July/August 2002 Newsletters

 

Katz & Stone, L.L.P. Construction Newsletter
July/August 2002

 

COURT ALLOWS TOTAL COST METHOD OF RECOVERY
FOR DIFFERING SITE CONDITIONS CLAIM

One method of valuing the direct impact of unforeseen conditions on the performance of a construction project is to calculate the difference between the contract price (i.e., what the contractor expected the job to cost) and the total cost of performance (i.e., what the job actually cost). This methodology of calculating a contractor’s damages is known as the “total cost method.” Though many courts have expressed reluctance to compute a contractor’s direct damages using the total cost method, in the case of Baldi Brothers Construction v. United States, 50 Fed. Cl. 74 (2001), a federal court recently employed such a method to calculate damages on a differing site conditions claim when almost all aspects of contract performance were affected by the condition.

In Baldi Brothers, a contractor contracted with the Department of the Navy to perform cut and fill site work for the construction of a tank training facility at Camp Lejeune, North Carolina. In preparing its bid, the contractor relied primarily on plans and contract documents furnished by the Navy. Based on these documents, the contractor assumed when developing its price that its equipment could utilize the shortest route between the service road and construction sites. After contract award, however, the Navy provided a wetlands designation map that depicted approximately 80% of the site as untouchable wetland areas. The presence of federally protected wetlands dramatically increased the contractor’s costs to complete the project. After the Navy’s contracting officer issued a final decision denying the contractor’s claim for additional compensation based on a differing site condition, the contractor sued the Navy in federal court seeking recovery of the costs arising out of the wetlands issue.

The central issue before the court was whether the contractor sufficiently proved its direct damages by calculating such damages using the total cost method, rather than by discretely tracking increased costs attributable to the wetlands. In addressing this issue, the court recognized that the total cost method should be used with caution because a contractor’s bidding inaccuracies can create an unrealistically low estimate of performance costs, and because a contractor’s inefficiencies can increase the total cost of performance.

Ultimately, however, the court allowed use of the total cost approach because the designation of such a large portion of the site as wetlands “was the equivalent of the 800-pound gorilla landing on the contractor’s plans for performing the contract.” Because almost every aspect of the project was affected by the designation and because of its “snowball effect” on the rest of the project, it simply made more sense to award total costs than to attempt to identify and separately price impacted work.

For contractors, Baldi Brothers is best viewed as an exception to the general rule that the total cost method, by itself, is not sufficient proof of damages in a court’s eyes. Given the court’s reluctance to use the total cost method, contractors should still use their best efforts to thoroughly document all costs on the assumption that they will have to link each cost to an act or event for which they bear no responsibility.

 

COURT REFUSES TO RENDER CONTRACTOR'S WARRANTY MEANINGLESS BY REQUIRING OWNER TO INSURE AGAINST DEFECTIVE WORK

In cases across the United States, courts have held that contract provisions requiring one party to a construction contract to maintain property insurance covering losses do not cover the cost of replacing defective work. While the courts have cited a number of reasons for their holdings, the rationale underlying this body of law most often stems from either: (1) the terms of the contract itself, or (2) the affect that requiring coverage of defective work would have on other contractual obligations or relationships. In Chelm Management Company v. Wieland-Davco Company, 2001 U.S. App. lexis 24297 (6th Cir. 2001), a federal court ruled that an owner’s property insurance did not cover a contractor’s defective work for both of these reasons.

In Chelm Management, an owner entered into a written contract with a general contractor to construct a commercial building. After project completion, the general contractor claimed it had not been fully paid and sued the owner for the remaining contract balance. The owner counterclaimed, alleging that the building’s concrete floor was defective and that the general contractor, in constructing a defective floor, breached contractual warranty provisions.

Upon motion by the general contractor, the trial court dismissed the owner’s warranty claim, finding that any damages the owner may have suffered resulted from its own material breach of the contract. Specifically, the trial court found that the owner was required by the general contract to purchase insurance to cover the cost of repairing and replacing defective work. Paragraph 10.5.1 of the contract required the owner to:

obtain and maintain property insurance . . . upon the entire Project for the full cost of replacement at the time of any loss . . . . This insurance shall insure against loss from the perils of fire and extended coverage, and . . . "all risk" insurance for physical loss or damage . . . resulting from defective design, workmanship or material.


The trial court concluded that, because the owner failed to purchase insurance covering any loss resulting from defective work, it was precluded from pursuing its warranty claim.

After dismissal of the owner’s warranty claim, the parties’ reached a settlement that resolved all claims except the warranty claim. The owner then appealed the dismissal of its warranty claim to a higher court.

Reversing the trial court, the appellate court held that paragraph 10.5.1 did not require coverage of defective work, notwithstanding its applicability to “any loss.” The appellate court reasoned that, when interpreting contract language, it must adopt an interpretation that gives every provision meaning and purpose. Examining the provisions of the general contract in their entirety, the court explained that if “any loss” truly meant “any loss in the whole world" (which was the construction given to it by the trial court), the general contractor's contractual warranties would be “meaningless and irrelevant.” If the owner was obligated to insure against defects in the general contractor’s work, the contractual warranties would serve no purpose. To give those warranties relevance, the contract must be interpreted to hold the general contractor liable for defective work.

The appellate court further noted that paragraph 10.5.1, by its own terms, only required coverage of “damage resulting from” defective work. According to the court, if a defective floor caused a support beam to crack, damage to the beam would be "damage resulting from” defective work and would thus be insured under paragraph 10.5.1. Damage to the defective floor itself, however, does not “result from” the defect and would not be insured under paragraph 10.5.1. Thus, because the contract did not require the owner to insure against defective work itself, the owner’s failure to obtain such insurance was not a material breach of contract and the owner was granted leave to pursue its warranty claim against the general contractor.

Chelm reveals the importance of reading each provision of a contract as part of a whole. An interpretation of a contract provision rendering other provisions meaningless will not be viewed favorably by a court. Chelm further illustrates the risk of settling a legal action without obtaining a global release of all claims among the parties involved. In Chelm, the general contractor ultimately regretted its decision to settle its own contract claims without settling the owner’s warranty claim, as it was forced to return to court to defend against a breach of warranty claim that might have been settled earlier.

 

 

FEDERAL COURT DENIES CONTRACTOR RECOVERY FOR DELAY DAMAGES INCURRED WHILE DEVELOPING A CONTRACT-COMPLIANT CONSTRUCTION PLAN

In the construction industry, a “design specification” is one in which the manner of performance is precisely detailed and from which the contractor has no discretion to deviate. A “performance specification,” on the other hand, merely sets forth the objective or standard to be achieved by the contractor. The contractor is expected to exercise his ingenuity in achieving the objective or standard specified, to select the means of performance and to assume a corresponding responsibility for that selection. As demonstrated in the recent case of P.R. Burke Corporation. v. United States, 277 F.3d 1346 (Fed. Cir. 2002), so long as a performance contract sets forth a standard that is possible to achieve, the time needed to develop plans complying with the contract’s specifications is chargeable to the contractor.

In P.R. Burke, a contractor was awarded a federal contract for the demolition and replacement of certain structures of a sewage treatment plant by no later than October 7, 1995. The contract required that the plant “remain in operation” during the entire construction period and that the contractor develop, and submit for approval, a demolition and construction plan conforming to the contract’s requirements.

The contractor’s original demolition and construction plan required that structures necessary to the effective treatment of sewage be off-line for most of the construction period. Accordingly, the government rejected the contractor’s plan and ordered the submission of a new plan that avoided the shutdown of these structures. At the same time, the government suggested a means of sequencing the work that would avoid the shutdown of structures necessary to keep the plant in operation. Several months later, the contractor submitted a revised plan incorporating the government’s suggestion and demanded an extension of the contract completion date to accommodate the additional time involved in developing the plan. The government approved the new plan, but denied any time extension. As a consequence, after timely completing its work, the contractor brought suit seeking damages for the delay entailed in redesigning the construction and demolition plan.

Before the trial court, the contractor argued that the contract provision requiring the plant to “remain in operation” was ambiguous in that it was impossible to perform the project’s scope of work without shutting down portions of the plant’s sewage treatment process. The contractor further argued that because the contract was a design contract (i.e., one in which the manner of performance was precisely detailed by the government and from which the contractor had no discretion to deviate), responsibility for delays experienced due to the government’s inadequate design rested with the government. The trial court found neither argument convincing and ruled in favor of the government. Undeterred, the contractor appealed.

The appeals court, however, affirmed the trial court’s decision. First, the appellate court found that it was possible to perform the project without shutting down the plant and that the meaning of “remain in operation” was not ambiguous. The contractor’s original plan, which called for the shutdown of structures vital to the plant’s treatment of sewage, did not comply with an unambiguous contract requirement. Second, the appellate court found that, even if “remain in operation” was ambiguous, any ambiguity was patent (i.e., on the face of the contract) and required the contractor to inquire about its meaning before bidding. Because the contractor failed to make such inquiry, the court was required to resolve the ambiguity against the contractor and hold it responsible for the delay involved in revising its construction plan.

Finally, contrary to the contractor’s argument that the contract was a design contract and that the government was therefore responsible for time and cost incurred in redesigning the project’s demolition and construction plan, the appellate court held that the contract was a performance contract. As such, the time needed to develop a construction plan that complied with the contract’s performance specifications was chargeable to the contractor. The fact that the government suggested a work sequence which ultimately proved successful did not convert the contract’s performance specifications into design specifications and did not remove the responsibility for selecting the means of performance from the contractor. In sum, the appellate court concluded that the contractor was itself liable for any delays incurred while it developed a revised construction plan.

P.R. Burke illustrates the importance of recognizing the importance and effect of performance specifications. Any questions regarding the meaning or feasibility of a performance specification should be addressed prior to bidding. Contractors that notice apparent ambiguities or inconsistencies on the face of bidding documents are well-advised to raise them with the contracting authority before submitting a bid. Otherwise, such ambiguities will likely be construed against the contractor, and the time and expense incurred in dealing with their consequences charged to the contractor’s account.

 

 


FEDERAL COURT SHEDS LIGHT ON THE NOTICE REQUIREMENTS OF THE MILLER ACT

The Miller Act requires prime contractors on federal construction projects to furnish a payment bond for the security of subcontractors and suppliers of labor and materials. To establish a right of action against the prime contractor’s payment bond, second-tier subcontractors and suppliers to a first-tier subcontractor must give the prime contractor written notice of its bond claim “within ninety days from the date on which it performed the last of the labor or furnished the last of the material for which such claim is made.” Although the federal Miller Act provides subcontractors and suppliers with a useful remedy in the event of non-payment, failure to strictly comply with the Act’s notice requirements may completely foreclose on any right to recover. In the case of J.D. Fields & Company v. Gottfried Corporation, 272 F.3d 692 (5th Cir. 2001), a federal court decided when the ninety-day notice period begins to run against a supplier of rental materials.

In J.D. Fields, the Department of Veterans Affairs awarded a contract for construction work at an existing VA Hospital, located in Biloxi, Mississippi. The prime contractor on the project subcontracted-out the construction of two steel, sheet-pile cofferdams necessary for the construction of an elevator shaft and stairwell. The cofferdam subcontractor executed a rental agreement with a supplier for the pilings used to make the cofferdams.

By its terms, the rental agreement was to terminate when the subcontractor notified the supplier that the pilings had been removed and were ready for inspection and return shipment. According to daily logs, the subcontractor finished removing pilings from the cofferdams on December 18, 1997. The pilings were not actually returned to the supplier, however, until February 27, 1998. After the subcontractor failed to fully pay for the piling rental, the supplier provided notice to the prime contractor of its claim against the project’s Miller Act payment bond on March 20, 1998. Ultimately, the supplier sued to enforce its claim against the bond.

The trial court dismissed the supplier’s action on the bond, holding that the supplier failed to provide the requisite notice within ninety days of the last day that it supplied materials. The trial court based its holding on the opinion that the ninety-day period began to run on December 19, the day after the subcontractor finished using the pilings, and expired on March 18. Therefore, the supplier’s March 20 notice was untimely.

Upon appeal to a higher court, however, the trial court’s judgment was reversed. The appellate court noted that the supplier’s rental agreement called for the rental period to end on the date the supplier received written notification that the pilings were ready for inspection and return shipment. As the supplier had not received actual notice that the pilings were no longer in use until February 27, when the pilings were returned, the ninety-day period for giving notice did not begin to run until February 27. Until that date, the pilings were still in the subcontractor’s possession and still available for use on the job if necessary. Therefore, the supplier’s March 20 notice was well within the ninety-day period and, therefore, was timely.

This case highlights the need for suppliers to be vigilant with regard to the notice requirements of the federal Miller Act or any comparable state bonding statute. A keen understanding of when courts deem such suppliers to have last supplied labor or materials will better ensure that requisite notices are timely given.