Year-End Insurance Review: Common Coverage Oversights

Carrying adequate insurance on construction projects is a critical aspect of risk management for developers, builders and designers. But it’s a complicated and time-consuming subject, and if you haven’t slogged through the complexity of the details in policies, you may be vulnerable to unintended consequences. In my recent article for the Daily Journal of Commerce, I offer ways to mitigate that danger by addressing some common insurance oversights and ways to be prepared for potential coverage issues. Read the full article here.

“Year-End Insurance Review: Common Coverage Oversights” was originally published by the Daily Journal of Commerce on November 18, 2016.

Idaho Reads Force Majeure Clause Broadly as Written

In a ruling supporting common sense, the Idaho Supreme Court ruled that a county could not avoid the application of a broad force majeure clause in its development agreement with a developer based on the county’s denial of the rezoning required for the very development.

The key facts in Burns Concrete, Inc. v. Teton County, No. 43527-2015, 2016 WL 6462138 (Idaho Nov. 1, 2016) are fairly simple:  The County and a developer entered into a development agreement whereby the developer was to build a certain facility, of a certain type and size, subject to the County’s rezoning approval for the land.  The development agreement included a fairly common force majeure clause, with language that stated that extensions of time would be given for “delays resulting from weather, strikes, shortage of steel or manufacturing equipment or any other act of force majeure or action beyond Developer’s control.”  (Emphasis added.)

Although the development agreement was approved and executed and the property rezoned, the nature of the request by the developer got caught in a procedural delay with the County, in essence, as to the type of permit or rezone required.  Ultimately, the developer could not comply with the development agreement timeline to construct the permanent facility within the required deadline.  On that basis the County revoked the authority it had previously provided to the developer.  The developer sued to enforce the development agreement and the force majeure clause.

While the County maintained that the clause limited the excusable events to the nature and type in the list and to those not reasonably foreseeable by the developer, the Idaho Supreme Court looked to the plain language of the agreement and its terms, emphasizing that the phrase “or any other act of force majeure” was broad enough to include the County’s own inconsistent conduct:  “[t]he failure of the County to give zoning approval for building the 75-foot-high permanent facility was not reasonably foreseeable because the development agreement required the Developer to construct a permanent facility that was 75 feet high.”  Moreover, the Court also emphasized the conjunction and last clause in that force majeure provision (“or action beyond Developer’s control”) to point out the obvious here: “[t]hus, to comply with the agreement, the Developer would be required to build a facility that was 75 feet in height.  It would not be foreseeable that the County would require the Developer to build a facility 75 feet in height and then prevent the Developer from doing so.”  The County’s inconsistency was patently outside of the developer’s control.

This decision should help in disputes between parties to read the plain language as written.  And, while every intent and future potential anomaly cannot be eliminated when drafting agreements, clients should take time to evaluate even the “standard” clauses to reflect the circumstances at hand.  Here it is plain that the developer was in a Catch-22 if it could not have relied on events outside of its control, and yet, despite that plain language the County was intent on reading the provision to its own advantage, resulting in almost four years of litigation for the developer and taxpayers of the County.  And the costs will be more so to the taxpayers under the prevailing party fee provision in the development agreement, as well as the likely Idaho attorney fees statutes, given that the County will be liable for the reasonable fees of the developer.

Joint Washington/Oregon Construction Law Seminar – November 4, 2016

On November 4, 2016, my colleague, Andrew Gibson (from the Portland office of Stoel Rives), and I will co-chair a joint OSBA/WSBA construction law CLE, entitled Two States of Construction Law: Working in Both Washington and Oregon, located at the Heathman Lodge in Vancouver, Washington. This seminar will include a panel of knowledgeable lawyers with broad experience comparing and contrasting the laws of both Oregon and Washington that impact the construction industry.  Topics include competing change order and notice requirements, construction claims on public projects (prompt payment, retainage and payment bonds), contractor and developer licensing and registration, the economic loss rule and the independent duty doctrine, legislative and case law updates for 2016, a discussion on the ethics of mediation and arbitration, along with perspectives from both Washington and Oregon trial court judges.  My colleague, Sean Gay (also from the Portland office of Stoel Rives), and I will also speak on the key differences in the mechanics’ and materialmen’s lien laws in Oregon and Washington.  Click here to learn more and to register online.

Redefining Priorities: Risk Management, Enhanced Quality, and Minimizing Disputes

When engaging in a new construction project, the primary focus is frequently on the immediate issues — plans, permits and the build-out itself.   But building good risk management procedures and techniques into the front end of your project planning can have bottom-line business benefits. In my recent article for the Daily Journal of Commerce, written with Dwain Bateson of Bateson Consulting Services, we discuss the many benefits of  making risk management a priority throughout the project.  Read the full article here.

 “Redefining Priorities: Risk Management, Enhanced Quality, and Minimizing Disputes” was originally published by the Daily Journal of Commerce on Friday, October 21, 2016.

 

Concerns over California’s Increased Earthquakes? Landlords and Developers Should Manage Their Risks Now

During the last month or two there has been a rise of news reports regarding potential earthquakes in California at a greater magnitude than in recent history:  see here and here.  These risks have even been reported recently in a London newspaper.  While the unusual Southern California “big one” warning is now past, the risk has not been eliminated of course.  This recent flurry of new reports has brought this topic to the attention of landlords, and stability concerns for one very prominent building and its developer and buyers.

the big one earthquake road sign in los angeles

So what is a landlord or developer to do?  Understand the law and the obligations in light of the inevitable earthquake in California, including understanding that mere compliance with code, together with seismic retrofitting, is not a ban or bar to a negligence lawsuit.  For example, in Myrick v. Mastagni, the court held that statutory compliance is not a complete defense to a negligence action (or any tort action) against the landlord.  111 Cal. Rptr. 3d 165 (2010) (rejecting argument that owner had no duty to retrofit building until deadline set by local ordinance). Myrick arose from the “death of two women who were killed in 2003, when a portion of a building collapsed on them during an earthquake.  The women’s survivors sued the building’s owners for negligence in failing to perform seismic retrofitting of the building.  The jury found the owners negligent and awarded substantial damages.…  On appeal, the defendants contend[ed] they had no duty to retrofit the building until 2018, the deadline established by city ordinance.”  Id. at 167.  Knowing that California courts have “not looked favorably on the use of statutory compliance as a defense to tort liability,” the court also recognized that such was the case because a statute, ordinance or regulation normally sets only the minimum standard of care. Id. at 169.  Importantly, the court ruled that “[a] minimum standard of conduct does not preclude a finding that a reasonable person would have taken additional precautions under the circumstances.”  Id.

With that in mind, the basic rule is that an owner must use ordinary care in the management of his or her property to prevent injury to another.  Cal. Civ. Code § 1714.  And that is tested by a review of the factual circumstances surrounding the property, the injury-causing event, and “whether an owner has acted as a reasonable person in view of the probability of injury. “ Myrick, 111 Cal. Rptr. 3d at 169 (citing Rowland v. Christian, 70 Cal. Rptr. 97 (1968)).  For the particular ordinance at issue in Myrick, the clear public policy was stated as the public’s safety and the reduction of personal injury or deaths that “may result from the effects of earthquakes on existing unreinforced masonry bearing wall buildings.”  Id. at 171 (quoting city ordinance).

Landowners in areas of California with seismic retrofit ordinances would be wise to evaluate whether they can or should take steps now.  Developers too should consider the nature and use of the building and reasonably likely use of neighboring property that may or could impact the stability of a building in a known unstable location.  In certain locations, landowners or developers may “pre-certify” a building in case of an earthquake by arranging post disaster building inspections by prequalified licensed structural and civil engineers or architects with special training in emergency structural inspection, thus reducing tenant and business interruptions when the governmental agencies are overwhelmed.  See, for example.  As aptly put by Sophocles in Oedipus Rex: “I have no desire to suffer twice, in reality and then in retrospect.”

One Unanticipated Cost of Being an Owner-Builder in California: Liability for Retained Control over Safety

Many times I hear from people who want to “save money” and serve as their own “owner-builder” under the exemption to the California Contractor’s Licensing law, which generally requires that any “construction” work over $500 to be performed by a licensed California contractor in the absence of an exemption.  (Bus. & Prof. Code section 7048).  I always remind them of the old adage “penny-wise and pound-foolish,” and suggest that they review the risks, including those “oh so helpful” resources on the Department of Consumer Affairs webpage for the Contractors State License Board, such as Owner-Builder Overview and Owner-Builder Risks.

Well, now I have yet another tale to tell about the “what-ifs” in such a situation as found in the recently published decision Regalado v. Callaghan, No. D069647 (Cal. Ct. App. Sept. 22, 2016).  Callaghan, who is a licensed concrete subcontractor, decided to act as his own “owner-builder” when building his “dream house” for his wife in sunny Southern California.  Under the exemption to licensing for building a home, Callaghan would obtain his own permits for the construction at his own home, and serve as the responsible person for the construction as if he was the general contractor.  While Callaghan performed his own concrete work, he did hire licensed subcontractors to complete the other work on the home and also kept track of the progress himself.  He was on site daily and called for county inspections after work was complete.  So far so good, it seems.

Sectional view of the poolCallaghan also decided to build a pool, and appears to have had some of the underground work pre-planned and performed, including a planned noise minimization design for the pool equipment by using an underground vault.  He also hired a plumbing subcontractor to run an underground line for the propane heater.  That subcontractor may or may not have warned Callaghan about the dangers of propane, including particularly the dangers associated with the use of a propane line in a vault.  Unfortunately, the pool was not installed by the original subcontractor, who was too busy when Callaghan was ready to complete that part of the project one year later.  The hired pool contractor, a friend and colleague of Callaghan’s, performed the work as requested by Callaghan, including installing the natural gas to propane conversion kit for the vault, and the design layout of the equipment in the vault.  Callaghan secured permits for the pool and spa, but did not know he was also required to secure permits for the vault itself and the propane line, or have the county inspect the vault.  In a series of unfortunate events, the employees of the pool subcontractor did not have experience in work in this area, nor did they (nor their supervisor) read the relevant instruction manuals that warned of the risk of explosion under the circumstances.  You guessed it – after another series of “I thought you” between the same inexperienced employee and his supervisor, the propane that had bled into the vault ignited when the employee (the plaintiff) turned on the propane heater.  Sadly, the plaintiff was severely burned and injured.

Following a jury trial, on appeal the court among other legal analysis affirmed the trial court’s exception to the general rule that employees of independent contractors, here the plaintiff working for the pool subcontractor, cannot sue the party that hired the contractor to do the work except “insofar as [the hirer’s] exercise of retained control affirmatively contributed to the employee’s injuries.’ [italics in original, citations omitted].”  Such “affirmative contribution” may also be in the omission of certain acts over which the hirer has retained control, including oversight and coordination of permits and inspections as an owner-builder.  Under the facts of the case, the jury found Callaghan’s oversight and failure to secure permits and inspections negligent enough to share in 40% of the verdict, or approximately $3 million.

A “lessons learned” aspect of this decision, among a number of legal issues, is that it normally does not pay from the risk management perspective for a homeowner – even a fairly knowledgeable licensed contractor presumably – to act as an owner-builder and assume all of the responsibility and liability for the project as the general contractor.  And, while not discussed in the case, the pragmatic issue is whether the individual owner-builder had proper and sufficient insurance coverage for conduct, actions and a role that he did not normally undertake in building his own home as the owner-builder.  If not, in seeking to collect on that affirmed judgment of $3 million, the plaintiff may look to the dream house that the owner-builder was intending for his wife.  Regalado v. Callaghan

Self-Imposed ADA Audits: The Developer’s Best Option

Recent rulings indicate that courts across the country view project owners’ and developers’ liability for ADA claims differently than they do other compliance violations.  Owners’ attempts to raise questions of contractor negligence, breach of contract or breach of warranty are being rejected.  So what can a project owner do? In my recent article for the Daily Journal of Commerce, I discuss why the courts’ rulings suggest that thoughtful, thorough self-audit by owners is their best protection.  I also offer other steps that should be taken to minimize the risk of ADA-related claims.  Read the full article here.

“Self-Imposed ADA Audits: The Developer’s Best Option” was originally published by the Daily Journal of Commerce on September 16, 2016

 

“All Risk” Coverage Is Not Equal to “All Loss” Coverage Under Customary Provisions in California Builder’s Risk Policies

Home improvement, - close-up of handyman laying tile

A common insurance question asked by our owner/developer clients when they discover that their completed project has defects is whether their own insurance will cover the cost to fix the defect or any damage from the defect.  While trying hard not to sound like the proverbial lawyer, we often have to say “it depends.”  What it depends on is multifaceted and includes, among other considerations, the cause of the defect, whether there is more than one cause (and what those causes are), what the defect is (inherent in the product or component, or impacting another component), whether there is damage to another element of the project (often referred to as “resulting damage”) or just the design or the work itself is defective, and, of course, what exactly the Builder’s Risk policy says (and if there are any exceptions to the various exclusions in the policy).

In a recent unpublished opinion from the California Court of Appeal, Olympic & Georgia Partners v. Arch Specialty Insurance Co. (No. B264647, 2d Dist., Div. 2, July 28, 2016), these questions played out in a very expensive way for the owner and developer of a 54-story high-rise, mixed-use development that consisted of a Marriott hotel on the bottom floors, a Ritz-Carlton hotel on the middle floors, and 212 Ritz-Carlton luxury condominiums on the upper floors.  As expected, the owner (the LLC) hired a general contractor, which hired two subcontractors to install stone flooring in the condominiums.  The subcontractors split the complete installation of the stone assembly by room.  Again, as expected, the LLC had secured a Builder’s Risk policy—actually eight via a consortium, with each holding less than 10% of the risk, although the language of the policies was essentially the same.  Every policy was an “all risk” policy, insuring “all risks of direct physical loss or damage to insured property” during construction, subject to exclusions.  Two key exclusions, B and C, which are common, excluded the costs to repair any “faulty or defective workmanship” unless the loss was caused by an “insured peril,” and then the “ensuing loss or damage only” would be covered, and they also excluded coverage for fixing the defect unless the loss or damage caused by an insured peril is the result.  Yet still, the policy would cover the ensuing loss or damage only under the second key exclusion.

Relevant to the above question, the LLC submitted a claim to the Builder’s Risk insurers for hairline cracks that had been discovered in the stone in some of the condominium units.  Not surprisingly, scope and cost estimates varied for the repairs, from $7.5 million by the insurers to $21.5 million with an additional $16 million in related costs calculated by the LLC.  An investigation of the loss was conducted by all involved.  It was determined that an uneven application of mortar thickness under the stone caused shrinkage movement that resulted in the hairline cracks. The poor application was itself the result of the architect’s inadequate plans and the project manual erroneously directing thicker application of mortar to level the uneven floors.  There was no dispute that an overly thick application of mortar was the “primary” cause of the hairline cracks.  Following the insurers’ investigation of the causes, the policy language and the damage, the insurers denied the claim in whole.  The LLC sued the insurers on several grounds and, relevant here, sued them for breach of the insurance contracts for denying coverage under the policies.

On cross-motions to have the trial court decide the interpretation of the policies and whether there was coverage, the trial court granted the insurance companies’ motion and denied the LLC’s motion.  Importantly, because it was undisputed that “the overly thick mortar bed was the primary if not exclusive cause of the cracking of the natural stone,” the court concluded that Exclusions B and C applied, barring coverage for the “cost of making good” defective design and defective workmanship. Court of Appeal opinion at 8. The trial court further concluded that the “ensuing loss” exception to those exclusions did not apply, reasoning that “the cracking of the natural stone was not a severable ‘ensuing loss’ such that it qualified for the exception to the exclusion.”  Id. After considering two questions on these issues, the appellate court affirmed the ruling, precluding the Builder’s Risk policies’ obligations for coverage of the multimillion-dollar claim:  “(1) is the cost of repairing the stone part of the ‘cost of making good’ the faulty design and workmanship with the mortar, so as to be excluded from coverage by Exclusions B and C; and, if so, (2) is the damage to the stone a ‘direct physical loss or damage by an insured peril,’ so as to be covered by the ‘ensuing loss’ exception to Exclusions B and C?” Id. at 10-11.

In addressing these questions, the Olympic & Georgia Partners appellate court noted: “A ‘cost of making good’ provision excludes from coverage a contractor’s ‘own work,’ thereby placing ‘the risk of replacing or repairing [a contractor’s] defective work or product’ on that contractor’s insurer rather than the general contractor or builder’s insurer. [Citations omitted.]”  Id. at 11 (first brackets and emphasis in original).  And “[b]ecause only one subcontractor installed the flooring in any given room, and because it is physically impossible to replace the mortar without replacing the stone sitting atop it, the ‘cost of making good’ provision excluded from coverage the cost of replacing or repairing the stone as well as the mortar. [Citations omitted.]”  Id.  As to the second exclusion, the “ensuing loss,” the court found that existing California law makes it “clear that an ‘ensuing peril’ provision applies only if there is, in fact, a second and subsequent ‘peril.’” Id. at 13.  In short, the court reasoned that because “the original, excluded peril (the defective mortar) directly caused the very damage for which the insured is seeking recovery (the cracked stone),” there is no coverage under the “ensuing peril” clause.  Id.

The reason this is important for our owner/developer clients, as well as our general contractor clients, is the ongoing consideration of “Risk Management” and where the risk is placed for defective work in construction projects.  As was the case here, the Builder’s Risk policies (and other property policies) have standard exclusions for faulty or deficient work, and they have more and more robust “ensuing loss” limitations.  An owner/developer should therefore not rely too heavily on its own insurance policies for protection.  Although not discussed in the case, it is also expected that the owner/developer sought coverage from the general contractor and subcontractors, and perhaps others, and their insurance policies.  Several issues could be in play there as well to limit or exclude coverage or damage recovery against the parties at fault, including perhaps waiver of consequential damages, limitations of liability, “your work” exclusions in the subcontractor’s insurance policies, no direct claims against the subcontractors as the “work” assembly was inclusive of the mortar and stone (and thus no tort damages), possibly no professional negligence by the designers, and lack of coverage for resulting damage under the general contractor’s policies.  As well, particularly given the size of the loss, it is possible that no ready cash for any breach of contract would be forthcoming for the repairs and replacement by the contractors involved.  Finally, a consideration for our owner/developer clients is whether a performance bond that included the warranty period and did not terminate at substantial completion would be a consideration for allocation of the risk and placement on the parties that are responsible for the damages to the LLC, such as is evident in a high-profile project such as this one.  See our prior articles on insurance and bonds for additional relevant information and my prior blog regarding common CGL insurance limitations, which could be at play in this case too.  Of course, our first and last recommendation is a strong and robust Risk Management program, with field inspections during the course of construction by a highly qualified independent construction consultant.  Catching defects early in the field is wildly less expensive than the costs to repair after the project is complete.

“Slip Sliding Away”: Recent Washington Court of Appeals Decision Further Erodes Economic Loss Rule and Expands Independent Duty Doctrine Against Design Professionals

On May 3, 2016, Division 2 of the Washington Court of Appeals issued a decision that renders seemingly moribund the economic loss rule and extends the reach of the independent duty doctrine (“IDD”) against design professionals. The case of Pointe at Westport Harbor Homeowners’ Association v. Engineers Northwest, Inc. P.S., 193 Wn. App. 695, — P.3d — (2016), involved what has become commonplace litigation in condominium developments – a suit by a condominium homeowners association (“HOA”) against an engineer for negligent design.  The HOA in the Pointe case alleged that the condo building was “rendered unreasonably dangerous to its occupants” because of the design defects and sought costs for investigating and repairing the defects.  The defendant engineer moved for summary judgment on the basis that the IDD (previously known as the economic loss rule) barred negligence claims for purely economic loss.  The trial court denied the engineer’s pre-trial motion, apparently without addressing whether the IDD applied, finding material issues of fact to preclude summary judgment.

During the trial, the HOA presented a structural engineer as its expert to testify that the structural engineering work had been deficient and led to the defects that rendered the building dangerously unsafe in a large seismic event (which events occur in the area) and prepared a scope of repair work that involved fixing each defect in the building. Id. at *2.  The jury ultimately returned a verdict in favor of the HOA and found that the resulting damages amounted to over $1 million for which the defending engineer was 97.5% at fault. Id.  The trial court entered judgment against the engineer for the entire amount of negligence damages. Id. at *3.

On appeal, the engineer again argued that the HOA’s claims should have been barred by the IDD. Id. at *4.  The appellate court disagreed and affirmed the trial court decision, but, unlike the trial court, specifically addressed the legal issue of whether application of the IDD barred the HOA’s tort-based claims for purely economic damages.

The IDD generally “bars recovery in tort for economic damages suffered by parties to a contract unless the breaching party owed a duty in tort independent of the contract.” Id.  (citing Eastwood v. Horse Harbor Found., Inc., 170 Wn.2d 380, 393-94, 241 P.3d 1256 (2010)).  Although the “foundation of any liability analysis for . . . design professional[s] rests in contract,” the Washington Supreme Court has held that “design professionals also owe duties to their clients and the public to act with reasonable care, which can sometimes give rise to a tort duty independent of the contract.” Id. (quoting Donatelli v. D.R. Strong Consulting Eng’rs, Inc., 179 Wn.2d 84, 92, 312 P.3d 620 (2013)).  Engineers owe such a duty of reasonable care not only to developers and contractors to whom they provide engineering services (see Jarrard v. Seifert, 22 Wn. App. 476, 479, 591 P.2d 809 (1979)), but also to holders of legally protected interests in the property (see Affiliated FM Ins. Co. v. LTK Consulting Servs., Inc., 170 Wn.2d 442, 455, 243 P.3d 521 (2010)). Id.

The engineer in the Pointe case argued on appeal that this tort duty is limited to cases where the engineer’s failure to exercise reasonable care results in personal injury or actual physical damage. Id.  To support its argument, the engineer relied on the cases of Michaels v. CH2M Hill, Inc., 171 Wn.2d 587, 593, 606-09, 257 P.3d 532 (2011) (engineering firm owed an independent tort duty when a person was killed because of a catastrophic failure at a wastewater treatment plant), and Affiliated FM, 170 Wn.2d at 443-44 (engineering firm owed an independent tort duty when property damage resulted from a fire on the Seattle Monorail). Id.  At trial, the HOA had only presented evidence of potential damage to the condominium buildings, not actual injury or physical property damage.

The Washington Court of Appeals disagreed with the engineer’s argument and held that an engineer’s duty of care encompasses, inter alia, the prevention of safety risks.” Id. at *5 (emphasis added).  “Even where such safety risks do not cause consequential damage to persons or property, the risk itself constitutes an injury within the class of harm contemplated by a design professional’s duty of care.” Id.  The Pointe court ultimately held that the engineer “owed an independent duty to the developer and to members of the HOA, as holders of property interests in [the condominium project], to take reasonable care to design a building that did not present safety risks to its residents or their property.” Id.

The Pointe case illustrates a considerable weakening (if not the end) of the economic loss rule in Washington and a design professional’s ability to limit liability for purely economic damages resulting from alleged design defects.  With the expansion of a design professional’s duty of care to prevent mere risks of (rather than actual) damage or injury, design professionals face even more liability exposure in Washington, which likely will only fuel the fire of owners’ and homeowners associations’ design and construction defect claims.  Of course, the Pointe case is a decision from only one division of the Washington Court of Appeals, and time will tell whether the current status of the IDD will continue (or even expand further) or whether the Washington Supreme Court will overturn this case in favor of a different interpretation of the doctrine.  The design professional community can only hope for the latter.

Architect Off the Hook for ADA Defects

Continuing a disturbing trend, another recent case finds that an architect is not liable for a design that failed to comply with the ADA and Section 504 of the Rehabilitation Act (RA). In Chicago Housing Authority v. DeStefano & Partners, Ltd. (here), an Illinois appellate court followed several other federal and state decisions in holding that only the project developer is liable for ADA and RA defects. The developer’s duty under the Acts is non-delegable, according to the courts’ interpretation of the language of the Acts, and any attempt to seek indemnity or contribution (or any other legal remedy) from the offending architect will be dismissed.  These holdings rest on flimsy support in the Acts themselves, and diverge from many other statutory and regulatory building mandates, including building codes meant to provide life/safety protection, which allow owners and developers to seek a remedy against the party(ies) they relied upon (and paid) to design and construct the buildings properly.  The better policy—and the legally correct result—would be to hold owners, developers, architects and contractors all liable for ADA and RA defects.  This result ensures proper motivation for all players to get it right, increases the availability of insurance and other assets to pay for the remedy, and allows long-standing principles of indemnity and contribution to be allocated by contract and legislated under state law.

 

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