Inside this Issue

A1 - “Pay-when-paid” treated as a “Pay-IF-paid” due to Condition Precedent Language (Virginia law)
A2 - Pay-if-Paid Clause Enforced to Deny Payment to Subcontractor (Missouri law)
A3 - Correcting the Additional Insured Problem when Named Insured is not in Privity of Contract with Additional Insured
A4 - Professional Liability Exclusion in CGL Policy Bars A/E from GCL Additional Insured Coverage for Laborer’s Injuries From Alleged Failure to Plan for Safe Removal of Digester Tank Lid
A5 - Encountering Soil Conditions Differing from data in Government Provided Geotechnical Report Entitled Design-Builder to Differing Site Condition Recovery (ASBCA Decision)

Article 1

“Pay-when-paid” treated as a “Pay-IF-paid” due to Condition Precedent Language (Virginia law)

See similar articles: Ambiguous | Condition Precedent | Pay-If-Paid | pay-when-paid | Payment

A question sometimes arises as to whether a payment clause in a subcontract creates an absolute bar to subcontractor payment in the event an owner fails to pay the prime contractor or creates merely a time frame for paying the subcontract, thereby requiring payment within some reasonable time even if no payment is received by the prime contractor from its own client. We often call the first type of clause that requires eventual payment within a reasonable time a “pay-when-paid” clause. And the clause that makes payment to the prime contractor a condition precedent to payment of the subcontractor is generally called a “pay-if-paid” clause.

Sometimes, however, a clause may use the “when” terminology but the court will nevertheless apply it as an “if paid” clause due to language in the clause that otherwise clearly and unambiguously makes payment by the owner/client a condition precedent to the prime’s obligation to pay the subcontractor.

(This decision was reversed on appeal by the Court of Appeals of Maryland, 185 A.3d 170 (2018)) In Young Electrical Contractors, Inc. v. Dustin Construction, Inc., 231 Md. App. (2016) the Maryland Court of Special Appeals, applying Virginia law due to a choice of law provision in the contract, concluded that where a project was allegedly delayed by the project owner and caused delay and impact costs to the subcontractor, the “pay-when-clause,” in combination with a separate clause addressing payments arising from owner-initiated changes, set a condition precedent such that the subcontractor was not entitled to payment since the owner failed to pay the prime contractor for the changes. Interestingly, despite concluding that payment was due to the subcontractor only IF the owner paid the prime, the court never referred to the clause as a “pay-if-paid” clause but instead called it a “pay-when-paid” clause with a clear “condition precedent” to the payment obligation.

Comment: The case demonstrates the importance of using clear and precise language for subcontract payment clauses. Regardless of what terminology the clause may use, the courts are going to look at the entirety of the language to determine whether it sets an absolute condition precedent or just a reasonable time after which payment must be made. Subcontractors may be able to avoid the draconian impact of a “pay-if-clause” by adding a sentence to the end of the clause stating something like the following: “In no event, however, shall payment of any invoice be made later than 45 days from the date the subcontractor’s invoice is submitted.”

The court explained that for a valid condition precedent to exist within a pay-when-paid clause, courts will look to the unambiguous language of the contract to see whether such a condition is established. The inclusion of conditions precedent in a subcontracting agreement involves a shift in the credit risk from the general contractor to subcontractor.

“A provision that makes receipt of payment by the general contractor a condition precedent to its obligation to pay the subcontractor transfers from the general contractor to the subcontractor the credit risk of non-payment by the owner for any reason (at least for any reason other than the general contractor’s own fault), including insolvency of the owner.”

According to the court, “This shift in risk accordingly demands an express reference in the subcontract to a condition precedent.”

The subcontract must therefore make an express reference to a condition precedent, regardless of reason for the condition, as long as subcontractor understands there is a shift in credit risk.

Section 2(c) is a valid pay-when-paid clause under Virginia law, concluded the court, and sets forth the understandings between the parties and the procedures for the prime contractor’s payments to its subcontractor for the electrical work under the Subcontract. The clause in Section 2(c) states, in relevant part:

“It is specifically understood and agreed that the Contractor’s obligation to pay all or any portion of the Subcontract Sum to Subcontractor, whether as a progress payment, retainage, or a final payment, is contingent, as a condition precedent, upon the contractor’s receipt of payment from the Owner of all amounts due Contractor on account of the portion of the Work for which the Subcontractor is seeking payment.”

(Emphasis added).

The Subcontract explicitly establishes that George Mason University’s payment to the prime contractor is the condition precedent to the prime’s payment of the Sub.

The second clause (Section 13 (c)) that the court concluded must be read to harmonize with the intent of Section 2 was one that specifically addressed payments arising from owner-initiated changes. It provided in pertinent part:

“In the event a change is made to this Contract as a result of the Owner’s change to the Prime Contract and such change causes an increase or decrease in the cost of and/or the time required for performance under this Subcontract, Subcontractor may submit to Contractor in writing in accordance with the requirements of the Changes Clause of the General Contract a request for an equitable adjustment in the Subcontract Sum and/or the Subcontract Time, or both .... Contractor shall pay to Subcontractor that amount paid by the Owner to Contractor on account of any such change to this Subcontract, less any markup and other amounts due Contractor on account of such change. Contractor shall have no liability to Subcontractor on account of any such Owner initiated change except for such amount, if any.”

The court found that although Section 13(c) did not contain an express condition precedent, it does contemplate payments to Young where George Mason has initiated a change in the Project. As Section 2(c) sets forth the procedure for payments to Young, its applicability to 13(c) should not be ignored. Accordingly, when both sections are read together, the Prime’s receipt of a change payment from George Mason is the condition precedent that must be met if the Sub is to receive that payment. “By consenting to Section 2(c), [the subcontractor] has accepted the credit risk and cannot hold [the Prime] liable for non-payment if it does not receive its change payment.”

(This decision was reversed on appeal by the Court of Appeals of Maryland, 185 A.3d 170 (2018))

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. 5 (May 2017).

Article 2

Pay-if-Paid Clause Enforced to Deny Payment to Subcontractor (Missouri law)

See similar articles: Ambiguous | Condition Precedent | Pay-If-Paid | pay-when-paid | Payment

Where a subcontract clause stated that the subcontractor agreed that the prime would not be responsible to make any payment to the Sub “unless and until [Prime] receives payment … from Owner of the project,” a Missouri appellate court found that the language was clear and unambiguous in establishing owner payment as a condition precedent to any duty of the prime contractor to make payment to the subcontractor. The clause in question had been revised by negotiation to include, “If Subcontractor is not paid within 45 days of when a pay application is submitted, Subcontractor may stop the Work of this Subcontract until payment is received.” The court found that time-period language did not conflict with condition precedent but rather just eased the burden on the subcontractor by allowing it to stop work on the project entirely if payment was not forthcoming within 45 days. “Rather than being contradictory or ambiguous [the] paragraph logically distributes financial risk between the parties and provides both a measure of financial protection.” This court frames the issue in the more standard terminology of “pay-when-paid” as contrasted with “pay-if-paid.” A. Zahner Company v. McGowan Builders, Inc., 497 S.W.3d 779 (Missouri 2016).

Comment: Note the different result that would be attained by stating the subcontractor could cease in 45 days if payment were not made, as compared to instead stating that in no event would payment be made later than 45 days.

Article 3

Correcting the Additional Insured Problem when Named Insured is not in Privity of Contract with Additional Insured

See similar articles: Additional Insured | Additional Insured Endorsement | CG 2032 04 13 | Gilbane | John Feeney

The April 2017 issue of ConstructionRisk.com Report included an article about a case in which the court held that a CGL insurance carrier of a construction contractor was not obligated to defend the project owner’s construction manager as an “additional insured” because there was no privity of contract between the contractor and the CM. The contractor had been required by its contract with the project owner to make the CM an additional insured, and the contract even included a sample certificate of insurance with the CM listed as an additional insured. The issue was, however, that the CGL insurance policy stated that an additional insured would be an entity with whom the contractor agreed in writing to make an additional insured. The policy would not extend additional insured status to an entity for whom the contractor agreed to make an additional insured where it is not also in privity of contract with that entity. This is a real problem because it is quite common that a contractor or a subcontractor is required by their client, such as the project owner, to name someone such as engineer, with whom they have not privity of contract, as an additional insured under their CGL policy. The court held that this did not obligate the CGL carrier in Gilbane Bldg. Co./TDS Construction Corp. v. St. Paul Fire and Marine Insurance and Liberty Insurance, 38 N.Y.S. 3d, 143 A.D.3d 146 (2016) to honor the contractor’s obligation.

Upon reading the newsletter, John Feeney, IOA Insurance Services, Pleasanton, CA, sent me an email attaching what he calls an apparently underutilized endorsement that seeks to remedy the problem created in situations such as the Gilbane case. It is titled, “Additional Insured - Engineers, Architects or Surveyors Not Engaged by the Named Insured endorsement CG 2032 04 13.”

It is specifically intended to create additional insured status for engineers, architects and surveyors that are not in privity of contract with the named insured, but only covers liability arising out of “ongoing operations.” It does not cover liability from completed operations. When using this endorsement, John advises that something such as the following clause should be included in the contract between the project owner and its contractor to require naming additional insureds using the CG 2031 04 13 form:

“Additional Insured Requirement. CLIENT agrees to require its contractors and sub-contractors to include DESIGN PROFESSIONAL as additional insured on commercial general liability policy(ies) inclusive of operations, completed operations, and products liability coverage provisions. Such additional insured coverage shall be provided by Additional Insured - Engineers, Architects or Surveyors Not Engaged by the Named Insured endorsement CG 2032 04 13, or other comparable endorsement.”

Comment: In reviewing different additional insured endorsements being used in the market, it can be perplexing to understand whether an entity not in privity with the named insured can actually be provided the additional insured coverage that many contracts seem to demand. I invite CGL insurance brokers to submit comments on this issue.

Article 4

Professional Liability Exclusion in CGL Policy Bars A/E from GCL Additional Insured Coverage for Laborer’s Injuries From Alleged Failure to Plan for Safe Removal of Digester Tank Lid

See similar articles: Additional Insured | CGL | Coverage Dispute | Jobsite Safety | Professional Liability Exclusion

Sparks from a cutting torch being used to remove bolts from a wastewater digester tank ignited a methane gas explosion that killed an employee of a construction subcontractor and injured an employee of another subcontractor. Both subcontractor’s were required by their contracts to name the project design professional (DP) as an additional insured on their commercial general liability (CGL) polices. When claims were brought on behalf of the subcontractor employees against the DP, the DP tendered the claims to the subcontractor CGL carriers for defense. The carriers refused to defend. In a subsequent declaratory judgment action, the appellate court sustained summary judgment on behalf of the two carriers on the basis that the professional liability exclusion in their policies applied to the claims.

The court found that regardless of how the underlying cause of action was framed, “The substance of the underlying claims is that [DP] is liable for failing to properly plan for, and take preventative measures to ensure, the safe removal of the digester tank lids. ... The underlying plaintiffs allege that [DP] had a duty as the project’s consulting engineering firm to do so. Even if some of the underlying factual allegations implicate tasks that do not, in and of themselves, involve a specialize skill, such acts and omissions are reasonably related to [DOP’s] overall provision of professional services.” DP’s own professional liability carrier defended it in the two actions and the court concluded that the CGL policies were “never intended to cover professional negligence claims.” Orchard, Hiltz & McCliment (OHM) v. Phoenix Insurance Co., 2017 WL 244787 (U.S. Court of Appeals, 6^th Cir., 2017).

On this project, in addition to having responsibility for design, the DP, during the construction phase, was responsible for “contract administration, construction engineering, construction observation, and construction staking.” It was also responsible to provide daily observation of work, prepare daily field reports, and check completed work for “compliance with contract documents.”

The overall plan for the upgrades of the wastewater plant included removal and replacement of two sludge digester tank lids. The DP met with the prime contractor regarding how this work would be done. The prime subcontracted part of the digester work to a subcontractor who in turn subcontracted with another firm to remove the lids. The court mentioned only in passing that there was an issue of whether the DP was even an additional insured under the polices in question due to a question as to whether the promise to make the DP an additional insured would only be enforceable if it were contained in a contract between the contractors and the DP. Since the professional liability exclusion otherwise barred coverage even if the DP was an additional insured, the trial court and appellate court focused on that issue.

Court Decision on Professional Liability Exclusion

The court stated that,

“The prime contractor’s policy contains an additional insured endorsement extending general liability coverage to “any person or organization that you agree in a ‘written contract requiring insurance’ to include as an additional insured[.]” Excluded from this endorsement, however, is coverage for bodily injury, personal injury, or property damage arising out of the rendering of, or failure to render, any professional architectural, engineering or surveying services, including:

The preparing, approving, or failing to prepare or approve, maps, shop drawings, opinions, reports, surveys, field orders or change orders, or the preparing, approving, or failing to prepare or approve, drawing and specifications; and
Supervisory, inspection, architectural or engineering activities.”

The subcontractor’s CGL policy had an exclusion for injuries and damages caused by,

“[a]ny person or organization whose profession, business or occupation is that of an architect, surveyor or engineer with respect to liability arising out of the preparation or approval or the failure in preparation or approval of maps, shop drawings, opinions, reports, surveys, field orders, change orders, designs, drawings, specifications or the performance of any other professional services by such person or organization[.]”

The court found that both CGL policies “broadly exclude coverage for liability ‘arising out of’ performing or failing to perform any professional architectural, engineering, or surveying services.” As to whether any of the underlying allegations against the engineer could fall outside the exclusion by implicating non-professional acts or omissions, the court looked to the applicable Michigan law that provides “whether a professional service is being rendered depends on the nature of the act or omission, not the character or tile of the person who acted or failed to act.” Professional services are defined by the courts of Michigan to be “those involving specialized skill of a predominantly intellectual nature.”

“Both underlying complaints allege that OHM, as the project’s consulting engineer, was negligent in its duty to supervise construction operations, provide adequate safety supervision, and to include in its project plans ways to ensure the safe removal of the digester lids. These acts are predominantly intellectual in nature, and both insurance policies exclude coverage for liability “arising out of” an engineer’s or architect’s failure to prepare or approve drawings and specifications, other ‘supervisory, inspection, architectural or engineering activities,’ and indeed ‘any other professional services.’ Assuming the underlying plaintiffs can show that OHM owed such duties, accounting for and ensuring the safe removal of the lids in its project plans and on site would require OHM to exercise the specialized knowledge and expertise in wastewater facility project design and supervision that Dexter hired it to provide.”

Although the DP claims that the plaintiffs’ assertions in the underlying action are of a general liability nature because they seek to hold the DP liable for unskilled construction and accident prevention tasks. The appellate court rejected that characterization. For the reasons described herein, the allegations were deemed to be of a professional liability and therefore excluded from coverage under the CGL policies.

Article 5

Encountering Soil Conditions Differing from data in Government Provided Geotechnical Report Entitled Design-Builder to Differing Site Condition Recovery (ASBCA Decision)

Geotechnical, Saturated Soil, Geotechnical Report, Metcalf Construction

During site excavation, a design-build contractor encountered a large quantity of unsuitable soils, and this required remediation before foundation work could commence for a building. In this appeal the Armed Services Board of Contract Appeals (ASBCA) from the U.S. Army Contracting Officer’s Final Determination, the appellant, Tetra Tech Facilities Construction, LLC (“design-builder” or “contractor”), argued it was entitled to equitable adjustment under its contract due to soupy clay that differed materially from the medium to stiff clay shown in the government’s geotechnical report that was provided to bidders. The ASBCA opinion, written by Judge O’Sullivan, agreed with the design-builder. The government attempted to argue that the geotechnical information it provided with the contract documents should not have been relied upon by the contractor because the contract obligated the contractor to satisfy itself as to the character and quality of the subsurface materials, and also required the contractor to perform additional site investigation after award of the contract before it would be permitted to construct the building. The Army also argued that its geotech report adequately disclosed the site conditions.

The ASBCA rejected virtually all arguments by the government, and found that the government’s soils report told bidders to expect medium to stiff constructible soils with close to idea moisture content for compaction and did not warn of the conditions actually encountered. The Board found that the design-builder reasonably relied on the subsurface conditions indicated in the soils report. “The fact that the contract labeled its representations as to subsurface conditions as ‘for information only’ or that the contract contains a requirement that the contractor perform further subsurface investigation after award does not deprive the contractor of the right to rely on those representations. Metcalf Construction Co.. v. United States [citation omitted].” The ASBCA wisely noted, “The government does not explain how it thinks [Design-Builder] could have ‘adjusted its proposal’ after contract award based on [it’s own post-contract award geotechnical study]….”

Comment: After the Metcalf Construction case, it was hoped by government contract attorneys like myself who represent government contractors in differing site condition claims, that contracting officers would cease their attempts at using broad contract disclaimer language in their efforts to avoid payment of differing site condition claims. Unfortunately, there is still a learning curve, especially where it appears that some contracting officers believe a greater burden should be imposed on design-builders since their own post-award site investigation is required anyway in order to determine the extent of site conditions necessary to finalizing the design and constructing the project. This current decision helps further lay to rest these spurious arguments. Appeals of Tetra Tech Facilities Construction, LLC, 16-1 BCA 36562, ASBCA 58568, 2016 WL 7025999.

The facts of this case, and the import of the legal conclusions, can perhaps be easiest understood by quoting at length from several key passages in the well-written and analyzed 27-page decision.

Key findings of fact by the Board included the following:

“Contract Indications Regarding Site Conditions

5. Included with the Phase Two solicitation as Attachment B was a document entitled “Geotechnical Engineering Exploration and Analysis” dated 11 February 2009 and prepared by Giles Engineering Associates, Inc. for the Maryland Military Department² (Giles Report) (R4, tab 74 at 488-523). The Giles Report was included in the solicitation documents to provide the bidders with geotechnical information about the project site to allow them to develop proposals (id. at 111, 491). The Executive Summary of the report summarized its findings as follows:

Six geotechnical test borings were performed at the subject site to evaluate subsurface conditions. Topsoil consisting of silty clay and sandy clay with trace organic matter was at the surface at the test borings. The topsoil was measured to be between about 4 and 8 inches thick. The native soil below the topsoil generally consisted of firm silty sand and stiff to very stiff silty clay and sandy clay. It is estimated that the water table was about 7 to 11 feet below-ground at the test borings with perched water at about 1½ feet below-ground when the [exploration] was conducted.

The proposed building will be a two-story structure. It is assumed to be a masonry structure that will not have a basement or other below-ground spaces. Based on the assumed first floor elevation...a spread footing foundation designed for a 3,000 pound per square foot (psf) maximum, net, allowable soil bearing capacity is recommended for the proposed building.

(Id. at-491)

6. Giles reported Material Conditions in Section 6 of its report. The topsoil was characterized as consisting of silty clay and sandy clay with trace organic matter in layers 4 to 8 inches deep. Below that:

The native soil below the topsoil at Test Boring No. 1 generally consisted of firm silty fine sand to at least the 16 foot test boring termination depth. The native soil at Test Boring No. 2 generally consisted of stiff silty clay to at least the 21 foot test boring termination depth. The native soil at the remaining test borings generally consisted of stiff to very stiff silty clay and sandy clay and firm clayey sand, silty sand, and sandy silt to at least the 16 and 21-foot test boring termination depths.

Giles also addressed groundwater:

7.0 GROUNDWATER CONDITIONS

It is estimated that the water table was about 7 to 11 feet below-ground at the test borings with perched water at about 1½ feet below-ground....Groundwater conditions will fluctuate and groundwater may become perched above the water table.

The estimated water table depth is only an approximation based on the colors and water content of the retained soil samples, and water levels that were encountered at the test borings. The actual water table depth may be higher or lower than estimated. If a more precise depth estimate is needed, groundwater observation wells are recommended to be installed and monitored at the site.

7. The Giles Report was the only source of information provided by the government about subsurface conditions on which bidders could base their proposals (tr. 4/31-32). While a site visit was conducted prior to bid, Tetra Tech and the other bidders were limited to visual observations-no invasive investigation was allowed (tr. 1/52,298-99).”

The Board explained the significance of the Report’s characterization of the soils was testified to by several witnesses, including Tetra Tech’s design manager, who said that after looking at the report and soil boring logs and the description of soils as “firm or stiff,” he had no concerns about the project from a design perspective. The design-builder’s senior project manager testified that the Report described the soils as being “firm, stiff soils that we could work off of and build off of, that there was nothing out there that would indicate that we had to remove soils or replace soils due to unsuitable conditions.”

He also testified that the prominent description of the soil conditions was something like “medium to stiff,” which generally “exhibits good engineering behavior [-] the soils tend to be stronger, they tend to be less compressible and so when we put load on them they are less likely to fail, they are less likely to move [and]they have good engineering characteristics.”

The government’s expert testified to the contrary and asserted that the government’s soil report put the design-builder on notice that it would encounter soils at or near saturation. The Board was not persuaded by the government’s expert but instead found that the government report did not warn of soils “at or near saturation” and that the borings logs and geotechnical evaluation thereof told bidders on the project to expect (and thus the contract indicated) medium to stiff constructible soils with close to ideal moisture content for compaction.

The Board explained the essence of the government’s argument as follows:

The government contends that Tetra Tech has not established either a “Type 1 or Type 2 differing site condition existed because it should have known before it bid, from the raw boring data contained in the Giles Report, that the site was saturated by groundwater at very shallow depths. Having known that, the government continues, Tetra Tech should have engaged in extensive dewatering before beginning excavation, and it cannot recover for expense that it incurred because it failed to do so. The government also disputes Tetra Tech’s breach of warranty, superior knowledge, and breach of implied duty arguments.

* * *

In this appeal it is undisputed that the contractor actually encountered a large volume of saturated, unsuitable soils during excavation of the project site. It is also undisputed that the only information on subsurface conditions that the government made available to Tetra Tech and the other bidders before bidding was the Giles Report, which was Appendix B to the Phase 2 solicitation and was incorporated into the contract upon award (findings 2, 5). The parties disagree on what the Giles Report indicated about the soils at the site.

The Board has found that the Giles Report told bidders on the project to expect medium to stiff constructive soils with close to optimum moisture for compaction (finding 17). This finding is based on not only the characterization of the soils by the government’s geotechnical engineers (Giles) but also on the data contained in the boring logs themselves (findings 5-16).”

As noted above, the Board found the evidence did not support the government’s arguments against a differing site condition claim based on the content of the Report.

The government also argued that that the conditions actually encountered at the site were reasonably foreseeable based on the contents of the government Report, because:

“(1) the “very moist” soil conditions Tetra Tech encountered were as reported by Giles, which characterized the soil as “moist” or “moist to wet” (gov’t br. at 45); (2) the Giles Report warned against the effects of adverse weather which Tetra Tech encountered when it excavated in December of 2010 (id. at 46-47); and/or (3) the Giles Report data warned of soil at or near the liquid limit, “dangerously close to saturation” so that a reasonable contractor would expect soil instability (id. at 48).

The Board rejected all three of the government’s propositions concerning what a reasonable bidder would determine from reviewing the government’s soil report.

The government made one last-ditch effort to avoid honoring the bona fide differing site condition claim. “The government asserts that the soils conditions encountered by Tetra Tech were ‘entirely foreseeable’ given the site’s close proximity to the Chesapeake Bay and the fact that excavation commenced in the winter.” The Board stated that, “This assertion is not further explained or supported….”

Final Comment: One can only hope that contracting officers will, in future determinations regarding differing site conditions claims, apply the lessons learned from this excellent decision as well as the decision of Metcalf Construction cited therein.

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ConstructionRisk.com Report (May 2017)