ConstructionRisk.com Report (December 2015)

Inside this Issue

• A1 - Contractor’s Code Violation Does Not Create Negligence Cause of Action by Subsequent Homeowner
• A2 - Only Jury (and not the trial judge) Can Use the Parties' Course of Dealings to Determine the Meaning of an Ambiguous Contract
• A3 - Termination for Convenience Clause does not require Reason for Termination or Render Contract Illusory
• A4 - Engineer’s Lien Effective only from Date Filed, and did not Relate Back to Beginning of Construction

Article 1

Contractor’s Code Violation Does Not Create Negligence Cause of Action by Subsequent Homeowner

See similar articles: Building Code | Code Compliance | Contract Privity | Economic Loss Doctrine

J. Kent Holland, Esq.

A subsequent (non-original) homeowner may not bring a negligence suit against a homebuilder for economic losses arising from latent construction defects when there has been no physical injury to persons or property. The builder’s violation of a building code did not give rise to a public-policy based tort duty. The appellate court affirmed the trial court decision that the purchasers were not within the class of persons protected by the public policy framework that mandates specific design and construction standards for safe residential construction. Sullivan v. Pulte Home Corp., 237 Ariz. 547 (2015).

In this case, the homebuilder, Pulte Home Corporation, built a home and sold it to an original homeowner in 2003. That homeowner sold the house to a new owner in 2009, and that owner subsequently discovered problems with a hillside retaining wall. An expert for that owner concluded that the wall was constructed without proper structural and safety components, including footings, rebar, and adequate drainage and grading.

In an earlier reported decision on this same matter (Sullivan 1), the court held that the economic loss doctrine did not bar the homeowner’s negligence claims against the builder because, in the absence of a contract between them, there was no barrier to tort claims otherwise permitted by substantive law. The current appellate decision does not address the economic loss doctrine but instead deals with the trial court’s subsequent decision on remand that granted the builder’s motion for summary judgment on the basis that the builder owed no duty of care under the building code to a subsequent purchaser. The court affirmed the trial court decision that the purchasers were not within the class of persons protected by the public policy framework that mandates specific design and construction standards for safe residential construction. Sullivan v. Pulte Home Corp., 237 Ariz. 547 (2015).

The court turned first to the City of Phoenix Uniform Building Code (“Building Code”) that specified its purpose as “provid[ing] minimum standards to safeguard life or limb, health, property and public welfare by regulating and controlling the design, construction, quality of materials, use and occupancy, location and maintenance of all buildings and structures ....” The court pointed out, however, that this same section of the Building Code specifically disclaims any intent to protect or benefit a particular group or class, stating, “[T]he purpose of this code is not to create or otherwise establish or designate any particular class or group of persons who will or should be especially protected or benefited by the terms of this code.”.

The court explained that a statute or regulation typically gives rise to a tort duty premised on public policy only if it “is designed to protect the class of persons, in which the plaintiff is included, against the risk of the type of harm which has in fact occurred as a result of its violation, and concluded, “It would be anomalous, as well as inconsistent with this well-established legal tenet, to premise a tort duty on a regulatory scheme that expressly eschews any intent to protect or benefit a class or group of persons.” And the court stated that,

“Although Arizona’s appellate courts have held that statutes enacted for public safety may support public policy-based tort duties, they have done so largely in the context of injury and death cases.” *** “Nor do we find Arizona’s statutory and administrative schemes governing licensed contractors a sufficient basis for holding that homebuilders owe public policy-based tort duties to subsequent homeowners for economic loss. Like the Building Code, the governance of licensed contractors has a broad, general purpose: ‘to protect the public health, safety and welfare by licensing, bonding and regulating contractors engaged in construction.’”

In conclusion, the court found:

“The [homeowners] have no contract with Pulte, and they concede that no duty arises from a relationship between the parties. Although licensed contractors are subject to discipline for, inter alia, ‘[d]eparture from or disregard of ... any building code of the state or any political subdivision of the state in any material respect,’ A.R.S. § 32–1154(A)(2), this regulatory provision does not support imposing public policy-based tort duties in favor of subsequent property owners asserting economic loss. Professional codes frequently establish standards for licensees that do not give rise to private causes of action.”

In further explaining the holding, the court stated,

Finally, our conclusion is consistent with, though not dependent on, the Restatement (Third) of Torts: Liability for Economic Harm (“Restatement”)…. Section 1(a) of the Restatement states that “[a]n actor has no general duty to avoid the unintentional infliction of economic loss on another,” explaining that such duties are “notably narrower” than duties to prevent physical harm and “that duties to avoid causing economic loss require justification on more particular grounds than duties to avoid causing physical harm.” … The Restatement also expressly rejects the imposition of a duty of care on homebuilders for economic losses that subsequent homeowners experience due to latent construction defects.”

Comment: This decision does not technically alter the earlier Sullivan 1 decision with regard to the applicability of the economic loss doctrine in the state of Arizona. But it further refines the bases upon which economic losses can be sought and rejects the imposition of a duty of care on homebuilders for economic losses that subsequent homeowners experience due to latent defects, regardless of whether there had been code violations.

 

Article 2

Only Jury (and not the trial judge) Can Use the Parties' Course of Dealings to Determine the Meaning of an Ambiguous Contract

See similar articles: ambiguity | Contract Interpretation | extrinsic evidence | guaranteed maximum price | Incorporation by Reference

J. Kent Holland, J.D.

A trial court erred when it considered the course of dealings of the parties to determine the meaning of a design professional contract, and then issued a jury instruction advising the jury that the contract was not ambiguous. As a result, a $2 million judgment for an architect was reversed and remanded for the jury to determine the meaning of the contract and determine what, if any, relief the Architect was entitled to. Facilities Cost Management Group, LLC, v. Otoe County School District 66–0111, 291 Neb. 642 (2015).

Comment: The rules of contract interpretation are well established and vary only slightly from state to state. One such rule is that a court cannot speculate as to the meaning of the terms of a contract. If the terms are susceptible to different interpretations or the wording is vague, the parties must be allowed to present additional evidence (referred to as parol evidence) to prove the parties' intent. In a jury trial, it is the jury rather than the judge that interprets ambiguous language, based on all the facts and circumstances. Had the trial court not erroneously determined that a key section of the contract was unambiguous, the parties could have presented evidence with respect to the meaning of "scope of work" at trial. Based on such potential evidence, the jury's award to the Architect could have been very different.

In this case, a dispute arose over whether the architect’s scope of services had increased such that it was entitled to an additional $2 million in fees, or whether the agreement constituted a guaranteed maximum price contract that capped the architect’s fee. During construction, the project owner made changes to the project, and the Architect presented the Owner with updated information regarding the project’s budget and regularly submitted invoices for the work performed by the contractors as well as for the services of the Architect.

The owner paid the invoices for Architect’s fees until it learned that the project was almost $2 million over budget. Architect filed suit. A point of contention was whether the contract included a guaranteed maximum price that could not be exceeded for the scope of services that were performed. Based on the contract language, and the parties’ course of dealings, the district court instructed the jury that the contract was not ambiguous. This resulted in the jury awarding the Architect damages of $1,972,993 for the additional services that the Owner argued were barred because they were subject to a GMP cap.

On appeal, the Supreme Court of Nebraska held that district court committed prejudicial error when it gave a jury instruction that stated, “the contract in this case is not ambiguous.” The Supreme Court thus reversed and remanded for a new trial.

In its appeal, the Owner argued that the contract provided for a guaranteed maximum price; but failing that interpretation, the Owner argued that the contract was ambiguous both as to whether the parties intended to fix a guaranteed maximum price, and how to calculate Architect’s fees for increases to the scope of the project. Architect argued that the contract was not ambiguous and that the parties’ conduct during performance of the contract indicated their intent concerning the payment of costs and fees beyond any type of a cap.

The contract was the 1987 version of the American Institute of Architects’ “Standard Form of Agreement Between Owner and Architect,” but the parties had added certain sections, including sections 11.2 and 12.7.

Section 11.2, “BASIC COMPENSATION” provided:

Fees shall be as outlined in the attached Recommended Compensation schedule ... These fees and costs are intended to be converted to Lump Sum amounts ... Lump Sum amounts and inclusions shall remain effective for the duration of the Project(s), except in the event of approved changes in the scope of work or alternatives to be bid adding two percent or more to the scope. In such event the Lump Sum fees and costs shall be increased proportionately to reflect the full percentage of changes.

Section 12.7, “RESPONSE TO DISTRICT’S REQUEST FOR PROPOSAL” provided:

The Architect’s Response to the District’s Request for Proposal is attached to this Agreement for general reference purposes including overviews of projects and services. The District’s approvals following execution of this Agreement and related to the scope of work on the individual projects and corresponding portions of Project Budgets during the various Phases shall incorporate applicable adjustments through the project’s development.

After receiving Architect’s proposal, the District sent Architect a series of written questions concerning its proposal. With respect to the question “Do you have a guaranteed maximum price for the project?”, Architect responded “Yes” and “Guaranteed maximum price options are clearly available to the District in our planning approach.”

Section 12.7 Was Not Ambiguous

On appeal, the Owner argued that section 12.7 of the contract was ambiguous, that Architect’s proposal and its responses to the Owner’s questions were incorporated into the contract via section 12.7, and that by incorporating these documents, the contract provides a guaranteed maximum price.

The district court had rejected the Owner’s argument, stating that while the words ‘for general reference purposes’ were possibly ambiguous, they did not serve to incorporate the Architect’s responses into the terms of the contract and, therefore, could not be a basis to determine fees and costs. The Supreme Court affirmed that part of the trial court’s decision, agreeing that section 12.7 did not incorporate Architect’s responses into the contract, and found that there was no language in the contract to indicate that the parties intended the budget to be fixed with respect to construction costs. In fact, section 5.2.2 of the contract provided: “No fixed limit of Construction Cost shall be established as a condition of this Agreement by the furnishing, proposal or establishment of a Project budget, unless such fixed limit has been agreed upon in writing and signed by the parties hereto.”

Section 11.2 Was Ambiguous

The Supreme Court found, however, that section 11.2 was ambiguous and that the trial court erred in deciding otherwise on the basis of the parties’ course of dealing. The trial court noted that the Architect met with the Owner in March 2008 to review the billing process and that the Owner continued to pay Architect’s invoices through May 2009. The court also pointed to the parties’ discussion with respect to various invoices as evidence of how fees on increases in the scope of the project were to be calculated. These actions by the parties were used by the court to conclude that the contract was not ambiguous.

Under section 11.2, increases in the scope of work were to serve as the basis for Architect’s increased fees and costs. The Supreme Court found this section was ambiguous because it was not clear how the scope of work was to be determined. The Court noted that while square footage is one way to determine the scope of work, there are other ways. Indeed, the Architect asserted that "increases in the scope of work" included not only square footage increases, but also increases in items such as equipment and Owner’s Representative fees.

The Supreme Court held that the jury, and not the judge, must decide the intent of the parties under an ambiguous contract, and thus remanded the case accordingly.

Comment

The rules of contract interpretation are well established and vary only slightly from state to state. One such rule is that a court cannot speculate as to the meaning of the terms of a contract. If the terms are susceptible to different interpretations or the wording is vague, the parties must be allowed to present additional evidence (referred to as parol evidence) to prove the parties' intent. In a jury trial, it is the jury rather than the judge that interprets ambiguous language, based on all the facts and circumstances. Had the trial court not erroneously determined that section 11.2 was unambiguous, the parties could have presented evidence with respect to the meaning of "scope of work" at trial. Based on this evidence, the jury's award to the Architect could have been very different.

Article 3

Termination for Convenience Clause does not require Reason for Termination or Render Contract Illusory

See similar articles: fair dealing | good faith | illusory contract | Termination for Convenience

J. Kent Holland, J.D.

Where a subcontractor sued the prime contractor for wrongfully issuing a termination for convenience, the trial court found in favor of the prime contractor, concluding that as a convenience termination a prime is not required to have a reason for termination, and holding that enforcing the clause in the contract would not render the subcontractor’s rights under the contract illusory. The appeals court affirmed the ruling, holding that payment by the prime for the sub’s partial performance was adequate consideration for the subcontract’s “termination for convenience” clause. The court also held that the prime was permitted to terminate at will, and that it did not need a specific reason for doing so. Sak & Associates, Inc. v. Ferguson Construction, Inc., 357 P.3d 671 (Wash. Ct. App. Div. 1 2015).

In this case, the subcontractor entered into a fixed sum contract with a prime contractor to provide concrete materials and paving services at an airport hangar. Part way through the work, the prime terminated its sub for convenience, paying the sub only for the work actually performed. The sub sued the prime for damages, alleging both that the prime contractor breached the subcontract by unilaterally terminating without cause, and that the reasons given for the termination were a mere pretext.

The trial court found that the prime had properly exercised the termination for convenience provision in the subcontract, and granted the prime’s motion for summary judgment. The appeals court affirmed the ruling, holding that payment by the prime for the sub’s partial performance was adequate consideration for the subcontract’s “termination for convenience” clause. The court also held that the prime was permitted to terminate at will and did not need a specific reason for doing so.

The Subcontractor’s argument was that the termination clause was an invalid illusory promise and since the clause was invalid, the Contractor breached the subcontract by invoking it. The clause, Section 7 of the subcontract, stated:

7. .. Contractor may, after providing Subcontractor with written notice, terminate .. the Subcontract, or any part of it, for its own convenience .. Contractor shall pay the Subcontractor for the work actually performed in an amount proportionate to the total Subcontract price. Contractor shall not be liable to the Subcontractor for any other costs, including anticipated profits on work not performed or unabsorbed overhead.

Under contracts law, a contract is not valid and enforceable unless both parties have provided "consideration." Consideration means something of legal value; it can be money or goods, but is often the promise to do something. If the provisions of an agreement leave the promisor’s performance entirely within its discretion and control, the promise is illusory. In other words, if there is an absolute right not to perform at all, there is no consideration.

In construction contracts, consideration usually consists of the reciprocal promises of the contractor and the owner, or the subcontractor and the general contractor, to perform work and to pay for that work. In this case, the Subcontractor contended that because the termination for convenience clause allowed the Contractor to terminate the contract at its discretion, the clause lacked consideration and was therefore illusory and unenforceable. However as the appeals court pointed out, it is well-settled law that partial performance provides consideration for what might otherwise be an illusory provision that appears to grant unilateral control to one party. The court found that since the prime had paid the sub for the 24 percent of the project it had completed by paying a proportionate amount of the fixed contract price, there was adequate consideration for enforcement of the clause.

The Notice of Termination

The Subcontractor also alleged that it had not been given proper notice for the termination and that the content of the notice was critical to submitting timely notice of a claim or dispute. The Contractor's notice of termination stated the following:

Ferguson Construction has determined that SAK’s services for this project are no longer required. Due to overall phasing restrictions, site logistics, and basic convenience, it has become apparent that it is in the best interest of the project to complete the site concrete paving with Ferguson’s own forces. This decision is not based on SAK’s work performed to date. Pursuant to Section 7 of the Subcontract General Conditions, the subcontract is terminated, effective immediately.

The sub complained that the prime contractor’s references to phasing, site logistics, and convenience were merely false and pretextual excuses for the prime’s goal of increasing its profits from the project. However, the termination for convenience clause, which the parties had agreed to by executing the contract, simply required that the Subcontractor be given written notice and receive payment for the work it had performed. Nothing in the termination for convenience clause required that the notice state any reason beyond “convenience.” Thus, the appeals court found that the Subcontractor had no basis for a claim.

Comment on Termination for Convenience

Like much of the law relevant to construction contracts, the concept of “termination for convenience” developed in federal government contracts. The federal government began including termination for convenience clauses in its contracts during the Civil War to avoid costly purchases that were no longer needed because of changes in war-time technology or cessation of conflict. Over time, the concept migrated to private contracts.

Courts in some states hold that exercise of a termination for convenience provision is limited by an implied duty of good faith and fair dealing. However, in Washington State, implied covenants of good faith and fair dealing do not trump express terms or unambiguous rights in a contract. The Appeals court noted that as a matter of law, there cannot be a breach of the duty of good faith when a party simply exercises its rights to require performance of a contract according to its terms. The court found that the termination for convenience clause unambiguously allowed the Contractor to terminate the subcontract for convenience; the only requirements were that the Contractor give notice and pay a proportionate payment of contract price. In the court’s words, “The implied duty of good faith and fair dealing does not allow one party to reshape or evade the bargain that was mutually agreed.”

Article 4

Engineer’s Lien Effective only from Date Filed, and did not Relate Back to Beginning of Construction

See similar articles: engineering lien | Lien Release | Mechanic's Lien

J. Kent Holland, J.D.
ConstructionRisk, LLC

An engineer’s lien that was filed two years after commencement of the contractor’s construction of a project was not entitled to priority over a mortgage holder’s lien that was filed when construction first commenced. The court focused on language of the state’s lien statute that specified that an engineer’s lien does not attach unless and until the lien is duly filed of record with the circuit court. Crafton, Tull, Sparks & Associates v. Ruskin Heights, LLC, 453 S.W. 3d 667 (Ark. 2015).

The construction of a project was almost complete when the engineer filed an “Architect's and Engineer’s Account and Affidavit of Account” stating that it was owed a little over $37,000. A couple months later, the engineer filed a lien against the property. A few months prior to that, however, the mortgage company had filed a foreclosure complaint alleging breach of the financing note by the project owner.

The engineer sought to have its lien declared superior to any lien or claims by the mortgage company. Although the trial court agreed that the engineering lien was valid, it found it lacked priority over the mortgage lien because the engineering lien did not relate back to the date of construction. The sole issue on appeal concerned whether the statute had been correctly interpreted and applied by the trial judge. Section 18–44–105, the engineer’s lien statute, provides as follows:

“(a) Every architect, engineer, surveyor, appraiser, landscaper, abstractor, or title insurance agent who shall do or perform any architectural, engineering, surveying, appraisal, landscaping, or abstracting services upon any land, or who shall issue a title insurance policy or provide landscaping supplies upon any land, building, erection, or improvement upon land, under or by virtue of any written agreement for the performance of the work with the owner thereof, or his or her agent, shall have a lien upon the land, building, erection, or improvement upon land to the extent of the agreed contract price or a reasonable price for those services.

(b)(1) However, the lien does not attach to the land, building, erection, or improvement upon land unless and until the lien is duly filed of record with the circuit clerk and recorder in the county in which the land, building, erection, or improvement is located.

(2) The lien shall be:

(A) Subject to the notice requirements of §§ 18–44–114 and 18–44–115;

(B) Filed under § 18–44–117; and

(C) Enforced under this subchapter.”
(Emphasis added.)

The court explained that lien statutes are in derogation of the common law and must be strictly construed. Given a strict interpretation of section 18-44-110 of the statute pertaining to the date to which the lien will relate back, the court concluded that any relate-back provisions in section 18-44-110 do not apply to engineer's liens and do not allow for an engineer's lien to relate back to the date of construction.

Comment: In reviewing design professional contracts we are noting that more and more frequently, project owners are attempting to obtain advance lien waivers as part of the contract terms and conditions. These may not be enforceable in all states, but we nevertheless seek to negotiate such advance waivers out of the deal. The next aspect to address is the partial lien releases. Specifically, care must be taken with the language of such releases so that the right to make claims or file liens is waived only as to work that has been invoiced prior to the date of the lien release.