May/June 2003 Newsletters

 

Katz & Stone, L.L.P. Construction Newsletter
May/ June 2003

 

FEDERAL COURT IN VIRGINIA AFFIRMS ECONOMIC LOSS RULE AND DISMISSES LAWSUIT OF A SUPPLIER AGAINST CONTRACTORS AND DESIGN PROFESSIONALS WITH WHOM IT HAD NO CONTRACT


A recent decision by a Virginia federal court sheds light on the scope of a contractor’s liability to others involved in a project where there is no contractual relationship between the parties. In Kohl’s v. Target, 2003 U.S. Dist. lexis 5373 (E.D. Va. 2003), the United States District Court for the Eastern District of Virginia dismissed a material supplier’s claim for contribution against contractors and design professionals with whom it had no contractual relationship.

The action in Kohl’s arose out of the construction of the Chesterfield Crossing Shopping Center (the “Project”), a shopping complex occupied by a number of entities including a Ukrop’s Super Market grocery store, a Target store, the Chesterfield Crossing Shopping Center, L.L.C. (“CCSC”), and a Kohl’s department store (collectively, the “owners”). Under a site development agreement between the owners, Target agreed to perform the preliminary site development work, which included constructing a building pad on which the Project’s stores were to be built.

After the building pad was in place, Target turned the site over to each of the store owners. Each owner proceeded to contract for and build its respective store. Shortly after the Project was completed, however, cracks and other structural damage began appearing in the walls and floors of each store and in the sidewalks and other common areas of the shopping complex. After some investigation, the owners determined that the damage resulted from defects in the fly ash used as fill material under the building pads.

Damage in some areas was so severe that the owners feared that it was necessary to tear down and reconstruct the affected stores. Kohl’s, Ukrop’s, and CCSC thus sued Target, the party who performed the site development work. In their respective complaints, the plaintiffs attributed their losses directly to the fly ash fill.

Seeking indemnification for any unfavorable judgment the plaintiffs recovered, Target brought suit against its general contractor, which ultimately lead to suits against the sitework subcontractor and then the supplier who furnished the fly ash fill material.

At that point, every party added to the action had only sued an entity with whom it had a contract. The fly ash supplier changed this, however, when it filed twelve sixth-party complaints against various contractors, engineers, and architects who performed work related to the construction of the owners’ buildings. Asserting a claim known as “contribution,” the supplier alleged that the damage to the buildings was caused at least in part by these defendants’ failure to exercise reasonable care in performing their respective portions of the work. Thus, the supplier argued that the contribution defendants were obligated to offset or to completely negate any of the supplier’s potential liability related to furnishing defective fly ash. One of the defendants sued by the supplier was L.F. Jennings, Inc. (“Jennings”), who was Kohl’s general contractor.*

Jennings, along with the other contribution defendants brought motions to dismiss the supplier’s complaints for failing to state a valid contribution claim under Virginia law. As argued by Jennings, for a right to contribution to exist the supplier and Jennings must share a common obligation to the same party arising out of a single injury. Jennings also argued that, even if the supplier had stated a claim for contribution, the economic loss rule prevented the supplier from recovering economic losses against parties with whom it had no contract.

The court agreed with Jennings on both points and dismissed the supplier’s contribution claims. The court found that: (1) the injury for which the supplier had been sued (defective fill for the site development) was not the same injury for which the supplier sued Jennings (defective construction of the Kohl’s store) and (2) the economic loss rule, which prevents a plaintiff from recovering economic losses from a defendant with whom it has no contract, prohibited the contribution claims.

For strictly applying the elements of contribution and affirming the validity of the economic loss rule under Virginia law, the Kohl’s decision should be welcomed by construction professionals. Allowing a supplier to pursue contribution claims against contractors with whom it had no contract would have opened a hornets nest for virtually all construction participants, who would risk being sued for contribution by any party whenever any litigation arises on a project, even if the allegedly defective work had nothing to do with their contracts.

* Katz & Stone, L.L.P. represented L.F. Jennings, Inc. in this matter.

 

FAILURE TO PROVIDE TIMELY WRITTEN NOTICE FORECLOSES
CLAIM UNDER GENERAL LIABILITY INSURANCE POLICY

The failure to timely comply with notice provisions frequently forecloses certain remedies. While it is good practice to review and consciously observe all notice provisions appearing in the contract documents, contractors should also be aware that notice provisions appearing in documents outside the contract, such as bonds and insurance policies, may also affect their rights. In the case of The Travelers Ins. Co. v. Volmar Construction Company, 752 N.Y.S.2d 286 (N.Y. App. Div. 2002), a subcontractor learned this lesson the hard way when a New York court denied its claim against an insurer due to the subcontractor’s failure to provide adequate written notice in compliance with an insurance policy on which it was named an additional insured.

In Volmar Construction Company, a subcontractor sued its general contractor’s insurer alleging that the general contractor’s insurer had an obligation to defend and indemnify the subcontractor as an additional insured under the general contractor’s general liability policy. The action originated after a fire damaged a high school renovation project and the owner filed an insurance claim with its carrier. In response, the owner’s carrier sought indemnification from the subcontractor, who it alleged was responsible for the fire. The subcontractor subsequently brought a third-party claim against the project’s general contractor. The general contractor thus notified its insurer who proceeded to defend the contractor.

The contractor’s policy required that the insured, be it the contractor as the named insured or the subcontractor as an additional insured, provide notice of an “occurrence” which may give rise to a claim “as soon as practicable.” It further required that if a claim or suit is brought, the insured must provide “written notice of the claim or suit.”

Some 19 months after the original suit was commenced against the subcontractor, the subcontractor served the general contractor’s insurer with a demand for defense and indemnity against the owner’s claim as an additional insured under the policy. The contractor’s insurer denied the demand based on the subcontractor’s failure to timely provide written notice.

A New York court agreed with the insurer and granted the insurer’s motion for summary judgment against the subcontractor. The court interpreted the insurance policy’s requirement to give notice “as soon as practicable” to mean notice within a reasonable time under the circumstances. On the facts presented, 14 months after the commencement of litigation was not reasonable. Thus, the subcontractor’s failure to provide timely, written notice foreclosed its ability to seek coverage under the policy.

Attempting to avoid this result, the subcontractor argued that the insurer received notice from the general contractor when the subcontractor filed its third-party claim and because other subcontractors had filed claims with the insurer relating to the same fire. The court rejected this argument holding that the law is clear that an insured’s obligation to provide timely notice is not excused on the basis that the insurer has received notice of the underlying occurrence from an independent source. A party seeking coverage under a policy must provide its own notice in writing.

As illustrated by the outcome in Volmar Construction Company, courts frequently interpret notice provisions strictly. Thus, contractors should acquaint themselves with all such provisions in their contracts and ensure timely compliance. Contractors should also be aware of notice provisions in documents outside their contract, such as insurance policies and payment bonds, as the failure to timely provide notice may foreclose the ability to access rights provided within such documents.

 

INABILITY TO QUANTIFY CLAIMS IS NO EXCUSE FOR FAILURE TO GIVE NOTICE

Sometimes contractors experience conditions during performance that they know will have an adverse impact on their bottom line, but are of such an elusive or continuing nature that the impact cannot be quantified until the job is largely completed. As the case of Maryland State Highway Administration v. Engineering Management Services, Inc., 147 Md. App. 132 (2002) instructs, in this situation, a contractor who withholds giving notice of a claim until the amount can be precisely defined does so at its own risk.

Engineering Management involved a contract between the Maryland State Highway Administration (“owner”) and Engineering Management Services, Inc. (“contractor”) for the removal of lead paint and the repainting of five bridges. In April 1993, the owner opened bids and notified the contractor that it was the successful bidder for the project. On May 4, 1993, the Occupational Safety and Health Administration issued new regulations, effective as of June 3, that imposed more stringent standards regarding workers’ exposure to lead. The new regulations were applicable to the contractor’s work and required special precautions, such as protective clothing and equipment, and special hygiene facilities and practices.

In September 1993, the contractor commenced performance, but, by agreement, shortly thereafter suspended work until April 1994 due to winter conditions. At that time, at the contractor’s request, the owner confirmed that the new OSHA standards governed the contract. Subsequently, on May 2, 1994, the contractor informed the owner that it would complete its evaluation of the cost of complying with the new regulations “in a few days.” The contract required the contractor to file a written “notice of claim” within 30 days after the basis for the claim is known or should have been known.

Notwithstanding the contract’s notice requirement, the contractor did not submit a request for additional compensation due to the change in the safety regulations until June 1995. After the owner denied the contractor’s claim, the contractor filed an appeal before the Maryland State Board of Contract Appeals seeking an equitable adjustment to the contract price. In response, the owner moved for summary judgment on the ground that the contractor failed to give timely notice of its claim. The Board granted the motion and dismissed the appeal.

Upon the contractor’s appeal to the Maryland Court of Special Appeals, the court considered whether the Board properly granted summary disposition of the contractor’s claim for failure to file timely written notice. The contractor argued that the Board improperly dismissed its claim because there was a genuine issue as to when it knew or should have known about the basis for its claim. Specifically, the contractor argued that its request for additional compensation could not be accurately quantified until the close of its fiscal year on April 30, 1995, when the results of its work over a significant period of time were available. As this financial data was not available until the end of May 1995, the contractor contended that its notice in June was timely under the contract.

The court disagreed and upheld the decision of the Board. The court first noted that the relevant contract provisions and regulations concerning the notice of claim did not require that such notice contain a precise claim amount. In fact, the contract did not require the contractor to specify an amount until the claim itself was submitted subsequent to the initial notice. All that was required in the notice of claim was to state the circumstances giving rise to the claim and that such circumstances were regarded by the contractor as a change to the contract.

On this basis, the court approved the Board’s conclusion that, in order to timely comply with the contract, the contractor should have filed its notice of claim no later than 30 days after the new regulations became effective on June 3, 1993 or, at the latest, within 30 days of the contractor’s completion of its evaluation of the effect of complying with the regulations in May 1994. As such, the Board acted properly in summarily disposing of the contractor’s claim.

While the notice requirements of any given contract should be individually analyzed and observed, the court’s holding in Engineering Management illustrates the wisdom of furnishing prompt notice of claims, even when their precise amount has not or cannot be determined. This practice should generally offer contractors the most protection while at the same time best fulfilling the purposes underlying notice requirements, such as enabling the notified party to take specific action and triggering the dispute resolution process.

 

MARYLAND CONTRACTOR GIVEN LIMITED IMMUNITY
FROM LIABILITY TO EMPLOYEE OF A SUBCONTRACTOR INJURED WHILE PERFORMING WARRANTY WORK

Under Maryland law, an employer’s liability to an injured employee under Maryland Worker’s Compensation Act is exclusive, meaning that the employer’s liability is limited to the remedy provided by the Act. A general contractor who has contracted with a subcontractor to perform work within the general’s trade or occupation may be deemed the “employer” of an injured subcontractor employee and, therefore, also protected from liability beyond that required by the Act. In the case of Lumpkins v. United States, 212 F. Superior. 2d 464 (D. Md. 2002), a court found that a contractor may be so protected even when the subcontractor’s employee was injured while performing warranty work after completion and acceptance by the owner.

Lumpkins arose out of an accident on a utility renovation project for the National Institutes of Health in Bethesda, Maryland. The government hired a contractor to renovate certain boilers on the project, and the contractor, in turn, subcontracted much of the boiler renovation work to a subcontractor. An employee of the subcontractor was working on the boiler project when a section of grated walkway on which he was standing gave way, causing him to fall and sustain injuries. The employee received workers’ compensation in accordance with the Act, but also initiated suit against the government and the government’s construction manager. The construction manager then sued the contractor, seeking to hold the contractor liable for any loss to the employee.

In response, the contractor argued that it was immune from liability because of its status as the “statutory employer” of the injured employee under the Act. Having entered into a contract with the government as principal contractor for boiler renovation work, and having subcontracted such work out to the injured employee’s employer, the contractor contended that it had satisfied the necessary requirements for statutory employer status under the Act. The construction manager, however, argued that the contractor was not the employee’s statutory employer because the employee was not performing boiler renovation work within the contractor’s scope of work with the government when he was injured. Rather, the construction manager asserted, the employee had been called in after hours and was performing warranty work on a boiler that had already been renovated and accepted by the government. Thus, the contractor was not a statutory employer and was subject to suit by the construction manager.

The court disagreed with the construction manager’s position. While the court was not convinced that the “warranty work” being performed by the employee was outside of the contractor’s scope of work on the boiler renovation project, even assuming that the warranty work was distinct, the court concluded that a warranty does not arise without the presence of a contract. As such, regardless of whether the employee was replacing a boiler or repairing one that had already been replaced, there still must have been some agreement between the government and the contractor for the contractor to conduct such repairs. Moreover, regardless of whether the work was part of the original boiler renovation project undertaken by the contractor, the employee was only involved as a direct result of the subcontracting relationship between his direct employer and the contractor. Therefore, the court held that the contractor was the employee’s statutory employer under the Act, and was thus immune from suit by the construction manager.

When an employee of a subcontractor is injured on the job, a contractor in Maryland should promptly confirm whether the employee was, at the time of injury, performing work within the scope of the subcontract. If so, the contractor generally will be deemed a statutory employer under Maryland law and, upon confirming payment of worker’s compensation to the injured employee, the contractor will usually be immune from claims for any further damages.