Highlights: Construction projects are typically an exciting and a challenging time for an owner. A new facility is being built to provide new space or to expand or renovate existing space. These projects are most often very complex. This complexity can lead to a variety of problems that may result in claims. In this article, Ben Hyden provides the basics about some of the claims that can arise on a construction project. Ben also provides some best practices for use in drafting contract documents to help protect the owner during the claims process.

The goal of every owner is to have a successful project. Typically, this means a project that is completed on time and within budget, without any defects, and a project that is completed with minimal or no claims. Unfortunately, this goal is not always achieved.

Construction projects can be complex and are often subject to costly disputes. Unfortunately, some project owners have experiences involving projects with leaking roofs, HVAC systems that do not work, cost overruns, and contractors’ claims eclipsing several millions of dollars.

When a construction project goes bad, the owner is often left trying to pick up the pieces by defending a multitude of claims and repairing work that was never designed or constructed properly. However, the owner is typically not the party directly responsible for a project’s problems. After all, owners do not install roofs or HVAC systems. Owners do not design buildings or coordinate the details within the construction documents. These are the responsibility of the contractors and design professionals hired by the owner to construct buildings.

In most cases, in order to recoup any damages incurred by an owner during a construction project, the owner must file a claim against the responsible party -- generally either a contractor or design professional. This article will explain some of the theories of recovery that may be available to an owner.

What is a Claim?

The term claim has developed a bit of a sinister meaning in regards to its use on construction projects. A claim, however, is nothing more than a request by one party to another party for some type of relief under a contract. The AIA A201-2007 General Conditions of the Contract for Construction define the term claim as “a demand or assertion by one of the parties seeking payment of money, or other relief with respect to the terms of the contract” and “other disputes and matters in question between the owner and contractor arising out of or relating to the contract.”

The Owner’s Claims Against a Contractor

When evaluating a potential claim against a contractor, the owner’s evaluation must start with the construction contract. After all, the relationship between the owner and contractor is governed by the terms of the construction contract. The construction contract defines the obligations of each party. An owner’s claims against a contractor, more often than not, arise when a contractor fail to perform an obligation that it was required to perform under the construction contract. These types of claims are commonly referred to as “breach of contract” claims.

When evaluating whether an owner has a valid breach of contract claim against a contractor, the owner must evaluate not only the contract form itself (which may be very short), but also all of the documents incorporated into the contract by reference. These documents, referred to as the “Contract Documents,” establish both parties’ obligations under a contract.

Most frequently, construction contracts incorporate the drawings and technical specifications prepared by the design professional. Most technical specifications also incorporate various industry standards and manufacturers’ requirements, which also may become part of a contractor’s contractual obligations to an owner. An owner should always take a close look at the contract and the various documents that may be incorporated by reference into the contract when evaluating a potential claim against a contractor.

Breach of Contract - Warranty

The most common claim made by an owner against a contractor is to recover the costs incurred by an owner in correcting “defective” or “nonconforming” work performed by the contractor on a project. These claims arise from the general warranty that is included in most of the form construction contracts in use today.

The general warranty in Section 3.5 of the AIA A201-2007 General Conditions states:

The Contractor warrants to the Owner and Architect that materials and equipment furnished under the Contract will be of good quality and new unless the Contract Documents require or permit otherwise. The Contractor further warrants that the Work will conform to the requirements of the Contract Documents and will be free from defects, except for those inherent in the quality of the Work the Contract Documents require or permit. Work, materials or equipment not conforming to these requirements may be considered defective. The Contractor’s warranty excludes remedy for damage or defect caused by abuse, alterations to the Work not executed by the Contractor, improper or insufficient maintenance, improper operation, or normal wear and tear and normal usage. If required by the Architect, the Contractor shall furnish satisfactory evidence as to the kind and quality of materials and equipment.

Under this warranty, a contractor has an obligation to perform its work in accordance with the contract documents and free from defects not inherent in the quality of the work. Put simply, under this warranty, the contractor has an obligation to install the work in the manner required by the contract documents. If the contractor does not, the contractor will have breached the warranty and its contract with the owner.

As an example, a contractor breaches the warranty if the contractor failed to construct a roof system in accordance with the manufacturer’s recommendations when compliance with the manufacturer’s recommendations is required by the specifications. Furthermore, a contractor also can breach the warranty by installing shingles that contain a manufacturing defect.

Breach of Contract - Indemnification

Indemnification is a contractual right to reimbursement for costs incurred by one party from another party. Since indemnification is a contractual obligation, the breadth of the scope of a party’s obligation to indemnify another is defined by the terms of the contract.

Broad Indemnification provisions are important in Ohio, because on most public construction projects, the owner is required contract with multiple prime contractors. For example, the owner may hold separate contracts for, among others, the general trades contractor, the plumbing contractor, the HVAC contractor, and the electrical contractor.

This arrangement puts the owner right in the middle of the disputes that arise between the separate contractors. In fact, in cases where purely economic losses are in dispute, the law precludes the multiple prime contractors from directly suing each other because they are not in privity of contract.

When one prime contractor delays another prime contractor, the delayed prime contractor’s chosen remedy is most often against the owner. If the owner is then required to pay monetary damages to the delayed contractor, the owner, if the contract documents contain broad enough indemnification language, may bring an indemnification claim against the contractor responsible for the delay to recover the costs paid to the delayed contractor.

It should be noted, however, that the indemnification language contained in most of the standard form construction documents is not broad enough to allow an owner to seek indemnification in the manner described above. These provisions can, and should, be modified to broaden their scope, especially in a multiple prime contracting environment.

The Owner’s Claims Against the Contractor’s Performance Bond

Performance bonds help assure that a construction contract is properly performed. As a result, anytime a contractor breaches an obligation under a bonded contract, the surety that provided the bond may be looked to as a source of recovery for the owner’s damages. Generally, anytime that an owner makes a claim against a contractor the owner can make the same claim against the contractor’s surety bond. On most public projects, the terms of the bond are set by law.

Surety bonds used on private projects can be very different. As a result, the bonds must be reviewed carefully because they may contain several conditions that must be met before the surety is obligated to perform. An owner should be careful to fulfill every condition contained in the bond.

The Owner’s Claims Against the Design Professional

Some problems on a construction project may not be the fault of a contractor at all. A contractor is typically hired to construct a facility according to a set of plans, which does not necessarily entail a guarantee that the finished project will function as desired. While design professionals are not expected to prepare perfect plans, design professionals are expected to meet a minimum standard of care in performing their services. In Ohio, the standard of care for architects is contained in the Ohio Administrative Code, O.A.C. § 4703-3-07(A)(1):

In practicing architecture, a registered architect shall act with reasonable care and competence and shall apply the technical knowledge and skill which is ordinarily applied by registered architects of good standing, practicing in the same locality.

In Cincinnati Riverfront Coliseum v. McNulty (1986), 28 Ohio St.3d 333, the Ohio Supreme Court announced the rule for holding a Design Professional liable for negligent design:

Generally, one who contract[s] in a specialized professional capacity to provide the design for a particular structure may be held to respond in damages for the foreseeable consequences of a failure to exercise reasonable care in the preparation of the design.

If the services provided to the owner by the design professional service fall below the required standard of care, then the design professional may be liable to the owner for the resulting damages.

Other Claims Available to the Owner

Special Warranties. In some instances there may be other special warranties required by the contract or given by a manufacturer, say for example, a roof manufacturer. However, some roof warranties exclude coverage if the work was installed improperly. So, if the contractor agreed to install the work in accordance with the contract documents, failed to do so, and the manufacturer’s warranty does not apply, the owner should then look back to the contractor under the general warranty described above.

Conclusion

An owner’s most powerful tools, and potentially the owner’s nightmare, in the claim process are the contract documents. Remember Rule 13 of Bricker & Eckler’s 20 Rules for Public Owners’ Contracting Success:

Use contracts that protect your interests and that are consistent with your expectations. Have your contracts, including owner-architect agreement, owner-construction manager agreement, and owner-contractor agreement, drafted to protect you.

Good contract documents that are drafted to protect the owner from project specific risks can be both a sword and a shield for the owner throughout the claims process.