Inside this Issue

A1 - Contract Drafting Tip: The Flow–Down Incorporation by Reference Clause
A2 - Implied Warranty and Workmanship Claims Cannot be Waived by Homeowner
A3 - Engineer has no Exemption from Liability under Statute Providing Insurance Companies Exemption from Liability
A4 - Arbitration Award Affirmed Despite Objections that one of Arbitrators Failed to Disclose Relationship with Two of the Parties

Article 1

Contract Drafting Tip: The Flow–Down Incorporation by Reference Clause

This article is written from the subcontractor’s perspective. When negotiating its subcontract, the subcontractor may be successful in obtaining reasonable clauses concerning standard of care, time for performance, indemnification, limited warranties and other significant risk allocation matters. But then, by agreeing to an incorporation by reference clause, the subcontractor agrees that the terms and conditions contained in the prime contract will control over any conflicting or different clauses it worked so hard to get into its subcontract. Thus, higher standards of care, warranties, and uninsurable indemnification obligations contained in the prime contract will be enforced if a matter ends up in litigation. This article explains what ConstructionRisk, LLC does when reviewing a subcontract to assist the subcontractor to avoid some of these uninsurable flow down provisions.

At the conclusion of whatever flow down clause the subcontract has (particularly if there is a long prime contract that might contain uninsurable warranties or indemnity obligations), add the following in order to do a disclaimer of warranties and Indemnitees:

Option (1) “provided however, that notwithstanding any clause in the Prime Contract or this Agreement to the contrary, Subconsultant expressly disclaims all express or implied warranties and guarantees with respect to the performance of professional services, and it is agreed that the quality of such services shall be judged solely as to whether Subconsultant performed its services consistent with the professional skill and care ordinarily provided by firms practicing in the same or similar locality under the same or similar circumstances (“Standard of Care”), and provided further that Subconsultant shall not provide indemnification of any indemnitee other than to the extent damages arise out of third party claims against the indemnitee and to the extent caused by Subconsultant’s willful misconduct or negligence, and provided further that Subconsultant shall not defend any indemnitee against professional liability claims, and provided further that Subcontractor shall not be obligated to indemnify the Owner or any other Indemnitees other than the Prime under any indemnity provision unless the Prime Contract expressly requires the Subcontractor to do so.”

Option (2): Eliminate flowing down uninsurable warranties and indemnity obligations by adding this shorter version of the clause suggested above. Add the following clause to the end of the incorporation by reference clause:

“… provided however that the Standard of Care and the Indemnification provisions set forth in this subcontract take precedence over the Contract between Prime and its Client.”

Option (3) Make the subcontract terms prevail over the prime agreement terms

Consider this from the AIA A C401 - § 1.3:

“To the extent that the provisions of the Prime Agreement apply to This Portion of the Project, the Architect shall assume toward the Consultant all obligations and responsibilities that the Owner assumes toward the Architect, and the Consultant shall assume toward the Architect all obligations and responsibilities that the Architect assumes toward the Owner. Insofar as applicable to this Agreement, the Architect shall have the benefit of all rights, remedies and redress against the Consultant that the Owner, under the Prime Agreement, has against the Architect, and the Consultant shall have the benefit of all rights, remedies and redress against the Architect that the Architect, under the Prime Agreement, has against the Owner. Where a provision of the Prime Agreement is inconsistent with a provision of this Agreement, this Agreement shall govern.”

Option (4). If you are the Prime, consider using this flow down clause. This makes the strictest terms apply instead of stating that either the Prime Contract or Subcontract apply.

“Subcontractor is bound to Prime for the performance of the Work in the same manner as Prime is bound to Owner under Prime’s contract with Owner. The pertinent parts of such contract will be made available upon Subcontractor’s request. In event of any conflict between these Terms and conditions and a contract between Prime and Owner, the more strict provision in favor of Prime shall govern.”

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 ConstructionRisk 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 Report and may be reached at Kent@ConstructionRisk.com or by calling 703-623-1932. This article is published in ConstructionRisk Report, Vol. 23, No. 8 (December 2021).

Article 2

Implied Warranty and Workmanship Claims Cannot be Waived by Homeowner

Arizona Court of Appeals held that where homeowner signed a contract that waived its right to make claims against the Builder for breach of implied warranty of workmanship, the waiver was unenforceable. Arizona common law precludes such waiver because it is deemed to be contrary to public policy. Although the courts generally enforce the freedom-of-contract –- that principle applies primarily in contracts between commercial entities. In this case involving a homeowner, the court held “the new homeowner cannot waiver – and a builder cannot disclaim – the implied warranty of workmanship and habitability.” Zambrano v. M & RC II LLC, et al. 496 P.3d 789 (AZ 2021).

Zambrano initialed paragraph 15. Immediately below her initials and as part of paragraph 15, the agreement reiterated:

THE HOME BUILDER'S LIMITED WARRANTY REFERENCED ABOVE IS THE ONLY WARRANTY APPLICABLE TO THE PURCHASE OF THE PROPERTY. ALL OTHER EXPRESS OR IMPLIED WARRANTIES OF MERCHANTABILITY, FITNESS FOR A PARTICULAR PURPOSE, HABITABILITY AND WORKMANSHIP ARE HEREBY DISCLAIMED BY SELLER AND ITS AFFILIATES AND WAIVED BY BUYER, ANY IMPLIED WARRANTY THAT MAY EXIST DE[S]PITE THE ABOVE DISCLAIMER IS HEREBY LIMITED TO A ONE (1) YEAR PERIOD.

The separate, forty-page express warranty's cover page also specifically disclaimed any implied warranties, saying:

WE make no housing merchant implied warranty of habitability or any other warranties, express or implied, in connection with the sales contract or the warrantied HOME, and all such warranties are excluded, except as expressly provided in this BUILDER'S LIMITED WARRANTY. There are no warranties which extend beyond the face of this BUILDER'S LIMITED WARRANTY.

In it decision, the court noted that courts in Arizona judicially eliminated the caveat emptor rule for newly built homes. In the cited case, the court held:

The caveat emptor rule as applied to new houses is an anachronism patently out of harmony with modern home buying practices. It does a disservice not only to the ordinary prudent purchaser but to the industry itself by lending encouragement to the unscrupulous, fly-by-night operator and purveyor of shoddy work.

In the decades since that decision was decided, the Arizonan courts have consistently enforced the implied warranty and even expanded it – holding that a subsequent buyer may enforce the implied warranty given by a builder/seller. Builder’s in Arizona “cannot rely on a disclaimer of the implied warranty, standing alone, to avoid the implied warranty.”

Article 3

Engineer has no Exemption from Liability under Statute Providing Insurance Companies Exemption from Liability

A summary judgment in favor of an engineer was reversed on appeal, with the court holding that an engineer that performed a post-loss insurance claim investigation was not protected by a state statute exempting liability for furnishing safety inspection or advisory services for insurance carriers. Here, a homeowner suffered property damage and made a claim to their insurance carrier who then hired an engineer to conduct a “post-loss claim investigation” of the damage so the carrier could decide how much to pay. The homeowner sued the engineer, alleging that its negligent performance caused them damages because they failed to discover the full extent of the damage caused by water infiltration. The court held that the statute was not intended to protect an engineer against liability from services rendered for a post-loss claim, but that the statute was only for services rendered before a property damage loss clam is made to the carrier. Cincinnati Insurance Company v. Ropicky, 397 Wis.2d 196 (2021).

8 WISCONSIN STAT. § 895.475 provides:

EXEMPTION FROM CIVIL LIABILITY FOR FURNISHING SAFETY INSPECTION OR ADVISORY SERVICES. The furnishing of, or failure to furnish, safety inspection or advisory services intended to reduce the likelihood of injury, death or loss shall not subject a state officer, employee or agent, or an insurer, the insurer's agent or employee undertaking to perform such services as an incident to insurance, to liability for damages from injury, death or loss occurring as a result of any act or omission in the course of the safety inspection or advisory services. This section shall not apply if the active negligence of the state officer, employee or agent, or of the insurer, the insurer's agent or employee created the condition that was the proximate cause of injury, death or loss. This section shall not apply to an insurer, the insurer's agent or employee performing the safety inspection or advisory services when required to do so under the provisions of a written service contract.

The trial court granted the engineer summary judgment on the basis of the court’s finding that the engineer acted as the insurance company’s “agent.” In reversing the summary judgment, the appellate court held the statute does not provide immunity from liability for a post-loss claim investigation. It, therefore, didn't’ address the issue of whether or not the engineer was acting as an agent of the carrier.

According to the court, no reported court decision in Wisconsin or any other state has applied the statute to a situation involving a post-claim investigation. The Court concludes that the “statute is unambiguously forward-looking”, meaning that the “advisory services” must be “intended to reduce the likelihood of loss.” The loss sought to be reduced by the “advisory services” is necessarily in the future. In this case, the engineer was investigating the cause of the homeowner’s reported property damage that already occurred. This is a post-loss evaluation of an insurance claim.

There being no evidence that the engineer provided any pre-loss advisory services, there was no basis to apply the statutory liability exemption.

Article 4

Arbitration Award Affirmed Despite Objections that one of Arbitrators Failed to Disclose Relationship with Two of the Parties

In an interesting court decision enforcing an arbitration award, the Court of Appeals of Washington, D.C. affirmed a three person arbitration panel’s decision in favor of a contractor against a subcontractor and rejected the subcontractor’s argument that the decision was not issued by an impartial arbitrator because it was tainted by the fact that one of the arbitrators (an attorney) failed to disclose that he was on the board of directors of the District of Columbia Associated General Contractors (“AGC”) where he served with one of the principals of the contractor who was also a member of that Board. The subcontractor also argued that the attorney failed to disclose that attorneys in his law firm represented the project owner on previous projects. C.R. Calderon Construction, Inc. v. Grunley Construction Company, Inc., 257 A.3d 1046 (2021).

The court analyzed the statute governing arbitration, and it stated that prospective arbitrators must disclose “any known facts that a reasonable person would consider likely to affect the impartiality of the arbitrator in the arbitration proceeding.” One of the types of disclosures required by the statute is “An existing or past relationship with any of the parties to the agreement to arbitrate or the arbitration proceeding, heir counsel or representatives, a witness, or other arbitrators.” The court concluded that a “reasonable person” would not consider the arbitrator’s relationships, “individually or collectively, likely to affect [his] impartiality, so [he] was not required to disclose them. The court also found that the arbitrator did not have “a substantial relationship” with the contractor. The subcontractor failed to establish evident partiality of the arbitrator.

Comment: The court noted that one reason parties choose to arbitrate is because the arbitrators are supposed to be highly knowledgeable in their field. Such knowledgeable individuals, notes the court, often belong to associations where they interact with other people that might become involved in arbitration. This does not disqualify them from serving as arbitrators. But the court notes that it would have been prudent for the arbitrator in this case to have erred on the side of disclosure to the subcontractor in advance of the arbitration. Such disclosure was not, however, legally required in this case. This court decision once again demonstrates how difficult it is to overturn an arbitration decision in court.

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