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Inside This Issue:

  • Arbitration Clause in AIA Design-Build Subcontract Bars Third-Party Claim in Litigation;
  • Architect’s Admissions in Settlement Agreement used against Him by State Board of Examiners to Revoke his License;
  • Additional Insured is not Covered for Sole Negligence;
  • Court Finds Coverage for Construction Defects Despite Exclusions to the Contrary

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Construction Law & Risk Management — Case Notes 2003-2005:

If you enjoy this newsletter, you should buy this 300 page book that compiles and organizes all the articles and case notes that were published in ConstructionRisk.com Report during the three years of 2003, 2004 and 2005 are included here. The cases and articles included in this book demonstrate risk management principles to be considered and applied on construction projects.  The intent is to give a sampling of issues and cases, providing risk management ideas and information to serve as a useful resource for contractors, design professionals, project owners, attorneys, educators, risk managers, and insurance professionals.

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Article 1

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Arbitration Clause in AIA Design-Build Subcontract Bars Third-Party Claim in Litigation

By:  J. Kent Holland, Jr.

A Design/Builder that was sued by project owner for alleged design and construction defects was barred from bringing a third-party claim or separate legal action against its subcontractor architect, because the AIA sub-contract document required that claims first be submitted to arbitration.

In the case of The Hillier Group, Inc. v. Torcon, Inc., (Case No. 2D05-4615, Florida District Court of Appeal,  2006),  when Torcon was sued by the project owner, Torcon, in turn, filed a separate action against its architect, Hillier, as well as against several other subcontractors – asserting actions for indemnity and breach of contract.  Hillier responded by moving the court to dismiss the complaint on the basis that Torcon had failed to first submit its claim to arbitration as required by the contract.

Torcon responded to Hillier’s motion by arguing that judicial economy required the court to decide all matters related to the owner’s claim against Torcon, including Torcon’s claims against its subcontractors, in a single judicial proceeding.  Torcon also argued that Hillier waived any right it may have had to arbitration by failing to timely serve a demand for arbitration as required by the contract.  And Torcon argued that the arbitration provision of the AIA contract did not require binding arbitration but could have contemplated nonbinding mediation or arbitration instead.  One final argument by Torcon was that by filing an answer to an action for declaratory relief that had been filed by Torcon, Hillier waived any right to arbitration. The trial court rejected Hillier’s motion and allowed the third-party claim to proceed in the litigation.

The appellate court reversed the trial court for a number of reasons.  The court found the language of paragraph 6.1 of the AIA form is sufficient to create an enforceable agreement for binding arbitration.  The language states that disputes “shall be subject to and decided by mediation or arbitration.”   In reaching its conclusion concerning the adequacy of the language, the court said it declined to adopt a rule requiring an arbitration clause to contain one or more “magic words” to be enforceable.

With regard to the argument concerning judicial efficiency, the court followed the precedent of another appellate district in Florida that in a similar case concluded “we cannot accept the proposition that a party to a contract calling for arbitration may avoid that undertaking by the simple device of joining as defendants in its lawsuit others with which the party has no such agreement to arbitrate.”   A party cannot avoid a contractual duty to arbitrate, says the court, by asserting claims against additional parties.   Thus, considerations of judicial economy have no role to play in determining whether the parties’ dispute is subject to arbitration.

In rejecting Torcon’s argument that Hillier waived its right to arbitration by failing to make a timely arbitration demand, the court found that all that was required under the AIA language was: “A demand for arbitration shall be made within a reasonable time after the claim, dispute or other matter in question has arisen.”  No specific time frame is established by the contract.

The trial court found that Hillier’s failure to demand arbitration prior to being sued amounted to a waiver of its arbitration right.  But since Hillier had no claim against Torcon, it had no reason to file a lawsuit or initiate arbitration against Torcon.  Consequently, the appellate court concluded that it was sufficient that Hillier promptly opted for arbitration instead of litigation after Torcon initiated its suit against Hillier.  The way the appellate court explained its reasoning is as follows: “We think that the adoption of the rule that a defending party waives the right to arbitration by failing to demand it prior to being sued would be unwise.  Such a rule would enable one of the contracting parties to circumvent an arbitration provision by filing a lawsuit before the other party filed a demand, thereby encouraging the immediate resort to litigation as soon as a dispute became a glimmer on the horizon.  This would upset the established expectations of contracting parties who have chosen arbitration as the preferred means of settling their disputes.

For these, and other reasons, the court reversed and remanded the case to the trial court for the entry of an order compelling arbitration of the parties’ dispute.

Comment: This case demonstrates once again how important it is that the dispute mechanism specified in subcontracts be consistent with that which is set forth in the prime contract with the project owner.  It is possible that on this project, the design-builder utilized the AIA subcontract containing arbitration language without giving any thought to whether that language needed to be modified due to the prime contract provisions.   Form contracts serve an excellent purpose but they need to be carefully reviewed on a project by project basis to determine what terms and conditions may need to be deleted, added or modified in order to provide appropriate allocation of risks for the specific project—particularly in light of any conflicting terms in other contracts applicable to the work.    One possible way to remedy the language of the subcontract form that created the problem in this case is to add a sentence stating that in the event that either party is sued in court, on a matter arising out of or relating to the project, by someone that is not party to the subcontract,  it will be agreed that for the purposes of judicial economy either party to the subcontract may assert  third-party claims or other causes of action against the other party in that judicial proceeding.

About the author: Kent Holland is a construction lawyer  in Tysons Corner, Virginia, and is a risk management consultant for environmental and design professional liability insurance and contracts.   He is also publisher of ConstructionRisk.com Report.  He may be reached at Kent@ConstructionRisk.com.  This article is published in ConstructionRisk.com Report, Vol. 8, No. 6.

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Article 2

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Architect’s Admissions in Settlement Agreement used against Him by State Board of Examiners to Revoke his License

J. Kent Holland, Jr.

A State Board of Examiners of Architects was legally permitted to consider admissions against interest by Architect in a settlement agreement with its client which was incorporated into a court order resolving litigation.   The architect’s argument that the settlement was intended to be confidential and that it should not have been considered by the Board was rejected by a court.  In addition, the appellate court held that the facts admitted to in the settlement agreement, when adopted by a trial court order containing conclusions of fact and of law, establish res judicata—meaning that the issues are resolved and need not be further litigated.

In Nye v. Ohio Board of Examiners of Architects (No.05AP-833, (Ct. of Appeals – Ohio, 2006),  the appellate court affirmed a judgment of a lower court that had affirmed an order of the state Board of Examiners revoking the architect’s certificate of qualification to practice architecture in Ohio.

The architect argued that the Board should not have deemed admissions by the architect in a settlement agreement with its client to be binding and irrefutable evidence of professional misconduct.  The client had filed lawsuits against the architect asserting fraudulent transfer of assets, misstatements made with fraudulent intent, and fraudulent actions involving the creation of corporations for illegal purposes and breach of contract.  The architect, according to the court, “specifically admitted to fraud, fraudulent transfers and conduct preventing the discharge of debt under the bankruptcy code.”

The settlement agreement was by its own terms incorporated into an agreed judgment entry that the common pleas trial court issued.  The court order entered judgment against the architect, pursuant to the settlement agreement, in the amount of $110,000 and stated that the judgment entry “constitutes a finding of fact and law regarding the substantive merits of each of [client’s] underlying claims.”

After the matter was resolved by settlement agreement and court order, the client filed a complaint with the board of examiners requesting that the board revoke or suspend the architects’ license.  The architect received an administrative hearing before the Board and the Board considered as documentary evidence the court’s judgment entry as well as the facts contained in the settlement agreement.  The hearing officer for the Board concluded that the architect’s actions violated various sections of the state statutes.  The court of common pleas (trail court) then affirmed the decision of the Board and the architect appealed the court’s decision.

On appeal, the architect argued that it was improper for the trail court to affirm the board’s order because the board improperly applied the doctrine of res judicata and deemed architect’s admissions in the settlement agreement to be conclusively binding evidence in the proceedings before the board. The court explained that the doctrine of res judicata includes two separate concepts: (1) claim preclusion, historically called estoppel by judgment, and (2) issue preclusion, traditionally called collateral estoppel.  The doctrine of collateral estoppel, said the court, “provides that an issue or a fact that was fairly, fully, and necessarily litigated and determined in a prior action may not be drawn into question in a subsequent action between the same parties or their privies, whether the cause of action in the two actions be identical or different.”

Because the architect’s factual admissions were incorporated into the agreed judgment entry, the civil action by the client is deemed actually litigated and determined by final judgment of the court.  But the architect argued that because the Board was not a party to the civil action that gave rise to the admissions, the principal of res judicata cannot be applied because mutuality of parties is a prerequisite to apply res judicata.

The appellate court declined to apply the general requirement that there must be complete mutuality of parties for res judicata to be applied.  Instead, it held that “because [architect] was not preclude from litigating whether the admitted facts from the prior civil litigation warranted the revocation of his architect’s license, the trial court did not err in affirming the board’s use of offensive collateral estoppel to give conclusive effect to [architect’s] prior admissions, even though the board was not a party in the prior civil litigation.”

Comment: When entering into a settlement agreement with an angry client, it may be advisable to put as few substantive facts and admissions as possible into the agreement.  I prefer settlement agreements that state that without either party admitting wrong doing, fault or liability, it is agreed that the matter is settled according to terms set forth in the settlement agreement, and this agreement should further state that it is waiver and release of all claims–known and unknown.  If possible under relevant state law, it may be advisable to make the settlement agreement conditioned on waiver of subsequent complaint to the Board. Rules of ethics do not permit such a release of ethics complaints a client may have against their attorney, but the rules may be different for other professions in different jurisdictions.  In this current case, the settlement agreement purported on its face to be confidential.  A major exception to the confidentiality requirement was provided for in the agreement, however, to allow disclosure if either the client or architect “requires use of this Agreement for evidence or otherwise in litigation, bankruptcy proceeding or other court proceeding.”  The appellate court concluded hat this was broad enough to allow its use before the board of examiners.  It is likely, however, that the intent of this exception to the confidentiality agreement was merely to permit a party to enforce divulge its contents in a subsequent proceeding in order to enforce its terms.  Having it used as a weapon in an unrelated matter such as before a state board of examiners was probably never anticipated by the architect.

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Article 3

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Additional Insured is not Covered for Sole Negligence

J. Kent Holland, Jr.

Insurance coverage was provided to a third-party (project owner) as an additional insured under a contractor’s excess insurance policy.  Where the additional insured endorsement excluded coverage for the additional insured’s sole negligence, the court determined that contract language such as indemnification requirements had no bearing on the scope of the coverage because only the insurance policy and endorsement would determine the extent of coverage.

In Evanston Insurance Company v. ATOFINA Petrochemicals, Inc. (No. 03-0647, Texas – 2005), Triple S Industrial Coporation (Contractor) was hired to perform maintenance and construction work for ATOFINA Petrochemicals (Owner) at ATOFINA’s Port Arthur oil refinery.  An employee of the Contractor was killed at the owner’s facility while performing work.  Relatives of the employee sued Owner for wrongful death and received a favorable settlement for $6.75 million.  ATOFINA then sought indemnification for the settlement from the Contractor’s insurance carriers.  The primary commercial general liability (CGL) carrier tendered its $ million policy limit to ATOFINA.  The excess carrier (Evanston Insurance Company), however, denied the claim and refused to contribute toward the settlement.

ATOFINA was named as an additional insured on both the Admiral CGL policy and on the Evanston excess policy.  The Admiral CGL policy specifically excluded from coverage any liability arising from ATOFINA’s sole negligence.  The Evanston excess policy was a “follow form” policy so that it covered only the same liabilities covered by the underlying policy.  In addition, the Evanston policy contained two relevant definitions of who is an insured under the policy.  Under section III.B.5 it stated that an insured is “any … person or organization who is insured under a policy of ‘underlying insurance.’  The coverage afforded such insureds under this policy will be no broader than the ‘underlying insurance’ except for this policy’s Limit of Insurance.”   The policy contained an additional provision stating that an insured may also be “a person or organization for whom [Contractor] has agreed to provide insurance as is afforded by this policy; but that person or organization is an insured only with respect to operations performed by [Contractor] or on [Contractor]s] behalf, or facilities owned or used by [Contractor].   ATOFINA qualifies as an insured under both provisions of the policy.

As an initial matter, the Texas Supreme Court noted that the indemnity clause in the contract between the Contractor and ATOFINA would not limit the scope of the insurance provided by the carriers because the additional insured provisions stand separately from the indemnity provision.   Next, the court found that regardless of what insurance coverage the Contractor may have been required by contract to purchase for the benefit of ATOFINA, it was only the terms of the actual policies that would determine the coverage provided and, therefore, the extent of responsibility of the carriers.

Looking at the terms of the excess policy, the court held that the two definitions quoted above had to be read holistically rather than independently.  Since the one section clearly stated that ATOFINA would not be covered for its sole negligence, ATOFINA could not avoid that restriction by arguing that it was covered under the other section which did not contain that same limitation.  The sole negligence restriction had to be read into both definitions of the contract to make sense of the policy as a whole.

The court determined that ATOFINA has no coverage under the Evanston policy for its own sole negligence.  But because the wrongful death claim was settled with no admission of liability by either party, it was impossible for the court to determine whether ATOFINA’s responsibility for the accident was “sole.”  The court, therefore, remanded the case to the trail court for a determination of the respective liabilities of the parties.

Comment: The court in this case addressed an argument by Evanston that its coverage was limited in scope by the indemnity agreement between ATOFINA and the Contractor.  The indemnity agreement in the contract specifically excluded indemnity for any acts of ATOFINA’s sole negligence.  The court rejected Evanston ’s argument in this regard, holding that the additional insured provision was not limited to covering only the liabilities reflected in the indemnity agreement.  As explained by the court, “While the indemnity agreement is relevant to determining what the parties intended with respect to the scope of the indemnity obligation, an insurance policy secured to insure that obligation stands on its own.   To the extent the insurance policy fails to satisfy the indemnity obligation, the obligor [contractor] remains exposed.”

When reviewing a contract to determine whether risk allocation is appropriate, it is important to understand that parties are free to negotiate terms that shift risk from one party to another in a manner that creates uninsured liability for the party that assumes the risk.  In the case at issue, the indemnity clause of the contract did not limit Evanston ’s insurance obligations, but nor did it increase those obligations.  The policy speaks for itself and coverage scope is neither increased nor decreased by the terms of a construction contract.

Another point for consideration in drafting contracts is what dispute resolution mechanism will be utilized.  This case was resolved by a settlement agreement that did not assign any responsibility or liability to any party.  Many cases are resolved by arbitration proceedings which generally do not set forth any factual or legal reasoning for decisions granting monetary damages to one of the parties.   If insurance is at issue it may be prudent to require that arbitration decisions include findings of fact and conclusions of law so that an insurance carrier may determine whether the liability is covered in a situation like this one under an additional insured endorsement or other provision of the policy.  Without such information, the carrier might be justified in declining coverage.  With the remand to the trial court in the instant case, the parties will end up back in trial court with the time and expense of proving the extent of responsibility for the injuries in order to prove entitlement to insurance coverage.

About the author: Kent Holland is a construction lawyer  in Tysons Corner, Virginia, and is a risk management consultant for environmental and design professional liability insurance and contracts.   He is also publisher of ConstructionRisk.com Report.  He may be reached at Kent@ConstructionRisk.com.  This article is published in ConstructionRisk.com Report, Vol. 8, No. 6.

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Article 4

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Court Finds Coverage for Construction Defects Despite
Exclusions to the Contrary

J. Kent Holland, Jr.

Where a contractor was sued for defective work on a construction project, it demanded that its commercial general liability (CGL) policy carrier provide coverage for the claim.  A trail court ruled that the policy did not cover the damages because they were excluded by the “work-product exclusion” of the policy.  This was reversed on appeal, with the court holding that the subcontractor exception to the work-product exclusion rendered the exclusion inapplicable.  In addition, the court held that the policy provided coverage for this loss under its “products-completed operations hazard” provision.

In Supreme Services and Specialty Co., Inc. v. Sonny Greer, Inc. (04-1400, Louisiana , 3d Cir. Court of Appeal – 2006), Supreme Services and Specialty Co. (Owner) contracted with Sonny Greer, Inc. (Contractor) for the construction of a commercial building on a lot owned by Supreme.  After the project was completed the Owner sued Contractor for breach of contract and breach of a separate warranty agreement arising out of a problem with cracks in a concrete slab installed by the contractor’s subcontractors.  Contractor filed a third party claim against its CGL carrier, AXA Global Risk U.S. Insurance Company (AXA).  AXA filed a motion for summary judgment alleging that the policy specifically excluded coverage for damages arising out of Greer’s work.   The contractor in turn filed a motion for summary judgment against AXA seeking a declaratory judgment that the AXA policy provided coverage.   The trial court granted judgment for AXA – finding that the exclusion precluded coverage for the damages.

In its reasons for judgment in favor of AXA, the trail court explained as follows: “The issue before the court is whether the ‘work product’ exclusions in the CGL policy exclude coverage to Sonny Greer, Inc.  The pertinent exclusion in the policy reads as follows: Property damage to … (6) that particular part of any property that must be restored, repaired or replaced because ‘your work’ was incorrectly performed on it.  19.  ‘Your work’ means: a. work or operations performed by you or on your behalf; and b. Material, parts or equipment furnished in connection with such work or operations.”  The court found that this exclusion applied to the work performed by the subcontractors on the concrete slab.  The cracks in the slab did not cause damage to any other property at the site. It was only the damage to the work itself that was at issue.  (Note:  This application of what is commonly called the “your work exclusion” is how insurance carriers intend for the policy to be read and applied.  The key that sometimes permits a contractor to get around the exclusion is that some policies only apply the exclusion to the contractor’s own work and not to work performed by a subcontractor for the contractor.  The language of the policy in this case, however, was apparently intended by the carrier to apply equally regardless of whether the work was performed by prime contractor or its subcontractor.)

In reversing this decision, and finding coverage, the appellate court quoted at length from the policy, focusing on exclusion j. “Damage to Property”, exclusion k. “Damage to Your Product”, and exclusion l. “Damage to Your Work.”  The court also focused on the definitions of Property Damage”, “Your Product”, “Products-completed operations hazard”, and “Your Work.”

The Property Damage exclusion stated that there would be no coverage for “That particular part of real property on which you or any contractors or subcontractors working directly or indirectly on your behalf are performing operations, if the ‘property damage’ arises out of those operations.” (j. (5)).  It also excluded “property damage” to “[t]hat particular part of any property that must be restored, repaired or replaced because ‘your work’ was incorrectly performed on it.” (j. (6)).   An exception to the j.6 exclusion stated “Paragraph (6) of this exclusion does not apply to ‘property damage’ included in the ‘products-completed operations hazard.”

In exclusion L, the policy stated that it would not provide coverage for “’Property damage’ to ‘your work’ arising out of it or any part of it and included in the ‘products-completed operations hazard.’”  An exception to this exclusion stated “This exclusion does not apply if the damaged work or the work out of which the damage arises was performed on your behalf by a subcontractor.”

Based upon its review of the second paragraph of 2.L stating that the work-product exclusion does not apply to work done by subconrtractors, the court concluded that this constitutes an excepton to the work-product exclusion and thereby creates a conflict with exclusion 2j(5), “which purports to exclude coverage for the work-product of subcontractors as well as the insured.”  The court found “the subcontractor exception to the work-product exclusion in part ‘l’ herein renders the exclusion in the AXA policy inapplicable.  To the extent that other language conflicts with the exception, the ambiguity created by the conflict also leads to a finding that the work-product of each subcontractor of Greer is covered under the policy.”

The contractor also argued that the policy provided coverage under the “products-completed operations hazard” provision of the policy.”  The court agreed that it did.  To reach that decision, the court interpreted the damage to the contractors and subcontractors concrete work itself to be property damage arising out of completed operations, and also understood this work to be a “work product” creating product operations liability instead of “your work” which would have been excluded.  (Note:  This is paraphrased based upon the way the author of this casenote understands the court’s explanation).  Since the court sees this as a work product and products-completed operations hazard, it looked to the language of exclusion 2j(6) which excludes insurance for “that particular part of any property that must be restored, repaired or replaced because ‘your work’ was incorrectly performed on it.”  The court relied upon the exception to that exclusion which states “Paragraph (6) of this exclusion does not apply to ‘property damage’ included in the products-completed operations hazard,” and concluded that the exception rendered the exclusion void as to the cracked concrete which the court opined was work product of the insured with regard to property damage included in the “products-completed operations hazard” provision.

Comment: In reading this decision it is easy to see why contractors file suit against their carriers who deny coverage based on exclusions that although they have a long history of use in the market place may yet appear to some courts to be ambiguous and confusing.  Generally, the type of loss in question in this case would be called damage to “your work” and would be excluded pursuant the damage to your work exclusion of the policy.  The court focused instead on work “product” and on “completed operations” neither of which seem most appropriate.

The view of many courts would be that damage to a contractors own work is not deemed “Property Damage” within the context of the policy, or that it is not caused by an “accident” and is therefore not covered.  The language in the policy at issue made it clear that the exclusion for damage to the contractor’s own work applied regardless of whether the work was performed by the prime contractor or its subcontractors.  Some other policies are not as clear on this point and courts have found coverage where the work in question was performed by a subcontractor rather the insured prime contractor.

In a lengthy law journal article that I co-authored with John B. Lennes, Jr. (Zurich North America Insurance), entitled “The Jonah Perspective on Construction Defects: A View from Inside the Fish,” (Federation of Defense & Corporate Counsel, Vol. 53, No. 4 – 2003), we review the wide variety of court interpretations of policy language that often creates insurance coverage where insurance carriers thought they had carefully constructed language to limit or exclude coverage, which AXA no doubt thought it had done in this case.    If you are considering suing your carrier for denying coverage you may find this article useful in framing your arguments.

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ABOUT THIS NEWSLETTER & A DISCLAIMER

This newsletter Report is published and edited by J. Kent Holland, Jr., J.D. 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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