Inside this Issue

A1 - Why Getting the Wrong Result in Arbitration May Be What You Bought
A2 - Indemnification is only for Third Party Claims Unless Clause Expressly States it applies to First Party Damages
A3 - Certificate of Merit not Required with Joinder Complaint against Architect
A4 - Project Owner Can’t Sue Architect working under subcontract to Design-Builder for Alleged Negligent Approval of Pay Applications
A5 - City not a Third Party Beneficiary of Design Professional’s Contract
A6 - Project Owner Can’t Sue Design-Build Contractor’s Design Subcontractor

Article 1

Why Getting the Wrong Result in Arbitration May Be What You Bought

Arbitration is often seen as a way of getting a more predictable result in complex construction disputes. The subject matter expertise available with experienced arbitrators and the finality of the arbitration process itself are certainly important considerations. But resolving disputes in arbitration can sometimes lead to surprising results, even ones that might be inconsistent with the underlying contract or with applicable state law.

The Eighth Circuit’s recent decision in Beumer Corp. v. ProEnergy Services, LLC, No. 17-2862 (8th Cir. Aug. 9, 2018), is an example of such a case. The arbitrator in this case awarded attorney’s fee of nearly a million dollars more than the liability cap in the contract. Despite the possibility that this result was inconsistent with state law, the Eighth Circuit let the award stand.

ProEnergy Service, LLC contracted with Beumer Corporation and Beumer Kansas City, LLC to fabricate and supply steel for Beumer’s pipe conveyor system. As work progressed, Beumer came to the conclusion that ProEnergy’s work was deficient. The resulting dispute led to ProEnergy filing a demand for arbitration. ProEnergy sought $500,000 and Beumer counterclaimed for $2,300,000.

The contract between ProEnergy and Buemer had a limitation of liability clause. The contract also provided for the prevailing party to recover attorney’s fees and the application of Missouri law.

The arbitrator entered an award in Beumer’s favor for damages and prejudgment interest of $699,702.39 (the amount of the liability cap) together with attorney’s fees and expenses of $916,027.90.

In the award, the arbitrator concluded that the attorney’s fee recovery was not limited by the limitation of liability clause, which provided that ProEnergy’s liability for “any loss, indemnity, damage, or delay” will not exceed the contract sum. The arbitrator found that Beumer’s attorney’s fees were not a “loss” and were not “damages.” According to the arbitrator, attorney’s fees are routinely treated in caselaw as “costs” and not damages.

ProEnergy challenged the attorney’s fees award in court, arguing that the award exceeded the arbitrator’s powers. In arbitrations that are subject to the Federal Arbitration Act, this is one of the only grounds upon which a court may vacate an arbitration award. See 9 U.S.C. § 10(a)(4).

In its opinion, the court noted that “an error of law or fact, even a serious one” does not mean that the arbitrator exceeds his or her powers.

ProEnergy argued that the arbitrator did more. ProEnergy argued that the arbitrator exceeded his powers by ignoring the choice of law provision in the contract and by ignoring Missouri law, which provides that attorney’s fees are a “loss” or “damages.” If correct, this would mean the $916,027.90 award of attorney’s fees would be capped by the limitation of liability. ProEnergy’s argument would do away with the award of attorney’s fees because the limitation of liability cap was already exhausted by the damages award.

The court could not find evidence that the arbitrator had intentionally ignored the choice-of-law provision or Missouri law. Although the arbitration award did not cite Missouri law on the attorney’s fee issue, the arbitrator never stated that he was substituting his own preferences for those specified in the contract.

The arbitrator may have mistakenly overlooked Missouri law, but the court concluded that such an error would not justify vacating the award. The court made a point of noting that it did not agree with ProEnergy that Missouri law holds attorney’s fees are part of the “loss” or “damages.” But the court also noted that its assessment of whether the arbitrator was right or wrong on this issue is “beside the point.”

In the court’s words, “[t]he parties bargained for the arbitrator’s decision; if the arbitrator got it wrong, then that was part of bargain.”

About the author: Ken Slavens is a partner with Husch Blackwell. He represents architects, engineers, owners and contractors in construction disputes over alleged defective design and construction, delays, cost overruns, interference, obstruction, property damage and suspension of work. He litigates claims arising from injuries on project sites or from defective construction. His substantial experience also includes related civil litigation, arbitration and mediation.

This article was originally published on September 25, 2018 on the Husch Blackwell website.

Ken A. Slavens, Esq.
Husch Blackwell
190 Carondelet Plaza, Suite 600
St. Louis, MO 63105
314.345.6419
ken.slavens@huschblackwell.com

This article is published in ConstructionRisk.com Report, Vol. 21, No. 3 (Mar 2019).
Copyright 2019, ConstructionRisk, LLC

Article 2

Indemnification is only for Third Party Claims Unless Clause Expressly States it applies to First Party Damages

An indemnification clause will only apply to liability for claims brought by third parties. It will not apply to claims between the contracting parties. In Florida, a contract’s general indemnity clause does not apply to first party claims for costs and expenses unless the clause specifically states it applies to such claims. To depart from the normal default position that indemnity provisions apply to a third party liability, the parties must expressly state that intent in their contract. International Fidelity Ins. Co. v. Americaribe-Moriarty JV, 906 F.3d 1329 (U.S. Court of Appeals, 11^th Circuit – Florida 2018).

In this case, a subcontractor to the general contractor (GC) was found by the trial court to be in default under its construction subcontract. Fidelity, as the subcontractor’s surety, issued a performance bond on behalf of the subcontractor. When the subcontractor defaulted, the GC retained another contractor to finish the sub’s work and then subsequently made a demand on Fidelity under the performance bond.

Fidelity denied the GC’s claim because the CG failed to comply with the requirements of the performance bond in that it failed to give Fidelity reasonable notice before undertaking the remedy to the subcontractor’s default, and commenced efforts to supplement the subcontractor’s work before providing Fidelity with an opportunity to remedy the alleged defect. Fidelity asked the trial court to declare the bond null and void due to the actions taken by the GC. It also asked the court to grant it attorney’s fees pursuant to the performance bond and the subcontract indemnification clause.

The trial court decided in favor of Fidelity and awarded it attorney’s fees under the indemnification clause. On appeal, the court reversed the attorney’s fee decision –holding that the indemnity clause applied only to third party claims and could not be used to recover attorney's fees arising in the dispute between parties to the contract.

Florida Statutes, Sec. 57.105(7), explained the court, renders a unilateral contract clause for prevailing party attorney’s fees bilateral in effect. But his didn’t matter in this case because the court found as a threshold matter that the indemnity clause didn’t even constitute an attorney’s fee provision applicable to the situation in dispute. The court explained:

“Generally speaking, ‘a contract for indemnity is an agreement by which the promisor agrees to protect the promisee against loss or damages by reason of liability to a third party [emphasis in original]…. That is, it is generally not the case that an indemnity clause will be understood to include protections for the expense of liability caused by the indemnified party itself…. ‘An indemnification provision that is silent or unclear whether it applies to first-party claims will normally be interpreted to apply only to third-party claims.’… Likewise, ‘a party to a contract cannot use an indemnity clause to shift attorney fees between the parties unless the language of the clause shows an intent to clearly and unambiguously shift the fees.’”

In conclusion, the court stated that if the parties to the subcontract intended to depart from the default position that indemnity provisions apply only to third party liability, they would have had do to so expressly in the contract. And likewise, if they wished to depart from the general rule in Florida that prevailing litigants are not entitled to attorney’s fees, they would have needed to include a prevailing party attorney’s fee provision in the subcontract.

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. 21, No. 3 (Mar 2019).

Article 3

Certificate of Merit not Required with Joinder Complaint against Architect

See similar articles: Breach of Contract | Certificate of Merit | change order claim | Negligence

General contractor (GC) filed a joinder complaint to join an architect in a suit brought by a subcontractor against the GC based on GC’s failure to grant a change order that was alleged required due to defective plans and specifications. The GC didn’t submit a certificate of merit with its joinder complaint against the architect. Based on a state statute requiring a certificate of merit be filed with, or within 60 days of filing, negligence complaints against design professionals, the architect was granted summary judgment by the trial court. This was reversed on appeal, with the court holding that the original complaint by the construction subcontractor included allegations of negligence in the plans and specifications of the architect. The negligence allegations in the sub’s complaint against the GC and the GC’s complaint against the architect were related. Because they were related, it was not necessary for the GC to file a certificate of merit regarding the same or related negligence claims that had first been raised by the construction subcontractor. Kelly Systems, Inc. v. Leonard S. Fiore, Inc. 2018 WL 5629644 (PA Superior Court 2018).

The sub alleged that a mounting system for exterior wall panels was “impossible to construct” due to defects in the architectural drawings. It proposed a solution for $225,000, and the GC refused to grant a change order for the changed work. The sub went ahead and continued to work on the project and included its proposed solution to the allegedly defective designs. It then filed suit against the GC to recover additional costs of implementing its solution.

The architect in question was under subcontract to the GC and not to the project owner. Although the decision doesn’t explain it, this contract for the exterior panels (possibly a curtain wall) must have been a design-build or design-assist element of the overall project. The GC was responsible for designing the mounting system (through an architect subcontractor) as well as for then constructing the walls that would be supported by that system.

In analyzing whether a certificate of merit was required the court determined that the complaint by the sub against the GC was based on breach of contract but that the essence of the complaint was that design plans had been negligently devised by the architect, and then negligently provided by the GC to the subcontractor. The court determined that the GC joinder complaint against the architect was adequate to allege that if the GC was found liable to the sub for negligent plans, then the architect was liable to the GC for having been the one that prepared those allegedly negligent drawings.

The court stated that the GC was not required to admit that the plans were defective in order to pursue its claim against the architect. The court also concluded that the crux of the issue with the change orders will be whether designs relied upon by the subcontractor were defective. And the court found that expert testimony will be needed by both the subcontractor and the GC to prove the design specifications were defective. “The same expert testimony and same evidence will be used to show whether the design specifications were defective and whether a change order should have been granted.”

Because the alleged acts of negligence by the GC against the architect as an additional defendant are related to the acts of negligence alleged by the sub against the GC, the court held that the GC was not required to file a certificate of merit with its complaint against the architect.

Article 4

Project Owner Can’t Sue Architect working under subcontract to Design-Builder for Alleged Negligent Approval of Pay Applications

See similar articles: Design-Build | pay application | Third party beneficiary

A contractor was awarded a design-build contract to design and build a four-story parking deck. The contractor subcontracted the design to an architectural firm. The Owner-Builder agreement between the contractor and owner listed the name of the architectural firm as the “project architect.” Although the design-builder completed the project late, and there may have been payment issues, the architect approved the contractor’s payment applications and did not take any action to withhold liquidated damages for the delay. When the project owner was unable to locate and sue the design-builder, it filed suit against the architect alleging it breached a duty of care owed to the owner by negligently approving the pay applications, by failing to protect the owner against claims by unpaid subcontractors, and failing to account for liquidated damages allegedly owed. Auburn Hills Tax Increment Finance Authority v. Haussman Construction Company. Court of Appeals of Michigan (2018)

Summary judgment was granted, and affirmed on appeal, for the architect, holding that the architect owed the owner no duty under its contract with the design-builder and no duty independent of the contract. The appellate court found that the contract itself didn’t contain any express duties with regard to payment applications or the other issues alleged. It explained that there could be no independent duty owed to the owner absent some special relationship, a voluntary undertaking of a risk, an obligation to the public, or some similar circumstance.

Comment: A project owner on a design-build project may protect itself against problems such as those that arose on this project by retaining under separate contract a construction manager or owner’s representative to be responsible for observing the design-builder’s work and approving such things as change order requests, payment applications and final payment. A design professional that is under contract to the design-builder has the design-builder (and not the owner) as its client.

Article 5

City not a Third Party Beneficiary of Design Professional’s Contract

See similar articles: Breach of Contract | Negligence | Third party beneficiary

The City of New York filed a breach of contract claim against an architect (Perkins Eastman) that was under contract to the Dormitory Authority of the State of New York (DASNY), claiming it was an intended third party beneficiary of that contract. The state Court of Appeals held that the city was not an third party beneficiary, and its negligence claim was duplicative of its breach of contract claim and must be dismissed. It also found there was no duty of care to perform in accordance with professional standards that was independent of its contractual obligations to its actual client. Dormitory Auth. of the State of N.Y. v Samson Constr. Co. 2018 NY Slip Op 01115 Decided on February 15, 2018 Court of Appeals.

The court noted that under a separate contract between DASNY and its construction contractor, the City of New York was expressly made a third party beneficiary. In contrast, there was no similar provision in the design professional contract.

The design professional contract provided that Perkins would "indemnify and hold harmless" DASNY and the "Client" (that is, OCME, and the NYC Police and Fire Departments) from any claims arising out of Perkins' negligent acts or omissions and that extra costs or expenses incurred by DASNY and the Client as a result of Perkins' "design errors or omissions shall be recoverable from [Perkins] and/or its Professional Liability Insurance carrier."

The court stated, “Although there are passing references to the Client in the Perkins Contract, no analogous language providing that the City is an intended third-party beneficiary appears there.”

The breach of contract claim alleges that Perkins breached the contract by "failing to provide adequate designs for the Project, by failing to properly supervise the subcontractors and subconsultants that it retained with regard to the Project, by failing to monitor the progress of the Work to ensure that it was being completed properly and in substantial compliance with the design recommendations, specifications and their intent, by failing to ascertain the actual field conditions, including the subsurface conditions at the Site and the foundations beneath [the C & ]D Building and by failing to advise DASNY of the risks to the [C & ]D Building posed by the installation of the [excavation support system] and taking precautions against such risks."

The court stated that, “The allegations set forth in the negligence cause of action are virtually identical in every respect, but with an introductory phrase that references Perkins' failure ‘to comply with professional standards of care’ instead of breach of contract.”

Intended Third Party Beneficiary Claim

The court explained that it has previously sanctioned a third party's right to enforce a contract in two situations: when the third party is the only one who could recover for the breach of contract or when it is otherwise clear from the language of the contract that there was "an intent to permit enforcement by the third party".

With respect to construction contracts, the court stated, “We have generally required express contractual language stating that the contracting parties intended to benefit a third party by permitting that third party ‘to enforce [a promisee's] contract with another.’ In the absence of express language, ‘[s]uch third parties are generally considered mere incidental beneficiaries’ (citation omitted). This rule reflects the particular nature of construction contracts and the fact that — as is the case here — there are often several contracts between various entities, with performance ultimately benefitting all of the entities involved.”

Although the performance of a construction-related contract may benefit a third-party end-user such as the City of New York, that does not in itself establish enforcement rights in that third party.

Duplicative Negligence Claim

The court provided an excellent analysis and explanation of the distinction and interplay between breach of contract and tort actions. It stated, "It is a well-established principle that a simple breach of contract is not to be considered a tort unless a legal duty independent of the contract itself has been violated…. Where the damages alleged ‘were clearly within the contemplation of the written agreement . . . [m]erely charging a breach of a duty of due care,' employing language familiar to tort law, does not, without more, transform a simple breach of contract into a tort claim.”

“To determine whether a tort claim lies, we have also evaluated the nature of the injury, how the injury occurred and the harm it caused (see 79 NY2d at 552). However, we have made clear that "where plaintiff is essentially seeking enforcement of the bargain, the action should proceed under a contract theory"

Here, the court explained that the only damages alleged under either theory of recovery are the additional expenses required to complete the project, including the costs to repair the damage to adjacent structures. “Significantly, in the contract itself, the parties contemplated Perkins' responsibility for additional costs or expenses incurred by DASNY or the Client (in effect, the City) as a result of the architect's design errors or omissions, and addressed it in the contract terms.”

“Clearly, there are circumstances where a professional architect may be subject to a tort claim for failure to exercise due care in the performance of contractual obligations. In seeking to "disentangl[e] tort and contract claims," we focused in Sommer both on potential catastrophic consequences of a failure to exercise due care and on the nature of the injury, the manner in which it occurred, and the resulting harm. We distinguished between the situation where the harm was an "abrupt, cataclysmic occurrence" not contemplated by the contracting parties and one where the plaintiff was essentially seeking enforcement of contract rights.

Here, the C & D building settled during the course of several months, damaging adjacent structures. However, even if any "abrupt" or "catastrophic" consequences either could have or did result from Perkins' alleged negligence, the fact remains that the only damages alleged appear to have been within the contemplation of the parties under the contract — and, indeed, as set forth above, are identical for both claims.

Put another way, there was no injury alleged here that a separate negligence claim would include that is not already encompassed in DASNY's contract claim. In these circumstances, DASNY ‘is essentially seeking enforcement of the bargain, [and] the action should proceed under a contract theory.’"

Thus, we hold that the negligence claim is duplicative of the breach of contract cause of action and Perkins' motion for summary judgment to dismiss that cause of action should have been granted.”

Comment: In order to prevent claims like this one by an entity asserting that it was an intended third party beneficiary, design professionals and contractors are well advised to include a clause in their contract expressly stating that there are no third party beneficiaries of the contract. If it is contemplated that there will, in fact, be a third party beneficiary, then a clause can be included in the contract to identify that particular entity as a third party beneficiary and then state that there are no other third party beneficiaries.

The negligence count was dismissed by the court, as explained by the decision, because the design professional owed no independent duty of care to the City with regard to the economic losses claimed, and the appropriate avenue of recovery was limited to breach of contract actions which could be brought only by the design professional’s client. It is interesting to note that DASNY, as the client of the design professional would also be limited to only a breach of contract claim against that design professional and could not add a negligence count for the same damages arising out of the alleged negligent actions that caused the breach of contract.

Article 6

Project Owner Can’t Sue Design-Build Contractor’s Design Subcontractor

See similar articles: Contract Privity | Design-Build | Individual Liability

An owner developing a project under a design-build contract filed suit against a design professional that was a subcontractor to the owner’s design-build contractor. The suit was based on negligence and also breach of contract and named the engineering firm and two engineers individually. Summary judgment was granted for the engineers and this was affirmed on appeal, with the court explaining that under New York law, a breach of contract claim requires direct contractual privity (being parties to a contract), but an exception to privity can occur if the plaintiff’s and defendant’s relationship “is the functional equivalent to privity.” The court held that the owner failed to meet the requirement of a critical element for establishing “the functional equivalent of privity,” which is to show evidence of “linking conduct” by the design professional—words or actions that link the professional to the non-client. Stapleton v. Barrett Crane Design & Engineering. United States Court of Appeals, Second Circuit (2018).

There was no direct contact between the two engineers and the owner. The owner argued that by the engineer stamping his name on the design drawings he had established a link to the owner. The court found this unpersuasive, noting that the engineer didn’t convey the drawings to owner, or make any related contact or communication.

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