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.


On Guard: A Look at Subcontractor Default Insurance

Whether you call it SDI or SubGuard, subcontractor default insurance is yet another consideration for public and private project owners as they look at protection from subcontractor default.  But what exactly is this relatively new option and when is it most appropriate?  In my recent article for the Daily Journal of Commerce, I discuss SDI, how it works, and what you should consider when deciding if the circumstances are right for SDI coverage.  Read the full article here.

 “On Guard:  A Look at Subcontractor Default Insurance” was originally published by the Daily Journal of Commerce on August 19, 2016.


Oregon Construction Law Seminar

On September 22 and 23, 2016, my colleague Eric C. Grasberger will co-chair The Seminar Group’s Oregon Construction Law seminar in Portland, Oregon.  This seminar will include a panel of knowledgeable lawyers with broad experience addressing Oregon construction law.  I will be presenting and will speak about design-build contracts and the project delivery method.  Two of my colleagues will also be presenting: C. Andrew Gibson will present on Oregon statutes of limitations and repose; Richard E. Alexander will speak on ways to maximize mediation.  Click here to learn more and to register online.

Considerations Before and After the Government Comes Knocking (or Preparing for Condemnation)

The status of infrastructure throughout the United States, and the need to expand and rebuild facilities, is often in the news. Funding these improvements remains a challenge, but when funding is identified, the government often has to acquire private property. If the government and the property owner are unable to reach agreement, the acquisition may result in the use of the government’s eminent domain power.

The use of eminent domain requires that the government pay fair market value. Case law has developed, however, holding that some damages are not compensable. In many cases, for example, a taking may adversely impact access, but compensation for that element of injury will not be available. For impacts such as these, participation at the project design phase is the property owner’s best course. And, even where damages are compensable, being proactive both before and after the government comes knocking may simplify the process and minimize business disruption. Suggested steps include:

  • Reviewing Any Leases

Both property owners and tenants may be entitled to government compensation when property is acquired for a public project. To the extent compensation is owed, lease condemnation clauses are the first place the parties will go to determine who gets what. In the best case, the lease makes clear how any compensation is to be distributed. If the lease is silent or unclear, the tenant is entitled to participate in any condemnation proceedings. In Oregon, for example, the court will distribute the money awarded in a manner it determines is just and reasonable. Addressing in the lease how those dollars will be shared, if at all, may avoid a costly dispute down the road. The parties may also want to consider identifying with specificity in the lease the owner- versus tenant-owned fixtures.

  • Ground-Checking Any Cost-to-Cure Numbers

In many cases a condemnation action does not acquire the entire property but rather takes a strip of property for a road expansion or a utility easement. In a partial take, the just compensation paid by the government will include the fair market value of that strip of land or easement. If the taking reduces the value of the property the landowner will retain, the compensation owed includes severance damages, the difference in the value of the property before and after the take. If, however, it is possible to remedy the severance damages with a physical fix, the compensation owed is the lesser of the severance damages or the cost to cure. If the government offer includes a cost to cure, it is often a worthwhile investment to consult with engineers, land use planners and other relevant experts on the feasibility of the fix and to ensure that the government’s cost estimate includes all the items likely to be required by permitting agencies.

  • Developing a Relocation Strategy

In many instances, relocation benefits are available to reimburse some of the cost associated with being displaced by a public project. Displacement may mean the move of personal property off a strip of land being acquired. If, for example, the strip of property being acquired is used as storage for nursery plants, the owner of the plants likely has a claim for the reimbursement of certain costs associated with moving those plants out of the path of the public project.

Displacement may mean the relocation of an entire business from a site because the entire property is taken by the government. Moving an entire business is a time-consuming enterprise. In addition to finding a new site, the business may, while endeavoring to meet the government’s move deadline, have to navigate a local land use permitting process for the new site. Certain permit-related costs are reimbursable as relocation expenses.

The relocation regulations include caps on reimbursement of certain types of expenses, documentation requirements and claim deadlines. Not all costs associated with having to move—whether it be a few plants or an entire business—are reimbursable. Understanding

  • how to document a claim
  • how to optimally structure a move and claims and
  • how to evaluate whether to even move personal property as opposed to utilizing benefits to help finance replacing that property in the new location

can all help to substantially reduce costs often associated with a condemnation but not addressed within the condemnation proceeding or related negotiations. Relocation benefits also receive beneficial tax treatment.

Laws may vary by state but these are generally applicable rules. Understanding what is and is not compensable and who will be compensated, ensuring that mitigation proposed by the government is feasible and the cost accurately estimated, and understanding the relocation benefit options available will help minimize business disruption and best position the business to succeed post-project.

Going Green in a Big Way.

As the new State Route 520 floating bridge nears completion in Seattle, the 31 original bridge pontoons are ready for removal. Rather than breaking them up, the Washington Department of Transportation (WSDOT) will tow them through the Seattle ship canal and Ballard Locks to Puget Sound.  In an epic display of recycling, they will be delivered to True North Projects, which will market them around the world as floating docks, storage platforms, or breakwaters.  The WSDOT website has background about the SR 520 project in general and the True North website has lots of information about the pontoons’ construction and potential uses.  If you want a pontoon, this is your opportunity.  Even if you don’t, you may be interested in how pontoons are built and how they can be used when not supporting a highway.

Lake Washington Bridge 7-25-16

The pontoons for the new bridge were built in various places, as far away as Aberdeen on Washington’s Pacific Coast, and towed to Seattle. Upon arrival, some were found to be cracked and leaking.  A panel of experts studied the problem and recommended a solution.  A combination of repairs and modified casting methods was implemented, with the result that the new pontoons are in place and in use.  This is a reminder that what might at first appear to be a relatively simple task (make a big concrete box to support a bridge) can lead to unexpected and complex problems.  But smart and experienced people can solve problems, for which we should all be grateful.


Negotiating by a Thousand Texts: LOL? Think Again.

The law may be slow to evolve, but courts are beginning to embrace 21st century communication methods.  The prospect of negotiating a deal by text message may seem like a laughing matter, but a Massachusetts court recently relied on parties’ email and text communications to determine the essential elements of an agreement for the sale of land.

In a time when parties are increasingly relying on alternative methods of communication, it is important to be mindful of the fact that when communications are reduced to writing (by email, text, tweet, or otherwise), they may be used to determine the existence and terms of a contract. In a perfect world, carefully drafted contracts would ultimately replace and supersede these informal communications.  Nonetheless, parties should be careful when using alternative means of communication to negotiate a deal and they may want to consider including disclaimers with such messages, for example, “No binding agreement will be formed by this exchange.  Only a mutually signed final contract will be binding on the sender.”  At a minimum, a party conducting substantive negotiations via text message should consider capturing and recording those conversations and negotiations as some evidence of its discussions.

For readers interested in exploring this issue in more depth, I recommend reviewing the Court’s decision in St. John’s Holdings, LLC v. Two Electronics, LLC, No. 16 MISC 000090 (RBF), 2016 WL 1460477 (Mass Land Apr. 14, 2016).