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Inside This Issue:

Choice of Law Provision Incorporating law of one state into contract for performance of design services in another state does not incorporate the Statute of Limitations;

Mechanic’s Lien cannot be Filed by Contractor Removing Drums of Hazardous Waste because not Deemed Improvement to the Property;

Economic Loss Doctrine Does Not Preclude Professional Negligence Action against Architect by Project Owner for Damages Imposed under Fair Housing Act

CGL Carrier Held to Have Breached its Duty to Defend Engineer against a Laborer’s Bodily Injury Claim.

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Article 1
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Choice of Law Provision Incorporating law of one state into contract for performance of design services in another state does not incorporate the Statute of Limitations

J. Kent Holland, Esq.

Where the A/E firm of Carter & Burgess entered into an AIA B141-1997 contract in 2004 to perform design services for a project in the state of Kentucky , it included a choice of law provision stating that the contract would be governed by Texas law.  When the project owner filed suit for alleged professional malpractice, the A/E moved for summary judgment on the basis of the one year statute of limitations applicable under Kentucky law.  The owner argued that pursuant to the choice of law provision of the contract, the longer statute of limitations under Texas law must be applied.

The complaint would be timely under Texas law.  The trial court granted summary judgment for the A/E – concluding that when a contract states it will be “governed” by the law of another state, it is only  the “substantive law “of that state that is incorporated into a contract.  This does not include the statute of limitations which is procedural.  In addition, the court honored the parties contractual agreement that the clock on the statute of limitations would begin to run from the date the certificate of occupancy was issued.  It did not matter that “substantial completion” of the A/E’s services occurred after that date.   The court applied the 1 year statute of limitations that is applicable to professional services to all counts of the complaint since it concluded all the counts,  including allegations of breach of contract and  misrepresentation, as well as an indemnity claim,  were related to “professional services” and therefore subject to the 1 year statute.

In Van Eekeren Family, LLC v. Carter & Burgess, Inc., 2009 WL 541265 (W.D. Ky, 2009 slip opinion), the primary basis for the complaint by the project owner, Land O’Frost,  was that the architect should have told the owner that the area in Kentucky where the owner was considering building its facility was in the New Madrid Seismic Zone, the most seismically active region in the United States east of the Rocky Mountains.  The heightened structural requirements related to anticipated seismic activity increased project costs beyond initial estimates.  The owner asserts the A/E should have advised it about this so it could have decided differently about the state in which to locate its new facility.

The contract between the A/E and owner made the A/E “responsible for instituting design changes if the project would exceed the $28,000,000 budget by more than $500,000, and for reviewing the proposed locations for the food processing facility.”  The owner claimed that in addition to increased costs due to seismic design issues, the A/E ‘s design was substandard as evidenced by the fact that a total of 547 requests for information (RFIs) were submitted by contractors during the pre-bid and construction process, which it claims was far in excess of the number of RFIs customarily anticipated for a project of the same size and complexity.

The complaint by the owner was filed more than one year after the certificate of occupancy was issued.  As explained above, the court concluded that the one year Kentucky statute of limitations was applicable. The parties were free to negotiate in their contract the date on which the statute would begin to run.  Having lost that argument, the owner next argued the one-year statute should apply only to the single count in the complaint that specifically alleged negligent performance of professional services.  The plaintiff argued that the statute should not apply to the other counts of the complaint such as breach of contract, misrepresentation, and the contractual indemnity provision.

In applying the one-year statute to all counts of the complaint, the court said that all allegations in the complaint arise from the defendant’s professional services.  “The fact of the matter is that Plaintiff’s distinction between errors in design and a failure to timely disclose information is without relevant difference.”  The court also found that the claims for breach of contract and indemnification are “based on the very same acts and omissions that underlie Plaintiff’s professional negligence claim.”

“Furthermore,” says the court,  “the indemnity clause specifically provides that Carter & Burgess indemnifies the owner ‘from and against claims, damages, losses, and expenses … arising out of or resulting from the performance of the work and services called for … to the extent caused by the negligent acts or omissions of the architect.”  The fact that this indemnity obligation was limited to “negligent” performance was therefore considered significant.

With regard to whether the one-year statute of limitations for professional malpractice claims was applicable to the breach of contract count, the court concluded that “Plaintiff’s argument that ‘breaches of contract which are independent of any standard of care issues … should not be subject to the professional liability standard’ is untenable.”   The court explains that “ Kentucky courts have held that it is the existence of a professional performing a task and not the nature of the task itself that brings a claim within” [the professional malpractice statute of limitations.]

Comment: In four short pages, the court has provided an excellent decision with a wealth of significant points from which we should take note and learn important lessons.

1)    To make the statute of limitations from the other state apply to the project, the court states that the contract would have to specifically state that intent.

2)    The decision demonstrates the importance of making contractual indemnification obligations conditioned upon “negligence” rather than just all acts, errors and omissions.  It must be noted that this is the consistent message of insurance carriers to their insured design professionals.  If the architect had agreed to indemnify the owner for damages caused by anything other than negligence, it would create an uninsurable liability since the policy covers only negligence.

3)   It is valuable to specify a date certain for when the statute of limitations (and statute of repose) will begin to run.  Courts look favorably upon such provisions that have been mutually agreed upon.

4)   Design firms should rethink the provisions of some of the standard form contracts that require them to redesign a project because the cost estimate is exceeded.  Unless the estimate is exceeded due to negligent performance of services by the design professional, why should the DP accept such an uninsurable risk of the cost of reperforming services that were performed consistent with  the standard of care?   Particularly with the unpredictability of construction costs in this economy (and the fear  thre there may be huge inflation in the not too distant future) there could be a lot of firms redesigning projects when the reason for the cost escalation was beyond their control or responsibility.   It is recommended that these clauses be revised to state that the design firm will only revise the drawings or redesign the project for no additional fee when it was the negligence of the design firm that caused the cost estimate to be exceeded.

5)  The court’s explanation that all counts in this complaint arise out of allegations of professional malpractice no matter how they are titled is exactly right.  In contrast, consider decisions recently reported in the Construction Risk.com Report where courts in other states have been confused on this issue and consequently held that a certificate of merit is needed only for the negligence count of a complaint but not the breach of contract count.

About the author: All articles in this issue of the ConstructionRisk.Com Report are written by J. Kent Holland, a construction lawyer located in Tysons Corner, Virginia,  with a national practice (formerly with Wickwire Gavin, P.C. and now with Construction Risk Counsel, PLLC) representing design professionals, contractors and project owners.  He is also founder and president of ConstructionRisk, LLC, a consulting firm providing consulting services to owners, design professionals, contractors and attorneys on construction projects.  He is publisher of ConstructionRisk.com Report and may be reached at Kent@ConstructionRisk.com or by calling 703-623-1932.  This article is published in ConstructionRisk.com Report, Vol. 11 No. 7 (July 2009).

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Article 2

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Mechanic’s Lien cannot be Filed by Contractor Removing Drums of Hazardous Waste because not Deemed Improvement to the Property

Where an environmental cleanup contractor sued a property owner to foreclose on a mechanic’s lien due to owner’s failure to pay for the removal of sealed drums containing waste, the court agreed with the owner that the drum removal services performed by the contractor did not constitute a contract for the improvement of the site.  The court noted that the contractor’s work did not include filling the drums but instead involved only removing and disposing of drums that had been filled by others.  The court noted that the contractor also performed some incidental cleanup activities none of which were shown to be part of an overall plan to improve the property and not just maintain it.   The court concluded that the activity of removing and disposing of drums containing hazardous waste, in and of itself, does not constitute an improvement to real property so as to be a lienable activity under the Act.  Another point made by the court was that even if some of the activities performed by the contractor  had been lienable, “the entire lien must fail”unless the lienable items could be separated out from the non-lienable work.  Inter-Rail Systmes, Inc. v. Ravi Corporation, 387 Ill.App. 3d 510, 900 N.E.2d 407 (December, 2008).

Comment: As the economy continues to be problematic, and payment problems are becoming more common place, the ability of a contractor to perfect a lien on property is increasingly important.  Liens are critical to achieving payment when a project owner is experiencing financial stress and cannot pay everyone it owes.   The analysis here of what work constitutes an improvement to property should be a source of concern to contractors.  This could be particularly problematic for environmental cleanup contractors that often perform some combination of services and work that includes work that is clearly improving the property, but also includes removal of drums or other materials that have been staged by others.  Note the court’s point about the need for the contractor to separate out the lienable from the non-lienable work.  This means documenting the amount of work performed on each and the dollar value of that work so that when it comes time to file a mechanic’s lien, there is documentation to prove that the lien is limited to the work that is for improvement to the property and therefore lienable.

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Article 3

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Economic Loss Doctrine Does Not Preclude Professional Negligence Action against Architect by Project Owner for Damages Imposed under Fair Housing Act

J. Kent Holland, Esq.

Property owner’s suit against an architect alleging professional negligence and seeking purely economic damages was not barred by the economic loss doctrine.   As a result of a Fair Housing Act complaint filed by HUD claiming that the design and construction of apartments violated the FHA, the owner was required to incur expense in remedying the design deficiencies.  The owner then filed suit against the architect to recover its economic damages in responding the FHA violations.  The architect filed a motion to dismiss the complaint on the basis of the eight year statute of repose.  The trial court granted the motion but this was reversed on appeal, with the court holding that the statute applies on to breach of contract and not to tort actions such as negligence.  The court concluded that the design professional’s duty to use ordinary skill, care and diligence arises out of tort — not contract, and that the economic loss doctrine does not foreclose a cause of action for professional negligence even though the claim seeks only economic damages.

In Flagstaff Affordable Housing Ltd. v. Design Alliance, Inc., 221 Az. 433. 212 P.3d 125 (Ariz. Appl. Div 1) (2009), the plaintiff, Flagstaff Affordable Housing (“Owner”) entered into a contract with Design Alliance (“Architect”) for the design of apartments in Flagstaff, Arizona.  Construction of the apartments was completed in accord with the design.   No design defects were alleged.    Subsequently, the U.S. Department of Housing and Urban Development (“HUD”) filed a complaint against the Owner for housing discrimination, claiming that the design and construction violated the Fair Housing Act (“FHA”).  The owner incurred costs in correcting the issues identified by HUD as design deficiencies.

Owner then filed a complaint against the Architect for breach of contract and negligence — and seeking to recover the costs it incurred as a result of the design changes necessitated by the FHA suit.  No personal injury or property damage was alleged to have occurred.  The suit was strictly to recover purely economic damages.   In response, the architect filed a motion to dismiss the complaint on the basis that the 8 year period under the Arizona statute of repose had lapsed, and also that the economic loss doctrine precluded the professional negligence claim.    Owner agreed to withdraw its breach of contract claim but it pursued the negligence count – arguing that the economic loss doctrine did not apply to professional negligence claims.   The trial court granted the motion to dismiss, but this was reversed on appeal.

In analyzing the merits of the case, the appellate court began by explaining the concept of the economic loss doctrine.  It explained as follows:

The economic loss doctrine precludes an aggrieved party from recovering economic damages in tort unless accompanied by physical harm-either in the form of personal injury or property damage…. The doctrine is a creature of judicial origin, its purpose grounded in the judicial hallmarks of distinction and clarity.  ‘The purpose of the “economic los rule” is to maintain the distinction between those claims properly brought under contract theory and those which fall within tort principles.’ [citation omitted].  ‘The economic loss rule thus “serves to distinguish between tort, or duty-based recovery, and contract, or promise-based recovery, and clarifies that economic losses cannot be recovered under a tort theory.’ [citation omitted].

The court went on to state that in Arizona , the economic loss doctrine has been applied in two categories of disputes:  construction defects and products liability.  The court stated that because there was no construction defect involved in the case at bar, the Arizona cases pertaining to the economic loss doctrine are inapplicable here.   According to the court:

Here, Owner alleges Architect negligently fell below the standard of care for architects by failing to design the apartments in accordance with the Fair Housing Act.  If proven, this would amount ot a tort claim for breach of duties imposed by law upon Architect: namely, to act with the ordinary skill, care, and diligence of other design professionals in the architectural field. [citation omitted].  Because Architect’s professional duties arise independently of any contract, the purpose of the economic loss doctrine-maintaining a distinction between tort and contract actions-is not implicated.

The court further stated that application of the economic loss doctrine here would have the effect of eroding an implied duty of care that the architect has “to use ordinary skill, care, and diligence.”  The court then cited a number of state statutes concerning the practice of architecture and concluded that application of the economic loss doctrine to limit claims of professional design negligence would be inconsistent with public policy as established by the state statutes.

Having determined that the architect had a duty to the project owner independent of the contract, the court proceeded to find that the state statute of repose did not apply to bar the negligence action since the statute on its face stated that it applied to actions “based in contract.”  The statute of repose statute provides, in pertinent part, as follows:

[N]o action … based in contract may be instituted or maintained against a person who … performs or furnishes the design … or construction … of an improvement to real property more than eight years after substantial completion of the improvement to the real property.

The court concluded:  “Because we are addressing a professional negligence action rather than a contract action, no violence is inflicted on the statute of repose by allowing a professional negligence claim to proceed despite the expiration of potential contract claims.” For these reasons, the court held that the negligence action against the architect is not barred by either the economic loss doctrine or the statute of repose.

Comment: In order to hold against the architect in this case the appellate court had to get around both the economic loss doctrine and the statute of repose.  It got around both by finding that the action against the architect arose independent of the contract between the project owner and architect – that at common law the architect owed a duty to care with regard to performance of its design in a manner consistent with the standard of care applicable to the performance of professional services.   As understood by this court, “Because Architect’s professional duties arise independently of any contract, the purpose of the economic loss doctrine-maintaining a distinction between tort and contract actions-is not implicated.”    What this holding fails to appreciate is that unless the architect had a contract to perform services for the owner, it would have no duty whatsoever with regard to design services.  It is the contract that creates the duty to provide the services.  Once that duty has been contractually created, then and only then does a duty exist to perform the services consistent with the generally accepted standard of care.

The court has created a common law duty of care where no such would otherwise exist in the absence of the contract.  Having created this duty independent of the contract, the court then proceeded to find that the state statute of repose would not apply because the complaint is independent of the contract and therefore not within the parameters of the statute of repose.  But this is surely contrary to the intent of the drafters of the statute of repose – who when drafting it would have logically understood that any action against a design professional would have to arise under its under contract and would not have an independent basis outside the contract.

The court cited a number of other states that have also refused to apply the economic loss doctrine to protect design firms against actions for purely economic damages.  The cited cases include Moransais v. Heatherman, 744 So. 2d 973 (Fla. 1999); Robinson Redevelopment Co. v. Anderson, 547 N.Y.S. 2d 458 (1989); Business Men’s Assurance Co. of America v. Graham, 891 S.W. 2d 438 (Mo. Ct. App. 1994); Magnolia Construction Co., Inc. v. Mississippi Gulf S. Engineers Inc., 518 So.2d 1194 (Miss. 1988); and E. Steel Constructors, Inc. v. City of Salem, 209 W.Va. 392, 549 S.E.2d 266 (2001).

In the opinion of this commentator, the holding of the court in this Arizona case is contrary to the principle of honoring the intent of the contract.  It also fails to honor the intent of the statute of repose which plainly assumed that any action against a person who performs design or construction would necessarily arise under a contract.  One remedy to correct the ill affects of this court’s decision and others like it, might be to revise the state statutes of repose to clarify that the statute applies to any cause of action against a person who performs design or construction where that individual or firm was under a contract to perform such services.  In other words, if there is a contract for the services, it would make no difference whether, in the opinion of a court, there might be a duty independent of that contract.  The statute would apply in any event.  Since that is already the intent of the statute, however, one would not think it really needs any further clarification to explain that intent.

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Article 4

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CGL Carrier Held to Have Breached its Duty to Defend Engineer against a Laborer’s Bodily Injury Claim

J. Kent Holland, Esq.

An injured construction worker filed a tort action against an engineering firm for injuries the worker sustained when he fell through a hole in a floor.  The commercial general liability (CGL) insurance carrier for the engineer asserted that the professional services exclusion of the CGL policy barred coverage for the claim.  It consequently declined to defend the engineer in the action.   After being found liable to the worker, the engineer filed suit for breach of contract against its CGL carrier for failing to defend it.  The trial court entered judgment for the insurance company but this was reversed on appeal – with the court holding that the injured worker’s tort claim was potentially outside of the “professional services” exclusion of the policy and was a potentially covered occurrence under the CGL policy which required the carrier to provide a defense.

In the Food Pro International, Inc. v. Farmers Insurance Exchange, 169 Cal.App. 4th 976, 89 Cal.Rptr.3d 1 (2009), Food Pro (engineer) was hired to assist a company (Mariani Packing Company) in relocating its operations to a new plant.  The services of the engineer were to include “(1) a preliminary design phase involving the development of ‘the conceptual plan and design criteria.’ (2) a final design phase involving the development of ‘detailed plans and specifications,’ and (3) an equipment installation phase involving the coordination of ‘the implementation of the plans to help insure that the final result conforms to the plans and specifications and is completed on time and within budget.”  The final phase of the services included “making on site-inspections of the work in progress as required to determine, in general, if the work is proceeding in accordance with the contract documents.”   The engineer had no contractual duty to take action to protect workers from injury or to otherwise ensure the safety of the site.

As part of the engineer’s role in observing the construction process and reporting progress to the owner, Mariani Packing, was to have an employee observe the work and keep a daily log containing progress notes.  An electric company was hired by the plant to disconnect equipment.  The plant also hired a mechanical contractor to dismantle and remove machinery.  The plant owner, itself, acted as general contractor for the coordination of the various trade contractors.

In removing a large piece of equipment, the mechanical contractor left large hole in the mezzanine floor.  He then left the job site before securing the hole.  The engineer’s representative recognized the danger and apprised the plant’s employees so that they would address the problem.  They in turn placed a sheet metal cover over the hole.  Unfortunately, they didn’t bolt it down.  About a week later, one of the workers for the electrician fell through the hole while the engineer was talking with his foreman.   The workers compensation carrier for the electrician filed a subrogation claim against the engineer for reimbursement of the payments it paid to the worker.   The engineer notified its CGL carrier of the claim.  The CGL carrier advised the engineer that it had “no obligation to indemnify” the engineer for the incident because of the professional services exclusion in the policy.

In response to the engineer’s request for reconsideration of the adverse decision on the CGL coverage, the carrier obtained coverage opinions from two different coverage counsel – both of which concluded that there was no duty to defend or to indemnify the engineer due to the application of the professional services exclusion.

Both the worker and the workers compensation carrier filed suit against the engineer.  After initially defending itself at its own expense, the engineer lost its counsel due to nonpayment of legal fees.  Eventually, “unable to continue to defend the action due to a lack of funds, [engineer] agreed to have its answer stricken and a default judgment entered.”  Default judgment was entered for the worker in the amount of $1,621,627, and in favor of the workers compensation carrier in the amount of $114,000.  The engineer then tendered the judgments to its CGL carrier for payment which was refused.

In the law suit against its insurance carrier, it argued that the CGL carrier owed it a duty to defend because the allegations against the engineer were based on “normal negligence” and not limited to professional malpractice in the rendering of “professional services.”  The trial court concluded, however, that the injury arose out of the rendering of professional services that were intentionally provided and could therefore not be an “occurrence” (i.e., accident) under the terms of the policy, and thus there was no coverage “and no reasonable expectation of coverage.”

In reversing this decision, the appellate court acknowledged that the engineer was responsible under its contract for performing professional services, but that the issue in dispute concerned the extent and breadth of those professional services and actions as they related to the worker injury.   The court explained it was finding there might be a CGL covered claim against the engineer by the worker because the contract, as well as the actions of the engineer, so clearly demonstrated it was beyond the engineer’s professional services to do anything with regard to site safety or the safety of this worker in particular.  Since there was no safety responsibility within its professional services obligations, the court reasoned the basis of the claim for injuries must be something other than professional services.

In its conversations with its CGL carrier about the matter, the engineer according to the court:

“explained unequivocally that it was [the plant owner’s] responsibility to cover the extruder opening.  They noted that Food Pro [the engineer] was not obligated to ensure the safety of the site, that each contractor had its own set of safety standards, and that Food Pro informed the contractors that it was their responsibility to check the work areas and to confirm they were safe.  [Engineers] also explained that Food Pro’s role was to determine which equipment needed to be disconnected at what time and to keep the contractors to this overall schedule.  It was, however, up to the individual contractor to determine how to complete each project that was an identified step in the relocation process.  In other words, Food Pro’s supervisory role was limited to coordination of the overall process and the contractors were responsible for the details of their work.  In addition, [plant owner] hired Valley Welding to relocate the machine without Food Pro’s involvement and Valley Welding removed the extruder “under direct [ ] instruction [ ] from [plant owner]s staff.”

At the deposition of the engineers representative, the court notes that “he reiterated that he was not under an obligation to ensure the safety conditions at the site and further explained he did not have the authority to direct [plant] employees, just to request and advise.”

According to the court, the engineer’s facts suggest that the involvement in the accident “was merely as an observer who noticed the danger and notified the responsible party.  The court concluded:

“Thus, any failure to rectify the situation or warn of the danger, as alleged in the [worker] complaint, would implicate only ordinary negligence…  The alleged link between Food Pro’s responsibility for [the worker’s] injury and its professional services is its supervisory role, the extent of which is disputed.  The complaint does not allege, for instance, that the injury was related to Food Pro’s designs or specifications for the relocation and installation of [the plant’s] processing operations, or to other engineering work….The facts available to [the CGL carrier] at the time it denied a duty to defend thus show potential liability arising from the breach of a common law duty, and not from the performance of professional services. …Absent a trial to resolve the genuine factual dispute, [the CGL carrier] could not conclusively negate the potential for coverage and, therefore, had a duty to defend.”

The court rejected outright the CGL carrier’s contention “that under any interpretation of the facts [engineer’s representative] was only at the site to perform his professional duties; thus, any act of his at the site that resulted in injury “arises from” a professional service and is covered by the exclusion.”  According to the court, the CGL carrier’s “proposed interpretation of the provision, if accepted, would render the CGL policy inapplicable to any incident that occurs while [the engineer] is on a project site as an engineering consultant.  As Food Pro is an engineering firm, its general liability policy … would be essentially useless.”  In conclusion the court stated, “[W]e find ample evidence that the claimed injury did not arise out of the rendering, or failure to render, professional services.”  For these reasons, the court found that the CGL carrier failed to meet its burden to show the absence of any potential for coverage, and thus, breached its duty to provide the defense to which Food Pro was entitled.

Comment: The court’s reasoning in this case seems at odds with the facts of the matter as well as the law as generally applied by other courts.   The engineer had a contract that the court acknowledged called for only professional services.   The court quotes at length from the engineer’s representative statements and deposition stating that the engineer had no contractual safety duties and had not undertaken any professional services in the field with regard to site safety.  Yet the court then concludes that because the engineer didn’t do anything in regard to safety within its professional services, any claim against the engineer based on site safety must therefore of necessity be related to something other than the engineer’s professional duties.  But if the engineer didn’t do anything other than professional services at the site, what other grounds for suit for injury could there be?  There is no mention in the case of allegations against the engineer being made on the basis of anything other than the professional services it performed under its contract to the project owner. The complaint alleged faulty “supervision.”  But the court concluded that “supervision” was part of what was defined as “professional services.”  How, therefore, could the complaint not be deemed to be based on professional services?

One question that was not addressed is why the engineer didn’t tender the defense to its professional liability carrier since that would appear to have been the logical place for this claim.  Is it possible the engineer didn’t have a professional errors and omissions policy?

Another troubling aspect of the case is that the court rejected the written opinions that had been given by two well-respected coverage counsel who provided opinions to the CGL carrier that there was no potential for coverage of the claim under the CGL policy because the professional services exclusion applied.  In reviewing the reported facts and reasoning of the court, it appears quite reasonable that coverage counsel concluded there was no duty owed by the GCL carrier.

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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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