Inside This Issue:
- Why Project Owners Aren’t Made Additional Insureds Under a Design Professional’s Errors and Omissions Policy;
- New TxDOT Consultants Errors & Omissions Procedures: Design Professionals and Insurers Beware!
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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
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.) [1]
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. [2] 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.
[1] The article written by David Hatem, Esq., for Central Artery/Tunnel Professional Liability Reporter, Vol. 2- No.1 (9/96) is as relevant today as it was when first published. He is with the law firm of Donovan Hatem, LLP in Boston. (617-406-4800).
[2] It must be noted, however, that even if a professional liability insurer, in some rare circumstance, for significantly increased premium, issued an additional insured endorsement, the endorsement would at a minimum (a) exclude any duty to defend the additional insured, and (b) expressly state that it provided indemnity to the additional insured only to the extent of liability directly attributable to the named insured’s negligent acts, errors and omissions as finally determined by a court of competent jurisdiction, and only after any appeals of a final determination have been exhausted. If the contract provided for arbitration, or any form of alternative dispute resolution in place of litigation, there would be no circumstances under which I would advise issuing an additional insured endorsement since the dispute determination would not adequately issue a fact finding and legal opinion establishing the factual and legal basis for determining the insured’s negligence and assessing damages directly attributable to that negligence.
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
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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RED VECTOR.COM — ON-LINE COURSES
Do you need year end continuing education courses? Currently available on-line risk management courses written by Kent Holland for RedVector, (http://www.redvector.com/instructors/view_related_courses.asp?id=195) include: ABCs of Time, Goals and Purpose – The Big Picture. Also available are: Contract Guide for the Design Professional, Design Build Professional Liability Risk Management and Insurance; Site Safety Risk and Liability; Risk Management for the Design Professional; Managing Communication, Documentation and Reports; Insurance for Design-Build and Complex Projects; Construction Contract Law; Contract Claims against Design Professionals; Insurance Coverage Disputes; and Environmental Claims.
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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.
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Publisher & Editor:
J. Kent Holland, Jr., Esq.
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