Construction Risk

Liquidated Damages Properly Assessed against Design-Builder Without Regard to Whether Excessive Compared to Actual Damages

admin — Thu, 12 Jan 2012 21:17:03 +0000

Where a design-builder (“contractor”) was assessed liquidated damages by the Contracting Officer under a U.S. Coast Guard contract for the design and construction of prefabricated metal buildings, the contractor filed suit against the Government seeking remission of the liquidated damages based on its argument that the amount set for the LDs was arbitrary and not consistent with actual damages. The court denied the contractor’s motion for summary judgment on the issue of liquidated damages, concluding that there was no evidence that when the amount of the liquidated damages was established during contract formation that the LDs were without reasonable relation to any probable damage which may follow from delay or breach of contract. The contractor sought to prove that the LD rate was arbitrary by showing that different rates had been used by the Coast Guard on different similar projects, and also that certain components of damages included with the LDs (e.g., Govt personnel costs and administrative costs) were inappropriately included. In rejecting the contractor’s argument, the court stated that just as a contractor can recover its own personnel and administrative costs as part of damages claimed against the Government in various claims, so likewise the Government can claim its personnel and administrative costs when it has a claim against the contractor. As far as different rates being applied by the Government on other projects, the court said the only relevant matter was whether the rate on this particular project was appropriate – and that is judged principally by what appeared reasonable at the time of contract execution. K-Con Building Systems, Inc. v. United States, 97 Fed.Cl. 41 (2011).

The court’s analysis of the matter is so well stated (with supporting case law) that it will be quoted herein at length as follows:

Liquidated damages are used “to allocate the consequences of a breach before it occurs,” Jennie–O Foods, Inc. v. United States, 580 F.2d 400, 412 (Ct.Cl.1978) (per curiam), which “save[s] the time and expense of litigating the issue of damages,” DJ Mfg. Corp. v. United States, 86 F.3d 1130, 1133 (Fed.Cir.1996). Liquidated damages “serve a particularly useful function when damages are uncertain in nature or amount or are unmeasurable, as is the case in many government contracts.” Priebe & Sons, Inc. v. United States, 332 U.S. 407, 411, 68 S.Ct. 123, 92 L.Ed. 32 (1947). Thus, “[w]here parties have by their contract agreed upon a liquidated damages clause as a reasonable forecast of just compensation for breach of contract and damages are difficult to estimate accurately, such provision should be enforced.” Jennie–O Foods, Inc., 580 F.2d at 413–14; see also FAR 11.501 (noting that use of a liquidated damages clause is proper if damages “would be difficult or impossible to estimate accurately or prove” and that the “rate must be a reasonable forecast” of the anticipated damages).

On the other hand, courts will not enforce a liquidated damages clause when the amount of liquidated damages is “plainly without reasonable relation to any probable *50 damage which may follow a breach,” Kothe v. R.C. Taylor Trust, 280 U.S. 224, 226, 50 S.Ct. 142, 74 L.Ed. 382 (1930), or is “so extravagant, or so disproportionate to the amount of property loss, as to show that compensation was not the object aimed at or as to imply fraud, mistake, circumvention, or oppression,” Wise v. United States, 249 U.S. 361, 365, 39 S.Ct. 303, 63 L.Ed. 647 (1919). In these circumstances, liquidated damages amount to a penalty. Priebe & Sons, Inc., 332 U.S. at 413, 68 S.Ct. 123; United States v. Bethlehem Steel Co., 205 U.S. 105, 118–21, 27 S.Ct. 450, 51 L.Ed. 731 (1907).

When presented with a challenge to a liquidated damages clause, a court must judge the clause “as of the time of making the contract” and without regard to the amount of damages, if any, actually incurred by the nonbreaching party. Priebe & Sons, Inc., 332 U.S. at 412, 68 S.Ct. 123; accord Bethlehem Steel Co., 205 U.S. at 119, 27 S.Ct. 450 (noting that courts will enforce liquidated damages clauses “without proof of the damages actually sustained”); Steve Kirchdorfer, Inc. v. United States, 229 Ct.Cl. 560, 565–67 (1981) (upholding an award of liquidated damages although no actual damages were sustained); Young Assocs., Inc. v. United States, 471 F.2d 618, 622 (Ct.Cl.1973) (“It is enough if the amount stipulated is reasonable for the particular agreement at the time it is made.”). The party challenging a liquidated damages clause—typically, in government procurement cases, the contractor—bears the burden of proving that the clause is not a penalty. DJ Mfg. Corp., 86 F.3d at 1134; Jennie–O Foods, Inc., 580 F.2d at 414. The burden is a heavy one “because when damages are uncertain or hard to measure, it naturally follows that it is difficult to conclude that a particular liquidated damages amount or rate is an unreasonable projection of what those damages might be.” DJ Mfg. Corp., 86 F.3d at 1134. And because of this difficulty, it is generally improper for a court “to inquire into the process that the contracting officer followed in arriving at the liquidated damages figure that was put forth in the solicitation and agreed to in the contract.” Id. at 1137; see also id. at 1136 (noting that courts will enforce a liquidated damages clause, “regardless of how the liquidated damage figure was arrived at,” if the amount of liquidated damages is reasonable).

The court further stated that if the contractor’s position is that the LD rate is unreasonable because a component of the rate is improper, the contractor must prove that the component amount is improper as it relates to the particular contract at issue. And that determination is based on what was reasonable when the contract was entered into rather than what may look reasonable in hindsight. As stated by the court:

In other words, it is plaintiff’s burden to demonstrate that the Coast Guard could not have expected, at the time the parties executed the Elizabeth City contract, to spend $8,444 per month on inspection services if the project was delayed. Merely asserting that $8,444 per month is unreasonable because the Coast Guard used different amounts for different projects does not suffice.

On the issue of whether the contractor should be excused from paying liquidated damages because it was delayed due to defective specifications, the court found the contractor did not prove either that as a design-builder, the contractor did not prove that the Government was legally responsible for the specifications, but that even if Contractor had established that the Coast Guard caused a delay through the provision of defective specifications, the contractor had not proved that the Coast Guard affected the critical path of performance and thereby delayed the overall contract completion. For these reasons, the court denied the design-builder’s motion for summary judgment.

Comment: This case reiterates an important point that needs to be understood by contractors and that is that it is difficult to challenge the Liquidated Damages rate after they are imposed – arguing that the actual damages are lower or that in hind-sight the LD’s are unreasonable. The key as stated by the court is whether the amount set for the LDs was reasonable based on information available to the Contracting Officer at the time the contract was executed.

About the author: Article written by J. Kent Holland, Jr., a construction lawyer located in Tysons Corner, Virginia, with a national practice (formerly with Wickwire Gavin, P.C. and now with Construction Risk Counsel, PLLC) representing design professionals, contractors and project owners. He is founder and president of a consulting firm, ConstructionRisk, LLC, providing consulting services to owners, design professionals, contractors and attorneys on construction projects. He is publisher of ConstructionRisk.com Report and may be reached at Kent@ConstructionRisk.com or by calling 703-623-1932. This article is published in ConstructionRisk.com Report, Vol. 14, No.2 (Feb 2012).

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Contractor Cannot Recover for Extra Work Performed without Change Order Approved by Authorized Officials

admin — Thu, 12 Jan 2012 21:13:29 +0000

A design-build contractor that entered into a fixed-price contract to upgrade the heating, air conditioning and ventilation (HVAC) system in college dormitories satisfactorily performed all the work it was contracted to do, but also performed significant additional work to correct problems with the existing HVAC system that had not been identified at the outset of the project. Although the additional work was “approved” by the Construction Manager for the University, it was not submitted and approved by the University Purchase Department as required by the contract to obtain a change order. The court in Mallory & Evans Contractors and Engineers v. Tuskegee University, 2010 WL 5137580 (M.D. Ala., Dec. 2010), granted the University’s summary judgment motion dismissing the contractor’s law suit for breach of contract and unjust enrichment – finding that the contractor requirements were clear and the contractor could not rely justifiably on the purported approval of the changes by the CM. Nor could the contractor recover under the principles of unjust enrichment or quantum meruit since there was an express contract applicable to the relationship between the contractor and university, and where there is an express contract there can be no implied contract or quantum meruit.

The original contract amount was $3,850,535. The changes claimed by the design-builder amounted to $765,915. For the design-builder to prevail on its breach of contract action, it would have to prove the University obligated itself contractually to pay the extra cost for the additional work. The University argued that the purchase order specifically required prior approval by the Purchasing Department for such changes that exceed the original contract amount and that satisfying that requirement was a condition precedent to any right to be paid extra. The court agreed. Even if the CM may have represented that he had authority to approve payment of the extra work, this does not bind the University since it was not the University itself that made any representation to the design-builder that it could rely upon the CM instead of going through the official process required by the terms of the contract. As stated by the court, “The scope of an agent’s apparent authority is defined based on the principal’s [University’s] representations to third parties concerning the agent’s authority…. Apparent authority ‘rests upon the principle of estoppel, which forbids one by his acts to give another an appearance of authority which he does not have and to benefit from such misleading conduct to the detriment of one who has acted in reliance upon such appearance.” The University made no such representations in this case, it was only the CM who may have made representations.

With regard to the fact that the design-builder may have encountered “unforeseen contingencies with respect to the amount of work that needed to be done,” the court said that is irrelevant because “The contract did not give [design-builder] a mandate to get the work done no matter the cost.” The court states that the design-builder “did not protect itself contractually in [its] … proposal for unforeseen contingencies [ and ] is not entitled to compensation for the additional work simply because it was done.” No recovery is available for the design-builder under the principles of unjust enrichment or quantum meruit, because the court states “[U]nder Alabama law, claims of both an express and implied contract on the same subject matter are generally incompatible.” For these reasons, the court granted summary judgment against the design-builder.

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Engineer Required to Indemnify Client for Costs of First Party Claim, Including Attorneys Fees to Extent Attributable to Engineer

admin — Thu, 12 Jan 2012 21:12:16 +0000

Pursuant to a contractual indemnification clause, a trial court awarded damages of $810,000 in attorneys fees against an engineer in favor of a project owner, Wal-Mart Stores, Inc., on a jury verdict of $48,600 in actual property damages. Wal-Mart’s first party claim against the engineer, a general contractor, and others was for damages arising out of stress and failure within a store and parking lot on which the engineer had provided geotechnical and design services to allow the store and lot to be built on a layer of clay just below the surface. A jury found the total damages to the building were $486,000, with engineer being 10% at fault and the general contractor being 90% at fault for the damages. With regard to the parking lot, the jury found no liability on the part of the engineer, but instead found Wal-Mart 50% liable and a general contractor 50% liable, and awarded Wal-Mart $1.6 million in damages for the parking lot. In a post-trial motion, Wal-Mart sought to recover its attorneys fees incurred in the litigation on all the claims (both the ones it succeeded on and the ones it lost). The court awarded the entirety of the attorneys fees against the engineer pursuant to the indemnity provision of the contract. This was reversed on appeal, with the court holding that Wal-Mart’s recovery of attorneys fees should be limited to those claims upon which it prevailed against the engineer. Wal-Mart Stores, Inc. v. Qore, Inc., 647 F.3d 237 (5^th Cir., 2011).

The indemnification clause in question provided the following:

The Testing and Inspection Firm [Qore] further agrees to indemnify and hold Wal–Mart free and harmless from any claim, demand, loss, damage, or injury (including Attorney’s fees) caused by any negligent act or omission by the Testing and Inspection Firm, its agents, servants, or employees.

An initial question to be determined by the court was whether this indemnification only applied to claims brought against Wal-Mart by third parties or whether attorney’s fees were permitted in a first-party dispute (i.e., Wal-Mart directly against the engineer) as well. The court held that the language of the indemnity clause allowed recovery in first-party actions.

Even if first party claims were to be included in the indemnification, however, the engineer argued Wal-Mart’s recovery of attorney’s fees must be limited to those incurred in prosecuting the single claim upon which Wal-Mart prevailed against the engineer, and only to the same fractional share of liability on the building repair claim. Moreover, the engineer argued that the fees were not recoverable under state law. The court agreed that the attorneys fees would not be imposed under state common law or statutory law, but explained that attorney’s fees may be awarded where provided for by contract as was the case here. The court stated:

Here, the attorney’s fee provision in the testing and inspection contract entitled Wal–Mart to reimbursement for those attorney’s fees “caused by any negligent act or omission” on the part of Qore in performing work under the contract. Qore’s duty to reimburse Wal–Mart for its reasonable attorney’s fees was limited accordingly to those fees proximately and legally “caused by” Qore’s negligence, and the matter of causation could only be addressed once the jury made findings on the issue of Qore’s negligence. Until then, Qore’s legal liability remained latent for indemnification purposes. See Hopton, 559 So.2d at 1013 (“[T]here must be legal liability before a claim of indemnity arises.”). Because Wal–Mart’s indemnification rights were derivative of Qore’s negligent acts or omissions, i.e., the fault allocated to Qore on the building repair claim, Qore is only liable for the reasonable attorney’s fees Wal–Mart incurred in enforcing those rights. All other fees were not “caused by” Qore within the meaning of the testing and inspection contract, and could not be awarded thereunder. Wal–Mart’s recovery should have been limited to those attorney’s fees incurred in proving Qore’s liability on the building repair claim.

The court concluded that because the engineer was not found liable on two of three claims submitted to the jury, and the claims were not inextricably tied to a single claim but were readily capable of partition from each other, the attorney’s fees likewise should have portioned among Wal-Mart’s successful and unsuccessful claims. The fees could have been easily segregated along two lines, “those fees incurred in proving liability relating to planning and design, and those fees dedicated to proving liability relating to construction.” The court concluded “Wal-Mart’s successful and unsuccessful claims were not so interwoven that the district court could not have differentiated among Wal-Mart’s attorney’s fees incurred in prosecuting the various claims and defendants.” For these reasons, the appellate court concluded that the trial court’s award of attorney’s fees was an abuse of the court’s discretion and vacated the award accordingly.

Comment: As noted by the court in this case, responsibility for paying attorneys fees incurred by another party can arise by express contract language despite the fact that they would not otherwise be recoverable under state common law or statutory law. When negotiating indemnification clauses in design professional contracts (and other types of contracts as well) it is important, therefore, to carefully craft the clause so that the obligation to indemnify is limited to the extent of damages caused by the design professional’s negligence, and to make the clause applicable only to damages arising out of third party claims against the Indemnitee. It is often assumed that the indemnity clause is only intended to respond to legal liability that the Indemnitee incurs as a result of third party claims, but that may be a bad assumption, as the decision in this case demonstrates that if that is the intent it needs to be clearly stated.

Design professionals should also be aware that the contractual liability exclusion in their professional liability policy states that there is no coverage for liability assumed under indemnification clauses that would not have been imposed by law (meaning either state common law or statutory law). If the only legal basis for recovery of attorneys fees from the design professional is the contractual indemnification language, there is no insurance coverage for those fees since they are not “damages” that would be awarded by the court in the absence of the contract language.

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“Pay-If-Paid Clause” Enforced as Condition Precedent to Subcontractor Right to Payment

admin — Thu, 12 Jan 2012 21:09:19 +0000

A “pay-if-paid” clause was enforceable to deprive a subcontractor (Sub) to sue the general contractor (GC) for withheld retainage where the project owner, a condominium developer, failed to pay the balance it owed to the general contractor which would have included payment for the sub’s retainage. The Alabama Supreme court in Lemoine Company v. HLH Constructors, Inc., 62 So.3d 1020 (AL, 2010), stated that the contract clause made payment from the owner to the GC an absolute condition-precedent to the GC’s duty to pay the Sub. The Sub argued that a separate “pay-when-paid” clause in the same contract required payment within 30 days regardless of whether the GC was ever paid. The court rejected that argument and also rejected the Sub’s argument that it could recover under the theory of Quantum Meruit. Allowing quantum meruit recovery would render the “pay-if-paid” clause meaningless and be contrary to the clearly expressed intent of the parties to the contract. Moreover, according to the court, “when an express contract exists, an argument based on quantum meruit recovery in regard to implied contract fails.” Where the parties clearly agreed upon their respective rights and liabilities in the contract, the “law will permit the enforcement of that agreement as written.” “This Court has consistently held that the freedom to contract is an inviolate liberty interest.”

The “pay-if-paid” clause of paragraph 5 of the contract provided the following:

Notwithstanding anything else in this Subcontract or the Contract Documents, the obligation of [GC] to make any payment under this Subcontract … is subject to the express and absolute condition precedent of payment by [Vista Bella]. It is expressly agreed that [GC] and its surety shall have no obligation to pay for any work done on this Project, until [GC] has received payment for such work from [Vista Bella]. … [Sub] expressly assumes the risk of nonpayment by [Vista Bella].

The GC argued that the above-quoted language clearly states that the Sub assumed the risk of nonpayment by the Developer to the GC and that the condition precedent in that paragraph is enforceable. The court agreed, finding:

The facts of this case indicate that [GC] and [Sub] “knowingly, clearly, and unequivocally enter[ed] into [the subcontract] whereby they agree[d] that the respective liability of the parties [would] be determined by some type of agreed-upon formula,” namely, the condition precedent of paragraph 5; therefore, “Alabama law will permit the enforcement of [the subcontract] as written,” and Vista Bella’s payment to [GC]under the general contract is an enforceable condition precedent to [Sub’s] right to payment under the subcontract.

The Sub argued that the condition precedent in paragraph 5 conflicts with the “pay-when-paid” clause of paragraph 4 of the subcontract and that “the conflict should be resolved in favor of the prior clause.” Paragraph 4 provided, in pertinent part, that “a final payment, consisting of the unpaid balance of the Price, shall be made within 45 days after the last of the following to occur: (a) …; (b) …; (c) Final payment by [Developer] to [GC] under the Contract on account of the Work.”

The court did not see any conflict between the two clauses, but instead found that the “pay-when-clause” does not create a right that was expressly waived by the very clear “pay-if-paid” provision which served as an absolute condition precedent to the right to any payment.

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Contractor Permitted to Sue Architect for Implied Warranty of Specifications

admin — Wed, 04 Jan 2012 17:08:01 +0000

A Builder/Contractor that was building a house for a client/homeowner, used architectural plans that were drafted by an architect under contract with the homeowner, was permitted to sue the architect (with whom it had no independent contract) for breach of implied warranty of the plans and specifications to design the house, aligned in a manner to maximize a hilltop view of the city. After construction began, it was discovered that the house was aligned to view a water tank instead of the city, and the contractor tore it down and started over – and sued the architect for the tear down and reconstruction costs, alleging it relied on the architectural plans and specifications and that case law in Arizona recognizes that design professionals warrant that they have exercised their skills with care and diligence and in a reasonable, non-negligent manner. In North Peak Construction, LLC v. Architecture Plus, Ltd., 254 P.3d 404 (AZ, 2011), the appellate court agreed that the contractor could pursue an implied warranty claim against the architect.

The case precedent the court relied upon for its holding is an Arizona Supreme Court decision – Donnelly Construction Co. v. Oberg/Hunt/Gilleand, 677 P.2d 1292 (AZ, 2007) in which the court held that a contractor need not be in privity of contract with an architect to sue for negligence and breach of implied warranty. The court in that case stated that a design provides an implied warranty “that they have exercised their skills with care and diligence and in a reasonable, non-negligent manner.” In the current mater, the architect acknowledged that a contractor possesses a claim for breach of implied warranty, but argued that absent a contractual obligation, the professional’s duties are “implied-in-law” or pure legal duties, the breach of which would give rise to claims for negligence. The breach of implied warranty claim would thus be identical to the negligence claim, and that the statute of limitations period applicable to negligence claims must be applied to bar both the negligence claim and the breach of warranty claim.

The court stated that it concluded “it very likely” that the implied warranty at issue in this case “sounds in contract” (not necessarily meaning that it “arises out of contract”), but later in the decision said “We decline to decide which statute of limitations is applied to North Peak’s breach of implied warranty claim.” The contractor was also permitted by the court to maintain an action against the individual architect and his wife. The Architect argued that he only signed the contract with the homeowner in his capacity as president of the architectural firm and should therefore not be deemed individually liable. This argument was rejected by the court because the “implied warranty is not based on [homeowner’s contract] with Architecture Plus, Ltd. Rather, the implied warranty is based on (1) North Peak’s alleged reliance on the architectural plans and specifications, (2) Donnelly’s recognition that ‘design professionals’ warrant ‘that they have exercised their skills with care and diligence and in a reasonable non-negligent manner,’ and (3) the alleged signing and sealing by [the individual architect] of the plans and specification.” For these reasons, the court reversed the trial court’s dismissal of the breach of warranty claim, and remanded the case for further proceedings.

Comment: In most states, the design professional is not deemed to grant any implied warranties of the plans and specifications. Suits can typically only be brought against the design professional for defective specifications by the party with whom the design professional contracted. The economic loss doctrine, for example, generally prevents actions against design professionals for negligence that claim economic losses. Unless there is an independent duty owed by the design firm to a third party, and the design firms’ failure to meet its standard of care in performing that duty caused bodily injury or property damage, there is no viable cause of action. The only implied warranty of specifications that is created in the more typical state and case is the implied warranty of the specifications by the project owner to the contractor who is entitled to rely on the specifications. In that situation, the contractor must make a claim against the project owner and is entitled to recover its extra costs incurred in performing its work under defective specifications – without regard to whether the plans and specifications, although defective, met the standard of care and were, therefore, not negligently drafted by the design firm. Where a project owner pays the contractor a change order for its extra costs, the owner can only recover from the design firm for those costs if it can prove the designer performed its services negligently. This is the typical gap between (1) what is owed the contractor by the owner pursuant to the owner’s “implied warranty of specifications” and (2) what the owner can recover from the design professional (since recovery is limited to negligence).

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Assignee of Contract Indemnification Rights under a Design-Build Contract Stands in Shoes of Indemnitee and is Entitled to Recover Defense Costs

admin — Tue, 03 Jan 2012 22:31:58 +0000

Where a firm (Parsons Infrastructure) entered into a contract to design and construct a soda ash processing plant for Kerr-McGee Chemical Corp (KM) and agreed to provide KM with a defense and indemnity against losses arising out of negligent performance of its work, and KM later assigned its property and contract to a new firm (Searles Valley Mineral Operations), Searles, as assignee of KM, paid defense costs on behalf of KM that were incurred in defending against a wrongful death action by the heirs of a deceased laborer who was killed while working at the plant. A California court held that Parsons was obligated to reimburse the defense costs even though they were not incurred directly by KM but were instead paid by Searles on behalf of KM. Searles Valley Minerals Operations, Inc. v. Ralph Parson Service Company, 191 Cal.App. 4^th 1394 (Cal. 2011).

The court concluded that an assignee of contract indemnification rights stands in the shoes of the indemnitee. Consequently, where the indemnitor refuses to pay an indemnitee’s defense costs, the indemnitee, and in turn the assignee of the indemnitee, can pay the costs and then seek reimbursement from the indemnitor.

The indemnification clause in question provided the following:

Contractor [Parsons], agrees that it will, at its sole cost and expense, defend, indemnify and save Owner [KM], its subsidiaries, and their officers and employees, harmless from and against any and all claims, demands, causes of action and liabilities for loss of use or damage to property … or for bodily injury, personal injury or death arising out of Contractor’s (or its subcontractor’s) negligence (including, as respect bodily injury, personal injury or death, the contributory negligence of Owner [KM] ) in connection with any work which Contractor (or its subcontractors) shall perform pursuant to this Agreement or any operations or activities of Contractor (or its subcontractors), in connection therewith.

In determining the obligations under this indemnification clause, the court cited Crawford v. Weather Shield Mfg., Inc, 44 Cal. 4^th 541 (Cal. 2008), and the California Civil Code, section 2778 that specifies indemnification obligations. The code provides the following:

In the interpretation of a contract of indemnity, the

following rules are to be applied, unless a contrary intention

appears:

1. Upon an indemnity against liability, expressly, or in other

equivalent terms, the person indemnified is entitled to recover upon

becoming liable;

2. Upon an indemnity against claims, or demands, or damages, or

costs, expressly, or in other equivalent terms, the person

indemnified is not entitled to recover without payment thereof;

3. An indemnity against claims, or demands, or liability,

expressly, or in other equivalent terms, embraces the costs of

defense against such claims, demands, or liability incurred in good

faith, and in the exercise of a reasonable discretion;

4. The person indemnifying is bound, on request of the person

indemnified, to defend actions or proceedings brought against the

latter in respect to the matters embraced by the indemnity, but the

person indemnified has the right to conduct such defenses, if he

chooses to do so;

5. If, after request, the person indemnifying neglects to defend

the person indemnified, a recovery against the latter suffered by him

in good faith, is conclusive in his favor against the former;

6. If the person indemnifying, whether he is a principal or a

surety in the agreement, has not reasonable notice of the action or

proceeding against the person indemnified, or is not allowed to

control its defense, judgment against the latter is only presumptive

evidence against the former;

7. A stipulation that a judgment against the person indemnified

shall be conclusive upon the person indemnifying, is inapplicable if

he had a good defense upon the merits, which by want of ordinary care

he failed to establish in the action.

Applying this code section to the current case, the court stated the following:

As explained in Crawford, section 2778 “first provides that a promise of indemnity against claims, demands, or liability ‘embraces the costs of defense against such claims, demands, or liability’ insofar as such costs are incurred reasonably and in good faith. (§ 2778, subd. 3, italics added.) Second, the section specifies that the indemnitor ‘is bound, on request of the [indemnitee], to defend actions or proceedings brought against the [indemnitee] in respect to the matters embraced by the indemnity,’ though the indemnitee may choose to conduct the defense. (Id., subd. 4, italics added.) Third, the statute declares that if the indemnitor declines the indemnitee’s tender of defense, ‘a recovery against the [indemnitee] suffered by him in good faith, is conclusive in his favor against the [indemnitor].’

In the current case, the court states that KM tendered its defense to Parsons, Parsons rejected KM’s tender of defense, Searles paid for KM’s defense, and the wrongful death action against KM and other defendants resulted in Parson’s subcontractor being found 25 percent at fault, but no fault was found directly against Parsons itself. The court states “Under section 2778, subdivisions (3) and (4), KM was entitled under the indemnity agreement to a defense from Parsons and, since Parsons did not provide a defense, KM was entitled to recover its defense costs….” The jury in the wrongful death action awarded the heirs $6.75 million in damages. No fault was assigned to either KM or Parsons. Searles was found to be 75 percent at fault and a Parson’s subcontractor was found to be 25 percent at fault. Searles incurred over $800,000 in attorneys fees, costs, and expenses from providing KM with a defense in the suit, and is entitled pursuant to the indemnification obligations of the contract to recover those costs from Parsons.

Comment: This court’s reiteration of the affect of California Civil Code, section 2778, and the import of the holding in Crawford v. Weather Shield should serve as a reminder of how important it is to carefully craft indemnification clauses to specify exactly what types of claims and damages are covered by the indemnification, and whether or not there is a duty to defend the indemnitee or to otherwise reimburse the indemnitee for defense costs after-the-fact, as part of the indemnification obligation. In this particular case, the indemnification clause contained an express defense obligation. But even if it had not contained a duty to defend, the court’s decision once again makes plain that pursuant to the California Code, that duty to defend would be automatically read into the indemnification clause unless the parties expressly, affirmatively stated a contrary intent. It is not sufficient merely to strike out the words “defense” or “defend” when they appear in a sentence such as “Contractor shall indemnify, defend and hold harmless the Owner….” Even if those words were struck from the contract, the California courts would read them right back into the contract pursuant to the Civil Code. In California, therefore, if parties want to eliminate a duty to defend in the indemnification provisions of the contract, they must affirmatively insert a parenthetical or sentence clearly stating that there is no duty to defend.

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Expert Survey of Small Sample of Walls Sufficient to Justify Opinion that Much Larger Area of Walls Must be Torn out and Replaced by Design-Builder for Failing to Meet Specifications for Rebar

admin — Tue, 03 Jan 2012 21:55:52 +0000

Where a design-builder filed suit against the project owner (animal fee manufacturing plant) to collect the balance of fee that was being withheld, the owner countersued for almost $2 million alleging that contractor breached the contract’s requirements for concrete strength and placement of rebar in the concrete. An expert witness testified for the owner that based on ground penetration surveys done on a number of walls within the plant finding horizontal reinforcement with highly varying concrete covers and spacing (and testimony form employees concerning how they installed the rebar), it was his opinion that the bin walls of the plant were weakened to such an extent that 4,440 square feet of bin wall should be torn out and replaced. The design-builder filed a motion to have the testimony excluded based on failure of the expert to survey every wall that was recommended for replacement instead of just a sample of walls. Objection was also made to the fact that the expert did not present his opinion “with absolute certainly.” In denying the motion, the court found although only a small segment of walls was tested, the expert’s results were uniform and consistent, and they confirm eyewitness evidence that the contractor ignored its contractual obligations when placing the rebar. The court, therefore, concluded that the expert’s opinion was amply supported and not merely “unsupported speculation” as argued by the contractor. Younglove Construction, Inc. v. PSD Development, LLC, 2011 WL 1004916 (N.D. Ohio, 2011).

Comment: This case is instructive with regard to the use of expert testimony and the question of whether sampling or surveying is sufficient to justify an expert opinion concerning areas that were not part of the surveyed areas. On the underlying issue of non-compliance with the rebar placement specifications, the decision does not dwell at any length. Since this was a design-build project, however, it seems likely that the rebar specification was drafted by the design-builder (or an engineer working as a subcontractor to the design-builder). If that is so, the owner is alleging here that the design-builder was in breach of contract for failing to follow its own plans and speculations. It is important to note that just because the design-builder is the creator of the plans and specifications does not mean that it can later ignore them. Once plans and specifications have been approved by the project owner, the design-builder contractually commits to designing and building the facility consistent with the approved plans and specifications. To do otherwise, without adverse consequences, would require a contract modification or change order approving the changes or deviations to the plans and specifications. Likewise, if the owner provides bridging documents containing partial design documents, the design details contained in those bridging documents must be met unless a change has been agreed to in writing. A good example of a contractor having to rip out and replace work that did not meet the design details of the bridging documents is found in the case of Dillingham Construction v. U.S., 33 Fed.Cl. 495 (1995).

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Liquidated Damages in Design-Build subcontract Are Enforceable Even Where Far Exceeding Actual Damages

admin — Tue, 03 Jan 2012 19:46:53 +0000

Where a contractor entered into a design-build contract with the U.S. Navy to build four buildings at the Pensacola Naval Air Station, and included a liquidated damages (LD) provision in the subcontract with its subcontractor, that LD provision was enforceable despite evidence that the actual damages incurred by the contractor as a result of alleged delays by the subcontractor were far less than the LD amount, and despite the fact that the Navy did not impose any LDs on the prime contractor for delay. In United States v. Dick Corporation, 2010 WL 4666747 (N. D. Fla. 2010), a Miller Act claim was filed against Dick Corp. by the United States on behalf of a subcontractor. Dick made a counter-claim against subcontractor, arguing Dick was entitled to withhold payment and anything it owed to the subcontractor was more than offset by Liquidated Damages the subcontractor owed to Dick. The subcontractor argued that the LD provision was unenforceable because (1) the Navy didn’t assess LDs against Contractor; (2) the sub caused no delay to trigger the LDs; and (3) the LDs constituted an unconscionable penalty – far exceeding actual damages sustained. The court concluded that although LDs were “far in excess” of the actual damages, it was not possible to ascertain when the parties entered into the contract what the actual damages would be. Even if Dick could calculate part of its potential actual damages when entering the contract, there were additional unascertainable factors. The LDs were not “grossly disproportionate to damages that might reasonably be expected to follow… from delays.”

A test established by the Florida Supreme Court, to determine if a liquidated damages clause will be upheld or stricken, was cited in this case as follows: “First, the damages upon a breach must not be readily ascertainable.” “Second, the sum stipulated to be forfeited must not be so grossly disproportionate to any damages that might reasonably be expected to follow from a breach as to show that the parties could have intended only to induce full performance, rather than to liquidate their damages.” In this case, the court found that it was because of factors that could have resulted in damages that were unascertainable as of the date of entering into the contract that the parties agreed to the liquidated damages provision. As stated by the court: “Not only were Dick’s damages as a result of delay not ascertainable at the time the parties entered into the subcontract, but they also were not grossly disproportionate to damages that might reasonably be expected to follow from [subcontractor’s] work delays. Indeed, had the Navy assessed liquidated damages against Dick as a result of [subcontractor’s] delays, Dick’s actual damages could have exceeded its liquidated damages. The court therefore finds that the liquidated damages provision in the parties’ subcontract is valid and enforceable.” It would have been possible that the subcontractor’s delays, for example could have delayed other trades and resulted in costs and possibly even damages that could not have been ascertained at the time the subcontract was entered into.

Comment: It continues to baffle me when parties to a contract make the argument that the amount of damages calculated under a liquidated damages provision must be compared to actual damages sustained to determine whether the LD provision is reasonable and can be enforceable. As the court here correctly decided, a comparison of LDs to actual damages is not the determinative factor in deciding whether an LD provision is unenforceable. The concept is that at the time the contract is entered into it is not possible to readily ascertain what the actual damages from non-performance or late performance will be. Since that is so, the parties establish a pre-determined amount of daily damages that they reasonably believe will cover whatever actual damages might result. It doesn’t matter that the actual damages ultimately turn out to be a lot lower. What matters is whether the LD amount when established at the time of contract negotiation was an amount that might reasonably be expected to result from actual damages, the amount of which could not at that time be ascertained. If they are not grossly disproportionate “to damages that might reasonably be expected to follow from delays, LDs are generally enforceable even if it turns out that the actual damages are considerably less.

An interesting insurance question is sometimes asked concerning coverage for liquidated damages – particularly in the context of professional liability policies. It is sometimes argued that the professional liability policy provides no coverage for liquidated damages because those damages are created by contractual agreement, and as such the contractual liability exclusion of the policy bars them from coverage. If a court would award the amount of the LDs even at common law in the absence of the LD provision of the contract, the insurance policy would cover them to the extent they were caused by the negligent performance of the insured design professional. However, what happens if as in a case like this one, it turns out that the actual damages are less than the pre-agreed LD amount? Will the policy only cover the actual damages and not the full amount of the LDs that are assessed? Even if there is a clear answer to that question, it is a rare case where the actual damages are ultimately determined and can be contrasted to the LD specified amounts. More typically, the court simply enforces the LD amount because it is determined to be reasonably based and not unconscionable. If that is the situation, will the contractual liability exclusion bar coverage for those LDs? I have not seen any definitive opinion on that issue. But I believe the coverage question can be framed as whether the damages awarded against the design professional result exclusively from the LD provision without regard to a finding of negligence and without regard to whether there were any actual damages. If the design professional is found to be negligent, and that negligence caused some damage, one could make an argument that so long as the LD provision, when entered into, was a reasonable effort to establish what otherwise unascertainable actual damage amounts would be, the policy should cover those damages. Indeed, it is possible that the amount calculated under the LD provision could be less than the actual damages if they could be ascertained. Thus, the LD amounts claimed for coverage under the policy could be less than what would be required if actual damages could be calculated. If the amount of actual damages cannot be ultimately ascertained, instead of this proving that coverage should be denied, it might instead tend to show that the LD provision was reasonable for the very reason that it is impossible to ascertain actual damages.

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Design-Builder Entitled to Contractual Indemnity from Subcontractor for Damages to Turbines

admin — Tue, 03 Jan 2012 17:48:48 +0000

Black & Veatch (“B & V”) contracted with Portland General Electric (“PGE”) to engineer, procure and construct a power generating facility called the Port Westward Power Plant, and it subcontracted to a specialty subcontractor to install the combustion turbine and associated air inlet filter house and air inlet filter duct. The combustion turbine was manufactured by Mitsubishi Power Systems who supplied it directly to PGE pursuant to a separate agreement, which was assigned in part by PGE to Black & Veatch. After the turbine, filter house, and duct work were erected and installed by the subcontractor, they were successfully started-up and operated, but during a later scheduled outage of the turbine, a walk-through of the filter house discovered “foreign object damage” to a number of the compressor blades. Various foreign objects were found, including a cutoff bolt, a welding rod, and a half-moon shaped cut metal plate. B&V paid PGE for the damage to the combustion turbine and then sought from the subcontractor, pursuant to the indemnification clause of the subcontract, $1.5 million in direct costs to repair the damage, and another $2.1 million due to delays caused by the damage. Summary judgment for B&V was granted by the court, finding that the indemnity language was broad enough to require indemnity for all damages, including delay damages, and finding that the waiver of consequential damages clause was inapplicable because that clause expressly stated that the waiver of consequential damages would not apply to liability obligations incurred under the indemnity clause. Black & Veatch Construction, Inc. v. JH Kelly, LLC, 2011 WL 1706223 (U.S. District Court, D. Oregon, 2011)

In defending against the indemnification claim, the subcontractor did not dispute that B&V may seek reimbursement for the actual repair costs (although it denied liability for those damages), but it disputed recovery of the delay costs, which it call “consequential” damages. It argued that an agreement to indemnify for “physical damage to third party property” is not an agreement to indemnify for economic delay damages. In rejecting that argument, the court quoted the language of the clause that required the subcontractor to indemnify “for any and all liability [and] costs” and concluded that it is broader than just an obligation to repair the damage to third party property. As stated by the court: “In other words, [subcontractor’s] negligence in causing ‘physical damage to third party property’ is the trigger for application of the indemnification provision, at which point [subcontractor], as the indemnitor, becomes responsible for ‘any and all liability’ with which the indemnitee had previously been charged.”

A waiver of consequential damages clause in the contract provided for what appeared to be an absolute waiver of consequential damages by all parties under a “legal theory, for cost of capital, loss of profits or revenue, loss of anticipated profits or revenue, loss of use or increased expense of equipment or plant, loss of power or production, … or for any special, indirect, incidental, consequential, exemplary, or punitive loss or damages.”

The court said this clause would prevent B&V from recovering the delay costs in question from the subcontractor, but for the very next clause of the contract that stated the clause “will not apply to: (a) damages of any third party for which Subcontractor has an indemnification obligation under this Subcontract….”

Another interesting aspect of this case is that the subcontractor sought common law indemnification from Mitsubishi, alleging that Mitsubishi was at least partly responsible for the claim concerning the foreign object damage because the contract between Mitsubishi and PGE called for Mitsubishi to inspect the inlet filter house and ductwork for debris prior to start-up. But nothing in that PGE contract, according to the court, required Mitsubishi to inspect or take responsibility for or guaranty the work of the subcontractor who had an independent duty under its contract with B&V to clean the equipment. Under the B&V subcontract, the subcontractor could have liability to B&V for the damage caused by the foreign objects, even if the source of those objects was unknown. The court concluded that the subcontractor failed to identify any contractual duty Mitsubishi breached for which Mitsubishi could be responsible to B&V, and therefore owe any indemnity obligation to the subcontractor for the damages claimed by B&V. An alternative theory of a right to common law indemnity by the subcontractor against Mitsubishi based on tort was rejected by the court since B&V did not make a negligence based claim against Mitsubishi. A contribution action was also rejected by the court because “a claim for common law contribution must be premised on the existence of common law liability, such as co-debtorship, common ownership of property, or common contractual obligations” none of which are present here.

Comment: Among other things, the case demonstrates the importance of the language used in the indemnification provisions of the contract and also the importance of carefully considering how any waiver of consequential damages clause will or will not be applied to indemnification provisions. The waiver of consequential damages provision in the contract at issue here would have barred B&V from recovering the delay damages from its subcontractor if it had not been for the sentence in the contract stating that the waiver of consequential damages provisions would not be applied to claims under the indemnification provisions of the contract.

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Damages Caused By Chinese Drywall Are Excluded From Coverage Under Homeowner’s Insurance

admin — Tue, 03 Jan 2012 17:30:47 +0000

Chinese Drywall caused damage that was not from coverage under a homeowner’s insurance policy because of several exclusions for (1) faulty, inadequate or defective materials, (2) latent defects, (3) rust or corrosion and (4) pollution. Two years after purchasing their home, the homeowners began having chronic malfunctions in the heating, ventilation and air conditioning (HVAC) system. It was determined that Chinese Drywall had been used in building the house and that it was releasing sulfuric gases causing corrosion of various metal components, including HVAC coils, refrigerator units, electrical wiring, plumbing, jewelry, appliances, electronics, and other household items. The homeowners filed suit against the homebuilder, the builder’s CGL insurance carrier (State Farm Insurance) and its own homeowner’s insurer (Louisiana Citizens). On cross motions for summary judgment on the homeowner’s policy, Louisiana Citizens argued that each of the four exclusions reference above applied to bar coverage under the policy. The trial court granted summary judgment in favor of the insurance company. This was affirmed on appeal in Ross v. C. Adams Construction & Design, LLC, 70 So.3d 949 (La. 2011) for the reasons explained herein.

Although the court agreed with the homeowner that the inherent qualities of the Chinese drywall caused a direct physical loss to the home, each of the exclusions of the policy cited by the carrier were effective to exclude coverage. First, the court said that “using the plain meaning of ‘faulty, inadequate, or defective material’ leads to a conclusion that the drywall in question is a faulty, inadequate, or defective material and is specifically excluded by the homeowner’s policy.” The complaint even referred to the drywall as “defective,” noted the court. Due to the defect causing it to emit sulfuric gasses, even if the drywall were still in place in the home, it could not be considered to be serving its intended purpose as a component of a livable residence. It was faulty, inadequate, and defective, and therefore excluded from coverage.

Next, the policy states that it does not insure for “mechanical breakdown, latent defect, inherent vice, or any quality in property that causes it to damage or destroy itself….” Was the Chinese drywall latently defective? In answering this, the court states, “A latent defect is considered a defect that is hidden or concealed from knowledge, as well as from sight, and which a reasonable customary inspection would not reveal.” The original complaint by the homeowner included an allegation that the material contained hidden defects and that the emission of gasses was unknown to them. This, says the court, falls within the definition of latent defect and is therefore excluded from coverage pursuant to the latent defect exclusion.

Another exclusion of the policy states, “We do not insure, however, for loss … caused by … smog, rust or other corrosion, or dry rot.” The complaint alleged that the drywall caused corrosion, and since the policy on its face states it does not cover corrosion, the court found this exclusion applies.

The final nail in this insurance coverage coffin was the pollution exclusion that provided the following:

2. We do not insure, however, for loss: …

c. Caused by: …

(6) Any of the following: …

(e) Discharge, dispersal, seepage, migration, release or escape of pollutants unless the discharge, dispersal, seepage, migration, release or escape is itself caused by a Peril Insured Against named under Coverage C.

Pollutants means any solid, liquid, gaseous or thermal irritant or contaminant, including smoke, vapor, soot, fumes, acids, alkalis, chemicals and waste. Waste includes materials to be recycled, reconditioned, or reclaimed.

As understood by the court, “The sulfuric gas emitted from the [ ] drywall qualifies as a pollutant pursuant to this definition in the policy. Therefore, any damage caused by the release of these gases is excluded from coverage by the homeowner’s insurance policy.” For all these reasons, the court affirmed judgment in favor of the insurance carrier.

Comment: This decision only addresses the summary judgment motion concerning the homeowner’s insurance policy. It does not deal with the suit by the homeowner against the contractor of the contractor’s general liability carrier. Depending upon the contractor’s policy terms and conditions, it is conceivable that there could be coverage under the contractor’s policy. The “your work” exclusion could be an important potential impediment to coverage. If the drywall was installed by a subcontractor, however, the subcontractor exception to the “your work” exclusion might apply so that the contractor may have coverage for the damages caused by the defective work performed by its subcontractor. That will be little comfort to the contractor, however, if the policy contained a broad pollution exclusion since the sulfuric gasses that caused the corrosion could be deemed by the courts in California to the environmental pollutant subject to the exclusion. The need for contractor’s pollution liability (CPL) insurance is once again manifested by the problems associated with Chinese drywall.

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