March 2001 Newsletter

• VIRGINIA SUB-SUBCONTRACTORS CAN ASSERT BOND CLAIMS UNDER EITHER THE SUBCONTRACTOR'S OR GENERAL CONTRACTOR'S PAYMENT BONDS
  
  
• CONTRACTORS NOT LIABLE UNDER CALIFORNIA TORT LAW FOR CONSTRUCTION DEFECTS THAT CAUSE NO HARM TO PROPERTY OR PERSONS
  
  
• OHIO COURT ENFORCES CONVERSION OF WRONGFUL DEFAULT TERMINATION FOR CONVENIENCE
  
  
• OREGON COURT HOLDS THAT GENERAL CONTRACTOR IS NOT LIABLE FOR INJURY TO SUBCONTRACTOR'S EMPLOYEE RESULTING FROM OSHA VIOLATIONS AND NEGLIGENCE
  
  

 

Katz & Stone, L.L.P. Construction Newsletter
March/April 2001
Volume XI, Number II

 

VIRGINIA SUB-SUBCONTRACTORS CAN ASSERT BOND CLAIMS UNDER EITHER THE SUBCONTRACTOR'S OR GENERAL CONTRACTOR'S PAYMENT BONDS

The Circuit Court for the City of Chesapeake, Virginia recently held that although a general contractor on a city road project required a payment bond from its subcontractor, a second-tier subcontractor could nevertheless sue under the general contractor's payment bond provided pursuant to Virginia's "Little Miller Act."  See Crofton Construction Servs., Inc. v. Reliance Ins. Co., No. CL99-1204, 15 V.L.W. 705, November 27, 2000 (Va. Cir. Ct. Oct. 26, 2000).

Under Virginia's "Little Miller Act," so named after the federal statute, general contractors performing public construction projects must post payment bonds assuring payment to lower-tier subcontractors and materialmen.

The Crofton Construction case involved a general contractor hired by the City of Chesapeake to construct an interchange.  Pursuant to Virginia's Little Miller Act, the general contractor was required to post a payment bond for the project.  The payment bond promised to make payments "to all persons, firms, subcontractors, and corporations furnishing materials for or performing labor in the prosecution of the work provided for in such Contract."

The general contractor contracted with a subcontractor to build a bridge who in turn subcontracted with a second-tier subcontractor to perform pile-driving.  When the second-tier subcontractor was not paid, it filed suit against the general contractor's payment bond instead of the bond provided by the bridge subcontractor with whom it had a contract.

The court found that the general contractor's payment bond provided coverage to lower-tier subcontractors such as the plaintiff and rejected the surety's arguments seeking to avoid coverage.  First, the court noted that nothing in the Virginia Code prohibits a bond executed by the general contractor and its surety from providing broader coverage than that required by the applicable provisions of the Code.  Accordingly, the court found that the language of the general contractor's bond provided coverage to second-tier subcontractors such as the plaintiff.

Furthermore, the court rejected the surety's argument that Virginia Code Sections 11-58 and 11-60 required a second-tier subcontractor to pursue the first-tier subcontractor's payment bond if available instead of the general contractor's payment bond.  The court held that sub-subcontractors may elect to assert a claim against either bond.  Sections 11-58 and 11-60 of the Virginia Code do not expressly limit the subcontractor's right of action.  The statute reads that when a subcontractor is required to post a payment bond by the general contractor, any claimant "may bring an action on the subcontractor's payment bond."  The language is not restrictive, but permissive.  As such, in situations where both the general contractor and subcontractor have payment bonds, the second-tier subcontractor "can assert a claim against either bond."

Crofton Construction confirms the right of lower-tier subcontractors and suppliers to elect which payment bond they wish to pursue when payment bonds have been secured by both the general contractor and upper-tier subcontractors.  The ability of lower-tier subcontractors to elect to pursue a claim against the general contractor's bond can be a useful and effective means of applying pressure to the higher-tier subcontractor and forcing an earlier resolution of its claims.

 

CONTRACTORS NOT LIABLE UNDER CALIFORNIA TORT LAW FOR CONSTRUCTION DEFECTS THAT CAUSE NO HARM TO PROPERTY OR PERSONS

In many states, contractors whose work is defective may face liability not just for breaching their construction contract, but also for negligence and other torts.  However, in many jurisdictions contractors may not be held liable under tort law unless their work causes actual property damage or personal injury under the so-called "economic loss rule."  In Aas v. The Superior Court of San Diego County, 24 Cal. 4th 627 (2000), the California Supreme Court reaffirmed that the economic loss rule applies in that state.

In Aas, homeowners and a homeowner's association brought suit against the developer, general contractor, and subcontractors of a condominium project in San Diego County.  The plaintiffs sought recovery for a variety of construction defects including building code violations.  Along with their contract claims, the plaintiffs brought tort (negligence and strict liability) actions seeking damages for diminution of their property values and the potential cost of repairs.  Based on state case law denying recovery in a tort action of such purely "economic losses," the lower court granted defendants' motion to exclude evidence of all alleged construction defects that had not caused actual property damage or personal injury.  Plaintiffs appealed, claiming that the California Supreme Court's decision in J'Aire Corp v. Gregory, 24 Cal.3d 799 (1979), permitted recovery in tort of economic losses where a "special relationship" existed between the parties.

The Supreme Court denied plaintiffs' appeal.  First, the court recognized that under certain circumstances there is an exception to the general rule that a party cannot recover purely economic losses in tort.  To determine whether appropriate circumstances exist, the California court developed a six-factor test in the J'Aire case for identifying whether a defendant has a "special relationship" with, and thus special duty to protect the economic interests of, the plaintiff.   The factors are: (1) the extent to which the transaction was intended to affect the plaintiff, (2) the foreseeability of harm to the plaintiff, (3) the degree of certainty that the plaintiff suffered injury, (4) the closeness of the connection between the defendant's conduct and the injury suffered, (5) the moral blame attached to the defendant's conduct, and (6) the policy of preventing future harm.

When the court applied the J'Aire factors to the facts of the case against the contractors, the court determined that the plaintiffs had failed to satisfy all of the factors of the test.  Though the court determined that several of the factors were satisfied, the court found that the defects had created only the threat of future harm to the plaintiffs and had not caused them to suffer the sort of property damage, personal injury, or even out-of-pocket losses contemplated by factors 2 and 3 of the test.  While the court acknowledged that the policy of preventing future harm provided plaintiffs' strongest argument and would make contractors responsible for remedying building code violations that have not yet caused property damage or personal injury, the court concluded that imposing tort liability might lead builders to raise housing costs to cover the increased risk and that buyers had ample protection through contract, warranty, and inspection rights as well as code enforcement by building authorities.  In the final analysis, the California Supreme Court was unwilling to apply the "special relationship" exception and upheld the lower court's exclusion of evidence of all alleged construction defects that had not caused property damage or personal injury from the plaintiffs' tort action.

In so doing, the majority of justices rejected the dissent's proposal that would: (1) prohibit recovery for "minor" defects and code violations that caused no property damage or personal injury; (2) allow recovery for "serious" defects and violations that pose a significant risk of death, injury, or considerable property damage; and (3) use the courts to supervise the disbursement of any damages awarded to ensure monies are actually spent on repairs.  The majority found that the distinction between "minor" and "serious" defects and violations could not be adequately defined by the courts.  As a result, the proposed rule would not easily screen out trivial claims.  The majority also opposed involving the courts in monitoring the spending of damage awards.  Finally, the majority held that any new rule of tort liability should be enacted by the state legislature not the judiciary. 

The Aas decision represents a victory for contractors in an important, large jurisdiction.  However, the economic loss rule is not recognized in every state and contractors in those states may still face tort liability for routine construction defects.

 

OHIO COURT ENFORCES CONVERSION OF WRONGFUL DEFAULT TERMINATION FOR CONVENIENCE

In Peterson & Assoc. v. Dayton Metropolitan Housing Authority, 2000 Ohio App. Lexis 3259 (2000), the Ohio Court of Appeals held that while the plaintiff contractor was wrongfully terminated by the project owner, the parties' contract converted that wrongful termination for default into a termination for convenience.  As a result, the court limited the damages available to the contractor to the narrow class of damages available under the termination for convenience clause.

The underlying dispute arose in July 1995, when Dayton Metropolitan Housing Authority ("Housing Authority") requested bids to replace the roofs and other related work on eight residential units located in Huber Heights, Ohio.  After several rounds of bids, the Housing Authority awarded Peterson & Associates the job.  After signing the prime contract the contractor began work on October 16, 1995.

Although the work was scheduled to be complete within ninety (90) days, numerous design problems, delays, and materials problems extended the completion date.  On June 17, 1996, the Housing Authority terminated the contractor for default.  The contractor sued, alleging that it had been wrongfully terminated.  The Housing Authority defended its action, claiming that the contractor had not completed its contract work within the scheduled time.

After a hearing, a magistrate found that the Housing Authority had indeed wrongfully terminated the contractor.  However, even though the Housing Authority had wrongfully terminated the contractor for default, the magistrate limited the contractor's damages to those specified in the contract clause which applied to recoverable damages in a termination for convenience.  The contract specifically provided that an improper termination for default would be automatically converted into a "termination for convenience."  The contract's termination for convenience clause specifically enumerated five elements of damages which were recoverable: (1) the total cost of the work performed  which had not yet been paid; (2) the cost (including reasonable profit) of settling and paying outstanding subcontractor and supplier claims; (3) the cost of preserving and protecting the work until the owner took possession; (4) actual or estimated cost of legal and accounting services reasonably necessary to prepare and present a termination claim to the owner; and (5) an amount consisting of a reasonable profit on the contractor's completed work.

Because the contractor was not satisfied with this limited remedy, it appealed to the Ohio Court of Appeals.  Specifically, the contractor argued that under federal law if a public owner abuses its discretion when invoking a termination clause, the terminated contractor may receive "full breach of contract" damages, which include loss of bonding ability damages.  However, in order to prove the Housing Authority abused its discretion, the contractor needed to prove it was terminated solely because the Housing Authority wanted to "get rid" of it.   The Ohio Court of Appeals concluded that the contractor did not meet its burden in this regard.  The evidence suggested that because of delays, workmanship and other issues, the Housing Authority had grown "unhappy" with the contractor's performance, which itself justified a termination for convenience.  Furthermore, the Housing Authority testified that it had lost faith that the contractor would complete its work even if the design problems (which were responsible for many of the delays) were resolved.  Accordingly, the Ohio appellate court determined that the resulting termination fell within the class of wrongful terminations for breach which the contract would automatically convert into a termination for convenience. 

Notwithstanding the above, the Ohio appellate court did reverse the lower court on one significant point.  The appellate court permitted the contractor to  seek recovery of expenses paid by the contractor's surety stemming from the termination and even though such expenses were not specifically enumerated in the contract's termination for convenience clause.  The Ohio court noted that it would have been inappropriate for the  Housing Authority to keep payments made by the contractor's surety when its default termination had been deemed wrongful.

Many construction contracts contain provisions which convert a wrongful default termination into a termination for convenience.  While these clauses are typically enforced as written, contractors should be aware that exceptions to this rule do exist and that additional categories of damages may be recoverable under appropriate circumstances.

 

OREGON COURT HOLDS THAT GENERAL CONTRACTOR IS NOT LIABLE FOR INJURY TO SUBCONTRACTOR'S EMPLOYEE RESULTING FROM OSHA VIOLATIONS AND NEGLIGENCE

In the recent case of George v. Myers, 10 P.3d 265 (Or. Ct. App. 2000), the Oregon Court of Appeals found that a general contractor was not liable for the injuries suffered by the employee of one of its subcontractors.  In doing so, the court discussed and affirmed a number of legal principles that may be useful to general contractors facing similar claims in Oregon and other states.

In George, an employee of a subcontractor hired to do framing work on a residential building project was injured when he fell from the third floor of a building while attempting to move a bundle of wooden boards.  The employee brought suit against the general contractor, alleging that the contractor was liable: (1) for violating certain safety regulations promulgated pursuant to the Occupational Safety and Heath Act ("OSHA") and adopted by the state of Oregon; and (2) for its negligence in failing to provide its subcontractors with certain safety equipment and in failing to adequately supervise the work.  The trial court rejected both of the employee's claims and granted summary judgment to the general contractor.

On appeal, the Oregon Court of Appeals first examined the employee's claim that the general contractor was liable under OSHA regulations as adopted by Oregon law.  The employee argued that the regulations obligated the general contractor to comply with certain workplace safety rules applicable to "employers," regardless of whether it retained subcontractors to perform part of the work.  The court rejected this argument, finding that the general contractor was not the subcontractor's "employer" and was not liable for alleged violations of substantive safety regulations applicable only to "employers."

The court then examined the employee's claim that the general contractor was negligent in failing to provide necessary safety equipment and in failing to adequately supervise the subcontractor's work.  In doing so, the court invoked the common law rule that an owner who orders work to be done by a third-party owes no duty to that party or his workmen to warn of any obvious dangers surrounding the work which fall within that party's special expertise or knowledge.  Viewing the case under this framework, the evidence showed that the general contractor hired the subcontractor because of its expertise in framing, that the general contractor had no expertise regarding appropriate safety equipment for framing work, that the general contractor exercised no control over the subcontractor's method of performance and that the risk of falling was an obvious danger.  Given these circumstances, the court concluded that the general contractor, as a matter of law, had no duty to undertake safety measures for the protection of the framing subcontractor or its employees and, therefore, that it would be improper to find the general contractor liable to the employee in negligence.

As illustrated by the court's decision in George v. Myers, a general contractor can raise legitimate defenses to the legal action of an injured subcontractor's employee.  The arguments successfully raised in George offer a useful roadmap for similarly-situated general contractors charged with failing to take safety measures for its subcontractors or their employees.  Although the general contractor was ultimately successful in defeating the employee's claim, the general contractor would have been better served by obtaining contractual indemnification and insurance coverage against such employee claims from the framing subcontractor involved.