May/June 2005 Newsletters

 

Katz & Stone, L.L.P. Construction Newsletter
May/June 2005

SUBCONTRACTOR BOUND BY CONTRACTOR’SDECISION BECAUSE OF FAILURE TO TIMELY OBJECT

A subcontractor who fails to follow the contractual requirements for timely protesting a contractor’s decision can be bound by the contractor’s decision. This lesson is illustrated in the case of Holt & Holt, Inc. v. Choate Construction Co., 609 S.E. 2d 103 (Ga. Ct. App. 2004). 

In Holt & Holt, Inc., a subcontractor entered into an agreement with a contractor to perform drywall work on a new high-rise building. According to parties’ contract, if the subcontractor failed to meet its obligations under the contract, the contractor could issue a written decision terminating the subcontractor’s employment or could supplement its work with labor and materials, the cost of which would be deducted from payment due the subcontractor. The contract also provided that the subcontractor would be bound by the contractor’s decision, unless the subcontractor commenced arbitration proceedings within thirty days of the decision. 

In May of 2002, the contractor informed the subcontractor that it was in default due to extensive project delays. The contractor sent the subcontractor a certified letter informing it that it was in default, that it was supplementing its work force, and that it intended to hold these costs against the monies owed to the subcontractor. Over the next several months, the contractor employed additional workers and provided the subcontractor with three change orders detailing the backcharges against the subcontractor for supplementing its work force. 

In November of 2002, three months after the last change order had been issued and after the contractor had closed out its contract with the owner, the subcontractor filed suit for breach of contract. The subcontractor contended the contractor’s May letter was ineffective as a formal decision of the contractor because it did not contain the proper terminology, the customary content, or give the subcontractor adequate notice that it had thirty days to challenge the decision. The subcontractor also argued that the three change orders issued after the May letter indicated that the issue of adding supplemental workers was still being debated between the parties.

The court rejected the subcontractor’s arguments. It found that the change orders which backcharged the subcontractor for supplementing its work force were consistent with the contractor’s May letter. In addition, the court noted that the plain language of the contract placed the burden on the subcontractor to arbitrate any decision made by the contractor or risk being bound by that decision. Furthermore, the decision did not need to be in a specific format. The contractor’s certified letter of May informed the subcontractor of the contractor’s decision to supplement its work and to backcharge these costs to the subcontractor. Given that the subcontractor signed the contract, it was presumed to know that it had thirty days to arbitrate any decision by the contractor.  Since the subcontractor failed to provide timely notice of its intent to dispute the contractor’s decision as required by the contract, it became bound by the contractor’s decision.

Contractors should be fully aware of the disputes procedures in their contracts so they will not be barred from pursuing a claim in court or arbitration because they failed to follow the steps set forth in the disputes procedure.

PENNSYLVANIA COURT HOLDS THAT ECONOMICLOSS RULE DOES NOT APPLY TO ACTIONS BYCONTRACTORS AGAINST DESIGN PROFESSIONALS

The majority of U.S. courts have adopted the “economic loss rule,” which holds that a plaintiff who is not in privity of contract (i.e., have a contractual relationship) with a defendant cannot bring an action in tort to recover purely economic losses (i.e., financial losses, as opposed to damages for injury to persons or property) arising from the defendant’s breach of a duty of care.  However, as evidenced by the decision in Bilt-Rite Contractors, Inc. v. The Architectural Studio, 866 A.2d 270 (Pa. 2005), courts may make an exception to that rule for duty-of-care breaches by design professionals.

In Bilt-Rite, the architect prepared drawings and specifications for submission to contractors for bidding, and these were incorporated by reference in the prime contract that was ultimately awarded.  The architect had expressly represented in the drawings and specifications that the project could be constructed through the use of normal construction means and methods.  Once construction commenced, however, the general contractor discovered that the work required special means and methods, resulting in substantially-increased construction costs.  The general contractor sued the architect for negligent misrepresentation to recover its increased costs.  The trial court dismissed the action, however, based on the economic loss rule.

On appeal to the Pennsylvania Supreme Court, the contractor argued that the court had recognized the tort of negligent misrepresentation and, in setting forth the elements of that cause of action, had not included contractual privity.  Instead, the court had focused on whether there was reliance upon the misrepresentations and the foreseeability of that reliance.  The contractor contended that the architect knew that contractors would rely upon its design documents in submitting bids, but failed to exercise reasonable care in preparing those documents.  As its reliance on the design documents was both justifiable and foreseeable, the contractor argued, it stated a viable claim for negligent misrepresentation.  Moreover, the contractor pointed to decisions by federal courts applying Pennsylvania law, as well as courts in other jurisdictions, which permitted contractors to maintain negligent misrepresentation claims against design professionals without requiring contractual privity.  The architect responded that the economic loss rule plainly precludes negligence actions where the plaintiff claims only economic loss and the parties are not in privity of contract, that the rule applies to services rendered by design professionals, and that Pennsylvania state and federal courts have held that design professionals cannot be held liable for purely economic losses to a party with whom they share no contractual relationship.

Holding for the contractor, the court was persuaded by decisions from other jurisdictions that there is no requirement of privity in the architect/contractor scenario and, thus, the economic loss rule does not bar a contractor’s recovery of economic losses arising from an architect’s negligent misrepresentation.  The tort provides that a duty of care is owed when one supplies information to others, for one’s own pecuniary gain, with the intention or knowledge that the information will be used by others in the course of their own business activities.  As such, the court concluded that the tort is narrowly tailored, as it applies only to those businesses which provide services and/or information that they know will be relied upon and it covers only foreseeable users of the services and/or information.  Moreover, the tort readily applies to design professionals, whose design documents, created for the owner, have foreseeable third-party users in the contractors, subcontractors, and suppliers that work on the owner’s project.  In addition, given the important reliance placed upon their services, there is no reason to exempt design professionals from the tort consequences of a negligent failure to perform those services in a competent fashion.  The court determined that the tort serves the overall public interest by discouraging negligence among design professionals, while the consequence of imposing such a duty of care upon design professionals is neither unreasonable nor unduly burdensome, as it merely subjects them to the same sort of professional responsibility that other professionals face.

The decision in Bilt-Rite represents a further erosion of the economic loss rule which traditionally has protected design professions in most jurisdictions.  Architects and designers should determine how the jurisdiction in which they work treats the economic loss rule, though as Bilt-Rite indicates, the courts are always free to change previous decisions.

WISCONSIN COURT HOLDS THATVALID CHANGE ORDERS DO NOT NEED TO BE IN WRITING

In an unpublished opinion, Boulanger Construction Co., Inc. v. United Fire and Casualty, 690 N.W.2d 884 (2004), the Court of Appeals for Wisconsin held that when an owner has knowledge of, and benefits from, additional work performed by its contractors, including its subcontractors, those contractors are entitled to recover their costs to perform that additional work. In its opinion, the appeals court also held that a subcontractor can directly sue an owner to recover its claim for unpaid contract balance and extra work.

The underlying dispute arose out of a road construction project that the Town of Hobart, Wisconsin (“owner”) awarded to a prime contractor. A subcontractor was retained by the prime contractor to perform excavation and hauling.  The prime contract incorporated the general contractor’s bid, contained a liquidated damages for delay provision (if the project was not completed on time), and required that all changes to the work be accomplished through written change orders.

Almost immediately, the project experienced problems which required additional work. Among other things, the underground utility lines were in different locations than set forth in the drawings, causing delays and additional work. Moreover, the existing road, which the subcontractor was to grind up and use as base material for the new road, was not as thick as anticipated.  This meant that the subcontractor had less recycled material and needed to purchase more new material than originally planned. Other modifications to the prime and subcontract scopes of work made at the direction of the owner included driveway and drainage modifications.

Many of the changes were made without executed written change orders.  At the weekly project meetings, both general contractor and subcontractor testified that the owner assured them that the extra work claims would be resolved at the completion of the project and stressed that the primary focus was to timely complete the project. 

At the end of the project, however, when the general contractor submitted its final bill, which included additional charges for its and the subcontractor’s extra work, the owner refused to pay.

The dispute went to trial and the trial court found that both general contractor and subcontractor had performed additional work. It also held (a) the subcontractor was entitled to recover for its extra work on a theory of unjust enrichment, but (b) the lack of written change orders precluded the general contractor from recovering any money for the extra work it performed. On appeal, the Wisconsin Court of Appeals upheld the trial court’s granting of judgment to the subcontractor and reversed the trial court’s denial of the general contractor’s claims for extra work.

In holding that the theory of unjust enrichment gave a subcontractor a direct right of recovery from the owner, the appellate court found that the record supported the subcontractor’s position.  Specifically, the subcontractor performed work not contemplated by the contract, the owner was aware of the extra work being performed, and it would be inequitable for the owner to retain the benefit of the subcontractor’s extra work without paying for the value of that work.

The appellate court further found that despite the fact that the prime contract required all changes to be in writing, “a contract may be modified orally even if it provides that it may only be modified in writing.” Here, the court concluded that the record supported a finding that the parties’ evidenced, by their words at the progress meeting and subsequent conduct, an intent to waive or modify the written change order requirement. Thus, because the owner knew that the prime contractor was performing extra work, and had not paid for that extra work, it would be inequitable for the owner to retain that benefit without paying its general contractor.

Boulanger reflects what often happens on a construction project as the parties proceed without regard to the formalities of their contracts.  However, Boulanger represents a minority decision among the many decisions made by other courts who enforce the formalities the parties in Boulanger ignored.

SUBCONTRACTOR’S FAILURE TO COMPLY WITH NOTICEPROVISIONS OF CONTRACT PRECLUDES CLAIM AGAINST CONTRACTOR

A subcontractor who fails to comply with the notice provisions of the prime contract may be precluded from making a claim against a general contractor. This was the outcome in the case of American National Electric Corp. v. Poythress Commercial Contractors, Inc., 604 S.E. 2d 315 (N.C. Ct. App. 2004). 

In American National Electric Corp., an electrical subcontractor entered into a contract with a general contractor to provide all material and labor to perform electrical work on a fire station project. The subcontractor agreed to perform its work in accordance with the project schedule, which provided that the subcontractor had a specified number of days to perform the electrical work. As the project progressed, the general contractor made several alterations to the project schedule and sequence of the subcontractor’s work. 

The subcontractor claimed that as a result of these alterations it was denied sufficient access to the work site to perform its work in the proper sequence. When the subcontractor ended- up being on the project for sixty days beyond the anticipated project schedule, it brought suit against the general contractor claiming that it was damaged as a result of its labor inefficiencies and loss of productivity.     

The general contractor contended that the subcontract incorporated the notice provisions of the general contract between the general contractor and the project owner. The subcontract provided that claims for delay compensation had to be made in accordance with the terms of the general contract. The general contract provided that claims for delay had to be made in writing to the project architect and owner within twenty-one days after the occurrence of any event giving rise to the claim or within twenty-one days after the claimant first recognized the condition giving rise to the claim.

The subcontractor’s president admitted in deposition testimony that it was aware that its work was being delayed, but did not notify the general contractor in writing of such delay until months later. The contractor contended that the subcontractor’s failure to provide timely notice of delay, as required by the general contract, defeated the subcontractor’s claim. The court agreed, finding that the plain language of the contract provided that the subcontractor was bound to the general contractor under the same obligations as the general contractor was bound to the owner. Those obligations bound the parties to a time certain during which notice of delay for compensation was required.  The court found that the subcontractor did not comply with this obligation and thus its claim was defeated. Hence, the subcontractor was foreclosed from making a delay claim against the general contractor because of its failure to abide by the notice provisions of the general contract.  The decision in American National Electric Corp. reinforces the importance of a contractor following the contract in pursuing claims.  Failure to follow provisions in contracts such as notice requirements can have the unfortunate effect of causing a valid claim to be dismissed on a technicality.

STATUTORY CONDOMINIUM WARRANTIES IN THE METRO D.C. AREA

Condominium construction is booming in the Metropolitan Washington, D.C. area.  Thus, it is more important than ever for condominium developers and contractors to be aware of the statutory warranties imposed on new condominium units and common elements by the area’s three jurisdictions: Maryland, Virginia, and the District of Columbia.  As an aid, we provide the enclosed matrix, which summarizes the substance of the jurisdictions’ statutes relevant to condominium warranties.

All three jurisdictions have statutory warranties specific to condominiums, including, in Virginia and the District of Columbia, warranties against structural defects in units and common elements.  In addition, Maryland and Virginia statutes expressly apply standard implied warranties for residential construction to condominiums.  The three jurisdictions have varying statutory warranty periods, and Maryland and the District of Columbia apply certain exceptions, exclusions, and/or modifications to such warranties.  Finally, each jurisdiction has distinct statutes of limitations and repose which impact when claimants may bring actions on the statutory warranties.

Click here to download Statutory Provisions for Condominium Warranties Matrix