Inside this Issue

A1 - Economic Loss Doctrine did not bar a Contractor’s Negligent Misrepresentation Claim against Architect Seeking Indemnity against Subcontractor Delay Claim
A2 - Implied Warranty of Habitability does not Apply to Design Professionals and Material Suppliers who did not Perform Construction Work on Condominium
A3 - Americans with Disability Act (ADA) Penalties against Project Owner can be Recovered from Engineer and Contractor through Indemnification and Contribution Claims
A4 - Indemnification Clause that Included Voidable Provision was Enforced to Extent Legally Permissible Instead of Throwing out Entire Clause

Article 1

Economic Loss Doctrine did not bar a Contractor’s Negligent Misrepresentation Claim against Architect Seeking Indemnity against Subcontractor Delay Claim

See similar articles: Delay Claim | Duty of Care | Economic Loss Rule | Negligent Misrepresentation | Waiver and Release

Where a subcontractor sued the prime contractor based in part on delay claims, the prime filed a third-party complaint against the project owner and the architect seeking indemnity. The court held that the architect owed the contractor a duty of care and that the economic loss did not apply. Change orders that had been signed by the subcontractor did not serve as a waiver or release of its negligent misrepresentation claim against the architect. The key holding of the court was that the economic loss rule does not apply to a claim of negligent misrepresentation where there is no privity of contract.” D.W. Wilburn, Inc. v. K. Norman Berry Associates, 2016 WL 745774 (Kentucky 2017).

Comment: This decision gives the contractor a way to circumvent the waiver and release of claims by having signed change orders and having accepted final payment and closeout of the contract. Although it can’t make claims against the project owner, the contractor was permitted to make claims against the design professional that was under separate contract with the owner.

The contract incorporated the American Institute of Architects (AIA) Document A201-1997. This included a provision that change orders must be signed by the architect. It also included standard language stating that acceptance of final payment would constitute a waiver of claims.

During the course of the project, twenty change orders were approved and signed by the owner, architect prime contractor. This resulted in a time extension for the final completion date. A comprehensive change order was issued that included any and all claims regarding the final schedule and completion date. At that same time, the prime contractor submitted its final application for payment and signed a closeout form.

After the project was completed, the subcontractor sued the prime for delay and impact costs. The prime filed a third-party claim against the architect asserting that the delays claimed by the subcontractor were caused by the architect’s failure to properly prepare plans and specifications that prevented the project from being timely approved for a building permit.

The trial court granted summary judgment in favor of the architect based on lack of privity of contract between the contractor and architect. This was reversed on appeal, with the court holding that the subcontractor was entitled to its day in court to attempt to prove the elements of a negligent misrepresentation claim.

In reaching that decision, the court followed precedent established in the decision of Presnell Construction Managers, Inc. v. EH Construction LLC, 134 S.W.3d 575 (KY. 2004), where the court stated that legal duty, rather than contractual privity, is the fundamental element under tort law, and that a contractor could recover if the architect “breached some duty to the [contractor] apart from its duties to the [owner] under the contract—i.e., and independent duty.” The court concluded:

“[W]e are convinced that it does not apply to a claim under Section 552 where there is no contractual relationship between the parties. It is the very purpose of the tort to compensate purely economic losses when there is no contractual remedy available but there is a breach of the duty described in that Section. To apply the rule would essentially eviscerate the tort. We agree with the Court in Bilt–Rite, 581 Pa. at 484, 866 A.2d at 288, that the result would simply be “nonsensical.” “[I]t would allow a party to pursue an action only to hold that, once the elements of the cause of action are shown, the party is unable to recover for its losses. We conclude that the economic loss doctrine does not apply to a claim of negligent misrepresentation in the architect/contractor scenario.”

“We further hold that the economic loss rule does not apply to a claim of negligent misrepresentation where there is no privity of contract.”

Subcontractor Claim against the Architect was not waived by Prime Contractor Having Executed Change Orders with the Owner and Accepting Final Payment

The Architect argued that even if the claim was not precluded by the economic loss rule, the contractor was barred from doing do because it had executed twenty change orders and accepted final payment and closeout. This argument was rejected by the court because it found that although those change orders and final payment would preclude a delay claim against the Board, it wouldn’t bar that same claim against the Architect who was “not a party to those documents and cannot seek to enforce their provisions.” According to the court, “Any change order executed by the parties affected only the contract between [the Board] and [contractor].”

For these reasons, summary judgment was reversed, and the case must go to trial to give the contractor an opportunity to prove the elements of negligent misrepresentation.

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. 19, No. 11 (Dec 2017).

Article 2

Implied Warranty of Habitability does not Apply to Design Professionals and Material Suppliers who did not Perform Construction Work on Condominium

See similar articles: Condominium Association | Implied Warranty of Habitability | Insolvency | Park Point | Warranty

A condominium association filed an implied warranty of habitability complaint against architects, engineers and material suppliers – asserting that they were responsible for certain defects in construction that rendered the condominium units uninhabitable. An Illinois appellate court affirmed the trial court’s dismissal of the case, holding that implied warranty of habitability claims cannot be made against design professionals that do not engage in the actual construction of the allegedly defective structure.

Quoting from an earlier case precedent, the court stated, “Engineers and design professionals… provide a service and do not warrant the accuracy of their plans and specifications.” This is so even where the project developer is bankrupt and the condo association has not recourse for recovery due to that insolvency. Likewise, where material suppliers did no construction work but only supplied materials for the project, they are not subject to liability for breach of an implied warranty of habitability liability. Sienna Court Condominium Association v. Champion Aluminum Corporation, et. al., 75 N.E. 3d 260 (Illinois 2017).

The court relied heavily upon an appellate court decision in Board of Managers of Park Point at Wheeling Condominium Association v. Park Point at Wheeling, LLC, 48 N.E. 3d 1250 (2015). In doing so, the court reiterated that it was rejecting the plaintiff’s argument that the court should expand the extent of the implied warranty of habitability to a new class of defendants who designed, but were not involved in the actual construction, of the condominiums at issue. The court stated, “It is clear that liability is limited to parties who actually ‘took part in the construction or construction–sale.’” The court likewise reiterated that, “owners have no breach of implied warranty action against a mere material supplier….”

Construction Subcontractor Potential Liability

Construction subcontractors in this same case, however, were held to be subject to potential responsibility for implied warranty of habitability claims where the developer or general contractor has become insolvent. The court found that “insolvency is the determinative factor.” It didn’t matter that the plaintiff might have other recourse to recover damages possibly from the insurance carriers of the developer or general contractor.

Potential recovery from insurance policies of an insolvent developer or builder does not preclude the implied warranty of habitability claim. Nor does potential recovery from an insolvent developer's “warranty fund” bar the potential cause of action.

Article 3

Americans with Disability Act (ADA) Penalties against Project Owner can be Recovered from Engineer and Contractor through Indemnification and Contribution Claims

Where disabled individuals sued the City of Los Angeles for alleged failure of the city’s bus facility to meet the accessibility standards of the Americans with Disabilities Act (ADA) and of the Rehabilitation Act, the city filed a third party complaint against AECOM Services, Inc. and Tutor Perini Corporation for indemnification of the damages or contribution. The city contract with AECOM required AECOM “to defend, indemnify and hold harmless the City against all suits, claims, losses…to the extent that any such claim results from negligent and/or intentional wrongful acts or omissions….” Similar indemnity language was in the Tutor Perini contract.

In an important decision by the U.S. Ninth Circuit Court of Appeals, the court held that federal law did not preempt state law or otherwise prohibit the City from being indemnified. The court distinguishes the facts in this case from those in two other federal court decisions where indemnity obligations of the designers and contractors were found unenforceable. The difference, according to the court, is that the City did not attempt to allocate the full risk of loss to the firms and completely insulate itself from the penalties of ADA non-compliance. Rather, the liability was passed along to the firms only to the extent that they caused the non-compliance due to their own negligence or willful misconduct.

The court, correctly in my opinion, concluded that it would make no sense to impose all liability upon the city if the damages were caused by the designer and contractor. The court found that the issue is not a question of permitting the city as a responsible party from completely insulating itself from liability – but instead, “the greater concern is the potential for contractors to shield themselves from any liability they caused under both state contract law and federal disability regulations if [Disabilities Act] and [ADA] are found to preempt [City’s] claims.” City of Los Angeles v. AECOM Services, Inc., 2017 WL 1431084 (9^th Cir., 2017).

The Indemnity Clauses

The indemnity clause included the AECOM's predecessor-in-interest clause provided as follows:

“to defend, indemnify and hold City ... harmless from and against all suits and causes of action, claims, losses, demands and expenses ... to the extent that any claim for personal injury and/or for property damage results from the negligent and/or the intentional wrongful acts or omissions of Consultant, its subcontractors of any tier, and its or their officers, agents, servants, or employees, successors or assigns.”

The applicable clause for the Tutor Perini contract (based on its predecessor in interest contract) was the following:

“to defend, indemnify, and hold harmless the City against all costs, liability, damage or expense ... sustained as a proximate result of the acts or omissions of [Tutor] or relating to acts or events pertaining to, or arising out of, the contract.”

Commitment by the Firms to Comply with Law

The Tutor contract also required that the contractor, in performing its contractual obligations, “comply with all applicable present and/or future local, ... State and Federal Laws, statutes, ordinances, rules, regulations, restrictions and/or orders, including ... the Americans with Disabilities Act of 1990.” It also stated that “Contractor shall be solely responsible for any and all damages caused, and/or penalties levied, as the result of Contractor's noncompliance with such enactments.” The contract provided:

“[e]xcept for the City's sole negligence or willful misconduct, Contractor expressly agrees to ... defend, indemnify, keep and hold City ... harmless from any and all costs, liability, damage or expense ... sustained as a proximate result of the acts or omissions of Contractor, its agents, servants, subcontractors, employees or invitees; or [ ] relating to acts or events pertaining to, or arising from or out of, this Contract.”

The court explained that based on the these contractual provisions between the City and Appellees' respective predecessors-in-interest, the City's third-party complaint against Appellees sought damages for breach of contract, express contractual indemnity, and declaratory relief establishing Appellees' obligations to defend and indemnify the City.

The Question of Federal Preemption

The court did a thorough analysis of the federal law preemption doctrine, including explaining three recognized ways that a federal law may preempt to state legislation. Neither the Rehabilitation Act nor ADA contain express preemption. The District trial court incorrectly, according to the appellate court, concluded that “field preemption” applies to preclude the city’s claim for indemnification.

“Field preemption” only occurs:

“where the scheme of federal regulation is sufficiently comprehensive to make reasonable the inference that Congress left no room for supplementary state regulation,” or “where the field is one in which the federal interest is so dominant that the federal system will be assumed to preclude enforcement of state laws on the same subject…. [citation omitted]. Title II specifically states that “[n]othing in this chapter shall be construed to invalidate or limit the remedies, rights, and procedures of ... any State or political subdivision of any State or jurisdiction that provides greater or equal protection for the rights of individuals with disabilities than are afforded by this chapter.” 42 U.S.C. §12201(b). In other words, the ADA expressly disavows preemptive federal occupation of the disability-rights field.”

The corporations arguments were based largely upon the Fourth Circuit Court of Appeals' decision in Equal Rights Center v. Niles Bolton Associates, 602 F.3d 597 (4th Cir. 2010) and also Independent Living Center v. City of Los Angeles, 973 F.Supp.2d 1139 (C.D. Cal. 2013). Those decisions dismissed actions for indemnity in somewhat similar circumstances. The California decision determined that state-law indemnity and contribution claims posed an obstacle to the full implementation of Title II and § 504, and that they were accordingly preempted.

The Ninth Circuit explained the doctrine of the presumption against preemption of state laws by federal laws and concluded that it would “find presumption only if Congress indicated a ‘clear and manifest purpose’ to that effect.”

“Obstacle preemption” applies, says the court, “when a given ‘state law [ ] stands as an obstacle to the accomplishment and execution of the full purposes and objectives of Congress.” Here, the court found that the indemnity clauses posed no obstacle to the federal law goals. As explained by the court,

“Any concern that a public entity will be able to contract out of Title II or § 504 compliance makes sense in the context of indemnification for an entity's failure to maintain appropriate policies and practices—in other words, for its failure to take action solely within its control, as was arguably the case in Equal Rights Center. Permitting a shift of liability to a party lacking the power to remedy the violation would frustrate the federal statutes' regulatory purpose.”

Since the City’s claim seeks only to collect for violations arising out of the corporations “own negligence or wrongdoing” the indemnification provision functionally seeks contribution from those firms for the damages they caused. This was a key to the court’s decision. The indemnity clause only required that the firms indemnify for damages from non-compliance with the law to the extent those damages were caused by their negligence or wrongful misconduct. Even though that is stated in the “indemnification” clause is the equivalent of “contribution” that could arise under state law for damages caused by a culpable party.

“Allowing the City to seek redress for liability incurred by virtue of a third-party contractor's actions does not plausibly pose an obstacle to the intended purpose and effect of Title II or § 504. Rather, finding such claims precluded would itself hamper the statutes' regulatory purpose. The most a public entity may be able to do in furtherance of its duties under the respective acts may, in many situations, be to expressly contract for compliance (contractual provisions for which it will potentially have to pay a premium to the contractor). From there, the entity best situated to ensure full compliance may well be the contractor tasked with designing or constructing the public resource in question, and precluding contract clauses for contribution reduces a contractor's incentives to do so.”

For these reasons, the court the federal laws of the ADA and Rehabilitation Act do not preempt the City’s state-law claims for de facto contribution, however styled, against the corporations.

Article 4

Indemnification Clause that Included Voidable Provision was Enforced to Extent Legally Permissible Instead of Throwing out Entire Clause

An indemnification clause in a contract between a school board and a general contractor contained an indemnification clause requiring the contractor to defend and indemnify the owner against all claims and damages even if caused by the owner. This violated the state’s anti-indemnity statute that prohibits recovery under a contractual indemnity provision when damages sustained by third parties are caused the public owner’s own negligence.

The Board was sued by an individual who was injured by debris that was expelled as a result of a tire blowout on a dump truck being operated by a general contractor on a construction site. When the Board sought to be indemnified, the trial court found the indemnity clause to be void and unenforceable. This was reversed on appeal with the court finding that although the clause was void to the extent it required the contractor to indemnity the Board for the Board’s own negligence, it was nevertheless enforceable in this case where the underlying claim alleged that damages were caused by the contractor’s negligence. Johnson v. Hamp’s Construction, LLC, 221 So.3d 222, (2017).

Comment: This is why it is wise to begin an indemnity clause with the introductory wording, “To the fullest extent permitted by law, the Contractor shall….” That language was included in the clause at issue. It permitted the court to strike out the offending language and enforce the balance of the clause to the maximum extent legally enforceable to accomplish the intent of the parties.

The indemnity provision of the public works contract executed by the OPSB and WWCC states:

3.18.1 To the fullest extent permitted by law the Contractor [WWCC] shall indemnify and hold harmless the Owner [the OPSB], Architect, Architect’s consultants, and agents and employees of any of them from and against claims, damages, losses and expenses, including but not limited to attorneys’ fees, arising out of or resulting from performance of the Work, provided that such claim, damage, loss or expense is attributable to bodily injury, sickness, disease or death, or to injury to or destruction of tangible property (other than the Work itself), but only to the extent caused by the negligent acts or omissions of the Contractor, a Subcontractor, anyone directly or indirectly employed by them or anyone for whose acts they may be liable, regardless of whether or not such claim, damage, loss or expense is caused in part by a party indemnified hereunder. [Emphasis added by Court].

The Court focused on the language that stated the contractor must indemnify and hold harmless the owner “but only” to the extent that the claims were “caused by the negligent acts or omissions of the Contractor, a Subcontractor, anyone directly or indirectly employed by them or anyone for whose acts they may be liable.” The court noted that the “final phrase of the clause allows the OPSB to recover even if a party to be indemnified thereunder, including the OPSB [the Owner], partially caused the third party’s claim, damage, loss or expense.”

The contractor also was found to owe a duty to defend the owner even if there had been an allegation that damages were caused in part by the Owner’s negligence. As explained by the court:

Considering that an indemnification claim is not ripe until the conclusion of the lawsuit, by which point a determination will have been made as to whether the public body was negligent, it is consistent with [citation omitted] that if a public body is not found to be negligent that it is entitled to seek indemnification for defense costs. A plaintiffs’ litigation strategy will most likely include suing the public body that retained the contractor and who may own the premises where an accident occurred and/or where their damages were sustained.

Should a contractor be relieved of his or her contractual obligation to indemnify a non-negligent public body because a plaintiff alleges the public body was negligent? We think not. Similarly worded indemnification provisions would be rendered virtually useless for public bodies that have entered into public works agreements with contractors thereby limiting their recovery of defense costs to the lawsuits where they have not been sued for negligence. If this were the case, taxpayers ultimately would have to bear this cost. A plaintiff’s allegation of negligence should not be the determining factor in applying the contractual provision. It is a finding of negligence that should be dispositive.

Comment: When drafting indemnity clauses it common to find a provision stating that the duty to defend and indemnify applies even if the damages were caused in part by the Indemnitees. So long as the clause states that the contractor’s duty is limited to indemnifying for damages to the extent caused by its negligence, the logical way to read the clause is just as was done by the court in this case, i.e., (1) the contractor indemnifies for those damages caused by its negligence; (2) the owner remains responsible for the damages caused by its negligence and the contractor does not indemnify for those; and (3) the defense duty is triggered if there are allegations of negligence by the contractor even if there are also allegations of negligence against the Indemnitees (e.g. Owner).

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ConstructionRisk.com Report (Dec 2017)