Construction Risk

ConstructionRisk.com Report, Oct 1999 – Vol. 1, No. 7

Kent Holland

In this issue:

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Year 2000: Implications For the Construction Industry

Caryn A. Kauffman

As the year 2000 draws closer, the construction industry has become well aware of the “Y2K” computer problem that may cause technological failures in a wide range of products, from complex software to HVAC or security systems run by microprocessors. The ripple effect of these failures may lead to business losses and legal disputes.

The risk for construction companies arises not only in your own systems, but in the systems of vendors, suppliers, and other companies with whom you may do business in the U.S. or abroad. This article outlines several issues companies should consider in managing their exposure to Y2K-realted problems.

Evaluate Your Own Systems and Programs

The first step in any Y2K Plan should be to evaluate your own internal systems and programs to determine which of them could be affected by Y2K. You should decide which systems and programs are critical for day-to-day operation of everything from payroll to inventory. If your electronic ordering system fails, will you be able to ship goods to your customers? If your scheduling system fails, do you have hard copies of the scheduling data for ongoing and prospective projects? What if a Y2K failure to your plant’s monitoring equipment results in environmental pollution?

It is important in doing your evaluation to decide whether and how the various systems might fail and how important that failure will be. To determine whether the systems are Y2K compliant, you may need to contact your vendors and service providers. Many companies have posted web sites on the internet that discuss the Y2K compliance (or lack thereof) of their products and services. In addition, you should investigate available fixes or repairs. Again, this may involve contacting your vendors and service providers. Finally, you should develop a contingency plan to prepare for failures that cannot be fixed or repaired in time.

Evaluate External Y2K Problems

Once you have determined how your internal infrastructure will handle Y2K, you must also determine how external Y2K problems will affect your business. For example, if the bank’s computer system fails and you are unable to access your accounts, can your business run for the days or weeks it may take to get the system running again? What if your suppliers are unable to provide the goods and equipment they promised? What if any owner or contractor is unable to pay you for a job you have completed?

As with your internal systems, you may need to contact the various parties you have identified to determine whether their systems are Y2K compliant. You should also develop a contingent plan to prepare for Y2K failures that may occur regardless of the representations those parties make.

Evaluate the Systems on Construction Projects

Of particular concern to the construction industry will be the various systems designed, provided, or installed on construction projects. According to the American Society of Civil Engineers (ACEC), the most Y2K-sensitive construction components are those driven by computer software and microchip technology such as (1) heating, ventilating, and air conditioning (HVAC) systems; (2) building security systems; (3) fire alarm and sprinkler systems; (4) building access and locking systems; (5) telephone and data systems; (6) emergency power systems; (7) timekeeping, lighting, and electronic systems; and (8) elevators and escalators.

Since learning of the Y2K problem, construction industry associations have been diligent in urging design professionals and contractors to notify owners of the potential problems so that problems can be addressed, thereby seeking to transfer the risk to owners to eliminate any potential damages. Nevertheless, construction industry members should evaluate the systems they have designed, provided or installed on past projects, as well as systems on future projects, to determine potential risks. It is important to realize that regardless of whether owners have been notified of potential Y2K problems, legal risks exist. Design professionals face potential claims of defective design; contractors face potential claims of breach of express and implied warranties; and product manufacturers face potential claims of misrepresentation and breach of Uniform Commercial Code (UCC) warranties of fitness and merchantability, as well as claims of strict liability for those products determined to be “ultra-hazardous.”

Reviewing Existing and Potential Contracts

Any Y2K Plan should include a review of all existing and potential contracts, including maintenance agreements, license agreements, equipment leases, supply contracts, and service contracts, to determine whether they address Y2K issues. If Y2K is not expressly addressed within the contract language (which it usually is not), who will be responsible if a Y2K failure occurs?

“Force Majeure” clauses. Most contracts contain a “force majeure” clause which protects a party when the party fails to perform due to an “act of God” or other event that is deemed to be beyond the party’s control. Because Y2K problems can be controlled with sufficient planning and resources, however, force majeure clauses will likely not protect a party who is unable to perform the contract due to aY2K-related failure.

Indemnity clauses. Owners, contractors and subcontractors should consider adding Y2K indemnity clauses to their contracts to protect future Y2K-related problems. Although some of the indemnity clauses currently being used may cover for Y2K problems, it would be advisable to review those existing clauses and specifically add Y2K to ensure protection.

Y2K warranties. In any contract for goods or services entered into over the next several years, the party purchasing the goods or services should ensure that the contract contains clauses that protect the party in the event of Y2K-related failure. For example, a subcontractor purchasing goods from a supplier should require a warranty that the goods are “date compliant, including Year 2000 compliant.” This broad warranty will ensure that any future date failure will be covered by the warranty, even if the failure does not occur exactly as 12:01 a.m. on January 1, 2000.

Insurance Coverage for Y2K

It is important for all construction firms to review their current insurance policies to determine whether those policies will cover Y2K-related problems. Although it is difficult to predict how insurers will react to Y2K issues when they arise, it is likely that most insurers will deny coverage for Y2K-related problems under most standard insurance policies.

Commercial general liability. Commercial general liability insurance (CGL) typically provides coverage for bodily injury, property damage, or personal injury caused by the insured to a third party. Two problems exist with most standard CGL policies that may prevent coverage. First CGL policies require an “occurrence” to trigger coverage. An “occurrence” is typically defined as an event that is not intended or expected. Because Y2K has been so widely publicized, many insurers may take the position that Y2K was an expected event and will deny coverage under the CGL policy. Second, “property damage” in a CGL policy is typically defined as physical injury to or loss of use of tangible property. CGL carriers will likely argue that data or source code does not constitute tangible property, thereby denying coverage for Y2K problems to those electronic media.

Business interruption. Under most forms of business interruption insurance, coverage is triggered only by interruptions that result from a “fortuitous event.” Again, because Y2K has been so widely publicized, many insurers may not consider Y2K to be a fortuitous event that will deny coverage for business interruption.

Year 2000 Information and Readiness Disclosure Act

One final issue that must be addressed is how to respond to inquiries about your own Y2K compliance. Fortunately, as of October 19, 1998, Congress put in place the Year 2000 Information and Readiness Disclosure Act. The purpose of the Act is to encourage disclosure and exchange of information regarding Y2K readiness. TO that end, the Act provides safeguards– but not immunity from liability– for those who disclose information regardingY2K readiness. Essentially, the Act provides that any lawsuit based on a “Year 2000 Statement,” which is a statement regarding a party’s Y2K readiness, must be supported by clear and convincing evidence that the maker knew that the statement was inaccurate, or made the statement with reckless disregard for its accuracy.

The Act provides additional protection for the specific subset of “Year 2000 Statements” called “Year 2000 Readiness Disclosures.” A “Year 2000 Readiness Disclosure” is a written statement that is identified on its face as a “Year 2000 Readiness Disclosure.” Under the Act, the Year 2000 Readiness Disclosures cannot be introduced into evidence in a civil lawsuit to prove the truth or accuracy of anything stated in it, subject to certain limited exceptions.

To take advantage of the protection provided by the Act, you should label any written information you disseminate dealing with your Y2K readiness, including internet web sites, as Year 2000 Readiness Disclosures. While this may not make you immune from Y2K-related litigation, it will provide you with some protection if you are sued for representations made about your Y2K readiness.

This article first appeared in the August 1999 issue of “Construction Law Update,” the legal newsletter of Faegre & Benson, LLP. The firm is located at 90 South Seventh Street, Minneapolis, MN 55402; Phone: (612)336-3000. Copyright ã 1999, Faegre & Benson, LLP. Reprinted by ConstructionRIsk.com with permission.

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ISO 9000: What Is It and How Will It Impact You?

By Timothy Cummins, CPA

Executive Summary of Article. Because ISO 9000’s focus was primarily initiated within the manufacturing industry, especially the automobile and airline industries, many contractors have not given it much thought. However, it has expanded and will continue to expand to service providers and the construction industry. Read this article to learn about ISO 9000 and how it could impact your operations.

ISO 9000 Benefits. “An ISO 9000 certified contractor is credited for its procedures not for the products or facilities it produces.”

“The benefits to a contractor include an increased top line and real cost to operations as a result of the efficiencies created.”

In 1987, the International Organization of Standardization published (ISO) 9000. The original purpose of ISO 9000 was to demonstrate a commitment and ability to provide uniform quality assurance standards for product manufacturing and has since expanded to service providers. When an organization becomes ISO certified, that organization has demonstrated a commitment to its procedures and the total quality of the product or service by establishing an effective quality management system.

ISO 9000 is effectively the establishment of a quality system. A quality system has a good organizational structure and identifies responsibilities, procedures, processes and resources required to achieve stated management goals and objectives.

ISO 9000 does not guarantee product or service quality, but it is a quality system standard. An ISO certified entity is credited for its procedures, not its products. As such, a contractor’s product is not guaranteed. However, if a company is ISO certified, owners can be assured the company maintains a quality focus to ensure its products or services are the best that can be provided to consumers.

Quality Standards

There are different types of ISO quality standards. Those quality standards can be classified as primary, secondary and support standards and are generally defined as follows:

ISO 9000 requires that documentation be made of procedures for performing work that affects the product or service quality. It also requires the work be performed in accordance with the documentation. In addition, records of activities should be retained as evidence of compliance and to compare actual results with what was planned. Lastly, a program should be in place to improve any inefficiencies identified. In reality, this should be occurring on a routine basis in order for the company to utilize past performance to more accurately estimate future projects.

The best approach is to structure a quality system in steps:

The first step is creating and documenting policies to satisfy each of the standard requirements by developing a quality manual. The manual should describe the quality policy statement, organization, responsibilities and policies for each element of the organization. A well-written manual should act as an advertisement for the quality of the products or services of the company.

The second step is to document system procedures. This describes the purpose and scope of an activity including what will be done, by who, when, where and how. Further descriptions may include the equipment and documentation required and how it shall be controlled.

The third step includes identifying the word instructions, specific procedures, forms, records, inspections, test plans and quality plans. Adequate documentation is essential for contractors — as turnover can be high and several people may perform the same tasks. With power documentation and ISO certification, a company can be assured that procedures will be followed in accordance to specific requirements whether your employees are new or have worked for you in the same job for years.

The Certification Process

A third-party assessment is performed by an accredited ISO 9000 representative or independent registrar. The focus of the onsite review is to evaluate the company’s documented procedures to ensure compliance. The microscope is on the contractor’s systems and processes, not the end product. The ISO 9000 goal is not to tell you how to do your business, but to ensure that a consistent and well-documented process is in place.

The registration process can take on to two years to complete and costs for the independent registrar range from $12,0000 to $25,000. In addition, you will likely incur consulting costs. The certification is valid for three years and can be renewed. Certainly, the time and effort incurred during the initial certification process will not be repeated during the renewal stage. The more extensive a contractor’s existing documentation and quality assurance program, the easier the certification process.

IS ISO 9000 Really for Contractors?

Most contractors become ISO 9000 certified because certain project owners or customers require it. Contractors on the front end of the ISO 9000 certification process include those in the electrical or mechanical field. It may be a matter of time before most construction operations are certified. This may occur as a result of a pass through requirement, from those contractors that are certified, whereby non-certified, lower tier contractors will not be contracted by prime contractors.

Benefits to ISO 9000 Certification

Beyond meeting project owner or prime contractor requirements, certification can produce benefits that the contractor can enjoy. These include:

Additionally, the processes for ISO certification will provide management with information regarding the operations and efficiencies of the organization they might otherwise take for granted.

These benefits to the contractor can actually increase the top line and reduce cost in certain areas as a result of the efficiencies created. The ultimate result is an improved bottom line.

The certification process can be an expensive task. However, savings over the long run resulting from eliminating unnecessary procedures, as well as using the certification process as a marketing tool can very quickly pay for the certification expenses.

About the Author: Timothy Cummins, CPA is with the public accounting firm of Aronson, Fetridge & Weigle, 6116 Executive Blvd., Fifth Floor, Rockville, MD 20852; Phone (301) 231-6200. Article copyright ã 1999, Aronson, Fetridge & Weigle, first published in the firm’s Fall 1999 issue of “The Contractor” newsletter. Reprinted by ConstructionRisk.com with permission.

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This newsletter is distributed with the understanding that ConstructionRisk.com, LLC is not engaged in the rendering of legal services.  Further, the comments in this newsletter are for general distribution and cannot apply to any single set of specific circumstances.   If you have a legal issue to which your believe this newsletter relates, we urge you to consult your own legal counsel.   Any content or opinions expressed by the writers of this newsletter are set forth in their individual capacity and do not necessarily reflect the opinion of any writer’s employer and are not to be attributed to any such employer.

Copyright ã 1999, ConstructionRisk.com, LLC

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