Inside this Issue

A1 - Economic Loss Doctrine Bars Negligence Claim Arising out of Breach of Contract
A2 - Liquidated Damages Found to be Unenforceable Penalty; but Waiver of Differing Site Conditions Claim was Enforced
A3 - Court Applies 'Professional Liability Exclusion' So Had No 'Duty to Defend' Architect Under CGL Policy
A4 - The "Your Work" Exclusion in CGL Policy Barred Coverage for Replacing Brick Wall Due to Defective Application of Joint Tape to the Underlayment Board

Article 1

Economic Loss Doctrine Bars Negligence Claim Arising out of Breach of Contract

Where a condominium association filed suit asserting negligence claims against the general contractor that built the complex, alleging defective workmanship including deficient masonry work and use of unauthorized black building paper in place of specified "Tyvek or equal." The trial court dismissed the negligence claims, fmding that they were barred by the Economic Loss Doctrine, and this was affirmed on appeal. Saratoga at Toms River Condominium Association v. Menk Corporation, et al., 2014 WL 3510872 (N.J. Super. A.D., 2014). The plaintiff asserted causes of action based on negligent construction, negligent design" and negligent misrepresentation. All of these claims were deemed by the court to be "essentially breach of contract claims."

The trial court and appellate court plainly stated they were not impressed by the merits of the plaintiff's factual arguments (and the fact and expert witnesses) concerning the alleged defects - noting that the expert testimony was not adequate to prove that the black construction paper contractor used, (which met the building code requirements) was not equal to Tyvek. Nor was the evidence persuasive concerning the alleged defects on masonry work and use of “damp proofing” as opposed to waterproofing in foundations, crawl spaces and basements.

Economic Loss Doctrine

The appellate court began its analysis by citing a New Jersey Supreme Court decision, Spring Motors Distributors, Inc., for the proposition that the Economic Loss Doctrine is based on the principle that economic expectations between parties to a contract are not entitled to supplemental protection by negligence principles, and that when addressing economic losses in commercial transactions, contract theories were better suited than were tort-based principles.

The court stated:

"This case similarly involves commercial transactions between Menk and the unit owners. Their contracts required, among other things, construction of the units in accordance with applicable building codes and the seller's plans. The contracts also required that the units be fit for their intended use, and free of defects in materials and workmanship for a period of two years.

Plaintiff claimed that defendants performed the contract negligently, that is, that they did not complete the work in a workmanlike fashion, and/or in accordance with industry standards or accepted practices. Thus, if proven, defendants' alleged negligence would constitute a breach of the express and implied promise to complete the construction in a workmanlike manner. Ibid.

We are therefore convinced that plaintiffs allegations essentially sound in contract, not tort. Notwithstanding plaintiffs arguments to the contrary, the Economic Loss Doctrine applies. We conclude that the trial court correctly determined that Menk was entitled to summary judgment on the negligence claims."

Comment

This is an excellent reiteration of the legal reasoning for barring economic loss claims in the context of negligence causes of action that have historically been reserved to bodily injury and property damage. In the context of commercial parties who are in privity of contract, the decision enforces the point that the parties have ample opportunity to negotiate the terms and conditions of their contract and must be bound and limited by their agreement rather than expanding basic breach of contract claims into distinct negligence causes of action. What the court is saying is that negligent performance may cause a breach of contract to occur, but the remedy for the plaintiff is to sue to breach of contract based on the negligent performance, and not sue for a separate negligence cause of action.

About the author: Article written by J. Kent Holland, Jr., 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 founder and president of a consulting firm, ConstructionRisk, LLC, 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. 17, No. 1 (January 2015).

Article 2

Liquidated Damages Found to be Unenforceable Penalty; but Waiver of Differing Site Conditions Claim was Enforced

Contractor brought suit seeking additional compensation for costs resulting from differing site conditions and alleged inaccurate site plans. The Owner counterclaimed for liquidated damages based on delayed completion, being a 397 day delay at $700/day. The court held due to failure of the contractor to comply with the claim notice provisions of the contract (i.e., the contractor gave notice to the project engineer but not directly to the town itself) it was not entitled to either additional compensation or time extension. A contractual waiver of the right to make any claims based on differing site conditions was enforced against the contractor. The good news for the contractor, however, was that the court found the liquidated damages clause was an unenforceable penalty, stating that "the amount of damages is so manifestly unreasonable and disproportionate that it plainly constitutes an unenforceable penalty." The court stated that it rejected the contractor's claim for additional compensation because the contractor "did not follow the parties' unambiguous notice provisions to claim additional compensation, [and] the contract explicitly precluded recovery for additional costs related to subsurface conditions encountered." Boone Coleman Construction, Inc. v. Village of Piketon, 13 N.E. 3d (Ohio, 2014).

Notice Requirements for Submitting a Claim

The contract included a clause stating that "all time limits for Milestones, if any, Substantial Completion, and completion and readiness for final payment as stated in the Contract Documents are of the essence of the Contract." The contract further provided that all work was to be substantially completed within 120 days after the work commenced.

The time of the essence requirement was reiterated in the liquidated damages clause of the contract which provided the following:

4.03 Liquidated Damages

A. CONTRACTOR and OWNER recognize that time is of the essence of this Agreement and that OWNER will suffer financial loss if the Work is not completed within the time(s) specified in paragraph 4.02 above, plus any extensions thereof allowed in accordance with Article 12 of the General Conditions. The parties also recognize the delays, expense, and difficulties involved in proving in a legal or arbitration [proceeding] the actual loss suffered by OWNER if the Work is not completed on time. Accordingly, instead of requiring any such proof, OWNER and CONTRACTOR agree that as liquidated damages for delay (but not as a penalty), CONTRACTOR shall pay OWNER $700.00 for each day that expires after the time specified in paragraph 4.02 for Substantial Completion until the Work is substantially complete.

The court found that during the project, the contractor did not request time or additional compensation in accordance with the parties' contract, which set forth a specific procedure to resolve these claims as follows:

10.05 Claims and Disputes

A. Notice: Written notice stating the general nature of each Claim, dispute, or other matter shall be delivered by the claimant to the ENGINEER and the other party to the Contract promptly (but in no event later than 30 days) after the start of the event giving rise thereto. Notice of the amount or extent of the Claim, dispute, or other matter with supporting data shall be delivered to the ENGINEER and the other party to the Contract within 60 days after the start of such event (unless ENGINEER allows additional time for claimant to submit additional or more accurate data in support of such Claim, dispute, or other matter). A Claim for adjustment in Contract Price shall be prepared in accordance*1194 with the provisions of paragraph 12.01.B. A Claim for an adjustment in Contract Time shall be prepared in accordance with the provisions of paragraph 12.02.B. Each Claim shall be accompanied by claimant's written statement that the adjustment claimed is the entire adjustment to which the claimant believes it is entitled as a result of said event. * * *

* * *

D. No Claim for an adjustment in Contract Price or Contract Times (or Milestones) will be valid ifnot submitted in accordance with this paragraph 10.05.

* * *

12.01 Change a/Contract Price

A. The Contract Price may only be changed by a Change Order or by a Written Amendment. Any Claim for an adjustment in the Contract Price shall be based on written notice submitted by the party making the claim to the ENGINEER and the other party to the Contract in accordance with the provisions of paragraph 10.05.

* * *

12.02 Change a/Contract Times

A. The Contract Times(or Milestones) may only be changed by a Change Order or by a Written Amendment. Any Claim for an adjustment in the Contract Times (or Milestones) shall be based on written notice submitted by the party making the claim to the ENGINEER and the other party to the contract in accordance with the provisions of paragraph 10.05.

The contract required several notice of requests for time extensions and extra compensation be sent BOTH to the village's consulting engineer as well as to the village itself. The court held that the letters failed to satisfy the notice requirements of the contract because ''they were not sent to the village." In strictly enforcing the notice requirements of the contract, the court rejected the contractor's argument that its failure to comply with the provision was not fatal because the village had actual notice of the requests through its engineer. The court cited Ohio Supreme Court precedent for strict enforcement, quoting as follows:

"[W]e reject [the contractor's] argument that it was excused from complying with the specific change-order procedure for requesting extensions because the state had actual notice of the need for changes to the deadline, and therefore any failure to comply with procedure was harmless error. The record lacks evidence of either an affirmative or implied waiver by the department or OSU of the change-order procedures contained in the contract. [The contractor] has not convinced us that its failure to request extensions was harmless to *1197 OSU. To the contrary, [the contractor] agreed that the contract language stated that failure to provide written notice "shall constitute a waiver by the Contractor of any claim for extension of or mitigation of Liquidated Damages." The court of appeals correctly concluded that [the Contractor] "has not demonstrated that it was entitled to disregard its obligations under that part of the contract * * *."

Waiver of Claims for Subsurface Conditions

Even if adequate notice pursuant to the contract requirements had been given, the court held that the contractor would lose on its differing site condition claim because "the construction contract expressly stated that it was the 'sole responsibility of the Contractor to take any and all measures he feels necessary to ascertain the subsurface conditions prior to bidding/ and that 'no claims for additional costs will be considered for material, labor, equipment, or subcontractors/subconsultants to address subsurface conditions encountered during construction." The court states: "The Spearin doctrine does not invalidate express contractual provisions like these."

Liquidated Damages Provision is Unenforceable

After acknowledging that parties have the right to contract freely with the expectation that contract terms will be enforced, the court said "penalty provisions in contracts are invalid on public policy grounds because a penalty attempts to coerce compliance with the contract instead of representing damages that may actually result from a failure to perform." A three-part test for evaluating the enforceability of a liquidated damages provision was previously established by the Ohio Supreme Court as follows:

"Where the parties have agreed on the amount of damages, ascertained by estimation and adjustment, and have expressed this agreement in clear and unambiguous terms, the amounts so fixed should be treated as liquidated damages and not as a penalty, if the damages would be (1) uncertain as to amount and difficult of proof, and if (2) the contract as a whole is not so manifestly unconscionable, unreasonable, and disproportionate in amount as to justify the conclusion that it does not express the true intention of the parties, and if (3) the contract is consistent with the conclusion that it was the intention of the parties that damages in the amount stated should follow the breach thereof."

The court found that test 1 and test 3 were both met for enforcing the LD clause but that the evidence did not satisfy the second test. "That is, when we view the contract as a whole in its application, we conclude the amount of damages is so manifestly unreasonable and disproportionate that it is plainly unrealistic and inequitable. Given the circumstances of this case we conclude the amount of damages is so unreasonably high and so disproportionate to the consideration paid that the clause amounts to a penalty." The court cited other case precedent for the principle that "Reasonable compensation for actual damages is the legitimate objective of the liquidated damages provision and, where the amount specified is plainly unrealistic and inequitable, courts will ordinarily regard the amount as a penalty." An LD provision would also be unenforceable, concluded the court, where the amount specified is manifestly disproportionate to the consideration paid or the damages that could foreseeably result for a breach."

Here the court found that the LD amount was nearly a third of the contract price and that the village did not testify as to how that amount bore a reasonable relationship to the amount of damages in the event of a breach. "Where the resulting amount is manifestly inequitable and unrealistic, courts are justified in determining the provision to be an unenforceable penalty." For these reasons, the court found the LDs in this case to constitute an unenforceable penalty and reversed and remanded to the trial court for further proceedings on damages.

Article 3

Court Applies 'Professional Liability Exclusion' So Had No 'Duty to Defend' Architect Under CGL Policy

By James Rhodes, Esq.
ConstructionRisk Counsel, PLLC

Introduction

A federal appeals court, applying Louisiana law, held that an insurer did not owe a duty to defend its insured, an architect, in a suit by the architect's former client. The court explained that the "professional liability exclusion" in the commercial general liability (CGL) policy applied because the damages resulted from the performance of professional services. The architect attempted to point to references of general negligence in the former client's complaint as triggering the duty to defend. In applying the "eight comers" test, the court explained that the factual assertions in the complaint-as opposed to conclusory statements-determine whether the duty to defend is triggered. Because the factual statements, liberally construed, would not support an ordinary claim for negligence (as opposed to professional negligence), there was no duty to defend under the CGL policy. Wisznia Co., Inc. v. General Star Indemnity Co., 759 F.3d 446 (5th Cir. 2014).

Wisznia Company, Inc. (Wisznia) is an architecture firm that was sued by Jefferson Parish, Louisiana, its former client, for improper building design and inadequate coordination with the builders during construction. Following the initiation of the lawsuit, the firm sought legal defense from the provider of its commercial general liability (CGL) policy. The insurer, General Star Indemnity Company (General Star), refused to offer defense and coverage to Wisznia, citing the standard-form "professional liability exclusion" provision found in the policy. The architecture firm subsequently sued its insurer for breach of insurance contract. A federal district court, applying Louisiana law, agreed with the insurer that it was not obligated to defend or provide coverage.

The United States Court of Appeals for the Fifth Circuit agreed, offering insights into the scope of the duty to defend and the interplay between a CGL policy and a professional liability policy. Under Louisiana law - as well as in most states - an insurer's "duty to defend suits against its insured is broader than its liability for damage claims." Accordingly, the allegations in a third party's complaint against the insured may trigger the insurer's duty to defend the insured, even though coverage under the policy is not complete, and may later be deemed to be inapplicable. Courts generally apply the "eight comers" test to determine if this "broader" duty to defend applies. Under this test, courts compare the "four comers" of the third party's complaint against the insured with the "four comers" of the insurance policy, construing the language liberally in favor of the insured.

Professional Liability Exclusion Details

In this case, the insurer argued that there was no duty to defend because the allegations by the owner against the architect concerned the rendering of professional services. Consistent with standard CGL policies, the policy included an exclusion of coverage for damages related to performing professional services (a "professional liability exclusion"). This professional liability exclusion typically draws a line between the scope of a general business liability policy with the coverage of a separate professional liability policy, which specifically covers errors and omissions in performing professional services. The insurer characterized the factual basis of the complaint as solely for damages due to improper performance of professional services.

The architecture firm, in turn, pointed to several portions of the complaint that generally alleged "negligence." They argued that this meant that the plaintiff had alleged "ordinary" negligence, which would be covered by a CGL policy, in addition to professional negligence that would not be covered. Accordingly, the firm argued that the insurer had a duty to defend because at least some of the allegations stated in the complaint would trigger coverage.

The appeals court held that under Louisiana law the mere invocation of general negligence in a complaint will not necessarily defeat a professional liability exclusion. The court explained that a proper analysis under the eight comers test focuses on the specific factual allegations, as opposed to conclusory references. They concluded that the factual allegations in the complaint, even liberally construed, could not give rise to a claim for ordinary-as opposed to professional negligence.

In reaching its holding that there was no duty to defend, the court distinguished from a few cases that seemingly reached a different result. In these cases, construction professionals succeeded in invoking the duty of their CGL providers to defend, against the insurers' attempts to apply the professional-liability exclusion. However, all of these cases involved injuries from alleged failures in workplace safety, such as an exposed high-voltage wire or the fall of a construction elevator. The appeals court explained that liberally construing the factual allegations in those cases, they included "claims for breach of the general duty of reasonable care to report dangerous conditions." In contrast, the factual basis of the instant case was solely for professional liability .

Conclusion

This case provides a sound illustration of the scope of the duty to defend and the application of a professional liability exclusion in a CGL. Like the plaintiff in this case, an insured will have trouble invoking the duty to defend under a CGL when a common sense reading of the facts in the complaint shows that the damages stem from professional conduct. However, cases related to professional conduct that also involve workplace safety violations or similar instances will be more likely to trigger the duty to defend under a CGL because those situations may give rise to beaches of a general as opposed to professional-duty of care. Architects, engineers and other professionals should remain mindful of the scopes and limitations of their professional and general liability policies in relation to each other.

Article 4

The "Your Work" Exclusion in CGL Policy Barred Coverage for Replacing Brick Wall Due to Defective Application of Joint Tape to the Underlayment Board

See similar articles: CGL | Defective Workmanship | Insurance Coverage Dispute | Your Work Exclusion

A subcontractor's CGL policy was held not to cover costs for removing and replacing a brick wall due to defective installation of joint tape that had been used by the subcontractor to seal the blue board insulation before constructing the brick wall. When the prime contractor noticed that the tape was coming loose, he removed a portion of the wall and required the subcontractor to replace the tape before the wall could be reconstructed. The question for the court was whether there was "property damage" and an "occurrence" as defined by the CGL policy.

The trial court found that the only loss by the subcontractor was the liability it incurred when the general contractor tore down and reconstructed the otherwise undamaged brick veneer wall for the remedial purpose of bringing the subcontractor's own work into compliance with its contract with the prime contractor. The court found the loss was not "property damage." It also found the loss resulted from the nonconforming work, and that the costs of faulty workmanship and repairing defective work were not an "occurrence" under the Policy. Finally, the court found "even if the losses ... were found to be within" the Policy, they were excluded under the "your work" exclusion. This was affirmed on appeal. Precision Walls, Inc. v. Liberty Mutual Fire Insurance Co., 763 S.E. 2d 598 (2014), with the court stating, "The exclusion applies to property that must be restored, repaired, or replaced. The exclusion specifically includes materials furnished in connection with such work. Here, the contract between the [general contractor] and [subcontractor] required the [subcontractor] to 'correct the affected work and all costs incurred as the result of [a] breach of warranty .... ' We find the defective tape, and all costs associated with its replacement, fall squarely within the exclusion."

Comment: It is important to note that the defective tape did not cause any damage to occur to the wall or any other property. The wall only had to be removed and replaced in order to correct the defective work of the subcontractor (i.e., replace the loose tape).

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ConstructionRisk.com Report (January 2015)

Inside this Issue

Article 1

Economic Loss Doctrine Bars Negligence Claim Arising out of Breach of Contract

Economic Loss Doctrine

Comment

Article 2

Liquidated Damages Found to be Unenforceable Penalty; but Waiver of Differing Site Conditions Claim was Enforced

Article 3

Court Applies 'Professional Liability Exclusion' So Had No 'Duty to Defend' Architect Under CGL Policy

Introduction

Professional Liability Exclusion Details

Conclusion

Article 4

The "Your Work" Exclusion in CGL Policy Barred Coverage for Replacing Brick Wall Due to Defective Application of Joint Tape to the Underlayment Board

Search

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Connect

Contract Guide for Design Professionals

Recent Newsletters

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Risk Management Workshops

Life Skills Workshop Slides

Contract Clauses – Papers and Articles

IRMI Expert Commentary

Construction Risk Management