The Increasing Importance of Performance Bonds
There are now 25 states in the U.S. that hold that construction defects are not an “occurrence” and are therefore not covered under commercial general liability policies insuring contractors. Couple this troubling statistic with the ever increasing number of policy exclusions and limitations, and we begin to realize that in many situations the contractor’s insurance policy is inadequate (or non-existent) protection against defects.
The importance of performance bonds as security to pay for construction defects is therefore growing. While some sureties who sell the bonds will tell you that bonds merely guarantee completion, and do not insure against latent defects, the language of the typical bond defies this position.
Bonds plainly state that they guarantee each and every obligation of the contractor under the contract. Those obligations usually include the duty to perform work according to the plans and specifications, the standard of care, and without defect or nonconformity. This author has not seen a bond that attempts to carve out construction defects from its coverage. And bonds do not have the host of exclusions or limited coverage grants that plague the value of insurance policies. By the same token, bonds are not perfect and owners should consider the following to get the most protection from a bond:
First, the bond duration should extend at least as long as the warranty period (typically one year from completion but sometimes longer) and for as many years thereafter as possible, up to the statute of repose period in the state in which the project is located. Because construction defects often appear years after completion, the bond duration is critical. You may pay more for a bond with a longer duration, but if the bond is needed, you should be paying less for the unreliable insurance carried by the contractor.
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Washington Supreme Court Re-Examines Economic Loss Rule
The Economic Loss Rule plays an important part in construction disputes, but it has not been clearly defined or understood, or so the Washington Supreme Court has recently stated. The Economic Loss Rule has been generally described as applying to “economic damages” in cases where the plaintiff has a contract that addresses or could reasonably address the risk of those economic damages. The Economic Loss Rule has been applied in Washington to disputes relating to product liability and construction matters.
The Washington Supreme Court revisited the Economic Loss Rule in two cases issued on November 4, 2010, Eastwood v. Horse Harbor Fdn., Inc., and In re Affiliated FM Insurance Co, v. LTK Consulting Services, Inc. The court concluded that the Economic Loss Rule had been misunderstood. The nature of damages is not determinative (since many kinds of damages can be stated in monetary terms), and the presence of a contract is also not determinative. Instead, the key issue is really whether the plaintiff can identify a duty owed independently of any contract. The court said that the Economic Loss Rule should be renamed the Independent Duty Doctrine.
In Eastwood, the court ruled that a tenant’s duty to avoid waste was independent of a similar duty stated in the lease, and so the plaintiff in that case could pursue claims in tort and for breach of contract simultaneously. In Affiliated FM Insurance, the court held that an engineer hired by the City of Seattle to make recommendations about repairs to the Seattle Monorail owed a duty of care to the company that operated the Monorail, independent of its contractual duty to the City. As a result, the operating company could pursue a claim against the engineer for negligence after a Monorail train caught fire.
Both Eastwood and Affiliated FM Insurance include multiple opinions, concurring and dissenting, that discuss various aspects of the old Economic Loss Rule, now renamed the Independent Duty Doctrine. All of the opinions should be examined to understand the status of the law in this area.
Two results of interest to construction litigators should survive the restatement of the rule. In Washington, a contractor given faulty plans by its client/owner may not sue the owner’s architect for negligence in preparing those plans. And Washington does not recognize a cause of action for negligent construction. Any case needs to be analyzed on its particular facts, however.
Be careful what you ask for Idaho
In the last two decades, the Idaho State Legislature has authorized design-build contracting for many different types of public projects. It appears that the Legislature will continue this trend for highway projects. In February, a House committee voted to print a bill that would allow the Idaho Transportation Department (IDT) to award design-build contracts for highway projects. A similar measure nearly became law last year.
For the most part, the Legislature’s acceptance of the design-build process is good thing. Several years ago, I worked for a commercial contractor. In 2001, I visited our largest project at that time -- a $500 M design-build facility in California. When I asked the project lead whether he liked design-build projects, he was quick to praise the process. He believed that design-build projects equated to fast results, decreased change orders, and less litigation. To him, it was a no-brainer. Many of my colleagues agree.
Since then, I have been involved with several design-build and design-bid-build projects. Although some design-build projects have been successful, that’s not always the case. The moment an owner enters into a design-build contract, it loses something that can be very important to a successful construction project: control. This lack of control – which is caused in large part by undefined design requirements – can lead to significant cost overruns and delays.
To avoid such results, owners should focus on two important actions: careful planning and diligent execution. On the topic of planning, design-build owners should spend significant time defining the project requirements. The design-build contract documents must include, among other things, detailed project design criteria, program requirements, performance specifications, and deliverables. Absent such defined requirements, design-builders are free to run wild.
Professional execution of the plan is equally important. Owners must prudently monitor the design-builder’s work. Too often, owners in design-build projects overlook this task, believing that such role is limited in design-build projects. In fact, the opposite is true. Because the design-builder has more flexibility in design-build projects, owners must arduously monitor the budget and schedule.
Design-build projects present many benefits. IDT, however, should know that it will not be less work for them. The key is for IDT to clearly define the project programs and performance requirements before the contracts are signed, and to monitor the design-builder’s compliance with these requirements throughout the project.
Negligence Claims Take Another Twist in Oregon
Just when you thought it was safe to go back into the water, the Oregon Court of Appeals strikes again with another iteration of the “economic loss doctrine” which defines when parties can sue each other in negligence for construction defects. In Abraham v. Henry (September 2, 2009) the Court held that parties to a contract can sue each other in negligence if a rule, code or standard “independent of the contract” has been violated. A prime source for independent rules, held the Court, is the Oregon Building Code. From now on, we can expect to see plaintiffs including in their complaints that one or more provisions of the Oregon Building Code have been violated. It will be easy to find such violations in most construction defect claims.
The prior standard, enunciated in the Jones v. Emerald case, held that there must be a “special relationship” between the contracting parties in order to support a negligence claim. No one really knew what a special relationship was, but most believed that alleging in the complaint that the owner relied on the contractor’s expertise was sufficient to create such a relationship and thus a right to sue in negligence. Abraham may have changed that belief by pointing out that, at least in that case, there was nothing “special” about the arms-length owner/contractor relationship, and, with or without reliance on the “expertise” of the contractor, each party was acting on its own behalf and for its own benefit.
Other decisions from Oregon courts support the argument that the economic loss doctrine does not bar negligence claims if there is physical property damage, but this argument was not made or at least not addressed by the Abraham court.
The principal reason – if not the only reason – why the economic loss rule is relevant is that Oregon’s statute of limitations for breach of contract is six years from the date of breach (which, at the latest, is usually the date of substantial completion or failure to honor extended warranties). For claims discovered and/or brought after six years, you must be able to assert a negligence theory for the claim to be viable, because the negligence period runs two years from the date of discovery of the claim (as opposed to the date of breach), capped by the 10 year statute of repose (which states that all claims must be brought regardless of discovery within 10 years from substantial completion). Thus, if you cannot assert a negligence claim, you may have no other claim to assert.
The vast amount of time and fees generated in litigating statute of limitations issues in Oregon construction cases is fueled by (1) disparate limitations periods for breach and negligence claims, (2) disparate limitations periods for claims against designers versus contractors, and (3) the every changing – and arguably inconsistent – decisions from Oregon courts on what the rules of the game really are. Oregon needs a “Construction Defect Reform Act” with one limitations period for all claims against all parties on a construction project, governed by a discovery rule and capped by a statute of respose, with a clear statutory answer to the economic loss rule. Until then, uncertainty and high legal fees will continue to be the norm.
