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#24:  Design Specs and Performance Specs

1/4/2015

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When a contractor bids on a set of construction specifications, he looks beyond what specific materials, configurations and connections are called for, and considers the means and methods his crew will employ to build the project.  Rarely are those means and methods dictated to him in the specs.  On those rare occasions when the specs dictate not only the “what” but also the “how,” deviations from the “how” specs are not allowed.  These are often called “design specs.”

Sometimes the desired end result of the construction is not only to “be” something (like a bridge or a residence), but also to “do” something―to perform in a specified manner (like a “clean room” or waste water treatment plant).  These are often called “performance specs.”

Courts have picked up this verbiage.  To quote from Stuyvesant Dredging Co. v. United States, 834 F.2d 1576, 1582 (Fed.Cir.1987), “Design specifications explicitly state how the contract is to be performed and permit no deviations.  Performance specifications, on the other hand, specify the results to be obtained, and leave it to the contractor to determine how to achieve those results.”  This makes it sound as though a set of specs must be one or the other.  The truth is that a given set of specs will often have elements of both.

The distinction is important when it comes to assigning blame for a project that doesn’t work out as planned.  If the contractor implements the precise design he is given, then regardless of how he implemented it and regardless of whether the owner or the contractor dictated the means of implementing it, the contractor is off the hook.  This is the so-called Spearin doctrine, named for the case of United States v. Spearin, 248 U.S. 132, 136 (1918) (“But if the contractor is bound to build according to plans and specifications prepared by the owner, the contractor will not be responsible for the consequence of defects in the plans and specifications”).

Not only does the contractor have no liability when he implements the specs he is given, but he is entitled to be paid for his work
―even if the outcome is unsatisfactory.  This is the teaching of Perkins v. Roberge, 69 N.H. 171, 173 (1897), in which a contractor “agreed in writing with the defendant to build a baker's oven and furnace in a workmanlike manner, in accordance with a plan and specifications furnished by the defendant.  The oven was built by the plaintiff in accordance with the contract.  It did not work in a satisfactory manner on account of the fault of the plans.  The failure of the oven to work in a satisfactory manner being attributable to the defects in the plans furnished by the defendant, and not to the failure of the plaintiff to perform his contract, he is entitled to recover the contract price for the performance of his undertaking.”

The Spearin doctrine and the rule enunciated in Perkins apply to design specs, not to performance specs.  Consequently, contractors often find themselves arguing that a relevant spec is design and not performance based.  If, as some courts hold, design specs are those which eliminate contractor discretion as to the means and methods of implementation, the argument is a hard one to win.  In my view, such a focus on discretion is overblown.  The first question should always be whether the fault lies in the plans and specs themselves, or in how they were implemented ―and only in the latter case should we ask whether the means and methods of implementation were dictated or chosen.

Losing this argument is not always the end of the game for a contractor.  As Smith, Currie and Hancock’s Common Sense Construction Law (5th ed. 2014) notes, “an owner still can be liable for a contractor’s unanticipated difficulties under a performance specification if the contractor shows that the owner-furnished performance specification was impossible or commercially impracticable to achieve.  A performance specification is commercially impracticable if it can be performed only at an excessive and unreasonable cost.”  I’ll be blogging on this at a later date.


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#23:  The Consequences of Shop Drawing Review and Approval

12/19/2014

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There is more than one way to build a project to the plans and specs that Architects and Engineers provide.  The “means and methods” for doing so are typically up to the contractor.  But sometimes those means and methods are subject to advance scrutiny by the design professional, through the “shop drawing” submittal process.

As the popular AIA A201 General Conditions of the Contract for Construction (2007) explains in Section 3.12.4, shop drawings “demonstrate the way by which the Contractor proposes to conform to the information given and the design concept expressed in the Contract Documents for those portions of the Work for which the Contract Documents require submittals.”  Section 3.12.5 requires the contractor to review shop drawings “for compliance with the Contract Documents, and approve and submit to the Architect Shop Drawings, Product Data, Samples and similar submittals required by the Contract Documents.”  By the act of submitting them, the contractor warrants that he has “(1) reviewed and approved the shop drawings; (2) determined and verified materials, field measurements and field construction criteria related thereto, or will do so; and (3) checked and coordinated the information contained within such submittals with the requirements of the Work and of the Contract Documents.”  Section 3.12.6.

At that point, the Architect’s own review kicks in―but it is more limited.  Section 4.2.7 says that a design professional’s review of shop drawings is "only for the limited purpose of checking for conformance with information given and the design concept expressed in the Contract Documents."   The phrase “design concept” is undefined, and vague enough to preclude the argument that an Architect’s shop drawing approval incorporates the drawing into the Contract Documents. 

The Catch 22 for the contractor is that he has no choice but to implement approved shop drawings, yet he is on the hook if they don’t conform to the Contract Documents.  Section 3.12.8 says that “The Work shall be in accordance with approved submittals except that the Contractor shall not be relieved of responsibility for deviations from requirements of the Contract Documents by the Architect’s approval of Shop Drawings.”  Since the contractor must implement that approved drawing, in practical effect it is indistinguishable from any other plan or spec in the Contract Documents that the Contractor must implement―except that the contractor “owns” it; the Architect does not.  The drawing effectively becomes part of the design, but the only part of the design that a contractor implements at his own risk.

How great is the risk that an approved shop drawing will come back to haunt the contractor despite Architect approval?  This is where human nature kicks in.  Because the Architect who approves a shop drawing is normally the same person signing off on compliance with the Contract Documents for purposes of payment and substantial completion, any “deviations from the requirements of the Contract Documents” arising from that shop drawing are unlikely to be called out.  Subjecting the contractor to liability for repair and replacement of the “approved” item could subject the Architect to a bit of embarrassment as well.  But even if the Architect certifies compliance with the Contract Documents, that won’t relieve the contractor of liability under his warranty.   Section 9.10.4 makes sure of that (“The making of final payment shall constitute a waiver of Claims by the Owner except those arising from . . . failure of the Work to comply with the requirements of the Contract Documents . . .”).

If Architect approval doesn’t get the contractor off the hook to the owner, does it put the Architect on that hook with him?  That depends.  An Architect who didn’t catch or correct an error in a shop drawing and approved it could well be liable to the owner if his contract doesn’t absolve him in advance.  The AIA B101 Standard Form of Agreement Between Owner and Contractor (2007) attempts to do exactly that, parroting the A201 in providing that review is “only for the limited purpose of checking for conformance with information given and the design concept expressed in the Contract Documents” (Section 3.6.4.2).  Once again, “design concept” is undefined.

No surprises here, when you remember what AIA stands for.


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#22:  Working Without a Signed Contract

12/9/2014

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I’ve seen it many times: a contractor hires a subcontractor, sends him its standard form contract to sign, and then lets him start work before a signed contract is returned.  Sometimes this is a result of extended negotiations over particular terms coupled with the need to get started in a hurry.  Sometimes it just slips through the cracks until the first pay requisition is submitted.  And sometimes it’s never signed, with varying consequences as to payment and as to whether the sub is allowed to continue.  I’ve even seen subs send in their insurance certificates and other required documents, but mark up the GC’s form in ways unacceptable to the GC, while the project continues to completion with the sub getting paid anyway.  The form never gets signed, yet the parties treat it as though it was.  Until something goes wrong.

If you think of this scenario as working without a contract, you’d be wrong.  Laymen automatically think of the piece of paper as the contract.  Lawyers know it’s not.  A contract is an agreement, a meeting of the minds on bargained-for exchanges of performance by both sides.  The piece of paper simply memorializes that agreement, but the agreement itself is the “contract,” and it can be verbally expressed or even inferred from conduct.  As long as certain essential and material terms are agreed to (scope of work and price being the main ones), and as long as no statute prohibits the courts from enforcing an unwritten contract (lawyers call this the “statute of frauds;” it doesn’t apply to construction contracts capable of being performed within one year), the courts will enforce the deal―provided those legally essential terms can be proven.  The value of the paper is twofold: making such proof easy, and expressing the parties’ assent on the legally non-essential terms of the deal (schedule, timing of payment, retainages, insurance, change order procedures, documentation, tests for acceptability of workmanship, lien waivers, dispute resolution mechanism, etc.)―terms which may be “essential” to one of the parties even if not to the court.

Sometimes an unsigned form can nevertheless bind the parties to its terms.  Such “acceptance by conduct” can happen if the GC tells the sub “These are the terms on which I will hire you, and if you show up and start performing you will be deemed to have accepted all of them that I haven’t waived in writing – so if you have any reservations about any of them, either get my signature on something that waives it, or don’t show up.”  In such a case, showing up becomes acceptance.  This can work both ways.  Suppose a sub sends a written proposal or quote to a GC, and the GC sends back a lengthy form subcontract that isn’t signed but the GC nevertheless allows the sub to work on site.  The bare bones terms of the written proposal, which usually include the essential and material terms needed for legal enforcement of a contract, may end up governing.

Unwritten contracts are still contracts, and still require payment for performance.  But it is not certain that they require partial payment for partial performance at regular intervals, even if an unsigned form provides for that.  The usual legal rule in contract cases is that unless the parties agree otherwise, payment is due only upon full performance.  This rule can be harsh when a project is lengthy, and courts often temper it by resorting to “custom in the industry” as an implied term.  The custom in the construction industry is for regular (usually monthly) progress payments.

More generally, a covenant of “good faith and fair dealing” is implied in every contract, written or unwritten.  That covenant will often be invoked by the courts to constrain one party from taking unfair advantage of the other, in ways often indistinguishable from enforcement of some of the terms in an unsigned form.

The bottom line is that a written contract, while always a good idea, need not be “signed, sealed and delivered” in order for legally enforceable rights to arise.  Those three features were required hundreds of years ago when contract law was in its infancy.  Today the phrase only applies if you’re marrying Stevie Wonder.


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#21:  Lower Tier Mechanic's Liens: The Westinghouse Wrinkle

11/29/2014

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Several months ago I blogged about the Notice of Intent to Lien required of a subcontractor, whose mechanic’s lien will be capped by the amount that the owner owes (or will owe) the general contractor on the date the notice of intent is received by the owner.  The precise language of the statute, RSA 447:6, is “Such notice may be given after the labor is performed or the material is furnished, and said lien shall be valid to the extent of the amount then due or that may thereafter become due to the contractor, agent or subcontractor of the owner.”

What if you are a third-tier sub or supplier?  By whose unpaid contract balance is your lien capped on the date of receipt of your Notice of Intent?  Is your cap (1) the amount due or to become due from the owner to the GC, or (2) the amount due or to become due to the party with whom you contracted?

While one can read the statute to suggest that (2) is the answer, (1) makes more sense as a policy matter.  After all, the point of the Notice of Intent is to protect owners from having to pay twice for the same work, once to the GC and a second time to a lienor who performed the work but whom he didn’t know about when he wrote his check to the GC.  On this logic, once the owner has fully paid the GC for all work without notice of any lien claims from unpaid lower tiers, his property should be lien-free.

But consider the case of Westinghouse Electric Supply Co. v. Electromech, Inc., 119 N.H. 833 (1979).  Westinghouse sold electrical supplies on credit to an electrical subcontractor, Electromech, who worked for two separate GCs on two separate projects.  When Electromech went bankrupt before paying for the materials, Westinghouse gave notice of intent to lien the two projects.  In each case the owners had not yet fully paid their GCs on the day the notices arrived, withholding sums more than sufficient to cover what Westinghouse was owed.  However, the GCs each had backcharges against Electromech such that Electromech wasn’t owed as much as it, in turn, owed Westinghouse.  The Court limited Westinghouse’s lien, saying: “We hold that a correct interpretation of RSA 447:6 limits the lien of the materialman to amounts due or that may thereafter become due to the subcontractor with whom the materialman contracted. Accordingly, Westinghouse can only recover the amount the owner owes the subcontractor, Electromech.”  Id. at 837.

(This may have been loose language.  An owner has no contract with the GC’s subs, so without some equitable remedy -- or perhaps an interpretation of RSA 447:8 -- “the amount the owner owes the subcontractor” is always zero.  Indeed, the Court in Westinghouse rejected the plaintiff’s argument that “once the owner's indebtedness to the principal contractor is established, the materialman's claim to the proceeds in the owner's hands becomes direct and completely independent of the rights of the contractor or other subcontractors.”  Id. at 836.)  

The Court’s decision that “RSA 447:6 limits the lien of the materialman to amounts due or that may thereafter become due to the subcontractor with whom the materialman contracted" leaves an important question unanswered: is the lien also limited by what the owner owes the GC?  If not, an owner who has fully paid for the project prior to getting a Notice of Intent can still suffer a lien from a third tier sub or supplier whenever the second tier who owes him money is itself owed money by the GC.  Perhaps both (1) and (2) are caps!  That would be consistent with Westinghouse’s purpose “to protect the owner from unknown liability to the subcontractor or materialman and from liability for payments in excess of the amounts owed to the general contractor.”  But the Court never had to reach this two-cap issue, since there was still money owed from owner to GC.  Until our Supreme Court gets a case that presents the question squarely, it is safest to assume that lower tier subs and suppliers who delay sending a Notice of Intent to Lien will have two hurdles to clear.


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#20:  Appeals From Arbitration Awards

11/10/2014

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Last month I blogged on the pros and cons of arbitration vs. litigation of construction disputes, and mentioned that appeals of an arbitrator’s award are somewhat limited, promising some follow up.

As is true of trials in the courts, appeals from arbitration awards can be either for mistakes of fact or for mistakes of law.  Appellate review of an arbitrator’s mistakes of law turns on whether the arbitrator intended to apply the law correctly and messed it up, or intended to apply a different rule than typically applied in the courts.  The latter intent is not reviewable on appeal.  Here is a link to an article I wrote for the October 2014 New Hampshire Bar News, explaining the difference
:
http://www.nhbar.org/publications/archives/display-news-issue.asp?id=7597

As to appellate review of an arbitrator’s mistakes of fact, these are limited as well.  When a trial court or jury finds facts based on the evidence presented, the Supreme Court defers to those findings and will not “retry” the case as long as there is some evidence apparent on the record to support the trial judge’s findings.  Review of an arbitrator’s findings of fact is similarly limited; the courts will “defer to the arbitrators' decision if the record reveals evidence supporting it,” Merrill Lynch Futures, Inc. v. Sands, 143 N.H. 507, 509 (1999).  But there is an extra layer of deference to arbitrators’ findings not accorded to a judge or jury.  The Supreme Court “will set aside a jury verdict if it is conclusively against the weight of the evidence . . . Conclusively against the weight of the evidence should be interpreted to mean that the verdict was one no reasonable jury could return.”  Quinn Bros. v. Whitehouse, 144 N.H. 186, 190 (1999).  Not so an arbitration award; a court will not “set aside the decision merely because it believes the arbitrator’s award is against the weight of the evidence,” Masse v. Commercial Union Ins. Co., 136 N.H. 628, 632 (1993).

Because "arbitration is a matter of contract and a party cannot be required to submit to arbitration any dispute which he has not agreed so to submit," Appeal of Merrimack County Bd. of Commissioners, 142 N.H. 768, 771 (1998), reversal on appeal is also possible if the arbitrator exceeded his or her authority by deciding a matter not within the scope of the arbitration agreement.  “A judicial challenge to arbitral authority requires the reviewing court to consider both the contract and the arbitral submission,” Lebanon Hangar Associates, Ltd. v. City of Lebanon, 163 N.H. 670, 673 (2012).  “Moreover, an arbitrator's view of the scope of the issue is entitled to the same deference normally accorded to the arbitrator's interpretation of the contract.”  Id.  While some arbitration clauses are broader than others, “In the absence of clearly restrictive language, great latitude must be allowed in the framing of an award and fashioning of an appropriate remedy,” John A. Cookson Co. v. New Hampshire Ball Bearings, Inc., 147 N.H. 352, 361 (2001).   Courts have taken this to heart.  The boilerplate arbitration provision in the AIA General Conditions form A201 (1997 version), referencing arbitration of “[a]ny claim arising out of or related to the Contract,” has been almost universally held to require the contracting parties to arbitrate everything under the sun – including the question of whether a demand for arbitration was timely filed (the most common area of attack on an award for allegedly exceeding the arbitrator’s powers).

The final basis for attacking an arbitration award is for fraud, corruption, or misconduct of the arbitrator.  Since arbitrators are an honest lot, and are typically picked by the parties after they disclose any interest or familiarity they may have with the case or the parties, it will be a rare day when this comes into play.  Suffice it to say that the New Hampshire Supreme Court has never once overturned or affirmed the overturning of an arbitration award on this basis.

If you’re getting the idea that an arbitration award is close to appeal-proof and overwhelmingly likely to be affirmed, you’re getting the right idea!


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#19:  Bankruptcy Preferences: When the Trustee Comes Knocking

11/2/2014

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A contractor, subcontractor or supplier who properly performs its agreed contract and gets paid for its labor or materials expects to keep its hard-earned money.  Imagine having to give it back!  If the payer files for bankruptcy protection within ninety days of making the payment, that is exactly what can happen.                                                             

One of the policies of the Bankruptcy Code is to foster equality of distribution among creditors of the debtor.  Any creditor that received a greater payment than other similarly situated creditors is required to disgorge so that all may share equally.  Section 547(b) of the Bankruptcy Code gives the bankruptcy trustee power to “avoid” or demand back any payment (1) to or for the benefit of a creditor; (2) for or on account of an antecedent debt owed by the debtor before such transfer was made; (3) made while the debtor was insolvent; (4) made within 90 days before the date of the filing of the petition; and (5) which would enable the creditor to fare better than it would fare in a Chapter 7 liquidation.  The debtor is presumed to be insolvent during the 90 days prior to the filing (meaning, the payee has the burden of proving otherwise).  If these conditions are met, the payment is deemed “preferential” and subject to disgorgement, leaving the payee in the position of an unsecured creditor who will be lucky to get pennies on the dollar.

There are some exceptions to this avoidance power, chief among them the “contemporaneous exchange for new value” exception―but if the payee had to wait for its money beyond the normal payment turnaround time (and chances are that anyone filing bankruptcy hasn’t been paying his debts on time!) this exception likely won’t apply.  The common practice of creditors applying payments to the oldest open invoice can also deep-six the "new value" exception.  Bogdanov v. Avnet, Inc., No. 10-cv-543-SM, 2011 WL 4625698, at *10 (D.N.H. Sept. 30, 2011).

Worse, it’s almost certain that any mechanic’s lien rights will have expired by the time notice of the bankruptcy is received, leaving the creditor without an alternative way to get paid.  The argument sometimes raised by creditors that giving up their lien rights in exchange for payment counts as “contemporaneous exchange for new value” has fared ill in the courts.  Even if a lien was actually filed and then released in exchange for payment, most courts refuse to apply the exception, particularly where the debtor is not also the land owner and thus any “new value” in the form of a lien discharge was not given to the debtor.  The outcome is different, however, if at the time of the lien discharge the owner still owed money to a now-bankrupt general contractor and could have set it off against any lien.  In that case, “the subcontractor’s release of lien rights against the owner causes ‘a coincident release of the owner's [secured] claims against debtor, thereby creating new value to the debtor.’”  In re Charwill Const., Inc., 391 B.R. 7, 12 (Bkrtcy. D.N.H. 2007).

When the debtor happens to be the land owner, however, a filed lien released in exchange for payment might protect the payment from preference attack on a different basis: if the lien would have resulted in full payment to the creditor in a Chapter 7 liquidation (because secured creditors get first dibs), there is no preference.  That approach won’t work when the debtor is the general contractor or a lower tier contractor, since any mechanic’s lien wouldn’t be on the debtor’s property.

Unlike some states, New Hampshire law does not automatically provide that payments received by general contractors or subcontractors are “trust funds” for the payment of lower tiers (although RSA 447:8 may impose a trust on money an owner owes to a general contractor if the proper notices are given).  If such payments were trust funds in the hands of the debtor, they would not be considered the debtor’s property, and a preference attack would falter (assuming the payments have been segregated and can be traced).  Some general contracts and subcontracts have language which imposes such a trust on payments – so if you are a sub or lower tier, before you swallow hard and write the bankruptcy trustee a check, make sure to check the language of the contract governing the tier above you.
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#18:  Lien Rights in Tenant Fit-up Cases

10/11/2014

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A commercial tenant signs a long term lease with a landlord.  The lease expressly contemplates that the tenant may make improvements to the property.  Maybe it says the improvements become the property of the landlord at the end of the lease term, maybe it says the tenant must restore the property to its pre-lease condition at the end of the lease term, and maybe it's just silent on the issue.  Say the tenant hires you to build out the fit-up, and doesn't pay you.  A mechanic's lien against the tenant's leasehold interest, while theoretically possible, isn't much help (a sheriff's sale of the leasehold won't fetch many interested bidders if, as is usually the case, the landlord has reserved the right to approve any new tenant -- and won't fetch any at all if the rent is at market rate and other space is available).  Can you lien the landlord's property as well?

The New Hampshire Supreme Court has yet to answer this question.  Other states take varying approaches.  Some (California, Illinois) allow the lien as long as the landlord knew of the improvements and didn't object; others (Florida, Massachusetts, New York) require proof of the landlord's express consent to the improvements; still others (Michigan, Missouri, Tennessee) allow the lien only if the tenant was acting as the landlord's agent.  A few states (Georgia, Ohio, Texas) disallow the lien unless the owner was a party to the construction contract.  Some of these differences track differing language in the applicable statutes.  For instance, Massachusetts lien law gives lien rights to "A person entering into a written contract with the owner of any interest in real property, or with any person acting for, on behalf of, or with the consent of the owner . . ."

New Hampshire's statute is not so generous, and requires that the debt arise "by virtue of a contract with an agent, contractor or subcontractor of the owner" (RSA 447:5).  Agency can be express or implied.  It is safe to say that many factors (is the tenant required or merely allowed to make improvements? does the lease give the landlord the right to approve any plans? does the landlord benefit from the improvements? is the cost of the improvements borne by the landlord through offsets in rent?) may play into whether a tenant is acting as agent for the landlord.  The underlying concern is generally one of fairness to the landlord.

The balance was struck in favor of the landlord in I.B.E.W. Local 490 v. Maureen Electrical, Inc., Merrimack County Superior Court No. 2012-CV-684, a case involving a lien asserted against the owner of the Merrimack Premium Outlets.  The leases required all tenant fit-up work to be approved by the landlord
after submission of plans and specs; required the landlord's approval of the contractors implementing them; and provided that with one exception (track lighting) "all tenant improvements shall become the property of Landlord when installed."  Nevertheless, the Court concluded that the landlord received little benefit from the improvements contracted for by its tenants, and rejected the argument that the tenants were acting as agents of the landlord in constructing improvements, based on three factors: "The improvements will not become the property of the lessor until the end of the lease, in 10 years.  The alterations, while substantial and permanent, are not beneficial, but are actually a cost because a new tenant will want to fit up the space it rents for itself.  Finally, there is no evidence the rental payments reflect any increased value of the property as a result of the improvements."

The lesson here is that a contractor considering doing a tenant fit-up should always ask to see the lease and verify that the landlord both allows the improvements and owns them once they are made.  Even that is not enough to ensure lienability of the landlord's interest -- but it is a safe bet that without them lienability will not be found.

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#17:  Arbitration vs. Litigation: Which Is Best For Your Contract?

10/1/2014

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Experienced trial lawyers will tell you that the judicial system is ill-suited to resolving certain types of complex civil cases, and if pressed for an example are as likely to point to construction disputes as any other.  It's not just that construction cases aren't sexy (and perhaps for many judges and juries downright boring).  It's that their blending of arcane questions of engineering and architecture with the practicalities of construction means and methods cries out for a particular expertise in the decision-maker.  This explains the popularity of arbitration in construction cases, a dispute mechanism now largely enshrined in form contracts like those promulgated by the AIA.

Of course forms can be altered, and arbitration clauses can be stricken from a proposed contract so that litigation will become the default mechanism for dispute resolution.  Not knowing what some future dispute will look like when you pick up a pen to sign your contract, predicting which procedure will yield the fairest result at the least cost can be difficult, particularly since these two considerations are often in tension.

The conventional wisdom is that arbitration is less expensive than litigation despite the fact that the arbitrator and any arbitration administrator (such as the American Arbitration Association) will charge a fee for their services.  Proponents of this conventional wisdom point to the relative speed of the arbitration process as compared with courts, its limitations on "discovery" (e.g., depositions) that often run up huge bills in litigation, possible avoidance of expensive expert witnesses to educate a judge and jury on matters already within the arbitrator's expertise, curtailment of "motion practice" that marks many court cases, and the diminished likelihood of an appeal (I'll have more to say on appeals from arbitration awards in a future blog).  But these considerations should be tested before you agree to arbitrate up front.  Here are some practical questions to ask yourself:

First, is the contract price at least six figures?  If not, chances are that the amount at stake in any future dispute won't justify the expense of paying an arbitrator and an arbitration administrator, even under the streamlined rules governing smaller arbitrations.  Not having to pay a judge and a jury for their time may save you more than not having to pay for the "discovery" costs that litigation can impose but that arbitration will limit or even prohibit absent the parties' consent.

Second, is the scope of work complex or tricky?  If not, there is less likelihood that an expert witness will be required at trial to educate a judge or jury untrained in engineering or in construction means and methods.  One of the things you are buying when your arbitrate is the expertise of the arbitrator; don't be in a rush to buy it if it isn't likely to be needed.

Third, is budgeting your time predictably critical to your bottom line?  For the busy businessman, arbitration offers more flexibility and certainty of schedule.  The parties schedule the arbitration hearing when convenient for them, and don't get "bumped" by a court which has suddenly found its priority criminal docket to be beefier than anticipated when the trial was first scheduled.  Those "bumps" can end up costing you.  (This can be a money-saver in legal fees as well; your attorney won't have to gear up for trial twice.)

Arbitration may have other advantages over litigation that may tip the balance.  For one, it is a private procedure, unlike a trial in open court that creates a public record of the result.  If confidentiality is of value to you, arbitration becomes more attractive.  And if you are the type of person who gets nervous on the witness stand in front of a jury of your peers, you are likely to prefer the informality of the conference room to the formality of the courtroom.

In residential construction, the psychological factor must be considered as well.  Because jurors can more easily identify with them, homeowners may fare better than their contractors with a jury than with an arbitrator, and vice versa.  I typically counsel residential contractors to present their customers with a contract containing an arbitration clause for this reason.  But you never know!


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#16:  Recovering Overhead Costs Due To Delay

9/1/2014

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As with any business that has fixed as well as variable costs, a contractor must earn enough revenue to cover both before turning a profit.  If the job is delayed, the variable costs can often be cut until the delay is over, but fixed costs like salaries of office staff, utilities, rent, office equipment, accounting and payroll services, taxes – what we refer to as “overhead” – cannot be.   When a contractor’s work force is idled as a result of delays caused by the owner, that unabsorbed overhead is a compensable element of damages.   R. Zoppo Co., Inc. v. City of Dover, 124 N.H. 666, 673-74 (1984) (“An adjustment in unit price should be calculated in relation to the increased costs (if any) Zoppo faced by having its service connection crew idle . . . In assessing the increase in these costs, the master may consider . . . a proportionate amount of Zoppo’s administrative overhead associated with this crew.”).

While there is more than one way to quantify this element of delay damages, one basic methodology comes from Eichleay Corp., a 1960 decision from the Armed Services Board of Contract Appeals which established a formula in recognition of the fact that home office overhead cannot be allocated to a particular contract, but must be spread across all contracts proportionately.  What has come to be known as the Eichleay formula is applied on federal contracts, and the United States Court of Appeals for the Federal Circuit has recognized the formula as “the only means approved in our case law for calculating recovery for unabsorbed home office overhead.”  Melka Marine, Inc. v. United States, 187 F.3d 1370, 1374-75 (Fed. Cir. 1999).  Thus far no New Hampshire case has either adopted or rejected it, although it has been met with some criticism in other states.

The Eichleay formula aims to find an amount allocable to overhead from a particular contract in terms of a daily rate.  Here is the three-step calculation:

(1)    Contract billings/Total billings for contract period  x Total overhead for contract period =              Overhead allocable to the contract
(2)    Allocable overhead/Days of performance = Daily contract overhead
(3)    Daily contract overhead  x  Number of days of delay = Amount of the claim

This is an arithmetic formula, nothing more.  The real sticking point is in identifying the appropriate cases for using it and the required proof of prerequisites to its use.  P.J. Dick, Inc. v. Principi, 324 F.3d 1364, 1370 (Fed. Cir. 2003), illustrates the difficulties:

“To show entitlement to these damages, the contractor must first prove there was a government-caused delay to contract performance (as originally planned) that was not concurrent with a delay caused by the contractor or some other reason. The contractor must also show that the original time for performance of the contract was thereby extended, or that he finished the contract on time or early but nonetheless incurred additional, unabsorbed overhead expenses because he had planned to finish even sooner.  Once the contractor has proven the above elements, it must then prove that it was required to remain on standby during the delay.  If the contractor proves these three elements, it has made a prima facie case of entitlement and a burden of production shifts to the government to show that it was not impractical for the contractor to take on replacement work and thereby mitigate its damages.  If the government meets its burden of production, however, the contractor bears the burden of persuasion that it was impractical for it to obtain sufficient replacement work.”

The burden is formidable.  The contractor must prove that the delay (1) was caused by the government; (2) was not concurrent with any other cause of delay; (3) actually extended the contract performance time (or deprived the contractor of early completion); and (4) was of uncertain duration, requiring the contractor to be “on standby,” thus depriving the contractor of reasonable opportunity to find replacement work during the delay period.  Unless the owner has expressly suspended performance, either completely or as to a critical path item, chances are that the extended home office overhead claim will fail, regardless of the formula used.


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#15:  Differing Site Conditions

8/24/2014

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Like darts thrown in the dark, dealing with site conditions you cannot see or predict is risky business.  Poking holes in walls or in the earth to try and figure out what might be lurking under the surface is all well and good, but doesn’t always yield perfect information.  Hazardous or unsuitable materials, ledge, groundwater, dead bodies, you name it – if encountered, these surprises need to be dealt with in order to complete the project, and somebody needs to absorb the cost of doing so.

If the parties’ contract doesn’t address the issue, the contractor will end up bearing this risk.  In many contracts, the risk is shared between owner and contractor through a “Differing Site Conditions” clause.  The phrase immediately raises the question, “Different than what?”  The answers “Different than represented” and “Different than expected” correspond to the two types of differing site conditions for which an adjustment of the contract price may be available.  For example, AIA Document A201-2007 General Conditions of the Contract for Construction contains the following language in § 3.7.4:

“If the Contractor encounters conditions at the site that are (1) subsurface or otherwise concealed physical conditions that differ materially from those indicated in the Contract Documents or (2) unknown physical conditions of an unusual nature, that differ materially from those ordinarily found to exist and generally recognized as inherent in construction activities of the character provided for in the Contract Documents, the Contractor shall promptly provide notice to the Owner and the Architect before conditions are disturbed and in no event later than 21 days after first observance of the conditions. The Architect will promptly investigate such conditions and, if the Architect determines that they differ materially and cause an increase or decrease in the Contractor’s cost of, or time required for, performance of any part of the Work, will recommend an equitable adjustment in the Contract Sum or Contract Time, or both.”

Federal Acquisition Regulations, 48 C.F.R. 36.502 and 52.236-2, have similar language.  It’s easy to see why the owner would benefit from such a clause, even if it means potentially paying more.  Without that opportunity for an upward adjustment in price, contractors will pad their bids to protect against the unknown, and the owner will definitely pay more.  And with unlimited access to the site, the owner is in a superior position to do subsurface and other investigations than are bidders with limited opportunity to inspect a site.

Even when boring logs, soils reports and other information are provided to bidders, however, most contracts contain disclaimers about relying on their accuracy, and caution the contractor to rely on his own investigation.  Such disclaimers are in tension with Type 1 differing site conditions clauses, and won’t overcome them when it would be unfair to the contractor.  That was the case in Frederick Snare Corp. v. Maine-New Hampshire Interstate Bridge Authority, 41 F.Supp. 638 (D.N.H. 1941), where the Court awarded a contractor extra compensation for excavations considerably in excess of what was shown on the plans despite a clause in the bid documents stating “Certain borings have been made by the Owner and the data therefrom available to the Engineers is shown on the plans. . . The Owner does not guarantee such data and will not be liable for and will not pay any claim made by the Contractor because the sub-surface conditions found during construction do not correspond with conditions as indicated by the data shown. Should the Contractor consider such data insufficient he shall make such investigations as he considers necessary and shall base his bid upon his own opinion of the conditions.”  Id. at 646.  The Court relied on the fact that there wasn’t sufficient time for bidders to investigate conditions themselves:  “[N]o accurate soundings could be made to determine the subsurface conditions in the four days allotted.”  Id.

While each case is different, it is fair to say that “requirements for pre-bid inspection by the contractor have been interpreted cautiously regarding conditions that are hard to identify accurately before work begins, so that ‘the duty to make an inspection of the site does not negate the changed conditions clause by putting the contractor at peril to discover hidden subsurface conditions or those beyond the limits of an inspection appropriate to the time available.’”  Metcalf Construction Co. v. United States, 742 F.3d 984, 996 (Fed. Cir. 2014).


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#14:  Lien Waiver Pitfalls

8/13/2014

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To avoid the risk of mechanic’s liens, a project owner naturally wants to ensure that everyone involved in his project is paid out of each progress payment check he writes to his GC.  A contract requiring the GC to pay subs and suppliers out of that check is nice, but as we all know, contracts aren’t always honored.  Because the flow of funds from owner to general contractor to subcontractors/suppliers doesn’t always work smoothly, it is common for an owner to condition both interim and final payment to the GC on submission of lien waivers, not only from the GC itself but from virtually everyone down the line who furnished any labor or materials being paid for by the owner’s check.  Construction lenders want this as well, and typically require such waivers as a condition of any loan disbursement.

Lien waivers, whether interim or final, give up the signer’s right to assert a mechanic’s lien.  Over the years I’ve seen many different forms used to accomplish this (and sometimes to accomplish more than this – read on!), but they all fall into one of two formats: those conditioned on receipt of payment (“soft” lien waivers) and those acknowledging receipt of payment (“hard” lien waivers).  Each format has its issues.  From the owner’s and lender’s perspective, “soft” lien waivers give no certainty that payment will flow downstream and liens will be avoided – the very thing that motivated the request for lien waivers in the first place!  For this reason many owners and lenders view “soft” lien waivers as close to useless, and insist on the unconditional “hard” lien waivers.  But subs and suppliers don’t like them.  Because the owner doesn’t write his own check until all the lien waivers are in hand, “hard” lien waivers are typically outright lies; unless the GC is fronting its own money (which rarely happens) there is no swapping of a signature for an immediate check.  The sub swears otherwise because that’s the only way he will get paid, and he is obliged to take the risk that the promised payment will not follow and yet his lien rights will be lost.

How much of a risk is it?  If the signer of a “soft” lien waiver doesn’t get paid, then the express condition of effectiveness is unfulfilled and he can still lien the project.  But if the signer of a “hard” lien waiver doesn’t get paid, he will likely be held to the literal terms of the waiver despite nonpayment and be unable to lien the project.  Waivers do not need consideration to support them if an owner disburses in reliance on the truth of the waiver. 

There are ways to strike a fair balance between both sides’ interests.  Some contracts require the GC to furnish its own “hard” lien waiver through the date of a current payment, but to furnish subcontractor and supplier “hard” lien waivers only through the date of the immediately prior progress payment.  This eliminates the need for the lie inherent in many “hard” lien waivers from subs and suppliers, without putting them at risk.

What the signer should never presume, however, is that the requester of the lien waiver is being fair.  Much can be buried in a document titled “lien waiver,” and they can be broader than intended.  For example, interim lien waivers may specify either the date through which the furnishing of labor and materials will not give rise to a lien (generally the end date for the current requisition for payment), or the dollar amount of the labor and materials furnished that will not give rise to a lien, or both.  If retainage is being withheld on your job, specifying the dollar amount is particularly important, since simply waiving lien rights through a given date could end up waiving the right to lien for the retainage that will eventually fall due on that work.

Lien waivers bear careful reading, since so many forms now in vogue go well beyond the mere waiver of lien rights – such as giving up any claim for payment, swearing that downstream sub-subs and suppliers have been paid, promising indemnity, and the like.  Spending five minutes thinking about what the language really means will repay the time invested.


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#13:  Contractor Delay Claims: An Uphill Battle

8/3/2014

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The old saying “Time is money” has no more obvious application than in construction.  The sooner a contractor finishes a project (consistent with quality construction, of course), the less the cost of construction and the quicker he can focus on other projects.  The sooner an owner has a completed project, the quicker it is open for business (if a commercial project) or useable for living (if residential).  Both sides want to get the job done quickly.  And when either side delays the other beyond an agreed completion date, there can be financial consequences.

From the owner’s side, an unexcused contractor delay – generally, anything not occasioned by an owner-imposed change, a supply shortage, or unusually severe and unexpected weather – is most often handled with a “liquidated damages” clause in the contract, providing for a fixed amount to be paid by the contractor per day of delay.  From the contractor’s side, dealing with an owner-caused delay is rarely so simple.  If the delay results from a change requested by the owner, the compensation for the contractor’s extra time on the job will be built into the change order price.  But what if the owner delays the job due to financing woes, or difficulties in dealing with permitting, or simply slow decision-making?  An extension of time to complete is nice, but puts no money in the contractor’s pocket.  Cost escalations, idled labor and/or equipment, extended field office overhead, unabsorbed home office overhead, even additional materials storage costs can rear their ugly heads if the delay is lengthy.  Unless the parties’ contract specifies that an extension of time is the contractor’s sole remedy for owner-caused delays, a fight may be looming.

It is not an easy fight to win.  The contractor’s right to compensation for delays depends in the first instance on whether “time is of the essence” of the parties’ contract.  Otherwise a stated completion date will be deemed by the courts as a guideline rather than a deadline, and a delay of reasonable duration will be forgiven.  Normally, time is not of the essence unless it is expressly stated to be.  Guy v. Hanley, 111 N.H. 75, 75 (1971) (“The general rule is that unless specifically so stated, time is not to be considered as of the essence” and “[t]he mere fact that a date is stated in the instrument is not sufficient alone to alter this rule.”).

Even if time is of the essence, the owner’s promised performance must be identified before a breach of that performance will be found.  A contract which speaks in terms of completion of the contractor’s performance but mentions nothing about the owner’s duties (other than payment) presents a harder case for compensation than one which specifies and sets deadlines for the owner’s performance of particular items (getting permits, removing obstacles, turnaround time for making decisions, etc.).  Nevertheless, contracting parties have an implied obligation not to hinder each other’s performance.  That is sometimes enough to justify a finding of breach by an owner.

Assuming that an owner breach is present, delay damages are recoverable only if the breach actually causes the delay.  When there has been a concurrent delay -- if the contractor’s completion would have been delayed anyway due to causes not attributable to the owner -- that portion of the delay will not be compensable.  Moreover, “a party seeking damages occasioned by the fault of another must take all reasonable steps to lessen his or her resultant loss,” Grenier v. Barclay Square Commercial Condo. Owners' Assoc., 150 N.H. 111, 119 (2003).  To mitigate his damages, the contractor must find other available work to occupy his work force and absorb part of his overhead once he knows that a delay will befall him. 

Lastly, if the contractor clears all of the foregoing hurdles, he has one remaining: proof of the amount of damages with reasonable certainty.  I’ll talk more about the difficulties of proving delay damages in a future blog (particularly about the so-called Eichleay formula for proving unabsorbed overhead), but for present purposes, suffice it to say that a contractor who is delayed by an owner has a tough road to hoe in collecting compensation.


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#12:  Escaping a Mistake in a Bid

7/22/2014

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The legal rules surrounding the bid process are driven by considerations of fairness -- to other bidders, to the awarding authority, and to a contractor who makes a mistake in his bid.  Often these considerations are in tension.  In some circumstances the law comes down on the side of a low bidder's right to withdraw a bid and decline a contract based on an honest mistake.

Courts are not blind to the realities of the bidding process and the opportunities for inadvertent error.  “Contractors do not work under ideal conditions in the rush to meet the deadline for submitting bids and equity recognizes that honest, sincere men, even in the exercise of ordinary care, under such pressure can make mistakes of such a fundamental character that enforcement of the apparently resulting agreement would be unconscionable.  In such a situation, if the parties may still be placed in statu quo, equitable relief will be granted.”  Kenneth E. Curran, Inc. v. State, 106 N.H. 558, 561 (1965).

In Curran, the State advertised for bids for an addition to Silver Hall at Plymouth State College.  The plaintiff submitted a bid of $102,171.98, far below the other six bids which ranged from $159,957 to $189,945.  When the bids were opened and read, plaintiff knew at once that something was amiss, and soon found the problem – an adding machine incapable of recording a total of more than $99,999.99.  Plaintiff promptly asked for permission to withdraw its bid, but was advised that it would be held to its bid and its bid bond called if it refused to perform.  Plaintiff sued for rescission, and won.  The Supreme Court adopted a four part test: “'Equitable relief by way of rescission will be granted by most courts, in the case of unilateral mistakes, when the following conditions are present: (1) The mistake is of such consequence that enforcement would be unconscionable. (2) The mistake must relate to the substance of the consideration, that is a material feature. (3) The mistake must have occurred regardless of the exercise of ordinary care. (4) It must be possible to place the other party in status quo.”

Elaborating on the third factor, the Court stated that “it is only when negligence of a contractor resulting in a mistake in submitting his bid amounts to such carelessness or lack of good faith in calculation as to violate a positive duty in making up a bid, taking into consideration the nature of the transaction and position of the offeree, that equitable relief will be denied.”  The defective calculator case is a rarity, but it points up the operative principle: arithmetic and clerical errors, such as writing down sub-bids incorrectly or failing to enter the number intended on a spread sheet, are precisely the types of mistakes that courts are likely to excuse.  A misreading of specs or a failure to gauge a measurable quantity in a take-off, by contrast, would be unlikely to qualify.

The practical lesson of the Curran case is that relief from a unilateral mistake in a bid is more likely to be granted (1) the sooner notice is given to the awarding authority (before contracts are signed and other bidders are off to other projects), (2) the less the negligence of the bidder (clerical and arithmetic errors rather than inattention to plans and specs), and (3) the greater the disparity between the erring bid and the second low bid (such that the awarding authority knows or should know that a mistake has likely been made).

It is noteworthy that the remedy for unilateral mistake in a bid is rescission rather than reformation, i.e., withdrawal of the bid rather than award of the contract followed by a modification of the contract price to correct the bid error.  This is the teaching of Midway Excavators, Inc. v. Chandler, 128 N.H. 654, 658 (1986), where a contractor “which chose not to exercise its option to rescind the bid and re-attain its bid bond, cannot now seek to reform the bid, and therefore the contract.”  My personal view is that this is too harsh a rule when the correction of an arithmetic error would still keep the low bidder’s bid below the next lowest bid.  But I don’t wear the black robe.



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#11:  The Regulatory Backdrop: Lessons from the Bell/Heery Case

7/15/2014

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When a contractor takes on the responsibility to obtain permits and comply with governmental requirements in constructing a project, it also takes on the risk that those permits and requirements will be more onerous than anticipated.  No matter how experienced a contractor is at estimating, sequencing and planning a job, the unforeseen may leave it without a remedy when things don’t go as expected.

Such was the case in Bell/Heery v. United States, 739 F.3d 1324 (Fed. Cir. 2014).  The plaintiff was awarded a $238 million project by the Federal Bureau of Prisons to design/build a new correctional facility in Berlin, New Hampshire.  Included in its contract was the following clause, a variant of which is commonly found not only in federal but in state and private construction contracts:  “The Contractor shall, without additional expense to the Government, be responsible for obtaining any necessary licenses and permits, and for complying with any Federal, State, and municipal laws, codes, and regulations applicable to the performance of the work.”

Bell/Heery assumed, based on its earlier experience with the New Hampshire Department of Environmental Services, that it would be able to perform “cut and fill” operations in a single step, moving earth from the high area of the site to the low area to level the terrain.  That proved to be wishful thinking.  DES conditioned its Alteration of Terrain permit on disturbing a maximum of forty acres at any given time, and then imposed a number of multi-step requirements which, according to the contractor, “caused excessive re-handling and handling of materials, increased equipment and manpower needs, caused problematic stockpile management, required additional import materials, increased costs for erosion control measures, added temporary stabilization areas, required temporary  stockpile stabilization, required additional areas of restoration and rework and necessitated work during unanticipated winter weather conditions.”  Id. at 1329.  Bell/Heery sought an adjustment of over $7 million as compensation for these unanticipated burdens.

The federal Court of Claims would have none of it, and the appellate court likewise rejected the claim, finding that the burden of obtaining and complying with state and local permits for the project was on the contractor.  Moreover, the court ruled that no equitable adjustment was due because the federal government did not control the actions of the state environmental agency, and had no duty to intervene on the contractor’s behalf.


Although the case was decided under federal law, don’t expect a different rule under New Hampshire law.  Our Supreme Court has stated that “One who by contract or agreement binds himself to an obligation possible to perform must perform it, and he will not be excused from performance because of unforeseen difficulties.”  Town of Bedford v. Brooks, 121 N.H. 262, 266 (1981).  Unlike a post-execution change in the law, misgauging at bid time how an existing set of regulations will be applied by the regulator “is not a case where an unforeseen situation has arisen since the execution of the agreement,” Colebrook Water Company v. Parsons, 88 N.H. 217, 219 (1936). 

Faced with contract language similar to Bell/Heery’s – such as AIA A201 § 3.7.2 (“The Contractor shall comply with and give notices required by applicable laws, statutes, ordinances, codes, rules and regulations, and lawful orders of public authorities applicable to performance of the Work”) – a wise contractor will confirm his understanding of the applicable regulatory requirements, preferably in writing, with the agency involved before finalizing his bid.  Even if the agency is noncommittal on a proposed construction methodology, valuable insight can be gained in the dialogue, and the risks can be better quantified.


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#10:  The Risks of Construction Change Directives

7/4/2014

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Most large and complex commercial projects today are marked by numerous changes in the original scope of work, as issues are discovered during the course of construction, or as owners change their minds mid-stream.  What starts out as a defined scope of work for a defined price on a defined schedule ends up getting altered on all three fronts.  The owner wants the flexibility to change course, yet not be ambushed by a price for the change that busts the budget or by unacceptable delays in project completion.

Under Article 7 of the AIA’s popular form contract AIA A201 General Conditions, these owner protections are provided for.  If owner and general contractor agree on the price and time effects of a change in scope, they simply execute a written Change Order which modifies their agreement, and everybody is happy.  If they don’t agree, however, the contractor must still implement the owner’s desired change in scope―provided that he receives a Construction Change Directive, defined as “a written order prepared by the Architect and signed by the Owner and Architect, directing a change in the Work prior to agreement on adjustment, if any, in the Contract Sum or Contract Time, or both.”  In effect, by issuing a CCD the owner says “do what I tell you to do, and we’ll deal with pricing and/or schedule changes later.”

Despite mechanisms built into the contract for pricing the change later (agreed-upon unit prices; time and materials plus a mark-up for overhead and profit; etc.), a CCD presents some risk for the contractor.  If the CCD requires a significant reduction in scope, the contractor who was counting on the full scope of work must now scramble to fill a sudden hole in his schedule in order to make up for lost revenue.  If the CCD requires a significant expansion in scope, the contractor may have other projects on his schedule that will now suffer.  But the biggest risk is one of profitability of the new work.  Precisely because the price is not agreed upon up front, the control that the contractor enjoyed at the bid stage and at the contracting stage is gone; his compensation for a portion of the work will now be determined by a third party (generally the project Architect) who will scrutinize his measurements – measurements that must now be carefully logged and documented by the contractor (for free!) as to units/yards/linear feet, as to man hours, as to materials used.  The documentation headache that he hoped to avoid by entering into a fixed-price rather than a cost-plus arrangement has just started pounding.  And if the Architect isn’t satisfied and asks for more detail, payment that should have been received this month is delayed until next month – a potential cash flow problem for the contractor.

Notwithstanding issuance of a CCD, if the change desired by the owner is a “cardinal change” the contractor can decline.  Cardinal changes are those that either drastically increase scope (say, tripling the amount of work) or call for a different type of work (say, changing the framing from wood to steel).  Some recognition of this principle is built into the A201 General Conditions, which limit Construction Change Directives to work “within the general scope of the Contract.”  The distinction is between tweaking a project, and asking for what amounts to an entirely different project.  As one court has put it, "There is no exact formula for determining the point at which a single change or a series of changes must be considered to go beyond the scope of the contract and necessarily in breach of it.  Each case must be analyzed on its own facts and in light of its own circumstances, giving just consideration to the magnitude and quality of the changes ordered and their cumulative effect upon the project as a whole."  Wunderlich Contracting Co. v. United States, 351 F.2d 956, 966 (Ct. Cl. 1965).  And without a bright line test for when a change is cardinal, the contractor is at risk in declining a CCD and walking away from a project.   Allied Materials & Equip. Co., Inc. v. United States, 215 Ct.Cl. 406, 569 F.2d 562, 564 (1978) ("Undoubtedly, the cautious contractor might often proceed under the revised contract because of doubt whether he could invoke the cardinal change doctrine.").


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#9:  Licensing of Contractors: Is It Needed?

6/25/2014

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The widespread practice of licensing professionals – doctors, lawyers, architects and engineers, insurance brokers, real estate agents, even barbers – stems from the notion that a basic level of competence ought to be demonstrated before these professionals are turned loose on the public to practice their trade.  In about half of the states (check out www.nascla.org for a list) and in some cities or counties of other states (New York comes to mind), residential and occasionally even commercial contractors are included among those who must be licensed.  Here in the land of “Live Free or Die,” however, contractors are free of state licensing requirements.  No demonstration of skill or knowledge of building codes is required as a condition of going into business.  

There are exceptions for certain specialty trades.  New Hampshire does require licensing of plumbers, electricians, septic system installers, water well contractors, asbestos abatement and lead abatement contactors.  The Department of Transportation also requires bidder prequalification for its projects, a process that does inquire somewhat into the bidder’s experience and abilities.  But when it comes to most tasks involved in the construction process, be it digging a cellar hole, pouring concrete, framing, roofing, installing HVAC or masonry, anyone can be in business, whether or not they know which end of a hammer to grab or which lever of a backhoe to pull.  It’s not that our Legislature thinks that contractors can do less damage than barbers (they surely realize that a bad haircut eventually corrects itself, a bad building doesn’t).  Still, every time a bill has been before the Legislature to require statewide licensing of contractors, it has been defeated.  Soundly.

If I may offer my $0.02 here, I don’t see a compelling need for contractor licensing, even in the residential arena where owners tend to be less sophisticated than their commercial counterparts and less likely to engage an architect or other professional to protect their interests by reviewing compliance with plans and specs and certifying payment of requisitions. 

First, in construction settings the market does a particularly good job of weeding out incompetence.  The various trades involved in constructing a building are coordinated by a general contractor who interfaces with the owner, relieving the owner of the burden of hiring individual subs.  The GC is in a far better position than the owner to check on the competence of drywallers, insulators, painters, etc. – and has every incentive to hire only the good ones, because the GC is on the hook to the owner for their performance.  If they are bad, they make the GC look bad -- and in this era of electronic communication and Better Business Bureau/Angie’s List websites, bad builders don’t last in business. 

Second, most municipalities have building inspectors and code enforcement officers whose job it is to review construction for compliance with building code requirements.  When they do their job right, this regulatory inquiry provides owners with at least some basic protection from unsafe structures – which is precisely the rationale of a licensing scheme.  Sure, they miss things occasionally, but a builder can’t count on that, and so must at least try to build a code-compliant structure.

I am not saying that there is no need for legislation of any kind related to contractors – but I do think that where problem areas are identified, legislation addressing them should be targeted and narrow.  For example, one of the largest category of complaints against contractors made to the Consumer Protection Bureau at the Attorney General’s Office is not poor quality construction, but abandonment of the project after taking a substantial deposit.  That type of fraudulent practice can be dealt with by requiring a surety bond as a condition of taking a sizeable deposit.  A full blown licensing law would be overkill here.

All things considered, the quality of construction in the Granite State does not appear to be below average.  If it ain't broke . . .


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#8:  Payment Bonds

6/16/2014

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If they’ve been in the game long enough, subcontractors and suppliers all eventually run into difficulties getting paid for their work and materials by those who contracted for them.  The option of suing for payment isn’t always attractive and won’t always be fruitful (e.g., when a general contractor goes under).  For those occasions, wouldn’t it be nice to have a third party with deep pockets step up and guarantee payment?  That is precisely what a payment bond is supposed to do.  In exchange for the contractor’s payment of a premium and a written promise to indemnify any losses (secured by a pledge of assets and personal guarantees of the contractor’s principals), a bonding company will put its own credit on the line.

On some private construction projects and on virtually all public construction projects, general contractors are required to furnish a bond, typically issued by an insurance company, for the benefit of those who supply labor and materials to the job.  In the public setting this is a matter of statute (RSA 447:16-18 for state and municipal work, 40 U.S.C. §§ 3131-3134 for federal work), intended as a substitute for mechanic’s liens, which do not attach to public buildings. 

Bond claims are subject to strictly-enforced notice requirements.  Under the federal statute the claim must be made by giving written notice to the contractor within 90 days of the claimant’s last day of work or furnishing of materials.  The state statute is more generous: a claim must be filed with the appropriate governmental body “within 90 days after completion and acceptance of the project by the contracting party.”  The express terms of the bond may have additional notice provisions and deadlines – but if these differ from the statutory provisions, the statutory provisions will control for any bond given on a project that is subject to the statute.

One important difference between payment bonds on federal projects and payment bonds on state or municipal projects lies in who can claim under them.  The federal project payment bond covers persons having "a direct relationship with the principal or a subcontractor of the principal;" lower tiers are shut out.  The state statute has no such limitation.


A payment bond guarantees payment of what the contractor actually owes, and that amount may be in dispute.  If the contractor purchasing the bond disputes the claim in whole or in part, the bonding company will typically do some investigation to determine how much is justly due―including asking for a sworn itemization of the claim and supporting documents, and getting its principal’s side of the story documented as well.  If a good faith investigation leaves the matter unclear, it’s a safe bet that the bonding company won’t pay the amount in dispute without its principal’s consent, which usually means that a lawsuit must be filed on the bond.  Those lawsuits have their own separate statutory and/or contractual requirements and deadlines.

Procedural defenses like insufficient notice or untimeliness aside, it is often said that a bonding company has all of the defenses to payment that the general contractor has (bankruptcy being the most notable exception).  That may be overstating things.  Thus far no reported New Hampshire case has ruled on a key question that has divided courts in other states: if there is a “pay-if-paid” provision in the subcontract and the general contractor hasn’t been paid by the owner, can the bonding company also hide behind the “pay-if-paid” clause and avoid paying the sub?  The issue is nuanced; I will elaborate in a future blog.  It may seem unfair to the bonded contractor to require the bonding company to pay in such circumstances, given that the contractor must reimburse the bonding company for every penny paid out on a claim, despite not having been paid itself. But there are a few precedents reaching that result.

A payment bond takes the place of a mechanic’s lien only in the public works arena; the availability of a payment bond on a private project does not prevent simultaneous pursuit of a mechanic’s lien remedy.  Even on a state or local government project, a bond does not preclude the claimant from also getting a lien on the monies due or to become due from the awarding authority to the general contractor under RSA 447:15.  And in my experience, liening the money is the more powerful choice.


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#7:  Statutes of Limitation, the Discovery Rule, and Statutes of Repose

6/4/2014

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Statutes of limitations – deadlines for bringing a lawsuit – are premised on the notion that the passage of time naturally tends to result in lost evidence, disappearing witnesses and faded memories, eventually reaching the stage where justice cannot confidently be dispensed by the courts and forcing a defendant to defend becomes unfair.  In New Hampshire this length of time is generally three years from the time of the breach of duty – and in the construction setting, this will typically be a breach of a contractual duty.

If forcing a defendant to defend a stale claim is unfair, so is shutting out a plaintiff who couldn’t sue within three years of the breach because he or she didn’t have a fair opportunity to discover it―for example, when a latent construction defect first surfaces after three years. In that case the three-year clock will start ticking only when the breach is or reasonably should have been discovered.  Naturally enough, lawyers call this the “discovery rule.”

You can see the tension between these twin fairness concerns.  Theoretically, the discovery rule could allow a lawsuit to be brought decades after a breach, making defense an iffy proposition.  But in the construction setting, the Legislature has restruck the balance by enacting an eight year statute of “repose” – a deadline after which breaching parties can rest easy even if their breach has not yet been discovered.  RSA 508:4-b states:

“Except as otherwise provided in this section, all actions to recover damages for injury to property, injury to the person, wrongful death or economic loss arising out of any deficiency in the creation of an improvement to real property, including without limitation the design, labor, materials, engineering, planning, surveying, construction, observation, supervision or inspection of that improvement, shall be brought within 8 years from the date of substantial completion of the improvement, and not thereafter.”


There are some exceptions in the statute, but in general a claim is extinguished eight years after substantial completion regardless of whether the breach has yet been discovered.  In practical effect, the statute of repose is simply a cap on a plaintiff’s invocation of the discovery rule.  If the plaintiff knew or should have known of the breach within five years of substantial completion, the statute of repose isn’t really needed, because the statute of limitations will shut the plaintiff out anyway after eight years.  But if the breach is first discovered (or reasonably should have been discovered) more than five years after substantial completion, the repose clock will run out before the limitations clock does.  The plaintiff’s usual three-year post-discovery deadline is shortened by one day for each day beyond five years from the date of substantial completion that discovery occurred.

Note that neither the discovery rule nor the three year period applies to contracts for the sale of goods.  Unless the seller has warranted future performance of the goods for some longer period of time, the limitations period is four years from the date of sale, even if a problem with the goods is not discovered or reasonably discoverable until after those four years have expired.  (This can sometimes put a contractor in a pinch.  If you inadvertently build a building with defective goods, and the defect is first discovered by the owner more than four years after you bought those goods, the discovery rule may allow the owner to sue you, but you will have no recourse against the supplier!)

Whatever the statutory deadlines are, contracting parties are free to alter them by agreement, both as to length and as to triggering event – and many of them do.  The popular AIA form contract A201-2007, for example, overrides the discovery rule: “As to acts or failures to act occurring prior to the relevant date of Substantial Completion, any applicable statute of limitations shall commence to run and any alleged cause of action shall be deemed to have accrued in any and all events not later than such date of Substantial Completion.”  It is obviously smart to check your contract language at the first sign of trouble.  If you don’t, you may discover that SOL stands for something other than “statute of limitations!”


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#6:  Pay-when-paid, Pay-if-paid and Good Faith Obligations

5/27/2014

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It’s a common scenario in construction: the owner pays the GC, who then pays the subs, but because the subs have contracted with the GC rather than the owner they look to the GC for payment.  And unless the subcontract says otherwise, the GC must pay for their performance regardless of whether the owner pays the GC.

Many subcontracts do say otherwise.  GC’s are understandably reluctant to risk liability to their subs despite nonpayment by owners, and often try to pass the risk of owner default down to their subs by making their obligation to pay contingent upon receipt of payment for their work from the owner.  The law will enforce that risk-shifting if the sub has clearly and unambiguously agreed to assume the risk of an owner default.

In this regard, courts frequently distinguish “pay-when-paid” clauses from “pay-if-paid” clauses.  A "pay-when-paid" clause typically provides that the GC will pay the sub within X days of receiving payment from the owner.  Some contractors mistakenly assume that this shifts the risk of nonpayment to the sub (reasoning that if the GC never gets paid, the sub has to wait forever plus X days before its payment falls due!), but most courts view these provisions as timing mechanisms rather than permanent excuses not to pay, and will require payment to the sub eventually regardless of whether the owner pays the GC.  By contrast, a "pay-if-paid" clause makes receipt of payment from the Owner a condition precedent to the GC’s obligation to pay a sub.  (An example might be “Contractor shall have no obligation to pay Subcontractor unless Contractor has first been paid by the Owner for Subcontractor’s work, receipt of which payment by Contractor is a condition precedent to any right of Subcontractor to be paid for its work.”)

There is an important qualification to this, one which arises most often in the context of change order disputes: the GC must make a good faith effort to get paid by the owner for the sub’s work.  And it must do so even if it disagrees that the sub is entitled to extra payment.  This principle was in play in Seaward Const. Co., Inc. v. City of Rochester, 118 N.H. 128 (1978).  In that case, a contract to lay sewer pipe for the city provided that “All monies due under the Contract are subject to the receipt of said monies by said Rochester Housing Authority from the Federal Housing and Urban Development Agency (HUD)” and "Payment to said Seaward Construction Company, Inc. is contingent upon receipt of funds by the Rochester Housing Authority.”  The price per installed foot depended on the depth, and when a dispute arose over how deep 920 feet of pipe was laid, the city refused to pay Seaward the higher price, pointing out that it had received no money from HUD to do so.  The Court
acknowledged that “the agreement is perfectly clear that the city will not be required to expend its own funds for payment,” but also held that “the city was under an implied obligation to make a good-faith effort to obtain funds from HUD to pay the plaintiff.”  Id. at 129-130.  The Court ruled that the city would be liable “unless it proves that, given a reasonable time, it has made a good-faith effort to obtain the funds from HUD and it has been unsuccessful.” Id. at 130.

Broadly worded “pay-if-paid” clauses can conceivably shift risk the risk of nonpayment even onto subs whose work is acceptable to the owner.  If the owner refuses to pay the GC due to some separate breach not involving a particular sub, will a “pay-if-paid” clause avoid the GC’s obligation to pay that sub?  That depends on the intent of the parties.  Rather than leave it to chance, this scenario should be addressed in the subcontract. 


Because subcontract terms only bind the parties to the agreement, a “pay-if-paid” clause will not protect an owner who hasn’t paid the GC for the sub’s work from direct liability to the sub on principles of unjust enrichment.  (The Merrimack County Superior Court so ruled in 2011 in Axenics, Inc. v. Turner Construction Company, No. 217-2010-CV-5001), rev'd on other grounds, 164 N.H. 659 (2013).  I’ll address this in a future blog.

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#5:  Mechanic's Liens and the Notice of Intent

5/20/2014

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New Hampshire law gives unpaid contractors, material suppliers and others involved in the construction process a lien on any private property improved, to secure the amount they are owed.  General contractors (those whose contracts are directly with the owner of the property) can obtain a mechanic’s lien without any advance notice to the owner, simply by marching into court any time within 120 days of the last date of work and getting a court-approved attachment of the property.  Subcontractors and others who do not have direct contracts with the owner, however, must give advance written notice of their intent to “lien the job” if they want to protect the full amount owed to them.

The rationale for this is easy to see.  Owners presumably know what they owe their general contractors, so they don’t need any advance notice in order to protect themselves.  But they may not know who all of the subs and suppliers are, or whether they have all been paid – even if they are smart enough to ask their GC for subcontractor and supplier lien waivers prior to cutting checks.  So, to protect the owner against having to pay twice for the same work (once to the general contractor and again to an unpaid sub or supplier), New Hampshire law provides that such lower-tier parties must give the owner a written “Notice of Intent to Lien” – or risk losing their liens, which will be capped by the amount that the owner still owes (or will owe) the general contractor on the date the notice of intent is received. 

This notice can be given before work starts, or during construction, or even after the construction is finished (although obviously not later than 120-days after the last date of the lien claimant’s work – the legal deadline for obtaining a lien).  But if the sub or supplier waits until after the GC has been fully paid the agreed contract price (or most of it), his notice will come too late to protect himself.  So why is it that subs and suppliers rarely take the ten minutes required to send owners a simple “Hi, I’m here, you need to worry about me” notice, alerting the owner up front of their intent to file a lien for any unpaid amounts?  Laziness?  Blind trust?  Not knowing who the real owner is?  These are all possible explanations, but I’ve found the most common reason is this:  For fear of upsetting the GC.


Here’s the thought process:  (1) “I want to continue to sell or work for this GC in the future.”  (2)  “If I notify the Owner of my intent to lien before my payment is due, my GC will find out and take it as an insult.”  (3)  “I’ll never do another job for this GC.”  Sub-subs go through a similar thought process with their subs.  So do supply houses (although this is less likely the larger the supply house is.)  Is it a valid concern?  Perhaps.  Can it be lessened?  Definitely!

The Notice of Intent has no prescribed form; anything that alerts the Owner to your existence as a potential lienor is sufficient.  You can soften it by making it appear –and actually BE – a matter of routine.  I recommend sending a benign statement after you start performance, one which puts the owner (and thus the GC) at ease.  You might try “Dear [owner]:  We have been contracted by [name of GC or sub] to furnish [describe the labor and/or materials] to your construction project, and have [now started/just completed/substantially completed] our performance.  While we anticipate no payment issues with our customer, it is our policy to alert owners up front that a mechanic’s lien may be placed on their property if, for some reason, that flow of funds is interrupted and we are not paid for our performance.  In that unlikely event, we will be placing a lien on your property.  You can minimize that risk by ensuring that your general contractor is timely paid for work performed, and by asking your general contractor for a lien waiver from us, which we will be happy to sign.” 

No GC should be offended by that.

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#4:  Warranty Obligations and Substandard Construction

5/14/2014

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When a builder builds for an owner, the contract will usually recite one or more warranties―what we lawyers call “express” warranties.  Or, the contract might be silent on the issue, raising the possibility of what we lawyers call “implied” warranties.  (I suppose a building contract could also disclaim all warranties express or implied, but I’ve never seen one of those.)  Building contracts can carry both express and implied warranties as long as they pertain to different subjects; if they are on the same subject, the express warranty will override any implied warranty.

Some construction contracts expressly warrant “good workmanship.”  Even if that is not expressed, New Hampshire law “recognizes an implied warranty that the contractor or builder will use the customary standard of skill and care," Lempke v. Dagenais, 130 N.H. 782, 794 (1988).  In either case, the warranty is that the work will meet the standard of care applicable to the building trades―that threshold level of quality we think of as acceptable construction. 


Building codes may prescribe the standard of care for some aspects of construction, but these codes are generally safety oriented, and don’t address everything.   Efforts to define the standard where the code is silent―when something should be deemed out of square or out of plumb, what fraction of an inch will be deemed “within tolerance” for some given aspect of the work, and so on―have occasionally been attempted (the National Association of Home Builders’ Residential Construction Performance Guidelines comes to mind).  But no written set of rules governs every possible situation.  Like Justice Potter Stewart’s famous “I know it when I see it” comment on the difficulty of establishing a legal test for obscenity, substandard construction is often easier to spot than to define.

Meeting this threshold standard of care will not always produce a satisfactory result for the customer.  The parties are free to agree on something more, and many express warranties do go further, warranting that materials used will be of a given quality, that a particular result will be achieved, or that the end result will be structurally sound.  (The one-and-only statutory warranty I am aware of, RSA 356-B:41, II, is of this type, providing that the declarant of a condominium “shall warrant or guarantee, against structural defects, each of the units for one year from the date each is conveyed, and all of the common areas for one year.”)  In such a case, meeting the standard of care won’t be enough; the builder must do what he promised, and repair or replace the warranted item regardless of whether the work was otherwise up to industry standards. 

Whether they are express or implied, warranties don’t last forever; they have a particular duration, and if a problem with the construction arises during that time frame, the builder is legally bound to make it good.  Notice that I said “arises,” not “is discovered.”  If the warranty period runs out before a problem is discovered, but the owner can prove that it actually arose earlier (although nobody noticed at the time), the builder is still on the hook.  Our Supreme Court said in Terren v. Butler, 134 N.H. 635, 639 (1991), in commenting on the condominium structural warranty, “We do not construe the one-year life of the statutory warranty to be a statute of limitations or even a time limit on the delivery of effective notice.  The one-year period describes the life of the duty, that is, the period during which breach may occur.”  Chances are good that the same analysis will apply to contractual warranties of good workmanship.

The length of an express warranty is a matter of negotiation.  Most express warranties I have seen recite a one-year duration.  Implied warranties last “a reasonable time,” and depending on the circumstances that could be more than a year―which is why I usually recommend to my builder clients that they specify a one year period for a warranty of good workmanship rather than roll the dice on how long a court might think the implied warranty lasts.  (As I said before, if they are on the same subject, the express warranty will override any implied warranty.)


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#3:  Is Your Sub-sub Really an Employee?

5/10/2014

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On May 8, the New Hampshire Supreme Court dealt a blow to businesses that hire one-person “independent contractors” on a regular basis to help them perform the usual scope of their services.  The case did not arise in the construction setting, but it has implications for subcontractors. 

Appeal of Niadni, Inc., 166 N.H. 256 (2014), ruled that a musician was an employee of the resort whose night club he had performed at nearly three hundred times in a two year period, even though he performed at other venues as well during this time.   The parties negotiated a pay rate for his services, and he was paid weekly for his performances.  He provided his own instruments and selected the songs he performed; the resort provided the stage and sound system.  After the relationship terminated he filed for unemployment benefits with the Department of Employment Security.  Following a hearing, a DES tribunal concluded that he was not an employee under the relevant statute, RSA 282-A:9, III, which provides:

"Services performed by an individual for wages shall be deemed to be employment subject to this chapter unless and until it is shown to the satisfaction of the commissioner of the department of employment security that:

(a) Such individual has been and will continue to be free from control or direction over the performance of such services, both under his contract of service and in fact; and

(b) Such service is either outside the usual course of the business for which such service is performed or that such service is performed outside of all the places of business of the enterprise for which such service is performed; and

(c) Such individual is customarily engaged in an independently established trade, occupation, profession, or business."

Specifically, the tribunal focused on item B of this ABC test, and concluded that the resort was in the business of, among other things, “coordinating” entertainment, which it distinguished from “the business of singing, playing instruments, or other forms
of entertainment.” 

The musician appealed to the DES Appellate Board, which had a very different view, finding that tribunal’s decision regarding the coordination of entertainment services was a “distinction without substance.”  It awarded benefits.  The resort then appealed to the Supreme Court, pointing to all the other things it did besides provide musical entertainment and arguing that these facts made the musician’s services “outside the usual course of the business for which such service is performed.”  While the Court acknowledged that this “can be an elusive concept,” it ultimately adopted a standard that doomed the resort’s appeal:  “[i]f . . . an enterprise undertakes an activity, not as an isolated instance but as a regular or continuous practice, the activity will constitute part of the enterprise’s usual course of business irrespective of its substantiality in relation to the other activities engaged in by the enterprise.”  Under this standard, it didn’t matter to the Court that the musician “was free to perform, and did perform, for other entities,” nor that its ruling “could encourage New Hampshire businesses to refrain from hiring those individuals and thus jeopardize the employment prospects of independent musical artists.”

Suppose you have a painting business or a drywall business, acting as a sub to various GC’s.  If you hire the painters or drywallers who do the actual work on an independent contractor basis, you’re going to want to keep using the good ones over and over, and if you are providing them steady work they may want that as well.  At some point the regularity of the relationship may convert these independent contractors into your employees, regardless of whether they furnish their own tools, regardless of whether they also work for others from time to time―perhaps even regardless of whether they buy the paint or the wallboard.  While your business may entail a lot more than just applying paint to surfaces or hanging wallboard on studs, under the standard adopted by Appeal of Niadni, Inc., their services are unlikely to be deemed “outside the usual course of the business for which such service is performed,” which would make them your employees at least for unemployment compensation purposes (the ABC test is not used for all employment determinations, e.g., workers compensation).


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#2:  Builder's Risk Insurance and Waivers of Subrogation

5/7/2014

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Almost all construction contracts require contractors to carry liability insurance, which covers most project accidents resulting in (a) bodily injury and (b) damage to property other than the work being constructed.  But liability insurance generally does not cover damage to “the Work,” i.e., the structure being built or the materials being used; it will almost always have an exclusion for “‘[p]roperty damage’ to ‘your work’ arising out of [‘your work’] or any part of [‘your work’].”  Nor will most owners’ ordinary property insurance policies cover that type of loss, thanks to typical coverage limitations excluding damage to an ongoing construction project.   For that, a “builder’s risk” policy is needed, with coverage for property losses during the course of construction.  

Either the owner or the contractor can obtain a builder’s risk policy, and the parties’ contract will typically specify which party buys the coverage.  In my experience, it is more common for owners than contractors to purchase builder’s risk insurance―perhaps due to the AIA form contract (The A201- 2007 provides at section 11.3.1: "Unless otherwise provided, the Owner shall purchase and maintain … property insurance written on a builder’s risk ‘all risk’ or equivalent policy form … comprising total value for the entire Project…This insurance shall include interests of the Owner, the Contractor, Subcontractors and Sub-subcontractors in the Project").  If the owner hasn’t bought builder’s risk insurance, the contractor still has the option to buy it.  It’s always wise to make sure up front, and not assume that the owner is obtaining builder’s risk insurance―even if the contract says the owner must procure it.  That’s better than buying a lawsuit, even one the contractor is likely to win (breach of an owner’s obligation to buy the builder’s risk insurance will almost surely result in a win for the contractor if the owner sues him for damaging “the Work”).

One pitfall here is that an owner’s builder’s risk policy does not automatically protect the contractor from liability if property loss occurs as a result of the negligence of a contractor (remember, the contractor’s liability policy won’t help here).  Without more, the contractor is at risk of being sued and having to pay damages―not to the insured owner, but to his insurance company who, upon paying out, is “subrogated” to the owner’ s rights. 


Although an insurer acquires a right to be subrogated to any claim an insured may have against the offending party upon payment of the loss, the insurer's right to subrogation derives from the insured's right against the offending party and is limited to those rights.  So, if the insured releases any claims the insured has against third parties to the extent covered by insurance―precisely what results from a “waiver of subrogation” clause such as is found in the typical AIA form―the insurer cannot chase the offending party for reimbursement of what it pays out under the policy.  (Naturally, insurers aren’t thrilled about this arrangement.  Some builder’s risk policies actually prohibit such waivers, in which case execution of the construction contract will violate the policy conditions and prevent recovery under the builder’s risk policy.)

The typical “waiver of subrogation” is a mutual one; each party waives rights against the other to the extent of insurance coverage.   (For instance, the AIA form says “The Owner and Contractor waive all rights against each other … for damages caused by fire or other perils to the extent covered by property insurance obtained pursuant to this Paragraph 11.3 or other property insurance applicable to the Work, except such rights as the Owner and Contractor may have to the proceeds of such insurance held by the Owner as fiduciary.”)  But for builder’s risk insurance purposes, it is the owner’s waiver that matters.  If the owner gets paid out by builder’s risk coverage and has waived the right to chase the contractor for any loss to the extent covered by insurance, the insurer is stuck with this, and contractor is safe from both owner and insurer.


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#1:  Contracting Around the Flow of Funds in the Construction Process

5/4/2014

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We live in a credit economy; few of us pay COD for anything anymore.  This is certainly true in construction.  Typically, everyone is paid for their labor or materials a month or more after their performance―owners need time to satisfy themselves (or to have their architects satisfy them) that work being invoiced for has been accomplished satisfactorily, and so they pay general contractors weeks after the end of a requisition period; general contractors pay their subs a week or so after that; subs pay their sub-subs and suppliers after they are paid (hopefully before their supplier’s “net 30” terms kick in).  And the lower you are in the food chain, the more risk of something going wrong above you; a weak link in the chain will plunge those below into the abyss when it snaps.

It all starts at the top.  Reasons that owners might not pay their GC’s for work performed usually fall into one of four categories: either (a) they don’t have the money, or (b) they think (rightly or wrongly) that some or all of the work being billed for is deficient, or (c) they think (rightly or wrongly) that “extra” work being billed for under a lump-sum or fixed-price contract is within the original agreed scope of work and not a true change, or (d) they think (rightly or wrongly) that the GC isn’t paying its own bills, e.g., insurance has lapsed, subjecting the owner to a risk of liability, or lower tiers aren’t being paid, subjecting the owner to a risk of mechanic’s liens.

What will happen in each of these scenarios is a matter of agreement between the parties.  Each party in the process can seek contractual provisions to limit its risks under each of these potential link-busters.  For example, GC’s can bargain for suspension and termination provisions in their contracts if payment is not timely received due to (a), or insert “pay when paid” or “pay if paid” clauses in their subcontracts in order to share the risk of (a) with their subs.  [I’ll be discussing this tool in a future blog.]  Subs can bargain for the right to be paid by the GC for their portion of the work even if there is a dispute under (b) regarding someone else’s scope of work.  Owners can bargain for “continue to work during disputes” clauses in their general contracts, foisting more risk onto the GC when payment is stopped due to (c).  Owners can bargain for “joint check” or “direct payment” methods of seeing lower tiers paid when (d) is in play.  I can think of dozens of other approaches.  The key is simply anticipating that what can go wrong will go wrong – and contracting around the problem up front as best you can.

Successful bargaining on these and similar matters is generally a matter of negotiating leverage.  A party will have more or less bargaining power depending on how much competition there is for their particular scope.  It all comes down to the alternatives available to the bargainers, and how badly they want/need the party with whom they are contracting.  Form contracts provided through the AIA and other groups attempt “fair” solutions on many of these issues, and are so popular that they have come to establish informal “default” rules on a number of payment topics.  This is often a useful bargaining chip when resisting an onerous payment provision in an owner’s or a GC’s proposed contract form – even one presented on a “take it or leave it” basis.

You don’t need a lawyer to negotiate a contract, and as long as you are savvy enough to anticipate the things that might go wrong and address them in your contract up front, you are probably well-served to try and negotiate your own deal with an AIA form as your template – at least for smaller contracts.  The larger the job, the more running a contract by your attorney makes sense.  But don’t wait too long; you will lose leverage once you are into the job.  If I had a nickel for every client who started work before their contract was signed, I’d retire from the practice of law and just write bogs full time!


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