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Construction In Brief: Summer 2011

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Understanding the Risks in a World of Volatile Building Material Costs

By Anthony M. Bottenfield

The severe and rapid price increase in building materials and related commodities is not breaking news to many contractors. In addition to the economic recession that has vastly impacted the construction industry over the last few years, many contractors have also faced economic challenges stemming from sharp increases in the prices of oil, steel, cement, plastic tubing and various other construction materials. The challenges created by volatile material costs have been magnified as more and more contractors are bidding projects with thin profits in order to secure contracts and keep working. Further complications arise in the context of public works projects where contract terms are predetermined and nonnegotiable. With contract terms that are predetermined, contractors have little to no ability to change material price provisions, which almost always heavily favor the public entity owner.

Although contractors' options to overcome this conundrum are limited, there are a few helpful pieces of information that can aid contractors in avoiding huge losses due to significant material cost escalations.

Public Contracts
In contracts for private work, contractors can attempt to negotiate contractual material escalation provisions which allocate the risks relating to material cost increases between the parties. In contrast, contracts for public work are ordinarily "takeit or leave-it," with no chance for negotiations. The form contract for a public project is generally provided with the project's bid documents and does not allow a contractor to alter, strike, or add terms to the contract. However, this protocol does allow a contractor to review the terms of the contract prior to submitting its bid. During the review period, contractors are provided the opportunity to submit questions to the public entity accepting bids in order to clarify questions regarding the project or explain contractual provisions. Unfortunately, public contracts, combined with general conditions, specifications, and various addenda, are often voluminous and ambiguities or inconsistencies are not initially apparent.

Despite this sometimes onerous pre-bid process, courts have consistently determined that it is the contractor's responsibility to read, review and understand the contract prior to submitting its bid to the public entity. Contractors must undertake this process and submit any questions or concerns to the public entity for comment prior to the bid submission date. It is of particular importance for contractors to attempt to clarify any questions regarding material cost escalation provisions because most often the contractor bears the risk of material cost increases.

Meco Provides a Warning Sign in New Jersey
A recent New Jersey case underscores the dangers associated with material cost escalation and highlights the fact that contractors must understand their potential risks, even if material cost escalation is beyond contemplation of the contract. In Meco, Inc. v. Township of Freehold, a contractor, Meco, contracted with a municipal government entity, the Township of Freehold, for the resurfacing of a public roadway. After the cost of asphalt cement increased by over 100% ($410 per ton to $822.50 per ton) in 2008, Meco submitted a change order request to the Township for compensation due to the price escalation. The Township denied Meco's request by pointing to the parties' contract and specifications, which did not provide for compensation relating to material cost escalations. Meco sued the Township and argued that the contract incorporated New Jersey Department of Transportation guidelines for determining asphalt price adjustments, and, therefore, Meco should be compensated for the price increase for asphalt.

The New Jersey Appellate Division overturned the trial court's decision in favor of Meco and found for the Township. The Appellate Division found that no material price escalation clause existed in the contract, and if the contract was ambiguous as to the incorporation of the New Jersey Department of Transportation guidelines, Meco had a duty to clear up any confusion prior to submitting its bid.

The Meco case illustrates how a contractor bears the risk of a potential material price increase when contracting with a public entity. Furthermore, the Appellate Division's opinion demonstrates most courts' strong inclination to protect government bodies and taxpayers when it comes to material cost escalations.

Contractual Provisions & Legal Doctrines Often Provide Little Help
Common contractual provisions and widely recognized legal doctrines may provide some help to contractors who are hurt by drastic material cost increases while performing public work. However, reliance on these provisions and doctrines will yield unpredictable results.

Force Majeure – This is a clause that excuses a contractor's performance due to events that are outside of that contractor's control. These "events" usually must be extraordinary in nature and generally relate to weather, war, acts of God, terrorism, or political unrest. These clauses often do not cover unforeseen economic conditions (i.e. a sharp increase in crude oil prices). A contractor would likely need to link the price increase to an event covered by the force majeure clause.

Mutual Mistake – In order to rely on this legal doctrine, which effectively voids the contract, the contractor must prove that the parties made a mistake in the contract, that the mutual mistake is factual, goes to the basis of the bargain between the parties, materially affects the parties' performance, and is not something for which the injured party bears the risk. These requirements provide a steep uphill climb for contractors.

Impossibility/Commercial Impractibility – This doctrine excuses a contractor's performance if, after the contract is entered into, performance is rendered impossible/commercially impracticable by an unforeseen event that the parties assumed would not occur at the time they entered into the contract. As a result of past extreme material price fluctuations, it is increasingly difficult for contractors to prove that a certain cost escalation was unforeseen.

Hope on the Horizon?
In 2010, the New Jersey legislature amended a statute to address material price adjustments in contracts governed by New Jersey's Local Public Contracts Law. In N.J.S.A. 40A:11- 16, the legislature amended the existing statute in the specific context of contracts containing asphalt and fuel expenditures. The changes to the statute are similar to those employed by other states and in the federal contracting arena. Essentially, the statute provides that for contracts involving a certain quantity of materials (i.e. over 1,000 tons of asphalt; 500 gallons of fuel), material fluctuation provisions are to be specifically included in contracts' specifications. These provisions will be based upon published asphalt and fuel indexes. This legislation was clearly in reaction to the skyrocketing oil costs that swept the world over the last few years.

The New Jersey legislature's reaction to widespread commodity increases shows that state governments are cognizant of economic difficulties facing construction contractors. With more and more contractors plagued with soaring material costs, and the fact that legislatures are paying attention to contractors' woes, comes the potential for more public entities and state legislatures to build sensible and equitable escalation provisions into public contracts.

Anthony is an Associate in the Firm's Construction Group. He can be reached at (215) 564-1700 or abottenfield@cohenseglias.com.

A Brief Note

Even with all of the pleasant distractions of summertime, the challenges of running your business are never far from mind. In the sophomore issue of the new Construction in Brief, we have highlighted issues and tools that can help protect your business and your bottom line. However, we want your feedback on other types of topics that interest you. Keep your eye out for a brief survey that will help us improve and tailor the content of Construction in Brief. In the meantime, enjoy the summer because the leaves will be changing colors before we know it.

Jack Graham, Esq.
Editor-in-Chief

What's New

Congratulations

We are pleased to announce that nine Cohen Seglias attorneys have been named Pennsylvania "Super Lawyers" and three attorneys have been named "Rising Stars" by Law & Politics Magazine in their 2011 edition.

Our "Super Lawyers," named for their work in Construction are: Roy Cohen, Jason Copley, John Greenhall, George Pallas and Ed Seglias. Marc Furman was named for his work in Labor and Employment, Steve Usdin for his work in Bankruptcy and Creditors/Debtors Rights, Michael Payne for his work in Government Contracts and Jim O'Connor for his work in Business Litigation.

George Pallas was also named a "Super Lawyer" in New Jersey.

Jack Graham was named a "Rising Star" for his accomplishments in the Construction field. Jonathan Landesman was recognized for his work in Employment and Labor and Doug Hart for his work in Commercial Litigation.

Law & Politics publishes "Super Lawyers" annually to recognize accomplished lawyers in more than 70 areas of practice.

Also, Jonathan Landesman has been appointed Chairman of the H.R. Committee of the Business Law Section of the Philadelphia Bar Association.

In the Media
Our attorneys have been very busy this summer writing articles.

Michael Payne authored an article, "From Legal Pad to iPad: Using Tablet Computing to Increase a Lawyer's Efficiency," which appeared in the Legal Intelligencer. Ed DeLisle authored an article, "Beware of the False Claims Act," which appeared in Government Contracts Law360. Marc Furman and Eric Kimbel authored three articles on the Construction Workplace Misclassification Act which appeared in Breaking Ground, Construction Today and the Mid-Atlantic Real Estate Journal. Steve Williams authored an article, "Employment Law: Pennsylvania's 'At-Will' Standard," which appeared in Pennsylvania Perspective, the newsletter of the PA Manufactured Housing Association.

For copies of any of these articles, please e-mail zklein@cohenseglias.com.

Legislative Update
Update on House Bill 377

Pennsylvania Governor Corbett has signed House Bill 377 into law. The new law repeals the sprinkler mandate that became effective on January 1, 2011 and required builders to install sprinkler systems in all new single- and two-family homes.

Under the new law, builders must provide homebuyers with the option to install a sprinkler system and inform them of the benefits of sprinklers. The state code already requires that hard-wired smoke detectors be installed in new homes. If a homebuyer opts not to install sprinklers, the home must be built with extra fireproofing material on the floor boards in order to slow the spread of fire.

In the Courtroom

Cohen Seglias Partner Ed Seglias, along with Associates Matt Gioffre and Kathleen Morley, was successful in defending a large, regional concrete contractor in a matter adverse to a major residential developer concerning the deterioration of concrete sidewalks in a development in Chester County, PA.

In the beginning of May, Ed was contacted by the client to put together a trial team for a trial starting on June 6, 2011. After a 6 day trial, the jury returned a verdict in favor of the defendants on all counts. The plaintiff had sought damages in excess of $1.25M.

Insurance Coverage for Faulty Workmanship Claims in New Jersey – You Better Call Your Insurance Broker!

By Jonathan A. Cass

As a result of two decisions from Pennsylvania courts, insurance carriers in Pennsylvania have been aggressively taking the position that there is no insurance coverage under a commercial general liability (CGL) policy for property damage claims caused by faulty workmanship. Thankfully, this was not the case for contractors based in New Jersey. However, law in New Jersey may now be changing as a result of the decision of the Third Circuit Court of Appeals in Pennsylvania National Mutual Casualty Insurance Company v. Parkshore Development Corporation.

In Penn National, Parkshore was the developer and general contractor of a residential condominium complex in New Jersey and hired subcontractors to perform all of the required work. Approximately a year after completing the project, the condominium association (Association) notified Parkshore that stucco around some of the windows had not been caulked properly, causing water infiltration. In response, Parkshore hired a contractor to re-caulk the windows. Seven years later, the Association sued Parkshore and alleged that Parkshore failed to properly remediate the earlier water infiltration problem, and that the condominium complex suffered from a litany of other construction defect-related problems.

Parkshore turned the case over to its long-time CGL carrier, Penn National, and requested that the insurance company defend and indemnify Parkshore for the claims asserted by the Association. Penn National responded by filing a separate action against Parkshore seeking a declaration from the Court that it did not have to provide insurance coverage to Parkshore for the Association's lawsuit.

Parkshore defended the action by asserting that the defective workmanship performed by its subcontractors had caused damage to its non-defective work (meaning, for example, that the defective caulking had caused water infiltration which damaged non-defective sheathing). Since this qualified as "property damage" caused by an "occurrence" (defined as an "accident") within the meaning of its CGL Policy, Parkshore argued that there should be coverage for the Association's lawsuit.

Parkshore further asserted that the water-related property damage at the condominium complex was an accident, and was neither expected nor intended by Parkshore and, as such, constituted an "occurrence" within the meaning of its CGL policy. Parkshore relied on a long-standing New Jersey Supreme Court case, Weedo v. Stone-E-Brick, Inc., for the proposition that construction defects resulting in consequential damages to the property itself could qualify as an "occurrence."

Both the trial court and the Third Circuit rejected Parkshore's argument and its reliance on Weedo. The Court found that there is no "occurrence" where faulty workmanship causes damages to the completed project itself (as opposed to faulty workmanship that causes damage to something that did not involve the contractor's work). Since Parkshore, as the general contractor, had constructed the entire condominium complex, and the damages caused by its alleged faulty workmanship only involved the complex, there was no "occurrence" and, therefore, no coverage. The Court also did not find it significant that Parkshore had subcontracted out all of its work, finding that since Parkshore was the general contractor, the entire project was considered its work.

What does this mean for New Jersey contractors? We expect that with the ruling in Penn National, insurance carriers issuing policies to contractors in New Jersey will now start to become more aggressive in denying faulty workmanship claims arising out of projects where the only claimed property damage is to work performed by the insured contractor, even if performed by a subcontractor.

What should you do about it? In response to these same developments in Pennsylvania, many insurance carriers that provide CGL coverage to contractors are now offering a socalled "Resultant Damage" endorsement for CGL policies. This endorsement has the effect of restoring, or partially restoring, insurance coverage for property damage arising from faulty workmanship that had been eliminated by the recent court decisions in Pennsylvania, and now, New Jersey.

Accordingly, it is important that all contractors, in both Pennsylvania and New Jersey, talk to their insurance agents and brokers to ensure that their CGL policies have the Resultant Damage endorsement and, if necessary, take immediate steps to obtain the endorsement.

Jonathan is a Partner at the Firm and Chair of the Insurance Coverage & Risk Management Group. He can be reached at (215) 564-1700 or jcass@cohenseglias.com.

Low Man on the Totem Pole: Options for the Subcontractor When the General Contractor or Owner Files for Bankruptcy

Imagine that you just received notice that the general contractor (GC) on one of your projects is filing for bankruptcy protection, or perhaps it's the developer or property owner who's out of funds. In either scenario, you have invested time and materials into a project that probably will not be completed, and your chances of collecting payment are getting slimmer with each passing day.

Subcontractors are the most vulnerable and exposed parties in the contractual chain. While a GC should be in regular contact with the developer or owner, a subcontractor is probably less in tune with the state of the project's funding, and is more likely to be blindsided by a bankruptcy filing.

A subcontractor generally has two viable options to try to recover some of its investment in the project: a mechanics' lien and a payment bond claim.

Mechanics' Lien
A subcontractor's first and best recourse for getting paid is to file a mechanics' lien against the property. A mechanics' lien is a legal claim against the real estate by those who have supplied labor or materials that improve the property.

While the automatic stay of a bankruptcy filing prevents a subcontractor from initiating any collection proceedings against the GC itself, the stay does not apply to the subcontractor's lien rights against the property owner.

Even if the developer or owner files for bankruptcy protection, the subcontractor still has a right to file its lien, because the lien right is a state right that is not waived or stopped by a bankruptcy proceeding involving the developer or owner.

A subcontractor must be aware of the deadline to file the mechanics' lien. Subcontractors who fail to exercise their lien rights or miss the filing deadline have no recourse to collect funds from the bankrupt GC, unless they can make a claim against a payment bond.

Keep in mind that lien rights are unique to each state, so subcontractors should be aware of the particular laws governing each state in which they operate. The law that will control mechanics' lien procedures is the law where the real estate is located.

Payment Bond Claim
Whether or not a subcontractor can exercise its lien rights, it should immediately file a claim against the GC's payment bond. A payment bond is a guarantee from a surety that the GC's subcontractors and suppliers will receive payment for labor and materials supplied to a construction project.

Increasingly, commercial developers and owners are requiring that their GCs furnish payment bonds in an effort to guarantee that the project will not be interrupted, delayed, or stopped as a result of the GCs' inability or failure to pay their subcontractors and material suppliers.

Each payment bond has its own requirements and claim procedures, including notice and filing deadlines. Strict compliance with the claim procedures is necessary in order for a subcontractor to preserve its claim under the payment bond.

Don't Get Stuck Holding the Bag
The best solution is always to attempt to minimize the risk of the GC's insolvency from the outset. We recommend taking the following steps before taking on a potential project:

  • Carefully screen the GC. Some subcontractors have lists of approved GCs and only work with GCs who have a proven history of completing projects on time and on budget.
  • Consider whether the GC is the right fit for the project. Is the GC experienced with this type of project? Does it typically operate in this region? Or is it stretching its capabilities to the limit? For example, a suburban residential builder would likely not be aware of many of the issues involved in building a downtown high-rise and could end up under-bidding the job. Also, ask if the GC is bonded for the project, ask what its bonding capacity is, and ask for a copy of the bond.
  • Find out where the project financing is coming from. Is the project funded by the state, or is it bank-financed? Is that line of credit going to be sufficient? Usually, the GC will already have asked these questions of the owner or developer, and should be able to pass that information on to its subcontractors. If not, ask to talk directly to the owner.
  • Be wary of any contract that requires you to waive your lien rights. This is the best arrow in your quiver – do not give it up without a fight.
  • Try to shift the risk of nonpayment to the GC. A subcontractor generally is more likely to get paid if the contract contains a "pay-when-paid" clause rather than a "pay-if-paid" clause. A "pay-when-paid" clause might read something like: "All progress payments shall be made within X days after payment is received by the General Contractor from the Owner." In contrast, a "pay-if-paid" clause would include the condition that payment to the subcontractor only occurs if the GC gets paid by the owner. While each state decides how these clauses are interpreted, many courts have held "pay-when-paid" clauses to mean that the GC is responsible for paying the subcontractor, even if the owner does not pay the GC. In other words, the GC bears the risk of nonpayment. A properly worded "pay-if-paid" clause, on the other hand, unambiguously shifts the risk of the owner's nonpayment to the subcontractor.

At a time when most subcontractors are happy to take whatever work they can get, it might seem counter-intuitive to consider walking away from a project. But when the alternative is to sink money into labor and materials that may ultimately be unpaid-for, the smarter move is to hunker down and keep an eye out for a better opportunity.

Since these decisions can be hard to make even in the best of times, savvy subcontractors should seek the support of business advisors, including attorneys, who can help them evaluate contracts and select projects with the highest likelihood of being completed at a healthy profit margin.

Steve is a Partner at the Firm and Chair of the Creditors' Rights Group. He can be reached at (215) 564-1700 or susdin@cohenseglias.com.

World's First BIM Claim: A Harbinger of Things to Come

By Daniel E. Fierstein

Building Information Modeling (BIM) is a technology that allows building and construction data to be modeled and managed three dimensionally. As is often the case with technological advancements, BIM has seemingly limitless potential to enhance efficiency and reduce errors in construction, but it is not without potential problems and future implications that must be addressed as BIM becomes more prevalent.

Some potential issues with BIM were recently illustrated when the parties involved in what is believed to be the first major lawsuit relating to the use of BIM reached a settlement. Due to the confidential nature of the settlement, many of the facts that gave rise to the dispute are unknown. Here is what we know and what we can learn from the lawsuit.

The construction of a building at a major university went awry when the mechanical, electrical and plumbing (MEP) contractors ran out of room in the ceiling plenum to assemble the MEP systems. The project architect and MEP engineer used BIM to fit the systems into the ceiling plenum, but the contractors ran out of room because no one informed the contractors that a specific installation sequence was necessary for the systems to fit.

As a result, the MEP contractors sued the project owner, the project owner sued the architect, and the architect joined the consulting engineering firm that designed the MEP systems. Clearly, the central issue of this case was a breakdown in communication between the owner, the design professionals and the MEP contractors. Communication is critical in the construction industry regardless of the type(s) of design technology in use, but the larger issue that the use of BIM raises is its potential impact on the allocation of risk in construction contracts.

Ordinarily, architects and engineers are responsible for the design of the project, and the contractors bear responsibility for the means and methods to construct the project. Here, unbeknownst to the MEP contractors, a specific installation sequence was necessary for the MEP design to fit into the ceiling plenum. Does this make the engineer, rather than the contractor, responsible for means and methods? What did the contract documents say about this issue for this project? Was the issue discussed among the parties at the contract formation stage?

The answers to these questions are unknown, but the lawsuit that arose from this project brings to light two undeniable facts regarding BIM: (1) BIM can be incredibly useful and efficient but still requires clear communication between the designer and the installer, and (2) construction contracts must address the allocation of the risks associated with the use of BIM.

As we learn more about this particular project and other projects like it, we will provide a more substantive analysis of BIM's effect on your businesses.

Dan is an Associate in the Firm's Construction Group. He can be reached at (215) 564-1700 or dfierstein@cohenseglias.com.

Recent Developments in Employment Law

By Jonathan Landesman

Philadelphia Enacts the "Fair Criminal Record Screening Standards Act"

Employers must beware of all kinds of pitfalls and hazards in the hiring interview process. For example, you cannot ask questions that would require job applicants to reveal their ages or if they have children because these types of inquiries can lead to claims of unlawful discrimination.

Philadelphia employers now need to review their hiring policies again because of a new law that Philadelphia Mayor Michael Nutter signed on April 18, 2011. It is called the Fair Criminal Record Screening Standards Act and took effect on July 17, 2011.

This law restricts what employers can ask job applicants about their criminal histories. It is now unlawful to ask about an applicant's criminal background on an employment application or before the completion of a first interview. Employers are subject to a $2,000 per violation fine and the law will be enforced by the Mayor's Office of Labor Standards.

The law specifically prohibits the following: First, employers cannot put questions on employment applications about arrests that did not lead to a conviction. Second, employers cannot seek any information regarding criminal convictions during the applications process, i.e., from when a job applicant asks about a job opening to when an employment application is accepted. Third, employers are prohibited from asking about any criminal conviction before or during a first interview.

Every Philadelphia employer will need to review its employment application and hiring policy to ensure compliance with the new law, and make sure that all persons in the hiring process are aware of the new limitations imposed by the law.

Maryland's Job Applicant Fairness Act
On April 12, 2011, Maryland enacted the "Job Applicant Fairness Act," which goes into effect on October 1, 2011. This law prohibits most Maryland employers from using credit reports and credit histories when making hiring decisions and undertaking other employment actions. There are 17 other states with similar legislation currently pending, including New Jersey, Pennsylvania, Ohio, Connecticut, and New York.

Generally, the law prohibits employers from using a job applicant's or employee's credit report or credit history in making hiring, firing, and other employment decisions (pay, benefits, promotions, etc). However, there are certain exemptions. Employers can use credit information if it is "substantially jobrelated," and then only for specific purposes relating to:

  • Managerial positions involving direction or control of part or all of the business;
  • Positions that are provided with expense accounts or corporate credit or debit cards;
  • Positions involving access to personal information of employees, customers or the employer;
  • Positions involving access to the employer's protected trade secrets and intellectual property or confidential business information; or
  • Positions involving money-handling (authority to issue payments, collect debts, transfer money or enter into contracts).

Also, certain kinds of employers are exempt from the law, including financial institutions, investment advisors, and other employers legally required to perform credit checks or histories.

Maryland employers will need to review their employment application process and employment policies to comply with this law.

The U.S. DOL's iPhone and iTouch Timesheet Application to Track Overtime
The U.S. government has now made it easier for employees to pursue overtime wage claims. On May 9, 2011, the U.S. Department of Labor (DOL) armed employees across the country with a free downloadable "timesheet application" to use on the iPhone and iTouch.

The DOL application allows employees to easily track their hours worked, view them in a calendar, make notes and calculate their wages. Applications for other smart phones are currently in development.

By law, every employer must ensure that their employees are paid all of the wages earned and to keep accurate payroll records for up to three years. Retention of payroll records is critical because, when faced with an employee's overtime wage claim, an employer will need to have the right records – and to have properly classified their employees – in order to be able to defend against that lawsuit.

Of course, no business wants to be involved in any kind of lawsuit. But, employers who are sued for unpaid wages are in one of the worst positions: lawsuits for unpaid wages allow a plaintiff to get liquidated damage penalties and mandatory attorneys' fees awards.

There is a "zero tolerance" policy for the failure to pay the correct wages due to employees, and a "zero margin of error" for the employer. As technology makes it easier and easier for employees to bring these type of wage claims, it becomes that much more important for employers to re-evaluate their payroll practices, record keeping policies and employment handbooks, and also to make sure their employees are correctly classified.

Jon is a Partner and Mark is an Associate at the Firm, both practice in the Labor and Employment Group. They can be reached at (215) 564-1700, jlandesman@cohenseglias.com or mleavy@cohenseglias.com respectively.