September/October 2002 Newsletters

 

Katz & Stone, L.L.P. Construction Newsletter
September/October 2002

 

SUPPLIER STOPS WORK ON PROJECT AFTER FAILING TO REACH AGREEMENT WITH GENERAL CONTRACTOR ON ESSENTIAL CONTRACT TERM AND RECOVERS REASONABLE GOODS SUPPLIED

It is almost always a risky proposition for a subcontractor or supplier to walk off a job after starting work on a job or signing a contract. The case of Rouse Construction Co. v. Interstate Steel Corporation, 2002 Tenn. App. Lexis 34 (2002), represents one of the few instances where a supplier was able to stop its work and still receive payment for its efforts.

The case began innocently enough: a contractor notified a supplier that the supplier had submitted the low bid to fabricate, supply, and erect certain structural steel for the contractor’s project. While the parties were negotiating a written contract for this work, the supplier, anticipating a contract, began fabricating and supplying the necessary materials to the project. When the parties could not agree on a contract schedule for the steel shipments, the supplier notified the contractor that it was quitting the job and would not execute a contract or deliver any more goods to the project. The contractor, in turn, refused to pay for the steel the supplier had already provided and sued the supplier for its refusal to continue to supply steel once contract negotiations collapsed. In response, the supplier counterclaimed for the cost of the steel it had already supplied.

The case hinged on whether the contractor and supplier had reached an agreement on all “essential” terms of a contract. If the scheduling of work was an essential term then the parties’ inability to agree on that term would mean that no contract was ever formed and the contractor had no right to recover against the supplier for stopping work. If scheduling was not an essential contract element, then the supplier’s use of scheduling as a pretext for stopping work constituted a breach of contract. Both the trial and appellate courts considering this case found that scheduling was an essential element of the parties’ attempted contract. Thus, the supplier was, in this instance, within its rights to stop work. The appellate court reasoned that, even though the supplier submitted a bid, was awarded the bid, accepted the award, and commenced work on the project, there was no binding contract because there was no “meeting of the minds” as to all essential terms of the proposed contract.

The question then became whether the supplier was entitled to payment for the materials it had supplied and, if so, how to value those goods. Under a doctrine called quantum meruit, the supplier was entitled to recover the “reasonable value” of materials provided to the project. According to quantum meruit, which only applies when there is no enforceable contract, because the contractor received the supplier’s materials, and should have known that the supplier expected to be paid for them, it was obligated to pay for their reasonable value.

The Rouse decision illustrates the wisdom of subcontractors and suppliers conditioning their bids on “the execution of a mutually-acceptable contract.” Such language in a bid gives the bidder an additional leg upon which to walk away from a job should the contractor insist on unreasonable terms. In Rouse, the supplier was fortunate that the court held scheduling to be an essential term of the contract proposed by the contractor. Had the deal-breaking term not been essential to the existence of a legally enforceable contract, the supplier would have faced a drastically different result.

 

STATE COURT FINDS THAT ENDORSEMENT TO CONTRACTOR’S
CGL POLICY EXTENDED COMPLETED OPERATIONS HAZARDS COVERAGE TO DAMAGE CAUSED BY SUBCONTRACTORS’ WORK

Endorsements to commercial general liability (“CGL”) insurance policies often broaden or restrict the scope of such policies’ coverage. Contractors generally assume that such endorsements are given a uniform interpretation by the courts. As demonstrated by Corner Construction Company v. United States Fidelity and Guaranty Company, 2002 SD 5, 638 N.W.2d 887 (2002), however, courts sometimes disagree as to the meaning of language used in endorsements.

In Corner Construction, a South Dakota general contractor built an administration building for a school district. Almost immediately after occupying the building, the school district began experiencing problems with areas of the building worked on by the general contractor’s subcontractors. Upon investigation, the school district discovered various construction deficiencies in the problematic areas, and advised the general contractor that it planned to initiate an arbitration proceeding regarding the subcontractors’ work. The general contractor contacted the agent for the insurer that had issued its CGL policy to ask whether the policy covered the faulty workmanship of its subcontractors and would provide for the defense of the arbitration claim. The agent advised that, under the CGL’s completed operations coverage, which was modified by a broad form property damage endorsement (“BFPDE”) for which the general contractor had paid an additional premium, there was no coverage for the subcontractors’ work. In the arbitration, the school district was awarded $180,500.00 against the general contractor.

The general contractor later brought an action against the insurer, alleging that the CGL furnished liability coverage for damages caused by the faulty workmanship of subcontractors. Although, the trial court found that the CGL policy, as modified by the BFPDE, extended coverage to the general contractor for the faulty workmanship of its subcontractors, the court ultimately concluded that the insurer was not liable for coverage under the policy because the general contractor failed to comply with the notification provisions of the CGL policy. The insurer appealed the court’s ruling that the BFPDE covered subcontractor work.

On appeal, the appellate court noted that a difference of opinion existed among those courts that had previously addressed the affect of the BFPDE on the scope of coverage provided by the standard form CGL at issue. Some courts had held that the BFPDE extended coverage to property damage caused by the work of subcontractors, while other courts refused to give the BFPDE such an interpretation because CGL policies were intended only to insure against tort liability for physical damage to others. The difference of opinion among courts stemmed from the interpretation of the deletion in the BFPDE of the words “by or on behalf of.” While the standard form CGL policy expressly excluded coverage for property damage to work performed “by or on behalf of” the general contractor, the BFPDE, with respect to completed operations hazards, modified this exclusion to apply only to property damage to work performed by the general contractor.

Examining the affect of the BFPDE, the appellate court agreed with the trial court that the CGL policy, as modified, covered the general contractor for the faulty workmanship of its subcontractors. Because the BFPDE-modified completed operations exclusion did not mention work performed “on behalf of” the general contractor, such as that performed by its subcontractors, the court determined that such work performed by the subcontractor on behalf of the general contractor was covered by the CGL policy. The court found support in other courts’ opinions and in insurance industry literature for its conclusion that the absence of the phrase “on behalf of” in the BFPDE indicated that the coverage exclusion for completed operations hazards only applied to work performed by the general contractor, not its subcontractors. Moreover, the court held that the purpose of a CGL policy is to insure a general contractor against risks outside his or her control, such as those posed by subcontractors’ work.

As for the issue of the insurer’s timely receipt of notice of the arbitration, the court found that the trial court had failed to address whether notice allegedly given to the insurer’s agent satisfied the policy’s notice requirement. According to the court, if the general contractor informed the agent of the pending arbitration, South Dakota law deemed the insurer to have received such notice through its agent.

Corner Construction illustrates the importance of knowing the effect that courts with jurisdiction over your projects will give to the language used in endorsements to CGL policies. As exemplified in Corner Construction, courts can disagree as to the meaning and scope of language intended with the insurance industry to broaden or restrict the scope of CGL coverage. Therefore, it is highly recommended that contractors obtain professional advice in reviewing any endorsement modifying the scope of coverage afforded by their CGL policies.

 

STATUTE OF REPOSE PROTECTS CONTRACTOR FROM CLAIM FOR TWELVE-YEAR OLD DEFECTIVE WORK

Many states have enacted in some form a law known as a “statute of repose”. Statutes of repose are intended to preclude lawsuits based upon claims arising out of allegedly defective work or design against persons who improve real property (i.e., claims against general contractors, architects, engineers, etc.) after a specified number of years following completion of the improvement. These statutes vary from state-to-state in terms of what they cover, who is protected and the time periods after which a suit cannot be brought. In the case of Hagerstown Elderly Assoc. Ltd. P’ship v. Hagerstown Building Assoc. Ltd. P’ship, 368 Md. 351 (2002), a court affirmed that Maryland’s statute of repose applies broadly to all actions, whether based on tort or contract, and to all property damage caused by defective work, even damage to the defective work itself.

In Hagerstown, the Maryland State Community Development Administration financed the construction of a public housing facility. The owner of the facility subsequently entered into a contract for its construction. In December 1983, the City of Hagerstown conducted a final inspection and issued an occupancy permit. In the same month, the contractor and the architect issued a certificate of substantial completion and the owner granted permission to occupy all 110 units of the facility.

In 1995, a severe storm hit the project, causing a collapse of the exterior insulation finish system (EIFS). In 1996, the owner filed suit against the contractor alleging breach of the construction contract due to the performance of defective work. The trial court dismissed the owner’s suit against the contractor, citing Maryland’s statute of repose, which prohibited such a suit against a contractor more than ten (10) years after the building first became available for its intended use.

The owner appealed the trial court’s decision on several grounds. First, the owner argued that the statute of repose applies only to actions based on negligence and not to actions based on the breach of a contract. Second, the owner argued that the statute only proscribes actions or damages to property other than the defective improvement itself. According to the owner, because it was suing the contractor for breach of contract, not negligence, and because it sought damages only for the defective improvement itself, and not damages for injury to other property, the statute of repose did not bar its action.

The Maryland Court of Appeals rejected both of the owner’s arguments and affirmed the trial court’s dismissal of the suit against the contractor. The Maryland statute of repose provides that a cause of action

does not accrue . . . for damages incurred when wrongful death, personal injury, or injury to real or personal property, resulting from the defective and unsafe condition of an improvement to real property, occurs more than 10 years after the date the entire improvement first became available for its intended use.

In rejecting the owner’s arguments, the Court of Appeals noted that Maryland’s statute of repose was intended to protect contractors and others involved in the construction industry from being hauled into court due to latent defects that did not manifest themselves until years after the completion of construction. The court refused to limit the statute to actions based on negligence, reasoning that the statute would provide very little protection if its applicability depended on whether the plaintiff pleaded its action as one in contract or negligence. The court also found no support for the argument that the statute did not apply to actions for damage to the defective improvement itself, citing the “clear intent” of the statute to terminate contractor liability after 10 years for damage caused by a latent defect to any property.

As the project was available for its intended use upon substantial completion in December 1983, the statute of repose barred any action from arising after December 1993. Because the owner’s suit was not commenced against the contractor until October 1996, the owner’s suit was untimely.

In Maryland, the statute of repose protects contractors against claims for damages arising out of defective work that was completed more than ten years earlier. As illustrated in Hagerstown, Maryland courts tend to give this statute a broad interpretation on the theory that only such an interpretation would give effect to the statute’s purpose of allowing contractors to close the books on work performed ten years earlier without the threat of unforeseen future litigation over that work.

 

 


MASSACHUSETTS COURT HOLDS SUBSTANTIAL COMPLETION DOES NOT OCCUR UPON “FIRST USE” OF AN IMPROVEMENT WHEN SUCH IMPROVEMENT SUBJECT TO PERFORMANCE SPECIFICATIONS

On many construction projects, the term “substantial completion” is either defined by contract or accepted within the locality of the project to mean the time at which the project is first available for its intended use. In the recent case of Agri-Mark, Inc. v. Travelers Indemnity Co., 2002 U.S. Dist. Lexis 1866 (D. Mass. 2002), a court looked at when an improvement to a milk evaporation system was substantially complete for the purpose of determining whether the operator of that system sued for defects within the time required by law. The court’s holding illustrates that substantial completion in the construction industry will not always hinge on the time that an improvement is first used.

In Agri-Mark, a consortium of dairy farmers operating a powdered milk production plant contracted with a contractor specializing in evaporators to upgrade its milk evaporation system, which processed and dehydrated over 100,000 gallons of milk a day. The contract called for the upgraded system to increase production capacity from 100,000 to 150,000 pounds per hour. Although nearly all of the material and equipment necessary to achieve the contracted rate was installed in 1992, the new system failed to boost system capacity when tested. After years of subsequent analysis and remedial efforts on the system, in 1995, the system finally met the promised capacity.

In 1997 and 1998, however, the system seized and required extensive repairs. After the second set of repairs, the consortium sued the contractor in 1999. The contractor defended the suit on the basis of the applicable statute of repose, which barred all tort actions arising out of an improvement to real property unless filed within six years after the date of substantial completion. The contractor argued that because the upgraded system was largely installed and available in 1992, the consortium’s suit in 1999, seven years later, was too late.

The court disagreed. First, the court noted that the consortium had no choice but to use the equipment in 1992 in order to stay in business. Thus, the fact that the upgrade was “turned on” in 1992, as contemplated by the parties’ contract, was immaterial to whether the system was substantially complete.

Second, while the consortium took possession of, and first began using, the improvement in 1992, the court held that “substantial completion” under the statute only occurred once the evaporation system reached the rate of performance required by the contract. The consortium’s first use of the improvement in 1992 did not equate with substantial completion because it did not coincide with the systems’ achievement of the contracted rate. Until it reached that performance level, construction was not substantially complete. Therefore, the statute of repose did not bar the consortium’s suit in 1999.

As the Agri-Mark decision illustrates, contractors who promise to deliver an improvement that satisfies certain performance criteria must pay attention to how a court will view substantial completion of that improvement. Being clear as to when substantial completion will be deemed by a court to have occurred on such projects is often critical to protecting your legal rights as the date of substantial completion may determine the time in which to give notice of claims, the time to commence legal action, and the duration of warranty or insurance obligations.