Including Non-Signatory Subcontractors in Arbitration Clauses in Construction Contracts

Jaime Dewees | Framing Issues

Arbitration is an increasingly popular forum for the resolution of construction disputes.  It often provides a more predictable procedural process specially designed for the industry in light of construction-specific rules and mediation procedures enacted by alternative dispute resolution providers, such as the American Arbitration Association (AAA). Of course, there are pros and cons to private arbitration proceedings administered by AAA and other organizations, including, among other things, those discussed in last week’s post about the increased up-front costs incurred to initiate an arbitration proceeding and paying the fees and expenses associated with a single arbitrator or multiple arbitrator panel. On the other hand, construction arbitrators are generally highly-qualified and experienced construction attorneys and industry professionals capable of resolving complex and highly-technical disputes  Given the complexity of construction disputes this is often advantageous and preferable to a state court judge or jury of laypersons with little or no construction experience.

When planning a construction project, construction professionals should anticipate claims or controversies and make an informed decision up front about the ideal forum for resolving these disputes when they inevitably arise.  Whether arbitration or litigation is preferred depends on a number of time and expense factors, as discussed above.  However, if arbitration is preferred, then “consistency is key” in order to bring all claims and controversies into an arbitration involving many contractors and subcontractors (and their subcontractors and vendors) and to avoid piecemeal dispute resolution outside of arbitration.

The arbitration clause in construction contracts defines the scope of the claims, controversies, and disputes arising from construction projects and directly influences the parties that are bound by an agreement to arbitrate.  The contracting parties should express a clear intent to arbitrate, and must also consider other parties who do not actually sign the construction contract but are nevertheless contemplated by the terms of the operative agreement. In Texas, a non-signatory to an agreement to arbitrate within a construction contract—including a subcontractor, for example—may be compelled to arbitration under legal theories establishing the non-signing subcontractor’s agency with and for another contractor, or as an alter ego of a general contractor that is in essence the same entity as between the general contractor and subcontractor (which is, generally, difficult to prove absent fraud).

At the outset of beginning a construction project, contracting parties can contemplate and capture non-signatories to the main construction contract through incorporating by reference the respective party’s signed subcontract agreements or even reference to the subcontractors themselves. Generally, contracting parties seeking to arbitrate their disputes must establish both a valid agreement to arbitrate and that their claims fall within that agreement’s scope. See Jody James Farms, JV v. Altman Grp., Inc., 547 S.W.3d 624, 629 (Tex. 2018) (citing In re Kellogg Brown & Root, Inc., 166 S.W.3d 732, 739 (Tex. 2005)). If the goal is to keep construction disputes wholly confined in the arbitration forum, the arbitration clause must be given special focus.  That is, the owner/developer and its general contractor, and all subcontractors and second-tier or below subcontractors, should be expressly contemplated by and accounted for in the arbitration clause.  The parties to the prime construction contract should endeavor to reference all of their respective signed subcontract agreements, to the extent they exist, as well as develop the arbitration clause to capture all disputes arising from the construction project and include joinder or consolidation with the arbitration proceeding of any other person or entity that is necessary to resolve the claim, controversy, or dispute, or that is substantially involved in or affected by the same. In doing so, the contracting parties can better avoid bringing piecemeal, fact-intensive litigation against subcontractors.

It is often penny-wise and pound-foolish not to consult with an experienced attorney when drafting a construction contract on any project of significance.  A well-drafted arbitration provision can later save significant time and expense in an effort to avoid costly multi-party (and potentially multi-forum) litigation.  The KRCL Construction Team has significant experience guiding clients through the contract formation process.  The cost of preparing an enforceable arbitration provision costs pennies on the dollar as compared to potential extensive discovery and prolonged litigation in state or federal court.

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

Jeremy Macklin | Traub Lieberman Straus & Shrewsberry

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.

10 Reasons to Intervene in Bid Protests

Aron C. Beezley | Buildsmart

As we noted recently, the number of bid protest filings peaks in October as a result of increased government spending at the end of the government’s fiscal year, which ends September 30. Thus, our previous article provided a fiscal year-end refresher for government contractors on the process for intervening in bid protests at both the Government Accountability Office and the U.S. Court of Federal Claims. This follow-up article provides 10 reasons why government contractors should consider intervening in bid protests.

10 Reasons Why

  1. The contracting agency’s interests may not be the same as your company’s interests, and your company is in the best position to protect and advocate for its own interests. In fact, contracting agencies owe an equal duty to all offerors, and thus their interests are broader than, and potentially distinct from, your company’s interests.
  2. Some government attorneys have limited resources or are overworked. Other government attorneys are “green” when it comes to bid protests because their offices simply do not see very many of them.
  3. Intervening will help your company better protect its confidential and/or proprietary information if it becomes part of the record during the bid protest.
  4. Similarly, by intervening, your company will be in a better position to protect its business reputation.
  5. Your company knows its proposal better than anyone. As such, your company is best equipped to rebut challenges to your technical proposal, cost/price proposal and past performance. Likewise, intervenors often are in the best position to respond to allegations regarding key personnel and organizational conflict of interest (OCI) matters.
  6. An intervenor can make arguments that, for whatever reason, the government fails to address.
  7. If your company is the incumbent-contractor, then you may be more knowledgeable than the protester (and possibly the government) about the actual work under protest. As such, incumbent contractors may be uniquely able to rebut the protester’s assertions about the scope and nature of the work at issue.
  8. In a U.S. Court of Federal Claims bid protest, your company, as an intervenor, will be able to more persuasively and specifically articulate the harms that it will suffer if a temporary restraining order or an injunction is issued in connection with the protested contract.
  9. Most bid protests are covered by a protective order that prohibits the attorneys from disclosing protected information (i.e., confidential, proprietary and source selection sensitive information). By intervening, however, your company will have the ability to be better informed about the course of the protest and the status of the procurement (subject, of course, to the terms of any protective order that is issued in the protest).
  10. If the contracting agency decides to take corrective action in response to the protest, an intervenor will be in a much better position than a non-intervenor in terms of being able to influence the scope and nature of the corrective action.

Intervention in Bid Protests: A Fiscal Year-End Refresher

Aron C. Beezley | Buildsmart

As a result of increased government spending at the end of the government’s fiscal year — which is the 12-month period beginning on October 1 and ending on September 30 — the number of bid protest filings peaks in October. Accordingly, government contractors should be particularly mindful this time of year of their rights with respect to intervening in bid protests both at the Government Accountability Office (GAO) and the U.S. Court of Federal Claims (COFC).

Who May Intervene in Bid Protests?

GAO Bid Protests

The GAO’s Bid Protest Regulations provide the following definition of “intervenor,” in relevant part: “Intervenor means an awardee if the award has been made or, if no award has been made, all bidders or offerors who appear to have a substantial prospect of receiving an award if the protest is denied” (4 C.F.R. § 21.0(b)(1)).

U.S. Court of Federal Claims Bid Protests

The rules of the COFC allow for two types of intervention: (1) intervention as of right and (2) permissive intervention. With respect to intervention as a matter of right, COFC Rule 24(a)(2) requires a would-be intervenor to demonstrate, via a “timely motion,” that (1) its interests relate to a property or transaction that is the subject of the proceedings, and (2) its interests are so situated that disposition of the action may impair or even impede its ability to protect that interest.

Pursuant to Rule 24(b) — which governs permissive intervention — the COFC may allow anyone to intervene who (1) files a timely motion; (2) is given an unconditional right to intervene by a federal statute or has a claim or defense that shares with the main action a common question of law or fact; and (3) whose intervention will not delay or prejudice the adjudication of the original parties’ rights.

When determining whether a potential intervenor’s motion is timely, the COFC considers (1) the length of delay in making the application for intervention; (2) whether the prejudice to the existing parties by allowing intervention outweighs the prejudice to the would-be intervenor by denying intervention; and (3) the existence of “unusual circumstances” weighing either for or against intervention (see Belton Indus., Inc. v. United States).

Notably, the U.S. Court of Appeals for the Federal Circuit has held that the requirements for intervention are to be “construed in favor of intervention” (see Am. Mar. Trans., Inc. v. United States).

How Do You Intervene in a Bid Protest?

GAO Bid Protests

The GAO’s Bid Protest Regulations require the contracting agency to “immediately” provide a potential intervenor with notice of the protest. Specifically, the regulations state, in pertinent part:

GAO shall notify the agency by telephone within 1 day after the filing of a protest, and, unless the protest is dismissed under this part, shall promptly send a written confirmation to the agency and an acknowledgment to the protester. The agency shall immediately give notice of the protest to the contractor if award has been made or, if no award has been made, to all bidders or offerors who appear to have a substantial prospect of receiving an award. The agency shall furnish copies of the protest submissions to those parties, except where disclosure of the information is prohibited by law, with instructions to communicate further directly with GAO… (4 C.F.R. § 21.3(a))

The next step in the process is for the potential intervenor to promptly file with the GAO a “notice of intervention.” The notice typically is a brief letter that includes the name, address, and telephone and fax numbers of the intervenor or its representative, if any, and advises the GAO and all other parties of the intervenor’s status.

U.S. Court of Federal Claims Bid Protests

A party seeking to intervene in a COFC bid protest must file with the COFC — and serve on all parties — a motion to intervene (see RCFC 24(c)). The motion must “state the grounds for the intervention and be accompanied by a pleading that sets out the claim or defense for which intervention is sought.” Before filing the motion to intervene, it is generally prudent to ask the other parties to the protest whether they oppose the motion and then to state in the motion whether the parties oppose the motion.

Fifth Circuit Holds That Ensuing Loss Provision of Builders’ Risk Policy Requires Two Separate Events to Qualify for the Construction Exclusion Carve-Out

Benjamin Stearns | PropertyCasualtyFocus

In Balfour Beatty Construction, LLC v. Liberty Mutual Fire Insurance Company, No. 19-20216 (August 3, 2020), the Fifth Circuit determined that Liberty Mutual’s policy does not cover a construction company’s claim for window damage to a skyscraper caused by a subcontractor’s welding because the policyholder failed to show the damage resulted from a covered peril.

The case turned on the court’s interpretation of the policy’s construction exclusion, which included an exception for “an act, defect, error or omission that results in a covered peril.”  The policy defined “covered peril” as a “risk[] of direct physical loss or damage unless the loss is . . . caused by a peril that is excluded” under the policy. The court characterized the exception as an “ensuing loss provision” or a “resulting loss provision,” which “act as exceptions to property insurance exclusions and operate to provide coverage when, as a result of an excluded peril, a covered peril arises and causes damage.” Such provisions are “only triggered when one (excluded) peril results in a distinct (covered) peril, meaning there must be two separate events for the exception to trigger.” (emphasis added).

The policyholder’s claim resulted from damage to a skyscraper’s windows caused by molten slag dripping and blowing in the wind from a welding job being conducted 18 stories up on the same building. The parties agreed that the damage would be excluded (because it resulted from an act or error relating to construction), unless the ensuing loss exception applied.

The Fifth Circuit found that the ensuing loss exception did not reinstate coverage because there was no second, separate event that caused the damage. “Put simply, Appellants’ welding operation involved falling slag, which damaged the exterior glass of [the building]. The welding operation is inseparable from the falling slag; they are not two separate events. The falling slag is not an independent event that resulted in a covered peril.” The court contrasted this sequence of events with a hypothetical claim involving a construction-related act that caused holes in the windows, with subsequent water damage to the interior of the building resulting from a storm that forced water through the holes. In such a case, the water damage would be covered by the ensuing loss provision, although the damage to the windows themselves would be excluded.

The court rejected the appellants’ attempt to fit the claim within the reading of the exception adopted by the court, reasoning that while it could be argued that “the slag is separable from the welding operation, we do not think that a single phenomenon that is clearly an excluded risk under the policy was meant to become compensable because in a philosophical sense it can also be characterized as a distinct peril.”

As a result, the Fifth Circuit held that the claim was excluded, affirming summary judgment in Liberty Mutual’s favor.