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Inside This Issue:

•  Consultant’s Duty to Defend Under a Contract with Developer Arises At the Time of Tender Despite the Lack of a Finding of Negligence Against the Consultant.

•  Contractor Can Sue Architect on Quantum Meruit Basis Where no Contract Exists

•  Statute of Limitations for Negligence Actions Bars Suit against Engineer that was based on Breach of Contract Allegations.

•  When Does a Notice from Client Become a Claim that Must be Reported to Insurance Carrier?

•  Economic Loss Doctrine in Pennsylvania Bars Owner’s Negligence Claim against Designers and Construction Subcontractors.

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Article 1
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Consultant’s Duty to Defend Under a Contract with Developer Arises At the Time of Tender Despite the Lack of a Finding of Negligence Against the Consultant.

By:  Gordon & Rees, LLP

The California Court of Appeals issued an important opinion regarding UDC v CH2M Hill affecting construction professionals. The decision is the first of its kind to interpret a design professional’s duty to defend under an indemnity agreement in light of the California Supreme Court’s recent decision in Crawford v. Weathershield.  In short, the court concluded that CH2 Hill (CH2M) was obligated to defend the project developer despite the fact a jury did not find any negligence on the design professional’s part. The court’s conclusion was based on the fact that the professional services agreement between the parties provided that CH2M Hill would “defend any suit, action or demand brought against Developer or Owner on any claim or demand covered herein” to the extent it arose out of or was in any way connected with any negligent act or omission by CH2M. UDC-Universal Development, L.P. v. CH2MM Hill, 2010 DJDAR 794

Under the court’s interpretation, the duty to defend arose at such time as the homeowners’ association made claims implicating CH2M’s work. The court further found that the indemnity provision in question did not require an underlying claim of negligence directed specifically against CH2M in order to trigger a defense obligation, and that the obligation was not excused by virtue of the jury’s exoneration of CH2M on the negligence claim. The court also determined that it was appropriate to apply Crawford retroactively. Due to the finding of no negligence, however, CH2M would not have any duty to indemnify the developer.

Developer UDC and CH2M Hill entered into two contracts in which CH2M was to provide consulting services in the development of a residential project. The homeowner’s association (HOA) sued UDC for property damages resulting from defective conditions at the project, due in part to negligent planning and design. Subsequently, UDC cross-complained against several subcontractors, including CH2M, and tendered its defense to all cross-defendant’s based on their contracts with UDC. CH2M rejected UDC’s tender, and thereafter UDC sought reimbursement for costs associated with its defense. CH2M claimed that its contracts with UDC did not require a defense because 1) negligence on behalf of CH2M was not asserted in the HOA’s complaint, 2) nor was it established in UDC’s action. Further, CH2M argued UDC’s cross-complaint was barred due to the illegality of the contract based on UDC’s lack of a “Class A” contractor’s license. CH2M also sought review of the Court’s refusal to award attorneys fees to CH2M based on the developer’s failure to comply with California’s Certificate of Merit statute, CCP§411.35. (See footnote 1)

The Appellate Court first addressed CH2M’s argument that it only had a duty to defend UDC against the HOA’s lawsuit if a claim against UDC was based on CH2M’s negligence. CH2M’s contract with UDC stated in part that:

Consultant shall indemnify…Developer…from and against any and all claims…to the extent they arise out of or are in any way connected with any negligent act or omission by Consultant…Consultant agrees, at his own expense, and upon written request by Developer or Owner of the Subject Property, to defend any suit, action or demand brought against Developer or Owner on any claim or demand covered herein. (Emphasis added).

CH2M argued that under the contract, it had a duty to indemnify UDC only if it was found negligent in performing its work and a duty to defend only when the HOA alleged a claim that directly implicated CH2M.

The Court agreed that the “negligent act or omission” language shielded CH2M from a duty to indemnify, as that duty was dependant upon a finding of negligence. However, following Crawford v. Weather Shield Mfg. Inc., the Court construed the duty to defend provision as requiring CH2M to defend “any suit, action or demand” against UDC insofar as it was “in any way connected with any negligent act or omission” of CH2M’s work on the project. The duty to indemnify and the duty to defend are separate and distinct obligations. Thus, CH2M’s duty to defend was triggered when “any claim against UDC implicated CH2M’s performance of its role in the project…when the HOA alleged harm resulting from deficient work that was within the scope of services for which UDC had retained CH2M.” It was irrelevant that the HOA had not alleged negligence on the part of CH2M. The Court reasoned that an “indemnitee should not have to rely on the plaintiff to name a particular subcontractor or consultant in order to obtain a promised defense by the one the indemnitee believes is responsible for the plaintiff’s damages.”

Comment: The court’s opinion necessarily is based on the contract language, leaving open how changing the wording might alter the design professional’s defense obligation so that it is only triggered by a finding of negligence on the part of the design professional. The court placed some emphasis on the fact that the “indemnity” language (which is triggered if CH2M is found negligent) was separate from the “defense” language, which is more ambiguous and applies to “any claim or demand covered herein.” For example, would a provision that reads that the design professional must “defend and indemnify” the developer for “any claims to the extent caused by any negligent act or omission” by the design professional trigger an immediate defense obligation on the part of the design professional? In this example, the “defense” obligation is specifically linked to a finding of negligence, so counsel for the design professional would be able to argue that the “defense” obligation would only arise at the end of the case, after a jury determined that the design professional is negligent.

On the other hand, the court included language in its opinion that may suggest that the design professional’s obligation to provide a defense to the developer would be immediate even if specifically linked to a negligence finding. Here, the court stated,

If “any claim or demand covered herein” refers back to claims and demands identified in the indemnity clause, it obviously cannot be premised on a proven “negligent act or omission” by CH2MHill unless there is first a finding of such negligence.  As the trial court pointed out, requiring such a determination would render meaningless the defense obligation and contravene Civil Code section 2778 and the Supreme Court’s admonition that a duty to defend arises out of an indemnity obligation as soon as the litigation commences and regardless of whether the indemnitor is ultimately found negligent.

The practical effect of the decisions in Crawford and now UDC is to further impact the availability of insurance since in these cases the costs of defense frequently exceed the cost of repairs. In the case of design professionals, many of the professional liability insurers argue that their policies do not provide any coverage for the costs of defending a client under a contractual indemnity provision in the absence of evidence of professional negligence. If the obligation to provide a defense is triggered at the time of the tender, the design firm may be forced to bear this cost on its own without help from its insurer.

The retroactive application of the broad duty to defend standard of Crawford in the UDC opinion renders it applicable to contracts entered into over the past 10 years, at a time when most construction professionals, and their attorneys and insurance brokers, had a different understanding of the law. This is likely to drive the cost of “claims made” professional liability insurance higher and result in many insurers taking hard line positions against paying defense cost claims.

This decision will negatively impact design professionals. This decision will only encourage developers when sued to name “everyone who walked by the project” with whom they have a contract arguing that they owe a defense because the developer “believes [they are] responsible for the plaintiff’s damages.” Designers with significant assets and the financial strength to be selective may further withdraw from the residential market except where they can negotiate around such duty to defend clauses.

Although the court’s opinion is not yet final and may be modified, depublished, or reviewed by the Supreme Court, UDC v CH2MHill is nonetheless significant in its extension of Crawford directly to design professionals and its broad interpretation of defense obligation under the standard language typically found in owner/design professional contracts. It remains to be seen whether these decisions lead to legislative action or revisions to professional liability policies. In the interim the Crawford and UDC decisions may led to an expansion of Owner Controlled Insurance Programs (OCIP’s) which include the design team or the use of Joint Defense Agreements.

Footnote: (1) CH2M argued that it was entitled to attorney’s fees because UDC failed to file a certificate of merit. California CCP § 411.35 requires counsel for a claimant alleging professional negligence against an A/E to file and serve a certificate declaring that the attorney has received an opinion from at least one A/E stating that there is reasonable and meritorious cause for the suit. UDC had failed to comply with the statute. However the Court of Appeals upheld the trial court’s exercise of discretion in refusing to order an award of attorneys fees because CH2M failed to show that the failure to file the certificate caused CH2M any “further expense of any kind.”


About this Article: Reprinted with Permission from Gordon & Rees, LLP, Construction Law Update (January 2010).  For further information, contact Kenneth Strong, Esq., Gordon Rees, 275 Battery Street; Suite 2000; San Francisco, CA 94111; Phone: (415) 986-590; KStrong@gordonrees.com; http://www.gordonrees.com.

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Article 2
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Contractor Can Sue Architect on Quantum Meruit Basis Where no Contract Exists

Lauren McLaughlin, Esq.

Briglia McLaughlin, PLLC – Vienna , VA

The Latin phrase “quantum meruit” means “as much as he deserves” and is a legal theory relied upon by those seeking to make another party liable for services rendered in the absence of a contract.  Through this quasi-contract theory, the aggrieved party seeks to be made whole for the benefits conferred upon that party.  In order to be successful on a quantum meruit count, the plaintiff must show: (1) that a benefit was conferred upon the defendant through plaintiff’s acts or services; (2) that the defendant knew there was a reasonable expectation on the plaintiff’s part that it would be paid for those services; and (3) the reasonable value of its services. In a case from New York , an appellate division court did not follow the typical legal elements of a quantum meruit count.  Instead, the court allowed a contractor to proceed with a lawsuit against an architect, in the absence of a contract, even though the contractor’s services were rendered on a project for the owner, who was not a party to the lawsuit.

In Pulver Roofing Company, Inc. v. SBLM Architects, P.C., a roofing company (Pulver) was engaged by a school district (Owner) in New York to install a roof on a school.  Under its contract with the Owner, Pulver was required to install a roof in accordance with plans provided by the architect (SBLM Architects).  The Owner rejected the roof and the parties entered into a settlement agreement that allowed the roofer to perform remedial work.  After Pulver performed the work, it brought a lawsuit against SBLM Architects alleging that the architect had ordered additional work outside the scope of the settlement agreement but did not pay Pulver for the extra work.

The architect moved to dismiss the quantum meruit claim and the trial court granted the motion on the grounds that Pulver, in performing extra work on the Project, necessarily conferred a benefit on the project owner, not the architect.  On appeal, the court determined that Pulver had sufficiently stated a cause of action for quantum meruit and let the suit go forward.  The appeals court relied on allegations in the complaint that SBLM Architects promised Pulver it would be paid for its work.  The court made no distinction as to whether SBLM Architects promised Pulver that the Owner would pay it for the work, as one might expect.  Clearly, the architect would not typically finance extra work on the owner’s project by paying the roofer.  Astonishingly, the court noted that even though the extra work was indeed for the benefit of the Owner, Pulver was not required to establish that the defendant actually received the benefit; merely that the work was done at defendant’s behest.

The decision can fairly be characterized as an aberration from how courts typically handle quantum meruit counts.  Rarely are contractors entitled to go forward with suits against architects under a quasi-contractual theory.  According to this court, the contractor’s only legal burden going forward is to establish: (1) that it performed work at the architect’s request pursuant to a promise it would be paid; and (2) the reasonable value of its work.

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Article 3

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Statute of Limitations for Negligence Actions Bars Suit against Engineer that was based on Breach of Contract Allegations

Kroger Company brought suit against an engineering for breach of contract based on allegations that the engineering service were “ineffective, performed negligently, and their implementation caused additional damages to the Kroger Store.”   Summary judgment was granted for the engineer finding that the action was barred by the three year statute of limitations applicable to tort (negligence) claims, even though the complaint was framed as breach of contract, and the statute of limitations for breach of contract actions was ten years.   The key to why the court applied the tort limitations period instead of the contract limitations period was its finding that Kroger did not allege breach of a specific  contract provision but rather that the engineer’s services were negligently performed.  “Thus, Kroger’s petition states a cause of action for breach of a person’s general duty to perform repair work in a non-negligent, prudent and skillful manner.”   In concluding that the complaint was untimely filed, the court stated that “The mere fact that the circumstances arose in the context of a contractual relationship does not make the cause of action contractual.  The courts are not bound to accept a plaintiff’s characterization of the nature of his cause of action if unsupported by factual allegations.”  Kroger Company v. L.G. Barcus & Sons, Inc., et al, 13 So.3d 1232 (La.App.2 Cir. 2009).

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Article 4

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When Does a Notice from Client Become a Claim that Must be Reported to Insurance Carrier?

J. Kent Holland, Esq.

Where a project developer sued its engineer that was responsible for the site and grading plan, the engineer’s carrier refused to defend the suit because it asserted the engineer had not provided notice of the claim within the time permitted for reporting under the policy.  The developer wrote a letter to the engineer in March stating that the engineer’s slope design failed to follow the recommendations of a geotechnical report and therefore resulted in the parking not draining.  The letter concluded by directing the engineer to “develop a plan to correct the drainage problem.”   The engineer did not give notify its insurance carrier of this letter as a “claim” against it but instead responded by letter to the developer with an explanation that the problems were caused by defective construction rather than defective design.  After follow-up meetings with the developer at which the causes for the problem were reviewed, the engineer sent another letter reiterating that the problem was caused by construction defects.  After receiving that letter the developer sent a second letter or e-mail to the engineer in the month of May specifically accusing the engineer of design error and chastising it for failure to “accept responsibility.”    Three months later (August), the engineer advised its carrier that this May correspondence by the developer constituted a “claim” against him.   Subsequently, the developer filed suit against the engineer as well as the architect and contractor, and the engineer’s carrier refused to defend the suit because the engineer didn’t give timely notice of the claim as required by the policy.

The engineer filed suit against the carrier in a separate action for alleged breach of duty to defend it in the underlying litigation.  The court in this case (Matkin-Hoover Engineering, Inc. v. Everest National Insurance Company, 2009 WL 1457669 (W.D. Tex., 2009)) denied the insurance carrier’s motion for summary judgment – meaning that the case will go forward on its merits to determine whether the carrier properly declined to defend the engineer.

The issue of what communication from the developer to the engineer first constituted a “claim” that the engineer must report to it carrier was carefully analyzed by the court, but it seems to this author that the decision failed to address a critical point and that if this case goes forward on the merits the carrier may yet prove that it owed no duty to defend the engineer in view of exclusions that may potentially apply. (See Comments at the conclusion of this case note).

Policies were issued by Everest Insurance to the engineer for the time period of April 15, 2005 to April 15, 2006, and a renewal policy covered the following twelve month period of April 15, 2006 to April 15, 2007.  When the engineer gave Everest notice of what it deemed to be developer’s claim in August 2006, the second Everest policy was in effect.  Since the developer’s March 2006 letter was written during the first policy period, Everest argued that the claim occurred during that policy and must be reported within 60 days of the end of that policy period.   This is the claim event that the carrier asserted the engineer was required to report during the first policy period pursuant to the requirement that for coverage to be triggered, “the claim arising out of the wrongful acts is first made against any Insured during the policy period” and the “the claim is reported in writing to [Everest] no later than 60 days, after the end of the policy period. . . .

The engineer argued that it was not until receipt of a May 19, 2006 letter from the developer demanding that it pay to correct the defects in the parking lot that it was clear that the Owner was making a claim against him.

“Claim” was defined in the policy as follows:

Claim” means a demand for money or professional services received by the Insured for damages, including but not limited to, the service of a lawsuit or the institution of arbitration proceedings or other alternative dispute resolution proceedings, alleging a wrongful act arising out of the performance of professional services.”

The court explained that it found nothing about this definition to be ambiguous.  According to the court,

[W]hether a claim has been made on an insured doesn’t depend on whether a demand is formal or informal—it depends on whether the communication ‘demand[s] . . . money or professional services . . . for damages . . . [and] allege[es] a wrongful act arising out of the performance of professional services.

As further stated by the court, “The definition anticipates that communications other than ‘the service of a lawsuit or the institution of arbitration proceedings or other alternative dispute resolution proceedings’—whether formal or informal-may implicate the duty to defend. . . .”    The absence of words in the definition stating that that a “claim” applies to informal proceedings is not a latent ambiguity, says the court.

Having determined that the language of the policy was not ambiguous, the judge continued to evaluate the letter from the developer to determine whether it fit within the definition of a “claim.”  In this regard, the court stated that this determination requires a fact-specific analysis to be conducted on a case-by-case basis.  The inquiry “asks when circumstances known to the insured would have suggested to a reasonable person the possibility of [a] claim.”

In this case, the court considered the insurance company argument that a reasonable person should have understood the letter to constitute a claim because, according to the carrier, it demanded performance of professional services to repair the drainage problem and alleged a wrongful act arising out of the engineer’s performance of professional services.  In rejecting the carrier’s argument, the court found that this characterization of the letter was overstated and that “considering the circumstances known to the insured, the letter did not necessarily suggest to a reasonable person the possibility of a claim.”  There were several communications between the parties after receipt of the March 2006 letter, culminating in a letter from the engineer to the developer dated May 18, 2006 reporting the results of a “comprehensive as-built survey” showing how the road as built by the contractor did not meet the engineer’s plans and specifications.  Upon receipt of that letter, the developer responded by letter dated May 19, stating, “Your letter contains suggestions to correct the problem but you did not discuss the costs, [make] any attempt to determine the costs, or how to pay for the costs.  You simply dumped your suggestions on my laps [sic], which I interpret to mean that you have refused to accept responsibility for your design error.  Do I read you correctly?

Until receipt of this letter, the court stated “a reasonable person could have believed that [the developer] had not decided who caused the drainage problem. . .  I agree with [Engineer’s] position that the [first letter] ‘could be reasonably regarded not as a demand but as a request for additional engineering services to help correct a construction defect for which [the engineer] was not responsible and for which it thought, at the time, it would be paid.”   The fact that the developer eventually sued everybody (including the engineer, architect and contractor) supports the engineer’s argument that the developer was uncertain about who was responsible for the problem.

The final focus of the court’s discussion addressed whether the fact that the first letter from the developer demanded professional services constituted a “claim” since the definition refers to a demand for professional services as being a possible claim.   Although the letter demanded professional services, the court found “the letter did not demand professional services for damages as the definition of ‘claim’ requires.”   This is the important distinction that the entire decision rests upon.   The court summed up as follows:

The [developer] letter does not suggest that [Developer] expected [Engineer] to pay an amount which [Engineer] was legally obligated to pay for a covered claim.  A reasonable person may likely have viewed the [Developer] letter as [Engineer] says it did—as a request for additional engineering services to fix the drainage problem for which it would be paid.  Because a reasonable person may not have viewed the letter as a demand for professional services for damages, a question of fact exists, precluding summary judgment.”

Comment: It is not uncommon for problems to arise on a project where there is uncertainty or dispute over who is responsible for defects in the project as constructed.  The construction contractor might not have met the plans and specifications.  Or the architect or engineer may not have met the standard of care is drafting the plans and specifications.  Or there could be shared responsibility for the problem if it is determined that the problem was caused by a combination of defective plans and specifications as well as defective construction work.    The claim notice issue that confronts design professionals is when does it become necessary to report a matter as a claim if the professional believes the problem is created solely by defective construction work, and that the contractor is inappropriately asserting that the design professional is at fault.   This can be a difficult judgment call.  Design professionals may not want to report every contractor change order demand as a claim under their professional liability policy merely because the contractor has alleged a basket or reasons for entitlement, including some tenuous argument of design error.  On the other hand, what happens if a party with standing to make a claim (such as the project owner/client) eventually makes a written demand or files a suit against the design professional?   Will the claim be denied by the insurance carrier as untimely because it was not reported when the design professional first became aware of the issue?

To reduce the risk design professionals have in missing deadlines for reporting claims,  professional liability carriers generally include language in their policies permitting what is known as “circumstance” reporting.  This permits the insured to report any incident that it reasonably believes may become a claim against it.  The policy in effect when the  “circumstance” is reported to the carrier is the one that will ultimately be responsible for responding to a “claim” if such claim eventually results from that “circumstance.”   In the case reported in this article, if circumstance reporting was permitted, then even if the engineer had not recognized the letter from its client as a claim, it could have reported it to its carrier as a “circumstance” and thereby preserved coverage under the 2005-2006 year policy even though the law suit was not filed until a subsequent year’s policy was in effect.

Recognizing claims, and timely reporting them to the carrier, is important as demonstrated by this case.  It can become even more of an issue if the policy was not renewed with the same carrier but was instead replaced with a different insurance company’s policy.  The application for insurance requires the applicant to identify any known claims or known situations that could reasonably become claims.  If a few months after changing carriers an Insured gives its new carrier a claim to defend, that carrier is going to want to know when the Insured first knew the circumstances giving rise to that claim – and may deny the claim if it determines that knowledge of the claim pre-existed the issuance of the new policy.  If that happens, the Insured could be stuck in the middle—with no coverage under either its old policy or the new policy—since it didn’t report the matter to the old carrier within the required time frame permitted for filing claims under that policy.

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Article 5

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Economic Loss Doctrine in Pennsylvania Bars Owner’s Negligence Claim against Designers and Construction Subcontractors

Where retaining walls for the foundation of a food distribution center began to evidence stress and potential failure, the building owner filed a suit against various design firms, contractors and subcontractors that had been involved in the design, inspection, testing and construction of the retaining walls – based on allegations of negligence.  The U.S. District, applying Pennsylvania law, held that the owner’s negligence claims were barred by the economic loss doctrine  because the claims related to the cost of repairing and replacing the walls and did not allege any physical injury to any person or damage to property other than the retaining walls.

In the decision in American Stores Properties v. Spotts, Stevens & McCoy, 2009 WL 2513437 (U.S.D.C., E.D.Pa 2009), the plaintiff offered three different arguments against application of the economic loss doctrine –  each of which was rejected by the Court.  Plaintiff argued that (1)  the doctrine can only be applied where there is privity of contract between the parties; (2) the doctrine is not to be applied when dealing with professionals whose information is to be relied upon by others in the industry (citing Bilt-Rite Contractors v. Architectural Studio (Pa. 2005); and (3) property damage had been suffered.    The District Court dealt concisely with each of these arguments finding the following:

1)  Privity of contract is not required for application of the economic loss doctrine to negligence claims.  “Even where the parties are not in privity of contract, Pennsylvania law does not recognize a cause of action based on negligent acts that result in only economic loss.”   The court cited several Pennsylvania state court decisions holding that negligence claims against contractors were barred despite the absence of a contractual relationship.  As stated in one of the cited decisions, “Purely economic loss, when not accompanied with or occasioned by injury, is considered beyond the scope of recovery even if a direct result of the negligent act.”

2)  The Bilt-Rite case cited by the plaintiff was not relevant because it concerned negligent misrepresentation claims against a design firm and the holding of that case was that the economic loss doctrine would not apply to negligent misrepresentation claims under Section 522 of the Restatement (Second) of Torts (1977).   The Court explained that the Bilt-Rite holding  only applies in the situation where a plaintiff relies on “expert supplier of information” with whom it has not contract, and that courts have further restricted the holding of Bilt-Rite to negligent misrepresentation claims under Section 522.

3)  Plaintiff suffered no damage to “other property.”  The plaintiff tried to argue that soils reports and other services were the defective “product” and that his in turn caused damage to the retaining wall which were “other property.”  In rejecting that argument, the court found the retaining walls were the “product” for which the plaintiff bargained and damages to the wall were therefore subject to the economic loss doctrine.  The court pointed out that if the plaintiff had alleged damage to goods or inventory that was stored in the food distribution center, recovery for that damage would not be barred by the economic loss doctrine since it would indeed be damage to “other property.”  “However, in this case, the retaining wall is the relevant product that was bargained for by Plaintiff.  There is simply no ‘other property’ at issue.”   Since the plaintiff did not allege damages other than those related to the cost of repairing or replacing the walls, the court concluded that recovery was barred under the economic loss doctrine.

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ABOUT THIS NEWSLETTER & A DISCLAIMER

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. 12 No. 1 (January 2010).

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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