Inside this Issue

A1 - Contractor not a Third Party Beneficiary of Engineer’s Contract with Owner
A2 - Homeowner Suit against Project Developer’s Geotechnical Engineer Barred by Economic Loss Doctrine
A3 - Certificate of Insurance Binds Carrier to Provide Insurance to the Entity that was Incorrectly Listed as an Additional Insured
A4 - Unlicensed Contractor Forfeits Right to Recover All Fees

Article 1

Contractor not a Third Party Beneficiary of Engineer’s Contract with Owner

An engineer under contract to a federal agency (USAID) provided preliminary designs (the bridging documents) for a design-build project that the owner then provided to the contractor to complete the final designs for the project and then construct it. The contractor filed a breach of contract suit against the engineer for alleged defects in the 30 percent design documents, which it asserted caused it to spend time and resources to redraw, obtain new permits, conduct additional excavation, soil compaction, and hydrogeological studies and demolishing more structures than it anticipated. The contractor alleged it was a third-party beneficiary of the engineer’s contractual obligation to USAID to conduct adequate site assessments and prepare preliminary designs for the projects. Engineer’s motion to dismiss the suit was granted because the court found the contractor lacked third party beneficiary status. Arco Ingenieros, S.A. de C.V. v. CDM International, Inc., 368 F. Supp. 3d 256 (District Ct., Mass. 2019).

In bidding for the design-build contract, the court states that the contractor relied on the preliminary designs and on representations by USAID and the engineer that the designs constituted at least thirty percent of the final designs for each project. According to the court, after starting its work, the contractor claims it learned that the preliminary designs were substantially less that third percent complete, “failed to follow building-code requirements, and did not account for soil-condition and subsurface issues, … failed to address flooding requirements, lacked a plan for bio-infectious waste disposal, and did not identify that the annex to the clinic was structurally unsound.”

There is no discussion in the court decision concerning why 30 percent preliminary design documents should have necessarily accomplished any of the items mentioned above. When documents are only preliminary bridging documents, it is not reasonable for a contractor to expect to be entitled to rely upon to contain level and extent of design details expected in final Construction Documents that are 100 percent complete. Because the court granted the engineer’s motion to dismiss for lack of standing, it didn’t have to address these more substantive issues.

Analysis of Third Party Beneficiary Status

Massachusetts’ courts have adopted the Restatement (2d) of Contracts approach to determining third party beneficiary status under which not every party that derives a benefit from a contract can sue to enforce that contract. The key is whether that entity is an “intended” beneficiary or merely an “incidental” beneficiary.

For a party to quality as an intended beneficiary, “the language and circumstances of the contract” must show that the parties to the contract “clearly and definitely” intended the non-party to benefit from the promised performance.

Under general contracting principles, a third party is not necessarily precluded from being an intended beneficiary “simply because it is not specifically named in the contract.” The court explained that, “If the contract language does not clearly evince the contracting parties’ intent, courts consult extrinsic evidence about the circumstances surrounding the contract.” With construction projects, however, the requirements for proving third party beneficiary rights are stricter.

Here the court explained,

“The caselaw on point from other jurisdictions does not support third-party beneficiary status in the construction context without a clear indication of intent. This is because significant construction projects generally involve multiple contracts that are “inevitably intertwined” to ensure the project is completed in a timely manner according to the agreed-upon specifications…. Unless a construction contract manifests a contrary intent, it will not create enforcement rights in a third party that separately contracts with the project owner.”

In this particular case, the court concluded that while the engineer’s contract with the project contemplated that the engineer would work with the design-build contractor, it included no provision indicating that the parties intended to impose liability on the engineer to the contractor for defects in the preliminary designs or for delays.

Risk Management Comment: (1) To avoid any chance of a contractor successfully asserting that it was an intended third party beneficiary under a design professional’s contract with a project owner, it may be prudent to include a simple clause in the design professional contract clearly stating that there shall be no third party beneficiaries under the contract. (2) Because we are seeing so many claims by design-build contractors asserting that the design firm’s preliminary designs were inadequate or defective, it may be prudent to add a clause in the design firm contract stating that the designs are only preliminary and will be judged only by what can reasonably be expected of preliminary designs, and that they are not expected to be as accurate or complete as 100 percent complete Construction Documents.

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 ConstructionRisk 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 Report and may be reached at Kent@ConstructionRisk.com or by calling 703-623-1932. This article is published in ConstructionRisk Report, Vol. 22, No. 2 (Feb 2020).

Article 2

Homeowner Suit against Project Developer’s Geotechnical Engineer Barred by Economic Loss Doctrine

A homeowner’s house developed large cracks in its foundation and walls due to settling, lateral movement of the foundation, and an unstable slope of the building lot. It filed suit against a geotechnical engineering firm that had ten years earlier prepared a site condition report for the subdivision developer. The suit brought tort claims for negligence, negligent misrepresentation, and negligent infliction of emotional distress. A third party beneficiary claim was also asserted. The engineer’s motion to dismiss the third party beneficiary claim was granted without even discussing it because it was apparently so obvious to the court that the homeowner wasn’t an intended beneficiary of the contract. The court also dismissed all the tort claims because these claims were barred under Utah statutory economic loss rule. Hayes v. International GeoEnvironmental Services, Inc., 446 P.3d 594 (UT 2019).

The general principle of common law is that “the economic loss rule prohibits tort claims for purely economic losses.” In addition, the state of Utah adopted a statute expressly barring economic loss claims in “actions for defective design or construction.” The statute provides that “an action for defective design or construction is limited to breach of the contract [and in general that] an action for defective design or construction may be brought only by a person in privity of contract with the original contractor, architect, engineer, or thee real estate developer.”

There is an exception to the rule, however, for damage to “other property.” The homeowner in this case argued that the “other property” exception applied. That argument was rejected by the court. It found that regardless of whether it could be argued that there was damage to the house separate from damage to the building lot, this was tied to the same legal action theories for the defects that created the damage. The key, the court said, was to consider what relief was sought by the plaintiffs as well as what was the plaintiff’s basic underlying theory of causation.

As explained by the court,

“A common-sense understanding of Plaintiffs’ action is that they claim to have suffered damages arising from something that went wrong—a defect—in the design and construction of their house. Even if the architect or the builder did not cause this defect, it is nonetheless a defect in the design and construction of the house, and the action is one “for defective design or construction.”

The court concluded that the plaintiffs’ claims for damages and diminution in value of their house, as well as decreased value of their building lot, must be characterized as “an action for defective design or construction” that was barred by the economic loss statute.

Article 3

Certificate of Insurance Binds Carrier to Provide Insurance to the Entity that was Incorrectly Listed as an Additional Insured

An insurance company was held bound by its agent’s written representation-made in a certificate of insurance—that a particular corporation was an additional insured under a given insurance policy. The certificate turned out to be inconsistent with the policy that only extended additional insured status to entities in privity of contract with the named insured. The carrier argued that the certificate contained language broadly disclaiming the certificate’s ability to “amend, extend or alter coverage afforded under the policy,” and, therefore couldn’t create coverage where it didn’t exist under the policy.

In deciding against the insurance company, the court concluded that the agent acted with apparent authority in issuing the certificate and the carrier was bound by the agent’s representation. It held that the specific typed words of the certificate that listed the name of the additional insured took precedence over the more general boiler plate wording of the broad disclaimer that attempted to disavow anything stated in the certificate. The carrier was, therefore, required to indemnify the party that was incorrectly listed on the certificate as an additional insured. T-Mobile USA, Inc. v. Selective Insurance Company of America, 194 Wash. 2d. 413 (Supreme Court of Washington, 2019).

This case has a long history through the courts. It started as state court action and was removed to federal district court at the request of the insurance company. The district court granted summary judgment for the carrier. It then denied a request for reconsideration. The matter was then appealed to the U.S, Ninth Circuit Court of Appeals, which certified a question to the Washington state supreme court asking whether an insurance company is bound by its agent’s written representation in a certificate of insurance under these circumstances. The Washington court answered “Yes: an insurance company is bound by the representation of its agent in those circumstances. Otherwise, an insurance company’s representations would be meaningless and it could mislead without consequence.”

The facts are these: T-Mobile NE (“NE”) hired a contractor to construct a cell phone tower on a rooftop. Its contract required the contractor to obtain a commercial general liability (CGL) policy and to annually provide T-Mobile NE “with certificates of insurance evidencing [that policy’s] coverage,” and to name T-Mobile NE as an additional insured under the policy. T-Mobile USA (“USA”), a parent company, although not a party to the contract, was aware of it, and approved it as to form.

By virtue of its written contract with the contractor, NE automatically became an additional insured under the contractor’s CGL policy. This is because the CGL policy provided that a third party would automatically become an additional insured under the policy if the contractor and the third party entered into their own contract and that contract required the contractor to add the third party to its insurance policy as an additional insured.

The USA company, however, was not under contract with the contractor and therefore didn’t become an additional insured under the policy. Nevertheless, the insurance agent over the course of about seven years issued a series of certificates of insurance to “T-Mobile USA, Inc., its Subsidiaries and Affiliates,” which stated that that those entities were “included as an additional insured under the CGL policy. In this regard the court states,

“The agent explained that it “began issuing the T-Mobile Additional Insured [certificates of insurance] because [the contractor] informed us that its agreements with T-Mobile required that T-Mobile be named as an additional insured under [the contractor’s] insurance policies and that T-Mobile qualified as an additional insured per the standard terms of Selective’s policies for that reason.” Id. Selective never objected to the agent’s issuance of the certificates. Id. at 826 (declaration of agent’s principal).”

The parties apparently failed to make the distinction between the USA and the NE T-Mobile corporate entities.

It was based on these facts that the Ninth Circuit Court of Appeals held that the agent acted with apparent authority in issuing the certificate that listed USA as an additional insured. A key question for the state Supreme Court to decide however, was what was the affect of the disclaimer language in the certificate, and would that prevent the representation concerning coverage to be of no consequence since the policy itself didn’t provide coverage.

The certificate stated in bold capital letters that the certificate “is issued as a matter of information only and confers no rights upon the certificate holder,” “does not affirmatively or negatively amend, extend or alter the coverage afforded by the” insurance policy, and “does not constitute a contract between the issuing insurer(s), authorized representative or producer, and the certificate holder.”

The certificate also stated in bold, “If the certificate holder is an ADDITIONAL INSURED, the policy(ies) must be endorsed. ... A statement on this certificate does not confer rights to the certificate holder in lieu of such endorsement(s).” Id. (boldface omitted).

The carrier, in arguing that the certificate of insurance didn’t obligate the carrier to grant coverage where none was otherwise provided in the policy itself, the carrier argued that “the preprinted disclaimers made all the specific, written-in, additional statements about coverage completely ineffective. It points outs that the certificate of insurance stated that it was issued as a matter of ‘information only’.”

In opposition, USA argued that the preprinted disclaimers were ineffective because they were general boilerplate, whereas the addition insured statement had been specifically written into the certificate. The court agreed with USA because “A basic rule of textual interpretation is that the specific prevails over the general.”

Comment: A lesson learned from this decision is that serious attention needs to be given to certificates of insurance to determine that the intent of the parties is accurately reflected by the certificate and also the insurance policy and its endorsements. This is not this first time I have reported on a court decision that addressed the question of whether a certificate of insurance bound the carrier to provide insurance to party that was not in privity of contract with the named insured. In the case of Gilbane Bldg. Co./TDS Construction Corp. v. St. Paul Fire and Marine Insurance and Liberty Insurance, 38 N.Y.S. 3d, 143 A.D.3d 146 (2016), the court found a construction manager was not additional insured under the contractor’s CGL policy despite the fact that the owner/prime contract required the contractor to name the CM as an additional insured. Our ConstructionRisk Report article can be viewed here.

As explained by the court in the T-Mobile decision, if a party that is not in privity of contract with the named insured is to become an additional insured under a policy with wording like the one at issue here, the insurance policy itself should be endorsed to provide that coverage.

Article 4

Unlicensed Contractor Forfeits Right to Recover All Fees

See similar articles: Contractor license | forfeit fees | illegal contract | unlicensed contractor | void contract

Where an HVAC subcontractor lacked the relevant license to do business in Washington, D.C. as a refrigeration and air conditioning contractor, its subcontract on a project was illegal and, therefore, void. It thereby forfeited any right of the to recover its fees and out of pocket costs from the general contractor (“GC”). Even though the GC was aware that the subcontractor had no D.C. license at the time they entered the subcontract, “the doctrine of unclean hands does not entitle [HVAC] to recover in the instant action.”

“The rule is well-established in the District of Columbia that a contract made in violation of a licensing statute that is designed to protect the public will usually be considered void and unenforceable, and that the party violating the statute cannot collect monies due on a quasi-contractual basis either.” HVAC Specialist, Inc. v. Dominion Mechanical Contractors, Inc., 201 A.3d 1205 (District of Columbia 2019).

In this case, the GC didn’t raise the issue regarding lack of subcontractor license in its defense against the subcontractor claim for almost four years after litigation was initiated. In fact, it appears it never raised this as an “affirmative defense” until it belatedly filed a motion to dismiss the action based on the lack of subcontractor license.

The subcontractor argued that the court system and subcontractor were prejudiced by the long delay in raising this argument. The court was not persuaded, and explained,

“Whether or not that is so, we conclude that under the public policy exception to the waiver rule, which is precedential law in our jurisdiction, the affirmative defense of illegality is not waivable in the context of a contract entered into in contravention of a District of Columbia law, such as a licensing requirement, that is “designed to protect the public,” Sturdza, 11 A.3d at 257, and that “affords significant protections to the public.”

Search

Get the Newsletter

Contract Guide for Design Professionals

Recent Newsletters

All Newsletters

Risk Management Workshops

Life Skills Workshop Slides

Contract Clauses – Papers and Articles

Construction Risk Management

ConstructionRisk.com Report (Feb 2020)