Under Construction - March 2017

by Snell & Wilmer
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Snell & Wilmer

Letter from the Editor

Welcome to the spring 2017 edition of our Under Construction newsletter. We hope 2017 is off to a good start for you and your company.

An issue that seems to commonly come up in cost-plus contracts is whether certain insurance costs are considered a cost of the work. Typically, under a cost-plus contract, an owner pays a general contractor for all of its allowed costs. Within those costs, there are usually insurance costs and subcontractor costs. Subcontractor costs also often include insurance costs and an issue is sometimes raised by project owners when those general contractors and subcontractors utilize some form of self-insurance or large-deductible insurance coverage on a cost-plus contract. The first article in this newsletter will take a look at this dilemma, make some owners aware of the issue, and discuss things that general contractors and subcontractors can consider doing to protect themselves.

Recent industry reports indicate the business value of Building Information Modeling (BIM) for Owners is increasing. Our second article reviews this trend, discusses BIM and addresses how owners can benefit by maximizing a building’s value throughout its lifecycle.

Troubled construction projects are often marked by failures to cooperate, failures to perform or failures to generally progress the work. In these circumstances, there are as many options and remedies as there are reasons. When these conditions occur repeatedly, it is sometimes tempting for the owner to consider terminating the contractor for default. Even if the parties’ contract contains a robust default termination provision, owners should think twice before issuing a default termination. Our next article will discuss some default termination pitfalls and provide some practical thoughts based upon decisions from courts, arbitrators and boards.

A recent California Court of Appeal decision has turned the tables on a general contractor and rejected the general contractor’s promissory estoppel argument that it could enforce the subcontractor’s bid it relied upon in submitting its price to the owner. Our fourth article will discuss how the outcome of this case should alert general contractors and subcontractors regarding reviewing their procedures in making or accepting bids and awarding subcontracts, particularly when the general contractor uses standard forms at odds with material terms in the subcontractor bid.

Our final article will provide some timely information on state and federal actions to fund and streamline development of large scale infrastructure projects. The State of Utah is following the Trump administration with significant appropriations, authorization of private/public partnerships and efforts to streamline permitting for highway projects, pipelines and transmission lines.

We hope you will find these articles informative and enlightening. Please let us know if you want us to address a specific construction issue in a future newsletter. Enjoy spring!

Regards,
Jim Sienicki

General Contractors (and their Subs) Beware – Lesson Learned in Private Arbitration

by Justin L. Carley

Typically, under a cost-plus compensation model, an owner pays a general contractor for all of its allowed costs, plus an additional percentage for profit. Within those costs, there are usually insurance costs and subcontractor costs. Subcontractor costs also often include insurance costs, whether the subcontractor provides that level of detail in their billing or not. At the time of the billing, no one disputes that these are valid costs under the cost-plus contract. However, general contractors and subcontractors may be vulnerable to claims from project owners when those contractors utilize some form of self-insurance or large-deductible insurance coverage on a cost-plus contract project.

For example, a subcontractor may implement a large-deductible insurance policy for workers compensation insurance. Large-deductible insurance policies provide significant savings on insurance premiums for financially secure subcontractors with strong safety records. However, the subcontractor must pay a substantially higher deductible for each individual workers compensation claim, when compared to a traditional full-coverage or first dollar insurance model. Under those models, the insurance company usually pays claims right away, or after a small deductible, hence the higher premium. So, if a subcontractor qualifies and obtains a large-deductible insurance policy, it is typically required to have a certain amount of money allocated to satisfy future claims, and may even be required to enter into letters of credit or other financial arrangements sufficient to satisfy the insurer of the subcontractor’s ability to pay claims as they are made. The subcontractor may choose to fund an account with the money collected throughout the billing life of the job. Because workers compensation claims may be subject to lifetime opening and reopening in certain states, the subcontractor’s risk for claims may reduce over time, but does not fully expire until every worker employed during a coverage year has died and their estates have been settled.

A subcontractor or contractor should be aware that a project owner may claim that savings realized by a subcontractor who had an exemplary safety record under these insurance models mean that the subcontractors didn’t truly incur these insurance costs. The project owner may claim that those savings should be refunded to the project owner. Even where the subcontractor has not directly contracted with the project owner, the subcontractor may be vulnerable to claims of unjust enrichment and conversion. The project owner may also allege contractual claims against the general contractor for failure to audit the subcontractor and return payment for these claimed excess costs. Accordingly, while self-insurance or large-deductible insurance policies have the potential to generate significant savings, there is a risk that an owner will view those savings as an invalid cost of the work that should be refunded.

The take-away is that general contractors and subcontractors should carefully review their contracts to see if any provisions address this issue. If not, it may be prudent to include specific provisions or agreed upon insurance markups in your subcontract and contract to increase the likelihood that these insurance markups cannot be challenged in a cost-plus contract.

Resources for Owners Implementing Building Information Modeling In Their Projects

by Jason Ebe

Recent industry reports indicate the business value of Building Information Modeling (BIM) for Owners is increasing. Dodge Data & Analytics 2014 reported 68 percent of U.S. owners surveyed either require or encourage BIM for their projects. As BIM adoption continues to rise, owners can benefit to maximize a building’s value throughout its lifecycle.

In January 2017, the National Institute of Building Sciences published its National BIM Guide for Owners. This Guide is intended to outline for the building owner how to develop and implement BIM requirements for application in internal policies and procedures as well as in contracts to plan, design, construct and operate buildings. The authors note in their executive summary:

Merely requiring BIM on a project does not equate to success if the Owner’s goals for the project are not clearly set and BIM requirements do not correlate to achieving these goals. BIM must be well planned and properly executed; not just BIM, but “BIM DONE RIGHT”, aligning the right amount and types of resources to achieve the right results.

The Guide offers a toolset addressing three broad areas - process, infrastructure and standards, and execution, to enable project owners to successfully direct the project team in its use of BIM. The Guide also provides an extensive list of resource documents for owners wishing to further explore and develop BIM best practices.

Developing the plan and procedure for BIM implementation is, however, only part of the equation. Owners must also establish contract agreements with project team participants to clearly define the benefits and obligations, rights and remedies of each team member relative to BIM. For that aspect, several leading construction industry organizations have published templates that owners may utilize to define these contractual terms. For example, the American Institute of Architects publishes several documents, including the E202-2008 Building Information Modeling Protocol Exhibit, the E203-2013 Building Information Modeling and Digital Data Exhibit and the G202-2013 Project Building Information Modeling Protocol Form. The ConsensusDocs® publishes its Building Information Modeling Addendum (Form 301-Last Revised 2016). These industry templates provide a broad range of relevant business and legal terms that owner should negotiate and document relative to their implementation of BIM. For example, E203 addresses general provisions, transmission and ownership of digital data, digital data protocols, BIM protocols and other terms and conditions; and the ConsensusDocs® 301 addresses general principles, definitions, the BIM manager’s role, the BIM execution plan, risk allocation and intellectual property rights. In this context, however, every project can be unique, and owners should not necessarily feel bound to use any particular form independent of project and stakeholder-specific revisions. Each of the foregoing documents is fully editable, allowing for adaption to meet specific needs. Further, consultation with knowledgeable construction legal counsel is advised as the consequences of certain terms and conditions, including risk allocation and indemnities, can have far-reaching effects on the contractual relationships and project as a whole.

BIM is the future, and the future is now. The Guide and the agreement templates are but a few of the numerous resources available to educate owners as to best practices for successful implementation of BIM for buildings, site elements and facilities. BIM is not just an asset during design and construction but rather it provides value through the project’s entire life cycle.

Default Terminations - Some Cautions And Some Advice

by Daniel R. Frost

Troubled construction projects are often marked by failures to cooperate, failures to perform or failures to generally progress the work. In these circumstances, there are as many options and remedies as there are reasons. When these conditions occur repeatedly, it is sometimes tempting for the owner to consider terminating the contractor for default. Even if the parties’ contract contains a robust default termination provision, however, owners should think twice before issuing a default termination. Default terminations can be hard to document and substantiate, and even harder to uphold. While resort to a default termination clause may have significant theoretical appeal, the practical implications can be quite different, especially when viewed with the benefit of hindsight. This article will briefly discuss some default termination pitfalls and then provide some practical advice based upon decisions from courts, arbitrators and boards.

Substantial Performance

First, if a contractor has substantially performed, a default termination is likely to be held to have been wrongful. Courts uniformly hold that a breach of contract is not material if substantial performance has been rendered. This is so, because substantial performance is the antithesis of material breach. Thus, where a contractor substantially completed its work, it is likely that the other party is powerless to properly terminate the contract for default.

Courts and boards have also readily found that even where only a partial certificate of occupancy has been issued, or “mechanical completion” has been achieved, or the contractor has embarked on punchlist work, default termination is wrongful. Allowing an owner or construction manager to reap a windfall by waiting until the contractor has spent a considerable amount of time and money finishing substantial performance of its work, and then defaulting the contractor on an earlier claim of breach, and claiming offsets, such as administrative expenses and attorneys’ fees and costs, is generally considered to be inequitable and unfair.

This bright-line rule regarding substantial performance is based on fairness. At its core, it is an equitable doctrine, intended to prevent unjust enrichment and to avoid an injustice to a party to a contract whose performance has not deviated from the contract in a substantial way. Therefore, “[i]n view of judicial dislike for the forfeiture aspects of default terminations, courts frequently have rejected owner allegations of material breach in the face of apparent substantial performance.” 5 Bruner & O'Connor Construction Law § 18:12.

Waiver

Even where an owner otherwise is fully entitled to terminate a contractor for default, that right can be waived by continuing to accept work after the justification for default termination arose. A party impliedly waives a breach by permitting the contractor to continue working on the project beyond a reasonable time after it had the right to terminate the contract for default. Furthermore, “[t]he materiality of a breach, like the breach itself, can be waived by agreement or conduct.” 5 Bruner & O'Connor Construction Law § 18:17. Thus, the right to terminate a contract for a material breach may be waived by accepting continuing performance.

Like the doctrine of substantial performance, waiver is designed to prevent unjust enrichment to a party that permits its contractor to continue work on the project and then seeks to terminate that contract well after the basis for termination arose. Waiver in this context is simply a recognition that it is unfair to wait to terminate for default until the contractor has added more value and incurred more expense. A party who continues to accept performance in the face of an uncured breach for a significant period of time after the initial opportunity to terminate arose waives its right to terminate for the uncured breach in the view of many judges, arbitrators and boards.

Good Faith

Motive, although highly subjective, also plays a major role in default terminations. For example, in many states every contract contains an implied duty of good faith and fair dealing. Therefore, a party seeking to terminate a construction contract based on technical default must demonstrate that “the termination decision resulted from the exercise of independent discretion and good-faith motives of those having authority to terminate the contract.” 5 Bruner & O'Connor Construction Law § 18:39.

When legal questions begin to predominate over technical and engineering questions, or where the decision to terminate is basically subjective, emotional or visceral, courts and boards have not hesitated to find a termination wrongful. Notably, terminations for default that are motivated by a contractor filing a lien or claim or a simple pretext to satisfy legal requirements, have often been held to be wrongful. Even a general desire to be rid of a troublesome contractor can render a termination wrongful. In other words, discretion must always be reasonably exercised. As the cases recognize, bad faith or other illegitimate motives for terminating a contractor render the termination wrongful even where ostensibly proper grounds for termination exist.

Some Suggestions

On this basis, here are some suggestions to owners considering a default termination. It would be prudent not to terminate a contractor for default unless there is no other alternative. And, if it is absolutely necessary, don’t wait. The more time, work and money a contractor puts into the project, the harder it becomes to justify the termination decision. It would also be sensible not to continue to accept performance after it becomes clear that a termination is necessary. In that regard, it would be wise to not ignore and carefully follow all of the notice and cure provisions of the contract. In addition, it would be prudent not to terminate a contractor without a clear-eyed, objective evaluation based on solid construction or engineering data. In addition, don’t make the decision simply to avoid dealing with a difficult contractor. If necessary, consult with, or even obtain a report from, an independent professional. It would also be wise to not ignore opportunities to reasonably reduce the expenses to be charged to a terminated contractor. And, above all, it would be prudent to not neglect documenting that the default was exercised in a careful, fair and well-considered manner.

Subcontractor Bid and Promissory Estoppel in California Takes an Unexpected Turn

by Michael J. Baker

In an interesting and important case for contractors, the California Court of Appeal in Flintco Pacific, Inc. v. TEC Management Consultants, Inc., 1 Cal App 5th 727 (2016), turned the tables on a general contractor and rejected the general contractor’s argument that it could enforce the subcontractor’s bid it relied upon in submitting its price to the owner. The subcontractor refused to contract with the general contractor and the general contractor attempted to recover its losses for having to replace the subcontractor with a new higher priced subcontractor. General contractors frequently invoke the legal theory of promissory estoppel with great success to recover the increased subcontract price when a subcontractor backs out of its bid used as part of the general contractor’s price to the owner by arguing that the subcontractor should be estopped from asserting there was no promise.

Under the theory of promissory estoppel, a promise which the promisor should reasonably expect to induce action or forbearance of a definite and substantial character on the part of the promisee and which does induce such action or forbearance is binding if injustice can be avoided only by enforcement of the promise. This principle is applicable to a proposed subcontractor who makes a bid, and with it an implied subsidiary promise to keep the bid open for reasonable time after the awarding of the general contract, to a general contractor who in turn bids on a construction contract with the owner in reliance upon the subcontractor’s bid. The elements of a promissory estoppel claim are (1) a promise clear and unambiguous in its terms; (2) reliance by the party to whom the promise is made; (3) the reliance must be both reasonable and foreseeable; and 4) the party asserting estoppel must be injured by his reliance.

The published cases in California almost exclusively come down in favor of the general contractor on the promissory estoppel theory. However, in Flintco Pacific, the appellate court upheld the trial court’s finding that the general contractor did not reasonably rely on the subcontractor’s offer in concluding that the subcontractor would accept the general contractor’s standard form subcontract agreement which omitted some of the conditions in the subcontractor’s bid. Here is what happened.

On May 17, the subcontractor submits its bid to the general contractor for $1,272,960. Immediately below the bid price, the bid provided: “A DEPOSIT OF 35% IS REQUIRED FOR THIS WORK.” The deposit was for security and to enable the subcontractor to lock in a price with its suppliers. Other conditions of the subcontractor’s bid were that the bid could be withdrawn if not accepted within 15 days and that the proposed price was “subject to a minimum 3% escalation, per quarter, after 15 days acceptance period.”

The subcontractor received notice that it was the winning bidder on July 1. On July 5, the general contractor sent a letter of intent to the subcontractor that it intended to issue the subcontractor its standard form subcontract. The letter stated that the “contract award is contingent upon the following terms and conditions, including (1) a requirement that subcontractor accept liquidated damages and retention provisions, and (2) agree on a complete scope of work.

On July 14, the general contractor’s project manager sent the subcontractor the standard form subcontract with exhibits, which was incomplete because it did not identify the scope of work or list the price. The subcontractor testified that a lot of items that were in its May 17 bid were in conflict with the terms in the form subcontract. The parties had major differences including scope of work, the necessity of providing a bond, the liquidated damages clause and the lack of the subcontractor’s bid deposit requirement which the subcontractor testified was critical. Subcontractor also testified that the offer, which remained open for 15 days, had already lapsed triggering the subcontractor’s escalation clause.

On September 8, the general contractor project manager emailed the subcontractor that the general contractor would not relieve the subcontractor of its obligation, and repeated its request that subcontractor sign the general contractor’s standard form subcontract. On September 12, the subcontractor told the general contractor that its bid had expired, and that it was exercising its right to withdraw. The general contractor did not indicate that any of the terms or conditions in the general contractor’s subcontract were negotiable.

Ultimately, the general contractor found a new subcontractor to do the glazing work and sued the subcontractor for $327,050 in a single cause of action alleging promissory estoppel.

The trial court ruled in favor the subcontractor, and found that the general contractor did not satisfy the elements of promissory estoppel because its reliance on the subcontractor’s bid price only, without regard for the other material conditions of the bid, was not reasonable. By sending the subcontractor its standard form subcontract, with terms that conflicted with the subcontractor’s bid terms, the general contractor made a counteroffer that gave the subcontractor the right to withdraw its bid. The subcontractor withdrawal was caused by the general contractor’s unwillingness to accept a number of material terms of the subcontractor’s bid. The trial court also determined that the general contractor’s written communication to the subcontractor demonstrated the general contractor’s “hardball” tactics or a take it or leave it attitude.

The trial court’s decision was affirmed on appeal. The appellate court agreed with the trial court that it was unreasonable for the general contractor to rely solely on the bid price while ignoring material terms and conditions stated therein. Custom and practice cannot alter that result. The subcontractor’s bid was written and contained terms and conditions that were underscored and material because they affected the price. The court restated the principle that when a general contractor uses a subcontractor’s offer in computing its own bid, he bound himself to perform in reliance on the subcontractor’s terms. The appellate court noted that a general contractor is not free to reopen bargaining with the subcontractor and at the same time claim a continuing right to accept the original offer. The submission of the standard form subcontract agreement and failure to include the material terms of the subcontractor’s bid, constituted the rejection of the subcontractor’s bid and a counteroffer and thereby terminated the general contractor’s power to accept the subcontractor’s original bid. The appellate court further held that it was irrelevant that the general contractor did, or may have been able to, negotiate the terms of the subcontract because as soon as the general contractor communicated a response to the subcontractor’s bid that differed materially from the subcontractor’s offer, the general contractor lost its power to accept the subcontractor’s bid.

The take away here, or lesson learned, should be that if a general contractor uses a subcontractor’s offer in computing its own bid, the general contractor binds itself to perform in reliance on the subcontractor’s terms. The practical effect of this decision is to increase the burden upon a general contractor at bid time to pay close attention to the material terms and conditions in a subcontractor’s bid as opposed to primarily or exclusively focusing on subcontractor bid price. Over time, at least in California, general contractors have relied on promissory estoppel case law to leverage their position to focus primarily on subcontractor price to the neglect of other material terms in a subcontractor’s proposal. The outcome of this case should alert the general contractor to review its procedures in accepting bids and awarding subcontract agreements, particularly when the general contractor uses standard forms at odds with material terms in the subcontractor bid. The general contractor runs the risk of rejecting the subcontractor’s winning bid price when it ignores the material terms and conditions. Be forewarned, “hardball” negotiating tactics can backfire and be expensive in these situations.

High Priority Infrastructure Development: the 2017 Utah Legislature Takes a Page from the Trump Administration

by Denise A. Dragoo

The Utah State Legislature has joined with the Trump administration to help facilitate large scale infrastructure development. On February 28, 2017, President Trump asked Congress to approve a $1 trillion investment in infrastructure, financed through both public and private capital to create millions of new jobs. The president also struck a decidedly, “America First” theme by promoting the use of American-made steel and products in these projects. Previously, the president took executive action to lift regulatory obstacles and help streamline environmental permitting for large scale infrastructure projects.

Following the lead of President Trump, last week, just two days before the end of its 2017 Session, the Utah Legislature authorized $1 billion in general obligation bonds. Under S.B. 277, sponsored by Senator Wayne Harper, these bonds may finance state or local highway construction, reconstruction, transportation facilities or multi-modular transportation projects. Funding for transportation projects was further supported by early implementation of a state-wide motor fuel tax increase. The tax is calibrated to increase with the wholesale fuel price, under S. B. 276, sponsored by Senator Kevin Van Tassell.

Similar to the president’s “America First” policy, the Utah Legislature enacted several measures to keep jobs local. Joint resolution SJR 2 was passed to encourage the Salt Lake City Department of Airports to substantially employ Utah workers for its $2.6 billion airport terminal redevelopment project. The Governor’s Office of Economic Development is directed by SB 164, “Utah First Economic Development Amendments,” to promote employment of Utah workers, goods and Utah business.

Finally, the Trump administration is seeking to jump start project construction. President Trump took action on January 24, 2017, to streamline the permitting of high priority infrastructure projects. Only four days following his inauguration, an Executive Order was issued by the president entitled, “Expediting Environmental Reviews and Approvals for High Priority Infrastructure Projects.” By the terms of the order, the Chairman of the White House Council on Environmental Quality (“CEQ”) determines whether a project qualifies as a “High Priority Infrastructure Project.” The CEQ is to respond within 30 days to a request for project designation from a state or federal agency or governor. The selection of a project is based on broad criteria, including its importance to the general welfare, value to the nation, environmental benefits and such other factors as the chairman deems relevant. The types of high priority projects listed by the order include those to improve the U.S. electric grid and telecommunications systems, repairs and upgrade to critical port facilities, airports, pipelines, bridges and highways.

The first two high priority projects were directly designated by the president rather than by CEQ. Presidential memoranda, issued January 24, 2017, designated the controversial North Dakota Access Pipeline and the Keystone XL Pipeline, which had been blocked by the previous administration. Designation cleared the way for final approval for these two significant crude oil projects. On February 8, 2017, the North Dakota Access Project received a key permit from the Army Corps of Engineers.

A third presidential memorandum, also issued on January 24, 2017, directs the Secretary of Commerce to develop a plan to require that new and retrofitted pipelines use U.S. steel, iron and products in their construction. Although the memorandum is broadly based to cover products manufactured in the United States, the National Mining Association has petitioned the secretary to extend this policy to require the use of minerals mined in this Country. Notably, this policy has been somewhat difficult to fully implement. On March 3, 2017, the administration confirmed that the Keystone Pipeline was grandfathered from the “America First” policy.

Prior to inauguration, the Trump administration transition team identified some 50 potential projects totaling some $137 billion for designation as high priority infrastructure. To date, only one high priority infrastructure project affecting Utah has been identified for environmental streamlining. The TransWest ExpressTransmission line is proposed to connect wind energy produced in Wyoming and routes through Utah to the Desert Southwest region. Due to the large amount of public land involved in the transmission right of way, the high priority infrastructure designation should help to expedite permitting. The Utah Governor’s Office is also working on additional requests which include, construction of a unit-train capacity rail line to service an “inland” port from Salt Lake City’s NorthWest Quadrant, a new liquefied natural gas facility located in Utah and network of natural gas pipelines connecting to export facilities in Coos Bay, Oregon, an oil pipeline project to transport Uintah Basin’s waxy crude from Duchesne to Carbon County, Utah and the Gateway South Transmission Project to extend a high-voltage transmission line from southeastern Wyoming to Mona, Utah.

Overall, the 2017 Utah Legislature has taken significant steps to fund the development of large scale infrastructure including: acceleration of the state gas tax, bonding authority increases to an unprecedented $1 billion and authorization of public/private partnerships. This year, the Governor’s Office of Energy Development is also implementing a new high-cost infrastructure tax credit which, over a 20-year period, would allow a credit of up to a 50 percent of the cost of infrastructure construction. Further, these legislative changes and tax incentives appear to be “in sync” with the president’s high priority infrastructure policies. This combination of state and federal policies may allow Utah to realize the Trump administration’s promise to help fund “shovel ready” infrastructure or at least streamline the permitting process for these projects.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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