Inside this Issue

A1 - Assignee of Contract Indemnification Rights under a Design-Build Contract Stands in Shoes of Indemnitee and is Entitled to Recover Defense Costs
A2 - Expert Survey of Small Sample of Walls Sufficient to Justify Opinion that Much Larger Area of Walls Must be Torn out and Replaced by Design-Builder for Failing to Meet Specifications for Rebar
A3 - Design-Builder Entitled to Contractual Indemnity from Subcontractor for Damages to Turbines
A4 - CGL Insurance Covers Damages Caused by Defective Workmanship of Subcontractor
A5 - Liquidated Damages in Design-Build subcontract Are Enforceable Even Where Far Exceeding Actual Damages
A6 - Contractor Permitted to Sue Architect for Implied Warranty of Specifications
A7 - Architect Owes No Contractual or Common Law Duty to Third Party for Alleged Negligence in Construction Administration Services Performed for Its Client-Homeowner

Article 1

Assignee of Contract Indemnification Rights under a Design-Build Contract Stands in Shoes of Indemnitee and is Entitled to Recover Defense Costs

Where a firm (Parsons Infrastructure) entered into a contract to design and construct a soda ash processing plant for Kerr-McGee Chemical Corp (KM) and agreed to provide KM with a defense and indemnity against losses arising out of negligent performance of its work, and KM later assigned its property and contract to a new firm (Searles Valley Mineral Operations), Searles, as assignee of KM, paid defense costs on behalf of KM that were incurred in defending against a wrongful death action by the heirs of a deceased laborer who was killed while working at the plant. A California court held that Parsons was obligated to reimburse the defense costs even though they were not incurred directly by KM but were instead paid by Searles on behalf of KM. Searles Valley Minerals Operations, Inc. v. Ralph Parson Service Company, 191 Cal.App. 4^th 1394 (Cal. 2011).

The court concluded that an assignee of contract indemnification rights stands in the shoes of the indemnitee. Consequently, where the indemnitor refuses to pay an indemnitee’s defense costs, the indemnitee, and in turn the assignee of the indemnitee, can pay the costs and then seek reimbursement from the indemnitor.

The indemnification clause in question provided the following:

Contractor [Parsons], agrees that it will, at its sole cost and expense, defend, indemnify and save Owner [KM], its subsidiaries, and their officers and employees, harmless from and against any and all claims, demands, causes of action and liabilities for loss of use or damage to property ... or for bodily injury, personal injury or death arising out of Contractor's (or its subcontractor's) negligence (including, as respect bodily injury, personal injury or death, the contributory negligence of Owner [KM] ) in connection with any work which Contractor (or its subcontractors) shall perform pursuant to this Agreement or any operations or activities of Contractor (or its subcontractors), in connection therewith.

In determining the obligations under this indemnification clause, the court cited Crawford v. Weather Shield Mfg., Inc, 44 Cal. 4^th 541 (Cal. 2008), and the California Civil Code, section 2778 that specifies indemnification obligations. The code provides the following:

In the interpretation of a contract of indemnity, the

following rules are to be applied, unless a contrary intention

appears:

1. Upon an indemnity against liability, expressly, or in other

equivalent terms, the person indemnified is entitled to recover upon

becoming liable;

2. Upon an indemnity against claims, or demands, or damages, or

costs, expressly, or in other equivalent terms, the person

indemnified is not entitled to recover without payment thereof;

3. An indemnity against claims, or demands, or liability,

expressly, or in other equivalent terms, embraces the costs of

defense against such claims, demands, or liability incurred in good

faith, and in the exercise of a reasonable discretion;

4. The person indemnifying is bound, on request of the person

indemnified, to defend actions or proceedings brought against the

latter in respect to the matters embraced by the indemnity, but the

person indemnified has the right to conduct such defenses, if he

chooses to do so;

5. If, after request, the person indemnifying neglects to defend

the person indemnified, a recovery against the latter suffered by him

in good faith, is conclusive in his favor against the former;

6. If the person indemnifying, whether he is a principal or a

surety in the agreement, has not reasonable notice of the action or

proceeding against the person indemnified, or is not allowed to

control its defense, judgment against the latter is only presumptive

evidence against the former;

7. A stipulation that a judgment against the person indemnified

shall be conclusive upon the person indemnifying, is inapplicable if

he had a good defense upon the merits, which by want of ordinary care

he failed to establish in the action.

Applying this code section to the current case, the court stated the following:

As explained in Crawford, section 2778 “first provides that a promise of indemnity against claims, demands, or liability ‘embraces the costs of defense against such claims, demands, or liability’ insofar as such costs are incurred reasonably and in good faith. (§ 2778, subd. 3, italics added.) Second, the section specifies that the indemnitor ‘is bound, on request of the [indemnitee], to defend actions or proceedings brought against the [indemnitee] in respect to the matters embraced by the indemnity,’ though the indemnitee may choose to conduct the defense. (Id., subd. 4, italics added.) Third, the statute declares that if the indemnitor declines the indemnitee's tender of defense, ‘a recovery against the [indemnitee] suffered by him in good faith, is conclusive in his favor against the [indemnitor].’

In the current case, the court states that KM tendered its defense to Parsons, Parsons rejected KM’s tender of defense, Searles paid for KM’s defense, and the wrongful death action against KM and other defendants resulted in Parson’s subcontractor being found 25 percent at fault, but no fault was found directly against Parsons itself. The court states “Under section 2778, subdivisions (3) and (4), KM was entitled under the indemnity agreement to a defense from Parsons and, since Parsons did not provide a defense, KM was entitled to recover its defense costs….” The jury in the wrongful death action awarded the heirs $6.75 million in damages. No fault was assigned to either KM or Parsons. Searles was found to be 75 percent at fault and a Parson’s subcontractor was found to be 25 percent at fault. Searles incurred over $800,000 in attorneys fees, costs, and expenses from providing KM with a defense in the suit, and is entitled pursuant to the indemnification obligations of the contract to recover those costs from Parsons.

Comment: This court’s reiteration of the affect of California Civil Code, section 2778, and the import of the holding in Crawford v. Weather Shield should serve as a reminder of how important it is to carefully craft indemnification clauses to specify exactly what types of claims and damages are covered by the indemnification, and whether or not there is a duty to defend the indemnitee or to otherwise reimburse the indemnitee for defense costs after-the-fact, as part of the indemnification obligation. In this particular case, the indemnification clause contained an express defense obligation. But even if it had not contained a duty to defend, the court’s decision once again makes plain that pursuant to the California Code, that duty to defend would be automatically read into the indemnification clause unless the parties expressly, affirmatively stated a contrary intent. It is not sufficient merely to strike out the words “defense” or “defend” when they appear in a sentence such as “Contractor shall indemnify, defend and hold harmless the Owner….” Even if those words were struck from the contract, the California courts would read them right back into the contract pursuant to the Civil Code. In California, therefore, if parties want to eliminate a duty to defend in the indemnification provisions of the contract, they must affirmatively insert a parenthetical or sentence clearly stating that there is no duty to defend.

About the author: Article written by J. Kent Holland, Jr., a construction lawyer located in Tysons Corner, Virginia, with a national practice (formerly with Wickwire Gavin, P.C. and now with Construction Risk Counsel, PLLC) representing design professionals, contractors and project owners. He is founder and president of a consulting firm, ConstructionRisk, LLC, providing consulting services to owners, design professionals, contractors and attorneys on construction projects. He is publisher of ConstructionRisk.com Report and may be reached at Kent@ConstructionRisk.com or by calling 703-623-1932. This article is published in ConstructionRisk.com Report, Vol. 14, No.1 (Jan 2012).

Article 2

Expert Survey of Small Sample of Walls Sufficient to Justify Opinion that Much Larger Area of Walls Must be Torn out and Replaced by Design-Builder for Failing to Meet Specifications for Rebar

Where a design-builder filed suit against the project owner (animal fee manufacturing plant) to collect the balance of fee that was being withheld, the owner countersued for almost $2 million alleging that contractor breached the contract’s requirements for concrete strength and placement of rebar in the concrete. An expert witness testified for the owner that based on ground penetration surveys done on a number of walls within the plant finding horizontal reinforcement with highly varying concrete covers and spacing (and testimony form employees concerning how they installed the rebar), it was his opinion that the bin walls of the plant were weakened to such an extent that 4,440 square feet of bin wall should be torn out and replaced. The design-builder filed a motion to have the testimony excluded based on failure of the expert to survey every wall that was recommended for replacement instead of just a sample of walls. Objection was also made to the fact that the expert did not present his opinion “with absolute certainly.” In denying the motion, the court found although only a small segment of walls was tested, the expert’s results were uniform and consistent, and they confirm eyewitness evidence that the contractor ignored its contractual obligations when placing the rebar. The court, therefore, concluded that the expert’s opinion was amply supported and not merely “unsupported speculation” as argued by the contractor. Younglove Construction, Inc. v. PSD Development, LLC, 2011 WL 1004916 (N.D. Ohio, 2011).

Comment: This case is instructive with regard to the use of expert testimony and the question of whether sampling or surveying is sufficient to justify an expert opinion concerning areas that were not part of the surveyed areas. On the underlying issue of non-compliance with the rebar placement specifications, the decision does not dwell at any length. Since this was a design-build project, however, it seems likely that the rebar specification was drafted by the design-builder (or an engineer working as a subcontractor to the design-builder). If that is so, the owner is alleging here that the design-builder was in breach of contract for failing to follow its own plans and speculations. It is important to note that just because the design-builder is the creator of the plans and specifications does not mean that it can later ignore them. Once plans and specifications have been approved by the project owner, the design-builder contractually commits to designing and building the facility consistent with the approved plans and specifications. To do otherwise, without adverse consequences, would require a contract modification or change order approving the changes or deviations to the plans and specifications. Likewise, if the owner provides bridging documents containing partial design documents, the design details contained in those bridging documents must be met unless a change has been agreed to in writing. A good example of a contractor having to rip out and replace work that did not meet the design details of the bridging documents is found in the case of Dillingham Construction v. U.S., 33 Fed.Cl. 495 (1995).

Article 3

Design-Builder Entitled to Contractual Indemnity from Subcontractor for Damages to Turbines

Black & Veatch (“B & V”) contracted with Portland General Electric (“PGE”) to engineer, procure and construct a power generating facility called the Port Westward Power Plant, and it subcontracted to a specialty subcontractor to install the combustion turbine and associated air inlet filter house and air inlet filter duct. The combustion turbine was manufactured by Mitsubishi Power Systems who supplied it directly to PGE pursuant to a separate agreement, which was assigned in part by PGE to Black & Veatch. After the turbine, filter house, and duct work were erected and installed by the subcontractor, they were successfully started-up and operated, but during a later scheduled outage of the turbine, a walk-through of the filter house discovered “foreign object damage” to a number of the compressor blades. Various foreign objects were found, including a cutoff bolt, a welding rod, and a half-moon shaped cut metal plate. B&V paid PGE for the damage to the combustion turbine and then sought from the subcontractor, pursuant to the indemnification clause of the subcontract, $1.5 million in direct costs to repair the damage, and another $2.1 million due to delays caused by the damage. Summary judgment for B&V was granted by the court, finding that the indemnity language was broad enough to require indemnity for all damages, including delay damages, and finding that the waiver of consequential damages clause was inapplicable because that clause expressly stated that the waiver of consequential damages would not apply to liability obligations incurred under the indemnity clause. Black & Veatch Construction, Inc. v. JH Kelly, LLC, 2011 WL 1706223 (U.S. District Court, D. Oregon, 2011)

In defending against the indemnification claim, the subcontractor did not dispute that B&V may seek reimbursement for the actual repair costs (although it denied liability for those damages), but it disputed recovery of the delay costs, which it call “consequential” damages. It argued that an agreement to indemnify for “physical damage to third party property” is not an agreement to indemnify for economic delay damages. In rejecting that argument, the court quoted the language of the clause that required the subcontractor to indemnify “for any and all liability [and] costs” and concluded that it is broader than just an obligation to repair the damage to third party property. As stated by the court: “In other words, [subcontractor’s] negligence in causing ‘physical damage to third party property’ is the trigger for application of the indemnification provision, at which point [subcontractor], as the indemnitor, becomes responsible for ‘any and all liability’ with which the indemnitee had previously been charged.”

A waiver of consequential damages clause in the contract provided for what appeared to be an absolute waiver of consequential damages by all parties under a “legal theory, for cost of capital, loss of profits or revenue, loss of anticipated profits or revenue, loss of use or increased expense of equipment or plant, loss of power or production, … or for any special, indirect, incidental, consequential, exemplary, or punitive loss or damages.”

The court said this clause would prevent B&V from recovering the delay costs in question from the subcontractor, but for the very next clause of the contract that stated the clause “will not apply to: (a) damages of any third party for which Subcontractor has an indemnification obligation under this Subcontract….”

Another interesting aspect of this case is that the subcontractor sought common law indemnification from Mitsubishi, alleging that Mitsubishi was at least partly responsible for the claim concerning the foreign object damage because the contract between Mitsubishi and PGE called for Mitsubishi to inspect the inlet filter house and ductwork for debris prior to start-up. But nothing in that PGE contract, according to the court, required Mitsubishi to inspect or take responsibility for or guaranty the work of the subcontractor who had an independent duty under its contract with B&V to clean the equipment. Under the B&V subcontract, the subcontractor could have liability to B&V for the damage caused by the foreign objects, even if the source of those objects was unknown. The court concluded that the subcontractor failed to identify any contractual duty Mitsubishi breached for which Mitsubishi could be responsible to B&V, and therefore owe any indemnity obligation to the subcontractor for the damages claimed by B&V. An alternative theory of a right to common law indemnity by the subcontractor against Mitsubishi based on tort was rejected by the court since B&V did not make a negligence based claim against Mitsubishi. A contribution action was also rejected by the court because “a claim for common law contribution must be premised on the existence of common law liability, such as co-debtorship, common ownership of property, or common contractual obligations” none of which are present here.

Comment: Among other things, the case demonstrates the importance of the language used in the indemnification provisions of the contract and also the importance of carefully considering how any waiver of consequential damages clause will or will not be applied to indemnification provisions. The waiver of consequential damages provision in the contract at issue here would have barred B&V from recovering the delay damages from its subcontractor if it had not been for the sentence in the contract stating that the waiver of consequential damages provisions would not be applied to claims under the indemnification provisions of the contract.

Article 4

CGL Insurance Covers Damages Caused by Defective Workmanship of Subcontractor

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

Where a general contractor – builder was sued by a homeowner to recover damages from leaking windows, fungus growth, decayed OSB sheathing, deteriorating and decaying floor joists and water damage to the home interior, the contractor tendered the claim to its commercial general liability (CGL) insurance carrier on the basis that the claim arose out of alleged defects in work performed by subcontractors. Pursuant to the subcontractor exception to the “your work” exclusion of the CGL policy, the Supreme Court of Indiana held the damages were covered by CGL policy. As an additional insured under the subcontractor’s separate CGL policy, the contractor may also be covered for the damages. The trial court had granted summary judgment to the insurance carriers on the grounds that there was no damage to the property “other than to the structural components of the homes themselves” and thus there was no “occurrence” or “property damage.” In reversing the summary judgment the court held that faulty workmanship may constitute an accident and a covered “occurrence” if done “without intention or design.” Sheehan Construction Company v. Continental Casualty, 935 N.E. 2d 160 (Dec. 2010).

In this case, the underlying litigation against the builder was initiated by a single homeowner, but was eventually turned into a class action suit when other owners started experiencing similar problems. Continental Insurance agreed to represent the builder with a reservation of rights. Mediation of the suit resulted in a $2.8 million settlement. Continental filed a declaratory judgment action asking the court to declare that it was not obligated to indemnify the builder.

After the trial court found there to be no “property damage” resulting from an “occurrence,” the homeowners appealed to the intermediate court of appeals of Indiana, and that court upheld the trial court decision because it concluded the damage to the homes “cannot be treated as distinct from the underlying faulty workmanship….” What the court appears to be saying is that what the homeowners were claiming as their damages was the work itself, which the owners demanded be replaced. Without damage to something other than to the installed work, the court didn’t believe there was the type of “property damage” intended to be covered by a CGL policy which was the current version of the standard ISO policy form for CGL.

In reviewing the matter, the Supreme Court did an extensive review of almost 30 court decisions from around the country that have considered whether faulty workmanship is covered by a CGL policy. This will be a good resource to keep handy for attorneys that may be making the argument for coverage under a CGL policy. The court concluded: “[W]e align ourselves with those jurisdictions adopting the view that improper or faulty workmanship does constitute an accident so long as the resulting damage is an event that occurs without expectation or foresight.” The court then goes on to explain that “As applied to the case before us, if the faulty workmanship was the product of unintentional conduct then we start with the assumption, from Sheehan’s viewpoint, that the work on the Class member’s homes would be completed properly. The resulting damage would therefore be unforeseeable and constitute an “accident” and therefore an “occurrence” within the meaning of the Insurers’ CGL policies.

In reaching this decision, the court noted the subcontractor exception to the “your work” exclusion, and further explained that “If the insuring provisions do not confer an initial grant of coverage, then there would be no reasons for a “your work” exclusion.” The court quoted favorably from an ABA law journal article authored by Clifford J. Shapiro at 25 Construction Law, Summer 2005, as follows: “By incorporating the subcontractor exception into the ‘your work’ exclusion, the insurance industry specifically contemplated coverage for property damage caused by a subcontractor’s defective performance.” For the reasons, the trial court judgment was reversed and remanded.

Comment: One of the first things an attorney representing parties in construction defect cases should do is evaluate what potential insurance coverage may be available – both under the contractor’s policies as well as the subcontractor’s policies. This includes reviewing the certificates of insurance and tendering timely notice of the claims to the insurance carriers. For additional commentary on the applicability of CGL policies to faulty workmanship, see Clifford J. Shapiro & Linda B. Foster, Point/Counterpoint: Inadvertent Construction Defects Are an “Occurrence” under CGL Policies, 22 Construction Law, Spring 2002. See also, John B Lennes and J. Kent Holland, The Jonah Perspective on Construction Defects: A View From Inside the Fish, Federation of Defense & Corporate Counsel Quarterly, Vol. 53, No. 4, Summer 2003.

Article 5

Liquidated Damages in Design-Build subcontract Are Enforceable Even Where Far Exceeding Actual Damages

Where a contractor entered into a design-build contract with the U.S. Navy to build four buildings at the Pensacola Naval Air Station, and included a liquidated damages (LD) provision in the subcontract with its subcontractor, that LD provision was enforceable despite evidence that the actual damages incurred by the contractor as a result of alleged delays by the subcontractor were far less than the LD amount, and despite the fact that the Navy did not impose any LDs on the prime contractor for delay. In United States v. Dick Corporation, 2010 WL 4666747 (N. D. Fla. 2010), a Miller Act claim was filed against Dick Corp. by the United States on behalf of a subcontractor. Dick made a counter-claim against subcontractor, arguing Dick was entitled to withhold payment and anything it owed to the subcontractor was more than offset by Liquidated Damages the subcontractor owed to Dick. The subcontractor argued that the LD provision was unenforceable because (1) the Navy didn’t assess LDs against Contractor; (2) the sub caused no delay to trigger the LDs; and (3) the LDs constituted an unconscionable penalty – far exceeding actual damages sustained. The court concluded that although LDs were “far in excess” of the actual damages, it was not possible to ascertain when the parties entered into the contract what the actual damages would be. Even if Dick could calculate part of its potential actual damages when entering the contract, there were additional unascertainable factors. The LDs were not “grossly disproportionate to damages that might reasonably be expected to follow… from delays.”

A test established by the Florida Supreme Court, to determine if a liquidated damages clause will be upheld or stricken, was cited in this case as follows: “First, the damages upon a breach must not be readily ascertainable.” “Second, the sum stipulated to be forfeited must not be so grossly disproportionate to any damages that might reasonably be expected to follow from a breach as to show that the parties could have intended only to induce full performance, rather than to liquidate their damages.” In this case, the court found that it was because of factors that could have resulted in damages that were unascertainable as of the date of entering into the contract that the parties agreed to the liquidated damages provision. As stated by the court: “Not only were Dick's damages as a result of delay not ascertainable at the time the parties entered into the subcontract, but they also were not grossly disproportionate to damages that might reasonably be expected to follow from [subcontractor’s] work delays. Indeed, had the Navy assessed liquidated damages against Dick as a result of [subcontractor’s] delays, Dick's actual damages could have exceeded its liquidated damages. The court therefore finds that the liquidated damages provision in the parties' subcontract is valid and enforceable.” It would have been possible that the subcontractor’s delays, for example could have delayed other trades and resulted in costs and possibly even damages that could not have been ascertained at the time the subcontract was entered into.

Comment: It continues to baffle me when parties to a contract make the argument that the amount of damages calculated under a liquidated damages provision must be compared to actual damages sustained to determine whether the LD provision is reasonable and can be enforceable. As the court here correctly decided, a comparison of LDs to actual damages is not the determinative factor in deciding whether an LD provision is unenforceable. The concept is that at the time the contract is entered into it is not possible to readily ascertain what the actual damages from non-performance or late performance will be. Since that is so, the parties establish a pre-determined amount of daily damages that they reasonably believe will cover whatever actual damages might result. It doesn’t matter that the actual damages ultimately turn out to be a lot lower. What matters is whether the LD amount when established at the time of contract negotiation was an amount that might reasonably be expected to result from actual damages, the amount of which could not at that time be ascertained. If they are not grossly disproportionate “to damages that might reasonably be expected to follow from delays, LDs are generally enforceable even if it turns out that the actual damages are considerably less.

An interesting insurance question is sometimes asked concerning coverage for liquidated damages – particularly in the context of professional liability policies. It is sometimes argued that the professional liability policy provides no coverage for liquidated damages because those damages are created by contractual agreement, and as such the contractual liability exclusion of the policy bars them from coverage. If a court would award the amount of the LDs even at common law in the absence of the LD provision of the contract, the insurance policy would cover them to the extent they were caused by the negligent performance of the insured design professional. However, what happens if as in a case like this one, it turns out that the actual damages are less than the pre-agreed LD amount? Will the policy only cover the actual damages and not the full amount of the LDs that are assessed? Even if there is a clear answer to that question, it is a rare case where the actual damages are ultimately determined and can be contrasted to the LD specified amounts. More typically, the court simply enforces the LD amount because it is determined to be reasonably based and not unconscionable. If that is the situation, will the contractual liability exclusion bar coverage for those LDs? I have not seen any definitive opinion on that issue. But I believe the coverage question can be framed as whether the damages awarded against the design professional result exclusively from the LD provision without regard to a finding of negligence and without regard to whether there were any actual damages. If the design professional is found to be negligent, and that negligence caused some damage, one could make an argument that so long as the LD provision, when entered into, was a reasonable effort to establish what otherwise unascertainable actual damage amounts would be, the policy should cover those damages. Indeed, it is possible that the amount calculated under the LD provision could be less than the actual damages if they could be ascertained. Thus, the LD amounts claimed for coverage under the policy could be less than what would be required if actual damages could be calculated. If the amount of actual damages cannot be ultimately ascertained, instead of this proving that coverage should be denied, it might instead tend to show that the LD provision was reasonable for the very reason that it is impossible to ascertain actual damages.

Article 6

Contractor Permitted to Sue Architect for Implied Warranty of Specifications

A Builder/Contractor that was building a house for a client/homeowner, used architectural plans that were drafted by an architect under contract with the homeowner, was permitted to sue the architect (with whom it had no independent contract) for breach of implied warranty of the plans and specifications to design the house, aligned in a manner to maximize a hilltop view of the city. After construction began, it was discovered that the house was aligned to view a water tank instead of the city, and the contractor tore it down and started over – and sued the architect for the tear down and reconstruction costs, alleging it relied on the architectural plans and specifications and that case law in Arizona recognizes that design professionals warrant that they have exercised their skills with care and diligence and in a reasonable, non-negligent manner. In North Peak Construction, LLC v. Architecture Plus, Ltd., 254 P.3d 404 (AZ, 2011), the appellate court agreed that the contractor could pursue an implied warranty claim against the architect.

The case precedent the court relied upon for its holding is an Arizona Supreme Court decision - Donnelly Construction Co. v. Oberg/Hunt/Gilleand, 677 P.2d 1292 (AZ, 2007) in which the court held that a contractor need not be in privity of contract with an architect to sue for negligence and breach of implied warranty. The court in that case stated that a design provides an implied warranty “that they have exercised their skills with care and diligence and in a reasonable, non-negligent manner.” In the current mater, the architect acknowledged that a contractor possesses a claim for breach of implied warranty, but argued that absent a contractual obligation, the professional’s duties are “implied-in-law” or pure legal duties, the breach of which would give rise to claims for negligence. The breach of implied warranty claim would thus be identical to the negligence claim, and that the statute of limitations period applicable to negligence claims must be applied to bar both the negligence claim and the breach of warranty claim.

The court stated that it concluded “it very likely” that the implied warranty at issue in this case “sounds in contract” (not necessarily meaning that it “arises out of contract”), but later in the decision said “We decline to decide which statute of limitations is applied to North Peak’s breach of implied warranty claim.” The contractor was also permitted by the court to maintain an action against the individual architect and his wife. The Architect argued that he only signed the contract with the homeowner in his capacity as president of the architectural firm and should therefore not be deemed individually liable. This argument was rejected by the court because the “implied warranty is not based on [homeowner’s contract] with Architecture Plus, Ltd. Rather, the implied warranty is based on (1) North Peak’s alleged reliance on the architectural plans and specifications, (2) Donnelly’s recognition that ‘design professionals’ warrant ‘that they have exercised their skills with care and diligence and in a reasonable non-negligent manner,’ and (3) the alleged signing and sealing by [the individual architect] of the plans and specification.” For these reasons, the court reversed the trial court’s dismissal of the breach of warranty claim, and remanded the case for further proceedings.

Comment: In most states, the design professional is not deemed to grant any implied warranties of the plans and specifications. Suits can typically only be brought against the design professional for defective specifications by the party with whom the design professional contracted. The economic loss doctrine, for example, generally prevents actions against design professionals for negligence that claim economic losses. Unless there is an independent duty owed by the design firm to a third party, and the design firms’ failure to meet its standard of care in performing that duty caused bodily injury or property damage, there is no viable cause of action. The only implied warranty of specifications that is created in the more typical state and case is the implied warranty of the specifications by the project owner to the contractor who is entitled to rely on the specifications. In that situation, the contractor must make a claim against the project owner and is entitled to recover its extra costs incurred in performing its work under defective specifications – without regard to whether the plans and specifications, although defective, met the standard of care and were, therefore, not negligently drafted by the design firm. Where a project owner pays the contractor a change order for its extra costs, the owner can only recover from the design firm for those costs if it can prove the designer performed its services negligently. This is the typical gap between (1) what is owed the contractor by the owner pursuant to the owner’s “implied warranty of specifications” and (2) what the owner can recover from the design professional (since recovery is limited to negligence).

Article 7

Architect Owes No Contractual or Common Law Duty to Third Party for Alleged Negligence in Construction Administration Services Performed for Its Client-Homeowner

In a case decided last year by the Court of Appeals of Texas (Black + Vernooy Architects v. Smith), it was held that an Architect could be liable to a young woman who fell 20 feet and sustained permanent injuries when she fell from a balcony due to defective construction work that the Architect failed to report to its client – the homeowner – during its construction administration services. That decision appeared to find that the third party had rights as a third party beneficiary of the Architect/Owner agreement and also had rights under the common law as a foreseeable person that could be injured from defective work. That holding was such an extraordinary deviation from normal case law, that the court was persuaded to reconsider its decision.

On reconsideration, the court reached the opposite conclusions from the previous holding – finding that the AIA B141 (1997) contract between the Architect and Owner only created contractual obligations of the architect to the owner, and it expressly precluded any third party beneficiary rights. As to the alleged common law duty, the court held there was no such duty because even if the plaintiff was a foreseeable user of the balcony that likely would be injured from defective work, the architect owed her no independent duty of care under the circumstances – particularly because the Architect did not perform the defective construction and its contract did not give it control over the contractor who did the work. The court found the Architect did not notice the defects and it therefore did not violate its contract which only required it to report to the Owner “known deviations.”

The court quoted extensively from the AIA contract and explained that, based on the contract language, it was clear that Architects were not guarantors or insurers of the contractor’s work, but that the plaintiff’s theory of the case would be to render Architects guarantors. Nailing this argument, the court concluded,

"The duty sought by the [plaintiff] would expose the Architects to lawsuits brought by parties that the Architects could not have identified at the time of entering into the contract. To protect against liability, the Architects would have needed to effectively take on the duty of care of a guarantor so as to ensure that all critical matters were fully observed."

The court further observed that:

"Holding the Architects liable would also have the consequence of curtailing the freedom of homeowners and architects to establish by contract the nature and scope of an architect’s services."

"If the homeowner had desired for the Architects to be guarantors they could have contracted for such services, says the court, “and would likely have to pay a higher fee….” The court further explained:

"Under this type of agreement, the owner obtains an architect’s assistance without having to pay for a full guarantee, and the architect provides assistance without having to incur the type of liability involved with providing a guarantee. Imposing the type of duty suggested by the [plaintiff] onto architects under the type of industry-standard agreement at issue in this case would reduce the likelihood that architects would agree to enter into such agreements in the future or, at the very least, increase the compensation required for the architect’s services, despite the significant social utility of such agreements."

For these reasons the court withdrew its 2010 decision and issued Black + Vernooy Architects v. Smith, 346 S.W. 3d 877, (TX 2011), reversed the judgment of the district court, and rendered judgment in favor of the architects.

There was never any question concerning the architects’ design. The problem was not the design but rather the fact that the contractor’s balcony subcontractor failed to follow the very clearly delineated design details for the balcony of the vacation house. The design drawings required that the metal pipes supporting the balcony be welded to steel plate tabs, which would then be bolted to the balcony. As constructed, however, the metal support pipes were attached to the balcony using thin metal clips.

The design drawings also required that a metal support piece, referred to as a “joist hanger,” be used to reinforce the attachment of each of the balcony joists to the exterior wall of the house. In the actual construction of the balcony, however, no joist hangers were used. Although required by the design drawings, the balcony handrail was not bolted to the house.

Finally, the design drawings called for the balcony to be attached to the exterior wall of the house by bolting it to a one-and-one-half-inch-thick rim joist and another one-and-one-half inches of wood blocking. Contrary to the plans and specifications, the contractor did not attach the balcony to the house with bolts, a rim joist, and blocking, but was instead nailed to a one-half-inch piece of plywood.

A year after the vacation house was completed, two young women stepped onto the balcony and a few seconds later the balcony separated from the exterior wall of the house and collapsed, causing the two women to fall approximately 20 feet to the ground, where one was rendered a paraplegic as a result. They sued the homeowner and general contractor, along with the architects. The owner and contractor agreed to a settlement of $1.4 million, but the architects did not settle.

The case against the Architects went to a jury trial that determined the architects to be 10% responsible for the injuries on the basis of negligent performance of its contractual duty to perform construction administration services. In reviewing the mater on appeal, the appellate court stated, “We have only been asked to decide whether the contractual duty that the Architects owed to the homeowners also extended to the [plaintiffs].”

In reviewing whether the architects had any contractual liability, the court focused squarely on contract language which called for “periodic site visits” for the purpose of reporting “known deviations from the Contract Documents.” The court noted the significance of the fact that the language did not call for continuous site visits. The 1997 version of the AIA B141 stated that the Architect was to perform its services “to endeavor to guard … against defects and deficiencies” and to determine “generally” whether construction of the home was being done in accordance with the plans and specifications.

In the 2010 decision of the appeal, the court suggested that this “endeavor to guard” language created a greater duty on the part of the architects. This time around, however, the court found that language did not change the limited purpose of the architects’ services as otherwise stated in the contract, or increase the scope of the services to extend to the benefit of anyone other than the owner. In this regard, the court quoted language from the agreement stating that “[n]othing contained in this Agreement shall create a contractual relationship with or a cause of action in favor of any third party….”

The court further noted that an individual can only be a third party beneficiary if the parties to the contract intend that to be so and entered into the contract for that third party’s behalf. In this case, the contract reveals that no third party beneficiary status was intended to be granted to anyone. For these reasons, the court concluded that when they entered into the contract the Architects assumed no contractual duty to third-parties to the agreement.

With regard to any potential common law duty allegedly owed by the architects to the plaintiffs, the court noted that in the absence of contractual authority to control the contractor and the absence of actual control of the contractor in the field, the architects could have no responsibility for the contractor’s defective workmanship. The court characterized the plaintiff’s argument as follows: “[Plaintiffs] urge that the Architects' owed a legal duty extending to them as house guests because they were ‘foreseeable users.’ In addition, the Smiths assert that due to the dangers resulting from faulty construction and due to the public's reliance on architects, ‘public policy’ demands that contractual privity not be an indispensable requirement for a duty of care to houseguests, or other for[e]seeable users of the balcony.” The court acknowledged that the plaintiffs might be foreseeable users of the balcony, but nevertheless concluded:

"[F]oreseeability and likelihood of injury are not the only factors to consider when deciding whether a duty exists. Rather, the risk, foreseeability, and likelihood of injury are to be weighed against the social utility of the actor's conduct, the magnitude of the burden of guarding against the injury, and the consequences of placing that burden on the “actor.” The “right to control” consideration weighs against extending an architect's duty to third parties in this case.

Specifically, the agreement provided that the Architects “shall neither have control over or charge of, nor be responsible for, the construction means, methods, techniques, sequences or procedures, or for safety precautions and programs in connection with the Work.” Instead, the agreement explained that those obligations “are solely the Contractor's [ ] rights and responsibilities.” Further, the agreement specified that the Architects were responsible for their own acts or omissions but that they “shall not have control over or charge of and shall not be responsible for acts or omissions of the Contractor, Subcontractors, or their agents or employees, or of any other persons or entities performing portions of the Work.”

Similarly, the agreement stated that the Architects were not “responsible for the Contractor's failure to perform the Work in accordance with the requirements of the Contract Documents.” In addition, the agreement explained that neither the authority bestowed on the Architects by the agreement “nor a decision made in good faith either to exercise or not to exercise such authority shall give rise to a duty or responsibility of the Architect[s] to the Contractor, Subcontractors, ... their agents or employees or other persons or entities performing portions of the Work.”

Having favorably determined that the Architects’ agreement with the owner did not create duties of control over the contractor, the court next considered in great detail the construction contract (also an AIA form) and concluded as follows:

In contrast to the agreement between the Architects and the Owner, the construction contract between the Owner and the contractor gave the contractor the absolute right to control the worksite and the means of construction and also imposed on the contractor significant supervisory responsibilities and liability. As further explained by the court,

"Specifically, the agreement stated that Nash “shall not be relieved of obligations to perform the Work in accordance with the Contract Documents either by activities or duties of the Architect[s] ... or by tests, inspections or approvals required or performed by persons other than the Contractor.” Moreover, the agreement also explained that Nash “shall supervise and direct the work[;] .... shall be solely responsible for and have control over construction means, methods, techniques, sequences and procedures and for coordinating all portions of the Work[;] .... shall be responsible to the [Owner] for acts and omissions of [Contractor’s] employees [and] Subcontractors[;]” and “shall be responsible for inspection of portions of Work already performed to determine that such portions are in proper condition.” In addition, the agreement provided that [Contractor] “warrants to the [Owner] and [the] Architect[s] ... that the Work will be free from defects not inherent in the quality required or permitted, and that the Work will conform to the requirements of the Contract Documents.” Finally, the agreement explained that the “Contractor shall indemnify and hold harmless the [Owner and the] Architect[s] ... from and against claims, damages, losses and expenses ... to the extent” that the claims, damages, or losses were “caused by the negligent acts or omissions of [Contractor or] a Subcontractor.”

The next step in this analysis was the court’s conclusion that nothing in the record established that the Architects exercised actual control over the construction of the balcony.

One final plaintiff’s argument of note was that by signing certain payment certifications the architects had expanded and exceeded the contractual scope of service. According to the court, “As proof that the Architects exceeded the scope of the agreement, the Smiths point to the language in some of the certificates that stated that the Architects had ‘inspected’ the construction.” In rejecting this argument, the court stated that even if the “inspection” language in the certification forms that had been prepared by the contractor did indeed increase the scope, it would have been solely for the benefit of the owner and not any third parties.

For all these reasons, the court reversed the trial court decision and ruled that the architect was not liable.

Comment: This decision, especially in conjunction with the earlier withdrawn decision by the same court in December 2010, is fascinating. There is enough contract and legal analysis contained in these decisions to provide sufficient material for a full day seminar on the standard of care, what duties are owed by design professionals and to whom, and finally contractual risk management.

It is particularly significant that this decision corrects a previous decision that many attorneys and risk managers felt had expanded the duties of design professionals in a manner that made them responsible for finding and reporting to its client all errors in a contractor’s work, and essentially guaranteeing that the work was not defective.

As if this uninsurable liability of the design professional to its client was not bad enough, the previous decision created an independent duty of the design professional to third parties contrary to clearly expressed intend of the contract language of both the AIA Owner-Architect agreement and the Owner-Contractor agreement. This new decision is in line with that of courts from jurisdictions around the country that enforce the contract as written, and solely for the benefit of the parties to the contract and not to third parties.

Contract language favorably quoted by the court from the AIA is affirmation of the prudence of using standard form contracts such as those of the AIA and EJCDC whenever possible. The AIA forms contain appropriate language specifying the scope of services, the standard of care, and various responsibilities of the architect – and also articulates various matters for which the architect is not responsible – all as explained in this decision.

When assisting design professionals in negotiating non industry standard contracts with owners that have devised their own forms, this decision can provide a good road map for language to be included in those contracts. As noted by the court, if design professionals are to legally become the guarantors of the quality of work performed by contractors, the design professionals will either opt not to provide the service, or if they provide it, the fees charged will have to be significantly higher to justify the increased risk.

With regard to the point about assuming the risk for higher fees, it is likely that most risk managers would advise against accepting guarantee and warranty responsibility regardless of how much extra fee the design professional might obtain, since this effectively creates liability for which the design professional has no professional liability insurance.

Reference to this decision is almost guaranteed in future workshops and webinars that I teach on design professional contractual risk management.

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