Inside this Issue

A1 - Principal of Limited Liability Company can be Sued without Need to Pierce Corporate Veil
A2 - Subcontractor Was Wrongfully Terminated Where Its Performance was Delayed by the Prime Contractor and Others
A3 - General Contractor Can Recover Damages Caused by Sub’s Defective Work From the Sub’s CGL Policy
A4 - Economic Loss Doctrine Bars Contractor’s Insurance Carrier from Bringing Subrogation action against Design Professional for Negligence
A5 - Architect Not Entitled to Recover Fee for Services on Foreign Embassy Because Not Licensed in Washington, D.C.

Article 1

Principal of Limited Liability Company can be Sued without Need to Pierce Corporate Veil

See similar articles: Construction Defects | Corporate Veil | Individual Liability | Limited Liability Company

Where a property owner filed suit against a limited liability company and sued the individual principal of the company as well as the company itself, alleging negligence, fraud and violations of the state unfair practice act, it was held that the owners were not required to plead facts sufficient to pierce the corporate veil since the claim against the principal was that he was personally and individually liable in tort despite being a member or manager of the LLC.

In the case of Sturm v. Harb Devleopment, 298 Conn. 124, 2 A.3d 859 (2010), the allegations by the homeowner against the contractor were poor workmanship in the construction of their new home constituted breach of contract, negligence, fraud, and negligent misrepresentation. The plaintiff claimed that the foundation for the house lacked an adequate concrete slab; the lot was not properly sloped – causing water to pool against the foundation; the dormer was incorrectly built; the floors varied from the plans; adjacent windows were not installed symmetrically; and numerous other issues. The trial court granted summary judgment for the individual defendant on the basis that the plaintiff failed to plead sufficient facts to warrant piercing the corporate veil. That part of the decision was reversed on appeal. The trial court also found that the allegations against the individual and company based on fraudulent and negligent misrepresentation must be dismissed for failure to plead sufficient facts to establish a viable claim. That aspect of the trial court decision was affirmed on appeal.

On appeal, the homeowners argued that the trial court misconstrued the complaint against the individual defendant, failing to understand that it was asserting that the defendant was personally and individually liable in tort despite being a member or manager of the LLC, and that there was no need to pierce the corporate veil since they were attempting to prove individual liability based upon the individual’s actions rather than liability based upon the actions of the LLC. In response, the individual defendant argued that he is immune from liability because of the protection afforded against personal liability under the relevant state statute applicable to LLC’s. Specifically, he argued that “because the allegations against him not only arise from his membership in or management of Harb Development but also appear to be substantially similar to the allegations against Harb Development, the defendant contends that the plaintiffs must allege facts sufficient to warrant piercing the corporate veil.”

After briefly reviewing what would be required to pierce the corporate veil, the court stated that the question of whether the veil could be pierced was not relevant in this case. Explaining the applicable state law, the court quoted from previous case precedent as follows:

“It is well established that an officer of a corporation does not incur personal liability for its torts merely because of his official position. Where, however, an agent or officer commits or participates in the commission of a tort, whether or not he acts on behalf of his principal or corporation, he is liable to third persons injured thereby.... Thus, a director or officer who commits the tort or who directs the tortious act done, or participates or operates therein, is liable to third persons injured thereby, even though liability may also attach to the corporation for the tort.”

The particular state statute at issue here provides in part:

“Any member, manager, agent or employee of a limited liability company rendering professional services ... shall be personally liable and accountable only for negligent or wrongful acts or misconduct committed by him, or by any person under his direct supervision and control, while rendering professional services on behalf of the limited liability company to the person for whom such professional services were being rendered....”

Because contractors do not provide “professional services” as defined in the state statute, the defendant contended that contractors therefore do not fall within the statutory exception to the corporate veil.

In analyzing the intent of the state statute, the court considered similar statutes from other states and concluded that the way courts had been interpreting such statutes was that a member of an LLC cannot be held liable for the malfeasance of an LLC by virtue of his membership in the LLC alone; but rather “he must do more than merely be a member in order to be liable personally for an obligation of the LLC. The statute thus does not preclude individual liability for members of a LLC if that liability is not based simply on the member’s affiliation with the company.” Tort liability against the individual member for his own actions therefore remains a viable exception to the protection afforded under the LLC act according to the court.

All was not completely lost for the individual defendant despite the above described holding, however, because the court went on to find that the plaintiff failed to plead in its complaint sufficient elements required to make a case against the defendant for negligence or fraud. Of the five specific allegations of negligent acts, three of them concerned a violation of the LLC contract. But the plaintiffs had not pleaded that the defendant was personally a party to the contract – only the LLC was alleged to be party to the contract with the plaintiff. Consequently, the court found that the individual owed no contractual duty to the plaintiff. In view of that, the court explained: “There is no question that a duty of care may arise out of a contract, but when the claim is brought against a defendant who is not a party to the contract; the duty must arise from something other than mere failure to perform properly under the contract.” Here, the plaintiff failed to please what the other “something” was.

As explained by the court:

“The two remaining allegations claim that the defendant failed to install correctly the concrete slab foundation and improperly instructed Harb Development to deviate from the contractual plans. These two allegations similarly fall short in establishing any duty on the part of the defendant. The plaintiffs failed to allege the source of the defendant's duty to install the slab, such as a contract or an established building code. The plaintiffs further neglected to plead the manner in which the defendant instructed and caused Harb Development to deviate from the plans and specifications of the contract. Such an allegation is too general and unspecific to either support the conclusion that the defendant had a duty to avoid such instruction or allow the defendant to anticipate the harm claimed.”

With regard to the negligent and fraudulent misrepresentation claims, the court held that those must be dismissed because the plaintiff failed to sufficiently plead all essential elements of the actions, most specifically being that the defendant knew his statements were false.

Comment: This case note has been included in this newsletter because it may be an eye opener for members of limited liability companies who may have thought that they are completely protected against individual liability for their actions performed on behalf of the LLC. This case shows that the individual may have personal tort liability (including, negligence, negligent misrepresentation and fraud) for his own actions, and is not protected against suit by virtue that he is part of a limited liability company.

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. 13, No.6 (May 2011).

Article 2

Subcontractor Was Wrongfully Terminated Where Its Performance was Delayed by the Prime Contractor and Others

See similar articles: Default Termination | Delay | Interference with Contract | Liquidated damages | Termination

Demolition delays by others for whom the subcontractor was not responsible significantly impeded the subcontractor’s ability to timely perform its work. Stored equipment and activity of other subcontractors prevented the subcontractor from accessing work areas. And revisions to plans that were required as a result of design errors required removal and relocation of piping the subcontractor had previously installed. Although the subcontract contained language stating that the subcontractor acknowledged it had inspected the site and assumed responsibility for completion of the work under the existing conditions, this did not mean it assumed the risk of conditions outside of its control that did not come into existence until after the contract was executed. Termination of the subcontractor was found to be wrongful under the factual circumstances. In addition, the termination was also procedurally defective because the subcontractor had been permitted to work at correcting alleged defects after the notice requirement period had elapsed, and the prime contractor failed to provide additional notice that the work continued to be inadequate. The subsequent partial termination constituted a breach of contract. Bast Hatfield, Inc. v. Joseph Wunderlich, 78 A.D.3d 1270, 910 N.Y.S.2d 256 (2010).

In this case the subcontract was for the performance of sitework. The prime contractor was under contract with a developer to construct a Lowe’s Home Improvement store on land owned by the developer. The prime contract called for the store to be substantially complete by a certain date, after which liquidated damages would be assessed. The dates were expressly conditioned on timely demolition of several existing buildings on the site by the developer. As of the date that the prime contract was to be signed, the dates for demolition had already passed and none of the buildings had yet been demolished. Consequently, the developer and prime contractor executed a separate letter agreement (instead of changing the terms of the actual prime contract itself), providing that no liquidated damages would be assessed until 180 days after the buildings were demolished.

Two months after executing the prime contract and letter agreement modifying the liquidated damages, the contractor executed the sitework subcontract for removal of existing parking lots, and site grading, installation of storm drainage and sewer piping, and placement of underground utilities. Demolition still had not occurred as of the date the subcontract was executed, and the subcontractor was given a copy of the letter agreement that tied the project completion dates to the dates of demolition. A “time of the essence” clause in the subcontract required the “project” to be substantially complete by October 31, and further required the subcontractor to “coordinate its work so as to be completed by the date indicated on [prime contractor’s] schedule in support of the overall completion date.”

Due to failure of the developer to get the demolition of the existing store accomplished, the prime contractor was granted a change order extending the substantial completion date by several months. Demolition work that was originally to have been done by April was not completed until September – 5 months late. Meanwhile, the subcontractor started its work in August, a month before the demolition work was completed. The court does not explain how the subcontractor was able to perform site grading and utilities work before the demolition was completed. In any event, the subcontractor was delayed in its performance and on October 17, the prime contractor gave a 48-hour written note per the subcontract that the work was inadequate and that a failure to provide additional manpower and equipment within 48 hours along with a plan showing that paving could begin by November 10 would result in termination.

In response to the notice, the subcontractor advised the prime it would get the work done and it proceeded to move forward. A month later, the prime contractor partially terminated the subcontractor and filed suit seeking damages for default. The subcontractor countersued for wrongful termination. As the basis for the prime contractor’s assertion that the subcontractor was in default, it argued that the substantial completion date in the subcontract was not met and that the fact that the prime contractor’s own substantial completion date had been extended by letter agreement due to the late demolition did not apply to change the dates in the subcontract.

In analyzing this, the court held in favor of the subcontractor that the termination was wrongful based on a number of reasons. First, the subcontract required the sub to comply with the prime contractor’s construction schedule. Since that schedule had been extended, this meant the specified dates set forth in the subcontract would also be extended. Second, the sub was unable to complete the work more quickly because its performance was frustrated by obstacles attributable to the prime contractor and developer – all of which were beyond the subcontractor’s control. As stated by the court:

“[GC] was properly held accountable insofar as [Subcontractor’s] performance was impeded by [Developer’s] delays. By entering into a contract that required [Sub] to comply with a schedule dependent upon [Developer’s] demolition, [GC] made an implied promise to {Sub] the demolition would be complete in time for [Sub] to perform under the subcontract. [Citation omitted]. We reject [GC’s] argument that [Sub] assumed the risk of delay. [Sub’s] contractual acknowledgement that it had inspected the site and assumed responsibility for completion of the work under the existing conditions cannot be construed to include conditions outside its control that did not come into existence until after the subcontract was executed.”

Even if there had been merit to the general contractor’s reasons for termination, the court found that procedurally the GC failed to follow the termination notice requirements and this resulted in the termination being wrongful regardless of any merits. The court stated:

“More than a month passed between the date when [GC] sent the 48-hour notice that, pursuant to the subcontract, was a necessary predicate to cancellation and the date that [GC] partially terminated [Sub]. By [GC’s] own admission, some of the items set forth in the notice were incorrect, while [Sub] rectified the others, in whole or in part, during the following weeks. Under such conditions, the subcontract provides that the causes of cancellation set forth in the October notice were waived. By partially terminating [Sub] without additional notice that its work continued to be inadequate—or indeed, any other communication indicating that [Sub’s] performance was unsatisfactory—[GC’s] partial termination of [Sub] breached the subcontract.”

For these reasons, the court found in favor of the subcontractor.

Article 3

General Contractor Can Recover Damages Caused by Sub’s Defective Work From the Sub’s CGL Policy

See similar articles: CGL | Construction Defects | Insurance - Defective work | Insurance Coverage Disputes

Where a plumbing subcontractor installed water lines that did not meet the project specifications, and this caused damage to a neighboring property, the prime contractor sued the sub for negligent work and was entitled to recover its damages from the sub’s commercial general liability (CGL) policy because the court found the defective work constituted an occurrence and accident within the meaning of the policy. The prime contractor obtained a default judgment against the subcontractor who failed to answer the complaint, and then sought payment from the sub’s insurer. The insurer denied coverage, asserting that the defective work was not an “occurrence” defined under the policy as an “accident.” The trial court agreed with the insurer’s argument and granted it summary judgment. That decision was reversed on appeal. In concluding that the policy provided coverage the state supreme court, citing Black’s Law Dictionary, stated:

“It is commonly accepted that, when used in an insurance policy, an ‘accident’ is deemed to be ‘an event happening without any human agency, or, if happening through such agency, an event which, under circumstances, is unusual and not expected by the person to whom it happens….[I]n its common signification the word means an unexpected happening without intention or design.”

The court held:

“[A]n occurrence can arise where faulty workmanship causes unforeseen or unexpected damage to other property. In reaching this holding, we reject out of hand the assertion that the acts of [Subcontractor] could not be deemed an occurrence or accident under the CGL policy because they were performed intentionally. ‘[A] deliberate act, performed negligently, is an accident if the effect is not the intended or expected result; that is, the result would have been different had the deliberate act been performed correctly.’”

The court stated that its decision is in accord with the trend in a growing number of jurisdictions which have considered construction defect claims under CGL policies and interpreted the word “accident” in this manner. American Empire Surplus Lines Insurance Company v. Hathaway Development Company, 707 S.E. 2d 369, 288 Ga. 749 (2011).

Article 4

Economic Loss Doctrine Bars Contractor’s Insurance Carrier from Bringing Subrogation action against Design Professional for Negligence

Where Contractor’s insurance carrier brought a subrogation action against the project’s design professional for negligent performance, including failure to prepare contract drawings and specifications in a manner “fully coordinated for bidding by the various contractors” as required in the design professional’s scope of service, it was held that the insurer had no third-party beneficiary rights under the contract between the contractor and design professional, and it was also held that the economic loss doctrine barred recovery for alleged negligent performance, and that the sole exception to the doctrine for “negligent misrepresentation” claims had not been proven because no special relationship between the contractor and designer existed. Travelers Casualty v. Dormitory Authority-State of New York, 734 F. Supp.2d 368 (U.S. Dist Ct., NY, 2010).

This case arose out a series of complex litigation cases involving a 785,000 square foot vertical campus for part of the City University of New York (“CUNY”). As a result of delays, problems, and deficiencies, the dormitory authority issued dozens of change orders to extend the time for work and provide extra compensation to various contractors. This did not adequately satisfy all the costs claimed, and litigation ensued. Travelers filed suit against the design professional and construction manager for negligence and breach of contract. The essence of the negligence claim was that the defendants owed a “duty of care to [Contractor] and or [Contractor’s subcontractors/suppliers” either “based on those contractors’ “status as third-party beneficiaries” of the Owner-design professional contracts, or alternatively “as a result of the functional equivalent of privity existing” among the parties.

An expert witness report by Travelers concluding that the bidding documents were “not thoroughly checked for accuracy” and were “not fully coordinated for bidding,” and that the designer’s failure to provide clear, coordinated and unambiguous bid documents caused numerous RFI’s, change orders and delays on the project. The expert also stated that the designer “failed to provide timely interpretations of its Contract Documents and design” thereby causing delays, and that “the abilities of [Contractor] to perform their contractual scopes of work were unreasonably and chronically hindered by the style and substance of KPF’s professional services.”

Travelers argued that the contractor was an intended beneficiary of the DP-Dormitory Authority contract and entitled to enforce its terms by recovering damages directly against the designer. In holding that Travelers claim must be dismissed, the court stated that the contract between the designer and Authority “in no way suggests that the purpose of those contractual provisions was to confer a benefit upon [Contractor] as opposed to giving [Contractor] that which was ‘necessary to assist it in its own performance.” The court explained that “It is ancient law in New York that to succeed on a third party beneficiary theory, a non-party must be the intended beneficiary of the contract, not an incidental beneficiary to whom no duty is owed.”

On the Travelers claim to recover the contractor’s economic losses from the designer on a negligence theory, the designer moved for summary judgment on the basis that New York’s “economic loss doctrine” prevents recovery of pecuniary damages in the absence of contractual privity or proof of a special duty of care owed by the designer to the contractor. The designer also argued that sole exception to the economic loss doctrine in New York for negligent misrepresentation under a “functional equivalent of privity” theory was not applicable under the circumstances. In granting summary judgment for the designer (and also the construction manager), the court stated “New York’s economic loss doctrine is a jurisprudential principle that a plaintiff cannot recover in tort for purely economic losses caused by the defendant’s negligence.” Under this principle, says the court, “the defendant is not liable to a plaintiff for the latter’s economic loss unless there exists ‘a special relationship that requires the defendant to protect against the risk of harm to plaintiff.” The court found no such special relationship in this case and therefore enforced the economic loss doctrine to bar the claim.

The decision of the court so nicely presents the rationale for the economic loss doctrine that it seems worthy of quoting from the decision at length as follows:

This principle is justified on several grounds. First, to the extent that a plaintiff claiming economic damages is seeking to recover the loss of an expectancy interest created by contract in the first instance, the doctrine channels the dispute into a breach-of-contract action, in keeping with the nature of the interest that the plaintiff claims has been damaged. “[C]ourts have applied the economic loss rule to prevent the recovery of damages that are inappropriate because they actually lie in the nature of breach of contract as opposed to tort.” [citation omitted].

---

Second, to the extent that “economic loss” is difficult to quantify, but also a highly foreseeable outcome of negligence in the commercial context, the economic loss doctrine reflects a policy interest in protecting defendants from disproportionate, and potentially limitless, liability. “[R]elying solely on foreseeability to define the extent of liability in cases involving economic loss, while generally effective, could result in some instances in liability so great that, as a matter of policy, courts would be reluctant to impose it.” [citation omitted]. As a result, to avoid “crushing exposure” to suits by countless parties who have suffered economic loss, New York courts have concluded that “[a]bsent a duty running directly to the injured person there can be no liability in damages, however careless the conduct or foreseeable the harm.” [citation omitted].

The decision of the court also provides six pages of analysis regarding the limited exception to the economic loss doctrine for negligent misrepresentation, and in particular what is required to prove a relationship between the parties so close as to approach that of privity of contract.

Comment: The court’s decision provides an excellent analysis of the law concerning the economic loss doctrine, as well as a persuasive rationale for the doctrine and the public policy benefits derived from it. In addition, the six pages of the opinion explaining the limited exception to the economic loss doctrine for negligent misrepresentation, and in particular what is required to prove a relationship between the parties so close as to approach that of privity of contract is commended reading, especially for any one involved in arguing a case against a plaintiff that is trying to get around the economic loss doctrine by pleading counts of “misrepresentation”.

Article 5

Architect Not Entitled to Recover Fee for Services on Foreign Embassy Because Not Licensed in Washington, D.C.

See similar articles: Embassy Contracts | Licensing Issues | Quantum Meruit

An architect licensed in the state of Maryland but not in Washington, D.C. entered into, and won, a competition for the architectural design of a new embassy and chancery building in Washington, D.C. for the United Arab Emirates (“UAE”). Because she was not licensed in Washington, she was found by the court to have violated the licensing statute and therefore not entitled to recover any fee from the UAE for the services she had performed. The architect argued that she was not required to have a license as of the date she entered into the competition but that she would have obtained the license once she had a signed contract. In rejecting that argument, the court stated that the architect went beyond submitting bides and actually performed architectural services without a license. The court concluded: “District of Columbia law bars an architect from recovering (i) on a contract to perform architectural services in the District or (ii) in quantum meruit for architectural services rendered in the District, if the architect lacked a District of Columbia architect's license when he or she began negotiating the contract, entered into the contract, or performed the architectural services, even if the architect was licensed to practice architecture in another jurisdiction at such times…. There is no exception for international design competitions or the submission of bids to perform architectural services for foreign embassies (or public buildings or monuments) in the District.”

After winning the UAE’s design competition, the architect entered into contract negotiations with the UAE, and while negotiations were ongoing she modified her original design and worked with an engineer to address technical issues raised by the UAE and to make changes requested by the Ambassador. The UAE did not ultimately execute the contract and instead, several years later, awarded the contract to someone else. The architect then sued the UAE in the U.S. District Court for breach of contract and for quantum meruit. The court granted UAE’s motion for summary judgment, concluding that the architect was barred from recovery because she was not licensed. This was appealed to the United States Circuit court for Washington, D.C. which concluded that it could not decide the case without first certifying a question back to the D.C. courts to answer how the licensing statute was interpreted locally by the courts.

In the subsequent decision by the District of Columbia Court of Appeals answering that question, the court described the statute as follows:

In its current form, the D.C. Code provides in pertinent part that “[u]nless licensed to practice architecture under this subchapter, no person shall engage, directly or indirectly, in the practice of architecture in the District....” The same prohibition was in effect at the time of the events giving rise to this case. For licensing purposes, the “practice of architecture” is defined to mean “rendering or offering to render services in connection with the design and construction, enlargement, or alteration of a structure or group of structures that have as their principal purpose human occupancy or habitation ... includ[ing] planning and providing studies, designs, drawings, specifications, and other technical submissions, and the administration of construction contracts.” The “practice of architecture” thus encompasses not only the performance of architectural services, but also any negotiations and agreement to provide such services.

The architect argued that the licensing statute was intended to benefit the general public in Washington, D.C. and should not be applied when the client was a sophisticate foreign government that was building an embassy. She argued that insistence on licensure would disable and diminish international architectural competition in the District, because “leading international architects cannot be expected to apply for and await receipt of local licenses in every jurisdiction to which they bend their talents.” In addition to rejecting those arguments, the court also rejected her arguments that the licensing statute was pre-empted by either the Foreign Missions Act of 1982 or the International Center Act. The court concluded:

The rule is well-established in the District of Columbia “that a contract made in violation of a licensing statute that is designed to protect the public will usually be considered void and unenforceable, and [that] the party violating the statute cannot collect monies due on a quasi-contractual basis” either. Although the operation of this rule may appear to be “harsh and disproportionate” in some cases, we have “uniformly” rejected appeals to deviate from or mitigate it; the “potential unfair applications of the rule at the margins have not persuaded us to sacrifice the benefits of a clear-cut, unmistakable requirement, with equally clear consequences for noncompliance, in this area of consumer protection.” Architects who practice without a license are not exempted from the general rule. We have held that one who engages in the “practice of architecture” in this jurisdiction without having secured the necessary District of Columbia license is barred from recovering for his or her services in an action for breach of contract or quantum meruit.

For the foregoing reasons, the court concluded that the licensing law prevents the Architect from recovering under the theories of breach of contract or quantum meruit for the services she provided.

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ConstructionRisk.com Report (July 2011)