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ConstructionRisk.com Report
http://www.ConstructionRisk.com
Vol. 9, No. 3, March 2007
Inside This Issue:
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Article
1
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Why
Project Owners Aren’t Made Additional Insureds Under a
Design
Professional’s Errors and Omissions Policy
By:
J. Kent Holland, Jr., JD.
ConstructionRisk,
LLC
www.ConstructionRisk.com
Executive
Summary
Adding
either a project owner or another architect/engineer as an additional
insured under a professional liability policy could have such serious
adverse consequences to all concerned parties that insurance carriers
historically have refused to issue such endorsements.
Design
professionals understand that it is contrary to their best interests to
name anyone as an additional insured under their professional liability
policy. For this reason,
they have historically insisted both to their clients and their
insurance carriers that additional insured endorsements can not be
issued.
Some
of the key problems with providing an additional insured endorsement
include:
1)
It may expand coverage to include claims against the additional
insured that are not attributable to the negligent acts, errors and
omissions of the named insured.
2)
It may create confusion concerning responsibility for the
Owner’s implied warranty of specifications to the contractor, which is
broader than A/E’s responsibility to the Owner for negligent design.
This could cause defense or asserted coverage for risks that only
the owner should bear as part of enhanced owner risks.
3)
It may turn routine contractor change order requests into claims
against the policy.
4)
It confuses the nature of the coverage in that project owners who
are not licensed professionals have no legitimate need for professional
liability coverage for professional services that they are not legally
entitled to perform.
5)
If the insured is a subconsultant to a prime A/E that is named as
an additional insured, the prime A/E could tender defense of a claim
against itself to the carrier
a) if the third party
claim includes any allegations (regardless of how minor) against the
subconsultant, or
b) if the third party
claim does not include allegations against the subconsultant but the
prime A/E defends itself against the claim by impleading the
subconsultant in to the suit or otherwise alleging negligence on the
part of the subconsultant.
6)
Defending the additional insured could seriously erode or even
exhaust the insured’s self insured retention (SIR) if defense is
included in an endorsement. But
since an insurance company would not agree, in any event, to include
defense as part of an additional insured endorsement, the insured would
actually be paying all the additional insured’s defense costs of the
additional insured out of its own pocket without limit..
Only
Negligence of the Insured Design Professional is to be Covered
Professional Liability Insurance for design professionals or
architects/engineers (AEs) has historically, and almost universally,
been unavailable to project owners as “additional insureds.”
There are good reasons for this, as explained in this memorandum.
If a project owner is named as an additional insured on a design
professional’s policy it could result in the policy responding to
claims that are not within the intent of the underwriter.
When underwriting a design professional, the insurance company
intends to cover only those claims that arise out of the negligent acts,
errors and omissions of the design professional.
Not all acts, errors and omissions that cause increased project
costs are covered.
Hypothetical: Omissions in
Drawings
Consider a situation in which the A/E’s drawings fail to show
details that affect the contractor’s ability to install HVAC duct
work. The contractor may
have fabricated its duct work off-site, and only when beginning
installation at the project learns that there are interferences with
structural steel members, plumbing lines and electrical conduits that
will prevent the use of some of the duct that has been fabricated.
In fact, this may cause a delay to the contractor and additional
cost in removing duct work, fabricating new duct work, and installing it
in a different configuration, manner and sequence than planned.
The contractor may be entitled to recover under a change order
for its reasonable additional costs resulting from the errors in the
drawings. This is because
the owner has a legal obligation to the contractor known as “implied
warranty of specifications.” The
question is whether these additional costs that must be paid by the
project owner to the contractor may be recovered by the owner from the
A/E. The answer is: “It
depends.” Specifically,
it depends on whether the omissions and errors by the A/E were negligent
or were merely errors that are reasonable errors within the normal
standard of care.
Owner
has Implied Warranty of Specifications but A/E Makes no Warranty
Whereas the A/E makes no guarantee or warranty that its
services, designs and specifications will be error free or perfect, the
project owner is deemed to have given an implied warranty of
specifications to the contractor. This
means that regardless of whether or not the specifications or drawings
were negligently drafted, the project owner is liable to the contractor
for the costs of changes in the event that the contractor cannot carry
out its work using those specifications and drawings.
In the hypothetical situation described above, if the project
owner were to deny the contractor’s change order request, the
contractor might file a claim or suit against the owner to recover its
damages. The project owner,
under common law principles, would not be entitled to recover its costs
of that contractor claim from the A/E absent proof that the costs were
attributable to the A/E’s negligence.
In the event that the owner made such an assertion, the A/E’s
policy would defend the A/E against the claim.
The A/E policy would not, however, defend the owner against the
contractor claim, nor would it pay any of the owner’s legal fees in
pursuing a claim against the A/E in the event that the owner brought the
A/E into the action a defendant.
Adding the Owner as
additional insured may broaden damages covered under the A/E’s policy
– including routine contractor claims
In the example above, when the contractor sues the owner to
recover its additional costs that it alleges were caused by the
defective specifications, the owner might tender the defense of the
claim to the A/E’s insurance carrier.
That could effectively give the owner access to the A/E policy to
defend against any and all contractor claims since most contractor
claims allege at least some minimal element of design defect.
In defending a contractor claim, the A/E’s policy would be
doing something that it fundamentally was not designed to do.
It would be responding to routine contract administration issues
and disputes rather than negligence on the part of the A/E for which the
A/E would have been liable at common law.
A stubborn and litigious owner that fights with its contractors
over change orders could tap into the A/E’s policy to help the owner
be even more litigious.
Knowing that its defense costs are being paid by the A/E’s
carrier would be an open invitation to a project owner to play hardball
with its contractors, disallowing change orders even when they are
reasonable. The project
owner could arbitrarily deny a change order and force the contractor to
file a claim or suit against the owner.
Since the contractor claim would naturally include an allegation
that the drawings were defective, the owner would tender the claim to
the insurance carrier—saying that the claim is based on negligent
design professional services. The
A/E and its insurer could find itself defending all kinds of run of the
mill change order requests that the owner effectively turns into claims.
Owners’
Risk of Design Defect may be Termed “Enhanced Owner Risk” and is
Different from that of the A/E
As explained by David Hatem, Esq., in an article first published
in the Central Artery/Tunnel Professional Liability Reporter, Vol. 2-
No.1 (9/96),
Owners
on construction projects typically are exposed to various risks,
including the risk of design defects, which are qualitatively and
quantitatively different and beyond the risk which generally are
assigned to design professionals.
By
granting an owner blanket, or qualified additional insured status, the
professional liability insurer would be exposing itself to coverage
(defense and indemnification) for risks, liabilities and claims which
potentially may substantially exceed the coverage traditionally offered
to design professionals.
Assuming
that the professional liability insurer has the obligation to defend the
owner (as additional insured) against such ‘enhanced owner risk’
claims, the professional liability insurer would potentially be
confronted with the frequent need to reserve its rights.
This would presumably disappoint the expectation of the owner.
It would also potentially deprive the insurer of the right to
control the defense and settlement of such claims—depending upon the
state law.
In
addition, ‘enhanced owner risk’ claims will expose the design
professional’s insurance coverage (typically written on an aggregate
basis) to significantly greater risk exposure and payment of claims
expenses. This will
generally serve to diminish coverage limits.
Moreover,
a blanket grant of additional insured status to the owner may indirectly
result in an expansion of the design professional’s contractually
negotiated indemnification obligation.
This could result from the deductible, SIR payment, or insurance
payment of the design professional being exposed to substantially more
risk than intended under the negligence-based indemnification
obligation.
Additional
Claim Scenarios Where Claim is Against Owner but an Allegation of
Professional Negligence is Thrown in for Good Measure
In addition to a variation of the change order claim scenario
described above, Mr. Hatem presents five other hypothetical claim
scenarios for the purpose of demonstrating the types of claims for which
an owner named as an additional insured under the design professional
liability policy might seek coverage.
In each of the claim scenarios, a claim arises against the owner
by either a third party or a construction contractor. Each claim
includes multiple allegations or theories of recovery, including design
professional negligence. The
negligence allegation may be completely unfounded and unsubstantiated.
It may be included in the complaint as part of the “kitchen
sink” approach so common today.
Examples of claim scenarios include the following:
1.
An adjacent property owner sues the project owner for property
damage and consequential damages due to negligent construction
operations, including alleged ‘design errors and omissions’ of the
owner’s design professional.
2.
A contractor sues a project owner for its failure to make timely
decisions in response to the design professional’s recommendations and
for arbitrarily rejecting contractor claims that the A/E recommended for
approval. In the
alternative, the contractor alleges owner liability for contract
documents containing ‘errors and omissions.’
3.
A family of an employee who was killed while working for a
general contractor on a construction site sues the project owner.
The allegations are that the owner severely limited site access,
failed to coordinate the activities of multiple contractors on the site,
and issued defective contract documents which failed to sequence
construction activities.
4.
A contractor sues a project owner for delay damages caused by
severe weather conditions, lack of owner-furnished permits, untimely
owner payment, owner failure to timely issue a notice to proceed with
construction, and unanticipated environmental conditions.
One final allegation is that the drawings contained ‘errors or
omissions.’
5.
Contractor sues the project owner due to differing site
conditions. Contractor
asserts that the owner had superior knowledge of the conditions that he
did not disclose to anyone. He
also asserts, as an alternative cause of action, that the contract
documents were ‘defective’ because they did not disclose the
conditions. (In this
scenarios, the design professional believes the contractor has a
legitimate differing site condition claim that should be paid by the
owner.)
In each of the claim scenarios above, the claims are brought
solely against the owner, but the allegations upon which the claims are
based include a combination of assertions.
Primarily, the allegations argue owner fault.
But they also make assertions concerning the design
professional’s performance.
By virtue of the owner being named as an additional insured, the
owner would likely tender to the professional liability carrier every
one of these claim scenarios. The
Owner would argue that the claim arose out of professional services
because each scenario contains an allegation concerning the professional
services. As a result, the
professional liability carrier could find itself defending the owner for
differing site conditions claims, site safety claims, etc. – none of
which the underwriter could have anticipated when issuing the policy.
Adverse
Consequence of Additional Insured Status Where
Project Owner is Additional Insured
Before responding to the claims presented in these scenarios the
insurer would first
carefully consider the allegations to determine if there is genuine
potential that the claim arises out of negligent performance of the
insured design professional. If
the insurer deems that the allegations do not suffice to prove
negligence against the A/E but instead are based on actions of the
project owner or others, it would either reject coverage outright or
proceed with a reservation of rights.
Moreover, it is almost impossible to imagine an insurer granting
an owner a “duty to defend” as part of any additional insured
status. Consequently, the owner would obtain no defense of any of the
claim scenarios. Since
the coverage of the policy is intended to be triggered only by the
negligent performance of professional services, the insurer may likely
also refuse to settle or resolve any dispute until a court had first
issued a judgment against the design professional.
The insurance company should be quite concerned if the project
owner, or an insurance broker, take issue with the established principle
that the E & O policy is intended only to respond to the A/E’s
negligence rather than to claims arising out of the Owners acts, errors
and omissions.
A project owner should be made aware that if it were to be named as an
additional insured under the policy, the "insured versus
insured" exclusion would then be applicable to bar coverage for
claims by the project owner against the named insured design consultant
-- quite the opposite of the intent desired by the owner.
Project owners are not
performing professional services.
The project owner does not have an interest in
obtaining professional liability for its own actions since the owner is
not a design professional. The
owner will have no license to perform professional services and it must
not perform professional services. For
this reason, therefore, there can be no purpose for a project owner to
be named as an additional insured for liability arising out of its own
actions since by definition its own actions cannot include professional
services.
Design professionals have good reason not to want the project
owner named as an additional insured.
Naming the owner complicates and strains the relationships
between the parties. It may
encourage claims against the owner by contractors and others to
inappropriately include unfounded allegations of professional
negligence.
In potentially having to defend the owner against claims that
arise because of owner acts, errors and omissions, the insurance
available to the A/E could be severely eroded or even exhausted.
There may be insufficient insurance remaining to cover legitimate
claims against the A/E. There
is also the problem for the A/E that its future ability to obtain
insurance will be impaired and/or that its insurance premiums will be
significantly increased.
For all the reasons discussed above, design professionals,
insurers and brokers should explain to project owners that additional
insured status is not necessary and appropriate to protect the
legitimate interests of the owner. It
also is harmful to the design professional and may have unintended
consequences for all concerned.
Where another Design
Professional is the Additional Insured
The Harm to the Insured. Additional
problems are created if the insured design professional is providing
services under a subcontract to a prime architect or engineer and that
other firm requests that it be named as an additional insured.
Where the prime architect is performing professional services for
the project in addition to the services being provided by the
subconsultant, it is possible that a suit by a third party alleging
professional liability will name both the prime architect as well as the
insured subconsultant. This
could also happen even if the only professional services allegedly
performed by the prime A/E involve negligent selection and supervision
of the subconsultant.
Defending a complex claim against the prime A/E could be
extremely costly to the insured.
Since an additional insured endorsement would not cover defense
costs, the insured would be paying out of its own pocket all the defense
costs of additional insured, prime A/E.
The subconsultant would be paying the A/E’s legal defense costs
as they are incurred rather than reimbursing them after a final
determination of liability. If,
however, the additional insured endorsement covered defense costs, the
insured would still be gravely injured because the defending the A/E
would erode or exhaust its self insured retention (SIR). For an insured
that has a large SIR for each and every claim (with no aggregate SIR),
this could be especially devastating.
The Harm to the Insurance
Company. In virtually
every claim against a prime A/E, the
claim will also name the subconsultant or will include allegations
concerning services performed by the subconsultant.
Even if the complaint does contain allegations concerning the
subconsultant, however, the prime A/E who is an additional insured will
most certainly bring its own action (impleader claim) against the
subconsultant so that the subconsultant becomes a co-defendant and the
prime A/E reaps the benefit of coverage under the additional insured
endorsement.
The insurance carrier had no opportunity to underwrite the prime
A/E. It may have even been
willing to provide coverage to that A/E if it had an application from
that firm showing its claim history, project history, financial
information, and other information needed for underwriting.
Basically, the prime A/E would be obtaining professional
liability coverage for its own actions as well as those of the
subconsultant, without having to go through the underwriting process and
without having to pay premium for the coverage.
In addition to other problems, this could create a moral hazard
in that the prime A/E would have an incentive to be creative in
responding to claims so that it could shove claims under the named
insured’s policy and thereby avoid having to have its own carrier pay
the claim. In future
insurance applications, the A/E might even reap lower premiums from its
own carrier for having successfully shifted the claim to the
subconsultant’s carrier.
For these reasons, it is not advisable for professional liability
carriers to issue additional insured endorsements for the prime
architects and engineers for whom their insured’s serve as
subconsultants.
.
About the author: Kent Holland is a
construction lawyer located in
Tysons Corner
,
Virginia
, with a national practice representing design professionals,
contractors and project owners. He is principal of
ConstructionRisk, LLC, providing insurance risk management services and
construction risk management services, including but not limited to,
advice to insurance underwriters; guidance to those procuring insurance;
change order and claim preparation, analysis and defense; contract
preparation; contract review and contract negotiation. Mr. Holland
is publisher of ConstructionRisk.com Report and may be reached at
Kent@ConstructionRisk.com
or by calling 703-623-1932. This article is published in ConstructionRisk.com
Report, Vol. 9, No. 3.
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Article
2
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..
New
TxDOT Consultants Errors & Omissions Procedures:
Design
Professionals and Insurers Beware!
By:
J. Kent Holland, Jr., JD.
ConstructionRisk,
LLC
www.ConstructionRisk.com
In December 2006, the
Texas Department of Transportation (TxDOT) issued new procedures to be
applied in engineering, architectural and surveying contracts. These are
called “Consultant Errors & Omissions Correction and Collection
Procedures.” These
procedures appear to create significant uninsurable risks for
consultants and will deprive consultants of due process to challenge
determinations by TxDOT concerning responsibility for errors and
omissions.
TxDOT Procedures based on Fundamental Misunderstanding of Common
Law.
The problems begin with the following statement that appears
at page one of the Procedures: “During
and after construction, errors and omissions can result in additional
costs that TxDOT would not have incurred if the construction plans has
been correct. Under contract law, the resulting additional costs are
considered damages that TxDOT is entitled to collect.”
This inaccurate description of the law is the foundation for
the Procedures that follow in which TxDOT states that it can assert that
all errors and omissions that cause extra contractor costs (change
orders) are per se the
responsibility of the consultant and that TxDOT will issue a demand
letter to collect such extra costs without regard to whether it can
demonstrate that the consultant was negligent.
Presumption of Liability, and Deprivation of Due Process.
The structure of the Procedures, and the hearings provided
for by the Procedures and the Texas Administrative Code, are not
intended to address whether the consultant was negligent.
Instead, there is a presumption built into the Procedures that
any change order costs arising out of errors and omissions are the
responsibility of the consultant without regard to whether the
consultant’s errors and omissions were made within the standard of
care. There appears to be no
way to challenge that determination within the administrative process.
At common law, the project owner is deemed to have given an
implied warranty of specifications to the construction contractor, but
the consultant does not give the same warranty to the project owner.
This means that it is entirely possible that the project owner may be
required to pay a construction contractor change order costs resulting
from changes necessitated by errors and omissions in the drawings and
specifications, but be unable to recover those same costs from the
consultant that was responsible for the drawings and specifications. In
the absence of these peculiar Procedures, in order to recover from the
consultant, TxDOT would have to present expert testimony in court to
prove the standard of care and to prove that the consultant failed to
meet the standard of care, i.e, that the designer was negligent.
If I am reading the Texas Administrative Code correctly, the
consultant and its insurance carrier will never have a day in court in
which to have the opportunity to argue that whatever errors and
omissions may be alleged, they are not negligent ones.
Since the decision of the TxDOT can only be reversed on appeal if
the Administrative Law Judge finds fraud or abuse of discretion by the
TxDOT officials in reaching their decision, the actual merits of the
underlying case may never get litigated.
Manipulating the Claims Process.
The effect of these Procedures is that every construction
change order will become a potential claim by TxDOT against the
consultant. In what may
appear to be an effort to capture as much insurance coverage as possible
for these “claims,” the Procedures state that TxDOT will cooperate
with the Consultant whose “consideration
of a deductible and number of occurrences per year may affect their
preference for combining or staging payments related to one project. One
total payment versus two or more separate payments may be preferred.”
(Section 7.0)
Insureds must keep in mind that each change order that arises
out of a unique negligent act, error or omission will be considered a
separate “claim.” Separate
claims cannot be combined as suggested by TxDOT into a single claim to
avoid the deductible applicable to each claim.
Moreover, the consultant would be required to report each
individual claim arising out of a change order promptly as it becomes
aware of it. It is not permitted by the policy to withhold notice until
it has combined a number of change order claims into one single large
claim.
Requiring Pre-payment of Change Order Costs before Administrative
Review. Another problem
with the Procedures is that they appear to require the Consultant to pay
change order costs demanded by TxDOT before an Administrative Review may
be requested. In my view, this is a rather stunning deprivation of due
process, particularly in view of the fact that most consultants do not
have large assets and will not be able to pre-pay a “claim” before
defending against it.
Contractual Liability
Exclusion. The insured
consultant, and its insurance broker, should keep in mind that pursuant
to the terms of the professional liability policy, coverage is only
provided for claims arising out of the Consultant’s negligent
performance of professional services.
Not all errors and omissions are deemed negligent at common law
and consequently, at common law, a consultant is note deemed liable for
costs or damages arising out of every error or omission.
To the extent that the Consultant, by virtue of entering into a
contract with TxDOT, becomes contractually liable for change order costs
resulting from all errors and omissions instead of only negligent errors and omissions, coverage could be barred pursuant to
the contractual liability exclusion of the professional liability
policy.
Warranty Exclusion. It
would appear that committing to these TxDOT Procedures could constitute
a warranty of perfect, error-free services. Coverage for claims arising
out of such a warranty may be excluded pursuant to the warranty
exclusion of the policy.
Unauthorized Compromise
and Settlement. In
addition to the exclusions of the policy that make risks assumed by
consultants under the new TxDOT procedures uninsurable, the Consultant
should keep in mind that the Claims procedure of the policy establish a
duty of the Consultant to cooperate with the insurance carrier and to
not take any action that would compromise or settle any claim without
prior notice to the insurance carrier.
By agreeing to the TxDOT Procedures, the consultant would appear
to be forfeiting its rights to ordinary due process, thereby prejudicing
the ability of the insurance carrier to adequately defend a claim,
present expert testimony, and otherwise assert typical defenses showing
it complied with the generally accepted standard of care.
Such prejudice to the claims process set forth in the policy may
be a basis for denying coverage under the policy.
Material Change in Risk
Presented by Insured Consultant. The
insurance carrier will also be concerned that if a consultant must pay
large change order costs to TxDOT, this may impact the financial ability
of that consultant and thereby adversely affect its ability to
satisfactorily perform services on other private projects on which
insurance coverage is applicable.
A consultant’s uninsured claims on TxDOT projects could
materially change the risk that the consultant poses to the insurance
carrier—even on projects not related to the TxDOT project.
Such a material change may influence the carrier’s underwriting
decisions, including the decision to terminate or non-renew consultants
that perform services for TxDOT under the new Procedures—or at a
minimum, significantly increase the insurance premium to cover the
increased risk exposure.
Additional
Comments on Specific Language Include the Following:
*
2.0 Error and
Omission Correction. “Consultants
are responsible for promptly correcting errors and omissions without
compensation….”
On projects in most states (including Texas as far as I know),
the question of whether or not a consultant will be compensated for
correcting errors and omissions without compensation depends on the
nature of the error and omission. When
performing additional services as a result of errors and omissions in
their initial drawings and specifications, consultants are often
compensated for their time and effort – provided that their errors and
omissions aren’t deemed to have been negligent.
There is no blanket rule depriving a consultant of such
compensation. In fact, a
project owner may deem it more cost-effective to pay for some redesign
services along the way rather than attempt to design perfection up front
and pay significant additional up-front design fees for having the
consultant attempt to create the perfect, error-free design in the first
instance.
2.1.
(last sentence) “TxDOT
Design PM should be able to clearly differentiate among routine
mark-ups, design changes identified at TxDOT’s request/preference, and
errors and omissions in the form of an incorrect design or unacceptable
plan sheet preparation.”
Comment:
From the above statement, it might appear that TxDOT recognizes
that not all errors and omissions rise to the level of consultant
responsibility. But if this
is a recognition that only negligent acts, errors and omissions are the
responsibility of the consultant, it does not clearly so state.
Moreover, even if that were the intent, it is difficult to
understand how a “PM should be able to clearly” decide that the
errors and omissions are negligent ones.
In court, an expert witness is required to testify before that
determination can be made. In
court there would also be an opportunity for opposing experts to counter
that testimony. How is that
accommodated in this procedure? It
is not.
4.0
When to Finalize Additional Costs (2nd paragraph)
“
Within a reasonable time after execution of each change order [involving
consultant errors and omissions], the TxDOT Construction PM should
coordinate with the consultant to verify and finalize the additional
cost to be recovered and complete any necessary documentation.”
Comment: This
paragraph reiterates that TxDOT expects a project manager to make a
decision on each change order as to whether to demand that the
consultant pay the costs of the change.
This has the affect of turning each and every change order into a
claim against the consultant. Later
in the procedures (7.0), TxDOT recognizes that this might create an
insurance problem and thus suggests that the consultant (with TxDOT
consent) might want to aggregate the change orders into a single
claim—apparently so as to meet deductible requirements.
See my comments on that at section 7.0 below.
4.1 Project Completion.
This section
states that upon completion of the project, TxDOT is to review change
orders and notify the consultant of the additional costs to be paid by
the consultant. The
consultant is given 30 days to request a meeting in response to that
letter/notice. If the
consultant fails to request a meeting, TxDOT proceeds to cost recovery
procedures set forth in section 7.0 “Cost Recovery Procedures” and
section 10 “Debt Collection.”
Comment:
There is never an opportunity in this process for the consultant
or its insurance carrier to have due process and an opportunity to
legally challenge its responsibility.
There is a presumption of negligence and the consultant has no
opportunity under this procedure to disprove that presumption.
5.0
Contractor Claims Following Construction.
This section creates all the same issues as identified in
paragraph 4, but is for a different point in time—contractor claims after
construction has been completed instead of during construction.
7.0
Cost Recovery Procedures (2nd paragraph)
“The
consultant may disagree with the determination of responsibility at the
time of change order, at project completion, or during the processing of
a contractor claim after construction.
If there is a genuine disagreement, TxDOT should look for a way
to resolve the disagreement through negotiation and compromise prior to
initiating cost recovery procedures.
The consultant cannot request Administrative Review [see 8.0] of
the disagreement until after the initial notification letter [see
7.1].”
“The
involvement of an insurance company is the consultant’s decision, but
the consideration of a deductible and number of occurrences per year may
affect their preference for combining or staging payments related to one
project. One total payment versus two or more separate payments may be
preferred. Within reason,
TxDOT should be flexible in considering options, if requested.”
Comment:
Pursuant to the Claims provisions of the insurance policy, the
consultant must not settle or compromise any claim without prior notice
to the carrier. If the TxDOT
determination of consultant responsibility for costs on a change order
is considered a dispositive decision of error and omission, it would
appear that every change order must be treated as a claim since it
automatically results in a determination of responsibility by TxDOT.
This section is also troublesome because it appears to suggest
that TxDOT and the consultant may cooperate to combine multiple claims
arising out of multiple change orders into just one or two claims so as
to avoid multiple deductibles. One
can only imagine the arguments over whether these multiple change order
occurrences—each with its own deductible since it is an individual
claim—can be reduced to a single large claim as suggested by TxDOT
with only a single deductible. Unless
the change orders arise out of the same error and omission, there would
be not basis for combining them into a single claim.
The consultant and insurance carrier would instead have to
address each as a separate claim as it is occurs.
7.1.
Initial Notification Letter
“The initial notification letter serves as the first formal request
for payment indicating the consultant’s liability for the identified
debt.”
“The letter should also indicate the following:
●
Within 30 days of the date of the letter a response is required
with:
° payment or
° intent to pay with
explanation of when the payment will be submitted or
° written
explanation of disagreement with request for Administrative Review
●
Payment is required in order to file a contract claim….
●
If payment is not received, TxDOT will proceed to collect the
debt according to 43 TAC 5.10 Collection of Debts.
●
Specific Instructions on how to remit payment.”
Comment:
This “notification letter,” being what the TxDOT calls the
“first formal request for payment” might reasonably be deemed the
“Claim” that the insured must provide to the carrier and that would
require a response under the insurance policy.
Failure of the consultant to submit within 30 days a “written
explanation” and a “request for Administrative Review” could be
deemed a breach of the duty to cooperate with the insurance carrier in
defending a claim, and could cause forfeiture of the consultant’s
potential coverage under the policy.
This section is confusing in that it contains a bullet stating
that “Payment is required in order to file a contract claim.
The Texas Administrative Code defines a “Claim” as any
“dispute” and not just as an affirmative demand by the consultant
for compensation from the Department. Even if
the language is to be restricted to apply only to affirmative consultant
claims, however, the consultant is put at a major disadvantage if it has
to first pay contractor’s change order costs before it can recover its
own final payment for professional fees.
8.0
Administrative Review
This
section, when read in conjunction with section 7.1.2, provides that the
consultant may seek review of the initial notice letter by the
“Assistant Executive Director of Engineering Operations.”
Comment:
It is not at all clear how the process works, but it appears that
the request for review goes to the district office of TxDOT and that
this office then involves the Design Division—Consultant Contract
Office (DES-CCO). After the
Assistant Executive Director makes a decision, the DES-CCO prepares a
letter and sends it to the consultant.
The procedures do not state whether the letter will contain any
fact finding or legal opinions—but
presumably not.
The letter issued by TxDOT gives the consultant only two options
in the event that the decision is adverse to the consultant.
The first option is to make payment immediately, and the second
option is to respond with an intent to make payment on a payment plan.
The section states “Payment is required in order to file a
contract claim. Upon
payment, a claim can be submitted to the TxDOT Contract Claim Committee
according to the procedures set forth at 43 TAC 9.2 Contract Claim
Procedure.
This language about making payment prior to being permitted to
file a claim is the same as found at 7.1 “Initial Notification
Letter” and remains confusing as to whether it means that the
consultant cannot challenge the administrative decision that was issued
by the AED without first paying the amount that the decision stated was
due. See also 9.0 below.
9.0
TxDOT Contract Claim Committee
“In
order to file a contract claim, the consultant must first pay the amount
requested and proceed with submitting a claim to TxDOT….
Without payment, there can be no claim.”
Comment:
See my previous comment concerning this matter where it also
appears at section 7.1 and 8.0.
10.0
Collection of Debt
This
lengthy section of the procedures addresses how TxDOT is to prepare and
send certified letters to the consultant, and initiate collection of the
amount previously determined due, in the event that the consultant fails
to pay the amount demanded.
Comment:
Although the consultant could litigate to contest the debt
collection, there appears to be no way to litigate the basic issue of
whether the consultant’s alleged acts, errors and omissions giving
rise to the change order were negligent.
The pertinent section of the Texas Administrative Code, Title 43,
Part 1, chapter 9 that is referenced in this procedure is located at:
http://info.sos.state.tx.us/pls/pub/readtac$ext.TacPage?sl=R&app=9&p_dir=&p_rloc=&p_
tloc=&p_ploc=&pg=1&p_tac=&ti=43&pt=1&ch=9&rl=2
The procedures for a having a contested case heard by an
Administrative Law Judge in Texas are set forth in Title 43, Part I,
Chapter 1, Subchapter E, Rule 1.21, et seq.
See:
http://info.sos.state.tx.us/pls/pub/readtac$ext.TacPage?sl=T&app=9&p_dir=N&p_rloc=119113&p_
tloc=&p_ploc=1&pg=7&p_tac=&ti=43&pt=1&ch=1&rl=2
It appears that the party bringing the contract claim (i.e., the
consultant) has the burden of proof to prove that the department
decision was not only incorrect but was “based on fraud, misconduct,
or such gross mistake as would imply bad faith or failure to exercise an
honest judgment.”
This is an extraordinarily high standard.
It is essentially the same standard of review that a party must
meet in order to get a court to overturn a decision by a arbitrator.
What this means is that the consultant never has an opportunity
to get a decision on the merits concerning whether it performed its
services within the standard of care and therefore was not negligent.
This also means that the E & O carriers never gets an
opportunity to have a court determine whether the alleged act, error or
omission was negligent and therefore covered under the professional
liability policy. In the
absence of such a determination, I do not understand how coverage for
claims on TxDOT projects can be resolved.
Conclusion:
For the reasons explained above, consultants need to
understand that they may incur significant uninsured risks when
performing professional services for TxDOT under the new Procedures.
Insurance carriers that insure consultants performing services
for TxDOT will need to be aware of the problems that they and their
insureds may experience as a result of these new Procedures.
About
the author: Kent Holland is a construction lawyer
located in
Tysons Corner
,
Virginia
, with a national practice representing design professionals,
contractors and project owners. He is principal of
ConstructionRisk, LLC, providing insurance risk management services and
construction risk management services, including but not limited to,
advice to insurance underwriters; guidance to those procuring insurance;
change order and claim preparation, analysis and defense; contract
preparation; contract review and contract negotiation. Mr. Holland
is publisher of ConstructionRisk.com Report and may be reached at
Kent@ConstructionRisk.com
or by calling 703-623-1932. This article is published in ConstructionRisk.com
Report, Vol. 9, No. 3.
_______________________
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Also available are: Contract Guide for the Design Professional,
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Design-Build and Complex Projects; Construction Contract Law; Contract
Claims against Design Professionals; Insurance Coverage Disputes; and
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______________________
ABOUT THIS NEWSLETTER & A DISCLAIMER
This newsletter Report is published and edited by J. Kent Holland,
Jr., J.D. The Report is independent of any insurance company,
law firm, or other entity, and is distributed with the understanding
that ConstructionRisk.com, LLC, and the editor and writers, are not
hereby engaged in rendering legal services or the practice of law.
Further, the content and comments in this newsletter are provided for
educational purposes and for general distribution only, and cannot apply
to any single set of specific circumstances. If you have a legal issue
to which you believe this newsletter relates, we urge you to consult
your own legal counsel. ConstructionRisk.com, LLC, and its writers and
editors, expressly disclaim any responsibility for damages arising from
the use, application, or reliance upon the information contained herein.
Copyright 2007, ConstructionRisk.com, LLC
Publisher & Editor:
J. Kent Holland,
Jr., Esq.
8596 Coral Gables Lane
Vienna
,
VA
22182
703-623-1932
Kent@ConstructionRisk.com
_____________________________________________
_____________________________________________
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