Inside this Issue

A1 - The “Completed and Accepted Doctrine” Bars Third Party Suit against Architect that Failed to Observe and Report an Obvious, Patent Construction Defect to Owner/Client
A2 - Certificate of Merit Requirement was Waived by Engineer’s Failure to Timely Push for Dismissal
A3 - Condominium Association Barred by Economic Loss Doctrine from Suing Consultant for Repair Costs, and Lacks Third Party Beneficiary Rights to Sue the Consultant for Breach of Warranty
A4 - Engineer Owed Independent Duty to a Construction Contractor to Provide Design Specifications That Do Not Cause Delays and Disruptions
A5 - Arbitration Results Between Owner and Contractor Have no Collateral Estoppel Affect in Subsequent Litigation Against Architect (Lost Profits not Recoverable in any Event)
A6 - Subcontractor’s Waiver of Claims Against Payment Bond is Void and Unenforceable
A7 - Subcontractor’s Waiver of Consequential Damages is Enforced where the Waiver Clause was Incorporated by Reference from the Prime Contract

Article 1

The “Completed and Accepted Doctrine” Bars Third Party Suit against Architect that Failed to Observe and Report an Obvious, Patent Construction Defect to Owner/Client

The “Completed and Accepted Doctrine” was held by a court to bar a slip and fall case against an architect who failed to observe that a construction contractor had failed to install “contrast marking stripes” on steps inside a theater the architect designed. The architect failed to make a final observation and certification that the contractor had installed the specified marking stripes as the architect was required to do by its contract with its client, the project owner. It also failed to include the absence of the stripes from a list of pending construction items it provided to the owner.

Regardless of whether the architect was contractually obligated to observe and report the missing marking stripes, however, the court found that their absence was so obvious that the owner must be charged with knowing they were not installed as required by the plans. This was deemed an intervening cause of the injuries sustained by the plaintiff. As explained by the court, “When a contractor completes work that is accepted by the owner, the contractor is not liable to third parties injured as a result of the condition of the work, even if the contractor was negligent in performing the contract, unless the defect in the work was latent or concealed. The rationale for this doctrine is that an owner has a duty to inspect the work and ascertain its safety, and thus the owner’s acceptance of the work shifts liability for its safety to the owner, provided that a reasonable inspection [by the owner] would disclose the defect.” Neiman v. Leo A. Daly, 210 Cal App. 4^th 962 (2012).

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. 15, No. 2 (Feb 2013).

Article 2

Certificate of Merit Requirement was Waived by Engineer’s Failure to Timely Push for Dismissal

See similar articles: Certificate of Merit

A Texas requirement, that a plaintiff must file a certificate of merit signed by an expert when it files a complaint against an engineer, was deemed waived by the defendant (engineer) where the engineer substantially participated in the litigation process over a three and one-half year period (including interrogatories, depositions, and motion for summary judgment), before it asked the court to issue a decision on its previously submitted motion to dismiss based on failure of the plaintiff to file the certificate by the date required by statute. In Murphy v. Gutierrz, 374 SW 3d 627 (Texas 2012), the court looked at a number of factors in deciding that the Engineer had rested on his rights for such a long period as to have forfeited the right to dismissal. Ironically, the engineer filed its motion to dismiss quite promptly at the outset of the case but the court never acted upon it. Only after participating in lengthy discovery, motion of summary judgment and court ordered mediation, did the Engineer finally “reurge his motion to dismiss only five days before trial was scheduled.” The court found the Engineer demonstrated intent to “substantially invoke the judicial process and intended to relinquish his right to seek dismissal.”

Comment: This decision could impact litigation strategy. In some jurisdictions, the certificate of merit can be filed several months after the initial complaint has been filed. If the plaintiff misses the deadline, the complaint is dismissed with prejudice – meaning that is the end of the case. It can’t be filed again. A defendant (design professional) in such a jurisdiction might want to wait until the final deadline for filing the certificate has lapsed before making an issue of it with the court, because to raise it earlier would enable the plaintiff to quickly file it before missing the deadline. In following that strategy, however, counsel for defendants might want to consider how deeply involved to become in the litigation process lest a court follow the Texas court reasoning and find that the certificate requirement has been waived.

Article 3

Condominium Association Barred by Economic Loss Doctrine from Suing Consultant for Repair Costs, and Lacks Third Party Beneficiary Rights to Sue the Consultant for Breach of Warranty

Where construction defects caused significant repair costs, a condominum association at Stratton Mountain (along with the project developer) sued and settled with the construction contractor for the defects for over $7 million but then incurred more than that in conducting the repairs. The condo association then filed suit against a professional consultant that had been under contract to the developer to provide value engineering and construction feasibility reviews and consultation on a selection of materials and equipment, along with zoning and permits. The trial court (which was affirmed on appeal) granted dismissal of that case because (1) the economic loss doctrine barred the negligence claim and (2) the association did not have a contract with the consultant and therefore lacked any implied warranty from the consultant. Long Trail House Condo Association v. Engelberth Construction, Inc., 2012 WL 4465561 (VT 2012).

The repair costs were alleged to have been caused by defects in the construction, including water penetrating exterior walls, improperly supported trusses, water damage to balconies, unsupported load bearing walls, and improperly braced gables and end walls – all of which they argued could cause collapse.

In holding there to be no third party rights by the association, the court quoted from the contract, which provided that the contract documents “shall not be construed to create a contractual relationship of any kind between anyone other than the owner and contractor.” The association argued that implied warranties were included as part of the contract between consultant and developer and that the association was entitled to bring this cause of action because the warranties “pass from a developer to a subsequent purchaser.”

The court was not impressed and explained, “We reject this argument. Our case law plainly contemplates the existence of contractual privity before a breach of implied warranty claim can be raised.” The plaintiff tried to assert uniform commercial code (UCC) principles to support its argument. In matter-of-factly rejecting that theory, the court said, “we do not find it useful to discuss provisions of the UCC …, as we are not here dealing with the sale of movable goods or indeed, with any sale at all between [association and consultant].”

In applying the economic loss doctrine as a legitimate basis for dismissing the negligence count of the complaint, the court rejected the plaintiff’s assertion that the consultant owed it a duty to use “professional care” in performing its services. It also rejected the association’s argument that the consultant would have foreseen with reasonable certainty that the association would be injured by its failure to exercise professional care.

The costs claimed amounted almost entirely to the cost of repair that stemmed the alleged fault construction and “represented the difference in market value between the units as built and as they should have been built.” Under Vermont law, the court stated that the remedy for such purely economic losses resulting from “the reduced value or costs of repairs of … construction defects sound[s] in contract rather than tort.”

The Condo Association argued that applying the economic loss doctrine where it lacked a contract and had no contractual basis for a suit against the consultant would be unfair. Specifically, the plaintiff Association argued that the economic loss rule should be applied to “strip a plaintiff of its tort remedies if the plaintiff has no other recourse and the defendant owed the plaintiff a duty.”

The Association contrasted this current case with economic loss decisions by other courts that have addressed the situation where a plaintiff had a contract and therefore an opportunity to negotiate the terms and conditions with the defendant. But the court here concluded that the economic loss doctrine applies to bar the suit regardless of whether there was a contract between the plaintiff and defendant.

Article 4

Engineer Owed Independent Duty to a Construction Contractor to Provide Design Specifications That Do Not Cause Delays and Disruptions

See similar articles: Economic Loss Doctrine | Liquidated damages | Privity of Contract | Third Party Claims

Where a project owner assessed liquidated damages against its construction contractor for untimely completion, the contractor filed a claim against the project engineer asserting that the delay was due to defective plans and specifications, and also that the contractor had relied upon representations by the engineer that the contractor would not be held to the project schedule. In Greater LaFourche Port Commission v. James Construction Group, LLC, 2012 WL 4320228 (Louisiana 2012), the court rejected the Engineer’s argument that because the engineer’s representations were within the scope of its contractual authority for its client it could have no liability to the contractor. Moreover, the court found that where the damage sued for by the contractor is not for the defective work itself but rather the losses caused by the Engineer’s allegedly defective work, a tort (negligence) action can be brought by the contractor against the engineer, even though it may not assert a cause of action against the Engineer based on the Engineer’s alleged breach of contract with its client, the Port Commission. The court concluded that genuine issues of material fact exist to be determined by jury – including whether the Engineer was independently negligent in its performance of services and in its representations to the contractor as to whether the Port would agree to waive the LD provision.

Comment: Based on prior court decisions cited by the court, it appears that the “economic loss doctrine” is not a defense in Louisiana, and that design professionals have an independent duty to third parties for purely economic losses such as those claimed by the contractor in this case. Allowing a design professional to be sued by a contractor for how it exercises its professional services and renders professional opinions for the benefit of its client, the project owner, could have a chilling effect on the ability of the designer to make proper decisions for its owner. If a designer has to worry about being sued by a contractor who feels plans and specifications are not clear and complete, or is dissatisfied with constructability of plans and specifications, or disgruntled with a decision not to grant substantial completion, a designer would have a personal financial stake that could cause it to act contrary to the best interests of its client. The reasoning of the Louisiana court is unfortunate.

Article 5

Arbitration Results Between Owner and Contractor Have no Collateral Estoppel Affect in Subsequent Litigation Against Architect (Lost Profits not Recoverable in any Event)

See similar articles: Arbitration | Collateral Estoppel | Consolidation | Joinder | Res Judicata

After a project owner lost its arbitration against a construction contractor it filed a lawsuit against its Architect to recover damages for breach of contract on the same project. The trial court granted summary judgment to the Architect on the basis that the adverse arbitration award constituted collateral estoppel and barred the suit against the Architect. This was reversed on appeal – with the court holding the doctrine of collateral estoppel was inapplicable because that doctrine only applies to preclude a party from relitigating, in a subsequent action or proceeding, an issue that was clearly raised in a prior action or proceeding and that was decided against that party. Crystal Clear Dev. v. Devon Architects, 97 A.D.3d 716 (NY 2012).

Here, the contract between the owner and architect was separate and distinct from the contract with the contractor, “and different duties and obligations were promised.” “The arbitration, which was mandated by the construction contract, did not include claims by or against the defendants.” The court held that the Owner failed to establish that the issues of negligence or breach of contract by the architect were “actually litigated, squarely addressed, and specifically decided in the prior arbitration proceeding.” Consequently, collateral estoppel could not be applied, and summary judgment could not be based on that principle.

Partial summary judgment was properly granted to the architect on that part of the complaint that sought to recover damages for lost profits because the court found this to be “special or extraordinary damages” not recoverable as general damages that were the “natural and probable consequence of the breach.” To recover such damages, the court explained, there must be a demonstration that the damages were contemplated by the parties in entering into the subject contract.” Here, the court found “A review of the terms of the subject contract demonstrates that there was no intent by the parties to allow for economic loss as a potential basis for damages in the event of a breach.”

A gross negligence count of the complaint was also correctly dismissed on summary judgment because as explained by the court, “The plaintiff’s conclusory assertion that the defendants performed their duties … recklessly and with … willful disregard” was unsupported by any factual allegations of conduct evidencing a reckless disregard for the rights of others.

Comment: This short (two page decision) covers a lot of legal ground quite well and succinctly. With regard to the lack of collateral estoppel, this is a good reason to provide by contract the same mechanism and jurisdiction for resolving all disputes. Including an arbitration provision in the construction contract but a litigation contract in the architect’s contract resulted in having two separate disputes involving the same project and apparently many of the same problems. The current AIA contract language provides for consolidation and joinder in the event that arbitration is selected as the dispute resolution mechanism. Use that type of language to avoid the situation described in this decision.

The sections of the decision dismissing the claims for lost profits and gross negligence are also instructive. Too many courts fail to grant summary judgments on frivolous claims of gross negligence that contain no supporting factual allegations. Even “notice pleading” requires some solid factual allegations be pleaded that would, if proved later at trial, establish there was gross negligence. Merely saying there was gross negligence does not constitute “factual allegations.” It seems that plaintiff attorneys have an idea that it would be malpractice for them not to assert that an allegation of an ordinary mistake also constitutes “gross negligence” or “fraud.” I long for the day that courts begin issuing sanctions and fines against plaintiffs and their attorneys for filing such abusive claims.

Article 6

Subcontractor’s Waiver of Claims Against Payment Bond is Void and Unenforceable

See similar articles: Payment Bonds | Surety

Whereby the terms of its contract, a subcontract waived its rights to make a claim against the prime contractors payment bond, the Supreme Court of Massachusetts held the waiver to be contrary to public policy and, therefore, void and unenforceable. In Costa v. Brait Builders Corporation, 972 NE 449 (Mass. 2012), the subcontractor provided labor and materials on a public construction project. A state statute required the general contractor (GC) to provide payment and performance bonds. After the GC terminated the subcontract for default, the subcontractor filed suit and won a jury verdict for general damages in the amount of $199,000 for breach of contract, and consequential, incidental damages, pre-judgment interest, and other damages, including attorneys fees, far exceeding its general damages – for a total judgment of $1,124,039. The GC and its surety provider, however, were granted a directed verdict by the trial court – based on the subcontractor’s contractual waiver of “its right to claim against the Contractor’s performance and payment bonds as provided to the Awarding Authority.” This was reversed on appeal, with the court holding that the contractual waiver of claims against the bond violated public policy.

The surety company asserted that the bond requirement served primarily a private purpose: to place laborers and materialmen who work on public construction projects, for which mechanics liens are disallowed, on the same footing as those working on private construction projects where mechanics liens are allowed. As argued by the surety, “Any benefit the statute may provide to the public is only incidental [ ] and not sufficient to override freedom of contract and mutual risk-taking.” This argument was rejected completely by the court.

Comment: The surety company’s argument that the contract terms which were negotiated between the GC and subcontractor should be honored by the court is generally a good argument for enforcing most terms of a contract because courts respect the right of commercial entities to negotiate contract terms with allocation of risk acceptable to the contracting parties – even if that allocation might seem onerous or unreasonable to others. Where statutes and public policy are applicable to certain aspects of the contract such as surety bonds, however, the courts will take a harder look at the contract deal to determine whether the agreed upon terms violate a statute or public policy – in which case the court will determine the contract term to be void and unenforceable, as was done in this case.

When confronted by a contract that requires advance waiver of liens or waiver of claims against surety bonds, the holding by the court in this case may provide a good argument for refusing to agree to such contract terms.

Article 7

Subcontractor’s Waiver of Consequential Damages is Enforced where the Waiver Clause was Incorporated by Reference from the Prime Contract

Where a subcontract contained an “incorporation by reference” clause, expressly incorporating the terms of the prime contract between the general contractor and project owner, the “waiver of consequential damages” clause of the prime contract flowed down to the subcontract and barred the sub from recovering any consequential damages when it was terminated. In Costa v. Brait Builders Corporation, 972 NE 449 (Mass. 2012), the same decision that held the subcontractor’s release of bond rights was unenforceable, the court found that the prime contract language clearly flowed down and that the waiver of consequential damages clause was enforceable to prevent the subcontractor from recovering lost profits, loss reputation costs, attorneys fees, etc. – all of which had been awarded to the subcontractor by a jury.

The prime contract provided in relevant part as follows:

“The Subcontractor agrees to be bound to the Contractor by the terms of the [general contract] and to assume to the Contractor all the obligations and responsibilities that the Contractor by those documents assumes to the awarding authority….”

The article of the prime agreement that flowed down to bar consequential damages provided the following:

“The Contractor waives Claims against the Owner for consequential damages arising out of or relating to this Contract. This includes: (1) damages incurred by the Contractor for … losses of financing, business and reputation, and for loss of profit except anticipated profit arising directly from the Work.”

In holding that the waiver was applicable to the subcontractor and barred its recovery of consequential damages, the court explained that “flow down” clauses “are an acceptable and common method for general contractors to limit risk.” The court also stated that it saw no special policy reason to create an exception to flowing down waiver of consequential damages clauses and that indeed “there may be good reason for the parties in construction contracts to exclude such damages.”

Making a point that should be obvious to risk managers, attorneys, and insurance brokers, who review contracts for their firms and clients, the court stated: “Subcontractors, particularly those with substantial industry experience … are well advised to examine both their own subcontract and any provisions that might be incorporated from the general contract, before agreeing to them.”

Comment: The point about the importance of reading the prime contract before signing a subcontract that incorporates its terms cannot be overemphasized. A subcontractor might go to a lot of effort to negotiate reasonable terms and conditions in its subcontract only to later learn that those are trumped by onerous conditions that are flowed down from the prime contract. It is therefore, imperative to review the prime contract during negotiation of the subcontract, and take exception to terms and conditions of the prime and that are deemed unacceptable.

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ConstructionRisk.com Report (Feb 2013)