February 2013

Because of the Bankruptcy Trustee’s “strong-arm” powers, the news that the Revel Casino in Atlantic City has filed for bankruptcy should concern any contractor who received a payment from the owner of Revel — and they are many — within the last ninety days.   Under 11 U.S.C. Section 544, the Trustee is granted the ability to, among other things, seek the return of any payment made by the bankrupt party within ninety days prior to bankruptcy filing.

The Trustee’s strong arm powers come as a shock to many when they receive a letter demanding repayment of a payment made by the debtor, especially because the payment was probably long overdue and less than the full amount owed.   However, before you rush to write a check to the Trustee consider whether the following defenses to the Trustee’s preference action are available.

1.  New Value.

The Bankruptcy Code recognizes an exception to the Trustee’s strong arm avoidance powers when payment from a debtor is made in exchange for “new value.”  This defense is grounded in the principle that the transfer of new value to the debtor will offset the payment, and the debtor’s estate will not be depleted to the detriment of other creditors.

Material suppliers are the most obvious candidates for this defense because a supplier owed money for material previously supplied will usually refuse to supply additional material unless the previous material is paid for.  Likewise, a contractor who refuses to perform any additional work and to return to a project until past due invoices are paid could avail themselves of the new value defense as well.  

Some have argued that giving waiving or releasing lien rights in exchange for payment triggers a new value defense.  The theory is that the filing of a construction lien would diminish the bankruptcy estate in some capacity.  Case law is divided on the issue of whether a release of construction lien rights constitutes new value and the Third Circuit (whose jurisdiction covers the Revel Bankruptcy) has not addressed the issue.

 2.  Ordinary Course of Business.

The Bankruptcy Code also recognizes an exception to for “payment of a debt incurred by the debtor in the ordinary course of business or financial affairs of the debtor and the transferee; made the in ordinary course of business or financial affairs of the debtor and the transferee; and made according to ordinary business terms.”

Typically, this would mean that if your payment application was due within thirty days and payment was made within thirty days, then the Trustee could not avoid the transfer.  Of course, that is usually not the case in a construction related bankruptcy because if payment were made within thirty days their probably would not be bankruptcy.

Yet, even if payment is made beyond the time for payment set forth in the contract, the “ordinary course of business” defense may, nonetheless, be made available.  The theory that payments made beyond a contractual payment deadline are made in the ordinary course of business is predicated on the — unfortunate – fact that contractors often receive late payment.  Moreover, an ordinary course of business defense is strengthened if a contractor can show a pattern and practice of late occurring payments on a project.  This is because a contractor can argue that the terms of the parties agreement changed and their was an agreement to accept later payments and the alleged preferential payment was made according to those terms.

While these defense are far from foolproof and are not always successful, they nonetheless give a contractor negotiating leverage with the Trustee when a demand for repayment of a transfer is first received.

 

 

 

 

 

 

The headline of a recent article on Lexology grabbed my attention:  “How to Guarantee the HOA Can’t Litigate the Condo Construction Defect Claims.”  The authors’ means to preventing litigation of construction defect claims was even more intriguing: arbitration clauses.

How can arbitration clauses guarantee that no ligation over construction defect claims occurs?  It can’t.  Arbitration is litigation just decided in a different forum.  Like many, the authors appear to misunderstand what arbitration is and what the parties can expect.

The misunderstanding of the arbitration process leads to a misguided bias for and against the process.  In construction defect cases, plaintiff’s counsel, in particular, bristle at the prospect of arbitrating a construction defect claim clinging to the belief that juries render larger awards.  On the other hand, defense counsel champion arbitration as a means to chill potential claims, snuff out allegedly frivolous claims, and to avoid the unhinged damages awards of juries.  These misplaced beliefs are grounded in a lack of understanding of the arbitration process and certain myths regarding arbitration.

Myth #1:  A Jury Will Give Me A Larger Damage Award.

In the early 1990’s, Professor  Ted Eisenberg of Cornell Law School published a famous law review article that examined plaintiff success rates and damage awards in jury trials and bench (Judge) trials.  To the surprise of many, the Professor Eisenberg’s revealed that plaintiffs won more frequently and received larger average awards in bench trials.  Despite empirically data to the contrary, there remains a widespread perception that jury awards are larger.

This misconception extends to arbitration panels.  Among many plaintiff’s attorneys, arbitrators are more disfavored than judges.  However, as those regularly litigating construction disputes in arbitration already know, arbitration panels regularly award extremely large damage awards.

Myth #2:  Arbitration Is Too Expensive Up Front.

It is true that the fees to initiate an arbitration proceeding are larger compared to the fees for filing a complaint in state or federal court.  Alas, litigation expenses are not limited to the initial cost of filing suit.  The overwhelming amount of attorneys fees in litigation are spent on discovery (interrogatories, document production and review, and depositions).  In arbitration, discovery is either limited by statute or agreement of the parties.  The result is usually a cost saving for the parties.

There is also a costs savings to be appreciated at the “trial” portion of the arbitration. Because the rules of evidence and procedure are relaxed (that does not mean not followed it means relaxed) the hearings are run more efficiently.  Moreover, particularly in construction defect cases, the parties benefit from the experience of the arbitration panel when it come time to explain technical areas of the construction critical to the claims.  Obviously, it is much more efficient, and thereby costs less, to have an expert explain a technical area related to the construction of an certain portion of the structure to a panel of arbitrators, who is likely already familiar with the terminology and methods described, than it is a jury, who likely has no experience with construction.

Finally, there are very few grounds for appeal of an arbitration award (much to the chagrin of those opposed to arbitration).  These efficiencies result (usually) in a lower overall litigation cost to the parties involved.

Myth #3:  Arbitration Panels Are Defense Biased.

As someone who has been on litigated cases in front of a panel of arbitrators on behalf of both claimants (in arbitration plaintiffs are called claimants) and defendants (in arbitration defendants are called respondents), I can attest that is certainly not the case.  I am unclear where this mistaken belief comes from.  However, I suspect that it comes from the unfamiliarity with the process and litigation folklore.  The fact is a good case, a good expert, and a good presentation yield good results no matter what the forum.

All of this is not to suggest arbitration is perfect.  However, it is certainly not the judicial purgatory as some believe it is.

 

The number one thing that a contractor bidding on a condominium project should know is actually two things:

  1. your client will  not occupy the structure you are building; and
  2. is trying to divest itself of ownership of what your are building as quickly as possible.

There is probably no other project that you will build where these two elements exists.

Why should you care?  Risk.  This unique factor has a tremendous impact on your risk analysis.  Risk impacts your bid – the higher the risk the higher the bid – and your construction contract, which is a series of risk shifts and allocation.

The risk that you might not be considering in a condominium project comes from the condominium buyer, who is not your client and who you will have no contact with.   Most states recognize that builders of condominiums give an implied warranty to the buyer of the condominium that the unit and structure are fit for habitation and the construction was performed in a workmanlike manner.  This is true even if you do not have a contract with the buyer (otherwise known as lack of privity) and, in some states including Pennsylvania, courts extend the implied warranty to subsequent purchasers.  Therefore, your risk is increased on a condominium project by a rather large – and unknown — class of potential plaintiffs.

Bottom line – plan (or bid) accordingly.

A contractor denied a DBE certification by a State unified certification program approved by the Department of Transportation has the right to appeal the denial to the Department of Transportation.  Contractors who have seen their certification revoked can file a similar appeal.

Appeals are taken to the Department of Transportation, Office of Civil Rights and must be made within 90 days of the decision denying certification.  Once the Department of Transportation receives the appeal, it will request a copy of the complete record from the agency that denied the certification.  The State agency is required to provide the Department of Transportation with the record within 20 days and the Department usually makes a decision on the appeal within 180 days after receiving the record from the State agency.

Importantly, the Department of Transportation will look only to the record sent to it by the State agency to see if the State agency’s decision is supported.  The Department does not conduct a new hearing or receive new evidence into the record.  This means a contractor seeking DBE approval should make sure to submit as much information as possible to the State agency when making its DBE application.

Last week, I gave an overview of the claims typically raised in a construction defect case.  This week we look at the defenses that a defendant in a construction defect case can raise.  Typically, there are three categories of defenses a defendant in a construction defect case may be able to raise:

  • Contractual;
  • Statutory; and
  • Common Law.

1.         Contractual Defenses.

In my last post, I discussed how plaintiffs in construction defect cases should look to the contract documents when evaluating what claims to bring in a construction defect case.  The same contract documents that give rise to a construction defect case can provide defenses to construction defect claims.  Three common contract clauses that can be used in defending a breach of contract claim in a construction defect case are:

  • Express waiver of warranty;
  • Integration; and
  • Release.

            Waiver of Warranties.

Many states, including Pennsylvania, recognize an owner can waive the implied warranty of habitability and workmanship by contract.  For the waiver to be valid, courts usually require that the waiver be clear and unambiguous.  Pennsylvania courts go a step further and require that the waiver specifically reference latent defects.

           Integration Clauses.

Plaintiffs in construction defect cases will sometime allege that they were fraudulently induced by the contractor based upon oral representations concerning the quality of construction.  These representations do not appear in the contract documents.  Integration clauses are clauses in contracts that state that terms in the written document represent the entire agreement and that no representations not contained in writing in the document are not part of the parties agreement.  When these clauses exist in the contract, courts have dismissed claims that owners were fraudulently induced by a contractor’s oral representations which do not appear in the written agreement.

             Release.

A contract may also contain a release of claims against the contractor or developer.  If properly worded, the release may be enforceable against claims brought by a plaintiff in a construction defect case.

2.        Statutory Defenses.

             The Statute of Limitations.

Every state has a statute of limitations that bars claims brought a certain period of time after the injury giving rise to the claim occurs (or a claimant first learns of the injury).  The length of time varies depending on the claim alleged.  If a plaintiff in a construction defect case brings its claim outside the statute of limitations, the court can dismiss plaintiff’s case.  Because the statute of limitations begins to run from the date the plaintiff first knows or should have known about the damage, it is important to discover early on in the litigation when that occurred.

            The Statute of Repose.

Most states also have something known as statutes of repose.  Statutes of repose bar all claims construction defect claims brought a certain period of time after the building was completed regardless of when the plaintiff learns of the defect.  In Pennsylvania, the statute of repose is twelve years  Therefore, suppose a plaintiff first learns of a construction defect in December 2012, but the building was completed in 1995.  If she filed her construction defect case in January 2013 she would be within the statute of limitation for whatever claim she brings, however, the statute of repose may bar her claim, notwithstanding the statute of limitations, because the building was completed more than 12 years before her claim.

3.       Common Law Defenses.

            The Spearin Doctrine.

The Spearin Doctrine is one of the best defenses to a construction defect case for a contractor but is also one that is usually not raised.  We have written about the Spearin Doctrine on this blog before.  The doctrine gets its name from a 1918 United States Supreme Court decision United States v. Spearin, 248 U.S. 132 (1918), which held that a contractor will not be liable to an owner for loss or damage that results solely from defects in the plan, design or specifications provided to the contractor. Effectively, Spearin created a doctrine where the owner impliedly warrants that the plans and specifications if followed will result in a function system.  Essentially, Spearin holds that if a contractor is required to build according to plans and specifications prepared by the owner (or the owners representative) then the contractor will not be responsible for the consequences of defects in the plan.   In other words, if the contractor builds it as he was told to by the architect and the design does not work, he is not liable for those defects.

          Economic Waste/Betterment.

Even without a defense barring plaintiff’s claim, defendants in a construction defect case can often mitigate the damages plaintiff is entitled to recover under the dual theories of economic waste and betterment.  Generally, the measure of damages in a construction defect case is the cost of completing or correcting the defective work.  However, when the cost of completing or correcting the work is disproportionate to the probable loss in value to the injured party then damages will be measured by the difference between the market price that the property would have had without the defects and the market price of the property with the defects. This is known as economic waste.

Betterment prevents an owner from receiving a windfall when repairing or replacing defective construction.  Under the theory of betterment, an owner cannot recover the cost of any enhancement or improvement of the replacement work.  In other words, the owner can only recover the cost of what he originally bargained for.

 Next week, we will look at insurance coverage issues in construction defect cases.