You Can’t Always Get What You Want – “Economic Waste” in Construction Defect Claims

Michael L. Meyer | Taft

The Rolling Stones’ Mick Jagger famously sang, “You can’t always get what you want, but if you try sometime, you’ll find you get what you need.” Jagger wasn’t singing about damages in construction defect litigation. But his message rings true, especially when the cost to repair a defect is high and the final product meets the owner’s requirements.

The goal of any construction project is to build a structure that meets the owner’s needs. If the project does not meet that goal, the owner will want the shortfall corrected. When a defect is major, preventing any practical use of the building, a repair is almost always necessary. A non-functioning electrical system or a foundation sinking into the earth requires repair. But what about conditions that don’t substantially impair the use of the finished project? Must a contractor remove and replace components even if those components function properly?

Contractors understand that the owner should receive the finished product called for in the contract. If it does not, the owner has not received what it paid for. But even in that case, the owner is not always entitled to precisely what the contract specifies. Examples of this problem abound. Perhaps a new parking lot is discolored but otherwise has a smooth and functional surface. Or what if a residential construction contract calls for copper water supply lines but the builder uses PVC? Or a contractor uses the wrong color mortar and brick?

In a defect dispute, the owner is generally entitled to the building as specified in the contract. Often that means the owner receives the cost to repair and place the project in the condition called for in the contract. But if the cost to repair is grossly disproportionate to the actual benefit of that repair, should the owner receive that remedy? This question highlights the concept of “economic waste.”

“Economic waste” is a legal protection that prevents the unnecessary use of financial resources to repair a defect. With the discolored brick and mortar, must the contractor fully remove and replace the brick? What if the mortar is not only discolored but also structurally weak? If the building lacks structural integrity, most courts would require removal and replacement. But if the only defect is the use of the wrong color, should the result be the same? Although each case is unique, a cosmetic defect often does not justify complete removal and replacement. In that instance, the excessive cost to remove and replace components outweighs the benefit to the owner.

What about the case of a garage built using trusses different than those shown in the plans? The storage area ceiling is six inches lower than expected. Must the contractor remove the roof and trusses and replace them? Unless the structure is unsound, probably not. The cost to do so would be extreme. And in most cases, that cost would be disproportionate to the value of the extra storage space – an “economic waste.” Instead, the owner should receive the difference in fair market value between the structure as contracted for and the structure as built. This ensures the owner pays for what it received. It also prevents unnecessary economic harm to a contractor when it substantially complied with the contract.

Of course, not all instances of cosmetic defect implicate economic waste. If cosmetic elements are the primary purpose of a component, replacement may be necessary to achieve substantial compliance. But when a contractor substantially complies, an owner has no right to perfection, especially if achieving perfection is disproportionately expensive.

When facing a defect, an owner must consider whether a repair short of removal and replacement would allow the building or system to function. If so, that alternative may be appropriate and legally required. But contractors must understand the importance of full compliance whenever possible. And they must be ready to craft a remedy that gives the owner a finished product it can use.

Be a Good Neighbor: Techniques to Mitigate the Risk of Claims From Adjacent Landowners

Joshua Levy, Josh Neudorfer and Madeleine Bailey | Construction Executive

In May 2020, a real estate developer performing excavation work in New York was sued by a neighboring property owner for property damage. A court overturned an injunction preventing the developer from continuing excavation work after reviewing a preconstruction assessment that showed the damage to the neighboring property was preexisting—not caused by the excavation (see Feldman v. 3588 Nostrand Ave. LLC as an example)

A preconstruction assessment is one of the most important tools in the arsenal of a developer protecting itself from neighbors bringing claims for property damage. Part two of this series will review the benefits of risk mitigation tools recommended for developers such as postconstruction assessments and monitoring during construction.

PRECONSTRUCTION ASSESSMENT OVERVIEW

A preconstruction assessment is a review of a property adjacent to a site where demolition and/or construction activities are to take place. The goal of the assessment is to establish baseline conditions by conducting an inspection of buildings and infrastructure, including identification of existing damage to improvements, so that causation of any alleged damages can be more easily determined.

The types of construction activities that would warrant a preconstruction assessment include foundation work in close proximity of adjacent structures; overhead work such as scaffolding and overhead crane access; demolition work generally, and particularly where blasting work or explosives are used; delivery routes where heavy hauling will occur; and construction work above existing utilities or transportation lines (i.e. subway tunnels).

The following items should be included in a preconstruction assessment:

  • Location of the proposed structure and adjacent structures;
  • Evaluation of potential concerns and sensitive buildings and/or infrastructure;
  • Location and conditions of existing structures or monuments;
  • Existing roads and parking lots to be retained;
  • All utility lines, gas lines, phone lines or cable lines near the proposed construction area;
  • Any existing objects to be demolished, and any existing trees or vegetation to be retained;
  • Observed deficiencies and anomalies;
  • Identification of conditions such as background noise, lighting, vibrations, water conditions and ambient air quality sufficiently in advance of project commencement; and
  • Still photos, videos and survey documentation of existing conditions in addition to a written summary of findings.

Preconstruction Assessment Technology


The preconstruction assessment can be conducted using photo, video, survey tools including laser scanning, vibration monitoring equipment and a variety of other tools depending on the nature of the work being conducted. For example, decibel meters should be used when noisy work is anticipated, and passive and active collectors should be used when air quality will be affected. The preconstruction assessment should also evaluate subsurface conditions that are important to wave transmission such as localized geotechnical information and regional soil conditions and lithology. The preconstruction assessment can also be used to identify signs of structural issues on adjacent properties that should be monitored throughout the construction to monitor potential changes. The preconstruction assessment can ultimately be compared to a follow-up post-construction assessment to determine whether damage occurred during construction.

Who Should Conduct a Preconstruction Assessment?

A third-party engineering group should conduct the assessment to minimize conflicts of interest. The conducting party and the adjacent property owner may want to retain their own third-party investigators to provide separate condition assessments. This is acceptable, however, both parties should meet to review the condition assessments and confirm and agree as to the existing conditions on the neighboring property.

ESTABLISHING A REGULATORY BASELINE

In addition to establishing a baseline for structural site conditions, developers should consider involving relevant regulators in the project before project commencement, for example, by inviting the regulator to the jobsite prior to commencement. This way, the regulator is aware of baseline site conditions and is familiar with the site and the project scope. Early involvement of relevant regulators sets a productive tone for the relationship, and can be a cost-saving measure as it prevents delay-inducing surprises that can result from involving a regulator later in the project or after issues arise.

MONITORING DURING DEMOLITION/CONSTRUCTION

Monitoring during demolition and construction can allow developers to identify concerns quickly, allowing for rapid work modifications and proactive management of contractor behavior to limit more severe issues that might develop during field activities. Often, early discovery of a developing issue can lead to proper identification of the root source of the issue, potentially a source wholly unrelated to the work on site. Developers should consider use of monitoring tools that alert project managers of site conditions in real time.

The background assessment provides a key element to addressing potential concerns identified during the on-going monitoring process, as it allows for a comparison to baseline conditions. Monitoring detail will be addressed in part three of this series.

This is the second article in a three-part series. Part one reviewed how to avoid a lawsuit on a project in close proximity to other buildings.

Be a Good Neighbor: Protect Against Claims by an Adjacent Landowner During Construction

Joshua Levy and Madeleine Bailey | Construction Executive

There’s nothing like working in an office while pilings are being pounded into the ground next door, leading to crashing sounds of pile driving and the attendant afternoon headaches. Fortunately, that’s often the extent of a neighboring project’s real inconvenience. In other cases, however, construction in close quarters can mark the beginning of costly and emotional disputes, which can escalate to costly legal battles during and after construction.

NUISANCE AND STRUCTURAL DAMAGE CLAIMS

Construction claims are often based on the concept of “nuisance,” or on structural damage to adjacent property. Nuisance claims are typically based on noise and dust from construction sites, while structural damage claims are based on direct physical damage caused by neighboring demolition, vibrations, excavation and dewatering. These types of claims can result in monetary damages for neighbor plaintiffs, loss of permits for contractors and reputational damage to the developer.

In one recent case in New York City, the developer faces up to $10 million in damages in a lawsuit with a neighboring property owner. The developer was conducting excavation, dewatering and installation of steel sheet piles, which the plaintiff alleges caused its five-story building to settle and shift, rendering doors inoperable and causing extensive cracking and separation of floors and ceilings from walls and supports. The plaintiff filed its complaint on Jan. 24, 2019, and the lawsuit is ongoing, exemplifying that construction claims such as these can be time consuming and costly (Complaint, 642 East 14th St. v. 644 E. 14th Realty [N.Y. Sup. Ct. January 24, 2019]).

Non-monetary costs associated with adjacent property damage claims can also be steep. In one infamous Philadelphia case, a construction crew destroyed a shared foundation wall while working underground, causing the ceiling of the neighboring rowhouse to cave in, and the stairs to separate from the wall. The city ordered demolition of the neighboring house, revoked the contractor’s permits and ordered a district attorney investigation of the incident.



Nuisance claims can be similarly costly. In a Texas nuisance case, plaintiff homeowners sued a developer constructing a project near their homes, alleging that vibrations, lights and noise caused “loss of use and enjoyment” of their properties. The court upheld an award of more than $200,000 to the neighbors even though the developer held proper city permits. The court specifically relied on the facts that the contractor worked “around the clock” for approximately four months, including weekends and holidays, using bright lights placed directly behind the plaintiffs’ homes to illuminate the worksite at night. Some of this around-the-clock work included excavation work performed within 20 feet of one of the plaintiff’s homes. The court held that these actions were “abnormal and out of place.” ( C.C. Carlton Indus. v. Blanchard, 311 S.W.3d 654 [Tex. App.—Austin, 2010, no pet.])

RISK-MITIGATING MEASURES

High-risk projects in urban or high-density areas also put developers at risk of being sued by neighbors falsely claiming that preexisting damage was caused by the developer’s construction. Preconstruction surveys can save developers from opportunistic neighbors by debunking claims that they caused such damages.

One New York court reversed a previous injunction which prevented a developer from construction based on evidence shown in a preconstruction survey. In this case, the plaintiff alleged property damage resulting from excavation work. The court specifically relied on an independent engineering report showing that the damages alleged by the plaintiff were actually preexisting as shown by the preconstruction survey. (Feldman v. 3588 Nostrand Ave. LLC, 2020 NY Slip Op 31274 [U], ¶ 18 [Sup. Ct.])

Minimizing potential nuisance claims is a bit simpler. Developers can mitigate this risk by maintaining appropriate work hours and good worksite housekeeping practices. Also, developers should conduct a thorough review of the jurisdiction’s noise and vibration ordinances to ensure compliance. Proactive developers may consider visiting neighbors in advance to review the days and times when more obtrusive activities will take place.

Finally, while nuisance and structural damage claims can result in costly damage awards, the potential costs to goodwill between neighboring property owners should not be overlooked. Recognizing the disruption a project will cause and implementing disturbance mitigation measures can help owners and contractors avoid neighbor disputes.

This is the first article in a three-part series. Parts two and three will review preventative measures that can mitigate the relational fallout from construction incidents, and minimize the chances a construction project is tied up in costly and time consuming litigation.

Fifth Circuit Holds Insurer Owes Duty to Defend Latent Condition Claim That Caused Fire Damage to Property Years After Construction Work

Jeremy S. Macklin | Traub Lieberman

Most general liability policies only provide coverage for “property damage” that occurs during the policy period. Thus, when analyzing coverage for a construction defect claim, it is important to ascertain the date on which damage occurred. Of course, the plaintiffs’ bar crafts pleadings to be purposefully vague as to the date (or period) of damage to property. A recent Fifth Circuit decision applying Texas law addresses this coverage issue in the context of allegations of a condition created by an insured during the policy period that caused damage after the policy expired.

In Gonzalez v. Mid-Continent Cas. Co., 969 F.3d 554 (5th Cir. 2020), Gilbert Gonzales (the insured) was a siding contractor. In 2013, the underlying plaintiff hired Gonzales to install new siding on his house. In 2016, the underlying plaintiff’s house was damaged in a fire. The underlying plaintiff sued Gilbert in Texas state court alleging that when Gonzalez installed the siding in 2013, he hammered nails through electrical wiring and created a dangerous condition that caused a fire three years later in 2016.

At the time Gilbert performed construction work, he was insured by Mid-Continent Casualty Company. Mid-Continent disclaimed coverage to Gonzales on the basis that the complaint unequivocally alleged that property was damaged in 2016 and there were no allegations that property damage occurred prior to 2016 or was continuing in nature.

The Fifth Circuit started its analysis by acknowledging Texas’ strict eight-corners rule for determining an insurer’s duty to defend. Relying on prior Texas and Fifth Circuit decisions (Don’s Building Supply, Inc. v. OneBeacon Insurance Co.Wilshire Insurance Co. v. RJT Construction, LLC, and VRV Development L.P. v. Mid-Continent Casualty Co.), the court narrowed its focus to “actual, physical damage alleged in the underlying litigation.” The court reasoned, “[i]f the only alleged damage occurred outside of the policy period, then there is no duty to defend. But if any of the alleged damage occurred during the policy period, then the duty to defend attaches.”

The court held that the underlying lawsuit “plainly alleges physical injury to property that occurred within the policy period.” The court identified three reasons for its holding: (1) the underlying complaint stated that the 2016 fire “relates back to [the] construction and/or installation of siding” in 2013, (2) the policy defined “property damage” to include “all resulting loss of use of that property,” so damage to the wire includes damage to the entire house, and (3) the underlying plaintiff’s claim of damages alleged that “the electrical wires were damaged in 2013.”

Judge Catharina Haynes dissented, explaining that she would hold that property damaged occurred after the policy period ended, when the fire broke out in 2016. Judge Haynes agreed that the court is bound by Don’s BuildingWilshire, and VRV Development, but she emphasized that those cases also hold that when an underlying plaintiff alleges actual, physical damage due to the insured’s negligent conduct, the alleged property damage does not relate back to the time of the negligent act when determining when the property damage occurred. Judge Haynes criticized the majority for focusing on the time of the negligent conduct.

The Gonzales decision highlights the importance of analyzing each allegation in an underlying pleading to determine when any physical injury may have occurred. The dissent also leaves the door open for a different panel of Fifth Circuit judges to distinguish or reverse Gonzales.

Owner Disgorgement Claims Against Unlicensed Contractors Given Short Statute of Limitations

Matthew T. Porter | Smith Currie & Hancock

Eisenberg Village of the Los Angeles Jewish Home for the Aging v. Suffolk Construction Company, Inc. (2020) 53 Cal.App.5th 1201.

Under California Business and Professions Code section 7031(b), “a person who utilizes the services of an unlicensed contractor may bring an action … to recover all compensation paid to the unlicensed contractor for performance of any act or contract.” The Court of Appeal held that such disgorgement claims against unlicensed contractors are (1) subject to a one-year statute of limitations and (2) accrue upon the completion or cessation of the performance of the act or contract at issue.

Eisenberg Village of the Los Angeles Jewish Home for the Aging (“Eisenberg”) hired Suffolk Construction Company, Inc. (“Suffolk”) to construct a 108-unit assisted living facility. During construction, Suffolk’s responsible managing employee (“RME”) moved to another state, no longer supervising anyone at Suffolk connected with the project. As a part of its claim for construction defects against Suffolk, Eisenberg included a claim for disgorgement under section 7031(b), alleging that Suffolk was not a duly licensed contractor at all times during the project because Suffolk was out of compliance with RME requirements. Suffolk argued Eisenberg’s disgorgement claim was barred by the statute of limitations. The Court of Appeal agreed.

Statute of Limitations for Section 7031(b) Disgorgement Claim

Because section 7031(b) does not set forth a limitation period, the court looked to the California Code of Civil Procedure (“CCP”) to determine the applicable statute of limitations for Eisenberg’s disgorgement claim. The question turned on whether section 7031(b) disgorgement was a “penalty or forfeiture.” The court noted that section 7031(b) disgorgement “deprives the contractor of any compensation for labor and materials used in the construction while allowing the plaintiff to retain the benefits of that construction.” It also noted that a plaintiff may bring such a claim “regardless of any fault in the construction by the unlicensed contractor.” For these reasons, the court held that a section 7031(b) disgorgement claim is a penalty and is, therefore, subject to CCP § 340(a)’s one-year statute of limitations.

Accrual of Section 7031(b) Disgorgement Claim

After determining that the one-year statute of limitations applies, the court turned to the question of when Eisenberg’s disgorgement claim accrued. Eisenberg argued that the “discovery rule” applied and that the statute of limitations did not begin to run until Eisenberg discovered the potential issue with Suffolk’s licensing, which was well after completion of the project. The court rejected this argument. The court reasoned that a contractor’s unlicensed status does not in itself cause harm to a plaintiff, so delaying accrual of the statute of limitations until discovery of harm would leave accrual of the limitations period open ended. The court also sought to avoid what it considered the “absurd result” of plaintiffs bringing disgorgement claims long after the successful completion of a project based on a lapse or suspension of a contractor’s license during the project.

Comment

This case significantly reduces the power of section 7031 to protect the public from unlicensed contractors. The burden is now on project owners and other participants to investigate and uncover any licensure issues of participating contractors and bring section 7031(b) claims against those contractors within one year of the contractor’s ceasing performance on the project. In some cases, this may prove to be impracticable, and in many cases—especially where subtle automatic license suspension issues are involved—this will necessitate aggressive litigation action by counsel to preserve potential disgorgement claims.

This ruling may also affect the litigation strategy of contractors in their disputes with owners. For example, contractors who are aware of potential licensure issues during the course of a project may want to consider delaying the pursuit of their claims against an owner until after the one-year statute of limitations has run on the owner’s potential disgorgement claim. Of course, this strategy may require the contractor to forego its lien rights by declining to bring an action within 90 days to perfect its lien rights.

Finally, this case is plowing new ground, and there is much room for other courts to disagree with the Eisenberg Court’s ruling.  Expect further litigation of these statute of limitations issues.