Cases of the Month
Significant Cases and Decisions Impacting the Construction Industry
BY: Ira Genberg
1. Effect of Owner’s Participation in Making Improvements to Leased Property, Howard S. Wright Constr. Co. v. Superior Court, 130 Cal.Rptr.2d 641 (Cal. Ct. App. 2003).
* What the Court Considered: A contractor sued to enforce a mechanic’s lien on leased property for work performed pursuant to a contract with a commercial tenant. The court considered whether a notice of nonresponsibility, recorded and posted by the commercial owner to deny any responsibility for payment of claims arising from the construction work, insulated the leased property from the mechanic’s lien.
* What the Court Said: The court found that an owner may not use a notice of nonresponsibility to shield its leased property from a mechanic’s lien when the owner has participated in construction of improvements on the property. The owner was deemed to have participated in the construction contract because the parties had contemplated that the tenant would be required to obtain significant property improvements to prepare the warehouse for its intended purpose. The owner also participated by retaining significant control over the construction by requiring that the tenant obtain the owner’s approval of the plans and specifications of the improvements.
* What the Opinion Means: If an owner of leased property participates in construction of improvements contracted for by its tenant, the owner may not then shield its property from a mechanic’s lien by filing a notice of nonresponsibility. Also, if a tenant cannot accomplish the specific purpose of a lease without making significant improvements to the leased property, then the tenant is implicitly required to make such improvements and the owner is deemed to have participated in the improvements. In the case of optional improvements, an owner’s notice of nonresponsibility generally shields its property from liens.
2. Government’s Right to Withhold Progress Payments; Johnson v. All-State Constr., Inc., 329 F.3d 848 (Fed. Cir. 2003).
* What the Court Considered: While considering the termination of a contractor for default, the government refused to make a progress payment, claiming that its liquidated damages (if the termination occurred) would exceed the amount of the progress payment. The court considered, under these circumstances, whether the government was entitled to withhold from progress payments an amount greater than the ten percent retainage permitted under the contract’s retainage clause.
* What the Court Said: The court found that the government did not have the right to withhold funds in excess of its contractual retainage rights solely because the government was considering a termination for default. However, the government could withhold funds in excess of its contractual retainage rights based upon its common law right of set-off, which allowed the government to apply any funds in its possession to debts currently owed to the government by the contractor. Because the contractor had breached the contract, the government was entitled to set off as liquidated damages an amount greater than the amount due to the contractor as a progress payment.
* What the Opinion Means: Where it has a legitimate basis to do so, the government may withhold payment in excess of its contractually-permitted retainage. However, a contractor can defeat the government’s common law right of set-off when statutory or contractual language bars the government from utilizing such right.
3. Contractor’s Right to Recover Unabsorbed Home Office Overhead Costs; Nicon, Inc. v. United States, 331 F.3d 878 (Fed. Cir. 2003).
* What the Court Considered: Due to a bid protest, the government did not issue a notice to proceed. The contractor was forced to remain on standby from the time of the bid protest to the government’s termination for convenience. The court considered whether the contractor was entitled to damages for unabsorbed home office overhead for the period between the contract award and the termination for convenience.
* What the Court Said: Under the commonly-used Eichleay formula, a contractor may recover unabsorbed overhead costs if the government creates a delay that causes contract performance to take longer than anticipated. However, the court explained that the Eichleay formula is limited to situations in which the contractor has begun performance prior to the government-caused delay. Therefore, the Eichleay formula did not apply since the termination occurred prior to the contractor having begun work.
* What the Opinion Means: A contractor may not recover damages for unabsorbed home office overhead under the Eichleay formula when the government terminates a contract for convenience before the contractor begins work. However, under such circumstances, the contractor may be able to recover such costs in a termination for convenience settlement if the contractor satisfies certain requirements, or under the contract’s suspension of work clause, which may provide for equitable adjustments when the contractor’s performance is suspended or delayed by an act or failure to act by the government. Further, as the court pointed out, a contractor may protect itself against damages for pre-performance delays by negotiating with the government for financial protection where it is delayed by a bid protest or an untimely notice to proceed.
4. Illegal Payment for Public Contract, Howard v. Brantley County, 579 S.E.2d 758 (Ga. Ct. App. 2003).
* What the Court Considered: Without using a competitive bidding process, the chairman of a county board of commissioners negotiated with a contractor for a road paint striping project. The work was never presented to or approved by the board of commissioners. Georgia statutory law requires that all county contracts be let by public bid and prohibits counties from negotiating contracts in excess of $20,000. The court considered whether the county was entitled to recover the $190,600 paid to the contractor for work performed.
* What the Court Said: Under Georgia statutory law, road paint striping is classified as a type of road construction. A county must publicly bid, and cannot privately negotiate, such construction work. Therefore, the contract, beyond the county’s contracting authority, was illegal.
* What the Opinion Means: A public entity that illegally pays out public funds will be entitled thereafter to bring a suit to recover such funds. Even where a contractor already has been paid for services rendered, the public entity may reclaim the wrongfully paid funds. Accordingly, if a contractor fails to ensure that a public entity has complied with all applicable public contracting laws, the contractor may suffer serious consequences despite the fact that the contractor itself has complied with such laws.
5. Incorporation of Arbitration Clause into Performance Bond, Travelers Cas. & Sur. Co. of Am., Inc. v. Long Bay Mgmt. Co., 2003 Mass. App. LEXIS 851 (Mass. App. Ct. 2003).
* What the Court Considered: Pursuant to the terms of their construction contract, a contractor and owner agreed to arbitrate their disputes. In the course of its project, the owner terminated the contract for cause and called upon the surety to complete the project. The contractor’s performance bond incorporated by reference the construction contract. The court considered whether the surety was entitled to participate in the arbitration between the owner and contractor even though the performance bond did not contain an arbitration clause.
* What the Court Said: The court concluded that a surety generally is required to arbitrate a dispute with a contractor or developer if the performance bond incorporates by reference an underlying construction contract that contains an arbitration clause, even when the performance bond itself does not contain an arbitration clause. The incorporation of the contract into the bond gives the surety the right to compel arbitration even if it has no direct contractual relationship with the owner.
* What the Opinion Means: Upon a contractor’s default, its surety has an option to step in and complete the work. When a performance bond incorporates by reference an underlying construction contract, the incorporation is not limited to only a certain part of the contract, such as a provision setting forth the scope of work to be performed under the contract. Instead, the entire construction contract is incorporated, including any arbitration clause.
6. Validity and Enforceability of Incomplete Blanket Lien, The Brickman Group, Ltd. v. Compass Bank, 2003 Colo. App. LEXIS 1223 (Colo. Ct. App. 2003).
* What the Court Considered: The developer failed to pay a landscaping contractor for work at a forty-eight-unit townhouse development. The contractor filed a blanket mechanic’s lien against the development’s common area and nine unsold units, but the lien statement omitted twelve other unsold units. The court considered whether the mechanic’s lien remained valid and enforceable despite its failure to include all properties that benefited from the contractor’s work and materials.
* What the Court Said: The court found that a blanket lien that omits certain properties that benefited from the contractor’s materials and work remains valid and enforceable against the properties that are included in the lien statement.
* What the Opinion Means: If a contractor fails to include all of the benefited properties in its blanket lien statement, the effect is to release the omitted properties from the lien. However, the lien remains valid and enforceable against those properties included in the lien statement. The contractor may then foreclose on the listed properties in the apportioned amount.
7. Lien Claimant’s Right to File Successive Liens, Geo Exch. Sys., LLC v. Cam, 65 P.3d 11 (Wash. Ct. App. 2003).
* What the Court Considered: A subcontractor (GES) recorded a lien against an owner’s property. GES then assigned its contract rights to another party (TECI). TECI continued to perform work on the property for almost three years and then recorded a second lien against the property. The second lien included the unpaid amount from the first GES lien. The court considered whether the right to file successive liens was extinguished because TECI did not file an action to foreclose the first lien within the statutory time period and because the limitations period expired before TECI completed work on the project.
* What the Court Said: The court found that a lien claimant is entitled to file successive liens as long as it continues to work or provide materials under its contract. Successive liens may include amounts previously claimed, but not paid, under expired liens.
* What the Opinion Means: The Washington statute establishing an eight-month period for foreclosing on a lien does not limit a claimant’s underlying lien rights. Instead, although a specific lien claim expires after eight months, the underlying right to make a claim does not expire, under Washington law, until ninety days after the claimant has ceased work on the project. Therefore, a lien claimant may revive amounts owed for work previously included in an expired lien by filing another lien claim within the statutory period after completing its work.
8. Applicability of Pollution Exclusion to Paint Fumes, Belt Painting Corp. v. TIG Insur. Co., 2003 N.Y. LEXIS 1745 (N.Y. 2003).
* What the Court Considered: A painting subcontractor purchased a commercial general liability policy for stripping and painting work in an office building. The policy contained a standard form pollution exclusion clause that excluded coverage for bodily injury or property damage arising from discharge, dispersal, seepage, migration, release or escape of pollutants by the subcontractor. The policy defined pollutants as any solid, liquid, gaseous or thermal irritant or contaminant including smoke, vapor, soot, fumes, acid, alkalis, chemicals and waste. The court considered whether the pollution exclusion clause unambiguously excluded coverage for injuries caused by the inhalation of paint or solvent fumes in an office that the subcontractor was painting.
* What the Court Said: The court concluded that reasonable minds could disagree as to whether the pollution exclusion unambiguously applie[d] to ordinary paint or solvent fumes that drifted a short distance away from the area of the insured’s intended use. Thus, because the exclusion clause did not clearly and unequivocally exclude personal injury claims arising from indoor exposure to the subcontractor’s paint or solvent fumes, the insurer was required to provide coverage.
* What the Opinion Means: To negate coverage through the use of a policy exclusion, an insurer must set forth the exclusion in clear and unmistakable language that is subject to no other reasonable interpretation. Any ambiguity in a policy exclusion is resolved against the insurer; however, courts will not adopt an interpretation that would enlarge the pollution exclusion to an extent where it would contradict a common speech understanding of the relevant terms and reasonable expectations of the parties.
9. Requirement that Insurer Provide Primary Coverage to Additional Insureds, Pecker Iron Works of N.Y., Inc., v. Traveler’s Ins. Co., 786 N.E.2d 863 (N.Y. 2003).
* What the Court Considered: A subcontractor agreed to name its employer as an additional insured on its certificates of insurance for liability and workers compensation. The subcontractor obtained an insurance policy that stated that coverage for additional insureds would be excess coverage only unless the subcontractor agreed in a written contract for the insurance to apply on a primary or contributory basis. The court considered whether the insurance policy at issue provided the employer, as an additional insured, with primary coverage when an employee of the subcontractor was injured at the site.
* What the Court Said: The court found that additional insuredis a recognized term in insurance contracts and the well-understood meaning of the term is an entity enjoying the same protection as the named insured. Consequently, the subcontractor promised to provide primary, rather than only excess, coverage for its employer.
* What the Opinion Means: An insurer is required to provide primary coverage for additional insureds unless there is an unambiguous agreement stating otherwise. Based on the common understanding of the term additional insured, the parties contemplated that the subcontractor’s insurer would provide primary coverage to the employer.
10. Insurer’s Duty to Notify Additional Insureds of Policy Cancellation, Wainwright v. Charlew Constr. Co., Inc., 302 A.D.2d 784 (N.Y. App. Div. 2003).
* What the Court Considered: A subcontractor named its general contractor as an additional insured on its general liability policy. The insurer later notified the subcontractor and its insurance agent, but not the general contractor, that the policy would be cancelled for nonpayment of premium. When an employee of the subcontractor was injured on the site, the insurer denied coverage to the general contractor because the policy had been cancelled. The court considered whether the policy was properly cancelled in light of the insurer’s failure to notify an additional insured of the cancellation.
* What the Court Said: The court concluded that the insurance policy was properly cancelled because the insurer strictly complied with the New York statute governing notice of cancellation by providing timely notice of cancellation to the first-named insured (the subcontractor) and such insured’s authorized agent or broker.
* What the Opinion Means: Although the insurer failed to comply with its internal courtesy policy of providing notice of cancellation to additional insureds, the policy was properly cancelled because the insurer complied with the state’s statutory notification requirements. Even though the general contractor detrimentally relied upon its status as an additional insured, it had no right to coverage because the policy was not in existence at the time of the accident.
Ira Genberg is a Senior Partner at the Smith , Gambrell & Russell law firm in Atlanta, Georgia, and also General Counsel for Associated Owners & Developers (AOD), McLean, Virginia. For more information or if you have any questions, contact us at: