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Inside This Issue:

Construction Manager is Immune from a Contractor’s Employee Personal Injury Suit pursuant to the Workers Compensation Statute

•   Arizona Supreme Court Reaffirms Economic Loss Doctrine;

Professional Services Providers Should not Agree to Defend Clients;

$26.9 Million in Liquidated Damages Not a Windfall to Power Plant Owner.

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NEW BOOK — Risk Management for Design Professionals in a World of Change,

J. Kent Holland, Esq., — Editor

Chapters include:
— Green Design and Construction
— Integrated Project Delivery (IPD);
— Building Information Modeling (BIM);
— Public Private Partnerships (P3);
— International Projects;
— AIA Contract Documents;
— ConsensusDOCS
— EJCDC Documents

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Article 1
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Construction Manager is Immune from a Contractor’s Employee Personal Injury Suit pursuant to the Workers Compensation Statute

An individual who was employee of Company X, a firm that contracted with the project owner to perform electrical work at a construction site, fell from a forklift being operated by a project superintendant employed by a Construction Manager (Company Y) who was under separate contract to the project owner.  The CM hired an individual, Greg Beaver, employed by yet another firm  (Company Z) to supervise the construction site, including the work performed by the electrical contractor, and to make regular progress reports to the CM firm.  There was no written contract between the CM and this superintendant, but they had an oral contract and the CM paid the superintendent weekly — but not as part of payroll.  Neither the superintendant nor the CM had any contract with the electrical contractor.

When the electrician fell and was injured, he filed a personal injury suit against Mr. Beaver, alleging that his negligence in operating the forklift caused the laborer’s injuries.  Beaver moved for summary judgment on the basis that the CM for whom he was working functioned as the general contractor on the site and that he was merely acting as the CM’s employee or representative, thereby entitling him to “up-the-ladder immunity.”   The trial court granted the summary judgment, agreeing that that Mr. Beaver was the CM’s representative on the jobsite and as such was immune from liability due to the workers compensation statute.

The summary judgment was reversed on appeal to the intermediate appellate court, with the court finding that was no contractor/subcontractor relationship existed between the electrical contractor for whom the injured laborer worked and the CM or Mr. Beaver.  This was reversed by the Supreme Court of Kentucky – reinstating the summary judgment in the case of Beaver v. Oakley and Crawford Electric, 279 S.W.3d 527 (Kentucky 2009).  The key to the decision was whether Mr. Beaver was acting as a “construction manager” rather than a “constructor”  who would be protected by the workers compensation act.  Under the law of the State of Kentucky an injured worker is not entitled to tort damages from his employer or his employer’s employees for work related injuries.  Instead, the injured worker must rely exclusively upon workers compensation.  The term “employer” is broadly construed under the state law to cover not only the worker’s direct employer but also a contractor utilizing the worker’s direct employer as a subcontractor.  The issue then for the court to decide was whether the evidence established Mr. Beaver as a representative of the injured laborer’s statutory employer such that Mr. Beaver would be entitled to up-the-ladder immunity.

Factors that the court considered in deciding that the CM firm and Mr. Beaver functioned as a “constructor” during the construction phase of the project included the fact that they had responsibilities of management, coordinating the work of various parties, making sure that tasks were completed in accordance with plans and specifications and actual day-to-day supervision of the construction project.  The court stated that it recognized that a firm can function as the contractor on a construction site “as a practical matter” despite “the lack of a direct written contract between subcontractor and contractor.”  Based on deposition testimony the court stated the evidence “demonstrates that [CM] actually functioned as the contractor and Beaver as [CMs’] representative even though they may not have established the type of written contract with [injured worker’s] direct employer that was customarily expected in a contractor-subcontractor relationship.”   The court found that the statutory language of the workers compensation act “does not demand evidence of formal written contracts between a defendant and the plaintiff’s direct employer for the defendant to have up-the-ladder immunity but, rather, shows, that contracts might be found in this context when the facts show that the defendant is effectively functioning as a contractor.”

About the author: J. Kent Holland is 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. 3 (March 2010).

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Article 2
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Arizona Supreme Court Reaffirms Economic Loss Doctrine

P. Douglas Folk, Esq. –  Folk and Associates, P.C.

I am very pleased to report the Arizona Supreme Court’s favorable decision in the Flagstaff Affordable Housing L.P. v. Design Alliance, Inc. case 2010 WL 476683 (Arizona, February 12, 2010). ACEC Arizona, AIA Arizona and ASFE joined in filing an amicus curiae brief with the Supreme Court and we participated in oral argument in this case before the Court.

The Supreme Court has held design professionals may use the economic loss doctrine as a legal defense in claims brought by their clients. The Supreme Court decision went even farther than we thought it might, and it leaves no uncertainty that a design professional’s client is limited to its contract remedies when a design defect causes economic loss but no physical injury to persons or other property. This ruling will enable design professionals to negotiate with their clients over how much risk they will assume, what compensation will be paid for assuming that risk, and the remedies available to both parties in the event of a claim or dispute.

In the Flagstaff case, the developer of an apartment complex sued its architect for the cost of curing violations of the Americans with Disabilities Act and Fair Housing Amendments Act. The developer claimed that the architect and contractor’s violation of accessibility standards under federal disability rights laws authorized the developer to sue for damages under either contract or negligence law. The architect and contractor obtained a dismissal of their respective contract or warranty claims because they were barred by Arizona ’s eight?year statute of repose, Ariz.Rev.Stat. § 12?552. The architect also convinced the trial court to dismiss the owner’s professional negligence claim under the economic loss doctrine, because the owner sought money damages unrelated to personal injury or property damage. The Arizona Court of Appeals reversed this decision on appeal, and held that the economic loss doctrine was not available to design professionals. That ruling left the architect exposed to a tort claim even though the client could no longer sue for a breach of contract.

The Arizona Supreme Court has now vacated the Court of Appeals decision, holding that the economic loss doctrine applies across the board in construction defect cases. A property owner is “limited to its contractual remedies when an architect’s negligent design causes economic loss but no physical injury to persons or other property.” (We believe this rule protects all design professionals or contractors, regardless of their professional discipline or occupation.) The term “economic loss” is defined in the decision to mean “pecuniary or commercial damage, including any decreased value or repair costs for a product or property that is itself the subject of a contract between the plaintiff and defendant, and consequential damages such as lost profits.”

Reiterating another recent decision upholding contractual limitations of liability, 1800 Ocotillo, LLC. v. The WLB Group, Inc., 219 Ariz. 200, 196 P.3d 222 (2008) (in which we also submitted an amicus curiae brief on behalf of ACEC Arizona, AIA Arizona, the Arizona Professional Land Surveyors Association and ASFE), the Supreme Court held that “in construction defect cases involving only pecuniary losses related to the building that is the subject of the parties’ contract, there are no strong policy reasons to impose common law tort liability in addition to contractual remedies.” To hold otherwise, the Court held, would undermine the contract and upset the expectations of the contracting parties. Arizona Supreme Court Re?Affirms Economic Loss Doctrine 2

The Supreme Court’s decision in Flagstaff also includes these additional holdings that will be binding in future cases against design professionals:

Arizona ’s economic loss doctrine precedent in products liability cases, which could allow tort claims in some cases considered “accidents”, is not applicable to construction defect cases.

If a design professional’s client wants to preserve a tort remedy in addition to its contract rights, it must write a contract that explicitly says so. If the contract is silent on this point, the presumption is that the economic loss doctrine will bar all tort claims seeking only economic loss.

This rule does not bar a tort claim when economic loss is accompanied by physical injury to persons or other property.

The rule in this case does not bar claims by third parties against design professionals. If the substantive law allows liability in a particular context—such as a contractor’s claim for negligent misrepresentation based on defective plans and specifications—that tort claim may be asserted by a third party. (As noted below, we believe this issue will be addressed in a subsequent case for which review by the Arizona Supreme Court has been requested.)

Violation of a legal duty imposed by statute, such as a building code, does not override the economic loss doctrine; a client’s tort claim will still be barred.

The design professional’s legally?imposed duty of care also does not displace the general policy that “parties to construction?related contracts should structure their relationships by prospectively allocating the risks of loss and identifying remedies.”

There is no reason under Arizona law to distinguish design professionals from contractors (or anyone else) for purposes of applying the economic loss doctrine.

It is likely that the Arizona Supreme Court will accept review of another recent Court of Appeals decision, Hughes Custom Building , LLC. v Davey, et al., 221 Ariz. 527, 212 P.3d 865 (App. 2009), in which a third party sued a civil engineer with whom it did not have a contract for economic loss damages when there was no personal injury or damage to other property. That case, if it is reviewed, will allow the Supreme Court to address how and when the economic loss doctrine will apply to third party claims against design professionals. We hope to file another amicus curiae brief in that case when it is heard by the Court.

If you have any other questions about this important new ruling, please contact me. This is a great decision for design professionals and proof that much can be accomplished when the design professions take an active role as amicus curiae in key cases.

P. Douglas Folk, Esq.
Folk & Associates, P.C.
3636 N. Central Avenue, Suite 600
Phoenix , AZ 85012
602-222-4400

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Article 3

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Professional Services Providers Should not Agree to Defend Clients

J. Kent Holland, Esq.

There is no common law duty of a consultant to defend its client against third party actions.  That duty can only arise as a result of a contractually liability created through the indemnification clause of the contract.  Since this is a contractual liability, it is excluded from coverage pursuant to the contractual liability exclusion of the errors and omissions policy.

Courts that have interpreted indemnification provisions that included the duty to defend have explained that this means the consultant must defend its client (pay legal fees on behalf of its client) as the litigation is ongoing — and that it cannot wait until the conclusion of the litigation to determine whether it is found to have negligently performed services and therefore owe a separate duty to indemnify.  The courts see the duty to defend and the duty to indemnify as two separate and unique duties.  The insurance policy only covers damages to the extent they are caused by the consultant’s negligence – and that determination can only be reached at the conclusion of the case or by settlement to which the carrier agrees.

Although it is theoretically possible that the damages awarded by a court might include some attorneys fees if there is statute that requires the same, attorneys fees are generally not awarded as part of a judgment in the American system of justice.  Therefore, a clause stating that the consultant will defend (pay on behalf of) or will indemnify (pay attorneys fees after judgment is rendered) both may create uninsurable liability.  Agreeing to defend on behalf of a client, however, is the far worse situation since the consultant would be paying out of its own pocket its client’s attorneys fees as they are incurred to defend against a third party claim that might not even ultimately be found to have been caused by the consultant’s negligence.

My routine advice for design professionals when reviewing their contracts for insurability of risks:

“Please note that any duty to defend its client that the design professional may agree to under an indemnification clause, or other provision of the contract, is uninsurable pursuant to the contractual liability provision of the contract.   Note also that it is our opinion that any duty to defend should be struck from a contract, even if the contract states that the duty to defend and indemnify is limited to damages resulting from the negligent performance of professional services.  This is because we believe courts may interpret the duty to defend to be such a broad separate duty from the duty to indemnify, that the consultant could be expected to begin defending a claim on behalf of its client (paying attorneys fees as they are incurred) as soon as a claim is tendered by the client even if no determination of negligence has been rendered.”

The way I look at the issue is that a contractually agreed upon duty to defend is triggered as soon as the claim is made because it is a separate duty from the duty to indemnify.  It is comparable to an insurance company providing you a defense against a claim.  It doesn’t wait to see if you are negligent before defending you.  The carrier defends you in the hope of proving you are not negligent.

In my opinion, the clause below is not a reasonable one for a design professional to sign because courts may interpret the clause to mean that the indemnification requirement only applies to damages ultimately caused by negligence – but that the defense obligation is immediate and is not limited by the language of the clause concerning negligence.

INDEMNIFICATION (example of problem clause)

The Consultant covenants to save, defend, hold harmless, and indemnify the County, and all of its elected and appointed officials, officers, employees, agents, departments, agencies, boards, and commissions (collectively the “County”) from and against any and all claims, losses, damages, injuries, fines, penalties, costs (including court costs and attorney’s fees), charges, liability, or exposure, however caused, resulting from, arising out of, or in any way connected with the Consultant’s negligent acts, errors, or omissions, recklessness or intentionally wrongful conduct of the Consultant in performance or nonperformance of its work called for by the Contract Documents.  This indemnification shall survive the termination of this Contract.

See, for example,  the recent California court decisions of Crawford v. Weathershield Manufacturing, as well as the CH2M Hill decision, that were reported in previous issues of this newsletter.

Because of the confusing language in so many of the contracts I am reading these days, I have suggested in some instances adding the following paragraph to clarify the intent of the indemnity obligations.  It  attempts to make clear that there will be no defense duty, and that the indemnity is limited to costs and damages the indemnitee is legally obligated to pay to third parties.

Indemnification. Notwithstanding any clause or provision in this Agreement or any other applicable Agreement to the contrary, Consultant’s only obligation with regard to indemnification shall be to indemnify and hold harmless (but not defend) the Client, its officers, directors, employees and agents from and against those damages and costs (including reasonable attorneys fees and cost of defense) that Client is legally obligated to pay as a result of the death or bodily injury to any person or the destruction or damage to any property, to the extent caused by the negligent act, error or omission of the Consultant or anyone for whom the Consultant is legally responsible, subject to any limitations of liability contained in this Agreement.

About the author: This article is 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. 3 (March 2010).

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Article 4

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$26.9 Million in Liquidated Damages Not a Windfall to Power Plant Owner

By:   Judah Lifschitz, Esq.,  — Shapiro, Lifschitz & Schram, P.C.

On October 30, 2009, the DC Superior Court confirmed an August 17, 2009 arbitration award issued by a three-member arbitration panel in New Athens Generating Co. et al. v. Bechtel Power Corp. et al. The Panel awarded $26,950,000 in liquidated damages against the construction giant Bechtel Power Corporation, EPC contractor of a $533 million power plant, after finding that it was responsible for over 200 days of delay and that the liquidated damages provisions of the EPC contract were not a penalty and were enforceable as a matter of law.  The arbitration panel further found against Bechtel on virtually all of its $94 million in claims against the project’s owner, merchant power company, New Athens Generating Company, LLC (“New Athens”).

The decision in New Athens is particularly significant regarding the enforceability of liquidated damages provisions.  Liquidated damages provisions are too frequently overlooked, but can – and will – be enforced, often without consideration of actual damages.

American courts use two models to determine the reasonableness and enforceability of a liquidated damages clause.  Under both, the clause is enforceable if the stipulated amount is found to constitute reasonable compensation to the owner for inexcusable delay, and unenforceable if the amount is found to constitute a penalty.  The two approaches differ as to whether the actual damages suffered should have any bearing on the “compensation” versus “penalty” determination.  While jurisdictions differ on the issue of how the reasonableness, and consequently the enforceability, of a liquidated damages clause should be determined, i.e., whether the liquidated damages clause should be viewed solely as of the time of contracting, or with the benefit of hindsight, the New Athens decision reflects on the former, as the Panel found that the owner’s actual damages, calculated in hindsight, were irrelevant to the determination of the reasonableness and enforceability of the liquidated damages provision.

The panel ruled that in order for the $149,000-a-day liquidated damages to amount to constitute a penalty, “the quantum of damages proposed must be shown to be unreasonable at the time that the contract between the parties was negotiated.”  The fact that the amount may, with the benefit of hindsight, be higher than the damages actually suffered is of no consequence.  The panel concluded that the evidence clearly established that the amount stipulated by the parties in the EPC contract “was reasonable at the time the contract was entered into.”

This conclusion was based on both parties’ knowledge and sophistication with respect to the economics of financing, construction and operating a power plant, Bechtel’s previous experience working with New Athens’ parent company on “numerous other EPC projects,” and the fact that both parties were represented by “competent and experienced negotiators” at the time the EPC contract was entered into.

The final award provides a clear and succinct statement of the law regarding the enforceability of liquidated damages provisions.

Facts:

The case involved a March 2001 Engineering Procurement and Construction Contract between New Athens and Bechtel for the design, procurement and construction of a $533 million 1080 megawatt power plant in upstate New York .  Prior to entering into the EPC contract with Bechtel, New Athens had issued a purchase order to Siemens Westinghouse Power Corp. in April of 2000 for three 501G gas turbines.  New Athens subsequently assigned the Siemens contract to Bechtel in June of 2001, after which Bechtel assumed responsibility for Siemens’ performance as a subcontractor.

The EPC contract required Bechtel to achieve substantial completion on certain dates during July and August of 2003.  Bechtel, however, did not achieve substantial completion until March 18, 2004, eight months behind schedule, triggering the contractual liquidated damages of $149,000 a day.  At the end of the project, Bechtel claimed $94 million for the outstanding contract balance of $26 million plus some $70 million in alleged changes and compensable delays of over 200 days.  Central to Bechtel’s claims was its assertion that New Athens had directed changes and improvements to the Siemens gas turbines, thereby interfering with and delaying Bechtel’s work.  Siemens was a third-party respondent in the arbitration based on New Athens’ claim for indemnification.

The Arbitration Proceedings:

The arbitration proceedings were organized into three phases, sequenced to address three major issues: (1) technology risk – did New Athens or Bechtel bear the “technology risk” associated with Siemens’ new 501G gas turbines; (2) Force Majeure – was Bechtel entitled to its claimed $9 million for an alleged Force Majeure event relating to adverse winter weather; and (3) Project Delays/Liquidated Damages and Other Related Issues including – (a) were product modifications issued and implemented by Siemens during construction “betterments” for which New Athens was liable, (b) who was responsible for the delays to the project, (c) were $149,000/day in liquidated damages provided in the EPC contract an illegal penalty, (d) was a 2004 settlement agreement between New Athens and Bechtel setting the date for substantial completion enforceable, and (e) was Siemens liable to New Athens for indemnification.

Technology Risk

Bechtel and New Athens each claimed that the other bore the technology risk associated with Siemens’ newly designed gas turbines, and thus was responsible for the interferences and delays caused by design problems and product modifications.  Agreeing with New Athens on virtually every point, the Panel ruled that Bechtel had assumed the technology risk associated with the three 501G turbines and the resulting impacts, and that Bechtel was therefore responsible for project delays associated with the Siemens equipment.

Force Majeure

The Panel found that winter weather in 2002 constituted a Force Majeure event, under the EPC contract.  However, with regard to Bechtel’s $9 million weather Force Majeure claim, it rejected the vast majority of Bechtel’s claimed damages and awarded Bechtel a mere $1 million out of the $9 million claimed.

Project Delays

In the final phase, the Panel ruled that the product modifications issued and implemented by Siemens during construction were necessary to achieve substantial completion, and not, as Bechtel claimed, unnecessary enhancements or “betterments” for which New Athens was liable.  Since Bechtel assumed the technology risk associated with the Siemens equipment, the Panel denied Bechtel’s product modifications claims in their entirety.

In reaching its decision, the Panel held that Bechtel understood that the project was intended to use three early 501G turbines which Siemens had marketed without confirmation that the equipment would operate with minimal need for further product modifications, and thus, Bechtel assumed the risk that remedial product modifications might be necessary to address problems with the immature Siemens technology.

The Panel also rejected Bechtel’s claim that the $149,000 a day liquidated damages provided for in the EPC contract were an illegal penalty.  The Panel held that under New York law, New Athens’ actual damages, calculated in hindsight, were irrelevant to the determination of the provision’s enforceability.  Rather, in order to constitute a penalty, “the quantum of damages proposed must be shown to be unreasonable at the time that the contract between the parties was negotiated [and] [t]he fact that the quantum may, with the benefit of hindsight, be higher than the other party actually suffered is of no consequence.”  The Panel concluded that the evidence established that the amount stipulated by the parties in the contract “was reasonable at the time the contract was entered into.”

This conclusion was based on, inter alia, the parties’ knowledge and sophistication with respect to the economics of operating a power plant, Bechtel’s previous experience working with New Athens’ parent company on “numerous other EPC projects” and the fact that both parties were represented by “competent and experienced negotiators” at the time the EPC Contract was entered into.  The Panel also noted that Bechtel’s power plant economics expert had failed to consider the reasonableness of the liquidated damages amount as of the time of contracting, and, simply focused on the reasonableness of the economics of New Athens operating the plant at the time in 2003 and 2004.  Instead, the Panel accepted New Athens’ expert’s testimony because he had “investigated the reasonableness of the quantum of liquidated damaged at the time of contract formation.”

The Panel also ruled that the 2004 settlement agreement between New Athens and Bechtel, setting the date of substantial completion, was enforceable and that Bechtel had failed to present any credible evidence that it was misled into entering into the agreement.  Because the Panel rejected Bechtel’s claims, Siemens was not liable to New Athens for contribution or indemnity.

Award:

In its final award, the Panel ruled that Bechtel had a contract balance of $22.4 million, was owed $4.5 million for uncontested change orders, and was entitled to $1.3 million for Force Majeure events.  The Panel awarded Athens $26.95 million in liquated damages due to Bechtel’s late completion of the project.  Thus, the net amount which Bechtel was awarded was a mere $1.35 million as compared to its claimed $94 million.

About the Author:

Judah Lifschitz was lead counsel for New Athens Generating Co. LLC.  He is Co-President of Shapiro, Lifschitz & Schram, P.C., (www.slslaw.com) a Martindale-Hubbell AV-rated attorney and SuperLawyer.  He can be reached at lifschitz@slslaw.com or 202.689.1900, ext. 3025.

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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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