Inside this Issue

A1 - Subcontractor Entitled to Punitive Damages for Prime’s Breach of Contract
A2 - CGL Insurance Carrier in Tennessee Owed Duty to Defend – Based on Subcontract Work Exception to “Your Work” Exclusion
A3 - CGL Insurance Carrier in Connecticut Owed Duty to Defend Contractor – Based on Subcontract Work Exception to “Your Work” Exclusion
A4 - Indemnification Clause Required Engineer to Indemnify Owner for Losses it Incurred
A5 - Where Owner Alleges Only Future Possible Damages and Not Current Actual Damages, Summary Judgment Must be Granted to Engineer

Article 1

Subcontractor Entitled to Punitive Damages for Prime’s Breach of Contract

A written subcontract called for the Subcontractor to perform certain debris removal. This work was necessitated by Hurricane Katrina. Although the contract was only for work to be performed north of a particular highway, the subcontractor claimed that shortly after work began, it was orally requested by the prime contractor to also remove debris from south of the highway. No written contract modification was ever requested or granted, however, and the prime later denied knowing that the Sub was performing the additional work. During trial, it was determined that the Prime not only knew about the work, but had also included the sub’s invoices in the payment requests submitted to the owner/county government for payment. Moreover, the Prime had received payment from the Owner for over $3 million in costs that the Sub had invoiced the Prime for the extra work, and that the Prime had forwarded to the Owner for payment. It was held that the conduct of the Prime was so egregious that the Subcontractor was entitled to recover not only its actual costs, but also punitive damages. The matter was thus remanded to the trial court to have a jury determine the amount of punitive damages to be awarded. TCB Construction v. WC Fore Trucking, Inc., 2013 WL 718628 (2013).

Every week, the Sub submitted invoices to the Prime that the Prime in turn submitted to the county. In addition, the Sub submitted “work tickets” or “truck tickets” as daily reports. Despite the Prime claiming during trial that it didn’t know the work was being done south of the highway, the court found that testimony to be “disingenuous” especially in that the entire area north and south had to be cleaned up, and was in fact cleaned up entirely by the subcontractor whose invoices were all passed along to the County with the Prime contractor’s invoice for payment. The Prime refused to pay the Sub almost millions of dollars that the Prime recovered from the county for work the Sub performed.

In concluding that this breach of contract justified punitive damages, the court explained that the Prime “represented to the local government that [Sub’s] invoices were accurate and that it received full benefit of TCB’s work without compensating TCB. Moreover, an accounting firm hired by the county oversaw the entire process, and TCB was the only company removing debris in the area…. [I]t defied credibility to suggest Fore, the corporation, had no knowledge TCB was submitting invoices for work south of Highway 53.” “TCB provided sufficient proof that [Prime] acted in bad faith, with complete disregard for TCB’s rights, seeking to reap the benefits of its contract while at the same time denying its obligations. Based on the evidence, a reasonable, hypothetical juror could find that [Prime] had breached the contract either maliciously, by an intentional wrong, or with reckless disregard for TCB’s rights.”

For these reasons, the court remanded the matter to have a jury determine the amount of punitive damages appropriate.

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. 15, No. 7 (July 2013).

Article 2

CGL Insurance Carrier in Tennessee Owed Duty to Defend – Based on Subcontract Work Exception to “Your Work” Exclusion

See similar articles: Insurance Coverage Disputes

A CGL insurance carrier owed a duty to defend its insured against a homeowner suit that alleged defective work, despite lack of clarity in the complaint that the work was performed by a subcontractor, and despite any indication in the complaint that the work caused damage to anything other than the work itself. The homeowner’s complaint alleged (1) “significant cracking in the foundation at the right rear corner of the dwelling, creating an unsafe and potentially life-threatening condition;”(2) “Forrest recklessly performed, or caused to be performed, work of such poor workmanship that it created an unsafe condition, causing a potentially deadly collapse of the residence;” and (3) Forrest recklessly constructed the foundation or recklessly caused to be constructed the foundation of the … residence.”

The carrier denied coverage on the basis that the allegations concerned the insured’s own work, and no coverage existed under the policy due to the “your work” exclusion of policy. The carrier acknowledged the exclusion would not apply “if the damaged work or the work out of which the damage arises was performed on your behalf by a subcontractor.” In rejecting that argument, the court held that the complaint, as quoted above, included sufficient allegations to get around the exclusion by using the words “or caused to be performed,” “or caused to be constructed.” Forrest Construction v. The Cincinnati Insurance Company, 703 F.3d 359 (6^th Cir. 2013).

What is odd about the court’s explanation, however, is that there is no allegation or indication whatsoever that anyone other than the prime contractor actually performed the defective work in question. It seems like the court found a duty of the carrier based on merely the hypothetical possibility that a subcontractor might have performed the work. It is surprising that there was no affidavit or other information to flesh out the details of what happened on the project.

Another aspect of the decision that is surprising is that the court rejected the carrier’s argument that there was no “property damage” as defined by the policy. The carrier argued that only the work itself was damaged, and that based on case precedent, there must be a finding that the defective work caused damage to some property other than the work itself – otherwise there is no property damage to cover. The trial court found that the allegations in the complaint were “ambiguous” regarding the extent of the damage to the house. Despite that finding, however, the appellate court stated that “while not a model of specificity as to the nature of the damages flowing from the faulty foundation, … implies that the faulty foundation caused damage elsewhere in and to the house and allegedly rendered the house unsafe to even enter, putting Cincinnati Insurance on notice that more than the foundation itself was affected by the faulty workmanship and that the [Homeowners] were alleging loss of use of their property.” The court held that the ambiguous complaint must be interpreted in favor of providing coverage to the insured.

Comment: Taken to its logical conclusion, the holding of this decision would mean that even if there was no subcontractor on a project and no damage to anything other than the defective work itself, a CGL carrier would have to defend its insured prime contractor against every construction defect claim. I have no knowledge concerning the facts of this case other than what was reported in the decision.

But what if the insurance carrier investigated the matter and determined that there was no subcontractor. Would that change the outcome? Or would the court still rule that only the ambiguous allegations of the complaint implying that a subcontractor might have been involved still trigger duty to defend despite the actual facts of the matter? And what if the investigation determined there was no damage to any other property? Would that affect the carrier’s duty to defend?

Presumably, the work was indeed done by a subcontractor, and there was actually damage to something other than the work itself in this case, otherwise a carrier is entitled to seek reimbursement of its defense costs from the named insured prime contractor as soon as it is legally determined through depositions or discovery that there were no subcontractors involved in the alleged damages or that there was no actual damage to the house other than the defective work itself.

One thing that is surprisingly missing from the court’s analysis is the nature of the hypothetical injuries and damages claimed. The plaintiff alleged that the defective work created “an unsafe and potentially life-threatening condition.” They also alleged that the poor workmanship “created an unsafe condition, causing a potentially deadly collapse of the residence.”

This type of future possibility of damage is generally rejected by courts as a basis for finding current property damage. More than a mere possibility of future damage must be alleged in most jurisdictions. If I am reading this case correctly, insurance companies insuring construction contractors in Tennessee better take notice that the risk they are insuring just got a lot riskier.

Article 3

CGL Insurance Carrier in Connecticut Owed Duty to Defend Contractor – Based on Subcontract Work Exception to “Your Work” Exclusion

Under Connecticut law it was held that a CGL carrier had a duty to defend its named insured, swimming pool construction prime contractor, against suits by homeowners alleging cracking in their new pools due to defective workmanship by concrete supply subcontractors. The summary judgment that had been granted by the trial court in favor of the carrier was reversed. The trial court found the carrier owed no duty to defend its insured against the claims alleged from the defective work because they could not be deemed an “accident,” and thus there was no “occurrence” to be covered under the CGL policy.

In reversing that decision, the appellate court held that the damages could be deemed an accident and occurrence. Furthermore, the court went on to say that this is the obvious intent of the policy based on logical interpretation of the subcontractor work exception to the prime contractor’s “your work” exclusion. By making an exception to the exclusion when the damages arise out of the subcontractor’s work rather than the named insured’s own work, the court says the policy affirmatively establishes insurance for damages arising out of defective work performed by subcontractors. In this case, since there is no dispute that the allegedly defective work in question was performed by subcontractors, the carrier was required to defend the prime contractor against the homeowner suits.

Article 4

Indemnification Clause Required Engineer to Indemnify Owner for Losses it Incurred

See similar articles: Contractual liability policy exclusion | Indemnification clause

Does a typical indemnification clause that requires a party such as a contractor or design professional to indemnify its client for damages the client sustains due to the actions of Indemnitor apply only to damages resulting from third party claims against the client, or does it apply even if there is no third party claim but the client suffers a loss due to the Indemnitor’s actions? Historically, it was generally understood that indemnification was only to apply to damages resulting from third party claims against the indemnified party. But several recent cases around the country are concluding that indemnification is broader than that. They are interpreting contracts to require indemnification for damages and losses the Owner sustains even if there is no third party claim involved. The decision in Central Brown County Water Authority v. Consoer, Townsend, Envirodyne, 2013 WL 501419 (E.D. Wis. 2013), is a striking example of this.

Central Brown County Water Authority v. Consoer, Townsend, Envirodyne

The Authority filed suit against its engineering firm alleging that various deficiencies in its services caused the Authority to incur costs of having to dig up and investigate pipelines installed by its contractor, and also to incur costs in repairing the contractors work, and other related costs. The court rejected the engineer’s argument that the damages sought were barred by the language of the contract that provided the engineer would perform in accordance with the generally accepted standard of care, and “If during the two year period following the completion of all Services covered by this Agreement, it is shown that [Engineer] failed to meet those standards [Engineer] shall indemnify [the Authority] from and against any and all damages, loss, or costs if and to the extent arising from [Engineer’s failure to meet generally accepted professional engineering standards….”

Rather than applying the narrow definition of Black’s law dictionary that indemnity is “to reimburse (another) for a loss suffered because of a third party’s or one’s own act of default,” the court cited the broader Webster’s Dictionary that indemnity is “to make compensation to (another) for incurred hurt, loss, or damage.”

Applying what the court said was a general principle of Wisconsin law that indemnity agreements “are liberally construed when they deal with the negligence of the indemnitor,” the court concluded “[Engineer’s] liability is not limited to reimbursement of the Authority for payments it has been required to make to others. Instead, CTE agreed to pay the Authority for any and all damages, loss, or costs arising out of CTE’s failure to property perform its duties….”

Attorneys fees

Another interesting aspect of the decision is that the Authority demanded that the engineer reimburse the Authority’s attorneys fees incurred suing its construction contractors for faulty work. The Authority alleged that the work did not comply with the plans and specifications, and that the engineer should have detected and prevented such non-compliance during site observation.

The court dismissed that aspect of the Authority’s claim, holding that to allow recovery upon an allegation of mere negligence would contravene the “American Rule” that holds attorneys fees are to be paid by each party regardless of who wins and loses.

In this case, the Authority did not persuade the court it had established facts sufficient to demonstrate that the litigation costs it incurred in suing the contractors were caused by the engineer’s conduct. Nor the did the Authority demonstrate that the engineer’s alleged conduct was sufficiently “wrongful” as to constitute a basis for making an exception to the American Rule and thereby allow the Authority to recover its legal fees incurred in pursuing its claims against the contractors.

Sample Indemnification Clause

Comment: Limit indemnity to third party claims. When drafting indemnification clauses, a good risk management practice is to very specifically state that the indemnity is only as to damages arising out of third party claims against the indemnitee to the extent caused by the negligent performance of the indemnitor. An example of a clause I sometimes recommend is the following:

“Consultant shall indemnify and hold harmless the Client, its officers, directors, employees and agents from and against those damages and costs that Client is legally obligated to pay as a result of a third party claim concerning 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.”

Attorneys fees may be excluded from insurance coverage. When it comes to drafting indemnification agreements, carefully consider the significance of this court’s decision, that as a result of the “American Rule,” the Authority had no common law right to recover its attorneys fees from the engineer.

If an indemnification clause states that the indemnitor will indemnify the indemnitee for all damages caused by the indemnitor’s negligence, “including reasonable attorneys fees,” there may be no insurance coverage available under the indemnitor’s policy to pay for those attorneys’ fees. This is because the only basis for having to pay those attorneys fees would be contractual agreement to do so (such as the indemnity agreement).

The contractual liability exclusion of the policy may be applied to deny coverage for the attorneys fees that the indemnitor incurs on behalf of the indemnitee solely as a result of having agreed to pay the fees pursuant to the indemnification agreement.

Article 5

Where Owner Alleges Only Future Possible Damages and Not Current Actual Damages, Summary Judgment Must be Granted to Engineer

See similar articles: Damages | Damages – Pleading | Damages – Speculative

A Water Authority filed suit against its engineering firm for negligence and breach of contract, alleging that various deficiencies in its services caused the Authority to incur costs of having to dig up and investigate pipelines installed by its contractor. The Authority also alleged it incurred costs in repairing the contractor’s work, and that all these costs should be borne by the engineer. The engineer moved for summary judgment on the basis that the complaint alleged only future possible damages that might occur if the pipelines eventually failed, but there were no allegations of any actual damages from current pipeline failure.

The court agreed that as to the tort claim of negligence, the complaint must be dismissed due to the absence of actual damages. The breach of contract count, however, was permitted to proceed because evidence presented was sufficient to raise an issue of whether the Authority received the benefit of its contractual bargain in that the Authority presented some evidence that the pipeline that was built by the contractor was of lesser quality because of the engineer’s breach of its contractual duties to monitor and inspect the work to ensure installation in conformance with the plans and specifications. Central Brown County Water Authority v. Consoer, Townsend, Envirodyne, 2013 WL 501419 (E.D. Wis. 2013). Note that another case note about this decision is included in this newsletter on a different aspect of the decision.

Claims by the Authority, that the engineer asserts were speculative, include the Authority’s allegations that “CTE failed to perform its services in accordance with generally accepted professional engineering standards by: (1) failing to require the contractors to perform deflection testing or to properly perform post-construction compaction testing to determine whether the pipeline is deflecting; (2) neglecting to correct the contractors' failure to install the specified concrete saddle under all of the 47 butterfly valves as opposed to the as-built concrete blocks installed under some of the valves; and (3) failing to ensure the flanged connections for the 48" butterfly valves, including the gaskets and bolts used, were constructed in accordance with CTE's plans and specifications so as to prevent leakage in the pipeline over time.”

As to each claim, CTE argued that it did not fail to meet the required standard of care, but that even for purposes of argument it were assumed it did, the complaint must nevertheless be dismissed because the Authority failed to establish that it suffered any injury or damage resulting from the alleged breach.

In rebuttal, the Authority argued that for a finding of breach of contract, it is not necessary to prove actual damages. Rather, the Authority argued, “the breach itself is the wrong” and proof of liability is complete when the breach is established. The court, holding that the Authority’s contract claim, as well as its tort claim, would have to be dismissed in the absence of actual damages, rejected this argument.

Having determined that actual damages are required in order for the complaint to survive a motion for summary judgment, the court went on to review the evidence of damages presented. The court said, “the measure of damages for actions in tort is actual harm to the plaintiff’s person, property or interests.” CTE argued there was no evidence of damage. It asserted:

“The pipeline continues to function without leaks and as intended. As CTE sees it, the Authority has at most produced evidence that it has concerns about the future performance of the pipeline. But the fact that the Authority has concerns is not by itself evidence of damage. CTE argues that a mere showing of the possibility of future harm does not satisfy the actual damage requirement. In CTE's view, the Authority's claims are speculative at best and fall far short of constituting evidence of actual damage.”

The court agreed with this argument, concluding that the Authority failed to produce any evidence that the pipeline shifted or leaked due to the defects alleged in its construction. Summary judgment for the engineer was therefore appropriate to grant as to the tort claim.

With regard to the breach of contract claim, however, the court found the Authority had presented sufficient evidence to withstand the summary judgment motion because a different standard of proof of damages applies to breach of contract claims. Specifically, the court explained, “The fundamental idea in allowing damages for breach of contract is to put the plaintiff in as a good a position financially as he would have been in but for the breach.”

Put another the way, the court said, “An injured party is entitled to the benefit of his agreement, which is the net gain he would have realized from the contract but for the failure of the other party to perform.” Here the court explained the Authority’s allegations this way:

“[T]he Authority contends, as a result of CTE's failure to properly perform its duties under the contract, it has a defective pipeline that is likely to develop problems earlier than would have otherwise occurred. The Authority has offered evidence, for example, that without the concrete supports that it claims were called for by the contract, ‘there is a probability that the pipeline will not perform its intended function.’ (Pl.'s PFOF, ECF No. 88, ¶ 162.)

The Authority has also offered evidence that as a result of the CTE's failure to insure that proper bolts and gaskets were used in the butterfly valves ‘there is a probability that problems will occur in the pipeline....’

The failure to test for deflection, the Authority contends, leaves it without the assurance that the pipeline was properly constructed that it contracted for. This evidence is sufficient to raise an issue whether the Authority received the benefit of its bargain.

In other words, the Authority has presented some evidence that the pipeline that was built is of lesser quality because of CTE's breach of its duties under the contract. If true, the Authority would be entitled to damages that would be determined under the principles set forth above.”

Recovery of the Authority’s costs to investigate the contractor’s work was also found to be recoverable under the breach of contract count of the complaint if proved to the satisfaction of a jury. The engineer’s motion for summary judgment to bar the claim for those damages was denied.

In a breach of contract action, “the injured party is entitled to damages that flow directly and necessarily from the breach of contract, and that were reasonably foreseeable to or contemplated by the parties at the time the contract was made.” Here, the Authority contended that such cost of investigation and testing was a reasonably foreseeable result of CTE’s alleged breach of the agreement.

Since the court could not conclude as a matter of law on the record before it that such costs would not be recoverable damages if a breach of contract was established, the court denied summary judgment for the engineer on that issue.

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ConstructionRisk.com Report (July 2013)