February 2000

In This Issue

• Ten Killer Contract Clauses
• Inspecting Engineers Found Personally Liable
• State Working on ADR Rules
• Legislation on the Move
• Sub Not Required to Indemnify Architect

Ten Killer Contract Clauses

Donald W. Gregory, Construction Law Chair

Assuming a prudent Subcontractor has maintained the leverage to negotiate subcontract terms through conditioning his bid upon acceptable subcontract language, he will be walking a fine line between removing onerous provisions and chasing away new business. Therefore, subcontractors may want to focus on the true "deal breakers."

My personal list of frequently encountered "killer contract clauses" follows:

1. Contingent Payment Clauses: "Pay When Paid" vs. "Pay If Paid"

"Pay When Paid" subcontract clauses are structured in a way that payment from the general contractor to the subcontractor is conditioned upon prior receipt of payment from the owner to the general contractor. Ordinarily, the subcontract will state that payment is due to the subcontractor within a certain period of time after receipt by the general contractor of payment from the owner. Such a conditioning of payment in a subcontract is known as a "Pay When Paid" clause.

Many courts have traditionally interpreted "Pay When Paid" provisions as an unconditional promise to pay, with the time of payment being postponed until the happening of a certain event, or after a reasonable period of time has elapsed if such event does not take place. That means that the general contractor must pay within a "reasonable time" if the triggering event does not occur — not that the general contractor need not ever pay the subcontractor in the event of non-payment by the owner.

With increasing frequency, many general contractors have been inserting "Pay If Paid" provisions in their subcontracts, stating something to the effect that the subcontractor assumes the risk of non-payment by the owner and payment by the owner to the general contractor is a condition precedent to payment by the general contractor to the subcontractor. In this way, the general contractor is attempting to insulate himself from any liability to the subcontractor at any time in the event of non-payment by the owner.

A "Pay If Paid" clause not only shifts the credit risk associated with the owner to the subcontractor but also the risk that the owner will not pay the contractor because of disputesinvolving performance wholly unrelated to the subcontractor's scope of work.

Court decisions in many states have upheld the validity of "Pay If Paid" provisions if they unambiguously express the intention of the parties to shift the credit risk to the subcontractor.

Yet there is a growing legislative and judicial trend finding "Pay If Paid" provisions against public policy and unenforceable. In those states contractors must pay subcontractors within a reasonable period of time for their work.

Despite the unalterable fact that "time is money" on any construction project, "no damage for delay" clauses purport to limit the subcontractor's remedy for delay to a time extension, but no additional compensation.

In many states, the waiver of lien and bond rights in advance of payment at the time of contract is enforceable. Subcontractors should vigorously resist giving up the additional payment security provided by lien and bond rights.

Many subcontracts require an unconditional lien waiver from the subcontractor in advance of payment, which may waive lien rights even if the promised payment is never received. An acceptable compromise might be to offer a conditional lien waiver in advance of payment to be followed by an unconditional lien waiver once payment is received.

All subcontractors should be alert to the provisions of the prime contract when an incorporation by reference clause is encountered. Particularly inequitable are provisions which incorporate only the contractor's responsibilities, but not his rights, against the owner.

As change orders are typically the most contentious issue between parties on a construction project, subcontractors should pay special attention to the notice and approval provisions for change orders contained in both the subcontract and prime contract and ensure that they are satisfied.

Subcontractors may want to resist provisions which allow the general contractor to direct the changed work without an agreement in advance to pay a mutually acceptable price for the change.

Subcontractors should also insist upon similar notice from the general contractor before "backcharges" or deduct change orders can be assessed.

Many subcontractors favor arbitration over litigation. Virtually all subcontractors should resist venue and jurisdiction provisions that attempt to force the dispute to be resolved in an inconvenient forum far from the project. It is also important that a subcontractor's claim not be stayed pending resolution of any contractor/owner dispute.

Subcontractors will want to minimize the risk shifting in indemnity clauses, particularly if they relate to non-insurable risks. Examples of unacceptable risk shifting might include a broad indemnification relating to matters other than personal injury and property damage, indemnification of a party from its own negligence and indemnification for OSHA fines, particularly any enhanced penalties based upon the contractor's prior experience on unrelated projects.

Subcontractors who neglect to carefully compare the scope of work in the Subcontract to their earlier bid proposal are greatly disappointed to learn that this standard clause will allow the Subcontract to control over the bid proposal or any prior negotiations. Some add the bid proposal as an exhibit to the Subcontract to deal with this problem.

Under this clause, unresolved subcontract claims or change order requests may be inadvertently waived when final payment is received for the original contract sum. Therefore, subcontractors are counseled to avoid this provision, or in the alternative, to be careful not to request payment in full until all claims are resolved. An acceptable compromise might be to exclude written claims which remain pending when final payment is received from such an inadvertent waiver.

Inspecting Engineers Found Personally Liable

In this case, an engineering corporation, through its engineer employees, conducted a home inspection prior to its purchase. After purchasing and occupying the home, the plaintiff learned of substantial structural defects that rendered it uninhabitable. The plaintiff sued the registered engineers in their individual capacity, despite the fact that he had hired the engineering corporation. In Florida, as in many states, the fact that a registered engineer practices through a corporation or a partnership does not relieve the engineer from personal liability for negligence, therefore the court allowed the suit to proceed against the engineers in their individual capacity.

The Florida Supreme Court also ruled that the economic loss rule (which basically states that you cannot sue someone that you do not have a contract with if the alleged negligence does not result in personal injury or property damage) did not apply to claims for professional malpractice and therefore did not bar the plaintiff's suit against the individual engineers.

This case presents a personal liability risk for inspecting engineers in Florida and other states who have ruled similarly. See Moransais v. Heathman, No. 92, 199, 1999 Fla. App. LEXIS 1134, 1999 WL 462629 (Fla. July 1, 1999).

State Working on ADR Rules

"ADR" stands for Alternative Dispute Resolution - in essence any process designed to resolve disputes without further litigation - whether it be through partnering, mediation, arbitration or other means.

While many associated with the State, and in particular the Department of Administrative Services ("DAS"), have utilized ADR for years to resolve claims, there is a specific statutory mandate in O.R.C. §153.16 to adopt specific policies and procedures relative to ADR. There has been little progress in formalizing these policies in past years, however, the new administration is now beginning to focus on this mandate and to formulate draft guidelines on this subject. Those interested in having input on these written guidelines may want to contact the DAS Deputy Director of Public Works or his legal counsel.

Meanwhile, the Ohio School Facilities Commission ("OSFC") has embarked on an innovative ADR program including a heavy reliance upon partnering, early intervention, informal evaluation of claims by a third party consultant and mediation of disputes. OSFC is optimistic that this progressive approach will minimize disputes and litigation in the future, as the OSFC engages in an aggressive school building program. 

Legislation on the Move

There are several bills pending in Ohio's General Assembly that affect Ohio's construction industry.

1. H.B. 401: This bill would revise the arbitration statutes so that certain procedural delays used to frustrate arbitration could be eliminated so that arbitration of disputes involving commercial contracts, particularly those utilized in the construction industry, could be further encouraged.

2. H.B. 490: This bill would attempt to straighten out Ohio law on payment bond claims, in view of the Thomas Steel decision, to clarify that subcontractors and suppliers have 90 days from final acceptance of the entire project (not just their work) to assert a claim against the bond.

3. H.B. 491: This bill would make contract provisions requiring venue or jurisdiction in another state unenforceable if the project is located in Ohio.

Sub Not Required to Indemnify Architect

Owners often require Contractors to indemnify them and their agents, including Architects, from loss. In turn, Contractors "pass down" these indemnity obligations upon their Subcontractors.

In a recent case, the Owner's Architect sought indemnification, and reimbursement of its legal fees, from the Roofing Subcontractor after the Owner sued the Architect with respect to a leaky roof. Crownshield v. Campeon Roofing (1998), 129 Ohio App. 3d 819. The Roofing Subcontractor had signed a contract containing an indemnity clause which required the Sub to indemnify the Architect for claims arising out of "performance of the work" if the loss arose from bodily injury or property damage (other than the work itself).

The subcontract specifically incorporated the prime contract, including the AIA General Conditions.

The Court of Appeals agreed with the Sub's argument that the claim for attorney's fees related to the alleged faulty construction of the roof, rather than for property damage "other than to the work itself" and denied the Architect's claim.

This case points out the important difference between limited and broad form indemnity clauses. A limited indemnity clause like this one only requires the Subcontractor or Contractor, as the case may be, to indemnify from personal injury or property damage risks (like a jobsite accident) and are generally insurable under standard policies. In contrast, a broad form indemnity might require the Contractor or Subcontractor to indemnify parties from any and all risk associated with their work (like defective work) and may not typically be covered under standard insurance policies. Obviously a more limited form of indemnity, like that found in the standard AIA documents, is more beneficial to the party (typically a Contractor or Sub) being required to indemnify others.

Contractors and Subcontractors are also cautioned to see that their specific contract indemnity clauses are forwarded to their insurance consultants to make sure that all of the risk in that particular clause is adequately insured when certificates of insurance are issued.