losses make it impossible or highly impracticable to determine them with a reasonable degree of accuracy; (2) the plaintiff’s bid or estimate was realistic; (3) its actual costs are reasonable; and (4) it was not responsible for the added expenses.”[23] 

If successful, the modified total cost method will result in an award of the total cost of the contract minus the bid price, with adjustments made for a contractor’s inability to satisfy the four elements, such as excluding costs associated with delays the contractor caused, or adjusting the bid price for miscalculations.[24] 

D. Common Breakdowns of Delay Damages

Damages from delay can come in various forms.  Impacts include increased labor costs, increased material and equipment costs, overhead, and loss of efficiency or productivity.  When asserting a delay claim, it is important to adequately track any direct costs (labor, material, or equipment) with appropriate backup when a project is delayed.  Conversely, when defending a delay claim, it is crucial to ensure that damages are supported and, for loss of efficiency or productivity claims, supported by reliable expert testimony.

1. Labor Costs

Extended or additional labor costs impact nearly every party in connection with project delay.  Delays to a project can force the contractor to perform work out of sequence, under different labor conditions, or at a later time.  Each of these will impact the work and result in an increase in labor costs.  For example, a delay that pushes work into a later period can result in stacking of trades, disruption of trades, and slower progress.  If pushed to a later time, work that previously had no shortage of trained labor could face shortages or unrest as labor agreements are impacted.  However, not all labor costs should be considered part of damages due to delay. Rather, the damages are for the labor actually impacted by the delayed work.

2. Material and Equipment Costs

Equipment standby damages usually “take the form of lost opportunities to rent idle equipment to others or the plaintiff’s inability to use the equipment at an earlier date on another job.”[25]  Such losses—when foreseeable—are “a natural consequence of the . . . delay, and, thus, are compensable.”[26]  Courts may award the plaintiff its lost profits and unavoidable costs (namely, its equipment leasing costs).[27]  The court will examine the damages to place the plaintiff in the position it “would have occupied had [the delaying party] performed the contract.”[28] 

3. Direct and Indirect Overhead

“Unabsorbed overhead” may be recoverable as part of delay damages.  “[I]f the delay prevented the contractor from obtaining contracts during the delay period that would have ‘absorbed’ the ongoing overhead expenses,” the unabsorbed overhead is recoverable.[29] 

4. Loss of Efficiency/Productivity Claims

In construction delay claims, disruption can be compensable when it results in: (i) a “loss of productivity; (ii) caused by a change in working conditions; (iii) for which the owner is responsible.”[30]  Whether a contractor is entitled to recover the increased costs of disruption “depends on the nature of the disruption, the cause of the loss of productivity, and on the terms of its contract as may be interpreted in the light of industry practice.”[31]  Of particular note, timing factors are common causes affecting project productivity and efficiency.  For example, acceleration,[32] out-of-sequence work,[33] schedule compression,[34] and simultaneous operations.[35] 

Disruption is a separate and distinct phenomenon from delay.[36]  Federal courts have noted that “[t]here is a distinction in the law between a delay claim and a disruption or cumulative impact claim. Although the two claim types often arise together in the same project, a delay claim involves the time and cost of not being able to work, while a disruption claim involves the cost of working less efficiently than planned.”[37]  Indeed, in order to “succeed on a disruption [or loss of productivity claim]” a claimant “need not establish delay to overall contract completion.”[38] 

Finally, courts have articulated that a high level of proof is required to prove loss of productivity or efficiency.[39]  Mere assertions of delay or changes in a project fail to constitute adequate proof.[40]  A party asserting loss of productivity must firmly establish the elements of liability and causation, or that disruptions or inefficiencies on the project were caused solely by the alleged project delays or changes.[41] 

Courts generally require the testimony of a properly qualified expert witness to prove the amount or impact of lost productivity.  In Luria Brothers & Co. v. United States, the court stated:

It is a rare case where loss of productivity can be proven by books and records; almost always it has to be proven by the opinions of expert witnesses.  However, the mere expression of an estimate as to the amount of productivity loss by an expert witness with nothing to support it will not establish the fundamental fact of resultant injury nor provide a sufficient basis for making a reasonably correct approximation of damages.[42]

Indeed, the failure to use an expert has resulted in many courts finding the claimant unable to meet the required burden to prove inefficiency.[43]

Conclusion

Practical tips to consider when met with delays include: (1) conducting a critical path delay analysis to determine the party responsible for the delay; (2) retaining a delay expert to consult regarding schedule issues; (3) being mindful of deadlines set forth in the contract for requesting change orders, including requests for time extensions; (4) requesting a time extension when impacted by delays; (5) including additional days for completion of change orders in each change order; (6) tracking all labor, material, and equipment expenses with a separate job cost code; and (7) keeping supporting backup for all expenses organized by expense.

Unfortunately, delays on construction projects are commonplace.  If it has not happened yet, it is only a matter of time until a steel fabricator will incur substantial damages due to delay or be accused of delays alleging millions of dollars in damages.  Understanding delay claims and proactively monitoring the project schedule, as well as enlisting legal counsel and delay experts early in the process will assist in development of proof to prove or defend delay claims.


[1] See Colorado Environments, Inc. v. Valley Grading Corp., 779 P.2d 80, 84 (Nev. 1989) (citing Zook Bros. Constr. Co. v. State, 556 P.2d 911 (Mont. 1976)).

[2] See Dynalectric Co. of Nevada, Inc. v. Clark & Sullivan Constructors, Inc., 255 P.3d 286, 289 (Nev. 2011).

[3] See Plato General Const. Corp./EMCO Tech Const. Corp. v. Dormitory Authority of State, 89 A.D.3d 819, 825 (N.Y. App. Div. 2011).

[4] See Philip L. Bruner & Patrick J. O’Connor, Jr., Bruner & O’Connor on Construction Law, § 15:29 (Thomson Reuters, 2018) [hereinafter Bruner & O’Connor].

[5] See Haney v. U. S., 230 Ct. Cl. 148, 168 (1982) (“[S]ome items of work are given no leeway and must be performed on schedule; otherwise the entire project will be delayed. These latter items of work are on the “critical path.” A delay or acceleration of work along the critical path will affect the entire project.”); Appeal of Southwest Marine, Inc., A.S.B.C.A. No. 36854, 95-1 B.C.A. (CCH) ¶ 27601, 1995 WL 139424 (Armed Serv. B.C.A. 1995) (“The critical path is crucial to the calculation of delay damages because only work on the critical path has an impact upon the time [in] which the project was completed; the Government delay must have interfered with the project’s critical path.”); see also Safeco Ins. Co. Of America v. Cty. Of San Bernardino, 347 Fed. Appx. 315, 318 (9th Cir. 2009) (citing treatise and opining that because the owner “has not shown that any of the insignificant delays [the contractor] caused were on the project’s critical path . . . whatever delays [the contractor’s] improper actions caused do not impact the amount of delay damages”); see also Cty. of Galveston v. Triple B Services, LLP, 498 S.W.3d 176 (Tex. App. 2016) (citing treatise regarding the distinction between “delay” damages and “disruption” damages, and concluding that both types of damages fell within the statutory waiver of sovereign immunity and thus were recoverable).

[6] See Robert M. D’Onofrio et al., ASCE Standard 67-17, Schedule Delay Analysis, 4.7 [hereinafter Schedule Delay Analysis].

[7] Kiewit Power Constructors Co. v. City of Los Angeles by and through Dep’t of Water and Power, No. CV 16-02590-AB, 2018 WL 5880919, at *7 (C.D. Cal. Mar. 22, 2018).

[8] JMR Constr. Corp. v. Envtl. Assessment & Remediation Mgmt., Inc., 198 Cal. Rptr. 3d 47, 60 (2015) (citing William F. Klingensmith, Inc. v. U.S., 731 F.2d 805, 809 (Fed. Cir. 1984) (“contractor generally denied recovery for government-caused delays where there are concurrent delays and absent ‘proof a clear apportionment of the delay and expense attributable to each’.”).

[9] See Schedule Delay Analysis, supra note 6, at 4.5.

[10] Morganti Nat., Inc. v. U.S., 49 Fed. Cl. 110, 132 (2001); see, e.g.R.P. Wallace Inc. v. U.S., 63 Fed. Cl. 402 (2004).

[11] See, e.g., Appeal of Kirk Bros. Mechanical Contractors, Inc., A.S.B.C.A. No. 43738, 93-1 B.C.A. (CCH) ¶ 25325, 26188, 1992 WL 197581 (Armed Serv. B.C.A. 1992) (“Where the delay is caused solely by the Government, it is compensable; where the delay is caused solely by the [contractor], [the contractor] is responsible . . . Where the delay is prompted by inextricably intertwined concurrent Government and contractor causes, the delay is not compensable.”); Andrew D. Ness, Delay, Suspension of Work, and Acceleration, in Federal Government Construction Contracts 413, 424–27 (Bastianelli et al. eds., 2003).

[12] Nev. Rev., Causes of Non-Excusable Delays in Construction and Remedies, (May 2020), https://thenevadaview.com/non-excusable-delays-in-construction/.

[13] Id.

[14] See W. Stephen Dale & Robert M. D’Onofrio, Construction Schedule Delays § 1:4 (Thomson Reuters, 2018) [hereinafter Construction Schedule Delays].

[15] Appeal of Dawson Const. Co., Inc., V.A.B.C.A. No. 3306, V.A.B.C.A. No. 3307, V.A.B.C.A. No. 3308, V.A.B.C.A. No. 3309, V.A.B.C.A. No. 3310, 93-3 B.C.A. (CCH) ¶ 26177, 1993 WL 243270 (Veterans Admin. B.C.A. 1993), aff’d, 34 F.3d 1080 (Fed. Cir. 1994); Dawson Const. Co., Inc. v. Brown, 34 F.3d 1080 (Fed. Cir. 1994) (holding contractor bears the burden of proof and broad generalities of government delay are insufficient). See also Fire Security Systems, Inc. v. General Services Admin., G.S.B.C.A. No. 12120, G.S.B.C.A. No. 12163, G.S.B.C.A. No. 12175, G.S.B.C.A. No. 12349, G.S.B.C.A. No. 12351, G.S.B.C.A. No. 12403, G.S.B.C.A. No. 12406, 97-2 B.C.A. (CCH) ¶ 28994, 1997 WL 251389 (Gen. Services Admin. B.C.A. 1997), on reconsideration, G.S.B.C.A. No. 12403-R, 97-2 B.C.A. (CCH) ¶ 29186, 1997 WL 473205 (Gen. Services Admin. B.C.A. 1997) (contractor’s base allegation that liquidated damage rate imposed by government was unreasonable did not shift the burden to the government to prove its reasonableness). See also Patrick M. Kelly & William E. Franczek, Clearing the Smoke: Forensic Scheduled Analysis Method Selection for Construction Attorneys, 33 Construction L. 30 (2013).

[16] Morrison Knudsen Corp. v. Firem’s Fund Ins. Co., 175 F.3d 1221 (10th Cir. 1999) (discussing burden of proof in the context to a challenge in jury instructions and finding harmless error as contractor bore the burden of not simply showing excusable delay so as to avoid a default termination, but also that such delay delayed the overall completion of the job, i.e., was to the critical path).

[17] See Construction Schedule Delays, supra note 14, at § 19:1.

[18] Construction Schedule Delays, supra note 14, at § 19:1.

[19] Rubin, The Total Cost Method of Computing an Equitable Adjustment – An Analysis, 26 Fed. B.J. 303 (1966) (stating the total cost method is “generally disfavored.”); see Amelco Electric v. City of Thousand Oaks, 38 P.3d 1120, 1130 (Cal. Ct. App. 2002) (citing Servidone Constr. Corp. v. U.S., 931 F.2d 860, 861 (1991) (“A trial court must use the total cost method with caution and as a last resort.”)); Ames Constr., Inc. v. Clark Cty., No. 2:18-cv-00299-JCM-EJY, 2020 WL 3488736, at *3 (D. Nev. Apr. 6, 2020) (citing Elte, Inc. v. S.S. Mullen, Inc., 469 F.2d 1127, 1131 (9th Cir. 1972); Raytheon Co. v. White, 305 F.3d 1354, 1365 (Fed. Cir. 2002)); Youngdale & Sons Const. Co., Inc. v. U.S., 27 Fed. Cl. 516, 541 (1993) (“Use of [the total cost] method is highly disfavored by the courts, because it blandly assumes…that every penny of the plaintiff’s costs are prima facie reasonable, that the bid was accurately and reasonably comp[uted], and that the plaintiff is not responsible for any increases in cost.”) (emphasis added).

[20] New Pueblo Constructors, Inc. v. State, 696 P.2d 185, 203 (Ariz. 1985); AMEC Civil, LLC v. DMJM Harris, Inc., No. 06–64 (FLW), 2009 WL 1883985, at *7 (D.N.J. June 30, 2009) (citing North Star Alaska Hous. Corp. v. United States, 76 Fed. Cl. 158, 213 (2007) (“The United States Court of Appeals for the Federal Circuit and the Court of Federal Claims have emphasized that ‘the preferred way for a contractor to prove increased costs is to submit actual cost data because such data provides the court, or contracting officer, with documented underlying expenses, ensuring that the final amount of the equitable adjustment will be just that–equitable–and not a windfall for either the government or the contractor.”)); but see Kansas Gas & Elec. Co. v. United States, 685 F.3d 1361 (Fed. Cir. 2012) (allowing total-cost allocation method when contractor “used an internal accounting system which coded costs to specific projects, the allocation rates were re-examined on a regular basis in order to reflect actual capital project costs, and the total-cost allocation method complied with required FERC accounting regulations.”).

[21] Boyajian v. United States, 423 F.2d 1231 (Ct. Cl. 1970).

[22] See Ames Constr., 2020 WL 3488736 at *4 (The way for a claimant to demonstrate this is by using a four-part test “to offset the methodology’s deficiencies.”). See Insulation Contracting & Supply, Inc., 131 Nev. 1302 (2015).

[23] Raytheon Co., 305 F.3d at 1365.

[24] See Propellex Corp. v. Brownlee, 342 F.3d 1335, 1339 (Fed. Cir. 2003); Boyajian, 423 F.2d at 1240.

[25] Colorado Environments, Inc. v. Valley Grading Corp., 779 P.2d 80, 84 (Nev. 1989) (citing L.L. Hall Constr. Co. v. United States, 177 Ct. Cl. 870 (1966)).

[26] See id. (citing Restatement (Second) of Contracts § 347(b)).

[27] Id.

[28] Id.

[29] Yacht West, Ltd. v. Christensen Shipyards, Ltd., 464 Fed. Appx. 626, 629 (9th Cir. 2011) (citing Golf Landscaping, Inc. v. Century Constr. Co., a Div. of Orvco, Inc., 39 696 P.2d 590 (Wash. Ct. App. 1984)).

[30] Wunderlich Contracting Co. v. United States, 173 Ct. Cl. 180, 198 (1965).

[31] Construction Schedule Delays, supra note 14, at § 18:2.

[32] See, e.g., Appeal of George A. Fuller Company, E.N.G.B.C.A. No. 1957, 1962 WL 225 (Corps Eng’rs B.C.A. 1962) (“The speed-up of the work was accomplished by adding workmen to the force and by increasing the hours of work per day and the days of work per week. When men work longer daily hours and weekends, much beyond the normal, their efficiency is impaired resulting in less production for a given number of man hours of work.”). See also Angelo Iafrate Constr. Co. v. Commw. of Pa., No. 3654, 2006 WL 2585021, at *23 (Pa. Bd. Claims June 13, 2006) (“Iafrate’s work productivity was adversely affected by Iafrate’s agreement to accelerate the completion of Phase II which caused the stacking of activities, working areas being over-crowded because multiple tasks were being performed out of sequence and because there was present extra workers and equipment, and the inability to move equipment, manpower and materials efficiently within the work zone.”); Tony Depaul & Son, No. 1452, 1993 WL 764322, at *18 (Pa. Bd. Cl. Oct. 28, 1993) (“Acceleration of work, including out of sequence work, start and stop operations, stacking of trades, simultaneous operations, additional manpower and equipment and additional work, causes a loss of efficiency and productivity in a contractor’s work efforts. Working in winter weather conditions, including rain, cold and freezing conditions, also causes a loss of efficiency and productivity in work efforts.”).

[33] See, e.g., Appeal of DANAC, Inc., A.S.B.C.A. No. 33394, 97-2 B.C.A. (CCH) ¶ 29184, 1997 WL 484579 (Armed Serv. B.C.A. 1997), on reconsideration, A.S.B.C.A. No. 33394, 98-1 B.C.A. (CCH) ¶ 29454, 1997 WL 763050 (Armed Serv. B.C.A. 1997), dismissed, 168 F.3d 1318 (Fed. Cir. 1998) (“We have long recognized that lost efficiency caused by a disruption of a contractor’s planned sequence of work may be compensable.”). See also Southern Comfort Builders, Inc. v. U.S., 67 Fed. Cl. 124, 145 (2005) (stating out of sequence work allegedly caused by waiting for RFI’s caused loss of productivity but was contractor’s responsibility for failure to prepare coordination drawings); Appeal of Parsons of California, A.S.B.C.A. No. 20867, 82-1 B.C.A. (CCH) ¶ 15659, 77418, 1982 WL 7041 (Armed Serv. B.C.A. 1982) (out of sequence of work in construction contract caused by drawing defects); Central Ceilings, Inc. v. Suffolk Const. Co., Inc., 2013 WL 8721044 (Mass. Super. Ct. 2013), aff’d 91 Mass. App. Ct. 231 (2017) (where prime required a sub “to constantly de-mobilize, re-mobilize, and alter the natural sequence of its work under the Subcontract” found loss of productivity). But see Electrical Contractors, Inc. v. Pike Co., Inc., No. 3:11–cv–01449, 2015 WL 3453348, at *20 (D. Conn. May 29, 2015) (agreeing that “just because work moves to a different area, a different time frame, doesn’t mean that it’s going to be less productive, [that] the contract was going to be automatically incurring loss of productivity. It means you’re doing it at a different time frame.”).

[34] See, e.g., Central Ceilings, Inc., 75 N.E.3d 40.

[35] See, e.g., Tony Depaul & Son, 1993 WL 764322 at *18 (“Acceleration of work, including out of sequence work, start and stop operations, stacking of trades, simultaneous operations, additional manpower and equipment and additional work, causes a loss of efficiency and productivity in a contractor’s work efforts. Working in winter weather conditions, including rain, cold and freezing conditions, also causes a loss of efficiency and productivity in work efforts.”).

[36] Construction Schedule Delays, supra note 14, at § 18:3.

[37] Bell BCI Co. v. U.S., 72 Fed. Cl. 164, 168 (2006).

[38] Sauer Inc. v. Danzig, 224 F.3d 1340, 1348 (Fed. Cir. 2000).

[39] Aetna Cas. & Surety Co. v. George Hyman Const. Co., 155 F.R.D. 113, 115 (1994) (citing various adjudications as to loss of productivity claims).

[40]  Id. (citing Southwest Marine, Inc., DOTBCA No. 1663, 94-3 B.C.A. (CCH) P27, 102 (1994)).

[41] Id. (citing Dawson Constr. Co., VABCA No. 3306-3310, 93-3 B.C.A. (CCH) 026, 177, aff’d 34 F.3d 1080  (Fed. Cir. 1994)).

[42] Luria Bros. & Co., Inc. v. U.S., 177 Ct. Cl. 676, 696 (1966) (emphasis added).

[43] See, e.g., U.S. ex rel. Salinas Constr., Inc. v. W. Sur. Co., No. C14-1963JLR, 2016 WL 3632487 (W.D. Wash. July 7, 2016) (vacating a jury verdict award because damages for inefficiency require expert testimony not lay testimony under Federal Rules of Evidence 701 and 702); Norment Sec. Group, Inc. v. Ohio Dept. of Rehabilitation and Correction, 2003-Ohio-6572, 2003 WL 22890088 (Ohio Ct. Cl. Dec. 2, 2003) (holding expert testimony not provided and inefficiency claim failed for lack of proof); Appeal of Dawson Const. Co., Inc., V.A.B.C.A. No. 3306, V.A.B.C.A. No. 3307, V.A.B.C.A. No. 3308, V.A.B.C.A. No. 3309, V.A.B.C.A. No. 3310, 93-3 B.C.A. (CCH) ¶ 26177, 1993 WL 243270 (Veterans Admin. B.C.A. 1993), aff’d, 34 F.3d 1080 (Fed. Cir. 1994) (ruling project manager’s testimony of inefficiency percentage insufficient to prove inefficiency); Havens Steel Co. v. Randolph Engineering Co., 613 F. Supp. 514, 540 (W.D. Mo. 1985), (finding that the court did not accept witness as a loss of productivity expert for lack of training or expertise); Appeal of Preston–Brady Co., Inc., V.A.B.C.A. No. 1892, V.A.B.C.A. No. 1991, V.A.B.C.A. No. 2555, 87-1 B.C.A. (CCH) ¶ 19649, at 99,520, 1987 WL 41248 (Veterans Admin. B.C.A. 1987), clarified on denial of reconsideration, V.A.B.C.A. No. 1892, V.A.B.C.A. No. 1991, V.A.B.C.A. No. 2555, 87-2 B.C.A. (CCH) ¶ 19925, 1987 WL 46592 (Veterans Admin. B.C.A. 1987) (“A general statement that disruption or impact occurred, absent any showing through use of updated CPM schedules, logs or credible and specific data or testimony, will not suffice to meet that burden.”).

Claim Investigation Not Necessarily Protected by Work Product Doctrine in Illinois

Alycen A. Moss and Elliot Kerzner | Property Insurance Law Observer

In determining when the work product doctrine is triggered, the Northern District of Illinois recently held that, rather than adopting a bright-line rule, the issue should be decided on a case-by-case basis at the court’s discretion. In Club Gene and Georgetti, LP v. XL Insurance America, Inc., No. 20 C 652, 2021 WL 1239197 (N.D. Ill. Apr. 2, 2021), the insured’s steakhouse was damaged in a fire. When the insured sued for coverage, the insurer refused to produce documents prepared in the course of its investigation of the claim on the basis of the work product doctrine. The issue of contention was: at what point in an insurer’s claim investigation can the insurer claim that litigation was reasonably anticipated?

In addressing this question under Illinois law, the court noted that, because litigation can be anticipated at the time almost any incident occurs, a “substantial and significant threat of litigation” is required before an insurer can invoke the work product doctrine and decline to produce a document requested in discovery. To demonstrate the existence of this “threat,” an insurer must show “objective facts establishing an identifiable resolve to litigate.” The fact that litigation actually ensues or that a party has retained an attorney, initiated investigations, or engaged in negotiations over a claim, is “insufficient to dispositively establish anticipation of litigation.”

The court cited cases in other jurisdictions that have drawn the line at the point where a subrogation decision is made. However, the Club Gene and Georgetti court was “reluctant” to go quite so far. Instead, the court assessed the circumstances and content of each redacted portion of the documents at issue in order to determine whether they can be withheld or must be produced. The court rejected the application of a priori results or “mechanical application of broad principles” in favor of court discretion. Such discretion, the court stated, “involves a range not a point.” Accordingly, the court listed its individual determinations for each disputed document in the case.

In the wake of Club Gene and Georgetti, insurers should be careful not to assume that documents prepared in the course of their claim investigations are subject to the work product doctrine even if an attorney has been retained and investigations are underway, and even if the parties are in the process of negotiating over the existence or scope of coverage. Rather, a court could look to the circumstances surrounding each individual document to determine whether it was prepared after “a substantial and significant threat of litigation,” and whether “an identifiable resolve to litigate” has been shown.

Developer Pre-Conditions in CC&Rs Limiting Ability of HOA to Make Construction Defect Claims, Found Unenforceable

Garret Murai | California Construction Law Blog

The Davis-Stirling Common Interest Development Act (Civ. Code §4000, et seq.), also known simply as “Davis-Stirling,” is a statute that applies to condominium, cooperative and planned unit development communities in California. The statute, which governs the formation and management of homeowners associations or HOAs, also governs lawsuits filed by HOAs for construction defects.

In the next case, Smart Corners Owner Association v. CJUF Smart Corner LLC, Case No. D076775 (May 20, 2021), the 4th District Court of Appeal addressed the pre-litigation voting requirements of Davis-Stirling and the impact of recent amendments to the Act.

The Smart Corners Case

In 2004, CJUF Smart Corner LLC contracted with Hensel Phelps Construction Company for the construction of the Smart Corner condominium project, a 19-story mixed-use development with 301 residential units and common areas, in San Diego, California. As part of the development an HOA was formed, the Smart Corner Owner Association.

On July 6, 2017, the Smart Corner HOA filed a notice of construction defects with CJUF Smart Corner and Hensel Phelps under the Right to Repair Act (Civ. Code §895 et seq.) and under Davis-Stirling. The notice identified defects in the project’s exterior barrier coating, windows, door casings and doors, private decks, waterproofing, concrete, bathtubs and showers, roof membrane and roof flashing, roof laps and seals, tower floors, plumbing, venting, garage, and parking structure.

On September 27, CJUF Smart Corner and Hensel Phelps notified the HOA of their election to opt out of the Right to Repair Act and Davis-Stirling pre-litigation procedures.

On October 6, 2017, the HOA filed suit against CJUF Smart Corner and Hensel Phelps alleging causes of action for negligence, strict liability, breach of warranties, and violation of the construction standards of the Right to Repair Act. In its answer, CJUF Smart Corner asserted as a defense that the HOA had not complied with the CC&R requirements for maintaining a claim, specifically, that a majority of the members of the HOA did not vote in favor of filing suit.

On May 14, 2018, the HOA filed a declaration by its attorney who, while stating that he did not believe the majority-vote requirement of the CC&Rs were enforceable, that by February 15, 2018, a majority of the members of the HOA had voted in favor of filing the lawsuit and ratified the past actions of the HOA’s Board in filing the lawsuit.

While the case was pending, the 4th District Court of Appeal, in another case entitled Branches Neighborhood Corp. v. CalAtlantic Group, Inc. (2018) 26 Cal.App.5th 743, upheld an arbitration decision which found against an HOA which had failed to obtain a 51% vote prior to filing suit against a developer, even though 92 of 93 members of the HOA later voted ratify the HOA’s Board’s earlier decision to file suit against the developer.

In December 2018, based on the decision in Branches, CJUC Smart Corner filed a motion for summary judgment arguing that Smart Corner HOA’s lawsuit was barred because it had failed to follow the pre-litigation voting requirements of its CC&RS and, pursuant to Branches, the members of the HOA could not later ratify the actions of the HOA’s Board in filing the lawsuit.

On July 29, 2019, the trial court, rejecting the HOA’s argument that the Branches decision only applied to arbitration decisions, found in favor of CJUC Smart Corner, stating that “Branches analyzes the substantive, legal issue of enforcement of a CC&R member consent requirement and, as such applies irrespective of the forum” and that under Branches “Plaintiff’s failure to obtain the requisite consent of the membership prior to bringing this action against the [Developers] renders [the Association’s] original complaint invalid.”

CJUC Smart Corner appealed.

The Appeal

In a case marked by twists and turns in case law while the case was pending before the trial court another twist occurred during pendency of the appeal. On August 30, 2019, the California State Legislature enacted Senate Bill 326 which was signed by the Governor, and became effective January 1, 2020. The new legislation nullified pre-litigation vote requirements like those involved in the Branches decision.

One of the legislative analyses of the bill described it as follows:

As part of the creation of a new HOA, the developer typically begins laying the groundwork for the HOA’s future self-governance. This includes establishing the initial governing documents for the HOA, including the HOA’s “declaration” [of] covenants, conditions, and restrictions (CCRs). While the HOA developer is still selling off the separate properties within the HOA to homeowners, it is also common for the developer to serve, or appoint people to serve, on the HOA board of directors. In these ways, HOA developers exercise a great deal of control over how the HOA will operate going forward, even though, over time, the developer’s direct involvement with the HOA typically fades away.

The involvement of HOA developers in the creation of the HOA’s initial government documents and the appointment of early HOA board members can sometimes create conflicts of interest because the HOA and the developer’s interests are not necessarily aligned.

[T]his bill addresses one such circumstance. In drafting the governing documents for the HOAs they are creating, developers sometimes add provisions that make it quite difficult for the HOA to sue the developer in the event that construction defects are discovered at the HOA. [¶] While it could be argued that requiring a vote of the HOA members prevents the board of directors from spending the HOA’s money on legal disputes without the support of the members, the fact that these provisions are limited to construction defect claims against the developer suggests that more is afoot. Moreover, Civil Code Section 6150 already provides some protections against an overly litigious board bent on suing the developer: it requires an HOA board to hold a meeting of the members 30 days prior to filing a lawsuit, stating its reasoning and laying out the options available to the HOA. [¶] This bill ensures that developers cannot reap the benefit of having taken advantage of their participation in the creation of the HOA in this way.” (Sen. Rules Com., Off. of Sen. Floor Analyses, 3d reading analysis of Sen. Bill 326, as amended May 1, 2019, pp. 6-7)

The bill added Civil Code section 5986 which provides in pertinent part:

The governing documents shall not impose any preconditions or limitations on the board’s authority to commence and pursue any claim, civil action, arbitration, prelitigation process pursuant to Section 6000 or Title 7 (commencing with Section 895) of Part 2 of Division 2, or other legal proceeding against a declarant, developer, or builder of a common interest development. Any limitation or precondition, including, but not limited to, requiring a membership vote as a prerequisite to, or otherwise providing the declarant, developer, or builder with veto authority over, the board’s commencement and pursuit of a claim, civil action, arbitration, prelitigation process, or legal proceeding against the declarant, developer, or builder, or any incidental decision of the board, including, but not limited to, retaining legal counsel or incurring costs or expenses, is unenforceable, null, and void. . . . 

This section applies to all governing documents, whether recorded before or after the effective date of this section, and applies retroactively to claims initiated before the effective date of this section, except if those claims have been resolved through an executed settlement, a final arbitration decision, or a final judicial decision on the merits.

God, or rather the State Legislature, had spoken. In response, CJUC Smart Corner argued that the HOA could not benefit from the recent enactment of Section 5986 because the trial court’s decision on CJUC Smart Corner’s motion for summary judgment was a “final decision on the merits” which had been entered before effective date of the statute.

Noting that “no court of review of this state has yet interpreted the phrase ‘final decision on the merits,’ the Court of Appeals explained that what the phrase means, depends on statutory interpretation. And, here, explained the Court, the general rule is that “civil statutes are presumed to operate prospectively ‘in the absence of a clear indication of a contrary legislative intent.’” 

In interpreting a statute, explained the Court of Appeals, three-step process is followed: “We first look to the plain meaning of the statutory language, then to its legislative history and finally to the reasonableness of a proposed construction.” Following each of these steps, the Court found that:

  1. Plain Meaning: Analyzing the use of the phrase “final judicial decision” in Section 5986, the Court of Appeal explained that the term “judicial” is a general term that refers equally to a trial court, appellate court, or a high court of review” and that “[h]ad the Legislature meant to exclude from the retroactive reach of section 5986 claims that had already been resolved by the trial court, it could have easily have done this by inserting the words ‘trial court’ in place of ‘judicial.’”
  2. Legislative History: As to the legislative history of Section 5986, the Court of Appeal found it compelling that the State Legislature was attempting to address a “trend of developers taking advantage of their ability” to dictate CC&R provisions and that the State Legislature clearly intended the statute to apply retroactively but placed limits on its retroactive effect to cases in which a final judicial decision  had been reached. As such, the court found that the “Legislature intended ‘final judicial decision’ to refer to a judgment for which the time to appeal had passed, or, if an appeal was then, had reached finality after completion of the process of appellate review.”
  3. Reasonableness of Construction: The Court of Appeal also noted that its interpretation was consistent with reason and common sense because if “final judicial decision” meant a “final judicial decision” by a trial court it would “create the possibility of judicial enforcement [by reviewing courts] of a provision that our Legislature has already declared in the strongest possible terms – through explicit statutory directive – should be treated as null and void.”

As a further, independent ground the Court of Appeal also found that the majority vote requirement as a pre-condition prior to filing suit was void as to public policy when a majority of the members voted in favor of filing suit after the lawsuit was filed.

Conclusion

For developers, the most important take-away from the Smart Corner case is that under Civil Code section 5986 CC&R provisions establishing pre-conditions or limitations on a HOA Board’s authority to commence and pursue construction defect claim will be found void and enforceable.