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Inside This Issue:

  • Duty to Defend and Indemnify: Understanding the CH2 Decision and Avoiding Uninsurable Risks;
  • Modified Total Cost Method of Proving Damages: Approved For California Public Works;
  • Developer Cannot Sue Engineer that Prepared Environmental Impact Report for County Government (Not Entitled to 3 rd Party Beneficiary Rights);
  • Statute of Limitations Period Starts on Date when Engineering Report was Issued, and Summary Judgment cannot be Granted based on Contract Language Disclaiming Right to Rely on Site Conditions Report

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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

 

Article 1
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Duty to Defend and Indemnify: Understanding the CH2 Decision and Avoiding Uninsurable Risks

J. Kent Holland, Esq.
ConstructionRisk, LLC.

I am sometimes asked during my risk management seminars if a party to a contract can safely sign an onerous contract with harsh indemnification clauses or other clauses that create excessive liability for an “innocent” party and then avoid the consequences by having a court hold the terms to be unconscionable and, therefore, unenforceable.

Those who ask this generally are contractors and consultants. They suggest that if the contract is grossly one-sided or unfair, it should be obvious to a court that it was signed under duress.

This never fails to bring a smile to my face as I recall a scene from my contract law class at Villanova. It was the third week of our first year. All of us were still in awe and fear of law school — especially of the tough, old, grouchy (and later beloved) professor of contracts who was much like the Professor Kingsfield in the movie “Paper Chase.”

After reading a sad case where a court enforced a contract that created a particularly bad deal for one of the parties, one “naïve” student asked the professor how such a terrible and unfair result could be tolerated by the court.

Our professor turned red. His bushy eyebrows rose. He began to tremble and sputter. He slammed his book closed and stared at the unsuspecting student before bellowing:

“This is the study of law. If you want ‘fair’ you belong across the street and not in law school.”

He stomped out of the class and left us there, with a half hour remaining, to ponder that heavy thought. Of note, “across the street” referred to the Augustinian Theological Seminary. As participants in contracts duly negotiated between parties, we should expect courts to enforce our bargain as we made it rather than to reinterpret it and revise it to apply some sense of what they think would be a more reasonable and fair result. Some of you may know it as “Freedom of Contract”.

That brief performance left a greater impression on me and taught me more about the law of contracts than anything else before or since.

It turned out that it wasn’t necessary to abandon law school and join the seminary merely because one expected contracts to be fair. All that was necessary was to accept the responsibility for negotiating and signing reasonable contracts.

You get what you negotiate — not necessarily what you deserve.

I retell this story from time to time to encourage contractors and design professionals to negotiate diligently for a reasonable contract, and to not expect a court to fix contractual difficulties of their own making. It is a good introduction, I believe, to the recent case of UDC-Universal Development v. CH2M Hill.

Synopsis of CH2M Hill Decision

The indemnification clause in the CH2M Hill contract that has been so much discussed recently provided the following:

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 it had no duty to indemnify UDC unless it was found negligent in performing its work, and it further argued that any defense duty it had would only be triggered if a claimant’s claim alleged negligence on the part of the consultant.

The Court acknowledged that the “negligent act or omission” language of the clause shielded CH2M from an obligation to indemnify its client since such obligation was dependent upon a finding of negligence and CH2 was not found negligent. The court nevertheless found that the language of the clause created a duty to defend against actions even if there was no allegation of negligence or finding of negligence. In reaching that decision, the court cited the 2008 opinion in the case of Crawford v. Weather Shield Mfg. Inc., that held is separate and distinct from the indemnitor’s duty to indemnify its client. Moreover, as held in Crawford and reaffirmed by the court here, the indemnification agreement creates an automatic duty to defend the indemnitee against actions that implicate the services performed by the Indemnitor (in this case CH2M Hill).

Applying those principles of California statutory and common law, the court in CH2 thus concluded that CH2’s duty to defend was triggered when “any claim against UDC implicated CH2’s performance of its role in the project….” This occurred “when the HOA alleged harm resulting from deficient work that was within the scope of services for which UDC had retained CH2M.” It did not matter that the claimant, homeowners association, had not alleged negligence on the part of CH2M.

To summarize, the court could have reached its decision requiring CH2 to defend its client based on the affirmative duty to defend that was stated in the clause. As explained by the court, however, the defense obligation would arise even in the absence of the duty to defend language since indemnification clauses are understood under California law to automatically include a separate and much broader duty to defend the indemnitee against claims, as well as to provide indemnification for ultimate damages.

Synopsis of the Crawford v. Weather Shield Decision

In the case Crawford v. Weather Shield Mfg., Inc., 187 P.3d 424, 44 Cal.4th 541 (2008), the Supreme Court of California addressed the question of whether the subcontract indemnification provision obliged the subcontractor, Weather Shield Manufacturing Co., to defend the developer/general contractor, J. M. Peters Co., (JMP) against law suits brought by third party homeowners whose complaints alleged construction defects arising from the subcontractor’s work.

The pertinent language of the indemnification clause required the subcontractor

“to indemnify and save [prime contractor] harmless against all claims for damages … loss … and/or theft … growing out of the execution of [subcontractor’s] work.” A second part of the clause further required the subcontractor “at [its] own expense to defend any suit or action brought against [prime contractor] founded upon the claim of such damage … loss or theft.”

According to the state Supreme Court, the duty to defend was triggered by the initiation of the law suit insofar as claims concerned the windows supplied by Weather Shield regardless of the fact that a jury ultimately found Weather Shield was not negligent. This decision was affirmed on appeal to the California Supreme Court. The court stated:

We focus on the particular language of the subcontract. Its relevant terms imposed two distinct obligations on Weather Shield. First, Weather Shield agreed “to indemnify and save [JMP] harmless against all claims for damages to persons or to property and claims for loss, damage and/or theft … growing out of the execution of [Weather Shield’s] work.” Second, Weather Shield made a separate and specific promise “at [its] own expense to defend any suit or action brought against [JMP] founded upon the claim of such damage … loss, … or theft.” (Italics added.)

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We agree with the Court of Appeal majority that, even if strictly construed in Weather Shield’s favor, these provisions expressly, and unambiguously, obligated Weather Shield to defend, from the outset, any suit against JMP insofar as that suit was “founded upon” claims alleging damage or loss arising from Weather Shield’s negligent role in the Huntington Beach residential project. Weather Shield thus had a contractual obligation to defend such a suit even if it was later determined, as a result of this very litigation, that Weather Shield was not negligent.

The court further stated:

A contractual promise to “defend” another against specified claims clearly connotes an obligation of active responsibility, from the outset, for the promisee’s defense against such claims. The duty promised is to render, or fund, the service of providing a defense on the promisee’s behalf -a duty that necessarily arises as soon as such claims are made against the promisee, and may continue until they have been resolved. This is the common understanding of the word “defend” as it is used in legal parlance. [citations omitted] A duty to defend another, stated in that way, is thus different from a duty expressed simply as an obligation to pay another, after the fact, for defense costs the other has incurred in defending itself.

Attorneys reading the court’s analysis up to the point above-quoted might not find much objectionable about it. Courts throughout the country have explained in the context of insurance policy language as well as indemnification language in commercial contracts that the duty to defend is much broader than the duty to indemnify. This part of the decision have come as no surprise. Indeed professional liability carriers, risk managers and attorneys have long been advising design professionals to strike any language in the indemnification clause that would suggest any duty to defend.

Unfortunately, the court didn’t stop there in its analysis. It, instead, went on to interpret and apply sections of the California Civil Code that set forth general rules in California for the interpretation of indemnity contracts, “unless the parties indicate otherwise.” The court states:

In this regard, the statute first provides that a promise of indemnity against claims, demands, or liability “embraces the costs of defense against such claims, demands, or liability” insofar as such costs are incurred reasonably and in good faith. (§ 2778, subd. 3, italics added.) Second, the section specifies that the indemnitor “is bound, on request of the [indemnitee], to defend actions or proceedings brought against the [indemnitee] in respect to the matters embraced by the indemnity,” though the indemnitee may choose to conduct the defense. ( Id. , subd. 4, italics added.) Third, the statute declares that if the indemnitor declines the indemnitee’s tender of defense, “a recovery against the [indemnitee] suffered by him in good faith, is conclusive in his favor against the [indemnitor].” (Id., subd. 5.)

The court concluded that the California Code’s defense obligations “are deemed included in every indemnity agreement unless the parties indicate otherwise.” (emphasis added). “This duty,” concluded the court, “arises immediately upon a proper tender of defense by the indemnitee, and thus before the litigation to be defended has determined whether indemnity is actually owed.” Ultimately, the court held that Weather Shield owed JMP a duty to defend immediately upon JMP’s defense tender upon Weather Shield; and despite Weather Shield’s lack of obligation to indemnify JMP since it was not found liable on the underlying claim for damages.

What the court is basically saying is that the contractually agreed upon duty to defend (or the defense duty automatically arising under California law in every indemnification agreement) is triggered as soon as the claim is made because it is a separate duty from the duty to indemnify. The duty is comparable to an insurance company providing a defense against a claim made against its insured. The carrier does not wait to see if its insured is found negligent before providing the defense, and the court is saying the indemnitor’s duty is equivalent of that of an insurance company’s duty to defend.

Risk Management Commentary:
What to Do When Performing Contracts Governed by California Law

First. Don’t agree to indemnification clauses that contain any duty to defend – regardless of how narrowly you may think that duty has been drafted. Any language affirmatively creating a duty to defend is bad language. Such a duty in a professional services contract creates uninsurable risk due to the contractual liability exclusion of the policy.

Second. In California it is not enough to merely avoid including bad language in the indemnification clause. What might otherwise be considered good language that only agrees to indemnify your client for damages to extent arising out of your own negligence is not sufficient to avoid the duty the courts of California will impose on you to defend the indemnitee. In essence, the California Supreme Court has put all on notice that if the contract contains an indemnification agreement whereby an indemnitor agrees to indemnify an indemnitee for damages arising out of the indemnitor’s services, the agreement will be interpreted to impose an additional obligation for the alleged indemnitor to defend the proposed indemnitee immediately upon the tendering of the defense. The only way around this, is for the parties to affirmatively state that there is NO duty to defend any claim that is subject to the indemnification provisions.

By signing what many risk managers have long thought to be innocuous indemnification provisions, the indemnitor/design professional may be committing to a defense obligation that is excluded from coverage.

Third. Because professional liability insurance only provides insurance for what a professional would be liable for if there had been no contract (i.e., under common law), professional liability insurance policies specifically exclude contractual language that expands that liability. There is no common law duty of a consultant to defend its client against third party actions. Since the duty can only be created via a contractual obligation, it is excluded from coverage. It is important to educate the parties so they understand that asking a design professional to defend the indemnitee or to otherwise indemnify the indemnitee for anything other than damages caused by the negligent performance of professional services is uninsurable and, therefore, an unreasonable risk to impose upon the design professional.

Fourth: Because of the confusing language in so many of the contracts, and the mixed interpretations of parties and courts, it is appropriate to devise a clause that in plain and unambiguous language limits indemnification to damages the indemnitee is legally obligated to pay to third parties as a result of the design professional’s negligence. An example clause that has been suggested is as follows:

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 (but not defend) the Client, its officers, directors, and employees from and against those actual damages and costs incurred that Client has been determined to be legally obligated to pay to third parties 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.

Conclusion
For contracts on which California law will be applied, make sure that the indemnification clause is carefully written to affirmatively state that there will be no duty to defend. It could state something like the following: “Consultant shall indemnify (but shall not defend) the client … against third party damages actually incurred by the Client to the extent caused by the negligent acts, errors or omissions of the Consultant or anyone for whom he is legally responsible.”

There are no circumstances that would justify a design professional agreeing to defend its client. JUST SAY NO to contract language that requires a duty to defend regardless of how that duty may be defined or limited.

About the Author: Mr. Holland is a construction lawyer located in Tysons Corner, Virginia, with a national practice (formerly with Wickwire Gavin, P.C (1986 – 2007), and now with Construction Risk Counsel, PLLC) representing design professionals, contractors and project owners. He is founder and president of a consulting firm, ConstructionRisk, LLC, providing consulting services to owners, design professionals, contractors and attorneys on construction projects – including assistance with contract drafting, review and negotiation; change order and claims analysis (preparation or defense); risk management advice concerning insurance coverage – including assistance with negotiating and drafting the terms and conditions of policies and endorsements, advice to insurance underwriters; guidance to those procuring insurance; change order and claim preparation, analysis and defense; contract preparation; contract review and contract negotiation. Contact: 703-623-1932, Kent@ConstructionRisk.com.

Disclaimer: The opinions expressed herein are solely those of the author and are not to be attributed in any way to any law firm, insurance carrier or client with whom the author may be associated. The ideas and commentary expressed herein are for general risk management education purposes only and are not written with the idea of being applied to any specific situation or facts. Likewise, the commentary is not intended to provide a legal opinion or legal advice. Legal counsel familiar with the law of the state that will be applied to a given contract should be consulted to assist in drafting contract language appropriate to the circumstances and the state law.

 

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Article 2
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Modified Total Cost Method of Proving Damages: Approved For California Public Works

By Edward B. Lozowicki and Bram Hanono

In Dillingham-Ray Wilson v. City of Los Angeles, the California Court of Appeal signaled its holding in the first sentence of its opinion: “The City of Los Angeles (City) obtained millions of dollars worth of construction work that it does not want to pay for.” The City argued it was absolved of any obligation to pay the contractor, Dillingham-Ray Wilson (DRW), pursuant to Public Contracts Code sections 7105 and 7107 and Amelco Electric v. City of Thousand Oaks (2002) 27 Cal.4th 228 on the theory that they dictate a method of proving contract damages, a method DRW said was impossible under the circumstances. The Court disagreed because “section 7107 [sic] and Amelco impact the measure of damages, not the method of proving them . . . .” The Court also held that the modified total cost method of proving damages is permissible in California. Dillingham-Ray Wilson v. City of Los Angeles, 182 Cal.App.4th 1396 (opinion modified by 106 Cal.Rptr.3d 691, (April 16, 2010, No. B192900))

Background

The City awarded a contract to DRW to expand the digester capacity at the Hyperion Wastewater Treatment Plant. During construction, the City issued over 300 change orders containing more than 1,000 changes to plans and specifications. On rare occasions the City directed DRW to perform changes on a time and material basis, but as a general rule, the City requested an estimate of the cost of the work, told DRW to commence work, and agreed that the parties would negotiate a lump sum payment at a later date. Not all change orders were settled. When DRW completed the project, it requested an equitable adjustment to compensate it for expenses and losses incurred due to interference and delays by the City. The City refused and assessed liquidated damages against DRW. DRW sued for breach of contract, and the City cross-complained.

Before trial the City filed a motion in limine to prevent DRW from proving its damages with engineering estimates, based on Public Contracts Code section 7105(d)(2) (all further statutory references are to the Public Contracts Code). Section 7105(d)(2) states that the compensation due a public works contractor for amendments and modifications, such as change orders, can only be determined as provided in the contract. The trial court ruled the General Conditions of the contract (section 38(c) of the C-741 contract) required plaintiff to proceed on a time and materials basis and document actual costs if the parties failed to agree on a lump sum.

Based on Amelco, the City also filed a motion in limine to preclude DRW from presenting a total cost claim to the jury. The trial court agreed and precluded DRW from proceeding on a total cost theory of damages on the ground that DRW’s evidence in support of that theory was insufficient, and held that a modified total cost theory was not recognized in California.

In response to the motions in limine, the trial court barred three of DRW’s claims, including a claim for breach of implied warranty of correctness of plans. The jury found the City had breached the contract and caused DRW damages, and the City’s assessment of liquidated damages was unreasonable.

Proof of Damages With Best Available Evidence Permitted

On appeal, the Court ruled that the in limine rulings be reversed. First, the Court held the trial court should have submitted the interpretation of the General Conditions section 38(c) of the contract to the jury. Since the terms of the contract were ambiguous as to the method to be used to document the cost of extra work, parole evidence was admissible to aid interpretation and DRW was entitled to a trial on the issue of contract interpretation.

Second, the Court held DRW was entitled to prove its damages with the best evidence available, even if that evidence takes the form of engineering estimates. Based on Amelco, DRW was precluded from recovering the reasonable value of its services based on a theory of abandonment, because the contract at issue was a public contract based on competitive bidding. Further, Amelco and section 7105 combined to prevent DRW from seeking to recover anything more for changes than it was entitled to receive by contract. Accordingly, the Court explained that “the benefit DRW would have received for change orders if the City had performed is the measure of damages.” The Court concluded:

Section 7105 impacts the measure of damages for public works contracts, but it does not impact the permissible method of proof. In other words, an award of breach of contract damages under [common law] does not represent a contract modification barred by section 7105.

This is a significant clarification of this statute which has been controversial in public works circles. In effect the Court was adopting the traditional “benefit of bargain” measure of damages codified in California Civil Code §3300.

Breach of Implied Warranty of Correctness of Specifications Permitted Against Public Agency

The Court also held, pursuant to Souza & McCue Constr. Co. v. Superior Court (1962) 57 Cal.2d 508, that DRW was permitted to assert a claim for breach of the implied warranty of correctness of plans and specifications against the City. According to the Court, recovery based on a claim for breach of implied warranty of correctness would not “represent a contract abandonment barred by Amelco, nor would it represent a payment for an amendment barred by section 7107, subdivision (f)[sic]. Rather, it would simply represent an award for contract damages under longstanding common law.”

Modified Total Cost Method of Proving Damages Permitted in California

Finally, the Court held that on remand DRW may pursue a modified total cost theory, if it is not required to document its actual costs. Under the total cost method, damages are determined by subtracting the contract amount from the total cost of performance. Under Amelco, the total cost method may be used only after the trial court determines the contractor has a prima facie case by showing the following: (1) it is impractical for the contractor to prove actual losses directly; (2) the contractor‘s bid was reasonable; (3) its actual costs were reasonable; and (4) it was not responsible for the added costs. If some of the contractor’s costs were unreasonable or caused by its own errors, then those costs are subtracted to arrive at the modified total cost.

In its Order Modifying Opinion and Denying Petition for Rehearing, the Court held, “Amelco recognizes that a contractor can recover on a total cost or modified total cost theory.” Therefore, the trial court abused its discretion by not following Amelco. “Section 7105 does not expressly abrogate common law, and the statute and common law can be harmonized because the total cost and modified total cost theories are merely methods of proving damages.”

Conclusion

Dillingham significantly clarified Amelco, and breathed new life into the total cost and modified total cost methods of proving damages. SinceAmelco was decided, common law contract damage principles as to public agencies have been under attack. Public agencies have argued with some success that Amelco insulated them from any form of damage proof other than daily costs tracked in the field, even where it was impossible to do so and could only be determined by engineering estimates or a modified total cost method at a later time. Dillingham holds that Amelco did not limit common law methods of proving damages against a public agency. Rather, it held only that the abandonment theory of liability is not allowed against a public agency.

About the Authors: Edward B. Lozowicki is a partner in Sheppard Mullin’s San Francisco office (415) 774-3273. Bram Hanono is an attorney in Sheppard Mullin’s Del Mar office (858) 720-8900.

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Article 3
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Developer Cannot Sue Engineer that Prepared Environmental Impact Report for County Government (Not Entitled to 3rd Party Beneficiary Rights)

Where an engineer was contracted by a county government in California to prepare an environmental impact report as required by state statute, to determine whether to approve a developer’s project proposal, the developer had no cause of action against the engineer for failing to prepare the report within the time specified in the contract. Nor did it have a cause of arising out of negligence since purely economic damages alone were sought and the engineer owed no independent duty of care to the developer to protect its economic interests.

In Lake Almanor Associates v. Huffman-Broadway Group, Inc., 178 Cal.App. 4th 1194 (2009), the plaintiff was a real estate developer that submitted an application to the county government for a proposed development. The county was required by state law to obtain an environmental impact report (EIR) before approving the development plan. The county entered into a contract with an engineering firm (“engineer”) to prepare the EIR. According to the contract, the engineer was to prepare the report for the county, but provide a copy to the developer. The developer was required to reimburse the county for the cost of preparing the EIR. Engineer failed to meet the contractually specified deadline for submitting the report. When a draft copy of a report was belatedly submitted, the county rejected it as unacceptable and thereafter terminated the engineer’s contract. The engineer submitted invoices to the County for payment and the county sought reimbursement of the engineer’s fee from the development along with reimbursement for a second engineer that prepared a subsequent report.

Developer filed suit against the engineer on the basis of breach of contract (asserting rights as a 3rd party beneficiary) and also negligence and negligent interference with prospective economic advantage. Under California Civil Code section 1559, “A contract made expressly for the benefit of a third person, may be enforced y him at any time before the parties thereto rescind it.” But this same section “excludes enforcement of a contract by persons who are only incidentally or remotely benefited by it.” The court concluded that the code was not intended to give the developer third party beneficiary rights, and quoted from another section of the code as follows:

“A promisor who contracts with a government or governmental agency to do an act for or or render a service to the public is not subject to contractual liability to a member of the public for consequential damages resulting from performance or failure to perform” unless certain conditions occur. In this case, the court found that the provisions of the contract were not sufficient to to demonstrate any intent that the engineer be liable to a developer in the event of breach of its contract. Nor does the code create any statutory duty for the county to complete the EIR on a timely basis. No action could brought against the public entity for failure to complete the EIR on time.

To allow the suit directly against the engineer could, according to the court, undermine the analysis of the relevant environmental issues by the engineer and thereby create a conflict between the consultant’s duty to the public and its financial self-interest. Quoting another decision addressing a similar issue, the court stated that if suits such as the present one were permitted, “the independence of the professional experts and the objectivity of their specialized findings and conclusions would be undermined and jeopardized by fear of retaliatory action. Accordingly, a direct action against [consultant] is not consistent with CEQA.”

On the question of whether the developer could pursue an action against the engineer for negligence, the court held that because the developer sought only purely economic loss, its action must be dismissed for failure to state a claim. Quoting several cases as precedent, the court explained that whether a duty is owed to a plaintiff is a question of law to be determined by the by court rather than a question of fact to be decided by a jury. This means the question is ripe for a summary judgment motion. In determining whether such a duty exists, the court first considers whether any statute creates a duty. In this case, since there was no statutory duty, the court assessed whether the nature of the activity or relationship of the parties gave rise to a duty. As explained by the court in this regard, “Recognition of a duty to manage business affairs so as to prevent purely economic loss to third parties in their financial transactions is the exception, not the rule, in negligence law [ ] so courts are reluctant to impose duties to prevent purely economic harm to third parties.”

The court stated that whether a duty exists is ultimately a question of public policy that is generally determined by balancing a number of factors including “(1) the extent to which the transaction was intended to affect the plaintiff; (2) the foreseeability of harm to the plaintiff; (3) the degree of certainty that the plaintiff suffered injury; (4) the closeness of the connection between the defendant’s conduct and the injury suffered; (5) the moral blame attached to the defendant’s conduct; and (6) the policy of preventing future harm.” In this case, the court state that foreseeability was due little weight where the harms are only economic even though foreseeable. As other factors concerning the moral blame attributable to a defendant’s conduct and the policy of preventing future harm, the court stated that allowing suits against consultant’s by plaintiffs such the developer in this case “would be likely to compromise the independence and objectivity of environmental consultants by exposing them to substantial liability.” Based on its review of the facts and the balance of the factors, the court concluded they “militate against a conclusion that a consultant owes a duty of care to a project applicant in the timely completion of a draft EIR.”

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Article 4
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Statute of Limitations Period Starts on Date when Engineering Report was Issued. (Summary Judgment cannot be Granted based on Contract Language Disclaiming Right to Rely on Site Conditions Report)

Where a contractor on a wastewater treatment construction project submitted a differing site condition claim to the City, the City refused to issued a change order – arguing that the soils report that was referenced in the contract was not made a part of the contract and that the contract otherwise disavowed the ability of the contractor to rely on the report or make a claim. The contractor filed suit against both the City and the engineer that issued the report. An appellate court held that the statute of limitations on the contractors negligence action against the engineer had lapsed since the date for calculating the time period was from the date the report was written by the engineer rather than the date on which the contractor later signed its contract with the City and allegedly obtained the report and relied upon it. As far as the right to rely upon the report, the court held that the exculpatory clauses addressing reliance on the report did not clearly absolve the defendants for any consequences of negligence, and the issue of justifiable reliance, as well as whether a differing site condition existed must be decided by jury rather than summary judgment.

In Bryan v. City of Cotter, et al., 2009 WL 3337558 (Ark 2009), the court stated that in determining when the statute of limitations begins to run in an action for professional malpractice, the applicable period begins when the negligent acts occurred, not when it was discovered.” The contractor asserted that the action against the engineer for the alleged errors in soils report was not ripe until he signed the contract, began excavation, and discovered the true conditions. In upholding summary judgment against the contractor’s negligence claim, the court that although the “discovery rule” and the “date of injury rule” have some appeal in determining when the statute of limitations period begins to run, “we have adhered to the ‘occurrence rule’ in professional malpractice actions.”

Next, addressing the question of whether contract provisions prohibited the contractor from relying upon the soils report, the court analyzed the following two clauses of the contract:

SC.26 Test Borings.

Contactor may rely upon the general accuracy of the test pit or soil boring data contained in the reports or drawings, but such reports and drawings are not Contract documents. Contractor may not rely upon or make any claim against Owner, Engineer, or Engineer’s Consultant’s with respect to (1) the completeness of such reports and drawings for Contractor’s purposes, including, but not limited to, any aspects of the means, methods, techniques, sequences and procedures of construction to be employed by the Contractor and safety precautions and programs incident thereto, (2) other data, interpretations, opinions and information contained in such reports or shown or indicated in such drawings, (3) any Contractor interpretation of or conclusion drawn from any data or any such data, interpretations, opinions or information. (Emphasis added.)

SC.7 Knowledge of Conditions

The Contractor states that he has examined all the available records and has made a field examination of the site and right-of-way and that he has informed himself about the character, quality and quantity of surface and subsurface materials and other conditions to be encountered; the quantities in various sections of the work; the character of equipment and facilities needed for the prosecution of the work; the location and suitability of all construction materials; the local labor conditions; and all other matters in connection with the work and services to be performed under this contract.

The court found that the two clauses were not clear and unambiguous since SC 26 provided that the contractor may rely upon “the general accuracy” of the data but then states that the report is not part of the contract documents. Even the terms “general accuracy” and “completeness” are subject to interpretation says the court, and a jury will need to determine how the clauses are to be applied to the facts of the matter.

Can the City avoid the intent of the Differing Site Conditions Clause on a Partially Federally Funded Project?

The final aspect of the case concerns whether the City successfully avoided the affect of the federally mandated “differing site conditions” clause by virtue of the special conditions clauses of the contract that limited reliance upon the soils report. The contractor argued that the differing site conditions superseded any conflicting clauses in the contract that might otherwise seek to eliminate differing site conditions claims. Rather than address that question, the City argued that the differing site was not applicable in any event because the soil conditions were not “materially different” from those shown in the soils report. That issue, concluded the court, was another one to be decided by a jury rather than by summary judgment.

Comment: Project owners are ill advised to attempt to avoid appropriate differing site conditions claims by inserting language into their contracts language that would deny contractor reliance upon site data and other information provided by the owner with the bidding documents. There are a number of cases applying federal law that have held that where a project is using federal funds and the contract, therefore, incorporates the federally mandated differing site conditions clause, the DSC clause takes precedence over the conflicting disclaimer clauses.

The reason the federal contracts, and contracts on projects receiving federal assistance dollars, include the DSC clause is that history has taught the wisdom (and ultimate cost savings) of granting equitable relief to a contractor who encounters a differing site condition. The government doesn’t do this to be nice. It does it because by allocating risk in this reasonable manner it is more cost effective in the long run for federally funded projects.

The way I have sometimes explained to project owners who don’t understand that they save money by allowing differing site conditions claims is something like this:

Hypothetical 1

Where A standard differing site conditions clause in included in contract

  • Ten (10) projects are constructed by a city;
  • $1 million is average fixed price contract award;
  • Four (4) differing site conditions claims arise (1 on each of 4 different projects);
  • $150,000 is the average claim. (Multiply this by 4 claims);
  • $600,000 is the total paid by the City on the 4 claims;

Result:

  • $10.6 million is what it therefore costs City to complete all 10 projects

Hypothetical 2

Where No differing site conditions clause is included (or Onerous Denial of Right to Rely on Data is Attempted)

  • Ten (10) projects are constructed by a city.
  • $1,200,000 is the average fixed price contract award. (The extra 200,000 on each contract is due to contingency added by prudent contractors to cover the risk of DSC since contractors know they may be unable to recover on claims);
  • All DSC conditions claims are denied by the City;
  • No dollars are paid by the City for differing site conditions claims (but much legal cost is expended as well as time and energy, as contractors try to recover DSC claims despite the contract language – this is almost inevitable!);

Result:

  • $12 million is the total paid by the City to contractors to complete all 10 projects – and that is not including the litigation costs and settlements the city’s will have with some of the contractors.

Conclusion: Based on the facts of the above hypotheticals, the city that allowed differing site conditions saved $1.4 million over the course of constructing its ten projects. It would therefore appear to be fiscally irresponsible to attempt to deny contractor’s the right to rely upon site data that they cannot logically obtain through their own investigations prior to bidding a project.

Not a sermon – just a thought – although a strongly held one!

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ACEC Webinar – 2009 Year in Review – Cases Concerning Design Professionals

2009 litigation involving contractors and project owners against design professionals gets a timely review from Kent Holland Esq., and Lauren Mclaughlin Esq. Key cases to be presented will address limitation of liability, indemnification, licensing, procedural issues such as certificates of merit and time limitations on filing suits, electronic discovery, and the economic loss doctrine.

Instructors:
J. Kent Holland, Esq., ConstructionRisk.com LLC, and
Lauren McLaughlin, Esq., BrigliaMcLaughlin PLLC

Date: Tuesday, June 8, 2010
Time: 1:30 PM – 3:00 PM

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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 issue may be cited as ConstructionRisk.com Report, Vol. 12 No. 5 (June 2010). Articles may be reprinted for use in other newsletters provided attribution is given to this Report and the author. Permission is hereby granted for links to be created on other websites to any article on this website.

This newsletter Report is published and edited by J. Kent Holland, Jr., J.D. The Report is independent of any insurance company, law firm, or other entity, and is distributed with the understanding that ConstructionRisk.com, LLC, and the editor and writers, are not hereby engaged in rendering legal services or the practice of law. Further, the content and comments in this newsletter are provided for educational purposes and for general distribution only, and cannot apply to any single set of specific circumstances. If you have a legal issue to which you believe this newsletter relates, we urge you to consult your own legal counsel. ConstructionRisk.com, LLC, and its writers and editors, expressly disclaim any responsibility for damages arising from the use, application, or reliance upon the information contained herein.

Copyright 2010, ConstructionRisk, LLC

Publisher & Editor:
J. Kent Holland, Jr., Esq.
1950 Old Gallows Rd
Suite 750.
Vienna , VA 22182
703-623-1932
Kent@ConstructionRisk.com