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Inside this Issue
  • Economic Loss Doctrine Bars Contractor Suit against Engineer;
  • Expert Testimony is Required to Prove Construction Management Failed to Meet the Standard of Care;
  • Professional Services Exclusion of Engineer’s CGL Policy Properly Applied to Bar Coverage for Wrongful Death Action Resulting from Trench Collapse;
  • Unlicensed Contractor forced to Refund all Payments back to the Homeowners

About the author: All articles in this issue of the ConstructionRisk.Com Reportare 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.  Articles in this newsletter are published in ConstructionRisk.com Report, Vol. 12 No. 6 (Oct. 2010).

Article 1

Economic Loss Doctrine Bars Contractor Suit against Engineer

The economic loss doctrine was enforced by the Supreme Court of Wyoming to bar a general contractor’s (GC) complaint against a project engineer with whom it lacked privity of contract. The GC had a contract was with a town to construct water and wastewater lines. The city had a separate contract with an engineering firm for design and project management services. In addition to suing the town for breach of contract, the GC sued the engineer sued the engineer claiming the engineer had engaged acted negligently, intentionally interfered with its contract, breached a duty of good faith and fair dealing, and committed negligent misrepresentation. The GC accused the engineer of unreasonably refusing to certify substantial completion for the work, hindering and delaying work by refusing approve change orders, refusing to provide accurate and constructible drawings, and generally interfering with the contractor’s performance of its contract. In sustaining the trial court’s summary judgment in favor of the engineer, the state supreme court explained and reinforced the sound basis for the economic loss rule. The court stated: “The Court continues to believe that parties to a construction contract have the opportunity to allocate the economic risks associated with the work, and that they do not need the special protections of tort law to shield them from losses arising from risks, including negligence of a design professional, which are inherent in performance of the contract.” Excel Construction v. HKM Engineering, Inc., 228 P.3d 40 (Wy, 2010).

Facts and Allegations

In this case the Town of Lovell, Wyoming entered into a contract with Excel Construction, Inc., (“Excel”) to construct water and sewer lines. The town entered into a separate contract with KHM Engineering, Inc. for engineering services to include design of a new water and sewer system and project management. The contract between HKM and the town was based on an Engineering Joint Contracts Documents Committee (EJCDC) form and included the following provision at article 9.10(A):

“Neither ENGINEER’s authority or responsibility under this Article 9 or under any other provision of the Contract Documents nor any decision made by ENGINEER in good faith either to exercise or not exercise such authority or responsibility or the undertaking, exercise, or performance of any authority or responsibility by ENGINEER shall create, impose, or give rise to any duty in contract, tort, or otherwise owed by ENGINEER to CONTRACTOR, and Subcontractor, any Supplier, any other individual or entity, or to any surety for or employee or agent of any of them.”

By its contract with the town, HKM was authorized to issue written clarifications of contract documents, authorize minor variations in the work, and reject the contractor’s work that the engineer deemed to be defective or in non conformance to the plans and specifications.

The GC alleged that the specifications called for insufficient backfill in certain locations and that the engineer advised it to purchase required backfill and bill for it at the end of the month rather than immediately submitting a change order request. The contractor was not paid for the extra backfill and it alleges that it relied upon the engineer’s representations that it would be paid. The contractor also alleges that the engineer improperly denied certification of substantial completion and that liquidated damages were wrongfully assessed.

Negligence and Misrepresentation Claims Subject to Economic Loss Rule

In reviewing the allegations of the complaint, the court concluded that the negligence count of the complaint as well as the misrepresentation count were both subject to the economic loss rule which bars recovery in tort (negligence) when a plaintiff claims purely economic damages unaccompanied by physical injury of property damage. The contractor had framed the misrepresentation allegation as “negligent misrepresentation” and therefore, it must be treated as any other negligence based claim. The court noted, however, that if the count had been framed as intentional misrepresentation or fraud, the complaint lacked sufficient details in the allegations to satisfy the elements of fraud. The court also noted that the existing case precedent holds that “A party may not sidestep contractual limitations by simply pleading an intentional tort.” In the current case, the court considered the pleadings and found that regardless of how the contractor wanted to characterize its allegations, its claim “can only be construed as one for negligent misrepresentation” and that claim is barred by the economic loss rule.

Tortious Interference with Contract Claim

The contractor attempted to get around the economic loss rule by arguing that even those courts that have rigorously applied the economic loss rule do not apply it to bar claims based on intention torts. Thus, the contractor argued that its claim against the engineer for tortuously interfering with its contract should not have been dismissed. In finding against the contractor here, the court stated that because the engineer was an agent for the town which was a party to the contract with the contractor, such an agent could not legally be found to have inferred with such a contract. The court went on to explain that the engineer was not an “outsider” to the contract between the town and the contractor. Instead, the engineer, pursuant to its own contract with the owner, had a project management role in monitoring the contractor’s performance and making decisions concerning that performance. As explained more fully by the court:

“In this case, HKM was charged with determining compliance with the contract, approving change orders, and otherwise serving as decision-maker for the Town of Lovell by the express terms of its agreement. HKM therefore acted not only as an agent, but as an agent with the power to make decisions on behalf of the town. Its actions, if they breached the contract, may entitle Excel to recover against the town for that breach, but Excel may not recover from HKM on a theory of intentional interference with a contract for actions taken as the town’s agent.”

The Allegations of Breach of a Covenant of Good Faith and Fair Dealing

Citing the language of Article 9 of the engineer’s contract with the town, as quoted above, the contractor argued that the language created an obligation on the part of the engineer to act in good faith in its decision-making as the town’s agent and that the engineer failed to do so. Two key points were made by the court in rejecting this argument. First, the court states that the duty of good faith and fair dealing applies to all contracts but that duty is only applicable between the parties of the contract – thus the contractor would receive no benefit under the contract between the engineer and town. Second, the Article in question was not intended to create any affirmative duty but quite the contrary was intended to be an exculpatory clause to limit the engineer’s liability such that it would have no liability for decisions made in good faith. As stated by the court, “In other words, the clause means that the contractor may not recover from the engineer for careless errors which were not made in bad faith….” And “while it does not bar claims involving bad faith such as fraud,” the contractor would only be entitled to pursue such claims if the substantive law permitted it – but in this case the law in fact bars such claims.

For the reasons explained, the court affirmed the summary judgment in favor of the engineer.

Article 2

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Expert Testimony is Required to Prove Construction Management Failed to Meet the Standard of Care

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A Court of Appeals in Texas ruled that expert testimony is required to establish the standard of care of a construction management firm since a lay person would not have sufficient knowledge of the duties of a construction management firm. Judgment was entered for the construction management firm as no expert testimony was put forth to establish its liability.

Facts and Allegations

The owner of an apartment complex, brought suit against 3D/I, a construction management firm, when water overflowed from a temporary retention pond and caused damage to the apartment complex. 3D/I contracted with the County of El Paso, Texas to “supervise, direct, and manage the complete construction” of an annex building and retention pond. The Contract did not extend the responsibilities of 3D/I to include constructing or designing the retention pond, only to supervising the contractor tasked with its construction.

The provisions in the Contract limited the duties of 3D/I to scheduling work and funding, reviewing design documents to ensure compliance, making recommendations to the County regarding construction, and guarding against defects and deficiencies. The contract contained a clause that determined the liability of 3D/I based on “standards and quality prevailing among first-rate, nationally recognized design/construction management firms of knowledge, skill and experience engaged in projects of similar size and complexity.”

At trial, the Plaintiff put forth expert testimony that determined the drainage pond was responsible for the flooding. However, no expert testimony was put forth to determine the standard of care that 3D/I needed to exercise as a construction management firm; thus, 3D/I moved to have the case dismissed. 3D/I argued that a lay person without the guidance of expert testimony would not know the role of a construction management firm, and therefore, could not determine liability. The Trial Court denied the motion and ruled that no such expert testimony was necessary. This was reversed on appeal in the case of 3D/I + Perspectiva v. Castner Palms, Ltd., 310 S.W.3d 27 (Court of Appeals of Texas 2010)

When Expert Testimony is Necessary

Expert testimony is required where the “alleged negligence is of such a nature as not to be within the experience of the layman.” If an ordinary person would not be familiar with the equipment or techniques used, then expert testimony is required. In this case, 3D/I argued that since its duties were limited to supervising work as stated in the plans, expert testimony was required as a lay person would not know what duties a construction management firm might extend to.

The appellate court in this case stated it could not conclude a layman would have knowledge of whether a construction management firm’s responsibilities extend beyond mere supervision. While a jury could determine the pond was negligently built, specialized knowledge is required to determine whether the supervisory duties extend beyond merely ensuring the plans were built to specification. Additionally, even if the appropriate standard of care were specifically stated in the Contract, expert testimony would still be required to establish the standard of liability for construction management firms.

 

Article 3

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Professional Services Exclusion of Engineer’s CGL Policy Properly Applied to Bar Coverage for Wrongful Death Action Resulting from Trench Collapse

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An employee of a contractor died due a trench collapse during installation of a sewer line. His wife filed a wrongful death action against the project engineer, alleging that the firm overseeing the project owed a duty to the worker to perform its professional services in accordance with appropriate standards and acted negligently by failing to take steps to ensure the trench’s structural integrity. The engineer sought insurance coverage and defense under its commercial general liability (CGL) policy. The CGL carrier brought a declaratory judgment action asking the court to declare it owed no duty to the engineer because the professional liability exclusion of the policy was a complete bar to the plaintiff’s complaint. In the trial court, summary judgment was granted on the basis that the engineer’s actions were intentional rather than accidental and there was consequently no “occurrence” as defined by the CGL policy that could trigger coverage. On appeal, the U.S. Court of Appeals of the Fifth Circuit affirmed the decision but focused exclusively on the clear and unambiguous professional services exclusion to the policy – finding that the exclusion applied to the complaint that contained allegations entirely based upon professional services and professional negligence.

Facts and Allegations

In this case, a mother of a deceased worker (“Plaintiff”) who died as a result of injuries caused by a collapsed trench filed suit against Brown and Mitchell, Inc. (“BMI”), alleging it was responsible for the collapse by virtue of not taking steps to ensure its structural integrity. The accident occurred on-site while a BMI representative asked the Plaintiff to assist him in measuring a pipe to determine payment. The Plaintiff alleged that BMI had a duty to “perform its professional responsibilities as engineers in accordance with the appropriate standards. BMI acted negligently … in the performance of its responsibilities….” (emphasis in original)

QBE Insurance Corp., BMI’s excess commercial general liability (CGL) insurer, filed a separate declaratory judgment action to determine whether it was liable to pay the costs of defending BMI and to indemnify BMI for any judgment rendered against. The CGL policy contained two provisions that QBE argued insulated it from liability.

First, the policy provided for coverage caused by an “occurrence,” which is defined in the policy as “an accident, including continuous or repeated exposure to substantially the same general harmful conditions.” Second, the policy contained a provision that excluded coverage for bodily injury or property damage “due to the rendering or failure to render any professional service.” The phrase “professional service” as stated in the policy included engineering, supervisory or inspection services.

The trial court judge ruled on summary judgment that BMI had no coverage under the CGL policy because the complaint alleged only intentional conduct. Since the policy only covered actions that are accidental, BMI was unable to recover. The trial court did not reach the merits of whether the professional services exclusion shielded QBE from liability.

Applying the Eight Corners Test (4 corners of the Complaint + 4 corners of Policy)

Whether an insurer is responsible to defend a lawsuit is determined by comparing the policy language to the allegations in the complaint. That analysis is referred to by the appellate court here as the “eight-corners test”. This means that the court considered the four corners of the complaint plus the four corners of the insurance policy. The insurer has a duty to defend its insured only if the wording in the complaint states a claim within the scope of coverage provided in the policy. In affirming the trial judge’s decision, the appellate court didn’t state whether it agreed with the judge’s analysis of intentional and accidental conduct, but instead focused its decision on the question of whether the professional services exclusion of the policy was applicable to bar coverage for the allegations in the complaint.

Professional Services Exclusion

In focusing on the question of “professional services” the court explained that Mississippi courts have defined a professional service as a service that “involves the application of a special skill, knowledge and education arising out of a vocation, calling, occupation or employment.”

The Court determined that while the actions of BMI at the time of the accident did not necessarily require the “application of special skill, knowledge or education,” the professional services exclusion nonetheless applied because the alleged duties of the engineer to ensure the trench’s structural integrity required the professional services of an engineering firm. The Court’s conclusion is supported by the wording in the complaint, which explicitly attributes the breach of BMI’s duties as “professional responsibilities.”

In an apparent effort to avoid the professional services exclusion of the policy, BMI argued that its employee that was present at the time of the accident was not performing a professional responsibility since he had only a high school level education and was simply measuring pipe for the purposes of payment. In rejecting that argument, the Court stated that the complaint on its face alleged negligent performance of professional services and did not assert improper non-technical activities. As explained by the court:

“We recognize that some of the conduct complained of may not require ‘the application of special skill, knowledge and education.’ The complaint does not, however, allege that it was improper performance of BMI’s non-technical activities that caused [the worker’s injuries]… Nor is there any dispute that BMI’s role on the project was the provision of professional services.”

Moreover, the court noted that “the complain is explicit in attributing the accident to a breach of BMI’s ‘professional responsibilities’ as the ‘engineering firm’ on the site.”

For all these reasons the court in the case of QBE Insurance Corp v. Brown & Mitchell, Inc., 591F.3d 439 (U.S. 5th Cir., December 2009), summed up by stating: “[E]ven studiously construing the policy in favor of BMI, the allegations in the complaint are precisely the sort of potential liability the professional services exclusion is designed to excise from coverage.”

Comment: No explanation is provided by the court as to why the engineer looked to a CGL policy for coverage instead of to a professional liability policy. Perhaps the answer is as simple as the engineer didn’t have a professional liability policy. There are some design firms, however, that have both types of policies but who would still prefer to see coverage for bodily injury and wrongful death covered under their CGL policy instead of the professional liability policy. This may be because the deductible on the CGL policy is often significantly less than that under the professional policy. Or perhaps it is because bodily injury claims and wrongful death seem to have more of a general liability feel to them. Nevertheless, it is possible for services that are purely professional to cause errors or omissions that might lead to bodily injuries. Such claims arising out of professional services fall within the coverage typically provided by professional liability policies (otherwise known as errors & omissions policies) and are excluded from coverage under the CGL policy due to that policy’s professional services exclusion.

 

Article 4

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Unlicensed Contractor forced to Refund all Payments back to the Homeowners

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A homeowner in California that contracted with a construction company to build a house filed suit for breach of contract and negligence, and violations of the state licensure requirements – seeking to recover sums it had paid to the contractor. The construction company filed a separate suit to enforce its mechanic lien and to recover unpaid sums under theories of breach of contract and quantum meruit for unjust enrichment in the event contract remedy were determined to be unavailable. The cases were consolidated and the trial court directed a verdict in favor of the homeowner based on the fact that because the construction company had lost its key employee who held a contractor’s license, the company itself was no longer licensed since corporate licensure is dependent upon employing a qualifying individual that holds a license.

Facts and Allegations

The construction company in question, JC Master Builders, Inc., depended for its license upon a licensed qualifying individual, by the name of Mr. Diani, that had left the employment of the company. Another individual (a Mr. Cridlebaugh) replaced Mr. Diani and he took primary responsibility for constructing the house. While the dispute arose when the Homeowners ordered the firm to stop construction due to a disagreement concerning billing, the case rested on whether the firm possessed a valid contractor’s license. The homeowner argued that since the there was no license qualifying individual working for the construction firm while the house was built, the firm itself was not qualified as a licensed contractor and therefore was not only barred from bringing suit against the homeowner but was also required by law to refund the homeowner for all payments previously made to the firm.

Consequences of working as an unlicensed contractor

Under California law, contractors must maintain a valid contractor’s license throughout the duration of the construction. When a construction firm employing the contractor seeks to obtain a valid license, it must qualify for such license through either a “responsible managing officer” or “responsible managing employee.” These people are referred to as “qualifiers.” If such a qualifier disassociates from the firm, the firm has 90 days to replace the qualifier, otherwise the firm’s license is suspended.

The construction firm, and thus, the new individual the performed the work, Mr. Cridlebuagh, were not qualified in this case to perform the work since the original qualifier was never replaced and there was no qualifier “actively engaged in its construction business.”

California law “bars a person from suing to recover compensation for any work he or she did under an agreement for services requiring a contractor’s license unless proper licensure was in place at all times during such contractual performance. “ Furthermore, the court states that under the law, “A person who utilizes the services of an unlicensed contractor may bring an action . . . to recover all compensation paid to the unlicensed contractor for performance of any act or contract.” These laws are designed to serve as deterrence to contractors working without a license. Additionally, contractors cannot offset or reduce the amount returned to the homeowner to account for the value to materials or services.

As explained by the court, “The licensing requirement and the penalties for violating that requirement are designed to protect the public from incompetent or dishonest providers of building and construction services.” Deterrence from violating the licensing requirements can best be realized, says the court, “by compelling violators to return all compensation received from providing their unlicensed services.” Even where the contractor may have honored its contract performed its services well, an unlicensed contractor is not entitled to be paid, and is not entitled to any offset for having provided good materials and work. The court says that “If such reductions for offset were allowed, deterrence of unlicensed work would be diminished.” White v. Harper, 178 Cal. App. 4th 506 (2009).

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ABOUT THIS NEWSLETTER & A DISCLAIMER

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

Copyright 2010, ConstructionRisk, LLC

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J. Kent Holland, Jr., Esq.

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