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Inside This Issue:

•  Recent California Decision Erodes Certainty of 10-Year Statute of Repose Against Construction Defect Claims

•  Risk Adjusted GO-NO-GO Decision Process

•  Waiver of Subrogation Enforced, Denying Insurance Company Recovery against Contractor it Alleged was Grossly Negligent

•  New California Law Prohibits Type I Subcontractor Indemnity in Favor of Residential Builders

•  Proving Constructive Acceleration Claims Can be Difficult for Contractors

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ARTICLE 1

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Recent California Decision Erodes Certainty of 10-Year Statute of Repose Against Construction Defect Claims

by Gregory R. Shaughnessy, Esq.

For many years, contractors and construction lawyers in California understood that a bright line existed regarding potential liability for construction defects – no liability 10 years after substantial completion of the project. The recent decision by the California Court of Appeal in Acosta v. Glenfed Development Corp., 128 Cal.App. 4th 1278 (2005) took a narrow exception to the 10-year rule, for actions based on “willful misconduct or fraudulent concealment,” and expanded the exception to the point that it may swallow the rule. In so doing, the Court took a statute intended to provide certainty and reduce risk and created a great deal of uncertainty and potential added risk.

Background

Code of Civil Procedure §337.15 provides a statute of repose that bars actions to recover damages for construction defects more than 10 years after substantial completion of the work of improvement. Case law has clarified that this 10-year bar does not apply to personal injury claims. See, Geertz v. Ausonio, 4 Cal.App.4th 1363 (1992).

In Acosta, the court granted summary judgment in favor of a developer/contractor on the grounds that 47 of the 59 named plaintiffs had been brought into the case more than 10 years after recordation of notices of completion on their single-family homes. The plaintiffs argued that an exception to the 10-year rule applied, namely subdivision (f) of §337.15, which provides: “This section shall not apply to actions based on willful misconduct or fraudulent concealment.”

In opposition to the motion for summary judgment, counsel for the plaintiffs asserted this exception.

Plaintiffs submitted two declarations from expert witnesses that listed defects that are commonly found in reports by expert witnesses in substantial construction defect litigation, including:

Horizontal attachments for vertical truss supports in the garages were missing.
Lack of adequate shear transfer.
Missing or inadequate holddowns.
Missing or inadequate straps and hangers on load-bearing members.
Some driveways were short by as much as 3.5 feet.
Stucco defects.
Leaking windows.
Less expensive kraft paper used to flash around the windows instead of the asphalt polyethelene sheeting specified on plans approved by the city.

The experts opined that most of the defects undermined the structural integrity of the homes and created a substantial risk of injury to persons and/or property. They also opined that the defects:

Involved conspicuous failures to comply with applicable building code provisions, with the city-approved building plans and with basic construction industry practices.
Were of a type that inevitably would have been recognized by any competent construction supervisor conducting even minimal day-to-day inspections of the type required in a construction project such as the one at issue and would have caused the construction supervisor to require the responsible subcontractors to remedy the defects immediately before work could proceed on the houses.
Had the financial impact of producing, in defendants’ favor, substantial cost savings.

The experts stated that the defects appeared to be the result of willful misconduct by defendants in that they were “so serious and prevalent that they were either the result of [a] deliberate decision to ‘cut corners’ for cost savings or the result of a near total, virtually reckless, failure by the developer to adequately supervise subcontractors.”

Analysis

The Acosta court recognized that other case law had emphasized the purpose of §337.15 was to “provide a ‘firm and final’ outside limitation period for construction suits involving claims for latent defects.” Nonetheless, the court held that the “willful misconduct exception” applied, holding that the term encompassed “not only intentional wrongdoing, but negligence of such a character as to constitute reckless disregard for the rights of others.”

The Acosta court was able to locate only one other decision applying the exception in §337.15 (f), Felburg v. Don Wilson Builders, 142 Cal.App.3d 383, 390 (1983). There, a defendant builder sold plaintiffs a home that had been built over an oil sump. After subsidence caused considerable damage to the home, the plaintiffs filed suit about 12 years after substantial completion of the home. In opposition to the defendant’s motion for summary judgment, the plaintiffs submitted an expert declaration that stated that “it would have been impossible to pour the foundation of the home without seeing the evidence, in plain view, that the lot was over an oil sump.” The plaintiffs also offered evidence indicating that the builder actually had received a boring report from a soils engineer that showed the existence of the oil sump on or near the plaintiff’s lot.

The Acosta court found that the facts in Felburg were “remarkably similar” to those in the Acosta case. It is submitted that the obvious knowledge in Felburg that a house was being built on a woefully deficient construction site with total disregard of a soils report showing the existence of the oil sump is not remotely, much less remarkably, similar to garden variety construction defects that were present in the Acosta case. Indeed, the principal defects in Acosta appeared to be defects that may have undermined the structural integrity of the houses and which created the risk of injury but that had not actually caused any injury.

Importantly, the Acosta court held that the developer/contractor could be found to have engaged in willful misconduct even if it did not have actual knowledge of the defects, for example, where the work was performed by subcontractors. The court reasoned that the developer/contractor was liable to buyers for the acts of the subcontractors because developers/contractors “have supervision over the construction, including the work of the subcontractors” and found that this duty was non-delegable. The court also found that imposing supervisory obligations on developers/contractors was consistent with the contractor’s license law. Finally, the court found that under the exception in subdivision (f), which states that it applied to “actions based on willful misconduct,” “it is only necessary that the action be based on and arise from willful misconduct by someone. It does not matter whether defendants committed such misconduct directly or it was done by subcontractors hired by them.”

Comment

The California Supreme Court denied a petition for review and request for depublication. Thus, plaintiffs now have authority that could make overcoming the 10-year statute of repose in most construction defect cases easier. The 10-year statute of repose no longer will be seen as an almost insurmountable barrier.

It is difficult to imagine a case where a creative plaintiff’s lawyer will be unable to come up with a declaration that the construction defects were the result of a deliberate decision to cut corners for cost savings and that there must have been a near-complete failure by the developer to exercise even minimal supervision. In such cases, it may be difficult for a defendant to escape from the case by a motion for summary judgment that relies on the 10-year statute of repose. Thus, plaintiffs frequently will be able to get cases before a jury that would otherwise have been disposed of by summary judgment. Whether the conduct by the developer/contractor was willful misconduct normally will be a question of fact for the jury. Colich & Sons v. Pacific Bell , 198 Cal.App.3d 1225 (1988).

The Acosta decision is not remarkable in its application of the “willful misconduct” exception but rather in the manner in which it applied the exception. It allowed expert declarations that were not remarkable and that did not remotely approach the egregious facts in the Felburg decision to create a triable issue of fact, even against a developer/contractor when there was no direct evidence that the developer/contractor had knowledge of the defects. In effect, the Acosta decision could create strict liability by the developer/contractor for any willful misconduct by the subcontractors or when the defects were the result of a lack of supervision.

Some steps can be taken by developers/contractors to try and keep the 10-year limitation period intact. This includes conducting special inspections and keeping good records of such inspections. This would tend to show that proper supervision was provided and that attention to quality control was given, perhaps enough to overcome the conclusory and self-serving declarations of the plaintiff’s experts on a motion for summary judgment. Notably, there was no discussion in Acosta of the fact that the allegedly grossly defective work presumably had passed inspections by local building officials.

Special inspections actually have been fairly common for the last five years on condominium projects in California , as most such projects were built with wrap OCIP insurance policies, which typically require such inspections as part of the OCIP program. However, such OCIP policies typically also have 10-year “tail” coverage following substantial completion. Under Acosta, construction defect actions can be brought after the expiration of the 10-year tail, leaving developers, contractors and subcontractors exposed to liability for construction defects with no insurance coverage — thus further chilling the market for construction of single-family housing in California .

About the Author:  Gregory R. Shaughnessy is an attorney in the law firm of Thelen Reid & Priest. This article originally appeared in the legal newsletter of Thelen Reid & Priest as well as their website, www.ConstructionWebLinks.com. For more information about the issues covered in this report, contact Gregory R. Shaughnessy in the San Francisco office of the firm at 415-369-7235 or at gshaughnessy@thelenreid.com.

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ARTICLE 2
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A Risk Adjusted GO-NO-GO Decision Process

by Matt Lutz,  FMI Corporation

Risk identification and the subsequent management or mitigation of these risks has become a focal point for leading construction exectuives around the world.  As owners seek to minimize construction risk exposure via onerous contractual arrangements and government agencies shed control over labor and safety issues, contractors must become experts at identifying, pricing, and managing risk.  This article provides an introduction to some of the techniques leading contractors are using to identify and manage risk. The link to the full article in pdf format is the following:

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ARTICLE 3
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Waiver of Subrogation Enforced, Denying Insurance Company Recovery against Contractor it Alleged was Grossly Negligent

By J. Kent Holland

In an insurance case arising out a church fire, a state supreme court held that Reliance National, and other insurance carriers of the church, were not entitled to subrogate against the contractor whose employee allegedly caused the fire, because a waiver of subrogation in the church’s contract with the contractor was enforceable to bar the claim.

The contract between the church and contractor contained the following provision: “”The Owner and Contractor waive all rights against each other, separate contractors, and all other subcontractors for damages caused by fire or other perils to the extent covered by Builder’s Risk or any other property insurance, except such rights as they may have to the proceeds of such insurance.”

The fire was caused when an employee of the contractor, Knowles Industrial Services, Corp. (Knowles),  brought a cigarette or open flame within ten feet of a section of the Church to which large quantities of the paint stripper had been applied earlier that day.  The church was destroyed, with damages totaling almost $15 million.  The church’s insurance carriers paid it about half of those losses.  Those carriers then sought to bring a subrogation suit in the church’s name against Knowles and the manufacturers of the paint stripper that was used.

As to the contractor, Reliance’s complaint alleged willful and wanton misconduct, negligence, breach of contract, and breach of warranty.  As to the chemical defendants, the complaint alleged strict liability, negligence, and breach of warranty.

The lower appellate court granted a motion for summary judgment in favor of Knowles and the chemical defendants, and against the church/Reliance because the court found that the waiver of subrogation barred the claims

On appeal to the state supreme court, Reliance argued that genuine issues of material fact exist with respect to whether Knowles misrepresented its qualifications and intentions to comply with all pertinent federal and state regulations in order to obtain the contract from the Church.  In reviewing this allegation the Supreme Court stated that as subrogee of the Church, Reliance is bound by the Church’s statement of material facts and record references.  Since the church did not argue or prove that Knowles made misrepresentations, the Court said this issue was not genuine and could not be presented by Reliance.
The court next dealt with the question of whether a wavier of subrogation is void as against public policy.  As explained by the court, “ A waiver of subrogation is a provision by which parties to a contract relieve each other of liability to the extent each is covered by insurance, thereby shifting the risk of loss to an insurer.”  The court further explained that it has previously held “waivers of subrogation are encouraged by the law and serve important social goals: encouraging parties to anticipate risks and to procure insurance covering those risks, thereby avoiding future litigation, and facilitating and preserving economic relations and activity.”

In this case, Reliance argued that there must be public policy exception to the general rule that waivers of subrogation are enforceable.  Specifically, Reliance contended that public policy precluded the enforcement of the waiver of subrogation in this case based on Knowles’s willful and wanton misconduct or its violation of a positive statutory duty, or because enforcement will be harmful to the interests of society.

The Supreme Court rejected all these bases.   It acknowledged that exculpatory clauses are unenforceable in the face of claims of gross negligence or willful and wanton misconduct.  But, the Court concluded “that principle is inapposite to waivers of subrogation.”  “The rule exists for exculpatory clauses to ensure that “a party injured by another’s gross negligence will be able to recover its losses. [citations omitted].  In cases involving waivers of subrogation, however, there is no risk that an injured party will be left uncompensated, and it is irrelevant to the injured party whether it is compensated by the grossly negligent party or an insurer.”  The point that the court was making is that there is a major distinction between a party indemnifying another for its own negligence and parties allocating risk to insurers.

What was particularly problematic to the Court with regard to Reliance’s argument was that, “Adopting the approach advocated by Reliance would require us to distinguish between varying degrees of negligence.  We have rejected the concept of gradations of negligence,  [citation omitted] and we decline to change our approach with respect to waivers of subrogation for two reasons.”  The first reason given by the Court is that “waivers of subrogation deter litigation among parties to complicated construction contracts.”

In this case, the Court noted the real injured party in this case—the Church—was not a party to the appeal because the waiver of subrogation did what it was intended to do: it allowed the Church to resolve its claims quickly.  The court further explained that the Church was made whole to the limits of its insurance and it was not divested of a remedy, and, “Were we to hold that parties cannot bar subrogated claims for gross negligence or willful and wanton misconduct, these benefits will evaporate, as the parties will have the incentive to litigate the question of whether a heightened standard of negligence applies.”

The second reason given by the Court was that “waivers of subrogation have a beneficial economic effect that furthers the public interest.  They help parties avoid the higher costs that result from having multiple insurance polices and overlapping coverage.  [citation omitted].  In addition, because insurers can account for such waivers when setting premiums, [citation omitted], there is still an economic incentive for parties to refrain from committing gross negligence or willful and wanton misconduct.”  For these reasons, the Court concluded that “public policy favors enforcement of waivers of subrogation even in the face of claims of gross negligence or willful and wanton misconduct.”

Reliance National Indemnity et al. v. Knowles Industrial Services, Corp. et al. (868 A.2 220, 2005 ME 29).

Comment. This case highlights why project owners routinely seek waivers of subrogation as one of the terms of the construction contract.  It also demonstrates why insurance carriers need to take these waivers seriously during the underwriting process—deciding whether to put limitations on them, or to charge additional premium for permitting the insured to grant a waiver of subrogation.  Some carriers, particularly in professional liability policies, have granted greater leeway to their insureds to waive the right to subrogate.  But the policy language states that such waivers must not be granted after the damage or claim, but may only be granted as part of the initial contract terms and conditions.  Exercise caution before agreeing to any waiver.  Be sure you know what your insurance policy permits.  Discuss this with your insurance broker or carrier as appropriate.

About the author:  Kent Holland is a construction lawyer in Tysons Corner, Virginia, and is a risk management consultant for the environmental and design professional liability.  He also publisher of ConstructionRisk.com Report.

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ARTICLE 4
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New California Law Prohibits Type I Subcontractor Indemnity in Favor of Residential Builders

By: Dion N. Cominos, Esq.

Under an Assembly Bill recently signed into law by California Governor Arnold Schwarzenegger, “Type I” subcontractor indemnity agreements in favor of builders entered into after January 1, 2006 will no longer be enforceable in the context of residential construction projects.

Existing law provides that Type I indemnity agreements between builders and subcontractors are permissible except where they purport to indemnify the builder for its sole negligence or willful misconduct.  However, AB 758 will amend section 2782 of California ’s Civil Code to provide that a builder may no longer obligate a subcontractor to indemnify the builder for the builder’s own negligence or for damages unrelated to the scope of work set forth in the agreement.

The new law will not prohibit a subcontractor and builder from mutually agreeing to structure defense or reimbursements arrangements in any particular fashion so long as the central prohibition against Type I indemnity clauses is not affected.  Further, the obligation of a subcontractor’s insurance carrier to defend an entire action against a builder under an additional insured endorsement remains unchanged under the legislation.  The legislation is also inapplicable to contracts entered into prior to January 1, 2006, contracts involving commercial construction, condominium conversions or apartment construction, and also does not apply to personal injury claims.  Further, AB 758 does not restrict a general contractor’s ability to incorporate Type I indemnity clauses into its subcontracts so long as the general contractor is not also a “builder” (I.e., in the business of selling residential units to the public).

Interestingly, the bill does not specifically mention design professionals by name, and speaks only in terms of “subcontractors.”  It is thus unclear at this time whether residential builders will be able to include Type I indemnity provisions in contracts with design professionals after January 1, 2006.

About the Author:  Dion Cominos is an attorney with the firm of Gordon & Rees LLP, 275 Battery Street, CA 94111; (415) 875-3133; dcominos@gordonrees.com; www.gordonrees.com.

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ARTICLE 5
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Proving Constructive Acceleration Claims Can be Difficult for Contractors

By: Katz & Stone

When claiming entitlement to cost for constructive acceleration, contractors must prove that any time extensions received were inadequate to remedy their excusable delays.  Time extensions do not have to be granted immediately, and the mere failure to grant extensions does not, by itself, constitute constructive acceleration so long as the procedures set forth in the parties’ contract for time extensions are being followed.

In Fraser Construction Co. v. United States, 384 F.3d 1354 (Fed Cir. 2004), the government contracted with a contractor to excavate material from the bottom of a shallow lake.  The contract period was from May to September of 1993.  To facilitate excavation, the water level of the lake was lowered, leaving only a small stream running through the lakebed which the contractor diverted with a dike.  The contractor designed the dike to withstand water flow substantially higher than the average water flow for the lake.

Shortly after the project began, the lake began experiencing high water flows because of rain in the region.  The high water flows overran and destroyed the dike and caused damage to the work site.  The contractor experienced delays associated with repairing the dike and inundation of the work site.  The contractor requested a time extension which the government denied but later granted.  The contractor contended that the extensions that were later granted were not sufficient to compensate it for the extra expenses it had incurred in dealing with the high water flows, because upon being told that it would not receive time extensions or that those extensions would be dealt with later, it was forced to continue its operations at a substantial additional cost. The contractor further argued that many of the time extensions that it was ultimately granted were of no use to it because they were not granted on a timely basis.

The court rejected the contractor’s argument that the extensions were not timely, finding that it was standard practice for parties to negotiate after the fact to determine the number of days to extend the contract period.  The court found it significant that the government followed the standard procedure for reviewing extension requests and had daily discussions with the contractor regarding delays and progress on the project.

The court also rejected the contractor’s claim that the government forced it to accelerate its performance by pressuring it to work through delays that should have resulted in an extension.  The contractor’s evidence of constructive acceleration consisted of a letter from the government urging the contractor to adhere to the contract schedule and threatening termination if it did not.  An expression of concern about progress combined with a refusal to issue extensions can be the equivalent of an order to accelerate.  However, this letter was sent by the government before the contractor ever made a claim for excusable delay based on high water flow.  Also, the delays which precipitated the government’s letter were due to subcontractor problems not associated with high water levels.

As a result of this case, contractors should be aware that when making claims for constructive acceleration, they must prove that extensions granted by the government were not sufficient to offset excusable delays.  Furthermore, time extensions do not have to be granted immediately and the mere failure to grant extensions does not, by itself, constitute constructive acceleration so long as the procedures set forth in the parties’ contract for time extensions are being followed.

About the Author: This article is reprinted with permission from Katz & Stone, L.L.P. Construction Newsletter (March/April 2005 issue).  Katz & Stone’s practice is devoted to the construction industry, with its attorneys working exclusively for those who own, develop, design, build and bond construction projects.  The address is 8230 Leesburg Pike, Suite 600 , Vienna , VA 22182 . (703) 761-3000.

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ABOUT THIS NEWSLETTER & A DISCLAIMER

This newsletter Report is published and edited by J. Kent Holland, Jr., J.D., a construction lawyer and risk management consultant for Environmental and Design Professional Liability.  The Report is independent of any insurance company, law firm, or other entity, and is distributed with the understanding that ConstructionRisk.com, LLC, and the editor and writers, are not hereby engaged in rendering legal services or the practice of law.  Further, the content and comments in this newsletter are provided for educational purposes and for general distribution only, and cannot apply to any single set of specific circumstances. If you have a legal issue to which you believe this newsletter relates, we urge you to consult your own legal counsel. ConstructionRisk.com, LLC, and its writers and editors, expressly disclaim any responsibility for damages arising from the use, application, or reliance upon the information contained herein.

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Copyright 2005, ConstructionRisk.com, LLC

Publisher & Editor: J. Kent Holland, Jr., Esq.

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