Under Construction - June 2012

Letter from the Editor

Welcome to our summer 2012 issue. Hope you are keeping cool!

The first article discusses Colorado’s statute of repose for construction defect claims, and a recent Colorado opinion addressing these issues. The next article discusses an important Arizona construction case regarding attorneys’ fees that will have a significant effect on settlement tactics and settlement offers in future Arizona contract cases. The third article addresses preserving owner claims against subcontractors and design consultants under Utah law when the owner does not have a direct contract with these parties. Finally, this issue concludes with a timely article about the new California mechanics' lien statutes that become effective July 1, 2012.

If you have any questions or comments about any of these articles, you can feel free to e-mail them to me.

Sincerely,

Jim Sienicki

Colorado Court of Appeals Clarifies the Application of the Statute of Repose in Contractor v. Subcontractor Claims Arising from Multi-Phase Projects

by Scott C. Sandberg

On February 2, 2012, the Colorado Court of Appeals addressed issues of first impression arising under Colorado’s statute of repose for construction defect claims, which imposes an absolute deadline of six years from substantial completion of an improvement to assert defect claims against construction professionals.

In Shaw Construction v. United Builder Services, an HOA sued the general contractor of a multi-phase condominium project. The general contractor then sued its subcontractors, but those claims were dismissed under the statute of repose. The contractor appealed, arguing that (1) in multi-phase projects “improvement” means the entire project; (2) the “substantial completion” triggering the statute did not occur until the project architect certified completion (after a certificate of occupancy was issued); and (3) the statute of repose was tolled by the HOA’s service of a Construction Defect Action Reform Act (CDARA) notice. The subcontractors argued that (1) the “improvement” was limited to their specific work; (2) “substantial completion” occurred when each subcontractor completed its work; and (3) a CDARA notice of claim served on other parties does not toll the statute of repose for the subcontractors.

The Court of Appeals sided with the subcontractors.

First, the court ruled that an improvement “may be a discrete component of an entire project,” meaning completing one phase of a multi-phase project may constitute completion of the “improvement” and the six-year clock may start ticking before project completion. Whether a project component constitutes an improvement depends on whether the component is permanent and essential to the project’s function. But the court did not decide whether an improvement triggering the statute of repose can be determined on a trade-by-trade basis.

Second, the court ruled that, because the project components that encompassed the subcontractors’ work were completed more than six years before the contractor filed its lawsuit, the statute of repose barred the contractor’s claims. But the court did not decide whether substantial completion occurs when a certificate of occupancy is issued or when the architect certifies completion.

Finally, the court ruled that CDARA’s notice of claim process does not toll the statute of repose unless the subcontractor is served with a notice of claim. So, the contractor could not rely on the HOA’s notice of claim to toll the statute of repose for the contractor’s claims against the subcontractors.

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Arizona Court of Appeals Clarifies Who Is The “Successful Party” in Litigation for Purposes of Awarding Attorneys’ Fees and Holds that a Subsequent Homeowner Cannot Rescind Its Purchase With Respect to the Original Builder

By James J. Sienicki and Eric H. Spencer

A recent Arizona case will significantly impact settlement tactics, settlement offers and which party will be awarded its attorneys’ fees in contract-based disputes. This was a case where the attorneys’ fees drove the case and far exceeded the value of the underlying dispute. Its effect should ripple through many attorneys’ fees disputes in construction cases, since “successful party” is a term used in A.R.S. § 12-341.01, which governs disputes arising out of contract. The facts in the case are summarized below. In 1999, Jane Hall purchased a previously owned house. Soon thereafter, Hall experienced various structural problems with the house. In 2004, Hall filed suit against the original contractor, alleging breach of the implied warranty of habitability and requesting “rescission of the purchase,” or damages for the cost of repair in the alternative.

The trial court ruled that Hall was not entitled to rescission because, as a subsequent purchaser, Hall did not have a direct contract with the original contractor. Later, the jury found in favor of Hall on her breach of implied warranty claim and awarded $30,000 in damages. Both parties then requested their attorneys’ fees pursuant to A.R.S. § 12.341.01(A). Hall cited the court’s discretionary ability, in absence of a contractual provision addressing attorneys’ fees, to award the “successful party” its reasonable attorneys’ fees in any action arising out of contract. The original contractor, citing past settlement offers, based its request for fees on the statutory provision stating “if a written settlement offer is rejected and judgment finally obtained is…more favorable to the offeror…, the offeror is deemed to be the successful party from the date of the offer and the court may award [that party] reasonable attorney fees.” Hall countered that the original contractor’s prior $40,000 and $126,000 settlement offers did not exceed the “judgment finally obtained,” because the judgment finally obtained consisted of the $30,000 verdict plus Hall’s attorneys’ fees and costs. The trial court agreed: since Hall would be awarded $225,000 in fees and $10,757.79 in costs as the “successful party,” the aggregate amount, including the $30,000 in damages awarded by the jury, exceeded the contractor’s prior settlement offers.

The Arizona Court of Appeals upheld the trial court’s decision to include attorneys’ fees and costs in the “judgment finally obtained,” but on different grounds. As a preliminary matter, the court agreed there can be two competing “successful parties” in a contract-related case—(1) the overall successful party in the litigation, based on the jury’s verdict, and (2) the party whose offer was rejected and never beaten by the “judgment finally obtained,” but that party is deemed “successful” only from the date of the offer forward. (If this analysis results in there being competing “successful” parties, the trial court should offset these amounts when awarding fees and costs—for example, if plaintiff is the overall successful party and incurred $100,000 in total fees and costs, but the defendant is deemed “successful” from the date of its settlement offer and incurred $70,000 in fees and costs after that date, the court has discretion to award the plaintiff net $30,000 in fees and costs).

The court clarified that the amount of fees and costs the trial court should consider in determining what the “judgment finally obtained” are those fees and costs incurred up to the date of the offer, not through the date of the judgment. In this case, the original contractor made a $40,000 settlement offer in January 2007 but, at the time of that offer, Hall had incurred $69,396.50 in fees. Later, about one month before trial, the original contractor made another settlement offer for $126,000—however, Hall had incurred $206,692.81 in fees as of that date. In both cases, the “judgment finally obtained”—Hall’s pre-offer attorneys’ fees and costs along with the $30,000 damages award—exceeded the original contractor’s various settlement offers and therefore precluded the original contractor from being a “successful party” from the date of the offers. Therefore, since Hall was the only “successful party,” the trial court’s $225,000 fee award and $10,757.79 cost award in Hall’s favor was upheld.

The Arizona Court of Appeals also agreed that Hall could not seek rescission of her home purchase. Although the Supreme Court long ago eliminated any privity requirement for subsequent homeowners to maintain a breach of implied warranty of habitability claim against the original builder, privity of contract is nonetheless required for any homeowner seeking rescission of the contract. The remedy of rescission “undoes” a contract from the beginning—the parties are not merely released from further performance, but rather the contract is annulled and the parties are to be restored to their relative positions as if no contract had ever been made. The court could not effectively restore these parties to the status quo because they never contracted with each other; doing so would require the original contractor to return funds to Hall even though Hall never paid the original contractor for the home. Thus, a subsequent purchaser like Hall is limited to the remedy of recovering damages for any breach of the implied warranty of habitability.

Hall v. Read is significant because it should (and has) caused construction attorneys to modify their practice of crafting settlement offers in contract-based cases. In particular, the decision effectively requires one to ask the other side how much it has spent in fees and costs to date and to evaluate whether that amount is reasonable before making any intelligent settlement offer—at least if one hopes to use that rejected offer to mitigate against the risk of an adverse attorneys’ fee award later on. Attorneys should now expect to be routinely asked to provide this information to the other side as well (although there is no legal obligation to provide it). Hall v. Read is still subject to appeal to the Arizona Supreme Court so further changes could be coming, but in the meantime, expect this case to have a significant impact on settlement tactics, settlement offers and the award of attorneys’ fees under A.R.S. § 12-341.01 going forward.

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Leapfrogging Privity - Preserving Owner-Direct Claims Against Subs

by Stewart O. Peay and Mark O. Morris

Utah law requires that owners’ claims against general contractors and design professionals with whom the owner has direct contracts (collectively referred to hereafter as “generals”) and their respective subcontractors and subconsultants (collectively referred to hereafter as “subs”) for construction and design defects be based upon contract rather than tort. This does not present a problem when owners bring claims against generals with whom they are in privity, but does present problems when owners want to sue subs directly, a situation that often arises particularly in design-related cases. Thus, owners must be vigilant when contracting with their generals to ensure that generals include language in their subcontracts and consulting agreements (collectively referred to hereafter as “subcontracts”) that provide owners with third-party beneficiary rights to pursue claims against the subs. This has become even more necessary in today’s construction industry when even venerable and trusted generals are struggling to survive.

Utah courts long ago concluded that when dealing with construction claims, Utah courts would not accept negligence and negligent misrepresentation claims that many other jurisdictions embrace.[1] This was a conscious decision. The Utah courts’ reasoning was based on the economic loss rule and the “importance of the parties' right to negotiate the terms of a contract, limited only by statutory prohibitions or public policy.”[2] The Utah legislature subsequently codified the economic loss rule and required plaintiffs in a construction or construction design defect case to be “in privity of contract with the original contractor, architect, engineer, or the real estate developer.”[3]

To overcome this rule in Utah, an owner is best served by ensuring that the subcontracts identify the owner as a third-party beneficiary. “Third-party beneficiaries are persons who are recognized as having enforceable rights created in them by a contract to which they are not parties and for which they give no consideration.”[4] To be a third-party beneficiary under Utah law, a plaintiff must show that the contract was “undertaken for the plaintiff's direct benefit and the contract itself must affirmatively make this intention clear.”[5] To determine this intent, the court must “look to the language of the contract to determine its meaning and the intent of the contracting parties [and] consider each contract provision . . . in relation to all of the others, with a view toward giving effect to all and ignoring none."[6] Thus, to preserve rights against subs, an owner is best served making sure that the direct benefits intended for the owner are reflected in the subcontracts. In addition to language in a subcontract that specifically states that the subcontract is intended to provide a direct benefit to the owner, two other potential options may exist for establishing a third-party beneficiary claim under Utah law: 1) incorporation of the prime contract into the applicable subcontract; and 2) a flow down provision in the subcontract.

The owner may require his generals to include language in the various subcontracts that incorporates some or all of the terms of the prime contract into the subcontracts.[7] By incorporating the terms of the prime contract into the subcontract, the owner ensures that the subcontractor “would be subject to and abide by the governing plans and specifications of the [prime contract]. In turn, that ensured [the general] would deliver to [the owner] ‘precisely the Project it…agreed to.’”[8] Although it does not appear that any Utah court has decided whether incorporating the terms of the prime contract into the subcontract makes the owner a third-party beneficiary, it stands to reason that if the terms of the prime contract call out distinct benefits to the owner and those benefits are incorporated into the subcontract, then the owner would or ought to be a third-party beneficiary of the subcontract.

The second potential option is for the owner to require the general to include “flow down” provisions in the various subcontracts. A “flow down” provision typically states that it is the intent of the parties to have the terms of the prime contract that are applicable to the sub’s work on the project flow down to the subcontractor. “Such clauses mean that ‘the same rights and duties should flow equally from the owner down through the general contractor to the subcontractor, as well as flowing from the subcontractor up through the general contractor to the owner.’”[9] “In effect, ‘[t]he parties to the subcontract thus assume the correlative position of the parties to the prime contract.’”[10] To date, it does not appear that any Utah case has articulated the circumstances under which flow down clauses create third-party beneficiary rights in owners. Considering the Utah courts’ requirement that parties to construction contracts negotiate the specific terms of their contracts, it would seem only logical that the courts adopt a rule that if the provisions of the prime contract “flow down” to the subcontract, then they provide a distinct benefit to the owner giving rise to third-party beneficiary rights against the sub.

In today’s constantly evolving construction industry, owners will want to maximize their protections against the errors of the subcontractors working on their projects. To do this, owners can maximize their rights by requiring that their generals include language, either direct language naming the owner as a third-party beneficiary of the subcontracts, or through incorporating the prime contract into the subcontracts, or having key terms of the prime contract flow down to the subcontracts, and by following up and obtaining copies of the subcontracts to make sure this was in fact done. Otherwise, the owner may just have a breach of contract claim against the generals who are now out of business. This type of language and follow up should allow the owner to directly make subcontractors accountable to them.

[1] See SME Industries Inc. v. Thompson, Ventulett, Stainback and Associates, 2001 UT 54 ¶¶38-43, 28 P.3d 669; citing American Towers Owners Ass'n, Inc. v. CCI Mech., Inc., 930 P.2d 1182, 1190 (Utah 1996). [back]

[2] Id. at ¶44-45. [back]

[3] Utah Code Ann § 78B-4-513(4); and see Davencourt at Pilgrims Landing Homeowners Assoc. v. Davencourt at Pilgrims Landing, LC, 2009 UT 65 ¶19, 221 P.3d 234. [back]

[4] SME Industries, 2001 UT 54 ¶47, 28 P.3d 669 (internal quotations omitted). [back]

[5] Id. [back]

[6] Cafe Rio, Inc. v. Larkin-Gifford-Overton, LLC, 2009 UT 6 ¶25; quoting Green River Canal Co. v. Thayn, 2003 UT 50, P 17, 84 P.3d 1134. [back]

[7] SeeEncon Utah, LLC v. Fluor Ames Kraemer, LLC, 2009 UT 7 ¶¶14-26, 210 P.3d 263 (When interpreting the terms of a subcontract that has a prime contract incorporated into it, the terms of the prime contract are interpreted as terms of the subcontract.). [back]

[8]Encon Utah, 2009 UT 7 ¶26. [back]

[9] Plum Creek Wastewater Authority v. Aqua-Aerobic Systems, Inc., 597 F. Supp. 2d 1228, 1232 (D. Colo. 2009); quoting United Tunneling v. Havens Const., supra, 35 F.Supp. 2d at 795 (quoting R. Cushman, The Construction Industry Formbook, § 5.08 (1979)); see also Industrial Indemnity Co. v. Wick Construction Co., 680 P.2d 1100, 1103 (Alaska 1984). [back]

[10] Id. (citing A. Dib, Forms and Agreements for Architects, Engineers and Contractors, Chap. 7, § 1[1] (1979)). [back]

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Summary of Changes to California’s Mechanics’ Lien Law – Effective July 1, 2012

by Stuart J. Einbinder and Colin R. Higgins

Effective as of July 1, 2012, the existing statutes governing California’s mechanics’ lien law, including stop notices and payment bonds, will be repealed and replaced with entirely new statutes. The Legislature has portrayed the new law as a largely non-substantive reorganization of existing law, and in most respects this portrayal is accurate. However, there are many notable changes that contractors, owners, lenders and design professionals should familiarize themselves with to avoid potential pitfalls.

The following is a brief summary of some of the significant changes to California’s mechanics' lien law that will take effect on July 1, 2012:

• Certain long-standing terminology will change under the new law. A “stop notice” will become a “stop payment notice.” An “original contractor” will be renamed a “direct contractor.” A “materialman” will be called a “material supplier.”
• If an owner files a lawsuit to expunge a lien that has not been timely acted upon by the lien claimant, the attorneys’ fees the owner can recover are no longer capped at $2,000. Under the new law, the prevailing owner is entitled to recover all of its reasonable attorneys’ fees in connection with the action to expunge.
• Lien release bonds are reduced from 150 percent to 125 percent of the lien amount under the new law, making it more affordable to bond around a lien.
• The new law requires the use of revised conditional and unconditional waiver/release forms for both progress payments and final payment (note that the mechanics’ lien form itself was previously modified in January 2011).
• The definition of “completion”—which starts the time to record a mechanics’ lien, file a stop notice and make a bond claim—has been modified. Of significance, completion will no longer include acceptance by a private owner.
• The deadline for an owner to record a notice of completion is extended under the new law from 10 days to 15 days after completion of the project.
• Where a work of improvement is done pursuant to separate direct contracts with the owner, the owner may record separate notices of completion for each scope of work set forth in each direct contract.
• The new law changes the language required in a “preliminary notice” (previously called a “preliminary 20-day notice”). In addition, the new law clarifies that contractors in direct contract with the owner are required to give a “preliminary notice” only to the construction lender or reputed construction lender, if any.
• The new law requires owners to provide all entities who served it with a preliminary notice of the name and address of any construction lender who made a post-commencement construction loan for the project.
• Existing design professional lien laws have been repealed, and design professional liens will be part of the mechanics’ lien law. Landscape architects will also be added as protected design professionals under the new law and be able to record mechanics’ liens.

Now is the time for contractors, owners, lenders and design professionals to familiarize themselves with the new law and to update their contracts and forms accordingly.