Surviving Your First American Construction Project

Essence Is Voluntary
Party Cannot Be Compelled to Participate in, Pay for Mediation, California Court Holds

Immigration Issue
Federal Contractors Must Use E-Verify to Check Employee Work Status, President Orders

New or Significantly Improved
$38 Billion in U.S. Loan Guarantees for Alternative Energy Technologies – Overview of Selection Process and Financing Terms

New FAR Rule
Federal Contractors Can Lose Out on Projects, Be Debarred for Tax Delinquencies

Adverse Court Decisions
AIA Issues Stopgap Amendment to Its A312 Payment Bond After Complaints by Sureties

3 Washington Cases
LLCs, Though Legally Canceled, Still Face Construction Defect Suits – but Cannot Sue Subs

Owner Required
Contractor that Failed to Take Field Measurements Liable to Sub, Idaho Supreme Court Holds

Contractor, Architect Forms
Revised AIA Contracts: An Overview of the Changed Terms and New Approaches

Previous Issues

Construction Industry News


	Surviving Your First American Construction Project – An Interactive Overview October 22, 2001


	Back to Doing Business in the United States

		U.S. Construction, Architecture and Engineering Industry: An Overview for International Investors
		Complying with U.S. Contractor Licensing and Design Professional Registration Laws: An Overview, with Case Histories and Checklist
		Doing Business in the United States – A Primer for International Companies
		Licensing Laws for Architects, Engineers and Contractors (below)
		Design-Build (below)
		Mechanic's Liens and Stop Notices (below)
		Construction Contract Bonding (below)
		Indemnity (below)
		Total Cost Claims (below)
		Economic Loss Rule (below)
		No Damage for Delay (below)
		Bibliography (below)

The following paper, in outline form and with links to related reading, accompanied a panel discussion at the Global Construction Superconference on November 5 and 6, 2001, in London. The panelists were Stephen V. O'Neal, Andrew D. Ness and Jesse B. Grove III of Thelen Reid Brown Raysman & Steiner; Michael Feigin, executive vice president, Bovis Lend Lease Americas, New York; and Alison Gough, head of legal, Lend Lease Europe, London.

By James E. Acret

Licensing Laws for Architects, Engineers and Contractors

Every state has its own set of licensing requirements for contractors, architects, engineers, and surveyors.

1.	Most states classify contractors according to trade: general, electrical, roofing, plumbing, etc.

2.	It is a violation for a trade contractor to operate outside its licensed specialty.

3.	In most states, the definition of "contractor" includes construction management, so construction managers must be licensed. An architect's, engineer's, or contractor's license authorizes the licensee to act as a construction manager.

The doctrine of illegality.

Under the doctrine of illegality, courts will not enforce an illegal contract.

In many states, the courts accord this treatment to unlicensed contractors: The unlicensed party is turned away at the courthouse door when it seeks to enforce its contract, which is treated as illegal for lack of a license.

The first step taken by a construction lawyer in defending against a claim is to check license status of the plaintiff.

State licensing requirements do not apply to projects of the U.S. government and its agencies.

Qualifying for a license.

As a general rule, a corporation, partnership or joint venture qualifies for a license through the offices of the owner or a managing employee.

A qualifying person must show experience and pass a test, and the firm must submit evidence of reasonable financial responsibility.

Most states also require a contractor's license bond to protect any consumer who suffers damages because of a violation of the license law.

Design-build implications.

1.	A design-build contractor may need to be licensed as a contractor, an architect and an engineer. Work can be subbed out to licensed subcontractors and to surveyors.
2.	In some states, the architectural and engineering work also can be subbed out.

3.	In some states, a licensed architect or engineer can contract for a work of improvement and sub out all the construction work.

4.	Joint ventures must be separately licensed. It often is feasible for a contractor to joint venture a design-build project with an architect or an engineer in order to attain proper licensing.

MORE READING ON THIS TOPIC:

	California Contractor Licensing Laws Again Applied Strictly

	Unlicensed Contractor Can Sue for Civil Rights Violation but Not on Contract

	Our Industry Newsletters: Licensing and Governing Regulation

II.	Design-Build

	A.	Definition. Design-build is a construction protocol in which the constructor undertakes, by contract with the project owner, both to design and build a work of improvement.

	B.	Advantages. The joint employment of the resources of the contractor and the designer promotes buildability. If there are problems on the job, the designer and the contractor work together to overcome them rather than trying to pin blame on each other. Even if a blame game develops, the owner does not have to take sides. The team will involve major subcontractors at the design stage. Project may more easily go fast track.

	C.	Disadvantages. The owner may not have the resources to properly evaluate a design-build proposal. If competitive bidding is required, it is difficult to judge which is the lowest responsible bidder. If competitive bidding is abandoned, the contract price may escalate. Compliance with state licensing laws may be difficult or even impossible.

	D.	Design-build documents. It is amusing to compare the standard design-build contract documents published by design professions with those published by contracting professions. In those published by the design professions, the architect or the engineer becomes a true master builder. In those published by the contracting professions, the designer becomes something closer to a clerk of the works.

	E.	Popularity. Many owners conclude that design-build is the way to go despite its manifest drawbacks. Owner's primary motivation is the hope of avoiding construction disputes. As more public agencies are authorized by statute to pursue design-build projects, more and more private owners are convinced of its virtues.

MORE READING ON THIS TOPIC:

	Oregon Court of Appeal Rejects Attack on Award of Light Rail Project Without Competitive Bidding

	Transit Systems in Certain Counties Are Authorized to Enter into Design-Build Contracts

	Limited Partner of Failed Power Plant Project Cannot Sue Designers or Contractors

III.

Mechanic's Liens and Stop Notices

Mechanic's Liens

Mechanic's lien law is purely statutory, and every state has a mechanic's lien statute. The fundamental purpose is an equitable one: If a contractor improves an owner's property, to prevent the unjust enrichment of the owner, the contractor should have a lien on the property until paid.

Since subcontractors and material suppliers also have lien rights, a problem arises. An owner who has already paid the contractor can catch a lien from a subcontractor or supplier. This is the "double payment" problem.

The ultimate end result of the foreclosure of a mechanic's lien is for the sheriff to sell the owner's property at public auction and use the proceeds of the sale to pay off the lien.

The best protection for the owner is a qualified, experienced and financially sound contractor. It is the prime contractor who protects the job against liens.

a.	Payment bond also protects owner.

b.	Owner also may protect the job by carefully processing progress payments so that no payment is made to the prime contractor until potential lien claimants have been identified and paid. To process progress payments in such a way requires highly trained personnel.

Most lien statutes include notice provisions, relatively short deadlines, statutes of limitations and documents that can be recorded by owners to cut down the period for recording liens. Owner may tender the defense of a mechanic's lien foreclosure suit to the prime contractor for defense, but care is required. The owner may find the contractor's interests are more aligned with those of the claimant than with those of the owner.

Stop notices. A stop notice is ancillary to the mechanic's lien remedy. It enables claimants, usually subcontractors and suppliers, to attach construction funds in the hands of project owner or construction lender. The owner or lender must withhold the funds from the prime contractor pending resolution of the claim in court.

1.	In most states mechanic's liens are not allowed on public property, and, therefore, the stop notice substitutes for the mechanic's lien remedy on public jobs.

2.	On private jobs, the stop notice and the mechanic's lien remedies may be asserted at the same time. Stop notice usually is considered to be more effective and in most situations, it is. Well-advised claimants pursue both remedies at the same time.

Payment bonds. The payment bond remedy also protects claimants who have mechanic's lien and stop notice rights. Payment bonds usually are in place on all public jobs and large private projects. They usually are not provided on smaller projects. Payment bond surety undertakes that all parties who have mechanic's lien and stop notice rights will be paid in full.

Self help. Owners, contractors and potential claimants need to understand lien, stop notice and payment bond laws in states where they operate. The mechanic's lien statutes for all states are available in a single book. See Bibliography.

MORE READING ON THIS TOPIC:

	N.Y. Mechanic's Law Bars Recovery for Work for Private Developer When Public Benefit Corporation Owns Underlying Land

	Trucking Company That Delivered Fill to Job Site Is Entitled to Enforce Stop Notice

	Nebraska Contractor Denied Relief for Breach of Contract after Pursuing Mechanic's Lien Remedy in Another Suit

IV.

Construction Contract Bonding

Performance bond. The surety undertakes that the principal (usually a contractor or a subcontractor) will perform the contract. (Performance bonds are usually held to cover contractual warranties and may apply to construction defects discovered many years after completion of the project.)

Claims against the bond. There is no specific format for making claims against a performance bond. The best policy is to promptly inform the surety in writing, with adequate backup.

Position of surety. The surety will refer a claim to the principal (the contractor). If the contractor disputes the claim, the surety is caught in the middle.

a.	For obvious reasons, the surety is likely to favor the contractor's version. This is because if it pays a claim over the contractor's objection, it will have to sue the contractor for reimbursement.

b.	When the surety denies a claim, the owner will find itself fighting both the contractor and the surety.

Indemnity agreements. Surety will have required the principal or its officers and directors to sign agreements to indemnify the surety against loss and expense. The surety, therefore, will look to the principal or its officers and directors to reimburse any loss. The surety, thus, is motivated to cultivate a good relationship with them. So, the surety's natural desire to curry favor with the indemnitors creates conflicts of interest with the owner.

Bonding requirements. Performance and payment bonds are required on all public jobs and on most major private projects. For smaller projects, they are seldom required. Smaller contractors do not have the bonding capacity, and many owners resist incurring the expense of paying the bond premium.

Taking over the job. If contractor defaults, there are three basic alternatives for the surety.

1.	Surety finances the contractor to finish the job.

2.	Surety employs a new contractor to finish the job.

3.	Owner employs a new contractor to finish the job and claims reimbursement from the surety.

Strategic considerations from the standpoint of the surety:

1.	If the owner finishes the job using a replacement contractor, maximum liability is the penalty amount of the bond; if we take over the job or finance the contractor, we "blow the bond penalty."

2.	If we finance the job or if we take over the job and use the same contractor to finish it, we save the expense of orienting a new contractor to the job.

3.	If we let the owner finish the job, we lose control of costs.

Strategic considerations from the owner's point of view:

1.	We don't want the same contractor: he is a proven incompetent.

2.	If we finish the job ourselves, we'll probably have to sue the surety for a settlement.

3.	If the surety employs a fresh contractor, it may turn out to be a stooge for the defaulted contractor. Any fresh contractor will take time to mobilize and may try to cheapen the job.

Bad faith. In some states, sureties may be liable for punitive damages for bad faith in processing claims.

Provisions of the bond. As a general rule, owner should carefully scrutinize bond provisions because most of them will be loopholes for the bonding company. Owner should not accept such provisions.

Reports to surety. Performance bond sureties usually have a form letter by which they request monthly reports from owner. Owner should have a policy not to respond. If owner criticizes contractor, contractor may claim defamation; if owner fails to criticize contractor, surety may claim waiver. Owner should be diligent in reporting actual problems to the surety but not necessarily as a response to a form letter inquiry.

Surrendering the bond. A year or two after completion of job, the contractor may request that the owner surrender (or release) the bond, pleading that the contractor's bonding capacity is reduced as long as the bond remains open. Owner should never release the bond.

Payment bonds. The purpose of a payment bond is to protect an owner against mechanic's lien and stop notice claims.

1.	The surety agrees to see to it that subcontractors, material suppliers and others who could assert mechanic's lien or stop notice claims on the project will be paid.

2.	Here, the obligee is not only the owner. Potential mechanic's lien and stop notice claimants also are obligees. They make their claims directly against the bonding company.

MORE READING ON THIS TOPIC:

	Construction Case Study: The Bond Indemnitor

	Surety Is Responsible for Penalties for Contractor's Overtime and Prevailing Wage Violations

	Owner's Settlement with Contractor Precludes Recovery from Surety

	Surety Exonerated When General Contractor Enters into Settlement Agreement Without Surety's Consent

Indemnity

Assume a contractor is required to indemnify the owner against losses arising out of a construction project. Such indemnity clauses are classified as follows:

Claims and losses. Indemnity against losses becomes effective when a loss is sustained. Indemnity against claims takes effect when a claim is made, and the indemnitor must defend the indemnitee against the claim.

Liability vs. loss. An indemnity against liability takes effect when liability is established by a final judgment; indemnity against loss takes effect when the loss has actually been paid.

Fault or no fault. The obligation to indemnify may be triggered only when the indemnitor or its subcontractor is at fault or when the indemnitor is faultless. Some clauses provide indemnity even if the indemnitee wholly at fault. (A liability insurance policy is an example of an indemnity contract that provides coverage when the indemnitee is wholly at fault.)

a.	A clause will be interpreted to provide indemnity against the indemnitee's own negligence only if the language is unmistakably clear.

b.	In some states, statutes prohibit indemnity in a construction contract against the indemnitee's own sole negligence.

Mechanic's liens. Prime contractors usually are required by contract to indemnify the owner against mechanic's lien claims.

Tender. Indemnitee should promptly demand a defense. Costs of defense before the demand are waived. The demand should be carefully considered.

1.	Indemnitor may not provide an adequate defense.

2.	Indemnitor may not be able to pay an adverse judgment.

3.	Indemnitor may in fact have a conflict of interest, e.g., prime and subcontractors who are lien claimants may be cooperating against the owner.

4.	Indemnitee should reserve the right to select, or approve the selection of, defense counsel.

Liability assumed by contract is a form of liability insurance coverage in which the obligation to indemnify is passed on to an insurance carrier. This could be described as an insured indemnity clause.

Indemnity against loss does not protect an owner against construction defects. The word "indemnity" implies not merely a loss but also a third party claimant.

Equitable indemnity, sometimes called implied indemnity, arises in the absence of a contract of indemnity. The doctrine implements an equitable principle allocating blame among defendants and cross-defendants. Example: Claim is made against a prime contractor for a leaky roof installed by a subcontractor. Contractor may cross-complain against roofer to seek equitable indemnity even absent an indemnity clause in the subcontract document.

Limitations. A cause of action accrues on an indemnity against loss and the statute of limitations begins to run when indemnitee has paid the loss. This makes for an extremely long limitations period.

MORE READING ON THIS TOPIC:

	Subcontractor Must Indemnify General Even When Sub Was Not Negligent

	Contractor Fault Not Always a Prerequisite to Triggering Indemnity and Additional Insured Provisions

	Are Your Construction Contract Indemnity Clauses Faulty?

	The Interaction Between Indemnity Provisions and Liability Insurance Is an Important Aspect of Risk Management in the Construction Industry

VI.

Total Cost Claims

Application of the total cost rule is a boon to claimants and a despised perversion of the law to defenders. It is a special instance of the principle that a plaintiff should not be deprived of a remedy just because the damages it suffered are difficult to prove with specificity.

The seven steps to prove total cost damages:

1.	Introduce the estimate and prove it was reasonable. If there are any busts in the estimate, establish the amounts of the busts.

2.	Show how the actions of the owner or the general contractor are (a) unlawful and (b) caused damage. Unlawfulness may be breach of contract, breach of warranty, failure to follow trade practice, misrepresentation or negligence. (If misrepresentation or negligence, the claim may be defeated by the economic loss rule, discussed below.)

3.	Show that the damages cannot be proved precisely because records do not exist. Example: There is a bust in plans, crews repeatedly had to demobilize, move, remobilize, reorient and resume work at a different location. It was not feasible to assign a timekeeper to document these events.

4.	Have your expert estimate the loss of productivity caused by the improper acts of the defendant, e.g., "We only got 80 percent of the productivity we figured in the estimate."

5.	Compute the losses caused by the claimant's own mistakes.

6.	Determine the total cost of the project.

7.	The damages are the total cost of the project minus busts in the estimate minus the mistakes and minus payments.

Some courts use the label "modified total cost" because the total cost is modified by the bid busts and the mistakes.

Note the estimate of lost productivity will, quite naturally, approximate the claim figured by the modified total cost method.

.
MORE READING ON THIS TOPIC:

	South Dakota Approves Use of Total Cost Method of Pricing Damages

	Use of Mechanical Contractors' Factors to Prove Productivity Claim Approved

VII.	Economic Loss Rule

	The economic loss rule is the most frequently overlooked defense and the most devastating to the claimant.

	A.	Under the rule, economic losses unaccompanied by physical injury cannot be recovered in any cause of action that sounds in tort.

	B.	Privity. The economic loss defense is similar to what is labeled the "privity" defense. This was and is a defense often asserted, for example, by architects and engineers to deflect claims of liability by parties with whom they have no privity of contract, e.g., patrons, workers, subcontractors, remote owners.

	C.	Justification for the rule. The economic loss rule rests on a plausible theory: Persons should be required by tort law to avoid causing bodily injury or physical property damage to strangers, but they should not be responsible for economic expectations of making a profit or avoiding an expense.

	D.	Economic loss examples: Value of building is diminished because shear walls are absent; roofs wear out prematurely; cost of heating and cooling a building is increased because of negligent design of air handling units; power plant cannot produce power at a profit because of negligent design and improper economic analysis; subcontractor loses money on job because of busts in plans. In all the foregoing cases, plaintiff might recover in contract or for breach of warranty, but if the economic loss rule applies, plaintiff could not recover in tort.
	E.	Whether bodily injury or physical property damage has occurred may become a sophisticated question. Emotional distress may be accompanied by physical manifestations. Deflection is a physical manifestation, but nothing is broken. In its most extreme form, recently adopted by the Nevada Supreme Court, the economic loss rule was a successful defense to a claim against a subcontractor because the physical damage (caused by defective framing) was to the product itself (townhomes) and not to other property.

	F.	Information-for-the-use-of-others exception. Many states hold architects and engineers responsible for economic loss sustained by contractors on the ground that they prepared information to be used by contractors even though their identities may have been unknown.

	G.	Services exception. In some states, the economic loss rule protects builders, manufacturers and material suppliers but not service providers, such as architects and engineers.

	H.	Defenders blew it. In legions of cases, the courts have awarded economic loss damages in tort without ever considering the economic loss rule: it was not raised by the defense.

	I.	Motions in limine. The economic loss defense may be asserted by a motion in limine to exclude all evidence of damages not caused by physical injury.

MORE READING ON THIS TOPIC:

	Most of Utah Subcontractor's Claims to Recover Delay Damages from Design Professionals Are Rejected as a Matter of Law

	Construction Manager Has No Duty to Protect Architect Against Economic Loss

	Colorado Supreme Court Holds Economic Loss Rule Bars Recovery in Negligence When Damages Arise from Breach of a Contract Duty

	Subsequent Owner Cannot Sue for Leaks that Were Manifest During the Tenure of Prior Owners

	California Supreme Court Bars Recovery for Economic Losses in the Absence of Physical Damage from Construction Defects

	New York Appeals Court Departs from Economic Loss Rule in Business Disruption Case

	Collapsed Scaffold and Hoist in Times Square Fail to Provide Basis for Economic Loss Claims

	Economic Loss Rule Applies to Nevada Construction Defect Cases

VIII.

No Damage for Delay

Although American law enshrines freedom of contract, courts do not like "no damages for delay" clauses because they can put the contractor at the mercy of the owner. Several theories have been advanced by ingenious lawyers to avoid enforcement.

1.	The clause only applies to such delays as were within the contemplation of the parties at the time when the contract was signed.

2.	The provision does not apply to delay caused by active interference by the owner with the progress of the contractor's work.

3.	The clause does not excuse delay caused by breaches of contract. Some courts have held that an exculpatory clause can never excuse a breach of contract.

4.	The clause is invalidated by code provisions found in many states to the effect that a party to a contract may recover damages for delay in the performance the obligation where the delay is caused by the promisee even though there may have been a contrary stipulation in the contract.

5.	In some states, contractors have lobbied the legislature to enact statutes that invalidate the clause in public contracts.

How to avoid the application of the clause. Suppose your client's work has been delayed by a bust in plans, delays in providing necessary information, lack of access to the jobsite and inefficient processing of multiple change orders.

Characterize the defendant's acts as "interference" not "delay."

Characterize the claim as damages caused by a loss of efficiency and productivity.

a.	Witnesses should be cautioned to avoid using the word "delay" in their testimony.

b.	Introduce testimony as to the productivity assumed in the estimate and show from job cost records that the productivity was not achieved.

c.	Show that inefficiency and lack of productivity was caused by the defendant's breaches of contract, negligence and failure to follow established trade practices.

Sophisticated drafters expand the clause to encompass damages for delay, interference, disruption, inefficiency and lack of productivity caused by actions or inactions of the owner, its agents and contractors.

MORE READING ON THIS TOPIC:

	No-Damage-For-Delay Clause Bars Claims for Delay Due to Gaps Between Phases, Changes in Testing and Defective Plan

	No Damage For Delay Clause Held Inapplicable

IX.

Bibliography

On This Site

	Doing Business in the United States – A Primer for International Companies

	OWNER'S PERSPECTIVE: A Guide to Avoiding and Responding to Construction Claims

From Publishers

	James Acret, Construction Industry Formbook (West Group 2d ed.)

	James Acret, National Mechanic's Lien Handbook (BNI 2000).

	James Acret, Construction Litigation Handbook (West Group 2d ed.).