Letter from the Editor

Welcome to the Fall 2016 edition of our Under Construction newsletter. We hope your summer has left you relaxed and refreshed to successfully finish out the remainder of the year.

Most states have implemented laws governing the qualification and licensing of contractors. Therefore, we will first examine the contractor’s license requirements of three states (Arizona, California and Utah). As the article explains, contractors failing to comply with these licensing requirements could face the harsh penalty of losing their right to receive payment for work done or, worse, the more draconian penalty of disgorgement of all amounts the contractor has been paid for work done. It is obviously imperative to comply with the controlling licensing statutes in the jurisdiction where work is being performed.

We will then take a look at how to navigate prospective price redeterminations under the Federal Acquisition Regulations. These price redeterminations are used in long-term federal construction contracts. The next article describes how a recent California case helps provide guidance on how California courts may resolve the frequent battle on construction projects between the contract forms used by material suppliers versus the contract forms of contractors and whether prejudgment interest can be recovered on a construction claim. From there, we address whether resultant damages are covered by insurance policies governed by Colorado law. Finally, we wrap things up by taking a look at Nevada’s Notice of Non-Responsibility and whether the owner could nevertheless be responsible for work done by a contractor for the owner’s tenant, even when the construction contract is only between the contractor and the tenant. Some, or all of these articles, cover topics which may significantly impact your company.

We hope you will find these articles informative and enlightening on these very important subjects. Please let us know if you want us to address a specific construction issue in a future newsletter. We hope you have a profitable, busy and safe fall season!

Regards,
Jim Sienicki

Beware: Unlicensed Contractors in AZ, CA and UT Cannot Collect Payment for Their Work

by Sean M. Mosman

Most states have implemented laws governing the qualification and licensing of general building contractors. State contractor licensing statutes serve an important function – to protect the health and safety of consumers of contracting services – but they can also represent a costly pitfall for the unwary contractor. Several states have adopted statutes prohibiting a contractor without a valid license from bringing a claim to recover outstanding payment for their work. Some states even mandate disgorgement of the amounts already collected by the contractor. The inherent difficulty of maintaining compliance with these laws is compounded when a contracting business seeks to qualify for a license through the application of a representative holding a contracting license on behalf of the company, generally known as a Responsible Managing Officer (RMO), Responsible Managing Employee (RME), Qualifying Party or simply a “qualifier.” Qualifiers are often subject to additional duties and responsibilities that must be satisfied to preserve valid licensure. This article examines the licensing schemes of three states that have adopted non-payment and/or disgorgement statutes – Arizona, California and Utah – and explores how a contracting company can maintain compliance with licensing laws through the involvement of an RMO, RME or qualifier.

ARIZONA

In Arizona, contracting companies are permitted to qualify for a license through a “qualifying party,” also called an RME, who meets the qualifications of the Registrar of Contractors^[1] and is “regularly employed by the licensee and . . . actively engaged in the classification of work for which such [RME] qualifies in behalf of the licensee.” A.R.S. 32-1127. While engaged as a qualifying party for a licensee, this individual “shall not take other employment that would conflict with his duties as [RME] or conflict with his ability to adequately supervise the work performed by the licensee.” Id. Thus, an Arizona RME must (a) be employed by the licensee, (b) maintain active engagement with the licensee’s specific classification of contracting work, and (c) supervise the licensee’s work.

Arizona has adopted a “non-recovery” statute to penalize contractors who violate state licensing statutes. A.R.S. 32-1153 states, “[n]o contractor [may] commence or maintain any action in any court of the state for collection of compensation . . . without [first] proving that the contracting party . . . was a duly licensed contractor . . . when the alleged cause of action arose.” A.R.S. 32-1153 (“Proof of License as Prerequisite to Civil Action”). A.R.S. 32-1153 provides “protection to the public by strict licensing requirements, even where harsh consequences fall upon those who do contracting work in good faith without an appropriate license.” B&P Concrete v. Turnbow, 561 P.2d 329, 331 (Ariz. Ct. App. 1977). While recognizing the harshness of the non-recovery remedy, Arizona courts have generally continued to enforce it as written.

An RME’s actions can trigger the non-recovery statute in several instances. For example, an RME who “disassociates” from his or her employer’s license by leaving the contractor’s employ can render the contractor unlicensed for purposes of A.R.S. 32-1153 if the contracting company does not qualify another person to serve as its RME within 60 days. See A.R.S. 32-1167 (If a qualifying party ceases “for any reason” to be connected with the licensee, both the licensee and the qualifying party must notify the Registrar of Contractors within 15 days after the disassociation, and the licensee must qualify through another person within 60 days of the disassociation). The license is “automatically suspended by operation of law” at the end of such period unless the licensee qualifies though another person. Id. As noted above, under A.R.S. 32-1153, a contractor with a suspended license may not bring an action to recover outstanding payments for its contracting services. See Morris v. Achen Const. Co., Inc. 155 Ariz. 507, 509 (Ariz. Ct. App. 1986) (barring recovery under mechanic’s lien where RME had disassociated himself from contracting company during construction of appellants’ residence) judgment rev’d in part, vacated in part, 155 Ariz. 512 (1987).

Further, an RME may trigger the “non-recovery” statute by failing to satisfy his or her statutory duties to supervise and be actively engaged with the licensee’s classification of contracting work. For example, an RME must ensure that a contracting company does not perform work in a specialty not covered by the contractor’s license. Courts treat contracting companies operating beyond the scope of their license as unlicensed contractors, subject to A.R.S. 32-1153. See Schlicht v. Curtin, 117 Ariz. 30, 31 (Ariz. Ct. App. 1977) (forbidding recovery of unpaid compensation for masonry where contracting company was licensed as general contractor but had not obtained specialty license to do masonry work).

Arizona contracting companies must employ an active RME at all times, or risk running afoul of the “non-recovery” statute as it applies to contractors whose RME has disassociated from the business. Further, contracting companies must take pains to ensure that the scope of their work does not exceed the its licensing qualifications.

CALIFORNIA

California has adopted a set of statutes known as the Contractors State License Law, or “CSLL,” to govern the qualification and licensing of contractors. See Business & Professions Code (B&P) § 7000, et seq. The CSLL requires a contracting company to qualify for a license via the application of a responsible managing individual (known as an RME or RMO) with “such degree of knowledge and experience in the classification applied for, and such general knowledge of the building, safety, health and lien laws of the state . . . as the board deems necessary for the safety and protection of the public.” B&P § 7068(a). This person is “responsible for exercising that direct supervision and control of his or her employer’s construction operations as is necessary to secure full compliance with the provisions of [the CSLL] and the rules and regulations of the [Contractors State License Board] relating to construction operations.” B&P § 7068.1.

Under the CSLL, a RME has a duty to actually apply his knowledge and skill in managing the contractor’s work on the project. See Hydrotech Sys. Ltd. v. Oasis Waterpark (1991) 52 Cal.3d 988, 995 (“[The CSLL] licensing requirements provide minimal assurance that all persons offering such services in California have the requisite skill and character, understand applicable local laws and codes, and know the rudiments of administering a contracting business.”). B&P § 7068.1(a) requires that the RME “shall be responsible for exercising direct supervision and control” over the company’s construction operations. CSLB regulations define the term “direct supervision and control” to encompass the following activities: supervising construction, managing construction activities by making technical and administrative decisions, checking jobs for proper workmanship, and directly supervising on construction job sites. 16 CCR § 823(b).

A contractor whose RME fails to actively supervise and control its construction work is subject to the automatic suspension of its license. See White v. Cridlebaugh (2009) 178 Cal. App. 4th 506, 518 (contracting company’s license revoked by operation of law where RME left the country for two years on a missionary trip); Buzgheia v. Leasco Sierra Grove (1997) 60 Cal. App. 4th 374, 386-388 (“Once the RME is not performing his function, it is as if the contractor has no license at all.”); see also B&P § 7068.2. When an RME is not actively involved in its contractor’s operations pursuant to § 7068.1 and no replacement is qualified in its place, the RME is considered disassociated and the contractor’s license is suspended automatically by operation of law via § 7068.2.

Much like A.R.S. 32-1153, California’s “non-recovery” statute, B&P §7031(a), prohibits any person “engaged in the business or acting in the capacity of a contractor” from “bring[ing] or maintain[ing] any action, or recover[ing] in law or equity in any action . . . the collection of compensation for the performance of any act or contract where a license is required by this chapter without alleging that he or she was a duly licensed contractor at all times during the performance of that act or contract.” B&P §7031(a) is known as the “shield” provision, because it protects consumers of unlicensed contracting services from liability in any lawsuit to collect payment. Unlike Arizona, however, California pairs the shield with a sword – B&P §7031(b), which states, “Except as provided in subdivision (e), a person who utilizes the services of an unlicensed contractor may bring an action in any court of competent jurisdiction in this state to recover all compensation paid to the unlicensed contractor for performance of any act or contract.”^[2]

The stated purpose of § 7031 is “to encourage careful adherence to the licensing laws, and to deter persons from offering or providing unlicensed contractor services for pay[.]” MW Erectors, 36 Cal. 4th at 430. Section 7031 advances the purpose of the Contractor's State License Laws of protecting the public from the incompetent and dishonest provision of building and construction services “by withholding judicial aid from those who seek compensation for unlicensed contract work.” Id. at 430 n.10 (quoting Hydrotech Systems, Ltd, v. Oasis Waterpark (1991) 52 Cal.3d 988, 995).

In California, an RME is not permitted to sit back and passively allow the contractor’s license to be used by a contracting company without significant personally engagement with the project. Instead, an RME must exercise “direct supervision and control” over the construction operations. An RME’s failure to satisfy its duties can subject a general contracting company to catastrophic liability – including the sting of the B&P §7031(b) “sword,” which requires disgorgement of all compensation paid to the contractor if contractor was not validly licensed at any time during the performance of a construction contract.

UTAH

As in Arizona and California, a general contracting business in Utah seeking a contractor’s license must demonstrate competence to hold the license via the application of a “qualifier.”^[3] Pursuant to Utah Code Ann. § 58-55-304, a qualifier for a business entity licensee must be “an owner, officer, or manager within that business entity who exercises material authority in the conduct of that business entity’s contracting business” by (a) “making substantive technical and administrative decisions” related to the contractor’s work; (b) directly managing the contractor’s employees, “either by himself or through others”; and (c) not being involved in any other activity, including additional employment, which “conflicts with the individual’s duties and responsibilities to ensure the licensee’s performance of [contracting work] does not jeopardize the public health, safety and welfare.”

In Utah, “[n]o contractor may...commence or maintain any action...for collection of compensation for performing any act for which a license is required...without alleging and proving that he [or she] was a properly licensed contractor when the contract sued upon was entered into, and when the alleged cause of action arose.” Utah Code Ann. § 58–55–604. Utah’s non-recovery law “serves the dual purpose of protecting the public from incompetent contractors, while sanctioning contractors who fail to obtain proper licensure.” A.K. & R. Whipple Plumbing and Heating v. Aspen Const., 977 P.2d 518, 522 (Utah Ct. App. 1999).

Nevertheless, Utah’s version of the “non-recovery” statute is softened considerably by the existence of several statutory and common-law exceptions. Utah Code Ann. § 58-55-305 sets forth various types of projects and categories of construction professionals that are not subject to Utah’s licensing requirements. Further, Utah appellate courts have recognized several common-law exceptions under which an unlicensed contractor may sue to collect payment, each “premised on the theory that rigid insistence on proper licensure is unnecessary as long as the public is otherwise protected from the harm the statute is designed to prevent.” A.K. & R. Whipple, 977 P.2d at 523 (citing American Rural Cellular v. Systems Communication Corp., 890 P.2d 1035, 1040 (Utah Ct. App. 1995)). Consequently, many courts that have addressed the application of Utah Code Ann. § 58–55–604 (and its statutory and common-law predecessors) to lawsuits involving an unlicensed contractor have allowed recovery to the unlicensed contractor. See, e.g., Govert Copier Painting v. Van Leeuwen, 801 P.2d 163, 171 (Utah Ct. App. 1990) (reversing and remanding for determination of whether appellee was “adequately protected from the harms the licensing statute was meant to prevent” despite appellant’s lack of licensure); Kinkella v. Baugh, 660 P.2d 233, 236 (Utah 1983) (unlicensed contractor permitted to recover because general contractor’s son, who supervised the project, was a licensed contractor, and thus homeowner received whatever protection was afforded by compliance with licensing statute); Lignell v. Berg 593 P.2d 800, 805 (Utah 1979) (contractor’s lack of licensure did not preclude its recovery for breach of contract against owners of condominium complex, who were not deprived of kind of protection licensing statute was designed to afford).

Utah’s “non-recovery” statute appears to act as an absolute bar in only the most egregious circumstances. See, e.g., A.K. & R. Whipple, 977 P.2d at 520 (denying recovery under mechanic’s lien claim where contractor was not licensed to perform HVAC work); George v. Oren Ltd. & Assoc., 672 P.2d 732, 734 (Utah 1983) (denying recovery where contractor had willfully refused to renew his license); Meridian Corp. v. McGlynn/Garmaker Co., 567 P.2d 1110, 1111 (Utah 1977) (denying recovery because contractor’s license in another state could not be substituted for Utah license). While strongly worded, § 58–55–604 is subject to such a litany of exceptions that it is largely an ineffective “shield” for consumers of unlicensed contracting services. However, as the courts’ enforcement of similar statutes in Arizona and California shows, the risk of an absolute bar to recovery is too great for a Utah contractor to carelessly run afoul of Utah licensing laws. Utah contracting companies should therefore abide strictly by the letter of the law – particularly as it relates to RMEs, by appointing only a bona fide owner, officer or manager with decision-making authority to serve as a qualifier and by ensuring that the qualifier is sufficiently involved in the contracting business to make decisions related to the work, directly manage employees and not undertake any activities that could interfere with the qualifier’s statutory responsibilities.

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Notes:

[1] In general, before a license is issued, the RME must have had a minimum of four years' experience with the type of construction for which the applicant is applying for a license. A.R.S. 32-1122(F). Further, the RME must pass a written examination demonstrating that he or she is “qualifi[ed] in the kind of work for which the applicant proposes to contract.” A.R.S. 32-1122(F)(1). This examination must test the applicant's general knowledge of the building, safety, health and lien laws of the state, the administrative principles of a contracting business and the laws applicable to contracting companies. A.R.S. 32-1122(F)(2). The qualifying party must also “demonstrate knowledge and understanding of construction plans and specifications” applicable to his or her particular industry “and of the standards of construction work and techniques” associated with that industry. Id. [back]

[2] Moreover, B&P §7031(e) states, “The judicial doctrine of substantial compliance shall not apply under this section where the person who engaged in the business or acted in the capacity of a contractor has never been a duly licensed contractor in this state. However . . . the court may determine that there has been substantial compliance with licensure requirements under this section if it is shown at an evidentiary hearing that the person who engaged in the business or acted in the capacity of a contractor (1) had been duly licensed as a contractor in this state prior to the performance of the act or contract, (2) acted reasonably and in good faith to maintain proper licensure, (3) did not know or reasonably should not have known that he or she was not duly licensed when performance of the act or contract commenced, and (4) acted promptly and in good faith to reinstate his or her license upon learning it was invalid.” A contractor should not rely on a substantial compliance defense to a § 7031 action, however, because the CSLL has been both amended by the Legislature and interpreted by courts to “limit[] the availability of the substantial compliance exception.” MW Erectors, Inc. v. Niederhauser Ornamental and Metal Works Co., Inc., 36 Cal.4th 412, 418 (2005). [back]

[3] See Utah Admin. Code r. R156-55a(8) (defining “Qualifier”). [back]

Navigating Prospective Price Redeterminations Under the Federal Acquisition Regulations

by Jason Ebe

Contractors performing work for the federal government may enter into long term contracts whereby the government pays the contractor a Firm Fixed Price (FFP) for each Contract Line Item Number (CLIN) work description for each year of the term. By way of example, the Department of Defense has privatized its utilities infrastructure at many of its military installations by conveying ownership of the infrastructure to a qualified entity which operates and maintains the infrastructure as well as performs renewals and replacements of aging infrastructure components over a 50 year term, in exchange for annual FFP payments. However, recognizing the difficulty in predicting anticipated costs for a period of 50 years in the future, many such contracts, as well as other federal contracts providing long term FFP compensation to contractors, utilize a procedure called Prospective Price Redetermination (PPR). Using this procedure, the government and contractor agree to review on a periodic basis, typically every few years for a long term contract, the contractor’s historical costs in order to redetermine, as needed, the FFP for future years. This benefits both the government and the contractor by limiting the long term effects from unforeseen changes in pricing.

The PPR process is set forth in the Federal Acquisition Regulations (FAR), specifically FAR 52.216-5. Generally, the contract at the time of award will specify the period for redetermination and the deadlines for submission of information relative to that redetermination. Within those deadlines, the contractor is expected to submit proposed pricing for the future period based upon historical costs (plus appropriate markups and profit) for the prior period. As an example, if the contractor’s 2015 FFP for a CLIN was $750,000, but the contractor’s actual costs plus markups and profit for 2015 totaled only $500,000, an evaluation should be conducted by the government and the contractor as to the reasons for that difference and whether the 2016 FFP CLIN should be priced lower to avoid a windfall to the contractor. Conversely, if the contractor’s actual costs plus markups and profit for 2015 totaled $1,000,000, it’s likely the 2016 FFP CLIN will be priced higher to avoid loss to the contractor. To be clear, the PPR process should not result in an adjustment of the FFP for CLINs prior to the redetermination period: in the foregoing example, the 2015 FFP would not change based on actual costs. However, the process is intended over the term to balance out peaks and valleys in comparing FFP to costs.

Upon the government’s receipt of the contractor’s data, the Contracting Officer (CO) is to promptly negotiate with the contractor to determine fair and reasonable prices for services and supplies that may be performed in the period following the effective date of the price redetermination. Each negotiated redetermination of prices shall be evidenced by a modification to the contract, signed by the contractor and the CO, stating the redetermined prices that apply during the redetermination period. The FAR also provides for a procedure by which the government can pay the contractor during the PPR process pending the final redetermination. However, this procedure is not intended to provide a substitute by which the government can avoid paying a contractor a FFP for its CLIN and instead pay the contractor based on costs. In other words, FAR 52.216-5 does not authorize a CO to unilaterally change a FFP CLIN to cost reimbursement. The FARs contain entirely separate clauses for cost-reimbursement contracts.

Under the PPR FAR provision, if the contractor and the CO fail to agree upon redetermined prices for any price redetermination period within 60 days (or within such other period as the parties agree) after the date in which the data is required to be submitted, the CO must promptly issue a decision in accordance with the Disputes clause (FAR 52.233-1). For purposes of payments to the contractor, and pending final settlement of the disagreement on appeal, or failure to appeal by the contractor, or by agreement, the CO’s decision shall be treated as an executed contract modification. Pending final settlement, price redetermination for subsequent periods, if any, shall continue to be negotiated as provided in the PPR clause. In other words, using the foregoing example, if the contractor and the government are unable to agree upon a 2016 FFP CLIN, the CO is to issue a final decision as to the 2016 FFP, which is then subject to appeal by the contractor. At no time does the FFP CLIN revert to cost.

Notwithstanding the clarity of the published PPR procedure, instances occur where the parties do not properly follow the clause and a dispute may then arise whether the redetermination process that occurred was authorized and appropriate. In those instances, the appeal may encompass as significant a legal component as a pricing component. Knowledgeable counsel, in conjunction with an experienced cost consultant, can assist the contractor in all aspects of the PPR process, from submission of the proposal, to negotiation with the government and through the appeals process.

What Terms of Sale Control and Can I Get Prejudgment Interest on My California Construction Claim?

by Mark D. Johnson

A recent California case helps answer both of these questions and provides guidance on how California courts may resolve the battle between the forms used by material suppliers and contractors. The California court evaluated the purchase orders and invoices for construction items and whether prejudgment interest might be available to the prevailing party in the dispute. Watson Bowman Acme Corporation v. RGW Construction, Inc., (8/9/2016) 2016 WL 4212124. In that case, the issue was whether Watson (WBA) agreed to supply the general contractor (RGW) on a California Department of Transportation (CalTrans) project with a particular product specified in WBA’s quote or whether WBA agreed to supply a product that complied with CalTrans’ specifications. The product was “joint seal assemblies” which CalTrans’ identified as “JOINT SEAL ASSEMBLY (MR 101 MM—160 MM)” and which Cal Trans stated must meet all applicable specifications.

RGW obtained bids from Watson (WBA) and others to supply these joint seal assemblies. WBA offered to provide 146 units of “JOINT SEAL ASSEMBLY (MR 101–106MM), WaboModular BET–1200 Strip Seal” for a unit price of $3,940 per unit and a total price of $605,990 (Quote 1). RGW told WBA that its bid was substantially higher than the other bids that RGW received. WBA decided to submit a revised bid. WBA’s representative testified that he told RGW that the product WBA would specify in its follow up bid might not meet CalTrans’ specifications.

WBA’s follow-up quote offered to furnish 146 units of “JOINT SEAL ASSEMBLY (MR 101–106MM), WaboModular STM600 w/ bulkhead plates” for at a unit price of $1,304 per unit (Quote 2). RGW’s purchase order regarding WBA’s Quote 2 stated that WBA would supply “Wabco Modular STM600 w/bulkhead plates” joint seals “per [CalTrans’] plans and specifications with addenda.” WBA signed RGW’s purchase order and contended that it sent it back to RGW with WBA’s “terms and conditions of sale” attached. WBA contended its terms and conditions of sale became part of the contract between RGW and WBA and expressly disclaimed warranties of fitness for a particular purpose and warranties of merchantability.

CalTrans rejected the shop drawings that WBA prepared for RGW to submit for WBA’s products. RGW directed WBA to revise and resubmit the drawings. In response, WBA prepared shop drawings for submittal to CalTrans that depicted the product WBA had proposed to supply in Quote 1. CalTrans approved these shop drawings.

WBA then submitted a change order to supply the Quote 1 product instead of the Quote 2 products. WBA told RGW that it would not supply the Quote 1 product unless and until RGW signed the change order. However, WBA ultimately shipped the Quote 1 products but reserved its rights to seek additional compensation.

WBA filed a lawsuit against RGW for breach of contract and other claims asserting that RGW revised the contract by changing the products from those described in the purchase order and Quote 2 from the products described in Quote 1 and that WBA was essentially entitled to the price difference between the two quotes. RGW denied all of WBA’s claims and filed a counter claim alleging that it had suffered about $135,000 in damages due to defects in WBA’s products.

At trial, the sole question presented to the jury about WBA’s complaint was: “What was the amount of the subject agreement [between RGW and WBA]?” The jury found the amount was $605,000, the amount of WBA’s price under Quote 1. The jury also found that RGW suffered $111,771.08 as a result of defects in the products supplied by WBA. After accounting for the amount previously paid by RGW, the jury found that RGW owed WBA $383,032.32.

RGW filed a motion for judgment notwithstanding the verdict, or alternatively for a new trial. At the hearing on RGW’s motions, WBA submitted a request for $136,000 in prejudgment interest. The trial court denied both of RGW’s motions and also denied WBA’s request for prejudgment interest, stating it was untimely. Both parties filed appeals.

With respect to its change order request, WBA argued that it was entitled to its change order request because RGW’s purchase order was ambiguous as to what was ordered, and that parol evidence showed it advised RGW that the product WBA specified in Quote 2 would not be approved by Caltrans. WBA further argued that despite this warning, RGW specifically requested a quote from WBA for the product. In contrast, RGW argued that the price quoted in Quote 2 applied to the joint seal assemblies delivered by WBA because WBA signed RGW’s purchase order which stated that the joint seal assemblies would conform to all of Caltrans's specifications. With respect to this issue, the Watson court found that the trial court correctly determined that RGW’s purchase order was ambiguous and correctly allowed the jury to evaluate the conflicting parol evidence before deciding the meaning of the contract. Therefore, the jury’s findings on the issues of liability and damages were affirmed.

In terms of the award of prejudgment interest, the Watson court noted that under California law prejudgment interest should be awarded if a defendant knows the amount owed or from reasonably available information could have computed it. The court also noted that where the amount of a demand is sufficiently certain, the existence of a set-off, counterclaim, or cross claim which is unliquidated will not prevent the recovery of interest on the balance of the liquidated sum minus the offset. Prejudgment interest is thus calculated on the net amount owed.

The Watson court found that the request in WBA’s initial complaint for “interest as provided by law” and statement in its amended complaint that it was “entitled to … interest on the money that RGW has wrongfully withheld at the statutory rate” notified RGW that WBA sought both prejudgment and post judgment interest and provided a proper basis for an award of prejudgment interest. The court also found that WBA’s request for prejudgment interest was timely because it was made less than 15 days after the judgment was filed and within the statutory time limit. The court also found that the trial court’s denial of WBA’s request for prejudgment interest on the grounds that it was not made in connection with a motion for new trial or a request for modification of the judgment was improper. The court said that WBA’s request for prejudgment interest advised RGW of the nature of the request, the grounds for it and time to oppose it and, therefore was sufficient to be awarded prejudgment interest. The court reversed the trial court and awarded WBA prejudgment interest on the net amount owed. Thus, the court provides guidance in future California cases involving the battle of the forms and prejudgment interest.

Resultant Damage Remains Covered Under Insurance Policies Governed by Colorado Law — For Now.

by Daniel R. Frost

One of the more difficult issues faced by contractors, owners and carriers on construction insurance claims is whether coverage exists for resultant damages, or the costs attributable to destroying non-affected work to obtain access to repair defective work. These costs are sometimes referred to as “rip and tear” or “get to” costs.

The Colorado Supreme Court has recently approved a settlement between the parties to an appeal of the 2012 Colorado Pool Systems v. Scottsdale Insurance Company Court of Appeals case, confirming that such damages are covered under Colorado law. The ruling parses a fine line between uncovered costs of repairing defective work and covered costs of damage caused to non-defective work while repairing defective work. This nuanced opinion, which is now established Colorado law, is worth a second look.

In Colorado Pool Systems, Inc. the Colorado Court of Appeals determined that so-called resultant damage caused by a construction professional to non-defective work while correcting defective work is covered as an “accident” under standard CGL insurance language. 317 P.3d 1262 (Colo. App. 2012). A pool company excavated and built a rebar frame in order to construct a pool, but it hired a subcontractor to pour the concrete. An inspector later noticed that some of the rebar was too close to the surface, and the pool company agreed to demolish and replace the pool after an agent of its insurer represented that this loss would be covered. But the agent was wrong, the insurer denied coverage and litigation ensued.

After determining that the Colorado Builder’s Insurance Act (which creates a presumption that property damage caused by construction work is an accident) could not apply retroactively, the court set about interpreting the insurance policy. This question came down to whether the faulty workmanship was an “accident” under the policy. The policy did not define “accident,” and the court found that its common meaning was ambiguous; it could mean either a chance occurrence or an unintentional one. The court sided with the insured’s unintentional reading, in line with Colorado’s requirement that ambiguous provisions in insurance contracts are construed in favor of the insured.

With this reading in mind, the court borrowed a test from the 10th Circuit case Greystone Constr., Inc. v. Nat’l Fire & Marine Ins. Co., 661 F.3d 1272, 1289 (10^th Cir. 2011). Under Greystone, “injuries flowing from improper or faulty workmanship constitute an ‘occurrence’ so long as the resulting damage is to non-defective property, and is caused without expectation or foresight.” 661 F.3d at 1284. Applying this test, the court determined that the policy did not cover repair of the defective work because construction professionals both expect and foresee that they must correct defective work. However, the court held that damage that the pool company caused to other non-defective work while correcting its defective work was covered under the policy. This damage—inflicted upon a non-defective deck, sidewalk, retaining wall and electrical conduits—was deemed an “accident” that was covered under the policy.

It is also worth a second look at how resultant damage is treated under all-risk policies. In Blaine Construction Corp. v. Insurance Co. of North America, 171 F.3d 343 (6^th Cir. 1999), a construction contractor sought coverage under an all-risk policy for ceiling insulation that was damaged when a subcontractor deficiently installed a vapor barrier in the roof membrane, causing water to condense in the insulation cavity. The insurer denied coverage on the grounds, inter alia, that the damage resulted from faulty workmanship. The insured conceded that the costs to repair the workman’s mistake – sealing the edge tabs and creating a continuous vapor barrier, came within the faulty workmanship exclusion. However, the insured sought coverage for the costs to replace ceiling insulation that was ruined when water condensed in the insulation cavity due to the defective barrier. The insurer argued that the damaged insulation was covered by the exclusion, and that in order for the ensuing/resulting loss exception to apply, there must have been some further accident, or a “new, separate and independent peril from the peril that is excluded, rather than a loss that flows naturally and ordinarily from an excluded peril.” The court rejected the insurer’s contention, holding that the loss claimed fell within the ensuing/resultant loss exception. “What was damaged here was not the vapor barrier edge tabs – the items that should have been sealed and weren’t – but the adjacent material.” Given the reasoning in this and the Scottsdale case, it seems likely that a Colorado court could find resultant damages covered under an all-risk policy.

These decisions raise some interesting policy questions, especially given the multi-subcontractor specialist environment in modern construction litigation. Construction professionals and insurers alike should take note of the fine line between uncovered losses incurred while correcting defective work and covered “rip and tear” damage caused to non-defective work while correcting defective work.

Nevada’s Notice of Non-Responsibility: The Toothless Tiger of Landlord Protection

by Leon F Mead II

Any good commercial real estate attorney (or leasing agent for that matter) will tell you - long term commercial leases hold many hazards for landlords and tenants alike. Among them, construction of the tenant improvements can be a nightmare. Not only does the landlord need to worry about the work itself, mechanics liens make the landlord’s property ownership at risk if the tenant fails to pay the contractors. The landlord’s protections are limited if the tenant fails to pay. The most widely used protection throughout the country is the Notice of Non-Responsibility. But not all such protections are the same.

Nearly all states give unpaid construction workers a mechanics lien right against the property their work improves, if the owner does not pay for the work. But a landlord doesn’t really have a dog in that fight – contractually (after the tenant improvement allowance is paid) the tenant is generally obligated to pay for its own improvements to the rented space. To overcome landlord objections to mechanics lien laws, most states also have enacted statutes that allow a landlord to avoid mechanics liens by informing the tenant’s contractors the landlord will not pay for their work. This is done through a Notice of Non-Responsibility (NNR). The NNR basically says “Look only to the tenant for payment, contractor” or “contractor beware” for short. In most places, as long as the landlord timely records, posts and serves a NNR in the proper form, any mechanics liens recorded due to the tenant improvements will not affect the landlord’s ownership interest in the leased property.

Well, most places, except Nevada.

Like other states, Nevada has a statute that provides for a NNR to protect a landlord or other property owner from a tenant’s mechanics liens. NRS 108.234 is long and cumbersome (and provides the details for content and service, which are not relevant to this article), but all the words hide a couple traps for the unsuspecting or careless. Not every landlord can rely on a NNR to protect its interest. In fact, a plain reading of the statutory prose would indicate almost no landlord can. Simply put, the landlord doesn’t qualify.

NRS 108.234(1) starts off by making every construction project deemed to be constructed by the request of all of its owners (with certain exceptions):

Except as otherwise provided in subsection 2, every improvement constructed, altered or repaired upon property shall be deemed to have been constructed, altered or repaired at the instance of each owner having or claiming any interest therein, and the interest owned or claimed must be subject to each notice of [mechanics] lien ….

(Emphasis added).

To assuage the landlords now quaking in fear, NRS 108.234(2) offers a glimmer of respite. In pertinent part, it reads:

The interest of a disinterested owner in any improvement and the property upon which an improvement is constructed, altered or repaired is not subject to a notice of lien if the disinterested owner, within 3 days after he or she first obtains knowledge of the construction, alteration or repair, or the intended construction, alteration or repair, gives notice that he or she will not be responsible for the improvement by recording a notice in writing to that effect….

(Emphasis added).

“Whew!” The landlord figures he has no interest in the tenant improvement – contractually he allows it to happen, and yes, provides the tenant some money for it – he may even have some mandatory design criteria for them or a specific contractor the tenant must use – but he figures he obviously is a “disinterested owner”, so the NNR is his savior.

Well, not so fast.

NRS 108.234(7) actually defines what a “disinterested owner” is, so before celebrating we should take a peek just to make sure the minor level of our landlord’s interest is actually disinterest. NRS 108.234(7) says:

As used in this section, “disinterested owner” means an owner who:

(a) Does not record a notice of waiver as provided in NRS 108.2405; and

(b) Does not personally or through an agent or representative, directly or indirectly, contract for or cause a work of improvement, or any portion thereof, to be constructed, altered or repaired upon the property or an improvement of the owner.

→ The term does not include an owner who is a lessor if the lessee fails to satisfy the requirements set forth in NRS 108.2403 and 108.2407.

(Emphasis added).

It appears that qualification as a “disinterested owner” has 3 elements – all negatives:

1. Does not record a notice of waiver under NRS 108.2405;
2. Does not cause the tenant improvement to be constructed, and
3. Does not have a tenant that fails to satisfy the requirements of NRS 108.2403 and 108.2407.

Notice of Waiver

The first one seems easy enough – who is going to waive the right to record a NNR? Well, no one, but that isn’t really the point. This isn’t really a notice of waiver of the right to record an NNR (although that is how it is accomplished): It is instead really a waiver of the obligation to require the tenant to post security for the work of improvement. NRS 108.2405 provides in pertinent part:

1. The provisions of NRS 108.2403 and 108.2407 do not apply:

(a) …

(b) If all owners of the property, individually or collectively, record a written notice of waiver of the owners’ rights set forth in NRS 108.234 with the county recorder of the county where the property is located before the commencement of construction of the work of improvement.

(Emphasis added).

So what does a landlord care about NRS 108.2403 and 108.2407? The landlord should care because it affects the ability to perform the tenant improvement work at all (and therefore, perhaps, enter into the lease). NRS 108.2403 provides in pertinent part:

1. Except as otherwise provided in NRS 108.2405, before a lessee may cause a work of improvement to be constructed, altered or repaired upon property that the lessee is leasing, the lessee shall:

(a) Record a notice of posted security with the county recorder of the county where the property is located upon which the improvement is or will be constructed, altered or repaired; and

(b) Either:

(1) Establish a construction disbursement account and:

(I) Fund the account … or

(2) Record a surety bond for the prime contract….

(Emphasis added).

NRS 108.2407 provides certain notice obligations and lien claim modifications if the posted security takes the form of the construction disbursement account, but that is not the focus of this article. The key is that security for the tenant improvement must be provided, and notice thereof given, before the tenant can actually begin construction.

But what if the tenant doesn’t do this and just starts construction anyway? NRS 108.2403(3) clarifies that in the face of no security for the improvement, the tenant contractor can stop work until the security is posted and if it is never posted terminate the contract and sue for damages. So, that is not really an option for the tenant. And since you don’t want to waive the right to record an NNR anyway, the landlord decides the tenant must post the security under NRS 108.2403 as part of the tenant’s lease obligations. Simple enough.

Well, again, not really. NRS 108.2403 also requires that the escrow account be fully funded for 100 percent of the contract amount of the tenant improvement before construction starts (including all of the tenant improvement allowance). That isn’t always palatable to a landlord or a tenant. NRS 108.2415 requires the surety bond to be in the penal sum of 150 percent of the amount of the prime contract and many tenants cannot qualify to obtain a surety bond of this amount anyway. Neither of these are usually commercially viable options. So if the landlord wants the lease to go through, there may be no choice but to waive the right to record the NNR.

Does Not Cause the Tenant Improvement to Be Constructed

Leaving the decision on whether to waive the NNR aside, certainly the landlord is not causing the tenant improvements to be constructed. The tenant has to enter into the construction contract after all. True, but this one is kind of murky too. It is not as simple as who enters into the construction contract. NRS 108.234(7)(b) is a bit more detailed:

• Does not personally,
• or through an agent or representative,
• directly or indirectly,
• contract for or cause a work of improvement, or any portion thereof, to be constructed, altered or repaired upon the property or an improvement of the owner.

Does not personally construct the tenant improvement is probably covered by the landlord not entering into the construction contract directly with the contractor. “Does not though an agent or representative” is more problematic if the tenant itself, having the right (or actual obligation) to construct the tenant improvements on the landlord’s property, can be said to be the agent of the landlord. If the lease actually obligates the tenant to perform the tenant improvements, arguably the landlord indirectly contracted for or caused the tenant improvement to be constructed through the lease agreement. While this argument certainly would be contextual, it seems the more mandates the landlord imposes on the tenant for design, construction methods, or pays for through tenant allowances the more the landlord looks factually to be the indirect cause of the involved improvements.

The Nevada Supreme Court raised the question of whether a tenant is an agent of the landlord in Hardy Cos. v. SNMARK LLC, 245 P.3d 1149 (Nev. 2010), and decided that the tenant is not the Owner’s agent. For a number of reasons, this decision ignored the statutory language. Nevertheless, the Nevada Supreme Court ruled that a tenant is not the landlord’s agent for mechanics lien purposes. What the Nevada Supreme Court will later decide regarding this issue for notice of non-responsibility purposes is an open question.

Does Not Have a Tenant that Fails to Provide Security for the Work of Improvement

Finally, the last element is fairly simple. If the tenant fails to provide the bond or establish and fund the escrow, the Landlord cannot qualify as a disinterested owner, and therefore cannot enforce a notice of non-responsibility. This is the ultimately the main requirement of the statute – the tenant must provide security to ensure the contractors get paid either through the procurement of a payment bond or putting the construction funds in an escrow controlled by a 3rd party. Landlords should ensure that their tenants undertake these requirements before releasing any tenant improvement allowances. Without one of these security measurements in place, a notice of non-responsibility appears to be unenforceable in Nevada.

Conclusion

To summarize, it is critical to note that landlords are not protected merely by recording a notice of non-responsibility, unless security for the work of improvement is provided as well.