On July 28, 2015, the Pennsylvania Supreme Court agreed to consider an appeal from a Superior Court opinion involving the Pennsylvania Contractor and Subcontractor Payment Act.  To call the case significant is  an understatement because if the Supreme Court overturns the Superior Court, agents and principals of real estate development entities will become personally liable for debts owed to unpaid contractors.

In Scungio Borst & Associates v. 410 Shurs Lane Developers, LLC, et. al., a divided Pennsylvania Superior Court ruled that an individual owner and agent of a real estate developer was not personally liable for Payment Act damages owed to a general contractor.  (The Payment Act permits an unpaid contractor to recover interest at 1% per month, penalty at 1% per month, and reasonable attorneys fees incurred in collecting amounts owed to it from an owner.)  In that case, the the 51% owner of the developer interacted with the contractor, approved change orders, and processed the contractor’s payment requests.  The contractor argued that the plain language of the Payment Act permitted imposition of damages against the individual owner of the real estate developer because Payment Act’s definition of “owner” specifically included “agents of the owner acting with their authority.”

The trial court rejected this argument and granted summary judgment to the individual. The case then went to trial against the real estate developer entity and the trial court awarded the contractor over $1.5 million in damages. The contractor then appealed the trial court’s granting of summary judgment to the individual owner of the developer.

The Superior Court affirmed the trial court.  In affirming the trial court, the majority of the Superior Court explained that the language of the Payment Act was ambiguous on whether it imposed personal liability on the owners of real estate developers.  However, the Superior Court held (I believe correctly) that the Payment Act merely exemplifies contract damages and does not extend liability beyond traditional breach of contract principles.  To hold otherwise would be to impose statutory penalties for breach of contract on non-contracting parties.  Accordingly, the Superior Court rejected the “contention that the General Assembly intended to make every authorized agent of a property owner, or even corporate decision-makers, subject to liability under [the Payment Act] as owners. [Payment Act] liability lies against contracting parties only.”

The Supreme Court agreed to hear the appeal which will resolve the issue of whether the Payment Act makes the owner and“agent[s] of the owner acting with the owner’s authority” liable to contractors.   The ramifications of the Supreme Court’s decision for real estate developers cannot be underscored, especially for smaller developers.  If the Court overturns the Superior Court and holds that the Payment Act can impose personal liability on individual owners of real estate firms, it is hard to imagine when an individual owner of a developer would not be personally liable for non-payment.  The relationship between the 51% owner in Shurs Lane and the contractor – whereby the individual approved change orders and interacted with the contractor – is hardly unusual and is probably the norm on 99.999% of all construction projects.

Conversely, an overturning of the decision would be a boon to contractors and would give them tremendous leverage against developers who fail to pay.  This is especially true because many development entities are “single purpose entities” and unpaid contractors can only look to the assets of the entity itself to satisfy a judgment.  Except for limited circumstances, the individual owners of those firms enjoy immunity from personal liability based on the entities inability or unwillingness to pay.

We can expect a decision sometime next year.

Over budget construction projects are all too common problem for project owners.  A Google News search of the term “construction cost overruns” yields the following stories for the month of July 2013 alone:

  • A VA hospital that is $400 million over budget;
  • A nuclear power plant that is $700 million over budget; and
  • An airport terminal that is “substantially over budget.”

That is over $1 billion in total cost overruns for only three construction projects.

While most of the blame usually is directed towards the project’s general contractor, in reality project owners should only blame themselves.  Owners usually spend little time (and money) making sure their construction documents are drafted to fully protect their interests.

Owners usually make three common mistakes, all with simple fixes, during the project’s contracting phase that cause them to have construction projects that are over budget: (1) failing to make sure the architect issues fully complete construction documents; (2) failing to require contractors to review the drawings and specifications prior to bidding; and (3) simply accepting the lowest bid.

 1.         Incomplete Design Documents.

While other forms of project delivery, such as design-build and construction manager at risk, are gaining acceptance, the most common delivery method remains design-bid-build.  Under the design-bid-build delivery method, the owner hires an architect to design the project (Design).  The architect designs the project and prepares drawings, plans, and specifications outlining what the contractor are to build.  The owner then takes the plans and specifications and obtains bids from contractors to build the project (Bid).  Finally, the owner selects a contractor to build the project (Build).

Projects go over budget when contractors demand more money from the owner for work that was not clearly shown on the plan and specification that the architect prepared.  These payment demands are referred to as change orders.  This mistake that most owners make is assuming that the architect has prepared a 100% complete set of plans and specification that contain every detail necessary for the contractor to build the project.  To the contrary, most owner-architect agreements only require the architect to prepare plans and specifications that show the architect’s general design intent.  It is up to the contractor to fill in the blanks by requesting information from the architect during the construction phase of the Project.  Problems arise when contractors claim their bid was based on details not shown on the plans and specification and when the detail is revealed during the construction of the project the owner is forced to incur additional costs.

In order to address this problem, owners should insist that their owner-architect agreement contains language requiring the architect to produce a fully 100% complete set of drawings that are fully coordinated with any documents prepared by engineers and designs working on the project.  By including such language, owners can look to the architect for compensation for cost overruns incurred because of missing details in the drawing.  Of course, owners routinely look to the architect for compensation when they are forced to incur additional costs because of incomplete plans, however, by including language requiring the architect to produce a fully complete set of documents they undercut the number of defenses the architect can raise.

2.         Failing to Require Contractors to Review Documents Prior to Bidding.

In order to combat the contractor who seeks additional compensation for work allegedly not shown on the plans and specifications, owners need to include language in their owner-contractor agreement that stating that the contractor has fully reviewed the plans and specifications prior to submitted its bid.  The owner should also require the contractor to affirm that it is fully familiar with the plans and specifications and fully understands the architect’s design intent and that the contractor’s price includes all of the work necessary to achieve the architect’s implied or express design intent.

3.         Accepting the Lowest Bid.

Whether it be demands of shareholders, boards of directors, or investors, the owner’s need to complete a project at the lowest possible price is understandable.  However, unlike in the public contracting, there is no need for the owner to select the lowest bid among the bids it receives.  As any experienced owner knows, the lowest bid does not equal the best bid.  Indeed, some unscrupulous contractors are known to purposely under bid a project only to make up the cost through a series of change orders which request additional compensation.

Owners are much better off going with a trusted contractor rather than simply selecting the lowest bid.  Selecting a trusted contractor with a track record of constructing projects like the one the owner wants to build combined with changes to the contract suggested above will greatly increase the chances that a contract will be completed on budget and on time.

Owners should never be “thrilled” with bids that come in substantially under budget because it usually means something is either wrong with their construction documents or their contractor intends to make up there thrilling under budget bid with scope related change orders.

According to ENR, Taisei Construction Company has filed a lawsuit against San Joaquin Delta College, which seeks $25 million, claiming the College “substantially increased the scope of work” on a project to construct a new math and science building.  The story goes on to say that the College estimated the cost of construction to be $65 million but was “thrilled” when Taisei bid just $35 million for the project.  Shockingly, the contractor is claiming that the actual cost of construction was close to the College’s original estimate.

Two things could have happened here.  Either, College’s construction documents (the drawings) were woefully inadequate for the contractor to accurately prepare its bid.  In other words, the contract document did not fully show the contractor what was intended to be constructed.  In which case, the College can proceed against its design profession (construction speak for the architect or engineer) who prepared the contract documents.  Or, the contract documents were in fact 100% complete and the contractor simply deliberately underbid the job in order to be awarded the contract with the intent to make up its price through change orders.

Either way, the College could have prevented this lawsuit.  First, it should have assured its contract with its design team required the design team to prepare a fully complete set of construction documents that were fit for construction, rather than simply preparing a set of documents showing the general intent of the architect, which is often the case.  The College apparently did not do that because College officials are quoted in the article as saying “here was no such thing as a perfect set of design drawings.”  Second, it should have assured that its contract with Taisei required that Taisei fully familiarize itself with the drawings and to raise any objections to the drawings prior to construction.  Finally, and perhaps most importantly, it should have asked why the Taisei’s bid came in $30 million under budget!

Three simply things that could have potentially avoided a $25 million lawsuit.

One of the great things about living in a large city is being able to walk everywhere.  I like walking because it is when I do my thinking.  Sometimes I do too much thinking that it causes me to walk several blocks past my intended location. We sometimes lose focus on what is happening around us while we are focused on the task at hand.  It is easy to lose focus on the bigger picture on a complex construction project with its multiple moving parts, men, and material.  Unfortunately, the consequences of losing your focus on a construction project are much worse than simply walking past your intended location.

In recent years, federal prosecutors have raised the stakes for contractors that lose focus on a construction project.  One area where you can easily lose focus is in complying with the multiple federal laws that apply to the project.  Under the False Claims Act, contractors — and their executives — can be prosecuted for failing to assure that their subcontractors are following certain those laws.

A False Claims Act violation occurs when a person “knowingly makes, uses, or causes to be made or used, a false record or statement to get a false or fraudulent claim paid or approved by the Government.”  Importantly, unlike common law fraud, the government need not show that you intended to defraud the government when you submitted your claim.  The false certification need not be an expressly false statement for there to be a False Claims Act violation.  Under the implied certification theory of liability you can be liable for violating the “continuing duty to comply with the regulations on which payment is conditioned.”

The case U.S. ex rel. Wall v.Circle C Construction, LLC, is a good example of what can happen when you fail to make sure that your subcontractors are following federal regulations before submitting an application for payment.  The defendant, Circle C Construction, had a contract with the Army to perform work on buildings at Fort Campbell in Tennessee.  Prosecutors claimed that Circle C violated the False Claims Act by submitting applications for payment falsely claiming that all of its subcontractors paid prevailing wages under the Davis Bacon Act.

As is typically the case, Circle C’s contract with the Army required Circle C and its subcontractors to pay prevailing wages, to submit certified payroll showing the payment of prevailing wages, to insure its subcontractors complied with the Davis Bacon Act, and to assure that the certified payroll submitted to the Army was accurate and complete.

Circle C, however, neglected to submit certified payroll for its electrical subcontractor, Phase Tech.  The reason for the failure to submit accurate certified payroll for Phase Tech was not because of some scheme to defraud the government by Circle C, rather, it was Circle’s C sloppiness in determining who was working on the project.  In other words, it was not intentional. However, intent was not required because the court applied the implied certification theory of liability and found against Circle C and awarded the government over $500,000 in damages, which it then trebled (tripled) under the False Claims Act, for a total damage award in excess of $1.5 million.

The Circle C case is just one example of easily you can run afoul of the False Claims Act by failing to be diligent that you and your subcontractors are following the federal laws and regulations regarding your project.  Other examples where contractors have run into similar False Claims Act issues are when it fails to assure that federal DBE rules are being complied with on a project.   You should be particularly concerned about the False Claims Act because False Claims Act prosecutions have nearly doubled over the last few years and there have become “en vogue” for federal prosecutors.

 

We are witnessing an explosive growth of newly constructed pipelines to carry shale oil and natural gas.  This is a tremendous opportunity for contractors looking for new markets to grow revenue.  Because pipeline construction is happening in many areas for the first time in decades, for many contractors it is probably  the first time they have worked a pipeline construction project.  However, this is not the case for the owners of the pipelines.  They are seasoned pipeline construction veterans who have been building pipelines for years.  Their contracts reflect the battle scars of past disputes and shift as much risk as possible to the contractor.

Pipeline construction clearly involves a lot of digging.  Where there is digging, there is the unknown of what lies in and below what is being dug.  To address this risk, pipeline owners will include in their contract a differing site conditions clause.  Generally, these clauses disclaim any warranty or representation as to what you will encounter once you start excavation and shift the risk to the you if what you encounter is different than what the contract (or bid) documents represented you should expect to encounter.  When a differing site conditions clause like this appears in your contract, you cannot recover additional costs because you encountered conditions that you did not expect, like addition or different rock, soil, or (as the case below) existing pipeline crossings.   (This is not typically the case for projects performed for the federal government )

El Paso Field Services v. Mastec North America, involved the construction of an underground gas pipeline.  El Paso’s bid package showed only 280 “foreign crossings” (crossings of other existing pipelines along the proposed pipeline right of way) when there were actually 794.   Mastec sought compensation for the additional costs associated with encountering the 594 additional crossing.  The contract, however, contained several sections that broadly addressed differing site conditions and that shifted the risk entirely to Mastec causing the court to deny Mastec’s claim.

If pipeline construction is a new field for you, be aware of what your contract says about differing site conditions.

 

(Note:  My DBE related blog post are always among the most read.  When I recently asked folks for help coming up with a future blog post topic, DBE “regular dealer” issues was a near unanimous response.)

Under the Department of Transportation (“DOT”) DBE regulations, contractors can only count the value of the work actually performed by a DBE towards the contractor’s DBE goals.  This is usually not a problem when the DBE is performing actual construction of a component of the improvement.   However, a problem arises when using DBE material suppliers to meet DBE contracting goals.

Under DOT DBE regulations, contractors can count 60% of the value of supplies and materials purchased from a DBE supplier only if that DBE supplier is a regular dealer.  The regulations define “regular dealers” as:  “a firm that owns, operates, or maintains a store, warehouse, or other establishment in which the materials, supplies, articles or equipment of the general character described by the specifications and required under the contract are bought, kept in stock, and regularly sold or leased to the public in the usual course of business.”

However, this definition that appears in the DOT DBE regulations, which are binding legal regulations, leaves open several questions.  Must a DBE regular dealer physically have the item in stock in order for its value to be counted?  Can a DBE regular dealer “drop ship” specialty products?

In 2011, the DOT Office of General Counsel attempted to answer these and other related questions concerning DBE “regular dealers”  when it published a “Q&A” that attempted to address these issues. The DOT periodically publishes Q&A’s concerning questions and issues that are raised by the public.  Although they are not legally binding regulations, they do represent the represent DOT’s institutional position.

In short, the DOT’s Q&A on regular dealers suggests that there are very few circumstances, except for being out of stock, where a contractor can be given credit for the value of materials that a DBE supplier must order for the contractor.  Moreover, the DOT ruled out drop shipments as being counted towards DBE goals.

Why is this important?  First, it impacts you bid and subjects your bid to attack from both the contracting agency and a disgruntled bidder.  While an agency cannot reject your bid per se  for failing to meet stated DBE goalsit can reject it if you cannot demonstrate your “good-faith” efforts – as defined in the regulations – to meet the stated goal.  Furthermore, if you have used DBE suppliers to meet the stated goal and your are the low bidder, a disgruntled bidder could challenge your bid on the grounds that your DBE goals fail because they rely upon DBE suppliers who are not regular dealers in the products required by the specifications.

Second, the DOT is pressuring state agencies to more closely monitor compliance with the DBE supplier counting requirements and DOT investigations concerning DBE fraud and compliance are on the rise.  In fact, late last year PennDot revised its rules for counting DBE suppliers to be consistent with DOT guidance offered in its Q&A.

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.

The Justice Department’s decision to drop its False Claim Act case against Kellogg, Brown, and Root (“KBR”) over armed private security contractors (“PSC”) in Iraq says as much about the touchy subject over America’s increasing reliance on a private army as it does about the need to fully understand ALL of the terms of your contract.

In United States of America v. Kellogg Brown & Root, U.S. District Court for the District of Columbia, No. 1:10-cv-00530, the Justice Department alleged, among other things, that KBR had violated the False Claims Act when it requested payment for services provided by PSC’s to KBR, KBR executives in theater (i.e, Iraq), and KBR subcontractors also operating in theater.  The government claimed that KBR failed to obtain proper authorization from US Central Command (“CENTCOM”) before employing armed PSC’s to provide security to it and its subcontractors.  The government claimed that KBR’s contract prohibited KBR from employing armed PSC’s.  The basis for the government’s claim is one all too familiar to contractors – the incorporation by reference and compliance with laws clauses in KBR’s contract.

KBR entered into a logistical support contract with the government in 2001, before the War in Iraq began, that had nothing to do with private security.  The contract contained a typical incorporation by reference and compliance clauses found in most contracts.  The clause stated:

[KBR] shall ensure that all personnel hired by or for [KBR] will comply with all guidance, instructions, and general orders applicable to U.S. Armed Forces and DoD civilians as issued by the Theater Commander or his/her representative.  This will include any and all guidance and instructions issued based upon the need to ensure mission accomplishment, force protection, and safety, unless directed otherwise in the task order SOW [Statement of Work]

. . .

The contractor shall comply, and shall ensure that all deployed employees, subcontractors, subcontractors employees, invitees, and agents, comply with pertinent Service and Department of Defense directives, policies, procedures, as well as federal statutes, judicial interpretations and international agreements (e.g. Status of Forces Agreements, Host Nation Support Agreements, ect.) applicable to the U.S. Armed Forces or U.S. citizens in the area of operations.

After several high profile incidents involving PSC’s, CENTCOM and the Coalition Provisional Authority issued order essentially banning PSC from owning privately owned firearms without obtaining permission from CENTCOM first.  The government alleged that these orders became part of KBR’s contract via the incorporation and compliance clauses in the contract and KBR, therefore, violated its contract when it employed PSC who carried privately owned firearms without first obtaining permission of CENTCOM.

The parties litigated the case for two years until the government voluntarily dismissed the case without prejudice.  It is doubtful that KBR is celebrating victory, however. First, because the government withdrew the case “without prejudice” that means it can re-file the case against KBR at a later date provided the statute of limitations has not then run.  Second, KBR probably spent close to – if not in excess – of $1,000,000 in legal fees defending a case brought on by one small clause in its contract.

Like most contractors, before this case, I doubt KBR ever gave much thought to the ramifications of the incorporation and compliance with laws provisions in its contracts.  But, I am sure it will now.  As my old mentor used to tell me, if it was not important, it wouldn’t be in the contract.  Therefore, contractors need to the impact of each clause in its contract.  And, in the case of incorporation, compliance with laws, or flow down provisions, they must consider what other terms will apply to the contract other than those in the written agreement before them.