January/February 2005 Newsletters

• FEDERAL COURT HOLDS THAT COLLAPSE PROVISION IN INSURANCE POLICY DOES NOT CONDITION COVERAGE ON ACTUAL COLLAPSE
  
  
• MASSACHUSETTS APPEALS COURT HOLDS THAT AIA A401 AND A201 ARE NOT ‘PAY IF PAID’ CLAUSES AND DO NOT CREATE CONDITIONS PRECEDENT TO PAYMENT
  
  
• IN LIGHT OF CONTRACT LANGUAGE TO THE CONTRARY COURT RULES ALL CHANGES NEED NOT BE IN WRITING
  
  
• OHIO COURT AWARDS DAMAGES AGAINST CONTRACTOR FOR FAILURE TO PERFORM IN A “WORKMANLIKE MANNER”

 

Katz & Stone, L.L.P. Construction Newsletter
January/February 2005

 

FEDERAL COURT HOLDS THAT COLLAPSE PROVISION IN INSURANCE POLICY DOES NOT CONDITION COVERAGE ON ACTUAL COLLAPSE

Property insurance policies typically limit their coverage to very narrowly-defined circumstances. As Assurance Company of America v. Wall & Associates LLC of Olympia, 379 F.3d 557 (9th Cir. 2004) demonstrates, however, courts are reluctant to interpret policies so narrowly as to make them ineffective or illogical.

In Assurance Company, soon after construction of a building was complete, the owner began experiencing problems with leaking water. Extensive testing revealed that the building’s External Insulation Finishing System (EIFS) had decayed and deteriorated as a result of water intrusion to the point that it was in danger of completely falling off the building. The EIFS cladding and brick panel facades were removed and replaced, and the owner sought coverage from its insurer for the cost of the remedial work.

However, the insurer denied the claim on the basis that there had been no covered collapse of property. The owner’s insurance policy excluded coverage for damage due to collapse, but, under an exception, did provide coverage for “loss or damage caused by or resulting from risks of direct physical loss involving collapse of a building or any part of a building” caused by, among other things, water damage. Following the denial of the owner’s claim, the insurer sought a declaratory judgment as to whether the owner was entitled to coverage under the exception to the collapse exclusion. The trial court held for the insurer, concluding that, in the context of the policy, “collapse” unambiguously meant “a sudden falling down,” and because there was no sudden falling down of the EIFS, there was no coverage for the cost of its replacement.

On appeal, the Ninth Circuit Court of Appeals found that Washington state courts had not interpreted the word “collapse” in the context of insurance coverage, but the Washington Supreme Court had interpreted a similar collapse provision in another case. In so doing, the Washington Supreme Court had held that a loss could occur either when the building actually collapsed or when decay posed only a risk of collapse. From this, the Ninth Circuit Court of Appeals concluded that, under Washington state law, policies providing for “risk of direct physical loss involving collapse of a covered building or any part of a covered building” did not condition coverage on an actual collapse.

Moreover, the Ninth Circuit Court of Appeals asserted that, in construing the language of an insurance policy, all of its terms must be construed together so as to give force and effect to each of them, and the policy is to be practically and reasonably interpreted, not given a strained or forced construction that leads to an absurd conclusion that renders the policy nonsensical or ineffective. As such, the court concluded that the policy’s “collapse” provision comprehended a broader meaning than that assumed by the trial court. Of particular note, the term “collapse” did not appear in the policy in isolation, but was instead qualified by the terms “risks of direct physical loss” and “involving.” To interpret the clause as a whole to mean that coverage existed only upon “a sudden falling down” improperly ignored and rendered ineffective the other aspects of the provision. Thus, the Ninth Circuit Court of Appeals concluded that the policy language not only covered actual collapse but also imminent collapse of the EIFS.

Insurers often deny coverage based on a very narrow reading of specific terms of their policies. However, insureds should be aware that, as in Assurance Company, courts typically interpret the language of insurance policies as a whole in order to ensure that all terms therein are given reasonable effect.

MASSACHUSETTS APPEALS COURT HOLDS THAT AIA A401 AND A201 ARE NOT ‘PAY IF PAID’ CLAUSES AND DO NOT CREATE CONDITIONS PRECEDENT TO PAYMENT

In Framingham Heavy Equipment v. Callahan & Sons, Inc., 807 N.E.2d 851 (2004), the Massachusetts Appeals Court affirmed a trial court decision granting judgment to a subcontractor for the subcontract balance and work performed under a construction change directive (“CCD”), and held that the general contractor’s failure to pay the subcontractor was a breach that justified the subcontractor’s abandonment of the project. In the process, the court rejected the general contractor’s argument that AIA forms A401 and A201 (1987 eds.) contained “pay if paid” provisions that obligated the subcontractor to continue work in the face of long unpaid bills.

In December 1997, an excavation subcontractor entered into a written subcontract --based on the AIA A401 Subcontract and AIA A201 General Conditions-- with a general contractor to perform site work at a high school for $594,000.00. At that time, the general contractor already had contracted with the City of Lynn, Massachusetts (“City”) for school renovations and an addition. Before the subcontract was signed, large quantities of peat and other materials unsuitable for a building foundation were discovered beneath the building addition and in the utility trenches, requiring far more site work than originally anticipated.

In November 1998, the City issued a CCD to remove the unsuitable soil in the utility trenches. Under the CCD, the unit prices per cubic yard to excavate and dispose unsuitable soils, and for replacement fill and stone, were set at the same rate as found in the subcontract. The general contractor thus wrote the subcontractor that, among other things: (1) the CCD "guarantees that compensation will be made at least for the values presented"; and (2) the “clerk of the works” would sign daily slips for the peat excavation to “guarantee payment”.

The subcontractor followed the required steps for payment, submitting a total of four monthly requisitions, with backup, for the work. In March 1999, its final requisition indicated total claims, including the CCD work, of $754,944.14. The general contractor included line items for the CCD work in its December 1998, and February and March 1999 payment applications.

The City, however, struck the line items in those applications and on the March application noted "No CCD's." After the architect recommended approving payment for the CCD work, the general contractor again sought payment for that work, but the City, once more, struck the line item.

By March 1999, the subcontractor demobilized without having completed its work and moved its equipment off-site. On April 30, 1999, the subcontractor wrote to again demand payment. The general contractor did not send any money. Instead, it demanded that the subcontractor return to the site. The subcontractor, frustrated by the lack of payment, ignored the general contractor.

On June 22, 1999, the general contractor terminated the subcontractor. The subcontractor promptly wrote back, asserting that the general contractor had breached the subcontract by failing to pay and subsequently sued the general contractor for the subcontract balance.

The general contractor argued that its failure to pay was justified because the subcontract contained "pay if paid" provisions making the City’s payment to the general contractor a condition precedent to its obligation to pay the subcontractor. The court noted that to create a conditional precedent payment clause or a “pay if paid” clause, a contract “must clearly state ‘that payment to the subcontractor is to be directly contingent upon the receipt by the general contractor of payment from the owner.’" Furthermore, a “pay when paid” provision only postpones the time for payment “for a reasonable time” after requisition to allow the general contractor an opportunity to obtain funds from the owner. Here, the general contractor had more than reasonable time to obtain payment.

The Massachusetts Appeals Court thus affirmed the trial court’s holding that the general contractor’s nonpayment excused the subcontractor from further performance and the subcontractor was not required to continue working without being paid.

The Framingham decision illustrates the law in a majority of states that payment terms such as those used in the AIA documents are not “pay if paid” clauses, but instead merely allow the general contractor a reasonable period of time after requisition to obtain funds from the owner to pay its subcontractor for amounts owed. As always, subcontractors should be conscious that subcontract language that explicitly links a subcontractor’s right to payment to the general contractor’s receipt of payment from the owner will generally be enforced and thus prudent subcontractors should not sign any such contracts without modifying or striking condition precedent payment language unless they are prepared to accept the shifted risk of nonpayment.

 

IN LIGHT OF CONTRACT LANGUAGE TO THE CONTRARY COURT RULES ALL CHANGES NEED NOT BE IN WRITING

Parties to a written contract should be aware that their contract can be modified by silence, inaction or implication despite a contractual provision requiring change orders to be in writing. The recent decision of Aqua Pool Renovations, Inc. v. Paradise Manor Community Club, Inc., 880 So. 2d 875 (La. App. 2004) illustrates some of the circumstances in which inaction, silence or implication can modify the terms of a written contract.

In Aqua Pool, a contractor specializing in renovating residential and commercial swimming pools entered into a written contract with a country club to perform pool renovations. A representative of the country club’s board of directors was appointed to sign the contract and oversee the contractor’s work. According to the written contract, the renovations were to be completed by a certain date or the contractor would be penalized. In addition, the contract provided that all change orders had to be in writing.

A dispute arose over payment of the contract sum when unanticipated problems with the pool renovation required additional work to be performed. The country club decided to withhold money because it believed the pool renovations were not timely completed. In response, the contractor brought suit against the country club to collect the contract sum as well as the costs associated with the additional work. While both parties agreed that no written change orders were executed, the contractor claimed that the additional work was authorized by the country club’s representative. The country club claimed that because there were no written change orders, the additional work was not authorized. The Court of Appeal of Louisiana examined the issue of whether the country club, through the actions of its representative, had in fact authorized the additional work.

The court first considered additional work the contractor performed in providing new piping and plumbing for the pool’s intake manifold. Although the new piping and plumbing were not part of the original written contract, the contractor determined that because of the age of the pool, the work needed to be done. While there was no written change order for this additional work, the court noted that the country club’s representative knew that additional labor and materials would be required to fix the problem. The court ruled that the representative’s knowledge of the additional work performed by the contractor and his failure to oppose such work amounted to authorization. Accordingly, the court found that the contract had been modified and the contractor was entitled to additional compensation.

The court next analyzed the additional work the contractor performed installing niches in the pool for lighting. While pool lighting was included in the original contract, installing niches was not specifically included. The court found that even though the contractor performed additional work, he was not entitled to additional compensation because it was implied that this work was included in the original contract. The contract provided that the contractor was responsible for providing all of the labor, materials, and equipment necessary to accomplish its work, including installation of pool lighting. The court ruled that because of the age of the pool, the contractor should have known that niches would need to be installed in order to accommodate the lighting provided for in the contract. As a result, the court ruled that the contract implicitly included the additional work and the contractor was not entitled to additional compensation.

Finally, the court examined the costs associated with providing additional concrete decking around the pool. Although additional concrete decking was not included in the original contract, the court found that the country club’s representative was aware that additional decking was provided by the contractor. The court ruled that the representative’s knowledge that additional decking was being provided coupled with his failure to object to the additional work amounted to an authorization of such work. Accordingly, the court ruled that the contract had been modified and the contractor was entitled to additional compensation.

As a result of this case, all contracting parties should be aware that silence, inaction or implication can modify a written contract as easily as a written change order.

 

OHIO COURT AWARDS DAMAGES AGAINST CONTRACTOR FOR FAILURE TO PERFORM IN A “WORKMANLIKE MANNER”

Most construction contracts obligate contractors to perform their work in a “workmanlike manner.” The decision in McMonigle Excavating Concrete, Inc. v. Riley, 2004 Ohio 1508 (Ohio Ct. App. 2004) illustrates what this standard means.

In McMonigle, the homeowners hired a contractor to perform excavation for and place the foundation of a new home. The contract specified that all work was to be completed “in a workmanlike manner according to standard practices.” The homeowners claimed that the contractor did not complete the job in a workmanlike manner or according to standard practices, because, among other things, the contractor failed to excavate to the proper level and used nonstandard practices in pouring a separate foundation for the front porch and garage, including failing to compact the soil in order to provide a proper base for the porch and garage. Eventually, the homeowners hired other contractors to complete the work. When the homeowners refused to pay the contractor for its work, the contractor brought suit against them, and the homeowners counterclaimed.

The trial court found that the contractor had failed to perform some of its contractually-required work and had performed other work in a nonworkmanlike manner, and awarded damages to the homeowners. On appeal, the contractor objected to the trial court’s finding that the contractor had an implied contractual duty to compact the fill dirt under the porch and garage. The contractor claimed that the contract unambiguously did not obligate the contractor to compact the dirt, and the court should not have gone beyond the plain language of the contract in determining the obligations of the parties. The Court of Appeals of Ohio concluded that the obligation to compact the fill dirt before the foundation was poured arose out of the contractor’s express contractual duty to perform in a workmanlike manner. This duty requires a contractor to exercise the degree of care which a member of the local construction trade would exercise under similar circumstances. The Court of Appeals of Ohio found that, in determining the contractor’s compliance with this standard, the trial court had relied on the testimony of another excavator that it is the job of the contractor preparing the concrete foundation to also prepare the soil for the concrete, and the testimony of a consulting engineer that the problems that the homeowners were experiencing with cracking was due to the foundations in the porch and garage area having been being placed on uncompacted fill. Accordingly, the Court of Appeals of Ohio held that the contractor had failed to perform in a workmanlike manner when it failed to compact the soil prior to placing the garage and porch foundations.

Contractors often do not pay much heed to the rather generic obligation in their contracts to perform in a “workmanlike manner.” However, McMonigle demonstrates that a contractor’s failure to comply with this general standard may result in its having to pay damages for its work to be performed correctly by another contractor.