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ConstructionRisk.com Report

Vol. 2, No.5 - May 2000

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No Excuse for a bad contract

I am sometimes asked during my risk management seminars if a party to a contract can safely sign an onerous contract with harsh indemnification clauses or other clauses that create excessive liability for an "innocent" party and then avoid the consequences by having a court hold the terms to be unconscionable and, therefore, unenforceable.

Those who ask this generally are contractors and consultants. They suggest that if the contract is grossly one-sided or unfair, it should be obvious to a court that it was signed under duress.

This never fails to bring a smile to my face as I recall a scene from my contract law class at Villanova. It was the third week of our first year. All of us were still in awe and fear of law school -- especially of the tough, old, grouchy (and later beloved) professor of contracts.

After reading a sad case where a court enforced a contract that created a particularly bad deal for one of the parties, one naive student asked the professor how such a terrible and unfair thing could be tolerated by the court.

Our professor turned red. His bushy eyebrows rose. He began to tremble and sputter. He slammed his book closed and stared at the unsuspecting student before bellowing:

"This is the study of law. If you want 'fair' you belong across the street [at the Augustinian Theological Seminary] and not in law school."

He stomped out of the class and left us there, with a half hour remaining, to ponder that heavy thought.

That brief performance left a greater impression on me and taught me more about the law of contracts than anything else before or sense.

It turned out that it wasn't necessary to abandon law school and join the seminary merely because one expected contracts to be fair. All that was necessary was to accept the responsibility for negotiating and signing fair contracts.  You get what you negotiate -- not necessarily what you deserve. Don't go into a contract with the hope that a court will bail you out of bad terms and conditions when things turn sour. Negotiate your own good terms.

I retell this story from time to time to encourage contractors and design professionals to negotiate diligently for a reasonable contract, and to not expect a court to fix contractual difficulties of their own making.  It is a good introduction, I believe, to the case that is here described.

In Bond Drug Company v. Amoco Oil Co., 654 N.E. 2d 540, 211 Ill. Dec. 78 (1995), the court held that Amoco was not entitled to summary judgment to rescind a sales contract under which it had to pay almost $1 million to cleanup pollution from a gas station on property that it was selling for only slightly more than that.

When the contract was executed the purchaser paid the full purchase price in an escrow account to be held for the benefit of Amoco. During the time that Amoco remediated the pollution problem, the purchaser waited for its land. With the land appreciating in value, Amoco apparently decided it could obtain a better deal if it rescinded its contract and sold the property to someone else.

Amoco made two arguments that the that court agreed with in issuing summary judgment in Amoco's favor. First, Amoco argued that the representations and warranties clause of its contract did not require it to pay for the cleanup of environmental damage. Second, it offered an alternative argument that even if the clause required cleanup, the contract should be rescinded because the cleanup costs were so high as to show that there was a mutual mistake of fact concerning the property and the extent of the contamination.

The warranty clause provided: "Amoco warrants that Amoco has received no notices from any city, village or other governmental authority of zoning, building, fire or health code violations in respect to the Premises that have not been heretofore corrected and if any violations occur or notices are received as to the same prior to the time Bond takes title and possession, Amoco shall promptly advise Bond of same and Amoco shall correct same, unless same is due to Bond's fault. If same is due to Bond's fault, Bond shall promptly cause the violations to be corrected at its expense."

The trial court concluded that this warranty did not apply to environmental contamination. The appellate court disagreed with the trial court's conclusion because the warranty required Amoco to "correct all health code violations of any governmental authority." Since environmental contamination is considered an issue of public health and safety per the terms of the various environmental laws, it must be deemed a violation of a health code and, therefore, Amoco's responsibility to remedy.

The appellate court also disagreed with the trial court's conclusion that there had been a mutual mistake of fact that would justify rescinding the contract. The court found that instead of there being a mutual mistake concerning the extent of the contamination and the cost that would be incurred, it was merely a unilateral mistake of Amoco.

According to the court, one party's mistaken assumptions concerning costs is not excuse for not honoring the contract. "A contract fairly entered into cannot be avoided or disregarded by one of the parties because he discovers that the contract is less profitable to him that he anticipated when he entered into it."

As the court saw it, "Amoco knew ... how to protect itself contractually from such risks prior to negotiating and entering into the [contract.]"

Finally, the court rejected Amoco's argument that enforcement of the contract would be "unconscionable." And here, my professor could not have said it better:

"No equitable principle, including unconscionability, will compel the cancellation of a valid contract merely because one of the parties thereto will possibly or probably sustain a loss. Where the parties to an instrument are competent to contract with each other, and there is no question of fraud, neither can be relieved from his agreement on the ground that he did not use good business judgment in entering into the contract."

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About the author:  Kent Holland is Director of Risk Management Services for the A/E Professional Liability unit of Zurich U.S. Insurance, located at One Liberty Plaza, New York, NY 10006, 212-748-2357.   This article is reprinted from the Zurich A/E Briefings with permission of Zurich U.S.  Copies of all Zurich A/E Briefings are available at http://www.zurichamerican.com/za/newsnwslttrs

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Insurance Recovery Forfeited by Failure to Report Damages Before Undertaking Repairs

Where a developer performed repairs to correct water intrusion before reporting to its Commercial General Liability (CGL) insurer, a court held it had lost its right to demand that its insurance carrier indemnify it for the cost of repairs. The developer investigated the problems and spent $1.24 million in performing repairs – thereby avoiding any lawsuits being filed against it.

After the repairs were completed, the developer made a claim under its CGL policy to recover its costs. The insurer, General Star Indemnity Company, denied any duty to indemnify the developer because it had not been notified by the insured of the underlying problems before making the repairs and thereby incurring the "damages" for which it sought indemnity from the insurance company.

The court agreed with General Star that the developer had violated the terms of the policy requiring no voluntary payments to be made. That provision states: "Should any claim or suit to which this policy applies appear likely to exceed the Retained Limit, no loss expenses or legal expenses shall be incurred on behalf of the company without its prior consent." This provision, according to the court, must be enforced in the absence of economic necessities, breach by the insurance company, or other extraordinary necessities. The purpose of the provision is to give the insurance company control over the defense and settlement of a claim. An insured is not permitted to unilaterally settle a claim before it has been established and before the insurance company has had an opportunity to defend it. As stated by the court, "In short, the provision protects against coverage by fait accompli."  By this, the court in essence held that the voluntary payments provision is equivalent to a policy exclusion and that there is no requirement that the insurance company demonstrate that it has been prejudiced by the actions of the insured in order to enforce this provision. Jamestown Builders, Inc. v. General Star Indemnity Co., 77 Cal. App.4^th 341, 91 Cal. Rprt.2d 514 (1999).

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No Coverage Under CGL Policy for Contractor’s Professional Opinion

A roofing contractor that contracted with a homeowner’s association to recommend and specify re-roofing materials, was sued by the association for negligent advice because the recommended material allegedly did not adequately insulate the building. The contractor tendered the claim to its CGL carrier but the carrier denied coverage on the basis that the advice rendered constituted professional services that were not covered by the policy. Coverage under the CGL policy was for an "occurrence," which was defined as "an accident, including continuous or repeated exposure to substantially the same general conditions." The court held that the insurance company was entitled to summary judgment against the contractor because there had been no "accident" as defined by the "occurrence" definition of the policy. Specifically, the court stated that a contractor’s deliberate act of rendering professional advice could not constitute an accident. Further, the contractor’s intent to induce the homeowner’s association to rely upon using the recommended materials could not, in the opinion of the court, constitute an "occurrence" that was insured under the policy. Ray v. Valley Forge Insurance Company, No. B129058, (1999 Cal. App. LEXIS 1142).

Risk Management Note: The standard CGL policy contains exclusions for damages arising out of professional services. It is not uncommon to endorse the policy to provide some limited professional liability coverage. When such coverage is added, however, it typically only covers professional liability damages if there are also bodily injury or property damages. Purely economic losses are typically not covered. A contractor that intends to provide professional opinions or recommendations should consider purchasing a contractor’s professional liability policy to cover errors and omissions. These policies are offered by most major professional liability carriers at premiums that have become increasingly competitive.

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Owner Not Liable For Site Safety

When an employee of a contractor was injured on a job site, he sued the owner on the theory that by employing a safety employee for the job site the owner had assumed control and responsibility for the site. The plaintiff, worker, testified that before he was injured while moving pipe, he had questioned his supervisor about the safety of moving the pipe in the manner intended. This conversation took place within ear shot of the owner’s safety employee, and on this basis the plaintiff argued that the owner should have ordered the pipe to be move in a safe manner.

The Supreme Court of Texas held that merely employing a safety person at the jobsite of an independent contractor does not render the owner liable under the "retained control" doctrine. That doctrine would only apply, says the court, if the "contractor is controlled as to his methods of work, or as to the operative details. There must be such a retention of a right of supervision that the contractor is not entirely free to do the work in his own way." In this case, since the contractor was free to perform its work any way it wished, the court concluded the owner had not retained control. Moreover, even if the owner’s employee had instructed the contractor to perform its work in a safe manner, this alone would not create a duty to intervene to ensure that the contractor safely performed its work. Koch Refining Co. v. Chapa, No. 99-0228, 199 Tex. LEXIS 130 (Tex. Dec 16, 1999).

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