Volume 18, Number 3
A CONSTRUCTION LAW PRIMER
Marc M. Schneier
The construction industry transforms vacant lots or dilapidated buildings into new or renovated office buildings, manufacturing plants, subdivision developments, single-family residences, highways and bridges, or other structures. For better or for worse, standing shoulder-to-shoulder with the construction industry participants-owners, design professionals, developers, general contractors, subcontractors, insurance companies, sureties, and lenders-is the construction industry bar. This article provides an overview to the organizational structure of a construction project, followed by a discussion of some common legal issues.Organizational Structure
The traditional model for construction projects is a design-bid-build format. Under this format, the owner separately contracts with an architect or engineer (A/E) to design the project and a general contractor to implement that design. The first step is for the A/E to create plans (drawings) and specifications (written descriptions of the work to be performed) that embody the owner's ideas.
Once the design is complete, general contractors review it and submit bids to perform the described work for a fixed price. Often the general (or prime) contractor hires subcontractors to perform the specialized trades, such as the electrical, plumbing, heating and ventilation, or roofing work.
The bifurcation between design and construction under the traditional project arrangement has distinct drawbacks. This arrangement produces a long production schedule, because the owner must wait for the architect to complete the design before beginning even to solicit contractor bids. At this point, sticker shock may set in as contractors submit bids greatly in excess of the owner's budget, even though the architect supposedly created a design with that budget in mind. During performance, the contractor may complain that the design contains omissions or errors. Once the building is completed and defects are found (a leaking roof, for example), the contractor is likely to blame the architect for having produced a defective design, and the architect will likely accuse the contractor of having performed poorly. In sum, the traditional bifurcation between design and implementation naturally creates tension between the design professional and the contractor, with the owner caught in the middle.
These well-known drawbacks to the traditional organizational structure of construction jobs have engendered new project-delivery arrangements. Projects may be bid on a fast-track basis in which the contractor begins working even though the design documents are only partially finished. Another approach is for the owner to enter into a design/build contract, in which (as the name implies) a single entity is responsible for both design and construction of the project. Design/build firms raise licensing issues: Must the firm itself be licensed to perform design work? Does an architect who is on staff with a construction company retain his or her professional independence to serve and protect the client's interests?
Yet another organizational response has been the rise of construction management companies. Construction managers (CMs) promise efficient operation by bringing modern management skills to construction projects. CMs are of two types. The CM-as-agent coordinates and administers the project but neither performs the construction work nor guarantees the contract price. The owner, not the CM, hires either the general contractor or the trade contractors who perform the actual construction. In evaluating the liability of a CM-as-agent, the courts usually analogize to the liability of a design professional.
By contrast, the CM-at-risk hires the trade contractors and may even perform some of the work. This CM agrees to deliver the project for a stipulated sum or a guaranteed maximum price. The at-risk CM is responsible to the owner for performance deficiencies, construction delays, and cost overruns. The liability of a CM-at-risk is like that of a general contractor.A Pressure Cooker
Construction projects contain all of the ingredients for a pressure-cooker atmosphere. The owner is operating under a limited budget, and time is money. A construction loan has a higher interest rate than a standard mortgage, and an uncompleted building cannot generate rental (or other) income. The general contractor, accordingly, is under the gun to perform expeditiously.The general contractor is not necessarily in a position to guarantee timely performance. The contractor may have turned much, if not all, of the work over to subcontractors. Getting all the subcontractors to show up when they are supposed to, do the work in the time allotted and no longer, and do that work right the first time presents a major logistical challenge. And, because structures are built from the ground up, faulty performance in compacting the soil, for example, will often have ramifications for many other subs. No design is perfect, and the contractor is also dependent on the architect to answer the contractor's questions regarding design omissions or ambiguities. The owner, too, may create delays by deciding during performance to change the design in ways that have a significant impact on the contractor's schedule. Lastly, it should be remembered that construction remains a hazardous undertaking. An accident at the job site can cause havoc, in terms of morale, schedule, and the potential for civil and criminal liability. Delay Claims
Although it is advantageous to both the owner and contractor for the project to be completed on time, the owner is generally in a stronger position to place safeguards in the contract against such a possibility. First, the owner can insert in the contract a no-damages-for-delay clause, which limits the contractor's remedy for owner-caused delays to time extensions. Second, a liquidated damages clause can impose a specific cost on the contractor for each day work continues beyond the contract's completion date. One advantage of a liquidated damages clause is that the owner can deduct the liquidated sum from the contract balance; a drawback is that the owner is normally precluded from suing for actual damages. Although courts impose some public policy limitations on both no-damages and liquidated damages clauses, these provisions otherwise are enforced as readily as any other part of the parties' bargain.
The contractor's entitlement to damages for owner-caused delays is more difficult to prove; remedies are more likely to be found in common law than in the contract. As an example, suppose the contractor claims that the owner delayed completion of the project because the owner ordered changes to the work and because the owner's architect was slow in responding to the contractor's queries about design requirements.
The contractor's first obstacle to recovery is to prove entitlement. Especially on large projects, the owner may counter that the contractor is entitled to no delay damages for any number of reasons: the contractor itself delayed the work; the time spent on the changed work would have been spent on the original work anyway; the architect's responses, while delaying one portion of the work, did not prevent the contractor from forging ahead on other work. Entitlement often becomes a battle between scheduling experts, with the contractor's expert using a critical path method (CPM) analysis to show how the owner's acts caused particularized delays.
Once entitlement is established, the contractor (again with expert help) must prove damages. A delayed contractor experiences both direct and indirect damages. Direct damages are increased labor costs, extended bond and insurance premiums, and the like. Although a conscientious owner will not contest payment of such expenses legitimately incurred, it is often difficult for contractors to cull delay-caused performance expenses from costs (especially labor costs) they would have incurred anyway.
A contractor's indirect, delay-related damages involve overhead expenses: business costs that accrue daily regardless of whether the contractor is working. These expenses include such things as salaries, office rental, insurance, and so on. A contractor who bids on a job must include overhead costs in his contract price. If a contractor is on the job three months longer than intended, that project will absorb more overhead costs than anticipated. A 1960 federal agency decision established the Eichleay formula to calculate a contractor's per diem overhead costs, and that figure is multiplied by the length of delay.1 Contractors on federal projects are entitled to payment of overhead damages using the Eichleay formula, and the number of states that have adopted the formula is increasing.
A contractor seeking recovery under Eichleay must prove standby from a government-caused delay of indefinite duration and that the contractor was unable to obtain replacement work during the same period. "Standby" means that the contractor must be ready to return to work on short notice but does not know when, because the delay is indefinite. Once the contractor establishes standby, the burden shifts to the government to show that either it was not impractical for the contractor to obtain replacement work or the contractor's inability to obtain such work was not caused by the government's delay.Contract versus Tort
Construction law lies at the borderland between contract and tort. The owner, design professional, general contractor, subcontractors, sub-subcontractors, and material and equipment suppliers are all on the project site by virtue of a contract. However, delayed or faulty performance by any one party can have serious financial consequences to numerous other project participants who lack privity with the wrongdoer. Any effort by the other project participants to recover economic damages directly against the wrongdoer must therefore be under a tort theory.
Let us assume a subcontractor claims the architect's defective design caused the sub to incur far higher performance costs than anticipated. The subcontractor's claim raises the specter of the economic loss rule, which eschews the recovery of contract-like damages (economic losses) under a theory of nonintentional tort. The economic loss rule first arose in the products liability area, and its rationale was that the courts, out of deference to the legislature and its adoption of the Uniform Commercial Code, should not undermine that legislative choice by permitting a plaintiff to recover, in strict liability, damages for the repair or replacement of the defective product.2
However, many courts have embraced the economic loss rule beyond the products liability area to include service contracts, and beyond strict liability claims to include claims of negligence. These courts view the economic loss rule as establishing the proper demarcation between contract law, with its concern for financial loss, and tort law, with its concern for physical injury. Advocates say the rule prevents contract law from being swallowed in a sea of tort.
Opponents of the rule are alarmed by its ramifications. As applied to the construction industry, the rule immunizes any project participant from the consequences of its own negligence to any non-privy party to whom the wrongdoer caused financial injury. For the subcontractor prevented from suing the architect, the economic loss doctrine eviscerates the preexisting, well-established law of professional malpractice. For the homeowner stuck with a defective residence because of a subcontractor's negligence (and with a bankrupt developer as well), the practical effect of the doctrine is to nullify the law of implied warranty of habitability.
The competing arguments in favor of and against application of the economic loss rule in any given situation has resulted in a near 50-state patchwork of economic loss rules. Some states limit the doctrine to products liability claims, others (often citing the Restatement (Second) of Torts § 552) hold that the doctrine does not apply to claims against design professionals and others sued under a theory of misrepresentation. Various exceptions to the rule have been created, finding that the doctrine does not apply if the accident was sudden and unexpected; the defective performance created a potentially dangerous condition; the parties, while not in privity, were in a relationship that approximated privity; or the defect caused the release of hazardous substances into the environment, e.g., noxious fumes or asbestos fibers.Safety
Construction work is a vital and vibrant part of society yet carries with it an element of danger to the workers that cannot be eliminated entirely by even the most careful contractor. The history of construction accident law reveals that society wrestles with the twin aims of promoting the construction industry by shielding the principals involved in a project from liability, and attempting to promote workplace safety and guarantee compensation to injured employees, usually by expanding the worker's source of legal remedies beyond the immediate employer.
As a result of this interplay between competing societal goals, construction accident law is complicated and complex. The injury of a subcontractor's employee may well entangle a myriad of project participants in litigation: the worker's immediate employer, other subcontractors, the general contractor, the owner, and design professionals. Behind each of these entities (except the worker) is an insurance company, and legal resolution may be further complicated by insurance coverage issues. In addition, each of the project participants is on the site by virtue of a contract; legal ramifications of contract terms addressing indemnity, insurance procurement, and safety issues must be analyzed. Finally, the accident may have involved the use of construction equipment or products, thus implicating products liability law.
The law applicable to construction accidents stems from both the common law and statutes. Under the common law, owners and general contractors may be liable to injured workers under general negligence principles and also under a theory of premises liability if a latent, hazardous condition of the premises caused the injury.3
Counterbalancing that liability is the independent contractor rule, which states that the principal of an independent contractor-whether an owner hiring the general contractor or a general contractor hiring subcontractors-is not liable for physical harm caused by the negligence of the independent contractor.4 That immunity from liability traditionally has been severely restricted by numerous exceptions, one of which (although variously phrased) imposes vicarious liability on the principal if the contracted-for work is inherently dangerous.5 Another exception, especially applicable to general contractors employing subcontractors, imposes a duty of due care on a principal who retains supervisory control over the independent contractor's work.6
In the first decade after the adoption of the Second Restatement of Torts, courts split on whether to permit a contractor's employees to sue the principal under the inherently dangerous work exception. Beginning in the early 1980s, however, an increasingly large number of courts began to rule that the exception does not apply to injured employees of the independent contractor; some cases have overruled well-established precedents. Today, the overwhelming number of states that have addressed the issue have ruled that the principal of an independent contractor is not vicariously liable for the injury or death of the contractor's employees that is caused by inherently dangerous work.
Principals may be liable for construction accidents under statutory law as well. Several states have safe workplace statutes expressly applicable to construction sites; these often impose strict liability on the owner and general contractor to provide workers with scaffolding and other safety devices. Of course, construction sites are also subject to the federal Occupational Safety and Health Act and the regulatory scheme applicable to construction work.7 The OSH Act has been interpreted to impose liability not only on the injured worker's immediate employer but also (if the victim is a subcontractor's employee) on the general contractor or design professional.
Injured construction workers are entitled to workers' compensation benefits from employers. Legislatures have recognized that subcontractors are less likely to maintain compensation insurance than are better-financed general contractors. As a result, almost all states designate the hiring party (usually limited to the general contractor) as the "statutory employer," liable for compensation benefits in the event the immediate employer is uninsured. In return, the statutory employer can often claim immunity from tort liability-definitely, if it paid compensation benefits, and sometimes even if the immediate employer was insured.
Finally, under egregious circumstances, either the principal or immediate employer may be subject to criminal prosecution for the worksite death of an employee. Since its inception in 1970, the federal OSH Act has provided for criminal prosecution of employers who engage in willful violations of the Act or its regulations if the violation results in an employee's death.8 However, prosecution is more likely under state penal codes, usually under a theory of criminal negligence.Notes
- Eichleay Corp., ASBCA No. 5183, 60-2 BCA (CCH) 2688, aff'd on recon., 61-1 BCA (CCH) 2894.
- Seely v. White Motor Co., 63 Cal. 2d 9, 45 Cal. Rptr. 17, 403 P.2d 145 (1965).
- Restatement (Second) of Torts §§ 343, and 343A (1965) (discussing a land possessor's duty of care toward invitees).
- Id. § 409.
- See id. §§ 413, 416, 427.
- See id. § 414.
- The OSH Act is found at 29 U.S.C. §§ 651-658 (1994) and the Construction Industry Standards are at 29 C.F.R. 1926 (2000).
- 29 U.S.C. § 666(e) (1994).
Marc M. Schneier writes Construction Litigation Reporter, a national newsletter of construction law published by West Group. He is the author of Construction Accident Law: A Comprehensive Guide to Legal Liability and Insurance Claims (American Bar Association, 1999), has written several articles on construction law topics, and was an adjunct professor of construction law at the University of San Francisco School of Law. He provides consulting on all aspects of construction law from Wynnewood, Pennsylvania. His website is www.construction-law-consulting.com.