The Construction Advantage

In this new edition of The Construction Advantage, Mike Bosse reviews the scope of the duty to defend for a design professional, Asha Echeverria discusses the enforcement of an arbitration clause, and Conor Shankman explains a contractor’s duty to help resolve a design defect.

A Design Professional’s Duty to Defend an Owner in New Hampshire Under Contract is Alive and Well

By Mike Bosse

In May, the Merrimack County Superior Court in New Hampshire decided the case of Penta Corporation v. Town of Newport v. AECOM Technical Services.  This case reaffirms that in certain circumstances, the design professional on a project will likely owe a defense to an owner when litigation arises, and the allegations concern the design professional’s scope of work.

In this case, Penta performed a project for the Town of Newport, New Hampshire, on a waste water treatment facility “WWTF” which discharged treated waste water into the Sugar River. The town had selected AECOM as the engineer to complete a preliminary evaluation and design services necessary to upgrade the WWTF to satisfy requirements that had been put in place by an administrative order from the EPA. Penta was awarded the contract for construction but the upgrade was never completed and the WWTF was eventually forced to shut down.  Among other issues, a certain type of disc filter was specified that turned out to be unable to handle the required flow of waste water. When AECOM failed to verify and approve Penta’s progress payments, Penta filed suit against the town to recover the monies it believed it was owed. They claimed in the lawsuit that it performed its work according to the designer’s specifications, and that accordingly, Penta was not responsible for the failure of the project.

The town sought defense and indemnity from AECOM under its design contract, and AECOM refused to defend or indemnify the town. AECOM maintained that Penta’s complaint did not have any allegations that proved negligence, breach of contract or breach of warranty against AECOM. The Superior Court looked at the precise language of the indemnity in the design contract which required AECOM to “defend (with counsel acceptable to the Town of Newport) against “any” claims, including without limitation claims predicated on theories of negligence fault breach of warranty products liability or strict liability litigation.” Then, the superior court determined that the language anticipated unproven allegations, meaning that the duty to defend would arise prior to there being any factual findings of negligence or breach of contract against the designer. The court also found that the allegations of the complaint were sufficient to cause the duty to defend obligation to arise. Penta’s complaint had specifically alleged that AECOM had designed the upgrade which included specifications that formed the basis of Penta’s contract with the town of Newport. Penta alleged that it completed its construction in accordance with the specifications, including the use of the disc filters that were specified by AECOM and ultimately failed to handle the required flow of wastewater. Thus, the court concluded that AECOM owed the town a duty to defend and had breached its contract by not supplying that defense.

Finally, the town also requested an award of attorney fees that it had incurred in enforcing the engineers duty to defend. The court concluded that even though AECOM had breached its contract by failing to defend, the duty to defend provision was not so clear that the court could find that AECOM was acting in bad faith by not defending the town against Penta’s complaint. Therefore, although the town did win on its argument that the engineer had to defend the town, the court did not award the town attorney fees against the engineer for taking that position.

Another Bite at the Apple: Sixth Circuit Permits Claims in Federal Court After Arbitration Award

By Asha Echeverria

In W.J. O’Neil Co. v. Shepley, Bulfinch, Richardson & Abbott, Inc. et al., 765 F.3d 625, W.J. O’Neil Co., a sub-subcontractor for the Cardiovascular Hospital at the University of Michigan brought claims against:

• The subcontractor with whom it had contracted
• A designer who held a contract with the university
• A designer’s subcontractor

The sub-subcontractor brought claims for $19 million alleging that it incurred substantial damages due to design errors and other failures.  The Federal District Court dismissed the claims between the sub-subcontractor and the subcontractor because the contract between the two entities required that they resolve disputes between one another through arbitration.  The District Court initially stayed the claims of the sub-subcontractor against the designer and the sub-designer but later entered a stipulated order dismissing the claims without prejudice in light of the arbitration.

The arbitration between the sub-subcontractor and subcontractor resulted in a cascade of claims.  The subcontractor brought an indemnification claim in the arbitration against the university; the university sought the same from the designer, who in turn sued the sub-designer also seeking indemnification for damages. The arbitration resulted in an award against the subcontractor in favor of the sub-subcontractor in the amount of $2.4 million.  The arbitrator refused to pass liability through the subcontractor to the university finding that the bulk of the claims had been settled and released by the subcontractor through change orders.  No party sought judicial confirmation or review of the award.

The sub-subcontractor then re-filed its claims for professional negligence, tortious interference, and innocent misrepresentation against the designer and sub-designer in federal District Court.  The court dismissed all claims as barred by the Michigan doctrine of res judicata, specifically that the arbitration result bars further claims by the sub-subcontractor against the designer and sub-designer, both of whom were parties to the arbitration.  The Sixth Circuit disagreed.

First, the Sixth Circuit ruled that the doctrine of res judicata does not apply to unappealed or unconfirmed arbitration awards. The court held that if the arbitration award had been confirmed by a federal court, federal preclusion law might apply.  Lesson: Whether the arbitration award is in your favor or not, grant of the award is not the end – consider the importance of having the decision confirmed by a court of competent jurisdiction.   

The court went on to say that because no agreement to arbitrate, contractual or otherwise, existed between the sub-subcontractor and the designer or the sub-designer, the sub-subcontractor had no obligation to raise the pending claims in the arbitration and therefore was not precluded from raising such claims now. Res judicata is not applicable where the claims sought to be precluded were not subject to the arbitration.  The court understood and accepted that this could result in some claims being arbitrated and other claims being litigated.  Lesson: To avoid being pulled into multiple forums, on complex projects, parties should consider arbitration provisions that require all parties to arbitrate, and join in a pending arbitration, all claims against any other party to such arbitration. 

These lessons can save a lot of hassle later.

Parties Must Cooperate to Resolve Design Defect Disputes

By Conor Shankman

Under Texas law, contracting parties may allocate the risk of defective designs, plans, and specifications to the owner, rather than the contractor, through clear contractual language that indicates the parties’ intent. Similarly, contracts can share the risk of design or specification defects between a contractor and owner through the allocation of specific tasks/roles, e.g. defect notice provisions, duties to inspect plans and specifications during the bidding process, and/or change order processes, to specific parties. When parties share this risk, they have a duty to cooperate to identify a solution; failure to cooperate can result in breach of contract.

For example, in a recent Fifth Circuit decision, Dallas/Fort Worth Int. Airport Bd. v. INET Airport Systems, Inc., 819 F.3d 245, a dispute arose between Dallas/Fort Worth International Airport Board (“DFW”) and INET Airport Systems (“INET”) concerning the proper allocation of risk for defective plans and specifications. INET was hired by DFW to install rooftop air handling units (“rooftop units”) for passengers boarding bridges in terminal E of the DFW Airport. The trouble began around October 2009 when INET expressed concerns to DFW that the rooftop units specified in the plans and contract might not function correctly for the project.

After receiving no response, INET submitted a formal request for information, and extensive discussions ensued between DFW and INET debating the proper solution, but explicit agreement was never reached. Because of the delay, INET failed to meet the substantial completion date and DFW:

• Assessed liquidated damages
• Declined to pay at least one invoice
• Asserted claims against a related performance bond
• Hired an outside contractor to complete the Rooftop Units
• Filed suit against INET for breach of contract

INET quickly responded with a counterclaim for breach of contract and a claim for unjust enrichment for withheld payments.

The District Court granted summary judgment against DFW on INET’s affirmative defenses of excuse and prior material breach of contract by DFW. The court held that DFW was the first to breach the contract because the contract placed risk of defects in the design and specifications on DFW. Therefore, because DFW acknowledged the design defects without issuing appropriate change orders a breach had occurred.

On appeal, the Fifth Circuit vacated the District Court’s decision, holding that the Contract placed the risk of defect on both DFW and INET. Because design changes required the assent of both parties through a formal change order process, the court concluded that DFW and INET had an affirmative duty to cooperate in identifying the proper solution for the defective rooftop units. The Appellate Court determined that sifting through the evidence to determine if an agreement was reached and why or why not was a task ill-suited for summary judgment. The case was therefore remanded to the lower court for further proceedings.

This decision is odd, and potentially troubling, because the court took standard contract clauses involving a contractor and concluded that it had an affirmative duty to work with the designer to reach agreement on a change order.  That duty would not normally exist because the contractor does not take any responsibility for the design, unless it does so explicitly in the documents.  Time will tell whether this court decision remains as an island, or is cited by future courts in analogous situations.