CONSTRUCTION CONTRACTS AND YOUR “ORDER OF PRECEDENCE” CLAUSE

UnknownDuring the negotiation of construction contracts there is often consideration as to the priority of the Contract Documents.  In other words, in the event of a conflict with the Contract Documents, what is the priority that you want to govern the conflict?  To address this, parties may include an order of precedence clause that clarifies how conflicts with the Contract Documents are to be interpreted by prioritizing the Contract Documents.

 

The AIA Document A201 (General Conditions) deems the Contract Documents as complementary (see § 1.2.1 -“The Contract Documents are complementary, and what is required by one shall be as binding as if required by all….”) without including an order of priority to determine which Contract Document truly governs a conflict.  The AIA does not really favor establishing an order of precedence;  but, if supplementary conditions are added to modify the A201 General Conditions, the AIA does suggest model language:

 

§ 1.2.1.1 In the event of conflicts or discrepancies among the Contract Documents, interpretations will be based on the following priorities:

1. Modifications.

2. The Agreement.

3. Addenda, with those of later date having precedence over those of earlier date.

4. The Supplementary Conditions.

5. The General Conditions of the Contract for Construction.

6. Division 1 of the Specifications.

7. Drawings and Divisions 2–49 of the Specifications.

8. Other documents specifically enumerated in the Agreement as part of the Contract Documents.

 

 

The EJCDC C-700 (General Conditions) contains virtually identical language as the AIA A201 deeming the Contract Documents as complementary: (see § 3.01.A- “The Contract Documents are complementary; what is required by one is as binding if required by all.”)

 

The ConsensusDocs 200 (Agreement and General Conditions) takes a much more proactive approach regarding conflicts by containing the following clauses:

 

14.2.2 In case of conflicts between the drawings and specifications, the specifications shall govern….

 

 14.2.5 ORDER OF PRECEDENCE In case of any inconsistency, conflict, or ambiguity among the Contract Documents, the documents shall govern in the following order: (a) Change Orders and written amendments to this Agreement; (b) this Agreement; (c) subject to subsection 14.2.2 the drawings (large scale governing over small scale), specifications and addenda issued prior to the execution of this Agreement or signed by both Parties; (d) information furnished by the Owner pursuant to subsection 3.13.4 or designated as a Contract Document in section 14.1; (e) other documents listed in this Agreement. Among categories of documents having the same order of precedence, the term or provision that includes the latest date shall control. Information identified in one Contract Document and not identified in another shall not be considered a conflict or inconsistency.

 

 

Even Federal Acquisition Regulation 52.236-21 incorporated into government prime construction contracts contains language that, “In the case of difference between drawings and specifications, the specifications shall govern.”

 

There are certainly pluses and minuses to creating an order of precedence provision.  A minus is that implementing a provision takes away from the complementary nature of the Contract Documents.  Thus, whatever hierarchy you determine and include is a hierarchy you need to understand because you will be living by it. There is also the concern that the provision is incorporated to perhaps serve as a substitute for properly executed, coordinated, and detailed plans and specifications or is incorporated to reduce the contractor’s risk to check the Contract Documents to address any inconsistencies on the front end.   On the other hand, as a plus, these clauses provide necessary guidance in the event there is a claim due to a conflict with the Contract Documents. Most of the time, I tend to favor an order of precedence provision to prioritize direct conflicts in the Contract Documents.  Depending on whether you are the owner, the contractor, or even a subcontractor, forethought should be given to the order of precedence of the Contract Documents since there is a good chance this order will be relied on once construction commences.

 

 

imagesTo illustrate the application of an order of precedence provision, in Hensel Phelps Const. Co. v. U.S., 886 F.2d 1296 (Fed.Cir. 1989), a prime contractor sought an equitable adjustment of its contract. The contractor relied on an order of precedence provision that required the specifications to govern over any conflict between the drawings and specifications (see routinely incorporated F.A.R. 52.236-21).  In this case, the specifications called for a minimum of 18” of fill under concrete floor slabs; however, the drawings called for 36” inches of fill.  The contractor priced the job with the 18” of fill.  During construction, the contracting officer directed the contractor to install 36” of fill which triggered the equitable adjustment.   The government, however, argued that the contractor knew of this discrepancy all along.  The Federal Circuit Court nevertheless held that the contractor should be entitled to an equitable adjustment since the specifications had priority over this direct conflict:

 

Reliance was properly placed on the order of precedence clause to resolve a discrepancy between the specifications and the drawings and this resolution was reflected in the bid. When the government insisted on 36 inches of fill, rather than the 18 inches called for in the specifications, the contractor was required to perform more work than the contract required and more than its bid price contemplated. Consequently, on the record here neither Hensel Phelps [prime contractor] nor Watts [subcontractor] can be said to have profited or otherwise benefited by reliance on the order of precedence clause.” 

Hensel Phelps, 886 F.2d at 1299.

 

Please contact David Adelstein at dadelstein@gmail.com or (954) 361-4720 if you have questions or would like more information regarding this article. You can follow David Adelstein on Twitter @DavidAdelstein1.

NOT SO FAST DEVELOPER WITH YOUR CREATIVE EFFORT TO WIPE OUT THE CONTRACTOR’S (INFERIOR) LIEN!

imagesTwo things are certain in construction: (1) developers will obtain construction loans to finance the construction of their project and (2) there will unfortunately be bad projects where the developer’s lender forecloses on the (first priority) mortgage given in connection with the construction loan.   Not only is this bad for the developer, but it is bad for contractors because the lender will look to foreclose (and wipe out) all inferior liens, such as unpaid contractors and suppliers’ liens (which will be inferior to the lender’s mortgage).

 

 

The case of CDC Builders, Inc. v. Biltmore-Sevilla Debt Investors, LLC, 39 Fla. L. Weekly D1997a (Fla. 3d 2014) illustrates a bad project where a lender moved to foreclose on a construction loan.  But, unlike a more traditional example of the construction lender foreclosing, this case involved a hyper-creative attempt by the developer to purchase its own construction loan and then foreclose on the corresponding mortgage for the sole purpose of intentionally wiping out its general contractor’s lien.

 

 

In this case, the developer hired the contractor to build luxury homes.  The contractor completed the homes, but the developer failed to pay the contractor for the last eight homes.  The contractor recorded construction liens to collateralize its nonpayment.  The developer was unable to pay off its construction loan due to a lack of luxury home sales. To avoid the lender foreclosing, the developer negotiated loan extensions where the developer was required to pay money to reduce the lender’s exposure on the loan. However, the developer did not want its payments to reduce the principal of the loan.  Why? Because the developer wanted to ensure there would be no equity in the real property to satisfy the contractor’s liens.  So, the developer negotiated with its construction lender to treat any money it paid the lender for loan extensions as junior liens against the property.   The developer then had another company created. This other developer-related company purchased the construction loans from the construction lender in exchange for loan assignments. (This was done so the other company maintained a first priority interest with the real property since it purchased the original construction loans.)  Once this other developer-related company purchased the construction loans, it moved to foreclose on the loans.  Why?  Because, by doing so, the developer could wipe out the contractor’s liens as inferior liens on the real property.  Very creative and it actually worked as the trial court entered a final summary judgment of foreclosure in favor of this  developer-related company (meaning the contractor’s inferior liens would be valueless based on the equity in the real property).

 

 

The Third District Court of Appeal reversed the trial court’s foreclosure judgment (as there were questions of fact as to whether the developer-related company was actually created by the same investors that controlled the developer).  The Third District, employing a policy of fairness,  held that:

 

The law does not permit a person to borrow money from a bank, give the bank a mortgage, incur additional liens and junior mortgages on the property, purchase the mortgage back from the bank, and then foreclose on the mortgage for the primary purpose of eliminating the additional liens and junior mortgages.

***

[I]nvestors cannot grant mortgages, contract for the improvement of the property mortgaged, and then use a network of companies to purchase and foreclose the mortgage for the primary purpose of extinguishing the construction liens that increased the value of the property.  To hold otherwise would undermine the long-standing principle…persons cannot do indirectly what they are not permitted to do directly.

CDC Builders, supra

 

 

Stated differently, and less eloquently then the Third District, the law does not permit a developer to undertake creative avenues to purchase the very mortgage and loan it originally obtained to finance its construction for the sole purpose of cheating its contractor out of payment for improving the real property.  To find otherwise would simply give the developer a windfall since it would not have to pay for construction improvements that it wanted and which improved the value of its property.

 

 

Please contact David Adelstein at dadelstein@gmail.com or (954) 361-4720 if you have questions or would like more information regarding this article. You can follow David Adelstein on Twitter @DavidAdelstein1.

THE “PRIMARY AND NONCONTRIBUTORY” INSURANCE REQUIREMENT

CaptureIf you were ever involved in a construction defect claim or lawsuit, you may have heard the phrase “primary and noncontributory” when referring to YOUR insurance coverage.  Or, you may have come across this phrase when discussing with your insurance broker the additional insured insurance coverage requirements you need to provide pursuant to your contract.

 

But, what does this mean when referring to YOUR insurance coverage? This phrase refers to the priority of YOUR insurance coverage.

 

For instance, a general contractor will require that that its subcontractors obtain CGL insurance coverage that not only names the general contractor as an additional insured (for both ongoing and completed operations), but also includes an endorsement reflecting that the subcontractor’s policy is “primary and noncontributory.”  (See above picture for example of endorsement)   The subcontract may provide, by way of example, that, “Insurance coverage provided by you [subcontractor] to the additional insured [general contractor] shall be primary and noncontributory with respect to any insurance coverage otherwise available to the additional insured.”  This means that if the general contractor is sued associated with the negligence of its subcontractor, it will tender the claim to the subcontractor’s insurer to defend and indemnify it since it will (hopefully) be an additional insured under the policy.  The subcontractor’s policy is the “primary” policy without contribution from the general contractor’s policy (as the general contractor’s policy will really come into play as excess insurance).

 

otherThe general contractor, to be safe and circumspect, may want the subcontractor to obtain a “primary and noncontributory” endorsement that says that the subcontractor’s insurance will be primary and noncontributory when required by written contract.  The reason this is safe is because most CGL policies already contain a section called “Other Insurance.” In this section (as depicted in part in the adjacent picture), the policy will state that it is primary except when other insurance (specified in the policy) is available in which case it will serve as excess insurance.  One of the other insurance conditions that will deem your policy as excess is when you are identified as an additional insured under another’s policy (e.g., the subcontractor’s policy that identifies the general contractor as an additional insured is the primary policy and the general contractor’s policy will serve as excess insurance). The primary and noncontributory endorsement modifies this “Other Insurance” language.

 

 

Understanding the application of insurance and the interrelationship of potential policies is never easy.  But, this understanding is of the utmost importance for construction risk assessment purposes where risk is inherent in the very nature of construction.

 

 

 

Please contact David Adelstein at dadelstein@gmail.com or (954) 361-4720 if you have questions or would like more information regarding this article. You can follow David Adelstein on Twitter @DavidAdelstein1.

 

COMPELLING REASONS NOT TO ENFORCE SUBCONTRACT VENUE PROVISIONS IN MULTI-PARTY CONSTRUCTION DEFECT CASES

imagesSubcontracts oftentimes contain venue provisions as to the exclusive venue for lawsuits.  These venue provisions or forum selection clauses are consistent with the general contractor’s preferred venue; the venue, however, may be in a location unrelated to the project site. Sometimes the general contractor is sued by an owner (or association) for construction defects in a venue different than the venue included in the subcontracts.  The general contractor, as it should, will third-party into the lawsuit those subcontractors that are implicated by the owner’s complaint for breach of contract, indemnification, etc.

 

Certain subcontractors will move to transfer venue based on the venue provision in their subcontract.  Despite the venue provision, transferring venue is really in no one’s best interest since it is more efficient and economical to have multi-party construction defect cases tried and adjudicated in the same action versus many separate actions.  The recent case of Love’s Window & Door Installation, Inc. v. Acousti Engineering, Etc., 39 Fla. L. Weekly D1963a (Fla. 5th DCA 2014) supports this position.  In this multi-party construction defect case, a sub-subcontractor that was sued by the subcontractor that hired it moved to transfer venue.  The trial court denied the motion and the sub-subcontractor appealed.  The Fifth District Court of Appeal agreed with the trial court that there were compelling reasons not to enforce the venue provision (e.g., to prevent multiple lawsuits, minimize judicial labor, avoid inconsistent results, and reduce expenses).

 

Yes, venue provisions are important and routinely enforceable.  But, there are times where it is in the interests of justice and the parties NOT to enforce a venue provision, such as a multi-party construction defect case.

 

Notwithstanding, I always like to include a joinder provision in a construction contract that allows the hiring party (e.g., general contractor) to sue the hired party (e.g., subcontractor) in any forum and venue that the hiring party is sued.  For example, in a subcontract, I would want a provision that allows the general contractor to sue (or third-party / join) the subcontractor in any venue and forum the general contractor is sued by any third-party, association, or owner.  Such a provision ensures that even if the hired party (subcontractor) wants to rely on the venue provision, there is a joinder provision in the subcontract that negates the application of the venue provision in this context.

 

Please contact David Adelstein at dadelstein@gmail.com or (954) 361-4720 if you have questions or would like more information regarding this article. You can follow David Adelstein on Twitter @DavidAdelstein1.

DO NOT LET LACK OF NOTICE VOID YOUR INSURANCE COVERAGE

UnknownThe Southern District of Florida’s opinion in Pharm. D v. Founders Insurance Co., 2014 WL 32557844 (S.D.Fla. 2014) illustrates that absolute importance of notifying a liability insurer of a claim and a lawsuit; otherwise, coverage that would be afforded to an insured could be voided.  This should never occur!

 

In this matter, a water pipe ruptured and a fire occurred at the insured’s premises.  This resulted in damage to a pharmacy located below the insured’s premises.  Due to this damage, the pharmacy filed a lawsuit against the insured.  The insured failed to take any action in the lawsuit and a default judgment was entered against the insured for in excess of $500,000.

 

Years later, the (third party) pharmacy sued the insured’s CGL (commercial general liability) insurer to recover the amount of its default judgment against the insurer.  The insurer argued that coverage should be voided because its insured violated the terms of the policy.  Specifically, the insured had the obligation to notify the insurer of any claim or suit as soon as practicable and to send copies of any lawsuit to its insurer.  Apparently, the insured never did this and the insurer had no notice of the lawsuit.  The Southern District agreed with the insurer that the lack of notice voided coverage:

 

The insurance policy in question had a continuing notice obligation for a reason: the insured had the best information on legal action brought against it and, therefore, the insured was required to keep its insurer informed of developments. Accordingly, the insured had two distinct duties: (1) to notify Defendant [insurer] of any claims and (2) to notify Defendant of any lawsuits filed which may implicate the insurance policy.

***

The record shows there is no genuine dispute of material fact that the insured failed to notify Defendant of the state lawsuit and, thus, materially breached the insurance policy. As a matter of law, this breach absolved Defendant of its contractual requirement to defend in the state lawsuit and renders Defendant not liable on the default judgment entered in state court.”

Pharm. D, supra, at *3, *5.

 

The lesson learned from this matter is that if suing a party in which liability insurance is applicable (such as any case involving property damage or personal injury), take affirmative steps to ensure that the party’s liability insurer (CGL insurer) is notified of a claim and of the lawsuit.  Even if the party does not respond to the lawsuit, send a copy of the lawsuit to the party’s insurer.  Take steps to locate the insurer or the party’s insurance broker to ensure that proper notice is served and so that you are not relying on a potentially silent party to notify its insurer of a lawsuit (especially, when you are relying on insurance to cover your damages).  Clearly, in this matter, the insured-party did nothing despite having CGL coverage that perhaps would have covered some of the pharmacy’s damages.

 

Please contact David Adelstein at dadelstein@gmail.com or (954) 361-4720 if you have questions or would like more information regarding this article. You can follow David Adelstein on Twitter @DavidAdelstein1.

 

HMM–WAIVER OF SUBROGATION–SHOULD IT STAY OR SHOULD IT GO?!?

imagesHRB623GAParties involved in construction are familiar with the phrase “waiver of subrogation” because there is commonly, and virtually always, a waiver of subrogation provision in the construction contract.  For instance, the AIA Document A201 (General Conditions) contains a waiver of subrogation provision for damages or loss covered by builder’s risk property insurance.  A waiver of subrogation provision prevents an insurance company from paying a claim and then stepping in the shoes of the insured (through subrogation) to sue a waived third party responsible for the claim.  To ensure the waiver of subrogation provision does not conflict with any other rights in the contract, the A201’s waiver of subrogation provision provides: “A waiver of subrogation shall be effective as to a person or entity even though that person or entity would otherwise have a duty of indemnification, contractual or otherwise, did not pay the insurance premium directly or indirectly, and whether or not the person or entity had an insurable interest in the property damaged.”

 

For example, let’s assume a fire during construction caused substantial damage to an owner’s property.  The owner submitted a builder’s risk claim and it was determined that the damage caused by the fire (peril) was covered.  Let’s assume the fire was attributed to the negligence of the contractor and its electrical subcontractor.  With waiver of subrogation language, the carrier cannot pay the claim to the owner and then subrogate to the interests of the owner to pursue claims directly against the contractor and/or electrical subcontractor to recoup the proceeds it paid to the owner.  This waiver would apply even though the owner’s contract with its contractor required the contractor to indemnify the owner for damage caused by the contractor or the contractor’s subcontractor’s negligence.  Without the waiver of subrogation language, the carrier would not be deprived of this subrogation right.

 

 

waiver of rightsIn addition to the waiver of subrogation relating to builder’s risk property insurance, parties are requesting waivers of subrogation endorsements for CGL policies and other liability policies.  With CGL policies, the waiver of subrogation endorsement is referred to as the “Waiver of Transfer of Rights of Recovery Against Others to Us” endorsement.  Sometimes parties want a blanket waiver or at least they want to know they are specifically identified in the endorsement to ensure the CGL carrier waives a subrogation claim against it if the carrier pays out insurance proceeds.   This endorsement is important because without it a party could be breaching its insurance policy and voiding applicable coverage by contractually agreeing to waive subrogation that is in conflict with the policy’s subrogation language.  If a carrier is willing to issue this endorsement (and there are times it may not), it will usually come at a cost through a higher premium, etc., since the waiver of subrogation impacts an insurer’s risk assessment.

 

I like contractual waiver of subrogation language relating to builder’s risk property insurance claims.  As long as the insurance broker and carrier are aware of the contractual waiver so that there is not any issue that the waiver impacts policy language / coverage (and, the broker and carrier should inquire since it’s become boilerplate language in construction contracts), the waiver of subrogation allows a covered claim to be paid without an otherwise waived party worried about whether the carrier is going to try to later recoup losses against it.

 

From an owner or contractor’s perspective, I also usually like the idea of the party being hired to provide the waiver of subrogation endorsement / waiver of transfer of rights endorsement in its CGL policy irrespective of the requirement to identify the hiring (or paying) party as an additional insured.  The primary reason is that in the event there is any issue whatsoever with the additional insured status under the hired party’s policy such that it does not apply  to the hiring party (e.g., additional insured status of a general contractor under its hired subcontractor’s policy), with the waiver of subrogation, if the hired party’s policy pays it has at least waived its right to recoup that money against the hiring party through subrogation.

 

I know there are some parties that do not like waiver of subrogation language, especially with CGL policies, due to underwriting issues that it poses and/or potential increased premium costs associated with the endorsement.  Sure, this is true.  But, a waiver of subrogation does enable a dispute to be streamlined by allocating risk to a party that is in a position to control the risk and has insurance to cover that risk and by reducing continued litigation associated with a claim.

 

Please contact David Adelstein at dadelstein@gmail.com or (954) 361-4720 if you have questions or would like more information regarding this article. You can follow David Adelstein on Twitter @DavidAdelstein1.