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Inside This Issue:

  • Turnabout at Trial:  Contractor Ordered to Pay $50 Million for Fraudulent Claims;
  • Design Professional Decreed to be Fiduciary of Project Owner;
  • Entitlement to Contract Reformation to Recover Inflation Costs Exceeding Inflation Factor Specified by GMP Contract  ;
  • Women Construction Owners & Executives Adopts an Aggressive Agenda ;
  • BIM:  The Professional and Legal Ramifications – A Voyage into the Unknown ;
  • Risk Managers for Two Large Contractors Wanted

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Article 1

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Turnabout at Trial:
Contractor Ordered to Pay $50 Million for Fraudulent Claims

By J. Michael Littlejohn, Esq.

Akerman Senterfitt Wickwire Gavin

In October, the Court of Federal Claims issued a decision determining that, based on trial testimony, a construction contractor that had been seeking affirmative claims against the United States Corps of Engineers had actually submitted false claims and committed fraud under the Contract Disputes Act.  As a result, instead of recovering on its multi-million dollar claim, the contractor was ordered to pay more than $50,000,000 to the Government under the CDA’s fraud provisions and $10,000 under the False Claims Act.

The facts and issues in the 89-page decision are too voluminous to recount in this newsletter, and there is ample room for the decision to be questioned on appeal.  In sum, the contractor, Daewoo Corporation, had a construction contract with the Corps to build a 53-mile road on the island of Palau .  The Corps estimated the project to be worth around $100 million and Daewoo’s bid was only $73 million.  After experiencing severe weather delays during the project, Daewoo submitted a certified claim to the Contracting Officer in the middle of its work in the amount of $64 million, seeking $13 million for added costs incurred and $50 million for “costs to be incurred” after the date of the claim.  Daewoo’s basic argument was that it had been misled by the weather clause in the contract and that the Corps had understated the amount of adverse weather to anticipate on the project.  Daewoo argued that it was entitled to an adjustment for the impact of the weather because the clause was defective and that the Corps had superior knowledge about conditions.  It also argued that the embankment clause in the contract was defective and that the specifications were impossible to perform.

A few of the more interesting aspects of the case are set forth below:

<        DOJ did not raise a fraud defense until after Plaintiff rested its case at trial.  At that point, DOJ argued that unexpected testimony by Plaintiff’s witnesses should allow DOJ to amend its answer to assert counterclaims based on the False Claims Act (31 USC § 3729), the Special Plead in Fraud (28 USC § 2514), and the CDA Fraud Provisions (41 USC § 604).  The court allowed the counterclaims.

<        The court appears to have been troubled by several issues that led it to believe the claims were fraudulent:

—  Plaintiff pursued legal arguments relating to the interpretation of the weather clause in the contract that the Court found were “not credible.”

—  The testimony from Plaintiff’s witnesses was “disturbing” according the court.  The Korean company’s executives apparently testified in a “vague and unreliable manner.”

—  One of the company’s witnesses testified that it filed its $50 million-plus certified claim with the Corps as a “negotiating” ploy to make the government to “pay attention” to the situation on the site.

—  Plaintiff’s loss of productivity claim stated that it was based on the “cost of operations” but trial testimony revealed that the claim was based on “planned costs of operations.”  Accordingly, the judge found that the claim misled the Corps into thinking that it was based on “actual” costs rather than “estimated” costs.

—  After submitting the claim, Plaintiff engaged an accounting expert that “updated” or “repriced” the claim.  The court was concerned that the “updating” resulted in the original $50 million claim being reduced to $29 million.

As a result of its findings, the court held that the contractor had attempted to defraud the Government by submitting its claim.  The court entered judgment for the United States under the fraud provisions of the CDA for the amount of the claim that was filed in bad faith by the contractor — $50 million.  It also reserved entering final judgment against the contractor under the False Claims Act and for the Government’s costs related to the CDA counterclaim.  According the court, it could enter additional judgment against the contractor for $4,000,000, representing the Government’s costs of trying the counterclaim.  It also has reserved deciding whether the overstatement of more than 700 items of equipment and 27 items of scrapped equipment in its claim would allow the court to enter judgment for multiple violations of the False Claims Act, amounting to $7,620,000.

About the Author

Michael Littlejohn, Esq. is a shareholder with the law firm of Akerman Senterfitt Wickwire Gavin, in the Tysons Corner , Virginia office located at 8100 Boone Boulevard, Suite 700 . Vienna,  VA   22182-2683 .  He advises government contractors on day-to-day contract administration issues, claim avoidance, and claim preparation; Litigates claims and bid protests before boards of contract appeals, United States Court of Federal Claims, GAO, and other federal agency dispute resolution offices; and Represents government contractors on issues before Congress and federal agencies. He may be reached at michael.littlejohn@akerman.com.

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Article 2

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Design Professional Decreed to be Fiduciary of Project Owner

By:       Michael S. Zetlin, Esq.
Zetlin & De Chiara, LLP

In a decision that could have far-reaching implications for design professionals, a court in California recently concluded that a fiduciary relationship existed between an architect and an owner.  As a result of the architect’s breach of this purported fiduciary relationship, a jury rendered a verdict in favor of the owner for over $8,000,000.

The owner, Lake Merritt Plaza , in the case of Lake Merritt Plaza v. Hellmuth Obata & Kassabaum, claimed that the project architect failed to properly monitor and report upon the work of a curtainwall designer and contractor.  In particular, Lake Merritt Plaza (“LMP”) sued Hellmuth Obata & Kassabaum (“HOK”) and the general contractor, Turner Construction Company (“Turner”), for curtain wall defects that arose in connection with the construction of the Lake Merritt Plaza building.

The court apparently relied upon standard language used in American Institute of Architects (AIA) contracts to find that a fiduciary relationship existed between the owner and the architect.  As a result, the court expanded the role of the architect beyond the explicit contract terms.

Factual and Procedural Background

Turner retained a curtain wall subcontractor to design and install the curtain wall system.  After the work was supposedly completed, the curtain wall leaked continuously.  The curtain wall subcontractor performed repairs but leaks continued severely thereafter.  LMP then apparently waited several years before investigating the causes of the leakage.

LMP never retained a waterproofing consultant, although its contract with HOK provided that LMP would provide the services of a consultant “when such services [were] deemed necessary by the Owner and the Architect … for determining … water conditions, with reports and professional recommendations.”  HOK recommended the services of a consultant to evaluate the watertightness of the curtain wall.  LMP never retained the consultant, however, because it apparently was led to believe by Turner and others (not HOK) that the mock-up test passed.  In fact, the mock-up test failed.  One of LMP’s primary claims against HOK was that it was never apprised of the failure of the mock-up test.  LMP alleged that HOK, as its fiduciary, had the obligation to advise it of the results of the mock-up test.

According to LMP, had it known of the failure of the test, it would have retained a curtain wall waterproofing consultant which would have prevented the leakage that subsequently occurred.  LMP also argued that HOK had an obligation to ensure that the remediations prepared at the mock-up tests were incorporated into the shop drawings for the project.  HOK countered that it was unaware that LMP never received the report of the mock-up test failure, and it was incumbent upon LMP to provide such information to HOK.  In any event, argued HOK, LMP had the independent obligation to retain the waterproofing consultant to inspect the installation.  That obligation was not dependent upon the results of the mock-up test.  HOK also stressed that the partners of LMP were experienced developers and lawyers.  HOK argued, therefore, that it was unnecessary and inappropriate for the Court to impose a higher standard to the relationship than was otherwise imposed by the terms of the contract itself.

HOK’s Contractual Responsibilities and the Fiduciary Relationship

HOK’s contract with LMP was predicated on standard American Institute of Architects contract language.  HOK agreed to “endeavor to guard the Owner against defects and deficiencies in the work of the Contractor.”  HOK, however, was not responsible “for construction means, methods, techniques, sequences or procedures.”  Similarly, HOK was not responsible for the acts, omissions or failures of the contractors.

Nothing in the contract explicitly imposed a fiduciary obligation on the architect or a relationship of trust and confidence.  Nevertheless, the Court apparently relied on other language in the contract which declared the architect to be a representative of the Owner and other scope provisions to conclude that HOK owed fiduciary obligations to LMP.

The Significance of the Fiduciary Relationship Determination
As a result of the Court’s finding of a fiduciary relationship, LMP was given free reign at the trial to present evidence of HOK’s “duties” which apparently far exceeded the explicit duties set forth in the contract.  LMP presented witnesses who testified about the expectations and understandings of HOK’s construction administration services rather than relying on the express terms of the contract.

HOK, therefore, was imparted with considerable responsibility for protecting the interests of the owner with respect to the curtain wall, even though (i) the general contractor was solely responsible for construction means and methods, and (ii) HOK had no explicit contractual responsibility for supervising or inspecting the curtain wall or the mock-up tests.

Even more damaging to HOK’s case was a finding that HOK’s fiduciary relationship with LMP excused LMP’s inaction after discovering the leakage problem.  The curtain wall leaked repeatedly and the curtain wall subcontractor attempted to repair the leaks on several occasions.  The repair failed and severe leakage occurred but LMP did not actually seek to investigate the cause of the leakage.  Had it done so it would have discovered the cause of the leakage several years earlier.  The Court excused LMP’s delay in taking affirmative steps to discover the cause of the problem of the fiduciary relationship finding, depriving HOK of a possible statute of limitations defense.

Under the circumstances of this case, the Court held a design professional to a higher standard of care than agreed to as part of the contract terms.  As a result, in this case, the design professional had to defend against phantom responsibilities never bargained for as part of the underlying agreement.

While this decision does not reflect a trend of courts to expand a design professional’s responsibility to an owner, certain precautions are still warranted.  In particular, it would be prudent for a design professional to explicitly incorporate in its contract with an owner that nothing contained in the agreement or otherwise is intended to create a fiduciary relationship between the parties.  Without taking certain precautions, a design professional will run the risk of being saddled with more responsibility than it anticipated for a project.

About the Author:  Michael S. Zetlin is founding member of Zetlin & De Chiara LLP, a New York, New Jersey and Connecticut based law firm that represents architects, engineers, design professionals, contractors, construction managers, owners, developers, and other parties in the construction industry.  A graduate civil engineer as well as an attorney, Mr. Zetlin represents national and multi-national firms in a wide range of construction and real estate matters. He lectures frequently on many topics relating to the design and construction industries and he is a member of the Governing Committee of the ABA Forum on the Construction Industry.  He may be contacted at Zetlin & De Chiara, 801 Second Ave. , New York , NY . 10017, 212-682-6800 or by e-mail at  mzetlin@zdlaw.com.

Publisher’s Note: This article was written by Mr. Zetlin several years ago when  the case was decided and was published in the Zetlin & DeChiara newsletter.  I am re-printing it here because this issue continues to be of concern and I am seeing more and more contracts in which the project owner is seeking to use language stating that the design professional will have a fiduciary duty to the owner. For the reasons explained in this article, design professionals should strike that kind of language from the contracts.

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Article 3

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Entitlement to Contract Reformation to Recover Inflation Costs Exceeding Inflation Factor Specified by GMP Contract

By:       J. Kent Holland, Jr., Esq.
ConstructionRisk, LLC

I.  Executive Summary.

Where project owners have declined to grant requested cost increases to account for unexpected inflation, contractors have succeeded in obtaining relief from courts.   “Commercial impracticability” is the legal basis most often used by federal courts and federal agency Boards of Contract Appeals for granting either contract rescission or reformation.  This is also one of the principal bases cited by the state courts.  When arguing entitlement to an increase in the guaranteed maximum price (GMP) or other cost basis for a contract, it is important to consider the reported decisions of the state whose law applies to the contract.  State courts have held in favor of reforming contracts based on a number of different legal theories, including commercial impracticability, mutual mistake, and frustration of purpose.

Due to my participation in a matter in Washington State , I recently briefed the arguments entitling a contractor to recover actual inflation costs exceeding the inflation factor established in its GMP contract.  There is a significant body of Washington State case law holding that contract performance is excused due to “frustration of purpose” or “mutual mistake.”  Washington courts have also adopted and applied the Restatement 2d Contracts, §265, “Discharge by Supervening Frustration.”   This article, which is based on a legal brief that I wrote as part of a request for equitable adjustment, presents both federal and Washington State case law supporting equitable relief and contract reformation for the contractor. Although there have been some reported decisions holding against relief for the contractor, I believe that the analysis presented in this article/legal memorandum presents the better and more reasonable view.  A contractor should not be penalized for cost escalation that is beyond its own control.  And a project owner should not expect to reap a windfall benefit by sticking its contractor with the risk of inflation and cost escalation over a multi-year project construction. For all parties to be made whole and remain in the position that anticipated at the time of contract award, it is necessary that the contractor be paid the reasonable cost of material and labor escalation.

“Performance of a contract may be excused under [the commercial impracticability] doctrine based upon extreme and unreasonable difficulty, expense or injury.” Evans v. Meyers, 2002 Wash. App. LEXIS 1844. The court in Evans stated that having to incur excessive costs renders performance impracticable and, therefore, impossible, as understood by the law of the State of Washington .” This doctrine of commercial frustration has been applied to justify contract rescission.  Weyerhaeuser Real Estate Co. v. Stoneway Concrete, Inc., 96 Wn.2d 558, 637 P.2d 647 (1981).

Washington courts recognize mutual mistake as a basis for contract rescission or reformation. Simonson  v.  Fendell, 101 Wn.2d 88; 675 P.2d 1218 (WA Supreme Ct.. 1984), (buyer of a corporation was entitled to contract rescission due to mutual mistake concerning the solvency and operating profitability of the company.)

Where contractors have sought contract reformation to recover unforeseen cost escalation, courts have granted reformation—applying one or more of the theories of commercial impracticability, frustration of purpose, or mutual mistake.  One federal district court found in favor of contract reformation on all three theories in Aluminum Company of America (Alcoa) v. Essex Group, 499 F. Supp. 53 (W.D. Pa 1980).  The court determined that significant cost increases resulting from sudden escalation in cost were not anticipated by the parties to the contract and that the losses that would be caused to Alcoa made performance of the contract commercially impracticable.  As explained by the court, “The focus of the doctrines of impracticability and of frustration is distinctly on hardship…. Impracticability focuses on occurrences which greatly increase the costs, difficulty, or risk of the party’s performance.”

The court in Alcoa also determined that both parties to the contract made a mutual mistake of fact in agreeing to use a specified cost index because they misjudged the suitability of the index, and “their mistake is legally sufficient to warrant modification or avoidance of Alcoa’s promise.”  Just as in the Alcoa contract, the parties to the instant contract consciously undertook to calculate inflation risk and provide a specified escalation amount that they reasonably anticipated would cover the inflation that would occur during the term of the contract.  They could not have anticipated the events that would render that amount grossly inadequate.

II.        Commercial Impracticability and the Defense of Commercial Frustration
in  the Washington Courts

The Washington courts hold that to successfully assert an impracticability defense, a party must show the following: (1) the event made performance as agreed impracticable; (2) the nonoccurrence of the event was a basic assumption on which the contract was made; (3) the impracticability resulted without the fault of the party seeking to be excused; and (4) that party must not have assumed a greater obligation than the law imposes.  Sampson v. Trend, 94 Wn. App. 1066 (WA Appeals, Div. 1, 1997).

Each of the four elements specified above by the court in Sampson v. Trend, is satisfied in the case of the contract at issue in this particular instance, in that (1) the extraordinary cost escalation experienced for construction materials and labor in the Seattle area rendered performance impracticable; (2) nonoccurrence of such high cost inflation/escalation was a basic assumption under girding this contract; (3) the cost escalation was certainly beyond the control of this contractor, and neither Hurricane Katrina nor the excessive escalation could have been foreseen or anticipated by the contractor; and (4) the contractor did not intend to assume by contract an obligation for such unforeseeable cost escalation (in this regard, see the discussion below concerning mutual mistake that is also applicable under Washington law).

In Sampson v. Trend, 94 Wn. App. 1066 (WA Appeals, Div. 1, 1997), the Court of Appeals for the First Division held that a developer who signed a contract to build a home was excused from performing the contract because of commercial impracticability.  The developer-seller was unable to complete the home as agreed because of an unforeseen permit condition imposed on the project by the city.  The court held that the city’s imposition of an unforeseeable additional parking requirement made the performance of the contract impracticable. The developer-seller’s timely performance of the contract was excused due to the imposed impracticality.  The court explained:

Where, after a contract is made, a party’s performance is made impracticable without his fault by the occurrence of an event the non-occurrence of which was a basic assumption on which the contract was made, his duty to render that performance is discharged, unless the language or the circumstances indicate the contrary.

Id., citing  Restatement (Second) of Contracts 261 (1981) (quoted in Washington State Hop Producers, Inc. Liquidation Trust v. Goschie Farms, Inc., 51 Wash. App. 484, 488, 754 P.2d 139 (1988), aff’d, 112 Wash. 2d 694, 773 P.2d 70 (1989)).
The court stated: “The event which renders performance impracticable must be fortuitous and unavoidable on the part of the promisor.”  And, added the court:

To successfully assert an impracticability defense, a party must show the following: (1) the event made performance as agreed impracticable; (2) the nonoccurrence of the event was a basic assumption on which the contract was made; (3) the impracticability resulted without the fault of the party seeking to be excused; and (4) that party must not have assumed a greater obligation than the law imposes.

The court found each of the four conditions was present.  It also found that the circumstances rendered timely performance of the contract by the seller impracticable and, therefore, excused the seller’s performance.

In Evans v. Meyers, 2002 Wash. App. LEXIS 1844, the Third Division of the Washington Court of Appeals held that a real estate buyer was relieved of performance of its purchase contract because of commercial impracticability.  The court stated that “performance of a contract may be excused under this doctrine based upon extreme and unreasonable difficulty, expense or injury.”

The court in Evans considered a situation in which a seller of land asserted that the buyer was in breach of contract for not maintaining a sewage system as it was required to do pursuant to the terms of the contract.  The buyer argued that it was relieved of its contractual obligations due to impossibility and impracticability to bring the sewage system into compliance with state health department requirements.  The trial court agreed with the buyer’s position.  In affirming the trial court, the appellate court stated:

The doctrine of impossibility and impracticability discharges a party from contractual obligations when a basic assumption of the contract is destroyed and such destruction makes performance impossible or impractical, provided the party seeking relief does not bear the risk of the unexpected occurrence. Pub. Util. Dist. No. 1 v. Washington Pub. Power Supply Sys., 104 Wn.2d 353, 363-64, 705 P.2d 1195 (1985) (citing RESTATEMENT (SECOND) OF CONTRACTS §§ 261, 263 (1981 )) . In other words, performance of a contract may be excused under this doctrine based upon “extreme and unreasonable difficulty, expense or injury.

The court in Evans further explained that having to incur excessive costs renders performance impracticable and, therefore, impossible, as understood by the law of the State of Washington .  The court concluded:

Rather, “‘[a] thing is impossible in legal contemplation when it is not practicable; and a thing is impracticable when it can only be done at an excessive and unreasonable cost.'” Thornton v. Interstate Sec. Co., 35 Wn. App. 19, 31, 666 P.2d 370 (1983) (quoting Schmeltzer v. Gregory, 266 Cal. App. 2d 420, 424, 72 Cal. Rptr. 194 (1968 ))

Applying the Evans’ court analysis, performance by the contractor in the situation at hand is impracticable because it “can only be done at an excessive and unreasonable cost.”

In a significant decision applying the principle of commercial impracticability to relieve a party from its contractual obligations, the Supreme Court of Washington, in Weyerhaeuser Real Estate Co. v. Stoneway Concrete, Inc., 96 Wn.2d 558, 637 P.2d 647 (1981), addressed a situation where Weyerhaeuser, a lessor, sought rent due under a mineral lease. The lessee had abandoned the project because of its inability to obtain in a reasonably timely manner the permits necessary for mining. Based on the doctrine of commercial frustration, the trial court held that the lessee was excused from paying rent as of the day the mining permits were expected to be obtained. The Washington Supreme Court agreed with the trial court, but explained that its affirmation was based on the doctrine of commercial frustration.

In the State of Washington , courts treat the doctrines of commercial impracticability and commercial frustration very much alike, but appear to prefer to describe the basis of relief as the “defense of commercial frustration.”

Quoting from the original restatement of Contracts, §288, the Supreme Court explained that the doctrine of commercial frustration as follows:
Where the assumed possibility of a desired object or effect to be attained by either party to a contract forms the basis on which both parties enter into it, and this object or effect is or surely will be frustrated, a promisor who is without fault in causing the frustration, and who is harmed thereby, is discharged from the duty of performing his promise unless a contrary intention appears.
In applying this standard to the facts of the case, the court stated:

That Stoneway’s purpose of obtaining sand, gravel and other aggregates by strip mining the leased premises was frustrated by its inability to obtain the necessary permits is unchallenged. Stoneway was without fault in the occurrence of the supervening event causing the frustration of its purpose. There remains only the question of whether the parties contemplated the possibility of nonissuance of required permits and provided for that contingency in the lease, thereby allocating that risk to one party or the other.
The Supreme Court in Stoneway held that although the parties contemplated that the permit process might be lengthy, they did not anticipate the public’s “massive outpouring of negative reaction to the proposed mining operation.” Further, the Stoneway court held that it would be inequitable to require the lessee to bear the entire risk that the purpose of the contract would be frustrated. Stoneway, at 564-65.  Even if the parties had contemplated that there would be a lengthy permit process, the court concluded they could not have anticipated it would take as long as it ultimately took.  This inordinate length of time for permit frustrated the purpose of the contract.

The Stonewall analysis is applicable to this current contract situation.  The parties anticipated inflation.  They even specified a percentage or dollar amount for it.  Unfortunately, force majeure events such as Hurricane Katrina caused cost increases well beyond what the parties reasonably anticipated.[1]

The courts in Washington appear to use the terms “frustration” and “commercial impracticability” almost interchangeably.  In one case, a Washington State trial court explained that its decision to grant contract rescission was based commercial impracticability.  But the subsequent Division 3 Court of Appeals, in affirming the decision, stated that although the trial court called it impracticability, it had actually applied the principles of “frustration of purpose.” The Washington Supreme Court then affirmed the decision of the appellate court in Washington State Hop Producers, Inc. v. Goschie Farms, Inc., 112 Wn.2d 694; 773 P.2d 70 (Sup. Ct. WA 1989).

III.       Cases Holding for Contract Rescission in Washington
based upon Mutual Mistake

Washington courts recognize mutual mistake as a basis for contract rescission or reformation.  In Simonson  v.  Fendell, 101 Wn.2d 88; 675 P.2d 1218; ( WA Supreme Ct .. 1984), the court found that a buyer of a corporation was entitled to contract rescission due to mutual mistake concerning the solvency and operating profitability of the company.[2] The buyer’s agreement to purchase the seller’s interest in the corporation was based upon a financial statement that purported to show that the corporation was in good financial condition.  It was subsequently discovered that, through no fault of the parties, the financial statement was incorrect. The seller filed an action to enforce the contract. The purchaser pled the affirmative defense of mutual mistake to rescind the contract. The trial court found that the mistake was unilateral because the seller was willing to sell the business regardless of its financial condition. The court of appeals affirmed the trial court’s ruling.

The buyer claimed on appeal that there was a “mutual” mistake independently made by each party. The Supreme Court agreed with the buyer’s claim. It found the parties had agreed to the purchase and sale of a corporation that was operating at a profit and that the “mistaken fact was within the contemplation of both parties as the basis for the entire bargain.” The court explained:

A party seeking to rescind an agreement on the basis of mutual mistake must show by clear, cogent and convincing evidence that the mistake was independently made by  both parties. [citations omitted]. A mistake is a belief not in accord with the facts. Restatement (Second) of Contracts § 151 (1981). It is undisputed that at the time of contracting both the petitioner and the respondent independently believed that the business was solvent and operating at a profit. This belief was not in accord with the facts. Therefore, there was a mutual mistake independently made by each party in this case.

IV.       Inflation as the Basis for Decisions Granting Contract Reformation

A.   Mutual Mistake Justifies Reformation

(Aluminum Company of America (Alcoa)  v. Essex Group)

In Aluminum Company of America v. Essex Group, 499 F. Supp 53 (W.D. Pa 1980), the court considered a 15-year service contract under which Alcoa was obligated to transform aluminum into wire under a fixed price contract that included a limited  price escalation factor.  Due to unanticipated increases in electricity costs, plus additional pollution control devices that became necessary under new federal laws and regulations passed after the contract was executed, Alcoa would have sustained large losses if it continued performing its services pursuant to the terms of the contract.  The court determined that the significant cost increases resulting from sudden escalation in cost were not anticipated by the parties to the contract and that the losses that would be caused to Alcoa made performance of the contract commercially impracticable.

Alcoa sued to have the court reform the contract to eliminate the Wholesale Price Index-Industrial Commodities (“WPI-IC”) that had been included in the contract.  Alcoa sought to replace the WPI- IC with actual costs incurred by Alcoa for the non-labor items. The price index worked well for the early years of the Alcoa contract but then OPEC actions to increase oil prices and unanticipated pollution control costs greatly increased Alcoa’s electricity costs.  Electric power is the principal non-labor cost factor in aluminum conversion, and the electric power rose much more rapidly than did the WPI-IC.  “As a result,” said the court, “Alcoa’s production costs rose greatly and unforeseeably beyond the indexed increase in the contract price.”

Alcoa successfully argued to the court that the shared objective of the parties with respect to the WPI-IC that had been included in the contract had been totally frustrated and that both parties to the contract made a mutual mistake of fact in agreeing to use the WPI-IC to escalate non-labor costs.  Specifically, Alcoa argued that “both parties were mistaken in their estimate of the suitability of the WPI-IC as an objective index of Alcoa’s non-labor production costs, and that their mistake is legally sufficient to warrant modification or avoidance of Alcoa’s promise.”  In opposition to Alcoa’s argument, Essex Group (the “buyer”) argued that the asserted mistake is not legally sufficient because it is essentially a mistake as to future economic events rather than a mistake of fact.

In deciding whether this type of mistake was one of material fact, the court carefully reviewed and applied the Restatement 2d of Contracts, sections 293, 294, 296 and 502.  The courted quoted from section 294 of the Restatement 2d as follows:

(1) Where a mistake of both parties at the time a contract was made as to a basic assumption on which the contract was made has a material effect on the agreed exchange of performances the contract is voidable by the adversely affected party unless he bears the risk of the mistake under the rule stated in section 296.”

“(2) In determining whether this mistake has a material affect on the agreed exchange of performance, account is taken of any relief by way of reformation, restitution, or otherwise.

The found that the parties’ use of the WPI-IC was a mutual mistake entitling Alcoa to contract reformation.  The court stated its conclusion as follows:

The Court finds the parties’ mistake in this case to be one of fact rather than one of simple prediction of future events.  Plainly the mistake is not wholly isolated from predictions of the future or from the searching illuminations of painful hindsight.  But this is not the legal test….  The testimony was clear that each assumed the Index was adequate to fulfill its purpose.  This mistaken assumption was essentially a present actuarial error.

Essex Group argued that any mistake in this contract concerning the WPI-IC was a unilateral one of Alcoa alone.  The Chairman of the Essex Group testified at trial that “he had no particular concern for Alcoa’s well-being and that in the negotiations of the contract he sought only Essex ’s best interests.”  The court in rejecting any significance of Essex ’s motivation found that “While he [the Chairman] did not share the motive to protect Alcoa, he understood the functional purposes of the agreement.  He therefore shared this mistake of fact.”  The mistake concerning the price index was vital to the agreement.  In explaining this, the court said, “The assumed capacity of the price formula in a long term service contract to protect against vast windfall profits to one party and vast windfall losses to the other is so clearly basic to the agreement as to repel dispute.”

Essex argued that Alcoa could not be relieved of the consequences of the mistake because (1) Alcoa assumed the risk that the WPI-IC would not keep up with Alcoa’s non-labor production costs, and (2) that the parties made a calculated gamble with full awareness that the future was uncertain, so the contract should be enforced despite mutual mistake.  The court acknowledged some validity to these arguments but concluded that “The proper question is not simply whether the parties to a contract were conscious of uncertainty with respect to a vital fact, but whether they believed that uncertainty was effectively limited within a designated range so that they would deem outcomes beyond that range to be highly unlikely.”

In Alcoa, the court found: “Both [parties] consciously undertook a closely calculated risk rather than a limitless one.  Their mistake concerning its calculation is thus fundamentally unlike the limitless conscious undertaking of an unknown risk which Essex now posits.”  For these reasons, the court found that Alcoa was entitled to contract reformation based on mutual mistake.

B.  Commercial Impracticability Justifies Reformation

1.  Aluminum Company of America v. Essex Group

The Alcoa court also found in favor of Alcoa on the basis of commercial impracticability as well as frustration of purpose.  The court stated:

In broad outline, the doctrines of impracticability and of frustration of purpose resemble the doctrine of mistake.  All three doctrines discharge an obligor from his duty to perform a contract where a failure of a basic assumption of the parties produces a grave failure of the equivalence of value of the exchange and allocation.

The Alcoa court’s decision analyzed and applied the Restatement 2d of Contracts, stating that “The doctrine of impracticability requires that the non-occurrence of the ‘event’, Restatement 2d of Contract §281, n11 or the non-existence of the ‘fact’, Id. §286, causing the impracticability be a basic assumption on which the contract is made.”

As understood by the court, the Restatement does not limit the doctrine to events occurring after the execution of the contract.  In fact, the Restatement “recognizes that circumstances existing at the execution of a contract may render performance impracticable or they may frustrate the purpose of one of the parties so as to excuse his performance.”  Id. §286.

The courts in Washington have likewise adopted these principles of the Restatement.  Any argument by the Owner, therefore, that the cost escalation had already (before the contract was executed) exceeded the construction cost inflator specified in the contract should be rejected.

“The focus of the doctrines of impracticability and of frustration is distinctly on hardship,” says the Alcoa court.  The court further explained:  “Impracticability focuses on occurrences which greatly increase the costs, difficulty, or risk of the party’s performance.”  “The doctrine of frustration, on the other hand, focuses on a party’s severe disappointment which is caused by circumstances which frustrate his principal purpose for entering the contract.”   In Alcoa, the court concluded that Alcoa satisfied the requirements for both the doctrine of commercial impracticability and the doctrine of frustration of purpose.

There are decisions issued by other courts that do not necessarily follow the reasoning of the Alcoa decision, but they all appear to rest on the fact that the contracts in question were firm fixed-price contracts in which the contractor intentionally assumed all the risk, as well as all the windfall, depending upon how actual material and labor costs turned out during performance of the contract.   Because of the nature of the current cost reimbursement GMP contract on this project and the fact that neither party to the contract intended for the contractor to assume all the risk of price escalation, the analysis by the court in Alcoa is most applicable.

The Alcoa decision appears to be somewhat unusual in finding relief for a contractor based upon all three doctrines discussed above, yet it is by no means alone, in holding that a contract must be reformed to account for cost escalation.  Decisions by other courts and Boards of Contract Appeals appear to most often base relief on the doctrine of commercial impracticability.

2. Mutual Mistake of Fact Found in Case Where Contract Included                                    an Insufficient Unit Price for Steel 

In the case of Southwest Welding & Manufacturing Company v. United States, 179 Ct. Cl. 39; 373 F.2d 982, (U.S. Ct. Cl. 1967), the United States Court of Claims held in favor of reforming a construction contract to allow cost escalation that exceeded the cost specified in the contract.  The contractor in that case asked the court to exercise its equitable powers to reform the parties’ written contract to reflect what the contractor said were the true intentions of the parties.   The increased costs were due to increases in the price of steel that the contractor paid to its steel supplier.  The contract provided for payment based upon a steel cost of $7.53 per hundred pounds.  But the contractor argued that this dollar amount was intended to represent the contractor’s actual cost for procurement of steel, and was not intended to arbitrarily assign a fixed dollar amount to steel.

According to the court, when the parties’ signed the contract they both “shared a mistaken notion that $7.53 was plaintiff’s steel procurement cost [and] it was not until August 2nd that plaintiff learned that its acquisition cost was $7.98, rather than the lower figure.”  The court went on to say that “The Government, also, although it had made cost estimates, was unaware that the contract had not represented the plaintiff’s actual costs.  The agreement, as written, conferred benefits upon the Government which neither party desired or intended.”

Having reviewed the facts of the matter, the Court of Claims in Southwest Welding concluded that “both the Government and Southwest intended that the plaintiff be compensated on the basis of its actual costs.  This intention formed the essence of the parties’ understanding.”  The court found that both parties were guilty of “mutual mistake,” making it appropriate to reform the contract to reflect their actual intentions. As stated by the court, “Divergence of understanding from formal embodiment, such as this case reveals, is not at all novel, either in general contract litigation or in this court.”

3.  Mutual Mistake of Fact Concerning Applicable
Minimum Wage Rate

When executing a contract, the government and contractor had the mistaken belief that the current wage rate was $1.12 per hour.  They believed it would likely increase in the future but were unaware that it had already been increased before the date of contract execution to $1.20.  The court reformed the contract based upon that mutual mistake, so that the contractor would be paid the higher amount.  Walsh v. United States , 121 Ct. Cl. 546, 102 F. Supp. 589 (1952).

Agreeing to a specified amount of inflation that failed to reflect the actual inflation rate that was known to exist at the time of contract execution would be tantamount to the mutual mistake that was made in Walsh with regard to the hourly rage rate.

C.  Other Decisions of Significance Addressing Cost Escalation

In Poirier & McLane Corp. v. United States, 128 Ct. CL. 117, 120 F. Supp. 209 (1954), reformation was granted where mutual mistake of fact was the parties’ mutual ignorance of the actual prevailing wage rates for area laborers, resulting in costs above those stated in the written contract.

In National Presto Industries, Inc. v. United States, 167 Ct. Cl. 749,338 F. 2d 99 (1964), cert denied, 380 U.S. 962 (1965), the court concluded that the parties “wished the Government to bear the cost of the steel, whatever it was….”  It should be noted that the court rejected the Government’s argument that if the contractor had been negligent in ascertaining the proper price of steel, the contract cannot be reformed.  The Court stated that even if the contractor was indeed negligent in how it priced the contract, this did not bar reformation.  As explained by the Court, “In most, if not all, cases of mutual mistake, at least one party to the contract has not exercised the highest level of care.  But the contractor’s negligence, alone, does not prevent reformation.  This is especially true where the other party, rather than being harmed by the plaintiff’s actions, has become an unintended beneficiary as has the Government in this controversy.”

V.        GMP Contract Form has Cost-Reimbursement Contract Elements

Numerous decisions by federal and state courts have held that a contractor is not entitled to contract reformation where the contract is a firm fixed-price contract.  In some cases involving fixed-price contracts, courts have said that because the contractor reaps the benefit of any cost savings due to deflation or reductions in costs, the contractor must also accept the risk of cost overruns.

This contract principle may not have the same applicability if the contract is cost reimbursement or Guaranteed Maximum Price (GMP).  A GMP contract may somewhat of a hybrid form of contract that is more similar to a cost reimbursement contract than a fixed-price contract.  Invoices under a GMP contract are subject to audit to show the necessity and reasonableness of costs claimed.  A contractor under a GMP contract  does not assume all the risks of cost overruns.  Nor does it reap all the benefits of cost savings or cost under-runs.  The contractor is not entitled to the GMP amount unless it incurs actual costs and earns fees that reach the GMP amount.  If the costs and fees are less than the GMP, then the contractor will be entitled to only that amount.  If as a result of value engineering or change orders, the contractor is able to save money on the project, the cost savings must be shared with the Owner.

A. Force Majeure Event

Most contract include a Force Majeure clause allowing for equitable adjustment to the time and cost “for any delay in or impediment to completing the Work which arises from a Force Majeure condition” and for any “acts, omissions, conditions, events, or circumstances beyond [contractors’] control….”  “Force Majeure” is a defined term.  A contract may define it, for example, to include “hurricanes or unusual weather conditions, fire, unusual delay in transportation or delivery, … material shortage, and delay in the approval of any required permits (provided such delay is not the result of Design-Builder’s actions), or any other similar act or condition, each case only to the extent the event in question is beyond the reasonable control of the delayed party.”  In a typical GMP contract, there is a provision stating that in addition to a time extension for Force Majeure, the contractor is entitled to “an appropriate adjustment of the Guaranteed Maximum Price.”

Hurricane Katrina and other major storms caused severe shortages of materials resulting in significant cost increases in materials, increases in transportation costs, and long delivery times.  Pursuant to the terms of the contract, the contractor has a reasonable basis for asserting entitlement to recover the Cost escalation resulting from this Force Majeure event.

VI.  Conclusion

Based on the cases and the legal arguments presented herein, it is submitted that the contractor is entitled to a cost escalation adjustment to the guaranteed maximum price established by the contract.

About the author: Kent Holland is a construction lawyer located in Tysons Corner , Virginia , with a national practice.  He is principal of ConstructionRisk, LLC, providing construction risk management services including change order and claim preparation, analysis and defense, contract preparation, review and negotiation, insurance consulting and risk management, and other services.  Mr. Holland is publisher of ConstructionRisk.com Report and may be reached at Kent@ConstructionRisk.com.  This article is published in ConstructionRisk.com Report, Vol. 9, No. 4.  All articles published in this newsletter are available at www.ConstructionRisk.com.


[1] The courts in Washington appear to use the terms “frustration” and “commercial impracticability” almost interchangeably.  In one case, a Washington State trial court explained that its decision to grant contract rescission was based commercial impracticability.  But the subsequent Division 3 Court of Appeals, in affirming the decision, stated that although the trial court called it impracticability, it had actually applied the principles of “frustration of purpose.” The Washington Supreme Court then affirmed the decision of the appellate court in Washington State Hop Producers, Inc. v. Goschie Farms, Inc., 112 Wn.2d 694; 773 P.2d 70 (Sup. Ct. WA 1989).

[2] Another Washington case granting contract rescission, held that both commercial frustration and mutual mistake justified rescinding a contract.  Chemical Bank v. Washington Public Power Supply System, 102 Wn.2d 874; 691 P.2d 524 (WA Supreme Ct., 1984).

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RED VECTOR.COM — ON-LINE COURSES
Do you need year end continuing education courses?  Currently available on-line risk management courses written by Kent Holland for RedVector, (http://www.redvector.com/instructors/view_related_courses.asp?id=195) include: ABCs of Time, Goals and Purpose – The Big Picture.  Also available are: Contract Guide for the Design Professional, Design Build Professional Liability Risk Management and Insurance; Site Safety Risk and Liability; Risk Management for the Design Professional; Managing Communication, Documentation and Reports; Insurance for Design-Build and Complex Projects; Construction Contract Law; Contract Claims against Design Professionals; Insurance Coverage Disputes; and Environmental Claims.

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Article 4

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Women Construction Owners & Executives
Adopts an Aggressive Agenda

Press Release:  April 3, 2007

Women Construction Owners & Executives, USA recently installed its new Board of Directors and adopted an aggressive agenda for the coming year.  WCOE , USA is a national trades association representing women business owners and policy making executives in the construction industry.

The newly elected Board of Directors is a diverse and determined group of women business owners, associates and executives.  The following is a list of the newly elected national officers: Deborah E.G. Wilder, President, Contractor Compliance and Monitoring, Inc., Bay Area, CA; Arnice Lamb, Senior Vice-President, The Walt Disney Company, Anaheim, CA; Theresa Kern, MA Steel Erectors, Chicago; Kristine Lindsey, Secretary, CEI Group, Howell, MI; Dorothy Erickson, Treasurer, East Bay California; Judy F. Grammer, Southeast Region Director, Grammer Construction Co., Georgia; Gina Raffin, Central Region Director, Scale Construction, Inc., Chicago; Nancy Goshow, Eastern Region Director, Goshow Architects, New York, New York; Ellen Everitt, Western Region Director, Kaiser Permanente, Oakland, CA; Caryn Boisen, National Associate Director At Large, Larson – King, St. Paul, MN.

The new Board of Directors adopted a plan which focuses on expanded services to individuals and a greater presence in the Washington D.C. area as an advocate on Women Business Issues.  “The model of monthly dinner meetings used in the 1980’s and 1990’s is no longer viable.  Business owners are too busy, but they still need the information and connection that WCOE provides,” says newly elected President, Deborah Wilder from California .

WCOE , USA in addition to its national meetings is now focusing on regional meetings and bringing services directly to their members through electronic bulletin boards and webinars.  Newly elected Vice-President, Theresa Kern owner of MA Steel Erectors in Chicago , supports the new focus, “We are also seeking to promote and encourage our members to serve on local, statewide and national boards to have a more positive impact on the industry.”

WCOE , USA recently submitted testimony to Congress on the Federal Government Efforts in Contracting with Women Business Centers.  WCOE , USA considers itself the advocate and voice for women business owners and executives in the construction industry.  For more information, please contact Executive Director, Shannon Schaeffer at 800-788-3548, email: info@wcoeusa.org, or visit the website: www.wcoeusa.org.

Shannon Schaeffer
Executive Director
Women Construction Owners & Executives, USA
P: 800-788-3548
E: info@wcoeusa.org

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Article 5

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BIM:  The Professional and Legal Ramifications –
A Voyage into the Unknown

By:  Michael K. Ke Chiara, Esq and
Marianne Merritt Talbot, Esq.

Zetlin & De Chiara, LLP

The era of BIM (an acronym for “Building Information Modeling”) is arriving.  Although not yet a formal part of the traditional design process, the inexorable advance of technology is bringing this dramatic design and construction tool closer to daily reality.  Industry experts have opined that within 10 years, BIM will be the principal construction delivery tool.  What is BIM?  In its purest form, it is a model-based technology that utilizes one database for all design and construction elements and processes.  This single database could conceptually be accessed by dozens –and perhaps hundreds—of personnel during the life of a project.  Design information from all disciplines is fed into the BIM database—from architectural designs and specifications to structural and mechanical systems information such as HVAC ducting, piping and structural slabs, columns and shearwalls.  The data base contains and connects all elements of a completed building to one main database of linked project information.  Thus, for example, if a change were made to one element of the design, the sophisticated BIM database would automatically reconfigure all related elements embedded in the interrelated database.  A BIM database will go well beyond the traditional use of 2-D modeling and will have the capacity to work in 3-D, 4-D (construction scheduling) and even 5-D (cost-flow analysis).  The database could dramatically reduce waste in construction, including time delays caused by RFIs and change orders.  It could also detect design errors and omissions in early stages of a project.

Although BIM may ultimately save time and expense in design and construction processes, making it appealing to owners, issues such as those raised in the questions contained in the balance of this article must be adequately and fairly resolved in order to ensure that all professionals on such projects are protected and rewarded for their efforts.  Not surprisingly, these protections will be overwhelmingly dependent upon the contract terms agreed upon between all parties to a project.  At a minimum, design professionals will need contract provisions that will place a realistic limit on their liability for any BIM-related issues, as well as all liability which may generally arise in the context of a professional’s involvement in a project.  While design professionals and their counsel should always fight for limitations of liability in their contracts, such limitations become critical in the context of BIM…………….  The balance of this article and several other excellent articles on BIM are available as a pdf document at the link immediately below.

http://www.zdlaw.com/newsletters/2006_volume11_num4.pdf

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Article 6

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Risk Managers for Two Large Contractors Wanted

A new position reporting to the CEO for a large Midwest Contractor with revenues of about $1.5B.  Requires knowledge and experience in construction insurance, ideally as a Risk Manager with a large contractor.  Also, requires heavy experience in handling OCIPs/CCIPs and strong knowledge base of construction risk mgmt.  This individual will also have a Claims Manager as a direct report.  Needs to be an excellent communicator at all levels of management.  Should possess a BS/BA degree, 10-12 years in risk mgmt., preferably with a large general contractor.  Must have a demonstrable record in the development of risk mgmt. policies/ procedures and claims admin.  Either possess designations such as CPCU, CIC, ARM, CRIS, CRM, or significant progress toward obtaining.  A similar risk management position, reporting to the General Counsel, is available with a large contractor in Phoenix , Arizona .  The same knowledge and experience apply. For more information, contact:

Barney Mercer, CPCU, ARM
Mercer & Associates
6060 N. Central Expy. , Ste. 560
Dallas , TX 75206
www.mercerrecruiting.com

Office:  (214) 522-4133
Cell:     (214) 213-7652
Fax:     (214) 237-2923

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.

Copyright 2006, ConstructionRisk.com, LLC

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

8596 Coral Gables Lane

Vienna , VA 22182

703-623-1932

Kent@ConstructionRisk.com