In This Issue:
* Introducing A/E/C Select – Professional Liability Insurance
* Differing Site Conditions and Lost Productivity Entitle
Contractor to Additional Compensation
* No E&O Coverage for Intentional Business Decisions
* Project Owner not Liable for Site Safety
About this Newsletter
This newsletter is edited by J. Kent Holland, Jr., J.D., and published by e-mail once per month. The case summaries in this current issue were also written by Mr. Holland. Past issues are archived at http://www.constructionrisk.com, where you will also find an extensive, free risk management library. Additional risk management materials, including a contract guide, on-line seminar, contract review questions and answers, and access to professional liability insurance quotes are available at http://www.AECselect.com, also maintained by Mr. Holland.
Introducing A/E/C Select, LLC – Professional Liability Insurance
In order to provide easier access to professional liability insurance, Kent Holland (the editor of this newsletter), has established an independent insurance agency — A/E/C Select, LLC, currently licensed in Virginia, and soon to be licensed along most to the east coast. The agency will provide risk management services, and will provide access to multiple insurance markets for professional liability insurance. In addition to publishing a wealth of risk management material at http://www.aecselect.com, the agency will find other innovative ways to use the internet to facilitate insurance transactions and the exchange of information. Small and midsize firms, in particular, will benefit from obtaining the type of risk management services that have typically been available only for larger firms.
Differing Site Conditions and Lost-Productivity
Entitle Contractor to Additional Compensation
A construction contractor was entitled to change orders where it encountered differing site conditions that required the use of form footings instead of trench footings as has been planned. The plans and specifications incorporated into the contract contained affirmative indications that the subsurface conditions would be consistent with the use of trench footings. The owner was not entitled to enforce contract terms that attempted to deny bidder reliance on soil reports and other information provided by the owner. The contractor’s reliance upon the soil borings was reasonable and its failure to conduct a pre-bid site investigation did not foreclose recovery on its differing site condition claim.
The trial court’s judgment against the contractor (“Smoot Company”) was reversed on appeal, with the appellate court finding that the contractor had encountered subsurface conditions that were materially different from those represented in the contract documents and soil-boring logs provided by the owner. The trial court also erred in denying the contractor additional costs for decreased labor productivity that resulted from the owner’s failure to properly coordinate schedules of different contractors. Proper interpretation of the contract language was the key to the appellate court holding.
Smoot’s differing site condition claim alleged that the contract indicated that the subsurface soil conditions would permit trench footings to be used. Actual conditions, however, required the use of more expensive form footings. As background, the court briefly explained the difference between the two types of footings. Trench footings require a trench the same size and dimensions as the planned footings. The walls of the excavation serve as the form for the concrete. These can only be used where the soil is sufficiently cohesive to permit an excavation in the precise size and shape of the planned footings. Form footings, on the other hand, are made by excavating an area larger than the planned footing, and placing a temporary wood or metal form in the size and shape of the planned footing into the hole for concrete to be poured into it. These are more expensive because of the additional time and materials involved.
As it attempted to excavate for the footings, Smoot encountered large rocks, coal and shale that made it impossible to use trench footings. Its requests for change orders for additional compensation to use form footings were denied. The owner asserted that Smoot was not entitled to rely upon soil borings that had been provided to bidders but not made a part of the contract documents. The contract expressly disclaimed reliance upon the soil borings with the following language: “Use of the information is totally at the risk of the Contractor. Additional soils information, if needed by any Contractor, shall be obtained by the Contractor at not costs to the [owner].” In addition, the owner asserted that the contract, itself, made no representation concerning the site conditions or the practicability of using trench footings, and expressly disallowed compensation for encountering any subsurface conditions. The Supplemental General Conditions provided: “No increase in the contract amount will be permitted for removal of any type of below grade material that appears in the Soils reports.”
Smoot argued that the contract contained affirmative indications that the subsurface conditions would permit use of trench footings. The contract expressly incorporated the plans and specifications into it. In reviewing these, the court found that they included section views of typical foundation structures, including two different views of typical wall footings – both labeled “trench footing.” The court concluded that the architectural plans, in fact, contained affirmative indications that the subsurface conditions would be consistent with the use of trench footings. In attempting to rebut the importance of this, the owner argued that Smoot didn’t rely on the contract and drawings, but instead relied upon the soil borings. Even assuming that to be the case, however, the court said this would not deprive Smoot of entitlement. END OF PART I FROM E-MAIL NEWSLETTER.
PART II (NOT INCLUDED IN E-MAIL NEWSLETTER):
It was apparent, said the court, that the owner intended bidders to rely upon the soil borings in preparing their bids. Under the circumstances of this case it was incorrect for the owner and trial court to conclude that Smoot’s failure to conduct a reasonable pre-bid site investigation barred recovery. A site investigation would not have revealed the subsurface conditions in any event. Because of the cut and fill nature of the site, the actual elevations at which Smoot had to work didn’t even exist at the time of bidding, and thus “the job site did not exist until after Smoot had been awarded the contract.”
Having provided the soil boring information, the owner has given an implied warranty of accuracy of the affirmative indications regarding job site conditions. This doctrine is based upon the principle that it is unreasonable to expect every bidder on a government contract to perform expensive job site investigations, which the government is in a position to perform once for the benefit of all bidders. The court cites Spearin v. United States. In this current case, Smoot’s reliance upon the soil borings was reasonable and its failure to conduct a pre-bid site investigation did not foreclose recovery on its differing site condition claim.
A separate issue contested in this case was the question of whether the contractor was entitled to recover lost-productivity costs on a separate and distinct contract as a result of the owner’s failure to obtain timely performance from one of the other contractor’s on this project. The trial court believed that damages incurred on one contract as the result of the breach of another unrelated contract are never legally recoverable. In fact, says the appellate court, such damages are known as “special” or “consequential” damages, and are legally recoverable in certain circumstances.
The court gives as an example a case in which a subcontractor on a sports arena project was able to recover the profits it lost on several unrelated projects as a result of being constructively forced to accelerate its work on the arena project. In complying with the constructively accelerated schedule, the subcontractor had to divert equipment and manpower from the other projects, causing its delay in completing those projects and its loss of profits on those projects. These costs are recoverable as damages under the first project if the contractor shows that, at the time of entering into the primary contract, the defendant had reason to foresee that a breach of the primary contract could cause the plaintiff to suffer damages on a second unrelated contract.
In this case, the court held that Smoot was entitled to recover only the lost-productivity costs incurred on the job itself. It was not entitled to recover consequential damages on an unrelated contract since there was no evidence showing that the owner had reason to know that delaying the contractor’s work on one contract would cause it to suffer damages on another contract. Sherman R. Smoot Company v. The State of Ohio, 2000 Ohio App. LEXIS 180.
RISK MANAGEMENT NOTE ON THIS CASE
This case teaches several valuable lessons that are most applicable to government contracts. Applying principles of federal procurement law, courts frown upon attempts by federal and state agencies to deny bidders the ability to rely upon site information provided prior to bidding. They are likewise hesitant to permit agencies to deny reliance upon plans and specifications that are incorporated into the contract. Government contract principles have historically recognized the benefit to the government in paying for costs incurred by the contractor arising out of differing site conditions. If claims for differing site conditions were not permitted, the bidders would all load up their bids with contingent costs to protect them in the event they encountered an unforeseen condition. If a lump sum bid includes pricing for contingencies, and no changed conditions are encountered, the contractor will reap a windfall profit since it receives the extra money without having to perform any extra work. Owners will pay higher contract prices under every contract instead of paying change order costs only for those contracts where a differing site condition is encountered.
A simple hypothetical may help to explain this point. If City X builds ten projects with anticipated construction values of $1 million each, it might expect total bids of $10 million for those ten projects. Let’s assume that contracts allow for equitable adjustment to the contractors for differing site conditions, and that differing subsurface conditions are encountered on three of these projects. After some review and haggling between the owner and contractors, let’s say change orders are issued in the amount of $200,000. The total construction costs to the owner for the ten projects is then $10,200.000. If, on the other hand, the owner issued contracts forbidding any equitable adjustment to the contractors for differing site conditions, it is possible that every contractor would include an additional ten percent contingency (i.e., $100,000) in its bid. The total construction budget to the owner then would be $11 million. This may not be a perfect hypothetical, but it does show the logical basis for the government’s insistence on including equitable adjustment clauses, including the changed conditions or differing site conditions clause, in the construction contract. In the long term, it saves the owner money.
Contractor’s should not assume that these government contract principles will be applied in contracts with private parties. Contracts with private, commercial parties, will generally be enforced exactly as written. Private developers should be encouraged, however, to consider the reasonable principles discussed in this case and write their contracts in such a way as to permit equitable adjustments to contractors where appropriate.
No E&O Coverage for Intentional Business Decisions
After its engineering firm performed design services for a wastewater treatment plant, the municipal project owner (Orland, Indiana) and a citizens group became concerned about cost projections and certain technical aspects of the design. The Town suspended all activities on the project while it evaluated various options. During the delay, the engineer filed suit against the town for the unpaid fee for the services it had rendered. After settlement negotiations, the town consented to an entry of judgment against it for the fees, plus prejudgment interest. Because the town’s errors and omissions insurance carrier refused to defend or indemnify the claim, the town sued the carrier for breach of its coverage obligation. The court held that because the engineer’s claim was based on the town’s intentional business decisions, there was no negligent act, error or omission to which the town’s e&o policy would apply.
When it was sued by the engineer, the town notified its insurance company (“carrier”) on a Local Government General Liability Policy which contained Errors and Omissions Liability Insurance. The carrier refused to defend or indemnify the town. The town then sued the carrier to recover under the terms of the E&O insurance. In reviewing the coverage dispute, the court observed that the language of the policy stated that it specifically excluded “any loss to the insured or for any loss caused intentionally by or at the direction of the insured.” The town argued that this provision should not bar coverage because it believes a fair reading of the engineer’s suit was that the relief sought by the engineer against the town was based upon its “perceived mismanagement of the sewer and water projects.”
The policy provided coverage for “any claim for breach of duty made against the insured by reason of any negligent act, error or omission. . . .” In analyzing this language, the court found that it provides coverage only for breaches of duty by the town “that arise from a negligent act, negligent error or negligent omission. Thus, clearly not all breaches of duty are covered by the clause.” In this case, the court found that the town’s conduct was not a matter of negligent performance but consisted rather of “deliberately made business decisions which caused [Engineer] to question Orland’s commitment to the contract and, thus, bring the federal lawsuit. We hold that such conduct does not result in liability under the Errors or Omissions Clause.” Town of Orland v. National Fire & Casualty, 726 N.E.2d 364 (Ind. App. 2000).
Project Owner not Liable for Site Safety
Under Texas law, a property owner had no liability for the injuries sustained by a laborer employed by the contractor since the owner did not retain any control over the manner in which the work was performed, and it had no actual knowledge of the danger or condition that resulted in the laborer being injured. An employee of the contractor fell from a ladder while constructing a store on land owned by Lee & Chang Partnership (“Lee”). The laborer argued that Texas law should not be applied to protect Lee from liability because the statute was only intended to apply if the individual was injured by the very same improvement he had worked on. In this case, the individual worked on an air conditioner unit. He argued he wasn’t injured by that unit or while working on the unit, but rather by falling from a ladder that he used to reach the roof where the air conditioning unit was located.
The court rejected the laborer’s clever argument, holding that the protection afforded to the owner by the statute is not limited to situations where the defective condition is the object of the contractor’s work. In this case the evidence showed the owner didn’t know of the defect concerning the use of the ladder, but that the employees of the contractor knew of the danger and used the ladder anyway. Owner’s only duty would have been to warn of any known dangers, and since it knew of no danger, it didn’t violate any duty to warn. Kevin Fisher v. Lee & Change, 16 S.W.3d 198 (Tex. App, 4/20/00).
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Editor: J. Kent Holland, Jr., J.D.
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