Upon completion of a construction project, the owner will “accept” the work and thereafter release final payment to the contractor. Typically, a contract sets procedures for the administrative closeout of the project, including clauses covering substantial completion, reduction and release of retention, final inspection of the work, final acceptance, and final payment.
As can be expected, contractors usually focus most heavily on what is necessary to receive final payment. However, “final acceptance” by the owner is the most important closeout event as far as the contractual and legal relationship of the parties. Under the common law of contracts, upon final acceptance, the owner takes control and ownership of the project and the risk of loss passes from the contractor to the owner. Final acceptance generally means acceptance of the work as completed, including any deficiencies known to exist. At that point, the owner’s contract rights against the contractor become far more limited. Therefore, final acceptance of the work should be considered the most significant contract event only after contract award.
Consistent with the common law, contracts often define how final acceptance will occur, but that is not always the case. In federal government contracts, the contracting officer will often issue a letter formally “accepting” the work, or designated portions thereof. On the other hand, some form contracts avoid using the term “final acceptance” in favor of discussing the conditions the contractor must satisfy to obtain the release of “final payment.” For example, the ConsensusDOCS standard “General Conditions” state that when “Final Completion” has been achieved, the contractor may invoice for its “Final Payment.”
Even though contracts may avoid using “final acceptance” language, the law will always recognize that at some point in the closeout process, the owner “accepts” the work as performed and the risk of loss passes to the owner. While the precise moment of “final acceptance” cannot always be determined, contractors should nevertheless be aware of the significance of this contract milestone and the restrictions it places on the owner’s right to subsequently require corrections to the work.
Ohio: Owner’s Post-Acceptance Claim
In an Ohio case, Beasley v. Monoko, Inc., 958 N.E.2d 1003 (Ohio App. 10th Dist. 2011), the Ohio Department of Transportation (“ODOT”) made final inspections and acknowledged final acceptance of work on a bridge painting contract. ODOT then made final payment to the contractor. Several years later, post-completion inspections connected with a statewide highway contractor kickback investigation, revealed that the original painting work had not been performed correctly.
ODOT then sued the contractor arguing that its acceptance ODOT then sued the contractor arguing that its acceptance of the work did not mean that ODOT could not demand full compliance with the plans and specifications. According to ODOT, the contractor’s obligations to meet the plans and specifications survived any final acceptance.
The contractor argued that ODOT’s final inspection and acceptance of the work precluded all subsequent allegations that the work was not performed properly. The contractor relied on ODOT’s original Report of Final Inspection, which stated that the project had been “completed in substantial conformity with the approved plans and specifications . . . . Accordingly, the Contractor is relieved of responsibility for further maintenance of this project.” The contractor also argued that ODOT had inspection rights throughout performance and that the final inspection was intended to be ODOT’s final chance to object to any problems with the work.
The court relied on the common law and on specific language in the contract and found ODOT’s formal acceptance of the work was a legal acknowledgement that the work met the requirements of the plans and specifications. The court cited the following contract language:
This contract will be considered complete when all work has been completed and the final inspection made, the work accepted and the final estimate approved, in writing by the director. The Contractor will then be released from further obligations except as set forth in his bond.
The court found that the quoted bond exception was limited to the contractor’s post-acceptance duty to pay its subcontractors and suppliers. While the contract allowed ODOT to reject work at any time before final acceptance, the quoted language indicated that “final acceptance” was effectively a final acknowledgement of contract compliance and thus precluded any subsequent arguments that the contractor had not performed properly. The court therefore dismissed all claims against the contractor.
Of course, the binding effect of “final acceptance” is tempered by express warranty provisions that may exist in the contract. Contracts often include express warranty provisions obligating the contractor to correct any defects or problems arising one year (or longer) after final acceptance. These warranty clauses give the owner an independent contract right to demand corrections or repairs even after final acceptance. An express warranty clause therefore creates an exception to the general rule that once the owner accepts the work, it cannot go back and allege deficiencies. It is not unusual for an owner to perform warranty inspections near expiration of contractual warranties to identify existing deficiencies and to demand their correction under the contractor’s warranty obligations. In Beasley, the court recognized that an express warranty could give ODOT a legal basis to demand corrections but found that no warranty provisions existed and any warranty would have expired by the passage of time (the suit was filed more than four years after final acceptance).
“Latent Defect” Exception
The binding effect of final acceptance is also subject to any “latent defects” that may exist in the work. Final acceptance does not foreclose an owner’s right to pursue the contractor for latent defects until the applicable statute of repose runs. A latent defect is generally defined as a defect in the contractor’s work that was latent or hidden, that was not discovered during inspections leading up to final acceptance, and that could not have been discovered through reasonable inspections. In other words, a contractor cannot conceal (whether intentionally or not) defects in its work and then argue that the owner lost its right to object when the owner failed to discover the defects during final inspections. Because latent defects are problems that are hidden and not reasonably discoverable, the law implies that the “final acceptance” would not include acceptance of these hidden defects. Once those defects are discovered, the law will treat the defects as never having been accepted, or give the owner the right to rescind an earlier acceptance. As a result, a contractor can remain legally responsible for latent defects until the statue of repose runs.
In Beasley, the court recognized the “latent defect” exception but found that the defects ODOT was attempting to raise were not “latent.” According to the evidence, the alleged defects were substantial and so significant that they could not be considered latent. Therefore, ODOT could not use the latent defect exception to argue that it had a right to pursue the contractor. Also, an owner
cannot claim a latent defect when it is actually aware of a deficiency at the time of final acceptance. Accepting the work, including deviations or deficiencies, which are known about, precludes all further rights to strict performance.
Statutes of repose place an outside time limit on any suit involving the design or construction of a project, including claims for latent defects. This statutory period varies from state to state but typically runs from substantial completion for as little as 5 years and as long as 15 years. Thus, owners can bring latent defect claims against their contractors until the applicable statute runs.
Federal government contracts subject to the Federal Acquisition Regulation emphasize the importance of final acceptance and limit the government’s rights once final acceptance is made. The FAR Inspection of Construction clause states that “Acceptance shall be final and conclusive except for latent defects, fraud, gross mistakes amounting to fraud, or the government’s right under any warranty or guarantee.”
After final acceptance, the owner’s rights against the contractor are limited to its warranty rights and rights to demand correction of latent defects. Otherwise, final acceptance of the work, whether complying with the specification or not, is final and binding on the owner. It is therefore important for a contractor to be aware of when this significant milestone is reached on its contracts and ensure that this event is appropriately documented.