Washington Court Holds Statute of Limitations Doesn't Apply to Arbitration
Contributor: Stephen P. Kelly
In Broom v. Morgan Stanley DW, Inc., the Washington State Supreme Court held that state statute of limitations did not apply to a contractual arbitration. The arbitrators of an investment-related dispute had dismissed certain claims because plaintiffs failed to bring them before the applicable statutes of limitations lapsed. Analyzing the Washington statute of limitations and arbitration statutes, the court found that the legislature didn’t intend the term “action” in the statute of limitations – to include arbitration. Because of this, the court reasoned, the arbitrators weren’t authorized to apply the state statute of limitations to plaintiffs’ claims. The court made clear, though, that people can agree, by contract, to apply a state statute of limitations to arbitration provisions.
Construction and design contracts as well as many other types of contracts commonly specify arbitration as the exclusive forum for disputes, and commonly select what laws apply to the contract. This decision could affect a variety of construction-related disputes including construction defect and payment claims and the full impact of the decision remains to be seen. In the meantime, for a construction contract in Washington where arbitration is the forum for disputes, parties that want the Washington statutes of limitations to apply to the arbitration should make this clear.
Bond. Performance Bond.
Performance bonds—insurance-like arrangements in which a surety (the bonding company) contractually agrees to pay for the performance of a principal (the contractor) to an obligee (the owner) in case the principal fails to perform the obligations of its contract—should be used more often in construction agreements to provide owners with a source of funds to cover defective work in a project.
Currently, owners typically require contractors to obtain insurance policies with the hope that such policies cover defects in the work they perform for the owner. Though owners are willing to spend a lot of money, time, and effort in obtaining these policies, insurers continue to make revisions to their policies to limit, and sometimes prevent, coverage for these defects.
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Performance bonds may provide better protection to an owner. Typically, the bond provides funds to pay for repair of defective work that may not be covered by insurance as part of the bond’s guarantee of the faithful performance of the contract by the contractor.
Unlike insurance policies, performance bonds provide coverage only for the owner’s project—if an owner discovers a defect in the contractor’s work, the owner will not have to worry whether another owner’s claim against the contractor for another defective project will reduce the coverage available under the contractor’s bond. The performance bond’s recovery pool belongs to the owner for the specific project it is drafted to cover.
Government Involvement Has Consequences (Part 2)
Here is list of laws that may apply to projects in which the federal government is involved.
These reflections about government involvement are prompted by recent changes to the Federal Acquisition Regulations that give federal contractors an affirmative duty to disclose any “credible evidence” that comes to their attention of (a) the violation of certain criminal laws (e.g., those involving fraud or bribery), (b) violations of the civil False Claims Act, and even (c) “substantial overpayments” from the government. Contractors are also required to train their employees to ensure that misconduct will be detected and reported. This regulation reminds us that working with the government can trigger serious legal issues. As public-private partnerships and other forms of government involvement become more common, it is important to find out whether the government is involved in your project and, if it is, what consequences that has for your company.
Government Involvement Has Consequences (Part 1)
In an effort to stimulate the economy, federal and state government agencies are seeking to promote new construction projects. This trend of government involvement in construction projects is likely to continue. When the government is involved, it is important to know whether this involvement causes public contracting laws to apply.
Governmental involvement in a construction project can range from outright ownership to a behind-the-scenes role in financing. Multiple governmental agencies may be involved in a single project. If you have a project in which a federal or state agency is involved, you risk substantial penalties for failing to follow applicable public contracting laws.
There are many federal and state laws that may apply if the government is involved in a project. In Part 2 of this post, I’ll link to a list of some of the federal laws.
But I already paid for that! So you have a mechanic's lien; now what? (Part 2)
Four Practical Points for Avoiding and Responding to Construction Liens
Step 1: Who’s healthy in 2010?
Within the bounds of the Fair Credit and Reporting Act and any state obligations, it is imperative for both owners and general contractors to understand the financial fortitude of the parties doing the work. If you don’t obtain the bonds to protect the project, you need to be aware of what you can do to protect your rights. While you cannot request a complete financial audit, good due diligence will save you time, energy, money, and headaches in the future. Keep an eye out and an ear to the ground for any questionable items or rumblings related to the trades. Has anyone complained of “slow-pay” issues? Are there any “marks” against the contractor on any registration or licensing entity with the state? How timely is the contractor in meeting and agreeing to the terms you proposed (discussed below) that have active and proactive involvement for ensuring that the project remains clear of liens? Where is the contractor’s facility? Will it be condemned because it’s so rundown or has that “almost vacant” look, or is everything shiny and “new,” which in this economy could reflect an overleveraged or overextended trade contractor just waiting to fold if that next job doesn’t come through? While these items alone cannot “tell” you the contractor’s financial status, do not race past any yellow flags – the red ones are just behind it waving in the wind. These precautions are as true for the owner, who can get sideswiped by the general contractor or any of the lower-tier trades or suppliers.
Step 2: Is it time to update your contracts and specifically your right of inspection, payment, and mechanic’s lien provisions?
Do you know what your contract allows you to do at the beginning of the contract term or during the project to avoid liens? Do you have a list of the trades and suppliers (at least the major ones if not everyone) in the contract or within 30 days of its execution? Is your state a “preliminary notice” state such as California or Nevada, or a “surprise” state such as Idaho? Is your contract an “open-book” agreement? Can you communicate with lower-tier trades at any time? Do you have payment provisions relating to timing of payment for lower-tier trades or suppliers in your prime agreement? Do you require a sworn statement for the work performed for prior payment applications and a listing of the trades? Do you have joint pay or direct pay provisions if you have any concern whether those trades might be paid? Can you require waiver and lien releases with each payment (as permitted by law, of course)? Are you allowed to offset payments if you do discover there are some financial or payment concerns?
Step 3: Do you check in on the status of the work?
It is important to both monitor the work to keep up on the status and to communicate with the trades and suppliers on a regular basis to make sure they are being paid. While a few trades may promptly bring a slow pay or non-pay to the owner ’s or general contractor’s attention, many others in this economy will not until the very last minute out of pressure from the nonpaying party or fears of “not playing along” and not getting future work. The key is to allow the owner or general contractor to discover any issue early in the process – early enough so that any money can get to the right party and not the party that disappears with the dollars.
Step 4: Someone’s filing a claim; what do I do?!
There are times when something may slip past you despite the best-laid plans. Do you have a checklist action plan? Does everyone know what to do and what information and documents are required? Many times these claims arise at the most inopportune times and create a “fire drill” atmosphere. Avoid the confusion and rush, and know what you need to get done in your state to avoid a lien on the property or obtain the prompt removal of the lien if one has already been filed. The more information you have in advance, the better decisions you will make during the process and the less money it will cost you to address the issue.
But I already paid for that! So you have a mechanic's lien; now what? (Part 1)
Your project is coming along fine, despite the economy. You’ve weathered the squalls of bids, design changes, agency approval, and credit (mercifully), and now even construction completion is looking good. You can see the finish line through the haze on the horizon, and you’re fairly pleased with how you have pulled everything together with what has been a long haul through the system. You’re in the home stretch. You’re closing down the last items and payment obligations to ensure everything will get done. You didn’t even have to spend much money on legal fees in drafting the contract or during construction (that alone is reason to cheer for your department’s budget). You may just go on a “road show” to tout your expertise about how projects should be run. And then....
You receive a call from your project manager letting you know that a subcontractor says it wasn’t paid and will file a mechanic’s lien in five days if it doesn’t get a check. Well, how could that be? You have a record of payments to the general contractor, but you cannot find a release for those payments. You get two more calls from unpaid trades.... Yet, you feel somewhat confident; after all, the contract says the general contractor “is responsible” and you have that record showing you did pay him. It’s his responsibility to pay all the people he contracted with, right? Well, yes and no (of course!) is the legal answer your construction lawyer will likely give you.
Unfortunately, this scenario is becoming all too common in this lingering depressed construction environment. Tight bids, job or trade failures, and an ailing economy have trapped many owners and general contractors, causing them to potentially pay twice for work they thought was already “clear” and paid for.
Although each state’s laws on mechanic’s liens govern each party’s obligations and rights, in my next post I will provide you with some simple, general guidelines that owners and general contractors should keep in mind at the beginning of each project to help protect against the possibility of such a double payment.
You Are a Project Owner or Developer Who Wants to Build a Green Project? So, What Do You Actually Put in Your Contracts?
Despite the explosion of articles, seminars and webinars on green building and development during the last year or so, there is a dearth of information in the development world regarding what project owners and developers who do want to build a green project should actually put in their design and construction contracts.
Here is what I think is important regarding this subject:
General Green Building Certification Goal. The project owner first must decide in general what green building goal it wants to achieve. LEED certification (from the US Green Building Council), at a particular certification level (general, silver, gold, platinum), is an obvious option. But there are other general green building certifications, too, such as Green Globes (Green Building Initiative) and SBTool07 (International Initiative For a Sustainable Built Environment), as examples. The owner should make this basic decision early on, based on good information and analysis and the advice and recommendations of design and green building consultants, as applicable.
Industry-Specific Green Building Certification Goal. Deciding on an overall green building goal such as a LEED certification is not the only certification goal a project owner should consider, however. There also is a growing number of industry-specific certifications that the owner should evaluate, depending on the nature of the project and the owner’s business. For example, there are certifications available for health facilities (Practice Greenhealth), restaurants (Green Restaurant Association) and hotels (Hotel Pure Green). How important an industry-specific certification of this type is to an owner is a question to be addressed at the start of the design process.
Tax and Other Governmental Incentives Goal. Another element of green building goals to be considered is tax and other governmental incentives relating to green building. Particularly in Oregon and under new federal stimulus legislation, there may be tax credits, grants and other public sector incentives for green, sustainable and energy efficient construction that can be of substantial benefit to a project. However, these incentives must be identified as project goals early in a project’s design in order to ensure that the owner is able to take advantage of them.
Making Green Building Goals Explicit. Once an owner has sorted through its optional goals for LEED or other general certification, for industry-specific certification and for tax and other governmental incentives, these goals should be expressly set out in the owner’s design and construction contracts. Otherwise, the owner’s architect and contractor will not have any contractual obligations to achieve the owner’s green building goals. Typical form contracts, including 2007 American Institute of Architects (“AIA”) forms of contract, include minimal references to these kinds of obligations and do not include language in which to make the goals explicit.
Continue Reading...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.
Be Alert to New AIA Construction Contract Forms
Contractors and owners used to the pre-2007 AIA document forms should know that the AIA has revised its most popular forms and that the AIA software no longer supports the older versions. You may still see the older forms in Word or similar formats, but you won’t be seeing the official AIA document that automatically highlights changes from the official forms. That means you need to be more cautious about form contracts you receive that appear to be based on the older AIA forms. Changes from the official AIA versions won’t necessarily be highlighted. Construction lawyers have mixed feelings about the new AIA forms. They correct some provisions that didn’t work well in the past, but create some new concerns. As always, you need to consider the specific circumstances of your project before using any standard form contract.
The Risk of Builders Risk
Contractors and owners obtain builders risk policies to protect themselves from risks associated with construction. But a lack of care in understanding and negotiating the provision of the construction agreement governing the builders-risk policy and the policy itself may lead the parties to expose themselves to needless and significant liability.
What owners and general contractors should do to protect themselves
If a construction contract requires the owner or the general contractor to obtain a builders risk policy—and it should—then that party should in fact obtain the policy. This may seem painfully obvious, but sometimes parties do not obtain required policies.
Courts have held, unsurprisingly, that a construction contract calling for a builders-risk policy means what it says. If the party whom the contract required to obtain a builders-risk policy does not obtain a policy, that party assumes the risk of loss that ought to have been covered by the policy. So, if a construction agreement requires, say, the owner to obtain a builders-risk policy, the owner should obtain the policy, and the other parties relying upon the policy should confirm the existence of the policy and its terms.
The Builders-Risk Policy Should Allow for the Construction Contract’s Mutual Waiver of Subrogation
Construction contracts frequently include a clause in which the owner and the contractor, both covered by the builders-risk policy, waive their right of subrogation against each other regarding any damages covered by that policy. The owner should not be able to sue the contractor for a loss if the owner has already obtained builders-risk insurance that would make him whole (or vice versa)—the mutual waiver of subrogation prevents the owner or the contractor from recovering twice.
However, if the builders-risk policy itself contains a provision preventing the parties from waiving subrogation, the execution of the construction contract may violate the policy conditions and might prevent recovery under the builders-risk policy.
As the owner and contractor negotiate the construction contract and the builders-risk insuring agreement, they need to pay attention to the provisions in each agreement governing subrogation. Broadly, they need to pay attention to the effect that each agreement has on the other, and should ensure that the builders-risk policy does not prevent the parties from waiving their subrogation rights. Moreover, they need to pay attention to the interaction between a builders-risk policy and any property insurance policy the owner may have (see below). The waiver of subrogation should apply to claims brought under the property policy for a few years after termination of the builders-risk policy.
The Construction Contract Should Specify When and under What Conditions the Owner Can Terminate the Builders-Risk Policy
Builders-risk policies are, as their name suggests, designed to cover risk arising from building. Once the structure is built, though, the builders-risk policy usually terminates. Builders-risk policies also typically terminate on the occurrence of a number of other conditions.
For example, the builders-risk policy may end when the equipment in a plant is first energized, on the theory that once you fire up the plant, it is no longer under construction but is operating as a business and therefore presents different insurable risks.
Once builder-risk insurance terminates, usually the owner’s property insurance kicks in. Property insurance, however, does not usually protect the contractor because the contractor is not a named insured under that policy, and it will not protect against all the events that a builders-risk policy would. If an insurable event occurs that would have been covered by the builders-risk policy after the policy has been terminated, there may be no coverage, possibly causing the parties to argue about whether the policy was properly terminated. If the owner terminates the builders-risk policy without telling the general contractor—and yes, this does happen—the parties will then argue whether the termination actually occurred.
Simply, unexpected termination of a builders-risk policy can ruin your day. The term of a builders-risk policy, then, is a critical point to negotiate and to stick to. Owners should not terminate a builders-risk policy early, and contractors should ask for a provision in the policy requiring the owner to give them notice before termination of the policy so that the contractor can arrange for adequate coverage elsewhere.
New Oregon statute shortens period for asserting building defect claims on "large" commercial projects.
On July 14, 2009, Oregon Governor Ted Kulongoski signed HB 2434 passed in June by the Oregon Legislative Assembly. Although a chapter number has not yet been assigned to the new act, the law will go into effect for building defect claims that arise on or after January 1, 2010.
As addressed in prior Legal Updates from Stoel Rives’ Development Law Group, HB 2434 reduces from ten years to six years after substantial completion the maximum time period during which an owner of a "large commercial building" can assert claims against those who performed design, planning, surveying, architecture, engineering, construction, repair, or construction supervision or inspection of or for the building.
As defined in the statute, the term "large commercial building" includes but is not limited to:
- rental residential structures of more than four stories
- mixed-use projects
- commercial structures that cost more than $250,000 to construct
- motels, hotels, nursing homes, hospitals and recreational facilities
- commercial structures with a ground area over 10,000 square feet or a height over 20 feet
- commercial rental units in a larger structure, if the unit has a ground area of over 12,000 square feet or a height over 20 feet
The term "large commercial buildings" does not include publicly-owned buildings or condominium buildings.
One concern for affected building owners and developers is simply the shortening of the period from ten years to six years after substantial completion during which the owner or developer can pursue a defect claim of its own against the designer or contractor of the building.
A second concern, however, is that building owners and developers may end up with legal obligations to a purchaser or tenant regarding building defects for a longer period than the six years after substantial completion during which the owner or developer can assert the claim against the building’s designer or contractor. In this way, a building owner or developer could have a multi-year exposure to getting "caught in a squeeze" by having a defect claim asserted against it by a buyer or tenant yet having no right to assert that claim against the parties that designed and constructed the building.
Owners and developers of "large commercial buildings" in Oregon should consider modifying the claims, warranty, correction of defects, and statute of limitations provisions in their purchase and sale agreements, leases, and construction and design contracts to respond to the changes in Oregon law made by HB 2434.
If you have any questions about the issues of this posting, please contact James A. Zehren, a member of the Construction & Design Section of the Development Law Group in the Portland office of Stoel Rives LLP, at jazehren@stoel.com or 503-294-9616.
Oregon Statute Regarding Defective Design and Construction Claims Pending Governor Action
Oregon HB 2434, passed by the House of Representatives on May 4, 2009 and by the Senate on June 22, 2009, is currently awaiting the Governor’s approval or veto. The bill would reduce from 10 years to six years the maximum time period during which an owner of a "large commercial building" could assert claims against those who performed design, planning, surveying, architecture, engineering, construction, repair, or construction supervision or inspection of or for the building.
Read our full client alert on this topic.
If you are opposed to, or favor, this significant change in Oregon’s statutes, we encourage you to contact Governor Kulongoski. Because the Governor could take action on HB 2434 at any time, please convey your comments as soon as possible in order to increase the likelihood that they will be considered.
New WA Supreme Court Opinion has several Construction law implications
On June 18, 2009 the Washington Supreme Court issued its decision in Cambridge Townhomes, et al. v. Pacific Star Roofing, Inc., et al., 81003-6. The decision touches on several issues of interest to the construction industry in Washington. In particular, the Court clarified the law about when a corporation may be held liable as a successor in interest to a sole proprietorship (generally, where control in the company remains in the same hands, such that the old entity was effectively just wearing a “new hat”). The Court also enforced a broad indemnity provision in a subcontract, rejecting the subcontractor’s argument that its indemnity should be construed to apply only to third party tort claims. Finally, the court had occasion to revisit RCW 4.16.326(1)(g) which went into effect in July 2003 and requires that construction defect claims be filed within six years of substantial completion of construction or termination, whichever is later. The Court had held in 1000 Virginia Ltd. P’ship v. Vertecs Corp., 158 Wn.2d 205 (1994) that this provision did not apply retroactively. In Cambridge Townhomes, the Court clarified that application of the statute of repose turns on the date when the claim accrues, not when it is filed. You can read the entire decision here.
Bankruptcy as an Event of Default - Unenforceable Contract Provisions
Contract provisions stating that either the owner or the contractor’s bankruptcy will constitute an event of default are common. A corresponding provision typically sets out the nonbreaching party’s rights in the event of default, one being the right to terminate the contract. For all practical purposes, these provisions are meaningless and unenforceable.
Section 365 of the Bankruptcy Code deals with the debtor’s right to assume or reject executory contracts. (“Executory contracts” are essentially contracts for which performance is not yet complete. A construction contract is an executory contract.) That same section also gives the debtor the right to assign such contracts. Section 365(e)(1) states that any provision in an executory contract that permits one party to terminate the contract in the event of the other’s insolvency or in the event that the other files a bankruptcy petition is unenforceable. And section 365(b)(2)(A) similarly states that any provision in an executory contract that prohibits the debtor from assuming and assigning the contract is unenforceable.
A participant at one of our recent “Financial Defaults” seminars suggested one possible reason for using such a provision. If the contract is guarantied by a third party and the guaranty obligation is triggered only by a default under the principal contract, such a provision might work to trigger the guaranty. To us that seems unnecessary, since the guaranty could be drafted to state that it is triggered by the principal’s default.
Notwithstanding section 365’s nullification of bankruptcy default provisions, they continue to be used with presumably little effect.
Terminating a Contractor for Default - Caution Is the Rule
Risks of Termination
While most construction contracts permit the owner to terminate a contractor in the event of default, any owner will be well counseled to exercise such rights cautiously. The risks of termination are both practical and legal. Terminating the contractor will almost certainly result in delays. Finding a replacement contractor can be difficult, particularly if the project suffers from defective work. The cost of a replacement contractor can be significantly more than the amount left in the contract, and this in turn can lead to financing problems and perhaps even result in a default of the construction loan. The owner might not have the ability to assume the subcontracts, which could require any replacement contractor to also find subs to take over uncompleted work. Enforcing warranties later on could be difficult due to disputes over who was responsible for which portion of the work. And perhaps most concerning of all is that in most cases, the termination is likely to generate a lawsuit in which the contractor will be seeking all sorts of damages, including lost profits on this and possibly other projects.
Faced with these risks and problems, owners often elect to continue with a defaulting contractor, sometimes even in the face of enormous problems. Nevertheless, there are circumstances when termination needs to be considered and exercised. Careful planning, detailed analysis, and good documentation are critical.
Importance of a Well-Drafted Contract
Termination needs to be considered at the contracting stage, and well-drafted default and termination provisions are critical. The contract needs to set out clear, objective standards for what will constitute events of default and reasonable, but not overly burdensome, notice provisions. Many contracts will provide that the contractor is entitled to notice and an opportunity to cure. The time periods for curing need to be spelled out and should not be unreasonably short or long.
Termination for Convenience Provisions
Owners should try to include in their contracts provisions allowing them to terminate the contract for convenience. Such provisions are common in most public construction contracts. Owners should resist provisions that require the owner to pay the contractor some amount of unearned overhead and profit and instead commit only to payment for compensation earned up to the point of termination, plus reasonable winding-down (demobilization) expenses.
Right to Supplement Work Provisions
Owners might also consider trying to include in their contracts a provision authorizing them to supplement the contractor’s work force in the event of default. Such a provision essentially permits the owner to hire additional work crews to supplement the contractor’s work force. Any such provisions need to be drafted carefully, and such an arrangement presents its own set of risks and problems, but is a less risky option than termination and one that, in appropriate circumstances, might be of real benefit to the owner.
Strict Compliance with Contract Termination Provisions
When problems arise during the course of a project that might warrant termination, the owner needs to refer to the contract and follow all of the notice and pre-termination procedures precisely. At the same time, though, the owner’s initial response should be to consider options other than termination. One step might be a meeting with the contractor to discuss the defaults and to try to reach an agreement on a schedule and procedure for curing them. In the course of pursing termination alternatives, the owner needs to notify the contractor that efforts to resolve the defaults short of termination will not result in a waiver of the defaults or of any rights. If the owner agrees to give the contractor additional time for curing defaults or agrees to other concessions, the agreement needs to be spelled out clearly in a writing that clarifies precisely what the owner has agreed to and when the owner will be permitted to proceed with termination. Any such agreement will effectively result in an amendment of the contract and will therefore warrant the same attention to detail that went into drafting the original contract.
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