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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Oregon Supreme Court Declines to Reconsider Abraham Decision
In March of this year, the Oregon Supreme Court issued its opinion in Abraham v. T. Henry Construction, Inc. Unhappy with one aspect of the opinion, the Abrahams promptly filed a petition for reconsideration. Last week, the Oregon Supreme Court denied the Abrahams’ petition. While it was making its way through the appellate courts, Abraham provoked considerable interest from lawyers and construction industry groups alike because of its potential to change Oregon law.
Abraham involved construction defect claims by the Abrahams, homeowners, against their contractors. The central issue in Abraham was whether the Abrahams could recover in negligence for damage to their home even though there was a contract between the Abrahams and their contractors. This was a significant issue for the Abrahams: If their negligence claims were barred, they could not recover because the statute of limitations had expired on their breach of contract claims. The Supreme Court concluded that, in the absence of contract language limiting the Abrahams’ right to assert negligence claims, their allegations of property damage stated a claim for negligence. This meant that the Abrahams’ case against their contractors could move forward.
Still, the Oregon Supreme Court did not stop there. The Court went on to state that that negligence claims arising out of the construction of a house must be brought within two years from the date on which the plaintiff discovers or should have discovered the injury. While a two-year statute of limitations is generally assumed to be the applicable period for negligence claims, at least one recent case (Waxman v. Waxman & Associates) has, for some lawyers, cast doubt on that assumption. Indeed, those same lawyers have contended that rather than two years from discovery, the applicable limitations period for negligence claims is six years from the date of the injury. This apparent conflict has, in some cases, allowed lawyers to argue one of two potentially applicable statutes of limitations, depending on which party they represent and when it appears the injury occurred or was discovered.
By filing their petition for reconsideration, the Abrahams sought to have the Oregon Supreme Court modify its opinion and omit the reference to a two-year statute of limitations for negligence claims. The Abrahams argued that, among other things, they did not ask the Oregon Supreme Court to decide any statute of limitations issues. While it is true that the Court’s reference to a two-year statute of limitation was not essential to the holding in Abraham, it certainly indicates how the Oregon Supreme Court might rule. As a result, Abraham provides some measure of guidance on the issue of which statute of limitations should apply in construction defect cases. However, because Abraham did not decide any statute of limitations issues, it is likely that the two-year versus six-year dispute will continue until Oregon’s appellate courts address it directly.
Oregon Supreme Court Hears Abraham Appeal
Last month the Oregon Supreme Court heard oral argument in Abraham v. T. Henry Construction, Inc., a residential construction defect case. Shortly after the Oregon Court of Appeals published its opinion in September 2009, Ahead of Schedule authors Eric Grasberger (“Negligence Claims Take Another Twist in Oregon” and Kip Childs (“Oregon Court of Appeals Provides Clarification to Contractor Negligence Claims” commented on the decision. The case pits the homeowners, the Abrahams, against their general contractor, Keith Lucas, and framing contractor, Kevin Mayo.
Unhappy with the result in the Court of Appeals, Lucas and Mayo petitioned the Oregon Supreme Court seeking review on several questions that are described in the Court’s media release. Because the case involved several issues frequently litigated in construction defect cases (economic loss rule, statutes of limitation, building codes as the basis for a negligence claim, etc.), the Oregon Trial Lawyers Association (“OTLA”) and Oregon Home Builders Association (“OHBA”) weighed in and filed amicus curiae (literally, “friend of the court”) briefs. These briefs followed predictable lines of argument. Among other things, OTLA urged the Court to decide in favor of the plaintiffs and hold that, among other things, a discovery rule applies to breach of contract actions. For its part, OHBA suggested that the Court find that, absent a special relationship, one party to a contract (such the plaintiff project owner) should not be permitted to assert a negligence claim against the other party (such as the project’s general contractor).
Whether the Court will take up these important issues remains to be seen. However, until they are addressed by Oregon’s highest court (or legislature), these controversial issues will continue to be the source of much legal wrangling and uncertainty for both plaintiffs and defendants alike.
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.
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.
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.
Statute of limitations: State entity trumps in Safeco Field case
On March 5 2009 the Supreme Court of Washington issued a 6-3 decision in WA State Major League Baseball Stadium Public Facilities District v. Huber, Hunt & Nichols-Kiewit Construction, No. 81029-0, in which the court held that the 6-year the statute of limitations for breach of contract did not apply to a construction defect claim concerning the construction of Safeco Field due to the exemption in RCW 4.16.1 for actions brought “for the benefit of the State”.
The case arose after the Mariners discovered that the fire protection coating system to the stadium’s structural steel beams and columns failed, allegedly because the contractor applied a primer layer that was incompatible with the coating layer. The Public Facilities District and the Mariners (who are responsible for the maintenance of the stadium) filed suit more than seven years after the date of substantial completion of the stadium. The court of appeals granted summary judgment in favor of the contractor because the matter was not timely filed. In holding that the statute of limitations did not apply in this case, the Court stated that the State’s sovereign powers had been delegated to the Public Facilities District, the public municipality created to build the baseball stadium. The Court reasoned that the construction of Safeco Field was a manifestation of the State’s sovereign function of providing for public recreation, in much the same manner as the improvement of a city park or public library. The dissent disagreed that the action was for the benefit of the public, noting that the public had to pay a private for-profit entity for a ticket to gain admission to the stadium.
As a consequence of this decision, contractors should not assume that the statute of limitations will apply on projects involving a state-delegated entity, even where the improvement being constructed appears to be substantially or exclusively for private use. In such circumstances a reasonable limitation period for claims should be agreed and set out in the construction contract.
