Professional Documents
Culture Documents
B.
C.
D.
E.
F.
1.
2.
3.
4.
5.
6.
2.
3.
2.
Bond Claims..................................................................... 35
3.
4.
TORT ACTIONS............................................................. 50
2.
Michael R. Libor
Morgan, Lewis & Bockius LLP
V.
Complications arise when the claimant has not directly contracted with the
party against whom claimant wishes to file its claim. For example, claims may
arise between an owner and a subcontractor or materialmen. Under these
circumstances, the subcontractor has no cognizable claim against the owner for
breach of contract because no privity exists between the parties. In Pennsylvania,
as in most states, these types of claims are often brought in the form of
mechanics lien or bond claims, in the appropriate circumstances.
Other claims may arise with even more remote third parties, either against
the project owner or in some cases against one another, such as financing entities,
end users and other members of the construction process for whom there are no
contractual remedies. These claims are often brought as tort claims (for example
negligence, fraud and strict products liability), or statutory claims (for example,
under consumer protection statutes or the Uniform Commercial Code). These
claims are addressed in Section E, below.
C.
Michael R. Libor
Morgan, Lewis & Bockius LLP
Disruption Claims
Acceleration
Termination Claims
Quantum Meruit
1.
Any discussion on liability for changes assumes that the work was
performed, and that it was outside the scope of the original contract. If either of
these events is not true, a contractor is not entitled to recover on a claim.
The analyses of issues involved in the pricing of direct costs and/or
disruptions, delays related to formal change orders are similar to those involved
with claims for constructive changes. The only major difference is that in a
formal change order the owner has, in essence, admitted that something is owed
for the changed work. Many times the contract provides the pricing scheme for
the change. On other occasions, the owner waits for the contractors pricing
quote. Therefore, the pricing of direct cost related to formal changes is similar to
the pricing discussion regarding constructive changes.
Any conduct by a contracting officer (or other representative of the owner
authorized to order changes), or any event which is not a formal change order, but
which requires performance of work different than anticipated or prescribed by
the original contract, may constitute a constructive change order. There are a
great many actions and events that can result in constructive changes to contract
work. Set forth below is a partial list of these actions and events. The reader will
observe that many of the items overlap, or in some instances are caused by each
other:
-
suspension or delay
acceleration
disruption.
Direct costs as defined in this section include only the costs of labor,
equipment and materials needed to perform the actual work within the scope of
Michael R. Libor
Morgan, Lewis & Bockius LLP
the change. It does not include the consequential effect of changes such as costs
for the disruption and inefficiency created by change orders; costs of acceleration
of work; and costs as a result of project extensions. These ripple effect costs
are explained below.
a.
Michael R. Libor
Morgan, Lewis & Bockius LLP
b.
costs of operation, repair and maintenance costs can be calculated from these
sources. Actual job conditions may require that these averages be adjusted either
up or down. The rates do not include job site or all home office overhead costs.
However, because depreciation, taxes and storage can be considered part of home
office overhead, to the extent possible these costs should not be counted twice (in
the cost pool for home office overhead claims and again in the claim for
equipment usage).
d.
Job-Site Overhead
Interest Claims
Weld Div., 498 A.2d 895, 899 (Pa. Super. 1985); JMB Realty Corp. v. Allright
Co., 34 Phila. Co. Rptr. 229, 252 (Pa. Cmwth. June 4, 1997).
The contractor may refer to change order logs as a basis to set the date of
the onset of the claim for interest. In other areas where the timing of the
occurrence is not as well established, such as claims for acceleration or
inefficiency, the contractor should prepare a cause effect analysis to show whether
and when interest is appropriate. This can be done by a cash-flow analysis to
determine whether the contractor was actually out of pocket, and if so to what
extent and for how long. Sources of financing (internal vs. borrowings) should be
documented. The ultimate goal is to show periods of negative cash flow or loss of
use of funds that were due to compensable delays.
The appropriate rate for postjudgment and prejudgment interest is stated as
the legal rate of 6% simple annual interest. Carrolla v. City of Philadelphia,
735 A.2d 141, 146 (Pa. Cmwth. 1999); Daset Mineral Corp. v. Industrial Fuels
Corp., 473 A.2d 584, 595 (Pa. Super. 1984); 41 P.S. 202. However, if a
contract provides for a specific rate of interest higher or lower than the legal rate,
the specified rate should apply for all prejudgment interest. See OBrien & Gere
Engr., Inc. v. Taleghani, 525 F. Supp. 750 (E.D. Pa. 1981) (12% applied);
Reliance Security Service, Inc. v. 2601 Realty Corp., 557 A.2d 418, 419 (Pa.
Super. 1989) (18% applied). However, the court in Reliance explained that once
a judgment against the creditor had been obtained, the rate of interest on the
judgment was to be 6% per annum, even if the contract provided for a higher rate
of interest.
If funds are obtained internally, then the appropriate rate may be argued to
be the lost opportunity to use those funds elsewhere. The success of this argument
is not certain.
f.
Profit
when the Commonwealth failed to provide site access. The court awarded
damages for the delay, plus it affirmed the Board of Arbitrations mark-up of
10%, although the Board did not explain whether the mark-up was to cover
overhead, profit or both. The full contract price plus excess costs were paid, but
the contractor argued it was entitled to additional profit on its excess costs. The
court denied the recovery for profit on the excess costs for the following reason:
The total contract was to be performed in 280 working days and,
by incurring the costs for extra time and labor herein recovered,
[the contractor] completed the work on time. Whatever profits
were anticipated on the total contract were presumably duly
received, there being no evidence to the contrary. We know of no
rule which provides that a contractor is entitled to receive a profit
on each and every item of work on a contract of this nature.
Id.
The Pennsylvania Supreme Courts opinion in Exton Drive-In. Inc. v.
Home Indem., Co., 436 Pa. 480, 261 A.2d 319 (1969) explains the tough burden a
new and untried business must meet to recover lost profits from untimely
performance by a contractor. There, a contractor did not timely complete all of its
work to grade and pave a drive-in. The court denied the owners request for loss
of anticipated profits and stated that the anticipated profits of a new and untried
business which were attributable solely to the unfinished condition of the business
premises were too speculative to provide a basis to award damages. See also
Delahanty v. First Pennsylvania Bank, N.A., 318 Pa. Super. 90, 117-26, 464 A.2d
1243, 1257-61 (1983) (burden of proof is very high with respect to new business
profits). Lost profit may be awarded, however, if sufficient and proper proof is
provided. The traditional method is to present evidence of past profitability in an
established business. Draft Systems, Inc. v. Rimar Mfg., Inc., 524 F. Supp. 1049,
1055 (E.D. Pa. 1981); Mass. Bonding & Ins. Co. v. Johnston & Harder, Inc., 343
Pa. 270, 279, 22 A.2d 709, 714 (1941). It is clear, however, that under
Pennsylvania law, a plaintiff may not recover for loss of profits to a business
because of customer dissatisfaction or loss of goodwill. Neville Chem. Co. v.
Union Carbide Corp., 422 F.2d 1205, 1225 (3d Cir. 1970), cert. denied, 400 U.S.
826 (1970); National Controls Corp. v. National Semiconductor Corp., 833 F.2d
491, 495 (3d Cir. 1987).
The rate of profit may be set forth in the contract; or the bid rate of profit;
the contractors historical rates; or industry rates. No single profit rate is correct
for every claim. The appropriate rate should be determined by the nature of the
industry and job, and the risk inherent in the work. For example, if changes
dramatically delay or disrupt the work, it does not follow that a contractor which
has bid a low profit should be limited to that low profit on changes because the
project and conditions as they actually existed may not be as the were anticipated
to be at the time of bid.
Michael R. Libor
Morgan, Lewis & Bockius LLP
g.
Legal Fees
delays, disruptions or other causes beyond our control, we reserve the right to
forward those costs at a later time.
Probably the most successful method of calculating loss of efficiency is to
present objective evidence of work productivity during a normal period on the
project and compare this measure with the productivity during the disrupted
period (the so-called measured mile approach). See Natkin & Co. v. George A.
Fuller Co., 347 F. Supp. 17 (W.D. Mo. 1972) (lost productivity computed by
comparing actual productivity rates before and after the impact); General Ins. Co.
of America v. Hercules Constr., 385 F.2d 13 (8th Cir. 1967); Clark Concrete
Contractors, Inc. v. General Services Admin., GSBCA No. 14340 (March 15,
1999) (upheld one of measured mile approach even where compared work was
not identical). In Luria Bros. & Co. v. United States, 369 F.2d 701 (Ct. Cl. 1966),
the court noted that mere expert testimony on an efficiency loss projection is
insufficient; comparison of similar work activities on the same project or similar
projects, or other corroborative evidence is necessary.
The emphasis here is to identify the actual rate of production that the
contractor would have realized if not for the claimed hardships. The time and
activity periods compared should be broken down into the smallest detailed
components; the normal and affected work should be as similar as possible; and
the trial period should be unaffected and sustained. For example, a contractor
installs only 15 sheets of drywall per person each day in an affected area, but
installs 20 sheets per person per day in an unaffected area. The claim would be
based on the increased costs of 5 sheets per person per day in the affected area.
Critical analysis of this type of claim includes comparison of the type of
work involved; length of the base periods for comparison; whether material
shortages were a problem; whether labor shortages were a problem; and other
factors which may have caused the difference in the productivity rates such as
weather.
Once the trial period productivity measure(s) have been identified,
calculated and adequately supported, it is important to assess the overall
reasonableness of that rate of production, in light of industry standards, bid
productivity, historical productivity, and the resources available to commit to the
effort. Any trial period rate of productivity that differs substantially from the bid
level of efficiency should be analyzed. Similarly, standard industry productivity
rates may not consider the unique aspects of the subject project. However, they
can be used as a general gauge of the reasonableness of the selected rates.
After the predicted productivity rate is determined, it is compared to the
actual productivity rates incurred on affected work. Consistent with the causeeffect claim methodology, the comparison is made only for identified, supported
periods of impact. To compare the trial period efficiency with work that cannot
be established as affected or damaged results again in a meaningless mathematical
calculation.
Michael R. Libor
Morgan, Lewis & Bockius LLP
10
Acceleration Claims
Contractor-Directed Acceleration
In some instances, the contractor may fall behind schedule due to factors
that are not the responsibility of the owner, and may choose to accelerate his
efforts to meet the established deadline. If he determines that the costs of
acceleration would be exceeded by the costs of project delays (possibly including
liquidated damages imposed by the owner, the contractors own extension costs
and failure to meet other contractual obligations that require the committed
manpower and equipment), the contractor may decide to absorb the acceleration
costs as the least costly alternative. In this case, the liability for the delay and the
Michael R. Libor
Morgan, Lewis & Bockius LLP
11
acceleration costs clearly lie with the contractor, and disputes or claims would be
inappropriate.
b.
Owner-Directed Acceleration
In other cases, such as a compensable delay, the owner may decide that it
is in his best interest to pay the acceleration costs of the contractor rather than
face the costs associated with delay. The owner then will issue an order to
accelerate. Here again, the liability for the decision to accelerate and the resulting
costs is clear and should not cause disputes other than perhaps the quantification
of the associated costs.
c.
Constructive Acceleration
12
4.
Construction delays are very costly. Extended costs for delays are a
common and hotly contested element in pricing. Quantification of delay damages
requires (1) an analysis to determine the type of delay; (2) time analysis of the
delay period; (3) an analysis of the cause and liability for the delay; and (4) an
analysis to determine the costs related to the delay.
a.
Types of Delays
Project delays can be segregated into three types regarding their impact on
the construction schedule:
(i)
Direct Delay
Concurrent Delay
Serial Delays
Serial delays are a chain of individual delays. These delays may arise
from different causes, but impact and extend the same activities. In serial delays,
one delay can give rise to or exacerbate the impact of a subsequent delay, such as
a delay in the receipt of materials extending project performance into a cold or
rainy period.
b.
Michael R. Libor
Morgan, Lewis & Bockius LLP
13
(i)
Excusable/Compensable
Not the fault of the contractor, these delays are the result of actions or
inactions by the owner or its representatives, or events for which the owner is
responsible, and for which the contractor is entitled to be compensated.
(ii)
Excusable/Non-Compensable
The fault of neither owner nor contractor, these delays are due to events
outside of the control of both parties-causes such as acts of God or labor strikes.
As such, neither owner nor contractor is generally liable for damages. Thus,
damages are non-compensable. However, the contractor may be entitled to an
extension of time to complete its work.
(iii)
Non-Excusable
Time Analysis
14
Costs of Delay
these costs is to establish a daily rate for time-related costs. The daily rate can
then be applied to the period of compensable delays. The costs included in the
pool of job-site overhead costs should be screened, however, to delete: (1) nontime-related costs; (2) costs that do not benefit the subject contract; and (3) costs
included elsewhere in the claim. Examples of non-time related costs are onetime
purchase costs of photocopiers; telephone hook-up charges; and utility hookup
charges. These charges are independent of time an will not change if the project
lasts longer than expected. Costs of general conditions can also be included in
other prior change orders. These should be excluded from the cost pool.
Other delay costs can include storage fees, winter weather protection and
extended insurance costs.
(ii)
Escalation
Actual Labor
$ 600
40 hours x $10 =
$400
480
$1,080
60 hours x $12 =
720
$1,120
The claim would be for $80 (the lesser of the actual and planned timephased labor costs). An important tool in calculating escalation is the
construction bid and original and modified schedules of manpower and material
purchases.
Michael R. Libor
Morgan, Lewis & Bockius LLP
16
Again, previous change order work may have been recovered at escalated
rates. Previously recovered escalation costs should be deleted. Otherwise, this
would result in double counting if also included in an overall delay claim.
Inefficiency
(iii)
(iv)
2.
3.
Daily Contract
Overhead
Number of Days of
Delay
Allocable Overhead
Many courts follow the Eichleay formula in public contracting, but some
do not. In fact, this formula has come under attack because (1) there is no proof
of causation between delays and damages for extended home office overhead; and
(2) there may be no relationship between the overhead damages and actual costs.
For example, in Berley Industries. Inc. v. City of New York, 412 N.Y.S.2d 589
(1978), the court rejected the Eichleay formula as mere speculation or conjecture.
The court also pointed out that home office involvement normally follows a bell
shaped curve during the contract, and therefore the average rate arrived at by the
Eichleay formula may overcompensate the contractor for delays near the start or
completion of the project, and undercompensate the contractor for delays in the
middle of the project.
In any event, a contractor should support a claim for home office overhead
by showing that the home office was actively involved by devoting time and
effort to the project to solve design or engineering problems which caused the
delay or disruption. Fehlhaber Corp. v. State, 419 N.Y.S.2d 773 (1979). The
contractor should also show that it was not reasonable or feasible for it to obtain
Michael R. Libor
Morgan, Lewis & Bockius LLP
17
other work to absorb the overhead during the period of delay. Finally, the pool of
overhead costs should be screened to remove costs of other lines of business or
non-time related costs which could not possibly be effected by a delay.
5.
18
6.
Quantum Meruit
This section has focused on pricing the most common type of claim: a
claim arising from alleged breaches of, or changes to, the construction contract.
Such claims compose the overwhelming majority of construction disputes.
However, this discussion on claim pricing would not be complete without
including a discussion of the quantum meruit claim.
The quantum meruit claim is based on the theory that the contractor
should be compensated for its work to prevent unjust enrichment of the party
receiving the benefit of the work. The claim attempts to quantify the increased,
unreimbursed value of the project accruing from the contractors additional efforts
that are caused by the owner. A difference between the quantum meruit claim
and a claim related to the changes or extra work clauses in the contract lies in
the rationale for recovery. Where a traditional changes claim is based upon the
rights conferred by the contract to recover the costs of changes imposed by the
owner, the quantum meruit claim is based on an implied right to be reimbursed
for work performed. A claim for quantum meruit is inapplicable, however, where
the parties have a written or express contract. Roman Mosaic & Tile Co., Inc. v.
Vollrath, 226 Pa. Super. 215, 313 A.2d 305 (1973).
The claim is usually brought by a subcontractor against an owner with
whom the subcontractor does not have a contract, or after termination. These
third party claims typically fail. In Kemp v. Majestic Amusement Co., 427 Pa.
429, 234 A.2d 846 (1967), for example, a heating and air conditioning contractor
brought an action in quantum meruit against an owner. The contractor had a
contract with a tenant which the building owner did not learn of until after the
installation. The contractors relief was denied. In Meyers Plumbing & Heating
Supply Co. v. West End Fed. Sav. & Loan Assn., 498 A.2d 966 (Pa. Super.
1985), the court rejected the quantum meruit claim brought by a subcontractor
against an owner where the owner had paid the contractor, but the contractor had
failed to pay its subcontractor. The court reasoned that having paid for the work
once, there was no basis for claiming that the enrichment of the owner was
unjust. Id.
Similarly, in D.A. Hill Co. v. Clevetrust Realty Invs., 573 A.2d 1005 (Pa.
1990), the court ruled that an unpaid subcontractor could not recover from a
lender which had purchased the project from a defaulted owner. The lender was
not liable under a theory of quantum meruit because the lender was not enriched,
as the value of the property was less than the funds it had advanced to the
defaulted owner. Furthermore, even if the lender was enriched by the
subcontractor, it was not unjustly enriched because it requested no work for the
subcontractor and it did not mislead the subcontractor into performing work.
Instead, the subcontractor had waived its lien rights and went forward without the
protection of a payment bond. Id.
Michael R. Libor
Morgan, Lewis & Bockius LLP
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If, however, a party contracts with another and accepts the service but
without specifying what compensation shall be paid, the party may recover the
value of the services under quantum meruit. Martin v. Little, Brown & Co., 304
Pa. Super. 424, 450 A.2d 984 (1981)
The measure of damages on a claim of quantum meruit differs from
damages available under theories of quasi-contract or unjust enrichment. The
measure of damages on a quantum meruit claim is the reasonable value of
claimants materials and services.
D.
Owners may suffer direct damages from the actions of several parties in
the construction process. In many instances owners may have recourse against
parties for claim amounts owing to contractors. This section will briefly discuss
certain parties against whom owners may have cause to seek compensation for
damages, the events and actions that can give rise to those damages, and methods
of quantifying the claim amounts.
1.
Contractors/Subcontractors
Architectural Firms
20
Government Officials
Delay
Delays in project completion can be very costly to the owner in that they
deny access to the use of the facility. Delays caused by a contractor can arise
from many factors, including inadequate planning or scheduling and poor
coordination. As always, the complaining party bears the burden to show that the
contractor caused the delay; that it was not an excusable delay; and that the
owners conduct did not concurrently cause the delay. The owner should also
show that any delays it may be responsible for were not critical activities.
b.
Contracts with owners may include provisions where the other party
expressly guarantees its work, design or actions. Even in absence of such a
clause, the law recognizes an implied warranty on contractor work, holding it to
meet certain standards. Any deviation from these specified levels of quality and
performance can result in the provision of a substandard facility, unsuitable for
the owners needs.
Michael R. Libor
Morgan, Lewis & Bockius LLP
21
In Elderkin v. Gaster, 447 Pa. 118, 288 A.2d 771 (1972), the Pennsylvania
Supreme Court recognized an implied warranty of habitability, as well as an
implied warranty of reasonable workmanship, in contracts by builder-vendors
selling newly constructed houses. The court reasoned that these implied
warranties were necessary to equalize the disparate positions of the buildervendor and the average home purchaser by safeguarding the reasonable
expectations of the purchaser compelled to depend upon the builder-vendor s
greater manufacturing and marketing expertise. Id. See also Tyus v. Resta, 476
A.2d 427, 430-33 (Pa. Super. 1984) (implied warranties apply to newly
constructed homes). In Tyus, the court held that an implied warranty of
habitability could be limited or disclaimed only by clear and unambiguous
language in the parties agreement. Language which merely provided that the
purchaser inspect the premises before purchase and that he accepted it in its
present condition did not amount to a waiver of the implied warranty. The court
further ruled that a reasonable pre-purchase inspection did not require the
buyers to examine the crawlspace below the house.
In Groff v. Pete Kingsley Bldg., Inc., 543 A.2d 128, 133 (Pa. Super.
1988), the court extended the concept of implied warranties of habitability and
workmanship to a builder who constructed a house on land already owned by the
owner/purchaser. The court explained that [W]e can see no difference between a
builder or contractor who undertakes construction of a new home and a builderdeveloper. Id.
c.
In some instances, actions by one party may give rise to a claim against
the owner by a third party. For example, if the architect produces defective
drawings, which delay the work of the contractor (for time lost during drawing
revisions and rework necessary due to the error) and impact his productivity, the
contractor may seek to recover those damages from the owner. In such a case, the
owner may have recourse to sue the offending party (the architect in the example
above) for the amount of the owners liability on the third-party claim.
d.
Contract Termination
If the owner terminates a party for default, the owner may suffer damages
related to the delays and increased costs associated with having a different party
complete the work. Loss of labor learning curve benefits, remobilization costs or
other factors can substantially increase the costs to complete the work.
3.
22
The Owners damages for delay can include loss of use and revenue from
the facility; increased financing costs; increased costs to other contractors and
extra administrative costs. All of these are typically recoverable.
The owners damages for delay frequently are governed by a liquidated
damage provision in the contract. The concept of liquidated damages arose as a
method of reimbursing the owner for delay damage where actual damages arising
from delay could not be forecast with certainty when the contract was negotiated.
As such, liquidated damages are a substitute for the actual damages suffered by
the owner, rather than a penalty to the contractor for late completion. Liquidated
damages are generally expressed as an amount to be paid per day that the
contractor is late completing all or a portion of the work.
The court in In re Plywood Co. of Penna., 425 F.2d 151 (3d Cir. 1970),
explained that liquidated damages is the sum which a party to a contract agrees to
pay as agreed damages if breach occurs. The liquidated damages are good faith
estimate of the actual damages that will probably ensue from a breach. A
penalty is not a pre-estimate of probable damages but is in the form of a
punishment designed to prevent a breach. See also Commw., Dept. of Envt.
Resources v. Hartford Accident and Indem. Co., 396 A.2d 885 (Pa. Commw.
1979).
In Holts Cigar Co. v. 222 Liberty Assocs., 591 A.2d 743 (Pa. Super.
1991), the court struck down a clause as a penalty. The damages clause in the
parties agreement provided for $500.00/day liquidated damages. The court held
that the clause was an unenforceable penalty because the amount was picked
arbitrarily and applied even on days that the lessees business was not open. The
court declined to enforce an agreement which clearly is not one for true
liquidated damages. See also RESTATEMENT (SECOND) OF CONTRACT 356(1)
(1979).
In some states, [a] term fixing unreasonably large liquidated damages is
unenforceable by statute, on grounds of public policy. See, e.g., Virginia
Uniform Commercial Code Section 8.2-718(1).
For liquidated damages to be enforceable, it is vitally important that
parties to a contract specify when the liquidated damages will start and end. In
Sutter Corp. v. Tri-Boro Municipal Auth., 487 A.2d 933 (Pa. Super. 1985), the
court addressed the issue of when liquidated damages end under a contract
provision assessing $200/day damages for any work that shall remain
uncompleted after the agreed completion date. Thirteen days after that date the
Michael R. Libor
Morgan, Lewis & Bockius LLP
23
project was substantially complete and the owner began using the sewage
treatment plant. The contractor did not finish all punch-list work until 283.5 days
later when the engineer certified final completion. The contractor argued that no
liquidated damages should be assessed after issuance of the punch list since the
project was substantially complete. The Court disagreed, and held that the
contractor was liable for liquidated damages until final completion under the
contract terms.
Pennsylvania courts can be harsh in enforcing liquidated damages. In
Commw. Dept of Transp. v. Interstate Contractors Supply Co., 568 A.2d 294
(Pa. Commw. 1990), a contractor was hired to clean and paint 6 bridges. The
work was eventually completed after a long period of delay caused by inclement
weather. The owner assessed liquidated damages of $200/day. The trial court
held the damages unrecoverable as a penalty. On appeal, the court held the
liquidated damages were recoverable, even though there was an apparent absence
of actual damages and the owner never manifested its displeasure with the work.
The court explained that the contract clearly shifted to the contractor the burden
of delays not caused by the owner, including the burden of unanticipated
happenings such as bad weather.
Actual costs of delay are recoverable if liquidated damages are not
applicable, or if the contractor abandons the project without completion, even if a
liquidated damage clause is present. See J. R. Stevenson Corp. v. Westchester
County, 493 N.Y.S.2d 819, 113 A.D. 2d 918 (1985). Actual damages usually
includes the costs of the loss of use of the facility. Such loss of use costs are
fact specific and vary from case to case. In addition, the owner may claim excess
financing costs, interest and other incremental costs because of the delayed
construction.
b.
24
(1962), involving an owners claim for failure to perform the contract work in
good faith and in a workmanlike manner, the court stated that generally the
measure of damages is the difference in value between what is tendered as
performance and what is due as performance under the contract, which may
consist of the costs to repair. Damages are measured as of the date of the breach.
In cases where the cost of repairs is prohibitive or exceeds the diminished
value of the facility, measuring damages by the costs to repair is not
appropriate. In this instance, the accepted measure of damages is the difference
between the market value of the building as built and the value had the project
been built to contracted specifications. In Freeman v. Maple Point, Inc., 574 A.2d
684, 689 (Pa. Super. 1990). For example, the homeowners purchased a new
house for approximately $96,000. Water collected on certain parts of the lot due
to an improperly installed driveway, poor grading, and high clay content in the
soil. At trial, the homeowners presented testimony that it would cost
approximately $50,000 to correct the problem, but presented no evidence as to the
diminution in value of the property. The jury awarded only $45,000 in damages.
On appeal, the court reversed the award because there was no evidence whether
the cost to repair was less than, or greatly exceeded, the diminution in value of the
property. The court ruled that there must be some reasonable basis for
determining reduction in value, before a judgment may be made that the costs of
repairs is a proper measure of damages, when required repairs to a new house
represent a high percentage of the cost of the house. Id.
Another explanation of the measure of damage can be found in Rabe v.
Shoenberger Coal Co., 62 A. 854 (Pa. 1906). In Rabe, the Pennsylvania Supreme
Court explained that the measure of damages for damage to property is generally
the cost of repair where the injury is reparable, unless the cost to repair is equal to
or exceeds the diminution value of the property injured. If the injury to the
property is permanent, however, the measure of damages becomes the decrease in
the fair market value of the property. Id. Examples of non-reparable, permanent
injuries when the measure of damages is the diminution in the value of the
property include Schlichtkrull v. Mellon-Pollock Oil Co., 152 A. 829 (Pa. 1930)
(infusion of salt water to wells due to defendants oil well drilling deemed
permanent), and Bumbarger v. Walker, 164 A.2d 144 (Pa. Super. 1960)
(infiltration of high sulfur content water into a spring due to defendants strip
mining deemed permanent).
Therefore, the rule in Pennsylvania is that the measure of damages where
an owner sues for defective construction is the difference in market value of the
property as constructed and the market value that the property would have had if
constructed as promised, with the qualification that if it is reasonably practical to
repair the defects in construction, and if the costs of repairs do not exceed the
difference in market value, then the measure of damages in the cost of repairs.
Gadbois v. Leb-Co Builders, Inc., 312 Pa. Super. 144, 153, 458 A.2d 555, 557
(1983)
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c.
If the owner is sued by a party, and the owner believes that a third party is
the real culpable party who may have injured the suing party, the owner may
recover amounts by way of indemnification or contribution against the culpable
party. The measure of recovery is the amount that the owner was required to pay
to the complaining party, to the extent the owner shows that the real culpable
party caused or contributed to the complaining partys damages.
d.
Creature of Statute
of the claim exceeds $500.00. 49 P.S. 1301. Should payment not occur, the
debt may be satisfied ultimately through execution of a mechanics lien and
distribution of the resulting proceeds from the sale of the secured property
through judicial proceedings.
The mechanics lien is entirely statutory. Since proceedings under a
mechanics lien are in rem, the law of the state where the property is located
controls. See Halowich v. Amminiti, 190 Pa. Super. 314, 315, 154 A.2d 406, 408
(1959). Therefore, although a number of other states have patterned their
mechanics lien acts after that of Pennsylvania, many have not, including New
Jersey and Maryland, whose lien statutes are substantially different in form,
theory and practical application. Each states statute and cases should be
consulted to file liens and perfect lien rights in the respective states. See 53
AmJur 2d (Mechanics Liens) 26.
b.
General Requirements
(i)
Although the Mechanics Lien Law protects the party who does not have a
direct contractual relationship with the property owner, there must be a contract
between the owner and general contractor, either written or implied, sufficiently
specific in its terms to serve as a foundation for valid mechanics lien claims. In
order to protect all claims, the contractor should describe in the greatest possible
detail the full extent of the work to be done and should incorporate the
architectural plans, specifications, and blueprints into any contract with the
owner. Prior to commencing work, the subcontractor should examine the prime
contract and satisfy himself that its terms are reasonably specific.
(ii)
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c.
General Contractor
Subcontractor
The right to lien lies with both the contractor and the subcontractor against
the improvement and title or estate of the owner. 49 P.S. 1301. Generally, the
subcontractor enters a contract, either express or implied, with the general
contractor to perform a specific portion of the work required under the contract
between the general contractor and the owner. As with the general contractor, the
subcontractor who erects, constructs, alters or repairs an improvement or any
part thereof; or furnishes labor, skill or superintendence to a construction project,
or supplies or hauls materials, fixtures, machinery or equipment reasonably
necessary for and actually used therein . . . whether as superintendent, builder or
materialman, 49 P.S. 1201(5), is entitled to a mechanics lien.
(iii)
Material Supplier
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(iv)
A mechanics lien binds the interest of the party named as owner of the
property at the time of the prime contract, or acquired subsequently by him. 49
P.S. 1509. In other words, the lien attaches to the improvement and
compromises the title of whomever holds it when the lien attaches. The owners
interest need not be in existence at the time a building is erected; the lien will
attach to a title subsequently acquired. Weaver v. Sheeler, 124 Pa. 473, 17 A. 17
(1889). For a claim to be valid, it must be filed against whomever owns the
subject property when the claim is made. Edwards v. Stevens, 4 Pa. D.&C.3d
137, 138-39 (C.P. Chester Co. 1977).
(vi)
Lower-tier Subcontractors
Employee of Owner
purely public purpose. Visor Builders, Inc. v. Devon E. Tranter, Inc., 470 F.
Supp. 911, 919 (M.D. Pa. 1978).
Where a governmental entity, in owning and operating a property, acts in a
proprietary and quasi-private manner, an exception to the general rule that a
municipal property is exempt from mechanics liens is created, and a mechanics
lien claim can be brought against such entity. American Seating Co. v. City of
Philadelphia, 434 Pa. 370, 375, 256 A.2d 599, 601 (1969). Where the City of
Philadelphia acted as an absentee landlord of the property upon which the
Spectrum sports arena was built, the arenas construction was arranged and paid
by a private party tenant, and the city, in its capacity as a landlord was engaged in
a purely proprietary activity, the Pennsylvania Supreme Court permitted
mechanics liens claims against the property. Id.
The Pennsylvania legislature has provided protection for public works
contractors, similar in practical effect to a mechanics lien, through the Public
Works Contractors Bond Law of 1967, 8 P.S. 191-201.
(ix)
Against Landlord/Owner
Labor
The Mechanics Lien Law expressly provides that labor may form the
basis of a lien against property. 49 P.S. 1301. Labor includes the furnishing of
skill or superintendence. 49 P.S. 1201(9). However, the work in question must
be done as part of the construction, erection, alteration or repair of a building. See
Metropolitan International v. Union Investment Co., 17 Pa. D. & C.3d 519 (C.P.
Phila. Co. 1981) the (rejecting mechanics lien claim where security guards had
provided services during the construction of a building project).
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Materials
Off-Site Improvements
Incomplete Work
31
improvement for recovery, the courts may insist upon evidence that the property
was in fact improved in some manner. Courts have held that, where the
claimants efforts have not improved the value of the property, there is no right to
a lien. Dagit v. Radnor Convalescent and Nursing Home. Inc., 38 Pa. D. & C.2d
389, 392 (C.P. Delaware Co. 1965).
(vi)
The Act does not address whether rental equipment and temporary works
may form the basis of a claim. The statute at least suggests that under certain
circumstances, such materials may be lienable:
No lien shall be allowed for that portion of a debt representing the
contract price of any materials against which the claimant holds or
has claimed a security interest under the Pennsylvania Uniform
Commercial Code or to which he has reserved title or the right to
reacquire title.
49 P.S. 1303(e) (emphasis added).
Furthermore, the statute defines materials as those supplies and fixtures
reasonably necessary to and incorporated into the improvement. 49 P.S.
1201(7) (emphasis added). Where materials are used in construction but then
retained by the claimant, (e.g., scaffolding), the statute suggests that no lien may
be placed against those materials. However, 49 P.S. 1303(e) and 1201(7)
should be read in conjunction with 49 P.S. 1201(4) and 1201(5) where
contractor are defined. Both contractor and subcontractor are defined to include
those who supply or haul materials, fixtures, machinery or equipment reasonably
necessary for and actually used therein. Read together, these provisions suggest
that where materials or equipment are used in construction by a claimant who
retains title in the materials or equipment during and after construction, his claim
will be rejected, since title was retained by him and the materials were not
incorporated into the improvement. However, where the claimant rents
equipment reasonably necessary for and actually used in a project, his costs may
be the subject of a claim.
(vii)
Overhead
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e.
Waiver of Lien
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(ii)
An owner who has been served with a notice of intention to file or a notice
of the filing of a claim by a subcontractor may retain out of the funds due or to
become due the contractor a sum sufficient to protect the owner from loss until
such time that the claim is finally settled, released, defeated or discharged. 49
P.S. 1601. In so doing, the owner avoids paying twice for the same work, and
may prevent the perfection of the mechanics lien against his property.
(iii)
Should the contractor fail to settle, discharge, defend or secure against the
mechanics lien claim, the owner may pay the subcontractors claim. Upon
making this payment, the owner shall be subrogated to the rights of the
subcontractor against the contractor together with any instrument or other
collateral security held by the subcontractor for the payment. 49 P.S. 1604(1).
(iv)
Where the contractor fails to settle, discharge, defend or secure against the
claim, the owner may undertake a defense against the claim. If the owner elects
to defend, the contractor is liable to the owner for all costs incurred in the defense,
including reasonable attorneys fees, regardless of whether the owners defense is
successful. 49 P.S. 1604(2).
(v)
As will be explained more fully in the discussion of bonds, the owner may
arrange for a surety to post a bond to insure the owners payment to all concerned
parties upon the completion of the improvement.
(vi)
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(vii)
An owner who is served with a notice of intention to file claim may give
written notice of such to the contractor. If the owner retains funds due to the
contractor, he must give such notice to the contractor. 49 P.S. 1602(a).
(viii)
When the contractor receives notice as described above, within thirty days
from receipt the contractor must do one of the following:
(a)
Settle or discharge the claim of the subcontractor and furnish the owner
with a written copy of a waiver, release or satisfaction, signed by the claimant, 49
P.S. 1603(1); or
(b)
Bond Claims
The use of surety bonds on construction projects serves to shift and spread
certain risks faced by owners, contractors and suppliers. The primary risks are
that the general contractor will either prove unable to complete a project, or will
fail to pay all of its subcontractors or suppliers. While subcontractors and
suppliers usually have some degree of protection against non-payment from their
right to file mechanics liens against the property, the owner may be left at the
mercy of the general contractor and may suffer from an encumbered title where
the general contractor fails to meet its obligations to subcontractors and suppliers.
Additionally, subcontractors and suppliers with lien rights still face a difficult
process of foreclosure, and run the risk that the encumbered equity will not suffice
to pay their claim. Moreover, these lien protections are generally unavailable on
government construction projects, since most governmental entities are insulated
by statutory immunity to lien claims.
The intent of this section is to discuss the type and form of claims that
may be brought against surety bonds.
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a.
Types of Bonds
Bid, performance and payment bonds are the three basic surety
agreements in the construction industry. These instruments come in a variety of
forms.
Generally, the purpose of a bid bond is to assure the owner (the obligee)
that the successful bidder will enter into a contract and meet all precontractual
requirements. For sake of brevity, bid loads will not be covered here.
The payment bond functions as assurance to the owner that the
contractors obligations to subcontractors, suppliers, and laborers will be satisfied
so as not to constitute a charge to owner.
The performance bond obligates the surety to fulfill the terms of the
contractors contract so that the owner receives the project it bargained for.
In private projects, the parties negotiate the terms of bonds. As to public
works, the scope of responsibility under these instruments is set by the legislative
enactments of the federal and state governments and political subdivisions.
Under Pennsylvania law, surety contracts (bonds) must be in writing.
Tudor Development Group. Inc. v. U.S.F. & G, 692 F. Supp. 461, 463 (M.D. Pa.
1988) (oral agreement to answer for the debt of another is unenforceable). See
also 33 P.S. 3 (Purdon 1967) (agreement to answer for default of another must
be in writing).
b.
The terms of payment bonds on private projects may vary widely. The
claimant on a payment bond must examine the bond itself to determine the scope
of his rights. The payment bond is a guarantee by the surety to the obligee
(usually the owner) that the contractor (principal) will pay the claims of those
persons who furnish labor and materials to the owners construction project,
thereby avoiding liens against the property. The payment bond also provides
assurance to subcontractors and material suppliers that their legitimate bills will
be paid.
(i)
Unlike federal and state projects where statutes determine who is covered
by the payment bond, on private project, the language of the bond instrument
itself determines who is protected. Parties are free to negotiate the extent of
protection, and such bonds may cover sub-subcontractors if the bond so provides.
Potential claimants should obtain a copy of the payment bond to ascertain their
rights. Should litigation ensue and a question as to the claimants status arises,
helpful precedents can be found in cases interpreting statutes governing payment
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bonds for federal projects known as the Miller Act and, on state projects, the
Little Miller Act, which are discussed later.
Typically, however, payment bonds protect all persons who provide labor,
materials, equipment and machinery, or render services in the prosecution of
work, directly to the contractor or to a subcontractor of the contractor. As
explained more fully in the sections on the Miller Act and the Little Miller Act
regarding public projects, a person providing labor or material to a supplier
(rather than a subcontractor) of a contractor or a subcontractor is typically not a
permitted claimant under payment bonds. The crucial distinctions between a
supplier and a subcontractor are explored in the sections regarding the Miller and
Little Miller Act.
Unpaid claimants can bring a direct action against the principal and the
surety.
(ii)
Notice Requirements
37
(iv)
The great majority of federal works bonds are governed by the Miller Act,
40 U.S.C. 270a-270f (1982), which pertains to any contract for the
construction, alteration or repair of any public building or public work of the
United States the value of which exceeds $25,000.00. To encourage private
parties to contract with the federal government, and to alleviate the harshness that
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The Miller Act provides that the payment bond is for the protection of
individuals who supply material or labor for use in the prosecution of the prime
contract and who have not been paid in full. The Miller Act defines person to
include any individual, partnership, corporation or other legal entity. While the
Acts express language suggests that its scope is broad, the Acts coverage
extends only to those parties who supply labor or material directly to the prime
contractor, and to those who supply labor or material directly to a subcontractor
(rather than a supplier) of the prime contractor. Consequently, a third-tier
subcontractor or a person who supplies to a supplier of the prime contractor has
no protection under the Miller Act.
(a)
39
Employees
The rule that third tier parties are beyond the coverage of the Miller Act
payment bond has several limited exceptions which require close scrutiny of the
particular facts of each case. A third tier subcontractor may receive Miller Act
protection where a first or second tier subcontractor has become insolvent, and the
former second or third tier subcontractor has thereafter dealt directly with the first
tier subcontractor. The insolvency and new dealings may elevate the status of
prior second or third tier subcontractors. Another exception exists where a first
tier subcontractor is a wholly owned subsidiary of the prime contractor, and a
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court may be persuaded to view the prime and the first tier subcontractor as a
single entity if the subsidiary is merely a sham corporation. In such case, the
subcontractor who contracts with the prime contractors subsidiary may be
characterized as a first tier subcontractor, and the status of other subcontractors is
elevated accordingly.
(ii)
The Miller Act performance bond only protects the government; failure to
provide this bond affects no other party. This is not the case with payment bonds;
failure to require or provide payment bonds may seriously jeopardize the interests
of subcontractors and material suppliers. In Appeal of R.T. Madden Co., ASBCA
No. 22999, 81-2 BCA 15,312 (1981), it was held that a contract is formed
despite the failure to obtain Miller Act bonds, and subcontractors and suppliers
are left with few practical remedies where a prime contractor fails to make
required payments. Generally, there no liability on the part of the United States
for failure to require Miller Act bonds. In 4 Star Construction Corp. v. United
States, 6 Cl. Ct. 271, 273 (1984), a subcontractors suit against the government for
failure to require a Miller Act payment bond was dismissed, since the Act does
not create a right to sue the government for compensation owed by the prime
contractor.
Miller Act claimants may, however, have an equitable lien on funds
retained by the government under the prime contract. See Aetna Casualty and
Surety Co. v. United States, 526 F.2d 1127, 1130 (Ct. Cl. 1975), cert. denied, 425
U.S. 973 (1976). Resort to this equitable remedy against those funds is extremely
limited and has been permitted only in situations where the claimant showed that
the surety on the Miller Act payment bond was insolvent. United States ex rel.
Reuter v. McDonald Construction Co., 295 F. Supp. 1363, 1366 (E.D. Mo. 1968).
Federal courts will generally limit a Miller Act suretys liability to the
express terms of the bond it provides. Therefore, where no payment bond exists
and a performance bond does not include guarantees other than completion of the
project, there is no liability of the surety to unpaid subcontractors and suppliers.
Babcock & Wilcox Co. v. American Surety Co., 236 F. 340, 342-43 (8th Cir.
1916).
(iii)
The Miller Act allows recovery for labor or material. Most items can be
readily identified as such, but the scope of this provision has been the subject of
many lawsuits. What, for example, is the status of rented equipment, purchased
equipment, equipment repairs, items supplied for but diverted from use in the
bonded project, delay damages, attorneys fees and lost profits?
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(b)
Delay Damages
Unlike the law regarding delay damages, the law regarding recovery of
attorneys fees, finance charges and lost profits is well settled: they are not
recoverable. Knecht Inc. v. United Pacific Ins. Co., 860 F.2d 74 (3d Cir. 1988)
(attorneys fees not recoverable on a payment bond as a sum justly due);
Reliance Universal Ins. Co. v. Ernest Renda Const. Co., 454 A.2d 39 (Pa. Super.
1982) (service/finance charges not recoverable); Arthur N. Olive Co. Inc. v.
United States ex rel. Marino, 297 F.2d 70, 72 (1st Cir. 1961); Lite Air Products.
Inc. v. F. & D. Ins. Co., 437 F. Supp. 801, 804 (E.D. Pa. 1977).
(iv)
Statute of Limitations
claimant may not bring an action on the bond unless he remains unpaid 90 days
after last performing work or supplying material. Therefore, the claimants
cause of action does not accrue until after that 90 day period of time.
Additionally, the claimant must provide notice within ninety days of
completion of the work of his intention to file a claim. 40 U.S.C. 270(b).
Failure to provide timely notice results in forfeiture of the claim; courts have no
discretion to waive the notice requirement. Id.
(v)
The surety and prime contractor can defend an action brought against a
Miller Act payment bond by asserting that all of the Acts technical requirements
have not been met. The defendant may challenge the claimants standing. For
example, in an action brought by a second tier subcontractor, the prime contractor
may assert that the first tier party was a supplier rather than a subcontractor so
that the claimant is not covered by the Act. The defendant may assert that
materials provided by the claimant were not used on the project and that no
reasonable belief existed that they would be used. The defendant might also
challenge the adequacy of notice.
In an interesting decision, the Florida Supreme Court in American Gas.
Co. v. Coastal Caisson Drill Co., 542 So.2d 957 (Fla. 1989), ruled that a
contractor could not waive its rights under a public payment bond as against
public policy. This issue apparently has not been decided by the Pennsylvania
courts, although some federal decisions appear to permit a party to waive its rights
under a payment bond. See United States v. James McHugh Sons, 21 F. Supp.
202 (D. Okl. 1938), affd, 108 F.2d 55 (5th Cir. 1938).
A charge, claim or setoff which a prime contractor has against a Miller
Act subcontractor claimant may also be asserted as a defense to a Miller Act
claim. However, a general contractor cannot raise a setoff defense against a
claimant with whom he does not have privity of contract. United States v. Avanti
Constr., Inc., 750 F.2d 759 (9th Cir.), cert. denied, 106 S. Ct. 60 (1984).
d.
Each state has enacted its own version of the Miller Act to provide
subcontractors and suppliers with protection comparable to what they would
receive on private projects through mechanics lien law. The Public Works
Contractors Bond Law of 1967, 8 P.S. 191, et seq. (Pennsylvanias Little
Miller Act), so closely parallels its federal counterpart that courts interpret this
statute by applying Miller Act case law.
As with the Miller Act, the single most important factor in determining
whether Pennsylvanias Little Miller Act applies is whether the Commonwealth
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The owner is the named obligee in the bond and is the party primarily
protected by the contractors performance bond. The Little Miller Act provides
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that the performance bond . . . shall be solely for the protection of the contracting
body which awarded the contract. 8 P.S. l93(a)(1). Sometimes, however, the
project lender may also be named as the co-obligee.
(ii)
In the event of a default by the principal, the surety will be called upon to
either complete the project, or pay damages to finance the completion of the
project. The suretys obligation is limited to the penal sum of the bond. As work
progresses on the project and the contractor is paid, those progress payments
reduce the penal sum of the bond.
Direct and consequential damages may be recovered on the performance
bond. Direct damages are those sustained by the owner as a direct result of the
contractors failure to perform, and typically consist of the lesser of the cost to
complete the project, or the difference between the market value of the project as
contemplated by the contract and the market value of the project as built,
including defective work.
Consequential damages are those that indirectly result from the
contractors default, and under basic contract law are recoverable only if the
parties could have reasonably foreseen such damages as likely to result from a
default at the time the contract was executed. Consequential damages may include
additional fees and loss of opportunity or loss of use of the facility.
The prevailing view is that a surety is liable for delay damages resulting
from a project being completed behind schedule, including liquidated damages.
Riva Ridge Apts. v. Robert G. Fischer Co. Inc., 745 P.2d 1034 (Colo. App. 1987).
The owner must assert these claims prior to releasing final payment as, once final
payment has been made, the owner loses the right to recover liquidated damages
from the performance surety. County of Dauphin v. Fid. & Dep. Ins. Co. of
Maryland, 770 F. Supp. 248 (M.D. Pa. 1991).
A surety may also be liable for the cost of replacing work which is
defective and in breach of contract warranty or guaranty. Tudor Development
Group, Inc. v. U.S.F. & G., 692 F. Supp. 461, 463 (M.D. Pa. 1988); see C&B
Construction Co. v. Nashville School Dist., 484 S.W.2d 519 (Ark. 1972)
(defective roof on school).
(iii)
The surety may assert any defense available to the principal under the
contract. In addition, the surety may raise any defense arising either by virtue of
the terms of the bond or the conduct of the obligee or principal. See Houston Fire
& Cas. Ins. Co. v. E.E. Cloer General Contractor, 217 F.2d 906 (5th Cir. 1954)
(where surety steps into the shoes of the contractor upon default, it is entitled to
all the benefits owed the contractor, but it also assumes all the contractors
liabilities).
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The surety has no obligations under the performance bond until the
contractor is declared by the owner to be in default, except that the surety in some
circumstances must attend conferences called by the owner when the owner is
considering declaring a contractor in default. See AIA Document A3l2
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Performance Bond (1997 ed.). The contract or the bond instrument will usually
define a contractors default. See AIA Document A3l2 Performance Bond (1997
ed.). Examples include failure to timely prosecute the work, performing defective
work, abandonment of the project, failure to pay subcontractors or suppliers, and
contractor s bankruptcy.
Generally, there is no default where the contractor ceases work due to
circumstances beyond his control, such as weather, an unforeseen strike, an unjust
refusal of the owner to make payments, or because the owner refuses to permit
reasonable adjustments to accommodate significant changes.
(v)
47
(v).
(vii).
73 P.S. 201-2.
b.
Types of Claims
48
Creamer v. Monumental Properties, Inc., 329 A.2d 812 (Pa. 1974); Com. by
Zimmerman v. Bell Tel. Co., 551 A.2d 602 (Pa. Commw. 1988).
(i)
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(ii)
TORT ACTIONS
a.
In the construction context, strict products liability claims can arise when a
building product or assembly fails to perform as expected, causing injury or
damage to a contracting party, a third party, or the project itself.
To recover under Pennsylvania law for a strict products liability claim, a
plaintiff must establish that the product was defective, that the defect was the
proximate cause of the injury to the plaintiff, and that the defect which caused the
injury existed at the time that the product left the sellers possession. Davis v.
Berwind Corp., 547 Pa. 260, 267, 690 A.2d 186, 190 (1997). Because a
construction product rarely passes directly from the manufacturer to the
construction site, but instead is handled, fabricated and often incorporated into
larger assemblies by other parties, all parties within the supply chain may be
subject to this type of claim. At the same time, each of the parties in the chain
may assert as a defense that the actions or inactions of the other parties in the
supply chain caused the complained-of defect or injury.
In at least one case, a federal district court sitting in Pennsylvania ruled
that a design-build engineering concern could be sued by an owner under a strict
liability theory. See Abdul-Warith v. Arthur G. McKee & Co., 488 F. Supp. 306,
310 n.3 (E.D. Pa. 1980).
As with many tort claims, a claim grounded in a strict products liability
theory may be subject to limitation under the economic loss doctrine. See East
River S.S. Corp. v. Transamerica Delaval, Inc., 476 U.S. 858, 871 (1986) (purely
economic losses are not recoverable in negligence and strict liability tort actions
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in the absence of personal injury or damage to property other than the product
itself).
b.
Claimants often contend that another party involved in the project was
negligent and that such negligence was a legal cause of damage sustained by
claimant. In order to prevail on this negligence claim, a claimant must prove, as
in all negligence actions, that: 1) defendant owed a duty of care to plaintiff; 2)
that the defendant was negligent; and 3) defendants negligence was a legal cause
of damage sustained by plaintiff.
Negligence claims are often asserted in addition to, or in lieu of, breach of
contract claims because negligence claims may permit recovery of punitive or
exemplary damages and avoid contractual limitations on the amount or type of
recoverable damages. Courts in some jurisdictions hold that the existence of a
contractual relationship generally excludes the opportunity to present purely
economic harms as tort claims. See Wolfe v. Continental Cas. Co., 647 F.2d 705
(6th Cir. 1981), cert. denied, 454 U.S. 1053, (1981) (under Ohio law, when the
essence of a claim is to seek recovery for the value of a contract, the action is for
breach of contract rather than negligence); Berschauer/Phillips Constr. Co. v.
Seattle Sch. Dist. No. 1, 124 Wash. 2d 816, 881 P.2d 986 (1994) (purely
economic loss is remediable only in contract claim). Other jurisdictions hold that
the negligent performance of a contractual duty can support a negligence action.
See St. Paul Ins. Co. v. Estate of Venute, 275 Ill. App. 3d 432, 656 N.E.2d 113
(1995), appeal denied, 165 Ill. 2d 565, 662 N.E.2d 431 (1996) (contractor owed
Owner duty of care when performing renovation work that resulted in flooding of
Owners medical building); Langner v. Charles A. Binger, Inc., 503 So. 2d 1362
(Fla. Dist. Ct. App. 1987) (negligent performance of a contract may support
actions in both tort and contract). A third line of reasoning focuses on whether
the duty breached is imposed by agreement of the parties (breach of contract) or
whether it is imposed by operation of law regardless of the agreement or
non-agreement of the parties (tort). See Sam Finley, Inc. v. Barnes, 156 Ga. App.
802, 275 S.E.2d 380 (1980) (Owner has right to maintain an action in tort if the
contractor violates a duty owed to owner, independent of the contract, to avoid
harming owner). Consequently, in some jurisdictions a Contractor may be liable
to an Owner both in tort and contract if the Owner can establish that there is an
independent duty of care owed by the Contractor to the Owner.
However, most jurisdictions require contractual privity prior to imposing
tort liability for purely economic loss. See Danforth v. Acorn Structures, Inc.,
608 A.2d 1194 (Del. 1992) (economic loss doctrine precluded buyer of building
kit for home from recovering from seller); Council of Co-owners Atlantis
Condominium, Inc. v. Whiting-Turner Contracting Co., 308 Md. 18, 517 A.2d
336 (1986) (developer and builder liable to homeowners association for negligent
construction of building); Floor Craft Floor Covering, Inc. v. Parma Comm. Gen.
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Hosp. Assn, 54 Ohio St. 3d 1, 560 N.E.2d 206, 209 (1990) (no cause of action
for economic damages against design professionals who drafted plans and
specifications, in the absence of privity of contract); Spivack v. Berks Ridge
Corp., 402 Pa. Super. 73, 586 A.2d 402 (1990) (economic losses may not be
recovered in tort absent physical injury or property damage).
c.
Negligent Misrepresentation
Some courts have ruled that some negligent misrepresentations may give
rise to a claim for damages. This cause of action generally arises out of Section
552 of the Restatement (Second) of Torts, which provides:
Information Negligently Supplied for the Guidance of Others.
(1) One who, in the course of his business, profession, or
employment, or in any other transaction in which he has a
pecuniary interest, supplies false information for the guidance of
others in their business transactions, is subject to liability for
pecuniary loss caused by them by their justifiable reliance upon the
information, if he fails to exercise reasonable care or competence
in obtaining or communicating the information.
(2) Except as stated in Subsection (3), the liability stated in
Subsection (1) is limited to loss suffered
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Morgan, Lewis & Bockius LLP
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rule for negligence actions against an architect, structural engineer, and project
inspector in Berschauer/Phillips Constr. v. Seattle Sch. Dist. No. 1, 124 Wash. 2d
816, 881 P.2d 986 (1994). There, the plaintiff contractor suffered economic
damages for delays on a project for renovation and new construction work at a
school. The plaintiff alleged inaccurate and incomplete architectural and
structural engineering plans, as well as negligence for failing to competently
inspect. Finding that there is a beneficial effect to society when contractual
agreements are enforced and expectancy interests are not frustrated, the court
held that in construction disputes, the contracts entered into among the various
parties should govern their economic expectations. Id. at 828. See also Hartford
Fire Ins. Co. v. Associated Construction and Mgmt. Corp., __ F. Supp.2d __,
2000 U.S. Dist. LEXIS 4959 (E.D. Pa. 2000) (no economic loss recovery against
engineer retained by design-builder); Calloway v. City of Reno, 993 P.2d 1259
(Nev. 1999) (no economic loss recovery against contractor).
f.
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the economic loss doctrine has been adopted in a majority of jurisdictions. See id.
at 868.
The primary rationale for the economic loss doctrine is that principles of
tort law are not intended to compensate commercial parties for losses suffered as
a result of breach of contract duties. Contract principles, such as warranty, on the
other hand, are well suited for commercial controversies because the parties can
set the terms of their agreements and, within limits, disclaim warranties or limit
remedies while allowing the purchaser to obtain the benefit of the bargain.
These policy rationales are particularly applicable to construction claims.
Construction projects are characterized by detailed and comprehensive written
contracts that define the parties rights and responsibilities. The contracting
parties are usually free to adjust their respective obligations to satisfy their
expectations. A buyer can also often address or avoid economic loss problems
from construction defects by obtaining insurance, negotiating a warranty, or by
reducing the contract price to reflect the risk of any hidden defects.
(a)
A majority of jurisdictions have adopted East River and find that damage
that a product causes to itself to be economic loss, unrecoverable in tort, while
damages to other property are recoverable in tort. While adhering to the
product itself vs. other property distinction, courts have differed on the
interpretation of these terms.
In 2-J Corp. v. Tice, 126 F.3d 539 (3d Cir. 1997), the Third Circuit Court
of Appeals, applying Pennsylvania law, held that inventory and other items being
stored in a warehouse at the time of its collapse was other property, damage to
which was recoverable in tort. The court stated that for the purposes of the
economic loss doctrine,
the product is no more and no less than whatever the manufacturer
placed in the stream of commerce by selling it to the initial user.
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Michael R. Libor
Morgan, Lewis & Bockius LLP
Most courts apply the economic loss doctrine in equal force to service
contracts in the construction industry. In Commercial Union v. Kirby, Nos. 977272, 97-7285 affd without opinion, 149 F.3d 1163 (3d Cir. 1999), the Third
Circuit Court of Appeals ruled that under Pennsylvania law, the economic loss
doctrine applies to claims involving the provision of services as it does to product
liability claims. There, the plaintiff claimed negligent design and engineering
services with respect to the design, sale and erection of a pre-engineered building.
The court recognized that the principal cases applying the economic loss doctrine
generally involved actions based on products liability, but found that a host of
courts applying Pennsylvania law have employed the economic loss doctrine in
actions having nothing at all to do with products.
F.
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Morgan, Lewis & Bockius LLP
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New York, 58 N.Y.2d 377, 448 N.E.2d 413 (N.Y. 1983), stated the exception as
follows:
...[A]n exculpatory agreement, no matter how flat and unqualified
its terms, will not exonerate a party from liability under all
circumstances. Under announced public policy, it will not apply to
exemption of willful or grossly negligent acts. *** More pointedly,
an exculpatory clause is unenforceable when, in contravention of
acceptable notions of morality, the misconduct for which it would
grant immunity smacks of intentional wrongdoing. This can be
explicit, as when it is fraudulent, malicious, or prompted by ... bad
faith. Or, when, as in gross negligence, it betokens a reckless
indifference to the rights of others, it may be implicit. *** In either
event, the policy which condemns such conduct is so firm that
even when ... it is determined *** that the conduct sought to be
exculpated was within the contemplation of the parties, it will be
unenforceable.
Id., 58 N.Y.2d at 384-385 (citations omitted; emphasis added). See also
Georgetown Steel v. Union Carbide Corp., 806 F. Supp. 74 (D.S.C. 1992),
remanded, 1993 WL 358770 (4th Cir. 1993) (exculpatory clauses generally
disfavored and strictly construed). Some states have statutes which further
circumscribe the inforcement of exculpatory provisions. See, e.g., N.Y. Gen.
Oblig. Law 5-322.1 and 5-323 (McKinneys 1999) (clauses exempting a party
from "liability for injuries to person or property" caused by his ordinary
negligence in a contract for work performed or services rendered in connection
with the construction of real property or its appurtenances is void and
unenforceable as a matter of public policy.)
1.
One of the most common exculpatory clauses is the no-damages-fordelay clause, which relieves the Owner from paying damages for delays on the
Project. Indeed clauses such as these can even be found in multiple prime
situations where the Owner attempts to relieve itself not only of delay damages
but also from coordinating multiple prime contracts. Broadway Maint. Corp. v.
Rutgers, 447 A.2d 906 (N.J. 1982). Exculpatory clauses are enforceable unless
the claimant can show parties did not contemplate the situation at the time the
contract was executed. See Coatesville Contractors & Eng.. Inc. v. Ridley Park,
509 Pa. 553, 506 A.2d 862 (1986) (clause not enforceable because Owner
breached express promise that the lake bed would be dry for the Contractors
work); Gasparini Excavating Co. v. Pennsylvania Turnpike Com., 409 Pa. 465,
187 A.2d 157 (1963) (lack of complete access to work site due to operations of
third parties not with contemplation of the parties); Commonwealth Dept. of
Highways v. S.J. Groves and Sons Co., 20 Pa. Commw. 526, 343 A.2d 72 (1975)
(lack of access to the work site for causes not within the contemplation of the
Contractor). But see John B. Gregory & Son, Inc. v. A. Guenther & Sons Co.,
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147 Wis.2d 298, 432 N.W.2d 584 (1988) (refusing to recognize uncontemplated
delays exception to enforceability of no-damages-for-delay clause). However, a
delay that is reasonably anticipated from the circumstances attending the project
will not invalidate a limitation of damages provisions. Henry Shenk Co. v. Erie
County, 319 Pa. 100, 104, 178 A. 662, 664 (1935). See also P.T. & L. Constr.
Co. v. Dept. of Transp., 108 N.J. 539, 531 A.2d 1330 (1987).
Exculpatory provisions such as a no-damages-for-delay clause may also
be waived by the Owner. In Findlen v. Winshendon Housing Auth., 28 Mass.
App. Ct. 977, 553 N.E.2d 554 (1990), a Massachusetts court ruled that an Owner
waived a no-damages-for-delay clause by paying one delay claim and indicating a
willingness to consider others.
2.
A pay-when-paid clause provides that a prior payment from a thirdparty is a condition precedent to a Contractors payment to its subcontractor so
that the contracting parties share the credit risk of the source from which the funds
will come. To the extent the clauses are not well drafted, courts are not inclined
to enforce them. Instead, courts hold that they fix a time period for payment and
that after a reasonable time period the money must be paid, despite the language
in the clause. See Schuler-Haas Elec. Corp. v. Aetna Cas. & Sur. Co., 371
N.Y.S.2d 207 (App. Div. 4th Dept. 1975) (language in contract did not set a
condition precedent); United Plate Glass Co. v. Metal Trim Indus.. Inc., 525 A.2d
468 (Pa. Commw. Ct. 1987) (clause not enforced because it was not a condition
precedent); but see Crown Plastering v. Elite Assoc., 560 N.Y.S.2d 694 (App.
Div. 2nd Dept. 1990) (clause enforced because payment was a condition
precedent). In order to be enforceable, a pay-when-paid clause should be drafted
to provide expressly that (1) payment from the owner is a condition precedent, (2)
that the parties share the credit risk, and (3) that the subcontractor agrees that it is
to be paid only from a specific fund from the owner. State statutes governing
prompt payment may govern payment terms on contracts, and trump conflicting
contract provisions. See, e.g., Pennsylvania Contractor and Subcontractor
Payment Act, 73 P.S. 501-516 (Purdon 2001); Md. State Fin. & Proc. Code
Ann. Section 15-101 through 105 (Repl. Vol. 1995 and 1997 Supp.).
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Morgan, Lewis & Bockius LLP
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