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#33:  Conflicting Contract Clauses

9/7/2015

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 Contracts are prepared by human beings, and human beings are imperfect; therefore, contracts are sometimes imperfect too.  One kind of imperfection is a conflict between two different contractual provisions.  It happens more often than you might think.  When it does, the question of which provision governs must be resolved.

Some contracts actually plan for the possibility of a conflict, and include an “order of precedence” clause to resolve conflicts among different documents or classes of documents comprising the contract.  These can be simple, such as Federal Acquisition Regulation 52.236-21 incorporated into government prime contracts (“In the case of difference between drawings and specifications, the specifications shall govern”), or exhaustive, such as the AIA A503 Guide for Supplementary Conditions (2007) suggested model language:

§ 1.2.1.1  In the event of conflicts or discrepancies among the Contract Documents, interpretations will be based on the following priorities:
     1. Modifications.
     2. The Agreement.
     3. Addenda, with those of later date having precedence over those of earlier date.
     4. The Supplementary Conditions.
     5. The General Conditions of the Contract for Construction.
     6. Division 1 of the Specifications.
     7. Drawings and Divisions 2–49 of the Specifications.
     8. Other documents specifically enumerated in the Agreement as part of the Contract
         Documents.

For situations in which the conflict appears within a single document or in documents of the same class, one sometimes sees a provision to the effect that the more burdensome one shall be deemed controlling.  An example is Steele Foundations, Inc. v. Clark Const. Group, Inc., 937 A.2d 148, 155 (D.C. 2007) (“in the event of a conflict between or among the terms of this Subcontract, the higher standard or greater requirement for Subcontractor shall prevail; and in the event of a conflict between or among the terms of the Contract Documents, the higher standard or greater requirement for Subcontractor shall prevail.”).

If there is no tie-breaking language in the contract, the matter can get dicey, particularly given that in New Hampshire (unlike many other states), conflicts and ambiguities in a contract are generally not resolved against the drafter.   Centronics Data Computer Corp. v. Salzman, 129 N.H. 692, 696 (1987) (“This court has applied the rule of construction that interprets ambiguous contract language strictly against its writer only in the context of insurance contracts.”).  On the flip side, there is no New Hampshire case law construing an ambiguous provision against a party who failed to request clarification.  The closest we have come is Summit Electric, Inc. v. Pepin Bros. Const., Inc., 121 N.H. 203, 207 (1981), which declined to address a lower court’s suggestion that failure to request clarification at bid time barred a claim for an extra (“We need not discuss, therefore, the correctness of the master’s finding that a general contractor must resolve any contract ambiguities prior to bidding”).

Courts apply various rules of contract construction in an effort to resolve ambiguities.  One common rule of contract interpretation is that if specific and general terms in a contract are in conflict, “a special clause qualifies a general one,” Shelby Mut. Plate Glass & Cas. Co. v. Lynch, 89 N.H. 510, 512 (1938).  See also Restatement (Second) of Contracts § 203(c) (1981) (“specific terms and exact terms are given greater weight than general language.”).  Another is that the court will place the same construction on a disputed provision that the parties, by their conduct, appear to have placed.  Auclair v. Bancroft, 121 N.H. 393, 395 (1981) (“In determining the parties’ intention, the court may properly consider their actions after the contract was executed.”).  This can have unintended consequences for a contractor who performs minor work he considers outside his scope without seeking an extra, and then finds that the minor work has mushroomed into major work.

The smart course is for contractors and subcontractors to scrutinize proposed contract language, including notes on plans, as carefully as time will permit before picking up a pen.  If an inconsistency is spotted, seek clarification or modification.  Even in a pre-bid meeting where concerns about educating one’s competitors loom large, speaking up will end up the wisest choice more often than not.
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#32:  The "Independent Duty" Exception to the Economic Loss Rule

8/2/2015

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Several months back I blogged on the Economic Loss Rule―the doctrine that restricts liability in tort for “economic loss” except in cases of a “special relationship” or negligent misrepresentation. Such losses are typically the province of contract law, not tort law.  I noted that the Plourde case made clear that the absence of a contract relationship with the offending party doesn't alter the application of the rule.  A few years later Wyle v. Lees, 162 N.H. 406 (2011), closed the loop, making clear that the presence of a contractual relationship doesn’t matter either.  One cannot sue for economic loss in tort “unless he is owed an independent duty of care outside the terms of the contract,” id. at 410.

At first blush, this quote from Wyle seems a bit tautological.  After all, if one is owed a duty “outside the terms of the contract,” then it must be a tort duty. But drilling deeper, the point being made is that an actionable negligent misrepresentation must be based on something more than what the parties' contract already promises.

The plaintiff in Wyle had purchased an apartment building from the defendants based on a listing agreement which stated that no improvements had been constructed without permits, and based on the contractor’s statement that he had done everything the Town asked him to do.  Both representations turned out to be false.  After correcting numerous code violations and thus incurring an economic loss, the plaintiff sued for negligent misrepresentation.  The defendants argued that the claim was barred by the economic loss rule, thus teeing up a question for the Court:  “While we have recognized an exception to the economic loss doctrine for a negligent misrepresentation claim when the plaintiff and defendant are not parties to a contract, we have never addressed the issue presently before us—whether the economic loss doctrine bars recovery for such a claim between two contracting parties.”  Id. at 410.

The Court ultimately decided in the plaintiff’s favor, noting that his claims “do not merely relate to a breached promise to perform the terms of the contract or attempt to recharacterize a breach of contract claim as a negligent misrepresentation,” but rather “alleged that the defendants' misrepresentations, unrelated to any material terms of the actual purchase and sale agreement, induced him to enter into the agreement.”  Id. at 412.  This “unrelatedness” was key, making the tort duty an “independent” duty.

The bottom line is that economic loss is recoverable in a negligent misrepresentation case despite the presence of a contract if a party’s misrepresentations induced the other party to enter into the contract in the first place.  Schaefer v. Indymac Mortgage Services, 731 F.3d 98, 109 (1st Cir. 2013) (“the negligent misrepresentation exception reaches only those representations that precede the formation of the contract or that relate to a transaction other than the one that constitutes the subject of the contract”).

Negligent misrepresentation, like fraud (i.e., intentional misrepresentation), is by nature an “economic” tort―in the sense that the expected value of something has been diminished as a result of disappointed expectations―so it stands to reason that the rule prohibiting economic loss recovery in a tort case would have an exception for the tort of misrepresentation, whether or not plaintiff and defendant have entered into a contract.  If they do have a contract, the misrepresentation claim must be based on something other than breach of the contractual promise, or else it is exclusively the subject of contract recovery.  In either case, a “benefit of the bargain” or “benefit of the representation” measure of damages is appropriate―in other words, economic loss.  The independent duty requirement assures that a valid tort theory is in play, and not a contract claim under a different guise.

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#31:  Insurance Coverage for the Consequences of Defective Work

7/15/2015

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Defective construction often has a domino effect, as poor workmanship in one area can damage perfectly good work in others.  A steel beam atop a multi-story steel-framed building, if welded improperly, can fall on and damage properly welded beams below.  The law is clear that a standard commercial general liability policy won’t cover the cost of replacing the poorly-welded beam.  But what about the others?

Consider this scenario:  a contractor builds a home, and months later gets a call from the homeowner complaining of water infiltration where the deck meets the house.  The contractor investigates, and finds out that improper flashing is the culprit and will have to be redone.  The adjacent sills were installed correctly, but they are now damaged and need replacing as well.

On reading his insurance policy, he finds the standard exclusion in section (J)(6) for "[t]hat particular part of real property that must be restored, repaired or replaced because 'your work' was incorrectly performed on it."  He asks his lawyer whether the clause excludes coverage for replacing the sills, pointing out that no defective work was “incorrectly performed on” the sills themselves.  His lawyer checks the latest developments in New Hampshire law, and gives him some good news:  the sills should be covered.  Cogswell Farm Condo. Ass'n v. Tower Group, Inc., 167 N.H. 245, 252 (2015), held that “exclusion J(6) bars coverage for property damage to the defectively constructed portions” but “does not bar coverage for damage to those portions of the units that were not defectively constructed . . . but were damaged as a result of the defective work.”

When the insurance carrier receives the contractor’s claim, however, it is unimpressed by the Cogswell Farm ruling, and denies coverage on the ground that there has been no “occurrence” – defined in the policy as “an accident, including continuous or repeated exposure to substantially the same general harmful conditions“ – to trigger coverage in the first place.  It notes that Cogswell Farm declined to consider whether there had been a triggering “occurrence” because the insurance carriers in that case raised the issue too late.  And it points to the Supreme Court’s admonition in Brown v. Concord Group Ins. Co., 163 N.H. 522, 528 (2012), that “to constitute an ‘occurrence,’ the damage at issue must have been to property other than [the contractor's] work product.”  For this purpose, the carrier maintains, the contractor’s “work product” means all of its work, not just the defective work.

Is the carrier right?  A definitive answer must await a case squarely presenting the issue that Brown did not present: whether damage to elements of the construction that were not defective is considered damage to a different work product for purposes of defining “occurrence.”  But contractors have reason to be optimistic.  A popular treatise on insurance law, quoted in Concord General Mutual Ins. Co. v. Green & Co. Bldg. and Development Corp., 160 N.H. 690, 693 (2010), states that “an occurrence is an accident caused by or resulting from faulty workmanship, including damage to any property other than the work product and damage to the work product other than the defective workmanship."  9A S. Plitt, D. Maldonado & J. Rogers, Couch on Insurance 3d § 129:4, at 129-13 to 129-14 (2005) (my emphasis).

Unless all the subsequent dominoes are insured, CGL policies have diminished value.  As the Alabama Supreme Court recently observed in Owners Insurance Co. v. Jim Carr Homebuilder, LLC, 157 So.3d 148, 155 (2014), “to read into the term ‘occurrence’ the limitations urged by [the carrier] would mean that, in a case like this one, where the insured contractor is engaged in constructing an entirely new building, or in a case where the insured contractor is completely renovating a building, coverage for accidents resulting from some generally harmful condition would be illusory.  There would be no portion of the project that, if damaged as a result of exposure to such a condition arising out of faulty workmanship of the insured, would be covered under the policy.”  The court found coverage for the subsequent dominos.  Perhaps our Supreme Court will do likewise.

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#30:  Termination for Cause or Convenience

7/4/2015

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The concept of termination of a contract for breach (usually referred to as “cause”) is as old as contract law.  If one party materially breaches a contract, the other party is excused from further performance and can end the contract without liability.  “Materiality” is the key here.  “Only a breach that is sufficiently material and important to justify ending the whole transaction is a total breach that discharges the injured party's duties.”  Fitz v. Coutinho, 136 N.H. 721, 725 (1993). 

From the contractor’s perspective, a failure to get paid always feels like a “material” breach.  But that is not necessarily the case.  The Fitz case just mentioned held that “[w]hether a delay in payments is a material breach is a question for the trier of fact to determine from the facts and circumstances of the case,” and affirmed a trial court finding that a failure to make the weekly payments prescribed by the parties’ contract did not qualify as “material.”  Conversely, from the owner’s perspective, a contractor’s poor workmanship feels like a “material” breach.  But that is not necessarily the case either.  McNeal v. Lebel, 157 N.H. 458, 465 (2008) (“so long as any flaws in Lebel's performance did not amount to a material breach . . . the plaintiffs were contractually obligated to allow him to finish the job.”).

Because the materiality of a breach is often debatable, contracting parties may prefer to specify in their written agreement the defaults that will justify termination.  For example, the AIA form A201 (2007) General Conditions of the Contract for Construction allows a contractor to suspend work on 7 days notice if not paid within 7 days after payment falls due (§9.7), and terminate the contract if the work remains suspended for an additional 30 days on account of that nonpayment (§14.1.1).  The Owner may terminate the contract if the contractor fails to supply enough workers or materials, fails to pay subs and suppliers, or repeatedly disregards applicable laws or regulations (§14.2.1).

Invoking specified grounds for termination is not without risk: if a court ultimately finds termination not to have been justified, the party who was wrongfully terminated can sue for breach and recover damages.  This risk is greatest for owners, whose grounds for termination are typically less clear-cut than a contractor’s termination for nonpayment.  Owners can lessen this risk by inserting a clause in their contracts that any purported termination for cause, if ultimately proved to be wrongful, shall automatically be deemed to constitute a termination for convenience.  This is a standard provision in government contracts.  See 48 C.F.R. 52.249-8(g) (“If, after termination, it is determined that the Contractor was not in default, or that the default was excusable, the rights and obligations of the parties shall be the same as if the termination had been issued for the convenience of the Government.”)

A termination for convenience clause allows termination of a contract without cause, and specifies the compensation to which the contractor (or subcontractor) will then be entitled.  For example, the AIA form A201 (2007) provides in §14.4.3 that upon termination for the owner’s convenience, “the Contractor shall be entitled to receive payment for Work executed, and costs incurred by reason of such termination, along with reasonable overhead and profit on the Work not executed.”  Some contracts have a less charitable measure of recovery for convenience terminations, limiting the terminated party to payment for work performed and denying any lost profits on work not performed.  In such a case, automatic conversion of a botched termination for cause into a termination for convenience not only insulates the terminating party from breach, but is a real money saver.

When contractors agree with owners (or subcontractors agree with contractors) to such reduced compensation upon termination for convenience, a peculiar and perhaps unintended result is that the owner or contractor can continue to shop the contractor’s or subcontractor’s price throughout the project, and if it finds someone willing to complete the work for less money, it can simply terminate the higher-priced contract and make a change.  Implied obligations of good faith and fair dealing are theoretical restraints against such a practice.  So are transaction costs.  But it can happen.

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#29:  The Economic Loss Rule

5/17/2015

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Tort law―the rules governing liability when one’s negligent or intentional conduct harms another―and contract law―the rules governing liability for broken promises―provide remedies for two different types of damages.  In general, tort law compensates victims for personal injury and property damage, while contract law compensates for loss of the benefit of a bargain―a commercial or “economic” loss.  Under tort law, “persons must refrain from causing personal injury and property damage to third parties, but no corresponding tort duty exists with respect to economic loss.”  Ellis v. Robert C. Morris, Inc., 128 N.H. 358, 364 (1986).  Under contract law, the economic loss rule “preclude[s] contracting parties from pursuing tort recovery for purely economic or commercial losses associated with the contract relationship,” Plourde Sand & Gravel Co. v. JGI Eastern, Inc., 154 N.H. 791, 794 (2007).

Notice that the statement I just quoted from the Plourde case follows automatically from the rule announced in Ellis, which would preclude everyone, not just contracting parties, from pursuing tort recovery for purely economic or commercial losses, whether associated with a contractual relationship or not.  Plourde itself made clear that the lack of a contract relationship with the offending party doesn't change this.  The plaintiff, a gravel supplier on a road project, was required by the site work subcontractor to replace gravel that the Town engineer’s testing company claimed was off-spec.  The plaintiff sued the testing company for negligence in testing the material, thereby costing the plaintiff needless expense―an economic loss.  It argued unsuccessfully that the Court should “decline to apply the economic loss rule because the plaintiff is not in privity with the defendant and therefore cannot recover its economic loss in an action for breach of contract.  We have never applied this principle before and decline to do so here.”  Id. at 795.

The message seems to be that you can only recover economic losses from parties you have a contract with (or, in legalese, are “in privity” with).  The economic loss rule, however, is not quite so ironclad.  New Hampshire recognizes two exceptions, also discussed in Plourde: (1) where there is a “special relationship” between the parties giving rise to a duty of care despite the absence of a contract between them; and (2) where there was a negligent misrepresentation relied upon by the plaintiff.

The “special relationship” exception, sometimes referred to as the "professional negligence" exception, applies when the negligent party has contracted with a third party to provide services that he knows are intended to benefit or influence the plaintiff.  (Example: insurance investigators “owe a duty to the insured as well as to the insurer” to perform their services properly; Morvay v. Hanover Ins. Cos., 127 N.H. 723, 726 (1986)).

The negligent misrepresentation exception applies where “the defendant has some special reason to anticipate the reliance of the plaintiff” on the defendant’s statements.  Spherex, Inc. v. Alexander Grant & Co., 122 N.H. 898, 903 (1982) (imposing tort liability on an accounting firm for economic loss suffered by a third party creditor who relied upon unaudited financial statements prepared by the firm).

In the construction setting, a contractor’s or subcontractor’s reliance on a design professional’s negligent drawings, specifications, opinions or instructions could allow recovery of economic losses under either one of these exceptions.  But don’t count on it.  Neither exception helped the plaintiff in Plourde, even though the defendant testing company must have known that its test results would be relied upon by everyone down the chain and ultimately require the plaintiff to replace its gravel.  Until our Supreme Court weighs in on particular fact patterns, the best an attorney can do here is make an educated guess.

The bottom line is that the economic loss rule is actually two rules.  If you don’t have a contract with the negligent party, recovery of economic losses flowing from that negligence requires proof of a “special relationship” or of negligent misrepresentation.  And if you do have a contract with the offending party, you cannot look beyond your contract to tort law for recovery of economic loss unless that party breached a duty to you independent of the contractual promises.  What constitutes an "independent" duty here will be the subject of a future blog.

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#28:  Excusing the Failure to Meet a Performance Spec

4/26/2015

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A few months back I blogged about design and performance specs, and noted that difficulties in meeting a performance spec can be excused when implementing it is impossible or commercially impracticable (i.e., impossible to achieve or achievable only at excessive cost).  In such a case, the contract documents call for a result that cannot reasonably be expected of the contractor under the parameters given.

The problem can arise whenever the designing engineer fails to appreciate how his specs are interrelated, and calls for two things that are in tension with each other.  To take a simple example, if a given design for a turf field requires permeability of X inches per hour (a performance spec) but also requires the underlying base stone to contain a high minimum percentage of small particles (a design spec), the net result will be that the air voids needed for good drainage will be filled with too many fines to achieve the required permeability.

Many contracts require the contractor to call to the architect’s or engineer’s attention any inconsistencies of this sort that the contractor happens to notice.  Unless the tension is glaring, however, a contractor will typically not spot the problem at bid time.  Even if subcontractor bids have been solicited for portions of the overall specs in advance of the contractor’s own bid, chances are they will not have been solicited very far in advance, and the most experienced specialty subcontractor could fail to notice a latent problem―particularly where other specs imposing some physical constraints on the options available to implement a given performance requirement happen to be buried in another spec section.

Some courts hold that the constraints imposed by those other specs can excuse a performance spec simply by unduly restraining the contractor’s choice of means and methods to achieve it.  That was the case, for instance, in Niagara County v. R & D Engineering, P.C., 298 A.D.2d 971, 973 (2002), a suit by a Water District against Goulds Pumps for furnishing pumps with “excessive vibration” beyond the maximum levels required in the specs.  Because the contract documents included “at least seven pages of the ‘details of construction’ for the pumps and their motors,” the Court found that “the vibration specification was not a performance specification, inasmuch as it cannot be said that Goulds was ‘free to choose the materials, methods and design necessary to meet the objective or standard of performance.’"

Other courts hold that “when a contract contains a mix of both design and performance specifications, the contractor may defend on an implied warranty theory if the design specifications are defective to the degree that adherence to them results in an article that fails to satisfy a stated performance specification."  R.J. Crowley, Inc. v. U.S., 1990 U.S. App. LEXIS. 21618 (Fed. Cir. 1990).

Still other courts hold that meeting a performance spec is excused if meeting related design specs renders the performance spec commercially impracticable.   An example is Waldinger Corp. v. CRS Group Engineers, Inc. Clark Dietz Div., 775 F.2d 781, 789 (7th Cir. 1985) (“We conclude that Ashbrook's inability to supply a filter press that would both satisfy Dietz's mechanical specifications and perform as required is sufficient to establish that performance of its contract with Waldinger was commercially impracticable.”).

Whichever of these approaches is taken, the basic concept is the same.  If design specs foreclose a contractor’s options to the point that meeting a performance spec becomes impossible or impracticable, failure to meet the performance spec will be excused. 

The risk to the contractor is that commercial impracticability, like beauty, is in the eye if the beholder.  A contract is commercially impracticable when performance would cause "extreme and unreasonable difficulty, expense, injury, or loss to one of the parties." Restatement (Second) of Contracts § 261 cmt. d (1981).  One judge or jury may have a different view than another of what is “extreme and unreasonable.”

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#27:  Contractor Liability for Dangerous Products

3/8/2015

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Recently 60 Minutes aired an exposé on Lumber Liquidators’ sales of Chinese-made laminate flooring containing elevated levels of formaldehyde, a known carcinogen.  Class action lawsuits against Lumber Liquidators in California and Florida quickly followed, alleging that the company knew or should have known that its laminate flooring products were mislabeled, improperly tested and unsafe.

The safety of a product purchased by a contractor is typically not something that the contractor worries about.  If the product is sold on the open market, the contractor presumes it to be safe, essentially relying on the seller to make sure that it is.  But to the homeowner, the contractor is the seller – and the homeowner usually indulges the exact same presumption.  If a contractor buys and installs a dangerous product, is he liable to his customer for any resulting injury?  The answer is far from clear.

In the context of a “transaction in goods,” the Uniform Commercial Code provides that all products sold by “a merchant with respect to goods of that kind” carry an implied warranty of “merchantability” promising, among other things, that the goods “are fit for the ordinary purposes for which such goods are used.”  Dangerous products – at least those whose danger is not apparent -- typically are not considered fit for their ordinary purposes in the absence of a warning.  Unless this implied warranty has been disclaimed by agreement of the parties (a rare event in the typical residential construction project) the contractor may be at risk―but only if he is both engaging in a “transaction in goods” and is a “merchant with respect to goods of that kind.”

Whether a contractor building a project is engaged in a sale of goods for purposes of the Uniform Commercial Code, or is simply furnishing a service, depends on which of two tests is applied: the “predominant factor” test, which asks “whether their predominant factor, their thrust, their purpose, reasonably stated, is the rendition of service, with goods incidentally involved,” or the “gravamen of the action” test, which asks “whether the underlying action is brought because of alleged defective goods or because of the quality of the service rendered.”   In re Trailer and Plumbing Supplies, 133 N.H. 432, 436 (1990).  While the “predominant factor” test was applied in that particular case (no claim of defective goods was made), the “gravamen of the action” test could well be applicable where defective installation is not at issue and the claim centers on a defect in the product itself―with the result that the contractor is more likely to be deemed a seller of goods under the Uniform Commercial Code.  The answer must await a test case.

But is the contractor also a merchant who “deals in goods of the kind?”  A singular sale of the offending product, standing alone, is not sufficient; such sales must be frequent enough to justify the conclusion that the contractor “deals” in them.  The more such sales it makes, the more likely the contractor is to pass this second test as well.

Apart from the Uniform Commercial Code, ordinary tort law sometimes renders a seller strictly liable for “unreasonably” dangerous products, i.e., where “the magnitude of the danger outweighs the utility of the product,” Vautour v. Body Masters Sports Industries, Inc., 147 N.H. 150, 154 (2001).  Fortunately for contractors, our Supreme Court has rejected strict liability for contractors, at least as to the structure as a whole:  “Although a building contractor supplies a structure to the owner, ‘[t]he generally accepted view has not been to impose strict liability, either on a warranty or tort theory, to the building contractor who is regarded as being engaged primarily in the rendition of a service, i.e., the construction of a building on land owned by another pursuant to plans and specifications provided by the owner.’”  Bruzga v. PMR Architects, P.C., 141 N.H. 756, 762 (1997).  Whether the case will immunize contractors from liability for a particular defective component of a structure remains to be seen, but this language certainly bodes well for contractors.  And the Court’s mention of a “warranty” theory within the scope of the general rule of nonliability may have promising implications for claims under the Uniform Commercial Code as well.

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#26:  Indemnity Obligations

2/13/2015

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Indemnity is the obligation of one party (the “indemnitor”) to protect another party (the “indemnitee”) from claims and damages asserted by third parties.  It can be either express (written into a contract) or implied (imposed by law as a matter of policy when a party who is free from fault is nevertheless held vicariously liable for the negligent acts or omissions of another). 

Express indemnity provisions are common in construction contracts, particularly for tort claims. An example is Section 3.18.1 of the AIA form A201 (2007) General Conditions of the Contract for Construction: “[t]he Contractor shall indemnify and hold harmless the Owner . . . from and against claims, damages, losses and expenses . . . arising out of or resulting from the performance of the Work, provided that such claim, damage, loss or expense is attributable to bodily injury, sickness, disease or death, or to injury to or destruction of tangible property (other than the Work itself), but only to the extent caused by the negligent acts or omissions of the Contractor, a subcontractor, or anyone directly or indirectly employed by or anyone for whose acts they may be liable.”

Providing indemnity “only to the extent caused by the negligent acts or omissions of the Contractor” or those for whom it is vicariously liable is an important limitation, making indemnity obligations proportionate to fault.  If, for example, an Owner’s negligence was the partial or sole cause of a third party’s damages, this language would require Owner and Contractor to bear the liability in proportion to the negligence (if any) ascribed to each.  But like any other clause in a form contract, this limitation is sometimes sought to be eliminated by the contracting parties.  I have seen a number of construction contracts that require one party to indemnify another even from the consequences of the indemnitee’s own negligence.  Such provisions were once enforceable in New Hampshire, at least where the parties had insurance to cover their indemnity obligations.  Commercial Union Assurance Co. v. Brown Co., 120 N.H. 620, 625 (1980), explained:

“Contracts which provide for indemnification of a party against his own future acts of negligence are generally not prohibited.  See 41 Am.Jur.2d Indemnity § 9 (1968).  This is especially true in the construction industry.  See 27 A.L.R.3d 663 § 2 (1969).  The courts have recognized that ‘Ordinarily the financial responsibility for the risk of injury during the course of a construction project is shifted in any event by the primary parties to their insurance carriers and the parties ought therefore to be free to determine how the insurance burdens will be distributed between them and who will pay for specific coverage for specific risks.  The impact of the indemnity agreement between owner and contractor and contractor and subcontractor is therefore, in practical effect, the parties’ allocation between themselves of the total required insurance protection for the project.’  Doloughty v. Blanchard Const. Co., 139 N.J.Super. 110, 116, 352 A.2d 613, 616 (1976).  The purpose of the indemnity agreement in the case before us was to allocate the insurance burdens of the parties; we do not see such an allocation as contravening public policy.”

In 2004 the New Hampshire Legislature changed this rule.  RSA 338-A:2 now provides: “Any provision for or in connection with a contract for construction, reconstruction, installation, alteration, remodeling, repair, demolition, or maintenance work, including without limitation, excavation, backfilling or grading, on any building or structure, whether underground or above ground, or on any real property, including without limitation any road, bridge, tunnel, sewer, water, or other utility line, which requires any party to indemnify any person or entity for injury to persons or damage to property not caused by the party or its employees, agents, or subcontractors, shall be void.”

After this statutory change, indemnification for personal injury and property damage claims (precisely the claims typically covered by a Commercial General Liability policy) now tracks fault regardless of whether the indemnitor's liability can be sloughed off to an insurance carrier.  But the statute does not address broader indemnity clauses which purport to shift liability for all claims, whether or not related to personal injury or property damage.



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#25:  Building Codes: The Baseline for Proper Construction

1/25/2015

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Since 2000, the International Code Council has published a version of its International Building Code every three years, setting forth the minimum requirements for design and construction of buildings within its scope.  (A separate International Residential Code governs the construction of one- and two-family dwellings.)  The Council also puts out an International Mechanical Code, International Plumbing Code and International Energy Conservation Code on the same three year cycle.

Currently New Hampshire has adopted the 2009 versions of these documents as its State Building Code (along with the 2014 version of the National Electrical Code).  Municipalities are free to adopt stricter standards than contained in these codes, but few municipalities do so.  Enforcement of the State Building Code is the responsibility of the municipalities; if they don’t have code enforcement officials, the State Fire Marshall steps in to fill that role.

RSA 155-A:2,VII is explicit that “The contractor of a building, building component, or structure shall be responsible for meeting the minimum requirements of the state building code and state fire code.”  But responsible to whom?  Certainly to the municipality for any fines assessed (RSA 155-A:8 and 676:17 authorize fines of $275 for the first offense and $550 for subsequent offenses, for each day that a violation continues after notice of noncompliance).  Likely to the owner, who will have a hard time getting a certificate of occupancy without a code-compliant structure.  But what about liability to third parties for physical injury or financial harm arising from the structure being out of code?

Our Supreme Court has yet to rely on this statute as a basis for contractor liability to an injured plaintiff, for the simple reason that no plaintiff has yet pressed the issue.  But the Court has noted in other contexts that violation of a statute or regulation can amount to negligence when the defendant already owes a common law duty of care to the plaintiff.  In such a case the defendant “will be held to the statutory standard of conduct if the plaintiff is in a class the legislature intended to protect, and the harm is of a type the legislature intended to prevent."  Marquay v. Eno, 139 N.H. 708, 714 (1995).  In the case of building codes, the harm intended to be prevented is physical injury from an unsafe structure.  If, indeed, a contractor owes a common law duty to potential occupants of a building to make it safe―and despite occasional hints, the Supreme Court has never explicitly declared that such a common law duty exists―the State Building Code would likely set the threshold standard of care, in which case its breach would automatically amount to negligence.

As to financial harm, it’s pretty clear that RSA 155-A:2,VII imposes no liability on the contractor, nor does it establish the standard of care for a common law duty owed by the contractor to the owner.  Building codes are intended “to protect the health and secure the safety of occupants of buildings, and not to protect the personal or property interests of individuals,” Island Shores Estates Condominium Ass'n v. City of Concord, 136 N.H. 300, 307 (1992).  An owner who wants the latter protection must get it from his contract, not from the statute.  (This is a variant of the “economic loss rule” that precludes recovery of purely financial harm in a tort case.  I’ll have more to say about the “economic loss rule” in a future blog.)

RSA 155-A:2,VII also states that “No municipality shall be held liable for any failure on the part of a contractor to comply with the provisions of the state building code.”   This language settles a question left unanswered by the Supreme Court in Island Shores Estates.  The case rejected an owner’s claim of financial harm against a municipality based on a building inspector’s issuance of a certificate of occupancy in the face of code and structural problems, because no duty was owed by the city to protect the owner’s financial interests.  However, the Court declined to decide “whether recovery can be had for a physical injury sustained on the premises in reliance on the inspection.”  The statute now answers that question in the negative.
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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 (Jan. 16, 2013), 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 the project is paid out of each progress payment check he writes to the 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.  For that reason, 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, limit 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).  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 “hard” lien waiver doesn’t get paid, he may well be held to the literal terms of the waiver despite nonpayment, and be unable to lien the project.  But if owner or lender is not disbursing in reliance on the truth of the waiver, and indeed knows it to be false, enforcement of the waiver may be difficult. (Chicago Bridge & Iron Co. v. Reliance Ins. Co., 46 Ill.2d 522, 264 N.E.2d 134 (1970), is worth a read on this subject.)

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 a document titled “lien waiver” does no more than give up lien rights.  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, 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 before picking up a pen 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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